Steve Keen – Global Macro Series - 10th September 2020

Steve

I think one of the most sensible ideas about money was Gesell’s idea that money should depreciate. He was focusing on money as a means of transactions, a means of payment. If you have a money system where people are focused upon hoarding, what you get is a slowdown in the effectiveness of money as a means of payment.

I think you all know the story of the town of Wörgl, in Austria, during the Great Depression. Are you aware of that?

Moritz

Yeah, they had their own currency system.

Steve

Yeah, and that was a Gesellian currency designed to depreciate. The whole idea being that if you didn’t spend it, what you had, the value of it declined over time because of a stamp script. That actually meant that town went from Depression levels of unemployment to zero unemployment in the middle of the Great Depression until it was stopped, in that experiment, by the Austrian Central Bank, and they went back to the same level of Depression as everybody else. Of course, they voted for the annexation to the Nazis not long after.

So, a depreciating currency actually encourages spending.

Niels

For me, the best part of my podcasting journey has been a chance to refine my own investment framework through a series of conversations with extraordinary investors in every corner of the world. In this series, I along with my co-hosts, Robert Carver and Moritz Seibert, want to continue our education by digging deeper into the minds of some of the thought leaders when it comes to how the world economy and global markets really work to try and learn how they think.

We want to understand the experiences that have shaped them, the processes they follow, and the historical events that have influenced them. We also want to ask questions outside our normal rules-based playground. We’re not looking for trade ideas or random guesses about an unknown future but rather knowledge accumulated over the course of decades in the markets to try to make us better-informed investors and we want to share those conversations with you.

Our Guest today is not one of these stereotype economists, but rather someone who really stands up for what he believes and, for decades, has been very vocal in his critique of mainstream economics and who has gone on to develop some unorthodox ways of modeling money.

So, I’m absolutely convinced that you will have your eyes opened from our conversation, today, with Professor Steve Keen, where we did some audio challenges, but I hope they won’t distract you from the important topics discussed.

Steve, thanks so much for joining us today for a conversation as part of our series into the world of Global Macro where we relax our usual systematic, or rules-based framework, to provide you, with a broader context as to where we are in a global and historical framework and, perhaps, discover some of the trends that may occur in the global markets in the next few months or even years and, ultimately, how this will impact us as investors and how we should best prepare our portfolios.

We very much look forward to diving into a few different topics in the next hour or so, not least because you are not one of these stereotypical economists, but rather someone who really stands up for what you believe in and have been very vocal in your critique of mainstream economics for decades and who has gone on to develop some unorthodox ways of modeling money. So, we’re very excited, indeed, Steve.

I want to kick off with a general question, but slightly different from what we normally ask because you do reside, now, in Asia. Most of our guests so far have been based in the U.S. So, I’m thinking you might actually have a different perspective. The perspective that I’m looking for is just to see where you think we are in a big global macro picture.

We hear a lot of these analogies being made to previous crises: 1929; the Japanese Bubble in the ‘80s; the Tech Bubble; the Great Financial Crisis ( which, of course, you accurately predicted); then, on top of this we have a global pandemic which makes it a very unique period in time. So, how do you see the world, right now, and how does this tie in with the predictions that you have made about this period in time as well?

Steve

Well, obviously the Coronavirus is the overwhelming frame of reference for where we are at the moment. I certainly can’t say that I anticipated the timing of the virus. I did expect the experience because I have read Laurie Garrett’s book, The Coming Plague, back in 1994. If anybody hasn’t read it, I would highly recommend taking a look at that. She said that a pandemic like this was inevitable.

We know, of course, the Obama government was planning for something of the nature of a pandemic like this. Those plans were trashed by Trump. There has been plenty of knowledge that something like this would come along. Unfortunately, from the negative preparation, it has hit at a time when we are still on the remnants of the impact of the Global Financial Crisis, back in 2008. This is the main point of reference that I have.

First of all, the crisis itself is both a demand and a supply shock. This is the unusual thing for this crisis. It’s not an indigenous crisis to the economic system per se. It’s a crisis to the impact the economic system has on the planet’s ecology. But it’s not strictly within the economy itself. We have never had a crisis like this before. Every other crisis we’ve had has been driven by the financial sector itself.

