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What's up everybody?
My guest today is Dr. William White.
He is a veteran journeyman of the central
banking world.
He is a Canadian economist who began his career
as an economist at the Bank of England, the
central bank of the United Kingdom.
He was also at the Bank of International Settlements.
In fact, he had the job that my recent guest,
Claudio Borio now has as Head of the Monetary
and Economic Department at the BIS.
He was also Deputy Governor at the Bank of
Canada, and he was Chairman of the Economic
and Development Review Committee at the Organization
for Economic Cooperation and Development,
the OECD from 2009 to 2018.
So, he's been around.
He's seen a lot.
He's someone that I've wanted on the program
for a very long time.
We've been in touch for about a year.
I had been trying to schedule it to do it
in person with him when he would be next in
New York, but it proved difficult, and I just
elected for us to do it remotely.
And I'm glad I did because it was a phenomenal
conversation.
I think the overtime went for about 40 minutes.
I literally just finished the recording now.
We talked about so much.
We talked about a reordering of the global
financial system.
We discussed the way in which the system has
changed since 2008, both on the regulatory
front driven by changes in regulations, but
also non-regulatory changes and how that has
altered this complex dynamic system.
This organism that is the global financial
system.
Before I let you guys have a listen to the
conversation, I want to make an appeal.
I mentioned that the overtime was something
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Overtimes can vary.
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And now, without any further ado, here is
my conversation with economist and former
Deputy Governor of the Bank of Canada, Dr.
William White.
Dr. William White, welcome to Hidden Forces.
Well, it's great to be here.
It is so exciting having you on.
I think we've been in touch for about a year
now.
We were trying to make this happen in person
because you know how much I love doing these
things in person.
But on account of the fact that that has proven
difficult, and because I really wanted to
have you on, we've decided to do it remotely.
Also, for listeners, I'm going to assume that
you have knowledge of our episode with Claudio
Borio, which was recently ... I think that
was episode 99.
I'm going to assume you've listened to that.
If you haven't, I suggest you go back and
listen to it before this episode because it's
going to be very helpful in this conversation.
Dr. White, Bill, as I was saying to you, I've
done an enormous amount of research for this
episode, even more than I normally do.
And I would love to kind of begin with a general
structure to answer the question of, "where
are we today?"
You know, after 10 years of recovery since
the great financial crisis, how has that system,
the financial system, this dynamic organism,
how has it evolved?
How has it changed?
How have regulations changed it?
And what have been perhaps some of the non-regulatory
forces that have acted upon it?
And what are we likely to see going forward?
Not just from the system itself, but let's
say the actions of policy makers.
And we're going to talk about all of that
as we go forward.
I have all those questions.
But I kind of wanted to put that out there.
But maybe you can start us off with where
you think we are today?
Well, insofar as the economy is concerned,
I guess what I'm concerned about is that we're
not really in a very good place.
The problem I think that was underlying the
crisis that broke out in 2008 really was a
problem of excessive debt accumulation that
had been stoked up really by central banks,
an overly expansionary banking system.
Well, since the crisis, the 10 years since,
one might have thought, you know after a ... you
get into these boom bust cycles.
That we went through the boom phase and then
you go through the bust phase.
The former of course, has a big increase in
credit and debt and the rest of it relative
to the size of the economy.
You would have thought in the bust phase that
you then go back into the deleveraging phase,
you know?
So, that the problems that built up during
the boom would be rectified during the bust.
But the very opposite is true.
What has really happened here over the course
of the last 10 years is that global debt ratios,
and by that I mean sort of the sum of government
debt, household debt, and corporate debt,
the ratio of that debt to global GDP is actually
up by 30 or 40 percentage points of GDP.
So, we're way off a process of deleveraging
and restructuring.
In effect, it's been more of the same.
So, if there were problems that emerged in
2008 because of debt and other imbalances
in the global economy, I dare say those problems
are even bigger today than they were then.
So, that's something that sort of bothers
me looking forward.
So, what's the source of those problems?
What was it that led to 2008 and how many
of those forces are still pushing us in a
similar direction, right?
And I'd also wonder what has been done in
the years since to try and change that?
What efforts have been made?
Well, what sort of got us into the situation,
it seemed to me was the confluence of three
good things.
But when you put those three good things together,
they produced a bad thing.
Now, let me expand on that.
The whole period really, sort of 15-20 years
prior to the crisis, was characterized by
a number of very positive supply side shocks.
And what I mean by that, was that the global
capacity of the economy to produce things
went up pretty sharply.
And that was really due to two factors.
I mean, one of them was the demographics,
the baby boomers coming through and the advanced
market economies.
But the other thing was the return to the
global trading system of China, India, and
all those other command and control economies.
So, we had a huge positive supply side shock
that basically drove down prices or increased
disinflationary forces in the economy.
Now, that was a good thing in itself.
But the second thing that happened, was that
the central bankers had really, since the
middle of the 1990s, become more and more
focused on establishing stable prices.
And so, what that meant was that with the
real side changes leading to prices starting
to decline, the central bankers felt that
it was their duty if they were going to maintain
stable prices to lean against that.
Which of course they did by relatively easy
monetary policy.
Then, the third thing that came along was
again, one could say, another sort of good
thing, which was there was deregulation in
the financial system.
There was huge amounts of innovation in the
financial system.
All sorts of new products, new services, new
sources of credit.
And one might have said, "Well that's a good
thing too."
But then, when you put all three of them together,
what you would up with was the disinflationary
forces coming out of the real side led to
the central banks to conduct relatively easy
monetary policies for long periods of time.
They never had to raise rates very much.
