The 25th Annual Milken Institute Global Conference 2022 kicked off live in Beverly Hills on May 1st to 4th. This year, we present a RealClearMarkets exclusive interview with Dr. Komal Sri-Kumar.
Dr. Komal S. Sri-Kumar is President of Sri-Kumar Global Strategies, Inc. He is the former Chief Global Strategist of Trust Company of the West (TCW). He is also a Senior Fellow at the Milken Institute.
I interviewed him on the sidelines of Global Conference. We discussed inflation and monetary policy post 2008, during Covid and post Covid and its influence on inequality, as well as his solutions to income inequality and sustainable growth.
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Altenbach: Dr. Sri-Kumar, it is a pleasure that you join us today.
You were at the Los Angeles-based Trust Company of the West (TCW) from 1990 to 2012, serving for the last several years as the firm’s Chief Global Strategist. `
It is noteworthy to point out that you received your Ph.D. degrees from Columbia University where your doctoral dissertation was supervised by Robert Mundell, Nobel Laureate in Economics (1999).
Sri-Kumar: That's right. It was a great experience and not only was I his student, but I have also been to his Annual Global Symposium, which he held at his Castello outside Siena, Italy, where we gathered with monetary leaders from different parts of the world to talk about the global economy, and global monetary policy.
Sri-Kumar Global Strategies
Altenbach: You left TCW in 2013 and started your own firm Sri-Kumar Global Strategies, Inc. Please tell us about the firm you started in 2013:
Sri-Kumar: It is an independent research firm that focuses on evaluating global country risk and opportunities. Recently, the focus has been very much on the Federal Reserve interest rates and the implications on markets.
But historically my focus has been on emerging markets which were a small part of the global economy when I began in 1979. Now the emerging market GDP is about 60% of the world and is now bigger, collectively, than the developed markets, and thus a much more important part of the global economy than when I started. China and Russia were about the same size in terms of GDP 30 years ago. Now China is eight times the size of Russia.
Milken Institute Research
Altenbach: You are a Senior Fellow of the Milken Institute. I know you focus on fiscal and monetary policy. What other areas of research do you conduct?
Sri-Kumar: Fiscal and monetary policies are of interest. Emerging markets are a key part of the common connection. Yesterday I moderated a panel at the Milken Institute Global Conference dealing with what has happened in the last two years. Leaders from investing firms, plan sponsors and institutional public funds were on the panel which perceived that “We have gone, after a decade of peace and what they call the Goldilocks scenario, to now being in the rapids, being in a storm, first with COVID then with the Russian invasion. And how do people invest in that setup?”
A Letter to the Next President
Altenbach: In September of 2019, you co-authored a Milken Institute report titled, ‘A Letter to the Next President.’ In it you identified the problem of Wealth Effect and outlined solutions which included Education Reform, Tax Reform, and Universal Basic Income to mitigate income inequality and create sustainable growth. I want to share with my readers a very important passage in that document:
"The critique of capitalism is a distraction from a deeper issue. We believe that the fairest and most effective way to accelerate growth and reduce income inequality is to move away from a system that creates incentives for the powerful to profit by avoiding the discipline of markets" - Komal Sri-Kumar and Masood Sohaili (2019)
Wealth Effect and Income Inequality
Altenbach: You identified monetary policy and the resulting "wealth effect" from the post 2008 Great Recession as a major factor of inequality. Could you expand on this "wealth effect" cited in your September 2019 report.
Post 2008 Policy:
Sri-Kumar: Talking about the wealth effect, after the 2008 financial crisis, Ben Bernanke, then the Chairman of the Federal Reserve, essentially said, ‘since interest rates were very low and near zero and they cannot lower the interest rate to a negative level, that he would have the same impact with what has come to be known as quantitative easing or buying bonds from the U.S. Treasury market [and also other types of bonds including MBSs] and giving the market cash in exchange.’
Chairman Bernanke's argument was that all of you have more cash in your hands. Some of which you will spend on goods and services, and you will help create a recovery. Second, you will use some of your cash to go into the stock market, stock prices will go up. All of you will feel wealthier as a result of your stock portfolios going up. So, you will have even more money to spend, and the economic recovery would strengthen.
As we all know, that just did not happen partly because the low-income wage earners do not invest a significant portion of their income in the equity market – nor did low interest rates coerce them to do so. They get their investment income mostly from bank interest which went down dramatically.
The wage earners went down in living standards. If you look at something called a GINI coefficient, which measures the income inequality of countries, the income inequality in the United States worsened significantly between 2008 to 2019.
Altenbach: Could you give us your views of the Fed actions and Government policies during Covid-19 and post Covid-19?
COVID and Post-COVID:
Sri-Kumar: Let's go to COVID and post-COVID, and it's the same thing that is true today. We have a different Fed chairman, Jerome Powell. He learned nothing from the post 2008 experience. Why? In March of 2020, they repeated the 2008 experience, lowered interest rates to near zero. And they were there until March 16th, until just about six weeks ago, they were near zero, now they were raised by 25 basis points. And the next move is going to come tomorrow, where everybody expects 50 basis points further increase [Update: 50 basis point increase was announced on May 4].
