- Gary Shilling says there is nothing on the immediate horizon that would trigger a correction, but he warns that Fed tightening has caused a recession 11 out of 12 times since the World Wars.
- The Fed doesn’t understand why low unemployment hasn’t pushed up inflation, Shilling says. He says most of them are economists and are too theoretical. They don’t understand that the Phillips curve has broken.
- Shilling says that when it comes to trade, the buyer has the upper hand when there’s plenty of supply. And in the scenario of the global trade war, the US is the buyer.
- Investors should be long the dollar, according to Shilling. He says, “Whenever there’s trouble in the world, even if we start it, the dollar benefits because it’s the safe haven.”
Gary Shilling, the president of A. Gary Shilling & Co., spoke with Business Insider editor-at-large Sara Silverstein about the state of the market and the economy.
Following is a transcript of the video.
Sara Silverstein: I’m here with legendary economist Gary Shilling, the president of A. Gary Shilling & Co.
So what can you tell me about where US markets are right now, where equities are, and do you think they’re headed for a downturn?
Gary Shilling: Well, you could say they’re expensive, but you could have said that last year and the year before and the year before and the year before. I mean, obviously, you have runaway on the upside and you have the stock market growing much faster than the economy, and sooner or later, that won’t last, but you know, forever is a long time. You don’t know how long it’s going to last.
There’s nothing on the immediate horizon that says that you’ve got a problem, and what usually happens is bear markets are associated with recessions, and they’re caused by two things. One is the Fed tightens; they never intend to precipitate a recession, but by my count, 11 out of 12 times in the post-World War period they have gotten a recession. The only soft landing was in the mid-’90s. Now the Fed is tightening; they’re selling off their portfolio, raising the funds rate, but there’s enough – there’s so much excess liquidity in the system. I think it’d take a couple of years for them to do the job.
The other cause of recessions in bear markets is a shock, a financial shock, and that’s what we had in the late ’90s with the dot-com explosion, and then of course the mid-2000s with the collapse in subprime mortgages. If you look around right now, there’s nothing that’s really that big, that sort of just stands out and says, “This is just cruising for a bruising.” But I think if there is a candidate, it’s probably what’s happening in emerging markets. They have huge debts, dollar-denominated debts and with the dollar soaring, and that I think is a very key factor. It takes more and more of their local currency to service those debts. Also, most commodities are priced in dollars, so as the dollar goes up; it takes more of their local currency to buy their commodity imports. So if there is a crisis coming, I think it’s in these countries, and of course you see Argentina and Turkey as the standouts in terms of big problems.
Silverstein: And what sort of indicators can investors look at to see if trouble is coming from one of these places?
Shilling: Well, the big question right now in these developing countries is the risk of contagion. I mean, so far you’ve got Argentina has the usual problems, Venezuela is a basket case – I mean, that economy is barely functioning, you wonder why they don’t have some kind of revolution – and Turkey where the president is really – well, he really hyped the economy with a lot of spending financed by hard-currency borrowing and now they’re dealing with that problem. But if that – those things spread, if you go back to the late 1990s, you had the currency collapse in Thailand and then it spread to other East Asian countries and then to Latin America, Argentina, Brazil, and all the way to Russia.
It’s the contagion, which is the issue, and that’s something that’s really hard to predict. You just have to keep your eye on it, and if you wake up one day and find out that people are retreating.
Now people are – they’re not putting money into emerging markets. You look at mutual funds flows and they have virtually ceased. Last year, tremendous rush in there. People thought this was a great place to invest, developed world didn’t look all that strong, I’ll put it there. And they forgot that these economies really don’t grow on their own, they’re dependent on exports, they’re dependent on borrowing, and they are obviously not sustainable. But as they say, if you start to see massive outflows of mutual funds and ETFs that are invested in emerging markets, I think that’s probably as good as indicators as any that the end is near.
Silverstein: And you said 11 out of 12 times Fed tightening leads to a recession?
Silverstein: So how is the Fed doing so far and what can they do to be the one out of 12 times?
Shilling: Well, the Fed is moving very slowly. They obviously are concerned about upsetting the applecart and they – so they are not only raising interest rates, but now for the first time ever, they’re selling off a portfolio. They have never had that huge portfolio, the result of quantitative easing after bailing out Wall Street, so they have got both those issues and as they say in the past, they haven’t had much success in soft landings, when it was just raising interest rates and they have had experience using interest rates as a policy instrument for literally a century. Now they’re – not too much luck with that and now they’re adding selling off the portfolio, so I think you can pretty well say that in time, they will do the job, but they’re moving slowly, they’re moving cautiously. And of course, one of the interesting things is you’re not getting the rise in long-term interest rates that they probably would expect.
