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Dawn Bennett, Host of "Financial Myth Busting," Interviews Dr. Pippa Malmgren, Author of "Signals: The Breakdown of the Social Contract and the Rise of Geopolitics"

 

Wasington, D.C. -- (ReleaseWire) -- 03/09/2015 --BENNETT: Dr. Pippa Malmgren was the Deputy Head of Global Strategy at UBS and the Chief Currency Strategist for Bankers Trust. She was also a member of the U.S. President's Working Group on Financial Markets and the Working Group on Corporate Governance, also known as the Plunge Protection Team. In her new book Signals: the Breakdown of the Social Contract and the Rise of Geopolitics, she explains in detail the signals of the financial repression we are in, as well as what she foresees as the end game of the financial crisis. In the book, she says something that I keep coming back to: 'There is no price discovery any more by the market. Governments impose prices on the market.' That's where I want to start today. Pippa, welcome to Financial Myth Busting.

MALMGREN: Great, thank you.

BENNETT: I've been managing money for 30 years, and during some of the most difficult times for the stock market in 2008 it was fairly clear to me that someone or something with pretty deep pockets was able to support the market on some very critical days. Is this true, or am I dealing in conspiracy theories?

MALMGREN: Yeah, it's so interesting. Having worked both on the trading force and in the White House, I've been able to see how this picture looks from both angles. Having served on the President's Working Group on Financial Markets, the idea that those guys have the power to just intervene in the stock market is really, it gets crazy. They are a bunch of bureaucrats, they don't know anything about how the stock market works, let alone have the power to intervene. However, I would say this. There are relationships always between the most senior policy makers in Washington and the folks on Wall Street and they do talk to each other and there's no doubt that when the stock market's starts really falling, really wobbling, those guys at Wall Street will reach out to Washington and say, 'Hey, what do you think?' And if the response is anything like, 'We're worried,' that alone is enough to get the market thinking, they might do something. So, the sense that there might be a response is often enough. You don't even need to do anything, if that makes sense.

BENNETT: Oh, it does make sense. So, we'll call that a fact and a conspiracy.

MALMGREN: OK. (Laughter)

BENNETT: You have said that, because of this, there's no price discovery anymore by the markets, and that governments, the United States government, actually imposes prices on the market. I know we're not the only government that does this but it has removed the need for, or at least the utility of active money management.

MALMGREN: The way I phrase is this. The fact that the U.S. Government and others have decided to enter into quantitative easing, what that does is several key things. One, it definitely pushes up asset prices. It intends to do so. Its purpose is to make the price of stocks and property and bonds all rally. So, you can't be surprised if those prices start moving when they make such announcements. Can they micromanage the exact level? No, but they can make the environment so painful to go against where they want it to go that investors get hurt.

For example in Europe right now, we have more than 25 percent of all the government debts is in what they call negative interest rates. That means you, yes, you have to pay the government to lend your money to them, which is a concept people can't even get their head around. But the purpose of negative interest rates is to make it so painful to hold debt that you're forced to put your money in and risk your assets, and that is the name of the game. So, this kind of intervention to compel investors into investments they wouldn't normally undertake for fundamental reasons, this is what I mean by saying that price discovery has kind of gone. You basically can't tell unless you know what the head of the Central bank had for breakfast that morning, where they wanted to go.

BENNETT: Why are the Central banks avoiding a stock market correction at all costs? Are they simply frightened?

MALMGREN: I think they are and I would go a little further and say it, put it this way. When the financial crisis happened, it was almost like the market was just punch-drunk on its own egotism.

And almost drove the world economy into irrecoverable debt. But the central bankers feel that they grabbed the steering wheel just in time and controlled the situation, and now that they've steered the world economy back on to what they view as a better path, a better situation, they are very reluctant to hand the control back to the market. I've had conversations with the senior folks, for example at the Federal Reserve, and their view is, 'Are you insane, you want to give control back to those traders who can't hold a single idea in their head for more than 30 seconds before they change their mind?' And my answer is, 'Yes, we want to give control back to the markets because what we know for sure is that when states direct outcomes, you get bad outcomes.'

BENNETT: Market buoyancy, especially in the United States, hinges on our Federal Reserve, almost their every word indeed. I'm curious about something, why is it that the main stream media doesn't report what you talk about, what you write about and why isn't anyone saying this isn't about fundamentals?

