Ep 6 - Brian Wesbury - Will Inflation Keep Trending Lower…and Is a Recession Still Coming? - ROI Podcast

In this episode of the First Trust ROI Podcast, Ryan talks with Brian Wesbury, Chief Economist at First Trust about his expectations for the US economy, inflation, and the Fed. 

📚 Suggested Authors to read: Ludwig von Mises & Milton Friedman

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Chapters

• 1:10 Working in the private sector vs. Washington DC
• 2:50 Viewing the economy through a supply-side lens
• 5:00 Keynesian economic theories dominate in Washington…but today, even John Maynard Keynes is spinning in his grave
• 7:12 Government spending programs…China is better at being communists than we are
• 10:07 Irresponsible federal budget deficits…When will Washington develop discipline?
• 13:13 Inflation, M2 money supply…and what’s ahead for inflation?
• 18:28 Impact of the Fed’s shift to an abundant reserve policy from a scarce reserve policy
• 23:38 From the Taylor Rule to the Wesbury Rule…where should the Fed set rates?
• 26:10 Why did the Fed hold rates so low for so long?
• 28:32 Money supply growth determines inflation, not interest rates
• 33:53 Government likes inflation…at first. Then they lose elections.
• 37:12 What sort of recession do you expect?
• 40:21 Is the stock market overvalued or undervalued today?
• 45:27 When stocks are expensive, selectivity is key
• 48:00 What makes you optimistic over the long-term?

Transcript

00:00:13:23 - 00:00:37:22
 Ryan
 Hi, welcome to the First Trust Our Way podcast. I'm Ryan Isa Keenan, an ETF strategist. At First Trust today, I'm joined by Brian Wesbury, chief economist at First Trust. Brian and I will talk about the US economy, the likelihood of a recession, why inflation surged and then has come down in the likelihood that it will reaccelerate, as well as the Fed policy where we go from here.

00:00:37:23 - 00:00:50:09
 Ryan
 A number of other topics. It should be a great conversation. I hope you enjoy it. Joining me today is Brian Wesbury, chief economist here at First Trust. Brian, thanks for joining us on the podcast.

00:00:50:09 - 00:00:52:15
 Brian
 Ryan, It's great to be with you as always.

00:00:52:17 - 00:00:58:03
 Ryan
 So you've worked in Washington; you worked in the private sector.

00:00:58:05 - 00:00:59:06
 Brian
 Don't hold it against me.

00:00:59:06 - 00:01:04:03
 Ryan
 You were chief economist for the Joint Economic Committee of the US Congress. Have I got that right?

00:01:04:03 - 00:01:04:16
 Brian
 You did.

00:01:04:17 - 00:01:14:20
 Ryan
 Okay. So my first question for you is, What is it like to work in government versus the private sector? Is government everything we imagine it to be?

00:01:14:21 - 00:01:38:16
 Brian
 First of all, I'm glad I'm gone. But actually, I will tell a little story. I used to do business radio in Chicago. They have a lunchtime business hour on one of the big AM stations there. And Len Walter was the host, and when I came back from Washington, I started doing his show again. He finally stopped me.

00:01:38:16 - 00:02:11:12
 Brian
 One day he goes, Brian, Before you went to Washington, you spoke sentences. Now you speak in paragraphs. This is a problem. And I made a lot of great friends in Washington, DC, at the Wall Street Journal in politics on Wall Street in a lot of different areas overseas because we got to visit with a lot of overseas economists and Treasury officials.

00:02:11:14-00:02:40:08
 Brian
 So those relationships have stuck with me. Some of the developments from those relationships have obviously stuck with me. I'm a member of a few different groups that I wouldn't be today. However, I will tell you, I would recommend to anyone that they take Milton Friedman's advice, which is to never go to Washington, D.C., to work it. It is especially true with the government.

00:02:40:08 - 00:02:49:00
 Brian
 So big, you begin to think you are the center of the universe. Right. And I think that's a dangerous thing.

00:02:49:02 - 00:03:05:00
 Ryan
 Okay. So one of the things that you do for first trust is give a lot of speeches and a lot of talks around the country. You talk to a lot of investors and investment professionals. What do you think most people don't quite have? Right.

00:03:05:02 - 00:03:39:12
 Brian
 Yeah, this is a great question. Well, I mean, I guess let me put it this way. A lot of the things that I believe to be true about the economy come from Adam Smith, who wrote in 1776 about economists that other people have never heard of, like Ludwig von Mises and Friedrich Hayek, who were both Austrians. Everyone has heard of Milton Friedman, but he was a hero and still is a hero of mine.

00:03:39:14 - 00:04:17:15
 Brian
 But the idea that those economists, if you will, if you put them in a pool and there are many, many others, I, I left that listIshort, are opposed to sort of the Keynesian kind of view of the world. So it's really all about how the world works. Does it work from the demand side? And in other words, we have to have people buy stuff to make the economy grow, or does it work from the supply side, which is that inventions and entrepreneurship are what make the economy grow?

00:04:17:17 - 00:04:50:08
 Brian
 I am a supply sider. It turns out that that puts me in the minority of economists, especially academic economists out there. And that's why I think a lot of people who learned Keynesian economics in school and in academics are missing a lot of where wealth actually comes from, how we produce growth, why it falters, and where recession has come from.

