Episode 21: In
this episode of the Bellarmine on Business podcast, host Jim Ray welcomes back
professors Frank Raymond and Carl Hafele to discuss key economic topics
including inflation, interest rates, stock market valuations, tariffs,
immigration, and the concept of “sea change” in economics. The conversation
delves into the causes of inflation, the current state of the stock market, the
implications of tariffs, and the importance of immigration for economic growth.
The professors share their insights on how these factors interact and shape the
economic landscape, emphasizing the cyclical nature of economic trends and the
potential for significant shifts in the future.
Chapters
00:00
Introduction to the Episode and Guests
03:42
Understanding Inflation and Interest Rates
09:57 Stock
Market Valuations and Economic Outlook
13:46 The
Impact of Tariffs on the Economy
21:15 The
Role of Immigration in Economic Growth
24:50 Sea
Change in Economics and DOGE
Introduction to the Episode and Guests
Jim Ray
Friends, welcome to the launch of a new season of the
Bellarmine on Business podcast sponsored by the Rubel School of Business right
here in Louisville, Kentucky. My name is
Jim Ray. I'm a 2008 Executive MBA graduate at Bellarmine University. I've got a
regional, small business consulting firm here in town. I'm very proud to
welcome back two of my business school professors, and you guys have heard them
before. If you've listened to Episode 3, Episode 16, or Episode 20 of the
podcast, Dr. Frank Raymond and Mr. Carl Hafele. Frank, how are you guy?
Frank Raymond
I'm doing well Jim, thanks for having me here.
Jim Ray
Good. Carl, thanks for your time. We've got your remote from
Florida these days, right?
Carl Hafele
Yes, sir. And it's very nice and warm today.
Jim Ray
I woke up at 17 degrees, so enjoy every bit of it my man.
Let's do this. This is a new season so some people may not have heard some of
the previous episodes. Dr. Raymond would you do me a favor? Would you introduce
yourself give us a little bit of your background?
Frank Raymond
Sure. I'm Frank
Raymond a professor of economics here at Bellarmine in the Rubel School of Business
and I've been here for 25 years. I
taught a few other places before that. My
area of specialty is primarily international growth and development, although
I've written in other areas as well; including resource management and things
like that.
While at Bellarmine I've taught a variety of courses from
macroeconomics to econometrics to development, international trade and finance,
those kinds of things. I served as
Department Chair for the Department of Economics and Finance for 13 years. I
was an Associate Dean for four years and Interim Dean for a year. I was also
the MBA director for about six years.
Jim Ray
Outstanding. And Carl, how about your background guy?
Carl Hafele
Well, Jim, I've been in the investment business now for
about 40 years. My claim the fame was as CEO of National Asset Management that
we eventually sold to Invesco. Currently, we have our own firm, Hafele
Investments, of which my daughter, Nikki, and my son, Michael, are part. Our
distinguishing features are we have stocks for public exposure, hedge funds
from my Wall Street contacts.
We do a lot in the private market, mainly in senior living.
But CFA, Dan Bauer former the Dean of the Ruble School is also was part of Hafele
Investments. I had the privilege of working for Dan and Frank as instructor at
Bellarmine for over 20 years. That's flown by, hasn’t it? And I still teach in
the MBA program. Usually the history of financial crisis. It’s a course I developed and wrote a book
about.
Jim Ray
Absolutely and both of you guys were my professors there, so
I really appreciate that. It's always good to reconnect with you guy. I know we talk offline from time to time, but
it's always good to be in this forum.
For the audience, I want to give you an overview of what we're going to
do today.
We're going to jump into basically a discussion of
macroeconomics and maybe some microeconomics. I'll let Frank to determine which way he goes
with that, but we're going to talk about interest rates right now. We're going
to talk about inflation, some stock market valuations tariffs and some of the
general “sea changes” there. We’ll see
what’s going on in the economy.
