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Chris: Welcome to this Peak Prosperity Podcast. I am your host Chris Martenson and it is Thursday, Feb 9 2017. Now look, the pensions in the United States are in complete disarray. And the Federal Reserve is mainly responsible for that because of eight, going on nine, years of so called emergency ultra-low interest rates. It’s a real mess. But as destabilizing as it will be will for millions of retirees to suffer vastly reduced payouts along the way. With millions of more taxpayers being absolutely nailed for more to close some of that pension gap. The social instability resulting from the widest income and wealth gaps, in all of history, will be even worse. Now that’s my opinion. It’s based on the fact that we primates are wired to dislike unfairness. There is nothing more unfair than making one group slave away from table scraps while a very tiny elite are showered with free wealth primarily consisting of money printed out of thin air. Today’s guest is the perfect person to connect these dots and talk to us about the inner workings of the Fed. And how it came to make the decisions it’s made.

Danielle DiMartino Booth spent nine years as a senior financial analyst of the Federal Reserve of Dallas and served as an advisor on monetary policy to Dallas Federal Reserve President, Richard Fisher, until his retirement. Fisher called on Danielle to serve at the Fed after becoming a loyal reader of her financial column in the Dallas morning news. She began her career in New York at Credit Suisse and Donaldson, Lufkin & Jenrette, where she worked in fixed income, public equity and private equity markets. She’s got an MBA from the University of Texas at Austin and an MS in Journalism from Columbia University.

Danielle is the current president of Money Strong LLC and the reason we are talking with her today, the author of the very newly released book, Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. Danielle, welcome to the program.

Danielle: Chris, I’m delighted to be with you.

Chris: Well, thank you. Where do we even start. Out of them all I admired Richard Fisher the most. He came not from academia, but private industry. He ran his own business. He regularly criticized Fed policy. He even recently said, “Fed monetary policy put beer goggles on investors and protected Congress from fiscal malfeasance.” What was he like to work for?

Danielle: I will say he was like a breath of fresh air. We both started off as rookies, him obviously, a bit earlier than me, on Wall Street. We both had MBA and we both have a deep appreciation for how the financial markets interacts with economic data and with monetary policy. It was an absolute honor for me to work with him. He has called me his eyes and ears on the market. He’s also called me his secret weapon.

He never walked into an FOMC meeting without being armed with a lot of my take on where the markets were and how they were reacting to Fed decision making.

Chris: From 2006-2015 one of your job duties at the Dallas Federal Reserve was to, “Advise policy makers on potential systemic risks building within the financial system.” I have to ask, what sorts of potential systemic risks did you surface and was anybody besides Richard listening?

Danielle: Well, I think that there were a handful of people who were listening throughout the years. I became a great admirer and I got to know Jeremy Stein. He could’ve stayed longer on the Board of Governors. But he chose to return to Harvard. He was, what I considered to be, the best of both worlds. He had a deep academic understanding. He carried a PhD in economics but he also had another foot planted on planet earth and that gave him a unique take. That’s why he and Richard got along so well when they were both serving on the FOMC.

Chris: In your book, Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America, which by the way…

Danielle: Subtle subtitle, isn’t it?

Chris: Subtle subtitle, but perfect right in my sweet spot. By the way, it’s the best one. Really great writing. You had me right from the opening scene where you are outlining the December 2008 meeting when everyone walks in. What the weather was like, just really painting the stage for us. But you note there, right in the front that one “feature” of the Fed is that almost all of the staffers there are PhD academics. People with really no practical, no real world experience, but plenty of models and rigid, dare I say dogmatic, ideas about how things work. Why is that a problem?

Danielle: I think it becomes a problem because it fosters myopia. If you consider what economics in the United States, and for that matter all around the world, has become, there has been a global movement against dissent. There’s been a global movement within the entire economic profession against thinking outside of that proverbial box. I think you run into serious issues if you’ve got the majority of people seated around a table about to undertake, as they did in December 2008, an extraordinarily important decision, but most of them are thinking alike. It’s going to be very difficult to poke holes in arguments or play devil’s advocate when there is such a supermajority of the same type of thinking.

