April 8, 2021Patrick DonohoePodcastComments Off on Capitalizing On The Massive Economic Shift Through Multifamily Real Estate With Michael Becker
There is a massive economic shift going on that comes with a corresponding demographic shift towards areas with lower living costs and tax requirements. In what way is this development conducive to multifamily real estate? Joining Patrick Donohoe on the show, SPI Advisory Principal Michael Becker invites us to take a look at the case of Texas, specifically the DFW market, and how the changes going on in the economy are giving rise to massive opportunities to invest, whether actively or passively, in this no-income-tax state. Whether you’re looking to set up your own mom-and-pop or you just want to let your money do the work by involving yourself with REITs or syndications, terms are going to be very favorable for you in Texas and other areas that have been at the receiving end of the massive in-migration of people and businesses from more costly metros like New York and California. Join in to learn more on how you can start to build more wealth by capitalizing on these changes!
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Capitalizing On The Massive Economic Shift Through Multifamily Real Estate With Michael Becker
My guest is Michael Becker. He is the Principal at SPI Advisory firm and also the host of The Multifamily Investing Podcast. You can check him out at MultifamilyInvestingShow.com. I wanted to have Michael on for a few reasons. First, I had Ken McElroy on a few episodes back, speaking about what’s going on in the economy in multifamily investing. I wanted to have Michael on as well to emphasize some points that Ken and I talked about then in that show. Many real estate investors start out excited. They see potential, opportunity but it becomes a job of sorts, hence the word active.
What I’ve seen is people gravitate toward more passive types of investment. Multifamily investment is an excellent way for accredited investors mostly to invest for cashflow in a passive way. The second reason is I believe our economy is shifting. Richard Duncan was on a few episodes back, and we spoke a lot about what’s going on in the economy, what’s likely to happen and what’s happening. It’s causing some seismic shifts. You are having some big capital flows impact things. You also have immigration, people moving from state to state based on the ability to work remotely, leaving a high cost of living areas, high tax areas. You also have a gist of emotion that’s driving investments up, driving some investments down, fundamentals are out the window and there’s a lot more. Multifamily is an ideal way to capitalize on some of these shifts.
It’s dependent on the market, but I wanted to have Michael on because his specialty is Texas. I look at the economy and human nature. It’s not a straight line. It’s not always predictable. In fact, I don’t think it’s predictable that often. There are variables that can lead to outcomes. At the same time, humans are odd where they make decisions that are irrational and subsequently cause their behavior, what they do to not be a straight line, but to be more of a curved line. We’re seeing that with a lot of movement out of high-income tax states like California, into states like Utah, Nevada, Arizona and Texas, which is a no-income-tax state.
This movement is going to continue. That’s how people behave when there’s more money taken from them, where there’s a high cost of living. I believe that Texas has a very interesting economy and there are a lot of people that are moving there. There are additional benefits to multifamily investment and there are risks. Make sure you do your due diligence. I’ve known Michael for several years. I think you’re going to enjoy the interview and make sure you go check his podcast out and learn more about investing passively in multifamily. Thanks, guys.
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Michael, it’s awesome to have you on. First off, congrats on your podcast.
It’s good. I’ve been the co-host of the Old Capital Real Estate Investing Podcast for many years. In 2020, I started a show called The Multifamily Investing Show with Michael Becker. It’s a video-audio show done in a studio. I’m focusing on high-level guests in the multifamily industry brokers, owners that own tens of thousands of units. If you’re an apartment nerd, it’s probably a place for you. We’re talking about the industry and all the various things that go into it.
It’s an interesting time. With COVID, housing and markets have been shaken up because of relocation. A lot of companies are moving to a hybrid or full-on remote working environment, which makes a lot of sense. People have figured that dynamic out. Maybe speak to what you’re seeing with regards to occupants of multifamily, apartment complexes and what the behavior is of people. Reference specifically Texas because I know Texas is the recipient of a lot of immigration.
It’s important to talk about the perception or view I have of the world is coming from you, from Dallas, Texas. We own multifamily properties in Dallas, Austin. We’re expanding into San Antonio. That’s what my lens of the world is colored with. We’ve done about 10,000 units in the last decade or so. We own about 6,500 units give or take as I talked to you between Dallas-Fort Worth and Austin is where we’re focused. That matters because if I’m sitting here talking to you from New York City or San Francisco, I probably have a different lens of the world than what I do from Dallas.
It’s funny, we’re in this backward world and a lot of ways where generic suburban multifamily, and Dallas-Fort Worth trade at lower cap rates than multifamily on the Island of Manhattan does and whatever world have you been in where Manhattan Island has a higher cap rate than a generic Dallas does. It doesn’t make sense in a historical context. It’s been an interesting year. We’re at the end of Q1 2021. This time in 2020 where I’m stuck in my house and wondering if we’re going to collect rent in April 2020 because everything started to shut down in mid-March 2020. Every day we are wondering if we’re going to collect 50% or 60% of our rent.
The reality turned out to be much better. In a normal month going into COVID, we’d probably have about 1% of our scheduled rent is be delinquent or non-collectible. We’d collect 99% or better. In the early months, we went from about 97%, 96%. The worst we got was probably around Christmas time between Thanksgiving and Christmas, we got to about 95%. We collected about 5% to 6% delinquent portfolio-wide in Dallas-Fort Worth. That’s not great, but it’s manageable. We’ve seen an uptick as we get to Q1. Seasonally, a lot of our tenants every year around Christmas time prioritize buying Christmas gifts over paying rent. That’s a normal high watermark for delinquency.
We’re doing well. Occupancy is full. We’re 95% plus across the portfolio over 6,000 units on average. That’s higher than what it has been in the last several years. Places are full. We do have a small contingency of people within our units that are multiple months behind and they have the eviction moratoriums. Most people probably have heard or read headlines about the CDCs, put some eviction moratoriums in.
As we are talking, it’s about to expire, but we anticipate the Joe Biden administration extending that, but the counteract that we’ve been seeing, some of the stimulus money from the December $900 billion stimulus bill, and then I was added on with the $1.9 trillion stimulus bill out of some rental assistance. We’re in the process of probably collecting 75% or 80% of those large balances that we otherwise would have evicted those residents. The 75% or 80% of that would probably be collectible. I have manually written that money off. It’s going to be like a windfall. Magic money comes out of nowhere or maybe there’ll be no ramifications. We’ll see what the real-world ramifications are.
It’s one of those give and takes. When you put those eviction provisions in there, even though people might be able to pay their rent, they’re not. The mortgage industry from those who owned homes, being able to go into forbearance without having to be foreclosed on, people may have had the capacity to pay their mortgage, yet took advantage of that. That dynamic is interesting too. If they include those elements of the stimulus bill where they would pay back landlords, it would have been weighted in the favor of tenants and would hurt landlords.
It’s obvious that they put those different points in the bill to pay back landlords for the bill that they were paying over the course of time. Maybe speak to the role that multifamily is playing in society nowadays. The big apartment complex, who’s the tenant, why is there demand? Where are we at with the cycle of demographics and the demand especially in Texas for housing, specifically apartments?
Multifamily Real Estate: The current demand for multifamily comes from a variety of sources, from young people right out of college, all the way to empty-nesters and a whole bunch in between.
It’s a variety of sources for demand anywhere from young people, right out of college, or young working professionals, all the way to empty nesters and a whole bunch in-between. It’s across the current of all society types and depending on the type of asset you own. We own anywhere from workforce housing to brand new Class-A stuff. We see a little bit of everything, but in your workforce housing, it’s a lot of blue-collar-type tenants. People that work manual jobs, construction, work at Starbucks, serve your coffee in the morning, to the nicer newer stuff where you rent or buy by choice more than necessity. Where either you want to be in the urban coordinator amenities when they were open and active.
We’re starting to come back a little bit. That was a lot of your gateway cities people that want to be next to the museums and the restaurants, the nightlife and etc. There were a lot of suburban people as well. We have a lot of suburban multifamily in my portfolio. We get some families in Dallas-Fort Worth disbursement of jobs is not just concentrated in the urban core is well dispersed throughout the metropolitan areas is a bunch of pockets of employment throughout the whole region. People want to live close to those suburban jobs. It’s a little bit of everything and seeing the demands insatiable. A lot of that demands are driven here locally by the migration that we’re seeing, a lot of the corporate relocations that have taken from the higher-tax states, predominantly California.
We see a lot of California reloads to Texas for big corporations. They bring people or jobs and hire people locally. We’ll get a little bit of a transitory population. A lot of people come into the market. They don’t typically buy a house. A lot of the large segment of the population doesn’t buy a house out of the gate to go rent for a year or two until they realize that they want to stay in the area and then to find out what part of town fits their lifestyle best, then be in such a large metropolitan area. We were like 7.7 million people. We are the fourth largest metro in the country which should surpass Chicago in the next many years.
There’s a lot of cross-market movement as well. People will move from this part of town to that part of town. Austin, which is the other market I focus on is a little bit younger city than Dallas-Fort Worth even. You get a lot more tech jobs. It’s more liberal than the greater Dallas-Fort Worth area. There are a lot of people coming from the Bay Area who tend to relocate to Austin. That tends to be a higher rent or concentrated market than even Dallas-Fort Worth.
Every market is different. Some markets are different. It’s across all current populations across demographics cross country. You see a lot of younger people not married. The natural delay of people getting married gets older and older. We tend to see in our renter demographics, people stay in the rental pool longer than maybe they would have many years ago when you and I were probably renting out first apartments before we got married and had houses.
Speak to how does someone invest in apartment buildings? There’s clearly an opportunity, especially in Texas, with the demand coming in and most likely is not going to end anytime soon. How does someone invest? You have some of the institutional types of investments, like real estate investment trusts. You’re starting to see more crowdfunding opportunities. What are the different and predominant ways? Speak to the way in which you’ve learned to set up investments so that people can invest?
It’s anywhere from a mom and pop landlording where you go buy a ten-unit deal with your own money, run it, collect rent yourself, and fix the leaky toilet yourself, all the way to sophisticated institutional ownership groups that are public and trader reaps that are best institutional quality properties and everything in between. We’re in-between where I’m an apartment syndicator. It’s what I think of myself. We do private equity. We raise capital from high net worth individuals. I know you had Ken McElroy on, our mutual friend. I do a very similar model to what he does, where we go raise from high net worth individuals $100,000 at a time.
The syndication model is popular nowadays and it’s much more popular than many years ago when I got started. The crowdfunding was starting with the JOBS Act in 2012 when that came out, which allowed you to raise money from people you don’t have a preexisting and substantive relationship with, so you can do advertising and that’s when all those crowdfunding portals popped up. What I’ve found through my raising $250 million to $300 million equity that we raised over the last decade or so, people do business with people they know, like and trust. You can try to have all this technology, which is great to be efficient, but at the end of the day, if they don’t, one, get to know who you are. Two, get to know, like and trust you, and didn’t find you credible, they’re not going to invest in your deal.
A lot of it is going to different real estate investing clubs. We have a podcast. Referrals are big things. Getting out there, getting network, and knowing people, getting referrals, that’s where we source most of the people that invest with us. From there, we take all different types of investment from cash. People have money to buy their trusts and LLCs. Retirement is a big chunk of that as well. A lot of people invest through self-directed IRAs or solo 401(k)s, and they get it out of the financial system, and the main mainstream financial system through Wall Street, and put it in the “alternative investments” like multifamily, syndications or the likes.
That’s how it is. It is evolved quite a bit with the crowdfunding platforms. You can take that software and raise money efficiently. It’s all virtual through our online portal and you fill out paper electronically wired, and it’s streamlined where we first started out. You had to email someone something, they print it off, hand fill it, scan it or fax it back to you. There’s a lot more laborious. It’s been a good transition from a technological standpoint and moved the industry forward quite a bit.
As you’re raising money or private capital, where has the focus been? Are there opportunities that exist that you’re buying into, or are you buying into dilapidated complexes that you fix up? Especially based on demand, are you seeing opportunities to develop ground-up projects?
Everything in the above is something that works. What we focused on when we first started out, we did a lot of workforce housing. Texas in the 1960s or 1970s, that’s when we first started seeing large-scale multifamily properties built in the region generally speaking. That’s most of our older stock. We’re not like New York where you can buy a 100-plus-year-old building because Texas didn’t have very many people. Hundred years ago, we didn’t have AC. Most of our apartment stock is a lot younger than if you’re in the Northeast then, their C-class stuff might be 100 years old, where our stuff is 40 or 50 years old. Buying that, renovating it, increasing the rents through renovations, that was very popular, still is nowadays with where we’re focused.
Over the last many years, we’ve been slowly transitioning in older stuff, buying newer, better, bigger. This has been a function of the marketplace where when I started out there used to be a larger spread. The rates of returns, you can get by buying older, tougher deals compared to newer deals. Commercial real estate, multifamily included trade on cap rates or what we call Capitalization Rates. It’s like your unleveraged return. If I were to buy a building that produces $100,000 in net operating income, so all the income that I get is less all my operating expenses excluding my debt. If I produce $100,000 and I bought it on a 10 cap, I would pay $1 million for that $100,000 income stream.
If I bought it on a 5 cap, I’d pay $2 million for that same income stream. My rate of return would be 10% if I paid $1 million or 5% if I pay $2 million. What happened many years ago to nowadays is those cap rates used to be maybe 3% of point spread between the top of the grade and the bottom of the grade. I’d pay an 8 cap for a C class deal when I started and a 5 cap for an A class deal. Now those cap rates are basically on top of each other where most of these caps are somewhere around 4% nowadays in Texas. We’re irrespective of location quality. To me, it doesn’t make as much sense to pay the same or similar cap rate for something built in the ‘70s that I can for a brand-new deal.
We’ve been trading up and buying bigger, better, nicer things and getting similar cap rates. That’s been the evolution of our business over the last many years. It’s been a good trade for us. They are developing it. People keep moving here. We need to supply more housing because there’s a demand for it, especially in Dallas-Fort Worth, and also markets where I predominantly focus. If data is done well and right, that certainly is a good business model as well. You have different levels of risks because you start a project now and two years later before yet you start leasing units and collecting rent. A lot of things can happen in between then. You hear the headlines all the input costs, labor, land, lumber in particular, are all going up. You could start a project with certain economics and then lumber, which is maybe 15% or 20% of your costs could double, then that could blow your profit out quickly.
Speak to the economics of interest rates too because you’re not buying these things in cash. You’re raising private equity, but then you’re utilizing a mortgage and debt. From what I recall, that’s your background. It’s where you started in the financing side of multifamily. What’s the market nowadays, and why has that helped with the opportunity in multifamily?
My professional background is in commercial real estate lending. In the last part of my banking career, I focused on multifamily lending and that’s how I cut my teeth in the business. One thing I’ve learned from being a banker and a borrower for a long time is whatever the environment is, it’s always changing over time. You’ve got certain principles that are timeless, but at the end of the day, the markets are always shifting wherein the multifamily space, the agencies, Fannie Mae and Freddie Mac are the two largest lenders, not only single-family space, but they’re the largest lenders in the multifamily space as well.
Multifamily Real Estate: We need to supply more housing because there is a demand for it, especially in the Dallas-Fort Worth area.
The only lenders that were loaning money this time in 2020 where the agencies were Fannie Mae and Freddie Mac because of a mandate to do it and all the other lenders shut off. It was impossible, but it was next to impossible to get a loan that was in an agency loan because there are so much fear and uncertainty in the marketplace. It’s turned off. For the better part of 2020, if you wanted to buy a multifamily property, you are going to get a most likely a Fannie Mae or Freddie Mac loan. They have these caps that are mandated by the regulator FHFA.
They started getting full because that was the only game in town. To slow the demand, they started increasing their spreads. They charge on the interest rates of their indexes, the ten-year treasury or LIBOR, depending on which you floated or fixed it. They’d become less competitive. At the same time, the alternative lenders like your banks or life insurance companies, they have some debt bonds out there that are prominent popular. Those were completely on the sidelines. Now they started loaning money, and then they realized that they didn’t loan any money in 2020 or they’re way behind their projected goals. They needed to get some assets out. They started getting a lot more competitive on the leverage that their offer, interest rates, fees, etc. They’ve been trying to win the business.
The marketplace nowadays is shifting, and we’re doing a couple of deals where we do a bank loan, and we’re about to do a life insurance bridge loan where before it would be 100% Freddie Mac loan, where nowadays is not. It’s always ever-evolving. That’s one of the things that you need to stay on top of, and what’s separates the good from the better within the industry is paying attention to the debt because it’s 65% to 75% of the capital stack with the remainder 75% debt and 25% equity. It’s a large part of the business and staying on top of that.
It’s the key. It’s always evolving and ever-changing, but the multifamily space is a darling of the commercial real estate industry. We get the most favorable terms relative. Let’s say, like an office building, a retail building, or a hotel, they have much inferior debt markets than what we have in the multifamily space are. It helps the returns and then the environment that we’ve been in for several years. Particularly, in 2020, we’ve seen extremely low interest rates. It makes the returns you can get on your assets go up quite a bit. That’s why we’ve been seeing these cap rates get lower because people were able to pay more for that same income stream because our cost of capital is lower. They can produce similar returns even if they have to pay more because the debt market is low.
In the first quarter of 2021, we’ve seen rates take back up on the long end of the curve, but on the short end, your LIBOR, SOFR, the indexes are 1 and 11 basis points respectively nowadays so it’s zero. All these adjustable-rate mortgages, we took out a couple of years ago. In other words, I’m printing money on those deals because these indexes are zero. We have many loans out that have a sub 2% interest rate on them that we took out a few years ago. It’s a free money, which is unbelievable.
