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299: The Lords of Easy Money

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Buck: Welcome to show everyone today. My guest on Wealth Formula podcast is Christopher Leonard. Christopher is a business reporter whose work has appeared in The Washington Post, Wall Street Journal, Fortune in Bloomberg Business Weekly. He is also the author of multiple books, including The Lords of Easy Money, The Meat Racket, and Kochland, which won the J. Anthony and Lucas Work in Progress award. Christopher, thanks for joining us today. 

Chris: My pleasure. Thanks for having me. 

Buck: So really, obviously, the focus of what you’ve been talking about lately and writing about has been the Fed. And I’m curious kind of what your take is. Obviously, this is information that’s pretty relevant to immediately. Jerome Powell says he’s likely to raise interest rates in March. Do you think he will? And how will interest rates hike potentially impact the economy right now? 

Chris: Yeah. One of the most important things I think anyone trying to save money or with an investment, I think one of the most important things they need to understand is the stakes, what is at stake when Jay Powell talks about raising rates. And this book, The Lords of Easy Money, is really a history of the last decade. And the reason I wrote it is because even as a business journalist, I was really shocked back in 2016 when I started to really understand just how radically the Fed has reshaped our economic system and our financial system in a really important way. I mean, we’re all familiar with the great crash of 2008, 2009. We know that the Fed stepped in at that time and pumped money into the markets. Okay. They use the phrase liquidity, but it’s really the Fed creates dollars out of thin air. It pumps them into the banking system. And that’s why we have a Fed to be the lender of last resort. Right. To me, what’s really critical to understand is what happened after the crisis starting about 2010. And the headline here is that the Fed took a more central role in our economy than it’s ever taken before. Between 2008 and 2014, in that short window of a few years, the Fed printed 350 years worth of money. What I mean to say by that is over a century, the Fed had expanded the monetary base, which is sort of the pool of original new dollars the Fed can create. The monetary base had grown to about a trillion dollars over 100 years. And then between 14, the Fed prints 3.5 trillion. This is a step change. And I think what’s really important for us to understand now is what this did out there in markets. This book is based on not just interviews with people at the Fed, but people out there in the markets, the private equity people, the big banks like Credit Suisse, the hedge fund operators, they understand that what the Fed did when it printed all this money and kept interest rates pegged at zero for seven years. What the Fed did was it created a massive Socalled search for yield, which is just a fancy way of saying it encouraged a lot of risky lending and it pumped up the price of a lot of asset markets like stocks, corporate bonds, you name it. So what that means is that as today, when the Fed is sort of having its hand forced and being forced to raise rates, it’s going to affect in kind of a backward, cascading way all those markets that the Fed has been pumping up for about ten years now. 

Buck: Right. One of the things that you mentioned, I think you talk a little bit about in the book is the idea that the Fed is now stuck in a money printing quagmire. And that it can’t escape it. I think obviously, this relates to what you just said. We’ve been printing an enormous amount of money. We’ve got a huge effect on multiple asset classes. They’re all pretty rich right now. I guess the question is how do you escape that? 

Chris: Well, not easily is the answer to that question. There’s no smooth path forward. One of the most interesting episodes I reported on was the period from roughly 2016 to 2019. And what’s so interesting about that little time frame is the Fed really was trying to, quote normalized, it was trying to raise interest rates up from that zero level to a historically normal level of just two and a half, maybe 3%, while at the same time drawing out that cash it had printed through quantitative easing. And what you see is it never worked. Or another way to put it is that every time the Fed tried to tighten the markets react rationally, it starts to pull their money out of risk assets. 

Buck: Right. Okay. And they didn’t have the courage of their convictions to continue with that when they saw the markets reacting. 

Chris: That’s exactly right. Do you remember Christmas Eve 2018 when the markets fell so dramatically? 

Buck: I do. I remember exactly what you’re talking about because I think that’s a very good example of this idea of being stuck. Right. But then you put on top of that some of the latest challenges that we’ve had with the Coba economy and all that. And it’s amplified by about 100 fold now, right? 

