Working Capital The Real Estate Podcast

Inflation, Interest Rates and Modern Monetary Theory with Kevin Muir|EP55

May 26, 2021

In This Episode

Long passionate about markets, Kevin grew up in a household where his father was an equity research director. Being exposed to market talk as long as he can remember, Kevin’s true love was always macro. In fact, his first trade was in the US dollar index which promptly went limit-locked against him.   Not deterred, Kevin persevered and got a job on institutional equity desk for a big Canadian bank in the 1990s. Kevin moved into a proprietary group where he was in a charge of the equity derivatives book. Kevin had a ringside seat for the madness of the DotCom bubble, but in 2000, with a new young family, and the desire to no longer work for a bank, Kevin set off on his own. For the next 17 years, Kevin would solely trade his own account with another former co-worker from the bank and a full-time computer programmer student they hired. Since then, Kevin has joined a well-establish prop group. In this episode we talked about:

  • Kevin’s Background 
  • The current state of the economy
  • Central banks in the post covid world
  • Types of inflation
  • Fiscal policy
  • Monetary policy
  • MMT
  • Globalization
  • Real Estate outlook
  • How to deal with inflation in Real Estate
  • The Rental market
  • Working from home


Jesse (0s): Welcome to the working capital real estate podcast. My name is Jesse Fragale. And on this show, we discuss all things real estate with investors and experts in a variety of industries that impact real estate. Whether you’re looking at your first investment or raising your first fund, join me and let’s build that portfolio one square foot at a time. All right, ladies and gentlemen, my special guest today on working capital. The real estate podcast is Kevin Muir. Kevin is a professional trader. He has previously was on an institutional equity desk for a large Canadian bank in the nineties.

Kevin then moved into a proprietary group where he was in charge of the equity derivatives book. Kevin is also the creator of the macro tourist blog. Kevin, how’s it going?

Kevin (45s): Great. It’s good to be with you today, Jesse. Yeah,

Jesse (48s): My pleasure. Thanks for joining. Yeah, I thought it would be great to have you on the show. You had have a really interesting past as it relates to trading and investing. And I thought for our show, even though we’re a real estate centric show, I think the backbone of everything we do is economics. And we want it to get a perspective from a macroeconomic view, especially in today’s landscape. So maybe what you could do here is give us a little bit of a background on kind of how you started your career and where you are today.

Kevin (1m 22s): Sure, no problem. So I was fortunate enough to get a job. I actually worked for a Canada’s largest bank at RBC dominion securities. I got a job in my early twenties. I was going to university and I actually got a job before I’d finished my school. And what had happened was that they were looking for somebody that was good at computers, and that was good at trading. And I was the lucky mix of both. And I was hired on to the institutional equity desk to do computerized trading, which back then was for the burgeoning, newly found indexing.

You know, it was very, very complicated. People didn’t understand it. And it was something the young people did. And I was fortunate enough to get a job there and I worked my way up and it was a fantastic place, very entrepreneurial. And even though I was young, they let me trade and it ended up being very quickly that I was actually in charge of the bank’s balance sheet, meaning that instead of trading on behalf of clients, I traded on behalf of the bank. And I did that for kind of from 94 to not to 2000, 2000, my wife and I are 99, actually my wife and I, we had our first child and she was born with a heart defect and it was luckily corrected at birth.

The wonderful doctors at the hospital for sick kids fixed her up, but it was kind of one of those moments where you have a questioning what’s important in life. And some people have near death experiences and change their lives. And for me, it was my daughter and I’ve kind of decided that the bank has slowly taking over what was before dominion securities and is becoming more bureaucratic. And I decided to go off and try on my own. So me and another guy, we went off and we started our own little firm and we, you know, said to, well, at some point, if I have to get a job, I’ll go get another job.

And one year turned into two, which turned into five, which turned into 10 and it’s almost 20 years, I guess it is 20 years now that I’ve been trading, you know, not for the bank and just for myself and for other people. And along the way, I started writing the macro tourist and the kind of the Genesis of that was that I was, I started off as a diary. They often encourage investors or, you know, traders to write diaries, to kind of flush out their thoughts and to, you know, figure it out, put it onto paper.

And I started doing this and then some buddies would phone up and say, what do you think of the markets or whatever? And I would shoot them off what I wrote in and they kept asking. So I ended up saying, just putting it on the internet. Next thing I know I’d go downtown. And people would say, well, I love reading your stuff and things like that. And I realized there was a business there. So I’ve been writing the macro tourist for, you know, half a dozen years now. And it’s been great and a lot of fun and I really

Jesse (4m 2s): Right on. That’s great. So over those years, I mean, you’ve experienced obviously quite a few different markets through the eighties, nineties, early two thousands. Oh eight. And, and now today, what if you could tell listeners what your, your general investment philosophy or your outlook is?

Kevin (4m 21s): Sure, Jesse, you’re making me older than I really am. I the way I wasn’t trading very much in the eighties, I was in my parents’ basement, listening to new order albums. No, but in the nineties, I, I, you know, that’s when I started and when I have seen a wide variety of, of different markets, I, you know, I experienced a, although I didn’t get the 87 crash, I definitely was in the thick of it with the long-term capital debacle in 98. And, you know, our bank was affected by it. I had lots of positions. I experienced that. Then the two crash was the same deal. I experienced that.