Sri-Kumar: On the other hand, and this is the big difference from 2008, the fiscal policy jumped in. The first two years following President Obama’s election brought in a Democratic Congressional majority but starting January 2011 the Republicans regained the House and for the remainder of Obama’s term he was unable to get a Republican House to support his spending measures. Therefore, Ben Bernanke said, "If fiscal policy is not stimulative, then the Federal Reserve, has to be stimulative."
The difference with post-COVID is the fact that while the Fed repeated the mistake of 2008, 2009, the fiscal policy became enormously expansionary. We had $900 billion spent in the final weeks of the Trump administration. We had $1.9 trillion that the Biden administration quickly got permission for and started spending. And they wanted another $2 to $3 trillion dollars. What happened? Inflation shot up and Jerome Powell kept saying that inflation is transitory (by this Powell meant temporary).
Powell thought that the inflation was due to supply bottlenecks that would automatically go away. To help the unemployed he increased the money supply to finance benefits. This increased the crisis because more cash in peoples' hands boosted inflation and people were less willing to work.
I said over a year ago in my weekend pieces called SriKonomics that Powell and the Fed are totally wrong. This inflation is not transitory (temporary). It's going to be sustained. It's going to stay at a high-level fed by the fact that the Fed balance sheet continues to increase, and it kept increasing into 2022, even after the recovery had started.
Additionally, “The poor and the low- income groups suffer the most from inflation.” The rich own assets, often indexed to inflation.” E.g., equity and home prices go up along with inflation.
But wages don’t keep up with inflation, causing real wages to fall.
Education Reform
Sri-Kumar: A key point in the Milken report was that to increase the growth rate you need technological changes, you need skilled labor to come in, and you need to train your existing employees to accept jobs which are in demand. For example, “unexpectedly 11.5 million jobs are available. This is the latest number from the Labor Department. You have 11.5 million jobs, which employers are offering and there is nobody to take them.”
“There is nobody to take them because they don't have the skill to accept those jobs. The point is, the Fed starting with Bernanke, quintupled the balance sheet of the Fed, from $800 billion on the day Lehman bankrupted, on Labor Day 2008, to $4 trillion just before COVID began in early 2020. If you were a plumber to begin with, after the money supply is tripled, you don't become a nuclear physicist. You're still a plumber.”
To change you from being a plumber to becoming a nuclear physicist – a skill in demand -- you need to be well educated, and you get the necessary skills and training.
Altenbach: In “A Letter to the Next President,” you talked about education reform similar to the vocational training in Germany, Post Reunification. That's like an apprenticeship, right?
Sri-Kumar: Correct. An apprenticeship program was put in effect in Germany in the 2003–2005 time frame.
The reason Germany was in that shape was because, like the United States, fiscal benefits were given to workers. Changes known as Hartz reforms were made in 2003. Those reforms said if you are earning €100, and if you agree to lower your wages to say €60, the government will spend another €20 for your training, and they will give another €20 to your employer.
Your employer is happy to hire you because they get the subsidy from the government. Your education is paid for. You must spend your evenings going and getting yourself trained as an apprentice, as a carpenter, or a welder. By the time your apprenticeship is finished with your employer, that employer is very happy with you because you are already trained, and they are ready to hire you.
And the unemployment rate in Germany went down dramatically, and it was the pride and joy of the Germans and why the German unemployment rate has consistently stayed lower than that in France, Italy, or Spain, for example.
Altenbach: I think the culture's different in the U.S. They're going to have a problem getting young people to sign up for that, because we are obsessed with college.
Sri-Kumar: You're absolutely correct. That mentality has to change. But the culture of young employees continues to be that way.
And then there is the issue of student debt. We wrote in a Milken Review, that “student debt has ballooned to $2 trillion of total debt. They are petitioning President Biden to cancel the debt. And the reason why they were all bid up was they were getting education in skills which were not employable.”
Universal Basic Income (UBI)
Sri-Kumar: If the young were to NOT learn ancient Greek history e.g. – where there are not too many jobs available - but instead, had trained to become a welder, or a carpenter, where there are jobs available, then they can go and improve their skills and do something even better.
That's why we recommended the Universal Basic Income (UBI), which is part of the suggestions.
The exact dollar amount of UBI needs to account for inflation, but “let's say that every adult will be given $10,000. It will not be considered a handout, because it is given to everybody.
What does that do? If I go to my employer and the employer will not give me a wage increase, it gives me the strength to say, "That's okay. I get $10,000 a year. I'm going to use that for my education, train better. I don't have to accept your low wages. I'm going to go and accept higher wages elsewhere."
Tax Reform:
Altenbach: You want to abolish corporate income tax as proposed by Milton Friedman and tax shareholders like partnerships. You would tax capital gains the same as ordinary income.
Sri-Kumar: Exactly. There has been so much abuse of the privilege of income coming from capital gains that the way to remove it is by taxing it the same way as ordinary income without increasing the tax rate. If you remove those loopholes, the expectation is that the total tax revenue for the government will increase.
