The Bond Market is Hitting its Breaking Point! Steve Hanke

0:00inflation genie is out of the bottle and it's not going back in and it would have to go down to 2% Which is the inflation target to get back in it's it's not gonna happen and anytime soon And the reason we know that is that is these huge lags between changes in the money supply and changes in inflation So the inflation we're seeing now is is actually been generated by what was going on with the money supply, you know, maybe it maybe a year year and a half two years ago So so as they say it's kind of baked in the cake from something that happened a long time ago Hey, everyone my name is Anthony Fatsies and welcome to another episode of the What the Finance Podcast on this podcast So the pleasure of welcome back very popular guest professor Steve. Thank you. So Professor Hanky. Thanks so much for coming on the podcast Great to be with you today Anthony Yeah, looking forward to the conversation as we're saying before we got on the interview

1:02There's a lot happening in the world so definitely lots to speak about But where I'd like to start is very broad where I normally start. So what are you currently seeing the economy and markets? Well the big thing Focusing on the US and said is the the world's capital market The bonds have had lots of trouble and in the last few weeks And one reason they're having trouble is that the money supply keeps growing at very rapid rate in the United States the broadest measure that divisia M4 measure Which is put out by the Center for Financial Stability in New York that works done by Professor William Barnett the growth rate is 7.9 percent right now and and Hanky's golden growth rate a rate consistent with hitting a 2 percent inflation target 6 percent So it's it's it's hot and and and when it's hot with a lag of between

2:0912 and 24 months inflation picks up and if inflation picks up of course bond yields are going to go up and bond prices go down so that's that's the underlying factor Behind the movement the bond market is the money is the money supply that's always the case. It's it's a it's a three step process Big change in the money supply step one step step two with a lag you will get more inflation and the third final step is the yields always follow inflation so so that's The basis behind it, but there are other things going on that are also hurting the bonds and and one of those is the fact that we have considerable fiscal deficit in the United States a A big fiscal overhang and there's always the worry that the fed will be induced to monetize some of that deficit

3:13As they did by the way after coven coven the the deficit in the United States and February of 2020 it's it's soared and and about 90 percent of that deficit was being monetized by the fed and in other words the deficit occurs the Treasury issues Treasury bonds and bills and and about 90 over 90 percent of those were being bought by the fed And when the fed does that it's it's like you Quantitative easing the money supply goes up and of course it did go it rocketed up To a record high growth rate by the way, and then we of course with a lag we had Not record inflation, but the most recent record it was 9.1 percent it hit Which if you're following the money supply and using the quantity three of money which John Greenwood night we're doing at the time

4:16We predicted and published in the Wall Street Journal an article Anticipating the inflation and we said given the growth rate in the money supply it looks like the inflation rate could hit as high as 9 percent while it did it hit 9.1 So so that's that's that's that's going on too. So the money supply is growing you've got the fiscal debt deficit uh Should we say out of control and and and then that comes back into there's kind of a loop in here because if the if the yields stay high And and the total debt now has just gone over 40 trillion dollars in the United States You end up with a huge increase in financing cost For the government budget and and with that of course that that actually increases the the deficit So so it's kind of a negative doom loop thing feeding back in it and and it's very significant by the way now with the debt as high as it is

5:23About 35 percent of all personal income tax revenues that come in are just used to Service the debt to pay interest on the debt So it's a it in in in a way it's a tax on a tax the personal income tax is levied And then the personal income taxes come into the government and there's a debt servicing Tax put on top of that revenue of 35 percent So so the bond market is A big thing to be watching. I've been very negative on bonds for a long time Staying staying away from long bonds because as these yields go up for example like the 10-year bond Is is the key interest rate in the United States and and all mortgage rates credit card rates and all all other rates are keyed off of that So it's so it's it's it's a big deal. It comes

6:26You know Merle tripping along through the economy all all aspects all veins of the economy Get hit by the bond market so The inflation genie is out of the bottle because it many supplies growing too fast and and finally the bond vigilantes of come out of hibernation and they're working over the bond market and and In reaction to that we have the Secretary of Treasury beston has indicated that he wants to engage in yield curve control where long bonds are being bought back by the US government to support their price and keep the the yield down. So that's that's the yield curve control aspect and And that doesn't have much credibility the bond vigilantes have kind of given thumbs down on that So that's another negative factor So there's just nothing positive about the bonds

