Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast is Richard Duncan. Richard is an economist. He’s the author of three books including The Dollar Crisis, The Corruption of Capitalism, The New Depression: The Breakdown Of The Paper Money Economy. He’s appeared frequently on CNBC, CNN, BBC and Bloomberg Television and is widely published in major economic journals. Richard also has a video newsletter called Macro Watch, which we’ll talk about a little bit as well, which analyzes the forces and events that currently impact the global economy. Richard, welcome back to Wealth Formula Podcast.
Richard: Buck thank you for having me back on.
Buck: So when we were talking before we had started there is just you know December of last year’s it’s been over a year since we spoke so a lot has happened since then, lots of uncertainty not only in the I guess in the equity markets but just in the economy in general. Last week we saw the biggest sell-off on the Dow since and then today we had the biggest single-day gain in the mark and of course this has all been attributed to the Novel Coronavirus stock market aside, how has Coronavirus really impacted the economy to date?
Richard: So Buck you know I live in Asia. I live in Thailand. And if I can begin on maybe what will be a rare optimistic note, it’s amazing that there have not been more cases in Thailand. So far where I live then there have. So far I think there are only 40 to 43 reported cases and the reason this is so extraordinary is because last year Thailand had 11 million Chinese tourists. So in January alone there probably would have been more than 1 million Chinese tourists here and the fact that Thailand only has 43 cases and most of those were Chinese tourists it doesn’t seem to be spreading very quickly here and the point I’m trying to get to is I think the reason it’s not spreading is because Thailand is warm and sunny therefore I think there’s reason to be optimistic at least grounds for optimism that this virus will go away when the summer comes just like SARS did.
Buck: Yeah that’s interesting thought there and also I mean my guess is that in Thailand they may not be you know most of the cases in Novel Coronavirus or still people I mean the ones that are reported of course are serious but you know the majority these cases are probably still going under the radar you know they’re just people with colds.
Richard: Yes but things have been more concerning in this part of the world for longer than they have been in the US I think the Americans are really just beginning to realize what this could mean in the last week or two but it’s been considerably more serious for those of Awesome Asia already and you can see the impact on the economy. Thailand relies very heavily on tourism now half the tourists are gone, the restaurants are empty, the hotels are empty, the taxi drivers are having to give up their cars because they can’t afford to tell you the rent on them anymore and the economy is being very severely hit. So you can yeah extrapolate assume that something quite similar is going to happen in the United States as well and around the world so long as this virus continues to spread.
Buck: So yeah I think obviously you alluded to it you know with regards to you know you’ve got less tourism, what about you know the impact on corporate earnings asset prices you know in the global economy in general look what are you and obviously in the US we’re just starting to see some of that, but what are the you know what are the things to really look out for here I mean in terms of how this impacts the global economy and the corporate earnings etc that really ultimately you know define what what’s going on with the economy rather than necessarily just fluctuations in the stock market?
