Show Notes:
Welcome to Episode 12 of Offshoot with Christopher Thornberg from Beacon Economics.
Dr. Thornberg is an uncommon economist. Chris is as much at home with philosophy as the nuts-and-bolts of economics and forecasting. As the Founder of Beacon Economics, Chris is not only one of the few, like Hank Paulson, who called the collapse of the housing market, but also one of the few economists who can call it like it is, and share beliefs rooted in facts rather than opinion.
Chris’ no-nonsense delivery, deep knowledgebase, and genuine good nature shine through in this wide-ranging, fast-paced conversation. Immediately after speaking with him I already wished I could go back and drill further down on several topics by simply asking ‘why?’ a couple more times.
Listen in as Chris explores:
- Big wisdoms. They are worth learning, and relearning.
- Government spending. Every $1.00 of income lost in the COVID downturn was met with $2.60 of government spending.
- A 2005 repeat. The current economic picture looks a lot like ‘05, too much capital is in the system.
- The story. The political narrative is taking over the utility of data and the insight it can provide. It’s important to nail the facts before you guide policy and behavior. You need to get the plot, first.
- Inflation. It’s not going to be 8% going forward, it will be higher. Looking at unit money supply, M2/Nominal GDP, alone, will point to that. 20% more inflation may be needed to balance things out.
- Crypto. A generational Ponzi scheme.
- Government. What is its appropriate role?
- Class divide. How bad it isn’t, now, in the USA.
- Uncertainty. It’s value in a world of social media induced isolation.
- Business Partners. Good ones and their benefits.
- History. Know it. What’s happening now has happening many times in the last 500 to 600 years.
Transcript
Kevin Choquette:
Hello, everyone. Thanks for tuning into the conversation with my guest, Dr. Christopher Thornberg. Christopher is the founder of Beacon Economics which is started in 2006. Under his leadership, the firm has become one of the most respected research organizations in California, serving both public and private sector clients across the United States. Originally from upstate New York, Chris holds a PhD in Business Economics from the Anderson School at UCLA and a BS in business administration from the State University of New York at Buffalo. Typically, I don’t spend a lot of time listening to economists. I might align well with Harry Truman who had famously asked for a one-armed economist who could speak with conviction rather than outlining the conflict between one item, and on the other hand, it’s counter.
Christopher is different. He’s got conviction and he’s not sure about sharing … Excuse me, he’s not shy about sharing his perspective and the basis for his conclusions. He’s also got an uncanny purchase on the nuances of what might be seen as the dark arts of economic forecasting. I’ve heard him speak several times and I always leave the room feeling that I’ve been given a healthy orientation or reorientation to economic reality. And while I do think that underwriting unique real estate transactions each on their own merit is a great way to get through uncertain times, I’m always appreciative of the view from above that someone like Christopher can provide. Chris, I’m very excited to speak with you. Welcome to Offshoot.
Christopher Thornberg:
It’s great to be here.
Kevin Choquette:
Yeah, look, I know you’ve got a lot of opportunity to share your expertise in formal presentations and I think that knowledge is undoubtedly going to come through here, but you’re also an entrepreneur and a remarkable thinker, who I’ve heard offer a lot of no [inaudible 00:01:47] insights to the data, insight that I would say is quite un-economist, if you will. How did a guy like you get into economics and what led you to start Beacon Economics?
Christopher Thornberg:
Interesting question. I guess, going back in time, of course, this all started when I decided to pursue a PhD which was odd. I actually am the second person in my entire extended family to go to college and the first one to go on for a PhD. Everybody thought I was some sort of weird creature who didn’t know why I just didn’t go out and get a job. But for me, I always found the logic, the way of looking at the world, the way of thinking about how the world around us operates, I just found that so intriguing and ended up really pursuing it, again, right through a PhD program.
Now, it’s interesting because as attracted as I was first time seeing it when I got in academia itself, I actually got disenchanted with it. I’ve always thought that the big wisdoms are worth learning and relearning and reapplying, but the world of academia is more about just trying to tear everybody else down, rather than shall we say really educating people as to understanding the world around them. I think, in a lot of ways academia, has become adrift from the needs, if you will, of the economy. And so when I realized I wasn’t going to go through the typical tenure track regime, I ended up back at UCLA working for the UCLA Forecast and that’s really where I started cutting my teeth, if you will, on this almost application of economic understanding, of economic theory and data analytics, really being applied to what I would call the day-to-day questions that everybody needs to be thinking about.
Kevin Choquette:
And so from there, what brought you to fly around flag and strike on the entrepreneurial venture?
Christopher Thornberg:
Well, I think that’s a standard story that a lot of folks … Yes, I think, as my former boss once put it, I think, quite politely, “Well, Chris, shall we say, had a little bit too much of an entrepreneurial streak for UCLA.” In other words, I was out there doing my own thing, and eventually, the school and I just realized that what I was doing, how I was going about doing it wasn’t going to work within their auspices. So at that point in time, we all decided, “Maybe it’s best for Chris to, shall we say, move on to his own endeavors.” So I left UCLA, started Beacon Economics in 2006.
And along the way, again, using the tools that I had learned and the way I’ve learned to think about the world, I made an interesting call. Of course, I was one of the few folks out there when I left UCLA was free to have my own opinions. I said, “Gee, I think real estate’s in a bubble and I think it’s going to burst and I think it’s going to cause a major recession.” Of course, as we know now, that prediction came quite true two years later and a lot of things changed rapidly, both for the economy and for my company.
Kevin Choquette:
Yeah, it’s a somewhat tricky time to launch a business as the entire global economy melts down.
