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.
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.4Additionally, 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.
Show host Gene Tunny interviews UMass Amherst Professor Gerald Epstein about his new book “Busting the Bankers’ Club”, which is about the powerful influence of banks in politics and regulation. Epstein argues the bankers’ club maintains control through political allies and regulators. The conversation also covers financial deregulation, insufficient Dodd-Frank reforms, Quantitative Easing impacts, and alternatives like public banking and non-profit financial institutions.
Gerald Epstein received his Ph.D. in economics from Princeton University, is a professor of economics, and is a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts Amherst. He has published widely on various economic policy issues, especially in central banking and international finance. His most recent book, Busting the Bankers’ Club: Finance for the Rest of Us, was forthcoming in January 2024 from the University of California Press.
What’s covered in EP226
Banking industry’s influence in politics and regulation. (0:04)
Financial deregulation and its impact on the economy. (8:58)
Financial system’s impact on democracy and fairness. (13:24)
Transcript: From Jekyll to Hyde: Exploring the Dual Nature of Finance | The Bankers’ Club w/ Prof. Gerald Epstein – EP226
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.
Gerald Epstein 00:04
There’s a phenomenon in the US. The political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate, often in the in the interests of the industry.
Gene Tunny 00:29
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 shownotes relevant information. Now on to the show. Hello, thanks for tuning into the show. My guest this episode is Professor Gerald Epstein. He’s professor of economics at the University of Massachusetts Amherst, and he’s co director of the Political Economy Research Institute. We discuss his new book busting the bankers club published by the University of California Press. It’s a great book demonstrating Professor Epstein’s deep knowledge of the US financial system. I thoroughly recommend it. So if you enjoyed this conversation, please consider buying a copy. I’ll put a link to it in the show notes. As always, please get in touch. If you have any thoughts on this episode, guest suggestions or ideas for how I can improve the show. You’ll find my contact details in the show notes. Right? Oh, we’d better get into it. I hope you enjoy my conversation with Professor Gerald Epstein. Professor Gerald Epstein, welcome
01:53
to the programme.
Gerald Epstein 01:54
Thanks so much for having me. Excellent. Gerald,
Gene Tunny 01:57
look, I’m really grateful for you appearing on the show to talk about your new book busting the bankers club finance for the rest of us. To start off with, could you tell us what is the bankers club?
Gerald Epstein 02:12
So the bankers Club is a group of allies, very powerful allies that support the banks and the financial Titans more generally. And the reason that’s important is because the banks in the United States in the book is mostly about the United States, but I think it’s true in many other places. They’re not very popular, people don’t like banks very much as a whole. I have my students look at a bunch of American movies about banks, they say, please find me a movie that has a favourable gives a favourable impression of the banks and, and they really can’t find them. So in the popular culture, you know, banks aren’t very popular, but they’re incredibly powerful. They’re in powerful politically, they’re powerful economically. And this is, despite the fact that we have these prices that the financial institutions seem to create every 10 years or so. And so the question is, how do they remain so powerful? And my answer is that it’s the bankers club is this group of allies that support the banks politically, economically, and helps them sustain their both economic and political power? And so I go into some detail discussion of various components or various groups within the bankers club,
Gene Tunny 03:37
broad and who are they? I mean, are you able to give some examples?
Gerald Epstein 03:42
She, of course, so there’s some usual suspects as you is what anybody would think about. So they’re the banks themselves and by banks, in this context, I mean, the mega banks, like Chase Manhattan Bank and Bank of America and the large banks, then the major hedge funds and private equity firms, and the large asset management firms. So we’re talking about mega finance more generally. So, of course, they’re the head of the club, but they get politicians to help them out, then that’s well known in the US and in other countries, and they get politicians to help them out by giving them campaign contributions by offering them good, lucrative jobs when they get out of the legislature. And in a variety of ways. They find finance friendly politicians, that will help them with legislation and so forth. So that’s kind of well known in many countries. Perhaps less well known is that the our central bank, Federal Reserve Board, is what I call the chairman of the club. The central bank, is historically Since it was founded in 1914, has been a big supporter of the banks. Partly this is for structural reasons that is, they rely on the banks, when they make their monetary policy they operate to the banks that interest rates, they expect the banks to pass these interest rate changes, up or down, depending on whether they’re fighting inflation or trying to get the economy going. So they have a kind of an intimate relationship with the banks. But what it also means, however, is that they tend to see the world through what I call finance coloured glasses. And so they tend to see the world the same way the bankers do. And more than that, they help out the banks in very significant ways. And we can see that most clearly in two areas. One is when they bail out the banks, like we have this great financial crisis of 2007 2008, and the Federal Reserve along with the US Treasury, but in trillions of dollars that keep the big bankers operating. But they also do it with regulation. That is they the Federal Reserve, and I think is true in many other countries, tends to really push for fairly flexible, and even very easy forms of regulation on the banks. And I’m very reluctant to put on very tough regulations on them. So we have politicians, the Federal Reserve, and then we have regulatory agencies, in the United States, we have various regulatory agencies that are in charge of regulating the banks. And there’s a phenomenon in the US, the political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate often in the in the interests of the industry. And once again, this is a process that goes on with financial regulation, the SEC, the OCC and other financial regulators we have, and I’m sure you have some in Australia. And we have the same revolving door processes that we have with the Fed. And then there are a couple of other groups that maybe are less well known. One is lawyers, many lawyers work for, for banks, they, they when they’re working in the regulatory agencies or in Congress, they help fashion regulation and and, and regulate and laws that help the banks. And they actually help write laws that are very bank friendly. And so we have a whole group of lawyers that are that are involved. non financial corporations, you think that one thing that I started during the Great Depression when this books my book starts talking about in talking about the Great Depression, and the New Deal financial regulation put into place by Franklin Delano Roosevelt and his administration. At that time, the big companies like us steel and the big industrial companies, they kind of parted way with the banks, the banks had helped crash the economy. And the big industrial companies said, Look, we need a new path. And they supported a lot of the financial regulation, like the Glass Steagall Act that separated for a commercial from industrial banks. But these days, our biggest corporations are very supportive of the banks, they don’t want to regulate finance. And so there many of them are members of the bankers club, too. And finally, I have to admit my own profession, economists, were very many of us are very me, but many are loyal members of the bankers club, become stuck with economic theories that say low regulation is best for society. Markets are efficient. They work better on their own, and this all works in the interests of the banks.
