Jason Hartman: Welcome to the Creating Wealth Show. This is your host, Jason Hartman, and this episode number 274. Thanks so much for joining me today. We’re going to talk about some interesting stuff. We’ve got a great guest coming up after the intro portion of the show that I’m doing with one of our investment counselors, Steve. How are you, Steve?
Steve: Not too bad. How are you?
Jason Hartman: Good. Hey, not too bad, that’s not optimistic enough. You know what? Everybody listening and Steve, you got to try this out. Sometimes when people ask me, “How are you?” or “How are you doing?” I say this, and it really freaks people out, “If I was doing any better, I’d owe the world a rebate.” Try that one, okay?
Steve: I will do that today. I’ll report back on how it goes.
Jason Hartman: Okay, let’s do a test. Steve, how are you doing?
Steve: If I was doing any better, I’d owe the world a huge rebate.
Jason Hartman: Awesome! Fantastic. Or at least a tarp bailout, right?
Steve: Oh, wow. Yeah.
Jason Hartman: I wanted to have you on today. You know, you’re one of our investment counselors and we haven’t had you on the show before. I’ve known you for – I don’t know, about a year now, maybe a little over a year slightly, and I’m glad that you’re working with us, but we have not exposed you to the podcast yet, so thanks for joining us here today and helping me with the intro portion of the show. So, it doesn’t have to be a monologue, right?
Steve: Yeah. My pleasure, yeah. Well, we’re going to talk about a few interesting things before we get to our guest today. You know, the first one, Steve, I wanted to chat with you about is commandment number three, thou shall maintain control. Probably one of the most important of my ten commandments of successful investing and there’s just story after story after story of scandals in the financial world. I mean, I’m sure it just blows your mind as much as does mine and all the listeners and, you know, we’ve got this new story about Knight Capital. This is a firm that’s on the brink of disaster now after millions of accidental trades. Wow, what do you think?
Steve: Well, we’re looking at the commandments here. Obviously, we want to maintain control of our investment because in one of the subheadings of that commandment, you might be investing with an idiot and I think that’s what happened here.
Jason Hartman: Yeah. That’s a very good point. A lot of times, I really hedge – I really sort of focus on you might be investing with a crook. There are three things, so that’s very good that you brought that up. The first one, you might be investing with a crook, the second, you might be investing with an idiot, and the third, assuming they’re honest, assuming they’re competent, they take a huge management fee off the top. But here, this is just an example of investing with an idiot, right?
Steve: Yeah. How would you like to be manning the tech support desk that day? Forty-five minutes and $440 million in trades in that period, because this new software that they implemented apparently just went haywire.
Jason Hartman: Unbelievable.
Steve: Yeah, it’s crazy. I just don’t thing I can put any kind of money into something like that, where you can have some kind of a bad horror movie plot take over and the machines just run wild and burn through all the money in 45 minutes.
Jason Hartman: Well, you know, there are many science fiction movies about that, including the most famous 2001. That was a great movie produced back in the ‘60s and how computers might take over the world and really mess things up. This is an example of it, isn’t it, $440 million? Almost half a billion dollars as an ‘accident’. I mean, it’s shocking, huh?
Steve: That’s right. Yeah, four times their annual net earnings in 45 minutes.
Jason Hartman: Unbelievable. So, do you think the investors are going to lose money or it still has to be determined?
Steve: Oh geez, who knows? It’s a big chunk of money, but I think they got somebody who offered to buy them. They’re getting some capital to hopefully erase this mistake. But they got a big whole to dig out of. The too big to fail criteria is very subjective and there’s only a couple of people who have that instruction manual, and I’m not one of them.
Jason Hartman: Yeah, and that whole too big to fail and depending on government bailouts thing, especially if Romney wins in November. I think you’re going to see that go largely by the wayside because there’s just so much anger and opposition against these bailouts that it will be interesting to see if it actually happens. If Obama wins, I think it would be more likely we’d see more of that in the future if it happens. So print fake money, bail out the rich, bail out the elites, so that they basically have corporatized socialism.
So, all of their gains and wins, that’s part of capitalism. All of their loses are socialized and on the burden of the taxpayer, but not really even the tax payer and that’s the interesting thing. You know, we always talk about it’s a taxpayer bailout. Not really, because when you really think about it, Steve, it’s really a bail of anybody who has any assets denominated in dollars because the value of those dollars will decline as the print fake money to bail these criminals and idiots out over and over again. It’s just unbelievable.
Steve: Yeah, it is, and it will require more and more money for every additional bailout. It’s going to continue to separate the poor and the middle class from the elite. It’s going to be horrible. The inflation that’s going to result from that is just going to absolutely wipe out anybody who hasn’t positioned themselves correctly now.
Jason Hartman: Yeah, and in the basic positioning concept, just as a reminder to all of our listeners, is denominate your assets in things. This is the Jason Hartman philosophy basically right here. You’re going to hear it in a sentence. Denominate your assets in things; things that are of universal need like housing, for example, and denominate your liabilities in depreciating dollars where the debt will be inflated away. So, have debt, long-term fixed rate debt that buys you those things like packaged commodities, housing, right?
Steve: That’s right.
Jason Hartman: Good stuff. Well, let’s talk about a really negative article. You know the website ZeroHedge, a lot of my friends like this website. It’s sort of pretty wonky. You know, I guess nobody knows who writes this. This article was submitted by, get this name, Tyler Durden. Now, do you know who that is, everybody?
Steve: I don’t know who that is. Educate me.
Jason Hartman: Well, let me tell you something. One of the best written movies – I’ll just tell you a little story about this. I saw the preview for a movie called Fight Club many years ago and I was in Chicago and I was waiting for this girl to fly in who was going to come hang out with me. She was flying up from Dallas and she missed plane and she was late. I was wondering around Michigan Avenue in Chicago and I didn’t have anything to do, so I wandered by a movie theater and the only movie that was playing at the time that made sense for me to just walk in and see a movie was, guess what, Fight Club.
From the previews, I didn’t want to see this movie. It’s looked barbaric, like a bunch of guys who fight and beat each other to pulp. I mean, terrible. But let me tell you, that movie is so well-written. It was very, very clever. It’s really one of the great movies in terms of the writing quality. I really appreciate writing quality and dialogue in movies and a concept like that. And Tyler Durden, as I recall – my memory is foggy here, was the guy who was trying to wipe out all the debt by basically bombing all these corporate offices and at the end of the movie, you see all these skyscrapers just crumble away. The whole concept was to wipe out the debt that the corporatocracy had gotten all the consumers to charge up, so they became basically slaves to the system.
So, this is obviously a fake name, right, on ZeroHedge. You never know who writes these articles here. It’s all like an anonymous blog site.
Steve: Yeah. It does have Brad Pitt’s picture there at the side of the articles.
Jason Hartman: There you go, yeah. Exactly. So anyway, this was kind of an interesting article and I wanted to kind of dissect it a little bit. Tell us about it.
Steve: Well, essentially the article, it’s very doom and gloom-oriented about the future of the housing market. It’s forecasting that there are essentially 14 million homes in the so called shadow inventory. Everybody has their own definition for what shadow inventory is, but, you know, a really broad definition of that for our purposes here are homes that are at high risk of being foreclosed and being distressed, for sale homes on the market. And he thinks that the homebuilder projections over long-term, where they’re at right now, are still way, way, way too low despite all the positive news about homebuilder sentiment and housing starts and building permits that’s come out the last few days.