Chris: That’s right. And as you know, the people on Wall Street call this the everything bubble. And back in 2018, the Fed was trying to tighten and the economy was really good at that point. I mean, this wasn’t Covid time. And as you know, up until Christmas Eve of 2018, JPOW was saying, hey, we are going to tighten. We have the resolve. It is on automatic pilot. Well, the market started to react in a negative way, and we had the power pivot of 2019. So since that time, of course, we’ve had the Covid crash, which was highly significant. And then the Fed printed roughly $3 trillion in a matter of months to sort of staunch that bleeding. And what we saw after the Covid crash was that these asset prices didn’t just heal, but they climbed even higher. Right after Covid. We’ve had a record level of corporate bonds, issued leveraged loans Clos. The stock market is breaking records. So now we’re even in a more precipitous place to try to raise rates. And I think this helps explain why you’ve got this real tension out there right now. As recently as last week, the market didn’t believe the Fed. Okay, the Fed was saying we forecast going to raise rates to about two and a half percent, and the market was pricing in a rate hike to about one and a half percent. The market did not take the Fed seriously. Now, there were, of course, new minutes released from a Fed meeting that make people think maybe the Fed is serious. And so it’s this guessing game right now of how serious the Fed is about tightening. And that’s what nobody knows at this point. 

Buck: Surely the boy who cried wolf story in a way, right? 

Chris: Yes. 

Buck: I guess the question is, though, what would have a pivot away from money printing obviously the concern is these big asset bubbles coming home to roost. But do you feel like there’s a way around that to soften the blow, so to speak, and to normalize without creating a huge crash of some sort? 

Chris: Well, okay, to answer that question, let’s first talk about what the Feds patiently been doing over the last ten years, which is push money into risk assets by as you know, quantitative easing wasn’t just pumping cash into Wall Street. They specifically targeted the long end of the maturity spectrum. They bought ten year bonds, not one year bonds. And what that did, it took down what you could earn to save money. And I described that as like squeezing toothpaste out of a tube. They were pushing investment forward into these risk assets. But what that necessarily means is that today, if you’re going to let those longer term interest rates rise by tightening, that money is going to want to seek safety again if it’s going to have that option to save. So it’s very difficult to see how in a world where short term rates are two and a half percent and ten year Treasuries, or maybe at three and a half percent, how does it make sense to be invested in these collateralized loan obligations in Tesla stock that gained more in value in one month in December than like Ford and General Motors are worth in total? How does it make sense to be in those risk assets when you’ve got the ability to save long term? So my answer to you is no, you can’t make the adjustment without having a downward adjustment in asset prices unless you have a runway of maybe five to ten years. If the Fed had five to ten years to carefully, gradually, slowly unwind all this, you could kind of see a smooth hat. But inflation is more than likely going to force the Fed’s hand. 

Buck: Yeah. And that’s the tricky thing, right. I guess the question is we’ve had people on the show recently talking about inflation. There was initially talk even from Powell that this was a temporary inflationary transitional or I don’t remember the word you use exactly. 

Chris: Transitional. That’s exactly right. 

Buck: Yeah, transitional. And they’ve kind of moved away from that. But there’s also still a true supply side issue in the economy, and potentially inflation does start to smooth out a little bit. Do you think that they’re going to in reality try to actually wait and see and not necessarily make any big moves here? 

Chris: I mean, that would obviously be the path of least resistance. The last thing I would imagine the Fed would want to do is actually raise rates and do so called quantitative tightening where you withdraw the cash from Wall Street because that is going to create the adjustment we just talked about. I have a great deal of sympathy with the Fed getting it wrong on inflation. We’ve never seen anything like the code shutdown. It’s never happened in history to have global supply chains stop and then start in the midst of trade disputes between China and the United States. It’s very hard to predict how that’s going to all play out. So I can sympathize with that. To me, what’s important is that there was just a very interesting policy decision inside the Fed that really started back in the green span years. And it was this decision that as long as we don’t see price inflation, we are not going to worry about asset inflation and we’re not going to pop the bubbles. And now to see significant price inflation for the first time since the 80s again, it’s almost certainly going to force the Fed’s hand. I think that, of course, the easy option would be to kind of keep rates extremely low, hope that inflation passes like a thunderstorm and then wind down slowly. But unfortunately, reality is being very stubborn, and inflation is obviously much more broad based and longer lasting than the Fed hoped it would be, and it just seems like the Fed will be forced to tighten. 

Buck: So this show has investors, right? Retail investors. And so if you put your investor hat on, how do you interpret this information that we have right now? What do you do with that? 

