In this latest installment of our Zombie Month series, we welcome Daniel Lacalle onto the Gold Exchange Podcast. Daniel is an economist, fund manager and professor of Global Economics. Daniel discusses the recent fallout in the UK, the pressures building up in the global economy, and the central banks’ creation of zombie firms. Listen to Ben, Keith and Daniel get into everything from quantitative easing to zombie slaying.
Connect with Daniel on twitter @dlacalle and on his website
Connect with Keith Weiner and Monetary Metals on Twitter: @RealKeithWeiner @Monetary_Metals
Additional Resources
How to Make and Break A Pension in 22 Easy Steps
Earn Interest on Gold and Silver
How To Make and Break A Pension Fund in 22 Easy Steps
Financial Repression and Zombification
Podcast Chapters
01:24–5:50 UK Collapse and Global Dollar Vacuum
5:50–12:10 Spend Now, Consequences Later
12:10– 18:15 The Printing Panacea
18:15–27:14 Central Bank Perversities
27:14–31:16 Zombie Firms and Financial Repression
31:16–36:00 The Fed Pivot and Doubling Down
36:00–38:52 Economic Unreality
38:52–42:30 Rate Hikes and Ivory Towers
46:34–50:02 The Case for People’s….
50:02–52:47 Yield Curve Inversions
52:47–55:05 Slaying the Horde?
56:46–57:29 Outro
Transcript:
Ben:
Welcome back to the Gold Exchange Podcast. My name is Benjamin Nadelstein here at Monetary Medals with founder and CEO of Monetary Metals, Keith Weiner. And our special guest for today, Daniel Lacalle. Daniel Lacalle is an author, columnist and chief economist at Tressis. Now, Daniel, I want to jump right in. I know we’re in a bunch of different spots all over the world. I’m here in the United States. He’s here in Zurich. Daniel, where are you and what do you see around you at the moment?
Daniel Lacalle:
Well, talking from Madrid, Spain, recently arrived from the US and the UK. So seeing a little bit of everything, a little bit of fun in the UK actually these days.
Ben:
Yeah, well, let’s start with some fun in the UK. There’s been a lot of talk about Liz Truss and some of her policies that she was planning on implementing and I think there is in some ways a scapegoating happening.
Keith Weiner:
Right.
Ben:
I think you talk about this Liz Truss, you know, her policies come out and next thing you know there’s chaos in the markets. Is Liz Truss to blame?
Daniel Lacalle:
Certainly not. There’s chaos in the market in Japan, there’s chaos in the market in Europe, there’s chaos in the market everywhere. What people are doing is to utilize a catalyst that is fake a budget that is obviously a very bad budget because it’s a deficit spending budget, very keen to increase in spending and reduction in taxes and say that that was the reason why the pound fell and why pension funds all of a sudden needed to provide higher levels of collateral for their margin calls. Well, obviously that has absolutely nothing to do with the budget. What has everything to do with the collapse in bonds and the situation in markets in general is interest rate hikes and this global dollar vacuum that we’re living in which after years of monetary excess, what we have is margin calls in energy providers, margin calls and pension funds, margin calls in everyone that bought into the aggressive monetary stimulus situation. So nothing to do with the budget. But anyway, miss Truss has resigned and interestingly enough, as you will see, we will have another budget in the UK where the deficit will increase, the spending will increase, but they will say that they’re calming the markets.
Keith Weiner:
I was just going to add two things. One, the problems in pension funds are obviously decades in the making, and then to blame it on Truss is terribly convenient. And then two, it seems like every country in the world has two parties the party of tax and spend versus the party of borrow and spend. Ironically, borrow and spend. Keynesian was a hard leftist of his day. Your Keynes. Excuse me, the party of borrow and spend today seems to be the conservatives. Tax and spend seems to be the left.
Daniel Lacalle:
Yes.
Keith Weiner:
Although modern monetary theory, I think, is making inroads on the left. And MMT says you don’t have the tax at all except as an inflation stop.
Daniel Lacalle:
Exactly.
Keith Weiner:
Truss resigned today because I haven’t seen that news yet?
Daniel Lacalle:
She has resigned. It is Thursday and she resigned, as was expected, to be fairly honest. It was the chronicle of something that was going to happen almost inevitably. No, but funnily enough, at the same time as she resigned. What I find most interesting in terms of what we’re likely to discuss further is that the labor leader was mentioning what would be his massively different economic policy. And what is the massively different economic policy of the labor leader? Spend a lot more and tax a lot more.
Keith Weiner:
A lot more and not allow domestic production of natural gas.
Daniel Lacalle:
Exactly. Well, that’s the other thing. Ban fracking. Obviously. It’s all a train wreck, to be fairly honest.