You know Richard Duncan and I had him on. He was talking about the massive amount of excess reserves that banks are carrying. It’s going to continue for quite some time as far as 2021 is concerned. The interest rates are going to keep it that low. Michael, let’s wrap up with two points. Describe what you’re seeing in some of the stimulus bills in regards to multifamily. I know we briefly touched on how eviction moratoriums were in place, but now part of the stimulus is to essentially pay back those missed rents. Can you speak to that, and other provisions you’re seeing, and the $1.9 trillion? In the end, speak to your typical investor. What are they looking for? What’s their financial profile so readers of the show can identify with that, potentially reach out to you, and learn more about multifamily or at least start listening to your podcast.
With the $900 billion stimulus that passed in late 2020, they had earmarked about $25 billion approximately for rental assistance within that greater bill. That money was distributed to the states. The states and local housing authorities would then disperse that money. It took a while to get the programs going. In February 2021, they started rolling out in Texas and every state has different rules, but they were allowed to go back to March of 2020 and three months forward. At this point, you could get it. If someone had not paid me their rent in the whole year, I could get a whole year with a back rent plus three months’ forward to get caught up. There’s some paperwork to fill out that both on the property and on the resident side that proved that their loss their income.
We had over 6,400 to 6,500 units. We had somewhere around $600,000 in accrued accumulated deferred rent over that twelve-month period. That’s relatively instead of getting on a percentage basis in the grand scheme of things. It’s a lot of money in the real world. We anticipate that we’re probably going to collect $450,000 to $500,000 of that. That would tell you if there’s about 75% to 80% of that. I tell you there’s probably 20% to 25% fraud within the system where these residents could have otherwise paid, just said that they didn’t have a job.
They filed a fraudulent CDC declaration to stay an eviction. That’s what roughly I’m deducing from what we’re about to experience so then those people are going to be evicted and credit ruined, etc. because they can’t produce the paperwork that showed they lost their job. There’s somewhere around that type of fraud in the entire system. With all the stimulus stuff is why Michael Becker’s cowboy Math is here. That’s how much waste is out there. I know you said Richard Duncan doesn’t believe there’s going to be inflation and he thinks rates are going to be low. I concur that I think rates are going to be low. There’s so much excess liquidity on the system that is going to drive it down.
On the short end of the curve, you’re floating adjustable-rate mortgages. Your two-year treasury rates will stay low for a while. We’ve seen a little pressure on the ten-year treasury, but I don’t think that’s going to go very far either. I think we’re range-bound somewhere around where we are for a period of time. If it starts going, the Fed will start doing yield curve control and start buying the long into the bonds and then keep it from going. I do believe there is inflation. They mask it with having a flawed calculation. If they would calculate CPA as they did many years ago, we would see a lot of inflation because you look at all the input costs to all the real things of the world, the oil, lumber and you try to get an appliance package.
They’re doubled in the last several years to get the same basic appliance. All these input costs are going up. I can promise you looking at my portfolio with 95% occupancy, all this back rent about to get paid, all these people moving here, and the input costs to build a new multifamily product going up. We’re raising our rents. We see in the markets I play in. We had a flat year. Austin was negative 2%, Dallas is positive 1%, and rental rate growth, as a market as a whole in 2020, in spite of everything, it’s relatively tamed. It was flat. We see 5% to 6% rent growth in 2021. Real-time when I’m trading out my old leases, my new leases, that’s what we’re seeing and we need to because these places are full.
We’re able to push rents. That’s what I’m seeing. I believe there’s inflation out there in the things that matter, like housing, and buying a car or trying to drive a new one with oil. There’s real inflation there. I don’t see what’s going to stop it. Seeing the pricing of these things feels like we wrap it up in the first quarter of 2021. It feels like prices moved $20,000 a unit citywide, both in Austin and Dallas, because there’s so much capital coming here. It’s insatiable the amount of demand because all these people that were previously investing in the coastal markets are starting to look in the center of the country and Arizona, Florida, Texas, Georgia, the Carolinas, those are on the end market.
California, New York and Seattle are on the out markets. That money is coming here and a lot of money is rotating out. If you want to make commercial real estate, it’s hard to invest in hospitality, retail or even office. They’re rotating out of those sectors more into industrial and multifamily. There’s more money chasing it. At the same time, they printed 25% or so of the money circulation was generated in the several months or something like that. This is all money sloshing around and it’s going into risk assets like commercial real estate. It’s disproportionately going to multifamily. We’re seeing prices accelerate.
You have the dynamic of when somebody moves from California, first off, tax savings. Second, they’re going from $3,500 to $2,000 a month for an apartment or maybe less. You have the built-in flexibility where raising rents by 5% to 6% will be a no-brainer for most.
Multifamily Real Estate: Rates are going to be low. There’s so much excess liquidity on the system that is going to drive it down.
That’s what we’re seeing. I’m still bullish on Texas multifamily. We have done well. One of the things is talking to investors that have been with us for a while. Leading up to the COVID lockdowns, people would talk to me about what happened in the prior decade, the teams basically. What seemed to me was in the Dallas-Fort Worth, in the workforce housing space, in particular, rents much doubled in the last many years. The price has tripled because the rent has doubled and then the cap rates compress. It’s the combination of those two things. This hasn’t stopped. We went on hibernation for about three months, got right back at it and prices didn’t move at all.
If you had the ability and the guts to buy something in that 2 or 3-month period in April or May 2020, maybe you got a 3% to 5% discount if you bought it in that two-month period, and someone was willing to sell. Most everyone else took their ball, went home for a few months, and put the head back up and things were okay in the multifamily space, at least. Most people that come to us, your second party question was, we get a diverse investor base. Mostly high net worth people from various industries, either they have a good income, make over six figures, accumulate some money and want to get a return. We have some business owners, doctors, a lot of people that pay high-income taxes, especially in the coastal markets where you not only pay the Federal Income Tax.
You pay California, not only Uncle Sam, but Uncle Gab out in California. They come to multifamily space and they get some good tax savings with the depreciation, the law, the way it’s written at is favorable for the multifamily industry. We see quite a bit of that. Business owners, you see a lot of people that even have bought some commercial real estate that appreciated, and they want to stay into space. It was a diverse mix of people. We would finish up our tax returns not too long ago. We did $1,300 and $50,000 ones for the 2020 tax year. We have 700 or so unique investors that invested with us. We are growing by the day seemingly. It’s been a good business and bullish on multifamily in Texas.
I don’t see what is going to stop that. Immigration wasn’t going to stop the price appreciation because rents are going to grow. Was fuel ever going up? I don’t see how it let interest rates rise to any material respect. If they do let it rise, it’s going to make single-family housing, even that much more expensive to own, which will then further drive rental rates up. All things being equal. There’s a world full of bad options from an investment standpoint. If you want to get some yield, you’ve got to take some level of risk and there’s no rule. You can’t go get a 5%, one-year CD as you could have many years ago. If you want yield, you got to put risks either in the stock market or some investment as I do or various other things out there. All things being equal among the better asset classes out there, which is why I dedicated my career to it.
Michael, thanks for your time. Thanks for sharing your expertise. What’s the best way readers can follow you to learn more about multifamily investing?
I appreciate you having me on. Hopefully, we see each other for the next cruise sometime. The best way is to go to a company’s website, which is www.SPIAdvisory.com. There’s a Contact Us form. You fill that out. We’ll happy to send out information about what would we do and potentially working with us.
What a crazy time to be an investor. At the same time, there are lots of opportunities out there if you know what you’re looking for.
Michael Becker is a Principal at SPI Advisory LLC and heads SPI’s Dallas, Texas office where he oversees all aspects of property operations, including asset management, property management oversight, accounting and taxation, capital improvement and renovation projects and investor relations. Michael is a lifelong resident of North Texas and a graduate of The University of North Texas with a BBA in Finance. He is married and has two young children.
Michael is a 15 year veteran Commercial Real Estate Banker and has originated and managed numerous portfolios of permanent and bridge loans in all major asset classes. Over the last 5 years of his banking tenure, Michael focused exclusively on multi-family properties, where he was the number one loan producer for his division at a Top 3 National lender for his last 3 consecutive years.
As a Portfolio Manager, Michael directly oversaw the management and financial performance of the countless C & B class Multi-Family properties he originated loans for. As a result, he accumulated an exceedingly diverse network of suppliers, contractors, consultants and service providers during his tenure. This gives him the ability to quickly and efficiently implement a breadth of value-added strategies for a fraction of the typical cost.
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The two biggest things that drive the economy are credit growth and liquidity. And because of the COVID-19 pandemic, the United States market has now shifted to a different scale, mainly in terms of inflation. Richard Duncan returns on the show with Patrick Donohoe to discuss the current status of the US economy that is hugely impacted by the decisions of the Fed and the current activities within the stock market. They also talk about how the country can avoid over-inflation without raising taxes, thus saving everyone from financial pressure. Richard also explains how the United States is falling behind China in the technological innovation race and how this may spell doom to every American if the government does not put proper funding into research and development.
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Watch the episode here:
Listen to the podcast here:
How Credit Growth And Liquidity Drive Today’s Economy With Richard Duncan
My guest is Richard Duncan. Richard is an economist and author of several books and also the creator of the Macro Watch newsletter. Richard has a perspective on monetary policy that is unique to most other economists. In 2020, right as everything was shutting down, if you have been reading for a while, Richard was my guest. He lives in Thailand and has lived there for many years and is familiar with Asia, specifically what’s going on with monetary policy there. The interview was long and he offered an incredible discount on his newsletter. If you follow that newsletter, thenyou’ve seen everything that played out from the perspective of how the US intervened as well as how they leveraged the central banking system.
He called everything. It’s interesting to see what he’s saying. Before we get into the interview, go check out his website, RichardDuncanEconomics.com. If you want to subscribe to his newsletter, he kept that code open so you get 50% off of his newsletter and that code is June. It’s an unprecedented time, as far as liquidity that is slated to go into the capital markets. It’s incredible how much there is over a short period of time. You’re definitely going to want to pay attention to what Richard is saying so that you can understand how that’s going to impact what markets do. Without further delay, let’s get to the interview with my friend, economist, Richard Duncan.
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Richard, it’s good to be with you. Thank you for reaching out and wanting to have another conversation. A lot has transpired since our last interview. You’re spending some time in Northern Thailand at a house you have. What’s been your experience since?
Patrick, thank you for having me back on. I enjoyed our last conversation and I’m looking forward to this one. You asked about my experience living here in Thailand. Luckily, Thailand has not been hard hit by the pandemic. Thus far, there have only been 29,000 cases in total, which is difficult to understand why that is. Thailand has been largely spared but in any case, normally, we live in Bangkok, but we also have a house in Northern Thailand out in the countryside.
For 2020, we have been here out in the countryside. I would never have thought that I would have stayed in the countryside for an entire year but it’s turned out to be pleasant in most respects. It’s beautiful. We’re surrounded by rice patties. We would wake up and hear the birds chirping in the morning. I ride my bicycle. It’s a beautiful countryside. The people are nice. It hasn’t been a great hardship. Thanks to the internet, I’m able to do all my work here and communicate with people like you. Life has been good. Thanks.
It’s an interesting dynamic where you live in this beautiful place. With a chaotic time in human history, you’re probably looking at the news and getting onto websites. It’s a stark contrast to what you’re experiencing. Tell us about what your experience has been, seeing what’s gone on around the world, what the response has been and then we can shift over to what your thoughts are on what’s to come.
When we spoke, it was uncertain how the pandemic would play out. It is still uncertain but also the government’s policy response was not entirely clear at that time. On March 15th, 2020, I published a Macro Watchvideo called Recession or Depression? In that video, I argued that whether the United States collapsed into a full-fledged great depression or merely suffered a recession. It would depend entirely on the government’s policy response. If the government borrowed and spent enough money to keep the economy intact then we could get by with only having a recession.
If the Fed created enough money to help the government finance all of that debt at low-interest rates, then we would come out of this pandemic looking more or less as we did when we went in. If they failed to act aggressively enough then the economy would collapse into a 1930 style depression from which we might never have escaped. Luckily, as it turns out, they have responded aggressively. Government debt increased by $5 trillion and the Fed has created $3.5 trillion to help finance that debt. The government has done the right thing.
They had two options. They could have done what the government did in 1930 when the bubble of the 1920s popped. At that time, the government didn’t do much of anything. The economy collapsed, 1/3 of the banks failed and unemployment went up to 25%. We were stuck in a depression for ten years and only when World War II started and the government spent much more money did that depression end. That was one option. The other option was to do what they did in 2008. When that bubble popped, the government jumped in with $1 trillion budget deficits and the Fed created again roughly $3 trillion to finance those deficits.
They tapped the bubble inflated from 2008 up until the time this pandemic started. We didn’t collapse into a depression then. Luckily, they chose the 2008 option, which was far wiser than the 1930 option. Here we are, the economy is now on the verge of booming. We’re likely to have 6% to 7%, possibly even 8% GDP growth in 2021, the highest since the 1980s. By the way, the reason we had such rapid economic growth in the 1980s under President Reagan is because during his eight years as president, he tripled the government debt. He had such massive budget deficits that the government debt tripled. During World War II, the government debt expanded five times in four years.
Under President Reagan, it expanded three times in eight years so we’re nowhere near expanding the government debt by three times as President Reagan did. That was just an aside. The economy boomed in the ‘80s because of all of the government debt. President Reagan had the government invest aggressively in the military and that worked out well for us and badly for the Soviet Union, which couldn’t keep up. They collapsed and we won and the economy boomed. That’s what happened in the ‘80s. Here we are, the economy has survived and it looks like it’s not going to collapse into a depression. I’m thankful for that and everyone else should be as well.
Looking at the positives you’ve highlighted, we can see that their response helped a lot. Specifically, in the United States, it kept businesses afloat. It had some parameters in there as far as a stimulus to businesses where you couldn’t let go of employees. From the housing market standpoint, when you go back to 2008 and 2009, it was interesting to see how quickly the response was to creating forbearance programs. They prevented people from defaulting on their mortgage and they’d be able to tack on payments that they missed to the end of the mortgage.
It’s interesting to see the response but Richard, it seems too easy where something goes wrong, prints a bunch of money and stimulate this. I know that there are a narrative and philosophy that has to do with economics. There are different perspectives in that regard. Are there unintended consequences to this type of response? We’re past the point of no return. We want the economy to keep going. This is what has to happen.
One more point about what the government did to save the economy. If the government had not sent out these big stimulus checks and extended the unemployment payments to the unemployed workers, then tens of millions of Americans would have defaulted on their mortgages, their credit cards, car payments and the corporations as well. The corporate revenues would have collapsed so they would have defaulted on their bank loans as well. All of the US banks, therefore, would have failed, destroying all the deposits in the country. People probably are not as aware of that as they should be.
We don’t talk about what happened this time as being a bank bailout but the great beneficiaries of what the government did were the banking system. The banking system would have completely failed without a doubt had the government not provided funding to individuals and corporations who had borrowed from the banks. This saved our banking system. If the banking system had failed then the economy would have collapsed. That’s all been great. The banks are keen to start paying large dividends again to their shareholders, carrying out share buybacks and keeping their tax rates low.
People don’t understand that they were saved by the government but it’s important for everybody to be aware that the banks owe their survival to government intervention and everybody who has a bank account only has one now because of the government intervention. That’s another thing we can be grateful for. The financial system didn’t collapse and all the deposits weren’t destroyed. To answer your question, are there potentially any negative side effects? What we’re living through is probably one of the greatest economic experiments in history because after all, everyone was taught in their economic class at university.
If the government has big budget deficits and heaven forbids, if the Fed creates a lot of those budget deficits, that inevitably leads to high rates of inflation that destabilizes the economy and creates all kinds of chaos. Therefore, they must not do those things. What we’ve seen now twice, first in 2008 and the years immediately after that and again in 2020 and 2021, is that the government has run large budget deficits. In 2020, the budget deficit was $3.1 trillion and in 2021, it’s going to be closer to $4 trillion probably. The Fed has already created $3.5 trillion in 2020. If you go back to 2008, since then the Fed has created eight times as much money.
There are now eight times as many dollars in the world as a result of quantitative easing as there was at the end of 2007 and still we haven’t experienced inflation at this consumer price level in any meaningful way. We are going to see some pickup in inflation going forward because first of all, in March and April of 2020, prices were falling. Remember, gasoline fell to minus $40 a barrel. You had to pay people $40 a barrel to take your oil. On a year-on-year comparison with March and April of 2020, the inflation numbers that come out are going to be higher. There will be some tick-up and inflation but that is completely transitory. That will wash out later.
We’re also seeing commodity prices move up. Commodity prices though are extremely volatile. They shoot up 20%, 30%, 40% in one year and 1.5 years later, they’re down to 20%, 30%, 40%. That’s why the Fed ignores food and energy prices when they’re conducting monetary policy. What would the Fed do when you have a spike in commodity prices? Jack up the federal funds rate to 10% and crash the economy when the next year, we’re likely to see a 20% drop in commodity prices? What do they do then? It would be impossible to conduct monetary policy if you didn’t strip out the commodity price inflation swings. We are going to see higher rates of commodity prices.
The headline inflation number will move up some. What the Fed focuses on is core inflation. In particular, one measure of inflation that they call is the Personal Consumption Expenditures price index, the PCE price index that strips out the core and strips out food and energy. The Fed would like to see this increased by 2% a year. In January of 2021, it was up 1.5% year-on-year. The Fed has not been able to make the inflation grow as much as they would like for decades. Going back to 2000, this core PCE price index has averaged 1.7% a year for twenty years. Over the last ten years or so, it’s been even less, 1.6% a year. The Fed has an extraordinarily loose monetary policy. They’re creating $120 billion every month and injecting it into the financial markets by buying bonds.
Wasn’t there a day where they injected almost $300 billion in one day?
