Steen Jakobsen: The End Of The Debt Cycle
As we've been watching closely, something is wrong with the big banks. Their shares have lost 25-33% of their market value since the beginning of the year. What's going on?
The turmoil seems greatest in Europe, where bank shares have fallen the hardest, and negative interest rates have appeared with increasingly frequency across member countries.
To make sense of it all, we've invited Steen Jakobsen back on, Chief Investment Officer of Saxo Bank, who can provide an eyes-on-the-ground perspective on the European banking system from his location in Copenhagen:
Clearly what we've seen over the course of the first quarter this year is that the ability of central banks to do their magic in terms of talking to the market with the rhetoric of "low for longer" and the likes is running on empty now.
If we look back in chronological order of what happened this year, first we had, of course, the Fed with Yellen and Fischer backing down slightly from the three to four hikes they promised in December. That was followed very quickly by, of course, Draghi promising to do 'Whatever it takes!' yet again in March this year. Then the BOJ went negative on interest rates and a number of European central banks followed suit. So much so that actually right now if you look at the G7 governments, about 50 percent of all G7 government is now trading at a negative yield, which seems to be the new solution from central banks.
I think the market is seeing right through that because, of course, at the center of all of this at all times will be the banking system, a banking system that is getting penalized for the negative interest rate. Coming from a country which has some experience with negative interest rates, what is really happening to the banking sector here is that, as a depositor, I get paid 0% to have my money in the bank. I should, in reality, be paying 30-, 40-, 50-basis points, but so far I've been cushioned by the banks. That cushion is costing the banks money.
Likewise, that is reason why negative interest rates are not having any bearing in terms of growth. Very dramatically last week I made the headline that, to some extent, in a monetary-policy history perspective, this could be the Berlin Wall coming down because we've had the Greenspan put, then the Bernanke put. But there doesn't exist a Yellen put for a number of reasons. Not because of her, but just because time has run out. So I think that explains the volatility.
The real question for an investor, in my opinion, is to ask yourself: Is this merely the latest "extend and pretend" maneuver, which is about to happen again with Draghi coming full online in March and the BOJ doing another desperate action and the Fed backing down. Or is it the end of the debt cycle? That is the trillion-dollar question right now.
Click the play button below to listen to Chris' interview with Steen Jakobsen (40m:01s)
Chris Martenson: Welcome to this Peak Prosperity podcast. I'm your host Chris Martenson. Well, here in early 2016 volatility has returned to the markets with a vengeance. Perhaps like a beach ball held underwater it has only inevitably returned because it's just long suppressed volatility doing what it does, but perhaps it's something more serious than that. Last week, markets were falling apart, but last night and this morning, they all shot higher with the Japanese Nikkei climbing over 1,000 points from its lows on Friday after falling 11 percent last week. Last week bad news was bad news and this week maybe bad news is good news because Chinese trade data was horrible, and that was good news for equity markets, at least for now.
So how do we even begin to make sense of all of this? Fortunately returning to be with us today is one of my favorite people, Steen Jakobsen, Chief Investment Officer of Saxo Bank. He has many years of deep experience within the field of proprietary trading, alternative investment. He travels widely, reads and writes constantly, and thinks very broadly about the world and where it's headed. Steen, it's a real pleasure to have you back with us today.
Steen Jakobsen: Thank you for having me, Chris.
Chris Martenson: The negative market sentiment hit a fever pitch last week, so was it overblown? Does today's market action suggest that risk-on and buying the dip…are they back?
Steen Jakobsen: It's a difficult one, of course, but clearly what we've seen over the course of the first quarter this year is that the ability of central banks to do their magic in terms of talking to the market to have the rhetoric of low for longer and the like is running on empty now. If we look back in sort of the chronicle order of what happened this year, first we had, of course, the Fed with Yellen and Fisher backing down slightly from the three to four hikes they promised in December. That was followed very quickly by, of course, Draghi promising to do whatever it takes yet again in March this year.
