WEBVTT - How Private Sector Balance Sheets Changed Recessions 0:00:11.920 --> 0:00:16.200 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:16.320 --> 0:00:22.840 I'm Joe Wisenthal and I'm Tracy Alloway. Tracy, obviously, we're 0:00:22.880 --> 0:00:25.520 in a moment in which there's a lot of debate 0:00:25.600 --> 0:00:29.760 about whether we're headed for an imminent recession, maybe in 0:00:29.800 --> 0:00:34.479 the next few months or maybe in the next year. Right. 0:00:35.080 --> 0:00:38.040 I think we're recording in the week that Jamie Diamond 0:00:38.159 --> 0:00:41.239 was talking about how we're definitely heading for a recession. 0:00:41.400 --> 0:00:44.880 The only question is timing, which is kind of always true, 0:00:45.040 --> 0:00:48.080 I guess, but it definitely feels like the chorus of 0:00:48.240 --> 0:00:52.640 people talking about a potential recession is getting louder. Yeah, 0:00:52.680 --> 0:00:56.600 between the trade war, the curve and version which as 0:00:56.640 --> 0:01:00.520 of right now is actually uninverted. Uh, some we data 0:01:00.680 --> 0:01:06.080 in the US. Uh, there's clearly we're back on recession watch. 0:01:06.200 --> 0:01:09.880 There's no real doubt about that. But as you point out, 0:01:10.200 --> 0:01:13.080 we're always heading for recession, and Jamie Diamond point out, 0:01:13.760 --> 0:01:16.000 it's only it's only a matter of time. At some 0:01:16.040 --> 0:01:18.680 point we'll have another one. So to say we're headed 0:01:18.720 --> 0:01:21.560 for one but we don't know why, it's kind of obvious, right, 0:01:21.560 --> 0:01:24.320 And I think we're still in the longest economic recovery 0:01:24.480 --> 0:01:27.880 on on record now, right, So we're kind of do 0:01:28.240 --> 0:01:32.400 for something to happen. But I think there's a more 0:01:32.440 --> 0:01:38.640 perhaps interesting and consequential question for investors in the economy 0:01:38.840 --> 0:01:45.600 than merely when will the recession happen? What's that? Well, 0:01:45.840 --> 0:01:49.320 I think the bigger question is when the recession hits, 0:01:49.360 --> 0:01:52.480 what's it going to look like? Because we've been scarred 0:01:52.640 --> 0:01:57.680 recently or recent recessions have all been pretty brutal in 0:01:57.760 --> 0:02:00.920 some sense. So if you think about the recession that 0:02:00.960 --> 0:02:04.200 started in two thousand seven, the financial crisis that was horrible, 0:02:05.200 --> 0:02:09.440 the recession that came after the dot com boom, it 0:02:09.480 --> 0:02:12.640 wasn't really devastating overall, and it was kind of quick, 0:02:12.680 --> 0:02:15.520 but you know, it was a tremendous loss of wealth 0:02:15.600 --> 0:02:18.880 due to the crash in the stock market. And prior 0:02:18.919 --> 0:02:22.880 to that, we had a recession, uh, following the savings 0:02:22.919 --> 0:02:26.680 and loan crisis. So we don't have we don't seem 0:02:26.760 --> 0:02:30.200 to have these sort of old style recessions anymore. They 0:02:30.240 --> 0:02:37.320 always seem to be accompanied by something big in systemic Well, 0:02:37.480 --> 0:02:41.400 people who talk about recession now do seem sort of 0:02:41.440 --> 0:02:44.160 oddly hopeful that the next one is going to be 0:02:44.200 --> 0:02:46.880 what they call a shallow recession. Right. You hear people 0:02:46.919 --> 0:02:49.119 who talk about it every once in a while and say, 0:02:49.360 --> 0:02:52.880 just because it's a recession, that doesn't mean it's going 0:02:52.919 --> 0:02:56.000 to be like two thousand eight all over again. We 0:02:56.040 --> 0:03:00.000 can have a contraction in economic growth without a huge 0:03:00.280 --> 0:03:03.680 crisis in the financial sector. But I think what you're 0:03:03.680 --> 0:03:06.840 getting at is whether or not that's true, and whether 0:03:06.960 --> 0:03:10.720 the examples of recession slash financial crises that we've seen 0:03:10.800 --> 0:03:15.480 over the nearest past decades suggests that that maybe that 0:03:15.520 --> 0:03:18.360 can't happen anymore. Yeah, this really is the big question. 