Jim Grant, editor of «Grant's Interest Rate Observer», argues that ultra-low interest rates and record-high debt are the main cause of today’s unprecedented market turmoil. More than ever, he’s betting on gold and mining stocks.
Global financial markets are in uncharted territory. After severe losses, stocks have seen a brisk recovery in the past few days. Monetary and fiscal policy measures of historical dimensions seem to have restored some confidence – at least for now.
For Jim Grant, however, there’s no reason to breathe a sigh of relief. For the editor of the iconic investment bulletin «Grant’s Interest Rate Observer», the pandemic was not the fundamental cause of the recent turmoil. Rather, it laid bare the fragility of today’s financial markets.
«I believe that the same central bankers we are celebrating as the heroic firemen to fight this current financial 6-alarm fire, are actually also the arsonists,» says the battle-hardened value investor.
In an in-depth conversation with The Market/NZZ, Jim Grant points out the unintended consequences of policy experiments like negative interest rates and quantitative easing, compares the current crisis to the great panic of 1825, and explains why he expects gold and mining stocks to shine.
Mr. Grant, you’ve been observing interest rates and financial markets for almost five decades. What’s your take on the turmoil investors have experienced over the past few weeks?
Such extreme movements – both up and down – in so compressed a period of time have never happened before. But altogether, they are as unprecedented as is the response of our central bankers. So what strikes me most, is the state of things before the pandemic arrived.
What do you mean by that?
To be sure, the virus has caused a great deal of chaos, fear and disruption. Yet, it seems to me that the pandemic was not the fundamental cause of some of the financial disturbances we see. Rather, Covid-19 unmasked an essential weakness in American finance which is owed to the past ten years of artificially cheap credit. Of course, no financial system, no matter how conservatively financed, could weather this kind of a shock. But this blow has been especially traumatic in a system in which equity valuations and the quantity of debt, particularly low-grade debt in relation to earnings power, are at or near all-time highs.
How did artificially cheap credit weaken the system?
Not only were speculative promotions like Tesla or Virgin Galactic sent into the stratosphere. Very low interest rates and easy access to leverage also sustained the unnatural lives of profitless companies that would otherwise not have been in business. In Europe, there are a lot of zombie companies, and we have many of them in the US, too. For instance, more than a third of the companies in the Russell 2000 index are not showing a profit under accepted accounting principles. Or, what accounts for Uber remaining in business all these years without being profitable? What accounts for the spectacular rise and equally spectacular fall of WeWork? What these companies all have in common is access to capital made much cheaper than it otherwise would have been thanks to the non-stop exertion of Central Banks which gave us zombies and unicorns on both sides of the Atlantic.
Then again, without accommodative monetary policy we would likely have experienced a recession already earlier on.
There is an analogy between Central Banks suppressing the symptoms of excess leverage and misallocation in capital and the rise of America’s opioid problem. Some years ago, doctors in the US decided that patients don't need to be in pain, even though pain is counted as one of the vital signs of human health, along with temperature, respiration, pulse and other things. But if you were admitted to an emergency room or if you had other health troubles, you were immediately asked to characterize your pain on a level of 0 to 10. Sure, you can see the good in the decision by doctors to suppress pain. But you can also see how it led to the oversubscription of very dangerously habit-forming drugs.
And where’s the link to monetary policy?
When the stock market pulls back 15 or 20%, we don’t like that pain. It is most uncomfortable, especially in a leveraged economy. So central bankers are lowering rates and letting us know that they would be there to address these difficulties. Investors, of course, absorb this information and decide that investing was actually rather safe because central bankers had their backs. So essentially, central bankers have become Dr. Feelgood. I don’t mean to impugn their motives. They are consciously attempting to keep things on even keel and to maintain employment. However, they are seemingly averse to consider unintended remote consequences of their immediate acts and that is a dangerous thing for people who are investing money.
However, one could argue that today’s super low interest rates are due to demographic changes, the rise in global savings and other factors.
Sure, but that doesn’t explain the great disorder in bond markets and the sudden rise in many yields over the past several weeks before Central Banks acted so aggressively. To get back to the point: It seems that the complacency of investors owning securities priced to yield less than the running rate of inflation might be the product of two titanic forces of our time: a) aggressive, unprecedented monetary intervention and b) the prospects of equally aggressive and perhaps equally unprecedented fiscal intervention.
Over the past few weeks, the Federal Reserve has dramatically expanded its balance sheet and launched various other emergency measures to prevent a meltdown of the financial system. Wasn’t that the right thing to do?
I believe that the central bankers we are celebrating as the heroic firemen to fight this current financial 6-alarm fire, are actually also the arsonists; unintentionally, to be sure. But through their actions, they have helped to create a structure that is very leveraged and very vulnerable to external shocks. We’ve certainly had that external shock now, and we’re here with still greater interventions and still bigger kitchen sink policy actions.
You’ve written several fascinating books on financial history. Was there any episode in the past when Central Banks went to similar extremes?
