The Central Banks' Easy Money Experiment Will End Badly (w/ Jim Grant & William White)
CREW: Can you say your name, your title, and the company? JIM GRANT: Yes. Oh, I should do it? Yeah. I'm Jim Grant. I'm the editor of Grant's Interest Rate Observer. And what I do for a living is write. I want to interview famous people, but who are famous, perhaps, for reasons that the public is not fully aware of.
I hope to elicit from them new thoughts, frank admissions of things that they had not previously admitted to, and I want to get them to laugh once or twice. Hello, viewers of "Real Vision." This is Jim Grant, and it is a great privilege to be in the company today of William R. White,
economist extraordinaire, international financial-- what might be the noun here-- certainly authority. I daresay in the minds of some of the central bankers of the world, you're not only an authority, but also rather a troublesome one. I'm thinking back to the year 2003 and 2004 when you said things that were not exactly welcomed.
But Bill White has made his reputation as one of the seemingly impossible combinations of establishmentarian and original thinker. Who was it, Bill, who said that when brands impinge on experience, you get an idea. And sometimes, that idea is not the one that is authorized from on high.
Bill White has made his career by thinking things not always authorized. He began as a young alumnus-- you had a University of Manchester PhD by the time you started with the Bank of England, did you not-- that was 1969. WILLIAM R. WHITE: Yes. Yes. JIM GRANT: You returned to your Canadian roots and served with the Bank of Canada, finally rising to Deputy Governor over the course of 22 years. It was on to the Bank for International Settlements, the central bankers-owned Swiss Bank.
And there, Bill headed the monetary economics department for upwards of 12 or 13 years. We know him principally by his work in the early aughts when it appeared that everything was moderate and swimming and financially invulnerable. And, Bill, I'm thinking to the famous Jackson Hole conference in the year 2003.
WILLIAM R. WHITE: Oh yes. JIM GRANT: And you and Claudio Barrow gave yourselves some notoriety by presenting a paper that had to do with the imperfection of the state of affairs then ruling in international finance. And that seems to me, if I recall correctly, had something to do with leverage with interest rates and with unintended consequences. And it was that paper that not necessarily distinguished, but really it was characteristic of the approach you have taken for well-nigh five decades.
I speak five decades, respectfully, as a fellow who is actually slightly older than that. And then after this career-- a storied career in the BIS, it was on to the OECD and now the CD Howe Institute in Toronto. But Bill is currently speaking to us from quarantine in London.
And after that somewhat windy introduction, Bill, welcome to "Real Vision." WILLIAM R. WHITE: It's a pleasure to be here. And it's a great pleasure to be interviewed by in particular.
JIM GRANT: Oh, thank you, Bill. WILLIAM R. WHITE: I'm more than pleased to be here. JIM GRANT: I want to divide this into two or three parts, one of which is to do with the monetary arc preceding the truly Big Bang of 2007, 2008, and 2009.
But that is somewhat historic. And not all of our viewers share our interest in that long ago episode. I daresay they should. But before we get into the backstory, I want to begin with a question or two about the moment. And I want to ask you-- you're an authority on bubbles, having first of all asserted that they could exist in a world of conscientious central bank administrations. In the light of your work and the area of excesses, unintended consequences, and bubbles, tell us-- RAOUL PAL: Hi, I’m Raoul Pal.
Sorry to interrupt your video - I know it’s a pain in the ass, but look, I want to tell you something important because I can tell that you really want to learn about what’s going in financial markets and understand the global economy in these complicated times. That’s what we do at Real Vision. So this YouTube channel is a small fraction of what we actually do. You should really come over to realvision.com and see the 20 or so videos a week that we produce of this kind of quality of content, the deep analysis and understanding of the world around us. So, if you click on the link below or go to realvision.com, it costs you $1.
I don’t think you can afford to be without it. RAOUL PAL: Hi, I’m Raoul Pal. Sorry to interrupt your video - I know it’s a pain in the ass, but look, I want to tell you something important because I can tell that you really want to learn about what’s going in financial markets and understand the global economy in these complicated times. That’s what we do at Real Vision. So this YouTube channel is a small fraction of what we actually do. You should really come over to realvision.com and see the 20 or so videos a week that we
produce of this kind of quality of content, the deep analysis and understanding of the world around us. So, if you click on the link below or go to realvision.com, it costs you $1. I don’t think you can afford to be without it. JIM GRANT: conscientious central bank administrations. In the light of your work and the area of excesses, unintended consequences, and bubbles, tell us is there a bubble today? And if so, where might it be? WILLIAM R. WHITE: Well, Jim, that story that I was telling well before the pandemic arrived
was that, in fact, we were in another unsustainable bubble-- an accident that was waiting to happen. All that was required was the trigger. And as it turned out, the trigger came from a totally unexpected place, which was the pandemic-- at least unexpected by the economists. It was a pandemic.
But the conditions beforehand struck me as being classic sort of pre-crisis conditions, which was leverage, a huge expansion in debt. I mean, if you take a look, for example, at the IIF numbers on global debt as a proportion of global GDP, they were actually up 50 percentage points from 2008 through to the last quarter prior to the pandemic. So if one thought about the great financial contraction as being a period of deleveraging in which we went back to normal, it was the very opposite. The leverage continued to go way, way up, and all around the world-- not just in a few countries, but basically globally. And then you looked at the spreads which were coming down, you looked at the level of equity prices, particularly in the United States, PE ratios-- all of those things seemed to me to indicate that we were in troublesome territory.
And as I say, it was, in a sense, an accident waiting to happen. And the pandemic now, of course, has only made it significantly worse, not just because of the supply side implications of the pandemic, but because the reaction of the governments-- in a sense, rightly-- but nonetheless the reaction that has made the underlying debt problems significantly worse than they were before. So yes, we have some issues out there as we speak. JIM GRANT: Bill, to me, the most extraordinary single fact about our finance's decay is the level of securities, debt securities, priced to yield less than nothing on a nominal basis. And a while ago, not so long ago, the figure was $17 trillion-- with a T-- plus.
