Chris Whalen: Time To Go Risk-Off, Why A Treasury Crisis Could Be Ahead, & Gold Displaces The Dollar

Our government is so pressed financially that they're doing dumber and dumber things to make it work. And that, to me, is the big risk when you talk about the Treasury market. We're at the end of a long run where Congress thought they could do whatever they wanted. They thought they could legislate economic outcomes. And you and I both know that that's not really possible. But in the strange world of Washington, it all makes sense. Chris Whalen, Chairman of Whalen Global Advisors, author of the Institutional Risk Analyst blog, author of multiple books, including your latest, the second edition of Inflated Money, Debt, and the American Dream, which also, folks, the audiobook version is now out. So if you are an audiobook person like I am, go download your copy. Chris, always great to see you. We love having you on the show every month. We're actually going to have you on twice this month. So super excited. Thanks for joining. My pleasure. Yeah, gosh, I always say so much is happening. I don't even know where I... You know, I'm just going to start where I always start with the big picture. Where we are today, what do you make of what's happening in the economy, in the markets? What's on your mind these days? What are you paying most attention to? How is it shaping your outlook? And as you know, Chris, you can take all the time you need to set the table. Well, where does one begin? I got up this morning and first thing I read was a little note from Politico about Scott Besant threatening to punch Bill Pulte in the face. I read it too. Yeah, and you know, I think what's happening is that the first six months of the Trump administration were very well scripted. They have an agenda. They've been following that agenda. Unfortunately, though, the various personalities who are orbiting around the president are not getting along so well. So, you know, Bill Pulte in particular, who's head of the agency that regulates Fannie and Freddie in the mortgage world, has been right out front. He's probably the most visible member of the administration doing the president's bidding, attacking Fed governors, all the rest of it. So it's getting a little messy. And in fact, at the end of August, really coming into last week, I was really going risk off with most of my portfolio. I think that the rebound from April has pretty much concluded. It was very profitable. I took my year to date up to about plus 30, a little more. So I figured, well, we're going to take the acorns off the table and see what happens. The rest of Wall Street is pretty much risk off as well. They're a little worried about the economy. They are very definitely up in the air about the Fed. Nobody really knows what's going to happen. They are trying to get Steve Mirren on the board of governors, but I don't know if that's going to happen by next week. So, you know, there's a lot of questions in the air right now regarding the Trump administration. The tariffs may get shot down by the Supreme Court. The war in the Ukraine continues, and the Europeans and the U.S. are threatening to escalate at least sanctions. We may also see European soldiers going into the Ukraine, which is not a good thing. So I think there's a lot of questions for the markets right now and for the economy, Julia. The crypto trade seems to be losing steam, which I find very interesting. So, you know, it's a time when I think you want to be cautious. I would say risk off is where Chris is right now. And that's what I've been telling my readers. I just wrote up Klarna and Figure. Klarna is a long in the tooth payments platform that was created. The buy now, pay later. Yes. And, you know, SoftBank put money into it at a $45 billion valuation. Well, they're not going out at $45 billion this week if they get the IPO priced. There's a five to one ratio between insiders trying to sell and the money that the company wants to raise in the offering, which is not a good sign. You usually want to keep the secondary sellers in a IPO as small as you can so you don't scare the investors away. You know, let's face it. Private equity is not about creating value for public shareholders, is it? So, you know, it is what it is. And, you know, the economic statistics, you know, to your question are all over the place. We're seeing weakness in the jobs market. But on the other hand, inflation is still clearly a problem. So what does a Fed governor do? Yeah. Okay. I want to give you some credit because going back to like April Liberation Day, you were the one who said like tariffs were a distraction. I take it you obviously found opportunities in the market at that time. You're happy with your gains, like 30%. You're taking the acorns off the table, if you will. And are you sensing that from other folks in the markets as well? They're also doing similar things because it's funny, like you'll still have some people get pretty angry in the comments section of like about like, you know, the market's going higher and whatnot. So just kind of curious as someone who is a player on Wall Street, you're probably sensing similar things from other folks, aren't you? Yes. I think if you look at the broad statistics on longs and shorts, the hedge fund community has been going really to a net short position after doing the obvious that you just described, right? The market sold off in April. I went in and bought some