Taps Coogan – September 23rd, 2022

Hugh Hendry is the founder and Chief Investment Officer of the now-defunct hedge fund Eclectica. Famous for his eccentric style as well as making big profits during the 2002-2003 recession and the Global Financial Crisis, he eventually retired and went into a self-imposed exile on Saint Barts after struggling for years to make big gains in the post-Global Financial Crisis world.

He has been trying to make a comeback of sorts lately through an economics/finance podcast and other ventures and recently spoke with Bloomberg to offer his outlook for markets.

Some excerpts from Hugh Hendry:

“I want to raise the stakes. I fear that this could be more severe than 2008 because I fear that we may have muted the ability of the Federal Reserve to underwrite a binary situation… (In 2008) the system was set to reset to zero with the bankruptcy of the Global Financial System and the Fed… as an agent of all of us underwrote the financial system. Will it be able to do so again? The market wants that question answered… This market is like deep sea diving without air… it is going to go to a depth below the surface, probably in 30%-50% below that all-time-high and it’s going to wait and say to the Fed ‘What you gonna do?'”

“We’re seeing drama in the most unsuspecting places. The solidity of the Yen has just slipped away like sand into the sea. Why? Because the Fed is tampering and is calling on the spirit of Volcker from the 1970s. Why could the be catastrophically wrong? Because the 1970s as 40 years after the bankruptcy of the US financial system (during the Depression) and we had 40-years where we deleveraged and global debt was like one-times GDP. Today it’s five-times. If you raise rates, the whole edifice of this system could crash… Profound market turning points are always about… undermining the confidence in collateral. Collateral is money…”

“Central bankers do not understand money. Tell me the last time the Federal Reserve got it right?… They get things wrong… This year began with two consecutive quarters of GDP contraction in the United States. What is the response of the Federal Reserve? It’s not a recession. I’m getting on in years and for as long as I’ve been on the planet, guess what? It’s a recession. They say ‘Wait until the wise economists at the NEBR confirm it.’ I dare you (to) wait, because look at the charts. The S&P is typically down 50% when the ‘wise guys’ get it.”

“Private banks create money through collateral and taking reputational risks trading with their neighbors. QE does not generate inflation… The Federal Reserve has studied this. There is a recent Federal Reserve paper that maintains that a two trillion dollar reduction in the Federal Reserve would be equivalent to 27 basis points of hiking. It’s a joke. The greatest danger is the unwinding and the lack of confidence in collateral…”

“Desist. Walk away. The hardest thing you can do is walk out of the casino… Don’t take risk at this point. That’s the gamble. It may be wrong…”

As far as whether this could be worse than 2008… of course it could be! There is more debt, we’re coming off a bigger stock market bubble, the Fed is more intransigent, China cannot play the stimulus card like before, and Europe’s got an energy crisis with no easy fix. 

Nonetheless, this need not be as bad as 2008. If the Fed would take a breather here and let the lagging effects of its tightening actually sink in, we could probably get away with just an ‘average’ recession. 

I am not sure I entirely understood Mr. Hendry’s point of quantitative tightening, but it is essentially a dollar-for-dollar subtraction of liquidity available to financial markets. It may not have much effect on bank lending on a first order basis, but guess what will happen to banks’ willingness to lend when the value of their collateral falls another 25%?