That’s possible. I didn’t see that. I don’t think that happened in 2021 but there was one week in March of 2020 when they injected $500 billion in one week, which was off the charts. Especially up until 2007, in the first 93 years of their existence, they had only created less than $900 billion in 93 years and then in March of 2020, they created $500 billion in a week. Monetary policy is loose and the Fed keeps telling us, “We don’t think there’s going to be any significantly higher inflation anytime soon.” Here’s why. We recognize the commodity prices are going to go up but that’s transitory so we’re going to ignore that.
The real factor that will determine whether or not there is inflation in the United States is whether there’s wage inflation and here, that seems unlikely because ten million fewer Americans have jobs in 2021 than 2020. Until these tenmillion Americans get their jobs back, it seems unlikely that there’s going to be a whole lot of wage-price inflation when you have all of these unemployed people looking for jobs. The Fed is saying, “We’re going to keep supporting the economy with the loose monetary policy until these people get their jobs back.” We see inflation at the core level beginning to move higher. Their target is 2% but in August of 2020, they announced quite a significant change in their policy.
They said, “In the past, we have targeted 2% inflation at the core level and anytime that we thought the economy was getting too hot, the unemployment rate was going too low. If the unemployment rate goes low then you would think wage inflation would pick up. If the unemployment rates started going too low, they would start hiking interest rates preemptively to make sure that they could cool the economy down before there was inflation setting in.” What they saw is over the last couple of cycles, for instance, before the pandemic started, the unemployment rate had dropped to 3.5%, which was a 50-year low.
Still, the inflation rate was less than 2%. Even then, they couldn’t hit their inflation target but they had acted preemptively and had already started increasing interest rates. That slows the economy down unnecessarily and causes people not to be able to find jobs, who would have found jobs had they not increased interest rates. They changed their policy. They have said, “First of all, we’re not going to hike interest rates preemptively anymore. We’re going to wait until we see that there is a core PCE inflation. Furthermore, since we’ve undershot our inflation target for the last twenty years or so, we’re going to allow the inflation rate to move above 2% so that it averages 2% over the long run.”
Even if the inflation rate does move up to 2%, it can move up to even 2.5%, perhaps even 3% for 6, 12, 18 months. Still, before the Fed would act because they’re trying to target an average of 2% over the long run. The Fed is going to continue to have a loose monetary policy for the rest of 2021 unless something extraordinary happens and they do an extraordinary monetary policy U-turn. In every speech they make, they say, “We are going to keep the federal funds rate at 0% and we’re going to keep pumping in at least $120 billion a month into the financial system and into the economy until these ten million Americans get their jobs back and we start to see some wage-price inflation.”
Everyone is frightened of inflation and because of that, the ten-year government bond yield has moved up quite quickly. People are afraid of inflation and they don’t want to buy a bond that pays 1% because if the inflation rate moves up to 3% thenthey’re going to lose money on their bond. The ten-year government bond yield is less than 1% of the beginning of 2021 and it moved up quickly to 1.75%. With the bond yields moving up quickly, that has spooked the financial markets to some extent and caused some of the higher-flying Nasdaq stocks to be hit. That said, the markets are still all close to their all-time highs.
The Fed is telling us that they’re not going to tighten monetary policy anytime soon but the markets are not sure that they believe them. It’s unlikely that they’re going to tighten monetary policy. There’s this battle going on in the markets. On the one side, the markets are being hit by a tidal wave of liquidity. There’s so much new money going into the markets that it should drive them higher, even though the asset prices are already expensive by historic standards. That’s the bullish side, this tidal wave of liquidity. This liquidity tsunami hitting the markets should push stocks, gold and other asset prices higher.
On the other side, there are growing fears of inflation and therefore, that’s pushing up interest rates on the ten-year government bonds. If they keep moving higher quickly then that could cause the stock market to sell-off. It’s going to be fascinating to watch which side wins out the enormous surge in liquidity hitting the markets or the fear of inflation undermining the markets because of pushing up higher interest rates.
What are they using other than just logic as far as fearing inflation? Is there anything that they’re looking to numerically objectively that tells them that there’s going to be inflation?
There are a number of things. First of all, they see this $1.9 trillion stimulus bill and therefore, as a result of that bill, most Americans are receiving $1,400 checks.
Take every member of the family gets a check.
This changes a lot because Americans have been locked down to some extent. Because they have been receiving such generous support from the government, they have much more in savings than they have for decades. The savings rate is high. With the vaccines rolling out, people want to go out and spend money, go places and do things. There’s concern that by itself, given that they have a lot of money to spend, is going to result in inflation. On top of that, there are some significant supply bottlenecks in terms of things like semiconductors and various things across many different supply chains have been disrupted by the virus. That will work itself out before too much longer.
Credit Growth And Liquidity: The United States doesn’t source goods from within its borders anymore but from the entire planet.
That’ll impact prices though because typically, there’s not much response over the short-term to those types of supply chain expenses or costs of goods. The prices are adjusted a couple of times. Maybe once a year, if anything. You’re saying that those costs of manufacturing are going to influence some manufacturers having to increase their prices.
There will be some inflationary pressure, but should you view this as permanent or is this a transitory factor? Does it hit one year and then goes away or is this something that’s going to be sustaining and recurs year-after-year? If it’s only a transitory impact then the Fed is going to ignore it. The most important thing for people to never forget is the United States no longer has a closed domestic economy. What the United States buys is not what the United States produces. In the past, we had a relatively closed domestic economy.
If the government spent too much money and the Fed printed too much money then soon all the Americans would have jobs and all the American factories would be working at full capacity. This would lead to upward pressure on goods but also on wages. This would lead to a wage-push inflation spiral. That’s what happened in the 1960s, particularly in the first half of the 1970s. Now, we’re in a completely different environment. We don’t source goods simply from within the borders of the United States. We source things from the entire planet and the entire planet, the labor supplies are 23 times larger than the American labor supply.
Moreover, most of these people work at a substantially lower wage rate than the Americans. For instance, 2 billion people out of 8 billion on the planet still live on less than $3 a day. This has completely transformed the economic environment in which our economic system functions. That’s why it’s been possible to run the economy so hot with these massive government stimulus programs after 2008 and all the paper money creation that financed them after 2008 and also in 2019 and 2020. It’s not just a matter of getting the ten million Americans back to work who’ve lost their jobs. We also have to keep in mind that we have a whole world full of people willing to work.
We have generations ahead of us where we’re going to have excess low-cost labor. That’s why we’ve moved into this low inflation environment starting in the 1980s. When President Reagan tripled the budget deficit and tripled the government debt in just eight years, you would have expected that to cause high rates of inflation in the ‘80s as it had as high of government debt did in the 1960s and ‘70s. That didn’t happen because starting in the early 1980s, that’s when the first time the US started running these huge trade deficits with the rest of the world.
Never before did the US have these trade deficits but by the middle of the ‘80s, the trade deficit was 3.5% of USGDP and by 2006, it was 6% of GDP. $800 billion in that one year alone and that changed everything. Since we started running these deficits and since we started moving factories offshore and hiring people for less than $10 a day, inflation has collapsed because wages haven’t risen. We’re not going to return to a period of high wage growth and high inflation in the United States unless globalization collapses and that doesn’t seem likely.
Maybe explain for readers that don’t necessarily understand the impact of trade deficits. How do trade deficits give the US leverage or maybe the ability to institute these types of monetary stimulus packages and their monetary policy being driven to continue to stimulate and inject capital?
It’s interesting. All of the classical economic theory, which everyone is still being taught, was constructed on the cornerstone of the gold standard. The whole theory began with the understanding that gold is money and because gold was money, there were certain constraints and those constraints define how the economy could work. The central bank was not free to create limitless amounts of money because they had to have gold to back the money that they created. They couldn’t just simply do as they do now and create $120 billion a month because they had to have gold in the safe at the central bank to back the money they created. It limited how much money they could create.
Also, importantly, under the gold standard or the Bretton Woods system, which lasted up until 1971, it was impossible for countries to have large trade deficits with other countries. If the United States, for instance, had a large trade deficit with the rest of the world or any one country, in particular, let’s say China, a few years ago, the US trade deficit with China was $1 billion a day. It’s more than $400 billion a year. That was not possible under the gold standard because the United States would have had to pay for its trade deficit by shipping its gold to China. The more gold is shipped to China, the less gold and therefore, the less dollars there would be in the United States.
The money supply would contract. Everybody would have fewer dollars and they would lose their jobs. Companies would lose business and unemployment would skyrocket and there would be deflation and then depression. Countries with trade deficits lost their gold and had to stop buying things from other countries. Whereas the countries with trade surpluses got more gold and they could expand their credit on the back of that larger gold base. Their economy would boom and they would have full employment. They would have inflation and soon, they would be richer and they would start buying more things from the poor country that was deflating with the deficit.
The deficit country would have to buy less. The surplus country would be able to buy more and trade would come back into balance. There was an automatic adjustment mechanism that ensured the trade between countries that had the balance and it did. You can look at a chart of the US current account deficit going back as far as the data goes. Until 1980, there essentially was no trade deficit. The Bretton Woods system broke down in 1971 and afterward, dollars were no longer backed by gold or anything else. The Fed was free to create as many of them as it dared. The only real constraint was they were afraid if they created too many that it would lead to higher rates.
It would over stimulate the US economy and cause everybody in the United States to be fully employed. The factories would be working at full capacity. It would end up being a lot of bottlenecks both in industrial capacity and in labor. This would lead to higher rates of inflation for goods and wages in a wage inflation spiral. That’s what happened in the late ‘60s and early ‘70s. Starting in the early 1980s, the United States caught on to the reality that since they didn’t have to pay with gold anymore, they could start running large trade deficits with the rest of the world. Also, buying things from other countries and paying for those things not with gold but with dollars of which there was no limit as to how many they could create or government bonds more realistically.
There was no limit as to how many government bonds the government could issue. There are 330 million Americans and let’s ignore the children and the people who are not working. Rather than being limited to a labor pool of 330 million Americans, we can source our goods from a labor pool of 7.8 billion people. Our labor pool has expanded by 23 times as a result of this change that only came about when the money stopped being backed by gold. This completely changes the way our economic system functions. All of the economic theory, which was constructed on this foundation stone or gold, once that foundation stone was removed, that entire edifice of classical economic theory collapsed.
It can no longer explain the way our economy works because for one thing, the Fed is free to create as much money as it chooses as we’ve seen in 2020 and particularly since 2008. Trade no longer has to balance so they can get away with all of this money-creation without causing high rates of inflation. It used to result in the past when we had a closed domestic economy but it no longer does when we’d have 23 times more people in our labor pool.
Richard, we’re setting the stage for what’s to come. Where I see conflict is there are many who still subscribe to maybe not pure classical economics but still they subscribed to helping should be not how things are and they’re making decisions based on how things should be. Looking at our economy and operating the way that it is, is leading to the demise of the economy. The classical theory would say that that is probably true but yet, given the points you’ve just made, it’s highly unlikely.
I want to talk about the impact of what our monetary policy is going to make on markets and on asset prices and what people should be paying attention to. Maybe before we move to that, where are people stuck? Why are they not able to see what you see? Are they just clinging to ideas, wanting to be right and finding all sorts of proof and variables that backup and validate their theory? What explanation is there for the more traditional, classical view of how things should operate rather than how they are operating?
When you havegenerations of people who have been taught this theory that large government debts and a lot of paper money creation by the central bank is undesirable and leads to high rates of inflation that is destabilizing and they’ve been taught this as gospel, it’s hard to persuade them that it’s not true.One great stroke of luck that I’ve had is I’ve spent almost all of my career in Asia. I moved to Hong Kong when I was 25 and have lived here most of the time since then. What I realized early on is that looking North from Hong Kong, as far as you could see, there were Chinese factories to the horizon full of nineteen-year-old women making $5 a day. This clearly was going to completely change everything.
How could the United States paying its workers $200 a day with benefits compete? It was clear that this was going to de-industrialize the United States and cause great deflationary pressures and eventually social instability.That’s what we’ve seen. Unless you understand the significance of globalization and understand that our labor pool has expanded by 23 times and is now full of people earning less than $10 a day. Unless you grasp that our economic environment has completely changed then you’re still going to be stuck in the old mindset that if you overheat the economy by too much government debt and too much money creation, that’s going to lead to inflation.
Everyone expected this to happen after 2008. The first round of quantitative easing was in 2008 and we had three rounds altogether, the last one ending in 2014. During that time, the Fed expanded its balance sheet from $900 billion to $4.5 trillion. In the government debt, we had $1 trillion budget deficits for 4 or 5 years in a row and almost everyone believed and I have to include myself in that group. People thought this was going to lead to high rates of inflation. Especially in the early years, it looked like that was going to happen. In 2011, for instance, food prices went out a lot in the world and this led to the Arab Spring.
When people in North Africa couldn’t afford to buy food, they started toppling governments and this looked like it was going to end badly just like the textbooks said it would.What happened? Food prices were high. The next year, the farmers planted a lot more food and prices collapsed again. We‘re in a different economic environment. We had this extraordinary surge in government debt. There’s an extraordinary round of money creation by not only the US central bank but by all the central banks in the world and we still don’t get to 2% inflation at the core level.
The first round of quantitative easing caused the monetary base to grow 100% year-on-year. That was much more than it grew at the peak of World War II. In World War II, the large increase in the money supply will lead to high rates of inflation. They had to put price controls in place to try to control inflation. This time, the money supply grew much more in 2009 100%, again in 2011 and again in 2013, three times it grew more than at the peak of World War II and inflation didn’t budge. People need to understand what has changed and what has changed is our labor pool has expanded 23 times. Not only has it expanded butone billion people would probably be glad to work for $15 a day.
It’s interesting where you look at also with what’s happened in 2020. I haven’t studied this but you would assume that there were some supply chain breakdowns and there was disruption. At the same time, when things like that happened, they only get stronger. I was reading some news about some of the US-based manufacturing specifically Ford moving a $1 billion a year plant to Mexico. You’re going to probably start seeing more of that, especially if you have tax increases that this administration wants to push forward.
Before we get into how this type of economics is going to influence investments, the large global economy and the US economy, maybe speak briefly to the role of taxes in all of this. This might be classical but it’s money printing or stimulating the economy creating this type of injection also comes with the need to increase revenue. Either that’s going to come in volume staying at the same tax rate or tax rate is going up and increasing the volume that way. Maybe go and speak to the role of taxes in all of this especially in the US.
Let me give you a roundabout answer to that and make sure I don’t forget to come back to the taxes. I don’t think it’s necessary to increase taxes and I wouldn’t particularly object if they did increase taxes but that’s not something I advocate.What I do advocate and what we are beginning to see now is more people are going to reach the same conclusion that I have. In fact, you can see that more people are reaching this conclusion. A modern monetary theory has become mainstream now.
Are you saying that your philosophy and theory is akin or closely aligned with modern monetary theory?
Let me tell you what my theory is and then we can compare the two or what my ideas are because we’re now living in this different environment and we’re beginning to see this implemented in government policy. We have managed to pull through the crisis of 2008 without having hyperinflation.We’ve responded to this global pandemic with a $5 trillion increase in government debt in 2020 so far with no inflation. There’s probably going to be some pickup in inflation but we’ll probably be back to below 2% core inflation again.
What lessons should we learn from this?The Biden administration was talking about having perhaps a $3 trillion infrastructure spending plan. That would not be in one year. They haven’t said over how many years but we’re probably talking 5 to 10 years perhaps. This already represents quite a different shift in ideas about what the government is going to do going forward. The lesson that is vitally important for us to learn from this is since we have been able to have the government borrow so much money and the Fed finance that by paper money creation. What I would like to say is for the government over the next ten years or so to undertake a multi-trillion-dollar investment program in the industries of the future in cooperation with the private sector.
Credit Growth And Liquidity: Countries with trade deficits lost their gold and had to stop buying things from other countries. Meanwhile, those with trade surpluses got more gold.
The industries of the future are artificial intelligence, quantum computing, robotics, nanotech, biotech, genetic engineering and green energy. If the government can increase its debt by $5 trillion in one year alone, it would be quite easy for the government over a ten-year period to finance a $10 trillion investment program. Not handing out money for free to everyone but investing it in these industries. If they do that, that would turbocharge our productivity and economic growth globally. They could do this by entering into joint ventures with the private sector. For example, the government could pick the 10,000 most promising American entrepreneurs and scientists and set up hundreds, if not thousands, of companies with them.
The government funding these companies lavishly in exchange for keeping a 60% equity stake and the managers get to manage the company. The entrepreneurs and the scientists manage the companies and keep a 40% equity stake. The US economy for most Americans has been stagnant since the 1970s. This would radically accelerate. It would induce a new technological revolution. It’s crucial that the United States do this. First of all, it should because it can and in a sense, it’s a moral imperative. With these sorts of investments, you can see what happened through Operation Warp Speed with government funding and government guarantees. We got a vaccine in less than a year.
We need to target a cancer vaccine using the same process. We have effectively limitless amounts of money that we could invest. The National Cancer Institute, which is the government institution in charge of finding a cure for cancer, its budget is $6 billion a year. That’s not working. Let’s try $60 billion or $160 billion. If we do invest on this scale, we have the chance of curing all the diseases, ending aging and radically expanding life expectancy. For that reason, we should do it. Also, in addition to that, we are in a race with China and we’re losing. China is investing more in research and development than the United States is.
They’re also expanding their economic influence through Belt and Road. They’re expanding that into multiple countries, essentially investing in their infrastructure, which also strengthens their financial-economic power.
It’s one thing if they colonize Africa. It’s an entirely different thing if they develop artificial intelligence before we do. Whoever gets to artificial general intelligence first, that level where computers can do everything humans can, from there the computers become exponentially smarter fast. Whoever controls that controls the future. China has won the 5G race and America is not even in the race. If the United States doesn’t ramp up its investment in artificial intelligence and all of these new industries, China is going to win. Once they do, the world will be at their mercy. I have nothing against China or Chinese people at all but it’s generally a bad idea to allow some foreign power to become vastly superior to you technologically.
