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Richard Helppie
Well, the economy is on everybody's mind. And here we are on The Common Bridge with a return guest...
Kerry Killinger
Hey Rich, how are you, good to see you.
Richard Helppie
My good friend, Kerry Killinger, Episode 95 of The Common Bridge. This was in March of 2021. March 23 to be specific. Mr. Killinger and Linda Killinger previewed their very well researched book called "Nothing Is Too Big To Fail". I highly recommend their reading about economic history, what we're experiencing today and especially what the future might hold. Now Kerry Killinger is eminently qualified for this - his full bio will be on our website. Be sure to listen on Mission Control Radio, subscribe on Substack, and follow us on social media and at Richard Helppie.com. So Kerry, back in March of 2021 we talked about inflation, the price of things over their intrinsic value in six asset categories. And if memory serves me correctly, it was stocks and housing, commercial real estate, luxury goods, household net worth and Chinese real estate. And maybe could we add commodities and food today?
Kerry Killinger
We can add lots. And Rich, thanks for having me back, it's great. And by the way, congratulations on your podcast. It's my go to, (Rich Helppie: Thank you, it's been fun.) checking in every week to see what's going on in the world. And you've just got some great guests, and I appreciate it. I got my subscription into your new deal. (Rich Helppie: Great, thank you for that.) I'm getting broadened out beyond just the podcast to your update report and the different things you do and so good luck. I hope it goes well for you.
Richard Helppie
Well, thank you. And we do have some really terrific guest columnists coming up. And later this month, February, we will be publishing our first newsletter. What we're really hoping for is a lot of dialogue. There's a lot of rancor out there. We think that we can discuss issues of the day as adults that have an interest in making this a better country and a better world.
Kerry Killinger
I think you're doing a great job and I think the country needs it right now. Let's talk about inflation for a minute. It was pretty funny last March when we were talking with you - I was fortunate to have my wife, Linda, who co authored a book with me, on that [show]. And we said at the time, I remember saying, inflation has really taken off in this country. The Federal Reserve had a saying that they were doing everywhere at that time, don't worry about it. They said inflation is transitory, it's not for real and all that. And all of a sudden, the real experts at the Fed were just flat wrong. What's happened is, over the last couple of years in particular, we stimulated the economy so much to try to fight COVID, not only with the Government going into huge deficit spending and all the safety net programs they put up and the like, but the Federal Reserve kind of almost went berserk in terms of how fast they grew the money supply, how low they kept interest rates in relation to inflation. And in the purchases of assets they did, themselves - they bought $4 trillion of assets the last two years. And guess what? When the Fed's buying all those assets, that drives prices up.
Richard Helppie
They're not bargain shoppers.
Kerry Killinger
They are not bargain shoppers [laughter].
Richard Helppie
Who would have thought?!
Kerry Killinger
So that stuff is really cool in the short run. It's kind of like, you take a drink, that feels pretty good, and [then] you take two, three, four and five - well the Fed got just totally drunk. And now we're having the impact of it, which is runaway inflation, the greatest in 40 years in this country. So we have seven and a half percent inflation over the past 12 months on everyday items that are measured in the consumer price index. But beyond that the inflation that went on into common stocks, Bitcoin, NFTs (Non-fungible Token), SPACs (Special Purpose Acquisitions Company), all these kinds of new speculative instruments were multiples of that. So all the asset bubbles that I talked about last spring that we were worried about, have become even more inflated today. Now, I think the bloom is starting to come off that rose. I think that the expected - the peak - of all that activity may have been late summer for stocks and some of the more exotic instruments, and I think the peak of speculation may have been right at the end of the year for housing and some of the real estate things. I think that we are now seeing the other side of that - that speculative boom may be coming off and we may be headed for a fairly significant correction in some of those bubble prices.
Richard Helppie
Well, it's going to be a wild ride. When I think about this on fairly simple terms, we put all this liquidity, all this new money out there at the same time we had broken supply chains, we had construction down because of COVID. So isn't that kind of basic economics - a lot of dollars chasing fewer goods, that's inflation.