Jason Hartman: And let me tell you – I just want to mention on homebuilder sentiment. It is amazing how bullish the homebuilders are and how quickly that has changed. I mean, it’s like I read article after article after article about how the homebuilder sentiment is the best it’s been in five years and builders are starting to build again. That is amazing. Imagine if you’re one of clients listening and you have the foresight and the vision and courage really, because it took some courage a few years ago, to buy in some of these properties when you could get them for $35 or $40 per square foot. And now, builders are building and in most markets, the stuff they’re building is about $100 or even a little more per square foot in markets like California or something like that, It’s way more. You just build your profit in, there it is. You got, okay? Congratulations! You won the game.
Steve: That’s right. If they were feeling any better, the world would owe them a rebate.
Jason Hartman: There you go. Now, one of the things that causes builders to build and makes builders feel optimistic is when the money starts flowing, right? And so, this shows us that the money is moving off the sidelines and that is causing builders to feel the wealth effect, but also people are buying the houses. I mean, inventory is dwindling. But here, you got this article that is very negative, right?
Steve: Right, it is, and one of the main things that it brings up that I think is very good from what we’re doing here when it comes to purchasing income property with long-term, fixed rate debt, it’s saying that consumers don’t want to buy these houses because they’re uncertain about the economy. They don’t want to make any long-term decisions, and purchasing a home is a long-term decision. So even if that were the case, obviously you want to own a bunch of rentals, right?
Jason Hartman: Most definitely, because that means more renters, right?
Steve: That is exactly right.
Jason Hartman: And here’s the other thing. When they say something like people are afraid to take risk, they’re afraid to make decisions like long-term commitments like buying a house or an investment. The reality is, though, in most cases, Steve, and you know this as well as I do, the person taking the risk is the bank. It’s not the buyer. I mean, the buyer, if it’s an investor and they can get financing, they’re taking 20% of the risk and the bank is taking 80% of the risk. If it’s a home owner who’s buying on a conventional mortgage, they might be taking 5% of the risk or 0% in some cases, depending on the type of financing they get, and the bank is taking 95 to 100% of the risk.
So, what is the risk? Committing to a 30-year mortgage? We’ve all seen what happens. I mean, this is counter-intuitive. We’ve all seen what happens. If people can’t pay the mortgage, what do they do? they just walk away. Show me where the big consequences are. You see all these strategic defaulters out there and it sounds crazy, it sounds counter-intuitive, it sounds irresponsible if you’re a first time listener and listening to me say this. You think, “This guy is out of his mind.” Well, not really. Go back and listen to some of the old episodes where we interview some of these people. We interview some of the experts on this and you’ll see where, in some cases, it’s almost a no-risk equation, isn’t it?
Steve: I think so, and as long as we follow that commandment that the deal must make sense today, the economy and the housing market can do what it will in the future. But if the deal made sense when you purchased it and you’ve got that long-term fixed rate debt, like you said, there’s really no risk. I mean, tenants are paying all that mortgage for you and it’s so cheap right now. I mean, most of the properties that we do are $100,000 and under and the mortgage payments are very, very small on those things and they’re fixed. They’re fixed for the next 30 years. I just don’t see the doom and gloom that this article presents. I don’t see it.
Jason Hartman: Yeah, I don’t see it either. I’d love to see one of these guys. Whenever I see this kind of stuff, they never really take into account population. Now granted the population is increasing pretty dramatically, both through birth rate and immigration – now, immigration has declined since the economy hit the skids for sure, which almost points out how Mexico is exporting their poverty to the U.S. Mexico needs to solve their own problems and the corrupt government there. What they really need is a revolution in that country, so the people can start to have rights because it is just unbelievable how their government is just constantly abusing the people there and it so sad really. But Mexico is just taking its problems and exporting them to the U.S. but at the same time, the U.S. is really an accomplice in Mexico doing this, because what they’re doing is they’re importing deflation and this is why inflation isn’t much worse. Because if you can import cheap labor from Mexico and import cheap goods from China, the only thing you don’t have in America is jobs.
Steve: That’s right.
Jason Hartman: You get to say the inflation rate is much lower because it is, but it’s just interesting to see how this will turn out. But these guys never really talk about the population. They talk about the shadow inventory and I agree there is a lot of shadow inventory there, but the other thing they don’t talk about — and Steve, we’ve had this discussion before. Remember all of those articles we saw a few years ago about the timeline for adjustable rate mortgages adjusting? You remember those?
Steve: I do, yeah.
Jason Hartman: I mean, the doom and gloomers love this stuff, whether you were reading The Daily Reckoning, you know, any of Bill Bonner’s work or Addison Wiggin who we had on the show. I think Addison Wiggin was like episode 111 or back there somewhere in that range, and all the Agora press and we’ve had a lot of those Agora guests on the show. All of the Agora press and, you know, a lot of the major media press was saying, “Oh my gosh! There’s going to be this tsunami of foreclosures as adjustable rate mortgages adjust, and they could tell based on the origination times of these mortgages when they were going to adjust. Very true, but you know what they completely left out of that equation? They were looking at origination data. They had no idea how many millions of these properties were sold, how many of them were already foreclosed on and being resold, how many did loan modifications were work outs, and how many, where the people could actually absorb the payment and make the payment. They didn’t tell you any of that. And one of these big waves, by the way, was last year. I think it was May or June of 2011. That was like a huge spike whenever you’d look at these graphs of these desperate mortgages. Oh, the world is going to come to an end.
When these mortgages adjust, there’s going to be 10 million new foreclosures. I’m just making that number up, but a whole bunch of them and everything’s going to go to hell in a hand basket. The reality was a lot of those problems had been solved already before those loans even adjusted. They were solved preemptively, either by the person selling their home, refinancing it, short-saling it, getting foreclosed on already, doing a workout or a loan — I mean, it just doesn’t tell you that. It’s like it gives you half the picture.
Steve: Yeah, you’re just assuming that because it’s an adjustable rate mortgage. It ends up in a foreclosure. That’s not the case. You know, there’s plenty of people that took those out that actually could afford them, that could get the work outs that already sold the house. So, that storm wasn’t nearly as big as those people predicted it to be and they defined that as a shadow inventory. Nobody really has effectively defined what that is. You know, this ZeroHedge article was talking about 14 million homes in a shadow life. We have recent reports from Morgan Stanley that say it’s more like six, then I hear on CNBC that it’s one. If the deal makes sense today, you’re good.
Jason Hartman: Right. I agree. Just in this talk, we’ve gone from 1 million, 6 million, to 13.5 million. It’s all over the board, that’s the whole point. No question about it. And then you look at stuff like this. Here’s an article. This is an Associated Press article and it stated August 8th. Okay, so it’s fairly recent here and it says, “U.S. late payments on mortgages hit a three-year low in the second quarter.” It says, “Los Angeles: U.S. homeowners are getting better about keeping up with their mortgages, driving the percentage of borrowers who have fallen behind to a three-year low according to a new report.”
