Washington, DC -- (ReleaseWire) -- 10/01/2015 --DAWN BENNETT: Tres Knippa is here has been trading futures in currency markets for 17 years, and became a member of the Chicago Mercantile Exchange in 1996. It's Tres's expertise at currencies that brings him back again today, as I believe there's a currency war going on worldwide that very few have noticed, much less understand. Tres, welcome to Financial Myth Busting.
TRES KNIPPA: Thank you very much for having me. It's good to be back.
BENNETT: I believe most economists and analysts and investors out there believe that the currency war that we are in refers only to the competitive devaluations that nations engage in to boost their economies. At this time, I'm beginning to see that it's much more profound than I think people are giving it credit for. I believe there are differing agendas out there that revolve around one goal, which is the demise of the US dollar as the international reserve currency of choice. Do you think the clock is ticking on the U.S. dollar as the world's reserve currency?
KNIPPA: The clock is ticking, but let's back up a second. In your introduction to this discussion, you mentioned competitive devaluation. Now, me being from Texas, everything's a football metaphor, so you'll have to excuse me. But that implies that some currencies have become weak through an offensive move, as in the Chinese. The Chinese, they devalued the yuan in August. That was an offensive move; they're trying to do something, they're trying to spur exports. But weakness in other currencies can be a side-effect of a government that is mired in debt. Now, clearly that will dovetail into the U.S. dollar discussion, but in a situation like Japan, the Japanese are not devaluing the yen because they're trying to make something positive happen. The Yen is devaluing because they have so much debt that the market does not want their bonds. And here, if you start with politicians, you and I can probably agree that there is a massive disincentive for politicians to cut spending. So it's not going to happen; we can forget that. The politicians are not going to cut spending, ergo more debt will be on the balance sheet. They're going to issue more debt to pay for that spending, right?
BENNETT: Right.
KNIPPA: And now who is there as the savior? The central banks. So in the case I brought up a second ago, a lot of your listeners, they may sit there and go, 'Why do I care about what's going on in Japan?' You should care, because we need to be learning what the side effects of policy are. Now, it used to be that bond markets would equal the playing field; if politicians messed something up, the bond markets would punish them for it. There's no such thing as a bond market anymore. A market implies that you've got a normal supply-- a supply and demand. That is not the case. So bond markets can't push back on politicians anymore, because central banks are going to sit there. In the case of the yen, the yen is not being devalued as an offensive move; it's being devalued because the government is mired in debt, and the world does not want its bonds, so they have to devalue. The yen devaluation is a side effect of all that government debt. Now, when does that happen in the United States? Well, that's obviously a more long and drawn out question. Clearly we've got debts that are not going away, and our debts continue to go up. But in an environment where the rest of the world is all doing the same thing, that makes that discussion of the dollar being the reserve currency a lot harder, right?
BENNETT: Do you believe that a currency should be policy neutral, without any regard to any party to it, so that it can be a true medium of exchange? Do you think that's what we should be doing here in the United States?
KNIPPA: Well, like I said, currency movements tend to be side effects of those decisions, you know. But by the same token, they can also be policy tools. Governments can say, 'Oh, I don't want to cut spending, so I will go this other route,' and, 'A devaluation of your currency, why is that any different to a tax?' Things like that. This will clearly dovetail into a discussion about inflation. So if we want to talk about policy decisions, how odd do we think it is, from a policy standpoint, that Janet Yellen and other central bankers continue to target inflation as a specific policy goal? I find that a little weird. Inflation is a negative side effect. Now, it can be a positive side effect of growth, but in this case, just targeting inflation seems rather odd; why wouldn't you want to target growth?
BENNETT: Do you think there are problems out there that are just too big for central banks to manage?
