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“Nixon Shock” 50 Years Later, Remembering the 1970s

“Nixon Shock” 50 Years Later, Remembering the 1970s

John Hathaway and Bill Strong join Stephanie Pomboy to reflect back on the Nixon Shock, and draw parallels to today. Pomboy describes it best: "Marking an anniversary can often seem like a hollow perfunctory exercise but I'd say this time, that is definitely not the case. The 50-year anniversary of the Nixon Shock and the policies he outlined in his speech carry unique resonance today."

William Strong 

William Strong is the portfolio manager and founder of Eschaton Opportunities Fund, a global value, cross-capital structure hedge fund that he launched in 2016. Mr. Strong received a Bachelor of Arts in economics from Williams College in 1971. From 1973 to 1975, Mr. Strong attended Columbia, served in the Army Reserves, and began his investment career as an underwriter of municipal bonds for Loeb Rhoades & Co., a Wall Street investment bank. He earned an MBA from Harvard Business School in 1979. (Source: Columbia.edu)

Stephanie Pomboy

After graduating from Dartmouth College with a degree in economics, Stephanie joined the economic research team at Cyrus J. Lawrence. In 1991, the team left to establish ISI Group, an independent economic research firm. During her tenure at ISI, Stephanie worked closely with the largest and most sophisticated institutions, providing timely economic insight and analysis. Stephanie now runs her own firm, MacroMavens. She is one of the most widely respected women in finance; her clients include the largest U.S. mutual funds, investment management firms, and global hedge funds. (Source: Barron's)

Video Transcript

Richard Nixon, August 15, 1971: In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation's currency is based on the strength of that nation's economy, and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interest of the United States.

Now, what is this action which is very technical? What does it mean for you? Let me lay to rest the bugaboo of what is called devaluation. If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

Stephanie Pomboy: Marking an anniversary can often seem like a hollow, perfunctory exercise, but I'd say this time, that's definitely not the case. The 50-year anniversary of the Nixon Shock, as the policies he outlined in that speech, carry unique resonance today. We find ourselves in the last year, transported to this bizarro world where the Fed's balance sheet has suddenly mushroomed to almost half a GDP, fiscal policymakers are making with multi-trillion dollar stimulus bills seemingly on the daily. And inflation is back to levels we haven't seen since we were all sporting bell bottoms in the 1970s.

One imagines that even to the most jaded observer, the question of how long we can maintain this fiat money standard that was ushered in that Sunday evening 50 years ago really begs. The problem for most of us is it's the only monetary standard we've ever known, which is why I'm particularly pleased to be able to emcee this conversation with two gentlemen who are just getting started in their investment careers when the Nixon shock happened. Without further ado, my name is Stephanie Pomboy. I'm the President of Macro Mavens, a macroeconomic research firm. And I am joined today by John Hathaway, who is the Co-Chief Portfolio Manager of Sprott Gold Fund, and Bill Strong, who is the Managing Partner of Eschaton, a global value hedge fund. And we are gathered here today as summer neighbors in the beautiful mountains of Colorado, albeit a little smoky right now. So we're in our Western best, or at least two of us are in our Western best. Gentlemen, thank you for being with me today.

Stephanie Pomboy: I'm very excited because I was in diapers, I'll confess, when this event, this shock happened.  Obviously, what I know about it comes from history books. But you guys were there. You were on the scene. You were just getting started in the business. So it has surely informed your entire career since then.

But I'm curious to know when it happened, and you came to work the following Monday morning, whether you understood at the time how radically transformational the policies that were outlined in Nixon's speech would prove to be. So I'd love your reminiscences about what strikes you the most when you look back on that time. John, if you would kick things off.

John Hathaway: Sure. For me, I was with a firm called Spencer Trask, a white-shoe brokerage firm, which I don't know if they exist anymore, but our job was to promote the most expensive stocks, desert island stocks. The idea is that if you went to a desert island and came back, your portfolio would look just fine. So if you had Polaroid, Simplicity Pattern, Kresge, and so forth, you would come back and you would be just fine. But if you actually did that, you would be broke.

Stephanie Pomboy: Right, those companies don't exist today.

