Economist and Best Selling Author
Porter goes for round two in his critical review of the annual shareholder's letter from Berkshire Hathaway (BRK). The most important details are not what's included in the letter from Warren Buffett, but it's what's missing that has Porter wondering if the Oracle of Omaha has lost his touch. Has the fundamental investment philosophy that has proven to work so well for Berkshire been altered? Will Buffett ever beat the S&P 500 ever again with the current makeup of Berkshire's holdings?
Buck and Porter welcome economist and author Richard Duncan to the show. Richard talks about how the Fed is running behind on the Quantitative Tightening (QT) schedule it set for itself in 2017 to unwind the Quantitative Easing (QE) put in motion back in 2008-2009. Any QT or "crowding out" from the government's trillion-dollar-a-year budget deficits are likely to be a toxic combination for investors. Richard says the US could be headed for another recession if the Fed continues to tighten as planned.
Porter answers listener questions about autonomous vehicles and their potential future impact on insurance premiums, and how the type of corporate bonds covered at Stansberry Research are quite different than what most people think.
Buck Sexton: Hey, everybody. Welcome back to another episode of the Stansberry Investor Hour. I'm nationally syndicated radio host Buck Sexton, and with me here, as always, the founder of Stansberry Research, Mr. Porter Stansberry. Today, on the show, we welcome author, economist, and financial market expert Richard Duncan.
Richard is a well-known expert when it comes to analyzing the forces and events currently impacting the global economy and what's moving the financial markets. Just like Stansberry Research, Richard's goal is to provide a framework that will enable you to make more informed investment decisions. Richard recently wrote about the Fed running behind the quantitative tightening schedule published last year.
Richard is here today to give you his thoughts on the direction of the markets given the current never seen before combination of a record worldwide debt, massive monetary policy manipulation by governments everywhere, and bubbles in just about every asset class. All right. Just before we get started, we have to give a quick note of thanks.
Just last week, we had another Richard on the show; Richard Smith, the inventor of TradeStops. He told you all about the TradeStops software he developed that tells you when to cut your losing positions, and how to let your winners run. He also talked about the one thing you can do to your portfolio right now that will give you better returns without changing the stocks you own.
Richard sent us a note this week to thank all the Stansberry Investor Hour listeners that joined the trial of TradeStops last week after his interview. You still have a little time to take advantage of the offer Richard made for just Stansberry Investor Hour listeners to see how TradeStops can help you manage the risk in your stock portfolio, and how you can beat the billionaires, just go to www.tradestopsoffer.com. That's TradeStops Offer dot-com. All right, Porter, kick it off for us this week, my friend. What is on your mind?
Porter Stansberry: Well, you know, Buck, I think what's on my mind is the suicide mission that I assigned for myself last week, which was to read, carefully, Warren Buffett's most recent quarterly letter. And talk about what's been going wrong at Berkshire. And anytime you criticize America's financial grandfather, you are just asking to be taken out and shot, which, of course, is what has happened since.
But I just want to say because so often times people quote stuff back to me, and they miss what I said completely. They're taking things out of context. What I have described about what's going on at Berkshire is two things. Number one, Buffett used to almost exclusively invest in very high quality, very capital-efficient, gigantic consumer giants.
American Express, Coca-Cola, and Washington Post made up 50% of his portfolio as late as the 1990s. You add GEICO to that pile, it's virtually 80%of his portfolio. These are iconic American businesses that are just bulletproof. Now, the newspaper has since gotten obliterated. So I'm not saying his approach was flawless, but look, he spent $10 million buying his stake in the Washington Post. You know, it was a 10-bagger plus for him a long time ago.
The same with Coke. Coke has not done that well lately, but, you know, he's probably making 25% a year in dividends now on his original investment cost. I mean, it's still been a great investment for him because he bought a long time ago. So I'm not criticizing those stocks, although I think, in some cases, he would have been smart to sell awhile go. What's changed is that since 2000, he's almost completely abandoned buying those kinds of companies.
And think for a second. In 2008-2009, we recommended, in my newsletter, a handful of these kinds of businesses. We recommended Visa. We recommend Starbucks. We recommended eBay. We recommended Tiffany. I'm not trying to be rear-looking and say Buffett should have bought more stuff like this. We bought stuff like this. And my point is if we could see the value in it, why didn't he?
Starbucks has gone up tenfold. Visa has gone up tenfold. The others are up 500% plus. They've all dramatically outperformed Berkshire. Why didn't Buffett buy any more of these companies? And don't give me the size nonsense. These companies are enormous and highly liquid. He could have bought $10 billion of any of these companies. And this is a fraction. I'm just talking about the ones we specifically recommended in '09.
There's another two dozen out there that we recommended at different times. McDonald's, for example. And there's also stocks that he's owned over the years, like McDonald's and Disney. Why didn't he go buy $50 billion in Disney in 2009? He could have. It's far outperformed Berkshire. But he didn't. What did he buy instead?
Well, most people know that he bought Bank of America. And he did. He put $20 billion into it. Most people know that he bought IBM. And he did. He put $20 billion into it. Most people know that he's bought a lot of Wells Fargo. And he did. He's bought $30 billion at Wells Fargo. Most of it are in the last 10 years. And those investments have been marginal. The Bank of America was good but isn't growing fast anymore. IBM was terrible, and Wells Fargo has underperformed the market, itself.