We’re also going to include a little bit about DOGE so
you're have to hang around to the very end to get the get the ideas and
perspectives on that one, but with that being said guys, let's jump into the
mix here and just kind of talk about generally where are we and what's going on
with the interest rates and the inflation.
Understanding Inflation and Interest
Rates
Frank Raymond
I'll get us started here. Well, as for inflation, they're
just now coming out with studies that have been completed because the data is
still fresh in terms of what the causes of inflation were. But I mean, just
generally speaking for the audience, in the shorter term, inflation is caused
by either excessive spending or caused by supply shocks, right? Where the price
of things goes up because you just can't get them to market and there's excess
demand for the product. That's it. That's the cause of inflation.
So, in a nutshell, the inflation we experienced the last
four or five years has been primarily due to the COVID-19 supply shocks.
Roughly speaking, 55-60% of the inflation we saw was due to the supply shocks,
which are getting better, right?
And then the other 40-45% was due to the stimuli that took
place during both the Trump administration and the Biden administration. When
you look at the stimuli, break it down, about 60-65% came from the Trump
administration and about 35-40% came from Biden.
Unfortunately, when Biden did it, the inflation didn’t occur
in a very smooth way. Think about two
gears that are kind of locked together. They normally would move but they
haven't moved and there's pressure on them pressure on them. Then all of a sudden something happens and
they just kind of break apart and they start to move again. Well, let’s think
about moving it in terms of prices moving up.
All right, so we had all these pressures and then
essentially Biden’s moves were, the straws that broke camel's back on that
mechanism. And I think that's why you saw the inflation that we got at that
moment.
Now, a lot of people misinterpret inflation. Inflation is
not a single rise in prices. For
instance, people back in the campaign talked about the price of eggs. Well,
that has nothing to do with anything any president did. That has to do with the
avian flu that's knocked out the population of chickens. People throw
assertions around this stuff like it actually has any reality behind it, and it
often doesn't. But inflation is a sustained increase in prices, right?
So, whether it's on the supply side or the demand side, in terms
of supply shocks or aggressive spending, what happens is that eventually the
supply chains go back to normal. Eventually, people kind of have spent the
extra COVID checks that they received and then the increase in prices will
cease. However, prices don't go back to where they were. Carl and I know, Jim,
you're a little young, I don't know, but we certainly remember the inflation in
the 70s.
Carl, did you see prices fall after the inflation of the ‘70s?
I know I didn't. Anyway, so that's this prevailing attitude that prices are
going to fall again. They will in
individual markets depending upon things that are happening like in individual
markets, like the avian flu and the egg market, right? Maybe the opposite
happens and there's a population boom in chickens in two years and all of
sudden now the price of eggs is falling across the board.
One last thing, and I'll let Carl jump in. We actually
separate inflation into two kind of distinct definitions. There's overall
inflation and then there's core inflation, where you take out food and gasoline,
individual market forces tend to cause those to oscillate quite a bit. So, if
you really want to get an idea how general prices are increasing, you look at
core inflation.
The Fed did an admirable job bringing core inflation down up
to this point. But the only way you do it is by letting supply chains get back
to normal and reducing spending. And one way you can reduce spending is to
raise interest rates.
Jim Ray
And Carl, where does that leave us if the next step might be
increasing interest rates?
Carl Hafele
I don't think we're anywhere close on the inflation front to
worry about increasing rates at this point. The trend is still down. We've had
a couple cuts. The Fed dot plots going forward predict several more, smaller
ones over the next several years, but no hurry right now for legitimate good
reasons. The Fed did an admirable job at the end of the day. We got the soft
landing, which never happens.
We've had a 2% growth rate for 20 years. We're two and a
half to three now. It has a lot to do with the wealth effect of the last couple
of years of 20% plus stock market gains. And by the way, we're late in the
cycle and those who are thinking that they want the third year of that, they're
not particularly deserving of a long leash. That's pretty rose colored glasses.
