The Central Banks’ Monetary Policy Is Backfiring (w/ Simon White)

The Central Banks’ Monetary Policy Is Backfiring (w/ Simon White)


SIMON WHITE: My name is Simon White. I’m co-founder of Variant Perception which
is a macro-economic research company. Our aim is to look for leading economic relationships
so that we can find actionable trading ideas. Really what we’re trying to get away from
is a Guru approach to economic research so we’re very data driven, and we’re agnostic. We try and come up with a repeatable and resilient
processes so that our clients can understand the process and so therefore, it’s something
they can understand for themselves and also, at the end of the day trust. The current monetary policy is failing for
a number of reasons. We’ve been in this situation since the Great
Financial Crisis. We’ve had so-called unconventional monetary
policy, and we’ve had lower and lower rates. We’ve had zero rates, we’ve had negative rates,
and we’ve also had large scale asset programs, quantitative easing. They really haven’t worked and the reason
is, is the fundamental issue here is the private sector is desire to run a saving surplus. The private sector since the Great Financial
Crisis has been running a saving surplus. Now, there may be a number of reasons for
that, I’d say foremost, might be the fact that the financial crisis was so severe, it
basically created such an effect on these companies. They’re still licking their wounds and still
trying to rebuild their balance sheets. Monetary policy is really there to try and
if you like, persuade these companies to try and reduce their savings surpluses, and that
is what it’s not been able to do. You take lower rates, that’s basically not
worked for three main reasons, I would say. The first of all, is what’s called the income
substitution effect. The closer you get to the zero bound, when
you have a sector that desires to save, that means that they have to essentially save more
and more to maintain the same level of income. It starts becoming counterproductive. The second thing is the wealth effect, you’re
seeing greater wealth concentration across the world. Again, you can speculate some of the reasons. You might say that, for instance, you look
at the tech companies takes fewer and fewer people to create a lot more capital than it
used to. You could also blame monetary policy itself,
QE, for the rise in wealth inequality. That means the pervasive impact of lowering
rates is much less effective than it once was. The third reason, and this is the one that’s
obviously invoked quite a lot today, is negative rate. They, if anything, are deflationary. The main reason is, is because of the impact
they have on banks. Banks under a conventional monetary policy
are the, if you like, the transmission mechanism. They are the things that you supposed to transmit
monetary policy. But when you have negative rates because banks
are loathed to cut rates to negative on retail depositors, their net interest margins are
getting squeezed, and they’re getting squeezed further and further. That means ultimately they have lower profits,
they have less retained earnings. Then that means that ultimately they can lend
less so the whole thing starts to become counterproductive. In fact, there was a good piece of research
from the University of Bath recently and they looked at 7,500 banks across 30 OECD countries,
banks have been impacted by a negative interest rates policy and over the period of negative
interest rates, on average, their net interest margins fell by 16% and the return on assets
fell by 3%. It’s clear that these policies not only aren’t
working, they’re becoming counterproductive. You take QE, the only main policy that we’ve
seen since the Great Financial Crisis, now, that’s also been ineffectual in trying to
persuade the private sector to reduce its saving surplus. All it’s really done is caused the private
sector to change the composition of its savings. The central bank buys government debt, it
bids up government debt. The private sector basically exchanges one
savings vehicle, which is government debt for another savings vehicle, which is reserves. The overall level of savings remains the same,
but the composition changes. As I mentioned earlier, you have the political
toxicity effect from QE because it’s probably adding to a huge amount of wealth inequality. It’s quite clear from these reasons that monetary
policy, current monetary policy isn’t working. That leads us down the path of if current
policy isn’t working, what are some of the alternatives? Now, the one that’s very much involved right
now is MMT, everyone’s talking about that, stands for modern monetary theory. It’s as old as the hills really, it’s nothing
more than good old-fashioned monetary financing. In a nutshell, really, it’s just them central
bank financing of government deficits, that’s all really MMT is. Now, governments can fund themselves in two
ways. They can do so through taxation and they can
do so through borrowing. Under MMT, the government is supposed to essentially
borrow without limits. Don’t pay attention to your deficits or your
debt or anything like that until you reach full employment. That’s the point where you’re supposed to
stop. Taxation just really takes the place of what
conventional monetary policy there before. Taxation is really there to basically simulate
or dampen the economy and to redistribute income. The only really overall constraint of MMT
is basically what are the productive limits of the economy? You’re supposed to stop when the economy is
