Author: Alec Krishna

Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

Post author By Alec Krishna
Post date March 31, 2023
No Comments on Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

The Australian Government has been having trouble getting its proposed Housing Australia Future Fund (HAFF) passed by the Senate. The policy looks odd. With some justification, the Australian Greens have commented: “In its current form the Housing Australia Future Fund (HAFF) legislation will see the housing crisis get worse. We can’t fix the housing crisis by gambling money on the stock market and not guaranteeing a single cent will be spent on housing.” In their dissenting report on the bill, the Greens’ cited the views of this episode’s guest, Dr Cameron Murray. Cameron is a Post-Doctoral Researcher at the Henry Halloran Trust at the University of Sydney.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

About Dr Cameron Murray

Dr Cameron Murray is Post-Doctoral Researcher at Henry Halloran Trust, The University of Sydney. He is an economist specialising in property and urban development, environmental economics, rent-seeking and corruption.

Book: Rigged: How networks of powerful mates rip off everyday Australians

Website: https://fresheconomicthinking.substack.com/

Twitter: @drcameronmurray

What’s covered in this bonus episode

Cameron’s submission to the Senate Inquiry into the Housing Australia Future Fund Bill [2:39]
What’s going on with the Housing Australia Future Fund [5:02]
The only reason you can make a premium is if you take risk [8:57]
Why you need to separate the funding and the spending [10:36]
Why doesn’t the Future Fund just directly invest in new houses? [14:21]
How governments are increasingly doing financially tricky things that don’t make sense [19:23]
Cameron’s thoughts on the impact of the bill on the level of investment in housing [23:14]
What’s going on behind the scenes at Parliament House [26:18]

Links relevant to the conversation

Cameron’s submission to the inquiry into the Housing Australia Future Fund:

https://fresheconomicthinking.substack.com/p/australias-housing-future-fund-my

Direct link to Senate Committee inquiry report:

https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/HousingPackageofBills/Report

HAFF inquiry home page:

https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/HousingPackageofBills

Transcript: Odd way to fix housing crisis proposed by Aus. Gov’t: invest in stocks first w/ Dr Cameron Murray, Sydney Uni.

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny 00:06

Cameron Murray 02:39

Thanks for having me again, Gene.

Gene Tunny 02:40

Oh, it’s a pleasure, Cameron, I read with much interest your latest post on fresh economic thinking. And it’s about your submission to the Senate inquiry into the housing Australia Future Fund Bill 2023 and other bills. Could you tell us a bit about what that involves? So you’ve written a submission to this inquiry? And you’ve also presented to the inquiry you gave testimony? Did you?

Cameron Murray 03:07

Yeah, that’s right. So this bill was passed their house, the lower house, and now the Senate is reviewing it. And what they’ve done is held this inquiry asked for public submissions, and had people who made submissions come in for a day of expert testimony so that their senators can ask specific people, you know, technical questions, what do you think about this? What about this design element? And so I was part of that on on Wednesday, this week. And yeah, so the bill itself is called the housing Australia future funding bill. And the basic idea is the government has decided to address Australia’s current housing problems. We’ve seen rents rise, we’ve seen rising homelessness, we’ve seen longer queues in public housing waiting lists, they’ve decided the best thing for them to do is take $10 billion from the Treasury and give it to the Future Fund, which is a sort of publicly managed investment fund, and cross their fingers and hope that that fund makes a return that’s higher than their opportunity cost, you know, the cost of the government’s dead and use that margin on the risk to fund something in the future, some unspecified, granting in relation to what in the text of the bill is called supporting housing need. So that’s what it was all about. And, and yeah, I gave some testimony on Wednesday.

Gene Tunny 04:35

So the federal government’s claiming that this is going to help them build I think 30,000 social housing dwellings over the next five years or so. So that’s their that’s the plan. But I think what I like about your submission is it essentially talks about how this is a rather roundabout way of going about it, which doesn’t actually guarantee you’re going to deliver it to you As in,

Cameron Murray 05:00

this is the mad thing. And this is. So let me start by saying, to be clear what they’re doing to build houses is taking $10 billion and buying all sorts of assets in the future funds that are not houses. Right? So that’s what they’re trying to do. And it’s really funny because there’s an actually an episode of Utopia, you know, the comedy show about the bureaucracy in Australia, where Rob switches character, who’s the sane one, amongst the insanity is explaining to a political staffer who says to him, What about an infrastructure? Future Fund? Yeah, don’t you get it, it’s about the future, he says. But spending the money on infrastructure today solves the future, we don’t need a fund. We don’t need a new office, we don’t need these fund managers. And you know, when we watch utopia, we all laugh and think we’re the same guy in the room. But what happened at the Senate inquiry is that I was the only guy and everybody else who laughed at Utopia when they watched it was the crazy guy who thinks that spending money on not houses is the best way to spend money on houses. And so there was this really perverse political slogan that kept creeping in, which was, this is going to secure funding for the future and insulated from future political decisions. And I just sat there going, I don’t, I’ve read this bill, because this funding is riskier, because you’re investing in a risky asset and the current Future Fund loss $2.4 billion last year, and spent half a billion dollars on fund managers to achieve that outcome. So we almost lost $3 billion last year. So it’s possible that we put 10 billion in this fund and have 9 billion next year. And then that’s the way we’re securing the future funding. The legislation is also written such that the future Minister has the discretion of how much from the fund to spend, and on what projects. And it also introduces a cap of 500 million per year that a future minister can withdraw from the fund. So what you’re actually doing is providing a great excuse for a future minister to spend less than 500 million. And in fact, zero if the fund is losing money. So there’s this weird disconnect between the political slogan of securing long term funding insulating it from politics and the reality, which is adding risk to a fund compared to just having 10 billion in the bank or at the Treasury where it is, and not insulating at all, and just still relying on future ministers discretion with no commitments. So that 30,000 dwellings you said, is not enough. There’s no, it’s not written in their rules. It’s written in the guideline as a hypothetical of how much, you know, if all went according to plan, and we would expect this, and I’m like, but there’s like, like many housing strategies and plans that the federal government and state governments have had in the past, there is nothing holding them to account on those promises. So yeah, it’s, it’s a really, really strange one. And I felt like there are about 20 or 30 witnesses or experts at the hearing. Now, only two or three of us actually calling this out the majority of the industry. And the researchers had really, I don’t know, bought the line that this is something that it’s not.

Gene Tunny 08:16

Yeah. So what’s going on, it appears to me is they’re essentially that borrowing, they’re going to be borrowing this money, or it’s going to increase the borrowing requirement by $10 billion, because we’re currently we have been running budget deficits. So it’s going to increase that, that borrowing requirement, we’re going to put that into this the future funds, so we’re essentially borrowing money to then invest in the share market or Enron’s Yeah, well,

Cameron Murray 08:45

if we’ve invested in bonds, we’re borrowing money to buy the bond back off ourselves. If this fund, if this fund is like eight or seven or 8%, government, Australian government treasury, that’s just pure accounting. Yeah, you know, trickery, you know, and that shows it but the whole thing is accounting trickery, right? Because, you know, you’re just recycling the money via the current shareholders of BHP into Telstra and Commonwealth Bank, right, by buying the shares off them and then later selling it back to them. And the only reason you can make a premium with this fund over the over not borrowing it, right, because you still gotta pay interest on the Treasury borrowing. The only reason you can make a premium is if you take risk. Yeah, if you’re taking risk, then it’s not a secure, long term funding thing. You’re just adding risk unnecessarily, and delaying spending money on building houses. And, you know, it took a little bit of explaining to get that through at the hearing. But ultimately, I had, for example, John Corrigan, you know, back me up on that argument, and I think Brendan Coates from the Grattan Institute who is a big supporter, the policy sort of had to concede that Yeah, at the end of the day, you’re adding risk in the hope of increasing the funding. But risk is real, right? We just can’t count on winning In the next few years,

Gene Tunny 10:02

right, so Brennan was buying the government’s line that this is about getting a secure funding source. He, I mean, I know you can’t speak for Brendan, I’m just wondering where he was coming from?

Cameron Murray 10:13

Well, actually, the idea is actually from one of our Grattan Institute report, and they proposed a $20 billion social housing fund. And, and, and, you know, I’m not averse to the government sort of diversifying the capital side, right on its balance sheet. Yeah. And and owning some high risk assets? I don’t, I’m not averse to that, in principle, right. But you’ve got to separate the funding and the spending idea. So the way I try to tell people, if the government’s saying we don’t have the money for it, it means we don’t want to do it. Because look at the submarines look at every other big look at the Olympics, right, no one’s has gotten the Olympic Future Fund, no one’s got a submarine future fun. We spend on what we want. And if someone’s saying where’s the budget, or where’s the funding, you sort of missing the idea, but but even more fundamentally, you know, if you go and raise money in the share market, from new investors for your business, each investor doesn’t say, I’ll give you this money, but you can only spend this money on, you know, cleaning your office and and the other shareholder says, no, no, but I only want you to earmark my money for doing this, right. What we do is we pool that money together and spend it the best way we can on the operations we need to do and it’s the same for the government, you need to separate Well, we’re gonna raise money, the best way we know how, whether that’s different types of taxes or borrowing, and we’re going to spend money the best way we know how and tying two things together is bad. Operationally, it’s just like, it’s bad for my business to promise one shareholder that their money goes to one type of spending, and another shareholder that I’ll only spend yours on new trucks. You know, it doesn’t really make sense it and it’s very hard to break through this kind of weird, I don’t know, budget illusion that we’ve all got that, you know, we must do this. For this, we must raise money in this way for this spending.

Gene Tunny 12:06

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 12:12

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you Frank and fearless economic analysis and advice, we can help you with funding submissions, cost benefit analysis, studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world, you can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny 12:41

Now back to the show. I liked how you wrote about this off balance sheet trick or the off balance sheet tricks, the basic idea of the half. So that’s the housing Australia Future Fund is to create an off balance sheet accounting trick whereby the debt associated with the fund and the assets in the fund are considered as a bundle and hence not counted in measures of public debt. So I mean, I haven’t seen exactly how they’ll what the accounting treatment of this will be in the budget, it seems to me what they’re doing is they’re setting this up as a, it’s an SPV, or some sort of public Financial Corporation so they can get it outside of the traditional balance sheet measures. They put in the budget, which is for they have it for general government, but then they also have public non financial corporations, but they don’t have public Financial Corporation. So I’m wondering if that’s what they’re going to categorise it as

Cameron Murray 13:34

I think, yeah, that’s part of the intention. And we actually see those types of budget tricks a lot, I think, New South Wales rail, you know, they tried to shift things off balance sheet, but at the end of the day, you know, we as economists should be looking through that, right. Oh, yeah. And saying, Look, you know, debts debt, but, you know, these are all assets, we can bundle them all together, you know, doesn’t matter where you’ve accounted for them. And the way we’re going to assess whether that debt was, you know, justified or efficient or productive is what, you know, what the investments made in general are, so whether it was on budget or off, you know, it should be the same, right, and you’re borrowing money to buy these assets. Doesn’t matter how you account for it. And that’s the that’s what sort of leads me to my other point is that houses are assets. Yeah. Australia’s property market is the hottest market every property every investor wants to own some. Yeah. So why doesn’t the Future Fund build new houses to expand this pool of property assets in the process, that equity can be on its balance sheet, but instead of, you know, bumping up the prices of BHP shares that you’re going to buy, you actually expand the housing stock in the process, and you can still have your off balance sheet tricks. I actually looked historically and since the Future Fund started in 2006, that’s the current investment fund Australia hands. They’ve made 7.8% average return annually, the average Australian dwelling increased in value by 7.7% per year since 2006. So just the capital value increase of owning a representative sample of Australian property would have got you the same returns as the Future Fund. So it’s not clear to me why we’re recycling this money via other assets, before we build housing assets, we can look at the balance sheets of state, public housing managers. Yeah. And when they value their land and their property portfolios every year, they got to bump it up, you know, 5 million billion. So here 10 billion here, because all this portfolio of properties they own, you know, it’s a valuable asset that rises in value. So So I’ve proposed quietly to a lot of people involved that if you want to have your financial trick and your Future Fund, get the border of the future find to only spend the money, building new dwellings, and then put the equity that you have, yeah, into the fund, you can keep your financial track, but at least you’re you know, keeping the housing construction going. And you’re immediately accumulating a pool of houses that you can allocate to the people who need it at a cheap price.

Gene Tunny 16:13

Yeah. And so is this been driven by the State of the Commonwealth budget, they, they want to make sure that they think they’re gonna get some earnings from this housing Australia Future Fund that can then offset the spending that they’ll have to make on public housing. So they want to get that they’re hoping they can get that. Because if they just go ahead and start building public housing, then they don’t have that revenue to offset that. Is that what they’re thinking?

Cameron Murray 16:39

I think you’re right, I think that’s what the thinking is. But at the end of the day, you know, having those houses supplied to people at a cheap price offsets are the spending on those people already. So the benefit is there, either in the form of the rental, or in the form of the income from the other assets. So, if I was to put on my cynical, political economist hat, I would say the reason this programme has gained so much traction and is probably going to be the law few months, is because it doesn’t change the housing market, it’s going to pass because it doesn’t achieve anything. And that’s what is truly desired. By, you know, the political parties involved is that they want to look like they’re doing something without actually doing it. I’ve had conversations with politicians who’ve told me what’s wrong with the housing market? You know, prices went up, because we dropped the interest rate, that’s good. And rents went up, because incomes went up. That’s good. There’s no market failure here. government shouldn’t do anything. So if that’s what they say to me, how is it then that they passed this bill that’s meant to do something, the only coherent story there is that this bill is to look like you’re doing something, but not doing something because you genuinely think the property market is doing what it’s doing? Well? Yeah, that’s my super cynical. Political Economy hat.

Gene Tunny 18:08

Yeah, you may well be right. I mean, it’s the Sir Humphrey Appleby type of approach where people actually don’t care about whether a problem solved, they just want it look as if something’s being done.

Cameron Murray 18:21

I’ve had a lot of people message me since my testimony to tell me their experiences of this. And I don’t know what I’m going to call this pattern, you know, does it have a name? I’ve tried to call it something like pre compromising. Where you take a good idea, you turn it into a bad idea, but it’s still got the same words in the bill. While so it looks like you’re still doing something. Yeah, you push that. And you’ve totally compromised the content, or the effectiveness, just so you can keep the name because the name is what people will talk about. And it looks like you’re doing something. It’s a what’s it called housing Australia Future Fund? Yeah. Sounds like something important is being done. Right. Yeah. And the more that gets in press headlines, the more we give credibility to the current government, who is trying to, of course tread this line of keeping prices up for people who own property, and pretending they want to keep prices down and rents down to people who don’t own property. And that’s a real interesting political tightrope. That happens a lot in this country.

Gene Tunny 19:23

Yeah, I really liked your submission, Cameron, because I thought it. I mean, it highlights our governments are increasingly doing these sorts of things. And they don’t really make a lot of sense when you think about it, because I remember when I was in Treasury, we had to set up these buildings Australia fund education investment fund, that’s I forget the name of the other one. And it didn’t really make a lot of sense because you’re just taking money and we ended up I think we ended up having to borrow money to put into them, because of the time you know, but the original idea was that there was Yeah, and they were gonna stick them in these funds, but then by the time On had to transfer the money, it was the financial crisis. So the timing wasn’t very good. And then they we see they constrain your ability to get cash. I mean, because you’re saying, Okay, we’re going to lock up all of this money in these funds, even though we don’t need it at the moment. So it can it can constrain your budget flexibility. So I don’t like them for that reason. And the other point that you’re making is your your, if you end up having to borrow to invest in it, well, you’re, you’re borrowing money just invested in the share market. And it’s not necessarily achieving the public policy objectives that you that you want to achieve. So yeah,

Cameron Murray 20:43

that’s exactly the way to put it, you’re gonna borrow 10 million to build houses for people and give it to them below market? Why do you need to recycle that money through the share market? Why don’t you put it through the pokies, there’s also a chance of making more money there, you know, it’s high risk. Why don’t you just take your half million, that half billion that you want to spend each year and spend it for the next 20 years, and just start a construction programme? Like, the really bizarre thing? To me, I read this bill. And in Part Seven H or whatever it is, it says, The Treasury will credit the housing Future Fund with $10 billion. It just doesn’t. And I just think to myself, How does where’s this 10 billion coming from? Aren’t we having this fund to get the money that we don’t have a now you’re saying we have 10 billion? If we have 10 billion? We don’t need the fund? Right? Yeah. And, you know, no one else seems to pick up on that, oh, we just credit with 10 billion. I’m like, why don’t you just build houses, credit them? Credit, the builders is 10 billion. Yeah.

Gene Tunny 21:45

So this is where they’re hoping that by doing it, you know, essentially gambling or well investing with borrowed money, they can get enough of a return on that, to then help fund this additional expenditure. And that’s going to lessen the budgetary impact. So that’s essentially what’s going on. And I just think it’s interesting, because it’s an interesting example of one of these. These things, these clever financial vehicles, the Polly’s and the advisors, I think, in particular, they love it, they think they’re geniuses, but it’s not really solving the problem.

Cameron Murray 22:20

Yeah. And let me just talk you through what I think is the best case scenario. They put money in this fund, sometime in the middle of this year, after we’ve had a big asset market correction, and they they’re near the bottom. In the next 12 months, there’s a real big boom. And in 12 months time, the ministers say, Oh, look, we’ve been making all this money. I’m gonna make this happen. Yeah, that’s the best case. The worst case is, you know, we’ve just seen a bank collapse in the United States, and you know, Swiss government bailout the Credit Suisse bank, the worst case scenario is they put $10 billion into the Future Fund, start accumulating assets in the next six months. And then come September, October, you know, popular time for financial market crashes, the fund loses 10% of its value. And next year, the minister says, oh, we can’t spend anything on public housing, because we just lost a billion dollars on the share market. Yeah, that’s, I don’t know which one’s more probable, but both are potential outcomes. And if the second one happens, you know, I hope the public and the press hold the government to account and say, Hey, this is what you wanted. You were told this is the risk you’re taking. And you still did it anyway. I really hope that opens people’s eyes. If that happens.

Gene Tunny 23:34

Yeah, that’s a good. That’s a good point. So you’re saying that the the level of investment in public housing could end up being dependent upon the returns on this fund

Cameron Murray 23:46

highly likely, implicitly, tells the minister only spend what you make, you know, for funds doing well spend money, if it’s not don’t spend money, the way it sort of described, and it’s got this cap in it as well. I would say there’s a sort of, you know, a built in excuse, yeah. Whereas you kind of want the opposite incentive. You want more public spending on housing during a downturn in the markets, right? You want to smooth out construction cycles. Yeah. Whereas I sort of feel this builds in the opposite political incentive. But the you know, the next 12 months are going to be very interesting if this bill is finally passed. And you know, the markets are very volatile at the moment. And the Future Fund, of course, lost a couple of percent last year, you went down the existing funds. So if that happens again, yeah. Who knows? Yeah.

Gene Tunny 24:40

Just before we wrap up, Cameron, can I ask you what was it like presenting to the committee? I mean, did anyone get it? Did any bells rang? Or what’s the expression? I mean, I imagined some of the Imagine that. There must have been, some of them must be sceptical, or I hope some of the people on this committee worse sceptical. But yeah. What was your impression?

Cameron Murray 25:05

My impression is that this process is a little bit of a charade. So that each political party in the crossbenches can get their sort of own experts on to provide excuses for the political bargain that they want out of this in the Senate. So I think most of the action is happening behind the scenes. And this is just each, each person in the Senate had a chance to call forth their own experts. And so that was done. My impression is that your committee is loaded based on the political party of the day, right. You know, I was cut off from my introduction, when I was saying, you get a few minutes to make introductory remarks. And I was explaining how I can’t believe you’re trying to describe this as a low risk secure, politically insulated funding stream when it seems the exact opposite. Yeah. And they’re like, oh, you know, we only allowed two minutes for these opening remarks get. And, of course, if you if you go and check the footage, everyone bloody rambled for five minutes. So you can sort of see that and, and, you know, I’ve spoken to a variety of Senators offices, as well. And they’ve obviously taken on board what I’ve said, but you don’t see minds being changed. Live during this process. That’s not where it happens. It’s all happening with phone calls and meetings and negotiations amongst each party and independents are

Gene Tunny 26:36

all behind the scenes. Okay. Because I was just wondering, I imagine that the, the greens would probably be pushing the for the government just to build public housing. Right. Yeah. Well, that must be in there. That’s right. So

Cameron Murray 26:50

I think it’s Nick McKim is the green senator from Tassie. And he was, you know, onboard when I started my opening remarks by saying, you realise there’s a scene in the comedy show utopia, right? We started today. That is exactly what you’re doing. But you all laughed with the other side of the joke. And now you’re you are the joke. And so he got a few chuckles But you know, the other the other people didn’t really like it. So yeah, the greens are definitely not keen on these off balance sheet financial tricks at all, which is really puzzling, right? It’s really puzzling to me. I don’t know what the Liberals should be sort of have a similar mind being a bit more honest financially and say, let’s focus on what’s a waste of money and what’s not. Let’s not focus on where you record it in the accounts. So I don’t I don’t know what their views are. But my impression is the Labour Party, you know, they’ve almost got this superannuation brain, or this Future Fund brain like this sort of, yeah, it’s inhibited their ability to go, you know, this is not magic. It’s not a Magic Pudding. It’s just buying different assets.

Gene Tunny 27:57

Yeah, yeah, exactly. So I’ll put a link to your submission in the show notes. I think it’s really good. And you make a good point about how, yeah, I didn’t realise the fees paid by the Future Fund for funds management was so high, but I guess it makes sense, given the amount of funds under

Cameron Murray 28:13

point 2% of the funds under management. That is still half a billion dollars a year, which is of course, again, the maximum that this Future Fund for housing can actually spend on housing subsidies or housing construction. Yeah. So the maximum they can spend is roughly what the average management fee is for the existing Future Fund. Yeah, just to get your orders of magnitude straight of what’s involved.

Gene Tunny 28:40

Okay. And, yes, it has been passed by the lower house, it’s going to it’s being considered by the Senate at the moment, and it’ll probably be passed, I imagine, based on what you were saying,

Cameron Murray 28:51

my understanding is the cross bench has a lot of power in the Senate here to get things changed. My suspicion is that if there are key crossbenchers that take my argument seriously and a couple of other of the submitters as well, they may, for example, put in the legislation a minimum amount of spending out of the fund instead of a maximum to sort of guarantee it. And they may, you know, and that might just be a way of diverting instead of buying bhp shares and Commonwealth Bank, you know, build houses with it and own the equity of those houses with your public housing developer or however you account for that. So that that that may be a realistic change. I don’t think it’s gonna get thrown out or go back to the drawing board.

Gene Tunny 29:38

Right. Okay. Well, again, well done, Cameron. Yeah, excellent submission, lots of very sound, economics and public finance in there. Any final words before we wrap up?

Cameron Murray 29:49

No, I just want to, you know, cross my fingers that the best case scenario turns out if this fun gets passed.

Gene Tunny 29:55

Very good. Okay. Cameron Murray, thanks so much for appearing on the show.

Cameron Murray 29:59

Thanks for having me, Gene.

Gene Tunny 30:02

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

Cameron Murray 30:49

Thank you for listening. We hope you enjoyed the episode. For more content like this or to begin your own podcasting journey. Head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Tags assets, australia, balance sheet, bill, borrowing, buying, economics, fund, future, government, houses, housing, market, money, people, public housing, spend, submission, treasury

Podcast episode

How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Post author By Alec Krishna
Post date March 23, 2023
No Comments on How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Have democracies failed and is authoritarianism winning? How can democracies reinvigorate themselves? Does the West need to decouple from China? These and other questions are considered in Economics Explored episode 180. Foreign affairs expert Charles Dunst talks about his new book Defeating the Dictators with show host Gene Tunny. Among other things, Charles and Gene talk about the potential benefits of Public Private Partnerships (PPPs), such as Operation Warp Speed, the Trump administration’s COVID-19 vaccine plan.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

About Charles Dunst

Charles Dunst is deputy director of research & analytics at The Asia Group, an adjunct fellow at the Center for Strategic and International Studies, and a contributing editor of American Purpose. He is the author of Defeating the Dictators: How Democracy Can Prevail in the Age of the Strongman (Hodder & Stoughton, February 2023).

For further information about Charles, check out https://www.charlesdunst.com/.

What’s covered in EP180

What is the Asia Group and what does it do? [1:35]
Is democracy no longer seen as the path to prosperity in developing economies? [5:28]
What are the most important organizing principles for a democratic system? [11:38]
Accountability and the lack of trust in government [16:34]
Best practices for running a democratic country in the 21st century [21:36]
Too much money in politics in the US [25:41]
Does the West need to decouple from China? [27:37]
The role of public private partnerships (PPPs) such as Operation Warp Speed [32:27]
How will dictators be defeated if we govern ourselves better? [34:59]
The importance of engaging in the conversation through social media and local governance [38:32]
Inequality and the Dream Hoarders [39:00]

Links relevant to the conversation

Defeating the Dictators (Please buy the book via this link to support the show):

https://amzn.to/3liQrjx

Matthew Engel’s FT article “The foreign states that own Britain’s railways”:

https://www.ft.com/content/e57c5fd0-bf54-11e9-9381-78bab8a70848

Dream Hoarders: How the American Upper Middle Class Is Leaving Everyone Else in the Dust, Why That Is a Problem, and What to Do About It

https://amzn.to/3LvCOrL

Track Nancy Pelosi’s stock portfolio:

https://www.capitoltrades.com/politicians/P000197

https://twitter.com/PelosiTracker_

Transcript: How to Defeat the Dictators w/ Charles Dunst, Asia Group – EP180

Gene Tunny 00:06

Charles Dunst 01:35

Thanks for having me on.

Gene Tunny 01:36

It’s a pleasure Charles. Nicholas grew and passed on your details to me, regarding your new book, defeating the dictators and yes, very keen to chat about that. I understand you’re the deputy director of research and analytics at the Asia group. Could you just tell us a bit about the Asia group and your work there first, please.

Charles Dunst 02:00

Sure, the Azure group is a strategic risk advisor, essentially, for companies looking to do business in Asia, and we’re headquartered in Washington. But with offices in Tokyo, we have an office in Vietnam, we have an office in in New Delhi, I think we had one or one or two advisors at one point in Australia. But basically, it’s mostly companies looking to do business in Asia on things like how do I start selling cell phones in Vietnam? Or how do I start manufacturing something in India and kind of understanding those marketplaces given just challenges of doing business in those markets. And basically, people come to us looking at former US diplomats, people with longtime business experience in the region, who just need a new knee to help and we can kind of provide that expertise. And at the research team, I kind of said to denied point of the firm where I’m not super client facing in terms of on a day to day basis, I’m not necessarily engaging with, you know, X, X company or y company. It’s more so we look at pan indo-pacific issues. So we Lee, I write a daily news wire that goes to clients, that’s basically four stories from overnight, overnight us time, that happened throughout the region that matter for either business, economics or politics. So we do that we lead coverage on things like the Indo Pacific economic framework on the quad issues that don’t directly fall in one country team baskets, there’s something that’s not China’s specific or something that’s not Australia specific, we kind of handle the pan regional issues. And I handle a lot of the public facing media stuff, just given my given my own background as a journalist. So it’s a really interesting, firm really dynamic. And we just, I think our New Delhi office is now under a year old. So really, lots of lots of movement.

Gene Tunny 03:42

Raw. Yeah, absolutely. Okay. That’s very good. And depending on I mean, it’s hard to know what the right stats are. But India could well be the largest country in the world at the moment. I mean, given China’s declining population, so yes, makes sense to be boosting that Indian presence. Absolutely. Okay. Well, we better talk about your book. It’s getting some it’s got some good testimonials, is really impressive. You’ve got a testimonial from the current UK Chancellor of the Exchequer, Jeremy Hunt, you’ve also got one from? Is it McMaster, a former national security adviser? Yep. And then yes, yes, very good. So defeating the dictators. What motivated you to write this? Charles, why did you think this was an important book to write?

Charles Dunst 04:31

Sure. I mean, I’ve spent a lot of time living in non democracies or kind of countries on the on the cusp, as one might say. So I lived in Hungary when I was still in university. And I remember I was kind of a quasi young journalist at the time, and it was writing articles and pitching around articles about Hungary and writing academic work about Hungary. And it wasn’t getting so much attention because it was this was 2017. So kind of right before Orban became an internationally known figure, precisely because of his his illiberal ism. Ah cracy his notion of kind of setting the stage for folks who win elections legitimately come into government, and then do away with the liberal institutions within. And I basically lived in Hungary I then lived in Southeast Asia and I lived in London and I kind of travelled all throughout Eastern Europe, all throughout Southeast Asia spent a lot of time in the Middle East. And something that kept coming up, when you talk to the intelligence is of say, Hanoi, or the intelligencia. In Kabul, maybe less so Cairo, but the intelligence is certainly in the Gulf. There is this notion that democracy is no longer the path to prosperity, there is a sense that you can follow the models of the Singapore’s of the world that you can follow the model of China that you can follow the model of Saudi Arabia. And I think more and more when I travel around the developing world, that was something I heard, and particularly in our little Western bubbles, sometimes, particularly in the US and the UK, I think we don’t do such a great job of communicating the virtues of democracy, and basically answering the question why democracy for people in the developing world, because if you are Vietnamese, and you’ve seen your country’s GDP, and you’ve seen it grow so much, and you’ve seen your, your life expectancy increased so rapidly over the last 3040 50 years, it’s not entirely clear to me why you might look around and say, well, this system’s not working, we need a democracy, when you see January 6, there when you see three prime ministers in three months in the UK, so I wanted to write a book to make a very affirmative case for democracy. Because there are many books, I think, in recent years, kind of lamenting the decline, the decline of democracy and the rise of the Viktor Orban types. But I wanted to say, write something a bit more affirmative. And saying, well, here is what can be done to actually make sure democracy works once again. And when democracy works, once again, most importantly, you can keep democracy where it already exists. democracy works better in the United States. So if democracy works better in the United Kingdom, you’re going to get fewer elections of people like Trump, who may not necessarily be the biggest believers in the democratic system. And once you can kind of tamp that discontent at home, it’s my belief that democracies can serve as a better model for countries in the developing world, well, maybe this, they might not look at the United States and look at Australia, and look at the United Kingdom in five to 10 to 10 years and say, well, those systems are more innovative than the one in China that they’re more solid. I mean, that right now, I think, if you’re sitting in Vietnam, that might not appear to be the case. So I wanted to write a very affirmative case for democracy and looking how do we can advance our values and really practical ways?

Gene Tunny 07:32

Sounds? And we’ll use that affirmative case for democracy. What do you think are the key points in favour of democracy?

Charles Dunst 07:38

But key point for me is study after study still shows, despite the kind of discontent in our democracies that if you live in a liberal democratic society, or even just the democratic society, you are likely to live longer, you are likely to make more money. And I know there are no studies that can necessarily show this, but it is my belief that you’re likely to live a richer cultural life, and you are more likely to innovate, that is true as well, that the world’s best generally still comes from democracies. And this is not to say that Singapore and China cannot innovate. Of course, of course they can. And of course, great art and great movies and all that can come out of non democracies. But there is a reason why when you travel around the developing world, particularly in Asia, that the media is the the music people listen to his Japanese and Korean democracies, or the movies on TV are mostly American, maybe British, maybe Australian, but it’s not like Chinese, Chinese culture has become predominant in the developing world. And that is kind of a silly example. But it’s indicative to me, of the ways in which democracies embrace the kind of tumult and chaos of our systems and we are better for it in the long run. So it’s just about making sure that we are making sure that our systems are providing for our people, while also embracing this chaos that allows for a Jackson Pollock painting, or allows morikami to write when a cue for these are not works, that someone will be able to conceptualise in a non democracy and think that’s a very, very key point that the art and the innovations that are going to be really necessary for the future particularly think about things like climate change. Well, the Evie transition is going to be fixed by innovations that are primarily coming out of democracy, or democracies. And it’s the same thing on healthcare innovation. I mean, where did where did the COVID vaccines come from? Exclusively democracies, not only the United States, Germany as well, of course. So that was my affirmative case for democracy was starting at this point of saying, well, even the things look really messy. Right now, if you look around, you would rather be the citizen of a democracy than an autocracy bar, not

Gene Tunny 09:41

just on Vietnam, and that was an interesting point you made. Do they recognise that? I mean, a lot of their prosperity does come from embracing the market, doesn’t it from embracing the market and as someone who I mean, I’ve read a lot of Milton Friedman when I was younger, and I mean, Friedman used to make the case that the market and democracy were very closely entwined. Or that you can’t have one without the other. I think Friedman’s argument was. So the people in Vietnam recognise that the importance of the market, and then the importance of freedom more broadly,

Charles Dunst 10:17

I think not so much the notion of freedom more broadly. But I think there is a recognition of the need to have liberal ish economics, I mean, Vietnam, China, Singapore, these countries all got richer. I mean, certainly Vietnam is not rich, like Singapore is, but they all got richer by embracing liberal trade. And I think what’s really not troubling, but a little concerning if you’re in a democracy is that those countries and others have proved that you can have mostly liberal trade without liberal politics. And that is a very different scenario than with the Soviet Union, or the kind of Soviet bloc writ large, or China before dung XIAO PING, where essentially, these were the countries that were illiberal politically, and also illiberal economically, so they couldn’t really grow in any meaningful way. So those systems never had a tonne of legitimacy, because they never worked. Whereas now, I’d be hard pressed to say that the Vietnamese system has not worked, or that the Singaporean system has not worked. Clearly, you can get rich without democracy. And that’s a new relatively new point over the last 180 years. It really was this notion that the way to get rich in the post colonial era was to be a democracy. So the fact that you can actually decouple liberal values from liberal trade is definitely a concern. And part of the reason why why I wanted to write the book,

Gene Tunny 11:38

yeah, just on Singapore, you mentioned Singapore quite a few times in the book. And that’s an interesting example. And probably, I mean, that relied upon just that extraordinary figure of Lee Kuan Yew, didn’t it and someone who was, you know, almost just by his background, and by his education could be that benign dictator or authoritarian, that he was an exceptional individual and probably someone you can’t count on having another another kind countries. So I thought it was interesting. You did tackle that question of Singapore, head on in your book. So yeah, just an observation just while I remembered it on Singapore. Okay. In your book, you give a really good summary of your argument early on, and you’re talking about a No BS approach to the future, committing to our values and, and also to the practices but not buying into utopianism. I really like this, but you go that we must convince the world in practical terms why our organising principles remain preferable to those of autocracies both at home and abroad. We need to look our own failures in the eye while learning from the successes of others. You talked before about the affirmative case for democracy, but could you just restate or reiterate? What are those organising principles? What are the most important ones, Charles,

Charles Dunst 13:03

when I was talking about liberal organising principles, I’m really thinking about the things that are necessary to be a democratic system. So things like freedom of speech, things like free and fair elections, broadly open societies space for civil discourse, space for civil rights organisations, for civil society organisations, this notion that it is actually good to have a dynamic and open society where there can be really aggressive, loud debate and disagreement. And that’s not I don’t think that’s a bad thing. I don’t think it’s a bad thing that we can have really heated political debates. I’d rather that than the opposite of kind of no debate at all. So but I think we really do need to convince countries of well, why should I have? You know, why? If you’re Vietnamese, or your, you know, rich, Chinese rich, rich Chinese person, you turn on CNN, you’re gonna say, Well, why would I want that? Why would I want two people kind of debating angrily at each other over on TV? I mean, how is that helpful for my government? So I think we really need to say, well, here’s why. Because that loud debate tends to lead to a society that’s open enough to produce really strong innovations that’s really good, strong to produce the best kind of art. And these are all things that are vital to the future, but clearly just kind of walking around and dropping into annoyance. And well, you shouldn’t be like us, because our systems are open, and they’re so great isn’t enough, when there is a need to demonstrate very practically, well, why is the United States or why is Australia? Why do we offer a better path for prosperity broadly, than do China or Singapore? So that’s really how I how I thought about it.

Gene Tunny 14:41

Gotcha. Right. And what do you think the failure is? You talk about the failures, so we have to look at our own failures in the eye. What failures do you think are most significant?

Charles Dunst 14:53

I think honestly, one of the biggest ones that I talk about very frequently is this is more of a problem I would say in the US in the UK than Australia, but broadly kind of the mismanagement of globalisation in the sense of thinking that we could essentially export manufacturing to places like Vietnam and China without experiencing any domestic discontent at home, that people who would had who’ve had who have had these manufacturing jobs for generations are mining jobs for generations, would lose them turn around and say, I’m all good. Okay, and wouldn’t revolt in one way or another, and particularly in the US the it is this programme designed to kind of ameliorate that loss with some economic assistance, but it’s kind of a mess and doesn’t really work effectively. And that, to me is so indicative of the problem that the United States China, the UK comes through this free trade through globalisation, we all got richer, but the average person did not get as rich as their as the god the government did, or as the kind of top 1% did. So I think there’s this increased frustration, it’s saying, well, people turn against globalisation, because they turn away because they’re mad or with the way globalisation was managed. And I think really pushing back against that is really important and saying, Well, trade isn’t the problem, or liberalism isn’t the problem, the problem was the way it was managed. And that gets into the broader question of inequality, where, particularly in the United States, particularly in the United Kingdom, inequality is one of the major fuels beyond anti immigration politics beyond I would argue, kind of very strong, populist politics, that lead to things like Brexit or elections of people like Trump. So that those are kind of two big ones. And the other, I think, really, really vital. One is a relative lack of accountability and which is fueled a lack of trust. I think there was a notion if you talk to enough people in the UK or the US and even even Australia times, that there are two sets of rules that there’s a set of rules for normal people and a set of rules for everyone else, me everyone else who kind of that top 1% of rich people and rich people in the government. And that view in the US, I think about the example of the fact that there are so many Congress, people who trade stocks, I’m sure some of them are I’m sure many of them are not doing it illegally, technically. But clearly, you’re privy to some kind of information as a lawmaker with a certain type of security clearance that you probably should not be allowed to turn around and trade stocks. And even when a lawmaker is caught either not filing their stock disclosures on time, nothing seems to happen. They pay a little slap on the wrist fine, and then they’re done. And that’s fuel this notion that if that’s a normal person, that person is getting punished very severely. And I think making sure that we’re restoring accountability is key. So it’s about economics, but it is also about things like accountability, which leads to distrust in government. And when when your government lacks trust, it’s really hard to do just about anything.

Gene Tunny 17:50

Wrong. Yeah. Yeah. Good point. I’ll put a link. I think there’s a Twitter account that tracks Nancy Pelosi stock portfolio. So Pelosi has been one of the strongest performers in the Congress. And I don’t think she’s the top performer. But I’m sort of stuck fix, which is, you know, far exceeds market performance. So yes, does does raise some questions there. Charles, do you have any reflections on how democracies fared relative to autocracies during the pandemic?

Charles Dunst 18:22

Yeah, I mean, I think certainly the US performance was was quite poor. And I don’t think that’s anything intrinsic to democracy. And that’s kind of how I would approach the UK as well as there was nothing intrinsic to democracy that made them fail on the pandemic, it was more so we were just the two of those two countries, my country and then the United Kingdom, kind of had not great leaders for pandemic management when a pandemic happened. Whereas certainly, there are other democracies that did much better, certainly South Korea did much better. Certainly, Taiwan did much better. Certainly, Japan did much better for a period. And when you think about the autocracies, Vietnam had a very strong performance for a while. And again, that’s not because Vietnam was an autocracy, it’s because Vietnam had an extremely high level of social trust, that this is trust in government and social trust between one another so in the government, the government was extremely blunt, and extremely honest with its people and said, This is going to be very painful economically. But please stay home, stay off the streets, and we’ll get through it. We’ll get through it as a country and there was really smart messaging of talking about it like it was another war like the Vietnam wars, the another foreign invader was gonna be kind of overstating, but it was another war, the long line of wars against the Vietnamese people, and they banded together. And for a long time, Vietnam, controlled the pandemic extremely well, kind of until the Omicron variant showed up which no one could contain. So Vietnam performed quite well. And I think the the example people go to all the time, and I think kind of wrongly, to talk about COVID and a COVID. Management in a positive light is China where people say, well, zero COVID policy was great. And I think the irony is that The zero COVID policy was maybe very effective and could have been more effective for like a year, in the sense of if you can manage to have these strong lock downs, where you kind of say, well, you know, please stay home, whatever, whatever. And then you get vaccines and you get good vaccines, the Western vaccines and you get your way out, maybe I would sit here and say, well, that’s not a policy I would sign up for. It’s too restrictive, keeping people at home that long. I mean, as a as a democratic citizen, I am not in favour of giving your government that much power. But I do think the irony of the Chinese approach was they kind of demonstrated the efficiency kind of quote, unquote, efficiency of autocracy of saying, well, we can because we have so much power, we can shut everything down for a year, and then we’ll open up it’ll be fine. But the irony is that autocracy was then the reason she didn’t things her personal disdain for the West, was the reason why China didn’t accept the COVID vaccines from the West, that there was no way of reopening, without what models they were probably a million people who died when China reopened. And certainly that’s a lower death fold in the United States. But most of the US deaths took place before the vaccines were if it were available. So I do think at this point, it’s very hard to sit here and say, well, the autocracies managed COVID. So much better than democracy. did. I just don’t think that’s the case. I think it is. Countries with a large amount of social trust in their governments managed COVID better than others. And that’s kind of the Taiwan case. That’s the South Korea case. Those are both democracies, and they manage COVID better than most countries because, I mean, in Taiwan more so people do trust the government raw,

Gene Tunny 21:35

okay. Are they places to learn from? Are they countries and economies to learn from? You mentioned that in your book, you look at examples of good governance from everywhere past and present to detail best practices for running a democratic country in the 21st century could? What do you think those best practices are? And what examples Could you point to Charles?

