Bruce Norris is joined this week by Eric Janszen. Eric has over 20 years of experience as a product management sales executive in the high technology industry. He was CEO of two venture-backed companies, managing director of a seed stage investment firm that enjoyed six liquidity events including two IPOs and four sales to Cisco, Microsoft, Nortel, and EMC. He founded iTulip.com in 1998 and is the president of iTulip, Inc. since 2006. Eric authored the book The Post Catastrophe Economy in 2010. He speaks at a wide range of investor conferences from MIT and Stanford to hard assets New York City and Vegas.
Since the book in 2010, Bruce wondered how the last five years have played out differently than he thought they might. Eric said they have not been terribly different. He does think that the central banks have become more active than he thought. Before the crisis, he was one of the people who thought we were going to have some kind of crash. There were two sides to this thinking: a deflationist side and an inflationist side. His view was always that we were not going to have a prolonged period of deflation and that the economy after the crash would be deflated. He proposed that the Fed would do a lot of unorthodox things to cause this to happen, but even he underestimated the extent to which they were willing to cross the line into an area of market activism that would turn out to be imprudent.
It seems like we have made progress. If you look at some charts you see how unemployment has improved, asset prices and improved, etc. The question whether the progress is real or if we just delayed something that was inevitable. Eric said the question everyone is asking is if the economy is running on stimulus or if it is running on its own fuel. Did the private sector improve enough that it is self-sustaining, and will this begin to draw stimulus? The evidence that they can comes in the form of the withdrawal of fiscal stimulus long ago if you look at the way that years ago there were concerns about budget deficits. You do not hear about this much anymore since they have been declining very quickly as the economy grows. There is evidence that the Fed’s tapering may actually achieve the objective of meeting the economic growth somewhere in the middle of the year and let the reinforcing growth of the private sector take over from where the monetary stimulus left off.
What is interesting was there almost a reaction to a rumor that they were going to taper. Bruce remembered when ten-year T-bills shot to three plus, maybe 3 ¼, and today it is 1.98. Bruce wondered if this is a statement that the economy is really less than it appears. Eric referred to yield shape curving and other phrases the Fed uses as bond price-fixing, which effectively is what it is. The Fed’s were restrictive to only modifying the value of the short end of the yield curve, six months of treasuries, and six months of government notes. This is all they are allowed to use, but now they have been buying. The trouble is that it is very difficult for the bond market to understand what the actual price of a bond is because supply and demand has been perturbed by the Fed involvement. Every time they do something, the market would necessarily go through a period of dislocation as it tries to figure out what the real supply and demand dynamic is within the bond market without the participation of the central bank, whose balance sheet is, in theory, “infinite.”
When Bruce first got into the real estate business in 1981, the Fed fund rate changed 21 times that year, both up and down. Now it has not changed in six years. Bruce thinks there is a lot of complacency about the lack of volatility, and that at some point will not be the norm. Eric said they have gotten several warnings from Yellen and Greenspan that when the Fed finally raises rates there will clearly be some period of dislocation in the markets, it’s just not understood what it will be. Eric happened to be at a meeting in Boston when Janet Yellen gave a speech back in June 2012. He got to ask her a couple questions in public, and afterwards he got to speak to her for a good ten minutes. Nobody realized at the time she was going to be the next chairman. After a few questions regarding how the Fed would go about making its decisions sometime in the future. Her presentation regarded how sometime this year the Fed will very likely be raising rate and making the decision criteria to go back to rules based versus other decision-making.
He remembered thinking at the time when she put a chart up that showed indications of future rate hikes. Once the Vice Chairman of the Fed puts a chart up there like that, it says you have to do it. Either this or you have to make a strong argument that none of the criteria you put forward then have been met. They know at some level that when they do raise rates, the markets are going to overreact and it could potentially cause problems with the real economy as well. Eric’s theory is they are going to wait to do this until there is a substantial amount of momentum already in the economy to where it already feels like it is behind the curb. You hear a lot of talk about this and pressure about them being too slow to make a decision. This is why they are part of the fear. The concern that they will raise rates in the middle of the year is inaccurate.
Bruce asked what he thinks of the value of the dollar and the ramifications that it has being as strong as it is. Eric described the term “currency war” and how he is not a fan of this concept. He thinks the central banks are extremely cooperative, and he thinks of it more accurately as a merry-go-round where they take turns depreciating currencies in order to stimulate economies. We went first because if the U.S. is in trouble, then everybody is in trouble. We depreciate the dollar heavily back in 2009, and this helped stimulate inflation and export growth. Subsequently it was Japan’s turn, which seemed to work pretty well. They got some inflation going, although they also gave themselves a recession. Now it is Europe’s turn, and you can see that the euro is almost on parity with the dollar now. Sooner or later when they are on their feet, it will be our turn again. He believes a strong dollar will be here for another 6-9 months before it weakens again.
Regarding the price of oil, there are consultants out there who did not think it would drop by half in the next six months. Bruce asked if there was anybody who saw this coming and well as what caused it and if it will be something that will change abruptly and go the other way. Eric did not see this, but one of his iTulip members who was an expert in the energy industry did say in the early part of the year that this was going to happen, although it did happen to a greater extent than what he expected. His argument was that the U.S. assembly overproduced oil and we had a number of reasons, largely political and economic, of going after oil when the price was high. Everybody did this, and it became lucrative after a while. It is not purely a matter of supply and demand; another factor is that others want to reassert their role as a producer, make their case, and keep the price there until they get what they are trying to achieve of lower U.S. production.