John Hathaway: I was blissfully unaware of what had happened at the time. I only became aware in the bear market of '74. And I started reading Austrian economics. I read Ludwig von Mises, and I got the idea that something was horribly wrong. And I became very interested in gold back in the mid-1970s. And what I remember for the rest of the decade was how unattractive to most people the idea of being in the investment business was. And people took pity on me that I was actually in the investment business.

And that was the mood at the time when stocks made a huge low and bonds made a low, I guess, with the onset of Volcker and his policy. So that was my fast-forward experience in the 1970s.

Stephanie Pomboy: Wow. Fascinating. What about you, Bill?

Bill Strong: Well, I wasn't exactly in diapers, but I hadn't started work yet either. I was a couple of years behind John. I resurrected an old photograph, which I think is fun. I don't know if you can see this. This was a photograph of me in August of 1971. I was in London at the end of my tour of Europe, which my father had given me as a graduation present. I just graduated from a Liberal Arts College on the East Coast [Columbia]. And we were traveling around.

And so, we were exchanging U.S. dollars for foreign currencies. And I remember the event, not for what Nixon said in the speech, but because my U.S. dollars, the last transaction I made, bought fewer pounds than it had the rest of the summer. I read about this in the Financial Times. But I was an econ major in college. And in those days, the '60s and '70s, the East Coast Liberal faculty of an econ department were very much Keynesian. And so we had a Keynesian macro-perspective, which basically ignored gold completely.

Gold was considered a barbaric relic and the faculty that I talked to never even mentioned it. It was clear we had a foreign currency issue because the exchange rates were fixed at the time, but the system was under stress because we were running big current account deficits. We studied that in college. People explained that this was a problem, but it wouldn't seem to be an emergency and had to be dealt with at some point.

The basic is, I think back, the basic perspective of the faculty teaching econ in those days was that this new development of Keynesian spending and the monetary policy with it was countercyclical and had been very successful from the end of the Korean War until I got to school. There's been successful in smoothing out the cycles, and we had good economic growth. The '60s were a good decade.

But by the end of the decade, Johnson's guns and butter policy was beginning to put stress, and we're starting to see an acceleration of inflation. And my professor said, of course, we got two big budget deficits. You're violating the game plan for the Keynesian stimulus and contraction. In those days, it was understood that when inflation began to pick up, you were supposed to tighten the money supply, cut back on government spending. That was the policy that they were recommending.

When Nixon made the speech, I was barely aware of it. I was not, at the time, employed. Two years later, I ended up in the investment business, in the bomb business in New York. And like John, people felt sorry for me. You just didn't want to do that. And even later, in getting out of business school in 1979, I went to work for an equity management firm, which was an absolute suicide career wise.

Again, it was very unpopular, but in the '70s, and we obviously talked a lot about that, I learned some lessons from that, I think are applicable today. But at the moment this happened, I was yet to be employed.

Stephanie Pomboy: What's really interesting about then versus now is there are so many really strong similarities between what we're seeing today and what we're starting to brew following that Nixon shock, specifically inflation. I mean, we've seen the CPI soar to almost five and a half percent just in the span of a few months. And it even seems like the nature of the inflation is very similar to how it started back then, in terms of being primarily a supply-side phenomenon, an issue of supply. There was, I guess, back then, there was a food shock initially that sent food prices soaring, and then that followed on with the oil embargo that sent oil prices up.

And today, of course, we're seeing inflation confined to some areas where there are supply issues. But I guess the question then is back then obviously, it eventually bled out. And maybe I don't know if Nixon described it or as people described it as transitory back then, only to discover down the line that it was anything but that's certainly where we are today, is this feeling that, well, it's just isolated to a few things, it's transitory. Can you all talk a little bit about the similarities or differences you see in terms of the nature of the inflation that we're experiencing today versus what we went through back then? John, do you have some thoughts on that one?

John Hathaway: I would say a big difference today versus then is that interest rates are suppressed. The nominal rates are very low, as we all know. In the '70s, I think rates were rising. And Arthur Burns was told by Nixon not to let them go up too much and he wanted to get re-elected, which is the whole point of the speech. This was totally political.

