The David Einhorn Podcast: The Fed Is Monetizing Debt Again

It was back in 2012 that famed contrarian and value investing hedge fund icon, David Einhorn, first took aim at the pinnacle of market manipulation when he slammed the Fed for creating the ultimate toxic cocktail: something he called the Jelly Donut Policy. As the Greenlight founder wrote in May 2012, the Fed is “presently force-feeding us what seems like the 36th Jelly Donut of easy money and wondering why it isn’t giving us energy or making us feel better. Instead of a robust recovery, the economy continues to be sluggish.”

Seven years later, the recovery is just as sluggish and yet nothing has changed; in fact, just two months ago, the Fed launched what Fed Chair Powell sternly refuses to admit is QE4 but… is QE4. And while Einhorn has been right that the Fed is ultimately destroying the very fabric of not only the US economy, but taking down society with it as the growing wealth and income disparity chasm will eventually culminate in civil war, by fighting the Fed, Einhorn has seen his AUM plummet in recent years, his hedge fund a shadow of what of what it once was, largely due to the relentless ascent of the so-called “bubble basket” of stocks, those names which benefit entirely due to the Fed’s monetary generosity, and which have seen their stocks prices explode in the past decade.

Which brings us to another Jelly Donut – that’s the name of a new podcast service, which in recent weeks has interviewed, Julian Brigden, Ben Hunt, Miles Kimball, and others. Most notably, among those interviewed is that man responsible for the concept in the first place: David Einhorn.

While David Einhorn has recently been in the press for yet another feud he is currently waging, this time with Elon Musk, in which he first accused the Tesla CEO of “Significant fraud”,  followed up with even more specific accusations of accounting irregularity profiled here, in the podcast with Ryan – which marked the Greenlight CEO’s first appearance in two years – Einhorn goes back to his roots and takes on his primary nemesis, the Federal Reserve, which is why among the topics covered are QE, ZIRP, MMT, fiscal and central bank stimulus. Oh, and gold, because seven years after the “Jelly Donut policy” was first coined, Einhorn remains just as bullish on the precious metal as the following excerpt confirms:

We’re running a very high  deficit  to  GDP.  And this is many years into an economic recovery with something that’s very close to full employment… In the event that the economy weakens, there’s going to be an enormous, both natural fiscal  stimulus  that comes from higher benefits, and less tax revenue, as well as an urge for Congress to do things to help  people out in tougher economic times.  So, what you have is a deficit right now that is very high and then you combine that with  an accumulation of debt. You have a situation where the debt to GDP is much higher going into whatever the next down cycle is, and where we’ve had before similarly you have of monetary policy, which has been very aggressive. The balance sheet is much larger than it used to be and the rates going into down cycle are much lower than they used to be. There will be enormous pressure on the central bank to be very aggressive. And, so when you combine aggressive fiscal policy with  aggressive  monetary policy, historically that can lead to a problem with the currency and then when you realize that the same dynamic is essentially in place and in some cases worse in all of the other major developed currencies, it seems to me  it’s a situation where sooner or later it might be good to have a fraction of your assets in gold, which is not subject  to appropriation by the whim of the central banks.

Or rather, it is not yet subject to appropriate by central banks. Because all it takes is another Executive Order 6102 for all that to change.

All this and much more in the podcast below (phonetic transcript attached below):

Transcribed:

Ryan:  David welcome to the podcast.

David:  Hi Ryan. Thanks for having me.

Ryan: Well, it’s great to have you here.  Really appreciate you coming on.  First off, I wanted to  explain  a little bit to the  audience of  why we  have you here,  and  when  I  decided to launch this  podcast,  I  was trying to  think of  a great name that  captured the subject of  the show  everything  related to macro and  monetary policy  and I immediately thought about your article.  So, going back to 2012 you wrote an article called  The  Fed’s  Jelly Donut Policy in The Huffington  Post  and used a story  about The  Simpsons  to  explain  a  long periods of  QE and zero interest  rates  may  actually be harmful  to the real economy.  And  it turns out  a lot of  what you  said,  they’re  panned out  inefficient allocation of Capital  stock  Buybacks with no urgency for corporations  to  invest to reach for yield  from all investors,  especially  to Retirees  so  a lot  has happened  since then  take us  back  to the feedback you  got from the article and  if your views have  changed  since.