So those were not great choices. But what most people don't know, Buck, is that all of those investments combined, all of them combined, are less than the one investment he made coming out of the crisis, which was Burlington Northern Santa Fe Railroad. In total, Buffett has put $80 billion into a railroad. That's 80 times than he invested in Coke. It's 80 times more than he invested in Amex. It's his largest investment by a factor of at least four.
And how has that investment performed? And the answer is miserably. We calculate that his annualized return on that investment is 2.6% a year. Right? He would have done twice as good if he would have bought bonds. This is an enormous mistake. It is a mistake that's been cataclysmic for Berkshire. And no journalist has asked Buffett about it. No one has put this math out before. No one is willing to talk about it.
And, suddenly, Buffett removes any discussion of the railroad from his annual letter. Doesn't mention it. Also, doesn't mention the big loss he took in IBM. I don't know if he actually lost cash in IBM, but he definitely didn't make any money over 10 years, which is the same thing as a loss. So my point is I'm not holding Buffett to a higher standard. I'm holding Buffett to a standard. If he was any other investor, and he had made these mistakes, he would at least be asked about them. And he wasn't and isn't. And won't talk about it, which seems odd.
So to give you an idea of the scope of Burlington Northern. Well, I'll just tell you this number. Buffett has currently about $500 billion in capital, total, at Berkshire Hathaway. He's put $80 billion into Burlington Northern, into the railroad. And here's where I get that number because people are going to look back and say he only spent 34 billion when he bought the railroad. No, all of the capital involved is what he paid for the business in terms of cash and stock, and what the value of that stock is today.
That number is 80 billion when you add in all of the assumed debt. That's the pile of capital that he's working with at Burlington Northern. Sorry, that number is 52 billion. The value of the cash in stock that he paid for the company, and the debt, was 52 billion. He since put in 30 billion in additional capital investments. The total amount of invested capital in that company that he owns is now over $80 billion. And the analyzed return on that invested capital is 2.6% since he bought it. That is an abysmal failure.
Now, let me go ahead and grant you, Buck, I know that he has received more money than that in terms of dividends. In total, he's gotten paid $26 billion in dividends from Burlington Northern. And that sound great, until you realize that every year, the railroad is paying him a larger dividend than it's making in free cashflow. In other words, all he's doing is loading a subsidiary with debt to generate a very meager return for Berkshire.
Again, this is not typical Buffett behavior at all. This is an anomaly. And sooner or later, Buck, some Berkshire shareholder is going to have to pay the price for all these additional debts that keep loading down the railroad. Now, Buffett would say these debts are non-recourse to Berkshire, blah, blah, blah. I get all that. But the railroad is still going to have to pay them back, and that's going to reduce the economic return, from that railroad going forward, for another 40 years.
This has been a disaster. And it's an even bigger disaster because it's completely the opposite strategy that built Berkshire. Buffett went from investing in insurance companies, and building an insurance company float, and taking all that money, and buying great iconic consumer brands that are capital-efficient. They're buying a regulated utility that consumes capital.
And Burlington wasn't the only one. He also has his other business called MidAmerican Energy. It owns electrical production in Iowa and other places. It's the largest utility in America, I think, now. If not, it's the second largest. Anyways, he brags that the utility company has never paid him a dividend. He brags in his letters that the utility company has never paid him a dividend. Well, what the hell – what's the point of the investment if you can't recycle the cashflows back into your insurance companies to produce more float, to buy more stock.
That's how Berkshire works. And this is totally the opposite of that formula. So when you put in the capital he's put into the railroad, and the capital he's put into the utility, it's $100 billion, Buck. That is 20% of Berkshire. But when people buy Berkshire, they're thinking they're buying a growing insurance and consumer brand company. And they used to be, but they're not anymore. Now, about half the value is insurance, and about half the value is utilities. That's a really bad structure.
So I believe that Berkshire should be split. You should be able to choose below growth, safe, high dividend yielding utility company, or you can buy the faster growing, more valuable insurance and consumer brand company. And I think if you did that, you'd have most Berkshire shareholders opt for the insurance than the consumer brand company.
The point of all this is, Buck, for decades and decades and decades, Buffett promised his shareholders that if Berkshire's book value did not grow faster than the S&P 500 over any five-year rolling period, that he wasn't doing his job as a capital allocator, and that they should demand to be paid a cash dividend so they could make better investments. Well, guess what? Berkshire has now underperformed the S&P 500 for a 10-year period.
And not only will Buffett not pay a dividend, he's locking up more and more capital into regulated utilities. There is no way he's going to outperform the S&P 500 going forward. Now, is anybody going to ask him those simple questions? No. And are they going to [beep] all over me because I did? Yes.
Buck Sexton:You're being mean to Grandpa.
Porter Stansberry: I've already gotten several e-mails saying thanks for beating up on an 80-year-old man [beep].
Porter Stansberry: I'd be willing to bet a million dollars, and I'll give the money to charity if I win, that Becky Quick will not ask him about the railroad, about MidAmerican, or about IBM. She certainly will not ask him about, "Hey, Buffett, what about beating the S&P 500 over any five-year period? You're now down for 10 years. Uh, any change to the dividend policy?" She will not ask that question.
And, listen, this is important. It's not about Buffett. It really isn't. In part, it's about his legacy. And I hate to see someone who built his entire career around a reputation that was based around not moving the goalposts, and setting a standard, and living up to it. And it's sad to see that he has completely given up on all these ideas. And he's totally unwilling to admit, wow, maybe I've made a mistake. Maybe they are a heck of a lot of shareholders that don't want to own a regulated utility.