But overall, things are going well and American
exceptionalism is here. As you look at our market cap of America versus world
GDP, it's higher than it's ever been. So, we've done a fabulous job of getting
through a very, very difficult time. With
one exception, we have a lot of debt to show for it.
Stock Market Valuations and Economic
Outlook
Jim Ray
Yeah, looking forward, as you forecast forward and you start
talking about stock market fluctuations or valuations, we've got a lot of
things going right now. I mean, there's
possibility of some military actions and various hot points around the globe. In
just a second we're going to start talking about tariffs. But kind of what do
you see going on as far as the valuations in the stock market? I mean, is it
better to look at it by sector or by the market in general?
Carl Hafele
I'll take that one, Frank. Without a question, you can look
at by sectors, but you have to start at the macro-level, the overall market.
And by the way, valuations here are the worst indicator, predictor of
short-term future market returns.
In the long run, it is the best where you're at. So, I have
to caveat anything I say about valuations, don't run out and sell your
portfolio. But we are at higher levels right now than we were at the beginning
of 2022 where we had a 25% correction. Don't
be surprised about it. Market timing is kind of futile, but don't be expecting
long-range rates of return is defined as five to 10 years of getting the norm
of 10% per year, or even the 12 or 13 we got because the valuation levels are
significantly above long-term norms, right?
Jim Ray
Interesting.
Frank Raymond
Yeah, I mean, it's obviously that's your area of expertise,
Carl. I look at the stock market in terms of long-term. But I will say this is
that right now, you know, people are trying to figure out what the long-term is
going to look like in a lot of policies that are being considered now and were
considered before, as well as the outstanding debt.
It's going to influence profitability of certain companies,
right? Especially companies that are more internationally intertwined. We'll
see how that goes, but I think right now the stock market's just trying to
figure out what's going to happen. So, expectations in the short term really
drive the stock market, and those expectations can change on a daily basis.
Carl Hafele
And they've been very high on the earnings growth, higher
than the normal 7%. We're looking at last year being 10, this year probably
being 10 to 12, primarily propelled by AI. Seeing is believing. I am a doubting Thomas.
Frank Raymond
So Carl, do you think there's any danger of a real bubble
forming?
Carl Hafele
Oh, we're absolutely, we could be in the bubble of
everything. As you know, interest rates
have been going up now for four or five years, not a whole lot, but they have.
The higher the interest rate, the higher your required rate return, the lower
the value of everything. There's no way that the stock market should be trading
at 22 to 24 times earnings at these interest rate levels, which are driven by
inflation levels. So yes, we could have all types of things happen. Never be
surprised by the next storm. It's always just around the corner.
Jim Ray
It's interesting you brought up AI. This is episode 21, but
in episode 22, we're actually going to have some people talking specifically
about AI, which will be kind of interesting. So, I'm looking forward to
recording that episode with everybody.
The Impact of Tariffs on the Economy
Jim Ray
Let's jump into the topic of tariffs. There's a whole bunch of different ideas
about it; a whole bunch of different fact cases that we could discuss. Where do you see it going? What do you see
the real effect of it being? And is it going to work?
Frank, we'll turn it over to you.
Frank Raymond
Well, alright, this is not a subject that there's a lot of
debate over. There's a lot of political debate, but historically, I mean, and
in terms of logic, common sense, and if you want to say theory, fine, you know,
theory is only as good as it mirrors common sense. Tariffs increase prices, and
uncertainty about tariffs will increase prices.
I'll give you an example right now. As soon as it was
announced that these tariffs were going to happen, several businesses that I
know of have increased their inventories. They're buying in advance because
they're afraid the prices are going to go up, right?
A lot of them are looking to, and by the way, what that
does, remember what causes inflation is increases in spend, massive increases
in spending, as well as supply chain issues. Well, here we have a massive
increase in potential spending by firms, but nevertheless, to buy stuff, in
order to hopefully avoid any tariffs should they come through.