Keith Weiner:
Yeah. It was a few days ago comment about it was inevitable, this press conference that Liz Truss had. And of course, the British reporters are terribly, terribly polite, unlike American reporters. But the first one said, with Kwarteng out, why do you get to remain as Prime Minister? And then she somehow dodged that question. And then the next one said, well, yes, just to follow up, why should you still be Prime Minister? And they just kept asking the same question. It was like, wow, this is really open insurrection, mutiny on the bounty. And, you know, I don’t know how a politician survives that, once there’s that feeling of the inevitable. And I guess she didn’t so onto the next one, whoever it may be.
Ben:
I want to jump in here, because this idea I know, Daniel, you write about this spend now, deal with the consequences later. And Keith, obviously you’ve just given a talk about pensions and how to destroy pension in 22 easy steps, and I like this idea of spend now and we’ll deal with those consequences later. And if that’s not the slogan of MMT, I really don’t know what is it?
Keith Weiner:
Somebody said, what did you say? Your policies were all going to be dead, and then said, in the long run, we’re all dead anyway. They’re very cynical. Anyway, we’re now later. Okay? We spent and deal with consequences later. It means now dealing with them.
Daniel Lacalle:
That is exactly it. The problem with spend now and deal with the consequences later is it gives the impression to the nondiscerning public that deal with the consequences later is simply, well, nothing is going to happen and everything is happening and everything is happening. And the easy thing, obviously, as we’re seeing all over the world, is you blame it on the budget of one prime minister, you blame it on the Ukraine war, you blame it or you blame it on anything. The best scapegoat that exists out there is the external enemy. But it’s interesting that in the eurozone we’ve had the same collapse in bond deals sorry, the same collapse in bonds and the same rise in bond yields that we have seen in the United Kingdom, for example. Yet everybody says that all of the problem is Brexit, so it’s always anyone to blame except monetary policy. It’s never to blame. So the fact that UK pension funds are entered into £1.8 trillion of derivatives to cover for the alleged risk of interest rates and inflation with very little collateral, and that a 20% decrease in the price of those bonds has triggered massive margins, is going to be blamed on Brexit.
And meanwhile, this morning in Japan, this morning, Thursday in Japan, the yen is at 32 year lows after the bank of Japan has been intervening for two weeks without stop at least the abrupt effect of monetary laughing gas coming to an end.
Keith Weiner:
I don’t know how it is in the UK, in the US. My understanding of pension funds is that they must continue to pay out at the full rate, essentially until they fall off a cliff. So they pay and they pay and they pay when they run out of money like that. And so decades of falling interest rates have forced them to move out on the risk curve, move out on the yield curve in terms of seeking more duration, move out into assets that should never be owning in a pension in the first place, in my opinion, such as equities. And then finally leverage via all kinds of mechanisms, including swaps, just to try to make their nut, which is seven or 8%. You can’t go back to the taxpayer public and say the interest rate fell, now we have to give another billion pounds injected of capital. That’s not politically feasible, so you just seek more and more leverage. And finally, the favorite trick, borrowing short to buy long assets and then you get an uptick in interest rates and boom, the whole thing collapses like the house of cards that it was for decades, but now finally revealed to be and right its Liz Truss’ fault.
Daniel Lacalle:
Exactly.
Keith Weiner:
And how do you explain the rise in yields in the United States? Because it isn’t Brexit and isn’t Liz Truss?
Daniel Lacalle:
No, but it doesn’t matter, Keith. The rhetoric is that if something happens in the United States, you will be to blame because of the uncertainty about Trump possibly winning the election someday. They will create a narrative. The narrative is the narrative that is we have every day on the media in the UK and everywhere else, is that anything is to blame except the monster liquidity injection and government spending of 2020, 2021. Everything except that.
Keith Weiner:
That’s the elephant in the room. So we’re not supposed to look at it?
Daniel Lacalle:
Exactly. So it’s like you have this massive elephant in the room, the room is being wrecked and you blame it on the kids, you blame it on the housewives, you blame it on the husband, you blame it on the weather, but instead of the elephant and the elephant is there destroying the furniture and that is what’s going on. And obviously now they’re blaming on Liz Truss in the next everyone that’s watching us and listening to us right now, pay attention to this. The next one, the one to blame will be the Italian government. Will be the Italian government. The next one, the one to blame will be the alleged rise of the extreme right in Sweden. It’s never going to be the ECB or the bank of England.
Ben:
And Daniel, I like you posted this. You posted, hey, there’s breaking news that the Japanese yen is falling to 149.9 per US dollar, which is a new 32 year low. And you commented “that evil Liz Truss” trying to point out this joke, which is that why is it that in all these other countries they’re having these other structural issues, right? This isn’t just something that happened one day out of the blue. These are structural decades and they’re making long issues. Obviously the interest rate being a huge part of that. And because one politician had a plan that some people didn’t enjoy, everything now is to be blamed on Liz Truss. When I show up late on my date, it was Liz Truss’ fault. Obviously there’s bad connection. Liz Truss is messing with the WiFi. And I want to go to this point for a second. These are decades in the making long issues, right? The interest rate obviously falling pretty steadily for decades. Now, how is it possible that printing money, borrowing money, however we want to call it, is that really the panacea that the central banks think it is? Hey, listen, there’s a big structural problem.