And on the authority of Dick Sylla's and Sidney Homer's History of Interest Rates, these are the lowest rates in, let's see-- WILLIAM R. WHITE: Ever. JIM GRANT: 4,000 years. And certainly the level of bonds and notes perhaps yield less than nothing.
It's a new thing under the sun. Would you venture the hypothesis that there is a bubble in debt? WILLIAM R. WHITE: Absolutely. Absolutely. JIM GRANT: Is there a bubble in bonds, as an investment? I know you're not a professional speculator, but does this strike you as a characteristic investment excess? There are very successful people who've made a whole career by being long bonds from the peak in yields on September 30 of 1981 to the present.
And there is a body of theory, almost an ideology, almost a kind of a belief that has grown up around the invincibility of the asset class of bonds. And we see this hypothesis regarding perpetual deflation-- or what's the term from the '30s-- secular stagnation. WILLIAM R. WHITE: Secular stagnation. Yeah, it sort of came out a bit later, but the same kind of thing. Larry Summers has been pushing this for quite some period of time. JIM GRANT: So are you a buyer or seller of bonds? We got to know, Bill.
WILLIAM R. WHITE: The truth is that the bond rates are low because the central banks have been caught in a kind of debt trap. And what I mean by that is that every time there's been a slowdown-- and this really goes down sort of 30 years or more, it goes back to 1987 at least with the Greenspan put, and maybe even before then. But in any event, let's start off with 1987, which is long enough ago. So we had the kind of Greenspan put.
But the basic message was when the economy's in trouble, looks as if it's going to turn down, or the financial markets look as if they're in trouble, the answer is, lower the interest rates and print the money. The problem is that when you do that, you simply encourage an accumulation of more private sector debt, and potentially even more public sector debt, because the public sector knows that they can finance its increased expenditures at a reasonable rate of interest. So you get this expansion of debt that over a period of time, Chairman Greenspan rightly characterized as generating headwinds so that you get an immediate positive effect through this monetary easing. But the medium to longer term effect is an increase in debt, which actually works in the very opposite direction. And this continues. And it has continued since the late 1980s.
But the accumulation of debt has now got to such a point, and the interest rates have been lowered to such a point, repeatedly cycle after cycle, that we now have a situation where the central banks know, I think increasingly, that the path on which they have embarked is unsustainable. But they're so far down the path that they can't get off it by raising rates. Because in raising rates, they create the very problem that they're trying to avoid. So we've gotten ourselves to a place that's been a very long path, but we've gotten ourselves to a place where we don't want to be. So your question, really, is what takes us off that path? I would contend that debt of any sort-- if it's unproductive debt, which much of the debt we have is now unproductive debt-- essentially narrows the path. And you can fall off that narrow path in one of two directions.
And one of them is the debt deflation direction, which is what I think we're probably heading for short term. The other one you could fall off in the inflationary direction. And which side basically determines how you feel about bonds? Now, I guess my sense of it is that over the course, and I could well be wrong here-- it's tipping points all the way, and who knows where they emerge.
I think we're going to fall off from the debt deflation side, in which case monetary easing will continue. The bond rates will continue to stay very low. Whether they will go any further, I guess I have more doubts about that.
But I think the likelihood that they will stay quite low for an extended period is reasonably great. Having said that, if the central banks finding themselves in this situation say, as indeed many people recommend, that you simply double down on monetary expansion and fiscal expansion-- and fiscal expansion-- for the first time, then this combination of a lot of fiscal stimulus supplemented by central bank financing could very easily lead you into a world of fiscal dominance, where the expectations suddenly start to shift. And if that happens, then you're into an inflationary world where, obviously, bonds is the last place that you want to be. So I suspect it will be near term deflation and longer term inflation-- and potentially, even very high inflation. Because once these processes get out of the box, it's very hard to rein them in.
We've seen this over and over in terms of historical experiments. JIM GRANT: Bill, you have been around central bankers. Indeed, you have been one of them for most of your career.
What is wrong with these people? And I'm going to illustrate with a story from the American game of baseball. All right, so you've got to imagine a journeyman second baseman named Dick Schofield. He plays for the St. Louis Cardinals.
And the formidable, looming Bob Gibson, one of the great pitchers of all time, is sitting in the dugout when Schofield strikes out, as he so frequently does. Schofield comes back to the bench, he proceeds to throw a tantrum. He slams his helmet on the floor.
He breaks his bat. He swears up a blue storm. And Gibson says, come over here, please. He says, look, here is your batting average. It's .230, what did you expect?
All right, what do the central bankers expect? The Fed has 700 and something PhD's-- I know you're a PhD, I don't mean to disparage the title-- these people have heard once or twice about this unintended consequences business, and yet they persist in administering the most critical, certainly consequential rate, in capitalism, which is the basic rate of interest-- we call it price control under other contexts. So my question to you is, what do they expect when they manipulate this most consequential price and generate behavior that they deplore in their speeches but nonetheless egg on in their actions? What do they expect? WILLIAM R. WHITE: Well, I've been around this community now for pretty close on to 50 years. And let me assure you that most of the people that you're talking about are enormously smart people and their hearts are in the right place, and they're wanting to do good. The fundamental problem is, in a sense, not with the central bankers but with the analytical framework.
These people have bought into an analytical framework, but unfortunately, from my perspective, it's wrong. And the fundamental error that I think has been made is not even an economic error. It's a philosophical here.
It's an epistemological error. They have made an assumption about the character of the economic system that is wrong. They're starting off with the idea that the system is comprehensible, it's understandable, and it's controllable. And my view, and it has been for quite some period of time, is that this is wrong-- that the starting assumption ought to be, the economy is a complex, adaptive system.
And it has characteristics, including unintended consequences, that are not present in models or analytical frameworks that assume the system is comprehensible and controllable. So the fundamental mistake is an analytical mistake, which is basically coming out of the universities. And something I know given your long history of interest in economic history, I think one of the biggest mistakes that the universities ever made was to stop giving courses in the history of economic thought, where many of the unintended consequences are, in fact, given pride of place. And also, economic history demonstrates that systems don't equilibriate, that they are not operating towards equilibrium all the time, and that really bad things can happen. So I don't think these are dumb people. I think the fundamental problem is buying into the wrong analytical framework.