There is a question of wages, they’re not going up. I think there are a lot of good reasons for that, but it isn’t the kind of world that the Fed is interested in. They have – now, Powell is a different animal. He’s not an economist and I’m glad that – I’m a Ph.D. economist, and I’m glad that there’s somebody else other than an economist at the helm there, because they tend to be very theoretical. They believe, for example, in the Phillips curve. They can’t understand why the low unemployment rate hasn’t pushed up inflation.
Well, there are a lot of reasons for that. You know, you’re getting a shift in employment, the jobs are created in low-paid areas, like hospitality and retail, and so on and so forth. You’ve got globalization, probably the most important development in the last three decades on a worldwide basis, which is holding down wages, decimated manufacturing jobs in this country; there a lot of reasons. But these Fed economists – you know, the Fed, a lot of board members and economists there, they’re scratching their – “Wait a minute, it’s coming, it’s coming, it’s coming.” Well, you know it’s coming, but when?
Silverstein: Is the Phillips curve model broken? Is it no longer relevant?
Shilling: Yeah, it really is, and I think one of the things they’re just not concentrating on – I’m playing my song here and I’m a bias. I mean, in 1981, when the yield on the long-term – on the long bond, the 30-year treasury was 12.6%, I said we’re entering a bond rally of a lifetime and since then that yield has dropped to 3%, and as a result, long treasuries have outperformed the S&P on a total return basis by six times in the interim.
So I’m very much – and the whole basis of that forecast was the idea that inflation was on the way out and I think that’s the thing that the Fed just doesn’t understand: that we’re in a basically – a deflationary world. You look at the excess supply that’s opened up with globalization, you look at the downward pressure on wages, I mentioned a minute ago. There a lot of factors here. Look at what’s happened with the Uberization of the world, if you will, where people are working part-time. They’re trading off income and benefits and so on for flexibility in their pay and – you’ve got a lot of strong deflationary pressures and, of course, protectionism simply adds to that and I just don’t think the Fed is comprehending the strength of that.
Silverstein: Do you think our inflation measures are incorrect, the current ones we’re using?
Shilling: Well, they’re correct for what they measure. They’re correct for what they measure and of course, there’s always this attempt to show that inflation is higher than you think it is and everybody thinks it is. I mean, you or I pay more for any product, and we say, “It’s the devil personified.” If we pay less, “Oh, I’m a great shopper. I’m really a good bargainer.” You know, people are very unrealistic about that, and of course, there’s all kinds of alternative measures of inflation, including the Fed has one where they sort of chop off the extremes and look at the middle or some of them are concentrated on the most frequently purchased items, like bread and gasoline and so on and so forth.
But you know, the numbers for what they measure are – I think, are correct, but that doesn’t mean that they are going to have the kind of relationships that the Fed thinks they should have with the employment.
I mean, you know, one of the reasons the unemployment rate is low, is you had so many people drop out of the labour force. Well, a lot of those people, the postwar babies are retiring. OK, they left, but now, and there were a lot of other people who left. The younger people stayed in school. They said, “I’ll get more education, better chance at a job.” And people in between, the postwar babies and these young people, they just said, “There are no jobs available.”
Well, what’s happened now? The younger people are graduating from college, they’re coming back in. People in the middle, they’re coming off the bench. You look at numbers back in June, the unemployment rate went down. Why? Now because fewer jobs, there’s more people entering the labour force, they heard jobs are available, they rushed in.
And the interesting thing is on the top end, people over 65, their labour-force participation rate, the number of people that are out there looking at jobs or employed, is increasing faster than that population. That population is growing very rapidly with the retiring postwar babies. So you have some really interesting dynamics in the labour force, which I think have a lot to do with the restraint on wages.
Silverstein: So are wages going to go up?
Shilling: Yeah, they’re going up but they’re not going up much faster than inflation right now. And I don’t see any reason why that’s going to change anytime soon. Now of course, that’s a very important development, because I think that is what has really spawned populism in this country. Populism, a lot of other areas, of course have it, but I think that’s what got Trump elected. Because in the US and indeed all of G7, the major developed countries, they have had literally no growth in inflation-adjusted wages, no growth in purchasing power for over a decade and so what happens? You know, people are mad as hell. They’re just not going to take it anymore. You remember the movie “Network”?
And I think that’s what got Trump elected, and of course that’s what he’s playing to. Now he blames this on immigrants and imports. It’s not that simple, in my view. Globalization has a lot to do with – it’s the other factors I mentioned earlier, but it is a fact and I don’t see that changing demonstrably. Unless we put a complete tariff wall around the country, I don’t think it’s going to happen.
I mean, look at China. China is a big target. They’re the bad guys, and, you know, they have cheated by international rules, at least as we interpret them. But what’s happening? The low-end manufacturing is moving to Vietnam, Bangladesh, Pakistan – and of course, the 800-pound gorilla is India. Boy, India, the population’s still increasing, and those guys get their act together and I think they are – they’re going to outdistance China.
