Inflation, Inequality and the Next Economic Disaster - with Richard Vague

The single largest component of the private sector debt, Mark, by far, is real estate. It's something like 16 trillion out of 35 trillion. So roughly half of all debt in the United States is about real estate. About 11 trillion in home mortgages, about 5 trillion in commercial real estate debt. So any way you look at it, real estate is the big factor. And, you know, even though commercial real estate right now, in terms of conventional office space is beleaguered because of COVID we have areas like server farms, warehouses for Internet companies that are continuing to grow rapidly. One of the needs we're seeing a lot of recently is with the, with the genetic engineering revolution. We're seeing this massive growth in the need for laboratory space for these very sophisticated companies here in Philadelphia that's creating a real estate boom all by itself.

It's my pleasure to welcome Richard Vague. He is Secretary of Banking and securities for the Commonwealth of Pennsylvania, former Managing Partner of Gabriel Investments, Chair of the Governor's woods foundation, and co founder, Chairman and CEO of Energy. Plus, he's got a whole additional business history and resume that we won't go into. He is author of three great books including the Next Economic Disaster, why It's Coming and How to Avoid It, A Brief history of doom, 200 years of financial Crises, and the new book, An Illustrated Business History of the United States. Richard, welcome.

It's a privilege to be here. Thank you.

It's a pleasure to have you. Where are you located specifically? I'm guessing Pennsylvania, but whereabouts?

Philadelphia.

Fantastic. City of Brotherly Love. Good stuff. So your new book has got a really interesting title, Business History of the United States. Are we talking about the country as a business or businesses within the country.

Or both businesses within the country? A history of that sort, strangely enough, had never really been written. And we were doing some research on financial disasters back in the 1800s and found that a lot of research had never been done about US Business history. So we've tried to remedy that and put some together that folks would enjoy.

That is pretty amazing. Give us an overview, if you would. I mean, it's amazing that it hasn't been written about. That's what I mean.

And I agree with that. We really start in the 1760s and 1770s as you go into the revolution, and then bring it up to 2015. We divide American business history into 14 eras. There's a chapter for each. And in each chapter we tell you who the wealthiest individuals were. We tell you what the business biggest businesses were, the key inventions, and then we kind of write a narrative of what happened. And interestingly for me, as I got into it, it's clear the central business of the United States from the very beginning was real estate. George Washington, as a very young individual in 1748, joins with his brothers and some other Virginians to create a company that tries to acquire 500,000 acres in the Ohio Valley. And that becomes kind of typical of what happens with Patrick Henry and Robert Morrison and a number of folks. America is about acquiring big chunks of land and developing those big chunks of land.

You know, that's interesting that you say that. And I remember when I first got my real estate license, first year of College at age 19. They initiate you and, you know, the preamble for the national association of Realtors is under all is land, right? So land is a very fundamental thing. It's really where all resources kind of come, or at least all commodities oriented resources come from land. If the business of the US Is real estate, we would that have been true of all countries at that time? And even still, or was that different in some way? Maybe it's because America was so expansive. Or give us the. Compared to what on that, if you would.

Great question. If you were in some place like England and France, the land had already been owned, typically by the wealthy families that became the nobles in that countries. And it had been owned for hundreds of years, if not thousands of years. So the chance for the average person to come in and amass a land holding was much more limited. When you go to the United States, of course, it's this discovery of all this very great land, great river systems, very fertile soil that goes on for millions of acres and promises opportunities that are absolutely dazzling to everyone. Interestingly, one of the things that happens is that the Appalachian mountains form kind of a barrier, and the colonies have the land to the east of that and want the land to the west of it. They absolutely salivate about the opportunities there. But the British government precludes them from doing that in major pronouncements in 1763 and 1773. This is one of the things that leads to the revolution is Americans are sitting there. How dare you reserve that for somebody else? Like British nobles, for example. So, you know, it's about real estate, and the opportunities in the United States are unparalleled.