MALMGREN: Well, I definitely wrote the book with a view to giving air time to the views of the dissenters. The people on the board of the Fed who have been an opposition to the continuation of quantitative easing, but also the emerging market policy makers who've also felt the adverse or spill-over effects from quantitative easing, who've had some serious questions as well. I guess the simple answer might be that anybody who challenges the status quo is potentially going to be not held in the inner circle anymore. But the thing is I've already been in the inner circle, I already know what their views are and what goes on there, so I can afford to step forward and say, 'Here's what I think.' It's so interesting when I talk to my Russian and Chinese policy maker contacts, they are all like 'Hey, who is more communist now? You guys, with the level of intervention you have, or us?' And you know, they kind of have a point.

BENNETT: As you've said, the Fed is destroying price discovery, and no one is talking about it. Can we survive without it now in the world that we're in?

MALMGREN: Well, this is a huge question. I think the answer is yes. And the person that I cited in my book is a guy called Ludwig Erhard who no one remembers, but he was the guy who—after the Second World War in Germany, when they moved on to price controls for everything in order to prevent inflation and because the market obviously couldn't work in a war zone—he became the finance minister and he did something truly astonishing. He announced that Germany was going to abandon all price controls and put the discovery of prices back into the hands of the market and they just did it. And it was scary because the price of bread could have been the equivalent of a thousand dollars overnight, but if you trust that markets are responsive, people are able to discern what the right incentives are and it's worth making bread if you think there's demand, then you can do it. But I fear that the problem today is that our policy makers really have lost their faith and trust in markets while the American public has not but the policy makers have.

BENNETT: How could they be so different than us? What world are they living in?

MALMGREN: Well, it is another world, and having lived in that world in Washington, it's a very rarefied environment—almost none of them have any market background. I mean, when I was in the White House and we had for example 9/11, I remember after 9/11, basically showing the other policy makers in the White House the charts of what was happening in the stock markets around the world and basically being reassuring that markets are adjusting to these facts as they always do so we don't have to be too worried about something like a catastrophic market failure. And what I was showing were graphs and charts and I realized what they saw were squiggly lines. What I saw was meaningful price movement. What they saw were squiggly lines so they were like, 'Why is this relevant?' Yes, Washington doesn't get markets.

BENNETT: I'm in awe. I've gotten the feeling that probably the White House doesn't understand the economic charts in the last six years but I didn't realize the Federal Reserve and a lot of people in Washington were that disconnected. I think Americans would be very afraid if they knew the truth.

MALMGREN: At one point in the book I quote an interesting meeting that happened between a former White House Adviser Ambassador Richard McCormick and the former Head of the Federal Reserve William McChesney Martin, who was the longest serving chairman of the Fed. And McChesney Martin basically says, 'There's a reason we keep the macroeconomists here at the Federal Reserve in the basement of the building and that is because they are very useful there, but you don't really want them to be running things because they don't have practical experience of what is out in the real world.' And I do think that the Fed and the Treasury experience, both under President Bush and under President Obama—it's not a partisan issue—I think they have all been quite shocked by how formidable markets are. How hard it is to know where they're going, to try to determine where they're going, to try to make them go where you want them to go. But on the other hand, I don't blame them either.

I mean, their area of expertise is different and people in markets would do well to also respect the fact that they spent their career doing other things that are also valuable, they just don't understand this area. So when people ask me what's my skill set, I always say I speak both Klingon and Federation, which is only apt, in light of Leonard Nimoy's recent passing—

BENNETT: That's right.

MALMGREN:—because the Klingons are the market guys and they don't understand the policy makers and the policy makers are the Federation and they don't understand the market. So I just explained one side to the other and that's what I do in the book.

BENNETT: Let me go back to your book, you write about shrinkflation, a term you used to describe many factories selling smaller amounts of their goods for the same price. Cereal boxes for example, are the same price, the same sized package, but with less inside. And airplane seats are also getting smaller. What are other examples you came across in your research of shrinkflation?