I know what we’re going to do. We’re just going to print our way out of it. We’re going to borrow our way out of it. Maybe I’m not an economist and I just never understand how these ideas work, but maybe you can explain it to me, Keith.
Keith Weiner:
So there’s this rusty can on the side of the road and you go up to it and you give it a kick and then, hey, that works, let’s kick it again. And you keep kicking it, but each time it gets a little more dented. There’s little pairs in the aluminum and can you keep kicking it forever. So that should be obvious. I guess it isn’t intention with Adam Smith who said there’s a great deal of ruin in the nation that these seemingly horribly destructive not seemingly, these horribly destructive policies. And it doesn’t blow up right away because what they’re doing is they’re causing the nation to consume its capital. Well, there’s a lot of capital in Europe and there’s a lot of capital in America. And look at Venezuela. They implemented chavismo. That’s what they called it. Chavez was elected. And you get away with it for a while. And Venezuela had far less capital to consume than Europe or America. And they got away with it for what, a decade or two before things got decidedly nastier, around the time that Chavez died and this guy Nicholas Maduro took over. And then things are worse.
And why can’t you bring back the Chavez miracle as they regard it? Well, you know, Chavez’s miracle was consuming capital, and then when it runs out, then the miracle is not repeatable anymore. And so now, here we are.
Daniel Lacalle:
I was mentioning this morning to my pupils at the business school where I teach that in the French Revolution, when they created the assignat, which was a completely fake currency that they created when hyperinflation came to forefront, what the French Revolution did was to try to elect a new Minister of Finance. So they looked at three people, three people with different policies. One of them says that they had to stop printing currency. The other said that they had to continue printing currency, but they had to slow the pace. The third one said that what they had to do was to print even more because the problem was lack of available currency in the system to stimulate the economy. Get who elected, who they are.
Keith Weiner:
Let me guess, the first guy went to the guillotine, the second guy second guy went to the best deal and the third guy was elected.
Daniel Lacalle:
Let me just get the third guy was elected. And this is the reason why Ben, Keith, the reason why we get so angry and at the same time so surprised that the public, the media, analysts, et cetera, don’t see what is plain, clearly evident because there are so many perverse incentives to continue with the aggressive monetary policy that no one wants the lights to come down and the music to stop in the party. The problem is that there’s a point, as Keith was mentioning, in which the party is over because you’ve consumed all the capital in an economy. And obviously we’re far from having consumed all the capital in the economy. That’s why things as stupid as what we have seen these past weeks in which you hear that markets have been calmed by the intervention of the central bank, destroying the currency even more. But ultimately, the problem here is the following is the law of diminishing returns. Because for a while, the monetary factors do create a sense of acceptability, but it only took a recovery in inflationary pressures and people the average citizens doesn’t believe anymore the narrative. No. First, they said it was base effect.
Second, it was temporary, then it was temporary but persistent. Then it was temporary but persistent, but with long term side effects. There’s lots of adjectives that have been added to the narrative but temporary but persistent. I love that. That was one of my favorites, temporary but persistent. And the problem is that basically the narrative is based on the following that the central bank that has a perverse incentive in continuing with this policy and governments that have an even more perverse incentive because they benefit. Money creation is never neutral. They benefit first, obviously they pass. The problem to the rest is that those two agents are going to be the ones that safeguard the reserve of value and purchase and power of the currency. And it’s obviously ridiculous. It’s like saying that the guy that’s stealing the food in the supermarket is the one that’s going to make it viable.
Keith Weiner:
The fox guarding the henhouse. You bet. The problem runs very deep. I’ve had a number of ongoing arguments, particularly with George Selgin, about this idea that you can have a so called sound money that’s irredeemable currency managed by a central planner, a central bank, if only you do central planning, right? Which is just nonsense. And so even I called them the otherwise free marketers, they could tell you what’s wrong with the minimum wage. They can say why rent control is going to be harmful, they can explain the problems of tariffs and banking regulation and how it makes it harder to raise capital. They can talk about all these things and explain why a framework is better. But when it comes to money, suddenly it’s, well, we need a central bank and we need a fiat currency. And here’s the magic formula by what you managed no, no, no, don’t manage it by inflation and unemployment as the US does it. Don’t manage it by inflation as the way Germany I think Europe is one mandate, not two mandates. Manage it instead by GDP targeting, nominal GDP, and it’s all the same thing. It’s a counterfeiting of credit, which is the only they only have one button on their so called sophisticated dashboard.
