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Podcast episode

Inside Project FASTT: Real-Time Payments for All – EP278

Show host Gene Tunny and the World Bank’s Nilima Ramteke delve into the transformative impact of fast payments. They discuss how Project FASTT (Frictionless Affordable Safe Timely Transactions) bridges financial gaps and drives inclusive economic development worldwide. For example, they cover how QR codes and mobile apps make digital payments more accessible for small merchants and rural communities.

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

  • Introduction (0:00)
  • Overview of Project FASTT (2:28)
  • Benefits and Implementation of Fast Payment Systems (7:50)
  • Challenges in Implementing Fast Payment Systems (14:51)
  • Role of Central Banks and Trust in Fast Payment Systems (20:33)
  • Impact of Fast Payment Systems on Cryptocurrencies (25:53)
  • Conclusion (31:36)

Takeaways

  1. Fast payments enable 24/7, low-cost, secure, real-time transactions, making them vital for financial inclusion.
  1. Project FASTT provides a toolkit and support for implementing fast payment systems globally.
  1. Central banks, in collaboration with private sectors, play a key role in designing and implementing fast payment systems.
  1. QR codes and mobile apps make digital payments more accessible for small merchants and rural communities.
  1. Fast payments offer an alternative to cryptocurrencies in emerging markets, significantly where volatility and regulatory risks hinder crypto adoption.

Links relevant to the conversation

World Bank Project FASTT website: 

https://fastpayments.worldbank.org

World Bank paper on “What Does Digital Money Mean for Emerging Market and Developing Economies”:

https://documents.worldbank.org/en/publication/documents-reports/documentdetail/099736004212241389/p17300602cf6160aa094db0c3b4f5b072fc

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Transcript: Inside Project FASTT: Real-Time Payments for All – EP278

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.

Nilima Chhabilal Ramteke  00:03

So the inherent characteristics of FPS is to receive funds in instantly on a 24 by seven basis for 365 days over the year.

Gene Tunny  00:22

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. In this episode, I’m joined by nalimah Aram Takei, a senior financial sector specialist with the World Bank’s Payment Systems Development Group, nalima brings a wealth of experience from her extensive career, including over two and a half decades at the Reserve Bank of India, where she worked on implementing and overseeing Payment and Settlement Systems. Now at the World Bank, nalima is CO leading efforts to promote fast payment systems worldwide, including project fast FAS Double T, an initiative supported by the Bill and Melinda Gates Foundation. These fast payment systems enable frictionless, affordable, safe and timely transactions, providing critical infrastructure for real time financial inclusivity the World Bank is supporting the implementation of fast payment systems in various countries and regions, including the Gambia Mauritania, Liberia, Sierra Leone, Guinea Somalia, Central African economic and monetary community and Georgia. You can find further details via our link in the show notes. In this episode, we discuss the benefits of fast payments, their transformative potential in both developed and emerging economies, and the challenges of implementation, ensuring access to underserved populations. Before we dive in, I want to thank Lumo coffee for sponsoring this episode, economics explored. 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. Helena, thanks for joining me on the program.

Nilima Chhabilal Ramteke  02:34

Thank you for having me here. Jen, it’s good to be part of this podcast. Thank you so much. Yes,

Gene Tunny  02:40

no problem. I’m keen to learn about Project fast that you’ve been involved in at the World Bank. So project FA s TT, can you tell us a bit about the project, please, what it stands for and what your involvement has been, please. Nalema,

Nilima Chhabilal Ramteke  02:59

thank you, June for the question, and as you spelled out yourself first with the double T stands for missionless, affordable, safe, tangy transaction. This is an initiative support on past payments, supported by the Bill and Melinda Gates Foundation to further accelerate the adoption of past payments worldwide, and this is an ongoing work of the World Bank over the last two and a half decades in the field of payment systems, to basically Where we are supporting jurisdictions, as the developers say, reliable and efficient national payment systems. And this comprises a bit a lot of other things, like the legal and regulatory framework, the large value payment system, security, settlement, foreign exchange. Then we have the retail payments. One of them is the past payment, then the government payments, remittances, and also oversight and cooperation. And with the new developments which are happening, we are also supporting in the FinTech, notably on the crypto, CBDCs and open Banking project fast is a comprehensive knowledge product of the past payment FPS, and it’s organized as a toolkit across four broad thematic areas. One is the flagship reports, which covering the FPS developments framework and which incorporates the lessons learned through the wide number of technical assistance projects around the world, and also the research across all facets of FPS development. And this framework actually aims to provide the holistic tool for policy makers to manage their FPS journey and conceptualize this. Nine and implement the FPS, which again, is a continuous part. Then second is the portfolio of case studies covering a wide area of diverse experiences in terms of geography, Country Profile and the key aspects of FPS developments, such as the ownership models, payment types enabled, among the few things. Then the third point, the third thematic area, is focus notes, which we call technical notes and webinars, providing technical deep dives into topics of high relevance for fast payments, such as interoperability, cross border Overlay Services, then messaging standards. These are certain things which are there. And as part of the fourth one is a global tracker for the FPS, which provides the essentials of the past payments initiatives around the world. Our aim is to use the project fast in providing technical and financial assist support and help our client countries build technical, operational and regulatory capacity to implement the state of the art, safe, efficient and low cost past payments in their jurisdiction. Also the toolkit provides guidance on the aspects that authorities needs to consider when developing a FBA system. Another important objective of this toolkit, that is the project. First toolkit is to act as a catalyst in fostering an international dialog and facilitating a concerted agenda the global FPS development by involving global stakeholders, partners, including the standard setters like the cpmi, the central and regional central banks across the jurisdictions, And also in light of the FSB and the g20 cross border roadmap. This, this helps, and if you see the project Nexus is also referring to the the our FPS tracker, as well as part of their development thing. So these are certain things, and our aim is to keep on updating this and expanding the Toolkit by capturing the latest developments and innovations which are happening in this space. Gotcha.

Gene Tunny  07:28

Okay, so it sounds like your project. This project fast. This is providing the capability, is providing case studies lessons. So the is it typically central banks in in the countries which will be implementing the fast payments. I know in Australia, our reserve bank was involved with the, I think it’s the Osco system. If this is what we’re talking about, we’re talking about the almost real time payments that occur. You transfer money straight away to someone else or another business. And then, whereas years ago, it would have taken a day or two for it to get through, it had to, had to settle who’s implementing this in the different jurisdictions. Can you give us some examples, please? Elena,

Nilima Chhabilal Ramteke  08:13

well, it depends on the jurisdictions how they want to do. VC, the central banks themselves being implementing the system. There could be the collaboration as well between the central banks and the private or it could be a private initiative as well. But definitely the the central banks play a role as the regulator and overseer of this infrastructure. So if you, if you if you see like the, if we can go to the benefits of it as well, we can talk on that, yeah. But normally, it’s not that. It is only the central banks which we implement, like the in in Australia, like you mentioned, the NPP system. It’s like a collaborative effort, and market peers are quite involved in that,

Gene Tunny  09:01

yeah, yeah, yeah, absolutely. Okay. And so what are the what are the benefits to the the fast payments? So why would the World Bank be interested? Why would Bill and Melinda Gates Foundation be interested in this? What do they see as the benefits of it? Yeah.

Nilima Chhabilal Ramteke  09:16

So, like the past payments, like the name suggests itself. It’s instant real time for rapid payments and with various name it’s called. It’s basically a reflection of our meeting our end users demand for round the clock availability, and providing, instance, availability of funds for the pay space, in the sense the beneficiaries, and which actually resonates with the time where everything is so instant and is available around the clock. So the inherent characteristics of FPS is to receive funds in instantly on a 24 by seven. Basis for 365, days over the year, and the main characteristics of past payments, like I mentioned, it’s the instant so instance availability. It’s immediate exchange of messages from the payment messages, and immediate availability of funds for the beneficiaries. It also supports, actually, a wider area of use cases as well, like the P to P payment, person to person payments, person to merchant payments, and also supports bill payments as well. And you can the governments have also used for what to say, instant payments, or payments for the benefit in times of emergencies as well, like we have seen during the time of COVID. So many governments have used this infrastructure for transferring funds the beneficiaries as a social benefit transfer as part of this, using this infrastructure, also because of the the service the FPS, not only provides access, but definitely depends on the design as well access to the banks, but also the non bank players. And this expands the coverage and and what you say, availability of infrastructure to the underserved population as well. And this helps in facilitating financial inclusion, and this is one of the objective of the World Bank and for Financial Inclusion. And that’s why, apart from other reforms, which we always do in the payment systems, fast payments is one of the benefits out of that. Yeah, and also with the the the advent of technology, the fast payments also support QR payments aliases, like you have in in in Australia, you can use your corporate ID, your email ID. So similarly, these first payments across the globe also provide a lot of support various type of aliases. Then you have the near field communication. So this gives a good user experience, which actually has helped in expansion of the usage of the past payment one more from the merchant side as well, is the the the use of QR codes which pass payments facilitate a small merchants. Does not need to have a boss terminal. You can just have a QR pasted, printed and pasted. So it’s like an asset light infrastructure which is required, so which has also helped in the onboarding of merchants and merchant accepting digital payments on the far flung areas as well. So what we see is that the fast payments deliver a lot of benefits. It also offers as a gateway to other financial services for the other otherwise excluded population, and enabling them to get access to other financial services, like the credit which they were not otherwise having access to. And also, as I mentioned about allowing small businesses are also getting on board and and it has also helped the government to better deliver their social assistance payments, especially specifically during, especially during the crisis, pandemics or national disasters, as well a good fast payment systems also infrastructure also helps in reducing the cost and times associated with international remittances. So what we have seen is that the FPS has helped in reducing uncertainty, because you get the funds immediately responding to immediacy in a increasingly digital economy, fostering interoperability and competition. That is what we mentioned about access to banks, non banks and everybody can getting a level playing field, and also because of the support of areas. We don’t need to share your credential or bank details, you can just say, share your email ID, and that’s it. So you don’t the security aspects are also taken into account. So in a nutshell, this is where we see one of the drivers for fast payments adoption as well. Yeah,

Gene Tunny  14:36

no, it’s all it’s interesting. I mean, I like that example of the QR code. I can see how that can work. And I’d like to come back to that point you made about the underserved population and how there may be you look at what infrastructure is required, and I think we can talk about that in the challenges, the the of implementation. And okay, so I want to ask now to Lima about, what are the challenges in implementing these fast or instant payments? I think you sort of alluded to some of them before, in terms of, well, what if you have a population that’s underserved? I mean, in many emerging economies, as we know, there’s a large informal economy, still many people live and work on the land. It can be difficult to to reach those, those populations also, I imagine things like, I mean, yeah, just the basic digital infrastructure. Can you tell us a bit about the the challenges of implementing the fast payments, please?

Nilima Chhabilal Ramteke  15:37

Yeah, so I think you yourself had identified a few of that. But before we go to the challenges, probably what is required would help us. Yes, sure, yeah, standing better. What is the challenges? So for implementation, pass payments, like we see for all IT related payment systems development, it actually requires, thorough market consultation and preparation to onboard all type of stakeholders that would be part of it. It also needs to leverage bodies such as the National payments of financial institution inclusion councils. So because this is past payments we are talking about, then you need to look at those aspects as well. A lot happens also on the adaption, on the design choices, because who all will be there, how the system would be, will function, so that goes as part of the design. And because we see that the requirements varies across jurisdiction, so you cannot have one size fits all approach for this. So you have to have your systems designed to meet the needs of the country, and also needs to, because it also needs the countries, needs to, or whoever is implemented, needs to have the technical capability and the conducive legal and regulatory environment and framework for supporting that. So establishing a sound and efficient governance framework is also key, which involves that you have all your stakeholders on board. And this will also include that whatever system you design should give a good experience to the users as well. The other enabling environment which is required is the adoption of the smartphones also, if the if the smartphones are not there the country, mobile feature phones also, then you need to have the channels to support those type of transactions as well. So there is a cost cutting legal provision. So to tackle that is also key to that, and such as the cyber security aspects, because you are looking at infrastructure which is totally digital, so you need to have those aspects as well as consumer protection, because you are looking at serving population which was earlier and served they may not be financially literate. So that brings us to the challenges which are there, and some of the key challenges, typically, what you mentioned about the emerging markets is about the lack of infrastructure, both the payment infrastructure as well as the enabling IT infrastructure, also the internet penetration, specifically for the rural areas, the emerging and means markets also face issues and constraints because of the private player may not be wanting to so some of these areas also, as I mentioned about the smartphone or mobile phone penetration. So that’s an important key aspect, because we are looking at the first payments, which is more mobile based access channel. Then also, one needs to look at the financial literacy aspects, which is because we are trying to see population which was earlier, not financially included so and also because the trust the system should provide, and because so far, the economy was more cash driven, so now you’re moving from cash to a digital aspect, so you need to have all this enabling infrastructure and to overcome these challenges, we see that the Developing countries need to have a multi pronged approach that addresses all aspects of digital payments ecosystem, and not only implementing the technology but also creating and enabling regulatory environment and investing in initiatives to educate the end users, this is something which. We think is there, and towards this, we see that most of the championing role is of the central banks, which is very crucial to steer these initiatives, promote the ongoing commitment of all stakeholders. If they have also taken initiative, then there needs to be a commitment and align the interest of all private as well as public, so that these are certain things. And keeping this in mind, we also have one of our focus notes, the on this championing role played by some of the Select central banks in the same

Gene Tunny  20:39

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

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Gene Tunny  21:14

now back to the show. I mean, I guess it’d be good to talk about the central banks, because the central banks obviously play a critical role in a payment system, because the well, at least in Australia, the banks bank with the central bank, they have accounts there. They’re exchange settlement accounts. And so when there’s a when there’s a deficit from one bank to another, or when one bank has to at the end of each day. Because of the flow of funds between customers at different banks, one bank may have to transfer some money to another bank, so there’s the settlement of accounts at the end of the day, so the banks have to trust each other. So the this is what I find really interesting about this. How did the how do the banks know that, like, if someone I’m I’m a farmer, say, and I’m going to buy seed or what, some, you know, some consumables or equipment from from a merchant in town, and I make the the fast payment on my mobile phone, and I’m at a different bank from the merchant how does the Yeah, how does the Merchants Bank know that I will have the funds in my account to that so that that merchant bank will get the funds from the the buyer’s bank. So how do they know that, in real time? Is that That’s all about the it? Technology? Is it?

