Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisn't Thal and I'm Tracy all Away. Tracy
Speaker 1: sometimes we have guests on this podcast and my my
Speaker 1: first thought that I always have is, how have we
Speaker 1: waited this long to talk about? That? Is such a
Speaker 1: humble brack? Sorry it is. I don't think it's a brag.
Speaker 1: I think there are just like certain people who like
Speaker 1: are like natural fits for the type of thing that
Speaker 1: we talk about. And we've been doing this podcast for
Speaker 1: years and it kind of seems crazy that we never
Speaker 1: talked about. One day we're going to get Jerome Powell
Speaker 1: on the podcast and we'll say, you know, like we
Speaker 1: were thinking of having you on. You're such a natural fit.
Speaker 1: I can't believe it took this long. Um, But yes,
Speaker 1: you're absolutely right. There are people, well, there are people who, um,
Speaker 1: you know, everyone talks about and I am going to
Speaker 1: say that. I love that. It's like, how did we
Speaker 1: not think to have follow him? I love that. Um.
Speaker 1: There are people out there who have had a big
Speaker 1: influence in markets and who consistently think about and write
Speaker 1: about the subject matter that all Thoughts concerns itself with
Speaker 1: and there are still some that we haven't had on
Speaker 1: the podcast. This is true, right, So obviously very excited
Speaker 1: about today's guests. We're gonna jump right into it. He's
Speaker 1: a former managing director at Pimco. He is the coiner
Speaker 1: of the term Minsky moment, even coined the term the
Speaker 1: shadow banking system. Currently a senior Fellow, currently an adjug
Speaker 1: professor at the McDonagh School of Business at Georgetown University.
Speaker 1: We are going to be speaking to the economist and
Speaker 1: investor Paul McCulley. I'm really excited about this conversation, so Paul,
Speaker 1: thank you very much for joining us. Thank you very much,
Speaker 1: Joe Paul. I listened to her speech you gave last
Speaker 1: year at the U Levy Institute, and one of the things,
Speaker 1: this sort of main theme that you identified is that
Speaker 1: over the last you know, roughly forty years, we've had
Speaker 1: these sort of big turning points, not just in sort
Speaker 1: of business and market cycles, but it's sort of idea
Speaker 1: cycles and policy cycles. So the late seventies, the rise
Speaker 1: of monetorism, supply side policies under Reagan, monetary policy dominance
Speaker 1: under Greenspan and Bernanke, and so the big question and
Speaker 1: It's a big thing that Tracy and I have been
Speaker 1: talking about a lot lately, is are we at the
Speaker 1: cusp of a sort of new policy regime. The short
Speaker 1: answer is unambiguously yes, and I want to stress unambiguously yes.
Speaker 1: For the last forty years, essentially, we've been in a
Speaker 1: monetary policy dominant world, and it's ebbed and flowed, demanding
Speaker 1: upon the cycle. But it has been clearly a world
Speaker 1: where monetary policy was the dominant lever in the monetary
Speaker 1: physical policy mix. Uh. Sometimes you know, uh, the phrase
Speaker 1: was used the only game in town, that the FED
Speaker 1: could fix anything, and therefore the FED should fix anything,
Speaker 1: and the FED should be in charge, and that actually
Speaker 1: the FED should be the facto the fourth branch of
Speaker 1: government because that's where the adults were and they could
Speaker 1: make technocratic good decisions. Um. And this messy thing called democracy,
Speaker 1: which was in charge of physical policy could be uh
Speaker 1: pushed to the side, paid attention to as necessary. But
Speaker 1: that we were living in a monetary policy dominant world,
Speaker 1: which also would be a world in which effectively capitalism
Speaker 1: would be superior to democracy. Uh. And the daily ebb
Speaker 1: and flow of economic policy making. What do you think
Speaker 1: makes this crisis different or maybe if I phrase it
Speaker 1: a different way. Why do you think that change is
Speaker 1: coming now? In particular, because we had people, you know,
Speaker 1: writing and talking about the breakdown um in the church
Speaker 1: and state separation of fiscal and monetary policy. Uh, back
Speaker 1: in the nineteen eighties. So why now. Actually it's interesting
Speaker 1: that you mentioned the nineteen eighties because that's essentially when
Speaker 1: the church and state separation became very solidified, as in
Speaker 1: almost a wall, if you will. Uh. In fact, I
Speaker 1: think back to nineteen eighty I was actually in graduate school.
Speaker 1: I was in New York at Columbia in nineteen eighty
Speaker 1: when I graduated in nineteen eighty one, which was not
Speaker 1: the most fortuitous time to graduate from business school. Uh,
Speaker 1: but that's when Paul Boker was establishing essentially monetary policy dominance.
Speaker 1: In fact, Mr Reagan had run on a policy of
Speaker 1: supply side tax cuts, which were a trojan horse for
Speaker 1: tax cuts for the rich. Uh. It was for not
Speaker 1: essentially until Boker finally relented um from monetary policy. Dobins
Speaker 1: continues saw the effect come through in the recovery of
Speaker 1: the nineties. So I think the church and state separation
Speaker 1: between monetary and fiscal policy really UH is rooted uh
Speaker 1: in the epic turn forty years ago. UM, and it's
Speaker 1: moved back and forth over town, depending up on the cycle.
