Episode 131: The Financial Crisis Loop with Alex J. Pollock & Howard B. Adler

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to the WealthAbility Show, where we’re always discovering how to make way more money and pay way less tax. This is Tom Wheelwright, your host, founder and CEO of WealthAbility. So we are in this 10-year boom and bust cycle, and here we are again in the bust side of the cycle. And this is something I’ve been looking at for many, many years. How do you anticipate these booms and busts? What do you do during these booms and busts? So today we have two of the experts, Alex Pollock and Howard Adler, and we have two of the best that there are on this topic. They have written a book called Surprised Again! – The COVID Crisis and the New Market Bubble. And now, 10 years from now, you can write a new one, guys. So if you would, let’s start with you, Howard. Give us a little bit of your background and why you guys are talking about this and then Alex, same for you.

Howard Adler:

Sure. Thank you very, very much, Tom, and thank you for having us on your show. I’m a lawyer by training. For over 30 years, I was a partner at Gibson, Dunn, & Crutcher, LLP, where I was Co-Head of their Corporate Transactional Practice. Before that, I’d been Executive Vice President and General Counsel of the Riggs National Bank in Washington, DC. From 2019 to 2021, I served as Deputy Assistant Secretary of the Treasury for the Financial Stability Oversight Council. And one of the jobs of the Council is to find risk in the financial system and remediate it.

And obviously, nobody foresaw this particular crisis. As our book says, we have had a crisis about once every 10 years, it’s just that nobody can tell exactly where it’s coming from because of the very nature of financial uncertainty. And generally nobody for foresees these crises. Nobody foresaw the Great Depression in 1929. Nobody really foresaw the Great Recession in 2008, 2009. And certainly, nobody put together the idea that a health crisis, through political action, would morph into an entire shutdown for the first time in history of an economy and lead to another staggering financial crisis, followed by the government pumping in liquidity, building up the economy, building up a bubble, and now that bubble is deflating again. Let me turn it over to Alex.

Alex Pollock:

Thanks, Howard. I am Alex Pollock. I’m a Senior Fellow at the Mises Instituting, a pre-market think tank. Before that, Howard and I worked together in the Treasury. I was the number two in the Office of Financial Research, which like Howard’s staff at the Financial Stability Oversight Council, tries to look ahead and see what may be coming. Howard and I worked very closely together on that. When the administration changed, he said to me, “Why don’t we write a book about this?” And I said, “Great idea.” So here’s the book, Surprised Again! I have a previous book called Finance and Philosophy: Why We’re Always Surprised. So this one is Surprised Again!

Tom Wheelwright:

Awesome. Yeah.

Alex Pollock:

And there were a number of surprises in this one. As Howard said, while it was very clear scientifically that some new pandemic, some mutated virus would go around the world, that was probable or maybe even certain over time, nobody including unfortunately Howard and me, linked the fact that that happened, you would then get political actions which closed down a big part of the economy, not only in this country but in others. And that, in turn, would trigger an economic contraction of amazing proportions. And thinking about that, that would panic markets, so we got a financial market panic in the spring of 2020, the panic of 2020, where every financial market was dropping like a rock.

And one of the things we do in this book is the history of that flow, and try to remind people it’s sort of evened… Financial memories are so short, as you know. It’s sort of hard to remember already how bad it was, that we try to get people to remember the intense uncertainty and how it seemed like there would be no bottom and maybe there’d be a depression, and all of the things that were governing markets at that point, primarily fear of different kinds. So that’s part of the history.

In my own history, I have been working in Washington think tanks on problems of political finance for more than 15 years. Before that, I ran the Federal Home Loan Bank of Chicago for about 13 year. And I have been in banking and finance all the time since I finished studying philosophy, hence Philosophy and Finance.

Tom Wheelwright:

There you go. So if we can, let’s start with this crisis and then let’s go back and look at historically and go to that ten-year cycle, because that’s actually something I’ve been looking at for many, many years is this ten-year cycle and how to predict it and how to deal with it.

But if you look at this crisis, so when we look at inflation, inflation is simply too much money chasing too few goods, right? And it’s a pretty simple computation. And so, we knew we had too few goods because of the pandemic. So we had had all the supply chain disruption, and now all of a sudden, you put in huge amounts of money. So how is it that… So we get the big stimulus in May of 2020, the CARES Act. Totally understand that one, that seemed to have worked. Then we have another one though, then we have two more in 2020 and a third one in 2021. Here’s my question. So why the third and fourth one? Why a third and fourth stimulus when the economy seemed to be already on its way? And do you think that it’s those, because that’s my theory is that it’s the December and the March stimulus that really pushed the inflation button and really triggered this.