JIM GRANT: Yeah, well for smart people, they certainly make the same mistake over and over again. There was a guy named William Goldman, one of the great screenwriters of Hollywood. And one day-- he wrote "Butch Cassidy and the Sundance Kid" and other such films.
One day, he had finally had his fill of the studio heads predicting some outcomes and success of the movie. He said, you know what? Nobody knows anything. WILLIAM R. WHITE: That is right.
Nobody knows anything about nothing. JIM GRANT: Right. And certainly the points you bias is exaggeration and in regard to this complex system that the conceited authorities and central banks think they have mastered, they don't know nothing actually.
The dynamic, stochastic, general equilibrium model-- what is that? WILLIAM R. WHITE: Well, it's based on the-- JIM GRANT: What is it? WILLIAM R. WHITE: The premise that we have a relatively simple system which is invariant over time and which can be understood and controlled. And it has certain characteristics, not least of which is that inflation relatively quickly goes to the level that the central banks want it to go to. And if the real side of the economy is shocked away from full employment, it will rapidly go back to that equilibrium.
And as I've suggested, these premises are wrong. JIM GRANT: This is still an operation. This is still a basic macroeconomic forecasting model in the central banks, is it not? WILLIAM R. WHITE: To be honest, I don't know. There's an old colleague of mine, however, Scott Roger, who wrote a piece for the IMF a number of years ago.
And his contention was that in practice, the models receive less emphasis than you might think. The central bankers are always sort of thinking in terms of their own analytical framework. The problem is that the analytical framework, whether it's one equation or 100, tends to have the same sort of underlying premise. And that's the thing that's wrong. And when you talk about humility, the thing about complex systems, adaptive systems in particular, is that they do have tipping points, they are highly nonlinear, they have unintended consequences. And the central thing that comes out of that is that if you're trying to control them or influence them, you should be humble in terms of your capacity to do so.
JIM GRANT: You read these learned analytical papers that come out in such profusion from the research department of the Federal Reserve and from other central banks as well, and you look at the citations and the attached bibliographies, and none of them-- almost none-- is dated any older than 10 years before the publication date of the paper. There is a positively myopic focus on the analytical apparatus, pretense, whatever the word might be, of the present. Writing in the 1850s and the '60s, Walter Bagehot, the muse of modern central banking, famously said that-- apropos of the national figurehead of Britain-- John Bolton can stand anything, but he can't stand 2%. He uttered this great epigram in the wake of the nth speculative bubble that was egged on through very low interest rates. So he observed that low interest rates caused people to do strange things with money.
It was if they were under the influence of some abusive substance. But this bit of non-quantified, homely folk wisdom seems to have eluded the formidable intelligences that run our monetary institutions. And I want to know why.
I got to know why, Bill. WILLIAM R. WHITE: I mean, you know this as well as I do-- you go back to people like Thomas Kuhn and The Theory of Scientific Revolutions where he talks about paradigm shift and how difficult it is even in the realm of science to get a paradigm shift. And Darwin spent 10 years before he was prepared to publish-- Copernicus was on his deathbed. And in both instances, it was because of concern about what right thinking people would think. Paradigms are hard to shift in whatever area.
And our difficulty is we have a paradigm which needs to shift. But getting that shift is proving, well, I've been bumping my head against this now for 25 years, so I know how hard it is to change people's views. JIM GRANT: What is a Canadian doing in the business of monetary trouble? I ask this, because Canadian banks famously do not fail. Some put this down to the phlegmatic national character of Canada, which is perhaps-- perhaps it's the conceit of the speculative mind of Americans.
But Bray Hammond, the famous to me author of one of the most marvelous books on financial history, Of Banking and Politics in America from the Revolution to the Civil War, devotes a chapter, this Canadian does, to Canadian banking. And he points out that it's tended to be oligarchic, as has been the politics of Canada over the course-- he said that sometimes the Canadians are more royal than the House of Windsor, and that there are ever so few banks in Canada and still fewer failures. So my question to you is, what are the Canadians doing that we're not doing? And why has a Canadian become one of the foremost authorities on bank failures? WILLIAM R. WHITE: Well, I'm not sure that that's the case. I do think that there's more attention being paid, particularly in the light of the pandemic, but even before, to the question of the resilience and the sustainability of systems, that efficiency isn't everything. And this is where you get into some tricky stuff when it comes to banking.
Because it may well be that a degree of consolidation that allows competition. But nevertheless, a new level of profits that can be plowed back in to sort of higher capital and greater resilience has got something to say for itself. Whether the Canadians have got it exactly right because there always is, in a sense, a trade-off between efficiency now and resiliency going forward-- whether they've got the optimal position, that I'm not in a position to say. But certainly, there's something to be said for that range of territory. JIM GRANT: Bill, we are looking, some of us are really rooting for the year 2021.
It could hardly be worse. But next year brings three, if you ask me, three seminal anniversaries. One is the 100th anniversary of the Depression of 1920-21, which ended with high interest rates and with a balanced federal budget-- I'm talking about the United States of America. That's one anniversary. The second anniversary it's the 50th-- the end of Bretton Woods that stopped in 1971.
And the third anniversary is the 40th of the great bond bull market that began in 1981. So this trifecta of anniversaries, it can't be without meaning, right? There are no accidents. WILLIAM R. WHITE: I was just thinking, I know you wrote a book about the Great Depression of-- what was the title? Remind me again, the-- JIM GRANT: Forgotten Depression, which, unfortunately, my book has not actually changed that state of affairs. The Depression is still by and large forgotten. WILLIAM R. WHITE: Well, there's a wonderful line-- I'm sure you know this, but it was
new to me-- so Sir Joshua Stamp in 1922, looking back on the recession in Britain in 1921, he said-- and maybe there's something for us looking forward-- quote, "it was the failure of an anticipated inflation to materialize. It was exactly the feeling that you get when you walk up the steps in the dark and put your foot on a stamp that isn't there." And I wonder now in the light of what's going on with everybody being so convinced that inflation can't happen because of all of the arguments that I've just mentioned, that they become oblivious to the fact that these are just arguments that say it might not happen.
