TDI Podcast: Decoupling Stability (#941)

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1:50October, will history repeat again? New tariffs announced again. Again, again, thinking about 401k plans and our guest today, Dr. Barry Eichengreen, professor of economics studies at UC Berkeley. All this and much more on episode number 941 of the Disciplined Investor Podcast.

2:27Hey, welcome to the Discipline Investor Podcast. It is October and welcome to October or maybe we don't want to be in October because the color of the month, the official color of the month is red. 25 % more volatile than other months and historically has been one of the worst months in all the 12 when it comes to stock markets. We know about that. Black Monday, Black Tuesday, the worst month during the financial crisis. Seasonality does not favor October. But then again, the bulls are buying and maybe it'll be different this time. We'll have to see. We see a lot of things that are going on right now that could push against and create some headwinds, like the new tariffs that were announced at the end of the week on pharmaceuticals, on certain trucks, big trucks, as well as kitchen cabinets.

3:22I guess that was something. And that is going to possibly be very significant because they're talking about 100 % tariffs on some things like pharmaceuticals, unless you have some plants you're already building here. And there's, of course, all these little openings to each of these things and their own little peculiarities. Is that the right word? Anyway, the bottom line here is that there are some things that are pushing and could impact October. But before we get to our guest today, I was thinking about something. You know, we had on last week Pat Camuso, and he was talking about taxation and about cryptocurrencies.

4:02And we really focused in on the idea of stablecoins. And that was something that I think was really interesting that – that was two weeks ago, actually. But why I was thinking about all week was because the new 401k rules that were enacted by executive order back in August. And what happened was the Department of Labor now is seemingly signaling this endorsement of private equity and cryptocurrency investments for investment inside of 401k plans. and for a very long period of time, both the cryptocurrency, as long as they've been around in private equity, has wanted to, I'll say, infiltrate the market, which has like trillions of dollars invested in it in defined contribution plans.

5:00And that was a big prize. Like if we can get in there, the automatic investing, even at three, four, 5 % of the total, which is the number that we're going to talk about, of course, as the number that everybody should have in their portfolio, because that's what they want a little piece. But all long access was restricted. There was this stringent fiduciary standards that was under ERISA, the Employee Retirement Income Security Act. And from my perspective, what I was thinking about this was that ERISA basically was designed to safeguard. And it was designed to protect retirement savers by imposing this very high fiduciary standard on the plan sponsors and the administrators too.

5:48So it was the employers and the sponsors and the administrators of those plans. Everybody across the board had this massive amount of fiduciary responsibility. And part of that was to safeguard the assets. So it required that those managing the defined contribution plans, in this case, the 401ks, act with this total loyalty and care, making decisions solely in the best interest of the participants. Okay, that's fine. And that also included applying a certain level of skill and prudence, due diligence. And that was really important. Okay, now, this whole framework that has been in place for a very long period of time, it served to protect, to create a barrier against inclusion of high-risk, non-transparent or opaque and illiquid investments inside of the 401k plan.

6:54And what are those two things that are now thinking about coming in? Well, they're opaque, high risk, illiquid, private equity, and cryptocurrencies. Cryptocurrencies being a little bit more liquid, of course. But that was basically designed to keep those kinds of things out of the reach of the average retirement investor inside of the 401k plan. They can do whatever they want outside of it. The idea was that while these asset classes Maybe had some great opportunity The elevated fees, the lack of transparency The sophistication you had to have To understand what was going on in these things I gotta tell you something I know a lot of very well seasoned investment advisors That really can't tell what the hell is going on Inside of some of this private equity Or some of these hedge funds So ERISA's intent was not necessarily designed to limit the opportunity, but it was really created and implemented to ensure that that opportunity didn't come at a major risk.

8:08That's what it was, really, that would swamp investors. So back in 2020, there was a little bit of a change.

8:21The Department of Labor issued some guidance that state of the private equity could actually be included in professionally managed investment vehicles within 401k plans. Provided that the decision was made in accordance with ERISA's fiduciary principles. which basically, it was weird because it opened it up, but then it closed it. But the idea that they were saying that could be done was a significant shift. So plan sponsors started saying, well, maybe there's something we could do here. However, the central idea, the tenant of all that was going on with ERISA and the fiduciary standards and the prudent manuals and all this other stuff remained with this fiduciary offer.