Nixon didn't understand gold and didn't care about it. And so the dynamics are very similar is basically there was an attempt to suppress inflation interest rates. And back then, you had wage and price controls. They're not dumb enough today to try to do that, so far. Another big difference is that in the 1970s, the government was not that big a part of the economy. But today, the government is 22% of the economy. And we'll talk about this later. But transfer payments are a big percentage of personal consumption expenditures. So a big difference there as well. And Bill probably has a couple of other thoughts on that.

Bill Strong: Yes, I think there are some parallels. I think, certainly, I remember distinctly as I started in the bond business and people were thinking about interest rates. And the idea was that these forces, these one-time forces, were transitory. And everybody was absolutely certain, I mean, everybody, that inflation was temporary. And we'd go back and this wasn't going to go away, but the higher levels were going to go away and instead they kept going up.

I remember distinctly going to the supermarket in the early '70s and seeing no meat in the meat department. That was absolutely directly a function of Nixon's wage and price controls. And so we began to run out of things. And so you had to ration meat, you had to ration other things. And so Nixon began to unwind, the administration started to unwind those price controls. And that initial unwinding created a surge in inflation.

Stephanie Pomboy: A surge in inflation and wages as well.

Bill Strong: Yes. We'll come to wages in a minute. Of course, in the '70s, the unions were much stronger. So we'll come back to that point, which I think is an interesting difference today. But I remember as a young guy in a bond department, rising interest rates, of course, were terrible for us. We were losing money as rates rose.

It was important to try to get some idea of what was happening. And we had this, I guess, it was the '74, you can see the inflation rate started to surge, and it really surged into the mid-'70s, partly because of taking off the wage and price controls, which it held artificially low, but also because of the Arab oil embargo in the latter part of that in '73, I guess it was the Arab War. And so, again, we'll come back to those specific points of why inflation surged. But I remember it was so similar this day that the marketplace, all of us, we're certain it was-

Stephanie Pomboy: It was transitory. I mean, I think that's really the thing that stands out today is if you look at the surge we've seen in the CPI and overlay that with a 10-year bond yield, it's just you've never seen a disconnect like that. And it speaks to the success the Fed has had and selling this transitory narrative. I think it's also evident in gold, which you think, given what's transformed in terms of the monetary fiscal policy and the increase in the inflation measures that gold would be much higher, but clearly, people are betting as they did then, I guess, that this really will prove transitory.

And I guess the interesting thing about that is the interest rate valve, which finally did serve as a check back then, is being artificially manipulated today. Inflation is the most important similarity. But the interest rate dynamic is clearly the most important difference today. And it's just strictly a function of this dramatically different approach to monetary policy, where the Fed is just going to sit there and suppress interest rates, which eventually they couldn't do. At some point, they gave up on, I guess, back then, John, but now there's an infinite runway for them to suppress interest rates.

John Hathaway: Don't know the limits of what... I mean, they bought more TIPs that have been issued. So people look at TIPs and say, well, there's no inflation because you look at the TIPs spread. So all of these indicators that used to work are being, in one way or another, controlled. The CPI itself is nonsensical. And yet I see many very smart economists who confine their analysis to parsing the components of the CPI as if that were the thing. Inflation is psychological.

Stephanie Pomboy: They probably forecast to the nearest decimal point.

John Hathaway: Exactly. Inflation is a hundred percent psychological. And it's how human behavior adapts to rising prices and it's self-reinforcing. I know Bill has some eloquent thoughts on that. But I mean, that to me, is what is not captured in the CPI.

Bill Strong: I think back over my experience in that period, I learned painful lessons in being in the bond business. I learned that the experience of inflation, not the CPI, whatever its way, it's measured by whomever. But the actual experience of inflation changes people's behaviors. And that means people will accelerate their spending. They have dollars sitting in the bank, and they start to expect things to cost more next month, next year, or whatever.

They buy it today as opposed to waiting. And that a change in behavior. That would probably affect the velocity of money. Companies, the management starts a hoard raw materials for the same reason. They don't want to pay more tomorrow, so they buy it today. There are all kinds of other consequences.

But the change in behavior that happens once people actually experience inflation is not a theoretical idea. That change in behavior and economists refer to, and I think this is one of the main points I think we need to talk about, as inflationary expectations. And they think people think you can measure them, maybe you can. The measurements that we see are up substantially.

