Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy Alloway. So, Tracy, one
Speaker 1: of the things that we've been talking about lately, uh,
Speaker 1: and we really sort of drove it home in the
Speaker 1: last episode was this idea of the entire market kind
Speaker 1: of implicitly looking like it's one trade. So many things
Speaker 1: seemed to go up and down together that while you
Speaker 1: sort of think that, okay, investing should be some search
Speaker 1: for interesting individualized opportunities, everything kind of looks like it's
Speaker 1: it all trades is one. Yeah, that's exactly right. And
Speaker 1: I think there's been quite a lot of discussion at
Speaker 1: this point, including on that last episode, about how the
Speaker 1: market is being generally driven by interest rates a k a.
Speaker 1: The central banks. Right, So, the story that multiple multiple
Speaker 1: guests have told us is that, well, we get into
Speaker 1: this situation, you know, which growth is slow, perhaps due
Speaker 1: to income inequality. That means that asset prices rather than
Speaker 1: sort of actual demand, becomes a key vehicle of what
Speaker 1: drives the economy. That means the central bank then is
Speaker 1: ends up becoming more sensitive to asset prices when it
Speaker 1: comes to easing policy. That few further fuels asset values
Speaker 1: that further exacerbates the inequality problem, that further uh causes
Speaker 1: weakness and growth, that further causes the central banks to
Speaker 1: then act, and that we're like in this spiral that
Speaker 1: you know, by some accounts maybe has gone on four decades.
Speaker 1: And if that's the story, then I would say, you know,
Speaker 1: it really feels like COVID right now is sort of
Speaker 1: a accelerant of that whole process. Yeah, I think that's right,
Speaker 1: And I think it gets to a theme that we
Speaker 1: keep coming back to in all these episodes, which is
Speaker 1: if we are slowly recognizing that the financialization of the
Speaker 1: economy is not a good thing and we're trapped in
Speaker 1: this sort of endless cycle, then how do you actually
Speaker 1: break out of it? And we've had so many of
Speaker 1: those discussions now with proposed solutions ranging from fiscal stimulus
Speaker 1: to full employment policies and that sort of thing, right,
Speaker 1: and you know, it sort of gets to this idea
Speaker 1: or it's like, okay, if you know that every time
Speaker 1: there's going to be a crisis, you know, like I
Speaker 1: were saying before the crisis, and this is something that
Speaker 1: you and I talked about a lot and You've written
Speaker 1: about it a lot, the rise of private sector debt,
Speaker 1: particularly corporate debt, share buy backs, corporate leverage, private equity,
Speaker 1: uh leverage, you know, like people like, okay, but this
Speaker 1: is all fine. But if there's a downturn, then this
Speaker 1: all explode. But of course, if the you know, central
Speaker 1: banks expand credit start buying bonds directly, then you can
Speaker 1: have an economic downturn in theory without the financial market exploding.
Speaker 1: And that's kind of what we saw up and in
Speaker 1: March and then through now. Yeah, exactly, And I think,
Speaker 1: I mean, this is one of the reasons why we're
Speaker 1: talking about this right. People intuitively feel a little bit
Speaker 1: uncomfortable about the real economy being in a terrible state
Speaker 1: while financial assets are booming. Well, well they mind. Were
Speaker 1: you going to say that they were booming up until
Speaker 1: a few weeks ago, Yeah, I was. I was trying.
Speaker 1: I'm trying to cave it just in case the market
Speaker 1: crashes further over the next few days. Well, we are
Speaker 1: recording this on Thursday, September. I think the episode will
Speaker 1: be out in a week, so who knows. Either we
Speaker 1: may have had a crash since then, or we may
Speaker 1: be back to all time highs on the sp but
Speaker 1: hopefully whichever way it is, or maybe's be flat hope, hopefully,
Speaker 1: whichever way it is, I suspect that the conversation will
Speaker 1: still be will still be useful, still be relevant. I agree,
Speaker 1: I think so. Today we are joined by three guests
Speaker 1: for all the the co authors of a new book.
Speaker 1: It's called The Rise of Ry, The Dangerous Consequences of Volatility,
Speaker 1: Suppression and the New Financial Order of Decaying Growth, Recurring Crisis.
Speaker 1: That that last line, decaying growth and recurring crisis certainly
Speaker 1: feels like a theme. And I'll do a quick bio,
Speaker 1: quick intro of our guests. So we're going to be
Speaker 1: The three authors are Tim Lee is the founder of
Speaker 1: a PI Economics and has a long time study of
Speaker 1: the field. Jamie Lee he worked for Jeremy Grantham, also
Speaker 1: a long time expert, also an environment and environmental research
Speaker 1: and volatility trading. And then Kevin cold Iron, a lecturer
Speaker 1: in financial engineering at you see, Berkeley's host School of Business.
Speaker 1: So we're gonna see how this goes. We're gonna see
Speaker 1: what the Rise of carry is all about. Before we
Speaker 1: bring them in, I was just you know, reading the
Speaker 1: dust jacket again, and the questions at the beginning feel
Speaker 1: like the questions that I really do think are on
Speaker 1: everyone's mind. Why have markets risen and crashed so suspectacularly
Speaker 1: over the past years. Why is the stock market outpacing
Speaker 1: the growth of the economy. Why do companies buy back stocks?