I’d recommend taking a look at Richard Vague’s recent book, A Brief History of Doom. He goes through 150 years of crises. There have been roughly 150 crisis across major economies over that one and half centuries. Every last one has been a financial crisis.

Now, this (the COVID crisis) is unusual: it’s a crisis coming from the real economy going back to the financial sector. My theory is… Well, first of all, there has been something of the order of a 30% to 40% fall in both demand and supply, courtesy of the crisis: people can’t work; people don’t have incomes, to spend at the same time. Yet, they’re still carrying the financial burdens from the last crisis when they were saying that, in America’s case, private debt got to be five times what it was by the end of the Second World War. [This constitutes] a gain from roughly 35% of GDP to 170%.

In the aftermath of the crisis, we have the potential for a financial breakdown. That’s what really scares me; that our payment system is not able to cope with what’s happening courtesy of the virus itself. Globally, we’ve been divided into two sorts of economies: those that have managed to eliminate the virus (and that’s predominantly China, itself; Southeast Asia; maybe New Zealand and Norway; and possibly Australia), and the rest of the world, which is basically lining up for wave after wave of the virus. So, I see us having a fragmented globe after the crisis, for those countries that can talk about it after. Those that are in, during the crisis, this is going to be the dominant pattern for the next two to three years.

So, it’s a very unhealthy economy and I think, a push away from globalization back towards localization as well because there’s no way we can have the long supply chains that have been a feature of the globalized economy.

Niels

What about you, Rob? What’s on your mind this morning?

Rob

Yeah, it’s interesting because I think quite a lot of our other guests have tried to draw parallels between this crisis and other crises, so, I really like your statement that this is completely different. We need to think about it in a different way. What a lot of those other people have said, looking partly at other crises and also looking partly at orthodox economic theory, is to say, “Well, there’s all this money being printed by central banks.” They’re buying up assets, they’re doing all the things from the 2008 playbook. This is what these guys say, “Inevitably this is going to lead to massive inflation.”

I was wondering whether you agreed with them or whether you disagreed. If you disagree, why? Do you disagree with them in a kind of fundamental way, or do you disagree with them just because this crisis is unique and special?

Steve

Unfortunately, I suffered a lot of crackle effect with that question, Rob (audio problems). So, if I don’t proceed to answer it, re-ask it afterward.

The reason this crisis is so different is, as I have said, it’s coming from the physical side of the economy and hitting the financial. The usual story is that it comes across the financial side and hits the physical. That, alone, is a major reason why this process is alike [others] and whether it has occurred before. That said, it’s going to manifest itself in a lot of financial ways.

So, if you have people who suddenly lose their jobs, and therefore can’t pay their rent, or can’t pay their mortgage, then that will play through the financial sector with landlords who currently can’t service their debts and then you have a banking sector that can fail. So, I see the causation as being reversed but many of the manifestations will be similar in the sense that there will be bankruptcies coming out of this and potential banking crisis that the Federal Reserve will dive in and try to rescue.

Fundamentally the analysis that I give to try to point out why this is different is, to use one of Marx’s great insights in saying that there were two major circuits in capitalism, there is what he calls the CMC Circuit (Commodity, Money, Commodity). From that particular circuit, people have got a commodity that they can’t really use, they work, with the work they then sell that commodity to use the money that they get from laboring that commodity to buy other commodities. There’s no attempt to make a surplus out of that. That’s pretty much the consumption cycle. It’s mainly workers who are doing it, and that’s about 70% of aggregate demand.

The one which causes crises is what Marx called MCM+ (You have money, you use it to buy other commodities in the manufacturing process, and you then try to make more money after it – MCM+) That’s pretty much the circuit of investment and that’s about 30% of the economy. Most of our crises come out of a breakdown of the MCM+ circuit. So, you have a plunging, very volatile part of the economy which accounts for about 30% of total demand.

This time around, because it hit the capacity of workers to work, the capacity of small businesses to function, and so on, it’s actually more on the CMC circuit. That’s about 70% of the economy. So, the side that’s being hit is much, much bigger than the side that normally brings the economy unstuck. I think that’s why I think this is a very different crisis to any we’ve had beforehand.