Then BOJ went negative on interest rates and a number of European central banks followed suit in terms of having dovish talk, so much so that actually right now if you look at G7 government, about 50 percent of all G7 government debt is now trading at negative yield, which seems to be the new solution from central banks, and I think the market is seeing right through that because, of course, at the center of all of this at all times will be the banking system, a banking system that is getting penalized for the negative interest rate. Coming from a country which has some experience with negative interest rates, what is really happening to the banking sector here is that, as a depositor, I get paid zero to have my money in the bank. I should, in reality, be paying 30-, 40-, 50-basis points, so far I've been cushioned by the banks. That cushion is costing the banks money. Likewise, that is the reason why negative interest rates are not having any bearing in terms of improving things.
Very dramatically last week I made the headline that, to some extent, in a monetary-policy history, this could be the Berlin Wall coming down because we've had the Greenspan Put, then Bernanke Put that doesn't exist, a Yellen put for a number of reasons, not because of her, but just because time has run out. So I think that explains the volatility, and it explains the hope this week because oil was slightly higher. That drives the market higher, but by the end of the day, we are still—like the last conversation we had, it's still about pretend and extend. The real question for an investor, in my opinion, is to ask yourself: Is this merely the last extend and pretend, which is about to happen with Draghi coming full online in March and BOJ doing another desperate action and the Fed backing down, or is it the end of the debt cycle? That is the billion-dollar question right now.
Chris Martenson: Maybe a follow-up question to that billion-dollar question is: Have the central banks lost control?
Steen Jakobsen: To say they've lost control would imply that they don't have any ability to move the market, but they lost control in a sense that they don't have a model at work. I think to a large extent people are—and we all have been victims of over dramatizing and focusing on central banks. I think it's kind of morally sad, at least, that central bankers are now bigger rock stars than prime ministers and presidents of countries. I mean if you think of a central banker, it's a bureaucrat. It is a person who should be working behind the line, not in the front limelight, and it is a person who should be basing all of the things on ruled-based roots.
Instead they, all now with one voice, are saying we don't really know what's going on, but we will continue to do what we do, if for no other reason, it's better than just having a non-rule-based system. I don't think central banks are bad economists. I just don't think they're ever listening to the reality of a business. You know well as I do, Chris, that business is about incentives and about tax structure. It's about having the smartest people around you because there is a direct correlation between people's intelligence, the average intelligence of a company, the average intelligence of a country. That equates totally to productivity. I think academically the r‑2 numbers are actually 72 percent, so we become dividend-yield chasing investors, and nonproductive people.
Chris Martenson: What an important set of concept you have in there because, as a businessman, I know, yes, you want the smartest people. Intelligence counts, but so does experience. And what you just mentioned is…I look at the FOMC; we went from one academic, came from Princeton, to another academic, currently housed at Berkley. We've got a couple of people with the right law degrees, who were on all of the right committees coming up through. We have nobody on the FOMC who's ever run a business as far as I know, and so let's talk about these incentives.
I have to confess, Steen, I am really confused by what is being attempted with negative interest rates because, if you carry it far enough, let's imagine Japan goes even further. Let's imagine we get to minus 2 percent. Let's imagine I can take a loan out at a negative interest rate. I'll do that all day long, Steen, but I'll take a $10-million loan, earn $400,000 for not having done anything, and I won't do anything. I'll just sit around and collect my $400,000. I don't understand what the central bankers think they're doing. My concern and the question is: Do we have people who are playing with something where they don't actually have the experience or the understanding of what they're really up to potentially?
Steen Jakobsen: Clearly, because you're never going to be able to take out a loan at negative interest rate. I will almost guarantee you that, Chris. Theoretically in the world, the models they have at the Fed and vis-à-vis at BOJ, it shouldn't matter if interest rates are positive or negative. Don't forget, it's just an equation. It's put into a spreadsheet, and it actually has near zero impact on how it works in reality. The reality is, as we've seen in Denmark, that the banks have to cushion the depositors to keep them by not enforcing a negative interest rate. I can tell you, being one of the first countries with negative interest, there's no one in Denmark that pays negative interest rates. What we instead do, and what will also happen to you if you ever go to that sort of lower boundary, is that the fees associated with banking goes up.