And, you know, this really also sort of speaks to the foundation of our democratic ideals, right? That the land should be in the hands of the people. It's really, really interesting. You know, I don't want to harp on the real estate thing, but he started with that. And so much of our audience is interested in real estate investing. I always like to say it's the most historically proven asset class in the world. And how is that today is the business of America still real estate? I mean, obviously there are tech companies and so forth.

I would say the answer is absolutely yes. If you look at debt markets, the single largest component of the private sector debt, Mark, by far is real estate. It's something like 16 trillion out of 35 trillion. So roughly half of all debt in the United States is about real estate. About 11 trillion in home mortgages, about 5 trillion in commercial real estate debt. So any way you look at it, real estate is the big factor. And even though commercial real estate right now, in terms of conventional office space is beleaguered because of COVID we have areas like server farms, warehouses for Internet companies that are continuing to grow rapidly. One of the needs we're seeing a lot of recently is with the, with the genetic engineering revolution. We're seeing this massive growth in the need for laboratory space for these very sophisticated companies here in Philadelphia that's creating a real estate boom all by itself. So, you know, I don't think the centrality of real estate will ever change.

Yeah, that's really interesting. Good stuff. So some highlights as to these different times in businesses, the major discoveries, I mean, I know we gotta go through like 240 years, but you started with the real estate. And that was a very good point. Any others that sort of really like capture should capture our attention?

You know, when you moved through the 1800s, the 800 pound gorilla, if you will, is the railroad industry.

Right?

The railroad industry is what compels the United States from, and also ran to the largest economy in the west, which we, we pass England and France in about 1870. And it's powered by railroads. And wherever railroads go, real estate speculation and development follows. Because, you know, to have a railroad going from here to St. Louis or Chicago, you need towns along the way, you need farms along the way to grow wheat, which, you know, the transportation of wheat is the big revenue producer of railroads during this period. So transportation in the 1800s, and then you see that same big thing happen in the 1900s with the Interstate highway system, which again is largely about land. I'll give you one little tidbit that almost no one thinks about. But the great Depression, it comes on the heels of this massive real estate boom in the 20s. Well, one of the reasons you have a massive real estate boom in the twenties is, is the automobile. All of a Sudden makes land available for development that had never been realistic to develop prior to that.

Because you could get to it.

Because you could get to it.

Yeah, right, yeah. So it shrunk the distances and the automobile ultimately, you know, created a very American phenomenon, Suburbia. Right. That was huge. And it's too bad though, on the railroad side of it that the auto companies, I mean, I don't know, this is maybe not the exact history, but they just sort of ruined the railroad, which it would be nice to see a decent amount of railroads today. I mean, the country is so large. It's just too bad we don't have high speed trains and stuff like they do in Europe and Asia. You know, America fell in love with the automobile and went that direction.

Yeah. And you know, again, we get back to this issue of government support, which, you know, has been critical from time to time. You know, government was involved in the real estate business, it was involved in the development. It financed the Erie Canal and the transcontinental railroad. So, you know, government paying a little bit of attention to that could help things as well. You know, I marvel when I go travel the Eurostar between London and Paris, you know, it's smooth as silk.

It's great.

And you don't, you really don't find.

That anymore in the U.S. yeah, no. And you, and you just have an alternative. You know, driving is just too darn slow and even, even when the cars become autonomous, they're not going to beat a high speed train. And speed, you know, maybe, maybe the speed will double and the packing distance of the highways will increase, so traffic will be virtually eliminated. But even then it's just never going to beat the speed of a train. So, you know, it's just not. So that's too bad. Jumping to maybe one of your other books, the Financial Crises, when you started writing about that in, well, at least in the book, in 2014, what were you thinking then? What was coming? And did any of it happen? You know, it kind of. We were probably in for a change in the business cycle, but then Covid happened and massive amounts of money printing, you know, just give us your thoughts on the economy, where we are now, where we might have been, had Covid not happened.

