Bessent’s Mentor Stanley Druckenmiller Calls Bond Buying a Mistake

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2:14Carol Massar:Daily Podcast with Carol Masser and Tim Stenevek on Bloomberg Radio. Billionaire Stanley Druckenmiller out with some harsh words for Treasury Secretary Scott Bassett. Druckenmiller writing in a Wall Street Journal opinion piece, quote, Governments defending prices against fundamentals always lose. The only variable is how much they spend before conceding. The U.S. shouldn't put itself on the wrong side of that trade, not with the most important price in the world, and not when that price is trying to say the one thing Washington most needs to hear. Let the bond market speak. Druckenmiller's comments coming off the back of Treasury last week, announcing an increase in purchases of long-dated bonds.

2:56It's a move that markets are interpreting as an attempt to push down yields. We knew there was one person we wanted to talk to about this because it was just a year ago that he had the Bloomberg Businessweek cover story about the Treasury Secretary. You can see the cover right there if you're watching us on TV or on YouTube. And for that story, he interviewed Stan Druckenmiller. That's Eric Schatzker. He's the editorial director of Bloomberg New Economy. He joins us here in the Bloomberg Businessweek studio. Eric, I want to get into Druckenmiller's history with the Treasury Secretary, with George Soros.

3:25Before we do that, why is it such a big deal that he went to the journal with this opinion piece? Well, first of all, the journal is the place that Stan Druckenmiller typically goes if he wants to make a public statement. So that part of it is not unusual, but he does not do this very often. So pay attention when he does. And why do we pay attention to Stan Druckenmiller? Because few people would argue that he is the best investor in modern history. Never a down year when he was running Duquesne Capital Management. He was George Soros' chief investment officer. He hired Scott Besant in 1991. He sent Scott Besant to England.

4:04It was on the basis of information, partly on the basis of information that Scott Besant was providing, working for Soros Fund Management in the early 1990s, that Druckenmiller and Soros decided to bet against the British pound. They shorted it and broke the Bank of England. And it is that fundamental truth that governments defending prices against fundamentals always lose that was proven there and which Druckenmiller argues will once again be proven here. So take us to today and we'll actually to last week because we do need for the benefit of many to review what sparked this disagreement. Or this right post from from Stan Druckenmiller, which, by the way, you cannot not look at as anything but a harsh scolding.

5:02Right. The mentor publicly admonishing his protege. And it would also add for those who haven't read it, go and read it. if you're lucky enough to have a Bloomberg terminal it's simple nh space wsj put in Druckenmiller as a keyword it'll come up you can of course read it in the Wall Street Journal you would look you will look long and hard to find a piece of writing this savage and this devastating I mean that so last week the treasury announces that it is going to double the size of its long term bond buyback program from$2 billion to$4 billion. And then Besant doubles down effectively and says, well, we might spend more than$4 billion.

5:48And Druckenmiller says$4 billion understates the gravity of this mistake. And I have, for my own purposes, broken it down into four component parts. This is how Druckenmiller dismantles the argument behind a long-term bond buyback program. Number one, it's unwarranted. There is no crisis. Yes, yields are rising, but that is the market functioning the way it is supposed to function, right? Pricing in the growing risk of two things. One, inflation or more inflation. We have some already, obviously. And two, the growing possibility of a US government default. This is what the bond market does. It's not March of 2020.

6:33This is not the 2022 crisis in UK gilts, right, that cost Liz Truss her job as prime minister. There were, as Druckenmiller points out, no failed auctions, no dealer balance sheet seizure, no forced unwinds. Number two, it's hypocritical. Who was more critical of quantitative easing? Maybe some people, but few more vocal and more aggressively so than Scott Besant. And Druckenviller points out that this is effectively a version of QE. And so what you have, what the other thing he hated about QE was that, Besant that is, he made the case that it was a blurring of the lines between fiscal policy and monetary policy.

7:17And here you have the treasury department, the treasury secretary, usurping the authority of the Fed chairman. Number three, going back to this idea of fundamentals, it violates one of the cardinal laws of the financial universe, right? Governments will always lose when they try to fight fundamentals. Again, I mentioned that this is exactly what Druckenmiller and George Soros proved when they bet against the Bank of England. And as Druckenmiller says, this is another useful quote to draw from this essay. Once markets believe Treasury is defending a price, every rise in yields becomes a test of official resolve.