Why in the world would you turn the greatest property and casualty insurance company, and the greatest consumer brand company in America, into a regulated utility? I'm telling you, it just makes no sense. It's 180 degrees from what got him to where he is today. And there has to be some shareholders that don't understand what's changed.
And so I wanted to bring this up to people, and say, look, what you bought when you bought Berkshire 10 years ago, is not at all what you own today. It has been transformed. That $100 billion that he put into regulated utilities, that could have gone into buying fantastic stakes in a dozen great American businesses. And if it had, Berkshire would be three or four, five times bigger than it is today. The underperformance is incredible.
Berkshire has underperformed the market for 10 years. Buffett went 40 years of his career without underperforming the market over any five-year period. And, now, he routinely suffers, beats, and he can't beat over time. This is a big change.
Buck Sexton:Do we want to get to our guest?
Porter Stansberry: Yeah, that's my rant. Why don't we just move on?
Buck Sexton:All right. Richard Duncan is with us now. He's the author of three books on global economic crisis. He began his career as an equities analyst in Hong Kong in 1986 and has served as global head of investment strategy at ABN Asset Management in London, financial sector specialists for the world bank in Washington, and consultant for the International Monetary Fund in Thailand.
His books include The Dollar Crisis, The Corruption of Capitalism, and his latest, The New Depression: The Breakdown of the Paper Money Economy. Richard has published articles in the Financial Times, Finance Asia¸ and The Far East Economic Review. He currently writes Macro Watch for his own publishing company, Richard Duncan Economics.com.
Macro Watch digs deep into global monetary policy to give you a deeper understanding of the economic imbalances that exist in our world, so you can make well-informed investments decisions. Please welcome, everybody, to the Stansberry Investor Hour, Richard Duncan.
Porter Stansberry: Richard; Porter Stansberry here. Thanks again for joining us. I know we spoke for the first time several years ago back in 2013. And I know we have a lot of the same macro concerns, particularly the incredible financializaton of the global economy via the dollar and the tremendous credit successes that have been created over the last several years. How much longer can this system of ramping up debt in America and in other major G20 economies, and financing it all with paper, how long can that all go on before there's a major breakdown in the system, itself?
Richard Duncan: Well, Porter, first of all, thank you for having me back on. I enjoyed our earlier conversations. So, well, honestly, I believe this system could go on for quite a long time. Why is that? Look at Japan. Japan's economic crisis started 28 years ago. They've taken their government debt to GDP, up to 250% of GDP. And has that caused double-digit interest rates or hyperinflation? No. The yield on their 10-year government bond is six basis points.
And, in fact, the Bank of Japan has done so much quantitative easing because the Bank of Japan actually owns 40% of all Japanese Government debt. And with the interest rates only six basis points, that means that even the new Japanese Government debt that's being issued is almost free to the government in terms of how much it costs, in terms of financing that debt.
So the lesson that we have seen from Japan is that this can go on for a very long time with the combination of very large budget debts just keeping the economy going, and paper money creation by the central bank to finance them as necessary.
Porter Stansberry: Richard, I have two questions about that. Obviously, I'm pretty familiar with a that argument, and there's a lot of data and a lot of history there to support it. But I think there are two things that are very different about America's financial crisis and Japan's. And I want to know your take on this. Number one, global commodities and global commodities trading does not typically take place in Japanese yen-denominated contracts.
So the inflation of the U.S. dollar has a larger economic impact globally in the first place because commodities are priced in dollars and traded bilaterally all around the world in dollars. That's the one question. What kind of difference should that make over time? And then the second thing is I'm sure you're familiar with, the role that the dollar plays as a reserve currency globally, more so than the yen. I think something like 60%-plus of all global banking reserves are dollar-denominated.
Now, that's of course because the U.S. economy is large, but it's also because all around the world, most people have confidence and trust in the dollar, and it's used so highly in trade. So the question I have for you, as dollar credit grows to almost 400% now of U.S. GDP, isn't there a risk that basing the world's economy on a single currency, like the dollar that's so highly leveraged, isn't there a risk of some kind of an accident that upsets the whole applecart?
Richard Duncan: Well, there's certainly many risks, and many things could go wrong. But the reason that the dollar is the reserve currency is because the United States has such a massive trade deficit. This year, for instance, the trade deficit will be somewhere around $550 billion. So that deficit will throw off $550 billion into the global economy.
Now our trading partners have a choice. They can refuse to expect dollars, and, in that case, not sell $550 billion worth of goods to the United States, which would cause massive unemployment in countries like China and all around the world, and crash their economies, or they can continue to sell their products in U.S. dollars, accumulate dollars, which will mean that the dollar will remain the reserve currency far into the future.
There's no way of getting off the dollar standard. The dollar standard; the world is built around the dollar standard, and it seems – it's very unlikely that that's going to change within the foreseeable future. The U.S. trade deficit drives the global economy, and the deficit is paid for in dollars.
Porter Stansberry: Yeah, I get the logic. But isn't it – I mean, to me, it just seems like a giant circle that will have to break sometime. I mean, sooner or later, our trading partners are going to go, hey, you know what? We keep sending America our treasure. We keep sending them our excess labor. We keep sending them our oil and our commodities, and our manufactured products, and our iPhones. And they keep sending us paper receipts that are a claim for, at some point in the future, for goods and services in return.