Nilima Chhabilal Ramteke  22:39

So this is a good question, actually, and that is the i i said, one of the benefits and trust is that the beneficiary gets the funds real time I’m making a payment, I scan the QR and I make the payment that you as a merchant would receive it immediately, and it depends on how the banks are communicating with it, but normally, most of the jurisdictions, they have gone for the immediate response to the beneficiary as well that the funds have come to your account. So this has helped in bringing the trust. But then that is on the design side as well, because on alerting, both whose account is debited, but also the account the person whose account is credited. Yes. So that alert needs to go across, but with mobile apps and all, it automatically gets updated immediately. If you are your bank is providing that service to you. So on your app, you’ll always you’ll be able to get the response of the transactions which are there. So if you see many countries, like the India’s ups as well, you are able to make payment for online purchase of airline tickets, and you can do that using your first payments. So once you give your what you say, BPA, what’s your address that is either your areas, no, like we said about corporate or email ID. Once you give that and the payment is made by the beneficiary, it immediately gives time, and it responds back to the bank that this payment has been received, and you get your airline tickets immediately issued, because of this infrastructure, which is integrated, but then that depends On the various message that flow through the system. So the merchant should be able to get the response from his bank with whom he’s banking, because once I scan the QR, I’m making a payment to the merchant. My my transaction, my account is debited, and that transaction flow this to this channel which is there, and the the merch. And receives the funds immediately, right?

Gene Tunny  25:02

So does it go from one bank to the other at the same time? Does it right? Okay?

Nilima Chhabilal Ramteke  25:11

The the, the the and that is the beauty of the system payment, real time credit on your real time credit to the beneficiary, the settlement between the banks could happen on real time, or we call at a defer net basis, depend on the design of the system so it could the settlement between the banks could happen real time, yeah, or at a designate point of time, yes. But in the end users, it’s immediate field. Gotcha,

Gene Tunny  25:39

okay, yeah, yeah. It’s all fascinating, trying to, yeah, I was just trying to figure out in my head how it must, how it must work. So, yeah, that’s great, okay, and the issue of, I find this issue of the internet and availability of that, I mean, that’s, that’s a critical part of it. I mean, mobile phones. I mean, there has been extensive mobile phone penetration through even in emerging economies, I’ve seen that. But what about the internet? I mean, does the program, I know some of this is confidential, but does project fast? Does it actually provide funding or support for connecting people to the Internet, whether it’s via actually, is it satellites or Starlink technology like that? Can you talk about that at all?

Nilima Chhabilal Ramteke  26:27

So the funding, financing of the product, a project, is for implementation of the system, but also the bank supports fraud social causes as well. So that goes as part of that social benefit, and all as part of that in some of the projects, the bank has supported the client countries as part of the not part of the project pass, but as part of the other projects where in the client countries have provided mobile instruments to the beneficiaries, so, but that that is a different channel. Totally

Gene Tunny  27:11

Gotcha. Okay, that’s fine, right? Oh, okay. And finally, I’m wondering, does does this help reduce the appeal of crypto currencies? I’m just wondering to what extent, you know, there’s a lot of buzz about crypto, and to what extent is there appeal of crypto in emerging economies, and is this something that is, this is something that is a substitute for that, or something that is will reduce the appeal of cryptocurrencies. Can you talk about that please? Yeah,

Nilima Chhabilal Ramteke  27:46

this is the good area, I think so. And yes, a lot of countries are looking at it, and the World Bank has actually published a technical note. What does digital money mean for emerging markets and developing economies. I share that link probably you can share with the and the note categorizes new digital money proposals, which includes crypto assets, and cryptocurrency is one of them, so stable coins and central bank digital currencies, the note also assesses the supply and demand factors that may determine in which countries these innovations are more likely to be adopted, and it compares actually the digital innovations such as mobile money, retail, fast payment systems, new products By incumbent financial institutions and new entrants, such as specialized cross border transport operators as well. So when we talk about crypto assets, actually, they suffer from various impediments, including high price volatility and scalability challenges, which actually prevents them from being adopted as a mechanism, as a mainstream means of payments or store of value, and much less unit of account. And this is, as per the BIS paper, 2018 I can share that link as well. And many jurisdictions have also banned the use of crypto, also due to these, these issues, but also from the angle of AMS, CFD aspects as well the other now we’ll hear more about stable coins, which has entered the free and more stable coins actually attempt to maintain a stable value relative to the fiat currency, or the basket of fiat currencies, which which they identify and but stable coins also face various challenges and post news new type of risk, particularly in the emerging and developing economies, though some of the countries have begun to accelerate. Their investigations, we see that some of the countries have started investigation into cbdc for consumers, central bank digital currency for consumers, but however, a new digital equivalent of cash, which is cbdc, also raises various challenges for the emerging markets and developing economies. We see that the research is ongoing, but it’s not yet clear whether cbdc are necessary or desirable for all jurisdictions. And when we look at this in a holistic manner with see it is it is seen that fast payments serve the payments needs of the people, and the other argument in favor of FPS is that it’s key to the needs of the bulk of the end users, because it also supports different type of use cases and the ease of with which it can be used, and also because of the cost consideration and convenience it provides, also fast payments have sort of put in place. Many jurisdiction have put in place fraud mitigation measures, consumer redressal measures as well, which could be a point in placing FPS over crypto and reducing the appeal of crypto, while we know that crypto caters to a different user base then so although and the appeal is still there for a different reason For the different

Gene Tunny  31:39

Yep, fair points. Okay, very good. Well. Nalima, thanks so much for this overview of project fast. I think, yeah, I’ve learned a lot, actually, about what’s going on and the issues with these fast or instant payments. I think that’s been that’s been really great. Is there anything you think we missed? Anything that’s worth reiterating before we wrap up, please.

Nilima Chhabilal Ramteke  32:02

Yeah, I would, I would like to, once again say about thanks for having us. And I would like to share the link of the fast payments as well, probably because this has a good publication on the past payments, on the focus notes, as well as the research which has gone into that. And people who are interested in the subject would also benefit out of this. So yeah, absolutely.

Gene Tunny  32:25

I’ll share that in the show notes. Okay, malema, thanks so much for for joining me this episode. I’ve I’ve really enjoyed the conversation. I’ve learned a lot. So thanks again. Thank you so much for having me. Thank you, 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 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

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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
Economic update

Does Quantitative Easing primarily benefit the wealthy?

Couple pouring champagne into wineglasses on yacht

With aggressive fiscal and monetary policy responses to the 2008 financial crisis and the COVID-19 pandemic, new evidence has emerged of the unintended consequences of activist macroeconomic policies. This article considers the impact of Quantitative Easing (QE) on wealth inequality.  It is cross-posted on www.adepteconomics.com.au. 

QE is an unconventional monetary policy used by central banks such as the US Federal Reserve, Bank of England, or RBA to stimulate the economy. It was widely employed in the aftermath of the 2008 financial crisis and during the COVID-19 pandemic. QE involves the central bank purchasing government bonds and other financial assets with newly created money and is intended to lower long-term interest rates. While it is designed to benefit the overall economy, there is a debate about its impact on wealth inequality. 

Some argue that QE has primarily benefited the wealthy, as it has increased the value of financial assets, such as stocks and bonds, predominantly owned by the rich.1 This has resulted in a significant boost to the wealth of the wealthiest individuals and households.2 However, proponents of QE contend that it has prevented a deeper economic slump and reduced income inequality by preventing larger increases in unemployment.3 The distributional effects of QE are complex, and its impact on wealth inequality remains a topic of ongoing research and discussion.

Professor Gerald Epstein of the University of Massachusetts Amherst is one of those who argues that quantitative easing primarily benefited the wealthy. At the same time, its effects on employment and the cost of capital for borrowing were relatively modest. Professor Epstein expressed this view in an interview on his new book Busting the Bankers’ Club in Economics Explored episode 226. You can listen to the conversation wherever you listen to podcasts (e.g., Spotify) or use the embedded player below. 

Professor Epstein suggests that the main impact of QE in the United States was an increase in the wealth of the wealthy. This is because the rise in asset values, resulting from the central bank buying up these assets, primarily benefited those who already held significant assets, such as banks and other wealthy individuals. On the other hand, the cost of capital reduction for borrowers and investors was relatively modest.

Did Quantitative Easing Increase Income Inequality?

Professor Epstein does not argue that the Federal Reserve intentionally pursued a policy to benefit the wealthy primarily. Instead, the impact of the policy was an unintended consequence of quantitative easing. The increase in asset values and wealth accumulation for the rich due to QE can further widen the wealth gap. At the same time, the modest impact on employment and borrowing costs may not effectively address the needs of the bulk of the population.

The findings mentioned in the podcast conversation align with studies conducted in other countries during the same period, which also found that QE had a greater impact on asset values and wealth accumulation for the wealthy than on employment and borrowing costs. The European Central Bank (ECB) published a study showing that QE in the Eurozone primarily contributed to an increase in the wealth of the richest 20% of the population.4 Additionally, a report by the UK Parliament’s House of Lords Library stated that QE is likely to have exacerbated wealth inequalities in the UK. However, it noted Bank of England analysis concluding the effect was relatively small.5 Research published in the Oxford Bulletin of Economics and Statistics found that expansionary QE via asset prices led to net wealth inequality increases on some (but not all) metrics for most countries under review.6

These findings suggest evidence broadly supports the claim that QE has disproportionately benefited the wealthy and exacerbated wealth inequalities. However, it may only be a small net impact as there are effects in both directions. While many households benefit from house price growth, those at the top of the wealth distribution disproportionately benefit from financial asset price increases. 

Regarding the Australian experience, the Housing and the Economy study by UNSW and University of Glasgow researchers surveyed experts and found that two-thirds of economists either agreed or strongly agreed that “ Monetary policy reliance on low interest rates and Quantitative Easing has exacerbated inequality by boosting the prices of housing and equities.” However, this was based on a sample of fewer than 50 economists, so we should note that it would be subject to substantial sampling error.

In a 2021 Agenda paper, leading Australian macroeconomist Stephen Anthony identified the contribution of QE to “the enormous widening of inequality across advanced economies.” Anthony saw some value in QE as an “expedient remedy for short-term crisis management”, but he was mindful of its adverse longer-term consequences, such as impacts on inequality and economic efficiency. The adverse efficiency impact can occur because cheap money can end up directing significant resources to “lower-valued activities.” These could include the activities of some tech companies that saw valuations soar as ultra-low interest rates meant that speculative gains in the distant future had higher expected values in the present (see Investopedia’s explainer How Do Interest Rates Affect the Stock Market?).   

While some studies suggest QE has primarily benefited the wealthy, some research has also found evidence to the contrary. For instance, a study by the European Central Bank (ECB) indicated that its QE program increased the net wealth of the poorest fifth of the population by 2.5 percent, due to QE lowering the interest rate paid by this group on their debts, compared with just 1.0 percent for the richest fifth.7 However, it’s important to note that the overall consensus from multiple sources and studies suggests that QE has exacerbated wealth inequalities and primarily benefited the wealthy.