00:04:50:10 - 00:04:58:22
 Brian
 And that's what I think Milton Friedman, the Austrians, and Adam Smith gave us a much better view of than John Maynard Keynes.

00:04:59:00 - 00:05:10:00
 Ryan
 So is it fair to say that in the most, most, most circles in government today, especially in Washington, it would lean more towards the Keynesian school of thought?

00:05:10:00 - 00:05:40:14
 Brian
 Absolutely. Yeah. I mean, if you think about John Maynard Keynes, who invented it really during the Great Depression, he said that when unemployment goes up, people can't spend because they're not making incomes. Right. If you've lost your job, So it's time for the government to spend. And then a lot of Keynesian economists that have followed along have created new kinds of models within this Keynesian framework.

00:05:40:16 - 00:06:05:17
 Brian
 One of them is that if we increase unemployment benefits by a dollar, it has a multi-applicable effect on the economy. It actually increases economic growth by a dollar, and when we're in a recession, we ought to run a deficit. And so if you're a politician, this is great news because it's a free license to spend.

00:06:05:19 - 00:06:37:08
 Brian
 And, by the way, they always spend other people's money. So they love John Maynard Keynes because these deficits, and now we have permanent deficits, are just part of the economic model. I think we're abusing all of this today. By the way, if unemployment was three and a half percent, which it is today, John Maynard Keynes would argue vehemently against increasing the budget deficit because that's full employment.

00:06:37:08 - 00:07:08:20
 Brian
 We don't need I don't think we ever need that deficit in spending. But put that aside. Keynes would say we need it. If unemployment's high, we don't need it if unemployment is three and a half. And yet here we are, doubling the government budget deficit in the last year. And that's what we wrote the other day: this is the least responsible budget we've seen this year, maybe in the history of the United States, because the unemployment rate is so low.

00:07:08:22 - 00:07:13:04
 Brian
 And we also argue that John Maynard Keynes is probably spinning in his grave.

00:07:13:05 - 00:07:38:10
 Ryan
 So there's still hundreds of billions of dollars of these fiscal programs that were set up, especially during COVID. All the different acts—the Inflation Reduction Act, the Infrastructure Act, and the CHIPS Act Right. And those are set to be spent over the next three or four years, even still. So I'm guessing you would argue that that's not a good allocation of resources.

00:07:38:16 - 00:08:00:21
 Brian
 Yeah, I totally agree. I mean, I'm not saying that we shouldn't build computer chips. I think the private sector ought to do it right. In fact, the reason we passed the Jobs Act is to compete against China, which means we are competing against China in the same way China does business. And America is a capitalist country, or is supposed to be.

00:08:00:23 - 00:08:26:14
 Brian
 China is a communist country. You don't want to emulate the economy; you can't emulate the economy. They're better at being communist than we are; let's put it that way. So I think it's a waste. The second thing is there is a way. I do not believe government spending actually increases growth. And I would add that in the long term, I like the medium term too.

00:08:26:20 - 00:08:55:08
 Brian
 In the short term, like we saw during COVID, if you pay people not to work right, it can increase spending when it shouldn't have increased. So I'm not arguing that you can't, it doesn't, and it can't boost growth in the short term. But this year we had so much of that spending happen next year when, when you look at deficits, they always have to keep getting bigger to have a positive impact on the economy.

00:08:55:13 - 00:09:22:03
 Brian
 If they ever get it, you can have a deficit. But if it's smaller than the year before, then it's having a negative impact on growth. So I think 2023 is the peak. It's also the peak of all the money we printed as well. So this is the last year where we're going to see whether those types of spending bills really have any kind of measurable impact on economic growth.

00:09:22:05 - 00:09:51:13
 Brian
 And then what we're left with is all that money printing created inflation, all this bigger government misallocated resources. Because, think about it, if we build $200 billion worth of semiconductor plants, that's $200, and the government subsidized that, right? It sucked $200 billion away from other kinds of manufacturing or investment that maybe we should have done. And that's what happens with government spending.

00:09:51:13 - 00:10:07:19
 Brian
 It distorts investment over time, and I think that slows growth in the long term. That's why I don't think government spending is positive in the long term. In fact, it's negative because it pushes resources to places that are less efficient.

00:10:07:21 - 00:10:26:14
 Ryan
 So it definitely has an impact on the deficit you were talking about. Now I'm curious how it will play out, and, you know, it's in the future, so none of us knows. But do you think that, you know, Washington is going to develop discipline at some point and, you know, these deficits will come down? Will they be forced to?

00:10:26:15 - 00:10:54:21
 Brian
 Yeah, I mean, you would think that what is unsustainable will end right. But I will tell you, I thought it was unsustainable during COVID and here last year, the budget deficit on a cash flow basis. And we won't go into the accounting of the student loans, and all that stuff was $1,000,000,000,000 this year; it's $2 trillion on a cash flow basis.

00:10:54:23 - 00:11:19:09
 Brian
 That's astounding to me, especially when we have $33 trillion in debt. We know Social Security, Medicare, and Medicaid are going to hit the wall within the next ten, 15, or 20 years. And it's almost like they're willfully blind. And that's sort of par for the course for politicians because they only have to worry about the next election.