Gene Tunny 08:58
Yeah, yeah. Okay. Look, yeah, I think there’s definitely scope for discussion about the appropriate regulation of banks. That’s right. And we might get into that a little bit later. I’m just thinking about, you know, some of the people involved, I mean, often you hear their accusations levied against people like, was it Robert Rubin. And then Larry Summers, who were the treasury secretaries in the Clinton administration. That’s right. Is there a was there a concern that they were perhaps too close to, to the banks and that yes, yeah. Yeah.
Gerald Epstein 09:35
So Larry Summers, Robert Rubin. Alan Greenspan. They are, you know, golden members of the bankers club, all of them. The major deep financial deregulation that happened in the United States that kind of took apart the New Deal, structure of financial regulation. It happened. First, slowly building up. But then it really happened with the Big Bang. under President Clinton, who was a Democrat with the advice of Robert Rubin, who was chair of Goldman Sachs, and then city city Corp. Alan Greenspan, who was a libertarian, he was a follower of the philosopher Ayn Rand. And he was head of the Federal Reserve. And Larry Summers, who was a was was a very good economist, but somehow found himself kind of, as part of his part of the bankers club. And that was, that’s what really led us down the path to the great financial crisis. And to the problems we’re still having with banking. Yes,
Gene Tunny 10:39
yeah. It’s interesting, this idea the bank is clogged because it reminds me in Australia here, I mean, we’ve had successive treasury secretaries, that’s the head of the cabinet. First and responsible the Treasury is called the treasurer, that we’ve have successive treasury secretaries who have gone on to be the chairman of a bank. And I think for years that was seen as a pretty sort of cushy job. And it was until like, we had David Morgan who became head of Westpac, and then my old boss, Ken Henry ended up head of NAB, but for Ken ended up getting grilled at the Royal Commission into banking, and I don’t think he ever expected that that because we had a whole bunch of bad behaviour. Yeah, the bank’s due to a guest lacks oversight by our Prudential regulator. So absolutely. Same kind of thing. Yeah, yeah. Okay, so I think you’ve, you’ve given us a good description of the bankers club. What’s your case? Can you state your case, please, Professor Epstein, as to why the bankers club should be busted? Well,
Gerald Epstein 11:51
yeah, the title of the book is busting the bankers club finance for the rest of us. And the problem with the system as it is, is that our, our financial system has been has become incredibly bloated. It’s much too much too large. It uses way too many of our financial and human resources, it sucks in some of the best and the brightest of our young people, I can tell you, from my classes here at the University of Massachusetts, when I teach classes, a lot of our best and brightest students want to go into finance and banking. And they want to go in to the mega banks. And you know, the really the really lucrative ones. And there’s a whole literature, which I registered my built on, which is called too much finance. It’s an economics literature, which shows that its financial sectors get too large relative to the size of their economies. And this is a cross national study, that after a while, they’re they’re too big, or they’re structured inappropriately, or they’re doing negative things in the economy. And they actually contribute, after a certain point to lower economic growth, lower national income. And there’s something about having a bloated, an excessively large and complex financial system, which really harms everybody. So that’s, that’s one problem. But we have that’s just one of the problems. Another problem is that it’s bad for democracy that is, you know, Australia’s democracy, the United States is trying to risk to remain a democracy. And the idea is that it’s one person, one vote. But the process I’ve described, where the, these large institutions of powerful institutions are able to, by essentially legislation, regulatory practices that benefit them at the expense of the rest of society. That’s a major problem. But it’s, it’s even worse than that in the United States, because people understand that, that the whole process is unfair. When we had the great financial crisis, the Federal Reserve the Treasury, the government, and this was under both W Bush and Obama bailed out the banks. But they didn’t bail out the people, people lost their homes, people’s jobs were lost. And this made many Americans, understandably, very angry. And I think this turn to this very anti government kind of politics in the United States. That started with the so called Deep party at that time. And it’s now morphed into very, very extreme right wing populism that we had, that has kind of organised around and been organised by Donald Trump. Really stems I think, from this sense that our system is not fair. And so yeah, well understand that it’s not democratic. And I think it’s really poisoning our politics.
Gene Tunny 15:06
Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 15:41
Now back to the show. Well, I think this idea of this, too much finance literature, I’m gonna have to have a look at it or a closer look, I’ve seen some of it, I think. I mean, obviously, we need banks. Okay. I mean, we’re not necessarily any banks, because banks do play an important role in providing credit and supporting businesses. I mean, you asked most bankers, they will think they’re adding value to society. What are the activities where there’s this so called too much finance? I mean, how, like, what how does that manifest? Yeah,
Gerald Epstein 16:18
excellent question. Well, I start off my book with a chapter called the Jekyll and Hyde finance. It builds on this idea from the Robert Louis Stevenson story, which some some of your listeners might have heard of, this very upstanding doctor, Mr. Dr. Jekyll, who was a pillar of the community and really supported the committee and did all kinds of things with it. But we had another base hidden inside of him, this Mr. Hyde, who was who was a criminal, and murderous, and so forth. And, and these different phases of this one entity would show itself depending on on the conditions. So our financial system is kind of like that, you’re absolutely right. We need a financial system that works for the everybody that works for the economy, we need to be able to finance people’s retirement be able to finance people’s ability to buy homes, we need to finance credit for businesses to invest in new plant and equipment. And the list goes on and on and on. The problem is that our current financial system in the United States, which I call roaring banking, it’s kind of comes from the bill boring banking idea of the 1950s and 60s that was very regulated, and morphed into roaring banking as a result of this deregulation, it led this financial markets and these big financial institutions to engage in more speculation taking on more and more risks, to invest in speculative bets and derivatives and other kinds of speculative activity. Yeah, and it resulted in them taking on much more risk, which allowed them to increase the profits and wages, going to the major investors, and to those at the top, without, at the same time, investing a lot in in new plant and equipment for businesses and so forth. In the United States. Many big corporations do not rely on the banks or even the financial markets for their major investments, they get most of the financing from the major investments from their own retained earnings, their own profits. And so it raises the question, well, what are these these big banks, hedge funds, private equity funds, what are they really doing? And many of them are not really supporting the real needs of the economy. In the United States, we have a lot of smaller banks and community banks. And they’re the ones who are much more likely to give home mortgages to give to lend to small businesses, and so forth. And the problem is, in the United States, we have a particular system, your system is different in Australia, what we have is these very speculative mega banks that are driving out to smaller banks. Part of the reason that happens is that when there’s a financial crisis, our government has a too big to fail policy. That means if you’re a really big bang, chances are you’re gonna get bailed out by the government. Whereas if you’re a mid sized or smaller bank, and you get in trouble, you’re not going to get bailed out or you’re gonna go bankrupt or get merged into another bank. And so depositors and investors don’t feel that safe, putting their money in the smaller banks. They Put them in the big banks as well. So the cost of capital for the smaller and community banks is higher, because of the too big to fail subsidy that the big banks get. So it’s an unfair competition. And it’s not a one of the things that I propose in the book is a set of policies that help make this competition, more level more, more fair, so that we have a whole variety of financial institutions that provide the needed services, as you said, that our economy needs. Okay.