Richard: Okay well I think the best way to look at this is through a very large framework I believe that credit growth drives economic growth first first of all and what we’ve seen is that anytime in the United States credit grows by less than 2% the economy goes into recession. Now so what I mean by that is total credit equals total debt, so total credit means all that all the debt in the country government debt household sector debt corporate debt financial sector debt all the debt. So I think going back to 1952 total credit there have been nine times when total credit adjusted for inflation grew by less than two percent and every time the US went into recession up until 2009. Now since 2009 credit growth is the private sector has been too heavily embedded to take on a lot of a lot of debt so it has been government debt that has been growing very rapidly and driving economic growth to the extent that it has but even with the government debt really practically tripling since 2008 that still hasn’t been enough to make the credit grow by substantially more than 2 percent. So the Fed has had to jump in and drive the economy by pushing up asset prices, they’ve done this initially with the first three rounds of quantitative easing and then more recently they started cutting interest rates again and launched a fourth round of quantitative easing. So to sum this up credit growth drives economic growth in the United States and when credit growth is too weak as it has been recently this had to be supplemented by asset price inflation. So the feds been driving the economy by making the stock market go up. Now suddenly we find ourselves in the situation where it’s very possible that credit could begin contracting and at the same time asset prices could crash so we could actually have a you know a very serious double blow of credit contraction and asset price contraction which would throw the US into a very severe recession or worse so starting with the credit side. Well first of all the corporate sector is already very heavily indebted relative to GDP the corporate sectors debt relative to GDP is higher now than it’s ever been is it a record high and in the last three times it was anywhere near this high it started to contract and the US went into recession each of those times so now we’re in a situation where a lot of corporations are going to have problems we already have a large amount of poor quality corporate debt to begin with and so now oil prices have been crashing that’s going to hurt a lot of the people related to the oil industry the airlines are in the hotels are in trouble the restaurants are going to be in trouble and the virus is not even know this is this is before we had this sudden outbreak in the United States so it’s very likely that the corporate cash flow is going to deteriorate very rapidly and we’re going to see a spike in corporate sector defaults and as that occurs that then the banks are going to have more non-performing loans and they’re going to be much more reluctant to lend to the corporations and of course it’s going to be harder for the corporations to sell bonds on the capital markets as well so the corporate sector debts like to contract and that’s going to be bloat of the economy in itself. Now if this spreads to the households which it seems likely to do as well it seems very likely that just as it has occurred in Thailand people aren’t going to go out and shop as much as they used to do rather than traveling they’re going to stay home and they are going to go to the restaurants I’m not going to fly around and so you would expect people in those industries are going to lose their jobs and as the unemployment rate begins to move higher then it’s going to be more difficult for the normal Americans to make their car payments and their credit card payments and perhaps even their mortgages. So in that case again the banks will be hit by higher non-performing loans and then credit to the households will contract. Now if credit grows by less than 2% the US goes into recession is barely at 2 percent now if credit actually turns negative then you know we’re talking about a very severe recession so that’s on the credit side. As I said earlier credit growth has already been very weak just barely above the 2 percent recession threshold so that’s his force the Fed to be very aggressive in pushing up asset pricing asset prices and as you know when we spoke last time the Fed was still increasing interest rates fifteen months ago and expected interest rates to move higher in 2019 but then in just about the time we were speaking last time in December 2018 the stock market fell about 20% and that made the the Fed completely reconsider everything then that following month announced that it was going to stop hiking rates and that quantitative tightening was going to end much sooner than expected. So the market revived in stock market went back up but then there was another dip in May and soon after that the Fed started cutting interest rates in July September and November they cut raised three times and then in October they relaunched quantitative easing. Sixty billion dollars a month the Fed is printing money and buying assets to try to push the stock market higher and this has been very successful stock market was at all-time record highs about two weeks ago and very pricey, very expensive on PE terms and overall asset prices are very stretched in the country relative to income. So the asset prices are very vulnerable to any sort of shock and this virus is an extreme shock. So there’s a real danger as we saw last week the markets fell nearly 12 percent in a week as last night as you mentioned they rebound but policymakers are going to have to try very very hard to prevent the stock market from crashing.
Buck: So one of the things I heard Richard and maybe you’d addressed this is that you know one of the reasons that there was some optimism in the market was that there was some signaling from the Fed that they may intervene in some way and I guess there’s two parts of this question one is okay so I guess what are the extreme ways in which they could intervene I can add that would be one question for me the second question is what are you you’re intervening in the stock market but the underlying economy it doesn’t seem like you’re gonna be able to do much from what tools are left in the feds arsenal. Can you address those two issues?
Richard: Yes you’re right this is very it’s going to be very challenging for them but I would not underestimate how drastic their policy response will be if push comes to shove. So already the market is anticipating big rate cuts on the federal the federal funds rate the markets price and 100 percent chance of a 50 basis point cut at the next FOMC meeting this month if not before but that’s not going to have much of an impact because you can cut interest rates as far as you want and people still are not going to get on airplanes.