Well, you know, after the great financial crisis of 08 09, et cetera, debt levels came down and have been relatively flat in the United States since then. When I say flat, I say flat in relationship to gdp, which I think is the correct way to think about these things. It's been very benign in the United States since then, it's only begun to percolate in 2019. And then obviously we've had this massive increase in debt in 2020, which continues to the present. So we're starting to see upward trends that we got to watch carefully now. Even though I think the US Is in okay shape. The places that you have massive accumulation of debt is China. And we're seeing that and things like Evergrande, which, as you know, we're currently worried about defaults. They're the largest borrower in the world by far and they're a massive commercial real estate developer. And we're seeing isolated France has a runaway lending situation right now, in my opinion. And so I think we're okay in the US but if we look around the world, there's several places we need to be worried about.

Yeah, you know, I'm really glad you said that, Richard, because I just think that people are far too critical of the US and seem to be a myopic when looking around the rest of the world. And they just don't ask the question compared to what? Sure, there's a lot of stuff to be critical for, but I mean, with reserve currency status, largest military debt to GDP, lower than Japan, lower than others as well, no demographic problem like China and Japan. China's coming into, Japan has, Russia has, Western Europe has. I think the US Kind of has it made, relatively speaking. Am I wrong about that?

No, you're exactly right. Yeah. The United States is in relatively good shape compared to the rest of the world. We have plenty of problems, but they're manageable problems. If you look at real estate, housing in particular, if you look at the number of houses being built compared to that problematic 050607 period, we're far below those levels. Home sales are far below those levels. Mortgage debt levels in ratio to GDP are below those levels. So I don't think there are. You know, we may be on a path to some problems over the next few years, but nothing of the consequence that we saw at that point in time. I'm bullish on the United States.

And the other thing you didn't mention, but I'm sure you know, is that debt is likely far more sustainable for at least two reasons, if not a lot more. The debt is much cheaper than it used to be. So I mean, the interest rates compared to inflation are literally negative interest rates compared to real inflation, I would argue, at least. And also that debt, at least on the real estate side is extremely well underwritten. I mean, we just don't have A bunch of liars loans and all of the liberal ridiculous lending we had last time around. So it seems to be pretty solid. I mean, there's a couple of examples where maybe it's not, but they're a drop in the bucket. Right?

You're exactly right on both those counts. Real interest rates are very low. That's a huge factor in the market right now. And then, you know, Dodd Frank made it law that folks had to, lenders had to see that whether there was the ability to repay on a mortgage loan. So that pretty much stopped all of that problematic underwriting behavior. And you know, as, as you know, as you announced at the outset, I'm in the regulatory business at the moment and you know, I feel good about what's being done there.

Yeah, that's good to hear. Talk to us a little bit about your regulatory career. I mean, you're Secretary of Banking and securities for the Commonwealth of Pennsylvania. Is that sort of like the SEC of Pennsylvania, the state agency that would be comparable to the sec?

Not quite, but directionally, yes. You know, we're, we're in charge of examining state chartered banks and licensing a number of other financial institutions, including investment advisors and mortgage servicers and mortgage lenders and like. So we have a lot of responsibility there. We work hand in glove with national federal regulators like the FDIC and the OCC and the Fed and others and have a terrific relationship there. And as you said, we've gone through one of the most stressful periods in American history and I think the financial services industry has held up really, really well. I think that's in part because of a lot of positive things done at the federal level.

So it sounds like you're more on the banking side than the securities side, even though securities is in the title. Right.

We have an equal dose of both.

Oh, okay, right. Okay. Interesting. Good stuff, good stuff. So pretty solid. You know, I'm curious about FDIC insurance and maybe you don't deal with the credit union side of it, but credit unions have a similar type of insurance and I guess the limits are the same. Is that as secure as the FDIC or maybe more or less? So of course, if there was a huge crisis, the FDIC could never afford to pay out. We know that. But no one's lost any money so far. Right?

Yeah, I feel very good about NCUA and the credit union's safety and soundness and the adequacy of that insurance. You know, credit unions are invaluable providers of financial services and we certainly very supportive of it.

Yeah, yeah, I was just always curious if that insurance is pretty much on par with the FDIC or better or worse. You know, I just never knew the answer to that question. So what are we headed for? Mainly maybe inflation wise, because that's a, that's a huge issue for, for people's future and what it means for the price of everything and the value or devaluation of their savings, stocks, bonds, et cetera. What are your thoughts there?

