Mike Gleason: It is my privilege now to welcome back Michael Pento, President and Founder of Pento Portfolio Strategies. Michael is one of our very favorite market commentators that we have on the podcast and is a well-known money manager, and author of the book The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market. He’s been a regular guest right here with us over the past few years, and we always love getting his wonderful insights. Well, Michael, I’d like to start out with a question about the repo markets and I’m hoping you can make sense of all this for us. Now the Fed is pumping hundreds of billions of dollars into these markets in ongoing overnight operations. We’re being told that this is just a matter of routine.
The markets certainly don’t seem too bothered, perhaps because Fed officials are out front assuring people that there is nothing to worry about. Unfortunately, that may be a signal that the opposite is true. Our central bankers are notorious for not telling the whole story and for being wrong, if not outright dishonest. So, if these operations are not extraordinary, one has to wonder why we don’t see the Fed doing this on a regular basis.
So, can you give a quick explanation for our listeners of what the Repo market is starters and then tell us Michael, what is your theory as to why the Fed is suddenly pouring huge sums into that market?
Michael Pento: I’ll try to give you a quick framer in the repo market, even though I’m not a bonafide expert in it, I will tell you this, there are problems in markets. You said there isn’t any manifestation in the problems in the repo market and the stock market and you’re completely correct, but the repo market is a huge problem.
Basically, think of the repo markets in two ways. So, there’s the Fed funds market, which is the target rate that the central bank sets for primary dealers to exchange cash. This is an unsecured line of credit. Bank A, which is a primary dealer and bank B is a primary dealer. They want to exchange cash with each other because one is short on reserves, one wants to borrow reserves. So, bank A loans money to bank B unsecured in the Fed funds market for around two percent, that’s what the Fed’s target is.
And then that money is repatriated back the next day and it’s unsecured. Then you have the repo market, which is different than the Fed funds market, but the Fed funds market sets the rate for repo. This is where primarily you see shadow banks asking for cash from primary dealers and they’re bringing collateral into the OTC market. And they’re saying, “Hey, I have, for example, in 2007, I have a mortgage-backed security that I’d like to borrow cash overnight.” And then you bring this mortgage-backed security to the primary dealer. And the primary dealer, “No, I don’t want it for two percent, or five percent, or six percent, or any rate anywhere near that. I want it for 10%, or no rate at all. I don’t want it.” So that’s when the money markets become clogged.
What I find interesting now is that the repo market we just talked about the evidence of distress wasn’t yet manifest in the stock market, but the repo market, which is supposed to be the rate that you exchange collateral around the rate where the Fed wants it to be exchanged for around two percent, now you take mostly high quality assets, these shadow banks take high quality assets – like mortgage-backed securities, CLOs, Treasuries – they tried to repo this rate at near two percent, but they got it at 10%. 10%, Mike!
Yet, this is what I find most amazing. This is not yet like 2007, where you had distressed assets being repo’ed by mostly insolvent institutions, that caused repo to spike to 10%. You have “High quality” assets yet. And I put “High quality” because when the recession comes, they’re going to be bankrupt even worse than they were in 2007, but we’re not there yet. But you’re still paying 10%.
This is what I want your audience to get out of this kind of complex issue. There is no liquidity any longer in the repo market, okay, it’s much worse than we were in 2007, a bit over a decade ago, these were very deep and liquid repo markets. Because of Dodd-Frank and Basel III, these banks no longer want to principle trade these assets, they don’t want to hold these assets, so their liquidity is razor thin. Hence, when we have a problem with these assets, the repo market will skyrocket. The rates will skyrocket much higher than they did a few days ago and much higher they did in 2007. This is the tenuous fragile nature of the money markets, which is the financial grease liquidity that helps the economy run. Without it, the economy can’t function.
Mike Gleason: So that begs the question, why are we not seeing a bigger deal out of this in the markets? I mean, to me it seems like a pretty major issue and maybe that’s overblown, but why is it hardly causing a ripple?