at the level where if you start to produce anymore, it becomes inflationary. That’s the big question, does anyone know
when that point is? MMT and QE are very different beasts. QE creates the supply of money but crucially,
it doesn’t create the demand. It doesn’t create the demand for that money. What you end up with is lots of reserves sloshing
around the system, but not really having any impact on the real economy. MMT is very different. It creates the supply of money, but it also
creates the demand through the government purchases of goods and services. Just because QE is not inflation rate, that
doesn’t mean to say– and by that of course I mean it doesn’t create consumer inflation,
of course, it creates a lot of asset price inflation. Just because QE has not been inflationary,
people shouldn’t be lulled into a false sense of security that MMT also won’t be inflationary. Now, I think MMT will be very inflationary. Why is that? Well, there’s three main reasons I would say. First of all, under MMT, they say that deficits
don’t matter. It’s also said that debt, total debt doesn’t
matter and the government, as I mentioned earlier, is supposed to know when to stop
stimulating, at that point when you reach full unemployment– or full employment, sorry. Taking the last part first, is it possible
for anyone to know where that point is? I would argue no, ex ante, to know when an
economy is going to hit full employment. Even if you did catch the right moment, it’s
very difficult. You have a little bit of inflation, but inflation
is like toothpaste. Once it’s out the tube, it’s much harder to
put back in. I would also argue that the last person you
want trying to make that decision is the government. Central bank independence was all about trying
to take this away from governments. Governments have an inherent inflationary
bias. Their main aim is to essentially win elections. How do they win elections? They do that by buying votes. They buy votes by essentially spending money
on sections of the electorate. How do they pay for that? Well, they’d rather not tax because that might
lose them votes on the other side, so they borrow. They have the situation where they tend to
borrow seemingly without limit and don’t pay attention to the deficits. They’re inherently inflationary actors, if
you like. I think that’s going to be very difficult. When you look at deficits, deficits are supposed
to matter of course, but when your deficit is too big, that seems to give some impression
that the government’s spending too much and you’re going to end up hitting inflation. MMT says this doesn’t matter but if you look
at basically the composition of debt, most countries like the US, for instance, a third
of outstanding USTs owned by the foreign sector. The foreign sector will pay attention to the
fact that you’re running massive budget deficits. Then people might say, “Well, look at Japan.” Japan’s already down that route. Well, the big difference there is the Fed
owns only like 11% of outstanding debts. We’re a long way off that point. Even in Japan, the BOJ owns 50% of JJBs. Even then, we’re a long way off from the fact
where you can say that deficits don’t actually matter. Then the final point, I think this is very
important is debt, the total debt, or debt to GDP also ultimately matters and you need
to find out about this, you look to Reinhart and Rogoff, great book, This Time, It’s Different. They looked at financial crises going back
to like two centuries and what they discovered is that when your debt to GDP ratio goes above
90%, you tend to get higher interest rates. The response to that from someone who’s maybe
an MMT supporter might then be well, why would you ever default in your debt if you just
owe it to yourself? Like if the central bank is facilitating this
borrowing, why would you ever default? Well, the response to that then if you look
at the history again in what Reinhart and Rogoff have written, you do get domestic defaults. They do happen. There’s been three or four in the last 20
years. You’ve had Jamaica has done it twice. You’ve had Estonia in late ’90s. You’ve also had Argentina in 2001. They do happen and also, what they point out
in their book is that inflation in the run up to domestic default is much, much higher
than the run up to an external default. You have a number of reasons to suggest that
what is considered not to matter, does matter. What are some concrete examples? I’d say the 20th century is littered with
examples of inflation. A fantastic book that we’ve recommended to
our clients is called Monetary Regimes and Inflation by a guy called Peter Bernholz,
who’s a professor at the University of Berlin in Switzerland. What he does is he examines all the main high
and hyperinflations of the 20th century and try to look for what he considered to be similar
characters within them. What he’d noticed was every one of them was
preceded by central bank financing of large government deficits. Specifically, what he noticed is when the
budget deficit exceeds 40% of government expenditures, and the central bank is monetizing this, in
every situation where this happened, it led to a high or hyperinflationary episode. The interesting case today is Japan. Japan is probably furthest along the path
of like the major economies that’s closest to going down to MMT like policies. An interesting about Japan is everyone thinks
they hold it up as a reason for not to worry about MMT because Japan has never had inflation. If you look under the hood, Japan has actually
been sailing very close to the inflationary wind. Back in 2012 to 2015, they were running a
budget deficit that was over 40% of expenditures, maybe just a smidgen above, but crucially,
