Heading to Recession Island | Will the Trump and Powell Puts Help Us Reverse Course? | Andy Constan

[00:00:00] I think what all of them want is a slower growth to kill inflation so that the economy can normalize. And that's not good for the stock market.

[00:00:18] I left higher for longer island in January and started off what I call the slowdown C. And I'm heading toward Recession Island.

[00:00:32] I have a lot of criticism about the Fed, and it's primarily around them managing their balance sheet. But from where they are relative to conditions and their ability to be flexible, I think they're in pretty good shape. It's not the level of interest rates that matter to financial conditions. It's what they would have been if the policymakers had not acted.

[00:01:02] Andy, how are you? Thank you very much for joining us again on Excess Returns. Oh, thanks for having me. Our audience always gets a lot of value from these conversations. And so I think today's it's an interesting time to have you on just given what's going on in D.C. with the new administration and all the possible changes coming down the road for the markets and the economy.

[00:01:27] So we always sort of like to try to get under the hood of this stuff and figure out what's going to be meaningful and what investors should be paying attention to. So everything from tariffs to some of the deficit reduction initiatives with Doge and, you know, a lot of other things are going to be the topics of today's conversation.

[00:01:49] So really appreciate it. Sounds great. People can follow you on Twitter and also get your research and thoughts at Dan Spring Advisors. So if you just bring up Google or X and Twitter, you can follow all of Andy's thoughts. We appreciate the support of the guests that take their time to educate our audience.

[00:02:07] So the first thing I want to ask you about is and you've kind of talked about this on X a little bit that, you know, Bessett, Trump and Powell, to some extent, you know, all want to see sort of the market maybe go down a little bit here. So can you just explain sort of your thought process on that? Yeah. And I think that's being it's a meme and it's funny, but I think what I'm trying to get at is not so much that they are targeting the stock market.

[00:02:38] I think what all of them want is a slower growth to kill inflation so that. The economy can normalize. And. That's not good for the stock market. It's good for the bond market, which. During the first Trump administration.

[00:03:06] Trump often cheerleaded the stock market. And perhaps I think it's likely. Validated the success of his minute, his administration on the returns of the stock market. And personally, I think that's a much more riskier thing to do now. And secretary Bessent has made it very clear what he thinks success should be measured by. And that's the bond market.

[00:03:35] And I think what he's trying to do is convince President Trump to also think about that. And so. Why does the bond market rally? Why do long term bond yields fall? Well, and that's principally due to deficit reduction, which gives more confidence that the. That there'll be less issuance and less spending. And.

[00:04:03] Slower growth and inflation that is truly killed. And so. You add up the policies of. And certainly. Chairman Powell wants the same thing. That's literally his goal. No one wants the economy to roll over and cause a recession with high unemployment or anything like that. But.

[00:04:27] Slowing the economy to kill inflation does make a great deal of sense for all three of them. And. Then you look at the policies. And the policies are consistent with that goal. So that's what I'm really trying to get at. That all three of them. Nobody. They don't. They don't want to bet on the stock market. Maybe Trump does. But he's being convinced not to.

[00:04:53] Two, they want to enact policies and monetary policy that will kill inflation and return growth and. To normal. And be. Have then be sustainable. Well, I you know, I couldn't help but chuckle a little bit because for most of my professional career, I've been involved. I'm not doing this anymore, but involved in working with private investors and helping them sort of.

[00:05:22] Invest and make it through. And, you know, the thinking long term and staying invested in it. When I saw like Besset, you know, on some of these. Channels, it almost sounded like he was talking like a financial advisor, like you got to think longer term. We're not going to react to short term news type thing. So I don't know. It's just. It was. I just kind of found it like kind of funny in that sense that I felt like he was like saying what a financial advisor would be saying to a client. Right.

[00:05:45] I mean, I think he's trying to tell the United States that the deficit is unsustainable and that needs to be reined in, in particular via spending. And the inflation needs to be ended in order to get high quality, real growth, primarily through things like deregulation. That's sustainable.

[00:06:11] And to make smart investments, not short term consumption, which he feels and many of us do. But I think it's also been a bipartisan problem that for recently and really for the last 40 years in a bipartisan way. Congress and the president have spent more than they received in taxes.

[00:06:36] And so I think it's a good, thoughtful, long term outlook. And I hope it works. But there are short term consequences. Because we do know that in order to make that short term shift, there will be an anti-growth impulse. And what we don't know, and so we can't just look through it, look through that short term to the long term.

[00:07:06] We don't know if the long term will work. And so markets react to they're not really reacting to the short term. They're reacting to the short term with an uncertainty on whether the administration's policies will work to achieve their goals. Can you just quickly describe what the Powell or Trump put actually is?

[00:07:33] And then do you think those exist or are they not here anymore? Well, I look back to 1987 when the first put was really described. And that was the Greenspan put. And essentially he offset the stock market crash of 1987 with very aggressive monetary easing.

