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Podcast episode

Industrial Policy vs Free Trade w/ Ian Fletcher, Coalition for a Prosperous America – EP271

Ian Fletcher, co-author of Industrial Policy for the United States, published by Cambridge University Press, joins the show to argue free trade does not always serve national interests. Fletcher defines industrial policy as government intervention to support better industries, emphasizing that some industries are inherently more valuable. Fletcher highlights successful industrial policies in Japan, Korea, and Germany. He also discusses the role of tariffs in protecting domestic industries, using the example of U.S. electric vehicle tariffs on Chinese imports. 

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About this episode’s guest: Ian Fletcher

Ian Fletcher is an Advisory Board Member for Coalition for a Prosperous America. He is the author of Free Trade Doesn’t Work (2010) and a co-author of The Conservative Case Against Free Trade. He was Senior Economist at the Coalition for a Prosperous America and a Research Fellow at the US Business and Industry Council. He was educated at Columbia and Chicago.

Timestamps for EP271

  • Introduction (0:00)
  • Defining Industrial Policy (3:31)
  • Ian Fletcher’s Journey into Industrial Policy (6:48)
  • Better Industries and Manufacturing (11:27)
  • Arguments Against Free Trade (18:10)
  • Case Studies and Successes of Industrial Policy (28:07)
  • Tariffs and Modern Industrial Policy (48:21)
  • Taiwan’s Success Story (51:46)
  • Conclusion and Final Thoughts (53:51)

Takeaways

  1. Industrial Policy Defined: Industrial policy focuses on nurturing high-value industries that provide higher wages and foster innovation.
  2. Free Trade Critique: While free trade reduces consumer costs, it can lead to job losses, regional economic disparities, and reliance on foreign manufacturing.
  3. Global Lessons: Successful industrial policies in countries like Taiwan and Germany show strategic government intervention can be successful in some instances, while failures in the UK and India underscore the risks of mismanagement.
  4. Technology Pipeline: Ian Fletcher argues that a robust pipeline connecting scientific research to commercialization is critical for maintaining competitiveness in manufacturing and innovation.

Links relevant to the conversation

Ian’s book “Industrial Policy for the United States: Winning the Competition for Good Jobs and High-Value Industries”:

https://www.amazon.com.au/Industrial-Policy-United-States-Competition/dp/1009243071

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Transcript: Industrial Policy vs Free Trade w/ Ian Fletcher, Coalition for a Prosperous America – EP271

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.

Ian Fletcher  00:03

People’s mobility from job to job is not frictionless. It’s not frictionless for people to move where the new jobs are. People’s entire lives, friends, family, support systems are in one place. If they pick up and, you know, try to move someplace else just to get a job. There’s reasons why people don’t do that. When you have the economy collapse in some Midwestern factory town, the real estate market collapses with it. So anybody who lives there wants to move someone else is trying to sell a house that is now worth very little there’s not worth enough money to buy a house in the place they’d have to move to, where there are jobs, where real estate prices are high because people have money. There are all these factors, which, when you look in detail at what happened, you discover that the Ricardian free trade story is just full of holes in gene,

Gene Tunny  01:04

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 and welcome to the show. This episode, I’m joined by Ian Fletcher an advisory board member for the Coalition for a prosperous America. Ian’s previously served as senior economist at the coalition and as a research fellow at the US Business and Industry Council. He holds credentials from Columbia University and the University of Chicago. In this episode, we talk about Ian’s latest book, industrial policy for the United States, published by Cambridge University Press, this book explores both the rationale and the practical steps for implementing industrial policy. Ian and his co author lay out their blueprint for developing high value industries, fostering innovation and boosting economic growth in the US. If you’ve listened to this podcast before, you’ll know that I’ve made some criticisms of industrial policy, criticisms that many economists share. There’s often a fear that governments, by trying to pick winners, might end up picking losers instead. That’s why I’m especially keen to hear Ian’s take, even if I disagree with him on certain points. His views come from a deep understanding of economic history and a careful examination of how policies have worked in the real world, whether you’re skeptical of industrial policy or all for it, I think you’ll find plenty of insights here before we dive in. I want to thank Lumo coffee for sponsoring this episode, economics explorer, listeners can enjoy a 10% discount on their premium organic coffee from the highlands of Peru. You’ll find the details in the show notes. Now let’s jump into the episode. I hope you enjoy it. Ian Fletcher, welcome to the program.

Ian Fletcher  03:18

Thanks for having me on your show gene, of course,

Gene Tunny  03:21

you’ve written or co authored a real weighty book on industrial policy, industrial policy for the United States, winning the competition for good jobs and high value industries, published by Cambridge University Press. Can we start off Ian by understanding your definition of industrial policy. When you talk about industrial policy, what do you mean, please. Well,

Ian Fletcher  03:51

industrial policy is about three basic facts. The first fact is, is some industries are better than others. They can pay higher wages, their output is worth more. They can provide higher profits, the more fruitful for producing growth in other parts of the economy and a bunch of other things. Anyway, some industries are better than others. All industries are not created equal. Second idea is the free market. Our beloved free market will not, on its own, give any particular country, the US, Australia, Taiwan, you name it, will not give any particular country the best industries that it could hypothetically acquire. Free markets are great, but they’re not the whole story. And the third idea is that judiciously chosen government policies have and can make a difference in terms of getting a country better industries than it otherwise would have, which means that the workers get. Paid more, your capitalists are happy. They make more profit and a bunch of other advantages. So that’s the basic idea of industrial policy, right there.

Gene Tunny  05:11

Got you. And in terms of the policy measures, we’re talking things that it may be grants for support for innovation, R and D. It could be tariffs, it could be concessional loans, a whole bunch of things, procurement policy, just, just so we just set out what, what’s involved. It’s a there’s a broad range of policies. Is that correct?

Ian Fletcher  05:33

For sure, some people who criticize industrial policy think it’s about nothing but tariffs, which are one part of it or one tool. Other people who criticize it think it’s nothing about subsidizing industries. You just shovel money out the government store. Industrial Policy is a package of about three dozen different tools, all sorts of things. You mentioned some of them, for example, most technologies are developed by the private sector, but there are some technologies that are too speculative, too risky, too long term, or they’re difficult to patent and keep to yourself. So they work a lot better when they’re developed by the government. The Internet is the most famous example. The internet was not invented by some company trying to make money. It was invented by government scientists to share data, and people figured out later that you could do all these wonderful things with it, and the private sector on its own is kind of unlikely to have developed it, yeah.

Gene Tunny  06:36

Okay, so there’s a I think we’ll I’d like to explore that later. What are the boundaries between science and innovation policy and industrial policy? I think that would be good to discuss so that, I think that’s a good introduction. But asking, How did you get interested in industrial policy in the first place?

Ian Fletcher  06:53

What happened was I wrote my first book, which is called free trade doesn’t work, because I got interested around 2007 in the fact that America was supposedly doing everything it was supposed to do economically, and yet we had all these problems. So I went looking on Amazon to see if I could find a book that could explain to me the critique of free trade, why this might not be the best idea, and I didn’t find it. There was no such book. So in order to read the book, I had to write it myself. So I had some help from a friend of mine who was working at a Washington think tank. At the time, he got me some sponsorship, and I had some philanthropic support. So that’s how I wrote the first book. And when I wrote free trade doesn’t work, it came out in 2010 and for the first month after it came out, I was terrified that I was going to get an email, what day suddenly, and someone’s going to say, hey, Fletcher, I read your book. Nice try, but you’re completely wrong. And free trade really is best because of x. And I didn’t know what X was going to be, but there’s a true story. I was afraid that somebody was going to come up with something, and it’s now 15 years since the book came out, and that isn’t what happened. Instead, an idea that was very much on the fringe when I wrote about it, has now become mainstream in in both political parties, in the US and in some other countries around the world. So you actually asked about industrial policy. Well, industrial policy, which is the current book, it’s the next step after you repudiate free trade. If you say, okay, free trade isn’t best, well, then you’ve also repudiated the whole globalist model of successful economics, because what they tell you is that free movement of goods, free movement of capital, privatization, fiscal austerity and a bunch of other deregulation. They tell you, that’s the way a country gets economic growth. Now, if you take free trade out of the picture, the rest of it, one you become skeptical of it, because if the free trade component is wrong, what else could be wrong? And the other thing is, the model starts to fall apart in practice. So the question then becomes, okay, smart guy, if you don’t want free trade, what do you want? What is your recipe for national economic success? And that’s really what industrial policy is. It consists in saying that a successful economy, a high wage economy, a wealthy country, it comes from having productive industries and. The market will do a lot to get you there, but it won’t do everything for some very deep seated reasons, so governments need to step in. Now, historically, this is what happened in all the countries that became rich, starting with Great Britain in the 19th century. And it goes back even earlier than there the United States, France, Germany, Japan, most recently, you’ve seen it in East Asia. But when you dig into the real economic history of these things, you discover that industrial policy has kind of a huge but largely ignored role in the success of lot of industries, and therefore of a lot of countries and the US is in a situation now with its own economic decline, particularly in manufacturing, and with the geopolitical threat posed by China of having to get its Economic act together again. And that, pretty much by definition, means you’re going to have to be doing industrial policy, but you want to be doing it right, because there are many, many ways to screw it up, and people who criticize it on grounds of, yes, this screws up all the time. They’re correct, and that’s part of why we wrote the book, is to avoid that happening here.

Gene Tunny  11:22

Yeah, yeah, okay, yep, yep, good point. Okay. Now there are lots of things I want to explore, but I want to go back to the when you defined industrial policy, you mentioned there some industries are better than others in your view. What are those better industries?

Ian Fletcher  11:41

Well, you’re talking about industries like in the US, manufacturing, cars, manufacturing, computers, manufacturing, aircraft, manufacturing pharmaceuticals. These are industries which have, above all, they have a high value added per man hour. Now how much can pay your workers depends on how much value they produce. Otherwise you’re going to lose money. You can’t pay somebody $10 an hour if they produce $9 an hour of value, but if you’re producing $20 an hour of value, maybe you can pay them $15 an hour and still make a profit. So that means you have to have certain industries in your country. If the only jobs out there are tiny number of people working on farms in every developed country, and then local service industries, which is the bulk of the jobs in any developed country. But those are, you know, things like working at McDonald’s or working in Walmart, those kind of jobs don’t have a potentially very high value added because the value of a cheeseburger is just not even remotely as high as the value of an automobile. So you want to get into these high value added industries now they’re difficult because you require technology that doesn’t grow on trees. You require supply chains, skilled labor, large corporate organizations that can administer these complex companies. So these industries are hard to get, and in the face of international rivalry, they’re hard to keep, but they’re very lucrative to have.

Gene Tunny  13:22

Is it the manufacturing per se, or the manufacturing itself, or is it the design of the products, actually developing the products, doing the R and D? I mean, think of Apple. I mean, it doesn’t do the manufacturing in the United States, does it? But yet it designs high value products. Do you have any thoughts on that? How do you how do you define manufacturing?

Ian Fletcher  13:45

Yeah, the first thing I want to tell you is that Apple and the iPhone, which people love to talk about, are just about the worst case study example for understanding how modern economies do and should work, because Apple is a very exceptional company, starting with the fact that they’ve managed to prevent the Chinese from just stealing all their intellectual property and flooding the market with copycat iPhones. It’s a mistake to think that an entire nation can specialize in simply design and just outsource the manufacturing elsewhere. That’s been a very popular idea in the United States, and that’s probably a recipe for having enough high value jobs to keep the San Francisco Bay area where I live, Silicon Valley, keep that going nice. But the United States has a population of over 300 million people. Most of those people are not going to be computer chip designers. They’re not going to be iPhone engineers. They don’t have the skills. They’re not going to acquire them. They also don’t live in places that have the headquarters of giant international computer companies. This is why the. So we have the problem in America, flyover country is the term Some people use to describe the vast interior between the two glamorous centers of power and money on the East Coast and the West Coast. You need manufacturing if you push high value added technologically rich jobs, down to the bulk of your population and across your national geography. The other problem is, when you outsource the manufacturing, you often end up outsourcing the production as well. There’s a long list of companies in the US that started by sending simple bits of fabrication to the Far East and more advanced bits, then they’re making the whole thing there. And then, lo and behold, they’re surprised to find that they now have competitors in that part of the world who are making a product similar to theirs and competing with them. And when you lose the manufacturing capability, you lose a lot of the innovation capability, because a lot of innovation doesn’t consist in scientists discovering things in a lab or even engineers drawing up a blueprint on computer aided design machine. It’s stuff that emerges from the factory floor. It merges from the experience of what’s called manufacturability. There are whole classes of expertise that really don’t exist in the US very much anymore, because nobody manufactures the product here. The US would love to have people here who can manufacture carbon fiber aircraft wings, which we currently get from the Japanese Boeing outsource something like 30% of the 787. Is foreign. And if you don’t have that manufacturing, you’re not going to have the expertise needed to develop the next better form of it. And you have to remember that manufacturing does not mean these images we have from 1950s black and white movies of you know, barely literate proletarian labor, hammering at metal objects going down an assembly line. I suggest anybody who’s listening to this and is skeptical. Find some modern manufacturing plant in your vicinity that occasionally lets people have a tour. Some of them do. I’ve visited some on this basis, and take a look at what’s going on you inside, you find these incredibly advanced precision operations, these computer controlled pieces of machinery, lasers, you You name it, and you have people milling around, keeping the machinery working and doing a few things that it can’t do. But modern factories have far more in common with the Starship Enterprise than they do with Dickensian mills. Yeah,

Gene Tunny  17:58

yeah. I agree with you on that one. I mean, I’ve visited various factories, the Coca Cola factory. Just go to any Coca Cola Bottling plant or manufacturing facility. Now, it’s just extraordinary. The level of automation. You hardly see anyone on the factory floor. You just see all these conveyor belts with all these cans whizzing by. It’s incredibly impressive. Okay, right? Just on free trade. I just want to go back to that. So I guess the traditional argument for free trade is that it does result in lower costs, lower prices for consumers, so consumers are better off, lower input costs for industries, and that should, yep, okay, look, I would understand your where you’re coming from, that what that that should result in, you know, improved, uh, improved output. Higher GDP is the argument, higher welfare for consumers. What are your arguments against free trade? Please. Ian, okay,

Ian Fletcher  18:59

the package of ideas you just presented forms a complex known as the theory of comparative advantage. And it goes back about 200 years to David Ricardo, who is a British economist who kind of first worked this out. And I’ll say straight up that a lot of these theories are in fact true, which is why neither I nor the organization whose advisory board I’m on, which is Coalition for prosperous America, which you can find at prosperous america.org none of us are in favor of abolishing Trade. We’re against free trade. We’re not against trade. Nobody here favors autarky, which is what completely crazy countries like North Korea try to achieve. But that theory of free trade is, I don’t know if it’s 75% true or what number. You want to put on it, because there are huge gaps in the theory, huge holes in the theory, huge exceptions that are big enough that taken together, it’s very expensive to ignore. For a start, you talked about low consumer prices. Low consumer prices are not the only good thing in an economy you want low prices, you also want high wages. Okay? And if you look into this theory, the problem with it is it depends intellectually on a lot of unstated assumptions that range from dubious to obviously false. One assumption. It assumes, and this is more aimed at the economists watching than most non economists, it assumes that there’s no international capital mobility. It assumes that what are called factors of production don’t migrate internationally. It assumes that there are no what are called externalities, that is social costs like pollution or the social damage due to job loss. The other interesting thing is this theory doesn’t even say, even if it is true, which it isn’t even if it were completely true. It doesn’t say a lot of the things that people who cite it think it says. For example, a lot of people think that Ricardo proved that a rising tide lifts all boats, as I say, that free trade is good for everyone. No, even Ricardo didn’t think it said that a lot of people think that free trade is a long term strategic answer for how to develop a country or keep it prosperous if it already is. Well, the theory doesn’t even say that. The theory only tells you what the right thing to do right now, you know, if you have coconuts and an island next to you has oranges, you exchange coconuts and oranges and you end up better off. It doesn’t say anything at all about economic growth. It doesn’t say anything at all about long term development trajectories of countries, but that’s what really counts. One of my favorite quotes on the subject, which is in both of my books, and I can’t remember where I saw it first, or I would claim originality, is that economic growth is about turning from Burkina Faso into South Korea. It is not about being the most efficient possible Burkina Faso forever that cuts through a lot of sophistry in the economic discipline, where people forget what a narrow concept efficiency is. I mean, efficiency is great. You don’t want to be inefficient, but it’s not the only thing that counts in economic life. It’s not the only thing that’s good for you.

Gene Tunny  23:05

Okay, can you talk about, or you know that this idea the rising tide lifts all boats? What? What’s the concern, what boats didn’t get lifted with? I mean, I presume you’re sort of talking about NAFTA China entering into the WTO what? What are the concerns that you’ve seen there? What boats weren’t lifted? Ian, is that part of your argument, one

Ian Fletcher  23:27

of the assumptions that was made when the United States entered NAFTA, when the United States led China into the World Trade Organization and opened up its markets, was that sure you’re going to lose certain jobs because you’re going to start importing things. But people lose their jobs all the time. People find new jobs all the time. It’s going to be okay if you have an economy that’s growing overall, people just go from one job to another job. Now it’s now being studied in detail. The key paper on this is called the China shock by a gentleman named David Autor at MIT. That’s a U, T, O R, for those of you want to look it up. And basically what was discovered is that’s not what happened to vast areas of the United States, secondary and tertiary urban centers where jobs were destroyed. People’s mobility from job to job is not frictionless. It’s not frictionless for people to move where the new jobs are. People’s entire lives, friends, family, support systems are in one place. If they pick up and, you know, try to move someplace else just to get a job. There’s reasons why people don’t do that. When you have the economy collapse in some Midwestern factory town, the real estate market collapses with it. So anybody who lives there wants to move someone else is trying to sell a house that is now worth very little. It is not worth enough money to buy a house in the place they’d have to move to where there are jobs, where real estate prices are high because people have money. There are all these factors, which, when you look in detail at what happened, you discover that the Ricardian free trade story, it’s just, it’s just full of holes. There are a number of things that are just wrong with it, even though, at some level, yeah, it’s an okay generalization about 75% of the time. Maybe,

Gene Tunny  25:37

yeah, I guess. What I’m wondering is, was there the potential for, I mean, there was there were gains from from NAFTA, or there were, well, I mean, China’s another story. When we chat about chat that a bit later. I mean, that’s a very controversial one, but I’m just wondering it was there the prospect for redistributing some of these gains, because I look at Australia and the story we tell ourselves in Australia, I used to be in the treasury here, and the story we we would tell ourselves, is that we had a high tariff wall up to the late 80s, and then we started bringing the tariffs down. We were trying to protect our car. Have a car industry. We protected it. We had a 57% tariff. At one time. We had high tariffs on textile, clothing and footwear, and we gradually reduced them. And then the story we tell ourselves is that that was good for consumers. We ended up with cheaper cars, cheaper clothes. In real terms, we had a period of strong productivity, strong economic growth in the from the like sort of second half of the 90s into the early 2000s and that allowed us to catch up. We went from the bottom third of the OECD to the top third of the OECD. We had job losses too, and I think because we had a Social Security system, we had a public health system, Medicare, then that sort of ameliorated or or meant that a lot of these problems you’re seeing in the United States. We didn’t see them as much here in Australia, and so we see the story as more of a positive story. Do you have any thoughts on that? Ian, yeah,

Ian Fletcher  27:11

for your international viewers, I just want to remark that it’s a myth that the United States doesn’t have a welfare state like other developed countries, it does, it’s just not quite as extensive. One of the things that’s different about the kind of economics that I and people who think as I do espouse and the consensus we’ve been living under, is the consensus generally gives the same answer for every industry, for every country, for every circumstance, it’s always the market. The market is always right, and we tend to come up with different answers based on different facts in an industry, in a country, a moment in historical time and so forth. So the problems that Australia has faced from free trade are quite different from those that the US has faced. For example, you talk about your car industry, by which I presume you mean Holden motors, the old Australian GM subsidiary, yeah,

Gene Tunny  28:13

we had Toyota and and also Mitsubishi. And I forget, sorry, a silly me, a toy Ida were here. Yep, for a while. Yep, yep, right.

Ian Fletcher  28:24

Well, the thing is that there’s a minimum efficient scale for a modern car plant, which means you need a minimum sales base if you’re going to be able to produce cars at the level of productivity comparable to the global standard, which is what you need to have pricing competitive with the rest of the world, and Australia is probably too small to support an auto industry on its own. So to go from having an autarkic auto industry to saying, okay, that’s not the right industry for us to be in, we’re going to let that go. Okay, that could have been a winner for you. But what I would point out is that Australia, throughout its modern history, is written on a succession of commodity booms, and your Australian listeners will know what the commodities involved were, as well as anyone right now, iron ore, coal, aluminum used to be, what did they say? Australia rides on a sheep’s back? Yeah, saying back in the day. Well, the problem with living off of commodity booms, a couple of problems. One is commodity booms come, they also go, I mean, coal, for example, given climate change concerns, eventually, either mankind is going to stop burning coal or it’s going to be so hot that nobody has to burn the stuff to stay warm. Okay, and I don’t know what’s going to happen with iron ore. I mean. Eventually China will finish building out its urban infrastructure and so forth. So commodity booms are not the best thing to stake your national prosperity on, from a global perspective, from an economic perspective, the other problem is, if you’re lucky to have commodities good for you if you don’t, well, you can’t create them the way you can create an auto industry. And what you basically got in Australia selling off non renewable commodities is you think you’re producing wealth. What you really have is an existing stock of wealth that was deposited under your country’s landscape by God, and you’re kind of extracting that and gradually selling it off bit by bit. It could work for as long as it works. Mean, you can look at the Petroleum Exporting Countries, they have a commodity that is in such huge demand that you can you can live off it, but there are problems with having a resource centered economy. What the better thing for Australia to do, I think, is to be a bit more like what Canada used to be, though Canada has kind of gone in that direction as well Canada, before NAFTA took the view that, yes, we have a huge quantity of natural resources as a large land mass country with a small population, but we don’t just want to end up a resource colony for the British Empire in the United States, so We are going to make the effort to develop manufacturing here. And for those of you who know Canada, Southern Ontario, which you can find on a map, used to be a very highly industrialized place, and still is, to some extent, and Canada was well integrated into the American automakers and and so forth. And the reason for that is it enables you to penetrate these high value industries with the high value added per man hour, among other things. If your best industries are going to be mining coal and iron ore, well, they don’t do that in suburban Sydney, they don’t do that in Brisbane or Melbourne. You can have manufacturing jobs in these other places. And I think the correct thing to do, if you face the fact that Australia is not big enough to have its own auto industry, say, is you specialize. That’s what a lot of successful countries have done. If you look at small countries like Singapore, they don’t have their own car industry either, but they specialize in, for example, electronics for automobiles. So you could be the people who make the computer chips that go into automobiles, the electrical harnesses for automobiles, and you ship them around the world to be assembled into cars or some other specialty, but that’s the way a country like Australia would get a desirably significant share of the really high value added industries.

Gene Tunny  33:20

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Gene Tunny  33:54

now back to the show. I think the point you make about the extraction of resources and well, yep, you’re depleting your wealth at the same time as you’re you’re selling them. That’s that’s a fair point. So the issue for the community is, how do we make sure that the community gets the right compensation for that? And so there’s a we’ve had a long standing debate about whether we’re doing that the right way royalties versus a resource rent tax. And then we look to you, look to Norway, and you see they’ve done something, you know, that looks pretty extraordinary in terms of what they’ve managed to do with with North Sea oil, and the wealth that they’ve managed to accumulate. So yeah, that they’ve really set a high standard there. So I think, yeah, that’s a I think so those points, I think they were, they were good to eject in the conversation. You know, I’d like to ask, what, what do you see as the tools of industrial policy that have the most merit, or the or, what are some case studies around the world that we should look to? I what I like about. Your book is, you’ve got some studies of different countries. You’ve got you look into the detail, the institutional detail, yep, the you know what’s happened? I like you talk about Taiwan. Well, I like the discussion of Taiwan and how that sort of, what are the agencies there that help foster some of some innovative businesses there? Can you tell us about what do you see as some of the successes? Yeah, we

Ian Fletcher  35:23

have a whole bunch of case studies in the book. We have success cases of Japan, Korea, China, Germany. We have France as a kind of half success case. Then we have failure cases of the UK, India and Argentina, partly to prove that we’re intellectually honest about the limitations of industrial policy, partly to show that when it does go wrong, it does not go wrong because the very idea is doomed. It does not go wrong because governments are too stupid or corrupt to do it right. It goes wrong because nations make what are upon examination fairly obviously elementary errors. Now getting back to your your actual question in terms of the policies that have the biggest impact, and this is going to vary from country to country, but for a country like the United States, you absolutely have to get your trade in balance, which means that your imports and your exports are approximately equal. Right now, the United States runs a trade deficit in goods that is physical stuff of over a trillion dollars a year, and only about a quarter of that is offset by services exports. So we have this gigantic trade deficit. So you want to have strong exports, creating jobs, if you’re going to have massive imports destroying jobs. So you want to get your trade in balance, which means tariffs, but it also means managing the price of your currency, because international currency rates are a gigantic sleeper issue that nobody is really talking about, but it’s incredibly important. The single biggest reason the US is running giant trade deficits is the US dollar is and has been significantly overvalued. I don’t know the status of the Australian dollar, so

Gene Tunny  37:21

not at the moment. Yeah, go ahead. You

Ian Fletcher  37:24

want to get that under control with policies like taxes or limits on international capital flows, because it’s foreign investment money flowing in the United States, buying existing assets and purchasing debt from Americans that pushes the dollar up too high. So when you get your trade in balance, I think the other thing you have to worry about is you need to have a good technology pipeline. That is to say, companies invent products, and sometimes companies invent technologies. But the most important, most fundamental technologies have a long history of coming from government, not just the internet, but jet passenger planes, for example, it all derives from military technology that was developed for reasons of the Cold War. Pharmaceuticals are almost entirely based on governmental research and then commercialized all sorts of humble things from a laser pointers, lactose free milk, I mean, all sorts of stuff derives from governmental technology research. So you need to push that hard. Or if you’re a small country, you need to figure out how to commercialize it early when it comes out of places like the US, Europe and China, which are doing it as large countries. And then you need a pipeline leading that to commercialize products. Because one thing that’s happened over and over in the United States is that we invent something, and then 20 years later, it turns out that all the jobs producing that something, all the corporations making profit producing that something, are in another country, for example, the flat panel displays that you’re probably watching this podcast on, that’s based on what’s ultimately American technology, but almost all of those displays Are Made in China, Japan, Korea, and part of why that happened is because the predecessor technology, the liquid crystal display, which you probably remember from digital watches, and you still see them around, that was also an American developed technology that ended up being produced abroad in. Yeah, and the reason for that is that these other countries have a much better pipeline between invention and production than the US does. There’s an assumption in the US, and as far as I know Australia too, that pure science just naturally turns into new products. And that’s not true. So there’s all sorts of institutions that you need in between. For example, in the US, under Barack Obama, they established a thing called a National Network for Manufacturing Innovation has since been renamed manufacturing USA, and this is a very small attempt at the US to solve this problem, because it’s a network of research and development institutions around the country, specialized according to different industries, where companies can go to work with government and also universities to develop new technologies. That it’s partly funded by the companies themselves to keep these institutions focused on things that are genuinely useful, but it’s also partly funded by the government in recognition of the fact that a lot of these ideas, when they are discovered, no one company is going to be able to keep that to itself. So why should they want to pay for something that everyone can use. This is an example of what you can do in the United States. And we do do these things. It’s just what we have is It’s a tense the size of the network the Germans have for an economy less than a quarter our size. I mentioned Germany before. They are European country that has, or has had, I mean, recently they did really stupid things, like becoming dependent on Russian natural gas and getting rid of their nuclear power stations. But Germany, and by extension, Germanic Europe, that is the countries that also follow the German example, which includes Austria, Switzerland, Poland and Scandinavia, they’ve had good industrial policies. The UK, for example, in Europe, has very much not had good policies.

Gene Tunny  42:12

Yeah, yeah. Exactly, exactly, yeah, okay, just on the UK. What? What went wrong in the 60s and 70s, with what the the UK was doing. I mean, we had some spectacular failures, like Concord, ultimately, which didn’t end up being commercial. What? What were the what was the problem in the UK? Well,

Ian Fletcher  42:31

I would actually trace the decay a little bit earlier than that. If you look at the Second World War when the American economy expanded 70% because the US was able to build plants at scale before entering the war, the British were fighting from the start, so their economy only expanded 17% and yet, because of wartime propaganda, people believed that they’d had a production miracle. They thought the British economy had done well during World War Two as a result, unlike in France, where, after the war was over, the country went through a very severe bout of frequently very honest self criticism, and they said, we just got defeated by Germany. Our economy wasn’t up to the military industrial complex we needed our wages weren’t high enough to keep the communists at bay. We’ve got to figure out what was wrong with our pre World War Two economy in this country and change it. And they did. The British thought after World War Two that their economy was fine, and the big thing they were worried about was, how do you transition to democratic socialism, which seemed like a nice idea to share the wealth of the workers without having some crazy communist revolution with storm troopers in concentration camps, etc, etc. So in the 1950s Great Britain had the opportunity to change fundamental things about its economy, but it didn’t. They thought they’d been doing well. And in fact, as late as 1950 with the rest of the world in ruins, it looked like Britain was doing well. I mean, exports had more than doubled since the end of the war. Britain, in 1950 was the world’s largest exporter of automobiles. They were pioneering new technologies like jet aircraft. I mean, they built jet passenger planes before, before the Americans, they had the world’s first nuclear power station. They thought they were doing well, but that meant that they never criticized their traditional ways of doing things. And in Britain, the traditional way of doing economics was very liberal in the old fashioned, 19th century sense of the government really doesn’t get involved. The government assumes that the private sector. Here can do everything. The government doesn’t see the need for a national economic strategy, so they just coasted on what they thought was a successful economy. And at the same time nations all around the world, because you got to remember the incredible shock of Japan being defeated, that caused them to think very hard about how to rebuild their own country from scratch, let alone Germany, which was, you know, utterly wiped out and politically discredited. So the Brits just kind of sat on their laurels and you asked specifically about Concorde? Well, Concorde was the result of building an aircraft based on simply the mindless extrapolation of one performance parameter, namely, speed. I actually used to work for an airline, so I can tell you that airlines are in the business to make money, which means that aircraft doesn’t just have to be fast, it has to be able to carry a large number of people and not be a horrendous gas guzzling so the Concord had a very narrow fuselage because it was supersonic, so It had to so it had low passenger capacity, and because it flew at twice the speed of sound, it had extremely fuel hungry engines, so it had terrible economics. It was only kept in service with British Airways and Air France for prestige reasons, and you could have thought that through at the beginning and realized this was a mistake. Interestingly enough, the United States actually made that call correctly. In the late 1960s the federal government was subsidizing Boeing to build a plane called the Boeing 2707 which was going to be a supersonic plane, kind of like the Concord. You can look up pictures of it on the internet. And at the outset of that project, somebody talked to the airlines, and they worked out what the parameters of range, payload, cost, passenger capacity, so on and so forth you would have to have for the thing to be commercially successful. I mean, they figured this out, and the project progressed for a few years, and got a certain amount of government money, but eventually Boeing wasn’t willing to go any further without a huge increase in the subsidy, and that’s when it was put to a vote. Was when Richard Nixon was president, and it was voted down in the Senate. They killed it. And the interesting thing is that none of the designs that Boeing had proposed for the plane that they said we could build this, we can build this. We can build this. None of those designs even promised in theory to meet the required parameters that have been set at the outset. So that’s one of the ways you make mistakes. That’s one of the ways you get things right in industrial policy, is you have to face the need for commercial viability, and you have to be disciplined about your objectives, rather than being distracted by the politics or distracted, which is equally as big a thing, by the difficulty in admitting you were wrong and you just spent a billion pounds doing something that’s better off abandoned before you spent 5 billion pounds on it.

Gene Tunny  48:35

Yeah, yeah. Okay. Can I ask before we go, what’s the role of tariffs in a modern industrial policy? In your view, Ian, are they a legitimate tool? Are they beneficial? In your view? Could you tell us, please,

Ian Fletcher  48:50

it depends what you’re doing, because tariffs can do a lot of different things. The tariffs that Trump imposed on China were about driving China to the bargaining table so that they would, for example, let our exports into the country. And if China is not going to do that, you want to reduce imports from China, which those tariffs have indeed done. The other thing that tariffs do, and the great virtue of tariffs is their industry specific, is, if you want to have a certain industry in your country, it’s got to sell product. And there’s only two ways to sell product. You either sell it domestically or you export it. And in order to export it, you need to have access to foreign markets, which is what we didn’t have in China, and that’s what I just mentioned. But you also don’t want to see your own domestic market taken away from your own producers by foreign imports, and that’s where tariffs come in. So in terms of whether President Biden would. Is right to impose a prohibitive tariff on imports of Chinese electric cars, which he did last year. Yeah, he’s absolutely right. Because if you don’t do that, there will not be an electric vehicle industry in the United States. There just

Gene Tunny  50:16

won’t right, yes, yes, yes. So the argument is that they were they’re subsidizing their their cars. Is that? That’s the argument? Is it what charge they’re

Ian Fletcher  50:27

subsidizing? But it doesn’t even really matter why their cars are cheaper than ours, whether it’s because of subsidies, whether it’s because they got there first, because of all the policies they used to push the country into electric vehicle adoption that were much more aggressive than the US and Europe, or the cheaper because they’re employing exploited labor, or whatever. Those are legitimate issues. But the bottom line is, if you have a massive flood of imports, you’re not going to be able to have this industry in the United States, and these are the kind of industries that you want. There are a limited number of industries that have the potentially high value added per man hour that you should be going after.

Gene Tunny  51:15

Yep. I mean, it’s look. I think these issues are certainly worth discussing. I mean, I just look at Chinese EVs. And I mean, they’re the popular EVs here at the moment the BYD, build your dreams. They’ve got a store down on Wickham Street and fortitude valley there. They’re incredibly popular. I think, you know people, people like the, the Chinese EVs, arguably, that, you know, probably because of the price that they’re cheaper, in a way, than a Tesla, I think, aren’t they? So, oh,

Ian Fletcher  51:45

sure, sure, yeah, I don’t take any position on what Australia should do. This is industrial policy United States, not for Australia. As I said, my way of thinking. Countries are different, industries are different, circumstances are different. I suppose I could look at Australia for a year and figure out what I think you should do, but as things stand, I have no opinion. Okay, that’s

Gene Tunny  52:13

fair enough. I mean, I think it’s, I think that’s a good point. I mean, every, every country is is different. So just before we go, I just want to go back to Taiwan, because I thought that was, that was something I found fascinating, because that’s a, that’s an success story. So they, I mean, I see industry policy as a bit of a or industrial policy as a bit of a gamble, right? I mean, sometimes you could have a success. I mean, economists tend to think most of the time, or there’s a, there’s a bias towards picking losers, but sometimes you do get some winners. And Taiwan is an example where they had an agency that helped out the major manufacturer of integrated circuits in the world. Is that correct? Yeah, you’re

Ian Fletcher  52:55

talking about it. Ri Yes, sure. They had, like all the East Asian countries have had very heavy handed, government centered policies that weren’t afraid to pick winners very explicitly, down to the corporate level, and do things that are relatively unlikely in any Western country. But you’ve also had strong industrial policies, as I mentioned, in Germanic Europe. So there are other ways of doing it. When I advocate industrial policy and I tell people what Japan did or Korea did, I’m not saying we should be like that. We don’t have to, you know, eat our food with sticks and eat cold fish for dinner. It’s about learning from what they did, which is more than just imitation. It’s about looking at the case study to see what underlying views of real economics. It reveals because the received laissez faire story that we were pretty much all brought up on is not true, and it’s becoming dangerously untrue, right? Okay.

Gene Tunny  54:01

Thanks for yeah, thanks for the conversation. Ian, I think this book, yeah, there’s a lot to think about. How many pages this is 700 or something, 700 and over 800 actually, yeah,

Ian Fletcher  54:13

it’s the reason it’s got reason it’s so big is because one, as I said, our way of thinking is very fact intensive. We view our opponents as just dishing off glib, ideological generalizations without bothering to get out of the classroom. The other thing is because what we’re saying is so controversial that every point we make is fastidiously footnoted, so that if economists want to argue with us about this stuff, we are prepared. And the third reason it’s so big is we don’t expect everyone to read all of it. It’s got a variety of content. So look at the table of contents and then pick out the bits that interest you. If you’re more interested in cars or you’re more interested. Interested in American history, or if you’re more interested in why economic theory is wrong, or so on and so forth, you pick out the bits. Maybe you’re familiar with the aircraft industry, I don’t know.

Gene Tunny  55:09

Yeah, yeah, exactly. I mean, I I agree with you. I mean, I think it’s you are you have been very fastidious. There are a lot of good references in there. And I mean, I’ve learned quite a bit from reading that you mentioned Danny Roderick. There was an interesting study that Danny Roderick did about how every his estimate was that every dollar gain from free trade for the US of GDP actually was associated with a $5 of redistribution or something of that magnitude. Yeah. What he’s talking

Ian Fletcher  55:43

about is that even if you assume that the conventional Ricardian theories of efficiency are true, the way that free trade makes your economy more efficient, it’s kind of like rearranging the furniture in your room to get more space, you have to move a lot of heavy stuff around to squeeze out a couple more square feet. So he’s absolutely right that well, he estimated that for every $1 in efficiency gain, free trade caused $5 of redistribution inside the economy that is changes in who gets wages, who gets profit, and so forth. I think that’s broadly true, though. I don’t have a quantification of my own to go up against his $5 figure. The highlight

Gene Tunny  56:35

of that in the book is I thought, Oh, that’s interesting. I’m going to look, look into that. Because, I mean, he’s a very if you want

Ian Fletcher  56:40

to, if you want to be in touch with him and ask him about that. I mean,

Gene Tunny  56:44

I’d be keen to, because he’s always been seen as someone who’s been very like as an economist. He’s someone who other economists look up to and think, okay, he’s saying some really interesting, clever things about industrial policy that really make us have to think about it. So I think, yeah, certainly be good to connect with him at some stage. But Ian Fletcher, I really appreciate the conversation. And again, learning to Yeah, talking about your new book, industrial policy for the United States. So I’ll put a link in the show notes. And yeah, certainly anyone interested in industrial policy, trade policy, with their innovation policy, they’re all related in a way I think would would get a lot out of it. So Ian, thanks so much for your time, and look forward to speaking with you in the future. Yes,

Ian Fletcher  57:30

thank you very much for having me on your show. Gene,

Gene Tunny  57:35

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 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.

Obsidian  58:22

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Credits

Thanks 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 and other podcasting platforms.

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Podcast episode

How LBOs, Share Buybacks & Private Equity Revolutionized Corporate America: Don Chew’s Case for Transformation – EP270

Donald Chew discusses the evolution of corporate finance, emphasizing the shift from old-fashioned corporate finance, which focused on steady earnings growth, to modern corporate finance, which aims for high returns on capital. He highlights the decline of conglomerates in the 1970s and the rise of private equity. Despite criticism, Chew argues that modern corporate finance has been a success story, citing the doubling of U.S. public company market capitalization in the 1980s and the significant correlation of R&D and selling, general and administrative expenses (SG&A) expenses with corporate value. He also addresses the financial crisis, arguing it was due to mispriced mortgages and government policies, not market inefficiencies.  Donald Chew is the founding editor of the Journal of Applied Corporate Finance, and joins show host Gene Tunny to discuss his latest book, The Making of Modern Corporate Finance, published by Columbia University Press.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

About this episode’s guest: Donald Chew

Don Chew is the founding editor and Editor-in-Chief of the Journal of Applied Corporate Finance (JACF), a publication he started almost 30 years ago. He has published over ten books on corporate finance, including The New Corporate Finance: Where Theory Meets Practice and The Revolution in Corporate Finance (with Joel Stern), which are both widely used in business schools throughout the United States and Europe. Don has both a Ph.D. in English and an MBA in finance from the University of Rochester.

Timestamps for EP270

  • Introduction (0:00)
  • The Decline of Conglomerates and the Rise of Modern Corporate Finance (5:58)
  • The Role of Private Equity and Corporate Governance (14:25)
  • The Impact of Modern Corporate Finance on Corporate Value (15:03)
  • The Future of Corporate Finance and Productivity Measurement (16:37)
  • The Role of Corporate Finance in Economic Growth (19:27)
  • The Critique of Modern Corporate Finance and Corporate Social Responsibility (27:26)
  • The Financial Crisis and the Role of Government Policy (35:40)
  • The Future of Corporate Finance and the Role of Private Equity (43:21)

Takeaways

  1. Modern Corporate Finance Principles: The shift from prioritizing steady earnings growth to maximizing long-term firm value has reshaped corporate strategies globally.
  2. The Importance of R&D: Increases in R&D and SG&A spending are now critical indicators of corporate value and long-term success, according to Don Chew.
  3. Private Equity’s Role: Private equity has transformed underperforming companies, streamlining operations and reallocating capital for growth.
  4. The Evolution of Corporate Governance: Shareholder activism has replaced hostile takeovers as the primary tool for enforcing corporate accountability.
  5. ESG and Value Creation: Enlightened value maximization is the idea that corporations can address societal concerns while enhancing long-term profitability.

Links relevant to the conversation

Don Chew’s new book The Making of Modern Corporate Finance:

https://www.amazon.com.au/Making-Modern-Corporate-Finance-History/dp/0231211104

Econometric study of benefits to consumers of Wal-Mart:

https://onlinelibrary.wiley.com/doi/abs/10.1002/jae.994

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Transcript: How LBOs, Share Buybacks & Private Equity Revolutionized Corporate America: Don Chew’s Case for Transformation – EP270

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.

Donald Chew  00:03

If you see large increases in R and D and S, G and A, that is kind of the best indicator of increases in corporate value. And it suggests that, you know, corporations, the investors, are recognized the values of these companies, even though it’s not reflected in earnings, and the companies keep pouring more money into it. So you see these PE multiples going through the roof, and you also see lots of companies with negative earnings. You know, in the old days, in the 70s, only 10% of US companies would have negative operating cash flow. Today it’s over 30% of publicly traded companies are losing money every year.

Gene Tunny  00:52

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 you don, hello and welcome to the show. In this episode, I’m thrilled to be joined by Don Chu, a true pioneer in corporate finance. Don’s the founding editor of the Journal of Applied corporate finance, which he launched nearly 30 years ago. He’s also authored or co authored over 10 influential books, including the new corporate finance, where theory meets practice and the revolution in corporate finance. With a PhD in English and an MBA in finance from the University of Rochester, Don brings a unique and deeply informed perspective to the discussion in our conversation, Don shares insights from his latest book, The Making of Modern corporate finance, exploring how the evolution of corporate finance has helped shape today’s global economy. We cover everything from the rise and fall of conglomerates to the role of private equity and the importance of R and D in driving corporate value before we begin a special thanks to Lumo coffee for sponsoring this episode. Their premium organic coffee source from the highlands of Peru is packed with healthy antioxidants, economics explore. Listeners can enjoy a 10% discount. Details are in the show notes. Now let’s dive into the conversation. I hope you enjoy it. Donald chew, welcome to the program. Great

Donald Chew  02:35

to be here. Thanks for the invitation.

Gene Tunny  02:38

Of course, we’re talking about your new book, The Making of Modern corporate finance, published by Columbia University Press. And the subtitle of it is a history of the ideas and how they help build the Wealth of Nations. Now, as you point out in in the introduction to your book. I mean, this is, this is not necessarily a take that many people will. You know, people might find this controversial. They because finance, the financial industry has been much maligned in recent years, particularly after financial crisis. I’d like to ask you about that a bit later. To start with Dom, could you tell me what do you mean by modern corporate finance? Please.

Donald Chew  03:26

Modern corporate finance is a it’s a different approach to financial management that it’s it’s probably got its roots from academic work in the it started in the late 60s, and then proceeded through the 70s, and has been going on since then. But the basic idea is that, well, let me start with what old core, old fashioned corporate finances that that is the notion that a company’s obligations to its shareholders really consist of just, you know, basically satisfying their needs for steadily rising earnings per share. The job of the corporation, in a financial sense, is just to keep earnings per share rising with the understanding that the price stock prices will sort of rise proportionally in tandem. So the corporate mission is just to produce enough cash flow to be able to report steadily rising earnings per share, probably with minimal use of debt, and you probably want some diversification too, so that you can ensure this steady increase in earnings by by having a diversified, you know, set of industries and businesses. Modern Corporate Finance says no, the aim of the corporation is not to produce steadily rising earnings per share, but to produce high rates of return on capital, higher than the cost of capital, and do as much of that as possible, and and your mission is basically to maximize the long run value of the firm. And in defense of that proposition, you Well, I’m getting ahead of myself. No,

Gene Tunny  04:58

no, that’s okay. Yeah, go. Ahead, yeah, that was the old corporate finance, yeah. And what are some of the names associated with that historically, Jack

Donald Chew  05:08

Welch is the preeminent practitioner of old fashioned corporate finance. He, he viewed his mission as as again, he know he, he never missed an earnings target in his 20 years of managing, being the CEO and and to be fair to Welch, he created the firm with the largest market capitalization of its of it of its era. But it was a diversified conglomerate. It had, it was 50% financial firms in a variety of industries, power, health care, and you name it, but, but, but again, his goal was to keep reporting steady increases in earnings per share, and then when Welch stepped down in 2000 there was no no future CEO was basically able to manage that unwieldy conglomerate that he had produced, Jeff immolt ended up failing, and the conglomerate ended up being pulled apart over time, as were conglomerates throughout the United States. I should say that the failure of old fashioned corporate finance became clear in the 1970s when all these bloated conglomerates were unable to restore their profitability, and they did the S, p5, 100, lost half it’s valued during that point, and then that basically triggered the reaction of active investors who began in the 1980s to start pulling apart these conglomerates.

Gene Tunny  06:38

Right. Okay, so you Jack wells. You were talking about General Electric GE, yeah, what was some of the blighted conglomerates of the 70s? What are the prominent ones? And you said they were pulled apart?

Donald Chew  06:51

Well, General Mills was became. It called itself the All Weather growth company. It was really its core business was cereals, and then it was taken over by a retired former general who decided he wanted to make small submarines. They bought Play Doh and they but the goal, again, was, was to provide businesses that would offset whose fortunes would offset one another and create this corporate diversification. Again, it’s you know, we you you wanted to protect your employees and communities from the business cycle, and the way you did that, in theory, was to buy lots of different kinds of businesses. But the outcome of that was that the businesses ended up all being they didn’t perform well. Some businesses were starved of capital. Others were over invested in, and they all urged virtually to a company ended up being dismantled over the next 20 or 30 years. Other companies were it and T beat Beatriz foods, RJR Nabisco, ended up diversifying into different areas, if we could talk about the RJR, Nabisco, LBO, I’d

Gene Tunny  08:04

like to cover it, because that was one of the fascinating examples. Wasn’t there a famous book about it, the barbarians at the gate? Is that barbarians at the gate? Yeah, that’s right, yeah, yeah. The

Donald Chew  08:15

wonder of all this was that RJR, in the late 80s, was widely viewed as a very profitable company and well run and had a market cap of $12 billion so at that point, a number of private equity firms, one of them was Colberg, Travis and Roberts, began to look inside the operations, and there was a There was a competition to buy the firm, which actually included an offer from the CEO itself, but they ended up paying twice the amount of the firm to take it private, 25 billion for a $12 billion company, and the amount of waste inside the firm led Michael Jensen to basically declare that the barbarians were inside the gate, that Johnson was wasting through cash flow, just to conceal the profit potential the business from his competitors. And, you know, and the rates of return on new investment were from two two to 5% you know, for a new cookie manufacturing company. And so you basically double the value of the company, even if the buyers didn’t make a cent, you know, you know, just by virtue of the, you know, the amount of mismanagement that was going on behind the scenes. Again, colossal waves. You

Gene Tunny  09:33

mentioned Michael Jensen. I mean, that he’s one of the big names in modern corporate finance, isn’t he? Could you tell us a bit about Jensen and his contribution. Please, Don

Donald Chew  09:45

Michael Jensen, with his colleague Bill mechling at the University of Rochester, wrote what became the most cited article in the corporate finance literature in 1976 called theory, the firm, agency, costs and I. Forgotten the rest. But the basic argument is that there is a a conflict of interest between management and shareholders at the very heart of the organization. That means it’s going to be very you can’t expect managers to maximize firm value. They have their they’re torn in two different many ways. And the biggest conflict between management and shareholders is not, you know, corporate jets and perks. You know, that’s that’s one source of conflict, but the big one is over the optimal size and diversity of firm. If you’re a corporate manager with minimal stock ownership and you’re a resourceful person, what you want to do is build an empire. You want to buy as many different companies as you can. Again, which makes you more famous and actually raises your pay given the way CEO pay evolved in corporate America, which was to say that the larger the company you ran, the higher your pay would be. And and again, this is all premised on the idea that CEOs didn’t own much stock in their own companies, which was true in the 70s. But Jensen and meckling set themselves the task of, how do we explain the dominance of the corporation, given this basic conflict at the heart of it, you know, Adam Smith that we go back 250 years, said the public corporation could not work. You know, managers could not people could not manage other people’s money in any kind of operation requiring lots of managerial discretion and control. So what you saw in Smith’s day was, were these joint stock companies that were like canals and turnkeys and regulated banks, but that, but nowhere else. Everything else was closely held partnerships because outsiders could not trust other people with their money. There were no mechanisms that would allow the joint stock company to end up managing large scale operations. Well, well, Jensen found a solution to that problem, in the sense that that there are all these mechanisms, governance mechanisms that evolved over time to give outside shareholders a measure of control. You know, there were audit financial statements, there were boards of directors that were in CEO incentive pay plans, and then and then, there were competitive product markets. You had to sell a product and make money, and then you had labor markets. If you were a CEO and you wanted a good job, you had to do a, you know, you had to have shown the market that you were in the labor market, that you were doing a good job. And then if all else failed, there were supposed to be some outside forces. That is, you know, maybe eventually there were hostile takeovers, but there really was not, not much sign of it, of a hostile market for corporate control. When Jensen was writing his paper, so he and Bill meckling said to themselves, you know, we really don’t understand how these companies work, where CEOs earn just minute. You know, I have minimal stock ownership, they Jensen and Murphy concluded that the average CEO, for every $1,000 increase in the value of the stock, they earn $3 so it was, which was a bit people are being paid like your occurrence. So this, this is that there’s got to be a problem. And then, and then, at the very end of the article, they said, Well, what if managers went out and bought back 99% of the shares using debt finance and then became basically the sole owners of the firm? We are going to propose here that this would lead to wonderful efficiency gains in these corporations if they could transform their structure. And this is basically what happened. This was the LBO that they forecast. They showed us the template and and all of the 80s can be seen as a vindication of this forecast by Jensen and meckling back in 1976 and as I said it is far and away the most cited article in the corporate finance literature, with like 150,000

Gene Tunny  14:06

sites. Yeah, yeah. So this provided the theoretical support for the leveraged buyout, which has been controversial at times. Yes. Can I ask, like, because as an economist, to what extent has the is it economic logic that has led to this transformation in corporate finance? Is it the applicant like fully understanding the economic value and how to maximize the economic value of the corporation, looking at it in a you know, over the future, looking at the discounted cash flow is, is that? Is that fair to say

Donald Chew  14:44

yes and no. I mean, it’s, it’s certainly, it’s part of the answer. But it’s not enough. So you had to, you know, by law and custom, hostile takeovers were frowned on you. Just if you were a Morgan Stanley, you. Not fund the hostile takeover because you were violating, you know, the rule about, how do you how do companies deal with you know, they have their beholden to their investors, and they’re beholden to their corporate clients, and it was a rule, Thou shalt not do hostile takeovers. Everything has to be done with the agreement of management. Well, anyway, that that consensus shifted over time, and active investors became, you know, they they, what they saw was the huge difference in the values of these companies, if they were dismantled, the sum of the parts was vastly greater than the market values of these companies. And as the as that gap became larger and larger, the pressure to actually break them up grew great enough that people like Michael Milken and all the people he funded saw this opportunity. And then when the Reagan administration came in, there were, there were relaxations of some kinds of financial constraints, anti trust, and this, this collocation and and the discounted cash flow met, you know, method and modern finance, all these forces work together to lead to this eruption of the market for corporate control. In carrying out the market for corporate control basically ensured that the principles and methods of modern corporate finance would would go into action, would be implemented. This provided the basis, but, but again, you had to allow active investors to assert their control, their voice, which just didn’t happen in this in the 70s or the six or the fifth, yeah.