it was above. At that point, they weren’t really monetizing
many of these expenditures. Then the monetization started to rise later
on in the decade, but the budget deficit ratio, the ratio of expenditures start to fall again. Although it looked like they got away with
it, if you look under the surface, they were actually sailing very close to the inflationary
wind. That’s why I think Japan is going to be the
place to watch. It’s going to be like the canary in the coal
mine to see if and when MMT policies go too far. I think you can have a situation where, obviously,
if everybody’s trying to do the same policies, and that will obviously mute the impact. I think it’ll probably happen in stages. This is very difficult to speculate in this
stuff so longer term. I certainly think Japan’s at the front of
the queue. I think there, you will find them pushing
the situation further than other countries but it’s clearly the path that places like
Eurozone and America are wanting to take. They want to go down that path. I think what will happen is it’ll be a progressive
series of currency collapse, but I also think that when someone has seen what happens to
Japan, there may obviously be a reaction to that. There might be some rolling back. The thing is, what do you then do? If you’ve already hit the limits of conventional
monetary policy, you’re going back to fiscal policy or central bank enabled fiscal policy,
what’s the alternative after that? It might just be a case of they try and rein
it in a little bit more but clearly, the risk is that the problem is with MMT, is that the
people in charge of that policy are not the ones that are the best able to know when to
not to push that policy too far. That’s why you can end up with these inflationary
episodes. I think it’s something that happens, say you
go from the disinflationary episode which causes the behavior of the central actors,
central banks, governments to become more inflationary. You take Japan as an example. I think that the ultimate endgame in Japan
is very high inflation, as I say, the way that the policies that they’re doing but how
do you get there? The way I think about it is like the road
to hyperinflation is paved with deflation. What will probably happen is that we have
a very deflationary episode in Japan, one that’s extremely bad that pushes their currency
extremely strongly. The dollar/yen falls a great deal. They have a very, very major slowdown in their
economy and that essentially causes them to take a full caution to the wind and ease on
a scale that they’ve never used before. I think you have to see that disinflation
and deflation before you get to that inflation, but arguably, we’re already there. Even in the whole Western world, we’ve obviously
talked about sector stagnation. Sector stagnation really is harking back to
what we’re saying earlier. That’s that private sector is not willing
to draw down a surplus. Japan has been in that situation since the
late ’80s. They had their crisis in the late ’80s, the
early ’90s. The corporate sector is still running this
huge surplus. The fundamental reasons are there, sector
stagnation and low inflation. You may not even need to see a severe deflationary
episode. Already, the wheels are turning that people
realize that this isn’t enough. The structural limits of conventional monetary
policy have been reached and the central banks are now just throwing their arms up almost
in despair. They’re saying, “We need help, because we
cannot fix the productivity. We cannot fix the structural high unemployment.” We’re already running along that path. What’s the implications to markets for these
policies? Well, I think that it’s going to turn a lot
of things on its head but I see three main structural themes from the shift away from
conventional monetary policy towards MMT like policies. Just to make something clear, this isn’t going
to happen overnight and we’re not going to hit full MMT overnight. There’s a clear progression towards the policies. The three main structural changes I foresee
is the long boom in financial assets versus real assets. I think it will come to an end and real assets
will begin to outperform financial assets. I think cross-asset volatility will begin
to rise on average, and I think we’ll see more frequent bursts higher in volatility
and also I see because the tail risks are shifting from lower inflation to higher inflation
and that means that the risk of higher short term rates will be higher. That makes leverage a much more of a dangerous
game. When it comes to financial assets, why are
they going to begin to underperform? Well, you look back to the ’70s, ’70s is a
great poster child for long term high inflation that was pockmarked with double digit inflation
and stagnating growth. You look at which assets performed the best,
which asset classes performed the best and the worst, best performing assets were commodities,
and the worst were equities. In fact, the only asset that actually gave
you a positive real return in that decade was commodities. Equities on the other hand became like a shunned
asset. Very simplistically speaking, if you think
about an equity as an infinite maturity bond, you had the higher rates to deal with inflation,
the present value of these things just got absolutely decimated. Nobody wants to hold them. Even though in price terms, the market bottomed
in 1974 in equities, PEs didn’t actually bottom until the early ’80s. They really were not an asset that people
wanted to hold collectively speaking. Within equities, there was actually some quite