So, when you’ve got rates this low, there are so many escape hatches for people. With the shadow inventory, I think it’s overplayed. It really is overplayed. Now, of course, we’d be amiss if we didn’t talk about this, Steve, but remember the famous quote, “All real-estate is local?” So, the question is where in a country as large and diverse as the United States, there are 400 distinct major markets here. I’d say that yeah, the places where you have the most adjustable rate mortgages are markets that we’d avoid like the Socialist Republic of California, where you have high land values, where you have properties that do not makes sense that you buy them. Yet I do have to say prices are actually rising in many California cities right now as we speak, but I still wouldn’t touch it because the cash flow doesn’t make sense and the risk is still very high. But places like New York City that are expensive, any expensive markets, that’s where you see more of the adjustable rate mortgages. You see a lot less of this stuff in the Midwest, in the South where people are more conservative, where they can actually afford their homes more often than not, and it’s just kind of a different world. So, that’s another thing to know.
Steve: Yeah, it definitely is. I talked to a client from New Jersey the other day and told him what the investment of one of the properties we’re doing right now and we had to talk for a few minutes about how that was the whole price. It wasn’t the down payment.
Jason Hartman: Yeah, it’s like sticker shock in reverse, right?
Steve: It is, yeah. It’s ridiculous.
Jason Hartman: We should make up a new phrase for that, Steve. Let’s call it sticker joy, instead of sticker shock. Yeah, absolutely. And then there’s a whole nother component that we didn’t mention yet and that brings me to another article about – this one’s entitled – this is a news article entitled “Foreigners Gobbling up American Homes”. This says that non-natives, non-Americans are taking 8.9% of all U.S. home sales. I mean, that’s an amazing thing, that almost 10% of the American market, just right now, is driven by foreigners. The articles starts of, it says, “The Canadians are coming… for our real-estate.” A weakened dollar coupled with a buyer’s market is prompting foreigners to snatch up expensive homes here in the U.S. Of the $928 billion spent on U.S. real-estate in the year-ending mark in March. $82.5 billion came from foreigners. Our neighbors to the north accounted for the most with 24% of all foreign home sales just going to Canadians followed by Chinese at 11% according to Forbes Magazine. The Russians might get most of the media attention for the millions they drop on swanky apartments. That’s my favorite word, isn’t it, swanky?
Steve: It is. I didn’t know you were Russian.
Zz: No, no. But I like the word. It’s good. The Russians are dropping a lot of money on swanky apartments and I’m quoting that from the article. Buyers hail from all corners of the globe, including Argentina, South Korea, Armenia, Brazil, Peru, and Malaysia. So, isn’t that amazing, Steve?
Steve: That is amazing, and I would say two things to that. Number one, congratulations to the foreigners, you know, the Canadians, Australians, Israelis, everybody that sees the opportunity in this market. They see I for a reason and they’re willing to put their capital into this market. Number two, Americans, your country is on sale and everybody else knows it. It’s time to buy some income property. I talk to foreign investors every single day who are searching for good deals here in the U.S. because they know that this is such an opportune time. You know, much of the world, especially Europe with all the turmoil that it’s in. If the article mentions this, they need somewhere safe to put their money and they feel like putting it the U.S. housing market is a good place to go, considering what their expecting to happen in the Euro zone.
Jason Hartman: No question about it. Now, the U.S. has, for a long time, been thought of as the brinks truck, okay, in other words, the armored car; the place that foreigners could go and they could stash their money in the U.S., in our banking system and in our financial system, and that one I wouldn’t trust, but – But, you know, they could buy assets here and have them outside of their country. And what’s really interesting is some people talk about the decline of the U.S. and the rise if China, is that Chinese millionaires are scrambling to put their money in the United States. I mean, folks, this talk of U.S. decline, it is accurate. I agree that the U.S. is going downhill, but my point is compared to what? I mean, China has a long way to rise before it even comes close to the U.S., in my opinion. We’ll see, but our guess – I think it’s our next guest actually that I’m going to have on here in a couple of minutes. I think we talked about that in that interview. I can’t remember, but one of our upcoming guests is going to talk about import-export parity between the U.S. and China, which is quite an interesting discussion. We’ve got that coming up either on this guest here in a few minutes or on a future show. But Steve, any more thoughts on that?
Steve: Well, I just – it’s blatantly obvious to the foreigners that this is the time to buy and they feel they’re willing to go through that process of getting their money, especially out of China, for example. That’s not easy to do. I’ve worked with clients on that and getting a good chunk of money out of China into the U.S. is not an easy project, but they’re willing to do it because of how confident they feel and where these assets are priced at right now.
Jason Hartman: Yeah, the deals are nothing short of incredible. They really are. And by the way, foreign nationals listen to the show now. I just want to remind you that we do have special financing available for foreign nationals. So, make sure you go to JasonHartman.com. You can contact one of our investment counselors about that through the website and they will be glad to help you line up financing for foreign nationals. Very unique opportunities there. Two more quick things, Steve, and then we got to run. But I wanted to talk to you about two more articles. One is about student loans, and this one, you know, I’ve talked about it many times on prior episodes, but this whole – the student loan thing, this is the next big bubble in our financial system and there are over a trillion dollars in student loans now. See, this is what happens, is the government flooded a certain system, the college system, with money by doing these student loan guarantees and all that they did is make the price of college sky rocket through the roof.
College is largely a rip off nowadays. I mean, if you compare the regular inflation rate, the broad inflation rate and the consumer price index to the tuition inflation rate, you’ll see that the tuition inflation rate has been about double — double the standard inflation rate. I mean, that’s just mind-boggling. What has gotten so much more expensive about running a college, I think it’s gotten a lot cheaper with technology. I mean, all these kids today — you know, I live a block from ASU, Arizona State University. You know what all these kids do? They take their classes online now. They use a program called Blackboard and they do everything online. I mean, they don’t even need to go to a campus anymore. It’s unbelievable. I’ve got a friend of mine, she wants to move to Washington, D.C. and she goes to ASU and she wants to into politics. Oh boy. And I said, “Well, what are you going to do? You’re going to change schools?” She says, “No, I’m just going to stay with ASU and take all my classes online and live in Washington, D.C.” So think of how easy that makes it for the university, how cheap it makes education to provide it. They have massive scalability of the internet.
So, I think if they want such bloated bureaucracies, the cost of tuition should really be lower than it was decades ago, not higher. But the government flooded the system with money, and so – look what’s the definition of inflation. What happens? Too many dollars chasing a limited supply of goods and services that causes prices to go up, doesn’t it? And that has absolutely happened with college. But what does this particular article say? This is a new twist on it, right?
Steve: This is a new twist and this is going to sound eerily familiar with a very broke government scrambling for dollars wherever it can find it. But if you’re a current recipient of social security benefits and you owe money in student loans, expect to see a part of those social security checks levied by the government in order to pay off the student loans.
Jason Hartman: Unbelievable. So now what they’ve done not only are student loans. The only debt not dischargeable in bankruptcy. It’s the only one. They are now saying that they are going to levy your social security payments, okay? When you deserve them years later, they’re going to take those. If you haven’t paid your student loan, they’re going to steal your social security. Social Security was supposed to be a totally separate indistinct program, completely on its own, but now the government is finding ways to just cheat people out of that. It’s unbelievable. You could have paid into the system your whole life and they have now found a way to tie the student load to that. But you know what this all means, Steve? What this is means is this Generation Y, the largest demographic cohort in American history, 80 million people, depending on who you talk to, bigger than the Baby Boomers. These people are going to be renters for a lot longer. Their family formation starting much later, they’re not getting married as young, they’re not having kids as young, many aren’t getting married or having kids at all, and they’re going to be poor because they’re going to be burdened by this massive student debt. And you know what that means? That means a lot of unfortunately are not going to be able to buy a home. So what are they going to be? They’re going to be renters and folks, you people listening, are investors. Let them rent that housing from you, provide a service to these people because God knows they need it. The demographics coming at the rental market now are probably the best they’ve ever been in the history of the human race. I mean, it is so incredibly powerful. This is a – to use the words, I used of those articles about desperate mortgages. This is a tsunami of renters coming at you. Take advantage of it.
