WEBVTT - Volatility Suppression Turned The Entire Economy Into One Big Carry Trade 0:00:11.039 --> 0:00:14.680 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.720 --> 0:00:19.000 I'm Joe Wisenthal and I'm Tracy Alloway. So, Tracy, one 0:00:19.040 --> 0:00:21.880 of the things that we've been talking about lately, uh, 0:00:21.880 --> 0:00:25.240 and we really sort of drove it home in the 0:00:25.360 --> 0:00:29.319 last episode was this idea of the entire market kind 0:00:29.360 --> 0:00:33.159 of implicitly looking like it's one trade. So many things 0:00:33.200 --> 0:00:35.919 seemed to go up and down together that while you 0:00:35.960 --> 0:00:39.839 sort of think that, okay, investing should be some search 0:00:40.040 --> 0:00:45.159 for interesting individualized opportunities, everything kind of looks like it's 0:00:45.159 --> 0:00:48.600 it all trades is one. Yeah, that's exactly right. And 0:00:48.760 --> 0:00:51.839 I think there's been quite a lot of discussion at 0:00:51.840 --> 0:00:55.200 this point, including on that last episode, about how the 0:00:55.240 --> 0:00:59.120 market is being generally driven by interest rates a k a. 0:00:59.800 --> 0:01:03.480 The central banks. Right, So, the story that multiple multiple 0:01:03.600 --> 0:01:06.280 guests have told us is that, well, we get into 0:01:06.319 --> 0:01:10.360 this situation, you know, which growth is slow, perhaps due 0:01:10.400 --> 0:01:15.280 to income inequality. That means that asset prices rather than 0:01:15.800 --> 0:01:18.679 sort of actual demand, becomes a key vehicle of what 0:01:18.800 --> 0:01:22.440 drives the economy. That means the central bank then is 0:01:22.760 --> 0:01:26.200 ends up becoming more sensitive to asset prices when it 0:01:26.240 --> 0:01:30.840 comes to easing policy. That few further fuels asset values 0:01:31.240 --> 0:01:35.480 that further exacerbates the inequality problem, that further uh causes 0:01:35.480 --> 0:01:38.120 weakness and growth, that further causes the central banks to 0:01:38.200 --> 0:01:41.200 then act, and that we're like in this spiral that 0:01:41.400 --> 0:01:44.399 you know, by some accounts maybe has gone on four decades. 0:01:44.920 --> 0:01:46.720 And if that's the story, then I would say, you know, 0:01:46.760 --> 0:01:49.920 it really feels like COVID right now is sort of 0:01:49.960 --> 0:01:54.160 a accelerant of that whole process. Yeah, I think that's right, 0:01:54.200 --> 0:01:56.760 And I think it gets to a theme that we 0:01:56.880 --> 0:01:59.160 keep coming back to in all these episodes, which is 0:01:59.600 --> 0:02:05.360 if we are slowly recognizing that the financialization of the 0:02:05.400 --> 0:02:08.200 economy is not a good thing and we're trapped in 0:02:08.240 --> 0:02:10.800 this sort of endless cycle, then how do you actually 0:02:11.080 --> 0:02:13.160 break out of it? And we've had so many of 0:02:13.160 --> 0:02:18.440 those discussions now with proposed solutions ranging from fiscal stimulus 0:02:18.480 --> 0:02:21.799 to full employment policies and that sort of thing, right, 0:02:21.880 --> 0:02:24.200 and you know, it sort of gets to this idea 0:02:24.320 --> 0:02:27.119 or it's like, okay, if you know that every time 0:02:27.160 --> 0:02:29.760 there's going to be a crisis, you know, like I 0:02:29.840 --> 0:02:31.840 were saying before the crisis, and this is something that 0:02:31.880 --> 0:02:33.440 you and I talked about a lot and You've written 0:02:33.440 --> 0:02:35.880 about it a lot, the rise of private sector debt, 0:02:36.000 --> 0:02:40.880 particularly corporate debt, share buy backs, corporate leverage, private equity, 0:02:41.240 --> 0:02:44.400 uh leverage, you know, like people like, okay, but this 0:02:44.480 --> 0:02:46.720 is all fine. But if there's a downturn, then this 0:02:46.800 --> 0:02:50.520 all explode. But of course, if the you know, central 0:02:50.520 --> 0:02:54.280 banks expand credit start buying bonds directly, then you can 0:02:54.320 --> 0:02:58.560 have an economic downturn in theory without the financial market exploding. 