KNIPPA: Yeah, the problem that is the inherent cornerstone of this discussion is that there is not an incentive for politicians to cut spending. That's a fact. Never mind that you've got second rate economists out there, saying, 'No, no, no. We need to increase spending. That's the way to go.' Well, I mean, how many places have we seen that completely delegitimized, as you can't just spend your way out of problems. Yes, you've got some economists saying, 'Oh, no, we've got to increase spending. It's not enough. We need more debt.' And what's peculiar is that those same economists will say, 'Hey, there is no inflation,' which I disagree with, by the way, 'and bond market yields are very low, so clearly we should borrow. The world is willing to lend the US government money, as the 10 year bond yields something like 2.13%, so that is a low cost of money. The government should borrow it can and finance infrastructure spending and this, that, and the other.' Now, hold on. I mean, that is a little bit ridiculous, because bond yields are low because the fed's keeping them there. Give me a break. Are we to assume that the safest bond in the entire world is the Japanese government bond, because their 10 year bond yields 0.38%? Give me a break. Bond yields are not a market.
BENNETT: One of the other problems, of course, is this raising of interest rates. I think it's important for non-mathematicians out there to understand the dilemma, which I don't think is discussed a lot, which is raising rates from 1 percent to 2 percent, a mere 1 point rise, has the same effect on the cost of money you've borrowed as raising rates from 5 percent to 10 percent. It's a doubling of the cost. I think that that's one of the problems our central banks are facing, and I don't know if they have the guts or knowledge to solve that.
BENNETT: Well, there's actually two side effects to a positive move in rates. Number one is their cost of borrowing. Anything the government wants to borrow, they've got to pay more to borrow that money. That's the way that works, cost of money. Second is the adverse effects to the currency, right? You don't think that Janet Yellen's sitting there going, 'Oh, man. I don't want the dollar to get any stronger.' It's funny if you think about it this way, is the Chinese sit there and go, 'Oh, Janet Yellen, you want to raise rates? Well, that the firms the dollar up. Hey, how would you like a little help? We'll just go ahead and devalue the Yuan.' 'Hey, thank you, Chinese. That was really nice of you.'
BENNETT: To your point, central banks are actually, in fact, individual entities, but everyone needs to know that they often try to coordinate their moves, although I think when push comes to shove, it's going to be each central bank for itself.
KNIPPA: Yeah, here's a coordinated move. When we started the taper, it was when Japan increased their QE, and they also expanded the asset base which they were buying. So now, as the Fed is backing off, the Bank of Japan is picking back up. Wait a second. Hold on, that sounds like it might be coordinated. 'Oh, you guys are going to back off? Okay, well we're going to step in and fill in the gaps.' You bet they're going to coordinate. Why do you think they meet every year and discuss that sort of thing?
BENNETT: Don't you think, going forward, that they're going to coordinate less, and it's going to be each central bank for itself?
KNIPPA: To some degree; we can't speak in generalizations and say all of them.
BENNETT: I agree.
KNIPPA: The Chinese will act selfishly.
BENNETT: Absolutely.
KNIPPA: But I do want to push back on this. There is an idea that the Chinese want to actively try to steal that reserve currency status from the US dollar, and I could not disagree more. Let's start with the basis of what's happening in China. You've got the social contract. The leaders there say, 'Listen, if you let us lead, we'll make sure you get taken care of.' The only way they lose that job is hunger, people are out of work, they're starving, an Arab Spring kind of thing. That's the only way that doesn't work, so the Chinese economy, in keeping all those people fed, it's the only way that they keep their jobs as the leaders. They're not going to risk that. Do you think starting a trade war with the United States over the US dollar, that sort of thing, do you think that keeps the Chinese in leadership position? No, it does not. So them actively attacking the dollar for some sort of desire for a chair at the table of the big world game here, I disagree. They do not need to see the United States not be able to buy their goods and services. That would cause them problems. You'd cause drought, cause hunger, and the leaders there could be tossed out of office. But clearly I'm speaking in kind of broad terms here.