Charles Dunst 21:58

Yeah, I mean, in Vietnam, I think one example, I’d point to a lot of government’s focus on winning social trust, and the focus they spend on being communicative to their people. And even in a one party state, I think there’s a recognition of what because there are not elections are not real elections, you need to win over that social trust much earlier. And you need to kind of maintain it much earlier, because there is no way at the ballot box of kind of seeing how citizens actually feel. So you need to be a little more transparent and communications at times. And some of the other examples I think about where I would like if democracies had more put on paper and more of these long term plans. People like to make fun of China’s five year plans because they are modelled off the Soviet five year plans, which of course, set these targets Soviet Union was never going to hit. But I do think the idea of democracies happening, well, maybe let’s have a 10 year critical minerals plan, or a 10 year health care plan. Because far too often, those plans are very much focused on security and defence, which are important. It’s important to have maybe a four or five year review of the state of your country’s defence infrastructure, or of your security infrastructure, what are your cybersecurity infrastructure, but I would like that apply to other things I’d like that applied to things that actually matter to normal citizens on a day to day basis. I think the idea of saying, Well, what’s our healthcare sector looking like right now? What’s our infrastructure looking like right now? On what do we want it to look like in 10 or 15 years? And I think that’s something that there are a few autocracies, particularly China and Saudi, spend a lot of time putting out these reliefs, five years to five year plans, or in Saudi Arabia, kind of the vision 2030 plan, and of course, because they’re autocracies, I would argue that they’re probably less likely to actually fulfil many of those goals. And certainly I don’t think Saudi Arabia is on perhaps the greatest trajectory. But I do think the idea of putting things on paper can be really beneficial. And one other example I don’t, I’m not gonna run through all of them. But one good one that I thought the UAE has pulled out in recent years, is they ranked every health care centre in the country, and then publish the results, and said, you know, this one in Dubai is great, this one in Sharjah is terrible. And it I really do think that’s not the worst idea, particularly in a smaller, smaller countries, you can do it state by state or city by city, where I’m from New York City, I can only imagine if New York City, the New York City government, basically brought in an unbiased agency and have them rank the New York City hospitals, and the ones that are at the bottom, clearly, you’re going to be motivated to perform better, because nothing motivates people like a fear of being embarrassed. So I do think that is this kind of odd way of being accountable and transparent. Of course, as a democracy, you can be more transparent in those rankings and and you can be more accountable than an autocracy ever could. So that was kind of the main thesis of the book was well, there may be things that autocracies put out plans or they look to build social trust, kind of in ways that I think are, are okay are kind of they’re interesting, but because democracies are a kind of a superior system, any of those reforms that we look to put in place into a liberal democratic system, I think we can do better.

Gene Tunny 25:09

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny 25:44

Now back to the show. Just thinking in the States, one of the things I hear a fair bit is that there’s too much money in politics in the US. And that’s related to that was at Citizens United that decision. Do you have any thoughts on that? Is that an issue that the lobbyists have too much power to sway the the people in Congress, and they’re, you know, they’re looking for donations and all of that. So do you have any concerns over that?

Charles Dunst 26:13

Yeah, I mean, I think I definitely do have concerns about it, even if at times, it’s slightly overstated. I think maybe in the media of how much power lobbyists actually have preside over the reality is perception at one point or another. And people do think that the lobbyists do have so much power in one way around that. And something I suggested in the book is to essentially, make sure you’re being much more transparent about where the money is coming from and who it’s going to where if the Supreme Court made a ruling, clearly the money is going to keep flowing. There’s no way around that at the moment. But what a government can do, what the US government can do is create a really accessible online database that very clearly demonstrates, well, where’s the money going? Who is it going to, and there are efforts to do that. But you know, the current system is so not user friendly, it’s so difficult to go online and actually look at who’s donated to who, there’s certainly some kind of dark money that doesn’t come that doesn’t isn’t clearly registered. And I think it would be very helpful just to have this transparency, it’s a way to kind of mitigate the problem. Because if you’re a politician running for Senate or running for Congress, and you know that every donation you accept from they come from a big corporation, or every lobbyist to meet with is going to be very much public, it’s going to be a very easy to access database, you might be a little bit more hesitant to take those meetings. Whereas now you do have to register those meetings, but no one knows where to find them, and no one’s actually looking. So that’s not a wholesale solution, but I think we could mitigate the problem.

Gene Tunny 27:37

Okay, a lot ask you about how do we think about and how do we deal with authoritarian countries? So at the moment, the major ones are China and Russia? I mean, obviously, we’ve cut off a lot of ties with Russia due to their invasion of Ukraine. But what about China? I mean, in the last five years, there’s this new concern about China as a strategic threat. And they’re increasingly calls to decouple to. I mean, there are some rather extreme proposals out there, almost trying to cut ourselves off from China and not trade with China. Which, you know, in Australia, we’ve actually had some retaliation from China. And that’s affected some of our exports. But I mean, China has been a major destination for our exports. So that would be very difficult for us. How do you think about that? How should we engage with these authoritarian regimes in the future?

Charles Dunst 28:38

Well, I think it’s important not to, of course, lump them all together, where I think approaching China is very different. We’re approaching Russia at the moment, where certainly, I’m in favour of the broad sanctions policy against Russia saying, Well, this is a country that invaded its neighbour, I don’t know if there’s anything wrong with setting this precedent of Oh, you don’t get to evade your damper. I just kind of continued business as usual, at least with with the broader West. When it comes to China. I think the question is, how do you compete responsibly? I don’t think the idea of complete decoupling is, is really workable, if you’re the United States, if you’re the United Kingdom, if you’re Australia, because the economies are too intertwined. I mean, this is not the Soviet Union, where basically our economy didn’t really touch theirs. Whereas every basically every field is these overlap again, do I think there’s anything problematic about selling a refrigerator to China? or selling shoes to Chinese consumers? No, I that’s not a concern for me. But I do think there was a question of, well, where do you draw the line? What kind of tech is to sell what kind of goods are too sensitive to be sold to to a one party state in China, in which basically, the government does kind of oversee everything and it does seem like if you are selling some type of technology to a private firm, you could never be just how sure how private that firm actually is. And if the government could step in and kind of take that tech in one way or another. Every country is going to define a different only, but basically do I think there’s anything wrong with not selling military applicable semiconductor technology to China? No, I think that’s fine. I think basically recognising that this is a country helmed by a government that does not, frankly seem super interested in positive ties with the West. And that, of course, has been more aggressive in the broader Indo Pacific in recent years. Think about the South China Sea, you think about the drills around Taiwan, I think it makes a lot of sense to deny them certain technology. But the broad way I think about relationships with autocratic countries is just to make sure they’re in our own benefit. Where when you think about us ties with Vietnam, the current state of us Vietnam ties seemed very much in America’s interest. You know, you get a trade partner, you get, broadly a security partner, we raised human rights with them privately. I think we’ve successfully made some advancements on LGBT rights in Vietnam has been broadly kind of a success. Certainly Vietnam is not just liberal society, or is Liberal government as we would like them to be. But we don’t have the luxury of saying we’re only going to engage democracies, there are more autocracies than there are democracies today. So we do have to engage Vietnam, we do have to engage Saudi Arabia, we do have to engage Oman, and we do have to engage Rwanda. It’s just making sure that those relationships are in our benefit, and that we’re using them in our national interest, whether that’s trade, whether that’s security, and making sure that we’re not, we’re not giving the autocrats too much credit, if that makes sense. So we’re not overstating well, how important is the US, the US Saudi relationship, when I don’t think we should just sweep, sweep things under the rug, because we think that relationship is important. I think it requires a real reevaluation of well, how important is that relationship? Actually? How much how much do we actually care and it’s gonna be different for every country, it’s gonna be different. Of course, Australia has a different relationship with Vietnam, United States does, but I think that my broad sentiment is, it’s not reasonable to cut off all ties with autocracies, but it is about managing those relationships carefully.

Gene Tunny 31:59

Okay, Rod, I’ve got two more questions, if that’s okay, I’ve got a question about PPP, public private partnerships. One thing I really liked about your book is, is your openness to the potential gains from these arrangements, these cooperative arrangements between public and private sectors? Could you tell us a bit about PPS, please, Charles, and what you see is their merits?

Charles Dunst 32:27

Sure, I mean, I’m in favour of public private partnerships, only when the goals match at the beginning. And one example I talked about here very frequently, is operation warp speed in the United States, which was the development of the COVID 19 vaccines. And basically, the government gave out a pot of money to companies to develop the current vaccines as quickly as possible. And certainly, while some of these companies share, they probably had a profit motive very well. So thinking, well, this is a terrible pandemic, we need to get our vaccines out as soon as possible. And that was the government goal as well. So clearly, the goals were very meshed from the beginning. And even if the companies in the end are going to make profit, the goal was not necessarily on profit, the goal was then actually delivering. Whereas some of the examples that I’ve other people have raised, particularly when I talked to British media, as well, our our PPVs haven’t necessarily worked as well. And I would argue, well, that’s because the goals weren’t aligned from the beginning, where the government wondered one thing, and the other party was much more focused on profit than anything else. So making sure that you’re partnering with responsible private sector actors, he’s really key. I mean, he should not just be throwing money at private sector firms hoping they’re going to deliver, it needs to be a 5050 partnership goals need to be aligned. But when PPP is work at their best level, I think they serve to actually boost trust in democratic governments, because poll after poll shows that and I showed it for last three or four years, that the private sector is actually more trusted than the government. And that’s true across Europe. It’s true in the United States are basically people look at their governments think of them as sclerotic, and think of them as old and not super effective. When they look at Tim Cook and Apple, they look at the company at Tim Cook, they look at something someone like Pfizer and say this, these are great look at these great innovations they’re doing, look at the iPhone, look at the vaccines, look at the pharmaceuticals. And people do tend to trust the private sector more. And I think governments would be wise to leverage that trust in a way that also helps the government’s deliver. And I think it’s just a question of making sure you’re doing that in a responsible way. And I think there’s this irony, I raised it all the time. That’s the study from a few years ago showing that in the United States, when Americans get good public service, they actually believe that it’s coming from the private sector, because the idea of effective government service is like incomprehensible. Because our system doesn’t work. So well at times that people think, well, of course, you know, I got this, I got this great assistance, I got this homeowners assistance, or I got this vaccine, it must be from the private sector, even when it’s actually from the government. So it’s just one way of basically saying well, publicising, that cooperation, I think can actually help boost trust.

Gene Tunny 34:59

Yeah. Yeah. Okay. And you mentioned that there have been failures of P PPS in Britain that have meant that people in Britain have been negative about them. And we’ve had some notable ones here in Australia too. But what I found interesting is you noted one of the great successes or most successful PPS in the book. So I’ll, I’ll put a link in the show notes to your book, Australia’s upgraded the Ballena bypass highway, completed in 1996, along with four private firms, as in conjunction with the government seven months ahead of schedule and for USD 100 million less than estimated. So that’s an impressive example. And so one I’ll probably use in the future. So yeah, good, good work finding that one. Excellent, Rado? So my final question, Charles is, I mean, how do you think this will will actually work? I mean, how, in what ways will the dictators be defeated? If if we in the democratic countries govern ourselves better? What’s the mechanism here?

Charles Dunst 35:58

I think the mechanism works twofold. Where primarily, if democracies are working better at home, you are less likely to elect people like Viktor Orban, or like Donald Trump, or like ei or Bolsonaro, who come to power through liberal democratic means, and then don’t necessarily govern in a liberal, democratic way, who have little concern, I would argue, in most cases for those liberal institutions, particularly in thinking about Orban Bolsonaro, where there’s no sense of respect for freedom of the press, there’s an effort to stack the judiciary, these are all things that can hollow out democracies from the inside. My argument is that if democracies are delivering better on economic issues on issues like the social safety net, and issues like infrastructure, if people feel optimistic about their future, which many people in democracies Do Not at the moment, they are less likely to vote for reactionary people like these that can erode democracy internally. So that is way one to defeat the dictators at home. And point to is only if you can defeat the dictators at home and prevent that autocratic impulse from taking root at home. Only then can you turn around and actually say, well look at how good we are, as a model. Look at how the United States is outperforming China or look at how Australia is outperforming Singapore, and more people in the Vietnams of the world, or people in I don’t know in a rock or in Egypt might actually look and say, well, we would like to be a democratic system. Even if we don’t agree the United States of the West, then everything. We see how well Australia is functioning, or we see how well Taiwan is functioning. Were looking at how sclerotic Saudi Arabia is their kind of messy, messy internal politics, that corruption scandals, we don’t want that. But it’s making sure that we are working well enough to fend off the autocratic impulse, and simply just that we can be the world’s model once again. Gotcha.

Gene Tunny 37:45

Okay. So showing that you’re the world’s model. Okay. Yeah. Any final thoughts? Charles, before we wrap up? Yeah,

Charles Dunst 37:55

the one thing I would just say briefly is one thing is the line, I keep using it over and over again. But I think it’s important is the lack of faith in democracy right now is really troubling to me. But something I want to say that’s positive is faith in democracy is not necessarily the problem. We all should believe in democracy and work for it. The problem is faith and democracy is automatic functioning, and the sense that everything will work without our engagement. I think the key message of the book for citizens for people who are not lawmakers, not politicians, not in government is just make sure we stay engaged. And we keep pressuring our politicians to actually make democracy work for us.

Gene Tunny 38:31

Got you. And that’s through, I suppose social media or in through, I guess, you’re engaging in the conversation? Is that what you mean?

Charles Dunst 38:40

engaging in the conversation, making sure you don’t miss elections, engaging in your local governance? I mean, it can be on a school board in the United States, you can be in your city council, you can all these local thought their town council, I think far too often we look at our messy politics or messy governments, they just write it off and stop being engaged. But I think engagement is really key to making anything work down the line.

Gene Tunny 39:01

Okay, very good. I guess one more thing, just looking back on my notes. You mentioned one of the big issues with inequality was inequality, I should ask before we go, I mean, do you have any thoughts on how that can be addressed? Or use proposing specific measures to address inequality in your book?

Charles Dunst 39:17

Yeah, one of the things I talked about was inequality in terms of education. And the notion that, basically, I think far too many democratic governments are not starting or not looking at the unequal starting points of children. And basically saying, Well, you know, once you get to university, it’s meritocratic. Its meritocratic when you get into your universities. But of course, if you are born into a lower income household, you’re less likely to have certain academic achievements that gets you into one of those schools. And if you don’t get into one of those top universities, you’re less likely to earn as much money as those who do. And I think there’s this increased need to actually look at starting points and say, Well, how do we make sure that we are doing all we can to let the talented children from lower income households actually rise? Is to top tier universities. And that’s how I think about inequality. There are certainly broader economic reforms that other folks have proposed. But I think about inequality in terms of the lack of meritocracy in the way that basically it does seem like we’re perpetuating kind of an elite with the same people and go to the same schools, their kids go to the same schools, because they have a nice starting point. But I want to make sure that we’re kind of giving more believing and more active inequality of opportunity.

Gene Tunny 40:28

Yeah, and there’s probably another episode in that, talking about how we improve that. But yeah, just wanted to check on that. Because that’s, that’s clearly one of the big issues. Yeah, but I hear about the dream hoarders Is that what you call them in the States? Of hurt? That’s one of the terms that’s been applied to your just that self perpetuating elite or whatever? Have you referred to it? So yeah,

Charles Dunst 40:52

I’ve never heard that one. But that’s a good one. Yeah,

Gene Tunny 40:54

I think that’s what yeah, I’m trying to remember who wrote that book. I’ll put a link in the show notes. So yes, it seemed a bit overly negative to me. But, but I think the data do show that the US is not as there’s not as much social mobility, as people might think, and not as much intergenerational mobility as you might like, relative to some other countries. So I think that’s an uneven in Australia, and in Britain, it’s not as high as as we would hope so. Absolutely. Good point. Okay, Charles Dance from the Asia group. Thanks so much for your time. I really appreciate it. And good luck with the book. I’m sure it will go. Well, I think the message is an important one. And I really enjoyed reading it. So thanks so much. Thank you. Okay, I hope you found that informative and enjoyable. I think Charles is someone we’ll be hearing a lot more from in future years, so I’m very glad I could interview him about his first book. I must say I was impressed by Charles’s passionate advocacy for democracy, and his call for existing democracies to provide better examples to other countries. I hope that Charles is right that we can inspire movements for freedom in non democracies by improving our democracies at home. Maybe that’s a vain hope, but at the very least our own countries will be better run. In our conversation, Charles and I touched on a few ways that democracies could be strengthened. I liked how he talked about improving our education system so that all children get the best start in life. I found a link to the book on the dream hoarders that I was reminded of while chatting with Charles and I’ll include it in the show notes. I think it’s worth having a look at. As always, feel free to email me at contact at economics explore.com. I’d love to hear from you. Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

43:46

Thank you for listening. We hope you enjoyed the episode. For more content like this or to begin your own podcasting journey. Head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags authoritarianism, china, education, geopolitics, PPE, ppp, russia, usa

Podcast episode

SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Post author By Alec Krishna
Post date March 23, 2023
No Comments on SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Silicon Valley Bank (SVB) has collapsed and now Credit Suisse is in trouble. Should we be worried about Global Financial Crisis 2.0? Have the policy responses been sensible? Economics Explored host Gene Tunny provides his initial thoughts.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

Links relevant to the conversation

Chris Joye’s article on SVB:

https://www.livewiremarkets.com/wires/why-silicon-valley-bank-died-updated-2

NPR Indicator episode:

https://www.npr.org/2023/03/13/1163157993/silicon-valley-banks-three-fatal-flaws

Sebastian Merkel’s paper on narrow banking:

https://scholar.princeton.edu/sites/default/files/merkel/files/narrow_banking.pdf

World Bank paper on Bank Runs and Moral Hazard:

https://documents1.worldbank.org/curated/en/548031537377082747/pdf/WPS8589.pdf

Bloomberg article on policy response:

https://www.bloomberg.com/news/articles/2023-03-12/us-moves-to-help-depositors-offer-bank-backstop-in-wake-of-svb?leadSource=uverify%20wall

Breaking Points video SECRET Fed BAILOUT Pumps BILLIONS Into Banks

https://youtu.be/Lj5BE951aP8

Transcript: SVB & Credit Suisse | Bank runs & Moral hazard – Bonus episode

Gene Tunny 00:06

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, welcome to this bonus episode of economics explored. The failure of Silicon Valley Bank happened after I recorded my last episode on central banks and banking and I didn’t get any time to add any reflections on that collapse in In my last episode. So I thought I’d better do that now. This bonus episode is even more timely given. It now appears Credit Suisse is in trouble. Because things are happening so fast, I’d better clarify that I’m recording this Thursday morning, Australian time on the 16th of March 2023. While I’m not panicking at this point, I do acknowledge that there’s an elevated level of risk in the US and global financial systems. So I’m not going to make any definitive predictions, I think it’s just too hard to tell what’s going to happen. Instead, I want to talk about the underlying economic issue an issue which has been challenging us for centuries. This is the mismatch in maturities between the assets and the liabilities of banks. So colloquially banks, they borrow short, they borrow money from depositors, for example, and those depositors may want to withdraw their money at short notice. And banks lend long, so borrow short lend long, they lend money to homebuyers, for example, to buy houses, and those home buyers repay the bank over many years. If you’ve seen the classic film from the 40s, It’s a Wonderful Life. You’ll recall how Jimmy Stewart’s character, George Bailey, he explains to his worried bank customers how their money was invested in the houses of their neighbours, it’s there, he just can’t get it right away. Banks don’t have the cash on hand to pay out all of their depositors, if all the depositors come in to withdraw their money at any one time. They’ve got some cash on hand, but not enough. This is the concept of fractional reserve banking that Darren Nelson and I discussed last episode. In normal times, there’s nothing wrong with this because most people are happy to leave their money in the bank. And deposits and withdrawals are predictable. It’s something that the bank can manage, they can manage the level of cash, they know what they need to be able to, to satisfy the customers at any one time. But when the financial health of the bank comes into question, a panic or a bank run can happen. And there can be this contagion, there can be a panic across the economy. And it’s not just that bank that there’s a run on there could be a run on all banks as people worry about the stability of the whole system. That’s why central banks and regulators are so concerned when banks get into trouble and and we’ve seen just how quickly they’ve responded to what happened with SPV. And now what’s happening with Credit Suisse. SBB got into trouble because there was concerned about the state of its balance sheet, it had a heavy investment in long term treasury bonds. And if these were not held to maturity, and they were sold in the current market, that would result in the bank losing money. And that’s because of what’s happened with interest rates. So because the interest rate and the price of a bond vary inversely as interest rates have increased, bond prices have fallen. The story is that words spread fast in the venture capitalist community in California that they should encourage all the startups they invested in to pull their money out of sVv. Fast. So once they saw the state of the balance sheet word got around quickly, there was a classic bank run, and SVB collapsed. Incidentally, the concentration of SBBs business in Silicon Valley was a contributing factor to its vulnerability. It’s a well connected community. So the panic spread fast. I’ll link to a great article by Chris joy of Coolibar capital, which explains in detail what happened and also to an excellent episode of NPR as the indicator podcast, which also explains the problems faced by SVB. In his article, I think it’s on Livewire markets, Chris joy, he’s shocked that SVB didn’t hedge against the interest rate risk faced on its holdings of long term bonds. He suggests that this would have been standard practice for banks, meaning SBBs financial risk management was was suspect. According to Chris SVB, had exploited a regulatory change that was made during the Trump administration. It’s a change that SBB had lobbied for several years ago. And it meant that the bank could engage in more risky behaviour, so check out Chris’s article for the full details of that. A note that bank runs have happened periodically throughout history. Fans of the BBC TV show Poldark set in the time of the Napoleonic wars will recall how the scheming George Will Ligon brought about a run on Pascal’s bank in Cornwall. And the show’s hero Ross Poldark had to step in as an investor to help save it by restoring public confidence by making people confident that it had plenty of money after after Ross had invested in it. does this all mean? We shouldn’t have fractional reserve banking? Should we move instead toward full reserve banking or so called narrow banking, whereby banks have to ensure they can access enough money to 100% back all deposits. Historically, this was recommended by eminent us economists, as part of the Chicago Plan in 1933, during the Great Depression. This was in the wake of the collapse of the US financial system earlier that year. To me, narrow banking would not make sense. So rather I can’t see how we could move to this system without being without it being massively disruptive and costly. To pause deposits are one source of funding for banks, they they help reduce the cost of capital and they mean banks can lend more money. This is good for private sector investment and economic growth. I found an intriguing working paper by a former Princeton Postdoctoral Fellow and now University of Exeter lecturer, Sebastian Merkle on the macro economic implications of narrow banking and I’ll link to it in the show notes. He’s developed a macro economic model, which predicts that real productive investment and economic growth would be lower in a case of narrow banking. That said his model predicts the near elimination of banking crises with under narrow banking and in his model, people are better off overall because of that. So, look, there is there are pros and cons of fractional reserve banking versus narrow banking. I’ve got the feeling that narrow banking would be just very difficult practically, and I’m not sure we’d be better off. That said, I think there’s an important debate to be had there, and I’ll try to come back to it in the future. The relevant question to me is whether we can get the right regulations in place to maintain public confidence in the banking system. Can we do this in a cost effective way which doesn’t lead to future problems or unintended consequences. various mechanisms exist to help guarantee confidence in banks and to prevent panics and bank runs. These include regulations regarding the amount of liquid assets that banks should hold the central bank’s lender of last resort function, and deposit insurance regarding the lender of last resort function, the US Federal Reserve has been lending money to the US banking system in the wake of the SVB and Signature Bank collapses I’ll link to a Bloomberg article with some of the details. And now we see Credit Suisse turning to the Swiss central bank for emergency support. I think most people expect Credit Suisse will be supported as it’s probably too big to fail. It’s been plagued by scandals, and it’s lost money in recent years, but I expect it will be saved. Indeed, I’ve just noticed the Financial Times has reported Swiss central bank offers Credit Suisse liquidity backstop after share plunge okay, just as we would expect. I should note here that the lender of last resort function is not meant to save every failing bank. Only those which are facing a temporary cash shortage and whose underlying balance sheets are okay. It’s meant to allow good banks to get ready access to cash so they won’t run out of money in the short term, which is something that could spark a panic and a run on banks across the economy. It’s designed to try and stop that panic as summarised by British bankers or Paul Tucker. Walter Badgett famous dictum is that, to avert panic, central banks should lend early and freely that is without limit to solvent firms against good collateral and at high rates. That is, it shouldn’t be a bailout of badly performing banks, and borrowing rates should be high enough that banks only seek this assistance in genuine emergencies. We need to be careful to avoid moral hazard a concept which is also relevant to deposit insurance which we’ll talk about in a moment. Regrettably, it looks like the US Fed hasn’t been operating strictly according to badgers dictum and its new financing facility for US banks appears concessional. There’s a great story from saga and jetty and crystal ball at breaking points on this, which I’ll link to in the show notes. So please check that out. Alas, the Federal Reserve is arguably contributing to moral hazard in the financial system and to future financial instability. Regarding deposit insurance, given what’s happened with SVB, the US Federal Government has now effectively guaranteed all bank deposits, it’s gone well beyond the defined level of insurance of $250,000. As John Humphries and I discussed on the Australian taxpayers Alliance, econ chat live stream the other night, this could create a big moral hazard. Depositors might not care too much, or they might not look closely enough at the banks that they’re putting their money in. And they might be solely attracted by what interest rate they they earn on those deposits. Banks might figure that their depositors won’t care much, and they’ll take more risks to try and earn higher rates of return. So they can pay their depositors more and they can earn more profits. This could be a recipe for future instability. If the US government is going to do this, it will need to charge higher premiums for deposit insurance to ensure the costs of the insurance are explicit and not burdensome for taxpayers. And banks that have riskier balance sheets should pay higher premiums for deposit insurance. We need to avoid or minimise any moral hazard that comes from deposit insurance. There’s a great 2018 World Bank working paper that I’ll link to in the show notes that’s relevant here. It’s titled bank runs and moral hazard. I’ll read a paragraph from it because I think this paragraph nicely summarises the relevant policy issues. It’s now well established in the empirical literature that overall deposit insurance may ensure depositor confidence and prevent bank runs. But it also comes with an unintended consequence of encouraging banks to take on excessive risk. The empirical evidence points out the importance of design features, and shows that poorly designed schemes can increase the likelihood that a country will experience a banking crisis. It is important for deposit insurance schemes to incorporate features to help internalise risk taking by banks, in addition to specific design features deposit insurance that is complemented by more stringent capital regulations and a system in which supervisors are empowered to take prompt corrective action tend to function more effectively in practice. I think that’s that’s a really good summary. In a future episode, we might have to have a closer look at this deposit insurance scheme in the states and what these latest developments mean for that and what it all means for the the incentives facing banks the potential moral hazard. Honestly, I’m concerned that The US government would bail out all the depositors in SVB. I’m not sure it made sense, particularly given that those depositors or many of them should have known better than to have left so much money sitting in one bank. We’re talking about highly successful companies, such as Canva. I was truly stunned by the revelation regarding just how much money some of these tech firms had in SVB. Citadel hedge fund founder billionaire Ken Gryphon argue that with the government fully bailing out depositors, US capitalism is breaking down before our eyes. As he was quoted by the Financial Times, he would have preferred no bailout. The FT went on to quote him as saying, it would have been a great lesson in moral hazard. losses to deposit depositors would have been immaterial, and it would have driven home the point that risk management is essential. Gryphon highlighted that it appears the relevant regulator, the California Department of Financial Protection and innovation was asleep at the wheel. Apparently there were warning signs that should have been picked up. The Shanter clear columnist in the Australian Financial Review has suggested that the regulator might have been too focused on promoting innovation and startups, rather than focused on what should have been its core mission of promoting financial stability. What lessons should we learn from all of this? Well, bank runs will unfortunately occur from time to time in a capitalist economy. We just hope they’re not when they’re not too frequent. That it seems that we haven’t found a way to prevent them from happening entirely. We get a lot of benefits from the capitalist system in terms of innovation and higher living standards. But there’s no doubt the system can be unstable from time to time. It may be that the US needs to impose tougher regulations tougher capital requirements on banks so that they have better balance sheets, and they’re much less susceptible to bank runs. That is they’ll need to be required to hold a higher amount of quality liquid assets which can be converted into cash quickly. One of the reasons for confidence in Australia’s banking system is apparently stricter bank regulations overseen by the Australian Prudential Regulation Authority APRA, which is currently headed by my old Treasury colleague, John Lonsdale. The financial review has reported that APRA had resisted lobbying by local banks to loosen capital requirements on banks. Given what’s happening in the US at the moment, Apple is looking pretty smart right now. It’s hard to know how to compare what we’re seeing today with the past. SVB is the second largest bank failure in US history. But I don’t think it’s the start of GFC 2.0. Or rather, I hope it’s not the start of that. The GFC the global financial crisis, financial crisis of 2008 that involved financial institutions, which were household names, and much closer to the centre of the financial system. Of course, if Credit Suisse ends up collapsing that the story could be much different. My general inclination is not to worry too much over the latest developments as many things turn out to be unimportant. In hindsight, that said, you never know. Okay, that’s how I see things at the moment. It’s still early days, so my thinking may change over coming weeks. I’ll provide any updates to my thinking in future episodes. What do you think about what’s happening with US banks? And now with Credit Suisse? How concerned are you? Please let me know by emailing me at contact at economicsexplored.com. I’d love to hear from you. Thanks for listening.

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags australian, banking, banking crises, banks, cash, collapse, credit suisse, deposit insurance, depositors, deposits, fractional reserve banking, money, regulations, swiss central bank

Podcast episode

Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

Post author By Alec Krishna
Post date March 21, 2023
No Comments on Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

In his recent Spectator Australia article, Darren Brady Nelson argues for a radical, not a reserved review of Australia’s central bank, the Reserve Bank of Australia (RBA), which he describes as reckless. In Economics Explored episode 179, Darren provides an Austrian economics perspective on central banks, fiat money, and inflation. Show host Gene Tunny wraps up the episode with a discussion of the historical evidence on different monetary systems and inflation, evidence which confirms economies with fiat money are much more inflation prone. Gene then discusses whether a return to the gold standard would be desirable.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP179

Darren’s thoughts on the current review of the Reserve Bank of Australia [1:46]
How the RBA interprets the stability of the currency objective [6:54]
What is the Austrian School? [10:19]
Would the Austrians recommend abolishing the central bank? [21:08]
The Bank of England’s report on modern banking [25:54]
The need for a broader review of the Reserve Bank of Australia [30:35]
Fiat money systems are much more prone to inflation than commodity money systems [34:20]

Links relevant to the conversation

Darren’s bio on the Economics Explored website:

https://economicsexplored.com/regular-guests/

Darren’s opinion piece on the Spectator Australia website:

The RBA (reckless bank of Australia) needs a radical, not reserved, review

Bank of England paper on money creation:

Money creation in the modern economy | Bank of England

Minneapolis Fed paper on fiat money, commodity money, and inflation:

Money, Inflation, and Output Under Fiat and Commodity Standards | Federal Reserve Bank of Minneapolis

US Gold Commission Report

Minority report of the Gold Commission, co-authored by Ron Paul:

The Case for Gold: Minority Report of the US Gold Commission 1982

Alan Greenspan’s autobiography discusses his advice to President Reagan regarding gold:

The Age of Turbulence*

Another great book on Greenspan which discusses Friedman’s views too:

The Man who Knew: The LIfe & Times of Alan Greenspan*

*You can help support the show by buying a copy of either book via the links above.

Transcript: Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

Gene Tunny 00:06

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning in to the show. This is episode 179. In this episode, I chat with my old friend Darren Brady Nelson about his recent spectator Australia opinion piece on the Reserve Bank of Australia. Darren’s piece is titled The RBA reckless Bank of Australia needs a radical not reserved for review. Although Darren’s article focuses on Australia’s Central Bank, the issue is considered irrelevant to central banks around the world such as the US Federal Reserve and the Bank of England. Before we get into it, I should note that Darren is coming from a non mainstream school of thought known as Austrian economics. While it’s outside of mainstream economic thinking, I think the Austrian perspective is valuable. Nonetheless, it’s forced me to confront some of the things I take for granted about the modern mixed economy, such as fiat money and the existence of a central bank at all. I’ve had to think more deeply about whether they make sense. Please stick around to the end for some additional thoughts from me. Okay, let’s get into the episode. Darren Brady Nelson, welcome back to the show.

Darren Brady Nelson 01:46

Thank you. Thank you. It’s been a while now actually.

Gene Tunny 01:48

It has Yes, I’ve given you a breakdown. And I’ve tried to get here a broad range of guests on the show. But yes, sir. Good to have you back on the show to chat about some recent work that you’ve done. So work in both public finance or fiscal policy, you could say, and monetary policy. Darren, so we’ve got a monetary policy review in Australia at the moment, and you’ve written a piece on the monetary policy review. And could you just tell us what your thoughts are on that review, please?

Darren Brady Nelson 02:21

Well, look, just to step back slightly from that, you know, I’ve kind of been disappointed over, you know, probably the course of a decade or something like that, that, you know, obviously, it’s good to have a variety of different takes on things like the Reserve Bank are obviously, you know, this review, that’s, you know, nearing the end, I believe the reporting to government next month. But, you know, there’s, there’s this never been, you know, look, I’d love to see kind of more of an Austrian take on things, at least once in a while in the Australian media, or even in Australian think tanks. To tell you the truth, I’d settle for a bit of a Chicago take on things and you just don’t get really neither of those takes for the most part, certainly not in the media. You know, look, I’ve never had a chance to read our friend, Tony, Megan’s take on the Reserve Bank. I know, he wrote an article for spectator, just like the article I’ve just written is meant to be published soon by the spectator, Australia. So I’m not sure his his exact take, and maybe you can tell me if you’ve read his article, I’m not sure, Gene, if you can give a little bit of overview of what how he viewed things, but so I just wanted to kind of bring a little bit of a, you know, an Austrian, take two things, in terms of, you know, linking sort of, you know, the Reserve Bank, the money supply and inflation, in a nutshell. And also, I found that people often didn’t kind of step back. And they, they vaguely mentioned what the Reserve Bank is supposed to do, and kind of leave it at that just kind of go into in to have a very different take than what I wanted to give. So, as not only an economist, but also a former law student, I also wanted to kind of start out and go, Hey, this is, you know, this is what, you know, the legislation says, for instance, about the Reserve Bank, and what they’re doing what they’re supposed to do, and then kind of jump in to, you know, like I said, sort of an Austrian economics take on things and, and also kind of stir the hornet’s nest a little bit, you know, by using a little bit of satire at the beginning and at the end of the article.

Gene Tunny 04:29

Right, okay, so yeah, we might get into a few of those things. So what does the law say? What, what does the what was your analysis of the, of the legal underpinnings or what they’re supposed to do under the is it the Reserve Bank act?

Darren Brady Nelson 04:45

Yeah, I mean, some people really just don’t understand what it is, you know, exactly, you know, sort of made that clear this, this is a central bank, you know, they, they basically have a monopoly control over currency in Australia. And you know, people kind of vaguely maybe understand that, but just to make that kind of really clear, you know, this is what it is. It has some other roles, of course, it has, you know, kind of these other banking, regulatory functions, but they really, you know, those are really to support the main goal, which is, obviously, Reserve Bank’s not unusual, it’s a central bank, very similar to the other central banks around the world, like the Bank of England or the Federal Reserve. But just to remind people, Hey, this is, you know, this is a government entity, it has a monopoly on on money, essentially, but at the same time, it’s required to do, you know, in that context, it’s, it has, you know, some of these broader sort of things, it’s three main things, you know, where it goes under Section 10, A, the stability of the currency, the maintenance of full employment, very, you know, 1940s 50s sort of thing that was thrown in, because the, you know, the Reserve Bank act is from 1959. So, you know, very Keynesian sort of thing there. And the other one kind of, you know, somewhat more vaguely, but, you know, still important, obviously, the economic prosperity and welfare, the people of Australia. Now, you know, look, there’s only so much you can say, in an in an article, even though my article is a bit longer than your average op ed, if you like, but there’s even within that there’s so much you could say, and I couldn’t say, but, you know, obviously like to say the audience, I think they got some issues, because these things conflict, or, you know, you can interpret these things and quite different ways. You know, clearly, I think, you know, I would argue, and I do to some extent, at least I think in my piece is, you know, certainly printing the sort of amounts of money that they have, and not just not just recently, and not just since COVID, but actually over a much longer period of time. is, you know, quick, you know, I would question that that really helps the stability of the currency. You know, that seems to me to be at least something questionable. I think it harms the stability of the currency, but I think it’s at least questionable. It also argued that it actually helps out the other two, I don’t think it may help with statistical, full employment. But does it really help with economically efficient, full employment, much less, you know, actual economic prosperity and welfare? Yeah, sorry. Go ahead.

Gene Tunny 07:19

I was just thinking it was an interesting point you made about stability, the currency. And you don’t think that the growth of the money supply we’ve seen that the RBA has overseen is consistent with stability of the currency, they have essentially redefined stability of the currency, they now we now define stability, the currency is not zero inflation, we define it as a two to 3% inflation on average over the economic cycle. So we’ve accepted a certain, a small well – I won’t make any judgement a lower than average historical average rate of inflation as the target. That’s what they’re going for. And over the last 30 years, they would argue that they’ve achieved that. And it’s much better than the performance in the post war period prior to that. So they would argue that they’ve done a good job at achieving stability of the currency in that regard. But yeah, it just occurred to me that when you said that that’s in the Reserve Bank act, that they’ve redefined what stability actually means, in turn, using that inflation target.

Darren Brady Nelson 08:24

Yeah, look, I mean, it’s fairly easy to pull up what, for instance, CPI looks like, and it’s an, even though CPI is only accounting for, you know, something like 40% of the economy, and we, you know, it’s a big chunk of the economy, but people have this impression that accounts for 100% of the economy or something like that. So even in that context, it’s not a pretty picture, you know, and we’re not talking about just like, oh, for a quarter or two, or for a year or two, we’re talking over, you know, quite long, you know, timeframes, you know, we’re talking from the basically the 1970s, with some flattening out, I would argue, do some pretty good counter reforms, if you like more that counter reforms that, you know, reforms that, you know, would counter some of the bad effects of, of just, you know, kind of having fairly loose monetary policy. And that not equally loose throughout that whole period of time. But, you know, it’s really, really hasn’t had a Volcker, for instance, you know, that I’m aware of, in the same sort of timeframe that, you know, since Volcker appeared on the scene in the late 70s, and has since left it. So putting aside, you know, again, my pieces and obviously, to go, so, do some technical thing to go like, Well, did they meet their own sort of technical requirements, and then just criticise them that way? Because there’s plenty of articles like that. You know, my aim was to point to the broader thing that just looks money like this. And if you look, I mean, CPI doesn’t look good over time. But if you start looking at money supply, whichever one you want to pick, it’s not a pretty picture.

Gene Tunny 10:00

right. Okay, so can I ask what do you mean by an Austrian Economics take?

Darren Brady Nelson 10:05

Yeah, look at that. So for those who don’t know, Austrian Economics is, I mean, I mean, a lot of people even economist for some reason don’t fully are aware that there’s actually different schools of thought, quite a few different schools of thought. And one of them is the Austrian School. It started with Karl Menger, in the sort of mid to late 1800s. He’s also, you know, attributed along with a couple other economists is kind of starting the marginal revolution as well. In the end, they call it Austrian School, basically, because he is actually from Austria. And then some of the other sort of people who followed him like Bomba Virk, Mises, Hayek, etc, they were also literally from the country of Austria. So I guess that stuck, obviously, is the name of the school of thought. I mean, I mean, the very free market, I argue that the there’s certainly the most free market oriented, I’d argue that they’re not the most free market oriented because they have an ideological stance. So you can always say that, you know, certainly, like someone like Mises, certainly, you know, went to great pains to go like, this is what I think the logic and even the data, even though they’re not sort of like the, they’re not, they use data, they’re not they don’t think data, without theory tells you anything, but they would argue that, you know, they take a scientific approach to things like, you know, like other schools of thought would also argue, and, you know, they have very, they, they have the most comprehensive take on understanding money, basically, including, you know, I mentioned Bomba Virg actually Menger even before that, that even from the start Menger Bomba, Varick and Mises were, were and still are kind of, you know, the greatest thinkers on money. Some may argue that you could put Keynes in that category, you know, that was one of his, you know, one of his big sort of focuses prior to him writing the general theory. But, you know, the Austrians certainly have a lot to say, and I think, a lot of credible things to say, with the, you know, you ultimately agree with them or not, you know, I just want to get those kinds of ideas, you know, out there in the Australian public.

Gene Tunny 12:20

Okay, and what are those ideas, Darren, and how are they relevant to the RBI review?