I hope that was an answer to your question, I’m not really sure.

Rob

It wasn’t, don’t get me wrong, it was very interesting. The question was specifically about the outlook for inflation given what central banks are doing.

Steve

Inflation, OK, yeah, I expect deflation. That’s one reason my website is called DebtDeflation.com, not that I’m actually active there anymore. I have expected deflation right from the very beginning of the ’87 crisis when I first started modeling financial instability because we have an excessive level of private debt.

The best explanation of what happens with private debt being excessive was given by Irving Fisher on the Debt-Deflation Theory of Great Depressions. He says that if you have too much debt and too low a level of price change at the beginning, then firms will try to lower their prices to attract customers in through their doors rather than their rivals. When they cut those prices the impact is to actually cut GDP as well.

So, you’re dropping prices, you’re dropping the price level at the same time, you might pay your nominal debt down, but your actual debt ratio can rise. That’s what happened in the early periods of the Great Depression. Even though we had a rising level of private debt to GDP from ’30 to ’32, that was matched with a falling level of private debt. So, private debt was falling but nominal GDP was falling even faster. It affected real demand and a fall in the price level. I expect a similar phenomenon this time around, which is one reason why I want as much government money creation as possible right not, to stop that from happening.

Niels

But is that, Steve, is that consistent with your view that we’re going to have more localization of supply chains and not globalization? I imagine that localization is going to be more expensive if we can’t have everything produced by China.

Steve

The reverse of globalization might have an impact in the opposite direction on the price level, but not a lot of one. The main thing it’s going to cause is a need to invest domestically. If you think about, if you’re going to try to remove your supply chain back from China to America, you’ve got to build factories. You’ve got to invest.

Now, the problem, again, is that if you have a shock hitting you like the Coronavirus, how much are you going to invest? The answer could be very little to none. I don’t think it will quite come to that but a lot of goods supply chain is going to have to have a two-week to three-week buffer on either side of the Pacific Ocean.

If you want to send goods from China to America you’ve got to have people on that ship. You’ve got to be sure they don’t have the virus when they leave. You can be confident that Chinese workers leaving a Chinese port won’t have Coronavirus. When they dock in America you can only be confident they didn’t come back without that disease.

You have to quarantine them somehow, either side of the whole thing. The whole supply chain gets smashed by this, ultimately. The simple decision is, “Let’s just bring production back onshore again because the cost advantages that have made it advantageous to relocate production in the first place are no longer there.”

If you want to do it, at the same time, you haven’t got the skilled labor anymore. The skilled labor is now in China. How do you build it domestically? You need people that can operate machine tools, even if we’re talking computer-controlled machines. So, I think it’s an enormous disturbance to production systems. Its impact on the price level – I’m not really sure there is going to be much because there is such disruption to aggregate demand overall that I think that will still dominate the whole trend.

I expect our central banks to get it wrong as well, being staffed by neoclassical economists. So, my bias towards deflation even if there are going to be some impacts coming out of having to go from globalization to localization.

Moritz

That’s interesting. By the way, Steve, thanks for coming on. It’s really great to have you. What is certainly true… I mean the impact, like you say, has been on the physical side. The markets have had a V-shaped recovery and maybe they’re continuing with their V but the economy, as far as I can see, they don’t have that V in them.

I live in Germany and when I look at the businesses here, they’re supported by the state. We’re certainly not producing the same number of cars when you look at the stock prices of Daimler and BMW, that’s not a very nice picture, right? So, there is an impact. We have massive rise in unemployment in the United States and around the world. So, all of that stuff is demand destruction and it’s very deflationary, and it may lead to insolvencies of businesses. So, there is that deflationary pressure, I guess, in the immediate term.

I (and this is certainly above my pay grade even though I studied economics) have no feeling for the level of stimulus that is supplied by central banks, around the world. All of them, all of them at the same time, whether that magnitude of the money that is being created and monetized and this, that, and the other thing, all the stuff that they’re doing, that maybe, eventually, it will just tip.