9:06Basically, employees that, or participants of 401k plans that had no idea and understanding of any of this, allowed them to have this access to this opaque investment with these huge fees rather than just index funds. Because a lot of them didn't even disclose where their capital was being deployed. So how do you have the mix of the ERISA rules and the fiduciary standards and all that with regard to this? And at the same time say, yeah, that's fine. But yet you have these investments that you have no idea what's going on inside of them. These are things that many professionals and sophisticated investors often say, no, I'm not sure I'm going to do that because very difficult to understand.

9:52So the question then was, why should retirement savers that really don't have that sophistication be the fallback source of capital, which is essentially what they want to do? So fast forward a year, 2021, under the Biden administration, the Department of Labor said, well, you know what? Forget it. They made a big cautionary comment about private equity investments and saying that these more complex plans that many fiduciaries might not possess the expertise, forget it. The warning was met with all this opposition at the same time from private equity firms, of course, and venture capitalists, of course, who saw it as a threat to their ability to raise capital and tap into this very lucrative and very easy pick-ins 401k participant plan.

10:42They'll just make it look good and they'll throw it down there and just check a box. Now, that pushback against the guidance escalated and the Trump administration intervened and urged the agency to reverse course. So the DOL, the Department of Labor, reversed their course, saying it had a chilling effect on innovation, unfairly cast doubt on the competence of plan fiduciaries, and effectively dismantled a key regulatory safeguard, clearing the way for this broader inclusion of alternative assets. And I'm a big fan of alternative assets, but not these inside of 401k plan. I think it's dumb. So this marked a really significant shift in the policy with regard to 401k plans.

11:31And that policy which prioritized expanded investment access. But the story didn't end there. Not only did this change shift and allow for the potential for private equity, venture capital inside of 401k plans, but also now cryptocurrency. Currency, another asset that's known for, as we know, volatility, complexity, and speculation. Right? That's kind of what it is. Now, the prudent standard was kind of being said that, well, if they're allowing that, well, we can allow this. And now it's on the green light of the whole thing. So that raises a lot of concern. We know Bitcoin's about, you know, somewhere between 3 to 10 more volatile than the S &P.

12:17And while individuals can speculate all they want, could this expose 401k savers? Which the 401k is the only retirement plan for most people these days. To find benefit plans, whereas you work for a company for years and all of a sudden they say, you know what? Thank you very much for your service. Here's 66 % of your salary for the next indefinite period of time, plus a cost of living adjustment. And then you're fine. No, now you have to put away your own retirement, augment it with some, obviously, augmenting Social Security, which is a small amount, but the company no longer is providing a major long-term benefit.

12:57So here's the deal. The deal is that this Department of Labor stance

13:09is showing this shift towards expanding investment choices. but it's also loosening of the framework that they have protecting individual investors that has governed retirement savings for a very long period of time. And by allowing these complex and high fee and speculative assets into 401k plans, the government is once again effectively transferring risk from sophisticated investors to everyday workers. You know, talk about, you know, hey, we got all this stuff. We don't understand it. Let's unload it on somebody else. Well, who's it going to be? It's going to be the people in the 401k plans.

13:49And many of those who lack the financial literacy to navigate these options. And that's why we have such simple investment choices in a lot of 401k plans. Many people don't understand what exactly it is to be in an S &P 500 fund. How are they going to understand how to be in the blah, blah, blah, private equity fund that's invested in leverage credit in certain sectors of the real estate industry? Seriously? I mean, that's just dumb.

14:21and there is a new sense of stress and volatility that's showing up in some of the private equity where they can't get access because interest rates are higher than they were and people are not ponying up money as they were before and alternative asset managers are looking for these new sources of capital and that's why they're pushing on this. Retirement plans, the 401k plan, obviously is their next frontier. But here's the question, just the, okay, with all that information, let's think about this. Let's ponder this. And I hope there's some people in areas of Congress or government or in power or maybe even plan administrators, employers that are listening to this.

15:08I really hope so. Because my question is very simple. Is this innovation or exploitation? Now, you know from what I've been talking, how I've been talking about it, what I've been saying, you know my thoughts on this. But what are you thinking? Are you going to allow this opaque, high cost, very sophisticated, very difficult to understand investment inside of your 401k if you have the choice? And by the way, if you do, are you going to take the responsibility as the fiduciary of that plan to allow it inside and then take the responsibility if it craps out with people that really had no idea what it was to begin with?