And then the 2008 with the great financial crisis was just unbelievable. I actually, if you told me in 2000 that we would experience something worse than that, I would have told you you’re insane. And yet there was 2008. And then, you know, recently with the 20, 20 COVID crisis, I, you know, that was, although it was shorter, it was probably even more intense than any of those other ones in terms of my thinking and kind of what drives me.

I think that one of the, the kind of unique aspects that I have in terms of how I look at it is that many people look at the past 40 years and I call it the past four decades of monetary dominance. And what do I mean by that? I mean, that ever since Volcker came and broke the back of inflation in 1981, and the way he did that was he came in and he was running the federal reserve and he raised rates. And at that point, nobody thought that inflation could be teamed.

There was, there was all sorts of people that made their living saying that how inflation was going to be forever and it was going to, there’s no way you could stop it. And there’s a, you know, a famous fellow by the name of Kaufman at Solomon brothers. And he was known as Dr. Doom. And then, you know, everyone thought that inflation was just something that we’re going to have to live with. And then basically Volcker came and he broke the back of inflation and ever since then, and the way he did it, by the way, is he wrote raised rates way higher than we ever imagined. Like rates were almost 20%. I think there was a long bond that was 15 or 16%.

And ever since then, all of our kind of fine tuning of the economy has been basically based upon monetary stimulus or, you know, or, or tightening. So what happens is the economy, you need to get it going, you lower rates. And when you lower rates basically encourages people to borrow it, encourages companies to spend, and the economy gets going the trouble is that we we’ve gone the last four decades focusing almost solely on the monetary side of things.

And what that’s done is that every time that we’ve gotten into some trouble, we’ve had to lower rates to a lower amount, like, you know, it used to be you lower it to five and that would encourage new people to buy it. Then the next time there was a recession you needed to lower to three. And then in 2000 they lowered it to one. And then the trouble was in 2008 during the great financial crisis, we hit the point of zero. We lowered to zero and yet we couldn’t change the consumer or the private, the corporation’s behavior.

And then we went down this whole road of kind of extraordinary monetary measures to try to get the economy going. Now there’s a whole reason why those don’t work. We can talk about that. But I think the important thing for, for listeners to understand is that as we realize that those didn’t work and as there was some other kind of schools of economic thought that came into being, and you know, one of the most common one that people are hearing about now is something called monetary modern monetary money.

And what these people realized was that there was a whole other side of the kind of economy that we were missing. And that’s the fiscal side. And the fiscal side means instead of going and trying to stimulate the economy by, you know, lowering rates and changing, you know, consumer or private comp corporations behaviors, we’re going to run the government’s going to run a deficit and it’s actually going to spend into it. And so what we see with the COVID crisis is that for the first time, we didn’t try to fix things with monetary policy.

We tried to fix it with fiscal. If you look, there was no training, there was no talk of putting rates to negative. We didn’t do like what they did in, in, in Europe. Yes, of course we did do a lot of what’s called quantitative easing, where they, you know, bought bonds to try to push it into the system. But the main mechanism upon which the governments actually try to offset that this recession was through fiscal means. And if you remember back it’s, it’s, it’s hard. It’s hard to remember back. Cause it seems like so long ago, but in March of 2020, more than a year ago, everyone was so bearish people thought that the economy was going to crash.

They thought there was no way you’re going to fix this. They thought this was just the end of the world. And I was telling people, I said, listen, you have to be understand that if the government steps in and fills the hole with demand, you’re going to be shocked at what can be done. And since then the government has come in and fill that hole and S in, in, in a huge way, like way more than I would’ve ever imagined. And the big surprise has been how great the economy and the market is being.

Now, a lot of people will say, this will end badly that this is going to cause inflation. And I’m a hundred percent in the camp that this will cause inflation. If the government continues, the whole point of this is for the government to take up enough slack to create inflation. But the thing is that everyone assumes that we are going back to the old kind of, as soon as COVID is over. And as soon as this thing’s over, we’re going to go back to the old guard. You know, the old way of doing things, trying to fix everything with monetary means.

And I contend that the COVID was a switch, and it was a switch in terms of how people think about the economy, how, you know, we were going to F you know, deal with things. And what’s going to happen is that in the past, we had basically four decades of disinflation, meaning lower and lower inflation. I think that we’re going to have the exact opposite we’re going to have for decades. Well, maybe not for decades, but we’re going to have many years, probably decades of inflation going up, which is going to mean a lot of changes to people’s investment portfolios and how they deal with things.

If you think about how, you know, most investors have set up their portfolios right now, you know, the typical strategy of 60% equities, 40% bonds is going to get crushed, because the reality is that as inflation comes up, whereas those bonds used to be a balanced for your portfolio. They could actually become a, you know, an anchor as opposed to a ballast and going back to like, you know, there’s a real estate show. When I think about what you need to own, you need to own real assets and in an inflation environment.

So to me, yes, I understand that the cap rates are extremely low and it’s scary in terms of real estate, but at the end of the day, they’re still real assets. And so to me, a lot of different parts of real estate are very attractive.

Jesse (11m 42s): Yeah, that’s interesting. So there’s, there’s a lot to unpack there. So why don’t we first, from a definition standpoint, monetary monetary policy, we’re talking about the central banks basically changing the interest rates, setting interest rates, and guiding the economy from a macro perspective, using those tools, as opposed to fiscal policy, we’re talking about governments asked actually using policies, whether it’s spending taxing and the like, and what, what you’re saying, you know, if I hear you correctly, as we started getting really much more heavy into that, as a result of COVID something we haven’t, haven’t done for a long time.