There’s only one knob, which is issue war. The US government or the Fed right now is trying to unissue currency and you can see the enormous problem. So basically it only goes in one direction and it’s basically a knob that controls the rate at which they’re issuing more. And the whole thing doesn’t work. It’s just a process of playing out, feeding out the seed corn, how fast you have the hopper dumping it onto the conveyor belt to feed the people of the seed corn. And it doesn’t really matter which methodology you use. The point is that the seed corn going out and next year we’re not going to have a planting and therefore the following winter we don’t have a harvest. So anyways, if even the otherwise free marketers want it, and of course, all the monetarists Chicago school, all the Keynesians, all the New Keynesians, all the modern monetary theorists, all the so called neoclassicals, everybody in the economics profession, from left to right to center and everywhere in between, supports this and every special interest group. Wall street, of course, loves it. Everybody owns real estate, demands it. And who was the constituency?
Exactly. Who stands for sound money? Yeah, I mean, it feels like we’re a ragtag little bunch, maybe really vocal, maybe a tireless, I read minority. But we’re a tiny little group that get very little mainstream play, and the rest of the world just loves this gravy train as they perceive it.
Daniel Lacalle:
Yeah, but until it stops, then everybody.
Keith Weiner:
Will be angry at Bush.
Daniel Lacalle:
Yeah, exactly. The problem is how this transfers from financial and monetary narrative to a political narrative. So now we have learned this is what we have learnt these days, is that if you increase spending and cut taxes and blow to the deficit, it’s really bad. But if you increase spending and you increase spending and blow the deficit equally, it’s really, really good. This is what we have been told over and over and over again, and it comes from a very simple, at the end of the day, a problem, which is that as the size of government becomes larger and larger in the economy, there are more and more agents that are incentivised to keep increasing the size of government. And it’s both on the side of people that receive some subsidies in the form of a currency that is constantly depreciated. They don’t understand why those subsidies don’t work. All the people that actually benefit because their job is to spend all day saying that the elephant in the room doesn’t matter. And look at the narrative of these days. The bank of Japan intervention doesn’t work. What does the IMF immediately come out and say?
First, that the bank of Japan intervention is not enough. Second, that it’s targeted and that it’s limited. What?
What do you mean targeted? Unlimited. The last time I heard Mr. Kurola talk, he used the word unlimited twice. So this is, for example, what we hear all the time this morning on TV. Somebody said to me, the problem is that central banks are reacting too aggressively and too quickly. And I said, really? That is a problem?
Keith Weiner:
I was going to say, that seems to be like that’s finance Minister candidate number two in revolutionary France. We have to print more, but at a slightly slower rate. Central bank should react aggressively, but slightly less aggressively than they’re doing now. And I have the magic formula that says 42. 42 is the right number. I’m sorry. That’s a reference to Douglas Adams and Hitchmikers Guide to the Galaxy. For those who are watching this, if you haven’t read it, it makes an entertaining read. But, you know, it’s just a magic number. I mean, who’s to say what the right amount is, how targeted and how limited should it be versus what spray it everywhere? They live in an unreality and people support it because they think they’re benefiting from it.
Daniel Lacalle:
Exactly. It comes to the point of what Krugman mentioned was the social value of money, which you say, oh, sounds very nice, the social value of money. What does it entail? It means that one economic agent, the government, decides what the value of money has to be in order to disguise its own imbalances. And the problem that I see, in any case, is something that we have been discussing for a while, which is everybody now believes that the entire solution is for central banks to pivot and to continue with a much looser monetary policy. What very few people seem to realize or to say, is that in order to continue to support the numerous number of bubbles that have been created in the past years of the so called bubble of everything, is that pivoting is not enough. Is that it’s not just reducing the pace of rate hikes or stopping the rate hikes. It’s not just not reducing the balance sheet. Is that what happened between 2000 and 22,021 is that the entire market got used to an expanding money supply growth that required more expanding money supply growth because of all the things that you mentioned before, the collaterals and the amount of leverage involved in derivatives, I was.
Keith Weiner:
Going to say not only expanding, but expanding exponentially while the interest rate continues to fall. That is what the entire present system depends upon. And if they pause in that, let alone attempt to tighten, they’ll destroy. Or I shouldn’t say destroy. Destruction is already there. I think the Austrian school makes a point that is probably not emphasized enough, even amongst Austrians and totally unheard outside of Austrian circles, the destruction occurs during the boom. The bust is simply the accounting, the realization, catching up to the reality of what’s already occurred. They’re not causing a destruction. Destruction already happened. They’re just causing it to be revealed. When the tide pulls out, you see who swimming naked. But there’s little that they’ve done. And so I have to give a nod. October is Zombie Month here at the Gold Exchange podcast and we have several episodes talking about the zombie so called zombie corporations and zombie debt, which the bank for International Settlements defines basically as profit for less than interest expense, with a few extra stipulations packed on the end of that. And you know, a zombie only exists, it should be obvious, only exists by grace of two things.
