Jim Grant Sees an Era of Higher Rates That Could Last For Years

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1:26Hello, and welcome to another episode of the All Thoughts Podcast. I'm Traci Alloway. And I'm Joe Weisenthal. Joe, did you see the jolts number that just came out? We are recording this May 31st, 2023. I did. Job openings back up, you know, that's the thing. Like, they keep thinking, oh, the labor market's going to cool, it's going to cool. But here we are, over 10 million job openings again. Right. So job openings far exceeded, I think, any analyst estimate. 10 million openings for the last month. And I guess the question is, the market seems to be of two minds here, right? You have a lot of people who seem to be talking about the inevitability of recession, and yet you have the data that's still coming in stronger than a lot of people are expecting.

2:09And of course, those two things are related because if data keeps coming in stronger than expected, then maybe inflation doesn't start to go down and the Fed has to hike even more and it pushes the economy into recession. But it does feel like not only is there a lot of doubt at the moment, but we're sort of heading in two possible polar opposite directions? Well, the thing that I keep coming back to is striking is if you told someone, you know, at the beginning of, you know, January 2022, you know, when rates were at zero, that by spring 2023, we'd be at five and a quarter on the Fed funds rate.

2:42Everyone's like, oh, you know, the market would have crashed. We'd be in recession, et cetera. And yet here we are with more than 10 million job openings. And something that we've talked a lot about is like, you know, the entire 2010s was sluggish growth. And everyone's like, oh, this is the pickup. This is when inflation is going to come back. And it doesn't. And so far this decade, it feels like, OK, this is finally when inflation is going to roll over. This is when the recession is going to happen, et cetera. And these expectations get kicked forward. Absolutely. And I'm glad you mentioned interest rates just then.

3:13And I mean, the implication is kind of we've had years of people warning about what's going to happen when interest rates rise. Is it going to lead to an explosion in interest rate costs and things like that? And we have seen some bankruptcies, but we're still sort of at this inflection point, it feels like. So I'm very pleased to say that we have the perfect guest for this episode. We are going to be speaking with the man, the myth, the legend, Jim Grant, the founder and editor of Grant's Interest Rate Observer and a longtime longtime commenter of financial markets. I've been a fan of his work for many years.

3:47So I'm so glad we can finally have him on the show. Jim, thank you for coming on. Tracy, it is lovely to be here. And yes, interest rates are a thing again. I began to doubt the efficacy of my business model. People are observing. People want interest rates observed. It is a good time for observation. Well, maybe that's a good starting place. But how would you characterize the current period in markets versus the trajectory of history? You've been through and written about many interest rate cycles at this point. Well, first place, I would call it good copy. This is what we like. It doesn't matter up or down.

4:25Just give us some good copy. Yeah, we don't want peace and quiet. Well, there are so many singular features and dogmatism has been, I think, I hope has been expunged from the conversation. and it's hard to dogmatize after 2020, 21, et cetera. What is new and different is, for example, interest rates have gone from nothing to five plus on the short end of the yield curve. And wouldn't you suppose that the homebuilders would have taken a big, but instead the homebuilders are right behind NVIDIA as the stocks and what you would think that they produced computer chips rather than two by fours. But the homebuilders made new highs recently.

5:06And you know why? Because rates have kind of put interest rate handcuffs on people who are in possession of one of these sweet mortgages, beginning with the numbers two or three or four. I think most of the homeowners now that have loans have something less than five. So people aren't moving and there's no supply. Oh, I exaggerate slightly. But there's little supply. And the homebuilders are hot-footing it into that gap. And they are coining money with huge margins and great perplexity all around. So you're speaking our language on multiple levels. You mentioned semiconductors with NVIDIA, 2x4s.

5:47We've talked lumber. We've talked homebuilding. So what does that say then about our efforts to fight inflation? You know, we think of housing as like the ultimate rate-sensitive sector. And yet here we have homebuilders close to all-time highs despite the surge. What does that say about, I don't know, perhaps the Fed's toolkit in fighting this kind of inflation? Well, the Fed only about two weeks ago was propagating it. All the central banks of the world for years and years were bemoaning the fact they could not hit their 2 % arbitrary, mind you, the arbitrary 2 % inflation target. And the Fed as recently as the Jackson Hole speech of 2020, that remote Jackson Hole conference, Chairman Powell said, you know, we are going to search for a flexible inflation target.