0:03:18.400 --> 0:03:22.000 Like we don't want to be too um, I guess 0:03:22.040 --> 0:03:25.000 scarred by recent events to say, oh, every recession now 0:03:25.080 --> 0:03:28.160 is going to be a crisis. But on the other hand, 0:03:28.680 --> 0:03:31.440 we don't want to dismiss the fact that, uh, the 0:03:31.480 --> 0:03:34.240 sort of old business cycles is we know them have 0:03:34.480 --> 0:03:38.800 given way to financial market cycles, and that sort of 0:03:38.920 --> 0:03:41.240 is seemed to seeming to be the main driver, and 0:03:41.240 --> 0:03:44.640 in fact, you know, there's not novel concept. Jerome Powell 0:03:44.760 --> 0:03:47.920 at Jackson Hole two summers ago kind of said the 0:03:47.960 --> 0:03:52.240 same thing that whereas the FED on our traditional models 0:03:52.480 --> 0:03:57.360 think about trade offs of inflation and jobs and the 0:03:57.480 --> 0:04:00.960 sort of very sort of standard view of the economy 0:04:01.000 --> 0:04:04.320 overheating and then slowing down. The real game in town 0:04:04.920 --> 0:04:08.000 is what happens with asset prices and how it declined. 0:04:08.000 --> 0:04:12.600 An asset prices uh spills over into real economic activity. Right, 0:04:12.640 --> 0:04:16.160 So if you think that the economy has become financialized, 0:04:16.200 --> 0:04:19.160 which a lot of people do seem to think nowadays, 0:04:19.200 --> 0:04:22.520 then it would stand to reason that when we get recessions, 0:04:22.520 --> 0:04:26.440 they're going to be financialized as well. I like this topic, joke. 0:04:26.720 --> 0:04:29.000 I like this topic too, and we have the perfect 0:04:29.640 --> 0:04:32.560 guest for it today. Today we're going to be speaking 0:04:32.600 --> 0:04:37.280 with David Levy. He is the chairman of the Jerome 0:04:37.360 --> 0:04:40.560 Levy Forecasting Center, and you recently came out with a 0:04:40.640 --> 0:04:45.160 very interesting report called Bubble or Nothing, and it talks 0:04:45.200 --> 0:04:49.200 about how the private sector swelling balance sheets compel increasingly 0:04:49.320 --> 0:04:53.960 risky financial behavior and it really addresses the role, the 0:04:54.080 --> 0:05:00.400 growing role that financial assets themselves play in the economy 0:05:00.440 --> 0:05:04.280 and in economic cycle. And so maybe in this conversation 0:05:04.400 --> 0:05:07.359 we'll get an answer to can we have old fashioned 0:05:07.400 --> 0:05:12.279 recessions or we doomed to have big crises or many 0:05:12.400 --> 0:05:15.800 crises that are a result in swings and prices. So 0:05:15.839 --> 0:05:18.800 without further Ado, I want to bring in David Leaving. 0:05:19.400 --> 0:05:22.200 Thank you Joe, and Hi Tracy, and thanks for both 0:05:22.200 --> 0:05:25.520 of you for having me here. These podcasts are just 0:05:25.560 --> 0:05:29.840 such a refreshing change from the SoundBite world. We spend 0:05:29.839 --> 0:05:33.440 too much time and I'm really excited to think this 0:05:33.480 --> 0:05:35.720 is a great topic. Hand you on TV a couple 0:05:35.760 --> 0:05:38.599 of weeks ago and we talked for like six minutes, 0:05:38.680 --> 0:05:40.160 but it's so deep. I was like, we gotta have 0:05:40.240 --> 0:05:42.240 them back and actually do something really deep because it's 0:05:42.279 --> 0:05:46.119 such an important topic. But just to start off, would 0:05:46.160 --> 0:05:49.560 you say that our sort of characterization of the evolving 0:05:49.640 --> 0:05:52.200 nature of recessions is correct. Whereas in the old days 0:05:52.720 --> 0:05:56.840 you think about the economy overheating, maybe factories built too 0:05:56.880 --> 0:06:00.160 many widgets, there wasn't demand for widgets, the factory had 0:06:00.200 --> 0:06:03.000 to lay off some workers for a few quarters. They 0:06:03.080 --> 0:06:05.800 draw down the inventory of widgets than they build up 0:06:05.880 --> 0:06:08.760 them up and everything is back again. That just doesn't 0:06:08.760 --> 0:06:11.000 seem to be the way cycles work. I agree very 0:06:11.040 --> 0:06:13.120 much with with with the thrust. What you're saying, I'm 0:06:13.120 --> 0:06:15.200 going to try to paraphrase a little bit by saying 0:06:15.640 --> 