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Stagflation Is Coming Soon, Staying Awhile: Axel Merk (Szn 4, Ep 25)

Last updated on October 19, 2022

This podcast episode was recorded on Sept. 16, with a short highlight clip containing the most actionable items released to premium subscribers that same day. The full episode was released to premium subscribers without ads or interruptions a day after recording. 

Axel Merk, president and chief investment officer at Merk Investments, joins the podcast to discuss his views on stagflation, the Federal Reserve, U.S. dollar, and why the bottom is not yet in for stocks.

Content Highlights

  • Printing money does not fix supply issues. Next stop: Stagflation (2:59);
  • The current environment simply is not conducive to taking risks (11:15);
  • There’s too much groupthink at the Fed and it’s time for Jerome Powell to step down (13:21);
  • The bottom for stocks is not in yet. The Fed needs to pivot first. What to watch for there (15:26);
  • Background on the guest (24:43);
  • The outlook for gold (31:20);
  • How high might the Fed go with interest rates? (34:09).

For More Information About Axel Merk

Quick Video Highlights From Our YouTube Channel


Nathaniel E. Baker 0:35
Axel Merk of Merk investments, thank you so much for joining me contrarian investor podcast today. I’m very thrilled and honored to have you on the show. And we are here to talk about a bunch of things. And what I wanted to kick off with is this idea of stagflation. The idea is nothing new. The fact that people are talking about it is nothing new. But your view is that the stagflation that we may get, are going to get potentially, is going to last a decade or more, not just a couple of years, like I guess it did in the 70s. So please tell me about that.

Axel Merk 1:16
Sure, great, great to be on your program.

Nathaniel E. Baker 1:18
Thanks for coming on.

Axel Merk 1:19
The great inflation actually is defined, I believe, from the late 60s until the early 80s. A chunk of that was stagflationairy. And many people think about a stagflation or a shock where properly right COVID is a supply shock, stagflation or a shock, war in Ukraine supply shock. The reason why these shocks don’t just fizzle out, the moment the economy opens up again, is because of the human factor. The when you are faced with a supply shock, the politically attractive thing is economically counterproductive. And so everybody knows that, oh, we have supply shortages. Everybody’s locked up. But everybody needs help. So we write them a check. Right. And so guess what? Printing money does not fix the supply issues. Europeans are just discussing an excess profit taker windfall tax on non energy companies. Well, guess what? That discourages supply. Right? And so any which way you turn from and think about it from a politician’s point of view? Right? It says we don’t have enough supply? Well, let’s How about we make it more difficult right to work. So that right to consume goods. Politically, it is just the attractive thing to do is the counterproductive thing economically and, and Bernanke, the former Fed chair, he talked about how, when you’re faced with high inflation, you don’t just go back down to low inflation. And there’s a reason for that. And the reason is that there are ripple effects. high inflation has consequences, you you enter an era of instability. And Bernanke argues that we’re not so much smarter now than in the 1970s. But we’re still human. And we also human at the Fed. And I trust, we’ll talk plenty about the Fed here. As you may be aware, we launched the stagflation ETF in May, not because it’s we think it’s a three month product, but because we think that they’re going to be many years of that sort of thing. And that creates numerous challenges for investors.

Nathaniel E. Baker 3:39
Okay, so stagflation is the combination of inflation and low growth. We have the inflation piece. The Fed, however, is raising rates. And you don’t think that’s going to do anything, you don’t think they’re going to be effective in bringing down inflation?

Axel Merk 3:54
Well, first of all, when you raise interest rates, you’re throttling growth. Again, you’re not increasing supply, which is at the core of the issue. Now, historically, and obviously, when you’re throttling supply, it’s an indirect way, also reducing inflationary pressures. The question is, how much will they achieve, and they give us all this tough talk that they’ll do it. I’d like to remind people that even Volker who was very successful in killing inflation, he got inflation down to about 4%. And it took several years for inflation to get down to 2%. So it’s certainly not an easy task. We have so much more leverage in the economy. And what the Fed wants to do. Of course, yes, they want to have the soft landing, they want to hike rates gradually and steadily and throw things down. The problem with that is that’s not how life works. Right? When you when you push the brakes enough, at some point, some wheels are going to come falling off. And ultimately, financial stability is what the Fed cares about more so than anything else. And So let the high yield spreads blow out completely have some sort of shock in the market. At that stage, there’s only one way that the Fed can react and come to the rescue is with a fire hose. And I’ll come back to that. But you mentioned the dollar earlier when we talked about the dalai come back to that as well. But but it’s just there. Yes, in a textbook environment, they raise rates economy slows down, we got 2%. Real life is not like the textbook. And that’s that’s big. One of the big, big challenges that the Fed has.

