Most Experts Are Wrong About the Economy

Release date: June 22, 2022
Duration: 55min
Guest(s): Raoul Pal
Raoul Pal rich dad radio show

Crypto-King Raoul Pal joins Robert and Kim Kiyosaki. Raoul is the founder and CEO of Global Macro Investor and Real Vision.

Tell us what it means when the IMF at Davos, Switzerland says we are ‘heading into the worst financial headwinds since World War II’?

This is about as macro environment as I've ever seen. And I think most people's read on it is probably wrong right now. So, okay, let's go back and say, I'm going to go take you through a history lesson and then we'll get to today and tell you why I'm concerned. So, why World War 2? World War 2 was a fascinating period because, like COVID, the entire world had basically been stuck at home or been on battlefields. Everyone came back, there was no supply of commodities and goods, global supply chains were broken, and everybody came back and started consuming again. And guess what? Inflation went up to 13% or something, maybe even higher. And that period was fascinating because interest rates went up. And the first thing that happened was the economy went straight back into recession and inflation went negative. Because it was a massive tightening of monetary conditions. You raised the cost of goods on people and didn't raise their salaries enough.

People couldn't get the goods that they wanted, exactly like now, and everything collapsed. So, we went back into recession and then, eventually, some better times. And I'll come back into the 1940s and '50s, because I think it's a really important parallel that most people misunderstand. The next time we saw anything remotely like this was 1974. A lot of people tell you it's the '70s again, inflation, inflation. Well, the inflation episode we had in the late '70s was driven by demographics. That was the baby boomers entering the workforce all at the same time. It was the largest demand shock the world had ever seen. And we had a supply shock of these oil crisis of the Arab oil embargo. That's not repeating now. What is actually more similar is 1974. 1974 was the Arab oil embargo. The price of oil tripled and interest rates went up, inflation shot up, and the immediate effect was the economy went down the toilets. Almost, do not pass go.

The stock market fell 50% and the ISM survey, which is a good guide to the business cycle, it's the Institute for Supply Manager survey. Anytime it crosses below 50, suggests the economy's getting weak. A recession comes at about 47. It hit 30, which was the lowest in all history. And it happened in a space of four months. It went from roughly where it is today, which is around 55, and went to the lowest level in four months, based on exactly the same kind of setup we've got now.

You are saying that the 1970’s and our current predicament are pretty close?

Yes, and inflation fell in 1974 afterwards. People are still thinking inflation goes on forever. It did not. And it did not in the 1940s either. Then the next one up is 1984. 1984, we saw an issue where global trade... There was a huge amount of trade disputes. The dollar was pretty strong, like it is now. Interest rates were going up and inflation was high. And everybody was fearing, looking back and saying, "Oh, we don't want the early '80s, late '70s again, the inflation, inflation. So, Volcker was tightening rates too much, and the economy collapsed. It didn't go to recession because the Fed quickly started cutting rates, but the dollar went up a lot more and created a lot more problems. We ended up with the Plaza Accord in 1985, when everybody had to stop the dollar going up from destroying the global economy.

So, then the next time we see something similar was 2008. 2008, if you remember, the oil price was at $147. Inflation was 6%. The Fed had been cutting into that because the economy was imploding. 2018, exactly the same, oil price is high, inflation high, the Fed were hiking rates trying to tighten the balance sheet, and what happened is the economy rolled over really quickly again. Okay, so what's going on here? Why does these phenomena keep happening? Everyone extrapolates inflation out forever. What actually happens is that consumption falls because we've tightened monetary conditions. So, tightening monetary conditions to ordinary people means the cost of your mortgage has gone up at the fastest pace in history. Over a one-year period, mortgage rates have never risen this fast. So, any money you've borrowed has suddenly got much more expensive. Your wages haven't kept up with the cost of just basic services like food.

So, you're actually feeling poorer. So, you can't consume as much, and you start not consuming other things. People overextended on housing because they rushed into housing in 2020 and 2021. And the rates have gone up for them. Also, just the rise in things like the cost of oil has meant that... gas prices, all of this stuff, and then the rise in the dollar, which is a monetary tightening. All of these things get together would suggest, and I put them on a chart, it'd suggest that the ISM is going back to 30, which is as it was in 1974, which is a terrifying fall.