This article was authored by Economics Explored host Gene Tunny. For further information, don’t hesitate to contact us via contact@economicsexplored.com.

Endnotes

  1. https://www.theguardian.com/business/2012/aug/23/britains-richest-gained-quantative-easing-bank
  2. https://www.positivemoney.eu/2017/04/ecb-shows-qe-benefits-richest/ and https://positivemoney.org/press-releases/qe-richest-gained/
  3. https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
  4. https://www.positivemoney.eu/2017/04/ecb-shows-qe-benefits-richest/
  5. https://lordslibrary.parliament.uk/quantitative-easing/
  6. https://onlinelibrary.wiley.com/doi/full/10.1111/obes.12543
  7. https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2170.en.pdf, p. 17.
Categories
Podcast episode

Do central banks stabilize or destabilize economies? w/ Addison Wiggin, NYT-bestselling-author – EP196

The episode delves into the effectiveness of monetary policy by central banks in managing the economy over the business cycle. Do the actions of central banks stabilize or destabilize economies? Show host Gene Tunny chats with Addison Wiggin, a bestselling author, market economist, and host of the Wiggin Sessions podcast, about monetary policy and financial crises. Addison also shares some reflections on the US debt ceiling drama. This is part 2 of the conversation Gene held with Addison in early June 2023, the first part of which was released as EP192 on the US banking crisis. 
Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. 

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

About this episode’s guest: Addison Wiggin

Three-time New York Times best-selling author, Addison Wiggin, is a 30-year market economist with a passion for the real-world impact of financial markets on our lives. Addison is the author and host of The Wiggin Sessions, a podcast that connects key thinkers and industry experts for a deep dive into history, politics, and economics. Some of his most accomplished works as a writer, publisher, and filmmaker include the New York Times Best Seller The Demise Of The Dollar and the documentary I.O.U.S.A, an exposé on the national debt crisis in America.

What’s covered in EP196

  • How is it that the US dollar can be the reserve currency of the world? (2:37)
  • Why not just accept that the business cycle is a thing and not do anything about it? (7:25)
  • Minsky’s instability thesis. (11:42)
  • The debt ceiling is just political theater. (16:52)
  • Central bankers and economists thought we’d solve the problem of business cycle management. (21:29)
  • How monetary policy was determined during the Gold standard era (25:06)
  • When the Federal Reserve presided over the contraction of the US money supply as multiple banks failed, the money supply fell 30% from 1930 to 1933. (30:17)
  • What does all this mean in the current context? (35:54)
  • Central banks need to choose wisely and they need some methodology to do so. (41:23)

Links relevant to the conversation

Part 1 of Gene’s conversation with Addison:https://economicsexplored.com/2023/06/18/exploring-the-us-banking-crisis-with-addison-wiggin-ep192/
US Federal Reserve on what happened to monetary policy during the Great Depression, “From the fall of 1930 through the winter of 1933, the money supply fell by nearly 30 percent.”:
https://www.federalreservehistory.org/essays/great-depression
Episode with Stephen Kirchner in April 2022 in which the “lean versus clean” debate was discussed:
https://economicsexplored.com/2022/04/20/nominal-gdp-targeting-w-stephen-kirchner-ep135/
Till Time’s Last Sand: A History of the Bank of England by David Kynaston:
https://www.amazon.com.au/Till-Times-Last-Sand-1694-2013/dp/1408868563

Transcript:
Do central banks stabilize or destabilize economies? w/ Addison Wiggin, NYT-bestselling-author – EP196

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It was then checked over by a human, Tim Hughes from Adept Economics, to pick out any clangers that otters sometimes miss. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:06

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 this show. In this episode, I chat about monetary policy and financial crises with Addison Wiggin, The New York Times bestselling author, market economist and host of the Wiggin Sessions podcast. This is part of the conversation that I had with Addison in early June 2023. I broadcast the bulk of that conversation in an episode on the US banking crisis a few weeks ago. But this bit I’ve held back I held it back to this episode, because I wanted to have more time to reflect and comment on the excellent points that Addison makes in this segment. Please stick around until after my conversation with Addison for some additional thoughts from me on the issues. I should note that this conversation that we have about monetary policy, it was triggered by an observation that I made about recent market movements in the Australian dollar in early June 2023. So my observations about the exchange rate are dated. But the discussion which follows is evergreen. Okay, let’s get into the episode. I hope you enjoy my conversation with Addison Wiggin.

It’s interesting how markets react Yeah, it’s just, we just had this situation where because we had this surprise, monthly inflation number, and then we had the minimum wage decision or the award wage decision yesterday, then the markets go oh that makes it more likely that the central bank here the Reserve Bank will increase the cash rate. And so what we’re seeing now is that the dollar has appreciated against the US. So it was going down, it was going down to below 65 cents US and now it’s back up to around 66. Yeah, it’s funny how…


Addison Wiggin  02:37

And that’s one thing that I wanted to point out, because I think it’s it’s a concept that a lot of people either have trouble with, but in this book, I so I’m going to hold up the book again, because I think it’s worth the read. It’s pretty short. And my son helped me write it for millennials. So it’s like a quick read. But I was trying to wrap my head around, how is it that the dollar can be the reserve currency of the world? Meaning it’s the place where people, other banks and like big corporations hold their asset value? And how can we have that at the same that gives the United States a massive amount of advantage globally, when making trade deals, and whatever selling guns to go shoot Russians or whatever, whatever people want to do, we can do that, at the same time that we have inflation domestically, because there’s a difference between the reserve currency of the world which, you know, the Central Bank of Australia is going to is going to make deals with the Federal Reserve. Like that is an exchange trade thing. Or if I don’t know if Apple wants to open a plant in Brisbane or something like those exchanges happen in US dollars. And a lot of the commodities that Australia exports are priced in dollars, gold, and their earths and copper, like those things, they’re all priced in dollars. So there’s a tremendous advantage for the for the US economy that we have the reserve currency of the world, but at the same time, we have a payment currency, which is the stuff that we buy eggs in or we finance our homes or, or we take out loans to put our kids through school, whatever, that you can have massive inflation in that at the same time that the stability of the reserve currency. You know, you were talking about a penny between, it used to be five now it’s six or six like it’s pretty, pretty stable, globally. It’s a freaking nightmare at home when they can’t figure out how to slow prices down or the bizarre thing that we were just talking about. They want people to they want the unemployment and the jobs number rate to go up, but they actually want that to be the result of slowing the economy.


Gene Tunny  05:00

Well, yeah, I mean, they want a sustainable rate of economic growth and you want to avoid the overheating economy, you want to avoid the, the huge boom and followed by the, the big bust. And that’s a concern. I mean, in Australia what we’ve had because particularly because in a combination of the massively generous pandemic response, I mean, just like nothing that was just ever expected. And I mean, incredibly generous to, particularly to small business people, and also to welfare recipients who had their, if you’re on the Jobseeker you had that doubled, compared with what it was before, for maybe six months to a year. And there’s all this and people were allowed to pull money out of their retirement savings, their superannuation, their compulsory super, so there’s all this extra money. And I mean, the boom we had was just incredible. And unemployment nationally got down to three and a half percent. And I mean, I never thought it would go below four, like we we thought full employment in Australia was around, or the natural, the non accelerating inflation rate of unemployment or natural rate of unemployment, we thought it was around 5%. And then suddenly, it’s got unemployment rates got down to three and a half percent never thought we’d see it. Cutting off immigration was possibly part of that for a time. But the idea is to try and set the interest rate so that the economy doesn’t get on, I mean, you know, this, it doesn’t end up in that boom bust cycle or that or it’s not as amplified as it as it would be, if you…


Addison Wiggin  06:33

Yeah, so that I my issue with that is that they that’s that was the idea of lowering interest rates for as long as they did is that they wanted to mitigate the boom bust cycle. They wanted to use the tools that they had from history to figure out a way to mitigate the booms, but also mitigate the busts, they wanted to like level the whole thing out. And look what happened, we had a pandemic. And then we had, we had to throw a bunch of money at citizens, and then they saved it, the savings rate went higher than the credit rate at one point on each money. And then as soon as the market I mean, as soon as the economy started opening again, it plummeted all the way to the lowest rates, we saw the the fastest rate of disposable income drop, since 1933. It just went whoo bump. Like they did anything but mitigate the business cycle. In, in my view, I mean, I’m just a guy who studies and writes about it and talks about it write books about it, whatever. But in my view, why not just accept that the business cycle is a thing and not do anything about it? Let, let credit go to the market price that is this, it’s designed to go to, don’t have a central bank that is trying to manipulate overnight rates so that their buddies on Wall Street can get, can keep funding their projects and stuff. It messes with the natural cycle of booms and busts. And that’s what I honestly believe would would do away with these kinds of massive inflationary cycles that we go through, or the opposite, which they’re really afraid of, which is a deflationary period where they can’t sell anything, and the economy just falls apart. That’s what happened in the 30s. I’ve been reading a lot recently about what’s going on, what went on in the 30s. And that’s when we got all these regulatory agencies, it’s probably about the time that Australia started enacting its own financial regulatory systems too. They don’t help. And in fact, they’re always late and they’re always wrong. So it’s like, they’re not mitigating the business cycle. And they’re not actually helping anyone be more honest and truthful in the marketplace. It’s it’s politics, and it’s nastiness. And nothing actually, like they’re not achieving anything. And I’m costing, casting a wide net here because I’m talking about regulatory agencies within the financial network, like we’ve got the SEC, we’ve got the FTC, we’ve got the CFTC, there’s a bunch of lawyers out there trying to stop people from doing anything under the guise that they can mitigate the boom and bust cycle, and that’s just the natural order of things. That’s capitalism. Let’s, let’s go. That’s the way I look at it.


Gene Tunny  09:44

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


Female speaker  09:49

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

Gene Tunny  10:19

Now back to the show.

Yeah, look, I think there’s, I think some of the fine tuning they’re doing or if that’s the right term, I think there’s there is a concern that some of it may actually be contributing to the instability of the economy. I, I think that’s right. What Bernanke would argue is that if he hadn’t, so if we go back to say, ’08, I mean, he would argue in, you know, Paulson and Tim Geithner, they would argue that if they hadn’t done what they did, or some variation of it, you could have had a rerun of the 1930s. And you could have had unemployment of 20%, or something, or whatever you saw during the Depression. I don’t know to what extent that’d occur, but that’s what their argument would be. Yeah, it’s a it’s it’s something I’ve been thinking about. I mean, I don’t really know the answer myself. I am concerned like you that a lot of the actions that they’ve taken have contributed ultimately contributed to instability rather than making things more stable.


Addison Wiggin  11:26

Yeah, well, let me go back to Hyman Minsky who was writing in the 50s. And he was mostly describing what he read, he lived through the 30s. And then when he was an adult, he was a professor, I think, at MIT. And he was talking about, like, his area of study was the 1930s. And he studied like Schumpeter, and those guys who were writing during that time, Garet Garrett is another one that I’ve been sort of fascinated with. Because as we’re moving through our own like situation, the the stuff that I read, sounds like it was written yesterday, but it was written in like 1932, or whatever. So Minsky’s idea was the longer you have a period of stability, the stability, it, it’s actually called the Minsky Instability Theory, that the longer you have periods of stability, the more mistakes get made, and the inevitability of a crash is going to happen. So artificially creating periods of stability by lowering interest rates, or by keeping them low for longer than the market demands, or by incentivizing the couple of the things that were talking about before 2018, were alternative energy, and areas of the market that had been underserved by the regular stock market, they were passing political motives, or political policies that encouraged, you know, wind and whatever, I wish they had gone into nuclear at that time, but they failed, they missed on that one. But there was a lot of money going into areas of the market that that weren’t rewarded by a return on equity, like money that was put in was not rewarded. And so there was a shit tonne of money going into areas of the market that didn’t deserve it for a long period of time. And so the Minsky instability thesis is that when you do that, for a long period of time, there’s people make mistakes, they don’t, they don’t get punished by the market, that’s a kind of a harsh way to say it. But they don’t, they don’t lose their money, they get rewarded for making bad mistakes that are based on policy. And if that goes on long enough, when you have to clean up the mess after that, which is what Powell has been trying to do, it’s hard to figure out what Powell even thinks, but when you have to clean up the mess, then all of those mistakes that were based on false premises. They come to light in that, like if you’re watching anything of the financial news, currently, that’s each headline is about the mistakes that were made in like 2015 or 2018. Or what the hell happened during the pandemic. Like we’re still cleaning up that mess and we don’t know, a way forward other than this debate of whether the Fed is going to lower either pause or lower rates again, like that’s the only tool they have. They will they have two tools, they have one, they can lower rates and then other central banks around the world will follow. Or they can engage in another round of QE and support specific industries. Like I think we’re gonna see a heavy push either later this year or early next year to support in industries that are trying to develop new technology for cleaner energy, just because there’s so much private equity going into that space right now. That when they start losing money as they have been, there’s going to be a push for government to step in and bail them out.