Kerry Killinger
It is and one of the things I take exception with the Government, is they have continually come back and said, all these issues we're facing on inflation are just supply chain and COVID related. And no, these things are all a reflection of those crazy policies that the Fed put out, as well as the expansive policies of the Federal Government. It put way too much money out, too few goods for people to buy. They went out and just kept bidding up the prices. And in some areas, like housing where the Fed kept interest rates artificially low, that made affordability very, very good for things. And people got panicked, just kind of kept going out and buying and buying and buying, and then we had new players come into housing - like private equity funds, pure investors - and they helped really drive the price of housing up in some markets.
Richard Helppie
And the price of that house is out-running wage increases. So people that are in the parts of their life where they're trying to get a down payment together, they can't reach it.
Kerry Killinger
You know, you're right. And what's going to happen is - everything we can tell - that interest rates are going to be going up. And the net result of that is [that] affordability of housing is going to get less. And if that happens, then we're probably going to see the other side of that and start to see supply come on the market for more houses and fewer buyers. That could turn from a very speculative seller's market to more of a buyers market, I think, in the next next six to 12 months.
Kerry Killinger
Are there any areas, any states that are more affected than others? I know that I've read things lately, well, of course, California is always a discussion. Texas, what's going on there?
Kerry Killinger
What's unusual with the housing bubble this go around is it's gone everywhere in the nation. The average prices have increased about 35% in the last two years. Remember, housing should only be growing at the rate of inflation, but about one or two percent. So when you have a 30 some percent increase over two years, that's not very sustainable. Now, certainly some markets are much more vulnerable than others. [I would] particularly worry about ones that don't have good long term prospects; where their tax policies are not attractive and people are moving out of there and the like, and others where you just got into a speculative boom. So I would just target those markets where you grew much faster than 30 some percent and say they tend to be a little more vulnerable than those that didn't.
Richard Helppie
I put on my cynics hat or skeptics hat, when I'm told not to believe my lying eyes about those empty shelves that I see in the grocery store and not to believe the price that I pay for a gallon of gasoline, even with my hybrid car. And then that same voice is telling me hey, don't worry about this seven and a half percent inflation, because it's only going to last a little bit. I have a hard time understanding, especially when the next thing is, well, we're going to raise interest rates. Now you and I did business at a time when interest rates were market. (Kerry Killinger: Yep.) And we've got a whole generation of people that have never dealt with the cost of money. It's going to be crazy.
Kerry Killinger
It's certainly going to be a new transition for a lot of people to realize. Now, let me give a real simple truism. Over the long run interest rates have to be at or above the rate of inflation. And that's historically been the case, whenever you keep interest rates way below the rate of inflation, you create these bubbles and we've been through that. Now, the Federal Reserve has no choice today but to start reining that in. They have to raise interest rates or inflation is going to go just crazy, even from where it is today. And they have to stop putting excess liquidity into the system through money supply growth. And they're going to reverse their purchases of all these mortgage and treasury securities. And so all of these tailwinds that the stock market and housing and everything has had that's really helped fuel these bubbles, is now going to be a huge headwind. And the question is going to be, will the Fed manage that deflation of those bubbles in an orderly manner? Or do we risk having like we did in 2007 and 2008, a piercing of the housing bubble with them not responding appropriately and we had liquidity crisis, and then we had a meltdown of the whole economy. We certainly hope we avoid that. But you can't assume it's avoided.
Richard Helppie
Well, I've read in my economic reading that governments cannot allow deflation to get into the economy because once it gets in, it's really difficult to arrest. And [to] think [of it] simply let's say I'm going to make a major consumer purchase, like a car or refrigerator and I think, if I wait six months, the price is going to be lower. And so I don't buy it. And then other people join in on that. And I say, well, maybe it's six more months. Well, then there comes a layoff at the manufacturing plant that's making that [item] now those people don't have spending power - they're not spending. Now the economy tumbles down into deflationary, into a depressionary cycle. Are we at any risk for that?
