MI272: The Crisis Isn’t Over: The Case for Deflation w/ Jeff Snider

24:04So now that the Chinese government has come to its senses, they're no longer locking down their people, they're letting the Chinese economy back up and do its thing. It sounds like China is going to be a source of real strength, because if you think that lockdowns were the problem last year, the removal of lockdowns would remove the problem this year. And since China is such a hugely important part of the global economy, it sounds like if China's coming roaring back because it has all this pent up demand after a year of being really restricted, that's going to contribute more to the same problems and imbalances that we faced in 2021 that led to consumer prices getting out of control.

24:40A resurgent China, given the still low-lying levels of supply problems, that really should be consumer price positive. In fact, I think the European Central Bank more than the Fed, but the European Central Bank has referred to this on a couple of occasions as one of the risks they see in inflation. But as you just said, Rebecca, it hasn't really materialized. In fact, markets are absolutely sure it didn't. And for a lot of reasons. One is that the reopening hasn't necessarily been as strong as advertised because maybe China's problems weren't actually zero COVID in the lockdown. Maybe China has more structural and longer running problems than just pandemic politics or what's left of them.

25:17Plus, China is also highly susceptible and it's a reflection of the global economic condition too. So as the global economy starts to head into recession, especially with the inventory cycle being such a big problem, that's going to negatively impact China regardless of whatever's going on in the reopening. So maybe China's reopening wasn't all about zero COVID. Maybe the reopening itself wasn't as good as advertised. Plus, global trade recession starts to really dig in here. And suddenly China's reopening goes from It's going to save us all from recession to it didn't really happen, complete disappointment.

25:54And if we start to see deflation coming into the data, how long do these periods typically last? There's such a wide variation. That's what makes it so incredibly difficult because you'd like to say there's a template that we can just follow. If this happens, then we know this happens in two to three months. The truth is that you can see any number, a variety of ways that this can work out, which makes sense because it's a complex system and you can't really predict how one individual thing or how one part is going to lead to the next and then to the next and then to the next because there's usually follow on and knock on effects, which is why he's talking about second, third order impacts.

26:31So, I mean, it could be, you go back to some of the examples, 1937, for example, which was sharp deflation inside of the Great Depression. You had the deflationary impact in the late 36, early 37. And then the economy didn't really fall off until summer, again, August, September. So, you know, seven, eight months there. Some other examples, 2008, you had the original deflationary shock, which showed up in August of 2007. Then you had a sort of a shallow recession develop. And then by the summer, again, the summer of 2008, it just kind of falls off a cliff. That's the repeating theme here. If there is a template, it seems to be August and September.

27:09So maybe that's the answer. However long it takes, if we get to August and September and nothing happens, then maybe we're in the clear. But, you know, it's just there's any number of factors that make it difficult, if not impossible, to say just here's the date on the calendar, scratch it down, and this is when we'll start to see things. But what we are seeing is in terms of the marketplace in these curves that we've been talking about, the markets, the curves are reshaping themselves into the sorts of patterns that are consistent with this deflationary outbreak happening now. One of the things that we see is called bad steepening.

27:42So, you know, the curves are inverted where we have short term rates up here and then longer term rates are down below here. And bad steepening is, well, curves don't want to be inverted. They want to be upward sloping because that's the natural way of things. You know, think about how we always think about interest rates over the long run need to be higher than they are in the short run. It's the fundamental, the most normal fundamental shape for a curve to take. So inverted, it can't be inverted forever. It's got to work. It's got to steepen itself back out one way or the other. The good way would be if we have short-term rates up here and longer-term rates down here, longer-term rates rise, that would mean we've avoided the recession.

28:17We've avoided the deflation. The market is now in greeting with the Fed that things are more likely to be better and inflationary than not. But we also have this bad steepening. And the bad steepening is where interest rates along the entire curve fall, but they fall faster at the short end than the long end. So the curve kind of goes like this. And that's typically what you see right when a recession is beginning, right when deflation is really starting to bite into the economy. And you also see this little bit of a tail on the end of the curve, which is another signal that the thing that we're all afraid about, the thing that the markets have been hedging against all this time leading up to now, they now believe it's happening.

28:54So there are some pretty compelling indications that, again, not putting a specific time on it, we'll just say sooner rather than later. I'm glad you mentioned that because I forgot to ask you that question. And I am curious because we just heard from Treasury Secretary Janet Yellen on how the US could run out of money as soon as June. And I wanted to get your thoughts on that. What is that being shown in these yield curve inversions as well? Or and I guess, what do you think is the likelihood that this could happen? Well, I mean, we've seen, you know, debt ceiling impasses before, I think notably in 2011, which is somewhat similar to what we're facing today.