Gene Tunny  15:24

Right, okay, even though, I mean you, you’ve just you’ve narrowly averted a debt default, haven’t you? And they’re going to have to have some cuts in discretionary spending. So yeah, I guess, yeah, maybe they’ll find some way to do it. But the


Addison Wiggin  15:39

let’s let’s talk about the debt default for just a second. It’s so absurd. Like, I’m like just a citizen of the United States. I grew up here. My dad is mildly conservative. I don’t really give a shit about politics at all, because I mostly think that they’re talking out of one side of their mouths, and then they’re making deals behind doors somewhere else, right. So the idea that we have a debt ceiling came about because Congress used to have to justify all of their spending every year, they had to, once they pass the budget, they had to like stand up and say, We want to spend money on this highway to do this, or this pipeline to do that, or whatever. They had to justify it. But when we went into the very expensive wars that we’ve been involved in World War One, World War Two, Korean War, war on poverty, war on drugs, war in Vietnam, war in Afghanistan, that’s our longest one, like you can’t justify spending that hasn’t happened yet. So they put the debt ceiling in place in 1960. Saying that, well, you can just spend money on whatever you want. But it can’t go above this amount. And 78 times now, I think it’s 79. Now that they’ve just reached a new deal, they’ve had to raise the debt ceiling since 1960. Like, the whole concept of a debt ceiling is just political theatre and it’s not even a useful tool to anyone. It just makes people anxious. I actually started watching the market. I was like, When is this gonna start impacting the market May 18. Nothing in the financial news. Like the banking crisis got wiped off the headlines, which I think is still sustaining right now. We’re gonna see more banks fail. And people other than the NVIDIA boost that we got last week, when AI started grabbing all the tech people’s attention, the markets were just trending slower and slower, lower, like, they were just kind of trending now. And everybody was waiting for Kevin McCarthy and Joe Biden, to come to an agreement. That’s it, it was like really boring. And all they were trying to do is figure out how much they’re going to pay their defence contractors, their buddies who make weapons to send to Ukraine, and that’s literally all they were talking about, one of the things they were talking about is the Republicans wanted work requirements for food stamps. And the Democrats didn’t want that. They just wanted people to get food stamps. And then there was a third one that was a pipeline from West Virginia to Virginia and the Democratic Senator Manchin, Manchin, wanted it to go through and the Democratic senator from Virginia didn’t want it to go through because his constituents, it was going to go through their farms, and they didn’t want it to go through their flocks. The details that they were fighting over were minuscule compared to that $31.4 trillion debt ceiling that they were arguing about. It’s all politics. It’s meaningless, and it’s it’s a charade that comes up and they supposedly put a cap on it for two years, but I’m gonna guess they’re gonna spend more than they agreed to. And we’ll be in this boat again next year or, or in 2025.

Gene Tunny  19:16

Yeah, because you’ve still got the problem of the unsustainability a lot of the the automatic spending really the


Addison Wiggin  19:24

Oh, yeah, that wasn’t even, that was off the table from the beginning. They’re like, Yeah, of course, they Social Security and Medicare and Medicaid and all that. We’re gonna pay that and that is adjusted according to the inflation rate, which earlier this year or late in 2022, it was 9% so that the adjustments were already baked in.


Gene Tunny  19:51

So unless they’re gonna do something about that, or you know, the alternative is to actually increase tax revenue, but no one wants to do that. And so if you not gonna do do that, then you do have to tackle those entitlement programmes. And again, you know, Donald Trump says, I’m not going to touch them. And so the other GOP people, they’re probably not going to do it want to do anything about it?


Addison Wiggin  20:12

It’s kind of ridiculous because one of two, or actually, both of two things need to happen. And I’m like, Libertarian, I don’t I I’m not, I don’t even vote. So for me to say this is like, I’m just talking about the economics, not the political side of things, but they need to raise taxes. And they have to cut spending, there’s no way out of this any other way, unless they can get a bunch of dumb ass central banks around the world to keep funding our debt by buying bonds. Like that’s, it’s just like, if, if I tried to teach this to a, you know, a class of like third graders, they would be like, those don’t make sense, like we can’t spend more than you take in and you have to borrow it from people who don’t like you. Pretty obvious that it’s unsustainable. And yet we tell ourselves day by day, week by week, month by month, year by year that we can do this forever.


Gene Tunny  21:24

Okay, I hope you found that informative and enjoyable. I think Addison made some great points about the effectiveness of monetary policy. At times, it may well have contributed to economic instability. Prior to the 2008 financial crisis, central bankers and many economists had thought we’d solved the problem of business cycle management. Inflation targeting policies were seen as contributing to the period known as the Great Moderation with low inflation and less volatile economies. But as we know, now, the victory was short lived. The fundamental problem of business cycle management has not been solved. It’s possible inflation targeting central banks, they didn’t pay enough attention to the financial risks that were building up in economies. They were too willing to cut rates to shore up financial markets with a view to preventing a wider panic which could cause a recession. There was the so called Greenspan put, named after Alan Greenspan, who chaired the Federal Reserve from 1987 to 2006. It was called the Greenspan put through a comparison to a put option in financial markets. So that’s an option, which allows the owner of stocks to lock in a certain price at which they can sell the stock in the future. There was a view in financial markets that Greenspan would intervene to shore up stock prices so they wouldn’t fall too much. Arguably, this created a moral hazard and encouraged excessive risk-taking in financial markets. So monetary policy could actually have been destabilising. I should note, there is an active debate on the extent to which and whether the central bank should intervene with a view to avoiding the accumulation of financial market risks. So this is the so called Lean versus Clean debate that I discussed with Steven Kirschner in Episode 135 in April 2022. So please check out that episode if you haven’t listened to it yet. I will put a link to it in the show notes. There’s no doubt that the monetary policy actions of Central banks can have significant impacts on economic activity, whether on the whole they are stabilising or destabilising is difficult to assess. In the 60s and 70s, Milton Friedman argued that the best thing for central banks to do would be to adopt a money supply growth rule, so committing to growing the money supply by a certain percent each year. This turned out to be easier said than done and Friedman’s approach known as monetarism was widely seen as a failure. We might come back to monetarism in a future episode for a closer look at how it was implemented and what went wrong. There’s a fascinating story there. The key point is that there’s been a an active debate for decades on the right way to conduct monetary policy and various approaches have been tried. We we’re still grappling for the right approach. The challenge is that central banks need some Northstar for setting monetary policy. So whether it’s inflation targeting or nominal GDP targeting, the latter being something that Stephen Kirchner advocated for in that discussion I had with him last year. It’s no longer as easy as it was during the gold standard, for instance. So if we look back to that period in history. In a 1908 speech to his Manchester constituents, Winston Churchill, who was then the President of the UK Board of Trade, he explained how the gold standard guided the hand of the Bank of England in setting its monetary policy rate, known as the bank rate. If England buys from America or Germany, more than she intends to buy having regard to our own productions, instantly, there is a cause for the shipment of bullion, that is gold, and bullion is shipped to supply the deficiency, then the bank rate is put up in order to prevent the movements of bullions. And the rise of the bank rate immediately corrects and arrests the very trade, which has given rise to this disparity. That quotes from David Kynaston’s excellent history of the Bank of England. Till time’s last sand, if I remember correctly, I’ll put a link to that book in the show notes. So if you want to get a copy of it, you can find it on Amazon. It’s a terrific read, and lots of great history in there. And yes, that quote from Churchill, is in there. So as the quote from Churchill suggests, setting the bank rate, or the federal funds rate in the age of the gold standard, would have been much simpler. Now, that’s not necessarily an endorsement of the gold standard as that system had its problems and economists such as I think it was Eichengreen, Barry Eichengreen have argued that the gold standard ended up contributing to the Great Depression. So there’s a, there’s a big debate around that, that we probably don’t have time to go into now. Going back to the gold standard, isn’t realistic. I’m just making the point here that in history, when there was a gold standard, it was more obvious what should be done with the monetary policy rate, the bank rate in the UK, the federal funds rate in the United States, or the cash rate in Australia. So we’re no longer in that era of the gold standard or even Bretton Woods, the era of fixed exchange rates, which ended in the early 1970s. And because of that, it’s much less obvious what should be done with with these policy interest rates of central banks, so we’re still trying to figure that out. Econometric evidence is only so convincing so any econometric evidence on which monetary policy regime might be more effective than others, which one might have lower inflation and lower economic volatility measured by the volatility of GDP, for example, it’s only going to be so convincing, it’s not going to convince everyone that there’s just so many influences on the economy, that it’s just very difficult to determine whether any particular policy, whether it’s making the impact, the size of the impact, it’s difficult to know what would happen in the absence of a specific monetary policy change. It’s difficult to know what the right counterfactual is so we can’t run controlled experiments in macro economics, there’s no, we can’t treat the economy like a laboratory in which we can test alternative monetary policy so we’re left with questions that are difficult, if not impossible to answer. For instance, what would have happened if the Fed hadn’t intervened so aggressively during the financial crisis or the pandemic? Would we have had repeats of the Great Depression? That was what the policymakers that was what the central bankers were worried about. Look, it’s hard to know there are many factors to consider, for instance, is fiscal policy fiscal policy is is set in a much better way in the post war era than it was during the depression or before that. We have automatic stabilisers in the budget such as progressive taxation and unemployment benefits and they can help prevent economic activity from collapsing and so therefore, there may be less case for an aggressive monetary policy response. So there are other things to consider it’s a very difficult question to answer. Regarding times of economic crisis we could ask, was aggressive monetary policy, so an aggressive monetary policy stimulus was that required, so was it required, or instead, did we simply need a monetary policy that didn’t make things worse. So there is an argument that the Great Depression was caused by bad monetary policy. When the Federal Reserve presided over the contraction of the US money supply as multiple banks failed. The US money supply fell nearly 30%, from 1930 to 1933. So that’s a statistic that you can find on the US Federal Reserve website. I’ll put a link in the show notes. As Ben Bernanke admitted to Milton Friedman in 2002. Regarding the Great Depression, we did it. We’re very sorry. We won’t do it again. That was Bernanke responding to the strong argument that Milton Friedman and Anna Schwartz made in their famous monetary history of the United States from the early 60s. It only took the Federal Reserve 40 years to to admit they agreed with Friedman on that. Now, if you do have a, an emergency, a major economic crisis, then look, the arguably there is scope for a monetary policy response, most economists, the large majority of economists would accept that there has to be some sort of central bank policy response, and probably even a stimulus of some kind, although there’d be debates on just how much that should be and how large it should be. One of the problems I think we’ve been we’ve had recently is that the well, the monetary policy response during the COVID period, when combined with the fiscal policy response was just massive, and it’s been massively destabilising. And it contributed to a very strong recovery, I mean, massive, massively. A very strong recovery in excess of anything that we really expected. And that’s contributed to the inflation that we’re experiencing that that we’re seeing in the United States and the UK and Australia. It’s, it’s what’s happening in Ukraine, of course, but it’s also a lot of it to do with just that, you know, the after effects of that massive fiscal and monetary policy response. So unintended consequences of of that, that policy response. So look, I think economists would accept that there is scope for some stimulus, some response in the face of a massive shock, adverse shock like that, but it looks like it was really over done. And then there’s the issue of just what central banks should do. Outside of these major crises just in the sort of normal course of events or the over the course of the business cycle, to what extent they, they should be actively managing interest rates, trying to control the money supply, trying to influence the course of the economy. There’s a big debate over that, this idea of fine tuning. Now, when I was studying in the early 90s, when I was at uni, the leading macroeconomics textbook at the time was, well it was called macro economics. It was by professors at MIT. So very famous professors Rudiger Dornbusch, and Stanley Fischer. I think Stan Fischer went on to be the governor of the Central Bank of Israel, if our if I remember correctly, he was a former Vice Chair of the Federal Reserve, and he served as the eighth governor of the Bank of Israel, from 2005 to 2013 so very distinguished economist, and what he wrote with Rudiger Dornbusch, in that textbook, they wrote that in discussing the desirability of activist, monetary and fiscal policy, we want to distinguish between policy actions taken in response to major disturbances in the economy. So, I was just talking about that earlier when we think about incidents like COVID or the financial crisis, or the depression. So there, so back to the quote. So in discussing the desirability of activist monitors monetary and fiscal policy, we want to distinguish between policy actions taken in response to major disturbances in the economy. and fine tuning in which policy variables are continually adjusted in response to small disturbances in the economy, we see no case for arguing that monetary and fiscal policy should not be used actively in the face of major disturbances to the economy. Fine tuning presents more complicated issues. The case for fine tuning is a controversial one. I think that’s a good summary of how economists think about monetary and fiscal policy as well, that was written in the early 90s but I think that is still a good summary of, of what the consensus would be. So what, what Dornbusch and Fischer were getting at in terms of the problems with with fine tuning, they’re thinking about the problem there is that you’re not sure whether a particular shock to the economy, is it permanent? Is it transitory? Is this just a normal part of the business cycle, and therefore, you shouldn’t really react to it. There’s also there’s the issue of of lags in policymaking, it can take time to recognise disturbances in the economy, then can take time to implement policy and for that, to have an impact on the the economy. So there are these lags, which complicate macro economic policy. And they mean that the case for having an activist policy, so trying to be clever in how you’re setting interest rates and making these fine adjustments to interest rates. It does make you wonder, just the extent to which we can do that the extent to which our policymakers will get that right, and won’t actually contribute to instability in the economy, which I think is a significant risk. What does all this mean, in the current context? Well, it probably would have meant after we got out of the, the emergency period during COVID, and it was clear that the economy was recovering very strongly. And inflation was a risk, I think, thinking about this, all these points that, that I’ve been discussing here, I think, possibly central bank should have increased interest rates much faster, they should have got them up to perhaps what you might call a neutral rate, or a bit higher than a neutral rate much more quickly than they did. And then leaving them there and not not adjusting them every month or every couple of months, depending on how various economic variables are tracking. I mean, it gets a it gets very difficult to, to do that, and to be sure that you’re making the right judgement. So perhaps that’s one, that could be an interpretation of what central banks could have done if they recognised that this whole approach and fine tuning so to speak, is is not really optimal. I think it’s an open question. I’m not necessarily saying that I’m not saying okay, this would have been the right approach that there isn’t, there isn’t still the potential to fine tune the economy, there may well be, but it’s not clear that some other approach may not be superior. And so therefore, I don’t think you can actually reject the hypothesis or reject the argument that these frequent adjustments of policy interest rates, they could actually contribute to economic instability. We, I think that’s, that’s a question economists should be thinking more about. So there are certainly real examples of where the monetary policy response as part of a fine tuning approach was probably excessive, and it sent the economy into recession. The example I always come back to is the early 1990s recession in Australia, which was arguably deeper than it should have been, much deeper. The unemployment rate went up to around 11% in 1992, our central bank, the Reserve Bank, increased interest rates to around 17 to 18% to slow down the economy so in Australia, we had this colossal boom in the 80s. It was the age of the entrepreneur. And there was a lot of investment particularly in commercial property. And the central bank intervened aggressively, it was also worried about the balance of payments, the it was worried about the current account deficit. And it thought that very tight monetary policy was justified. And at the time, they thought, Oh, well, the economy can handle this, they did their economic modelling the Treasury and the RBA, they were forecasting a soft landing for the economy, it turned out to be the worst downturn since the Great Depression. So when I think of that incident, I’m always reminded of just how difficult it is to fine tune the economy, so to speak, and, and looking back on it that early 90s recession, it happened when I was in high school, and it was something that really made me interested in economics. And it made me actively think about studying economics and, and even eventually becoming an economist. So that was one of the incidents that that stimulated my interest in economics for sure. Okay, so we’re going to start wrapping up this afterword. Central banks, they do need to set policy rates, so they’re at the centre of the monetary system, they can control the amount of liquidity in the overnight money market. So in the cash market, as we call it, in Australia. And that ends up setting the benchmark for interest rates across the economy. So central banks are playing a very important role in our monetary system in our, in our payment system in our financial markets. They need to choose wisely. And they need some methodology to do so. So whether it’s set and forget, some sort of set and forget methodology or some type of rule, whether it’s inflation targeting, nominal GDP targeting, some other method, they need something to help guide their decision making. And we still haven’t figured out what that should be. So for a while, we thought that inflation targeting was the right methodology but that’s imperfect, we’ve learned. Some critics of inflation targeting they argue, it’s given us too much financial instability. Other critics come at it from another direction, they argue central banks, they actually didn’t fully follow the inflation targeting policy, it hasn’t been properly implemented. So they would argue that central banks should have had looser monetary policy during the 2010s so that they could have got the inflation rate up. So it got into the target range. And, and they would argue that what we ended up getting was lower growth, lower employment, higher rates of unemployment than otherwise. So we’ve got criticisms of inflation targeting for a variety of reasons. So it looks like it hasn’t. It hasn’t lived up to the promise it, it’s been imperfect. Okay, in summary, there’s still an active debate over how to conduct monetary policy when it comes to fine tuning the economy. It’s possible that at times central banks have actually contributed to economic instability. We can’t say definitively one way or another, whether their policy actions have been stabilising or destabilising on average. I think that’s fair to say. That’s my interpretation of things. If you’ve got a different view, then please let me know. I would love to hear from you. I think that central banks are trying to do the best they can, I mean arguably, they have helped prevent a rerun of the Great Depression at at certain times, particularly in 2008, you could probably argue that actions by the Federal Reserve, in particular did help prevent a much more severe downturn, although that was a very bad downturn already. But look, outside of those sort of incidents, I guess maybe during COVID, the assistance was was was definitely some assistance was needed but then they overdid it, and now we’re suffering from the high inflation. So look, possibly they do some good in times of crisis, but then, in other times, it’s hard to know they could actually be destabilising. This is one of these issues where it’s difficult to read the evidence. And it’s, it’s unclear, and we’re still trying to figure things out. So that’s not a great answer. But that’s my understanding of what the evidence and the theory tells us at the moment. So yep, if you’ve got a different view, let me know. So any thoughts you have on what Addison or I had to say in this episode, please get in touch. You can email me via contact@economicsexplored.com. Thanks for listening.