00:11:19:09 - 00:11:52:16
 Brian
 They don't have to worry about 110 years from now. And so they never address a problem until it becomes so front-of-mind. So it hits the windshield. That's when they address the problem. So, you know, it's amazing. I mean, people have all kinds of conspiracy theories about what the government is trying to do, but it's pretty clear that, you know, building back better, reimagining the economy, or doing a great reset.

00:11:52:16 - 00:12:19:08
 Brian
 These are not conspiracy theories, but politicians all over the world are saying them, especially in the West. Boris Johnson and Trudeau in Canada—all these politicians said these things during COVID, and they really do want to remake the economy. They want to push all these resources towards solar and wind. And for the record, I'm for clean air. All right.

00:12:19:10 - 00:12:44:08
 Brian
 However, I'm also for sustainable growth. And so far, solar and wind cannot replace fossil fuels. And they won't, by the way. We're still going to use more fossil fuels, oil, and natural gas in 50 years, no matter how much they try, because you need to produce all the energy to charge the batteries, make the batteries, make the cars, and all of those things.

00:12:44:09 - 00:13:07:00
 Brian
 And so the point is that they're trying to push the world in a way that it doesn't want to go. And that would be, to me, the real problem here. It's not just the deficit; it's that we're pushing resources in directions that aren't as productive as the ones that the free market would.

00:13:07:00 - 00:13:28:12
 Ryan
 Find, though it's more of a command-style economy that they're advocating for. So I want to talk a little bit about inflation. You were one of the early forecasters that said inflation's coming, and, you know, it had a lot to do with your views. You were talking before about your supply-side views and watching him, too.

00:13:28:14 - 00:13:35:15
 Ryan
 So where we are right now, it looks like inflation has begun to come down. Some people think we're out of the woods. What do you think?

00:13:35:15 - 00:14:04:14
 Brian
 Yeah, this is so Milton Friedman. I knew him when he was alive, as did his wife, Rose. I feel really lucky about that. He taught me to watch him, too. And that's why we were I mean, I'm not trying to pat ourselves on the back, but I don't know many people who beat us to the inflation forecast back in July of 2020. That was when we really started writing about it, and it was pretty simple to me.

00:14:04:14 - 00:14:25:19
 Brian
 They had to print so much money, monetize the debt in order to pay people loans and pandemic unemployment benefits, all of those things. It was pretty easy. When you print that much money, the value of the dollar goes down. And I'm not talking about the euro, the yen, or the pound because they all printed more money too.

00:14:26:00 - 00:14:53:08
 Brian
 What I'm talking about is versus a gallon of gas, a loaf of bread, or a house. And so, that was easy to see. Well, now the money supply is turned around, and as Milton Friedman said, there are long and variable lags, especially with inflation. So when you tighten the money supply like we have done, they finally stop printing more.

00:14:53:13 - 00:15:35:23
 Brian
 In fact, in the past year, the money supply has been down 4% from the year before, which is the first time since the Great Depression. So I would expect that to hit growth. And this is what Friedman said in 6 to 9 months, followed by inflation and 18 to 24 months. Now, having said all of this, the supply chain issues that we had and Putin invading Ukraine, though, don't cause inflation, but they can put pressure on prices in a way that can make the CPI a perfect measure of inflation.

00:15:35:23 - 00:16:09:23
 Brian
 It's just kind of the best we can do. And so, it can put upward pressure on the CPI. I think it probably pushed inflation higher than it really was, but we're down to four and a half percent now. I think we're going to stay around there for at least the next 12 months. If we get a recession and the Fed reverses course, cuts rates, and starts doing QE again, remember, a recession means unemployment will be going up in an election year.

00:16:10:01 - 00:16:36:04
 Brian
 And so that's the scary part for me, because that's exactly what happened in the seventies. The Federal Reserve will go. Oh, no, we created inflation. They would tighten the money supply, and they would raise interest rates. And then that would raise unemployment even more. And even though inflation turned over a little bit, they would get scared and lower rates to start printing money again.

00:16:36:04 - 00:16:59:01
 Brian
 Inflation would never go back to that full 2%. And then it ratcheted back up. And every time they did it, it kept ratcheting higher. So this is why, when Jerome Powell says we're going to do it, we're going to be as tight as we need to be. What he's saying is that we will avoid the 1970s. The jury is still out.

00:16:59:03-00:17:06:22
 Brian
 Is he going to fold like a cheap lawn chair, or is he really going to keep his foot on the brake until this inflation goes away?

00:17:06:22 - 00:17:15:20
 Ryan
 So given the fact that we're heading into an election year, do you think that that will have an impact on the way that the Fed conducts policy next year?

00:17:15:21 - 00:17:45:12
 Brian
 Yes, definitely. I do believe they'll raise rates at least one more time this year. By the way, just today. But we see this all the time. We got housing prices for July 2023, and both of them were up seven, eight, 9/10. both the big measures, FHA and Case-Shiller. But it does matter. These are the two measures.

00:17:45:14 - 00:18:07:08
 Brian
 And this is kind of a shock because it seemed like housing prices were slowing down, and now all of a sudden we get a month where they jump, and this is what I mean by inflation's not gone yet. It takes more than just, you know, ten or 12 months of tighter money to fix inflation. It takes 18–24 months.

00:18:07:10 - 00:18:26:19
 Brian
 And that's why I worry about the election year, because for them to truly get inflation back to 2%, they're going to have to stay as tight as they are today, well into next year, maybe all year. What if we get a recession and unemployment goes up? They'll reverse course, and that's when they blow it.

