Below is the transcript for the podcast with Eric Janszen: We Are Witnessing The Death of the Dollar.
Chris Martenson: Hello. Welcome to another Chris Martenson.com podcast. I am, of course, your host, Chris Martenson, and today we are speaking to Eric Janszen, founder and president of iTulip. I have been a reader there for quite a while; it is a data driven economic analysis firm started as the website iTulip.com in 1998. Eric is a prolific economic and financial market analyst, and author of several notable books, including the most recent one, The Postcatastrophe Economy.
I have invited Eric to speak here today because he has made more right calls about the global economy than almost anyone I can think of or have been following in the past decade. Today we are going to discuss his “Ka-POOM” framework and what he sees next in his macroeconomic crystal ball. Welcome, Eric. I have been looking forward to speaking with you for some time now; it is great to finally have you as a guest.
Eric Janszen: Well, it is great to be on, Chris. I guess we saw each other in Denver a couple years ago, so it is good to catch up.
Chris Martenson: Yeah, we were at the ASPO Conference. And I know that Peak Oil is certainly a part of your framework, it is one of many pieces, and you have been sending warning signals about our macro economic predicament, if I could use that word, since you launched iTulip.com in 1998. So can you give our listeners here the background on the specific concerns that lead you to launch that site and your framework there?
Eric Janszen: Well, Chris, at the time I was the managing director of a seed-stage venture capital firm called Osborne Capital. This is Jeff Osborn, an old friend of mine out of the technology industry, and he made a bunch of money when UUnet went public. He was the head VP of Sales and Marketing, and he started investing in startups, mostly people that he and I had known over the years in the industry. So he brought me in to sit on the boards of companies and help with the investments and so forth.
So we had what I would describe as a front-row seat into the technology bubble; we could see that something was clearly amiss. So I started to do my research that ultimately resulted in iTulip. And my real objective here was [that] we had all these investments, we invested in 20 companies and we had seven liquidity events, a couple IPOs, sales to Cisco, Microsoft, Nortel, and others. My job was to understand that we were actually participating in a bubble and to know when to get out. So my research led me to believe that it was time to get out in March of 2000, and I started writing about this on iTulip as a way to share some of the information we were getting with the public and to counter what was coming out of the media at the time. That has really been the mission for iTulip ever since.
Chris Martenson: Well, that new economy, of course, it is always some sort of false belief or some new adoption of a rationale that enables us to go a little further. Greenspan, of course, adopted many of those rationales, including the idea that risk could be off-loaded and potentially made to disappear. It was no longer a real structure of our financial system and mispriced money accordingly. So in that context, I guess you were just at a Fed meeting of some sort, and you have been clearly observing the Fed for a long time. Do you have any observations you can share from that meeting, and generally speaking, why you follow the Fed and what you think they are up to here?
Eric Janszen: Well, this is a small conference, invitation-only, at the Boston Federal Reserve. It is on Atlantic Avenue in downtown, the financial district of Boston, and the title of it was “The Aftermath of the Greater Recession.” The format was a bunch of academic papers presented mostly by academic economists, peer-reviewed, and then discussed with the group. So the audience is various kinds of economists from investment banks and multi-family practices and so forth to different kinds of funds, and the media of course, CNBC, and lThe Wall Street Journal, The New York Times, and all those guys were there to cover it.
Also, Bernanke gave a speech, and it was actually a very important speech. It was not particularly well covered and I will be happy to talk about that in a minute. But what was interesting about it from my perspective, having covered the cycle of asset bubbles and reflations and various kinds of distortions that we have seen in the economy for 13 years on the site, if you go to a meeting like this, it is kind of a game of make-believe; everyone is talking around the real issues. The best you can really get out of it is to show up and ask some questions and hope by asking the right questions, you start to get people focused on the right subjects.
Chris Martenson: Are they focused entirely on just the economy, or are they looking at monetary interest rate, all these policy things? Do they have any sense yet of where oil and energy might be impinging on their world view any?