So theoretically I agree with you, you can probably borrow at –1 percent, Chris, but I guarantee there will be all sorts of administered fees that will make sure that your actual interest rate will be 1 or 2 percent after the fee. So it's purely a game of assuming in a model. I think that's where the big divided. At least before when they had the ability to lower interest rate, we could see that that was feasible, but Chris, you cannot go deep negative interest rate for all the reasons that you schedule. On top of that even if the model was right and you would be able to borrow at –2 percent, as you say, it would just be another credit boom on top of the single biggest credit expansion in mankind's history.
I mean McKinsey made a report recently where they stated that there's been $57-trillion dollars worth of new debt since the great financial crisis started in '08–'09. Let's just say the number again: $57 trillion of new debt. Very little of their growth you see today is based on productivity, people being smarter. It's very much based on the fact that we service debt, and the system is entirely dictated by a need to create liquidity. When you see the People's Bank of China selling U.S. bonds to finance while they're devaluing the currency, it's all to do with the fact that they want to create liquidity to service debt. I saw a paper recently that stated that 75 percent of all liquidity created by central banks is used to service in-place, existing debt. So think about it. Only 25 percent of all of that new credit that is created is actually being used to give it to you, Chris, as a business person. The rest is being used to keep in place the debt burden of a company, a country, a whole region like Europe.
Chris Martenson: That seems like such an obvious sort of... a conclusion can be drawn from that, which is that there's diminishing marginal returns from credit expansion, but we don't know how to do anything else. I saw that same McKinsey report, Steen. What caught my eye was that they said in 2000 there was $87 trillion of debt outstanding, so, in 2000, right. So in all of human history up to 2000, we piled up $87 trillion, but between 2007 and 2014, that's where all that $57 trillion went on, so that seven-year span accumulated pretty much three quarters of the amount of debt that had been accumulated in the prior 2,000 years, or however long we want to start recording it. That's an astonishing thing. How much of the pressures that the financial markets are feeling is simply a function of too much debt?
Steen Jakobsen: Well, as we're still in lower interest rate, the pain is not really there despite all of the volatility we're seeing. The other thing you have to remember, which is sort of a paradox, the numbers you just mentioned, if you divide that into the amount of assets in the world, you figure out there's actually four-times more credit than there are assets. Most people will argue, well, for every dollar I have in savings, someone else will have a dis-savings right? Of course it's not true because you have the banking system having a multiplier effect on the world economy. So we live in a world where for every one output dollar we need four credit dollars, and that number, as you said, indirectly has been driving dramatically since the great financial crisis started. So the ability of society to deal with a high interest rate is one the conclusion we need to take is zero. I mean we hiked the rates once, and we have a Fed that maintains that they're going to hike further, and the market is about to collapse.
Imagine if rates actually went up for real, which by the way, they have, which is the other part of this story. Policy rates remain low. Policy rates, as we economists call this of course, is mainly central banks but the actual rate you, as a business person, Chris, is confronted with of course, is they have a higher liquidity CCC junk bonds, you could look even at AAA rates. All of these rates have been rising dramatically, and they come with a higher volatility. So not only is it more expensive to borrow money, but since then the money has also become more volatile, and then there's tax on the ability to do it. So we have sort of a very strange world where policy rates and the promises towards policy remains relatively low for longer still, but I think privately the central bank is concerned that the market is very skeptic about the ability of "low for longer" to actually see through into the process.
One thing that has happened since you and I talked last year is the fact that in academic circles, certainly among central banks, the new paper that people are sort of using as the anchor for their academic status, which is the new paper, which is done on Japan. That paper argues, yes, you can have a trickle-down impact on the economy from "lower rates for longer", but if it happens at the same time simultaneously with a relatively restrictive environment, as you have in the U.S., as you have in Europe, and vice versa, the negative impact from a fiscal austere sort of budget is much bigger than the trickle-down effect. So they do know it both privately and academically, but to admit it is a totally different situation for central bankers.
Chris Martenson: Well, if they admit that, it feels a little like they're giving themselves an out, which is like, "look, we did our part, but the fiscal side, those guys, just forgot to deficit spend as much as they needed to." Is that true?
Steen Jakobsen: But isn't that interesting because what is the first thing Yellen and Fisher and Draghi always said at the press conference? It is exactly that. They say monetary policy cannot stand on its own. It has to be supported by fiscal policy.
