Submitted by Taps Coogan on the 6th of June 2019 to The Sounding Line.

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Legendary investor Stanley Druckenmiller recently spoke with Scott Bessent, Founder and Chief Investment Officer of Key Square Capital Management, at the Economic Club of New York. Druckenmiller offers a scathing critique of overly accomodative monetary policy and the risks it has created in the economy.

 

Some excerpts from Stanley Druckenmiller:

“I will go to my grave… believing that really loose monetary policy greatly contributed to the Financial Crisis. There were obviously problems with regulation, but when we had a 1% Fed Funds rate in 2003 after, to me, it was pretty obvious that the economy had turned (up) and I think the economy was growing at 7% to 9% nominal in the fourth quarter of 2003 and that wasn’t enough for the Fed. They had this little thing called ‘considerable period’ on top of the 1% rate just so we would make sure that their meaning was clear. And it was all rapped around this concept of an insurance cut… I’ve made some money predicting boom-bust cycles. It’s what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had every seen was proceeded by an asset bubble generally set up by too loose policy…”

“I think Bernanke and the rest of the Fed did an incredible job once the bust occurred in 2009. QE was aggressive. It was decisive. Interest rate policy, everything they did was spot on. But coming out of the crisis, QE2 I wasn’t thrilled with. QE3 I was really disappointed with and the reason was I was very fearful that the emergency days were over and the possibility was that we were going to set up another mis-allocation of resources. 2012 came around, 2013, 2014, the economy kept getting better and better and better and every time I would give a talk like this… I said ‘yeah I would sneak (a rate hike in) every time financial conditions allowed’ and hopefully at some point rates will be high enough that we will have an appropriate hurdle rate for investment where people won’t be doing stupid things like they have in past asset bubbles. But as you know, we got all they way into 2014 and 2015 and we were still doing QE3…”

“Corporate debt in 2010 was $6 trillion. It’s now $10 trillion, so it’s grown 65%… During that same period corporate profits grew from $1.7 trillion to $2.2 trillion, that’s cumulative over eight years. So on a $4 trillion increase in corporate debt we got a $500 billion increase in corporate profits. But it’s worse than that. The interest cost on the extra $4 trillion in debt only went up 23%, from $475 to $565 billion. So, think about the horrendous productivity of capital here. You increased your debt 65% but your interest costs only go up 23%. You would think your profits would explode with that formula. They went up 29% over eight years, not in one year. They compounded with less than a 3-handle (less than 3% a year). You might ask ‘but wait corporate profits have been great.’ No, I’m talking about total profits, not earnings per share, which is the other mis-allocation of resources. During that time period, $5.7 trillion buybacks, financial engineering, versus $2.2 trillion in capital expenditures… You are getting a pretty gross buildup in the private sector…. We have all these zombies walking around. So here we are in… one of the most innovative… economically disruptive periods since the late 1800s and you hardly see any bankruptcies because there have been no market signals from the Fed… Governments respond to market signals too and the clowns in Washington, unless they get a signal from the bond market, they’re gonna just keep spending. So for the first time in history, we have massive deficits and full employment… God help us if we get into a recession. If you just take the mean of what happens in a recession, (the deficit) would go to $1.8 trillion. Debt-to-GDP has gone from 65% to 105%…”

“I thought Brenanke and Yellen in particular, there were so many opportunities to just put a quarter (percent rate hike) in… while financial markets were booming… There is this belief at the Fed that if you are near the zero bound you are near deflation… and that’s the bogeyman that we dealt with in the 1930s. that the Japanese dealt with. But I’ve never seen a deflation happen because you were near the zero bound. Every one was proceeded by an asset bubble and we… are creating a mis-allocation of resources and an asset bubble that could set up a deflation…”

“I just don’t understand the 2% inflation obsession. We had 3% deflation in the late 1800s and the economy grew at 8% real for ten years. We had inflation at less than these levels in the 1950s with a Fed Funds at 4% and we were just fine…”

“We (investors) have all been forced way out the risk curve and we own a bunch of assets we don’t necessarily believe in… That TINA thing (There Is No Alternative), is a hell of a reason not to own an asset, but we are all guilty of it. That’s what worries me the most… that we all own a bunch of assets… that ultimately are probably in weak hands…”

There is much more to the discussion, so enjoy it above.

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