This week’s episode of the Gold Exchange Podcast explores the topic of Central Banks, most notably the US Federal Reserve. Monetary Metals’ CEO Keith Weiner explores why the Fed was created and what deleterious effects it has on our economy including inflation, boom bust cycles and monetary debasement in this recorded talk given to investment bankers. In this talk Keith discusses:[embedded content] Additional Resources Episode Transcript John Flaherty: Hello, again, and welcome to the Gold Exchange Podcast. Today’s episode is a presentation Keith gave on the Federal Reserve and its impact on financial markets. His audience was an investment banking firm who requested this presentation. Keith covered a wide range of topics including how the Federal Reserve
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This week’s episode of the Gold Exchange Podcast explores the topic of Central Banks, most notably the US Federal Reserve. Monetary Metals’ CEO Keith Weiner explores why the Fed was created and what deleterious effects it has on our economy including inflation, boom bust cycles and monetary debasement in this recorded talk given to investment bankers.
In this talk Keith discusses:
Hello, again, and welcome to the Gold Exchange Podcast. Today’s episode is a presentation Keith gave on the Federal Reserve and its impact on financial markets. His audience was an investment banking firm who requested this presentation. Keith covered a wide range of topics including how the Federal Reserve contributes to the boom-bust cycle. We hope you enjoy this episode.
And one of the big focuses this summer has been on Federal Reserve because one of the big topics that we’ve been talking about here is inflation. That’s one of the main things that our investors are concerned about, how to protect themselves against inflation, if inflation is really coming. We haven’t really seen inflation here in the US, a very topical issue since the 70’s and 80’s. So a lot of investors do not really know how to properly prepare for it, anticipate what inflation will really look like. So anyways, Federal Reserve, central banking, in general, is it such a complicated concept?
Sure. So I thought I might make this a little bit more interactive. You can just wind me up and I can just talk for an hour or hours and hours and hours, but maybe shorter, fire a question, and I’ll share a few thoughts on it?
So Monetary Metals, we are, in a certain sense, like an investment bank but in gold. So investors invest in gold and we’re developing gold fixed income deals that pay return on gold-in-gold. So if the interest rate is three percent, you put a hundred ounces in, at the end of the year, you have 103 ounces. Pretty simple concept but pretty radical because we’re saying gold is money. If that’s true, if gold is money, then money should earn a return and not be something that you buy it and then park it on the shelf, waiting for its price to rise so you can sell it and make more dollars.
I’ll start out with an observation about the Fed, and it’s true of all the other major central banks right now. They all have a mandate. So for the Fed, it’s called price stability, purchasing power stability. And right on the Fed’s website, they talk about this as two percent inflation forever. I have to think George Orwell would be either rolling in his grave or smiling down. It’s a gap. Called it. Got it right.
That purchasing power stability is defined as two percent debasement forever. How in the world does anybody get away with that? I mean, even just at a conceptual level, let alone the moral level, let alone practically what does that do?
And so I’m sure you guys have all got your compounding calculators out. What is two percent a year worth over? If you guys are all swimming around the age of 20, by the time you’re 65 and you put $1,000 in today, then you lose two percent a year. What is that worth at the end of 45 years? It’s a lot because of the compounding, right?
So how do they get away with that? Why does everybody just accept that two percent debasement is good? That’s the root of a thing that in addition to being CEO of Monetary Metals, I’m an economist, and I grapple with and try to shed light about banking and what they’re doing. And the idea is, essentially, that if we debase the money at the “right” rate, and I’ll put right in scare quotes, then that creates prosperity, whether that’s jobs, exports, growth in GDP, wealth effect, etc. that we get good benefits from debasing the money. That’s-
And does it have to do with the velocity of money? Is that what they’re arguing, that it increases the velocity of money, increases lending?
It’s not so much a velocity argument. If you debase the currency that makes the exports more attractive, and so you’re doing more exports. I wrote an article for Forbes when Yellen was nominated, but she wasn’t yet the Fed chairman, but she was going to be our next Fed chair. There were an article for Forbes. I said, okay, what’s coming? What does this person stand for? Everyone said she has came the same as Bernanke. I said, not quite. There’s some similarities, but Bernanke is basically a monetarist. Yellen calls herself a new Keynesian. She’s in the new-Keynesian School.
So I did some research. And so she was an academic before she was a central banker, and she taught at University of California, Berkeley, I believe. So I looked up and she was widely accounted as an expert in economics of labor, where labor hits monetary policy. So what is this so-called expert say. So I found her seminal paper that she wrote with George Akerlof, which also happens to be her husband.
This is the one that everybody on the left, and certainly the Keynesians, everybody just said, Janet Yellen. It’s this, why is expert guru? What did she say? She said, if you have people that are working for a company that feel that they are underpaid, they will slack off. And if they really feel upset about it, if the underpay is really growth, they’ll actually sabotage their tools that are given by their employer. That’s step one.
So step two, employers have to give them a raise in order to keep them from being pissed off that they don’t do any real work and that they actually break their tools that they’re given, which means, step three, employers only have a finite budget for payroll. If they have to give all the current workers a raise, then that means there isn’t enough to go around, and so you have unemployment.
So how do we solve this problem? Right now, you probably would have guessed it. We press the red button that’s labeled, print, print money. And that will give employers more money for their payroll budgets, and so we’ll employ more people, and then we’ll have full employment. Unfortunately, she does acknowledge this in her paper, that’s going to cause inflation. Prices are going to rise and then eventually employees are going to feel disgruntled, they’re not being paid enough, etc.