And they could lower rates whenever the economy
slowed down because inflation was not a problem.
Well, they did that but then with the sort
of ... the good news in the financial system
that it was becoming more efficient, deregulated,
et cetera, they were prepared in the financial
system to provide the credit, to supply the
credit that was now in high demand because
of the influence of ultra easy monetary policy.
So, when you put these three good things together,
what you would up with was enormous forces
towards increasing credit growth, increasing
debt levels, and basically leading to all
of the other imbalances, which in the end,
both contributed to precipitating the crisis
and leading to it being as deep as it was.
So, this gets you back to sort of something
I'm quite fond of, which is the theory of
complexity.
Which is that in these complex adaptive systems,
and I would include the global economy, it's
the characteristics of the system that are
really important.
As opposed to the characteristics of the individual
bits that comprise the system.
And here we had three goods adding up to a
very big bad.
I want to talk about that.
We've done a number of episodes on complexity
theory, going all the way back to our episode
with Brian Arthur.
I think that was nine, or eight actually.
But you also talk about Keynes.
You quote Keynes a lot.
And you quote some of the older economic thinkers,
back when economics was political economy.
Two questions.
One is, how much of a change have you seen
in terms of integrating these models from
alternative disciplines into economics since
the crisis.
Behavioral economics, for example, or complex
dynamic system, research.
And then, also, how much has there been a
look backwards to see what people were using,
how people were thinking about the economy
before the end of World War II?
Well, I think it depends on where you're looking.
I mean, I would have thought that the standard
economic models, the kind that they teach
in most undergraduate and graduate courses,
sort of called real business cycle models
or dynamic stochastic general equilibrium
models.
These models basically assume that the economy
has got very strong equilibrating properties,
so that if it's hit by a shock, which is basically
what causes problems in those sorts of models;
the assumption of exogenous shocks.
The economy sort of, as it were, sort of absorbs
the shock and then it very quickly goes back
to full employment or back to equilibrium
again.
And I guess I would have thought, given that
the crisis that we had in 2009 and '10, say
nothing of Europe in 2010, given that the
models basically rule that out as being impossible,
okay?
When they say the reality, I would have thought
there would have been a much greater tendency
to say, "The model is inconsistent with what
has actually happened and therefore, I'll
rethink my model."
But as it turns out, there really doesn't
appear to have been all that much change at
the level of academic inquiry.
Now, having said that, apparently ... and
I'm not in the academic community, apparently
a lot of the younger people are starting to
delve into this in a rather more serious way.
The serious analytical thinking, it seems
to me, where one says, "Let's start thinking
about the economy not as a kind of controllable,
understandable machine that can be reduced
to its component parts.
But let's think about it as a complex adaptive
system that is constantly evolving and has
all the properties of a complex adaptive system."
That kind of thinking is taking place, it
seems to me, mostly outside the academic community.
Now, I could be wrong here.
But I've just come back, for example, from
a two-day conference at the OECD, where they
have a big program, which is called NAEC,
New Approaches to Economic Challenges.
And the specific title of this conference
was averting systemic collapse.
And those people at the OECD, in associated
with groups like INET and associations concerned
with complex adaptive systems, they're the
ones that are sort of doing most of the thinking.
But it's by no means mainstream.
Even 10 years after the event.
And if we're looking back to history, there's
a great book.
I think it's David Simpson, who was a professor
emeritus at Sterling, and it's called the
Rediscovery of Classical Economics.
And basically, what he does is he reminds
us that the classical economists, I'm thinking
now, you know, Malthus and Ricardo and Mill
and Adam Smith and all those folks, that they
were really concerned about three major issues.
And one of them was the origins of growth.
You know, where does it come from?
The second one was the question of crises
and where do they come from because they suffered
them in those days as well.
And the third issue that they were concerned
about were distributional issues.
Marx and the limit, class war, [inaudible]
versus the others.
Well, in sort of modern economics over the
course of the last 20 or 30 years, everything
sort of boiled down to growth and questions
having to do with crises and sustainability
and distributional issues just sort of disappeared.
And I think it's unfortunate that that happened.
And I think it's very important that we go
back and that we start thinking more seriously
about these issues of system sustainability,
system resilience, and the distributional
implications of the policies that we follow.
And I think that's starting, but it's by no
means progressed as much as I think it should
have done given that we're 10 years after
the crisis.
I think one of the interesting observations
that you've made and I share it, is that we
live in a world where we feel extremely uncomfortable
with uncertainty.
There's no clear way to sort of grapple with
that and we expect certain answers from our
elected officials or policy makers.
And I wonder to what extent the certainty
that the model provides within the framework
of the model is traded for its effectiveness.
And I think you've also mentioned the work
of Daniel Kahneman, the fact that people,
when a crisis occurs and it's so unforeseen,
that they tend to dig in.
They tend to retreat to their models rather
than question them.
So, that kind of makes me think to ask you
the question, what did policy makers ask themselves
when the crisis happened?
Or, let's say, once they got through the firefighting
phase of it.
What were the questions that they asked when
they began to try and introduce regulations
to try and prevent this from happening?
Well, I'll be honest, Demetri, I left in 2008.
Left that community in 2008, so I've not been
sitting around the table with these men and
women in the intervening decade.
So, I'm probably ill-prepared to answer that
question.
But one of the things that has struck me is
that the policies that have been followed
on the monetary policy side, have essentially
been more of the same policies that were followed
before.
So, in a sense, one has to conclude ... one
does have to logically, but one's tempted
to conclude that the underlying analytical
framework has not changed very much either
because the polices that they've been following
have been the same sort of post crisis, as
they were, pre-crisis.