Kerry Killinger
I think at this point, the risks are a little bit different. The Fed would like to see inflation average about two percent per year. And I think most of us who have run businesses say, yeah, a predictable two percent of inflation, that actually is pretty good; you know that prices are going to go up over time, you build them into your wage structures, and it goes pretty well. What's happening today is now inflation surged to seven and a half percent and workers understand that. So they're demanding more and more, and the wage structures in the country are growing at a very rapid level. What's going to happen is that's going to be a self-fulfilling prophecy to inflation for a while. We saw that in the 80s in a major way. Once you get people's expectation of wage increases being very high, it's very, very hard to unwind. So I think the real risk over the next couple of years is going to be inflation remaining at a high level. And we probably don't have a big deflation risk for everyday items like the consumer price index reflects, but we do have a risk of deflating these asset bubbles. So don't be surprised if the stock market corrects 20% or 30% someday, don't be surprised if housing prices actually come down in a number of markets, don't be surprised if commercial real estate starts to soften a little bit. And don't be surprised at all if these highly speculative newer instruments like Bitcoin or some of the more exotic ETFs or NFTs, or all the little nomenclatures of things that we came up with in the last a couple years for speculative investments, those bubbles could easily burst in a major way.
Richard Helppie
I think that's a caution for our listeners. And based on my experience, and based on the very learned experience of Kerry Killinger, beware of financial funny works. When financial markets get cute and they start doing the financial engineering, the credit default swaps, where there really wasn't a counter-party there, the securitized assets with very weak underlying instruments, I get worried. And now the Special Purpose Acquisition Companies coming back, getting very popular, getting inflated and pulling back - that's also called a blank check company, [I'll] probably cover that in another episode of The Common Bridge. But when I look at all of these financial funny works coming in, that's another sign of a major correction or crash, perhaps.
Kerry Killinger
It is, and I commented a little earlier, I think we may have seen a speculative peak in some of those kinds of things sometime last summer. Remember when we had with the Robinhood platform, and all these meme stocks going kind of crazy and SPACs were the order of the day, IPOs were going on a hot and heavy way (Rich Helppie: Yes). What's happened now is that 70% of all IPOs last year are underwater now. Virtually all the SPACs, not all, but most of the SPACs that came are underwater, have not done well. And I think that people have kind of realized that speculative peak was a little bit crazy. So I'm not surprised to see if this starts to roll through other categories I mentioned, even housing, I think may have had a peak right at the end of the year or the early part of this year. And if I'm right that interest rates are going to keep moving up in here, I think that bubble is going to start to cool down pretty quickly.
Richard Helppie
Let's talk about the the effect of rising interest rates. So first of all it'll make less cheap money available for the purchasing of goods, but you also mentioned that the Fed won't be buying the mortgage securities. So that's going to drop demand for that, which means lower - potentially - asset prices there. The cost of servicing Federal debt is going to go up now because we are going to be paying a higher level of interest. We still would have - even if we did a 500 basis point increase, as they're talking about [with] much hand wringing, I'm frankly not worried about it - we're still going to have negative real interest rates, because our inflation rate will be greater than our borrowing costs, correct?
Kerry Killinger
In the short run. In the long run, we know that interest rates will tend to rise to meet or exceed the rate of inflation. So again, if inflation, even if it remains less than seven and a half, it comes down to three to five percent, that's still not reflecting in current interest rates. So I could see interest rates growing two or three percent just to kind of catch up with even more of a three or four percent kind of inflation.
Richard Helppie
Right, and savers are still at a disadvantage. (Kerry Killinger: Yeah.) And wage earners actually have illusory gains, because that extra dollar in their paycheck, it can't buy as much. These policies are really crushing the lower economic strata and the middle income earners.