Gene Tunny  16:37

Okay, and is it right that there’s a trend towards companies staying private or going private, so going off the the you know, not being listed on the stock the stock market, is that a trend? Is that driven by this new approach to corporate finance?

Donald Chew  16:55

Yeah, absolutely. There’s a bunch of factors here. You know that the number of publicly traded companies in the United States has fallen in half over the last 30 years. The ones that remain are actually much more valuable than the ones in the past. I think the average company, publicly traded company today is is four times what it once was, even so, so the the market value us publicly traded companies, is twice what it once was, say, 50 years ago, but with half as many companies and at whereas the number of private companies is now something like 8000 There are 8000 PE controlled companies, you know, double the amount of public but they are. They’re much smaller. In fact, if you add up all the private companies, they amount to maybe 10% of the market cap of public companies. So what you see here is that the companies with extraordinary growth potential, most of them end up going public, because that’s the beauty of the public corporation for growth is that is the dumb investors like you and me will provide them with cheap equity capital, because we know they have growth opportunities. It’s just clear as crystal you know that these companies will succeed so so for companies with growth opportunities, public equity markets are a great deal, but once you start losing your your luster as a growth company, then eventually your PE multiples fall and they become within reach of private equity investors. And I think it’s now, you know, Jensen has shown us that companies without growth opportunities are generally run better as private companies for all variety of reasons. For if you’re doing a dirty business that the newspapers don’t like, if you’re an oil and gas you want to be out of the public eye, so you’ll end up getting higher multiples from private investors. And you can do stuff in private that just doesn’t look good in the newspapers. You know, you’ll notice that lots of public oil companies are shedding their oil exposure to meet their carbon commitments by selling their operations to private companies. And this all makes perfect sense, and we benefit from it, in fact, because, you know, again, these companies get opera, and I’m not meaning to suggest they’re shady, but, people don’t like one of private equity’s poor competencies is is cutting unprofitable growth. You know, that’s what it’s famous for cutting, and it’s an essential economic function. It’s almost as important as growth itself. The capital for growth us comes from cutting unprofitable operations. And nobody talks about this. You never talk, you know, you never hear about the heroic efforts of PE to streamline and cut limb by limb so that this money can get recycled back into the growth sector. Which is what happens? Yeah,

Gene Tunny  19:54

well, well, I think economists are sympathetic to that, that perspective, if you. Think about Schumpeter with the gales of creative destruction. And yes, also, I think Friedman had one of he wrote an article about how one way of seeing the market outcome, or the mark market efficiency, is the result of competition being an evolutionary process, or a competitive process that weeds out the inefficient Darwinian. That’s it. Yeah, yeah. So, yeah, very, very sympathetic to that. Now don’t Can I ask, I got a question about, like, the contention you make, and this is, I mean, this is fascinating. And this American style corporate finance, a phrase that combines two, if not three, of the most vilified words in today’s English Language Media. It’s brilliant. Yes, it’s very true, social and otherwise, okay, you agree? Okay, yes, I agree. Has for the past 40 years been one of the world’s remarkable success stories. The principles and methods of Finance to continue to be taught in business schools around the world have played a critical role in the productivity of the US private sector. Now that is a I agree, I largely agree, but I want to know what empirical support is there for that proposition.

Donald Chew  21:19

Well, again, I have to, I have to go back to the 70s, when the dot the Dow Jones market lost half its value and the economy was struggling. It was a millez and and Jimmy Carter didn’t know what to do. His politicians didn’t know what to do. Inflation was out of control, and unemployment kept going higher and higher and and, but nobody, few macro economists, looked at what the companies were like, and that’s what my book does. It says these companies, back in the 70s, had been allowed to grow into these bloated conglomerates. There were no outside forces checking this managerial desire to build empires. And so in order to create a productive, prosperous society, you had to cut back these conglomerates and break them up. And this, although painful at first, this ends up creating the basis for more growth. And it starts as shareholder value, and it looks, it looks bad for a while, but ultimately it creates lots of growth opportunities. And I believe the last 45 years have borne this out. Jensen, when he tried to make his case, he looked at he said, well, the market capitalization of US public companies doubled during the 80s. So that’s that’s one data point. Labor productivity a total factor. Productivity statistics went up dramatically in the 80s. Some versions of labor productivity statistics went up. But, you know, these are the best market and operating data we have for that period of time. But then, you know, again, you have to point, I would point to the last 45 years and say, look, it’s been this. Us, equity returns have been 12% a year on average, you know, which is far and way higher than anyone else and and it is just in the process. It’s really a process of continuous restructuring. In other words, companies have to keep putting pressure on themselves, always squeezing out excess capital, always reevaluating every investment. Is it time to get rid of this, give it to somebody else, or is it time to grow it? And conglomerates were terrible at this. Conglomerates always, they starve their best opportunities, and they fed a lot of their and so they were horrible allocators of assets because they didn’t understand the businesses they were in, and and so and I just believe, you just look at the like, what has happened to America in almost every economic dimension is, is proof, you know, is proof of this process. And now we don’t, we don’t see hostile takeovers anymore. We see shareholder activists so and it’s a fundamentally different device, but it operates in much the same way. And in a hostile takeover, you go out and buy control of the company, and that a lot of people didn’t like. Peter Drucker hated that process. He said, This is a violation everything we know about good management, but today’s activists like Paul Singer of Elliot management, he will buy five to 10% of the stock, and he will say, Hey folks, we think there’s a problem out here, like south southwest airlines. So let maybe, let’s have a shareholder meeting and and so it’s all you large investors. I’m going to put the proposition out there. You get the vote on my idea. My idea is that, hey, maybe we should get a new CEO, or maybe you should follow a bunch of steps. But it’s sort of shareholder democracy in action. So and if the majority. Shareholders don’t like what Elliot management is doing. They can say, No, we’re voting against you and what? But what happened in the southwest cases, I think he won four out of 12 board seats. The CEO was not ousted, but he was put on notice, and they now have a the stock price is probably up 25% since they went in there, and the company is sort of getting right, you know, righted back to the way it should be going again. It’s putting the company on notice, suggesting alternatives, and then allowing the large institutional investors, the Black Rocks of the world, to vote on your proposal. And to me, I find that just a wonderful system. And I don’t know if you saw this last week, but the FT did a piece on Japanese shareholder activism. There was a statement by the the the leader of the association, who was welcoming a new era of shareholder of activism to end the 30 years of Japanese stagnation, I said that the Japanese slumbering for 30 years. We think this is the solution to our, you know, our economic melees, which includes a 7% drop in the population for last five years. I actually go so far in my book is to suggest those two things are directly related. You know, they’re just not wrong. Yeah, opportunities for in their quest for full employment, they basically have ensured that there are no employment opportunities for the next generation of workers and Germans heading for the same thing. If you saw what happened in Volkswagen, yeah? Which, to me, is a corporate governance failure.

Gene Tunny  26:44

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Gene Tunny  27:19

now. Back to the show, can I ask about what’s your take on ESG or corporate social responsibility? Ask that because there’s so much bad press about what we’re calling modern corporate finance, about private equity. I mean that there’s the, you know, concerns about job job losses. You look in the popular culture, wall the films, Wall Street, pretty woman, the private equity sort of people, the, you know, the financial markets. Person, Gecko, yeah. Richard gears character, and pretty woman, who’s, I think he’s in private equities, breaking up companies. And Julia Roberts’s character is sort of wondering, what on earth you’re doing, and pull apart companies to make them more valuable, and their concerns about job losses associated with that. And you’ve got issues, you know, various social issues, various social ills in the US. I mean, it’s quite clear what’s your take on do corporations have a responsibility for that. How to what’s the role? What’s the corporate social responsibility there? I think the

Donald Chew  28:27

mission of the corporation, as Milton Friedman said, is to maximize their own but they missed quoted. He is quoted as saying it’s to maximize its own profit. That’s not what they do. They maximize their long run value. And to do that, as you really you have to invest and take care of everybody you know. To maximize value, you have to decide how much, what kind of commitments are, am I going to make to each of my constituencies? How much and but with the idea that if you pay another that Michael Jensen’s rule was, pay another dollar to every stakeholder who matters, as long as you expect $1 in return. Measured. And you know, it’s, you know, the old rule. But Jensen, Jensen has this concept of enlightened value maximization, which is the perception that I hold out in this book. And it is, again, it’s about committing to every stakeholder who matters, making very clear what it is, what we’re going to do for you and what we expect in return, and just getting people on board and again, but all with the idea that this is going to increase the long run value of the whole franchise, and it means you can’t you want to pay, you don’t want to pay too much or too little. You want to get just the right amount. And to me, one of the best illustrations of a really good ESG program is Walmart. Yes, well before the pandemic, Walmart basically increased across the board, their employee pay and then they’ve also they they hire and promote from within. Their store managers make an average of $175,000 a year. They invest in their suppliers. They monitor their suppliers. They brought a lot of them back to America, and though they squeeze their suppliers, they also make sure that they’re working and take care of them. And they have the largest plastic waste facility in the world, plastic waste recovery through repackaging and Doug McMillan, the CEO who is a Walmart lifer, is now the chairman of the US Business Roundtable. In other words, that is the group of the largest, most prestigious US corporations. McMillan, this southern guy who was raised as a Walmart, you know, employee, is now the the head of this large lobbying organization. I you know what? To me, it’s a huge ESG success story, but there’s a lot of ESG failures. There’s a lot of bad ESG that basically doesn’t pay attention to corporate value. To me, anything that any investment has to have its focus on maximizing long run value, but there are lots of ways that you can address social problems through your investments, and it’s that magical, you know, Confluence that ends up, it ends up putting higher price earnings multiples on companies. Investors like to feel good about the things they invest in, and when they do that, your company, you know, Walmart, probably increased its value by 50% last year, and I would wager that 10% of that is just people feeling good about what the company does, yeah,

Gene Tunny  32:02

yeah. I like your comments on, yeah, on enlightened value maximization. I like that because, you know, this is these sort of concerns about corporations, and they’re in the news. They’re in the, you know, lot of commentators are coming quite, you know, very critical of corporate power. There was the extraordinary reaction to the killing of the United Healthcare CEO in New York City, gunned down in in Manhattan. And a lot of people were was almost celebrating, in a way. I mean, no, we don’t condone, obviously, we’re not going to support murder, but people were saying, Oh, you can understand this, because they’ve been ripping off people for years, like it had such a high rejection rate of claims. So yeah, just you don’t need to comment on that. It’s just putting that out there. As

Donald Chew  32:54

my daughter is sending love letters to Luigi man Jones, right,

Gene Tunny  32:59

yeah, yeah, yeah. He’s, he’s a become a folk hero, in a way, hero,

Donald Chew  33:04

right? Yeah, because the corporate pursuit of profit is inherently evil. It’s inherently anti social. And that you could go, take that back to Roman Catholicism, you know, the first time you go into church. But that is what you learn. You know, one man’s problem is evil because it’s it somehow comes out of the pocket of somebody else, and changing that point of view is one of the great contributions of modern capitalism. In other words, when you create, yeah, you’re not hurting somebody. In fact, in most cases, you’re helping somebody. It’s like they asked Jeff Bezos, Jeff, are do you really deserve to have a $200 billion fortune? Can you justify that? And he said, Yes, I’ve created $2 trillion of value for my investors, not to mention all the jobs, all the taxes paid. That just begins. My success is it’s just created enormous wealth for other people. And this is, this is not cheap, so I

Gene Tunny  34:09

Oh no, it’s certainly, certainly not widely appreciated, because now we’ve got people like Bernie Sanders and commentators on the progressive side saying, Well, every billionaire is a policy failure that’s becoming a widespread, you know, contention. The other Yeah. So it’s all very, you know, contentious and up for the up for debate. So, yeah. So, I mean, I think I agree with you. I mean, a lot of the value, like they do create a lot of value. There’s a lot of value from entrepreneurialism. And I remember Robert Barrow, The Economist at forget where he is now is he’s been at Harvard or Chicago, has been all over the place. He has an Institute in Washington. Now, does he right? Very good. I’ll have to, have to look it up. But he once said there are we wrote a column just to the effect that Bill Gates has created more value, or did more good for the world through Microsoft than he has done through his foundation. It was something along those lines. I mean, yeah, yeah. If you look at the

Donald Chew  35:13

I would say the Jeff Bezos is the world have done more for poverty than Mother Teresa than the Mother Teresa’s put it that way,

Gene Tunny  35:22

right? Yeah, through, through, yeah. Lower price goods through, yeah, so, yeah, yeah, yeah, very good. Okay, estimate

Donald Chew  35:33

that Walmart saves the average family $5,000 a year, just just by selling low cost products. You know, that’s consumer surplus and so and look at Walmart might be the only US operation that’s growing in China. China loves Walmart because it understands that its people are being helped by the operation of Walmart in getting these low cost products to them. So, you know, GM is leaving China because they don’t make enough money and because China basically they’re just being squeezed out by state owned enterprises by but government policy in China has chosen to allow Walmart to succeed, and to me, that’s incredibly telling, because they understand the social benefits. That’s my hip hop

Gene Tunny  36:28

question, yeah, yeah, yeah. I’m gonna have to track down that study that’s fascinating about the the 5000 saving from, okay, yeah,

Donald Chew  36:34

yeah. I believe that I’m shooting from that, but I think it’s great.

Gene Tunny  36:39

That’s okay. I know that it’ll be, it’ll be something of that, of that magnitude. I’ve got no doubt. I’ll just, I’ll just, I’m just interested, because that’s a useful that would be a useful empirical study, or to point to, yeah, but that is very good

Donald Chew  36:51

corporate mission. Their corporate mission is to save other people money so they can live good lives. You know that so that they’re saving their consumers money. That’s that’s their, well, that’s their mission statement. And I’ve never it’s

Gene Tunny  37:08

a rather, rather extraordinary story. Was it Sam Walton? Am I getting the name right? Well,

Donald Chew  37:15

that was when rod, yeah, awarded the Presidential, Congressional Medal of Honor, and that’s where he made that statement. He said, we’re going to make our job save other people money, you know, so they can live good lives. So help them

Gene Tunny  37:29

live good luck. Gotcha Okay, right. So now, and as a sort of final part of the the interview, I’d like to talk about the financial crisis, because, look, I largely agree about the theories or the hypothesis, the what you’re what you’re saying in the book. One, one area where I may have some hesitation is it’s an interesting perspective. You argue that the financial crisis isn’t something that violates or is in or contradicts the efficient market hypothesis. So this is Gene farmer’s idea that the market prices of financial products represent all of the available information and the market’s efficient. Can you explain? Please, Don What’s your view on the financial crisis and why you think that doesn’t violate the efficiency efficient markets hypothesis, please. Well,

Donald Chew  38:27

let me start with what I think the efficient market theory says, and then, because that’s generally misunderstood, the caricature of efficient market theory is that the price is always right. And that’s not the theory says that it’s it’s an unbiased estimate of that is it’s either too high or too low on on average. But Fisher black wrote a paper call on the noise theory that said, you know, the average price is within 100% of the correct value, 100% plus or minus. So yeah, and that’s not which just tells you there is a hell of a lot of uncertainty out there about things. Well, it turns out that, the way I read the global financial crisis there, there were something like $6 trillion of toxic mortgages sitting on bank balance sheets throughout the world that people just didn’t realize were out there. They didn’t understand how bad these mortgages were. And I’ve written about this, and I say a mortgage when it’s first issued is expected to lose 1% of its value, and the Basel risk requirements say, Okay, we need 1% backing for 1% expected loss. A corporate loan is supposed to lose 4% of its value, so we need 4% to back that. Well, what happened? What ended up happening is that these mortgages lost 10% of their value. They were, they ended up being and we don’t. We still. Don’t know, even to this day, how much they lost, because these numbers have just, you know, there has been no federal attempt to determine, as far as I know, to determine how much money these mortgages ended up losing, and and the problem, and, and I, I don’t want to I can’t blame the private sector entirely, because these mortgages were were pretty much demand, is too strong a word, but they were certainly blessed by the Federal Reserve that the government with government policy starting in 1992 was to make low down payment mortgages to underprivileged areas. And then that that became, that became expanded to not only underprivileged and low income people, but high income people were also given low down payment mortgages. And the the ability of Fannie and Freddie may to get their congressional their right to operate was premised on their making low down payment mortgages called all a and it meant that if you were I had a friend who was a commercial airline pilot Who bought a house in Hawaii for $750,000 put down 15,000 the down payment, and when down value fell by 40% he just walked away from the mortgage. And this was done everywhere and and as again the mortgage, the loss rate on these mortgages has turned out to be in excess of 10% and then, when you, when you understand that banks themselves were allowed to operate with three to 5% capital before the crisis, you’re just you’re losing money on every dollar. And in fact, if you you, if you compute the amount of if you take that 90% hole in bank balance sheets, it was almost equal to the 600 billion that the government poured into the banks as bailout money, and it, you know, I’m, I’m not doing a good job of explaining this now, but the the money that they put into the banks allowed the banks To continue to operate and if you’re on when you’re a bankruptcy judge, your first job is to say, okay, is this a viable entity? Does it deserve to be rescued, or should it be shut down? Well, what we now know every bank paid back every dollar the bailout money with 10% interest it within a year. But there was one company that never paid the money back, that was General Motors. General Motors has never paid back the $11 billion that company was really made probably should have been shut down. It was. It still owes us taxpayers $11 billion and it was and Obama rescued it. He became the self appointed bankruptcy judge, and, you know, and to this day,

Gene Tunny  43:11

yeah, I’ll have to look into, I didn’t realize that about GM,

Donald Chew  43:15

yeah, they don’t talk about that. That was one of the worst, run. That was one of the worst run companies in America. You know that that cup GM was immune to take over. It was too big, taken over by anybody, and the result was that in 2008 it had one and a half times the number of employees to service a normal market. There were employees that were being paid to stay home. It’s like the New York City school system, you there were people, there were rubber rooms where they said, Look, we have access. We don’t have any work for you. We’re just going to pay you to stay home. And this went on for years, you know, you know. And so this was a company that had somehow was immune to any kind of outside influence, and that’s what you get when you when you have and that’s really the story. The 70s, you know, lots of companies had grown to that kind of Elven time proportion, and that’s why, you know, one of the big predictions in my book was very few macro economists foresaw the ability of US companies to withstand the COVID pandemic, then the interest rate hikes that followed it, but you know, and I felt like I was the only person on Wall Street saying our companies are going to do fine because they’re lean and mean now they they’re not companies in the 70s, but every macro economist model is premised on the 70s, because they all go back and say, Well, that’s what happened in the 70s, but the companies are assumed to be the same ones, because macro just doesn’t look at corporate finance. They’re two as chapter 12 of my book is about what macro gets wrong.

Gene Tunny  44:55

Yeah, and yeah. I mean, I think there’s some some good points there. It’s. The problem of, you know, the data, they’re highly aggregated, and, like, how much detail do you get to get in there? I mean, that’s, that’s certainly an issue. Another issue is, you know, macro hasn’t really, they don’t really have a their financial model or sector model. They don’t really have the banking sector in there very well, if at all, in some of their macro models. So, yeah, I think there’s, that’s a really, really good point you make there. Okay, John, this has been, this has been great. Yeah, I’ve learned a lot about about what, you know, what’s been happening since, you know, 70s, 80s, so compared with the past. So you contrasted the modern cop corporate finance with the previous approach, where you had the big conglomerates, there was an aversion to debt. And I mean, by doing that, you’re reducing your return, aren’t you, because I mean, debt is a way of getting debts. Debts cheaper than equity. Is that the argument? And all the debt lets you leverage up and that enhances the the equity return. Well, it

Donald Chew  46:04

does both. So you, yeah, I mean, debt is really a control device. It basically, if you don’t have, this is the Michael Jensen argument that debt forces you to pay out excess capital. So you, if you So, the rule of thumb is, if you are a mature cash cow, you want as much debt as you can put on it, because you want to squeeze that capital out. If you’re a growth company, you want to avoid debt like the plague, because debt will cause you to pass up valuable investment opportunities. So it’s a very simple proposition, and that, and it it, you know, and it can be seen, private equity tends to go for the mature they squeeze out excess capital from companies without growth opportunities. But although private equity has started to move over into the growth spectrum, to a certain extent, they now operate with, in some cases, more than 50% equity. So the whole movement private equity has been to reduce the amount of debt and take on more growth. And now we see the largest companies, these unicorns, which is a company with more than a billion dollar market. They’re staying private because the costs of raising outside equity are just very high. You know, the I call it the cost of having dumb investors once. If you bring dumb investors into the party, you’re gonna, you’re just gonna have to say more you’re gonna provide more information. And you’re, they’re just not in a position to pay up for risk. So these unicorns are now. They look like public companies. They have the same collection of fidelities and black rocks, but there’s no retail investor. It’s just the smart money all sitting around the table, still very large market caps, growth opportunities, but they can have a private conversation about the value of the company. That ends up it just, it means the company’s worth much more, because you don’t have to spend money educating your investor base. You know, that’s it. There are huge public company, and that’s why there’s only, opposed to 8000 Yeah, and it’s not just Yeah,

Gene Tunny  48:19

absolutely no, I agree. And I agree. And I was just thinking, with all the additional regulation that, yeah, I mean, public companies tend to have more the regulatory requirements are much greater reporting requirements. So, yeah, that’s a good point, but it’s not,

Donald Chew  48:34

it’s not just the regulation and those costs. It’s the if you’re a small company that’s not attracting, not not much growth, you’re gonna, you’re gonna have a very depressed value. They’re all these tiny little companies that went public and they’re now orphans. Nobody wants them. Nobody covers them. So they trade at two or three times earnings. And that that’s a cost. With hindsight, they should not have gone public. They’re going to end up going back into private ownership. But you can’t. Is this? Public investors just can’t. They’re not smart enough to go in and rescue the values of these companies. So it just ends up leaving, you know, leaving them in a no man’s land and and I chopped that up to the the information costs of being a a public company. Gotcha,

Gene Tunny  49:26

are there some notable examples, or prominent examples of those smaller companies that have gone public and it’s not worked out for them? I can’t,

Donald Chew  49:33

I don’t know. I, you know, I wasn’t prepped for that, but, but I’ve heard people talk, no, I Yeah, it’s become a the liquidity is dried up. You know, lots of people will say that. And yeah, you would think, then they would sort the GO, GO private again. You would that would be the natural first step. But, but, but, no, okay, sorry,

Gene Tunny  49:55

no, that’s all right. I was just just wondering, because it was an interesting, interesting point. I. Right. Oh, well, Don just to finish up any final points, anything, any points in the book. You think it’d be worth bringing out in this conversation that we haven’t covered

Donald Chew  50:09

yet? Oh, yeah, let me. Let me take it one more shot. During the last 50 years, earnings relevance has dropped from something like 50% to zero. There’s a book called The End of accounting by Baruch Lev so the statistical correlation between five year changes in earnings and five year movements in stock prices, that’s how accountants track the relevance of earnings. That that statistical correlation has dropped from 50% to zero, and this is consistent with my, my view of modern corporate finance, which is not, it’s not about earnings, but there is one variable that actually has explained an incredible amount, an increasing amount of corporate stock prices. Would you care to take a wager? What it is? Well,

Gene Tunny  50:57

I’ve read the book. I’m trying to remember that this is your it’s the it’s the category. It’s one of the cost categories, isn’t it? Yes. Is that right? Yes. It’s,

Donald Chew  51:06

yeah, it’s, it’s R D, increase in R D, increase in S G and A and S G selling general and administrative expense. Well, during the last 50 years, that number has jumped from 25% of total assets to 55% which is amazing. And so yeah, the question, what is in SG and a that wasn’t in there before? And it’s all kinds of stuff like marketing and promotion, employee training expenses, all kinds of intangible expenses. And this stuff gets, you know, it gets expensed. It’s not capitalized, but it’s really, it’s kind of a modern day form of r, d, you know, Amazon has a ton of that stuff. And what we’ve discovered is that the the this, the correlation with those two variables and market prices, is is really remarkably high. So the one variable that you want to see, if you see large increases in R and D and S, GNA, that is kind of a the best indicator of increases in corporate value. And it suggests that, you know corporations are, you know they’re the investors are recognized the values of these companies, even though it’s not reflected in earnings, and the companies keep pouring more money into it, so you see these PE multiples going through the roof, and you also see lots of companies with negative earnings. You know, in the old days, in the 70s, only 10% of US companies would have negative operating cash flow. Today, it’s over 30% of publicly traded companies are losing money every year, and then every couple of years, they go back and raise private equity. They raise they raise public they raise equity from private sources because the public markets can’t invest in it. They don’t want to buy a company that’s losing money every year, but they go back to the Chase Manhattan Bank and get private equity so and the popular press thinks that these companies are zombies, but they’re not zombies. They’re actually quite valuable companies, but you won’t see it on their P and L’s. And I find this a really remarkable phenomena. I just, you know, I haven’t seen, there’s two or three academics that are talking about it, but it’s just, so, yeah,

Gene Tunny  53:27

but so what’s justifying the valuation? I mean, you, you show there’s this correlation between that, that those expenses and R and D and their value. So, but what are people who who are buying these, these companies, are investing in these companies. What are they seeing? Are they seeing that they’re building eventually, they’ll, they’ll earn a ridiculous amount of money, or that, or they building up an asset, intangible assets, knowledge, software, or whatever, that will be bought out by a Google or by, well, yeah,

Donald Chew  54:02

okay, it could be either those two. Okay, yeah. I mean, it’s probably more likely to be bought out by somebody else, but, but it’s the Amazon story. I mean, Amazon really didn’t show earnings a long time and but to their investors, the idea that these were investments and that they had phenomenally high margins, you know, once they turn cash flow positive, that you can see the amount of dollars they would earn on each you know, because the the requirements for future capital were so limited that they were bound and they were going to become money machines. But it’s hard to again, it’s hard to communicate that to a public market. But if you get a small people and group of people in the room, they share their your vision, and then, you know, for now, it’s private equity, but eventually, when the growth opportunities start to materialize and the cash flows, then it becomes public but the wonder of Amazon is that Jeff Bezos had the confidence to do this. You know, this is. When he did, I mean, because he had no earnings. I remember my firm, stern Stewart was once hired by an investor to determine if Amazon was going to go belly up. They were so concerned because he had no earnings, and so they had to hire us to then, you know, to verify that this was actually a solvent operation. And then that’s, you know, it’s really about, you know, smart investors versus dumb investors. You it’s hard to communicate with dumb investors, so you need to find and but Bezos had the confidence to say, I can keep doing this. He had his credo in 1997 and he got a following, and then he became, he basically conditioned these investors into following and rewarding him. You know, the larger his losses, the larger the stock price game for a period of time, which, which is the way a smart market should work. So anyway, more than

Gene Tunny  55:54

you want to know. No, not at all. I mean, I find it, I find it extraordinary that the end of accounting. So I’ll have to read that book. I haven’t read it, and it sounds, had you heard of it? No, I hadn’t, actually, not until I read your book. That’s, yeah, that’s fascinating. I mean, there are all sorts. I mean, as an economist, I’m often, you know, like economists often think, sort of try and look through the what accountants produce. Or, you know, because accountants don’t always represent things the way that economists would. So sometimes things the way accountants show things are not helpful. So yeah, it’s interesting about the end of the end of accounting. Yeah, yeah, I have to look into

Donald Chew  56:40

that. Very good. Are you trained in accounting or finance or

Gene Tunny  56:45

Well, I mean, I I’m an economist. So I’ve done, I’ve studied accounting, and I’ve studied some finance. I used to work in the treasury here in Canberra, and I work as an economist now. So do cost benefit analysis studies and business cases and things

Donald Chew  57:01

I really look forward to hearing what you have to say about my macro chapter, the chapter 12, yes,

Gene Tunny  57:08

well, I like the point you made about economists not not properly, considering that change in the corporate the composition of corporations, I’m gonna have To go back and read that more closely, but I think that’s a that’s a very compelling point, and I’ve got to think about what that means for how economists might model that. So yeah, I can’t. I probably haven’t got much to say on it at the moment that’s as profound, but yeah, leave it with me, and I might shoot you a note about it. Big debate

Donald Chew  57:42

is about productivity. Yes, you know, how do we measure it? And, you know, I just think, and people, a lot of people, think that GDP just doesn’t provide any grounds for measuring productivity. So the you know, but with the measures we’re getting from the national income accounts, just don’t. They don’t do a good job of reflecting inflation, but they’re even worse. Yeah, they’re even worse than reflecting productivity. And we can just kind of go after Robert Gordon and suggest that he was, you know, way too pessimistic about productivity growth in the latter part. So that’s the argument, yeah. And one, one last, are you a Robert Gordon, yeah, I like,

Gene Tunny  58:25

I think that’s a very good book. The I mean, his argument is that, that we’ve already, we’ve had major general purpose technologies, and we haven’t. We had that in the industrial revolution, then the second industrial revolution, yeah. And then the third industrial revolution with ICT, or the internet mate was actually, but, yeah, there was, or maybe back in the 80s with ICT. But what we’re seeing now isn’t quite of that same magnitude, and he’s pessimistic about productivity growth, but that’s before the modern I mean, AI is giving me cause to reflect on Gordon’s thesis. I think, yes, yes.

Donald Chew  59:06

Okay, well, anyway, I take issue it with it in my chapter 12 and and this is based on the work of an economist named James Sweeney at First Boston. But he says, when he my favorite line is, when, when I, he says, when I go in to talk to a CEO about Gordon’s book and productivity decline, I get laughed out of the room. You know, they they just don’t rot because the productivity doesn’t show it. Just can’t show up in GDP, the numbers they’re using just can’t reflect the quality. You know, you can’t make these quality product adjustments that are required to make something comparable and so. And my argument is, yeah, look at stock price. You want to see productivity gains, at least projected forward stock prices is the place to look, not, not at GDP. And I’ve got, I’ve been talking to the chairman of Columbia’s accounting. Department, and he’s very excited by that idea. In other words, the idea that macro actually suffers from the same problems that accounting suffered from, but finance is correct. Finances basically said, Look, accounting is just a point of departure, and you’ve got to look at many, many other things so you can get the stock prices. Macro economists are still stuck back with GDP, and they’re not looking they don’t trust stock prices. They just don’t

Gene Tunny  1:00:29

think, yeah, that’s true. And I think the reason is that economists suspect that that time, I mean, stock markets can the market pricing can be wrong for a significant period of time or divorced from fundamentals, so prior to the.com crash, for example. So I think that’s probably why the the macro economists are skeptical. Yeah, but yeah, I’ll let me reread that, because I must confess, I think I just skimmed that, whereas I focused on the the earlier chapters and the discussion of Jensen and Nick lean and but I’ll have to come back to you on that, because that’s a it’s an interesting argument. I agree with you about the difficulty of measuring productivity. I think that’s, yeah, that’s, that’s well appreciated by economists. And there’s a lot of you know, there’s a huge literature on this. There’s conferences, but it is something I haven’t looked at in a in a little bit, so I’ll have to, I’ll have to go back to that.

Donald Chew  1:01:24

Okay. No, I’d love to hear what you have to say. And one piece of business here, when we end up doing this recording, my thing will just be, will just be audio, if you should. Yes, yes. Confused to use, yeah, okay, that’s my hope.

Gene Tunny  1:01:44

Okay, yeah, yeah, just audio, yeah, just for sure, yeah. No, no problem at all. No, no, no,

Donald Chew  1:01:48

I have problem at all. All right, this is, it’s been a hell of a lot of fun. So

Gene Tunny  1:01:54

Excellent. Well, I hope you, hope you get on some other shows, and you your book is, you get, you get some good interviews out of it, and good coverage. Because I think it’s, it’s an argument that that needs to be made, and it’s, it’s a bit of, it’s counter to a lot of the popular understanding, the popular views on on corporate finance. So I think it’s, it’s definitely a welcome addition to the literature. So I

Donald Chew  1:02:22

ask you one more question. You think the book is written sufficiently clearly, or that it could actually be an introductory finance type? I view it as a supplement to a corporate finance and that’s what I’m trying to promote events. So if you’re teaching, if you’re using brilliant Myers in your finance 101, do you think undergrads or non finance types would be able to process the information in the book? Or do you think it’s too

Gene Tunny  1:02:56

maybe a third year a third year student or third year undergrad, yeah, yeah. Okay. I mean, that’s just, yeah, yeah. I think it could, I think it could be a good supplementary text, certainly that, like all of the history there, and the discussion of, I think, you know, the discussion on Jensen and mecklen is great, okay, and I think you’re very, you’re very clear about your, what your how you see this adding value and the market for corporate control. I think that’s all good stuff. Yeah. I think it certainly could be, could be, could be valuable there. I mean, it’s the sort of thing that, you know economists should read too. I mean, anyone doing a graduate graduate study should probably read as well, just to make sure that they understand how this matters in the real world. Like that’s what I think, is I like about the book, because often, you know, you see these, you know, there are these articles or these famous theories that are talked about, and they’re presented in a textbook, but you don’t often, some what’s hard to do is often relate it to the real world. So I think what you do, well in that book is is actually relate these concepts to the real world. So okay, good. Now that’s music my ears. Very good. Yeah. That might because your background in in working in the in the sector, or your journal, is it Journal of Applied corporate finance?

Donald Chew  1:04:20

Yeah, is your journey and win the way back past. I did a PhD in English and American Lit, so I was going to be an English professor. So then I got into this red took my first econ class when I was 27 so I’ve been, yeah, I’ve been trying to, like, I tried to communicate with my old finance, with my old literature, literature friends, and it’s two different disciplines. You know, everybody that I went to graduate school with shares all those beliefs that I end up they don’t find finance plausible or or socially constructive. You know, they. Mind stay, you know, exploitation, yeah, exploration of everybody but themselves. So anyway,

Gene Tunny  1:05:09

yeah, but I think you, I think you make a good case for for why that isn’t so, and why it’s actually added value. So I think, again, great, great contribution to the literature. Don, thanks so much. I’ll put a link in the show notes to your book, and I’ll encourage listeners to get a copy again. Yeah, terrific. Well done. And yeah, look forward to chatting with you some time again in the

Donald Chew  1:05:33

future. I hope you do it soon. Thank you very much. Gene, take care. Bye. Thanks. Don,

Gene Tunny  1:05:37

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 at economics explored.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. You

Obsidian  1:06:25

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Credits

Thanks 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 and other podcasting platforms.

Categories
Podcast episode

Jimmy Carter the Great Deregulator, AmFest, MAGA & Migration, and Why Competition? w/ Darren Brady Nelson  – EP269

Gene Tunny and Darren Brady Nelson discuss the economic legacy of President Jimmy Carter, highlighting his deregulation efforts, particularly in aviation, which led to increased competition and significant cost savings. They also touch on Carter’s appointment of Paul Volcker as Federal Reserve Chairman, credited with fighting inflation. The conversation shifts to the America Fest conference in Phoenix, where key speakers included Charlie Kirk, Tucker Carlson, and Glenn Beck. They discuss the tensions within the MAGA movement, particularly around immigration policies. Lastly, they explore the intersection of Christian economics and competition, emphasizing its ethical foundations and the potential for a moral case for free markets.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

Timestamps for EP269

  • President Jimmy Carter’s Legacy and Deregulation (0:00)
  • Carter’s Economic Policies and Personal Anecdotes (5:16)
  • America Fest Conference in Phoenix (14:36)
  • Trump’s Speech and MAGA Movement Dynamics (27:46)
  • Christian Economics and Competition (36:34)
  • Darren’s Critique of Mainstream Economics and Antitrust Regulation (51:22)
  • Regulatory Challenges and Natural Monopolies (55:55)
  • Final Thoughts and Future Directions (59:26)

Takeaways

  1. Jimmy Carter’s Deregulation Impact: Carter’s policies in aviation, trucking, and beer production revolutionized U.S. markets, creating long-lasting consumer benefits.
  2. MAGA’s Immigration Debate: Tensions exist between Bannon’s nationalist stance and Musk’s globalist vision for high-skilled immigration policies.
  3. The Role of Competition: Darren highlighted the economic and ethical importance of competition, criticizing overreach in antitrust regulations.

Links relevant to the conversation

Mises Institute article “Jimmy Carter’s Legacy Is Much More than Good Deeds Done in His Later Years”:

https://mises.org/mises-wire/jimmy-carters-legacy-much-more-good-deeds-done-his-later-years

The previous episode with Darren:

https://economicsexplored.com/2024/11/10/trump-2-0-w-top-wisconsin-door-knocker-economist-darren-brady-nelson-ep261/

Great Reset discussion with Darren from 2020:
https://economics-explained.simplecast.com/episodes/the-great-reset 

Larry Reed, President Emeritus of FEE, speaking about the Parable of the Vineyard Workers:

https://economicsexplored.com/2022/02/05/price-controls-to-fight-inflation-a-bad-idea-infrastructure-lessons-from-potus-21-ep125/

Darren’s articles in Concurrences on competition and antitrust (paywalled, alas):
https://www.concurrences.com/en/page/recherche/?recherche=darren+nelson#

Alfred Kahn’s Economics of Regulation:

https://www.amazon.com.au/Economics-Regulation-Principles-Institutions/dp/0262610523

Lumo Coffee promotion

10% of Lumo Coffee’s Seriously Healthy Organic Coffee.

Website: https://www.lumocoffee.com/10EXPLORED 

Promo code: 10EXPLORED 

Transcript: Jimmy Carter the Great Deregulator, AmFest, MAGA & Migration, and Why Competition? w/ Darren Brady Nelson  – EP269

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  00:00

Gene, 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 and welcome to the show. It’s Saturday, fourth of January, 2025 here in Brisbane, Australia. However, it’s Friday, the third of January in Milwaukee, in the USA, where my guest is based, and it’s Darren Brady Nelson coming back onto the show. Darren, good to have you back on the program. Thank you.3

Darren Brady Nelson  00:55

Thank you. Am I? Am I now in first place, or is that other?

Gene Tunny  00:58

Yeah? Oh, you’re definitely in first place. I think you’ve been in first place in terms of number of appearances for a long time, so

Darren Brady Nelson  01:08

not in quality, just but quantity. I’ll take.

Gene Tunny  01:12

Very good. Wow, yes, yes. I mean, it’s all about consistency, isn’t it that? Yeah, absolutely. Okay. Very good. Well, Darren, thanks for joining me. I wanted to chat with you about a few things. I mean, first we had the news about President Jimmy Carter. He died earlier this week, lived to 100 impressive innings, and you sent me something interesting on Carter being a great deregulator. And I wanted to talk to you about that. I also want to talk about the America fest that you attended. You’re in Phoenix, Arizona. That’s a turning point USA event. And then Doge Trump 2.0 what’s going on there? And finally, there’s an article you wrote recently on why competition. So I want to, want to touch on all of those things to begin with. Can I ask you about President Carter? Now Carter’s seen as well. Often this presidency is seen as an unsuccessful presidency, the presidency of malaise, the presidency before the Reagan administration. You sent an article on Carter being a great deregulator. So there were some positives that came out of the Carter administration. Can you tell us about those, please? Darren,

Darren Brady Nelson  02:30

well, I mean, I always think of two things, and I often even I kind of forgot about, you know, one of them, you know, then the article is about the second thing, which is about deregulation, essentially that, I mean, you think of deregulation in the US, you know, around that time, you probably would have thought, you know, Reagan, obviously, rather than Carter, I guess, you know, Carter would have, you know, certainly had the reputation, and Reagan, I guess, ran on that to some extent of you know, Jimmy Carter being a big government guy. And, you know, and maybe, you know, philosophically, perhaps he ultimately was, but, but the reality is, you know, two things that he did, obviously, was he did start the deregulation process in the US, particularly in transport, I believe, rail, trucking, aviation, and those are huge things, obviously, particularly aviation, you know, that really, I mean, I mean, all of them are, obviously, but I think aviation really is something that, you know, your average american really would have saw the benefits from, you know, maybe rail would have been a little bit more indirect, you know, kind of it might have been part of because they weren’t really deregulating in terms of, like, sort of so much transport, you know, like Amtrak, it would have been more kind of to do with, with freight, and people would have saw some of those benefits. But, you know, would have been kind of a little bit more indirect, same with trucking. You know, trucking would have fed through and, you know, lower prices and better services and all that to consumers, ultimately. But the aviation thing was the thing I think that really stuck out. And, you know, which later came to Australia. And perhaps I’m not, I guess, 100% sure, but you know, Australia usually, often does look to the US to, you know, to get some of its ideas both good and bad. So and the other thing just quickly to mention was that Carter appointed Paul Volcker as the head of the Federal Reserve. And you know, for mine, at least in my lifetime, I think he is by far the best Chairman of the Federal Reserve in terms of being, you know, someone was, you know, a very responsible person of the Federal Reserve, and, you know, having to do what he had to do to, like, try to fight inflation from the 1970s and then, you know, once he did that, to not then just go back to, sort of like, easy money. So sorry, I covered kind of probably more ground in just that introduction than. Than you were looking for. But

Gene Tunny  05:01

good, that’s good. I think it’s a good point about Volcker. I think most economists would agree with you on Paul Volcker, certainly. I mean, Greenspan’s legacy, he’s been his reputation was essentially wrecked by the financial crisis. If it weren’t for that, then he would have been the maestro. I mean, that’s what people were calling him, but, but since the financial crisis, I mean, and he’s seen as the Greenspan put they talk about. And, I mean, Greenspan’s policies are seen as having helped bring about that, that crisis. So I agree with you on Paul Volcker on airlines, I think you’re right. I mean, Australia, we had a two airline policy, and that wasn’t changed until the 1980s so we had the same problems, the restrictions on competition. Now, Carter introduced, it looks like it’s the Airline Deregulation Act in 1978 so that prohibited states from regulating air carrier prices, routes and services. So I think at one time in the states there, I mean, there are rules about how many airlines could compete in a particular market, and it was seen as, oh, this is better for consumers, because then you don’t have all of this terrible competition which is undermining the viability of the airlines. I mean, that’s how they thought, right? You’ve seen, well, you know, you

Darren Brady Nelson  06:19

don’t want the consumer to have too much choice. That’s just, you know, too difficult. Well, isn’t that?

Gene Tunny  06:23

Wasn’t there that scene in The Aviator with, with Alan Alda playing the the rate was he a regulator or a senator, and Alec Baldwin was playing one trip from Pan Am, and they were basically making the case. So this is justifying the regulation of the of the airways, and because they they wanted to crush Howard Hughes, who was trying to compete with them.

Darren Brady Nelson  06:49

Oh, okay, yeah, yeah, seen that movie. Sorry, yeah. Oh, you’d

Gene Tunny  06:52

love it. It’s great film. I mean, DiCaprio is an amazing actor and, yeah, but there’s that, that little, that sort of subplot there about the airline regulation and Alan Alda playing a senator. And I’m pretty sure that’s the avian I put a link in the show notes. It was really good. It’s worth, worth seeing. And I think there are some, sorry, so

Darren Brady Nelson  07:16

I was gonna say one. I forgot to mention the deregulation this. This one might, you know, be something that bit closer to your own heart, perhaps, is, you know, that his deregulation efforts extended to the production of beer making, making the kind of, you know, the particularly the craft beers and all that sort of thing. That industry kind of really grew in the wake of that, which is something I didn’t even realize I knew about the aviation stuff, and that’s really important, obviously, but, you know, it’s interesting that it even extended to things like beer, you know. So,

Gene Tunny  07:48

yeah, well, I mean, that’s important industry for Milwaukee, isn’t it, really, I mean, are you the beer capital of the USA?

Darren Brady Nelson  07:55

Well, they might have been against it because, you know, you know, they like the big, you know, like Miller was here. Miller still is here in Milwaukee. And there were other ones that, you know, have since probably really turned into craft beers, actually, industry interestingly, off these bigger like, there were Schlitz and Old Milwaukee and Pabst and all these other ones that, once upon a time were, you know, quite large beer companies, and, you know, I think they’ve kind of shrunk to become almost, you know, mid tier, possibly even, you know, more competing with the craft beers than they are with like Miller and Budweiser, yeah, yeah. So possibly, maybe walk ins weren’t all that keen on the deregulation, yes, yeah, yeah.

Gene Tunny  08:39

Good point. Okay, well, yeah, it’s an extraordinary legacy, and I’ll put some some links in the show notes, or estimates of how much it saved in terms of air airfares. I mean, airfares, certainly here in Australia, used to be prohibitively expensive, and you’d rarely fly. I mean, it was just so expensive, even in the in the 80s and and so there’s a story that Karen Chester tells she’s a former Treasury official here about how her mother, she couldn’t go visit her, her dying father or in Perth because the of the prohibitive airfares at the time. Just tragic story. And now, in real terms, they’re much cheaper. So many, you know, many poor, many more people flying. That’s the same as in the States. So and Alfred Khan. Was it? Alfred Khan, the economist who was an advisor to Jimmy Carter, who was an important figure in that story, Darren, yeah, I

Darren Brady Nelson  09:39

believe so. And you know, when I’ve, you know, my early days as an economist, you know, out of university, I first started doing sort of competition policy at New South Wales treasury. But then my second job was at the Queensland competition authority, doing, you know, regulation of of infrastructure and all that sort of stuff. And, you know, the, the first kind of textbook. That I kind of read was Alfred Khan’s, you know, he’s got, like, a super thick two volume, you know, sort of book on on the economics of regulation. And Volume Two, I think, was largely devoted to this sort of stuff. You know, a lot of these deregulation, deregulation efforts, particularly, you know, the current administration’s deregulation efforts that. So you know that that’s where I first cut my teeth on regulatory economics and the economics of deregulation as well, sort of thing. So the Queensland competition authority was trying to do kind of both, you know, like be a part of, you know, in, you know, as their name suggests, you know that maybe you help competition and where it can be, you know, sort of introduced or helped along, if you like, that was kind of, you know, their their dual mandate. I think all the kind of Australian state regulators kind of had that, you know, and the ACCC at the federal level now, you know, now they’ve kind of not so much involved in that sort of thing anymore. They kind of straight up regulation rather than being involved in deregulation. But at the time, when I joined the QCA, they were certainly, you know, trying to do that sort of thing as well.