There are certainly not arguments strong enough to say that it can't happen. And it'll be very interesting to see if this kind of inflationary push, let's say arising from changing demographics-- this is a big element that it seems to me that the Fed has missed, really, for decades-- JIM GRANT: All right-- WILLIAM R. WHITE: The implication that that has for inflation, maybe for more inflation going forward as the Baby Boomers go out, as China's working population goes down, et cetera, et cetera.
JIM GRANT: I'm still building my case against these people-- these people, central bankers, and bear with me a second-- so we're going to get around to Charles Goodhart and his co-author's view of inflation, which you have studied. But I first want to propose to you that it's not so much a paradigm shift that central bankers have missed, but rather it's been their inattention to the time honored observations of people who have been around and changed cycles also understand-- anyway. Apropos of 1921, to my mind what allowed that cycle to end was the price mechanism-- it was a free play of prices.
Wages fell almost in parallel with profits, and companies were able to reestablish profitability at lower levels of nominal which is the price. All right, so compare and contrast 1929, 1933, and Herbert Hoover put the kibosh on falling wages. He called it the industrial [INAUDIBLE] No cutting wages, because we can't have that-- not like '21. So my proposal to is that central bankers-- let's fast forward-- having missed the benign supply shock the early aughts with the internationalization of the labor market, with free trade-- benign, I say, except perhaps if you were out of a job. But still, the supply shock that generated so much business activity and so much GDP, they missed that and they missed the nature of that. That, to me, signals that the central bankers as a class of intellect are unobservant about capitalism, about markets.
They don't trust them. And I will further add to this windy question by observing that this shines through in their insistence on administering interest rates rather than letting them be discovered in the marketplace. So there must be a question there someplace, Bill. The question is, are central bankers as a class of person anti-capitalist or anti-market? And is this not their abiding sin that is going to cost us, has cost us, will cost us dearly? WILLIAM R. WHITE: Well, I go back to what I was saying before-- the fundamental mistake was to assume that the economy is somehow deterministic and controllable. JIM GRANT: And they determine it.
WILLIAM R. WHITE: Whereas I think the proper model, really, is an evolutionary and biologic model. And of course, there's a long history of this-- going back to Babylon and beyond.
That the proper way to think about it-- this is Schumpeterian in a certain way too-- what's really important is the birth of new companies and the death of old ones. And this evolutionary process, that it's the dynamic that brings the growth. And this is the thing that in a way does strike me as odd, but I think it has to do with the analytical framework.
It's all to do-- there's a presumption that efficiency is everything. That somehow if you use the resources you have available in an efficient way to produce the maximum amount today, that that's all there is to it. Whereas the reality is the big gains come from the dynamism of an evolving economy. And I do fear, actually, that one of the things that these low interest rates have done and ultra easy money is that they have had a negative effect on the supply potential of the economy, which certainly we're observing more and more, right? And in the United States as well are these zombie companies-- companies that don't really make enough profits even to cover their own interest payments. And so the banks, because they don't want to recognize the fact that their capital is going to take a hit or they're hoping that, like Mr McCarver, that something might just turn up for their clients.
So they've been keeping these zombie companies alive. And one of the difficulties, of course, is that because you've got this extra productive capacity still out there, it's pushing down prices. But at the same time, these companies are still absorbing the capital and the labor that the other competitors might conceivably want to use. So it keeps up their input costs. So these zombies are really causing problems for the new competitors.
And it's the new competitors, it's the guys in garages, right, who don't actually have any collateral who can't get the new lending to allow them to become effective participants in the capitalist economy. So there's definitely something there in terms of unintended consequences of easy money from the supply side of the economy. JIM GRANT: You have to wonder after a while, given the repetitive demonstration of the negative consequences of persistent easy money, whether you can actually call these consequences, unintended.
They might be bungled consequences, but how can they not understand, these people with their finger on the scale of interest rates, that there are consequences, much like what you have just described? WILLIAM R. WHITE: Can I just say, we've been focusing here on sort of the analytical challenges faced by central banks. And maybe they believe everything that they're saying, or maybe they don't. But there is another side to it too, which I think has to be recognized, which is the political economy side of it. And I think what that means is that certainly coming out of the Great Contraction in 2009 and 2010, fiscal went into reverse very, very quickly.
I think there was a sort of sense that everybody might become like Greece. And so however that worked, fiscal went into negative mode, went into contractionary mode. And that left monetary policy basically holding the bag. The regulatory side, OK, also went into negative mode.
The whole sort of concern of the regulators, it seems to me, before they had properly resolved the debt problems that came out of the Great Contraction, they were working very assiduously to try to change the regulatory framework to prevent another crisis. And what they did was basically contractionary. So the central banks found themselves, in a way, willy nilly, the only game in town. And if you said to me what would I have recommended that they do differently? I guess I would have said around 2010, probably did say it around 2010, was that central banks should have been saying to the governments, we have a collective insolvency problem here. The debt levels are too high to be sustainable at normal interest rates. Central banks cannot deal with insolvency problems.
We can only deal with illiquidity problems. And you want us to proceed as if it were any liquidity problem. And that, I think, was a fundamental mistake. But again, you have to imagine the kind of pressure on these guys to want to believe, as it were, their own rhetoric, because everybody else desperately wanted to believe the rhetoric that the central banks had it under control. So it's always more complicated than you would think. It's even more complicated than a fool or a knave.
Sometimes there's other considerations to take issue with. JIM GRANT: You mentioned efficiency is not, after all, the one and only criteria. Let me ask you about another aspect of the dear dead days before modernity took over the world of money and banking. Up until the early decades of the 20th century, there was something called a capital call-- go out to the owners of common equity banking institutions and find out if they're insolvent.