And I think you, you somewhat alluded to liquidity trap that we were, that we were kind of in, at a certain point where we were putting rates lower and lower and lower. And at a certain point, you can’t go any farther. You can’t, you can’t have that mechanism work any further. I wanna, I want to just pause there and talk a little bit about what you just said. Cause I remember in March where we were started getting into this and there was talk again, just, just like back in a way to nine about quantitative easing and basically, you know, the government using that as a method to lower rates and increase and create stimulus.

And a lot of people talk about that and there, you know, if you remember it, oh eight oh nine, all the articles that came out about how this is going to cause hyperinflation, you know, and then, and then all the subsequent articles that went, why didn’t it cause inflation? So maybe for listeners, you can kind of just talk a little bit about what quantitative easing, what the, what the purpose of it was and then how, in your opinion, I guess how we perhaps didn’t rely on that this time around.

Kevin (13m 28s): Okay. Sure. Well, we still did it, so it’s not like we didn’t rely on it, but we did it on top of something else. And so Jesse, you nailed it in 2008, they went and Ben Bernakie was in charge of the federal reserve and he went and did the first quantitative easing and quantitative easing for those who aren’t aware, it’s basically easing by buying a certain quantity of bonds. So the federal reserve goes out into the marketplace and they buy, you know, let’s say 50 billion a month of bonds of this duration.

And the idea behind that is that they’re buying bonds and putting liquidity out in of the system and that liquidity, then we’ll go in the economy, we’ll use it and we’ll create kind of economic prosperity and it’ll create inflation. So that was the, the idea. And so they started off with quantity easing program, number one, and then it, they tried, it seemed to be settled down the market and then it, they pulled off. And next thing they know the economy went into tail dive again a little bit.

And so they did quantitative easing number two, and then they tried something called operation twist, which was when they sold the front end of the curve and bought the long end it’s technical doesn’t really matter. And then he did quantitative easing number three. So along this way, he’s doing all these different extraordinary. And at one point a bunch of really smart economist, Margaret money managers, just market pundits, took out a full page ad in the wall street journal.

And it was an open letter to Ben. Bernakie telling them how these policies were terrible. They were going to call this hyperinflation is going to be the end of the dollar and Bernacchi just kind of kept doing it. And so now the question is, why didn’t it cause inflation, I would contend it did cause inflation. It caused acid inflation, financial asset inflation, but why didn’t it cause regular inflation? So let’s go through here and think about what happens when the government goes and buys bonds.

So let’s just actually, one of the things that I always like to do is whenever I’m having trouble understanding something, I actually just kind of follow the money that old line about going through it. So let’s imagine that the federal reserve is going to go buy a hundred billion dollars of, you know, let’s say 2030s, like the, the bonds that expired 2030 from, from JP Morgan. So they go up, they get up in the morning and they go and they ask for an offering. JP Morgan gives them an offering for the a hundred billion and they sell them the boss.

So now all of a sudden the federal reserve owns these a hundred billion dollars. And JP Morgan has a hundred billion dollars cash on the balance sheet. The thinking used to be that that a hundred billion dollars would go then get lent out and there would be a multiplier effect. And what would happen is the economy that would create economic activity we go through. But if you stop and actually think about JP Morgan, JP Morgan is a huge organization. They aren’t choosing to make loans based upon how much cash is on their balance sheet or how many reserves, because when they, when they buy, technically when the federal reserve buys bonds from JP Morgan, they settle, it’s called a reserve that they, they settle with.

It’s basically cash. But so in the old days, banks used to be what’s called reserve constraint, meaning that they only had so many reserves to lend out so that when the banks, when the federal reserve would go and put reserves into the system, they would instantly be lent out nowadays, no bank is reserved, constrained what they are is balance sheet constrained. And if you think about it, make sense like JP Morgan, they don’t care how much actual cash is on their balance sheet. They’re not lending based upon whether, you know, Ben Bernakie or Janet Yellen or Jay Powell bought bonds that day they’re lending based upon, is there a good borrower that wants to borrow?

And then what does JP Morgan’s BA balance sheet look like themselves? What is their equity and what is their, you know, the, the amount of debt they have and what is, how many loans do they have against that? It’s not against the reserves in the system. So this is kind of a, it’s called endogenous versus exogenous money. And it has to do with whether the loans are created because of demand or supply. And one of the things is that everyone else used the, like the big issue was that in the past, they thought that if you went and put those, those reserves into the system, that the banks would lend them out.

And what we found in 2008 was the banks did not lend them out. And another way to think about it is let’s just stop and think about interest rates. Okay. And I have a big beef about putting interest rates negative. I think it’s the dumbest thing in the world. I think that central banks, that will be the biggest central banking mistake of the past 30 or 40 years is when the Europeans went and put rates negative. Let’s just stop and think about, you know, like your European corporation, let’s imagine you’re Nestle and you’re thinking about making another chocolate factory.

Okay. So when the ECB goes and takes rates from 25 basis points and puts it to minus 50 basis points, theoretically, that means you can now borrow at a negative rate. So everyone thinks, well, holy smokes, I can borrow it. A negative rate. This is great. I can get paid to spend money. Okay. And everyone thinks this is going to be terrific. And everyone’s going to go out and take all of these loans. But if you stop and think about Nestle, when they’re thinking about doing CapEx expansion, you know, building a factory, yes, there is no doubt that part of the equation involves the cost of funds, but what’s a whole lot more important is whether there’s someone there to buy your chocolates that you make.