Chris Martenson: Yeah, well, but I thought... Perhaps I need to study that paper, but my impression of Japan is that they've tried everything. I mean under Abe, have they not also had the fiscal policy there, and did not Japan just recently turn in very dismal readings on their economic growth? So Japan looks to me like, if we wanted to be honest about it, they're a large floating retirement colony. They're losing population. It's rapidly aging. They don't have the fuel demographically for robust expansion, but they still need to create it, not because the people of Japan need it, but the banking system needs constant credit expansion, or it gets very unhappy. Is that a possible way to look at this?
Steen Jakobsen: It is certainly. I mean to some extent it's ending up with a balance sheet recession, which is of course Richard Koo or whatever economist is arguing. I'm just a pragmatic economist, as you know, Chris. The fact is that money doesn't flow, the central structure is wrong, and the policies, tools, and all sort of obstacles will always be to extend and pretend, i.e., buying more time and service debt. As long as we continue that game, we will have massive rallies, we will have massive sell offs, but we will not have a resolution that sort of caters for a better, more productive future.
But I think the beauty is that... To be honest, we're so unproductive today. We're the least productive. We're the stupidest generation in history according to academic papers from the U.S. now. It probably can't get much worse than it is right now in terms of our nonproductiveness. I think technology, I think evolution will take care of it. I think quantum computing will come online pretty soon inside of the next two to three years. So I think there is a solution around the corner.
But I also think we have this phase, the reality phase that comes. You and I, Chris, have both been very critical of where it comes from, but for every two of us, Chris, you will find 90 people who think that monetary policy should be lower for longer and actually it works, and putting praise on the central bankers every day on CNBC, so we are a minority still. I mean we will, ultimately, be right, but we may have to wait for a very long time before the clean out, the cleansing comes, the forest fire that cleans the deck comes through.
Chris Martenson: Well, certainly because unfortunately beliefs aren't changed with information. I think we've got a very faith-based, belief-based system here. That's why I was really asking if the central banks lost control; I'm really asking to what extent is it starting to seep into the wider consciousness that there are actual, real limits to what central banks can and cannot do, leaving aside their own human frailty, weakness, lack of experience, stuff like that, but that ultimately a small committee of appointed people is insufficient to really run a giant, multifactorial, complex system like an economy. I mean, come on.
When we look at that, what I'm coming up on here is this idea that there has been a change in the wind in the tenor of all of this obviously. I think central banks are not out of bullets by any stretch. They've done things that are pretty amazing, but I think they could do more. It sounds like you're saying under all of this, there's a crisis coming, and it might be good for us.
Steen Jakobsen: Yeah. It's very good. I believe in forest fire. Isn't it the Sycamore tree that figured out it was about to be extinct, and they figured out the reason why you, in the U.S., pointed that you had the forest service that stops all of the forest fires, so the Sycamore tree is a good sort of analogy to the markets. We need the forest fire. We need to create new life and clean up the mess in the under forest. It may sound very traditional, maybe sound very _____ [00:17:13], but the fact of the matter is, if you don't allow the business cycles to run, you will have artificial, non-performing loans as we just came from, you will have a steering rate, a policy rate, artificially low, you will have valuations, which are based on Excel, where when you multiply with a number very close to zero you get infinity, and that's not reality.
Reality is if you have to pay higher wages to your employees, it has to be based on productivity. You're not against paying higher salaries, you're just against it as long as they're non-productive. All of the basic rules of economics don't apply anymore at zero bound, or at very close to zero. On top of that, 90 percent of what happens in the media and the reporting, even my very esteemed fellow economists, 90 percent of what they say is simply not true. There so little fact-based analysis going on. There's so little scientific approach to analyzing things.
The other thing you constantly hear in monetary policy is, "Yeah, but Steen, haven't they done that we'll be in a worse situation." I go like, okay, first of all how do we know that? I can't prove a positive negative, right? I think the whole science of markets, the whole science of politics, I think that has dramatically changed. Not only is it a forest fire, it's a true and _____ [00:18:33] sort of in a traditional sense of a paradigm shift. It's a paradigm shift we stand in front of because I think we're going to go back to far more practicality. I think central bankers of the future will be people who come partly from the business side, partly from academia, so you have that common ground of trying to do and do the least amount of damage to the economy. I mean instead they're trying to have the highest impact on the economy in terms of persuading you and me things are fine.