However, basically, if we’re clever monetary policy people, we can get inside the workers’ decision loop. We’re going to create inflation, and it’s going to happen before the workers really take notice of it. Eventually, they will. And then they’re going to demand a raise, so we repeat the cycle, go back to step one. They feel underpaid, they’re disgruntled, and maybe they’re going to slack off. We have to give them a raise. They need more money. We’re going to print more money. And that’s the core of her paper.
So I said, this is frivolous. If I was a professor of economics, teaching ECON 101, and some students submitted that as a paper, I would give them a big fat F and say this isn’t economics. This is a big steaming pile of you know what, and obviously, terribly convenient because it justifies how the central bank is actually adding value in some way.
So let me take a step back and get to this idea of central planning because that’s really, in a nutshell, what all this is. And then once people concede a central plan that can do some good, then you’re fighting the mythical monster, the Hydra. Every time you cut off one head of the Hydra, then two more heads grow back and they threaten Hercules. And so there’s every different instance of every different kind of central planning possible, and they keep thinking of more ways.
So at root, central planning is somebody saying, number one, people can’t be trusted to conduct their own affairs using reason, therefore people have to be trusted to rule the affairs of others by force. That’s a moral premise of the whole thing. The practical premise is that the central planner knows better than you do. How much of that stuff you want to make? How much of it you want to sell? How much of it you want to buy and at what price or at least ratio relative to other goods?
So this was the theory the Soviet Union was founded on. And so they didn’t have prices internal to the Soviet Union, really, other than whatever the Politburo in their Gosplan, I think it was called, was their central planning agency. And so they tried to essentially plan simple things like wheat and wheat is simple…
I call wheat simple because all you need is the right patch of ground that’s in the right latitude with the right amount of drain and the right amount of sun and the right nutrients in the soil. And you can observe what’s already growing wheat. And so you take that over and say, okay, we’re going to direct you to plant.
And basically you have to put seeds in the ground and you have to wait. And then the crop grows and then you harvest it. And then you distribute it. Pretty simple. And there’s a one year cycle. Every year, you’re producing a wheat crop.
They failed so utterly that people starved to death under this regime. They couldn’t centrally plan wheat, which is very simple, very well known. And people have been successfully planting wheat without central planning for thousands of years. They couldn’t even do that.
So we in the west are smart enough to realize that we can’t centrally plan production in that sense, every once in a while we flirt with aspects of it. So Nixon had wage controls. We now have a minimum wage, of course. We’ve rent control in certain cities. But for the most part, we don’t try to do that because we realize it doesn’t work except for money.
In the case of money, we say that the central planners can set the right price, in this case, interest rate. And so the purpose of the central bank, really… I mean, setting aside their disingenuous claims about inflation management and so forth, it’s really about lowering the interest rate so that the government can borrow and spend more than it otherwise would be able to spend if it had to live on its tax revenues. That’s why we have a central bank, why everybody a central bank to enable the government spend and their cronies to borrow and spend more.
So in doing that, essentially, they’re trying to lower the interest rates, which gets back to the central planning problem, who knows the right price of money? Who knows the right interest rates? And so they claim that they do. And when they try to set the interest rates different from what people’s time preference is, that’s where all the fun begins. So they push interest down.
But what they can’t control is time preference. Everybody has some idea in their own heart or in their own head, this is my money. How much am I willing to let it go for? And if that time preference is violated because the market rate is below time preference, then people strike back. And what they do is they begin hoarding.
So you talk about the 1970s, I’m just old enough to remember. I was the kid in the late ’70s and my parents would hoard canned food, tuna fish, toilet paper, paper towels, and other things of that sort, laundry detergent, etc. And essentially, they preferred a pantry balance, as I call it, to a bank balance.
So whatever would be on sale that week, we would have two shopping carts, one for the cans and tuna fish and one for everything else. And as a family, we’d have tuna fish once a week or something like that. Maybe that was one or two cans, and they’d buy like a hundred cans when it was on sale or something. And so that was their way of dealing with us.
Once that is set in motion, you push the interest rates below people’s time preference and people respond. Consumers respond by essentially hoarding because they know the price that… As a kid, I was 12 years old in 1979. How much does a kid really know about prices in a grocery store? It’s not what you’re paying attention to, but prices were going up so much so fast that even I was really noticing that pretty much every price of every good in the grocery store was up every week to a degree that I noticed.
Hey, wait, wasn’t that $0.39 last week? I think the official inflation rate for 1979, something like 13 percent. But as I said, it felt like everything went up every week. It had to have been more than that. That’s how my parents dealt with it. And I don’t think they were unusual. I think everybody was accumulating. One person I remember had 100 boxes of Kleenex tissues in the closet and somebody else cleaned out. There was a white sale on President’s Day or something like that an they-
Now, is that simply an effect of people living with sustained price increases and deciding that, hey, I’d rather to buy this stuff today because I know it’s going to cost a lot more in the future? Do you think it’s an effect of that?
Begins with the interest rate is lower than their time preference. So they just say, well, I don’t believe in this banking thing. It’s just bullshit. So they start buying consumer goods, of course, that’s what begins to drive consumer prices to rise. Now, when really gets bad is when corporations get into the act.
So today, and since the early to mid-1980s, everything that has to do with manufacturing or distribution, is about just in time. It’s about lean. It’s about, I have a small angel investment in a company that was trying to be the Uber of trucking. And one of their customers was grocery, I don’t know if it was a grocery store or a grocery distribution company. And so they were doing a lot of the trucks that were carrying produce and other groceries from California to here in Arizona.