Speaker 1: But I take on your point very much with respect
Speaker 1: to a decade ago when the church and state separation
Speaker 1: was softened quite dramatically by necessity or as the FED
Speaker 1: would like to say, by excellency, with the financial crisis,
Speaker 1: because we hit the zero bound for policy rates, and
Speaker 1: the moment you hit the zero bound for policy rates, UH,
Speaker 1: then almost definitionally you will change, uh, the paradigm of
Speaker 1: monetary policy dominance. And we had that big experiment, if
Speaker 1: you will, of monetary and physical policy cooperation back in
Speaker 1: the period following the financial crisis. But then once it
Speaker 1: was over or not over, but had reached beyond its
Speaker 1: crisis proportions, then effectively there was a morphing back to
Speaker 1: the whole notion that we need to normalize the central
Speaker 1: banks balance sheet, normalized short term interest rates. And of
Speaker 1: course you also had around the same time, UH, the
Speaker 1: advent of the Tea Party, which wanted to normalize, if
Speaker 1: you will, budget deficits. So conceptually we could have had
Speaker 1: this epic turn a decade ago where we would have
Speaker 1: moved to a regime of full physical dominance, but we
Speaker 1: resisted it as a society. I think very much too
Speaker 1: democracies regret that was a decade ago. But now I
Speaker 1: think any pretense is over and we're clearly in a
Speaker 1: physical policy dominant world. And I say that with incredible
Speaker 1: admiration for the Federal Reserve UH. And I stand in
Speaker 1: awe in many respects of share Pal and his willingness
Speaker 1: to recognize the fact that facts on the ground had changed,
Speaker 1: particularly with the nature of this pandemic, and that we
Speaker 1: clearly need to be in a physcal policy dominated world,
Speaker 1: and the FED will be highly supporting UH. And I
Speaker 1: would also say subordinate. So I want to talk a
Speaker 1: little bit about the framing of the this discussion, because
Speaker 1: you said something very interesting I thought at the beginning
Speaker 1: that talks about this in a slightly different way than
Speaker 1: most people. So we talk about this idea of like
Speaker 1: some handoff between Okay, the FED is going to UH
Speaker 1: be our primary engine of stability, and now there's some
Speaker 1: handoff to fiscal policy. But you frame it a little
Speaker 1: bit differently, which is more the handoff from a sort
Speaker 1: of walled gardens secluded temple of people working at the
Speaker 1: FED to a handoff to democracy. And this is a
Speaker 1: point that actually Tracy has made a bunch that as
Speaker 1: we talk a lot about sort of new regimes, MMT
Speaker 1: ideas and so forth, these ideas are in a capable
Speaker 1: from politics. Their downstream from politics. You can't technocratically implement
Speaker 1: fiscal policy. Talk to us just sort of about the
Speaker 1: framing of thinking about this as the reassertion of democracy
Speaker 1: in managing the economy. That is a profound question. I've
Speaker 1: written major papers on it and given way too many
Speaker 1: speeches on it over the years. Uh, And we live
Speaker 1: very much in a mixed economy. And capitalism are our
Speaker 1: market based economy, and democracy are fellow travelers, and in
Speaker 1: many respects they are a holy marriage of incompatibility in
Speaker 1: the sense that both democracy and capitalism are governance systems,
Speaker 1: but they're distinctly different, and that democracy, at its core
Speaker 1: is is a socialist governance system. And I don't say
Speaker 1: that pejoratively. I say that district descriptively because you think
Speaker 1: in terms of the power of democracy is one person,
Speaker 1: one vote, each with inalienable rights. That sounds like socialism
Speaker 1: to me, and it sounds really really good. Uh So,
Speaker 1: democracy is inherently founded on a socialist distribution of power.
Speaker 1: All people are created equal. Uh So, that's a governance system.
Speaker 1: And then capitalism is also a governance system, but is
Speaker 1: the antithesis of socialism in the sense that it is
Speaker 1: a cumulty voting system. Not all are created equal. Under
Speaker 1: the banner of capitalism. It's the matter of the more
Speaker 1: dollars you have, the more votes you have. It is
Speaker 1: fundamentally a kumulty voting system. An example I frequently used
Speaker 1: when I'm giving speeches and so forth, is the decision
Speaker 1: when you get onto a airplane whether or not you
Speaker 1: get one of the big seats, are you get one
Speaker 1: of the little seats, are you know, go left on
Speaker 1: the plane or go right on the plane? Is a
Speaker 1: capitalist decision, and it's based upon kumul ty voting. If
Speaker 1: you want to have one of the big seats, you
Speaker 1: have to have a lot of votes otherwise known as dollars.
Speaker 1: And there's nothing wrong with that system. It's a market
Speaker 1: based system, but it is categorically not predicated on the
Speaker 1: notion that all citizens are created equal. It's it's founded
Speaker 1: on the notion that the more dollars you have the
Speaker 1: more power you have. So we live in a mixed
Speaker 1: economy of cap realism and democracy, and they're supposed to
Speaker 1: be in conflict all of the time because they're fundamentally different.
Speaker 1: But the tie that binds them uh is fundamentally the
Speaker 1: rule of law, because capitalism requires an enforceable rule of law,
Speaker 1: and an enforceable, credible rule of law is the one
Speaker 1: thing that capitalism categorically cannot do for itself. So democracy's
Speaker 1: gift to capitalism is a rule of law, and democracy
Speaker 1: can do a credible, enforceable rule of law round it
Speaker 1: in justice, and that is a true gift of democracy
Speaker 1: to capitalism. So I think both can flourish. I think
Speaker 1: this trade off that we hear about all the time
Speaker 1: democracy versus capitalism in many respects is a false trade
Speaker 1: off because they have to coexist. They need each other.
Speaker 1: Capitalism needs an incredible rule of law and democracy needs efficiency,
Speaker 1: and capitalism is a master at efficiency. You win or
Speaker 1: you lose based upon whether or not you're smart or dumb. Uh.
Speaker 1: So I think what we're evolving too is a better,
Speaker 1: more sustainable, more just mix between democracy and capitalism. That
Speaker 1: was a really long win answer to your question but
Speaker 1: I'm but I'm quite passionate about this, just on the
Speaker 1: intertwining of monetary with fiscal policy. What what downsides do
Speaker 1: you see if any? And I'm thinking back to you know,
Speaker 1: when when Congress was debating over stimulus measures, the additional
Speaker 1: unemployment checks. That took a really, really long time, and
Speaker 1: there's a lot of criticism of that process. And meanwhile,
Speaker 1: the Federal Reserve acted fairly quickly to address market turmoil
Speaker 1: back in March. What do you see as either negatives
Speaker 1: or or tradeoffs in the mix of fiscal with monetary policy.