Kerry Killinger
You're absolutely right on that point. And if we look in hindsight now at all these measures have gone to fight COVID, the biggest beneficiaries, by far, have been the billionaires of the country. (Rich Helppie: Mmhmm.) If you take somebody like Elon Musk - and I love Tesla, I happen to own a car - but first of all, the Federal Government policies helped make Tesla what it is with all the subsidies and the benefits that they got. And then when the Fed made all this money so easy and put speculative conditions, well, he's now the richest person in the world, and added billions and billions and billions to the value. He and the other high end folks were the major beneficiary of all these policies. The average consumer is no better off today than they were before COVID, despite all these government spending programs. So the benefits primarily went to the upper 1/10 or 1% of our society.
Richard Helppie
Well, there are scientists, one of my favorites [is] Martin Kulldorff, writes about this, how the policies really attacked middle income earners and attacked lower wage earners. And basically, we have a class system that people that could work out of their laptop from a remote location, kept right on rolling. But if you were needing to get to work to do whatever it is you did, you didn't have that opportunity. And is it any surprise that right behind Mr. Musk, you have Jeff Bezos, because people are at home, ordering off Amazon and getting their food delivered from Whole Foods. And so his worth has sky-rocketed based on Amazon, as have a lot of the other online platforms.
Kerry Killinger
The one other concern I have for the average worker or individual is that we have a very good likelihood of returning to a phrase that we all had back in the 1980s of "stagflation", where we have inflation above a comfortable level and the economy slows. Now, in recent times, all these Federal policies have helped prop up the economy. But I think we're at the end of that. The Federal Government can't stimulate it anymore. I think inflation is starting to take a toll. And I think the economic growth over the next year or two is going to slow. So we could have this simultaneous improvement, or I mean, very high inflation, very low economic growth. And that's not a good employment position in the long run for people. So I worry that for the average worker, we end up in a position where inflation is still going on, they're losing purchasing power and maybe the environment for getting jobs and changing [jobs] and the demand for work actually starts to slow down. That could easily happen later this year.
Richard Helppie
That's a very scary scenario. In my experience, with every time we've had a recession, we've talked ourselves into one. We said, we think a recession's coming so we all started acting like there was going to be a recession and we get one. The good news is that when we decided it was time to be over, we just talked ourselves out of it. [Laughter.] And that ends after, unfortunately, a lot of pain. So as we're talking about inflation, can the consumer just expect steadily climbing prices and they kind of get to a new level or steadily climbing and then perhaps a retrenchment? And are all those asset classes going to trade the same? And I know I want to get to [talk about] China too.
Kerry Killinger
Well, we know they're not going to all be the same and some of the things that have jumped up in price pretty dramatically, like used cars right now, I think that that's going to work itself through the system as we get through some of the chip shortages, and people get geared up with more of the newer high demand cars and the like. And I think we'll finally get through that. I do worry on the inflation front that Government does not factor in what's going on in housing prices in the consumer price index. They do a summary of what the impact is on rents, while rents always lag change in asset prices. Now, back in the 80s, they used to include housing prices and so that came right through it. This go around we said, we're not going to measure housing prices in the inflation rate the same way we did. That one's still coming through so I'm worried about the impact that's going to have. But I do think these supply chain bottlenecks are going to gradually go away. I'm a little worried that our demand is going to start slowing down for a lot of goods and services as the - if I'm right - economic growth slows. So some of these inflationary pressures will ease back. But will we return to less than two percent annual inflation? I don't think so. I think it looks like we're in a period where above two percent for a while is likely. And that's going to keep putting pressure on the Fed to keep raising interest rates to try to get that to catch up with the rate of inflation.