8:00And the operations must grow to survive the tests. Well, that raises an inevitable question. If it's a fight, effectively, between the policymaker and the market, how much ammunition does the policymaker have? Not enough ammunition to defeat the market. Well, it raises the question, and the journal piece doesn't go into this, but it raises the question about why the Treasury Secretary would do such a thing right now. You describe it essentially as out of character given his past comments. And I think it's fair to say, given his hedge fund history as well, why do something like this? Well, the most obvious answer to that question is that it's becoming awfully expensive for the federal government to issue long-term debt.

8:48The federal government needs to finance its deficit and its debt. And doing so means issuing treasury bonds. Well, issuing treasury bonds when your yield is at 470 is a whole lot more expensive, a whole lot more costly to the government and ultimately to the U.S. taxpayer than it was when yields were at 370. We could do the math, but it's the, let me just put it in Druckenmiller's words. The real problem is the fact that the government is running an outsized deficit. In fact, the real, so the nominal rate of growth, right, is approximately, is actually higher than the yield on the 10-year treasury.

9:34And he says that that historically is an accommodative circumstance. If anything, the market should be pricing yields higher because it fuels, you know, that financial accommodation or economic accommodation fuels inflation. And the reason this is the most read story on the Bloomberg and the reason that this is transfixing Wall Street is because of the implications. And this is the fourth reason that Druckenmiller cites, or at least my interpretation of his reasons, is that it's hazardous. Right. The long term treasury yield, as Stan says, is the most important price in the world. And furthermore, it is underpinned by central bank independence, the independence that was enshrined in the 1951 Treasury Fed Act.

10:24It is the bedrock of global financial markets. Stan says again in this piece, U.S. policymakers built the wall between debt management and price management for a reason. This intervention, he is specifically referring to the buyback program. This intervention starts dissolving it. So it's not just like we need to think about this in something other than just the short-term dynamics of the bond market. Whether Scott Besson will or will not win in his effort to bring down long-term yields. There are much bigger questions and much bigger implications at issue.

11:03Carol Massar:Well, when you think about Bessent and you think about Washington, do you think that Washington is remotely prepared for the economic and the political pain that would come with potentially allowing the bond market to set the price at the long end? You know the answer to that question. No, of course, because it probably means it means cutting spending, right? He makes the point in the piece that neither party does it. Right. Yes, exactly. Both Republicans and Democrats are guilty of this. Everybody has been kicking the can down the road. But now with bond yields where they are, interest payments exceed the amount of defense spending and defense spending vastly exceeds the amount of discretionary spending.

11:43So where can you cut? The only place arguably, and I'm certainly not advocating for anything one way or the other, but the only place arguably to cut, says Druckenmeller, is entitlements, entitlement reform. Nobody wants to undertake entitlement reform because it's so politically perilous. Yet where else do you cut if you need to reduce the deficit and bring and restore fundamentals to a point where people have confidence in yields and aren't, you know, gently or maybe in some cases not so gently driving them higher. Or and I'm going to say something crazy, Eric, maybe increase revenues. Well, that's another way of doing it.

12:24But of course, it's restoring fiscal balance to the equation. But there's no doubt here that and Stan has been consistent on this for years and years and years that he would prefer that the balance be restored by a spending cut. Once upon a time, you had options. Now effectively, there are no options. Given then entitlement. I want to make sure people go back and read the cover story for Business Week that you did on the Treasury Secretary a year ago. and reread it if you haven't read it in a year. But given your experience reporting that out, were you surprised to see this move from Treasury last week?

13:03And given your understanding of Scott Besson's investing history, who he worked with. I, and I'm reluctant to opine because opining sounds like editorializing and that's the last thing in the world that I'd like to be accused of. that he wanted to be an unconventional treasury secretary was to me self-evident. And thus, some of the announcements that he's made and some of the things that he has done are consistent with being an unconventional treasury secretary. He was almost in a unique position coming from his background as a hedge fund manager and becoming a policymaker the way that he did, there's very little precedent for that.

13:51And as a macro investor, you're constantly wrestling with these kinds of questions, and you're constantly questioning, you're constantly doubting what policymakers do, playing the role of armchair quarterback and thinking to yourself, I could do that better if only I were in that seat. Well, now he's in that seat, and he is running some unconventional plays. There is no question about that. But some of these plays come with risks of their own. The thing that I do want to mention about this piece that I found so, as I described it earlier, right, as savage and devastating, it's because of that foundational relationship between Druckenmiller and Bessett, which you can't ignore when Stan chooses to write an essay about treasury policy.