Chris: Not just the same type of thinking, but I think academic thinking. Which, Naseim Taleb wrote an extraordinarily good piece around that and Ben Hunt of Epislon Letters wrote a really nice piece about the same, to understand the culture of academia is to understand centrist thinking. Everyone wants to appear smart, no one wants to be the outlier, everybody feels safer as long as they are as smart as the centrist smart decision that’s being made. It’s really, of the cultures that exist out there, it’s one of the worst ones you could have for dissent. When it comes to things that are academic or intellectual in nature, and these were some of the most important decisions ever being made. “Hey, let’s take interest rates to a place they have never been in history.” They sort of trundled along. To understand what happened, we have to understand the culture of the Fed. Is that right?

Danielle: I think absolutely is right. If people ask me, why were you so compelled to write this book. I have four young children and plenty of other things I could’ve done with the last two years of my life. But when people ask me why I was compelled to write Fed Up, it is because of how ostracized I was within the institution, because I didn’t have this centrist way of thinking and because I chose to raise my hand over and over again and say, “Wait a minute, let’s stop and think through how this is going to play out in the real world. Let’s question where we are going rather than just go headstrong into a decision which, by the way, is not just going to affect just the United States, and pensioners and retirees and our country, but it is going to take a global lead. You will have other central banks around the world, as has been the case, follow your lead into uncharted territory making the implications that much more global and systemic and connected and interconnected. “

Chris: Very well said. You did decide to write this book, I have to ask, I guess that maybe not everybody at the Fed will be thrilled with it, or maybe some will because they share your views. How do you think your books going to play at the Fed?

Danielle: I don’t think it’s going to be on anybody’s coffee tables this Christmas.

Chris: Maybe not on purpose.

Danielle: But, that’s not the point. As somebody commented on a Wall Street Journal story on the book. I really did appreciate the comment, because there is a vast amount of end notes as you will see at the end of the book. This book is meticulously documented. But somebody commented on the original Federal Reserve Act verbiage that states and demands that there be a lot of diversity of thought on the Federal Reserve board and among Federal Reserve district bank presidents. It’s actually part of the law. It has been completely disregarded.

Because I was an outsider on the inside, would I have ever decided inside the Federal Reserve and work for anybody but Richard Fisher. Maybe Charlie Plosser; he was another wonderful maverick who served alongside Richard Fisher from the Philadelphia Fed. But I chose to do what I did for God, country and man because I’m concerned about my children and their children and all of the retirees. I have a 70-year-old mother who has been forced to make some very difficult choices. Not as difficult as a pension fund manager as you started out the podcast referring to, but all of these difficult decisions did not have to be forced upon us. That is one of the major reasons I was compelled to write this book.

Chris: Thank you for that. Let’s go there for a second, because the context was the world’s falling apart, we have to do something to save the world. The world to the Federal Reserve is the banking system and maybe a little bit of concern for the corporations that are out there that were also on the ropes. But here are a few of the sins that I’ve laid at the feet of the Fed. You’ve noted many of these as well and I’m sure you have others.

First, expensive housing that barely benefits the existing holders of housing, right? Because what does a more expensive house do for you except for drive up your insurance payments and your property taxes, potentially. While also punishing the young and first time buyers, as you mentioned with your own mother, savers who have lost of hundreds of billions in interest income that was transferred to banking income statements. A wealth gap that is the largest on record. Ruined pensions that are in many cases that are simply never repairable under current math. The math is that bad. Continuing to foster the delusion that Congress can borrow without any eventual ill effects.

Is it fair to lay all of that and maybe more at the feet of the decisions that were taken in 2008?