Alex Pollock:

Howard, I bet you want to start with this.

Howard Adler:

You’re right. I do.

Alex Pollock:

Okay.

Howard Adler:

And this hits one of the… But I knew you would, too. This hits one of the main themes of our book, a thing that Alex wrote about in his earlier book that we called the Cincinnatus Principle after the famous Roman, Cincinnatus, who was called from his farm by the Roman Senate to save the republic from an invasion. Did it, and assumed dictatorial powers, won the war in 16 days and immediately went back to his farm. You’ve got to know when to quit. After an emergency is over, you have to walk away from the punchbowl, which is the metaphor that was used for the Federal Reserve, and we failed to do it.

In December, Secretary Mnuchin was saying that basically all of the 22 Treasury and 14 Federal Reserve lending programs that were initially established under both the CARES Act and the Federal Reserve Act ought to be wound down. But in 2021, you had the American Rescue Plan, which was another $1.9 trillion, an enormous amount. I can’t really tell. We probably would have had some inflation had we stopped pumping money into the economy. And you’re absolutely right, Tom. That’s what causes inflation in December of 2020. But it would certainly never have been as bad as it got in 2022 had people stopped and gone back to the farm in early 2021.

Alex Pollock:

We have this little line in the book, is in effect, when the Fed has become the biggest investor in mortgages and bonds and the dominant investor in the world, how do we get them to go back to their farm like Cincinnatus? It’s very hard.

Tom Wheelwright:

Right.

Alex Pollock:

And that we call, as Howard said, there’s the principle and then there’s the Cincinnatian problem. And the problem is how do you get the interventions to stop, especially in a pure fiat currency or pure paper money system where there’s no inherent constraint on the financing of the central bank and the government so it runs note. One other thing I’d add is we are talking about goods and services inflation, but there’s also, especially for this show, another kind of really important inflation, which is asset price inflation.

Tom Wheelwright:

Right, right.

Alex Pollock:

So the printing all along and the suppression of interest rates down to zero nominal and negative real interest rates set off an amazing inflation in asset prices, which we also discuss in the book, and that makes the bubble in asset prices. So you’ve got these two things going on at once, and those assets of course include houses.

Tom Wheelwright:

Right. You know, Ron-

Alex Pollock:

There was this amazing bubble in house prices.

Tom Wheelwright:

Ron Paul said years and years ago, Ron Paul in his book said that the low interest rates were the enemy of the poor and the middle class, that that’s who they really went after the poor and the middle class, the low interest rates. And that’s certainly what we’ve seen in prices of rent and in prices of housing and in prices of energy.

Alex Pollock:

And in expropriating their savings.

Tom Wheelwright:

Exactly.

Howard Adler:

Absolutely.

Alex Pollock:

8% inflation is taking away 8% of your savings every year.

Tom Wheelwright:

Well, if you look at it, and I’m a tax guy. And if you look at this, the worst tax… People complain about a 40% income tax, but if you are earning 2% and your inflation is 8%, that’s a 400% tax rate. So that’s a way worse tax rate, and that’s a tax rate on the poor and the middle class. That’s not a tax on the rich because the rich can afford to deal with that and they can have investments that make more than 8%, whereas the poor and the middle class, they struggle to do so.

But if we can, let’s go back a little ways. I want to go back to Reagan Volcker, because there’s so many parallels being drawn right now between this high inflation and the high inflation of the late seventies and early eighties and what was done. And I want to just postulate my theory here, and I’d like your feedback on this if you would. So what we have right now is we have the Fed… So the Fed, all they can do is they can only reduce the supply of money, right? They can’t do anything about the supply of goods. So they can reduce demand, they cannot reduce supply. And so, they’re trying here to push down demand, take money out of the market. They’re doing it through the interest rates, they’re doing it through quantitative dis-easing, which I think it’s funny, because it’s a disease, right, a quantitative dis-easing. But when you go back to-

Alex Pollock:

But no sales, no sales of their portfolio, only letting them run off slowly.