15:49Are you willing to take that risk? Is it necessary? Is it necessary? If most of the private equity can't actually be invested in anybody that has a net worth of under a million dollars or certain level of sophistication and understanding about investments, or on the other hand, we say, you know what? People could do whatever the hell they want to do. Who cares? I don't see it that way.

16:15Exploitation, innovation at the crossroads.

16:21So let's get moving on to our next section of the show. So let's talk a little bit about Interactive Brokers, because if you want to navigate political uncertainty, well, if you're a disciplined investor, don't panic. Because disciplined investors prepare. At Interactive Brokers, you can help protect your portfolio and hedge market risks with bonds, precious metals, and foreign exchange, all from one powerful platform. With advanced tools, global access, and low costs, IBKR helps you manage volatility and stay ahead, even in uncertain times. The best informed investors choose interactive brokers.

17:00To learn more, visit ibkr.com slash navigate. So let me tell you a little bit about today's guest. His name is Barry Eichengreen. He's George C. Pardee and Helen N. Pardee, Professor of Economics at UC Berkeley. He's Distinguished Professor of not only Eco, but Political Sciences as well. He's a leading expert on the international monetary system and global finance, and he researches all sorts of things. He covers the history of global financial crises, the international monetary system, economic history, and the causes and consequences of populism. He holds fellowships from several institutions, including the National Bureau of Economic Research and the Academy, the American Academy of Arts and Sciences, and has previously served as a senior policy advisor at the International Monetary Fund.

17:54So, Professor or Barry, how are you? It's been a long time. It's been, what, 13 years? 13 years. It's been 13 years. It's our bar mitzvah edition is what we're doing here today, I guess. So I have a lot of things to talk to you about. I want to start with some of the beginnings for people that don't know you. You have both a degree in economics and history. That is correct. I guess what's kind of interesting is I drew some lines together, but I wanted you to draw the lines together on how you combined both these disciplines in shaping your approach to economic analysis today. Well, I think there has long been a strand of economic thinking that recognizes the importance of and insight that can be gleaned from history.

18:45And that includes the history of financial markets, what you do, Andrew. There have been literally for centuries people who've looked back at earlier history to try to understand current financial events. The 20th century then saw the advent of what we call macroeconomics with the Great Depression, John Maynard Keynes and those who came after. And a few of us then began in the 1970s and 1980s to look at macroeconomic history, the history of business cycles, monetary and fiscal policy, and what can be learned from earlier experiences of value for today. And that's what I've been trying to do ever since I've been in the business.

19:34And it's been changing ever since, though. Well, it's always changing, clearly. When I started studying macroeconomic history in the 1970s, who could have anticipated that we would see the great moderation and then the global financial crisis and then the COVID crisis and many others? You've been doing this for a long time. We're going to go with decades. And you've been studying the international monetary systems for a very long period of time, writing some great things on it. What was, do you remember, what was your first major research project that you did and how it kind of shaped your long-term interest in this area?

20:18When I was a graduate student in the late 1970s at Yale, I was looking for a topic that would combine modern international economics, where I could do some theorizing and model building with history. So I ended up looking at the 1931 devaluation of the pound sterling and the tariff that Britain then imposed in 1932. How did the tariff affect the exchange rate? How did the exchange rate affect the tariff? And here we are in 2025 with Donald Trump's tariffs and a weak dollar. So that was the first project, and I seem to always be coming back to something closely related. I guess we talk about the whole history doesn't repeat, but it rhymes concept, right?

21:09Well put. You know? So you recently authored a paper where you looked at poly markets and the betting markets. And you looked at that, and you were looking at central bank independence. and I think you're talking about, you know, central bank independence under pressure. And it was kind of the central bank independence meets blockchain prediction market. Tell me a little bit about that. So that project was a lot of fun to do. I should shout out to my co-authors led by Ganesh Natraj, who's at Warwick Business School in the UK. But there were four of us together on that paper. So polymarket is a betting market that is populated by hunters outside the United States, but they can bet on things like what's the probability that Donald Trump will fire Jay Powell by the end of the year?

22:10What will the Federal Open Market Committee do at its next meeting? What will happen to 10-year U.S. Treasury yields in the next three months? And what's really neat about Polymarket is that the bets, the individual wallets are on the blockchain. So we don't know the identity of the bettors, but we know whether the same person bet that Trump would fire Powell and that the FOMC would cut rates. And that's what we see. The higher the more money you put on Trump firing Powell, the more money you put on the FOMC cutting rates at its next meeting makes good sense. It's Trump's man, new man on the FOMC, Stephen Muran, voted to cut rates even more than his colleagues.