Danielle: Well, I would say two things. The first is, you left out the cohort to come. That would be my children. We have set up faux savings accounts here in our home so that we can try and do what Bank of America and their little savings accounts cannot do for them. Which is instill the miracle of compound interest in their minds. Foster a culture in our own home that savings is a good thing to do because it pays over time. Which an entire generation of Americans has been robbed of. That’s the first.

The second thing I would say is that it’s not just at the feet of the Fed. It is also what you mentioned earlier, Richard Fisher and congressional malfeasance. Congress has relied, overly relied, on the Fed to do their heavy lifting for them. But back to your original lifting for them.

But back to your original question, would they have been allowed to misbehave as they have had they not had a banker? The answer is no. It takes two to tango. If the Federal Reserve had not facilitated Congress’ bad behavior, we wouldn’t be in the same situation that we are in today. So yes, it’s circular, but it does lay at the feet of the Fed.

Chris: Taking the other sides of this, I run into this all the time, they say, “Look, if the Fed had not done what they had done things would be far worse. We’ve got a not-ruined economy today. We’ve got reasonable job growth. We’ve got a much sounder banking system.”

If you agree with those as the outgrowths of Fed policy, were those a reasonable trade-off for the other things we’ve just been talking about?

Danielle: Well yes and no. I don’t think that the housing bubble would’ve existed had Alan Greenspan not taken to heart what one of his chief advisors and closets associates, Ed Gramlich, said to him in the heat of the housing bubble, which is, “Sir we have a problem here. There are people buying too much home. There are people who are over extending themselves.” To which Allen Greenspan flippantly replied, “We only technically regulate 25% of mortgage lending in this country. The rest does not lay on us.” Which of course is not true.

The Fed was called in to clean up the entire mess that they created. So, you have to lay that as an essential backdrop. Then you get the justification for QE1. You don’t get the justification for zero interest rates. We never had to go to the zero bound at the Fed that was never an essential necessity. That was never a number one requirement for us to launch the liquidity facilities that had to be launched when it was DEFCON 1 and you were talking about a global depression. I think that absolutely had to be addressed.

Now, after we prevented the world from melting down, a situation that was created, again, by the Fed were the other things that were done to placate Wall Street necessary? Were we staring down the barrel of the abyss at that point?

No. No, no, no. It was the actions that were taken to subsequent to QE1 that really laid the groundwork for where we are today. And perpetuated the cycle of boom bust where we found ourselves since Alan Greenspan first launched The Greenspan Put on Oct the 20^th 1987. This is a problem of our own making.

Chris: And a long time in the making since it started in ’87 and happened with the corporate bond hiccup in ’94 which gave us easy money that led to the 2000, so here we are. It’s been a serial bubble blowing kind of an organization. Each one larger than the rest.

Today, if we can take, here we are today. I’d love to get your views as somebody who’s been able to spot these trends and critique them. My view is that today we have a global central banking system that is now hostage to the enormous balance sheets that they’ve got. They don’t know how to unwind them. They seem, and maybe this is not fair, but it seems to me that they’re terrified of financial markets having any sort of a down day given how often they trot out officials to talk markets down comp them and also throw more money.

Is that fair? If these are sort of franken-markets of central bank creation, how would they begin undoing what they’ve done?

Danielle: That’s the trillion-dollar question. We didn’t used to call it that did we? We used to call it the million-dollar question. But that is the trillion-dollar question. The punditry up there will tell you that The Fed has been in tightening mode since the taper began several years ago, but I say, hooey to that What we have today is absolute fungibility with central bank purchases on a global basis. You are talking about something upwards of 200 billion dollars every single month.

What the global bond market now revolves around, and relies upon, is the assumption that somebody somewhere will be conducting quantitative easing. As long as they do that, and I’m going to dig a little bit into the weeds here, and you consider supply demand, as long as they do that, then we are operating in a bond market that is assuming that every single bond purchased by a central bank globally has been expired permanently.

You’re taking supply out of the system which is the only thing that could get you to justify where bond yields are and, therefore the mirror image of that, where bond prices are, which is at record highs or close to record highs. That I think is at the crux of central bankers’ global dilemma. The first central bank that even hints that they are going to reduce the size of the balance sheet or even worse, sell off a single bond, it is game over at that point for the world bond market.