Eric Janszen: It is not on their radar, at least not in the context of this particular conference. The conference was really about the lingering effects of the so-called Great Recession. For example, there was one paper on the long-term effects of consumer attitudes towards the housing market. It was a very academic analysis, extremely rigorous from a data standpoint, but somehow or other they managed to miss any correlation between the fact that we have massive negative equity in the housing market and the fact that people do not want to buy houses. Also of course, unemployment, which is one of the main drivers of housing prices and drives home sales.
So you have these extremely academic papers very rigorously done that are not really getting to the point of the problem. Simon Johnson was there — he, of course, was his usual highly confrontational self — and I asked him a couple questions and he was very forthright in his answers. I did meet Bernanke in passing, I shook his hand on the way out the door, but I did not get to ask him any questions because for some reason at this particular speech, he did not take questions, which I was told was quite unusual.
Chris Martenson: So let us talk about the Ka-Poom Theory for a while, because this was really your larger framework, and you have held this framework for quite a while. Maybe you can date it for us when you first developed and got it out there, if that was right at the inception I would love to know that. But the Ka-Poom Theory is a way of understanding the macro cycles. If you could explain that for our listeners, I think that would be a real help, because I have a bunch of questions I would like to build off that framework as we try and peer into the future and address what might happen next.
Eric Janszen: Well what the Ka-Poom Theory intends to do is understand how all the debt built up during the era of the credit bubble. It began in the early 1980’s and accelerated starting around 1995. How it eventually gets resolved in an environment where politically writing down debt is not likely to happen and that ultimately the way that debt is written down is to the exchange rate mechanisms where markets discount the dollar. We could have a sudden dislocation in capital flows commonly known as a “sudden stop” that would apply to the United States. This is an idea that I thought was one way of looking at how this could all turn out that I first developed that back in 1999. Since then I have changed it a couple times, I would describe it as phase shifting it forward, moderating it somewhat. And I think what I have learned from the last two times that we have begun a sudden-stop process and it has been reversed is that we have a system which is difficult to predict in terms of its resiliency. There are trade partners extremely committed to maintaining the system as it is. On the other hand, they have been actively hedging their investment in the system by buying gold, as well, since about 2001.
Chris Martenson: Right, so in the Ka-Poom Theory, we have an enormous credit run-up eventually that has to give way at some point, It did in 2008 in a fairly spectacular fashion, and then you have the inevitable downward portion of that cycle where we see deflation, deflationary impacts. Certainly, we see that in housing right now, if we look at total credit market debt there is little blips there but it is really the financial credit that has taken a big hit. We have the Fed doing everything it can intervening, we have got trade partners helping. Still, in this Ka-Poom Theory, are we on the downward slope of that deflationary impulse that proceeds what you describe as the reflationary or massive or maybe even hyper inflationary wave that would follow?
Eric Janszen: Well, Chris, the most important thing to understand to forecast what is going to occur in our political economy is that we have effectively two economies, not one. We have one economy that is called a Buyer Economy, which is oriented around the finance, insurance, and real estate industries, and then a second one that is oriented around productive industries.
And the reason that it is important to keep them separated in your mind is because from a monetary policy standpoint they are treated quite differently. From a monetary standpoint asset, asset price inflation is good, the wage and commodity inflation is bad. And so if you watch for example what the Fed is doing in response to deflationary forces, both in asset prices and in commodity prices, there are two different approaches, right? So Operation Twist is an effort directly to drive down mortgage prices, which is really, if you think about it, a form of price fixing. They are trying to create scarcity, and therefore drive up mortgage prices, and therefore yields down.
This is a direct attempt to try to affect a change in asset prices, in this case the collateral, which is homes of all the outstanding mortgage debt. So they are trying to prevent asset price deflation within the fire economy, and at the same time they are trying to raise inflation in the wage and commodities prices, and the way that is done is through exchange rates. It is not the explicit policy, but it is clearly the apparent policy, which has more recently been dubbed the “weak dollar policy.” But the idea is if you can depreciate your currency through fiscal policy and through monetary policy. What tends to happen, particularly through energy prices, you can affect a change in the overall price level throughout the economy, and that’s what been done. So we effectively depreciated the dollar against oil starting in about Q2 2009, and that effectively halted a very brief period of deflation that we had.