Darren Brady Nelson 12:25

Well, look, I mean, in a nutshell, and, you know, I’ve used this quote, a million times, it seems, you know, using Milton Friedman, who’s not Austrian, but Chicago School, who him and Anna Schwartz, you know, sort of took a an empirical approach if you like, I mean, I don’t think you’re setting out to, if you, like, test the theories of Mises, and people like that as such, but they confirm that, you know, inflation, it’s a monetary phenomenon. And it’s always in, at least in practice, you know, you know, maybe the Chicago school don’t necessarily agree that in theory, things like central banks, are really the root cause of inflation. They certainly agree that in practice, that’s what actually happened in history. So but the Austrians, like I said, they go, they go one step further, they go in great detail, to set out the case of why central banks are at the centre of, of why we have ongoing inflation. And the only way you’ll ever solve the inflation problem is to do something about central banks, and they would argue you have to do something stronger than just holding them within certain bounds. As you know, the Chicago school would argue,

Gene Tunny 13:38

Rod, okay, and I mean, fiat money is relevant to isn’t it? So you’re yes, you’re saying the the issue is that you’ve got a central bank that has the monopoly on fiat money, the monopoly control of the currency, which is fiat money, and they can just print it, they can create it out of thin air. And we saw that during the pandemic in Australia, when they finally the RBA, finally engaged in quantitative easing, the Federal Reserve had done it previously, the Bank of Japan and Bank of England and ECB, but we hadn’t actually gone that we hadn’t taken that step yet. But we did during the pandemic,

Darren Brady Nelson 14:15

well, the Austrians were there to drag, you know, central banks always are involved in a process and printing money out of nothing. Now, quantitative easing, took it to new levels, makes the new mechanisms, new levels, and then obviously, modern monetary theory sort of opens the floodgates to go further than, you know, quantitative easing, but if you like allow within that sort of framework of thinking, and we may get onto this later on, but, you know, the Bank of England produced a couple, you know, excellent papers that an Austrian or a neoclassical or a Keynesian or Chicago can all appreciate. It takes something out of just like, you know, just clearly setting out how does the central bank work, but also You know, just as importantly, how does the banking system more broadly, in cooperation, if you like, with the central banks operate, you know, How is money created? I mean, I think the, the title of the paper is money creation in the modern economy, you know, that sets it out quite nicely, they have a different view of that, the course they don’t think that’s an issue as such, you know, it provided obviously, or you stay within certain bounds and all that type of thing. But it does set out the fact that, you know, money is being created from nothing, which is quite a different system, to what, you know, say, for instance, the gold standard, you know, the classical gold standard with all its whatever foibles it had, because Austrians would argue that there could have been a better gold standard, but fine, there was a gold standard, and even central banks. Were part of that system previously, if you like, and the Bank of England also nicely sets that out that history as well. Yeah. So basically, again, coming back, you know, the Reserve Bank’s not any different from the Bank of England Federal Reserve, largely speaking, I mean, there are differences, you know, obviously, you know, the Federal Reserve, obviously, they’re different sized economies, different sides, sizes of the Australian dollar, the US dollar being traded around the world, obviously, the US dollar is special in the sense that it’s still the reserve currency for the world. So you know, their, their prolific money printing, they can get away with it a lot better than, you know, a smaller economy or economies, it’s not the reserve currency of the world, you can get away with Australia being does punch above its weight, and its currency is traded a lot more than you would expect for a small country. Because of you know, obviously, Australia is a big player in commodities, for instance. And that kind of part of the reason is, Australia, punches above its weight if you like.

Gene Tunny 16:45

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Gene Tunny 17:20

Now back to the show. Now I’m just on the what the RBA review is doing it’s it has rather than a narrower terms of reference is looking at the monetary policy framework inflation targeting is looking at the governance the board, whether we have a separate Monetary Policy Committee, I think that’ll end up being one of the recommendations. And the way that John Humphrys described it to me on his Australian taxpayers Alliance live stream, he just said, Well, look, there’s an Overton window of what it’s going to look at, right? I mean, there’s things that are in the Overton Window, there’s things that are outside, and I think you are advocating that they should they should go outside of that window, they should go outside of what’s conventional and actually think about the role of the the RBA as a central bank, is that the type of thing we need? Is that working for us? Or Are there alternative approaches? Is that what you’re you’re arguing? Darren?

Darren Brady Nelson 18:18

Yeah, look, I think I’ve I pull out some recommendations I did. When for Liberty works at the request of Senator Malcolm Roberts, you know, did a submission to his rural banking inquiry, because he wanted to get on the record. And so did I just kind of some of these broader issues of monetary policy and how they do impact the kind of the more narrow review that he was doing at the time. And, yeah, basically suggests, you know, kind of a three pronged approach, you know, sort of, in a shorter term, doing something, you know, a bit broader than what this current review is doing, but nothing, you know, something that might still be within the Overton Window, as you say, and then, you know, what I’m suggesting over the medium term in the longer term are certainly things that, you know, I guess the average policy person, monetary policy person would think, would be outside the Overton Window, like, you know, the Overton window. It’s a good thing to understand in terms of what is, but it can be a very big obstacle to what should be, but because, because I can point to, you know, the reforms, the Hocking Kingdom reforms of the 19, mid 1980s were, you know, not particularly within the Overton Window, national competition policy when it came along in the early 1990s. Not quite in the Overton window. There’s been a lot of good reforms that that are not in the Overton window. Obviously, you know, there’s obviously a politics involved and making sure that even though it’s not quite the Overton window that you know, you don’t scare the horses too much. And people who who’ve been pushing things In the direction of more and more government interference in the economy, including if you like the more draconian stuff, you know, the the over the top lockdowns, the the censorship, all these sorts of things. Putting aside the fact that no a lot of censorship are done by private companies, but they’re done by the best of government, they’re done by the best of government, if you don’t do it, you know, there’ll be trouble for you, private company. So, you know, it’s it’s certainly not, I don’t think, you know, the libertarians have suggested that, so it’s private property, so doesn’t matter. That’s not right. So, you know, people on the left, in a nutshell, don’t care, a rat’s butt about the Overton window for the most part. They keep on plugging away. And they are largely winning. So which is why I wanted to point out some of these reforms, if you like, went more in the direction of the right centre, right, for instance, including, you know, a Labour Government and including, you know, some liberal governments in the past, things can be done. So the Overton window, you got to be aware of it, you got to understand it. And it’s something you need to deal with, but it shouldn’t be something that just stops you from doing

Gene Tunny 21:08

something. Right. And so what would, what would the Austrians recommend abolition of the central bank? I mean, what would happen? What would you recommend?

Darren Brady Nelson 21:18

But look, you know, look, the Austrians there’s quite a variety of views, even within the look, you know, there’s sort of a high IQ, sort of, like competing currency approach, there’s the Roth bar, it’s more, let’s do a new and improved version of the gold standard, if you like, obviously, these things are digitised. No one’s ever suggesting that, you know, that we carry hunks of gold. That’s fine. If you want to carry hunks of gold with you. You know, it’s probably not going to be a huge market for that. That’s going to be but I mean, they recognise that centuries ago anyway. So like, you know, the gold standard, really, there were people running around with bits of gold with them all the time that that was never the case. You know, because the goldsmith’s figured it out before the official gold standard came around today, certificates, it seemed to be a little bit more convenient, you know, which that’s where actually money came from your paper money, I should say, sorry, paper came from from those certificates. So have John freeze. It, he always has a bee in his bonnet about Murray Rothbard. In particular, his argument that he considers, you know, today’s system of fractional reserve banking to be fraud. You know, from a, from a common law perspective, you know, is that Rothbard is arguing literally, in the laws on the books, that it’s actually fraud. He’s saying, under common law, this would be considered fraud. Yeah, okay, maybe, maybe not. But certainly the market would allow a whole lot of fractional reserve banking, I’m sure there won’t be like a one to one alignment all the time, you know, between, you know, reserves and loans and all that sort of stuff, that’s fine. But there wouldn’t be such a huge disconnect that we have, you know, we’re talking 90% and above disconnect between, you know, safe savings and what’s being lent out, getting back to sort of Rothbard is not given sort of credit for being more practical than he was. Yeah, he goes like, here’s the ideal I want. Yeah, you get rid of central banks, and fractional reserve banking. But any little step in that direction, could be pain. How about is a start? What’s just what’s just audit this thing? And, you know, like they talked about in the US sometimes, so let’s just audit the Federal Reserve. Yeah. What are they up to? How do they do things, but the public know, this is what it is, you know, are you happy with this? Is this make sense? You know, yeah. Do you? Are you happy with the consequent the inflationary consequences? Are you happy with the fact that I mean, this thing is very inexorable. You know, like, it causes the booms and busts as well, at least from an Austrian perspective, because inflation and bubbles, it’s the same thing. Inflation doesn’t uniformly happen. It goes, it ends up in asset bubbles, it goes over here, it goes over there. Some people can make a killing out of really not being very good at what they do. They just, they’re just in the right place at the right time. Now, we’re not talking about discouraging proper entrepreneurialism, sometimes, you know, this is kind of like, you know, sort of not very good, sloppy, property oriented sort of entrepreneurialism. And there’s a lot of it, there’s a lot just, it’s a lot of just kind of transfers from, from the poor to the rich. I mean, let’s just get that all out there and report, I’ll be happy with multiple views, you know, red versus blue type of project, Hey, what are the Keynesian think of this, you know, what are the Austrians think of this, whether neoclassical think of this, you know, you know, get it all out there. And, you know, just make it more transparent would be a great start, rather than this kind of, you know, tweaking at the edges. There’s basically a lot of people in political and business power, who, who obviously liked the system as it is,

Gene Tunny 24:55

or they or they don’t want to, I mean, yeah, they haven’t really thought too deeply about Got it? Yeah, they don’t want to rock the boat too much, perhaps. I think we might have to come back to Rothbard views. That sounds interesting. And because it’s probably we probably don’t have enough time to go into it now. That yeah, I think it’d be worth coming back to that. Because yeah, I’m all for a more wider ranging review. I think it’d be fascinating. I think we chatted about this last time we caught up, but we hadn’t seen the terms of reference yet to the review. And I think you’ve predicted that it’d be quite narrow. And it’d be very, you’d get standard sort of mainstream economists on it as we ended up doing, as we ended up doing. I’m not critical of any of them. I think. But yeah, they could have had a broader terms of reference. For sure.

Darren Brady Nelson 25:44

Just one thing to say that the Rothbard you know, some people go look here, you’re kind of in your libertarian utopia, you don’t understand how the system works. He wrote the very best book on how banking works. modern banking, what’s the book called modern banking, is it? No, it’s called the mystery of banking, the mystery of banking. Okay. It’s in great detail exactly how so it’s basically the Bank of England, you know, they they don’t refer to the mystery of banking, they, but they did a very good job of doing something smaller. Got some really good graphics, you know, in the Bank of England report bits, they’re very much aligned. They just have different conclusions. You know, obviously, they don’t come to the same conclusion that Rothbard does.

Gene Tunny 26:26

Right. Yeah. I mean, that’s the article where they describe how the banks essentially, they’re at the vanguard of creating money, or they’re the, the money supply is endogenous to an extent, because the banks are extending credit. And when they’re extending more new loans and paid back then that’s an expansion of the monetary money supply. Now, the central banks involved, the central bank can influence the money supply. But the banks are heavily in the private banks are heavily involved in it. And I think that’s what they’re arguing with they it’s that endogenous view of the money supply. And yeah, I think it is worth reading. What What was the main takeaway for you out of it, Darren, what the Bank of England wrote, I’m just trying to remember what they what was in those articles.

Darren Brady Nelson 27:16

The main takeaway wasn’t like, wow, I’m surprised. This is how they do it. My main takeaway was, Wow, I’m surprised he said it. And I guess another WoW is Wow, thank you. That’s, you know, they explained it really well. It was a really clear, I mean, rock bards. Book mystery. bankings really big, you know. So, you know, it’s, it’s a tome, it’s huge. So, you know, the Bank of England’s report has both an introduction, if you don’t want to redeem read the more detailed report, but even the more detailed report is nowhere near the size of the mystery of banking, but they’re all saying the same thing in terms of like, describing the process, right. You know, you know, what is central banks do what do the commercial banks to? I mean, so basically, the thing, you know, when right away when someone gets gets a loan, that’s money already. So you’ve just increased the money supply right there. Yeah. They don’t need things to happen. It’s right there. They whack it in your bank account. Obviously, people do all sorts of different things with that. Yeah. But yeah, the right there. So there is one thing I must admit, I figured, you know, fractional reserve banking, or those banks creating money, I knew that I was, you know, over time, I was trying to understand that they were actually printing most of the money. It wasn’t the central banks themselves. But when I saw when I saw the Bank of England, I didn’t realise the percentage was quite as big as it is. They said, 97% 97% of all money. Yeah, in the UK. And it wouldn’t be very different from you know, going to any Western country, it’s probably all gonna be the 90s to some extent, was this, you know,

Gene Tunny 28:54

they actually used the term fountain pen money. Yeah. Okay. So I guess I was even surprised at the size. Right. Yeah. Okay. And so you see that as a, as a confession or just acknowledgement of the Bank of England by the Bank of England of, of how the money supply can grow. And in you’re taking from that, that the system that we have naturally leads to expansion of the money supply into inflation. Is that what you’re inferring? From that, Darren?

Darren Brady Nelson 29:27

Yeah, but basically, it’s, it’s that it’s even more than that. It is literally inflation. But, but obviously, there’s certain levels of inflation, the other can be vary quite a bit. I think it incentivizes, you know, high inflation or certainly, it’s certainly incentivize booms and busts. Yeah, I wouldn’t say necessarily there was a confession or anything like that, but they do actually, early on in the report. Take the method that I certainly read in my economic textbooks, you know, that basically banks are just purely these intermediaries who get savings and then lend them out. Obviously take a little bit of a cut. Okay, fine. That’s, that’s, that’s fine. I don’t have a problem with that as a business. Yeah. They basically knock that on the head. Yeah. But interestingly enough, they don’t do it in a way that they say this is bad. But for me, I read it and go, you know, because of my kind of Austrian take on things I go, Well, that’s not good. You know, they’re just kind of, they’re just saying, This is what it is basically, it’s not this. They’re not just simply intermediaries. This is what these banks are. And this is how we, as a central bank, interact with those banks. Again, I think any any economist of any school of thought would find it, you know, an informative paper.

Gene Tunny 30:42

Oh, absolutely. I’ve talked about it on the show before I’ll put some links in the show notes. I think it’s good paper. And yeah, I’ll link to your spectator article. Once it’s out. Gee, Darren, there’s so much to talk about. Really appreciate your time, we dealt with some big issues, and we’ve still got more to talk about. Certainly, I want to come back to Rothbard. Yeah, that’s, uh, I’ll have to have a read of his of his book, and mystery of banking. And, yeah, I really appreciate your time. So thanks once more for coming on to the show.

Darren Brady Nelson 31:15

Thank you for having me.

Gene Tunny 31:26

Okay, I hope you found that informative, and enjoyable. I welcome Darren’s call for a broader review of the Reserve Bank of Australia. Given the importance of the Reserve Bank in the economy, we should be thinking about what presuppositions were making about the bank, and we should subject them to critical thought. The current review of the bank appears to take for granted that the reserve bank should continue as an entity and it should retain its extensive powers under the Reserve Bank Act. The review focuses on the appropriateness of the inflation targeting regime and the governance of the bank, but it should be much broader. The reviews Terms of Reference noted explicitly that the review will exclude the RBS payments, financial infrastructure, banking and bank note functions. Arguably, it would have been desirable to review even these functions of the RBA. So I think Darren is on the right track here. Even if I disagree with him over what a broader review would recommend. There are at least two big related questions that a wider review would consider. First, do we need a central bank? That is Do we need a government owned or authorised bank which acts as a bank for other banks and is ultimately responsible for the currency. Secondly, would commodity backed money where money is convertible to gold at a fixed rate? Would that be preferable to fiat money, where money is decreed to be the legal tender of the land by the government and the money supply is the responsibility of the central bank. In a Wi Fi at money presupposes a central bank or an arm of government such as the Treasury which effectively acts as a bank. But a central bank can exist in a commodity money system too, and indeed several such as the Bank of England and US Federal Reserve. They did exist during the years in which the gold standard was in place or some of the years in which the gold standard was in place. A central bank can perform an important role regardless of the monetary standard in place. As the 19th century British polymath Walter Badgett illustrated in Lombard Street, a central bank and perform an important role by acting as a lender of last resort. That is lending to banks when they temporarily get into trouble. And, you know, saving those banks from collapsing and causing lots of hardship. My view is that a central bank is an indispensable part and an unavoidable part of a modern economy. Regarding the second big question, I wouldn’t recommend a return to commodity money by say reintroducing the gold standard. But I will concede that advocates of a gold standard have some good arguments on their side. These arguments are even more appealing in times of high inflation such as the time we’re now living in. Most importantly, in my view, it is clear that fiat money systems are much more prone to inflation, then commodity money systems. A 1998 study by economists at the Minneapolis Fed found that the average inflation rate for the Fed standard observations so this is observations and the data set they’re analysing the average inflation rate for the Fed standard observations is 9.17% per year. The average inflation rate for the commodity standard observations is 1.75%. That’s a big difference. The data set they use contain data on 15 countries including In the US, UK, France, Italy, Germany, Spain, Argentina and Brazil, among others. Every country in the data set had a higher rate of inflation under a feared standard than a commodity standard. What’s going on is that obviously, there are physical constraints on the amount of commodity money available. It’s limited by the rate at which it can be discovered dug up and produced. Under a feared standard, new money is virtually costless to produce. As Darren and I discussed, the central bank and commercial banks are both involved in new money creation. And it’s possible for the money supply to expand faster than the productive capacity of the economy, leading to inflation, there can be too much money chasing too few goods. This is not to say that you can’t have inflation in a commodity money system. For example, there was prolonged inflation in Spain in in the UK in the 16th and 17th centuries, due to new silver mining and Mexico and Peru following European conquest. Still, as the Minneapolis Fed economists point out the average inflation rates over the period in these countries, it was only around one to 1.2% over 100 to 150 years. That’s one to 1.2% per annum. I’ll link to that study in the show notes so you can check it out. To me, it really clearly shows that fiat money systems are much more prone to inflation and you end up with inflation at higher rates than under a commodity money system. While a commodity standard would yield better inflation outcomes and a feared standard, it would be very difficult to return to say the gold standard. US President Reagan appointed a Gold Commission in 1981. To consider whether the US should return to the gold standard. The majority of the commission rejected such a move, and prominent economists such as Milton Friedman and Alan Greenspan, they advised Reagan against the return to gold. GREENSPAN did, however, suggest issuing some US Treasury bonds backed by gold, something which would provide some fiscal disciplined. He did not, however, advocate a full return to the gold standard. GREENSPAN thought that a return to the gold standard would be impractical given the nature of the modern economy with a large role for government and a welfare state. A gold standard requires fiscal discipline for several reasons, which I might have to cover in a bonus episode. One of these reasons is that under a gold standard, a government can’t rely on future inflation to erode the real value of the debt it owes. In his 2007 autobiography, The Age of turbulence, Greenspan wrote the following. I have always harboured a nostalgia for the gold standards inherent price stability, a stable currency was its primary goal. But I’ve long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate functions of government. In particular, the need for government to provide a social safety net. The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded, has led to deficit spending in every fiscal year since 1970. With the exception of the surpluses of 1998 to 2001, generated by the stock market boom. The shifting of real resources required to perform such functions has imparted a bias toward inflation. In the political arena, the pressure to make low interest rate credit generally available, and to use fiscal measures to boost employment and to avoid the unpleasantness of downward adjustments in nominal wages and prices has become nearly impossible to resist. For the most part, the American people have tolerated the inflation bias as an acceptable cost of the modern welfare state. There is no support for the gold standard today, and I see no likelihood of its return. Austrian economists would say that Greenspan gave into big government into inflation, and there may be some truth in that. But Greenspan’s position is entirely pragmatic. I’ll put some links in the show notes so you can learn more about this fascinating episode of the Gold Commission, and about Friedman’s and Greenspan’s advice to Reagan. I’ll also add a link to the minority report of the Commission which recommended a return to the gold standard. It was co authored by Ron Paul, the noted libertarian politician. I’ll leave it there for now, but I recognise there are several aspects of monetary economics that I need to explore and explain some more. I think the process of money creation and how the central bank can influence the money supply would be good to go over in some depth, as it’s challenging to understand. My conversation with Darren also reminded me that it would be good to look at how we ended up with inflation. targeting in the first place? Why do we think it’s sensible to have a two to 3% inflation target rather than a zero target? I hope you’ll forgive me if I leave these questions to a future episode. Among other topics in coming episodes, I’ll have a closer look at the growing US China tensions and the rise of authoritarianism around the world. geopolitics obviously can have a big impact on economy, so I think it’s important that I cover it on this show. If there are topics you’d like me to cover in future episodes, please let me know. As always, feel free to email me at contact at economics explored.com Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

41:26

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags austrian economics, central banks, fed, fiat money, gold standard, inflation, monetary policy, money, rba

Podcast episode

Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Post author By Alec Krishna
Post date March 8, 2023
No Comments on Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Dave Belvedere is a software engineer who searches for opportunities to make the crypto market more efficient and to make money at the same time – e.g. by exploiting arbitrage opportunities. Dave gives show host Gene Tunny and his colleague Tim Hughes an overview of cryptocurrency and also talks about NFTs and decentralized applications (dApps), such as Wizards & Dragons.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP178

What is Dave’s role in the crypto market? [1:10]
What is a chain and how does it work? [3:39]
How long does it take to make a transaction? [9:26]
What does a crypto exchange (e.g. FTX) do? [15:30]
What do we know about miners? [20:20]
What’s the future of crypto currencies? [25:44]
What is Ethereum and how does it work? [45:57]
What are the pros and cons of crypto? [52:07]
What are dApps? [57:01]
What are the use cases? What would motivate you to have crypto? [1:06:33]

Links relevant to the conversation

Bitcoin creator:

https://en.wikipedia.org/wiki/Satoshi_Nakamoto

Wizards & Dragons game:

https://dappradar.com/ethereum/games/wizards-dragons-game

Transcript: Crypto arbitrage searcher Dave Belvedere on crypto and dApps such as Wizards & Dragons – EP178

Gene Tunny 00:06

Tim Hughes 00:43

Hey, Gene. Good to be here mate.

Gene Tunny 00:44

And Tim, thanks for introducing me to Dave, who is involved in crypto and crypto is something that Tim and I have chatted about before, and we’re conscious that we need to know more about it, we’re at a certain level of understanding of it, and it’d be good to increase that understanding. So to kick off with Dave, could you talk about your involvement with crypto, please?

Dave Belvedere 01:10

Yeah, so I’m what I do is I’m classified as a searcher within cryptocurrency. So a searcher is somebody who looks for opportunities to make the market more efficient. So one of the classic examples is arbitrage. So when somebody adds a cryptocurrency to one side of a pool, so those get created by automatic market makers, which we can talk about, so yeah, yeah. So if they add, say, you know, 20,000 ETH to one side of the pool, and the other side of the pool holds USD t, then there’s an offset of the balance of how much USD T costs versus what the general market says.

Tim Hughes 01:48

So David, USD t is,

Dave Belvedere 01:50

it’s so sorry, yeah, the USDt is tether. It’s backed by sort of the organisation that runs it to maintain a level pay going against the US dollar. So it’s one to one to the US dollar. Okay. So there’s a couple of coins like that, that are referred to as stable coins. So this is within Ethereum, which is USD T and USDC. So us coin but it’s not the US market coin. So it’s not connected to the US government at all. Okay, so ETH is Ethereum and if there’s a theory, okay, and then you’ll have BTC, which is Bitcoin? Yeah.

Gene Tunny 02:29

And is there a simple way to explain the difference between Ethereum and Bitcoin?

Dave Belvedere 02:34

Yeah. In essence, the cryptocurrencies. So it’s cryptocurrency really is just a digital asset that’s backed by a cryptographic hashing algorithm. Digital Asset is something just like a bank account, or something like that. So yeah, we see it every day. Yeah, technically, all Australian dollars, when you start to pay with your credit card, that’s really just a digital asset. In this case, it’s a digital asset that is then secured by cryptography. So when you go visit the bank, you’ll usually see HTTPS, that s stands for secure, and that’s backed by cryptography. So same sort of mechanism. And in this regard, when we talk about Bitcoin and Ethereum , they’re actually two independent cryptocurrency chains. So they’re not really connected together. And what that means is that they operate a little differently. So Bitcoin was the first one, they came in around 2009. So a lot of people would have heard it, because, yeah, that the market value quite, quite hugely, I think, a couple of years ago, it was up to like 80,000, US or 80,000, Australian. And it’s come back down now. But yeah, head has gained a lot of popularity. So when we get into a chain, there’s a couple of things when we talk about what a chain is. So we would have all heard of the classical blockchain. And that’s what sort of secures Bitcoin and Aetherium. So blockchain is really an ledger, we probably always, always heard it. So transactions just get added, and you can’t go back and modify the transactions. And one way, well, the guarantee for that is the consensus mechanism that gets used. So let’s just say I make a couple of transactions on Bitcoin. So I’m sending some bitcoin to somebody else, that transaction gets added to a block. So there can be many transactions or none, no block. Yeah. And then that block then goes through all gets consensus with the rest of the network. So one of the differences are that, I guess one of the big differences with blockchains is that for most of the blockchains, that distributed systems, so nodes all around the world make up the actual blockchain. So there’s no one entity that can control the blockchain itself.

Tim Hughes 04:53

So this is the decentralised term when it’s used. This is what the what they mean by that.

Dave Belvedere 04:57

Yeah, yeah. So that’s sort of like you can shut down, say everything in the US, but the chain will still operate because you know, it’s in Europe, it’s in Asia, it’s in Australia. So you can’t really shut the chain down.

Tim Hughes 05:09

And is that just on that subject, is that one of the reasons that so much energy is needed for a transaction? Is that where that consumption comes in?

Dave Belvedere 05:17

So to a degree, there’s a couple of things that will maintain the security of the blockchain. So a couple of blockchain. So in this case, Bitcoin itself is actually vulnerable to a degree to the 51% attack. So when we talk about distributed systems, it’s different control most of those systems, you can do whatever you want in the system, which is classified as the 51%. Yeah, so I haven’t heard that term before. So if I control 51% of all miners, and let’s just say in Bitcoin, then I can make any transaction valid, because I control the majority. Yeah, the consensus mechanism that gets used as always a majority, if the most of the nodes agree that this transaction is valid, it’s valid, and there’s no going back once that transaction, that transaction has been committed, there’s there is a couple of nuances to that. So you can challenge a block if it hasn’t been finalised. But for the most part, we you can always just assume, as soon as that transaction gets committed into a block, and it’s on the blockchain, it’s there forever.

Gene Tunny 06:19

Yeah, but because it’s so decentralised. And there are so many 1000s I don’t know how many 10s of 1000s of people around the world who are they’re mining or whatever they’re doing. They’re overseas, so they’ve got a stake in it, then the probability of having that 51% attack is extremely low, isn’t it?

Dave Belvedere 06:40

Yeah, you need sort of a lot of a lot of materials and a lot of money, honestly, to get to that point. Yeah. So when something small, obviously, it’s easy. But yeah, given its past sort of popularity, and its nature, yeah, it gets gets very hard. And yeah, so the Yeah, it’s, it’s extremely hard to try and try and get that in a bunch of, there’s a collection, so you might not be able to create the block. So when we, when we talk about these miners, yeah, suddenly, to I guess sort of to lead up to is why miner are unnecessary in Bitcoin, now and previously, in Ethereum, is that they are looking for the next block. So they’re trying to get consensus on the block. Yeah. So when somebody commits a transaction that doesn’t get added to the blockchain, automatically, it goes to the miners. And what they’re doing is running the consensus algorithm. So the algorithm is just really cryptographic hash. And what it includes is the hash of the header of the previous block, plus all the transactions plus a random number. And what they’re trying to do is run that hash it such that they get a viable block, the block is valid in accordance to the consensus algorithm. That is where all the power is spent all that time, because you’re running a cryptographic algorithm, which is usually quite computationally heavy. Yeah, in the best of times, and they’re trying to beat everyone to the block. Because if you create a block, you get a reward for it. So you might get one Bitcoin, or something like that. So it is viable to try and create as many blocks as you can to get those rewards.

Tim Hughes 08:16

That’s the reward for being a miner. Is that right?

Dave Belvedere 08:20

That’s the reward for creating a block. You spend all your time mining, not create a block and get nothing. Yeah, so one of the things that they’ve done, because obviously, that sort of starts to lean towards people with more money, more resources can deploy more things, is they’ve created these mining pools, such that you can contribute to the pool, and it might make up say, 25% on the network. And then if the pool itself creates a block, you get a you get a little piece of that based off of you know, how much you contribute to the pool.

Tim Hughes 08:57

Quick, quick question with that. So with the people who don’t manage to mine the block, is that part of the excessive amount of energy needed for a transaction because it’s basically wasted energy, they resource is a bit like an Olympic bid or how it used to be. So all that money is spent was for nothing, because it went to wherever

Dave Belvedere 09:18

Somebody else. Yeah, so they’re basically you know, running these things as quick as they can and they might get beaten by nanoseconds.

Tim Hughes 09:26

Yeah. And how long would a transaction normally take roughly?

Dave Belvedere 09:29

So it depends on the on the chain being used, I think at the moment with Bitcoin because they’ve like they’ve mined so much it takes you know, 10s of minutes to actually create a new block in Ethereum. They switched from proof of work the consensus of proof of work, which is what Bitcoin still operates on, to proof of stake which is less computationally heavy consensus mechanism and it also you can argue it distributed through the miners a lot cleaner to, and they’re fairly quick. So compared to Bitcoin, so they generate a new block, I think, every second pretty much and the transactions that get included are just transactions there.

Tim Hughes 10:14

Because yeah, this sorry, Jamie, because this is something like last year or isn’t it when Ethereum. So this is the change that they did way? I think it’s only 10%? Or is it like a 90%? reduction on 99.9%. Wow, okay, of their power, which is enormous. I mean, that’s because that was the we’ve talked about it before with outrageous amount of energy spent. And to hear it, they’re like is completely wasted? Any delegates not necessary for that transaction. So it’s wasted energy. Yeah. So Ethereum have made this quantum leap, basically, to make it far more efficient. Yeah, pretty

Dave Belvedere 10:46

well, efficient in terms of memory. Sorry, in terms of power. Yeah, like the contestants. So proof of stake, the way it works is like a scheduler just goes, you’re going to create the next block. And so only one person is effectively going, here are the valid transactions and pushes the block out, you still got validators that will be like, That’s a good job or challenge to do it. So I guess sort of a little difference between proof of work and proof of stake as the consensus mechanisms. Proof of Work is just really run, like find that cryptographic hash match. Proof of stake is you put up X amount of capital, or for this, in this case, it’s 32 ETH, which is about 80,000 Australian, and you say I will behave correctly and properly. And if I generate a block, you get sort of the rewards for that. Now, in order to avoid bad actors, or just somebody coming in with a massive amount of ETH. And being like, I’m just going to do this, they have challenge periods. So if somebody like, let’s just say, misbehaves as the node and puts in a bad transaction, somebody, anyone on the network, so like, you could be just a little guy on the network and these big, big mining groups around you can challenge the block. It’ll force everyone to go through and actually, like, compute this at a sort of hashing level. And if you’re right, and they did misbehave, they lose all the capital that they put up. So they get slashed, 32. And so the node gets bounced, and then that 32 ETH comes back to the network. Because you challenged it, I think you get like, 90% of that, and a bunch of it gets burnt offs. Yeah. So it’s sort of the that’s the mechanism to make sure everyone is behaving correctly.

Gene Tunny 12:39

Don’t can’t ask a basic question. Yep. Say you bought a couch off, Tim. And you wanted to pay Tim in cryptocurrency? I mean, maybe bitcoins the example to use, since that’s what most people are familiar with? How would it work? I mean, would Tim have to have a wallet, a crypto wallet?

Dave Belvedere 13:01

Yeah, so crypto will only really send to what we call wallets are really just public keys and private keys. So it’s the public key infrastructure that sort of backs a lot of lot of internet, mobile, a lot of sort of infrastructure around the world at the moment. And you have a public key and a private key. Okay, so most people might have heard this, like, somebody’s private key got lifted, and crypto got drained. If you’ve got a private key, you can decrypt anything that gets encrypted with the public key. So in this case, I’m sending it to Tim’s public key, and then only Tim will be able to, to get that from his public key if he’s got the private key.

Gene Tunny 13:43

So who sets up the public key? Tim need to do that?

Dave Belvedere 13:46

And Tim needs to do it. So in order to generate a wallet, you’ll get both the public key and its private key.

Gene Tunny 13:51

Okay. And who are the players that do that for you that is that a an exchange? A crypto exchange?

Dave Belvedere 13:56

Yeah, there’s, there’s a, like, you can do it through an exchange. But then typically, like, there are exchanges out there, okay. They might like to hold the private key or, you know, be able to recover private keys and things like that. Yeah, you can do it through a bunch of, sort of specialised applications. So we call them just wallets. So the most common one in Ethereum is Metamask. So it can you can just plug it in, it’s just a Firefox Chrome app, and you go create new wallet, and it’ll generate that those keys for you.

Tim Hughes 14:29

Is that user-friendly Dave or is that something that you’d need someone like yourself to help set up?

Dave Belvedere 14:36

No, it’s it’s it’s pretty easy. User friendly now. So yeah, like a couple years ago would have been like, what’s going on what’s up, but now, you know, they’ve made many changes has been very user friendly, like to go through you instal it. It’ll be like, how you like recovering your existing wallet. And if that’s the case, you got to provide the private key, or the seed phrases to generate the key Um, ball. It’s just like, okay, cool. Finding a new wallet, you click a button creates the wallet for you. Yeah, it stores the like, you won’t see the private key, but I’ll give you the seed phrases that are used to recover that private key and record these because if you don’t have the private key, this is the only way to get this back.

Gene Tunny 15:20

Okay, so who would do the transaction? Is that through the exchange? If you understand money to Tim, or is the exchange doing is FTX? I mean, what did a company like? FTX do so

Dave Belvedere 15:33

FTX was primarily changing, like currency for cryptocurrency. So they, they act as the middleman. Okay, so you know, I’d give them Australian dollars from the bank, okay, and then I could buy on their market at their rates, x amount of crypto that they’re holding in their wallet, okay. And then from that I can either like so as a part of that, typically, you’ll find an account with the exchange that will have like an embedded wallet associated with it, or whatever their infrastructure needs. And then I can transfer that to say, my wallet, and then I can transfer some to Tim or I can use that exchange to transfer it to Tim directly. Okay, so exchanges are primarily there for transferring currency. So, so transferring dollars to currency, or transferring between cryptocurrency across chains, or transferring between cryptocurrency on the same chain. So when we talk about an Ethereum is not just ETH it has a bunch of coins on the same chain. And yeah, you can use an exchange to say transfer one Eth to USD C or USD t. So the two stable coins you’re talking about before. Or I can, you do that what they call on chain through DEX’s. Okay, decentralized exchanges. Okay. So they create pools or what we call automatic market makers. Yeah, so they usually have a pool, which is, this is a 50/50 pool. So it has Ethereum and USDC. So the pool itself, ideally, at any point is trying to maintain half of its quantities Ethereum and the other half is USDC. And now what sort of I look for on chain is when somebody then dumps 20k Ethereum into that pool, means there’s an imbalance between the side. So yeah, who would automatically want USDC or getting rid of ETH. So it’ll make eath very cheap to buy, so wants to get rid of it to maintain the balance, yeah, or give me a really good price to put USDC into the pool, because it wants more of that to try and maintain that 50/50. And that sort of is the classical arbitrage from that I can buy low at some other pool or on the decks itself, and then put it into this. And what makes that possible is decentralise exchanges. Don’t look at you know, a fee that says the market price for ETH is x to what exchanges use. So exchanges will typically have, you know, the current market price of ETH is whatever $1,600 And that’s based off of, you know, what’s happening now what’s happening on other exchanges, like Binance and things like that, and they sort of get a get a market price for that. Whereas decentralised applications, their market price is literally what the pool says. So yeah, you can sort of get really good deals. And yeah, when you sort of try and make that market efficient on the decentralised side it Yeah, can can open up a bunch of opportunities.

Tim Hughes 18:55

Can I just ask Dave? So with winning that transaction in your, you know, for that particular situation, is that all about speed? Or is so what are the factors in being able to get that transaction?

Dave Belvedere 19:06

Yeah, so there’s, there’s a couple of things that will impact that transaction. So on Ethereum, it’s not necessarily about speed, you certainly have to be there when they’re trying to create the block. So let’s just say the timing window for creating a block is 100 milliseconds. So as long as my transaction to do that is in that block time creation window, I have a chance to potentially win that transaction. And what it comes down to on Ethereum is you can tip the miner to be like, you want to put my transaction first. So let’s just say I’m going to make three ETH. From this transaction, I can tip the miner 2.5 of that ETH so I get half of that if I can give the miner 2.5 If they put my transaction first, so which means the Miner is getting more money to make sure that my block Isn’t there first my transactions in there first, and then they can put the rest of the transactions. And so that’s sort of making up what we, you know, sort of what gets identified as MeV. So mine extractable value. So they’re looking for the most profitable transactions to put inside their block in order to make the most money. Yeah.

Gene Tunny 20:20

So what do we know about these miners? There are professional miners aren’t there? And are there amateur miners? I mean, is it guys in the basement? Or is it? I know there are some dedicated companies aren’t there that are doing the mining and they’re all around the world? Do we have any here in Brisbane, I’m just fascinated with these miners are.

Dave Belvedere 20:40

Ya know, it’s really it’s, it’s anyone that has the computer with the resources and is running the algorithm, you can be a miner at that point. Yeah, mine is there to operate the chain it does. Under proof of work, it is better to be with other miners, like around other miners, because you want to broadcast the block that you find to the network as quickly as possible, because two people might come up with the same solution or like different transaction orders. But both of the blocks that they produce pass the consensus algorithm, it’s whoever can saturate the network or saturate 51% of the network they’re blocked in is the next block. So you might do all this work, find a block, create the block and then still miss out.

Tim Hughes 21:29

Right, which was the original problem, anyway. So yeah, just is it? Well, as far as energy consumption goes. So with the changes that Ethereum made, it’s the same process, but just quicker, and with fewer people vying for it. Is that right?

Dave Belvedere 21:41

Just just one person vying for it. So it’s like, with proof of stake, it’s like, it’s your time to create the block. And you have to answer within a certain timeframe. If you don’t, there is a little bit of a penalty, like you lose, start to lose some of your stake, and they just go to the next person.

Tim Hughes 21:56

And how do you be in that little group or chain? Or?

Dave Belvedere 22:00

Oh, it’s just really running the node software, So the actual node software is executing, you just connect to it. And and you’re pretty much in it.

Gene Tunny 22:09

Yeah. What do you know about the profitability of the mining? Because is it something where there’s such low barriers to entry, there’s just, you know, lots of people have come into it seeking the profit. And then that gets, you know, that those opportunities get dissipated? Or? I mean, I’m guessing there are some players in the mining game who have, they’ve just got such great computer capability, or there, they’ve got a better algorithm, that they could get a lot of the winnings, but what do you know about the profitability of mining? And the, I guess, the market structure, I suppose you call it?

Dave Belvedere 22:48

Yeah. So um, under proof of work, mining profitability, I think sort of, when we talk about Bitcoin is starting to fade away very quickly, because you need to spend all this energy. And I’m, I’m pretty, pretty sure that they’ve dropped the block rewards, quite recently. So what you get for actually creating a block that’s come down, so you’re getting less and less, sort of Bitcoin for creating that block now, right? So the profitability is starting to go away. In Ethereum, it’s still kind of there, it’s sort of like a random random shoot, if you get a really good block, where let’s just say something skewed pool a lot. And you’ve got these searches, trying to like get money out of the pool to make it market efficient, you might end up with a block that might pay you say, 50 EtH, in those tips. So that’s random. But the problem is, is that there’s a lot of like, nodes around the world for a theorem, because now it’s just super, super, super basic to set up and those sort of requirements are starting to fall away a little bit. That yeah, it is hard to like, get to that block, like it is pretty much a random chance. Okay.

Tim Hughes 24:04

But, Dave, you mentioned a couple of terms, actually, you have Bitcoin operate and how Ethereum operate, which is essentially then the difference that made it possible for Ethereum to use so much less energy. What was that again?

Dave Belvedere 24:18

They’re their consensus mechanism. So proof of work versus proof of stake.

Tim Hughes 24:22

Yeah, right. Okay. So Bitcoin have proof of work, Bitcoin and proof of work? Yep. Is it possible for them to do the same thing as a theorem and move to proof of steak?

Dave Belvedere 24:33

It is they would have to change how the chain would not have the chain, well, how the miners would operate. So the actual software that the miners run. One of the things with Bitcoin is there are very big miner groups now. So there’s a lot of sort of power in these groups because they don’t want the status quo to change. Because they they’re making they’re making money. So proof of work, works for those miners. Yeah. And so you have to convince like majority of the miners or like 90% of the miners that this is the way forward. Otherwise, what will happen is you’ll get a hard fork. So you’ll potentially see if you’ve looked at sort of some of the crypto you’ll see like, Bitcoin classic and a theorem classic. Yeah, these are hard forks of the chains where miners have just disagreed. Okay, and so, you know, a group of miners went one way. And other group of miners went the other way. People yeah. Always soiling it.

Tim Hughes 25:34

Humans always do. Okay, so, um, because with that, I mean, it looked like such a big change for Ethereum that Bitcoin might have its days numbered, like, Is that a fair assumption?

Dave Belvedere 25:44

I think so. Like, I think bitcoins done really good stuff and trying to like break into the businesses and operate as like, Hey, here’s a digital asset coin and sort of challenge the status quo that was previously that it’s days to look, you know, pretty, pretty bleak. In terms of future it is just a coin, and it’s just a digital asset. And you’ve got other sort of crypto currencies like Ethereum that operate as a coin, but then also have these decentralised exchanges, as you know, on chain games that you can play and like, do stuff with, they’ve building out an entire ecosystem over top of them. So they’ve now got what what gets referred to as layer two chains. So chains that operate on Ethereum. So you can bridge assets, I can take what I’ve got on a theorem and hold it up to this layer two chain, and that layer two chain is secured by Ethereum. So typically, you’d like to take arbitrage, for example, it’s a really popular layer to chain on a theorem, what they do is they’ve got their own. They’re a centralised chain. So the way that they validate and sequence blocks is controlled by off chain labs. But what they do is when they’ve got a bunch of blocks, they roll them all up. So they have a rollup mechanism. And they send that data back down as a transaction on layer one. And so when it gets committed into layer one, I can essentially rebuild the layer two chain from just layer one. And that’s where I sort of think Ethereum is going to head towards the future, is that a Ethereum , what we call layer, layer one will end up being more of a security mechanism, rather than sort of what exists today with DEXIS and coins, that will still be around, but I think the majority of us will start to go towards layer two and potentially even layer three, because they can upscale the amount of transactions they can handle. So that’s, that’s the other one. That’s pretty key, if this was going to take over sort of like, a digital asset is how many transactions you can compute per second. So you know, take Visa, for example, I think can do like, what 4000 transactions a second. And so yeah, that sort of puts a minimum requirement on how many transactions you can compute per second, in order to like, not really notice, it’s like you don’t notice, like when you tap a credit card to go pay a delay of like, hang on, gotta mine that block.

Gene Tunny 28:22

This is where we need quantum computers. And are they, are they something that will actually happen?