Speaker 1: And this is a really big one. We should probably
Speaker 1: question ourselves this a lot at the media. Why do
Speaker 1: traders take every utterance of central banks is the word
Speaker 1: of God? These are the questions that their book purports
Speaker 1: to answer. So I think if we can answer all
Speaker 1: of these questions in the next thirty minutes on this podcast,
Speaker 1: listeners will have found a lot of value from that.
Speaker 1: So Tim, Jamie and Kevin, thank you uh so much
Speaker 1: for joining us. Thanks for inviting us our pleasure. Thanks. So,
Speaker 1: why do we take central bankers word uh words is
Speaker 1: the voice of God? That's a great question that I
Speaker 1: think sometimes our listeners and viewers of TV, they're like, oh,
Speaker 1: you guys sort of make such a big deal of
Speaker 1: every random utterance from J Powell or regional Fed president.
Speaker 1: What's the deal with that? So we're arguing in the
Speaker 1: book that um, the main transmission of main transmission mechanisms.
Speaker 1: Central bank policy has really been through at least over
Speaker 1: the last years, has really been much more through their
Speaker 1: actions in suppressing financial volatility. And Joey, you've already kind
Speaker 1: of uh said quite a few things that we would
Speaker 1: agree with in the book, that we seem to be
Speaker 1: trapped in this sort of circle vicious cycle of markets
Speaker 1: that rise for long periods, the economy seems to be
Speaker 1: rather asset price dependent, and then you get these crashes
Speaker 1: and central banks are sort of scrambling to support markets
Speaker 1: and when we go into a news cycle, and and
Speaker 1: we're agreeing with that really and and in the book,
Speaker 1: we're sort of saying that is taking us into this
Speaker 1: what we call it a carry regime, whereby markets have
Speaker 1: become increasingly disconnected with the real economy. And I think
Speaker 1: we've seen that kind of spectacularly this year, which is,
Speaker 1: you know, since we since we finished the book. But
Speaker 1: we're we're we're we're saying it's much less to do
Speaker 1: really with the kind of traditional idea that central banks
Speaker 1: are pumping money into the markets and kind of creating
Speaker 1: this surplus of liquidity that can only go into asset markets. Uh,
Speaker 1: it's it's it's much more to do with the fact that, um,
Speaker 1: we've come into this what we call a carry regime
Speaker 1: where a lot of financial structures, transactions trades across the
Speaker 1: boarder even even including things like private equity, but certainly
Speaker 1: including things like bier and property or various types of
Speaker 1: structured finance currency carry trades, which is where we start
Speaker 1: the board, because that's some more common type of carry trades.
Speaker 1: These kind of these kind of trades, which were essentially
Speaker 1: short volatility trades, have come to have come to dominate
Speaker 1: markets and really be the primary drivers of asset prices,
Speaker 1: even if we don't, you know, see that in an
Speaker 1: obvious way they are. And then so that's associated with
Speaker 1: more debt and more leverage, which kind of requires these
Speaker 1: kind of trades because their liquidity providing and these structures
Speaker 1: they provide liquidity to a system that needs liquidity. But
Speaker 1: at some point you end up there's too much leverage
Speaker 1: and there's too great to disconnect if you like, and
Speaker 1: then you get a rapid crash and central banks step
Speaker 1: in with all the measures that they do which suppress
Speaker 1: volatility again and encourage a renewed growth in those same
Speaker 1: sorts of carry trade. So we're sort of in this
Speaker 1: carry regime where the market has become disconnected from from
Speaker 1: the economy. And we argue further than that that as
Speaker 1: you've already touched on you're you're talking, I think about
Speaker 1: how all asset prices could have become seemed to be
Speaker 1: rather the same thing we say in the book that
Speaker 1: really has changed changed, changing the nature of money itself,
Speaker 1: and that the low levels of volatility of a lot
Speaker 1: of financial assets that should really be considered risky assets
Speaker 1: in a normal world, you know, they're included in ETFs
Speaker 1: and things like that, they suddenly seem to be too
Speaker 1: many people much more money like because the central bank
Speaker 1: is is standing behind in some sense, a lot of
Speaker 1: financial assets of effectively become contingent liabilities of the central bank,
Speaker 1: not just money being a liability. And so um. So
Speaker 1: we've had this, this carry regime has been associated with
Speaker 1: a kind of or the whole range of financial assets
Speaker 1: appearing more money like, and then in the crashes that
Speaker 1: those crashes appear as a kind of complete evaporation of
Speaker 1: liquidity across the board. And I mean that central banks
Speaker 1: feel they have no option but to take even more
Speaker 1: drastic measures than he did the last time. Around. This
Speaker 1: is really interesting, but I mean the argument here is basically,
Speaker 1: as I understand that the growth of carry generates easier
Speaker 1: financial conditions because financial assets become more liquid and more
Speaker 1: credit becomes available. And then when the whole thing starts
Speaker 1: to reverse, you see financial conditions tighten. And that's what
Speaker 1: sparks or what encourages central banks to step in and
Speaker 1: prop up the more ket because they don't want to
Speaker 1: see credit and liquidity drying up for the real economy.