0:06:19.760 what has changed is that as private sector balance sheets 0:06:19.760 --> 0:06:23.200 have become larger and larger relative to GDP, relative to 0:06:23.320 --> 0:06:26.920 personal income and in which sector are we're looking at. Uh, 0:06:27.080 --> 0:06:31.760 they have increasingly dominated the cycle. So things like balance 0:06:31.760 --> 0:06:35.159 sheet effects such as wealth effects when the stock marker 0:06:35.240 --> 0:06:38.520 goes up or down a lot, major refinancing effects when 0:06:38.520 --> 0:06:40.800 there's vast amounts of debt they get refinanced at lower 0:06:40.880 --> 0:06:43.960 rates and people pull cash. These things have started to 0:06:43.960 --> 0:06:47.320 play a much bigger role. But also, you know, it's 0:06:47.320 --> 0:06:50.680 important to realize balance sheets have been involved in the economy. 0:06:50.839 --> 0:06:53.640 Their expansion is an essential part of how economies works. 0:06:53.960 --> 0:06:57.880 Economy cannot generate profits without balance sheets expanding. This gets 0:06:57.880 --> 0:07:00.240 into the flows of funds that give us profits. It's 0:07:00.400 --> 0:07:03.360 what we call the sources of profits um. And it's 0:07:03.400 --> 0:07:07.320 it's a process that is is perfectly natural and normal. 0:07:07.640 --> 0:07:11.760 The problem is balance sheets having grown faster than income 0:07:11.880 --> 0:07:14.240 for really since the end of World War two, a 0:07:14.320 --> 0:07:16.640 little bit on and off, but but pretty much, uh, 0:07:16.840 --> 0:07:19.600 most of the time. We've got to the point eventually 0:07:19.600 --> 0:07:22.200 by the eighties where these balance sheet effects were starting 0:07:22.240 --> 0:07:26.680 to be distorting, and that has become more and more extreme, 0:07:26.720 --> 0:07:28.640 and that is why we see a lot of the 0:07:28.680 --> 0:07:31.640 distorces It's why interest rates were forced down is by 0:07:31.640 --> 0:07:35.680 the supporting these top heavy financially top heavy economies. It's 0:07:35.720 --> 0:07:39.080 why rates of return were forced down. It's why, Uh, 0:07:39.200 --> 0:07:41.880 there's a massive amouss of wealth that swings of which 0:07:41.880 --> 0:07:45.360 are have huge influence on on people's behavior. And and 0:07:45.400 --> 0:07:47.920 that's really, uh, the new world where and it's not 0:07:47.920 --> 0:07:50.400 when we're gonna be in forever, but that is the 0:07:50.400 --> 0:07:54.800 one we're in now. So, David, you're saying that these 0:07:55.040 --> 0:07:59.040 big balance sheets basically mean that wealth has become more 0:07:59.400 --> 0:08:03.760 important and sort of bigger relative to income, and that 0:08:03.800 --> 0:08:07.160 means that wealth slash balance sheets have an outsized effect 0:08:07.160 --> 0:08:10.440 on the economy. But how did we actually get to 0:08:10.640 --> 0:08:14.679 that place? Why in the nineteen eighties did balance sheets 0:08:14.720 --> 0:08:16.720 start growing in this way? If we go back to 0:08:16.840 --> 0:08:18.440 the end of World War Two, we've just been through 0:08:18.760 --> 0:08:22.080 fifteen years of depression and war, and balance sheets were 0:08:22.160 --> 0:08:25.080 extremely low. There was no one had done much investing, 0:08:25.120 --> 0:08:27.480 they hadn't been really been, They hadn't wanted to in 0:08:27.520 --> 0:08:31.440 the depression, they hadn't been allowed to during the war. Uh, 0:08:31.480 --> 0:08:33.840 there was a huge pent up cash. All the debt 0:08:33.840 --> 0:08:36.240 had been pretty much paid off or going bad by then. 0:08:37.040 --> 0:08:38.840 And at the end of the war, we had this 0:08:38.920 --> 0:08:43.520 tremendous boom rebuilding, and this meant expanding balance sheets. We 0:08:43.559 --> 0:08:46.240 had asset prices that were depressed by all the fears 0:08:46.679 --> 0:08:49.959 brought about by depression and then war, and gradually people 0:08:50.000 --> 0:08:52.920 became more comfortable, so we had a normalization that went 0:08:52.960 --> 0:08:55.720 on maybe for up let's say into the seventies somewhere. 