of the leading players in my bank universe. Eventually, I bought a little bit of Fannie Mae and all of them rocketed along double digit gains. And I took it because in this market, the volatility is such that if you're handed a double digit gain, take it. You can always get back in. I remember it was about a week ago, my stop loss on my NVIDIA position got kicked at $170 and off they went, right? But I had a 53% gain in the stock. So how are you not going to take that? And I think that's really the story this year is that the volatility that we are seeing in a lot of different sectors is your friend. If you realize that it's going to not be enduring, in other words, if you get a double digit gain in a stock in a period of weeks or months, take it. Likewise with crypto, that cognitive bias that we all have that says everybody agrees with us. I wrote about that in the blog this morning. Confirmation bias is not your friend in a market like this. You don't want to be following the crowd. You want to look for opportunities to go against the crowd because we're in a very crowded trade. Let's face it, Julia, you've seen markets like this before. When you see banks running 40, 50% less than a year, that tells you that we are in a very speculative market. So as you point out, there's signs that it's been a very speculative market, especially when you see those double digit returns, if you will. OK, one of the other areas of focus for folks will be the Federal Reserve. We have the FOMC coming up. It seems like a rate cut is a lock. I think the last time you and I spoke, you said don't necessarily expect a rate cut in September. Where do you stand today on the Fed? Well, we know that Mickey Bowman and Mr. Waller are going to vote for a rate cut. The question is the rest of the committee. I don't know really ultimately what Chairman Powell is going to do because on the one hand, he said he would be happy to entertain the idea of a cut when he was in Jackson Hole. On the other hand, no, they have numbers that can support doing nothing. And there are several other people on the committee that are not necessarily going to vote for a cut this month. So I think that unfortunately, there's still concern about the economy, no question. But on the other hand, prices aren't going down. October 1st, the budget deficit is going to start increasing because of the various tax measures that were passed earlier this year. And I think that the markets are looking at that and they're also looking at what the Supreme Court does with tariffs. Because if Treasury has to refund all of those payments, that's going to add to the amount of financing burden that the Treasury has to deal with. See, one of the things people need to remember is that the Treasury right now is building up their cash balance to something around $800 billion. And the movement of cash in and out of the Treasury when they make payments, when they raise taxes, all the rest of it, is an increasing factor in the financial markets. The government is the largest borrower in the US bond market now. And that tends to color the movements of the market very much. 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Can you elaborate a bit more? Because that sounds like that's going to be really, really important to pay attention to. How do you kind of see that one playing out, the Supreme Court decision on tariffs? Well, we don't know. If the court follows the logic of the lower courts, which I think is correct, then they're going to conclude that the president doesn't really have authority in current law to impose the tariffs that he has, in fact, been imposing. Will the Supreme Court somehow figure this out and leave this all undisturbed? I don't know. It's a lot of politics here because the court essentially could force the Treasury to refund all of those tariffs, and it's a fairly big number. And that would probably put them in a bit of a bind then, I imagine. They got to go out and raise the money. So that would mean that the financing needs for Treasury would be even higher than they already are, given the different things in the big, beautiful bill, right? We're going to be increasing the monthly deficit by something like 50% versus current law today. So that's a big number. And I think we are getting to the stage where I think a lot of professional investors are assuming that we're going to have some sort of a crisis in the Treasury market, and that's going to impact the entire economy. So when you see smart people who run money going to a risk-off posture, even going short, what they're telling you is they expect something untoward to happen. And so far, we've been relatively lucky this year, if you think about it. The market sold off in April with Liberation Day, but then they came roaring back. The managers want to be fully invested. And let's face it, this market is more than half passive strategies. Passive strategies are biased towards a long position. So when you put all that together, if you get a negative surprise, it's going to have a very sharp impact on market valuations, at least in the short term. And you could see another sell-off a la April. Would I call that a buying opportunity? Probably. Because that's the manic nature of this market right now, Julia. Julia Morrison Yeah, that's a good point. I want to point out, again, I take it you probably read Treasury Secretary's op-ed in the Wall Street Journal where he calls out, the Fed's reckless