Throughout history, technologically superior civilizations don’t treat inferior civilizations kindly. Years from now, we are going to be an inferior civilization at China’s mercy and they may be a kind master. They may not do anything. They may just stay in China and continue prospering there. On the other hand, they might not. They have been spending the years of COVID reading all of Winston Churchill’s books about World War I and World War II. He wrote five volumes on World War I and six volumes on World War II. His warnings are extraordinary about first, the rise of Germany in the years leading up to World War I.
Even more loudly, his warnings about Germany rearming in the 1930s and no one listened. We’re now in the same situation. If we don’t understand that we’re about to be surpassed technologically by China and do something about it soon, then we’re going to become a second-rate vulnerable power by the middle of the next decade. There’s no reason that we have to allow this to happen. We have the financial resources to do this. We have the scientists to do this. All we need to do is have the willpower to do this and if we do, we can remain the dominant, preeminent global superpower and locked in another American century. If we don’t, our destiny will no longer be within our own control.
This is what’s going through my head. First off, I look at what you just said and we do have the wherewithal, the mindset and the psychology to innovate. I’m not sure if you know what the XPRIZE is but there’s a group that raises capital. Collectively, it’s probably billions but their top prize is $20 million. They create a prize for anyone who can solve some problem. The problems that have been solved, the ones that come to mind are being able to grow meat from stem cells and be able to produce that at a certain dollar amount per pound. They get $20 million if they can figure that out. The wherewithal is there.
At the same time, psychology, I would say collectively in the United States, is a headwind of sorts. If you do start to encourage investment in these types of innovations with an equity stake, there’ll be this socialism psychology that resists that. It’s interesting in 2020 where you’ve had so much intervention, it’s curbing the psychology that would resist that type of activity. My question to you, is that on point? Do you see signs that there is the desire or at least the initiative of the administration to do things like you’re mentioning? Because China is already doing it. The US is extremely innovative. At the same time, it’s not innovation at the level that you’re speaking to where you have trillions of dollars going into these specific industries or innovations.
The government could invest on a so much larger scale or provide the financing. If you look at the list of the top ten American companies ranked by the amount of money that they invest in research and development, you have all the usual suspects that you would expect. Alphabet and Apple, even Intel are investing in research and development at the most $20 billion a year.Whereas the government could afford to do this.
That’s a drop in the bucket compared to what they’ve been talking about.
The Fed is creating $120 billion every 30 days. The potential is there for us to ramp this up on an aggressive scale like we did when the Soviet Union launched Sputnik. It appeared that they were going to overtake us technologically and the government responded by radically accelerating government investment in research and development and we won the space race. We landed a man on the moon and because of all of this investment in NASA, we were able to develop highly effective intercontinental ballistic missiles, which the Soviet Union couldn’t keep up with.
They effectively went bankrupt trying so there’s no longer any Soviet Union. That government investment worked out well and it created all kinds of new inventions and technologies like the handheld computer and calculator, for instance. The government is investing something relative to GDP.They’re only investing 1/3 as much relative to GDP in research and development as they did in the early 1960s. That’s one of the main reasons that productivity in the United States has slowed down. The private sector can’t fund basic research and development.
Those basic things that don’t immediately turn into products that can be sold but provide the foundation upon which later investment can lead to products that can be sold. We’re not investing enough in basic research and development. Are we moving in that direction? I’ve been talking about this now for many years, long before I ever heard of modern monetary theory.Yes, we are moving in that direction. First, we’re going to see a big infrastructure spending plan. Infrastructure is fine but it’s not going to do what a large-scale investment project program would do in investing in new industries and technologies.
We’ll have better bridges, roads, hopefully, better broadband and hopefully, a better clean energy network but it’s not going to cure cancer or make sure that we win the AI race. It’s still a shift.It will create jobs. It will improve the economy. It will make the middle-class better off. President Biden, when he was still running for office, he pledged that he would have this kind of investment in infrastructure. Also, in his campaign, he also pledged to invest $300 billion in research and development.$300 billion is far too little but it is a step in the right direction.
At the end of 2019, Charles Schumer also made a presentation in Washington in front of the defense establishment where he warned that we were in danger of being overtaken by China in artificial intelligence. He said he was going to propose a bill to invest $100 billion in these new industries and technologies over a five-year period.That’s nothing but it’s still a step in the right direction, an indication that our society is moving in that direction and the recognition that we can do this and that we need to do this.
In the past, people would always say, “You’re out of your mind if you think anything like that is going to happen.”Not so much anymore because things are moving in that direction. I suppose what I’m saying could be thought of as a subset of modern monetary theory. Essentially, what they’re saying is in a country that can create its own money like the United States, there are effectively no financial constraints on what it can do. However, there are resource constraints. If you use up all your resources or in other words, hit full capacity in using the resources available to you in terms of labor, factories, commodities available then you will then get high rates of inflation.
The inflation you need to worry about is not the fact that we can afford to do something. There’s no limit as to how much money the central bank can create. There are no financial constraints. The constraint is when do you hit the resource constraints? You’re going to have to stop spending for a while or take some other measures to get inflation under control. In a nutshell, that’s essentially what they’re saying and that is true. It’s hard to argue with that. I don’t want to take on and be required to defend the entire modern monetary theory in its entirety. All I want to do is to persuade the American public and the US Congress that the next ten years or so would be easy for the US government to finance a $10 trillion investment in the industries of the future. That’s all I’m asking for.
In 2020, the government debt expanded by $5 trillion in one year alone and the Fed created $3.5 trillion. What that experience is going to show is how easy it would be for the government to carry out the plan that I’m discussing so that’s where I’m drawing my defenses. That’s all I want to prove. That’s all I’m saying. I don’t want to overreach and try to defend any broader theories. I’m keeping it tight. This is what we can do. We can do this easily. This is what we need to do. If we don’t do it, not only will we fail to cure all the diseases but we are going to be in grave national danger.
Let’s unpack that maybe as one of the final points because there’s definitely evidence. Being in Asia, you probably are seeing things that most other people are not paying attention to. Talk about where China is because if they do reach that milestone before the US, why is that a bad thing for the US? Maybe AI would be a good example. If they reach 5G before us but we essentially are leveraging some of their technology for our infrastructure, wouldn’t it be safe to say that that would be a similar conclusion if they reached general AI before the United States?
One word before that, taxes. You were asking me about taxes so I don’t think we have to increase taxes to do what I just described, to answer your question. Should we increase taxes? Probably so. The top 1% of the top 1% have more wealth than the bottom 50%. That’s not healthy for democracy. This is not a battle I intend to fight. I’m not going to go out and say we must raise taxes on the wealthy. I don’t care that much whether we do it or not. That is not necessary for us to do in order to be able to invest $10 trillion in the industries of the future over the next ten years or so.
If threatening to tax the rich people more makes it more difficult to make these investments that I’m advocating then you don’t have to tax them. If that’s going to get in the way of making these investments, curing all the diseases, turbocharging economic growth and securing national security then forget about taxing the rich people and the corporations. It’s not necessary. In terms of social equity, it would probably be the right thing to do if somebody else can fight that battle. China has had brilliant leadership going on since the ‘80s, beginning with Deng Xiaoping.
They have a totalitarian regime so it was easy for them to carry out any policies that they devise. Totalitarian regimes are effective when they have brilliant leadership. The problem is sometimes, they haven’t signed leadership as they did under Chairman Mao and when that happens, they’re still totalitarian. About 30 million people starved to death in the early 1960s in China because of Chairman Mao’s madness. I’m not advocating totalitarianism by any means but just to analyze what has gone on in China is they’ve had good leadership in this totalitarian system since Deng Xiaoping in the 1980s.
He said, “I don’t care if the cat is white or black as long as it can catch mice. I don’t care if we have socialism or capitalism as long as it works.” What they have is effectively capitalism directed by the central government in a clever way with a plan to invest heavily in the most important industries. Also, develop their country so that they can become the dominant power in the world long before the middle of the 21st century. They have a plan and they publish it and talk about it. They talk about it a little bit less now since it caused the Americans to wake up to the fact that they’re about to overtake us. They have a plan and it’s working well.
What’s so bad about them getting to 5G first or AI first? Once they get to AI then it’s going to cause such a leap in technology that it would be the 21st century equivalent of China having a nuclear monopoly. It will make them all-powerful. Once they get to that point where machines become more intelligent than humans and continue to teach themselves to become more intelligent, which is going to happen soon then whoever has that power first can do anything it wants with the rest of the world.
Maybe two things. Number one, maybe illustrate an example of how they would exercise that power and then the second point is if they get to that level, are you saying that it’s possible to keep it completely proprietary so that others can’t use it or leverage it?
On the second point, yes, they could keep it completely proprietary. On the first point, which was will they use it? We don’t know if they will use it or not. It’s because they have the capacity to take over the world doesn’t mean they will but do we want to put ourselves in a position where a potential adversary has the power to conquer us and completely destroy our civilization? That’s the position we will be in, in less than fifteen years unless we begin acting aggressively in making full use of our financial resources and our capacity to innovate.
Sometimes, I laugh at the conversations that we have at this level. Two hundred years ago, people were still trying to figure out how to survive the winter and now we have completely transformed society and life. Richard, I love speaking to you because you have a different perspective than most and you also speak to what’s going on in the cause-and-effect side of things. We spoke about this last time and sure enough, we’re at this point where this is what the government does and it’s what they’re going to do. It’s creating a more buy-in psychology. I don’t want to put it in a negative context but the boiling frog.
You stimulate a little bit, you stimulate more and the more you do it, people have become accustomed to it. Once you hit a threshold of a billion, that’s one thing. Now we’ve hit thresholds of trillion and the psychology behind a trillion here, a trillion there is easier to stomach for those that would resist. Let’s talk about this as a final point. There’s still money from the 2020 stimulus that hasn’t been spent yet. This money is not all going to make its way into the markets in a day. It’s going to most likely happen over the course of time but a $3 trillion infrastructure, what should investors be taking from this? Those are some of the causes. That’s the stimulus. What’s the response? What are the effects?
Let’s talk about making money. We’ve gone into the philosophical realm here and geopolitics. That’s the important thing, in my opinion. With my video-newsletter, Macro Watch, this is not what I talk about. This is what I talk about in my books. Macro Watch focuses on the forces that are driving the economy and the financial markets. Big developments are likely to have some impact on people’s wealth and the state of the economy. The main forces that affect the economy are two big things, which are credit growth and liquidity.
Credit Growth And Liquidity: Throughout history, the technologically superior civilizations don’t treat the inferior civilizations very kindly.
Credit growth is how much does credit grow by every year in the country? Liquidity is how much money the Fed is creating and pumping into the economy? It’s a little bit more complicated than that. Something interesting is happening that could potentially have a big impact on the financial markets.There is truly a tidal wave of money that’s being pumped into the financial markets. We know that Fed is creating $120 billion a month. If we’re talking about April until June of 2021, that’s going to be $360 billion more. This is something that most people are not aware of.The treasury department has a bank account at the Fed that’s called the Treasury General Account.
That’s the $300 billion I was talking to you about. It was a drawdown from that account.
How does that work? In the past, no one knew about this Treasury General Account. It didn’t make much difference because the government never had much money in it. What happened in 2020 is we had the $2 trillion CARES Act in March or April. Immediately after that, everyone expected a second, even bigger stimulus package. The Democrats in the House passed a $3 trillion stimulus bill that never went anywhere but people were talking about $2 trillion or $3 trillion worth of stimulus in the second half of the year. The treasury department wisely issued a lot of bonds and borrowed money at low-interest rates to be prepared for this stimulus act when it did pass so they would have enough money.
Congress never passed the act until the middle of December. When they did, it was only $900 billion in the middle of December. The government treasury had borrowed all this money but Congress didn’t authorize them to spend it. It piled up into their bank account at the Fed until they had a peak of $1.8 trillion in this bank account. That was $1.8 trillion that they had sucked out of the economy and the financial markets by borrowing it. They borrowed it and they didn’t spend it. It was just stuck in their bank account. Now, everything has changed. We got the $900 billion in stimulus package in December so they started spending money out of their bank account at the Fed.
The $1.9 trillion stimulus package has passed so suddenly, the treasury department is spending this money and as they spend it, it pumps it back into the financial markets. You can see this by looking at the level of bank reserves. Bank reserves are a good measure of the amount of liquidity that there is in the financial markets. The treasury department has told us that it’s running down quickly. It expanded by $25 billion a week alone. They are running it down. It still has, as of announced, the data every Wednesday. Once a week, we get an update on how much they have in this account.
They still have $1 trillion in it. In March 2021, they had $1.4 trillion in it but they’ve told us by the middle of June, they’re going to run that down to $500 billion. That means they have $1 trillion in March and in June, they’re going to spend $500 billion and that’s on top of the $360 billion that the Fed is going to print. That’s $800 billion that will be pumped into the financial markets by the end of June and that will cause bank reserves to jump by a further 21% by the end of June.
It’s at a record level, isn’t it?
That’s right. It’s already at an all-time record high and it’s moving up vertically and rapidly. If you looked out toward the end of 2021, they’ll still have $500 billion in their account. Let’s assume it stays at $500 billion but the Fed is going to create $120 billion a month for six months. That’s another $720 billion. By the end of 2021, the bank reserves could be up by 36% from where they are, which is already a record high. This is a tidal wave of liquidity going into the financial markets and normally, every time bank reserves go down, the stock market goes up.
You can see QE1, QE2, QE3, pandemic, bank reserves go up, markets go up and asset prices go up. You have asset price inflation. It’s easy to understand why. When you create and inject a whole lot of new money into the markets, it’s not surprising that prices and asset prices go up. People need to be aware of this. It’s not surprising why there’s such a frenzy going on in the markets while you have these crazy Robinhood stocks doing insane things and shares like Tesla trading on infinite P/E multiples. It’s because of this tidal wave of money and this is not going to go away. In fact, it’s going to become more extreme.
The world is full of uncertainties but the most likely thing that could be real in this scenario from playing out is that we do get higher interest rates. If the ten-year government bond yield keeps moving up sharply because people are afraid of inflation, these inflation fears have already pushed up the bond yields from 1% at the beginning of 2021 to 1.75%. If they keep moving to higher interest rates, it could pull the rug out from under this big stock market, this liquidity-driven boom. People have a lot of money. There’s a lot of money in the system that doesn’t necessarily mean that they have to buy stocks with it.
They can put it under their bed and just sit on it if they become nervous enough and have a panic attack. We may see a few panic attacks in the markets, particularly if people become more concerned about inflation. It’s possible that they will become more concerned about inflation because in March and April of 2021 when the inflation numbers are reported, they’re going to look a lot higher in 2021 than they did in 2020 because, in 2020, the prices were falling. The year on your effect is going to be a bit scary. We may have a few sell-offs in the stock market before we get to2022.Who knows what else could happen?
If I had to bet, it would seem to me that this enormous amount of liquidity in the markets is likely to continue putting upward pressure on asset prices. This boom won’t last forever. Bubbles never last forever. Bubbles do eventually pop but you never know when they’re going to pop. Often, it’s the last part of the bubble that is the sweetest and the most profitable. Generally, I’ve learned that through my experiences that you can recognize a bubble but it’s probably the best strategy to surf that bubble until it pops because you never know how big it’s going to get. If you lose 10% on the way down from the peak, you could be up 100% from where you would have been if you’d sold it when you first thought it was a bubble.
Do you have a gauge on any behavior associated with the change in capital gains tax? If new tax legislation is introduced and there’s a high likelihood that it will pass and it includes capital gains being taxed at the marginal rate, do you think people will be like, “I’m going to take my gains right now. I’ll pay my 20% instead of having to pay ordinary?” Do you have a gauge for what could potentially happen there?
The main factor is the force of liquidity. If there’s this much more money going into the economy and into the financial markets, that weight of money is going to push asset prices up regardless of what they do to the capital gains tax. What the Biden administration is saying is they’re not going to increase taxes until this pandemic ends. That’s probably not going to happen until 2022 so that’s beyond the discussion that I’m discussing here. One day, the Fed will stop printing $120 billion a month and that’s going to be a sad day for the market. When they make that announcement or when they start dropping hints that they’re going to start reducing, we’re going to have a big taper tantrum again.
The hint itself is what’s going to cause it, not the actual action.
This brings up another interesting topic. In the past up until now, in fact, the Fed was concerned about the level of the stock market. They needed the stock market to go up to create wealth and help drive the economy because credit was growing too slowly after 2008 to drive the economy. Credit had been the big growth driver. It was expanding rapidly and that created economic growth but after 2008, it stopped expanding rapidly and it was growing just barely enough to keep the economy out of recession for years.
The Fed orchestrated higher stock prices and higher asset prices with 0% interest rates round-after-round of quantitative easing. Any time the stock market started to wobble, the Fed would concede and announce that they were going to loosen monetary policy in one way or the other to push the market back up again. Perhaps things are different now. The Fed is not so reliant in 2021 on the stock market. There’s no longer a hostage to the whims of the stock market because this massive stimulus package is going to generate 6% or 7% GDP growth in 2021. Perhaps that explains the attitude of Fed Chairman, Powell.
The markets have been nervous because the ten-year government bond yields have been going up so rapidly and many people have expected him to say something about that. For instance, if the Fed didn’t want them to go up, the Fed could say, “As you know, we’re buying $120 billion worth of bonds every month. We think the ten-year bond yield has gone too high sonow we’re going to buy an extra $100 billion worth of government bonds and push up the bond price and drive the bond yield back down to 1%.”
They have the ability to control the bond yield at absolutely any level they choose. People have expected him to say something. After all, the central bank of Australia did that. They intervened and bought more bonds and pushed the yield back down. The ECB in Europe did that. They said, “We’re going to buy more bonds.” They pushed their yields back down. The Fed hasn’t done that and that surprised a lot of people. Perhaps they haven’t done that because they wouldn’t mind the stock market correcting somewhat because it’s a wild frenzy going on in the markets and it’s going to become even wilder as this liquidity tidal wave hits the markets in the years ahead.