Speaker 1: Monetary policy can be very efficient, and there's a very
Speaker 1: simple reason for that is that it is one step
Speaker 1: removed from their sausage making of democracy. That's why we
Speaker 1: have political independence. There's a mandate obviously from Congress which
Speaker 1: created the FED, the fens not the fourth branch of government.
Speaker 1: There's a mandate, the full employment and price stability mandate.
Speaker 1: But as a practical matter, the Federal Reserve can move
Speaker 1: very very quickly because the decision making process is not
Speaker 1: subject to the bagarities of democracy. And also it can
Speaker 1: have a very very quick impact because essentially the central
Speaker 1: bank becomes the marginal player are the price center across
Speaker 1: the entire array of financial conditions. So monetary policy can
Speaker 1: move very very quickly and can actually have a profound
Speaker 1: effect on financial conditions. What monetary policy can't do efficiently
Speaker 1: at all is to channel the horsepower of UH, the
Speaker 1: money monopoly to main Street. It is always a bank
Speaker 1: shot through Wall Street and financial conditions, And so monetary
Speaker 1: policy has the benefit of incredible efficiency, but it has
Speaker 1: the liability, UH that it can't get to Main Street directly.
Speaker 1: And main Street is the home of democracy. And whence
Speaker 1: once you hit the zero lower bound, And the reason
Speaker 1: we've hit the zero lower bound, UH is because the
Speaker 1: FED failed. And here I'm not criticizing the Fed. I'm
Speaker 1: just making an observation. The FED failed to ever in
Speaker 1: the last ten years achieve its inflation target. So therefore
Speaker 1: there was a very little space to ease interest rates
Speaker 1: in your traditional sort of way to stimulate private sector borrowing,
Speaker 1: you know, housing cars, all of that sort of stuff
Speaker 1: things we learned in school about. You know, how does
Speaker 1: monetary policy work on main Street? It wasn't out of
Speaker 1: ammunition once it hit zero. But once you hit zero,
Speaker 1: effectively you have to become a partner of the physical authority.
Speaker 1: So when you asked the question about downside, I think
Speaker 1: the big downside of too much central bank independence, and
Speaker 1: I think we've certainly had it uh and and really
Speaker 1: in this century because it goes back to prior to
Speaker 1: the financial crisis as well, that if you have too
Speaker 1: much central bank independence, that effectively that becomes the soul
Speaker 1: tool of overall economic policy. UH. And monetary policy works
Speaker 1: through markets, and by definition, stimulating the economy or supporting
Speaker 1: the economy with monetary policy alone is going to dramatically
Speaker 1: exacerbate income and wealth inequality, which is an an anathemah
Speaker 1: to the spirit and the justice of democracy. So that's
Speaker 1: the downside of leaning too heavily on monetary policy, UH,
Speaker 1: is that you end up going against a fundamental tenant
Speaker 1: um of democracy because monetary policy works by driving up
Speaker 1: asset prices and low and behole rich people owned assets.
Speaker 1: That's simple. Every answer you've given given me like five
Speaker 1: ideas for questions. But I have a simple one, and
Speaker 1: it's one that we recently. We're talking to Vituur Constancia,
Speaker 1: a former ec B vice president, do we know what
Speaker 1: causes inflation? And we talked about the FED failing to
Speaker 1: hit its inflation goals. But a do we have a
Speaker 1: confident theory of what causes inflation and and does the
Speaker 1: central bank actually have the tool the tools to hit
Speaker 1: its mandate fascinating question. Joe In fact chere Powell has
Speaker 1: commented on this issue and a lot of people have
Speaker 1: as well, is that we really don't have a robust
Speaker 1: theoretical framework for what determines inflation anymore. I mean, the
Speaker 1: workhorse for my lifetime, Uh, probably before that too, was
Speaker 1: the Philip's curve. And essentially the Philip's curve has flattened dramatically,
Speaker 1: so that trade off between resource utilization as the FED
Speaker 1: would say, and inflation has broken down dramatically. So the
Speaker 1: short answer is, I don't think the FED or my
Speaker 1: profession has a good workable theoretical framework for inflation anymore. Uh.
Speaker 1: And that is really a big, big issue when you
Speaker 1: think in terms of central bank independence, which I think
Speaker 1: some degree of it is always necessary for efficiency. But
Speaker 1: if you don't have a good workable theory on what
Speaker 1: determines inflation, then it is a very dangerous proposition to
Speaker 1: lean too heavily on the central bank as your only
Speaker 1: game in town because central bank independence theoretically is to
Speaker 1: cut off the risk of democracy inherent inflationary bias on
Speaker 1: the whole notion that democracy involves elected officials who would
Speaker 1: always like to have the economy hotter rather than slower,
Speaker 1: who presumably would always like to spend more than they tax,
Speaker 1: who presumably would have a chronic systematic tendency to overheat
Speaker 1: the economy, which would therefore lead to inflation. So the craison,
Speaker 1: the atra of central bank independence UH is to cut
Speaker 1: off the fat tail of inflation, because democracy, through the
Speaker 1: electoral process, inherently has a pro inflation bias. And that's
Speaker 1: not prijority, it's just inherent in the structure. The last
Speaker 1: presidential camp candidate who tried to run on a platform
Speaker 1: of increasing taxes didn't do terribly wealth in So the
Speaker 1: reason for central bank independence and the isolation from the
Speaker 1: political process, or as I like to refer to it
Speaker 1: as the de facto fourth branch status, is to do
Speaker 1: that which democracy can't do or the physical authority can't do,
Speaker 1: which is say no and actually keep the economy from
Speaker 1: running hot. So that really is the UH foundation for
Speaker 1: central bank independence, and you would see that in Europe
Speaker 1: very much as well. But if you end up in
Speaker 1: a world where actually the fat tale that you're dealing
Speaker 1: with is not too hot economy generating inflation, but a
Speaker 1: two cold economy and also a fat tale risk of deflation, UH,
Speaker 1: then your fundamental argument for rigid central bank independence no
Speaker 1: longer holds. And I think the whole world is experiencing
Speaker 1: that reality. And here I'm not criticizing central banks, uh,
Speaker 1: and particularly not the Federal Reserve. But the world changed
Speaker 1: in part because of our forty year love affair with
Speaker 1: capitalism and globalism, uh, and the demise of unions and
Speaker 1: all sorts of other sort of things, and that we
Speaker 1: found out you can run this economy with an incredibly
Speaker 1: low on employment rate and have no inflation echo whatsoever.