Gene Tunny  11:11

Yeah, yeah, yeah. I’ll put a link in the shop. It

Darren Brady Nelson  11:15

was the textbook, basically. And that feel,

Gene Tunny  11:19

yeah, yeah. And do you have any memories of the Carter administration? Were you living in the States at the

Darren Brady Nelson  11:24

time? Oh, I was a little kid. And, yeah, but not really, you know, my kind of, you know, Reagan’s. I have stronger memories of Reagan because, you know, I was getting a bit older, so thing as a kid, so starting to remember Reagan more than than Carter. But, yeah, kind of small memories, you know, but you know, as a little kid, you know, peanut farmer or something, you know, and his brother and his brother Billy and his Billy beer, right? You go look that up. Yeah,

Gene Tunny  11:53

I vaguely remember all the bad news, because I think when I was first became conscious of the the news was probably late 70s, early 80s, and the news at that time coming out of, well, I mean, worldwide was just terrible. I mean, and you know, Carter had there was high inflation, wasn’t there, particularly after the revolution in Iran, and then because of, you know, impacts on the oil market, and then the hostage crisis, which just went on with the hostages from the American Embassy in Tehran, which just went on forever. And, I mean, that was, yeah, that was probably

Darren Brady Nelson  12:26

my first memories, along with the peanut farming and the fruitless sort of stuff you know about him, you know, being, you know, from a back his brother being a redneck who liked beer, yeah,

Gene Tunny  12:37

yeah. So, yeah, you’re right, yeah. So it’s interesting. He’s got a mixed record on the economy, good on the micro, but generally people think the macro story under Carter was was was poor and but his post presidential legacy has been extraordinary. Many seems to be much loved. He’s built houses for homeless people. He when He goes on flights, he shakes everyone’s hands. Yeah, it seems just to have a really quality, decent man. So, yes, I think an extraordinary, an extraordinary life

Darren Brady Nelson  13:14

well, and it’s funny that what the article I sent to you was from, you know, the Mises Institute. There’s another one which I could share with you. Won’t be too hard to find. Is there was an article there about, basically, the author was suggesting the last, if you like, you know, intellectual or debate, was actually Carter and Reagan, you know, like, you know, good debate about issues and policy, you know, not this kind of, you know, attacking each other and attacking each other as people and, you know, all that sort of stuff. You know, there was, there was levity, obviously, at times, you know, in the debate, you know, between Reagan and Carter, I think they even had some, at least, that levity carried over into the next election, 1984 with Reagan and trying to remember the film Mondale. That’s right, Carter is vice president. So, yeah, you know, times have changed, obviously, not always for the better in terms of, like, the quality of presidential debates. So, you know. So someone’s making the case. You know, basically the, you know, that was kind of the, the, the high watermark appeal of presidential debates was Reagan and Carter and, you know, in 1980

Gene Tunny  14:32

Yeah, okay, I love to check that out. That’s, that’s probably, that’s probably true, Alrighty, now, Darren, what was America fest? You went to this America fest conference in Phoenix. Can you tell us about that? Please?

Darren Brady Nelson  14:47

Yeah, so I think we talked about it, you know, like my the last time I was on the podcast that I was, you know, the door knocking economist, you know, there’s probably not too many of us like. That I’m guessing so, so that was for, essentially for turning point Turning Point action. It was a strange marriage, and I think I may have explained at the time, you know, between Turning Point action and Elon Musk’s America pack. So, you know, Charlie Kirk runs Turning Point action and turning point USA Turning Point space, kind of using the American parlance as a c4 it’s kind of, you know, more of a think tank type of outfit, although, you know, they do a lot of, sort of, like educating on on university campuses, and now they’ve extended that to sort of high school level as well. Turning Point actions, a straight up. You know, get out the vote for the candidates you like, right? Yeah, that’s a c4 sorry, yeah, I believe that’s, am I getting this wrong? No, but is that the c3 My apologies, my I think I need to drink some more coffee or something, but it’s all right. So, you know, they’re totally different types of organizations, and so anyway. So to make a long story short, all the people who did, you know, helped out on that election were offered the opportunity for, you know, free airfares and free hotel and free admission to America fest, which is put on by, you know, Charlie Kirk’s organization. And so it’s kind of like a, you know, if you’re aware of CPAC, you obviously wear CPAC Australia. CPAC Australia is obviously trying to do what CPAC us does, you know, big conference for not just conservative, just anybody, if you like, on the, you know, the right side of politics, whatever that means, you know, center right, whatever, conservatives, libertarians, including kind of, you know, modern day populists on the right. I mean, populists are in the left and the right. You know, over time. You know, that’s kind of a nebulous description populism, but you know, so in Australia, that would include, obviously, you know, Liberal National Party, folks, but include one nation libertarians, all that. And over here, obviously it’s, it’s Trump and, you know, Reagan conservatives, you know Ron Paul libertarians, whatever. And so America fest. I mean, you know it’s not, it’s basically trying to do what I guess CPAC does. And I don’t know the whole ins and outs on why it started out, they thought they needed this. And, you know, to, I’m not sure if they’re trying to be a rival to CPAC, or just, you know, or maybe if you like the markets big enough, and they wanted just another one, the way they hold it in Phoenix, it’s got a, you know, a more blatant, you know, America First type approach, you know, which is kind of a little bit more in line with, you know, the Make America Great Again movement, mega movement, not to say CPAC, not on board with that, because, you know, they are. I guess, if CPAC is trying to, maybe trying to combine that, but keep the establishment Republicans kind of still around, maybe an America fest is, like, we don’t really care about the establishment Republicans, you know, in fact, we want to push them out the door. So they’re probably a little bit more explicitly, you know, mega Not, not, not exclusively So, but they’re certainly, you know, they’re happy, obviously, probably for libertarian types, you know, like, you know, Ted Cruz is kind of bit of a more of a libertarian type, and, and he spoke, there’s certainly, you know, they’re definitely not for the establishment types and Mitch McConnell’s and and certainly not the Liz Cheney types, right? And certainly not the neoconservative types. So anyway, so that, and they hold it in Phoenix. I’m not sure how many they’ve had, I think they’ve had several or more. So basically, I think they took what was good of CPAC and they’ve added to it. There was certainly more energy. It was actually interesting, a bigger than CPAC in Washington, DC, which is saying something, because that’s pretty big, you know, that’s I’ve ever seen, was CPAC until I saw America fest. So

Gene Tunny  19:01

how many people? You’re talking 1000s of people. Oh, boy, oh, boy.

Darren Brady Nelson  19:05

I think the main hall holds 10,000 but the whole, but the whole, you know, conference area is bigger than that. Still, you know, so still, yeah, I don’t know what the numbers are. And, you know, we could probably find a link that maybe sort of said what those numbers might actually be, and I can share that with you where the audience can look that up. But, you know, the biggest thing I ever seen was CPAC, until I saw America fest, and it kind of reinvigorated me too, because I was, I was kind of getting sick of CPAC To be honest, you know, like not to say it was bad or whatever, I just kind of was getting sick of it. And this kind of, you know, the opening night of America Fest was like, you know, pretty Wow. Okay, you know the three key speakers that, I mean, there was more than three speakers. But I mean Charlie Kirk, like, I mean, I was impressed by Charlie Kirk coming in, but, wow, I was even more impressed by Charlie Kirk seeing him speak on the night. He was kind of the opening speaker and, you know, and then one of the last speakers on the opening night was Tucker Carlson, and I’ve been a big fan of Tucker’s for quite some time. And, you know, he certainly delivered as well. And and on the very last night of the conference, Glenn Beck was also, I thought, an amazing speaker as well. And they had plenty of other amazing speakers. We can talk about some of that, including one of the breakout speakers who talked about Marxism, was was amazing, and he’s an academic, and often academics aren’t very amazing speakers, as you probably have experienced yourself. You know, it’s not an easy thing to be someone who’s like, sound on what they’re talking about well and actually interesting at the same time. And who was that? Oh, boy. I mean, it’s really bad that I forgot the fellow’s name, considering he’s from Hillsdale College. He’s got a, he’s got a, he’s originally from Lebanon, so he’s got sort of, you know, you know, maybe I’m being a bit saying he’s got an Arab sounding name, and that’s probably offensive to Lebanese ago. Wait, we’re not Arabs, you know, but, and I think they’re not Lebanese, they’re kind of like a different sort of people’s group than strictly Arabs are, and then they obviously had that interesting mix of like, you know, kind of a bit over half the country’s Christian, and then slightly under half is Muslim. But I think it was originally from Lebanon, because even after the talk, he was talking to someone from Lebanon. He was speaking, you know, in Lebanese, which I understand, is a different language from Arabic, so um, and it sounds different too. So, but anyway, the interesting thing about him is, like, even though his speech was labeled, you know, Marxism, and you know, that obviously gets people, you know, kind of in to see that it was actually more about Jean Jacques Rousseau. Then it was actually about Karl Marx. Yeah, and I knew a bit about Rousseau, but I didn’t realize the importance of Rousseau to the left and he was making, he said, All Marx did was fill in some of the gaps. Rousseau is a guy who, you know, was really leading the charge on the ideas that were, you know, if you like, stuck with today in the 2020s they’ve come to fruition. Yeah. Well,

Gene Tunny  22:25

one of will Durant’s volumes in his history of civilization, I think, is Rousseau and revolution, after the after the age of Voltaire. And so Rousseau is one of those thinkers is associated with the French Revolution. And, yeah, with I mean, yeah, certainly, the Marxists wanted to have their own revolution whereby they get rid of the bourgeoisie, didn’t they? Whereas the French Revolution was, it was against the the aristocracy at the time. Yes, yeah, interesting. Okay, I’ll have to check out his work. And Donald Trump spoke at that event, didn’t he?

Darren Brady Nelson  23:03

He did, and I was, sadly, I got distracted by a pair of Aussies and and I didn’t. And I can tell you more about that. I didn’t. So I didn’t actually get into the main hall to see, you know, the orange MAN there, and, you know, live. So I had to actually just watch them on the big TV screen. So basically, they set these up similarly in CPAC, you know, they have the big main hall, obviously, all the big there’s lots of razzmatazz and all that. Then there’s like an exhibition hall where a lot of, you know, people just, you know, commercial people offering different services, go, hey, you know, here we’re here. You know, either come buyer service or, you know, think tanks go there and say, Hey, join us, or whatever. And then there’s a media row, which is pretty exciting and interesting. So, you know, you have the TV stations and radio stations and podcasts who do their shows live from, you know, from there. So that’s very interesting, too. So you can sit there as an audience and kind of watch this. And some of them you can will interact with the audience as others, they’re not. You’re just kind of watching them. Yeah. And so, so, yeah. So basically, you know, one of the one of the in the exhibition hall was a so not all the media is actually in media rose. Some of the kind of smaller podcasts are in the exhibition area. So one of them was an Australian podcast couple, and so I kind of came across them. They had an Australian flag up so that obviously. And I’ll get you a link to their, their podcast, you know, for for your for the audience, and,

Gene Tunny  24:39

yeah, what do they cover? Do they do politics or economics? Yeah,

Darren Brady Nelson  24:42

their angle is basically doing American politics, but from an Australian perspective, right? And they, and they come over here for big events like this or, you know, and I think they’re going to stay here roaming around until the inauguration, so they’ll end up in Washington. In DC for the inauguration. And, you know, very, you know, like, very cliche Aussies, they were like, you know, just super friendly and super, you know, and I kind of got to know them, and, you know, ended up having, you know, lunches and stuff for them. And sadly, I was chatting so much that the queue to get in to see Trump, you know, it got cut off. Basically, there was, you know, obviously, once it was full, that’s it, you know, you can’t get, but there’s more people in the overall sort of conference than that can fit into the main hall. Yeah, that’s, I’ve actually been, I went to the, the Milwaukee, um, Trump rally right before the election. So, you know. So, you know, it wasn’t, I feel bad for people who actually, that was their thing. They came there Trump, you know. So I’ve seen Trump another, you know, a number of times in person. So, you know, wasn’t as disappointed sort of thing to not see him in person. But, you know, but some people paid money to get there and they’re not from Phoenix, you know, that would have been kind of a real bummer, so I felt kind of sorry for them. Yeah, and there was a few, I’ve met a few other Australians too. So, you know, that was nice. See, there’s probably a lot more Aussies there than I actually ran into. So yeah, it was, oh, actually one of the Australians I did run into. This was a good story. And I think he’s been living in the US now for quite a number of years. And I don’t know perhaps he’s actually married to an American is there’s a quite a popular Catholic podcast, podcast called

Gene Tunny  26:36

pints with Aquinas. Oh yes, yes. It

Darren Brady Nelson  26:38

runs it as Matt Fred, and he’s an Aussie. Ah, yes, yes. I wanted to the, you know, these breakout sessions on, you know, Catholics and, you know, voting and that, you know, I’m was raised a Catholic, but I’m a Protestant nowadays, but I’m still interested. I’m not an anti Catholic, and I find it interesting. And I just went in there, and I sat at the back. And lo and behold, Matt Fred’s behind me. You notice? You notice my my jewel flag? Yeah, you have that, you know. And I told him the story, you know, Brisbane, blah, blah, blah. And then we had a little bit of a chat. Then he wasn’t an official speaker. He was actually there because his son wanted to be there. He’s got a 17 year old son that’s into all this sort of stuff and but, so we had a little bit of chat then. But then later on the day I went out of the conference, I got a good coffee, because you couldn’t get the greatest coffee in the conference. And you know, at the hipster cafe that I was I was talking about, yeah, to go back in, they said no outside coffees. And I go, Okay, fine. So I went to just go drink my coffee, you know, and he was sitting there smoking a cigar, and Matt, that is, and then I said, Oh, you mind if I sit down with you, and we had a good chat for 20 minutes while I drank my coffee and he smoked his cigar. And, you know, we talked about Australia, we talked about Trump, we talked about Catholicism and Protestantism and all that sort of stuff, and and podcasting, and, yeah, it was, it seems like a good, good bloke. Very

Gene Tunny  28:08

good. Well, as I think I’ve mentioned before, you’ve you have a radar for finding the hipster cafes, Darren, whichever city you’re in, so I’ve benefited from that at times. So very good. Now. Can you tell me? Was there any policy discussion at America fest? Did you get any insight into what could happen in the second Trump administration, particularly around migration? Because it looks like there’s a civil war within Maga at the moment between Steve Bannon, the people, you could say are nationalists or Nativists, versus Elon Musk and Vivek Ramaswami, who could be perceived as globalists. Do you have any insights into what’s going to happen? There any any thought, any insights into policy you got from America first?

Darren Brady Nelson  28:58

Yeah, look, I mean, America first wasn’t, you know, much of a policy oriented conference. And so true CPAC isn’t either it’s a lot of you know, it’s a lot of you know, celebration if something’s happened, or getting people you know, fired up for whatever is coming up. Now, look, I don’t know enough about Steve Bannon positions. I never got the feeling it was a nativist as such, like, you know, the one thing that I know Bannon, ramasami and musk agree on is the illegal immigrations that’s got to stop, right? Yeah, not just stop, but it’s got to be reversed. Basically, we can’t have, you know, and they’ll do it in sensible tears. I believe you’re going to, I’ve seen, you know, gangs and criminals, people who are literally, since they’ve arrived the they haven’t just broken the law to get here. They’ve been breaking laws, you know, inside the country too, and particularly the courageous ones. So they’ll prioritize this, you know, obviously, murders, rapists, etc, etc. You know what? You know they. Might come to a compromise with people who’ve, you know, peace, you know, who are peaceful, and they’ve entered and, and they actually did come here with families, as opposed of just, you know, child traffickers and all that sort of stuff. So look, I understood it was over those, those visas for, like, you know, highly skilled and targeted, yeah, you know, Bannon had a problem with that, is that? Is that? Oh, yes, yes,

Gene Tunny  30:21

yeah. But he was podcast the other day, because the the progressive commentators online are, they’re they’re enjoying this. They see this as a civil war within Maga, because you had Ramaswami come out and say, we need more h 1b, visas. Yeah, they’re the ones that Silicon Valley uses, like high skill, particularly bringing in high skilled Indians to work in Silicon Valley. And he, he writes, he wrote a tweet that was probably, you know, badly. He should have thought twice about it. It didn’t go down well with with Maga, really. He said that, oh, we need all of these people on H, 1b, visas, because Americans are, you know, a lot of Americans are lazy and won’t work hard. They’re not entrepreneurial, not not well educated. And that was just, yeah, that caused a bit of a firestorm. And then Steve Bannon on his show, he said, I will, you know, I’m going to fight for control, or something of the GOP. I don’t know the exact words, but he’s essentially saying, Look, we’re going to take on mask and Ramaswamy. We were here first. Well, he in terms of the Trump, you know, being supporters of Trump, where Maga, we’re not going to let you take over Maga. So I think it’s an interesting conflict there between musk and Ramaswamy, who who have a different outlook from that of a lot of the people in Maga, a lot of the supporters of Trump who see, who wants something different from Trump than what musk and Ramaswamy want?

Darren Brady Nelson  32:07

Yeah, look, I think, in a nutshell, I don’t think there’s going to be any sort of civil war, no. And to be honest, also, Bannon influence is just not anywhere near it was in, you know, 2016 2017 I think you know Ramaswamy is gonna certainly, if he hasn’t, he should really go out there and apologize for those statements. That’s just those are, there’s not, I mean, they’re not only offensive, they’re not even, that’s not completely accurate. Anyway, you know, the US is India as the entrepreneurial hub of the world compared to the US over history. No, there’s no comparison, like a really, Johnny Come Lately, you know, to that world. And obviously there’s some good stuff, and they’ve done some good reforms in India, but this is, you know, pretty recent sort of thing. So it’s not like the country that we look to for great entrepreneurs over the past 50 years. No, so you know. So I don’t think there’ll be a civil war. I think they’ll find a compromise Trump, Trump will, you know, Trump’s a strong leader. He’s going to sort this out. They’ll find something that, you know, not necessarily, that Bannon can live with, but I think something that at least your average mega supporter, it’s probably not like up in arms over these visas. But then, you know, when Swami says what? He says, Yeah, they’re gonna be up in arms about that sort of comment. And, you know, Musk, Musk comes from, you know, kind of a, you know, originally, you know, a Democrat type background, if you like. And he’s kind of become, you know, either he’s become more conservative over time, or he can just say the Democrats have become so out of touch with their previous base. Either way, you know, must not going to, he’s not going to be leaving the camp, and Ramaswamy is not going to be leaving the camp, and even Bannon at the end of the day, even if he doesn’t get what he wants on these visas, it’s not going to be, you know, he’s not going to, sort of, you know, be a constant thorn in the side. I would think, to, you know, President Trump. I think, you know, I think things, the compromises, will be reached. And, you know, maybe this on this issue will be one that they disagree, to disagree on. Basically, there’s bigger fights to be had. I think they’re going to fight. They’ll realize that, right? There’s far bigger fights, which is why they have the musks in their camp and the Tulsi gabbards and RFK juniors and stuff. There’s a bigger enemy to be fought, right? The weft type, globalists, you know, you know, rather than, if you like the musk type, small g globalist, if you, if you, if you like,

Gene Tunny  34:43

wow, okay, yeah. Well, we’ll big difference

Darren Brady Nelson  34:47

between that, because the big G globalists are not like, Oh, I just want to have access to better workers. It’s a far more nefarious globalism than than Musk’s type of globalism,

Gene Tunny  34:59

raw. But okay, well, I think we’ve talked about the great reset in the past, and, you know, whether there’s, whether there’s a conspiracy there or not. I mean, I don’t really think there is a conspiracy of any kind there is, because

Darren Brady Nelson  35:11

you can just go on the weft website, and it actually has a black and white it’s like, it’s not like a conspiracy theory. If it’s like, literally sitting there on their website, you know, like that. It’s not even a theory. It’s this is what they want to do. You know? You can say, like, oh, they don’t really want to do what they just said they want to do. Okay, fine, that’s fine. You can have that position, but it’s literally in black and white and reports, and you can go find it today easily. Yeah, they’ve

Gene Tunny  35:35

definitely said some silly things, right? The whole thing about you will, what is it? You will own nothing, and you will be happy. I mean, that’s just,

Darren Brady Nelson  35:43

I’m talking about statements. They have reports on what their is, you know, like it sets it out, you know, like, you know, you know, when someone says what they say, you know, the default should be able to believe what they said, you know, unless some reason not to.

Gene Tunny  36:00

Yeah. Well, I’ll put a link to our conversation on the great reset. I’ll have to go listen back to that. Yes, okay, well, yeah, look. I mean, I’ve got no idea what, exactly how economic policy will play out under Trump. I mean, I think it’s, it’ll be interesting, because there is that tension there, and we have to see how, what you know, how high the tariffs go up that are imposed on China, that are imposed on other countries, whether Australia gets an exemption. I mean, presumably we will, because of our, our strong relationship with the US. But, yeah, we just have to, have to wait and see about that. Okay, Darren, can you tell us about your article? You wrote an article. Why competition for concurrences journal? Can you tell us about that? Please?

Darren Brady Nelson  36:49

Yeah. Look, concurrences is essentially kind of an anti trust, you know, well, not just a magazine. It seems to be kind of bit of an association of particularly lawyers, antitrust lawyers, but also maybe other professionals in the field. And I can’t to this day, I can’t even remember how they approached me, but I remember in 2020 they kind of approached me and asked me to write a forward for one of their, you know, sort of their magazine that comes out, and I kind of wrote about anti trust economics, and kind of did a mix of, kind of like, you know, you know, I did kind of, here’s kind of a the mainstream kind of view on on this from an economics perspective, and then here’s kind of the free market perspective. I think the free market perspective is the better one. But anyway, laid it out and and then, you know, they kind of come back to me, you know, here and there to, you know, you know, ask me to write this or that. And earlier in the year, they were planning on doing a book entitled, you know, why competition voices from the antitrust community and beyond. Just to give it a little bit more context, they’re kind of focused on North America and the European Union, but they’re obviously open to kind of, you know, others around the globe as well. And this was going to have, you know, one of these books where, you know, each chapter has, you know, different author. I mean, they can be co authored or whatever, but they’re kind of in different themes. So my, the chapter that I wrote was, you know, basically, I think I entitled it, you know, kind of competition, economics, evidence, policy and ethics. Again, I kind of try to do, you know, a combination of of, kind of, you know, kind of, what’s the mainstream sort of view, and then kind of a free market view. But interesting enough, when I kind of proposed, you know, I thought, oh, you know, like, you know, as a Christian, as I kind of mentioned, I thought, oh, you know, how about kind of, also, because I’ve increasingly become interested in, kind of Christian economics is kind of even a different thing than than you get from the mainstream and the free market kind of way of looking at things. I thought, oh, you know, maybe this is an opportunity to write a little bit also from, you know, what, what is, what is this? You know, what does competition look like, you know, from a Christian economics point of view. So to my surprise, they went, Oh, yeah, that sounds interesting. Go ahead. So, so, you know, kind of, my, my, my chapter is kind of a mix of those three things wrong. Yeah, you know Christian, yeah. Sorry. Go on, I’ve got

Gene Tunny  39:27

to ask you about that. So, how is economics any different for a Christian versus a non Christian? I

Darren Brady Nelson  39:34

mean, well, it’s a complex thing to answer, because a lot of you know, you know, Christian economics is really just economics written by a Christian, right? So, so they kind of throw in some stuff or, you know, but, but interesting enough, there actually is, if you like, an actual proper Christian economics in the sense of, it’s built up from Scripture. It’s built up. From the Bible itself. Usually, you know, the better ones are people who’ve actually also been there are trained economists, you know, either, you know, from a mainstream perspective, or maybe a free market perspective, or maybe a bit of both. So, you know that, you know, so you kind of, kind of get some interesting feedback, you know, kind of from that. So, you know, like, for instance, you know, Gary north, you know, was, was, I believe, you know, trained in the usual kind of mainstream economics. Over time, he kind of became more an Austrian School economist. But then, you know, he also then tried to build up Christian economics, you know, purely from the Bible, as well as someone who was interesting enough, a trained theologian as well. So, you know, the Bible is, just like, you know, amazingly full of economics, you know, surprisingly full of it. And not just you know, like the parables you know, like the parable of it once or something that you know, probably sorry, the parable of the what’s all right, the talents, oh, you know, yeah, give me that one, you know, like, you know, where you know, a master gives you know, three of his servants, you know, he’s going to go away for a while. And he gives you know one, like one, one talent to go and do something with. And then another two talents, another five talents, you know, you know. So that, you know, there’s not just kind of, you know, they’re ultimately not. The main point of all these things is never just purely to make an economic point. Obviously, in the Bible, it was a more obviously theological point to be made. But, you know, it’s interesting to see just how much economics is in there, you know, as a teaching tool. Because, you know, obviously people can, you know, relate to, you know, least kind of economics in their own life, not necessarily, obviously, you know, the way we as economists necessarily think of things, but obviously economics touches everybody’s life. So, you know, I just wanted, you know, I’m certainly very much a, you know, a Padawan learner and not a Jedi in this just as of yet, okay, you know, I’m kind of, but I just thought it was a good opportunity for me to, kind of, like, write something and just, you know, give me the opportunity to learn more about it myself. Because obviously, you learn you know more from doing, you know, from writing and researching, than just, kind of just reading something, right? Yeah. So, you know, it was kind of a good you know. And I thought, you know, ethics is kind of interesting, too. And ethics, particularly, I don’t know, I find kind of secular ethics, kind of wishy washy for the most part, it’s kind of a lot of just like, how do I feel about things, you know? Like, if I’m from the left, I kind of feel these things. And if I’m on the right and not a Christian, I kind of feel these things. So I think, you know, whether you think Christianity or, you know, the is real or not, you know, it’s certainly more black and white than a lot of these kind of secular ethics is right? And as a Christian, I think it’s objective, right? And I think you go off into secular ethics, it’s kind of very subjective. So I thought it was an opportunity to kind of explore bringing, you know, that there’s an ethical element to economics, at least, you know, from a Christian perspective. And there’s not a, you know, there’s not a tension between the two. They’re kind of wrapped up together. They get like property rights is a concept and not just an economic concept, you know, like, Thou shalt not steal, is both economic and ethical at the same time.

Gene Tunny  43:29

Yeah, yeah, okay, okay, I think I see where you’re coming from, just on the parables. Someone you introduced me to, if I remember correctly, was Larry Reed at Foundation for Economic Education. When he was on my show, he talked about the Parable of the Vineyard workers. The vineyard workers,

Darren Brady Nelson  43:48

oh yeah, the martial, martial value, really, isn’t it? Yes,

Gene Tunny  43:52

yeah, where he’s paying them different amounts of money. And I think Jesus says, Oh, that’s okay, if it’s a fair bargain, if they all are better off because of it?

Darren Brady Nelson  44:03

No, it was. It was basically, it wasn’t even that. It was just like, well, you agreed to it, you know, like, yeah, exactly. So it was actually, I think they were paying the same amount, but these people came in and worked nowhere near as long hours, or, you know, towards the end of the day, and these other people have been working the whole day, and they’re just getting the same pay, you know, I think that’s

Gene Tunny  44:22

right. Okay, gotcha, yeah,

Darren Brady Nelson  44:26

qualifying it by going, Oh, well, as long as it was fair, you know, like it, you know, some nebulous way, he was basically like, you know, is it not the master’s money to decide what he does with it, right? And if he wants to do this bargain, because he needs more workers to come in. And, you know, it was actually strangely in line with, you know, the whole marginal revolution, you know, right, okay, fascinating. It was kind of like a marginal value,

Gene Tunny  44:53

Okay, interesting. I’ll have to put a link to that episode. I have to go to do it actually, to make sure I know the story. It’s quite embarrassing,

Darren Brady Nelson  45:02

that stuff too. But it was something slightly different. But it was, yeah, it was interesting, because then you often, like, people, you know, go like, well, he, he flipped over the the money changers, you know, sort of thing. Therefore he’s anti, you know, markets and anti exchange. No, that that point was to do with the temple and the Pharisees. You know, Jesus didn’t have a problem with commerce. He didn’t run around knocking over exchange tables everywhere. He had a problem with the way that the Pharisees and others are running the temple and, you know, turning it into a farce, you know, sort of thing totally different. So, yeah, yeah, you know. But the thing so, you know, it just was a great opportunity to throw some, I think Christian economics, to me, actually was even surprising to myself as an economist, was like taking the best of the mainstream and taking the best of the free market and not literally building on it like that, but it actually, I found it actually even more insightful, if you like, than even Austrian economics was, yeah, or, you know, neoclassical economics, you know, it had a lot of, you know, you know, good overlap with them. But it was, you know, yeah, I thought it was really interesting. One thing

Gene Tunny  46:15

I remember from Milton Friedman might have been in freedom. It was, it may have been in free to choose, or Capitalism and Freedom. I can’t remember the exact book, but he talks about how there’s a there’s a moral case for free markets, for competition, as distinct from the, you know, the the efficiency case that economists make for free markets is that the case you’re making, you’re saying there’s actually a moral case as well as an efficiency case, correct?

Darren Brady Nelson  46:42

Yeah. And I think the, you know, the Chicago school or Austrian School eventually get down to a level where it’s, it gets a little bit Sandy, you know, like the base wanted to argue an ethical, moral reason for free markets. Eventually it just runs out at depth, right? And I think, yeah, the Bible takes it to a level, you know, that that’s on a solid foundation, that’s literally on a rock, you know, of course, obviously not everybody’s gonna agree with that, if they not a Christian or even a Jew, who can, because they can also go down to the same you know, a lot of this is in the Old Testament too. You know, the, if you like, the ethical, moral foundation for, for, you know, least, largely free markets. But also found that the Christian economics finds doesn’t have the tension between the individual and the collective like the secular Do you know, like the free markets often go into kind of hyper individualism, and then, you know, the left wing ones go into hyper collectivism, right? Christian economics finds the right balance between those two. You know, really marries the individual and the group together better than the secular economics does.

Gene Tunny  47:57

Interesting. Love to think about this some more. Darren, I mean, I’m not, I can’t see how it would affect the laws of economics or or how we would apply economics in practice, but I could see how it could affect your judgments regarding what is good economic policy. I can see that I’d have to wonder though. I mean, what is it? I mean, is there anything superior about I mean, this, I guess, is a bigger conversation. But like, we can’t leave out the Chinese or the Indians or people in other parts of the world who aren’t Christian, can we? Or aren’t predominantly Chris that aren’t Christian countries. So where are they? I mean, they’ve obviously got economists. They’ve got economics. Economics is relevant to them. How to is this just something you that augments your understanding of economics? Or do you think it’s something that’s

Darren Brady Nelson  48:46

essential? Originally, I thought it was augmenting. I think it’s ultimately essential, and it and, you know, if, if the Christian worldview is correct, as I think it is it the God of Christianity is everybody’s God, right? So, so, and the laws that were set, you know, that God created all the laws of this world, right? Sorry, the the natural laws, which say, and I believe he created the economic laws of this world, right? So, and, and there’s good evidence for that. It’s not just a, you know, just a blanket statement, trust me, like we, you know, we told you it was this. So believe us, you know that that, I mean, we’re obviously going to go into a totally different thing. But the world of, you know, Christian apologetics and evidence, which this Christian economics, kind of also kind of overlaps with, it’s not just like these statements that you know we’re right and you’re wrong. Just trust us. You know, there’s a lot of, you know, natural world evidence for this stuff. So, you know, as a Christian, I argue these laws of economics are, you know, the ones that God himself put in place. And he put them in place for a reason, and they’re not in conflict with ethical sort of. The moral laws that he also put in place, and they applied, all of humanity, and all of humanity is welcome. You know, it’s not a case of like, Hey, this is for us, and that’s for you over there. It’s a totally different story, whether you believe it, and you know, whether you’re, you know, saved and all these sorts of things. But you know, and God’s, you know, in the Old Testament is blessed many people that that weren’t Israel as well. So it was never even like only the Jews get the benefits of this. No, it was something that was meant to benefit all of humanity.

Gene Tunny  50:34

Okay, interesting perspective, Darren. I love to come back to that. I mean, I but, yeah, let’s, let’s, let’s leave that there. I want to know what’s your main argument in your article? What’s the main thesis of your of your piece on for in this wire competition volume?

Darren Brady Nelson  50:56

Yeah. I mean, what you know, basic competition is a good thing. Very good. It’s a good thing economically, like efficiency wise, but it’s also good ethically. That’s, that’s, that’s in a nutshell the argument and I, and I draw from, I think, the best of mainstream economic because I’m not in there. In my antitrust article, I was criticizing mainstream economics, and this one, I was just taking some of the good stuff that I thought, you know, it’s still not in conflict with free markets or Christian economics, and just kind of tying it all together to go, yes, competition is a good thing. Yeah,

Gene Tunny  51:28

why were you critical of mainstream economics in that antitrust article?

Darren Brady Nelson  51:34

Well, we can consider a link to it, but you know, even some of the languages that it uses, it kind of presupposes that competitions, you know, either an unattainable thing, and thus government has to intervene, or it’s, you know, using words like power, you know, like, that’s, you know, like, well, free markets aren’t about power, really. They’re about, you know, voluntary exchanges, you know, they’re not the use of power, right? You know, no one’s forcing you to do anything. So, you know, market power. Look, I can understand it, and I there’s some validity to it. I’m not saying there isn’t a beast that’s kind of like that, but to use the word power is almost kind of misleading. And obviously, you know, like using a benchmark, like perfect competition, that they, on the one hand, acknowledge can never really exist, but at the same time using that to judge actual markets, which is what they all do. The a, Triple C does it. The the Department of Justice does it. They all use the same benchmark to go to then intervene. It’s like, Well, you said that this isn’t possible, that you’re using it as a as an excuse to intervene. That’s why I’m getting and you’ll see that in my antitrust article, which is, you know, available, yeah, so

Gene Tunny  52:50

you against all economic regulation, all antitrust action. Is that the position? Um,

Darren Brady Nelson  52:57

yeah, okay, not sure enough. It’s been misused and abused so much that I think it’s not something you know, and it’s usually political, even in Australia, but it’s more so in the US. It’s usually used against people who actually, really, you know, like, even, you know, the people that they supposed like Standard Oil. Well, okay, fine, Standard Oil, at the time, dominated its market. That’s true. But guess what? Prices were going down and quality and quantities were going up. So why were you intervening? Because even under, supposedly under the anti trust laws, you know, even if you are deemed a monopoly, that’s not good enough, you have to be abusing your monopoly power, and if your prices are going down, you’re not really abusing your monopoly power, yeah, yet, yet, they intervene, right?

Gene Tunny  53:48

And I saw in your your article, you had that chart about how all of the the industries that are heavily regulated, their prices have gone up at a faster rate than general prices, than CPI inflation, I think that’s, you know, that’s, that’s certainly something that advocates for regulation need to explain. I mean, the case they’ll make, of course, is that, well, they would have gone up even further if we weren’t regulating. So, you know, what’s the counterfactual? That’s what they’ll that’s what they’ll argue, I suppose, and I

Darren Brady Nelson  54:21

but the thing is, they go up. If you got out of there and you allowed them to go up, and you weren’t getting in the way with all your regulations, they’re good. Someone’s going to come into that market. And I’ll tell you that, you know what? They won’t even do it because, you know, I forgot what that limit. I think it’s limit pricing or something like, you know, we’re monopolists. Are always on the lookout for, oh, if I raise them too much, I’m going to get an entrant, right. So, so, yeah, I don’t know. And the antitrust authorities never go after the regulations that help people monopolize or cartelize their industries. So they basically, they hurt, they make it. They create. It in one hand, not necessarily the antitrust authorities themselves. Government creates these monopolies and cartels and then no pretends to come to the rescue, you know, with the antitrust authority, right?

Gene Tunny  55:10

So you don’t believe in the whole natural monopoly argument, do you? I think we might have chatted about that in

Darren Brady Nelson  55:15

a mainstream economist like Bom will, kind of, you know, kind of heavily question that too, and I believe he’s correct. You know, like, because you know, if you got a natural monopoly, and if you’re you can really produce at a lower cost than two or more others. So what you know, you know, basically the arguments like, so what you know, like, if, but you know, if you can’t, then someone’s going to enter your market unless there’s a, you know, a government created barrier to entry. So even bolmo, you know, mainstream economists recognize that. But even

Gene Tunny  55:50

for water infrastructure or electricity infrastructure, if

Darren Brady Nelson  55:55

you’re a natural monopoly, why do you then, why do you need the regulations that make you a natural monopoly? So you’re not a natural monopoly, you’re a government created monopoly. So monopoly like 99 out of 100 times, right? So, so prove to me that you’re a natural monopoly. Take away the regulations that don’t allow anybody to compete, and then if no one’s competing, then let’s, let’s, you know, then, then the regulator maybe does his thing in that situation. But it never happens that way. They always create the monopoly, or the cartel, and then the regulator comes afterwards. That’s exactly what happened in the US. You know, there was competition in water and sewage, there’s competition in electricity, natural gas, railroads, all the rest. And then some of them couldn’t hack the competition, and they went to get franchise monopolies, and in return for that, you had to have a regulator. Okay, so history is against this concept of net, and they invented the concept decades afterwards, you know. So that’s suspicious in itself, you know. So don’t know. I don’t believe in natural at all, please. Okay,

Gene Tunny  56:55

that’s interesting. That’s good to good to explore these things and and discuss them. One thing I do like about what Lena Khan’s been doing, although she’s getting sacked. I mean, she won’t be appointed. I think Donald Trump will have a different federal trade commission chair. She’s going after the companies that lock you into Subscriptions. Okay? I think that’s a that’s a that’s a really good regulatory action, and Australia is looking at doing that too. The the fact that you sign up to something online, and it’s easy for you to sign up, you give them your and you give them your credit card, but if you want to cancel your subscription, you have to ring someone up. They just make it incredibly difficult to cancel a subscription. And what Lena Khan said is, no, it’s got to be as easy to cancel as it is to sign up. And I think Australia is going to adopt the same thing. I think that is a really good thing to do, because it’s terrible how they do that. And companies which should know better, which should have which should protect their reputation, like the Economist newspaper or magazine in London does that too. I mean, the, you know, the Murdoch papers do it, but okay, probably expect that from them, but for the economists to do it, that’s just disgraceful. So I think that’s actually a good initiative of of the regulatory state, so to speak. If

Darren Brady Nelson  58:23

I wouldn’t be surprised if there was some regulation that made it easy for them to do that in the first place, because that’s usually what happens, usually because, because the regulatory states just constantly building on itself and has all these unintended consequences. You know, just unintended consequences built on unintended consequences, etc, etc, and it’s constantly overriding the common law that would probably would have dealt with that, you know, in a more efficient manner once upon a time, but the common laws been almost just pushed out the door. You know that that would usually not be, you know that would usually break contract law because you didn’t come, you didn’t come to a contract. You know, you can’t just, like, assume I’ve subscribed to your your service, something like that. That’s not how normal contracts work, right? So I would suspect that the, you know, the regulatory states, come to the rescue after it actually created the problem the first place. But I don’t know that for a fact. I’m just those things, having worked around this sort of stuff for 30 years, it’s usually the case, but I can’t say for sure. Well,

Gene Tunny  59:26

I think it’s good to be have that suspicion that you have that as something you certainly want to investigate. I agree there that that’s worth that’s certainly worth considering. Okay, Darren Brodie Nelson, we’ll have to wrap up soon. Any final thoughts, anything you want to come back to to discuss,

Darren Brady Nelson  59:43

oh no, look, you know, appreciate the time, and it’s always fun to kind of, you know, cover, you know, quite different topics. And I imagine, I don’t mean I can’t imagine, there’s too many sort of two economists talking about the kind of variety of stuff that we tend to talk about.

Gene Tunny  1:00:00

Well, I don’t know. I mean, maybe, maybe not, from the angles we talk about them from. I think certainly the the unexpected, the unexpected angles that that we come at things from, I think is, yeah, that that may be that may be unique. Anyway, Darren, it’s always, always a pleasure, and enjoy getting your insights and into what’s happening in the in the US particular. And yeah, well, thanks again for appearing on the show, and look forward to speaking with you in the future. Thank you.

Darren Brady Nelson  1:00:38

Thank you for having me.

Credits

Thanks 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 and other podcasting platforms.

Categories
Podcast episode

US Debt Ceiling: Why Trump is Right to Call for its Abolition & Gene’s Experience with Aussie Debt Ceiling – EP268

Show host Gene Tunny discusses the ineffectiveness of the U.S. debt ceiling, citing its frequent increases and the political grandstanding it entails. He notes that since 1960, Congress has amended the debt limit 78 times. Tunny argues that the debt ceiling does not enforce fiscal discipline and highlights the need for better fiscal rules, such as the Swiss Debt Brake or the Taxpayer Bill of Rights. He also shares his experience with Australia’s debt ceiling during the late 2000s financial crisis. Tunny concludes that Trump’s criticism of the debt ceiling is justified.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

You can also watch the interview on YouTube:

Timestamps for EP268

  • US Debt Ceiling Overview (0:00)
  • Historical Context and Modern Monetary Theory (4:09)
  • Ineffectiveness of the Debt Ceiling (7:07)
  • Australian Experience with the Debt Ceiling (13:00)
  • Conclusion and Alternative Fiscal Rules (24:49)

Takeaways

  1. Debt Ceilings Are Ineffective: The US debt ceiling fails to control spending or debt accumulation, as it is consistently raised to avoid financial crises.
  2. Alternative Fiscal Rules: Spending caps or frameworks like Switzerland’s debt brake are more effective at managing fiscal discipline than nominal debt ceilings.
  3. Political Grandstanding: The debt ceiling often serves as a stage for political drama rather than meaningful fiscal reform.
  4. Modern Monetary Theory Critique: Printing money to avoid debt constraints, as proposed by some MMT advocates, risks inflation and economic instability.
  5. Lessons from Australia: Australia abolished its debt ceiling a decade ago after recognizing its downsides, offering a model for US fiscal policy reform.

Links relevant to the conversation

Useful information on the US debt and deficit from the US Treasury:

https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit (discusses how many times the debt ceiling has been amended)

https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/ (contains the spending, revenue, and deficit figures that Gene mentions)

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Transcript: US Debt Ceiling: Why Trump is Right to Call for its Abolition & Gene’s Experience with Aussie Debt Ceiling – EP268

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  00:00

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 and welcome to the show. The incoming us. President Donald Trump has called the US debt ceiling ridiculous. In this episode, I’m asking, Is he right about that? I have some fairly strong views on the debt ceiling, having been involved in policy regarding the debt ceiling here in Australia. So we used to have a debt ceiling. So I’ll talk a bit about the Australian debt ceiling. In my experience with it back in 2008 when I was an officer in Treasury. I’ve been prompted to cover this issue because the debt ceiling is part of the ongoing debate about the US budget, which flared up in the week before Christmas, Congress had to pass a continuing resolution to continue the funding of the federal government. So the federal government agencies had sufficient funds, and part of it, part of the debate, is the debt ceiling, the amount of debt that the US government can have on its book, so the amount of money it can borrow, and the debt ceiling has been suspended for a couple of years now, and it has to be renewed next year. So this is going to be an issue for the Trump administration. The US federal debt is well beyond the debt ceiling. The current debt ceiling is, think it’s around $31 trillion it’s 31.38 and a few other digits, trillion dollars. So a trillion is 1 million million. So 31 million million dollars. It’s it’s a big number. However, the US government has significantly more debt than that. The current gross debt is around 36 trillion so when the US government, when the Congress approves an increase in the debt ceiling, which it’s, you know, almost certainly it will do it will have to do to avert a major financial crisis, then it will have to increase the ceiling to accommodate the current level of debt, plus additional debt that the US government will incur in in future years, given that the US is still running very large budget deficits. So I think there’s no doubt they will, they will increase the debt ceiling, and we end up with this. You know, with these frequent debates over what the level of the debt ceiling should be, and there’s a lot of political grand standing over it, and hence we have Donald Trump saying, well, let’s just get rid of it. Okay, so what is the rationale for the debt ceiling in the first place? The rationale for it is that it’s going to enforce fiscal discipline of some kind. It will limit the amount of debt. Now it hasn’t really done that. In fact, the US Treasury website tells us that since 1960 Congress has acted 78 so 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit, and that was 49 times under Republican presidents, 29 times under Democratic presidents. And the Treasury writes on its website, congressional leaders in both parties have wrecked. Recognized that this is necessary, indeed it is necessary, because without borrowing the additional money, the US government wouldn’t have the cash available to to actually pay the bills, to pay Social Security recipients to pay Medicare, to pay interest on the debt, all of the things governments spend money on. Now the modern monetary theory, people might say, well, the government can essentially just print money. And indeed, one of the ideas for getting around the debt ceiling is to for the US Treasury to mint a $1 trillion coin. Of course, as I’ve discussed in other episodes of of this podcast, I’m not a fan of modern monetary theory. I think that’s a very you know, that’s the wrong way to go about things, particularly because it’s going to be inflationary. So assuming we’re not going to follow modern monetary theory, the government does need to borrow money to cover deficits, and hence, if it weren’t able to do that, and then if it ended up defaulting on some of its debts, not paying bondholders interest in time, then that’s going to cause trouble in financial markets. I mean, it’s hard to imagine what a default of the US government could do to both the US economy and the global economy. It certainly would be, would be very bad. There’s no doubt about that. And the congressional leaders so they will politically grandstand, but ultimately they will, they will have to to change it. And hence, the debt limit really doesn’t seem terribly effective, in my view, because it just keeps getting lifted. It could be argued that at least it does spark a public and political debate on national debt and the spending priorities of the government, of the US government. And it’s also an opportunity to negotiate some broader fiscal reforms, such as, there was a Fiscal Responsibility Act of 2023 and that included some spending caps. So you could make an argument it does have some some benefit, but given the sizable US budget deficits we’ve talked about on this this show before, it doesn’t really seem to be having a substantial impact on the US budget, on prompting Congress to fix the budget in dealing with entitlements, which is where a lot of the spending is coming from, it doesn’t really have much of an impact on that. So if we look at the Treasury website, there’s a site fiscal data, treasury.gov.au, it will give you the the figures on on the on the deficit and for the fiscal year 2024 25 we see that there was $6.75 trillion of spending compared with $4.92 trillion of revenue for a total deficit of Well, the deficit is needed to make up the gap between revenue and spending. So to cover the shortfall in revenue, a deficit of $1.83 trillion which is, you know, another bit of evidence, in my view, supporting the notion that this debt ceiling is is rather ineffective. It it doesn’t really work to to address the underlying problems, other issues with it. Well, I mean one, one thing that is seems obvious to me is that it doesn’t really make a lot of sense to have a a debt ceiling or a fixed or set in nominal terms, in terms of current dollars, because the, well, the economy. Economy is going to get larger, there’s going to be inflation, and so hence having a debt ceiling in nominal figures, say 31 trillion. Well, what if you have inflation? Then that is lower in real terms. Or what if the economy expands and the the government could could actually tolerate if you could cope with a higher level of debt without any trouble? So having a debt ceiling in nominal terms is is a bit silly to me, so I’m not really a fan of it for that reason as well. So I would say that I think Trump is right about the debt ceiling, and it’s for those reasons the debt ceiling is ineffective, and also because, once the decisions around revenue and spending have been made by the Congress or by the Parliament here in Australia or in the United Kingdom, the amount of debt you end up with follows from those decisions. It’s not something that the government is choosing independent of those other of those other decisions. So it’s it’s the revenue and the spending decisions that are the critical decisions. That’s where the the action is. That’s where, if we are going to have rules that try to get better fiscal outcomes, that’s where they need to act the debt ceiling. All it seems to do is, once those spending and revenue decisions are made, and as we saw with those data for the US, with the with spending massively outstripping revenue, so spending on entitlements, Medicare, Social Security and also the large national defense budget, arguably you know, a necessary budget, but there is, of course, a lot of fraud, well, maybe not fraud, but a lot of waste in that budget. The Pentagon fails multiple audits. So there are concerns about that. Once those decisions are made, then the amount of debt really just follows from that, because the government needs to borrow the money to make up for the shortfall. So that’s that what that’s what needs to be fixed up. And given that, we can’t see any situation where Congress wouldn’t agree to to increase the debt limit, unless it, unless they wanted to, if, unless they were reckless in a way, or unless they they thought politically, it would make sense for them to crash financial markets so that I can’t see any any logic in that, or Political logic in it for their from their perspective, they’re going to increase it. And hence, you know, the action is going to be on revenue and expenditure. And this is where, as I’ve talked about on this show before, the Trump administration is going to face big challenges, because Trump doesn’t want to lift taxes. In fact, he wants to cut taxes. And he also doesn’t want to cut people’s entitlements, because he’s, you know, he’s a brilliant politician, really, and he knows that that sort of thing is not going to be popular. And he’s, uh, he’s going to try and find a way to control spending, which is politically beneficial or not politically costly for him, that will end up being difficult, I expect, because of the the nature of the entitlement programs and how it’s it’s hard to see saving a lot of money there without making some unpopular decision. So we’ve just got to wait and see how what happens there. Now, I mentioned earlier that I have some experience with a debt ceiling. In fact, we had a debt ceiling in Australia for several years from around 2007 at 2013 and this was set in the what’s called the Commonwealth inscribed STOCK Act. And I remember that act rather well because my team in Treasury. Three were in the debt policy unit. We had to amend that act of parliament. I mean, it was a very simple amendment. We had to change a number in in an Act of Parliament. So the bill was relatively simple, but we ended up having to do all of the paperwork associated associated with that, all the briefing, all of the analysis, I mean, the aofm, the Australian Office of Financial Management. It took care of all of the technical details and the borrowing the money. So big. Shout out to them in the treasury. We, we were looking at the budget and full, you know, based on what we knew about the state of the economy, the state of revenue, the government’s plans for a stimulus package. This is around late 2008 it was, wasn’t long before Christmas. I remember, we discovered that the revenue was much weaker than than previously forecast, and that, hence the the second stimulus package that government expected it would have to do, I suppose, or knew with a significant probability it would have to enact. It realized then that Okay, time, the time is, is right. This has to be done. And so the government suddenly has to start borrowing a lot of money. And the problem was that I can’t remember the exact figure, but at the time, we would have had between 50 to $55 billion of Australian government debt, of bonds on issue and in the Commonwealth inscribed STOCK Act, the limit was set at $75 billion now I have no idea. I wasn’t in the relevant team at the time that that limit was set, if I were, I would have advised against it, because it became clear very quickly that we were kind of sale well past at $75 billion when we had deficits of of many 10s of billions in in each year over the budget forward estimates, we had the financial crisis, and we, I think we would have had deficits of maybe 40 or something billion in one year, or I’d have to check the exact number, but we had rather large deficits, and over the forward estimates, they added up to an amount that meant that we would be approaching 200 billion. So 200,000 million dollars worth of debt. So we needed to change that number in the the Commonwealth inscribe STOCK Act to 200 to 200 billion. So we had the bill drafted, we prepared the explanatory memorandum, and we also worked on the the updated economic and fiscal outlook, essentially when we got back to Treasury after Christmas. And we did that in a, you know, very quick period in, uh, over January. And so it came out in early February, February 3, if I remember correctly, and then it just everything sort of went a bit crazy, in a way, the government announced, okay, things are much worse than we expected. We’ve got this new stimulus package. You can argue about whether that stimulus package was necessary or not. But regardless of whether or not the Rudd Government had a stimulus package, we would have, we would have had to have increased the debt limit, the debt ceiling, because revenues had collapsed, particularly in company tax receipts, because companies their revenues were down. Mining companies were making less revenue because of what had happened to commodity prices, and we were we needed to borrow more money. There was just no getting around it unless the government was going to engage in some sort of fiscal austerity, some perverse fiscal policy. And so we thought, okay with the government’s come clean about what’s going on. Everything’s okay. Now the aofm, the Australian Office of Financial Management, will be able to start borrowing money, and everything will be fine. Government won’t have to worry about whether there’s enough money in the bank, at the Reserve Bank, which you know, prior to getting that approval, or prior to having the AFM starting to borrow money again, that could have been an issue. There could have been an issue regarding whether there would have been sufficient funds. Dollars in the government’s bank account, the Reserve Bank. So we clearly needed to borrow money again. We needed to start the bond market up again, having larger bond auctions, and we needed to get that debt limit up to 200 billion. So what was a real surprise was when the then opposition leader Malcolm Turnbull announced that the gov, the opposition, at the time, wouldn’t support increasing the debt limit. And this was a huge, a huge shock politically, you can see why they do it, but it still came as a as a big shock. And when you think about it, I thought it, it didn’t make a lot of sense, given that in Australia, there’s been since the dismissal of the Whitlam government in 1975 which caused a lot of political turmoil and divided the country. Since that time, there’s been a consensus that the opposition would not block a federal budget. It would not block appropriation bills, which would, you know, which would bring a crisis of supply if they blocked those bills? That’s what happened in 1975 that’s what led to the dismissal of the Whitlam government. So there’s been a consensus that oppositions would support the budget. But here we had an opposition acting in a way which was effectively, would effectively have blocked the government’s plans with the budget or its updated budget, its mini budget, you could call it in February, 2009 and so this was a rather extraordinary situation. And I remember at the time, you know, we were scratching our heads about this, what’s going on? I mean, it did end up getting. It got passed at the end, I think, with green support in the Senate. I remember David Parker, who was acting treasury secretary at the time, and I had to go up to the Senate to explain to Bob Brown, who was the Greens leader at the time, what was going on, and provide some some background in the situation. So it was a it was a relatively tense time, and to what? Well, I guess the lesson that I took out of it is, let’s not have one of the lessons is, let’s not have really silly fiscal rules, like a debt limit of some kind, which ultimately just leads to political grandstanding, or at worst. I mean, if, if it actually did apply, then it could lead to a major, uh, financial and potentially wider economic crisis. So I’m not a supporter of a debt limit as much as I want to reduce debt as much as I believe in sound fiscal policy. I think a debt limit or a debt ceiling is the wrong way to go about it. And hence, I think President Trump, incoming, President Trump is, is on the right track there. And I think, look, perhaps he, he’s going to be the the president who will, he’ll be able to get them to to abolish it. I mean, he’s, he’s got a lot of seems to have incredible persuasive powers. So, so let’s see what happens Australia, by the way, we did away with our debt ceiling in in 2020 13. So the the new Abbott Government, it sought to increase the limit to 500 million, but 500 billion. But ultimately it decided to to abolish it, given that it now it’s inefficient, or it’s creates, you know, political risks. It’s, yeah, it’s just not terribly effective. So I think that was the right decision. And I’d also support getting rid of the budget, limit the budget, or the, sorry, the debt limit, debt ceiling in the US. And that’s not to say that they shouldn’t fix up their their budget. They need to do that. That’s an absolutely, absolute priority. But I don’t see the the debt ceiling has been as being part of that. What I would suggest, and this is something I I’ll cover in a future installment, is. What I think works better is a rule on spending. If you have some rule or some guideline regarding government spending, then that can be potentially more effective, or I think it will be more effective. And you know, arguably, may be desirable. And rules to look at include the Swiss debt break, and that requires that the the budget, the national budget in Switzerland, that’s balanced over the course of the business cycle, and that’s achieved by having a spending ceiling, so a limit on the amount of spending linked to revenue levels adjusted for economic conditions. So it’s a way of making sure that spending is is commensurate with the sort of long run revenue growth, so you’re not getting ahead of your revenue and not ending up with with permanent with structural deficits. So that’s the idea. You want a rule like that, of some kind. Another rule that is popular is the taxpayers Bill of Rights, which Dan Mitchell has called America’s fiscal gold standard, and any revenue above the growth of population plus inflation, any additional revenue that has to be returned to taxpayers, it rebated. So it’s a way of limiting the amount of of money that governments have to spend, it means that they don’t go and spend windfall gains in revenue. And that’s seen as a particularly effective way of of limiting government spending. That’s, it’s that’s possibly a bit more controversial than the debt break. I think the debt breaks arguably got more to recommend it. I have some concerns about table or just just the nature of it, and I have to you know how I want to look at that a bit more closely before I recommend it, I’d be more likely to recommend the Swiss debt break, and certainly I mean, Switzerland’s had a very good fiscal performance since it’s adopted it and over the last couple of decades, and it has low debt to GDP compared with the Eurozone average, so much lower. And the figure I’ve got in my notes is 37% of GDP, significantly lower than the Eurozone average of 97% so Swiss debt break looks like it’s a winner. Table. I’ll analyze that in more detail, in in future, in a future episode, because it’s a little bit more complicated than than the Swiss debt brake. So I’m not 100% confident in recommending that at the moment. Okay, so to conclude, I think that debt ceilings are a bad idea. The critical thing is to get control of spending relative to revenue. I mean, one option is to increase revenue, to increase taxes, but then that comes with economic consequences. I’d prefer that governments get control of their spending rather than try to close a fiscal gap, try to cover a fiscal deficit by increasing taxes. However, the critical thing is, whatever they do, they need to get control of their budget, to get their budget back into the into black, and it looks like things well, the debt ceiling, it doesn’t really help with that, because of the adverse economic consequences that would flow from a government being unable to borrow money when they need to borrow money because of the deficits that are being run. The political leaders, the Congress, they will always vote to to increase the debt limit, the debt ceiling, and so it doesn’t really have an impact on on improving the situation. Okay, so overall, I think Trump’s actually right on this one, that the US debt ceiling is ridiculous, right? I’ll be interested in your thoughts on this episode. Let me know what you think. If you have any views on fiscal rules that that could be helpful, then please get in touch. Send me a note. Contact@economicsexplored.com. Okay. Thanks for listening.