Buck: Right yeah that’s what I’m getting at is we’ve not really been challenged with true you know you might have some asset prices dipping but this is potentially a situation where there’s real decreases in GDP and so we’ve been unchallenged.
Richard: Yes so next step they’re already doing sixty billion dollars of quantitative easing already they say it’s not QE but it is. They’re creating money and buying government securities that’s QE they’re already doing sixty billion dollars a month. Well they could increase that substantially but that would drive interest rates even lower, the 10-year bond yield last night came very close to one percent so drive them even lower you could keep driving them lower but again that itself is not going to help very much either. Interest rates are already extremely low this is good this is it both a supply shock and a demand shock for the economy on the supply side US companies can’t in some cases do business because they’re not getting the goods from China where they’re made where they’re not getting the parts they need from China so their sales are going to be hit. That’s the supply side we’re beginning to see that already in some of the corporate earnings announcements. But the demand side shock is coming and that’s where people just simply stop shopping or a shop far less than they did before. So QE by itself is not going to help that either. So what are they going to do well. I would not rule out the possibility that if the Fed if the stock market starts falling you know in the range of 25 percent or more we may see some some form of direct intervention in the stock market where either the Fed starts buying stocks directly or else the Fed provides funding to the government and the government uses the funding to buy stocks directly and pushes up the stock market and if you have that sort of scenario where policymakers the government at one level or the other is actually in the market publicly buying stocks with unlimited amounts of money because after all the Fed there’s no limit as to the amount of money that Fed can create it can create as much money as it wants. And so you have policymakers jump into the stock market and begin buying it and allowing the markets know that they’re buying it and every fund manager in the world is going to have to jump back into the stock market and stock prices will stop falling and will go back up. Now technically the Fed is not allowed to buy stock has to ask you that they don’t really have that kind of mandate well no laws can be changed. The history of the Fed is one long history of the law being revised to allow the Fed to create more and more money. I mean initially you know back in the olden days remember the Fed was not allowed to create money if it didn’t have gold to back the money it created but all three of the hit feds history that law was relaxed until in 1968 it was removed altogether after 1968 the Fed was no longer required to hold any gold and of course afterwards the amount of money that created is it’s grown beyond exponentially. So laws are made to be changed and they’ve been changed every time there is any sort of pressing urgency to allow the Fed to do more than it was able to do before so you know if we I can’t emphasize enough how dependent the US economy is on the stock market and on asset prices and if asset prices start plunging twenty five thirty five percent then the US is going to go into a extremely severe recession slash depression and the policymakers are simply not going to stand back without fighting back and I advise investors to be prepared for some sort of really much more aggressive policy response than the markets are currently anticipating something now unanticipated like direct asset purchases of stocks to push the stock market back up. So if you can keep the stock market from falling if you can keep the stock market up that at least will go a long way to mitigating the harm that’s going to come in any case but if you have if you have the virus hitting the economy on all the fundamental levels and the stock market crashing then you know that’s going to be twice as bad.
Buck: And I suspect there’s also this element there we’re like you were talking about in Thailand because of the weather maybe things aren’t spreading the idea maybe here okay what do we do to get through the next two or three months you know.
Richard: Well that’s right I mean I think that everyone should hold out hope in that respect of course there’s the risk that it will come back again when the weather turns cold again but you know by then perhaps we will have some very effective treatments for this and eventually a vaccine and perhaps and it may not come back. I was living in Hong Kong during SARS and that was absolutely terrifying go into an elevator and it’s practically a capital offence if you’re in an elevator and sneeze and people will stone you know you don’t touch the elevator buttons it was terrifying but as the weather warmed up SARS went away and the WTO declared it effectively dead in early July so hopefully that will be the case again this time.
