Stanley Druckenmiller: Current Fed Policy Is Totally Inappropriate
Transcript
Joe: But first, Stan Druckenmiller, CEO of Duquesne Family Office. Stan just wrote a new op-ed in the Wall Street Journal — in his words, “The Fed Playing With Fire: Clinging to an emergency policy after the emergency has passed, Chairman Powell is courting asset bubbles.” And Stan, in the past you have pointed out that the Fed has stayed a little bit too long after the financial crisis with emergency accommodation. But you seem to have taken your criticism up to a new level, to the point of — if you combine fiscal policy that we’re seeing with the monetary policy — it’s the scariest combination in the post-World War II period, in your view.
Druckenmiller: Certainly the most radical policy, by a long shot, that I’ve ever seen relative to economic circumstances. Let’s not forget that Ben Bernanke at the peak was doing $85 billion a month. We are now back to normal — normalization on GDP, we’re above trend on retail sales. Funny, last year at the Economics Club around this time I said that a V recovery was a fantasy. I couldn’t have been more wrong. But this is all about risk-reward. I understand why the Fed and Congress did what they did at the time — I think it was the right decision on a risk-reward basis. But when the facts change, you have to change, and the facts have changed dramatically since then. And yes, I can’t find any period in history where monetary and fiscal policy were this out of step with the economic circumstances. Not one.
Joe: Stan, you talk about how quickly the job market has come back, and you pointed out retail sales and a lot of other things that are almost at pre-pandemic levels. In normal situations you might think that the Fed would be talking about an interest rate hike right now. And you point out it’s 32 months. The other statistic that I saw you point out was — and I don’t have it right here — but the amount of asset purchases that the Fed has orchestrated just in a very brief period of time eclipses what we did through the whole financial crisis, for the seven or eight years after the financial crisis.
Druckenmiller: What is that — in six weeks last spring, we did more QE, more purchasing of Treasuries, than we did the entire time — the nine-year period from 2009 to 2018.
Frankly, Joe, I don’t have a problem with that. We were in a black hole, no one knew where we were headed. What I have a problem with is the Fed is expected to do $2.5 trillion of QE after vaccine confirmation and after retail sales reached trend and we’re above trend. So the black hole didn’t occur — that’s wonderful, we’re all happy — but we’re still acting like we’re in a black hole. In fact, the economy is accelerating. Could your producers bring up the chart of retail sales? Is that possible?
Joe: Yep, I think we — yeah, we’ve got them all ready, we can bring up… there it is. I think it’s up now — US nominal retail sales.
Druckenmiller: Okay, so if you look at this — this is a chart of retail sales the last 20 years, and as you can see they grow about 3% a year. After the Great Financial Crisis it took about six years to get back to trend. If you look at the current recession, it’s like nothing we’ve ever seen — a sharper decline — but then within six months you were back to trend level. And you see Check One — that’s the first stimulus package, that’s the one I have no problem with, I think it was the right risk-reward, which was right at the bottom. But look at Check Two and Check Three when they’re coming — not only are we back to trend, we’re now 15% above trend. To put that in perspective, retail sales grow at about 3% a year, so we are five years’ worth of demand above trend. There’s some pull-forward here away from travel, but it’s not 15%. So when you look at this chart and then you look at the Fed policy and all the stimulus and them talking about the hole we’re in — I just think it’s totally inappropriate.
Joe: Let’s talk about the dollar. 85% of the transactions are still done in the dollar. You pointed out in a recent speech that you think we’ve crossed the Rubicon. Are you comfortable saying — with what you said there — that for the first time in your career you think we lose reserve status at some point?
Druckenmiller: I’m comfortable with it. That’s my central case. As you know, Joe, I can change my mind, but yeah.
Joe: You said that to some extent the Fed is enabling the fiscal transfers.
Druckenmiller: It’s not “to some extent” — they couldn’t be doing this without the Fed. The Fed is monetizing their activity. I mentioned all the QE after vaccine confirmation and retail sales. We’ve had $850 billion of direct transfers — $575 billion of them came after retail sales were above trend. $575 of the $850 billion. I’m old enough to remember the bond market vigilantes — I used to be one of them. Without the Fed buying — I don’t know what the exact number is, I think it’s 60% of all the debt issued — the bond markets would be totally rejecting this. So they are enabling this massive expansion in fiscal policy.
And the problem is, if you end up getting inflation — and frankly, even if you don’t — the debt is going to be so big. You remember I did my entitlement talks eight or nine years ago? That’s all happened, except for one thing: the interest rate level. So we’re right now at the crux of when the demographics — when the baby boomers accelerate in terms of getting Medicare, Medicaid, Social Security — that stuff. Right as we’re doing that, we just put $6 trillion of new debt on. Again, all enabled by the Fed — these guys could not be doing it, bond rates would go to a prohibitive level. So my issue here is in the future, as we go forward — if you look at, do you have chart five up there? Let’s get it. It’s federal spending — Social Security, major health care programs — federal spending percent of GDP.
Joe: This is the CBO, this is not me.
Druckenmiller: Okay, and they’re saying if 10-years go to 4.9%, which is their normalized projection, the interest expense alone will be close to 30% of GDP every year. That’s basically what we just spent on the COVID emergency in the last year. There is no way we can afford to have 30% of all government outlays go toward interest expense. So what will happen is the Fed will have to monetize that. When they monetize it, I believe it’ll have horrible implications for the dollar. And that’s why I said in that speech, yes, that I think it’s more likely than not within 15 years we lose reserve currency status.
Druckenmiller: Can we go to the chart on the dollar specifically? Because I think this is really important. Last spring, in the midst of an equity market meltdown — and I’ve been trading for 40 years and I’ve never seen anything like this — right in the middle of an equity market meltdown, the bond market went down 18 points one day. And everybody thought it was macro traders like me and others that were rejecting the implications of the CARES Act. The Fed did a deep dive, and in hindsight, foreigners sold a trillion — a trillion dollars of Treasuries overnight as we were proposing the CARES Act. They’ve continued to sell Treasuries ever since then.
Why is that important? Because for 20 years, Treasuries have been the go-to asset of foreigners to hedge global portfolios. In every case, whenever you had a problem in the equity market or in the world economy, they fled to Treasuries and they fled to the dollar. Last spring, that was violated. So since then they’ve continued to sell Treasuries. What we’ve gone from is — for 20 years, an average flow of $500 billion a year into Treasuries — to an outflow out of Treasuries. So when you have a $700 billion current account deficit — our estimate for the year — you need capital to flow in to offset that. If you just erase a $500 billion inflow and turn it into an outflow, you see the pressure that’ll put on the dollar.
A reasonable person might ask, “Well, if that’s true, why did the dollar not go down from March to July?” Very simple. Who was the biggest beneficiary of COVID? Obviously the massive digital transformation companies — Google, Microsoft, not so massive but Zoom, those kinds of names. What country dominates in terms of those names? The United States of America. So the $500 billion outflow out of bonds was offset by a massive inflow from world central banks, from sovereign wealth funds, into our equity market. By July, that had become pretty much priced in — the relative prices had gone up — and frankly, the vaccine profile was starting to look better. So that is when the dollar peaked, as that offset started to diminish. And as you know, Joe, the vaccine tends to cause a rotation out of growth stocks into value stocks. Our big advantage over here are the growth stocks. So that’s why I think the pressure on the dollar is going to continue.