Speaker 1: I'm wondering, could you maybe give us a concrete example
Speaker 1: of how you see a particular carry trade generating liquidity
Speaker 1: and credit in the real economy. It sort of walk
Speaker 1: us through the steps of how you see it working. Yeah,
Speaker 1: so currency carry trades are the most obvious case because
Speaker 1: you're you're the currency carry trader is borrowing in a
Speaker 1: you know, very liquid funding markets. Say, well, in the
Speaker 1: case of the dollar funded carry trade, which has become
Speaker 1: the dominant one at a low interest rate and then
Speaker 1: um providing those funds. In a sense, Turkey would be
Speaker 1: the obvious example now because Turkey is kind of liquidity
Speaker 1: deficient if you like, they've been in a continuing kind
Speaker 1: of rolling crisis. Provides those um that that liquidity too
Speaker 1: to the higher interest rate economy. But I mean we're
Speaker 1: we touch on in the book, how you know, it's
Speaker 1: hard to sustinguish sometimes between liquidity in the sense of
Speaker 1: economists use it and liquidity in the sense that financial
Speaker 1: market participants use it, meaning, um, you know, the ease
Speaker 1: of transacting in a financial asset and carry trades are
Speaker 1: particularly important I think for that latter case. And in
Speaker 1: the book we have quite a lot on volatility selling
Speaker 1: trades in the stock markets, say which which those kind
Speaker 1: of those kind of trades simply a simple one would
Speaker 1: just be writing put options, but or you know, you
Speaker 1: have shorting Vicks futures or a whole variety of ways
Speaker 1: ways that you can short volatility in the stock market.
Speaker 1: They essentially provide or buying the dip, as we say,
Speaker 1: to which their equivalent. They essentially kind of kind of
Speaker 1: like market making trades. They make it easier for level
Speaker 1: traders or those are a bit overexposed to exit the trades.
Speaker 1: And you could say the same. And I'm sitting in
Speaker 1: the UK where you know, by to rent properly or
Speaker 1: by to letters we call it. Here has been such
Speaker 1: a big factor in the property market. Bye, let's investors
Speaker 1: in the property market. That's the carry trade too, because
Speaker 1: they make it easier for properties pople want to sell
Speaker 1: to sell their property. Just zooming bag for one second.
Speaker 1: And for people who maybe aren't familiar with the terminology,
Speaker 1: how would you, to an average person, define what a
Speaker 1: carry trade is? And then you know, I still think
Speaker 1: it's probably not intuitive to people, how to say, buying
Speaker 1: the dip in the stock market is sort of economically
Speaker 1: equivalent to buying a house with the intention of renting
Speaker 1: it out to someone. So explain what carry is, and
Speaker 1: then how sort of you cannot you know, sort of
Speaker 1: the logistics of how that ends up being the same
Speaker 1: the same trade to So one definition we given the book,
Speaker 1: which maybe is a bit out of the ordinary, but
Speaker 1: we think it's quite useful, is that carry trades are
Speaker 1: trades that use liquidity to provide liquidity, and so a
Speaker 1: bye to rent house is a very good example. I mean,
Speaker 1: anyone who does bite almost anyone is almost certainly going
Speaker 1: to be taking out a mortgage to do it because
Speaker 1: they're enormous tax bunch doing it, and because how it's
Speaker 1: too expensive to buy without leverage. Now, so you're using leverage,
Speaker 1: but you're doing so to become an active participant who'll
Speaker 1: be alp liquidity to future house trade is as as
Speaker 1: Tim was saying. And and also you know you're converting
Speaker 1: the extremely long duration house into a bunch of one
Speaker 1: months or one year short term the sassets. Either way,
Speaker 1: you're liquefying the market, but in the process of doing so,
Speaker 1: you're taking on liquidity risk yourself. You can even think
Speaker 1: of it in a much more simpler way, where it's
Speaker 1: a trade that makes money when nothing happens. Right. So
Speaker 1: the classic example that we've talked about is, you know,
Speaker 1: you you borrow in the end of finance and position
Speaker 1: in the Australian dollar. That's a positive yield trade if
Speaker 1: the if the currency doesn't change, that that makes money.
Speaker 1: And the same thing of um, you know, if you're
Speaker 1: like an insurance type of trade where you're selling puts
Speaker 1: that has an income, a premium income, and as long
Speaker 1: as the market doesn't change, as long as the world
Speaker 1: stays pretty much the same, you're the trades profitable. So
Speaker 1: carry trades in all forms generate kind of this consistent income.
Speaker 1: And then there's these occasional sharp drawdowns and that that's
Speaker 1: quite important because what we're saying is as these trades
Speaker 1: kind of work their way across the financial system, the
Speaker 1: stock market and the overall economy is starting to basically
Speaker 1: show the same characteristics of carry trades, which are steady
Speaker 1: profits but occasional crashes. So it's no accident and that
Speaker 1: we've had these big crashes over the last you know,
Speaker 1: ten years, it's it's because they the underlying nature of
Speaker 1: the risk is is kind of mirroring carry trades, right,
Speaker 1: so this is kind of the picking up pennies in
Speaker 1: front of a steamroller idea. And the example that jumps
Speaker 1: out to me is what happened in the treasury market
Speaker 1: in March of this year, where we had a bunch
Speaker 1: of hedge funds that were arbitraging these tiny differences between
Speaker 1: cash treasuries and the futures contract for treasuries funded in
Speaker 1: overnight market, so they were basically borrowing liquidity and the
Speaker 1: trade worked really well as long as nothing happened in
Speaker 1: the treasury market. But then in March we got a
Speaker 1: bunch of volatility. Everything went haywire, and some of these
Speaker 1: hedge funds suffered really big losses. If one of the
Speaker 1: hallmarks of carry trades is this idea of steady profits
Speaker 1: and then a big blow up. What does it actually
Speaker 1: mean for investors and players in the mark. It doesn't
Speaker 1: mean that the people who are able to continuously survive
Speaker 1: those blow ups and continuously keep tapping liquidity are going
Speaker 1: to be the ones that that keep going. That's so
Speaker 1: we actually talked about that in the book, and there
Speaker 1: there's some people, I mean, ideally without you know, in
Speaker 1: a kind of totally free market, it would be the
Speaker 1: people with the very strong balance sheets who would um
Speaker 1: you know, be natural providers of carry and some some
Speaker 1: level of carriers important. As Jamie said to liquefy markets.