Dave Belvedere 28:28

Potentially, yeah, it depends on like, what gets used. So hashing is always a weird one for quantum computers, because hashes are typically not vulnerable to, I guess, you know, Shor’s algorithm, which says, basically, sort of at a high level, anything that’s secured by, say, just a cryptographic algorithm, you can break with Shor’s algorithm. Yes, yeah. it all up. So cryptography today depends on the fact that when I make like input equal output, if I have to break that output, it’s a brute force attack. So I have to just iterate through all possible inputs to try and find what input gave me that output. It depends on that that is pretty much impossible. You need a lot of resources. And it’s going to take a lot of time. Not to say it’s not impossible, but it’s so far out of just, it’s 100 years to like, try and work out what this input equals that output, that it’s just not worth it. So that’s what fundamentally secures all cryptography today in those sort of algorithms. What the concern with quantum is, is that you’ll be able to do that a lot quicker. Yeah, but with hashes, not so much. It’s still just run through how the hashes work.

Gene Tunny 29:56

Right? Okay. Yeah, fair enough. I had another had another question about this proof of work versus proof of stake. One. Criticism I heard at the time when this merge occurred was at the merge, like the merge. Yeah. Was that Well, the great thing about Bitcoin and I think I had Yeah, I had a guest on the show, who was a Bitcoin enthusiast, and he was also a writer of thrillers. Lars Emmerich. I think it was, yeah. It was interesting. Guest fun. Yeah. All right, is excellent. And former fighter pilot and oh, yeah, writes thrillers. And he’s, we talked about crypto among other things. And he’s a big Bitcoin enthusiast because he sees the risk of he’s concerned about the US dollar hyperinflation, etc. So we had a good conversation on that. But he was saying the great thing about Bitcoin is decentralised, the proof of work means that there’s benefits from having proof of work, and it is, I guess what I’m asking is Ethereum still crypto, is it still, I mean, there’s moving to proof of stake move away from the benefits of having to do that proof of work.

Dave Belvedere 31:23

I mean, oh, yeah. Yeah. No, not Not really. So okay. It is still crypto. It’s still cryptographically you know, okay, locked in and secured, as is still decentralised, still decentralised.Yeah, so absolutely. So it’s even some people can argue it’s even becoming more decentralised than say, Bitcoin. So Bitcoin itself is moving towards centralization, because you have the big miner groups that start to control more and more of the chain, sort of moving towards a centralised figure. And so that’s that 51% attack that we talked about earlier, with moving to a proof of stake in order to control or sort of start to centralise the chain, I have to control 51% of all Ethereum. So every single ETH that’s ever been issued, I need to hold 51% of that, which is, you know, starting to become trillions and trillions of dollars. Yeah, so it is less viable for me to actually try to attack at the network. And yeah, it’s sort of proof of stake kind of starts to push more of a distributed type of feel to it doesn’t stop big groups coming together and like, obviously, trying to pull the chain towards centralization. But I’d probably argue that proof of stake makes that harder than say, proof of work.

Gene Tunny 32:51

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny 33:26

Now back to the show.

Tim Hughes 33:31

Can I say what would happen with layer one, layer two, if someone was to get that 51% ownership? Do they then become the layer one? They’ve got their? They’ve got the conch as it were, you know, so is that where the layer one status is? Is like yeah, because the majority.

Dave Belvedere 33:49

so yeah, pretty much like yeah, if somebody can control, you know, the, the layer one and you’ve got layer two, and layer three is built on top of it. They call the shots, they call it. Yeah, they effectively have the control of the network.

Tim Hughes 34:02

Because it’s an interesting part of how this seems to be unfolding is that the decentralised nature seems to be one of the big attractions and I’m sure it still is. But as far as confidence in the currency, it seems to be the downfall of, so it’s it looks quite possible that so for instance, Reserve Bank of Australia or Bank of England may want to bring up their own cryptocurrency which would then be centralised that would be layer two as you were saying so if they did it with Ethereum it would for instance, you know, hypothetically will come on as a layer two and be centralised. Yeah. What are the is that the direction we’re heading in? Is that seem to be most likely?

Dave Belvedere 34:47

Yeah. Maybe. I think because they would want to control the chain. So one of the reasons I guess that a lot of people are still You know, fairly excited is that cryptocurrencies do bring some anonymity to the game. You’re just identified by a wallet, not by name, address or anything like that. Yeah, right, sort of what the banks need. So you don’t get KYC in exchanges, KYC so know your customer.

Gene Tunny 35:19

Yeah, that’s the stop money laundering. Dodgy transactions, technically, they’re supposed to know their customers. And this is where some banks have got into trouble. Yeah, he is that they actually didn’t know their customers and all of the money laundering through the Westpac ATMs. I don’t know if you remember that.

Dave Belvedere 35:39

It was it Westpac? There was a little I remember stuff with Commbank, they’ll doing.

Gene Tunny 35:43

maybe it was Commbank, I actually have to check that in the show notes. So I don’t get sued. But I thought it was Westpac is one of those four. Yeah. So

Tim Hughes 35:58

Good to know, because I’ve got to deliver a CAPTCHA apparently. So. Good thing to know.

Dave Belvedere 36:03

Yeah. So So currently, sort of government regulations, sort of say like, Okay, if you are transferring currencies and things like that, you have to KYC. So you have the customer have to provide details. Yeah, and one of the great things about digital coins is, you know, you just identified by a wallet on the network. So, you know, is that really you? I don’t know. So, you know, this is where, yeah, recently I had to go through tax in a year, which is, which was always fun. And yeah, you got to provide like, his wallet addresses, these are all the wallet addresses I touch. These are all the transactions I made to, obviously, ATO, so they can make sure that you are getting taxed correctly.

Tim Hughes 36:48

That’s a really good point. I hadn’t thought of that. So how does this work with a tax return? Like, you know, with your transaction, what you own what you dont own.

Dave Belvedere 36:56

Every transaction is considered an investment or sell, buy or sell order, basically. So cryptocurrency still is considered, well, it’s a high risk investment, right? It is extremely volatile. And yeah, and there are many dodgy things that do happen on chains. And, you know, one of the classic examples is you can’t even trust exchanges, because FTX, for example, they were messing around with customer funds and things like that.

Tim Hughes 37:27

So yeah, sorry I was always going to ask at some point, now is obviously that time, I guess, what happened?

Dave Belvedere 37:33

So sort of the story that we got for the collapse of FTX customers are obviously putting in the money FTX I believe that the time offered, you know, futures options, traditional sort of trading markets that people could play around with. However, they also sort of had a behind the doors deal with one of their sub companies, I think is Ella Mira or something, something similar to that, where they will lend them a bunch of money at them was backed by customer money from an FTX, FTX perspective. And they played around with it and lost, I think it was they lost billions and billions of dollars. And so when customers started to lose confidence in FTX, I can’t remember what the particular event was. And they tried to withdraw their money. They couldn’t, because FTX didn’t have that money anymore. So and that’s sort of what led to the collapse. And what Yeah, ultimately forced the US government to start to step in. And that’s where I think we’ll start to see more changes. I think crypto is here to stay. But in its current form, probably not. I think governments will start to get involved. And yeah, you’ll start to see sort of a traditional securities market approach, I think, come over the top of it. So yeah, whether you’re more KYC or, you know, more rules around what you can and can’t do in particular countries, which makes it quite hard because there is no one thing controlling crypto, and it’s all decentralised. So it’s like, well, if we see you’re coming from the US, you gotta use this. If we see you’re coming from Australia, you got to do this, which, yes, is it’s hard to make that work well.

Tim Hughes 39:27

So that was a failure of the exchange, not the currency.

Dave Belvedere 39:30

Yeah, that’s, that’s purely a failure of the exchange. So the people running the exchange are doing Yeah. Yeah, questionable. Questionable things.

Gene Tunny 39:38

Yeah, because they should have just been exchanging or holding that money on behalf of their customers. And they were going to use that to purchase cryptocurrencies were they?

Dave Belvedere 39:51

Yeah, so effectively, like, yeah, they would purchase cryptocurrencies and then they would sell it on so they, you know, if starting up they would prop we’ll be running at a bit of a deficit or like have a raw, somebody’s given them a bunch of money too, and have that initial crypto. Yeah. And then yeah, as people come in, and they, like, give money for that crypto, obviously at a particular market margin. Yeah, they start to be able to add more crypto and sort of become profitable in that regard.

Gene Tunny 40:22

Yeah. But they went in, did they go and lend that money that they should have held in trust, or they shouldn’t they were looking out for customers to that. That other company was run by his ex girlfriend. By Sam Bankman-Fried’s ex-girlfriend. Yeah. Yeah, it was a daughter of an economist, economist. MIT economist, I think, I think he’s a professor at MIT or one of those schools. Really good school. Yeah, that was a debacle. The other thing I hear about is the rug pull. Rebuild, goes on about rug pulls. And when coffees Zilla, you probably follow Him or you say he’s really sceptical of crypto. Have you seen coffee Zilla? I will flick you some videos.

Tim Hughes 41:07

I love the fact that rug pulled got a conversation. I’ve never heard of this. About this.

Dave Belvedere 41:13

It’s a funny term. So obviously there with with anything new and like, Give somebody a little bit of anonymity, they just go wild. You know, there are at the moment, a lot of yeah, a lot of good actors that people are trying to, you know, accomplish and create new things. But there are also a lot of bad actors. So classical pump and dump schemes are not uncommon. And yeah, one of the other ones is what gets what got its own name, which is a row pool. So let’s just say, you know, there’s, there’s a, there’s a token that I’m releasing, people buying that token, so they’re sending me money, and I’ve given them the token back, and then on the owner, cool, I can just like swipe all that money out of the account, and then that token is now worthless. That’s, that’s effectively a rug pull. So the people who created that, that have control of that sort of asset, because the assets on an Ethereum are controlled by contracts. So if you’ve got the private key to the contract, you effectively control the contract. And you can just take all the money that’s in that contract, and then the token then becomes worthless.

Tim Hughes 42:20

Actually, on that note, so this, this brings up the question I was going to ask, who started these? Obviously, they’re, you know, whoever is behind bitcoin or Ethereum? Are they known?

Dave Belvedere 42:33

So, Bitcoin, no. There is a famous paper that is written but no one knows the true identity. Within Ethereum, it’s Vitalik. So he traded a theorem and then it’s now run by the Ethereum foundation. So the people who sort of operate and try to improve the chain and things like that are known as a foundation whereas Bitcoin it’s, it’s murky, who started.

Tim Hughes 43:00

It’s very James Bond, the whole thing of like, you know, having something like Bitcoin with, you know, who’s behind it is fascinating that it’s anonymous at that level with potentially a lot of power.

Gene Tunny 43:11

Well, it was this person with a pseudonym was it’s a Satoshi

Dave Belvedere 43:16

Satoshi. It started with Okay, yeah, but yeah, Satoshi, something

Gene Tunny 43:19

like that. I’ll put links in the show notes. And what they did I think they published a white paper. So they publish the code or the rules for Bitcoin and then people read it and thought, actually, yeah, this would, could work. This is a great idea. Let’s go ahead with it. So it’s obviously a computer scientist of some kind, potentially. Yeah, I think is there an Australian who claims that he invented it? I think, as well?

Dave Belvedere 43:44

Yeah. There are claims that the Australian is Satoshi. Ah, right. Yeah, so sort of he released the white paper with the chain already there. So one of the things that you have to do to I guess, you know, start a chain, is you got to create the Genesis block. So the first block that then things build on top of, and typically, if you’re going to create the Genesis block, well, you might as well just create a good fundamental base. So I think, I think Satoshi has like, a ridiculous amount of bitcoin, because you’re effectively controlled. The base asset right at the start, and then you sort of like, give yourself as much as you need as you’re building these blocks, like you might release the chain to the public, say, and it’s got like, 200-300 blocks. So you’ve got all the rewards for those blocks are doing no work, no competition, but now you’re going to release the chain. And so I think, from memory, reading papers, like everyone knows which coins because obviously the coins effectively get numbered based on the block that they were minted in.

Tim Hughes 44:52

And on that note, Dave, there’s a certain number of Bitcoin and then that’s it. Is that right? And was that determined at the very beginning?

Dave Belvedere 45:00

yeah, so that would have been determined by the actual algorithm that that got generated for Bitcoin.

Tim Hughes 45:05

How many other?

Gene Tunny 45:07

21 million, isn’t it? Yeah, I’ll put it in the show notes anyway.

Tim Hughes 45:14

So that’s part of the strength of it, though, that it’s a finite number.

Dave Belvedere 45:18

It is a finite number. Yeah. So it’s like it is the strength. So once everything’s been mined, you know, that’s it, then it just becomes transactions passing between to and fro.

Tim Hughes 45:28

You need a level of scarcity for it to have a value.

Dave Belvedere 45:31

Scarcity will drive the wealth of the actual element up, or potentially not, depending on which way it flows. But yeah, that’s, that’s the sort of appeal for it is that it’s running out, so if you’re going to grab it.

Tim Hughes 45:45

And Is that comparable to how many Ethereum there are in the in circulation? No. I knew as I was asking the question, this is not right.

Dave Belvedere 45:57

So what gets classified as Ethereum? Has, it does have a max value, but it’s quite big.

Tim Hughes 46:05

So sorry, I mean, this is coming from a very base level of understanding. But I’m sort of fascinated by this. So how does that work? Then with Ethereum? How many? Like what do you call? So Bitcoin is a Bitcoin? Because Bitcoin isn’t what Ethereum? Worked with? ETH. So yes, okay. Yes. So the number of ETH isn’t determined, it’s not finite.

Dave Belvedere 46:28

It, there is a there is a finite, but they can always add more. So it’s, yeah, it’s backed by a contract. And you can always change that contract. Sort of as an example. Like, right at the start, it was ETH. So ETH, is the classical. Everyone knows, sort of what gets defaulted to, technically, it’s not ETH anymore. It’s actually wrapped ETH. So three or four years ago, I think, the foundation or or one of the one of the partners that works with Ethereum, closely, they published the standard that every token should follow, because a token is really just a contract on chain, and you’re calling methods on that contract to say meant, you know, how many does this address have? If everyone is, you know, everyone just goes, I’m going to create a new contract, that API of like, what do I call to, like mean to what do I call the burn could change from token to token. So what got published was what was being classified as ERC. 20 So it’s a standard that every token follows. So an ERC 20 token follows that standard. ETH at the time, didn’t meet that standard. And so they created a contract that did create that didn’t meet the standard called wrapped ETH and you can transfer ETH and wrapped ETH at a one to one. So I can have like eight ETH and automatically make it a wrap ETH, okay? It’s just like taking that asset and making it different. But it’s still what you know, it’s still what we call ETH on chain.

Tim Hughes 48:13

Yeah, okay. Yeah.

Gene Tunny 48:14

Here’s another basic question that just occurred to me. So a Bitcoin. I’m not sure what its value at the moment, but is it around 20,000 USD?

Dave Belvedere 48:23

26,00US.

Gene Tunny 48:27

Okay, yep. Yep, can I have a fraction of a Bitcoin? Can I or, but I How does that work? I mean, all because I thought if it’s in a wallet, does it have to be one Bitcoin? Or can it be gonna be a fraction?

Dave Belvedere 48:40

It can be a fraction of Bitcoin. So typically, with the tokens they’ll have? Like, we call it decimals on chain, but it’s really just precise. Okay, gotcha. So like, I think Bitcoin has a precision of six, I think six or eight. I’d have to double check that. So which means I can have point 000001 of a bitcoin. Right. Okay. Yeah, as long as it’s within that, that precision element, it doesn’t matter. You can you can still operate and work on it. Gotcha. Yeah, so as an example, ETH has a precision of 18. Right. So one eath, actually on chain is one times 10 to the power of 18. That’s what it looks like on chain.

Tim Hughes 49:23

Okay. And what’s a ETH worth nowadays? I think it’s around 1600 USD at the moment. Okay. So, as far as affordability goes in a single as against a Bitcoin.

Dave Belvedere 49:37

An ETH is more affordable.

Gene Tunny 49:40

Okay, can I ask you about smart contracts? So as an economist and speaking with other economists, and just reading about crypto and, and all of that, I mean, there seems to be increasingly there’s a view that will crypto might that There’s a lot of scepticism about crypto itself, but they’re saying, well, the blockchain is great, and smart contracts are great. So, can you explain what a smart contract is? And it’s linked to Ethereum? Is that correct? Yeah. How does that work?

Dave Belvedere 50:13

Yeah. So, um, a smart contract is really just code that’s on the chain. And so one of the one of the sort of, I think, very fundamental things that makes a theorem quite good is that I can store more than just the coin on the chain, I can create code, I can put it on chain, and then that’s the code forever. And so that code can no longer be changed, which does lead to some interesting problems, like, Oh, crap, that’s a bug. How do I actually, you know, patch and fix that bug? And you know, that’s, that’s kind of, we’ve seen consequences of that already. Yeah, somebody’s found a security flaw and just like, stolen millions and millions of dollars from contracts, or from DEXIS in particular. So they’re sort of the common hacks that are in theorem. So whenever you see somebody’s hacked, say, a bridge, or a Dex, that’s typically somebody’s found a flaw in the code and been able to exploit that code. Yeah, so a contract is written in solidity for the most part. So solidity is the most common language used for writing smart contracts. And it’s just, it’s just really code at that point. It’s just structured code. So similar to obviously different but like, similar to as if I was to read a C programme. So well, you know, a Ross programme or anything like that. It’s just common, it’s just code. So that’s why if you’ve ever heard coders law on some of the sort of the defences of hacks, that’s, that’s where that’s coming from, is that this is written as code. And the code allowed me to take millions of dollars, therefore, am I really responsible for it? My view is yes.

Tim Hughes 52:07

That is not a strong defence.

Gene Tunny 52:12

It’s like, if you get a million dollars deposited into your bank account, you can’t go out and buy a Ferrari.

Tim Hughes 52:20

The doors open, so I went in and took what I could carry. With that, as well, because I was zooming out a little bit as well. Dave? Yeah, you know, financial markets. There are so many issues like that may influence like a human emotions, like greed, panic, fear, these things happen all the time, you know, cyclical, or whatever it may be. And banks get robbed, you know, like, you know, cash was stolen, whatever. This doesn’t seem to be answering too many sort of problems, you know, they can get hacked. Yeah. So as far as, as a few questions that I guess, because the number one thing with all of that is trust, in my view is like, you know, if people trust something more and more, then it’s a stronger sort of system, and less likely to be driven by greed, panic, fear, etc. What was the pros and cons, if you like, of crypto, like if we ultimately heading towards something where we might be able to have more trust in a financial system than we currently have?

Dave Belvedere 53:23

Yeah, potentially. So I think if the people in on this so you know, sort of Ethereum, you know, who’s who’s running the show to agree.

Tim Hughes 53:35

So there’s trust there as well, compared to some phantom person with a white paper? Yeah. is less, less trustworthy, I guess. But yeah. Yeah.

Dave Belvedere 53:44

Sort of, yeah. Human nature, we sort of trust. If we can see somebody like that. That’s actually a real person. Yeah, there rather than like talking to a computer screen, we’ll be like, Yeah, who are you actually really talking to on the other side of that? So I think inherently, we will trust, obviously, the traditional market setups more because they are run by people. And that’s where, hopefully, you know, something like Ethereum can start to come in and sort of do that. But while you still have people who can misuse, I guess, the environment of like, these rug pools, and, you know, just doing pump and dump schemes and things like that, it does get hard to trust. Yeah, is everything on there. Really a scam or not? Yeah, yeah. Yeah. So it’s sort of a double whammy where it’s like, you know, for myself personally, it’s like, yeah, I trust a theorem like I don’t think the Ethereum ecosystem or anything like that. It’s going to go away anytime soon. The changes that they’re making to it a sensible and things like that, and you can actually see and talk to the people at conferences. However, that contracts and like opportunities that then can be a part of Ethereum, yeah, that’s where it gets a bit dodgy. And that’s where you need to sort of like, okay, I trust this exchange more than the others, you know, uni swap, for example has been around on Ethereum for so long. Well, probably since, uh, since it started, right. And they’re, they’re a decentralised automatic market maker. I trust that, you know, they’ve been around for so long, you know, probably so many people have tried to hack their pools. Nothing’s really happened to it. So if I’m dealing with any swap as a DEX, I’m pretty, pretty confident that nothing’s bad’s going to happen, other than I might not get the best price on chain for my tokens.

Tim Hughes 55:45

But that’s the most likely weak link in that chain is the exchanges or that the middle the people in the middle between the consumer and the Ethereum safe using us?

Dave Belvedere 55:56

Yes. And so sort of the users of Ethereum people are actually creating their own what we call DAPS. So decentralised applications. Yeah, that’s that’s where I think that that trust will start to fade. And and because crypto itself is, you know, it’s it’s quite volatile hasn’t had the best sort of, sort of time it’s been ups being down. It’s dumped to come back and don’t again. Yeah, a lot of people I think a lot of people look at and go cool, that might be a good way to, you know, make easy money because it’s just like going left, right and centre. But it can also backfire very quickly. Yeah. Where, where it sort of blurs the line is that it’s not treated as a traditional investment. Like because it is digitalized. And I can interact with it. And I can like, spend money on it. Like people treat it as money. But it’s really volatile money.

Tim Hughes 56:51

If you’re willing to take advice from Matt Damon and Kiefer Sutherland. I mean, like, it’s so you know, yeah, they are very confident of it being a good move.

Gene Tunny 57:01

Yeah. I’ve got a couple of two more questions. Dave. We’re probably getting close to time. Have you got a couple more Tim?

Tim Hughes 57:07

I’ve? No, I’m good. Thank you. I’ve been I’ve been enjoying as it’s gone on. And my big ones are gone. Thank you.

Gene Tunny 57:16

Yeah, I’ve learned a lot. It’s, it’s great. Would you have any examples of DAPS? That what are some daps that we might want to look at just so we can understand what what they are?

Dave Belvedere 57:28

Oh, yeah, um, a couple of pretty, pretty fun ones. So there’s a game called wizards and dragons. Okay, it’s a it’s a decentralised application, but it’s also a game. It’s pretty fun. It released, I think, a couple of years ago. And what it is, is, you meant an NF T, and it has a chance to be a wizard, or dragon. And then based off of, if it’s a wizard, it can, like interact with, you can stake it. So you can actually say to the contract, hey, here’s my wizard, which is staking, and it might earn certain rewards. So there’s a coin that’s associated with the game as well. So there’s a coin called windy. So it’s wizards and dragons. And that coin can then be used to spend on the contracts to interact with the actual game and stuff like that. So it’s not like I’m continually having to feed ETH it’s just like gas fees at that point. Or if you get a dragon like you have chances to steal wizards when they go and stake and non stake . It’s, it’s it’s pretty, pretty fun.

Gene Tunny 58:36

This is a computer game, is it?

Dave Belvedere 58:38

Yeah, it’s a game on chain. Yeah. So it’s a game that actually happens within the blockchain again, So the game is happening per transaction. So I send a transaction to do something with the game, like the contracts that make up the game are there. And then I like create a transaction to say, stake, my wizard, and then there’s a chance if dragons are staked, that my wizard goes to a dragon.

Gene Tunny 59:08

But okay, I’m gonna ask a really dumb question. But do I see a wizard on the screen? Or do I see dragons?

Dave Belvedere 59:15

Yeah, you can see both. So like, depending on what you’ve meant it, you get an NFT, which is a type of token so a non-fungible token so yeah, they were the ones that got talked about, I think, why the last couple of years because like, yeah, okay, and then the punks and the apes they’re all worth stupid amount of money.

Tim Hughes 59:37

So these are basically like, it’s an in the form of like having something that’s identifiable as being unique, even though it can be copied. So taking the Mona Lisa as an example of one painting, but there’s millions of copies. And so it’s basically a digital form a non fungible token or nifty I’ve heard them called Tim Ferriss calls them nifties. But so base Having something that can be identified as being the original and owned by a person.

Dave Belvedere 1:00:06

Yeah. And so we see that as like a token. It’s just really like a coin is not quite an NFT. Because there are many coins. But it’s like an NFT, sort of superset. There’s only like one coin that represents this thing. And so yeah, so like, it’s just a token. And yeah, that that has things. So like, I can go interact with the contract, you know, meant for a bunch of ETH. So that’s sort of how they get their startup is like, hand over like point zero seven ETH or point zero five ETH, to mint and have a random chance to generate a wizard or a dragon. And then they all sort of give you that NFT. So you’ll get that token back. And then yeah, you can use that token to then interact with the rest of their contract on the actual Ethereum chain.

Gene Tunny 1:00:54

Right. Okay. And are they used in these massive multiplayer games as well, online?

Dave Belvedere 1:01:01

The coins could be. Yeah. So I think they’re starting to come out. I think I read recently with like, digital coins. Yeah. But to sort of looking to go to be fair, that sort of already was kind of going there place anyway. So like, I could pay a bunch of money to the Microsoft store and have like, xbox credits. That was sort of already the lien. And then yeah, what, you know, one of the good things that has come about sort of what’s happening with blockchains? And things like that is Yeah, sort of companies are realising, actually, that’s, that’s a pretty nifty way of like, dealing with this sort of securing that data and making sure like, oh, okay, we can’t accidentally do something. Like, you can’t go back and try and change those records. It’s sort of there permanently. And you can follow a transaction at a time. For bookkeeping purposes, or, yeah.

Gene Tunny 1:01:59

I’m gonna have to come back to smart contracts in a future episode, because I think that’s probably its own episode, is it?

Dave Belvedere 1:02:07

There’s a lot yeah, there’s a lot, a lot of things to talk about, I guess, in contracts, and yeah, sort of, you know, that’s how that how they get built, you know, how they sort of interact. And you know, that’s where these bugs can can arise. And, you know, people might accidentally do something and somebody takes money.

Gene Tunny 1:02:27

Yeah. And I’d be fascinated to know who the parties to the contract are. I mean, could Tim and I have a smart contract where if certain conditions are met or if the then Tim transfers Ethereum. To me, so if, I mean, is there a way of programming, it’s so that if it’s, say, let’s take the weather, for example, if the maximum temperature for Brisbane ends up being over 35 degrees on one day in the future, then the smart contract, picks that up, and then transfers, I don’t know, one ETH from me from Tim.

Dave Belvedere 1:03:01

Yeah, it can do. So there’s, there’s a bunch of things that need to happen and be in place for that. But yeah, you can store like money. So you can store ETM with the smart contract, because it is itself really just an address. And then yeah, you like a transaction is usually always going to be the trigger just can’t do stuff automatically. You always have to trigger it with a transaction. And yeah, you can just be like, Oh, okay, cool.

Gene Tunny 1:03:27

All you have to trigger it with a transaction. Okay. So it’s not, it’s not going to automatically. It’s not a way of automating transactions. And I understood that.

Dave Belvedere 1:03:35

Yeah. Yeah, everything that happens on the chain has to have triggered from a transaction. Okay, so transaction might trigger a bunch of things to happen. Yeah, and interact with a bunch of stuff on chain. But yes, every everything will come through from a certain transaction has triggered this thing, which might then trigger events, but, you know, cascade of roll on.

Gene Tunny 1:04:00

Okay, I might have to look at that in a future episode. I promise. I’ve only got one more question. You got any more, but,

Tim Hughes 1:04:07

you know, I just want to comment, um, not surprisingly, to hear that wizards and dragons entered the conversation seems to be a natural progression from the smartest of the smart in, you know, the 80s or whatever it is, whatever they’ve come through to this point. And no doubt behind some of this technology or this, these theories.

Dave Belvedere 1:04:31

We’re all we’re all nerds on the inside. Right. So

Tim Hughes 1:04:33

yeah, but it’s great. It’s sort of like a bit there’s a human element to that as well, which is nice to see.

Gene Tunny 1:04:39

Great. Final question, Dave. For you. What are the use cases for crypto Why do you think it’s good to for you personally to be in crypto?

Dave Belvedere 1:04:51

It’s it’s a fairly exciting field. So I’m I’m a software engineer by trade. I studied as a computer systems engineer And it’s can be difficult to try and see how technology technology progresses through the years. So that, you know, unless you’re sort of, say deep in with Google and working on their, you know, bleeding edge stuff. For the most part, it’s all kind of pretty much the same. And so it’s pretty cool to see something. So you know, there’s this whole blockchain theories and the cryptographic proofs and stuff. I think we’re around since I think the 80s. So it’s always interesting to see how that is getting transformed and evolved into something new. And then yeah, then being used and sort of one of one of the cool things, I think that’s coming, a part of this, it’s sort of attaching itself to sort of a wider push of everyone should be and I think, you know, I think if you look at the world today, most of the kids growing up today are very computer literate. And it is sort of continuing to push that, like, computers are just going to become more and more part of it. And I think the common school like programming, or reading or writing code, should be sort of start to become one of the fundamental things just because of the heavy involvement that we start to have. So understanding why things are doing things, right. Yeah.

Gene Tunny 1:06:21

Now, the other part of that is your you personally, so assuming I may be incorrect, but I’m assuming you own some crypto of some kind. So do you what are the use cases? Why? What value do you see in having it all? So Lars Emmerich, for example, he’s concerned about the value of the US dollar, he’s concerned about all of the money printing, he’s concerned about hyperinflation, what are the what are the use cases? Or what would motivate you to have crypto?

Dave Belvedere 1:06:52

Yeah, it’s, I guess, you know, personally, I’m pretty, pretty basic. For me, it’s just a fun, high risk investment. So I see it as something that that might pay off. Or it might not. You know, personally, I don’t have a lot of money in it. But it also, because I’m in the area, it helps me like interact with chains. And yeah, play around with like, games, such as, like wizards and dragons. sort of have

Tim Hughes 1:07:18

There as a confession. Yeah. But

Dave Belvedere 1:07:21

I still see it as a very high risk asset. Yeah. Yeah. I’m still relatively young. So to me if I lose, lose what I’ve got, personally, I’ve only got about 20k. There. It’s not gonna hit me hard. Hit me hard in terms of I’m gonna make that back over my lifetime of work. Yeah. But you know if it if it goes and like, whoo, and yeah, all of a sudden that 20k goes to 100k. Yeah.

Gene Tunny 1:07:47

Right. Yeah.

Tim Hughes 1:07:49

But that’s actually a good point. Because none of this is in any way. investment advice from us. Oh, goodness, exactly. You know, like, it’s not investment advice. And the one thing that gets mentioned all the time, it’s like going to the horse races or something like that, you know, if you’ve got something that you can afford to lose, then go for it, because there’s a high risk investment and see what happens.

Dave Belvedere 1:08:09

I honestly look at this and go, it should be treated as a casino like, yeah, you gotta walk into a casino going, like, I have money. If I lose it, I’m not gonna, like get carried out by security. Yeah. Sounds like you can afford to lose the money. It is. Yeah, extremely high risk. And I think, like, especially now with the sort of scenarios that happened, like the FTX collapse, and you know, some of the other things that are happening there. And like the US government sort of taking notice, or like the SEC, taking notice more parts and like, pulling out rulings and stuff, it will become a little bit of, like, no one is really certain what’s going to happen in the area. Yeah. So it’s probably, you know, at this point still, quite, it’s probably riskier than it was before, because, you know, the SEC might turn around and say no, crypto goodbye, and like, you shut out the entire US market, like, that’s not gonna play well, for crypto.

Tim Hughes 1:09:07

Sec? The Securities

Dave Belvedere 1:09:08

and Exchange.

Gene Tunny 1:09:10

Okay, that’s been terrific. I mean, we’ve learned so much. I mean, I’ve never I’ve been blown away with all this info. And I think it’s helped me understand more what’s going on and it’s dispelled some, or it’s got rid of some ideas or misunderstandings I had. So that’s been really good. Are there any final thoughts? Any final words before we wrap up?

Dave Belvedere 1:09:37

No. Like, yeah, I encourage everyone to like, play around with it. Obviously, I think it’s an interesting technology. I think it’s going to be around for a long time. But in its current form, hard to say. I wish I would probably say I’m confident that as we know crypto today is probably not what we’re gonna see in the future. Yeah, this is sort of the first building block towards something that will become widespread.

Tim Hughes 1:10:08

Terrific. Now Dave, I really appreciate it because so we’ve often talked about this gene and I and it we we have fumbled in the dark somewhat. And I’ve been looking forward to the time where we can get somebody on and talk in depth, as we have done today. So yeah, I’ve really enjoyed that and got a lot from it. So thank you for coming in.

Gene Tunny 1:10:28

Dave Belvedere, thanks so much for your time. Thanks. Right. Hi, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com, or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

1:11:19

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com.

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business, www.adepteconomics.com.au.

Tags bitcoin, bitcoin mining, blockchain, chain, crypto, crypto exchange, cryptocurrency, dapp, decentralized, DEX, ethereum, ftx, miners, nft

Podcast episode

How performance-based pay can motivate employees, but there are risks – EP177

Post author By Alec Krishna
Post date March 1, 2023
No Comments on How performance-based pay can motivate employees, but there are risks – EP177

Can we get people to work harder and perform better if we make their pay performance-related – e.g. with performance bonuses or commissions? Does this work? What does the evidence say? We know that people respond to incentives, but, as Gene Tunny and Tim Hughes discuss this episode, getting those incentives right can be tricky.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP177

What is performance-related pay? [0:41]
The types of jobs in which performance-based pay works and doesn’t – e.g. fast food vs real estate [8:09]
The importance of getting incentives right and having transparency [23:16]
Performance-related pay is a difficult thing to put into practice [28:24]
Group-based incentive schemes – evidence from a recent European study of the Hydrema manufacturing business [52:54]

Links relevant to the conversation

IZA World of Labor – Performance-related pay and productivity

How group-based incentives increase worker performance | CEPR

Does Group-Based Incentive Pay Lead To Higher Productivity? Evidence from a Complex and Interdependent Industrial Production Process

The Use of Reward and Incentive Systems: A Case Study of McDonald’s – ToughNickel

McDonald’s Restaurants puts motivation and reward at heart of business strategy – Employee Benefits

Give and Take – Adam Grant

Performance-related pay | The Economist

Real Estate Agent Commissions: How Does it Work and How Much Should You Be Paying

Learn the Truth About Real Estate Commissions | PropertyNow

Transcript: How performance-based pay can motivate employees, but there are risks – EP177

Gene Tunny 00:06

Tim Hughes 01:30

Gene, good to be here.

Gene Tunny 01:31

Excellent Tim, I thought it’d be good for us to have a quick conversation on performance related pay. I’ve been thinking about this following on from this whole debate between Steven Crowder and the daily wire, which I talked about with John Humphries on his Australian taxpayers Alliance Econ Chat, earlier in the week, and I thought it’d be good for us to have a chat about a related issue, which is performance related pay I got starting to think about this. Well, when John and I were talking, we were talking about well, does the actual form of the contract matter? Or is it just all about the dollars that are being paid? Or that they expect to earn out of the contract? I mean, obviously, the money is important, but how do the contractual terms affect the amount of effort that you put in, in your work? And so I was thinking about that in the context of the debate between Crowder and daily wire, and then it reminded me that I should cover this issue of performance related pay on the programme, because I think it’s an important, an important issue.

Tim Hughes 02:36

Yeah, sure. It’s an interesting area for sure.

Gene Tunny 02:38

Yeah. I mean, did you have any thoughts on that whole crowder and daily wire?

Tim Hughes 02:41

I’d never heard of it until you mentioned it. So I didn’t even know if, so he’s a comedian, that guy?

Gene Tunny 02:47

Yeah. Yeah. So he’s on the right wing in the US. He’s more of the Magga type, Crowder, whereas the daily wire and more of the traditional Republican, and I think Ben Shapiro was originally anti Trump. So yeah, the different parts of the conservative movement in the States.

Tim Hughes 03:09

I think I know now, I haven’t heard of him. But as we often talk about like, it’s it’s good to be exposed to different areas and different views. So yeah, looking forward to hearing about it.

Gene Tunny 03:23

It’s just all over YouTube and social media, people are commenting on it and say, John went through it. And John’s view is that well, all they’re arguing over is the amount of money involved. And it’s not necessarily about, you know, the concern Crowder had was that daily wires just doing the bidding of big tech.

Tim Hughes 03:42

But so what was what’s the what’s the juice? Like? What was the story? Between those two guys? It was a it was a contract. Yeah.

Gene Tunny 03:49

It was a contractual dispute. Well, they were trying to recruit, Crowder to their platform, and they offered him $50 million over four years, but the payment that they have for you, yeah, but what they would pay would step down if he was demonetized on different platforms like YouTube and Okay, Twitter, or Facebook, or whatever. And he was saying, well, you’re doing the bidding of big tech. But look, it costs the money. So it makes sense to, to scale the contract down. And so in John’s saying, look, it’s just all about money. These contractual negotiations are just all about money, ultimately.

Tim Hughes 04:26

Just out of interest. So when he says you’re doing the bidding of big tech, what does it mean by bidding? Like, I can understand that, like big tech may affect that income? So if it’s monetized that’s basically the issue. Yeah. But how can they be doing the bidding of big tech? I don’t understand that.

Gene Tunny 04:43

Well, maybe I haven’t expressed that very well. But the idea is that, well, a lot of these conservatives think that big tech is trying to censor conservative voices. Yeah. And so he’s saying, well, you’re just going along with what they want. Alright, okay. I’m accepting that in the pocket. Yeah, no. Yeah, maybe that’s I don’t know. That was his concern. But look, as John said, it just all comes down to money and at what price you’re willing to, to work for Daily Wire and also to give up the IP because he would have to give up IP and the shows that are produced while he was at. At Daily Wire, they would get the copyright in that. Yeah. So yeah, ultimately, it all came down to money, but it did get me thinking well, okay, well, how would you structure a contract? To get the best performance out of a person was daily while we’re designing the contract, they were proposing a contract in a certain form to get the best outcome from their point of view. And then also, as possibly was from Crowder’s point of view, too, because there’s going to be more money available for both if he’s not demonetize, right, yeah. Yeah. I mean, he may think that, well, that’s bad for his brand. Or maybe he’s playing the longer term game. And he’s thinking well, yeah, I mean, I’m all about being edgy. I don’t care about whether I’m monetized on YouTube or not. But then again, he should have appreciated that if he wasn’t monetized on YouTube, then that’s less money overall. So the Daily Wire is trying to design a contract, where it’s essentially trying to encourage him to be monetized or as monetized as much as possible so that there’s more money for them. Now Share, They Share part of that with Crowder, and depending on what the share of the total revenue that YouTube was of the total revenue that comes in from Crowder, he may well have been better off with the deal they were offering, because he was I think they’re only going to dock 25%. Well, they’re going to dock 25% If he gets demonetized on YouTube, okay, I thought this was an interesting case. And it just got me thinking about incentives and how do you structure contracts.

Tim Hughes 06:56

yeah, yeah, it’s an interesting area, because I know we talked a little bit about this. And certainly, from my experience, like, you know, if you’ve got an incentive, as an employee, or if you can give incentives as an employer to get the mix, right is the tricky thing, because you know, you want something that’s attainable, and sustainable. So if it’s too easy to get the reward, you know, the employer can lose out. If it’s too hard, then the employee loses out. So it’s a bit of a fine balance. And obviously, this is used pretty successfully with commission based work, you know, where there’s a base salary plus commission, and they’re usually done over a period of time, so they can get that amount, you know, pretty much right? And some people can do really well with that. Particularly in real estate. Yeah, well, and with salesmen, it’s a big one for sales, of course, of all sorts of industries where no sales are used. And it makes a lot of sense, you know, if you’re a really good salesperson, then you can be rewarded for that. And if you’re not so good, then, you know, you, you don’t get so much. And so sort of a fair way of doing it. So I think now, wherever possible, it makes a lot of sense to have that involvement in the company. You know, that’s, that’s properly rewarded.

Gene Tunny 08:09

Yeah, exactly. So I thought this would be a good topic to, to talk about. So in the great majority of employment agreements, I would think would not involve any performance related pay that there’s really isn’t any incentive there. But they rely upon, well, the incentive is if you do the job, then you’ll keep your job. But if you don’t, we’ll get rid of you. So I guess that’s the that’s how it works, right? And but if you can monitor how people are working, and you’ve got a good, a good eye on that you can, you’re able to properly understand the contribution output and the profitability of the firm. And in many cases, I suppose you can, you can do that. If someone’s working at McDonald’s, they’ve got a sense of whether that person is able to prepare the number of Big Macs an hour that’s required or whatever they need to do. So you can monitor that sort of activity. And in those cases, there’s no real need to provide any incentive, if they do a better job, or if they suppose they will have to meet a particular level of service or or do so much an hour. And if they do more than that, well, it doesn’t really lead to more money or more profitability for McDonald’s because basically, McDonald’s ends up serving everyone who comes in and tries to buy something off them anyway, doesn’t it?

Tim Hughes 09:39

I mean, that I know people who’ve worked in McDonald’s and they seem to have obviously it’s all about systems have completely been the leader in that kind of business for a long time. Many people, many businesses have incorporated, that whole framework of heavily systemized but of course, it means that the expectations of what needs to be done? Pretty accurate, but I think they do have, you know, opportunities to sort of move within McDonald’s. So the scale or the pay scales quite clearly set out.

Gene Tunny 10:12

You’re right. And just after I gave McDonald’s as an example, I thought I better check that McDonald’s doesn’t actually have performance related pay. Because that was just the first thing that occurred to me. But I think most of the people are working there, they’re just going to be getting paid the award rate or whatever it is, or whatever. Yeah, the agreement. But it turns out, it looks like there is some performance related pay. This is in the UK, McDonald’s restaurants put motivation and reward at heart of business strategy. So I’ll put a link to this. This is for the the top restaurants and it looks like they give a bit of a bonus a small bonus in some cases. So each month, all employees in the top 10% of restaurants based on mystery shopper scores receive a bonus of 50 P for each hour, they have worked in a two week period. Okay, so that seems that seems okay. But it’s not related to your individual performance. It’s related to how the whole store goes. And that’s probably not as strong an incentive as if it’s an individual performance pay performance related pay measure?