And those policies basically said, "We're
going to have very easy monetary policy."
I've described it elsewhere as ultra easy
monetary policy.
You know, zero interest rates, negative interest
rates, forward guidance, quantitative easing,
all of that stuff.
And they've done this given two beliefs, which
I think preceded the crisis.
One belief being that monetary easing will
be effective in restoring aggregate demand,
full employment, and a return to potential
growth.
The second belief is that these policies do
not have unintended consequences of any magnitude
and particularly don't have undesirable consequences
of any magnitude.
And I guess my sense is that both of those
beliefs are wrong.
Now, whether people have been inside the central
banking circles thinking about that particular
range of territory, I don't know.
One of the problems ... and I've wrestled
with this over the course of the years, one
of the reasons why central banks have done
what they've done could be because they believe
what I have just stated that they believe.
The other, more charitable response is that
they've actually been sort of trapped by governments
who should have done certain things to help
sort these post crisis problems out, but who
didn't do those things.
So, the central bankers sort of lowered interest
rates and they did what they did in the immediate
aftermath of the crisis.
And I think what they did was spot on, absolutely
right, probably saved us from another Great
Depression.
But I think if they were then thinking about
the possibility of re normalizing policy pretty
quickly, they found themselves confronted
with the fact that fiscal policy, which had
also been sort of eased in the 2009 and 2010
period, went sharply into reverse.
It became significantly contractionary.
And then, we get into all the regulatory stuff.
So, the financial regulators put rather less
emphasis on trying to clean up the damage,
the financial damage from the crisis itself.
And they put rather more emphasis on measures
to prevent a recurrence of the crisis.
But what that essentially meant was that regulatory
policy, both microprudential and macroprudential
was also basically constraining aggregate
demand.
So, there's the poor central bankers finding
themselves in a situation where they followed
the right policies, they've got ultra easy
monetary policy, they want to re normalize,
but they're the only game in town because
everybody else is moving in the opposite direction.
Now, I suspect that both of these things may
have played out in different ways at different
central banks that you know, some of them
have done what they've done over the course
of the last 10 years because they really believed
it would work and it would have no side effects.
Others basically said, "I'm waiting for the
government to do what they should do, but
it's not happening so I just have to continue
doing what I have done.
I'm sort of caught in a kind of trap."
So, that's sort of what I suspect has been
going on.
So, a lot of things there.
One, let me ask you about your point about
the fiscal side.
What do you think needed to be done in the
years after the crisis on the fiscal side
in order to address what I assume was the
buildup of large amounts of private sector
liabilities that we discussed earlier.
What do you think should have happened?
Well, I guess in retrospect, and I wish ... I'll
be honest with you, I wish I'd seen things
as clearly then as I do now.
As I mentioned earlier on, there was in fact
a sharp expansion of fiscal policy, I think
in 2009 and 2010.
And then, there was an equally sharp movement
to really cut the fiscal deficits.
And we saw this in a lot of places, not least
in Europe.
But also in many other countries as well.
I think in retrospect, it would have been
better to have maintained the expansionary
fiscal policy and allowed some room for monetary
policy to re normalize at an earlier stage.
But I think the focus at the time was on the
fact that most governments, even then had
large debt ratios relative to where governments
felt comfortable with.
And so, when people started suggesting after
the Greek crises, that everybody could turn
into Greece, there was this kind of wholesale
movement towards austerity.
And I think actually that was a mistake.
And I think looking forward here, although
it's unfortunate because perhaps some countries
are less well placed to have fiscal expansion
now than they were earlier, I think that looking
forward, when we think about the possibility
at least of a further downturn, that there
will have to be more reliance on fiscal policy.
But I would say this: in the same sort of
way that the private sector has got debt levels
that I think are sort of unhealthily high,
nobody would suggest that the big countries
at least are all in a very good fiscal position.
So, if they are going to do more on the fiscal
side by way of expansion going forward, should
the economy slow down significantly, I would
really like to see that allied with a promise,
a credible promise somehow that the governments
would ensure that going forward, that there
would be a tightening of fiscal policy during
good times that would be as robust as the
easing of fiscal policy in bad times.
And that's something that we didn't have in
the past.
So that whenever we had bad times, fiscal
deficits generally got much larger.
But then when the good times rolled around
afterwards, the degree of tightening was never
symmetrical.
So, the upshot was that cycle after cycle,
we've had government debt ratios ratcheting
up cycle after cycle in exactly the same way
as the interest rates have been ratcheting
down cycle after cycle.
That's sort of where I think we have been
with respect to fiscal policy and where I
think we might be going with respect to fiscal
policy.
So, do you feel that the growth in debt, the
increased reliance on debt in order to fuel
economic growth is a result of the political
forces of our western liberal democratic systems
and the demographics as well?
What do you attribute it to, the fact that
we've had to rely ... we've seen this major
growth.
A lot of people would say, "We'll focus on
one particular thing," they might look at
going off the gold standard.
They might look at the regulation of the financial
system in the 80s.
How do you think about this?
Well, I think that the reliance on debt, I
mean, this is something really that sort of
started after the Volcker years, okay?
It's really sort of a product of the last
20-30 years I suppose.
In large part, I think it's because of the
fact that monetary policy encouraged the buildup
of debt.
I mean, in a sense, when you think about how
monetary policy works, you lower interest
rates and you induce people to bring forward
the spending that they might be doing later,
bring it forward to today.
But the vehicle through which they do that
is borrowing in order to get the finance to
be able to do the spending today as opposed
to later.
So, that's sort of ... the debt thing comes
with the territory of easy money.