Speaker 1: So that's the configuration of secular forces, long lasting forces
Speaker 1: that have brought us to this juncture. And all the
Speaker 1: things I just said were in place before the pandemic hit.
Speaker 1: So these are not new things. It's just once the
Speaker 1: pandemic hit, then it put them into technicolor in a
Speaker 1: way that was beyond imagination. To the pandemic. Capitalism has
Speaker 1: always had a very dark underbelly, and I'm a capitalist,
Speaker 1: so therefore I'm not criticizing capitalism. I am just saying
Speaker 1: it has a dark underbelly because it is a cumulative
Speaker 1: voting system. The more dollars you have, the more votes
Speaker 1: you have, and if you have robust, full throated cowboy capitalism,
Speaker 1: it is inherently I think disinflationary or deflationary for main
Speaker 1: street UH. And it is also going to skew your
Speaker 1: income and wealth distribution UH in a very anti democratic
Speaker 1: sort of way. In fact, when if you asked the question, UH,
Speaker 1: you know, from the standpard of a good workable theory
Speaker 1: of inflation, I think where we're gonna be morphing to
Speaker 1: over time. Is that a working model of inflation? This
Speaker 1: is not something that you can specify necessarily econometrically. Is
Speaker 1: that inflation at the end of the day, is going
Speaker 1: to reflect the relative pricing power of capital versus labor UH.
Speaker 1: And capitalism obviously has had the dominant role UH in
Speaker 1: power in our economy. If capital is the dominant power
Speaker 1: in your economy versus labor, you will tend to have
Speaker 1: a disinflationary environment. You will have an environment where also
Speaker 1: you will drive corporate profit margins to generational highs. His
Speaker 1: share of national income and Wall Street will absolutely, unambiguously
Speaker 1: love it. In contrast, if you switch to labor, which
Speaker 1: could also be called the citizens of democracy, that labor
Speaker 1: has relative power versus capital, then you will tend to
Speaker 1: see a bias George power inflation, lower shares for corporate
Speaker 1: profits relative to national income, UH, and more chickens and
Speaker 1: Main Street pots. What does that? What is the dominance
Speaker 1: of deflation mean for the Federal reserves mandate? For instance? Like,
Speaker 1: could you see a scenario where they start targeting wage
Speaker 1: growth instead of something like full employment? Or I guess
Speaker 1: to put it in other ways, if you were running
Speaker 1: the FED, what would you be targeting at this juncture?
Speaker 1: Kind Of hard for me to think in terms of
Speaker 1: that that last construct. But I don't envision the FED
Speaker 1: targeting wages per se. But I do think that the
Speaker 1: FED has and will look at wages as a measure
Speaker 1: of whether or not the economy is fully employed. And
Speaker 1: given the fact that they've lost the ability to specify
Speaker 1: the NEHRU or the natural rate of unemployment. And here
Speaker 1: I'm not again, I'm not criticizing the FED. It's just
Speaker 1: the fact that they have spent the last decade revising
Speaker 1: down UH. They're estimates of the natural rate unemployment. I
Speaker 1: think very prudently, the FED will quit trying to operate
Speaker 1: with precision. You know it is the naturative unemployment four
Speaker 1: point seven or four point four. Joe, I'm sure you
Speaker 1: remember all of these debates. You know, you know exactly
Speaker 1: where NEHRU is. And particularly following two thousand and twelve,
Speaker 1: when under Ben Bernanki's leadership, that FED start publishing uh
Speaker 1: it's estimate of NEHRU and then spent the next eight
Speaker 1: years revising it down every year. I think where the
Speaker 1: FED has evolved to very appropriately. And here I will
Speaker 1: be the first and the last man in the room
Speaker 1: of plotting uh is. Rather than a bunch of wonks
Speaker 1: trying to figure out where NEHRU is. UH is, let
Speaker 1: the data tell you where it is, which another way
Speaker 1: is saying is let the tightness of the labor market,
Speaker 1: which is presumed to be a harbor of inflation, actually
Speaker 1: UH tell the story. Now presume the outcome. Let the
Speaker 1: data tell the story. Well, let me ask you a
Speaker 1: question because and just bringing it to monetary policy right now,
Speaker 1: because one thing that's striking thinking about today in versus
Speaker 1: the crisis aftermath in two thousand nine. Is markets in
Speaker 1: two thousand nine expected the first rate hikes or sort
Speaker 1: of normalization to come soon, and some people thought in
Speaker 1: early two thousand nine we would get rate hikes by
Speaker 1: the end of two thousand nine or early and uh.
Speaker 1: Instead the first rate hikes weren't util Like now, the
Speaker 1: market seems to have this appreciation that even if we
Speaker 1: were to get, say a cp I spike of the
Speaker 1: short term, that the FED would look through it. And
Speaker 1: it's just not in a hurry at all two hike rates.
Speaker 1: And so I'm curious, A. Is this progress, this sort
Speaker 1: of idea that the FED isn't going to so perceived
Speaker 1: to be so aggressive in fighting inflation if it picks up,
Speaker 1: is that progress? And b is it effective? So will
Speaker 1: we see a more robust recovery than we saw last
Speaker 1: time because of this perception that the Fed would be
Speaker 1: willing to let it run hot while it looks for
Speaker 1: real signs of labor market tightness. Yes, and yes and yes.