0:02:58.600 --> 0:03:00.360 And that's kind of what we saw up and in 0:03:00.440 --> 0:03:04.040 March and then through now. Yeah, exactly, And I think, 0:03:04.080 --> 0:03:05.839 I mean, this is one of the reasons why we're 0:03:05.840 --> 0:03:08.800 talking about this right. People intuitively feel a little bit 0:03:08.919 --> 0:03:12.960 uncomfortable about the real economy being in a terrible state 0:03:13.000 --> 0:03:18.440 while financial assets are booming. Well, well they mind. Were 0:03:18.480 --> 0:03:20.160 you going to say that they were booming up until 0:03:20.160 --> 0:03:24.000 a few weeks ago, Yeah, I was. I was trying. 0:03:24.000 --> 0:03:26.080 I'm trying to cave it just in case the market 0:03:26.280 --> 0:03:28.840 crashes further over the next few days. Well, we are 0:03:28.840 --> 0:03:32.840 recording this on Thursday, September. I think the episode will 0:03:32.880 --> 0:03:35.400 be out in a week, so who knows. Either we 0:03:35.440 --> 0:03:37.280 may have had a crash since then, or we may 0:03:37.280 --> 0:03:40.120 be back to all time highs on the sp but 0:03:40.200 --> 0:03:43.840 hopefully whichever way it is, or maybe's be flat hope, hopefully, 0:03:43.840 --> 0:03:47.800 whichever way it is, I suspect that the conversation will 0:03:47.800 --> 0:03:50.880 still be will still be useful, still be relevant. I agree, 0:03:51.080 --> 0:03:54.200 I think so. Today we are joined by three guests 0:03:54.920 --> 0:03:57.760 for all the the co authors of a new book. 0:03:58.480 --> 0:04:02.680 It's called The Rise of Ry, The Dangerous Consequences of Volatility, 0:04:02.720 --> 0:04:07.880 Suppression and the New Financial Order of Decaying Growth, Recurring Crisis. 0:04:08.560 --> 0:04:11.640 That that last line, decaying growth and recurring crisis certainly 0:04:11.640 --> 0:04:14.440 feels like a theme. And I'll do a quick bio, 0:04:14.960 --> 0:04:17.039 quick intro of our guests. So we're going to be 0:04:17.320 --> 0:04:20.400 The three authors are Tim Lee is the founder of 0:04:20.440 --> 0:04:24.680 a PI Economics and has a long time study of 0:04:24.760 --> 0:04:29.320 the field. Jamie Lee he worked for Jeremy Grantham, also 0:04:29.480 --> 0:04:33.680 a long time expert, also an environment and environmental research 0:04:33.720 --> 0:04:37.240 and volatility trading. And then Kevin cold Iron, a lecturer 0:04:37.560 --> 0:04:42.080 in financial engineering at you see, Berkeley's host School of Business. 0:04:42.120 --> 0:04:44.120 So we're gonna see how this goes. We're gonna see 0:04:44.160 --> 0:04:46.479 what the Rise of carry is all about. Before we 0:04:46.480 --> 0:04:48.560 bring them in, I was just you know, reading the 0:04:48.640 --> 0:04:52.000 dust jacket again, and the questions at the beginning feel 0:04:52.040 --> 0:04:53.919 like the questions that I really do think are on 0:04:54.040 --> 0:04:58.680 everyone's mind. Why have markets risen and crashed so suspectacularly 0:04:58.760 --> 0:05:02.600 over the past years. Why is the stock market outpacing 0:05:02.640 --> 0:05:05.960 the growth of the economy. Why do companies buy back stocks? 0:05:06.000 --> 0:05:09.000 And this is a really big one. We should probably 0:05:09.040 --> 0:05:10.960 question ourselves this a lot at the media. Why do 0:05:11.080 --> 0:05:13.800 traders take every utterance of central banks is the word 0:05:13.839 --> 0:05:17.640 of God? These are the questions that their book purports 0:05:17.680 --> 0:05:19.520 to answer. So I think if we can answer all 0:05:19.520 --> 0:05:23.160 of these questions in the next thirty minutes on this podcast, 0:05:24.080 --> 0:05:27.039 listeners will have found a lot of value from that. 0:05:27.160 --> 0:05:30.680 So Tim, Jamie and Kevin, thank you uh so much 0:05:30.720 --> 0:05:34.719 for joining us. Thanks for inviting us our pleasure. Thanks. So, 0:05:34.760 --> 0:05:38.320 why do we take central bankers word uh words is 0:05:38.360 --> 0:05:40.599 the voice of God? That's a great question that I 0:05:40.640 --> 0:05:44.680 think sometimes our listeners and viewers of TV, they're like, oh, 0:05:44.760 --> 0:05:46.359 you guys sort of make such a big deal of 0:05:46.520 --> 0:05:50.240 every random utterance from J Powell or regional Fed president. 