Buck: It kind of hit the proverbial straw that breaks the camel’s neck with corona but there’s a lot of other things that you’ve been concerned about and specifically I mean one thing that comes to mind and I know you’ve been talking a little bit about how China you know where China was positioned last time where we talked and now what’s happened with and with the size of the economy and where they are with some technologies, you want to talk about some of those things and how you think that’s going to affect us in the US?
Richard: Sure it’s hard to think about the world as it was two weeks ago before the virus started spreading around the world very rapidly but the things I worked on then are still going to matter a year from now and even six months from now but before jumping to that on the subject of China you may have seen that on Friday they released their PMI numbers for industrial purchasing manager index numbers and it showed that the PMI in China had plunged to the worst on record even worse than 2008 in January fell to something like 38 on the index level down from 50 that was in one month and the non manufacturing PMI was even worse it felt the mid-20s from a level of 54 the month before. So this is showing us that China’s economy is already in recession is contracting and of course that is going to impact the entire world because China is the second biggest economy in the world they purchased commodities from everyone therefore commodity prices have been falling sharply and so you can just see how the the global impact of this is going to slam the world. Alright now so if we think about what was going on before the virus started disrupting the markets, one thing that I was working on is I’ve been making a number of videos Macro Watch videos that I called America’s national emergency and the emergency is this, China last year invested more in research and development than the United States did that by substantial amount and they have been increasing their investment in R&D and a much more rapid rate than the United States has now for decades if you extrapolate forward using current rates of investment growth in research and development for China and the United States by the year 2030 China will be investing forty percent more every year than the United States in research and development. So China has already rolled out 5g it rolled out 5g in 30 or 50 Chinese cities in November and they dominate the 5g market through Huawei globally. The United States is not even in the race. So this is going to get China a very big lead an advantage in areas like drones for instance and driverless cars and also in all kinds of data gathering so if China wins the race the way that it’s won the 5g race then that would be the 21st century equivalent of China having a nuclear monopoly. Whichever country reaches the level where artificial intelligence is on par with and then rapidly exceeds human intelligence they’re going to have an enormous enormous is an understatement advantage over the rest of the world in terms of their power technologically economically and militarily. So I view this news that China overtook the United States and research and development spending last year as a national emergency.
Buck: China has some challenges too.
Richard: Yes China and China’s economy was is a very big bubble there’s no doubt about it but if they can continue that can keep this bubble going for another five to ten years then in comparison the United States going to be a very second-rate venerable power and they’ve managed to keep this bubble going far longer than I ever imagined that they would be able to do. Now they’re developing this belt road project where they’re providing credit and industrial materials all around the world to develop infrastructure to connect the rest of the world to China. This is a very clever move on their part of course because they can use their bank credit to fund this and then they can use their excess industrial capacity for things like steel and cement and everything else they have excess capacity and which is everything to keep their economy growing. So yes China does have problems but in fact it’s going to be a very important issue whether or not China’s economy will bounce back from this virus or how quickly it will bounce back. There’s a real risk that knows you’ve probably seen the factories just aren’t producing in China we can see that from the pollution levels beside satellites are providing China’s horrible pollution problem has just disappeared because the factories have all been shut down. Now China has enormous levels of debt across the board and those companies are not going to be able to meet their debt service payments to the banks and so the banks non-performing loans which are already very high if realistically accounted for are going to become very much worse. So China’s economy is in serious trouble and you can’t rule out the possibility that this virus coming on top of the trade war with the United States which is not going to go away it doesn’t appear it could be a very serious blow very potentially a blow from which China’s economy just won’t recover. It may not look the same going forward as it has for the last 30 years but it’s too early to know that and so the United States had better begin adapting and becoming much more aggressive and it’s level