gain-of-function experiments have fueled inflation, crush working Americans, and put its independence at risk. It's time to restore accountability at the Fed and for it to return to simple proven tools. What was your take on the Treasury Secretary's op-ed? David Morgan He's criticizing Ben Bernanke and also Janet Yellen pretty directly. You could throw Jerome Powell in there too. What he's saying is that the Fed's decision to use what we call quantitative easing, which means they go out and buy a lot of Treasury bonds, was indeed reckless. And I agree with him. The Fed has always been a progressive New Deal institution going back to the 1930s. And I think that, unfortunately, the mission creep that we've seen at the board, the tendency to operate like a Soviet-style economic planning agency, which is not in their mandate. Their mandate is to adjust interest rates, adjust policy, to maximize employment and minimize inflation. Well, they do a lot more than that. The board staff is a very, very aggressive and, I think, largely arrogant group of people in Washington who think that they are beyond the law. They figure that members of Congress are too stupid to realize what they're doing, so they're going to do it for them. And I think that a lot of conservatives would like to see the Fed's wings trimmed rather severely. And that has both good and bad implications, Julia. Let me give you an example. There are a lot of conservatives who don't want to see the Fed pay interest on reserves. Judy Shelton, Ted Cruz, there's a whole bunch of them, right? And I think I understand where they're coming from, but if you do that, the Treasury market's going to collapse. You see a similar tendency over in the UK right now. This legislation to basically impose a tax on banks to claw back what they earn on reserves from the Bank of England. This is disastrous thinking, but it's the kind of thinking that occurs when politicians don't have any easy options to raise spending, and they're facing a population, both in the US and the UK, that is clamoring for more spending. So when they're out looking for money, the first thing they see is, oh my god, you know, we're paying interest on reserves to private banks who are somehow, you know, ripping off the taxpayer, right? No. If the Fed doesn't equalize the yield on reserves and T-bills and everything else in the US money markets, guess what happens? They stop working. You know, you can't have the Fed at zero, money market funds paying whatever, and then T-bill rates, and it's not going to work. The entire thing is going to become imbalanced, and it's going to capsize. And capsize is a bad word, Julia. Yeah, yeah. We don't want to have capsizing in US treasury in the same sense. So I take it the risk for you, or the big risk or worry, is in the treasury market. Can you elaborate a bit more, like, what that would look like, how something like that could play out, why that's so worrisome? Well, treasury has to go out and raise more money. That's the net net of the big beautiful bill. And if we also have unanticipated expenses, like repaying tariffs, or if we were to see legislation in Congress to take away the Fed's ability to pay interest on reserves, these are rather calamitous events, and we want to avoid that. Unfortunately, the level of knowledge and familiarity that most politicians have with finance and economics generally is minimal. These are third graders in relative terms. So when they get an idea, if it sounds good, then they run with it. Classic example, this was when Congress decided to tax mortgages in the United States to make up for spending, right? So they take 10 basis points off the top from the income that Fannie Mae and Freddie Mac get. Well, if we're going to release them from conservatorship, eventually they would like to have that money back. Otherwise, they're going to have to change their business model. But the last thing Congress is going to do is reverse a tax like that, because they need the money. Our government is so pressed financially that they're doing dumber and dumber things to make it work. And that, to me, is the big risk when you talk about the treasury market. Yeah, like they can't afford to do it now because they're in such a pickle because of their financial or fiscal picture. Yeah, well, look, we're at the end of a long run where Congress thought they could do whatever they wanted. They thought they could legislate economic outcomes. And you and I both know that that's not really possible. But in the strange world of Washington, it all makes sense. Real quick, the Fed meeting coming up, if they cut rates, is that a mistake or is that a good thing? I think it's neither. To be honest, a quarter point cut, in my view, would be a good thing for the street. It'll take a little bit of pressure off the short end of the yield curve. If they were to do one or two this year and then sit and let it be, then I think we would be OK. But if you start signaling to the market, so you have an economy that's got a problem, in other words, if they did a half point and the members of the committee were willing to go out in public and defend that decision, then that would say to everybody that the U.S. economy is slowing and that we're in a risk of a recession. I'm not sure that's the message you want to deliver right now, Julia. I think a quarter point now, maybe a quarter point in December, I think would be fine. I think the markets would probably