“It’s Beyond the Twilight Zone to Have $13 Trillion in Debt with a Negative Yield”

Mike Gleason: It is my privilege now to welcome back Michael Pento, President and Founder of Pento Portfolio Strategies. Michael's a well-known money manager and a terrific market commentator and author of the book The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market. He's a regular guest right here on the Money Metals Podcast and we always love having him on.

Mike Gleason: Well Michael, when we spoke last in March, you noted something very important, that being the equity markets were celebrating the Fed's shift to a more dovish posture. At that time, the Fed hadn't actually done much. They were telegraphing a pause in rate hikes but still selling assets. The celebration continues today but, in point of fact, the Fed still hasn't done a whole lot. It's all about expectations and right now everyone is sure they will be cutting rates in July. They're getting a lot of mileage out of a little more than some jawboning. The S&P 500 is up 20% from its December lows. What do you make of these expectations? Is the FOMC going to meet them with some aggressive rate cutting or do you think people are going to quickly find out that talk is cheap and the economy is headed for recession regardless of what the Fed does?

Michael Pento: Well, first of all, the market's doing well this year but that's because the calendar changed and the market went up after going down 30%... the Russell was down almost 30%, 28%, the S&P was down 20%. So, you pretty much just reversed what happened in the fall of 2018. So, this is not a runaway stock market by any means and people are going crazy how well the market's doing. It's actually, I think, it's putting in a triple top, that would be my best analysis of the situation. And the reason why I say that… well, before I go into that let me answer your question first, so you're asking me, will the Fed cut rates? I believe the Fed will cut rates later this year. I think they'll probably go 25 basis points in July and the reason why I think they'll go 25 basis points in July is that they are trying to catch up to what the bond market has already done.

So, if you look at the bond market, the Fed funds money market rates right now, the effective Fed funds rate is about 2.38%. And the 10-year treasury is below 2%. So, you have a pretty significantly inverted yield curve, which really hurts banks' profits and diminishes their rationale when it comes to making a loan. In other words, they're not going to make a lot of loans when they don't have a lot of profit margins. And they think the economy's slowing because of the reduction in nominal rates on the long end of the yield curve and they don't want to make loans to people who probably aren't going to pay the loan back because then their capital will go away. So, that's the reason why I think the Fed is going to cut rates in July. But the market is 100% convinced that they're going to cut rates probably as much as 50 basis points.

So, two or three rate cuts this year, and I will say that that is a possibility. However, if the Fed is aggressively cutting rates it's because the global economic recession is well underway. That would be the rationale behind cutting interest rates so aggressively. Don't forget that at the end of last year we had a Fed that was absolutely avowed to raise rates to 3% and then another 50 basis points… so 3% was what they deemed as being neutral… and then they were going to go above 50 basis points, right? You remember this? And you'll also recall that the balance sheet withdrawal process, the burning of cash, was supposed to be on autopilot. In other words, the Fed's destruction of its balance sheet to the tune of maybe two trillion dollars was supposed to be on autopilot. That all changed. So, they've gone a pretty trenchant difference, they've gone more than a country mile as they say, from being one central bank is going to raise rates to three and a half percent and drained the balance sheet down from four and a half trillion to around two trillion to one that is now supposed to be aggressively cutting rates?

I'll just say one more thing about this. The fact that the Federal Reserve is going to be cutting rates, they have two and a half percent, less than two and a half percent, before they go to zero. So, the question I have and I don't have the answer, I have a model that tells them what the answer will be, but I am willing to guess based upon the myriad and the plethora of evidence that I have that merely cutting rates by 25 basis points in July is not going to be nearly enough to stem the tide of a global recession, which by the way I believe has already begun.

Mike Gleason: You recently wrote a great piece on corporate debt, stating that it's a bubble that will eventually pop. You made a comparison between today's corporate debt and the housing bubble of 2007 and the dot com bubble of 2000. You pointed out that both Ben Bernanke and Alan Greenspan attempted to shirk responsibilities for the massive bubbles the Fed creates, the claim was that nobody can identify a bubble before it bursts. We know that isn't exactly true. You've done it and anyone willing to take an objective look can see that debt is one of the next bubbles likely to burst. The obligations are so large that they simply cannot be paid. Talk about the bubble in corporate debt if you would and what would you think are some signs that listeners should be watching for that maybe the reckoning is about to arrive?