Credits

Thanks 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 and other podcasting platforms.

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Podcast episode

How Global Events are Affecting Coffee Prices w/ Raihaan Esat, International Coffee Traders – EP267

Coffee prices have surged dramatically over the past year, with green coffee increasing by 78%. In this episode, International Coffee Traders GM Raihaan Esat joins hosts Gene Tunny and Tim Hughes to explore the key drivers behind this spike, including harvest shortages, supply chain disruptions, and geopolitical factors. Discover why your morning brew may soon cost more and how the coffee industry is navigating these challenges.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

About our guest: Raihaan Esat, General Manager, International Coffee Traders

Raihaan Esat is a passionate and seasoned coffee professional with extensive experience across the coffee industry. From working in bustling espresso bars and competing at the highest levels of barista competitions to managing roasteries and developing quality control systems, Raihaan has cultivated a deep understanding of every facet of coffee craftsmanship.

As General Manager of International Coffee Traders (ICT), a green coffee sales business, Raihaan connects both commercial and home roasters with premium green beans and equipment, sharing his love for exceptional coffee. Inspired by mentors like Phillip Di Bella and a history of innovation, Raihaan is also spearheading coffee events at The Coffee Commune, fostering a thriving community of coffee enthusiasts. Dedicated to excellence and driven by a lifelong passion, Raihaan continues to inspire others through mentorship, entrepreneurship, and a relentless pursuit of the perfect cup.

Source: https://www.roastmagazine.com/roastsummit/events/raihann-esat 

Timestamps for EP267

  • Coffee Market Overview and Initial Discussion (0:00)
  • Factors Contributing to Coffee Price Increases (7:36)
  • Quality Concerns and Market Dynamics (19:41)
  • Consumer Behavior and Market Volatility (26:44)
  • Impact on Coffee Shops and Consumers (47:07)
  • Geopolitical and Weather Impact on Coffee Prices (54:20)

Takeaways

  1. Green Coffee Prices Surge: Over the past 12 months, green coffee prices have increased by 78%, impacting every part of the supply chain.
  2. Major Producers Facing Challenges: Brazil and Vietnam, responsible for a large share of global coffee production, are experiencing lower yields due to weather conditions and harvest quality issues.
  3. Geopolitical Factors: Disruptions in trade routes, such as those caused by Middle East conflicts, have further strained the coffee supply chain, driving up costs.
  4. Changing Consumer Expectations: As prices rise, consumers may need to reconsider what they expect for a $5 cup of coffee and the value they receive in return.
  5. Sustainability of Cafes: For cafes to survive, they need to adjust their pricing to reflect increasing costs in labor, rent, and coffee supplies.

Links relevant to the conversation

Our previous conversation with Raihaan, “The Future of Coffee: Climate Change & Rising Prices w/ Raihaan Esat, International Coffee Traders  – EP217”:

https://economicsexplored.com/2023/12/06/the-future-of-coffee-climate-change-rising-prices-w-raihaan-esat-international-coffee-traders-ep217/

Raihaan’s slide explaining factors driving up coffee prices:

https://drive.google.com/file/d/1JAhmCl_TmfSoWRkh9wF9fDFU395mPnyL/view?usp=sharing

Chart of the green coffee price:

https://drive.google.com/file/d/1qnX28VagJ3FtD40JntMujADsNKI-NhBs/view?usp=sharing

International Coffee Traders at the Coffee Commune:

https://www.coffeecommune.com.au/international-coffee-traders

ABC News article “Coffee prices hit record high after bad weather”:

https://www.abc.net.au/news/2024-12-11/coffee-prices-hit-record-high-after-bad-weather/104711708

Greensquare coffee roaster app:

https://www.greensquare.co

Lumo Coffee promotion

10% of Lumo Coffee’s Seriously Healthy Organic Coffee.

Website: https://www.lumocoffee.com/10EXPLORED 

Promo code: 10EXPLORED 

Transcript: Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262

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  00:05

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 and welcome to the program. It’s the 20th of December, 2024 we’re rapidly approaching Christmas, and I’m here today at the coffee commune with my occasional co host, Tim. Hughes, Tim, good to have you on the show again. Good to be here. Thanks. Gene, yes, and we’re catching up with Ray at from international coffee traders at the coffee commune. So, Ray, good to have you back on the show. So good to be back. Excellent. Ray, so there’s been a bit of news regarding the coffee market. We’ve seen stories about how coffee prices have spiked. Can you tell us a bit about what’s happening in the market? Please?

Raihaan Esat  01:17

Yeah. I think in the last episode we recorded, I made some predictions, and I said, Oh, you know, the coffee market could go one or two ways. Things could get very, very, very expensive, or things could level out and flatten out and become more stable. Turns out, things got very, very, very, very expensive. Yeah. So, you know, there’s a huge amount of reasons, and I hope, hope we can tackle some of those things today in the podcast on why the coffee market has become so expensive, especially around green coffee, which is the input source for so many roasters who roast the green coffee, produce it into drink, produce it into roasted coffee, send it to cafes, who then produce it into drinks. But it starts as at the raw material, at the source. Okay,

Gene Tunny  01:59

so in terms of very expensive what are we talking about in price terms? Okay.

Raihaan Esat  02:04

So in a nutshell, coffee is traded on an exchange in us, dollars per pound, and roasters need to buy coffee based on the market rate at the time. Yeah. So historically, the market used to change no more than a couple of cents a week, you wouldn’t see that much volatility. Coffee prices were relatively stable. Then after COVID, things got a bit more volatile. But in the last 12 months, coffee has increased something like 78% we’re talking about green coffee here. The input that goes into roasters, 78% price increase in the market. That’s massive over 12 months. And that’s not something that a business can just absorb. It has to get passed on down the chain, down the supply chain, and eventually into cafes. So eventually you’ll see cups of coffee prices increasing quite substantially. And everyone’s kind of worried about it. You know, there’s a lot of talk in the media about we’re not willing to pay more than $5 for a cup of coffee, that sort of thing. That’s a value discussion that we can get into a bit later. But, you know, it’s unsustainable for businesses to continue charging what they’ve been charging up until now. Things have to move down the chain. You know, because the supply chain costs. The value increases through every step it’s it gets passed on. And it’s not just green coffee that’s gone up. Gas and electricity has gone up. Everyone’s feeling it, on water, on wages, on every single other input cost that goes into manufacturing coffee. It’s not just green coffee,

Gene Tunny  03:40

yeah, just on that, on the $5 coffees. I mean, I guess I’m paying that already at quite a few places, but yeah, I guess there is that sensitivity to the price of it. Maybe there are some places out I’m wondering what we won’t name any particular cafes, but I’m just just thinking, because a lot of Yeah, the coffee prices have started to rise already, haven’t they? I mean, we’re Yeah, I think

Raihaan Esat  04:03

so. I think we need to start asking a different kind of question here. Rather than asking, uh, you know, is $5 too much for a cup of coffee, we need to ask, if you’re gonna pay above $5 for a cup of coffee, what do you expect to get for it? Yeah, right, if you’re gonna pay six or $7 for a cup of coffee. What do you expect to get for it? Yeah, in return, what’s going to make it a valuable transaction to you? I’m sure we can find some sort of trade where you’re willing to sec to pay $7 for a cup of coffee, but what? What are you willing to going to receive in return? Yeah, are you going to receive incredible service. Are you going to have a barista that remembers your name and says hello to you joyfully the next time that he sees you? Are you going to have a very, very, very delicious cup of coffee? Are you going to have something that’s a little bit more premium in feeling? Is the paper cup going to be the cheapest paper cup on the planet, or is. Going to be something a little bit more substantial, something that feels nice to drink out of, is the environment that you step into, welcoming and friendly. I think all of these things contribute to how good a cup of coffee tastes and what it’s worth. So that’s

Tim Hughes  05:15

very much the experience, rather than just the coffee and the price of a coffee bean, it’s

Raihaan Esat  05:19

high value as well. How do you put a price on, you know, the atmosphere in the cafe, but it’s something that contributes to your perception of value. Yeah,

Tim Hughes  05:29

that’s a it’s a good point, because not every, I think we’ve all experienced that. When we go into a place where you don’t get that, and you don’t get a great coffee, and you don’t get any kind of experience, and then you go to somewhere, like we went to this morning, yeah, and the coffee we had, we remarked on it. It was so good here at the coffee commune, I’m gonna say it, you know, like, and it was a special blend that was put together for Christmas. It had shortbread in it. We tasted it. I could taste whiskey in it, yeah, which there wasn’t, but I could taste it. So it was that thing. It was an experience. It was beyond a coffee.

Gene Tunny  06:05

That was the taste of shortbread. It didn’t actually, literally have shortbread in it. Did it? No, no,

06:10

no. But that’s the thing. Like it was all

Raihaan Esat  06:12

done through the experience, right? That’s exactly right, yeah, yeah. And I’m not going to argue that cheap coffee shouldn’t exist. I think Cheap Coffee definitely has a place. It’s just the the the arbitrage, the the gulf between cheap coffee and expensive coffee will get wider and wider. And I think anything in the middle is probably gonna gonna need to rearrange themselves or reevaluate their business and figure out, do they want to be budget coffee or do they want to be experienced coffee? Yeah.

Gene Tunny  06:39

Yeah, exactly. Okay, Ray, we might get on to I want to ask you about the drivers of the price increase, but before we get there, Tim, do you have any follow on questions for Ray after that? No,

Tim Hughes  06:54

it’s funny, because I think we get hung up on price all the time. Yeah, but it’s absolutely, I absolutely I absolutely agree that the experience of whatever it is you’re having, and you see it in cinemas as well, like I think of cinemas often with these comparisons, the experience at a cinema is very different from one place to another. Yeah, the film’s the same, but the experience is different. And so, yeah, you can put that over to many different industries, but especially when it comes to coffee, going beyond just the price, how else can it be better and a different or better experience?

Raihaan Esat  07:26

Okay, so we’re going to get stuck into some green coffee talk, right? I

Gene Tunny  07:29

think so. So you, you did a presentation recently which itemized or identified, I think it’s nine different drivers of the price increase. Can you tell us a bit about what was that presentation? And then if we could, if you could tell us what you think the the drivers are, and I guess you know what the most significant ones are in your view. I know it can be hard to

Raihaan Esat  07:53

Okay, yeah, but So in a nutshell, the last 12 months have been a roller coaster for everyone in the industry. And my role has not just been to source coffee, but also to help educate roasters and understand what’s going on in the market so that they can make informed and educated decisions for their business in the future. So some of the drivers, some of the fundamental things that are affecting Green Coffee pricing, and I’ll just run through them really quickly, and then we can go deeper into them and talk about them one by one. But first of all, like I said, 78% cost increase on raw materials, green coffee, the base price, has gone up by that much, 78% and some of the factors that contribute to that, the two main producers, this is number one, the two main producers, Brazil and Vietnam, they produce close to 60% of the world’s coffee production. It’s massive how much they contribute to the world’s coffee they’re looking ahead to the 2025, harvest season, and they’ve said our harvest is not going to be that great. So there’s some speculation about the quantity of coffee that’s going to be available in 2025 second, you’ve got two main types of coffee. You got Arabica and you’ve got Robusta. Now, generally, there’s been an arbitrage between the two. Robusta is usually the cheaper option. Arabica is the more expensive option. But when you’ve gotten got a when you’ve got a shortage on the cheaper option, what happens? All the supply shifts back to the more expensive option, the Arabica, and vice versa. So you’ve had a couple of shifts towards Robusta and back towards Arabica through the year, which has created a lot of volatility, right?

Gene Tunny  09:38

Can I just ask you about that, in terms of that substitution, what’s the degree to which that can occur? I mean, is it within a certain Is it is it bounded? Or is it just or could it be 100% could you just shift completely, 100% from one to the other, the

Raihaan Esat  09:56

way I look at it? Okay, so everything is an ingredient, like a chef. Would a chef would choose the mushrooms for his pasta, right? Okay, yeah, I can’t get field mushrooms today, but tomorrow I can get Swiss mushrooms. Okay, right? There is a degree of substitution that you can do, yeah, but there is an impact. A Swiss mushroom doesn’t taste like a mushroom. Yes, it’s a little bit different. So there, there are some of those things to manage in the process, but there’s no reason why you couldn’t, from a purely fundamental point of view, right? Okay, interesting. Other things that have been affecting the Green Market, US politics. We’ve got President Donald Trump is has just been elected and is going to take office in the new year. So his promise has been to strengthen the US economy. How does that affect us in Australia and other countries around the world, while a strong US economy strengthens the US dollar, so we’re going to be seeing some effects based on transactions that have to happen. Coffee has to be financed, it has to be transported around the world. So you’re gonna, you’ve got, you’ve got effects from that decision by the US to elect President

Gene Tunny  11:03

Trump, and you’re buying coffee in US dollars, aren’t you? You have to, yeah, you have to. The contracts are written in US dollars, yeah, gotcha

Tim Hughes  11:10

on that note, because I know that he’s made a point about talking about tariffs as being his favorite word, and there’s a small question about how that affects the consumer, as to whether that actually makes it more expensive for somebody in America or not. So I’m putting that to Eugene, I guess yes, you How does is that a thing that the tariffs can ultimately make it more expensive for a US consumer? Yes,

Gene Tunny  11:34

because it’s the tariff is essentially a tax on, well, it’s a tax on imports and so, yeah, it’s passed on to local consumers or businesses. I mean, I think one, one of the problems is it’s going to impact both consumers and businesses, because they’ll face higher input costs. That’s why I think some of the people in the market expect that a lot of us is just tough talk from Trump, and he won’t go through as much as as he’s threatened, because, you know, ultimately, it will be counterproductive if they do this like, I think the markets are hoping that this is some type of negotiating tactic with China to get them to make some concessions, but who knows? Yeah, but it’ll definitely cost consumers. Yeah, it seems

Tim Hughes  12:17

to be a little bit more complicated than it would initially appear, where tariffs, you would imagine, is going to be to the expense of whoever is exporting to the US. But it’s not necessarily the case. Well, the

Gene Tunny  12:28

Tariffs applied when the at the when it’s imported, right? So it’s applied at the by the, you know, on the imports into the US, yeah,

Raihaan Esat  12:37

the producer doesn’t wear the cost of that. It’s the importer that weighs the cost of that and has to pass it on to to the to the next level,

Gene Tunny  12:44

yeah, I mean the so the producers in China could be it affected to the extent there’s an impact on the demand for their product, right? So, and maybe they have to discount to some extent to to compensate for the the tariff in the other country. Like there could be some impact, but the major impacts going to be on the consumers in in that country? Yeah, so that’s why, I don’t know how many dozens of economists, like prominent economists, came out critical of of Trump’s tariff plan, and the only argument you can make in favor of it is it’s some sort of strategic strategy. It’s a it’s a negotiating position to try and get some concessions from China. So it

Tim Hughes  13:23

would help American companies who for any products that can be produced in America. There’s an advantage given homegrown stuff, but where all those imports clearly, there’s not enough coffee being grown in America. In

Raihaan Esat  13:36

the context of coffee, and you’d expect these tariffs would protect a local industry. There’s not a lot of coffee grown in America. There’s nothing to protect. Everything has to get imported. Are they going to risk? You know, tariffing coffee, which is, which is 98% imported from overseas, yeah.

Gene Tunny  13:53

But if you know, and China’s not exporting coffee the US, is it all so?

Raihaan Esat  13:58

Well, China is an emerging origin. At the moment, they are producing a heck of a lot of coffee. The government is investing massive amounts into improving the networks, the processing facilities, everything around coffee production, to increase the amount of coffee that China produces in green form. So that could be a target for Donald Trump, if he specifically wants to target China, but that just means it’s got more coffee available for us, right?

Tim Hughes  14:25

Because China’s coffee consumption per capita has increased somewhat, yeah,

Raihaan Esat  14:30

massively, massively. Actually, this is another, another major factor that’s happened this year is the China’s very, very strongly growing in coffee consumption. They’re traditionally a tea drinking company. Country. However, we see brands like luck and coffee and Starbucks expanding very aggressively. And in fact, there’s been a deal done between luck and coffee and the Brazilian producers to to purchase. $1.4 billion worth of coffee from Brazil in the next harvest. So they’ve already contracted a huge quantity of coffee that hasn’t even been produced yet. Yeah, that’s what they’re expecting to need. That’s what they’re expecting to use. Now, the way that that affects us is, you know, we can’t access that coffee. That’s coffee going to China. That’s coffee off the market now. So there’s technically a shortage of Brazilian coffee for the rest of the world. Gotcha,

Gene Tunny  15:32

this is probably something that you probably don’t, you probably can’t answer. But you know, like, How significant is that as a share of the total market? I mean, 1.4 billion sounds like a lot of money, but a billion dollars doesn’t go as far as it once did. You know what I mean. So that’s a big global market, so look,

Raihaan Esat  15:51

it’s significant enough that everyone is worried. Okay, you know it’s enough to cause a stir in the market, because there’s a significant quantity of coffee behind that. And it’s an indication, more than anything else, that this is the direction that China is going in. They are willing to pre contract huge amounts of coffee well in advance and take it off the market. So, you know, if that’s their move this year, what’s the move in? 2026 going to be 2027 2028 right? So, so there’s a bit of forward thinking going on here that, geez, China’s Making Moves. You know, we should be thinking that far ahead as well. Should we be contracting that far ahead? Maybe we should,

Gene Tunny  16:30

yeah, well, I mean, so there’s a scramble, yeah, by you, you mean maybe we should, you talk, you’re talking about international coffee traders here, yeah, yeah, gotcha, yeah.

Raihaan Esat  16:38

But I’m not the only one thinking like that. There’s, there’s many traders and importers also starting to think like that and going. It’s creating a bit of a scramble to go, oh, well, okay, that coffee’s off the market. I better secure mine now. So we have this inflated demand for Brazilian coffee that’s been caused by this China deal,

Gene Tunny  16:58

right? Okay, very interesting. How

Tim Hughes  17:01

far ahead do people normally do those kind of deals? Like, is it like a six to 12 month sort of, you know, foresight, or is that now being extended to to longer periods with what’s happening with China? Yeah,

Raihaan Esat  17:13

generally, generally, you can, you can contract out, you know, something for next season. Producers generally don’t offer anything past that. So if the next harvest is coming up, for example, in February March, they’ll they’ll say, okay, you know, we’re expecting to produce this amount of coffee in February or March next year. We can start taking contracts against that now, you know, pair that up with what I just said previously, where Brazil and Vietnam both both forecast a lower production than expected. That creates a situation where there’s an increased demand and an expected shortage in supply. And so the price effects are crazy, because everything is so sensitive, because everyone is speculating. There’s people wondering, are we going to get our coffee? Are we not secure it now, even if it’s a high price, there’s other people sitting on their hands going, price will come back down. This is short term wait. And then they can’t wait any longer, and then they buy at a high, even higher price, yeah. So there’s this huge speculative effect that’s also feeding the volatility in the market, right? It’s, it’s really, I mean, if I was, if I had a box of popcorn and I could just sit back and watch it, it’d be very entertaining, but I’m in the middle of it, and it’s, uh, can get kind of stressful sometimes. Yeah,

Gene Tunny  18:38

it’s fascinating market dynamics. I mean, one thing I learned when we said, sat down earlier for a coffee, you’ve got a platform. Maybe we talked about it last time we caught up, but you’ve got a there’s an online platform where you do these trades, where you got all the data on the market. And what’s that platform called? Again,

Raihaan Esat  18:54

there’s a few different ones I use. You can look at just the basic C market. You can look at that on almost any trading platform that that that gives you data on any commodities like gold, silver, zinc, wheat, cotton, they’ll usually list coffee as well, yeah. But I have a platform that we look at called green square. It’s it gives us up to date data, all that every day. But there’s some other functionality that’s useful for us as well.

Gene Tunny  19:26

Good. One, okay, so we’ve have we covered one or two factors so far. What we covered, the demand, the shock to was it one, Brazil and three. I think we’ve got three. Rough three. Okay, okay, yeah. What else is

Raihaan Esat  19:41

there to mention here? There’s quality concerns over the next, next harvest in a number of countries, all because of these high prices. So I was just in China recently looking at some coffee farms there and connecting with some new producers. And one of the, one of the guys I spoke to, he said, You know, there’s, there’s some high pricing. Right now, farmers are very excited by it. They are getting paid higher prices for their coffee, but the result is they’re not sure if the high prices are going to last, so they’re just picking everything. They are harvesting coffees that should not be harvested yet. They’re not ripe, or they’re taking coffee that’s overripe and that’s outside of the acceptable quality, because they can get money for it. Yeah. So the quality is a little bit all over the place. Having said that, the way that they’re picking as well is that they’re just stripping coffee off the trees. In some cases, that affects the tree for next season, that tree will not produce the same amount of coffee next year, if it’s harvested incorrectly, if it’s basically just, you know, stripped of all of its coffee,

Gene Tunny  20:47

right? What’s the correct way to harvest? Well,

Raihaan Esat  20:50

I spoke to a farmer about this, and, you know, he said, When the coffee is ripe, if you’ve ever seen a coffee cherry before, it’s a red cherry. It’s beautiful. It looks delicious. You’ve got to grab it, you’ve got to pinch it, and you’ve got to twist it, and that breaks it clean, and that doesn’t do any damage to the branch on which it’s growing. If you damage the branch, like if you pull it and you strip some of the bark away, that area will not produce coffee again.

Gene Tunny  21:19

Yeah, that makes sense. So you know, it’s

Raihaan Esat  21:21

not just an impact now, but there’s an impact down the line of how you harvest that ensures whether you’ll get a good harvest next year or not. Yeah. So the short term thinking is, look, I can get a high price for my coffee now, get everything off the tree as quickly as possible. But the long term effect is, next year you’re not going to get as much coffee. Yeah, okay, that all makes sense, yeah. So you’re affecting next year’s supply, and I think there is some understanding in the market right now that next year’s harvest is not going to be quite as good. There are going to be some effects because of that, and people are willing to pay a higher price now to ensure that they get coffee, and to some degree, even stockpile coffee to see them through some part of next year, right?

Gene Tunny  22:04

So, yeah, everyone’s concerned. And I mean, how are we? How’s ICT? I mean, you guys, fine, you’ve got to talk about it. If it’s okay. If it’s

Raihaan Esat  22:12

No, I can’t. I can’t personally confident. There’s some things I can’t say, but some things I could definitely can say. ICT works on both sides. We work with producers and we work with roasters. Yeah. So, you know, traditionally, a trader will bring coffee into Australia, have it in their warehouse and say to a roaster, right, here’s 20 different coffees that I have available, right? Choose what you want, and this is the price. Yeah, that’s the traditional coffee trading model. ICT is a little bit different. We we go to our clients and we go, what do you want? We’re gonna go find it for you. Give us your price parameters. Give us you give us your idea for what you want, for flavor, what you want for quality, and let’s see if I can find that for you. If I can’t find that, let me, let let us take our knowledge of coffee, our understanding of roasting, our understanding of production and operations, and give you some good alternatives. Yeah, so even though you’re asking us for organic certified Peruvian coffee, you know that that has a high triple A antioxidant, high antioxidant content. Thank you very If I can’t, you know, if I can’t find that for you, I’m going to bring you three alternatives. One might be from Ecuador, one might be from Uganda, one might be from Siberia. I have no idea what I’m going to find, but unless I go looking, I don’t know what I’m going to come up with. Yeah. So we’re okay, from that perspective, because the coffee is pre sold already that we’re selling in the market. You know, we agree on a price, we agree on terms and conditions and everything before we sell the coffee, before we even bring the coffee into Australia. Yeah. So everything is kind of pre, pre agreed. Of course, all the volatility in the market makes those discussions a lot more difficult, but that’s why we do things like this? We put out a lot of media. We have discussions one on one with our clients to say, Hey, this is the situation on the ground. So you can make informed decisions for your business. Here are our recommendations. But we’re not the only people with knowledge out there. Go and do some research, find out, get other quotes from other traders, and you know, see what’s the best option for your business. But

Gene Tunny  24:22

so in terms of your clients, teams, one of your your clients, is that correct? Tim, a client of ICT. Yeah.

Tim Hughes  24:27

So I just want to explain. ICT is International Coffee traders, for those who don’t know, and based here in Brisbane. So it was through these guys that I was able to launch my coffee business, Lumo coffee. So, so yes, essentially, and that whole process that Ray just described was what we went through. And because it was such a specific brief, I was able to use the connections that Ray had had built over the years, and no way I could have done that on my own. And the and what they do here with the ray. Interesting as well. So the all of those connections. It’s a very complex business like I guess many businesses are, when you get into the nuts and bolts of it, but it just shows how those relationships that are built, and the dependency on the weather, the global economies, local economies, whether all of these things that we’re talking about now. It’s fascinating to see it play out. What goes on to get a cup of coffee in front of us. Yeah,

Gene Tunny  25:28

have you been impacted by the rising prices this year? Not

Tim Hughes  25:31

yet. So this, and this is one of the things, because this is normally six to 12 months out, so it’s a conversation we get to have when

Raihaan Esat  25:38

Tim’s coffee runs out. Yes, he will be impacted, but we’ve got foresight on that. You know, Tim. Tim knew what his price was going to be for the stock that he secured. And you know we’re holding that stock for him. It means that he knows exactly what his price is going to be. And guess what? When it when we’re running at, say, 25% of what’s left, when we know we’re at that level, 25% of stock remaining, we can go, Tim, this is your replacement cost for the same coffee. Gotcha. So you can make some decisions for your business.

Gene Tunny  26:07

Oh, that’s very good. And

Tim Hughes  26:08

that’s also the nature of I knew that at the time, whenever you get a supply of something like this, it’s not necessarily going to be there forever. You go with you have to be flexible. And we spoke about that at the time. You know that there’s, there are comparisons that you can draw with other ones. We’d have to test it because of the nature of what we do with the high antioxidants. So we need to find something that’s as good as, if not better, but that’s, we sort of knew that was likely to happen. So that’s always been part of the plan is to have contingencies and other options open and so, yeah, they’ll get explored if our supply gets impacted in any way,

Raihaan Esat  26:48

right? Yeah, I think we take it for granted that coffee is an organic product. It’s it’s an agricultural product. It’s something that’s grown on a tree. It has to be harvested. It’s not available all year round. It is seasonal, you know, and it’s something that has to be grown, harvested, produced, processed, dried, shipped halfway around the world, roasted, turned into a beverage and then served in a cafe. There is a huge supply chain behind getting a cup of coffee to a consumer at the end of the day. So, you know, the more that we can understand the supply chain and the pressures behind it, the more that we can do better, better business. You know, on both sides, we need the farmers to be sustainable. We need to be sustainable, the roasters need to be sustainable, and then the cafes need to be sustainable as well. You can’t have too much pressure on the supply chain in one spot, otherwise, things start to break. Yeah,

Gene Tunny  27:41

yeah, absolutely. Okay. It’s been a lot of pressure lately, that’s for sure. So Ray, so far, we’ve covered the harvest there. They weren’t what was expected. So that’s been an impact. We’ve we’ve covered quality issues. We’ve covered, uh, yeah. Buyers get it all, you know, the the traders getting ahead of the trying to get ahead of the market. They’re worried that price will be, will be higher later on, so they’re trying to secure supplies now. Or they’re worried about, yeah, they’re worried about the availability later on. What else is there that we, that we should, that you should mention, I

Raihaan Esat  28:14

think, since we’ve been talking about farms and talking about farmers and producing countries, there is an under undercurrent of producers are starting to understand that they can affect the global market. They, in the past, were kind of held to the bodies in their in their governments, or in their local areas, just sort of dictating prices. But producers are starting to understand now that if they withhold stock, they can drive the price up. Withholding supply into the market means that they create an artificial shortage, and the price will naturally increase as a result of that. So we’re starting to see traders all around the world, or sort of like producers all around the world starting to go withhold coffee if they feel like the market can move up, and then they sell coffee at the right times. They’re not just selling everything all at once. So So do

Gene Tunny  29:11

you is this? Is this coordinated? Is it? Are you saying there’s some sort of cartel like behavior in the coffee market? I

Raihaan Esat  29:17

don’t. Wouldn’t go so far to say it’s a cartel like behavior, but something like a communal behavior, there is an understanding, because the coffee producers are moving into a new generation now, okay, traditionally, you know, coffee producers were families that have had farms in their family for, you know, two, three generations, and It was just something they did. But the new generation, of coffee producers, they’ve been educated, they’ve gone to Europe, they’ve traveled the world. They’ve, you know, seen how business gets done, and they’re going back to their home countries and going, we have this coffee farm that’s capable of so much we can produce coffee, and it’s very good coffee. And. Let’s get what it’s what it’s actually worth,

Gene Tunny  30:02

yeah, which is fair enough. And so I mean that. So I’m just trying to understand to what extent, because economists are generally fairly skeptical of of of cartels. Cartels are very difficult to to enforce and to keep everyone, uh, cooperating, because there’s always an incentive to cheat, to go behind the back of the cartel. And, yeah, try and undercut the cartel. And so that’s why, you know, OPEC, historically is sort of waxed and waned in effectiveness. And yeah, so I’m just wondering to what extent there’s an actual genuine collusion or a cartel, because, because otherwise it’s hard to see how that could I mean, it’s an interesting hypothesis. I just have to think more about how that could work in what I

Raihaan Esat  30:45

should just preface this by saying that coffee actually has been too cheap for too long. Okay, and we’re suffering the effects of that now, coffee is probably back where it’s supposed to be. This is, this is a more sustainable price for the entire supply chain where we’re at now, it was just too cheap for too long. If you look at some of the historical data, coffee has had these spikes of volatility through its life. But then from the same mid 90s right up until the mid 2000s coffee price was actually going down, and it was getting cheaper and cheaper and cheaper a green coffee price, and that was because producers didn’t know the value, the actual value, of their coffee. Roasters were demanding cheaper and cheaper coffee. There was a lot of pressure put on the supply chain to deliver cheaper and cheaper products, but that was becoming very unsustainable, especially on the producer side, and now, because of this volatility, now we’re paying what we actually think the coffee is worth, but it’s a shock to the system, because it’s coming, because it’s come all at once, yeah, if it had happened gradually over the last 15 years, you know, this sort of price increase, we wouldn’t even have felt it. Yeah,

Gene Tunny  31:58

yeah. Gotcha. Gotcha. Okay, so what does

Tim Hughes  32:01

this look like by the time it gets to a cafe like so coffee’s sold in cafes underpriced, in your view, right?

Raihaan Esat  32:10

So I think cafes are where it’s going to hurt the pockets of the consumer the most, right? Because that’s where the consumers go, and that’s where they feel the effects of any price increases through the supply chain, cafes traditionally have also behaved like the supply chain, where they’ve just gone. We’ll bear it. We’ll bear it. We’ll bear the cost of labor increase. We’ll bear the rent increase. They’re not passing it. Haven’t passed it on well enough. So you know, if you think back 10 years ago, how much was a coffee? 350, $4 yeah, 10 years ago, yeah. And what is it now? Maybe $5 yeah. So $1 increase over 10 years. That’s nowhere near keeping up with CPI, with inflation, with interest rates, with everything that’s happened over the last 10 years on cost increase. So you know, cafes need to move their prices along with price increases, not just with green coffee from their roasters, but you know, the on all the input costs, actually, the biggest cost to a cafe right now is rent, not rent. Apologies, labor, yeah, especially in Australia. In other countries, probably not so much. But in Australia, most cafes would be running at least 45% labor. Yeah? Well,

Gene Tunny  33:21

yeah, yeah, yeah. Actually,

Tim Hughes  33:24

there was an interesting there was a good article in the ABC recently, Australian Broadcasting Corporation, for those in America,

Raihaan Esat  33:31

yeah, I think that article that you’re referring to actually showed labor at about 35% is on the low side. Yeah,

Tim Hughes  33:38

that’s what Gene said exactly that he thought that was lower, but I was interested to see, and if this sounds about right to you, so they had the coffee at around 11% and milk around the same. In fact, milk was a little bit more. And so we were talking before earlier, about just that. And the with milk, it’s including soy all the alternatives, which, of course, are a lot more expensive than regular milk, but that has a significant contribution towards a coffee price as well. So we were talking in the you know, for instance, if people just had espresso or long black, short blacks, basically anything without additives, that’s fundamentally a cheaper coffee for them to drink and for a cafe to produce. Do you think that might be reflected in how the pricing is changed in the future, with cafes to really reflect that in someone who’s having a grand day with, you know, almond milk,

Raihaan Esat  34:34

if you just drink black coffee, it’s definitely the one with the least amount of inputs into it. There’s still the labor, there’s still the rent, there’s still the cup to wash afterwards. Someone’s got to do all of that. But there’s no milk. There’s no extra syrups or any additives to it to make it more expensive. So if you’re looking purely from an economical way of drinking coffee, yeah, probably, probably black coffee. Is the way to go. But at the same time, am I going to encourage people to to give up their cappuccinos and start drinking black coffee? Probably not, because if you went to a restaurant, would you say, oh, you know, it’s cheaper for you to get the burger patty without the bun and the lettuce.

Tim Hughes  35:18

Yeah, I would do that. I would do that, but not everyone would not for the price just to not eat the bread. Yeah, I’m hearing it. I’m hearing it, yeah.

Raihaan Esat  35:26

So, you know, there’s that discussion to have on consumer preference. And I think with all of these rising prices, consumer behavior is something that’s very interesting to observe. You know, people making decisions on value now and really considering where they spend their money, how they spend their dollars, whether it’s on the production side, whether it’s on the cafe side. You know, we’re going to see some interesting observations. And the thing that I have about, I mean, I studied economics at university. I love economics, and it’s a big part of what I do. And the thing about supply and demand is that it assumes everyone is logical. And when have you ever met a logical human being? So that’s the that’s the only thing that like that that comes into preference, that comes into how consumers behave, how people behave based on emotion rather than logic, because that’s a decision making process. Sometimes emotion matters, and that’s one thing that, you know, it’s hard to measure.

Gene Tunny  36:29

Yeah. I mean, we like to think that markets tend back towards more rational outcomes over time, that there is an incentive to be rational, right? So you’ll go out of business if you’re irrational, or you’ll you’ll suffer if you’re irrational. So there’s a, there is a strong incentive for people to to act rationally and eventually or figure things out. But yeah, the markets can be markets, collectively can be irrational. And I guess that does reflect some irrational behavior. There’s a famous quote, was it? John Maynard Keynes, it was someone who said that the market can remain irrational longer than you can remain solvent, which is just a reminder that, yeah, you can have some outcomes that look a bit a bit irrational. Oh, well,

Raihaan Esat  37:14

I’m going to say that if the market is behaving in an irrational way, yeah, the best decision to make is an irrational decision, because it’s consistent with the market, right? If you’re making rational decisions in an irrational, behaving system, you’re almost fighting against a grain. You’re making a risky decision there, because you’re assuming it’s going to behave logic, yeah, yeah.

Gene Tunny  37:39

I guess there’s a bit of insurance too. So a lot of people are trying to take out insurance against things being worse in the future, the shortage in the future. So they’re scrambling to get get coffee now, yeah, that’s right,

Raihaan Esat  37:50

but the decisions are not based on logical reasons. The decisions are risk aversion,

Gene Tunny  37:55

yeah, yeah, which I guess, you know, maybe that is logical. I mean, if you had perfect foresight, it probably wouldn’t be but I guess we don’t have perfect foresight. So big questions here Ray about about markets and expectations and rationality. That’s

Raihaan Esat  38:11

also sparked a thought in my mind, when you said people are taking insurance by buying more coffee. Now that’s created another pressure on that’s on finance, yeah. So you see, not just not just us, not just small businesses, but even very large traders are starting to have financial difficulties right now, because in a market where the price of coffee has nearly doubled in 12 months, how do you finance that you know when you when you’ve got a Finance Facility of let’s just pick an arbitrary number here. If you’ve got ten million a year to spend on coffee, and the price of coffee doubles, your ten million doesn’t go as far as it used to last year. So how do you fund the coffee that you need when banks, financial institutions, prefer to lend on your balance sheet rather than on your stock holding, yeah, or on your stock requirements, yeah, yeah. There’s some really difficult situations that businesses are facing now when it comes to funding their coffee, because you need to buy your product before you’ve sold it. In most cases, you’ve got to buy it, get it here, into Australia, and then sell it. So you only get your money back after you’ve sold it, and sometimes that can be three to six months later,

Gene Tunny  39:26

right? Okay, so is this something that’s increasing the costs of to the Yeah, the producers. Is

Raihaan Esat  39:33

it? Well, the, it’s not so much the cost to the producer. It’s a cost now on the on the roasters side, roaster Yeah, yeah, the roast the roasters. The Coffee Roasters have to spend more on their coffee because they’ve got to finance it for longer terms. There’s a risk that they may not get it next year. So they’ve got to buy more coffee and hold it for longer Yeah, you’ve got store, extra storage costs now, yeah, to you know which increases the cost of your coffee and. And, you know, the finance rates haven’t been cheap lately. You know, think back to the to the mid 2000s the finance was quite cheap, but then interest rates went up and up and up and up to try to control Fla inflation. And that was, you know, that was monetary policy from the government side. They wanted to control inflation. Interest rates were going up. That’s the tool that they’ve got. But how that affects us? We are importers in Australia. Australia imports, not just coffee, but so many things, all of that has to be under finance that contributes to the increasing costs. So, you know, while it’s not a fundamental supply and demand sort of discussion on finance, it affects the price to the end consumer, because it’s an add on cost. Yeah, it’s important

Gene Tunny  40:47

to consider. It’s something you’re, you’re, you’re obviously dealing with, I think, in terms of the storage. I mean, you guys here, you’ve got those big silos downstairs, haven’t you? Yeah, that you can stick the,

Raihaan Esat  40:58

yeah, we store coffee. We store coffee here, but that we burn through that in no time. That’s only temporary. What we have downstairs in the silos, two ton silos. It’s probably only about a week supply. Okay? We have a warehouse over near the near the port that has a couple of 100 tons waiting, waiting to get pulled in and used. So we are holding enough stock, and we’ve got enough stock on the water to see through the contracts and see through our see through our clients for the next 12 months. Not everyone is in that position.

Gene Tunny  41:30

That’s impressive. I didn’t realize that. I mean, I guess I hadn’t thought about it in any great death, but that the amount of throughput you’re talking about is massive. So is this, I guess, I guess, compared with say, say, NES cafe or something up at Gympie or whatever, you’re smaller, but you’re still significant in terms of, where are you in the tunnel?

Raihaan Esat  41:53

We are international coffee traders. Is a very small coffee trader. In the grand scheme of things, there are many much larger coffee trading businesses in Australia. Okay? Last year, I’ll give you some numbers. Last year, we bought and imported something like containers, 20 tons of coffee, and we did about 30 containers, source, that’s 600 tons of coffee into Australia. That’s tiny in the grand scheme of things. What that makes in terms of, if you did the numbers, it, how many coffees could you make with 600 tons of green coffee, something like 1.9 million cups of coffee? Yeah, okay, okay. But the in Australia, 1.9 million cups of coffee. That’s not even a day, yeah? Days for assumption for the whole of Australia,

Gene Tunny  42:40

yeah, yeah, yeah. That’s right, yeah. I think I’ve seen stats like that somewhere. I’ll have to dig them up and put them in the show notes. I think Arturo, who works in my business, did an article on that. But, yeah, that’s interesting to think about it that way. It’s still impressive, like thinking about that many tons of coffee flowing through coffee commune that’s amazing, or ICT that you’re handling, yeah,

Raihaan Esat  43:02

look, ICT supplies green beans, not just a coffee commune, but to many roasters around Australia, right?

Gene Tunny  43:09

Gotcha. Yeah, extraordinary. Too many questions. No,

Tim Hughes  43:15

actually, I did have a thought, just going back slightly, because with coffee, for instance, like it is, you know, for instance, the emotional attachment that we have to coffee. You know, when you catch up with someone for a coffee, it’s never just to sit there and drink a coffee. It’s what comes with that where, whether it’s business, personal, whatever. So it’s this thing, of like, it’s, we have an emotional attachment to this product that is beyond just the drink itself, you know, it represents an opportunity to catch up with other people and exchange so that’s part of the experience that we attach with coffee, you know? So, yeah, it’s an interesting product to be talking about because it’s part of our DNA now, and especially over the last 20 years. For instance, living in Brisbane, I’ve seen that change in somewhere like Brisbane. There are certainly parts of the UK where that hasn’t happened, and you can imagine it happening. I’m sure it’s happening in the bigger cities, but out in the sticks where I come from, it hasn’t transferred it to be the same kind of cultural sort of norm coffee and tea and beer rather would have those but certainly not coffee yet.

Gene Tunny  44:21

Yeah,

Raihaan Esat  44:22

yeah. I’ve always wrestled with this, with this idea of coffee, because on one level, coffee is a commodity, just like other commodities, just like wheat and cotton and soya beans and products like that. And I don’t have the same attachment to those products yet. Wheat we consume every day, if you eat bread, and cotton is on all your clothing. And you know, coffee is lumped into commodities, just like those things, and it’s traded as commodities, just like those things, but we have such a deep emotional attachment to it, yeah, and even the people that don’t drink coffee have an opinion about coffee. Yeah. Up. So everyone’s got something to say about coffee. Well, I

Gene Tunny  45:03

mean, coffee was, you know, there’s a good case to be made that coffee was responsible for the growth of capitalism. I mean, well, essentially, because, you know, it powered all of the, all the business people in London, when all the coffee, the coffee houses opened up. And it was also responsible for the enlightenment, because all

Raihaan Esat  45:21

the coffees were actually called Penny universities, yes, because you could, because of the people that it attracted into the coffee houses, and they would have these high profile discussions. They would have educated debates over cups of coffee. And so people would pay a penny to get a cup of coffee, yeah, and they could be surrounded by these, uh, academics who were discussing, discussing intricate theories and concepts, and it was like going to university. That’s why they started being called Penny universities, exactly.

Gene Tunny  45:49

And didn’t Lloyds of London start out as a coffee house, a coffee house that, right?