You’re likely to have more velocity too. As people get vaccinated, they start to socialize. In 2020, most people did not spend stimulus money. They’d paid off debt or saved it because they were still in the middle. There wasn’t an end in sight. Now there’s an end in sight, which is going to change the behavior associated with the money that people are getting.
To wrap that up, the Fed may not be so quick this time to cave in if the stock market has a 20% correction as it has been in recent years. It’s hard to see how there’s going to be a 20% correction as long as all this tidal wave of money keeps getting pumped into the markets.
That’s such a good point with what’s already been committed to going in. It’s almost a little over $1 trillion.
Those are the sorts of things that I focus on in Macro Watch. Many videos that I’ve done have been discussing inflation and this liquidity tsunami. There’ll be more of that to come. The next video is going to explain why money supply growth no longer leads to high rates of inflation as they did in the past but that’s a long story.
At the same time, it’s such a compelling narrative. As to what’s happened in 2020, it is right in line with what you’ve been saying with the books that you’ve written and what you’ve spoken about for years. It’s the precedent upon which all future economic influence is going to be based. I would say it has legs to it, Richard. It’s going to be important for people to realize it because oftentimes, people will stick to past assumptions, which may no longer be valid. We spoke to that with regards to classical economics and people still looking at that as an axiom upon which they make decisions. The world has changed.
A lot of people do it morally wrong for their government to be managing the economy in this way and that’s fine. Even if they hold that opinion strongly, they need to be aware that this is what the government is going to do.
They’re already doing it. It could be wrong but they’re doing it. You can’t go to right or wrong at this point because that’s the way in which things are run. It’s how the economy is built.
If you want it to be able to make money, you need to understand how the economy works now. Whether you like it or don’t like it, you need to understand how it works. It doesn’t work the way that it used to back when gold was money. It works in an entirely different way now. What Macro Watch does without having a lot of political commentary at all, explains how the economy works now without imposing any value judgments on it for the most part. It explains that credit growth drives economic growth and liquidity drives the financial markets. It explains these trends in an easy way. We’re using lots of charts.
Each video is normally about 15 to 20 minutes long. Each one usually has about 30 or 40 charts. There’s a new one every two weeks. I hope your readers will visit my website and check it out. They can find Macro Watch at RichardDuncanEconomics.com. That’s my website. If they would like to subscribe to Macro Watch, I’d like to offer them a 50% discount coupon code. If they go to RichardDuncanEconomics.com and hit the subscribe button, they‘ll be prompted to put in a coupon code. If they use the discount coupon code, June, they can subscribe at a 50% discount.
Credit Growth And Liquidity: By the end of the year, bank reserves could be up by 36% from where they are now, which is a record-breaking number.
If they do, they’ll receive one new video from me every couple of weeks for 2022 and they’ll also have immediate access to all of the videos and the Macro Watch archives. There must be more than 75 hours of videos in the archives that I’ve made over the years explaining every significant macroeconomic development that has occurred since October 2013 and explaining how the economy works now. There are also a number of courses there that they can begin watching immediately. I’ll hope they’ll go to my website, RichardDuncanEconomics.com. While they’re there, they can sign up for my free blog.
Richard, this has been fascinating. It doesn’t seem like it’s been a year since we last spoke but I’m grateful for what you’re putting out there and the message you’re sending. I know it’s making a difference. I’m going to get the word out again because even though this was a long episode, the philosophy side of things is important to understand. The practical side of things is also important to understand. I’m grateful for the newsletter you put out. It’s an incredibly reasonable price. It’s not even a drop in the bucket. Thank you for keeping it economical. We’ll get the word out and make sure everyone has access to at least your blog so they can get some insight into what’s going on.
Thanks, Patrick. Thank you for having me back on. I always enjoy our conversations.
I love having them. Richard, thanks. Let’s try to do something sooner than a year. How about that?
Let’s do that. I look forward to it.
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My guest is Richard Duncan. Richard is an economist and author of several books and also the creator of the Macro Watch newsletter. Richard has a perspective on monetary policy that is unique to most other economists. In 2020, right as everything was shutting down, if you guys have been reading for a while, Richard was my guest. He lives in Thailand and has lived there for many years and is familiar with Asia, specifically what’s going on with monetary policy there. The interview was long and he offered an incredible discount on his newsletter. If you follow that newsletter then you’ve seen everything that played out from the perspective of how the US intervened as well as how they leveraged the central banking system.
He called everything. It’s interesting to see what he’s saying. Before we get into the interview, go check out his website, RichardDuncanEconomics.com. If you want to subscribe to his newsletter, he kept that code open so you get 50% off of his newsletter and that code is June. It’s an unprecedented time as far as liquidity that is slated to go into the capital markets. It’s incredible how much there is over a short period of time. You’re definitely going to want to pay attention to what Richard is saying so that you can understand how that’s going to impact what markets do. Without further delay, let’s get to the interview with my friend, economist Richard Duncan.
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Sometimes, I laugh at the conversations that we have at this level. Two hundred years ago, people were still trying to figure out how to survive the winter and now we have completely transformed society life. Richard, I love speaking to you because you have a different perspective than most and you also speak to what’s going on in the cause-and-effect side of things. We spoke about this last time and sure enough, we’re at this point where this is what the government does and it’s what they’re going to do. It’s creating a more buy-in psychology. I don’t want to put it in a negative context but the boiling frog.
You stimulate a little bit, you stimulate more and the more you do it, people have become accustomed to it. Once you hit a threshold of a billion, that’s one thing. Now we’ve hit thresholds of trillion and the psychology behind a trillion here, a trillion there is easier to stomach for those that would resist. Let’s talk about this as a final point. There’s still money from the 2020 stimulus that hasn’t been spent yet. This money is not all going to make its way into the markets in a day. It’s going to most likely happen over the course of time buta $3 trillion infrastructure, what should investors be taking from this? Those are some of the causes. That’s the stimulus. What’s the response? What are the effects?
Let’s talk about making money. We’ve gone into the philosophical realm here and geopolitics. That’s the important thing, in my opinion. With my video-newsletter, Macro Watch, this is not what I talk about. This is what I talk about in my books. Macro Watch focuses on the forces that are driving the economy and the financial markets. Big developments are likely to have some impact on people’s wealth and the state of the economy. The main forces that affect the economy are two big things, which are credit growth and liquidity.
Credit growth is how much does credit grow by every year in the country? Liquidity is how much money the Fed is creating and pumping into the economy? It’s a little bit more complicated than that. Something interesting is happening that could potentially have a big impact on the financial markets.There is truly a tidal wave of money that’s being pumped into the financial markets. We know that Fed is creating $120 billion a month. If we’re talking about April until June of 2021, that’s going to be $360 billion more. This is something that most people are not aware of.The treasury department has a bank account at the Fed that’s called the Treasury General Account.
That’s the $300 billion I was talking to you about. It was a drawdown from that account.
How does that work? In the past, no one knew about this Treasury General Account. It didn’t make much difference because the government never had much money in it. What happened in 2020 is we had the $2 trillion CARES Act in March or April. Immediately after that, everyone expected a second, even bigger stimulus package. The Democrats in the House passed a $3 trillion stimulus bill that never went anywhere but people were talking about $2 trillion or $3 trillion worth of stimulus in the second half of the year. The treasury department wisely issued a lot of bonds and borrowed money at low-interest rates to be prepared for this stimulus act when it did pass so they would have enough money.
Congress never passed the act until the middle of December. When they did, it was only $900 billion in the middle of December. The government treasury had borrowed all this money but Congress didn’t authorize them to spend it. It piled up into their bank account at the Fed until they had a peak of $1.8 trillion in this bank account. That was $1.8 trillion that they had sucked out of the economy and the financial markets by borrowing it. They borrowed it and they didn’t spend it. It was just stuck in their bank account. Now, everything has changed. We got the $900 billion in stimulus package in December so they started spending money out of their bank account at the Fed.
The $1.9 trillion stimulus package has passed so suddenly, the treasury department is spending this money and as they spend it, it pumps it back into the financial markets. You can see this by looking at the level of bank reserves. Bank reserves are a good measure of the amount of liquidity that there is in the financial markets. The treasury department has told us that it’s running down quickly. It expanded by $25 billion a week alone. They are running it down. It still has, as of announced, the data every Wednesday. Once a week, we get an update on how much they have in this account.
They still have $1 trillion in it. In March 2021, they had $1.4 trillion in it but they’ve told us by the middle of June, they’re going to run that down to $500 billion. That means they have $1 trillion in March and in June, they’re going to spend $500 billion and that’s on top of the $360 billion that the Fed is going to print. That’s $800 billion that will be pumped into the financial markets by the end of June and that will cause bank reserves to jump by a further 21% by the end of June.
It’s at a record level, isn’t it?
That’s right. It’s already at an all-time record high and it’s moving up vertically and rapidly. If you looked out toward the end of 2021, they’ll still have $500 billion in their account. Let’s assume it stays at $500 billion but the Fed is going to create $120 billion a month for six months. That’s another $720 billion. By the end of 2021, the bank reserves could be up by 36% from where they are, which is already a record high. This is a tidal wave of liquidity going into the financial markets and normally every time bank reserves go down, the stock market goes up.
You can see QE1, QE2, QE3, pandemic, bank reserves go up, markets go up and asset prices go up. You have asset price inflation. It’s easy to understand why. When you create and inject a whole lot of new money into the markets, it’s not surprising that prices and asset prices go up. People need to be aware of this. It’s not surprising why there’s such a frenzy going on in the markets while you have these crazy Robinhood stocks doing insane things and shares like Tesla trading on infinite P/E multiples. It’s because of this tidal wave of money and this is not going to go away. In fact, it’s going to become more extreme.
The world is full of uncertainties but the most likely thing that could be real in this scenario from playing out is that we do get higher interest rates. If the ten-year government bond yield keeps moving up sharply because people are afraid of inflation, these inflation fears have already pushed up the bond yields from 1% at the beginning of 2021 to 1.75%. If they keep moving to higher interest rates, it could pull the rug out from under this big stock market, this liquidity-driven boom. People have a lot of money. There’s a lot of money in the system that doesn’t necessarily mean that they have to buy stocks with it.
They can put it under their bed and just sit on it if they become nervous enough and have a panic attack. We may see a few panic attacks in the markets, particularly if people become more concerned about inflation. It’s possible that they will become more concerned about inflation because in March and April of 2021 when the inflation numbers are reported, they’re going to look a lot higher in 2021 than they did in 2020 because, in 2020, the prices were falling. The year on your effect is going to be a bit scary. We may have a few sell-offs in the stock market before we get to2022.Who knows what else could happen?
If I had to bet, it would seem to me that this enormous amount of liquidity in the markets is likely to continue putting upward pressure on asset prices. This boom won’t last forever. Bubbles never last forever. Bubbles do eventually pop but you never know when they’re going to pop. Often, it’s the last part of the bubble that is the sweetest and the most profitable. Generally, I’ve learned that through my experiences that you can recognize a bubble, but it’s probably the best strategy to surf that bubble until it pops because you never know how big it’s going to get. If you lose 10% on the way down from the peak, you could be up 100% from where you would have been if you’d sold it when you first thought it was a bubble.
Do you have a gauge on any behavior associated with the change in capital gains tax? If new tax legislation is introduced and there’s a high likelihood that it will pass and it includes capital gains being taxed at the marginal rate, do you think people will be like, “I’m going to take my gains right now. I’ll pay my 20% instead of having to pay ordinary?” Do you have a gauge for what could potentially happen there?
The main factor is the force of liquidity. If there’s this much more money going into the economy and into the financial markets, that weight of money is going to push asset prices up regardless of what they do to the capital gains tax. What the Biden administration is saying is they’re not going to increase taxes until this pandemic ends. That’s probably not going to happen until 2022 so that’s beyond the discussion that I’m discussing here. One day, the Fed will stop printing $120 billion a month and that’s going to be a sad day for the market. When they make that announcement or when they start dropping hints that they’re going to start reducing, we’re going to have a big taper tantrum again.
The hint itself is what’s going to cause it, not the actual action.
This brings up another interesting topic. In the past up until now, in fact, the Fed was concerned about the level of the stock market. They needed the stock market to go up to create wealth and help drive the economy because credit was growing too slowly after 2008 to drive the economy. Credit had been the big growth driver. It was expanding rapidly and that created economic growth but after 2008, it stopped expanding rapidly and it was growing just barely enough to keep the economy out of recession for years.
The Fed orchestrated higher stock prices and higher asset prices with 0% interest rates round-after-round of quantitative easing. Any time the stock market started to wobble, the Fed would concede and announce that they were going to loosen monetary policy in one way or the other to push the market back up again. Perhaps things are different now. The Fed is not so reliant in 2021 on the stock market. There’s no longer a hostage to the whims of the stock market because this massive stimulus package is going to generate 6% or 7% GDP growth in 2021. Perhaps that explains the attitude of Fed Chairman, Powell.
The markets have been nervous because the ten-year government bond yields have been going up so rapidly and many people have expected him to say something about that. For instance, if the Fed didn’t want them to go up, the Fed could say, “We’re buying $120 billion worth of bonds every month. We think the ten-year bond yield has gone too high sonow, we’re going to buy an extra $100 billion worth of government bonds and push up the bond price and drive the bond yield back down to 1%.”
They have the ability to control the bond yield at absolutely any level they choose. People have expected him to say something. After all, the central bank of Australia did that. They intervened and bought more bonds and pushed the yield back down. The ECB in Europe did that. They said, “We’re going to buy more bonds.” They pushed their yields back down. The Fed hasn’t done that and that surprised a lot of people. Perhaps they haven’t done that because they wouldn’t mind the stock market correcting somewhat because it’s a wild frenzy going on in the markets and it’s going to become even wilder as this liquidity tidal wave hits the markets in the years ahead.
You’re likely to have more velocity too. As people get vaccinated, they start to socialize. In 2020, most people did not spend stimulus money. They’d paid off debt or saved it because they were still in the middle. There wasn’t an end in sight. Now there’s an end in sight, which is going to change the behavior associated with the money that people are getting.
To wrap that up, the Fed may not be so quick this time to cave in if the stock market has a 20% correction as it has been in recent years. It’s hard to see how there’s going to be a 20% correction as long as all this tidal wave of money keeps getting pumped into the markets.
That’s such a good point with what’s already been committed to going in. It’s almost a little over $1 trillion.
Those are the sorts of things that I focus on in Macro Watch. Many videos that I’ve done have been discussing inflation and this liquidity tsunami. There’ll be more of that to come. The next video is going to explain why money supply growth no longer leads to high rates of inflation as they did in the past but that’s a long story.
At the same time, it’s such a compelling narrative. As to what’s happened in 2020, it is right in line with what you’ve been saying with the books that you’ve written and what you’ve spoken about for years. It’s the precedent upon which all future economic influence is going to be based. I would say it has legs to it, Richard. It’s going to be important for people to realize it because oftentimes, people will stick to past assumptions, which may no longer be valid. We spoke to that with regards to classical economics and people still looking at that as an axiom upon which they make decisions. The world has changed.
A lot of people do it morally wrong for their government to be managing the economy in this way and that’s fine. Even if they hold that opinion strongly, they need to be aware that this is what the government is going to do.
They’re already doing it. It could be wrong but they’re doing it. You can’t go to right or wrong at this point because that’s the way in which things are run. It’s how the economy is built.
If you want it to be able to make money, you need to understand how the economy works today. Whether you like it or don’t like it, you need to understand how it works. It doesn’t work the way that it used to back when gold was money. It works in an entirely different way now. What Macro Watch does without having a lot of political commentary at all explains how the economy works now without imposing any value judgments on it for the most part. It explains that credit growth drives economic growth and liquidity drives the financial markets. It explains these trends in an easy way. We’re using lots of charts.
Credit Growth And Liquidity: There’s this much more money going into the economy and financial markets that will push asset prices up regardless of what they do to the capital gains tax.
Each video is normally about 15 to 20 minutes long. Each one usually has about 30 or 40 charts. There’s a new one every two weeks. I hope your readers will visit my website and check it out. They can find Macro Watch at RichardDuncanEconomics.com. That’s my website. If they would like to subscribe to Macro Watch, I’d like to offer them a 50% discount coupon code. If they go to RichardDuncanEconomics.com and hit the subscribe button, they‘ll be prompted to put in a coupon code. If they use the discount coupon code, June, they can subscribe at a 50% discount.
If they do, they’ll receive one new video from me every couple of weeks for 2022 and they’ll also have immediate access to all of the videos and the Macro Watch archives. There must be more than 75 hours of videos in the archives that I’ve made over the years explaining every significant macroeconomic development that has occurred since October 2013 and explaining how the economy works now. There are also a number of courses there that they can begin watching immediately. I’ll hope they’ll go to my website, RichardDuncanEconomics.com. While they’re there, they can sign up for my free blog.
Richard, this has been fascinating. It doesn’t seem like it’s been a year since we last spoke but I’m grateful for what you’re putting out there and the message you’re sending. I know it’s making a difference. I’m going to get the word out again because even though this was a long episode, the philosophy side of things is important to understand. The practical side of things is also important to understand. I’m grateful for the newsletter you put out. It’s an incredibly reasonable price. It’s not even a drop in the bucket. Thank you for keeping it economical. We’ll get the word out and make sure everyone has access to at least your blog so they can get some insight into what’s going on.
Thanks, Patrick. Thank you for having me back on. I always enjoy our conversations.
I love having them. Richard, thanks. Let’s try to do something sooner than a year. How about that?