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.


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Podcast episode

Exploring the US Banking Crisis with Addison Wiggin – EP192

Economics Explored host Gene Tunny interviews Addison Wiggin, a New York Times bestselling author and market economist, about the US banking crisis. Addison shares insights into the origins and impacts of the crisis, and discusses the future of the US economy and financial markets. Listeners can download Addison’s recent report “Anatomy of a Bust: Winners and Losers in the Banking Crisis of 2023” for free via a link in the show notes. 

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

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

About Addison Wiggin

Three-time New York Times best-selling author, Addison Wiggin, is a 30-year market economist with a passion for the real-world impact of financial markets on our lives.

Addison is the author and host of The Wiggin Sessions, a podcast that connects key thinkers and industry experts for a deep dive into history, politics, and economics. Some of his most accomplished works as a writer, publisher, and filmmaker include the New York Times Best Seller The Demise Of The Dollar and the documentary I.O.U.S.A, an exposé on the national debt crisis in America.

What’s covered in EP192

  • Addison’s background and how he came to the conclusion that the US financial system is in danger of collapse. (1:53)
  • Will the Reserve Bank of Australia increase rates again? (10:46)
  • The uncertain lender of last resort: The Federal Reserve. (17:11)
  • The Fed’s job is to make sure fewer people have jobs. (21:52)
  • Banking crisis and the failure of regulation. (26:21)
  • FDIC and confidence. (32:00)
  • Why it’s important to understand how booms and busts even take place. (37:07)
  • Cryptocurrency as part of the story. (41:47)
  • What has happened to the dollar since 1913, when the US Federal Reserve was established. (46:41)

Links relevant to the conversation

Special download link to Anatomy of a Bust for Economics Explored listeners:

https://jointhesessions.com/ee/

Presentation by Addison that Gene mentions early in the episode:

Anatomy of A Bust: Banks Go First | Special Presentation by Addison Wiggin 

Transcript:
Exploring the US Banking Crisis with Addison Wiggin – EP192

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

Gene Tunny  00:06

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 into the show. In this episode, I chat about the US banking crisis with Addison Wiggin. He’s a New York Times bestselling author and market economist and commentator with three decades of experience. Allison has his own podcast the Wigan sessions, in which he talks to key thinkers and industry experts for a deep dive in history, politics and economics is the author of the best selling the demise of the dollar, and one of the writers of the 2008 documentary I O USA. Thanks to Addison for providing economics explore listeners with a free copy of his recent report, anatomy of a bust winners and losers in the banking crisis of 2023. I’ve included a link in the show notes so you can download it as well as sign up for Addison’s content if you’d like to read and hear more from him. Personally, I think Addison, someone with following if you’re interested in the US economy and financial markets, and if you’re listening to this show you probably okay, let’s get into the episode. I hope you enjoy my conversation with Addison Wiggin on the US banking crisis. Addison Wiggin, thanks for joining me.

Addison Wiggin  01:53

Yeah, no worries, I’m happy to actually meet you. As I was saying before, I’ve been forwarded some of your material in the past. So I know your name. And I feel like it’s a good opportunity for us to banter a bit about economics.

Gene Tunny  02:07

Absolutely. Thanks, Addison. And I’ve, yeah, I’ve seen the very know your research. And you’ve, you’ve been doing a lot of deep analysis of what’s been happening in banking and what’s been happening in financial markets. And you’re very keen to chat with you about that. In particular, I’ve come across a recent presentation, you’ve given anatomy of a bust, banks go first. And in that presentation, you make the argument that, well, we’re in a panic of the panic of 2023. America’s financial system is in danger of collapse. We’re here to protect ourselves. Would you be able to take us through what leads you to this conclusion? Addison, please. And also, perhaps maybe to begin with, what a bit about your background? How’d you? I mean, you’ve had, as I mentioned, you’ve had deep experience of this, it sounds like you’d be looking at these issues for decades. Can you tell us a bit about your story and how you come to this conclusion, this threat of collapse, please?

Addison Wiggin  03:17

Yeah, absolutely. I’ve been studying booms and busts for a long time. Since the mid 90s. This is literally the only work I’ve done in my adult life. And just to do a shameless plug right at the beginning, I just published a book called The demise of the dollar, which looks at booms and busts as they pertain to fiat currencies in the world. And US dollar is deeply connected to the Aussie dollar. And I addressed some of that, and also, the dollar is a reserve currency of the world. So like even the Aussie banks or New Zealand or Japan or European banks, US and China as well, which is a big part of the story, use the dollar to store their wealth in. So there’s, there’s a symbiotic international connection between my currency and yours. And that’s what that’s what I’ve been interested in for this particular book. But I’ve also been studying booms and busts going all the way back to the famous ones like the tulip bubble and the Mississippi scheme from John La, back in the early 1700s. And then the South Sea bubble which the bankers from from London just ripped off John Maas idea and then they went bust too. So booms and busts are pretty common in the financial cycle of of our lives. And we’re we have just gone through one and that’s what anatomy of a bust. It’s just a special report we put out because it was interesting to have our very own movement boss how Ben right in front of our faces, it starts really in 2018, where a lot of people were using low interest rates that the Fed was fed had kept interest rates low to recover from the 2008 bus for such a long period of time, that there’s like a whole group of traders who grew up in a world where interest rates were at zero or less than that. And so money was free, and they were speculating on all kinds of things. And one of the things they speculated on was cryptocurrencies in 2018. We had this massive bubble in, in cryptocurrencies and a lot of the banks that started failing in March of 2023, which we’re still I maintain, we’re still in that crunch. And I’ll explain why I think we’re still in it, and why we don’t talk about it that much anymore. But a lot of the banks like Silicon Valley Bank grabbed the headlines when they went bust in 48 hours, because they had invested all of the money they were getting from tech entrepreneurs. They had invested it in treasuries, and then the Fed started trying to battle interest rates. And they didn’t account they didn’t either believe the Fed would they didn’t have any risks. There actually was no risk officer on the payroll at Silicon Valley Bank at the time. And they didn’t realise what the impact of an aggressive rate rate hike policy by the Fed was going to be. And that was happening simultaneously with the collapse of X FTX, which was the crypto currency trading firm that a lot of tech startups had their money, had their money. So when they when FTX went bust, they had to pull their money out as fast as they could, or they just lost their money. And in the meantime, the startups were being also financed by Silicon Valley Bank, notably, and they needed their money back to keep their their startups going. So the conflicts of different trends follow the theme of booms and busts that we’ve seen throughout history. So when when it was happening, I was like, Oh, my God, this is our very own like we could write about, it’s actually happening right in front of us. So it’s, that’s what the special report is about is like how that actually happened. And when Silicon Valley Bank collapsed, it collapsed in 48 hours, because all these people wanted to take their money out to cover their own losses in crypto, that was technically what was robbing and they were just yanking their money out. And even though as you know, as credible bankers, we would look at the way that Silicon Valley had put their assets, more than 50% of their assets were in treasuries, which are meant to be, you know, the risk free asset that banks should hold anyway. But they didn’t calculate for the rising interest rates from the Fed to combat inflation. And then when there was a run on the bank, that’s what we call it. It wasn’t I mean, it’s a modern day, extraction of digits really. But when people started taking their money out, Silicon Valley Bank had to sell their treasuries at a loss. And it it happened very quickly. No one thought that with the FDIC, which is the Federal Deposit Insurance Corporation that was set up by the Treasury to like help small banks, stay solvent help, depositors stay solvent, nobody thought that can actually happen anymore. The FDIC was set up in the 30s, to combat some of the forces that were going on in Great Depression. And then the Treasury itself gets together they get all the Wall Street banks together, and they then they construct these bailout plans like what they did for first republic. So those, all of those things happen, and they were grabbing the headlines from March until like the beginning of May. But then our debt, what we call the debt ceiling debate. I prefer to call it the debt default debate over the dancin, and nobody’s really paying attention to the banks anymore, but the underlying issues of the Fed fighting inflation and over capitalization in treasuries. There’s 36 banks in the US that are still under FDIC protection, watch conservatorship, whatever you call it. And then there’s a bunch of other banks that are borderline if what happened in March where people started pulling their money out of banks as a sector in on Wall Street than those banks are going to be in trouble too. There’s a couple others that I’ve been keeping an eye on that that have the word PacWest was one of them. And they’re just banks that are lending to more risky clients. And then depending on the depending on treasuries to rule out there, or to keep their their investments safe. And depending on how long the Fed keeps raising rates, which I think they’re going to raise them again, because inflation is not under control. It’s not only under control here in the US, it’s not under control. In Australia, I think Australia was getting really aggressive recently. Why don’t they? Well,