interesting trends. The equity sectors, they’re the best, were
the ones that either owned real assets or benefited from real assets, so energies and
industrials, they’re the best in that decade, they were the best performing sector. At the other end of the scale, you had the
banks. The banks really struggled. Banks are nominal machines. They borrow short term, and they lend long
term. They are in a very difficult environment in
rising rate environment. It makes sense, going forward, banks have
benefited from this low rate environment where they’re able to provide leverage to boost
financial assets. If these things go into reverse, the whole
business model of banks is going to be challenged. They’re going to find life much more difficult
unless they overhaul their business model. Another very important theme here is the traditional
portfolio construction. I think that’s going to come under immense
pressure. You have risk parity, or you have the traditional
60/40, which is risk parity like, they’ve benefited for years from the negative correlation
of stocks and bonds. That’s not really the normal state of affairs. Over the last hundred years, 70% of the time,
that correlation has been positive. What you notice is that as rates go higher,
inflation heads higher, and that’s what you gradually expect to see under MMT, that correlation
reverts back to positive and that whole concept where you’re benefiting from the diversification
effects, doesn’t exist anymore. That has great changes for the markets too,
because the 60/40 thing, that’s been a major volatility dampener for the markets along
with risk parity. Whenever volatility falls, they essentially
have to buy more assets to rebalance. This is self-fulfilling effect. These guys are essentially short vol and they’re
short stock bond correlation. As these things reverse, you expect all these
things to begin to go higher. Really challenging what people’s general view
of markets have been for the last 30 or 40 years. Banks are going to struggle because of this
tail risk essentially shifting, because in the last 30 or 40 years, you could basically
rely on the fact that although rates might go higher, the general trend was lower, we
just had a series of lower lows. In an environment where the tail risks shift
to higher inflation, the risk is always going to be we’re going to have bursts higher in
shorter term rates. That, I think, makes the bank business model
extremely difficult because not only is it difficult for them, as I say, they’re borrowing
short term assets, essentially, they’re borrowing in the shorter term period, and lending longer
term. They also provide leverage to other people
and if there’s less demand for leverage, they’re really unable to provide that in the same
way that they would like to. The whole last 30 or 40 years, if you like,
the dominating times of banking will be very difficult under those circumstances. It’s really about not about what instantly
happens as they– I don’t think it instantly get higher inflation, or instantly see shorter
term rates rise, but the risk profile will change and it will really challenge that business
model. These structural changes are very difficult
to really get a handle on when they’re going to happen because they tend to go through
their regime shifts. They don’t go smoothly from one version of
itself to another version of it, it happens quite suddenly. It happens in the way that Ernest Hemingway
talks about how one goes bankrupt, how’d it happened? First, gradually, then suddenly, and the rise
to inflation will be like that, too. Inflation doesn’t go smoothly from 2% to 4%
to 6%, it goes 2% to 4% to 10% to 15%. It’s actually a very difficult thing to get
a finger on but one thing I would look to, I think, will give you some, at least mild
degree of heads up, where we’re seeing a beginning of change in this environment would be a rise
in monetary velocities. I begin to see that would start to pick up
in advance of any of these structural changes. When it comes to gold, obviously, we’re seeing
interesting moves today. I think that’s based on– rather than we’re
trying to early factor in MMT like policies, it doesn’t really need that. That will obviously help gold I think in the
longer term because its role as an inflation hedge, it’s certainly something you want to
consider having in your portfolio. I think what’s boosted it most recently, certainly
in the last few months, has been the shift to more negative rates. You can almost see an uncanny relationship
between the price of gold and the outstanding amount of negative yielding debt in the world. We’ve seen that negative yielding debt skyrocket
and along with it, the price of gold. I think gold is trying to straddle two things
right now, as I say, the negative yielding aspect of things because obviously, relatively
speaking, gold now has positive carry. A lot of people who shunned it now are looking
at as a serious alternative, a serious way to hold some of their investments but the
longer term picture is intact as well because certainly in an MMT world, with these tail
risks and inflation being higher than gold and other precious metals, it makes a lot
of sense to hold them. Expect to see real assets beginning to outperform
financial assets. I expect to see cross asset volatility rising
on average, and more frequent bursts higher in volatility. I expect to see the whole 60/40 portfolio
risk parity model challenged as it no longer offers diversification benefits. Really, financial markets are like history. It has eras, and we’re really going from one
era and we’re transitioning to the next right now.