Richard Duncan is the author of three books on the global economic crisis. The Dollar Crisis: Causes, Consequences, Cures (John Wiley & Sons, 2003, updated 2005), predicted the global economic disaster that began in 2008 with extraordinary accuracy. It was an international bestseller. His second book was The Corruption of Capitalism: A strategy to rebalance the global economy and restore sustainable growth. It was published by CLSA Books in December 2009. His latest book is The New Depression: The Breakdown Of The Paper Money Economy (John Wiley & Sons, 2012).
Since beginning his career as an equities analyst in Hong Kong in 1986, Richard has served as global head of investment strategy at ABN AMRO Asset Management in London, worked as a financial sector specialist for the World Bank in Washington D.C., and headed equity research departments for James Capel Securities and Salomon Brothers in Bangkok. He also worked as a consultant for the IMF in Thailand during the Asia Crisis.
Richard has appeared frequently on CNBC, CNN, BBC and Bloomberg Television, as well as on BBC World Service Radio. He has published articles in The Financial Times, The Far East Economic Review, FinanceAsia and CFO Asia. He is also a well-known speaker whose audiences have included The World Economic Forum’s East Asia Economic Summit in Singapore, The EuroFinance Conference in Copenhagen, The Chief Financial Officers’ Roundtable in Shanghai, and The World Knowledge Forum in Seoul.
Richard studied literature and economics at Vanderbilt University (1983) and international finance at Babson College (1986); and, between the two, spent a year travelling around the world as a backpacker.
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March 18, 2021Patrick DonohoePodcast00:24:23Comments Off on How The New Spending Bill And Tax Plan Can Impact Your Overall Wealth Strategy With Tom Wheelwright
With the new president and administration coming in, a new spending bill has been passed. It tells an interesting story, but what exactly is its difference from the past spending bills? Patrick Donohoe brings back Tom Wheelwright to tackle this very subject. They also go into Biden’s tax plan and its implications to the overall economy. Tom is an entrepreneur, bestselling author, and the personal CPA of Robert Kiyosaki. He is studying the goings-on of the Biden administration when it comes to the spending plan that passed, as well as some precedents that are being set for future changes to the tax code that could potentially impact your overall wealth strategy.
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How The New Spending Bill And Tax Plan Can Impact Your Overall Wealth Strategy With Tom Wheelwright
Thank you for reading another episode. Hopefully, you’re not just reading. You’re learning and getting some key insights into ways in which you can improve your wealth. I hope you’ve enjoyed the last couple of episodes, speaking about some current events. That’s what we’re going to do now with a good friend of mine, Tom Wheelwright. He is the personal CPA of Robert Kiyosaki and has been for years. He has been a great friend for years. I was intrigued based on some of the stuff he’s put on his YouTube channel and show. He is studying the goings-on of the Biden administration when it comes to the spending plan that passed, as well as some precedents that are being set for future changes to the tax code that could potentially impact your overall wealth strategy. It’s a great conversation. You guys are going to enjoy it. Make sure you check out Tom’s podcast. He has a CPA-facing show, as well as an investor and business-owner-facing show. He also has an awesome YouTube channel. Let’s get to my interview with Tom Wheelwright.
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Tom, it’s good to have you. Thank you for coming back. What a couple of months we’ve had of 2021. It’s entertaining, isn’t it?
It’s almost like 2020 hasn’t ended yet.
It’s a continuation. It keeps going and going. We talked about what the stimulus meant with regards to the response to COVID. We’re with a new president and administration. We have this massive, I don’t know if massive is the right word. There’s probably some crazy word three levels above that that’s appropriate. You have this spending bill. I think it tells an interesting story. As you’ve been monitoring this, what are some of the things that you were curious about or found interesting as it related to how this spending bill might be different than past spending bills?
New Spending Bill: We’ve made unemployment non-taxable up to $10,000. We’ve made forgiveness of student loans non-taxable.
First of all, of course, it’s the timing because we’re on the way to recovery. We have only 6% unemployment, which historically is a very good unemployment rate. We have lots of businesses that can’t find people like restaurants. What we’re doing is we’re extending the increased unemployment. We’re sending checks when we have a historically high savings rate. We have not had as high savings rate since 1984. What are we doing? We’re giving more money. It’s very interesting both the obvious stuff like the $1,400 checks, which by the way, unlike the CARES Act, doesn’t just go to you and your spouse but also goes to your kids. It’s not a reduced amount for your kids. It’s the same amount for two kids.
We’ve got this Child Tax Credit and Child Care Credit. We’ve made unemployment non-taxable up to $10,000. We’ve made forgiveness of student loans non-taxable, which is interesting because it sets up the obvious question. The only reason you do that is because you’re expecting to forgive student loans. They’re not forgiving yet. You’re expecting this to happen. It’s clear that the Democrats are expecting President Biden to issue an executive order. It’s very interesting. For example, you have $350 billion going to states with the requirement that they can’t use it for tax cuts which is an interesting question because it begs the question, “Money is fungible.” Let’s say to use it for that other stuff, which frees up money for tax cuts, to make new other tax cuts. Even if they have a banner year, are they prohibited from giving any tax cuts?
There’s some clear unintended, maybe unintended. We don’t know but it is a massive spending bill. There’s a lot of stuff in there. Some of the spending is not going to happen until 2027 and you’re going, “How does this have anything to do with this crisis?” The reality is that most of it doesn’t but Joe Biden’s agenda. For example, eighteen months of COBRA, the insurance paid by the government. It’s tough to argue that. People need insurance when they’re unemployed. They don’t have money to pay for it. Having the government pay for their insurance for eighteen months, there’s certainly an argument for it. If you look historically, presidents are trying to make a big impact in their first 100 days. It’s interesting that this is the direction that they chose.
Given what he ran on, does it surprise you that this has come out?
Yes, and no. They had to get it passed to some conservative Democratic senators. Joe Manchin in West Virginia and Kyrsten Sinema of my own state, Arizona. To do that, there are certain things they could include and didn’t include. As much as the far-left complains about it, it’s a good inroad into Joe Biden’s agenda right off the bat. It’s not overly surprising, the $350 billion to the states. I don’t have mixed feelings about this bill. I don’t like the bill at all. I’m not particularly opposed to some of the things, but I am opposed to the price tag. The price tag is enormous and it’s going to come back to bite us.
What does this tell you about other agenda items that the Biden administration campaigned with?
Take for example, healthcare. He was a very big fan of universal healthcare. This makes inroads into that. He was a very big fan of unions. There was some stuff for unions. There’s an expectation that he was voted in by the Left Coast, the West Coast and the East Coast, so a lot of money are going to those states. There are expectations that a lot of that money will end up to bail out pension plans.
That was one of the provisions of the bill. It’s billing out the Pension Guaranty Association.
There’s a lot of bailout money in this bill. Let’s be honest, there was bail money in other bills too. The PPP loans are bailout money. They’re just bailout money for small businesses. The $300 a week unemployment is bailout money for unemployed people. One of the differences is that it’s not just the big businesses that are getting bailed out this time. In 2008, 2009 and 2010, it was only the big businesses. The small guys got hammered. One thing that you can say is that this is a bailout for pretty much everybody.
Going to where your specialty lies, you understand the tax code better than anyone I know. You have read some of the bills, especially during COVID. What do you think this means for changes to taxes in all respects, the business and investment side of things?
Most of these payments are tax payments. The $1,400, that’s a tax credit. The $3,600 for kids, that’s going to be paid out ahead of time $300 a month, but that’s a tax credit. Dependent Care, that’s a tax credit. The forgiveness of student loans, that’s a tax exemption for that. The unemployment not being taxable, that’s taxed. You see that all of this policy, most of it, with the exception of the actual handouts of the $350 billion to the states and $300, there’s that but a lot of it is taxing. We’re seeing social manipulation through the Tax Law, which we’ve always had. Let’s face it. I’ve always said that the Tax Law is a series of incentives. What we’re seeing is a shift in where those incentives are going. They’re going towards families. Another thing, you no longer have to have children to get the Earned Income Credit. That’s new.
New Spending Bill: By definition, a company is valued-based on its PE ratio. If their earnings go down because you’ve got higher taxes, your price comes down with it.
They’re doing it for 65 and older too, right?
Right. Earned Income Credit has long been thought of as a negative income tax. That was first proposed by Milton Friedman, the conservative economist back in the ’70s. It’s a social payment. The Child Tax Credits are social payments because they’re refundable now. That is also new that they’re refundable. What you have already seen is, through the Tax Law, a redistribution of income. What will happen next is that they will use the deficits they’ve created to justify tax increases on the “wealthy.” They defined it at $400,000. Interestingly enough, Joe Biden is going to stick with that $400,000 threshold. That’s very important for everybody who’s reading.
As soon as I heard him say that in his campaign, I’m going, “That’s my target. I don’t want any clients making more than $400,000 of taxable income.” You can make millions and millions of dollars but don’t make more than $400,000 of taxable income. We’re already seeing in the dependent care credit that the threshold is $400,000. That’s a good indication that that’s where we’re going. This is a shift of benefits to lower-income, lower-middle-class. Not even middle-class, but lower-class because all of the stuff is refundable. It’s not just offsetting taxes. It’s a payment that’s a direct payment.
You can think of the child credit as a universal basic income for children. That’s what it is. They already are talking about making that one permanent. The Democrats have been very smart about this. They can make this shift for taxes using the reconciliation process. They only need right there 50 plus 1 majority in the Senate. They don’t need 60 votes in the Senate for this. The other thing they’ve been smart about is, rather than giving a universal basic income to adults, which gets a lot of pushback, they gave basic a universal income for kids. How do you argue with that? From a purely political standpoint, I have to applaud them.
There are probably some fundamental differences between what Biden has proposed and what he campaigned with as far as what’s going to happen with taxes. What happened in 2017 with Donald Trump in what he proposed? What are those 30,000-foot fundamental differences?
It’s just to get incentives. That’s all it is. They are still incentives. For example, Biden wants to increase the top tax rate back to 39.6%. I would guess that will happen. It’s hard to fight that one. That’s a tough argument that people that make that much money of $600,000 married need a tax break. They don’t. It’s not going to affect the economy if they raise those taxes. That’s a small shift. I don’t think that’s a big deal. He wants to tax capital gains over $1 million at a much higher rate. That will be an interesting one because as long as he exempts businesses and real estate, then that one could easily fly. That’s an easy one to exempt for personal residences. There are a few things they’re going to have to exempt in that one, but that will apply.
A lot of the other tax increases are much tougher. Joe Manchin does not like the change in the estate tax. He voted to get rid of it completely. There are uphill battles for Biden in his bigger agenda, but they’re making inroads. To President Biden’s credit and the Democrats, they’re being very careful. They gave up the $400 unemployment and cut it back to $300, but then they extended them. There were trade-offs here. They’ve been smart about what they’re doing. All we’re doing in 2017, we had big tax incentives for businesses and real estate. There are going to be social payments like we see in this bill, but there are also going to be a lot of incentives for clean energy. The next big thing is clean energy. That’s where the tax incentives are going to be. My clients are already talking about shifting their strategy from residential real estate to real estate associated with clean energy. It’s not that hard to do. It’s just a matter of understanding the law and taking advantage of the incentives that are there.
Do you think this is something that’s going to get pushed this 2021? Do you think it will go into 2022?
It will be this 2021. They have one more shot at reconciliation this 2021. It’s very tough for them to make changes like this in an election year. I would expect this 2021 that we’re going to see any changes that they make, they’re going to try to push this through while the iron is hot.
They have two years until midterm. It’s like they’re trying to get everything, all the major items, those big rocks through.
Let’s face it. Both parties do this. It’s not like this is, “The Democrats are horrible. The Republicans they’re saint.” The Republicans did exactly the same thing. The Republicans didn’t care anymore about the deficit that the Democrats do. You can’t even take that argument. There are very few people in Congress that are looking at deficits at all these days. To me, it’s politics as usual.
Tom, as we look at the economy, we’re not economists. Sometimes we talk about it. Of course, it’s opinion. Looking at some of the studies that have been done by Tax Foundation, where they analyzed if Biden’s tax plan went through, the implications to the overall economy were negative in all categories, not hugely negative, but 500,000 jobs lost. GDP is a negative one and a half-ish. When you look at the objective of Democrats, that side of things, the administration, it’s not necessarily pushing lots of growth. It’s pushing growth in certain areas.
It’s very much shifting incentives. There’s going to be more going to unions. President Biden has been very clear that he wants to expand union activities. There’s a provision in this COVID bill that gives sixteen weeks of COVID leave to federal employees. You’re going to continue to see that same thing continue to happen. One thing that was interesting in the Tax Foundation’s findings is that they estimate that the worst thing he could do is to raise the corporate tax rate. That was surprising to me. I’ve always thought 25% is not a horrible corporate tax rate. I thought that’s probably where it should have gone in the first place. That was one of the original proposals in 2017 that was taking the 25%.
For it to go to 25%, the challenge is you can’t go much higher. Remember, we don’t just have a federal income tax. We have a state income tax. You’ve got to add on 5%, 6%, 7% to that. Now, you’re in the 25% federal, you’re in the 30% plus range, which puts you equal to other countries. We’re lower than other countries, but if you raise it to 25%, you put us equal to other countries. If you go over 25% to 28%, the 28% that he campaigned on, we’re higher than other countries. That would be devastating to us. The other thing that I don’t know that is ever considered in the public discussion is, “Who owns Corporate America?” It’s not mostly big stockholders. It’s mostly pension plans and 401(k)s. As the stock market increases, that benefits pension plans and 401(k)s. Corporate income tax is a tax on pensions and 401(k)s.
Tax-Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes
The theory is that those values will go down just because profits are going to go down because of taxes.
By definition, a company is valued-based on its PE ratio. If their earnings go down because you’ve got higher taxes, your price comes down with it. That Price-to-Earnings ratio is you’ve got to look at the earnings to determine what the price is. That’s a tough one. When you’ve got an economy that you’re trying to stimulate to put big taxes this 2021, I suspect the corporate income taxes, they’re probably going to push these social payments. There are a couple of states in play for the Democrats in the Senate in 2022. Notably, Wisconsin and Ohio. There are a couple in play for the Republicans too. Notably, Arizona and Nevada. The Democrats think they can pick up seats if they do their legislation and follow the legislation appropriately. This is all towards gaining more control. What they like is a little more control so that they can pass more of their agenda.
Tom, this has been super helpful. I know that as we get closer to when certain legislation is going to happen when it comes to taxes, let’s chat again to talk about the specifics of it. Entrepreneurs and investors are always looking for opportunities. They’re trying to think where the puck is headed. It’s clear based on some of the things that you said, where the economy is going, where investment is going and where you can put money to pay less taxes but still get good gains. It’s going to be cool to see what are the strategies available once we know what’s coming down the line. Let’s circle back in a few months.
Yes, for sure. I don’t read some of the bills, Patrick. I read them all.
Heaven bless you, Tom.
It’s so much. These bills are fascinating. What’s in them is remarkable. The good news is they’re not going to get rid of incentives. They’re just going to change where the incentives are. Entrepreneurs can always get to tax-free wealth. We can always get there. We have to have good advisors, understand the law and have a good strategy for investing so that if we make the right choices, then we can pay less tax. We need to stay on top of it all the time.
Tom, you also have an awesome podcast. First, a podcast that is tax professional-facing, but also a podcast for the public where you teach a lot of these principles. Tom also has an incredible practice where he consults individuals just like you and businesses to navigate the waters of a complex system of sorts. Everything Tom-wise, you can go to WealthAbility.com, unless you want to cite some other things that you’re working on.
Tax-Free Wealth is the book that explains how the Tax Law works.
Are you going to do version three when the new stuff comes out?
I’m writing a new book that will come out at the end of 2021. I’m very excited about the new book. It’s a very in-depth look at some investments and the tax consequences of those investments. It’s very exciting stuff. Like you said, we have an entire network of tax advisors around the country and in Canada. In 2022, we’ll be launching internationally. WealthAbility.com is the place to go. Anything we can do to help, we’re happy to help any way we can.
Tom, as always, it’s a pleasure. Thank you for imparting your wisdom to us. We appreciate it. Like I said, we’ll circle back once we get closer to what’s going on with some of the things that are going to change in the tax code.
Tom Wheelwright, CPA is the visionary and best selling author behind multiple companies that specializing in wealth and tax strategy. Tom is also a leading expert and published author on partnerships and corporation tax strategies, a well-known platform speaker and a wealth education innovator.
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While the government’s efforts to provide stimulus packages to answer the economic issues that are happening due to the pandemic, it’s not a sustainable solution. The country is still dealing with more unemployment, and companies and businesses are facing the threat of inevitable inflation. In the first part of this interview, Ken McElroy of MC Companies sat down with Patrick Donohoe to share his investment philosophy to help people prepare for possible future opportunities in the real estate market. Today, they discuss what people can do to be on the right side of things and survive inflation: study what’s happening, gather the funds, and invest in the right stuff.
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What People Can Do To Survive The Inflation With Ken McElroy
Thank you for reading part two of an awesome interview with a real estate investment icon, Ken McElroy. If you didn’t read the last interview, go check that out, that’s part one, it will help create some context to what we’re talking about. It’s a singular topic and it’s focusing on the economy and the influence of the effect the economy is going to have on American wealth and finance and investments. I’m wrapping up a two-day financial advisor online summit that I hosted. I’m glad you’re here and you’re willing to learn. Kenny is an amazing guy. Go check out his website, go check out his books and his YouTube channel.
Let me give you a little bit of a preface before we get into this interview. The objective I took when coming up with interview questions and so forth was to bring out Ken his perspective of the economy. What’s going on? What is being done where we haven’t seen necessarily the impact yet, but we’ll see the impact in the future? There’s a lot going on right now. We try to focus on what’s going on in two areas. I believe that these are the two primary influences of the economy. Number one is monetary policy, which is the set of objectives the Federal Reserve takes to establish the reasoning behind their activities.