Tom Wheelwright:

Exactly, exactly. But they’re doing that. They’re doing that, okay. And they say, “Okay. Well, Volcker did that. He raised interest rates.” And everybody is comparing Volcker and Powell and what they’re doing. What I don’t see anybody doing is comparing what Reagan and Biden are doing, because I think that’s an important comparison. Because I’m a tax guy and I was actually in Washington, DC in the eighties in a national tax office for one of the big accounting firms.

And what I saw in the eighties was the very first bill that Reagan presented in 1981 was a tax bill that would encourage investment, not spending, investment. So it was encouraging investment in real estate, encouraging investment in other things. So at the same time we had he’s trying to increase supply basically, while the Fed is bringing down demand. And this time around, what I think we see, like with the Inflation Reduction Act, more so than the Semiconductor Act, which I think actually was more of an investment side. But with the Inflation Reduction Act, which I called the Inflation Enhancement Act, what he did was he actually put more money in, right? He’s actually encouraging, and there seems to be more sugar, if you will, going into the economy and less protein going into the economy.

So I’d like your take on that, because I’ve been thinking about this for years and years and years, especially for the last couple of years when we see this high inflation. Is there a correlation between investment and increasing supply and not pushing against investment like the Biden administration seems to be doing with energy in particular, pushing against investment in the energy sector and instead really just feeding the sugar into the economy?

Howard Adler:

Alex, do you want to go first?

Alex Pollock:

Okay. Clearly, the interplay between the financial policy and the monetary policy is very profound, and indeed essential. If the government wants to run big deficits without driving interest rates extremely high, it has to have a complacent Fed to print the money to buy the government debt. And when you compare Volcker with Powell, an interesting comparison, I wrote something recently that said the interest rates now feel high, but they only feel high because we were at zero.

Tom Wheelwright:

Right.

Alex Pollock:

They’re actually very moderate. These interest rates are average. The average Fed Funds Rate from the 1950s to now is 4.6%, so just slightly above where we are. But they feel high because we had a monetary policy suppressing rates to make the government finance cheaper to facilitate the deficit spending that you talked about. And so, then you build up a lot of financial structures dependent on the continuation of those low rates to succeed.

Tom Wheelwright:

Right.

Alex Pollock:

So you get a real deflation in asset prices when they go back to normal. But the point I’m trying to get to is there is nothing Volckeresque about today’s rates. Today’s rates are still, short-term rates, extremely negative in real terms. So if the inflation is 7% and the short-term rate is 4.5%, that’s a negative 2.5% real interest rate. There’s nothing Volckeresque about that. And what Volcker did was push interest rates up until they were positive, real interest rates.

Tom Wheelwright:

Got it.

Alex Pollock:

And then, you got a really deep and steep and painful recession in ’81, actually, the double dip recession in those days, which was very painful and made him extremely controversial in political terms. But then, after that he got the big rebound and the Reagan boom was on. So in sum, I guess it’s tempting, but you definitely see, as you were suggesting, very big differences between what was going on in the eighties with Volcker and Reagan and what is going now on in the 2020s with Powell and Biden.

Tom Wheelwright:

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Yeah. So Howard, there seemed to be a greater level of coordination between what Reagan was doing and Congress was doing and what Volcker was doing than we’re seeing right now, which seems to be that actually, the Biden administration seems to actually be at odds, completely at odds with what the Federal Reserve is doing. So how do you see that playing out?

Howard Adler:

Well, first of all, I completely agree with you. Remember, we hadn’t seen anything yet. The Biden administration basically proposed the so-called Build Back Better Plan, which would have poured another $3.5 trillion into the economy. And God knows where our inflation would be now had that been done. I think the country owes a lot to Senators Manchin and Sinema for putting-

Tom Wheelwright:

Agreed.

Howard Adler:

… for putting the kibosh on that. And yet, when he can’t get legislative backing, President Biden is doing it administratively.

Alex Pollock:

Yes. This is a key point. They just do it anyway.

Howard Adler:

The bailout, the two things in the news, the bailout of the Central State’s Pension Plan, a multi-employer plan, we write about those a lot in the book, again was another pro-inflationary action that he took by administrative action last week. And the student loan program, an utterly failed lending program, by doing what he tried to do and may, it’s in the courts and maybe the courts will overturn it, but by administrative fiat, by forgiving $10,000 in student loans per person and $20,000 to those with Pell Grants, the Congressional Budget Office costed that at another $400 billion, added to the cost of these emergency moratoria that basically stopped interest accrual on these loans and also stopped interest payments. I think the Wall Street Journal wrote in January, 2022 that the cost of that to that date was another $100 billion, with an ongoing cost of $4-5 billion a month because of the moratoria on interest and interest accruals. And that’s still continuing this day under the… It increasingly looks more like a fig leaf excuse that we’re still going through a Covid crisis.