I’m saying this because when we look back at, essentially, all the major currencies that have ever existed, and those that have become the reserve currencies like the Dutch Guilder, and the British Pound, and now it’s the U.S. Dollar when you look back at all of those currencies, essentially, they all devalue or they stop existing. They all go to shreds and they end up in a hole. So, I guess, maybe, the end game here (and maybe this is not in one or two years time), it’s an inflationary end game because, if it’s not, who is going to pay back all that debt? What are we going to do? We can then say, “OK, let’s just forget about it and we’ll Jubilee it away or we’ll, whatever we will do with it. If there’s no inflation, we’re stuck in the hole forever.

Steve

One of the problems that we have about understanding this crisis is about understanding money itself. We are continually getting it wrong. People think, “Oh, the government’s running up all this debt, that must be burdening me, etc. etc.” You all have heard of Modern Monetary Theory, of course, these days it has been one of the few heterodox theories that have gotten through to public discourse. I have some issues with some parts of Modern Monetary Theory, but the fundamental insights about the nature of money and government spending are completely accurate.

The way that I try to explain it is to start from the idea of equity. You all know that rule that assets minus liabilities equal equity. You also know that your asset is somebody else’s liability and vice versa. What that means, at the aggregate level, certainly if we’re working just in terms of strict money (leaving out the value of monetary assets that are now price times to the value of shares and price times the value of housing), leaving that out, assets minus liabilities minus equity equals zero. That applies to us all and it applies in the aggregate.

Now, if you have a private banking system or you live in a pure credit economy, the sort of things that Austrians fantasize about (no government, no central bank), for private banks to operate they must have positive equity. A private bank with negative equity is bankrupt. So, banks have to have positive equity. Therefore, the non-bank sector, in a pure credit economy, is necessarily negative equity precisely equal to the positive equity of the banking sector. That’s our starting point.

Now, nobody enjoys being in negative equity. So, what do we do? We borrow money to buy shares in houses and drive up the prices and we do a notional calculation that says our equity includes the last price that financial assets sold for times our personal share of the stock of outstanding assets. If we all do that we can fool ourselves into believing that we have positive equity. But it’s actually a notional thing. If we try to realize those prices all at once, prices would collapse. That sort of bad behavior is what actually gave us the Roaring Twenties and is what gave us the Naughties as well.

One thing that actually causes that is governments running surpluses. If you, then, throw a government into the mix (say, let’s go from the fantasy of a pure credit economy to the reality of the mixed fiat and credit world in which we live), the government is also subject to that same rule: assets minus liabilities equals equity. If the government is running as a deficit, it is driving itself into negative equity.

What it’s doing is that its spending is exceeding taxation. Where is that money turning up? It’s turning up in private bank accounts. So, the government running at a deficit generates an identical surplus for the private sector. If it does that sufficiently then the private sector can be in positive equity because the government sector is in negative equity.

Now, can the government finance the negative equity? Well, there it can because (and we’re certainly seeing this right now in the U.K. and some other countries as well) the central bank can finance the treasury directly. So, it’s quite possible for a government to maintain permanent negative equity. It’s not a problem, it’s actually a necessary position for the non-government sector to be in positive equity.

So, the idea that government debt is a problem is a problem of understanding what government debt is. We know what the Federal Reserve can do with its keystrokes. If it decides to cancel that debt, it can cancel that debt. It can buy back all the government debt outstanding tomorrow and it could cancel it the day after.

So, the worries about the government sector debt are simply not understanding how the monetary system works. The real worry is private debt and that’s what I have been focusing on, as you may be well aware, for decades now.

We have the highest level of private debt in the history of capitalism. At the same time, we have this virus crisis. Now, if we let the impact of the decline, that the cash flows have suffered, hit the private financial system then major parts of that sector will go bankrupt. So, that’s the real worry, not the government debt. That can be handled.

Ironically, one of the best ways to reduce government debt, as a percentage of GDP, is to run deficits. We think about government debt and we obsess about it: “What is the ratio of debt to GDP?” If you think about running a deficit then that is going to increase the government’s debt but it will also increase GDP by precisely as much because the definition of GDP includes government spending minus taxation: G – T; which is the government deficit.

So, if you have a government running a deficit, it increases its numerator (the debt level), it increases the denominator by precisely as much. Now, that money also turns over. So, if you have the money turning over one or two times per year, you increase the numerator by the G – T; you increase the denominator by G – T plus how often that money turns over in a year. This is one reason why the government, the American government’s debt level is falling all the way through the ’50s and ’60s when it was only running a deficit.