Michael Pento: Well, first of all, the Fed came in right away and they… and let’s just go back a bit. So, about a year ago, a little less than a year ago in the fall of 2018, remember the Fed was in the middle of raising interest rates. They raised rates nine times. And they drained about $800 billion of the Fed’s balance sheet. That caused the junk bond market to completely freeze up. So, the Fed changed course dramatically. Now the Fed is cutting rates and they’re now back into QE and Fed even opened up a repo facility, it’s supposed to end October 10th… I doubt it can end October 10th… they’ve infused hundreds of billions of dollars, Mike, into the repo market to re-liquify it.
Here’s the point. Here’s the salient point. The Fed can re-liquify the money markets temporarily and they can do this by they could cut interest on excess reserves, they can put the standing repo facility in there or they can even go back to QE. But here’s the question, here’s the point I want to make. Let’s just say that we’re correct and that the economy is going to have a recession at some time and I think it’s going to be much sooner rather than later.
At some point, the $5.4 trillion worth of triple B corporate debt, which is one notch above junk, $5.4 trillion of triple-B collateralized loan obligations, which are leverage loans and junk bonds. There’s $5.4 trillion of that. That is going to go belly up and bankrupt, and you’re going to have insolvent financial institutions, shadow banks, that are going to be trying to repo this crap, $5.4 trillion of it. And you can tell me, “Well, the Fed will by this stuff overnight.” Remember repos are overnight loans, primarily. Overnight. You can take a bankrupt junk bond to the Fed overnight, but you’re going to have to buy back that bond the next day.
Here’s the question. If that’s the case, you’re an insolvent institution trying to repo $5.4 trillion worth collectively of this junk bonds and triple-B debt, that’s worthless. Are you going to then take that money from the Fed to buy more junk bonds, and CLOs, and triple-B corporate debt? No, you’re not. You can’t. You need that money from the Fed just to keep the doors open and they’re not going to be open very long. So, you’re going to have another fall of 2018 event. It’s going to be exponentially worse because it’s going to involve not only just junk bonds, but it’s going to involve leverage loans, and triple-B debt, as I said, over $5 trillion of it, and that’s just the beginning.
And there’s no way these banks are going to be participating in the purchases of new corporate debt. So, the whole thing’s going to dry up again like it did in 2018, in the end of 2018, like it did in 2008, and we’re set for another massive draw down in GDP. Unemployment rates will skyrocket and the stock market is going to tank. That’s my prediction. Write it down, record it. We’ll play it again for our audience soon.
Mike Gleason: Switching gears here a little bit, you discussed the $100.07 trillion deficit in your latest weekly newsletter. It’s the largest amount since 2012 and more than doubled what was reported in 2016 just before Trump took office. Total federal debt is $22.5 trillion and its growth is likely to outpace what we saw under Obama. Candidate Trump talked about reducing deficits and debt. As president he was able to pass tax cuts, which were terrific, but there has been much less effort to reduce federal spending and economic growth has certainly not kept pace with that spending.
That said, President Trump probably isn’t going to have to defend the continuing explosion in federal debt. Most understand Democrat candidates would demand even more borrowing. Trump supporters may not like what’s happening with deficits, but they certainly aren’t going to jump ship over it. Debts and deficits seem dead as a campaign issue, but that doesn’t mean they don’t matter. Someday the bubble will pop and Americans will once again have to confront the issue. Do you think this might happen before the 2020 election? How about 2024?
Michael Pento: Well, let’s just go over a couple of things you said there. So, candidate Trump said he was going to pay off the national debt. And let me caveat this by saying that I voted for President Trump. I think he’s infinitely better than what we have to face possibly in November of next year. But candidate Trump said he was going to pay off the national debt, which was under $20 trillion is like $18, $19 trillion at that time. It’s now $22.5 trillion.
So, not only did we not pay off the debt, we’ve added to it, and we’re adding to it now at the pace, as you correctly point out, of over $1 trillion per annum. And this is when the unemployment rate, Mike, is at multi-decade lows. And when we have the next recession, when the automatic stabilizers kick in, welfare, food stamps, unemployment insurance, we are going to go from $1 trillion to 3 trillion. $3 trillion of deficits every year. And that’s assuming that the interest on the debt stays quiescent. So that’s a pretty big assumption, by the way, so we could be adding close to 15% of GDP, 15% of GDP per annum to our national debt. That’s how scary things could be.