6:35And if it's too low, we will overshoot and thereby bring the average over the cycles up to more than 2%. Now, that was, it seems to me, that was kicking sand in the face of the fates. Right. And so there's a bureaucratic dogmatism in the Fed. They've got these algebraic models. My goodness, how formidable. They look on a blackboard, but they don't actually function very well so far as the future is concerned. And the Fed was, in fact, dogmatic through 2021 into 2022 by mortgages recently, I think, as March 2022. So you asked about their inflation-fighting tools. Uh-uh. They're rusty, should we say.

7:17Well, just on that note, I mean, walk us through, why haven't the interest rate increases fed into the real economy more? Like, why are you not seeing house prices go down? Why are you not seeing the much anticipated wave of bankruptcies that people were warning about for, you know, many, many years after the 2008 financial crisis? Well, I think house prices have, in fact, gone down. Is this phrase existing house prices? That is the ones that are not imaginary. So existing house prices are down. New house prices are down from their peaks, you know, 8%, 10 % if I'm memory serves. But the point is well taken, Tracy, that, you know, the phrase I think is, something will break.

7:57Right. And I was of the view, am of the view, that try as Jay Powell might to emulate Paul Volcker, Mr. Powell is not working with Paul Volcker's economy. He's much more dead, therefore much more fragility. You know, people are head over heels over private credit. They contend that this is a not quite NVIDIA quality breakthrough in history of finance, but it's up there. But, you know, private credit is a manifestation of the seeming imperative to build leverage, whether it's on the federal level or the corporate level, not quite so much recent years on the individual level. So there's a lot of leverage.

8:37And I would say, Tracy, that with respect to the paradox of nothing breaking much yet, just be patient. I expected it might. It's coming. Where do you see vulnerabilities? You mentioned fragilities. Where are they? Private equity is one. I think private credit will be shown to be rather oversold as a breakthrough. I don't think it's any such thing. Actually, how do people think about, why do people think that there's something special about private credit? Well, I think the story goes that the lenders of private credit are more flexible. They have commitments by their limited partners to supply funds.

9:16They are not constrained by banking regulations. They are kind of a new breed, so the story goes. But they are lending to an important extent to software companies, which famously lack gap profitability. they are lending to the very same people that the public credit markets are lending to, but they're doing it at a somewhat cheaper rate. They're not doing it on a rated basis. So Moody's is not getting the ratings business it did. I don't know. The whole private credit business sounds to me as if it were the same wine in slightly more presentable bottles. Just on this topic, there's a line that you wrote many years ago now, and it kind of lives for free in my head.

10:02And it's slightly random, but it's basically in Valiant, a financialized age has produced a financialized pharma company. And I used to think about that quite a lot in the context of Valiant, of course. They borrowed a lot from markets cheaply. They bought a lot of companies. They used interesting accounting techniques such as ad backs to boost their valuation so that they could keep borrowing. And I wonder how much that type of financial financialization, in your opinion, is reflected across the market and across the economy, not just a valiant specific type thing. Well, I would say that it is rather endemic.

10:41I guess we ought to define it. What I mean by it, Tracy, is the finance for the sake of finance, not for the sake of making a better product, but finance for the sake of making money through structure, through fees, and the like. That's financialization. And you see it, again, in private equity, there's this thing called ad backs. Ad backs are a form of sly manipulation of cost structure. So you do a deal, you buy a company, and you say, we will lever it, meaning we will encumber it with debt to the extent of six and a half times EBITDA, this kind of non-gap measure of earnings. And the reason it's 6.5 and not 9.5 is because we project savings through the great managerial improvements that private equity invariably introduces to its - Synergies.

11:37Synergies everywhere. Yeah, to its portfolio companies. And don't you know that S &P does an annual ad-back study? That's the age in which we live. There is an ad-back study from that you can wait for every year. and it shows that most of these promised savings, Tracy, don't be shocked, don't materialize. But the fees surrounding them are paid. So that's an example, one micro example of financialization. I think it's all over the place.