In the 19th century, there were many bank runs and panics. In England, the panic of 1825 was arguably the most violent of these turmoils. The Bank of England met it like a lion: It lent aggressively and unconventionally, and even extended credit against the collateral of merchandise which was most unorthodox. A few years later, Jeremiah Harman, a long serving director of the Bank of England, testified how he and his colleagues rose to meet the occasion. Here’s what he said about how the Bank of England lent its assistance at that time: «We lent it by every possible means, and in modes that we never had adopted before. And, seeing the dreadful state in which the public were, we rendered every assistance in our power; and we were not upon some occasions over nice.»
How does this relate to today’s policy actions?
The Fed certainly is not over nice: But more importantly, it was not over nice during the time of prosperity. That is what's different: The Fed instituted many unorthodox policies in the past ten years when the country was not in recession. Also, the U.S. Treasury – I guess we should call it the Department of the Debt – was running a trillion-dollar budget deficit before the virus arrived. So to any observer from a generation ago, public policy was in what would have looked like crisis mode during a time of prosperity. Now, we are most unprosperous, and, of course, we are laying it on much bigger than we ever have before. So radical monetary policy begets not a return ultimately to normal market functioning, but rather begets still more radical monetary policy. One does wonder where it all leads.
So what do you think is the next step in monetary policy? For example, the prospect of ballooning government debt has investors wondering whether the Fed will soon deploy yield curve control.
To a great extent markets have been government administered: Mr. Market has ceded control to Uncle Sam. Interest rates, being the principal means of valuing securities, are under the thumb of the Central Banks. To be clear: Government administration of markets is not exactly new, nor is it without precedent that people are now calling for the re-institution of yield curve control which was a policy in the US from 1941 to 1951. But that was when the country was either mobilized for war or was demobilizing from war. And, from the start of this policy through 1946, price controls were in place. As these controls came off, consumer price inflation was running at almost 20% a year, and interest rates were around 2.25%. I’m not sure that if the CPI started to run that hot in these days, the bond market would be quite so obedient like after World War 2.
What are the chances that we’re going to see a spike in inflation when the economy gets back to normal?
There is a broad consensus – which the Fed shares – that inflation is dead: It's a yesteryears problem, and there is no need to be concerned about it. You can certainly conjecture as much from the $9 trillion or so worth of securities priced to yield less than nothing, principally in Europe and Japan. That said, I still think it’s wise not to underestimate the adverse unintended consequences of these most extraordinary policy actions.
Where do you see opportunities for investors in these challenging times?
The price of gold has moved slightly to the upside in the past few days. But people would rather own securities yielding essentially nothing or less than nothing denominated in paper currencies. What’s more, the stewards of these paper currencies have promised to make them abundant and more abundant as the circumstances require. So I am struck by the continued collective confidence of investors in the institution of fiat currencies and in the stewardship of our modern central bankers.
You’re known to be a passionate admirer of gold. What’s the case for gold right now?
Gold has two purposes in a portfolio: First, it constitutes a hedge against – or call it an investment in – monetary disorder. So, if you are a believer that the arch of monetary policy points to ever greater financial suppression and ever greater probabilities for disorder and the debasement of currencies, then gold serves a very important purpose in a portfolio.
And what’s the second purpose?
Gold is a form of cash which is superior to other forms of cash. In a moment of deep liquidation during a vast sell-off, that provides you an opportunity to invest in temporarily distressed assets at very advantageous prices. So the first reason to hold gold is you have a form of money that is enduring and likely to hold its value when the central bankers continue to do their thing and finally succeed in debasing currency. And then, number two, you will have a form of cash which is very liquid and will allow you to seize opportunities in stocks, bonds and real estate when that time comes.
How close are we to that moment?
It’s amazing to me that the trust in Central Banks is as durable as it is. I thought it would be shuttered in 2008/09, but Central Banks came back with more power and seemingly more prestige. I don’t know whether $1600 an ounce is the right price for gold since you can’t value it as one would with many other assets or financial claims. But for what it’s worth, I believe it’s going to go higher and it is an excellent investment in the consequences that are likely to follow from these Central Banking experiments called Quantitative Easing.
What about gold mining stocks?
Right now, mining companies are looking at a very favorable business and operating situation: If they can get the labor, they are looking at a collapse of one of their principal costs which is energy. Remember, in the summer of 2008, the price of crude oil went above $100 a barrel and that was murderous for the gold miners since they need a huge amount of energy to move around all this dirt. But today, they are looking at a favorable cost structure, and at a most favorable gold price prospect. That’s why we like names like Agnico Eagle Mines, Barrick Gold or Kirkland Lake Gold.
Since the peak of February, the S&P has lost more than 20%. Are US equities now attractive from a value perspective?
Not in general, but there certainly are opportunities we have been looking at. There has been chaos, and chaos does breed opportunities. For instance, in the current issue of «Grant’s Interest Rate Observer», we were looking at the preferred shares of Annaly Capital Management and AGNC Investment. And, through the sheerest of luck, on our publication date the price of these REITs was cut in half between the time we wrote our analysis and the time that «Grant’s» appeared. And then, through the sheerest luck, their price has doubled since then. So let’s just say things are volatile at the moment.