7:29So that's that's the big thing This stock market keeps Growing away and and and and that also the foundation is the money supply If the money supplies being boosted and growing at a in a 7.9% broadly measured with the divisive four That that determines where the economic Activity will go and where inflation will go and short where nominal GDP that's made up of the real component plus inflation component that's nominal GDP That's going to keep going up because the money supplies accelerating So and we saw that today we had we had very strong and employment numbers in the United States three times higher than the consensus and Everyone was surprised I wasn't surprised at all because you've got this big injection of money coming into the economy and when that comes in you get both

8:35hot Real growth and hot inflation. Yeah, thanks so much for Laying that out a lot a lot to dig into there. So yeah, you've mentioned sort of The bond obviously yields a sort of out of control at the moment. It seems is this link to inflation and uh You know, as you said the the monetary Numbers at the moment is it linked to the sort of geopolitics the Middle East is a link to the sovereign debt crisis Or is it all these things that are sort of links together to make it even worse? I think all the things linked together come into the picture But the the underlying factor with with bond yields is inflation and inflation expectations and that that comes From what has been going on with the money supply You know year ago year and a half ago two years ago So the the money supplies under is underpinning the whole thing If the money supplies going down and and contracting and are slowing down

9:40Uh the bond prices are going to be going up and the yields of The inflation expectation to be coming down then and and the the bond prices be going up and the yields are becoming down But that's that's not what's happening now. It's history verse Okay, and what what level inflation with this sort of monetary supply suggests that we should be because I guess in the moment Three percent is sort of going up a little bit a little bit more Yeah, where should we be? It's just gonna stay up Okay No particular forecast, but it's I I like to put it the inflation genie is out of the bottle and it's not going back in and it would have to go down to two percent Which is the inflation target to get back in it's it's not gonna happen and anytime soon And the and the reason we know that is that is these huge lags between changes in the money supply and changes in inflation

10:40So the inflation we're seeing now is is actually Been generated by what was going on with the money supply, you know, maybe it maybe a year year and a half two years ago So so as they say it's kind of baked in the cake from something that happened a long time ago It sounds like the inflation will be up and you know, similar to where we are now maybe three to four percent But it's not going to be as outrageous as what we saw and eat during COVID where it gets to sort of nine double the percentage in some countries Right, it's gonna it's it's gonna stay You know, we're talking about fairly significant inflation. I mean it's you know, we're we're up towards Double the inflation target at 2 percent That's that's a big miss actually and Kevin Warris in each term and the Fed was complaining about that at the Jackson Halls symposium last week He's he said their number one job was to get the inflation genie back in the bottle

11:43And and for the first time he he didn't actually mention money And And the fact that they have to be keeping their eye on the money supply now that that's a big change from Chairman Paul because chairman Paul kept testifying and repeating over and over again the changes in the money supply Didn't have any reliable connection to economic activity which of course is complete nonsense and rubbish, but That was the Fed's position and that's what got us the big high inflation that we had by the way And in 2021 2022 Yeah, how do you see Warris? I guess changing what the what the Fed does you've already mentioned now that is sort of focusing on monetary supply Is there any other differences that you're currently seeing? Uh, well That's that's one aspect but and a very important one, but we don't exactly know what he has in mind He he's kind of opened the window and and and indicated that

12:48The money supplies important, but he hasn't indicated Exactly whether he was going to latch onto the quantity theory of money and Have some target for the money supply growth as I indicated the Hankies golden growth rate for broad monies about six percent per year and the United States and that that would be consistent with the inflation Target, but hitting that target, but but we don't we don't know I think it's very early. We know he also doesn't like the The so-called dot plots and that Indication by members of federal open market committee were they were they thought the Fed funds rate would be going in the future He he but he can't control that in a way there's some members that still articulate where where they thank the Fed funds rate should go, but he's not doing it

13:50And he's not including that and is Regular statements So that that is a change And and he has five working groups set up to look into uh various aspects of the Fed and Maybe maybe make changes so so the The things are opened up we we don't know what the results going to be, but there's a there's a debate about things that this Systematic and open of course early is our all always debate about things, but usually it's kept kind of Should we say behind the curtain you don't exactly know what's going on, but he has five specific areas that he's Formed test forces to look into and we'll see what the result is Yeah, can interesting. What changes do you think he should make other than what he currently has?