MALMGREN: Oh, there's so many examples. Look up about this new phenomena called micro apartments right, tiny little apartments in big urban areas that you can't swing a cat in. It's like a thousand square feet. But now that's considered a perfectly legitimate reasonable size of an apartment. Everything is getting smaller but costing the same or more than before, and I think that reflects latent inflation pressure is building up in the system. It's an early indicator that the margin of the input cost versus the price you can sell it at is being squeezed because the input cost are rising. So when everybody says, 'Well there's no inflation and there's no risk of it,' I'm like, 'Wait a minute, if 99 percent of all the people surveyed in the market think that's the case, I'd like to take the other side of that trade just because of those numbers.' But more importantly, let's face it, every major central bank in the industrialized world is doing its level best to create inflation, and we've never seen this happen among all of them simultaneously, but usually any one of them can do it and it does succeed.

So my point is, what would be the early signals that it is succeeding? One of them is exactly what we saw on the 1970s last time we had inflation and that is the shrinkflation where the size of things starts to get smaller but the price stays the same. So what you're paying, for example, for steaks—I'm on a board at Indiana University, and when you go to mid-west it used to be that a steak that was less than 16 ounces was an hors-d'oeuvre. Now, it's normal to see 6, 8 ounce steaks on the menu and I don't buy that it's suddenly health consciousness. I think if you look at the price per ounce, it's gone up and that makes sense. We have record high beef prices.

BENNETT: The Fed uses the term hedonics, using it as a reason to adjust inflation downward when technology improves, for example, if a computer gets faster but the price remains the same. The Fed would say that the price has actually gone down, after being adjusted for hedonics. Does the Fed do anything like reverse hedonics for shrinkflation?

MALMGREN: No, and this is my question. How come it only goes one way? So we don't make adjustments for losses in productivity. I used the example of comparing Apple, as in Apple Mac, to apples as in the kind you eat. So in Apple Mac, yes, maybe the capability of each iPod is getting bigger but what about the people who can't possibly make use of that? They just don't have the technology skills. They just need it to do the basic stuff. They don't have the option of buying a cheaper version that has less content. And similarly, on the other side, we used to have apples that tasted great when I grew up in Washington D.C. years ago. Now they are better at making apples that can stay on the shelf a lot longer, they look beautiful but they don't taste great. Did we adjust it downward? No we don't.

BENNETT: Here's another example. This week the price of ground beef rose to an all-time high.

MALMGREN: Yes, it did.

BENNETT: Is this another kind of signal that's been sent out to the economy, aside from making tacos more expensive?

MALMGREN: I hear you. I think it is a signal. Listen, prices are signals and so what is it telling us... Well, it's very interesting that we've got the lowest level of the cattle herd in the United States since I think it's 1951, and we see land prices, farm land prices at nearly all-time record high. So the thing is, the price maybe record high but it's not like it's easy to make profits in the space, and therefore, I don't see a whole lot of new investment going in to this area. That tells me that I think the prices are going to remain higher, go higher which is exactly what the USDA is forecasting.

So, protein prices matter and we look around the world, we see protein prices rising in most locations. Fish, pork, and this has all kinds of consequences. But I guess one of the key points I make in the book is, we have these strange world of a kind of 'biflation.' On the one hand, the data says prices are falling and we have deflation. On the other hand, any barbecue, any dinner party, any school meeting, the only thing everybody's talking about is the rise in the cost of living. And so, we have these two worlds and I think that over time, we're going find that these signals like the fact that your hamburger cost more, is actually telling us something about what the future is going to bring.

BENNETT: Why don't Americans pay attention to signals. I have the sense that we are so comfortable being told what to do, but that outside of America, individuals are more independent in their thought processes and draw their own conclusions. I know you live in London now, do you agree?

MALMGREN: Actually I have to say no. I really don't see that. If anything I think, the country that has the most dynamic responses to price signals is actually the U.S., and I've been very bullish over the last four years on the ability of the U.S. economy to innovate and change, to tighten the belt and come up with new business models that generate good cash flow. And surely enough, the U.S. has emerged as the number one place for things like additive manufacturing or super high tech manufacturing, and we see manufacturing moving from China back to the U.S. in an incredible speed. This is because businesses are looking at the signals and saying, 'Hey, there's an opportunity here and we should act on it.' Whether that's true for somebody who is just kind of cruising through everyday life, I think they also pay attention and they start to change their behaviors depending on what signals are.

BENNETT: Is manufacturing returning from China back to the United States a good thing or a band thing? What type of manufacturing are you talking about? Expensive or cheap?