Michael Pento: I have to laugh when I hear people tell me, "This is time is much better than 2008… because in 2008, don't you know, that there was all kinds of malfeasance in the banking system." And people were making loans to people who couldn't pay back those loans, mortgages that were going to default, but there was only about one and a half trillion dollars’ worth of subprime mortgage debt. But I went and did the numbers myself and added up triple B debt, leveraged loans and junk bonds… and triple B is just one notch above junk… and basically the covenants behind these triple B loans make them essentially junk. That number is 5.4 trillion dollars. And what makes me laugh is, when I look back and I hear people on CNBC and all the financial networks, all the pundits come out, the carnival barkers, will tell you that in 2019 there are no massive dislocations, there are no excesses in the economy.

Well, how do you explain the fact that there are now 13 trillion dollars’ worth of sovereign debt that has a minus sign in front of it? Is it normal for a Japanese, a Swiss and a German 10-year note to have a negative yield? Think about that. Central banks have gone so insane concurrently that they have now forced bond yields so low that going out 10 years they get paid to borrow. And that hasn't caused any dislocations or malformations in the stock market or the junk bond market or the leveraged loan market or the housing market or the stock market? That is insane, prima facie. It's a prima facie case for insanity, in my opinion.

Mike Gleason: Let's talk about China for a bit. China has always been a tough one for us to evaluate. There have been people speculating that Chinese central bankers have blown a massive bubble of their own and the bursting of that bubble is imminent, but if they were close to a crisis, they've done a pretty good job of keeping the wheels on thus far. You've been watching developments in the Chinese banking sector and perhaps things are starting to get serious there. The Central Bank of China recently took control of a Chinese bank when it failed. There are certainly other banks then buried in bad debts. What are you expecting from China in the months ahead and what you think it will mean for investors here in the U.S.?

Michael Pento: Well, you have to understand, just to stay at 36,000 feet, China quadrupled their debt since 2007. And when any nation, not just China but any nation… and by the way there has been no nation that has done that in the history of mankind… but any nation that will quadruple the amount of existing debt outstanding in 12 years and have done so by an edict from the central government is sitting on a massive pile of unproductive loans that will go bankrupt. Baoshang Bank is just one example. This is replete throughout China and even in Hong Kong where their banking system is many, many times the size of their GDP. So, you're going to have a situation where – and this is by the way speaking parenthetically as I tend to do – why I am bearish on the global economy, not because of trade conflicts or conflagrations so much, more to the fact that China can no longer be the engine of global growth, responsible for one third of global growth since 2008.

They can't do it anymore because they're sitting on 40 trillion dollars’ worth of debt dung that they cannot pay back. And if China's not the global engine of the world, then Europe is going to suffer. It might surprise you to know, maybe not you but your audience and certainly those that watch mainstream financial media, it might surprise everybody to know that Japan, Europe, the U.K. and China are all in a manufacturing recession. Now that is not something that Michael Pento came up to talk about on Money Metals. That is public information released by governments, they're publicly released, purchasing managers indexes. They all show that all of those countries I mentioned and much of the developed world is in a manufacturing recession. Now, I want to pose this question to you. How can China, which was erstwhile in the habit of providing one-third of global growth by building out massive unproductive fixed asset investments, how can China possibly be growing at 6% if their manufacturing base is in a recession?

The answer is that they are not growing at 6%. China is lucky if they're growing at all because China has a shrinking labor force and plunging productivity. And if China isn't growing, then Europe's in deep trouble and Asia's in trouble and the Korean nation is in trouble and Japan is in trouble. And even in the United States, our manufacturing, the new order component just released for June, the manufacturing new orders component of ISM was 50. Flat. No growth. So, we are in the midst of a global manufacturing recession. We are in the middle of, according to Fact Set – which is the definitive voice on earnings on the S&P 500 – we are in the middle of an earnings recession that's going to last for three quarters. So, it’s not the second derivative of earnings growth is falling, so we're not going to grow from 24% earnings to maybe 20% or 15% or 5%, earnings growth is going to be negative, according to Fact Set, for three quarters in a row.

You add that to a manufacturing recession and then you add it to the fact that we have a stock market that is near all-time record high valuations – if you look at price for sales, if you look at total market cap to GDP. I'm not trying to scare people. I manage money for a living so I can't short the market and buy gold always and hope to be in business. So I have a model that tells me when to get net short and when to overweight gold, which we are at this point. Because, by the way, when you live in a world where interest rates are going towards zero and below, the carrying cost of gold doesn't look so bad. I could put a bar of gold in my safe at home that earns no interest and I can lament the fact that I'm not sitting in a bank earning 10% with my cash. But if I'm sitting at my house looking at my bar of gold and saying, "Gee, I'm forgoing almost nothing at the bank, and because interest rates are negative in a real sense because inflation is the goal of every horrific central banker on the planet, I'm actually making money, much more than I would in the bank.” Because gold, for 5,000 years, has maintained its purchasing power.