0:08:55.720 --> 0:08:58.480 There's no way to draw a precise line, but the 0:08:58.520 --> 0:09:01.120 problem is that there's a certain shore there and this 0:09:01.120 --> 0:09:03.719 this this kept going. I don't have you know, we 0:09:03.760 --> 0:09:05.800 don't try to explain exactly why it had to go. 0:09:05.960 --> 0:09:08.000 We we could have a long discussion about that, and 0:09:08.000 --> 0:09:10.040 there are a lot of reasons to believe that there 0:09:10.760 --> 0:09:12.640 were some forces behind it. But the important thing is 0:09:12.840 --> 0:09:15.200 we know what did happen. And once you get to 0:09:15.240 --> 0:09:19.640 the point where you start to uh, balances are so 0:09:19.679 --> 0:09:21.760 big that to support them, the FED is forced to 0:09:21.800 --> 0:09:25.280 lower interest rates. That it's not you know, housing uh 0:09:25.480 --> 0:09:28.520 just weakening or or or or car sales going down, 0:09:28.559 --> 0:09:31.480 but it's actually you have an asset market that's having 0:09:31.520 --> 0:09:33.880 a negative wealth effect or there are debt problems of 0:09:33.920 --> 0:09:37.000 financial crisis that comes when interest rates go too high. 0:09:37.000 --> 0:09:40.480 Those are the balances now start to take over interest rates. 0:09:40.640 --> 0:09:42.800 I want to talk a little bit about the sort 0:09:42.800 --> 0:09:45.960 of necessary FED response when asset prices go down. But 0:09:46.040 --> 0:09:48.679 before we do, I just want to back up the 0:09:48.760 --> 0:09:52.640 germ Levy Forecasting Center. You talked about how you use 0:09:53.040 --> 0:09:57.600 a sort of sources of profit, sectoral balances or balance 0:09:57.640 --> 0:10:02.120 sheet approach to under ending the economy. Can you just 0:10:02.200 --> 0:10:05.680 sort of talk a little bit more about what makes 0:10:05.920 --> 0:10:10.679 your approach to analyzing the economy distinct? Because when I 0:10:10.720 --> 0:10:13.880 read a lot of like self side research, I typically 0:10:14.000 --> 0:10:17.599 don't see a lot about sources of profits analysis. No, No, 0:10:17.840 --> 0:10:19.959 this is this is There are more people starting to 0:10:19.960 --> 0:10:22.520 pay attention to this. In fact, a piece which we 0:10:22.559 --> 0:10:24.960 give out a complimentary I don't know if I mentioned 0:10:24.960 --> 0:10:28.080 where profits come from. It's just an educational too. I 0:10:28.120 --> 0:10:30.400 know is used by a number of big investment houses. 0:10:30.400 --> 0:10:33.160 They've started to get interested in it. It was introduced 0:10:33.200 --> 0:10:36.800 to the discipline UH in the nineteen thirties by UH. 0:10:37.640 --> 0:10:41.520 To most people an obscure Polish economist who was a 0:10:41.559 --> 0:10:45.040 contemporary of Canes at at Cambridge, but it was that 0:10:45.120 --> 0:10:47.920 was Michael Koletsky. But he had a very left wing 0:10:48.000 --> 0:10:49.720 view of about a lot of things. There's nothing left 0:10:49.720 --> 0:10:53.840 wing about the profits identity. Profits identity of profits equation 0:10:54.440 --> 0:10:57.360 is just a cousin of the very well known savor 0:10:57.440 --> 0:11:02.400 investment identity. You just rearrange the terms because business saving 0:11:03.120 --> 0:11:05.520 is profits after taxes and dividend, so you can turn 0:11:05.600 --> 0:11:08.720 it into a profits equation and that is a much 0:11:09.080 --> 0:11:12.600 better causal way to understand what happens in the econic 0:11:12.960 --> 0:11:16.760 when investment takes place and people decide not to save 0:11:16.800 --> 0:11:20.040 too much. A lot of that the wealth created investment 0:11:20.080 --> 0:11:23.440 that isn't saved by households or governments ends up necessarily 0:11:23.480 --> 0:11:27.400 flowing to business and it becomes profits. So this way 0:11:27.400 --> 0:11:30.400 of thinking, it naturally ties into finance. You don't look 0:11:30.440 --> 0:11:33.439 at real concept. You're looking at financial flows because of 0:11:33.440 --> 0:11:36.520 the importance of investment or saving flows. It ties into 0:11:36.520 --> 0:11:40.200 balancing changes in a very direct way. Just to say, 0:11:40.200 --> 0:11:42.319 how does this