But I think you will begin to see behavior, you already begin to see people behaving somewhat differently, spending more saving less, certainly with these low interest rates. And that was one of the real key takeaways that inflation begets more inflation.

Stephanie Pomboy: Right. And we've seen that vividly in Japan in the other direction. But the little tricky thing about it now is that obviously the consumer inflation expectations numbers, as you noted, have gone up a lot. So whatever the TIPs indicator, which is broken or whatever investors might actually believe about transitory, consumers aren't buying it. They see the inflation and they expect it to continue to go higher. The problem is right now their wages aren't keeping up with that inflation. So their ability to start to stockpile things is limited, isn't it? Or how do you see that playing out in this narrative?

Bill Strong: I think the wage thing is quite interesting. The wages have yet to go up, but I'm pretty confident that this is the next leg of inflation, because everywhere I look, there's a labor shortage, and I mean everywhere. And you take the unemployment number, the unemployed number, and you think about the number of people that are getting federal assistance, the number of people that are still unemployed from COVID, there should be plenty of slack in the labor market. Everywhere I go, I see labor shortages. 

I got a hair cut down in Edwards [Colorado] a month ago. I had to wait an hour to get to the barber. The barbershop was so full. And it was interesting because they used to have three, now they only have two barbers. And I said, well, when was the last time you raised your prices on haircuts? Years ago. Well, that's coming. That hasn't happened yet. But there's a shortage at every place we go, there's a shortage of labor, particularly lower-end labor is in very short supply. And so we see this over and over again, anecdotally. And you're also seeing it in the surveys of companies and so on. They can't find workers.

I'll go back and make another inference about inflation. And that is my experience of inflation is that shortages and inflation are the same thing. And when you have shortages as an issue and supposed to some other issue, people again change their behavior. If I can't buy gasoline, I ration gasoline, I don't care so much about what I pay. I really want to be able to get it. So I'm not as price sensitive.

And the other thing is when there are shortages, that implies prices are too low.  I think certainly in the labor market, we're about to see a significant increase in wages. We're starting to see it. And management that I talk to in management I know about are putting in much higher wage numbers. We're starting to see it. Even here in this area, wages are going to go up a lot, I think, in the near future.

Stephanie Pomboy: We'll put you squarely in the secular inflationist camp in that debate between inflation or deflation. Where do you sit on that one, John? It's a raging debate right now.

John Hathaway: It is a raging and smart people on both sides, I think the argument, which you've alluded to, which is that because prices have gone up so much and wages have failed to keep pace, could argue for a big economic slowdown. And if that were to take place, you can be sure that this administration and whatever administration is to come is going to see to it that the transfer of payments are... And it's not the unions anymore. It's the government's willingness to... We saw the extension of rent forbearance, maybe forgiveness to student loans. It's the same thing as the union demands of the 1970s but in a different form. I would say, yes, there's a good chance that there will be an economic slowdown because of what you mentioned. But should that happen, I think the reaction function of government policy will be very supportive of higher wages and higher transfer payments.

And again, it's behavior, it's human behavior. Why aren't people working? Because, well, they haven't had to for a long time

Bill Strong: I think that my point is about the labor market is that in the 1970s, the argument is that the labor unions were a sort of flywheel. It pretty good kept inflation turning along with their wage negotiations. We don't have labor unions that strong anymore. So therefore, that's not an issue.

But when I went to a restaurant in Western Massachusetts three weeks ago, there was a sign that says no one wants to work outside the restaurant. Please be patient with the staff that did show up.

Help Needed

So the structural market has changed so that we have a... The labor force participation is falling off a cliff. So I'm going to argue that there's been a structural change in the labor market. It's putting upward pressure on wages and that's soon to happen.

Stephanie Pomboy: Well, whether it's because people are... There's this mismatch between labor and the jobs or they're just getting paid to sit at home. I mean, it seems clear that, as you mentioned, John, if there is a slowdown in demand and spending, they're just going to use it as a rationale to do another round of stimulus, which is I've snickered recently in commentaries to my clients that the inflation is going to be a rationale for more stimulus, which will feel more inflation because they'll keep handing people money.