Second is fiscal policy. Fiscal policy is the stance the government takes, especially the administration that has the influence on how it is going to accomplish its agenda through laws, through spending bills, through modifications, through the Tax Code. The reason I’m wanting to do this is that it’s clear based on the narrative, the activities are forthcoming, they’re happening and will happen over the coming years, but the activities are in motion. The impact it’s going to have on the economy is that there’s going to be more inflation and there are going to be higher taxes. I’m not going to get into the reasons and details, Kenny and I get into some of it, but there are important details in here that I do not want you to miss. That’s why I’m going through this little monologue so I can establish context for you.
Number one, inflation is the agenda, the purchasing power of your money, which means that the money you have right now buys many things, it will buy less in the future. That’s what inflation is. You also have taxes. Taxes, whether it’s on spending, taxes on investments, taxes on gains, taxes on income, are going up, they have to go up. It’s clear based on the narrative that’s already being set, that they are going to push forth activities to make modifications. It’s important to understand what impact it’s going to have on your specific wealth. Right now, American wealth is set up to be harmed by what’s to come. Hopefully, you extract out of Kenny some nuggets so that you can start positioning your investment strategy, your wealth strategy, your business strategy, your pursuit of financial independence strategy accordingly because these things are coming and we have to navigate around them if we want to be successful. Thank you for learning again. I hope you enjoy the second part with my friend, Ken McElroy. Thank you. Take care.
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Let’s move to the last point of the economy, because that is going to determine a lot of what’s going to happen, and it’s already happening. There are things that are in motion that haven’t necessarily manifested yet. How the economy is now is in large part stimulated by the government. What do you see is happening? Obviously, you don’t have a crystal ball, but you’ve experienced market’s ups and downs cycles enough where there are probably some leading indicators. What are the Feds doing? Will they continue to do? What are some of the variables that need to happen when they stop doing it?
First of all, things are going to unravel as you know. The Federal Reserve cannot continue to spend this much money on that. They have to let things emerge. There might be new tax incentives and new stimulus packages and all that stuff to make it a soft landing for people, for businesses. They’re all trying to figure that out. We’re not out of the woods yet on that side of it, but once the vaccine gets rolled out and things start getting a little safer, I don’t think we’re going to go back to the way we were, but there won’t be any longer an excuse to not go into the office and to move forward. It’s going to be a personal decision. I don’t want to go down that road because that is what it is. People decide what they want to decide. The point is that right now the Coronavirus is the reason. When that goes away, then the government is not any longer palpable, “You’re at home, here’s some cash.” We’re now back to an even playing field. Now, it’s up to you. There will be some cash available for people and some things that we’re going to have to do. What the governments are afraid of is homelessness, and that’s a big one. They’re afraid of things like food shortages and those kinds of things. They’re going to be focused on those kinds of things.
Surviving The Inflation: Inflation is inevitable because we pumped all this cash into the system.
As opposed to putting money in people’s pockets.
They’re going to maybe do that with the minimum wage and maybe some additional stimulus, but that doesn’t go far. $1,200 to somebody will give them a couple of months. I’m not saying that’s not good. I’m saying that at some point, you can’t continue to do that. It all leads to inflation of some kind. When you raise the minimum wage, what it does is squeezes the profit margin on a business that’s already in trouble. A restaurant as an example that got kicked out now has higher wages. All of that stuff turns into higher prices. A lot of people might disagree with me, but I don’t know how you can’t pay more people more money, and then you’re going to have businesses, either reducing employee, go to halftime, they’re going to try to run a little leaner or maybe the owner gets more involved, but potentially it’s going to create either more unemployment or prices are going to rise if they can.
That’s what’s interesting is you had businesses get the crap kicked out of them for a year. Instead of getting things back, filling their coffers again, now they have to pay out more money to employees, so their only option is to either take less money or raise their prices. Is it going to lead to not just what normal inflation would be if you had a normal economy pre-COVID and you raise the minimum wage? You’d have some inflation, but now the likelihood is a lot higher. Do you see the economy being able to support a lot more inflation? I know that’s subjective.
I’ve been trying to wrap my head around this. Our good friend, Andy Tanner, I bet he’s here more than you know, trying to figure this out because he is a massive student of this. We were in Japan together. We were talking with Robert Kiyosaki and we were there on Rich Dad. People are saying they’re on like QE 30 or something crazy. Their GDP is the highest in the world, and yet they’re not seeing this massive inflation. I call them up, “Andy, when we were in Tokyo, how can the government continue to pour all this cash into an economy, and then not see it?” What he described to me, which I thought was a good example. This is Andy, and I’m still learning like all of us, he said that the balloon has been inflated and the government has been putting money in and the balloons inflated to what it is. It could be gas prices, food prices, real estate. It’s not all just an inflation number. Everything’s a little bit different. He said that there’s a hole in it and that’s deflationary.
There are things that could be potentially deflationary, but they keep putting money in it to keep it at its size. That’s what’s happening now. We do have inflation on things. This phone here when I bought it, it’s worthless. I get more. That’s an easy thing to pick on. There are things that are deflationary and there are things that are inflationary, and it’s all bundled together. I do believe that we’re going to have inflation because we pumped all this cash into the system. There are going to be more goods chasing those things at some point in time.
What are some final thoughts you have in regard to the state of things and the individual investor in mind, and how they can stay even-tempered? You have the Bitcoin soaring, the crypto craze, you have the GameStop and you have forums that are trying to short squeeze some of the big, short positions that are out there. There’s a lot of buzzes. What do you do to maintain an even keel temperament? What do you talk about frequently with investors that sometimes get off the rails because of the craziness?
There’s a bunch of things. One, it’s a horrible time for a lot of people, and that’s inevitable and there’s not a darn thing we can do about it. What you can do is you can start to study what’s happening and you can be on the right side of that, whatever that is. I mentioned that with my trainer, “No one invests a bunch of money now because you’re going to have a bunch of gyms goes out of business in the next several years. Go find out what funds those are and figure that out.” It’s a long-term strategy. People, generally, like things quick and easy. Bitcoin, GameStop, that’s lazy man’s money. It’s easy to throw money into that and then watch it. That is not investing in my opinion. That’s speculative in its biggest nature. You can go online and there will be tons of people that say this is a certainty. There’s nothing certain except debt and taxes, even real estate isn’t certain.
The one thing I love about real estate is if you look at the numbers, and I thought and did this in 2008, I went through this ‘08, ‘09, ‘10, massive people dumped out of housing, out of mortgages, and they dumped into rental housing and they put this incredible pressure on rental housing. Then it moved back out again and that’s where we are. Take a look at the numbers, follow the math, and then try to be out in front of it. This is going to be the biggest transfer of wealth that we will see in a long time. That could be wrong, I don’t know what the future is going to be like. In my lifetime, this is it. This is a time that you need to have the education and be out in front of that stuff, and then put together your team so that you can go out and do things.
There are many things happening. It’s right in front of us. The hotel businesses are closed, the micro hotels especially. Nobody is going to those, nobody is paying those. There is nobody traveling. I was on the phone with my friend that owns a bunch of it. He’s getting killed, 10%, 20%, 30% occupancy. There are already funds being put together to buy those and convert those to housing. That’s what I’m talking about. All of this is right in front of you. There are people already swirling around the malls, looking at redevelopment. That’s real estate, it is what it is. You’ve got to pay attention to those kinds of things and ask a lot of questions and get educated.
Kenny, we could probably talk for a few more hours. I have 10 million questions, but let’s do this. I know you have some new digital resources that you are making available to people that teach a lot of these types of principles. Would you speak to that as we end the interview?
This has been the greatest part of the pandemic for me. I haven’t been a big social media guy or a big YouTube guy. I’ve been trudging along on real estate and buying real estate. We have 250 employees and we’re busy and flying all over the place looking at stuff. The pandemic, I was like, “I’m going to get camera crews here and I’m going to start teaching.” We started teaching in March 2020, I start putting these YouTube videos out. Now we’re up over 200,000 subscribers. We started doing these videos to help people and we put them on our website, KenMcElroy.com. It’s been great. We put out a masterclass that people could get. They can subscribe to these videos of stuff they are interested in and learning some of the things. We have a forum that people can go and talk to other members. We have thousands of people helping people now, which has been great. It’s all been collaborative. The premium membership is $19 a month. That’s $200 for a year and you could go look at all these different videos and all these what we’re talking about and get educated and learn. That’s the key to this next step.
Surviving The Inflation: Start to study what’s happening so you can be on the right side of whatever that is that you’re investing on.
Sometimes chaos is the mother of invention. I know it was always out there for you because you always have been teaching, but what a great opportunity to pivot a little bit. I know there are people that rave about some of the stuff that you’re doing. Kenny, you’re amazing. Thank you for what you do. Thanks for teaching people. Thanks for your time. We’ll have to do this again, maybe as to 2021 comes to an end and 2022 starts to rear its head, and we’ll see whether it’s ugly or pretty.
It’s going to be an interesting time. People have some hope, you can be on the other side of this. It’s going to be some rough roads, but you can be on the other side of it.
I appreciate that, Kenny. Thanks again for teaching us. We’ll talk to you next time.
For over two decades, Ken McElroy has experienced great success in the real estate world through investment analysis, acquisitions, property management, and property development. Ken believes in sharing these successes, as well as his setbacks, to help educate and inspire investors to bridge the gap between where they are and where they want to be. In addition to sharing his expertise, Ken also shares his mindset, because building wealth isn’t simply about putting money in the right place at the right time. It’s about understanding that determination and self-motivation are the real keys to thriving. Here you’ll discover a place that reflects Ken’s passion for real estate and helping others, where investors from all walks of life can learn, grow, and thrive. We believe that everyone deserves financial freedom. Let us show you how to get there.
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February 25, 2021Patrick DonohoePodcast00:38:56Comments Off on An Investment Philosophy To Prepare For Possible Future Opportunities In Real Estate With Ken McElroy
The real estate market is already unpredictable as it is. Yet, with the current COVID-19 pandemic we are all facing, this unpredictability is heightened, and you can either succumb to it or find opportunities. Patrick Donohoe is joined by Ken McElroy, the Principal of MC Companies, who has a couple of insights into possible future opportunities in the real estate market that you can take hold of. Guiding us in that process, he shares his investment philosophy around buying for cash flow and generating passive income. He then dives deep into some of the significant shifts happening, the obstacles newer investors typically see, and how they can start developing the mindset to have the confidence to take their first step. Join Ken and Patrick in this episode as they help us prepare for the future, uncertain as it may.
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An Investment Philosophy To Prepare For Possible Future Opportunities In Real Estate With Ken McElroy
I have an incredible guest, a dear friend of mine, Ken McElroy. Ken and I had an interview that lasted over an hour. We are breaking the show into two parts. The first part is going to be his investment philosophy, as well as the current state of the real estate market, and then part two is going to be a discussion we had about the economy. If you don’t know who Ken McElroy is, Kenny is first a real estate investor. He’s written a number of books on the subject. He’s been an investor for over three decades. He also is a Rich Dad Advisor. What that means is he works alongside Robert Kiyosaki, who is the author of Rich Dad Poor Dad. Kenny has developed a giving attitude over the years. He was born with it but he is doing so much on YouTube. He has a ton of digital resources that you can get access to at KenMcElroy.com.
Kenny also has a podcast that he does. Go check him out even if you don’t go in and take advantage of some of his digital resources. This is a guy that you definitely want to follow. He’s done billions of dollars of real estate, tens of thousands of doors, and has an incredible philosophy when it comes to how he invests. I think that’s important because we’re at the crossroads of many different elements, whether it’s housing, economy, unemployment, government intervention, possible inflation, most likely inflation. It’s going to stir up emotions for those that don’t necessarily have a sound investment philosophy.
We’ve already seen that with the number of people that have lost money on trading different things. We’ve spoken on the show extensively about that. It’s going to continue and most likely amplify. There are two things that are going to happen. You can either succumb to these emotional whims and make bad decisions or you can find the opportunities which will be there in spades. Kenny drops a couple of insightful things when it comes to possible future opportunities in the real estate market, so pay close attention. Thank you so much for the support. I appreciate you. Let’s get into my part one of the interviews with Ken McElroy.
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Thanks for joining me on this incredible interview. That’s somewhat presumptuous but I know Kenny. I’ve known him for a while. He’s a mountain of knowledge. I’m grateful for the opportunity for you to learn. I’m excited to learn as well. Ken McElroy, I have a bunch of your books here. You never stop writing these books. One that came out is ABCs ofBuying Rental Property. You’ve got ABCs of Real Estate Investing. There’s a bunch of others too but you’ve written extensively about real estate and also entrepreneurship. I’m excited to have you on. There’s a lot going on in the world and 90% of it has to do with real estate. I can’t wait to learn from you. We had you on 2020 and things were chaotic. I’m curious to see where things are at from your vantage point.
Thanks, Patrick. It’s always great to catch up with you. I love your stuff. I love following your investment philosophies. I know we’ve been friends a while. I adore your family. Let’s get to it. Let’s talk about what we see in our crystal ball.
Let’s start there. It’d be important for you to take a moment and describe your investment philosophy, how you view investments, purpose, good investment, bad investment.
We’ll talk real time, the GameStop thing, it’s still a buzz, how that happened, what happened, and all of that. That’s what I don’t like to do. I’m not saying that people didn’t make money but I know people lost money. In my opinion, that’s a bit of gambling. That’s throwing your money into something and hoping that it goes up. That’s not at all what I do. That’s what we would call a capital gain strategy. That’s flipping a house although that would take a lot longer. Buying something, hoping the market takes it up, and then selling it. I’m not saying that you can’t make money that way but what I’m saying is that we don’t know what’s going to happen. You don’t know if the market is going to crash or it’s going to keep going. People have strong opinions, however, on that. That’s what gets them in trouble.
What I like to do is I like to buy it for cashflow. All of my deals, Patrick, as you know, are cashflow based. I don’t have an exit philosophy. In other words, I’m not trying to time anything. What I’m trying to do is buy an asset. I’m trying to use other people’s money to buy it, the bank or investors. I’m trying to make cashflow so that everyone gets paid. I want the occupants, the tenants, the residents, or whatever you want to call them to pay it off. I want the tax consequences from that and I want to hold it. It’s a lot slower strategy. It’s a lot harder. It takes a lot more knowledge. You have to have a lot of experience to do it well. That’s my philosophy. It’s proven to be a good one. When you can get a tenant to pay off your asset, why wouldn’t you? That’s it in a nutshell.
Adding to that, you have some predominant investment purposes. People invest for capital gains or people invest for income, for cashflow. I look at the end result being unknown to most people. They don’t ask themselves, “Why am I doing this? Why am I doing that?” If you look at income, if you look at cashflow that produces month in and month out, that impacts what people were after, which is a better lifestyle. Capital gain is a short-term strategy and also it has a lot more risks associated with it. In the end, if people question their motives and their purpose, they would think twice about putting a lion’s share of their wealth into that type of strategy.
Real Estate Future Opportunities: Not all experiments work out. Not all bets work out. Not all risks work out. If you have that foundation of certainty, you learn from it as opposed to being taken out of the game.
It’s interesting if you take it in bite size. What I did in my first thing, Robert calls the financial freedom. He branded it. When I was getting out of university, that was my first thought. At the time my expenses were super low like $2,000 or $3,000 a month or something. I was like, “How do I cover that with cashflowing assets?” From there, that would be my first step at financial freedom. Like most people, I started buying bigger houses and better cars. I was driving an old Volkswagen when I was in college. There are things that you want to help the business and all that. Your monthly expenses do go up but my philosophy never did, which is how do I generate enough passive income to cover my monthly expenses?
When that happened, Patrick, everything changed. All of a sudden, I was like, “I can do deals that I want to do. There’s no real pressure on me. My bills are covered. What do I want to do next?” That’s when I started to build my business and start to create other streams of income like that. That’s all I do. I have all this passive income and the deals keep getting bigger and bigger. My core philosophy is first it was me, how do I become financially free, then it was my company. How do I generate enough passive income in my company to make it financially free so I don’t have to be there? My philosophy has been the same the whole time. The cashflow philosophy covering your expenses so that you can take months off. When my kids were in spring break, fall break, summer break, I took that time off period. I never worked during those periods of time and that was because of this philosophy. I had money coming in.
Whether it’s Abraham Maslow or other sociologists, psychologists, they’ve narrowed in on this motivation of human beings. I think some of the first motivations that people are after is certainty. They want some foundation that they can count on. Capital gain is not that strategy. Cashflow is, especially if education around developing that. When you start to establish those foundations of certainty, then risk or uncertainty, the variety of life, going on vacation, buying a car, trying this with business, trying that with business, it becomes more digestible, especially given the fact that not all experiments work out, not all bets work out, not all risks work out. If you have that foundation of certainty, you learn from it as opposed to be taken out of the game from it.
I think a lot of people work their whole lives for that certainty. They do it differently. They put their money on 401(k)s or IRAs or having their money over to wealth managers. That is the whole point. The whole point is that’s what they’re selling is they’re selling future certainty. I decided that I didn’t want to hand that off to other people. I wanted to do it myself. I wanted to learn myself. Also, if I did do that or I ever had to do that or I wanted to do that, I wanted to know what to ask them, what to say, and let them articulate the reasons. Maybe I can learn from them or maybe I could teach them. I never understood the philosophy of working your butt off and hand in your money over to somebody for the rest of your life and then meet with them once a year. That didn’t make any sense to me.
It’s a mirage of certainty. It’s a future promise that not many people are able to get to materialize. Let’s move on from that. I think we beat that dead horse. Let’s end with something that you did in 2020. I started seeing you on social media wearing this Be Infinite shirt. I thought that was intriguing. I bought one. I wear it often. I went into jeans and a long sleeve black t-shirt every day, except for my Be Infinite t-shirts. That’s my new attire because no one’s in the office anymore. Describe how that came to be and what that has to do with your philosophy.