Christopher Thornberg:
Oh, our running joke for a while was that the good news is we call it the recession, the bad news is we called it the recession.
Kevin Choquette:
Exactly.
Christopher Thornberg:
But with that in mind, we ended up working with a number of groups, quite successfully navigated their way through the Great Recession. One of my clients, I was on the board of Paulson & Co. in New York City, he was a famous hedge fund who bet against real estate at the right time and then a bent for the economy at even a better time and ended up making some real insane money, to say the least. So on that end, I definitely, shall we say, came out of that situation better than I went into it from a financial standpoint, but for all the wrong reasons, really due to what I would call the chaos of Wall Street and the snake oil investments they sold a lot of people in that period of time.
Kevin Choquette:
Yeah. And what’s happening in your business now? What are you guys seeing? What’s your typical client profile? What are your challenges? What’s the business look like for you?
Christopher Thornberg:
Well, it’s interesting because the business has completely morphed. At the beginning, it was really what I would call just a personality, a forecast business. I called it REITs, was getting a lot of press time, was flying around the country doing speeches at high-end events, but the company itself was only a few people. We were quite small and it was really wrapped around my work and the work wrapped around the Great Recession, but the funny thing about that kind of business is this, when there’s big calls to make and you’re making those big calls, the press loves you. But if you don’t make those big calls, they ignore you. And of course, about 2011, I felt there weren’t any big calls left to be made. To be honest with you, from 2011 to 2019, most of my forecasts really boiled down to is there’s not much to forecast, things are fine. It’s pretty straightforward where the economy is and where it’s going.
And because of that, that sort of business being on the news, jetting around the country faded away and I started building whatever call a real business. Now, we have 20 people, we continue to expand, we do policy work, impact analysis, development work. I still do the speeches here and there, but now I have more what I would call local clients and we work a lot on local trends. So it’s more of a business business and less of, again, one of these kinds of brand personality things so it’s been fun.
Kevin Choquette:
On the development work, is that large public works kind of infrastructure development or do you also work with local or regional or even national builder developer personalities, real estate actors?
Christopher Thornberg:
Well, you always dance with a real estate crew. You have to. There’s nothing more cyclical than real estate. And so a forecaster, particularly someone who’s gotten it right obviously continues to interact with those folks. But when I say the word development, I’m really talking more about economic development efforts that might happen within some of your local governments, or indeed, within the context of some of these PPPs, public-private partnerships such as well, BEN or the LAEDC, for example, is a classic case of a public-private partnership, which does a lot of economic development work.
So we will work with these folks and help them better understand what’s happening in their economy, better understand where the economy is heading and how to, I think, create local economic strategies that will better increase the average lifestyle, life whatever of the local residents, right? “How do we make the economy work better for them?”
Kevin Choquette:
Like I said at the outset here, I’ve heard you speak a lot, and to a certain extent, I feel like I’m speaking with the oracle. I have a lot of respect for your knowledge and the way that you go about conveying it to people in a way that has impact. It feels like I can just throw a few of these macro-softballs around and let you take a swing at them. I know you’re more than capable, but we just touched on the real estate cycle and I think that would impact the public-private partnerships and advising local governments and all of that, but if we talk about the cycle and where we are in it, I think we got $5 trillion from Congress, we got $4 trillion from the fed, money supply.
I just ran some calcs. I think 29% of the money in circulation as measured by M2 has been created during COVID. And whether you’re talking aggregate cash at banks and investors, there’s 21 trillion and I think you talk about it as excess like off-of-trendline cash, so maybe it’s either 9 or 10 trillion. But clearly, there’s a lot of money around and I wonder what your view of that, [crosstalk 00:11:01].
Christopher Thornberg:
Well, that’s exactly right. Like I said, I made the big call back then and then there were not a lot of big calls to make. And then suddenly, what popped in was, of course, the COVID situation and the world has become very interesting again very quickly. In fact, in a lot of ways, I almost feel like I’ve been transported to 2005, but this time, as opposed to subprime cash driving the economy. It’s just massive amounts of really stimulus provided by the Federal Reserve, provided by the federal government for no good reason. Now, again, we live suddenly yet again in profound times which means I do have to start, if you will, talking loudly the way I did back then. It all boils down to what happened.
Look, what I think about the economy in general, I always like to think of what I would call simple metrics for a complex world. I think there are good ways of thinking about the world and some basic numbers. And for me, having studying these numbers, follow these trends over a long period of time, thinking about how the economy operates, I have been able to, if you will … We have a pretty good sense of where things are going. And it’s funny because go back to that period of time from 2011 to 2019, in that period of time, how much stock market volatility we see? How many recessions have been predicted by economists that never happened?
We heard every time we turned around these dismal stories. In the beginning of 2019, 80% of economists who contribute to The Wall Street Journal said we’re going to have a recession by the end of 2021. Now, not one of these folks was talking about COVID. COVID didn’t exist as far as we do in January of 2019. They were talking about Chinese trade wars that really didn’t mean much or a real estate meltdown that really wasn’t happening. And for me, it was so perplexing, this constant need to be negative, relative to at least what I was seeing in the trend. But then I picked up a book last year, it’s interesting, not to digress from the conversation about the current economy, I will bring us back there in a second if you bear with me.
Kevin Choquette:
Yeah, of course.