Gene Tunny  10:46

they increased rates more than people expected. There was a surprise rate hike. And now the the question is whether they will increase again, we’ve got a Reserve Bank meeting next week, there’s it’s a bit unclear, there’s a lot of debate about what the bank will do. Everyone expects that they’re going to have to increase at least one more time by the end of the year, possibly two. It all depends on what’s happening with inflation, we’ve got a monthly indicator that on through the year terms has, has increased or as worsen. But there’s a debate about well, what it’s it’s very noisy month to month. So it’s difficult to read much into that we need to see what happens with a quarterly figure. They’ll be watching services, inflation, so goods inflation has been coming down but services inflation is has been rising. So that’s and now we’ve got a minimum wage hike of six to 8% or something, depending on the actual, whether you’re right on the minimum or if you’re on an award. So yeah, there are, there are concerns about the future of inflation.

Addison Wiggin  11:52

I’d like to ask you a question. I spent some time in Australia. And also we had an office there for a while. So we were trying to manage our own finances there. And it might just be a myopic point of view of my own, because I am an American and the Federal Reserve is what it is. But when the Fed makes moves, often the Ozzie bank or like Japan or EU will follow, like a month later, if to you to think that that’s true. I don’t want to sound like an arrogant American, which I probably am, but But it always feels like the Fed is sort of like the central banks of the world.

Gene Tunny  12:30

Yeah, that’s true. It’s not automatic. It doesn’t always happen. But certainly one of the things that our central bank is conscious of is what’s happening with the exchange rate. And if if we keep our interest rates too low, then that leads to a depreciation of the the Australian dollar. And that’s bad for inflation. So we start importing inflation. So that’s something that they are conscious of. And when the Fed started lifting, was it last March or March?

Addison Wiggin  13:04

A little over a year ago? Yeah. Yeah. And

Gene Tunny  13:07

so the first few rate moves increases by our central bank, we’re pretty much in line with what the Fed was doing. And I mean, my take on an Earth in Michael Knox, who’s a commentator here, and he’s, he’s Morgan’s financial chief economist. I think he’s one of the best market economists in Australia. That was his view on it that, you know, by essentially copying the Fed that they had, the Fed was moving. So our, our guys had to I mean, we read our, our central bank, really, I don’t know if asleep at the wheels the right way to phrase it. But our first rate increase didn’t happen until I think it was May last year. And so it was a couple of months after the Fed, the Bank of England had gone earlier. I think Reserve Bank of New Zealand really got on to it early. But yeah, I think our central bank just wasn’t concerned enough about the risk of inflation. They were too much in that secular stagnation paradigm that they had, prior to the pandemic and those that decade or so they thought, Oh, well, we’re in this world of permanently lower interest rates, and there’s no no concern about inflation. We don’t have to worry about that anymore. For various reasons.

Addison Wiggin  14:23

I mean, that’s literally what thought some of these regional banks, asleep at the wheel was the Fed got really aggressive picket quickly, and even in the books that I’ve been writing? So I have this one, but I’m also looking at another one that’s kind of like the political analysis of how we got to a position where we have 31 trillion in debt, which is just ridiculous, right? Looking at the trajectory of Fed policy from really from 1987 When, when there was a stock market crash and Alan green The internet just become our Fed chair, he dropped rates as a response so that people could get free money in and prop up their balance sheets. That has been the response since 1987. Until now, and no one I like they caught a lot of banks sleeping, when they started raising rates as aggressively as they did, and they were afraid of 1980 81 scenario where inflation would just get out of control. There’s no anchor to the dollar. And everything is based on the dollar index, which is a basket of currencies and including the Aussie dollar that determines what the value is. There is a tone. It’s just astounding to me, actually, with all the history that we have with banking, and even the Federal Reserve since 1913. Like there could be backers who still have jobs. what was gonna happen? Yes. Well,

Gene Tunny  16:04

I mean, it’s an but they play an important role in the economy. But yes, there’s a lot of monetary mischief with a lot of mistakes that a an aid for sure. Absolutely. I like to ask Allison about. You mentioned that this started in? Was it 2018? So you think this started before the pandemic? Is that right? And then the pandemic, all the policies during the pandemic made it worse or contributed to the instability?

Addison Wiggin  16:30

Yeah, well, I would say, though, is that there were separate events, I think that the policies really started in about 2012, when we were seeing QE two, meeting that the Fed was still buying bonds in the market, or in even actually buying up mortgage backed securities in response to what the federal what the, what caused the crash in 2008, which was a global event also, because all the big pension funds and hedge funds, they’re all interconnected globally. So when when we ran into our housing crisis in 2008, it affected everyone. And we saw the ripple effect really quickly. And what the Fed did to head that off, was they dropped the interest rates, we had zero to negative interest rate real interest rates for a number of years between 2012 and 2018. But they were also buying up assets in the market, they were buying bonds in the treasury market to support bonds, because they needed to fund the government. And then they were also buying, they were actually buying assets on Wall Street, which is like, that’s an extreme measure. The bank is not supposed to be buying assets to prop up the market. But anyway, so there was a period of time where we had zero, I mean, money was free. And there was the like, I like to phrase the, the uncertain lender of last resort, that’s what they call the Federal Reserve, you never know what they’re going to do. But in the end, they’ll come in and bail out, you know, they, if they had to, they bail out, gee, JP Morgan, which has literally the fifth largest GDP of any economy of the world, and it’s a private bank. So they would come in and bail them out. That’s just thinking

Gene Tunny  18:25

that on that point about had this, what was it the unexpected lender of last resort?

Addison Wiggin  18:32

Charles Charles, my book I forgot his last name, but he wrote us. Yeah, he wrote an entire book about there needs to be a lender of last resort, but it has to be uncertain. You can’t count on them. You just have to know that they’re there in case the shit hits the fan. And yeah, and that’s what the Fed has been trying to do. But what they’ve been telegraphing what they telegraphed from 2012 until 2018, was we’re gonna keep rates low, and we’re gonna keep buying assets to keep the market propped up. And the beneficiaries of that policy are Wall Street banks, big ones, you know, yeah, Oregon, Citigroup, Bank of America, those companies, those those corporations are beneficiaries of just an extended period of ridiculous monetary policy. And a whole generation of bankers grew up in that in the environment where they believed that the money was just going to be free forever. So when the Fed turn, turned around and started trying to combat inflation, then we started having a serious problem. And the first people that got taken out, were the regional banks who weren’t paying attention to risk policy at all. So that’s why I say it started in in 2018, because there was a big boom in cryptocurrencies stable coins. We’re coming out. Bitcoin had already like fluctuated up to 60,000 and then dropped and like it was already an object of speculation and Aetherium was sort of like its step cousin, you know, it was doing its thing. But there was a lot of money getting pushed into the market because of low interest rates, that tech firms and Wall Street banks the like, and new new banks, like the FTX exchange that that was built, that was only founded in 2017. Like it became one of the largest traders have actual money, dollars to crypto currency in like, under two years, there was a lot of money flowing into the system. And that’s when if you follow Austrian economics, like I do, but a lot of other people do, too. I’m not making any kind of claim to it. But all the mistakes that are made get, they happen in the blue, when there’s money, that’s cheap credit, and people are spending money on things that they don’t understand. That’s exactly what tech entrepreneurs especially were doing, because they were excited about this new money that we could trade. It wasn’t traceable. And then banks grew up around it, that silver gate was one Silicon Valley Bank was another first republic was another pack glass was involved. And so when the tech entrepreneurs started getting nervous about their, their investments, or even their own companies, they wanted to remove the money from banks, and was sort of targeting Silicon Valley Banks specifically because they were getting a lot of deposits. And they didn’t have to loan out money to make money. So they were buying treasuries. And then when the Fed started tackling inflation, which itself, inflation itself was a result of 10 years of, of low interest rates, like we had, of course, we had the pandemic, and then we had the war in Ukraine, which cut off some supply chain, so it created like pain points. But at the same time, there was so much money flowing around in the system, that the natural outcome just in economic terms of that much money flowing into the system is that prices go up. The amount of money chasing goods is more than what the goods have, in what I would call intrinsic value. So it just costs more if you want gas, it cost more if you want eggs, eggs were a big deal. In the US. They were in, in Australia, but they were a big deal for like two years, because they went from like, I don’t know, an average of three bucks for 12 eggs to something like seven bucks. And people were like, What the hell, you know, I need an egg a day. And now it costs Yeah, three times as much. So that’s that’s the way that people feel inflation, but the cause of inflation, inflation is rising prices, but the cause of it is money supply money going in to the system. And they did that in reaction to the 2008 housing crisis, they were pouring money into the system and making it cheap for years to a degree where people just started thinking that was the new norm. But when Powell got in place, and he started raising rates, there was a lot of bankers, especially who were like, Oh, he’s not going to do that. Because this is the new norm. And it wasn’t the new norm, because there’s they still don’t have inflation controlled. So my guess is they’re going to raise another quarter point and they meet again. And then that’s going to ripple out to banks in Australia, in Japan. And mostly, those are the three that I looked at Australia, Japan and EU. Yeah,

Gene Tunny  24:14

it’s quite quite possible. I saw that the US had a good was a good jobs figure was was that what I saw? Yeah. And so that they’re saying the economy is more robust than they expected. And so yeah, they’re doing isn’t it? conundrum a little bit that the feds job is just to make sure that less people have jobs. Yeah, well, that’s the Yeah, that’s the Elizabeth Warren take. And then she was trying to pin it really gets stuck in a jay Powell over that, I think in the in Congress, wasn’t she? Oh, I’m trying to remember. Was it Powell or was it she was given?

Addison Wiggin  24:53

That was a couple of weeks ago, she was giving a speech in front of Congress, but she was taking Jay Powell to test. So he wasn’t actually even talking to him. Right. But that’s just a weird thing that that the feds job has suddenly become too slow the economy down, make sure that more people are unemployed, so that the government can then take care of them. It’s like, it’s, it’s not a free economy, like we like to think that America runs a free economy, we don’t run a free economy at all. And their goal right now is to slow everything down. And then we got the jobs report that you’re talking about. It was, I believe, is yesterday or the day before, it was more robust than what they were expecting. So they’re saying, oh, yeah, the economy is still growing, we gotta raise rates more to slow it down. Like, if we got a jobs report that wasn’t as positive as it was, then the stock market would have actually rallied. But when the draw four came out, down because people were like, Oh, that means they’re gonna raise rates again, we can’t borrow money cheaply again. It’s like, yeah, Pretzel Logic to me. But it’s kind of fun in a way to follow it, because it’s like, it doesn’t really make that much sense.