Chris Martenson: So what we are talking about here is a very interventionist Fed that feels like it has the right capability, or maybe the obligation, to then have one hand on the asset lever and one hand on the wage and commodity lever, and then they are going to affect the proper outcome. Is there in your mind any historical precedent to suggest that such a command-and-control approach is a useful approach or workable approach or has a good chance of long-term success? Where you do fall in that whole free-market versus these-things-need-to-be-managed spectrum?
Eric Janszen: Well, a couple answers to that. Back in 2005 when I was doing my first forecast of how I thought the housing bubble would turn out, I had two forecasts, ten years and fifteen years to revert to the main. Ten years if there was a limited government intervention and the market was able to quickly correct and then come back, and much longer and more painful if it did get involved. I thought government interference in the correction was more likely, because from a political standpoint, the risks to the banking system under the current structure would have been too high, there is far too much concentration in our banking system to allow a “Natural” decline, the so called too-big-to-fail problem.
So you have to remember that Bernanke was the guy that inherited the mess from the Greenspan Fed, and it was really under Greenspan that we had these cycles of asset price inflation that were positioned and postured as free market phenomenon, when in fact they were simply, for the lack of a better term, rackets which were designed to shift risk fundamentally from Wall Street to the taxpayer. Now the way that Bernanke has had to respond to this, my view is that he was handpicked as the right guy to come in after Greenspan because Bernanke, you know, since he was relatively young and an undergrad at Princeton and was writing papers about the Great Depression and what went wrong and how to prevent deflation. So from my perspective he was picked specifically for his background and his interest in doing precisely what he did do, quite predictably, in response to the deflation that resulted from all the credit inflation that precede it.
Chris Martenson: Yeah, you know, I have always known that we were going to go down this printing road, and I knew that as soon as I read Bernanke’s 2006 Jackson Hole paper, which, I think, was really his application essay for the job. He very clearly laid it out, and it, of course, has been quoted widely and famously, and this is where he gets the helicopter moniker and all that. I am just the kind of person that says look, if somebody says they are going to do something and then they actually do it, there is no real mystery as to what just happened there. I know people are still on the side of the view saying that deflation is still the more powerful force; it is going to overwhelm the ability for the Fed to respond. Bernanke can have his magic printing press all he wants, but the forces here are just too large, too structural, and too embedded. Perhaps something like we see going on in Europe; it is just too big for the system. So you call it a political economy, thinking of the Fed maybe as part of that, or if you want to parse that out further, feel free, but how do you fall on that spectrum? Do you believe deflation, the markets, etc., are larger than the Fed at all, or do they have a number of tricks up their sleeve yet? In fact, can they continue this game for a lot longer?
Eric Janszen: Well, Chris, I have been hearing this argument from the deflationists since 1998 when I first started iTulip. I remember the first time was we had this big stock market bubble, and I was debating various economics analysts on the likely outcome event. And many of them thought that when the bubble finally collapsed we would have a deflationary depression like we had in the 1930s, the stock market bubble would crash like the stock market of 1929, and so forth.
I tried to explain to them that we, not being on the gold standard, that there was nothing limiting the ability of the Fed to expand its balance sheet to do two things. One to provide liquidity and also assume to take bad assets out of the market and put it on its own. Since most people did not understand that is how the Fed operates now and the situations are different, I understand why they would be confused. And then what I heard back in 2006 when I reopened iTulip was the same argument all over again, but this time, Eric, it is going to involve the whole banking system, the entire structure of credit. There are just too many trillions of dollars, and the Fed can’t possibly back it up.
I said, well, when you look at the Fed’s balance sheet a couple of years from now, you are going to see trillions of dollars of mortgaged back securities and all sorts of other stuff on it, because that is what they said they were going to do. So the answer is, it is a little bit like arguing with somebody over and over again about whether the world is round or flat and you go around the world a couple times and they still do not understand what that means. It means that the world is not flat.