0:05:50.680 --> 0:05:53.800 What's the deal with that? So we're arguing in the 0:05:53.839 --> 0:05:58.440 book that um, the main transmission of main transmission mechanisms. 0:05:58.480 --> 0:06:00.800 Central bank policy has really been through at least over 0:06:00.839 --> 0:06:04.560 the last years, has really been much more through their 0:06:04.600 --> 0:06:09.880 actions in suppressing financial volatility. And Joey, you've already kind 0:06:09.880 --> 0:06:12.640 of uh said quite a few things that we would 0:06:12.680 --> 0:06:14.200 agree with in the book, that we seem to be 0:06:14.279 --> 0:06:19.200 trapped in this sort of circle vicious cycle of markets 0:06:19.240 --> 0:06:22.680 that rise for long periods, the economy seems to be 0:06:22.760 --> 0:06:25.839 rather asset price dependent, and then you get these crashes 0:06:25.880 --> 0:06:29.240 and central banks are sort of scrambling to support markets 0:06:29.360 --> 0:06:32.360 and when we go into a news cycle, and and 0:06:32.800 --> 0:06:34.640 we're agreeing with that really and and in the book, 0:06:34.680 --> 0:06:37.599 we're sort of saying that is taking us into this 0:06:37.680 --> 0:06:40.880 what we call it a carry regime, whereby markets have 0:06:41.040 --> 0:06:46.440 become increasingly disconnected with the real economy. And I think 0:06:46.480 --> 0:06:49.080 we've seen that kind of spectacularly this year, which is, 0:06:49.160 --> 0:06:51.839 you know, since we since we finished the book. But 0:06:51.920 --> 0:06:55.080 we're we're we're we're saying it's much less to do 0:06:55.279 --> 0:06:59.039 really with the kind of traditional idea that central banks 0:06:59.040 --> 0:07:02.479 are pumping money into the markets and kind of creating 0:07:02.480 --> 0:07:07.520 this surplus of liquidity that can only go into asset markets. Uh, 0:07:07.680 --> 0:07:10.480 it's it's it's much more to do with the fact that, um, 0:07:11.040 --> 0:07:13.600 we've come into this what we call a carry regime 0:07:14.280 --> 0:07:20.920 where a lot of financial structures, transactions trades across the 0:07:20.960 --> 0:07:24.000 boarder even even including things like private equity, but certainly 0:07:24.000 --> 0:07:28.280 including things like bier and property or various types of 0:07:28.280 --> 0:07:31.200 structured finance currency carry trades, which is where we start 0:07:31.240 --> 0:07:33.800 the board, because that's some more common type of carry trades. 0:07:33.840 --> 0:07:36.640 These kind of these kind of trades, which were essentially 0:07:36.720 --> 0:07:40.880 short volatility trades, have come to have come to dominate 0:07:41.040 --> 0:07:45.520 markets and really be the primary drivers of asset prices, 0:07:45.520 --> 0:07:46.960 even if we don't, you know, see that in an 0:07:46.960 --> 0:07:52.360 obvious way they are. And then so that's associated with 0:07:52.400 --> 0:07:55.040 more debt and more leverage, which kind of requires these 0:07:55.120 --> 0:07:58.520 kind of trades because their liquidity providing and these structures 0:07:58.520 --> 0:08:02.640 they provide liquidity to a system that needs liquidity. But 0:08:02.720 --> 0:08:04.800 at some point you end up there's too much leverage 0:08:05.320 --> 0:08:07.760 and there's too great to disconnect if you like, and 0:08:07.800 --> 0:08:11.480 then you get a rapid crash and central banks step 0:08:11.520 --> 0:08:14.960 in with all the measures that they do which suppress 0:08:15.080 --> 0:08:20.160 volatility again and encourage a renewed growth in those same 0:08:20.200 --> 0:08:22.960 sorts of carry trade. So we're sort of in this 0:08:23.320 --> 0:08:26.400 carry regime where the market has become disconnected from from 0:08:26.440 --> 0:08:30.040 the economy. And we argue further than that that as 0:08:30.080 --> 0:08:33.640 you've already touched on you're you're talking, I think about 0:08:33.679 --> 0:08:36.720 how all asset prices could have become seemed to be 0:08:36.840 --> 0:08:39.640 rather the same thing we say in the book that 0:08:39.720 --> 0:08:42.680 really has changed changed, changing the nature of money itself, 0:08:42.760 --> 0:08:46.400 and that the low