00:18:26:21 - 00:18:45:16
 Ryan
 Now, one of the things that I've heard you talk about over the last several months that I haven't heard from many other places is the way that the Fed is using an abundant reserve policy versus a scarce reserve policy. And, you know, for those that maybe aren't familiar with that change, can you talk a bit about what that means?

00:18:45:16 - 00:19:12:14
 Brian
 Sure. And I'm going to just warn people a little bit. I think I have found a way to talk about this that makes sense, and I don't mean to discount how smart anybody is, but very few people focus on the Fed as much as we do. And so if you go back to Ben Bernanke in 2008, he changed our monetary policy.

00:19:12:16 - 00:19:40:04
 Brian
 So prior to that, we used a scare reserve model. In other words, the entire banking system needed it to meet reserve requirements. They had 10% reserves in their banks, and every quarter they had to make sure that they met the requirement, and some banks at the end of the quarter would have like 9% and other banks would have 11.

00:19:40:06 - 00:20:05:18
 Brian
 So that one would call up the one with the 11, and they would trade and they'd get their one. And now everybody has ten. And the Fed's happy because everybody's following the rules. And so that meant that banks had to have federal funds trading desks. Okay. So, every bank in the country did, because they all had topped up their reserves, and everybody was always a little lower, a little higher.

00:20:05:23 - 00:20:14:02
 Brian
 And there were just enough reserves—what we call scarce reserves—to have this kind of work out. Well, then that's.

00:20:14:02 - 00:20:16:02
 Ryan
 A market-based rate is what

00:20:16:02 - 00:20:36:10
 Brian
 You're saying. Now, the Fed has influence over it. So you don't want to, you know, forget that if the Fed added a bunch of reserves, they could drive the federal funds rate down. If they took a bunch out, they could. Right. But right, right. But the banks actually traded bids and asks every day. Every day, they traded.

00:20:36:12 - 00:21:04:20
 Brian
 Well, guess what? Banks Today, because of quantitative easing, we flooded the banking system with excess reserves. And banks don't have federal funds trading desks anymore. They don't need to trade them because every bank has excess reserves. And so, at the end of the quarter, they don't. I mean, they're out there. Actually, most banks have about 30% reserves, whereas back before, oh, eight, it was like ten.

00:21:04:22 - 00:21:35:05
 Brian
 So this is how big the Federal Reserve has become. But it's got it. I know financial advisors who left. They lost their job on the federal funds desk, and now they're financial advisors because they had to go somewhere else. They knew a lot about finance. They're great financial advisors. But those jobs are gone. So then the question becomes, all right, if banks are bidding and asking and setting a market for where the federal funds rate goes, where does it come from?

00:21:35:05 - 00:22:01:14
 Brian
 Right. And my answer is pretty simple. The Fed just makes it up. I mean, if you think about it, an interest rate should be inflation plus 1%. If you're the Treasury plus one and a half, if you're Apple, if it's your cousin Vinny's best friend starting a bar, it's inflation plus 94. All right. But inflation is at its core.

00:22:01:14 - 00:22:30:21
 Brian
 The reason I would invest in fixed income or why anybody should invest in fixed income is to protect themselves from inflation over time. Well, if you look at what the Fed has done in the past 15 years during this abundant reserve model shift, they've held interest rates below inflation 85% of the time over 15 years. They held them at zero for nine years.

00:22:30:23 - 00:22:53:18
 Brian
 And no wonder Silicon Valley Bank had had trouble because they thought rates were going to be zero forever and that they could buy a 2% mortgage, a two and a half percent mortgage, or a 3% mortgage and make money. Well, now all of a sudden they have to pay depositors four and a half, five, and a quarter percent.

00:22:53:20 - 00:23:20:15
 Brian
 And those loans only pay them two. And that's why banks are in trouble today, because the Fed officially held interest rates so low for so long that people got used to it and thought this was the new world. But you can't do that. It's like gravity is real. I mean, you can hold a £5 weight up above the ground.

00:23:20:17-00:23:37:13
 Brian
 I mean, you're stronger than me, so you're probably longer than me. But eventually that thing's going to hit the ground because gravity doesn't go away. You can't hold interest rates at zero forever and expect that to last. And now that's what we're finding out.

00:23:37:15 - 00:23:59:15
 Ryan
 So in the past, there's been certain reference points like the Taylor Rule, and there's different versions of the Taylor Rule. I mean, last I looked at, that's something around 6%, maybe six and a half percent. Right. I guess, given that they're maybe making things up, what's the appropriate policy rate? Is there any way to know that?

00:23:59:17 - 00:24:20:23
 Brian
 Or should they be? Yeah. So they tell you it's interesting you bring up the Taylor rule because one of the key parts of his rule, like where should the federal funds rate be, is that he would look at inflation relative to where it is the target rate, and he'd also look at growth, and that would be the real rate.

00:24:20:23 - 00:24:43:09
 Brian
 So you have inflation plus 1%, or, if I use a simple rule, I just use what is called nominal GDP. It's real growth plus inflation. So that gets me. That's what I mean when I say inflation plus one, or inflation plus one and a half. And so the Taylor Rule is just a version of that. It's like we know inflation is important as part of an interest rate.