Speaker 1: I think if I got the order of your questions,
Speaker 1: I know it is a pack a bunch of no no, no, no, no, no, no.
Speaker 1: This is this is great fun. This is what I
Speaker 1: do UH, and I think that we ask the society
Speaker 1: and the FED very very much as an institution UH
Speaker 1: learns from experience and learning that the Phillips curve has
Speaker 1: become flatter than a pancake is a existential piece of
Speaker 1: information UH. That the economy can be more fully employed
Speaker 1: uh than previously thought as in the last previous forty
Speaker 1: damn years. I think that's very much where the FEDS
Speaker 1: mindset is. Is they are politically independent to fight inflation,
Speaker 1: but that war has been one and over one. UH,
Speaker 1: So therefore they should have a very cooperative approach with
Speaker 1: the physical authority. Their job is not to say no.
Speaker 1: Their job is to say yes. Their job is to
Speaker 1: say yes to bigger budget deficits. That is their job,
Speaker 1: and in fact j is saying it every day in
Speaker 1: subtle ways and increasingly less subtling. God bless him for
Speaker 1: being less subtle about it. Because we so desperately need
Speaker 1: robust physcal policy relief and support for capitalism because of
Speaker 1: the unique nature of the pandemic as well as the
Speaker 1: all of the social injustices that were exposed by the
Speaker 1: shock of the pandemic. So yeah, I think the FED
Speaker 1: has learned a huge amount. And actually I think, uh,
Speaker 1: the political establishment very much has uh learned a lot
Speaker 1: as well, as they have a whole lot more degrees
Speaker 1: of freedom to act in a proper democratic fashion and
Speaker 1: not have to worry about being slapped on the risk
Speaker 1: by the monetary authority. So yeah, I think we've learned
Speaker 1: a lot as the society. I think we've learned a
Speaker 1: lot with respect to the institutions of economic management, um.
Speaker 1: And I think we as a society are also relearning
Speaker 1: the core tenants of democracy, which is for citizens not
Speaker 1: just to have you know, one person, one vote and
Speaker 1: inalienable rights as concepts, but actually to live those propositions
Speaker 1: uh in the making of policy. And actually, one of
Speaker 1: the things that's been delightfully surprising to me is just
Speaker 1: how quickly the congressional center of gravity has moved to
Speaker 1: recognizing these propositions. I mean, I think they would have
Speaker 1: recognized them over time, because the political process is fed
Speaker 1: up uh with income and wealth any quality, which I
Speaker 1: consider to be the approximate cause of the fact that
Speaker 1: Mr Trump's in the White House. So I think we
Speaker 1: would have gotten there over time. I would call it
Speaker 1: democratic enlightenment, small D democrat enlightenment, but the pandemic has
Speaker 1: really driven home we don't have time to do this
Speaker 1: in the fullness of time. We need to do it
Speaker 1: right now. UH and naval gazing about the long term
Speaker 1: consequence of budget Devisit is no longer the parlor game
Speaker 1: in Washington, and I consider that to be a delightful
Speaker 1: moment in history. The budget dev is is quite big
Speaker 1: enough to take care of itself and needs to be bigger.
Speaker 1: Just on that note, should the food measure fiscal space?
Speaker 1: That's a fascinating question. You're absolutely right, UM, and actually
Speaker 1: come up with a analytical framework by which UH Congress
Speaker 1: could be guided on how big the budget deficits should be.
Speaker 1: Is that what you're referring to. I'm not sure. I've
Speaker 1: never been asked that question before. Yeah, I think that's right.
Speaker 1: I was gonna say, if we agree that fiscal space
Speaker 1: might be bigger than we imagine before, then is there
Speaker 1: a role for the Federal Reserve to try to gauge
Speaker 1: that and maybe help Congress in figuring out how much
Speaker 1: there is and how it might be best deployed. That
Speaker 1: is really at a great existential question. I certainly think
Speaker 1: that the Fed should be very cooperatively involved in and
Speaker 1: analytically so UH with the physical Authority and trying to
Speaker 1: figure out the answer to that question, because we really
Speaker 1: don't know the answer. But I don't think that the
Speaker 1: FED should take it further to the point where effectively
Speaker 1: they would say to the Physical Authority, based upon our
Speaker 1: best modeling work and all of this sort of thing, uh,
Speaker 1: that you have X allowance two run budget deficit. I
Speaker 1: don't think that FED wants to go that direction. I
Speaker 1: don't think the FED shouldn't go that direction of effectively
Speaker 1: giving the Fiscal Authority on an allowance to exercise democracy.
Speaker 1: That that would be reminiscent of effectively Paul Boker and
Speaker 1: Alan Greenspan effectively telling Congress what to do uh, and
Speaker 1: if they didn't do it, then they would be consequences.
Speaker 1: So I don't think that that the FED should establish
Speaker 1: the moral equivalent of the f O m C for
Speaker 1: fiscal policy. Now that's a fascinating angle of a thought, however,
Speaker 1: in that should Congress itself have the moral equivalent of
Speaker 1: an f O m C uh. And that's an idea
Speaker 1: that I think is very intriguing and certainly doesn't originate
Speaker 1: with me whatsoever. In fact, a guy who wrote effectively
Speaker 1: a book on that concept was Alan Blinder over a
Speaker 1: decade ago. If we're gonna have monetary policy, have a demonstrable,
Speaker 1: technocratic or wonky sort of body to to debate and
Speaker 1: determine these sorts of things, maybe there should be something
Speaker 1: equivalent over on the congressional side that sets physical policy.
Speaker 1: Because you've got a huge body there, you know, for
Speaker 1: that's not an efficient way to make these sorts of decisions.