So the reality is that when you go and lower rates to negative, it doesn’t mean the corporations are actually more likely to go out and do CapEx. And there’s Goldman Sachs did a study and they actually found that in the eighties and nineties, when they lowered interest rates, there was a positive, you know, effect with cap ex spending. But in the two thousands, in the 2000 and tens, when they lowered rates, it actually had the opposite effect. There was less cap ex spending.

It B basically monetary policy was neutered. It didn’t work. Now you might say, why is this? And it’s because the actual real economy was getting starved of dollars. And you know, this kind of comes back now to the fiscal part of the equation. There’s two ways that money can be created in an economy. One is when a bank goes out and lens, let’s say, Jesse, you go take a loan out and you go, and you take a loan out to buy a building. Okay. The bank doesn’t really have the money that you’re, you know, like they have reserves or they have, they have equity in their, you know, their stock.

And they have, you know, capital that they’re lending out, but they don’t actually have money. They create that money for you. Okay. And for, and this is when I talk about the last four decades of monetary dominance, we focused on that private sector, money creation as the only way to grow the economy. Okay. Now that’s one way. And what we’d forgotten though, was there was another way. And that’s for the doll, the government to simply spend the money into existence.

And I know this gets really, there’s lots of people that have been taught. You know, the government is like, w you know, we’re, we’re spending our children’s grand, you know, inheritance, we’re going to burden them with all these things. And it ends up being a very difficult thing to, to kind of on program. But at the end of the day, the government is a currency issuer and is not a, it’s not a currency user. And really when you get into a situation, like for example, the COVID the only people that were able to kind of create and put money into the system was the governments.

And in the past in 2008, the problem was that we went through a private sector, credit, creative destruction, meaning that we had too much real estate loans out there. And it started imploding on itself. And what happened was everyone got so freaked out about debt. They all started saying that the governments have to balance their balance sheets. And so people don’t realize this, but if you go look at the last kind of 30 or 40 years of the U S discretionary budget, and look at the changes up until 2008, there was only three years when that discretionary budget fell.

It was 64, 68. So that was kind of 64. I think it was Kennedy 68 was Johnson. Both of those times, I think it was the war. And then it was 2096 for Clinton. But apart from those three years, every other year, the government put more money out into the system, meaning they spent more, well guess what, 2008 comes along, we get this huge private sector credit, create a destruction. And then what is the us government do on, on the, the deficit side, they actually go through five years of them actually, discretionary, you know, you have to understand it’s discretionary, but the other parts are harder to control, but they actually cut.

And this is the thing that people need to realize is that when we compare 2008 to 2020 in 2008, if you remember Ben Bernakie was begging the federal government to, to help them with fiscal, they were saying, please, please help us with fiscal. Well, 2020, they knew that problem. They understood it. And so they acted together in, in, in they, they work together, meaning that the, they understood that going out and just trying to do monetary stimulus was not going to work.

You needed to do actual fiscal stimulus, meaning the government had to give people money, had to kind of push money into the system. And that’s why basically the economy has done much better than, than otherwise would have been expected.

Jesse (23m 59s): Right on. So just to, just to recap on that, then the, so we, we do quantitative easing, we, you know, we’re by central bank purchasing government debt, and then we, in theory, interest rates decline, and then two points you made that just because the bank is on the balance sheet of the bank doesn’t mean that they’re going to let them out. And conversely, just because interest rates are low, doesn’t mean that businesses are going to go build that factory, build that, you know, whatever, what I’m curious about is you also said something that was interesting in the, in the fact that there wasn’t inflation of the ordinary type, but there was inflation from an investment standpoint.

And from the real estate perspective, it’s interesting to me because we don’t necessarily, unless you’re in development, we don’t necessarily build the factories when we are going out to buy assets. We’re basically when we do have interest rates come down, just like today, you start seeing more activity, cap rates, compressing, but then we do have kind of a business wedged in there that, you know, we’re also sensitive to where rental rates are going and what the drivers of that. So could you talk a little bit about that, about that piece of how it, it wasn’t inflation necessarily in the ordinary sense?

I think you’re kind of implying that there was different inflation at that time.

Kevin (25m 14s): Well, if you, if you think about what the government was doing, they were running, what’s known as loose monetary policy and tight fiscal policy, meaning that they were like lowering rates, low rates were lower and they were buying assets. So they were competing with the actual private sector to buy assets. And, and at the same time they, they weren’t spending so on the other side, so there was very little inflation. So you don’t create actual inflation.

There’s very little economic, you know, activity created from all that. And so what does that do? Well, you’re sitting there as an investor and there’s, there’s less, the interest rates are going down. There’s less assets to buy, you know, and it just ends up being that the government is causing a w let’s just say, competition, you know, to buy financial assets, like even just think about the idea that as rates go down, you need to go as an investor.

You need to save more because the reality is that you’re earning less of a yield, right? So I always say, this is the most, you know, insane part about the ECB lowering rates to negative. And I like using that example because it just goes to show when you take things to an extreme, it’s more obvious. But if you’re thinking about, if you’re an Italian investor or like, you know, Italian saver and you’re saving to put your kid through, let’s say you’re saving to put them into, through college.

Well, the ECB takes the rates and they lower them from 1% to minus 50%. And my find minus 50 basis points. Well, does that mean that you are going to go out and spend more? No, actually it means that you have to save more because you’re earning less, you still have your, you still have your obligation. You’re trying to put your kid through school and this is the whole part that people miss. And so if we have a situation where people are spending less, because they’re saving more and then not only that, the government’s not putting enough money into the system.