Stockholders with capital called up to the par value of the shares, and they would have to stump up what they could to make the liability holders, especially the depositors, whole. And so that was superseded by deposit insurance. But couldn't you make the case that the regulatory overreach in the wake of the trials of 2007 to 2009. The regulatory overreach was the consequence of the misplacement of the incentives on the part of the owners of leveraged financial institutions? So why is it that the taxpayers are there when there is that insolvency problem and not there when it's time to cut the melon-- no bonuses for the taxpayers, no dividend tax. So this to me has poisoned the well of our politics. And having made this little sermon to you, Bill, I'm going to pose a hypothesis.
This is apropos of getting back to the three-pronged anniversaries of next year. I'm proposing you that the monetary affairs and the governance of financial institutions, we have gone backwards for the past 100 years. Evolution has worked in reverse. There ain't no big theory of [INAUDIBLE] There is retrogression. We have gone from a system of individual responsibility for financial outcomes to a collective responsibility.
And we have gone from a more or less disciplined Bretton Woods regime to a kind of make your own adventure, print your way out of it fiat system that has actually astounded even those who thought it was unbalanced and rather out of control 10 years ago. So what about it? What do you say? Have we not net gone backwards? And this will be the next question of how the heck do we get out of this, and where do we go from here? But what about it? Would you agree? WILLIAM R. WHITE: I've been writing about this for sort of long periods of time and basically have come to the conclusion that both the monetary regime and the regulatory regime are unsustainable. And the monetary regime, really all the stuff we've been talking about, which is that if you're going to cycle after cycle use monetary stimulus and debt accumulation to move forward when the debt accumulation in the end means you're moving backwards, it's not sustainable. The regulatory side seems to me to be much the same. And there's a kind of, again, a kind of convoluted process that leads you to a place where you don't want to be.
So you start off by saying, there's runs on banks. And I'll get back to that in a second. There's runs on banks. Well, that's costly, so we have to have safety nets to stop that. And you say, oh, but safety nets, that's moral hazard.
Well, to deal with the moral hazard, we have regulation. But the regulation just breeds evasion. And then you have the secondary banking system, you get to run in the secondary banking system. You say, oh, gee whiz, we need safety nets. So you extend the safety net as they did the last time around.
And this has been going on for 200 years. And so it continues, and now we've got the asset management companies, where the sort of evaders have gone to, and we'll wait and see how it works out. But the whole point is that it's fundamentally a path that is not sustainable.
And we got on the path, some people would say, because the banks where this whole thing began were put in a position where there wasn't enough capital to convince everybody that there was no need to run because it was enough capital to support the institution. So I think that was a big mistake way back when. I can remember in the UK when they sort of went from these sort of mutual companies to limited liability companies-- when the banks, for example-- who was it who had that interview with Barron's and basically said the basic mistake in the States was when they let the big banks basically issue shares and got rid of the responsibility of the owners to back any of the losses. There's a lot to be said for that. JIM GRANT: There was one lonely general partnership left the city of New York's financial community, that's the Brown Brothers Harriman. WILLIAM R. WHITE: It's the only one left, eh?
JIM GRANT: The partners go to sleep at night knowing that they, their houses, their golden retrievers, and their Picasso's are at risk to the liability holders and partnership. By the way, it's precious little liability. WILLIAM R. WHITE: Yeah, yeah.
Well, it's all Doctor Johnson again. When a man is to be hanged in a fortnight, depend upon it. It concentrates his mind wonderfully.
So if you know you're going to lose everything, those 12 guys again and women will sit around the table and have a really deep think about what it all might mean. I'm sympathetic to that. And now what's the way out of it? I mean, for a starter, if we do have a huge debt overhang problem, and I believe we do-- and we're seeing it now, for example, in the emerging markets, not least in the low income countries where the implications of trying to maintain debt service in the middle of a COVID pandemic is, well, leave it to your imagination to figure out what the implications of that will be. But debt restructuring is very important in the current circumstances, before even thinking about where we go from here. And I know from my own personal experience that WP1 at the OECD has been all about inadequate bankruptcy and restructuring laws for years.
The G30 wrote a piece here about two years ago I think about, again, the same range of territory. The IMF has been on about it. Carmen Reinhart has been writing about it for years. Our procedures, our judicial administrative procedures for dealing with debt, and not least sovereign debt, through which there are no agreed principles-- even principles, much less practices. We've got huge problems there.
And nobody seems to be willing to address them in a serious way, because I guess if they do, they're implicitly saying we might actually have to use these procedures. And they don't want to admit that that's the endgame. But it is the endgame. And we should be getting on with improving all of those procedures to restructure debt. In a nutshell, orderly debt restructuring is an awful lot less costly than disorderly debt restructuring. JIM GRANT: Right.
But how is the very concept of orderly debt restructuring going to play in a market in which credit spreads are still very tight and the level of nominal interest rates so very low? Is there not going to be a quick rethink of what people are paying for these securities, and perhaps the beginning of a bear market in sovereign credit? WILLIAM R. WHITE: Clearly, it's a worry when you start moving from one regime to the next. I talked earlier on about it's debt deflation coming down the road. Oh, whoops, no it's not. It's inflation. JIM GRANT: Something like that-- something like that.
WILLIAM R. WHITE: Like it says in the Bible, in the twinkling of an eye. Well, it may well be the same thing with regime change with respect to debt restructuring. One minute, it doesn't seem like it's an issue, the next minute it's plausible it might happen. And I'm out of here. And I have no answer for that.
I guess what I might say is that I hope an awful lot of work is going on, as the French would say, [NON-ENGLISH SPEECH] in the off the scenes to do with debt restructuring and getting things ready for a different world that people are not talking about. But I'm not sure that that's happening. I don't know. JIM GRANT: Might this be the post-Jubilee world. WILLIAM R. WHITE: Post-Jubilee world.