Gene Tunny 20:36
Now, in your book, you talk about issues with mortgage backed securities, I suppose one of the things that people, you know, they were most critical of some of these major investment banks was there, you know, they’d be packaging up, or creating these mortgage backed securities and then selling them around the world. But at the same time, I forget which firm it was, but was one of the banks betting against products that was actually selling or one arm of Goldman Sachs. Yeah, Goldman Sachs was one of them. Yeah. So it’s, it’s,
Gerald Epstein 21:09
you know, it’s not really taking care of your clients. And it’s really betting against your own clients. And that’s kind of one example of a behaviour that this all allowed. Yes. Yeah.
21:23
And another. Another good point I think you make in the book.
Gene Tunny 21:29
And this gets to the fact that you argue that the Federal Reserve is at the head of the bankers club, you talk about the impact on of quantitative easing and the the adverse, or the unfair impacts of that. Could you elaborate on that, please? Professor Epstein.
Gerald Epstein 21:47
Yeah. So when the great financial crisis hit Central, the Federal Reserve and other central banks, were trying to revive the economy, understandably, that’s what they should have been doing. Interest rates were already in almost zero. So they wanted to come up with another tool to put liquidity in the in the economy and reduce the cost of investment, cost of capital and so forth, while helping to sustain the banks that were in trouble. So they engaged in what’s called quantitative easing. They put liquidity in the economy by buying up not just government securities, which is the typical way that they do open market operations. But they bought up asset backed securities, mortgage backed securities, this kind of thing from banks, which ended up increasing the value of these assets, which helped the banks because they had these, these assets on their balance sheets were which were not worth very much. So it helped the banks. But the the idea is that it was there hoping that it would also lower the cost of capital to borrowers and investors, and then to generate more employment, and so forth. So my graduate students, and I looked at whether what the impact was in the United States. So there could have been, there was this asset in value increase, which increases the wealth of asset holders, the banks and others, there was cost of capital mechanism that would have possibly lowered the cost for homeowners and others who were borrowing money. And then there was the impact on the interest rates that the consumers get on their savings in banks and banks. So we had a various impacts going in opposite directions, the asset value increase, we’re going to help the wealthy people because they’re the ones who have all the assets, reducing the cost of capital, would help those homeowners who needed to get their mortgage cost down. And the lowering of interest on savings might have hurt middle class and working class people because they hold their money in savings in the bank. So we have these different possible impacts. So we tried to figure out what the net effect was. And what we found was that in the case of the United States, during this period, the main impact was on increasing the wealth of the wealthy, that the other impacts were relatively modest. So there have been other studies of quantitative easing in other countries during this period, and most of them find something similar that it had a relatively small impact on employment and cost of capital for borrowing and a much bigger impact on the value of assets which helped primarily the wealthy. There’s some counter studies, but most of them go in that direction. Now. It’s not necessarily the case. But we weren’t arguing that the Fed was trying to do that, per se. I I think they would have liked to have seen the economy get going more. But that was the impact of the policy that they pursued.
Gene Tunny 25:05
Yeah, yeah. Okay. Why was Dodd Frank? So there were there were some changes to legislation, post financial crisis. So as a result of the financial crisis, why were they insufficient. So Dodd Frank in particular,
Gerald Epstein 25:22
right, so what what really needed to happen after the financial crisis, in my view, and in the view of other others who were looking for some big changes, first of all, these mega banks, Goldman Sachs, the Bank of America, and so forth, they’ve gotten too big to fail, too big to manage. Oftentimes, the people at the top didn’t really understand what the heck they were doing. The big jail that is, the government didn’t even put any of these people who ended up taking on fraudulent activity, they never made them have any consequences at all. So they were just too big. And so there were proposals during the Dodd Frank process, to shut down these big banks that one was to implement a new Glass Steagall Act, which was kind of a modern version of the separating commercial and investment bank, another was putting an asset cap on these banks to try to get them into a size that couldn’t run the economy that can be managed better, and so forth. That was never put on the table. Another thing that the some of us argued for, were consequences for the bad behaviour of the decision makers or the wrong decision makers. When these Goldman Sachs was selling these securities to their clients and betting against them. And then they they made a lot of bonuses and profits, and then the bank threatened to collapse. They didn’t have to give back their salaries, they didn’t have to give back their bonuses, they were able to take the money and run, there were attempts to put in so called law backs into the Dodd Frank legislation. So that we didn’t have moral hazard that is, so we didn’t have a situation where people didn’t have to pay the consequences of their bad behaviour. That was never really put in as in in a significant way. There were conflicts of interest all over the place, including with credit rating agencies, we had the credit rating agencies that were rating the securities, the asset backed securities and so forth, that were full of really dicey mortgages, they rated them leave parts of them triple A, which is this, which is the same as the US government securities, triple A ratings. And why? Well, because the investment banks demand that they rate them triple A, the veteran banks paid the rating agencies, if they didn’t rate them, triple A, then the investment banks would take their business elsewhere to another rating agency. So there are all these kinds of conflicts of interest. They weren’t really dealt with either the list could go on. We needed more regulation for derivatives, derivatives are relatively unregulated. And again, there wasn’t much done there is Well, the question is why? Why wasn’t there better regulation? And the answer is bankers club. Dodd and Frank were both very weak members of they had very kind of weak backbone for really taking the banks on both Republicans and Democrats in the Senate and the House of Representatives. Many of them were were on the take from the banks. Tim Geithner, who was Treasury Secretary, Larry Summers, we talked about before Ben Bernanke, head of the Fed, they didn’t really want to shake up the financial system. They just wanted to get it back up and running again. So the bankers club really did a number on Dodd Frank. Now, there were a few things that were done, and they were good, but they weren’t enough.
