PETER BOOCKVAR: Any central bankers, they're so good at getting into this policy. This is the asymmetry, but there's no thought about how to get out. We're now at a point where Draghi has proven to be and now, Lagarde. They've trapped themselves and they've created in financial history, the greatest financial bubble in the history of the world in credit and sovereign fixed income and everything that prices off that. How do you get out of that?
DANIELLE DIMARTINO BOOTH: Hello. Joining us today is Peter Boockvar, Chief Investment Officer of Bleakley Advisory Group. I'll introduce him by saying he is as close to on Wall Street as being a brother from a different mother. For me. We've gotten to know each other very well over the years. The work that we started to do together was done very much covertly. You fed a lot of the intelligence that went into the market briefings that I prepared for Richard Fisher when I was his advisor working at the Dallas Fed, and I'd like, if you could, to take us to the culmination of that relationship of being an indirect advisor to Richard and how it ended up in a bar, the King Cole bar, on a cold night.
It was you and me, Arthur Cashin, Howard Silverblatt of Standard and Poor's, and of course, Richard Fisher. Richard came to love your work after you made a particular outlook for the year and used the term beer goggles. It was interesting. The Wall Street Journal did a retrospective on all of his speeches. The number one most popular one that he ever made was your beer goggles reference. Take us back to that night and what it was like to meet Richard in person finally after having been such a critical part of his understanding of markets intelligence all those years.
PETER BOOCKVAR: Well, what was special for me that night was actually getting to meet him for the first time in person. Previous to that, through you, and directly in the occasional email correspondence, the speech where he gave the shout out to me was special. The good thing is that we all had a similar viewpoint of the way of the world and monetary policy and how it interacted with the regular economy and saw things a little different than the conventional thought process in Washington.
To actually get to meet him in person was pretty special, just as he was walking out the door and going off to his next thing, but one thing that did come out of that was also a continued correspondence. I don't think I've seen him since but the occasional email back and forth is always special to me.
DANIELLE DIMARTINO BOOTH: I know Richard continues to enjoy your work. It's how I start my day as well. I think a lot of us do. Take us back for just a second. What are beer goggles?
PETER BOOCKVAR: Back in the day in college, when you would have a little too much to drink, everything looked good. Everything looked better than it might have without the beer. The analogy was when the Fed is conducting extreme monetary policy, the zero rates for seven years and multiple rounds of QE, it puts beer goggles on investors. It makes that awkward lame investment all of a sudden look like roses.
It looks at that money losing company. Well, if we do a little bit of this and that and give him some money, everything will turn up roses. That was the analogy that investors become much less focused on the risk when they have those beer goggles on. There's monetary bill got beer goggles on, and only focus on where's my upside?
DANIELLE DIMARTINO BOOTH: I guess the CLOs all look better at closing time.
PETER BOOCKVAR: Exactly, yes, yes.
DANIELLE DIMARTINO BOOTH: Before we go to where we are today in collateralized loan obligations, tell us how you think the Fed got the idea in its head, how policymakers decided that they had to go to the zero bound before they could launch unconventional monetary policy, quantitative easing. There are examples that Chair Powell uses, as well as Vice Chair Rich Clarita. They reference back to the episodes in 1995 and 1998 when the Fed was able to execute three rate cuts and then gracefully extract itself from the markets and the economic expansion and the rally in risky assets continue undisturbed? Are we there today? Can he do this? What differentiates '95 and '98 from where we are now?
PETER BOOCKVAR: The important thing about understanding '95 is looking at what happened in '94. That's when Alan Greenspan raised, I think, the Fed Funds Rate from 3% to 6%, 300 basis points within a year's obviously a rather short increase. There were negative side effects from that. The Orange County pension fund, I think, the [indiscernible] themselves out.
DANIELLE DIMARTINO BOOTH: The Tequila Crisis in Mexico.