JIM GRANT: Yes, after student loans, sovereign debt, and the like is forgiven, do you see anything like a massive movement, a coordinated movement on haircutting debt or forgiving debt? WILLIAM R. WHITE: I think that's the great problem, and it's always been the same, right, is in a sense, the free rider problem, which is that everybody knows that if they were to all cooperate to get an orderly debt restructuring, they would all wind up better off than if they had a disorderly restructuring. But everybody's hoping that everybody else will get together and solve the problem and they'll be the last man standing. And judgments, for example, like the M and L against Argentina, didn't exactly help, because it indicated that if you were the last man standing, you'd get paid out.
And so now there's this great tendency for everybody to say, why should I cooperate? I'll just stay staying uncooperative. And at the end of the day, I'll wind up getting all the money. And when you've got a world in which you've got private creditors, public creditors in the advanced countries, and now the not unimportant presence of Chinese creditors now playing out in the Zambian case, everybody is basically inclined to say, why should I cooperate to the benefit of the other guy? I'm not saying what we're facing is going to be easy.
All I'm saying is it seems to me it may be the only way to proceed. JIM GRANT: Bill, I wanted to ask you about this business about record levels of debt. There are those in the financial community who would say, yes, record levels of debt, and record levels of assets. And there is a body of contention, if not a rigorous theory, called Modern Monetary Theory that goes back, I guess, their heyday was the 1940s. Abba Lerner wrote essays that were very cogent and seemed very persuasive. And indeed today, they do persuade.
WILLIAM R. WHITE: Do you remember in the original-- this is all sort of hearsay, it's an essay that I read a little while ago about that period-- Abba Lerner apparently said what he said at a meeting in Washington apparently. And Keynes was there. And Keynes listened to Lerner and he said something to the effect of, no, that's just humbug.
The government debt can't rise forever. That's what he said. JIM GRANT: Yeah. Well, Stephanie Kelton, who is the doyen of Modern Monetary Theory has a comeback to that.
They attacked her with the Keynes line. I thought the Keynes line was, it sounds good, but god help us if it ever gets implemented, I think something like that. But anyway, so the essence of this is, of course, that one of the main-- if you're a monetary sovereign, if you have control over your own currency, you can, with an especially compliant central bank, create interest rates such that debt is never a burden.
And you must remember [INAUDIBLE] federal debt is somebody's asset. So we owe it to ourselves, in effect. This idea has gotten traction. And what's your comment? And what does it say about the intellectual zeitgeist that this has become rather a popular meme. WILLIAM R. WHITE: Well, the first point to make about assets and liabilities is that most of the liabilities are fixed nominal principal repayment that always stays the same in nominal terms.
Whereas the value of the assets, as we well know, can fluctuate significantly. My recollection, and I bow to your historical studies greater than my own, is that during the Great Depression, that stock prices fell 90%. In Japan after the great Japanese contraction, stock prices fell 90%. But the liabilities were still there. So that's point number one.
On Modern Monetary Theory, in a sense, the dangerous part about MMT is that what they are recommending at the moment is precisely what I think most people would say needs to be done, which is monetary policy having, in a sense, outlived its effectiveness, we now need fiscal policy to sort of fill in the cracks. And that fiscal policy will be made more effective by interest rates staying low. And so we say, OK, that's fine for the immediate future. But this is where the problem-- and we talked earlier on about extrapolation. In order to do stuff that works, and people have a tendency to say, well, more of it will work even better. It's like 12 drinks after two drinks.
The difficulty will be going forward with this kind of hypothesis, because Modern Monetary Theory as far as I can understand it-- and I haven't read Kelton's book yet, but I certainly will do-- I read along sort of other stuff-- Randall Wray's stuff and others-- the emphasis on inflation, it goes back to what I was talking about before with complex adaptive systems. There's sort of a sentiment that inflation is the only thing to worry about, and it is easily controllable. And I would say on both counts, they're wrong. Let's start with, is it easily controllable? I think in a world of fiscal dominance-- and I said this earlier on in this conversation-- in a world of fiscal dominance, where the fiscal system is becoming more and more unsustainable, you're back into a Sergeant Wallace world.
You remember the famous article by Sergeant Wallace back in the early 1990s, I think, and it was called, rather ominously, some unpleasant monetarist arithmetic. And basically what it said was just cause you think you've got the money supply under control if the fiscal situation is bad enough, it will finish by blowing you out of the water. And I think that's exactly the kind of thing that could happen. So inflation is not easily controllable, necessarily controllable. And secondly, it's not the only thing to worry about, because we're continuing now with this Modern Monetary Theory.
The basic idea is very-- supplemented by fiscal expansion. But the very easy money is the thing that is creating all of the problems, the unintended consequences, that we were talking about before. So it's still more of still more of the same that's already led us to a place where we don't want to be. So I look at it as at the moment, it seems to be giving a policy prescription that is sort of what lots of other people would say, perhaps including myself. But it's the future that bothers me. We've sort of gone one step further down a path that we don't want to go down, and we should be thinking very seriously, reflecting on its unsustainability of how we get off that path and then how we set up a new system so we don't ever do this again.
JIM GRANT: Of course we'll do it again. We're human beings. Hey, bill, you know what journalists do for a living? They ask rude questions.
All right, what are you doing with your own money? Come on. WILLIAM R. WHITE: I was in Switzerland for 25 years, and basically I had a barbell strategy. So I was heavily into property and cash, effectively. And I've been sort of pushing the idea for a long period of time that this would all come unstuck. And as I said to you before about the narrow path, basically, you could fall off one direction or another.
And I had the cash for the deflate-- cash and bonds, right-- deflation and property is inflation. JIM GRANT: That's one indiscreet question. The second indiscreet question, perhaps given your time in the central banking world-- if you were running the Fed now, which for all I know you might be-- it's a strange year 2020-- but if you were running the Fed, what would you do? WILLIAM R. WHITE: I would be spending a lot of time at the Treasury trying to get them to formulate and then communicate their policy for dealing with the Federal debt overhang over time and restoring the assurance of stability, not just to the American people, but to everybody else.