Gene Tunny  26:19

Yeah, yeah. I better get back on to banking, because I want to ask you about where we’re going there. And this banking crisis. There are a couple of things I just wanted to just quick things a good to get your views on. So you mentioned that this SBB didn’t have a Risk Officer. Is that right? Which I find extraordinary. Is that a failure of regulation? Yeah, I

Addison Wiggin  26:42

only found it in passing. So there were two kind of oversight errors that took place. They didn’t have a Risk Officer evaluating what the impact of rapidly rising interest rates would be on their the holdings that were like the core of the bank. That was one thing. And I think it was just in transition or some of the there wasn’t somebody in that position at the bank for like a year. And that was the year that the Fed started aggressively raising interest rates. And at the same time, no, nobody in the bank thought that the Fed actually pretty much nobody in the economy, though did Wall Street banks didn’t think that they would do it either raise interest rates as aggressively as they did. So even while it was happening, we were like, Oh, they’re going to stop. So there was a lot of speculation of when they were going to pause or when they were going to pivot. I remember back in even before the banking crisis started, the big phrase in the headlines was, when is the Fed going to pivot, meaning they’re going to stop raising and they’re going to turn around and start dropping among regional banks anyway, the first ones to get under stress. They didn’t have people that were taking the Fed seriously at their word, the Fed was saying we’re going to we’re going to fight inflation until it’s done, which is a tough battle. And nobody believed that. So when the cost of treasuries went down, and the interest rates went up, it was harder for a bank, like I just use Silicon Valley Bank, because it was so pronounced. It was harder for them to raise the capital to pay back their depositors when they wanted their money back. And a lot of those depositors had just lost money in the collapse of fts. So it was just sort of an act of boom and bust, you know, a line of love crumbs from what was going on in the crypto market to what happened to the regional banks. And then you saw the entire banking sector get whacked in the market, like, there were other banks that were reasonably sound that were getting taken down because everyone was trying to get out of the banking sector. So when their stocks get are getting punished by institutional investors and by pension funds, then that messes with their balance sheets, as well. And the only reason we haven’t been hearing about it in since I actually tried to pinpoint it was May 18, that the debt ceiling debate sort of took over the headlines. All the issues with the banks still exist. And that was really just a speculation on my part. But if they didn’t, for some stupid reason, come to a political agreement. On the debt ceiling, we would have seen a massive wipe out of bets because Treasuries are supposed to be risk free ish. I mean, they’re about as risk free of an investment you can make other than maybe gold or precious metals, and banks had piled into treasuries for so long because it was cheap. And it was easy and it was risk free. If we had a debt ceiling debate, I mean, that the vault if that debate failed, and we had a default, then treasuries would have been become an object of speculation, like other assets in the market, people would be like, I’m betting they’re going to do this, I’m going to bet that they’re going to do that, and the risk free part of that, where you store your money would have disappeared, that would have been a nightmare for a lot of smaller banks. And then the thing that is kind of a nightmare too, would be that JP Morgan, Citibank, Bank of America, the big Wall Street firms would have just gobbled up all of the, those assets at pennies on the dollar, which is exactly what they did with SBB. And with first republic, they just went in and just took all the assets for like, it was three cents on the dollar.

Gene Tunny  31:04

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

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Gene Tunny  31:39

Now back to the show. So can I ask Allison, where are we going? Now? I mean, over the next six months or a year or so will we see more banks fail? Will we see a contagion? Or will we see impacts on the broader economy? Where do you think this is all going?

Addison Wiggin  32:00

Well, I’ll answer that in two ways. There is a certain level of confidence in the FDIC to like bank to back individual depositors. So like the fear of bank runs is probably abated a bit. Because the FDIC and Janet Yellen to the Secretary of Treasury, she has been going out saying no, we’re not gonna bail everyone out. But if it gets bad, we’ll bail some people out like she’s being that lender of last resort. So I think that the crisis part has abated. But that hasn’t fixed any of the the challenges that banks are facing right now with rising interest rates, and the battle against inflation in the uncertainty of of how committed the Powell Fed is going to be to that. So it would. So that’s why I say I’m going to answer in two ways. One, I detailed all of this special report that we were talking about anatomy of the anatomy of a bust, this is exactly how it happens. And I actually got that phrase from Garrett Garrett, who was writing about how all the banks failed from 1932. Until about they were still failing into the 50s. So they failed for a long time. But the three banks that failed in march into the early part of May, were larger in capital by percentage than all 25 banks that failed in 1932. So like, that doesn’t happen by mistake. And that also doesn’t happen without repercussions. And I expect that that we’re going to be talking about banking places like three years from now, because it hasn’t worked itself out yet. And they’re still trying to fight inflation. So so I don’t know if we’ll have a panic or a crisis period like we had between the beginning of March and mid May. But I think the tension is still there. And it’s definitely something that we want to pay attention to. Because the banking system is the the bedrock for all of the other stuff that we get, like when we buy and sell stocks, when we get mortgages, when we buy cars, send our kids to school and stuff like that that system needs to be. We need to have confidence in that system. And I don’t think it’s there yet. Brought we get a paper version of the confidence from speeches from Janet Yellen. And we forgot her name already, but that was the woman who runs the FDIC. But it’s just a fact the FDIC has like 300. Now they have $37 billion to support $17 trillion worth of deposits like it’s It’s, it’s absurd. Other than me and I’ve written this to this is it’s a competence game. Like, just like the way people, you know, take advantage of retirees because they gain their competence and competence gain is what it is. It’s a it’s a sham. Yeah. Yeah, right now the government is running a competence, that literally people have confidence that the government will figure this out. And so they’re they’re just biding their time. And what are they going to do next? My, my guess is they’re going to drop interest rates. As soon as there’s like a real crisis, they’ll drop interest rates, and now get another speculative boom going on Wall Street. And usually what happens when, when that happens is that mutates into bubbles in other markets, too, like Australia always benefits from booms in the commodities market. And China always benefits from new tech development and the Europeans benefit from new speculation in travel and tourism. Like it’s it’s almost predictable. What’s going to happen next,

Gene Tunny  36:11

abroad. Okay, so this is your report anatomy of a bar stock and put a link in the show notes to that. Can I add in just trying to think about what the risks are? I mean, you make the case that more banks are probably going to fail. What do you think the chances of something like 2008 happening again, or something worse than that? What would you put the probability of that ad in the next couple of years

Addison Wiggin  36:36

right now, I’d say it’s pretty low. Because one of the things that happens is like human beings that the people who run the government also learn. And they did what they thought they had to do in 2008, I’ve written about this many times, the Paulson, delivered a three page memorandum to Congress and said it at like midnight, and said, You have to bail out these banks, otherwise, the entire global economy is going to fall apart. There’s three pages, and they just followed it. So I think they’ve learned that through monetary policy, and also working in concert with other federal, like the Federal Reserve system of the world, that they can mitigate crises. But that doesn’t mean the problems aren’t still there. So that’s why it’s important to understand how booms and busts even take place, you can’t keep interest rates at zero for 10 years, and then expect that no inflation is going to pop up. But it is ridiculous. But it’s worth understanding the mechanisms behind the banks and whatnot, because that’s the that’s where the money flows, if that’s how the markets work. That’s how, you know, they determine interest rates for all kinds of things, credit cards, and student loans, and banks and cars and all that kind of stuff. The economy functions on credit. And banks are the source of that credit. And they’re all connected to the Federal Reserve System. So it’s worth paying attention to what they say. And I hate that. I don’t like politics. And I don’t like the banking system. But I warn people that they ignore those things at their peril. Because when you need to do something financially in your lives, you’re sort of dependent on decisions made by people who live far away from you, and don’t have your interests in mind.

Gene Tunny  38:45

Yeah, yeah, I just want to try to understand what this all means. So does this mean that, like, we’re in a situation where the Federal Reserve and the government is going to have to continuously? Well, maybe not continuously, but every now and then bail out the banks? And, you know, we’re gonna keep trying keep interest rates low, keep the flow of credit going? And therefore, ultimately, this is inflationary? Are we back in? Because we had a period of very low inflation? Are we going to be in a period of higher inflation for for longer than we expect? Is that one of the arguments was that a conclusion?

Addison Wiggin  39:22

Yeah, my conclusion is that we would, it’s not a conclusion because it’s an ongoing story. But we’re going to be in a period of inflation longer than, you know, the headline news tells us like, you can’t just stop inflation. And once it starts, it’s very hard to stop. And I actually got that quote, I, I interviewed, I did a documentary about 15 years ago, and I interviewed Paul Volcker, who was famously the inflation fighter of the early 1980s. He was the Fed chair at the time. And when he said to me, he said two things that have stuck with me he said a lot of other things and I published all buddy But, but he said a couple other things that are two things that have really stuck with me one he’s like, actually, I’m going to set the stage. So this is after walking past a couple of cartoon pictures of him that he had framed in his office of him like turning off the inflation spigot. And then another one where he was like wielding a sword and a shield, and he was like fighting inflation. So he was kind of like a caricature of that time. And that was the worst inflation that the world had seen in since the late 1800s, since the panic of 1893. And the reason was, we had gotten off the Bretton Woods, dollar peg to gold that there was a lot of reasons why it happened. But when I spoke to him, and this is on camera, and in the interviews that I’ve published, he’s, well, first of all, once inflation gets started, it’s very hard to stop. Because it, it creates, like a psychosis in people where they start thinking, if I don’t spend my money for that refrigerator, in June, by September, it’s going to be 30, Luxmore, or something like that. And they start thinking like they have to spend their money now. And that creates inflation, psychosis of sorts where people are just spending more money more quickly, because they think it’s going to be worth less later. And you’d like if the Feds goal is to slow down the economy, that inflation psychosis works against any Fed policy that they can put together.

Gene Tunny  41:43

Okay, just a couple of things. Because yeah, it’s great conversation quickly. What about crypto? You mentioned crypto as part of the story?

Addison Wiggin  41:51

Well, I have a theory about crypto. And it’s the same thing that it’s the same philosophy I have about the internet itself is that we had in 2001, we had a big boom in Internet stocks, like even Toronto, like right now. But the company that makes insulation for houses was doing fibre optic and they dropped the.com on the end of their name. They weren’t even a tech company. And they they exploded in value. Yeah. What’s the pink insulation that we all use? But I don’t even know why I’m drawing a blank on the net. But it’s because it’s a big installation. The point I’m trying to make is that during the.com, boom, there were just ridiculous investment being made. Yeah, all kinds of things. And then they busted. But we were, in the end, after all, the detritus fell to the floor, and people sort of like woke up from their hangovers. We ended up with internet and things like zoom, like I’m talking to you from Australia. Right now. I’m in Baltimore. And these things are possible because of that massive innovation and the investment that went into that period. Like that it even with a Gora, the company I’ve been working with for a number of years. We exploded when we went online, and we benefited greatly from the innovation of email, or changed our lives. So I have the same sort of perspective on crypto, is that I think it’s speculative. And I think there’s booms and busts and we saw that 2018 was crazy. Yeah. And then we saw another spike in in different like Bitcoin and Aetherium. And some of the stable coins in like 2021. Last year was a nightmare. We called it crypto winter, because the underpinning actually doesn’t part of the story I’m telling to is that two of the stable coins that FTX and Alameda research were investing in the traders that were supposed to be pegged to the US dollar, but the traders on pegged them without telling anyone and that started the FTX. So I think you’re gonna continue to see that kind of speculative nature in crypto. And we’ve got this spectre of central bank digital currencies coming up. We don’t know where that’s gonna go. Suppose there’s going to be a vote in the US in July, on whether the Federal Reserve should adopt one or not. But they keep saying that to that story is going to be ongoing, I think the real benefit of the the innovation and the spikes in the highs and lows and, and, you know, the turbulent market that Kryptos has gone through up to this point will ultimately be beneficial because we’ll we’ll end up with Blockchain as a more efficient way to to conduct transactions in the financial markets. So you can make money you can lose money in crypto. I’m not a crypto evangelist. Like I believe that it’s going to be a substitute to the US dollar or the world banking system. But I do believe it efficiencies that are brought to transactions are going to be beneficial to everyone. And that’s kind of how I look at it even from an investment standpoint, I’m like, oh, bitcoins at 15,000, neither should buy some, and then it’s at 27. And then it’s at nine. And it’s like, no, I’m not getting somebody tried to buy some property from a couple years ago, I think it was in 2021. And but they would only do the exchange and in Bitcoin and I’m like, I don’t know if my property is going to be worth less or more if I take your Bitcoin, but I do know what the value of the property is. Yeah. So I think the speculative nature of it is, it’s too early to, to like I prefer gold and silver to Bitcoin or Aetherium. At the moment, maybe there’s a time when, when it makes sense to like use it as a banking tool, but not right now. too speculative for me, and, but I do think that the benefits of blockchain are going to be like email to us a couple years from now, where everyone’s going to be using Blockchain for efficiency, which I think is great. In the boom, bust cycle, that’s what happens, people invest a lot of money quickly into innovative projects, and a lot of people get burnt, a lot of people get rich. And then what we end up with is the core technology that benefits humanity as a whole. I love technology.