Chris: This is probably going to be a very unsatisfying answer, but having interviewed and I’m sorry, this is a terrible answer, but I’ve interviewed enough people on Wall Street to know that I am the Mark at the table. I cannot compete against the likes of Blackstone and Carlyle Group. I take a very conservative 401K approach to my investment and my savings. And I don’t try to time the market or outsmart the market. That’s my personal approach. In theory, I think it’s very difficult to do. I have gained a true appreciation for the saying, don’t fight the Fed, because when Covid hit, you started to see these shaky towers of debt start to crumble, which had been inflated over the previous decade. I’m thinking of collateralized loan obligations. I mean, there are front page stories in The New York Times. Folks thought that these loans were going to go belly up. And then the Fed simply said, no, we’re expanding our mandate. We’re expanding our rent. We’re going to directly purchase corporate junk debt. So when you’re predicting what’s going to happen in the future, there are obviously a lot of people right now who are just absolutely of the mindset by the dip. There will never be a crash. The Fed will print our way out of this. The true question is, is that going to keep working time and time again? And we don’t have the answer. 

Buck: Yeah. No, it’s interesting that you’re absolutely right in the sense that no one knows exactly how to time this out. Right. So in a way, the issue we’re dealing with, it’s almost an academic one. If you can’t predict it. What else are you going to do Besides continuing to take your investing philosophy no matter what that is, presuming that these are not extremely risky assets and just continue to deploy. I mean, I’ve done enough of these shows lately where I feel like I always come to the same conclusion. There’s always, like, things to think about, and good boy, this could happen. That could happen. And then I’m like, what am I going to do differently? And it comes out to do anything differently. 

Chris: Yes. And for sure, as a reporter, I’m writing this book more from like a public interest. Sure. Of course. Really let citizens know what’s going on, because this has huge social political effects for our country. I mean, it’s dramatically income inequality, all the rest of it. 

Buck: Talk about that a little bit because we hear about that all the time. Income inequality. There are other ramifications other than our immediate pocketbook to what’s going on. And talk a little bit about that, because I think those are the things that we don’t necessarily think about much. 

Chris: This, to me, is a very big point. One of the main characters in the book is this fascinating guy named Thomas Hoenig, who was a senior official at the Federal Reserve. He was President of the Kansas City Fed, and he voted against these policies of easy money based on a very interesting argument. I mean, this guy is a little C, conservative kind of guy, and he was basically saying, once you start printing this money, you’re never going to be able to stop. But then importantly, he talked a lot about income inequality within the context of just social stability. And he would get up in front of these bankers in Washington, DC, and make these speeches along the lines of, we have a lot more to think about here than just making shareholders whole again. If citizens see that after 809, we have bailed out the banks that were too big to fail before the crisis, and we’ve made them larger and less able to fail while the middle class is still out there spinning their wheels and wages are stagnating more year to year, you’re going to have social instability. People get this increasing feeling like the system is rigged to use that cliche. But I thought it was really interesting that you’ve got this guy who when he said that he had retired from the Fed and became vice chairman of the FDIC, and I think he’s making a really important point that social stability is very important, particularly in a democracy. And when you’ve got this increasing widening between the very top and everybody else, it does create instability, which isn’t good for a capitalist economy. 

Buck: Explain for us, though, I guess in the context of the discussion about the Fed and Fed policy, how does that result in income equality? 

Chris: Oh, great question. Thank you. I mean, the Fed cannot build schools, build bridges, or hire people and put shovels in their hands. All it can do is make money cheaper and print money on Wall Street, which is exactly what it’s done. And when you go back and look at the internal Fed debates and the decision making, the Fed knew that the only way it can really try to stimulate growth is by driving up asset prices and then creating a so called wealth effect whereby people feel more free to spend or they feel like when the stock market’s going up, they’re more free to spend. And so the Fed knew that its economic growth policies were sort of an asset first policy. Well, the problem with that from a broader social perspective is that and I hate to use these terms, but it just is reality. 1% of the population owns about 40% of the assets, and then the bottom half of all wage earners in the United States, half the country owns about 7% of the assets. So when your growth policy is to Stoke asset prices, you are dramatically benefiting the smaller group of people at the very top. That’s how it drives income inequality. And there’s simply no question that that’s what the Fed has done. And as a side note, it’s even a little worse than that. According to a study from McKinsey Global Initiative, the Fed is punishing people who try to save money by keeping rates so low. So pensioner is just not earning what they used to earn on saving money, right? 