Because you've got to remember-- I mean, you know this as well as I do. The dollar is still at the heart of everything in terms of international commerce. And if we have a serious problem with respect to the dollar and its role in the international financial system, everybody's got a problem. So that would be my advice-- trying to get this thing under control, advising attempts to restructure private sector debt in the measure that it can be done. And then gradually-- and I say, gradually-- starting to reestablish more normal monetary conditions.
So I guess my order would be for better or for worse, we're in a place where we don't want to be. I guess I would say we should be thinking about orderly debt restructuring. We should then be thinking about restoring financial monetary normality. And then we should be thinking about fiscal restraint when the situation is under better control. Can anything go wrong in the path? Absolutely.
JIM GRANT: Well, normal monetary conditions would seem to imply a funds rate closer to 4 than to 0 or 3 to 0. But last time the Fed tried to left the funds rate, the stock market broke and the Fed came out and said, oops, sorry about that. So it seems-- anyway, that's it. Hey, Bill, does the name Felix Somary-- S-O-M-A-R-Y-- mean anything to you? Felix was your predecessor.
Felix was a guy who made a reputation for himself as one of the great prophets of the 1920s, 1930s. So he was a private banker-- called him a political meteorologist. And he worked for an outfit called Blankhart and Company in Zurich.
This comes to me from a very good book called 1931 by Tobias Straumann-- S-T-R-A-U-M-A-N-N. And in this book, Somary was studying at the University at Vienna and he worked as an assistant to Carl Menger, the great Austrian economist. So Somary was a banker who tried to tell people that the debt restructurings after World War 1 were, in fact, fundamentally and tragically flawed and that there would be hell to pay for it. And that the prosperity of the '20s was to just that degree, rather, an illusion than a fact. And he made a name for himself by being a calamity howler, and he encountered Keynes in 1926, and Somary told Keynes that, no, he was not actually talking about stocks.
What he wanted Keynes to understand was that there would be a reckoning for the bungled debt reordering of the late teens and early '20s. And Keynes was skeptical and said, we will not have any more crashes in our time. So this gets me to my question to you. Keynes said-- one more preliminary salary-- was taxed in the summer of 1929 at a banker's conference in Europe by none other than Charles E. Mitchell, who was the head of what is today Citicorp. And even then, Citibank was accident prone.
And Mitchell said it too Somary-- he said, always bearish, always wrong, and he called him the raven of Zurich that's Mitchell, raven of Zurich. So you're like the raven of Toronto. OK, so here's what Somary said about his experience. He said, quote, "in the '20s, I was completely isolated. And my urgent warnings to governments as well as to the business world were universally held against me," close quote. Is that you? Was that you? WILLIAM R. WHITE: No.
The honest truth is I have been on-- I was, again, making a presentation at the AEI, for example, about a year ago. And I was on the second half of the program, and Alan Greenspan was on the first half. And he was sitting in his office, and I went in to say, hello, to him, and he was absolutely delighted to see me, I'm pleased to say. And other people that I've known well over the course of the years at the Fed-- Don Cohn, in particular, whom I've known for many, many years, always been on very good terms with all of them. But we've just chosen over a long period of time to have a different interpretation of the way the world works. So I would say I've been not so much vilified, as ignored.
JIM GRANT: Yeah. Well, that happens. So something else that Somary said, he told his son once, when I sense the future in my bones, it is not only about knowledge. It is signaled not in my head, but in my marrow. Anything to that? WILLIAM R. WHITE: Yeah, absolutely. It's intuition in some fundamental sense.
And you referred to Homer's study of interest rates over the centuries. When you see something happen that has never happened before, like $17 trillion worth of debt that has a negative yield, it's your gut that tells you that there's something wrong here. And for years and years at the BIS, we used to talk about imbalances.
And what did we mean by, imbalances? And the honest truth was that it wasn't as well-defined as the model builders would like it. I think we used to describe it as a sustained and significant deviation from norms that had no obvious explanation. JIM GRANT: No wonder you note he was mad after-- you spoke in euphemisms. OK, this brings me to the promised portion of this interview having to do with the fraught years of 2002, 2003, 2004, 2005 when these imbalances, shall we call them, were building. And they seemed to be building in plain sight of every sentient human being, except almost everyone turned a blind eye. Tell me about the arc of your learning.
When did you catch on? Describe the build-up of your realization about the dimensions of our troubles. And when did it strike you this was really, really bad? WILLIAM R. WHITE: Well, I think my concern about debt and imbalances, things that are not in the standard models, it really goes back to the late '80s and the early 1990s, even before I came to the BIS. And it really had to do with observing Japan.
And I remember when I was the Deputy Governor International at the Bank of Canada, I had a file on Japan that was like this. And it struck me at the time that some really bad things could happen, even when-- and at this point, the Bank of Canada was already committed to an inflation target. And really, I think we pronounced an inflation target, I think, three months after the Bank of New Zealand. So we were early in the game inflation targeting. But even at that, I was looking at the Japanese thing, and what struck me was that these people had a huge current account surplus.
They had no inflation to talk about. And they still got themselves into a huge problem. And that sort of got me starting to think about, how does that happen? And you then sort of went on thinking about the Great Depression. You know better than I, there was no real inflation in the 1920s, right? There was no inflation in Southeast Asia before the Southeast Asian crisis.
So all of this stuff about if you just keep inflation under control, everything will be fine, to me, was just common sense. JIM GRANT: Bill, doesn't this speak again to the lack of confidence in our monetary masters and the institution of price discovery? They are deathly afraid of deflation, which I suppose is part and parcel of the debt pyramid that they have been instrumental in building-- or certainly in helping to promote. WILLIAM R. WHITE: This is a thing, actually. I think this was a mistake that was made that goes back, really, to the 1980s.
And again, it's a kind of analytical problem. And this is part of the Goodhart, Pradhan book, of course-- a good chunk of it. But the BIS has been saying something very similar, really, since the middle of the 1990s, which is that the world was on a disinflationary path, largely because aggregate supply had shifted outwards under the influence of globalization, and baby boomers in the advanced market economies. We had a huge positive supply shock.