The bottom is somewhere between 35 and 40, which is what a lot of the large energy companies are anticipating in their budgeting process. They do not expect it to stay there for more than 6-9 months before it rises again. There is a lot of speculation about the impact this has on the U.S. economy, and it is not good for employment. However, it is quite stimulating to the rest of the economy because it is freeing up disposable income for consumers. Bruce said we have had volatile shifts in years past. One of the first major purchases he made was in Grand Junction, Colorado courtesy of the oil price crash that came around in 1982. This felt like the same reasoning to where we were trying to get oil up and going, and the price fell out of the sky. The close up because it is not profitable, so Bruce wondered if people are trying to curtail production since it is no longer profitable to pursue it. Eric said for those who lived through several cycles and in areas such as Texas, it was very painful. You had rows of unfinished work and foundations in the ground. It was a very long road for recovery back in the ‘80s when that oil price crash occurred. This was engineered by the central bank for the purpose of inflation.
In this case, if you look at the prices of other commodities such as nickel, aluminum, and zinc, you will see these prices are either flat or up for the year. 2014 was a much better year than 2013 when prices were generally down. This is not really a question of commodities, but rather an oil question. In the oil industry, the idea of fracking is being challenged in places like New York but overall seems to be an acceptable means of extracting something that is new. We cannot possibly be the only country that has potential for that. The question is if the long-term supply is likely to grow faster than the demand. Eric said fracking was first invented in the 1930s and later refined in the 1980s. It did not really become economical until the oil price went up to $60-$80. This is when the process of building out and the investment in these products got going. As the price continues to go up, more products are being charged at higher prices. This will all reverse, and those who came in late will be the first ones out since they will have the least economical product.
The difference between this cycle and others is in a conventional oil field if the price crashes and you have to shut it down. You can damage the field and it is bad for long-term production. However, this is not necessarily true in the case of fracking and unconventional extraction. Here you can shut things down, and this improves the long-term viability of the field. The ability to shut this down and bring it back later will considerably ease the pain that a lot of people are expecting, especially those who remember the bad old days. Now the industry is more adaptable and malleable provided it does not drag on for years.
In The Post-Catastrophe Economy, Eric referenced the way we had orchestrated things under a fire economy. Bruce asked if this is still alive and well and how we are still pursuing the future. Eric said the housing industry remains about 20% of GDP, so that real estate portion is still a major part of the economy. It operates differently today than it did before the crisis. Fannie and Freddie bought about 90% of the loans in the secondary market and are now government entities. The structure of the market is different today, and Wall Street will never be what it was. The really positive development he has seen, particularly over the last few years, is in the area of the technology economy.
One of the things he talked about in the book was LED lighting coming down drastically in price and we would start to see a substitution of lighting for incandescent lighting. This in turn would have a pretty big impact on electricity demand. He was just at the local IKEA buying a 60-watt equivalent bulbs for $3 that were more expensive years ago. There are a lot of good things happening on the technology front.
Bruce asked about the manufacturing center and if there is any likelihood we will be regaining some of those entire industries in which we now do nothing. One of the things that has happened, particularly related to the oil and energy industries, is the change in composition. Back in 2004, our top exports were conductors, aircraft, parts for cars, computers, various kinds of industrial machines, among other things. Fast forward ten years, the biggest exports are aircraft, fuel oil, and petroleum products. The big change is we have been shipping more crude oil when before we were shipping more refined products. This was a small part of the export volume that later became a very large part. It is not too surprising that those observing this were not too keen on us becoming the new Saudi Arabia.
Bruce asked Eric what he sees occurring in the next couple years and if he feels comfortable with how things will turn out. Eric said this year will be a kind of boom year. The Fed knows that when it acts there will be problems that could very well induce enough of a contraction in growth that could potentially cause a recession. If you know you are going to take some kind of action that will cause your airplane to lose 10,000 feet in altitude, you do not want to do this from 10,000 feet. You want to do this from 20-30,000 feet. They are going to wait until the economy gets enough altitude before it starts to do anything that could potentially cause a downturn or disproportionate turn in the markets.
Eric’s intent when he wrote his book was his confidence in the future. He made a plan saying we have to remember who we are, we are really brilliant when the chips are down, and we have a lot of things at our disposal including the freedom to be creative. This is the America he wanted to see show up again. Bruce asked if we have implemented this again sufficiently to have a bright future again. Eric said you can go broke here in the U.S. If you look around, we have our share of problems and tend to do things to access, as is what occurred in the stock market and market for mortgage securities. This is one way we get ourselves into trouble. If you look at other countries, such as in Europe and Asia, you still cannot find a country as good at being self-correcting as we are. We are very adaptable and good at adjusting for change. One of our strengths is that we are not sentimental or conservative. We are not trying to stay the way we are, while other countries are devoted to that prospect. This is something he expects to continue to see do well.
Bruce asked Eric if he has any plans for another book. Eric said he is working on a couple projects in the area of start-ups. He does have a couple friends who have been urging him to write a book about China for a while. The reason for this is he believes China is vastly misunderstood by people, so it would be fun to write about this. Most Americans think China is a giant United States full of Chinese people, and this is not the case. It is a completely different kind of animal. In some ways it is very inspiring, and in other ways it is very scary. This is particularly because of the governance structure, which is quite brittle. If things go wrong, it is very difficult to predict what they will do.
If you would like to learn more, check out Eric’s website at www.itulip.com. Here you will find a lot of brilliant commentary from Eric and see he has quite a following of other highly intelligent people.