They should have the opposite goal, which is to do as little as possible to unsettle the market-based interest rate, the market-based incentive rule. But of course they're being failed miserably by the worst class of politician ever. Just look at the selection for the American president. If that's not the worst selection ever in history, I don't know what is.
Chris Martenson: Well, sometimes you get the leadership that you deserve. You can engage in some Schadenfreude from across the sea if you want.
Steen Jakobsen: No, no. Listen. Listen, Chris. This is not just the U.S. phenomenon. This a global phenomenon. I could do the same in France with Marine Le Pen. I could do the same in Denmark with what is called the Danish _____ [00:19:41]. I could do it in Sweden, I could do it in the U.K. There is a version of Trump or Sanders in every single country right now. And I think the fact we can find similar characters in every economy also shows you sociology wise, the social fabric is about to give up. I mean don't forget you and I talk about this like it's like the most important thing in life, meanwhile, less than five percent of Americans care about what we talk about. Less than three percent understand what we talk about it. I saw one in the U.S. Today had a number the economic illiteracy in the U.S. is 80 percent.
Chris Martenson: Yeah.
Steen Jakobsen: Chris, so also why is it important. I also think that we need to let people understand that an economy is a good thing. And just a final point, sorry for talking so much; you talk about the multifactored model. I've been doing this for close to 30 years. What I've really learned is this, what I've realized after all these years, is I know nothing about the black-box called economy or the markets. What I can observe, however, is what we put into the black box and what comes out of the black box.
What goes into the black box, of course, is the cost of capital, which I think is the far most important factor in anything you do in life, and the labor cost because everything being equal, human beings are part of the process in a lot of numbers. The output is profit and productivity, and if you observe those four factors, which I think is most important when the cost of capital is going up, the human labor costs are certainly going up in the U.S., number of jobs relative to population is unchanged, and the profitability and the desired terms, so free cash flow terms are and have been negative for the last 18 months. That's not a recipe for higher valuation of stock markets. Yes, the people want to believe that lower interest rate can guarantee, but there is an economic gravity. So instead of trying to understand the black-box called economy and the market, I think we look at the input and the output factors. Both sets of data are actually supporting that we have a correction in the marketplace.
Chris Martenson: Well, absolutely, and part of what happens inside of that black box with all of those incentives that you mentioned on the input side was CFOs came to the very rational conclusion that if they could borrow at one percent and retire stock yielding two percent and goose their share price in the interim with buy backs, that all made perfect sense. But in the meantime, where have been the pieces that are going to lay the fertilizer for the next stage of growth in that forest. So if we go back to that forest-fire analogy, I've got to ask you particularly about the European banks, banking system. Look. We've all seeing the drubbing that Deutsche Bank's shares have taken, but there's much more widespread weakness in a lot of bank shares across Europe at this point in time. My concern is that a little forest fire, which would've been great, I think, to have had a number of years ago, may be a ground fire at this point. Am I reading too much into what's going on? I really don't have any insight into what's happening at Deutsche Bank or why, but I'm hoping you can shed some light there.
Steen Jakobsen: Well, I'm not expert on Deutsche Bank, but I think if you look at the too-big-to-fail European banks, and that universe, it's very clear that the capital structure is much stronger than it was in '08, '09 for sure, but there is a number of unaddressed issues, which is of course the legacy costs from the _____ [00:23:03] scandal, the _____ [00:23:02] scandal and the likes, and then of course the U.S. Department of Justice is always on the heels of these guys. That's number one, and I think a number of these organizations have been very slow to adapt to a new world, and I think that the next phase will be that a number of major names you've been used to seeing in the U.S., they will close down totally in the U.S., partly because of regulation, partly because of the fines, and partly because they never have actually made money in North America. I think the risk and the penalizing of European banks that happened throughout the early part of this year is the fact that people look at the input and the output factors.