Tim Hughes 11:26

Yeah, and I guess put put a big part of that, because they work as teams, obviously. So to pick out an individual for having particular performance would be hard, but collectively, for that branch, you know, there might be incentives, if not, with McDonald’s with other similar kind of fast food chains. But I know, for instance, in the states, if you work in hospitality, a lot of the jobs are paid, not very much on the understanding that they’re going to receive, you know, pretty good amount of tips throughout the week. Yeah, because it’s customary and traditional to do it in most places. As I understand over there, I worked in Austria, myself in ski resorts years ago. And that was a big thing. There was you lived on your tips, it was fantastic. You know, it made a big difference. And you could save your wages, which weren’t high, because of it. Whereas in the UK, it was less likely you’re gonna get tipped, you know, you’re gonna be hungry. If you’re, if you’re working in hospitality in most places in the UK, and probably in Australia, too, to be fair. It’s not as customary here, either. So.

Gene Tunny 12:30

That is because we have high award wages, or well, maybe not high. If you’re, if you’re working in these jobs, you probably don’t think they’re that high. But yeah, relative to what you get paid elsewhere in the world, we’re doing the same job. It’s quite, it’s a bit higher than that. Yeah.

Tim Hughes 12:44

I mean, yeah, you get to the high end of that kind of scale, you get the concierge is at top hotels around the world. And who knows how much those guys make and women, of course, like in those roles of being in really flush hotels, where a lot of people have a lot of money and just dropping $100 bills everywhere.

Gene Tunny 13:04

Yeah, exactly. And I’ll put a link in the show notes to some of these articles I found on McDonald’s. So just put some clarity around exactly what they’re doing. That was just the first company that occurred to me, but my contention would be, and I think the evidence shows this as the majority of jobs out there. There’s no real performance related pay. Say, if you’re in the public service, generally not. Some public service agencies will offer bonuses, there’ll be some there’ll be some assessment of how you’ve gone through the year, and maybe they’ll pay you a little bit of a bonus. So a lot of that’s, I think that’s rare in the public. Yeah.

Tim Hughes 13:48

I would imagine it’s industry specific. So they’re probably like situations like that with? Well, certainly with government employees, where it will probably be difficult to put any of those kinds of things in place. Maybe not with all departments, but certainly with most we were talking earlier about it clearly is more suited to certain industries and others. And one of the interesting areas at the moment, because there’s a lot of people doing side hustles side gigs, doing their own kind of little business, while they’re still working for, you know, an employer. So their main employment is earning X amount of money every week, but putting time and energy into their own little gig, which is a tricky one, because like, you know, again, depending on what the work is, but if it’s not easily quantifiable, people can be putting less energy and time into their main job. So it’s a problem for the employer, where it’s like, clearly people aren’t getting satisfied from their roles or the work that they’re doing in that main job. And something that we both heard Phil Dibella talking about fairly recently was being an intrapreneur like so. Basically an entrepreneurial spirit within a company so you can be an intrapreneur and what you might be able to offer to that company. So, if a company is open to different sorts of ideas and innovations from within the company, then there might be a space and place for someone to grow within that company. Yeah. And and share their ideas and use that energy within within the business.

Gene Tunny 15:19

Yes, certainly. So if you can demonstrate that you’re, you are making a material impact on the profitability of the firm beyond your normal job, or what you’re doing at the moment and your job or what your role is, and you’ll make your contributions much greater than what you’re getting paid for, then that’s an opportunity to redefine your role to get a better better pay from your boss. And you can be this is what Seth Godin calls the linchpin be indispensable in the business you are and you can be a linchpin in your own business, but you can also be a linchpin in someone else’s. Yeah.

Tim Hughes 15:55

And of course, that that comes down to a symbiosis where obviously, the manager or your superior needs to be receptive to that. I mean, they need to be good ideas, of course, but if it’s a receptive environment that encourages that, they would need that to work. So there’s a few things obviously that have to come together. And again, that would be industry specific. And, you know, within guidelines or, you know, whatever, I think forward thinking companies can certainly take advantage of that, you know, with the event of encouraging intrapreneurship within their own company.

Gene Tunny 16:30

Yeah, exactly. So with, let’s think about the economics of, of all of this. So we’ve identified that there’s performance related pay in more sales and, and in real estate and in in other sales jobs. And that’s because it’s a way of compensating the top salespeople, and it motivates them, it motivates them to hustle or to work harder to make more phone calls or to aggressively go after properties to sell. I mean, what’s going on there? I mean, why is real estate different from, say, working behind the counter at office works or something?

Tim Hughes 17:10

I guess, with real estate, you make a significant sale less often. Whereas like with most retail, it’s going to be a less significant sale? pretty often. Real estate is a bit of an outlier, I think, isn’t it? Because depends where it is. And like, you know, it might be a handful of sales for some people who can do extremely well. Yeah. But you know, that it comes down to, yeah, just very few sales that are really significant. And, of course, are a big, dry periods. There’s not much happening in real estate. So it’s a very, up and down kind of market.

Gene Tunny 17:44

Yeah. So it’s obviously because or, or this, this is what I’m thinking is because this is so competitive, and there are big gains to the people who win, but the people who make the actual sale happen. There are big gains to to that company because of the commission that’s involved. And that’s shared with the agent, isn’t it? And that’s because it can’t just always observe what the agents doing because they’re often out and about, and it’s a job where they may have to work more than the usual hours, they often have to work after hours. There’s a lot of hustling involved, though, to get the sale. They might have to really go above and beyond and sharing the commission or having commission based pay. That’s a way of incentivizing them.

Tim Hughes 18:38

Glengarry Glen Ross Yeah. Like coffee’s for closers is the same. Is that same thing? Like, I can only imagine. I mean, I haven’t worked in that area at all. But I can only imagine it’s, well, pretty stressful. I mean, because if you’re not selling you’re not earning. And there’s a lot of jobs like that where its base salaries is either non existent, or it’s just minimal. So you really, the incentive is you have to you have to sell. Yeah, with real estate, it’s feast or famine, it would appear.

Gene Tunny 19:06

Yeah, I have to look more into that just exactly how they compensated. So if you’re a real if you’re an agent working at the Ray White, you’d be getting as a base salary, wouldn’t you? And then they’d be paid, you’d be getting a bonus or you’d be getting a share the commission that’s charged on the transaction, would you I would imagine, but I can’t say I’m not sure. I don’t know either. But I know I’ve got the sense that it’s related to that because Yeah, real estate is one of those industries where the high fliers the top real estate agents are just yeah, they’re they’re making a lot of money. Yeah, they appear to be making a lot of money. I know that having the BMW that’s part of the act out of the bottle. Yeah.

Tim Hughes 19:52

It’s definitely a regional thing as well. Like, depending on where you were, you’re an agent. You know, obviously the the margins are bigger in the The more expensive suburbs more competitive I imagined to. Yeah. But is that is that thing like sales is definitely the most common way of having incentives. And it makes sense from all sides and employers and employees, there’s a margin that can be shared. And it makes sense. If you haven’t made that sale, then the margin is not there. So it’s probably the most common one, and the fairest one too.

Gene Tunny 20:29

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 20:34

Gene Tunny 21:04

Now back to the show. The places where I’ve seen performance related pay is in consulting. So consulting firms often have a bonus scheme run bankers in banks, for their investment bankers, they’ll have a bonus scheme, hedge funds, they have bonus schemes for their for their people. And they’ll have their salary, but they’ll also be a bonus on top of that. And the idea is that if you’re a better performer, then you can get a generous bonus. And some of these bonuses can be pretty generous, like some of the bonuses that they’ll have in the City of London or on Wall Street for some of these bankers. I mean, that can be millions, millions of pounds or millions of dollars. Yeah, because a really good year. And if, if that particular banker, or trader, if they’ve done well, or it looks like they’ve performed well, like they’ve done incredibly well in the deals that they’ve signed, or on the trades that they’ve been executed. So there’ll be some link there, and I suppose why the bonuses work there to to incentivize people as well. If you’re working in that sort of industry, you’re probably you may be highly motivated by money to begin with. And so the prospect of more money is going to motivate you to work harder. And there’s also that the inability or the, it’s something where you can’t really closely monitor what they’re doing. And you’ve got to rely upon the person putting in the effort going, they’re going the extra mile, so to speak, to get the best outcome for the business or for the for the bank or for the for the consulting firm. So billing more hours getting projects done more quickly. So you can then get another project in, send the invoices out.

Tim Hughes 22:56

So actually, I mean, to be fair, this is where a lot of problems come though, wasn’t that the foundation of the GFC with mortgages been given for properties that shouldn’t have been mortgaged? And so a lot of a lot of deals been done that shouldn’t have been done on paper were worthless, and then that started the whole GFC process. Isn’t that correct? Like? Yes, yeah, absolutely. Like it was basically. And it was that incentive to yeah, get the Commission’s that was driving those deals, you know, so if, if it’s a bad deal, then yeah.

Gene Tunny 23:30

Yeah. The mortgage originators, who were signing people up. And the story was there all these people who had who were getting loans who had no income, no job, no assets, the ninja loans they called? Yeah, yeah, yeah.

Tim Hughes 23:45

Yeah. So it’s that thing of like, getting incentives right, is really important and having transparency as well. Yeah. So clearly, there wasn’t enough transparency with that.

Gene Tunny 23:56

Well, I guess the, the incentives weren’t there, they weren’t designed well, from the point of view of the of the company or from society. I mean, they it was all about the short term, it was all about, just sign as many people up as possible, right, as many loans or get as many loans approved. And regardless of who these people are, and so, yeah, it’s people who shouldn’t be getting loans. And then you’ve got the people in the bank. So the investment banks who, then they’re bundling up all of these mortgages, some of which, the people who, who have the loans, they’re going to be the first people to just walk away when things get tough, and they can’t service their mortgage, they just walk away and then this, this was part of the problem. What was happening is that all of these mortgages that weren’t worth as much as nominally they were worth they’ll be packaged up and then sold as a financial product, the mortgage backed securities and you know there were people making money out of that. The the investment bankers who were selling that to pension funds. And yeah, they were doing well in the short term. But it was there from a longer term perspective and for the companies themselves. And for the society, it really wasn’t. It really wasn’t great. Yeah, it’s terrible.

Tim Hughes 25:23

So it can see how it’s important to get all those elements, right. Clearly, there was a lot of people, I’m sure the writing on the wall was visible for a lot of people, but they’re just getting in there and doing it while they can.

Gene Tunny 25:34

Yeah, one point I should make, I think for the companies that fell over. So if you think about Lehman Brothers, and Bear Stearns, certainly what happened, those bad short term incentives did cost them in the long term. But one of the problems with the financial crisis was that some companies that probably acted, you know, that acted pretty sketchy, pretty badly in the lead up to the crisis. Ended up getting bailed out. Yeah, yeah. So and, you know, that’s, that’s a problem.

Tim Hughes 26:07

That’s a different, a different episode as well, I guess there’s a there’s a whole.

Gene Tunny 26:10

Yeah. Too big to fail episode. This is part of the problem. We’ve got that this is what happened during that episode. During that the financial crisis that’s caused a lot of the political problems we’ve had since then, I think, because people see Wall Street getting bailed out. So Bernie Madoff went to jail, but probably a lot of other people who should have gone to jail.

Tim Hughes 26:38

Well, yeah, and it’s, it’s difficult not to be cynical, when you see people getting away with, with things where, in other circumstances, people would be sent to jail. And so yeah, having being accountable and taking responsibility should be across the board for sure.

Gene Tunny 26:57

Yeah, exactly. I was just thinking team with the consulting firm example, because that’s what I know a lot better because I was working for a consulting firm before I went out on my own. Now, I mean, my pay is purely performance based. It’s just, it’s purely performance based. Rather, there’s no salary that doesn’t, there’ll be maybe I do effectively pay myself a salary, but I’ve got to generate, yeah, I’m gonna generate the revenue. Whereas if you’re working for a firm, you can the link between the work you do and the amount of money will the salary you get is indirect. There is a bonus scheme to try to encourage people to work harder. And that certainly does motivate a lot of people in consulting firms. And that can make sense, I think, because when you’re in a consulting firm, there’s a lot of extra effort or a lot of a lot of additional things you could do that it’s hard for the employer to hold you accountable for or monitor how you’re going with those things. I mean, we’re talking about well, how well are you really putting yourself out there to try and bring in new business? Yeah, how well, are you trying to get the deals done that sort of thing? How hard are you really working? How intensively are you working when you’re working on jobs to try and do them as quickly as possible, so you can bill as soon as possible, that sort of thing can be difficult to observe. And so therefore, it can make sense for some performance related pay. And so it can benefit the employer too, because they can pay you a bit less than you expect to earn if you’re a high performer, because you’re counting on the getting a bonus. So from the employers point of view, it’s they like it because okay, it’s some of the risk has been taken by the employee. And if they’re a dud, well, if or if they have a bad year, well, we don’t pay him as much. And then okay, if they make money for us, and you were happy to share some of that profit. It’s a difficult thing to put into practice, though, in consulting firms, I think, because the amount of money in the bonus pool and this is a problem with banking to what can happen is if you could have a really great year, and you could be a star, but if overall the whole firm doesn’t do well. Say the economy has a downturn, the economy, but say you might have had a great year, if you if you’re if your bonus scheme, and I think one of the problems in practice is that many bonus schemes are like this. They’re linked to the last financial year profitability or last quarter profitability. If the firm has a bad quarter or a bad financial year, you’ll suffer even though you’re a star, right? So you’ve really got to be careful how you design these bonus schemes because that sort of thing will cause resentment because the person who thought they did really well that year they’ll be mad because they had a great year, but because the firm didn’t have a great year, they didn’t get as much money. And then the other things that can happen is that if, if you don’t design your performance related pay scheme properly, then you’re gonna have all sorts of disputes between your staff, it doesn’t necessarily encourage a collegiate environment, because you may be trying to maximise your billable hours as a share of the total billable hours on a project. And therefore you might not want to bring someone else in the firm to take part in it because you’d have to share any upside with that person. And attribution. So say someone often, often there’ll be performance related pay linked to whether you’re bringing in projects or bringing in jobs. But then how do you attribute the contribution of bringing in the job? Does the fact that my cousin your consulting business, that he knows the person, he’s got a contact in the energy business and then the person there rings up Mike and says, Oh, Mike, do you know anyone who could help me out on on this job? And Mike goes, Oh, yeah, Janine over there. She could probably do it. She’s got the skill set. And then Janine talks to I didn’t give the guy in the energy business, and I did a berry berry. Berry. And then Barry goes, I’ve got this problem, I need this, this issue analysed. And Janine goes, Oh, yeah, I can do that. I can build this sort of model. And Janine does this really big pitch, she does this really great proposal, which convinces Barry that she’s going to solve his problems. And then Barry goes, Oh, that’s great. I’ll give you this big contract to deliver that. And then she goes, oh, that’s great. And then, and then Mike goes, hang on. I’m the one who introduced you to Barry. Yeah, yeah, I want 50% of that, if any profit on that job.

Tim Hughes 31:53

And Janine did 90% of the work? And yeah, it gets tricky, for sure. And I think this is where it’s industry specific. And also, you don’t want to create an environment where people are jealous, and and sabotaging other people that you don’t design it. Well, that’s exactly. So this is the thing. And I think this is where it gets industry specific. Because and this is also where intrapreneurs can help because you have to come up with your own solution, you have to come up with your best design for the situation that you’re in. There’s not one that sort of suits all.

Gene Tunny 32:25

Well, I think the best thing is, is actually to be generous. And you you win overall, you win the long game by being generous. Yeah, it’s that it’s a win, win and grand he’s got that give and take is that Adam grants thesis, I can’t remember. I’ll put a link in the show notes. But I think you do better in the long run by being generous and not being greedy.

Tim Hughes 32:49

Isn’t it one of Stephen Covey’s Seven Habits of win win? That’s, I think so. So because that’s, that’s basically what it is, isn’t it? Because, yeah, one you want it to be any incentive shall be a positive thing within a team with, you know, for an individual within a team within a department and company. Yeah. And you can have friendly competition and everything. But it’s so easily done, where it can be a negative force, you know, like, yeah, tricky, tricky thing.

Gene Tunny 33:17

And I must admit, I mean, I’d probably, maybe I wasn’t as collegiate as I should have been in jobs where I’ve had a bonus where there was a bonus scheme. And I look back on that and think, Ah, I probably wasn’t always being a team player. And I regret that. But that’s just the way it’s set up. So you got to set up the system so that it does encourage collegiality, and it doesn’t just rely on people doing the right thing out of the goodness of their heart, because when money’s involved, they won’t necessarily do that. It’s a good boy,

Tim Hughes 33:48

it’s a good point, actually, like you can design this around the behaviour that you want to encourage, you know, so if you can imagine that, it might encourage negative behaviour, like, you know, if it’s not a fair system, then you can end up with someone that happy employees.

Gene Tunny 34:04

Yeah, so I’m gonna have to try and dig up some examples of bonus schemes that work because I’ve seen various bonus games, not necessarily, I’m not necessarily making a comment on any organisation I’ve worked in. I’m talking generally about consulting businesses I’ve seen because I’ve known a lot of people who do consulting work, and I’ve heard of various different models. I haven’t heard of one that seems to get everything right. There seems to be issues with all of them. I don’t know how you design it, but you certainly have to have your bonus linked, not just to the short term results, but to the longer term outcomes, they maybe have to have it linked to profitability over several years. Yeah. which avoids the issue of well, what if someone has a great year but the whole company doesn’t do very well? And then they don’t have there’s no money to pay the bonus. And you also want to see whether, okay, maybe this person, you don’t want to pay someone a bonus if they’re actually making things worse in the long run, because they’re because they’re really toxic to work with, like, they might be a high performer, they might be generating a lot of sales or doing a lot of work. But they could be a nasty piece of work. And that’s no good for your company’s morale of other team members for your reputation.

Tim Hughes 35:19

It’s actually interesting, because it would be very hard to imagine a perfect system for any scenario. So I would imagine that any good incentive scheme would be constantly evolving, constantly being receiving feedback and, and changing because of all those reasons that we’ve mentioned, you know, like people who might just be a passenger and thinking I’ll just do as little as possible and, and try and, you know, right off the back of other people’s hard work, if it was a team incentive, you know, so it would have to be a very flexible, mobile kind of incentive system, you would imagine.

Gene Tunny 35:53

Yeah, I might look more into this. What are some examples of schemes that have done? Well, because there’s been, there must be a literature on this. So there must be people must have written about this. But what I’ve done is to prepare for this conversation, as I’ve looked up, or what is generally what does the economic literature tell us about the you know, the effectiveness of performance related pay? And? Well, as you probably expect, given that we do see examples of performance related pay out there, it must work, right? Companies wouldn’t be adopting it if it if it didn’t work in some way. And so there’s a great article on the IZA website. So that’s an institute that looks at labour market issues, I think it’s German. So the Z must mean something, mister, must be some German words, starting with Z. I could be wrong about that. I dont know why its IZA, I don’t know exactly why it’s IZA. But there are a great think tank that looks at labour market issues. There’s a great article by these two Italian academics performance related pay and productivity, I’ll link to it in the show notes. And what they find is, so the pros of performance related pay, linking paid or performance is expected to increase worker motivation, effort and loyalty to the firm, pay incentives, raise job satisfaction, lower absenteeism and turnover rates and have a sizeable effect on company performance. Right. So they’re actually finding that their review of the literature tells them that it’s a positive thing. They’re saying that this is a good point, I think the diffusion of remote work may involve a shift from input to output based compensation schemes such as performance related pay, I think it’s a really clever point. What that saying is that as more people are working from home, we really have to start thinking about performance related pay, because there’s less well, in the old days, I mean, where you had to go into the office, then that was how you were signalling your contribution of the firm, wasn’t it? That was your you were you were visibly in the office or you weren’t there. And then the boss could come and give you the tasks to do. And so I guess, just hourly base pay made more sense in that environment than if people are working at home where we’ll really when, when we’re during COVID. And afterwards, we’ve made this shift to working from home and now the boss isn’t really observing whether you’re turning up for work or not, are they they’re just they just expect you to get a certain amount of work done. Yeah. And to be contactable, generally, I mean, available. So it’s a different sort of thing. And so I guess it would force us to think more about how we could design a performance related pay scheme for jobs where in the past, maybe we didn’t have a performance related pay scheme, even though possibly they were amenable to one or they could have, there could have been a performance related pay scheme. But because of the power of debt, well, the status quo inertia, perhaps we didn’t think about that. It’s an

Tim Hughes 39:03

interesting point. Because in that situation, if it’s task based and say somebody’s working from home, it’s performance based, you’re not getting paid any more necessarily, or that might be part of the deal. But if you can do your work in six hours instead of eight, your bonus is you get two hours to yourself to do something else. So I think it’s really interesting point because I think looking at work to be quantifiable by tasks done and those kinds of things if possible, again, it’s an industry specific kind of thing, then absolutely. If you get the balance, right, where the right amount of work is fair within a certain period of time, then yeah, allows people to do that work well within that timeframe or not.

Gene Tunny 39:47

Yeah, another point they make is that digital technologies may improve performance measurement, thus improving the targeting and performance related pay. So how to think more about that in In professional services, jobs, that’s probably less relevant because you do see, I mean, you’d see the the effectiveness of their work in terms of how well, their their products or whatever they’re doing. They’re, you know, are they completing jobs on time? Is the customer satisfied? I’m not sure exactly what that points getting out there. Maybe I’ll have a closer look at the article. But I suppose if you guess you could really, you could monitor what they’re doing. If you mean, that sounds awful. But if you’re recording their screen, or their time spent on the computer, perhaps I mean, I’d hate to do a job like that if someone was doing that.

Tim Hughes 40:42

Yeah, I guess, if it’s tasks, down to what tests are being done, then you can quantify it that way. But for sure, I mean, to be fair to employers, like there’ll be employees milking, you know, the opportunity to work from home, you know, so it’ll be, it’ll be sort of a bit of give and take from both sides, I imagine as to the benefits of that. And again, industry specific, the creative industries. I know, for instance, I got a good friend who is in architecture, and that kind of industry is very collaborative. And so the value of having people in the same place and the interaction is and that energy is really valuable to that kind of industry, where you lose that when everyone’s working from home. So it does, it does have different impacts for different industries, for sure.

Gene Tunny 41:33

Yeah. So I’ll go over the cons are trying to get through these quickly. The effects of performance related pay schemes differ significantly, according to their design and the types of firms. Okay, so we were talking about before about how like performance related pay is going to make more sense in some circumstances and others in terms of the design, one of the points they make here, in the author’s main message. So they say that individual schemes linked to performance have been shown to be associated with higher firm productivity, while group performance related pay and financial participation generally exhibit smaller effects on performance. Right. Okay. It’s the individual incentive that matters. I mean, that that makes sense. Because if you’re say there’s a group incentive, there’ll be people in the group who are thinking, Well, I mean, I can end up working a lot harder. But if Jack doesn’t pull just doesn’t do work as hard as the others don’t, you know, they really don’t work any harder than I could do all this extra work, and we’re not going to get the prize anyway. So why should I bother? That’s what’s gonna happen, isn’t it?

Tim Hughes 42:42

Every scenario you can imagine will be happening somewhere. So yeah,

Gene Tunny 42:45

yeah. I mean, that’s a, I think that’s the issue, or it’s less likely that you’re the relationship between the performance of the firm, and you’re relying on the other group members to perform. Whereas if your incentive is linked to how you perform, then I think that’s more of an incentive to work harder, because it’s not, you know, it’s not contingent on the others working hard as well.

Tim Hughes 43:14

I hadn’t thought about it before. But the ultimate incentive scheme that works, the fairest is when you’re self employed. And you, you know, whatever work you you do and bring in is, that’s your income. Well, that’s the fairest of all incentive schemes, you know, and anything beyond working for yourself, like with more people just gets trickier and trickier, I guess, you know, like, there’s more things to consider as to how it might be fair. But yeah, if you’re working for yourself self employed, that is the ultimate payment incentive scheme.

Gene Tunny 43:45

Yeah, you kill what you ate. Now you eat what you kill.

Tim Hughes 43:49

Well, to be fair, if you’re gonna eat it, it’s probably gonna die in the process if you haven’t already killed it.

43:54

I think that’s what they say. You eat what you kill. Is that it? Yeah, that would make sense. Yeah,

Gene Tunny 44:00

I think so. Yeah, I’ll go with that. I’m pretty sure I’ve heard that it’s some of the consulting firms have worked in.

Tim Hughes 44:06

But it’s fair. And that would be the thing of like, you know, you you get out of it, what you put in and that’s pretty much every case of being self employed, you know, a very fair and reasonable way for for things to unfold.

Gene Tunny 44:19

Yeah, yeah, exactly. Okay. Now, some of the other cons. When pay incentives are real design, the effects can be perverse and counterproductive. And I think we’ve covered that. Yeah, about the problems that can happen. If you have badly designed schemes. People don’t work together. I mean, you could even have some people who are deliberately they could sabotage the work of others to make themselves look better. It’ll be happening, that hoard information. Yeah.

Tim Hughes 44:49

But that’s where I think the flexibility and you know giving allowing people to contribute towards these schemes, I think would be a good thing. And you can only imagine that that would make for a better scheme if people had a little bit of autonomy or choice in in how they worked.

Gene Tunny 45:08

Yeah. Another couple of good points on the cons when performance is difficult to measure or when employees intrinsic motivation is relevant, performance related pay may generate distorted incentives and have unintended consequences on worker morale. So I think that maybe that’s the case where somebody thinks that, well, I’m actually making a huge contribution to the company, but because of the way that the incentive scheme is structured, and what what it measures, so particularly if you’re in a support role, so say the, it’s the, the bankers or the consultants who are getting the bonuses, but someone who’s in a support role, maybe they’re an executive assistant, and they’re not getting, they’re not getting a bonus, because their output is less the contribution they make to the profitability, the firm’s less recognisable, then maybe they get their morale starts to suffer. I don’t know if it’s exactly what they’re if that’s what they’re driving out there. But I think the point, that point makes sense to me that the other con that they identify is that linking pay to performance may generate excessive stress and be detrimental to long term performance. Now, I guess that’s correct. So this is where you got to get the balance, right? Because if you’ve got a lot of your workers compensation linked to performance related pay is also linked to performance. So a big part of their compensation is expected to be the bonus. And their normal salaries lower than that could put a lot of pressure on them. That could create a lot of stress for the worker.

Tim Hughes 46:46

Yeah, for sure. I mean, because there’ll be, again, industry specific, but depending on seasonal, or, you know, upturns downturns in markets, you know, can be things out of their control. So there’s certainly situations where you’re willing and able to work, and there’s no work there to be done. So, you know, real estate’s a good example of that, you know, when, when no one selling well, no one’s making commission, you know, so that would certainly be, you know, relative to the real estate market. But yeah, you know, yeah,

Gene Tunny 47:17

I’ve got to look more into exactly the compensation schemes there. I thought I understood it. But when I started talking about it with you, it was clear my level of understanding was not at the level it should be. So I’ll try and clarify that. But I think yeah, that’s a good example, where there is performance related pay, okay, well not try and wrap this up. I will end with the author’s main message, their final words here. So performance related pay is a relevant policy to improve firm performance, and competitiveness. Although the adverse effects on work intensification and employees physical strain and psychological stress should not be overlooked. Looking forward, new patterns of work from home and remote work will increase the relevance of performance related pay. Yep, yep. I think that’s probably true. Because it’s not about how many hours you turn up to the office for. I mean, one of the issues I had when I was in the workforce many years ago was because I, I like to walk around. And I mean, I like to think I did a lot of work when I was working for companies, or for public service, or whatever. But one complaint, and maybe this happens in every workforce, but there was one, at least one or two times when there was a complaint made that I wasn’t at my desk enough, or I wasn’t in the office, because I was that was walking around thinking about a problem, or I was out trying to hustle. And yet, I’d be someone would criticise me because I wasn’t actually at work. And that’s the wrong way to think about it, isn’t it? I mean, it’s, it’s what you’re achieving, ultimately.

Tim Hughes 48:59

Completely, I mean, I guess, you know, that would be a good case for, you know, what work has been done, you know, and who cares who’s walking around, it’s, you know, it’s very good for you. But if you’re getting the work done, because, I mean, that’s definitely a thing where people might be busy, they might be work for many hours, but they’re not necessarily being very productive. And when there’s presenteeism, where people can be at work, and just not very good. Yeah. And especially when they’re side gigs happening, you know, because their energy and thoughts are being put to another, another pursuit. So in containing that, now, if any managers out there looking to encourage intrapreneurship, you know, this is possibly worth looking into.

Gene Tunny 49:43

Yeah, we’ll have to get Phillip Di Bella on the show to chat about that, because Phil’s just around the corner.

Tim Hughes 49:49

Yeah, he’s got a lot of good stuff. And that was when I hadn’t heard that term before, intrapreneur. But it makes a lot of sense because it’s an outlet for people who have ambition, but don’t Uh, you know, you don’t necessarily have to leave your job to have ambition. So yeah, it’s, um, depends on the culture within that company whether they can allow that to happen or not.

Gene Tunny 50:10

Exactly. Okay. Do you have any other thoughts, Tim, before we wrap up?

Tim Hughes 50:14

No, I just got to make sure that whatever I’m eating is dead before I eat it and hopefully, hopefully I can bring something in to keep me sustained.

Gene Tunny 50:20

Fanastic. Tim, thank you so much.

Tim Hughes 50:25

Thanks, Gene. You’re welcome.

Gene Tunny 50:33

Okay, I hope you found that informative and enjoyable. My main takeaway from looking at performance related pay is the importance of getting the design of the scheme right. So you actually motivate good behaviour. You end up with some bad behaviour if you don’t get the incentives right. As Tim and I discussed, on balance performance related pay schemes can be beneficial and boost overall business productivity and profitability. But that’s not guaranteed. We see that individual incentives work better when teamwork is limited, as in real estate, but they can be problematic when teamwork is required. One thing I should have noted in the main conversation is that rewards don’t have to be monetary. In a 2009 article on performance related pay, which I’ll link to in the show notes The Economist observed in their 1982 book In Search of Excellence, Tom Peters and Robert Waterman mentioned the great variety of non monetary incentives used by the excellent companies that they studied. They said that excellent companies actively look for excuses to hand out rewards. at Hewlett Packard, for instance, they found members of the marketing team who would anonymously send one pound bags of pistachio nuts to salesman who sold a new machine. That’s a bit of a quirky example, but it does illustrate that rewarding high performance and then be complicated. Celebrating wins with a team dinner or pizza night could be good for team morale. For example, I’ll put links in the show notes to articles mentioned in the episode, including to the eyes at a article on performance related pay and productivity. It’s really good and it’s easy to read. I’ll also add some links on how real estate agents get paid and on performance related pay at McDonald’s. This is how you can check out what McDonald’s has tried in Australia and in the UK. The Australian scheme does look better designed than the British scheme, because the Australian McDonald’s employees get extra benefits based on the individual performance rather than their team performance. My suspicion is that a group based incentive may be too weak to motivate performance. That said individual incentives can be difficult to apply when people have to work very closely together, and where it’s difficult to assess individual contributions. And in many businesses, teamwork is probably something you want to encourage. So it may be that you need to have a group incentive scheme of some kind, or an incentive scheme based on a mix of individual and group incentives. I’d say that you need to look at businesses and their workforces on a case by case basis to work out what’s right for that business. For now, I’d note that one of the major concerns with group based incentives is the free rider problem. Some employees may try to freeride on the efforts of other team members. However, there’s an intriguing new quasi experimental study which suggests the free rider problem may not be a big deal for some companies. The study was done by Anders Frederickson, Daniel Hanson and Colleen Flaherty Manchester, from Office University Siemens Gamesa in the University of Minnesota respectively. The researchers have written about the study in an ice at a discussion paper and an Avox EU article that I’ll link to in the show notes. They took advantage of the fact that a European dump truck manufacturer, high dreamer, introduced a group based incentive scheme and it’s planned in Denmark but not in Germany. Hence, they could treat the workers at the plan in Denmark as a treatment group, and the workers in Germany as a control group. The researchers then use what’s called difference estimation to establish that the group based incentive scheme increased performance by 19%. The researchers note that, despite free writing concerns stemming from group based incentives, being part of a group may have influence workers paid based on the performance of the group will naturally not tolerate that team members shirk, which leads to peer pressure. And team members even without peer pressure may feel some kind of internal pressure such as guilt or shame if they do not deliver in a team context. Okay, that sounds like a fair point to me. This new study adds to a small number of existing studies that actually suggest group based incentives can be beneficial in some businesses, particularly whereas there’s a close knit group which can prevent members from free riding How widely applicable is this finding? It may be too hard to say based on the limited number of studies so far, I might have a closer look at the evidence regarding performance related pay schemes and return to the topic in a future episode. But for now, I hope the discussion in this episode helps you understand the relevant issues and trade offs. Okay, please let me know what you think about this episode. What were your takeaways or thoughts on performance related pay? Do you have any experiences with performance related pay that you’d like to share? Where you’d like me to take a closer look at some of the issues covered? I was thinking that it may be worthwhile having a bonus episode discussing the methodology of the hydrangea study, as the difference in differences method can be very powerful. Let me know what you think. Feel free to email me at contact at economics explore.com. I’d love to hear from you. Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@ economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

56:43

Thank you for listening. We hope you enjoyed the episode. For more content like this. To begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags employment, motivation, performance-related pay, productivity, wages

Podcast episode

Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

Post author By Alec Krishna
Post date February 23, 2023
No Comments on Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

What are the characteristics of superforecasters? How can a superforecasting team be developed? Hear from Warren Hatch, CEO of Good Judgment, a leading global forecasting business based in NYC. Accurate forecasts from Good Judgment superforecasters have included the scale of the pandemic. In early 2020, Good Judgment superforecasters estimated the United States would have over 200,000 deaths from COVID-19 with 99 percent certainty, an estimate that was considered by many as excessive at the time. Warren gives show host Gene Tunny and his colleague Tim Hughes some valuable tips on how to become a superforecaster.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP176

The Good Judgment forecasting business [2:41]
What are the characteristics of superforecasters? [6:47]
How to identify someone who is good at pattern recognition? Raven’s matrices [9:24]
Link between subject matter expertise and forecasting ability [10:40]
What are some of the techniques that are used to help super forecasters rid themselves of prejudice and bias? [12:57]
How large does a super forecasting group need to be to be successful? [20:35]
Tips for being a super forecaster [25:59]
Using the percentages to retrospectively see how you’ve gone [27:56]
Bayes’ Theorem [31:41]
The importance of being open to a range of different views [42:47]

About this episode’s guest: Warren Hatch, CEO of Good Judgment

Warren Hatch is Good Judgment’s second CEO, succeeding co-founder Terry Murray.

Before joining Good Judgment, Hatch was a partner at McAlinden Research, where he identified thematic investment opportunities in global markets for institutional investor clients. Previously, he co-managed a hedge fund seeded by Tiger Management and was a portfolio manager at Morgan Stanley.

Hatch holds a doctorate in politics from Oxford, a masters in Russian and international policy studies from Middlebury Institute of International Studies at Monterey, and a bachelors in history from the University of Utah. He is also a CFA® charterholder.

Links relevant to the conversation

Good Judgment’s website and Twitter:

https://goodjudgment.com/ and https://twitter.com/superforecaster?lang=en

BBC Reel featuring Warren Hatch:

https://www.bbc.com/reel/video/p0dwntct/can-you-learn-to-predict-the-future-

Warren’s talk on YouTube which Gene quotes from in the episode:

What is Superforecasting? – Warren Hatch, Good Judgement

Article by Nicholas Gruen:

Making better economic forecasts

Links regarding foxes versus hedgehogs:

https://longnow.org/seminars/02007/jan/26/why-foxes-are-better-forecasters-than-hedgehogs/

https://goodjudgment.com/the-cost-of-overconfidence/

Transcript: Superforecasting w/ Warren Hatch, CEO of Good Judgment – EP176

EE_176_Superforcasting_FINAL

Fri, Feb 17, 2023 7:01AM • 47:45

SUMMARY KEYWORDS

forecasting, forecasters, warren, question, people, economists, judgement, probability, super, good, recession, models, world, economics, bias, episode, views, bayes, thinking, big

SPEAKERS

Tim Hughes, Gene Tunny, Warren Hatch, Female speaker

Gene Tunny 00:07

Tim Hughes 02:03

It was a BBC real little eight minute video, which is really good. And we’ve discussed these kinds of issues before ourselves. Gene mentioned all that sounds like the super forecasting book by Philip Tetlock and Dan Gardner. And of course, as it was, it was exactly that, you know, your association with those. And so we came full circle. And I reached out and thank you for making the time to talk in an area that we’re really interested in.

Gene Tunny 02:29

Yeah. And so to kick off, Warren would be keen to understand what’s your work, good judgement involved? What are you doing there? And, broadly speaking, can you give us some insight into how you work, please.

Warren Hatch 02:41

By all means, and by the way, it’s not just Australia with central bankers that don’t have a very good track record recently, when it comes to forecasting by any means. Our own Federal Reserve here, had some pretty spectacular misses, as well. And they’ve had to do some pretty severe course corrections. There’s, as you know, and the good judgement project itself came out of some pretty spectacular forecasting failures on the part of the US intelligence community where they had forecast weapons of mass destruction that weren’t. And then they missed 911, of course. So after that experience, they did some very deep soul searching to genuinely try and find ways to improve the forecasting skills of the intelligence community. And they ran a big competition. And as you know, that good judgement team did very well defeated all of the other university based research teams. And then four years after it started, it came to a conclusion, and they wanted to commercialise those findings. And the government, US government supports that kind of initiative as a way of showing the taxpayer dollars are being well spent. And so what we set out to do was to break down this big research initiative into smaller pieces that could be useful out in the real world. And we do a few things we do consulting for some more deeper engagements. But then we also provide a lot of workshop training. So organisations that want to improve the forecasting skills of their analysts and their teams can do so. And then we also have the super forecasters themselves, who are available to forecast on client questions. And we also have a public dashboard where we contribute to the public discourse in our way. And the questions are basically posed by organisations in the private and public sectors to improve their own decisions. Having probability estimates about uncertain events, that’s what we’re all about, is to come up with a number in our forecast rather than a vague word that lacks accountability. But then we also provide the context for those numbers. So it’s not just a dataset that we’re generating, we’re generating the stories that go along with it.

Gene Tunny 04:58

Okay, so buy in Number rather than a vague word, are you talking about a probability? So you’re saying that we are forecast is that within the next 12 months, there’s a 60% probability of recession or something like that? Is that what you suggest?

Warren Hatch 05:16

That’s it? That’s, that’s exactly the way we can frame it is, what is the probability of a recession in the next 12 months, or by a particular date? Or in different time spans? Will there be a recession this half of the year or the next half of the year, and so on?

Gene Tunny 05:32

And that’s about keeping forecasters accountable, is it and if you’re a forecaster, and you give a forecast like that, you can assess your track record, so to speak and adjust your forecasts in the future? Is that correct?

Warren Hatch 05:44

That is correct. And I am using a number it does, it does a lot of really good things. That’s one of them as you get feedback, right? So if you say maybe there’s going to be a recession next year, you’re not gonna get feedback from that. The other thing is that allows us to communicate in a shared language, right? If I say, Well, there’s a possibility of a recession, and you say, maybe there’s a recession? How do we kind of compare our thinking, how do we come up with something that reflects our joint wisdom. And that’s what this is about as having a wisdom of the crowd approach with a shared language with accountability with feedback, and a way to compare forecasts on different topics.

Gene Tunny 06:21

Okay. It’s amazing the type of work that you’re doing. So I had a look at your website a few days ago, and I saw that some of the things you’re forecasting, you’re providing advice to clients on this, you’re providing advice on, what’s the probability that Putin doesn’t survive, or like, what’s happening in Ukraine and all of that? So it’s a wide range of things that clients are interested in? Is that right?

Warren Hatch 06:46

That is correct. And what we’re looking for is the topics that affect decisions. And where there’s a lot of information and conflicting views out there, where our panel of super forecasters can take all of that publicly available information, and filter out a lot of the noise because there’s a lot of noise out there these days, and try and find the signal through their process, and then turn that in into a number on things like Putin’s future on things like Will there be a ceasefire between Russia and Ukraine? These are all quite consequential? Yeah.

Gene Tunny 07:19

And what, how do you get on this super forecasting panel? Who’s a super forecaster? What are their characteristics?

Warren Hatch 07:26

That’s a great question. And that’s something. And something to keep in mind, too, is that in the research project, that wasn’t part of the research plan at all. They just observed that in the first year, there were some people who are consistently better than everybody else. And being researchers that caused a new research question, what would happen to ask themselves? If we put them on small teams? Would they get better? Or would they revert to the mean, and they did not know at all, a lot of people thought there’d be a mean reversion, turns out, no, they continued to get even better. And so we still do the same process now with our public side, where we’ll just take within the top 1% of the forecasting population there, and other platforms to invite him to come and join the professionals and they have certain things in common, for sure, they gave us a lot of psychometric tests, hours of them before we got to do the fun stuff, you know, and forecast on elections in Nigeria in the light, and then to see what kinds of characteristics correlated with subsequent accuracy. And there are certain things that really pop out. One is being really good at pattern recognition, right? So you can think of, you know, you got a mosaic about the future that we’re trying to fill in, and see what’s coming faster than anybody else and fill in those tiles. And being good at that is a fundamental characteristic of a good forecaster. Another is being what they call cognitively reflective. And basically, that means that if you’re confronted with a new situation, you don’t automatically go to what first pops into your head, because what first pops into your head might not be right, you might be overfilling the mosaic too quickly, and getting the wrong picture. So you want to slow down in economy in terms let system to be your friend, you know, it’s hard work. But that’s the way you get a better a better result. So those are two very fundamental characteristics that good forecasters have.

Gene Tunny 09:24

Right? And how do I tell someone with good pattern recognition is that someone who maybe they excel at Pictionary or at certain games or certain board games and trying to understand how would you actually judge that

Warren Hatch 09:37

being good at Pictionary is a good quick and dirty way to do the more formal way is it’s called ravens matrices. And this comes from the UK originally, during World War Two. They used it as a way to identify people who would be good pilots during the war, because when the war first started, they went to you universities grabbed everybody put them in a in a cockpit or in a submarine. And of course, that means their life expectancy wasn’t very high. And they needed to be able to replenish pilots and submariners. And this was a way to go out to the countryside and identify people who perhaps didn’t have a formal education to an extent, but we’re very sharp, very good. And it turns out, that was a great way to spot good forecasting talent, and you can look them up to Ravens. You can see them out on the internet. And it basically what it does is it tests your ability to see different patterns and what rules there are to anticipate what those patterns will become.