PETER BOOCKVAR: That as well. Going into '95, by cutting rates 75 basis points after he just raised 300 the year prior, and also you were only four years into an economic expansion very early on. That was something that they were able to engineer. Then you fast forward to '98 and we have the long term capital management blow up. You have the Russian debt crisis. Well, that was coming together and a sharp decline in the stock market. The Fed was more responding to a decline in markets and a freeze up in markets rather than an actual deterioration in economic growth.
DANIELLE DIMARTINO BOOTH: Third time Alan Greenspan ever did that.
PETER BOOCKVAR: Well, exactly. That's how we became trained that on a market hiccup, as opposed to an economic hiccup, the Fed was going to come and cut interest rate, but we know in late '98, that sowed the seeds for the greatest stock market bubble in history. Saying that '95 and '98 are good reference points for us as the Fed, I think, is really not thinking through what went on during those two timeframes.
DANIELLE DIMARTINO BOOTH: Certainly. The years that followed '98 were some of the most-- Alan Greenspan had already said, irrational exuberance in December of 1996. We knew that the train has already left the station and but animal spirits are what animal spirits are. Let's jump forward in time a little bit, because Alan Greenspan and you would agree on something. When he was still Chairman at the Fed, he insisted against the protest of Ben Bernanke and Janet Yellen, he insisted that the ideal inflation rate was zero percent, what say you?
PETER BOOCKVAR: I agree, because that's actual price stability. When you think about zero, let's just take that, that means some things are going up 4%, some things are going down 4%, this price is going up, that price is going down but in a net way, prices are stable. Now we take technology, for example, it's a pretty safe bet since the history of time, the price of any technological good, whether it was a car in the early 1900s, or it's a computer or it's a phone, whatever, that those prices eventually continuously go down.
Then there are going to be some things where prices go up, mostly on the services side, whether it's housing or medical care or tuition or whatever, but if you can net out that being around zero, that's actually price stability. It makes your currency stable, it makes decision making much, much easier. Now, if you get into too much debt, and you sell a commodity product and the price of that product goes down, well, then you're going to run into trouble. Maybe knowing that, knowing that you don't have pricing power, maybe you don't go into too much debt to begin with.
DANIELLE DIMARTINO BOOTH: Now, there's a novel thought.
PETER BOOCKVAR: Exactly. Now look at, now getting back to the technology companies, look how successful Silicon Valley has become when they're selling a product that goes down in price every single year. Deflation actually has been a benefit to them, because it has expanded the market at which they can sell their products. I like to give the analogy, so an IBM PC in 1981 which retails for about $3,000, if you raise that price 2% a year to today, it's costing you $6,000 for the same exact machine.
DANIELLE DIMARTINO BOOTH: Technology, everything.
PETER BOOCKVAR: Right. Now, you can go into Best Buy and you can buy a laptop for under $1,000 instead. Somehow, technology companies found a way to make money when the price of the product goes down. When you say let's get 2% annual increase, that means in theory that everything has to go up 2%. Now, that's obviously not the case but that's what they're saying.
The reason why they want 2% is not because they model that out as being good for the economy or good for businesses are good for the consumer, they do it for selfish reasons. They do it because if the inflation rate is at 2%, they assume that the Fed Funds Rate is a certain level above that. If it's a certain level above that, let's just call it 3%, 4%, which historically, the spread was about 200 basis points, that in the next economic downturn, they would have ammunition to cut rates, a cushion. If inflation was zero, well, that would imply a very low Fed Funds Rate and that would imply very little ammunition to deal with any economic downturn. That 2% target is a central bank self-interest target, rather than what is economically good for the rest of us.
DANIELLE DIMARTINO BOOTH: Okay. The minute Alan Greenspan walked out the door, Ben Bernanke managed to push through his 2% inflation target. How do you think that has changed, not just monetary policy here in the United States, but worldwide? You've written extensively, extensively about the Bank of Japan, which still has the 2% target, even though-- you can tell me you've got the history in your mind. I know you do. When the last time they hit 1% was?