Gene Tunny 29:08
Yeah, okay. Okay. And did Trump do anything when he was in office?
Gerald Epstein 29:12
Yeah, Trump’s an interesting story. He ran on a platform when he was running against Hillary Clinton, a very populous platform, who said, All the banks are terrible. They really messed everybody up. Probably Clinton makes money from the banks as she terrible. I’m really going to do a number on the banks. But then when he was elected, he immediately put a bunch of Goldman Sachs people in his administration. And he appointed people to try to dismantle the Dodd Frank Act. And among the things that they did was to raise the size that banks could get before they were subjected to special capital requirements or liquidity requirements. The so called mid size banks, were set free to kind of do what they want and The result of that is we had the Silicon Valley Bank that went under, in 2023. Because they were a bank that had been subject to special reg regulation. Under Trump, they were, they were let go and not have had to be subject to this regulation. And they got in trouble. In the end, the government had to bail out the financial markets again. So the question is, you know, what would trump do if he got into power? Again, you know, it’s probably going to be a similar story, where he’s going to rail against the wealthy and the banks and so forth. But chances are, they’ll do more of the same and it will be kind of this the supreme member of the bankers club if he ever gets back into office. Okay. Do
Gene Tunny 30:43
you see a greater role for publicly owned financial institutions?
Gerald Epstein 30:47
I do. And so it’s time I think, to raise the point of about the others theme in my book, I talk a lot about the bankers club. But I also talk a lot about group I call the club of busters. That is, there are many legislators like Elizabeth Warren and others in our in our government, there are activists, there are economists and lawyers and regulators, who really do want to try to do the right thing. They really do want to try to regulate the financial institutions properly, and are pushing for legislation and regulation to do so Gary Gensler, for example, the head of the SEC, really wants to regulate crypto very strictly, as an example, is giving the crypto people a lot of headaches. He’s a member, he’s what I call a club buster. And what we need, I think, not only tighter regulations, and this is what most people argue for, but we need a whole ecology a whole set of public financial institutions. Now by public, I don’t necessarily mean government owned. But what I mean is financial institutions that have a public orientation, that is making the maximum profits is not their only goal. It’s not their goal. They have missions, public mission, social missions. So some of them can be owned by the government. And the United States, we have some community banks, state banks, and so forth. There are many government owned banks around around the world, but they can also be public private partnerships. They can even be privately owned, nonprofit, non nonprofit nonprofits, who have a social mission. We need many more of these financial institutions to provide low cost mortgages, and loans for small businesses, investment in deprived communities that need more investment, help with transition to a greener economy, at the local level, and the regional level. So we need what I call banks without bankers, that is, banks who don’t have typical bankers in them, they have to have skilled people, technically competent people. But for whom maximising profits is not the main goal. And in the United States, we have a very active public banking movement of activists around the country pushing for public banks of various kinds. Their major obstacles, like once again, is the bankers club who was trying to prevent them from from succeeding, but they’re, they’re these bank posted this quote, officers are working very hard.
Gene Tunny 33:29
Gotcha. Okay, I’ll have to look into that public banking movement. That’s interesting. I like your point that, look, it doesn’t necessarily have to be publicly owned, because like where I’m coming from, as in Australia, we’ve had some, we had some really colossal state bank collapses in the late 80s, early 90s, tri continental state bank of Victoria, and Bank of SA South Australia, if I remember correctly, so we’ve got a bit of a, an aversion to publicly owned banks here, because of the risks to the balance sheets. I liked how you describe that. And I think I’ll have to look more into that at public banking movement. It looks interesting. The one concern I would have is, is there a concern? Is there a risk that maybe, maybe they’re too cautious or they’re not innovative enough? Have you thought about that? Right?
Gerald Epstein 34:16
So, you know, there’s, there is an upside and a downside. As a graduate student, I study the cyclical behaviour of publicly oriented banks in different countries relative to the purely private for profit banks. And what we found was that they were much less cyclical that is they went up much less than the upside and went down much less on the downside. So it’s can be a stabilising force in the economy. But I think what you’re going to getting errors don’t we need some you know, real risk takers and people who are really good, willing to go out on the limb with some some crazy but maybe great ideas. Take the risks and we Absolutely do need that in a dynamic economy. The problem is, what we don’t want is the government backstopping that we don’t want the government saying, you when you gain, you lose, we pay. We don’t want a kind of lemon socialism. So, yes, we need a risk takers, and and they have to pay the consequences if it doesn’t work out. Yeah,
Gene Tunny 35:24
yeah. Yeah, that’s a good point. I mean, that was one of the points that came up during the financial crisis that they were privatising the profits, but socialising the losses. So exactly. That’s a that’s a good point. Right. Okay. Well, to finish up, we might, I might ask you about crypto because in your book, you talk about Jekyll and Hyde. You write just as finance, as both Dr. Jekyll and Mr. Hyde face crypto has a bit of a Dracula quality as well. Could you tell us more about that, please.
Gerald Epstein 35:56
So if anybody who’s followed crypto or invest in it, they know, they know that there was a big bubble and Bitcoin and other cryptocurrencies and 2122. But there was the so called crypto winter, and when the crypto values just, you know, collapsed, and then there are all kinds of scandals with sand bank and freeze in jail and several the other main crypto people are in are subject to criminal investigation, or maybe are in jail. So it seemed like around that time, the crypto was dead. But like the vampires you stick across in them, and they somehow, you know, they revive and now crypto I think, has has had a revival. It’s still trying to push ahead. And there are a lot of crypto friendly legislative leaders in the US and in other countries. And so it’s like, yeah, we all thought it was was dead, but it’s risen from the dead. And my view on crypto, is that again, it’s fine. It’s like, it’s fine if people want to mess with it, you know, in line and death, you know, gamble with it, and so forth. But we can’t let it do two things, one, either of two things. One is infect core banking system. Once we have crypto infecting the core banking system, we’re back to where we were in 2007 2008, when these exotic asset backed securities and collateralized debt obligations, and so forth, infected the very core of the banking system. So when they collapse, they threaten to bring down the banking system with it. As long as it’s a marginal thing. Have fun with it, I suppose, as long as people are aware of the the downsides, but there’s another problem. Most crypto is very carbon intensive, the crypto mining, it’s very bad for our environment, we have this, this existential threat of climate change. And the way crypto mining is done in most cases, not all cases now. It’s really adding as much carbon to the atmosphere as a small country like Iceland or some other country. So I think that has to be taxed. And if crypto can still you know, give some thrills to the its investors in a safe way without destroying the environment. Okay, go for it. But let’s not let it ruin the environment. And it let’s not let it infect our our core banking system. Yeah, very good points.