Nathaniel E. Baker 5:33
No question. Couldn’t you argue though, the fed back in Volkers day was faced with much more persistent inflation, dating to the 60s, as you said, and nowadays, this was really just a one year thing or two years or so. And therefore, this was just a little inflation shock brought on by COVID. And that it should therefore make the Feds job easier.

Axel Merk 5:54
While we got high inflation, once you have high inflation, it’s an unstable dynamic that you have unleashed. Now, there could be things that you could do, for example, you have a labor shortage, well, open the floodgates of immigration, legal or illegal doesn’t really matter from an economic point of view. That reduces the labor shortage. The Germans by the way, they got all the Ukrainians coming in the unemployment rate went up. Because they got more people in the labor force, they’re trying to allow them to to participate. That’s a choice politically, I hear it’s a bit dicey. Right? You could give a gazillion permits to start drilling for oil and other things. I don’t hear that happening. But politically, the things to do to ease supply shocks are just politically very, very difficult to do. And, and so yeah, the thing you’re pointing out that it’s not like the 70s, that is, of course, correct. And let me just without getting too technical, when you look at the market there, of course, longer term inflation expectations, and they have come down of light. That said, Nobody you don’t, I doubt the market, the Fed, nobody knows what inflation will be 10 years from now. And so when you look at these longer term inflation expectations, they are really a reflection of the confidence in the Fed. And so in that sense, you are correct, that the Fed has an easier job than they had in the 70s, because those long term inflation expectations are reasonably well anchored. But that doesn’t mean they won’t do anything stupid, right? The Fed has rarely ever been accused of worrying too much about the next problem. They’re always worried about the current problem that we have. And Mervyn King, the the former head of the Bank of England, I think said it properly. It would be good if central banks pursued policies that help anchor inflation expectations, rather than pursuing policies that rely on the fact that the market trusts the Fed, and then see what to get away with. And the Fed has done too much of that, in my view, we don’t have what I would call intellectual leadership at the Fed. Right, the the leadership we got is a 10 Minute Talk, that there will be pain in the markets. Well, that that’s a good gimmick. Right. That’s a good gimmick, and it got the message across. But we we don’t have we still have the official framework of this idiotic, idiotic is a CFA Level four term, backward looking inflation framework to manage forward inflation. We’ve been told that forward guidance is dead. And what we get forward guidance from all the Fed presidents and even from Powell right there. That makes it very difficult and, and the Fed is lucky that and Krugman by the way, he points out, Hey, we we don’t need to raise rates as much because look at inflation expectations are still anchored. Well, if the Fed would wait until inflation expectations are not anchored. Yes, we would have a much, much bigger challenge in our hand, and we have right now. So in that sense, it’s easier, but don’t kid yourself. They don’t have an easy task.

Nathaniel E. Baker 9:06
So how do you see this playing out with the Fed raising rates now, the growth? I mean, other than maybe housing and mortgages hasn’t really come down. And you mentioned employment. I mean, we’re basically at full employment here in the US just about as close as we’re gonna get probably, and the consumers out in force. I mean, notwithstanding what FedEx said yesterday. So but how do you play it? How do you see this playing out? How long before they the consumer gets affected by these higher rates? And the economy starts to roll over?