Here's the deal is that about 26% of our economy, when you
measure imports and exports against GDP, is tied internationally. Now that's
less than a lot of people think, but it's still pretty hefty, right? So, if you
are going to implement significantly higher tariffs across the board, you're
looking at, let's say 25%. Let's say on balance they're going around, Mexico
and Canada, they're essentially increasing by 25%. But even elsewhere, the
increases may be a smaller percentage increase.
If you're baking a cake, and going back to our egg example
before, but let's say there's a tariff on eggs and it causes the price of eggs
to go up by 25%. Guess what? Your cake's going to be more expensive to bake.
There's no getting around that. Not only that, but if you currently buy your
eggs from China, right?
And it does not necessarily make you or force you to turn
around and buy your eggs from the United States, not if the eggs in the United
States are already really expensive or you can't find them. You're going to go
to Indonesia to buy your eggs. You're going to go to Singapore to buy your
eggs, Thailand to buy your eggs. So, then what do you do? You slap tariffs on
everybody. Well, that's kind of what the threat is now, right? A lot of people
say, well, this is just a negotiating ploy. Okay.
Carl Hafele
So.
Frank Raymond
That's fine, but then you're creating uncertainty for
business and that in of itself, like I started this discussion with, will raise
prices with anticipated buying. I could go on forever on this, I think it's
time for Carl to talk.
Carl Hafele
Excellent Frank, excellent input. To add to what Frank said,
the import and export, 25% of our economy. But when you go to Canada and
Mexico, it's more like two thirds to 75%. So we're sending a message there that
their economy, those economies can't make it. We're using, for the first time,
we're using economic tools for non-economic goals. And the goals are to protect
the borders, shut them down, quit the fentanyl, period. Let’s stop all that.
That's the message there. Therefore, I believe, just like in Germany, they've
produced twice as many BMWs than they can possibly consume. They have to export
them. So, if they don't behave, we'll just, we'll stop it. How many Chevrolets
you see in Germany? None. They put on a $20-25,000 tariff.
The playing fields are not level and there are non-economic
examples like the fentanyl and the immigration system. I'm a big believer these are all temporary.
They're not structural. They won't last long, even though all the, companies on
their earnings calls mention tariffs because as Frank says, it's omnipresent.
And you know, you have to.
I also understand the Laffer curve applies to tariffs also.
In other words, raise rates high enough, you're going to get less revenue. So
this is all going to work its way out, but it's a for-real thing. Let's just
hope it is more temporary in nature than not so.
Frank Raymond
I can tell you what economic theory says about tariffs. Again,
people hear “theory” and it sometimes turns them off, but theory only prevails
if it's mirrored in common sense and if it is supported by data. Otherwise, the
theory ceases to be applicable and relevant and used, or even alluded to.
So, what economic theory says is that there's certainly a
spot where you sort of tit for tat approach on tariffs makes sense. But it
doesn't always make sense in the sense that if we arbitrarily respond by
raising our tariffs to meet the level that say our trading partners have
tariffs on us, that doesn't always help us. Many times it'll hurt us. Right?
It sounds sort good and when people look at, we want to make
sure that equal playing field and all that. I understand that approach. I get
it on a very basic level. It's logical. But it's also rooted mainly in feeling.
And then when you really take a deep dive into it, our particular businesses
and our exports rely on sort of a sense of freedom when it comes to being able
to export goods in a sense of certainty, right? Not a lot of disruptions.
You have to be very, very careful. Now, to what Carl's
talking about with respect to doing it for political reasons, especially
significant political reasons, I have say I agree with that. You just got to be careful because you are
playing with fire. Right? And you can't do it long term.
Carl Hafele
Right. Everyone except the investors understand that. It
blows me away because we're priced for perfection on interest rates, on
earnings, growth and all this. And this could be really something if it becomes
anything more than temporary.