Gene Tunny 10:40

Okay, I’ve got one more question. I’m gonna hand over to Tim, because I’ve just got one bill burning question. This is fascinating. What’s the link between subject matter expertise and forecasts inability? Is there any correlation? Because the best economic forecasters actually economists, for example, are? I mean, I’m guessing the best weather forecasters are meteorologists? Is it different across disciplines? Do you have any insights into the relationship between subject matter expertise and forecasting ability? Warren? That’d be great. If you could respond to that plays?

Warren Hatch 11:12

That’s a wonderful question. And what we have found, and the research shows is that there isn’t necessarily a connection between being a subject matter expert and a good forecaster on that topic. Subject Matter Experts are very good at telling us how we got to where we are, they’re also very good at asking the questions, we should be asking ourselves about the future. But they’re not always so good at saying what the probability of one outcome might be relative to another. And one reason for that is that experts, by definition, have models of the world. They have, you know, heuristics, they have shorthand, ways of interpreting what’s going on in the world. And in moments of a lot of flux, there might be small, subtle things, that their models and their expertise will just filter out as a matter of course. And by having a skilled generalist as part of that activity, then they don’t have those blinkers. They don’t have those fixed models. And they might detect something subtle that they go, Wow, this is actually something potentially quite significant. And so what we found is that rather than have experts versus skilled generalists, you have them both and and let them interact with one another on a forecasting platform, one way or another, and then you get really positive strong results we want but our favourite Boolean a good judgement is

Gene Tunny 12:48

and yeah, it’s not either, or, is that what you’re saying? It’s a no. Yeah, exactly. More crisply. Gotcha. Okay, good. Excellent. That makes sense. So just just wanted to make sure I understood it. Tim, do you have any questions?

Tim Hughes 13:00

Yeah, I do, actually. Because I remember in a little bit of research, seeing what you said about experts and skill generalists, and also the diversity in a group of super forecasters, which helps bring different perspectives to a decision, or a forecast. And I was gonna ask about the we’re all influenced by prejudice and bias, whether we’re aware of it or not. Some of it is hardwired survival biases, and, and others, we have more control over. I was interested to ask Warren, what your thoughts were on prejudice and bias and with super forecasters, what kind of techniques or if there are any sort of habits that are encouraged with those guys, to be able to rid themselves of those prejudice and bias to be able to make better decisions or forecasts?

Warren Hatch 13:53

Yeah, good question. And is goes to the foundations of what we’re trying to do. And we might usefully think of two categories of bias. There’s the kind of the bias that we all have the cognitive biases, the things that interfere with our judgments that are just built in to our wiring, right? Most people are overconfident, it just is built right in. Most people will get anchored on a high status individual, for instance, who was the first to speak at a meeting and everybody gets anchored on that it just happens. And for those kinds of cognitive biases, well, the psychologists debate a lot, whether you can eliminate those sorts of things. Some say it’s impossible. Some say there are things you can do. What we do know is that for that category, being aware of them, at least can let you counteract their effects, like being overconfident. You can measure and getting that feedback can get your over confidence in check. So if somebody asks you what your confidence about a particular forecast you might be making, you might say, oh, yeah, I’m 90% sure about that, or 90% sure about some particular fact, in the you can measure that. And it turns out, well, maybe more like 50%, right? Not 90%, right in those situations, so you can recalibrate yourself. Those sorts of cognitive biases, we can identify spot, and do at least some mitigation techniques to rein in their effects on our judgments. The other category is the kinds of biases or prejudices that we might acquire, as we live life, and we have different life experiences. And that will shape the way we interact with others think about issues in all kinds of different ways. And that can be a lot tougher to be sure to deal with, what are the two things that we can do is one, we can level the playing field so that we know as little about each other, when we’re forecasting as a team as possible, right. So if we were on a platform, we would all adopt made up names, we’d have no idea where we came from, we’d have no idea, ethnicity, or gender, or religion, or political beliefs or anything, as much as possible. And all that’s going to matter is, is the quality of our comments that we can contribute. And by doing that, we can at least hold those things at bay, we don’t eliminate them. But we kind of, you know, we put on our white lab coats when we go to the forecasting platform. The other kind is some issues are just really difficult. Because they are, they’re emotional, or they deal with very troubling topics. And that’s a difficult thing for forecaster to deal with. For instance, a lot of the work we did when COVID was was running rampant, is really tough. And a lot of forecasters just said, Look, I have a really hard time with these questions. I’m going to step aside or election questions, I’m gonna just step aside because my personal beliefs are interfering with my judgement. Yeah, the one little tool that you might do. And this comes from the head of our question team, and a super forecaster that I thought was just great to try and create at least a mental distance on these kinds of issues, is imagine you’re an Anthropologist on Mars, observing everything through a telescope, right? By doing that, at least for him. And for some others, too, it makes it easier to engage with these more emotional issues, not all the time. But it can be a helpful tool.

Tim Hughes 17:41

So a level of detachment as much as possible, and that self awareness to to not be involved from what your previous experiences may have been in those areas,

Warren Hatch 17:50

as much as possible. When you’re making your forecast. Then once you’re done, you take off your lab coat, you can go down to the pub, have a beer and just, you know, let it rip.

Tim Hughes 18:01

It’s really good. Like, because it’s come up in conversations we’ve had before. Along the same lines were softening the language around. Like we’ve had conversations around the truth. For instance, like politically and everywhere, like since the beginning of recorded history, there’s always been questions about what’s true and what’s not true. It’s certainly no different nowadays, like, we know, there’s still the same issues of like, is that true? Or is it not? And softening the language around what we consider to be true or not seems to be a good approach, which seems to be something that is adopted with using probabilities and percentages to say, the probability of something being true or not or happening or not. So that seems to fit in with being receptive to new information that may come in that allows you to change your position more freely. Is that sound familiar with what happens at Super forecasting?

Warren Hatch 18:53

Yeah, yeah. And a lot of our process is trying to think about how well do we know what we know? Right? So epistemic uncertainty, is the phrase that they that they use so and being humble about how much we really know. And being aware that there are pockets where we may not be able to quantify uncertainty on certain issues, we run up into a wall of irreducible uncertainty and we should respect that that is something that’s there and not get carried away and go beyond it. And because on that other side, there may be a different kind of uncertainty with a call Alia Tory uncertainty, right? And that’s the kind of randomness that’s just there. And we’re not going to be able to rationalise it away. It’s just, it’s sets a limit on what we can and what we can know. Now, what’s really fascinating, of course, is part of what all of this research project and a lot of what we do do is, is that for some topics, that wall is farther out than we had thought before, right? That irreducible uncertainty, that zone is maybe not as big as we might have thought. So we can quantify more than we had previously recognised. And we can also quantify it with more precision than we had been able to do so before. And putting those two things together means that we can come up with forecasts where we can have a much better informed judgement than we could before.

Tim Hughes 20:35

When you put the left code on the ego, it can’t be there as well, I guess,

Warren Hatch 20:39

as much as possible, right? Yeah, then you can only go so far, of course. But having that kind of an approach, at least gives you a shot at coming up with something that’s that’s good. And you’ll find out of course, because if over a lot of questions, your ego was actually creeping in, after all, it’ll show up in the feedback, you’re receiving the scores that you get on your forecast.

Gene Tunny 21:02

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 21:08

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Gene Tunny 21:37

Now back to the show. Warren, I’m just wondering, from what I’m hearing, it sounds like yeah, you need to it’d be good to have a diversity of views. You need people who question who act as a counter to other people’s biases? How large does a super forecasting group need to be? I mean, do you have a sort of, is there a rule of thumb you need I need at least half a dozen people, you need a dozen or you need dozens? I mean, is there a is there a rule of thumb about that,

Warren Hatch 22:06

you pretty much got a good rule of thumb is six to 12 is a good number to have, especially when you put your thumb right on it, you’ve got a diversity of perspectives and play definitely want to have people with different approaches, different philosophical views, different different life experiences, too. And they’re all bringing, you know, different pieces, right? So we’ve got that mosaic that we’re trying to fill out. And if we all went to the same schools all have the same backgrounds, we’re basically all going to be bringing the same tiles to our mosaic. What’s the point? What we want is people who have different experiences different perspectives, who can fill it out as quickly as possible to get the best possible result. And that’s one thing we see time and time again, is that working on teams is going to deliver a superior result over time. Even the best single super forecaster will not do better than a team of forecasters over time,

Gene Tunny 23:08

Ron, another question, and this will probably be my the final one I want to ask are prepared for? are you competing with mathematical or numerical modelling? Or is what you’re doing? Is that a compliment to it? Because, like I see in meteorology, for example, I think they’ve made some impressive improvements over the last 20 to 30 years, I see the huge range of data that they’re ingesting into their models, and they’ve gotten better economics. I mean, our models have actually not got any better. And if you rely upon a computerised, like a computer model for an economic forecast, you’re going to end up with something silly. So there’s always judgement involved in any economic forecasts that come out from treasuries or central banks. Just wondering how do you see the role of, of modelling? Is it compatible with what you’re doing?

Warren Hatch 23:59

Absolutely, yep, it is very much complementary. And a lot of individuals super forecasters have models that they build, and they craft and they put together. So on that side of the forecasting, process models are very integral. Also, when we put our forecast together and aggregate them, we have a model to help us do that with a machine learning element that will monitor for the accuracy of the forecast so that we can deliver the best possible signal. And then on the user side, what we create that number will go into into different models like quant funds, or regular users of our of our forecast because we’re quantifying things that they couldn’t otherwise get in the form of a number. And looking ahead, I certainly see that’s something that’s going to continue, where there’s a lot that the machines can do that models can do, and they can do it fast and they can do it better in increasingly doing the heavy lifting, that we would other why’s have to do and I love that the word computer itself used to be a person, right? When somebody would be added adding machine typing away furiously? Isn’t that a fine thing that a machine can now do that which lets the human go off and do things that the machines still can’t. And there’s a lot that the machines still can’t do when it comes to judgement when it comes to forecasting, especially how people will interact in an uncertain world. The machines are not there yet, maybe they’ll get there. But what we’ve seen in the research and the results is that right now, there’s a nice division of labour to be had, where the machines can really tell us a lot about a history of a particular forecast area, the base rates, right? So the comparison classes that we should have in mind when we’re thinking about a new situation, but then synthesising them, and converting that into something about the future is something that we do. So it’s a nice division of labour.

Gene Tunny 25:59

Yeah. When you mentioned base rate I just remembered in your, you gave a great talk. It’s on YouTube, I’ll put a link in the show notes for you mentioned, a few tips for how to be a super forecaster and one of them was starting with the base rate. So looking at, well just look at what in the population, what’s the probability that that this would occur? I think it was with Harry and Megan, I’m trying to remember if that was the example, if you’re thinking about what’s the probability that their marriage will, will last, then you know, just look at the start with a base rate for the population itself, and then go from there. I thought that was a good tip. If I remember that example correctly, and then record your forecast, compare with others, update it with new information and keep score. So look at how you’ve gone over time. So I thought they were really good tips. And I’ll put those in the show notes. So yeah, I really enjoyed that. That presentation. Yeah, no, no, that wasn’t a question. Just that observation is, that was really good. But if there were any thoughts you had on that, Warren, feel free to throw them in?

Warren Hatch 27:00

Yeah, that was a great distillation. So it’s all about process, right? And you want to have a checklist, and you’ll have your own checklist. But the five things that you just went through are really important things to have on anyone’s checklist to to come up with a better forecast, there’ll be other things that might be useful from time to time. But even just going through that in your head for a minute, right, can give you a better result, especially when things are you’re confronted with something you don’t know anything at all about. Oftentimes people will say, Well, I don’t know. It’s 5050. And they’ll say, Yeah, I’m 50%. But you know, pause, how often really, is 50% being neutral on something? Not very often. And by just going through a few steps like those, you can maybe come up with something that gets you in a better position than you otherwise would? Yeah, yeah, for sure.

Gene Tunny 27:55

Tim,

Tim Hughes 27:56

one of the things with using the percentages, I remember, hearing you say as well with, it allows you to retrospectively see how you’ve gone. So you can, if there’s something for instance, that is a regular prediction, you can then start to see how you went as a super forecaster, not necessarily yourself, but like anyone who’s trying to forecast to see how they went. And yeah, have a sort of checks and balances, so that you can see how accurate you’ve been. So an interesting thing that came up along those lines was, for instance, if your football team is 80% chance of winning a game. Our inbuilt prejudice and bias, I guess we refer to before would say, well, we’re pretty much home in house. But the reality is, there’s a 20% chance that they won’t win, which of course, is still possible. And so we we sort of edge towards what we want. And also we take something over 50% as being a bigger likelihood, then maybe it is. So it’s really interesting to sort of think in these terms. And it’s a very honest way of assessing situations. And there seem to be a lot of other benefits from approaching decisions and forecasts this way. It was along the lines of what I was asking about before, I guess. But is there a big influence of philosophy in what you do? Because I can see parallels with stoics. And I think you mentioned pragmatism as an influence in what happens that good judgement.

Warren Hatch 29:22

Yeah, and epistemic theology. Yeah, we were talking about earlier is how do we think about uncertainty, all very essential. And one other really important element is, of course, Bayesian ism, where recognising that you can better understand the world with probabilities of this sort, is something that’s very critical if you’re going to be using this kind of a process. And there are those who really genuinely believe that that approach is not useful in it for people like that, that are not going to be very good forecasters, and in this sense, but as you go around and you’re looking for tools to To help think about the world, those are very important touchstones for most people, whether they have studied formally or not, they certainly acquired a lot of those principles through experience and the feedback that they have, that they have received. So epistemology

Tim Hughes 30:17

is how we know what we know. So the other one was, did you say Bayesian theory? Yeah, so

Warren Hatch 30:23

b Yeah, Bayes Thomas Bayes?

Tim Hughes 30:25

Could you explain that one, please? Yeah, I think Gene knows everything. So. But I’m not familiar with that one. So could you would you mind explaining that one, please?

Warren Hatch 30:33

Well, gene can probably do a better job than I can. But at its foundation, it’s just that when you’re thinking about the future, that you can think about probabilistically. And you will identify different variables along the way, that would affect that probability that you have shaped that you’ve started with. So if we are thinking about if there’s going to be a recession in Australia in the next 12 months, there are things that we might be looking for along the way that would get us to update our forecasts of that probability. And identifying what those might be in advance. For really important things like that means that we can attach different probabilities to those different factors today. And then as we move forward into the future, and we find out more about how those variables are actually playing out, we can update those pieces. And that will inform our update of the bigger question as we go. How would you say a gene?

Gene Tunny 31:39

Yeah, that sounds fair enough for me. It’s an A. Yeah, it’s yeah, the Bayes is there. And there’s a good book on the theory that wouldn’t die. I might have to cover it in another podcast episode. So we can go deep on it that Yeah, I think that’s, that’s great, Lauren. Oh, yeah, really, really appreciate that. I was I was thinking of Bayes theorem, but whether I should ask you about that. But that was good that you brought it up independently. So that’s excellent.

Tim Hughes 32:05

That was gonna say it’s good. Common sense, though, isn’t it like it means that you’re less entrenched in your views, and that you’re open to change your mind, because anybody’s opinion is only as good as the information it’s based on. So as you receive more information, your opinion should be more well informed and be a better opinion. Ultimately, I guess that’s based in theory work.

Warren Hatch 32:26

Yeah. But here’s the thing is that not everyone subscribes to that view, for sure. There’s some people who genuinely believe it’s better to stick to their guns, you know, the people who are very fixed models of the world, that tell them how things will unfold. I mean, Karl Marx, not so much of a Bayesian, really. And people like Nouriel Roubini, not so much of a of a Bayesian either when it because he has a view of the world. And we and we kind of hear the same thing over and over. And this new incremental information is something that they will tend to dismiss rather than bring in and update their own views.

Gene Tunny 33:03

Yeah. And I’d target you’re familiar with the John Maynard Keynes, quote, aren’t you, Warren? Yeah, it’s a wonderful one. Yeah. When the facts change, I changed my mind. What do you do, sir? I think that was it. It’s very good.

Tim Hughes 33:17

I mean, the the tragedy with this is this is how we vote in governments around the world. And they often come from entrenched beliefs, with a lack of willingness on all sides to listen to new information. So it has a massive impact at a very individual level in how we vote. I think, you know, if we could all adopts Bayesian theory and in how we vote, then it might make give us better politicians and better outcomes.

Gene Tunny 33:44

To we might have to do a deep dive in a future episode on Bayes theorem and look into it for the intricacies of it. So we might go into that in a future episode. Yes. All right. You’ve been generous with your time has been fantastic. Do you have any final thoughts before we wrap up,

Warren Hatch 34:01

maybe a couple that might be useful, just based on what we were just talking about? One is, and this can be useful for, as we, as we think about politics, and debating issues of the day, right is that most of the time, these really important issues involve people yelling and screaming at each other. Right? It’s very adversarial. And one of the things that can be done with the sort of framework we’re talking about here is if we can get adversaries on opposing sides or multiple sides to come together and identify what are the really important things that they think would support their view, but be very difficult for the other side? What does that look like? Right? And once we’ve identified what those issues might be, we can then collaborate the ideas adversarial collaboration, and say, Okay, well, here are the things that matter for these different worldviews and And then we can, you know, let time unfold to see whose position is supported by the data by events as they unfold. But then we can take the extra step and pose those in the form of questions to a population of forecasters. And by applying that process, we can bring that future into the present and get a better sense of how those issues are going to be unfolding. From here with the input of the adversaries in a much more collaborative framework. I think that’s a wonderful approach. We’ve done a little bit of that others have to, we look forward to doing even more. And I think it can also very much apply in the world of economics, where there are very strident competing schools about what causes recessions. And so let’s get the Keynesians and the monetarists together to have some collaboration in that way, engage on a real world issue, like what’s the probability that there’ll be a recession in Australia in the next 12 to 24 months is a wonderful thing to do. The other thing that I think are useful to maybe think about is economists themselves, why they don’t do better. And I think one reason is that many of them continue to practice their craft, using state of the art techniques from the 19th century, in the way they model things and think about things and exchange things. And the sort of process that we’ve been talking about here, much more dynamic, much more nimble, and much more team based might be really interesting. So for instance, it’d be really, I think, potent, to do a survey of economists about the probability of a recession in the next 12 months, where we just take their snapshot like all these surveys already do. But then put them together and have them compare notes and probe one another’s reasoning. Yeah, and have an opportunity to update as a result of those different views, even anonymously. So their official forecasts could still be the same. But they could have kind of a informal forecast that they make through this process with kind of a shadow version of themselves. And I’ll wager that the number that comes out of that informed crowd is going to be better than any one single economist, Rod.

Gene Tunny 37:31

Yeah, that’s a good idea. I mean, we do have the economic society runs a poll of economists, but I’m not sure it forces them to give answers in a consistent numerical format on these questions where they are asking a question like that. So yeah, I’ll have to have to think about how that could work. Have you seen that work in economics or any other discipline anywhere in the world? Warren, that type of approach?

Warren Hatch 37:54

It’s happening at organisational levels. Okay, that’s, so we definitely see that, where were the things that are important to the organisation, they’ll use that kind of a framework to think about things, we also do it on our public site. And that’s one way to do this is that they could all just go and invent names, Mickey Mouse, whatever, and make a forecast on that very question on that platform, completely anonymously, and see how they do. The other thing, too, that I think is really interesting, is that often it’s rare, where even the word recession gets defined with some precision. Yeah, so one problem is that we all interpret it in different ways. We think of different thresholds, different, you know, different ways of defining what it is. So right from the starting gates, we are forecasting different things, and just having a shared understanding of what that means itself would do a world of good.

Gene Tunny 38:55

Yeah, exactly. I mean, there’s the is it two negative quarters of GDP? And I mean, you can get some odd results if you use that or is it is that the NBR declaring a recession? Yeah, you have to be very specific. I think that’s a good point. I just want to ask about the organisations that are doing this is is one of those organisations is it Bridgewater Ray? Dalio is Bridgewater, I’m trying to remember I read that in his principles book that he, he really tries to get people to be very specific and about what they’re forecasting or predicting.

Warren Hatch 39:26

They definitely do. They don’t work with us. But they’re doing it on their own. And obviously very successful at it by applying a lot of the same things that we’ve been talking yeah, here with with a lot of rigour

Gene Tunny 39:39

I might have revisit that book and just check whether that’s what exactly what they’re doing, but it just, yeah, it rang a bell in my mind that Oh, is that what Ray Dalio is doing? Because he’s very rigorous about in his thinking and questioning his judgement because he got something spectacularly wrong in the 80s and it almost destroyed I think it just destroyed his business at the time and so he learned a big lesson from that. Yes, yes. Okay,

Tim Hughes 40:03

wasn’t it 11 economists predict 11 out of seven recessions is that right?

Warren Hatch 40:13

Yeah, that was a great quote from an economist. Samuelson was his name. And he was writing in Time magazine in the 1960s. And and he that’s when he made that statement, that economist, I think it’s have predicted nine of the last five recessions and the ratio holds.

Tim Hughes 40:33

That’s, um, I love the idea of adversarial collaboration. I think that’s such a smart way to go around things and get better outcomes. And I think there’s so much to take from this. For everybody, like, way outside, the area of forecasting just seems to be a way to be a better human and to a good way to approach life. But so yeah, I’d really like to hear more about that. As you guys do more of that. We’d love to speak again, on the on that regard.

Gene Tunny 41:02

Yeah. Yeah, it’s been terrific. Warren, we really appreciate your time. So I’m really happy with that. And yeah, just incredibly grateful and excited. That was a really learned a lot. And I think it looks like you’re doing some great work there in the methodology or makes all makes sense to me. And it’s, from what I’ve seen over the years, I’ve understand why I’m thinking, why I’m forecasting or predicting certain things or what could be wrong with that question and trying to get other opinions. So yeah, and partly those because I read Philip Tetlock book, partly because I’ve seen the problems we’ve had with forecasting financial crises and recessions in the past. Yeah. So all great stuff and keep up the good work and really appreciate your time.

Tim Hughes 41:47

Just to finish off, I just want to say So one good judgement does work for people, if they want to work on a project, they can approach you guys how to how does that work? Warren? Is there a particular areas you guys work in? And how do people contact you.

Warren Hatch 42:01

So the way to contact us is we can just go to our website, good judgement.com And reach out there. And we do we do consulting work on projects, where organisations may want to bring in some of these things and customise and adapt their own processes. They may also just want to have training workshops. And we do an awful lot of that, especially in finance and economics. That’s a big part of what we do globally. And the third thing is the super forecasters themselves, where we’ve got a subscription service on a lot of topics that are nominated by the user. So it’s a crowdsourcing of the questions as well as the crowdsourcing of the forecasts, as well as doing custom question work for organisations, as well. And I very much look forward to that.

Tim Hughes 42:50

Once I get going. It’s hard to get me to stop. You’re in good company at all,

Warren Hatch 42:54

I’ll look forward to to picking it up again, in due course, and perhaps even meet up. I’m working on a way to do a project over in your neighbourhood.

Gene Tunny 43:03

Oh, very good. Yes, definitely. Yeah, we’re in Brisbane. Yeah. If you get up here, that’d be great. So if you have an event in Sydney or Melbourne, just let us know. So yeah, we’ll have to talk more about that. Yeah. Good one. Yeah. Well,

Warren Hatch 43:16

we have super forecasters in Australia, including a couple in Brisbane.

Gene Tunny 43:20

Oh, very good. Okay. I wonder if I know them. It’s a it’s a little secret. Is it so hush, hush.

Warren Hatch 43:28

Ah, no, no, I’ll put you in touch with a male.

Gene Tunny 43:31

Very good. Yeah. Be very interested. Orrin Hatch from good judgement. Thanks so much for your time. We really appreciate it.

Tim Hughes 43:37

I predict that we’ll have another talk in the not too distant future. Okay,

Warren Hatch 43:42

I look forward to it. Thank you, Tim. Thanks. Good. Thanks, Ron.

Gene Tunny 43:51

Okay, I hope you enjoyed our conversation with Warren hatch from good judgement. To me the big takeaway from the episode is the importance of being open to a range of different views. Think critically about your own forecasts and be open to changing them if you hear someone making a compelling argument for a different forecast. I really want to put some of Warren’s ideas into practice, including the idea of a super Forecasting team. It wasn’t explicitly mentioned in the episode. But one important concept is the wisdom of crowds. good judgement is relying on groups making better forecasts collectively than any one individual. But as Warren mentioned, you need to set up a process or a forum for doing so which is meritocratic, so the group’s forecast is only influenced by the quality of arguments presented rather than by any biases. I must say I was glad that Warren said there is still room for numerical modelling as an input into super forecasting. I really liked his advice about the importance of getting subject matter experts and non experts together to come up with better forecasts. One thing I wished I’d asked Warren about is the distinction between hedgehogs and foxes. This distinction comes from the philosopher Isaiah Berlin. According to Berlin, the fox knows many things. But the hedgehog knows one big thing. Philip Tetlock who popularised super forecasting, he’s observed that foxes make better forecasts than hedgehogs. Someone who’s more widely read and thinks more creatively can be a better forecast. And then someone who has deep expertise in a field but who doesn’t take in a lot of inputs and views from outside of the field. This reinforces the needs to be open minded to think critically about your own thinking and to actively seek out other views. If you’re a subject matter expert, you need to make sure you’re open to other perspectives, and that your thinking isn’t constrained by the conventional wisdom of the discipline. Arguably, this was a problem for many economists in the lead up to the 2008 financial crisis. In my view, economists need to go out of their way to become more like foxes and hedgehogs. I’ll put some links in the show notes about the foxes versus hedgehogs distinction, along with links related to concepts covered in our conversation with Warren. One of the links is to a great article making better economic forecasts by my friend and colleague, Nicholas Gruen, who’s appeared on the show previously, next, a big fan of the super forecasting approach, and he wants central banks and treasuries to adopt it. In his article, he also writes about the potential benefits of running economic forecasting competitions. So please check out that article of next for some great insights. Okay, please let me know what you think about this episode. What were your takeaways? Would you like to learn more about Super forecasting? Would you like a closer look at some of the things covered in the episode such as Bayes theorem, feel free to email me at contact at economics explored.com. I’d love to hear from you. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

47:32

Thank you for listening. We hope you enjoyed the episode. For more content like this where to begin your own podcasting journey head on over to obsidian-productions.com

Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.

Tags economics, forecasting, geopolitics

Podcast episode

Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Post author By Alec Krishna
Post date February 18, 2023
No Comments on Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Australian Treasurer Jim Chalmers argues for values-based capitalism and against neoliberalism in a January 2023 essay in the Australian Monthly magazine. In this episode, show host Gene Tunny discusses the Treasurer’s essay with Dr John Humphreys. John is the Australian Taxpayers’ Alliance (ATA) Chief Economist and the founder of the Australian Liberal Democrats. Gene and John discuss just how literally we should take the Treasurer, the risks of the so-called co-investment approach, and whether the Treasurer is arguing for socialism (or a different -ism).

This episode features audio from an ATA Econ Chat livestream broadcast on 31 January 23. You can watch the whole thing here:

https://www.facebook.com/AusTaxpayers/videos/509950911277607

You can follow the ATA on various platforms including Facebook and YouTube.

You can follow John Humphreys on Twitter.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP175

Jim Chalmers’ idea of co-investing with the private sector [4:21]
Regarding superannuation funds increasingly having social goals that they aim to meet as well as financial goals [9:12]
The Australian stage 3 tax cuts and values-based capitalism: are they compatible? [12:37]
ESG, stakeholder capitalism, and socialism [15:24]
How does the Treasurer intend to direct investment? [23:28]
How a poor government policy can lead to another poor government policy [27:31]
The social impact investment bank expected in the 2023 Australian budget [32:34]

Links relevant to the conversation

Jim Chalmers’ essay Capitalism after the Crises

Clean Energy Finance Corporation Financial Outcomes 2021-22

Australian Government principles for social impact investing | Treasury.gov.au

Impact Investing Won’t Save Capitalism

Transcript: Values-based Capitalism: What is the Aussie Treasurer planning? w/ John Humphreys – EP175

Gene Tunny 00:06

John Humphreys 09:12

Interesting points on that today. I think this is part of the problem that we’re sneaking up on the situation several ways. Super funds increasingly have social goals that they need to meet, as well as financial goals. You make a good point that, well, that needs to show that they’re going to meet the financial needs of the super investors. Increasingly, the super funds feel the need to meet their social KPIs, rather than their financial KPIs. And if they are required to meet social KPIs, then they’ll very easily get away with it. Remember, it’s not like this super is optional. We’re forced to give it and if the government gives the super funds who have guaranteed access to our money, social KPIs, you must do something social. By the way, here’s something social we want you to do. You can imagine it happening, even if it doesn’t have financial risk. I think the point Nick can correct me if I have not expressed her concern accurately, please jump into the chat again, Nick. But that’s my understanding of your point.

Gene Tunny 10:09

Yeah. So the whole thing with this values based capitalism, one of the concerns is that you end up with this very odd relationship between the government and banks and super funds. And in a way, it’s very odd for a Labour leader or an aspiring Labour leader. And this is a point that Matt Canavan made that he was very critical, as you probably would expect of this sort of thing. And I mean, he was saying that the treasurer seems to have been spending too much time in the boardrooms of banks and super funds. So yes, it’s, it’s very strange, but what I think might be going on, and this is, this is one thing that I’m wondering is, is this because he really doesn’t have many other options due to the state of the budget due to the high amount of debt, and due to the fact that he’s committed to the stage three tax cuts? Katherine Catherine Murphy on the Guardian podcast asked him, Okay, if you’re talking about values based capitalism, does this mean or she, she was basically asking me if you actually, given what you’re professing about values based capitalism and your concerns about inequality, etc? Does this mean you’d revisit those stage three tax cuts? And other there was a good question, and he just gave the standard line? I look, we’ve already dealt with that. And we’re, you know, my position on that. I think she probably could have pressed him more on that because it is a legitimate question, if in terms of traditional Labour government, some people have been saying that with this essay, Jim Chalmers is channelling Whitlam or it’s going back to the Whitlam government, I’m not entirely sure about that, because the Whitlam government was big spending on social welfare programmes, I really ramped that up. I mean, I know now we are spending more on that sort of thing. But there’s, I don’t know if there’s a capacity for this government, given the fiscal situation to really increase those welfare payments, or expand the welfare state much at all. And so he’s really falling back on this sort of thing, because he may not have any other option. And to an extent, that’s because the government’s had to go along with the stage three tax cuts for political reasons to win the last election. And now they can’t go back on it. So you know, this could be the only shot he’s got in the locker, so to speak. That’s one thought I’ve had on this, this essay.

John Humphreys 12:47

It will be interesting to see what they do in the next budget in terms of tax, I suspect, I’ll sneak that tax rate up, they are going into that. Look, I think that was politically hamstrung with their previous commitments. And quite frankly, I think they made the right decision to stick to their promise, both because I’m a big advocate of the stage three tax cuts, but also politically, if you want to keep any political capital, you can’t just line up lie after lie after lie in your first year in power. So I think it was the right political move and the right economic move. I suspect they also know it’s the right political move. They think it’s the wrong economic move, but they’re stuck with it. And so I’m happy about that. You’re not just a couple of quantifications. I haven’t thought about this article as long as you have, but I think you’ll write in one very important point. There’s been a lot of furor about the words. And I think the words of what Jim says, if taken literally, we shouldn’t be worried if they can, literally. But you pointed out, I think that it’s not necessarily true that we should take it literally, because there’s a lot of fluff and waffle in the middle there, that could be interpreted multiple ways. And to a large degree, what we have to do is go back to them and say, what does that mean, exactly? Exactly what I’m suggesting here. And I suspect what’s happening is there’s two things it’s worth responding to both. I suspect he’s the policy recommendations coming out of this, I suspect will end up being tinkering. I don’t think it’d be good tinkering. But this is probably a lot of grandiose statements. I’m not sure if they’re going to follow through on grandiose actions. I gotta say, as I say that, if I’m right, that would be a good thing. Because if they followed through on all the grandiose statements, I think it would be a supreme mistake for the future evolution of our country. So I am hopeful that this is a lot of bluff and bluster. But also if history is anything to go by, politicians are often full of bluff and bluster and grandiose statements. And then once they actually sit down and work out, what does this mean? It can be a tweak here and tweak there.

Gene Tunny 14:46

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 14:51

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Gene Tunny 15:21

Now back to the show.

John Humphreys 15:24

I do worry about them targeting the super funds, I do worry about what they when they say race, it just sort of interaction cooperation between the government in the corporate sector, that could be done in several different ways. Some of them supremely damaging, and some of them rather mild. And some of them perhaps useful, we really need to know the details first, but I worry that what he’s talking about is not the mild version. But hopefully what he does is the mild version. But what he’s talking about here has echoes of a lot of things that have been growing over the last couple of decades. Some people have actually said it in the chat and see if I can find some here. I think Percy said this twice. It’s the ESG goals. A lot of the language here is also the language of ESG, the environment, the social and governance systems. And it’s steadily in being embedded through several different means fair and foul into the goals of a lot of companies sometimes basically being shoehorned in there by governments, sometimes by industry super funds, which as was also pointed out by Percy, I think, that they are closely related to the union’s so you are getting lots of deviations from normal capitalism for ESG. Another term that’s been thrown around a lot by people that are it looks like Jim Chalmers is influenced by the stakeholder capitalism, and stakeholder capitalism, it sounds so benign, but if you scratch the surface, it’s a very worrying idea. The whole point of capitalism is that corporations are supposed to represent the owners and benefit the owner, it is capitalist who make a profit and the profit goes to the people who made the investment. That’s the idea. Stakeholder capitalism basically means all you know that ownership thing we told you about, yeah, not so much. Right? I mean, you don’t have to be an owner to have a stake, you could be a consumer, or a worker, or a neighbour or just anyone with a pet dog that ran across someone’s front yard. And that basically means society, if society is the owner, where that’s not a real thing, right? That’s always code word for government. If society is the owner of the business, i.e. government is the owner of the business. That does not, that system and economics does not have a good track record at work. There’s a couple of things here. The Chalmers thing has been likened to out and out socialism. I don’t think that’s quite right, because what he’s talking about is this incestuous relationship with big business and big government and big unions. And now socialism, just what’s the leaders of big business up against the wall, shoots them and takes their property. This is like traditional socialism. It’s been likened a bit to Whitlam. And you already mentioned that before, but it’s not quite that either. Because what Whitlam wanted to do was have the government take over all of the realms of how you help the massive welfare state, massive redistributions. He’s not really talking about changing the welfare state. He’s talking about changing the way business operates. So it’s not quite socialist. It’s not quite Whitlamisk, what I call it an eco socialism. It’s instead, this incestuous mix of big government, big corporations, big unions, and we need another word for that. There was a word for that this is not a new idea. This is the thing I’m seeing showing up by some of the op ed writers look at this wonderful new idea. It’s not Whitlam. It’s not Marx, it’s a new idea. It’s actually not a new idea. These ideas have been around for quite a while they were quite prominent, about 100 years ago. I believe, Jim Chalmers is the follower of an Italian economist at the moment. These ideas were very popular amongst a certain Italian politician. From about 90 years ago, if anyone knows their Italian history, El Deus, the Mussolini ideas were basically exactly this. But we don’t need to get rid of business. What we do is we need to have a really close relationship between big government, big business, big unions, we all work together. It may be better than for more efficient for socialism, but it’s a bloody dangerous system. And of course, if you actually call it fascism, everyone gets upset because they say no, no, no, Jim Thomas doesn’t hate the Jews. But fascism isn’t only the economic system of fascism isn’t just about being a Nazi. The economic system of fascism was quite literally the idea that big business can exist, but they just have to cooperate in bed with big government. That was literally the idea of the fascist model of the economy. And it’s not a new idea. I don’t think it has a good track record is actually working as an economic idea. And I’m not trying to say Jim Chalmers is a fascist, I’m just simply saying that we can look at how this has worked in the past. And I don’t think it’s been pretty. The other thing to note about this is they talk a big game about how much they want to cooperate with big business and integrate with them. It’s as if they that they’re unable to draw a distinction between the markets and a business. Right. I mean, most people on my side of politics we believe that a market is a better way of cool donating things, then bureaucrats and politicians. That’s true. That’s not from a love affair with business. Indeed, business are often also the enemy of markets. Like I am not pro business, I am pro markets and markets happen to have business in them. And it seems when a lefty stumbles across this idea and sees markets working, they think markets work, because there’s a couple of nice businesses. So they Co Op those businesses. But it’s not the existence of those businesses that make the market work. It’s the nature of the dynamic nature and the competitive nature of the market. That helps the market system to work. And sometimes a good market needs businesses to fail. If businesses make enough bad decisions, they fail this idea that markets defending markets are about defending businesses. Some people on outside of politics need to get out of that way of thinking, bad businesses should fail. We’re not here to defend businesses, I’m happy to defend people who make good decisions and get ahead and are rewarded for that, whether they are in any field of Endeavour. But it’s not just about defending businesses. And this approach the Chalmers has seems to be pro business anti markets, whereas I am pro market and indifferent to any individual business. And that’s some of the things I do notice in some of his language. He talks about redesigning markets, and that markets need to be carefully constructed. So I think once again, that shows a fundamental misunderstanding of what we mean with markets. Markets are evolutionary concepts. They’re not design. They’re not constructed at all. They happen sort of spontaneously out of the interaction of a bunch of voluntary interactions between consenting adults, it is a it is an evolved system. And one of the most dangerous things we have is these politicians that lack the humility to realise that they can’t design such a complex system meddling in a hugely complicated evolved system that is probably beyond their capacity, it’s beyond their can to actually understand the dynamics. It’s beyond the understanding of most people. Leonard Reed famously wrote a book saying no one knows how to, it’s called “I pencil”. And he pointed out that no one knows how to make a pencil, seems like a crazy statement. But if you unwrap each part of making a pencil, someone has to know how to cut down the wood, which means they have to know how to use a chainsaw, which means they have to know how to make the chainsaw, which means they don’t have to know how to get the metal for the chainsaw, which means they have to know how to make the iron, which the steel which comes from the iron, which comes from the mining. So you go back through all the parts of making a pencil, no one person can do it, but it comes together spontaneously, seemingly spontaneously without any central controller. That’s the important point. There’s no central controller in that. And yet, you can go and buy a pencil now for 10 cents. It involves the cooperation of literally 1000s of people around the world who speak different languages, and may not even like each other, they may hate each other. And yet 1000s of people around the world all coordinated and managed to bring you a pencil at your local store for 10 cents. That is insane. And there is no controller. It wasn’t designed, it wasn’t carefully constructed, as Jim Chalmers seems to think, it was a spontaneous order coming together. And that is the dangerous thing. I think there is when these politicians decide that they need to redesign markets in their own image. And often they have wonderful goals, right? I mean, their vision of the world, that vision of the future is not some dystopian nightmare. That’s just the accidental byproduct of their arrogance and their lack of humility. So anyway, that’s my rant on this. Now, I haven’t spent as little thinking about it as you, so maybe I’ll have to duck into it a bit more over the next week.

Gene Tunny 23:28

But I want to have a closer look at just what these vehicles are and how they intend to direct investment. I mean, he talks about, well, we’re not going to pick winners. Okay, that’s great. Oh, but we’re just gonna set the priority. So it’s like this state directed model that the French had, I think in the 50s or 60s, I wouldn’t call it fascism. I’d call it corporatism, or, or whatever the French used to call their system back in the day, the government’s got an idea of where the investment needs to go broadly. It’s sort of national economic planning. That’s the type of mindset and one thing I’m waiting to see is will they try and revive this idea of an infrastructure bank? So this was something that was raised during the time of the Rudd Government but got knocked down. Turnbull criticised Kevin Rudd has been Kev Lonnie, with reference to Kim Lonnie and there was the people were talking about well is this gonna be the new transcontinental I don’t know if you remember it was it transcontinental, the tri-continental, the, the Merchant banking arm of the state bank of Victoria that went bust in the late 80s. Victoria, when it just got into, you know, just made all these crazy loans during that, that colossal boom in the late 80s. There’s a real risk to government balance sheets here, and I just want to wait and see just what they’re proposing. And whether there is some bold scheme like that, that the treasurer could be announcing. That’s what I’m going to be looking out for.

John Humphreys 24:58

I think on the retail politics that is the right thing to look for I should reiterate, I don’t actually think Jim Chalmers is intended to be a fascist, because I don’t think he intends to follow through on the logical consequences of his own article. But I still think it’s worthwhile pushing back on the substance of the article, even if I don’t think you’ll follow through on it. I don’t want people to think of it as an ideal, because I still think the ideals in there are very dangerous. And look, I also take your point, in reality he’ll be whether it’s fascism, or corporatism, it’ll be a watered down version of that. And we need to see the details I agree. But still, the steel man version of that is worth addressing, in case it seduces the thoughts of any young people that stumble across these ideas. You make a good point that perhaps corporatism is the better word for it than fascism. I’ve thought about that a bit lately, that could work. I wonder though, whether there is a difference between the two, they both involve this incestuous relationship of big business and big government. Perhaps the difference is who has the upper hand. And I think in corporatism, perhaps the idea is that big business has the upper hand, and they kind of use big government as their tool for success. And in fascism, it’s the government has the upper hand, and they use big businesses, their tool for enforcement, or getting things done. But anyway, that’s a thought bubble there on what the potential difference could be. I don’t know which one Jim Thomas hopes he would achieve. Probably not corporatism. But I’ll cheekily put that aside for the voters. What he

Gene Tunny 26:17

wants to achieve is he wants to get enough votes from the labour left by imagining he’s can remake capitalism, where, really, he’s going to get some he’s going to create some investment vehicles. There’ll be some additional money into into renewables and housing. But is it really going to make much of a difference? And I don’t know, I mean, in housing that, you know, that’s one of their big challenges. I mean, that housing affordability is a massive problem now. And the number of people who can’t find accommodation, particularly in Brisbane, I mean, I go for a walk along Wickham terrace in Spring Hill. And I mean, the usual homeless people, you see, but now you see there are people living in cars, they’ve got all their worldly possessions, in, in the back of their vehicles. And it’s just tragic. And it’s because for years, we’ve just stopped people from building houses where people want them. So we’ve got, we’ve got problems that have been created, in part through government regulation. And now that’s going to be used as one of the excuses for remaking capitalism and providing, I don’t know, whatever, they’re going to do subsidised housing, there’ll be some money for that social housing, but it’s not really going to be enough to solve the problem, in my view.