Chris Martenson: Right, you know, I do not know what the limit is to the Fed balance sheet. If you sat me down five years ago and said we are going to have the Fed balance sheet at 2.8 trillion, I would have said what, no way, but here we are. So could it go to five, or seven, or ten, sure; I cannot think of a technical reason why it cannot. Maybe a political reason, maybe a geo-political reason, so as I look at what the Fed is really up to here, though, maybe you could clear up one mystery for me. So Bloomberg does a big foia thing and pries out of the Fed the fact that they had either directly or through guarantees backstopped an ungodly amount of trillions and trillions of dollars in both domestic and foreign firms both official and private. My question to you is do you have any insight into why it is a lot of those guarantees never showed up in any of the statements I read? They did not show up in the Fed balance sheet in any way; are those extra off balance sheet things? Do they not count guarantees in sort of an accounting standard? Do you have any idea as to what we are looking at on the Fed balance sheet is truly a good measure of what they are on the hook for, or they any way guaranteed?
Eric Janszen: Well, this is one of the other challenges in talking to economists about our modern economy, because we have a finance-based economy, and most universities have economics departments, and the finance is taught over in the business school. So most economists do not really understand enough about finances to understand how our economy really works.
So when they are confronted with this question of deflation and who is holding the bag, if you actually take a careful look at the Fed’s balance sheet, the Fed — unlike any other kind of bank — can do magical things. For example, it can take what is a liability for a commercial bank and put it on its balance sheets simultaneously as an asset and a liability that cancels out to zero. So, for example, we will take a few hundred billion dollars in assets backed securities, put it in a Maiden Lane Fund (or whatever those funds are called) as an asset, and simultaneously on the ledger as actually a deposit is technically how it is listed. Before the crisis, the net holdings of the Federal Reserve were something like 35 billion, and after they took on a couple trillion dollars of bad assets, it is still 35 billion dollars. So it is much like some people, it is kind of magical, but in theory, as Greenspan said many years ago, the Fed can in theory expand its balance sheet infinitely. The unique characteristic of the way Central Bank operates is different from the commercial bank.
Chris Martenson: Oh, that really clears up a mystery for me. So unless we had access to some sort of audit access or records access, we do not really know. I think the Bloomberg data, when I started poring through it, really opened up my eyes to exactly that dynamic that you just explained. So thank you for clearing that up.
So here we have the Fed, the ECB, Bank of Japan, also Bank of England, oh, let’s not forget the Swiss National Bank, and probably some others I have forgotten to list, all basically printing at this point in various ways, or we can call it providing liquidity, but let’s be fair. There is as much being created out of thin air, in many cases here, to manage all kinds of things, exchange rate risk, and dynamics, to buy up bad assets, to push liquidity back into the system, to recapitalize banks, whatever.
So all the way back from the time I first was aware of your work, you had been a pretty big proponent of gold, and I think you were there right at the second when the market was the beginning of the previous decade. Talk to us about the connection you see between monetary policy now in gold, if any for you, and as well you also talked about rising gold prices as probably going to have several distinct phases. Which phase are we in now?
Eric Janszen: So, Chris, my thesis in waiting 20 years, I started watching gold back in the mid 1980’s and was very much a stock market bull for most of my career in the high technology industry from the late 1980’s until the early 2000’s. So it was not until 2001 that I finally made a decision to take a 15% position in gold; it was at the same time that we had sold our stock from our equity positions and technology companies and bought Treasury bonds in late 2000, and that wound up being the portfolio was gold and Treasury bonds and has been ever since. The theory behind it is that the system, a global monetary system, was very US-centric, was really designed back in a time when the United States was about 54 – 58% of the global economy. As of now, it is about 18%, so we have this US-centered monetary system attached to a much more broadly based economy.
