The Juice Still in the Lemon

Podcast Transcript

Ed Coyne: Hello, and welcome to Sprott Radio. I'm your host, Ed Coyne, Senior Managing Partner at Sprott. I'm pleased today to welcome Steve Hanke, professor of Applied Economics at Johns Hopkins University. Steve, thank you for joining Sprott Radio.

Steve Hanke: Great to be with you, Ed.

Ed Coyne: Steve is a new guest on Sprott Radio. I thought it'd be interesting to hear a bit about yourself personally and your extensive background in economics.

Steve Hanke: I'll try to keep it simple because I've been around for a while. I have had three simultaneous careers that all overlap with each other. One, as an academic, I'm an economist. My first faculty position was at the Colorado School of Mines many moons ago. I'm almost into my 57th year at Johns Hopkins University, which has been home for most of the time. One year, I took a little trip to the University of California at Berkeley, which didn't suit me, so I retreated to Johns Hopkins. That's the academic side doing what academics do. That's career number one.

Career number two has been in business and trading. In that realm, there are many highlights. In 1995, I was president of Toronto Trust Argentina and Buenos AiresThat's part of the business side of the thing.

The third leg would be as a political economist, advising politicians and governments. One recognizable thing is that I served on President Reagan's Council of Economic Advisors in the U.S. I've also had positions in Argentina, Estonia, Lithuania, Bulgaria, Bosnia, Herzegovina, Montenegro, Yugoslavia, Indonesia, etc. There are three aspects: the purely academic scholarly side, the business and trading side and the political economy side of advising the government. That's the three-legged stool, Ed.

Ed Coyne: That's a very quick summary because when I was preparing for this, your background and bio were well north of a solid page of just your accolades and all the different things you've been involved with, which was incredibly impressive. For our listeners, I think it's worth noting that you have been at Johns Hopkins for over 56 years. I believe you've seen many changes in how we view data, what the economy is doing with quantitative easing and Operation Twist and that whole narrative. I'd like to start by discussing what has surprised you over the last five decades and what has remained the same.

Steve Hanke: I think the biggest thing, and it wasn't exactly a surprise, but it is something I've observed, is that economists have wandered further away from the real world. They spend their time piddling around with various theoretical models that have almost nothing to do with the real world. For example, let's look at macroeconomics. In macroeconomics, the models used are what we broadly refer to as Neo-Keynesian models. Still, these macroeconomic models don't even include an aggregate metric or measure for the money supply.

For me, macroeconomics is monetary theory plus capital theory. My most recent books include one I co-authored with a great polymath, Leland Yeager, called Capital, Interest and Waiting. Palgrave Macmillan put that out about a year ago, and it’s on capital theory. The most recent one that was released by Wiley in May, which I co-authored with Matt Sekerke, is called Making Money Work. That's about monetary theory. You got those two books, macroeconomics, but neither is in the Neo-Keynesian models used for the last 30 years.

If you look at the Federal Reserve, for example, Chairman Paul has publicly said that they don't pay any attention to the money supply. Now, he doesn't say that it's not included in the models that they use, but it's not. They pay attention to the interest rate in the models, but the money supply is not. My view is that monetary policy is not about interest rates; it's about changes in the money supply.

Ed Coyne: Why do you think they're getting that wrong? I don't disagree with that, obviously. I know if I have more personal money supply, my life's better, not worse, but I think it's the opposite with the government. What's going on there? Why are they discounting that?

Steve Hanke: It is these models. You say, "Hanke, you've been in trading and paying attention to the markets and that kind of thing, but you're also an academic." The disease comes from the academic part because traders don't design these models. This comes from the academy, and it is Neo-Keynesian. By the way, before the general theory, if you look at the Treatise, the two-volume work that Keynes did before the general theory, that's basically about money and banking.

The situation has morphed more: the Keynesians and Neo-Keynesians are now far away from monetary theory and the quantity theory of money. That's the story. The models are not that way. If the models aren't that way, that's not how the policy makers are getting their advice. They're getting it off these models that, I think, have very little connection to reality.

Ed Coyne: Is that where maybe we're starting to go astray here a little bit, as the models have evolved and the politicians are making decisions off these current models? Is that maybe causing a bigger problem than perhaps even they realize?

Steve Hanke: I think it is for sure. It causes problems in the press because about 75% of all the research, money and banking is done either by the Fed in the U.S., people who used to work at the Fed or in academia, who the Fed has financed. The gatekeepers, shall we say, are Fed economists one way or another. The Fed economists are using these Neo-Keynesian models and have embraced them. What the press gets from whoever they're talking to, whether they're talking directly to someone at the Fed or an academic, or they're talking to somebody who's been around the Fed, or financed by the Fed one way or another.