Speaker 1: Part of what we're arguing is that when central banks,
Speaker 1: you know, because of their role as a lender of
Speaker 1: last resort, come in and truncate volatility, they truncate the
Speaker 1: left hand side of distribution, they truncate losses. That does
Speaker 1: two things. One it you know, kind of makes the
Speaker 1: balance sheet of the people who were natural carry traders
Speaker 1: even stronger, so sort of reinforces their existing advantage and
Speaker 1: to it encourages people who maybe don't have the balot
Speaker 1: cheat like the hedge funds you revenue referenced earlier to
Speaker 1: enter the trade, and therefore the carry regime, as we've
Speaker 1: talked about it expands over time because carrie looks more
Speaker 1: profitable than it probably should have been, given the fact
Speaker 1: that central banks kind of truncated the volatility, they suppressed it,
Speaker 1: they stopped some of the losses. So that's not necessarily
Speaker 1: blaming central banks. They're acting to backstop the markets, but
Speaker 1: that has this kind of quite important second order effect
Speaker 1: of encouraging the growth of carry trades through time. So,
Speaker 1: you know, one of the things that people have pointed out,
Speaker 1: and I think there's a corollary between the sort of
Speaker 1: real economy on the market here, which is that we
Speaker 1: used to have like sort of recessions where there will
Speaker 1: be some inventory cycle and the economy would go in
Speaker 1: a downturn, and then companies would maybe layoff workers and
Speaker 1: celter their recessions, celter their inventory, and then over time
Speaker 1: maybe they would need to build it back and re
Speaker 1: higher workers than we'd come out of our recession. And
Speaker 1: we also use to have bear markets where maybe the
Speaker 1: market we just traded sideways or down for a few
Speaker 1: years and then there will be some new regime. And
Speaker 1: it feels like maybe since like two thousand one or so,
Speaker 1: in the last few downturns, we don't really seem to
Speaker 1: have recessions or arguably even bear markets anymore. We just
Speaker 1: seem to have crashes. And I'm curious if sort of
Speaker 1: what we saw with the Great Financial Crisis and then uh,
Speaker 1: sort of what we saw very briefly is sort of
Speaker 1: the new model as long as we're in this regime,
Speaker 1: that we don't have these sort of slow rolling downturns,
Speaker 1: it's just a crash because the moment the income starts
Speaker 1: to dry up, at the moment the asset prices start
Speaker 1: to go down, everything on ravels until very very quickly
Speaker 1: under the carry regime, until the sort of central bank
Speaker 1: steps in. Yeah, I mean, that's that's what we're saying.
Speaker 1: I think perhaps the point we haven't emphasized enough so
Speaker 1: far is that the way we define carry trades in
Speaker 1: the book is that the liquidity providing, as we said that,
Speaker 1: but also the level they're always leveled. You know, they
Speaker 1: involve leverage. If they don't involve leverage, they're not already
Speaker 1: carry trades under our definition, and they have that this
Speaker 1: they they kind of make money if nothing changes, If nothing.
Speaker 1: You know, if you don't have a lot of volatility,
Speaker 1: you don't have a problem. They make money, then you
Speaker 1: do have a problem they suddenly lose, and I think
Speaker 1: they also carry trade also always has a kind of
Speaker 1: target asset at the back of it, a currency carry trade. Obviously,
Speaker 1: if you kind of borrow U S dollars now and
Speaker 1: put it into a Turkish mirror bond or something, your
Speaker 1: target assets are Turkish lirror and and and the bond.
Speaker 1: And you're saying, you know, by to buy to let
Speaker 1: property I was talking about earlier here, although they're aimed
Speaker 1: um ostensibly at at extracting income the yield pick up
Speaker 1: or the premium for the volatility short you know, writing
Speaker 1: insurance to also is another form of carry trading, and
Speaker 1: credited fault swaps. These kinds of things your ain't your
Speaker 1: The primary aim is to pick up the income, but
Speaker 1: the the if there's an effect on the asset price
Speaker 1: which which will rise generally, and then the rise in
Speaker 1: the asset price creates as an economist I would call imbalances.
Speaker 1: You know, Turkey was a very good example of that,
Speaker 1: which we discussed in the book, where you have capital
Speaker 1: flows going into Turkey that were lever to some extent,
Speaker 1: and often those were actually Turkish entities, you know, Turkish
Speaker 1: businesses borrowing dollars overseas to invest locally rather than hedge
Speaker 1: funds or something. But that made the Turkish leery become
Speaker 1: progressively overvalued over time, and so Turkey had a huge
Speaker 1: current account deficit when you have a debt. Once you
Speaker 1: have that deficit between spending and income, you need continued
Speaker 1: carry trades to keep the whole thing going. So you
Speaker 1: get the double effect of imbalances very often and also
Speaker 1: the growth in leverage, and at some point that becomes unsustainable,
Speaker 1: and then you get the you know what you might
Speaker 1: call the margin call effect. That, yeah, the as Tracey said,
Speaker 1: picking up pennies in front of steam rollers. The steamroller
Speaker 1: arrives and everyone has to get out at the same time.