One, suppressed interest rates or financial regression. And two, markets that are so flooded with liquidity that in the desperate, desperate reach for yield that, for instance, the pension funds have been undergoing, but everyone else has a nut to crack. You can’t get that without huge leverage and even leverage isn’t enough. You have to reach for the extreme risks. That’s why the credit markets are so forgiving that a company that is unable to pay the interest expense. And part of the definition of zombie is basically unlikely. They’re not open ended, high tech, high growth companies. They’re unlikely to ever sort of emerge from it. Why is anybody lending them any money? And the answer is the lenders are more desperate than the borrowers and creating the excess of desperation amongst the lender side versus the borrower side is the central banks flooding the economy with pumping out. I call it credit effluent. It’s kind of nasty. It’s kind of smelly, it’s full of bacteria and icky brown stuff, you know, particles floating around in it and then pump it out at very high pressure, you know, is what central bank stimulus really is. And then the recipients of that are desperate to unload it and something, anything that promises to yield one basis point above their own cost of borrow and thus the zombies get funded.
The problem is those zombies are producing consumer goods and producer goods that enable the producers of consumer goods to produce what they produce. If you destroy all the zombies, first of all, there’s going to be a huge unemployment problem. But then secondly, supply of everything is going to go way down because zombies are producing everything. They’re a huge proportion of the economy. So do you destroy the zombies and take the blame for the average layperson will think that the central bank caused the depression and not merely precipitated it or allowed it to be recognized? Or do you just turn up the pumps to work? Factor eleven, Mr. Sulu. And to mix my metaphors and go to Star Trek there and of course they’re going to turn it to eleven. So my prediction is the central banks will not only pivot, but as you said, they will continue to push interest rates down even more and more aggressively pump a credit than ever before. Not because I think that’s the right thing to do. When you say what’s the right thing for a central event to do? There is no right thing. It’s destruction or destruction.
But my prediction is based on politically there’s no way that anybody is going to want to take the pain that recognizing the mess is going to entail. They’re going to continue to kick that can down the road until the last shred of aluminum tears off of it and it’s lost into the weeds. And the only question is when? And my suspicion is it’s coming soon. There’s a lot of wreckage and the US pension system is probably slightly less badly off than the British pension system and probably smaller as well. I think a smaller percentage of American workers have a defined benefit pension plan at this point. But my guess is it’s coming relatively soon. We’ll see.
Daniel Lacalle:
I would agree with that. I think that’s the problem for many market participants that are continuing to bet on the Federal Reserve and Central Bank Pivot. It might be very long time for them.
Keith Weiner:
Long enough for them to go insolvent anyway.
Daniel Lacalle:
That is exactly the problem, by the way. That is exactly the problem of the UK pension funds, because it’s not like the UK pension funds, for example, found themselves surprised. The UK has had higher inflation than the average of comparable economies for a while. The UK’s gilt market was completely absorbed by the UK central bank, by the bank of England, and the bank of England announced numerous times that they were going to reduce those purchases. Furthermore, the economy was not in the shape of the United States. The United States may have significant challenges as an economy and discuss about them, but the UK was certainly quite weaker. So the UK pension funds, that multiplied by three, their exposure to leveraged derivatives, were aware of the situation and increased it. So the last batch of margin calls came from a process of trying to capture a little bit more yield out of a portfolio that was in deep negative territory, not in 2022, but in 2020.
Keith Weiner:
Double down.
Daniel Lacalle:
Exactly. That is exactly what is going on. And this is the same thing I just read coming back to the zombie companies that in Germany. This is not new. This doesn’t create in Germany, unify, which was recently bailed out by the German government, may require, as you do, another 40 billion bureau of a bailout package. Think about that.
Keith Weiner:
…I require 40 billion euro package. Where’s mine?
Daniel Lacalle:
Exactly. But that is I come back to the point that you mentioned is that the narrative is not what are we doing by bailing out these massive zombie companies? The narrative is not that. The narrative is where is my Zombification? I want my zombification. It’s like that character in The Matrix that said I want to be in the Matrix. Please bring me back to the Matrix. I know that this steak is unreal, but I want to come back and taste it.
Keith Weiner:
Yeah. One of the perversities of the welfare system is everybody wants to claim victim status. To be a victim is to be entitled to special treatment and subsidies and all kinds of things, and it reverses the normal mechanism of pride and turns it into this abasement. No, I’m hurting even more than you. I’m an even bigger loser than you. No, I’m a bigger loser and that’s the competition. I’m a zombie. I desperately need that money because of course it’s coming from the non zombies. Of course it’s something that nobody talks about. They’re dragging them down into zombiehood and themselves.
Daniel Lacalle:
But it’s interesting because I had a meeting with a group of economic leaders on Monday and one of them said, what we don’t understand is that the environment is completely different from previous crisis. Because right now companies that don’t make money don’t have the need to shut down. But he said that from a positive perspective instead of a negative perspective. And one of the reasons why central banks will pivot earlier and probably more aggressively as you mentioned, is because there is no single government in any developed nation that is even mildly changed. It stands on deficit spending and government spending.