Speaker 1: So I would certainly be supportive of Congress establishing something
Speaker 1: that would have similarity to the f on C too,
Speaker 1: deliberate in a technocratic way, informed by politics and so forth,
Speaker 1: but actually informed analytically on determining you know, how much
Speaker 1: physical space uh there is, you know, kind of like
Speaker 1: you know, the f O m C is always you know,
Speaker 1: focused on what is nehru? What is nehru? What is nehru?
Speaker 1: And then everything shifted to what is our star? What
Speaker 1: is your natural real rate of interest? Uh? So I
Speaker 1: would be very open and supportive of of Congress having
Speaker 1: a body that would you know, deliberate about these sorts
Speaker 1: of things and inform the elected officials. In fact, conceptually
Speaker 1: you could morph the CBO in that direction. Heretofore CBO
Speaker 1: has tried to, you know, essentially say we'll just bottle
Speaker 1: out UH the implications of policy proposals and what it
Speaker 1: means for the budget deficit and all that feedback loop
Speaker 1: into py go and pay forwards and all of that
Speaker 1: sort of stuff. So conceptually you could take the CBO
Speaker 1: and turbo charge it into the moral equivalent of the
Speaker 1: f O m C. And again, UH, Alan Blinder is
Speaker 1: a brilliant man, has some really longstanding viewpoints on that,
Speaker 1: and I would hardly recommend that you have him on.
Speaker 1: I want to shift the conversation to actual UH markets
Speaker 1: and investing for a moment. As you mentioned at the beginning,
Speaker 1: you're a managing director at PIMCO, and this whole environment
Speaker 1: these last forty years, I mean, it's clearly just been
Speaker 1: fantastic for investors. If you just bought stocks, Sure you
Speaker 1: hit a few scary months here to there, but by
Speaker 1: and large they've just gone up. If you had a balanced,
Speaker 1: sort of classical sixty portfolio, you've done phenomenally well and
Speaker 1: less volatility because of this sort of way we've crushed inflation.
Speaker 1: But if you're thinking like sort of like from a
Speaker 1: portfolio management had on and you think, okay, we've come
Speaker 1: to the end of all these trends. As you say
Speaker 1: we're going to have this shift, then how what does
Speaker 1: that mean for sort of traditional portfolio allocation and risk management?
Speaker 1: And will the ideas that worked over the last forty
Speaker 1: years they are people gonna have to come up with
Speaker 1: new ideas. If the ideas that have worked over the
Speaker 1: last forty years work going forward, then democracy has failed.
Speaker 1: And I say that with great conviction may passion. If
Speaker 1: what has worked an investment management for the last forty
Speaker 1: years were to continue working, not immediately today or tomorrow
Speaker 1: the next day, but if it were to work on
Speaker 1: a secular basis for the next five years, ten years,
Speaker 1: twenty years, then we have unambiguously failed as a democracy.
Speaker 1: Because the reason the financial markets have done so spectacularly
Speaker 1: well over the last forty years is because we've been
Speaker 1: at a forty year disinflationary environment. I mean, you've had
Speaker 1: your cyclical ups and downs, but not ambiguously we've had
Speaker 1: forty years of disinflation. And that's because effectively, we shifted
Speaker 1: power in our economy, both domestically and globally from labor
Speaker 1: to capital, and capital has had the dominant UH influence
Speaker 1: in our economy for the last forty years, and global
Speaker 1: globalization is simply capitalism on a global stage. A disinflationary
Speaker 1: environment because of the dominance of capitalism, will also give
Speaker 1: you a fall over time in our star that real
Speaker 1: natural interest rate. It will also tend to dampen volatility.
Speaker 1: So when you think in terms of the three big
Speaker 1: forces of the last forty years that have made your
Speaker 1: old thing look wonderfully, well, those three forces is what
Speaker 1: drove it is the supremacy of capitalism over democracy, disinflation,
Speaker 1: and a falling natural real interest rate. And you can,
Speaker 1: just I love teaching this to my students, you can
Speaker 1: plug all three of those UH into a Gordon formula
Speaker 1: here I mean to be testing, you know, days ago
Speaker 1: from NBA school, but it's a really simple proposition of
Speaker 1: how you value things. And the Gordon formula is one
Speaker 1: dollar divided by the risk free interest rate minus the
Speaker 1: growth rate of profits plus a risk premium. And we've
Speaker 1: had a forty year tail wind of effectively falling real
Speaker 1: interest rates, which by definition is going to increase the
Speaker 1: market value of all income streams. And that's what capitalism
Speaker 1: is about is ownership claims on income streams. So actually,
Speaker 1: it's been uh forty years of incredible run uh bullmark
Speaker 1: invaluation for financial assets, and I certainly hope as a
Speaker 1: citizen that is not repeated. So I think my old profession,
Speaker 1: I'm retired now, I don't manage anybody's money but my own.
Speaker 1: I mean, I really hope that my old profession figures
Speaker 1: out a new paradigm for its own health. Because what's happened,
Speaker 1: what's worked the last forty years should not work unless
Speaker 1: you want democracy to fail. Okay, the old approach the
Speaker 1: won't work. Is there something that will work in the
Speaker 1: new system if democracy works, are their portfolios that can
Speaker 1: still work if we have this uh you know, reassertion
Speaker 1: of democratic economic management. Actually, I'm not so much critical
Speaker 1: of the sixty forty proposition. It's the payoff of the
Speaker 1: sixty forty proposition, the rate of return. Actually, I don't
Speaker 1: know what the right number is gonna be going forward
Speaker 1: on the split between equity and fixed income. I think
Speaker 1: the sixty forties pretty ingrained in our society, but theoretically
Speaker 1: it should be based upon you know, volatilities and all
Speaker 1: of that sort of thing. But actually one fly in
Speaker 1: the autment on the sixty proposition is that, uh, as
Speaker 1: we've seen, particularly in the last decade, that equities and
Speaker 1: treasury bonds have had a wonderful negative correlation. But differently,
Speaker 1: you hedge equity risk with credit risk free duration risk,
Speaker 1: and you know, Bridgewater built it's you whole business model
Speaker 1: on that proposition of risk parity, and risk parity models
Speaker 1: don't work all that very well when you have nowhere
Speaker 1: to go for the price of the treasury bond. So
Speaker 1: by definition, treasuries will be less of a quote unquote
Speaker 1: hedge to equity risk going forward. And I think that's
Speaker 1: hugely important for my profession of investment management is recognizing that,
Speaker 1: just as a result of a arithmetic uh, that government
Speaker 1: duration long government duration is less useful as a hedge
Speaker 1: against equity risk going forward. So I think that's where
Speaker 1: a lot of PhD uh dissertations should be written going forward. UH.