Tom Wheelwright:

And presumably, most of that money is just being spent into the economy.

Howard Adler:

That’s right. And it’s extremely pro-inflationary. And I completely agree with you. It’s as though the administration… The Fed kind of gets it and they’re trying now, and the administration doesn’t. And I agree with you that they do appear to be working at cross purposes.

Tom Wheelwright:

Interesting. So let’s go to energy, because energy is the most obvious one where they seem to be working at cross purposes. Biden says, on the one hand, “You need to refine more oil. You need to produce more oil.” And on the other hand, he says, “But we’re not going to give you any more leases.” So what’s going to happen there? Is that what we’re going to see for the foreseeable future, at least through 2024?

Howard Adler:

Well, President Biden is in a political bind, because obviously, a large portion of his political support are people who believe that we should never do anything with fossil fuel, even though gas is reasonably clean and we’re certainly energy sufficient. We’re now moving in the wrong direction. But I think he’s really constrained by his base. And whether people understand it or not, they don’t seem to be willing or able to do anything about it. And of course, it works in exactly the wrong direction. It encourages and supports countries like Russia that are certainly not our friends and the folks in the Middle East, who sometimes they’re our friends and sometimes they’re not. But it certainly doesn’t do anything to support the strength of the American economy.

Alex Pollock:

Tom, I’d say the current administration’s energy policy will, if persisted, it will ultimately run up against reality and be a failure. But as Howard says, it’s got deep ideological problems. And the ability of human beings to stick with what they want to believe as opposed to what is true is amazing.

Tom Wheelwright:

Thank you. So let’s talk about, let’s turn to this 10-year cycle here, because I think this is fascinating because we obviously had a crisis in 1979, ’80, ’81. We had another crisis in 1989, ’90, ’91. That was the RTC real estate bubble. Then we had the dot-com bubble in ’99, 2000. Then we had.

Alex Pollock:

Wait a minute. You left out the Russian collapse and the Southeast Asian collapse in the 1990s and the Mexican collapse in 1994.

Tom Wheelwright:

Right. So I’m just looking at the US here. I’m going, “Okay.” My mind’s not big enough to handle those other ones, so I’m going to stick with the US. But then, we had it in 2008, ’09, ’10.

Alex Pollock:

Yeah.

Tom Wheelwright:

But then, we seemed to have… It wasn’t 10 years. So there was a lot of prediction, 2018, 10 years again, we would have this next crisis. And one of my questions is, when you talk about that 10-year cycle, which we’re going to continue to, it seems to me like we’re just going to continue to have them, we’ve had them for 50 years. Why won’t we have them for another 50 years? My question is, when you’re looking at, because part of the goal for an investor is to predict it, right? So if you’re looking at this are going, “Does it tend to be 10 years from the end of the last cycle and then that would be about right, because that would be 2012 to 2022? Or is it just a 10 to 15-year cycle?”

Alex Pollock:

It’s approximately 10 years, about every 10 years. It’s by no means mechanical. And let me say, 2012 was not only the end of the house price collapse here, where the house prices finally bottomed, it was also the European Sovereign Debt Crisis, which was very deep going on at the same time. So that’s 2011, 2012.

Tom Wheelwright:

Got it.

Alex Pollock:

And of course, in the 20-teens we had the two biggest municipal bankruptcies in history, which were a generalized crisis but were very important financial crises. So it’s about 10 years, and it applies to this country but also to the world as I’ve been interjecting into your excellent sum here. It’s interesting, Walter Bagehot, who is the intellectual father of the central bank bailouts in financial crises, “lend freely in the financial crisis.” You put a bunch of other restrictions on lending freely, but the lesson that’s been taken by central banks everywhere in the world is lend freely in the crisis.