What does ISM stand for?

Institute for Supply Management. It's the survey of buyers and corporations who buy goods and services. They ask them, what is your reading of the economy? How much inventory have you got? What are prices paid like? That kind of stuff. And they create these surveys and they're readily available online, and you can have a look at them, and they go up and down with the economy. They tend to lead the economy. And it's suggesting that if we're not careful, we could have a very sharp, nasty, recession. Meaning, a negative 5% GDP recession. It might be short depending what the Fed does, and we'll come onto that in a bit. So, we've got the setup that we've seen many times in the past, we've got the forward-looking indicators, this monetary tightening, suggesting we've got some real pain to come. Then the anecdotal evidence, we're seeing all the tech companies who were bulletproof laying off staff and giving earnings warnings, because everybody can't raise prices enough.

So, their margins are falling, and people have overextended. Amazon said, "We've hired too many people." They're one of the biggest employees in the United States. This is not good. But the answer to higher prices is higher prices, and that's what's happened. And everybody's looking around you, themselves saying, "Well, what's going to break when stuff like this happens?" The market goes down, something's going to break. We're looking, what bank is it? What hedge fund is it? The actual answer is, it's the economy. The economy has just broken. And the Fed are going to have to pivot.

The definition of a recession is two, back-to-back quarters of negative growth. What does that mean to you and me and everyone else? And what is the possibility of sliding into a depression?

To you and me, I think it means a loss of jobs and a loss in your net worth. Because it's the falling of asset prices that comes with the recession. So, depression, I would suggest is a much longer, more extended period. I don't think that can happen right now. Now, I don't say that with certainty, I never do, talking probabilities. The reason being is, there's one piece of magic, the Fed balance sheet. The Fed balance sheet disguises all bad things. Because what it does is, when they print money, it lowers the purchasing power of the dollar.

And most of the central banks, at the same time, do it. And people always think it's going to be inflation is what it leads to. It leads to something much more pernicious and evil, which is the debasement of currency. And what that does, how it manifests itself, is all of these scarce assets, equities, real estate, gold, crypto, go up a lot. But all they're doing is reflecting the devaluation of the fiat currency itself. So, that optically can change everything because, suddenly, all of these things go up, everybody feels okay, and it changes the outcome. People are still worse off, generally, but it's a trick. And so, I think that trick gets played again pretty soon. This time, I think the trick gets played in a different way, which was the other genie that came out of the bottle in 2020, which the Europeans are doing now, some states in the US are doing, Japan is doing, and a few other countries, which is India's doing, which is direct transfer payments to individuals. So, as opposed to making a big fiscal stimulus, we're going to cut taxes to give people money.

What is the timing of all of this and how fast could this be happening?

Yeah, I think it's going to happen at a shocking speed. So 1974, we went from everything looks okay to the worst recessions since World War 2 in four months. I'm thinking it's going to look similar because of the speed of the monetary tightening, the speed of the rise of prices. So, I think we are going to have a very ugly few months, both economically and for markets. The question is, what comes next? And that's the key point. If my base case comes into play, which is the Fed pivot, they stop raising rates... They already started suggesting maybe we'll pause in September. My guess is, June will be the last hike. And after that, they will say, "Well, we're just going to see, and we'll see the economy stop going down the toilet." And they will start thinking, well, we're not going to do QT now either.

So, they're not going to start shrinking the Fed balance sheet, and before you know it, we're going to be talking about rate cuts. But we don't have many rates to cut. Rates are nowhere. So, the only outcome is they're going to have to print money. The credit market's already starting to dry up. That's usually an indicator. The housing market's rolling over, that's a bad indicator.