rally on that. But you're not going to help the long end. See, what they're really worried about is things like mortgages, things like corporate debt, refinancing a lot of private equity companies, for example, that have been unable to come to market. There's a huge amount of detritus out there that is causing problems for the banks, but they are keeping it under wraps. You know, we have more forbearance now and more obfuscation in terms of credit than we've had in 25 years in this country. Most of the numbers you see from the banks have been doctored rather heavily because they're trying to pretend that they don't have a problem. The consumer is still OK, but all the stuff on the commercial side of the ledger is looking pretty ugly right now. That's the pretend and extend. Oh, yeah. Well, you don't want that building in New York City. So if they're in default, you extend the loan. The degree of forbearance in commercial real estate right now is staggering. It's a big number. How about on the consumer side? Do you really think that it's OK? If you look at the banks, the default rates for most consumer loans were falling in the second quarter. If you look generally, you know, credit card defaults broadly outside of the banking industry really taking in everybody. Still pretty, pretty mild. However, let me say this. We are coming up on a reset in housing. It may not happen for another couple of years, but that's going to change the tenor of things, I think, rather dramatically when the cost of default becomes real and you start seeing banks and even Fannie Mae and Freddie Mac having to deal with that cost in a way we haven't had to. You know, when the Fed goosed housing prices by buying all those Treasury bonds and putting interest rates at zero for years, they distorted the credit metrics that we normally look at. So we don't really know. Now, we know consumers are having a hard time, but if somebody gets to the point where they can't pay their mortgage, they just sell the house. You don't see the default. And that's the difference today. There's a lot of money on the table that lenders can use to help consumers get out of trouble without actually having them go through a foreclosure. When home prices weaken, that won't be the case anymore. Interesting. So, like, imagine, too, like, that they're probably things that you just don't see because they're maybe not traditional or the traditional way of doing it. No, I mean, look, the industry, banks and non-banks alike, have been able to manage consumer problems in a way that normally you don't. You know, recall going back to COVID in 2020, right? The whole industry suddenly had to finance forbearance for millions of Americans who were told they didn't have to pay their mortgage and they didn't have to pay their rent either, by the way. How did we finance all of this? Low interest rates. But there is a cost. There is a cost. And so as we go back to, quote unquote, normal, that's going to be an interesting process. I think that's one reason President Trump has been so insistent on cutting rates, because he's a real estate guy. He understands what's going on in the background right now. There's an awful lot of unsold inventory out there, Julia. As you know, done by you, you could take your pick of new construction in the Carolinas. But that's the case in Texas. That's the case in Florida. We're already starting to see a buyer's market in Florida, which is usually a telltale for the rest of the country. I'm being patient. I'm waiting, Chris, for the right opportunity. Another topic I wanted to bring up with you is I want to just understand what's been going on with gold, because normally you think of gold as a risk-off asset. It's been going up while even the equity markets have been going up. We've had a lot of central banks buying it. What is going on in gold? I think the nature of the trade with gold has changed, to your point. People are buying gold because they're worried about the long-term situation with the dollar. They're worried about inflation in the United States. And they also see what's going on around the world, which you and I have been talking about. The gold is now the primary reserve asset in the world. It has displaced the dollar. So for good or ill, President Trump is accelerating the demise of the dollar as the chief reserve currency in the world. He's doing this in a variety of ways. I think some intentional, some not. But bottom line is a lot of countries no longer want to have dollars as their primary reserve asset. We should be concerned about this. OK, explain why you should be concerned. Well, your dollar is going to get cheaper. You're not going to be able to go to Europe on holiday anymore. You're going to have to stay home. We haven't seen this in the United States in 50 years. We haven't had a real currency crisis. I think the dollar is going to go a lot lower, and it should. Do you think the dollar will no longer be the global reserve currency then? I think it will be one of many currencies. We're going to have to compete with other currencies. Instead of being the default that everyone just used, the only thing that is slowing this process is our marketplace. We have the ability to finance stuff. We have a very dynamic growing economy, despite all the nonsense going on with the treasury. So when you talk about alternatives to the dollar, there aren't any. The world's going to have to develop them. You saw that meeting