29:35You had a banking crisis back then, too. You had we didn't have the yield curve inversion because the yield curve was already collapsed after the 2008 crisis. And then along comes this debt ceiling impasse in June and July of 2011 that actually led to a downgrade in U.S. debt, which it made a bad situation worse because it scrambled a little bit of the mechanics in the repo market and collateral and things like that, which, again, they were already bad to begin with. And then you have another disruption, another source of friction, and it just made the bad situation worse. So I think that's kind of what we've got right now.

30:08The debt ceiling to me is not a primary problem. It will get resolved at some point, but it's another unnecessary, really, really, it's just one more problem for the market to try to dissolve. And now we're getting into the part where it's starting to scramble up treasury bill prices, which is a huge problem. Treasury bills are the primary form of collateral to begin with. One of the primary sources of deflationary money in treasury bills, we don't like volatility in those markets. So when the debt ceiling makes treasury bill prices volatile, it just adds more strain to a system that is already highly strained.

30:42So maybe that is one reason why the curves are saying maybe this is just a straw that breaks the camel's back. The debt ceiling is not the problem, but once it gets resolved, we'll still have all the same problems, but it is a problem on top of so many other ones. And then I guess just thinking more broadly for a while now, it seems like investors were highly focused on hedging against inflation and how they can position their portfolios to protect themselves against this. And so what implications does a period of deflation have on asset prices and perhaps what assets do well during these times, if any?

31:20Well, anything that has safety and liquidity attached to it, because that's, again, the markets are telling you what they think will be in high demand over the months ahead. And by the way, you know, you got to follow these curves here. I know that central bankers and economists, they tell you, no, no, no, no, no, we don't follow the yield curve. We don't follow the bond curves. And they make that mistake every time, time and time again. Every time the yield curve inverts, they say, no, no, no, this time it's different. This time it doesn't mean anything. So markets have been, their track record is not perfect, but as near perfect as you can get, whereas policymakers are wrong every single time.

31:57So if the markets are telling you safety and liquidity are in high demand, you would do well to heed that advice because it's advice that's coming from inside the monetary system itself. The biggest, most sophisticated players in the monetary system, the people who make and distribute money, if they're hedging for high demand for safety and liquidity, that's what you need to take into account. The markets are saying you want to own safe and liquid assets. So for just the most basic retail investor, that means same investments that are being bid up now. So you want duration in terms of bonds, which I mean, there's a lot of risk involved there.

32:32But if you are convinced that we're heading into a deflationary period, long duration and bonds, especially in the middle part of the curve toward the end of the curve, so TLT and things like that, they're going to outperform because safety and liquidity. Another one which kind of seems counterintuitive is gold because gold, people perceive of gold as an inflation hedge when in fact gold is a terrible inflation hedge. It's a terrible hedge against regular levels of inflation. It's actually a good hedge against what Keynes call the twin monetary evils. Extreme levels of inflation as in the 1970s, gold did really well, or extreme levels of deflationary danger as in 2008 and its aftermath.

33:10Now, in 2008, gold was all over the place volatile, which is probably what's going to be moving forward. But by and large, in terms of all the asset classes in 2008 and the 2008 crisis, gold actually performed relatively well. And you can see with all of the problems that we have going on today, similar to 2008, but some differences too, gold might be another hedge that you could use, not against inflation, but disorder, dysfunction, and disarray. Let's take a quick break and hear from today's sponsors.

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37:11Well, we've seen silver outperform too and silver obviously is not outperforming for its industrial characteristics because the rest of the industrial metals are screaming deflation now copper is one but iron just recently fell off um aluminum is another one that former high flyer because of supply problems that one can't get a bit even with china reopening so silver it's interesting that silver is acting more like gold than it is like copper or something like that so you got to be careful about what exactly you're looking at. But yeah, silver, anything that exhibits or anything that historically correlates with safety and liquidity, you know, that kind of a hedge, that kind of instrument, that's what you're going to want to be looking for.