I mean, when you look at consumer spending versus the delivery of checks to the mailbox, it's perfect. When they stopped getting checks at the end of last year, at the end of the Trump administration, spending fell off a cliff. And then when the checks went out in January, it's soared right back. And then it collapsed until they passed the bill in March. And so we keep going up and down. And the growth is only as good right now as the sugar high.

But I think that factor, the difference between the monetary and fiscal policy today is probably the strongest single argument for the secular inflation case, which folks like me would couch against the forces of debt and demographics, which are major deflationary forces. And I'm wrestling to figure out how that plays out.

John Hathaway: Well, deflation basically, the deflationary forces are huge today. And the reason for that is the high level of that in the public and private sector. And I know we have a chart that would show that. We're stuck in this world where interest rates cannot go up without having very adverse effects on the economy. And the offset to that is the government's willingness, in fact, the expectation that the government will come to the rescue.

And that cycle, to me, is the pulling between deflation and inflation. They're very closely related. And we're at a place where I think the potential for further currency, debasement is the only way out.

Stephanie Pomboy: Absolutely.

John Hathaway: And, again, I'd love to get away from this idea that the CPI is really a metric that has no value at all in terms of what's going on with inflation. It's behavior in the marketplace. What we just showed is workforce participation. That's the labor shortage and the correction for that is higher wages. And it will flow through... It will eventually be seen by the CPI, but probably too late in the game.

Stephanie Pomboy: What I wrestle with on the inability for us to withstand any increase in interest rates is that the Fed can control the treasury curve unless or until they start going out and buying private debt as they did.

But if they closed that down, if they restart that facility and actually utilize it, right now, you're seeing corporate bond yields to actually start to edge higher. It's going to be very interesting to see how much control the Fed has. It's one topic we've also discussed is this unswerving faith in the Fed and their ability to somehow steer markets and make sure that we don't have any kind of all hell doesn't break loose. And it's evident in, I think, gold and the quiescent nature of the markets, and, of course, the soaring performance of the stock market.

Bill Strong: Before we start getting into today too much, I don't want to leave the '70s just yet. And I'm curious about John's experience. So there was a speculative episode in the early '70s and you were participating. You were helping a-

John Hathaway: I was fanning the flames.

Bill Strong: You were fanning the flames. And so you have a speculative episode at the beginning of that acceleration of inflation. And we've had this massive episode yet again since the '08 experience. I don't know, John, do you want to compare the two, the yes then versus now and speculation inequities?

John Hathaway: Sure. Yes. I mean, we had in those days, something called the Nifty 50, which again, were stocks priced for perfection. And my job as an analyst was to explain to people why a particular stock like Avon Products should trade, MGIC, is another one I remember, should deserve to sell at that and their earnings would grow ad infinitum and therefore higher prices would be expected. That was the Nifty 50.

But if you look at the chart of market cap to GDP, you can barely see the effect that I and my cohorts had relevant to where we are today.  I mean, I feel quite inadequate in that respect.

Stephanie Pomboy: Hey, you gave it your best effort.

John Hathaway: I gave it my best. And it just doesn't even register on a chart of market cap to GDP. So now you have all forces, the Federal Reserve being first and foremost among them, the financial media being right there with them in terms of thought control. And I think that's the best explanation I can think of for why market cap to GDP is today, I think, it's higher than it was in '07, '08 before the housing prices.

Stephanie Pomboy: That creates a real problem for the Fed, because if we were to revert to mean valuations-

John Hathaway: How are we going to do this?

Stephanie Pomboy: Yes. I mean, that's why I think they're so desperate to just make sure they keep that bubble inflated. And I guess the question is, how long can they keep doing that?

John Hathaway: And the relationship between the Fed's behavior and the belief that the Fed has the markets' back is so symbiotic. And once that cracks, then the repercussions are very widespread. And to me, that's just thinking about gold. What's missing is the idea that basically if you play it in the middle of the fairway, you're safe. And once that complacency is unnerved, then people will look for something, a different strategy, which is where gold would come in.

Stephanie Pomboy: I don't know about you, but I'm just shocked that we haven't gotten to that point yet. I thought for sure after they came in, guns are blazing after the global financial crisis. It started QE [quantitative easing] and then had to do QE2, QE3. Remember when people thought QE was transitory and then it kept coming back? You would have thought that each one of those moves would have attempted the credibility of the Fed, and instead, it seems like it's even more resolute today than it ever was before.