different? There are people who are told 0:11:42.400 --> 0:11:46.320 you mentioned sectoral um analysis, where people there's a there's 0:11:46.360 --> 0:11:48.960 a strong tendency among a lot of people to say 0:11:49.000 --> 0:11:52.199 to look at the private sector as a whole, look 0:11:52.200 --> 0:11:55.120 at what is the net balance the private sector. I 0:11:55.160 --> 0:11:59.520 believe it is absolutely essential to separate the corporate sector 0:11:59.640 --> 0:12:04.800 from households because if if household saving goes down, that's 0:12:04.800 --> 0:12:08.199 good for profits, Yet the total may not change. The 0:12:08.320 --> 0:12:11.800 households save and profits go down the total maybe you 0:12:11.800 --> 0:12:14.120 know you're missing critical asset because business is going to 0:12:14.200 --> 0:12:18.319 make the decisions about employment, about investment, and so forth 0:12:18.800 --> 0:12:21.720 when it comes to you know, you argue that basically 0:12:21.720 --> 0:12:26.520 the rising value of assets relative to income pushes down 0:12:26.559 --> 0:12:29.520 interest rates over the long run. Can you walk us 0:12:29.520 --> 0:12:31.800 through why exactly that happens? Is it because of the 0:12:31.840 --> 0:12:35.480 central bank is forced to lower rates to support an 0:12:35.559 --> 0:12:39.920 increasingly financialized economy every time there's a sign of trouble, 0:12:40.040 --> 0:12:43.000 Or is it because the actual rising value of assets 0:12:43.040 --> 0:12:47.400 somehow exerts some sort of force on interest rates itself. Um, 0:12:47.480 --> 0:12:50.200 it's it's it's really what it compels the central bank 0:12:50.240 --> 0:12:54.320 to do. You know, the general story told by probably 0:12:54.360 --> 0:12:56.240 the majority of economists for many years. I don't know 0:12:56.280 --> 0:12:59.000 if it's still people still even be interested. It was 0:12:59.080 --> 0:13:02.120 that the reason interest rates came down under the eighties 0:13:02.120 --> 0:13:06.000 and nineties was because of falling inflation expectations. The Fed 0:13:06.360 --> 0:13:11.000 succeeded in lowering people's expectations, Therefore there was less inflation 0:13:11.080 --> 0:13:13.400 interest rates didn't have to be as high. If we 0:13:13.440 --> 0:13:16.559 look at when the FED made decisions, it was they 0:13:16.640 --> 0:13:21.080 always were raising rates until the when they thought the 0:13:21.080 --> 0:13:23.600 economy was strong and there an inflation was harder they 0:13:23.600 --> 0:13:26.200 wanted to be and they all but they stopped and 0:13:26.240 --> 0:13:29.920 reversed when the economy got into trouble and increasingly that 0:13:30.040 --> 0:13:33.600 trouble was financially related. Now, but the real interesting part 0:13:33.679 --> 0:13:36.000 is what happens when you get into a recession or 0:13:36.040 --> 0:13:39.640 financial crisis. Each time the Fed had to lower rates 0:13:39.760 --> 0:13:44.200 further in order to UH stabilize financial problems. If we 0:13:44.240 --> 0:13:47.320 go back to the UH ninety nineties, when we had 0:13:47.360 --> 0:13:51.760 the underwinding of the commercial real estate bubble, we had 0:13:51.800 --> 0:13:56.160 bicoastal housing bubbles. We also had we had a lot 0:13:56.200 --> 0:14:00.440 of LBO excesses, We were still working through the problems 0:14:00.440 --> 0:14:03.360 from the savings and loan system, and we had a 0:14:03.400 --> 0:14:05.640 lot of of fall out, a lot of balance sheet 0:14:05.640 --> 0:14:08.720 problems over capacity, things that led the Fed to to 0:14:08.880 --> 0:14:11.400 cut rates and not just through the recession, but to 0:14:11.400 --> 0:14:15.400 continue to cut them for another almost another two years 0:14:16.160 --> 0:14:19.160 before the economy finally showed some life. If we go 0:14:19.680 --> 0:14:21.800 back to them going to the next cycle, when the 0:14:21.840 --> 0:14:24.520 tech bubble burst. Instead of going down to three percent 0:14:24.640 --> 0:14:26.240 with the FED funds right, the FED had to go 0:14:26.240 --> 0:14:28.800 all the way down to one percent, again, continuing to 0:14:28.840 --> 0:14:32.320 cut after the recession ended because the economy wasn't responded, 0:14:32.320 --> 0:14:36.080 because the balancie problems, and in the latest case, it 0:14:36.160 --> 0:14:37.800 was clear that they were going to have to go lower. 