Axel Merk 9:35
Well, I think your question implies some linearity. And I think that’s what we need to go out of the window. Okay. We’re gonna have an unstable dynamic unleash. One of the things you see in the markets is that many people don’t take strong positions. Our people are not as levered as they have been. And that’s because smart people, reasonable people don’t know we I don’t know how exactly this is going to play out this can go any which way. I look at things from a risk perspective and what risks I can take. And I’m taking much less risk than I used to and so many others, because this can go any which way. I mean, the Fed could be lucky that yes, things will fizzle out, we’ll live happily ever after. I cannot take that as my baseline. To me, that’s, that’s too dangerous. And so we have to be aware that once you have high inflation history shows, because it could be that for several months, at some point, inflation is going to come down. Well, if you declare victory, guess what the next month, you got to get whacked again. Right. And so that’s the sort of challenge that you have. And that’s precisely why you need intellectual leadership. Larry Summers pointed out, we only really get out of this, once you have a new framework. And since the current folks at the Fed and other central banks, by the way, as well, the only thing they have done is blame the model and saying while it was a tough environment, but give us if we don’t have a change in leadership, either intellectually, politics, that’s not coming in person, we cannot really move forward, right. That’s why it took the volca to come in to break the mindset and have a new philosophy. There’s too much groupthink at the Fed. And it’s been fostered as part of that institution. And so it’s very, very difficult for me to to assume that it was going to work out just fine.

Nathaniel E. Baker 11:22
But seems to imply that Jay Powell is not going to be there much longer.

Axel Merk 11:26
Well, that’s my opinion that he that it is time to have to move on. But I don’t really see him motivated to to to take my advice, right.

Nathaniel E. Baker 11:37
But Biden can can replace them?

Axel Merk 11:40
Well, yes. But Biden just says, ‘Hey, inflation is the Fed’s problem, let him deal with it.’ And for that he is not involved enough. And by the way, by Powell and Yellen or Yellen is going to leave probably at the end of the year. But I, yeah, who knows i He doesn’t strike me as a guy that makes a tough decision like that, right? Especially he was here and the Democrats that scold that Trump, rightfully, by the way for interfering too much with the Fed. And so Biden replacing a Fed chair, his advisers are going to tell him now, so I don’t think that’s going to happen.

Nathaniel E. Baker 12:18
But I mean, it looks a little like the the politicians have been kind of setting things up a little bit, some of the comments that you look at to have Make, make Powell The Fall Guy for inflation, if it persists, and then maybe move to replace him as a political move, who knows maybe after the midterms?

Axel Merk 12:40
In history, you always love to blame the Fed for your own problems, right. And you’d like to have the Fed solve all your problems. And the you pile on more responsibilities. I mean, the Fed should be doing less, much less rather than more. And so you, I’m just saying that I don’t see it and in in Biden’s constitute take that initiative, because it would be seen as interference and so forth. So they let them run. So and unless Powell yields himself, I don’t see that happening. And then by the way, I’ve talked in with talk with former Fed officials, and they, they tend to share that.

Nathaniel E. Baker 13:15
Okay, well, you know, better than me then. Perfect lead in to the next question, which was one of your talking points that was sent to me, which is that there’s the bottom for stocks is not in yet. You mentioned before that you’re more risk averse than you were maybe a couple years ago or so. So talk to me about that. Why isn’t the bottom in?

Axel Merk 13:33
Well, historically, markets bottom about two thirds through a recession. And we’ve had this political argument of whether we’re in a recession or not. Just on that note, keep in mind that the GDP numbers are released, with the third month really being a guessing game, we don’t really have those numbers. Also in the US, it’s a committee that decides rather than just to negative GDP growth, and with the exception of GDP growth, all the other indicators that they watch were positive. So it’s not officially a recession. And if you look at past recent and independent on whether it feels like a recession or not, but if you look at how the risk markets the s&p has performed, versus the officially classified recessions, the the bottom not always, but tends to be towards two thirds through the recession. And if I look forward to where we are in the economic cycle, some things are good, some things are falling off a cliff, we will get to a recession. But at this stage, I don’t think the official recession has started yet. And I certainly don’t think we’re two thirds through this. We don’t even know yet where the light of the tunnel is right? We usually we bottom when there’s a sense of the Fed pivoting for one reason or the other. And we’re not there by any stretch of the imagination.

Nathaniel E. Baker 14:54
When do you see think the Fed can pivot?