Now Howard and I call that central banking to the max, which is chapter 12 of the book. And we look not only at the Fed’s lending to the max, but also five other major central banks. And they all did it together and they all are in it together, which means you really have to think about it as an investor in a global sense, because you are up against a club of central banks who are in very tight with each other and very tightly in communication. And they tend to talk each other into the same thing, and so they do all the same thing together. So you get something interesting, which is one of the most important financial factors in the world are the ideas which are in fashion, because these are fashions. The ideas which are in fashion with the international club of central bankers, you’ve got to think about that as an investor.

I should say on the 10-year cycle is two quick things, that one, Walter Bagehot’s great book, Lombard Street, was published in 1873 and he was talking about a 10-year cycle in 1873, crises in the British financial system in the 1820s, 1830s, 1840s, fifties and sixties, and he’s writing in the 1870s. So there is something odd. Is it just long enough to forget? Is it long enough for the new, riskier structures to feel like they’re okay? Is it long enough for new people who didn’t live through the last one to come in and take a swing for the fences in this one?

I think there are all of these things, but we certainly do observe it. I’m sure you know the book Manias, Panics, and Crashes by Charles Kindleberger, which was published in 1978 where he talks about the 10-year on average. He says, “I’ve looked at four centuries of financial history.”

Tom Wheelwright:

Wow.

Alex Pollock:

“And I see approximately a 10-year cycle.” He wrote that book in 1978. And we had, as you and I were saying, crises in the eighties, the nineties, the 2000s, the 2010s, and now a real big panic in 2020. You definitely have to think about this. The problem is you don’t know the timing and you don’t know where it’s coming from.

If I can just make one more point, the book starts off relating how Howard and I were sitting, I wrote this line in the book, in what we described is Howard’s spacious office in the US Treasury building, trying to see what would happen next in December, 2019. And we went through a whole list of risk factors and so on, but didn’t think any were big enough to cause a crisis and finally said, “Well, in fact, it looks pretty good.” And I said to Howard, “Yes, but when the next crisis comes, we won’t see it coming.”

Tom Wheelwright:

Christine.

Alex Pollock:

And the next crisis was three months away. And nobody saw this coming, because nobody saw this link from virus to politics to close down to financial collapse. Well, there’s a challenge for all of your viewers.

Howard Adler:

Let me make, if I may, let me make two points.

Tom Wheelwright:

Yeah. And let me ask you, if you would address also, why are you going to do this, Howard. Would you address also depth and breadth of crises while you’re talking.

Howard Adler:

In what sense?

Tom Wheelwright:

Well, so you look at the depth and breadth of the 2008 Crisis. It was way broader than the 1999 or even the 1989 crisis.

Howard Adler:

So first let me make the two points I wanted to make. And I was going to mention our meeting in 2019 in December. We knew that by the 10-year rule we were due for a problem, but the economy had never been going better. And looking at it from the point of the investor, you really have to be a pretty gutsy investor to say, “Well, it’s been about 10 years, maybe I should sell in the short-term.” Because you think that you’re going to… Things look great, you don’t see any big problems, and you think you’re going to miss out on this enormous upside, which is a real problem of human psychology.

The other thing, let me just add a note of optimism here, the other point is that we have gone through this boom and bust cycle. And in each of the busts, people lose a lot of money and markets go down but they come back stronger.

Tom Wheelwright:

Right.

Howard Adler:

So if you have the fortitude to stay invested through the crisis, and of course, this is terrible if you happen to be retiring or be in a transition point in your life during the crisis, but if you have the fortitude to stay with the program, historically, you wind up fine and ultimately then participate in the next boom, and each time it gets a little better.

There’s a difference in the types of crises. If you go back to 2007 and 2008, you had a crisis that originated in certain asset sectors of the market, housing and banking assets. And that’s a classic financial crisis. If you have the ability to lend on those assets and keep them funded, you have some confidence that eventually those assets will reflate. And that’s what ultimately happened. The TARP program, which was set up to invest in those assets, ultimately, although not all of the sectors were profitable, but on the whole, the TARP program made a profit.

But you had, in terms of depth and breadth, the scary thing that we faced in the government in 2019 was we’d never really had a shutdown in every sector of the economy. People were out of work. Small businesses were failing. Restaurants were closed. People couldn’t pay their rent. It was very, very different, I think, than earlier crises. The only two health crises that I can, major health crises, the Black Death, there were no shutdowns because there was no economy in medieval Europe. And in the flu of 1918, the economy didn’t shut down. People kept working. And here you really had something that had never happened before. And so, in depth and breadth, the original actions, and as, I think, you mentioned at the beginning, before we started taking it too far, were great actions. The economy got saved. People were saved. Putting in the money, the Bagehot approach in 2019 was absolutely the right move. Things could have been awful.