They're all feeding at the same trough. You can't blame the journalists because if they return to the primary data and the research, it's all based on certain models. The journalists are not in the business of modeling; they're in the business of reporting what's supposedly going on, so we get a steady stream. Not only do we have the research based on one thing, but the press is dominated by it, too. Of course, the press is dominated by whatever the press office says at the Fed. That's the main source of everything.

Ed Coyne: The topic you hear more is debt to GDP or just debt. Can we service it? Does debt even matter? A few years ago, there was a theory that debt didn't matter as long as you could service it. Is money supply factoring into that at all, then? Are they rolling that all together as one term, or what's happening with that?

Steve Hanke: It comes indirectly in the following sense. If the government's running a big deficit, it can finance that deficit by selling treasury bonds and bills to the non-bank public. That's one way to finance it. The other way to finance it is to sell part of that to the non-bank public, but part of that debt to sell to the Fed. If that happens, it gets monetized, and the Fed creates credit. It creates money to buy the treasury bonds. That's what happened in 2020 and 2021. We had a very sharp increase in the deficit in the U.S. Remember, the pandemic hit in February of 2020, and the economy was shut down. At the same time, the government spending kept going, the receipts weren't coming in, the deficit soared, and about a little over 90% of that deficit was financed by the Fed. They just created money. When that happened, what happened? The money supply skyrocketed. It went up at its highest growth rate since the Fed was founded in 1913 after the pandemic.

As night follows day, Ed, we had inflation. We also had a huge increase in asset prices. Before the inflation, asset prices, land prices and housing prices went up. All kinds of physical assets and precious metals went up. That distorted the income distribution in the economy. The monetary policy was not only loose and inflationary but also non-neutral. Sekerke and I discuss this neutrality in our book Making Money Work. The monetary policy should aim to be neutral. It shouldn't be biased towards favoring particular groups or sectors of the economy by income. Now, to give you an idea of what happened, in January of 2020, the billionaires' wealth as a percent of GDP was 14.1%. Today, it's 21.7% of GDP.

Ed Coyne: Wow.

Steve Hanke: The rich became very rich with this explosion in money. Who says the money supply doesn't matter? This is a joke. Any normal person knows very well that the money supply has a big influence on inflation, the rate of growth in the economy and the distribution of income. Who benefited from the explosion in the money supply that caused an explosion in the asset prices? People who owned assets. Who owns assets? Rich people own assets. It's a pretty simple game, and this is what you don't find. You said, "What's been the big change in economics?" It's exactly the thing we're talking about.

Economists don't look at this stuff. They're fooling around with equations and models and so forth, and hardly ever looking at actual data in the real world. The causality and link between the biggest factors that cause changes in the economy and changes in the money supply. I've looked worldwide, and there's never been a significant inflation. That's inflation, which I define as 4%, lasting over two years. There's never been a significant inflation unless preceded by significant increases in the money supply.

Ed Coyne: It sounds like to me by not including money supply or not emphasizing that, I don't want to go as far as saying they're doing a shell game with their data, but it does feel that way. Talking about moving the goal post on inflation, we had 2% as our target. I said, "Maybe we're close enough. We're going to start lowering rates." That's what I want to really get to. Why is the Fed not holding the path? Do they need to lower rates? Let's talk about the rates briefly because that seems to be getting all the headlines right now. Wall Street is prognosticating two more cuts. What's your view on that? Are we too early, too late? What's your view on what the Fed's doing now?

Steve Hanke: The easiest way to find out where they're going is to go to the Chicago Mercantile Exchange. There's a Fed Funds futures contract. See how it's trading. The Chicago Mercantile Exchange has worked out the probabilities derived from the market trading that indicate what will happen to the Fed funds rate. We have a meeting coming up on the Federal Open Market Committee in October and one in December. It looks like, with a very high probability, around 75%, 80%, that there'll be a 25 basis point cut in October and another 25 basis point cut in December. Those are objective data, by the way. They're market prices.

Ed Coyne: Being on the precious metal and critical material side, we constantly get asked about cryptocurrencies. I want to hear your view on gold and if that's relevant in today's marketplace. Before we go into gold, do you think cryptos in general, or Bitcoin, or something new that we don't even know about yet, deserve a seat at the table as it relates to the economy and talking about different levers we can pull? What's your view on that, if you have one?