of investment in research and development if it intends to maintain control of its own destiny. In December Senate Minority Leader Schumer made a speech in which he said he was going to propose that the United States government invest 100 billion dollars in the industries of the future over the next five years and specifically he mentioned artificial intelligence that was the topic he was addressing but also in other areas all the genetic research biotech neurosciences robotics all the all the industries of the future so you already have signs that the government is waking up to this threat that China surpases to the United States in terms of China surpassing the United States technologically economically and militarily in the very near future if things don’t change. The problem is a hundred billion dollars is simply not enough over five years even if the US were to begin investing that much starting next year China would still be investing more than the US. The United States is going to have to become much more aggressive than that in the level of how much it invest this in other words this is this is a new Sputnik moment for the United States but potentially even more dangerous and when the Soviet Union launched the first satellite in 1957 well then the United States responded by creating NASA and pumping a lot of government money into research and development and eventually we won the space race and along the way the government invested so much in rockets that US dominated in the Soviet Union and developing intercontinental ballistic missiles eventually bankrupting the Soviet Union in their effort to match the US and military spending but this is at least a greater threat as the Soviets lead rocket technology was back then if China again I say if China develops artificial intelligence before the US does then it’s game over. So they’re going to have to respond accordingly we the Americans need to be aware of this and they need to pressure their congressmen to begin spending much more investing much more in research and development across all the industries of the future and luckily though the United States can easily afford to do this because as we’ve seen since the crisis of 2008 the government debt levels have gone up by roughly more than something like 13 trillion dollars now since 2008 and the Fed has financed about a third of that through creating money and we have no inflation at the CPI level. So the level of government debt to GDP now is something like it’s less than say one had been five percent and the interest rates on tenure government bonds last night fell to one percent. So there’s effectively no limit as to how much money the US government can borrow and invest it need be the debt can help finance it by creating more money QE five six and seven to finance it and that’s what they need to do and that’s what they need to do quickly.
Buck: So big government spending like that would require significant political support which especially the nature of the way politics is going right now seems to be increasingly insular and not really wanting to necessarily invest in things like infrastructure etc. So what happens if we don’t what if we just you know what if we don’t what if we don’t do the big Sputnik spend?
Richard: Better start learning Mandarin.
Buck: Because you would agree with me that it seems unlikely that that would happen.
Richard: No I think the United States normally does do the right thing after it’s exhausted all other possibilities to paraphrase Churchill, I think because Schumer did make this speech and in the speech I mean he emphasized correctly that national security is not a partisan issue this is very much a nonpartisan issue. Does the United States want to remain the dominant or the preeminent global power or even more than that is the United States wanted to retain its national security? Because if it doesn’t make these sorts of investments its is not going to be secure anymore that’s going to come as a big shock to everyone in America who for generations has lived in a world where the United States was the global superpower that will be but long before the middle of the century if current trends continue China will be much more powerful than the United States across the board and the consequences for the United States they just we don’t know what the consequences could be but normally history tells us that countries that have a significant technological lead over other countries don’t treat their interiors very kindly.
Buck: So we are in an election year I’d like to get your thoughts on what ifs all right I mean we kind of have an idea of what happens you know in the next Trump administration in terms of policies the way they are now the Democrats right now if the if the candidate were chosen today would be Bernie Sanders you could argue whether or not that’s a realistic you know that he has a realistic chance to win in a general election but say he does, does that does that change anything in your mind? Do presidents change anything and you know despite policies that might be considered a little bit more radical the reality is it seems like there’s a lot of guardrails around presidents in many situations to to you know not change things too much but I’m just curious from an you know how do you look at this election and you know what are you thinking about?
