Stanley Druckenmiller, iconic investor, hedge fund manager and philanthropist, will be live at The Economic Club of New York – in conversation with Scott Bessent, Founder and Chief Investment Officer, Key Square Capital Management LLC.
Stanley Druckenmiller: Every Bust I Had Ever Seen Was Preceded By An Asset Bubble
In public and you and Kevin Worf penned an article in The Wall Street Journal this past December outlining why you thought the Fed was making a policy or if they raised rates. And I’m curious what you were thinking then because for the past three or four years you had been urging them to raise rates.
Correct. Well I love to contradict myself. I need to go into a little background with the first part but with. The answer to the first question is. Even though I thought rates were still too low. Relative to maybe where they should have been. By that time period. We had observed that the global economy particularly trade this was. Pre the latest antics. Was starting to slow down and we were afraid it could seep into the US economy. Probably more important in my mind we were in a meltdown in financial conditions and.
Since 1913 when the Fed had been founded the Fed had never hiked with the decline we’d had in the S&P and other indexes going into that. Now. That was the primary reason the the.
Editorial has been way over read and way over analyzed the last two words and it were for now. The Fed shouldn’t hike for now take a pause. And. Just see how things develop. There’s some background though Scott. You’re correct. Let me start from the very beginning. I will go to my grave. And. Often wrong never in doubt. Believing. That. Really loose monetary policy greatly contributed to the financial crisis. There were obviously problems with regulation. But when we had a 1 percent Fed funds rate in 2003 after To me it was pretty obvious the economy had turned and I think the economy was growing at 7 and 9 percent nominal in the fourth quarter of 0 3. And that wasn’t enough for Fed. They had this little thing called considerable period on top of the 1 percent rate just so we would make sure. That their meaning was clear and it was all wrapped around this concept of an insurance cut. The last one an insurance policy but. The history of what I have seen and. I’ve. I’ve. Made some money predicting boom bust cycles. It’s what I do sometimes I’m right sometimes I’m wrong. But. Every bust I had ever seen was preceded by an asset bubble generally set up by two loose policy and the latest one at that time period that had just occurred was obviously Japan responding to our pleas on their own after the Plaza Accord. Setting up the bubble in the second half of the 80s and then we all know what happened in the 90s. So that’s sort of. The background I come at this with.
Students who’ve been good to more recent history this time last year. You’ve got the Alexander Hamilton award from the Manhattan Institute.
And during there is really slim pickings obviously what it was. Nikki Haley was on the other side. So the on it from my looks shoots for stuff since they needed an opening act.
But you said if I were trying to create a depletion Aerie bust I would do exactly what the world’s central banks have been doing for the past six now seven years. What did you mean by that. Yeah so. I think. Bernanke he and.
And the rest of the Fed did an unbelievable job.
Once the bust occurred in 0 9 the QE was aggressive it was decisive interest rate policy everything everything they did was spot on. But coming out of the crisis. And I loved QE 1 coming out of the crisis QE 2 I wasn’t thrilled with. QE 3 I was really disappointed with. And the reason was I was very fearful that. The emergency days were over and the possibility was we were going to set up another misallocation of resources. The most recent one was obviously the one I referred to which was the low interest rates which created the housing bubble. So I mean 2012 came around 2013 2014. Economy kept getting better and better and better. And every time I would give a talk like this which was not very often and everybody said well what would what would you do would you actually raise rates. I said Yeah I would sneak one in every time financial conditions allowed. And hopefully by some point rates will be high enough that we’ll have an appropriate hurdle rate for investment where people won’t be doing stupid things like they have in last asset bubbles. But as you know Scott. We got all the way in to 2014 and 15 and we’re still doing QE 3. And I was just afraid that people were gonna start to do stupid things and indeed they have. I’ll just give you a few things that occurred since 2010. So corporate debt in 2010 was six trillion dollars.
It’s now 10 trillion dollars so it’s grown 65 percent. I don’t know what anybody thinks about that. It’s not necessarily a disaster it depends on what they borrowed. But I would point out that during that same period corporate profits grew from 1.7 trillion to 2.2 trillion. So on a That’s cumulative over eight years. So on a four trillion dollar. Increase in debt we got 500 billion in corporate profits. But it’s worse than that. The interest cost on the extra four trillion in debt only went up 23 percent from four hundred seventy five dollars to five hundred sixty five billion. So think about the horrendous return productivity of capital here. You you increase your debt 65 percent but your interest costs only go up 23 percent. You would think your profits would explode with that formula. They went up. 29 percent. Over eight years not in one year. They compounded with less than a three handle. You might ask why where corporate profits have been great. No I’m talking about total corporate profits not earnings per share which is the other misallocation of resources during that time period. 5.7 trillion buybacks financial engineering versus 2.2 trillion. In capital expenditures. And if you go back to 2010 capital expenditures were 20 percent. I’m sorry. Buybacks were 20 percent of capital expenditures. There are now fifty five percent with a much higher stock market. So you can sort of see where I’m going with this you’re getting a pretty gross buildup in the private sector. And by the way if you look at it the companies that are growing innovating they’re not the ones are borrowing the money.
It’s not Google or Facebook. They’re spending their brains out on innovation. It’s old dying retail companies. Companies with by the way twenty four square feet per capita. In this country and that number is three in Germany and 2 in China. But we have all these zombies walking around so here we are in probably the most innovative. I would say economic disruptive period since the late teen 18 hundreds and you hardly see any bankruptcies because there have been no market signals. From the Fed. Now this is pre the last year we’ll get into that but there’s one other problem with all this. And that’s our government government response to market signals too and the clowns in Washington unless they get a signal from the bond market they’re just going to keep spending. So for the first time in history we have massive deficits at full employment. Estimates are this year there’ll be a trillion dollars. God help us if we get a recession. If you just take the mean of what happens in a recession that would go to a trillion 8 debt to GDP is gone from sixty five to one of five. So you get the drift. So this is where we were going into this fall. I felt that Bernanke and Yellen in particular. There were so many opportunities to just put a quarter end quarter in while financial markets were booming. But fear of deflation. Prevented them from doing so. There is this. Belief at the Fed. That if you’re near the zero bound you’re near deflation and that can cause. You know that’s the boogey man that we dealt with in the 1930s the Japanese dealt with. But I’ve never seen a deflation happen because you were near the zero bound. Everyone was preceded by an asset bubble.
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