Raihaan Esat  45:53

And then it became an in the world’s most well known insurance broker, yeah, yeah. And in fact, a lot of the workers in Lloyds are still called waiters. Is

Gene Tunny  46:02

that right? Yeah, okay, that’s interesting. Love to do a show about Lloyds sometime, yeah, and also the history of coffee, and it’s linked to capitalism and the enlightenment. Because I think I was, yeah, I was basically freestyling a bit there, right? Oh, okay, a couple of things we should pick up on. Tim, you were talking about the costs of a cup of coffee. And I think, did you ask, like, what’s the flow through from this thing? Like, we’re talking about a large increase in green bean prices, the figure, the figures you were quoting. Tim, so 12% of the cost of a cup of coffee is the beans, but that’s roasted beans. So that’s so the actual cost impact of the green beans on the cup of coffee is going to be smaller than that. So if you’re talking like you may have a large increase in the price of green beans, but it might translate into a relatively small increase in the price of a cup of coffee,

Tim Hughes  46:57

but it might eat into considerably the profit per cup, which we were talking about. So part of that, I’ll let you explain this ray in detail, like so if we talk about, say, three main sizes of coffee here in Australia anyway. So would you say the smallest is a six ounce, or is it an eight

Raihaan Esat  47:14

ounce? Yeah, generally, six or eight ounce is a small coffee in Australia. Then we got a 12

Tim Hughes  47:18

ounce and a 16 ounce. So sort of small, medium, large. What would that look like if, because currently you feel they’re underpriced?

Raihaan Esat  47:26

Yeah. Okay, so I’ve done a lot of research on this, and we’ve got about 700 cafes on our network here at the coffee commune. So, you know, we get a lot of data from those cafes on what they’re charging, what consumers are thinking, that sort of thing. There’s two parts to this. The first, first is a question I need to ask. If Green Coffee goes up by $1 Yes, how much does a cup of coffee need to go up by? Yes? Cover it exactly. All right, the answer may shock you. Okay, it’s only about three cents. Yeah.

Gene Tunny  47:55

And I think that makes sense, given what the figures Tim was saying, yeah, yeah. So

Raihaan Esat  47:59

if Green Coffee goes up by $1 the cup of coffee at the end of the line is impacted by about a three cent increase. Yeah, because one kilo of coffee makes about 40 cups of coffee, you know. So the increase gets spread over quite a large quantity. Yeah. Now the problem is those increases haven’t been passed on over the years, and so now there’s a bit of shock in the system, because all of it’s coming all at once, because businesses are failing, and businesses are finding it very difficult to maintain their prices. So you’re finding larger increases being delivered in the market, which don’t really refresh reflect the size of the increase on the green side, also, coffee is only 10 to 15% of the total cost of a cup of coffee. There’s all the other inputs as well. The second thing that Tim mentioned is you’ve got different cup sizes, and I think fundamentally, what the data is showing us is your small coffee, whether that’s a six or eight ounce, is roughly priced around the 480, to $5 mark. Your medium coffee, which is usually a 12 ounce coffee, is something like maybe $1 more, 50 cents to $1 more. So that’s 550, or $6 and then you some cafes even do a larger, large coffee, like a 16 ounce or a 20 ounce. And again, generally they go up by 50 cents to $1 the extra milk, the extra labor, the extra coffee that goes into the larger coffees is not being valued correctly for the most part. And I’d like to see cafes really nail down their costings, and what they’ll see is that their small coffee is the most profitable. Yet the 12 ounce, the medium and the large is what’s most popular. So they’re selling lots of those coffees which are much less profitable than the small coffee. So pricing strategy we’re now getting into behavior you can dry. People to buying the more of the small coffee by increasing the price of the large one. Yeah, right. So you can keep the small one the same, you can actually discount that a little bit, yeah, and offer that as a value option for a cafe, you can say our small coffee is going to be 450 we’re not moving the price, but the big ones we are. Yes,

Gene Tunny  50:20

yeah, that’s interesting. And consumer education, is there a consumer education piece in in that? Do you have to, yeah?

Raihaan Esat  50:27

Look, you need to know how to cost a product. You know? You have to be able to say, right, I buy 1000 lids at this price. What’s one lid cost? Yeah, I buy 1000 cups at this price. What’s one cup cost? When I build my coffee. It’s a lid, plus a cup, plus a shot of coffee, plus milk, plus a person to do it, plus a person to take the money, plus F plus charges, plus, plus, plus, plus, plus. You look at everything that runs your business, all the dollars in, all the dollars out, and you figure out the cost per unit, yeah,

Gene Tunny  51:03

yeah. So much depends on utilization. I was just thinking about this earlier, because if you can, if you can do more coffees an hour, your labor, cost per coffee falls. So yeah. So there may be scope to Yeah, cut, yeah, if you can increase the demand for your product by cutting the price. Yeah, so shifting demand from the larger coffees to the smaller coffees? Yep, and you could end up the company, the business could end up being better off.

Raihaan Esat  51:30

Yeah, you can make more coffees in less time because you’re doing the small ones, not the large ones. Oh, yeah. There’s a lot of lot of additional benefits to this. There’s here’s here’s another thing that that’s always been on my mind, is I, this is a consumer behavior sort of discussion. If I increase the price, even if I sell less coffee, I can sell that coffee. It’s more profitable, but I can sell less of them. Yeah, so there is already some parity that comes back just because of that. Making less coffee means I can do so with more quality, because I’m not rushed off my feet to make 400 coffees a day. Now I only have to make 300 coffees a day. I can deliver better service. I can use less staff to do it, and I have less input costs like milk. I’m using less cups. I’m using less less less less less. So I think there’s an optimum for every cafe on how many cups a day they should be producing, and then they should price accordingly. If they’re over producing, they need to increase their price and actually produce less. Or if they’re under producing, you know, discount a little bit and produce more. So there is some pricing to quantity ratio that that needs to be optimized, not, and I think that’s something that’s not well, scienced, if that makes sense.

Tim Hughes  52:48

Yeah, there is some, sorry, the that’s taking the experience into consideration and using that as a commodity, I guess, in a way, like it’s a focusing more on the experience rather than just the production,

Raihaan Esat  53:01

yeah, yeah. It’s very hard to produce more and maintain quality, right? So at some point you go, Well, I’m just going to increase my price. So that way, that way I actually keeping people away.

Gene Tunny  53:11

Yeah, yeah. It reminds me of Jerry Maguire. Show me the money. No fewer clients, more time, yeah. And then all of his colleagues just go,

Raihaan Esat  53:23

Yeah, but, but it, but it works. If you’re in that situation where, you know, you can’t really produce more,

Gene Tunny  53:30

yeah, that’s interesting. I have to think, yeah, that’s another consideration. So I mean, the way economists will often think about this is that, you know, to the extent that the demand is price inelastic, so demands not that responsive to price. You can increase the price, and then you can, you’ll get more from the higher price that compensates for the loss of some some customers. Yeah. And there’s always

Raihaan Esat  53:52

been the discussion on the green coffee side that, oh, if we increase quality, we can charge more. And now what we’re finding is that we can charge more because there’s a shortage, and it’s easier to do that than to do it on quality. And that’s a consumer mindset thing. That’s a production mindset thing, that I think we’re more risk averse than we are looking for better products. It’s an interesting trade off between the two. Yeah, it’s

Gene Tunny  54:19

amazing to get all these insights into the market, right? It’s great. We might go back to the just these nine factors, and I’ll put these in the show notes, because I think that slide you’ve you prepared for that presentation you gave here, which sounds like it was a ripper of a presentation. I mean, like, that’s some great insight in that that slide, I guess, to some to finish off with, what do you think the major factors are like, if I had to put a percentage contribution to each of those factors, what do you think the top one would be, and would it be about 50% or would it be about 40 or 30? I mean, do you have a sense of that?

Raihaan Esat  54:59

At the one that’s in the news that’s the most important, but, and that might be different every day, okay, so, you know, there’s one that was very topical about two weeks ago. It drove some prices up quite significantly, and that was, that was the I’m trying to try to figure out what’s a nice, neat way to say this. There was some conflicts in the Middle East. Oh yes, that were, that were a Frick affecting trade supply routes through the Red Sea. So through the Red Sea, you’ve got the the canal, and a lot of shipping lines use that canal to shortcut their way through to Europe and through to this part of the world now, with attacks on shipping vessels in protest of conflicts in the Middle East, all the shipping lines went we’re not shipping through that channel anymore. Guess what? There’s a container shortage now in Ethiopia, you can’t ship coffee out of Ethiopia. It’s had a massive effect on global supply chains, yeah, and that news going out to the world meant that everyone kind of overreacted. And was like, Oh man, we gotta buy coffee. We gotta get it out now we gotta there was caused a massive reaction. But then the news of, you know, that sort of dies down and quietens down, and then no one’s really acting on that, even though that that stuff is still happening right now. So whatever’s topical, whatever’s in the news, is kind of has the biggest impact at the time. At the moment, whatever’s being covered, there’s nothing, I don’t know how to say it, but, but there’s so it’s all about news. It’s all about what’s brought to our awareness.

Gene Tunny  56:41

But that impact on the supply side, on the harvests you mentioned, was it weather conditions in was it Brazil and Vietnam?

Raihaan Esat  56:49

Yeah, especially Brazil has had an unusually hot season, very little rain. So that’s, you know, there’s, there’s some speculation that that’s already caused crop damage for next year. So there are, there are some bodies in Brazil, like agricultural associations and stuff, that will report on this stuff, yeah. And, you know, with us, we deal directly with producers as well, and we can get on the phone and ask them, how are things looking, and they’ll go, we’re concerned, we’re

Gene Tunny  57:20

working, yeah, but now that must be one of the bigger drivers of what’s been happening with the price, because

Raihaan Esat  57:25

there’s a saying in the coffee industry that if Brazil sneezes, the whole world catches a cold, right? Yeah, because they are 30% of the entire world’s production. So they have a major impact on on pricing, on availability, on what happens in the world of coffee. Brazil, massive, absolutely massive. Vietnam, I would say the biggest contributors out of the things that we spoke to today, geopolitics, like the war in the Middle East, because that affects oil prices, transport prices, transport, trade routes. And that’s, you know, we need to get coffee from halfway around the world to Australia, Brazil and Vietnam and finance, those are probably the three biggest and then everything else after that. Yeah, okay,

Gene Tunny  58:11

right. This has been a really good summary of what’s going on the coffee market. I mean, if you’re listening and you got any thoughts or any questions on the coffee market, please send them through to contact at Ekta economics, explore.com and I’ll want to

Raihaan Esat  58:28

keep this discussion going. There’s a lot going on in coffee, and it means a lot to everyone. So I don’t mean to be the bearer of bad news, but I want to, want to, you know, voice what’s happening in the world right now of coffee and so that people understand what’s going on

Gene Tunny  58:43

Absolutely. Well, we’re realists on the show. We deal with reality, so we want to know what’s happening and and how do you best position yourself to deal with that reality? Tim, any final questions for Ray,

Tim Hughes  58:55

you had me at coffee? Very good. No, it’s great. It was really good. It’s funny. I wasn’t expecting it, but it’s such a big part of it, like is the experience that you talk about, as far as the value of a coffee is a really interesting prospect. And as humans, the probably the most interesting thing that we can look at, you know, like so I think it’s really good having that as part of the conversation. Yeah,

Raihaan Esat  59:26

I think my final thought for this podcast would just be on the consumer side. You know, we’re all consumers. We all go to coffee shops. We all go to restaurants, whatever it is, we’re all consuming coffee to some degree. And I think we can all be more mindful of the places that are doing a really great job and support them. Pay more for your coffee, but get value in return. It makes it worthwhile that we support the businesses, the local businesses, doing a fantastic job, and it allows the entire supply chain to be healthy if we’re pricing things correctly on the. Consumer side, it all flows back through for a healthy supply chain.

Gene Tunny  1:00:04

Okay, so support your favorite cafe everybody. I think that’s a that’s a good message. And yeah, the Yeah, recognize that they have to charge these prices to cover their costs, and those costs are rising. So I think that’s a important point, right? Oh, Ray from international coffee traders, thanks so much for your time. It’s been a lot of fun. Appreciated it. Yep, it’s been terrific. Tim, always a pleasure to catch up any to have on your show. And finally, 10% off Lumo coffee for economics explored. Listeners. Details are in the show notes. Okay, thanks. Gene, good on you.

Credits

Thanks 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 and other podcasting platforms.

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Podcast episode

Trump & Trade, France in Crisis, Global Capitalism’s Flaws & Job Losses from AI w/ Jean-Baptiste Wautier – EP266

This episode explores the economic implications of Trump’s re-election, France’s political deadlock under Macron, and the future of global capitalism. Jean-Baptiste Wautier, a private equity investor and World Economic Forum speaker, shares insights on trade wars and deficits. He argues that short-term profit motives undermine the global capitalist system. Jean-Baptiste also discusses AI’s transformative potential. Please note this episode was recorded on 11 December 2024, before French President Macron appointed François Bayrou as the new PM. 

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

Timestamps for EP266

  • Introduction (0:00)
  • Economic Implications of Trump’s Re-Election (2:55)
  • Potential Global Trade War (5:50)
  • Global Trade and Economic Interdependence (8:29)
  • Challenges Facing France and the Fifth Republic (13:55)
  • Risks to the Eurozone (20:07)
  • Flaws in Global Capitalism and Potential Solutions (27:34)
  • Examples of Enlightened Capitalism (33:01)
  • The Impact of Artificial Intelligence on Jobs (39:59)
  • Final Thoughts and Future Directions (44:50)

Takeaways

  1. Trump’s Second Term Risks: His proposed tax cuts and tariffs could reignite inflation and exacerbate the US federal deficit, leading to global economic consequences.
  2. France’s Political Instability: Macron’s government faces gridlock, which could potentially destabilize the Eurozone due to France’s growing budget deficit and political deadlock.
  3. Global Trade War Unlikely: Despite harsh rhetoric, economic interdependence makes a full-scale global trade war improbable, in Jean-Baptiste’s view.
    • Capitalism’s Short-Term Focus: Jean-Baptiste argues the current capitalist model prioritizes short-term profits over long-term sustainability, causing inefficiencies and negative externalities like mental health crises and economic inequality.

The Role of AI: AI is transforming industries at an unprecedented speed, raising concerns about job displacement and the need for economic adjustments, possibly extending to UBI (Universal Basic Income), depending on the scale of the displacement.

Links relevant to the conversation

Jean-Baptiste Wautier’s website:

EXPLAINER: Why is natural gas still flowing from Russia to Europe across Ukraine?

https://apnews.com/article/russia-ukraine-war-natural-gas-f9f00df7195d01404f8cb2a43152a8b1

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Transcript: Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262

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.

Jean-Baptiste Wautier  00:03

You look at all the negative externalities that our current system produced, they just gigantic. Think in terms of health, mental health, in particular, the younger generation. If you look at inequalities, not inequalities in the sense of, you know, morally, but inefficiency, the concentration of 10s of billions or hundreds of billions in the hands of a few individual means that they’re not going to be able to spend in a productive way this this amount of money. It’s yet another inefficiency when it comes to the economy. So there’s a lot of negative externalities that our system is producing and which is not making neither the best use of the resources we have, nor having the best impact on people’s well being.

Gene Tunny  00:56

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 and welcome to the show. Today, I’m joined by Jean Baptiste wartier, private equity investor, visiting lecturer and speaker at the World Economic Forum. We cover the economic implications of Trump’s re election, the potential for a global trade war, the challenges facing France and the state of Global Capitalism. Finally, we touch on the rapid advancements and the risks of job displacement associated with AI. Special. Thanks to Lumo coffee for sponsoring this episode. This top quality organic coffee from the highlands of Peru is packed with healthy antioxidants. Economics explored. Listeners can enjoy a 10% discount. Details are in the show notes. Now let’s jump into the episode. I hope you enjoy it. John Baptiste, welcome to the program. Thank you. Thanks for having me. Gene Of course, it’s great to chat. It’s such a interesting or what’s the word, suppose it’s challenging, and I mean, maybe vexing time for the global economy. There are, there are really some big things that are that are happening that it’s unclear what, what the ultimate impacts will be. So I want to chat about some of those with you today. And I mean, in brief, the election of Donald Trump to the second term, which I think has has surprised many, and that’s going to have implications. Of course, what’s happening in France is at the end of the Fifth Republic. What does that mean? And then also your thoughts on global capitalism? Because I know that’s something you’ve commented on. So to begin with, can I ask about the election of Trump to a second term. What are your thoughts on what that means for the global economy? Well,

Jean-Baptiste Wautier  03:06

thanks, Gene. I think it’s, as you said, it’s incredibly the objective I would use is consequential, because there’s going to be it’s not only a surprise, as you said, not not so much a surprise to some, because you could tell that the way the polls were measuring the real intention of votes for Trump was sort of not completely capturing what was going on and, and I think people were surprised by the popular vote in particular, but, but in terms of its consequences, first, you’re going to have major consequences on the US economy. And I think the first one that comes to mind is inflation, because all of the planned tax cuts and tariffs all have inflationary impacts. And as you know, and as probably most know, inflation is not completely tamed, and central banks are right now hesitating as to what they should do next. And there’s been a sort of a very surprising pose by the Fed and by other central banks, because, again, they observing underlying inflationary trends, and that’s before the Trump measures. So I think the first thing to watch is going to be certainly high. Inflation can be reignited, or will be reignited by those measures. And I would say the immediate second red flag in terms of the US economy is how they’re going to manage the deficit, the federal deficit. These numbers are now staggering. If you look not only at the debt service, but also at the total debt to GDP of the US and how it’s it completely skyrocketed over the last 20 years, we now at levels that we last time so right after World War Two, and we now have. A debt service, and we say that service, but it’s actually interest. So just the interest charge on the public debt, that’s already 20% of receipts, and could go up to 30% so we’re talking about roughly a trillion of interest that need to be paid every year, which even for the US, is a huge number. It’s bigger than the total spend on the US Army and total defense budget. So I think these are incredibly powerful forces that could be unleashed. And I don’t see an easy exit. Whether there’s, you know, some some new inflation trends in the next six to eight months, whether, suddenly, you know, you have all sorts of issues with the how deficits are being tamed. These are going to be major issues that US economy will face very soon. Yeah.

Gene Tunny  05:53

Yeah, absolutely. And what do you think about the potential for a global trade war? Is that a is that a real risk. I mean, we’ve had Trump threaten tariffs on Well, I mean, you know, tariffs against China, a big tariff against China, 60% or wherever, or 100% even 20% across the board, tariffs on Mexico and Canada, unless they control immigration. What do you see as the as the potential, all the risks there of a global trade war and consequently, global slump.

Jean-Baptiste Wautier  06:28

Yeah, I think this one worries me less, despite all the rhetoric that we’ve heard. And it’s not only Trump, it’s you hear that from China. You hear that from also the European Union, who’s talking about, you know, we need to protect our internal market more. We need to tax Chinese cars and all sorts of things. I mean, there’s, there’s, there’s a lot of rhetoric out there. Certainly, the reason why I’m less concerned is even though, you know, we should acknowledge that the world have a lecture at at transport Paris, which is called Global and multipolar world. And it’s indeed a multipolar world. So we have, for sure, exited this sort of Pax Americana and an economy that’s really dominated by the US economy, and where it’s all about globalization and free trade. I think now we have more regional powers. Now we still have a very global and interdependent economy. And despite all of the the efforts from the US, from Europe to try and relocate some of the supply chain, there’s still a lot of dependency. You know, if you look at the production of semiconductors, if you look at commodities, if you look at energy, there’s a dependency on very few places in the world. And I think it’s going to be very hard to really go aggressively with tariffs, even for the US and despite still the dominance that the US has. So I think it’s being used as a tool, as a threat, as a way of negotiating hard. And probably there will be, you know, a few things here and there which are going to be more symbolic than real, real tariffs that shut down the economy. I think it’s just not attainable these days for any economy, even the US,

Gene Tunny  08:21

yeah, yeah. Well, let’s hope sanity prevails. I like that point you made about just the connectedness of the global economy and the the importance of keeping trade open for critical, you know, for those crucial materials that are sourced from, you know, various particular parts of the world. And there’s a good book by Ed Conway recently on the material world, which I loved, which I think really illustrated that quite, quite well. Can I ask you mentioned a was it a lecture or a seminar in Paris, global and multi polar world? What was that? Again? What are the specifics, please?

Jean-Baptiste Wautier  08:58

Yeah, it’s, it’s, it’s a lecture I give to first year master students in Paris. And it’s really about trying to understand the new global economy, which, again, is a combination of exactly as you summarized. It’s global. Supply chains are global. This trade is at its peak compared to global trade at its peak compared to any time in history. But at the same time, there’s dependency on certain, certain parts of the world, on, you know, think of, I don’t know, batteries for electric cars, where all of those, those rare minerals, are only produced in one or two parts in the world, right? You know, in China, in Russia, like two or three countries, think, of course, oil, oil and gas. But also think manufacturing in general. You know, if you look at things like compounds that they use for many for drugs, those. Compounds. Half of the production is in India today, sort of the primary compounds that are being so this is what this seminar is about. It’s really about understanding how this interconnectedness, as you call it, is has become incredibly prevalent, and it’s very hard to revert, at least in short order. And that’s where sovereignty has become an issue for, you know, sort of regional economies like like the ones in Europe, but even for the US, again, you see this constant debate about the importance of Taiwan and the supply of semiconductors coming from, and how strategic this is, because there aren’t that many places that provide semiconductors, and at a time where it’s all about your ability to build data centers build artificial intelligence capabilities, you know, these are incredibly critical, not only to those to those industries, but also to your sovereignty. So it’s all about understanding this level of interdependency, and how, despite all the rhetoric in the world, there’s a limit to what you can do. I love that. There’s one. It’s a tiny example, but it’s so to me, it’s so telling. Which is the supply of natural gas from Russia that goes through Ukraine and then serves Europe is still functioning. So you have sanctions on Russia. You have a war between Russia and Ukraine. Ukraine has been invaded by Russia. And despite all of that, there’s still some gas produced in Russia going through Ukraine and, and, and, and being, being, being delivered to some European countries and, and it’s just because there’s no other way, you know, there’s this so that that tells you how this sometimes is a disconnect between the rhetoric and the actual dependency of the various economies.

Gene Tunny  12:00

Rod, hang on. So there’s a there’s a pipeline that goes through Ukraine, and so the Why don’t the Ukrainians sabotage it? Because the Germans are telling them, oh, you can’t sabotage that, because we need

Jean-Baptiste Wautier  12:16

so good question. It’s even worse than you think, because, because Russia is paying Ukraine for the pipeline, right? And, and they all interdependent. Russia needs to sell its gas. Ukraine needs the royalties from having the gas going through its pipeline and its country. And then the countries in Europe need, need, need the natural gas, and, and, and it’s, it’s a bit like, I don’t know it’s, it’s like Russian oil, you know, Russian oil, and ends up being recycled through a fleet, a ghost fleet, of tankers and ghost insurance companies, and that it gets acquired by in India or China, which To refine it and then sell it back to the European countries. It’s the same. It’s the same irony. There’s the sanctions, but then there’s reality of, we need, we need gas, yeah, and Europe doesn’t produce any, yeah,

Gene Tunny  13:14

it’s extraordinary. I mean, there are, there’s a story like that, I think, from the First World War, which is similar. And Ed Conway tells that in his book, I think there’s a story about how the British had to do a deal with Germany during the First World War, that it was in a bit of conflict with, you know, millions of men dead. And it did. It was, I think it was a range through Switzerland. It was a deal for for optical glass, but that they needed for binoculars. Because, yeah, the Germans were the leaders, you know, Zeiss and all of that in in optical glass. And I forget what the British maybe they provided them rubber, because the British had the plantations in Burma or so, yeah, just extraordinary. I have to look into that. That’s it is, yeah, incredible. So you’re, you’re teaching, you do some teaching in Paris. What’s happening with France? I mean, like I remember going to the the Bastille Day celebrations here in Brisbane, at the so Patel in 2017 which is a couple of months after Macron was elected. And there was so much enthusiasm about Macron and and so much excitement about what he could do for France, and it just all seems to have disintegrated, and now there’s a risk of talking about, is this the end of the Fifth Republic? Could you tell us a bit about what’s going on there? Please? Jean Baptiste,

Jean-Baptiste Wautier  14:36

of course, yeah. And it’s, you know, the French like to make it incredibly complex as always, but it’s, it’s, it’s, indeed, an incredible turn of event, because, you enthusiasm was shared by many people when Macron was elected as someone who was, you know, very modern, pro business, balanced and could really take, take the country further. Um. He did a few things, but not that many during his first mandate, then got re elected, and unfortunately, there’s two issues at play right now. The first one is Macron got elected, but it you know, we could say the same about the UK, probably, and other other countries in Europe. Macron got elected, not as a positive vote from the majority of the French voters, but it was elected against Marine Le Pen. Who’s this? You know, very extreme right, a very nationalist Populist Party, but which has, effectively, over the years, become the leading party in France. They today, they represent anywhere between a third and 40% of the total votes you take all of the last three elections. And she, she was always around around that mark. So that’s pretty high. And the second, the second party was probably elect Marcos party back back back in 22 during the presidential election, but it was far behind, like it was 10 to 15 points behind, and the only reason why he got reelected is because all of the other parties voted against my Le Pen and therefore said I don’t like Macron. I don’t like his policy, I don’t like what he stands for. I don’t like his personality, but it’s better than Le Pen. And so it’s, it’s, you know, you start off of wrong premise here, which is, it’s not, it’s not that people think is the right guy with the right ideas and the right program. It’s like, No, we just want to avoid the populist and the extremists. And then there was a European election in 24 earlier this year that Macron again lost, but it was just a reflection of if you if you looked at the first round of the presidential election, it was already pretty much the same numbers the one I just gave you. So Le Pen came in France with a third of the votes, and then it was not even Second. Second was a coalition of the left parties, and then Macron was third. So it was really a proper defeat. And and he had a very emotional reaction, you know, couldn’t believe that he was he was such a negative vote against him, and they decided to dissolve the assembly, which the President can do once a year, according to the Fifth Republic constitution. And so when you do that, you have parliamentary election. So even though there had been parliamentary election in 22 where already he had no majority. So keep that in mind, even though he’d won the presidential election, and that’s again, because of what I explained, that he didn’t really command a majority. Anyway, he lost again this parliamentary election, but by an even bigger margin, and now no party is commanding any majority in parliament. You have may Le Pen is still the biggest, but thanks to the way the voting system works in France, they don’t have 40% of the seats. Even though they had 40% of the votes. They have like more, like 2025 then the sort of Macron coalition of, you know, center right and center left have roughly another 30% and then there’s, there’s a large coalition of the left, but from extreme left to center left, which has another third. And so you have, you have a deadlock parliament. Is that nobody commands a majority, and everybody’s taking a very extreme position, like no one wants to work with one another. And this is the other very typical French thing at play here, which is France is a lot is long on the ideology, short on pragmatism, the opposite of the Anglo Saxon world. And so all of those three, those three thirds, if you wish, are really sticking to their guns in terms of ideas and programs and what they think should be done. So Macron thought, again, he could have the upper hand because he’s so smart and he’s going to manipulate all of these people, and he’s going to get them into a rhythm. But he actually failed, because again, the Prime Minister he appointed three months ago was was voted out by the parliament. Because again, there’s no majority, and there’s still no emergence of majority. Now is it the end of the Fifth Republic? I think not yet, because it’s a very high bar to change the constitution, and if you you can’t even pass a budget, which is right now, the dynamic at play in France, it’s going to be even harder to have a new constitution unless you put it to to a referendum. So I think you’re going to end up it’s going to be a bit like, like Belgium. Him as seeing for, you know, for two years, you’re going to go from one government to the next. Macro is never going to leave. I think it’s just too that’s his personality. I think he will never want to leave, and he doesn’t have to to be fair. And I think you’re just going to see trials and errors. Trials and errors probably budget never, really, never read, adopted, and they’re going to continue to function in that sort of very transitional mode until the next presidential election, which is in 27 so it’s not going to be it’s not going to be good for the country, because nothing’s going to happen. People are going to be very unhappy. Budgets are not going to be balanced, which is also bad because France is now running the largest deficit in the eurozone and needs to get its acts together, but without any majority in parliament, it’s going to be very hard to balance. So I think it’s, you know, it’s also a real threat for the European Union and the eurozone, because dysfunctional France for another two and a half years, it’s going to be a real issue for the for the entire region. Yeah,

Gene Tunny  21:05

yeah, that’s what I was wondering about. Just what does it mean for for the stability of of the euro, and whether there are any risks of of a Eurozone breakup at some stage? Is that actually a realistic prospect, or is that just something that you don’t think will ever happen.

Jean-Baptiste Wautier  21:23

So I don’t think it’s a zero probability, because again, France right now is running a deficit which is around 6% of GDP as a total debt to GDP of 120% and given the current political dynamic that we just talked about. It’s not going to balance its books anytime soon, and so far, because France is such a foundational country for the European Union and the Euro zone, together with Germany, the commission has been incredibly lenient, and as given France three years, and then five and now seven years, not not even to balance its books, to get back to 3% of GDP for its public deficit, which is the benchmark that you’re supposed to observe. But even if it does that in seven years, the debt is still, you know, it’s still spiraling. And so I see the risk of a Greek episode or a trust episode on France like a real possibility. So not necessarily the fact that the Eurozone is going to completely implode, that I think is a low risk, but I think there’s a real risk of sovereign crisis and the cost of the French debt suddenly spiking. It has already gone up significantly when you look at the spreads with Germany, but I think it could go much, much higher. When it starts to go much higher, you’re going to have to have like, like, in the case of Greece, back in the days, an intervention of ECB or IMF or both, which are going to force reforms on France in terms of balancing its budget, reducing its spending, so that, I think as a real probability. I wouldn’t say it’s, it’s, it’s certain, because there’s been a good amount of leniency so far, but I see that as a real probability of occurring. That would save the euro, but that would be a disaster for France.

Gene Tunny  23:28

And just briefly, what is the cause of the budget deficit? I mean, obviously too much spending relative to taxation and other revenue. But is it entitlement programs? Is it a an excess a blighted public service. Do you have any thoughts on that? So,

Jean-Baptiste Wautier  23:43

yeah, yeah, absolutely. I mean, first of all, if you to put things in perspective, Mark quandry during his seven years when he took over the French, total debt, total public debt, was 2000 billion euros. He added 1000 billion euros during his seven years, which is mind boggling. So when, when you try and disaggregate where this, this came from and and also to answer to your question on, on public deficits, of course, COVID is part of this, but COVID is only a third of this 1000 billions that were added. So a lot of money has been has been spent on two fronts. One Macron tried to make companies more profitable, more competitive, make France more attractive when it comes to investment. So a lot of money has been spent on reducing tax, both for companies and for wealthy individuals. So is introduced a flat tax wait when it comes to capital gains and on the corporate side, he’s reduced the overall tax rate, and he’s introduced a lot of exemptions, and that that is 10s of 10s of billions of euros. Yes, in terms of the spending, and then on the other side, the other source of deficit, and that was a lot of very, I was going to say generous, but crazy, excuse my term, but crazy spend on, you know, helping people with inflation, helping people with energy, helping people with all sorts of subsidies and public spending on things that would never have any structural impact. So you were just helping people for the next six months. But then, you know, and then what? And so they’ve been throwing, again, 10s of billions like this over the last two years, probably also help, you know, hoping that it would appease the country and it would help with people purchasing power and all the rest, but the budget was already in deficit, so you never had that money in the first place. And then the last thing that happened over the last 12 months, which frankly, is is farcical, is they made. They made mistakes in budgeting 2425 because they were hoping that their revenues, which follow the trend of the 2122 fiscal years, whereas these years were rebound from the COVID years. So they were not sort of a normative level. So again, then they didn’t size properly the spends, because they completely overestimated their revenues, and so that’s what created that huge deficit that that we’re seeing now, that’s been widening in less than a year, right?

Gene Tunny  26:31

Okay, yeah. I mean, we’ve had the energy subsidies here in in Australia, and yeah, I guess we’ve made forecast errors in the past, but not, not quite that sounds extraordinary, if they’ve ended up with a Yeah, it is seven, 6% deficit, extraordinary. Okay, well, that’s it is. I’ll keep an eye on what’s happening in France for sure. Yeah. Okay. We’ll take a short break here for a word from our sponsor.

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Gene Tunny  27:29

now. Back to the show. Last thing I want to cover Jean Baptiste is this question of capitalism. So you’ve you’ve been involved in World Economic Forum, and you’ve so you’ve been a in financial markets for decades, and so you’ve been a long term observer of what we you know, our capitalist system. And you’ve got some thoughts on like, what you see is the flaws in it and how it can be improved. Could you tell us what do you see as the flaws or the problems with our current system of Global Capitalism,

Jean-Baptiste Wautier  28:05

of course. I mean, the to me, the if you start at the very macro level, and you look at all the negative externalities that our current system produced, they’re just gigantic. Whether you look, I mean, the first one that, of course, comes to mind is, is global warming and environment and all the rest. But to me, it’s, it’s far it’s far bigger than this. Because I also think in terms of health, if you look at statistics, in terms of in terms of obesity, for example, whether it’s in the US or in Europe, if you look at mental health and how social media function, and how they impacted mental health, in particular the younger generation, if you look at inequalities, not inequalities in the sense of, you know, morally, but inefficiency, the concentration of 10s of billions or hundreds of billions in the hands of a few individual means that they’re not going to be able to spend in a productive way this this amount of money. So I’m not, I’m really not approaching this, you know, with a moral aspect and just it’s, it’s yet another inefficiency when it comes to the economy. So there’s a lot of negative externalities that our system is producing and which is not making neither the best use of the resources we have, nor having the best impact on people’s well being, simple as that, and and the planet well being so so that that is, to me, the issue right now. And when I try and look at the root cause, the root cause is, over the last, I would say, 3040, 50 years, capitalism has really shifted to becoming incredibly short term and becoming solely focused on profit maximizing, short term profit. And it’s not always been like that. If you if you go back in history, and you look. At the the great industrialist in the US, you know, the great billion of the Rockefellers of this world, the carnegies, the perspective was much more medium to long term. And we’re going to build companies to solve a problem. And if we solve that problem efficiently, profit will be the consequence of solving a problem, problem efficiently for the further society, as opposed to, is going to be the objective. And if you go even further back in history, and you look, you go back to Adam Smith, that’s exactly what Smith, you know, sort of theorized. So even if you go back to the father of liberalism and capitalism, that was already the way it was, it was conceived. So I think this is, this is the issue we facing right now. We’re trying to lay a regulation, you know, in the hope that, oh, we’re going to reduce carbon emissions, we’re going to reduce the use of plastic, we’re going to reduce energy consumption at its and it’s just not working. It’s not working. Because if you look at the global energy consumption in the world, it’s going up. If you look at where it’s coming from, it’s still coming 80% from, you know, fossil fuel. If you look at all the innovations, look at the energy consumption of a Google and Microsoft, it’s the size of a country consumption. You look at, again, you look at the impact on people of all the social media, you know, it’s not, you can’t argue that there’s a lot of negative there. And you look at obesity prevalence in the US or in most developed countries in Europe, it’s going up, up, up. And, you know, it’s, it’s, it’s neither good for the people, not for the society. So all of these things are not going in the right direction and and it’s, it’s not by regulation, by regulating, because we already over regulated, especially in Europe. It’s already impossible to know all of the regulation, and you can never capture it’s too complex. You know, the these, these are too complex to monetize, to measure, to regulate. It’s just impossible. So I think the only way is two things. One, to try and be longer term in terms of how company and investors make decisions, because again, time horizon does matter here. And the second thing is in terms of, again, investors, governance, the way we incentive boards and management, and it’s all about what is the problem which you’re trying to solve, as opposed to maximizing exported profit. And as long as we don’t turn this onto its head and and sort of make profit as a consequence rather than as an objective. I think we’ll continue to, you know, go in circles and observe negative externalities more and more and never come up with a solution. It’s still, you know, it’s a very, it’s a very fundamental issue. It’s not, it’s not one that can be sold easily, but it’s, it’s, I think it’s one we should be concerned with.

Gene Tunny  33:04

Okay, so just to understand, are you arguing that? Well, there are a couple of ways you could look at this. Should, should people have this in concept of enlightened self interest, where they they see beyond the immediate, and they see, well, we’d actually be better off if we thought longer term. So that’s one thing that so there’s that possibility, or are you arguing that they should take into account these wider social or environmental impacts, even if it isn’t of benefit to them directly, because they should have a wider concept of well being than just their company could. I’m just trying to understand what your position is precisely, please. Sean Baptiste,

Jean-Baptiste Wautier  33:49

yeah, no, of course. And it’s no absolutely, and it’s actually both. It’s both changing the time horizon and focusing on on a higher purpose, as opposed to just the bottom line and the profit that you’re going to generate for the fiscal year. So time horizon? Why? And this is something I’ve observed, you know, I’ve spent more than two decades in private equity, and private equity, despite what people may think is actually quite long term, because you invest in companies for 456, years, and then you need to sell this company to someone who’s going to hold it for yet another at least five years, if not more. So when you invest in a business, you need to think the next 10 years. And when you do that, I’ll give you a stupid example. You not going to buy a an incredibly profitable company that makes disposable plastic bags, because you know that the trend is not your friend. So you might look at amazing financials, amazing cash flow generation, amazing management team, blah, blah, blah. You know, great market position, but you know that in five years time, nobody would want to buy this of you. So. So that’s what having a long time horizon brings you, is you will automatically factor in those negative externalities that instantly may not necessarily impact your everyday profit, but in the long run, will, will will no longer be able to be monetized. And the second thing I’m advocating, because I’m trying to, I’m trying to, quote, unquote, see how we can save capitalism and liberalism, because I’m still a great believer in those two capitalism, because that’s the best way we found to create wealth for all you know, collectively, by rewarding risk taking and hard work. So I think we should preserve that, because that works, that engine works and liberalism, because that’s the world I want to live in where I have agency and freedom of starting my own company and freedom of speech. So I’m trying to see, okay, how do I save that? But by getting rid of all those negative things that you know, impacting our societies, and that’s where I’m thinking. Instead of layering regulation which is already impossible to navigate, let’s do this bottom up and have companies which now not only elongate the time horizon, but also focus on what problem are we solving and what is, what is our net benefit to society, not only how good is our product, but also, you know, the well being of my employees, of my suppliers, of my and the society around me, the community. So it’s, it’s what people call stakeholder capitalism. So you really factor in all of the the impacts that you have, direct or indirect, and that’s how you you manage your business, as opposed to what’s going to be my net income, net income for next year? Yeah.

Gene Tunny  36:51

Do you have any examples of companies that you think are doing this well, or could be examples to others?

Jean-Baptiste Wautier  36:57

So there are. There are fascinating examples of companies which are owned by foundations and which have been, you know, one that makes the headlines is Novo Nordisk, which, you know, has made this ozempic product that that is concurring the world. But you have, you have more and more companies, especially in Scandinavia and in the north of Europe, that are being owned by foundations, and those foundations are the shareholders and the way they look again at their businesses. I’m not obsessed with how much dividend can be paid up next year. I’m looking at my purpose, my competencies, my 1015, 20 years horizon, and profit will come if I if I’m doing things right, and if I’m doing things that really bring value to society, I’m going to be a profitable business. And again, that’s what Adam Smith theorized, and he was right. And so you’re seeing more and more examples of this, of, you know, this small, more inclusive capitalism, or companies which are so there are examples, it’s, it’s, it’s nowhere near the majority of companies today. But you know, if you combine those owned by foundations, those owned by families, or founders, very successful founders. I don’t want to it’s a bit of a funny example I’m going to use but, but if you look at musk, there’s a lot of negative things in terms of how much wealth is now being concentrated into his hands, granted. But on the other side, the way he’s built this business. Was never obsessing over next quarter profit. You know, he’s been people were saying, Tesla is going to go bankrupt because they’d been burning cash for so many years. And then when he launched SpaceX, people were like, what i How can you make a profit? You know, sending satellites and going to Mars, there’s no business for that. And Mesa is doing it better than you. And look at where we are today. So he’s an example of an incredible entrepreneur, whether you like him or not, you know you have to look at what he’s achieved. It was never thinking, I want to, I want to be worth 300 billion in 2024, which he, incidentally, he is now. So there’s more and more example that that, that one can can find of, you know, if, if we manage to really turn this onto its head, I think, I think there’s a there’s a path. It’s not an easy one, but I think there’s a path.

Gene Tunny  39:38

Yeah, absolutely, I think, yeah, certainly worth, worth considering, I think Musk is a, he’s a good example of that Bucha nearing capitalist. I mean, is the closest thing we’ve got say to someone, you know, I guess Howard Hughes many years ago, or, yeah, you know, I guess some of the great industrialists you mentioned in Carnegie and all of that. Yeah, absolutely, yeah, absolutely, right. Oh, this has been fascinating conversation. John Baptist, anything else before we we should go anything else that’s that you’ve been thinking about and things worth, worth covering before we wrap up,

Jean-Baptiste Wautier  40:13

right? Thank you, Gene. I enjoyed it. I mean, there’s so much, as you said in your introduction. You know, it’s not just these, these tectonic shift on the geopolitical front, and we only we talked about some of the hot topics, but talk about the Middle East. We haven’t talked about Russia, we haven’t talked about China, and there’s so many things happening there. So it feels like all of these tectonic plaques are moving right now at the same time, and just as if it wasn’t enough, I think artificial intelligence is the most, is the quickest, most far reaching industrial revolution of our times. So you’re overlaying on a world that’s sort of rearranging a massive industrial revolution, which is going to change so many things in our lives. I think we live really fascinating times, and I really enjoy talking about this, because I think we should all have eyes wide open and watch and learn. Yeah, absolutely.

Gene Tunny  41:17

I think just on AI, what are you most excited about? What are there some, are there some develop? I mean, we’ve seen chat, GPT and all of the large language models, but are there certain things that are that are exciting you at the moment? So

Jean-Baptiste Wautier  41:33

I think, well, what’s exciting me is, apart from things that really needs very human emotional intelligence or human presence. There’s so many and some element of judgment, but there’s so many jobs, so many things we do in our daily lives that are a few years away of being replaced by artificial intelligence is just mind boggling. And the only thing that was, you know, sort of delaying it is progress in terms of quantum computing. And you would have seen Microsoft announcement, I mean, the So, so we’re just a few years away of doing so many things with it in everything we do, I think humans will all will be social animals. So we’ll always need, you know, we’ll always need to meet in person. We’ll always need to share motions, to share ties together. When you try and think of care, and there’s certain industries or art investment where you need a lot of judgment at times they will, they will still be pockets where you need human input. But I don’t know, more than half of the things we do can be more or less replaced by by a computer tomorrow. And so that’s that fascinates me. And you know, medicine could be so much better. There’s so many things that could be so much better, but at the same time, it’s a revolution that has very little content when it comes to jobs, employment. All the previous industrial revolution, it was the creative destruction of Schumpeter, right? So they were sort of destroying some industries, but some others were being created. And the level of wealth and productivity was was going up this one not only is going faster than the previous ones, because it’s more like 20 or 30 years as opposed to 50 or 80, but on top of that, it’s not creating jobs. You look at the ratio of market cap of the largest tech companies to the number of jobs they have. I mean, it’s ridiculous. Yeah, we’ve never seen such a bad ratio and and that’s, that’s what worries me, on the flip flip side is, what are we going to do when we can replace, you know, so many things, and it’s not only that, it’s going to be efficient, it’s going to be very low on cost, so it’s going to be a no brainer to replace man by machine in minutes. What are we going to do with all of these job that we’ve destroyed and with all these people that become an employee? That’s that’s the one that worries me. Hopefully excited.

Gene Tunny  44:12

This is why some of my guests argue in favor of UBI So, yes, I mean, I’m not necessarily advocating that, but I think you know that if that scenario, if that’s what happens, and then UBI becomes, becomes more compelling, I’d say, so, yeah, absolutely okay. Thanks so much for the conversation. I really enjoyed it. You’re right. There are so many other issues we could have, we could have covered, but then I’d probably be talking to you for two or three hours, and we might have to have another schedule, another chat, subtitles. I found this very, very enlightening. And, yeah, I think, like the idea of that, course you’re teaching the global and multi polar world. I think that’s so important. This, this whole idea that, since certainly things are. Different from what we expected after the end of the Cold War. We saw the US dominant, but now we see Yeah, just yeah, the multi polar world, as you say, or even a G zero world as Ian Bremmer, yeah, says, Absolutely. I enjoyed it. All right. Thank you. Gene Thanks. John Burt, 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 at economics explored.com, or a voicemail via speak pipe. 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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Credits

Thanks 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 and other podcasting platforms.

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2024 Highlights: Reagan’s Budget Czar on Trump | Greedy Jobs | Super Abundance | Buffett in Omaha | Housing & Immigration

Host Gene Tunny discusses significant economic issues from the year. He features clips from interviews with experts on various topics, including the economic consequences of Donald Trump’s re-election, the U.S. budget deficit, the gender pay gap, and environmental impact. President Reagan’s budget director David Stockman criticizes Trump’s policies for being anti-capitalist, citing a $8 trillion increase in public debt. Fiscal policy wonk Dan Mitchell argues that higher taxes are not the solution to the U.S. budget deficit, as spending is the primary issue. Leonora Risse (Assoc. Prof., University of Canberra) explains the concept of “greedy jobs” contributing to the gender pay gap. Marion Tupy of the Cato Institute discusses the long-term decline in commodity prices, and Daniel Lawse of Verdis Group emphasizes the need for sustainable, long-term thinking in business and policy. Daniel also reflects on the modest lifestyle of Warren Buffett, another Omaha resident. John August discusses the impact of immigration on Australia’s housing crisis.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

Timestamps for EP265

Links relevant to the conversation

Episodes featuring the clips:

https://economicsexplored.com/2024/01/28/reagans-budget-boss-david-stockman-on-trumps-economic-policies-ep224/

https://economicsexplored.com/2024/04/17/is-uncle-sam-running-a-ponzi-scheme-with-the-national-debt-w-dr-dan-mitchell-ep235/

https://economicsexplored.com/2024/03/10/the-gender-pay-debate-understanding-the-factors-behind-the-gap-w-dr-leonora-risse-ep230/

https://economicsexplored.com/2024/10/16/abundance-mindset-exploring-the-super-abundance-thesis-w-marian-tupy-cato-institute-ep258/

https://economicsexplored.com/2024/06/01/helping-seattle-aquarium-others-go-to-net-zero-and-beyond-w-daniel-lawse-verdis-group-ep242/

https://economicsexplored.com/2024/04/17/housing-crisis-and-immigration-australias-tough-choices-w-john-august-ep236/

Leonora’s review of Career and Family: Women’s Century-Long Journey toward Equity, by Claudia Goldin

https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-4932.12716?domain=author&token=UPATKK2WTIAEZ49UMRMV

Principle of Charity podcast episodes on degrowth:

https://podcasts.apple.com/au/podcast/can-degrowth-save-the-planet/id1571868650?i=1000674757240

https://podcasts.apple.com/au/podcast/can-degrowth-save-the-planet-pt-2-on-the-couch/id1571868650?i=1000675655623

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Transcript: Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262

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  00:00

Gene, 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 the 2024 highlights episode, and this episode, I want to play some clips from some of my favorite episodes of 2024 Okay, to start off, we probably should cover one of the biggest stories of the year, if not the biggest story, which was the re election or of Donald Trump as US President. So that is going to have some very profound economic consequences. And I chatted with my friend and colleague, Darren Brady Nelson about it days after the news on the show. So that was a few episodes ago. Darren is someone who is supportive of Trump on the show, I’ve had critics of Trump and one of those prominent critics in the States is somebody by the name of David Stockman, who was Ronald Reagan’s Director of Office, of management and budget. So he was a budget official for Ronald Reagan, who is the celebrated Republican president of the 1980s and Stockman is one of the never Trumpers, and I had a very interesting conversation with him early In the year, and I wanted to play a clip from that episode, because I think Stockman is someone who deserves to be listened to, and I think, personally, I think he makes some good points. So without further ado, let’s play the first clip, and this is David Stockman on Trump’s war on capitalism. You argue that he is a clear and present danger to capitalist prosperity. Could you explain, David? How do you How can we reconcile these things? I mean, Donald Trump does seem to be the exemplar of a capitalist, but yet he’s a threat to capitalism. How do we reconcile these facts?