Christopher Thornberg:
Yeah, but this book Shiller wrote was called Narrative Economics and he said, “Economist, for the most part, like to think that people are rational, ergo, the data drives the story, know the data, you can ignore the story.” But the reality is, as Schiller puts it, is the story is everything and the story has a life of its own. The idea of Narrative Economics says, “You have to pay attention to what people are saying to themselves because that will in turn drive policy, which will in turn drive the economy.” So we went through this period of time where for the most part, again, as I noted, I didn’t have much to say except for really there’s not much to say and I can’t believe everybody’s freaking out, the pandemic suddenly shows up and it took that narrative, that story, that silliness of an economy in decline when it absolutely wasn’t and it turned into one of the most insane panics I’ve ever seen.
It’s almost comical in the rearview mirror to see what one would have thought otherwise pretty bright economists were saying about the economy. Zandi, who famously called the meltdown, told us that 30% of homeowners were going to stop paying their mortgage because of COVID. We heard from every group that 40 million people could end up being evicted. The UCLA Forecast claimed it was a depression-like crisis. Well, look, there’s no doubt that what happened during the pandemic was tragic. It absolutely was. It was a tragic natural disaster, but if you study the history of natural disasters, you very quickly learn they don’t have long-run economic consequences.
In fact, when the pandemic fades away, economies have typically come roaring back. And so there was no reason to think that as tragic as the situation was that we were going to drop into some long-run business cycle the way we were in post-Great Recession. But that wasn’t heard in these populous times, the story overwhelmed logic, “My industry was overwhelmed by the narrative,” and the net result was one of the most preposterous uses of monetary and fiscal policy one could have imagined. We’re talking $11 trillion, a little less than two-thirds of that in direct fiscal stimulus. Let me give you a context here, a little bit of a number. For every dollar of lost income suffered by Americans over the course of the pandemic, the federal government gave us back $2.60.
Kevin Choquette:
Wow.
Christopher Thornberg:
$2.60 to one replacement rate. Keynes never talked about that. Keynes is spinning in his grave, “What are you doing?” And then of course, on the other side of it, the Federal Reserve, which is supposed to be technocrats, it is now run by politely politicians, economic hacks who don’t seem to understand their job. Jerome Powell put up $4 trillion dollars of quantitative easing. To put this in context, Janet Yellen and Ben Bernanke did $3.5 trillion dollars in quantitative easing during one of the most severe financial crises this nation has ever faced. Jerome Powell did $4 trillion of quantitative easing when there was no financial crisis. There wasn’t even a mild financial crisis, Kevin. There was no financial crisis and he did, fortunately, now is a quantitative easing. It is a punchline, except for the fact that it’s very, very real.
And right now, we live in a time, you can’t look around this economy and not see one sign that doesn’t point to an overheating economy. Unemployment is continuing to fall. It’s way below 4%. Inflation is 8%. Asset prices are going through the roof. The current account deficit is widening dramatically. If I was Mr. Scott, I’d be screaming at Kirk, “Yeah, the engines can’t take any more captain. We got to back off.”
Kevin Choquette:
Yeah, so-
Christopher Thornberg:
And in DC, they continue to wring their hands and talk about a recovery that by the way ended nine months ago. What is wrong with this country? It’s crazy.
Kevin Choquette:
Yeah, so where do we go from here? There are lots of branches on the tree that we’re talking about right now, meaning there are lots of ways to look at what’s going on. We can talk about velocity of money. We can talk about inflation.
Christopher Thornberg:
Let me sum it up, okay? Let me sum it up the best I can. I don’t have a damn clue.
Kevin Choquette:
That’s so good to hear. That’s pretty much exactly where I’ve been.
Christopher Thornberg:
These guys who sit around and say, “Oh, I predict the future. I know there’s going to be a crisis in 2036,” you don’t know nothing, okay? Look, a forecaster can see two years relatively clearly, right? Typically. Look, in 2014, it was about as obvious as it could be, the forecast was 2.4%, plus or minus 2%. That’s it. It was completely boring. Right now, the range of potential outcomes are absolutely enormous. And one of the big reasons they’re enormous is because we have policy people who don’t seem to understand what is happening. The Federal Reserve raised rates a quarter point. You could not have done something more dramatically useless than that, okay? You have to extract trillions of dollars from the economy through quantitative tightening before you’re going to slow down this audit control train, chief.
This little bitty move you’re doing is not going to do anything. The federal government, I would argue the structural deficit is easy $1.2-1.3 trillion right now. I don’t know, it’d be interesting when the fourth quarter numbers are finally released tomorrow for the federal government budget, but at $1.4 trillion, we’re talking a structural GDP of what, 6% of the economy? That’s not sustainable. 8% inflation, that’s not slowing down. The Federal Reserve’s inflation forecast is absolutely preposterous. I know enough about the technical details of forecasting to know that no one in the Federal Reserve is running and honest to God forecasts and providing those numbers. They are filling it in on a spreadsheet according to what Jerome Powell tells them to put in there. It is a complete pipe dream.
So I don’t know when do the [inaudible 00:21:15] markets wake up? When does the Federal Reserve acknowledge what is done? When does the federal deficit become unsustainable? These are trillion dollar questions, and if I truly knew the answer, I’d have a yacht bigger than Putin’s.
Kevin Choquette:
Right. Well, let’s do this one. We’ll take them one at a time. Inflation for a long time, and it wasn’t just the fed, it was a bunch of other, I would say, well-educated and thoughtful people were arguing for transitory inflation. This was a supply chain, supply side-induced price appreciation, and once we clear that up, we should revert back to normal.