Gene Tunny 38:27
Okay. Professor Epstein, any final points? Before we wrap up? I think this has been a great conversation. And I did enjoy reading your book. And I’m going to recommend it. And I’ll put the link in the show notes. Any final points before we wrap up?
Gerald Epstein 38:42
Yeah, the final point is that was one of the things that’s kind of obvious from our conversation, my book is, is almost entirely about the United States. So whatever, if these processes happen elsewhere, it will happen in a different way. There have been people doing work in similar kinds of work in other countries, we have Nicholas Shaxson, who’s done interesting work in in England, and we have Jim Stamford, who you might know who is then actually work in Australia and Canada. So I don’t claim that this is a universal process. But But I do hope that other people explore some of these ideas in their particular countries in particular environments to see what’s similar and what’s different.
Gene Tunny 39:21
Absolutely. Okay. Professor Gerald Epstein, thanks so much for your time. I really enjoyed the conversation.
Gerald Epstein 39:26
Thank you very much.
Gene Tunny 39:29
Right. Oh, thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating thanks So listening, I hope you can join me again next week
40:16
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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.
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.
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)
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
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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
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Economics Explored host Gene Tunny talks about the “greedflation” (greed + inflation) hypothesis with his colleague Arturo Espinosa from Adept Economics. They discuss whether greedy corporations might be responsible for high inflation rates in advanced economies such as Australia and the United States. Gene talks about how the excessive fiscal and monetary stimulus during the pandemic has been a major contributor to higher inflation.
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 could join me for this episode, please check out the show notes for relevant information. Now on to the show. Thanks for tuning into the show. In this episode, I chat with my colleague Arturo Espinosa from adept economics about the greed inflation hypothesis, our greedy corporations to blame for the high inflation that we’ve been living through. After you listen to the episode, please let me know what you think about the greed inflation hypothesis. You can email me at contact@economicsexplored.com. I’d love to hear from you. Okay, let’s get into the episode. I hope you enjoy it. Arturo, good to have you back on the programme.
Arturo Espinoza Bocangel 01:12
I’m very happy to be here.
Gene Tunny 01:14
Excellent. Arturo. So it’s at the end of the week, it’s Friday the 28th of April 2023. Earlier this week, we had the March quarter inflation number for Australia. It came in at 7%. So it was lower than at its peak of 7.8%. The quarter before but it’s still it’s still high. And mean, there’s still concerns about cost of living in Australia for sure. I mean, that’s something we’ve all been noticing as we go to the supermarket and other stores. So for sure inflation is still high. One of the things I think is interesting, and I must admit I’ve come to this issue late. Is this issue or this accusation of greed, deflation? Have you heard about this concept of greed, deflation? Arturo?
Arturo Espinoza Bocangel 02:05
Well, lately, yes. But when I was student in Peru, I haven’t heard that
Gene Tunny 02:11
nine. I think it’s a it’s a new term that that’s been thrown around. There’s this accusation that a lot of the inflation we’re seeing is due to profiteering it’s due to greedy corporations. So obviously, we do need to be concerned about big business and monopoly power. There’s, that’s a legitimate thing to be concerned about. But there is this question of, to what extent can we explain the inflation that we’ve seen by greedy corporations? So is it greed, flotation. And this has been quite prominent in the media. So there’s a think tank here in Australia, the Australian Institute, and it’s put out a paper in which they’re saying that this is a big part of the inflation problem. So we might talk about that in a moment. And it’s an accusation that’s been thrown around in other countries, too, in the States. And also in Europe, there was an article in Fortune magazine earlier this week. Greed flash deflation is the European Central Bank’s latest headache amid fears it’s the key culprit for price hikes. And I mean, what we see in whether it’s in Europe, or whether it’s in the States, or whether it’s here in Australia or the UK, if you just look at the data, if you look at data on inflation, you look at data on corporate profits and wages, and you look at data on other input costs. It is the case that profits have been have been high and they have grown in this post pandemic period. And this has led some people to argue that, well, they’re just profiteering they’re putting prices up more than can be justified. Now, I think this is a difficult hypothesis to prove it been thinking about it a bit and how you might demonstrate whether it’s the case or not that this is true, or whether you can whether we can rule it out, or or is it something that is it is a legitimate possibility. We do know that certainly profits for oil and gas companies and also coal mining companies here in Australia. They’ve been, they’ve been very high and also profits in other sectors to have been, have been higher. So in banks and, and in other sectors, and that’s what The Australia Institute argues. One of the challenges I see however, is that in economics as in other sciences, you need to be careful to distinguish should join correlation and causation. I think what Institute’s such as research, researchers think tanks, such as The Australia Institute have found I think they’ve found a correlation isn’t causation I think that’s a lot harder to establish and might go into, into why that’s the case. So I want to talk about correlation versus causation, how might you prove whether there’s green inflation is, is a legitimate thing or not? And we’ve also got to think about here, what’s the what’s the scientific way to look at this and to come to a conclusion now, The Australia Institute is a think tank, and it has a particular agenda. It has a progressive or a left wing bias. And so this type of hypothesis of green inflation appeals to it. So we need to keep that in mind. And we should think rigorously about whether it makes sense or not. Okay, so that’s, that’s a bit of an intro to this idea of greed, inflation. Or one of the other things I just wanted to mention in the intro is that there have been calls for a windfall tax on oil and gas companies in, in many countries, and they did impose one in the UK, I don’t know if you saw the news about the that windfall tax that they imposed on oil and gas, know, what will happen are they put on a, an energy profits Levy, because arguably, a lot of the the excess profits that the oil and gas companies were making, that was due to the higher prices associated with the war in Ukraine. And if you think about it, from an economic perspective, they really didn’t need those profits to have been motivated to invest in the first place. So you could argue that they were, they were x supernormal profits. And so therefore, you could make a case for a some sort of excess profits. Levy. And so that’s what they did in the UK, they put on a an energy profits levy a 25% surcharge on extraordinary profits, the oil and gas sector is making and, and that’s we saw a similar thing here in Australia wheeling, Queensland with the higher royalty rates on coal. So they put in a new, a couple of new tiers in their royalty rates. I think they had a 40%. There’s now a 40. What is it a $40 a tonne royalty rate, once the coal price gets above a certain, certain level? And I mean, this, this is something that’s controversial, because then companies say, Well, there’s a sovereign risk that oh, there’s a risk of that, that we didn’t anticipate before. Now, we have to really think about whether we invest in your state or your country. So there’s that that to consider. But that’s just to say that why this is relevant is because if you think that this green inflation is a problem, then you might be more inclined to to advance policy measures like that, like a windfall profits tax or higher, higher company tax or something like that. So I think that’s a that’s one of the issues in the policy debate I thought I’d mentioned. Okay, Arturo, any thoughts on ADD or green inflation? So far,
Arturo Espinoza Bocangel 08:26
it seemed that probably these inflation can be caused by these corporate big multinational corporation that wants to maximise the profits. Without taking into account what happening in the White House household level, the pressure of these inflation particularly is on the household Australian households, that they need to pay higher prices in energy, fuel, my grocery staff, so that is, that is painful.