14:41and that to me what I read between the lines is profound a profound sense of disappointment and and Tim you and I were talking about this earlier because it's really something that maybe I'm overstating the case here but we've all been in a mentor protege teacher pupil relationship in our lives there's always been someone whom we've looked up to and the hardest thing in the world to take is the moment when that person looks you in the eye and says i'm really disappointed and that's what i read here eric there's a reason we wanted to talk to you about this you are the guy who wrote the story and you've spoken to both of these men quite a bit over the past few years eric schatzker editorial director of bloomberg new economy he joins us here in the bloomberg business week studio check out his story from last year in Besant we trust in on the Bloomberg terminal and at Bloomberg.com.

15:40Stay with us. More from Bloomberg Businessweek Daily coming up after this.

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17:08Carol Massar:Listen on Apple CarPlay and Android Auto with the Bloomberg Business App. Or watch us live on YouTube. Gold is steadying after a four-day rally, adding 7 % just over the past week, powered by the so-called debasement trade that's back in focus after last week's surprise bond market intervention by the Treasury. Investors perhaps growing skittish about efforts to control the cost of the U.S. debt pile, with worries around inflation and the U.S. dollar pushing some toward the precious metal. We've got with us Axel Merck, president and CIO at Merck Investments. He joins us from Palo Alto, California.

17:42Axel, I want to get your thoughts on the intervention that we saw from the Treasury last week. And then, of course, what we heard from the legendary hedge fund investor, Stan Druckenmiller, earlier today. Start with just last week and the intervention, your view there. Sure. As you pointed out, Gold's been up over the last week, ever since that announcement, and I call it more of an announcement than intervention. Besson himself, he used the word signaling. It's all about signaling. And what better time to, quote unquote, signal something than the middle of August when liquidity is dry. And so you might be able to rock the boat a little bit.

18:24I don't think Besant is under any illusion that what he said would move the markets dramatically or change the course of the fiscal trajectory to say any of that sort. But for the gold investor, the answer was clear. The Fed cares about the rates and they might do something. And they don't know what they'll do. The bond market didn't move much, obviously reversed its course as well. Equity markets in general didn't move much. But the gold market reacted and it's the gold bugs that are particularly sensitive to these sort of statements because of what they might mean in the future. Lots of hypotheticals there.

19:03But that's the sort of thing that the gold investor is sensitive to because you don't want to be late in that. And given that there wasn't much announced on the fiscal side, although Besant did say a bunch of things why we might have reached a peak deficit, there wasn't much on substance on changing the debt trajectory. And so there were more gold buyers. And I'm not surprised about that.

19:25Carol Massar:Well, Axel, talk to us a bit about this debasement trade and what we're seeing there right now and why. Well, we have everybody works based on incentives and governments are incentivized to spend money and politicians are incentivized to win elections. They do that by not worrying about the deficit. And the gold investor says, hey, wait a second, maybe the interests of governments are not aligned with those of investors. And the one thing I think that hasn't gotten enough attention is Besson has gotten a lot of heat for what he said. But he's actually done, I think, the country a favor by putting the fiscal debate back on the agenda.

20:09Neither Republicans nor Democrats were talking about the deficit. He says a few words. And we all talk about deficits again. I think it's wonderful. But are we going to do anything about the debt and deficit? Well, we have to go to Druckenmiller. We've got to let the bond market do what the bond market is going to do to say, hello, we do care about the deficit. And there's one other thing I'd like to mention. Earlier, you had a guest on that said that the Treasury is taking away the job of the Fed. No, those folks have it backwards. The Treasury is the right place if you want to intervene in the markets, in the Treasury markets.

20:52It's the Treasury that's supposed to do that. The Federal Reserve should have never engaged in QE, should never engage in Operation Twist. And I say that in the context of Jackson Hole coming up where Kevin Walsh has an opportunity to provide more clarity about his philosophy, about his framework. I do not think Kevin Walsh would want to buy securities. He's the one who says, hey, I don't, the referee shouldn't be part of the game. And so if, and that's a big if, of course, one wants to intervene in the treasury market, treasury is the right place to do that in. And so that delineation, some people say what Besant did hurts the Fed in its job.