Christopher Thornberg:
There’s two things you need for inflation, right? One, you need money. In other words, you need your tender, and two, you need a surge in demand. In other words, you need your spark. Well, look $4 trillion in quantitative easing in the midst of a strong financial market is nothing, but a pure … It just goes straight to M2. M2 grew at a level we’ve never seen. During the course of the Great Recession, and afterwards, Ben Bernanke and Janet Yellen did $3.5 trillion in quantitative easing largely to offset the deflationary effects of the collapse in wealth that was going on. There’s been no collapse and wealth this time, ergo, it’s straight into the money supply. And if you did again simple metrics for a complex world, if you looked at what’s called the unit money supply, which is nothing more complex than the M2 divided by nominal GDP, well, that thing has been incredibly steady for decades. And it now is about 20% above normal.
That says that even after an 8% inflation year, we got to hold probably 20% more inflation to get prices back in line with the amount of money out there. 20%, that’s not [crosstalk 00:23:29].
Kevin Choquette:
Sorry. Explain that one again to me. What’s the numerator/denominator? It’s-
Christopher Thornberg:
Right, right. It’s very simple. It’s M2, that’s the broad money supply divided by nominal GDP. If you will, it is the number of dollars in the system relative to the amount of transactions, nominal-
Kevin Choquette:
It’s the simple fractions, dollars to assets.
Christopher Thornberg:
No, no, no. No, no, no, GDP is a flow, not a stock.
Kevin Choquette:
Fair, fair. Good correction.
Christopher Thornberg:
That is just a flow.
Kevin Choquette:
But it is numerator denominator. And if you’ve got that much sitting on the top-
Christopher Thornberg:
But I like to flow stock. You know enough economics to be dangerous, sir.
Kevin Choquette:
Yes. Yes-
Christopher Thornberg:
That was good. That’s good. That’s good. So it is a flow and so it’s the amount of money, the stock of money relative to flow of economic transactions. And again, that is so crazy out of whack like you’ve never seen before. And what’s interesting is go back to the idea of narratives and norms and social standards. What’s interesting about money supply is it rose pretty steadily from about, I want to say about 1995 through 2019. It was on an upward trajectory. It seemed as if the economy was tolerating more and more money without changes in prices. But then again, most folks would tell you that prices don’t float as freely as your typical micro model would have you believe. People have concepts of fairness and there’s benchmarking and it can actually … Inflation can be constrained just by inflation expectations.
Now, what this all says is, let’s say for the sake of argument that that friction was preventing that increase in money supply up to the pandemic from causing inflation. Well, boom, now, Jerome Powell has just kicked down the door, broken the dam, looped the wheels, whatever you want to say, released the brakes, “Fuummm.” I can say 30% inflation before we get back to normal. Now, again, these are scary numbers. These are the kind of numbers that could cause a lot of problems in our economy. And of course, the only way to deal with it is to Volckerize things. And now for anybody under the age of 50 and probably means, “Well, Volckerize, what the heck is that?” Well, we had a big inflationary period of time in the ’70s and it really culminated in the late ’70s when inflation was in double digits and it more or less pushed Jimmy Carter out of office. It was a central issue in the economy.
And what’s interesting is we voted Jimmy Carter up. If I’m to understand, I believe he was a guy, I could be wrong, but I believe he was the guy who appointed Volcker and Volcker came in and he said, “Okay, we’re going to purchase economy of inflation,” and he did so, only course at the cost of what was at that point in time back-to-back recessions, 1980-1981. The second one was the worst downturn at that point in time in the post-World War II period. Unemployment got into double digits. Before, of course, inflation was conquered and the US got into the roaring ’80s. So could you see a phenomenon like that over the next few years where a big increase in inflation until, of course, the Federal Reserve finally has to come in and stop it? And lo and behold, boom, shoves us right into a downturn. So could that happen over the next few years? Absolutely. Will it? Again, trillion dollar question.
Kevin Choquette:
Boy, there’s a lot there. So interest rates, I get your point, the quarter point movement, it’s laughable, right? The mosh pit is fully rolling and these guys come in, I think they’re going to stop it with one guy or something. If you start talking about the implications of interest rate movements and talk about real estate prices, I understand it from 1975 to 1980, we had interest rates go from 7.5 to 15%, which presumably was at the hands of Volcker.
Christopher Thornberg:
No, no, no, no, no, it’s the hands of the bond market. Volcker and anybody who runs the Federal Reserve has control over the short end of the stick which will eventually drive the long end of the stick to where it needs, where it will ultimately end up.
Kevin Choquette:
Got you.
Christopher Thornberg:
But look, the thing about inflation is very clear, if you don’t get rid of inflation … Interest rates are going up because of inflation and Volcker had to conquer inflation to eventually get them to come back down again. So it’s a mistake to think that somehow rather interest rates won’t go up if you don’t do anything. Eventually, the bond market will respond. At some point in time, someone’s going to say, “Hey, I’m not really cool getting a 2.5% return on a government bond when the inflation rate is 12%. I don’t think I’m going to accept that.” And again, that becomes very painful very quickly for the economy. Look, high interest rates don’t hurt the economy. It’s going from low to high interest rates, that’s the painful part, right?
So yeah, so there’s going to be some reconciliation that’s going to have to take place over the next few years. Again, our Federal Reserve seems tragically lost, despite what I would call, again, just absolute shocking number of data points that suggests they have overdone it. And everybody should be commended on high alert to see how this thing shakes up.
Kevin Choquette:
Where do move? If you’re sitting … I think I really understood and heard what you say. If you’re sitting at 2.4% 10-year treasury and God only knows how many trillions of dollars are parked on that asset and you go, “Well, inflation is 12%,” what asset can they move over to to just pick up the 12% inflation?
Christopher Thornberg:
Well, interestingly enough, this time real estate may actually be a safe haven, right?