BENNETT: I think something else that needs to brought up is, China is the United States' largest creditor, after the Federal Reserve, and honestly if the Chinese government were so inclined, they could cause Washington DC a lot of serious economic, financial problems. But so far China's pursuing, I think, a more peaceful way. I mean, I think we kind of threatened them, but I do think that they are pursuing the most peaceful way possible. What's your thoughts on that?
KNIPPA: Well, first of all, the threatening stuff, how have we threatened them? 'Oh, you're a currency manipulator.' Well, who isn't?
BENNETT: Right. Including us.
KNIPPA: Yes, including us, or the Japanese. Do we use that strong language? You know, 'Bank of Japan, I can't believe what you're doing. You're a currency manipulator. You're weakening the yen.' Give me a break. I mean, Mitt Romney had that totally wrong when he ran, 'The minute I get elected into office, I'm going to name China a currency manipulator.' Well, who else are you going to name? You know, why don't you point that finger back at yourself, pal? We're talking pretty lofty stuff here, right?
BENNETT: Right.
KNIPPA: I mean, we're talking currencies and we're talking central banks, and your listeners right now might think, 'Hey, why does this matter to me? What can I do?' So let's talk about some actionable items. Let's talk about some actionable ideas. Here's one: short the yuan. Now, I know shorting currencies might not be every listener's ball of wax, and there are ways to do it through ETFs and a variety of other factors, but do I think that the yuan devaluation is over? Will the Chinese continue to devalue? You bet they will. So they have not stopped, never mind can we also learn from the Chinese? In August, they came out, they devalued the yuan, and they said, 'This is a one off event.' Okay, well that was proven to be a lie within 24 hours, because they devalued the very next day. How odd. So do I believe that those devaluations will continue in China? Yes, I do. So I love the idea of shorting the Yuan. And in addition to that, I think that the yuan goes easily into the double digits versus the dollar before this is all said and done.
BENNETT: What, though, are your ideas about U.S. markets? Now, again, I'm going to go back to raising interest rates, because I think it's a dilemma that isn't discussed a lot out there, and we've talked about it; it's going to double the cost of borrowing, just to go from 1 percent to 2 percent. And remember back in the 1930s, we had extremely low rates and we had a very difficult time raising them in 1929, 1930. So we've been there before; we didn't succeed. And I think that if they do it again, we are going to get some type of liquidation event in the markets, worse than the problems we saw in 2008. What are your suggestions for that?
KNIPPA: Any rate increase will be muted. I know that you've got some listeners out there right now that are fixed income investors. They are begging for rates to go up. Now, Janet Yellen looks like a grandmotherly kind of lady that might make good cookies and things like that, but the simple fact of the matter is that she's trapped. And I can tell you right now, I'm 45 years old, which puts my parents in their 70s, and there are a lot of your listeners out there who are desperate for some yield; you can forget it. Any increase in rates will be very muted, and by the time Janet Yellen leaves office, quantitative easing will be higher than when she first took office. Because any adverse effects to the economy, any hiccup along the way, will immediately bring back QE in the United States, and that day is coming. So any rate increase will be very, very small, it'll be very, very short term. She doesn't want the dollar to be too firm, she doesn't want to increase borrowing costs too much, and the rate increase will be muted, and then she'll turn right back around, slam them down to zero, and QE will come back. That'll happen.
BENNETT: Do you think there'd ever be a time when demand for American debt gets so bad that interest rates start rising, regardless of what the Fed intends?
KNIPPA: The bond market is no longer a market, and you're implying that the market should be pushing back on those decisions, and it will eventually. But I'll tell you where that'll come from; that'll come from the currency market, which I can elaborate on more.
BENNETT: I keep thinking about all these months and months of non-stop talk from the fed on whether they're going to increase rates, even just 25 basis points, and their lack of action. Does that show us how fragile our economy is?