Steve: It certainly is. It certainly is. The government is going to be looking for money wherever it can get it. You know, I’ll go on record on the program today, watch Next in Line on the student loan thing as they’re going to start to levy tax refunds in order to cover student loan defaults, and it’s just more pressure. Like you say, people have to downgrade. They can’t buy the McMansion, they can’t do these things and they have to live in reasonable rental housing. That’s their only alternative.
Jason Hartman: Yeah, and everybody listening can provide it to them, so do that. I want to talk to you about some more articles, but you know what, we don’t have time, Steve. This has been a great discussion. Thanks for joining me today.
Steve: Anytime, Jason. And I am doing so great now that the world would owe me a rebate. Do I have it right now?
Jason Hartman: Well, I agree. I hope everybody thinks so, too. So, that’s awesome. Okay, Steve, thank you so much. We will be right back. By the way, a couple of quick things I just want to announce here. Be sure to join us for our Atlanta Creating Wealth Boot Camp and Property Tour at the end of September. You can sign up at jasonhartman.com/events and that will be a great program. We’d love to meet you there in person. And also, check the website, the blog. Go back and listen to the past episodes of the podcast, and check out our educational products while you’re at the website as well. I think you’ll really like those. And we will be back with our guest here in just a moment.
Be sure to call into the Creating Wealth Show and get your real-estate, investing, and economics questions answered by me personally. We’d love to have you call in, share your experiences, ask your questions, and a lot of other people listening have those very same questions. So, be a participant in the show at 480-788-7823. That’s 480-788-7823 or anywhere in the world via Skype, jasonhartmanroi. That’s jasonhartmanroi, for Return On Investment. Be sure to call into the show and we’re going to enter all of the callers in a drawing for some nice prizes as well. So, be sure to call into the show and I look forward to talking with you soon.
It’s my pleasure to welcome Keith Fitzgerald to the show. He is the Chairman of the Fitzgerald Group and Chief Investment Strategist at Money Map Press. He’s also the author of a fantastic book entitled “Fiscal Hangover” and it’s great to have him on the show today. Keith, welcome. How are you?
Keith Fitzgerald: I’m doing well. Thanks for having me on the show. I appreciate it.
Jason Hartman: Where are you located today?
Keith Fitzgerald: Well, I am physically coming to you from Beaverton, Oregon. Normally, I split my time between here and Japan and the rest of the world. I do travel quite a bit in a effort to see things that other people don’t see. And I think that gives us an edge when it comes when to finding opportunities even in today’s world.
Jason Hartman: Fantastic. You’ve got subscribers in 35 countries and you’ve got a huge resume, so we’re looking forward to hear what you have to say. Maybe the first thing we’ll start, since it’s so topical is – can we talk about Goldman Sachs and the recent decision by the Justice Department not to do any enditements, which a lot of people are pretty appalled about that, but what are your thoughts on it?
Keith Fitzgerald: You know, there’s two levels on this. Number one, I think that’s an absolute travesty that they are dropping the criminal probe of Goldman Sachs. So far, we have not had a single mega bank nor even a trading been held accountable for the crisis. And technically, this is where it comes down. Technically, the Justice Department has really said that they can’t meet the criminal saying there’s a proof needed to prosecute. That suggests three things. It suggests A, a lack of confidence in the Justice Department potentially; B, the fact that we have a clear need to change the law so that they can prosecute this kind of stuff; and C, perhaps the worst of all things is that, you know, the sleazy characters that are involved in this continue to maintain their incestuous relationships on all levels. By this, I mean our regulatory authorities, the traders involved, the administrators involved, the folks inside the beltway who make the decisions. You know, this is just disgusting, that selling clients material privately described as crap is acceptable behavior.
Jason Hartman: So basically, the allegations stem out of Goldman Sachs unloading incredibly toxic and probably worthless assets onto other firms?
Keith Fitzgerald: Well, other firms, into the trading networks. You know, these were things that in many cases, Goldman Sachs was trading directly against their clients. Facebook is another great example of that. Goldman Sachs, when it gets involved in a transaction, frequently it comes in in the very early stages. One part of the firm buys it for its own accounts, the other part of the firm is sensibly selling it to other clients. So, you know, you’re at odds with each other. People who go to Goldman Sachs and think that the firm is acting in their best interest are in for a very nasty rude awakening.
Jason Hartman: I’m sure you’re familiar with that letter. I read it on a show from a departing high level exec with Goldman, how the firm has changed over the years and how it’s just become this orgy of greed, that’s my own description, but it’s unbelievable, isn’t it?
Keith Fitzgerald: I don’t think you’re far off. I think one of the sad things is that banking should be born and in today’s day and age, the financial crisis has proven that when you have bankers allowed to trade against their clients when they don’t have to disclose their activities and when, in fact, they can run the roost, something is dramatically wrong with the capital system that has functioned so well for so long.
Keith Fitzgerald: Yeah, and that actually leads to a good question. What is wrong with it? I mean, it seems that the attitude – really, there was a huge shift in the ‘80s, I would say. I’m not a Wall Street historian by any means, but it seems like the old mentality used to be invest for income and then it sort of changed, invest for speculation, it’s all about a good story, and all of the firms started acting like there’s no tomorrow. Just take what you can get today, rape, rob, and pillage, and let the chips fall where they may. What’s with this sort of short-term mentality that’s going on?
Keith Fitzgerald: Well, I think there’s a couple of things and I think I actually – I allude to this in my book, Fiscal Hangover. If you go back and you look at market history into the late 1800’s, early 1900’s. The stock market was viewed as the domain of professionals. The average individual did not invest in the stock market. That really didn’t come into vogue until about the 1920’s, when all of a sudden there was easy money available and there was the perception that somehow the stock market was to guarantee you future returns. Somewhere across the line in the last 50, 60, 70 years, that became a proxy for savings. So really, at the beginning, there wasn’t this idea that you could go and make your wealth in the stock market. That’s a relatively recent development in history.
As far as what drives this, I think there’s a couple things going on. Number one, we had the dramatic increase of leverage. At the end of World War II, we were levered up roughly ten to one, so that meant there was $10 in the system for every one that was borrowed or lent and that gave us a certain amount of flexibility when it came to rebuilding much of the world economy that literally have been torn apart through conflict. In the ‘60s and ‘70s, that went up to 31 then it went to 60 to 1.
In the Commodities Modernization Act in 2000, by the time that hit, the restrictions were removed on the transparency reporting requirements specifically associate with off balance sheet investments like the credit default swaps and things that are driving this financial crisis. Now, leverage reached almost 100 to 1. So, it became a constant battle of not necessarily the return on your money, but the return of your money. And when firms involved came to compensation plans and quarterly reporting accelerated, you had a tremendous mismatch between three things: the regulatory function, the needs of the investors, and the owners of the firm, all of which were at odds. And that promoted an activity that is unlike the gunfight at O.K. Corral. It’s the Wild West, the last man standing wins. In this case, it’s the firms.