14:52So I guess as he said it's hard it's hard to predict what he'll actually do, but maybe what should he do? Oh, I there's one big thing and that's It Latch on to the quantity theory of money and that should be the guiding star for monetary policy in the United States as well as elsewhere for that matter So that that would be a big change Because now all of macroeconomic models that the They use at the Fed and most other central banks are Post-Kainsian macroeconomic models that they don't even include a monetary aggregate Now the quantity theory of money does include a monetary aggregate That's the most important thing what's what's going on with money? So you got a major at the right way And then figure out how to adjust the levers of monetary policy to try to hit

15:53a Target that is consistent of monetary growth that's consistent with hitting your inflation target So that that would change the whole operation of the Fed by the way So it would be a huge change and and one I think that would be desirable Okay, it makes a lot of sense and then did you see him increasing interest rates to sort of try and fight inflation because Yeah, is it all right? Well Not exactly is Milton Friedman once quipped monetary policy is not about changes in interest rates is about changes in the money supply so the focus of most central bankers is on the you know the That whatever the interest rate is that they control the base rate we have the federal funds in the United States and and that's the lever that they Latch on to when they're trying to change monetary policy and it looks to me by the way now

16:55After this employment report today that there's there's a pretty good chance of being increasing the federal funds rate Because their their view is It's The federal funds rate, you know is the is the lever and and they will try to Tighten things up if they think inflation is too hot and the economy is running pretty hot They'll try to slow it down and as they see it The way you slow it down is the increased interest rates Yeah, it feels like it's as less of an effect as you know It's actually essentially similar to the economy because there's so much government and debt out there you probably get so much extra money going into Sort of the economy through repayments of of this debt as well as the US government not being very Interest rates sensitive at least currently maybe that changes in the future But it seems like they'll keep printing and keep a deficit even though they're

17:56Filled and bonds are very high Well We we don't exactly know if they're if they're going to be Printing money because the fiscal thing can it let's assume that the Federal reserve does not monetize with that then what happens well You're you're basically selling More bonds to the non-bank public and and and when the non-bank public rights checks for the bonds The money supply actually is it doesn't go down, but it's it's a contracting aspect Because a checking account is part of the money supply So if you're writing a check to buy a bond replacing your Checking account balance with with the bond the money supply actually will go down And the only other way to finance the the deficit If you keep the the fed in the central bank out of it is to increase taxes and of course we know

19:02And that that would slow things down Because again the What happens is that if you pay your taxes and write a check the money That you're checking account goes down and that's a subtraction to the money supply So it all comes back to the quantity theory of money There's no way to get around it Whether you're dealing with fiscal policy or so-called monetary policy it always You know The chickens come back to roost on a money And that's why the the money supply is so important and why the the theoretical construct of the quantity theory of money is so important Yeah, super interesting. So we got the employment data you know today which was a lot higher than consensus almost double Um, she said Quintetly theory of money seems like there's lots of money in the system Does that mean the economy is actually doing better than the maybe lots of commentators are talking about always Yes, yeah, it is because it's it's the money supply

20:06Accelerating in the growth. It's fueling the economy. So so there are all kinds of sectoral problems and In various ask various sectors of the economy due to due to mainly Trump's terrifors and as well as the war in the Middle East So so those things are negative because all kinds of disruptions, but but the overall aggregate picture is is one of a of strength and and a lot of the strength is coming through this investment and uh AI and AI data centers and so for that that's that's very strong and And what's happening you even get the big hyper scalers uh, you know, they're they're using all the uh free cash flow they get from operations or they're burning through that and they're actually going into debt They're borrowing money and when they borrow money, of course, that increases the money supply and then the banks have plenty of capacity to loan that to them now

21:11So So there's again, there's just a lot of liquidity in the economy and it turns out there's one huge sector of the economy that's this demanding the credit and and building capacity and employing people and what have you And how um, I guess how long can that last? He said, I imagine it's hard to predict. Well uh Well, we'll see I have no idea how long it can last It can go on for a long time, but We don't know we don't know what the Fed's going to do. I mean maybe maybe with wash and looking at the money supply and looking at inflation Looking at the economy being pretty hot. Maybe maybe help pull back on the reins and tighten things up I think one aspect of that will be signal by what they do with the federal funds right next Meeting of the federal open market committee and my guess is the probably increase the The federal funds rate by 25 basis points