Bill Strong: I guess we've had the same experience. It was just a shock. Month after year after year, these things have gone bigger and bigger and bigger. I guess what's happened is we have this massive stimulus from the Fed and now from the Treasury and the Fed. And there's up until now, there really been no adverse consequence. There hasn't been any inflation.

So this is a magical world, which I think is unsustainable, but there have been no bad consequences and the prices go up. And so what's wrong with doing this?

Stephanie Pomboy: Well, this is the perfect segue to return to the conversation about fiat money. Because we all agree whether we're in secular inflation or deflation camps, that the Fed has to keep doing QE, both to keep interest rates suppressed and also to keep the stock market at these nosebleed valuations because God forbid, they revert to the mean, and then it's lights out for the entire economy and every pension, etc., etc.

That being the case, the question is what causes this fiat money regime to finally jump the shark again? I would have thought that we would have pushed the limits already, but it's just hard. I guess part of the issue is that this old, cleanest, dirty shirt argument, what's the alternative to the dollar right now? You're not going to buy euros.

Bill Strong: Again, I want to go back to the '70s because this was very important... But this is an important difference with today and it goes to your point. And, again, I was a participant in the bond market. And I watched the central bank raise interest rates year after year, and it was painful for us. But we thought, oh, this is going to really slow down the economy. Just look at what we're doing. Interest rates got to very high levels, nominal levels, at least historically.

And shockingly, it didn't seem to matter. And of course, what was going on is this distinction that we really have to talk about today, which is real versus nominal interest rates. We were all focused on nominal interest rates, which were rising and rising to levels that were almost never seen before thinking that was very contractionary. And yet inflation was accelerating to such a level that real yields, real yields, went actually quite negative, so at least at worst, it had no effect to maybe it wasn't effected in at all.

Rising rates were unaffected or ineffective because the real yields went down. This happened in the mid-'70s, and then again at the late '70s until when Paul Volcker became a central bank. So you had negative real yields at a substantial level, even with some of the highest nominal rates we'd ever seen. And until you've got real yields to some of the highest levels seen, thanks to Mr. Volcker, that began to make a real difference.

And I remember Volcker's press conference on a Saturday night, October in '79. I watched it. He has a press conference on Saturday night in which he announced he was not going to raise. He's not going to focus on watching interest rates anymore. He's now going to focus on the money supply. And then, by the way, that'll make interest rates equal to volatile.

The next Monday, rates went crazy, went up. And for the next couple of years, rates went up to where the short rates got up to 20%. And that was enough. The real interest rate became very punitive and slowed everything down, and that finally broke the back.

Bill Strong: Then I think today one of the critical issues is what's happening to real interest rates today? And my thesis is that obviously, as we are finally seeing inflation for the first time in years, real inflation, that the real yield is gone very negative. They're not even raising rates today. The real rates are going very negative. And that's going to stimulate the economy may be like as much as Volcker's negative rates contracted it in the late, the early '80s.

Stephanie Pomboy: But that being the case, the question still begs, where does it end, if we're going to artificially cap interest rates and continue to pass stimulus bills. And we're not alone. We've got Europe, UK, Japan all doing the same thing. Aren't we pushing this whole fiat money experiments to the brink at this point?

John Hathaway: Pushing the envelope for sure. And what will bring it to its knees, I think, is inflation. That is not going to go away. And it just astonishes me that there's so much faith in the Fed, and the market flinches every time they say taper or talk about it. But let's remember 2018, when they tried to taper, the market went crazy, and I think this is the same thing.

The Fed is essentially hostage to the financial markets. The carnage would be so great if they actually did something, which I don't think they will and they know it, I think they know it, that they're not going to do anything. And that means that the inflation that we're talking about, which is really just getting started, is going to carry on much longer and do a lot more damage. And right now, we're in the party phase of inflation because the markets are great. But the hangover has yet to come. And if I knew when that would be, I'd be... But I'm not.

Stephanie Pomboy: You'd be taking aspirin right now.

John Hathaway: I'd be taking something. But that I think is that is yet to come.