Richard Helppie
So we're going to make it more difficult for people to buy a house or to rent. But we're not going to count that in inflation, because it's too scary. And you know what I hear about that we're not going to count it? Of course, I think about some of the COVID data, right, what we're going to count. But there was an old fable about a duel [that] was about to be fought. And one guy was very thin and the other guy well, he enjoyed his food, okay. And the larger fellow looked at the skinny guy, and he said, hey, this isn't fair, you got a lot bigger target. The person conducting the duel thought about it, went over, took a piece of chalk and he drew two lines down the front of the larger guy. And he says, okay, any hits outside the lines don't count. [Laugher, cross talk.] So America, your rent, your mortgage payment doesn't count. (Kerry Killinger: Yeah.) That's the policy from the Federal Government. And Kerry, we're in the middle of this re-start too, which is still a wild card. Look what's going on today on the Canadian border in my hometown: the Ambassador Bridge, the number one land connection to our number one trading partner, is not moving any cars.
Kerry Killinger
Well, again, those supply chain issues are going to be here for a while. We've got to attack all those individual ones, like that one. I'm actually encouraging the Government today to quit blaming everything on COVID. I think that we are in the final stage... personally, I think we're in the final stages of COVID having a huge impact on the economy. I think we're learning to live with it. Knock on wood, but I think unless there's a new major variant that's an issue, it seems like we're on the improving side of dealing with the disease across the board. I worried that the Government has put...it's easy to blame COVID, because then it's not you. You got an exogenous third party you can blame. But I think as some of this inflation comes through and they actually see the economy slowing down and there are other issues, many of those are self-inflicted wounds from policies, not from COVID. And I'd like to get us beyond trying to justify everything we're doing and blaming it on COVID.
Richard Helppie
Well, indeed, and I think you hit the nail on the head. It's not COVID, but it was the public policy responses. I see a lot of people scrambling for cover right now and that's, of course, going to be a topic for another day given the magnitude of it. Why don't we touch on China a little bit and then wrap up. I know you've got a keen interest in how the global economy interacts. What should we be thinking about relative to China?
Kerry Killinger
I think first of all, we've been talking about how the aggressive policies our Federal Reserve did, and our Government spending...that is going on pretty much around the world, everybody took our lead. And so the issues were dealing with - the rising inflation and slowing economies and concerns - is kind of hitting around the world. China in specific is one that I think could have a huge impact on the world because it's the second largest economy, and some expect it to exceed the US economy as a leader in the world sometime in the next decade or so. So anyways it's very, very large. Well, they too have built that economic growth on the back of enormous debt. Their debt to GDP is much, much higher than even the United States. And my wife, Linda and I travel to China quite often and the last time we were there, we noticed literally millions of unoccupied housing units around the country, particularly in some of the secondary cities and the like. And the price point on those new units is much higher than what people can afford. So they've done an oversupply of housing with the idea to try to keep the economy going. Now they're faced with the issue that they're probably worth a lot less, and their largest real estate developer, Evergrande, is some $300 billion dollars in debt, (Rich Helppie: Oh my.) and has - I think there are 280 communities with thousands of major multi-apartment kind of projects - and they're in a cash flow squeeze. So the Chinese government either has to bail them out, or if they don't, you have the potential ripple effect, like we saw with the financial crisis here in 2007-2008, that when - if they, for some reason - remove liquidity at the wrong time and they're over-extended and that huge amount of debt and things that don't make economic sense on the price of those housing units, that whole cascading effect, could not only affect China. And if China starts to have a really bad disease there, I can assure you, it's going to have a big impact in a negative way on the United States and other trading partners. And the other little subtlety I'll mention going by here, is because the US consumer has been so flushed with cash from these government handout programs, we are buying an increasing amount of goods and services from China and other foreign countries. So our trade deficit is the largest in history, which means we are totally dependent on getting all of our good cheap goods that we're all buying out of those guys. And if they have a disruption, that will have a disruption on our supply chain and our goods and all that kind of stuff in addition, so I think it makes a lot of sense for us to follow China fairly carefully.