Gene Tunny 09:04
Yeah. How plausible Do you think there’s greed inflation hypothesis is so basically it’s saying that the corporations are taking advantage of this concern over inflation? Or that they see that? Okay, so prices have started to rise and corporations think, okay, let’s just keep increasing prices, because we’re, we’ve got the cover to do. So now. We’re, it’s, we can get away with it, essentially. Now, what’s the problem with that argument? So we’re thinking like economists would say that the problem with that argument is that if one company decides to do that, and they’re doing it illegitimately that their costs of production really haven’t increased. Wouldn’t another company try and undercut them or try to they just, they wouldn’t raise their prices as much and then they could steal some market share from them. Yeah, the third point? Yep. So it requires some time. coordination among the companies, doesn’t it some sort of implicit collusion. And I think this is where some of these models, there are some theoretical models that appears which are trying to lend support to this greed inflation hypothesis. Did I think you found a study, didn’t you, Arturo, that said that this or that? Was that an empirical study you found that said that where there’s market power, it looks like there is some tendency to have
Arturo Espinoza Bocangel 10:25
there’s a few of them, the the those paper have found positive correlation between higher concentration higher inflationary pressure,
Gene Tunny 10:36
really? Okay. And do you think they’re good studies, though they published in good journals, do we what do we know?
Arturo Espinoza Bocangel 10:42
Those are probably most of them are publishing good journals. And also in economy, we know that the mythologies bar are different. And also each metal he has his pros and cons. So we need to, to consider that and analyse in detail what is.
Gene Tunny 11:05
So probably too much for us to do in this episode. But we’ll put links in the show notes. So if you’re in the audience, and you’re interested in having a look at those studies, you can check them out, and I might have a closer look at them after this. I know that there are studies like that, and that would lend support to this greed inflation hypothesis. And so maybe we can’t completely rule it out. There’s a paper by John Quiggin and Flavio ministers, and John and Flavio, their professors at University of Queensland and economics. I know both of them. Well. And John’s actually been on the show before. And they wrote a piece in the conversation. I think they had a working paper to back it up and inflation has been amplified by firms with market power. And so their argument is that where one or more firms is big enough to have market power for any given quantity sold, prices will be higher. Yep, and increasingly higher as demand for the product climbs, okay. This means that after a boost to demand such as the one that followed the COVID stimulus, in the end of the lockdowns, firms with market power amplify the resulting inflationary shock. Okay, so they’ve got a model where they come to a conclusion that having market power means that you’re more likely to be able to take advantage or to put your prices up if there’s this, this demand shock, okay. Possibly. I mean, my feeling is that if there is a level of competition in the market, then that should constrain that. But look, if there is market power, maybe that’s an interesting, interesting hypothesis. And there are studies from the States did you see this isn’t just something in Australia, there are studies from the US as well as a Kansas City Fed study from 2021 There’s a really interesting point they make in this that I think it’s worth thinking about in this whole green inflation conversation. So I think Andrew Glover Jose, I think you know how to pronounce his name. Yeah, cuz Sam was traded veal. Okay, that’s great. And Alice Vaughn and Rebecca they present evidence that markup growth so markups on products sold. So for the to get the profit. So the markup growth was a major contributor to inflation in 2021 markups grew by 3.4% over the year, whereas inflation as measured by the price index for personal consumption expenditures was 5.8%. Suggesting markups could account for more than half of 2021 inflation. This is what I think’s fascinating. They note that the timing and cross industry patterns of markups growth of markup growth are more consistent with firms raising prices in anticipation of future cost increases rather than an increase in monopoly power or higher demand. I think that’s a really critical point. So look, it might be the case that if you look at the data, at the moment, that it looks like the businesses are doing incredibly well. So they’ve got high profits. And they’ve they’ve increased their prices, but it could be that they’ve increased their prices in anticipation of future cost increases. Now to some extent, you have seen those future cost increases will in fuel I mean fuel prices were higher for I think they’re starting to come down. But energy prices here in Australia are still going up. Costs of other inputs are increasing labour costs. Labour hasn’t responded as much as some people have been forecasting for years. So wages growth is still It hasn’t really been that spectacular. But look, I mean, there’s something to that that could be the case that what we’re seeing is businesses. It’s not as if they’re being greedy. They’re just concerned about their own costs rising and they’re increasing their profits. Another thing to keep in mind, of course, is that that profits are procyclical. And this inflation has occurred at a time of a booming economy, the economy post COVID boomed. And as we came out of the pandemic, and that’s a time when you’d naturally expect to see higher profits. And we’ve also seen high inflation, unfortunately. So it could be correlation rather than causation. Again, look, lots of there’s a lot going on. There are lots of aspects of the economy. And I think that Kansas City Fed study, and I’ll link to that in the show notes that makes a good point about how you need to consider expectations in assessing what companies are doing. Okay. There was also a study by the Boston Fed that you found wasn’t there. So this is one of the other Federal Reserve Banks. So what was that cost price relationships in a concentrated? Economy? Was this a study you were talking about before?