Kevin Choquette:
Right.
Christopher Thornberg:
You go back to the last downturn, and of course, that was the center of everything because the hit that time really started from real estate because of all the crazy debt and all the crazy pricing and all the crazy subprime borrowers and it was just an absolute trainwreck. And well, it fell apart. Of course, there was a lot of damage to the housing market specifically. We’ve never seen home prices collapse the way they did. In fact, they almost assuredly overshot on the way down. It was such a bloodbath. Well, this time around … I would argue that I think housing is getting overpriced. I don’t think there’s any doubt about it, but with that in mind, the fundamentals are amazing. It’s a pure cash-driven market right now. It’s amazing.
We’ve seen over the last year, what, a 20% increase in prices in the United States. The outstanding amount of mortgage debt only went up about 8%. And by the way, that 8% is the highest pace of mortgage accumulation in a decade. It’s a remarkably low debt market out there right now. There’s not a lot of debt out there. Most of that that is out there is high-quality stuff, high FICO score borrowers. People are buying homes that they can afford given their incomes and those interest rates they’ve had. So the real [inaudible 00:31:47] people were, of course, making money hand over fist from 2008 to 2012. I’m afraid they’re going to find themselves, shall we say, a little bit high and dry through this particular [crosstalk 00:31:59].
Kevin Choquette:
Which folks were making it in the-
Christopher Thornberg:
The real Mac, sorry that REO folks, the foreclosure.
Kevin Choquette:
Oh, yeah, yeah, yeah. The B2R and REO, the rental and all of that.
Christopher Thornberg:
Well just … Look, and that’s all relatively new. I’m talking about the folks who … Look, there’s always been this REO market. There are bankers and real estate agents and investors who specialize in dealing with foreclosed properties. It’s a part of the business, a necessary part of the business, right? It just is, but that necessary part of the business went ballistic in that last meltdown and a lot of those folks made a ton of money. It’s not going to happen this time.
Kevin Choquette:
Right, I got you. The credit quality is too good. [crosstalk 00:32:48] too low. But look, let’s go back. So let’s say that your hypothesis proves true. The place to go in order to have an inflation-protected asset is into real estate and let’s stipulate that.
Christopher Thornberg:
Well, let’s say real assets in general, right?
Kevin Choquette:
Okay, sure.
Christopher Thornberg:
And as much as it’s a real asset. I’m not sure I consider the stock market to be a real asset anymore, even though functionally it’s supposed to be tied to real investment through corporate ownership. Who the hell knows anymore, right?
Kevin Choquette:
There’s a lot of distortion.
Christopher Thornberg:
Oh, yeah, absolutely.
Kevin Choquette:
But so then let’s … I’ll try to distill it. Let’s just go multifamily as one of the many real assets you could buy and let’s argue-
Christopher Thornberg:
The rents going through the roof right now across this nation.
Kevin Choquette:
Right, right. So rents in San Diego County are up 13% year over year.
Christopher Thornberg:
Oh, yeah, asking rents, asking rents.
Kevin Choquette:
Asking rents. Right, that’s right. Asking rents and the new leases are far more valuable than any of the renewals, but let’s say west of the five San Diego County three-cap, east of the five San Diego County three-and-a-half-cap, that’s a real. That’s across the board today. But if I go into that thinking that interest rates have to move, let’s just say that 10 years today, so we’re saying we’re March 29th, 2022, around 2.4%, I don’t know what movement we had today. And maybe this inflation is up eight and probably understated. Maybe it’s going to go up another 20, maybe even 30% and let’s say that rates have to at some point hit 6 or 7%. So what happens to cap rates? If I bought something at a three-and-a-half-cap and I was borrowing … Rates have moved quite dramatically very recently, but let’s just say I borrowed it 3.4% to buy my three-and-a-half-cap. Maybe I only took 50% LTV. Next guy in has to go borrow at 6%. What happens to the-
Christopher Thornberg:
Listen, listen. A cap rate is the same thing as ask me, “What’s going to happen to the nominal price?” right?
Kevin Choquette:
Yes, exactly.
Christopher Thornberg:
So if you looked at what happened in the 1970s as an example, and again, it’s a long time ago, the data wasn’t as good or harder to get a vision. But from what I’m seeing is nominal property prices just didn’t grow, right? They went flat. The market didn’t melt down. Prices just went flat and you saw a very few transactions. Now rents actually kept up. Rents did okay. If you go back and think about your rents didn’t keep up exactly with inflation, but they kept up a little bit, right? They weren’t that far behind.
So you saw what the rents people paying regarding almost at the pace of inflation, the value of property isn’t going up. So that all suggests the cap rates were indeed heading up, right? They were decompressing. You weren’t getting as much money relative to your flows. Okay, well, listen, if you’ve been in the market for the last four years, functionally speaking, you’ve gotten enough appreciation for the next 14.
Kevin Choquette:
Right.
Christopher Thornberg:
So you probably don’t have a lot to complain about.
Kevin Choquette:
Right, right. So the moral of the story there is you need to be buying for cash flow and not for asset price appreciation.
Christopher Thornberg:
Absolutely. That’s just given, always, always.
Kevin Choquette:
Yeah, well, come on, come on.
Christopher Thornberg:
And by the way, there’s a whole bunch of people in the cryptocurrency world who are about to learn that lesson at some point in time in the hard. Hey, [crosstalk 00:36:41].
Kevin Choquette:
But that crypto doesn’t pay you-
Christopher Thornberg:
It’s a Ponzi scheme. It’s a Ponzi scheme. It’s a Ponzi scheme. By the way, did I mention it’s a Ponzi scheme? It’s one of the most obvious Ponzi schemes in the history of the planet. Apparently, every generation has to learn it the hard way. Okay.