KNIPPA: I believe so. Or why don't we expand on that and say aren't we supposed to assume that Janet Yellen thinks it's fragile, right? I thought the whole idea of QE and keeping interest rates so low was supposed to make things better. Well, did it make things better? And if so, why can't we raise interest rates back up? So we are going to be in a prolonged period of very low rates. We talked earlier about wouldn't it be nice if markets responded like markets, and yields went up because people just didn't buy that debt, they just didn't buy it, and bond markets went down and yields went up? All you've got to do is go on Google and search for bond yields around the world and realize that our yields are actually kind of high. And I realize that it's odd that a 10 year bond yields 2.1, but if you start going through Germany, the rest of Europe, Japan, etc., etc., you've got lower than ours. So that in and of itself supports the dollar, thus makes Janet Yellen that much edgier about making our rate any higher at all, right? So that's the very odd position; we are sitting in an economic no man's land here. But to your listeners, if you think rates are going up, I strongly disagree. And what I think people need to start doing is-- I do believe there's a significant amount of capital that doesn't want to chase the stock market looking for returns there, doesn't necessarily want to do something in real estate, because they view that to be illiquid, or whatever. And you're going to have to find alternatives, you're going to have to be creative, you're going to have to work in it to find those yields. I mean, I don't think the market's going to take care of you and change anytime soon.
BENNETT: David Stockman said last week that the Fed is waging a personal jihad against savers. And indeed, it's just hard to see many ways for savers to earn a safe return on their deposits, when interest rates have been so low for almost a decade now. So if simple compounding interest no longer enables seniors to save for retirement, what can people do? How do savers earn a return during this era of quantitative easing slash zero interest rates?
KNIPPA: You're going to have to seek alternatives, you're going to have to be creative. Obviously, you're going to have to look into real estate, but not individual real estate, that sort of thing. And I had an opportunity that got thrown into my lap as a problem for two parties. By the way, my idea is not appropriate for everybody, everybody has to evaluate their own risk and that sort of thing. But what I did is I created an instrument, because in Texas we've got deregulated electricity, and because of that, you've got sales people that go out and sell electricity contracts, typically about a three year contract. Well, they get paid those commissions every single month, as those electricity bills are paid, in a commission. Well, in some cases, some of those brokers that are selling those are willing to discount those cash flows that are coming directly from utility companies, licensed, regulated electric companies. They're willing to discount those cash flows. So I started buying those discounted cash flows, and then the idea popped into my head; why wouldn't I aggregate those into a portfolio and sell notes against those? So the terms of that-- that company's called Bandon River Capital. And there's bandonrivercapital.com, and it talks about a lot of this that I do. But I'm offering a four year note to investors that pays 10% and starts returning their principal monthly, and giving them monthly incomes, starting in the second year. And all I'm doing is I'm buying discounted cash flow.
BENNETT: Tres, what's the downside to this?
KNIPPA: It depends on the circumstances. I would have to talk to each individual investor and explain to them where I've identified the risk. But the biggest risk is that if you had a massive disruption to the electric grid—I'm going to get paid commissions and I'm going to buy, and if people aren't paying their electric bill, if people aren't buying electricity, that would be the biggest risk. So what I try to do to mitigate some of that is spread my cash flows. These things are not that big; they're only averaging $6,000 a piece. But I'm going to buy thousands of them and create a portfolio of them, and then sell those notes against the entire portfolio. I'm separating that out over geographic areas. You know, like, you wouldn't want to concentrate it right in a hurricane zone. I don't want to buy a bunch of deals that are all in New Orleans, and suddenly the electric grid goes down, businesses go out of business, etc., etc. I want to spread that around. It's called portfolio risk. You talk about that on your show all the time.
BENNETT: All the time.
KNIPPA: It's not being concentrated in one area.
BENNETT: Thanks so much, Tres Knippa.
KNIPPA: Absolutely.
All data sourced through Bloomberg
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About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
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Dawn Bennett, Host of Radio Show "Financial Myth Busting," Interviews Tres Knippa, Member of the Chicago Mercantile Exchange