[00:08:02] And ever since then, any meaningful crisis. But let me just say, a crisis that is driven by, typically by leverage unwinding, has been met with monetary easing. And in 2007 and then again in 2020, significant fiscal easing also was done.

[00:08:30] Much more in 2020, pretty much not that much in 2007. And so there's this idea, a totally valid idea, that if things get bad enough, the monetary and fiscal authorities will offset, damper that negative. And so that's the put. It's the confidence that at some point the monetary and fiscal authorities will bail us out.

[00:09:00] And so people rest on that and think that that means that their investments have lower risk. And in fact, they do. So then the question becomes, what sort of strike is that put? And I've never seen one that's anywhere really close to the market. Never. It's always way out of the money. And this one is too.

[00:09:30] So I think a lot of people want the Fed to, I mean, there are people that think that QE is going to happen in the second quarter. It's not going to happen. It's not going to happen until interest rates are zero. So first there's a crisis. Then there's a financial response. And we're nowhere near to any sort of crisis in market pricing or in the financial system.

[00:09:55] And the best recent example, well, certainly COVID was a big example. But the most recent example was when banks were literally failing. And so in that case, there was a monetary and fiscal response.

[00:10:11] And I would expect if a financial institution, a systemic financial institution were to fail or were to be on the brink of failure, and we saw this with long-term capital, the GFC, then they will also act even if the economy is doing perfectly fine. But once again, it's very rare for a financial institution to fail when equity markets are robust and credit markets are tight.

[00:10:41] When we had you on last time, and you're known for this, this idea of like an island framework to describe sort of where you're at, where we're at in the markets. And I think you, we weren't on any island last time. You were here. You were kind of floating out to sea to see where we were going. Where, where are you now? Have you landed? Are you still kind of floating out there? What's your current take? So I describe these islands in three basic ways.

[00:11:10] One is a recession island in which you have negative growth, high unemployment, deflation typically. Some, there's a little cove that's stagflation on recession island, but that's not, that only was hot in the 80s, late 70s. So mostly there's recession island, which is deflationary negative growth.

[00:11:34] Then there's soft landing island, which has been the most crowded island for the last five or six years, four or five years. And then there's the island I went to and have been on for most of the time here. And that's higher for a longer island. And when I was on there initially, you know, people on recession island were laughing at me. And I was, well, there were a couple of guys out there with me, but very few.

[00:11:59] And my view was that the very large fiscal stimulus supported by quantitative easing supported created income and wealth that was going to cause the economy to be strong for a long time. And so that meant that the Fed was going to raise rates to a higher level and keep them at higher levels for longer. But I think things changed.

[00:12:27] And so I left higher for longer island in January and started off what I call the slowdown sea. And it's, I'm heading toward recession island. I'm sort of past soft landing island. I don't think we're going to land there, but I'm not at recession island. Fiscal policy, monetary policy decisions could reverse course and we could be heading right back to any of the islands.

[00:12:56] And it's possible we could actually have a soft landing. But right now we're in the midst of a slowdown. And that slowdown has been caused by, firstly, a significant tightening of financial conditions since September when the Fed, ironically, cut interest rates. And two-year yields and 30-year yields rose a lot. And that caused a fiscal financial market tightening.

[00:13:22] Equities continued to travel because of optimism and then the actual election and sort of peaked in January. But along the way, the Fed, after cutting for 100 basis points, made it very clear that they are on pause.

[00:13:41] And so those two things, the tightening of financial conditions due to higher long-term interest rates and a Fed that was on pause, caused me to project a slowdown in January. And on top of that, and now we're still, we still have great uncertainty. On top of that, there were, and this was not part of my call. The tightening was the part, and the pause was really why I thought we'd have a growth slowdown.

[00:14:10] The, on top of that, there is all of the Trump policies. The deregulation, and we haven't really seen much except rumors of deregulation in the banks, which doesn't really do much to the real economy unless there's loan demand.

[00:14:30] Deregulation is, deregulation is a short-term and medium-term pro-growth disinflationary policy and something that the Besant team has been saying is their big thing. The, so that's a good thing. That's a good thing for markets. It's a good thing for the economy to have pro-growth, pro-real growth disinflationary pressure.

[00:15:00] But the rest of the policies, starting with immigration, are anti-growth. When you reduce the labor supply, that means you can produce less. And so the pace of labor growth in the United States has essentially flatlined. And so that should be anti-growth. And then there's expenditure cuts. And expenditure cuts are happening in two ways.

[00:15:20] One is the reconciliation bill, in which the bill that's now in the midst of being passed is cuts $1.5 trillion, primarily from the poor, through cutting of Medicaid, income assistance, and food stamps. So that's when you cut the government expenditures. That's anti-growth. It may be desired.

[00:15:47] Maybe the government's too damn big, wasteful, not efficient. But it hits growth. There's no way of two ways about it. So that's anti-growth. Doge is, you know, that's, that's, the expectations for Doge are pretty light. I think there's a, it's very partisan.