And I asked them, what percentage of the inventory owned by the grocery company was, let’s say, on the display shelf versus how much was in the back room, the back of the grocery store versus how much was on a truck versus how much was in a warehouse? He said, well, it’s essentially almost nothing in the back room other than what the stock people are in the process of unloading and labeling and preparing to put out. There is no warehouse. Not really.
And I forget what the percentage was. But what you see on the floor is basically the inventory. And then most of it is on a truck headed to that store, which is going to arrive approximately, when whatever what’s on the floor is going to be sold through. So everything is a just in time. There’s almost no inventory in the system after all these decades of lean and just in time. All the inventory has been sucked out.
But rewinding back to post-war period and certainly through the late ’60s and into the 1970s this really accelerated, what corporations were doing was… Because they realized, if you buy raw materials and you put those on the slow boat from wherever you’re buying those raw materials, that takes a few months to get to your factory. And then you accumulate an inventory buffer in between each step, each production process step. So you have a work in progress, inventory buffer, and warehouse is filled with the rafters with this stuff.
The longer that you went from raw materials to finished product the higher your profits because inflation was so rampant. So once the corporations realized that, they began to borrow, not to finance more production lines, but to finance greater and greater inventory buffers, both the actual raw ingredients and then also partially completed work in progress. And so things became the opposite of lean. Everybody was overflowing in inventories, and not just finished goods, as I said, but all the partially completed work in progress back all the way back to the raw materials.
So you have corporations that are buying up all the raw commodities, which of course, is pushing up commodity prices and you have the consumers buying up the finished goods, at least the ones that were durable, and hoarding those. And so that’s pushing up prices. And then corporations are selling bonds or borrowing in order to finance this activity. And so they’re selling more bonds, which is pushing bond price down.
And so I’m sure everybody in finance knows the bond price and the bond interest rates are a strict inverse, it’s a seesaw. So you push the price down, which means you’re pushing interest rates up. And so you have period of rising interest rates and rising prices. And then to get to your question, “Do people see the rising prices and then they want to hoard more goods knowing the prices are about to go up?” Yeah. So it becomes a ratchet effect, and then you get more hoarding.
And so it’s a race condition. It’s not are people buying goods, it’s the rate at which people are increasing the speed with which they’re buying goods. How do you compare that against the rate at which goods are being produced? And is there a change in that rate? And the answer is there is a change in that rate, as the interest rates is going up, everybody in this room, I assume, can figure out the business case, should you borrow money to buy more equipment and open up, increase your productive capacity or open up a new plant?
And that calculation is highly dependent on the interest rate. So the interest rates goes up, that business case goes away. So there are few and fewer companies that want to borrow… As the interest rate goes up, there are fewer companies that want to borrow to increase production. And at the same time, when factories go end of life, there are fewer and fewer business cases to even buy new equipment to replace it, so production is actually decreasing as a function of the rising interest rate.
So you get this ratcheting up of interest rates and ratcheting up of prices. And the key… it’s a ratchet, because, although interest rates is rising, people’s time preference is rising also. When you realize you’re in that inflationary environment, the five percent that would have made you perfectly happy last year, you’re no longer happy with the five.
So although the interest rate has gone up, your time preference has gone up even more. And now they’re paying you eight percent but you really demand about ten. And so at eight percent, you don’t want to keep the bank balance. And so that runs and runs and runs and runs until it can’t run anymore. And that was 1981.
Interest rates finally spikes above time preference. It turns out that all of these raw commodities, much less partially completed work in progress has declining… Is everybody familiar with the concept of marginal utility?
I do. I think a lot of these guys are shy about not saying no.
So I live in a hot desert. I think it’s going to be 110 degrees here today and probably five percent humidity. So if you’re walking out there in the desert, you could die of thirst pretty quickly. And every once in a while, some idiot does that. So imagine you’re walking through the desert, you’re dying of thirst. And then you come across a guy who has a pickup truck and he’s selling bottled water in the back of the pickup truck. And you’re literally pretty close to dropping dead of thirst.
What is the first gallon of water worth to you? Anything you had. Your life. You might get mad. You might say “gauging”, but you’ll pay him. The second gallon, what is that worth? Well, you’re going to need that to carry with you to get back to civilization. What’s the third gallon worth? Well, it’s a spare. What’s the fourth gallon worth? Probably pretty close to zero.
So you can’t say what’s the gallon of water worth? You have to say what’s the gallon of water worth at the margin? And then as you keep adding more gallons, the margin becomes less and less valuable until the value of that commodity hits zero. Every commodity has this decline in marginal value, marginal utility.
And so what has been going on for a couple of decades by the time you get to 1981 is accumulation of all these raw materials and all of these partially completed inventory or inventory of partially completed goods. The marginal value that’s been falling, falling, falling, and the amount of debt they’ve been accumulating to finance it has been rising, rising, rising. Eventually you get to the point where it can’t be sustained anymore, and you have bankruptcies and forced liquidation.
So the interest rates spikes. The banks are now taking big hits and that pushes it up further. Volker chose that moment to try to raise the interest rate. So you get ahead of this. If you try to raise the interest rate in the 1970s, people would have been going with the flow. It would have had no effect.
But at that moment, he finally got interest above time preference, which means now people would prefer to have a bank balance to a pantry balance. At the same time, you begin to have liquidations of all these inventories, at least at first, it’s the companies that have been declared bankrupt. The stuff has to be sold to satisfy creditors.
And so now to commodities begin coming to market. Interest is above time preference. Unfortunately, interest is also above economics term as marginal productivity capital. But you can think of it… or marginal productivity of the entrepreneur, excuse me. But you can think of it as marginal return on capital, right?