David: Well honestly, I think the best feedback I got from  the article is  somebody’s naming their  podcast  after it. How can  how can you beat that?  And I’m honored to  be here for the first  one of these and I expect after I speak today, you’ll  probably get  all kinds of feedback  and I  will hopefully learn  from listening to the  feedback  you get  because I’m not a trained Economist.  I’m  not  a  macro-economist,  I’ve never worked in the plumbing of the fed  or any of these  things. I’m basically an equity Market investor,  and I  think I  have  a few  observations on  some of  these  things from time  to  time, but I  don’t  profess  to  be  a technical  expert in  all the  mechanics  of everything.  

Ryan: Right and  what was  considered  unconventional  monetary policy over  decade  ago is  really now  seen as  normal  not just  for the FED  but  central  banks around the world  and  these  policies  seem to only  be  going on for  longer and longer  and uh  others  talked  about using these  tools  and definitely  what’s your  view  on  these  policies as far as  do you ever imagine that  balance  sheet  still  being over $4.5T, you know  taking  up towards  there right now and before  the crisis was  $800B.  Did you see this still going on this long?  And  what’s your thoughts on the Fed using these tools  and definitely?

David: Yeah. I  don’t know  how to  predict  what  the FED is  going to do with  the size  of the  of the  balance  sheet,  you  know,  basically,  I think  there’s  two main  parts of  fed uh  policy  one  is the interest rate  policy  and then the uh other is  the  balance  sheet  size  the  main  thrust of the  jelly donut thesis  is  that  the interest rate policy  by  setting  rates  too  low  at some point you have a diminishing  return  from  lower rates and  eventually  ultimately  a marginally  negative return  from low rates, which is kind of separate from what you just  raised which has to do with the size  of  the  FED  balance sheet  and the  monetary base  and  how they  choose  to  implement  that.

Ryan: Yes,  so separating those  out a little bit, obviously with  the  all the easing,  you know,  short-term  rates, they’re able  to target  and  bring  down  low  and now  we’re  having some  issues in  the repo  Market  obviously some  change  some  things change  with  paying  interest  on  excess reserves  and there’s  been  some  other issues  that brought up  as far as the tax bill  and things like this.  What’s your thoughts right now on the  current  issues with the repo market  and  can  the  Fed really  keep  a hold of rates at  this  point?

David: Well,  I think  the FED ultimately can control whatever  chooses to control  within certainly within rates  or whatever  markets it’s willing  to  intervene in because  it  has  unlimited  fire  power  in  order  to enforce  whatever  policies that it wants . Sometimes eventually if  the fed or a central bank over overdoes it, then people can take it  out on the currency,  which would  be the  normal reaction, but within  the domestic  economy  in terms  of control…. The Fed can  set  any rate  that wants  actually  almost  anywhere on  the curve  by,  you know directly intervening  in the market  with  unlimited firepower.

Ryan:  Right, and  going  back to  a Bloomberg  interview did  in 2014, you  told  a story about  how  you  ask  Ben  Bernanke and a private dinner about QE  and he talked about how these policies would lead to higher inflation  talking about  usually it  only happens after  a war  and he  talked  about Japan  has done a  lot more  QE  than  the US and they don’t have inflation. Recently  Fed  officials have  said it’s kind of  a  mystery why. CPI  claims inflation hasn’t gone up more but we have seen  inflation in certain pockets: Healthcare, Housing, College tuition and you  mentioned the currency piece.  So  what’s  your thoughts  as far as, where  inflation goes  and  how long  it can actually  stay where it is right now?

David: When the Fed creates money  and  whether it’s  from  what you would call  money printing  or what they want to  call quantitative easing,  and most recently  they’re doing the same  thing and they  want to tell  us  that  it’s  not  quantitative easing.  I don’t really know what  the difference  between all of  these  things  is  except for  semantics  and messaging  in an attempt  to,  kind of control  things.  When the Fed increases  the money  the money  has to go  somewhere.  It  doesn’t  have the  same  impact  that  it  did  when  there were  fewer  excess  reserves  in the system, but we can  come back to that later.  I’ll just skip  over that for the moment,  but when they create  money, the money does  have to  go somewhere.  Now, the thing is,  they  don’t  have any  control  over where that is.  So it could be that the price of  corn goes  up  or it could  be  the  price  of  healthcare  goes up  or  it could  be  the price of  stocks  go up  or  the price of bonds  or  art  or Real  estate  or  oil  or what not  but it doesn’t  have to be  any of  those  particular  things.  So as  price levels in  general go  up  it may  or may not  be  prices that are measured  within the  CPI  basket,  which is  only,  you know, its a subset of possible places where  new money  can go.