Chris: Well and it has been a big, they’re all holding hands and singing “Kumbaya,” because they say, “The Fed is now tightening.” But if you add up the main central banks. Bank of Japan, United States, England, ECB, put them all on one balance sheet, chart, you can’t see any deflection in the line and it started in 2006 and they’ve just been adding, adding, adding as they go along. I’ll include China in that as well. It has been a worldwide, we are just going to keep growing kind of balance sheets trillion-dollar question.

Can they just keep doing that?

Danielle: We have seen that there are mechanistic challenges that have presented themselves along the way. You’ve got corporate bonds in Europe trading at record high prices because the ECB has been out there buying corporate bonds which is somewhere, thank heavens, the US Federal Reserve never had to go.

You have the Japanese central bank. You have the Bank of Japan hitting its outward limit in terms of owning every ETF out there. One of the reasons that’s less appreciated out there, that presented its own obstacle to the Federal Reserve. At some point, we were buying back 80% of the mortgage back securities net issuance out there. We were running into technical difficulties in keeping the mouse running on that wheel.

Are there limits? I think there are practical limitations to QE. The market distortion that are introduced the further we go out on that spectrum, in terms of assets that are being purchased, corporate bonds, equities, the more difficult it becomes to keep QE going, but by the same token the more difficult it becomes to extricate ourselves from the process.

Chris: I’ll tell you the next logical direction where, well illogical depending on your point of view, where this goes. Here I want to focus down a little bit is get into this idea of pensions. Turning to pensions here, I happen to be in Dallas at this moment where the police pension is in complete disarray and certainly a few bad, if not criminal, bets were made on real estate. That was a contributing factor to the Dallas Police Pension difficulties. But the zero bond rates forced on all of us by the Fed is a really big factor in the actuarial distress of the Dallas pension as it is for every pension in the land.

Is it as bad I’m making it out to be? I think it’s a complete disaster as many do. Is this another area that the Federal Reserve will step in and say, “Let’s just make this hole as well?”

Danielle: First of all, that’s illegal. What I would say, since we both happen to be in Dallas right now, I live in Dallas. What I would say is that the Dallas pension situation is an extreme example. But is also gives us a very clear prism into some of the more difficult decisions that have been undertaken by pension fund managers given their actuarial realities. That is, when you’re bumping up against the zero bound and zero interest rates, and your state municipalities do not have the funding to realistically lower the rate of return assumption to where they need to be.

The UK has a create of return assumption legally tapped at 3.5% so the pension fund managers are never forced to go out and buy things like real estate, that are highly inappropriate to put grandma’s money in, by the way. So many public pensions across the United States have been making these very poor decisions and piling into, not just into high risk investments, but illiquid ones. Which brings us back around to what is happening in Dallas. The most frightening thing about the de facto run on the Dallas pension is the headlines that it garnered and the potential precedence that it sets for when financial markets pull back and you have some kind of wholesale run. Not on one or two or three, but many pension funds and no legal wherewithal for anyone to pull them out.

Last I checked, we’ve got a Republican congress. Republicans don’t cotton to the idea of sending money to state municipalities and bailing out their pensions. Which gets us to the very first point your brought up, which is, social strife. The Fed has no legal charter, license, to bail out pensions.

Chris: Janet’s been hinting that the Fed would like to dabble in other assets, which I will assume are equities and also potentially bailing out pensions if it comes to that. I was reading a piece that was written by your real vision interview by Grant Williams. A great guy, I admire him a lot. In there, you noted that the 1.3 trillion, with a t, trillion deficit just takes into state municipal obligates with promised returns of 8% or 7%, but they are compounding at a much lower rate than that. You noted in there that it will take nothing short of an economic miracle to recover. “The average state pension,” quoting here, “In the last fiscal year returned something south of 1%. You cannot fill that gap with a bulldozer. Impossible,” you said. You also said, “Anybody who knows their compounding tables know you don’t make that up.” Please explain for people, who don’t know their compounding tables, what you meant by that.