37:51Okay. So you mentioned long duration bonds and gold as to, and so TLT was the ticker for that ETF, right? Right. Okay. And then I did want to ask you, because in one of your recent YouTube videos on Euro dollar university, you said that we continue to get warning signs as well as there's a lot of data that shows this crisis isn't over. There is more to come. What happened with the banking crisis wasn't the thing. It was the first stage of the thing. And so I wanted to ask you what you think is going to be the next domino to fall here. What should we be expecting? Well, that's a difficult question because again, you know, you never want to get into the business of making predictions because it's the least profitable business there ever is.

38:37What we attempt to do is look at what's happening today and sort of make judgments about what the situation is and kind of sketch out probabilities for the future. So in terms of what the markets are saying, the progression of how we got here, I think that's instructive too. Because remember, the curves inverted last year, back in March. Actually, the first inversion was Eurodollar futures way back in December of 2021. But the yield curve inverted the two-year, 10-year spread in March. And everybody said, no, yield curve inversion doesn't mean anything. We watched the near-term forward spread or the three-month, 10-year spread.

39:10Then that inverted. Those two inverted last November. And they said, nah, don't worry about those things. Those things don't mean anything either. We're going to look at the unemployment rate. The unemployment rate is incredibly low. And now they're saying, well, OK, yes, the unemployment rate is really low. But the risk of recession, yeah, that's probably gone off. But it's only going to be a mild one. So just in terms of that progression over the last year, we started out with there's no problem. Don't worry about it. Now, maybe we're facing a mild recession. So even the mainstream focus on the economy and interpretation of the economy is moving in the direction of at least something worse than a mild recession.

39:48Plus, I mean, you look around at what's happened over the last six, almost two months. Actually, it's almost two months since Silicon Valley Bank. We're still talking about U.S. regional banks. We're still thinking about things like commercial real estate and the rot that might be in those portfolios. We're still wondering what's going on in the monetary system. At least I am with repo collateral and things like that. Those continue to follow the same progression because before March 9th, nobody was talking about the banking system. Now we're talking about the banking system on top of talking about a recession.

40:19So in very broad terms, we're moving closer and closer to where we have probably a nasty recession and an ongoing banking crisis. because every time both of those have been declared over and done with, remember February, the jobs report and retail sales numbers, they said, oh, we're not even going to have to worry about a soft landing. This is a no landing scenario. The economy is just going to continue going on forever. It'll never even slow down. So we keep moving in the direction of at least a bad recession and at least an ongoing banking crisis that just neither of those things will go away.

40:51It's almost like a vampire or a zombie. They just don't want to die because, again, the markets are telling you those two things are going to happen. And what does that mean specifically? You can't really predict it. What are the next banks that are going to fail? I mean, there's a list of them now. I mean, Moody's downgraded 11 more just a couple of weeks ago, a week and a half ago. So we're reasonably certain there's going to still be more banking problems and more banking problems are likely to lead to a credit crunch And a credit crunch on top of what might be a mild recession on its own leads us into some pretty bad recessionary cases.

41:24And you did write that crises come in waves and waves are stages. They're incremental. And so you just kind of mentioned this of what we could be expecting in the coming months. But I guess I'm wondering what should investors be thinking about doing during this time? Because sometimes inaction can be just as detrimental to a portfolio waiting for things to get worse. Maybe they never do, or maybe you just end up sitting on the sidelines too long that you never get in. So I guess how should they be thinking about acting during this time and positioning themselves beyond what you mentioned with the gold and the long-term bonds?

42:01Yeah, Rebecca, that's the worst part of all this because it does go in stages. It doesn't go in a straight line, which would make it incredibly helpful. You would think that, okay, the crisis starts. We can see it coming. We can see it developing day after day after day. It's completely unambiguous. We know what's going to go on. But that's not how it works. Crisis, something happens, then everything seems okay. And something else happens, and then everything seems okay. And every time we go through these ebbs and flows, when everything seems okay, it's easy to convince yourself because everybody will be telling you this, the crisis is over, right?

42:33Because every time something happens, they say, that's it. That's the worst. So don't worry about it. And then something else happens. And they say, oh, that's it. That's the worst. Nothing else. And then something else happens. It's just back and forth, back and forth, back and forth all the time. Except over time, what you notice is what I was just saying. Slowly, we're moving in the wrong direction. We can't really perceive it because it's like the proverbial boiling frog where it doesn't notice that the temperature is rising because we keep going back and forth, back and forth. And every time something doesn't happen, it's like, okay, this thing is over.