Ryan: That makes sense.  And  you mentioned kind  of the  mechanics  of  how  QE works.  So  one camp  says  that  this is just an  asset Swap  and that  this  is a  swap  for  bank reserves for  Treasuries,  and  this  is  kind of  normal operations.  Where  the other  camp  says this  is something more like money printing and really something like debt  monetization  since  all the  interests  gets  remitted  back to  the Treasury  and  the so  far  a lot of  these  assets  haven’t actually  rolled off.  How do you actually view that  piece?     

David: Yeah. I think it’s a little bit of a  semantic  game. By only looking at one side of a transaction, in other words,  like what  happens  after a  treasury  is  issued, you can decide, you know, that this  isn’t  money  printing.  But when you  think about it in the totality  how do  treasuries  get issued, a  treasury is issued because the  government needs to borrow money.  And when the government needs to borrow money, there’s two places  they can borrow  it.  They can borrow it in the private sector  or  effectively they can borrow it  from the central bank.  Now, there’s a  rule that  says  they can’t  sell the debt  directly to the central bank, so they instead  issue a T-bill  to  a leading  commercial bank  and then  the central bank  can buy the  T-bill  and  you’re kind  of in  the same place.   What’s happened is that  the  Federal government  has borrowed  money  and ultimately  that loan  is  held  by  the central  bank  which  increases the central bank’s balance sheet  size  and thereby  in  there  for  the monetary base.  So it’s the equivalent of a debt monetization. When you  question  whether  its quantitative  easing  whether  the current Fed chairman says it’s  something different from that , whether it’s money printing,  it’s really all the same  things  because  all it  is, it’s the Fed  increasing the size  of  its  balance sheet  by buying  Treasuries in  one  form  or another. The difference is  some people want to look at it as a two-step thing where the treasuries are  issued by the Treasury Department  to the private sector and then the Fed  buys it  as opposed to  the  Treasury  issuing  it  directly to the Fed  which  is  illegal,  but the fact  that there’s  two  steps in the  transaction—I don’t think  it  makes any  economic relevance.  So think you have to look  through it  and when you look  through it, when the  Fed  buys  Treasuries,  they’re increasing the balance sheet. They’re increasing the monetary base and  effectively its debt  monetization.     

Ryan: Right, that makes a lot  of  sense. Now  going  back  to  interest rates  and  kind of  what your  article  focused on,  it’s  arguable  that  interest rates  are really the price of money  and  the  price of money has been manipulated.  Now, as far as  rates rising  on the longer end,  you mentioned  the Fed  can kind of control not just  the  short-end, but also the  longer-end.  We saw  recently when  the  repo  market  spiked up to a 10  from 2, that  people said, okay,  the price  of money is  not really what  the Fed says is  it is  the price  should  be  this.  So, the question is,  could  the Fed lose  control as  far  as  people  losing  faith  in their ability  to  just  start  tinkering and really  micromanage.  And will that show up  maybe on  the long end of the curve  or  how could that crisis  of confidence  happen?

David: I don’t know that you’ll have a  crisis  of confidence.  But when you think about what just happened in the repo  Market  essentially, there wasn’t a  huge amount  of  active  intervention in the exact moment  that it  spiked.  It spiked  and the Feds  saw what was  happening  relatively quickly after  and  announced new  programs with extraordinary  firepower  in  order  to make sure  that the problem  doesn’t  persist  and that’s  what I  mean by their  having  the ability  to  control  the rate.  So, it spiked for a moment, but  beyond that,  you  know,  they  managed  to  put it  back  together.  As for Relating to the long end the curve,  it  has to  do with how much  intervention  this  the Fed is  willing to do.  Presently, I don’t know that they’re doing a lot of intervention on the long-end, but if you look at other central banks around  the world, Japan and Europe and so forth,  there’s huge  amounts of  intervention  at the long-end of  the curve  and those  banks  have  effectively cornered and controlled those rates as  well.

Ryan: Yeah, that’s interesting when you look at Japan buying up  huge amount of  the JGBs is  outstanding  and obviously  buying  ETFs  and things like Apple  stock  and  seemingly distorting  markets and doing so.  Now, going  back to the article again, the thesis laid out  talking about  with the  Simpsons, it  was  actually really enjoyable  to  read for people  who are  trying to understand  how  this  is  all working.  And, I think when you look at  retirees,  when you look at  savers  and  obviously  pension plans  and insurance  companies,  a lot of  these  types of  things have really caused  a big  problem as far as rates  being low,  and  obviously for all  investors  going out  on the curve  to  bid up  risk assets.  Do you see a path to normalization  as far as rates  or  concerned?  And what  should the Fed  be doing right now, and  can they normalize  rates  or should they  right now?