Jason Hartman: Yeah, it’s just unbelievable. It’s certainly not just Wall Street. I mean, it’s government, too. I just can’t believe like year after year, there’s this debate on spending and debt. It’s been going on for decades, time in memorial really, and our spending is up another $2 trillion plus dollars. I mean, this is just crazy.
Keith Fitzgerald: It’s an abomination. It is irresponsible, it’s obscene, it ought to be an embarrassment to anybody that’s an elected official. But you know the sad thing? That $2.1 trillion that we’re about to argue about for another boondoggle here, another bunch of glad-handing politicians, that’s a fraction of what’s actually the problem. That is 0.96% of the money we already owe ourselves according to Lawrence Kotlikoff of Boston University. The actual fiscal gap, that’s the present value difference between projected spending and income. We’ve already approved it’s $222 trillion. That’s $11 trillion more than last year.
Jason Hartman: Unbelievable. I mean, that’s the unfunded mandates and entitlements then, right?
Keith Fitzgerald: That’s right. So they’re fighting over a rounding error. I mean, they’re trying to fix a wiki faucet when there’s a financial tsunami sitting out there. It is so unbelievably irresponsible as to defy belief.
Jason Hartman: Now, Lawrence Kotlikoff was on the show before. What year are you talking about? When you say — because I used to call it five years ago, I used to call it the $60 trillion time bomb and apparently, my estimate was just massively low and I’ve had a guest on talking about $120 trillion, but what year does that go through? Is that projected up to, say, 2030? How long?
Keith Fitzgerald: Yeah, his most recent work. The $202 trillion is the present value associated with last year’s data and that’s according to the Congressional Budget Office.
Jason Hartman: But I mean, those unfunded mandates and entitlements in terms of how far in the future is that projected to.
Keith Fitzgerald: That varies by the programs involved as I understand the research. So, some of the programs extent 2020, some of them are 2025, and the very long is Medicare and Medicaid, maybe even as long as 2030. But again, the difference in the way that he is calculating it versus the way that guys inside the beltway are calculating it is that he is saying look, it’s money we already allocated and appropriated. Therefore, it is not only appropriate, but necessary to estimate the present value cause to that. And I think Kotlikoff is on to something because the present value of money is how the entire world functions. It’s kind of like Wimpy in those old Popeye cartoons, you know, give me whatever dollar for the day for a cheese burger on Tuesday or however that expression goes.
Jason Hartman: You know, Keith, I got to say that I love that quote. I use it all the time in my live seminars and I think I’ve said it on the show before, because Wimpy understood inflation and how to invest. He said, “I’ll gladly pay you Tuesday for a hamburger today.”
Keith Fitzgerald: Exactly. And so, I think Kotlikoff is – you know, people are fighting over the $2.1 trillion and we’re going to have lots of sound bites and very earnest-looking politicians and attack all kinds of other things. But the reality of the situation is we got 535 dingdongs inside the beltway, none of them understands that they voted this stuff in. It’s not the president, it’s not the Bush era, it’s not Clinton, it’s not any particular administration. It’s the collective body of our leadership.
Jason Hartman: It’s just unbelievable. It really is, isn’t it? Many people have said you are a great visionary, possibly have the best predictive record in business. I mean, what do you think one should do in light of this; all the Wall Street corruption, the government corruption and just largesse. You know, I say just get into long-term fixed rate debt, you know, against commodities.
Keith Fitzgerald: Yeah, this is interesting because now you’re getting into the fun stuff. As devastating as this is going to be in terms of being a financial crisis, one of the things we know from history beyond any shadow of a doubt is that every time we have a great inflection point, we have massive wealth creation opportunities. What you have to do now is simply concentrate on protect your assets in the mean time. So to me, there is tremendous opportunity, for example, in energy, there is tremendous opportunity in medicine, there is tremendous opportunity, believe it or not, even in short-term U.S. treasury debt.
I, for example, don’t believe that we’ve seen the end of the debt bubble. I think that things are going to unwind a little bit further and that we’re kind of actually seeing negative interest rates in this country for a short period of time, much as we did in Japan and as Europe has already experiencing.
Jason Hartman: Let me ask you a question about that. Don’t you think we already have them? I mean, if you ask me –
Keith Fitzgerald: We have in the normal terms for sure.
Jason Hartman: In other words, and let’s just explain that to the listeners. We’re both talking about the same thing here, I hope, which is that you can borrow below the rate of real inflation, right? That’s negative interest to you, right?
Keith Fitzgerald: Right.
Jason Hartman: So we agree. Go ahead.
Keith Fitzgerald: I think we’re actually going to see coupons go that way. I think we’re going to see on Japan, for example, where I’ve been for more that 20 years now. We saw this in the ‘90s where things became so unsettled, that investors had to effectively pay the government to keep their money overnight. Now in Germany, we’re seeing some of those happen already. We saw that recently with several other countries over there where the rates on overnight lending literally went negative for a couple of days or a day or two. I think we’ll see that here and that suggests to me that we’re going to see the ten-year note, for example, break 1%. We might even see it go negative before this is done. So, the point is yes, this is terrible, yes, this is a fiscal disaster, but that doesn’t mean you have to A, stick your head in this thing and having to have somebody kick you in the butt when this is over, and B, there are plenty of defensive things you can do with your money today. Now, I heard many of the same comments back in 2000 when we had that bomb crash. People said there’s nothing to buy, this is terrible, we can’t do anything. Well, that’s not true, because if you look at something like Altria, for example, which is big, what I call a local stock, something with large diversified exposure, highly recognized brands. That stock, in fact, returned well over 1,000% in the last 12 years if you look at the total return. So the price and the dividends matter. So those are things you can do. Energy, for example, in times of stress, the world doesn’t start using less energy just miraculously. Even if we have perfect fundability right now with another source, scientists estimate we’re looking at 30 years before the 60,000 industrial processes that depend on petroleum are altered or changed or switched. You need oil, you need energy investments, and many those things actually pay very high dividends. So even if the market goes
[unintelligible 0:45:05] that you accumulating purchasing power, you’re hedging your wealth, you’re protecting your assets, and – this is the best part, you’re getting ahead for your recovery because it will get here eventually.
Jason Hartman: But most of the inflation is for the people who think society is going to collapse in general and some of those get pretty far out if you ask. They would say that in your answer, Keith, you left out one huge thing and you know what it is, it’s a four-letter word, gold. I just wanted to get your take on the metals. I’m definitely not a gold bug. I mean, I own some of it. I think it’s a defensive strategy, not an offensive strategy. I think it’s okay. I don’t think it’s anything great, but what are your thoughts about the metals, gold and silver?
Keith Fitzgerald: I think you need them. I mean, don’t get me wrong. I think gold is a very, very important part of any investor’s portfolio today. It has to be. And the question is do you want to buy gold because it’s going to appreciate or do you want to buy gold because it’s not going to appreciate. I think the answer is somewhere in between. If you think the world is going to hell in hand baskets then I would buy diapers, bullets, and medicine, frankly.
Jason Hartman: Yeah, and maybe some vodka, too.