43:03We're out of it. And Jay Powell is going to tell you and Janet Yellen is going to tell you and everybody in the financial media is going to tell you because they take their opinions from Jay Powell and Janet Yellen, everything is fine. So what I would recommend is if you believe we're heading into a crisis, make that decision today and act on it today. Don't get caught up in the back and forth. Don't get caught up in trying to time it. Oh, I'll be the, you know, don't be the greater fool. Don't think you're going to be the last one out of the excess. If you believe that we're heading into a deflationary crisis, make your decision today and act on it today and just let it happen.

43:34Because if you get caught up in the back and forth. As I said, the economy as well as the marketplace, it seems like it goes back and forth in a relatively narrow range where nothing bad happens. And then that one goes too far in your Wile E. Coyote and you realize you're way off the cliff. That's the September 2008. There are any number of warning signs. But if you were still thinking in the summer of 2008 that everything was fine, you found out too late. And because a lot of people made that mistake. Remember the, I don't know if you're probably too young, but you remember the market rally and from Bear Stearns until June and July of 2008, there was a rally in the marketplace because everybody thought Bear Stearns represented the end of the crisis because that was one of those incremental stages.

44:14So it's easy to get caught up in the back and forth. It's easy to get caught up in, well, we don't see the worst happening right now, so maybe the worst isn't going to happen. So that's why it's important to look at the information that's available right now. That's what's so important about these market curves, because they're telling you what the actual system believes as far as the probabilities of the situation moving forward. Make a decision based on the information you have and stick with it. I guess in terms of the market, we saw a recent rally or it's held up quite well, despite everything, at least the S &P 500 has.

44:50So in your view, do you think that all of these risks have been properly priced in so far? Why is it being complacent, if not? No, the stock market isn't a real market to begin with. It's a beauty contest. And no, these risks are not being priced in because there's several misconceptions about a lot of things, including inflation, including central banks being everybody's friend. If you thought that the stock market weakness from 2021 into 2022 and now this year is all about interest rates and rate hikes, if you think the Fed is the biggest problem in the stock market, and then you also think that the Fed ending its rate hikes and navigating into a soft landing Goldilocks scenario, that's going to be tremendously stock market positive because no longer have inflation, you no longer have the Fed hiking rates, and the economy doesn't suffer anything maybe more than a slowdown.

45:35That sounds terrific. So a lot of people are literally buying that in the stock market, ignoring all the warnings, including banks failing one after another after another, convincing themselves that we're heading into this golden era when that's a mistake that gets made repeatedly and I mentioned 2008 was a perfect example. Stock market hit a record high in October 2007, a record high in October 2007, which was two months after the crisis had begun and just a couple of weeks before the Great Recession started. And then there was another big rally, as I said, in early 2008. You can see these dead cat bounces all the time.

46:12I think that it really comes down to these rationalizations where because the system gets into these ambiguous periods, it's really easy to fall into that trap and say, this thing is over. So I better get in the market now because it's going to rally. As soon as everybody realizes it's over, it's going to be risk on forever. That plus the idea that the Fed's got everything covered. You can see why stocks are at least performing relatively well right now, at least until all of these things become unambiguous. Right. And so in terms of when things might actually be better. One signal that I thought we could look at is when the curve turns positive again, particularly the 210 yield curve gets into positive territory, perhaps then things have resolved by then.

46:58Is that something we can look at or is that skewed? Yeah, it's not a definitive signal. Nothing here is. I wish it was that easy, right? It'd be great if everything was just, hey, this means this. That's why you really have to take such a broad survey, you really have to pay attention to what's going on. But yes, that's the start of the end. The start of the end and getting toward recovery will be when the yield curve starts to come back up and straighten back out. We have to go through the bad steepening, which is bad because it represents the start of the problem that we're all worried about.

47:27But then once the curve steepens, that's just the beginning of the next stage of evaluation, which it doesn't necessarily mean we're getting close to the recovery phase. There's a lot more to really figure out what's happening at that particular time. But that is definitely one signal that tells you at least we're into the thing and starting to think about getting through the end of it. Because just as there's a variety of ways to enter a recession in a deflationary period, there's also a variety of ways to exit a deflationary period. We could have a very short, sharp recession, something like maybe 1920, 21, or even 1980, which lasted only about seven months.

48:04It was very bad, but we got out of it really quick, I mean, that might be the best case scenario. But you could also end up with something like 2008 or 1981-82, where it was the slow grinding recession, then we went off a cliff, and it took a very long time to recover. Of course, after 2008, we never did recover. So there's a lot of work to be done as we go into the recession and the contraction of the deflationary period. And then there's even more work to be done getting out of it. So there's a variety of ways that could happen. And so we really need to be careful about the individual signals as well as the individual conditions at that time.