with Xi Jinping and all the other wonderful democratic leaders that are part of the BRICS movement. They're all looking for an alternative, but none of these countries have the kind of depth in terms of the domestic marketplace, but the bond market and the equity market that the U.S. has. So for a little while, the superior quality, the openness of our economy is going to help us. But ultimately, people are going to look at the debt, and they're going to realize that the only way out is inflation. And the U.S. Congress, the Fed, all of them are going to have to basically embrace inflation to avoid default. Because let's think about it. If we wind the clock back to Abraham Lincoln in the Civil War, if Abe Lincoln was looking at this big pile of debt that we have, what would he do? He would turn it all into currency. I wrote about this in my book. I think that's ultimately what's going to happen. The central bank in the U.S. is going to have to monetize the debt. And what that means is that you grow the currency in the country, inflation goes up, real estate prices are going to soar, you know, the rest of it. Not quite Argentina, but it's getting there. So that's why all roads are going to lead to inflation. On the global reserve currency, when you have that status, I know it's a privilege to have that status, but I imagine it's also a bit of a burden to have that status too. Oh, it's a terrible burden. You know, initially we thought it was just going to require us to run large external deficits, which it does. But what we've seen more recently is it has a domestic inflationary component too. Because if you're constantly growing the currency, guess what? People are chasing assets. That's why you see the price action in real estate. High-end homes are still going up, Julia. It makes no sense because you know that these prices are going to compress. But it doesn't matter. There's so many people chasing high-quality real estate, other assets, that the prices have been going to the moon. That to me is a sign that we're, I laugh sometimes at how funny it is. You know, they say that history doesn't repeat, but it often rhymes. The great Mark Twain quote. Well, that's what we're seeing in real estate in this country. It might as well be 1924. Because if you looked a century ago at Florida, people were buying little pieces of real estate on a speculative basis. We're almost in that sort of situation now. So I think that we got to be very cautious going into the rest of this year, simply because there's a lot of built-up issues and pressures that we have not dealt with yet. Yeah, it's a good point. A repeat of the mid-1920s, if you will. So maybe I should be patient then. Well, be patient, but be opportunistic. If we get another sell-off in this market, particularly the large caps that I follow, the financials, I'm probably going to go in and buy them again. You know, when I saw American Express at five times book, it's normally at seven. That was a buy signal for me. And I had a couple of other good runs. I had been in an NVIDIA for a long time. But think about that stock. The AI hype, all the rest of it, right? Is it normal for a stock like that to go up 50% in less than 12 months? No. No, take your gains. It's momentum. So we are still very much in a momentum market. The economy is still running very hot. If you look around the country, there are a lot of markets that are quite overbeating. We're just going to have to see how it plays out. Yeah. I just wonder, how is it going to possibly be sustainable, Chris? When you're talking about if everything leads to inflation, chasing those assets, the real estate, at some point, does the math even work out? Because I, in many ways, feel iced out of the housing market. Well, yes. But look, I think we're going to see a blow off that's going to take home prices back down to 20 or maybe 21 levels. That's a significant reduction in price. It won't be like the 70s and the 80s when you had Paul Volcker whacking away at inflation. He deliberately forced home prices down. The Fed can't do that now. Politically, it would be untenable. But I think the markets can do that and surprise the hell out of everybody. Because really, Americans are not used to deflation. We haven't had a strong deflation in this country since 2008. And the Fed and the other parts of our government have tried very hard to avoid that again. But they may not have the power to resist it. You may simply need to have a flushing out of speculative excesses. And that could be a great opportunity for you, Julia. Go out and buy that little dream home. Yeah. Could be a healthy thing. You know, Chris, I have to say, I always enjoy our conversations. I want to let folks know, Chris is going to be joining me in studio in New York City after the Federal Reserve meeting. So we'll do a weekend special for you all. That will be a really fun one. Chris, again, we always, always enjoy you coming on this program every single month. I want to thank you for being so generous with your time, all of your knowledge, your wisdom, helping us all learn and get better. I always learn from you. So Chris Whalen, chairman of Whalen Global Advisors, author of the Institutional Risk Analyst blog, and author of the book Inflated, Money, Debt, and the American Dream. I will link it in the show notes. Go pick up your copy or download your audiobook. Really appreciate you, Chris. See you soon. My pleasure, Julia. Have a great day.