Is it also a reflection or commentary on something
you mentioned earlier, which has to do with
the focus, the maniacal focus as I said in
my episode with Claudio Borio, on inflation?
On consumer price inflation or producer price
inflation?
And the fact that the 1990s was a period where
we opened up our economy, the United States
was able to import, and other Western countries
were able to import cheap goods from Asia.
That kept inflation low, and central bankers
focused on that inflation number.
And perhaps, kept interest rates below the
natural rate for years and that this has been
a large contributor to the deflationary circumstances
that we now find ourselves in today.
Well yes, this gets back to sort of the initial
description that I have earlier on about how
the system got out of whack, even though the
various bits of the system were actually moving
in this direction that seemed to be more "efficient."
So yeah, the very low inflation coming in
from globalization and the demographics, the
baby boom, et cetera, really laid the foundations
as it were, trying to back in the demand through
easy monetary policy, in the process and inadvertently
building up these debt levels.
And over time, of course, as the debt levels
build up, as one might ... common sense tells
you, as the debt levels build up, the capacity
of monetary policy to induce still more spending
based on still more debt becomes less effective.
So, I think that's been one big force.
Another big force for the credit increase,
in some countries at least, has been the fact
that the income that has been generated has
been so unevenly distributed.
So you know, we've had this business about
the top .1 or 1% et cetera.
Raghu Rajan in a book that came out a number
of years ago, makes the point, I think he's
quite right, that a lot of people observing
what the Joneses were doing, i.e., the people
that were getting the income from the growth
in the economy, wanting to keep up with them
found that borrowing was a reasonable alternative.
At least for a period of time.
And of course, with the deregulation in the
financial system, the financial system was
more than pleased to supply the credit that
people were demanding in order to keep up
with the Joneses.
And they were able to get access to relatively
low interest rates.
So, it was a combination I think, of all of
those things.
I suggest also for listeners to listen to
our episode 83, with Raghuram Rajan.
I also want to take a quote that you've mentioned
before.
It's from the general theory.
Again, it goes back to my point that it feels
... in fact, I don't think I made this particular
point, but it does feel to me that there is
a reductive simplistic interpretation of Keynes
in particular, but generally speaking, there
seems to be a willingness by people to assume
that they understand certain economists or
thinkers without actually having read their
work.
There's a great quote by Keynes, I'm going
to say it now and it relates to your point
about the ineffectiveness of monetary policy
in the face of large amounts of debt.
It's not exactly the point he was making,
but it's relevant.
This is the quote, "If however, we are tempted
to assert that money is the drink which stimulates
the system to activity, we must remind ourselves
that there may be several slips between the
cup and the lip."
Now, this isn't I suppose, exactly a slip,
but I think the mechanism of monetary policy,
that process between the cup and the lip becomes
less and less effective in a system that's
overburdened with debt.
And you made the point that interest rates
are effectively a way of pulling spending
forward from the future into the present.
But if we assume that spending isn't infinite;
that future spending isn't infinite.
Then at what point does tomorrow become today?
In other words, at what point does this no
longer become effective, that the interest
rate mechanism is broken as a tool for stimulating
the economy?
And is it possible that that's kind of where
we are today?
Well, I think what we've observed over the
course of the last 10 years is that monetary
policy has not been anywhere near as effective
as people had anticipated it would be.
And one way of indicating that that's so is
that I think the IMF, the OECD, the Fed, and
virtually all of the major central banks have,
I think with the exception of last year, in
every year since the crisis, their forecast
for next year has been growth that in effect
turned out to be substantially greater than
what actually materialized.
And their forecast for inflation have been
almost exactly the same.
The forecast has been for a increase in inflation;
back to the target levels.
And in fact, year after year after year.
They've failed to meet those objectives.
And to me, that this says is that monetary
policy has been losing its effectiveness,
exactly as that quote from Keynes seems to
indicate.
It has been losing its effectiveness, and
if we would attempt to go back and do it all
over again, although I'm sort of asking myself
what precisely does that mean in a world where
interest rates are already negative on 16
trillion dollars worth of government bonds,
et cetera, et cetera, okay?
If we were to try to do, again, what we did
the last time around and it were possible,
would it work at all?
I'm actually pretty skeptical.
And I think in fact, that skepticism is now
gradually kind of effecting many other people.
And so, we're hearing more and more people
say, "Well, you know," reluctantly, "Well,
maybe this time we'll have to rely more on
fiscal policy."
And I think implicitly what they're saying
is, they know that the game is over on the
monetary policy side.
So, I do want to dig into that deeper.
I want to mention something that you said
in an episode with a mutual friend of ours,
Grant Williams, which I think he actually
reiterated in an episode that we did together,
which was using a metaphor.
In fact, I actually got in trouble for this.
Some people apparently took it literally,
because the title of the episode with Grant
Williams was something to do with quantum
mechanics.
But you used quantum theory as a great metaphor
for talking about how the way that we understand
physical systems changes at the quantum level;
that behavior changes from what we expect
traditionally with newtonian models.
And that there is this assumption that seems
to exist in the economics profession, that
the way it works is just, take it lower.
Just take the interest rates lower.
Just keep going low.
And if you go below zero, it doesn't matter,
it's just lower.
What's the difference between zero and negative
one versus one and zero if it's both just
one or a hundred basis points lower.
Can you give us your sense, talk to us a little
bit about what does it mean to live in a negative
rate world?
And why do so many of us struggle to understand
how that would work?
Well, I'm still struggling to understand how
it works.
I remember, I was in Switzerland at the time,
when some of the European central banks went
to negative interest rates on reserves.