48:39And you mentioned that there's not one specific way to get out of a deflationary scenario. But other than, I guess, looking at a yield curve, what are some other signals that investors can look out for and follow? Ironically, you want to look at some of the credit spreads because usually some of the best performing assets and some of that attract the early risk takers are distressed debt because as companies go bankrupt, nobody wants to buy those things. Of course, the sharks come in and circle and find distressed debt because you really, the best performing asset in history is distressed debt because after there's all sorts of failures and everybody's, these things are selling for pennies on a dollar and they start to come back up again.

49:21That's usually a sign that there are risk takers coming in and the risk takers have a pretty good idea when to come in and take those risks. And as they take risks, they attract other people who take risk. And really, risk taking is an important part of the recovery process getting out of the inflationary period. So distress debt, credit spreads, those are an indication, but also they don't go in a straight line either. There's always that back and forth with those. So you do have to put a lot of these signals together. So is the yield curve steepening? Is credit spread starting to come back? Are we seeing enough positive signals in a wide enough cross-section of the marketplace?

49:54What's the dollar doing? Exchange rates. What are stocks doing? Believe it or not, after stocks go through a substantial decline, there's some value in a potential recovery in stocks. It's really a comprehensive view where you find a majority of the signals or enough signals that tell you that there's a substantial enough foundation for recovery to finally start to happen. I guess lastly, I do want to ask you about your outlook on the dollars. There's been some worry about it depreciating. Yeah, there's the idea the dollar is going to be replaced is There's a lot of people who have been saying this over the last 15 years for quite obvious reasons.

50:33The dollar actually does need to be replaced because it's not actually a dollar system. It's a euro dollar system. And the euro dollar system malfunctioned in August of 2007. It hasn't been the same since, which has opened the door to all sorts of competing ideas. Everybody likes to talk about China, Russia, and the BRICS, but China, Russia, and the BRICS aren't actually trying to replace the dollar. They're trying to manage this dollar problem that they do have, which is not the dollar going to zero. that the dollar is in such short supply, it makes it very difficult for them to conduct their global trade business.

51:00So they're searching for ways to reduce their dollar issue, dollar shortage issue. And one of the ways you do that is bilateral trade. Do as much trade in your local currency as you possibly can. But that isn't going to bring the dollar down to zero. It's not the world replacing the reserve currency system, this euro dollar system. It's simply them trying to deal with it. But yes, the dollar system, the euro dollar system does need to be dealt with at some point. I'm not holding my breath on that one. But that doesn't necessarily mean the U.S. dollar exchange value is going to go to zero. In fact, it's probably going to go in the opposite direction as it has over the last 15 years.

51:34Every time we hear this dollar is doomed theory come up, what happens? The dollar goes up in exchange value because there's not enough dollars. That's not likely to change anytime soon. In fact, the markets are telling you that's not going to change in the foreseeable future. So it could be that we continue to incrementally replace the Eurodollar system with all sorts of other things. And the dollar continues to go higher in exchange value, even as it's being replaced. That's not actually, that seems to me the most likely case. The dollar system needs to be reformed, but that doesn't mean the dollar is doomed.

52:06That's conflating two different issues. Well, thank you so much for coming on today, Jeff. Before I let you go, though, where can our audience go to learn more about all the work you put out and learn more about all the topics that we've talked about today. Well, as I just mentioned, since we're on a global Eurodollar standard, I happen to name my enterprise Eurodollar University for that very reason, because hardly anybody has even heard the term, although more have nowadays than before. But there's a tremendous need to really understand what the monetary system is and what it actually does. So Eurodollar University, I have a YouTube show.

52:41Check it out. It's called Eurodollar University. I have a website, Eurodollar.university, where we have memberships and subscriptions available due to the research and things like that there. But basically, Eurodollar University, that's me. Perfect. I will make sure to include all of those in the show notes so the listeners know where to find you. Yes. Thank you very much, Rebecca. I really appreciate it. Thank you, Jeff. All right. I hope you enjoyed today's episode. Make sure to follow the show on your favorite podcast app so that you never miss a new episode. and if you've been enjoying the podcast I would really appreciate it if you left a rating or review this really helps support us and is the best way to help new people discover the show and if you haven't already make sure to sign up for our free newsletter we study markets which goes out daily and will help you understand what's going on in the markets in just a few minutes So with that all said, I will see you again next time.

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