00:24:43:10 - 00:25:00:09
 Brian
 So if the economy's growing faster, rates probably ought to be a little higher. The economy's growing slower. They ought to be a little lower. But inflation is key. And so his rule has worked really well. I use a simpler rule. I just use the Westbury.

00:25:00:11 - 00:25:01:05
 Ryan
 Rule of thumb

00:25:01:06 - 00:25:27:13
 Brian
 I just use nominal GDP. Yeah, that's all it matters, and I would argue, well, it's zero. When Jerome Powell was holding rates at zero, they were way below the Taylor Rule and way below the Westbury Rule. That's really what we want to call it. But today they're about where they're supposed to be. And so we have a slowing money supply.

00:25:27:16 - 00:25:51:23
 Brian
 They're not tight yet, you know. So if you go back to Paul Volcker, he was way above the Taylor Rule. And that, in turn, caused, I believe, some deflation. I think he was too tight. But today, they're just about right. I think they're going to go a little higher. If inflation falls, then they're too high.

00:25:52:01 - 00:26:17:19
 Brian
 You know, but for the first time in 15 years, interest rates are about where the Taylor Rule says they should be, which is actually good news because they're no longer artificially stimulating the economy. And I don't know whether I'm sorry if I'm jumping the gun on the question I've asked myself: why did they hold rates so low for so long?

00:26:17:22 - 00:26:20:06
 Ryan
 That's a great question. And we tend to ask that.

00:26:20:06 - 00:26:44:18
 Brian
 Question about rates. And one of my answers goes back to what I was talking about, where the government wants to push resources toward solar and wind, like reimagining things. And if you're the government, you have $33 trillion in debt. Right. Who do you want to finance—low interest rates or high interest rates?

00:26:44:20 - 00:27:16:00
 Brian
 And if the Fed can hold them low artificially and get away with it, you want them to do that. So that's part of it. The other thing is that these solar and wind projects pay more for them, which will make sense at 1% rates or then at 5% rates. Oh yeah. And if you look closely at the news, I mean, I think if you go Google, you know, canceled wind projects, you'll find four or five projects that have been canceled.

00:27:16:01 - 00:27:43:01
 Brian
 There are two reasons for it. One is that the cost of a windmill has gone through the roof because of inflation. But number two, the financing cost has gone up, and so the projects that were built during that low interest rate environment are now unprofitable because they're paying more for their interest and the debt that they used to build these projects.

00:27:43:03 - 00:28:11:15
 Brian
 And now they want to raise electricity prices. So so, I think Ludwig von Mises and I may want to go read his books if you have trouble sleeping. But he said that when you hold interest rates too low, you get bad investment, and I think we have seen that, and I think we're not done with banking problems.

00:28:11:17 - 00:28:31:00
 Brian
 We're not done with some of these big government projects funded by government debt problems. I think we're not done with the inflation yet because we were so low for so long. And if they cut rates again and do QE again next year, it's just going to get worse.

00:28:31:02 - 00:28:55:02
 Ryan
 So it's interesting that you bring up the period of ultra-low rates where we had ultra-low inflation. And again, I've heard you talk about this before: the fact that, you know, the Fed policy rate doesn't necessarily have the impact on inflation that we think it does. It's to talk a bit about that. Why do we go through that period of time where we had ultra-low rates and yet we still had low inflation?

00:28:55:02 - 00:29:25:09
 Brian
 Yeah, this is so it's in my view, it's not the rates, so it's not the rates that are determinant of inflation or not, it's the money supply growth. So Ben Bernanke held the federal funds rate at zero for seven years. And yeah, we didn't have inflation. We had one and 2% inflation. Jerome Powell only held rates at zero for two years, and we got 8% inflation.

00:29:25:09 - 00:29:55:18
 Brian
 Right. All right. So what the heck do I like? Is it really about zero rates? No. So what Ben Bernanke did was do all the quantitative easing. He flooded the banks with abundant reserves, then held interest rates at zero. But at the same time, he pounded banks with new capital requirements and new liquidity rules, so that all that money just filled the banks up.

00:29:55:18 - 00:30:15:17
 Brian
 It's like making foie gras. You like stuff the duck with corn and delivers grow, but you don't like it; you don't let it out. Yeah, that's a terrible thing to think about. But anyway, that's what happened. So the money supply didn't really grow in that period.

00:30:15:19 - 00:30:17:14
 Ryan
 It was just the balance sheet of the banks.

00:30:17:14 - 00:30:39:18
 Brian
 It just sat there because they made them hold more liquidity and more capital. And so that was QE one, two, and three, as we always referred to them. I say pandemic QE was four or five or six because it was the same 4 trillion, and we just did it again. But this time, we paid the banks to make loans.

00:30:39:19 - 00:31:18:19
 Brian
 Pep loans were also direct-deposited unemployment benefits so that the Fed could print money and buy Treasury bonds. The Treasury then gave it out in unemployment benefits as a direct deposit in the banks. And so what happened is that this time the money supply exploded, and we printed 40% more dollars. A simple example of this is that if we increased the pineapple crop by 40% and the demand for pineapples didn't change, the price of pineapples would plummet.