And there was a whole pre-war literature on this stuff about, what's the appropriate monetary response to positive supply shock, productivity shocks? And there was a big debate about we know real wages have to go up with productivity growth. Well, real wages are W over P. Should W go up and the P go down, or should W stay constant and the P go up? Sorry, I got that backwards-- the other way around. Should the wages go up or should the prices go down? And we've decided the wages should go up. But I think in retrospect, it probably would have been better to let the prices fall in the context of increased productivity arising from that positive supply side shock.
JIM GRANT: Isn't the history of capitalism one of positive supply shocks owing to the persistence of innovation and enterprise? And some of the great prosperity of the late 19th century would have been characterized, not present day, under this analytical regime as one of a very worrisome deflation, right? And central banks would have been in there printing away and pressing interest rates lower. So I wonder, Bill, now that I think of it, I recall now that there was not one single economist on the staff at the Bank of England until-- was it Governor Normand swore a big one in. He said, all right, your job is not to tell us what to do, but to explain to us why we did it. WILLIAM R. WHITE: A very famous line, actually, one of his advisors. JIM GRANT: They all said it was not, of course, automatic.
But the points about the exaggeration was somewhat self-governing. And the very absence of meddling would seem to have explained some of that success. Of course, there were drawbacks, but some of the success of that regime.
And now we have central banks with these computers and with these staffs and with this brain power. And there is an unending temptation, to which everyone seems to be [INAUDIBLE] to devise new techniques to intervene and manipulate and forestall trouble. And again, are we not going backwards? And so you have said that we ought to prepare for some reset of our way of thinking. And how about, again, reverting to the coincidence of three great anniversaries-- rethink the nature of money, which brings me to the question about modern money-- not Modern Monetary Theory, but modern money. And do you put any stock in the progenitors of Bitcoin who say, what is wanted is a finite stock of something that can't be replicated through government intrusion and something that is truly modern, and it's used like that. And so do cryptocurrencies answer some of your concerns about the next thing to happen? WILLIAM R. WHITE: To be honest, I haven't thought as much about crypto experiences as
I should have done. But I guess the thing that strikes me, and I mean did a number of years ago, I think it's all very well to say that in some longer term sense, Bitcoin keeps its value in terms of purchasing power, because there's a limited number of them that are going to be produced. But we know already, I think there's hundreds of these cryptocurrencies out there. So then the question becomes, have you got something that is in short supply and therefore maintains its value? Or have you got something that is easily substitutable by something else? Which, of course, is the problem that we've got with money as we define it at the moment.
There's so many different ways in which you can create stuff that looks like money and acts like money, which was the death of monetary targeting. You remember that back in the 1970s. JIM GRANT: Vividly.
WILLIAM R. WHITE: The Bank of Canada was very much preoccupied with that too. JIM GRANT: Remember shift adjusted M1D? The Fed had leapt through these hoops to define evermore narrowly the relevant monetary aggregate. And every Friday at 4 o'clock, the Dow Jones bell would ring, announcing some significant-- I guess Thursday, not-- or Friday, announcing some immensely important piece of news from the monetary authorities. It would be that shift-- M1 A or B had risen $14 billion. Subsequently, it'd be revised to a decline of $14 billion.
WILLIAM R. WHITE: It was how many angels-- how many angels. I did a big piece for the Bank of Canada back around 1976, '77 on monetary aggregates and their estimating demand for money functions-- different aggregates and different set of instruments to control them. But somebody reviewed it. And I can't remember who.
And they said, Mr. White has done everything with his data except take it down to the basement and beat it with a rubber hose. But it's the same kind of thing. You do a million regressions to get one that satisfies all the tests. And it was only later that I sort of realized, I mean, it's the same kind of thing as the analytical foundations of central banking. It was only later that I realized that it was an empirical farce.
If you keep on doing regressions long enough, you'll come up with one that satisfies every possible criterion. Nonsense. Simple as that. It is difficult as you look at where we are to see an easy way out of it.
I suspect that there will be attempts in various places to go back to the post-World War 2 approach, which is basically to try to engineer a moderate degree of inflation while at the same time keeping interest rates down through administrative and other kind of regulatory procedures. That may be the way in which we will manage to get the debt service burden down to a reasonable level, even when evaluated at quote unquote "normal interest rates." But even that in itself is a process that will be very difficult to do.
JIM GRANT: Does it not strike you as a form of theft? This whole business-- this phrase, financial repression, that people toss around so glibly, this involves taking from the saver in the interests of stabilizing a regime that has been mismanaged by arsonists cum firemen, the central bankers-- WILLIAM R. WHITE: Jim, I think the point is that the theft has already taken place. It's just that in a certain sense, it has to do with the signs, OK? You think about theft as all of a sudden, it's negative. I've lost something.
But the honest truth is you think you have something which, in fact, you do not have, because it has no value. So we're all living under an illusion of all of these assets that are actually worth what we say they're worth, and they're not. That's where the threat. In some fundamental sense, the theft has already occurred. The only question at the moment is, how do you allocate the losses? And of course, in a world where everybody is going to say, not me, that's going to make it very difficult.
JIM GRANT: Bill, is there enough gold to go around? WILLIAM R. WHITE: I haven't looked into the numbers, but my understanding is the price of gold would have to go to a very high level indeed to make it a suitable base for today's monetary system. JIM GRANT: Yeah. All right. Well, Bill White, what a pleasure it has been to be in your transAtlantic company.
WILLIAM R. WHITE: Well, it's been a huge pleasure for me too. And sadly, talking about things that are not so pleasant. But anyway, as the English would say, you have to laugh.
JIM GRANT: Ladies and gentlemen at "Real Vision," we have been in the company of the man who feels the future in the marrow of his bones. Bill White, thank you again. WILLIAM R. WHITE: It's been a pleasure, Jim.
Thank you very much for hosting me. JIM GRANT: Bye bye. WILLIAM R. WHITE: Bye. NICK CORREA: I hope you enjoyed this special episode of the Interview, the premier business and finance series in the world.
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2020-12-23 13:36