John Humphreys 27:30

But it’s so often the theme, isn’t it? A government programme goes wrong. And the lefties turn around for capitalists to say, Why did you do that? And then they use that to justify another government programme that also goes wrong. And the whole cycle repeats itself. I do like the fact that every time I try to get us distracted in a conversation about the grandiose philosophy of the implications of Jim Chalmers article, he brings us back to the real retail politics, which I think is entirely correct. I think your read on this is true that his grand philosophical statements, they’re mostly just fluff and waffles so that he can try to get the Labour leadership and it’ll mean a bit of tinkering. I think you’re right. I just still enjoy rebutting the actual words. Anyway, that this has been a fun discussion.

Gene Tunny 28:13

Definitely John. Okay, I hope you enjoyed my conversation with John Humphrys about the Australian treasurer’s essay on values based capitalism. I’d say the takeaways from the episode include firstly, that there’s clearly been a big change in the intellectual climate since the financial crisis, and treasurer Jim Chalmers has picked up on this making some of the standard criticisms of so called Neo liberalism. Secondly, it’s important to consider specific policies and to weigh up their costs and benefits and the likelihood that claim benefits will be achieved in my view. If we do so it’s understandable why there’s been such a negative reaction to Jim Chalmers essay by economists and financial commentators here in Australia, I should say, I don’t want to be too negative. I have met Jim Chalmers in the past when he worked for treasurer Wayne Swan, and he struck me as a nice person. He clearly thinks a lot about economic issues, and I respect that. And the treasurer did say some say on things in the essay, for instance, he writes, in the wider world, the contest between democracies and autocracies is economic as well as military. Despite deep disquiet about our own economic models. The reality is that democracies largely work. As of 2021 GDP per capita is around 60%, higher in democracies than in autocracies and the gap isn’t closing. Thankfully, Chalmers is a Social Democrat rather than a revolutionary. But he argues that to protect democracy, we need to have greater economic inclusion. That’s fair enough, but we need to think critically about the measures he proposes to promote it. obvious questions include, will they actually achieve greater economic inclusion, what will they cost? What are the risks to the government’s balance sheet and to taxpayers who will ultimately bear the cost of any bad investments? As I suggested in my conversation with John, history tells us we should be wary of governments owning banks or other financial institutions that don’t have a great track record. The failures of the state banks of South Australia and Victoria were big news in the early 90s. But now three decades have passed and the lessons may have been forgotten sadly. Also, as I noted, when chatting with John the results of the body that the treasurer calls a great success, the Clean Energy Finance Corporation, well, they’ve been pretty ordinary and they don’t appear to be meeting the target of return. The presentation of the financial results for the corporation is rather confusing, but it looks to me that they’re underperforming. I’ll put a link in the show notes so you can see for yourself. One thing I should have covered in my chat with John is the concept of social impact investing. This is an investment where there are both financial and social returns, such as in a profitable social housing development. Social impact investing is one of the concepts that Jim Chalmers is fond of. In a recent financial review article, John Keogh referred to an example from New South Wales in 2013, a social impact bond which raised $7 million from investors to finance the new PIN programme. N E W P I N. New PIN stands for New Parent Infant network. It appears to be a programme to support new parents so they look after their children properly and the children don’t end up in foster care. It looks like the Queensland Government has tried something similar. Typically, impact investments require government involvement of some sort to ensure that the private sector investors get a return. For instance, governments could pay performance bonuses if certain social outcomes are achieved. There’s a handy note from the Treasury which summarises the Australian Government’s principles for social impact investing, which I’ll link to in the show notes refers to such things as payments by results, contracts and outcomes focus grants, that’s how the investors will be rewarded if the investment achieves its social objectives. These payments could be justified because successful programmes could result in budgetary savings in the future. For example, if programmes result in healthier children, that could reduce health costs in the future. You could also imagine programmes resulting in savings in welfare spending, or cost of the justice system. I’d say that such savings are possible, but we should think critically about the likelihood of such benefits and follow up to make sure that they do actually occur. That is, so we’re not paying nonprofits and investors additional money for results that they don’t actually achieve. It looks like treasurer charmers might end up announcing a social impact investment bank in his next Australian government budget in May 2023. James says that the Financial Review gave a good summary of what this bank could do in an article in October last year, which I’ll link to in the show notes. He wrote, the new body would work with investors to supply capital to intermediary funds, which would direct private investment into social housing, aged care, early education or disability services alongside government funding. This could take some pressure off the government budget for providing these services alone. Okay, that’s the point I made in my chat with John, that some of the motivation for what Chalmers is proposing is the poor state of the government budget, they just don’t have the money to undertake traditional programmes. He’s talking about impact investing because he doesn’t have a lot of options. With his social impact investing bank, he can support things that he wants to do off budget, so to speak. James Ayers continues, the institution would make returns when service providers who would typically be receiving some government funding make predetermined improvements to social outcomes such as housing, education or caring for more people under agreed service standards. Apparently, there’s a body like this already in the UK called Big Society Capital. There’s a fair bit to explore with impact investing, so better return to it for a closer look at a future episode. There are a lot of players involved and I’ll do my best to get someone familiar with impact investing on the show for a deep dive. In the Australian model, it looks like there’ll be a government backed social impact investment bank referred to as a wholesaler. Major commercial banks could also provide capital for this bank. It appears based on reporting from the financial review. There’s talk about 200 million coming from the government and 200 million from the private sector. I expect the social impact investment bank will provide finance at lower than market rates for social impact investing funds. These funds then invest in nonprofits or so-called Social Enterprise causes which are delivering programmes under government contracts. An example of a social impact investing fund is the $91 million social impact investment trust, established by social ventures Australia, a nonprofit and Hester a superannuation fund. How the performance bonuses are shared by the nonprofit, the investors and the government back bank will need to be defined by various contracts between the players. This all seems very elaborate to me. There are no doubt a lot of investment bankers and fund managers earning healthy fees along the way. Does this lead to better results? It may do so if the investors push the nonprofit to deliver superior services. As always, I’m open minded but sceptical. I’ve seen that the consultancy firm Airbus has undertaken a positive evaluation of the New South Wales new ping programme. So it could be good to go through that in a future episode. I haven’t had a real chance to dissect that one yet. I do wonder just how much we can rely on impact investing to solve social problems compared with other measures. As I noted with John, I doubt it will solve the housing availability shortage, which to me appears related to restrictions on housing developments. And it’s not going to replace welfare state programmes such as Australia’s various support payments and the National Disability scheme. Maybe you can do positive things at the margins, we have to wait and see because it’s still early days when it comes to impact investing. For a sceptical take on impact investing, which I’ll link to in the show notes, I’d refer you to a 2020 Harvard Business Review article by Ruben Finnegan, who I know well and Alan Schwartz is a prominent Australian businessman. Impact Investing won’t save capitalism. Okay, that’s all from me on values based capitalism for now. If you’d like a closer look at impact investing or any other topic, please let me know. Thank you. Right oh, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

37:41

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Credits

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Tags australia, capitalism, climate change, corporatism, esg, impact investing, inequality, socialism

Podcast episode

China’s falling population & global population update – EP174

Post author By Alec Krishna
Post date February 14, 2023
No Comments on China’s falling population & global population update – EP174

The world’s population keeps growing and passed 8 billion in late 2022, but China’s population is now falling. There are concerns over what that means for its economy and the wider global economy. Is Paul Krugman right that a falling population means a weak Chinese economy? Show host Gene Tunny and his colleague Tim Hughes discuss the possible implications of a shrinking China, as well as global population projections out to 2100. The conversation touches on the environmental impact of a growing population and how well-placed we are to manage environmental challenges.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP174

The world’s population is on the rise and passed 8 billion in November 2022 [4:24]
Why post-war population growth was so strong [7:43]
What does a declining Chinese population mean for the Chinese and global economies? [14:09]
The importance of immigration in Australia population growth [19:27]
How the world’s population will eventually level out toward the end of the century [23:35]
Can governments solve environmental challenges? Discussion of the hole in the ozone layer and the Montreal Protocol [30:09]
Paul Krugman vs Dean Baker on the future of China [42:07]
Tim asks how do you maintain a growth mindset in a declining population? How do you make it work? [47:25]
Will demographics and a weaker economy bring down the Chinese administration? [53:06]

Links relevant to the conversation

UN World Population Prospects 2022 data

https://population.un.org/wpp/

Paul Krugman’s article “The problem(s) with China’s population drop”

https://themarketherald.com.au/the-problems-with-chinas-population-drop-2023-01-19/

Dean Baker’s article “Paul Krugman, China’s Demographic Crisis, and the Which Way Is Up Problem in Economics”

https://cepr.net/paul-krugman-chinas-demographic-crisis-and-the-which-way-is-up-problem-in-economics/

China’s old-age dependency ratio

https://population.un.org/wpp/Graphs/Probabilistic/Ratios/OADR/65plus/15-64/156

Stanford Business School article “Baby Bust: Could Population Decline Spell the End of Economic Growth?” discussing Charles I Jones views on the link between population, innovation, and economic growth

https://www.gsb.stanford.edu/insights/baby-bust-could-population-decline-spell-end-economic-growth

Transcript: China’s falling population & global population update – EP174

Gene Tunny 00:07

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. This episode, I discuss China’s falling population and other global population issues with my good friend, Tim Hughes, who helps me out in my business Adapt Economics from time to time. Tim is not an economist, but I always enjoy chatting with him and hearing his views. And I think he asked very good questions, please check out the show notes, relevant links and for some clarifications, for instance, I need to clarify that the fertility rate for Hispanic women in the US has fallen over the last decade, and is now lower than what I remember it being although it’s still higher than for non-Hispanic women. The general point I make about Hispanic fertility contributing to a higher than otherwise, total fertility rate for the US is correct. I think about doing a deeper dive on fertility rates and other demographic issues in a future episode. Please stick around to the end of my conversation with Tim for an afterword from me. Okay, let’s get into it. I hope you enjoy the show. Tim, he is good to have you back on the show in 2023. Good to be back gene. Yes, Tim. Lots to chat about this year for sure. And today, I thought we could talk about one of the big bits of news that’s already come out this year is the news about how China has had a falling population. The population started to fall for the first time. So that was over last year. Did you see that news?

Tim Hughes 02:01

I do. Yeah. And it’s sort of in line with previous conversations we’ve had about world population and declining growth in a lot of countries. But that’s been mainly in the Western countries. So I think it’s the first time we’ve seen this in China.

Gene Tunny 02:15

Yeah, and this is one of the big concerns for China that China could get old before it gets rich. So it’s got an ageing population. And now it’s got a falling population. And there’s concerns about what that means for its economy, its economic dynamism, its ability to look after the elderly people. So that’s one of the concerns, you know, there’s concerns over the dependency ratio and the number of people of working age to support those.

Tim Hughes 02:46

So that’s the same principles. Because I know we’ve talked about a lot of the Western countries have declining, population rates are declining growth rates. So there’ll be the same challenges that those countries face as well, then yeah.

Gene Tunny 03:01

To an extent, it’s much worse in China than in many Western countries, because China really shot itself in the foot, really, if you think about it with that one child policy. And it seemed like a good idea at the time, because at the time, we’re concerned about, well, how do we feed a billion people or so. And so there was a government policy, instituted late 70s, early 80s, that each family can only have one child. And that seemed like a good idea at the time, to help improve living standards, and help feed the population. But what it’s meant 40 years later, is that they’ve now got a declining population. And while they’ve relaxed that one child policy, what they’re finding is that Chinese couples, they’re quite happy with one child, because you know, that’s been the norm for four decades or so.

Tim Hughes 03:56

Yeah, because that was in place until 2016, I saw,

Gene Tunny 03:59

Yeah, around then I think. Yeah.

Tim Hughes 04:03

So I mean, it’s pretty radical, because I guess China is one of the few countries that could implement that – that kind of law. I can’t imagine many countries being able to do that. So it’s interesting seeing it pan out, because it’s interesting that Western countries have a declining growth rate anyway. So without that being put in place.

Gene Tunny 04:24

Yeah. And one of the other big challenges for China, which is less of a challenge for Australia, and for the US, for example. Immigration is a that helps us alleviate some of the challenges from an ageing population, not completely. We’ve got a really strong immigration programme here in Australia, the US gets a lot of immigrants from all around the world. And also because the US has got the benefit of having a large Hispanic population and the fertility rate among Hispanics. So people from Mexico or from South America or wherever Puerto Rico, it’s, I don’t know, it’s over 2.1 For sure, which is the replacement rate. And so what that means is that the US, their fertility rate is not as low as in other other economies. And so they’ve there not the pressure doesn’t come a lot from that source. I mean, in Australia, we’ll end up having that that natural increase turned to a natural decrease eventually. And then we will have to start relying on immigration for additional people at the moment, we’ve still got some natural increase, because we’ve got, because the baby boomer cohort was so big, and then their children, there was plenty of them. And so there are still more people being born in Australia than dying. You get a problem if you don’t have people being born and you got everyone die in, that’s when you know, you don’t have immigration. And that’s what’s happening with China.

Tim Hughes 05:56

immigration has been a big part of national growth for so many countries for since forever. Like, that’s always been the case. And so certainly, places like Australia has count on that massively. Zooming out to a macro level. We’ve been talking about the cause, I remember we had this conversation years ago, and I was open-minded at the time but I was wondering, like, what happens, you know, if world population gets out of control? And you mentioned at the time that the thinking was it was going to level off around 2050 at around 10 billion? I think that might have been raised?

Gene Tunny 06:33

Yeah, it’s been revised. So if we look, we might go to the World Population Prospects. So I’ll put a link in the show notes to this. This is the really authoritative set of projections from the UN. And I mean, they’re really good. They essentially, they were forecasting that China’s population would start declining around now. Yeah. And, you know, India’s, the mean, India’s population is going to overtake China pretty soon, if it hasn’t already overtaken China’s population that we chat about that a bit later. There are some good references I found on that. They’re on the 8 billion mark now. Yeah, I think we crossed 8 billion last year. If you look at the world population, Prospects report, they’re released last year. So the world’s population is projected to reach 8 billion on 15 November 2022. Can you remember what you’re doing that day, Tim?

Tim Hughes 07:24

No,

Gene Tunny 07:25

No. But that was back to the momentous day for the world. So you know, 8 billion amazing. I don’t know what it was, when I was born, it might have been in the 70s. It might have been put it in the shownotes. But I remember when I was at school, it was 5 billion or so

Tim Hughes 07:43

This is a thing that I saw, I remember at the time when we first had this conversation, because the rate of the doubling of the world’s population was so fast. I mean, the turn of the century around the First World War turn of the previous century, is around the 2 billion mark, I believe. And so to get where we are now is like a billion. I mean, that’s a huge growth. And this is the history of the universe, for instance, like for our species on this planet, any planet, you know, to be this money. So it’s a really, it’s a really fast growth.

Gene Tunny 08:19

So why that occurred? It’s because of improvements in agriculture is because of the fertiliser, the ability that’s that process the was invented by those German chemists.

Tim Hughes 08:33

Those German chemists, yes.

Gene Tunny 08:34

I’m not going to pronounce it. I’ll mispronounce it for sure. But there’s a there was a process that to artificially or create ammonium, I think for fertiliser, if I remember correctly, so there’s a something like that there’s a there’s a chemical process that was perfected in the early 20th century by some German chemists. And that meant that we were able to produce, you know, fertiliser artificially, and then that meant that our agriculture could be much more productive. And all of these, you know, we could support much larger populations in India and Bangladesh, and all over Asia, in Africa. So that’s a big part of it. And the other part of it, of course, is just improvements in public health and understanding of germs and bacteria and viruses and all of that eradication of smallpox, all sorts of things that have that mean that billions of people who wouldn’t have been born or wouldn’t have survived beyond infancy, are able to survive and now we’ve got 8 billion people. It’s just incredible. When you think about it.

Tim Hughes 09:42

Infant mortality at that time was terrible, like, it was very common for families to have any number of kids who didn’t make it through to adulthood. And that has definitely improved.

Gene Tunny 09:58

Well, just got any I mean, you got any cemetery and yeah, any older cemetery and you just see all the graves and memorials to infants. It’s incredible, isn’t it?

Tim Hughes 10:08

But go back to the conversation that started this? Well, certainly, as far as I was aware, because so I was of the mind, like, you know, what happens if we just get more and more and more, there’s a massive problem, and it just gets out of control. But you mentioned that this was actually foreseen that there will be a levelling off. So this extreme growth that we’ve seen from so taking that 2 billion mark around the 1900 mark, 2 billion to where we are now 8 billion. I mean, if, you know, I’m thinking, Well, what happens at the point where we can’t sustain any more people, but it was foreseen that we would have this levelling off around 2050. And then 2100, not much growth between 2050 and 2100. Is that still the case?

Gene Tunny 10:49

Yeah, yeah. So if I’m looking, I’m looking at the UN, the world population projections that were put out last year, the latest projections by the United Nations, suggests that the global population could grow to around eight and a half billion in 2039. 9.7 billion in 2050. And 10.4 billion in 2100.

Tim Hughes 11:12

So that’s a real that’s slowing down a hell of a lot from where we are now.

Gene Tunny 11:15

Yeah, yeah. And that’s because of that demographic transition they talk about. So I think we talked about that last time. How as economies get wealthier, as people get wealthier, public health improves, then they have fewer children.

Tim Hughes 11:30

That’s interesting to me, because you would think it’d be quite logical to think it would go the other way, that people would have more children under those circumstances. But there’s actually fewer.

Gene Tunny 11:39

Yeah, yeah because in poorer economies in poorer countries, children are in insurance policy. And they help look after their parents in old age. Yeah, So that’s, that’s how it works.

Tim Hughes 11:52

I’m thinking that my kids, I might have to mention that to them.

Gene Tunny 11:58

Yeah, so that’s why. And historically, yet, so you’d have that have more children, of course, birth controls, and other another thing, too, right. So birth controls part of the story. But I think largely, it’s, it’s due to the fact that if you’re in a more if you’re in a poorer economy, then it’s probably more likely to be agrarian, or you have lots of people on the farm. And you know, having children’s that’s, that’s your workforce. Right. Okay. Yeah. So, I mean, that sounds harsh, but that’s what it is, right. So that’s your workforce, it’s to help you out in the home, and it’s to look after you when you’re old. And so that’s why in poor economies, they have more children, and there tends to be this demographic transition, that’s well observed that countries really have this sharp or this big drop in fertility, as they get wealthier.

Tim Hughes 12:53

It’s a really interesting, I mean, I think it’s a good thing, like, you’d have to say, you know, I mean, I was, I was pleased and relieved, to see that that was going to level off, you know, because it’s obviously, you know, if we think of like, a parasitic kind of relationship, you know, and the planet, if we’re a parasite on this earth, and just gonna get too many of us, and potentially, like, trash it, which is still possible with 10 billion people. But it looks like everything’s turning around there to make better choices towards the future generations. So hopefully, that works out. But if the population was going to keep growing, that was certainly going to be a bigger issue. But hopefully, that will make it easier for us to manage the planet and our lives on it in some more sustainable way, you know, that we can sort of level out and do something. And I know, this then brought us to another question of, you know, sustainable growth being constant. Always more, always more. What would that sustainable contraction look like? Or D growth or flexible growth, that we’ve got a few different terms for it that we’ve come with for it. But it’s an interesting sort of concept of like, well, you know, not everything is going to grow, grow, grow. So how do we sort of like, manage that levelling out, you know, as humans on this planet?

Gene Tunny 14:09

Yeah. Well, this is one of the big questions about the Chinese economy and what that means for the global economy. Paul Krugman wrote a really provocative, I mean, really well written piece in The New York Times following that news, or might have been earlier actually a better check when he released it. We might cover that in a moment because there is a question about what a declining population in China or Japan what that means for the dynamism of the economy and your ability to keep everyone employed. So we might talk about that. Just wonder if we need to go back over those world population implication?

Tim Hughes 14:47

Yes. Because that’s in China, for instance. That’s what implications already hasn’t it with what’s going on there. So there’s a lot to unpack just with China, let alone the rest of the world.

Gene Tunny 15:00

Yeah, so these are the big takeaways from this World Population Prospects report. So population growth is caused in part by declining levels of mortality as reflected in increased levels of life expectancy at birth. So globally, life expectancy reached 72.8 years in 2019. So that 72.8 years, that’s a globally that’s not that’s across the whole world, right, not just in the wealthy countries an increase of almost nine years since 1990. So that’s a huge achievement. The other thing I think’s really interesting, in this UN report, this is this demographic transition we were talking about. In 2021, the average fertility of the world’s population stood at 2.3 births per woman over a lifetime. So that’s above the replacement rate of 2.1. Because you need that extra point one to account for the fact that some children won’t make it out of childhood. So that’s 2.3 births per woman over a lifetime having for having fallen from about five births per woman in 1950. Wow, that’s extraordinary, isn’t it? Global fertility is projected to decline further to 2.1 births per woman by 2050.

Tim Hughes 16:14

So was the baby boom, in 1950, yeah?

Gene Tunny 16:18

Yeah, I mean, a lot of that’s going to be in the reason, it was five births per woman. A lot of those births would be occurring in the developing economies in the emerging economies in India and China, because I think China had a big baby boom. And in Australian trying to remember what our fertility rate got up to, I think it peaked in the early 60s, because I remember looking at the data, because we will look when we were working on the intergenerational report in treasury, we were all over this data, I think, maybe got to three or three, between three and four. In Australia, which was pretty high for Australia. Now it’s under two. So it’s below replacement, if I remember correctly.

Tim Hughes 17:01

That reminds me because wasn’t it Peter Costello, who said, have one for each other and one for the country? Yes. So that was the opposite of what China were doing. So Australia was like popping out? Well.

Gene Tunny 17:11

Because we were determined that we need people. Yeah, so it’s interesting. So historically, we wanted to grow Australia’s population for defence reasons. I think Arthur Cornwall who was a minister under Chifley I think that was his he wanted and that’s why he encouraged migration. Isn’t that how you got over here?

Tim Hughes 17:33

Do not tell the authorities, will you. No, my mom’s Australian. So that is my connection.

Gene Tunny 17:42

Oh, that is right, I am just kidding. We encourage, we encourage migration after the war to try to build up the population, I guess, because we thought there’s a limit to how many you know how many how fast you can grow the population just relying on the fertility of, of the population.

Tim Hughes 17:59

I know there was a big like that there’s been a constant source of people from the UK anyway, like, the Ten Pound Poms and all of those guys who came over.

Gene Tunny 18:08

BJs. Yeah. And it’s so I guess we were relying on immigration quite a bit. And even with immigration, we will still have facing this ageing population challenge. And then Treasury crunched the numbers, and it looked like, Okay, this is going to be bad and 30 or 40 years time, because there are going to be fewer people of working age supporting the people of the elderly people also children in the dependency, like, I can’t recall the figures off the top my head, but you’d often see figures, which would suggest that whereas once there were five working people, for every dependents by, some data, there’d be two and a half or whatever, they’d be those sorts of scary statistics, and the budget deficit would end up being 5% of GDP if we didn’t correct this. And so then they the government of the day developed a strategy to try to boost population, or boost the fertility rate and the baby bonus and there’s a huge debate over whether it was effective, whether it was whether it made sense to spend that money, because a lot of people just got the whatever it was $5,000 baby bonus and went out and bought a plasma TV.

Tim Hughes 19:27

We had a baby at least one baby in that time, maybe two, we had three altogether, but I think two of them had a baby bonus. Yeah. So we’re very happy with that.

Gene Tunny 19:37

Yeah. Totally, but the fertility rate did increase over that period. And which, which meant that there was all this talk about Well, Peter Costello’s being the only minister in the Western world, has ever managed to increase the fertility rate or something like that. So we got a lot of praise over that. And there’s that famous photo of him with all the babies surrounding him. Yeah, so I guess we work tried to address our concerns about ageing about declining population, well, we don’t I mean, we’ve still got a growing population, we’ll end up where 26 million now, I think and we’ll end up at 40 million by 2050. Possibly.

Tim Hughes 20:16

So the reality of that is that that’s going to be mainly from immigration.

Gene Tunny 20:19

Yeah, there’s still they’ll still be some natural increase, but a lot of it will be immigration. That’s correct.

Tim Hughes 20:25

I think it’s a really good. I don’t think it’s widely known by everybody, of the importance of immigration, like it’s it, as far as like feeding that growth and like, supporting the ambitions of a country, immigration is essential to have that growth. You know, it’s a big part of it. I know, certainly, in the UK. I know, people from West Indies and, you know, the Caribbean, India, Pakistan, you know, massive influx at different times to be invited over into work, you know, it. And, of course, then there were thriving communities of generations now of people who are British and add to the whole vibrancy and diversity in the country. And that’s part of I mean, I know, it’s a very controversial subject in many countries. You know, we’re not going to cover here. But the fact is that immigration is needed for that growth. Yeah.

Gene Tunny 21:18

Yeah, there’s one way that you can get around this, this challenge in particularly in the western economies, which are projected to have falling populations, you can take advantage of the fact that, well, the population is not falling in other parts of the world in the emerging economy. So there is that opportunity for migration. And we’ve got to look at better ways of allowing people to, to migrate, including on a temporary basis, a lot of the concerns about migration or about people migrating for work purposes, and then settling there permanently and bringing their families. So there’s a lot of concern that. So countries like Germany, which have had bad experiences with or they do them perceive the perceived that they’ve had bad experiences with guest workers in the past, that they’d want to make sure that any migration is temporary. So I think countries are looking at ways that they can have temporary workers schemes that I mean, we’ve got all sorts of visas for temporary workers now. And we’re getting people over from the Pacific where we were before COVID, to help pick fruit here in Australia. So that’s, that’s, yeah, I think migration, certainly part of the solution. At the same time, you want to make sure that it’s, it has community acceptance, and you’re not putting too much pressure on community services, you want to make sure you’ve got the infrastructure to support the population. Yeah, so a bit of a challenge there. Okay, we’ll take a short break here for a word from our sponsor.

Female speaker 22:57

Gene Tunny 23:27

Now back to the show. Let me just check that Australian population forecast Tim.

Tim Hughes 23:35

So I was gonna ask you Gene like, with that levelling out, frustrating gets around 40 million.

Gene Tunny 23:41

That’s what I wanted to check. Yeah. Right, because that’s the number I had in my head. But let me just check with that. That, but go ahead, keep going.

Tim Hughes 23:48

Yeah, I was gonna say, I mean, I guess Western countries are already there, where they’re starting to level out and have a very slow rate of growth, or in decline. And so it’s just with infrastructure, and all those different things like at some point, you can imagine that people will still want to move around the world. So even with 10 billion, 11 billion, it might be a case of people leaving one area on mass to try and get into other areas, which happens all the time. I guess it’s certainly happening now. Yeah. And so a big part of that is just managing the amount of people that are on this planet, but with the sustainability sort of question, you know, it’s that up until now, everything’s been about growth, you know, population growth, and more, more and more, to getting back to the point I was talking about earlier, like, you know, it’s gonna get to the point where it’s like, well, this is we have to manage this the best way we can. And so yeah, it was going back to those areas of D growth or flexible growth, sustainable contraction.

Gene Tunny 24:45

Yeah, sure what you mean by that, Tim. And well.

Tim Hughes 24:47

I guess, I guess it’s the kind of thing because of, with that levelling out of the population, I mean, like I said, I think it’s a good thing, you know, because there are enough of us.

Gene Tunny 24:57

Yeah. If you’re concerned about the ability of the planet to support the population and there are plenty of people who are who are saying, Oh, well, we’re actually exceeding the planet’s carrying capacity at the moment, which I don’t believe because if we were, I mean, we wouldn’t be able to keep growing our population, and obviously, where we’re able to support the current population, just by the fact that we are supporting it, right,

Tim Hughes 25:20

I guess at some point as a planet, they’ll still be moving people moving around, like I mentioned, like, yeah, that’s understandable. But the growth mindset, as far as population goes, will have to change at some point, you know, like, you know, it’s not just going to be more and more, it’s a case of like, doing better with what we have. Does that make sense?

Gene Tunny 25:38

I think we should always be trying to do better with what we have. I mean, as an economist, as an economist, I think, yeah, I totally agree with that. We’ve got to be more efficient and do better and, and make sure we’re not we’re properly pricing our impact on the planet. So we’re talking with, we’re not polluting too much, or we’re managing the environment as best we can. Yeah,

Tim Hughes 26:02

yeah. I mean, I see good things coming from it. Like, I think it’s a good sort of place to be, because everything up until this point, like it’s, you know, from 2 billion in 1900, to a billion now to 10, or 11 billion. This is, I would imagine that things will have to change in the way that the world is looked at, as far as its population goes and said, Well, this is, this is, how many of us are going to be putting, you know, waste into landfill? How many of us are going to be, you know, how we deal with our own sewerage, and all that kind of stuff? You know, what I mean? Like, the stuff that ends up in the oceans, how we treat our soil, all of that, like as a global sort of, like management of, okay, how do we do this to the best of our abilities, so we can keep doing it indefinitely. And if we have if we had an exploding population that was getting forever, and that was going to be a scenario that would be potentially catastrophic. And so that’s, I guess, we’re looking at it’s like a macro sort of like view of the whole planet, it’s okay. Well, you know, what can we expect to do better? Where we’re not just constantly expanding? As far as like the population goes?

Gene Tunny 27:07

Yeah, I think why is this definitely an issue to manage? How do we deal with all of that, and greenhouse gas emissions? We’ve got to, we need to get them under control sometime, and then you can debate how quickly or not in the Greta Thunberg, we’re all going to die in 10 years, or there’s a climate catastrophe. I think we’re gonna I can’t say, well, basically,

Tim Hughes 27:36

I haven’t heard that.

Gene Tunny 27:39

Oh, yeah. I think so, I mean, we’ve had 30 years of blah, blah, blah, not doing anything, which is actually true, right? I mean, the government’s leaders around the world will talk about how they’re doing all of this, all of these great things to reduce greenhouse gas emissions and get climate change under control. And meanwhile, global emissions keep rising. And so this is one of the points that are the conservative critics of Jacinda Ardern pointed out was, she’s very popular. She’s a progressive politician. She’s very popular among progressives worldwide. And yet, before COVID emissions were rising in New Zealand, according to these commentators, I probably should fact check that one. It’s a big challenge, because our whole industry of our industry, and our economies have been reliant on fossil fuels for so long. And it’s like turning the Queen Mary around. Right?

Tim Hughes 28:34

Yeah, because I know, we’ve talked about that with the energy sector changing massively, yeah, at the moment, and there are good things that potentially can come from it, it seems to be heading in the right direction, but it’s, you know, obviously, in a transition period, at the moment. And I wonder how much of that, you know, is down to having short term governments, who, you know, we’re expecting too much from governments, with a limited term of three or four years to be able to make these changes, you know, like, because obviously, this is a long term view that we need to take, I don’t know, 2050. Net Zero, are these sort of like goals that get put in? But sometimes I think with the longer goals, it’s easier for people to say, Yeah, we’re gonna do that. And then the action is less than what it needs to be.

Gene Tunny 29:15

Hmm. I think you’re right. I mean, the system we have the democratic system, the three or four year electoral cycle, yeah, I think that makes it harder. But I think it’s better than the alternative. I mean, we wouldn’t want to have a dictatorship was I mean, they could end up imposing, you know, a very rapid decarbonisation or that is incredibly costly on us if they thought that that was the right policy, like look what China was doing with the lock downs with the COVID zero until I realised that okay, we’re going to have a revolution on our hands if we don’t relax this policy. I think you’re right I mean, I think the democratic system we have this short term focus. Yeah, the fact that it is easy to always point to the cost the short term costs of any action. Yeah.

Tim Hughes 30:09

I mean, because I have to say like, you know, at times it seems that with governments, it’s hard to know how much difference they do make, or they can make, you know, even with the best intentions in a term, which goes very quickly.

Gene Tunny 30:21

Well, I think they can make a lot of difference. Look at problems we have solved, look at the Montreal Protocol, which meant that we eliminated the use of Chlorofluorocarbons. The ozone hole.

Tim Hughes 30:36

I saw that that was that had improved that that was a Yeah, a good improvement from what it had been.

Gene Tunny 30:42

So 1987. I think that was the Montreal Protocol. Where all the governments, particularly all the governments of the world agreed that yet we’ll phase these things out. Now. That’s different from the climate change challenge, because there were easy substitutes or substitutes, which weren’t too expensive for CFCs. Yeah, that we could replace them in the aerosols. But I think, yeah, I think governments can make a huge difference. The problem with the current mean, there are all sorts of problems is the issue of, well, for Australia. I mean, the view I’ve always had is there’s no point us doing, doing much of if China and India are still going to keep increasing their emissions, and also the states. I mean, we need ultimately, you need the major economies to be leading this. Otherwise, it’s not, it’s not really going to happen.

Tim Hughes 31:37

Well, it seems clear that innovation is going to drive it, you know, because and I get that, yeah, because it’s hard to put yourself at a disadvantage when everyone else is able to take advantage of that, you know, so that argument, for instance, here in Australia, where we’re smack fairly small country, but not necessarily been supporting too many of the netzero sort of ambitions around the world, you know, because of what you’re saying, like, let the big guys lead the way. But innovation, I think we’ll do that as soon as it gets to the point where the energy is cheaper than digging coal out of the ground. If there’s a clean way of producing that energy, then everyone will follow.

Gene Tunny 32:16

Oh, exactly. And that’s what we need. We need that technological innovation.

Tim Hughes 32:21

And the market, like from our discussions before with people in the energy sector, has been that the market is driving this. So we don’t have to, I mean, governments can help by making it easier and sort of greasing the path towards encouraging those changes to happen. But certainly the market is driving it and innovation is providing the opportunity for the market to take up those options with renewable energy.

Gene Tunny 32:42

Yeah, you’re thinking about that conversation we have with Josh. Yeah, yeah, that was interesting. Or he’s talking about the fact that the nature of this transition of any transition really is it’s going to be disorderly, it’s hard to get these things done in an orderly fashion.

Tim Hughes 32:58

I always manage to steer it back to this, don’t I Gene. It doesn’t matter what we talk about.

Gene Tunny 33:01

It’s important. If I’m thinking about, well, what’s the big potentially the big risk to I mean, other than nuclear war, I mean, it’s always a threat, particularly with what’s happening in Ukraine. Now I’m in the risk of that elevated, but the other big, potentially existential risk. I mean, you’ve got to put some probability on it. I’m not as concerned about it as some other people. I’ve got the Steve Koonin view of it, he used to work for Barack Obama, he was in the administration, I think it was in science, one of the I don’t know if he was in cabinet, or he had a, he had a senior position in the Obama administration is a scientist, he was at Cal Tech. And his view is that Yep, this is something we’re going to deal with. But we’ve got decades to deal with it. So what we’ve got to do is to start putting in place agree on some policies globally that are going to get us on this smooth transition path and, and also fund innovation trying, you know, it’d be great if we could find the cost effective solution, perhaps nuclear fusion, that there’s, there’s a lot of excitement about that. But then you got to deal with the nuclear waste. And what was that? What was actually, maybe there isn’t waste with nuclear fusion? Maybe that’s one of the advantages of it. Well, there’s less waste.

Tim Hughes 34:18

I still get my fusion and fission mixed up. So

Gene Tunny 34:21

Fusion is more powerful. Fusion is what the sun does.

Tim Hughes 34:26

Yes, right. Yeah. Fission is the separating of fusion is the joining. Yeah. Yeah. But so and with and there was a breakthrough with Fusion then yeah, just the other week, but it was still claimed that that could be decades away from it being useful for an energy source on a commercial scale. However, if it’s decades where that’s significant in the history of humans, however, with that, especially with that conversation with Josh, it was record notion that, you know, having a suite of different options for clean energy makes a lot of sense. You know, we don’t have to put all our eggs in one basket. And, you know, one choice so, and clearly those things are happening as we speak. And quite successfully. I mean, like the, you know, there’s still a lot of clean, renewable energy is getting more and more prolific.

Gene Tunny 35:22

Oh, no doubt about that. I mean, aren’t they turning the North Sea into a wind farm in? Have you seen that in? Because the North Sea is really good for the wind turbines. Well, it’s I mean, it’s not shallow, but it’s it’s not very deep the North Sea? Was there’s bits of the North Sea that are only a few 100 metres deep, I think, isn’t there?

Tim Hughes 35:48

I mean, obviously, it must be, you know, viable. But it seems odd to me that a wind farm in an ocean, you know. But, obviously, there’s, you know, there’s something in it. Yeah, yeah. It’s extraordinary. It’s a really interesting time. So because all of this is coinciding with this levelling out of the population. So it seems to be a, I don’t know, it feels like it’s a good place to take stock and see how we can sort of really manage this planet. Well, you know, and cleaning it up is the first way to do it, you know, so how we can keep the oceans cleaner than they currently are, like, clean them and stop polluting them and how we can manage our waste, you know, 10 billion, it’s a lot of foods.

Gene Tunny 36:30

Well, I guess this is what’s part of this is what’s motivated all of these measures or measures we’ve had in Australia to reduce plastic waste, and then I was growning about it when they initially announced it. But I guess you adapt. I mean, you can’t get the single use plastic bags any more at the supermarket.

Tim Hughes 36:48

You’re still hurt about that one.

Gene Tunny 36:51

You can’t get the single use plastic cutlery Well, anyway, we should get back to this population stuff. It is important. I do recognise the importance of what you’re talking about. The population of Australia is projected by the Treasury, this was last year, or this was 2021, I mean, who knows. But if they updated and they’ve got different migration projections, these numbers could be significantly different. But they were forecasting the population would grow from around 26 million, around 2021, up to 32 million in 2041, 36 million in around 2050-51 and then 39 million by 2060-61. I think I’ve seen previous, I think I hadn’t had in my head the idea that it’d be about 40 million by 2050. And yeah, it’s hard. It’s hard to forecast. It depends on fertility, it depends on migration, and then all of that sort of thing. So and life expectancy. So quite a few moving parts there. Right. The other thing I want to talk about, Tim, if you still got time, yeah, it’s this issue of what does the declining population mean? So what is China’s declining population mean for its economy and therefore the global economy? One thing to keep in mind, of course, is that I think, what were we talking about a reduction of a population of 850,000 people. So that’s under 1 million, the Chinese population is 1.4 billion. So in percentage terms, we’re talking. What’s that less than point one of a percentage point? Yeah. Does that make sense?

Tim Hughes 38:37

Yeah, I mean, it’s. So it’s level that basically.

Gene Tunny 38:42

I guess that’s one way of looking at it is that it’s yeah, it’s hardly you’d have like, really noticed that on a chart, if you drew the population. The thing is, it’s a sign of things to come, because we all know that it’s expected that the Chinese population would, is going to start falling. And there are all sorts of projections as to where it could get to. By 2050-2100, I think I’ve seen an estimate somewhere that their population by 2100, could end up being, I don’t know, 700 million or so. Yeah, it’s a really big reduction because of that one child policy. I’ll put the actual figure in the show notes, but it’s quite dramatic. Just looking at what that impact of that one child policy, ultimately will be on their population in the future, because you’re not replacing your population. Right. So that’s, yeah.

Tim Hughes 39:42

So it’s funny actually, China is like a microcosm of the globe in a way, isn’t it? Because it sort of has fairly tight borders. And so the decline that that would be for China, would be an example of like, how do you manage that sustainably, how do you sustainably contract successfully from 1.4 billion to 700 million. And yeah, the thing is like, you know, China is extreme in many ways. They may manage it very well. Now, I’ve got no idea how but I think that’s a really interesting sort of point. I mean, they’ve had massive change. Was it 1962 to see the great leap forward? You know, I mean, certainly from 1980. They’ve made in the last 20 years, 25 years, they’ve made themselves this sort of, like, workshop of the world, you know, they’ve produced so much stuff. And they’ve become very wealthy in that time.

Gene Tunny 40:36

Well, the wealthier and some people have become very wealthy, their per capita income is still I don’t know, it’s under a third of what it is in the States. It’s gone. It has gone through big changes. I mean, yeah, considering that once but I mean, I don’t know when you were young and when I was young people were saying, well eat your food, because there are people starving in China. Right. I don’t know if maybe that’s an Australian thing. Yeah. I mean, yes. It was probably still true when I was when I was young. Right. But it’s not, I don’t think it’s true now. Or it’s only in small pockets. Right. Whereas famine used to be a huge problem. And you know, people were incredibly poor. And most people lived on the land. But now I’ve had all the shifts of hundreds of millions of people from the agricultural areas in China into the cities. And it’s just, it’s just amazing.

Tim Hughes 41:27

It is fascinating, because made in the 80s, like you couldn’t go to China, like it was closed off to I think it was around the mid 80s, that they sort of opened up or towards the end of the 80s. You know, and it was a new thing, like tourism in China was a new thing. And of course, it’s really well, I mean, COVID aside, you can travel there freely now. But it’s gone through massive change in a very short period of time. It’s really, you know, I don’t know, if they’ve come to a critical point in their sort of growth as, as this powerhouse of production. With a declining population, I guess that’s going to make a big impact.