So, the experience of rising debt levels (rising government debt as a percentage of GDP) is something which coincides with both the collapse of the financial bubble in 2008 and then the Coronavirus experience now where the economy is tanking anyway. If we obsess about the government debt without thinking about the contribution that government debt makes to increasing private equity, we’re going to get ourselves caught in the sort of tangles that have led us to this crisis in the first place.

Periods of governments running surpluses, to try to reduce its own debt level, have preceded our major economic crisis.

Moritz

Let me put in a, maybe, really weird thought. You may say, “Hey Moritz, this is really stupid of you to say.” If the government debt is not a problem the government could go out and say, “I’m going to save all those private businesses with government debt. Here’s the money, I’m going to bail you out. Once we’ve bailed you out I’m going to cancel my government debt, problem solved.” What’s wrong with that thinking?

Steve

Nothing.

Niels

OK, so let me chime in with my limited knowledge about all of these things. Let’s just take the U.S. as an example. Maybe they’re not a good example because a lot of foreigners own their debt, but let’s just say they start out by buying all of the debt back, all of the bonds. Then they cancel it. So, all the pension funds, all the insurance companies, they can’t buy any U.S. bonds.

Steve

And how do you cancel? What you do is you cancel by buying it back with cash, OK.

Niels

Right, but my thought is just this if there is no debt to buy from these institutional investors, won’t they just end up having to go and buy foreign debt which then weakens the currency, and then it shows up in the currency?

Steve

Yeah, again, what you’re pointing out is that government debt is a necessary element in the financial portfolios of the private sector.

Niels

From a regular point of view it has been, yeah.

Steve

So, if you want to carry cancel the government debt then you’re actually hampering the private sector. What I want to do is use the government’s capacity to cancel private debt. You know about a decade ago I was arguing in favor of a modern debt Jubilee but I didn’t bother developing the argument because I thought it had a snowflakes chance in hell of being implemented. Now that the Coronavirus has come along, well, welcome to hell and the snowflake is now necessary. So, I might actually finally write it up properly. But the basic idea was that we have caused the crisis by letting too much credit money get created. That credit money predominantly finances asset bubbles rather than genuine investment, which would be the desirable usage of credit in the first place.

So, we have to reverse that mistake. The easy way to do it is for the government to give a per capita injection into household bank accounts equivalent for every household. So, the Buffet household would get the same amount as my household, were I in America. Of course, this is far more beneficial to the poor than the rich.

Then, if you’re in debt, you pay your debt down. If you’re not in debt you get a cash injection. That cash injection could be limited in such a way that it could only be used to buy corporate shares, whether it’s new corporate shares (newly issued shares). Those newly issued shares must be used to pay down corporate debt. So, instead of accounting operations, this would basically replace a large amount of credit backed money with fiat-backed money; and then eliminate the excess of private debt that we’ve created and enable the private sector to get back into its usual level of spending which it used to have back in the ’50s and ’60s when it wasn’t terrified about whether it could manage to pay off its own private sector debt.

So, that’s what I’d like to do: eliminate the private sector debt and rebalance a system which is far too credit dominated and not enough fiat-backed money dominated. Now, part of Moritz’s point was about how all of these fiat currencies fail. They have failed over time. They always get replaced by another one. The British got replace by the American. Obviously, the Second World War was the event that led to that replacement.

You can say that fiat currencies, themselves, fail in general. We’ve had fiat currencies for more than two thousand years; five thousand years depending on the particular political stage you’re looking at and what that currency might be. Certainly, for the period of capitalism, we’ve had fiat currencies. We had a try at private bank money back in the 19th Century in America and Australia, and I think New Zealand and parts of Germany as well. All those gave way, ultimately, to go back to fiat currencies again.

Whether they’re failed comes down to the issue of what money is actually for in the first place. There’s an obsession with gold bugs, and bitcoiners, and so on, about money as a store of value, and it’s really terrible that it declines over time.

I think one of the most sensible ideas about money was Gesell’s idea that money should depreciate. He was focusing on money as a means of transactions, a means of payment. If you have a money system where people are focused upon hoarding, what you get is a slowdown in the effectiveness of money as a means of payment.