23:07But the other thing we find is that those same bettors bet that the 10-year treasury will go up in the next three months. They're betting on more inflation, in other words, going forward. So people see how these things are linked. And the message I took from the paper is that Trump fiddles with Federal Reserve independence at his peril. And so far as he wants lower interest rates, so he may get a lower setting on the policy rate, but he may not get the lower interest costs that he's really after. This has been done and tried and failed in Turkey, Erdogan, right? I mean, here along came up with this crazy notion that we all laughed at the idea that lower interest rates would mean lower inflation.

23:58And I think anybody with any kind of economic background or interest in this subject would be like, how does that exactly work? It makes no sense. And then I said at the time, all right, well, let's see what happens just for the heck of it, right? Well, obviously, we know it didn't work. So is the idea that we don't care about inflation or there's another power out there trying to push this down so that I guess maybe our debt is at a lower cost? How does this all work in theory and why? I don't think it works in theory, Andrew. You're trying to find a logical model behind Erdogan or Trump's not entirely logical economic instincts.

24:46So they have a world in their minds where lower interest rates will be disinflationary. And that does not correspond to any model of a normally functioning economy with reasonably well-developed financial markets that I know. So it's not only the case of Turkey, but many historical cases down through the ages in Latin America and elsewhere, where leaders advanced the view that lower interest rates would be good for the economy. Maybe lower interest rates would translate into faster economic growth, more supply would make for lower interest rates. That could be their implicit view, but more supply that's more than matched by more demand will make for higher interest rates.

25:38So the theory doesn't make sense when you think about it for more than 10 seconds. It does not prevent leaders confident in their ability to understand and dictate anything. It doesn't deter them from claiming they understand and dictating. But one point is harebrained theories, and the other point is weakening institutions like the central banks such that they come under pressure to implement harebrained theories. And the two together are much more dangerous than one or the other. So going back to your paper that you wrote, I think there was another piece of the paper that was a discussion and thought and a question posed of why aren't markets reacting to more strongly to a threat against central bank independence?

26:29Yeah, I'm not alone in wondering about that recently. So I did write a piece for Project Syndicate, actually laying out the paradox and speculating a little bit about why the market reaction has been so mild, so sanguine. And the best I can come up with is that there is still residual confidence in the strength of the Fed to resist pressure from the White House. That policy is not made by one or two newly appointed governors. It's not going to be made by whomever Trump appoints to succeed Jay Powell as chair in 2026. but it's made by a committee of 12 voting members at any point in time. And they are not poodles.

27:24So they will stand up to the pressure. The markets may believe the markets may have some residual faith in the Congress to stand up to the pressure when Trump tables a nominee who's not entirely qualified. I have my doubts about that guardrail and they may have confidence in, the Supreme Court to prevent Trump from arbitrarily firing Federal Reserve governors without cause. And I have my worries about that guardrail. Yeah, I was going to say ditto. Ditto on the end of that, on the same comment about the guardrails. But what's interesting is one of the things that made me take a moment and do a, just a breath, was when the idea was floated, I think by Steve Bannon, but then picked up by the White House much later in the day was that the idea that Scott Besson, the Treasury Secretary, would serve dual roles with the Treasury Secretary and Fed Chair.

28:25And now Besson may say, no, no, no, no, no. But here's the thing that's really kind of, I think, odd. I really don't understand is while there may be certain factions that can, well, the strength of the others, the strength of the 12, let's say, the strength of the 11, the 10, The fact is that we have almost like two areas that are supposed to be a Chinese wall, right, between the two of the U.S. government and the Federal Reserve. And that has been – Mirren is a – what would we call him? We call him a spy that has two roles? I mean, I understand. He's working both sides. Well, Mirren presumably has to stay in Trump's good graces in order to resume his post at the Council of Economic Advisors, assuming that's how things play out early next year.

29:22There's another scenario where he gets appointed to a full term after that. Who knows? But here again, I think history is informative. Before the Banking Act of 1935, I believe it was, the Treasury Secretary did serve on the board. And it was decided that this was not an ideal arrangement. We moved away from it. And, you know, I think we're seeing now another example of history being forgotten. That Chinese wall has always been permeable. It's never been secure, but I think it's important in the eyes of the markets, certainly in the eyes of all academics who study this matter to respect that wall.