But how could they ever pay us? They're now 400% of GDP in debt. And don't you think, at some point, another large rival economy, whether it's China, or whether it's Russia, or whether – or some consortium of economies say, hey, you know what? If we were to build a cryptocurrency that's backed with gold, or a digital receipt that's backed with oil revenues, or something that could compete.
And I think you've seen cracks in the system. For example, the dim sum bond market in Hong Kong has had a lot of growth, where businesses are able to finance their needs for credit in a currency that is perhaps more stable than the dollar. Although, obviously, Richard, I understand that if you're going to borrow money, it's probably best to borrow money in a currency that's depreciating. But I just wonder, I mean, I understand what you're saying that because it's the standard, it's going to go on for a long time. But just imagine, what might cause it to break?
Richard Duncan: Well, let's look at this from China's point of view. I mean, sometimes, China complains about the dollar standard. But more often, you hear many more American commentators complaining on China's behalf about the dollar standard. Actually, the dollar standard has worked miracles for China. Look at how China has been transformed over the last 30 years as a result of their trade surplus with the United States. China now has a one-billion-dollar-a-day trade surplus with the United States.
Now, if we move to some sort of gold standard, or any other kind of standard that didn't allow the U.S. to pay for its trade deficit with dollars, the U.S. only has so much gold. After about two months of a billion-dollar-a-day trade deficit, the U.S. would have no more gold, which would mean it would not be able to buy one more pair of tennis shoes from China.
Which would mean China's economy would entirely implode, resulting in tens of millions of Chinese factory workers losing their jobs, and political unrest. And catastrophic consequences for the economy domestically, and all kinds of drastic geopolitical consequences that you don't even want to think about. So we can't move to any other standard because the world depends on selling to the United States. The U.S. can only pay and only finance these imports from other countries if it can pay with dollars.
And so the whole world is really quite happy with this arrangement. It's transformed the world. Look at how China has been transformed over the last 30 years. Thirty years ago, when it didn't have a trade surplus with the U.S., it was a very poor third world country when I first moved to Hong Kong in '86. Now, Shanghai looks like the Emerald City in the Wizard of Oz. It's all because of the benefits China has received from the dollar standard.
Porter Stansberry: Yes. I completely agree with everything you've said. I just don't understand how it can go on for much longer because we're financing all of those deficits, and the result has been an enormous increase in both debt, so the debt load in the US economy, but even more importantly, in my mind, is sort of the financialization of the entire economy.
And at some point, whether it's the next credit cycle, or whether it's three or four credit cycles down the road, at some point, people are going to go, "This is just intolerable." Like, for example, there's now $1.5 trillion in debt on the necks of your average college graduate. I mean, it's insane, the amount of debt that America, our government, and Americans, our people, have to carry to finance the global economy.
And sooner or later, people are going to go, you know what, uh, having another iPad is not worth having the debt that goes along with it. I'm going to stop doing this. And you've seen that kind of consumption reversed in Japan. And if it happens in America, it's going to be – [laughter] it's going to be even worse because the debts and deficits are so much larger in scope. How does it all end?
We can't continue to add – what are we adding now, a trillion dollars to the federal deficit every year? We're adding something like, what, 250 billion to consumer debt every year? It can't go on.
Richard Duncan: Well, looking at Japan; Japan has 250% government debt in GDP. And the U.S. only has 100% government debt to GDP. The U.S. GDP is $19 trillion. That suggests the U.S. government could borrow and deficit another $19 trillion before it even hit 200% government debt to GDP. And that's assuming 0% GDP growth. Whereas, of course, if the government deficit spent $19 trillion over the next 10 years, the economy would grow by 10% a year, and would never hit 200% government GDP.
Porter Stansberry: All right. But, Richard, there's lies, there's damn lies, and there's statistics. Now, you and I both know that Japan finances all of that debt internally because they have an enormous domestic savings rate. So that the net position of the country isn't nearly as in debt as the U.S. I think the only major economy that's even close to as broke as America is Italy. I might have that a little bit wrong. There might be another one out there I'm not thinking of. But, I mean, Japan is not 400% of GDP, total debt to GDP. Not even close.
Richard Duncan: But Japan doesn't have a yen standard. The U.S. has a dollar standard. That means the larger the U.S. trade deficit becomes, the more dollars come into the United States to finance our debt. Because every country's balance of payments has to balance. That means the trade deficit and the capital inflows are a mirror image of each other.
So this year, the trade deficit will be about – the current accounting deficit will be about $550 billion, and that's going to result in $550 billion coming into this country to finance our debt. Unless there's a trade war. Now, this is one of the things that we do need to worry about. Because if we put policies into place that result in a lower U.S. trade deficit, well, that means by the formula, that there will also be lower capital inflows.
The capital inflows are the mirror image of the current account deficit. The lower current account deficit means lower capital inflows. And lower capital inflows mean less money to finance our much larger budget deficit. So while I think that dollar standard arrangement can go on for a very long time, and that it will go on for a very long time, what's concerning me more is the immediate future.
The immediate future where, suddenly, the government is running trillion-dollar budget deficits as a result of the tax cuts and the February 9 bill that cut spending, facing a trillion-dollar-a-year budget deficit as far as the eye can see in the future. So the government will have to sell an extra one trillion dollars a year. And making matters worse, the fed is reversing quantitative easing. In effect, simplifying things a bit.
The Fed is also selling government bonds. This year, they're going to sell something like $400 billion of government bonds. Actually, more precisely, they're not going to roll over about $400 billion worth of bonds that are maturing in their portfolio. So that means that other people are going to have to buy those bonds. So not only will the treasury have to sell a trillion dollars' worth of new bonds, but, in effect, the Fed is also selling $400 billion worth of bonds. The amount of financing that is required is going to be more like $1.4 trillion or $1.5 trillion.