And again, I think you're quite right, Demetri
in suggesting that in a sense it was nothing
more than a kind of linear extrapolation,
that if 2% interest rates are more expansionary
than 3% interest rates, and 1% is still more
expansionary, et cetera, et cetera, et cetera.
But the first thing that struck me, and I
think it happened within days of the Swiss
National Bank bringing in negative interest
rates on reserves held by the banks, is I
think it was Credit Suisse raised the mortgage
rate, okay?
Now, this is not in keeping with the linear
extrapolation.
But when you think about it, the logic is
perfectly straightforward.
And there's also a discussion of this in the
general theory by the way, banks have to make
profits.
And so, if you're going to charge them for
the reserves that they're holding, somehow
they've got to get the money back to maintain
the profit level.
You'd say, "Well, why don't you have negative
rates on deposits."
They're very loathe to do that because their
customers will hate them for it.
So the only other place to go is either start
raising fees in lieu of increasing loan rates,
or raising the loan rates, which is precisely
what Credit Suisse did.
So, the fact that the banks are there as intermediaries
who have to be profit making intermediaries,
changes the model in a significant way.
Again, I mean, I think in the early days not
much consideration was given to that.
And I guess the banks were making enough money
that they managed to sort of get through the
early years of the post-crisis period without
complaining too much.
But really, these ultra easy monetary policies
have been a source of great concern to pension
funds and insurance companies almost since
the whole policy began.
I mean, these people threatened as it were
by demographics, climate change, and whatever,
fintech, all of these other threats to their
business model.
Now find themselves having to cope with these
very, very low interest rates on the assets
that they hold.
As you know, increasingly, the banks have
been very worried about it and have been expressing
their worry about it.
And we're hearing sort of more and more rumors
that maybe if they do decide to do a higher
number for the negative interest rate on bank
reserves, that they'll try to tier the reserves
in such a way that the banks won't have to
bear the full burden.
So, some of the realities here are starting
to filter through.
But it does seem to me that it took a long
time for that to happen.
But again, it goes back to what I was saying
right at the beginning, is that there's this
tendency to think about everything in sort
of simple, linear terms, when the world isn't
simple.
It's complex and it's not linear, it's highly
nonlinear.
I think that really is the fundamental analytical
point that we have to grasp.
But as I said earlier on in this conversation,
I don't think we're there yet.
The paradigm shift is not yet occurring.
Well, I think also an interesting observation
is also, to your point about the system being
complex, is that for example, if we lived
in a world where people were 20 years on average
younger, perhaps lowering interest rates would
cause them to speculate more in asset markets.
But you can imagine a world where people are
older that their risk appetite has dropped
substantially.
And so, if you lower interest rates, they're
going to just end up saving more.
Well, I actually did a piece back in 2012
I think, which was published by the Dallas
Fed.
And it was called Ultra Easy Monetary Policy
and the Law of Unintended Consequences.
Through it, I mean, there was a big section
in there about why monetary ... it's back
to the quote from Keynes, why monetary policy
was likely to be ineffective.
And one of the points I made was the point
I made earlier, that you're just bringing
spending from tomorrow to today.
And I mean, obviously that's a short term
thing.
It can't go on for all that long because then
tomorrow is today.
But in addition, I sort of went through the
individual components of spending.
And on the household savings side, you're
absolutely right, that if you got a demographic
bulge with older people who are close to retirement
and who are saving, let's say, for an annuity
so that they lead a reasonable life in retirement.
If the roll up rate on their savings goes
down, then they've got no choice other than
to work longer, which of course many people
are.
They have to save more.
And so, what you get is the very opposite
of what you intended.
There's distributional issues as well.
I mean, if the low interest rates are basically
hurting people who've got a high marginal
propensity to consume, well then, that's also
counterproductive.
And in the investment side, again, in this
paper I run through a lot of things.
But something that I've become more and more
concerned about is the interaction between
easy monetary policies and management compensation
schemes.
And there's a friend of mine, Andrew Smithers
actually, who's just ... he's been saying
this for years, but he just published a book
on it.
And that the logic is actually pretty simple,
which is you've got the management who's options
depend upon the price of the shares.
And so, for them, it's sort of a no brainer
to sort of use easy monetary conditions and
very low interest rates to borrow the money,
which they then use to buy back the shares
or pay out in dividends.
This pushes up the share price, pushes up
their bonus.
The smart shareholders are prepared to sell
because they know that the shares are being
bought in at an inappropriately high price.
And so, in the end, what you wind up with
is these corporations that are gradually being
eaten away.
And of course, there's no investment either
because investment is a drain on cash flow,
and depreciation, and all that stuff.
So, you cut investment as well in order to
use the money to buy back the shares.
So, you get into a situation where everything
looks good, but the corporation is actually
being hollowed out and no investment is being
done.
And to me, that seems a lot like what we're
actually observing.
So, not so effective.
So, I want to continue on this larger point
you've made a number of times, which is unintended
consequences.
You said part of the titles of the paper that
you cited was Ultra Easy Monetary Policy and
the Law of Unintended Consequences, which
I believe you published in August of 2012.
It was one of the papers that I read in preparing
for this conversation.
There are of course, unintended consequences
that occur from regulation.
And one of the ones that we've heard a bit
about has to do with liquidity.
We might have seen something to this effect
recently in the repo market.
But I wondered, to what extent is that a concern
do you think?
Let's say the capital requirements that were
put in place with Basel III, first of all,
were they stringent enough?
And the second question is, in the current
environment, given what we've discussed in
terms of the impairment of the financial system,
could those requirements actually create illiquidity
at a time when the system needs it the most?