So imagine you have a business that can make eight percent return on capital and the interest rate is ten percent. You can’t finance that business. Nobody borrows a ten to make eight. So the interest rate is now above for the marginal borrower, where it’s above a marginal return. And so that begins a process of further bringing commodities to market liquidating, just squeezing that supply chain.
And that’s been the trend since the early to mid-1980s. Lean comes in from Japan. Of course, Japan had been developing it for decades. It didn’t become popular here in the US until after the interest rates turned around.
And today, here is my challenge, and think about this. Imagine you went into the board today of a major manufacturer. And so here’s what we’re going to do. We’re going to buy some warehouses and we’re going to start accumulating extra buffers of commodities as our raw materials.
And not only that, we’re going to accumulate buffers of inventory in between each stage of production. And then when we finish producing, we’re not going to sell it right away. We’re going to shove it in a warehouse, park it for six months. How would the board respond today if you said that? You’d be lucky to leave with your head. Get the hell out of here because you’re nuts, right?
That was how business was done in the 1970s. That’s what they were doing on purpose. And they were quite conscious of that. Today, we’re in the opposite environment. We’re in a falling interest rate environment.
So one other thing I want to point out about falling interest rates versus rising interest rates. Everybody familiar with net present value and how you calculate that? Same with cash flows, you have to discount each future year based on some assumed discount rate. So the present to figure out Warren Buffet, or maybe this was mentor Benjamin Graham, who came up with this idea.
Suppose you had a machine that spit out one dollar every year from now into eternity. What would you pay for that machine if you bought it today? And so, Warren Buffet, I think, he assumes 10 percent as an interest rate. And so you discount, you have a dollar this year and basically next year’s dollar is worth $0.90. Two years from now, dollar’s worth $0.81. Three year it’s worth $0.72. So you have a series that adds up to $10 and it’s an infinite series or is that the [inaudible 00:21:32] rule tells you what that series will add up to. It’s a finite value. It’s 10.
So it’s all based on the interest rate. If you assumed a five percent interest rate, it’ll be worth $20. If you assume a two and a half percent interest rate, it’d be worth $40. The one percent interest rate will be worth a hundred dollars. So my argument is that, and this is controversial and you may talk to other people who disagree, my argument is that the interest rate that you should use for discounting purposes is the market interest rate. That’s the one that actually matters. And that’s the one that gives you your benchmark you’re comparing to any other investment that you might make.
And so the net present value of everything you do has to be discounted by whatever the market rate is. Now this becomes interesting if you started to think about what about the debts you have and the debt service payments you’re making? Those also have to be discounted. And so the net present value of all the debt is going up as interest rate is going down.
So they’re trying to lower the interest rates to be stimulative. And yet what they find is that the lower the interest rate falls, the more the burden of each dollar of debt in addition to, of course, there’s a greater incentive to borrow more if it’s cheaper. And so as the interest rates falling and you raise velocity earlier, you can see the velocity falls also. So you have more and more of this so-called money that’s out there, which is really debt, but less and less circulation of it. And everybody becomes more and more bogged down under the weight of it all.
This gets to, and maybe I’ll just make one conclusion of this and then open up to questions because I’ve probably been talking rapidly about a lot of ideas and how this all connects is tough. There are two fatal flaws when they made the dollar irredeemable.
So if you rewind that Fed was created 1913. At that time, the dollar was a defined weight of gold. It was a unit of weight. And of course, across the Atlantic Ocean in Britain, their unit of a monetary measure is more obviously a unit of weight it’s called the pound. It originally meant one pound of silver as in a pound, and you put it on a scale, and that’s how much the silver weighed. That was a pound.
And so everybody understood, even before the founding of America, everyone understood money meant gold, and silver. If you deposit money in the bank and you got a piece of paper, that piece of paper was nothing more than a promise that we pay you the money. All they did when they defined dollar or pound or whatever was they standardized the bank deposit unit. So you can compare, if I had a dollar at my bank and you have a dollar, at your bank, we know that’s the same dollar.
So it’s like on the Internet, we say, okay, well, a packet is 1024 bytes. It’s not an attempt to tell people you can only send a 1024 bytes. It’s saying, okay, if you’re send 32,768 bytes, that means at 32 packets. So they were just standardizing that.
1933, Roosevelt developed the two things. One, is he said he’s repricing it from roughly 20th of an ounce to the 35th of an ounce per dollar. Number two, he said, you can no longer redeem your dollars. So now a dollar becomes a piece of paper, credit of the government or the Fed. It’s no longer something that you can present to the bank teller and get your gold back. You’ve lost your gold. And now you just have an irredeemable piece of paper.
Once you have an irredeemable currency, and that was inevitable because the Fed was created to manipulate the interest rate, but in gold, there are limits to what you can get away with. In gold, if the interest rate goes too low, people just simply withdraw their gold.
Now, in my company, we’re in a position to directly perceive this. Each deal comes out, and there’s an option to set the interest rate. Everybody has an opinion is what the interest rates should be. And those whose opinion is that interest rates should be higher willingly put their gold in if the interest rate is below that. And that’s fundamental to a free market.
If you go to the grocery store and you think I want to buy a steak. And for some reason, the price of steak was $500 a pound. Guess what? You’re not buying steak today for most people. So everybody makes their own decision.
So anyways, you make the currency irredeemable, which is what FDR did in inventing 1933 and arguably Nixon made it more consistent. When you have a new involved currency, you have two fatal flaws. One is without a method of redeeming, there’s no method of extinguishing debt. So if you owe somebody an ounce of gold and you pay them a gold coin, the debt goes out of existence. So it literally goes away.