levels of volatility of a lot 0:08:46.440 --> 0:08:49.720 of financial assets that should really be considered risky assets 0:08:49.760 --> 0:08:53.000 in a normal world, you know, they're included in ETFs 0:08:53.080 --> 0:08:55.079 and things like that, they suddenly seem to be too 0:08:55.080 --> 0:08:58.120 many people much more money like because the central bank 0:08:58.240 --> 0:09:01.800 is is standing behind in some sense, a lot of 0:09:01.800 --> 0:09:05.480 financial assets of effectively become contingent liabilities of the central bank, 0:09:05.520 --> 0:09:10.920 not just money being a liability. And so um. So 0:09:11.120 --> 0:09:14.880 we've had this, this carry regime has been associated with 0:09:14.920 --> 0:09:19.400 a kind of or the whole range of financial assets 0:09:19.440 --> 0:09:22.440 appearing more money like, and then in the crashes that 0:09:22.720 --> 0:09:25.440 those crashes appear as a kind of complete evaporation of 0:09:25.440 --> 0:09:29.319 liquidity across the board. And I mean that central banks 0:09:29.320 --> 0:09:32.160 feel they have no option but to take even more 0:09:32.240 --> 0:09:34.760 drastic measures than he did the last time. Around. This 0:09:34.800 --> 0:09:38.280 is really interesting, but I mean the argument here is basically, 0:09:39.120 --> 0:09:43.160 as I understand that the growth of carry generates easier 0:09:43.200 --> 0:09:47.600 financial conditions because financial assets become more liquid and more 0:09:47.679 --> 0:09:52.040 credit becomes available. And then when the whole thing starts 0:09:52.080 --> 0:09:55.720 to reverse, you see financial conditions tighten. And that's what 0:09:55.960 --> 0:09:59.280 sparks or what encourages central banks to step in and 0:09:59.320 --> 0:10:01.040 prop up the more ket because they don't want to 0:10:01.080 --> 0:10:04.719 see credit and liquidity drying up for the real economy. 0:10:06.360 --> 0:10:10.079 I'm wondering, could you maybe give us a concrete example 0:10:10.400 --> 0:10:15.520 of how you see a particular carry trade generating liquidity 0:10:15.559 --> 0:10:17.600 and credit in the real economy. It sort of walk 0:10:17.679 --> 0:10:21.400 us through the steps of how you see it working. Yeah, 0:10:21.800 --> 0:10:24.800 so currency carry trades are the most obvious case because 0:10:24.840 --> 0:10:28.320 you're you're the currency carry trader is borrowing in a 0:10:29.000 --> 0:10:31.440 you know, very liquid funding markets. Say, well, in the 0:10:31.440 --> 0:10:33.440 case of the dollar funded carry trade, which has become 0:10:33.480 --> 0:10:36.840 the dominant one at a low interest rate and then 0:10:37.120 --> 0:10:40.319 um providing those funds. In a sense, Turkey would be 0:10:40.320 --> 0:10:43.960 the obvious example now because Turkey is kind of liquidity 0:10:44.080 --> 0:10:46.360 deficient if you like, they've been in a continuing kind 0:10:46.400 --> 0:10:51.360 of rolling crisis. Provides those um that that liquidity too 0:10:52.200 --> 0:10:55.400 to the higher interest rate economy. But I mean we're 0:10:56.520 --> 0:10:58.480 we touch on in the book, how you know, it's 0:10:58.480 --> 0:11:01.120 hard to sustinguish sometimes between liquidity in the sense of 0:11:01.160 --> 0:11:06.439 economists use it and liquidity in the sense that financial 0:11:06.440 --> 0:11:10.240 market participants use it, meaning, um, you know, the ease 0:11:10.280 --> 0:11:17.000 of transacting in a financial asset and carry trades are 0:11:17.160 --> 0:11:19.800 particularly important I think for that latter case. And in 0:11:19.840 --> 0:11:22.880 the book we have quite a lot on volatility selling 0:11:22.920 --> 0:11:25.800 trades in the stock markets, say which which those kind 0:11:25.840 --> 0:11:28.960 of those kind of trades simply a simple one would 0:11:28.960 --> 0:11:31.080 just be writing put options, but or you know, you 0:11:31.080 --> 0:11:34.840 have shorting Vicks futures or a whole variety of ways 0:11:35.000 --> 0:11:37.480 ways that you can short volatility in the stock market. 