Well, there is a lot of concern out there.
The treasury market, from what I've read,
the standard measures of liquidity, turnover,
spreads, et cetera, don't seem to be effected
all that much.
But apparently, in many other markets, the
degree of liquidity is much reduced from what
we had before.
And certainly, one of the reasons that is
contributing to that, I'm sure not the only
one, is that the people that used to be market
makers, you know the big banks and the investment
houses, et cetera, because of the capital
requirements for doing that, they're now keeping
a much, much smaller inventory of bonds and
assets of that nature.
And so, the upshot is that they're not really
in a position to make the markets in the way
that they did before.
And in part, that's an unintended consequence
of the regulation.
But I think I recall reading not so long ago,
this was Mark Carney's letter as chairman
of the FSB, his letter to the G20, that I
think they explicitly recognize this as a
potential issue that they were going to be
looking into.
And I thought that was a positive step.
Well, I also ... you know, the way that the
Fed manages, I guess ... maybe it's not precisely
the way they manage liquidity, but I think
the Fed used to be, and you're in a position
to enlighten me on this, and central banks
in general, used to be more active in the
market with open market operations in order
to manage interest rates in the range that
they wanted.
It seems now they've relied much more on tools
like forward guidance and IOER, interest on
excess reserves.
And that perhaps part of what we saw recently
in the repo market is just a reflection of
the fact that they're draining reserves from
the system.
And also, do you think on some level, there
is ... I've talked about it in terms of a
loss of sensitivity, and this goes back to
the point about how the system has changed,
that market participants are just used to,
in this marketplace, things being kept low-vol,
right?
I mean, specifically their short-vol strategies
exploded during this period, but do you think
that there's less discrimination that maybe
perhaps market participants have lost some
skill and price discrimination in this market
today after 10 years of these policies?
Well, yeah.
Yes, I do.
In terms of markets more generally, I think
the fact that there's been so little volatility
in so many of these markets, to me at least
implies that the process of price discovery
... you know, which is where the market has
to make up its own mind, what's a fair price.
That perhaps the capacity to do that after
10 years of the central banks essentially
setting the price for most of these assets
has sort of atrophied a bit.
So, yes, that would be a worry.
In terms of the recent thing in the repo market,
again, I don't profess to be an expert in
that particular area compared to some of the
folks that are out there that really do understand.
But I guess one of the things that does strike
me is that there have been pressures on the
supply side of reserves.
So, that the treasury's been issuing an awful
lot of debt.
And then, sort of sitting on it and its assets
as it's trying to increase its reserves at
the Federal Reserve.
So, that's sort of the supply side.
But the thing that's sort of ... again, I
don't know much about this, but worries me
a bit is on the demand side.
And that, maybe what we're seeing here is
a little bit like what we saw at the beginning
of the crisis in 2008.
Which is that the interbank market essentially
dried up.
And in part, it was because people who had
the reserves, you know, the swings and the
roundabouts, they wound up getting sort of
the reserves.
But instead of sort of then lending them out
to the others, they basically decided to sit
on them because they weren't convinced really
of the soundness of the counter party to whom
they might be lending the reserves.
So, this is another sort of area that I think
people are starting to look into.
But there's little question that the way in
which the system operates is quite different
from the way that it used to operate prior
to the crisis, largely because the excess
reserve levels are so high relative to where
they were previously.
So, I think you're kind of referring to the
daisy chain phenomenon that happened which
was part of the contributor for the freezing
up of money markets around the time of Lehman.
There were a lot of off balance sheet entities
that were being used by banks at that time.
I think you've written about this.
That has largely gone away, I believe.
So, how do you think the system has changed
both through regulation and organically for
the better since the crisis.
And then, maybe we can talk a little bit about
the areas that concern you most.
Some of which we already mentioned.
But where have you seen an improvement?
Well, the improvement in terms of the regulatory
regime, I mean, is pretty clear.
I mean, the capital levels for the big banks
are much higher than they were before.
Liquidity levels are higher than they were
before.
On the particular complication posed by those
sort of sieves and conduits that were allied
with the banks in the pre-crisis and immediate
post-crisis period.
The FSB did a study into shadow banks here
quite recently.
And my recollection was that they concluded
that that particular problem basically was
no longer a problem.
That this daisy chain sort of set of arrangements
had basically been put to rest.
But what they did sort of note, and I think
lots of others have noted too, is that as
the regulations on the banks have tightened
and on those entities that were problems before
have tightened, that the money has basically
just gone some place else.
And this is what I think, Charles Goodheart
often refers to as the boundary problem.
You, that you tighten up the regulation in
one area and then the money just sort of moves.
So, what has happened, there have been all
sorts of things.
But one of the things that happened of course
has been this huge expansion in asset management
companies.
And that's an area which is essentially less
heavily regulated than the newly regulated
banking system.
So, then the question arises, what will be
the behavior when times get tough of those
particular kinds of financial institutions?
And they don't need a lot of capital because
they don't have much skin in the game.
But the reality is that if their customers,
let's say in the mutual funds, decide to take
their money out and do something else with
it.
Then there will have to be some kind of a
reaction on the part of these firms.
And the answer is what will the reaction be,
will it involve fire sales, what are the implications
for emerging markets?
There's a lot of issues for which I guess
we have no clear answer at the moment.
All we can point out is that the system is
different today from what it was 10 years
ago.
So, you mentioned emerging markets, you've
mentioned that before.
Emerging markets were part of the solution
in 2008.
China, I think, grew domestic credit by an
average of about 20% per year in the first
six or seven years after the onset of the
crisis in order to boost growth.