So here we have this mismatch between the monetary system and actual structure of the economy, and here we also have the United States behaving with these asset bubbles in a way that is not consistent with the country that is the issuer of the world’s reserve currency. To qualify for that position, you have to really stand well above other countries in the world in terms of transparency and other factors that prove the legitimacy of that position, and I saw that beginning to erode back during the period of the stock market bubble and then accelerate during the housing bubble.
There was no Plan B in the global monetary system when it switched over to the US dollar reserve basis for global monetary reserves. The only fallback is gold, gold is the only reserve asset that central banks hold other than dollars, and to some extent euros, but it is mostly gold. So gold is the fallback. So what I thought was going to happen is that over time, gradually, that there would be an increase at some point in gold holdings by central banks as they hedged the marginal increase and the number of Treasury bonds that they needed to hold as a result of conducting trade with the US and also simply maintaining the US economy through low interest rates and providing sufficient investment to continue to offer the US government.
So what is very interesting to me is [that] starting in the second quarter of 2009, right after the financial crisis, is when global central banks became net buyers of gold, which to me indicated that they had as a group, determined that it was time to more seriously hedge their dollar assets, even as they continue to buy Treasury bonds to increase their hedging.
Before that, there were effectively two teams: There were the buyers, who were countries like India and Russia and China, and the sellers, which are most of your European countries. And that structure of the gold market occurred and was maintained until the second quarter of 2009, and it shifted to a much broader base increase in the number of governments participating in the gold market, including Saudi Arabia, Mexico, and other allies of the United States.
Chris Martenson: Right, so we have the United States here operating the reserve currency, doing it poorly at some point. Because another piece I would like to toss in here is the current account deficit driven by the trade deficits, primarily, which really started to the downside in the early 1990’s right around 1990-1991 and then just never looked back. With that, I also combined the fiscal deficit, which together current account plus fiscal deficit is a pretty whopping funding bill that needs to be supported and is half supported at this point by foreign official buyers and foreign central banks.
As we look into that, we see this thing called the custody account of the Fed, which is one main repository for some of those reserve Treasury holdings and also agency debt, and it is just a whopper. I mean, Eric, when I look at that account, what I see is it is not driven by the response of the crisis in 2008. In fact, you can start in 2002, put a ruler under that current account and just draw a line about 45 degree line up to about a little over 15% annual compounded accumulation in that. What was driving that — and again, it is not in my mind linked to the crisis we’re in, because you cannot see any wiggle in the trajectory in 2008 or 2009 or 2007; there is no bump in it, it is just a ruler shot from 2002.
Are you saying that that was primarily driven by this, lets call it international global vendor financing, is that the mean dynamic behind that, or is there something else here?
Eric Janszen: Well, Chris, I think there are a number of theories to explain. Well, two things, the growth rate and the consistency of it. If you look at net capital inflows to the US, they grow when the US economy is growing, and the composition of those changes over time between official and private investors. But what is really important is that the growth rate overall be generally maintained in order to ensure markets that there is sufficient inflows to fund US economic activity.
It is probably not particularily well known, but back in 2003 when we had our earlier crisis, there was a point where 70% of the US government operations was being funded by foreign purchases of US debt. So the way the country operates is there are certain times when counting largely on domestic purchases, other times on foreign purchases but fundamentally we are kind of all in it together and this is the way the system works. The Chinese are not all that happy about having all the US Treasury bonds they have, but they know perfectly well what would happen if they were not buyers. On the other hand, they are behaving as if, okay, well, we will buy them, because you know we have to, to maintain the system, but we are going to buy more gold to hedge the risk that investment in US Treasury bonds represents.
Chris Martenson: All right, so I wanted to cover that territory just a little bit, because if there are two places that a foreign official buyer or central bank is going to stash their money, one is in Treasuries and obligations like that to maintain the system, preserve the status quo. The other being the gold holdings, and so you saw that secular shift away from being net disorders of gold to net accumulators of gold, it is a fairly recent shift, historically speaking, to become accumulators again. Does that change where you think we are in terms of the phase of gold prices at this point? Do you see a sharper trajectory now as the world monetary system experiences the slings and arrows of the fortune here, of certain difficulties, or do you think we are still in a phase of steady rising prices if even that?