Keith Fitzgerald: Yeah, vodka, right, exactly. Because if you look at, for example, Hurricane Katrina, it wiped out an area roughly the size of Great Britain. They weren’t trading gold for cheese burgers, but they were trading bullets, diapers, and medicine in the aftermath, and that says to me, boy, that’s something really critical here. On the other hand, I had a gentleman come up to me after I finished a talk in Florida and he says, “I get it. I didn’t understand you a few years ago when you made that comment, but I get it now because I buried my wealth in a fence post. It is now 30 miles out in the Gulf of Mexico.”
Jason Hartman: Meaning oil?
Keith Fitzgerald: His gold.
Jason Hartman: His gold, okay. He had buried gold coins in a fence post in a coffee can and it has been wiped out to sea. So he understood the difference. He said, “Okay, I understand this now.” What that points out is you want to buy gold really not because it’s going to go screaming higher. You want to buy it because it’s going to hedge the rest of the things in your portfolio.
My favorite way to do it is to buy it because it hedges the value of your bonds. Gold is never, ever — despite what you hear on those late night commercials, never, ever been proven to be an inflation hedge, but it has been proven to be a great prices hedge and that’s where, you know, you can hedge that against the value of your bonds, which in fact do react to inflation.
Jason Hartman: Why do you say contrary to? That’s interesting in your statement there, contrary to the popular belief, what you hear on late night TV, that gold is an inflation hedge. You say it’s not. What do you mean by that? Just elaborate on that, if you would.
Keith Fitzgerald: Sure, you bet. One of the things you see if you watch all those commercials at night, is gold an inflation hedge and you need to buy gold because of inflation. Really, that’s not true. It’s never statistically been proven to have a valid relationship to inflation, but it has been proven to have a statistical, roughly 10 to 1 relationship with interest rates themselves, which are symptomatic of inflationary pressure. Therefore, the more appropriate use of gold is not the fact that it’s going to go far higher, but the fact that it’s going to hedge the value of your bonds and therefore the income stream and those things kick off.
Jason Hartman: It’s just interesting, and I want to get off this gold topic, but I got to mention one more point because I have some other stuff I want to cover with you, of couse. You ask any gold bug and they talk about the performance of gold over the past ten years, which has been good finally.
Keith Fitzgerald: It’s been extraordinary.
Jason Hartman: But you know, we’ve waited a long time. I mean, you go a couple of decades before, it was lousy.
Keith Fitzgerald: And again, this points to – the term gold bug has some very negative connotations in my mind, one of which is that they invest in gold at the expense of a balanced and discipline investment program with the rest f their assets. If that is your definition of gold bug, for example, I would assume that’s a bad idea because essentially what you got to have is a pyrrhic victory. You got to have everything else go to hell in a hand basket in order to make out like a bandit on gold. On the other hand, if you’re using it as sort of a 5% or 10% allocation in your portfolio, you’re hedging the value of your bonds, you’re using it to preserve value and wealth as many central banks around the world are doing. I would submit that that’s a more appropriate use of gold.
Jason Hartman: Yeah, and I would agree. And so, what I was going to say is if you ask any gold fan — maybe I won’t use the word gold bug, I’ll just say a fan of gold. You ask any of them did the gold go up in value or did the dollar go down I value and they will universally say the dollar went down. Then what did you really gain? All you did is keep – you treaded water, that’s great. It’s better than losing money, but it’s an offensive strategy and that’s really my complaint about it.
Keith Fitzgerald: You know, and there’s something. There’s this one other thing that they need to consider at the moment and I talk to thousands of investors a year around the world about this, is that now, for the first time in history, we have the ability to collateralize trades with gold. What that means is that if the stock market gets into trouble, then very often the institutions, the very first thing they’re going to let go off is gold because it’s highly liquid and then perfect a counter party risk. So, gold, in fact, if stuff does go down, may be one of the very first things that get sold instead of marching higher.
Jason Hartman: Well, that’s a very good point. There will be an unloading of gold, which will actually supress prices initially at least.
Keith Fitzgerald: That’s right.
Jason Hartman: Yeah, a very good point. And I think the same rules apply to silver pretty much, right?
Keith Fitzgerald: Yes, and silver is an industrial metal obviously, so there’s a lot of use for it. But I think roughly speaking, the same rules apply, although silver does not have the relationship that we’ve been able to quantify with bonds and interest rate.
Jason Hartman: Let me take a bried pause. We’ll be back in just a minute.
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Jason Hartman: Let’s kind of switch gears here. Recently, you talked about China and missing its export estimates. What’s behind that? Is that just a sign of things cooling off?
Keith Fitzgerald: Well, a lot of people are interpreting it that way and they’re saying, “Oh my gosh, the sky is falling.” Well, they’ve been saying that effectively for 40 years and for 40 years they’ve been wrong. Now, one of these days they’re going to get right but so far they haven’t and I think that’s very painful because those who have set out China have certainly missed a tremendous run up in the expansion of wealth. But the thing that people are missing is this, is they’re saying China missed its exports and that’s a big deal because it was only 1% versus the 8% expected. Really, what they’re missing is that imports actually – China has got a stated goal, stated policy goals, official government policies and they want balanced imports and exports. People think China lives and dies by its exports, but exports really account for only 2% of the labor force and probably 30% of its GDP. So, that’s not a country that’s going to live and die by its exports. What they should be concentrating on is the imports. Ten years ago, they imported 90 cents on the dollar then it was 95, now it’s 97 cents on the dollar roughly. They will, by 2015, be importing just as much as they’re exporting. That’s going to naturally create surpluses like this in the meantime.
Jason Hartman: In just three years, they’re going to have a balanced trade?
Keith Fitzgerald: Import-export. That’s right.
Jason Hartman: That’s unbelievable, I mean, really.
Keith Fitzgerald: Well, again, this is what – you know, I have been speaking until I’m blue in the face about it for 20 years and I don’t profess to know everything, so don’t get me wrong. But here’s the thing, people talk continually about China being an export-based economy. It is not an export-based economy. A very small percentage of what it produces is actually export. The huge growth in China is due to 1.3 billion people who want what we have and who simply want to have a better life and who are developing their own economy at a speed that is five times ours, with a huge velocity of money flow that is much faster than hours and they’re doing what’s never been done in recorded history, raising the standard of living in the entire country at a speed that we simply can’t imagine. So, we make a mistake of applying western analytics to a market that is clearly not western and we don’t like the results.
Jason Hartman: Well, Keith, that really begs a whole nother area of thinking here, and that is if China really creates their own consumer class – I know they’ve been trying to that and I know they want to do it, of course, that makes sense. Then they can sell their great manufacturing power, can sell inside their own country if consumers have the money to buy. But that leads to a huge potential crisis, frankly, because the way I see it is that they have been kind of beholding to the U.S. to buy our treasuries and they won’t have to do that anymore. There’s already been a lot of talking about that and a lot of resistance, but when they don’t have to do that anymore and we can’t sell our toxic debt like Goldman Sachs is selling their toxic assets, everybody knows we can never actually repay then that propels maybe some pretty significant inflation because all we can do then, the last resort, is just print our way out, right?