And this number, with the quantitative tightening, will be even larger next year while the Fed has published its quantitative tightening schedule. They have already told us in advance how much government debt they're going to allow to mature each month. And this adds up to something like $400 billion this year, and $600 billion next year, and $600 billion the year after that.
So this is a double whammy in that we have much larger budget deficits. And on top of that, the Fed is reversing quantitative easing. So when the Fed was saving money through quantitative easing, and buying financial assets, that pushed the financial assets to a much higher level. Every time we had a QE, the stock market went up. And U.S. household net worth's went up to record level highs. In fact, since 2009, household net worth in the United States has gone up by $40 trillion, by 70% just since 2009, as a result of low interest rates and quantitative easing.
And even from the 2007 peak, household net worth is now up 40% form that peak level. And that's because of very low interest rates and quantitative easing. Well, now, that's going into reverse. The Fed is hiking the federal fund's rate, and it's conducting the quantitative tightening. So interest rates look very much likely to go up significantly from where they are now. The 10-year bond yield starting at 3%. And with these very large budget deficits – you remember the concept of crowding out, where you'd start crowding out in the old days.
Porter Stansberry: And the bond market vigilantes, who did the crowding.
Richard Duncan: That's right. So there's only a fixed amount of money, and the government borrowed more of it to finance large budget deficits. It had push up interest rates. And higher interest rates made it more difficult for businesses to borrow and invest profitably. So the economy suffered, and asset prices suffered. So we're now, once again, looking at old-fashioned crowding out.
The government is borrowing much more, and the Fed is not creating more money to finance it. The Fed is literally destroying money, now, through quantitative tightening. And this is creating a very dangerous environment, a toxic environment, for investors. The only thing that could make it worse is if we have a trade war, and the current account deficit becomes smaller, causing the capital inflows into the country to become smaller.
Porter Stansberry: What I think is interesting is that my concerns about our credit bubble, and the nature of our economy running on debt, has always been that it was very likely for there to be an accident, like lending a trillion dollars to college students. [Laughter]. I think that's very likely to cause a big problem. Like lending $400 billion on subprime U.S. auto. It's going to cause a gigantic problem.
But what's interesting is that Richard has the opposite take, which is like, "Yeah, no, all those debts can continue to grow to the moon, as long as our trading partners are willing to finance those debts." And that's what – so the crisis, in Richard's mind, is more likely to be caused by a decline in access to foreign capital, which would be caused by a trade war. And I know that Buck has a lot of questions about a trade war, too. So I want to get to the likelihood of a trade war, and I want to know what the financial consequences are. But let Buck ask a question.
Buck Sexton:Richard, I've been looking – I mostly cover the political side of things, right, but I've been looking for some contrarian economist, or economists even, to make the case about why Trump's proposed tariffs would be a good idea, up to and including the possibility of a trade war. And I feel like to fully understand the issue, one would have to know what does Trump – and there are some advisors.
I know there's that one guy, who was a professor out at the University of California system. It's a senior advisor on this issue. What do they think they will accomplish with this? Meaning what is the other side supposed to be? Because all I hear is everyone saying tariffs are a terrible idea. Trade war is a terrible idea. If everyone thinks this is bad, there's clearly a problem because what is it supposed to accomplish? And I'm just wondering if you can speak to – from a contrarian point of view, what Trump thinks this could do that is good?
Richard Duncan: Well, what he thinks he can do that is good is good things politically, not good things economically. He promised the people who voted for him that he would put a 45% tariff on everything coming from China, and a 30% tariff on everything coming from Mexico. And that they would all have their jobs back, and that their standard-of-living would start going up again. So far, he hasn't delivered on that. He hasn't declared China a currency manipulator.
So as he comes under increasing political pressure, he needed to do something to rally his base, to live up to his promises. And so he expects to reap political gains from this.
Buck Sexton:But why is that other countries are able to have tariffs; China, specifically, without suffering all these dire consequences? I mean, that's one of the arguments that you hear people making is that, well, if America puts a tariff in place, it's going to cause trade wars. But it seems like some of our trading partners can have tariffs, and we have no response to it. Is that just because we'd rather have the goods coming here?
Richard Duncan: So this situation has evolved starting from around 1980. Up until 1980, the United States did not have a trade deficit. Under the Bretton Woods system or the gold standard, trade deficits between countries were impossible. They had to be paid for with gold. But starting in 1980, the U.S. started running these massive trade deficits with other countries.
And this intrigued corporate profitability because it drove down wage costs, and it increased the share of profits that corporations took. And this resulted in much larger bonuses for the CEOs, and it benefited a lot of the people in the upper reaches of income brackets. And so this has evolved over a very long period of time. And as the U.S. trade deficit became larger, the U.S. government figured out that, hey, the larger the trade deficit becomes, that means the more capital comes in to finance our budget deficit.
So the more capital coming in to finance our budget deficits would keep U.S. interest rates low. And low interest rates will push up property prices, and push up asset prices, and that will be politically popular. And low interest rates and good financing for the government budget deficit will allow us not only to finance our social welfare programs at home, but it will also allow us to maintain our global military dominance abroad.