The Role of Immigration in Economic
Growth
Frank Raymond
Hey, since you brought up immigration, and Carl and I
haven't talked about this at all, but I imagine he thinks, I mean, I won't put
words in your mouth, but the idea here is that with immigration, we should have
and could have, and I'll say should have again, fixed this a long time ago. You
just set up basically areas, roughly speaking, all across the southern border
where you have a court in place, a standing circuit court, and you increase the
number of immigration officers on patrol. You increase the holding facilities
for people that are coming in illegally. And it costs a lot of money up front,
but that way you can handle this in an effective, more humane way, in getting
people processed quickly.
They're making this a lot harder than it has to be. On the
other hand, you also have to know most illegal immigrants here flew into the
United States or they came in through the North. They didn't come from the
southern border. So, you need a more comprehensive policy. But even when it
comes to the southern border, this isn't brain surgery. It's a little
expensive, but if it's that important to us, we could have and should have done
it a long time ago.
Jim Ray
You know, and I tend to agree with you on a lot of
that. The idea of setting up additional
courts and kind of expediting some of the approval process, to a point makes
sense. But if my bathtub is overflowing, the first thing I want to do is turn
off the faucet and then deal with the water in the tub. And I think what you're
dealing with is the water in the tub, but we're still continuing the influx.
You got to turn off the water first and then deal with whatever's remaining. At
least the way I look at this situation, that's kind of what's going on. But
yeah, I hear what you're saying about everyone who that was flown in and all of
that.
Frank Raymond
We wouldn't have an overflow if we had done something about
this 20-30 years ago, right?
Jim Ray
Yeah, but what's the number? We still take in roughly a
million legal immigrants each year. I mean, that's fairly generous.
Frank Raymond
Well, yeah, we'll see how generous it is. We've got to be careful. We need workers and our birth rate is going
down. So, the only way our population is increasing, which facilitates economic
growth and prosperity for everybody, is through immigration. So, we've got to
have with our country has been built on foundations of many things, including legal
immigration, right? So I think if you're in this country and working, you need
to be here legally so you can pay taxes and help support yourself and the
infrastructure that you're using while you're here. But, you know, I also think
that this has just been used as a political football on both sides. Or it's
been tossed around by people that really don't understand the issue very
well. I hate it when you see something
that could be fixed it should have been fixed not be fixed. I guess that applies to a lot of what is going
on it has been going on in government
Sea Change in Economics and DOGE
Jim Ray
We'll see where it goes over the next few years, I guess.
Guys, let's wrap up today's episode with something that Carl brought up in the
prep session. This theory of sea change, which Carl, you did a nice job of laying
that out, kind of the trends and that cyclical nature of what's going on. And
as we get into that, I think, you one of the things I'm interested in right now
in particular is this cost cutting initiative called DOGE. So Carl, do us a
favor, would you explain what you're talking about when you use that term “sea
change” as it relates to the economy?
Carl Hafele
Yeah. Well, what is a sea change, Jim? As Frank and I
discussed, it's just a big pendulum swing. And there's large pendulum swings
resulting in sea changes only four or five times every hundred years. As you go
back, there was definitely one after Hoover in the Great Depression, in the
‘30s. We had quite a change of way of life all the way up through, including
the World War II that my father served in.
We had another sea change in when in ‘65 when the Great
Society came in with LBJ. That was a significant change. And then we had a lot
of inflation all through the 70s, the misery index, unemployment, lot of things
didn't work. So, what happens when the pendulum swings? We have another sea
change.
Our friend Art Laffer talked to Ronald Reagan into
Reaganomics, which is take tax rates from 70 down to 28 % and lower regulation.
And we had very solid, higher than the 2% longer-term economic growth. We had
much higher economic growth through that. And that went uninterrupted. Sure, we
had a dot com busts in here there, up till 2008. In the words of Rahm Emanuel,
never let a crisis go to waste, because that's how these sea changes happen.
We got Obamonomics in 2008 and we basically accelerated with
COVID. We may never know where that came from or didn't come from, but up till
now, our debt was, as Frank says, it's been going up forever, but the
trajectory line changed significantly in recent years.