Eric Janszen: Well, that is an interesting question, indeed. It has gone through a number of phases. When I first got into it in 2001, gold was widely derided as a terrible investment and had been going down in price for over 20 years. If you open the Wall Street Journal, you would have to dig around to find any price, never mind a mention of it, and it did not really become a topic of news until quite a few years later. But the fact is it has been going up in price every single year, year after year, for ten years, and in fact, the rise has been so consistent that it has, with respect to almost anything else, particularly stocks, has been much less volatile and more consistent with its rise.
So this is to me indicative of this overall trend which is, I would describe it as, a dissolution of the US Treasury dollar-based monetary system. And that process of dissolution is going through various stages, the most recent one being global central banks becoming net buyers, and you probably saw a recent jump in prices the last couple of days. You can be pretty sure that what is going on in Europe right now is driving some additional sales. I think it is important to understand also that what you can read about who is buying and who has what by looking at the bank for international settlements reports is somewhat limited. I am aware of individuals that as families that are buying very large quantities of gold, in the order of tens of tons, that are not going reported there.
Chris Martenson: Well. it does not take very many families accumulating tens of tons to distort a market that is actually fairly tight when you look at the total gold market. I know a lot of dollar value of it flips every day, but in terms of the physical market, I have seen some work by Eric Sprott that really details what the physical market actually does, and it is a lot tighter than many sort of suspect the paper markets that give us some churn in the appearance of liquidity. But it is not a very big market. Lets put it that way, compared to the dollar flows that are available to siphon and funnel into one market or the other.
Okay. so I want to ask, so let’s talk about for a second, does Peak Oil, I know Peak Oil factors into you macro view a little bit, but if you could just tell us how Peak Oil, maybe peak other natural resources, how do these play in? We have got Jeremy Grantham recently I think really going off the reservation in terms of his investing style to really put his mark down and say look, there is a big looming story here, and he calls it a paradigm shift. I am certainly in that camp of thinking that anybody that has got a, say, an endowment or a pension timeframe to their thinking certainly has to be considering this story, and I argue everybody should because we are there, that is my view. What are you views on this and how do you weave this into your macro view?
Eric Janszen: Well, I met Jeremy Grantham, and he is obviously very wise and experienced veteran of the industry and has made some very good calls, particularly around the time when I was talking about the technology bubble — he was, as well, and quite clearly and rigorously. He has also started to build what I call Peak Cheap Oil into his models. It is a term that we adopted back in 2007 to try to distinguish between the overall physical fact of a reduction in the total amount of oil endowment and its impact on prices and on the macro economy.
So the fact is that there is a lot of oil out there still, and when I was writing my book The Post Catastrophe Economy, and I was interviewing people like Joe Petrowski who is the CEO of Gulf Oil and others to try to understand the industry perspective on this process. It became pretty clear that we have gotten in a relatively short period of time, really the last 40 or 50 years, from all that was relatively inexpensively extracted with relatively primitive technology to oil that is increasingly more expensive to extract and produce with extremely sophisticated technology. So I think to understand how wildly sophisticated technology is these days for oil production, you have to look at what is actually done, that the big shift that improved oil production over the last ten years has been in computers.
So we had a lot of data about where the oil was, but not a lot of computing power to crunch the data to determine exactly where the most likely sources are that can be economically extracted. And he used to take a bunch of Cray computers and now just takes a couple workstations. So the good news is we know where the oil is; the bad news is we know where the oil is. Meaning that it is very unlikely to be any large quantities that have not already been located and the economics of their extraction been determined.
Chris Martenson: And not just the dollar economics, but the energy economics as well, and clearly we are pouring a lot more energy in to get slightly less back out and increasingly less. And of course we run our economy on the net of those activities, whatever the price may be. It certainly is a view that I think anybody who has been solely focused in just the economics sphere really needs to start paying attention to it. It is one of my chief complaints