Bill Strong: Yes, I completely agree. I think the end game here ultimately has got to be inflation. And I think it's inflation that it becomes just really painful. My thesis is that because we're starting to see inflation, we're going to start to see these behavioral changes, inflationary expectations rising. At the same time that unlike the '70s, you've got interest rates at virtually zero, and they're going to stay there, I agree.

And that means that real rates are going to go very negative. And how much and how far, it's hard to know. But very negative real interest rates, I think, are going to stimulate more spending, more inflation. Maybe we think we're in a different paradigm. We think we've shifted over with the acceleration of inflation. We're now in a different world than we've been in the last 30 or 40 years. And ultimately, not right away, ultimately, when people begin to realize that this isn't transitory, it's going to be extremely painful.

What's the Fed going to do? They're trapped.

Stephanie Pomboy: I keep wondering where our foreign creditors are in this whole debate.

John Hathaway: They're in the same game. They have fiat currencies. And so all they care about is the relative value of one currency to another. But I would think, Bill probably has his own thoughts, but I think that inflation will show up everywhere in all countries. So it won't just be uniquely an American problem. I think the whole fiat monetary system is shared by all countries, all central banks, and therefore, I think they're all subject to this great risk of inflation, which nobody is paying attention to it.

Bill Strong: Yes, I agree, in general, and a couple of points. I agree with John, this is going to be international in scope. I want to come back and give some examples of why I think that's going to be. But I will take one difference when we say all countries are in this boat, all developed countries are in this boat. It's the Banana Republics of the world, which are really not Banana Republics.

Stephanie Pomboy: They are the creditors.

Bill Strong: Well, some are creditors, but these are countries that still follow orthodox economics. They have policies that post-COVID makes economic sense. And by the way, the stocks are incredibly cheap. So you have this valuation of U.S. stocks, you have seen exactly the antithesis in the rest of the world, the emerging world, where we're very active. And I think at some point, those currencies will do better than the developed world currencies for just the reason we've been talking.

Stephanie Pomboy: China's currency has been strengthening steadily throughout this, so they're blazing a different path. And they're one of our most important global creditors or worth, they've obviously been turning tail for quite a while now. But they clearly have a very different agenda. They've mapped out a very different course than the G3 developed world has.

Bill Strong: One of the points that I wanted to make about this being an international phenomenon is that the supply of all kinds of things, natural resources, and other things; there's been a lack of investment in this stuff for many, many years. There are shortages showing up across the board. We like the energy space because basically because the green lobby has become so powerful. Many energy companies are just in the process of liquidating.

We think there's going to be a big. We think it's developing a big energy shortage. But this is true across the board. And also, there are other issues, other shortages as well. I was reading this morning. The shipping industry is in real shortage, a shortage of containers. There's a shortage of ships, which is ships are on order, but they won't be here for another couple of years.

And the lack of investment in ports is now a big deal that The Financial Times this morning reports that there are 340 container ships stuck outside of ports because they just don't have the capacity. All of that, these kinds of things are international, and they are going to push up prices for some time.

Stephanie Pomboy: I'm glad you brought up resources, particularly because that gets immediately back to this dollar question. Because all those global commodity producers, most of them are still receiving payment in U.S. dollars, which are getting worthless every day. At what point do they say, why are we clinging to this dollar standard, particularly when our marginal customer isn't the U.S. anymore? It's China, and it's the developing world, etc. Does that play into your-

Bill Strong: I think I remember back in the '70s that the Saudis had exactly this objection. Why are we selling oil dollars when the dollar is going down? I think there was some effort to make them that they were going to get paid in gold. And I think ultimately, that's what brought Volcker in because the Saudis were very unhappy. And I think you're right at some point, the international producers of commodities in short supply, but what currency are they going to use?

Stephanie Pomboy: That's the question. That's why we come back to what's coming next. We've had 50 years of this fiat money era. And as I said, it's the only era, most of us and I would imagine most of the audience, has ever known. It's really hard to fathom what the next era looks like. John, how do you envision the next currency regime?

John Hathaway: You're already seeing the Chinese, Russians, many Middle Eastern producers are taking payment in other than U.S. dollars. The dollar still dominates world trade. That's not going to change immediately, but it's already beginning. What a new arrangement would be, I don't know. I think it probably will still have the dollar as a big component, probably RMB [Chinese yuan] would be a big component. I think that's just a matter of guesswork.