So the whole economy is doing, you know, is not doing as well. It becomes a negative self-fulfilling, you know, loop downward. And then the meantime rates just keep going lower and lower. The end of the day, you know, real estate has been driven by, by rates. And it’s really not that different though. Even if you think about tech stocks, like let’s just take people, wonder why does Google trade at this rate? Or why does Microsoft, or all the, you know, the top seven stocks in the S and P are all big tech stocks and they all treated these crazy kind of, you know, multiples and, you know, people are attracted to it.

It’s because there’s limited growth and interest rates are so low and of interest rates are so low. If you think about a growth stock growth stock, it’s the longest duration asset, meaning that all the, the actual, you know, money they’re going to earn is in the future. So it’s as opposed to somebody that’s paying a dividend, things like that. So you discounted at the rate, that’s this new lower rate. So it makes sense. And investors have been chasing the few growth stocks that there is, or there are, and that they’ve been paying at a higher and higher price for it.

So to some extent, you know, that’s probably what we’ve also experienced in real estate is that the reality is that there’s, you know, lower and lower interest rates. And so investors are chasing good, probably buildings that they can feel confident of owning, and they’re, they’re taking them to more and more ridiculous prices.

Jesse (28m 48s): Yeah. And I think the other component, I don’t think it’s talked about a lot when we hear cap rate, we just assume, you know, net operating income divided by the purchase price. But I think there’s a lot of dynamic models that talk about cap rate the anatomy of the cap rate as incorporating the expectation, the rental growth expectation. So if you think about it as, you know, really get technical, the risk-free rate of return, plus some sort of premium real estate premium, you know, liquidity premium, whatever you want to call it, then you would have to, after that subtract the rental growth.

So I’m curious from that perspective, when, when we talk about the outlook, so w w now we’re, we’re in this environment today where we’ve now used more fiscal policy than, than you’re contending. We ha we’ve had before. Where does that leave us now with the outlook, from an inflationary point of view where, you know, the dangerous part, I think a lot of the pundits, or, you know, academics, whoever that are talk about this in a negative way, whether it’s modern, modern monetary theory is the fact that they think that once people realize you can spend like this, where does it end do policy makers say, oh, well, we gotta buy this.

We gotta do this. We, so how does that, how does that look over the next year and beyond?

Kevin (30m 1s): So let me just quickly tell you my journey with MMT about three or four years ago. I started hearing about it and I, and I was by no means early, because I think the, the really kind of the true diehards got into it in the early two thousands, but three or four years ago, I started hearing a lot. And I figured I better know what it is. So I reached out to a buddy that runs a podcast. It’s a bespoke investments, and he’s a fellow Canadian. He said, do you want to be on my show? And I said, sure, I’ll come on your show. And he says, what do you want to talk about?

And I said, listen, you are nice enough to help me out, you know, explain to me what MMT is, why don’t we have a chat about it? And he said, sure. So the reality is that he knew way more about it than me. So I almost like the tables were turned and I almost quizzed him about it, but he kind of reached out the next week. And he says, Kevin, you know, your show, your episode is the third best show after Jim O’Shaughnessy and Jeff Gunlock. And these are big time, like, you know, money managers. And I was thinking, geez, like, they’re not coming for me. They’re coming for MMT.

They want to understand MMT. And I realized that there was a lot of people who had kind of were curious about it and they were interested about it and they, they didn’t understand it. And I was the same way. I kind of jumped into it. And when you first hear it, it sounds insane. Like it literally just, you go and you listen and you go, that can’t be right. And you just kind of think about things and you just sit there. And I, I, I’m an economics major. And if you had told me five years ago that I would be listening to any economics, ma professor lecture, you know, for more than 20 minutes, I would have told you you’re insane.

Because to me, economics is like the dismal science that it never works in terms of trading. It doesn’t explain anything. They all have these terrible theories and stuff like that. And I’ve, I’ve been disappointed by economics for a long time. And MMT comes along and they start explaining things. And it sounds so crazy and stuff like that. But then the more I listened to it that like, they go through things. And like, my explanation about how quantitative easing works is, is directly from MMT.

And this is the point that I just kind of, if anyone’s interested in, I would just want to kind of stress this point. M T is a way of describing how the economy works in real, in the real world. And the PR the reason we need MMT is that all of our economics books were, were based upon the old gold standard. They were all based upon, you know, when we used to be tied to gold and all those rules. And then what happened was Nixon went off the gold standard in 71 or whatever it, and we never changed any of our thinking.

And so we’re stuck in these thoughts that are, you know, that are based upon economics, that don’t really work. So M and T comes along and they start to say, listen, this isn’t how it actually works in the real world. And they start to go through, like, what’s known as the plumbing and, and for me as a trader, that’s what really interests me because I’m, I don’t really care about what should be done. Like when I, when I’m writing my letter, I always say, don’t focus too much on what should be done, focus on what will be done.

And I find too many pundits sit around and they want to argue about the best way to set all this up. And they want to argue if this is going to cause hyperinflation and all this stuff like that. And I’m just like, don’t worry about that. Figure out what will be done, what the odds are going to be done and what that means for your portfolio. And that’s basically where I come from now, back to MMT. MMT is a way of kind of describing how the system works in a modern monetary basis under a fee based system.