I think you all know the story of the town of Wörgl, in Austria, during the Great Depression. Are you aware of that?

Moritz

Yeah, they had their own currency system.

Steve

Yeah, and that was a Gesellian currency designed to depreciate. The whole idea being that if you didn’t spend it, what you had, the value of it declined over time because of a stamp script. That actually meant that town went from Depression levels of unemployment to zero unemployment in the middle of the Great Depression until it was stopped, in that experiment, by the Austrian Central Bank, and they went back to the same level of Depression as everybody else. Of course, they voted for the annexation to the Nazis not long after.

So, a depreciating currency actually encourages spending. To that extent, even though inflation wasn’t a deliberate policy of the government in the same way that depreciation is deliberately built into a Gasellian currency, it had the same impact. It means that we spent money. That was a major form of the level of economic dynamism of the ’50s and ’60s. Of course when we’re obsessing about government money as a store of value you’ve got the madness of things like bitcoin. I haven’t kept track of it but I believe, at the moment, by the level of bitcoin transactions per second is about three, three bitcoins per second?

Moritz

Yeah, relative to other things it’s nothing.

Steve

Yeah, people are trying to fix that by plastering on the lightening layer on top of it, etc., etc. I said that it’s partly lipstick on a pig syndrome. But the whole thing is, because of the obsession about money as a store of value, which is built into the nature of bitcoin, then what you get is money that doesn’t turn over. Money that doesn’t turn over isn’t money.

So, I think, let’s look at money as more of a means of transactions, and in that sense, inflation actually encourages them to some degree. It’s when they become crazy over inflation that you get a breakdown. The moderate level of inflation, say, 2% to 4% (I’ve seen over most of the last century, century and a half), that may be part of what actually makes money effective.

Rob

I’m inclined to agree with you but I guess the sorts of people who are worried about the very high levels of money being injected into the economy at the moment by central banks, you could argue that the way they are doing it is not efficient. The transmission mechanisms aren’t working: just look at this year and the size of the injection.

I am kind of with you in the sense that for developed countries, where you start off with reasonable levels of debt to GDP ratio, there’s a pretty weak relationship between government debt growth and inflation. It’s not the one-to-one correspondence that, I guess, the Austrian economist was saying.

I think there was a nice paper in 2008 from the IMF that basically pointed that out. It said that for developed countries there’s almost no relationship between growth in debt and inflation. This idea that, as we had in 2010, with the conservatists coming in the U.K. and saying, “Oh no, if we even spend a tiny bit too much money we’re basically going to end up like Greece.” That was absurd.

There is a point, right? There is a point and it’s, perhaps, more of a problem for emerging markets that already have very high debt levels. There is a point at which trying to print money to spend your way out will lead to higher inflation. I agree that we’re probably, we’re not at that point yet. Is it fair to say that you do think that there is a point at which that will be reached? If so, how will we know?

Steve

Not with a monetary sovereign.

Rob

OK.

Steve

Not with a country that has a trade surplus and not with a country that is in the reserve currency of the planet. So, that rules out Japan, for example. The government debt level in Japan; realize they were 240% of GDP. The inflation rate is what, negative? OK, what level are they going to say, 1000%, 2000%? If you have a trade surplus, and if you have your own money sovereignty, you’re fine. So, Japan should be enough… I tend to get colloquial in using the “shut the f*** up” expression for people who think that government debt necessarily leads to inflation. If that were true Japan would have a skyrocketing level of inflation. It’s actually, barely, barely got a pulse on the inflation rate.

Now, if you try that with Argentina, you’re going to get inflation. The reason being is that you’ve got a huge trade deficit. Nobody trusts your currency. You’ve got to issue bonds to cover your trade deficit in American dollars. They’re going to depreciate as well. You’ve got to import your inputs as well. You can’t provide all the inputs that you need. You have a collapsing currency and therefore you have runaway inflation because you’re buying overseas goods with a falling currency.

So, the breakdowns really come down to just how effectively are you monetarily sovereign? Now, Japan is monetarily sovereign and China is and Germany is because they run trade surpluses, massive trade surpluses.