0:14:37.840 --> 0:14:39.520 And I say it was clear when I When I 0:14:39.560 --> 0:14:41.640 say that, I mean we went out and I did 0:14:41.680 --> 0:14:43.600 something never done before and probably will never do again. 0:14:43.640 --> 0:14:45.600 I started a small hedge fund to do nothing but 0:14:46.080 --> 0:14:48.800 play the the eventual collapse in interest rate, because you 0:14:49.120 --> 0:14:50.960 the FED would have to go to the floor. Now 0:14:51.040 --> 0:14:53.280 we are timing wasn't perfect. Fortunately we ended up doing 0:14:53.400 --> 0:14:56.080 very well. But we I don't want to make sound 0:14:56.160 --> 0:14:59.200 like I'm too clever, because we we We certainly didn't 0:14:59.200 --> 0:15:02.120 do you know time everything thinks lasted loaning, we thought. 0:15:02.280 --> 0:15:04.600 But the point is it was clear that the next 0:15:04.640 --> 0:15:06.760 time there would be even more debt, there would be 0:15:06.760 --> 0:15:10.240 even more asset value of losing it that the FED 0:15:10.240 --> 0:15:12.920 would and the consequences will require even lower rates, And 0:15:12.920 --> 0:15:14.840 the FED was going to run out of room, and 0:15:14.880 --> 0:15:16.960 therefore we had The FED had to keep rates low 0:15:17.000 --> 0:15:21.880 for a long time. So sometimes when the stock market 0:15:21.920 --> 0:15:26.920 starts to fall and suddenly the chatter picks up among 0:15:27.080 --> 0:15:30.440 various ef I see people about rate cuts, and people say, ah, 0:15:30.480 --> 0:15:33.200 there's a FED put under the market and the Federal 0:15:33.280 --> 0:15:35.920 he cares about asset prices, and kind of what you're 0:15:35.960 --> 0:15:39.240 saying is like, that's not even a conspiracy, that's not 0:15:39.320 --> 0:15:41.680 even that's just how the world has to work these 0:15:41.760 --> 0:15:44.280 days with unfortunately or fortunately, and we don't have to 0:15:44.360 --> 0:15:47.240 make any judgments per se. But that is just kind 0:15:47.240 --> 0:15:51.760 of like the required mechanical operations because the consequences of 0:15:51.760 --> 0:15:55.000 falling asset prices in a world of gigantic balance sheets 0:15:55.440 --> 0:15:57.920 more or less leaves the FED. We have to remember 0:15:57.960 --> 0:16:00.640 the FED is is in a in a politic environment. 0:16:00.760 --> 0:16:03.560 And uh, I remember my father, who was in this 0:16:03.600 --> 0:16:07.360 business before me. Uh met with William at Chesty Martin 0:16:07.440 --> 0:16:09.960 and when he was in the FED chair, and he said, look, 0:16:10.240 --> 0:16:12.560 as long as the White House and the Congress disagree 0:16:12.720 --> 0:16:14.600 about what we should do, we can do anything we want. 0:16:15.440 --> 0:16:19.120 Implication being obviously, if everybody thinks you're not doing enough, 0:16:19.200 --> 0:16:21.800 you better do something. When if we think back to 0:16:21.960 --> 0:16:25.320 earlier in this this expansion, why why were people pushing 0:16:25.360 --> 0:16:27.600 for for zero race, Why were they pushing for qui? 0:16:27.640 --> 0:16:30.240 Why were they pushing for more? Because the economy was 0:16:30.320 --> 0:16:33.600 not behavior in a satisfactory way and people were We 0:16:34.120 --> 0:16:36.440 had fiscal stimus, but it wasn't enough and people were 0:16:36.480 --> 0:16:39.000 reluctant to use more. So the pressure was on the FED, 0:16:39.040 --> 0:16:42.720 and the FED was their Their objective is helped get 0:16:42.760 --> 0:16:44.720 the economy going, so that's what they tried to do. 0:16:45.040 --> 0:16:48.160 The problem is the FED, really and I'm really sympathetic 0:16:48.200 --> 0:16:51.400 to the FED because they really face an impossible task. 0:16:51.440 --> 0:16:53.880 Although I'm not sure they always realize it, or all 0:16:54.160 --> 0:16:56.560 all members of the of the Open Market Committee always 0:16:56.600 --> 0:16:58.960 realized it. And that is that on the one hand, 0:16:59.480 --> 0:17:01.520 you know they in order to get the economy going, 0:17:01.560 --> 0:17:05.240 you need to have balance sheets expand rapidly, especially when 0:17:05.240 --> 0:17:07.960 they're already this big, and we can talk about why 0:17:07.960 --> 0:17:11.280 that is. But at the same time, in doing that, 0:17:11.320 --> 0:17:14.080 they're making the balance she's even bigger, creating more pressures 0:17:14.600 --> 0:17:17.280 that are gonna make things worse. We see this very acutely. 