Kevin Choquette:
Okay. Yeah, so look, you’ve called bubbles in the past and what I hear you saying right now is, and I know this is very sound bit-ish which would be more appropriate for perhaps Fox News than having a conversation, but what I hear you saying is there’s a lot of uncertainty and there’s a lot of different paths we can go down and who really knows. Do you think there’s an asset price bubble or-
Christopher Thornberg:
Absolutely. Absolutely. There’s no question there’s an asset price bubble. Absolutely, there is, right? Absolutely. So the only question is, “How big does it get?” See, we’re on that part of the bubble, right? The bubble is now inflating.
Kevin Choquette:
Right.
Christopher Thornberg:
And the question is, “How big until this bubble starts deflating?”
Kevin Choquette:
Right.
Christopher Thornberg:
Trillion dollar question, I don’t know.
Kevin Choquette:
Right. Well, as an astute economist and I’m certainly an investor at some levels, where do you invest today?
Christopher Thornberg:
I’m going long on real estate and I’m getting as much fixed interest rate debt as I can possibly pick up. That’s not so great place to be in this kind of market. A 30-year fixed rate mortgage is a godsend in a market like this.
Kevin Choquette:
I couldn’t agree more. We just locked at 35-year mortgage for a client of ours yesterday. Unfortunately, the rates were considerably higher than they were a year ago when we started the process because it was a HUD loan, but 3.65% for 35 years, I think on year 13, 14 or 15-
Christopher Thornberg:
I think that’s still pretty damn good.
Kevin Choquette:
Probably going to look pretty good, yeah.
Christopher Thornberg:
Yeah, it will. I won’t tell you what our refinance for in July of 2020.
Kevin Choquette:
Yeah, it would have been significantly less. Look, I’ve heard in some of your other presentations, I’m just going to pivot a little bit here, that I don’t know if you coined this term or if it’s something that’s more broadly used, I’ve only heard you say it, miserabilism. The idea that there’s a bit of-
Christopher Thornberg:
Loss of investment.
Kevin Choquette:
Yeah, there’s epidemic of negativity and downward spiral-
Christopher Thornberg:
But it’s funny, I used to use that as a great way of trying to express my frustration with the broader story. It seems so out of line with the data. And then Robert Shiller showed up and goes, “Oh, yeah, I wrote this book,” and, “Oh, okay, that’s what I’m talking about.” Miserabilism is a conversation, is I’m talking about the social narrative, the one that drove this insane degree of X stimulus. We still exist in that world. In fact, that’s what’s … It’s miserablism. It’s that story, that narrative that is driving the populism in both of the parties. You look at Trump and Bernie Sanders, they’re actually not that different from each other. For all their vitriol, they actually don’t sound that different. They’re both just your tried and true populists, who just want to tell everybody that their lives are terrible and it’s everybody else’s fault.
Kevin Choquette:
I think I heard you say at some point, “The news isn’t really a source of information.” That may or may not have come from you, but where do you go for your information and what’s the anecdote for that kind of [crosstalk 00:40:37]?
Christopher Thornberg:
First of all, two things here and I would argue that the problem with news is the headlines, right? There’s a lot of really good stuff in the newspapers, you got to get away from the headlines. The headlines are there to titillate, to startle, to shock, to get you to pay attention, but if you find … Look, there’s a lot of good reporters out there who really do trying to get past that story who try to cut down to the truth. And so you just have to really, I think, be a careful reader and think about where this person is coming from and are they discussing the data and who’s trying to prove what to who. There’s a lot of good stuff out there. I love The Economist. It’s still a great newspaper. Like I said, a lot of the big publications, The Washington Post got some good stuff nowadays, right?
And, yeah, okay, there’s always a bias, there’s always a bent, but if you stay away from the editorial pages, it’s usually pretty obvious what’s going on and you should be able to find the information.
Kevin Choquette:
The general public, if you will, how do they … Well, let’s go into, what were the two social media documentary movies that came out, The Creepy Line and what was the other one that just came out? If we go into that world where everybody’s in their own echo chamber, how does the general public not get a wash in all of this narrative and just lose head from tails?
Christopher Thornberg:
It’s funny, I just saw, I know there’s a weird segue, but I’m a big David Bowie fan. And someone just sent me a clip, he was being interviewed and talking about the internet and it was creepy. He got it immediately in a way I never did. What he said was is that everybody’s going to fall into their own little bubble, their own little world and the narrative is going to go crazy and he’s right. There’s always been conspiracy theories. There’s always been these weird ebbs and flows, but for the most part, because those manias were constrained just by the sheer limits of communication and information, it could never be all that widespread, although here and there dramatically, you think about things like the South Sea bubble and you can see how they change world history.
The internet is creating a situation by which all these little groups find all their little crazy places, and basically, it pushes us towards our own worst instincts, where we look for confirmation, not information where we think we have the answers and we’re only looking for those answers to be agreed with rather than just starting with a basic idea that, “Maybe I don’t know everything, and if I’m openminded and listen to some different opinions and to really focus, if you will, on things that are somewhat objective, that maybe I can pierce through the bubble a little bit.”
But that unfortunately starts with the idea that we all have to be a little bit uncertain and we live in a world that you’re not supposed to be uncertain, right? We live in a world where we’re supposed to respect people’s emotions, “You have to respect my opinion, how I feel. It’s how I feel and you have to respect that.” “No, I don’t because what you’re feeling is complete lunacy.” So it is a funny place where you’re just somehow or other you’re not allowed to tell people, “No, you’re wrong,” because somehow that might hurt their feelings and so we enable this nonsense even further. And yeah, a lot of crazy dangerous stuff goes on. Just look at what happened January 6th and we know how crazy it can get.