Speaker 1: And as we you know, we we try to explain
Speaker 1: that the liquefying nature of carry trade. When when you
Speaker 1: get that the crash, it means liquidity evaporates, and as
Speaker 1: surprises crash liquidity evaporates, all asset prices seem to become
Speaker 1: highly correlated. They all seem to become the same thing.
Speaker 1: And because the economy, the U s economy particularly, but
Speaker 1: British economy, other economies to have become very as surprise dependent.
Speaker 1: You then end up with an economic crash. Two. That's
Speaker 1: what we argue that, And I think Kevin said that
Speaker 1: that the pattern of the economy has become like the
Speaker 1: pattern of the classic carry trade pattern of the saw
Speaker 1: tooth pattern of the steady rise and then the sudden crash.
Speaker 1: But over time it's still being profitable, partly because central
Speaker 1: banks have you know, truncated the crashes, and so carry
Speaker 1: traders over time have the crash wipes out quite a
Speaker 1: few carry traders, but central banks rescue a lot of them,
Speaker 1: and particularly the big guys, and they make money over time.
Speaker 1: But there's also an awareness of the risk. So you
Speaker 1: kind of get that's the the carry trade itself becomes
Speaker 1: sort of higher risk and high return because the carry trader,
Speaker 1: a carry trader not only provides liquidity is levied and
Speaker 1: provides liquidity, but the carry trader has to accept the
Speaker 1: crash risk to some degree and and relies ultimately on
Speaker 1: the central banks. So I want to ask, I guess
Speaker 1: the big question, which we already touched upon in the intro,
Speaker 1: but if we recognize that we are in this cycle,
Speaker 1: then how do we break out of it? How do
Speaker 1: you actually break out of the carry regime, given that
Speaker 1: it's gone on for quite some time at this point,
Speaker 1: and if anything seems to be intensifying in We're a
Speaker 1: bit pessimistic in the book, Really we needed we We
Speaker 1: kind of suggest at the end that maybe we've gone,
Speaker 1: you know, we've gone past the point of no return,
Speaker 1: and unultimately we will see the demese of central banking
Speaker 1: in one way or another, either a crash that cannot
Speaker 1: be contained like sort of two thousand and eight, but
Speaker 1: even worse, or m m T type measures which perhaps
Speaker 1: we could argue have already been happening, that that will
Speaker 1: ultimately create a lot of inflation and lead to the
Speaker 1: kind of demise of feat money and then and then
Speaker 1: the appearance of alternative forms of money. And you know,
Speaker 1: perhaps some people point to cryptocurrencies, where we argue that
Speaker 1: current cryptocurrencies, we only touch on them briefly and not
Speaker 1: really not really kind of legitimate enough perhaps to become
Speaker 1: a new form of money now, but something similar or
Speaker 1: some improved form could become a new form of money.
Speaker 1: So we could just be going to we may not
Speaker 1: there may not be a solution other than the end
Speaker 1: of the monetary regime that we've become used to just
Speaker 1: on the mm T think we've been as we've been
Speaker 1: seeing obviously massive deficits and a lot of inflation bears,
Speaker 1: at least in market commentary, if not in the markets themselves.
Speaker 1: We you know, we explicitly identify the carry regime with
Speaker 1: deflationary pressure for various reasons. But the one I like
Speaker 1: post is to do with the linking of options selling
Speaker 1: strategies and market making as the kind of basic form
Speaker 1: of carrying. You know, the world in which which was
Speaker 1: inflating very heavily is a world in which there's tons
Speaker 1: of cash on the sidelines, and in which people are
Speaker 1: willing to sit on the bidding ask and willing to
Speaker 1: sell options for free or less than free. So in
Speaker 1: in and in a highly inflationary world, volatility buyers rather
Speaker 1: than sellers will systematically make money. And of course perhaps
Speaker 1: we've already been seeing over the last couple of years.