And so it benefited the government, financially, and it benefited the wealthiest people in industry and also the banking industry. And so it was politically popular, and it evolved that way. Now, China always had tariffs, always had protectionism. But that did not deter this evolution of events. To a certain extent, this was not planned out in advance. It just evolved. And, of course, China is going to have an enormous trade surplus with the United States since people in China, on average, earn about $10 a day, whereas people in the United States earn something closer to $200 a day in the manufacturing sector.
So, of course, China was going to have an enormous trade deficit. But it benefited many of the power people, and they just ran with it until it, eventually and inevitably, led to a political backlash resulting in the election of President Trump.
Porter Stansberry: Yeah, I think, Richard, I mean, what you describe is just exactly what I've written in recent book, American Jubilee, where I talk about how productivity in the American economy has soared since the early 1970s. But wages have been completely stagnant. And what you're describing is the same thing I've described from a different angle, which is what I call the "financializaton of America."
Where because of the incredible deficits we've run, and the way they're financed, the rich just keep getting richer, and the wage earner in America keeps getting poorer. And, politically, sooner or later, that's going to cause a gigantic problem. And Trump is the first sign of that. So I want to wrap up our conversation because we've gone way over time, and we gotta get onto some other things in the podcast.
But I want to get you to make a prediction for me, and that is what happens in the future. Do America's debts continue to grow, and does the system continue for another decade, or does a combination of politics and trade policy cause the financial system to break down? And do debts stop growing because interest rates soar? What happens?
Richard Duncan: So, of course, things always play out in a particular sequence. What I think should happen is that because of the much larger budget deficits after the tax cuts and the spending increases, combined with quantitative tightening, interest rates should move significantly higher. And as interest rates move higher, then that's going to make credit growth slow down or even contract.
Now, credit growth has been driving economic growth in the United States for decades. Any time credit grows by less than 2% adjusted for inflation, the U.S. goes into recession, which is barely at that level now. So higher interest rates will cause credit to contract, and that would throw the U.S. into recession. And on top of that, higher interest rates would cause assets prices to fall, stock prices and property prices.
So, right now, the wealth-to-income ratio in the United States is at the highest level it's ever been. If you look at household sector net worth as a percentage of personal disposable income, it's higher than it was in 2007. It's higher than it was at the time of the Nasdaq bubble. So higher interest rates would cause asset prices to fall. That would cause a negative wealth affect, and that would cause the U.S. to go into recession as well. So we'd have a double whammy of higher interest rates – as a result of interest rates.
Now, next step, what happens? Well, first, when the stock market falls another 15%, they stop quantitative tightening. And as the stock market falls 20%, they launched QE four, and push the assets prices back up again. And they can get away with that just as long as they don't have a trade war. As long as the foreign capital keeps blowing in, then it can go on for a very long time. Now, these sorts of massive – these major waves in macroeconomic cycles play out over very long periods of time.
And so this is what I focus on in my work with Macro Watch. So I hope your listeners will check out Macro Watch. If they visit my website, and use the discount code, "double", they can subscribe at a 50% discount.
Porter Stansberry: Richard, thanks for all the insight today. I really appreciate it. You've given me a lot to think about. And I encourage our listeners to check out your website. RichardDuncanEconomics.com.
Richard Duncan: Thanks, Porter.
Buck Sexton:Let's get into the mailbag for this week, shall we? Thanks for writing in and filling our inbox with useful feedback. People like David W., Allen A., Don, C., Will B., Tim C., just to name a few. Your comments and questions are a critical part of us evolving this show into some fantastic and amazing stuff. So please keep them coming. It's really easy, too. You just write to feedback at InvestorHour.com. And with that, I'm going to start dropping feedback bombs here. Let's get to it.
First up, number one. Jamie H. "Hello, Porter. I was curious what you think the impact of autonomous vehicles will have on your insurance stocks. I know you are very high on insurers long-term, but have you thought through what they will look like in 10 years or so when humans aren't driving as much?"
Porter Stansberry: Well, yeah, obviously, claims will be greatly decreased. I have a feeling that computers are going to be better drivers than people are, especially certain kinds of people. Not to play any stereotypes. [Laughter]. I'm sitting across from someone, a country club guy, who's wrecked three cars?
Buck Sexton:Let's just say that I ordered new cars in a certain color. It's called guardrail gray. So when I hit one, you don't really see it.
Porter Stansberry: To give a better, more sincere answer, unfortunately, despite my best efforts, the average subscriber's knowledge of the insurance sector is still maybe 2.5 on a scale of 1-10. Most people just don't understand what I'm saying about insurance, the same way that they really don't understand what I'm saying about bonds. And that's because when you talk about insurance, you're talking about an enormous market. Insurance is actually the largest business in the world by revenues. Did you know that, Buck? It's the largest business in the world by revenues.
Buck Sexton: I do now.
Porter Stansberry: So there's all kinds of different insurance. Okay. And the kind that we recommend people invest in is called property and casualty insurance. And, yes, so not life insurance. But can you figure out why investing in life insurance does not usually provide higher than average returns?
Buck Sexton:Because people tend to die at a pretty predictable rate.
Porter Stansberry: Exactly. Everyone dies. So the claim will eventually come. So once people figure out how to stop dying, that's when it would be a good time to start buying life insurers. Until that time, the returns are going to be very average, and there's not going to be a way for you to find an edge in that space because the – everyone is going off of the same mortality tables. They're not called mortality tables. What are they called?
Porter Stansberry: Sorry, actuarial tables. I don't know why they don't call them mortality tables. Maybe it just sounds too mean. Likewise, when I say everyone dies, people are like, oh, he's so negative. [Laughter].