Axel Merk 14:57
Well, when the wheels fall off, then the Fed will pivot. And we don’t know when that happens that can happen, of course and on short notice. But the thing to watch for is the one of the one of the many things we can watch for is the foreign exchange lines that the Federal Reserve gives when federal and the Federal Reserve’s comes to the rescue of other central banks. That is, that is a sign that enough is enough, we need to make sure that this world is functioning. And you mentioned the reduction that we’ve been talking about the dollar that may be the big secular change in the dollar that we finally have, have come to an end of the dollar squeeze. And the Fed is providing the liquidity for for an unleashing of, of a reflation airy environment, right. So that to me, is is an obvious point to watch what might be others, but that that will be the most obvious pivot point.

Nathaniel E. Baker 15:55
Yeah, talk me through that. So first of all, where is this data available?

Axel Merk 15:58
they publish, the data balance sheet of the Federal Reserve shows the swap lines that they have extended to foreign central banks, and currently Daniel zero, the during the financial crisis, they were ramped up during the COVID crisis, they flared up. And so they happen during during peaks in crisis, right, foreign central banks have to deposit collateral with the US. And during COVID. They extended that to just about any country, rather than just a select few. politically very controversial. And, but but from a from a market signaling point of view, it means the Fed means business, right? They got to help out. So it’s more than little QE or this or that. But that means that there is serious stress in the global banking system. And that’s ultimately what they’re in business for. Inflation is all good and fine, but you don’t want the global financial system to implode. And we know the tools that they use. And those swap lines is a key to that.

Nathaniel E. Baker 17:04
And so they would use that to weaken the dollar, because the strong dollar, will

Axel Merk 17:08
they they would do that to provide liquidity to the system, right? Okay, the side effect of that is in the context of the dollar to to just take a step back, during an economic expansion, following us borrow US dollars, to invest. And so it’s the US dollar is like a huge carry currency in that sense. And that means it’s really, when you when you borrow in dollars, as a foreigner, it’s a short position on the dollar, because you short the dollar to get your currency. And then when you’re in a crisis, there’s a short squeeze, you reduce your leverage, and it happens to individuals happens to countries, which means they have to buy back the dollars. And that’s why you have this dollar go up in the crisis. And that goes until the policymakers say enough is enough. Now, this could be interesting, because we might get a little noise in this, the the Bank of Japan has indicated they might interfere the markets and whatnot, and depends on what scale they do it, my guess is, it’s going to be as much of a disaster as last time they did it, which is then just an opportunity to sell again, again, they just put it on sale, so to speak on by briefly, and you can double down. But if it’s a if it’s induced by a real crisis, you could see a more proactive effort. And to me, that would be a signal that the mindset of the Fed has changed.

Nathaniel E. Baker 18:28
Interesting, and we’re starting to get there you think?

Axel Merk 18:32
Well, it’s like any crisis, right? I mean, it’s gonna whack you at some point. And it’s rare that they tell you next week on Tuesday, the crisis is going to be there. But at the same time, when you have markets tumble 1000 points a day, you’ll suddenly have that that precondition. Now one reason why this may last late come later, is as I mentioned earlier, people have less leverage than they have been, because everybody knows this is kind of difficult, difficult environment. And so on the margin call side, it’s gonna be potentially less severe. And but you only need a survey of some institution somewhere with ripple effects, right? You You never quite know where the broken link is. That’s why it’s so difficult to say when that’s going to happen. But what I do know is that as the Federal Reserve raises rates, the odds of these things happening steadily increase disproportionally so and by the way, that is a key reason why forward guidance is so stupid, because you want to have that flexibility and not have egg on your face that you say, Hey, I’m gonna raise 75 basis points and then you do have some major crisis and they have to do a u turn two days later.

Nathaniel E. Baker 19:40
Yeah, really interesting. All right, Axel Merk, very interesting conversation. I want to take a short break, and come right back and ask you some more about your background,

Nathaniel E. Baker 19:51
Welcome back, everybody, Axel Merk here on the contrarian investor podcast. Axel, this is the segment of the show where we ask our guests a little bit more about them selves personally and professionally, how they came to investing in the first place, and how they came to the their professional career. So take it away, though. Yeah. I’d be curious to hear from you about that.

Axel Merk 20:28
All right, you go with that far?

Nathaniel E. Baker 20:29
Sure, sometimes.