Gene Tunny  46:31

Yeah. One thing I wanted to cover too, is this demise of the dollar you talk about? So is that a this is this is a long run concern of yours about where the US dollars going. And I mean, this is related to the point you’re making about.

Addison Wiggin  46:43

Yeah, the thing is, like, I mean, I could slip through the book is that one great chart that shows what has happened to the dollar, I’m not going to be able to find it and make it make sense to your viewers. But since the Federal Reserve was founded in 1913, the original goal of the central bank was to stabilise the currency, and maintain its purchasing power in the economy, for payment, currency users like me, like it’s supposed to be able to, I’m supposed to be able to figure out what my dollar can buy and for how long. But it’s lost more than 97% of its purchasing power since 1913. And it’s, it’s a steady slope downwards, the more money they pour into the system, the like every dollar that you print becomes worth less than the one that was printed last. And the entire banking system of the world is dependent on the dollar as a reserve currency. And at the same time, we’re losing the value of its purchasing power, every debt, and it’s been going on for more than a century. There, their main task was to preserve the purchasing power of the currency that we use in the payment system in the economy. And they have done anything but that it’s, it could be its historic fiat currencies never worked. It accelerated after 1971, with the Bretton Woods system fell apart, the only thing you can do is understand it and then try to move your money around into assets that accumulate value over time. That’s why I like gold and silver, because yeah, there’s a little bit more speculative, but gold when I was younger, and first trying to understand how these things correlate. Gold was trading at like 253 bucks an ounce in 1999, I think and now it’s trading on average, a little bit above 2000. Over that time, he has to be 500. It’s outpaced the s&p 500, which is a broadest measure of big stocks. It’s just been a better investment over time. And that’s that’s just generally what I think is it’s a reverse correlation to the dollar, which is supposed to be managed by the bankers who keep sort of forgetting about risk and inflation and those kinds of things.

Gene Tunny  49:20

I might have to come back to fiat currencies. Yeah, it’s a big, big topic, but another time, because I’ve really picked your brain and it’s been I don’t mind it. We’re very good. That’s great. And yeah, maybe if you if you wanted to sum up your the broadly, the anatomy of a bust. Would you like to summarise it? Or is there anything else you’d like to say before we wrap up?

Addison Wiggin  49:43

No. I mean, I would just say that it’s it was my attempt when, when I was already following the story of FTX and I knew there would be a knock on effect, and I had starting in about December of 2022. So like six months ago, I was like this story is not going to go away. And there’s going to be a knock on effect in other parts of the market that we’re not aware of right now. And that was in December. And then by March, we started having banks fail, which nobody thought was even possible anymore. With the Federal Reserve System and the FDIC backing out small depositors, like nobody thought we would have bank runs ever again. And and then we had the three largest ones within a six week period. So I had already been kind of following the story, and trying to just try and understand how it would even be possible. So that’s what’s in the report is like, here’s what happened, here’s why it happens. Here’s what you need to pay attention to. And here’s how it fits into the historical perspective of booms and busts, the credit cycle is a real thing, even if the government is trying to mitigate it. It does exist and impacts everyone. Because you need a bank, to save your money to borrow to do things that we want it to, to run your business you need, you need a bank that works with you. And if they’re making dumb choices with the assets that they have, it’s better to know that in advance. So that’s what the report is about. And then there’s a couple of recommendations on investment investments you can make. Once you understand what’s going on. We actually recommend bank.

Gene Tunny  51:31

Yeah, yes, it’s for US banks, a lot of to have a lot of have to have this conversation. I don’t know if you look at Australian banks, if I don’t, I

Addison Wiggin  51:40

haven’t looked at Australian banks, except for in a macro sense, where I’m aware that the Federal Reserve decisions that move rates also has a knock on effect in Australia, New Zealand, China, and Japan and Europe. Those are like the big ones. Russia was at two until they decided to destroy their neighbours. Yeah, the

Gene Tunny  52:09

general view here is that our our banks are in a much better position than

Addison Wiggin  52:14

it could be. I haven’t studied them closely enough to know, I think their requirements are different in Australia than in the US too.

Gene Tunny  52:23

Yeah, there. There are definitely differences. So you might have to I’ll have a close look at that myself. But look at us. And it’s been terrific. Yeah, probably more time than you might have expected, delving into it. Because I think what’s great is you you do deep research, and you make a big calls, I suppose what you make you make you really let us know what you think. And I think it’s great. And yeah, it’s it makes me think about what’s going on so much more. So really appreciate all the work you do. And I’ll put links in the show notes to your work. And, and thanks for making that. That report available for listeners. That’s terrific. Yeah.

Addison Wiggin  53:03

It’s information that I like, I would just caution people that I’m learning about it as fast as I can. But I’m also passionate about it. That’s why I do it. This whole project that I have the Wigan sessions is a passion project. I like talking about this stuff. And then it makes me think just like you’re saying, it makes me think. And I want to give away the report just to spread what I’ve learned, because I think it’s important stuff for, especially if you’re trying to manage your own money, it’s really important for you to understand the bigger trends. And, you know, I have a philosophy degree and I studied literature in school and stuff. So I’m interested in the stories of what’s going on. It’s late sound perverse, but I was actually excited when we started having our own banking crisis. It’s happening right in front of my face. I just have to read the news.

Gene Tunny  53:59

Yeah,

Addison Wiggin  54:01

get the report. It’s it’s interesting. And it’s helpful to like, make sense of what’s happening in the news, too.

Gene Tunny  54:07

Yeah, certainly, I guess it could be exciting, stressful. I remember being in Treasury. And here in Australia during the world of financial crisis. We didn’t have it as bad as it was in the States. But it was still quite, quite stressful at a time when we started seeing the drop in government revenues. And yeah, borrow lots more money. And yeah, well, my

Addison Wiggin  54:28

biggest concern, and I put this in the report to but my biggest concern right now is, we were talking about the savings rate during the pandemic. I think the same thing happened in Australia to the savings high because there was a lot of government stimulus, like direct payments to citizens. So the savings rate and then nobody could go anywhere. So the savings rate went really high. It actually peaked above consumer credit for like a, you know, like, a month, and then as the economy started opening up and people started travelling and Like making decisions I, oh, we’re free, we can go to one, the savings rate plummeted. And then the consumer credit rate for all of the things that I’m only talking about the US, but I’m sure it’s mimicked in other Western economies, the consumer credit rate, skyrocket skyrocketed before the Fed started raising rates. So like, all these people are taking on adjustable rate, credit cards and loans and mortgages and things. And then suddenly, the the debt service that they have to pay on those rates went through the roof, it’s tripled. So you had a plummeting savings rate, and at the same time that you have a service to debt ratio going through the roof. It’s not a good scenario. And we haven’t even really seen that impact on, like earnings in the s&p 500, the big retailers and stuff like that. We haven’t seen what that impact is going to look like yet. So that’s not kind of like, I guess, yeah. So other than the banks themselves, because they do it for there’s two points there that I’m keeping an eye on.

Gene Tunny  56:09

Yeah, fair point. We’ll definitely I’ll keep an eye on it, too. I think they’re really good points. Okay, Addison, we’re gonna thanks so much for your time. I really enjoyed that. That was terrific. Good luck to you, man. Very good. Thanks, Addison rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if you’re podcasting outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

57:10

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Credits

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

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

Categories
Podcast episode

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

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

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

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

What’s covered in EP179

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

Links relevant to the conversation

Darren’s bio on the Economics Explored website:

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

Darren’s opinion piece on the Spectator Australia website:

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

Bank of England paper on money creation:

Money creation in the modern economy | Bank of England  

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

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

US Gold Commission Report 

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

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

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

The Age of Turbulence* 

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

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

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

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

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

Gene Tunny  00:06

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

Darren Brady Nelson  01:46

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

Gene Tunny  01:48

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

Darren Brady Nelson  02:21

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

Gene Tunny  04:29

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

Darren Brady Nelson  04:45

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

Gene Tunny  07:19

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

Darren Brady Nelson  08:24

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

Gene Tunny  10:00

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

Darren Brady Nelson  10:05

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

Gene Tunny  12:20

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

Darren Brady Nelson  12:25

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

Gene Tunny  13:38

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

Darren Brady Nelson  14:15

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

Gene Tunny  16:45

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

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Gene Tunny  17:20

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

Darren Brady Nelson  18:18

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

Gene Tunny  21:08

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

Darren Brady Nelson  21:18

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

Gene Tunny  24:55

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

Darren Brady Nelson  25:44

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

Gene Tunny  26:26

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

Darren Brady Nelson  27:16

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

Gene Tunny  28:54

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

Darren Brady Nelson  29:27

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

Gene Tunny  30:42

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

Darren Brady Nelson  31:15

Thank you for having me.

Gene Tunny  31:26

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

41:26

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Credits

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Categories
Podcast episode

Normalization of interest rates & monetary policy – EP173

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

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

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

What’s covered in EP173

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

Links relevant to the conversation

Data released since the episode was recorded

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

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

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

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

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

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

Inflation targets

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

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

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

Bank of Finland article on monetary policy normalisation:

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

Chatham Financial article on US tightening cycles:

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

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

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

Chart on historical UK bank rate:

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

Chart on central bank policy interest rates since 1960:

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

Chart on inflation in the US, UK and Australia:

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

Wikipedia article on the Fisher equation:

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

Wikipedia article on UK consols:

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

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

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

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

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

Transcript: Normalization of interest rates & monetary policy – EP173

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, thanks for tuning into the show. This episode I talk about the normalisation of interest rates and monetary policy with my colleague Arturo Espinoza. Please note, the episode was recorded on the 11th of January 2023. Now, obviously, we weren’t able to cover any new economic data released after that date. So I’ve added some info into the show notes about important developments since then. One of the most important bits of data was the December US inflation rate. It came in at 6.5% yearly down from 7.1% in November. This figure was interpreted by economists as supporting the view that the US Fed will slow the pace of interest rate hikes in 2023. No longer increasing the federal funds rate in increments of half a percentage point or three quarters of a percentage point. Interest rates still need to increase because inflation is still too high and well above the 2% target. On the first of February, the Fed will probably increase its federal funds rate target by a quarter percentage point from the 4.25 to 4.5% range to the 4.5 to 4.75% range. If it doesn’t do this, I’ll release a short bonus episode looking at what’s going on. Economists expect there’ll be at least another interest rate rise in 2023. Beyond the quarter percentage point increase on the first of February, a view supported by the stronger than expected fourth quarter 2022 GDP figure that came out on the 26th of January. Unlike in the states in Australia, our latest inflation figures surprised on the upside coming in at 7.8% over 2022. I must say I was stunned yesterday when I noticed a 560 gram jar of Vegemite now cost $9 at Woolworths. The Reserve Bank of Australia really has no choice but to continue with its interest rate increases until it sees inflation falling or the economy crashing. As I noted my conversation with Arturo so much depends on how rapidly the economy slows down over 2023. Okay, let’s get into the episode. Please stick around to the end because I have additional thoughts after my conversation with Arturo. Okay, this is episode 173 on the normalisation of monetary policy. So, I’m joined by Arturo, my colleague at Adapt Economics. Arturo, good to have you with me today.

Arturo Espinoza Bocangel  02:58

Hi Gene, it’s my pleasure to be here.

Gene Tunny  03:01

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

Arturo Espinoza Bocangel  05:51

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

Gene Tunny  05:59

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

Arturo Espinoza Bocangel  10:28

Between two and 3%. Yeah,

Gene Tunny  10:31

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

Arturo Espinoza Bocangel  17:01

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

Gene Tunny  17:21

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

Arturo Espinoza Bocangel  18:43

and depending on what loan.

Gene Tunny  18:46

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

Arturo Espinoza Bocangel  21:42

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

Gene Tunny  22:07

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

Female speaker  23:31

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

Gene Tunny  24:00

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

Arturo Espinoza Bocangel  38:33

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

Gene Tunny  38:43

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

Arturo Espinoza Bocangel  38:47

Thank you for having me.

Gene Tunny  38:50

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

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Economics Explored is available via  Apple Podcasts, Google Podcast, and other podcasting platforms.