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14:11Since you mentioned NVIDIA twice already, I feel like the NVIDIA chart would make a lot of sense to me in the year 2021 or maybe 28, 2019, during the sort of like ZERP heyday when we associated low interest rates with booming tech stocks. But here we have the chart. It's not ZERP anymore. We're at five and a quarter percent. And yet that hasn't extinguished this sort of like animal spirits of the market to pile into some really hot area because AI is really exciting. What does that say about some of our assumptions about the relationships between investment and animal spirits and speculation and rates when we see this sort of activity at a time of five and a quarter interest rates?

14:54The wonderful thing about financial markets is that we keep on stepping on the same rake. In science, progress is cumulative. We stand on the shoulders of giants, but financial History is invariably cyclical and recurrent, which helps a lot if you can recognize patterns. Scott McNeely, who is the CEO of Sun Microsystems, gave that terrific little speech, I guess on Twitter maybe. It was an exasperated and rueful expression. It was kind of a post-mortem of the dot-com bubble, which now is so deep in the historical myths. But Sun was trading then at 10 times earnings. and Mr. McNeely said what do you have to do no 10 times revenue right sorry revenue of course sorry I didn't mean that I just want but I think it's important to understand that's the last line darn okay sorry so what he would have to do what do you have to do to break even with 10 times revenue well over the course of 10 years I would have to send you every single dollar so no more R &D no more salaries for the employees no taxes oops no taxes etc so he went through this exercise and he said and at the end he said why did you pay 10 times revenues?

16:03Okay. NVIDIA is like 35 times revenue. So that's 35 years of that. No cost. No employees. I read. No CapEx. No R &D. No taxes. I read somewhere that NVIDIA has introduced AI, which is TAN about. In fact, equal to, yeah, equal to TAN about, the invention of fire. It's the new fire. Tam on that's got to be huge. Yeah. That's always the warning sign, right, Tam, when people start talking about total addressable market size. I have a slightly personal question, but I've always wondered this. Do you consider yourself more of a journalist or more of a financial analyst? Journalist. Journalist. And how does that influence your work?

16:46I hired Evan Lorenz. He's a great financial analyst. Yeah, he's great. He's very good. But how does that inform your own work? Evan. well I started not quite a one man band it was never exactly a one man band this is our 40th year but for many a year there was no Evan there was often someone to lend a hand yeah there was a lot of help I have gravitated to journalism I think more than the really deep diving financial analysis I'm interested in history as well have read a lot written some You wrote a book on Badgett, right? Yes, I did. Walter Badgett is kind of the muse of contemporary central banking.

17:32They invoke his dictum about, in a crisis, they will say, the contemporary central bankers will say, lend freely to everybody, which is very much a paraphrase of Badgett's, lend at a high rate against suitable banking collateral to solvent institutions, et cetera. I just want to say, I thought you must have been exaggerating when you said the 35 times revenue, but you were like, I was like, that cannot be right. It can't be 30x revenue. But no, fiscal year 2024, the estimate for NVIDIA revenue is 40 billion. It's a trillion dollar company. And so, yeah, we're basically at - It looks like a typo.

18:12But we published it last night, and I say, no, please. Because even like looking at fiscal year 2027, currently on the Bloomberg, I find it's only at$77 billion. So even like you go out to$27, you're still like at 15x 2027 or 14x 2027 revenue. Bloomberg, which can get anyone on the phone, ought to call up Scott McNeely and say, what now? Let's do that. Let's do that. That's a really good idea. Scott's really – those earnings calls back in the day were really fun. Can I ask a question? You mentioned dogma. You mentioned the Fed's rusty inflation-fighting tools, which maybe understandably, because for the previous decade or really even longer, maybe the impulse was reflation and why are we missing on the downside, et cetera.

18:57What did that period teach you as a historian of financial markets, a student and someone who's like, what did the period of like 2009 through 2020, in which we had large deficits. We had this exploding size of the Fed's balance sheet, and yet this sort of inability to generate inflation. What was your sort of looking back on that decade? What is it? Well, it was very humbling for me. What I took away from it is that the inevitable is always certain, but not always punctual. I look back at some of my work there, I was rather impatient for the inevitable difficulties and crises attending upon this credit creation jag.