A lot of the decisions that people associate with MMT are not actually MMT what they are, are based upon your understanding about how this works. I choose from a political point of view to do this. One of the things Jesse is that if you look at human beings through a time, we always seem to take things to extremes. And I would contend that if you look at monetary policy and you look at what’s happened in Europe with negative rates there, this taken to an extreme.

And when I go and I look at this change from monetary dominance to fiscal dominance, and I see people saying, you know, we’re going to have hyperinflation. I might push back and say, no, we’re not going to have any fiber inflation, but does that mean that we’re not going to go and do probably too much fiscal for sure we’re going to do too much fiscal, first of all, it’s going to be really effective at first. There are going to be no doubt about it because there’s going to be a low hanging fruit because of the reality that we probably been under starving, the economy of fiscal that we need.

So at first it’s going to be great. It’s going to work really great. And then unfortunately, we’re going to do too much of it. And when I think about kind of what that means to your portfolio, it has profound ramifications. First of all, you’re going to have to realize that in the past bonds ended up being, you know, this balance for your portfolio. They could very well become the opposite. If we go into a period of inflation and you need to think about things dramatically different, we’ve had basically four years of interest rates going lower and lower and lower and lower.

And, you know, bonds have never really heard anybody in their portfolios. It’s always been something that’s, that’s been a positive. And, you know, as we talked about, we’ve had people like doing risk parity. We’ve had Ray Dalio and Bridgewater’s of the world, and all those things ended up being just absolutely fantastic trades, but the trouble is like all trades. They eventually go away and there’s going to be a new era. So we go from an era of kind of monetary dominance to fiscal dominance. We’re going to see a dramatic change.

We’re going to see different things that you should own your portfolio. We’re going to see different behaviors and things that worked in the past four decades. Aren’t going to work going forward.

Jesse (35m 60s): Yeah, that makes a lot of sense. And it kind of reminds me of econ one oh one and your, your first class in economics, where they talk about positive economics and normative economics, one where it’s an explanation of the world around us. And the other one maybe is more geared towards the end of the policy implication that you want. And that’s how I kind of think of how MMT could potentially be used or hijacked or any economic outlook for that matter. And w you know, in terms of actually encouraging listeners that want a background in modern monetary theory, Warren Mosler is one of, you know, the, the originators, I suppose, you’d call him.

You could, you probably know more on that than I would, but another one was, and we talked about this before, there was a debate on the Thomas Woods show, and you can YouTube that, and it basically, it was nice to hear from two Austrian economists and one Austrian changed. Mm. Change to MMT talking about that. It’s not a right left thing. It is something that it’s, it’s used as a tool. And it’s, I think that’s kind of what you were alluding to, for sure.

Kevin (37m 2s): See, you’re a man of many talents, law degree, MMT scholar, knowing all these things I’m awfully impressed, real estate, you know, fishing ADOT yes. I completely agree. Too many people look at him empty. And they think that it means just big deficits and spending, and they confuse it with that. MMT is, is a prescriptive kind of way of describing how the economy works. And one of the things that a lot of people don’t realize is that when we had a situation in the, before, when the economy was backed by gold, we had, we wrote all of our textbooks based upon those, that kind of relationship.

And then in 1971, or whenever that was Nixon went off, the gold standard changed. It changed the whole way that the system works. We went to a fee based system, but we didn’t change any of the rules in terms of like how the economy works. And so we’re stuck with these policies and that are based upon really economic relationships that don’t really exist. And this is one of the reasons that I was so attracted to him empty is that they work really hard at understanding the plumbing and understanding how the system works and going through those quantitative easings and understanding how, when you follow the money, this is what’s actually occurring for the economy.

And one of the things that you just need to be aware of when you’re going down this MMT rule road, or are starting to learn about it, is that a lot of the conclusions that people are taking from that are based upon their understanding of how it works, meaning that they understand that the government is not is, is not or lists let’s, shouldn’t say all governments, most governments that issue in their own currency and have an open account, you know, capital count and a few other kind of stipulations. Most governments are not financially constrained, meaning that they don’t have this.

We don’t have a hit a point where we’re going to go bankrupt. And one of the, one of the books that I think was the most destructive in terms of our actual economy was the sub book. This time is different by Carmen Rogoff and Reinhart and Rogoff. And what this book did is it talked about the situation where at a hundred percent Def debt to GDP, many countries go through a financial crisis. And when we went to 2008, and we went through this private sector, credit create a destruction.

A lot of them looked at the ballooning deficits that were occurring on the government level. And they looked at this book that was, you know, forecasting, this doom and gloom. If we hit this 100% level, and we therefore went through policies that were the exact opposite policies of what we needed, the government we know was experiencing, or the economy was experiencing a private sector, credit Creek destruction, meaning nobody wanted to spend. And what did the government do? The government went and tried to, you know, also cut.

So they were cutting into, you know, private sector, credit destruction. They were also cutting in terms of their spending. And that is why the monetary policy needed to be so extreme. That is why we had those three, you know, different programs of quantitative easing and then the fourth. But the twist was because the, you know, it was all the heavy lifting with left to the monetary policies. And then to top it all off the monetary policy didn’t work. So I really, I really believe that what came out of that was the realization that that book was crap.

And then it didn’t really work. And that the, that the rules in terms of how, what we work at the zero bound, meaning that as we approach zero, all of the rules of terms of monetary policies cuts thrown out the window, they just, everything stops working. Like I joke about it and say, zero is like when they cross the streams and goes busters, like it’s just strange things happen. And, you know, the ECB has gone and cross the streams and entered into another, another number of rules and it doesn’t work. And monetary policy becomes not only ineffective.