Author:

48 thoughts on “The Central Banks’ Monetary Policy Is Backfiring (w/ Simon White)”

  • Real Vision Finance says:

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  • It's only "Backfiring" if you were under the assumption that it was actually functional. You put a potato in the tailpipe of a car it's going to backfire pretty badly. You put the fed in charge of monetary policy the only thing it's capable of doing is making things worse than they already were. You can't "Fix" what was completely broken from the onset. The Fed is working as intended, funding cronies and stealing America's wealth to prop up worthless unprofitable Crony Capitalists. Seems to be doing the only thing it was ever capable of doing.

  • China中国 has a lower更低的 GDP than the US, 1.3billion十三亿 people, and the universal health insurance全民医保, and free education义务教育. No drug, no gun shooting, no work higher tax, money play lower tax, And no fake Banking theory or other fake economic theories to fog people. And it's illegal to get any money from any company for governers. And have to get scores for experiences in taking care of people for a higher position.
    Examination is better than vote.

  • Jayaraman Baskar says:

    This interview was taken on Sept 13. He sayst at 15:00 that short term lending will see inflation and hence problems with short term lending issues in financial sector.. 10 days later, the repo market crisis occured. I'm gonna follow this guy from now

  • TheCanMan Can Since 1990 says:

    About to make more accounts to down vote this
    Your guest is a complete lier an charlatan
    Private debt
    Not gov debt all money is debt

  • Complete nonsense sorry. You talk about policies that don’t exist in the US and have no relevance for the US. Where is MMT? You cite it as if it is a foregone conclusion and then speculate about scary implications that again have zero relevance. You guys are in Lalaland. Some make believe world about which much relish telling scary tales. Is that your formula for selling subscriptions? Shameful Realvision.

  • Central banking IS the problem and a debt-based momentary system ..
    The current corrupt system needs to remove and replaced with a sound money system, NOT based on debt !!
    Give bankers and governments the power to print money out of nothing ( FIAT ) you will end up with a f..k up every time !!

  • Yoshke Mamzer Baalam BenStada says:

    Crony capitalism that favors massive monopolies or oligopoly combined with FEDERAL RESERVE manipulation is what is wrong with this world.

  • Saving by companies are too high ? The share buy backs and the BBB rated bonds which should be rated at junk are savings ? 20% world wide and 17% US companies are Zombie companies which need to borrow just to pay the interest when it comes due. The private sector has too much in savings ? The increasing in debt in every sector is ignored. I don't know what this guy is on, but I don't want any. Its not debt saturation, its too much saving ?

  • Assembly of Silence RH says:

    I hope the pie-chart @7:54 is supposed to read 6.21 trillion instead of the 621 trillion it shows for foreign investment…or else something is very wrong indeed – and not just with the chart.

  • Assembly of Silence RH says:

    In economies where AI and automation continue to significantly displace job openings the MMT goal of full employment becomes a pipe dream. It would be interesting to have an in-depth critique of the consequences of a UBI policy.

  • Please watch your recording volume, it's too low. I'm at maximum on my volume control. When YouTube advertisements come on, my ears hurt.

  • The problem with monetary policy is… monetary policy itself. The very idea that the State (or anyone else on behalf of it) can know the "correct" amount of money and the "correct" interest rate is absurd. It is pure central planning. Taking into consideration the precious reflections put forward by Mr. White, one could wonder whether there's some sort of "supracycle" transcending the bussiness cicle; that is, a constinuous movement from conventional monetary policy, to unconventional monetary policy, to MMT-type policy, each of which with its own interest pattern (maybe, positive rates > negative rates > ???). Not to mention the distinc inflationaty patterns: from controlled inflation to hyperinflation.

  • MMT posits that a country that creates its own currency has no need to borrow it and no need to save, via deficit reductions, for a 'rainy day'. Deficits aren't really paid back, as conservative types like to claim all the time. Gov. deficits also result in greater private sector savings and/or private sector deleveraging and vise versa. MMT is actually just the monetary system post-Bretton Woods.

  • US already is doing MMT for the last 40 years ago least. It just goes mostly to military, pork, and bureaucracy. Yeah, inflation is thru the roof, shrinkflation too.

  • cash ban's and lock in's to negative rates being rolled out… targeting small people Governments are cool with the idea…!

  • No mention of the role of energy. I guess living in a world that is constrained by prices to low for energy producers and to high for energy consumers is unimportant?

  • Dear RV : pls bring back this speaker on a monthly basis. He is one of my top favorites beyond even the unicorn hedge fund managers (because he explains causality of mechanisms and this is often actionable insight).

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