Richard: Yes you’re right to point out the powers of the president are limited of course the Congress has to pass the laws and unless Bernie Sanders were to come in with a very with this with a majority of the House and the Senate then there would be a limit as to what he could achieve. However if he were to win and this would be a very clear signal that Americans are unhappy with the Democrats clearly just as the election of President Trump made it clear that the Americans were unhappy with Republicans, Trump Republican Party has very little in common with the Republican Party that existed before other than that it cut taxes right but they’re cutting the taxes of course made the budget deficit much larger which the Republicans always claim that they were opposed to. Now if Bernie were to win this would show that equally there’s venom there would be a revolution within the Democratic Party as well I think that to a large extent Hillary Clinton lost the election. The event that caused Hillary Clinton to lose the election to Donald Trump was when Bill Clinton signed NAFTA in the early 1990s essentially abandoning the core of the Democratic Party the working people in the manufacturing industry who haven’t seen a pay increase in decades as a result of this globalization they resulted from NAFTA and China being allowed into the WTO. So we very may well see Bernie win and that would tell us that yes there has been a revolution and that what that would imply is that the average Americans are going to demand that they get a bigger cut of the of the pie one way or the other that’s in a sense what Donald Trump had offered and that’s what Bernie is offering and so were that to happen, if the taxes went up on the billionaires and they were profits capital gains taxes put on stock prices and asset prices, that would hurt the asset markets but you could also expect significantly higher government spending and higher levels of income one way or the other for the majority of the Americans which would broaden the income base which would allow more consumption. You know the problem with giving tax cuts to very wealthy people is they don’t really spend that much more they’ve already got big yachts and jets but if you give a little bit more money to the 50% of people at the bottom of the income pile they all spend it right away. So in that sense that would be the the economy would be more well balanced in that respect but again a president Sanders would not be able to push through all of his objectives immediately certainly not if unless he had a majority in Congress which would probably be unlikely. You could see things moving in that direction I mean things will probably things tend to swing back and forth and we swung now to the point where the wealthy had become so wealthy that it’s very likely that things will swing back in the other direction and this probably would be healthy for the economy overall that sort of swing would go on for decades and most likely and then go too far eventually and then swing back again.
Buck: So Richard tell us a little bit about Macro Watch.
Richard: Okay thank you. So Macro Watch is my video newsletter. Every couple of weeks I upload a new video. These videos are essentially me making a PowerPoint presentation on something important that I think is happening in the global economy and how that’s likely to affect the stock market and property currencies commodities and economies around the world. So in this I focus on certain big themes one of the main themes is that I believe that credit growth drives economic growth that’s been the case now going back to at least 1980. In 1980, total credit in the United States was a hundred and fifty percent of GDP by 2007 it had increased at three hundred and seventy percent of GDP and that transformed the world. So I focus a lot on looking at the future of credit growth how much is it going to grow and if it doesn’t grow then the economy is going to suffer and in that case the Fed has to respond by pushing up asset prices so that’s the second big theme of Macro Watch is looking at the amount of liquidity in the financial system and how the Fed and other central banks pump liquidity in the market to try to direct the economy by creating a wealth effect through pushing up asset prices. So Macro Watch focuses on things like credit growth liquidity and also government policy to see how they’re going to impact the asset prices. So the most recent video which I did over the weekend was on the Coronavirus and in this effect on the economy and the markets in the near term and looking a little bit further out. So thank you for mentioning that. If your listeners would like to learn more about Macro Watch I would ask them to visit my website at richardduncaneconomics.com that’s richardduncaneconomics.com and if they would like to subscribe to Macro Watch I would like to offer them a 50% discount if they click on the subscribe button they’ll be prompted and they should use the coupon code formula. If they type in formula in the box when they’re prompted they can subscribe at 50% discount. So I hope your listeners will take a look and at the very least sign up for my free blog there at Macro Watch.
Buck: Absolutely. Richard a lot of great information and you know you come very highly recommended. I know Robert Kiyosaki’s also follows your work very closely so definitely check that out as what. We’ll also put the information there in the show notes and make sure you use that code and get the 50% off. Richard thank you so much for being on Wealth Formula Podcast.
Richard: Buck, thank you for inviting me. I look forward to the next time.
Buck: We’ll be right back.