Because don't forget, debasement of currency works in a simple way. If you're really thirsty and I have a bottle of water, you'll pay anything for it. If you're really thirsty and I've got five bottles of water, you're thinking, "Yeah, I probably need some of that water, I'll buy them all but at a lower price." If I say, "Here's a million bottles of water," you don't want any of it because there's too much water now. It has no scarcity. So, if you make too much of something, it becomes less valuable. So, if da Vinci created 50 million pieces of art, guess what? They're worthless. And so, it's that concept. And what it does is, if something gets devalued versus something else, so we're not making more shares in the S&P, actually, what we're doing is buying them back, making less of them. Therefore, the S&P goes up. Real estate, yes, there's periods where we try and create new real estate. But generally, real estate prices go up versus the Fed balance sheet, because it's a relatively scarce asset, same with gold, same with crypto. So, that's the phenomena.

You know that old saying? The bull goes up the stairs, the bear goes out the window. The bear's about to go out the window. The question is, when does the bull start climbing again?

That's right. And we either go through a scenario like 2000, which was a typical old school recession, where equity markets, unwound excesses, the bear market was 18 months or so, and then the Fed keep cutting rates and eventually, it stabilizes. But if we look at 2008, which was the next recession, as soon as the Fed used the Fed balance sheet, we pretty much stopped in its tracks, really quite quick after they did that. They cut rates first, didn't really help because the banks had seized up, then they used the balance sheet. Then they did it again in 2010, '12, '16, and then '18 was the Fed pivot, the Powell pivot, where they went from hiking to, "Oh my god, we need to cut."

Can they keep doing the same thing given the conditions of today?

Yeah. So, this is going to take us back to the 1940s in a sec. But an answer to your question is, what choice do you give people? Do you say, "Well, you're going to get destroyed because of the supply chain issues, because of COVID, and all of this, and your wages won't keep up. So, we're going to destroy household net worth and everything's levered. So, all those borrowings against houses and all the borrowings against equities and all of the borrowings on top of borrowings, and you're going to let the collateral go down and blow the entire thing up?"

So, what you're trying to do here, what they're trying to do is reduce the debt via financial repression. Which is, you basically have inflation running slightly higher than interest rates. So, what you want is to reduce the real value of the debt. So, if you think back to your parents how much they paid for a house and the mortgage they had, the mortgage seems laughable. It's because, over time, inflation raised the value of the house, and the debt doesn't get raised. So, in the end, the debt is nothing.

It makes the debt less valuable. So, it's okay if you are in debt, but if you are lending money, it becomes complicated. But anyway, the point being is you either have a fiscal stimulus, which is, let's say, the Republican view. We'll have a fiscal stimulus cut taxes and we'll put some spending. And what happens is, is that doesn't go to the people who are the worst off. So, it's creating this issue of 1% versus 99, which everybody can see, and nobody knows how to solve. The issue is actually the balance sheet because all of the expensive assets keep going up, because they keep printing money.

The rich get richer. But doing this blanket fiscal stimulus is hard because the rich get richer again. So, I think people have thought, well maybe we should just try and give it directly to the people who are most affected? Okay, fine. Those are the two choices, or you do nothing, which is too late because there's too much debt. So, you can't let the system clear anymore. The old way would've been, you let the system clear, it's all okay, you just have a recession, everyone stops borrowing as much money, blah, blah, blah, blah, blah. The world is 400% of GDP in debt. The world has never been this in debt in all economic history.

And what I'm saying is, regardless of your philosophy, it's difficult to find other outcomes that makes some sense. So, let's go back to the 1940s now, and figure out how bad it was then. This was the very similar setup, the worst supply chain issues, massive inflation, everybody coming back in. But what happened was, the economy collapsed. Then, interest rates came down and they stabilized. And they stabilized because the Fed stabilized them. Oh, and inflation was running slightly at 3%, and bond yields are about 2%. So, real rates, meaning, if you’re in the property market are going to make a lot of money. So, negative real rates become very good for assets. And what happened in the 1940s and '50s was a massive economic boom. What we actually got was the value of the war debt eroding because of this financial repression. We had the value of assets, like housing, the equity market went up 900% over that period of time.