So think about it, Chris. If you run a bank and the cost of capital is rising, it could be partly good for banks. Human labor cost is rising is also partly good because it increases the disposable income, but lower profits in organizations means lower bonuses and probably again lower salaries, and lower growth overall, so lower top-line growth, the two great growth engines of the world being China and the U.S., both of them operating at two thirds of what is their maximum capacity. U.S. is barely making two percent and China is barely making six percent these days. They come from China, and they come from nine, ten. U.S. comes from three and change, so top line is lower, cost of capital will reduce the profitability of the companies. Higher human labor cost will reduce the corporations' earnings, everything being equal, less tax receipts, less tax people.
That's why the banks are under pressure in Europe because we come from a lower rate of growth. Having said that, I think that the gap between U.S. and Europe will almost close entirely over the next 12 to 15 months, number one because Europe is having the single biggest impact from lower energy prices over time, being net energy importers. Secondly because the refugee situation, whatever you believe politically about that, right or wrong, you have to remember this is exciting the fiscal impulse we talked about before, which was impossible to institute under normal rules, but now you have refugees that are getting money to spend to buy coats and educational infrastructure investment an increase of nearly, I mean, Germany has one million more people more now driving on the U-Bahn on the freeways and the like, so Europe is going to close the gap on the U.S. in that respect. So you can argue that end of the day, the banking system as you say is entirely dependent on whether we get a forest fire. If it happens, I think European banks are just as bad or just as poor of an investment as American banks will be. For now the market seems, in my opinion, artificially that the U.S. banks are stronger, but having said that, who has the biggest debt margin in the world? U.S. consumers.
Chris Martenson: Yes. Well, absolutely. Let me ask specifically then about Italian banks. I was a bit floored reading in Financial Times that 18 percent nonperforming loans, maybe another 15, 16 percent of marginally performing loans, but the 18 percent alone, isn't a banking system insolvent when it gets to a level of nonperforming loans that are, I don't know, over the reserve ratio plus capital? I mean is there any way to look at the Italian banks besides systemically insolvent at this point.
Steen Jakobsen: See, that's interesting. It's two different business models. Of course, your conclusion from a balance sheet if everything had to be liquidated wouldn't be wrong, but you have to remember a bank is a growing concern as long as they have more deposit than they have outflows, right? That's what makes a bank very different from any other companies. If you ran a company according to the Italian bank's rules, you would've been closed a long time ago, Chris, but the fact is that if you have a central bank, and it is supporting them, they will have access to liquidity. Banks only die from illiquidity. They don't die from bad loans.
They get restructured. It gets delayed. It gets sold off in buckets of risk whatever, so the issue with Italy, in my opinion, is not even a nonperforming loan, it is the fact that about, I think, 80 percent of all government bonds in Italy are owned by pensioners, and it issues U.S. corporate paper indirectly through the banks or banks do it the other way around, right. So you have an interdependency whereby virtue of this interdependency, we have more risk to the sovereign risk of Italy than we had before the crisis because what has happened ever since is that Italian banks have been buying BTPs, the Italian bond market.
They've been selling it to the pensioners and savers of Italy, so they're all dependent on the Italian bond market surviving into a world as you say with, I think, there's about £400 billion or so worth of nonperforming loans. The Italian economy, of course, is much much bigger, but they are, like everyone else, coming back to the argument we keep having here, or the conclusion we keep having. Italy needs to service the debt. Why would we do that? To create more liquidity, ECB goes into negative, and we are onto another game of pretend and extend.
Chris Martenson: So again, wash, rinse, repeat. Here we are. Well, last year when you were with us, you said that 2015 would turn out to be a lost year. I think you nailed that one. What do you say about 2016, then?
Steen Jakobsen: I think that 2016 will be slightly different. I think it will be a year of two halves. I think the first half is always going to be very nasty due to what we discussed, but I think either we go that deep and get the correction and the paradigm forest fire in a many…or we get some desperate policy fiscal to a global plan for infrastructure investments. Don't forget we run a deficit of $3 trillion worth of infrastructure investment every year, which means that, if we don't invest the $3 trillion, we're actually getting a capital stock, which is deteriorating, which can be seen in any U.S. airport by the way, or any New York Metro which hasn't been renewed in 100 years.