[00:16:06] But the middle of the spectrum sort of sees Doge may be successfully reducing waste fraud and possibly muscle and bone from spending. That is between $100 and $200 billion per year. There have been claims of $2 trillion. There have been claims that nothing is happening.

[00:16:35] But, and I think that's a partisan thing. Um, what I think will, is built into market expectations is pretty low for how much expenditure cuts are going to happen. And that's partly because it's very hard to legislate that some of the expenditure cuts aren't going to change the budget. And so you have Congress that has to get on board with that. But they also have some tax cuts that they'd like to do. So there's that.

[00:17:00] And then I guess the last thing, which is getting all the attention, undeserved in my view, but all the attention and markets is tariffs. And tariffs are, uh, have a negative hit to growth. That is a level change in growth and a positive, an inflationary level change, uh, in price, in prices. And so add them all up, that's a fairly anti-growth set of policies.

[00:17:30] And so on top of financial tightening, um, sorry, monetary, uh, monetary tightening and a Fed on pause, you have the, the, the necessary, um, legs to cause a fairly meaningful slowdown. Not a recession, but a fairly meaningful slowdown. Markets were, uh, entirely not priced for such a thing.

[00:17:54] Um, and that has begun sort of in a scare way has begun to scare people, but there's nothing in the data that indicates that the slowdown is underway. So, um, I think that comes. So we first had a leg down in equities, slight increase in credit spreads, slight rally in the front end of the yield curve, bond markets rally. Um, but that was a scare.

[00:18:21] Now we're in the period of time where we actually get the slowing data. I would expect April and May to show some actual slowdown. On the idea that markets hadn't priced it in, it seems like people are, you know, thinking we're going to get the original Trump again, you know, the Trump from the first administration. And so far we haven't, and that seems to be the debate. Like, is he eventually going to switch back to the original Trump who, you know, had tweeted something about like if the S and P go, or if the Dow goes down 250 points in two consecutive days, the president should be impeached or something.

[00:18:50] Like he was all into that and now he's gone a different direction. So it seems like that's the balance back and forth right now. Right. And so for me, you know, there's all the sentiment and that things like the puts, the, the, the, uh, Trump and, and Powell puts, um, frankly, their behavior. I mean, everyone always eases. It's, it's, it's built into everyone's psyche that anytime the things go bad, they ease.

[00:19:16] Um, and so, yeah, there's definitely a buy the dip mentality because of confidence that they'll flip. I think that's fine. Um, but I've seen no evidence that they are, um, committed to that type of Trump 1.0 at this stage. On the puts, do you think there's an economic reasoning for why they should exist? Like there's been charts going around Twitter talking about how now that more people own stocks, the wealth effect has a bigger impact.

[00:19:44] You know, the, the effect of a 10% decline on the S and P is much bigger on GDP. Do you think there's a case that those puts have to be there? And like from an economic perspective? Right. So my, uh, company's name is damped spring and a damped system is like a shock absorber and a spring on your car. And that's what I, I believe the financial system is. And what that means is that policymakers should dampen the business cycle.

[00:20:13] That means not let it go wild to wild extremes, like a car that doesn't have any shock absorbers when it hits a bump, because that can send the car into a ditch. But if you dampen the response, when you hit a ditch with shock absorbers, that tends to be effective.

[00:20:33] So I'm a strong believer that the policymakers should act to, uh, mute, to dampen the business cycle. And they do, um, they wrote increased interest rates and started quantitative tightening. The fed did to dampen the hot inflation and tight labor market and strong, um, real GDP.

[00:21:00] And they should dampen the business cycle on the downside as well. And they will, the question is, and I think this is extremely important. If you do it too soon and it doesn't work, what do you do?

[00:21:16] Like, it may be true that the wealth effect is much more important, but damn, if you, if, if the market has more to sell than you're willing to buy and you eat and you say, well, you know, we dampened this and we, you know, we supported, we cut, we did all this sort of thing. And then you get an economic outcome that's worse. What do you do next?

[00:21:40] So I think you have to be very careful when you start to offset weakness until there's actual pain and there's no pain, not even any pain. I mean, frankly, the equity markets had a fairly meaningful sell-off and it's selling off hard today again. And then, okay, bonds have rallied. And so the 60-40 portfolio is actually pretty okay for the last few months.

[00:22:07] Even though the equity market's taken a ding, wealth isn't really changing much. So I don't think there's much pain at all. And there's no pain in the hard data from how the economy is doing.

[00:22:20] Of course, of course, the macro does not describe the individual experiences that people are having and that certain cohorts are in a great deal of pain while other cohorts are in no pain at all. But in aggregate, the economy is doing quite well. And so I don't think there's any need for dampening.

[00:22:45] In fact, based on the inflation data that continues to be sticky and the strong GDP and the strong labor market, it could be argued that you need to slow the economy more before you start to even think about easing. Can you talk a little bit more about tariffs? Because that's something, you know, if you go on Twitter and you see the reaction of economists to the tariffs, it's been pretty much negative. They don't think there's too many positive things that can come from that. I mean, do you think they're a valid tool to be used here?