So, I'm not trying to scare people, I'm just telling people that this is not normal. It is not normal to have one-dollar worth of sovereign debt that has a negative yield and it's certainly beyond the twilight zone to have 13 trillion dollars’ worth of sovereign debt with a negative sign in front of it. It is certainly completely abnormal to have the stock market at a record high valuation when you're in the middle of an earnings and manufacturing recession globally. So, if you think I'm trying to scare you, you're wrong, but if you think you want to go and call your local broker and put your money into a closet index fund and go to sleep at night, don't be surprised if very soon you wake up and find out you're in the middle of an event much like we saw in December of 2018, or October of 2008, or March of 2000, where are you at the cusp – especially in those last two I mentioned, the recession of 2000 and the recession of 2008 – where you are on the cusp of going off the cliff in the stock market.

And this time around, we don't have the tools available to readily pull us out of deflationary depression because, as I just mentioned, bond yields are already in the toilet of history. So, there is not going to be any rapid relief from plummeting bond yields around the world and there certainly isn't going to be this fiscal response coming from countries which are already massive overly indebted. We have a problem; it's going to take a lot of fiscal and monetary wrangling to get out of. That takes time, but in the interim I wouldn't be surprised to see the stock market lose half of its value again for the third time since the year 2000.

Mike Gleason: Obviously, a lot of black swans circling about and certainly a number of very interesting situations that we could see unfold here and obviously confidence is a big reason that the central bankers have been able to sort of get us out these messes in the past, and you've got to wonder if anybody's going to have any confidence in them this time around.

Well, Michael, I wanted to kind of further the point on gold before we let you go. These markets have been pretty range bound for a while, talking about gold specifically, silver as well. Gold finally broke out to a five year high recently, driven primarily by escalating tariffs and maybe perhaps the Fed will be cutting rates. Do you see gold finally starting a new trend higher here or are we going to drop back into the range?

Michael Pento: That's not a prediction any longer, it's the fact. You just said it, it's a fact. Gold massively broke out of that $1,350 ceiling that it was staring at. It went all the way well into the $1,400s. It pulled back here recently but what a wonderful buying opportunity, in my humble opinion. The fact is that we live in a world where money is going to be mostly free for a very long time because central banks have gotten into the business of eviscerating markets. So, for instance, in Japan, the Bank of Japan now owns 80% of all ETFs and over 50% of the entire Japanese government bond market. So, when do I have to worry about the Bank of Japan raising rates? They can't even get out of the business of buying ETFs, manipulating their stock market, or trying to manipulate their stock market higher. Likewise, with the ECB, when are we going to talk about raising rates? They threatened they were going to raise rates but now they're talking about lowering rates and getting back into QE.

And the same can be said for the United States. We were talking about draining the balance sheet and raising rates back to, normal now not being five and a quarter percent like it was in 2007, but they're talking about trying to get to three and a half and they barely got to two and a half, and now we're supposedly heading back to zero. So, the competition for a real currency, a real money, a real store of value, is going to increase exponentially and why would people go anywhere else but what's proven for millennia to be the best place to store your wealth and your purchasing power?

So, I predict that rates going to be… well it’s not a prediction because rates are already at zero… I think the United States will soon be back to zero and then after that back into Quantitative Easing, which means you're going to get a much higher rate. And by the way, you should understand that if rates are zero and you get even one basis point of inflation, real interest rates are negative.

But I can't see them stopping until they get 2% inflation. So, your real interest rates will be -2% but that's the way the government measures inflation and they do a hell of a bad job doing that. So, if the government's measuring it at two, it's probably closer to eight. You're going to get profoundly negative real interest rates, which is rocket fuel for gold, and why anybody would have nay faith in any fiat currency, not just hating the dollar, but how could you have faith in the euro over the dollar, or the yen, or the yuan? You have to have the belief that gold will rise and will continue to rise in all currencies, and I think that dynamic is just getting started.

Mike Gleason: All these central bankers are pretty much going from the same playbook, this Keynesian world that we live in and never-ending money creation.

Well, we'll leave it there for today, Michael. We appreciate the time as always.

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