I think it actually becomes counter effective as you go through the zero bound. And one of the things that I think is so important to come out of this COVID is this realization that the, at the zero bound, the governments need to coordinate together with monetary and fiscal policy and do both, and that’s much more effective. Now having said that, you know, it is more effective and therefore we are going to have, we’ve gone through years and years and years of disinflation, and that’s going to change.

And there’s other things also kind of working against disinflation, meaning working for inflation. We’ve had globalization for the past 30 years, 20 years, basically we had two big kind of supply labor shocks. The first was the falling of the Berlin wall, you know, the, the, the, the fall of the iron curtain. And that was, you know, east Germany and all the Russian, all these people coming into the labor force. And that, that was one labor shock. And then the even bigger labor shock was China entering the WTO.

And so they, all of a sudden we were competing against Chinese workers. And if you think about it, corporations, when you would go ask for a raise, or when workers would go ask for a raise, they say, listen, you’re lucky to have a job. Cause we’re trying, we’re about to, you know, sure. All this to China. So we’ve experienced kind of 20, 30 years of globalization and meaning that, that was another factor pushing down interest rates, pushing down inflation. Well, I would contend that the end of globalization is probably here. It started with Trump when he started putting on tariffs, but it doesn’t look like it’s ending in terms of, you know, Biden’s taking the same policies, you know, other G seven nations are doing this.

And not only that China has gone up the, the kind of the value add curve. There’s not as many, you know, new workers, they’re getting older, there’s not the same sort of labor, you know, kind of pushing down huge supply anymore. So if we have that, that’s another factor that is incorrect leasing, kind of the inflation that we’re about to experience kind of going forward. So we think about this. We have, you know, the government finally figuring out that we have fiscal and that, that fiscal will actually create inflation.

We have this labor change. I mean, this kind of globalization let’s call it de-globalization occurring. That’s going to basically push on that. And then also, you know, we haven’t touched on this yet, Jesse, but go look at Biden’s policies, go look at them now. And at times he says union, he says union all the time. And there is a realization that mainstream has lost versus wall street over the past few decades.

And that is about to change. And so if you go look at a chart of, if you plot Leber’s percentage of the GDP, and then you plot the capital profits, a percentage of GDP, well, you’ll find it that the labors has been doing this and the, the, the profits has been going the other way. And so that’s part of the reason that, you know, stocks had done so well and people have been hurting so bad, but you know, our job job is not to decide what should be done.

Our job is to look at what’s being done and adjust our portfolios. And one of the things that I think that’s going to come out of that is that we’re going to get more inflation. So you need to be careful about it. And you need to understand that the, the bonds, that used to be a great investment because of all these factors, all of a sudden, instead of those being tailwinds that are back, those are huge headwinds that we’re facing.

Jesse (44m 52s): Yeah. It’s, it’s interesting that you bring up the globalization point. I was listening to Richard Duncan. I think he’s a macro watch where he was talking about the, the past, you know, the past rules that we used for this stuff was very different. And prior to Bretton woods, like we’re talking about the gold standard, you know, we didn’t have us being Canada or the U S we didn’t really have much of a trade deficit at all. Usually you had to balance the books, right? When you, when you, you know, whatever did any trades with other countries, because you have to physically move gold.

And if you didn’t have gold, you couldn’t pay for it. So I think what he was basically saying is similar to your point, that globalization kind of turned that on its head, that once we got into a fi currency and, you know, taking us where we are today now on the more selfish end and for listeners that are real estate investors, what, what can this tell us? Or how can this guide us over the next few years as we invest in, are there any, you know, Easter eggs that we can use out of this to, to plan for our investments,

Kevin (45m 56s): For sure. Well, if I am correct, and we are about to experience this kind of secular change in inflation and interest rates, then you need to work hard on figuring out income kind of replacements for your portfolio. So, whereas a portfolio in the past, let’s just say that you were, you know, 60% equities, 30% bonds and 10% real estate, you might want to go and take that 30% bonds and make it 40% real estate because real estate has the kind of a unique feature in that.

Yes, it is, you know, sensitive to rates. There is no doubt about that, that it is influenced, you know, in cap rates are coming down with interest rates, but at the same, you know, by the same token, it’s still a real asset. It’s not going to be, you know, diluted away with inflation. It’s going to keep up. It’s a real asset that will, you know, go up with inflation. And one of my worries is that if we get a situation where we have, let’s just say a decade of 5% inflation, and that’s probably what I think will likely happen.

You know, we might have a couple of years with seven, we might have some threes, but let’s just say that over the next decade at average is five. Well, you know, if you own bonds and like you go buy, you know, Canadian long bond and you get 2% or something like that, you go figure out what’s going to happen to your purchasing power of that money. You’re going to get destroyed. Your it’s going to be terrible. But if you own a real estate that, you know, yes, the cap rates going to go up with interest rates, but having said that the, the actual inflation and, and it’ll it’ll help you, it’ll save you.

So I think that it’s important to go look at real assets and to figure out different ways to own things that will be protected in an inflationary environment. And I think real estate is an very important part of that, you know, portfolio, you

Jesse (47m 52s): Know, one of the fascinating ways I I’ve heard it described, I can’t remember where I was reading it, but basically they were saying how real estate investors. We don’t often think of renters as customers, but we’re in an industry. Very few industries are able to pass on their inflation to customers. And that is exactly what we do with rent, where we do have the ability to pass on. You know, like you said, those high cap rates, higher cap rates, you know, the valuations are going down, but also your rent in theory should be going up. And the nice thing about that, you know, take that one point that we pass on inflation to the customers and then number two, the other hypothesis being, and I think it’s, it’s empirical that rent is a very sticky thing in, in real estate.