If you owe somebody a $1,000 and you pay $1,000, the debt is merely shifted. The dollar bill on it…so bill is a word for credit. The dollar bill doesn’t say bill on it, it says Federal Reserve note. Note is another word that means credit. You’re giving somebody else’s note and you’re shifting the debt. You don’t owe that person a $1,000 anymore.
Now the Fed owes that person a $1,000. And what does that person do? He deposits it in a bank. Now the bank owes him the $1,000 and the Fed owes the bank. What does the bank do? They buy treasury bond. And now the treasury owes the bank $1,000. We just keep shifting the lump under the rug.
We can never get rid of the debt anymore, which means the debt necessarily, and this is a feature, not a bug, the debt necessarily goes up exponentially when you have an irredeemable currency. And that’s exactly what we see certainly since Nixon’s final move to make a dollar irredeemable in 1971.
By the way, if you haven’t seen it’s on YouTube, Nixon closing the gold window is what he called it of what he called it. It’s 30 seconds or so of just breathtaking dishonesty what he says. It’s worth everybody watching if you’re interested in the history of this stuff.
Anyways, the debt is going up exponentially. It doubles about every eight years. And we’re still on track for that. And now, when we have the crisis of 2008, I guess most of the people in this room, you guys would have been in elementary school at that time.
Before that, the government was running a deficit or shortfall of something like $400 billion a year. And at that time, that was considered to be gobsmacking. That was consider to be, oh, my God, $400 billion shortfall per year. Right after the crisis for fiscal 2009, they ran a trillion dollar deficit.
And then suddenly, it was, why can’t we get back to the good old days of $400 billion deficits? Well, when we were running $400 billion deficit nobody thought that was the gold old days. They thought that was, oh, my God, crazy. Then we’re running a trillion dollar deficit. And that’s where we had been until COVID, roughly.
And by the way, the deficit, they quote, when you see the headline number, there’s some accounting gimmick, which I haven’t figured out. The US Treasury runs a website called debttothepenny.com. On debttothepenny.com, you can put in any two dates and you can see how much the debt actually went up. And it’s much higher than the claimed deficit number. So some of the Obama years are claiming only seven or $800 billion, but actually the debt’s going up faster than that. So anyway, that’s an aside.
So COVID happen, and they said, right, well, let’s just lock down the economy. And then we’ll just pay everybody what they would have made if we didn’t lock down the economy. And so then they’re running five trillion dollars, something like that, deficit. So the deficit just grew by leaps and bounds. It has to in order to ensure that all of the debtors get their hands on enough dollars.
When you pay interest on your debt, that’s after all of your expenses and everything else. So it’s not your gross revenues that matter. It’s your gross margins. Everybody has to get enough gross margins in order to get their hands on enough dollars to at least pay the interest on their debt service.
So problem number one, the debt is growing exponentially. That trend continues. And we know from physics and from engineering that exponential trends do not end well. I mean, probably the quintessential example of an exponential growth trend would be a thermonuclear explosion. It’s a runaway positive feedback loop.
The second problem with irredeemable currency is interest rates is unstable. So if you look at the data and I wrote an article for Seeking Alpha, I don’t know, 10 years ago now, something like that, if we take a look at the interest rate on the ten year treasury from the founding of this country to present, what you see is that during the period of metallic money standard, the interest rate’s pretty darn stable. We had some existential threats, like the War of 1812. We had a Civil war. We had some other pretty big dislocations in the 19th century.
But what you see is something that almost table flat. There’s a little bit of jitter in it. And then there’d be a spike for the 1812 and then maybe a step up or step down as technology changed, railroads or whatever, it was pretty darn flat. 1913, when they created the Fed, they didn’t say full employment because structural unemployment was inconceivable in 1913. They didn’t say inflation because that wasn’t a problem either. They said, stabilize the business cycle.
If you look at a graph of the interest rate, you can see that in 1913, when they created the Fed to stabilize the business cycle, the interest rate becomes destabilized. First rising into the 1920s, then falling through the Depression and through World War II. Then it’s incredible meteoric rise from after World War II to 1981, and now it collapse to zero and if Europe, in Switzerland, and Japan, and the UK, are any indication. It doesn’t end at zero. It actually falls below zero and goes negative.
So at Switzerland, if you deposit francs in a bank, if you’re a small retail depositor, they’ve held the line it’s a zero interest rate. But if you’re larger than, I don’t know what it is, a hundred or 2000 francs, or if you’re a corporate deposit, it’s negative 0.75 percent interest. This is where they are at the moment and that will continue to go more negative.
So a friend of mine has one of those old vaults in the mountains that they were using in World War II to store munitions, bought that, refurbished it with modern electronics and has a vault where they’re storing gold and other things there. They have corporate clients that literally back up an 18-wheeler, unload palettes of franc bills that they store in the vault because that’s cheaper than the losses they would suffer by having it in the bank account. That’s the pathology of it.
Anyways, the interest rate’s completely unstable in paper, and now we’re falling, to the black hole zero and beyond. Assuming that all the debt is perpetuity, because there’s no extinguisher of debt, it’s all perpetual, what if the NPV of a perpetuity at 0 percent interest rate or 0 percent discount factor? Anybody know that?
So with every halving of the interest rate, the NPV net present value doubles, right? So that machine that generates a dollar a year, at 10 percent discount, it’s worth $10, at five percent discount, it’s worth $20, at two and a half percent discount, it’s worth $40, and one percent discount, it’s worth a hundred dollars.