[00:23:14] Do you think there's a positive case for them? I absolutely do. I think that – but it's a policy choice. I think, for instance, I think my favorite person to read is Michael Pettis on this topic. And I'll quote generally his theories on this. And they're standard economic theories. They're not just made up.

[00:23:37] A decision – the United States has had significant barriers to trade in many, many countries. Tariffs, non-tariff restrictions, intellectual property being stolen, currency manipulation.

[00:23:59] All of these things have made the playing field for the United States to be a manufacturing zone weak. Now, there are lots of other structural reasons like a workforce that has a certain standard of living and certain wage expectation that makes manufacturing in the United States hard. But the playing field is not even.

[00:24:22] And so I think it's a totally reasonable thing to decide that you want to change the nature of trading with the United States, global trade with the United States. And the Trump administration is going about that. And tariffs are a totally reasonable tool to do for that. And what your goal presumably is, is to reshape trade. Now, you can do that by tariffs.

[00:24:51] And if our trading partner keeps tariffs high, or you can do it by tariffs so that they'll lower their tariffs and then you remove your tariffs, lots of strategy can go about. But I think the takeaway is more important than the tactics. And that is, the goal of the Trump reshaping of global trade is to increase manufacturing in the United States.

[00:25:18] Not in Mexico, not in Canada, not nearshoring, but literal onshoring of manufacturing capability in the United States. Michael says this, I think it's an excellent point, that when you do that, it doesn't necessarily increase your GDP.

[00:25:40] All it does is shift the amount of share of your GDP from consumption to manufacturing. And so, essentially, what that shift does is it lowers the amount of GDP that's created by existing job holders and increases the amount of GDP that's created by new job holders who fill these manufacturing jobs.

[00:26:10] That is a transition, and that can be painful. It requires people to learn new skills, to find new jobs, and that takes a significant amount of time. That's not something that's going to happen on April 2nd. That's going to happen five years from now as this ongoing rebalance of our trade happens.

[00:26:34] And what it also requires is our foreign trading partners to reduce their share of their GDP on manufacturing and increase consumption. And culturally, that's hard for them to do. And so, it's not surprising that China is focused on increasing consumption when they're threatened by decreasing manufacturing.

[00:27:04] And so, that whole thing is all happening. It isn't net certain that the U.S. GDP will increase based on this. What is important, and I think a very reasonable goal, is if you believe that the geopolitical situation is such, and we saw this during COVID,

[00:27:27] where, and we see it when we have conflicts, military and geopolitical conflicts with our enemies, if you believe that it is important to have certain critical industries manufacture onshore for national security reasons, you have no other choice. I mean, you can do other tactics. You can do things like what the Chinese have done, which is subsidize their manufacturing.

[00:27:57] Or you can tariff. Lots of things. The goal is to increase on-shoring in critical technologies. The tactics are a big mess. Nobody knows how they're all going to work. Nobody knows what the tariffs are going to be, how long they're going to be kept. Are they well determined? Like, you don't want to tariff mangoes because we don't make mangoes in the United States.

[00:28:26] But you do want to tariff maybe semiconductors because you want to build critical industries in the United States. And so the actual choice of what the tariffs are and how they're applied, and then more potentially equally importantly, how our trading partners retaliate and then do we then subsequently escalate? Are all the things that markets are, in my view, overly focused on because it is a small –

[00:28:55] trade is a relatively small part of the U.S. GDP compared to the trillion and a half dollars of expenditure cuts and then whatever Doe is going to do on top of that, which will have a much more impactful effect on growth than tariffs. But tariffs are what is getting all the attention now.

[00:29:26] How do you think about this? I know you build with your DS Alpha portfolio. You build a portfolio for clients. How do you think about something that's so uncertain like this? Tariffs on one day, tariffs off the next day. I mean, you could argue you just look through and ignore it, or you could argue you have to at some degree react to it. But how do you think about something like that that's changing so quickly? So I think you have to have a – so what I do – I don't know if this is the right way to do it. This is just what I do.

[00:29:53] I have a outlook that is multi-months in nature that is driven by a variety of factors, including policy. And it's helpful to understand what consensus outlook for policy is. Like I mentioned with Doge, consensus is that it has pretty low impact. And then have your own view.

[00:30:24] And intraday, intraweek, intra – intraday, intraweek, I guess. I think there's a – it's a matter of managing the risk of your portfolio so that if things get out of whack relative to your view, you can – or frankly, if your view – and this happened with me, I was short a lot of stocks. And I thought the growth scare had gotten overdone, even though I expect an actual growth slowdown.

[00:30:52] You take that as an opportunity to lighten up your exposure. And so I don't think this is a particularly – it's a somewhat more volatile environment lately. VIX futures are sort of sticking north of 20. They're a little lower today. But, you know, sort of – there's some volatility.