David Stockman  03:05

Well, those are great questions. I don’t think really he’s an exemplar of capitalism, and we can get into that. I think he’s an exemplar of getting lucky when the Fed created so much inflation and asset prices and made debt so cheap that if you were a speculator in New York City Real Estate or elsewhere, you possibly made a lot of book wealth. But I don’t think it was capitalist genius behind it. That’s the first point. The second point is that his policies were really almost anti capitalist in some common sense. Notion of conservative economics. To have a healthy capitalist economy, you need three things. One, fiscal rectitude. You can’t be running up the public debt, spending like there’s no tomorrow, and having the government grow and mushroom and impinge in every direction on the economy. You can’t have easy money and a central bank that is flooding the system with cheap credit and excess liquidity. You can’t have a government that is really anti free market, which is what trade protectionism is all about, and he’s the biggest protectionist in the White House, you know, since, I don’t know, Hoover signed smooth Holly in 1931 so all of his policies were really in the wrong direction. Now, I do concede in the book that the one abiding virtue that Donald Trump has is he’s got all the right enemies. Okay? The establishment hates him, The New York Times, The Washington Post, CNN, The Washington what I call unit party establishment, the leadership and the long standing careerist of both parties can’t stand him, but basically, it’s because he’s an outsider. Because he’s unwilling to conform, and he’s pretty obnoxious and unpredictable. That’s why they’re against him. The point of the book, though, is none of his power his policies were wrong, even if he had the right enemies, and nothing that he did help the economy or addressed the huge long term problems we have of a runaway public debt, of a government that’s way too big and too costly and too intrusive, and especially at the heart of the matter a central bank that is out it’s a rogue central bank. It’s out of control, and yet Trump was constantly on their case, demanding even easier money, lower interest rates, even more, you know, of the same that got us into, you know, the huge bubbles and troubles that came from them. So the point of my book was to say he had a chance. He’s got a four year record, we can look at it as terrible. It offers nothing in terms of remediation of our great problems and putting us in a different direction for the future. So, you know, don’t waste the opportunity. And you know, that’s about where I come out,

Gene Tunny  06:20

right? Oh, okay, so you write about what you call the Donald’s reckless fiscal and monetary policy. So we might talk about fiscal first. Now, among other things, you talk about the most grotesque act of fiscal malfeasance in American history. So that was something that Trump was associated with you argue, are you talking about the the big tax cut, the Trump tax cut in 2017 is that? Is that something you see as as reckless? That’s

David Stockman  06:51

part of it. But I’m looking at the overall picture and the data, the big top line data on spending, and borrowing on the public debt. Now let’s just take it down to the core metric, which is the public debt. I mean, if you’re running huge deficits and spending far beyond your willingness or ability to tax, it comes out in the public debt. When Trump became president in wrong terms, the public debt was about 20 trillion. When he left, it was 28 that’s 8 trillion of growth, 8 trillion of debt, public debt in four years. You let me ask the question, when did when did we get the first 8 trillion of public debt, and how long did it take us to get there? The answer is, in 203, it took us 216 years, 43 presidents, to rack up 8 trillion of debt. He did it in four years. That’s kind of the bottom line. It puts it in perspective, in terms of how big the error was. If we look at other more conventional measures, you get the same picture.

Gene Tunny  08:01

Okay, so that was David Stockman, who was President Reagan’s Director of Office of Management and Budget, and he’s certainly no fan of President Trump, certainly, I mean, Trump is going to have big consequences for the economy. There’s a lot of concern about a global trade war. There’s concerns about, I mean, really, will he be able to get the the budget into shape he has Elon Musk and Vivek Ramaswamy at the Department of government efficiency. It remains to be seen how much real influence they will have and to what extent they’ll be able to to get the budget under control. One of the challenges, of course, is the the role of the entitlement program, Social Security and Medicare, which are such big parts of the budget, and just they’re on autopilot. Really, they’re, they’re demand driven. They respond to people’s needs that the entitlements are dictated by the acts of Congress, so they’re very hard to change, right? Oh, so on the the issue of getting the budget under control, I’d like to play a clip from my interview with Dan Mitchell. So I spoke to Dan in episode 235 in April, and it was about his new book, The Greatest Ponzi scheme on Earth. So it’s about us, government debt. So Dan is one of my favorite commentators. He’s got a really great blog called International liberty. If you’re not subscribed to that, definitely check it out. I mean, Dan’s coming from a libertarian perspective, someone who’s skeptical of. Of big government. So I’m generally sympathetic with with with that. So yes, I think it’s a it’s a good, good blog. So yeah, regardless of your views. So it’s definitely worth checking out because it’s Dan has a lot of good facts and talks about empirical work, empirical studies. So definitely worth, worth checking out. Even if you’re you think you’re unlikely to to agree with Dan. Okay, so let’s, let’s play a clip from my conversation with Dan, the way I set up this. This part of it was, I asked Dan about why he thinks higher taxes aren’t the solution to the US budget deficit, this large structural budget deficit they have. I made the point that, look, you’ve got these entitlement programs that the government doesn’t want to reform, so maybe the government, I mean, I was implying that maybe the there’s no choice but to increase taxes. Not that I’d necessarily recommend that. But how are they going to repair the budget? So that’s the that was the setup. So let’s hear what Dan has to say? Well, I

Dan Mitchell  11:24

guess there are two things that are important to understand. The Congressional Budget Office, every year publishes a long run forecast. And by long run that they’re looking out 30 years, they publish this long run forecast of the US economy, and in that document, the most recent one came out just last month. I think it was maybe two months ago, but it showed that revenues are above their long run average, spending is also above the long run average. And if you look at the forecast, 30 years out, the revenue burden is going to climb to record levels because, mostly because of real bracket creep. In other words, as you know, even in a sluggish growth economy, you know, people are going to sort of, their incomes are going to increase, they’re going to go into higher tax brackets. So the government winds up getting bonus tax payments with even modest levels of economic growth. So the tax burden is heading to be at an all time high, but because government spending is projected to grow much faster than the private sector, it means that that that we’re falling farther and farther behind. So just as a matter of pure math, our problem is more than 100% on the spending side of the budget. Again, revenue is climbing as a share of GDP, but because spending is climbing much, much faster. Why on earth would we want to increase taxes on the American people for a problem that is more than 100% on the spending side of the budget? But that’s just a math argument. Now let’s look at what I call the public choice, slash economic issue, which is that if you put taxes on the table. What are politicians going to do? They’re going to increase spending. And not only that, if they get the taxes through, the economy is going to suffer. Now, I’m never one to say, Oh, you raised this tax or that tax, there’s going to be a recession. I worry more about if you raise this tax or that tax, the long run, growth rate will decline, and even if it only declines a small amount, maybe two tenths of 1% a year, that has massive long run implications because of the wedge effect over time and then. And I think that even left wing economists, the honest ones, are going to admit that higher marginal tax rates and work saving and investing are not good for growth. So as GDP gets smaller and smaller over time, at least in terms of compared to some baseline projection, that means work on tax revenue, because there’s less national income to tax. So what’s the bottom line? Politicians will spend more money because of the higher taxes, and the higher taxes won’t generate as much revenue. And you don’t want to know what the most powerful evidence for this is. I think I did the data for the for the 15 countries of the old European Union. Other words, the core Western European countries that would be most analogous to the United States, or, for that matter, Australia, you know, relatively rich by world standards, Western oriented nations, and what did I show in the European Union? You go back and I did a five year average. So nobody could accuse me of cherry picking just one year that was favorable to my analysis. I did a five year average for the last half of the 1960s and I looked at government spending as a share of GDP, taxes of the share of GDP, and government debt as a share of GDP and taxes. Between the end of the 1960s and the most recent five years, the tax burden in Western Europe increased by 10 percentage points of GDP. Now politicians in Western Europe, in these various countries, Germany, France, Belgium, Netherlands, et cetera, et cetera, they. Said, Well, we have to raise taxes, because we have red ink, we have deficits in debt. So I said, Okay, taxes went up by an enormous amount as a share of GDP between the late 60s and today. What happened to government debt? Did they use this massive increase in the tax burden to lower government debt? No government debt during that period doubled as a share of GDP. In other words, politicians spent every single penny of that new revenue, plus some. So when I debate some of my left wing friends, I tell them, show me an example anywhere in the world where we’re giving politicians more money to spend has resulted in better long run fiscal performance. It just doesn’t happen. By contrast, I’ve gone through the IMS World Economic Outlook Database, and I have found not a lot, unfortunately, but I found many examples of countries that, for multi year periods, had government spending growing at 2% a year or less. And what do you find in those cases when they’re spending restraint? And we talked about this, by the way, we have an entire chapter in the book where I cite some of these good examples. When you have spending restraint, deficits go down, the burden of government spending as a share of GDP goes down. You have success. Yeah, I couldn’t. We could have had some blank pages in the book and lift and entitled that chapter success stories of higher taxes, because there wouldn’t be anything to write.

Gene Tunny  16:33

Okay, that’s good stuff from Dan Mitchell, from Center for freedom and prosperity. I think it is He? He was, once upon a time, he was at the Cato Institute. He’s a well known commentator in the US on fiscal policy issues. He’s on CNBC, Fox Business, etc. And yep, he’s a he’s a good economist, and he’s a terrific commentator. And I’m really grateful that I’ve been able to have him on the show as frequently as he’s been on the show. So I’ll put a link in the show notes to to that episode and to the others that I play clips from. So yep, if you if you liked what you heard from Dan there, then definitely, definitely check out that episode. What I liked about that? I think he made a really good point about how politicians will, they will find a way to spend any additional revenue. I think we all know that’s that’s generally true. I mean, I suppose not always. There are times when politicians act responsibly, say, in Australia, from about the late 80s through to maybe yeah, I guess the Yeah, essentially, until the late 2000s we had very responsible Treasurers and governments, and then we seem to have abandoned that since then, unfortunately, and in the US, we had the period when you had Bill Clinton and the House GOP led by Newt Gingrich, they were cooperating on the budget and managed to repair the US budget. So there are times when politicians have been, have been, have done the right thing, but I think generally, they can find ways to spend any additional tax revenue, as as Dan Mitchell is pointing out. And I mean, they all the politicians. I mean, one thing you notice is that they love going to the openings of the the movies, hanging out with Chris Hemsworth and all of the the Hollywood stars. That’s something that we see here in Australia, where there’s very substantial subsidies to the film industry. Okay, so that was Dan Mitchell, thought that was a great clip. I think I’ve played parts of that in other episodes through the year on tax and government versus the private sector. I think I may have played a bit of Dan in that, but it’s good stuff. So it’s, it’s worth, it’s worth replaying every now and then. Right? Oh, let’s move on to another clip. And this is about another issue that I come back to every now and again on the show. It’s this issue of the gender pay gap. And, you know, this is a very, you know, it’s very political this issue. And there are a lot of people who say, Oh, well, it’s, you know, this is terrible, and it’s an example of discrimination, is exploitation. Then other people say, Well, hang on, it’s, this is a multivariate, uh, phenomenon, and it’s, it’s due to the the industries that. Women work in, or the occupations that they choose, but then you get the counter argument. Well, hang on, those industries and occupations, they were imposed upon women, in some cases, or women by the, you know, the patriarchy, or gender norms, etc. So there’s a big debate about the gender pay gap that I’ve tried to cover on the show in an objective way. So just hearing all of the arguments and just thinking critically about what the data, what the evidence tell us, and one of the people that I’ve really valued talking to about the gender pay gap, is Leonora Reese, and she is a an associate professor at University of Canberra. She’s also an expert panel member for the Fair Work Commission, and that’s the federal body that regulates industrial relations in Australia, and earlier this year, in March, I interviewed Leonora about a new gender pay gap report that the federal government released, and that generated a lot of debate within Australia. And I was just alluding, well, I was just going through what some aspects of that debate are, the the question of whether you’re comparing like with like, etc. There was a criticism of the report that was very strident by the well known economics commentator for the Australian, very good economist, Judith Sloan. And that is, that was, that was how I set up this part of the conversation with Leonora. I mentioned that that article by by Judith, which was critical of that report. So that is the context for this. This part, this clip in which Leonora and I talk about this notion of greedy jobs. So greedy jobs, this is one possible explanation for part of the gender pay gap. So let’s hear from Leonora. I want to ask about Claudia golden because Claudia golden, she won the Nobel Prize for Economics last year. Judith Sloan quoted her work in so in Judas article and Judith because Judith is saying, Well, this is all nonsense, because this is just all Yes. You’re not comparing like with like. It’s it’s all just explained by difference, differences in composition, different choices people make, and she was interpreting Claudia golden. So this Judith is interpreting Claudia golden as saying that the gender pay gap, it’s mostly due to the fact that there’s this premium for long and unpredictable hours, and men are more likely to work those jobs, pursue that pursue those jobs because women are more likely to be carers and they don’t have the Yeah, they they’re more Yeah, they’re less likely to want to pursue those jobs like as males, pursue them so disproportionately. So what do you think about that as a theory. I mean, what? And because I only were chatted about Claudia Golden’s work before or since the Nobel Prize was announced. So would you be able to comment on that? Please?

Leonora Risse  23:51

Sure, absolutely. So Claudia Golden’s the concept that she’s coined here is greedy jobs to reflect these particular jobs in the workforce that demand a lot of you as a worker to work long hours, to be on call, on weekends, on late shifts, and to be rewarded for that. That’s the important part. So to be paid overtime rates, to be fast tracked your promotion, to get bonuses in reward for for being, I guess, more available to your employer. I think it’s partly a symptom of capitalist society as well. You know, to really, to really draw as much of the worker that you can out in terms of their time, their loyalty, their commitment. And so Claudia Golden’s work brings the gender dynamic into that. This concept brings the gender dynamic into that, because the way that society and policy is structured is that it forces couples, if we’re looking at a male and female couple, to make a choice. Services with as a household as to which of them are going to be that particular worker and be on call, and which of them are going to attend to caring responsibilities, to household tasks at home. So collectively, they’re maximizing or optimizing their total income and trying to balance, you know, both both spectrums. So the way that gender norms give rise is that it tends to be, on average, the male partner who will put their hand up for those greedy jobs, and females who who would opt to, you know, be on call at home, basically. And so the gender pay gap widens, even on an hourly basis, because this, there’s this premium attached with those types of jobs, and they’re rewarded, you know, it’s, it’s seen as a positive thing in workplace culture. And so the my, you know, the way that I interpret Claudia Golden’s work, and she articulates this, I think, pretty clearly in her book, career and family, is that unless you have gender equity at home, it’s very hard to achieve gender equity in the paid workforce. So as long as there’s some sort of gender division at home, you just don’t have that time availability in the paid workforce. So she’s actually advocating for for gender equality. She’s not saying this rationalizes or legitimizes the existence of the gender pay gap. She says it’s a an explanation that needs attention and that we should be looking at. How do we look for ways to reduce this culture of expecting workers to be working such extensive hours and to be on call? How can they be more substitutable with each other? So you know, if you’re not available, it doesn’t matter, because your colleague can step in, and she gives examples from the industry of pharmacy, the pharmacy industry, where that that is, is a change in cultural practice, and that allowed more women actually to advance in that industry. So her, you know, the action or the policies that emerge from that are ones that start to address that existing inequity in the system and steer us towards something that’s more equitable, and I would say, also healthier as well. Now, other people might interpret that differently, but I think that’s a very, very firm and widespread way of expressing Claudia Golden’s work. I did write a book review of her book, and it’s published in the economic records. Yeah, I’d be very pleased for people to have a read of that and see what, see what they think of the points that Claudia golden has expressed. And of course, yes, she did. She was awarded the Nobel Prize in Economics in recognition of decades and decades of work looking at women’s participation in in the workforce, and how that has changed over time from an historical perspective right up to contemporary time. So she is a big advocate and champion for working towards a more gender equitable economy.

Gene Tunny  28:35

Okay, so that really gives you something to think about, doesn’t it? Least, that’s what I thought. I thought that Leonora is explanation of the concept of greedy jobs and how you interpret that in a policy sense. So Leonora summary of what Claudia Golden’s position is. I thought that was, I thought that was very good. So I will put a link in the show notes to that episode. I’ll put a link to that, that book review of Golden’s book that Leonora wrote, and it was in the economic record. Hopefully it’s not pay wall, but it may well be which you would be disappointing. But anyway, I’ll look into that, right? Oh, we should move on the next two clips for this highlights episode, they relate to the theme of the environmental impact of economic activity, so we’re looking at environmental issues. And you know that if you’re a regular listener, you you’ll know that I speak with a wide variety of guests on the show, with a wide variety of opinions. I mean, often in stark COVID. Contrast in opposition, and this is certainly the case on environmental issues, or at least the issue of how much we should be concerned, how much we should sacrifice the economy, economic growth for protecting the environment. Of course, I think we all want to have a clean environment, and we want to protect the environment as much as we can. At the same time, we want to make sure we have a thriving, prosperous economy that keeps people employed, that provides high living standards. So there certainly is some trade off. So I’ve had, I had two really good conversations about this trade off, as I see it, this this year, at least two really good conversations. One of them was with Marion tupy, who’s a, he’s a senior fellow at the Cato Institute. So that’s a a leading economic think tank in the US. It’s, it’s on the well, you’d say it’s a libertarian or classically liberal. And Marion co wrote a very interesting book that came out last year called super abundance, and he has a very optimistic view regarding our impact on the planet. So I’m going to play a clip from my discussion with Marion earlier this year. Okay, so let’s listen to that. I’m very sympathetic to the argument about about super abundance. Can I ask? Is this a continuation of the work that Julian Simon has done is this because I see on your CV or your buyer, you’re part of something called the Simon project. Could you tell us what that is and whether this is continuing his work? Yes,

Marian Tupy  32:15

yes. Yes, absolutely. So Julian was a, obviously, a huge inspiration, but so he was actually a senior fellow at Cato before I joined the Cato Institute. He died in 1998 but he was senior fellow there, so we never met. But what I wanted to do back in 2017 is to look at his work and update it, you know, to the present and I found that his bet with with Ehrlich, he would still win. In other words, commodities continued to get cheaper, at least the ones that Julian looked at. But I was using the old methodology. I was just looking at real prices of commodities. And my co author, Gail Pooley, got in touch with me, and he says, well, let’s turn them into time prices. Let’s look, let’s look at the price of commodities relative to wages, how much more you can buy for an hour of work than your ancestors could. And then we published a paper in 2018 with this new methodology. And indeed, we found, once again, that Julian was right. And then we decided to turn into a book which goes back to 1850 and basically what we find is that commodities, relative to wages, are constantly getting cheaper. If it’s a long enough period, everything is getting cheaper, including gold. The only thing that continues to become more and more expensive over the centuries is human labor, essentially the human input, and we might as well talk about Simon and early quag, yes,

Gene Tunny  33:46

yes, yes, yeah, please.

Marian Tupy  33:48

So Julian Simon, since we mentioned him, he was an economist at the University of Maryland, here in the United States, and he was basically looking at the data, and he was noticing that things were getting cheaper, even though population was expanding whilst over in California, at Stanford University, Paul Ehrlich, who is still alive, he’s 93 years old now, was predicting doom and gloom. He was basically saying, you know, as population increases, we are going to run out of everything, and there’s going to be mass famine. And, you know, starvation of hundreds of millions of people. And so they had a bet between 1980 and 1990 on the price of five commodities, nickel, tungsten, tin, chromium and copper. And basically they made a futures contract for $1,000 and when the period came to an end in 1990 Ehrlich had to send a check for $576 to Simon, because commodities became 36% cheaper. Had Simon implemented our methodology, he would have won even bigger. He would have won by about 40, 42% rather than 36

Gene Tunny  34:55

very good. Okay, so. I must say, always do enjoy hearing or reading about that Simon Ehrlich wager, because it’s a reminder that we should generally be skeptical about predictions of doomsday. I mean, you know, certainly it could occur. I’m not going to be naive, but generally, I think, you know, we’ve got, you know, multiple predictions of of Doomsday, and maybe we should just think more rationally about these things than we are or than we have been. So I thought that was a very good clip. So really grateful for Marion his appearance on the show. I think Darren Brady Nelson connected me with him. So thanks to Darren. And yes, I’ll put a link in the show notes for that episode too. Also, having listened to that, I was reminded, I’ve been reminded that I did a podcast episode, or I recall I was on the principle of charity podcast, which is hosted by Emile Sherman, who is a very distinguished film producer. He produced The King’s Speech and lion. And also, I was surprised to see the other day, I was watching one of my favorite new shows, which is on Apple TV, slow horses, the show about MI, five agents in in London with Gary Oldman, love that show, and Emile is one of the executive producers I was on his podcast. So Emil hosts that and also Lloyd vogelman. They have a really interesting show. They like to have guests with opposing point of views, points of view, and the idea of the principle of charities you’re supposed to, you know, steel man, the opponent’s argument, or under try to understand where they’re coming from. So have a good, you know, think that have the go into the conversation, assuming they’re acting in good faith and give them the respect that they deserve. And so look, I think it’s a, it’s a novel concept for a podcast, given how most podcasts are, so I think it’s, it’s interesting. I’ll put a link in the show notes so that that that was a conversation on degrowth. And, yeah, that was something that, yeah, that yeah, that was an interesting experience that I had earlier in the year. So I’ll put a link in the show notes to that, right? Oh, now for someone with a different take on how we’re we’re going environmentally and going to Well, the the other guest I’m going to feature in this highlights episode is Daniel vert Daniel lossy from Vertis group. And Daniel is based in Omaha, Nebraska, and that becomes highly relevant, as you will notice in this in this clip that I play, and I really enjoyed talking to Daniel, his company does a lot of very interesting work. So they work with organizations such as Seattle Aquarium, and they’re helping to make those organizations more sustainable, helping them meet their or get on the path to meet their net zero goals? So he’s someone who’s a practitioner, and I thought he had a lot of really valuable insights. Okay, so now I will play a clip from Episode 242 helping Seattle Aquarium and others go to net zero and beyond. So that’s from May this year. I hope you enjoy this clip. Before we go, I’ve got to ask given you’re in Omaha, and this is a economic show. Do you ever see Mr. Buffett around town? Have

Daniel Lawse  39:25

I seen him? Personally, I don’t think I have, but I’ve been in one of his favorite restaurants before, where he eats pretty regularly. And you know, we host the Berkshire Hathaway every single year. So see all of the the tourists who come in for that, the shareholders who come in, and my wife owns a little tea shop, so that always gets a little bit more business during those Berkshire days. But I’ve not bumped into Warren myself. Personally, that’s

Gene Tunny  39:53

okay. I just Just thought I’d ask given when, when people hear Omaha, they’ll think that, you know, that’s often the. First thing, rightly or wrongly, people, people, people think of in their minds, particularly if they’re in economics or finance. So just sort of ask,

Daniel Lawse  40:08

well, on some levels, I think Warren’s actually a pretty sustainably minded person. We can argue lots of other things, but here’s the example. I drive past his house on a regular basis, right? He does not live in a gated community mansion. He’s lived in the same house, I think, for over 50 years, and he’s done some upgrades to it and at a few additions, but it is a very what I would call a modest house in a nice neighborhood of Omaha, but like probably hundreds of 1000s of people drive past this house and would never know it’s even his.

Gene Tunny  40:42

Wow. So the fact that

Daniel Lawse  40:44

he doesn’t go and just consume and build a big house because he has the money and he could, and I don’t, I don’t believe he owns that many homes, or second homes or third homes. He owns a couple different locations. But there are some people who have a lot of wealth, who own a lot of homes that they travel and vacation to. So in that regard, he’s making a sustainable choice by living in a in a modest house that he’s had for decades, and maintaining it and regenerating it. Perhaps we might, if we want to throw that in there, instead of tearing it down and creating something new and bigger.

Gene Tunny  41:18

Oh, it’s, that’s a good story. I mean, he’s embodying the, you know, the virtues, or the the the high point, or what’s the right word to describe it. He’s in, he’s embodied. He’s embodying those, the real great values of capitalism, or where it’s about saving and investing. So, so that’s terrific. Good last. Yeah, make it last. Good on Warren Buffett, very good. Okay. Daniel Lawson, this has been a great conversation. Any final points before we close?

Daniel Lawse  41:49

I love your questions. Gene, I think it’s so important to be aware of how we think, because it really does matter. And there are four critical shifts that I see at play, and all the sustainability work that we do, and I’ve talked about, probably all of them, but shifting our mindset from a closed system to an open system, right? We’re not alone in this world, and so let’s acknowledge the impact that other organizations and communities and businesses have on us, the shift from like this mechanistic worldview to a living and dynamic world, view like Change is the only constant thing in life, and when we recognize that I’m a living being, and organizations are made up of humans, so we’re more living. We’re more like a garden that needs nurturing and tending than a business as a machine that you just take a part out and replace it, right? Let’s, let’s humanize our organizations instead of dehumanize them. The third is the shift from really feeling like and thinking like we’re separate from everybody else, and shifting more to this interconnected way of being, recognizing that my actions have impacts on you, whether intentionally or not. When we do an organizational policy, it can shift things in good ways, unknown ways and unknown ways. And then the last one is the short term thinking, the long term thinking. I’ll end with this. The seventh generation principle comes from the Iroquois nation, the first peoples of the US or of North America. I apologize, and they said the decisions that we make for our community, we need to think about, what is the impact going to be on seven generations, which, you know, it’s about 150 years. You can’t even predict that far out, but it forced them to think about, what’s the long term impact of the decisions they made at Council. And I, I challenge your listeners to imagine a world where their elected presidents, council members, representatives, didn’t think about the next election cycle and being re elected, but thought in seven generations, what would be different? Yeah, and what would be different if our business leaders weren’t thinking about quarterly profits, short term feedback loops, and instead thought forward seven generations, what? How different would our businesses look, and how different would our communities be if we had leaders who were thinking in seven generations, changes everything in, I think, pretty good ways.

Gene Tunny  44:10

Okay, so that was Daniel lossy, who is the Chief century thinker at Virtus group in Omaha, Nebraska. So they do environmental consulting work all over the US. So yep, I’ll put a link in the show notes to that episode. I think it’s definitely worth a listen. And I think Daniel has some Yeah, really interesting. And yeah, really interesting, interesting perspectives that make me think and Yeah, certainly saying things that that are challenging to economists. Okay, final clip, this episode and this. This clip is from the episode that a. According to Spotify wrapped. So Spotify wrapped is the summary that Spotify puts out every year, and it’s actually what inspired me, in a way, to do this episode. According to Spotify rap, the most listened to episode of my show in 2024 at least on Spotify, was episode 236 the housing crisis in and immigration Australia’s tough choices with John August. So it, it may well have been the most listened to episode because John’s very good at sharing and, you know, material, and he’s got a good network. John has a radio we had a radio show in Sydney on radio Skid Row in Marrickville, and he’s heavily involved in the Pirate Party. And I’ve had John on the show several times, and if you’re a regular listener, you’ll probably appreciate that he always has very interesting and well thought out things to say. So he no longer has a radio show. He’s had to step back from that and but, but he’s will still be able to hear from him. Next year, he’s going to be putting out a podcast, and I look forward to catching up with him, either on this show or on his new podcast. So once I find out more about that, I’ll, I’ll pass on the details. Right? Oh, the clip I’m going to play is, again, it’s from this episode that on housing and immigration. And these are really big issues in Australia at the moment. I mean, we had that huge surge in immigration post COVID And there’s a lot of debate about, to what extent is immigration driving the housing crisis that we’ve had? To what extent is immigration behind the the economic challenges we face? And there’s a lot of talk about the per capita recession, the decline in household living standards. So yep, if you’re in Australia, you’ll you’ll be well aware of this debate. And I suppose it’s a debate that is occurring in in many, in many economies around the world. And certainly immigration was was one of the issues that that swung the election in Trump’s favor. That was the view that Darren expressed on my show, and I’ve heard others express that too. Okay, so let’s play the final clip, and this is from my conversation with John August on housing and immigration.

John August  48:06

Well, keep in mind, I think I’ve already said this, that I do not believe that, you know, just reducing immigration is going to be a magic one. We have to, in some sense, aggressively pay catch up on our infrastructure. And another thing I’ll point out is, I don’t know what it’s like in Brisbane, but certainly in Sydney, you’ve got the issue where you’ve got the rich suburbs, and the people who are like the nurses, the fire is the police officers, the people doing cleaning, the people doing whatever. Can’t afford to live there, so they’ve got to basically travel all the way across Sydney, and they’re putting a needless load on the road network that doesn’t really need to be there. And for the rest of us that are not in that situation, we’re obviously coping with congested roads. So you know, for me, that’s a side effect of that sort of asymmetric wealth distribution. And one of the things that may be happening in Brisbane, I know some councils in Sydney are looking at getting into public housing, not in a grand sweeping way, but key worker accommodation. This is, this is accommodation that will be there for the police officers and their families, for the nurses and their families, for the fireies and their families, and perhaps for the cleaners and their families that are actually servicing that area. And, you know, you’ll basically have to say, look, either I have a job or I will be getting a job in the area, and I’m in one of these professions, so the council will then give you some subsidized place to live. And, you know, that’s interesting, that councils are even contemplating doing that. I mean, I mean, I guess this is a, this is sort of a guess. It’s a bit of an issue around infrastructure and housing. I guess a few steps from New from your original question. But never mind. Can’t help myself.

Gene Tunny  49:49

I can understand the logic of it. So I’ve seen that in in rural towns in particular. So you’ve got a visited a potato process. Facility in one of the Riverina towns, and they actually own some houses in the local town, so that they’ve got places for the I think, you know, the migrant workers who come in to work at their processing facility, so they’ve got somewhere to live when they’re when they’re in the area. So I can see the logic of that and why it might make sense for some councils to look at that awesome. Well,

John August  50:24

I know that, you know, just traveling around country towns, it’s interesting when there’s some sort of development, and all the tradies have taken all the motels or or there’s some sort of running festival or something like that. You by golly, you know, you notice it when you, when you go to a country town thinking, Oh, this is just a quiet, sleepy country town. There’ll be lots of vacancies at the motel and, well, there aren’t anyway.

Gene Tunny  50:49

That’s very true. Okay, I want to go back to those numbers. So migration program. So there are in the permanent migration program. So remember I talked about how our net migration has been running at about 550,000 Okay, the permanent Migration Program, which is what you’re talking about, which is refugees, or the family reunions and skilled migration, that’s set at 190,000 places. So that’s just a fraction of the total net overseas migration, and a big part of it are students over foreign students come in universities. And also the, you know, students who stay on, they get an extension, so they do a degree, and then they stay here for a couple of years after that. And you know, some of them will have work rights, and they’ll be, they’ll be in our labor force. So I’ll end you know, a lot of it is that, and so we’ve got this big temporary migration number. So I’ll put a link to Leith post in the show notes, because I think it’s a nice summary of all of the relevant data. We’ve got around 700,000 student visa holders in Australia, but in terms of temporary visa holders. So that could be students, their families, people who are who did a degree, and then they’re still staying here. That’s at, is it 2.2 to 2.4 million people? So depending on whether you use the so there’s a quarterly, seasonally adjusted number, that’s about 2.3 million. It looks like. And I’ll put that in the show notes. So is

John August  52:23

that that at the moment, or per quarter, or per year, or what do we what are we saying here? Yeah,

Gene Tunny  52:28

that’d be at the moment. So that’d be the stock of them, yeah, at a point in time, yeah, yeah. And so we’re well above where we were at COVID, and you could argue that we’ve actually, you know, so some of the people will say, Oh, actually, it’s just catch up and we’re just on the same trajectory. Okay, maybe so. And this is something that Leith addresses here, and his his point is that, well, okay, this, this argument. The he refers to a tweet from a bull. Is it a bull Rizvi, who was a former immigration bureaucrat, where he was saying, Oh, look, we’re just we’re actually where we would have been if we were on the same trajectory pre pandemic. And then so Leith goes risby arguments ridiculous, because the pandemic completely constipated the supply side of the housing market by sending material costs through the roof, sending builders bus so you were talking about this before John and reducing building capacity by months of lockdowns, deliberately engineering a record immigration rebound into a supply restricted market was the height of idiocy, and is why we are suffering from the worst rental crisis in living members.

John August  53:37

Well articulated position, I suppose I’d have to think about it much more carefully to say, look, is it right or is it wrong? But it sounds very reasonable on the face of it. You know, prima faci is the legal people would say. But my broad position would be, look, we were playing catch up on infrastructure before, if we’re actually going to get some breathing space, we’ve got to have a commitment to catch up on infrastructure at the same time as we limit immigration, so we can actually get ahead of the curve. Because I think a lot of this, this silly bugger games of like, here’s a development will divert some of the benefits from that to building infrastructure that’s not getting ahead of the curve. And like, look just a bit of an anecdote from like, history of Sydney is way back when our first rail lines went out of Sydney to service the farmers, okay? And that was why they were built. So if you wanted to build a settlement, you know, 10 or 20k is out of out of the city center, or what would have then been the city center, you just build a railway station on some part of the railway track, and boom, boom, there’s the start of your community, your infrastructure has led your community, rather than the infrastructure coming sometime later, based on some deferred payment schedule, you know? So you know where, where? Yeah. I mean, Lisa van Olson may well have a good point. I’m not going to disagree with it, but my position is we were paying catch up. Four, and if we’re going to be serious about playing doing actual, proper catch up, then we can’t just do business as usual like it was however many years ago. So, but, but, yeah, he may well have a good point there.

Gene Tunny  55:13

Okay, so that was John August from my episode on housing and immigration. So yep, if you liked what John or I had to say in that clip, then Yep, and you haven’t listened to that episode, then please check it out. Okay, so as you’ll as you’ll gather. I mean, we cover some fairly controversial issues on this show, and I appreciate that you know these are issues that people may well have different views from me on, and I’m happy to hear other opinions. Happy to hear your perspectives on these issues. So yep, if you’ve got any any thoughts positive or negative, or get in touch. Let me know whether you agree, whether you disagree. What do you think about these important issues that we’ve covered today, so issues or about the environment, about housing, immigration, the gender pay gap and the US budget and what the return of President Trump means for the US and for the rest of the world. Please feel free to get in touch. You can email me at contact, at economics, explored. I’d definitely love to hear from you. I want to know what you’re interested in. I want to know how I can improve the show so I can continue this go. I can continue the show. I can make it even better and make it make it a really strong show. In 2025 so we’re, we’re getting very close to the new year, right? Oh, again. Thanks for listening. I hope you enjoy it, and I hope to catch up with you in a future episode. Thanks you.

Credits

Thanks 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 and other podcasting platforms.

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Podcast episode

Uncertainty and Enterprise: Harnessing Imagination and Narrative  w/ Prof. Amar Bhidé – EP264

Professor Amar Bhidé of Columbia University discusses his new book “Uncertainty and Enterprise”, published by Oxford University Press. It emphasizes the limitations of standard economic models that rely on probability distributions. He argues that entrepreneurship involves dealing with unique, non-quantifiable uncertainties, which require imagination and narrative skills. Bhidé critiques the over-reliance on incentives and statistical analysis, advocating for a more imaginative and contextual approach. He highlights the importance of routines and the need for accountability in expert decision-making, particularly in areas like public health and monetary policy. Bhidé also discusses the role of narratives in business success and the challenges posed by tech monopolies.

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

About this episode’s guest Professor Amar Bhidé

Professor of Health Policy and Management at Columbia University Irving Medical Center

Bhidé has researched and taught about innovation, entrepreneurship, and finance for over three decades. He now focuses on teaching, developing, and disseminating case histories of transformational technological advances.

A member of the Council on Foreign Relations, a founding member of the Center on Capitalism and Society at Columbia – and a founding editor of Capitalism and Society, Bhidé is the author of the forthcoming book Uncertainty, Judgment, and Enterprise (Oxford). His earlier books include A Call for Judgment: Sensible Finance for a Dynamic Economy (Oxford, 2010), The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World (Princeton, 2008), The Origin and Evolution of New Businesses (Oxford, 2000) and Of Politics and Economic Reality (Basic Books, 1984). Starting in the early 1980s, he has written numerous articles for the Harvard Business Review, the Wall Street Journal, the New York Times, and The Financial Times. He has periodically appeared on Bloomberg TV and CNBC.

Bhidé was previously the Lawrence Glaubinger Professor of Business at Columbia University and the Thomas Schmidheiny Professor of Business at Tufts University. He has also taught at Harvard Business School (as an Assistant, Associate, and Visiting Professor)and at the University of Chicago’s Booth School of Business.

His professional experience includes directorship of a FTSE 100 company. In the 1980s, Bhidé was a Senior Engagement Manager at McKinsey & Company, a Proprietary Trader at E.F. Hutton, and served on the Brady Commission staff, investigating the 1987 stock market crash.

Bhidé earned a DBA and MBA from Harvard Business School with High Distinction and a B. Tech from the Indian Institute of Technology (Bombay).

LinkedIn: https://www.linkedin.com/in/amar-bhide-8202ba10/ 

Timestamps for EP264

  • Uncertainty in Economic Theory and Practice (0:00)
  • The Role of Imagination in Economic Decision-Making (6:44)
  • Narrative and Storytelling in Entrepreneurship (15:01)
  • The Impact of Narratives on Markets and Investment (25:29)
  • Challenges of Regulating Tech Monopolies (32:34)
  • Accountability and Expertise in Governance (41:04)
  • Building Narrative Skills for Entrepreneurs (48:31)
  • Final Thoughts (52:14)

Takeaways

  1. The Distinction Between Risk and Uncertainty: Frank Knight’s distinction highlights that risk is quantifiable, but uncertainty involves unknowns, requiring judgment and imagination.
  2. The Importance of Narrative in Business: Entrepreneurs use storytelling to make ventures plausible to investors and stakeholders, even when data is incomplete or speculative.
  3. Imagination is Key to Profit: Success in entrepreneurship often depends on the ability to imagine scenarios, adapt to setbacks, and create compelling business models.
  4. Challenges of Accountability in Modern Institutions: Bhidé critiques the lack of accountability among experts in fields like public health and monetary policy, advocating for more robust governance structures.
  5. The Role of Plausibility in Decision-Making: Investors and entrepreneurs alike rely on plausible, if not always precise, projections to guide business choices.

Links relevant to the conversation

Amar’s new book Uncertainty and Enterprise:

https://www.amazon.com.au/Uncertainty-Enterprise-Venturing-Beyond-Known/dp/0197688357/ref=tmm_hrd_swatch_0?_encoding=UTF8&qid=&sr=

Corralling the Info-Monopolists (Project Syndicate Op-ed):

https://sites.tufts.edu/amarbhide/2018/05/14/corralling-the-info-monopolists-project-syndicate-op-ed/

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Transcript: Uncertainty and Enterprise: Harnessing Imagination and Narrative w/ Prof. Amir Bhidé – EP264

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. This was then looked over by a human, Tim Hughes from Adept Economics, to check for clangers that may have been misheard by the otter. 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.

Amar Bhidé  00:03

Whoever gave you the right to turn price stability into inflation stability? That may be the right thing to do, but that is a political decision, and our politicians certainly did not give you that right. But it’s sort of too complicated. We don’t understand public health, we don’t understand monetary policy, you know. And either we can sort of go the way of abolish the Fed, or abolish the FDA, or we need to figure out mechanisms by which there is more accountability, both into what the or the actors of power do and how the these actors are held to account.

Gene Tunny  00:46

Amar Bhide. Welcome to the program.

Amar Bhidé  00:48

Thank you. Pleasure being here.

Gene Tunny  00:50

It’s good to be chatting. You’ve written a fascinating book on the topic of uncertainty and enterprise, and this is something that economists think about, you argue that they may not have been thinking about it the right way. So I’d like to chat with you about that. I’ve had John Kay on the program to talk about his book Radical Uncertainty before, so this is certainly a topic I want to want to explore. To begin with can you tell me please, what motivated you to write this book, please Amar?

Amar Bhidé  01:27

I was given Frank Knight’s book, Risk, Uncertainty and Profit by a very wise dean in 1990 so that’s approximately what, a long time ago shall we say, 34 years ago? I was teaching entrepreneurship at Harvard business school at the time, and I was utterly captivated by the construct, and I had not seen that in any of my doctoral studies. Mike Jensen was a very popular figure on campus at the time, and he and most of the other economists were emphasizing incentives, and entrepreneurship was beginning to get some traction, and it was being seen almost entirely through the frame of incentives and that frame assumed that people knew what was the right thing to do, and they might simply lie about it, or they would slack off, or they would cheat. And in my observation, the problem not just with entrepreneurship but with everyday life, is that we don’t know, even in the most mundane activities, we don’t know we don’t know, what tie to put on, we don’t know what to order in a restaurant, and yet we must act. In entrepreneurship this problem becomes much more acute because it’s typically a relatively new a new enterprise that we are attempting, and so we have even less knowledge the the evidence at hand might give us a clue. It might tell us whether it’s something seems worthwhile or not, but beyond the seems to be to the action, the there’s a big gap, and even more so when you cannot act unilaterally, you have to persuade somebody else to come along with you, and that somebody else may, of course, worry about your your honesty and your truthfulness, but equally, that person would worry about whether you’ve gotten it wrong, whether you’ve made a bad judgment. That seemed to be, to me, to be, to be an absolutely central problem of economic life, both in entrepreneurship and beyond. And Frank Knight’s book, the construct that he offered, seemed like an excellent way forward, but Knight’s construct never caught on. Ironically, the book became famous because of his analysis of an economy where there is no uncertainty. That was the bit that was assigned to economic students at the London School of Economics, and the main part of the book, which is the significance of fairly mundane activities, like a business person deciding whether to expand his or her factory or not, which are which are not novel per se, but they are unique. They are one offs. The consequence of these problems was never properly taken up. Knight himself did not carry it forward. And I think Knight did not do full justice, or even half justice, to his construct. And he was principally interested in trying to explain where profit arises from in a highly theoretical sort of way. And yes, it’s important to know what the underlying sources of profit are. And I frequently tell my students, who I teach entrepreneurship, that if you could have a statistical calculation of the profitability of an enterprise that you could rely on, there would be no profit in the enterprise. Fair enough. But there’s much, much more to it than that, and that’s been a preoccupation of mine since roughly 1990 so it’s been a long time, and it’s been pretty much in everything I’ve written since 1990 and so I have tried in this book to connect a large number of dots, and these dots are invisible to standard economics because they’re not part of the theory. And if it’s not part of the theory, then why would you observe those dots? And if you don’t observe those dots, why would you even attempt to connect them. So I offered a preliminary sketch of what some of the important dots are and a preliminary sketch of how they might be connected, in the hope that it would be taken up and this monomaniacal obsession with incentives can be put aside.

Gene Tunny  06:41

Right? Okay, so there are a few things I want to ask about there, so you talk about standard techniques, so are you thinking of, well, all you have to do is to you mentioned this statistical or probability distributions. Work out what’s the, like attach a percentage probability to different outcomes happening, and then work out what the expected value of your course of action is. Is that what you’re talking about? Okay.

Amar Bhidé  07:07

Yes and the only place where imagination comes in standard economics in this activity, is to imagine what the probability distribution would look like if you don’t have data, that is the only way in which imagination is kind of allowed in through the back door, but it is always in the service of imagining a statistical distribution.

Gene Tunny  07:33

Yeah, and so Frank Knight distinguished between, famously distinguished…. So Frank Knight professor at University of Chicago in the 30s and 40s, distinguished between risk and uncertainty where risk can be quantified, it’s odds, as in a casino. And then he also talked about uncertainty, which is what you’re, you’ve been following, you’ve been exploring what that all means. And then what economists ended up doing was relying on models, which took the risk part of it and tried to look at how businesses, how agents in the economy, households, how they function given these quantifiable risks that they face and their expectations of of the future. Yeah. Right okay.

Amar Bhidé 08:22

So they, so they, I mean Milton Friedman, who was Frank Knight’s doctoral student, famously said we saw no reason to distinguish between risk and uncertainty. And as long as you can imagine a probability distribution, what did it matter whether something was a one off or not,

Gene Tunny  08:43

yeah, yeah, gotcha. And can I ask you about this? Your, the class, so at, you’re teaching entrepreneurship at Harvard Business School, you were wondering about, well, the you know that you were thinking, well, there’s part of the story is being missed here, have you, how have you brought this into your teaching? How has and how do students receive it? So like, what guidance do you provide to students now about how they should be thinking about entrepreneurship? If there’s your are you arguing that you move away from the like, stop thinking about it so analytically and start thinking about it more imaginably. Is that? Is that the argument?

Amar Bhidé 09:25

Analysis or reasoning, let’s call it more broadly, is not antithetical to what I try to teach and, but reasoning or analysis is, is a compliment to imagination. It’s not a substitute for imagination. So I have used what is at the back of my mind very, very lightly in my classes, because I think my students rather instinctively understand that life is not about probability distribution. Most of us understand that life is not about probability distributions. We we don’t behave like that. And so it’s sort of like an interesting observation to the lay person, they sort of raise their eyebrows and say, so what? Of course, that’s true, and the teaching comes into play into trying to understand what one actually does when, what are the kinds of questions one asks when one does not have a probability distribution? So for example, one of my colleagues used to ask the question, what, how good could it be if things go right, right? That’s not, that’s not a probability. That’s that’s an imaginative exercise. Just to ask, how large is the pot of gold at potential? How potentially large is the pot of gold at the end of the rainbow? What do you have to lose if things don’t go right, what has to happen in in order for things to go right? What could go wrong? So these are so you try and spur your students to think imaginatively, but not fantastically. So if you say this is the size of the pot of the gold at the end of the rainbow, we say, why? I mean, how large is the market? How large could the market be? How have similar ventures panned out? So you give them a series of heuristics, which substitute for statistics. And I have never seen honestly a venture capitalist use a probability distribution to evaluate a new venture. This does not mean that they go in blind by by any means. They are extremely thorough. They are thorough to a fault. But what they are emphasizing contextual facts. What did so and so experts say about the prospects of this technology? What did the, what reservations did the three potential customers I talked to have about it and then putting it all together, do I think that what I can potentially make from this and the likelihood that I will outweigh the the loss that I would suffer. With enormous effort, one could, I suppose, map all this into a probability distribution but no one ever does, and it would be a phenomenal waste of time for people to to attempt to do it.

Gene Tunny  13:23

Yeah, yeah. Exactly.

Amar Bhidé 13:28

The other thing, which I which I emphasize in in the book which Herbert Simon was not remembered, neither for being the father of AI nor being for his Nobel in Economics, had, was really on the right track, where he says routines are vital and how things are decided has a profound influence on what is decided. And I’ve taken it further to say one can then ask, what makes routines more or less reasonable? When do they become pathological? And when given and given the challenges at hand, are they reasonable? And then I argue that the the reasonableness of a routine must depend on what the stakes are, that when the stakes are very large one wants strict routines. Be it in business, be it in criminal trials and complexity also requires rigorous routines so if you are planning a hit and run guerrilla attack, then your planning routine is going to be much more superficial, shall we say, than planning an attack on the, planning the invasion of Normandy. And then how novel things are so if things are truly novel, then your routines cannot, it’s again a waste of time to spend too much time and effort in trying to analyze what could or could not happen. So so we have not, in economics, given we haven’t given attention to all these things, which are a constellation of dots, routines, imagination, story-like discourse, uncertainty, incompleteness of information.

Gene Tunny  15:07

Yeah, yeah. Um, there’s that book by Robert Shiller on, I’m trying to remember, is it Narrative Economics?

Amar Bhidé 15:16

Yes.

Gene Tunny  15:17

I think Shiller is making the argument that you know, these stories, these narratives, can have macroeconomic consequences, so I’ll have to cover that on the show in the future.

Amar Bhidé 15:28

Bob is a dear friend. I’ve known him from the time since, again, the early 90s when, and curiously, Bob is a, is himself an entrepreneur. I don’t know if you knew that, but…

Gene Tunny  15:46

Yes, yeah, the Case-Shiller Index do you mean? Shiller Index?

Amar Bhidé  15:50

The Case-Shiller Index and he’s tried various things, and so he is a very forward-looking, optimistic person, when it when it comes to markets, however, he’s deeply pessimistic about the stability and and when, when one talks about financial markets, one is really talking about largely about aggregates and about collective behaviour and Bob’s, Bob’s emphasis in his narrative economics is about the dysfunctions of storytelling and how bad stories get around. They create irrational uncertainty or irrational exuberance, and then infectiousness causes booms and busts, and that may very well be true. I am much more interested in the more micro effects of stories, and the more micro stories that an entrepreneur might tell her potential customers or might tell her potential investors, and to some degree, these stories have a common base in the mythology of entrepreneurship, but nonetheless, each story is fairly individual in its in its details, and it is, one could imagine markets where people were reasonable and were not carried away by by crazy stories, but I cannot imagine an entrepreneurial world where there was not some kind of story-like discourse. They’re not actual stories. But let’s let’s not go there. And so I’m looking at the positive side of story-like discourses or narrative-mode discourse, Bob is looking at the pathological consequences.

Gene Tunny  18:03

yeah, yeah, yeah, no, that’s a that’s a fair distinction. Can I ask about, well, I’ve got a couple, I’ve got a few questions about these narratives. So I just want to understand what your your hypotheses or your contentions are. So I mean, can I take out of this that, given the uncertainty with any well, with many business ventures, then often the best guide is just, you know, you can do all the number crunching you like, but once you get in, you know you’re running the business, that’s not your forecast can be, I mean, we know they could just be way out. I mean, you may think it may take a few months before you make a profit, but it can take 12 months or you never make a profit or something. I mean, you could just be completely wrong. And so therefore, it’s, the number crunching with the spreadsheet may not be as useful as just trying to get an intuitive understanding of what the overall market is, what the trends are, having a, you know, telling the story, figuring out what the story is, and then with investors too. Is it, do you is there any evidence on what moves investors to people to invest in startups? Is it, is it more the story than the numbers?