What happens if you push the interest rate to zero?
Would it be more than infinite?
Infinite. So this is like the singularity in the black hole in physics. All the math breaks down. Everything becomes completely irrational. And of course, what zero percent interest is saying is that nobody has any time preference. That whether you have a bird in the hand or whether you have two in the bush or the promise of getting a bird 50 years from now, that’s all the same to you. Nobody cares whether they eat today or whether they eat in 10 years. That’s just a contradiction of everything about human nature and reality.
And so that’s what happens when the central planners run a mock and they’re messing with something that I said wheat is very simple has a one year cycle, sticks the seeds in the ground, wait for the rain and the sun. Now they are central planning money, the cycle in money can be decades, and it’s complicated and nobody really understands it. And they’re central planning backed because they know we can’t central plan wheat because it doesn’t work. But with money, we haven’t figured that out yet.
And so here’s where we’re at we have an exponentially rising debt. And I argue necessarily so. It’s not because Congress is a bunch of profligate spenders, which they are, of course, but it’s because necessarily the debt has to go up like that. And then the interest rate keeps falling down so that the Keynesians say something that’s both true and disingenuous.
They say, well, the interest service expense to the government as a percentage of GDP has never been lower. It’s perfectly fine. What’s the problem? Well, yeah, that’s because as the debt is going up, you keep pushing interest rates down. And so sure, it’s a lower interest rate. Your debt service payment isn’t that bad great. What has that proven? You lowered the interest rate. But what happens when you lower the interest rate to the entire economy?
So you get falling. That’s one of the things I want to say about my Theory of Interest and Prices. As the interest rate’s coming down, imagine you’re a manager at a hamburger restaurant chain, or you’re the investment banker talking to hamburger restaurant chain. And you’re putting together the business case to borrow money to open up another store.
And the business case doesn’t quite work. And then they come along and lower the interest rate. Once a new lower interest rates, it works. So you borrow the money, you open the store. Now, what happens to the price of hamburger if you increase the supply but you don’t increase the demand? Price of a hamburger falls. And of course it isn’t just you. It’s all of your competitors also have the same business case that suddenly clicks into the place when the interest rate falls for the same reason.
So a falling interest rate may add to GDP, and it may temporarily add to jobs by stimulating or essentially subsidizing additional capacity. That doesn’t really make any economic sense. What you’re doing is feeding the investor through the entrepreneur to the consumer. You’re feeding the investor to the consumer.
And everybody loves it because they say, see, we don’t have inflation. Prices are steady, or maybe even declining slightly or whatever. Costco is famous for having the special you get a hot dog and a soda for a $1.99. They’ve been doing that since 1983. Certain prices have either fallen or held steady in this environment. And it’s all because of the falling interest rate.
So people love it because the only thing they’re looking at is consumer prices or CPI. And they’re missing that there’s something wrong when you’re feeding the investor to the consumer because of course, eventually you run out of other people’s money. And so this whole scheme is essentially a socialist scheme. It’s a redistributionist scheme, but it’s one that has the perversity to it.
When you read Keynes, there’s a famous quote that most of the people in the gold world would be aware of. And Keynes says, to overthrow the capitalist order you debauch the money. And he goes on and on and on to say, by leveraging all the hidden forces of economics in favor of destruction, but not one in a million can diagnose what’s going on. And he talks a lot about lowering the interest rate to zero. He thinks interest should be zero. And then he says, no one can diagnose what’s going on.
It’s obvious to me why that’s so. Most people think he means inflation. I can tell you, having remembered the 1970s, everybody was talking about inflation every day. To say one in a million would see it, just silly. I mean, on the nightly news, they talked about the Misery Index, which was some index of unemployment and inflation. Everybody saw inflation. What Keynes is talking about as you lower the interest rate to zero is you get an endless bull market because the NPV of every asset’s going to infinity.
Everybody loves a bull market. Buy stocks. They’re going up. Buy Bitcoin. It’s going up. Buy gold. It’s going up. Buy antique Ferraris. It’s going up. Buy real estate. That goes up even more. Everybody loves that.
And they’re missing the fact that as you drive the interest rate to zero, Keynes called it, he said, euthanasia, use the term rentier, but think of it as the saver. So the saver is anybody working for wages trying to hit a goal of retirement. The saver is anybody in retirement trying to live on fixed income without consuming the capital, its pension funds, it’s annuities. It’s insurance companies, continuing care facilities.
When you move into one of those, when you hit that age, there’s a buy-in, and then there’s a monthly rent. The buy-in goes into an annuity. Same thing with cemeteries, they buy an annuity. And that’s how they cover all the expenses that they have after that. But we’re destroying the annuities in the process of driving interest rate to zero.
So the whole world’s gone pathological. And most people look at the consumer price index and say, fine. If you have cancer and you go to the doctor and the doctor takes your temperature and says, nope, it’s 98.6. You’re fine. My argument is no, it’s not fine.
So let me stop there. I think I’ve thrown a lot of ideas at you guys rapidly. And I apologize for that. But there’s a lot going on. We need to surface in the monitoring system.
This has been great. Guys. Everyone here has questions. Everyone in LA and Stanford has questions. So why don’t we, in an orderly fashion get our questions out? Start with…
Okay. So I know you mentioned this before. So I have a couple of questions. One, can you go over how corporations borrow to finance inventory buffer again?
So they don’t do that today. That’s for sure. But back in those days, they realized that the longer you took, the longer the time delay in between the acquisition of the raw materials and the sale of the finished goods, the greater the profits, because prices are always rising, right? So if you bought something for a dollar and then you sold at the same day, you didn’t really get the benefit of inflation.