[00:31:14] And so what that tends to mean is that you widen where you'll add and widen where you might close down. And you take less risk. Yeah, it's funny referencing the uncertainty thing. I feel like at all times people will say there's an above average level of uncertainty. And I almost feel like myself there is one now. But I don't know. I can't even judge myself against it because people always think there's an above average level of uncertainty. No, I'm not so sure. I'm not so sure about that.

[00:31:41] People don't talk about it when there's a normal level of uncertainty. They only – just like vol. Vol only goes higher when it's higher. And otherwise it stays low. So, you know, it's what they're – it's – you have to – anyway, what I think is actually true is that we are on a path in which we're – in which things are changing.

[00:32:09] And that includes bond markets, currency markets, commodities markets, and equity markets. And so it's likely when you have some sort of shift that you have more volatility. And I expect that to, you know, by and large continue. You mentioned Doge and the consensus in terms of what they could do.

[00:32:29] I just wanted to get some more of your thoughts on that because on one hand, you look at the budget and there's some very, very big line items, you know, interest, defense, Social Security, Medicare, that are going to be tough for them to do anything to. So you say from that perspective it's going to be hard for them to do a lot. But then you hear a lot of optimism they might be able to do a lot. So how do you think about that balance in terms of what they can accomplish in terms of actual deficit reduction?

[00:32:51] I've looked – listen, I'm not an expert, but I've looked at those numbers from a bottoms-up standpoint and made estimates of what I think is possible. You know, one of the stories is that we have contractors. And I think the number for the contractor number is something like 700 – you know, about 10% of the budget in which the budget – most of the budget money actually just goes to people.

[00:33:18] Like Social Security, salaries for military, you know, all these things. Just go to people. But some of them go to contractors for services that they provide the government. I think the number was $750 billion out of the $7 trillion roughly of expenditures. And one of the conversations that has happened is let's renegotiate those contracts, squeeze the supplier, squeeze the contractor.

[00:33:46] So they either reduce employment or they often – they provide the service that they're providing to the United States for a lower price. And that's a – you know, that's – listen, we all think about that. Hey, let's get – cut our – you know, the salaries of our service providers. Let's – that's a pretty good place. Now, those people are part of the private economy and so they're probably public companies and all that. So you have to recognize that that's – impacts them as well, impacts unemployment, et cetera.

[00:34:17] But pick a number. You know, is it reasonable to assume that all of the $750 billion of contracts can be renegotiated? And to what? 10%? 40%? Well, it's probably somewhere around 10%. And so that's $75 billion.

[00:34:35] And so when I added it all up, unless you actually stop money going to real people, like Social Security, Medicare, you really can't get much more than $300 billion out of that. And that includes all the fraud and waste and all those things that Doge focuses on. But, you know, that's just me.

[00:35:05] That's sort of where I'm at. I'm all for – one of the things that when you talk about this stuff, people are like, well, you know, you must be anti – you must be pro-government if you think we – or you must be naive if you don't think we can cut the deficit by $2 trillion. And I would say, no, I'm just doing the numbers. And if you want to, you can cut whatever you want.

[00:35:33] There are certain things you can't, but like the interest. But you can cut whatever you want, but there's just consequence. And there's a political reality in whether you can do it. And so my outside number is $300 billion. My inside number is $100 billion per year. And I think consensus is closer to my lower number at this stage. Yeah, it's challenging for someone like me who doesn't know a ton about this. When so much of this is done, you know, back and forth, both sides on Twitter.

[00:36:03] You know, if you remember the thing about the social – all the people that were dead that weren't marked as dead in the Social Security database. You know, on one hand, you're like, well, that's a big problem. And then they're like, well, we're not actually paying them, so it's not a big problem. And then they're like, well, actually, they're applying for different programs rather than Social Security, so it is a problem. And you just see that back and forth all the time. And it's hard to figure out what to make of it. I think that – I basically assume that everything I read on Twitter is propaganda, either for or against anything that's happening.

[00:36:31] And I would say that, without a doubt, the Doge effort is more about propaganda so far than anything. And that is great because one thing about propaganda, it gets people moving. Is it the way I do it? I don't know. I mean, if you didn't put out crazy numbers or if you didn't say, we're going to the moon, would you ever get there? I'm not so sure.

[00:37:00] So I get the idea of highlighting these crazy things that turn out to be false. I don't – that wouldn't be my way of going about it, but I get the idea. And so I'm assuming that it's all propaganda. And so what I do is I just say, okay, what has – what can be done, what has been done, and what will be done through legislation. And I just want to say, I think your point about, you know, doing your own research, verifying – you know, a lot of times we're stuck in, like, these echo chambers.

[00:37:31] And people aren't digging. And unfortunately, that's just the attention spans of people these days. But hopefully the people that are listening to this, you know, that's an important takeaway for anyone. You know, do your own research. Don't just assume that, you know, it's correct. So I appreciate that for sure, Andy. Sure. So the issue underlying a lot of this is the national debt. And you see a lot of stuff on both sides of this in terms of how important this is.