There was a lot of fiscal stimulus because you had to rebuild after the war and companies were building factories. So, if you think of now, companies are going to be rebuilding factories in the United States or in Europe and not in China. So, that's going to add some stimulus. Yes, the jobs are not there, it's robots in the factories, but it's still stimulus for the economy. The government will do some stimulus, as we've talked about. Interest rates will remain relatively low. Inflation will remain controllable, but a little bit higher than it has been. And what that sets off is a period of stability and boom, because there's so much technology, there's a lot of big things happening in the world that could be.

So, my rosy outcome would be that. And I think that is still my highest probability, that we muddle through this in a way that we don't expect. Because it feels like the end of the world. Imagine what it must have felt like in 1948. All you can see is the end of the world. And then you get this massive inflation. You just think this is the worst thing that could possibly happen. What actually came out of it was something very different. It was the rise of technology, it was the rise of the US as a big superpower, it was the rise of the rebuilding of Europe, the rise of Japan. It was an incredible period.

And look, we're going to unwind a whole bunch of that stuff now, because it probably doesn't work anymore. We need to rewrite all of the Bretton Woods and we need to rewrite the IMF and the World Bank. And all of this stuff needs to be changed for the modern world, and blockchain technology, and all of this. But it's the same moment. All of those things got built then, every one of them, from the Geneva Convention to the IMF, to the World Bank, to the United Nations, they all came in that period from 1947.

Is that the great turning? Is this what the kind of you're alluding to but the great reset, that's all going to change again?

It's the fourth turning, and that's where we are. And this may be the final event of the fourth turning. It may be just another phase of pushing this towards it, 2001, 2008... sorry, 2008, 2020, and maybe now. It just keeps moving the world to the direction that we all know it has to go, is we need to stop what we're doing and change what we're doing.

Going forward, you say this could happen any time, months from now. Are there key indicators that we should be looking for and paying attention to?

I think I always say the bond market is the truth. The job of bond market participants is two things only, what is the future rate of inflation and what's economic growth? Now in the stock market, it's earnings and this, and emotion, and all of that. The bond market is simply two things. So, they usually get it right. The easiest way to look at it for most people is TLT. TLT is the bond ETF. If that starts rallying, which it's been doing strongly, before it was going down when the stock market was going down, because everyone's fearing inflation, it's just switched. So, bonds are now going up when the stock market goes down, which tells you the bond market's going, okay, enough is enough guys. You've gone too far.

The best train in the world at this phase, the next two to three months. At the end of this phase, I think the Fed come with their cannons again, whether it happens quickly or in three or six months’ time, it's coming and the Pavlovian response of the cavalry is coming. And then I think it's very positive for things like cryptocurrency, probably golds, and a few other things. Real estate, I think, is going to take a while. But I don't think it's probably a big event. It got very frothy. It probably corrects somewhat. But again, I don't think the Fed or anybody else wants to see the property market go down because everyone's got the learnings from 2008. So yes, it softens a bit, et cetera, I think it's okay and you'll probably get some bargains.

I have heard you say that he or she who has cash in a recession is King.

Correct. Because if we're right here and you've got cash, and we're going to see this big whoosh, and it probably means that the economy and asset prices, there's certain things it's going to set up for. We were talking off air about the opportunities to buy cryptocurrency into this selloff. Yes, because it is the technology of the future. It also protects against this debasement. We will see, let's say, technology equities, things like genetic sciences, and AI, and all of this stuff that's coming, it's coming faster than we can ever imagine. Most of this stuff is down 80%. Hell yes, this is what we are looking for. If you want to generate wealth, this best time to step up.

You have a new education program coming out?

Look, it is so important for people to get the right education. It is imperative. And there were lots of scams around education. We wanted to democratize the same kind of quality of financial education that we've done with financial information. You guys watch Real Vision, you know the quality and it's not... I can't fully announce what we're doing, but we are really going to change the game on what it is. Because these things cost fortunes. For a good course, it's thousands of dollars. Most of them are not even done by people who've been in the markets. But we're going to change everything and create something nobody's ever done before. So look, if anybody's interested in education and if you can tell from this macro environment how complicated it is, you need to figure out how to run your portfolios, then And if you sign up early, you'll get some treats for doing it.