And, and once we hit a threshold of rent, it’s really rare that that that comes down. So, you know, let’s use Toronto as an example, probably a bad one because we’re, we’ve been a hockey stick for so long, but even a mid-market town or starting mid-market city, if you have inflation, and then you hit a certain average rent per you know, for that particular city that usually stays there. Once you actually have a situation where you have inflation, you start, you have cap rates, decompressing, and valuations

Kevin (49m 1s): Going up. Right. I would say that probably the COVID, you know, it’s the first time ever that we’ve seen declines. And even then I think they would, did we have any real declines in Toronto liquids? And it bid it all, like, just as quickly it was, as it was declined, it’s been right back up. Well,

Jesse (49m 19s): It’s definitely sector specific. I know the, you know, the condo sector is one that definitely felt a little bit more downward pressure <inaudible> similar, but not really that much. And then, I mean, w commercial proper is a whole different story, retail office, you know, I think that’s just one of those things where we kind of shut the lights off and, you know, we need to kick that, kickstart that again, once this whole vaccine situation gets sorted out, but yeah, to your point, generally speaking, if you really think about how little or at least on the, the groups I mentioned first, how little impact there was, it just goes to show you how strong the actual rental market is in terms of kind of sustaining things.

Kevin (50m 4s): Well, Jesse, I’m going to wander into your square, a little hearing and probably make a fool of myself. But I know a lot of people are selling their Toronto property to go move out into the suburbs. And a lot of people are proclaiming the end of the big city and you see the same in New York city and all these places. I’m going to call BS on that. I think that you’re going to find that once we get on the other side of this, that the, the big cities are back. Like they’ve never been back before. And I know people are gonna tell me, but it’s different this time you can now go and you can work from home and all this things like that.

Well, if you look through thousands and thousands of years, like when the Romans, you know, they weren’t living out like when the, when the, you know, thousands of years ago, and when Rome was thriving metropolis and everything, nobody wanted to live out in the country. They all wanted to go into the big city. And this is as old as time. And yes, big cities, they ebb and flow, but I think we’re going to be shocked at once the vaccine, we get through it all, and everyone gets all fixed up at how quickly the big cities bounce back.

And the other thing is, I think that there’s all this talk about how office space, we don’t need it anymore, and how everyone’s going to work from home. I I’m a seller of that as well. I think that you’re going to find that, yes, it works. Okay. Working from home for little stints, but let’s face it. You know, if you’re a young person and I don’t like, I’m a trader, so I, I’m not gonna, obviously my job is different, but you can’t teach a young person how to trade over their shoulder on a zoom call.

Like it’s not going to happen. And you already see like the Goldman Sachs and the Morgan Stanley’s, they’re already telling all their staff everyone’s back in our office, come, you know, June or July. I think in Canada, we’re going to be a little slower. But, you know, I think that we’re going to find that sometime, you know, either late this year or early next year, that everything’s back. And a lot of these things that people thought in terms of the commercial real estate, that was that there’s going to be permanently impaired.

I’m taking the other side of that. And in fact, one of the issues about it is that, you know, we’d been putting people into smaller and smaller office, you know, cramming them in making the more dense question is, is that really safe? And are we going to find that there’s a pushback on that? And we actually need more space. And then if you combine it with the fact that corporations are going to do better, because let’s face it, the government spending more, the economy’s going better. Anyways. That’s just kind of my 2 cents on that. Yeah.

Jesse (52m 38s): Well, first of all, like that has been the, the talk in our industry, especially in the office side and like the conventional wisdom is that, you know, people thought we’d need less space and then there’s other proponents and we’ll meet need more. And now, you know, people are saying, maybe we won’t need, you know, we won’t change will be status quo. And you know, we’ll see how that goes. I do have to say, just reminded me. The reason I was smiling was it’s all coming back to me by Celine Dion was the song in a new Wrigley gum ad, or everybody’s coming out of COVID, I’ll send it to you. I, if anybody Google that, it’s so funny.

But yeah, I feel like to your point people are just going to be so happy to get out. And hopefully that kind of, you know, spurs that spurs activity. Listen, Kevin, this has been great. I don’t want to take up too much of your time. I just fantastic to have you on so much to about and think about for listeners that want to kind of hear about your blog or reach out what’s the best way to kind of contact you or find you

Kevin (53m 34s): Well, it’s been great being with you today, Jesse. It’s been a pleasure getting to know you a little bit and chat about all these things. If they want to, if listeners want to go and find out a little bit about me, they can go to my website. It’s www the macro or if you want to get some kind of examples of my work and get a few newsletters, feel free to give me an email. And I’m happy to send that off.

Jesse (54m 0s): My guest today has been Kevin, the macro tourist. Thanks for being part of working capital. Thanks, Jesse. It’s been a lot of fun. Thank you so much for listening to working capital the real estate podcast. I’m your host, Jesse Fragale. If you liked the episode, head on to iTunes and leave us a five-star review and share on social media, it really helps us out. If you have any questions, feel free to reach out to me on Instagram, Jesse Fragale, F R a G a L E, have a good one.

Take care.