Axel Merk 20:29
Well, well, as far as I grew up in a household where the stock market was a discussion on the dinner table, my dad was in the business. My dad on October 87, wanted to pop some champagne because he was severely short the market, the big ones, as they called them at the time, you talked about your witness, right. And in subsequent days, you lose when somebody but I picked up the phone or Kobo 787 crash, I was a teenager, the one client called him who had told him he must not hedge his portfolio. And I was had the pleasure of taking that phone call. I later in college, I took on my first clients, I later dropped out of a Ph. D program to start Merck investments. I started it back in Europe, I took it to the US in 2001 became SEC registered in October 2001. And at the time, we were managing several small strategies. And the the increased regulatory event that came in at the time. Instead of merging with another investment advisor, as many people did, we decided we’ll do the other direction. We go to public products, public products for as you might relate to our high cost, fixed income fixed fixed cost products, when if you scale them enough, then they are attractive. And so we launched our first mutual fund in 2005. At some point, we had four mutual funds. These days, we manage about a billion dollars, most of which in gold. We have a physical gold product gold mining, we have a closed and mining fund. I mentioned stagflation. We have a speculation ETF that we launched in May, we have a mutual fund on focused on currencies. And then we do a bunch of little things on the side, in addition to that, but in 2005, we became a business so to speak, and we have a small but fabulous team. And whenever we tried to get away from from the precious metals market, we’re drawn back into it, one of the mutual funds we had several years ago. Invest in the s&p 500 with a currency overly amazing product, but nobody bought it. And so we we stick to our knitting but part of that because we come from the currency world, and the precious metals world. We focus a lot on the fed on the ECB, and monetary conditions in general. And so, and on that note, we do a lot of both quantitative and qualitative work. So we have some, some amazing quantity and qualitative skills, I would think and I’m trying to manage that myself, by the way, I have a master’s in computer science, I never, I have an undergrad degree, also in business economics. I never completed my PhD. And I never really worked for anybody else. I had some summer jobs. And for better or worse. I started as a small business, I still think we lucked out. My wife growls when I say that. But, but for better or worse, I have not worked for for any of the big banks.

Nathaniel E. Baker 23:39
Wow, that’s interesting. That’s a pretty unique, interesting. So the stagflation fund, what kind of stuff does it invest in?

Axel Merk 23:48
So when when we looked at this, a good year ago, we figured well, what do we do, because if you’re in the stagflation environment, ideally, you want to invest in the CPI, the Consumer Price Index, because that’s the only thing that kind of goes up. And then you can’t invest in the CPI. I mean, you can do some inflation swaps, it feels sophisticated investment, whatnot, but But it’s kind of difficult. And, and the other thing that did well, in the 70s were certain commodities, oil, gold real estate. And so what we did then some quantitative analysis, what sort of investments go up when because we obviously not in the 70s? It’s not exactly the same economy. What’s our investments go up when inflation and inflation expectations come up? And we came up with an ETF that’s a fairly straightforward ETF that invests in tips, inflation, Protected Securities, gold oil and real estate, and we have a core investment position and tips and then use a trend following methodology for the commodities and the reason we use a trend following methodology because that had worked quite well in the 70s. So the idea is you kind of the tips core position, gives you the closest You can get to investing in the CPI and then you have a kicker. And our analysis shows it might do well in a normal environment, and particularly well in the stagflation environment. And we’ve had some people tell us why the hell do you have such a huge tips position? And why don’t you invest more in gold? Well, we like gold. But part of that is also the risk profile that you want to contain. We see this as a bond substitute more than anything else. And so you want to turn on the risk profile. The other thing is, and we’re going to publish a paper on this in the near future. Most people don’t understand tips Well, when you buy tips, you don’t buy, what you buy is what you lock in is real interest rates. So when you buy a tip today, you’re locking in the real return over the next several years. Today, it’s positive by 1%. Not long ago, it was negative by 1%. And so pips haven’t performed well in recent months as real interest rates have gone up. And so investors need to ask themselves, how high can go real interest rates go 10 year real interest rates, as priced into the market? Is this a good buying opportunity and tip certainly have been hit hard. But in any case, the Merc speculation ETF and if I can give a pitch, the ticket is SCDF, as the ticker is kind of a one click way for investors to do it. And then so it’s just part of our way, one of the things you ask kind of my background, where we’re trying to find ways well, what can we do to deal with his environment, and then we’re trying to find solutions and offer to the market. And of course, one way our subscribers and Twitter followers and this snack can support us is by looking at our products.