0:17:17.359 --> 0:17:19.880 We happened in a very rapid time in China where 0:17:19.880 --> 0:17:23.399 we saw they would constantly turn to opening the credits 0:17:23.440 --> 0:17:26.399 big it's af tremendous debt growth as the economy started 0:17:26.400 --> 0:17:28.439 to need boost here and there. Uh, and then they 0:17:28.480 --> 0:17:31.760 began to realize they were creating something that was completely unsustainable. 0:17:32.040 --> 0:17:33.760 And now they've been back and forth trying to figure 0:17:33.760 --> 0:17:36.200 out how do they stimulate the economy but not create 0:17:36.240 --> 0:17:38.119 too big a bubble, and they're they're not doing a 0:17:38.160 --> 0:18:00.840 really great job of it. So our negative yields on 0:18:01.280 --> 0:18:06.360 debts or securities are those the ultimate expression of this 0:18:06.560 --> 0:18:09.480 lower interest rate dynamic that you're describing, Because when you 0:18:09.480 --> 0:18:12.720 think about negative yielding debt, that's something where the only 0:18:12.760 --> 0:18:15.479 way you're really making money is either through you know, 0:18:15.560 --> 0:18:19.080 some sort of currency hedging or conversion, or by selling 0:18:19.080 --> 0:18:22.479 it onto someone else, in which case it's capital gains 0:18:22.840 --> 0:18:26.520 and not income. So is that basically what the world 0:18:26.560 --> 0:18:28.320 is going to look like if if we keep going 0:18:28.320 --> 0:18:31.439 down this road. Let's start to first talking about the 0:18:31.480 --> 0:18:34.399 negative policy rates, because that that has huge impact. That 0:18:34.520 --> 0:18:40.080 is critical to having negative yields on bonds. If you 0:18:40.280 --> 0:18:43.640 are going to lower interest rates and negative rates, now 0:18:44.560 --> 0:18:47.880 you create a situation where depositors ultimately can be either 0:18:47.920 --> 0:18:50.639 paying fees on their checking accounts or they're can be 0:18:50.640 --> 0:18:54.359 paying negative interests themselves. Uh, And certainly for large depositors, 0:18:54.359 --> 0:18:57.119 this becomes a big issue. So at some point they say, 0:18:57.200 --> 0:18:59.440 all right, uh, or even if we're not being charged 0:18:59.440 --> 0:19:01.760 a feast, now, if these negative rates become more negative, 0:19:01.960 --> 0:19:04.560 we will be. So let's lock in a negative rate. 0:19:04.600 --> 0:19:06.679 So at least we won't we know how much we're losing. 0:19:06.680 --> 0:19:09.800 We won't lose as much as we might lose if 0:19:09.800 --> 0:19:13.680 something else happens. So the expectation of negative short term 0:19:13.720 --> 0:19:17.120 interest rates is critical to having negative views and bonds. 0:19:17.160 --> 0:19:18.919 If you look at the Great Suppression US, we had 0:19:18.920 --> 0:19:23.840 deflation everything else. Yields did not go negative. The couple 0:19:23.880 --> 0:19:27.080 of tining caveats in that which were special circumstances did 0:19:27.119 --> 0:19:31.400 not go negative. Un bonds because people wouldn't take less 0:19:31.400 --> 0:19:34.920 than zero. They've just hold cash otherwise. So the title 0:19:35.000 --> 0:19:37.960 of your of this paper and you talk about is 0:19:38.000 --> 0:19:42.080 bubble or Nothing. The paper details how private sector swelling 0:19:42.080 --> 0:19:46.879 balance sheet compel increasingly risky financial behavior. So private sector 0:19:46.960 --> 0:19:51.720 actors are aware, either directly or implicitly, that we live 0:19:51.720 --> 0:19:54.840 in this balance sheet denominated world in which the only 0:19:54.880 --> 0:19:57.800 thing that sort of drives the cycle is the direction 0:19:58.040 --> 0:20:02.560 that asset prices are going in How does that change 0:20:02.600 --> 0:20:06.960 the behavior of households and firms when we when this 0:20:07.080 --> 0:20:09.359 is what drives the cycle, and how does it compel 0:20:09.720 --> 0:20:13.359 increasingly risky behavior? All right, we we identify nine ways 0:20:13.880 --> 0:20:18.399 where in which the expansion of balance sheet ratios has 0:20:18.400 --> 0:20:20.960 a higher debt to income and higher asset to income 0:20:21.040 --> 0:20:24.960 ratios actually change parameters in the economy that affect decisions. 0:20:25.000 --> 0:20:27.520 But I'll give you a very graphic illustration of what 0:20:27.600 --> 0:20:30.200 it looks like. First, uh I won't take you throw 0:20:30.240 --> 0:20:33.160 on nine. Don't worry, but the the don't check out 0:20:33.160 --> 0:20:35.960 the paper if you're listening. We've tried in the In 0:20:36.000 --> 0:20:39.680 the paper data from the uh I forget the of 0:20:39.680 --> 0:20:44.879 the organization, which the Pension Fund Association, and they show 0:20:45.040 --> 0:20:50.040 that the average target, that is what what the manager 0:20:50.160 --> 0:20:52.920 of that fund is supposed to be achieving on an 0:20:52.960 --> 0:20:56.639 average over the years, was just about just over eight percent. 0:20:57.400 --> 0:21:00.000 At that point, you could get almost a percent, about 0:21:00.000 --> 0:21:03.359 seven point eight percent on a thirty year Treasury didn't 0:21:03.359 --> 0:21:05.600 have to be very imaginative, taken a lot of risk 0:21:05.680 --> 0:21:10.000 in order to hit his target. Now, twenty years later, 0:21:10.040 --> 0:21:14.040 two thousand twelve, that target had barely moved was down 0:21:14.080 --> 0:21:16.879 slightly still about eight percent, Yet the yield on the 0:21:16.880 --> 0:21:22.520 third year bond was so Now how is he he 0:21:22.560 --> 0:21:24.760 can't just say, well, we'll buy some corporate or investment 0:21:24.960 --> 0:21:26.959 a little bit higher yield. Now now he has to 0:21:26.960 --> 0:21:29.560 they have to think of a whole different set of choices. 0:21:30.080 --> 0:21:34.000 There was quoting the I. M. F Uh making statement 0:21:34.040 --> 0:21:36.600 that we're having a problem with low interest rates because 0:21:36.640 --> 0:21:40.520 too many people are investing in in items, in assets 0:21:40.560 --> 0:21:43.119 that are too risky or too a liquid and this 0:21:43.160 --> 0:21:45.520 is going to lead to problems. This is exactly the 0:21:45.560 --> 0:21:48.560 dilemma that comes from balancing. Now again, we talked a 0:21:48.600 --> 0:21:51.520 little bit about interest racing forced down as balances get 0:21:51.520 --> 0:21:54.720 bigger and bigger, that the crises forced the Fed to 0:21:54.800 --> 0:21:59.320 lower rates to keep things stable. And we all also 0:21:59.400 --> 0:22:01.680 one of the things that happens as as as rates 0:22:01.680 --> 0:22:04.160 go lower, asset prices go higher. But what's the flip 0:22:04.240 --> 0:22:08.080 side of that low operating rates of return? If you 0:22:08.119 --> 0:22:10.879 have a low operator rates return, the rent on the 0:22:10.960 --> 0:22:13.080 building relative to the cost of building is low. The 0:22:13.560 --> 0:22:16.080 the dividends are stocks are you know, at a low rate. 0:22:16.359 --> 0:22:20.399 If you're looking to invest for conservatively for income, and 0:22:20.440 --> 0:22:22.880 maybe you'd have a little bit of blue chip equities 0:22:22.920 --> 0:22:26.520 paying paying UH dividends in the past with some investment 0:22:26.520 --> 0:22:28.439 create bonds. Now you can't do it that where you 0:22:28.440 --> 0:22:30.960 have to depend more on capital gains. So one of 0:22:31.000 --> 0:22:32.679 the things this does is it puts a lot of 0:22:32.680 --> 0:22:36.919 people investing in equities who really want UH steady income. 0:22:36.960 --> 0:22:38.560 And that's I think the origin of a lot of 0:22:38.600 --> 0:22:43.480 the pressure on on business managers to meet their quarterly 0:22:43.520 --> 0:22:46.600