Alex Pollock:

2020. Yes, good. It worked and then it went on too far.

Howard Adler:

Exactly.

Alex Pollock:

And we got what we call the everything bubble.

Tom Wheelwright:

Right.

Alex Pollock:

And then, the subsequent inflation and now the deflation. I do want to say one thing though that’s really important about this idea of the longer term. That works providing you don’t go broke in the meantime.

Tom Wheelwright:

Right.

Alex Pollock:

And as John Maynard Keynes famously said, “The market can stay irrational longer than you can stay solvent.” And one of the temptations, of course, in the bull market is always to lever up. But levering up will make you, if you’re not careful, so that you don’t survive the bust.

Tom Wheelwright:

Right.

Alex Pollock:

You don’t make it to the other side.

Tom Wheelwright:

So let’s look at what’s coming. All right? So a lot of predictions, headed to a recession. Fed says they can create a soft landing. The stock market is not believing, that we’re going to have a big crash. It’s been pretty soft in the market. The market has not taken huge hits like you might have expected from this. And so, what do you see coming for the next year, two years? How broad will this crisis be and how deep will it be?

Alex Pollock:

Well, that’s asking us for another prediction, and of course-

Tom Wheelwright:

Absolutely. I want your crystal ball, pal.

Alex Pollock:

… the thing that they’re saying.

Tom Wheelwright:

I want your crystal ball.

Alex Pollock:

The thing they’re saying is predicting is hard, especially the future. But I say predicting is easy. It’s just predicting correctly that’s hard. Let me start off with the fact that we still have negative real interest rates, which is not so contractionary. So my own guess is we’re going to have more inflation problems, goods and services inflation, than we think.

And we have the whole advanced world doing this together, which also there’s your breadth point. This is going on all over the world. We do have a real estate complete debacle in China, which will certainly weigh on the international economy. And needless to say, we have a war, and a pretty sizable war. One of the things we discuss in the book is, “What are the most important financial factors in history?” And it’s clear that wars are the biggest financial factor in history, because it’s really expensive to carry out destruction and killing and they always end up printing. So all this leads me to believe the inflation problem may be tougher than you think, and it may take… So you have a choice.

Another thing we stress in the book is nothing is free, whatever you do. It is the fundamental principle of economics, nothing is free. Whatever you do as a cost. Whatever you do has trade-offs. And if you carry out the Walter Bagehot salvation of the market in the crisis, you’ll pay for it later on in terms of inflation. And if you keep it up, you’ll really pay for it.

So with the war on and still negative real interest rates and all central banks in the world in on this game, my own intuition, which is no more than a guess, which is all anybody has is a guess, is the inflationary problem will be tougher than we think and then you’ll get a choice: let the inflation run or have a harder landing than you think.

Howard Adler:

I want to jump in. I agree with Alex, and obviously, all financial finances surrounded by so much uncertainty, a theme of our book. And so, all predictions have to be taken with massive amounts of salt. I, too, think the bond market has underestimated the inflation problem. I think that if the political forces and this administration are to prevail, then we will live with inflation and interest rates will come down. I think that J. Powell is a very, very conscientious person and sees the risk of inflation, and I think he is committed to following the Volcker formula and trying to fix it.

But what I really worry about is every time one of these crises has hit in recent years and the Fed jumps in, we sort of start from a worse point. We have less dry powder for the next crisis, and I worry about what’s going to happen the next time. What happens? We’re a very rich country. We were able to get through the crisis so far by deficit funding. And who bought the debt? The Fed, the central banks stood by and bought about $5.7 trillion of US government debt along with the $2.7 trillion of mortgage securities it bought, which has led to the housing price bubble.

But the Fed’s balance sheet, just in turn, has gone to $8.9 trillion. And before the Crisis of 2007 and 2008 and 2009, it was about $900 billion. After that crisis, Bernanke again bought government debt when he was chairman, and he said it would all be temporary. The Fed’s balance sheet got up to $3.8 trillion and it wasn’t temporary. That was pretty much where the Fed’s balance sheet was when we began this crisis of 2020, and it grew another $5 trillion. And that’s because, as Alex said, you can’t really sell this stuff. If you sold the $2.7 trillion in low interest mortgage debt for a huge loss now, you’d also tank the housing market.