I would be surprised if gold were given more than a cameo role in a new system if that were to come about, just because it's so problematic, because if you really adhere to it, the disciplines would be politically unacceptable. Every time they weaken the gold standard going back for the last century, it's been because gold was too restrictive on government spending and the kinds of monkey business the Fed is doing now in terms of keeping interest rates below market.

That, to me, is a speculation. What I would say on behalf of gold is that it offers protection against all of this. It doesn't have to be part of a financial system or a monetary arrangement to provide protection against the debasement that has to take place.

Stephanie Pomboy: It gets you from here to there.

John Hathaway: It gets you from here to there.

Bill Strong: And the correlation, I think, between gold and real interest rates, it's pretty solid, right?

John Hathaway: Yes. So I think it's 0.94.

Stephanie Pomboy: It's hard to beat that.

Bill Strong: So the negative real interest rates that I'm foreseeing should be really good for gold. It hasn't been yet.

Stephanie Pomboy: Do you think part of that is this new hot thing crypto and that people say, why do I need to own gold? That's for people who are around in the '70s- Crypto is obviously the new thing, the new gold. How do you see that?

Bill Strong: We own both. I don't know that you have to make a distinction between one or the other. We view Bitcoin as digital gold. We've actually sold a fair amount of it not so long ago. And I certainly think Bitcoin has a lot of issues, and questions, and tether, and other stuff, but we view Bitcoin as digital gold.

I think to the larger issue of what replaces fiat currency, it's very hard to know because I think the question itself demonstrates how bad things will have to get before this actually happens.

Stephanie Pomboy: Right. It's not going to be voluntary.

John Hathaway: It's not going to happen voluntarily.

Bill Strong: Yes. Exactly the point. So things will have to get really bad before the world, and the public, and certainly the politicians, except some kind of a stronger standard, whether it's based on metals, or Bitcoin, or whatever, I don't see that in the near future, and therefore, I think things are going to get really bad. And as it goes to my inflation argument that inflation is going to have to get really bad before people want to change the currency.

Stephanie Pomboy: It certainly seems like there is no end in sight to the Uber accommodative monetary and fiscal policy that-

Bill Strong: There's another alternative, I think, which we need to mention. So we can continue down this road. And as inflation begins to get worse, Russell Napier has an adjustment that he makes or talks about and that is basically capital controls. There are government controls, and whether it's wage and price controls, or capital controls, who can borrow money, or you have to lend money to the government, there are all kinds of things, which we haven't seen since the '60s and '70s. And that might temper the inflation fires temporarily for a while.

Stephanie Pomboy: Not if it's the wage thing, unless they do wage control.

Bill Strong:  Well, they can do that, and who knows. The political environment, the other thing is clear today, the political environment is so much more polarized and so much more disparate in the different ways that people think about things. We have one universally true for both political side and that is that the constituency for hard money has disappeared completely in the political world.

Republicans and Democrats spend like crazy. There's no real worry about deficits. I don't hear people talking about deficits. And they also support this radical monetary policy. Unlike in the '70s, where Conservatives were more focused on hard money than certainly not today.

Stephanie Pomboy: The irony, though, is that they do all this under the guise of helping the low-income or middle-class consumer. And ultimately, of course, those are the ones who are most disenfranchised.

John Hathaway: They're the most hurt.

Stephanie Pomboy: And then this wealth gap just continues to widen. But anyway, it's been a pleasure speaking with you gentlemen about this. As John so cleverly said when we sat down, this is the anti-Jackson Hole. So we're going to turn it over to Jay [Powell] and see if he come up with any great new euphemisms for transitory, I guess. Is that what we're waiting for?

John Hathaway: My expectations are low, high for new euphemisms, but any change, of course, forget it.

Stephanie Pomboy: Thank you again for joining us for this conversation. We'll catch you on the next side by a wheelbarrow.

 

John Hathaway
John Hathaway
Managing Director, Senior Portfolio Manager

William Strong
Founder of Eschaton Funds

Stephanie Pomboy
Founder of MacroMavens

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