Buck: Yeah. It’s curious because you mentioned the income inequality thing in it, you wrote a book called Kochland, and presumably I haven’t read it, but I presume it’s about the Koch brothers, right? 

Chris: That’s exactly right. 

Buck: Now these guys actually came out a couple of years ago. I think one of them died. Right. But pretty significantly concerned about income inequality. Do you remember that? And I’m curious, why do you think they would worry? 

Chris: It’s so interesting. I bet you’re talking about Charles Koch, who’s really the main focus of my book, Kochland. And he’s the CEO of KochIndustries. And he says a lot of folksy things during interviews. Like one time they asked if he voted for Hillary Clinton, and he said, well, you never know. And then the headline was, Charles Koch Supports Hillary Clinton. Well, pretty far from that. I could see him saying something about worrying about income inequality. But the entire reason I wrote that book was to try to draw a sketch of the corporate structure of America from 1967 until today to try to understand and that book dealt with a lot of the kind of mechanical elements of what’s going on in our economy that drives income inequality, the corporate lobbying, the death of labor unions, all that stuff we’re familiar with. And then the Fed is kind of the other aspect of that. 

Buck: I remember something. My memory on this was that it was related his comments were related to social instability. And I think effectively, like all of us from his perspective, all of us who are very wealthy should be worried about what happens to a civilization when there’s this kind of income inequality. So it’s interesting whether he meant it or not. Yeah, that’s what he said. What other impacts do you see on this, anything else that you think that we don’t know about some of the key takeaways from your research on this? 

Chris: Yes. To me, a key takeaway is this. We all know at this point our Democratic institutions in this country are just dysfunctional and paralyzed. So they’re not pursuing the United States Congress, for example, is not broadly pursuing a conservative agenda of slashing regulations and cutting taxes, nor a Liberal agenda of passing regulations on Wall Street or empowering labor unions. We’re stuck in the middle and treading water. And for ten years we’ve been relying on the Federal Reserve to kind of be the key engine of economic growth. And I would argue when you look back at the record, we can now safely say we shouldn’t be relying on the Fed to drive the economy. It’s not a good tool to do that. The Fed has two jobs, one to just manage the US currency responsibly and the second to be a lender of last resort and a banking panic. That’s why we created the Fed in 1913. The Fed was not supposed to be a jobs program. It was not supposed to be the main engine of economic growth. And a huge middle part of this book is showing how little these policies have actually done for wage earners in America while they have been piling up this systemic risk in financial markets. 

Buck: I was curious. You mentioned the political stagnation and this polarization. Do you think though, that to me it’s interesting whether it’s a chicken or the egg there. But what caused what right? I mean the polarization could very well be a function of what we’re seeing economically. 

Chris: Well, it’s so fascinating too. And then there’s a chicken and egg between Congress doesn’t act because the Fed will print money and the Fed prints money and then Congress doesn’t have to act. And I interviewed one of the governors of the Fed, Betsy Duke used to be a Wells Fargo executive and she was saying, it seems like Fed money is free and politicians love free money and it’s an age old seduction to try to print money rather than deal with these hard issues of do we cut spending or do we raise taxes? We now deficit spend and it is largely funded by the federal reserve. Buying that debt and it’s an unsustainable path is the important point. And critically, again, when you look back, what has it given us over a decade? It’s given us an economy with overall weak growth, weak productivity growth, stagnant wages more or less until the last couple of years and at the same time, booming stock prices, booming markets for corporate debt and leverage loans. That’s not a healthy economy. 

Buck: The book, again, is the Lords of Easy Money. And obviously, Christopher, this is available everywhere, right? Amazon and everywhere. 

Chris: That’s right. Amazon to your local bookseller, to Audible and the website. 

Buck: You have a website too. It’s ChristopherLeonard.biz. 

Chris: That’s right. Yeah. And what kind of stuff do we find there? You’ll see the articles I’ve written about the Fed, some of the essays about the Fed, my coverage around Koch industries and some of the history of that and then my first book, The Meat Racket is about the meat system and then Kochland about corporate America. So lots of good reading. 

Buck: Yeah, good. Fantastic. Well, Christopher, thank you so much for being on Wealth Formula podcast. 

Chris: Hey, thanks for the time. I appreciate it. 

Buck: Love to have you back again soon.