We’re watching replays from our 1st Annual Hedgeye Investing Summit and the investing insights keep flooding in.
- 1998 … Wall St banks bailed out hedge fund Long-Term Capital Management
- 2008 … central banks bailed out the Wall Street banks
- In the next financial crisis … the IMF will bail out the central banks (according to Strategic Intelligence editor Jim Rickards)
Read the excerpt below from Rickards’ recent conversation with CEO Keith McCullough. He explains in vivid detail his biggest concern (the debt-to-GDP ratio), why central banks are out of ammo, and how current Emerging Market turmoil is a harbinger of bigger things to come.
(CLICK HERE to watch the entire 53-minute webcast.)
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Jim Rickards: The biggest thing that I’m concerned about, and that I watch very closely, is the debt-to-GDP ratio.
The Keynesian view is that if the economy isn’t growing fast enough, you’re in a liquidity trap and the private economy won’t spend, the government should spend and there’s your liquidity. From there, you’ll get some growth.
Keynesians have this idea that the more money you borrow, the better, because if the government borrows money they spend it. And when they spend it, they put it in your pocket or my pocket and that’s the money that stimulates the economy.
That’s true right up until the point where everybody changes their mind. The one thing that central bankers do not understand is the importance of confidence. Confidence can be lost and when that happens things can change overnight.
According to research from Rogoff and Reinhardt, 30% debt-to-GDP helps a little bit with growth. But what Reinhardt and Rogoff say is that at 90% debt-to-GDP you’re through the looking glass. Above 90% you’re actually retarding growth. Not only do you not get a $1 of growth per $1 of debt you don’t get a dollar, you get 50 cents.
We’re at 105% and heading north. The Trump tax cut is a $1.4 trillion deficit on top of the existing deficit we’ve already got.
The Republicans are channeling the Reagan playbook again in a completely different world. Ronald Reagan had the lowest debt-to-GDP ratio since Calvin Coolidge in the 1920s. So Reagan had headroom and took debt-to-GDP from 30% to 50%, which is a 60% increase. And that worked. Then you had Bush 41, and Clinton, who had a lot more in common than people imagine, kept a lid on it. But then Bush 43 blew it out and Obama doubled that.
So now we’re at 105%. These are conditions conducive to slower growth, and loss of confidence, and that’s what we’ll be seeing sooner rather than later.
Keith McCullough: Exactly. We call these the pillars of structural risk. Right? They never went away. It’s just that the causal factors – like U.S. growth accelerating -- can mask them. Reinhardt and Rogoff said this too, that when the deficit gets to 9%, 10% of GDP, you’re really screwed.
And look at the countries this year that are completely screwed.
If you have 1) Growth slowing 2) Twin Deficits, and 3) Debt out the wazoo, you are Turkey, South Africa, Venezuela. These declines in currency and equity markets are getting epic. I wonder why people think it is different this time when they get on the back end of a growth curve?
Rickards: Our Macro topic today is what I called a slow-motion train wreck. A lot of people woke up in 2008 when Lehman Brothers went bankrupt and said, ‘Oh my goodness, Lehman Brothers is bankrupt. Sell everything.’
That crisis was 15 months in the making. To me, it was sort of like watching a movie I had seen before because I had a front row seat for Long-Term Capital Management. I negotiated their bailout. The LTCM problems started in June 1997.
It came to a head in September 1998. So that started with Thailand breaking the peg between the Thai baht and the U.S. Dollar. It spread to Malaysia, Indonesia and South Korea. Everything came to a head with Russia and everyone thought, ‘Oh, my goodness, Russia is going to default. Brazil is next.’ Little did people know that there was a hedge fund in there with a country-size balance sheet and it was Long-Term Capital Management.
That was a liquidity crisis that played out over 15 months. 2008 played out over 15 months. People have very short attention spans. 1998 started in Emerging Markets. 2008 started in the mortgage markets but the contagion took it worldwide. Now its starting in Emerging Markets again.
Turkey has approximately $400 billion of dollar denominated debt and no dollars. Their reserve position is draining down. And they’re not the only ones.
There’s a lot of dry tinder around and you just need a match.
If we went into recession tomorrow, I’m not saying we are, but if we did, you could cut rates 2 ¼ and then that’s it. You’re out of bullets.
QE4? Really, the Fed has a balance sheet $4 trillion, are they going to go to $8 trillion? I doubt it. So no, you can’t really deal with it.
There’s only one clean balance sheet left in the world and that’s the IMF. They have a very low debt to capital ratio, they have borrowing power and they can issue SDRs (i.e. Special Drawing Rights, a supplementary foreign-exchange reserve assets maintained by the IMF). They have an SDR printing press so they can print a trillion SDRs, hand them out to their members, China would buy them for U.S. dollars and get the whole thing going again.
So I asked former Treasury Secretary Tim Geithner about this and he said, ‘We tried this in August 2009,’ and he said ‘It’s too slow and too clunky.’ I talked to the former head of the IMF about this and he agreed. So I asked him, What are you going to do? And he said ‘Guarantees.’
In other words, they’re going to run the ’08 playbook again. My rebuttal was here’s the difference. In 1998, Wall Street bailed out a hedge fund. In 2008, the central banks bailed out Wall Street. The next crisis, somebody is going to have to bail out the central banks. The people that you think can issue guarantees are the people we can no longer trust. How could the central banks guarantee anything when they’re the eye of the storm?
McCullough: I’ve never heard anybody say it that way. You’re the best at contextualizing the long time series with the patterns that repeat. Look at what the IMF just did with Argentina?
Rickards: By the way, everybody says that was a $50 billion loan. No it wasn’t. It was in SDRs. Now, Argentina can take the SDRs and sell them to China and get dollars but the IMF makes its loans and collects in SDRs. So I think when the crisis happens again you’re going to have to go to the IMF because you’ll have no choice.
CLICK HERE to watch this entire interview.