Keith Fitzgerald: Well, don’t read too much into them. Here’s how I would push back on that and offer maybe two other things to think about. Number one – this is kind of like a high school thing. We have arrived at the uncertain place where we need China. China has arrived at the uncertain place where they need us. They can no more stop buying our treasuries than we can stop selling them. The two nations need each other because our currency, in fact, gives them the flexibility to produce their growth in any way, shape, and form. So they need that surplus, they need that value and the exports have to continue. That having been said, they are developing at such a speed with such a ferocity and they have so much demand that they have arrived in a space or they have developed a capacity where we are dangerously close to becoming irrelevant in their growth model. Now, Washington doesn’t understand this. Washington continues to [unintelligible 57:36] China and say, “You’ve got to do this and you’ve got do that.” China has never got to do anything. They’ve had the world’s largest GDP for 18 out of the last 20 centuries. They will have it again very soon. And I think smart U.S. companies, and these are the kind of companies I encourage people to invest in. Smart companies are already figuring this out. They understand that they’ve got to localize and they’ve got to go where the Chinese money is if they want the growth. If they just want status quo, they can go to Europe. They can go the many states of the east. But if the want the growth, they got to go to Asia.
Jason Hartman: There are some very significant changes. How do you predict that it will be balanced in three years? Can it really happen that fast?
Keith Fitzgerald: Well, it’s not me. It’s actually the Chinese government. They said this in 2010, they reiterated the goal in 2012.
Jason Hartman: I mean, does it look like it’s really possible?
Keith Fitzgerald: Absolutely.
Jason Hartman: Wow.
Keith Fitzgerald: There’s no question on my mind that they will achieve it. And in having spend, boy, more than my half my career in Asia at this point in time, one of the things I have learned about the Chinese and Chinese government in particular, is they never say anything that they can’t produce. This is already baked in the cake by the time it’s been made public and you allege, you know, as many people do. I run into this argument constantly around the world as will the Chinese cook their numbers. It’s like, really? MF Global doesn’t ring any bells? The United States government doesn’t ring any bells?
Jason Hartman: The U.S. government cooks the books too all the time.
Keith Fitzgerald: I mean, every government cooks the books. The difference is they’ve got $3.3 trillion in cash sitting over, there’s a surplus to pay for all this. They can recapitalize their banking system three times over and still have change. We are trying to print our way out of the whole. It is so deep we can’t possibly see the bottom. These are very different scenarios and I think there – this is not to say China is perfect. There are clearly massive problems over there. They will have their ups and downs. But if you look to our own history, again, it’s like in Fiscal Hangover. They’re a tremendous parallel. They are where we were in early 1900s, late 1800s and Beijing is much like Saint Louis in the 1850s. It’s the jumping off point for a better economy. It’s the Wild West. It’s a chance to expand. People forget that here in this country, we endured two World Wars, presidential assassination, multiple depression and recession environments. Over the last 100 years, the data was still up thousands of percent. This is simply their century.
Jason Hartman: Right, but the dow being up thousands of percent, that’s nominal dollars more – some of them may be real dollars but you can also argue since the federal reserve came along in 1913, the dollars lost 96% percent of its value or so.
Keith Fitzgerald: That’s a very fair point, which is why I continually refer to the need for total return as your investment benchmark. Forget the SMPs actually do. Look at the total return, the dividends plus reinvestment. What has that gotten for you? And the answer is a pretty darn decent return over that time period.
Jason Hartman: Peter Schiff made an interesting statement on CNBC a couple of years ago when he compard gold to the dow and gold to the SMP, and he said since the Great Depression, the only stock market returns have been dividends. That’s it. The rest is just an illusion created by inflation. I’m almost exactly quoting him. And I have my differences with Peter Schiff. Believe me, I’ve had him on the show. He’s kind of a master at the sound bite. It’s a pretty biting sound. I mean, I think he seems to be right about that one. I mean, has there been any real gain in stocks other than dividends? And if you don’t have dividend in paying stocks, then you just try to water like the gold bugs.
Keith Fitzgerald: Yeah, that’s pretty much – you’re treading water, you know, and that speaks to a lot of research we’ve done over the years. My research shows that on average, dividends contribute to somewhere between the neighborhood of 85 and 95% of total stock market returns. Why on earth – and, you know, this is work that’s backed up by Robert Shiller, this is Dr. Jeremy Siegel. They all show similar findings. There’s usually disproportion on emphasis on dividends because they actually produce the returns and the value. So, I look back hundreds of years in market history and I wonder why on earth people would invest in growth stocks when that’s the case. The answer is that Wall Street, in its self-interest, has created this huge – for lack of better terms, this huge marketing lie and hoists this upon the investing public that you’ve got to be exciting and you got to have all this growth stocks. The data just doesn’t bare that out.
Jason Hartman: Yup, I couldn’t agree with you more, the people looking to hit sexy homerun. I’d say if you can hit singles and doubles consistently, you’re going to win the game.
Keith Fitzgerald: Well, you know, there’s a reason why sports coaches know that that’s the philosophy. They’ve got to consistent runs batted in, they got to have consistent field goals, they got to have consistent scoring. The homeruns are nice and they’re fun and they pack the stadiums, bringing fans to their feet. But you know what? They heavy duty hitters hit their fair share every single game.
Jason Hartman: Right, no question about it. You had talked recently about how the Federal government told the banks prepare for claps and don’t expect any federal aid, no bailouts. What did they mean by that? They know something we don’t. It’s a pretty scary statement.
Keith Fitzgerald: Well, you know, that’s an interesting question. One of these things that people don’t think about is, “Oh my goodness! The government told them to do this!” Well, that’s a logical reaction. Now, from a professional’s perspective, every financial institution is responsible for preparing contingency plans and those have always been there. The contingency plans have gotten more detailed and more aggressive since the events of 9/11 and since the financial crisis. But what’s different in this particular directive from the Federal government is that this is sort of like a living will. The Federal government, for the first time, said, “Hey, you guys have to prepare in detail the actions you would take so that you could liquidate your businesses and not blow up the financial system while you do it. This is an idea that is outlined in the Dodd Frank Act, which I think is more like Dodd Frankenstein, but the bottom line is that it’s an attempt by the regulators and the congressional body to get our businesses to act decisively if we have another financial crisis. Now, I think it’s a great step, but the problem is this is more like a financial margin line and probably about as effective. The next crisis is going to be different than the one we’re going through now and until they break the big banks up and put in some regulation that forces them to choose between commercial banking activity and investment banking activity, we’re still at risk. And it doesn’t matter what kind of things we put in, but that’s where that comes from.
Jason Hartman: What do you think of Bill Gross’ recent comment about how equities or debt – I mean, obviously that’s a self interested comment on his part, but what do you think about that?
Keith Fitzgerald: Bill Gross is a fascinating individual. He makes some well publicized calls, unfortunately several of which have been massively wrong and very costly for his investors. For example, in February 2009, he says got out of bonds, you know, those are terrible, they’re going to go away. That cost an estimated $5.7 trillion. February 2012, he said the same thing. Again, a mistake. He’s back in bonds. So, for him to say the death of equities, you know, I can’t tell what’s going on there, but certainly his credibility as a bond manager is $1.4 trillion under management. I disagree. I think avoiding equities is a path to ruin. You know, equities have always involved risk and risk produces return. It’s how you control the risk that matters when it comes to profits and most people have that backwards. The other thing to think about, and I think that gross is missing or simply didn’t have time to get into his comments is this; is that the markets don’t price on growth. They price on risk. Pricing on growth is something Wall Street analysts hooked up to keep you distracted. And so, you again want to turn to conventional thinking on price for the consistency of returns and the consistency of your profits, not necessarily the growth aspect.