And of course, a lot of these other countries
that are part of the supply chains benefited
from that.
And of course, all of these emerging market
economies also benefited from the carry trade
and from the expansion of US monetary policy,
which perhaps brings us in to a larger conversation
about reforming the global financial system.
But what is the concern now with emerging
markets?
Are they now perhaps on the hook in the way
that we were 10 years ago?
Well, I think the answer is yes.
As I mentioned at the beginning of this discussion,
global debt ratios, you know, debt to GNE,
global GNE are way up.
And where they've risen particularly noticeably
has been in the corporate sector of emerging
markets.
Particularly China, but my recollection, not
limited to China.
There's a number of countries that have seen
their debt levels, corporate debt levels in
particular go up pretty high.
And the worries are of many sorts.
I mean, one of them is that just the debt
levels themselves may be a threat to the survival
of the corporation.
If the money hasn't been used for good purposes.
The other concern is really to do with the
currency in which many of these loans have
been taken out.
So, a lot of the corporate borrowing in the
emerging market economies has been done in
dollars.
And the concern would be that for whatever
reason, let's say if you had a crisis where
... you know, sort of a global crisis where
all of the sudden, it was risk off again.
And everybody was piling into US dollars as
a safe haven.
Then the dollar goes up, at least relative
to these emerging market currencies.
And then the debt servicing requirement for
these people who don't actually earn most
of their money in dollars is obviously bigger
than it would otherwise be, which just aggravates
the counter party, which aggravates the counter
party problem.
So, that is a concern.
Just a few days ago I think McKinsey Global
Institute published a piece that basically
talked about the Asian financial system and
raised a number of concerns.
And again, it's back to this kind of stuff
in a sense we saw during the Asian crisis,
which is that if the borrowers have got problems,
run into problems of the sort that I've just
described, then the lenders, which would include
domestic lenders as well as international
lenders, they might find themselves in some
trouble too.
And McKinsey seems to be concerned about that
at the moment.
I think you said it earlier on, that in 2009
the emerging markets were part of the solution.
Particularly China with a rapid expansion
of credit and loans there.
But now, they're part of the problem.
Let's actually talk a little bit more about
that.
I read a book when I was in college, it had
been published years earlier called the Crisis
of Global Capitalism.
It was by George Soros.
And there was also a documentary that came
out around the time that I was in college.
Or maybe it ... again, it came out earlier
during that period in the late 90s.
But I saw it some years later.
Called the Commanding Heights and I think
it was based off of a book-
Oh, I remember that.
Yeah.
Yeah, it was a TV series.
I think it was BBC.
Is that right?
I think.
I think.
I actually watched it while I was living in
Italy.
I was studying in Italy as a foreign exchange
student and we had a very progressive economist
doing some class on economics, economic development,
I can't remember.
It's actually really interesting to study
economics in different parts of the world.
There's a difference in how its taught and
I think it's useful to get those different
perspectives.
But Soros's book really stuck on me.
His message.
I mean, that was the first time I heard him
extrapolate his theory on reflexivity, which
he got from Karl Popper.
But that's the first time I also learned really
about the dollar carry trade and the power
of the dollar and these hot money flows.
And this is sort of a way of, again, bringing
it back to the question of how did we get
here?
And I wonder, for someone like you who has
... I think you began your career when?
In the 70s, did you start working including
central banking-
Aren't you ... in the 60s, I hate to say it,
but it's true.
So, the 60s.
Wonderful.
That makes you even more-
Even more old than you thought.
Great.
Well, so in fact, you've actually worked in
the field when we had fixed exchange rates.
When we were under the Bretton Woods Fixed
Exchange Rate System ad you experienced what
the world was like before 1971 and '73, and
after.
And that system was architected very deliberately.
But the system, it seems to me, and this is
sort of a question, right?
I'm not making a statement.
I'm making it without a question mark, but
it's a question.
The system that we have today, on the other
hand, doesn't seem to have been very well
architected.
It just kind of emerged out of the end of
Bretton Woods.
Maybe the late 70s.
And that's really what the deregulation was.
It was an attempt to grapple with this new
system on the fly.
Does that resonate, that that's sort of the
system that we're living in today?
Something that was sort of just kind of came
out of what ended without a really clear plan?
Yeah, I would certainly agree with you on
that front.
I think that people have cobbled responses
together to various problems.
But really, since the breakdown of Bretton
Woods, there has been no concerted attempt
to rethink the system.
And that sort of worries me because I think
what we do have ... and others have referred
to this as well, Robert Pringle and others.
We have a none system.
It just sort of is what it is, and a can do
whatever they want whenever they want without
any form of external discipline being imposed
upon them.
And I think that's sort of worrisome, not
least because I think ... you know, there's
all this attention at the moment to trade
wars.
I would contend that we've been in a kind
of hidden currency war for about a decade.
That you know, when the Fed first started
doing all of this sort of quantitative whatever,
and started pushing the value of the dollar
down, there were all sorts of other countries
who didn't want to see the value of their
currencies go up.
For exactly the same reason as the Fed was
easing, because they also faced problems of
high unemployment, whatever.
So, you had this sort of systematic leaning
against the appreciation of their currencies.
And in the advanced market economies, it showed
up as sort of mirroring the kind of policies
that the fed was following, okay?
Responding to decimal point deviations in
inflation from targets.
And in the emerging market economies, it was
more a question of sort of direct intervention
in the foreign exchange markets.
And also, monetary policy that was easier
than it would otherwise have been.
And so, you know, we find ourselves today
now with this huge expansion in the balance
sheets of central banks in most of the big
countries.