[00:37:56] I mean, I think Ray Dalio has a book recently talking about how this is a potential debt crisis we're about to face. And you're probably my guy to go to here to think about, like, is that really something we should be worried about? So how do you think about the national debt and the risk that it poses? Yeah. So Ray's book, unfortunately, doesn't actually come out until September. I've ordered it. And he's on a speaking tour to publicize it. And, of course, he's selling a book.

[00:38:24] And yet, and having worked with him for a number of years, I would say he thinks big thoughts and they don't necessarily play out in the time frame he has them. And the way he manages money is very different than the way he sells a book or writes a book for them. So I'm not going to take much from that.

[00:38:50] But to answer your question, I guess the question that one has to ask is, well, firstly, you have to understand the mechanics of money and know that 87% of our debt is held by us. Like, we owe the money to our debt.

[00:39:16] Like, we owe the money to ourselves.

[00:39:41] That does not affect each of the cohorts in a similar way. Inflation is not, doesn't affect people equally. And so if you're going to go through a continued sizable increase in our national debt, you're going to start pinching people in different ways. And that can lead to crisis, political crisis.

[00:40:11] It can lead to political policies that can lead to wars and, you know, revolutions and things of that nature. And so you always have to be concerned that the outcome of issuing a lot of debt is destabilizing to the citizenry. And so that's one, I haven't read the book, but that's one possible risk.

[00:40:34] The other risk is that the people who buy our debt, including foreigners who own a significant portion of our debt, stop buying. Now, foreigners are in an interesting position in that they have to own U.S. assets. And the reason why they have to own U.S. assets is because they get paid in dollars when they send us stuff.

[00:41:04] And so they're going to have dollars. Now, they can keep them in a bank where they can buy equity in the United States or they can buy hard money like gold or they can buy land or factories or all sorts of things. But mostly they buy treasuries because they're very liquid.

[00:41:26] So it's possible that one day they say no, and that causes U.S. people to now have to buy that excess debt. And that can be difficult. So it all comes down to a tipping point. I mentioned a revolutionary tipping point. There could be a market tipping point, though that seems very unlikely without market tipping points in other currencies at about the same time.

[00:41:55] But that's the sort of existential issue. The big problem for me, and this is just a personal issue, which is the reason why we have this debt is because it has allowed the United States voters to consume in excess of their production for 40 years.

[00:42:20] And at some point, and so their standard of living increases in the United States by and large have been very high because of this debt, financed with debt.

[00:42:33] At some point, somebody's standard of living, either a generation or a cohort within a generation, is going to pay with a lower improvement or possibly even a negative impact on their standard of living. That's the inevitable outcome. And so I just don't want to put that bag on a future cohort or a future generation.

[00:43:00] And so I'd like to see a curtailment in our deficit. And that has to happen, in my view, in two ways, lower expenditures and increased taxes. Unfortunately, no one wants to do both. One party wants to do one thing. The other party wants to do the other thing. And so we don't make much progress on that. And so that continues. But that's what I'd like to see.

[00:43:30] Unfortunately, it means economic that we'd be paying back some of this improvement in our standard of living today. And no one wants to do that. And the voters don't want to do that. And so it will take a tremendous leader to go through a period of higher taxes and higher and lower expenditures. And so far, our leadership has not done that.

[00:43:59] And maybe Trump will. But so far, we've yet to see it. I wonder, you mentioned higher inflation as a potential side effect here. If you think longer term on inflation, outside of what's going on right now, how do you think about the long-term drivers of inflation? I'm thinking technology is obviously probably still a long-term deflationary thing. Globalization seems to maybe be going the other way. Do you think we're going to return to a 2% inflation regime long-term? Or do you think inflation is going to be structurally higher for a longer period of time?

[00:44:30] I generally don't think that long out. Okay. But the basics for me are it's the amount of goods divided by the amount of money that determines whether we have more inflation. And if we can make more stuff and the amount of goods depends on the number of people and their ability to make it. And so it's population and productivity. And the amount of money depends on money and credit.

[00:44:57] Whether we're expanding money supplies, people want to go to M2 or something like that. That's not what I'm talking about. Overall money and credit availability, including government spending, really sets the other part of the fraction, which is the amount of money.

[00:45:16] And so to me, in order to have a low inflation, you need to have population growth and productivity growth and modest monetary growth. Population growth is going the other way. It's been going the other way in the United States and throughout the developed world and even now and in China for decades. And it's not improving.

[00:45:46] You know, no one's having kids. And so that leaves it to be immigration where you import your population. And that's going in the opposite direction in the United States and most everywhere around the world. So that worries me on population. Productivity is a miracle. You know, scientific advancements can lead to better production.

[00:46:14] And there have been big productivity shifts over the centuries. And there's a lot of hope for one now. Which I'm not qualified to know whether AI is going to deliver on the productivity gains that we'd be required to have a disinflationary world. I am more worried about inflationary trends.