Well, we've studied inflation pretty intently and we've studied it since the inception of the country forward. So we've got inflation data really back to the late 1700s. And the US generally speaking has not had a problem with inflation. For all the people that obsess about it, we generally have had fairly benign inflation. The exception has been post war periods. So after the Civil War, after World War I, after World War II, we've had a two or three year period of pretty high inflation. And the reason has to do with the destruction of production capacity. So a lot of farms in Europe after World War II and World War 3 simply couldn't grow any food until they were kind of restored and replenished. So the US had to supply the world with those things. Prices of grains went up. That's very easily to understand. And those farms came back on stream, prices went down. My own personal view is the period and we're in right now is very similar. We've had productive capacity, whether they're meat purveyors or chip makers or you name it, that's been wiped out. People are still having a hard time.

I can't believe it. I don't know how are we still in a shortage mode right now. The shortages should have ended eight months ago.

You know, I think we've got a couple of years of this. This is my personal view.

Wow.

That it's going to take, you know, a year or two for production to catch up to supply and you know that even that could be disruptive if we have, you know, a few more variants that are problematic. But I would say it'd be fairly typical to think we got a, a couple of three years of inflation and we'll be back after that we'll be back to a disinflationary period.

Okay, so, so what you're saying it sounds like is that the inflation problem we're having now and sounds like you predict we will have for a couple more years is a supply demand shock problem, not a monetary problem. So Milton Friedman, if he were here, he would of course argue and he would Say it's everywhere and always a monetary phenomenon. Right.

Never was a statement made that is less true than that statement.

Tell us about that.

From 19, late 70s, early 80s when he made that statement. The money supply has outgrown GDP fairly dramatically. Debt has. In the 40 year period since then, debt has done nothing but go up in relationship to gdp. The money supply has done nothing but go up in relation to GDP dramatically and interest rates have done nothing but collapse. So I think the opposite relationship exists.

Why are you pointing out the interest rates? Are you just saying that that's the way inflation is priced into the future manifest?

I could have made that other statement as well. We charted both interest rates and inflation go down in a somewhat rough parallel over that period. So inflation and interest rates have both gone down since let's call it 1981 to the President in the very period that there's been explosive government debt and monetary growth.

And I like how you mention comparing money supply to GDP and economists do that a lot. Do you think it's appropriate to also compare money supply to population?

Oh, absolutely, absolutely. Yeah. Yeah.

Because gdp. Yeah. Like I wonder how that looks on a chart. If you took population size, GDP and inflation rate. Now, of course that's the official inflation rate. A lot of people argue with it, including myself, but whatever, you know, we'll just use it because it's there. How would that look if you put in how would it compare to inflation, population growth?

We look at that, we look pretty similar and I think that's the best measure. So measuring it in relationship to per capita GDP is probably the best, most rigorous measure.

Do you think the thing, Richard, that's allowed inflation to be relatively benign? Even looking at the 70s where we had maybe 13% official inflation in one of those years, or the early 80s, possibly, I can't remember, it's nothing compared to Hungary, Zimbabwe, Weimar, Germany, anything in history or Argentina or even more modern examples. Do you think it's technology that's really tamped that down? Has that been the barrier to high inflation?

Certainly technology and other things that have enhanced productivity been helpful. But I would tell you that if you're comparing to Zimbabwe or Poland or one of those folks, they actually did print a lot of actual currency and put it into the economy. And we don't do that, we issue more debt. But debt has maturity and an interest rate associated with it and has an accountability regime associated with it. And these folks were printing actual currency. And this is also true in the Weimar Republic, that might have been equal to 50 or 75 or 100% of GDP for several years in a row. So it would be the equivalent in the United States of US our GDP is 20 trillion. If we printed 10 or 15 trillion dollars in actual bills for several years in a row, we'd have the same outcome. And of course, we haven't ever done anything even remotely close to that. So to me, it's a different phenomena.