Amar Bhidé  19:22

So I think there’s pretty good I think there’s pretty good evidence that they do not do not [inaudible] values to any meaningful degree, unless they are investing in real estate, which is a stable business where you can wherever you have some hope that you can predict the probabilities. They certainly don’t do probability distributions. But let me roll the tape back a bit to what you just said, about crunching spreadsheets, and I’ve taken that this is always an instinctive feeling of mine, but I was, it’s crystallized by reading a, a psychologist called Jerome Bruner, who draws a distinction between narrative mode discourse and logical scientific discourse. And where he says, in logical scientific discourse, what we, the ultimate yardstick is, is proof and truthfulness. And in narrative mode discourse, the criterion is plausibility. People are really looking not, not for something that is true, because you mean you don’t know what is true, you will not even know what is true, but you’re asking the question of whether something is plausible or not, given what the upside is and given what the potential downside is, and the kind of narrative mode discourse in its structure tends to vary depending on what the stakes are and what the novelty is. So if you are a venture capitalist who’s putting 10s of millions of dollars into, into a venture, you’re so you’re not simply, I mean, at least in normal times. I mean, we are not now, not necessarily living in normal times with AI, but in normal times you want a lot more evidence, with the understanding that that evidence has to be woven together through an imaginative process. So in my view, even a spreadsheet with made up numbers is an aid to this narrative mode discourse, because everybody knows the numbers are made up. And I mean, no serious investor believes that these numbers are going to be what they are, but what those numbers in the spreadsheet can give you a handle on is how deeply has the person who constructed the projections thought about the business. Are the assumptions of how many salesmen will be required to get $200 million in sales, and plausible or not? I mean, has he or she even thought about the need for salespeople? And then there’s sort of a very subtle aspect to this, which actually John Kay’s assistant pointed me to, which I thought was very clever indeed, that a very detailed, imaginative plan is a good indicator of when things go wrong, as they inevitably will, whether the person who proposing the plan has the imagination to adjust, because, again, you are going to need imagination, you will not, you will not be able to deduce in any logical way or in a evidence-based way what the right thing to do when you encounter a setback. And so there is a lot to be said for for made up numbers, for made up facts, and in many cases, without these made up numbers and made up facts, people just won’t believe you. So it’s the example I give is of historical documentaries. Why do they? Why do documentary filmmakers, or even Hollywood movies, why do they go to such trouble to have period costumes and period, you know, period sets and so forth, because people are more likely to suspend disbelief if they are taken to a place where they know that, you know, of course, you know that these are all actors, and that these costumes came out of some designers closet, but the fact that somebody went to so much trouble and that they that they resonate, gives a certain set of plausibility to the movie. And this is exactly the same situation, I believe, with with businesses, or, I don’t know if you’re a fan of of murder mysteries?

Gene Tunny. 24:36

Oh yeah, yeah, yes.

Amar Bhidé  24:38

So they usually comes a point at the end where the detective says, Well, let me tell you a story, Mr. So and So suspect, you know, and the so and so happened, and so and so else happened, and so and so else happened. And he’s making it up. And sometimes, if that story is approximately correct. The suspect crumbles, and then making it up also carries the audience along.

Gene Tunny  25:07

Yeah, yeah, absolutely. I think you made a good point about when you present the numbers or the business case, it shows to the what extent they’ve thought about how the business is going to operate, and then have they thought about what would happen if things go wrong? And you know, the potential to pivot? And I think there’s a like, there’s a lot of useful examples of businesses that have had to do that. I think even, I think YouTube originally started out as something different, didn’t it? Was it? Did it start out as a dating site or something like that. I know there are all sorts of examples like that, I might have to dig up a few…

Amar Bhidé  25:45

Well, I’m not sure about YouTube but the interesting thing about YouTube is that, was, that it was the first enterprise of its sort to have been launched, and the first to actually, and I think we’re both old enough to recall MySpace,

Gene Tunny 25:59

oh yeah,

Amar Bhidé  26:00

which was the the predecessor to Facebook and now called Meta and Meta’s, so we live in a world where no amount of evidence is going to provide us with a truly reliable guide to what is going to happen. A taste in business.

Gene Tunny  26:21

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

Female speaker  26:26

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 modeling 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.adeptecconomics.com.au, we’d love to hear from you.

Gene Tunny  26:56

Now, back to the show.

Now, beyond the obvious examples like Steve Jobs and Elon Musk, who do you think best exemplifies, or is a good example of what you’re talking about here, the the ability to use the imagination and to tell the story. Do you, are there examples that that you use with your students that you find valuable?

Amar Bhidé  27:20

Most of my cases are, I have not stopped teaching entrepreneurship, so I should make that clear as well. But most of my cases are about not celebrated entrepreneurs. The case studies themselves include examples of little, shall we say, tales that they tell to…, these, these are often extremely simple tales. And these are not the most famous entrepreneurs in the world. I mean, all their spreadsheets are tales. All you know, all the the description of of why, I have a case study about someone who started a restaurant in, in the then reviving area of Boston, which was urban reconstruction plan, and there was nothing that it was. It was a crime-ridden, blighted urban neighborhood, and the sale was to say, Oh, look at what happened in Station Square and in San Francisco. And there may be half a dozen reasons to to protect and say, Oh, San Boston is not San Francisco, you know, it’s and it’s different and but it can resonate with sufficient people’s imagination that they say, okay, you know, we understand it’s not San Francisco, but it worked. There’s a great deal of what one would call modest copycatting, which takes place in in business. And so you see something that has worked in place x or a=in application y, and then you say, well, we’re going to be the Uber of Rose delivery, you know? And so who knows whether you will or not, but by invoking the story of Uber, by invoking the story of Airbnb, that immediately gives the in the audience’s mind something to anchor their imaginations to. And so I mean, indeed, without imaginative analogy, I literally cannot imagine how you would, how you could sell anything to anybody. Likewise, if you say, This is my product, and the customer says, Well, why should I buy from you? Why don’t I just buy the old product? So because my product does this, this and this, and no one knows for sure whether it actually does this, this and this, if you can touch it and feel it, but, but you have seen the other, you see this, and your mind makes a bridge between these two things, and the bridge seems solid enough to warranty what could go wrong. You could try to walk over it.

Gene Tunny  30:50

Yeah, when you talked about, like, how businesses are saying this is the Airbnb of this, or it’s the Uber of that, I mean, one thing I remember, I thought in, well, I’ve heard that in Hollywood often. I mean films. I might have heard this on Tim Ferriss’s show or read it in one of his books. But he talks about how there’s like when Speed was pitched the movie Speed with Keanu Reeves and Sandra Bullock, they pitched that as Die Hard on a bus, if I remember correctly, just really it’s like that sold it, that’s quite clever.

Amar Bhidé  31:27

And the challenge in all these things is that if things are exactly identical, then people would say, Why do I need you? But if they are so different that the imagination, doesn’t go along, then you’re in trouble too. So for example, when I pitched this book, when you read a proposal for a book, you have to say, what other books in the market are there, which are like your book, and why is this different? So you have to answer two questions, what is what is the similarity, and what is the difference? And neither is actually quantified. When, when you write an economics article, you sort of say there is this and this and this literature before us, and I am going to do this, which is similar to, but somewhat novel, with, compared to what has come before, and, oh, by the way, nobody obviously knew any probability distribution of whether this is true or not. So…

Gene Tunny  32:39

Yeah, yeah, can I ask about you mentioned, how profit is the reward for dealing with uncertainty? Do you have any thoughts on a lot of the excess, I mean, there’s a lot of concerns about, well, monopolization, or, I guess, the concerns about techno feudalism and surveillance capitalism that are increasingly common concerns about the power of big tech and its ability to exploit, it’s the advantages it has, some degree of lock in, arguably, some degree of anti competitive practices. Do you have any thoughts on that? Whether, I mean, we should see the huge profits that they’ve earned as a reward to the entrepreneurs grappling with uncertainty?

Amar Bhidé  33:39

I tend to be a lean libertarian, shall we say, right? And my, my sort of pure libertarian answer would be, of course, these are just rewards for the risk that they took and but I don’t personally believe that, and I also, there’s a great deal of luck, but what bothers me so much is not the magnitude of the profit. I mean, I think that is a serious issue, but the distribution of labor, income and profits in the economy, and why it has gone in the direction it has gone, but that’s not my thing. I’m not a macro economist, but on, I’ve actually written a piece on corralling the techno monopolists, and I think there are very serious issues about the capacity of these very powerful companies to lock you in. Now I don’t happen, as I argue in this book, I don’t think nothing, I think nothing is forever. That, and that all monopolies eventually crumble under their own weight, because they keep trying to expand, and in the process of expanding, they lose their vitality and they become sclerotic. But I’m not sure I want to wait till they till they collapse under under their own weight. And I think there is, we live in a society we, property is again socially-defined properties, the rights that go with property, are also socially defined. We agree as society, what what is, and we argue about it. We argue about whether the oil rights underneath have lot, or off land are ours, they can be sold to somebody else. And whether air rights have value or not, whether my neighbor can put up a hideous eyesore, and whether I have the right to band together with my neighbors to prove it, there is no question that that even property rights, there’s nothing sacrosanct about them. One has to look at them in a pragmatic sort of way, and looking at them in a pragmatic sort of way I think the issues of privacy, and I worry as much about people having data which they make a mistake on, as much as they actually know what they’re doing and mess you up. And I mean, I I worry about my identity being not just stolen, but being lost somewhere and and so I think there are, there are issues about regulating business conduct which fall outside the standard problem, which monopolists and of the early 20th and late 19th and 20th century worried about, which is profit margins. I think profit margins are the least, least of it. I think acceptable conduct is, is something we need to discuss as a society. And I think again, there’s this problem is so new that we are there’s [inaudible] uncertainty involved, shall we say, in regulating this conduct. And I will again take my since I say in my book that routines are just absolutely crucial. In the reasonableness of routines are absolutely crucial, I don’t think we have developed a set of political or political economy routines to deal with issues of such conduct, and because profit is an easy construct for people to understand, and sort of it can sort of say well, but these issues of of privacy and uninformed consent, or, shall we say, sort of roughly forced consent, these are so complicated, and there are only a few people who can even understand them. And I fear that our politicians have just too much on their hands to engage their minds with what they should do, and then they delegate these issues to experts, and the experts pretty much take over. And when the experts take over this creates a backlash and and then we get to see the populist hatred of experts, which is, in some cases warranted, in some cases not warranted. So we are in the intersections of technology and its reasonable regulation thereof are vital. I mean, I teach at a school of public health. I mean, we have not come to terms with trying to figure out what, we don’t even have figured out what the appropriate goals for public health should be, because there’s a lot of uncertainty, both about means and ends, and we don’t know who we should delegate this, these issues to, and how we should delegate, we have failed in the regulation of monetary policy, we’ve basically given 12 of people extraordinary power. We have told them, in in in the law, that their goal is 0% inflation, and they merrily tell us, no, we’re going to we’re going to have a 2% inflation target. I’m just gobsmacked, if you would pardon the phrase that nobody calls them on it, whoever gave you the right to turn price stability into inflation stability. That may be the right thing to do, but that is a political decision, and our politicians certainly did not give you that right, but it’s sort of too complicated. We don’t understand public health. We don’t understand monetary policy, you know? And either we can sort of go the way of abolish the Fed, or abolish the FDA, or we need to figure out mechanisms by which there is more accountability, both into what the or the actors of power do and how the these actors are held to account.

Gene Tunny  41:13

Yeah, absolutely. I mean, I know it’s outside the scope of your book, so I better not open up a, we better not go down that, that rabbit hole. But it’s fascinating.

Amar Bhidé  41:24

Well I’ve actually discussed some of these things in my last show.

Gene Tunny  41:27

You do? Oh, good, okay, oh, sorry, yes. And what are your recommendations for, for how we deal with it? The, get this greater accountability?

Amar Bhidé 41:36

I think we need first of all, a conversation. I mean, the Federalist Papers were a grand and durable view of the world, which have done remarkably well in standing the test of time. But we need something, we need people like Hamilton and the founding fathers who were not experts, but who had a broad view of how how government should operate. Given that, as one of the Federalist Papers says, How does one have a government for people who are not angels, and how does I mean, the modern question is, how does one have I mean, when we have technology, we have uncertainty about its consequences. No one knows. We then delegate responsibility for managing that uncertainty to experts. But then we have ceded so much control to these experts that they, they become, they become a law unto themselves. And we desperately, badly need a conversation about, I mean, sort of, it’s all very well to say property rights and well maintained property rights lead to more prosperity. Then that’s fine, but there’s a Nobel prize which was given for that. But one needs to get to a much finer level of detail about property rights, about the rights of of experts and how they interact and how they’re held accountable, and the world were not such an uncertain places, would not be an issue. The only problem was incentives. Then we could in some way construct incentives for for experts to do the right thing, or for politicians to do the right thing. And no, do they make mistakes? And sometimes they make well meaning mistakes, sometimes they make self serving mistakes. Often, these two things interact.

Gene Tunny  43:56

Yep, yeah, absolutely. I mean, a colleague of mine, I don’t know if you’ve if you’ve come across this concept of sortition or citizens juries. A colleague of mine, Nicholas Gruen, and is a big advocate for those. He got a write up in, he got mentioned in Martin Walls book on the crisis of democratic capitalism, about that?

Amar Bhidé  44:16

No, I’m afraid I have not read that. What does he say?

Gene Tunny  44:19

Well he’s arguing that one of the ways that we get greater accountability or better decision-making is if we have randomly selected panels of citizens that provide advice or, I mean, maybe in some cases, make decisions, but certainly provide advice on recommended approaches to a legislative body or to an executive government. After they have, ah they go away for a few days, and they have different experts present to them the like the case for and against and they can, they’ve got their own sort of powers to to call in other experts and and ask for data and evidence. So it’s, it’s an interesting concept that where you’re trying to draw on that wisdom of crowds of of ordinary people, it’s that whole thing, you know Bill Buckley’s line about how he’d rather be governed by the first 1000 names out of the Boston phone book than the faculty at Harvard University.

Amar Bhidé  45:19

Yes, I think I mean, in some sense, town hall governance was, replicated the kind of juries that you described citizens juries, but they worked when your problems were confined to what happened in your town, and it’s, it’s and where the degree of technical complication was somewhat limited. When one gets beyond that, one, one has to think creatively. And I think perhaps one needs new institutions like the, like the citizens theories one may need, one may need think tanks that get their hands, shall we say, a little more grounded. The problem with think tanks and a lot of schools of policies that they deal at this very high level of abstraction, like economists, which is what is the most general principle that we can think of? Because the more general it is, the the more acclaim we will get as scholars. And they all want to be scholars, rather than how do we think about the plumbing?And the pump, the plumbing is enormously complicated, but there is very little reward or status for dealing with the plumbing. So it’s so you know, the the Fed has several 100 economists. They, many of them wish they were university economists, and they try to publish in, in journals which are respected academic journals, but the problem the Fed faces, as much as anything else, is the plumbing problem. And when nobody seems interested in that or this, there seems to be a lack of interest and accountability for the for these issues. So we have experts who are willing to go and deliver advice to third world countries by the World Bank and the IMF, but we don’t have solar experts who will look within and in a in a cool-headed sort of way, I hesitate to say objective, because I have already spoken at something about the need for imagination, but in a reasonable sort of way, shall we say, look at how one deals with these issues.

Gene Tunny  48:21

Yep, just finally, because we’re coming close to time, I really appreciate this conversation. This is, yeah, it’s all fascinating, because certainly given me a lot to think about. Can I ask about, like, storytelling, narrative? Do you give advice, or do you have thoughts on how people who aspire to be entrepreneurs or people in MBA classes, how can they build up their narrative skills? Is that something they should work on their storytelling skills? Do you have any thoughts on that?

Amar Bhidé  48:49

Let me distinguish between narrative and storytelling, because entrepreneurs do not, in the most part, tell stories. That’s what novelists do, because the story needs to have a surprise. A story needs to have an unexpected Reversal of Fortune. But narrative, like discourse, basically assumes, I mean, you at least have to pretend that you’ve thought of everything, and therefore there will be no surprises. Now both, both sides know that it isn’t true, no, but I think the the building blocks are fairly simple. It’s the it’s the degree of imagined detail. So detail helps. We cannot simply say, Oh, I’ll figure it out. In some cases, it may work, but and at that point, you need both detail that is imagined and yet plausible. Uh. You need good metaphor and good analogies. I mean, not necessarily flowery language, but very, you know, equivalent. And then you need sort of the old stuff that, Aristotle talked about, which is ordering of how you present your ideas and and I I often find that, forget storytelling, but simply describing what they what they expect to do and why in some kind of orderly, comprehensible way eludes many people. So either they get they get sunk in the swamp with so much detail that they lose their listener, or no detail, detail at all, in which case they’re implausible. So finding the balance and the rule of three, for example, is such a powerful rule in so many, I used to work at McKinsey’s, and we were thought, we made arguments, and, you know, and it was quote, unquote, fact based, but it was never entirely fact based. It could not be fact based, but there was, there’s a structure to what everybody did. And it was called the pyramid principle. And it was not far from the Aristotelian idea of the rule of three, the idea of a situation, a complication and a resolution. So there are templates, and increasingly, I think we have the the audio-visual tools that make our stories compelling, you know, and we sort of, it’s, this is now an old story, but this is when when the founder of Starbucks was pitching Starbucks, he had videotapes of of cafes and in Italy, and so you could imagine what a cafe might look like, even if you had not seen one. And and this was again, narrative-mode discourse. Story-like not necessarily, and it is so easy now. So that’s how I put pictures in my book. You’re not supposed to put pictures in in a in a scholarly book. But I said, why the hell not?. I mean, if it helps the reader along, and I do have a fairly complicated argument, why not help them all you can?

Gene Tunny  52:54

Yeah absolutely no, I agree. Well, this has been terrific. So your book, Uncertainty in Enterprise, it’s published by Oxford University Press. It’s got 2025 on here. So it’s coming out early next year is it?

Amar Bhidé  53:08

No, no, it was released on Friday.

Gene Tunny  53:12

Oh it’s already out. Oh, great. So it’s been released.

Amar Bhidé  53:15

So it was released on Friday you can go to Amazon, and you can download a Kindle version immediately, and you can order a hardback.

Gene Tunny  53:24

Oh, brilliant. Well, I’ll put a link in the show notes to that, and I’ll also put a link to, you mentioned you had an article on corralling the tech monopoly,

Amar Bhidé  53:35

Coralling the info monopolist. I don’t know whether that’s behind a paywall or not. That was in Project Syndicate.

Gene Tunny  53:42

Ah right, okay. I’ll put a link anyway. I’ll try to track it down, right?

Amar Bhidé  53:50

I think it was a couple of years ago. Are you based in Australia or here?

Gene Tunny  53:52

Yes, I’m in Australia. I’m in Brisbane, in Australia.

Amar Bhidé  53:57

So what time is it?

Gene Tunny  55:00

It’s 7:30am so I’ll probably go back. No, it’s not too bad. That’s why I generally, there’s a window when I can connect with people in the States, early morning here, afternoon, like East Coast can be hard sometimes, but generally, like West Coast, is a lot easier. But most of the people I end up talking to are in they’re either in New York City or DC.

Amar Bhidé  54:25

All the windbags are on the East Coast, on the west coast are the doers.

Gene Tunny  54:32

Well that’s very good. Well, however, I found this really fascinating. Good luck with the sales of the book. And I really, yeah, it’s good. We, I liked how you you’re able to connect or distinguish your contribution, like your thoughts, from, say, Mervyn King and John Kay and also from Robert Shiller. I thought that was a, that was interesting learning about that. And, yeah, you’re right about how…

Amar Bhidé  54:58

And they’re all friends of mine by the way, so it’s..

Gene Tunny  54:59

Very good.

Amar Bhidé  55:01

There’s no hostility at all involved in that so…

Gene Tunny  55:05

Very good. Okay. Well, thanks so much for your contribution. I really enjoyed the conversation.

Amar Bhidé  55:10

Pleasure.

Gene Tunny  55:12

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.

Obsidian  55:59

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Podcast episode

Elite Networks: The Hidden Driver of Inequality? w/ Dr. Vuk Vukovic – EP263

Dr Vuk Vukovic, economist and founder of Oraclum Capital, joins Gene Tunny to discuss elite networks, their economic impact, and the future of democracy. Delving into his research, Dr Vukovic examines how political connections affect income inequality and corporate success. He shares his innovative Bayesian approach to predicting financial and political trends, offering a glimpse into his hedge fund’s methods. The episode also tackles the dangers of centralized political power and explores solutions for empowering communities and fostering trust in democratic institutions. 

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

About this episode’s guest Dr Vuk Vukovic

In brief: an academic and practitioner

​Academic…

  • Oxford PhD, LSE Masters, Harvard, Berkeley
  • 5-year university teaching experience
  • Published in top journals, published a book (@Oxford University Press) => Elite Networks
  • Expert member of Parliament committee

Practitioner…

  • Running a hedge fund in NYC, Oraclum Capital (ORCA), based on our scientific innovation in network theory 
  • Before that, founded two companies: market research consultancy & boutique rating agency
  • Macro-based trader & investor for over 10 years (learning by doing: lots of mistakes, lots of helpful lessons).

Timestamps for EP263

  • 0:00 – Gene introduces Vuk and his work on elite networks and Bayesian analysis
  • 3:54 – Vuk explains how they use social network analysis to identify “super forecasters”
  • 7:47 – Vuk discusses the performance of his hedge fund Oraclum Capital
  • 9:29 – Vuk goes into more detail on their social network survey approach
  • 12:54 – Gene and Vuk discuss Vuk’s thesis on how political connections contribute to inequality
  • 20:21 – Discussion of Lina Khan and potential risks of Trump-Musk connections
  • 25:02 – Vuk discusses how corruption and concentrated power can lead to poor economic outcomes
  • 33:30 – Vuk outlines recommendations for decentralizing political power and re-empowering citizens
  • 39:13 – Vuk’s final thoughts on the role of elites and the need for system design to channel their influence positively

Takeaways

  1. Elite Networks Drive Inequality: Dr Vukovic’s research shows that corporate executives with political connections earn significantly higher salaries, fueling income inequality.
  2. Bayesian Analysis Enhances Forecasting: Dr Vukovic argues his approach improves financial and political predictions by weighting opinions based on network diversity and historical accuracy.
  3. Centralization vs. Decentralization: Dr. Vukovic argues for reducing centralized political power to lower inequality and enhance democratic processes.
  4. Democracy’s Resilience: Whilst acknowledging current challenges, Dr Vukovic remains optimistic about democracy’s ability to adapt through trial and error.

Links relevant to the conversation

Info on Dr Vuk Vukovic:

https://www.vukvukovic.org

Elite Networks book:

https://www.amazon.com.au/Elite-Networks-Political-Economy-Inequality/dp/0197774237

Oraclum Capital:

https://oraclumcapital.com/

Lumo Coffee promotion

10% off Lumo Coffee’s Seriously Healthy Organic Coffee.

Website: https://www.lumocoffee.com 

Promo code: 10EXPLORED

Transcript: Elite Networks: The Hidden Driver of Inequality? w/ Dr. Vuk Vukovic – EP263

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. The transcript was then looked over by a human, Tim Hughes from Adept Economics, to see what mischief the otters had been up to and to correct some of the things they might have missed whilst splashing around in the river. 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.

Vuk Vukovic  00:03

So you mentioned Musk before, just to briefly return to that. So the danger here would be that he would use because he’s not elected, right, the Trump administration, Trump is so it would be a danger if Musk uses his political connection to get favorable business decision for his companies, subsidies for Tesla, subsidies for his other companies, or, you know, preventing regulatory inquiries into his businesses. So that will be something that has a potential danger in terms of, you know, exploiting the system to your benefit.

Gene Tunny  00:35

Hello and welcome to the show. This episode, I’ve got a great guest to tell us all about elite networks and his Bayesian approach to analyzing financial markets. It’s Dr Vuk Vukovic, PhD, CEO and founding partner of Oraclum Capital. Vuk, welcome to the program.

Vuk Vukovic  00:57

Thankyou, Gene, thank you for having me. Pleasure to be here.

Gene Tunny  01:01

It’s good to have you on you’ve you’ve been doing some really fascinating work it appears, you’ve got your own hedge fund, and that’s come out of your Bayesian analysis of, I think it’s social networks, isn’t it, and that informs your financial market analysis. Can you tell us a bit about that please?

Vuk Vukovic  01:18

Yeah. So the network analysis is kind of the underlying, let’s say, motivational factor. But there are two different things, right? One was so the book came out as a part of my PhD thesis from Oxford, where I did use sort of network analysis to kind of look at relationships between politics and the corporate world and how it affects certain economic outcomes, in this specific case, the impact of income distributions, right? So I found that people, so corporate executives that are more connected to politicians tend to have much higher salaries than same corporate executives that are not connected to political executives, right? And this causes a very significant increase of, it explains a very large part of the rise of income inequality in the West in the past 40 years. So that was one that was kind of the academic thing, whereas the whole fund was basically that started on a also an academic paper, but it was something completely different for us, of me, me and my two my two partners and my two colleagues back then now partners in the fund looking at specifically how bubbles, social media bubbles, help us better explain and derive better signals from people making predictions right? So we use this with elections, specifically in 2016 with the Brexit referendum and the Trump election in 2016 got both of them really, really accurately. And then again, Biden, later on, Macron and a bunch of other things, and the underlying so again, the underlying factor, the underlying mechanism, is network analysis, but we used it to try to figure out which people are better at making predictions. Right? Because in our surveys, when we do a survey, not every person is valued the same way. Some people are better than others, and we’re using network analysis to figure out which people are better. So for example, if you’re in a cluster and like an echo chamber, then you’re very likely to be biased. Right? Either, think of it, elections, right left wing bubble, right wing bubble. You’re only surrounded by like minded people. You only see one version of reality. You’re own, right? But if you’re more heterogeneous groups, meaning if your friends who you hang out with in social media, if your friends are some of them are left wing, some of them are right with wings, some of them are centrist, then you have a higher probability of being right about an election outcome, right? Doesn’t necessarily mean that you’re right, but you have a higher probability. So what we basically do is we weigh people’s opinions based on the probability of them being more or less accurate. That’s the whole the whole approach,

Gene Tunny  03:54

Right! Okay, and are you scraping this data from Twitter, from or X or various different social media sites?

Vuk Vukovic  04:02

Yeah. So we started on Facebook back in 2015 like in 2016 before, before the whole Cambridge scandal, after that, and Facebook was no longer an option, but so we continued on Twitter and LinkedIn, mostly

Gene Tunny  04:15

LinkedIn, Okay, gotcha. Yeah, that’s interesting. So, I mean, what’s what’s interesting is, potentially, I’m part of your sample, and so are listeners of the podcast around the world. So I think that’s fascinating.

Vuk Vukovic  04:31

Yeah that’s the idea. We want to get it as diversified group as possible, so diverse decentralized opinions. That’s that’s the whole point. I don’t want clusters. I want people from all around, doing different things,

Gene Tunny  04:41

Gotcha, and what’s what’s your acronym? Is it based on Bayesian? Can you tell us a bit about that, please. What’s that stand for?

Vuk Vukovic  04:50

Yeah so we named it the Bayesian Adjusted Social Network Survey. Bayesian adjusted is because we asked people two questions. The first question is, what you think is going to happen? For example, who’s going to win an election, or, in case of markets, where the market is going to be by the end of the week. And the second question is, what do you think other people around you think, what’s going to happen? Now, when you get to that second question, that’s where the Bayesian element kicks in, right? Because we noticed and we did this initially, when we we were trying out this methodology, we tested on students, all three of us, myself and my two partners were academics, right? I have a PhD in economics. My partners have PhDs in physics and computer science, and we test some students by asking them to predict their test scores. And then later we did with elections, again, an experimental setting, right? So we give some some of them a question, some of them we don’t give a question, the second question. And we notice when we give the second question, the question of, What do you think your friends around you are going to do? That kind of encourages you to go back to your previous question and reverse it, or, you know, and be more accurate that way. It’s it forces you. It’s kind of, you know, Bayesian and you have a prior posterior probabilities. You, you adapt, you update them. That’s the whole idea.

Gene Tunny  06:03

That’s fascinating. And as you get into this, how did you identify this topic, and who was your thesis advisor? And I mean this, I mean this is very original work. It’s sort of not the standard sort of thing economists would look at, at least as far as I’m aware. So how did you get involved in it, and who was your advisor on it, please Vuk, I’m interested.

Vuk Vukovic  06:23

Again this was done before. So the whole thing, the network thing, analysis for the Bayes on right, what I mentioned was done before I went to Oxford. That was 2014/15. I went to Oxford, 2016 So, and this was done by myself and my two colleagues. As I mentioned, one is a computer scientist, one is a physicist, and we wanted to publish this as a paper, right? We were aiming to publish it like Nature or Science, but once we saw how good it was, we decided not to publish it, and we decided to monetize it instead, like, let’s make some money out of this. It’s very precise, right? It gives us really, really accurate results for whether it was like testing on students or when we did actual elections, it was really precise. But the thing to answer your question, so my PhD supervisor was Ben Hansel. he was a professor at Oxford. Really great guy. I But the research I’ve done there is a bit different, right, that was focused more on, like, the political outcomes of, you know, corporate and political connections and economic outcomes of corporate and political connections and its impact on inequality. So that was a bit different. That’s where the book came came out from. But again, as I said, like the underlying the common factor is network analysis,

Gene Tunny  07:37

Gotcha and you’re Oraclum Capital. So where’s that based? And I mean, how is it performing? Can you tell us a bit about that, please, before we talk about your book?

Vuk Vukovic  07:47

Absolutely So Oraclum Capital, it’s a hedge fund based in New York, and it’s performing really well. So we opened the fund in February 2023. Before that, I did almost two years of testing it, I had my own account. I took $20,000 of my own money and brought it up to 54 in over a year and a half. And we were doing this in a newsletter. So people were following us, and I was literally posting like screenshots. I bought this and I sold it so as to get like credibility from people. And once that was that happened, so we decided to launch the fund in February, we started with about 2 million AUM, and by now, by November, 2024 we’re up to 25 million, where performance has been about 56% since inception, gross return. So net is about 45 something like that, net return per investors. So pretty, pretty good.

Gene Tunny  08:38

Yeah, yeah, yeah. And again, this is for, like, on your website, this is for accredited investors. So it’s not just for, yeah, for ordinary mums and dads out there. It’s for, you know, people with significant assets.

Vuk Vukovic  08:51

Yeah there’s a minimum, we’re raising the minimum from January 1, $250,000 and yes, you have to have a status of accredited investor. Again, it’s a hedge fund. So it’s not really something that is for the retail and average retail investor, but we are planning down the line to have an ETF potentially, and that would be open to retail crowd. But that’s a, again, that’s a long term plan.

Gene Tunny  09:13

Good one. Yeah, it’s a fascinating approach. So you’re looking at, again, we were talking about it before, looking at what people are thinking in you’re scraping all this data from social networks. You’re trying to identify the people who are good at predicting and what they’re thinking…

Vuk Vukovic  09:29

Yeah and it’s and it’s all about two things, about, like, your consistency, your consistent responses. So since we have the market prediction, and that goes every week, so we’re tracking people’s performance over time, right? And it’s also about your positioning in the network. So we don’t take any data, you said, scraping. We only scrape the connections of your friends, right? And we can see your who your friends are if they also come into the survey. So we take your whole network, but we only see if your your friends, who’s friends with you, if they also come into the survey, right? We don’t have any we don’t collect any other socio economic. Like, we don’t even collect the names of these people, right? We know some of them. We reward. We give them money, right? So every quarter we reward, it’s a competition that we run. So we reward the top 20 with $5,000 for the distributed across top 20 people. We’ll probably be increasing that in the years to come. And and the whole point is, since, so since we reward them. So some of them have uncovered that they are, in fact, day traders, and they’re like trading markets, so we know their names, but this is just because we pay them the prize. Otherwise, a lot of them are even anonymous in the survey, which is fine to us.

Gene Tunny  10:35

Oh right. Okay. So you’ve got a survey, and then you you figure out who in that survey, are the best predictors based on, yeah, I guess there’s their network and also their…

Vuk Vukovic  10:47

The position in the network is number one and the number two is performance over time, right? So maybe your position in the network is like, I place you in a bubble, but you’re actually pretty good, so your performance goes up, so that means we value your opinion more, right? Yeah. And vice versa.

Gene Tunny  11:00

Yeah and one way of thinking about this, it just occurred to me, I don’t know if I’m the I’m on the right track here, but you’re identifying super forecasters, in a way. And I’ve had Warren Hatch on the show from Good Judgment. He’s worked with Phil Tetlock on the Superforecasting stuff, which is just fascinating. I think he’s in New York somewhere. He’s doing, he’s doing great work. You’ve got a you’ve got a different approach. And, yeah, sounds, sounds fascinating.

Vuk Vukovic  11:25

I read Tetlock’s book somewhere over there, right? I’ve read it, and it’s, it’s really good, and I like their approach. What we, so, yes, we do call them superforecasters, but we basically call them also our best observers, right? So people who are best at observing the environment around them. So that’s the kind of the most valuable opinion.

Gene Tunny  11:44

Yeah fascinating. That’s good stuff. Okay, I want to ask about your book Elite Networks, because I think this is an interesting thesis. It’s one that, I mean, I’ve got, yeah, I’ve got some real questions about this, because, I mean, inequality has always been with us, right? And so we understand why a significant amount of inequality exists, because there’s a distribution of talents and skills and resilience or grit across the population. And so we have people who, you know, we’ve got doctors or specialists who work, you know, ridiculous hours and have lots of stress, and so they’re going to be more highly paid. Corporate lawyers as well. But your thesis, it seems to be, is that much of the increase in inequality, if I’m interpreting you right, or a large part of the increase in inequality, particularly among that top 1% like if we look at what’s happening with income and wealth data, we do see particularly in the United States, I guess in the UK, to a lesser extent, and in Australia, to a much lesser extent, we see that top 1% or top point 1% really pulling away. And your, am I right? Your thesis is that much of this is to do with political connections. Can you tell us a bit about that? Please.

Vuk Vukovic  12:54

Mmm, absolutely. So what you mentioned is, so I’m not bothered by, as you said, like the inequality between people based on, like, unique talents and difference, again, some people are on a global market, superstars, right? On a global market, most popular singers, sports persons, etc, it’s a completely different game, right? The demand for them determines their payoffs. But what I’m looking at is, if you look at the distribution within the top 1% or even the top 0.1% which is, as you mentioned, was for the past 40 years, the biggest driver of income inequality. Is this has been shown by the inequality literature almost unequivocally when you look at the distribution within them. So there is this political effect that hasn’t been researched that much, right? So I looked at that specific issue. So he had a database of about a million corporate executives and politicians from the US and the UK. So I was totally focusing on these two countries, because that’s where I had the data from. Not a lot of data exists outside, unfortunately, even though it would be great to see that as well. So I was looking at these people, and I was trying to make the connections between who’s connected to politics among the top corporate, corporate executives. I was only looking at board members, right so C suite and board members. And I found that if you look at within companies, right, if you’re a board member that is connected to a politician, I’ll explain how we measure connections. If you if you’re connected to a politician in the United States, that means you have a salary, an annual salary higher about $150,000 from 2000 from the year 2000 in the year 2016 in the UK, it’s about 90,000 pounds, which is a very significant effect. It’s a lot. It’s a big increase in salary, right, on average. And again, so you’re looking at the tail of the distribution, and you’re looking at differences between them, meaning that some people have a much higher salary because of their political connections. The way I measure political connections is simple. I look at people who used to work together. So if you were, you know, if you’re a corporate executive, they used to work in government, or the people that used to study together. Or, and this is the most fun part, if you belong the same societies, right? So country clubs or like charity organizations or think tanks or stuff like that. Again, it doesn’t necessarily mean that these people are friends, but you can get to each other very quickly, right? So maybe, you know, you and I are not friends, but we belong to the same group, and you know, if I need to get to you and your personal power, I you know, it’s very easy for me to get to you, because we won’t belong to the same group. That’s kind of the idea. And if you have this level of connection, it shows statistically significant that it has an effect on on the increase of top incomes.

Gene Tunny  15:36

Yeah, yeah. It’s an interesting hypothesis, and there’s certainly some evidence of it. I mean, they talk about the revolving door between Goldman Sachs and US Treasury, or something like that, that sort of thing. And in Australia, we seem to have a revolving door between ministers offices and then the government relations positions in the big corporates like Qantas. And that’s become a bit of a scandal over here recently. What I’m interested though, is, you know, there’s correlation and then there’s causation. So how are you confident that this is actually a causal thing, that the political connections are what leads to the higher income or the, you know, the corporate sort of success it was, you know, higher incomes, uh, versus the fact that, I mean, if you’re in a, in a corporate, you’re, you’ve got to deal with government, right? You’ve got no choice, because government wants to get in your business, right? So you, you really have to make those connections. Can you, could you talk about that please?

Vuk Vukovic  16:37

Absolutely, that’s why I’m looking at, that’s why I’m looking at the within firm effect, right? So I’m trying to look at within firms. So you’re comparing two people that are the same level, right? One and the only difference, so there’s, you’re comparing always similar individuals, same amount of experience. So you’re controlling for like things like age, experience, the fact that they both work in the same company that has, you know, a level of connections to politics to whatever extent, and then. But the only difference between the two people you’re comparing is one is politically connected, the other is not, right, and based on it, so that’s your source of exogenous, exogenous variation, shock, right? And so because of this effect, you will see if this person’s political connections has any effect on their salary. And I found it that does, right? So the question that you asked would be, if, okay, obviously, if you look at between firm differences and yes, in some firms you’re going to have much higher salaries, and others, you can see the super the so called superstar firm effects. So obviously, some firms are more connected to politics. Look at big tech, for example, right? So they’re an example of companies that used to be that developed their business models based on economies of scale of innovation, obviously, right? Your Googles, your Amazons, your your Apples, etc. So they have this level of innovation, and this is what built their market share, right? Economies of scale as well. But then at this point, right, at this point, the life cycle of the company from innovators, they’re turning into rent seekers, because now it’s a question of preservation. Right now it’s a question of regulators trying to disrupt their monopoly positions, which, obviously they do have monopoly positions, so regulators trying to disrupt them. So what do they do? They hire former members of government to lobby the government not to do those, the legislations right? That’s how the political process works. So in that particular story, obviously, again, the between firm effect is going to be huge, which is why I look at within firms. So I go to within certain Microsoft or an apple or whatever, right across the basket of several thousand companies, and you’re looking at these connected and non connected individuals to try to see if there’s a if there’s an impact of the political connection. And it turns out it is. So again, causality is obviously difficult to prove, unless you have like, firm experiments. But this is as close as you can get to a experiment, not out of experiments. We could call it a quasi experimental approach. It’s not a real experiment, but it’s something close,

Gene Tunny  19:01

yeah, yeah, that’s interesting. I mean, there are clear, clearly, examples through history of I mean, people who are well connected politically, and that helps them out in business. We’ll have to see what happens with Elon Musk and how long his bromance with the President Trump lasts and what what that does for his business. Yeah, yeah. And then you’ve had like, someone like Donald Rumsfeld who moved between, like he was, he worked for the Nixon and Ford administrations. Maybe he was defense secretary. Then he went to Monsanto, I think, and then back to defense. So then the people like Hank Paulson, who went from Goldman Sachs, the US Treasury. And…

Vuk Vukovic  19:42

Yeah I have him in the book, right? So I have his network is drawn in the book, so you can see these connections, you can visualize them, and it looks amazing, right? I also have, like, (inaudible) saying the same impact, or Bob Rubin, who was Treasury Secretary, and then Clinton, and then went to Citigroup, and then he. He was running Citigroup during the crisis, and then got, you know, he went out of the company, got 100 and something million dollars of a bonus during the financial crisis. So that’s the kind of level, right?

Gene Tunny  20:11

Yeah yeah. Actually, he’d be a really good example now that I think about it.

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

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Gene Tunny  20:50

Now, back to the show.

I’ve got a couple of questions first, just so I don’t forget it. You mentioned big tech and the abuse of market power that is probably occurring in some cases. What do you think about Lena Khan? Do you have any thoughts on her and what she’s been doing at FTC and the and do you have any insight into what’s going to happen with the Trump administration? I mean, I imagine they’re going to get rid of her, but do you have any thoughts on how she’s been going?

Vuk Vukovic  21:20

No, I haven’t, I haven’t looked at that in particular, but, yeah, I mean, there is, there is a specific danger, because Trump is an example of a person, of an individual who is, you know, embodiment of an elite network himself, right? So this is a mixture of politics and business into one person, right? Where he has a strong business background. He’s obviously using this. I mean, again, the reason he was elected was not because of that. He transcended that, right, this whole pop, he created this whole populist image that people are kind of looking to towards as an agent of change. And that’s all fine, and well, um, but you know, if you, if you’re, the danger would happen if he would use his political power to promote his own businesses, right? Or to kind of prevent the people in government to do their own, to do their jobs in regulating and supervising, etc. Obviously, government itself is corruptible. That’s clear. You know, I’m so my background in academic research was corruption research, right? So I know a lot about the topic, and I’ve done a lot of research on that. So you mentioned Musk before, just to briefly return to that. So the danger here would be that he would use is because he’s not elected, right? The Trump administration, Trump is so it would be a danger if Musk uses his political connection to get favorable business decisions for his companies, subsidies for Tesla, subsidies for his other companies, or, you know, preventing regulatory inquiries into his businesses. So that will be something that’s a potential danger in terms of, you know, exploiting the system to your benefit. You know, hopefully it doesn’t happen. We’ll see. But yeah, if you look at kind of countries where inequality is high, you would see events like this happening, right, where you have a group of like oligarchs around the person of power, donating money or whatever, and getting back very, very concrete. It doesn’t even have to be like necessary corruption itself, but it can also be influence, right, misusing political power.

Gene Tunny  23:19

Right yeah, and on that. Do you have examples in your book of particular countries?

Vuk Vukovic  23:24

Oh yeah, yeah so, so I use, I go for, for example, I typically pick the most, like the autocratic ones, where you have these relationships, like like Ben Ali in Tunisia. That was an example of a person whose whose family directly controlled over 20% of the country right by allowing you know who gets the contract gets to do business in the country. You had a similar situation in Suharto’s Indonesia. You had Putin’s Russia, Fujimori’s Peru, for example, or Tangentopoli affair in Italy, where you had the whole government basically going down on corruption charges. This whole system buying political influence was institutionalized like companies had no other way of doing business unless they would give a bribe, right, a kickback, to the politician. But sometimes, you know this, this thing comes from the directionality. Goes from the politician to the business sector, but often it also goes from the corporates to the political level. The Odebrecht scandal in Brazil and South America is a great example of that. This was covered by the investigation Lava Jato in Brazil, where they found out that this, this huge conglomerate of a company, this construction company throughout South America was responsible for electing presidents, electing mayors, electing parliaments, right, determining political decisions, and by channeling over $800 million in bribes and corruption across the across the continent in order to secure huge, huge deals from the south they were building all the major infrastructure projects throughout Latin America. This company was building that’s a great example.

Gene Tunny  25:02

Yeah, okay, and there is evidence, isn’t there that corruption leads to poorer economic performance over time? Is that correct?

Vuk Vukovic  25:13

Yeah absolutely because it, over time, definitely because it channels the resources from like, more efficient to less efficient means, right? It channels the resources to a certain particular group, and it doesn’t distribute them, right? So this is, this is why you have, especially in developing country, this feeling where you have economic growth but the majority of the population doesn’t benefit from it, right? So only a narrow group benefits from economic growth. And when, whenever this happens, you get popular revolts. This happened in 2014 but you had the uprisings in a lot of countries, from Brazil to Turkey to Bulgaria to Ukraine over exactly that, right? So they had, like, 10 years of 15 years of progress, and the population is still relatively poor, so they’re not seeing the benefits. Otherwise, when you have economic growth, it’s supposed to pull everyone out of poverty, or at least, you know, towards the middle class and towards upper incomes, right? You had this in Western Europe. You had this United States, right? Even though, you know, we can, we can talk about different levels of inequality and different levels of corruption, but when you have high corruption alongside high inequality, then the people feel this most prominently, and that’s where where you have negative social outcomes and potential negative political outcomes. That’s where you vote for populist candidates to deliver change, right? And yeah, that’s why, it can become, it can become dangerous.

Gene Tunny  26:33

Yeah, yeah, absolutely. And I see on your bookshelf behind you, you’ve got a copy of Why Nations Fail. I think it is by Daron Acemoglu, and

Vuk Vukovic  26:41

I have all of their I have Power in Progress, Narrow Corridor, all great books,

Gene Tunny  26:45

Right. And they won the Nobel Prize this year for, yeah, for their work on what they call, I think, extractive institutions. And I think that’s one of the themes of your book, is it? So are you concerned that if this trend continues in advanced economies such as the United States, UK, Australia, that we could end up on a on a path towards, I don’t know, what sort of future are you sort of projecting if this trend continues?

Vuk Vukovic  27:14

Great question. I mean, I’m have to in the long run. I’m always optimistic, right? Because I’m aware of all the all the issues, right? Obviously, I write about them, I research about them, and I definitely agree with the conclusions from the Acemoglu and Robinson books. They were my inspiration throughout my PhD. But if you think about the way I coined, the phrase that I coined in the book is something they call the trial and error democracy, right? So you have in certain times, and this last, it can last for a decade or more, periods of what you can call error, right? Go back to the to the west, in the 60s and the 70s, right? Think of the outcomes that you had just in the United States. Right? You had assassination of the President, Assassination of civil rights leaders. You had the United States losing a war in Vietnam. You had geopolitical shocks with Iran, the revolution with Israel, the wars, right? Huge oil shocks because of that. So geopolitical tensions all around, the Cold War at its peak, right? The Cuban missile crisis, all those issues you had domestically. United States, peak racism, the KKK, all those groups. You had economics, stagflation, right? You had high double digit inflation, low economic growth, unemployment being high. A lot of economists in the West saying it’s matter of time before the Soviet Union overtakes the United States. Never happened. Why did it never happen? Because, you know, a democratic system learns from its mistakes, right? It’s not automatic, okay? So it doesn’t happen. Oh, you know, magically something appears, and we’re all better. No, you need to fight for it, right? So the way that people are fighting for it, because they ask for change, they vote for change, they vote for differences. Right now, you know, the whole Trump election was also something that people were asking for change. They were seeing something is wrong. We need, we need a change in the system. We want something better. Inflation was high, our costs of living went up, our living standards went down. We need, we need a change. So, so again, it’s, we’ll see to which extent this happens. But it’s always a question of, you know, people fighting for a better future. Maybe you need to go for a period of a slump in order to go, I mean, this is, you know, a life cycle, if you think about it, right, nothing ever goes up in a straight line. We can look at the average across the past 200 years of, you know, ever since the industrial revolution, we have amazing progress, but it always goes in cycles, right? You had the 1930s and 1940s you had disasters, right? Disastrous outcomes, the terrible war and the 19th century, you had all these issues and crises and social revolutions, etc. But you know, as we progress, it tends to be less and less, let’s say, dangerous to the system in the sense of destroying it, right? If you look at the mid 19th century or the mid 20th century, you were thinking, Oh, this is the end of capitalism, right? But so far, we’ve lived through 15 ends of capitalism and no end in sight, right? So again, the system is there is a problem, obviously. And you know, it’s a good, good thing that we can talk about this, and we can discuss this in a democratic setting. This is the only way to kind of get a get ahead. In an autocratic setting, you have pseudo stability, right? You think that, ah, you know, look at Russia, look at China. Look at all these countries. They’re great, you know, prosperity, etc. But this, this is pseudo stability, because as soon as you disrupt the leader, the system tends to fall apart. And I think, I mean, China didn’t necessarily have that. I think they are going dangerous in that direction with Xi Jinping. I think that before before him, they had his this level of where you don’t have one person dominating the system, right? You have a collective which is fine, but you know, I’m not that optimistic about I’m more or, less optimistic on China than I am on the west, to be honest, despite all the problems that we see there and that they’re evident, right? The problems were evident. But that’s the thing. You’re always going to see problems in a trial and democracy. You’re never going to see problems in an autocracy until it falls apart, and then all the problems surface. This is like classic Eastern Europe after socialism, right? Everything was fine until all of a sudden nothing was fine.

Gene Tunny  31:22

Yeah, yeah. Gotcha. Okay. Well, sorry you mean in terms of everything was fine until nothing was fine, you mean up until 1989 is that what you mean?

Vuk Vukovic  31:32

Yeah, so, so, I mean, I come from Croatia, so we went through for socialism and right in Yugoslavia, certain level of and you can, you can go most countries, okay, Yugoslavia is a bit different in some aspects. But then, you know, you had a system that was growing really strongly throughout the 60s and 70s, but then in the 80s, complete stagnation. If you look at, and I talk about that in the book, if you look at 10 years, the last 10 years of socialism in 1980s you will see in every socialist country stagnation or even economic decline. So the GDP per capita in 1980 1989 went down in almost every single socialist country of the Eastern Europe, Eastern Bloc. The reason is because the socialist model simply ran out of steam. That was it, right, you could no longer replicate the results that you had in the past. And that created these tensions that eventually brought revolutions different ways in different countries. In Yugoslavia you had the war, in Poland you had the revolution in Romania you had the revolution, in Russia things fall, fall apart, fell apart in a different way. But, yeah, it came to its inevitable end. As I said, everything seemed fine and stable, right? Growing. But then, you know, when you’re inside the system, you see that things are really not a fight, right? They’re brewing.

Gene Tunny  32:44

Yeah, absolutely. I want to ask about just coming back to how we you know, what we do about all of this so in the summary of the book, it it says that this book argues that to lower inequality and prevent incentives of elite network formation we must, first and foremost, lower centralized political power and re-empower the citizens and the community by rebuilding trust and relying on the Democratic trial and error mechanism. So we’re talking about democratic trial and error mechanism. Can I ask, do you have any recommendations, specific recommendations about the types of things that should be done to lower that centralized political power and re-empower the citizens please Vuk?