PETER BOOCKVAR: Right, the only time they actually even hit two was only after the VAT increase. It was a tax increase that resulted in higher prices. Higher inflation is a tax anyway, so whether it's a government administered hike in the valuate added tax or it's a central bank generated increase in the overall price scheme by 2%, it's the same thing. It still does the same damage to a consumer.
I think the 2% was just in their minds, their desire to anchor policy around something. In their models, while these are very sophisticated models with a lot of PhDs around it, there's a lot of simplistic thinking behind it. It's low rates are good, high rates not so good. Well, if low rates are good, even lower rates are even better. If you print money, and Bernanke gave the helicopter speech in the early 2000s, you print money, well, then you can create inflation, regardless.
Because the history of the Wyman Republic and Venezuela and Zimbabwe, you print a lot of money, you get inflation, but there was attached to that, at least with the Fed's experience since '08 was, well, you can print all this money but if it actually ends up back at the Fed in Reserves, it's not really out there. It's just landlocked back at the Fed.
Japan realized, well, yeah, you can create all this money but if it doesn't change consumer behavior, and it doesn't incentivize businesses to borrow and take advantage of low interest rates well, then there's no inflation to be had.
DANIELLE DIMARTINO BOOTH: It's the classic paradox of thrift.
PETER BOOCKVAR: Exactly. Now, we're at a point where monetary policy, I argue, is actually restrictive monetary policy, particularly in Europe and Japan, rather than being easing because of what it's done to the profitability of their banking systems, which is the transmission mechanism for their policy.
DANIELLE DIMARTINO BOOTH: Give us give us a feel for the banking stock indices in Japan and in in your-- given that, well, I don't know, our president is calling for negative interest rates, so just focus us on what's happened to the banking sector in those countries.
PETER BOOCKVAR: The Japanese bank stock index, the TOPIX bank stock index, since 1989, when the Nikkei hit its peak, the TOPIX did as well, is down 90% in nominal terms over the past 30 years. We destroyed the equity of the entire banking system. Now, you're at the point in Japan where least a lot of the regional banks are actually on the cusp of going out of business.
If you're a big Japanese bank, like Mizuho, Nomura, you have the opportunity to do some business overseas. You can offset the profitability pressures by having business in Japan. If you're a regional Bank of Japan, you really don't have anywhere to go. They're literally dying.
Then you look at Europe, and since '07, the Euro STOXX banks index is down 70%. In particular since June 2014, when Draghi went down the negative rate route, that index is down 40%. Now, they will say at least in Europe that well, their volumes have gone up, their loan volumes have gone up.
DANIELLE DIMARTINO BOOTH: Make it up on volumes.
PETER BOOCKVAR: Yeah. Pets.com in 1999 kept selling more and more pet products, but because they were losing money on every product, they went out of business. Yeah, banks are trying to offset the compression on their margins by trying to increase the volume, but they're actually making less and less because the margins are falling faster than their loan growth is.
DANIELLE DIMARTINO BOOTH: We know that unconventional monetary policy was not born in the United States. In fact, Bernanke gave a speech years ago in Japan where he suggested that perhaps if they wanted to generate inflation, they could just issue zero coupon bonds in perpetuity with no maturity at all, which I think you call cash, at last check, but I think something happened because the Federal Reserve is the world's leading central bank. When Bernanke crossed that Rubicon, he brought together all of his closest advisors at the 2007 Jackson Hole.
It was there that the Bernanke doctrine was born, and that the precondition of zero interest rates getting to the zero bound was necessary before they could embark upon growing the Fed's balance sheet. Do we absolutely have to have and we're finding out in real time, aren't we? Was it a necessary condition to go to the zero bound in order to launch unconventional monetary policy, whether you agree with QE or not, was that a necessary condition?