Kevin Choquette:
Yeah, yeah. Yeah, look, in hearing you speak, it’s the kind of thing that you just said that I always appreciate because I don’t have … Let me say it in a different way. I’ve had a lot of different people on this show and I asked them about macroeconomics and what they think of the monetary supply. And the most pragmatic amongst them says, “I don’t really care. It’s not that they turn a blind eye to it, but they just choose to focus on the micro, the specific transaction that is in front of them and be done with all of the noise that comes from, if you will, the sector where you operate. The kinds of things you’re saying now, I just don’t hear come from the economists, if you will.
Christopher Thornberg:
Well, the narrative reflects our inner subjective reality, but there are objective economic truths. And one of them is if you increase the money supply, prices will eventually adjust accordingly. And so you’re right, people aren’t paying attention. They’re not that interested. They’re not that concerned. They will be soon enough. It will force itself into their lives one way or the other. I truly believe we are on the edge of a really potentially dangerous cycle. Populism and economic turmoil are dangerous bedfellows. And it just seems like we’re heading that direction quickly. And I don’t see a lot of willingness to confront that in Washington, DC.
Kevin Choquette:
Perfect segue to two things I wanted to bring up. Look, COVID, I have seen make asset holders, even more wealthy across the board. And I think there’s a huge portion of this country that doesn’t candidly care about interest rates because they don’t own anything that’s related to interest rates. And I just spent a weekend down in Mexico and go drive around there and see like, “Okay, here’s the ultra, ultrarich and all these other homes that aren’t even complete in their construction. Not a knock against Mexico, but it concerns me that we’re really moving towards a class divide.
Christopher Thornberg:
Oh, no, no, no, no, no, come on, really?
Kevin Choquette:
No? Got it. Yeah, really?
Christopher Thornberg:
Two-thirds of American families own their own homes, okay? Two thirds, all right? We’re not Mexico. We’re not heading in that direction. Here’s another thing. One of the things that happened during the pandemic because 3 million people retired. What the nations did with labor shortages, the income gains for those in the lowest quartile of earnings are the fastest they’d been in 30 years and significantly faster than everybody else in the labor pool right now.
Kevin Choquette:
There we go.
Christopher Thornberg:
So income inequality is falling. Americans have opportunities like never before. So many of the technological things that have changed our life so profoundly in the last 20 years don’t even come up in the GDP numbers and they all suggest the quality of life has never been better for basically everybody in the United States, even the poor. I remember I used to tell people this story. I would say the iPhone, the modern smartphone was invented, I think, in 2006 or ’07. That was when the first iPhone came out, right? Now, think of that. 90% plus of Americans have smartphones. Nobody doesn’t have a smartphone. And on that smartphone is an infinite amount of entertainment that didn’t exist 20 years ago. An infinite amount of convenience.
Who would have thought of a world where a single mom who … 30% of single moms live in poverty. 20 years ago, a single mom didn’t have a smartphone. She didn’t have the ability to go online and order really well priced baby food and diapers from Mr. Bezos and company or Walmart and have it delivered to their doorstep. This idea that somehow we’re suffering is just nonsensical. And yet, to your point, you went there, right?
Kevin Choquette:
Well, but zoom out to conversation of rents. I’m in the business of pitching capital on pro forma rents for a lot of development projects-
Christopher Thornberg:
Stop right there. Let me ask you a basic question, okay? In the last 10 years, what has happened to the median rent-to-income ratio in the United States?
Kevin Choquette:
I can gather that my answer is wrong.
Christopher Thornberg:
Which is what? What’s your answer?
Kevin Choquette:
My answer would be that the rents have gone up disproportionate to income. Rent is now [crosstalk 00:50:32].
Christopher Thornberg:
Nah, they’ve gone down over the last decade, okay?
Kevin Choquette:
That’s interesting.
Christopher Thornberg:
Now let’s come to California. What’s happened to incredibly expensive California to median rent-to-income ratios over the last decade?
Kevin Choquette:
Median rents to median income, right, okay.
Christopher Thornberg:
I’m just going to go right to the answer, Kevin, it’s falling.
Kevin Choquette:
It’s falling. Yeah, that’s interesting.
Christopher Thornberg:
Now, here we go. Are you ready? What major city in California has the lowest rent-to-income ratio in California?
Kevin Choquette:
This will be fun, San Francisco.
Christopher Thornberg:
Absolutely. Ding, ding, ding, ding, ding.
Kevin Choquette:
Hey, at least I did get one.
Christopher Thornberg:
The most expensive apartment market has the lowest rent-to-income ratio of the major cities in the state. It’s a completely different story than what you hear about in the news. The data is right there for everybody to look at. And by the way, none of this is to say that there aren’t families out there who need a helping hand. There always have been, there always will be, and if we’re human beings, we should do so graciously. But the idea that that population is growing is incorrect.
Kevin Choquette:
Yeah. Well, there you go. So that was question one. Question two, what do you view as the role of government? And I never thought that highly of George W. Bush, but I heard him speak once. His answer was the role of government is to create an ecosystem where capital is willing to take a risk, which I thought was perhaps the most intelligent summary of what government might be about.
Christopher Thornberg:
Yeah, that’s one of his economist speechwriters wrote that for him.