Nathaniel E. Baker 26:42
Sure, sure. Cool. So what’s your outlook on gold, because gold has kind of taken a beating the last couple months. And if you’re long inflation, that might not be a terrible idea?

Axel Merk 26:57
Well, gold tends to understand where gold might be heading to, I think it’s good to understand what sort of investors buy gold. And the way I look at it is the folks are concerned about the dollar and purchasing power of the dollar, the diversify, the folks who believe and know that gold over the long run has a low correlation. And then the speculators they love to jump on it on a trend. The speculators had gone to the mean stocks, and I’m currently being ostracized by the Fed, they have been on the sidelines. If there’s a big trend and gold up or down, they’ll come back, but they prefer digital assets and whatnot. The diversifier has always been there. And we have seen more attention by investors choosing diversification. And so that core position is there. And then the purchasing power one. Well, it’s a question of real rates in some ways, and not so much about short term ones. And many people are saying, Oh, the inflation today is the one that matters. Well, yeah, but markets are forward looking. And and then it doesn’t matter where six 710 year real rates are, they have been moving higher. And in that sense, has actually been been very encouraging that gold hasn’t sold off more than it might have given given the the sort of historic correlations, but these correlations are not stable, they do break down. And so, again, I think your outlook on gold depends on where real interest rates will be. And if how far the Fed can take those up. And it is possible that the Fed will take them up further. But the question is, how far and again, when will the wheels fall off? And that goes back to the earlier question? Well, give me a timing right. I don’t know the timing, you don’t know the timing, when will the wheels fall off? And so Historically, it’s been more prudent to buy things before the something hits the fan, then afterwards. And so that’s the that’s the sort of context in which I see it. And more importantly, it is the context in which we see investors here. If I look at the ETF flows, they have been slightly negative in recent weeks. In our own ETF, it’s been mixed. Some of it has been positive. And we’ve certainly been gaining market share. There are some little differentiating features. Maybe that’s that’s presumably the reason. But we do see we do see buyers, we see them being reluctant. And we think they’ll come back more in earnest if and when we see more, more stress in the market.

Nathaniel E. Baker 29:31
Hmm. Interesting. So you don’t have any idea how I mean, nobody does, of course, but any any kind of speculation on how high the Fed might go, how far past 4%?

Axel Merk 29:40
Well, the market is priced in that they’ll peak out in the springtime. And they all if I look at my fancy Bloomberg, they’ll pick out at 4.4% very precise based on Bloomberg. Now keep in mind when you look at market expectations like a year and a half out, the market isn’t stupid, the market has to price in the risk of a shock happening. And so the market will always say, at some point, a shock is gonna hit us and think about everything that could possibly go wrong and assign them probabilities. Now, if your statistician say whether these things are dependent or independent, but the further you go out, the higher the probability that something is going to happen, that forces the Feds hands to go down. So if nothing bad happens, maybe the Fed is going to go higher. The odds of that happening, I don’t think are very high, but that quote unquote, risks is there. And also the market gold, by the way, historically performs well late in the economic cycle. And the reason gold performs well late in the economic cycle, is because there’s an anticipation that at some point, the Fed will ease again. Now, as we all know, the Fed has all the promise to be higher for longer, which means that moment might come a little later, with the caveat that if the shit hits the fan, it will come early anyway. Yeah. very precisely and answering your question.

Nathaniel E. Baker 31:11
But you also the fact that, you know, what do you make of the argument that if inflation doesn’t go down, the Fed can’t cut rates or can’t even shift? Maybe they could shift to neutral? But, I mean, if there’s like, I mean, if stocks get dumped by I don’t know, 10% that and people think the Fed is going to come to the rescue. Okay, maybe if inflation is down, but if inflation is still 678 percent, there’s an option two and a half