22:15I think it's looking it's looking to mean more and more like that the market even before today's job report the market The Chicago market till exchange the federal funds market Uh was indicating that there was about a 65% chance that they'd increase and Now I haven't looked at the numbers before we They're speaking today, but uh They're I bet it's I bet it's higher than 65% idea of an energy yesterday where I said yeah the market says the 65% I think it'll be higher than that. I think I think it should be higher than that That so the objective number yesterday was around 65% that's the market price and and the market probability My subjective view was it was higher than 65% chance. Yeah, it definitely seems seems that way Um, what do you what do you thoughts on Scott Besson's recent bond buybacks? Is that something that

23:16Talk to you yeah, that basically tanked I think it's a bad idea yield curve controls are the history of yield curve controls is that they they don't work uh and And create all all kinds of unintended and unwanted consequences. I mean we've had Well, not three episodes of that in the United States and they didn't work very well in Japan Most recently of course for some time this had yield curve controlling hasn't worked at all So and that's what the market the markets once Besson announced what he was going to do The markets didn't like it the that's again the bond vigilantes Came out of hibernation and it kind of smacked Besson down Yes, that's not Besson basically has a view that he knows better than the markets know

24:19and and and he's now done this two times once with the intervening and adjoining intervention Operation with Japan to try to boost the value of the Japanese yen and then the second thing he's done is this yield curve control with the Treasury buying back a lot of long-term debt Yeah, it seems like he's trying to find any ways to uh Resolve the bottom bond market without actually you know tied in the belts and uh doing what's needed to be done Yeah, well the problem it they they have to finance the deficit so if they're buying back Treasury bonds long bonds that they just have to issue more bit short-term bills so That's the yield curve control thing so They they trying to push that yield down on the long end of the yield curve But the other side of that story it pushes the short-term rates up

25:20and uh and and that creates a problem because right now They're issuing a lot of short-term bills to finance the deficit So he he's kind of in a corner Yeah, it seems super difficult. So what are we seeing around the world? I guess. So is there any other sort of countries that you're currently watching and looking to Well UK is pretty much Hopelessly in the tank and I think the new prime minister is That doesn't doesn't appear to know exactly what he's doing and To give you an idea of priorities the first foreign trip uh That the new prime minister took was where to to Ukraine to Kiev so That gives you is It's a typical British Russia folk thing His his most one of his his most important foreign policy thing is fighting a war against Russia

26:25Not it does that make any sense for the UK as much trouble as they're in So the UK is very troubled it also Europe in general is it pretty much in the tank going nowhere Uh and a lot of this is is directly associated with the proxy war they're fighting against Russia That natural gas inventory's of course Cutting cutting off Purchases from Russia cutting it way down not not off completely but way down. They now have a A Big inventory deficit really going into the winter so if there's a cold winter in Europe Europe is going to really be in trouble Uh So we had we have the two big economies Germany's in a lot of trouble tremendous amount of trouble and

27:25France The other one is is in quite a bit of trouble So that's that's Europe And including the UK China looks like it's in Better shapes and most people think it's it's been pretty much a big winter Uh, at least geopolitically and strategically from what's been going on in the in the Middle East So there there's a lot of pivoting towards China and the bricks And away from the United States and and you picked this up even in opinion polls about the International View an opinion of China versus the US see the US used to be positive and now the US image is actually negative And and and communist China used to be negative and that's positive Yeah, it's amazing how it's changing but I guess the challenges that previously their population used to you know invest their savings into property

28:30Um, and that's that went up and then now since the collapse you know, I saw recently it's As more values been lost than in the 2008 financial crisis in this Chinese Um, economic price yeah, yeah, the Chinese are still in a Delivery ging mood and and the fallout from the real estate bubble popping as Is dragging on things and and look also as dragging as the the money supply is growing below Anky's golden growth rate array consistent with hitting their 2% inflation target And and by the way, they're the only place that actually has a nominal GDP Target because the inflation targets 2% and and you have to add to that The inflation target is 2% you have to add to that the real growth target of 5% so nominal GDP target is 7 And they're not going to hit it Because the money supplies growing below a great of growth

29:32That would be consistent with hitting a 7% nominal GDP target so so the the economy is not Um Is not per is not performing As as well as the targets I think and so that's that's the economy but the geopolitical and strategic thing that is They're big winners They've gone from being negative to being hugely positive So and they're leading bricks so so at the margin everything happens at the margin and economics and at the margin China is looking pretty good Okay, interesting. How about Japan so they Japan's had issues with the sort of the yields? Yeah, I think Japan's continues to be in trouble because the the money supply is growing just a little Very in the name a little over 2% and the bank of Japan seems to be complete completely lost as they've been for the last 30 years