19:38I thought certainly it was going to happen like Tuesday or so. So it's like the elapsed time between the first signs of house prices going way above trend on the one hand and the onset of the housing-related credit difficulties of 2007, 2008, and 2009. that period of six years was approximately 20 years in journalistic time if you were a little bit too insistent upon yeah well just on this point let me ask a sort of devil's advocate question because i had you know a similar trajectory sort of i wouldn't compare myself to you obviously but you know post 2008 i wrote a lot about excesses in the corporate bond market And it seemed very clear to me that eventually this would blow up.

20:26It didn't really. And we could argue that maybe the time is coming for some of those excesses to get flushed out of the market. But it does feel like the solution to a lot of financialization is more financialization, or at least it has been so far. So for instance, with corporate bonds, when there was stress in the market, the central bank comes in, props up the corporate bond market through the bond buying program. Why can't that continue forever? And what is the tipping point at which financial solutions to financial problems is no longer viable? A tipping point was six years ago. That's very specific.

21:09My impatient clock, it was a long time ago, but it did not tip. So why can't it go on forever? I know there are always, these excesses do crop up. They are met with additional stimulus, intervention, manipulation, and still we go on. Who said there is a deal of ruin in a country? I guess that was Adam Smith. And there's a great deal of ruin, so to speak, in finance and manipulated finance. One of the singularities of the present time is the American position in international finance. This is countries emits the reserve currency, which means that we consume much more than we produce. We finance the difference with dollar bills that only we can lawfully print at a most reasonable price of like nothing.

21:57And we remit the dollars to our creditors, mainly in Asia, say. And those dollars don't leave the country because they come back in the shape of treasuries and mortgages purchased for the portfolio interests of our creditors. So that is kind of a new thing in the long historical sweep. It's not so new in terms of years, but in terms of phenomena. The reserve currency country being a chronic big debtor, that's kind of a different thing. Reserve currency country living on the kindness of strangers, so to speak. It's not exactly writ. So the more one learns, the less dogmatic one becomes about timing, certainly.

22:38Well, that actually leads to the exact next question, which is obviously currently today in 2023, there's yet another round of, oh, is the dollar going to lose its global status? But we've been hearing that forever, right? We heard that certainly after the great financial crisis. I think pre-great financial crisis, there was a lot of talk about the euro and we've talked about it on the show and who is the model that flashed euros. This is not a new thing. So when you think about like, okay, like timing is really tough with this stuff. Like, does it feel new? Does this moment feel different than past times when people had dollar status anxiety?

23:15Well, some of the rhetoric's the same. You know, I guess by definition, the excesses are greater. The U.S. international financial position, which is a piece of data that comes out every year about this time, It shows a deepening deficit between what we own of other countries' securities and businesses versus what they own of our securities and businesses and public securities. So the deficits deepen, but still, what's the competition? Turkey is mad at us and wants a different currency. Iran, ditto. China and Russia are the same, but I don't see those as strong competitors for an alternative currency.

23:57I see gold as a perennial option. Unfortunately, too few people share my enthusiasm for that. I wish perhaps Bloomberg - It's everyone else who's wrong. Perhaps Bloomberg could help along those lines as well. Well, just on this note, I mean, we were talking about NVIDIA. When you see markets react like that, what do you think is happening there? What is the thought process of an investor who says, I'm going to buy NVIDIA when it's up 40 % in three weeks? Well, I have a couple of things. First of all, again, under the heading of you never know, which I have come to embrace as a sound journalistic and life principle, there is a possibility.

24:38This time, it is the invention of fire part two. So one holds a mind share for that. I think more likely is that this is part of the muscle memory of a generation of 0 % interest rates and all-you-can-eat credit. The great all-you-can-eat credit buffet table was open for business for 10 years. Interest rates fell from 1981 until a couple of – actually, a couple of weeks ago. It's called 40 years. So that's a lot of muscle memory. Yeah. Central banks have intervened predictably until fairly recently when markets shuttered. Look what happened in 2019. The repo market, this obscure recondite thing caught a head cold in September, and the Fed resumes QE.

25:26They didn't call it QE. It's not QE. Yeah, it was QE. So naturally, people assume that the upside is the side to be on. It takes a true contrarian, almost a bloody-minded contrarianess to butt one's head against that, but it's a living. So why do people do it? Because A, because cyclical memories are short and cycles are recurrent, and B, because it has worked. Quote, that phrase ought to be in quotes.

26:03Thank you.

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