Speaker 1: So talk a little bit about this further. Let's say,
Speaker 1: from the perspective of a financial professional or someone who's
Speaker 1: a trader, how has the rise of the carry regime
Speaker 1: just changed, say to the day to day nature of
Speaker 1: the job of an investor of a trader. Um, how
Speaker 1: is this sort of this the way this is version
Speaker 1: sort of essentially changed the way people have to approach
Speaker 1: their roles. One thing, it's done and I actually want
Speaker 1: this kind of goes back to a question that Tracy
Speaker 1: asked earlier, like what are the implications for investors. It's
Speaker 1: made it very clear that there's much more skewness and
Speaker 1: asset prices, asset returns and than people expected. So and
Speaker 1: there's what we're saying in the book is there's compensation
Speaker 1: for that skewness. That skewness risk is compensated. So one
Speaker 1: of the reasons the SMP has UM done so well
Speaker 1: is that you're you're kind of collecting some of this
Speaker 1: liquidity premium that's built into it, but at the same
Speaker 1: time you have to accept this uh skewness risk. And
Speaker 1: UM that probably should mean that people allocate less to
Speaker 1: the SMP five they kind of normally would so that
Speaker 1: they can survive. I think it's also increased the demand
Speaker 1: for protection, which is why the skew and options prices
Speaker 1: is has gotten more extreme over time. UM and again
Speaker 1: you know, like I I ran a you know, a
Speaker 1: levered hedge fund strategy for many years, and and that
Speaker 1: that skewness and that liquidity risk should mean that kind
Speaker 1: of overall leverage levels you know, should be lower. But
Speaker 1: I don't actually think that that's happened. I think people
Speaker 1: have just relied more on kind of dynamically managing their
Speaker 1: risk and portfolios, which kind of actually reinforces the demand
Speaker 1: on the other side for liquidity provision. So I think
Speaker 1: that that's why you get these much more sudden drawdowns
Speaker 1: in hedge fund strategies than we saw before. So instead
Speaker 1: of running and kind of structurally lower leverage, they're managing
Speaker 1: their leverage um much more aggressively day to day um,
Speaker 1: which puts more prices on the on the people who
Speaker 1: are on the other side of that trade, or pressure
Speaker 1: on people on the other side that tally. So I
Speaker 1: forget which one of you mentioned it before, but it's
Speaker 1: sort of a common dictum and market that in crisis
Speaker 1: all correlations go to one. Things are bad, you gotta
Speaker 1: sell everything, whether it's the chair that you're sitting on,
Speaker 1: or stock or a bond or whatever. Are we in
Speaker 1: the in the carrier regime are we seeing the same
Speaker 1: thing apply except to booms, where essentially in the good
Speaker 1: times all correlations go to one in the same way,
Speaker 1: in a way that wasn't really the case in previous
Speaker 1: up cycles. You know, the part of the suppression of volatility.
Speaker 1: We're arguing that central bank suppressing volatility is ultimate driving
Speaker 1: force of some of these increasingly strange features. Were saying,
Speaker 1: but one of the ways in which you can get
Speaker 1: kind of market wide volatility down is by increasing dispersion,
Speaker 1: by by decreasing correlation. It should be the case that
Speaker 1: the boom periods of extremely low volatility are marked by
Speaker 1: relatively low correlation most of the times. So I have
Speaker 1: a weird question. But every once in a while I
Speaker 1: see analysts make the connection between suppressed volatility in markets
Speaker 1: and social instability or discontent in wider society. So this
Speaker 1: idea of chaos and populist anger and things like that.
Speaker 1: And I think it was a week or two ago
Speaker 1: there was a Deutsche Bank note where they touched on
Speaker 1: this topic, and I actually have it in front of
Speaker 1: me because I thought it was relevant to this conversation.
Speaker 1: They wrote that quote, asset price volatility is a powerful
Speaker 1: energy and when it is suppressed in the market due
Speaker 1: to central bank liquidity or buy backs, it needs to
Speaker 1: find a home, and that can be outside the market
Speaker 1: in society, especially in a very inequitable society. The vicious
Speaker 1: loot can then turn back into asset prices. So I
Speaker 1: remember when that note out, quite a few people were
Speaker 1: making fun of it, saying it's crazy how central banks
Speaker 1: get blamed for everything nowadays, even populous content and things
Speaker 1: like that. But I'd be curious to get your take
Speaker 1: on this. Can the suppression of volatility in financial markets
Speaker 1: and financial asset prices have an impact not just on
Speaker 1: the broader economy but society as a whole. Yeah, well,
Speaker 1: maybe I'll start on that. I think we probably could
Speaker 1: all speak on that, But I mean we we very
Speaker 1: much say that in the book. I mean, the last
Speaker 1: part of the book is on that on that topic,
Speaker 1: we were very much in agreement with that that this
Speaker 1: whole we call carry regime, that um that we that
Speaker 1: we're describing is associated with rising inequality and deteriorating real growth.
Speaker 1: So the wealthy benefit of the expense of those those
Speaker 1: who are not and um that does translate into we
Speaker 1: say in the book, I think at the very beginning
Speaker 1: undermining the social fabric, you know. But the question is
Speaker 1: we do we do lean towards blay central banks, But
Speaker 1: we rather say that in some sense, it's really all
Speaker 1: about the structure of power in society, and central banks
Speaker 1: put it. To put it in its simplest forms, central
Speaker 1: banks are really agents of that structure of power. So
Speaker 1: we are we are height say, but we are basically
Speaker 1: saying that central banks put it very bluntly. May think
Speaker 1: they're acting on behalf of America or Britain or wherever
Speaker 1: they are, but they're really not. They're acting on behalf
Speaker 1: of the wealthy and the powerful and the influential. It's
Speaker 1: curious we think that the carriage and yeah, it's inherently
Speaker 1: inequalizing because the wealthy benefit from it much much more.
Speaker 1: They have the balance sheets which enable them do things
Speaker 1: like I buy to let roperties or short volatility, you know,
Speaker 1: just one last thing or what one last sort of
Speaker 1: thought I have that I'm curious about. It's sort of
Speaker 1: when I listened to this discussion, particularly when people think
Speaker 1: about housing, or when people think about say, make buying, uh,
Speaker 1: the dip and the stock market. People don't think of
Speaker 1: themselves as like participating in a carry trade per se.