So, we have these central banks holding large
amounts of their own government's securities.
But in addition, we have sort of finance ministries
and central banks and sovereign well funds
holding huge amounts of other countries' government's
securities.
And somehow, the idea that you've got this
confluence of massive expansion in the holdings
of government assets by central banks or institutions
related to central banks.
I don't like it.
Nothing really bad has happened up until now.
But you sort of look at what's happened because
there's been no discipline sort of saying
to people, "You can't do that."
I'm worried about this going forward because
I think in the end, it's the international
monetary system that's sort of key to things
in an increasingly globalized world.
So, that's where I want to actually go.
I want to mention a couple of books for our
listeners that have been helpful for me in
thinking about the interwar period and this
beggar thy neighbor policies as historical
facts of history, and helping me think about
where we might be going.
One of this is Barry Eichengreen's Golden
Fetters.
Dr. Eichengreen was, of course on Hidden Forces
many episodes ago for our conversation about
currency and the great moderation and things
like this.
But also, Charles Kindleberger's The World
in Depression.
Very, very valuable book for me.
I'd love to dig in a little deeper here about
what might be a way of talking about currency
wars and the problem of these floating exchange
rate systems and where we go from here.
You actually have a quote, I have it here
in my rundown.
You write, "Every major country is engaged
in currency wars even though they insist that
QE has noting to do with competitive depreciation.
They have all been playing the game except
for China so far.
And it's a zero sum game.
China could really up the ante."
China's a really interesting variable in today's
world.
And talking about this complex dynamic system,
China was in a very different place and this
was a very different world politically and
also economically in the last crisis period.
What is your thought about China and its role
in the international financial system as it
is today and in whatever sort of might be
potentially emerge either deliberately through
cooperation internationally, which seems increasing
difficult today, or organically perhaps?
And we can talk about what that might look
like.
Well, certainly at the moment, I mean, China
has become so important in the international
trading system and the financial system that
it absolutely cannot be ignored.
And of course, you remember a little while
ago that when renminbi went through seven
renminbi to the-
Broke the peg.
... dollar, that there was a lot of concern
that somehow we were going to get into a competitive
depreciation, that the Fed might then respond
with intervention.
My concern was that if any of that happened,
that it might actually bring to the fore,
concerns that people ought to have had about
the potential inflationary implications of
all of this stuff.
But in the event, I mean-
What do you mean when you say the potential
inflationary implications of all of this stuff?
What do you mean?
What I mean is you know, we've had sort of
willy-nilly a big expansion in government
debt in many places.
And at the same time, a significant financing
of that from central banks.
And Japan I guess is the most extreme example.
But others are not a million miles behind.
What we know from history is that you can
do this for a long period of time, you can
run government deficits and run up the government
debt, and the central bank can finance it
so long as the markets are of the view that
the governments will eventually sort this
thing out in a noninflationary way; that they'll
eventually go back to more prudent sustainable,
fiscal policies.
But what often happens is that the sort of
the continued recourse to the central bank,
basically causes that expectation, you know,
eventual sanity.
Basically causes that expectation to dissipate.
And once people start to feel that we're actually
on a route here of fiscal dominance and central
bank financing, then the reaction is, "I'm
out of here."
And we've seen this so many times before.
I mean, just think of Latin America or many,
many other countries in other places.
You know, the confidence dissipates and the
game is over in a highly nonlinear way.
Everything has been fine up until now.
I mean, including in Japan.
But well, you know the old joke about the
guy that falls from the 22nd story window?
I do.
Yeah.
But please say it.
I've heard it from you-
For your listeners.
As he goes past the second story, someone
shouts out, "How are you doing?"
And he says, "So far so good."
So, the world is a highly nonlinear place.
And because everything is fine up until now,
everything will continue to be fine, is just
... I believe, false.
Not every floor, not every story is made equal.
Yeah.
There's a big difference between going from
50 to 49 and from 1 to 0.
Yeah.
So, what you're talking about is the path
to inflation.
And this is something that I've grappled with
a lot because on the one hand, we have a path
for deflation.
We've seen it.
It's what others referred to as Japanification.
Japan has seen the capacity to grow its public
sector enormously without being able to generate
inflation.
It's suffered under many of the similar forces
that we're experiencing today, demographics,
debt, et cetera.
So, that's something I'd love to continue
to discuss with you.
I'd also want to go deeper into this point
about the international monetary system.
And maybe explore two possible paths.
One which would be an international monetary
system more along the lines of Bretton Woods.
Not necessarily in terms of the gold standard
or any particular restraint, but simply a
deliberately architected one versus perhaps
something that would emerge organically.
And I'm thinking, of course, a recent example
of Libra, which attempted to step into the
breach and provide let's say, a non sovereign
currency that companies would be able to use
and people would be able to use.
We're going to discuss all of that in the
overtime, Dr. White.
Please stick around.
Or our regular listeners.
You know the drill.
If you're new to the show, or if you have
not yet subscribed to our Patreon subscription,
I suggest you head over to patreon.com/hiddenforces
where you can access the audio file, autodidact,
or super nerd tiers which give you access
to the overtime that I'm about to have with
Dr. William White, as well as the transcript
to our conversation, as well as all of my
notes which are exceptional today.
I'm also going to provide PDFs of articles
and papers written by Dr. White that I relied
on for this conversation.
Bill, thank you so much for being on the program
and please stick around for the overtime.
Well, thank you very much, Demetri.
I've really enjoyed it and I've also enjoyed
being introduced to Hidden Forces.
So, thank you very much.
Today's episode of Hidden Forces was recorded
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