Chris Martenson: Yes.
Steen Jakobsen: I think by the end of the year you and I will be laughing at this year, and there will be good things coming out of this year, unlike last year, but right now the market is very, very, very focused on the path of the Federal Reserve, and the market can only focus on one thing at a time. First there was China. I never believed that China would be a real issue. Is China having problems? Absolutely. You see the magnitude upsetting the world like most American economist before I mentioned think? I don't think so. I think China is not a hard landing, it's not a soft landing. I think it's a long landing, it takes a long time, and we don't really understand with balance sheet approach as to what goes on. With China it's oil and it's fed. Oil probably would need to trade 20-22, before this rout is over and they get desperate enough to have a real solution from OPEC. In terms of the global growth engine, both China and U.S. will be slow into the half year, and certainly China will…they constantly are lowering the cost of capital, they're trying to get things rebalanced, so maybe China can be the surprise at the end of the year. We need two things this year to make it an okay year. We need the dollar and China to be doing better than most fund managers in the U.S. seem to think that they can do.
Chris Martenson: Yeah. That's a big open question. I wish I had more insight into China. Peering from the outside just looking at their growth in bank assets from 2007 to current, it's certainly one of the more aggressive, if not frightening, sort of accumulations. It's hard for me to imagine that they got $20 trillion of new loans out of the window, and they were all good loans to make. I think that's hard to do given the magnitude of that compared to their economy, so yeah. Obvious open question. We'll see how they play that, but they've got different tools, I guess, as a command and control economy than we would have. So yeah. We'll see how that plays out, but so much sort of hinges on this idea of global growth. Recession indicators are all over the map. Where do you stand on the chance of a global recession this year?
Steen Jakobsen: I think mathematically it's at whatever, 15-, 20-percent likelihood, which means there are 80-, 85-percent probability it won't happen, but recession is just a technical term. Low growth or deflation is reality. The U.S. ever since the great financial crisis has not managed to have a single year above two and a quarter percent, so we are in a low-growth environment irrespectively, and that feels like a recession to wage earners, to mainstream, to small business people, and to central banks because they continue to be desperate. So I don't really think it matters where we go into a recession, the fact is we are not moving away from a low interest-rate, deflationary environment.
That's probably the way it is with most people. I think second half of this year we will have a reversal of many of these trends. I think the lowering inflation is coming in as we speak because core inflation remains relatively elevated, certainly relative to five-year forwards and the likes of inflationary predictors. So I think all over, Chris, there's no reason to be desperate here or go in panic mode, but we just moved from an extremely overvalued stock market to an expensive stock market. Whether it stops here and then reverses, I, of course, don't know, but I do expect that we will grow to sort of fair value to slightly cheap. But having said that, where would you want to put your money for the next 20 years, with a CEO who wants to make profit, or with the U.S. Government or Draghi offering you negative interest rates? I don't think it's something that works.
So to some extent whether we believe in it or not, as long as we have this negative-interest-rate environment, we need to be investing in equity. Inside equity, we need to invest in--in my opinion, and I think you agree with that--in stocks that are productive. I think the very question you need to ask yourself right now in terms of technology and where to be in the market and stocks is to ask yourself the product I buy, does it have a productivity component? For two reasons. Number one, because that is the survival of the product long term, which is at play, and if you are productive, by the way, you cannot be uprooted by another business model. As long as you're productive, the concept, of course, is that you have a moderate return on your capital, which is positive.
So I think the rules are changing. It may look the same, but I think the rules are changing dramatically, and only people investing in productivity in every single shape and form they can find will be rewarded over the next two to three years, but I do think there are huge amount of opportunities to be had away from supporting governments and their bonds.
Chris Martenson: How do you go about finding a company with good productivity? Are you scouring the financial statements or is there some other process here?
Steen Jakobsen: Both bottom up and top down. I mean early innovators are not necessarily the best. Look at Apple. I don't think Apple has led in anything but design in technology, but they still maintain the highest margin ever in history. But for opportunity terms I look at companies that are truly entrenched in the whole sort of business model of trying to save money for the users. Take Honeywell, who is the world's controlling company in terms of doing intelligent houses, smart houses, whatever. So I think all of these things we need to do more work on. Until now we've just been buying Apple because we like the product.