0:11:37.800 --> 0:11:41.559 They essentially provide or buying the dip, as we say, 0:11:41.600 --> 0:11:45.040 to which their equivalent. They essentially kind of kind of 0:11:45.040 --> 0:11:49.480 like market making trades. They make it easier for level 0:11:49.600 --> 0:11:53.720 traders or those are a bit overexposed to exit the trades. 0:11:53.760 --> 0:11:55.480 And you could say the same. And I'm sitting in 0:11:55.520 --> 0:11:58.360 the UK where you know, by to rent properly or 0:11:58.400 --> 0:12:00.240 by to letters we call it. Here has been such 0:12:00.240 --> 0:12:05.400 a big factor in the property market. Bye, let's investors 0:12:05.440 --> 0:12:08.120 in the property market. That's the carry trade too, because 0:12:08.559 --> 0:12:10.880 they make it easier for properties pople want to sell 0:12:10.920 --> 0:12:29.120 to sell their property. Just zooming bag for one second. 0:12:29.200 --> 0:12:32.719 And for people who maybe aren't familiar with the terminology, 0:12:33.280 --> 0:12:36.199 how would you, to an average person, define what a 0:12:36.360 --> 0:12:39.800 carry trade is? And then you know, I still think 0:12:39.800 --> 0:12:43.440 it's probably not intuitive to people, how to say, buying 0:12:43.480 --> 0:12:47.000 the dip in the stock market is sort of economically 0:12:47.160 --> 0:12:51.480 equivalent to buying a house with the intention of renting 0:12:51.480 --> 0:12:54.480 it out to someone. So explain what carry is, and 0:12:54.520 --> 0:12:56.679 then how sort of you cannot you know, sort of 0:12:56.720 --> 0:12:59.560 the logistics of how that ends up being the same 0:13:00.000 --> 0:13:03.960 the same trade to So one definition we given the book, 0:13:04.120 --> 0:13:07.240 which maybe is a bit out of the ordinary, but 0:13:07.320 --> 0:13:09.800 we think it's quite useful, is that carry trades are 0:13:09.840 --> 0:13:14.439 trades that use liquidity to provide liquidity, and so a 0:13:14.520 --> 0:13:17.600 bye to rent house is a very good example. I mean, 0:13:17.800 --> 0:13:21.120 anyone who does bite almost anyone is almost certainly going 0:13:21.120 --> 0:13:23.199 to be taking out a mortgage to do it because 0:13:23.240 --> 0:13:25.959 they're enormous tax bunch doing it, and because how it's 0:13:26.080 --> 0:13:30.240 too expensive to buy without leverage. Now, so you're using leverage, 0:13:30.559 --> 0:13:34.120 but you're doing so to become an active participant who'll 0:13:34.120 --> 0:13:38.160 be alp liquidity to future house trade is as as 0:13:38.200 --> 0:13:41.359 Tim was saying. And and also you know you're converting 0:13:41.440 --> 0:13:44.920 the extremely long duration house into a bunch of one 0:13:44.960 --> 0:13:49.480 months or one year short term the sassets. Either way, 0:13:49.520 --> 0:13:52.520 you're liquefying the market, but in the process of doing so, 0:13:52.559 --> 0:13:55.960 you're taking on liquidity risk yourself. You can even think 0:13:56.000 --> 0:13:59.079 of it in a much more simpler way, where it's 0:13:59.080 --> 0:14:03.000 a trade that makes money when nothing happens. Right. So 0:14:03.040 --> 0:14:05.840 the classic example that we've talked about is, you know, 0:14:05.960 --> 0:14:08.480 you you borrow in the end of finance and position 0:14:08.480 --> 0:14:12.079 in the Australian dollar. That's a positive yield trade if 0:14:12.080 --> 0:14:15.439 the if the currency doesn't change, that that makes money. 0:14:15.800 --> 0:14:18.360 And the same thing of um, you know, if you're 0:14:18.640 --> 0:14:21.440 like an insurance type of trade where you're selling puts 0:14:22.120 --> 0:14:25.960 that has an income, a premium income, and as long 0:14:26.000 --> 0:14:27.920 as the market doesn't change, as long as the world 0:14:28.000 --> 0:14:31.880 stays pretty much the same, you're the trades profitable. So 0:14:32.080 --> 0:14:37.640 carry trades in all forms generate kind of this consistent income. 