21:33I actually think it's an opportunity for Kevin Walsh to to help clarify that, no, the Federal Reserve is not going to be in those markets. And for what it's worth, they're not going to comment about what Treasury is doing. I think that's a clarification. And I think it's helpful for people to to help understand what the Walsh Fed is going to be about.

21:54Carol Massar:Well, you don't think that Bessett has tied Kevin Walsh's hands. And I want to know a bit more. Why not? We have Jackson Hole, of course, later this week. I want to know if you seem to think that this could give an opportunity for Kevin Walsh to speak on this at Jackson Hole, and if so, what he needs to say. Well, first of all, I'm in the camp that thinks where interest rates are going to be a quarter point higher, quarter point lower the next month doesn't really matter. The market is going to dictate that. Kevin Walsh has a huge reform agenda. Obviously, he couldn't just storm in and change everything.

22:30So he has all these task forces. And they're very meaningful. They're meaningful. And one of the key theme in those is to have the Federal Reserve do less. Notably that the Federal Reserve focuses on monetary, not fiscal policy. Monetary policy is about setting interest rates, credit supply, but not allocating that credit. and it is not about intervening in the bond market to do twists and turns. And so I don't know what he's going to talk about, but it would be an opportunity for him to take one of his task forces, all of them, and provide a bigger perspective. Some people are saying, oh, he's going to announce some action.

23:08No, he's not going to announce some action. It's a Jackson Hole is about big picture policy ideas. And so those that the naysayers are going to say, oh, again, he didn't raise interest rates. Of course, he's not going to raise interest rates in Jackson Hole. But he can get an understanding across where he's coming from. Everybody thinks, or everybody, a lot of people think that political intervention is about a tweet of the president. That's not what the Federal Reserve or Kevin Walsh Fed is concerned about. What the Walsh Fed is concerned about is that the Fed goes beyond its mandate, does things they're not supposed to do.

23:41That doesn't mean there aren't major fiscal issues. But Walsh was critical about extended 0 % environment that helped facilitate these deficits. Now he's taking a step back. Interest rates are higher. And the Druckenmiller philosophy is that's a good thing. And I happen to fully agree with that. The market needs to give politicians a signal. That doesn't mean they'll get their act together tomorrow. But the Fed cannot be an enabler of this and have the government help them to procrastinate. Axel, we're talking about gold rallying over the last week or so, but also what's rallied is Bitcoin just up about 10 percent.

24:20Excuse me, in the last 10 days of about 26 percent, it's been pretty remarkable. Trading close to$80 ,000 per Bitcoin. How do you view the role of Bitcoin with regard to how you view gold? Well, Bitcoin, I say, still wants to decide what it wants to be when it grows up. Gold has a proven ability to frustrate investors with a zero correlation to equities, sometimes phasing in, sometimes out. It was positive with real yields or very directly correlated with real yields during the Iran war in the beginning. And now it's decoupled from that. Now, clearly what happened a week ago is a signal to both Bitcoin and gold buyers, hey, Treasury might do something about the Treasury market.

25:07that was a go-ahead and clear for them. They serve different purposes. Bitcoin has been a little bit tightly correlated with the Nasdaq, and it's a speculative risk asset. I'm not suggesting it's necessarily always going to be like this, but for the time being, gold is the more quote-unquote proven diversifier. Of course, it doesn't always mean it's going to go up when there's a crisis, especially not when there's a supply shock, but the Bitcoin tends to attract more speculators and a lot of speculators were washed out during the during the volatility when the iran war started

25:42Carol Massar:if i'm an investor looking at gold after this run am i buying an insurance policy or am i essentially chasing a trade that's already gotten too crowded well there's all kinds of traders right i there will be those chasing a trend um they'd like to have a trend to have some legs um i happen to be a long-term investor. Anybody who has watched gold in recent years knows that the volatility can get quite substantial. In the long run, the volatility of price of gold is similar to that of the S &P 500, but it has these spikes. I happen to believe it's very difficult to time gold, but there are a lot of technical investors in gold, in part because the fundamentals are so simple.

26:21And if they know how to make money, good for them. But that's not my cup of tea. So what's the outlook for the rest of the year? I mean, if we – and look, I know you pushed back on the idea of intervention, but the outlook on gold for the rest of the year. Further activity from the Treasury Secretary notwithstanding, just very briefly, 30 seconds. We'll get nuances. The market, I think, the data is going to drive what's going to happen. We will eventually have slightly tighter policy. I don't know whether we're going to have a rate hike in September or December. Currently, that's what it looks like.