So all you get it, let’s say, you got a 10 percent markup, you bought it for a dollar, you turned one screw on it, and you sold the finished good the same day for $1.10. You’re only making 10 percent. But if you wait six months, that item is not $1.10 anymore and maybe it’s $2.10. So now you bought for a dollar, you sold for $2.10, and of course, the accountants know what you’ve paid for it. So you mark down $1.10 profit versus $0.10 profit.
So once you realize that it’s pretty simple to build a business case to borrow to increase inventory buffers, whether it’s raw materials or whether it partially completed work in progress, you want to accumulate that. You want to slow it down as much as you can, because the slower it goes, the more money you make.
Okay. Thank you. And also another one of my questions is, do you personally believe that the Fed had a direct impact in every single market cash that we’ve had?
The Fed and other government interferences. It’s my belief and my theory that if we had a free market, which we don’t and never did, even in the 19th century, even at the founding of the country wasn’t exactly the free market, certainly not in banking the money, that in an actual free market, all the feedback loops are negative. Everyone’s familiar with the concept of negative feedback versus positive feedback? So a negative feedback loop, the more that a process gets faster, all the forces tend to decelerate it.
So imagine you’re pedaling your bicycle on level ground, the negative feedback loop is a wind friction. The faster you’re pedaling, the more the wind is slowing you down. A positive feedback loop is relatively rare. And my best example of that is Jimi Hendrix holding his electric guitar to the amplifier, right? So it goes OWEEE and it squeals. That’s it.
Because the sound is coming out of the speaker cone, which is vibrating. And the string are six inches from the speaker. It hits the strings, which causes the strings to vibrate. The strings are sitting over an electromagnet. That’s what the pickup is, which induces a current, which goes into the amplifier, which then makes the speaker vibrate even more. So you have a positive feedback loop. The louder it gets, the more tends to get even louder still.
This is well understood in an amplifier design, so they always put in a circuit there to limit that. If they didn’t, it would run away until the amplifier caught on fire and burned down the house. So positive feedback loops, relatively rare and enormously destructive. So what was your question I want to tie it into?
I was asking how if the Fed directly impacted-
Oh, right. So in a free market, all the feedback which are negative. Let’s say, people are borrowing money to plant tulip bulbs. If you had a free market, the more that people want to borrow for tulip bulbs, the higher the interest rates would be for tulip bulb purchases. And so there’s 100,000 different corrective mechanisms that would be one of them that would tend to discourage that.
The tulip mania occurred in Holland shortly after they founded the bank of Amsterdam. So they created the first central bank, and then they hit the first bubble. Now, once the bubble happens, the prices get so far out of whack that you attract enormous amounts of investment. But that investment isn’t productive. And so it’s called malinvestments. And then the crash is the liquidation of the malinvestment.
So I would say the central bank and other government regulation, so, for example, usually when there’s a housing boom, you have the problem of zoning other… the permit and approval process can take years. So imagine you’re driving your car, but imagine if there was a 20-second delay in between, I turn my steering wheel, the car continues to go straight in for 20 seconds, and then it takes on that change. Of course, I will tend to overcompensate. Then the car would be veering off the left side of the road. And then I’m going to overcompensate this way.
And so it isn’t just the Fed. There are other kinds of really important distortions that occur that create these long lags and add to these feedback loops when you have first underinvestment and then overinvestment, so oil is a good example. Underinvestment, the price spikes, but it takes a lot of time to get through the environmental permits.
And as the interest rates falls, you get overinvestment. The price crashes. You get bankruptcies on liquidations then underinvestment. And so the permitting process and the falling interest rate have interesting synergies. But yeah, so governments behind it, for sure.
Thank you very much. I have a question about when you were talking about it’s impossible to service debt, you went through like the flow of where the debt goes. Can you go through that one more time?
If you can just add a few more words to clarify your question because there’s so many different places-
So when you’re talking about it’s impossible to service debt it grows exponentially, you went through a flow of, if I pay off my interest, then another person receives that bill.
Oh, okay. Yeah. So there’s no way to actually extinguish a debt and make it go out of existence because you’re paying a debt using an I owe you. You pay debt using dollars and the dollar is someone else’s credit paper. So all you do is shift the debt whether you go to a restaurant and you pay the tab at the end of the night and you put down a hundred bill, you’re out of the debt loop. You’re not going to get arrested for stepping out and not paying for dinner.
But now the Fed owes the restaurant. So we pay debt using someone else’s credit paper and there is no redemption at the end of it. It’s just paper on top of more paper. So the total debt has to grow by at least the amount of accrued interest across the entire economy for the year. That is all the debtors have to somehow get their hands on enough dollars to service their debts.
If you’re a debtor, let’s say, you owe a million dollars at a rate of five percent, you have to have $50,000 in free cash flow in order to surface that debt. And if you don’t, you default. Now the problem is if you’re the only one who’s defaulting, then nobody really cares and you go out of business and the bank takes your stuff.
But if everybody’s defaulting of you and millions of other of hundreds of thousands other small businesses are defaulting on those debts, then what happens is it impairs the banks balance sheets. So it becomes a banking systems problem. And so the banks always tugging on the robes of the wizard who runs the central bank, please make it possible for them to borrow more.
So you’re not necessarily borrowing more to service your debts. Your customers are borrowing to expand. And then as they expand, they need to buy more of your products, which then gives you the revenue that you need to service your debs. So everybody’s revenue is someone else’s borrowing. And so that’s a whole other problem.