Speaker 1: They don't think of themselves as doing the same thing
Speaker 1: as say someone borrowing in and investing in Turkish lyraor
Speaker 1: or Australian dollars. And sort of I'm curious off, like,
Speaker 1: you know, thinking about like the millions of sort of
Speaker 1: unwilling or or carry traders that don't know it in
Speaker 1: the way like to the degree to which asset prices
Speaker 1: become a societal value, because so many people livelihoods and
Speaker 1: lives essentially become more tied to asset values than um
Speaker 1: than their income. Yeah, exactly, And we try to towards
Speaker 1: the end of the book also we try to discuss
Speaker 1: that kind of the the kind of evolutionary aspects, if
Speaker 1: you like, in a financial sense of the carry regime,
Speaker 1: the fact that it's sort of change the way that
Speaker 1: really people think a little bit, if you you know,
Speaker 1: compared to say forty years ago that we've become used
Speaker 1: to um, you know, particularly here in the UK again,
Speaker 1: we're by to let property such a big thing. By
Speaker 1: to rent property is such a big thing. People assume
Speaker 1: their house prices will always be rising over time, and
Speaker 1: you know, you they don't really, they don't see themselves
Speaker 1: as being doing a similar thing to people who write
Speaker 1: put options or or or do things in you know,
Speaker 1: the credit default swap market or something they don't, but
Speaker 1: it's it's and and we we argued that really the
Speaker 1: way that even financial analysts or those involved in in
Speaker 1: you know, the financial industry think has been changed because
Speaker 1: this is changed to kind of accommodate this idea of
Speaker 1: the Carrey regime becoming the sort of normal and the
Speaker 1: way things are the sort of the norm. I think
Speaker 1: that we see that in you know, a much greater
Speaker 1: acceptance in the conventional wisdom in financial markets, you know,
Speaker 1: much greater acceptance of large scale intervention than there would
Speaker 1: have been, you know, thirty forty years ago. I mean,
Speaker 1: I remember very well when I and my formative period
Speaker 1: of the nineteen eight is when the dollar at the
Speaker 1: beginning beginning of the nine, when the dollar was in
Speaker 1: a big bubble, you know, the dollar was getting overly strong,
Speaker 1: and the Bunder's bank, uh, you know, try to do
Speaker 1: a bit of intervention. And I was kind of learning
Speaker 1: the learning at that at that time, and people, I think,
Speaker 1: I think they were kind of intervening in a scale
Speaker 1: like two to three billion and it seemed a lot,
Speaker 1: you know, and I remember being told by my mentors that,
Speaker 1: you know, it's hopeless. They can't defeat the market. The
Speaker 1: markets are much more powerful than any central bank. But
Speaker 1: you know, people then we're thinking in terms of central banks, yeah,
Speaker 1: being a little part of the market and being kind
Speaker 1: of trivial, trivial in that respect in the in the
Speaker 1: bigger picture, now there's a kind of the conventional wisdom
Speaker 1: is really that central banks pretty much control the market
Speaker 1: if they want to. It's very very different mindset that
Speaker 1: people who are involved in markets. Oh, I would say
Speaker 1: beyond that and generally have um And I think that
Speaker 1: is that this kind of this rise that you know
Speaker 1: the books called the rise of carry, is the rise
Speaker 1: of carry has changed the way that people think without
Speaker 1: people even realizing it, and it goes beyond financial markets.
Speaker 1: I mean, that's a big part of what we're trying
Speaker 1: to say at the end of the book. To step
Speaker 1: back a little, I mean, obviously the world is a
Speaker 1: lot older than before, at least in the West. There
Speaker 1: are a lot more people who are at retirement or
Speaker 1: near retirement and dependent on the assets or the living
Speaker 1: than they ever have been in the past Joe. If
Speaker 1: you're if you're looking for a an example of just
Speaker 1: how far buying the dip is spread. I was, I've
Speaker 1: got a sixteen year old son, and a couple of
Speaker 1: months ago, it's eleven at night to go into his room.
Speaker 1: I say, you know, time to go to bed, and
Speaker 1: he said, well, just one second, I gotta put my
Speaker 1: limit orders in for tomorrow morning. And I was like,
Speaker 1: you're what he said, yeah, limit orders. You I've got
Speaker 1: a couple of core positions, but you know, um, if
Speaker 1: they fall a couple of percent, I'd buy the dip.
Speaker 1: And you know, I've never told him that where he
Speaker 1: figured it out, you know, buying the dip. You asked
Speaker 1: this earlier. And you know, if I've got a lever
Speaker 1: position in the market right and the market falls, then um,
Speaker 1: I need to adjust my position or else, Um, you know,
Speaker 1: my leverage gets away from me. So people who are
Speaker 1: buying the dip, they're providing liquidity to to leverage traders.
Speaker 1: And so that that's why we draw the equivalence of
Speaker 1: buying the dip as as being like a you know,
Speaker 1: capturing some of the short volatility premium, being like a
Speaker 1: Carrie trade by delta hedging arguments. We argue that you know,
Speaker 1: whole forms, whether you're short fixed futures, short options, or
Speaker 1: even yes, just physically say buying the SMP every time
Speaker 1: is down over the last twenty four hours. All of
Speaker 1: these trades are highly analogous and highly correlated to actually
Speaker 1: market making, actually running a continuous h frequency trade market making.
Speaker 1: Trust you, well, you know, that was a fascinating conversation, Tim,
Speaker 1: Jamie and Kevin. Really appreciate the three of you coming on.
Speaker 1: One thing I just want to say before you guys go,
Speaker 1: is that, you know, one thing it's really interesting to
Speaker 1: me is how much what some of you the themes
Speaker 1: of what you're talking about, they're not that different in
Speaker 1: a sense from a lot of the sort of MMT
Speaker 1: friendly people that we often have on this podcast about
Speaker 1: the sort of destructive nature of an economy that's so
Speaker 1: driven by asset prices, so need for central banks. So
Speaker 1: you know, there there's some there's some synthesis out there
Speaker 1: that like between the sort of slightly more like fiscally
Speaker 1: oriented view and this view. You know, we'll we'll find it.