So the idea that this whole thing is going to change is just not relevant, and of course in the meanwhile you’ve had a huge change in technology. A lot of people who are not adapted at today’s technology are left behind. And this has happened a lot faster than normal. That always happens. Some people ever since industrialisation started in the late 1700s in England and New England, people’s jobs have disappeared.
Now an interesting example that the word “saboteur” – “saboteur” that comes from “sabot.” “Sabot” were wooden shoes that the early weavers would grind into the power looms to wreck the machinery because they were putting them out of business. And that’s how the word “saboteur” came from “sabot.”
So there’s always been people that have been left out, but the thing is that industrialisation as technology, if you will, has created more jobs than it’s destroyed. People who build the machines, cheaper products, more consumers, more demand, maintenance, developing new technologies, but globalization has speeded up that process, and you sort of got this big gap, and it’s really – I think from here on, we’ve exported just about all the manufacturing this country that we can. We’re down to irreducible minimums.
You go back to the early ’90s. About 20% of the labour force was in manufacturing. Now it’s 12%, but it’s leveled off, so that process is probably over. But the problem is that a lot of people simply have not adapted to the new technology, and, of course, a lot of the jobs being created require more than just brawn or some guy twisting on bolts in an auto plant.
Silverstein: And what do you think about Trump’s trade war? What’s the outcome going to be?
Shilling: Here’s the point that I continue to make: When you’ve got plenty of supply in the world, and I think you do – plenty of industrial capability, plenty of raw materials, and so on – it’s the buyer that has the upper hand not the seller. The buyer has the ultimate power, and who’s the buyer? US is the buyer; China is the seller. And besides that, if you say, if we weren’t buying all those consumer goods from China, and you and I enjoy them, they’re cheap, they’re great. But if we weren’t buying them, where would China sell them? They have no other place to sell them, and in the meanwhile, China’s growth is slowing.
They have got a problem of huge debt expansion they’re trying to curb, they’re trying to deal with a shadow lending – a shadow banking system and so on and so forth. China isn’t going to collapse obviously, but I think in this trade war, that the US has the upper hand.
If you look at how this whole thing developed, after World War II, the rest of the world was pretty much in ashes and we were promptly into the Cold War, so I think that implicitly or explicitly, we basically said, “We will let Japan and Europe export freely into the US,” because that gave them the growth to revive in a postwar era and that was cheaper for us than garrisoning even more US troops around the world and having more border wars. Well, that was fine, but that era’s over, and globalization has replaced it, so it’s an entirely different scene, and I think as a result, you have this situation where China – China, you know, grew basically through exports and they went to Europe and North America.
But you know, they did it with some rather underhanded – we’d let them into the World Trade Center in 2001 and they basically have not fulfilled their promises, they have not opened up their technology, they’re not opening up to our investments, they steal our technology, they demand tech transfers for companies that want to operate in China and so on. And so you’ve got a situation now where China is basically playing by the old game, when everybody could export to the US, but now when you see the unemployment problem, no growth and purchasing power for the average guy – the non-supervisory and production employees – no growth in real incomes for a decade and that has changed the whole scene and I think that’s really what has gotten Trump elected and he’s basically saying, “Hey, wait a minute. We’ve got the upper hand here, and we’re going to go ahead.”
I mean, people say nobody wins trade wars. Yeah, in the short run you don’t, but in the long run if it’s a matter of changing what has been the world exporting to the US and the US buying it and what do we do? We give them paper. That’s why they own half of our treasuries. I think that is being reversed and in the long run, the US will be better off. Now, they could go to the mat. Xi, who is basically the president for life in China, and Trump, he won’t be around forever, of course, but they could go to the mat and you could get a really nasty all-out trade war and a serious global recession. I’m not predicting that. I think they probably will settle and China will begrudgingly give ground. They will import more US goods, they will ease up on required tech transfers, steal less of it. They’re not going to change their views entirely, but I think under pressure, they probably will give way and we’ll end up winning the trade war.
Silverstein: So if you could give me one piece of investment advice for people who are looking at the markets today, what would it be?
Shilling: It would be to be long on the dollar. Now I know that’s not going out and buying a stock – there are exchange-traded funds on the dollar – but I think the dollar is going to – it’s really been declining since 1985.
Beginning of this year, I think it’s turned around and it is a safe haven. You have all the problems with the developing world, protectionism. And it’s interesting. Whenever there’s trouble in the world, even if we start it, the dollar benefits because it’s the safe haven. It’s where people want to be. So I think that being in the dollar, and you have to look at that broadly, because companies that suffer when the dollar is strong – I mean, exporters suffer and people in the supply chain can be affected, positively or negatively. But I would look at the dollar as the overarching theme and then look at the implications of that.
Silverstein: And biggest mistake, you think, investors broadly are making?
Shilling: Probably the biggest mistake investors have been making is betting that this economy was going to give out sooner than it has; it won’t grow forever, but it has continued to grow, and I think there’s been probably too much pessimism. Of course, the problem is when pessimism turns to activism, then the end is near.
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