Steve Hanke: There are different kinds of cryptos. Bitcoin is one, and Bitcoin's just a speculative asset with no fundamental value whatsoever. These stablecoins are something else because they are issued. Still, with the new regulations put in place, theoretically, they're supposed to be backed by dollar-denominated assets so that you can exchange the token for U.S. dollars at a fixed rate. Trump says that the stablecoin legislation will require that U.S. Treasuries back the stablecoins, increasing the demand for U.S. Treasuries and making it easier to finance the U.S. deficit. That's one argument.

It does come into play in that sense. It doesn't really do anything for the economy in that sense. If anything, it slows it down because these are speculative assets, and you have to use real money to buy them. These speculative assets are like buying fine art or something like that. You buy a painting, and what does the painting do? Is a painting producing anything? You get a non-pecuniary benefit from the thing, assuming you enjoy it at home. It's not like investing in a bankable project, a factory, a store or something like that. That's how it's connected to the economy, and who knows where it goes from here?

Ed Coyne: I do think it's interesting that you call it a speculative asset. I always thought of Bitcoin, and I don't want to be a hater on it because I think they've opened up a nice conversation on owning assets outside of the traditional market and so forth. It feels a little bit like Netscape, not to pick on Netscape. It's a technology, and technology is constantly evolving. It will be interesting to see how this story ultimately evolves or ends over time.

Speaking of paintings and things that don't do anything, Warren Buffett loves to hate gold because of that. I know you've previously talked about gold and its economic role. Is it still relevant? We've seen a tremendous move here recently, and central banks are buying it. I'd love your view on this because you've been at it for so long. What do you think of gold today? I guess two parts. What do you think of it today, and are you surprised by this aggressive move we've seen from a price standpoint?

Steve Hanke: Gold has always been a part of the international financial system, and I can't imagine a system without gold being part of it. It's been around for thousands of years and will not be displaced by cryptocurrencies or something like that. That's the end of that story. Now, what about the market? The market is interesting. People aren't talking about it very much. They're talking on and on about Bitcoin and cryptos and things like that, but not about gold, which is up 45% this year. It's making new highs. As we speak, on September 30, it's making new highs almost daily.

Ed Coyne: That gets me to the second part of that question. How is this environment different from 2000 to 2011? The last time we saw gold generate interest and people allocate to it, the miners exploded. How is this run-up or this environment different from what we saw over those 11 years?

Steve Hanke: The market is exactly what it was that last secular bull, regarding the market activity and things like that. The narrative is slightly different this time, with central banks buying big time, particularly Russia and China. Part of that story is sanctions. The financial sanctions the U.S. has put on, especially Russia, and is threatening other countries with sanctions, either direct sanctions or secondary sanctions. That weaponizes the dollar and spooks not only retail investors but also obviously central banks. The weaponization of the dollar is a big thing now. That's different. It creates a huge commotion, and people start thinking, "Maybe it's a good idea to squirrel some liquidity away in gold. Maybe gold's a safe place for it." So far, the proof of the pudding is in the eating. The eating is pretty good. As I like to say, as a gold bull, buy gold and wear diamonds.

Ed Coyne: There does seem to be this verbiage out there right now that gold is overbought. It seems to be that way from a narrative standpoint; people are talking about it. It doesn't seem to be that way from a capital-allocation standpoint. We don't see much money internally flowing to the space yet. It still seems to be grossly under-owned. Do you feel that investors, purely from an investment standpoint, are missing this move or this party?

Steve Hanke: I think they've missed a lot of it, but there's still a lot left—a lot of juice in the lemon. The thing is, it depends on what country you're in. If you're in China, that's not the case because the Chinese buy gold, and the Indians buy gold. In Europe, to some extent, and even more so in the U.S., the retail investor has been underallocated. Part of this narrative is Warren Buffett, who doesn't like it because it's not yielding an annual return, and in that sense, it is speculative. The negative narrative is that it's not going anywhere, something not worth having, and so forth; a lot of that comes from the crypto crowd.

Ed Coyne: It's amazing to me when you look at the performance. For the last two and a half decades, that rock that doesn't do anything has outperformed the S&P 500, which is loaded with intellectual capital, dividend-paying stocks, value creation and new products and ideas, yet this rock continues to add value. I don't know when the world wakes up to that, if they ever do. It's just been fascinating from an investment point of view to watch that happen, and you are hearing your economic point of view and your academic view on it as well, which is also equally fascinating.

Steve, thank you for sitting down. We've been really enlightened. Maybe more people will pay attention to the money supply, which, to your point, is an important one. It's a treat to have guests like you on. Thanks again for taking the time to share your thoughts on Sprott Radio.

Steve Hanke: You're welcome, Ed. Thank you for inviting me.

Ed Coyne: Thank you. Once again, my name is Ed Coyne, and you're listening to Sprott Radio.