You always got to remember people vote with their pocketbooks
the most. We hadn't seen inflation since the ‘70s of any magnitude. When you
got 20% overall, that's understated when you go for food and fill your gas tank
up, pay your insurance bill at 30-50 % higher over a four or five-year period.
That's what we're living with.
People change and they say enough is enough. And that's what
we're seeing. And you mentioned DOGE. DOGE is just a blunt two by six to the
head from the other side that we went through four or five years ago. We went
through massive spending at 25% of GDP and it's supposed to be 20% of GDP.
We talk about the debt, we talk about the deficits. It's a spending problem. You'll never win an
argument with me about that it's a revenue problem. It's a spending problem,
ladies and gentlemen. Some of it's structural, I know, but that doesn't justify
all the stuff that going on. So, we got this change around. That's what DOGE is
going to do. It's going to get ugly before it gets better. That's the only
thing I'll guarantee you. When you get a sea change, there's always pain. I
remember when Reaganomics came in, I remember in ‘82, ‘83, we ran a five and
six percent deficit, as a percentage of GDP.
Is this stuff going to work? I remember saying, oh my Lord,
it better work. And it did fine. And we had 28 years. I had the wind at my back
for 28 years in the investment business. We started in ‘82 at eight times
earnings and now we're 24 times earnings.
You know, put it in perspective. So, I could go on like Frank says
forever on that one, but I'll stop there.
Frank Raymond
Well, I mean, what I want to see is I want to see things
done legally and I want to see things done with efficiency. And I also want to
see Congress start doing their jobs. You know, they've been given power for a
reason and they've abdicated much of that power over the last 20, maybe even 30
years.
But yeah, what they should have done is they should look to
be more efficient. I think the best way to do that is, and certainly the attack
I would take, would be to just cut the budget by 5% and use in the words of
Ronald Reagan, let it trickle down. All right.
Find out where the budget is most bloated and you'll have
politicians and people wanting to keep their jobs and all that, so you want to
think about that as well but you know once you do 5%, you then evaluate and
then come back maybe again at 2.5%. Let
the dust settle on that and evaluate.
But going in, you know, the example I used I don't think
Carl would appreciate it if I said, “Carl you're spending too much money but
I'm an economist. You know I'm no dummy, at least I don't think I am. I'm going
to go in and I'm going to just cut your budget where I think it needs to be
cut.” When I first mentioned it to Carl one night, you could have taken a still
shot of that picture because his face.
Carl Hafele
So sir, sir, can I show you the front door?
Frank Raymond
It was the first time I saw Carl's confidence in me waver in
the last 25 years. In the words of Forrest Gump, that's all I had to say about
that.
Carl Hafele
Very true.
Jim Ray
That's outstanding. I think the theme through this was the
swinging of that pendulum. And yeah, we've been swinging and we're still going
to continue to swing. It's going to be an interesting ride. Grab a seatbelt and
grab a helmet. I think we're going to see what happens. Hopefully, it'll prove
out to the benefit of the country moving forward over the next few years and
beyond.
Guys, that's pretty much it for today. I really appreciate
your insights and perspectives. I mean, you guys have been there on the front
line. You guys have studied this thing. You've lived this thing. You guys have
made living talking about and interpreting these things. And it's really
interesting to get your perspectives. I hope the audience gains some value out
of that discussion that we had today.
I really want to thank both of you all for giving up some of
your time to the podcast today and letting us kick this around. I think,
obviously, we're going to have much more to talk about over the next year or
so. It'll be kind of interesting to see how things shake out for us.
As far as the audience, I really want to thank you for your
time. There's a lot of things you could have done today, but you decided to
give us 30 minutes or so of your time. Hopefully, you found it insightful.
Hopefully, you found it interesting. Maybe you got a little chuckle out of it.
That's always part of the goal here.
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and how they're thinking about things which are affecting all of us out there
today. So, from all of us here at the Bellarmine on Business podcast from the
Rubel School of Business, Swords up and Let's Go Knights.
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