Vuk Vukovic  33:30

So that’s the last chapter of the book, and that was, that’s the only chapter that’s not empirically backed, in sense that I didn’t do research on it, but it was kind of a natural extension of, you know, the findings of the book, right, the findings of the other parts. So I’m looking at things like, so the logic is, if political power is responsible for inequality, if you lower and decentralize power and give more power back to the communities and to the people, then you essentially lower incentives for the misuse of, you know of elite misuse of power. So my ideas, and I mentioned this in the final part, elites are not something that’s inherently negative, right? Even though I might portray it as such in the book, they always existed. They always will exist. And you have a lot of elites that are actually can be beneficial for societies, like, look at philanthropism, right? It developed a number of things throughout in our cultures. But then again, right? When you when they are incentives to misuse power, when power is highly concentrated within a single individual or a single party, that’s always bad, right? And so you want that. You don’t want the concentration of power. You want the dispersion of power. That’s the element of decentralization. So the way you do this, I mean, it’s, it’s not easy and it’s not simple. There’s no magic bullet here, right? There’s, there’s series of reforms that we can think about like so, you know, increasing transparency of government, right? In making sure that every citizen visits has a insight into every single check that the government ever spends. That’s one thing, right? Free, transparent media Absolutely. Media freedom is essential in that kind of kind of environment, doing things like, you know, I’m talking about introducing KPIs for politics, right? So you have a certain fiscal, budgetary constraints, or debt constraints or monetary policy constraints, and if the government, you know, exceeds those limits to a certain extent, and it has like, let’s say, six or 12 months to fix it, unless it doesn’t. Everyone loses their seat and is no longer viable to run for election. That’s a very strong commitment mechanism. So I’m talking about introducing mechanisms like these that will push incentives, not in the way of exertation of power, but in a way of, you know, making power more distributed, that’s the idea.

Gene Tunny  35:43

Yeah, absolutely. I think it’s a great idea. So there’s an idea from a colleague of mine, Nicholas Gruen, who’s an Australian economist who I work with closely, and he’s been getting a lot of attention internationally for his idea. It’s not his original idea, but he’s one of the leading advocates of it at the moment, for citizens juries, sortition, this idea, which I think is a terrific idea. And Martin Wolf, the FT columnist, he wrote positively about that in his book The Crisis of Democratic Capitalism, which is I think perhaps a companion book to yours. Uh, really, I mean that, you know, you similar, similar themes about, I guess that you know, he’s got observations on inequality and what’s driving that now, I guess this is where, this is the final question.

I want to make sure I understand this. So your hypothesis is that a large part of the inequality we’ve seen is due to these elite networks, connections to politics. How do you, how do you quantify that? Have you done a quantification, so how much of the inc…, the breakdown of the increase in inequality, increase in the share of the point 1% or the change in the genie coefficient, however you want to measure it, what proportion of that is due to the phenomena that you’re studying, versus, say that you know, wider access to markets through the tournament effect, or whatever you call it, through just being able to connect with the wire the whole world via the Internet and skill bias, technological change that David Autor has written about. Have you quantified this at all Vuk?

Vuk Vukovic  37:21

No, yeah. So again, I put a direct number, right? So $150,000 higher salary if you’re connected, compared to if you’re not connected, right? So that’s a very, you know, strong, strong number. And so high ends, a big number, right? But the thing is, so obviously, if you look at so what you mentioned, the tournament effect, the superstar effect. That is fine. That’s going to happen in a globalized world. It’s always going to happen. And there’s no problem with that. And my problem is when it happens as a form of (inaudible) of power. So to quantify in terms of size, I haven’t looked at that specifically, but we can. But I can say that this is if it explains 20% of the variation, it’s a lot, even if that’s much, and I think it’s probably even higher,

Gene Tunny  38:06

Yeah, gotcha, okay, I think that’d, that’d be a good question to ask. Yep, yeah. And there’s quite a bit of like, it’s a it’s an interesting research field, and it’s something I’ve got to be I’ve got to look at more. We’ve got a local there’s an Australian economist, Cameron Murray, who’s done a bit of research for this. He’s got a book called Rigged, which was Game of Mates, which is, you know, interesting idea. So, and, you know, Cameron sort of looked at how decisions regarding property rezoning and all that sort of thing is highly correlated or, you know, is you’re more likely to get a favorable rezoning change of use of your property if you’re politically connected than if you’re not. So there, there’s some interesting evidence there of of the role of politics in all of this so…

Vuk Vukovic  38:55

Absolutely, unfortunately, you know, again, that’s the thing, right? If there’s, if power is too concentrated, you know, you just have to get the one person to change some stuff. You’re going to do that, right? That’s, that’s the idea.

Gene Tunny  39:07

Yeah absolutely. Okay. This has been fascinating conversation. Any final points before we wrap up?

Vuk Vukovic  39:13

I mean, yeah, I think we, we kind of summarized it well. Your questions were great. So, so thanks for that. But yeah. I mean, kind of the main message, the main argument from the book, is like, again, elites are not necessarily bad, right? You they’re like, politicians. You have good politicians, you have bad politicians, right? It’s up to us to try to make the system design mechanisms of the system that can be they can channel their influence into something good rather than something bad. That’s the whole idea. You’re always going to have bad people around, right? My point is, let’s not, you know, let’s not. So even if you need to elect someone who’s bad, or, you know, a psychopath or sociopath whatever, people tend to be calling their, their their elected leaders, and they call them all of them psychopaths or sociopaths, why even give a you know, a sociopath so much power, let’s, let’s not give them, let’s not give them that much power. And it’s not a new thing, right? If you look at countries like, you know, in Scandinavia or Switzerland, power is not concentrated, that’s, that’s the idea.

Gene Tunny  40:14

Right, in Scandinavia, Oh, yep, in Switzerland, with the decentralization, yeah, yeah, gotcha, yeah. Really good point. Okay, Dr Vukovic, that’s been terrific. I’ve really enjoyed the conversation. I will put a link in the show notes to your book. I recommend people get a copy of it. And yeah, this is something I’m going to be having a closer look at in future episodes. So again, thanks so much for your time. I really enjoyed the conversation.

Vuk Vukovic  40:39

So did I it was really good. Thank you very much,

Gene Tunny  40:43

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 at economicsexplored.com or a voicemail via speak pipe. 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.

Obsidian  41:30

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Credits

Thanks 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 and other podcasting platforms.

Categories
Podcast episode

Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262

Explore the mechanics of decentralized finance (DeFi) with Professor Evgeny Lyandres, who breaks down how decentralized exchanges work and how VirtuSwap stands out in providing liquidity for small-cap crypto assets. With insights into the challenges and future of tokenization, this episode offers a clear view of where DeFi may be heading. Evgeny is Professor of Finance and Head of the Blockchain Research Institute at Tel Aviv University. Disclaimer: This podcast episode contains general information only and is not financial or investment advice. 

If you have any questions, comments, or suggestions for Gene, please email him at contact@economicsexplored.com.

You can listen to the episode via the embedded player below or via podcasting apps including Apple Podcast and Spotify.

Timestamps for EP262

  • Introduction to Decentralized Exchanges and Their Potential (0:00)
  • The Evolution and Functionality of Decentralized Exchanges (6:38)
  • Challenges and Solutions in Decentralized Finance (22:18)
  • The Future of Crypto and Decentralized Finance (43:32)
  • Optimizing Liquidity and the Role of AI in Decentralized Exchanges (55:15)

Links relevant to the conversation

Evgeny’s academic web page:

https://lyandres.sites.tau.ac.il

VirtuSwap website: https://virtuswap.io/ 

Previous episodes on web3, DeFi, crypto or blockchain:

The Future of VC: Blockchain, Web3, and Emerging Markets w/ Qin En Looi, Partner, Saison Capital – EP256

https://economicsexplored.com/2024/10/01/the-future-of-vc-blockchain-web3-and-emerging-markets-w-qin-en-looi-partner-saison-capital-ep256/

Navigating Volatile Crypto Markets & Avoiding Scams w/ Ben Simpson, Collective Shift – EP249  https://economicsexplored.com/2024/08/14/navigating-volatile-crypto-markets-avoiding-scams-w-ben-simpson-collective-shift-ep249/ 

Digital Money Demystified w/ Prof. Tonya Evans – EP216

https://economicsexplored.com/2023/11/30/digital-money-demystified-w-prof-tonya-evans-ep216/

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

https://economicsexplored.com/2023/03/08/crypto-arbitrage-searcher-dave-belvedere-on-crypto-and-dapps-such-as-wizards-dragons-ep178/

Bitcoin & books w/ author & ex-fighter pilot Lars Emmerich – EP157

https://economicsexplored.com/2022/09/18/bitcoin-books-w-author-ex-fighter-pilot-lars-emmerich-ep157/

Takeaways

  1. Tokenization of traditional assets, such as stocks or real estate, is a future possibility for DeFi that could expand its impact well beyond the current crypto market.
  2. Liquidity pools and smart contracts are essential to DeFi, providing a protocol-based framework where trades occur automatically based on programmed rules.
  3. VirtuSwap’s unique pool structure, including virtual liquidity reserves, is designed to address the liquidity challenges for less-traded assets in DeFi.
  4. With the aid of AI-driven systems like Minerva, DeFi platforms can optimize liquidity allocation, potentially offering higher returns for liquidity providers and more efficient trades for users.

Lumo Coffee promotion

10% off Lumo Coffee’s Seriously Healthy Organic Coffee.

Website: https://www.lumocoffee.com/10EXPLORED 

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Transcript: Is DeFi the Future of Finance? Exploring VirtuSwap’s Vision w/ Prof. Evgeny Lyandres – EP262

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.

Evgeny Lyandres  00:06

This is basically the reason why I think this market is important, right? It’s not because of its importance right now. I mean, it’s not that, right? It’s because of the potential, which I think is there, right, a potential to kind of revolutionize many of the financial technologies that that we’re familiar with.

Gene Tunny  00:29

Hello and welcome to the show. In this episode, I’m thrilled to welcome Evgeny Lyandres, a Professor of Finance and head of the Blockchain Research Institute at Tel Aviv University. He’s also the co founder of VirtuSwap, a decentralized exchange platform. Evgenys’ expertise lies at the intersection of finance and blockchain technology. Today, we’re diving deep into the world of decentralized finance or defi. We’ll explore how decentralized exchanges work, the challenges of providing liquidity for smaller crypto assets and VirtuSwaps’ unique approach to addressing these challenges.

Special thanks to Lumo Coffee for sponsoring this episode. This top quality organic coffee from the highlands of Peru is packed with healthy antioxidants. Economics Explored listeners can enjoy a 10% discount, details are in the show notes. Now let’s jump into the episode. I hope you enjoy it.

Evgeny, welcome to the program.

Evgeny Lyandres  01:34

Great to be here. Thank you very much for having us.

Gene Tunny  01:38

Excellent, of course. So yeah, I’m really interested in, in what you’re up to. I mean, you’ve got a background as a as an academic professor of finance and head of Blockchain Research Institute at Tel Aviv University, and you’re also involved in defi and in blockchain with your own company. So I’d like to ask you about your company, is it VirtuSwap?

Evgeny Lyandres  01:58

Yes.

Gene Tunny  02:00

Okay so what I’ve learned, or the information that was sent to me about it, is that it’s a decentralized exchange platform that gives traders direct liquidity for smaller cap assets. So I think what would be good is just unpack what all of that means. So one, what do you mean by decentralized exchange platform, and then what do you mean by direct liquidity for smaller cap assets? Could you take us through that, please Evgeny?

Evgeny Lyandres  02:34

Of course, of course. So starting with from from afar, to give a little bit of a background, right? So, so obviously, decentralized exchange is an exchange where assets are traded, right? In particular, in our case, it’s crypto assets, right? You know, think about Bitcoin, Ether, stable coins, and, you know, 1000s of other crypto assets. Now, there are two ways that the trading in those assets is conducted. The first and still kind of the predominant way, is trading on centralized exchanges. You know. Think of Binance or Coinbase, or maybe FTX, that you know existed until a year and a half ago, but no longer. A lot of trading happens there, and those exchanges are organized very similarly to, kind of the traditional exchanges of other asset classes, such as stocks, right? So think of, you know, NYSE or NASDAQ, right? It’s basically order book based exchanges. Now there are few issues, few problems with with centralized exchanges, and the problem basically stem from the fact that those are centralized entities in a largely unregulated environment, right? So some centralized exchanges, such as Coinbase, are regulated, right? Most are not, right? And so if you combine those two things together, right? So, a centralized entity in an unregulated environment, right? You know, bad things can happen. I’ll give you a couple of examples, right? So, of course, all of us know about exchanges that go bust, because basically they still, you know, depositors fund right? The FTX is a good example. There are other issues, right? One of them is that a lot of those exchanges engage in significant wash or fake trading, right? So basically, what they’re trying to do is they try to increase the reported trading volume, right? Because that is, you know, increasing their placement in the kind of the ranking the league table of of exchanges, right? So they’re interested in inflating volume, because this is, you know, one metric that investors or traders look at when deciding where to trade, right? Now, this is pretty bad for trader, right? Because if you go in exchange and you see an order book, right? You, you stink, you, it seems deep, right? So you want to place your trade. But the actual liquidity oftentimes is significantly smaller, right? And that basically means that your trade is going to be executed at, you know, far worse terms than you know, what you thought it would be executed, right? So basically, there is a big problem of lack of transparency that is driven by, you know, very strong competition, right? And competition is there just because, you know, the entry costs into this industry are very low. It’s, it costs very little to set up, you know, a centralized exchange. It’s basically kind of, you can use a white label software to just to set up a new one. And as I mentioned, lack of sufficient regulation, right? So the bottom line is, lot of people trade on centralized exchanges, and some of them are fine, right? So, you know, Coinbase is definitely fine. Binance seems to be fine, but not all of them, right? And there’s, you know, quite a lot of academic research on kind of the problems associated with the centralized exchanges. And so defi and in particular, decentralized exchanges, right? Is one way to address, you know, the problems that we mentioned. So let me tell you, you know, briefly, what a decentralized exchange, right? So decentralized exchange is basically a protocol, a computer program that resides on the blockchain, right? Any blockchain that enables smart contracts that basically defines the terms of trade in a very kind of precise, programmatic fashion, right? And that basically means that it’s a collection of basically formulas, right? Say, Well, you know, if you exchange this amount of one asset into another asset, right? You’re going to get precise amount of that other asset the function of some parameters of the you know, of the exchange. Those exchanges are organized using so called liquidity pools, right? And so that brings us to, kind of to the main players, right in this, in this market, right? There are two. The first one is traders, right? So those are people you know, that want to exchange one asset into another. The second, and the crucial type of players in this, in this market, is what’s called liquidity providers, right? So, liquidity providers can be, can be anybody, right? Can be you or me. It’s people who basically supply liquidity two so called liquidity pools with a goal of this liquidity, right, helping conduct trades, right? So let’s say that I want to establish a pool of two tokens, right? You know, whatever they may be. So I’m going to put $1,000 worth of one token and $1,000 worth of another token into the liquidity pool. Now the pool has been established, right? And those tokens right at this point, $1,000 worth of both could be used for trade, right? So you can come to the pool and say, Well, I want to take $10 worth of one token and supply another token into the pool, and the pool basically is going to be set at set up in such a way that you know the terms of trade are going to be defined by the amount of liquidity currently existing in the pool, by the relative prices of those two assets, right. And that basically the ratio of the two assets in the pool right, and the size of your trade. Okay, we can go deeper into, you know, what types of pools there are, but typically, you know, it’s involved in a pretty simple math, pretty simple kind of formulas for defining those exchanges, right? But it’s basically going to be a function of only two things, right, the current composition, the first state of the pool, and the size of the size of the trade and direction of the trade that you want to perform, right? So that is kind of the the basics of decentralized exchange and this type of trading technology that’s very novel, right? And does exist outside of decentralized finance, or outside of blockade based finance right is possible because of kind of the nature of the blockchain, right? That, basically, blockchains allow smart contracts. Smart contracts are, you know, no more than if that condition right, the defining if something happens was was going to be the result, right? And so, so basically, it’s possible, because of the technology of blockchain, right? But in theory, at least, you can even think about this technology being useful for trading other assets, right? So you will any pretty much, right. The financial technology is the same, yeah. So that’s kind of the basic or so decentralization, we’re very happy to go, obviously, deeper into it and, and, of course, we’re going to talk about, you know, what we do in the space. But what is our, what is Virtu of contribution,

Gene Tunny  09:50

you know? Yeah, absolutely, I definitely want to go deeper into it. Yes. So, I mean, what are examples of decentralized. Exchanges. I mean, there’s your decentralized exchange, Virtu swap, and how does it compare? What’s its differentiating factor from other exchanges? It sounds like that you’re focused on smaller cap assets. Can you tell us about that? Please. Evgeny, of course,

Evgeny Lyandres  10:17

of course. So in general, kind of decentralized exchanges started in about 2017 2018 so you know, about seven years ago now, by two protocols. The first one was called bancor. The second was called uniswap, still called uniswap, and both protocols still exist. Uniswap at this point is the most successful and the most famous decentralized exchange protocols currently responsible for, I would say, about half, if not more, of all trades in decentralized exchanges, right? And just to put things in perspective, about a quarter of all trades of crypto assets is done on decentralized exchanges. The other three quarters are done on centralized exchanges. And out of this quarter, uniswap, you know, gets about half of the market share. So this is the predominant kind of decentralized, you know, the biggest and the most successful decentralized exchange, and also an exchange that constantly produces a lot of innovation into this market, right? So let me give you maybe a half a minute kind of history of the evolution of this market, and then we’ll get to what we do, right? So it all started with, you know, with the first version of municipal in around 2017 2018 right? And basically, the idea there was, well, you know, we can exchange assets using this, this, this kind of smart, smart water based technology that we discussed. And in the first version, the exchange work very simply, right? So the exchange could only be done, you know, between ether, right, which is the the token of the Ethereum ecosystem, right, with Bucha, Spain, and any other, what’s called ERC 20 token, which is a, basically a token that that is based according to a certain kind of standard, and within the first version, right, which basically kind of it should you can think of this as a proof of concept, right? The trading was not very the terms of trading were not very attractive, right. So think about a situation where you want to exchange your two tokens, right? You know, think you know, USDC, a stable coin and some other token, wbdc, right, Bitcoin, okay, so what you would have to do, right, is basically do two trades, right? It would need to exchange USDP into, you know, ether, and ether against WBC now. And, you know, doing multiple trades would basically expose you to to multiple costs, right? So let’s first talk about all the costs involved in a trade, right? And then we’ll think about, you know, what does mean to have all those basically doubled or multiplied, right? So generally, three types of costs, you know, for a trader on a decentralizing change. The first one is so called full fee, right? And that is basically a fee that a trader needs to pay to the liquidity providers in the pool, right? Because, you know, you need to somehow incentivize people to provide liquidity, right? Otherwise, you know, nobody’s going to put money in the pool. There needs to be something in it, you know, for the liquidity provider, right? So, and you know, the the fee, basically, is, you know, some small proportion of the trade that is not being exchanged for another asset, but instead is given to the liquidity providers, right? So think about, you know, numbers between five, usually, and between five and 100 basis points. Okay? So 0.05 to 1% that’s the first type of the cost. The second type of the cost is what’s called the price impact. The price impact, right? Is basically due to the fact that the trading function on any exchange is not linear, right? And, you know, you can think about a good analogy, is a typical exchange of assets, right? When there is an order book, right? So the bigger your order is, the deeper you’re going to go into the order book, and the works is going to be the execution price, right? So smaller trades are going to be executed and the marginal the current price, right, the bigger trades are going to be executed at worst price. Same thing happens on decentralized exchanges, right? The typical kind of the most simple and the most famous, actually, formula for conducting the trade and decentralized exchanges is what’s called the constant product formula, right? And basically means x times y equals some constant k, right? So for example, you know, going back to example, to an example, I am. I mentioned before, right? So if I provided $1,000 worth of liquidity in one asset and $1,000 worth of liquidity on the other asset, right? You know, if you divide this $1,000 by the initial prices of those assets, right, that basically defines the quantities of the assets initiative deposited into the pool, right? So let’s say just let’s take the example that I deposited in 500 units of asset a and 200 units of asset B. If you multiply those two numbers, so 500 times 200 so that’s 100,000 right? That defines that constant product, right? And any trade you know in this pool, unless the liquidity changes, right, is going to be based on this product, meaning that if I want to take a given amount of one of the assets in the pool, I need to supply an amount of the other asset, right, such that this product remains constant, and that basically, you know, defines a so called hyperbolic function, right? It’s not linear, right? It’s a convex kind of function of price. What I’m trying to say here is that the second type of the costs of trading in on this centralized exchange is basically what’s called the price impact, right, the effect on the price at which you’re trading, right, as a function of the size of the trading and then, then the third part, the third cost of training, that is basically what’s called the guest cost, right? So this is the transaction cost that need to be paid by the, you know, people, kind of writing blocks on the on the blockchain, right, recording the new blocks and kind of certifying, right? So those are the three costs, three types of costs. Now coming back to this example of trading, you know, stable coin into rev Bitcoin, right, where the intermediate asset is, for example, ether, right? All of those costs, right, the price impact, the pool fee, the gas fee, need to be multiplied by two. And so that was the issue, right. So, so the trading terms were not super attractive, right? So, as a thought experiment, this was a fantastic innovation, right? So this was really a new way to conduct trading, you know, practical terms. It was not great yet. And so then, you know, this ecosystem, you know, started gradually improving and developing. The next kind of step was the second version of the unicorn protocol that’s called v2 okay, that’s that’s what people refer to, usually. And the biggest kind of innovation there was that you didn’t have to necessarily go through ether as an intermediate assets. You could basically construct pools, or establish pools with any two assets, right? With any two ERC 20 tokens, right? And so then you could think of us about a situation where, you know, someone would establish a pool of USDC against Red Bitcoin, right? And people would be able to trade in the school directly, without going through the third assets, obviously, reducing. The point is, this is important, and this is the point I’m going to come back to, right? But it didn’t really solve all the problems, for reason I’m going to describe in half a minute. Since then, you know, this kind of, this setup, right? This technology of decentralization, is have evolved further. The first big innovation was the third version of UNICEF, unusual v3 Right? Which basically allows so called concentrated liquidity, right? So here’s the problem. The problem with, you know, the trading technology that described so far is that, basically, the liquidity that liquidity providers put into the pool, right, is sort of uniformly distributed across all possible exchange rates in the pool between exchange rate between the two assets, you know, from zero to but it turns out that the price impact becomes quite significant for relatively large trades, right? So as a rule of thumb, the price impact which is a loss you know of a trader, you know from the trade, is roughly proportional to the ratio of trade size to the size of the pool, right? So if you want to do a trade which is 1% of the size of the pool, well, you’re going to pay this 1% roughly in terms of price impact, in addition to the pool fee and the guest right? So in practice, you know, in practical terms, you know, large trades are not really admissible, you know, on on decentral exchange, just because they become too expensive. This is also true for centralized changes, right? If you want to take out your 10% of the order book, that’s going to cost you a lot of money as a trade, right? So this idea of concentrated basically said, well, let’s quickly treat it not uniformly, you know, for all exchange rates, because you know, you know, trades that change exchange rates or more exchange rates, quite a lot are not going to happen in reality, right? Let’s concentrate. Trade humidity in the relevant range, right somewhere around the current exchange rate, right? We’re going to support those trades in a really good way, right, with deep liquidity, with the hope that large trades are not going to appear because those large trades are not going to be supported. So that really increased, many cases, the efficiency of liquidity provision by a lot, and improved in the terms of trading, you know, by by a significant amount for traders. And now uniswa is actually coming out with the next version of their protocol, before the fourth version, that is actually going to be quite interesting, because it allows to do many more things. It allows so called hooks. So hooks is basically additional smart contracts attached to the liquidity pool that define certain actions that the pool is going to do before, during or after a trade. Think about a situation, for example, where you know a trade changes the price, the exchange rate between the two assets in such a way that the current consider liquidity is not going to be adequate anymore to support trades, right? So the pool might define reallocation of liquidity in such a way that will support future trades as a result of an existing so before is not really active yet. It’s coming out, I believe this or next month, but this is going to, I believe, spur additional wave of innovation in defi or desks. Let’s go back to virtual swap and what you know we tried to bring to the table, right? So I kind of discussed very briefly the fact that liquidity in on Dex is often is not allocated in an efficient way, right? And this is actually an important point, because this is a big problem that currently, up to this point, actually prevents kind of the access to from from from really achieving a big success, right? Basically, from overtaking centralized exchanges, right? That has not happened yet. The reason is that it is very difficult to provide liquidity, you know, for all necessary trades, right, just because there’s a lot of assets right? Right now, if you go to coin market cap, which is, you know, the biggest aggregator of crypto data, there are 1000s, right, 678, 1000 of different assets, right, that are listed on coin market cap, and there are many more that are not listed. So if think about, you know, trading between one asset, one token, into another. Chances are that, despite the fact that it’s possible to establish any type of liquidity pool, it’s possible to concentrate liquidity. In practice, there are just too many asset combinations, right, for those pools to exist, right? So if there is, you know, 8000 crypto assets, right? You know, if you think about the number of pairs, well, it’s 8000 squared over two. That’s a huge number, right? You’re never going to have, you know, liquidity for, you know, for those trade Now, granted, most of theirs, those potential, theoretical pairs are never traded, right? So you don’t really need liquidity, right? But still, there are a lot of assets which are traded, right, but for which there is no direct liquidity, right, even now, right, with all the available technology, right? Because I know providing liquidity into pool, into the pool is a completed permission that’s connected, right? Anybody can do it, and we can establish a pool. Anybody can add, you know, money to the pool, right? People are only going to do it if it’s worth their while, right? If the returns they’re going to be getting are going to be offsetting the risks that they’re going to take in the day, right? And for many assets, it’s not the case, right? So you know, if there is, you know, some trading expected in a pair of assets. So think you know, whatever chain link against, you know, Matic, right? You know, which is the native token of olivine chain. There are going to be straight some trades like this, but probably not enough to make it worthwhile for liquidity providers to provide sufficient liquidity, right? And so, you know, despite the fact that the theoretical possibility exists in practice, right? People are still going to do two trades, right? They’re going to trade, you know, from chain link to some asset you know, with which you know, the pool of tailor exists, for example, ether or stable coin, USDC, or anything else, right? And then the others trade into the asset that they really want, right? So for the most part, the problem of insufficient liquidity is not solved, right? And it actually cannot really be solved, right, for the reasons we discussed, right? There is just not. There’s too many assets and too too little money in the pool, right? So. So that is basically the problem that, you know, I identified in, I guess, 2021 when I started looking very carefully into this, doing research on decentralized changes, right? It isn’t the problem that they’re trying to solve, right? And that basically what led to to virtual, right? So let me tell you, know, very briefly about our way to address this problem, and, by the way, before the problem, right? Just just the size of the problem, right? So those trades that involve what we call triangular trading, right? So trading, you know, through multiple pools. That’s about 30% of all trades on, you know, most important blockchain, right? Ethereum, Polygon, arbitrary and so forth. Right? About 30% of the trades are of this kind, right? So this is kind of the market that we’re trying to address, right? And, you know, you mentioned initially, kind of smaller coins, right, or smaller assets, right? So this problem is there in smaller assets, right? Because if you want to trade, you know, ether against USDC, you’re going to be fine, right? There’s enough liquidity, enough direct liquidity. That’s not our place, right? Our place is rates that I mentioned, right, which may be smaller asset, right? When I say smaller, it’s basically anything outside of top five, right? So when you go outside of top five or six on a given blockchain, that’s where the problem becomes, becomes acute. So how do we do this, right? So we basically came up with a different architecture, right, different structure of liquidity pools, right? So standard liquidity pools involve two assets. Ours are a little bit more involved. So in addition to the two assets right that we also have, we have so called reserves, right? So think about a pool that is, you know, two main assets, plus you know, some reserves, right? And you know, a good way to think about those preserves initially is basically like, say, deposit boxes that are initially empty, right? So the pool is established in exactly the same way as normal pool, right? So think about a pool of whatever ether and USDC that can accept reserves into those initially empty sale deposit boxes. So let’s say that you want to to buy, you know, ether, right? And to pay with it, with the Matic token, right, with the polygon top. Now, in a normal kind of situation, right, in the normal tax right, you’d have to do those two trades. Right triangle. Virtuous. Of what you can do is you can deposit the asset that you have into the reserve of the pool. Right, ether USDC are going to the to deposit the reserve of Matic polygon into the reserve of, you know, either USDC pool, and you’re going to take from the pool the asset that you want, right, the asset that you need. For example, ether, right? Now, of course, the question is, you know, what is the, what are the terms of trade, right? You know, how much do you need to deposit in order to take even amount of the asset from the pool? Now, you know, this historical trade are defined on purchase of via so called virtual liquidity pools. Right? Virtual liquidity pools are, you know, a result of, basically triangulation, right, of of different pools that exist virtual so they define a pool, sorry, a trading curve, you know, over which the trader can trade, right? Now, this trading curve is not a real trading curve, right? It’s not like, you know, he’s going to deposit the assets in the pool and take some other assets from the pool. This virtual trading basically, is defined by trading into the reserves, right? So you’re going to, you know, deposit your asset to the reserve, and take one of the kind of main, one of the main assets in the for a trader, it doesn’t really matter, right? It’s a seamless experience, right? You as a trader don’t really care whether you trading by reserves or by kind of normal kind of two effort trading, right? What you care about is getting the most, what’s called the mount out, right? The largest amount of the other asset that you want for a given amount of assets that you are trading now, this is not the end of the story, right? So let’s say that you perform this trade, the pool accepted those, those assets into the reserve, right? There is a problem, though, right? The liquidity provider right now is now exposed to the risk of holding some other asset in the pool, and that is not a risk that is desirable, right? So if I provided liquidity into either USDC pool, I’m okay exposing myself to the risk of those two assets, but I might not be. Exposing myself to the risk of others. Now, what do we do? What do we do with it? There are several ways in which we solve this problem. And then after I describe the ways we address this problem, right, I’m going to go to talk a little bit about the advantage of what we’re doing. So first of all, we don’t allow all of the possible assets into into the reserves, right? So every pool comes with a white list of tokens that can go into the reserves, right? Think about, for example, top 100 assets on a given blockchain. So this comes back to your initial point. Right? We solved the problem for smaller assets, not for the smallest ones, because the smallest ones are super risky, right? We don’t want to expose the liquidity provider to this type of risk. But in practical terms, you know, 95% of trading in smaller assets are, you know, it’s taking place in assets you know that are the top 100, right? So, I mean, the other ones are really not that important. Secondly, we basically limit the size of the reserves, right? We basically say that the overall value of all the assets that sit in the reserves, right? And remember, these are assets that are different in the two main assets in the pool, right? So the size of the result reserves overall cannot exceed 2% of the value of the pool. Once it hits 2% the pool basically closes itself to this type of reserve trading, right? And basically limits the amount of reserves, right? So there is some risk, but it’s not very, you know, very big. It’s up to 2% but most importantly, right? The way we, you know this risk is addressed, right? Is by a lever system of exchanging reserves between pools. Right? Think about a scenario where, you know, I have deposited money into ether, USDC pool that now has Matic reserves another pool right is, for example, Matic against ether that has USDC reserves, right, that accumulated the result of some other trade. Okay. Now, whatever this happens, right, those two pools can exchange the reserves between themselves, right, sending Matic to the pool Where it is one of the main assets, and sending USDC into my pool Where it is one of the two main assets. Now this happens without any price impact. This happens without any pool fee, right? It’s just exchange between two pools, just a little bit of gas that needs to be paid. But you know, this is, this is not a large number, usually, and that basically means that every time it’s possible, we kind of try to reduce the number of reserves in all possible pools to the lowest level possible, ideally to zero, right? We don’t want those reserves right. So those reserves are just kind of a place that allows trading, right? We don’t really like them. We’ve done, obviously, tons of simulations at this point. We have real world kind of trading data, those reserves are typically small, right? So, you know, this is not a risk that is that is large in the liquidity providers. But what is that do? It basically eliminates, in many cases, the need for the triangular trading right, and reduces the costs of trading to a single kind of type of cost, right? You still need to pay the pool fee, you still need to pay gas. You still have price impact, but only once, all right, and not multiple times. And so if you think about kind of a more kind of global picture, right, the whole ecosystem of different decentralized exchanges, and there many, there are dozens of Dexs, usually on every blockchain. The way this market is organized is that most often people are going to trade through so called aggregators, right? So think about basically the Expedia right of the dex market, right? Instead of kind of going and buying your air ticket in a particular airline, you’re going to go to Expedia and try to see where it’s cheapest. You know, what is the cheapest? In a way, to go to a particular place, and accurate, there’s a similar thing, right? It basically takes a given trade, it looks up on all the data on different decentralized exchanges, all the pools, you know, all the liquidity, and tries to compute the optimal route for the spring, right? Basically, you know, let’s say you want to swap, you know, $100 worth of stable coin into into it, right? You know, the aggregator is going to go and trade and say, well, $20 are going to be sent to this pool on this decks, and $15 is going to be sent to a different pool in different days, with an objective of maximizing your overall amount out now coming back to virtual spot, since our trading is more efficient, right? Because, you know, we don’t have to pay the multiple costs twice, right, that basically means that a disproportionate, you know, fraction of a trade is going to be sent our way, as opposed to to a. Other kind of to other debts, right? So in a sense, that means that, you know, from the liquidity providers perspective, you know, their liquidity is going to be working over time, right? There’s going to be kind of a bigger kind of bang for the Bucha, right? And that means that, in a sense, every trade carries some fee, proportional fee, the returns to liquidity providers is also going to be larger and kind of the liquidity provision to merge as well. In principle, maybe a better kind of proposition for liquidity providers than providing liquidity on other deaths, right? So that’s kind of the basics of what we do. Gotcha,

Gene Tunny  35:35

okay, geez, there’s a lot, a lot there a few, a few terms I want to go over. So you talk about gas fees. So I remember you defined them. I just just wanted to make sure I heard that right, and I looked it up and checked it is gas. So that’s a new one. I’ll have to have another look at at that. And then you mentioned ERC 20, and that, that means ERC

Evgeny Lyandres  36:01

20 is basically just a technical term for particular crypto assets, right? You know, having certain characteristics, right, that are compatible, you know, with other assets on a given block, right? You know, there’s nothing deep there. It’s just certain conditions that need to be specified, but you need to be kind of fulfilled by an asset to to be classified as ERC 20, right? I don’t want to go deeper into this. It’s just that is not a very kind of interesting part. The gas fee is actually more interesting, right? So, you know, any blockchain right, is basically maintained in decentralized fashion, right? So blockchain has nodes, right? Nodes are basically computers who record, maintain and update the state of the blockchain, right? But those nodes need to be compensated. They’re different and, and, and, you know, those nodes need to agree among themselves about the contents of the blockchain, right? So we need to make sure that blockchain, which is a database, distributed database, you know, is the same across all nodes of the of the block, right? There are multiple ways to achieve this, so called consensus between nodes. You know, of course, you know, everybody heard about proof of work. You know, which is, you know, what Bitcoin uses for proof of state, which is what most other blockchains use at this point. But the point is that, you know, the nodes on on a blockchain, any blockchain, need to be compensated for what they do, right? So you know, you’re not going to kind of run this, you know, Blockchain software for no reason, right? You’re only going to do it if there is something for you and and that’s why, you know, we need to somehow generate some revenue for the for the nodes of the blockchain that maintain it, right? And this revenue typically is generated by those gas fees, which are basically fees attached to, you know, by people who want to perform transactions on a blockchain, right? And those fees, you know, you know, I’m simplifying a lot, but those fees basically are paid by the people making transactions to people who maintain the blockchain. Gotcha, do

Gene Tunny  38:13

you know why it’s called gas? Why is it? I

Evgeny Lyandres  38:16

mean, it’s, it’s like, it’s like, gas in a car, right? That’s more, makes the makes the blockchain go.

Gene Tunny  38:21

Okay, that’s that’s as good as his explanation as any. Is just wondering if there was some particular reason, actually,

Evgeny Lyandres  38:29

in fact, there may be others. This is the one that I heard, and this seems reasonable to me, so I didn’t explore further.

Gene Tunny  38:38

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

Female speaker  38:44

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Gene Tunny  39:13

now back to the show. Okay, so just want to go back to just the what I’ve read about virtue swap, so you get about 50% cost reductions and then 400% higher returns for liquidity providers. So this is what you’re what you’re claiming. Yeah, right, got

Evgeny Lyandres  39:38

it very much depends on the parameters of the, you know, the pool, gotcha, yeah,

Gene Tunny  39:44

it has a TVL of $3 million What do you mean by that? What’s TVL stand for?

Evgeny Lyandres  39:51

Right? So, actually, the number is smaller right now. Some, some rough kind of periods of market. The market is improving right now, so hopefully it’s going to. Bigger, but TBL stands for Total value locked. Total value locked is the amount of liquidity that people provided into the into the protocol, right? So, so you know, any exchange be centralized or decentralized, relies on liquidity, right? And basically assets that some other people have deposited into the into the exchange rate in order to facilitate trading, right? So the bigger the liquidity, the more trades are possible, and the better terms at which trades are possible, right? So, so for every decentralized exchange is striving to increase the liquidity that’s deposited into it,

Gene Tunny  40:47

yeah, gotcha. Okay, so it’s still fairly, I mean, it is a niche product. So you’ve said that you’ve carved out a significant niche, right? Okay, and you’ve partnered with defi leaders like uni Zen, open ocean, odos, lifik, what are those companies doing? What partnerships have you developed?

Evgeny Lyandres  41:09

Right? So most of the names that you mentioned are basically aggregators, right? So we mentioned aggregators is basically the from the starting point of most trades, right, the experience of this office of this market, right? So any decentralized exchange wants to be, wants to eat, to be integrated by by as many aggregators as as possible, right? Because, basically, you know, like an airline, right? The airline wants to be on Expedia. It wants to be on Kayak, it wants to be on Skyscanner, right? Wants to be on every aggregator that people go to to kind of search for for air tickets, right? Any decks wants to be part of, and all aggregators that people go to submit their trades, right? So at this point, we are, in fact, have been. We have been integrated by most of the of the important aggregators. So I’m quite, quite happy about that. And you know, this is not trivial, right? Because integration takes time, right? So you know, the aggregator needs to basically go over the smart contracts of of the decks, right, and make sure they’re compatible with what they’re doing. Right? Our smart contracts are quite different from those of existing or other desks, right? We are not a so called fork of another protocol, right? We just didn’t just take another product code and make some small tweaks to, right? You know, we wrote everything from scratch which make, makes aggregation heavier endeavor, you know, from the or integrations and heavier endeavor from the aggregator sentiment, right? So I’m quite happy that we have been aggregated by by several, well, all basically important aggregators, right? And so that’s where the majority of trade and virtue are coming from, right? So, you know, we have our own website, our own trading app, our own UI, UX. People can go there and trade. Most people do that, you know, otherwise, right? They go to an aggregator, and the aggregator computes, you know, which part of the trade it makes sense to do on versions of, right? And we get, you know, those bits and pieces of trades immediately.

Gene Tunny  43:25

Yeah, gotcha. Okay, that makes sense, yeah. So it sounds like you’ve, you’ve found a real niche there and in the market. And, yeah, I mean, it’s, it all sounds. I mean, I think I was five years too old to have got into crypto, perhaps, but yeah, I really haven’t got into it in a big way, but I have a lot of guests. I’m having, increasingly, having guests come on the show talk about crypto and web three. It’s all, all very, all very fascinating. So it’s something I’ve still got to learn a lot more about. Can I ask you, where do you think all of this is going? Because you mentioned the huge number of coins there are out there. I mean, a lot of these coins. I mean, you have to wonder about the future of them. I mean, where’s, what’s the future of crypto? Where do you think this is all headed? I mean, will crypto become, you know, will people start using it as a currency, as a medium of exchange? Will all of these coins survive? What’s the future look like? What do you see is the future of crypto of yeah, please tell me. I’m fascinated. I’d like to know what the, what’s the, what’s the use case for all of this?

Evgeny Lyandres  44:40

Yes. So then this is a bunch of very loaded question in one. So let me try to kind of, you know, to the extent possible. So, so crypto, obviously is a new industry, right? And up to not too long ago, it was a real kind of wild west, right? So you might remember the time. Time, a few years back, of initial coin offerings, or ICOs, right? Where basically projects were raising money for something that they intended to do in the future, and there were tons of scams in this market. I mean, this market was very far from clean, coming back to the lack of regulation. Right now, ICOs are dead at this point, but the market is still not very well regulated, right? So different countries approach regulation of crypto in very different ways. You know, I’m sure that, you know, with the with the outcome the US election, we’re going to have big changes in the regulation, in the US of the crypto market, to predict in what way, but I’m sure that there’s, I mean, it’s going to be easier to do to the business, you know, in crypto, that I think that’s that’s pretty clear, but regulation is still still not there, right? And so there are several uses in of crypto in general, right? So you mentioned payments, right? So payment is kind of the first thing that the people thought about and that basically, if you read the Bitcoin white paper, right, it basically says that, you know, Bitcoin was supposed to become a medium of exchange, right? For many reasons, it didn’t happen. One big reason is that just the throughput of this, of this system, is very low, right? So you can only do very few Bitcoin transaction in every second, right? So it’s incomparable. Orders of magnitude is smaller than, you know, transaction Visa or MasterCard or suite or whatever. So they didn’t happen. But it doesn’t mean that it’s not possible, right? So, you know, it is definitely possible to transact in crypto. Stable coins are very convenient for it. Central Bank digital currencies that many central banks you know around the world are working on are going to, in principle, replace kind of traditional, traditional money. So that’s, that’s good, that’s what. That’s one kind of use case, clear use case of crypto is used, you know, just for Allah says about this use case, right, even now, right? So, crypto is used a lot in places where it’s hard to do business or make transactions in fiat currencies, right? So think about kind of countries or organizations under sanctions, right? You know, think, think about places with capital controls, right? So crypto is useful, or, you know, is a potential replacement for for fiat money, whether it’s good or bad. I mean, that’s that’s irrelevant. It’s but it’s definitely possible. The second use of crypto is, basically, you know, a as a fuel behind different types of finance applications, right? So pretty much any protocol in decentralized finance, right? So let’s take uniswap as an example. Since we mentioned that before, has its own token, right, its own currency, its own asset that the use that is used for incentivizing people towards a certain behavior, right? So think about a protocol. Well, we do it in virtual right? We basically want to try to influence where the liquidity providers are putting their liquidity right. Because, you know, we have developed, you know, a system of optimization of liquidity, right? And, you know, we think that we know better than a typical liquidity provider where the money is going to be, you know, bring the biggest, you know, benefit about right now, we did not force people to do anything. It’s their money, right? They’re going to put their money where they want to, but we can try to influence them, and the way we influence them, and, you know, many other protocols do it as well, right? It’s basically trying to give them extra rewards for doing certain things, right? In our case, you know, if I want a person or people to, you know, to put their liquidity in a particular place, well, I’m going to say, Well, if you do this, I’m going to give you something extra, right? This extra is going to be the token of my own protocol, right? So, in addition to the fees that people are going to generate, you know, as a result of liquidity provision, they’re also going to get something extra, which is the protocol token, right? So, and you know, protocol tokens, as most, most defi protocols, have their own tokens, right? And you know that is mainly used for for this purpose, and that basically defines kind of the valuation of this token, right? Is derived from the utility of the protocol, right? So uniswap token is very valuable because a lot of people trade via virtue purchase or generates a lot of fees, you know, for the liquidity providers, right? And that’s why uniswap tokens currently worth, you know, several billion dollars. Other tokens are worse less, right? It all kind of depends on, on, on whether and to what extent the protocol gives utility to to its users. Most tokens that are currently traded or, you know, registered on coin Mar. Cap are worthless, if you ask me, right? So, you know, I expect that many of them, the vast majority of them, probably including different mean points, are eventually going to go down to zero, right? So, you know, mean points is a definition of an asset that does not have any, you know, inherent utility, right? It’s, you know, it’s price, basically, is a function of the temporal demand that that exists, right? You know, there is nothing, nothing kind of behind it now. So if you think about the 1000s of assets that are currently, you know, out there in my prediction is most of them are going to go down, to go down to zero. And I don’t think many people are going to argue with that, but I think what’s really important, right? And it’s probably more important than, than the than the use cases that we discussed, is the possibility to to tokenize real world assets, right? So think about a Tesla stock, right? A Tesla stock is currently trading on, I believe, NASDAQ, but it’s trading in one place, okay? And in order to trade, you have to go to a particular exchange, okay, and play by the exchanges rules, right, including be limited to the liquidity on that particular exchange. Now think about a situation where Tesla stock is tokenized, and what it means is is the following, I buy a certain number of Tesla stocks, right? I put it in some custody, right, of the reputable custodian, right? And I issue Tesla tokens, right? Tesla tokens that are compatible with, you know, trading, or, you know, any activity on a blockchain, right? Those tokens are going to be one to one backed by Tesla stocks, you know, sit somewhere in a safe deposit box right now. Those social tokens, you know, can be traded on dexes, okay, they can be traded with all the advantages of the sophisticated kind of trading technologies that we discussed, right? And future technologies that are going to be not to be developed, right? Because this, this market is developing very fast and kind of and progressing very fast, right? If you think this possible, definitely right. What is currently not really possible, right, is this whole issue of custody, right? So regulation, right, is not there yet to, kind of to define, you know, what a sufficient kind of efficiently secured custody is, right, in order to allow this type of activity, right? I know the lawyer, right. I don’t know how the optimal regulation should look like, but imagine for a second that there is regulation that allows and makes this activity relatively easy, right? Once this is possible, the sky is the limit, right? So, so basically, think of any asset, you know, stocks, bonds, real estate, precious metals, you know, energy, anything can be tokenized, right? And this is the point where I think this defy decentralized finance. Markets, including decentralized exchanges, are basically going to explode. Because right now, this market is limited to a very particular, very niche type of assets, which is crypto. Crypto is still, you know, a tiny asset plus relative to stocks and bonds, right? So currently, the market cap of all of crypto is $2.7 trillion if you think about stocks, global stocks, about 100 trillion dollars, slightly more bonds, similar numbers. So, so crypto is small, right? But once you kind of allow trading in other assets, right, stocks, Bond, real estate, right? That could increase the importance of this market, but by at least two orders of banking, right? And so, so this is basically the reason why I think this market is important, right? It’s not because of its importance, right? Now, I mean, it’s not there, right? It’s because of the potential, which, I think is there, right? And potential to kind of revolutionize many of the financial technologies that that we’re familiar with,

Gene Tunny  54:13

yeah? Look, I think that’s a very good answer. No. That’s yeah, I actually see the potential there, particularly if you can have like that can give like you could have people getting tokens here for Australian government bonds, for example, that are typically not there’s no retail Australian government bond offering at the moment, but this is a way that you could get, you could get that exposure With the tokenization. I think that’s yeah. That’s fascinating, yeah. The whole regulation side of things is yeah, that that needs to be sorted out. I know that in Australia, the Treasury is supposed to have been looking at it, but it’s just taking them forever to come up with a regulatory framework. Which is, you. Which is rather disappointing, right? Okay, well, I’ll have to have a, I’ll have to have a closer look at all of that. Yeah, it looks like we’re coming up to time. I mean, yes, lots of fascinating things to talk about. I mean, I’ve got a lot, a lot to learn. There were some really, there’s some really technical concepts in there, and it looks like what you’ve done is a very clever way to to solve this, this problem of these thin markets, to actually make sure there’s enough liquidity there. So I think that’s for these trades that’s very good. Is there anything? Anything else we should cover before we wrap up? Kenny

Evgeny Lyandres  55:42

talked about, kind of the whole market. We talked a little bit about Virtu sock. I do want to mention that kind of this, this financial technology is sort of not the only thing we’re doing right. Another kind of aspect or facet of our productivity is, is basically trying to optimize liquidity allocation, right? Basically trying to make liquidity as useful as possible, right? You know, in the presence of the financial technologies we’ve discussed, right? So, you know, I briefly mentioned this, right? We have this, the system that you know, the fancy word, word for it right now is AI agent, right? It’s basically an AI based system that, you know, take some data from outside and make some decisions. So in our case, it our, our AI agent is called Minerva, and Minerva basically has two, two sides to it, right? So it first takes lots of data, right, concurrent, constantly updated data from, you know, from the markets, and tries to predict the distribution of future trades. Right? For example, Tunny speak, right? And, you know, we want to know right, how many trades are going to be, you know, Bitcoin against USDC, and you know any other pair that you can think of, right? So we build this distribution of expected trades, right? And then, you know, you know, conditional this distribution, we say, well, let’s say that, you know, we have a certain number of of tokens that we can give out to our liquidity providers as an incentive for what they’re doing. Let’s say that our liquidity providers require a certain rate of return on different pools, right? We also have estimates of that. What is the best way to distribute liquidity across pools in order to maximize some sort of objective function, right? And this objective hash function can be either the overall returns liquidity providers or overall volume of trading for versions, or, you know, some combination of the two or more, something else. Okay, so the system basically tells us, you know how to distribute our rewards and our token right to liquidity providers to maximize something. And this basically the combination of the financial technology and this data science, right? Is what brings to the up to 400% increased returns to liquidity provider, right? So it’s not just financial technology, it’s also basically pretty sophisticated, I think optimization that we do to further improve, you know, the what liquidity providers earn,

Gene Tunny  58:28

right? Okay, okay, so, Minerva, I like it. That’s excellent. Oh no, we better wrap up there. Kenny, that’s this buddy for me to absorb already. And I think, yeah, I think your explanation of the potential for for crypto, with tokenization, I think that’s, yeah, I think that’s that’s worth considering. So I’ve got to think about that some more. Again. Thanks so much for your time. It’s great that you could, you could join me and, yeah, really value your insights and and learning, it’s good for me to learn and get exposure to this, and I think it’ll be of great interest to listeners. So again. Afghani, thanks so much for your time. I really appreciate it.

Evgeny Lyandres  59:12

Thank you very much for the kind words and for having me. And yeah, it was a great chat, I

Gene Tunny  59:16

think, very good. Thanks. Evgeny, all right.

Evgeny Lyandres  59:19

Thank you very much,

Gene Tunny  59:22

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 at economics explored.com or a voicemail via speak pipe. 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. You.

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