I've heard a lot this has been sort of quoted around, and you sort of don't know exactly what the nuance of these statements are, how accurate they are at all. But 20 to 35% of all dollars ever created were created last year during the pandemic. Right. You've probably heard that or seen that out there. Is that not a concern very much. And then take us through why the money creation being the form of debt, is different than the actual currency units. I like how you talked about maturity dates and, and so forth, but what does that really mean? How does that play out? And why, why is that not so inflationary?

Let's think about the debt marks in the United States for a second. There's about $35 trillion worth of private sector debt and about 20, let's call it 20 to $25 trillion worth of public sector debt. So that's about 60 trillion. And that doesn't even include. You'd add a couple more trillion for states and local governments. And if you want to throw unfunded pension liability, you're talking 65 or $70 trillion worth of debt in the US market, if you're being honest about it. So for the Fed to create two or three trillion dollars in a short period of time, while we feel it, and it's a big deal, I don't want to minimize it at all. I think of it in relationship to 60 or 70 trillion. I don't think of it in relationships to the Fed's prior balance sheet of whatever it was. Four trillion.

Yeah, okay. All right, so that was one. So really what you're saying is in the overall scheme of things, even though it seems like a lot, it's a manageable number. Yeah. Okay.

And when we look at history, if you just anybody can do this at home, you don't have to be an economist to do this. These are easily accessible numbers. If you look at the creation of more government debt, or if you look at the increase in the money supply, or if you look at the Fed's balance sheet. So those are three kind of overlapping things, but they're their own things. And you look at that through time the relationship between inflation and interest rates and the growth in those, if you look at the actual data, has been inverse. My own view is forget the next two or three years in the COVID disruption of supply. Generally speaking, more debt brings lower interest rates and higher inequality and it brings inflation not of the CPI, but inflation of asset prices.

I was going to ask you to differentiate consumer prices versus asset prices and that does create more wealth inequality, but please go ahead.

Yeah, it creates more wealth inequality, which is to say it creates for the holders of real estate, it's a good thing. And for the folks that aren't holders of real estate, they get further left, further behind.

Yep. But how does more debt create lower interest rates though?

Well, I can tell you what any number of economists, including Adam Smith himself, have said about that. I'm rereading wealth of nations right now and it's a very painful process, I must tell you. But what early folks just said is the more of something you have, the less it costs.

Well, that's interesting.

Debt is always a two sided transaction. Money is created by debt. Debt is created by money. When you lend money, you create deposits. So you have to think about both sides of the individual balance sheets and the aggregate national balance sheet. More debt you have, the more money you have. The more debt you have, the more wealth you have. It's not the way people are used to thinking, but I tell you, in early America they were sitting there and they had interest rates of like 6 or 7%. And in England their interest rates were 3 or 4%. And they automatically said that's because their debt market is larger and more well supplied. Yeah, and as ours gets larger, we'll have lower interest rates.

That's an interesting point. And so it just basically says that the further we expand, what people are very critical of, which is this fiat money system. Right. The further we expand, it actually kind of the better it gets.

Well, the better it gets for some and I think the more unequal it gets.

Yeah, true.

I think one of the biggest problems in American society right now is the exacerbation of inequality. That's one we're going to be wrestling with for a while. And this is part of that equation.

And that's hollowing out the middle class, which is a very sad thing. Yeah, it really is.

And becomes a societally problematic thing as well.

Couldn't agree more. I totally agree. Good stuff. Well, what else would you like to share as we wrap it up? Richard, I could talk to you for three, four hours easily. You know just anything I didn't ask you. Anything you want to point out about your books or your predictions?

Well, I think you've asked all the right questions. I would just say two things. The first thing I'd like to say is, you know, if you're interested in American history, get the book An Illustrated Business History of the United States. It's a designed to be a fun book. It's designed to be an enjoyable book. You don't have to take Advil when you read it. So that's one thing I would say. And the second thing I would say is you've got a terrific show. You're a real leader in this industry, and it's an absolute privilege to be on your show.

Oh, well, thank you so much. That's really nice of you. Appreciate it. Good stuff. Well, Richard, do you have a website you want to share with people?

Well, you can go to richardvague.com r I c H-A-R-D v a g u e.com, excellent.

Richardveg.com. and thank you so much for joining us. We appreciate it.

Thank you.