“You can't blame the capital system for that, you have to blame the tax arrangements and that has to be changed.”
Altenbach: Would shareholders have unfunded liabilities under that proposal? Would that be based on the look-through earnings?
Sri-Kumar: Yes, it would be based on the look-through earnings. Shareholders would NOT have unfunded liabilities. Rather than tax the income at a corporate level, you let the thing flow through to the shareholders and they in turn can be charged.
Altenbach: If the corporate income tax is abolished, that would increase the growth in retained earnings. And wouldn't that be a push for faster economic growth?
Sri-Kumar: Yes, it would be a push for faster growth. If you were to reduce the corporate tax, this increases the amount of cash in the hands of corporations. Either they would be giving it away as dividends to the shareholders, or they would invest it in capital goods and equipment. If the companies invest it, that is boosting productive power. If they give it away as dividends to shareholders, they can spend it, and the aggregate demand increases.
A Disciplinary Mechanism for the Fed:
Altenbach: Would going back to a gold standard – or other hard asset backed standard - add value to restoring a free and fair market and re-establishing a stable store of value?
Sri-Kumar: Yeah. Gold standard would be one form of discipline. However, it has the shortcoming that is gold does not move in line with the necessities of the global economy. And it depends on the availability of gold, how much is being mined and how much is being sold by the private sector. For instance, people in France and India are two countries which have a huge private hold of gold in the world. If they decide to buy or sell gold, it usually increases or decreases the price of gold significantly.
The same holds true for any hard asset-based currency system such as oil, copper, semiprecious metals, and even industrial metals. So, that might be an issue.
Taylor Rule:
Sri-Kumar: Which is why in a recent SriKonomics piece, I wrote saying, "You need a monetary discipline, such as the Taylor rule." John Taylor is a professor at Stanford University. And what Professor Taylor advocated was to have a policy that responds when growth is below your target or inflation is above your target. Fed can change the interest rate accordingly.
However, NOT needed are forecasts of where inflation is going to be and make a wrong forecast, like Powell has done. Instead, depend on the latest data and a computer will move the interest rate up or down based on that. All nine voters on the Federal Open Markets Committee can stay home!
Current economic views: Stagflation?
Altenbach: Can you tell us about your views on the economy?
Sri-Kumar: “We are going toward stagflation. Stagflation is a situation when inflation remains high and you're also in a recession. We last had stagflation from 1979 to 1981. Jimmy Carter was President, and we had a hapless Chairman of the Federal Reserve named G. William Miller who was nominated chairman in 1978. He increased the money supply, which reduces the interest rates. And if inflation is up, he thought you should increase the money supply even more!”
President Carter removed him but only by kicking him upstairs to become Treasury Secretary. “Paul Volcker came in as Chairman and he was called the ‘Inflation Slayer.’ He pushed the federal funds rate up so that the mortgage rate surged to the 20% level. So, you could not buy a house. You could not get a car loan. Your expenses were cut back. Unemployment rate went up, but inflation came down and stagflation ended through this painful process. Now, today we are proceeding toward the same setup.”
Altenbach: What investments strategies are viable in stagflation?
Sri-Kumar: Bonds and equities are both losers in a stagflation. Investors can buy short three-month, six-month Treasury Bills, gold, or commodities. Also, medium term investments like a globally diversified real estate investment for instance. But there are few avenues for you to hide in a stagflation which is why it's very much more difficult to slay than having only inflation or only recession.
Altenbach: Do you think weakness in the USD has been an underreported factor in the past year in public discussions of inflation?
Sri-Kumar: I don't believe so. In fact, the dollar is near record strength right now, the DXY dollar index is near 103, and we were at about 95 for the index level about a year ago. The dollar has strengthened a lot, and the reason for that it's a safe haven during COVID. Due to the Russia-Ukraine War, foreigners, Europeans, Asians, and Latin Americans are putting their money in the US dollar.
Even though the US monetary policy is erroneous, you can get away with it because there is no other alternative to the US dollar. Two years ago, we thought that the Chinese Renminbi can move toward the status, but China, if anything has tightened capital controls.
Altenbach: More recently some commentators have questioned whether the US Dollar might lose its Global Reserve Currency status. However, with the Renminbi, you have currency controls. And the language of China is not the language of the international trade – English is. The rule of law is not respected like it is in the West. China does not have deep international and domestic markets for their sovereign debt. Those were other issues I had with the argument over the Chinese being ready to replace us, but economically and militarily, they are on par with us. Your views?
Sri-Kumar: “Absolutely. You said it all correctly. Those are all the various issues that they have on the currency side and the control side that preclude they're taking over the dollar anytime soon. Regarding the dollar you have the best house in an overall bad neighborhood.”
Sri-Kumar agrees that if the dollar ever lost its reserve currency status, the U.S. would lose the International Seigniorage from having foreigners hold on to the US dollar. Consequently, oil and commodities would be traded in another currency -e.g., Euro - which would cost Americans even more for fuel. “It would not only be a loss of prestige for the U.S., it would also be a significant loss of purchasing power for American consumers.”
Altenbach: Okay. It's been a pleasure
Sr-Kumar: Thank you.