Arturo Espinoza Bocangel 16:15
Exactly if the concentration, right,
Gene Tunny 16:19
okay. So the US economy is at least 50% more concentrated today than it was in 2005. So they, their findings suggest the increase in industry concentration over the past few decades, could be amplifying the inflationary pressure from current supply chain disruptions in a tight labour market? Okay, so this was a paper from 2000, until I’ll put a link in the show notes. Right. So that’s, that’s supporting that greed foundation thesis. Look, there’s there’s a whole bunch of you know, there’s studies that support it to an extent and then there’s others that question it, or there’s commentary that questions that. And one of the things you found Arturo, which I think was fascinating was that the so the Reserve Bank of Australia, so as central bank, and here in Australia, it doesn’t really give any credence it doesn’t really think much of this whole green inflation idea, does it or it hasn’t hasn’t raised it or doesn’t talk about it as a possible explanation does
Arturo Espinoza Bocangel 17:20
exactly here that RBA pointed out that there’s a place I fuck towards accounting for around half of the increase in inflation over the year to September 2022. But they didn’t mention anything about really corporations.
Gene Tunny 17:35
Right. Okay. So what I’ll do is so I can be to be objective and to be to be fair, on both sides of the argument, I’ll put links to, to, to what the RBA has been saying to both of those fed studies and also to what The Australia Institute has been, has been saying, I mean, they’re been the most vocal about about this. I mean, their analysis to them suggests this is an analysis of national accounts data. Again, it’s it’s an analysis of correlations of data that’s that they seen these things happening at the same time and drawing a conclusion based on that now, can you make the conclusion that this is due to greedy corporations, or corporations being more greedy than normal? Okay, I mean, we live in a capitalist economy. Okay. So businesses are going to maximise profits. There’s no doubt about that. But look, that’s the system we’re in. But is this something that in times of inflation, does it amplify the inflation or lead to, to more inflation than you you’d otherwise expect? I think that’s the hypothesis, The Australia Institute, based on their correlation, all analysis I call it says just looking at correlations, they would argue that it does. So their analysis suggests to them that 69% of excess inflation, so above the, the Reserve Bank’s target of two and a half percent, since the end of 2019, came from higher unit corporate profit margins, while only 18% of the student labour costs. Right. Okay. And they go on in that report to say that, look, it’s not just the profits in the mining sector, because it was just profits in the mining sector. And whereby, okay, the miners are really profitable. And so there’s a lot more profit in the Australian economy that’s on that’s because of all these export earnings. Right? So it’s not as if they’re making all of these profits by exploiting people in the domestic economy. So that’s where that argument of theirs would fall down. But then they do go on to point out it’s not just mining, that where there’s these excess profits in their view, there’s, you know, higher profits in it. in financial services and banking and in other sectors, so, yeah, check that out. And I think they ask a good question. And it’s good that they’ve made this contribution to the debate, because it forces us to think rigorously about what’s been driving inflation and what’s the cause of inflation. And we’ll get on to that again, in a moment. Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 21:03
Now back to the show. One of my old Treasury colleagues, John to in the financial review, John has written an opinion piece, which is very good. John’s good writer. Blaming inflation on greedy business is a populist cop out. And I think what John is saying here, I think this is where a lot of the economists in the Reserve Bank or the Treasury, I think they would agree with John, I think I largely agree with John, and I’ll go into into why in a moment. And John’s main message is that it was the spillover of public sector stimulus that lasted for too long, not price gouging by companies that fueled the inflation outbreak. Did you have a look at that? That article by John?
Arturo Espinoza Bocangel 21:55
Yeah, yes, I rebuilt the conclusion. Yes. He made a good point.
Gene Tunny 22:00
Yeah. And he relied on a study by Chris Murphy, who’s a former Treasury model. I actually work with Chris’s daughter in Treasury, Carol, I believe, if I remember correctly. So Chris, is a well known Australian macro, economist. And he was at KPMG e contact for a while. Now he’s a visiting fellow at ASU. And he’s done something a bit more advanced than what The Australia Institute did. The Australian Institute just looked at the national accounts and inflation data and tried to draw conclusions from that from just basic data analysis. Now, I think the problem in economics is, you can only go so far doing that, if we’re talking about testing hypotheses, what’s the scientific approach to do that, you probably need something a bit more than just the basic data analysis. Now, one of the problems we have in economics, of course, is that you can’t run controlled experiments as you can in the lab. So we’re always trying to come up with clever ways to, to analyse the data, to do econometric modelling of some kind, to work out whether these hypotheses can be maintained, or whether they’re, they’re rejected. That’s what I’d say on that. And what Chris Murphy does is he runs a simulation. He’s got this macro economic model, this econometric model of the Australian economy based on a broad range of macro economic data, and relationships that have some basis in economic theory. And what he does is he simulates the economy, if it was subject to COVID. But there wasn’t all of the arguably excessive monetary and fiscal policy response there was the there was some contraction in GDP. I mean, there’s a quite a substantial contraction in GDP still in that first quarter of COVID. Because people just would have naturally socially distanced anyway, right, even in the absence of policy measures. And we did say that in in some economies, that there was no, there was no way of avoiding the the economic shock from COVID entirely. But if you didn’t have the, all of that stimulus than by his estimates, you would have avoided a lot of the inflation. And I think this is really, really interesting, really interesting modelling. And Chris Murphy has a paper in the economic papers journal, which is a journal that’s actually published by the Queensland branch of the Economic Society was aranea, which I was once the secretary of. No longer though, but you can get that online, I’ll put a link in the show notes, fiscal policy in the COVID, 19. Euro. Really good paper. And what he does in this paper, which I think is excellent, is he just highlights how massively generous the COVID stimulus was, the stimulus during COVID was particularly job keeper, which was just incredibly generous, and he ended up because of the eligibility rules, there are all these people who are they were only employed part time, but they effectively get compensated as if they were full time workers. So there are a lot of people getting access excess money. And there’s an argument that that stopped some of those people from searching for a new job, if they were if they are on job keeper, or if they’ve been supported by job keeper. So, yeah, lots of problems with that, that stimulus and I think we’re, if we had another pandemic, I mean, let’s hope we don’t, I mean, still getting recovering from that last one. I mean, it was just the excessive response was just at it, and just, yeah, incredible. But if we do have it, I think we would have a much better, or a hope, whatever much better economic policy response. But what Chris Murphy found was that the fifth and this is in Australia, the fiscal response to compensate for income losses. In services industries meant that unemployment was around two percentage points lower for three years than otherwise, than it otherwise would have been. And there was over compensation for every $1 of income, the private sector lost under COVID, fiscal policy provided $2 of compensation. And then there was of course, the ultra low interest rates, point 1% cash rate, the hundreds of billions of dollars of monetary stimulus via quantitative easing, all of this additional money in bank accounts, I’ve got some charts that I’ll put in the show notes. So just show how much the Australian money supply is grown. I think since 2020, the amount of money so the stock of money in Australia has increased by nearly a third or around a third or something like that. And think about that. This is part of this whole. And this is something that what I’ve been saying on this show for the last couple of years, I mean, what we’ve got is too, too much money chasing too few goods, if you looked at what happened during the pandemic, and within the fiscal policy and monetary policy, what we saw with the inflation now, no doubt, significant part of it was due to the invasion of Ukraine. But what we end up seeing with inflation is what you would have expected based on the the massive stimulus and particularly the massive monetary growth that we saw. And so therefore, you don’t need this green inflation hypothesis. You can explain a lot of it by the excessive stimulus. And this is what Chris Murphy shows in that paper. Germany thoughts on that, Arturo?