I mean, talk about today, which is an increasing amount of the economy isn’t real. It’s just simply people spending money they just borrowed. So imagine if everybody borrowed $1,000 in their credit card and all went for a vacation in Las Vegas, revenues in Las Vegas will be off the charts. Is that really growth? I mean, how could you define that as growth? Only a PhD economist will say, yes, that’s growth because it adds to the GDP. But is that really growth or is that something pathological, something unsustainable?
We can go over about that later. We can go over the actual creation of money later.
No, that definitely helps.
What about LA kids? What about the LA kids?
Yeah, I got a question. Can you go more into depth on how your company works? I don’t really get it so far.
So a root premise is that there’s a universal human need to earn interest on savings. And if you can’t earn interest, then it’s impossible to really attain your goals. And because of the central banks and it isn’t just the Fed, because of the system, the interest rate has been driven down, where, at least at retail, essentially no interest to be had anymore. And arguably even for institutional investors, there’s yields to be had, but in a lot of cases, it’s by taking on a lot more risk.
And right now that risk is being masked by monetary policy. Are you familiar with the concept of a zombie? So the bank for International Settlements defines the term zombie or zombie corporation. There’s a couple of other components of the definition.
But basically a zombie is when interest is greater than free cash flow. So these are companies that shouldn’t exist. And they only exist by virtue of really low interest rates and a very forgiving credit market. I think it’s something like 20 percent of the S&P 500 are now zombies. So anyway, some yield to be had, but maybe some of that yield is picking up pennies in front of a steam roller.
And our premise is that people need interest on their savings. While gold can’t be inflated or debased, the gold is the logical place for people to get that return. And what we do is we find businesses who need gold either as inventory like jewelers or work in progress like jewelry manufacturers. And we’re just brokering the transaction. We make a spread in the middle. The investors are getting a return on their gold in gold, the businesses who have the gold financing.
The conventional way they would finance it is by borrowing dollars. But when you’re getting into a commodity like gold, the problem with borrowing dollars to buy your gold inventory is that the price of gold drops. Of course, your debt does not draw. So now it lets you borrow a million dollars, you buy a million dollars worth of gold. If you did that a month and a half ago, you now have a $900,000 asset, but a million dollar liability. So they have to hedge.
So it’s borrow dollars, buy the gold, and hedge. The hedging adds extra moving parts, extra cost, extra risk, extra complexity. And we’re giving them a simpler transaction, which is just least the gold that you need. And then you don’t have a currency risk. So they got the financing they need to get rid of the gold price risk which they don’t want and the investor gets returns. It’s a the win-win deal.
Wait, did you say that you pay them interest in gold, too?
Okay. Thank you. That’s super cool that you guys do that.
Either way, it’s an old idea. I mean, that’s what banks were for a couple thousand years. And then after 1933, that didn’t exist anymore. So we’re just bringing back something that was old, but finding a way to make it relevant today.
Okay. You were talking about the zero percent interest and the infinite value how the math falls apart and you compared it to a black hole. Could you just briefly explain that one more time?
So I like to use physics analogy. So supposedly in physics, the volume, star collapses into a black hole. Supposedly in a real black hole, the volume collapses to be a volume of zero, so the density of the matter is infinite, there’s no volume. Net present value is a similar collapse. If the interest rate’s zero, the net present value is infinite. It causes a variety problems. By the way, once you think of a wage, so if you hire workers, a wage is a stream of future payments. I mean, the net present value of a wage is also doubling with every halving of interest rates.
So the way that manifests, that’s the theory. What’s the practice? The practice is that as the interest rates falls, it becomes more and more attractive to replace labor with capital. And so what this tends to do is it tends to put downward pressure on wages and on jobs generally. And the worker either has to double their productivity or be made redundant because the NPV is going up with every halving.
Okay, thank you. Okay. That was it for us. Thank you.
What about Stanford? What about Stanford, guys? We can get one last one in there.
Yeah, sure. Thanks again, Keith, for talking with us. My question is a little bit something that I was curious about. Today, I was talking with someone about inflation and the Fed, and they mentioned the reflation trade. I was wondering if you can talk about reflation and what the reflation trade is.
Yeah. So everyone assumes that Fed can print enough to prop up prices. So speculators try to get ahead of that and they bid up the prices or whatever commodity they think is going to be most sensitive to that. So for a while, the price of lumber was skyrocketing. Now the price of lumber is down 30 percent from where it was two months ago. At the end of the day, price is going to be set by actual use of these commodities. But in the meantime, if everyone thinks that Fed is printing so crazy, if everyone believes in the quantity theory of money, which is what I am implicitly debunking presented my ideas, then they think, okay, all the printing is going to cause higher prices, let me get ahead of it by buying the commodities now when they’re cheaper and then I can unload them later when prices rise. So that’s the reflation trade.
The problem is what if you’re wrong? And what if prices really aren’t headed higher? What if they’re actually going to be soft in the future? And then there you are, you brought up all this oil, or all this lumber, or copper or whatever it is, and now you have to sell at a loss. So that’s what happens if commodity speculators get it wrong.
All right. All right. Hey, Keith, this is super helpful. This is really interesting. I learned a lot. I’m sure these guys learned a lot, too. I think probably you’re going to have to go over their notes again and make sense of everything they just heard. But guys, it seems like a hugely valuable thing to talk an economist like this. In time, we’re probably going to be experiencing some inflation. Or at the very least, it’s going to be in the news again. So anyway, it’s great to talk to an expert like you. We appreciate it-
Thank you very much.
Thank you so much.
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