KIRIL SOKOLOFF: But the excesses are so great that we get desensitized. And what would had been a single at the last cycle peak, this cycle peak, we're just okay, so it's another crazy excess. And I worry about people who bought bonds that didn't know what they bought, or that people who bought index funds who didn't know what they bought. And the heroes in the boom become the villains in the bust.
RAOUL PAL: When I got a big question in my mind, there's one person I really want to speak to. So, when I started developing this idea about thinking there's a recession coming, I always thought, I wonder what Kiril Sokoloff thinks. Kiril's a bit of a mentor for me, he really is a legend within our industry. And I don't use that word lightly. He knows everybody there is to know. And he's incredibly well-respected. And I've taken the long trip out from New York, up to the Adirondacks to Kiril's house on the lake here to come and sit down, spend some proper time with him to pick his incredible mind.
Kiril, 18 months since we actually got together on camera, and started to talk about things. And I've been thinking of something that I'm seeing in the data and the research that I'm looking at that I really want to pick your brains on, because I really respect how you think about things. And so, my hypothesis is that we're looking potentially likely to be going into recession, I think the global situation is more concerning than most people think it is. Even today, we've had Jerome Powell indicating that they're going to cut rates, but nobody really believes that maybe the cycle's ended. And I already think it is. But I wanted to know, what are you thinking?
KIRIL SOKOLOFF: Well, the great question of our time is whether this is a mid-cycle correction, like '95 or '98, with the Fed easing into a recovery, or whether it's recession, like 1989, 2001, or 2007. And I have a very hard time seeing that this is '95, and I can go into why I don't think it is. I'm totally agnostic, I'll let the market decide for me. But all the evidence on economic data and above all, confidence and trust. Because this is really a confidence and trust issue. How are you going to put confidence and trust back into the picture? You've done a savage cutting on that. I cannot believe it's possible for trust to be restored in the next year and a half. Just impossible.
RAOUL PAL: So, how do you rebuild trust?
KIRIL SOKOLOFF: It takes years, decades, it's extremely significant.
RAOUL PAL: So, your sense is we're maybe in a cynical turning point, but we're actually, this is a secular turning point as well in many respects?
KIRIL SOKOLOFF: It could be. If the US goes for protectionism and the rest of the world were to follow, it definitely would be a secular turning point. If the US goes for protectionism, and the rest of world doesn't follow, you won't be quite as bad. But then you have the whole cycle of wealth distribution coming. And how's that going to play out? And if Trump doesn't get reelected, what then happens to all of the deregulation and tax cut, all the things he did to get the stock market up? Will buybacks be outlawed? There's so many things that could happen that are significant watershed event that the market isn't paying any attention to but it's a significant risk.
And then, of course, you have what I call the burden of the debt, which might be the reason why it's so hard to get growth. And the last time we tried to do economic growth with more debt, solving the problem of debt with more debt, was in the 1920s. And we know how that ended up. So, we got 250 trillion and counting of global debt, which is more than three times global GDP, we've added debt at the rate of depending on the country one and a half or two times more than nominal GDP in the last 10 years. So, we've leveraged up the system. And maybe the burden of debt is too great to grow. And even though interest rates are low, a lot of the debt was used for nonproductive purposes. So, it's not generating any cash flow.
And then of course, you have demographics, which into recently, the US was a hopeful spot, and now, it's almost as bad as others with the population growing at the lowest rate in 8 years this last year. So, if in fact, it is beginning of a recession that has immense implications, which is why I'm glad you asked me the question. And the first is, will the recession be over by the election? And the second is how will this impact China-US trade relations? It is very, very significant.
So, my hunch is that President Trump wants to run on tariffs, and wants to run on protectionism and taking on China. And even if the economy were strong, he would do that. But if the economy gets weaker recession, he will double down. He's totally not going to say I'm in favor of free trade and take all the tariffs everywhere. It's not going to happen.
RAOUL PAL: The tariffs aren't going away.
KIRIL SOKOLOFF: Yeah. So, that means protectionism. And then the next question is, what does the rest of the world do? Do they put up barriers? And that's probably the most important question of all because that's what happened in the '30s, where everybody went protectionist and beggar thy neighbor and of course, you've got some very large export economies- China, South Korea, Japan, Germany- very important to the global economy. I fear we're on a slippery slope here. And when you open up the protectionist mind shoot, you can't bring it back.
And there's a guy named Jude Wanniski. He's since passed away, but he was one of the original supply-siders, along with Art Laffer and Robert Mundell, and Bob Bartley, editor of The Wall Street Journal. And he gave me his book and wrote it to me, to cure a disciple of the supply-sider revolution of 1978. And he wrote the book because he wanted to disprove that it was free market economics to cause the '29 crash and the Great Depression. And he plotted how the Smoot- Hawley Tariff made its way through Congress in the fall of '29 and how the stock market reacted to each support or against. And finally, when it became clear, what's going to happen? That's when the crash happened or happened for real.