Keith Weiner:
To go back to your point about instead of approvingly that companies that are losing money don’t have to close down, we’ve reached such a level of unreality that people can’t tell the difference between a feature and a bug. It’s like saying that Windows crashed. Approvingly. That was good. Yeah, because I didn’t have to do as much work today. That happened at 04:52 p.m. And I figured it would be more than eight minutes to reboot, so I just shut down for the day. Good thing windows crashed. How we’ve gotten to that point is a problem probably centuries in the making philosophically how things have degraded to the point where because the people who say this stuff, they know it at some level inside, they know that a wealth destroying enterprise is not a good thing. And what they’ve done is they’ve substituted get away with it for good because getting away with it is the only standard and of course the government has the resources to allow infinite getting away with that. So they think and Venezuela could never happen here. And that’s sort of a deeply held face, I guess.
Daniel Lacalle:
No, I think that when we look at the end of the year, mostly the biggest challenge for both businesses and market participants will come from the massive problem of crowding out because governments bond yields might go up, but governments are not going to find themselves in any real UK didn’t certainly problems to finance themselves. However, that is the case of the other participants in the economy. So the crowding artifact added to the shrinking of liquidity even for a short period of time generates that problem.
Keith Weiner:
I was going to say they use the term austerity, which is roughly, as I can tell, means French candidate for Finance Minister. Number two, the growth of the welfare state is lower than we would like. That’s austerity.
Daniel Lacalle:
Exactly.
Keith Weiner:
I don’t think politically any major developed economy is willing to even try so called austerity, let alone actually shrink the budget and spend less. There’s nobody yeah, so the world just continues to go on. So we were just at the New Orleans Investment Conference and we had a video set up and we interviewed a number of the speakers. The general consensus amongst the folks we interviewed at least, was that the Fed will continue with the rate hikes that it’s announced through the end of the year. After that, I’m not sure there’s as much agreement as to what the Fed is going to do next. My personal belief is that of course damage and pain is going on with every at one basis, point hike is causing somebody at the margin to fail the definition of the margin, right? Somebody is the margin is on fire. But the Fed, I picture them as in this ivory tower that’s like a hundred stories tall. So from their window, the people are the size of ants and they’re running around and some of them are on fire and they’re scheming or whatever, but in 100 story, you can barely see it, you can’t hear it, and they say, well, there’s no problem, there’s no problem, the economy is fine, it’s holding up well, subprime is contained, whatever they say.
So something has to happen to trigger a crisis where the flames are big enough that they rise to the 100 story window. So now, instead of having to look down at the little ants below, they see right out the window, the flames are looking at the window and then they say, well, we have to pivot now, we have to be responsive to the new economic. And of course, it wasn’t new anything, right? It’s quite predictable. The unintended consequences are quite predictable. And now we’re going to have to respond to that and that’s going to be a pivot. And we’re no longer concerned about inflation because demand destruction or whatever it is they’re going to say. And the question is, when will there be an event? Or insolvency is big enough that the flames are reaching the Feds window and the 100 story of the ivory tower?
Daniel Lacalle:
Yeah.
Keith Weiner:
What will that be? I don’t know. When will that be? My guess is fairly soon. But, you know, things there’s a lot of lag in the economy when homeowners feel that they’re underwater and to the extent that they have variable rate mortgages, and of course it accelerates it, then they stop making their payments. I wait for the bank to begin for closure, the proceedings. Eventually, they give the bank the keys and walk away. But, you know, the bank is going to go 30, 60, 9120. It’s like things don’t happen immediately. And then the first wave, they began evictions, but they still have reasonable comps, so that they’re not writing down the portfolio just yet. The next wave is bigger and then the comps are starting to be under pressure, so the bank has to start writing down, although I guess they changed the accounting rule, so maybe the bank doesn’t have to mark anything to market anymore. So all these things just delay the onset of recognition, the moment of admitting the damage has occurred. And that moment could be, you know, if you say quite a long time. I mean, I don’t think it’s years, but could be.
I mean, it wouldn’t surprise me if it was tomorrow. It wouldn’t surprise me if it was a year from now. It wouldn’t surprise me if it was in 2024. I kind of expect it will be 2023. First half because I think there’s a lot of things brewing and it could be any one of them. But that’s certainly not investment advice to go out and short the S and P or anything like that.