Buck Sexton:The same reason why they called it the Department of Defense instead the Department of War. It's actually the Department of War, folks.
Porter Stansberry: Yeah, the department of offense. [Laughter].
Buck Sexton:Yeah, there's a lot of that going on.
Porter Stansberry: I just wanted to follow up on the insurance thing. So, look, I'm just saying there's different kinds of insurance. Okay. And we really focus on one type, which is property and casualty. And inside that, we are generally – we generally avoid auto insurers. Again, because there isn't any mystery for how to do auto insurance, right. You go to Progressive, you put in your information. Progressive can tell you their quote, and everybody else's quote because there is no mystery behind it.
So what we're looking for is unregulated property and casualty insurance. So these are folks who insure private risk. So like summer camps, oil rigs, things that are unregulated. So the government is not telling you how much you can charge, and that, of course, allows people to charge a lot. It also allows them to build a better understanding of what the real risk profile is that can be proprietary, that gives them a huge pricing edge.
So what's funny to me about the question is it just – unfortunately, I'm not trying to insult Jamie. He's asked a reasonable question for someone who is interested in auto insurance, but I'm not. And what's interesting to me is that no matter – I've been writing about this now for six years, so pardon me for being a little frustrated. But no matter how carefully we explain our strategy, and give you the names of the stocks, and everything else we do, it still seems like most people really don't understand what we are saying about insurance.
And our process is unique. We're focused on a very certain area of the insurance market so that we can make excess returns. And, Buck, our insurance recommendations that come out of our model, 20% annual returns since 2012. Pretty good.
Buck Sexton:Somehow, this is just a fun study in how government works, you know that fires nationwide, so fires that get called to fire departments, have dropped 50%. And, yet, there about 50% more firefighters employed nationwide. Isn't that cute?
Porter Stansberry: Yeah, there you go. Because maybe the economics behind firefighting is not market-based; it's political-based.
Buck Sexton:That is correct. And nobody ever – no politician – there's actually a strategy called fireman first. Right. The moment that any municipality or city is faced with cuts, they trot out the fire department, and they say what are you going to do? Are you going to have less firefighters? And what's happened, for example, in New York and Boston, and some other big cities across the country, is that fire departments, which in New York, the fire department cost $2 billion a year, by the way.
FDNY. They have made themselves first responders as well. So that's why for a lot of you folks that live in cities across the country, if you're constantly hearing fire engines, but you're like I've seen one fire with smoke in the last 10 years in this city, it's be the fire department is actually responding to people that are having chest pains. That's what ends up happening.
Porter Stansberry: Yeah, and the economics of this stuff is pretty incredible. Buck, I'm sure you heard me talking about my Atlas 400 group. So, I don't know, 10 to 12 years ago, I got together with some friends, and the idea was instead of joining a country club or starting a country club, I don't really care about going to the same golf course every week to play golf and seeing the same people.
I was looking for people who wanted to travel all around the world and do incredible things like, you know, let's go to Munich and race Porsches. And let's to go the front row of the Super Bowl. And let's go to Patagonia and shoot birds and go on a stag hunt. You know, and just travel and meet new people, and see new things, and have new experiences and new adventures. So we started at Atlas 400.
And when we go to places, there's a couple rules. First of all, there's no buses. [Laughter]. So it's pretty cool. Like, we went to Oktoberfest, and we got a couple of tables and some nice tents at Oktoberfest. And Oktoberfest is a hoot. But we're doing it Atlas-style. So we pull up, and 20 black Mercedes sedans, you know, in a line. And people were like what the heck is going on? Is this President Merkel or something, you know?
And it's fun to travel that way because there's none of the usual hassles that you ever have to deal with. Instead, you've got advancement who set everything up. You just walk in. There's no checking into hotels. There's no waiting. You just boom, boom, boom, boom. So it's great. And, obviously, this is a very expensive way to travel, and it's for people who have done very well in life. And I don't feel guilty about it. I think I earned it.
Well, anyways, who's sitting next to us at this fancy tent at this fancy table at Oktoberfest? And I'm not making this up. This is a true story. An entire table of firefighters from San Francisco. Now, listen, I got no problem at all. They saved all their money, and they want to spend it on a trip to Oktoberfest, bully for them. But I know what it costs to sit at this tent. It's about a thousand dollars a seat for the day.
That's a lot of money for a firefighter, I would assume. Likewise, traveling from San Francisco to Munich is not cheap. And I'm like, so is this you guys – you know, your big trip for the year? And they're like, no, no, we go somewhere every month.
Buck Sexton:Did you write a Digest on that?
Porter Stansberry: No kidding. Yeah. These guys, they have some kind of a shift thing, where they're on 10 days, and then they're off 10 days, or something like that. And every time they're off, they go somewhere, mostly to Eastern Europe because that's the kind of women that they like. And they just do these enormous blowout trips. And I said, I mean, I gotta ask. I mean, it sounds like a pretty expensive lifestyle. He's like, "Yeah, well, I make quarter million dollars, so I can afford it." And I'm like, "Man, that's awesome. I should have been a firefighter." Huh.
Buck Sexton:It's a great gig. Not nearly as many fires to fight, and the benefits are very, very luxurious for what government is. But, you know, look, I could tell people stories, too. You know the NYPD when you retire, you get health care for life for you and your entire dependent family, including, I believe, divorced wives, forever. Just health care forever, so that's nice.