Richard Helppie
Indeed. So let me ask you to speculate a little bit if I might. You get an invitation, and the invitation is to go to Camp David over the weekend. The President wants to meet with you, along with the Chair of the Federal Reserve, and the Secretary of State. And they're saying, look, we've got this multi-dimensional problem going on, what do we do? If you had to pick out two or three things, saying let's go do this and maybe a thing like stop doing this or whatever, what would you advise?
Kerry Killinger
I think I would advise that they have to take the medicine now - for the Federal Reserve - of raising interest rates. Try to do it in an orderly way but you've got to raise rates to attack inflation or it's going to become an ever increasing major problem. And I think I would have the Fed continue - at a faster pace - of reducing its own purchases, because again, they've got us at the party drinking way too much and we're all drunk. They have got to sober everybody up and bring that back down. And the more of an orderly way that they can do it, the better off we'll be. I think I'd tell them, from the Federal Government standpoint, you guys have built such huge budget deficits, that's unsustainable, that's helped contribute to inflation. This is the time to try to return to more normalized budgets, try not to overspend, and give yourself a couple of years for the economy to kind of go through a transition to hopefully pull down the rate of inflation. Yes, we'll have slow economic growth. Yes, you politicians are going to be under attack - because they're not going to be able to stimulate the economy, have no inflation, and keep causing prices of assets to go up even more. That party is over. And so it's a matter of, can you manage in a very smart way on the other side and please try to avoid breaking those bubbles in a way that brings the kind of pain that we had back in 2007-2008.
Richard Helppie
Well that would be sound advice to raise that and also to have the Federal Government slow their spending. And I don't think this solves the problem but we do have some incomes and walls that are just way out of whack that need to be addressed. And perhaps we need to start looking at means testing or something for some of the big programs: Social Security, Medicare, and anything that we can do to eliminate spending in a way that's not as painful - all spending cuts cause pain. (Kerry Killinger: Yep.) Raising interest rates causes pain, but it's where it drops and right now we've dropped it on middle America - we, being the United States Government. Kerry, this has always been a great conversation, I really appreciate it. What didn't we cover today that maybe we should or any closing thoughts that you might have?
Kerry Killinger
Oh Rich, no, I think we've been very comprehensive and, as always, you're right on top of the subjects. I think we've had a good discussion. Again, I think, in the long run, this is still such a great country. We have every opportunity to be the long term winner on an economic basis, social basis, every other basis so I don't want to be doom and gloom about some of the challenges we're facing. It's all about how do we manage through them, but don't keep trying to have a super inflated party for the next two, three, four years. We need to get through this period, get ourselves back on solid footing and then I think the long term prospect for our country is excellent.
Richard Helppie
Well, look, if I could sum that up, if our Federal Government could treat us like adults, and maybe the folks that are running for office could treat us like adults, like, we have problems and we can't do stupid things. Maybe that's just too much. [Laughter.] We've been talking today with Kerry Killinger, a man with deep economic experience, who has researched a book, Nothing Is Too Big To Fail, that he co-wrote with his wife, Linda Killinger, again, highly recommend the book, Nothing Is Too Big To Fail. I keep it on my bookshelf, it's a great read, and their prognostications have been spot on. That's borne out of the study of history, the analysis of where we stand today. Be sure to register and subscribe to The Common Bridge at Substack. It's easy to do - substack.com is the name of the website, you put Common Bridge in the search bar, and for just $5 a month, get this kind of content, as well as our columns, our newsletters, our transcripts, and many great guests, and more importantly, an opportunity to join in the conversation be part of the nonpartisan future of America. Let us treat each other with respect and kindness while we exchange ideas. I hope you hear this on Mission Control Radio, as well. One of our guest columnists, Karl Bingle, talking about his experience in the music business and he's got a great program in Mission Control (Records), and of course, on regular social media and other media outlet channels. And with my guest today, Kerry Killinger, (Kerry Killinger: Thanks Rich.) this is Rich Helppie signing off on The Common Bridge.
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The Real Cost of Inflation