0:14:37.920 --> 0:14:41.800 And then there's these occasional sharp drawdowns and that that's 0:14:41.840 --> 0:14:45.160 quite important because what we're saying is as these trades 0:14:45.240 --> 0:14:49.000 kind of work their way across the financial system, the 0:14:49.840 --> 0:14:53.920 stock market and the overall economy is starting to basically 0:14:53.960 --> 0:14:56.680 show the same characteristics of carry trades, which are steady 0:14:56.720 --> 0:15:00.600 profits but occasional crashes. So it's no accident and that 0:15:00.680 --> 0:15:03.800 we've had these big crashes over the last you know, 0:15:03.880 --> 0:15:07.760 ten years, it's it's because they the underlying nature of 0:15:07.760 --> 0:15:11.880 the risk is is kind of mirroring carry trades, right, 0:15:11.920 --> 0:15:14.400 so this is kind of the picking up pennies in 0:15:14.600 --> 0:15:18.320 front of a steamroller idea. And the example that jumps 0:15:18.360 --> 0:15:21.080 out to me is what happened in the treasury market 0:15:21.320 --> 0:15:23.200 in March of this year, where we had a bunch 0:15:23.240 --> 0:15:27.120 of hedge funds that were arbitraging these tiny differences between 0:15:27.400 --> 0:15:31.520 cash treasuries and the futures contract for treasuries funded in 0:15:31.680 --> 0:15:35.200 overnight market, so they were basically borrowing liquidity and the 0:15:35.280 --> 0:15:39.040 trade worked really well as long as nothing happened in 0:15:39.080 --> 0:15:41.080 the treasury market. But then in March we got a 0:15:41.120 --> 0:15:44.640 bunch of volatility. Everything went haywire, and some of these 0:15:44.680 --> 0:15:49.040 hedge funds suffered really big losses. If one of the 0:15:49.080 --> 0:15:53.800 hallmarks of carry trades is this idea of steady profits 0:15:53.880 --> 0:15:56.720 and then a big blow up. What does it actually 0:15:56.760 --> 0:16:00.520 mean for investors and players in the mark. It doesn't 0:16:00.520 --> 0:16:03.880 mean that the people who are able to continuously survive 0:16:04.000 --> 0:16:07.360 those blow ups and continuously keep tapping liquidity are going 0:16:07.400 --> 0:16:11.440 to be the ones that that keep going. That's so 0:16:11.480 --> 0:16:14.040 we actually talked about that in the book, and there 0:16:14.160 --> 0:16:17.400 there's some people, I mean, ideally without you know, in 0:16:17.440 --> 0:16:19.840 a kind of totally free market, it would be the 0:16:20.080 --> 0:16:24.240 people with the very strong balance sheets who would um 0:16:24.320 --> 0:16:26.800 you know, be natural providers of carry and some some 0:16:26.960 --> 0:16:31.200 level of carriers important. As Jamie said to liquefy markets. 0:16:31.200 --> 0:16:34.640 Part of what we're arguing is that when central banks, 0:16:34.880 --> 0:16:37.480 you know, because of their role as a lender of 0:16:37.560 --> 0:16:41.720 last resort, come in and truncate volatility, they truncate the 0:16:41.800 --> 0:16:45.640 left hand side of distribution, they truncate losses. That does 0:16:45.640 --> 0:16:49.640 two things. One it you know, kind of makes the 0:16:49.880 --> 0:16:52.960 balance sheet of the people who were natural carry traders 0:16:53.000 --> 0:16:56.680 even stronger, so sort of reinforces their existing advantage and 0:16:56.800 --> 0:16:59.960 to it encourages people who maybe don't have the balot 0:17:00.040 --> 0:17:03.520 cheat like the hedge funds you revenue referenced earlier to 0:17:03.800 --> 0:17:07.040 enter the trade, and therefore the carry regime, as we've 0:17:07.040 --> 0:17:11.680 talked about it expands over time because carrie looks more 0:17:11.720 --> 0:17:14.760 profitable than it probably should have been, given the fact 0:17:14.840 --> 0:17:18.639 that central banks kind of truncated the volatility, they suppressed it, 0:17:18.680 --> 0:17:21.960 they stopped some of the losses. So that's not necessarily 0:17:22.000 --> 0:17:26.520 blaming central banks. They're acting to backstop the markets, but 0:17:26.600 --> 0:17:29.480 that has this kind of quite important second order effect 0:17:29.520 --> 0:17:33.600 of encouraging the growth of carry trades through time. So, 0:17:33.960 --> 0:17:36.320 you know, one of the things that people have pointed out, 0:17:36.680 --> 0:17:39.879 and I think there's a corollary between the sort of 0:17:39.880 --> 0:17:42.480 real economy on the market here, which is that we 0:17:42.560 --> 0:17:45.399 used to have like sort of recessions where there will 0:17:45.400 --> 0:17:47.840 be