Ben:
Well, I want to jump in here for a second. As long as Liz Truss keeps my Internet strong and my connection can sound, I really like that we had this moment of getting away with it doesn’t mean that it’s good. And I kind of want to stop there for a second. I remember Bernie Sanders, he was giving a talk and he was saying, listen, these big corporations, these big corporations, they’re getting tax breaks and they’re getting all this money and all these greaties free goodies from the government. But his next sentence was the important one, the people should also get those goodies. Not that the goodies were wrong, not that these free money and all these kind of wink and nudge from the government say, hey, don’t worry about what you’re doing. Not that that actual action itself was wrong, it’s that people weren’t also receiving it. And I think there’s a big disconnect here. Economic laws really do apply in some sense. I know Danny, you said someone said, wow, it’s incredible. This company is not profitable and yet it still exists, as if that were a good thing. I remember I had some friends who would say, oh, this isn’t socialism, this is democratic socialism, as if the democratic part is the important part of no, the socialism part is the important central banks.
I want to go here now. Central banks. The important word is banks, not central. Economic laws still do apply. And it seems like, yeah, maybe there’s a political privilege to not face reality, but reality still exists. And it looks like in 2023 we’re going to start in that reality.
Daniel Lacalle:
I mentioned this recently at a conference. The entire fabric of the system is pushing you to believe that two plus two equals 22, but it doesn’t. And there’s a point in which and it falls and it falls abruptly. This is what we always say, and people rarely understand, is that but obviously it’s like filling up a bath of water and blaming it on the last straw. The problem was the last drop. The problem is the policy. The problem here is that perverse incentive that you just mentioned is that the narrative will tell us that the decision to target it on a very misguided budget is very clear on that, is that as long as you are entering into massive deficits to pay for entitlements, that’s not a bad thing. But if you dare to reduce taxes and enter into the same deficit, then it’s really bad. And it comes back to that incentive. Is that why don’t people get their bailout? In fact, when Jeremy Corbyn, now forgotten in the UK, but not his policies, mentioned the concept of quantitative easing for the people, that was exactly it, it was the zombification of families and of small businesses.
He wanted the same type of exposure and the same type of problems not to reduce. So that is where central banks will pivot. Right now it is a problem of market. Now it’s a problem of equity, evil equity holders. Now it’s a problem of bondholders. Now it’s a problem of private equity aggressive investors. Okay, that’s fine from the central bank perspective. Wait until it becomes a problem of the trillion deficit spending of the Biden presidency or the trillion deficits or the tens of billion of the French or German Prime Minister.
Ben:
Yes. Daniel one of Keith’s favorite economists, Frances Coppola, wrote a book called The Case for People’s quantitative Easing. Not that there’s an issue with quantitative easing, it’s just who is receiving it. Daniel, the money printing, the borrowing, this kind of kicking the can down the road, that’s not the problem. It’s who gets the benefits of those can kicks. And I think the issue now that we’re seeing, of course, is the revealing of this moral hazard. I know, risk reward spectrums or maybe an elephant in the room that we’re not allowed to talk about. But there’s now an incentive to run on these kind of risk curves to try to get just that little bit of reward. And I know we talked about this idea of there’s no right way to do central banking and this is one of those perverse incentives. When there is no yield and there’s no honest way to make money, people will become riskier and they will become riskier knowing that, hey, listen, if the pension fund starts to burst, well, we just know that the central bank is going to be there and they’re going to make everything okay.
Daniel Lacalle:
It’s not just that you’re telling people that money is free. It’s that you’re telling people that money is worthless. Therefore, taking more risk does not have the type of consequences that one would expect. And when those consequences happen, you blame it on the central bank. But it comes back to the point of what you said. It’s not a problem of central planning, it’s a problem of doing central planning.
Keith Weiner:
Right.
Daniel Lacalle:
But that’s an oxymoron. You cannot do central planning. Right. There’s no such thing as right central planning for the very same reason why there’s no way in which I or if I was in power, I’m going to know exactly what the economy demands. At one certain point, I’m always going to run significant reverse incentives. So my concern is that instead of learning from what has happened, what we are doing is creating a new narrative that makes us unlearn from the bond route and the equity and the equity valuation collapse. And you have people out there that had huge exposure, for example, to no earnings, technology stocks that have not been blamed at all for buying things that were extremely expensive and extremely risky. But that are blaming central banks on not continuing to pump up the valuation of those stocks.
Keith Weiner:
That’s right. The fault is for not doing enough.
Daniel Lacalle:
Exactly.
Keith Weiner:
To your point about unlearning, I think when it comes to monetary economics, there’s been at least a century of unlearning. The things that used to be grasped pretty clearly are now ancient and forgotten more or outright in denial in the present day. And even the idea of perverse incentive seems hardly to be grasped. People sort of know what you mean by it, but they just want to gloss over it and get back to the fun stuff.