Speaker 1: And it has profound implications for risk parity business models.
Speaker 1: But away from that issue, I think it's just the
Speaker 1: rate of return on ownership claims otherwise known as assets
Speaker 1: going forward, because I would like to believe, and I
Speaker 1: fully believe the FED would like. This outcome is that
Speaker 1: inflation goes up from here over the next five to
Speaker 1: ten years. And inflation going up would be a d
Speaker 1: delightful thing for democracy because that means that labor is
Speaker 1: gaining bargaining power, our pricing power versus capital. So therefore
Speaker 1: I will applaud all day long as a citizen. But
Speaker 1: it will also tend to be a inflationary tail wind,
Speaker 1: not a disinflationary tail wind. And actually I'm saying that
Speaker 1: in a very positive sort of thing, not a negative
Speaker 1: thing like you hear frequently, Oh this is this is
Speaker 1: gonna lead to inflation. I pray it leads to inflation.
Speaker 1: If it does not lead to inflation, then it has failed.
Speaker 1: And that over the next five to ten years, if
Speaker 1: we shift more power to the people, if you will,
Speaker 1: you don't do that so much directly as you do
Speaker 1: that uh through the democratic process UM, and you get
Speaker 1: higher inflation, that it means that UM evaluation should come
Speaker 1: down for financial assets. Or if you want a bumper
Speaker 1: sticker for it, is that the environment, the pro democracy
Speaker 1: environment that I envision in the generation ahead, is barish,
Speaker 1: not bullish. For pe multiples, the last forty years have
Speaker 1: been a bull market invaluation, and going forward, I think
Speaker 1: that Wall Street and the investment management business and the
Speaker 1: wealthy need to recognize there's such a thing as a
Speaker 1: bear market evaluation, which would be a secular decline and
Speaker 1: pe multiples, a bear market in bonds, a increase in
Speaker 1: cap rates UH for real estate and so forth. So
Speaker 1: I think for the investment world, UM, there needs to
Speaker 1: be a embrace of the notion that the forty year
Speaker 1: evaluation expansion epic is over. Don't necessarily mean in the
Speaker 1: next few months. I'm talking about long term secular trends here.
Speaker 1: There's one more topic that we really need to ask
Speaker 1: you about, and I think Joe Joe mentioned in the
Speaker 1: intro that you know you coined the term Minsky moment.
Speaker 1: You also coined the term shadow banking with Sultan Poser,
Speaker 1: who has been on our podcast a couple of times. Now, UM,
Speaker 1: how do you think shadow banks contributed or what role
Speaker 1: did they play in the recent market turmoil UM that
Speaker 1: we've seen this year. I think shadow banks morphed after
Speaker 1: the financial crisis. Obviously the biggest shadow banks became real
Speaker 1: banks UH after Lehman went down, and the impulse to
Speaker 1: create a shadow bank shifted to other spaces, but shadow
Speaker 1: banking is very much alive and will always be with
Speaker 1: us because it's too tempting. Essentially, a shadow bank is
Speaker 1: nothing more than using a traditional banking model, which is
Speaker 1: inherently profitable, and doing it UH without government constraints. Julia
Speaker 1: will always be with us. The notion of eliminating shadow
Speaker 1: banking is nonsensical, and I think it should be nonsensical
Speaker 1: because shadow banking is basically an arbitrage around traditional banking,
Speaker 1: which is a joint venture between the public and private sector,
Speaker 1: and shadow banking is simply saying, let's take the public
Speaker 1: sector out of the banking model and make it a
Speaker 1: private one picks up when we blow up, and then
Speaker 1: we'd like the public sector back. And I think shadow
Speaker 1: banking will be with us for a long period of time,
Speaker 1: and it should be with us for a long period
Speaker 1: of time. It's just endemic to capitalism that you always
Speaker 1: want to arbitrage government rules. In the most recent episode,
Speaker 1: I think that shadow banks, and here I'm just I
Speaker 1: can use effectively call it the non banking sector, probably
Speaker 1: exacerbated the malfunk auctioning of the financial markets. And remember
Speaker 1: UH share Powace Pound at the table that a lot
Speaker 1: of what they've been doing is to restore and support
Speaker 1: market functioning, and market functioning requires market makers. And after
Speaker 1: the financial crisis, essentially UM government democracy dramatically limited the
Speaker 1: ability of Wall Street uh market makers to act like
Speaker 1: hedge funds, because that's essentially what they were doing. Lehman
Speaker 1: Brothers would be a perfect example, with leverage half the
Speaker 1: distance to the moon. So the depth of Wall Streets
Speaker 1: ability to absorb a risk on part of the system
Speaker 1: was regulated out of existence, not out of the existence,
Speaker 1: it was looted dramatically. Uh. So therefore, when you get
Speaker 1: a shock, then non market makers effectively can lock up
Speaker 1: the markets very very quickly. Uh. And therefore you have
Speaker 1: to have the FED come in and effectively be the
Speaker 1: market maker of last resort, which is what they've been
Speaker 1: doing obviously. So I'm not sure I would so much
Speaker 1: say that, you know, shadow banks are a culprit or
Speaker 1: anything of that nature, but they were truly major players
Speaker 1: and basically saying we've gotten hit with a shock that
Speaker 1: induces radical uncertainty and we need to offload will risk
Speaker 1: and in UM the post dot Frank world, whilst the
Speaker 1: traditional banking sector simply doesn't have the capacity to be
Speaker 1: the shock absorber in the system. Uh. That all mighty
Speaker 1: has to be the sovereign, as manifest in the Central
Speaker 1: Bank itself. Paul mcculey, that was a great conversation, and
Speaker 1: thank you so much for coming on out love UM absolutely, Pature,
Speaker 1: thank you, Tracy and Joe, thank you. That was great.