Porter Stansberry: That's expensive. Now, what about when you trip over into Medicare?
Buck Sexton:I don't know how that works. I just know that the department pays for your health care.
Porter Stansberry: Hmm. Okay.
Buck Sexton:Carlos is up this week in the mailbag. He writes, "Dear, Porter. You have several times railed on subscribers for not investing in bonds given how 'safe' they are. You have also repeatedly warned about the risks of runaway debts in the corporate spear among other areas of the economy. Doesn't that suggest that when the mega crisis you warn of hits, the safety of bonds will be severely challenged? In the last crisis, earnings evaporated, and went negative for the entire S&P. From, Carlos, with love."
Porter Stansberry: Yes. Carlos is quite correct. When we have the next credit cycle, when there is a recession, the destruction in the corporate bond market will be unbelievable and unpresented. The estimates that I've seen from reliable sources expect over $1.6 trillion in losses related to corporate-fixed income. There is no question about that, my friend. The biggest losses will be from companies that are currently rated investment grade.
And if you look, the last tranche, so if you get downgraded one more time, you're now a junk bond. You're no longer in investment grade. That last tranche of investment-grade debt used to represent about 15% of the market of total investment-grade debt. Now, it's over 40%. So there's a whole bunch of companies that are hanging on by a thread to their investment-grade rating.
And I know there's a ton of fraud in those ratings because the consequences for downgrading companies from that point is severe. So Moody's was reluctant to do it. S&P is reluctant to do it. So that will be where the big losses are when you're looking at that $1.6 trillion. Again, kind of like with insurance, what we do in the bond market is not typical. It is atypical, and it is contrarian. So we studied all of the bonds, and all of the bond losses over the years, and we found what we think is anomaly.
And here's the anomaly. If you buy an investment-grade credit, and it goes bankrupt – now, let me say, that's a rare thing. Historically, about 1% of investment-grade debt defaults. But here's the trick to that. That's only if it defaults while it's rated in investment-grade debt. If it gets downgraded, now, it's no longer investment grade. So when it defaults, that's part of the default of a junk bond, so it "doesn't count." But, trust me, if you were holding that bond since it was issued, it still counts.
My point is that investment-grade defaulting is rare. But when it happens, the recovery on those bonds, on average, is about $0.46 on the dollar. On the flipside, when you're talking about high-yield bonds, or aka junk bonds, these are bonds that are no longer rated investment grade. And they're no longer rated investment grade because there is a possibility that they will default.
And so when you study these bonds, you have to look at them much more like you would look at a stock. You have to really know the business you're investing in. You have to know a lot about the capital structure. You have to know about the interest. You have to know about the timing. There's lots of factors. And most bond investors don't want to do any of that homework.
So most people, big banks, insurance companies, pension funds, they do not invest in non-investment-grade debt. Aha. So they're not even looking. And that gives us an opportunity. It's an inefficient market, or pros are not studying it as much. So we dig into it. And here's the fun part. What we found is when a non-investment-grade credit defaults, when a junk bond defaults, the recovery rate is about $0.40 on the dollar.
So even though it seems like you're taking a lot more risk, you're really not because there's still a substantial recovery in most cases. Now, look, again, this is averages. Okay. So if you talk about – you know, there's lots of times when there is no recovery. All right. And we try to avoid bankruptcy all together. And with the new team that I have, and our experience over the last three years, we've had no bankruptcies, and we've had annualized returns over 20%, and we've had a profit – we've made a profit 80% of the time.
So what we're doing is safe and is effective. And what is it that we're doing? Well, we study all the issues separately, so it's 6,000 different securities we study every single month. And what we're looking for is simply anomalies. So, most of the time, the ratings, the S&P rating and the Moody's rating are the same as our rating. But, sometimes, they're not. And when they're not, and it's only about maybe 3% of the total market, when it's not, then that's when we start digging in.
And when we dig in, and we find something that we believe is safe, that we believe that will pay, then we're happy to buy where we can get good double-digit or better annualized returns. And so, yes, when the bear market comes, I'm sure we will take some losses on our bond portfolio. No question. But I'm also sure that our bond portfolio will vastly outperform the average corporate bond.
And, finally, I'm very certain that the worst damage, the biggest losses to bond investors will come from that lowest tranche of investment grade, not from the junk bonds. Yes, there will be losses in junk bonds. And the percentage loses may be even larger than the investment grade. But when you're talking about the nominal dollars, the 1.6 trillion that's expected to be lost, most of that money will come from the investment-grade bonds that fail.
So even though it's rate that an investment-grade bond will fail, when it does, the losses can be very substantial. When I say that bonds are safe, there's a spectrum. And what I'm saying is that they are way safer than stocks. And so the point I'm trying to make to people is if you're not making 20% a year in your stock portfolio, then why don't you try bonds? Because you can make 20% a year in bonds with us, and you will take less risk.
That's not no risk. We've lost on two out of our 10 recommendations. We've lost on 20% of them. But the total returns, losses included, is still more than 20% a year. So, you know, it's funny because people quote what I've said back to me, but they always miss the nuances. Right. Any time you make an investment, you're taking a risk.
But the question is how much are you getting paid to take that risk? And the point I'm trying to make to people is you can actually make more money in bonds than you'll make in stocks, and you will certainly take less risk. So with that, I think we should sign off.
Buck Sexton: All right, everybody. That's it for us. Thank you so much for joining. Love us or hate us, just don't ignore us. Appreciate you listening, and we will see you next time on the Stansberry Investor Hour.
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