Danielle: The problem with pensions, and what I was getting to, is that the sins are compounding over time. They are piling up. Every single fiscal year that goes into the history books with a 6% plus gap in what is assumed and what is returned piles on to the next year of equal, if not worse, relative underperformance. You’re talking about the equity in the bond markets and the majority of investments and pensions having to make up for all of that lost time but in spades. At multiples of what the current rate of return assumptions are. Going forward, on an ongoing basis for years to come. Which is highly unrealistic when you are staring down the barrel of an almost 40-year bull market in bonds and the second longest bull market in US history which culminated with the Internet, NASDAQ implosion. The assumptions are simply, they’re herculean in magnitude and impossible to achieve. That’s why you’re seeing, of course with CalPERS, they always start the trend, that’s why you’re seeing rate of return assumptions begin to come down.

This is all good fine and well until you completely square the circle and understand that every time a municipality or a state pension plan reduces their rate of return assumptions, some entity, whether it be the state, the school district, some entity has to write a bigger check in order to make up for the cash flow that is no longer being assumed in by the actuaries via rate of return investments. It doesn’t work. You can’t do it for very long when you’re not brining money in as a state municipality.

I’ll throw one example out there, which is my favorite. The city of Denver, this is well over a year ago, this is a Wall Street Journal story. It was kind of quaint. They were pulling their tulip budget for the city. They were going to make up for that with less expensive foliage of some kind with which to make the city look pretty. What happens when it’s police and fire department and sanitation and ambulance funding that’s being cut? What happens to the social fabric of these communities when you are starting to cut to the bone because you have to reduce your rate of return assumptions and put more tax revenues in the pensions to top them off?

Chris: I just, I giggled a little there. The idea that the Fed’s blown these bubbles and gotten us in this big trouble and ultimately Denver has to cut the tulip bulb budget. It circles back around to the early 1600s in Holland there. Fantastic example. But to go back to CalPERS, they just went from 7.5% to a 7% assumed rate of return. Their last two years averaged out just around 1% return. Even seven is highly optimistic given their most recent returns. But even that move from 7.5 to 7 that .5% wiggle is creating an enormous budget struggle for many municipalities. Point one.

Point two, is that the combined deficit of CalPERS now is around 95,000 dollars per household in California. Let’s assume each household has an average of 10,000 dollars in property taxes. Maybe that’s low, I don’t know, but it makes the umbers easy in my head. That means paying for nothing else in the next nine and a half years, assuming the hole doesn’t get any bigger, all property taxes in California would have to get funneled into CalPERS just to fill that hole.

Point three is, the hole isn’t going to get filled. How does this play out, Danielle?

Danielle: Well it doesn’t playout very well. If you really want to Shakespearian tragedy, look up the State of the State Address that Governor Brown recently presented to his legislature. It truly, it’s as if these people, maybe they were central bankers in their last life, that’s my gallows humor for the day, but this doesn’t work.

Where we are sitting today in Dallas, Texas, we are sitting in the middle of relocation central. Consider the Toyota corporation within Torrance California. For decades, it’s where it first established itself in the United States. By the way, it’s relocated to Texas. Over 9,000 companies over the last decade have abandoned California. They have relocated, mostly to a no income tax state, called Texas, where it is a lot easier to do business.

Now, extrapolate how many companies have left California to how many individuals have left California. Drive around Austin Texas, you will see a lot of California license plates. What California is going to be facing in the years to come, and I would venture to say other states like New York and Illinois, is a barbell population. They’re going to have the wealthy, who can afford to pay, you name it, in state income taxes because all they want is their view. And the ability to, by the way, express their view. Then you will have the people who are caught up in the social safety net and covered by the expansive state benefits. But as far as the middle class, the squeeze that you described in the property taxes and the amount of money that they simply don’t have because they might want to send their kids to college one day, they’ll leave and they will continue to leave.