[00:46:41] In particular, one of the things about deglobalization that I mentioned when we started is that by creating inefficient capacity on our shores, meaning we are not the most competitive maker of a particular good, is wasteful. It's inefficient use of capital, which is in itself inflationary.

[00:47:10] And why do we want that? Because we want to insure. Insurance is one of the, you know, is one of the classic costs. It's a sunk cost until you need it. You throw away your insurance premium and build on-shoring is a form of insurance to avoid as a national security goal.

[00:47:33] You're paying insurance by building inefficient capacity on our shores to achieve your certainty of production when you need it, when you're in a war, in a trade war, or during COVID. And so that's inflationary to me, and that's a concern, is wasteful use of capital.

[00:48:00] In terms of monetary, yeah, I mean, as I said, we have to be more fiscally responsible and make sure that from a monetary standpoint, we withdraw liquidity from the market, shrink the balance sheet, and keep interest rates high enough so that we don't have inflation. Just one more for me when I hand it back to Justin. I wanted to ask you about the Fed. It seems like they're in a tough spot right now. It seems like I wouldn't want to be them right now. You know, we've got slowing growth. We've got anti-growth policies.

[00:48:29] On the other hand, inflation's above target. Like, how do you think about the situation they're in right now? I have a lot of criticism about the Fed, and it's primarily around them managing their balance sheet. But from a – where they are relative to conditions and their ability to be flexible, I think they're in pretty good shape.

[00:48:53] Interest rates are – real interest rates are significantly positive, which gives the Fed a lot of room to cut in the event that they need to. And inflation has – it's not – it's sticky, but they've made major progress on inflation.

[00:49:18] So I think from a policy standpoint, my only complaint about the Fed is that they are – seem to be unwilling to bring their balance sheet back into the goals that they have in any sort of aggressive way. And I think that's because they're worried they may break something if they were to reduce their balance sheet faster.

[00:49:41] Going back to that demographic point you made earlier, there was an article yesterday that was talking about, like, home affordability in this country. And it was looking at how much over the past five years housing prices have risen relative to wages. And it was, you know, basically outlining, like, how, you know, for younger people starting families, like, homeownership has become a lot more difficult.

[00:50:03] And one of the sort of side effects to the point you made earlier is, like, because these young people can't buy a home, they're delaying having kids, which is sort of a knock-on effect of the, you know, higher housing prices. And that plays into demographics and stuff. So, I mean, this is all, like, kind of circular and has effects. Yep. Absolutely. Home affordability. I have four children, ages 23 to 30.

[00:50:31] And they are right in that sweet spot of when they're thinking about getting married and starting a family. And they have no expectation of buying a house. What are your, I think at one point Trump had floated this idea of, like, when rates were super low, maybe he wasn't even president. I don't know exactly when he made, but, like, floating, like, these 50 or 100 year, like, bonds and locking in, like, that low financing.

[00:51:00] Do you think, like, I don't think the Treasury has made any changes of issuance of, like, the longer duration bonds, maybe because interest rates are high. So they're maybe trying to game that and wait for rates to fall before they issue longer term debt. Does that, sort of, what are your thoughts on that?

[00:51:21] Well, yeah, Druckenmiller had a lot to say with complaining that Yellen had failed to lock in very low interest rates when interest rates were low.

[00:51:33] And I think that's, I respect Mr. Druckenmiller beyond belief, but I think the idea that the government is supposed to try to lock in low interest rates is a basic, is just a basic misunderstanding of the role of the government.

[00:51:56] If they were to have low interest rates, let's say they had sold a lot more 30-year bonds when rates, or 10-year bonds when rates were at 75 basis points in the midst of COVID, who would have bought them? More the banks? The private sector. And they'd be getting, sorry, bad word. They'd be getting destroyed. The SVB thing would have looked, it would have been tiny.

[00:52:24] In the event that the government had oversold. Their job was to do the opposite. They're acting as a damper. So when rates are very, very low, they're low for a reason. Monetary conditions are too tight. Rates are low, which makes you think monetary conditions are easy. But no, rates are not low enough to be easy.

[00:52:49] That's the problem that people don't necessarily understand, which is it's not the level of interest rates that matter to financial conditions. It's what they would have been if the policymakers had not acted.

[00:53:07] And if the policymakers had not, what the policymakers are trying to do is cause interest rates to be lower than they otherwise would have been to stimulate the economy. Now, if the government, while the Fed is trying to do that, if the government had started selling a ton of bonds, yields would have risen. And that would have defeated the purpose of what the Fed was trying to accomplish.

[00:53:35] So I don't, I think the government, while it is true that it would be great for us, for human beings, private sector people, to lock in long-term low interest rates. And part of the housing crisis is because boomers locked in low interest rates and can't get out of their house. So there's no housing supply.