00:31:18:21 - 00:31:51:03
 Brian
 And if and only if pineapples were friction-free, they never went bad. And if it didn't cost anything to ship them or whatever, the price would fall by 40%. Money. Pretty frictionless. It's way, way less friction than pineapples. But if you print 40% more money, you're going to get 40% higher prices than would have existed if that hadn't happened. So I believe it's not the rates that caused the inflation; it's the money supply.

00:31:51:06 - 00:32:28:00
 Brian
 And they both kind of work together. But when we switch from a scarce reserve model to an abundant reserve model, we can now move. They used to be way more correlated. Now they move wherever the Fed wants them to. And that's the biggest problem we have now. You know, I mean, I like to ask people all the time how many people trust the CDC and the NIH, and a lot of people trust them after COVID. Don't some people trust them more, I guess?

00:32:28:06 - 00:32:56:13
 Brian
 But a lot of people I know don't. And I'm and I would then tell them they're bureaucrats. So is the Fed. And if you think the CDC made mistakes during COVID, imagine the kind of mistakes the Fed can make. And by the way, money and the value of our money are as important as our Constitution because what we work for and what we save for are all stored in money.

00:32:56:15 - 00:33:22:09
 Brian
 And if the value of money changes, it distorts every decision you make. And that's what scares me about this: they literally have gotten themselves into a position where they control the level of interest rates directly. They just make it up. Well, I mean, think about this. Every time we debate about the Fed, we go, Are they going to raise 25, 50, or 75?

00:33:22:10 - 00:33:32:01
 Brian
 They're going to do it in November, September, or July. What market, for example, moves in 25 basis point increments?

00:33:32:01 - 00:33:32:06
 Ryan
 I don't.

00:33:32:06 - 00:33:51:16
 Brian
 Think so. Apple stock like no one did. No, I mean, I want to go to a Fed meeting and go. How about 31 and a half? And they're going to go. Oh, no, we only move in quarters. I mean, that's just proof to me that they make this stuff up. Because no market moves in quarters. Right.

00:33:51:18 - 00:34:15:20
 Ryan
 You know, one of the things that I remember reading from, unfortunately, I didn't know Milton Friedman, but one of the things I remember reading and hearing from recordings of Milton Friedman was talking about the reason why governments like inflation is that it reduces the real value of the debt outstanding. Do you think that is a part of, I mean, is there a sense that maybe Washington is okay with some inflation?

00:34:15:22 - 00:34:55:21
 Brian
 Oh, yeah, absolutely. It's it in the end, by the way. Just a quick aside, as you were saying, that it's it's everybody needs to read and listen to Milton Friedman for you to choose that old serious. That's great. It's like in his books. I mean, you know, we haven't had inflation in 40 years, and if and if we don't, if we don't go back and remind ourselves or learn about it, and you can with books and video recordings of Milton Friedman and others, we're going to be lost.

00:34:55:21 - 00:35:05:14
 Brian
 So, yes, I knew Milton Friedman. I wasn't. I hope I didn't sound like I was trying to brag. I am just that old. Like so. So and now.

00:35:05:16 - 00:35:07:03
 Ryan
 You're in Chicago.

00:35:07:05 - 00:35:38:15
 Brian
 And I was in Chicago and a member of my parents society and all that stuff. But yeah, so I got lucky, and I was in economics, and my boss knew him really well. And so I got really lucky. But anyway, to go back to this, the government thinks they like inflation, all right? Because at first, when you print all this money, it's kind of like morphine.

00:35:38:15 - 00:35:59:04
 Brian
 It makes you feel really good. All right? And then it wears off, and you get a hangover. It's like caffeine, and, you know, your jam, and for your test. And then once you pass, once you take your test, you pass out because you stayed up all night, you know. And so, it's a fake feeling. And then it comes with inflation.

00:35:59:04 - 00:36:25:11
 Brian
 And the problem with inflation is that voters hate it because it undermines their living standards. And so I go back to the seventies, when we had the last real problem of inflation. Jimmy Carter was a one-term president. If you look all over this country, we had one term mayor and one term governor. I always call inflation political kryptonite.

00:36:25:13 - 00:36:49:07
 Brian
 Peep it. It undermines all your decisions, your planning for retirement, your budget, you know, for your household costs of your vacations, the cost of building their new house. If you're in business, During the 1970s, cost overruns were everywhere. They'd say, We're going to build this bridge for $800 million. And the next thing you know, it's one and a half billion, right?

00:36:49:10 - 00:37:09:13
 Brian
 And that was real money back then. Now it's trillions and hundreds of billions. But the so-called inflation may look good on paper because it devalues debt in real terms. And in reality, it's devastating.

00:37:09:13 - 00:37:31:10
 Ryan
 Mm hmm. Okay. So you've been forecasting that there's a recession on the horizon. Nobody knows until it comes. You know what it's going to be like. But if you had to forecast the severity and depth, what sort of recession do you expect? Is there an analogy that you could point to? Maybe a previous recession might be like, yeah.

00:37:31:11 - 00:38:07:06
 Brian
 Well, it's not 2008. All right. We don't have mark-to-market accounting. We, the banking banks, are not; they don't; they're not squeezed on liquidity. They have abundant reserves. So this is not O8. It's also not the 1999-2000 Dotcom crash. I think there is some resemblance to that in that I remember people in 9899 saying we would never have a recession again today. What I hear people saying is that I was going to save the world.