So, he makes a very good point. But having seen that, and knowing that history repeats, I had this gnawing anxiety that we could be going down that same slippery slope here.
RAOUL PAL: Do you think it's already gone too far? Or do you think- because you've already said that they're not going to take tariffs away? Do you think it's likely to get incrementally worse? Are the Europeans or is- it already looks like the Japanese are putting up tariffs against the Koreans, I've noticed, it's not just about the US any longer.
KIRIL SOKOLOFF: That's right. That's what happens. For me, the rest of the Huawei's CFO on the day that Trump and Xi were meeting was the assassination of Archduke Ferdinand. And it's gone too far. And the Chinese have said, we're not going to negotiate or do anything until you remove the tariffs. And if I'm right that Trump wants to run on the tariffs and taking on the Chinese, that's not going to happen.
And Steve Bannon, who the President has said represents his thinking better than anybody else and who understands Trump better than anybody else- said recently on CNBC that they bid in the ass between the two sides is getting wider and wider. And the closer you get to the election, we're almost there now in terms of the calendar, the odds diminish and diminish and diminish. And then you have, for sake of argument, the Mexican- Canada trade deal that I thought was done last September, I said, ah, no, needs to be ratified by Congress.
And why would Congress ratify it? They're not going to say they won't ratify it so well, we have to make some changes and there'll be some conversations. And it was the former ambassador from the US to Canada who said that Trump could have done this in 2017 when he had control of both houses. So, in this sense, Trump's lack of experience in government and foreign policy came to haunt him because he didn't understand to do a deal like that. You got to get it done when you have a majority in the Congress, and to be sure that you maintain that because you never know about 2018 election.
RAOUL PAL: And what are you picking up from your network, whether it's corporations or over in Asia? I know you just come back from a long trip, are people taking this seriously that they're realizing that maybe the world has probably changed on- it shifted on its axis? Or they're still not sure?
KIRIL SOKOLOFF: I think there's been a realization that this is serious and they're settling in for the long haul. And one of my friends who I consider very, very smart, educated in the US who work in the US, born in China, his foot in both camps, believes that the old model is gone. The supply chain from China, it's only going to be the essential items that no one else can produce that China will produce for the United States. And China will be focusing on developing its domestic economy.
RAOUL PAL: So, then, knowing how you think, you're always looking ahead. How do you think this chips? Where's the opportunity within that situation? There's clearly- and we'll talk about the downside risk, but I'm just always interested because you're always looking ahead at, okay, if something's changing, there's going to be a winner and a loser here. How do you see that playing out?
KIRIL SOKOLOFF: We need to add into this my view that we're entering the cycle of wealth distribution, from wealth accumulation to wealth distribution. And it says all this history has been going on for thousands of thousands of years, Julius Caesar cancelled debt, for example. And there was a debt jubilee in the UK, I think, in the 18th century, and probably in the history of man, there's never been a period of greater wealth accumulation. I don't see it as socialism, per se. It's just a cycle. And if we put that in the picture here, this means that corporate profits are going to be hurt, because labor is going to take a greater share of the pie, has been going down for 40 years. So, that would obviously impact the stock market.
I happen to like gold a lot. It's been out of favor, it's not understood at all. People come to it very late in the cycle, they write it up and they think they understand it when they really don't. It's very sophisticated instrument with much different values and trading parameters than people are experienced. And I see it as the best barometer of deflation and reflation. I'm not using the word inflation, reflation.
Now, at the end of the last commodity cycle, or I should say the one in the 1970s, gold and all the commodities went up, because the dollar was very weak. We may get in that a period. So, I think right now, gold is very attractive, obviously, the mining shares are attractive. I saw they think having liquidity is very attractive. People think that there's so much liquidity and so much cash. And I've seen so many times when there's too much of something, it becomes not enough.
RAOUL PAL: So, let's get back to the beginning where you talked about the, oh, is this debt that we can get through by the election or not? What are your inclinations currently for that?
KIRIL SOKOLOFF: I'm intrigued with this concept of the Fed pushing on a string. And that's an old expression that people haven't used for years and years and years so it's about time to dust it off and bring it back. What it essentially means is that the Fed is putting monetary stimulus and it's not catching. And we had this in the early 1990s after the big commercial real estate bust and the banking crisis, Greenspan kept cutting rates and cutting rates and cutting rates and nothing happened. People were shocked. There was a lot of analysis done on why it wasn't catching, eventually, of course it did.