some inventory cycle and the economy would go in 0:17:47.840 --> 0:17:51.600 a downturn, and then companies would maybe layoff workers and 0:17:51.720 --> 0:17:55.320 celter their recessions, celter their inventory, and then over time 0:17:55.920 --> 0:17:57.399 maybe they would need to build it back and re 0:17:57.480 --> 0:17:59.439 higher workers than we'd come out of our recession. And 0:17:59.480 --> 0:18:02.320 we also use to have bear markets where maybe the 0:18:02.359 --> 0:18:04.720 market we just traded sideways or down for a few 0:18:04.800 --> 0:18:07.199 years and then there will be some new regime. And 0:18:07.240 --> 0:18:10.480 it feels like maybe since like two thousand one or so, 0:18:10.600 --> 0:18:13.280 in the last few downturns, we don't really seem to 0:18:13.280 --> 0:18:16.919 have recessions or arguably even bear markets anymore. We just 0:18:16.920 --> 0:18:20.199 seem to have crashes. And I'm curious if sort of 0:18:20.200 --> 0:18:24.480 what we saw with the Great Financial Crisis and then uh, 0:18:24.480 --> 0:18:26.920 sort of what we saw very briefly is sort of 0:18:27.119 --> 0:18:29.399 the new model as long as we're in this regime, 0:18:29.440 --> 0:18:32.440 that we don't have these sort of slow rolling downturns, 0:18:32.800 --> 0:18:35.240 it's just a crash because the moment the income starts 0:18:35.240 --> 0:18:38.480 to dry up, at the moment the asset prices start 0:18:38.560 --> 0:18:42.520 to go down, everything on ravels until very very quickly 0:18:42.640 --> 0:18:45.600 under the carry regime, until the sort of central bank 0:18:45.640 --> 0:18:48.960 steps in. Yeah, I mean, that's that's what we're saying. 0:18:48.960 --> 0:18:50.959 I think perhaps the point we haven't emphasized enough so 0:18:51.000 --> 0:18:54.560 far is that the way we define carry trades in 0:18:54.560 --> 0:18:57.119 the book is that the liquidity providing, as we said that, 0:18:57.520 --> 0:19:00.600 but also the level they're always leveled. You know, they 0:19:00.680 --> 0:19:03.440 involve leverage. If they don't involve leverage, they're not already 0:19:03.480 --> 0:19:06.520 carry trades under our definition, and they have that this 0:19:07.400 --> 0:19:10.160 they they kind of make money if nothing changes, If nothing. 0:19:10.200 --> 0:19:11.560 You know, if you don't have a lot of volatility, 0:19:11.640 --> 0:19:13.280 you don't have a problem. They make money, then you 0:19:13.320 --> 0:19:15.720 do have a problem they suddenly lose, and I think 0:19:15.720 --> 0:19:18.520 they also carry trade also always has a kind of 0:19:18.520 --> 0:19:21.040 target asset at the back of it, a currency carry trade. Obviously, 0:19:21.040 --> 0:19:22.760 if you kind of borrow U S dollars now and 0:19:23.000 --> 0:19:25.080 put it into a Turkish mirror bond or something, your 0:19:25.119 --> 0:19:28.639 target assets are Turkish lirror and and and the bond. 0:19:29.040 --> 0:19:31.200 And you're saying, you know, by to buy to let 0:19:31.200 --> 0:19:34.159 property I was talking about earlier here, although they're aimed 0:19:34.600 --> 0:19:39.600 um ostensibly at at extracting income the yield pick up 0:19:39.680 --> 0:19:43.240 or the premium for the volatility short you know, writing 0:19:43.280 --> 0:19:45.440 insurance to also is another form of carry trading, and 0:19:45.760 --> 0:19:47.760 credited fault swaps. These kinds of things your ain't your 0:19:48.040 --> 0:19:50.000 The primary aim is to pick up the income, but 0:19:50.720 --> 0:19:53.280 the the if there's an effect on the asset price 0:19:53.320 --> 0:19:58.240 which which will rise generally, and then the rise in 0:19:58.280 --> 0:20:04.040 the asset price creates as an economist I would call imbalances. 