00:38:07:06-00:38:33:15
 Brian
 Right. which is basically the same kind of thing. It's almost like technology. Back then, it was technology—the Internet, all that stuff. Today, it's A.I. that's going to be the savior. So I see a few similarities. The difference is that by late 1999, the market was over 60%. It was 60% overvalued. Today, it's 30, right? So we're nowhere near that.

00:38:33:17 - 00:38:58:14
 Brian
 I think one thing I do believe is that it's going to feel worse than it will. And here's the reason people don't pay attention to it, too. So we already talked about this. It's like we saw M2 go up in mid-2000. We wrote about inflation for the first time in July of 2020. The Fed said it's never going to happen.

00:38:58:14 - 00:39:18:21
 Brian
 All these other economists said it was never going to happen, and then boom, it did. And they said it was transitory. Then they found out it wasn't. In other words, it was all a big surprise. And so if you don't pay attention to M2, it was a surprise. And I think the recession is going to be a surprise. I just like the inflation.

00:39:18:23 - 00:39:40:16
 Brian
 And so it's going to, at first, be like, okay, what's going on? Why is this happening? The bottom's dropping out, and unemployment's going up. But in the end, I think it's going to be more like 1991. The Fed will cut rates. At the Fed, we have to cut the size of government. That's a different issue for a different day to really get growth back up.

00:39:40:21 - 00:40:06:10
 Brian
 But in 1990, 91, unemployment went to six, six and a half percent, if I remember correctly, whereas in 2009, 0809, it went to ten. So I'm looking for more of a normal, even though nothing we've done in the last three and a half years is normal with all this COVID and pandemic stuff. It's more; that's what I'm looking for.

00:40:06:12 - 00:40:19:03
 Brian
 30% drop in the stock market, six and a half percent unemployment rate. Fed eases. And as we move out of 24 and into 25, we can actually get some growth back.

00:40:19:05 - 00:40:40:14
 Ryan
 So you mentioned the valuation metrics, and that's based, I believe, on your capitalized profits model that your team has published for a long time. Maybe as we kind of wrap things up, if you would kind of give a summary of that and, you know, why is that a good metric? And really, more importantly, how do financial professionals look?

00:40:40:17 - 00:40:43:06
 Ryan
 How do they use that? Right. How does it apply?

00:40:43:08 - 00:41:09:09
 Brian
 Yeah, this is a good question. So we use a capitalized profit model. I'm a believer in keeping things simple. Like, I don't think economics is that hard. Right. And so what are the two most important things or stock values? Number one is profit. I mean all those profits. I'm not saying stock prices.

00:41:09:09 - 00:41:18:19
 Brian
 It can't go up if the company does that. I mean, remember 98, 99, we didn't like profits because we're buying market share, right? Yeah. So you wanted

00:41:18:19 - 00:41:19:17
 Ryan
 Cash burns back.

00:41:19:17 - 00:41:41:05
 Brian
 Then. Yeah. Yes, exactly. And then eventually we found out that that was stupid. All right, so. And then the market collapsed. So I want profits, number one. Number two, we use a discount rate, and we use the ten-year Treasury. So the higher the yield, the less profits are worth. The lower the yield, the more profits are worth.

00:41:41:07 - 00:42:15:11
 Brian
 So so it's, and then we have 70 years worth of data. We know what the profits were. We know what the ten years were. We know what the S&P 500 was. And it's a simple, three-variable model. You give me two; I can solve for the third. We just do it on average. So what that model says today, by the way, is that for 14 years it said we were undervalued and we were bullish forever, and people started calling me impermeable, which, like now, I hope they know isn't true because I'm not bullish anymore.

00:42:15:13 - 00:42:38:23
 Brian
 Because if you put in 4% for ten years, you're worth about $3300 on the S&P, and it's trading at about $4300. If you put a four and a half, I don't even want to tell you what the number is. All Right. And that's where we are today. What I will tell you is that in 2019, I'm going to give total averages here.

00:42:39:01 - 00:43:03:15
 Brian
 The S&P 500 average read a little bit less than 3000. That was pre-COVID. And then we lock down the economy. We borrow all this money, we print all this money, we put ourselves in a worse financial condition, and we have 6 million fewer jobs on average for three years in a row. And yet the stock market was worth almost $5,000.

00:43:03:15 - 00:43:31:18
 Brian
 The S&P went from 3000 to almost 5000. It's now back to about 4300. But my belief is that we could go down to 3000. It's not the same as 0809. And I think once that's done, it's not going to overreact or collapse. It's not that we'll have lower earnings and higher interest rates for longer, although I think they're getting close to their peak.

00:43:31:20 - 00:44:01:04
 Brian
 And then finally, let me just tell you that this model is not a trading model. I would never run a hedge fund off of it. It's an indicator. And what it says now is with profits, as they are with the ten years about where they were overvalued, like we were in 99, but we're overvalued. So I would argue that favor profits need to go up 40% from here for the market to be fairly valued.

00:44:01:04 - 00:44:35:18
 Brian
 Today. We've already had a 100% rise in profits during COVID. I just think that extra 40, and I don't know where it comes from. And so I would argue the downside is greater than the upside; doesn't that mean get short? Like,  that's not what this is. And so we're all close, even though you didn't ask. But the well, the high-value part of the growth stocks are the things that cost too much, the Magnificent Seven or whatever.