It started with my Infinite Return. I’m working on a book called Infinite Return, which is basically how do you invest a bunch of money, get it back tax-free, still own the property or the asset, not have any money in it, and how does it continue to produce cashflow when you don’t have any physical investments. That’s called an infinite return when you create something from nothing or you use somebody else’s money and then you give it back to them. You still own it and it produces a long-term annuity. That’s how it started. I bought the domain name The Infinite and we started rebranding it. What happened is it took off. The infinite doesn’t have to just mean financial. It could be the mindset and all these things. It’s a work in progress. I’m not completely done with it yet but we are going to roll something out.
It’s infinite so you can never be done with it.
It’s been fun to listen and weigh into other people. A lot of the people that follow me send some cool stuff about how they became infinite. It’s not a financial thing as I learned. I started off that way but I’ve opened my mind up to. It applies to a lot of things. It could be in your relationships, in your mindset, in your health, in your finances. That’s where it’s heading and you stay tuned on that one. I still am going to do the book Infinite Return, which is more about real estate but I’m excited about where that’s headed.
If you are reading and want to pick up your Be Infinite shirts, go to TheWealthStandard.com. Kenny is also going to talk about some online digital resources he has for you. Let’s move on to real estate and what’s going on. There are some significant shifts happening. Sometimes that takes people out of the mindset where they feel comfortable making an investment. Talk about the obstacles you typically see with newer investors, why they don’t pull the trigger, and then how they can start to develop the mindset where they have the confidence to take that first step.
Real Estate Future Opportunities: If you can zoom, why not zoom?
First of all, I want to acknowledge how hard it is to go from working somewhere hard and then trying to wrap your head around something so different. It is different. I totally get it. I call it analysis paralysis. They sit and they don’t want to make a mistake. I completely get that. There’s a lot of anxiety, stress and fear beyond that. I will tell you that what I find is if you’re open a little bit to the idea, then you can look at things. If I’m sitting at dinner with the stock guy, he’s fully against real estate. That’s the way it is. There are not many stock guys that are real estate advocates. There’s a financial reason. They get commissions and all that stuff. I’m not saying that it’s wrong to be a stock guy. I’m saying they’re close-minded in their bias. The hardest part is being biased. Let’s say you grew up poor like I did and my parents were poor. They would always say, “We can’t afford that,” and we couldn’t, all those things. You’ve got to get out of your way as I found.
The first step is backing up from the scenario and saying, “I’m in a bad relationship. Why? I’m in a bad financial situation. Why? I’m not happy at my job. Why?” People don’t do that. What they do is they point fingers out and they go, “It’s their fault. It’s somebody else. How can it be me?” You don’t have to tell everybody. You have to do it. You can start to open your mind a little bit about, “Maybe I am a little bit biased.” We all have biases. It’s interesting. It’s a long story but I had to go through a bunch of bias training to be on the Sheriff’s posse for Arizona. It was fascinating. I was in the room with all these County Sheriffs. It was all over this whole issue between Mexico, the US, and all that. That’s fascinating, the biases. I was like, “I have my own biases the way I grew up. I have biases around money. I have biases around all things.”
Once you can step back from that and peel that back and say, “Where do I want to be?” I love that be, do, have. You want to have, you have to be. First, you have to be. I think people struggle with that. They hold on tight to their beliefs and they don’t believe that they are. It could be religion too. I don’t want to make this political or religious but the point is that people have their beliefs and that is what it is. They defend them. It’s the same thing with real estate once people realize. There are millions of people making money in real estate and there are billions of people doing well in real estate. As you know, you do both. You have to have an open mind first and then start letting new stuff in. There are tax advantages. We’re heading into a renter nation, Patrick, as you know. How can you have 3.5 million people in mortgage forbearance or another 10 million to 20 million people facing eviction and not have a rental issue?
Also, defaults on debt. It takes them out of the credit game because they can’t qualify for it.
It’s acknowledging live birth. How many people are going to turn 50? We already know the number. Everybody knows it’s data. We have this data that shows that the next couple of years are going to be rough. We’re going to turn like in 2008, 2009 and 2010, which I was involved in. People have to rent more. It will swing back to homeownership like it always does. At the moment, there’s going to be massive pressure on the rental housing market because there’s going to be way more demand than there is supply.
If you stepped back from it instead of saying, “I’m a stock person.” My brother is a great example, by the way. He was the A-student in our house. He is very bright. I have a tremendous amount of respect for him. When he retired, I asked him, “How are you doing?” He’s like, “I don’t know. I haven’t even went down.” I go, “You don’t even know.” “No, I trust them.” That is the marketing behind it all. I’m his brother. We’re together all the time. We talk all the time. I’m over here building this massive real estate portfolio. He doesn’t even ask a question.
There are some primary fears that people have. One is having to change and two is being wrong. We don’t realize it until we’re arguing politically, arguing religiously. Those fears dominate us whether we want to believe it or not. I think real estate being is something different than what people are programmed and conditioned to believe is investment and where they should put their money and what that means. It’s different. At the same time, look at how the world is evolving in every capacity, transportation, entertainment, work. It’s always evolving. It’s always changing. It’s like you have these two poles. You have the pole because things are changing and you have to adapt. This pole is the one that stays the same. It’s not surprising. That’s where those obstacles are mental at the same time. You run numbers, read books, have an open mind. Real estate purchasing it the right way is infinitely less risky than what people are typically doing.
I’ll tell you a funny story. I’ve had drivers for a long time. Way before Uber, I had this guy Ted. I love Ted. He was my driver. He would take me to the airport and pick me. I was going to go out and have a couple of drinks. He would come and get me, and dropped me off. I was going to go to sporting events. I had him on a contract. I was in San Francisco, which is one of the areas that they started Uber. They piloted it. I don’t know if you remember. I’m like, “This is the greatest thing ever.” I leave Uber and come back to Phoenix. Ted picks me up. I’m like, “Ted, you need to take a look at this Uber thing.” He said, “There’s no way. Nobody’s ever going to use that service.” That’s my point. I never forgot that because I was like, “Sure enough, Ted is out of business.” People can call a black car and get it whenever they want. They don’t have to have anything like that. It’s easy. That’s my point, whether it’s my brother, my parents. It doesn’t matter. They have these fixed mindsets on where they are. I think that’s the first thing. People can shake that.
Kenny, we’re in the middle of massive disruption. I think we were already going in that direction. You came out here a couple of years ago and we’re going up skiing. We drove around the city and I was pointing out all these apartment buildings that we were going up. It’s everywhere. It’s city blocks coming down, ripping down old buildings, putting up these masks and it continues. COVID was one of those other massive shocks to the system. How do you explain the impact that 2020 had on the real estate market? What’s going to be happening in the near future because of it?
There are a couple of things. I don’t think we’ve seen yet the impact. The government said, “Everybody go home and shut down.” We can go on and on about that, states, cities, towns, mayors and governors. The bottom line is that the government threw a whole bunch of money at this issue and they needed to, stimulus unemployment, PPE, EIDL, forbearance, eviction moratorium and all those things. That has masked, in my opinion, the whole problem. Look at the facts. We have ten million more people still unemployed or somewhere in there. We have 3.5 to 4 million people in forbearance. About three million of those people are seriously delinquent. We have anywhere from maybe fifteen million people facing some eviction. They keep kicking the can down the road.
By the way, I’m a landlord. I believe they should. You can’t tell people they can’t go to work and then have the backside of it. The problem is the landlords are having problems, a lot of the small landlords. There are cracks showing up. There are people behind on their rent. There are people behind on their mortgages. There are people that have lost their businesses forever. They have lost their life savings forever. There are over 100,000 businesses that have shut down. The cities are going to lose their tax revenues. It’s going to be a mess for years. All of that has been propped up by this money. I know we’ll get to that at some point. I don’t think that it’s shown up yet but it’s all sitting there.
The question is, when is the government going to stop backstopping all that? I thought it would be earlier but with Biden coming in and the new administration kicking down the road a little bit longer. It’s there. There are real people behind that. There were landlords that can’t pay their mortgages. There are real people that can’t afford their cars, real people that can’t afford their rent, real people that can’t afford all things that they may be financed. All of that is going to make its way. I think businesses have changed the way they do business a lot. You’re going to have massive issues on the office building side. All the malls are done. We’re going to have a different economy moving forward. I don’t think that we’ve yet seen the issue. Revenues are down. Rents are down. Returns are down. Not with everything but businesses are closing. People are losing money. The mainstream media doesn’t seem to be talking much about that but it is there. I made a prediction in a video that had come out. I think that the fourth quarter of 2021 is going to be exposed a lot but 2022 is going to be rough.
I understand the objective of what the government tried to stimulate. At the same time, when you do that, there’s always the benefit that you get from it but there’s also the unintended consequence. It’ll be interesting to see how those unintended consequences play out. This might be important to talk about the migratory patterns of employees but also states that have high taxes, maybe even states that were little too strict on their protocols when it came to the quarantine. Talk about that because not only do we have this massive stimulus that has not only conditioned people psychologically to look to the government to help solve their problems, but you also have massive amounts of resources, money that has gone into not necessarily the most productive areas to stimulate. It’s more to fill the void but the hole is still there and continuing to drain. Talk about how COVID has impacted cities, what people being able to work remotely, how they’re going about moving from state to state. Speak to that. I know there’s a lot going on there.
In every city, state, and town is a little bit different. I had a conversation with a guy. He was on the 35th floor of a building in New York City. I was chatting with him. He’s a finance guy. We were talking about some debt and equity. I said, “What’s it like there?” I’ve talked to other people there as well. He said, “Our building normally has 5,000 to 8,000 people a day coming and going. The New York Times did an article on our building. They came and interviewed the door people and it’s about 100 a day. The hot dog guy out front usually sells about 400 hot dogs a day in the corner. They interviewed him and he’s doing ten.” I know I’m in New York but the point is this is going on in a lot, Seattle, San Francisco. Not in every city though, by the way. It isn’t Phoenix but it’s not Scottsdale. You have to pick and choose.
The story is those people pay for parking. They pay for gas. They get a cup of coffee. They get a bagel. They use the corner deli for lunch. They hit the ATM. Think of all the habits that happen when people are in and people are out. They have an early happy hour with some business folks. They grab the train. They go either Uber or taxi. They go back to wherever they go. All of those things are impacted every single piece. That’s one building. You start to take a look at the ripple effects of these small businesses. For sure, the landlords are screwed. They own those buildings. There are massive discussions around lease negotiation, lease modifications, forbearance, or whatever it might be. The landlords are not paying their mortgages. They’re probably not even paying a lot of their operating expenses, depending on how many businesses are paying.
I talked to another friend of mine who is in Chicago. He goes, “I’m paying rent. I’ve been paying rent on my space for a year. All my stuff is at home.” It depends on the capitalization of the business and all that. He said at the end he’s not going to renew. That’s all coming. I don’t want to make this about commercial office space but the point is that you’ve got all this ripple effect happening. I think what’s happened is people are looking. “Do I really need to spend $3,000, $4,000, $5,000 a month in rent?” They’re moving. That’s these migration patterns that you were talking about. I’ve heard crazy stories. Generally, what people are doing is they’re not moving far. They’re saying that they’re moving 20 or 30 miles away on the average, like 70% of the people. You think about that. If you’re in San Francisco, 20, 30 miles away, you could easily reduce your mortgage or your rent by half. There are a lot of people move in different states and all that’s happening.
That’s creating depressions and bubbles in individual areas depending on where people go. The jury is still out on what that’s going to look like but it’s looking like Arizona, Florida or Texas. There are little towns like Boise, Idaho, and stuff like that are jumping up too. I think that has a lot to do with Seattle. People are moving around and they’re looking for affordability. To your point, low tax, good weather, all of those things. If you can zoom, why not zoom when you can save quite a bit of money a month? That’s almost like a reverse commute. You use your office. You use your home. You go to your office every once in a while, as opposed to the other way around where you go maybe somewhere for a retreat. It’s the opposite.
Real Estate Future Opportunities: If you think that you have to save your own cash and do it yourself, then you’re thinking really, really small. You’re not using a system that’s in place for you.
The ripple effect, you hit the nail on the head. Economies depend on $1 turning into $30. Meaning, you pay a person $1, that person takes the dollar, spends a dollar. That’s not happening. The velocity of money is at the lowest point ever, especially in fear. Most people don’t spend when they’re afraid. They hoard and they stock up. It’d be interesting. You made the point where we haven’t seen the impact yet. You’re starting to see it. There definitely were patterns already of people moving out of these big Metro expensive areas but it’s almost inevitability. Do you pay attention to any specific resources? They give you data on that. It’s relevant.
I’m all over everything. I read as much as I can. I do. I think that’s what you have to do. For migration, I studied that moving companies have good data, North American Van Lines, Atlas Van Lines, U-Haul and Ryder Truck. You think about it if you live in Salt Lake. If people moved from Salt Lake to Phoenix, that’s a data point, a lot of that stuff. It’s not perfect but if you start to look at a lot of these different things out of state driver’s licenses turned in, all these things that you can look at to figure out the migration patterns that will give you a good sense of where people are going. The media gets it later, all these brokerage houses, CBRE, Berkadia, Transwestern, JLL. They all have these annual reports. They are slanted a little bit because they’re brokers. The truth is I get all of those. I love those because they have these big analysts that look at all the markets and what’s going on. Those go out to the investors.
That’s all free. Get on all those websites. Another good one is ULI, the Urban Land Institute. Pricewaterhouse does an incredible one. I got it right here. This is called the Emerging Trends Of Real Estate and it’s Pricewaterhouse. I love this thing because it goes into all this data. That’s all I do all day long is look at that stuff and try to figure out. Wayne Gretzky says, “You have to skate to where you think the puck is going to go, not to the puck.” GameStop. You want to look at the bigger picture. Elon Musk is a guy that does that. He’s way out over here. People get surprised but it makes sense. My friend was trying to turn in his Tesla on a lease and he couldn’t buy it. I go, “Why?” He was like, “He’s going to do the autonomous taxi service.” All of a sudden, there goes Uber and Lyft. It’s all coming. You’ve got to pay attention to the stop.
It’s chess. In chess, you can play by each move and respond to each move or you can know 3, 4, 5 moves in advance. There are a lot of mini-entrepreneurs. The successful ones are able to do that. In your space, you’re doing the exact same thing where you’re looking at those leading indicators which could do this. That’s where the opportunity is.
That’s a software play, Elon Musk getting into the taxi business. That’s how he sees it. The cars are insignificant.
There was a flyover of Starlink, which is the satellite internet company that he has. There are 1,200, 1,300 satellites. It’s not even online yet. They’re not live yet. He sees where all this stuff is going. He does crazy stuff.
This is my point. The key to entrepreneurship is solving problems. What can be done better? He does it at a massively bigger level than most people but for us and for your folks here on this show, it’s housing. There’s going to be a massive housing need in the next years as a result of everything that’s happening, unemployment, fall out on the evictions, fall out on the forbearance, fall out on the defaults, and the defaults that are going to happen to the lenders. It’s going to be like 2008. The government, at some point, is going to stop writing checks that prop it all up. Trust me, it’s going to happen. This next year run, Patrick, is going to be incredible for entrepreneurs.
I went to the gym. My trainer wants to open a gym. I said, “Wait. Find out who’s locked all the doors, put chains around, and then call the landlord and say, ‘I’m not going to give you any money but I’ll take this over.’ You have to pay for the equipment and then go from there.” He’s like, “How did you learn all that? Where do I learn all this stuff?” I go, “Trust me, it’s trial and error. It’s a lot of failures, a lot of bad decisions.” He’s like, “That’s a great idea.” I go, “If you have to use your own money and in the next years, you’re lazy. It’s all how you think and what you see.” Elon Musk did throw a lot of his money early on as we know. The overwhelming majority of everything he does is financed with other people’s money and it always will be. That’s the whole point. If you think that you have to save your own cash and do it yourself, then you’re thinking small and you’re not using a system that’s in place for you that is there. It’s a bias.
Principal of MC Companies and #1 New York Times’ bestselling author of “The ABCs of Real Estate Investing: The Secrets of Finding Hidden Profits Most Investors Miss” and “The Advanced Guide to Real Estate Investing: How to Identify the Hottest Markets and Secure the Best Deals.”
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Patrick is the President and CEO and started Paradigm Life in 2007 after learning from his mentor Kim Butler about financial strategies outside of Wall Street.
With a background in economics and marketing, Patrick immediately realized the opportunity to teach investors, business owners, professionals and families on a large scale using modern digital media and communication technology. Since 2007 Paradigm Life has worked with thousands of individuals in all 50 states.
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ABOUT THE AUTHOR
Patrick Donohoe is the Founder and CEO of Paradigm Life and PL Wealth Advisors. Patrick and his team teach thousands how
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Patrick was recently honored by Investopedia as one of the Nation's Top 100 Most Financial Advisors. He is a highly sought
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Patrick grew up in West Hartford, Connecticut, and attended the University of Utah, where he received his bachelor's degree in economics.
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1. ORIGINS OF THE AMERICAN DREAM
2. THE PERPETUAL WEALTH STRATEGY™
3. QUESTION EVERYTHING
4. BREAK AWAY FROM WALL STREET
5. AVOIDING THE INVESTING AND LENDING TRAP
6. THINK FOR YOURSELF
7. A SOLID FOUNDATION
8. B ELIKE THE WEALTHY
9. MYTHS AND TRUTHS OF INSURANCE
10. SAVE, BORROW, INVEST, AND BUILD WEALTH
11. START, BUILD, AND PROSPER YOUR BUSINESS
12. YOUR FINANCIAL FUTURE
13. MAKE THE SHIFT
14. TAKE BACK CONTROL
Heads I Win, Tails You Lose
by Patrick Donohoe
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