Arturo Espinoza Bocangel 28:09
Whoa, this point, you the last point that you have mentioned is very clear. It made me think, okay, yes. The these re the cooperation argument is not 100%? Sure, shall we, whether if some academics, or you know, researchers will try to understand the drivers behind inflation. When I mentioned, drivers, of course, we include these government expenditure in increments. And also lit, we can include another factors at fame level, like, for example, to, to use markups in order to maximise profits. So that kind of thing is,
Gene Tunny 29:03
yeah, I think you made a good point before. I mean, we really want to have a look at what’s been happening in specific firms. I think we’ll have to wait for studies that really examined what’s happened at that firm level, maybe using that business longitudinal database data? I don’t know. But yeah, clearly, this is a it’s a big issue. And I think it’s one that we need more evidence to resolve. But I guess what I would say is that we shouldn’t jump to the conclusion. I mean, I’m pretty confident that we shouldn’t jump to the conclusion that it’s greed flesh, and that is just because a greedy corporations, I think there’s there’s a lot more. I’m not even sure to what extent that’s a significant factor. In fact, the corporations more greedy than normal. I mean, it’s this idea that it could amplify a shock that is inflationary, possibly, but I’d like to see, yeah, I have to sort of think deeply about what that means. It’ll is and what that mechanism is, I mean, my view is that you don’t need that great inflation hypothesis to explain what’s happened because it’s perfectly understandable if you just think about the the massive, the massive shock that we saw now. So think Chris Murphy, what he found was that if you didn’t have the stimulus, if you just had COVID, then then by the end of 2022, you’d have inflation at around 4.2%. So you would have ended up with some inflation as the economy bounced back after COVID. But what ended up happening, of course, is that inflation went far beyond 4.2%. In Australia, we ended up with 7.8% in Australia. And what Chris Murphy’s modelling shows is that, in his scenario, his his actual forecast scenario, he’s worked out that the excessive macro stimulus drives inflation, three percentage points higher, so three percentage points higher to a peak of 7.2%. Okay, which is in the wall ballpark of where it did get. So in his model, he can you explain it with the stimulus. Now, of course, it’s a macro model and models that we all know the problems of trying to forecast the economy and modelling the, the actual path of the economy with an econometric model with with equations. We’ve got parameters estimated, statistically or using econometric methods there. They have their limitations. But to me what, what Chris Murphy does is, is a better way to think about this sort of try and answer this question than just this basic correlation analysis that’s done, where we go, oh, well, profits are up. inflation’s up. wages aren’t up by much. It looks like it must all be inflation’s. At the same time as we’re having inflation companies are making more money. Therefore, it’s greedy, greedy corporations, I think I don’t really think that’s, that’s the right way to think about it. Having said that, I mean, it’s worth having the conversation and forces us all to think more rigorously about the causes of inflation and what we should do about it. And he thought cetera? No, I think that’s pretty much all I wanted to go over. I’ll put links in the show notes, to all these various papers and reports we talked about. The RBA has put something out on inflation drivers where they look at the different factors and they don’t seem to think much of this whole green inflation, explanation. But look, I think it’s worth covering. I know that, you know, we do have to be mindful of corporate power we have to be mindful of, of monopolies or oligopolies that exploit their market power. There’s no doubt about that. I mean, then that’s why we have things like the a triple C, the Australian Competition and Consumer Commission, or we have the we have the antitrust statutes in the US. And we have whatever the equivalent is in the UK. Did you see in the in the they’re quite muscular in the UK? Did you see the they’re blocking that? Microsoft’s acquisition of Activision Blizzard? Oh, I haven’t seen that. Oh, yeah. That’s quite interesting, because one of the things I’ve covered on this show is this issue of big tech and to what extent we should be concerned about big tech, so might have to come back to that in a in a future episode. I thought that was a really interesting development, because they’re concerned about Microsoft’s already a behemoth, right. Concerned about Microsoft getting getting even more market power in games. Okay, well, thanks so much for your time and for helping me think about this issue of greed, inflation, it’s helpful to talk about these issues with with colleagues. So I can think about really clarify how I’m thinking about it. Am I on the right track? Am I being biassed? Am I too sceptical of this hypothesis, which might actually have some merit. But yeah, I think my view is that we can probably explain inflation most, if not all of the inflation by the excessive fiscal and monetary stimulus. We don’t need this great inflation hypothesis that said, Look, if they can provide convincing evidence that it is a thing then sure let’s let’s look at it a bit more closely. So think that’s where all I’ll end up. Tomorrow. Thanks so much for your time.
Arturo Espinoza Bocangel 34:37
Thank you for having me, as well was my pleasure. Very good.
Gene Tunny 34:43
rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.
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Credits
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When I recorded the latest episode of my Economics Explored podcast last Friday afternoon, the price of one Bitcoin was a bit above US$18,000 after having failed to get beyond US$20,000 in the previous weeks. In my chat with my friend Tim Hughes, I said who knew what it would end up at when the episode was finally released. Well, it turns out that the price of one Bitcoin has finally gone beyond US$20,000 (check out this Coindesk report).
The US$20,000 Bitcoin price is the latest illustration of the Greater Fool Theory. If you’re buying Bitcoin at this price you’re speculating/gambling you’ll find a greater fool who’ll buy it at a higher price. Coindesk suggests there could be a lot of greater fools out there:
Breaking above $20,000, which represented a significant hurdle in the mindset of most traders, is entirely new ground for bitcoin and opens the doors for a climb to $100,000 over the course of 2021, according to some.