30:33the money supply is just Hardly moving at all and That means that nominal GDP will not move So that that would that would be negative I'd be negative on Japan Okay, okay, make make a lot of sense then the other country you mentioned before that you sort of been in policy on quite a lot Lot of laws vending as well, and we did recently have the large probably large US agreements and for me a JV of certain amount of assets and other factors in the government Yeah, what are you currently seeing that? Well, I'd become special advisor And Ben Zawail and and in the past that was president caldera's Chief advisor in 1995 and 1996 so I've been I've been to that road here before what they really the first thing I'm proposing is that they get rid of the Bolivar and replace it with the US dollar that they don't they dollarize the economy

31:34So that's that's step one and right now that's very important because I just measured their inflation rate today and that's 384% It's a world's highest so to get that down the only way to do it is to Get rid of the Bolivar and dollarize the economy Which which I know a little bit about because I was involved in the dollarization of Montenegro 1999 and Ecuador in 2000 and symbol blend 2009 So that's one thing and then the oil sectors is another thing because the oil sector It's something that also I know a little bit about No, I just want to add to the Depletion rate It's way too love for

32:34The reserves that they have and it would take them about Around 550 years that the fleet half of the reserves that they have If they continue to operate as a current rate of pumping and depletion And so if you have to wait 500 50 years to get a barrel of oil It's not worth anything impressive value parents So that they have to increase or depletion rate and that's the same analysis That I used to Recommend to the UAE when I was on the financial advisory council in 19 I should say 2008 to 2014 That they should get an increased quota from OPEC and so the recommendation I made given my optimum pumping a model or depletion model Was that they should be Increasing their output and the only way to increase their outputs to get a bigger quota from

33:37OPEC which they couldn't get and so in May They did what I recommended they should do they they accident OPEC they got out of oil too So so there there'll be a lot of discussion and then's the way low about how how to get the rate of depletion up Start pumping faster and So that's that's the idea on that end of the spectrum Yeah, I imagine it's a hard thing because there's not much time to sort of turn this around and to Help the country before I imagine there's not much patience from within oh This this is a very long the oil problem is a long-term problem and and by the way the the Great of us food and 1990 899 when when the oil production peaked out they were producing about 3.4 million barrels a day And now they're producing about 1.2 So

34:37So it's but to get it back up is it's going to take a lot of time because the maintenance and investment is Terrible under the state-owned enterprise Pettonesa which controls all the oil and so things are kind of a shambles To get it back up. I think you're talking about like a five-year arise and something like that There's a lot of hype now that they're going to get it increase it by 1.5 billion barrels add to the 1.2 they're producing now and jack it up With an increment of 1.5 billion million million barrels a day That's that's not going to happen any types in Yeah, let's see if it remains stable for that long. So Professor Hanky, thanks so much for your time So they really appreciate it my last question is what is one message you want people to take away from the conversation Start focusing on the quantity of money where when you're looking at any economy that's that's the key to understanding what's going on

35:43if If the money supplies accelerating rapidly you know nominal GDP is going to be going up asset prices are going to go up Real growth is going to go up inflation is going to go up if if if it's anemic the growth in the money supply That's going to hold down asset prices and real growth and inflation And then and then that's the first order condition There are lots of second order things going on and everybody talks about the second order That that's the second third order conditions are are kind of noise the signal is the money supply And And it's tricky to watch because if you look at current changes in the money supply The results of those current changes won't I won't show up For months maybe years Because there's a big lag between changes in the money supply and changes in real economic activity

36:48And changes in asset prices Great message so thanks again for your time if anyone wanted to find out more about your work and what you do Where would the best place for that? The best places on X at Steve underscore hanky is the best place Perfect great I'll put that on the description below but thanks again for your time. Thank you Hey everyone. Thank you so much for listening really appreciate your support And I hope you found amazing value out of this interview If you really enjoyed it would appreciate if you liked and subscribe or share I really hope so the podcast was still trying to Expand get to more people to help make sure that everyone understands and decode what's really happening a lot of finance investing macro economics and geopolitics If you enjoyed this one then you might enjoy this other interview as well. It's really appreciated and thank you