PETER BOOCKVAR: I don't think so. I think what the Fed did is they turned the business of banking upside down by what they did to the yield curve, because on paper, it was get short rates down to zero and if that is not enough, then try to suppress long term rates to encourage people to go out and lever up whether you're a business or a household. What they did was they flattened the yield curve, which then damages your financial system, and then leads to reduce profitability and unlimited growth.
I think Bernanke he's mentality was-- and his learning process was the Great Depression when Milton Friedman came out and said, well, it wasn't, because it was not enough liquidity, and it was all this deflation and they didn't come to the rescue in the 1930s to save the day and then Bernanke saw what happened in Japan. Even though I think he misread Japan. Then he thought that Japan didn't act fast enough and soon enough, rather than saying, well, maybe what they did was the wrong medicine anyway.
His idea was, I need to go big, I need to go fast. I need to get rates down to zero. If that doesn't work, then we'll start to open up the printing press to suppress longer term interest rates, because he knows at least back then, obviously, housing was depressed and mortgage rates are going to be priced off the 10-year. Well, how do I get that 10-year yield down? Well, let's buy as many 10-year treasuries as we can.
DANIELLE DIMARTINO BOOTH: Once Bernanke embarked upon unconventional monetary policy, QE, it seemed like it was some a strange contagious disease. Now, we have $22 trillion and growing now that the European Central Bank is back in the QE game, now that the Fed is in the not QE, but still growing its balance sheet game. What do you think of the idea?
Our mutual friend, Jim Bianco, made the comment, especially of 2017, when there was what, $2.2 trillion of global quantitative easing, the same year that the VIX was south of 10 in single digits 53 times, taking out the next closest year, which I think was in '93 or something when they had three days that the VIX was in a single digit type territory. What do you think of Jim's idea that QE is and has become global and fungible that it knows no boundaries, knows no borders?
PETER BOOCKVAR: Well, it's dead on. The only border in a sense is your currency, because every time you go from one border to another, you take that currency risk, but putting that currency or risk aside, and assuming you can account for that currency risk through any hedging, yeah, it becomes borderless because it's that gets back to that old 506-- we call that old, search for yield. We have the big Japanese pension fund that is a huge holder of that three letter we talked about.
DANIELLE DIMARTINO BOOTH: The CLOs, going there yet. Going there.
PETER BOOCKVAR: Getting to my point of this simplistic thinking of a central banker is low rates are good and lower rates are even better. Well, if we cannot just lower rates to zero, but we thought how we can get that negative, well, then that's the greatest thing ever because we want to get you to lever up.
DANIELLE DIMARTINO BOOTH: Right, of course. Yeah, there have been academic studies that have come out that suggests that had we just gone to negative 5% here in the United States, that the pain of the great crisis would have been greatly mitigate. These studies, they even shaved off one percentage point to account for balance sheet expansion, meaning, I think a lot of the conventional wisdom among monetary policymakers today is that we can go deep into negative territory.
I know you don't agree with that. I know I don't agree with that. Talk to me if you will about Mario Draghi's legacy and what it implies for Christine Lagarde's future as head of the European Central Bank, because it would seem to me that if any bank is going to go way off the reservation when it comes to delving deeper into negative interest rates, that it's going to be the European Central Bank. Tell us about Draghi's legacy and what Christine Lagarde faces.
PETER BOOCKVAR: Draghi took the lesson of Bernanke, which also took the lesson of the Japanese like, I think everyone looked at Japan and said that deflation is a Boogeyman and that the reason why Japan is suffer for all these years is because they have deflation. The problem with that analysis is that deflation was just a symptom, wasn't a cause of their economic malaise. It was just a symptom. It was just consumers wanted to save more, the banking system and the corporate sector needed to de-lever, population stopped increasing.
DANIELLE DIMARTINO BOOTH: Aging population, demographic's [indiscernible].
PETER BOOCKVAR: Actually, the average CPI rate over the past 30 years in Japan is actually around zero, so they've actually had price stability. When you misdiagnose the patient and think that deflation is bad, well then you do everything you can, obviously,