Axel Merk 31:36
People think that the Fed cares about the stock market, the Fed cares about the financial system. If the stocks plunged like they did in the early 2000s. They don’t care. They care about the contagion. They care about financial conditions by now. They care about high yield spreads blowing out, and then that moving more towards investment grade stocks. And so they’re different financial condition indices, most of them overweight, the VIX, which is not a good idea, because that’s not what the Fed cares about the Chicago fed, financial conditions index is less biased toward that. It looks more at other financial conditions. That’s the sort of thing you want to watch or look at investment grade spreads like the sorry for being technical here, but looking for the premium that they are debt is the yields are at versus treasuries, right? That’s the sort of thing is that orderly or not orderly, just like when you listen to Lagarde at the ECB, she’s petrified of what happening potentially happening with Greek debt? Well, it’s okay for the, for those, those borrowing costs rise this proportionally, but you don’t want that to be disorderly. And so that’s what to watch for. And yes, the Fed will make you believe they’ll be tough no matter what. The question is how credible that is, and I don’t think that’s credible, if the wheels start falling off,

Nathaniel E. Baker 33:02
so they would risk further inflation to bail out the economy if they had to, I guess if that’s

Axel Merk 33:07
Well they have to, they have to because you got nothing left if if the system blows up. Right. And so ultimately, their mission in life is to preserve the system above and everything else. They’re not going to change that. No, that’s. And the problem is when you have so much debt in the system, that moment could come sooner than then people hope for,

Nathaniel E. Baker 33:29
right. Yeah.

Axel Merk 33:30
But we also know that they have the tools, right? They could do what the Europeans do, that they raise rates, but they keep QE in place. And you don’t know, they don’t know what to do with their freakin balance sheet anyway. And so they might try that. Right. And so it depends on the nature of the crisis, whether they’ll get away with that. Right.

Nathaniel E. Baker 33:48
Oh, wow. Okay, any other flash points that you’re watching, as far as you mentioned, a bunch of these indicators here? What are some of your favorites just as far as overall risk in a system? Do you have any?

Axel Merk 33:58
My teenager’s mood? That’s kind of one of the primary?

Nathaniel E. Baker 34:02
Well, that’s for your individual household. But what about the

Axel Merk 34:05
Oh? No, I mean, I’m, I’m I’m a Fed guy in that sense, right? The reason people say, oh, let’s get rid of the fat and so forth. Oh, that’s nice talk. It’s not going to happen. Although there is a, our Senior economics adviser is Bill Poole, the former president of the St. Louis Fed, and he’s going to present a model in early October, I hope it’s gonna get some media coverage, where he says we can replace what the Fed is doing with a tailor made model that that introduces some variables based on inflation expectations. So coming from, he’s not he’s a long retired, but somebody who is from the system, who gives a constructive comment on how to eliminate the Fed. But the short of it is we’re not going to get rid of the Fed. It’s not going to happen, and the Fed has the bazooka and it ever You think turns around that bazooka. And people say, Oh, what the QE hasn’t been effective and this and that. But it matters, it matters where interest rates have said it matters whether they found the floor that drives markets. Now, am I worried and watch certain things? When? Yes, I mean, of course, you look the carrot at the canaries in the coal mine. And the other thing, of course, we look at fiscal policy, right? Something we give too much credit to the Fed, it matters how much money is being spent, we get will likely get gridlock, right. That is also a contraction, right? The the reason why inflation blew out, is because we sent out stimulus checks that over compensated and, and then the Feds job would have been to tighten and they didn’t. Right. And so they feel defined. So it’s and they are you asked where the where the power is going to be replaced? Well, they did. The most important thing to watch, I think is whether Biden supports Powell in his inflation fighting efforts, Reagan supported Volcker. And that’s why Volcker was able to, to achieve it. But he did, but let Biden be a less effective leader. And I’ve heard some rumors that some people think that he’s not very effective. And and maybe there isn’t enough support that allows the Fed to do what the Fed wants to do. So a tough Fed is only possible with proper political backing. And if you don’t have intellectual leadership at the Fed, and no proper leadership elsewhere, then chips off the table as to how that’s gonna play

Nathaniel E. Baker 36:35
out. Yeah, I mean, we can’t eliminate the Fed, at least not realistically. But is there a way maybe we could kind of limit their powers. Like, if we look back at the last 20 years, these crises, a lot of them have been caused by the Fed, keeping interest rates, the Fed overdoing it, whether it be interest rates, usually it’s been interest rates too low. If you look at early 2000s, the Greenspan fed and their their role in the housing bubble? And then, you know, in the more recently, I guess, but so what would you think of some plan where you, because the Fed is not and doesn’t answer to anybody really other than I guess the president