Ben:
What I found interesting, I was not trained as an economist. I didn’t go to school or study economics in school. But I do have something called a brain and something about things that are illogical or don’t make sense. It hurts my brain. And so when I heard about something called a yield curve inversion, my brain hurt a little bit. I had to look into that. What does it mean? That the riskier type of yield that I’m trying to acquire actually doesn’t give me a higher yield. That confused me. So at monetary metals, obviously we offer a yield on gold paid in gold. And the risk here, that either a lease or a bond is we have to pay you with higher interest rate. There is a risk and a reward spectrum, and that is just true. It’s not true if you don’t want it to be true, or I’d rather not talk about it being true. It just has to be true. That the riskier. Something is you should be rewarded with a higher return. And yet we see a yield curve inversion. Keith, I really want to hear what you think about this. Is it am I just wrong that yield curves, they should kind of look like this weird little monster.
Keith Weiner:
Somebody drew a picture of J. Powell’s face and then rotate it sideways. The hump at 20 years was kind of the nose. I thought that was amusing. But obviously what happens when yield curve inverts is that there are huge forces of involuntary actions that temporarily take over. And the Fed is aggressively pushing up essentially the overnight rate, but they have much more limited ability to push up the long bonds. And so you got this inversion that’s not a signal by investors. They think that lending for 30 years is less risky than lending for one year. It’s that the savers are disenfranchised anyways. Irregtable currency system. And the market has a structure which is perverse. And when you have all these forced involuntary actions desperately rolling over short term liabilities and that sort of thing, you get inverted yield curves. And it’s one sign that the Fed is not going to be able to persist in hiking rates. I mean, right now the last inversion is the three months to ten years. What happens when that inverts? And that’s only a few basis points away at the moment. What happens when that inverts? To paraphrase Lord of the Rings, where then will you go, Gandalf?
Will you enter the Mines of Moria? I don’t know what they’re going to.
Ben:
Daniel, I want to get one last question here before we start finishing up zombie firms. Obviously, Zombie Months on the podcast, and we talked a lot about this kind of idea of zombification and maybe the people’s zombification. That’s really what we need. Maybe that’ll be the people’s zombification. But I want to get to a final question here, and obviously predictions are hard because they’re about the future. I think it’s the saying. But do you see this rising rate environment, which is slaying a lot of these zombie companies and putting other companies into zombie status? Do you think that in the next, let’s say five years, we are going to see more zombies, that there’s just going to have to be a turnaround and increase in zombie firms? Or do you think that they’re going to do it this time, they’re going to raise rates and they’re going to slay that zombie horde? What do you think?
Daniel Lacalle:
They’re going to raise rates, but they’re not going to slay that zombie landscape because the big problem is the constitution of who are those zombie firms? And the majority of the zombie firms are concentrated on that beautiful spectrum that governments tend to call strategic. Strategic companies, airlines, automotive companies, big industries. They’re not an idiot with a shop that has borrowed too much. They are newspapers, there are media companies, there are telecom companies that are considered that used to be public a few years ago. So interestingly enough to your question is that both things are going to happen and what that creates is that the entire negative impact of normalization of policy. If we can call it normalization. The entire impact of the rate hikes is going to be absorbed by those businesses and those families that have done the right thing. Not by the government and the zombie companies that have done the wrong thing.
Ben:
Which is obviously a horrible point and I don’t want to end on a low note. So instead I’m going to ask you, Daniel, where can we find all your work? Obviously, we love reading you on Twitter, we’ll link to your Twitter there, but where else can we find your work? Obviously your books are all great. Tell us where we can find more.
Daniel Lacalle:
Daniel, thank you so much. The best way to find me is my blog. It’s Dlacalle.com. You have it in English and in Spanish. You have also my YouTube channels too. One in Spanish, one in English. And my Twitter Instagram Facebook LinkedIn TikTok account. Unfortunately, it’s easier to find me than to avoid me. The only thing I would say to our English speaking friends is just make sure that you go to the Twitter account that’s in English. The website in English. The YouTube channel in English. Because we get from time to time comments saying we’d love to have you commented in English while there is an account in English.
Ben:
Well, Daniel, I’m going to say sorry for my bad Spanish adios from the Gold Exchange podcast. And thanks, Dan, for coming on.
Daniel Lacalle:
Thank you very much. And it’s much better to say hasta luego, which means see you later. Adios is very definitive and I’m hoping that we will continue our dialogue in the future.
Keith Weiner:
Absolutely.
Ben:
Yeah. The way the central banks are working and the markets are working, it’s going to be hasta luego. So, hasta luego from the gold exchange podcast.
Daniel Lacalle:
Have a great day!
Additional Resources for Earning Interest on Gold
If you’d like to learn more about how to earn interest on gold with Monetary Metals, check out the following resources:
In this paper we look at how conventional gold holdings stack up to Monetary Metals Investments, which offer a Yield on Gold, Paid in Gold®. We compare retail coins, vault storage, the popular ETF – GLD, and mining stocks against Monetary Metals’ True Gold Leases.
The Case for Gold Yield in Investment Portfolios
Adding gold to a diversified portfolio of assets reduces volatility and increases returns. But how much and what about the ongoing costs? What changes when gold pays a yield? This paper answers those questions using data going back to 1972.
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