I think it'd be very hard to get this started. And if you look at residential real estate prices around the world are starting to fall and that's a very important barometer. And the Chinese of course, aren't buying. They're withdrawing capital, the Russians aren't buying, they're withdrawing capital. Resilience aren't buying. So who's the marginal buyer here? And they're all pumped up to ridiculous prices. And what happens in these bubbles is that the excesses are so great that we get desensitized. And what would had been a single at the last cycle peak, this cycle peak, we're just okay, so it's another crazy excess. But this, this is normal.
RAOUL PAL: Do you think that the excesses- because you mentioned the 1920s before, it feels that we've coming off that gilded age feeling as well. You and I were talking over lunch about similar things, and we're seeing flags everywhere of just excesses. Just people are so hubristic because of the cheap money that they forget that the cost of money may not go up but the supply of money may disappear.
KIRIL SOKOLOFF: Exactly. Or it might not be available where it's needed.
RAOUL PAL: Exactly, exactly.
KIRIL SOKOLOFF: There was this great book in the '20s called, The Bubble that Broke the World, by Garet Garrett, beautiful writer, phenomenally excellent writer. And he labels the problem of trying to solve the debt with debt. That's exactly what we've done. Global debt is about 250 trillion, three times global GDP. And to get the amount of growth through that we've gotten as small as it is, we had to use much more debt than nominal GDP. So, you're building up the debt to get $1 worth GDP.
RAOUL PAL: And that's what worries me, because if the Fed are going to be pushing on the string, I think, I think we're going to learn that the Fed cannot generate inflation very easily. We're seeing inflation expectations collapsing right now. And I think, as you talk about, if the Fed start cutting rates, they'll realize they really can't shift that forward expectation of inflation. It's going to be very interesting to see what happens to debt burdens at that point, because I fear that that shift, and again, something we were talking about before, is I fear, that shift of the amount of corporate debt which has doubled- all the other debts since the last recession have eased off somewhat, but corporate debt is completely exploded. It's now 100% of GDP. I really worry about that. What do you think about the corporate debt situation?
KIRIL SOKOLOFF: Totally, that's where the real Achilles' heel is. And how much malinvestment was there, and where is it, and what happens if and when it has to pay an interest rate that reflects the risk of the credit?
RAOUL PAL: And what happens to buybacks if that's the case, because it's all driven by the same circle? And I'm worried that I don't know what the price should be for junk bonds, but it's clearly not what it is now. And if we see any defaults for BBB into junk bonds, then I think all the buybacks stop, which is the only buyer of equities, so the whole thing is very circular. And you could have a mild recession, but quite a big market event, like 2000 was.
KIRIL SOKOLOFF: Exactly. In the early 1980s, the name 13D, my company comes from filing a 13D state with the SEC by 5% and a public company have to file 13D. At that time, stocks were incredibly cheap, because you had the big inflation, interest rates were at 14 %, 15% on the long end, and you could break them up and sell them for twice or three times that they were selling. Michael Milken came along as the conduit and facilitator. And we became the world's expert on 13D filings.
And many of these companies had horrible management, they were very inefficient. And they were managed for the shareholder. Now, we're at the opposite at the extreme. So, the normal cycle, you go from no concentration of the shareholder to exclusive concentration of the shareholder. And that's the very nature of human nature, you go from one extreme to another. And the one thing that hasn't changed about the world is that human nature is the same. I don't care if they're machines or not, human nature is the same.
RAOUL PAL: So, in terms of how risky you think the situation is right now, just to give people a gauge of how concerned you are, where is that compared to where you've been in the last 10 years?
KIRIL SOKOLOFF: Well, you could have said the same thing at any point in the last 10 years for that matter, except it's just gotten bigger and greater. But now, we're coming off of a 10-year upside, at least in the US, and the rest of the world is tremendously slowing down- Japan, Germany, China, UK, Europe, they're just terrible. I remember in the late '90s, I was one of the first to get involved in the emerging Asian crisis. And I got that right. And we predicted that it would spread to all the emerging countries then come back to the US eventually.
But what I missed was that it would fuel a boom in the US for an extra two years, so that was very painful. And this is what's happened this time, again, people are saying the US is great, everything's fine. It doesn't matter what's going on the rest of the world, that Trump should get reelected, we're going to have another tax cut, whatever it is. And I've seen this movie before. And I would tell them over again, you're going to get zapped here, watch out. And the timing of it is hard to detect. And because of the way the system works now, you can't fight it, you have to be there, which makes it even more insidious, unless you have total discretion.
RAOUL PAL: And that's why I've always been, in this cycle, very enamored by the bond market as opposed to the equity market, because it seems to be the clearer signal. The yield curve dipped but it's supposed to do, bond yields fail at the right time. And it seems to be giving much clearer signals. The equity market seems almost impossible right now compared to what's going on in the global economy.
KIRIL SOKOLOFF: Well, the bond