Axel Merk 37:14
Congress can set the rules, but what you need to go back to basics if you can’t eliminate them. And for that, though, you need a proper introspection about the things that have gone wrong. And all the things you mentioned. The Fed doesn’t acknowledge as being a problem. If you read Bernanke spoke, and I read it, so thank me for it, because it’s very torturous to read. He wrote most of the book before the inflation search. And so isn’t isn’t by a book that he read is about what we’ve done to date is the baseline. And let’s just think about what else we can do. His nirvana is if the Fed works together with Congress to ensure absolutely maximum employment. And so like a some sort of socialist planned economy, as long as everybody has a job. That’s kind of the path that I saw in in Bernanke, Lucky’s dream. I’m not suggesting that Powell subscribe to that. But I think we are naive. It’s the same way. It’s I mean, we always we vote for politicians, because they say less government. Yeah, how much less government we have after voting for one of those guys. We feel a little better for a few years. But guess what, we haven’t gotten rid of any of the regulations we got the previous years. So call me a cynic. But I have ideas. setting interest rates with with paying interest on reserves has Krait created a huge, bureaucratic nightmare. But guess what, we’re building the bureaucracy to deal with it. Dodd Frank has inhibited a lot of business. We’re not getting rid of Dodd Frank. Right away. Sometimes we get a tweak somewhere. And so we need something more radical. Can it happen? Sure. Do I see any political candidate left or right or anywhere? That that gets us there? Not really.

Nathaniel E. Baker 39:04
Yeah. I don’t know if he started to hear that last thing. But I don’t know if he saw the hearing couple years ago over the meme stocks. But if you did, it became painfully clear just how little these men and women in Congress know about financial markets in general. I mean, we’re talking like, not even like any kind of basic literacy on some of these things.

Axel Merk 39:25
Well, the hearings about getting a Showtime for your constituents. And unfortunately, not to further the understanding and well being and society, democracy, whatever you want to call it. And so those who have become cynics and count me in that shall be excused. I mean, the stunning thing about democracy is, we get things done despite all that. And with some I’ll learn to deal with it. But to just without ranting too much. The way I look at regulation, is that it increases the barrier to entry meaning it stifles small business, it helps the establishment. It makes society less innovative. And turning to market, it reduces low long term yields. Right? The reason yields are negative or negative, now they’re positive in Europe is because of all the red tape, right? You have something serious wrong in government when long term rates are negative. And there are ways to fix it, right? You fix it by reducing red tape and so forth. Unfortunately, these things only happen at the margin. And fortunately, we’ve got enough intrapreneurial spirits that people come through this anyway. And those who have brilliant ideas and happen to be teaming up with the right people get sufficient funding so that they can break through that barrier to entry. But none of this is helpful if you really want to create employment and and other things. But we have to we can complain, ultimately, we have to deal with the concept we’ve dealt with. But we we managed to billion that sounds like a lot of money. But we are regulated, like much, much larger businesses. It’s ridiculous the sort of stuff that we need to do. And every few months the regulator’s dump a few new set of regulations on us. And so and the regulator doesn’t care, right. They care about the big bots.

Nathaniel E. Baker 41:15
Yeah. All very interesting points. Axel Merck, thank you so much for joining me contrarian investor podcast today. In closing, maybe you could just tell our listeners how they can find out more about you more about the firm, more about your mutual funds. I’ll put that all in the show notes as well.

Axel Merk 41:31
So the best starting point is probably to follow me on Twitter, at Axel Merck. That’s the place where you get instantaneous reaction and opinions, all my wonderful rants and everything. Otherwise, our corporate website, Merck is kind of a portal to get to our products. can’t discuss our products too much on these podcasts. So you have to find your own way. There is a way to sign up to our newsletter. Do that to stay informed so that you get the the analysis on tips if you want to stay on tips better, we’ll send that out in the near future. And yeah, stay in touch, communicate. And then maybe I’ll talk back on your program one of these days to you. I’d love to have one or two to have people follow up on questions. Yeah,

Nathaniel E. Baker 42:14
absolutely. Awesome. Well, thank you so much. Again, thank you all for listening. And with that, we look forward to speaking to you again next week.

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