0:20:04.160 --> 0:20:06.439 You know, Turkey was a very good example of that, 0:20:06.480 --> 0:20:09.119 which we discussed in the book, where you have capital 0:20:09.119 --> 0:20:12.280 flows going into Turkey that were lever to some extent, 0:20:12.480 --> 0:20:16.440 and often those were actually Turkish entities, you know, Turkish 0:20:16.520 --> 0:20:21.760 businesses borrowing dollars overseas to invest locally rather than hedge 0:20:21.760 --> 0:20:24.840 funds or something. But that made the Turkish leery become 0:20:24.880 --> 0:20:27.480 progressively overvalued over time, and so Turkey had a huge 0:20:27.480 --> 0:20:29.800 current account deficit when you have a debt. Once you 0:20:29.800 --> 0:20:33.480 have that deficit between spending and income, you need continued 0:20:33.560 --> 0:20:36.600 carry trades to keep the whole thing going. So you 0:20:36.640 --> 0:20:41.119 get the double effect of imbalances very often and also 0:20:41.200 --> 0:20:44.440 the growth in leverage, and at some point that becomes unsustainable, 0:20:44.960 --> 0:20:46.840 and then you get the you know what you might 0:20:46.880 --> 0:20:50.360 call the margin call effect. That, yeah, the as Tracey said, 0:20:50.359 --> 0:20:52.520 picking up pennies in front of steam rollers. The steamroller 0:20:52.640 --> 0:20:54.760 arrives and everyone has to get out at the same time. 0:20:54.800 --> 0:20:57.880 And as we you know, we we try to explain 0:20:57.920 --> 0:21:02.320 that the liquefying nature of carry trade. When when you 0:21:02.400 --> 0:21:06.960 get that the crash, it means liquidity evaporates, and as 0:21:07.000 --> 0:21:10.400 surprises crash liquidity evaporates, all asset prices seem to become 0:21:10.440 --> 0:21:12.600 highly correlated. They all seem to become the same thing. 0:21:13.240 --> 0:21:16.840 And because the economy, the U s economy particularly, but 0:21:17.080 --> 0:21:20.160 British economy, other economies to have become very as surprise dependent. 0:21:20.280 --> 0:21:23.960 You then end up with an economic crash. Two. That's 0:21:24.240 --> 0:21:26.600 what we argue that, And I think Kevin said that 0:21:26.600 --> 0:21:29.879 that the pattern of the economy has become like the 0:21:29.960 --> 0:21:32.720 pattern of the classic carry trade pattern of the saw 0:21:32.760 --> 0:21:37.520 tooth pattern of the steady rise and then the sudden crash. 0:21:37.680 --> 0:21:41.360 But over time it's still being profitable, partly because central 0:21:41.359 --> 0:21:46.240 banks have you know, truncated the crashes, and so carry 0:21:46.280 --> 0:21:49.800 traders over time have the crash wipes out quite a 0:21:49.800 --> 0:21:52.320 few carry traders, but central banks rescue a lot of them, 0:21:52.359 --> 0:21:57.080 and particularly the big guys, and they make money over time. 0:21:57.119 --> 0:22:00.399 But there's also an awareness of the risk. So you 0:22:00.520 --> 0:22:03.320 kind of get that's the the carry trade itself becomes 0:22:03.320 --> 0:22:06.879 sort of higher risk and high return because the carry trader, 0:22:08.359 --> 0:22:13.919 a carry trader not only provides liquidity is levied and 0:22:13.920 --> 0:22:16.520 provides liquidity, but the carry trader has to accept the 0:22:16.520 --> 0:22:20.080 crash risk to some degree and and relies ultimately on 0:22:20.119 --> 0:22:39.480 the central banks. So I want to ask, I guess 0:22:39.800 --> 0:22:42.680 the big question, which we already touched upon in the intro, 0:22:42.960 --> 0:22:46.880 but if we recognize that we are in this cycle, 0:22:47.560 --> 0:22:49.399 then how do we break out of it? How do 0:22:49.440 --> 0:22:52.720 you actually break out of the carry regime, given that 0:22:52.800 --> 0:22:55.160 it's gone on for quite some time at this point, 0:22:55.640 --> 0:22:59.840 and if anything seems to be intensifying in We're a 0:22:59.840 --> 0:23:05.600 bit pessimistic in the book, Really we needed we We 0:23:05.720 --> 0:23:08.440 kind of suggest at the end that maybe we've gone, 0:23:08.600 --> 0:23:10.600 you know, we've gone past the point of no return, 0:23:10.680 --> 0:23:15.520 and unultimately we will see the demese of central banking 0:23:15.520 --> 0:23:17.879 in one way or another, either a crash that cannot 0:23:17.880 --> 0:23:20.000 be contained like sort of two thousand and eight, but 0:23:20.119 --> 0:23:24.280 even worse, or m m T type measures which perhaps 0:23:24.320 --> 0:23:26.920 we could argue have already been happening, that that will 0:23:27.000 --> 0:23:29.719 ultimately create a lot of inflation and lead to the 0:23:29.800 --> 0:23:32.800