Speaker 1: Thank you Paul. That was great. Tracy. I feel like
Speaker 1: we've hit on a lot of these themes that we
Speaker 1: touched on with Paul in several of our recent episodes
Speaker 1: really throughout this crisis. But I don't think anyone has
Speaker 1: really put all the pieces together, uh as well as
Speaker 1: Paul Ken in terms of really politics, macro policy, fiscal handoff,
Speaker 1: and then also like just what it means for investing. Yeah. Um,
Speaker 1: Paul is really able to bring all those sort of
Speaker 1: different strands together in one big narrative. And I think
Speaker 1: I think there's a tendency on the part of investors
Speaker 1: in the market to sort of dismiss concerns about inequality
Speaker 1: as not really relevant to investing. UM. But I think
Speaker 1: Paul made a really good point that if you think
Speaker 1: that the deflation that has basically caused risk assets to
Speaker 1: go up or contributed to risk assets going up for
Speaker 1: the past forty years. All of that is because of
Speaker 1: that handoff or that dominance of capital versus labor. Then
Speaker 1: the inequality question becomes really really important for anyone investing.
Speaker 1: It's not just a topic of you know, social dynamics
Speaker 1: and justice and things like that. Yeah. I think the
Speaker 1: way like I think about it is like maybe people
Speaker 1: think that fixing inequalities like a technical fix that it's like, Okay,
Speaker 1: we have this like robust economy, booming market, what we
Speaker 1: need to do something about inequality too, as if it's
Speaker 1: just like this little piece of it, rather than seeing
Speaker 1: how widening in equal quality, as Paul puts, it is
Speaker 1: actually at the heart of this incredible economic and market
Speaker 1: model that we've had. And it's sort of like, you know,
Speaker 1: kind of playing people maybe think of this game's Jenga.
Speaker 1: Let's move this little piece, but we can keep the
Speaker 1: whole thing up. But it's really sort of integral to
Speaker 1: how it all works and how or the clauses of it.
Speaker 1: It's really deeply connected. I think that's absolutely right. And
Speaker 1: the other thing I will say is that even though
Speaker 1: we talk a lot about the handoff from monetary policy
Speaker 1: into fiscal policy or the mixing of the two. And
Speaker 1: we're starting to see some change on that front, even
Speaker 1: though that's happening, and you know, Paul thinks that that
Speaker 1: could be the thing that sort of brings capital and
Speaker 1: labor labor back into balance, or you know, democracy back
Speaker 1: into play. So far, all of the measures unleashed by
Speaker 1: the Federal Reserve have had the effect of increasing inequality
Speaker 1: as far as I can see, like both for individuals
Speaker 1: and for capital markets as well, where you know, big
Speaker 1: companies can access this booming bond market and smaller firms
Speaker 1: are still locked out because they can't get loans from
Speaker 1: you know, run of the millbanks. Look at today, we're
Speaker 1: recording this August. It's now been weeks since the unemployment
Speaker 1: insurance expansion lapsed, and there is not obviously a lot
Speaker 1: of political appetite right now. Now maybe by the time
Speaker 1: people are listening to it, they'll have something, but we
Speaker 1: everyone's like talking, including policy, like Okay, this is the handoff,
Speaker 1: this is the moment. And if we see we're the
Speaker 1: middle of a crisis, ten percent unemployment and we still
Speaker 1: can't get an unemployment insurance expansion. So for as obvious
Speaker 1: it is, as it is to some people that there's
Speaker 1: a hand off, the reality in d C is we're
Speaker 1: a long way in practice from actually having a sustained,
Speaker 1: robust fiscal framework that's outside of just a few months
Speaker 1: and the worst part of the crisis. We're clearly not
Speaker 1: there yet. Yeah. I think that's right, But it also
Speaker 1: does make you think what happens when when we do
Speaker 1: finally get like actually substantial fiscal stimulus in some form
Speaker 1: or another. I also just think in general, and this
Speaker 1: is a point that you've made a bunch of times,
Speaker 1: both a podcast and on Twitter. It's like, and you know,
Speaker 1: to what you said before about inequality, but it's like
Speaker 1: this is all downstream from politics. Like the idea of
Speaker 1: separating political fights from economic management or whatever, or the
Speaker 1: idea that we can have a handoff from monetary to
Speaker 1: fiscal policy, but in a way that somehow like a
Speaker 1: political it's unrealistic, Like the fight has to be and
Speaker 1: it's happening, of course, but the fight is first and
Speaker 1: foremost in politics, and then the change in policies, if
Speaker 1: we were to get one, comes after that. Yeah, the
Speaker 1: problem is and always has been politics and I'm not sure,
Speaker 1: you know, formally recognizing that does much to change the situation. Um,
Speaker 1: maybe it's a start, but I think I'm just very
Speaker 1: cynical about politics in general. I think you're you're well justified. Okay,
Speaker 1: so we leave it there. Let's leave it there, all right.
Speaker 1: This has been another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway, and I'm Joe Wisn't thought you could follow
Speaker 1: me on Twitter at the Stalwart. Follow our producer on Twitter,
Speaker 1: Laura Carlson. She's at Laura M. Carlson. Followed the Bloomberg
Speaker 1: head of podcast, francesco Leavi at Francesca Today, and check
Speaker 1: out all of our podcasts under the handle at podcasts.
Speaker 1: Thanks for listening.