And who’s going to buy all this debt? And at what interest rate? We were talking about repo market before, banks are loaded with Treasuries. By the way, these treasuries have a zero risk rating in the capital ratios. That’s how they’re calculated. What happens when these Treasuries really tank in price, what happens to the bank solvency? So, that’s a big question for us.
You and I talk about things all the time about how awkward and how tenuous and fragile the global economy has become. But so far, it hasn’t really become acutely manifest other than we had that little slight hiccup. We had one in 2016, we had one at the end of 2018, but central banks are doing something. Global central banks have printed $22 trillion worth of counterfeit money in the past decade to re-inflate asset prices and try to make the massive $250 trillion global debt pile serviceable. That’s a tremendous amount of printing to paper over what’s really going on in the world.
Let me repeat that. $22 trillion worth of new money, of fiat paper, has been created in the past decade. Think about that.
Mike Gleason: Yeah, it’s an unfathomable number. It’s really crazy, eventually you’ve got to think the chickens are going to come home to roost, as they say.
Well, as we kind of begin to wrap up here, we’re seeing some volatility in metals prices, particularly in silver. To us, it looks like prices have been pretty well-correlated with what is happening with yields in the bond market.
What do you make of the price action in metals and what are you expecting for the metals markets in the near term, in light of all of the aforementioned monetary issues, Michael?
Michael Pento: Well, I mean, I run an actively managed portfolio, so sometimes in very long metals, as I am right now, as I speak to you. But that could change. A lot of this is short-term contingent on what happens with President Trump and Xi Jinping when they meet early October, they’re supposed to have this grand bargain.
It wouldn’t surprise me if one is struck. If a bargain is struck and it’s substantial in nature, you will see a sharp and I think truncated selloff in the metals market, predicated on the fact that we’ve reached an agreement with Xi Jinping. Most of the tariffs will be rescinded, future tariffs will be discarded. And then a major reason why central bankers are currently cutting rates, especially the Federal Reserve, is predicated upon, and this is what they have avowed, predicated upon trade tensions. So, it would not surprise me to see a great buying opportunity in the metals market if such a deal is struck in the short-term.
But the truth of the matter is, we are going to enter into a recession very soon. The problems that are manifest in the global economy are not primarily derived from trade. They are primarily caused by China, which is a debt disabled nation, which can no longer stimulate the global economy into its growth trajectory of four percent, five percent. It’s now more like two, two-and-a-half percent. The U.S. economy waxes towards recession and you’re going to have a pullback in the global economic activity. You’re going to have a recession here in the United States and that’s when the bond market blows up, and that’s when you’re going to be very grateful you used an opportunity such as we could get in early October to purchase precious metals.
Now on the other hand, if there is no deal struck or if the deal does not eliminate most of the tariffs that are currently in place, I believe you’re going to have a direct response from the gold market and it will be very, very positive and very, very steep… a sharp rise in metals prices.
Mike Gleason: Well, we’ll leave it there for today, Michael, and we appreciate the time, as always, and love it when you’re willing to share your comments with our audience, as you have once again.
Now before we let you go, please tell folks a little bit more about Pento Portfolio Strategies and then also how they can follow you more closely.
Michael Pento: Sure, my website is PentoPort.com. My email addresses is firstname.lastname@example.org. I run an actively-managed 20 point model/strategy called the Inflation, Deflation, and Economic Cycle Model. It tries to make money in all cycles, but it particularly protects against periods of time where we’re entering a stagflation or intractable inflationary environment, or conversely, a disinflationary, depressionary, deflationary cycle.
Both of those outcomes are virtually assured, given the level of $250 trillion of global debt that cannot be ever paid back, and it can’t even be serviced adequately. It must be defaulted upon, and it will be defaulted upon either through deflation or massive inflation. I think it will be both at different times and you have to know how to invest in all of those environments.
Mike Gleason: Yeah, it’s certainly going to be a tricky market coming up here over the next several years, and obviously Michael is a fantastic person and his firm is a wonderful place to go if you are looking to navigate that and get some real expertise there. So, yeah, give him a call.
Well, good stuff, Michael, appreciate the time once again. Enjoy the fall, and we’ll look forward to our next conversation. Thanks very much and take care.