[00:54:02] It makes sense to lock in low interest rates when you're a private sector person. It doesn't make sense from a government standpoint. I think that is an excellent point and something that I should have talked to you before. Or like my thinking of it, you know, it's sort of like going down a level and understanding what the role of government is with this debt is just really, really great to, I think, point out for those people that think we should be issuing, you know, 50-year bonds or something like that.

[00:54:31] So, okay. So as we wrap up here, I know that you've talked about the impact of leverage ETFs on the market. We're kind of switching gears here, getting off the macro stuff a little bit as we get to the end. And just can you, you know, I don't know, maybe take, obviously, more and more investors are getting exposed to these. They're being marketed. They are seeing a lot of growth.

[00:54:57] But can you just explain, like, how these work and what you think their impact is on the market? Sure.

[00:55:05] So the idea of a levered ETF is that each day, based on the close from the night before, if you bought the leveraged ETF on the close the night before, on the close of business the next day, you will have experienced whatever the leverage ratio is versus the underlying security. So let's say you're doing a triple levered QQQ.

[00:55:34] The change from close to close should be three times the change in the QQQ. That's all it is. By the way, there's nothing wrong with that. That's a totally reasonable thing. If your expectations are you can buy the triple levered QQQ and experience three times the move on the day, and you're a day trader, that's a totally reasonable thing to do.

[00:56:02] Now, I would not ever, ever advocate anyone try to be a day trader. The odds are so stacked against you, you have absolutely no idea. Professionals are there to take your money, and they do, effectively, every single day. Whether you're trading levered ETFs, ETFs, single names, or options, they are taking your money.

[00:56:30] So I can't discourage it enough. So then the question is, what good are these things, if that's what they do? And the problem is, with these things, is in order to provide leverage every single day at 3x, on the close of the day, the triple levered ETF needs to do a bunch of trades.

[00:57:00] It has to either, and this gets into math that I don't want to belabor. Plenty of smart people, Chris, have written on about this.

[00:57:16] They have to, if the market is going up, a triple levered QQQ ETF has to buy on the close to get levered for next, tomorrow. If they left themselves in the same position they were in, they wouldn't provide triple leverage on the next day. So they have to buy. And so now they're set up to provide the day trader with that triple leverage for a day.

[00:57:46] If the market then fell back to where it did the day before, so after two days the market was unchanged, the triple levered ETF would actually then have to sell on the close. And so as an investor, the QQQ after two days has moved nowhere.

[00:58:08] Yet as a triple levered QQQ holder for two days, you've bought the high and sold the low. And so your nav will have fallen even, and your, and your return would be negative, even though QQQ hasn't changed at all.

[00:58:30] Now, imagine a world in which the market is very volatile and, and around a relatively stable mean like what we're experiencing. Markets have been very volatile, but we're really not moving that much. Every day, these levered ETFs do these trades on the close and piss away money. And that comes at the expense of the longer term sharehold.

[00:58:59] And so what you can do is you can look at that. You can look at the return over time of holding a triple levered ETF versus holding the underlying. And you'll find that in volatile, volatile mean reverting periods, you have massive underperformance relative to the leverage that you would otherwise have.

[00:59:21] And the reason why I say relative to the leverage, there's a lot of ways to get leverage that don't require this rebalance, this daily rebalancing. You could own deep in the money. Sorry. You can own in the money calls and put 10% down and have 10 X leverage. You can buy stock on margin. You can use futures.

[00:59:43] All these things are less convenient, perhaps, than the triple levered ETF, but are so much cheaper to generate leverage. And so if you're a day trader, you shouldn't be, but you're probably okay with using them. But if you're a, any longer term investor, there are so many better ways to generate leverage on your investment. That's good. Thank you for that.

[01:00:11] Um, so we have a new sort of standard, you already answered our standard closing question. So we have a new closing question for you, which is what is the one thing you believe about investing that you think the majority of your peers would disagree with you with? That's an easy one for me.

[01:00:26] I believe that, um, quantitative easing during, um, which is always pro growth and inflationary, despite the fact that everyone looks at the quantitative easing that occurred between 2008 and 2018 and sees that there was no inflation.

[01:00:51] And based on how I understand quantitative easing working. Um, and by the way, um, and by the way, they then see the high inflation that happened when both monetary and fiscal spending was done and say, it's not QE. It's just fiscal. And I'm just, I don't, I disagree.

[01:01:13] I think that what happened in 2008 to 2018 was that there were so many other disinflationary, uh, forces at play during that period of time that quantitative easing didn't cause and didn't result in inflation because of the disinflationary forces that were happening.

[01:01:37] If it hadn't occurred, if it hadn't occurred, if quantitative easing hadn't occurred, I believe we would have had much, much lower inflation during that period. And that is not, um, most people don't agree with. Thank you very much, Andy. It's always a pleasure to talk to you. Um, and we look forward to having you on in the future. Thanks for having me. Thanks, Andy. Thanks so much for tuning into this episode.

[01:02:03] If you found this discussion interesting and valuable, please subscribe on YouTube or your favorite podcast platform or leave a review or a comment. We appreciate it. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the participants or their clients.