Speaker 1: Between these conversations. There's I believe that there's less daylight
Speaker 1: than perhaps people think from your framework, and I really
Speaker 1: enjoyed listening to Thanks. Thanks a lot, Thanky Thanks. You know,
Speaker 1: like I said there at the end, you know, I
Speaker 1: think that this sort of description volatility suppression sort of
Speaker 1: bottling up a potential crisis. It's a different way of
Speaker 1: talking about a problem that I think a lot of
Speaker 1: people are recognizing, even who I come at the market
Speaker 1: from multiple angles. Yeah, I think that's right, and I
Speaker 1: think our previous guest, Jared Woodard, he spoke about this
Speaker 1: as well. But it's that notion that when you are
Speaker 1: in a sluggish growth environment, you kind of have to
Speaker 1: engineer profits in different or more creative ways, and I
Speaker 1: think that's often where the carry trades come in. The
Speaker 1: other thing I was thinking about was the mention of,
Speaker 1: or the discussion of, the change in investor behavior, which
Speaker 1: I think is really striking. So we spoke about by
Speaker 1: the dip or this idea that whenever stocks go down,
Speaker 1: people eventually come in and start buying on the assumption
Speaker 1: that the central bank is going to come in and
Speaker 1: stabilize everything. But I was also thinking about remember that
Speaker 1: that other saying from around the same time, which was
Speaker 1: bad news is good news, bad news is good news
Speaker 1: meant that whenever you had bad economic news, the central
Speaker 1: bank was going to step in with additional liquidity. So actually,
Speaker 1: if you had bad economic data, sometimes you'd see risk
Speaker 1: assets go up. And if you think about it, it's
Speaker 1: just such a perverse way of looking at the overall
Speaker 1: economy and the financial markets relationship to it. The fact
Speaker 1: that people are thinking that that bad news can be
Speaker 1: good news, bad economic news can be good news for
Speaker 1: risk assets, that should be a huge red flag that
Speaker 1: that something is off in that relationship. I think it's
Speaker 1: super interesting too, exactly that coming from the perspective of
Speaker 1: like say, even the US home owner they were talking
Speaker 1: about by the lent and the idea of buying a
Speaker 1: house with the idea of immediately turning into a rental property.
Speaker 1: But think about, Okay, in the US, for decades, we've
Speaker 1: prized homeownership as being really important, right, And you know
Speaker 1: the implication of that is like, obviously, as mortgage rates
Speaker 1: go down, which tends to happen every time there's an
Speaker 1: economic downturn with this sort of ongoing multi decade decline
Speaker 1: and more, you know, people can refinance their mortgages and
Speaker 1: that sort of like turns into a win for them
Speaker 1: in some sense, Like there are a lot of people
Speaker 1: who like it's been there's been a massive year for
Speaker 1: refives of the last several years. So, you know, I
Speaker 1: think there is like this sort of like very weird
Speaker 1: thing where we turn a bunch of people into economic actors.
Speaker 1: One of the big things that will sort of drive
Speaker 1: their economic well being is the decline of interest rates,
Speaker 1: right absolutely, And of course we haven't seen significant wage
Speaker 1: growth either. So you're basically telling people that one of
Speaker 1: the few ways to get wealthy at the moment is
Speaker 1: to invest in the stock market or some sort of
Speaker 1: financial asset like how purchase that you would expect to
Speaker 1: go up in value. And again, it seems to me
Speaker 1: it's almost inevitable that that impacts how policymakers think and
Speaker 1: how they view the real economy. This idea that maybe
Speaker 1: the stock market is the economy at least for people
Speaker 1: who have a significant proportion of their wealth tied up
Speaker 1: in financial assets. Yeah, totally, no, I think you know,
Speaker 1: there's a lot here and this sort of question of
Speaker 1: is there a way out maybe through more aggressive fiscal
Speaker 1: policy probably the best hope, but something like that to
Speaker 1: sort of get out of the cycle in which not
Speaker 1: only is policy supersensitive it seems to financial assets, but
Speaker 1: each cycle sort of perpetuates the cycle and it gets bigger. Yeah,
Speaker 1: fiscal policy or I guess in this case, after this
Speaker 1: particular discussion, you could also be thinking about macro prudential
Speaker 1: policy and ways to plant down on particular carry trading
Speaker 1: behavior in the market. Right. That sort of what they
Speaker 1: were getting at with the market structure argument. But yes,
Speaker 1: really interesting discussion, I think. Okay, shall we leave it there? Yep?
Speaker 1: This has been another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway and I'm Joe Wisn't Though. You can follow
Speaker 1: me on Twitter at the Stalwart and check out our
Speaker 1: guest book, The Rise of Carry, The Dangerous Consequences of Volatility,
Speaker 1: Suppression and the New Financial Order of the Cane Growth
Speaker 1: and Recurring Crises. Are the authors. Our guests were Tim Lee,
Speaker 1: Jamie Lee, and Kevin cold Iron. And be sure to
Speaker 1: follow our producer Laura Carlson at Laura and Carlton, follow
Speaker 1: the Bloomberg head of podcast Francesco Leavy at Francesco Today,
Speaker 1: and check out all of our podcasts at Bloomberg Onto
Speaker 1: the handle at podcasts. Thanks for listening to