Kevin Choquette:
Yeah, yeah. Totally. So what do you think-
Christopher Thornberg:
Listen, government is the glue that holds us together, let’s just be honest about it, right? Government, we live in an incredibly sophisticated world, gazillions of markets moving at incredible speed by individuals who for the most part are self-centered and greedy. And yet, we all managed to get along pretty damn well because of government. It is the framework by which we interact with each other. They establish the rules that we live under and whether that government is generated in our democratically operated bureaucratic legal systems or whether it was done under the Pharaoh King God with the high priest arbitrating the business disputes as they did in Ancient Egypt, it’s part of living in a complex human society. It’s part of it.
And the idea is … Do I think there should be less government? Sure. I think they should be less interference, but in other places, I think they should interfere more. But what we’re doing here is we’re discussing the fine tuning of the system that, by definition, defines what civilization is.
Kevin Choquette:
Yeah. I like it. Well, look, Christopher, I know you’ve got a busy day ahead of you. I would like to transition at least for a moment over to the more personal side. Thank you for everything you’re sharing here. It’s as expected. I think we could do this three times longer and go deeper and deeper. As an entrepreneur, as a businessman, as a lifelong learner, what daily routines might you have that keep you moving forward? For me, I try to go through a bunch of stuff to get my head right hoping I can have a win on the day and then maybe a longer term win-
Christopher Thornberg:
I will be honest with you that my life has been nothing but a cloud of chaos from my earliest memories. Everybody around me says I’m ADD. I’m bouncing off the walls constantly. I am constantly doing things last minute. I don’t have routines and I revel in that at some level.
Kevin Choquette:
Yeah. Well, a correlation between-
Christopher Thornberg:
But here’s what I do do, I go out of my way to continue to learn. I don’t watch TV. I have glommed onto Audible like nobody’s business and I’ve learned I will find a book I like like Narrative Economics or Homo Deus by Harari which is sheer genius or I read Diplomacy by Kissinger last year and I read all these books twice. I listen to them twice. Because if you’re constantly stretching and reading the wisdom of really, really smart people, it constantly alters and adapts your worldview and that learning process is what’s most important to me. I feel like I’m a smarter person than I was a decade ago and I want to be smarter yet a decade from now. That is my only one and true goal.
Kevin Choquette:
Yup. Do you have any guess how many books you’re able to consume a year? I’m just curious.
Christopher Thornberg:
It’s not a quantity thing. I think if you’re playing the quantity game, you’re missing it. You got to find what I think are really smart books which are hard to find, but they’re out there. And then like I said, you really got to give them a couple of shots. Again, basically, I know that fiction has a value and it’s wonderful, but I really have devolved largely into nonfiction and I’m getting stretched outside of my realm all the time. I love reading history. As a forecaster, you got to be a historian and I don’t me a historian of the 20th century. If you think about the cycle we’re going into today, this has been repeated time after time in the what I would call relatively modern world of last 500-600 years. You have to pay attention to what happened in the past, to truly understand what’s going on today.
Kevin Choquette:
Entrepreneurs, what one or several messages might you have for that band of renegades who’s willing to go out there on their own fruition or swept out the door to make their way and hopefully bring something of value to our society?
Christopher Thornberg:
Two things I would say. First, find a good partner. I had a bad partner and now I have the best partner ever. Find someone who’s different from you that you respect and they respect you. There’s nothing better than to have that person there as your sounding board. It’s hard. It’s probably harder to find a good partner than it is to find a good spouse, but it’s worth the effort I feel. Number two is to learn to take a step back. I think in my company right now I was involved maybe a little too much in what I would call content. And I’m realizing particularly nowadays that I need to be more strategic, I got to be really thinking like a boss and less like, if you will.
One of my very smart researchers who’s out there getting this stuff over the finish line, you have to let go and that, again, I think is going to be hard. But you get some good employees and you learn to trust them. You get a good partner and you learn to trust them and that should allow you to do whatever it was that made you want to do your business in the first place and enjoy that. In the end, that’s all you can ask, right?
Kevin Choquette:
Yeah, agreed. You’ve offered a bunch of these things already, but if you were to take that same sort of mindset and put it towards consumers or dare I say citizens, I always feel like the whole idea of consumers is degrading. Anything out there for just the average American who lives in this place under our nation of laws and navigates what we’re all navigating together?
Christopher Thornberg:
Yeah, well, you really got to take a step back and figure out what makes you happy. I know that sounds trite, but we get so wrapped up in the nonsense we see on the internet and who’s wearing what and who’s driving what and that’s a rat race you’re never going to win. There’s always somebody with a nicer jet plane than you. And in the end, you’re going to leave with what you came with, which is nothing.
Kevin Choquette:
Nothing.
Christopher Thornberg:
Enjoy the ride and stop worrying about the accounting.
Kevin Choquette:
Very good. I think I’ll let you go. I know you’re short on time. I appreciate, Chris, that you took the time to speak with me. Anybody who’s gotten this far, my team tells me to remind you please go ahead and rate the podcast if you’d like it. Chris, I’ll leave with you any closing remarks and if you want to provide any contact or your web [crosstalk 01:00:33].
Christopher Thornberg:
Oh, sure, sure. No, it’s been a pleasure to chat with you. It’s been a lot of fun. Great questions. I appreciate it. beaconecon.com is us. That’s our website. Please take a look. We got all sorts of information about who we are what we do out there. We operate here in Southern California, but we really do work across the west and every once in a while even fly over the Mississippi for stuff. So yeah, if we can ever be of any assistance helping you understand the world just a little bit better, do let us know.
Kevin Choquette:
Great. Thank you, Christopher.
Christopher Thornberg:
Great to be here.