MALMGREN: Well, I'm talking about the whole range. It is so interesting now that it's actually less expensive to make hula hoops and toys like rubber ducks in the U.S. than in China and that's partly because their wage demands have gone up so much and Americans have become willing to work and to innovate at lower levels of income. So suddenly the wage differential has narrowed a lot, but the innovation capability of the U.S. is so much greater. But it's also high tech. It's things like 3D printing which is being applied to so many different areas from manufacturing to food, to medical technology across the board. Now is it a good thing? I think it's a great thing, but for China, there's a question what are they going to do to generate revenue now that they are no longer the cheapest place to manufacture on the planet. The answer is they are going to have to move up the value added curve or going to learn how to start making more expensive higher tech items and that can only be a good thing because that's how you'll raise national incomes in China.

BENNETT: Among the main antagonists in your book are the central bankers, so I'm just wondering, what's your opinion about bitcoin?

MALMGREN: Well, I think bitcoin is fascinating because it's kind of the new version of gold. It's a way that the public express their lack of faith and confidence in fiat currency, as it's called, that means government's version of currency. And they look for some alternative place to put their savings. My concern about bitcoin is that that I think it's so interesting, we live in a world where we have front page news stories about how governments listen to everything that you're doing on the internet, as you talk on the phone, no doubt on this radio program.

BENNETT: No doubt. (Laughter)

MALMGREN: There's no doubt. And yet, we all think our passwords going to be safe and I'm like, 'Really?' So I don't know. I have concerns about electronic currencies, but there's a demand and even countries are now turning to electronic currency systems. Ecuador this year has implemented the first electronic currency for a nation.

BENNETT: Do you think this is an innovation that could actually help shape our future?

MALMGREN: I do, I think it's one of several innovations that's occurring in the financial arena than are really important. Another one of them is crowd funding. And I think, again, back to policy makers, it's so interesting that one of the indicators of inflation is the velocity of money, that means the money and the economy are actually moving. You can give it to the banks but are they lending it?

BENNETT: Correct.

MALMGREN: And banks can't lend partly because they've fired every lending officer. They no longer have the capacity to lend, but also they are so impaired with their balance sheets. But what's interesting is crowd funding. That's working beautifully. In fact I launched my book on Indiegogo, a crowd funding platform, just to prove that point that actually the velocity of money is higher than you think it is.

BENNETT: Was it successful for you launching it there?

MALMGREN: It was, it was unbelievable.

BENNETT: That's good.

MALMGREN: I put up on Indiegogo and raised 259 percent of my target during the period.

BENNETT: Wow!

MALMGREN: In fact, I got to 249 percent of the target in literally 15 days. It was unbelievable and then I threw it up on Amazon, and it went straight to the top of the Amazon Best Seller list in three different categories, and I think that's partly because people are watching the crowd funding space and when they see something successful there they go, 'Oh this is kind of cool.'

BENNETT: It is. Your book concludes on a hopeful note. You write that the economy of tomorrow is actually being built today. I'm very curious about that. What is it? Are we just innovating ourselves out of bad government? We've got a lot to fix, especially here in the United States.

MALMGREN: OK. Two things very quickly. One, regular people that are innovating I tell a great story about this woman in Missouri who runs a wonderful quilting company. She gets like a million hits on every how-to YouTube video she does on quilting. She's creating jobs. So it's not all high tech. But governments are also innovating and they are innovating in a good ways and bad ways. So a bad way in my opinion is becoming more aggressive with taxation, delivering less on what they have promised, that breaks the social contract between citizens and their state, and that's a problem. On the other hand, some are innovating in ways that are positive. I mentioned the legalization of marijuana as one interesting case in point because once you legalize it, you can generate tax revenue of it. And so far, I don't know, everybody seems to be reasonably happy with the outcome in Colorado, so that's a positive innovation.

BENNETT: Dr. Pippa Malmgren's book can be found on Amazon. It's titled Signals: The Breakdown of the Social Contract and the Rise of Geopolitics.

All data sourced through Bloomberg
Securities offered through Western International Securities, Inc., Member FINRA & SIPC. Bennett Group Financial & Western International Securities, Inc. are separate and unaffiliated companies.

About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com

She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.

She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett or dbennett@bennettg