So you can let it run off. It runs off slowly. Nobody’s refi-ing those mortgages now when interest rates are high. It runs off slowly, and is there some point when demand for US government debt will dry up? And how high can the Fed’s balance sheet go before we have hyperinflation? So the point I’m trying to make is that each time we do one of these things, we start off with less dry powder to fight off the economic assaults than we had before.

Tom Wheelwright:

Thank you. Very, very well put, both of you. So let’s wrap up with this. So what do people do? So give us a couple of practical ideas, some practical things. Everybody’s wondering, “Okay. So do I hold onto cash, which has a cost because of inflation? Do I put it into precious metals, which has transaction costs? Do I leave it in the market? Do I put it in the market and just say, ‘Well, if the market goes down, so what? It’ll come back up.'” What’s your solution? What are your suggestions?

Howard Adler:

Well, I’m the world’s worst investor, so I start with that caveat. My personal philosophy now is I’ve got what I’ve got in the stock market. I’m not adding to it right now because I think in the short term it’s going to go down further. But I’m going to stay put and hopefully weather the storm. I think, as I said, the bond market has it wrong, and I think long-term interest rates will be going much higher in the next year.

That’s my own personal view, but it could be wrong. And I’ve no degree or no study of being an investor, but I think that there are going to be opportunities in the bond markets, including even in Treasuries and also in municipal bonds. Of course, I would personally stick to the highest rated municipal bonds, but I think that they’re tax advantages. I think that long-term interest rates will go up and people will have an opportunity to invest at higher interest rates for a period of seven to 10 years that will eventually come down, and towards the end of that period they’ll be very happy with those bond investments. That’s my thought anyway.

Tom Wheelwright:

All right.

Alex Pollock:

I’ll show my classic conservatism in the answer to your question, Tom. Be diversified. I would be light now on equities, but own some of all of the above. Watch your debt. Keep the debt down in times of uncertainty. And I think in addition, a very old lesson as you should, especially as you get older, think of your wealth not only in terms of asset prices but in terms of income in the-

Tom Wheelwright:

Absolutely.

Alex Pollock:

You read old British novels, and you say, “Well, how rich is he?” And they say something like, “Well, he has 2,000 pounds a year.” Well, the present value of 2,000 pounds a year moves up and down all over the place, but the 2,000 pounds is still there. And you should simultaneously, in addition to thinking about the prices of your portfolio, which is the present value of all of those future flows, think about what your future flow of income actually is and how that compares to what you need. And the better it compares to what you need, the more staying power you have to get through this.

Tom Wheelwright:

I think that’s a perfect way to end. It’s all about cash flow. We talk about that a lot. It is about cash flow. Of course, all asset prices eventually come down to cash flow like you said. It’s the present value of the future stream of cash flow, right? So it doesn’t matter if it’s real estate, stocks, energy, it doesn’t matter. It’s always a stream of cash flow. And cash flow is always the king, which is what makes inflation-resistant or recession-resistant businesses so strong, because they’re producing cash flow. So with that, again, the book is Surprised Again! – The COVID Crisis and the New Market Bubble. Alex Pollock and Howard Adler, great, absolutely terrific interview. Thank you so much. Besides the book, any place people can go to get more information?

Alex Pollock:

They can. For me, I do have a website that has all my writing from five or six years. It’s alexjpollock.com, alexjpollock all written together, .com. And that’s one spot if they have an interest in pursuing this.

Tom Wheelwright:

Awesome. Thank you. Howard?

Howard Adler:

Thank you very much.

Tom Wheelwright:

All right.

Alex Pollock:

If you want more of Howard’s ideas, you’ve got to email him.

Tom Wheelwright:

All right.

Howard Adler:

That’s right. I’m a religious reader of the Wall Street Journal and The Financial Times.

Tom Wheelwright:

There you go. There you go. All right.

Alex Pollock:

Thank you so much.

Tom Wheelwright:

Oh, thank you. This has been terrific. We’ll let you go, but just remember, the reason we look at macroeconomic stuff like this and really look at the economy is because it does impact everything you do. It impacts everything you invest in. It impacts your taxes. And the reality is, the better you understand it, the more money you’re going to make and the less tax you’re going to pay. We’ll see y’all next time.

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