David:  Well, I think it  depends on what  one  thinks about  as  normalized rates.  We’re certainly in  a  situation that  there’s a lot more  leverage in the financial system than 20 or  30  years ago,  which  means that  the  debt  that’s in  the  system  can’t  support  nominal  rates  that  are higher  than a certain  amount,  you  know,  if you  think about what  the  deficit looked like  when  Volcker  raised the  short rates  up into  the teens,  the  debt to  GDP  was nowhere  near  what it is today.  So you didn’t create  a question about the government’s ability  to repay the even in  as rates went  even a short rates  went up  at a  at  a  good clip and  ultimately even cost  for long bonds. They  wanted to  sell  at the time  became  quite  expensive right once you  have debt  to  GDP or incorporate case  debt to EBITDA at higher ratios.   It becomes much more  sensitive  to  increase  rates in terms of, from a  solvency  perspective.  And  so  the situation  is  much different  today  than it  used to be.

Ryan:  Yeah,  I’m looking  at  equity markets,  especially here in the U.S.,  when you  look at  share buybacks  and  other  things that  have been going on.  How are you looking at  this  the market  based on these  share buybacks  uh  and  a lot of  people  have been  talking  about  it.  We’ve seen this many times before and it’s  only a matter  of  time until the cycle  has  turned  and  you’ve  talked  a little bit about this over  the past  couple of years,  but  it  really seems  we’re almost  kind of out  of breaking point.  How do  you feel about  the market  right  now?

David: I  have  no opinion  as to  whether the  market is  anywhere near  a breaking point.  Not the type of  forecasting or  thinking about  things  that  I  think  about,  you  know,  and in terms  of things  like  share repurchases  from my perspective, they are a  tax efficient way  to return  capital  and businesses to their owners  and to the extent that there  aren’t investment opportunities  at  better  returns than returning  capital  to their  owners, I think it’s  a perfectly  appropriate  thing  for  businesses  to do.

Ryan: Okay, that makes sense  and  you  mentioned  as far as  going  back  to  2008 and  even  previous with  the  derivatives and  all the debt  built  up in the system.  How are you looking at the current environment  compared  to  2008.  Obviously, it was built up more so in the mortgage  market.  How  are you  looking at the  market  now  compared to  back  then.  We now have some of these banking regulations  after Dodd-Frank and  others.  Are we actually worse off or more  levered up?    

David: Well,  there’s  leverage, but the  leverage is  in a different place  than it  was  last  time  last  time.  I believe (in 2008) that the  leading part  of the leverage  was  in  the real estate market  both  commercial  and  residential  and I  think  today  it’s  more  in  the  public  market  meaning  sovereign debt, municipal  debt,  and also  corporate  debt.   

 

Ryan:  Right  and we’ve seen corporates  levered  up to some of the highest they’ve been…The  last  thing to  touch on is, you’ve held a position  in physical gold  for a while now.  Other investors have  talked  about  hedging  against  inflation or  even a  “Black  Swan” type  event  with real assets.  How are you  seeing  a position  in  real assets  as far  as  hedging  against inflation?

David:  Yeah.  I don’t know that it’s a hedge against inflation  or a particular  Black Swan event.  But,  our  theory relating  to gold  is that monetary and fiscal policies  combined  are very  aggressive.  Just  take  the United States as an example  right now. We’re running a very high  deficit  to  GDP.  And this is many years into an economic recovery with something that’s very close to full employment… In the event that the economy weakens, there’s going to be an enormous, both natural fiscal  stimulus  that comes from higher benefits, and less tax revenue, as well as an urge for Congress to do things to help  people out in tougher economic times.  So, what you have is a deficit right now that is very high and then you combine that with  an accumulation of debt. You have a situation where the debt to GDP is much higher going into whatever the next down cycle is, and where we’ve had before similarly you have of monetary policy, which has been very aggressive. The balance sheet is much larger than it used to be and the rates going into down cycle are much lower than they used to be. There will be enormous pressure on the central bank to be very aggressive. And, so when you combine aggressive fiscal policy with  aggressive  monetary policy, historically that can lead to a problem with the currency and then when you realize that the same dynamic is essentially in place and in some cases worse in all of the other major developed currencies, it seems to me  it’s a situation where sooner or later it might be good to have a fraction of your assets in gold, which is not subject  to appropriation by the whim of the central banks.

Ryan:  Right, that makes a lot of  sense.  Well  David,  thank you so much  for coming on, I really appreciate it.

David: You’re welcome and  good luck with  the  whole  podcast  series.

The full podcast can be found here.