Gene Tunny 42:07

Yeah. So a lot of the discussion that pundits and commentators and economists having at the moment is around well, what does this mean for their economy? What does it mean for their society? Paul Krugman had a great article. I’m not sure I entirely agree with it, because there’s a really excellent response from another American economist, Dean Baker, which I’ll link to in the show notes. But so Paul Krugman in the, in the New York Times the other day wrote, a declining population creates two major problems for economic management, these problems aren’t insoluble. But will China rise to the challenge? That’s far from clear, the first problem is the declining populations, also an ageing population. And so you’ve got this issue of the dependency ratio, paying for looking after those people. The other thing Krugman is worried about is that a society with a declining working age population tends other things equal to experience persistent economic weakness, Japan illustrates the point. Now there’s a debate about just how badly Japan’s fared relative to other countries, it certainly hasn’t grown as fast as the US or, or the Australia. But it hasn’t collapsed either. I mean, it’s managed to maintain reasonably low unemployment, it’s kept people employed. But at the same time, they’ve been the government’s had to try to prop up the economy, it’s accumulated a huge amounts of debt. So there are certainly challenges with Japan. And partly that is because it’s, it does have that declining population, as Krugman notes. So the point Krugman is making its a Keynesian point, in a way. What he’s saying is that if you’ve got a growing population, then that, from that, for what follows from that is the need for additional capital investment in your economy, additional spending that helps keep people employed. Yeah, so that’s the that’s the point he’s making, and that if you don’t have that growing population, then you’re at risk of what Japan experience with his last decade or so and potentially at risk of deflation. So I’ll put a link in the show notes here, because we’re getting up to near the time we set for ourselves. This might take a while. Yeah. It’s incredible. And so Krugman is concerned because he thinks that what this declining population could mean ultimately is that China has a period it ends up being economically weak. And there’s also some evidence or there’s an argument from this, this economist at Stanford School of Business, Charles Jones, he argues that we’ll get a declining population is problematic because then you’ve got fewer people to solve problems, it’s less likely you’ll get an Isaac Newton or Albert Einstein, etc. So that’s one of the concerns. When who knows if that’s, I don’t know how valid that is. That’s enough. That’s a hypothesis. I mean, we’ve still got billions of people, right?

Tim Hughes 45:21

I mean, you can say those guys came around when there’s a far fewer people on the planet.

Gene Tunny 45:24

Exactly. So who knows if that’s actually a legitimate concern or not. But that’s quite a, that’s a, I should have him on the show just to talk through. It’s no Charles Jones, you know, and get him on the show rather than just say, I don’t agree with it, or maybe I haven’t done the the concept justice. But there’s certainly I can see the logic, but there are concerns that the dynamism of your economy would be at risk. If you have fewer people. There are concerns about well, how does your economy adjust to this in the short term as you’ve got declining population, and you’ve got less need for investment? We’ve got all of these buildings that have been, you know, what we don’t have as much need for new housing or new construction, which does help employ people? How do we how do we manage that? And that on the other hand, there’s this great critique of Paul Krugman by Dean Baker, who’s an economist and co founder of the Centre for Economic Policy Research, which is DC Think Tank, it’s a progressive Think Tank. I really thought this is a clever critique. And Dean Baker, apparently, his Wikipedia entry claims that he was one of the first people to have foreseen the subprime mortgage crisis in the States. So yeah, I think he’s, he’s got a good reputation. He makes the point that well, Japan’s not really as bad as you think. And then it hasn’t collapsed. They seem to manage to muddling through in some way. And then it’s not, obviously they’ve still got problems because of all the debt. But he’s saying look at something you can you can manage, and there are actually benefits from a declining population. He, he notes that Japan cities are less crowded than they would be if its population had continued to grow. This means less congestion and pollution, less time spent getting to and from work and less crowded beaches, parks and museums, these quality of life factors don’t get picked up in GDP. I’m actually not sure. Does Japan have many beaches? I mean, I understand his point.

Tim Hughes 47:25

Yeah, Echo Beach, yes that is in Japan. That’s one beach that I know.

Gene Tunny 47:32

I was just wondering, I don’t know, never haven’t been to Japan on an island. So I guess it’s yeah. Oh, of course, they have beaches. Yeah.

Tim Hughes 47:39

But that’s actually a really good way of putting, I guess one of the things that we’re talking about is like, you know, declining population doesn’t have to be bad news. I mean, I guess, you know, the, the challenge would be how do you keep maintain a growth mindset in a declining population where can you make it work to your advantage? Or, you know, how can you do the best, you know, with, because part of it would be in a declining population. Once that first surge of older people goes, then it should level out with the number of older people as opposed to the number of younger people, I guess, because as you’re peaking towards your peak population, you’d have the most amount of old people is that right? I’m sort of thinking out loud here. But I’m just wondering,

Gene Tunny 48:25

Tim, is a good question mate. I mean, you’re asking does the as if as your population declines, what happens to the age composition of the population? So I’m gonna have to take that on notice. I mean, I think that’s a hard one. I mean, there could be a point, there could be a time when both the dependency ratio gets worse and your population keeps falling? That’s a good question. I don’t know, let me put something in the afterword about that. I don’t know, conceptually, I can’t figure it out right now on the fly. That’s good question.

Tim Hughes 49:00

But it’s that thing of like, I imagine, like the you know, because the challenge is this is to manage that. Well. Yeah. And like, so. I mean, one thought that comes to mind with that is, like, the whole thing of retiring at 65 has been around for a long time and around 65, whatever it is now.

Gene Tunny 49:16

67 in Australia now.

Tim Hughes 49:19

Y eah, this thing of like, it’s not necessary for people to stop doing what they do, you know, there’s so much wisdom and, you know, a good life experience that gets lost with that mindset of like, see you later at 67. You know, and I think opening up the opportunity for people to stay in a lower capacity timewise you know, because I think it’s important for people to wind down or do something different or start a new career, you know, like whatever it may be. So, I think maybe the way that you know, we approach ageing or the way we look at ageing, could be one of the factors that changes that declining population as to no right this could actually be looking at how do we manage a declining population better you know, maybe it’s our attitude towards all the roads that we can start with.

Gene Tunny 50:04

Yeah, I think it has to start changing because all the baby boomers are nearly retired, aren’t they? And then Generation X will start retiring.

Tim Hughes 50:13

But it’s that thing of like, you know, as we live longer, we can expect to have more good years, you know? Yeah, hopefully, yeah. And they can be, they can be good years to contribute back towards society as well. It doesn’t have to be just a retirement where you don’t pay any tax at all, because that’s part of the problem isn’t like we’re fewer people paying tax to support an ageing population. You know, so I guess and it’s not just making people work later unwillingly. You know, to give people the opportunity to have different options, different levels of engagement, you know, so they don’t have to do 40 hours a week, of course, but yeah, doing something different stimulating that, you know, people could enjoy doing for longer.

Gene Tunny 50:57

Podcasting.

Tim Hughes 50:58

Podcasting. Exactly. Everybody wants it to be a DJ, everyone was a DJ in the previous life.

Gene Tunny 51:05

Yeah, exactly. I don’t have the turntable, give it time, give it time and we can bring that into the show. Cable

Tim Hughes 51:13

Maybe that’s the way we merge the two.

Gene Tunny 51:17

See how we go. Okay, so I’ll put a link in the show notes to this, these articles by Paul Krugman and Dean Baker. I mean, I don’t know. I mean, some hours of the day I think Krugman is right, then I think I actually Dean Baker is making some great points. I’m still processing it all myself. So Dean Baker, I’ll put a link to this article. It’s on the Centre for Economic Policy Research website. One final point, I thought that well, I thought I should make that Dean Baker may not that was a good one is that? Well, actually, I mean, see it as an opportunity. I mean, China’s got a, it’s got an ageing population, still, while its population is starting to decline, you can put people to well, you’ve built all of that’s right. He’s saying one of the issues that Krugman identifies is that they were building all of this, all of these buildings that, that they may not need these ghost cities. Well, you could use them for aged care accommodation. Or, you know, I don’t know how feasible that is. But that was one of the points that he made. So I thought that was that’s potentially interesting. I mean, there will always be things people can do that the challenge is, can your economy adjust to employ them? So do you have a flexible economy? Gotta make sure you’ve got you’re not regulating business, there’s not the burden on businesses and to hire so that there can be that that adjustment, you don’t have rigid wages or rigid, rigid IR policies that prevent people moving into to new occupations? Yeah, so Dean Baker’s quite positive about what could happen in China. And I’ll encourage, if you’re listening, please read his article. I probably haven’t done it, done it justice. With that, that quick summary there. So yeah, I’d recommend reading that I thought that was really good. And Oh, one other thing we should talk about is that there’s one other concern with the declining population. And the issues with ageing population in China lack of dynamism and what it could mean for their economy, the stability of the whole country, right, the political issues. So Peter Zeihan, I think that’s how you pronounce it. He’s a academic over in the States, he’s come out with his controversial view that the Chinese system as it exists now, that Communist Party regime can only last another 10 years out.

Tim Hughes 53:44

And I mean, it’s been speculation, but it could be true.

Gene Tunny 53:47

If it turns out to be right, he would be held as a genius, the genius.So who knows.

Tim Hughes 53:52

Someone, somewhere will be making those calls.

Gene Tunny 53:54

I mean, my feelings is what I was talking about with Alan Morrison in this chat about enterprise China toward the end of last year. And I think ultimately, that there has to be a regime change in China. I think as economies get wealthier, then there’s naturally more support for democracy.

Tim Hughes 54:14

There seems to be a bit of a paradox with ideology in China at the moment. I mean, we’ve communism is the main ideology, of course, but they’ve embraced capitalism, to the point where individuals are getting mega wealthy, but then they’re sort of getting called into the headmaster’s office and sort of like, you know, put in detention for a bit to sort of keep them in line Jack Ma, from Alibaba, and different people who sort of like disappear off the, you know, public space or forums. And so there seems to be a bit of a tussle there going on, and you wonder how long that can go for. But yeah, there certainly, I think it’s fair to say that there would be an expectation of change coming sometime in the next 10 years. I mean, it’s really everywhere. I mean.

Gene Tunny 54:57

I guess change of some sort. I mean, let’s hope it’s a peaceful change. And there is, uh, you know, maybe the I mean, I don’t know whether they’re going to relinquish power will Xi Jinping I mean what what are the chances of him relinquishing power? I mean, given he set himself up as Emperor for life or whatever it was, I mean.

Tim Hughes 55:15

There’s only Jacinda Arden that I can think of this relinquish power. Yeah, it’s it’s pretty rare thing.

Gene Tunny 55:22

It is very rare because power is seductive, isn’t it?

Tim Hughes 55:27

So they say?

Gene Tunny 55:31

Tim, that’s been an amazing discussion. That’s been fun. Yeah, it’s been good. I’ve really enjoyed that. As always, we managed to go much longer than we expect to or prepared for. Any final thoughts?

Tim Hughes 55:45

No, I mean, it’s funny because it does crossover. I mean, I guess that’s why other things come into it, you know, because they’re all connected. And they, it’s a really fascinating time to be going through this. I mean, like, you know, we’re at a really interesting time, for anywhere in humanity’s history in our like, we’re at these sort of peaks that haven’t been reached before. So yeah, I’m really, and I personally enjoy the direction that things are going in for, you know, the environmental future of the planet, you know, like, I think it’s the right way to go. And I think that’s the overriding direction that it has to get when because otherwise, potentially, yeah, we’re gonna end up in a situation that’s going to be very difficult to reverse. And so seems to be heading that way, which I think is a really good thing. And hopefully, we’ll get there as quickly as we can. Safely.

Gene Tunny 56:39

Yeah, yeah. I mean, I’m optimistic. I think the biggest threat we’ve got is nuclear annihilation. So see how that goes.

Tim Hughes 56:49

It’s still it’s funny, isn’t it? Because that was those threats come and go. But I think our capacity to have our attention on it sort of comes and goes, I mean, it’s sorry, the threats always been there. But our focus on it sort of comes and goes with different things. It’s hard to live under that existential threat constantly.

Gene Tunny 57:09

Yeah, very true. Very true. Okay, Tim Hughes. Thanks so much for your time. I really enjoyed that conversation. I thought that was really he really enjoyed it. We got through a lot, and it was a good discussion to kick off the new year. So thanks so much. Yeah.

Tim Hughes 57:22

Thanks, Gene. You’re welcome.

Gene Tunny 57:25

Okay, I hope you found that informative and enjoyable. In my view, the main takeaway is that China’s declining population is a big challenge to the Chinese economy. And by implication, the global economy, it will be difficult for the Chinese regime to manage this declining population. And indeed, it could even contribute to the end of Communist Party rule, if the declining population actually does lead to a weaker economy and hence an erosion of support for the party. Arguably, one thing that Chinese administration could do to help partly offset the problem of a falling population is to have a more liberal immigration policy. Of course, the administration may worry that bringing in too many foreigners may create political instability which could cost at power. I’d note that for countries which are more open to immigration, and also which didn’t have as bigger collapse in the fertility rate as China did, I’m talking about countries such as the US and Australia, those countries are much better able to cope with demographic challenges. And indeed, they’re actually projected to grow over the future decades. For example, the UN projects that the US will have a population of 375 million in 2050. And between 390 and 400 million in 2100. That’s up from 335 million or so today. Before I go, I better respond to a question that Tim had in the episode. Paraphrasing, Tim asked a question about what happens to China’s old age dependency ratio as the population peaks and starts falling? To answer this question in the shownotes. I’ll put a link to a chart from the UN showing the projected old age dependency ratio for China. That is the ratio of the number of people aged 65. And over to the number aged 15 to 64. The chart shows the old age dependency ratio in China will keep rising for several decades, probably into the 2080s. So in China, we’ve got a falling population, and we’ve got rising old age dependency. So that ratio will increase from around 20 People age 65 and over per 100 working age people. So that’s today it will increase from 20 to 90 people aged 65 and over per 100 working age people in the 2080s. It’s expected China will eventually have almost as many old age people as working age people. That’s the median projection from the UN and everything depends on how closely reality complies with the UN’s assumptions of course, that said there’s no doubt The dependency ratio is increasing and China has a big problem. China’s one child policy has meant that too few people have been born in the last few decades, nowhere near enough to keep the population growing and to look after an increasingly elderly population. Many of the Chinese born are the big cohorts after the 1949 revolution, and before the one child policy was introduced in 1980. They’re still alive and they’re ageing. Right? Oh, I must confess that population dynamics are complicated. And I might try to get a demographer under the show and a future episode for a deep dive. If that’s something you’d be interested in, please let me know and I’ll see what I can do. Okay, thanks for listening. rato thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if you’re podcasting outlets, you then place router review and later writing. Thanks for listening. I hope you can join me again next week.

1:01:30

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Credits

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Tags australia, china, climate change, environment, global population, immigration, population, usa

Podcast episode

Normalization of interest rates & monetary policy – EP173

Post author By Alec Krishna
Post date February 4, 2023
No Comments on Normalization of interest rates & monetary policy – EP173

Last year we saw the beginning of the normalization of interest rates and monetary policy, as central banks responded to accelerating inflation. Show host Gene Tunny talks about the current tightening cycle and when it might end with his colleague Arturo Espinoza. Among other things, Gene and Arturo discuss what history tells us about typical interest rates and returns on capital, referencing UK bank rate since 1694, interest rates on UK government consols, and returns on land written about by Jane Austen and Honoré de Balzac. They also consider whether we might see 17-18 percent interest rates again in Australia, rates which were last seen in 1989-90.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

What’s covered in EP173

What’s been happening with interest rates? [3:00]
What is monetary policy normalization? [6:00]
How many more interest rate increases will be needed? [11:11]
Will we have a recession this year? [19:12]
Is there a risk that we could get back to the crazily high interest rates seen in 1989-90 in Australia? [24:00]
What is the equilibrium rate of interest? What is the real interest rate? [26:54]
The main takeaway from this episode: monetary policy is still in a tightening cycle because inflation is too high [38:43]

Links relevant to the conversation

Data released since the episode was recorded

Australian retail trade fell 3.9% in December, suggesting interest rate increases are starting to bite, meaning the RBA faces an even more difficult challenge in deciding how many more interest rate increases to make:

https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/dec-2022

CBC article “U.S. inflation and consumer spending eased in December, new numbers show”:

https://www.cbc.ca/news/business/us-consumer-spending-holidays-1.6728173

Nine News story “Inflation in Australia rises to higher-than-expected 7.8 per cent”:

https://www.9news.com.au/finance/australia-inflation-consumer-price-index-december-quarter/9ef0ed13-e606-4c9e-b7db-feaccfae39fb

Inflation targets

US: 2%; see https://research.stlouisfed.org/publications/economic-synopses/2022/09/02/inflation-part-3-what-is-the-feds-current-goal-has-the-fed-met-its-inflation-mandate

Australia: 2-3%; see https://www.rba.gov.au/inflation/inflation-target.html

UK: 2%; see https://www.bankofengland.co.uk/monetary-policy

Bank of Finland article on monetary policy normalisation:

https://www.bofbulletin.fi/en/2022/3/what-is-monetary-policy-normalisation/

Chatham Financial article on US tightening cycles:

https://www.chathamfinancial.com/insights/historical-interest-rate-tightening-cycles

Jo Masters, Barrenjoey Chief Economist on how “Everything must go right for Australia to dodge a recession”

https://www.afr.com/markets/debt-markets/australia-will-dodge-close-call-recession-20221216-p5c71b

Chart on historical UK bank rate:

https://drive.google.com/file/d/1NDH7WjQBY0ZjWDWgY430qZdrrIf017_4/view?usp=share_link

Chart on central bank policy interest rates since 1960:

https://drive.google.com/file/d/1Mrzre-ijAKAvrU0j4YeQt71FkTr-gzob/view?usp=share_link

Chart on inflation in the US, UK and Australia:

https://drive.google.com/file/d/11lp880Wwb9bk_GI5wJ0EQ975h-ZkAuDK/view?usp=share_link

Wikipedia article on the Fisher equation:

https://en.wikipedia.org/wiki/Fisher_equation

Wikipedia article on UK consols:

https://en.wikipedia.org/wiki/Consol_(bond)

Guardian article on “UK bonds that financed first world war to be redeemed 100 years later”:

https://www.theguardian.com/business/2014/oct/31/uk-first-world-war-bonds-redeemed

What Jane Austen can tell us about historical rates of return:

https://janeaustensworld.com/2008/02/10/the-economics-of-pride-and-prejudice-or-why-a-single-man-with-a-fortune-of-4000-per-year-is-a-desirable-husband/

Transcript: Normalization of interest rates & monetary policy – EP173

Gene Tunny 00:00

Arturo Espinoza Bocangel 02:58

Hi Gene, it’s my pleasure to be here.

Gene Tunny 03:01

Excellent. Arturo. So I thought for our first episode of the year, it would be good to talk about interest rates. So one of the big developments last year was the, you know, the increases in the interest rates by central banks, their policy interest rates. So the cash rate here in Australia, the federal funds rate, we had some rather unexpected increases in interest rates, all unexpected by many people in response to the high inflation rates that we’ve been experiencing. And so this did catch quite a few people by surprise, and our RBA governor here in Australia, Philip Lowe, as late as I think November 2021, he was saying that, he thought they’d probably be able to keep their cash rate at 0.1% until 2024. So that was his central case scenario, as he was calling it. But it turns out that inflation was ended up being higher than the Reserve Bank expected. And you know, perhaps they should have seen it coming because you would seen inflation accelerating in 2021 in the US and the UK. And so maybe the central bank should have seen it coming, but they didn’t. And we ended up going from a 0.1% cash rate. And now it’s at 3.1%. And that was over a period of from May 2022 to December 2022. And they had the last cash rate increase. So the same three percentage points over seven months or so. So just an extraordinary rate of increase. And similarly in the US, we had high rate of increase. And what we’re seeing is that interest rates are responding to the high inflation. And one thing I thought it’d be good to talk about is, well, where do we think these interest rates are going? Is there any guidance historically, or is there any guidance from theory regarding what’s a normal level of interest rates? So that’s one question we could ask. And how I came to think about this is that I saw increasingly these references to normalisation, so normalisation of monetary policy, normalisation of interest rates, and, and it got me thinking, Okay, well, what’s normal? So I thought that’d be good to explore. Do you have any thoughts on that, Arturo? Does that sound like a reasonable thing to talk about?

Arturo Espinoza Bocangel 05:51

Yeah exactly, that is gonna be an interesting topic, to know, what will be the normal interest rate?

Gene Tunny 05:59

Yes, well, this is a bit of a spoiler, but I think the key message will be that there really isn’t any normal interest rate that we can say that the interest rates are adjusting to that’s one of the challenges it’s it just depends on a whole range of factors, variables that we’ll talk about in this conversation. So to begin with a lot I’d read this article I found from the Bank of Finland, this was back in October and I thought this was really quite a neat way of talking about this normalisation. So they talk about the articles called what is monetary policy normalisation. And so they’re written in monetary policy normalisation, key interest rates or policy rates are once again becoming key instruments of monetary policy. At the same time, the central bank is gradually withdrawing from asset purchases and other unconventional measures. Monetary policy normalisation may also involve adjustments to forward guidance, normalisation leads to a tightening of financial conditions, helping the central bank reduce the inflationary pressures in the economy. Okay. So what they’re talking about there is that during the pandemic, when all of those policy interest rates were effectively cut to zero, our cash rate here in Australia got cut to 0.1%. Right, so it’s effectively zero. That’s what economists call the zero lower bound. So there’s nowhere else for the that policy rate to go, then what central banks what the Australian Central Bank did for the first time. So this has been done previously by the US, and the ECB and Bank of Japan, in response to the financial crisis back in the late 2000s. But we hadn’t done this yet. We did the quantitative easing, what they call quantitative easing, which is printing money. well printing money electronically, and then using that to buy bonds or other financial assets to drive down yields to drive down borrowing costs, with the idea of stimulating the economy that way. So that’s unconventional monetary policy. So what the Bank of Finland saying is that part of this normalisation story is yes, increasing that policy rate getting it away from that zero, lower bound, and moving away from the unconventional monetary policy. Yeah, that’s essentially what they’re saying in that passage there. Okay. And then they go on to talk about where are interest rates going to settle in the future. And this is where this is where they’re essentially saying that will no one, no one really knows, it’s very difficult to forecast that. They’re saying that the normalisation of monetary policy does not mean that the central bank is attempting to restore its balance sheet and interest rates to a past levels such as that preceding the 2008 global financial crisis. Okay, so what they’re saying is don’t necessarily look to what interest rates have been in the past, rather than the aim of monetary policy normalisation is that the inflation rate should accord with the price stability objective. In the absence of further economic shocks, interest rates should in the longer term settle at a level where economic resources are in full use and inflation is at its target, ie at the equilibrium real interest rate, also known as the natural rate of interest. However, the level of the equilibrium real interest rate is affected by a number of factors unrelated to monetary policy. Okay, so, gee, there’s a lot going on that passage there that I’ve just read. The way I interpret this is that essentially, we’ve got to get to an interest rate. So what the central bank is trying to do, its increasing interest rates to get inflation under control. And after it gets inflation under control, the interest rate is going to settle at a rate whereby it’s consistent with keeping inflation in the target band. So in Australia, that’s two to 3%. On average, other countries have similar target rates for inflation and that sort of 2%.

Arturo Espinoza Bocangel 10:28

Between two and 3%. Yeah,

Gene Tunny 10:31

yeah, yeah. So just, I’ll just put some links in the show notes, clarifying that what they are for all other economies. So we’ll end up with an interest rate where it’s consistent with that. And it’s also consistent with a reasonable level of economic activity. So a stable, well, a sustainable rate of economic growth. And I mean, you could call it full employment, but I’d probably say unemployment at what you’d say is the natural rate of unemployment rather than full employment, which is, I think, a difficult concept to actually to define in practice. So, I mean, what would that be? I mean, it’s hard to know, because it depends on how the economy will first we’ve got to find out how the economy responds to the current interest rate increases, and just how far the central bank has to increase the rates from here. So I think there’s generally agree that well, there’s quite a bit of agreement among commentators among the market economists, that interest rates will have to increase a bit more from where they are now. Because we’ve still got inflation in Australia over 7% Us 7% over 7%, we’ve still got these high rates of inflation or higher rates than we’ve experienced for a long time. We’ve pushed the policy interest rates up to 3.1% in Australia, 4.25 to 4.5%. In the US, I think, is the current target band for the federal funds rate. There seems to be a view that there’s still scope for them to push those up further. So in Australia, we could have another maybe two up to two cash rate increases. That seems to be you know, that’s a possibility depends on what your outlook is for the state of the economy. Some people are thinking that might be too much given that, you know, these interest rate increases are really starting to bite already is having a big impact on house prices. We’re seeing that already. So house prices are really coming off. If I look at the ASX this thing called the ASX 30 Day interbank cash rate futures implied yield curve. So this is based on market pricing for financial market products. So this is this What is it 30 Day interbank cash rate future. So, essentially you can bet on what the cash rate is going to be in the future. And from this, it’s showing that the markets essentially expecting that the cash rate will peak at a bit over 3.8% later this year, and then it starts coming off from a peak around I think that’s October, and then it’s slightly falling. And then by June 2024, it’s down around 3.6%. So the market here in Australia is expecting two to three additional increases in the cash rate it appears of around 25 basis points or a quarter of a percentage point. So the markets expecting two to three more increases. I think other economists would be but there’s debate about just how many and the current state of the economy and how the economy will react to that. That’s one of the great unknowns, how will households react to these higher interest rates. And that’s one of the unknowns too in other countries in the States. It looks like there’s probably there will probably be another, at least one more increase in the federal funds rate in the States. There was a report in the Financial Times yesterday regarding some comments from one of the Federal Reserve officials, Mary Daly think she’s from San Francisco fed and the FT reported that Mary Daly became the latest Federal Reserve official to raise the prospect of the US central bank slowing the pace of its interest rate increases to a quarter point rise next month, even as policymakers backed the benchmark rates surpassing 5% Okay, so if you, I think in the Federal Reserve in their publication when they publish their decisions, they have these charts, which show what the Federal Open Markets Committee members, what they forecasting for future federal funds rate, which is a really interesting way to do it. And it gives you some insight and into how the members are thinking and where federal funds rate could be going. It’s really quite a clever thing to do and possibly something the Australian reserve bank could think about doing. And I don’t know whether this is an issue that they’re considering in their manage their review of the reserve bank that’s going on at the moment, I might have to look into that. But it looks like yep, so. So members are the people who are responsible for monetary policy, and the states are expecting a couple more increases in that federal funds rate. So they expect it’ll end up getting beyond 5%. They’re currently targeting 4.25 to 4.5%. But what this is saying is based on recent data in the States, which suggests that the economy might be losing some of the some steam, its inflation may not be as much of a problem as previously, based on that. They’re saying, well, the Federal Reserve can slow down the rate of interest rate increases. So that’s what’s going on there. Okay, so the general expectation that we’d have is that there will still be a few more interest rate increases this year in the US and the in Australia, maybe two, maybe three? I don’t know, it’s so difficult. Everything depends on how the economy reacts. New data. It’s just very difficult to forecast. But one thing I think we can say is that there will be additional interest rate increases. Do you have any thoughts on that? Arturo?

Arturo Espinoza Bocangel 17:01

I have a question about, at what point those heights interest rates will cause a slowdown in the economy. What do you think about that? We will face a slowdown or not?

Gene Tunny 17:21

Yeah, yeah, I think that’s starting to occur. All in Australia, I think households are really starting to feel those interest rate increases and, and more households will this year, because we’re seeing mortgages that were taken out. So the home purchases, they borrowed at fixed rates, and that was for a fixed term, a couple of years, or whatever it was. And then after that, these fixed rates reset to another level. And so that’s going to happen increasingly over this year, we’re going to see more people who borrowed at a fixed rate, they will end up facing a higher interest rate. So those rates that they’re paying reset at a higher level based on current rates, and the current variable rate based on that, and they will therefore have, they will have to pay more to service their mortgage. So there are various estimates of what it means it depends on the type of loan you’ve got, it depends on the amount you’ve got outstanding on your home loan, but for many households, the interest rate rises, we’ve seen it could mean an extra thing is $1,000 a month or something that they have to pay in mortgage

Arturo Espinoza Bocangel 18:43

and depending on what loan.

Gene Tunny 18:46

Yeah, it depends on a whole range of things. It depends on what was the deal you got originally and how much you borrowed, how much is outstanding still in, in what you owe and the principal that you are? So look, it’s going to depend, but there’s no doubt that it will be a substantial hit to the budgets of many households. And we should start seeing consumption spending slow. But look, I mean, the last year the Australian economy performed, I think extraordinarily well. And unemployment got down to under three and a half percent, which is just incredible. Yeah, but I think definitely will go we shouldn’t see, nothing’s definite in economics in macro economics. Yeah. Things could judge. You just don’t know what’s around the corner sometimes. But look, I mean, my guess would be that we will start to see the economy slow this year. Will we have a recession? Well, I hope not. I think I’ve seen some forecasts from some of the bank economists might have been Jo Masters, or I’ll have to dig it up. But basically, they, they’ll say, oh, look, we think it’s more likely than not we won’t have a recession. But the probability of a recession is, I don’t know is 30% or something or 40%. I don’t know, I have to look that up. But I know that there are some people saying, Look, yes, it is possible that there could be a recession here, and also in the States. In fact, there were some people last year saying, Oh, the US had already had a risk that it was in recession last year, because they were two negative quarters of GDP. But it turns out that that was a bit of a statistical anomaly or just a freak result, and really didn’t signal that an economy then in recession. So yeah, look, it’s possible, we could see some recessions. But I mean, as always, I mean, I think, given the complexity of the economy, and all of the moving parts and all of the shocks that could occur, it’s just so hard to actually forecast that sort of thing. I mean, I remember when I was in Treasury, and right up until 2008, we were saying, and most macro economic forecasters, were saying, Oh, we’re in this new era of the Great Moderation, and we didn’t have to worry about the business cycle anymore. And then, I mean, then we have the financial crisis, and it’s the worst, worst crisis since the Great Depression. So things can change the I’m always reluctant to to provide any, any forecasts. Okay. So yeah, those are my thoughts. I mean, what do you think, Arturo, do you have any thoughts on it?

Arturo Espinoza Bocangel 21:42

Well, I think that we are under a period of higher certainty than other times after the global financial crisis. Of course, there are a lot of Australians that are suffering with these higher tax rates. Mortgages, as you have mentioned, I think we need to be cautious about this period.

Gene Tunny 22:07

Yeah, exactly. I found that that article by that mentions, recession forecasts by Jo masters, she’s with think it’s a bank or some sort of investment being Baron Joey, is it. So masters thinks Australia will avoid a recession, but it will be a very close call. So this is an article in the financial review January 3, this year, so we’re recording this on the 11th of January, everything must go right for Australia to dodge a recession. Okay. So she’s one of the people who is concerned that because of these higher interest rates, then yeah, it’s going to have a significant impact on consumption, then she’s saying that offsetting that is the fact that we’re getting all of these international students coming back into Australia. So that’s one thing that’s going to add to demand. Okay. I’ll put a link in the show notes to this article by that mentions, Jo masters, predictions. Okay. So that’s, that’s where to from here. Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny 24:00

Now back to the show. One thing that is concerned some people is wondering, Well, is there a risk that we could get back to some of the crazily high interest rates that have been seen in past periods? So in Australia, for example, we had interest rates at 17 to 18%. At one time, back in the late 80s, early 90s, we had really high interest rates, but that was also at a point in time. When we had inflation of around 8% We had money supply growth of 20% plus. So we had a big boom in the late 80s. This was the age of the entrepreneurs a lot of lending a lot of property, lots of speculation, and I would say that it’s probably unlikely I can’t see interest rates getting back to anywhere near that sort of crazy heights. Given that the macro economic conditions are different today, there was much more entrenched inflation, people expected high inflation. I think if you look one year ahead, some market economists are expecting inflation of over 4% or something like that. But it’s not as if every year we’re expecting inflation of 8% or something like that. So monetary policy doesn’t have to be as restrictive to get inflation under control to to get all of the money creation, all the credit creation that’s leading to the growth in the money supply, it doesn’t need to be as aggressive to get that under control. So my expectation is that we don’t have to, we wouldn’t see that, again, just because inflation is not at those Well, it’s not entrenched at those rates. So we’ve got high inflation at the moment at 7%. If it turns out that the RBA can’t get inflation down, then they will have to increase, keep increasing the cash rate. But I would expect they wouldn’t have to increase it anywhere near some of those really high interest rates that they have in the past, because it seems like your households are already they’re going to start suffering even with the interest rate increases that we’ve seen. So if they increase the interest rates a bit more, say another half a percent, then the hope is that that will start you know slowing the economy taking the heat out of the economy enough that we can get inflation under control. So yeah, we won’t get back to those, those crazy interest rates that have been seen in the past, just because the nature of the economy is different. We haven’t had sustained inflation over such a long period as we had back then over several years. And then having that inflation, getting expected having these entrenched inflation expectations which the central banks have to then act aggressively against. I’ll put some links to some charts on on inflation and interest rates and what we’ve seen in the past, and just so people can see if you’re in the audience, you’re interested, you can have a look at what what these things have been in the past. They what strikes me is when I look at, well, interest rates, which is what we’re talking about today, you look at interest rates historically, and they’ve been all over the place. This is why when we’re talking about normalisation when we’re talking about normalisation to some, what do they call it some equilibrium rate of interest where we’ve got the economy balanced, we’ve got inflation at Target, we’ve got the economy going along smoothly. We don’t know there’s no one interest rate over history, that’s it’s not going to be the same interest rate, it’s going to depend on the macro economic circumstances at the time. There was an estimate that the Reserve Bank put out of what the equilibrium real interest rate is. And the central estimate they came up with, I think it averaged at 1%. Now, that’s a real interest rate. And then if we think about what would the nominal interest rate be, this is something I may not have defined yet, Arturo. But we’ve got to think about, one of the reasons you end up with a 17% or 18% interest rate is because inflation is expected to be about 8% or something, or whatever it is. So the interest rate at least has to compensate for the inflation that’s expected. And then you’ve got the real component of the interest rate, the so called real interest rate. And the inflation gets added to that to get the nominal interest rate. So when this is one of the tricky things with interest rates, it needs to be appreciated. There’s a there’s a nominal interest rate and all of these, these rates that we’ve been talking about the policy, the cash rate, the RBA cash rate, or the federal funds rate, that’s a nominal interest rate. That’s not the real interest rate that has been paid. Because one thing that inflation does, it erodes the real value of debts. So if you’re only earning, I mean, you’d be earning more than the cash rate, if you’ve invested if you’ve bought a you know, an asset of some kind of financial asset. But let’s just say you, the cash rates 3.1% at the moment, the inflation rate 7.1%. Now, you could argue or looking backwards, this is an ex post view of things. So after the fact, if you’re only earning 3.1% per year on your asset and inflation was 7.1% then you’ve gone backwards 4% hit right. Yeah. Now that’s an ex post calculation another way, well, what ends up happening is that the market is going to adjust these interest rates will adjust to incorporate expectations of future inflation. And so, therefore, the interest rate that you see at a point in time, should equal whatever people demand on the market determined real rate of interest, plus the expected rate of inflation, which I think is that’s the Fisher equation, I think, isn’t it? There’s a relationship between inflation and interest rates. That’s called the Fisher equation after Irving Fisher, that I’ll put it in the show notes. Yes. Okay. So that’s a that’s a bit of technical detail. I’ll put some links on all of that. Yeah. And what I find extraordinary is that just over recorded history, there are all these different types of interest rates that we’ve observed. And I always go back to this great passage from John Maynard Keynes, one of the great economists, obviously. And Keynes, in chapter 15 of the general theory, incentives to liquidity wrote that it might be more accurate, perhaps to say that the rate of interest is a highly conventional rather than a highly psychological phenomenon, for its actual value is largely governed by the prevailing view as to what its value is expected to be. Okay, I think that’s quite clever and observation. And, yeah, what he’s getting out there is that it ends up being conventional, in a way, it depends on what it’s expected to be. And I think that’s quite interesting, because for a long time, well, after the financial crisis, there was this expectation of low interest rates, and that was supported by the central bank’s pumping a lot of money into the economy. But now, I mean, who knows, I mean, the expectation could be of higher interest rates. So we’ll have to wait and see where things settle, and what expectations and being and what people, people think as an acceptable interest rate. Historically, we’ve seen interest rates and the ones I’m quoting, they’re going to be nominal interest rates of around three to 4%. On government bonds. And so this can be considered a risk free rate, this could be considered as similar to the the cash rate, although a bit higher due to the fact that there’s a yield curve that if you borrow for, for a longer period, you generally have to pay a higher interest rate. But if we look at what we see in the data, or what we’ve observed in history, these UK consoles, which are perpetual bonds, whereby the government, the UK government borrowed, say, I don’t know let’s say they borrow 100 pounds, and then you get this console, this note that says, The UK government will pay you three to 4% of that. So three pounds or four pounds every year, in perpetuity, on that, that console of 100 pounds. I don’t know if that was the actual denomination, but this is just to explain it. So these were perpetual bonds that the government never repaid. It just paid an interest rate each year. And historically, that was three to 4%, depending on when they issued the console, and what they thought was necessary to attract the people to buy the console to lend money to the UK Government, it turns out I think was about seven or eight years ago, the UK actually bought back the final consoles that are on issue. So there were these consoles that were that have been on issue for decades or centuries, that were still owned by nothing to various investors in England in the UK that the HM Treasury bought back finally, so I’ll put a link in the show notes there. So if we look at the historical evidence, we see consoles, they were yielding three to 4%. And if we look at the history of what’s called bank rate in the UK, which is the last day, that overnight interest rate, the policy rate, that the Bank of England influences historically, it’s ranged from, if we look at, from when the Bank of England was set up, so in 1694, it was looks like it was 6% or so I’ll put a link in the show notes to the actual data, and then it dropped down to what’s that nearly 3%, around 3%. Then for a long period from 1720 to 1820 it was about it was 5%. And then it fluctuates a bit more, I’ve got a chart that I’ve pulled off macro bond that I think that’s a great chart, I’ll put a link in the show notes. And then in the 19th century, it fluctuates quite a bit. And at times, it gets up to 10%. This must be related to the UK trying to maintain the gold value of sterling. So this is related. I think this is related to the gold standard, and having to maintain that and adjusting bank rate to do that. But I think what’s fascinating about that is for a very long time, so for about 100 years, it had the interest rate it at 5%. And that’s their policy rate. Okay, so we’ve been talking about interest rates, and these are interest rates related to financial securities. And other bit of evidence that is, that is interesting is the evidence, or the data points that you’ll see in novels by Jane Austen or Balzac? So Jane Austen, obviously, right Pride and Prejudice, Sense and Sensibility, etc. Balzac wrote old man glorioso, his French writer, this is something Thomas Piketty pointed out in his book on capital in the 21st century that if you read these novels, you’ll see that it was generally understood that the rate of return on land was about four to 5%. That’s a rate of return on an investment that’s different from the interest rate. But it gives you an idea of what was people were expecting to earn from investments in assets, and there’s some risk associated with land, or owning anything. So it’s not going to be a risk free interest rate. But I think it gives you gives you some idea of what rates of return were so right rate of return on land, historically, 4 to 5%. And it was taken for granted, that land yields 5% is what picket is writing. So the value is equal to roughly 20 years of annual rent. So I think that’s, that’s a really interesting data point. So what we’re getting is that, but another thing to consider is that that’s probably in a time when, historically there wasn’t a lot of inflation. I mean, there was during war time. But generally, until we had this, we adopted fiat currency in the 20th century, inflation wasn’t usually a problem, although you could have episodes of inflation, if there was a crisis of some kind. But I think you could probably interpret that as those is real rates, real rates of return almost. What we could conclude is that, yeah, I mean, interest rates are normalising historically, we’ve seen a range of interest rates, rates of three to 4%, four, or 5%. For risk free rates. That’s something you might expect, where current interest rates and up, it’s difficult to say it’s going to depend on the state of the economy, or how the economy reacts to those rate rises. I mean, this is something we’ll we’ll keep tracking we’ll keep following this year, and provide some more commentary, some more analysis on the future. Arturo, anything else you think we should cover?

Arturo Espinoza Bocangel 38:33

I think you have to cover most of the important things. So that was a good conclusion for this episode of the books.

Gene Tunny 38:43

Okay. Very good. Okay. All right. Thanks so much for your time.

Arturo Espinoza Bocangel 38:47

Thank you for having me.

Gene Tunny 38:50

Okay, have you found that informative and enjoyable. In my view, the main takeaway is that monetary policy is still in what’s called a tightening cycle. Interest rates will have to increase some more because inflation is still too high. It’s hard to know when the tightening will stop. The US experience suggests tightening cycles last a bit under two years on average, according to an informative note from Chatham financial, which I’ll link to in the show notes. The US Fed started tightening in March last year, and the Reserve Bank of Australia started last May, suggesting we could still have many months to go. Of course, this tightening cycle doesn’t necessarily have to conform to the average. Much depends on how the economy responds. In Australia, we’re hopeful we won’t need many more interest rate increases to sufficiently slow demand and get inflation under control. Even though the cash rate hasn’t been pushed up to a very high level in historical terms, the rate increases that we’ve seen could still be effective because of the heavy load of household debt that people have incurred to buy high priced properties. How much will the economy slow down? Will it just be a slowdown a reduction in the GDP growth rate or a contraction in which GDP falls? And we have negative growth for a couple of quarters at least that is a recession. Recessions in both Australia and the US are definitely possible. Indeed, recessions often occur after central banks tighten monetary policy. The 2009, New York Fed paper noted 11 and 14 monetary tightening cycles since 1955, were followed by increases in unemployment. That is, it’s very difficult for central banks to bring about a so-called soft landing. That was me speaking rather than the Fed. I’d note that some economists are even speculating that because economies will slow down substantially, we’ll start seeing interest rate cuts toward the end of 2023. Honestly, I don’t know whether we’ll have soft landings or recessions, a lot depends on psychology, and just how entrenched expectations of high inflation have become, the more entrenched they are, the more interest rates have to keep on increasing. We need to wait and see just how effective the interest rate increases we’ve seen already have been and will be. Obviously, this is one of the big economic issues of the year. And I’ll continue to keep a close eye on it. And I’ll come back to you in a future episode this year. Thanks for listening. Alright, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

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Tags central banks, fed, inflation, interest rates, monetary policy, rba, recession