Jason Hartman: Can you just elaborate on that a little bit more? You said markets don’t price on growth, they price on risk.
Keith Fitzgerald: Right, and if you think about this – let’s use the bonds for an example because that’s something new and dear to Gross’ world. If you look at bonds –
Jason Hartman: That is Gross’s world. That’s his whole world.
Keith Fitzgerald: Yeah, that’s his entire world, $1.4 trillion worth of his world. Here’s the thing. If people say, “Okay, I can get 3%, 2%, 1% on my bonds, that’s the return of my bond.” Well, a professional trader looks at that and says, “No, that’s the associated with your money.” And so the higher the return, the investors think, “Boy, I can get more from my money.” The trader looks at that and says, “How much additional do I have to risk to get my money back?” The market’s price is on risk. They don’t price on growth. Nobody looks at a stock and says, “I think it’s going to go up X,Y, and Z,” except for analysts who perpetually get things wrong. The old joke is God invented the analyst to make weather forecasters look good. The problem is that really, if you get down to it, this concept of total return and dividends that we talked about, that’s a function of risk. If you control the risk, you’ll get the returns and that’s where dividends come from.
Jason Hartman: Interesting. I can’t imagine bonds would be anything of interest in my view of the world. My view of the world is inflationary. Yours may differ, but bonds just get so –
Keith Fitzgerald: I share that belief. But here’s the thing, right? If you avoid bonds and if you’ve gotten out of them like Bill Gross suggested or other have suggested over the years on the assumption that bonds have bubbled out, you’ve missed one of the greatest bond rallies in recorded history. Now, I think we are dangerously close to the end of that game. I think that interest rates are going to rise and we are going to see inflation change here in the very near term. But before we get there, I think that the crisis in Europe has to unwind. That, to me, says that there’s still the need for additional security and the logical place, the best-looking horse in the glue factory is still the United States dollar and the United States Treasury. That says to me that there’s still appreciation left in the bonds, particularly on the short end of the spectrum. I wouldn’t touch 30-year bonds for all the money in China. I wouldn’t touch those kind of things now and I wouldn’t touch them in the future because those are going to be very volatile. But studies show that if you keep your duration under four, five years, keep that short-term ladder, you continually roll it over, you can avoid 70%, 80%, 90% volatility. The long bond is still achieved, very similar returns.
Jason Hartman: Yeah. I don’t know. That seems to risky for me, but that’s why there are people who are specialists doing that and trading and so forth. I just like my simple thing of own lots of income properties and have lost of debt against them.
Keith Fitzgerald: Exactly, there you go. Again, this is the greatest principle in the book. If you can use OMP or other people’s money, then if you can produce income with that, that broadens and improves your return on equity. I would argue that that’s a good thing to do.
Jason Hartman: And I just cannot wait for the debt to be decimated by inflation. The way I look at it is – we were talking about gold earlier, really any commodity. The commodity will tread water against inflation. It will keep up. It will just be maybe a nominal appreciation and no real appreciation. Maybe it exceed in inflation by a couple of points. and that’s great if it does, but at the same time, you got dividends being spun off by the income of, in this example, of property. And then the best thing of all is what I call and I coined this phrase, inflation induced debt destruction. Say that ten times fast.
Keith Fitzgerald: Oh, my goodness! That’s like unique New York. I don’t think I can say that ten times fast.
Jason Hartman: I said it ten times.
Keith Fitzgerald: I can’t even do it ten!
Jason Hartman: There you go. But then in inflation just come along and pay those debts for you. I mean, if you ask me, that’s the U.S. government strategy with China and Japan.
Keith Fitzgerald: I think you’re onto something. I think you’re very accurate in your comments. I think that is very clearly their goal. They want to have this inflationary piece actually pay off their debts. Now, I think they’re also delusional because unike real-estate, you know, if you buy the right property, you have a lot of variables going for you. Perhaps you get solid income stream, maybe you got some water in your buy, you got a key retail center, you got something that makes that uniquely appealing that’s going to produce hopefully a higher, more stable income stream all the time that can be reinvested and turned into other properties or, you know, other investments. The federal government has got a pile of hundreds of billions, trillions of dollars of shlack on the system and they are operating with assumption they’re going to be able to spin that off and sell it. Well, I don’t know if anybody inside the beltway stopped to figure that if this crap is so bad and nobody wants to buy it, what on earth makes them think they’re going to write it off on the taxpayer’s dollar and then somebody miraculously is going to want to buy it years from now. That just demonstrates to me they don’t understand how real money actually functions.
Jason Hartman: I don’t know if they understand or not, but I think even if they do, some of the 500 plus inside the beltway that do understand, some don’t, and I think buying large, they just think, “Who cares? My time is now and I’m going to keep buying votes with other people’s money,” and that’s the problem with incumbency. That’s the problem with incumbent politician, you know, whether it be Obama or anybody else. They just make more promises and create the money out of thin air to keep them.
Keith Fitzgerald: Well, it’s not only that, but it’s incredibly disrespectful and a disservice to the tax payers, they supposedly lead or support or whatever the word is you want to use. I think it’s incredibly arrogant of these folks to be doing exactly what they’re doing.
Jason Hartman: You know what’s amazing, Keith? I just want to get your thoughts on this final thing and I’ll let you go. It’s amazing when you look at the left of the political aisle, you look at the liberal side, they somehow have the trademark of the compassionate side. You know, we care about other people, we want to give them free healthcare, we want to have more welfare, expand the welfare state, all of the stuff that of course has been proven over and over not to work. We won’t even debate that. And I have no idea, by the way, what your political leanings are as I’m bringing this.
Keith Fitzgerald: They’re irrelevant when it comes to money, but that’s okay.
Jason Hartman: Okay, you’re agnostic in that sense. What’s amazing is I just have to say how compassionate can it possibly be to spend the money of future generations and settle them with massive amounts of debt. I mean, where is the compassion in that? To me, I would just call it selfish, get what I want today, buy votes today.
Keith Fitzgerald: It’s appalling. There’s no other word in the language. I think it can be used to describe what they’re doing. Other than a bunch of four-letter ones that are probably not appropriate for family radio shows. Really, these guys, it’s absolutely criminal what they’re doing and a whole lot of them ought to be removed from office.
Jason Hartman: Yeah. I couldn’t agree with you more. Keith Fitzgerald, thank you so much for joining us today. Great discussion with you. Your book is Fiscal Hangover and you’ve got some other books coming out. Of course, that’s available on Amazon with great reviews, by the way. And your website, that’s keithfitzgerald, and there’s a dash between the fitz and the gerald.com, right?
Keith Fitzgerald: There is a hyphen. It’s keithfitz-gerald.com. But you know what’s the better place to go? Actually go to moneymorning.com and they find myself and all of my cohorts and join, I hope, highly irreverent fun-filled family of investors around the planet.
Jason Hartman: Fantastic. Well, Keith Fitzgerald, thank you so much for joining us today. Great discussion.
Keith Fitzgerald: Thank you for having me and it’s a real honor. I appreciate it.
(Top image: Flickr | aerodesign.pl)
The Jason Hartman Team
Transcribed by: Renee’