You will see a tax base of the highest income and the lowest income status and nothing in between. This is going to roll around to, “Gee Uncle Sam, we’ve got a problem,” and whether or not Congress decides to step in and help out the state. Those are very tricky issues depending upon who is running Congress and who is in the White House.

Chris: It gets trickier too because it is like a housing crisis part two. Those who were prudent, really get punished and the people who were imprudent seem to get bailed out. Illinois failed to tax itself properly or make good decisions and maybe they get a bail out, but what about the state that ran itself more prudently? They get nothing. It just keeps digging this unfairness hole.

When I add all of this up, great the Federal Reserve is driven the stock market to all-time highs and created a lot of, a year and a half ago it was 62 people had as much wealth as 3.5 billion people have in the world. Today that’s eight people. That’s an example of this compounding effect of throwing money into the markets to try and get the tail to wag the dog hasn’t happened.

I also have three children they’re ages 22 to 16. They’re peered into this future and said, “I can’t connect with this story. It doesn’t make sense. We have this crumbling infrastructure. We haven’t really invested in ourselves. Corporations don’t have the loyalty to the employees they used to have anymore. There’s all this debt. I’m going to pay in a Social Security system that I’m pretty sure won’t be there for me.” The whole idea of the American Dream, including household formation, really seems to have been snatched away from an entire generation. That is something that the Fed needs to be attached to. It was the consequence of their sets of decisions in many ways.

I know you’ve hinted at this, what are our children really facing here?

Danielle: Our children are facing a crisis of confidence. I hate to say anything so cliché as we’ve lost an entire generation in the millennials. Unfortunately, a lot millennials were raise in a backdrop of their parents taking on too much debt. Now you have this sense of entitlement.

Talk about your children’s generation. Their first memory is 9/11. They feel they have been under attack from day one. Everything I hear from your children’s generation, the generation behind the millennials, is that they have a superb work ethic and they desperately want to save and get ahead. They recognize that something is bereft that something has been stolen from underneath them. They want to make things right and “Make America Great Again.” I can’t believe I just used those words. But that is there is a determined generation behind the millennials to rights the wrongs.

They might need a central bank that might want to go alongside with them and stop destroying the American Dream. Which is what’s happened. When you take away the virtues of saving today to invest tomorrow in a world where you can’t do that. If you look at the education system in this country that has been absolutely hollowed out, it is easy to leave education reform behind if you’re Uncle Sam if you’ve been borrowing at 1.8% for years on end. Thank you, Fed. You leave the hardest decisions under the carpet. You never undertake them. Who loses? All of the youngest generations.

Chris: Indeed, they do. When I think about what do they really have to look forward to in this story, it’s going to require really thinking differently. You will have to think bold and your first chapter in your book, Fed Up, is, Group Stink. What’s it going to take us to break the group stink, maybe not just at the Fed but maybe more broadly? To broaden this conversation up slightly, we have different groups of people who are talking past each other, seem to have lost the art of understanding the other side’s point of view. We are going to have to figure out how to close that gap. But the first thing we have to get rid of is the old thinking that just didn’t work.

In my mind the Fed achieved a few things that seemed to go its way, but unbalanced everything you and I have been talking about. All the things that are so beautiful characterized in your book, Fed Up. Is that on balance? Even more things went wrong. Because, hey, real world. You’ve got your theories, but then there’s the real world. I don’t see the Fed adjusting their stance, their reactions, their policies based on the data that is actually pouring back in. Things like, household formation, the educational gap, the loss of the American Dram, the wealth gap, all of that stuff.

You’ve got a chapter in there about heads must roll. How do we get back to this? Does it begin with accountability? Where do we go from here? How do we get started on closing this gap now?

Danielle: With any luck, we get started by filling the two vacancies on the Federal Reserve board with people who actually know that the word “no” is not a four letter word. You have to start with dissent. That has to