00:44:35:19 - 00:45:05:09
 Brian
 Right. There are still a lot of sectors if you look at energy companies versus their contribution to earnings of the S&P; they're way undervalued, as are low-value stocks. So our value stocks, and I just want to remind everybody, look at OH 2122 23 because that was the dot-com crash. The S&P 500 fell, on average, over 20% a year for three years in a row.

00:45:05:09 - 00:45:24:16
 Brian
 Right. Low vol and value both rows. Yeah. So, I don't want people to be out of the market or short of the market, but it is time to be. I hate the word defensive. Yeah, but to move into sectors that are cheaper, right? Than these high fives.

00:45:24:16 - 00:45:36:02
 Ryan
 So I'm hearing you say we should be more selective; maybe don't just buy, you know, the S&P 500. Right. But focus on those areas where there's value, where there may be growth that's not priced in already.

00:45:36:03 - 00:46:00:15
 Brian
 Yep, that's exactly right. The Magnificent Seven are just too big of a share. I mean, Apple itself, I think, has a bigger share of the market cap in the S&P 500 than all the energy companies combined. Yeah, and it's me. I'm not saying Apple is not a great company. Sure, but I don't; I find that kind of incomprehensible.

00:46:00:15-00:46:14:09
 Ryan
 That's one of the analogies to, you know, the 2000 period that makes you think it's so comparable. But with the top heaviness of the S&P 500, it's even more top heavy. It is more than where it is today than it was then.

00:46:14:09-00:46:24:03
 Brian
 Yeah, exactly. And so that's why the model doesn't say to get short. My guess is the market's overvalued, but that doesn't mean every sector is better.

00:46:24:03-00:46:31:12
 Ryan
 Be selective. Maybe adjust your asset allocation because there's some better value in some fixed income than stocks. Right. Is that.

00:46:31:14-00:46:59:14
 Brian
 Absolutely. Yeah. Yeah. And fixed income now, I mean, it used to be you got zero, right? And now you get, I mean, a 5% return, especially when the market's a little overvalued. Overvalued. I don't need to say much. It's overvalued. 5% return, or for four and a half. Now on the tenth year, I don't know if I'd go all the way out to ten because I think interest rates can still go up from here.

00:46:59:16-00:47:31:15
 Brian
 But because I don't think inflation is going to be over, A lot of people think it's going to be 2% by the end of the year. I am not in that camp. And if the Fed reverses course and gets ready, it's going even higher. But, you know, a two year three year rolling bond portfolio in this kind of in the seventies that kind of a23 kind of rolling bond portfolio beat the ten and it beat the three month.

00:47:31:16-00:47:54:01
 Brian
 So it was sort of getting caught at that point on that curve where it goes up. But it's not the cash, it's not the longer rates, and that's kind of where I would be; that's what I want in the seventies, and but I mean, you're actually getting paid all fixed income, right?

00:47:54:01-00:47:58:02
 Brian
 It's really been a long time because the Fed has held those rates artificially low.

00:47:58:04-00:48:11:11
 Ryan
 Okay. So on the ROI podcast, we like to end with something optimistic. You have been accused for a long time of being too optimistic. Now some people are in, well, a recession. Wesbury is saying recession. He's too pessimistic.

00:48:11:12-00:48:11:20
 Brian
 Right.

00:48:11:21-00:48:16:16
 Ryan
 I want to hear some optimism from Brian Wesbury. So what are you optimistic about looking forward to?

00:48:16:16-00:48:42:17
 Brian
 I hear. Here's what I'm optimistic about. And that's really what we have to decide. In my heart, I'm an optimistic guy, especially about America. And the reason I am is because we have the U.S. Constitution. You know, people love saying, you know, democracies fail after 200 years. And it was sort of true.

00:48:42:17-00:49:06:15
 Brian
 It's not exact, but I get what they mean, you know, and if you and there's a lot of people that feel like that about the United States, But what I would argue is that there's only one U.S. Constitution. And like that, the Roman Empire didn't have it. The Greeks didn't have it. Like all those failed democracies during the Peloponnesian War, you know, they didn't have the U.S. Constitution.

00:49:06:17-00:49:29:14
 Brian
 There's only one. And it hasn't failed yet. And I don't think it will. And so I do believe the pendulum will swing back. The pendulum swung. I mean, you know, the civil war in the seventies, in the civil rights movement, like the pendulum swung, you know, FDR in the Great Depression, as far as I'm concerned, was a socialist.

00:49:29:16-00:49:59:17
 Brian
 And yet the pendulum swung back. And I think we're in the process of seeing that pendulum swing back. And that's what will, you know, the federal cut rates, and we'll get through this business cycle. But what we really need is for the pendulum to swing back and slow down government spending. Yet the Fed is on a much more realistic level of interest rates and money supply growth.

00:49:59:19-00:50:02:07
 Brian
 And I think we can move to all-time highs.

00:50:02:09-00:50:19:01
 Ryan
 Man, there's so many other things I could talk about, but size of government being one of them I've heard you talk about, maybe we'll save that one for next time. All right. Thank you for being on the Arrow podcast. I really appreciate it. It's always great chatting with you. Thanks to all of you for joining us as well. We look forward to talking to you next time.

00:50:19:03-00:50:20:09
 Brian
 All right. Thanks, Ryan.