We invested with our heart, if I can say so, now you need to be doing it with your mind. But for me the standout sort of sectors to look at remain mining, and to some extent, the energy sector because, I think I even touched on it last year, I think that's where the fundamental value is. All of these companies are now priced to failure, and I do believe the weaker dollar will lead to stabilization of the commodity market, and ultimately I think oil will move back to whatever range of $30, $40, $50 on average for the next ten years.
I think the world is being forced into a new recalibration and resetting of the fundamental value. In that process the Unicorns and the like are getting overpriced and manufacturing production companies and the other entities are being mispriced. So for me, that's where I'm looking, Chris. I'm long the GDX index. I like gold for the first time in a long time. I know you like gold always, Chris.
Chris Martenson: Yes.
Steen Jakobsen: Yeah, but I'm actually with you for once, but I would rather buy the mines right now than anything else because I think lower energy cost is helping the mine productivity. They are really reducing CAPEX, which is going to create a _____ [00:36:21] supply and yeah. So I'm looking for tangible assets, to be honest, Chris, and companies that deliver through the tangible asset infrastructure investment, and I think infrastructure investment is going to be huge. Any company involved in infrastructure over the next 10 years is going to make a lot of money.
Chris Martenson: That makes sense, particularly if that fiscal meme gets picked up we talked about. Last question, then. You mentioned you think oil maybe goes lower. Oil at this price is destroying capital for everybody in the shale space. I don't believe for a minute any of these so-called analyses that say they make money at $30. That's true only if you cherry pick wells, but across the average of the entire plays, it's a very simple calculation to run. You only have so much oil coming out of these wells. They cost so much to drill. Your capital costs this. It's easy. By my calculations, you need $50 to $60 oil to make money. Anything under that, you're burning money. I know that there's a bottom coming in oil at some point, but my argument here is that oil has to go to the marginal cost of production, and shale is a marginal cost producing area, so I think we have to get to at least the breakeven for those plays, so I'm really looking for oil to rebound. I just don't know when yet because the supply overhang is really quite severe at this point, but we're only one OPEC decision away from that being reversed, so is it too early in your mind to begin nibbling at this?
Steen Jakobsen: No, no. I'm with you, Chris. I just think when I say it has to go lower, I'm really saying look, just technically I think 20-22 will be perfect, but as you know for the profitability of the industry and for the input to the economy in terms of energy cost, is it the average price for the year, and like you, I'm very, very, very confident that we will move to the marginal cost of production inside of this year and probably hit that as an average price for the year. Of course OPEC can one offset the prices, but as having been someone who lived through the nineteen seventies, when OPEC really was in force, it doesn't work a long time. But the fact is Iran's supply is overstated. The dramatic drop in U.S. ability is not price corrected, so I'm with you, Chris. We really need an average price of $50 for the next 10 years and probably going slightly higher because the last I checked the Earth was round, and we don't get any new sort of land territory involved, so yeah. I’m with you. Actually one of our outrageous calls this year are actually $100.
Chris Martenson: Very good. I'm with you also. The Earth is round. I checked yesterday. It was still round. Thank you so much for your time today.
Steen Jakobsen: In your telescope.
Chris Martenson: What's that?
Steen Jakobsen: In your telescope, I said.
Chris Martenson: Yeah, yeah. These satellites going around. It's amazing. Thank you so much for your time today, Steen. I follow you at TradingFloor.com. Is there anywhere else people can and should follow your work?
Steen Jakobsen: No. That's the perfect place. They put out most of my research. If any one of your listeners should want to be on the daily email list, if it's not too much inconvenience, just write to you guys or send it on to me, or do it on Trading Floor where people can find my name. I'm very willing to share the private stuff with you.
Chris Martenson: Fantastic. Well, thank you. I receive those. They're just wonderful updates. I really appreciate the way you look at the world, and also for taking your time to talk with me today.
Steen Jakobsen: Chris, it's always a pleasure to talk to you, and thanks very much for you and your team for having me on.