This, by the way, is one of the points that I distinguish myself with MMT. I think their arguments on trade and balance of trade are nonsense, and I’ve told them that. I don’t bother coming out with it strongly because, you know, I think that it’s great that a heterodox theory has got the ears of the public in a way that hasn’t happened ever since Keynes. So, congratulations to them for that front. They’re correct on the monetary stuff. Their trade stuff I think is bonkers and I will say it now because it stands out how bonkers it is in the year of the Coronavirus when America couldn’t produce facemasks. My supply of facemasks is in a box somewhere. I’ve got about 500 of the buggers. They’re made locally in Thailand. Whose exploiting facemasks in the rest of the world now? China. So the MMT stuff on trade, I think, is nonsense.

Back to the issue: you can be able to get away with any level of government debt, and interval government spending if you manage your early sovereign and/or you have a trade surplus. Now, America is monetarily sovereign because it’s the international currency.

Rob

But it doesn’t have a trade surplus.

Steve

No, it’s got a trade deficit but it can finance it because of owned American dollars. I think it should have balanced trade. If you go back to when we broke from the Bretton Woods Agreement to the floating exchange rates system after Nixon broke the gold standard, people believed that adjustments in the currency process would eliminate trade deficits. Well, great. How successful was that?

Rob

It hasn’t worked out so well, yeah.

Steve

We’re five decades into it. I think it’s about time I can say that one failed. So, what we have is huge trade deficits, huge trade surpluses, sustained over time, not corrected by the relative price of currencies and the problem is the trade deficits and surpluses themselves. If you go back to Keynes original ideas for the bank, back in the Bretton Woods before it was scuttled by the American delegation, they wanted a bank core of international currency for transactions and they wanted limits on trade deficits and surpluses to make sure that they rarely exceeded 2% of GDP.

Now, we’re in a world with 10% of debt to GDP deficits and surpluses, and that’s a major source of the imbalances that are breaking the system down. Within that, America can get away with it because it’s the international reserve currency. If that fails, if we get to the stage where a new currency comes in, and I desperately hope we do ultimately do it, then America will have serious trouble with its trade deficits.

Niels

Which currency do you think might replace the dollar?

Steve

I was hoping that the Russians and the Chinese would get together and form a currency basket system. The one thing I can say in favor of Donald Trump is he has accelerated discussions by central banks around the world about the need for, potentially, a basket of currencies; basically a version of SDRs to be for international trade as well. That would be the best possible outcome of the crisis that we’re going through: get away from the Americans being the dominant currency and bring in a basket of currencies. Something similar to what Keynes had in the idea of banks in the first place.

Niels

So, that could easily be a digital currency, do you think, actually, if it has to be a basket?

Steve

Yeah, I’m in favor of central bank digital currencies for two reasons. One is because that’s a potential avenue towards bringing about an international currency system which is not tied to a national currency. The second is that I think we’re going to need carbon rationing in the very near future.

I don’t know if you’ve read my reviews on William Nordhaus, but I think that man’s work has been a hoax that has fooled economists into believing that climate change is far less dangerous than it actually is. Once we realize the hoax he has pulled, we are going to need to bring in carbon rationing. It’s far too late for carbon pricing. Central bank digital currencies could be a way of bringing in carbon rationing. So, I’d like to see them set up in the first instance that they can be used for purposes that are entirely different to what central banks think they should be used for.

Moritz

Steve, I want to come back to the argument that you made that inflation encourages people to spend. I guess that’s true. So, therefore, you would say inflation isn’t necessarily a bad thing because it causes money to turn over. Now, we Germans (not me, personally, but my grandparents), they had their bad experience with inflation. So, here everybody is [saying], “No, no, we don’t want any inflation.” The Bundesbank is very, very tight about it.

So, two questions on that: the first question is, why do you think there is, for most central banks, this inflation target of 2% and how the heck did they come up with the 2%?

Steve

(Laughter)

Moritz

Is that because they want to achieve exactly what you said, to get people to spend money because they know that, yeah, if we’re reaching our target then it’s going to be 2% less in a year’s time from now? So why that target?

Then the second part of my question is: if inflation is kind of like a mainstay of the system then what would that do to the credit system – all those mortgages, people taking out 30-year mortgages? The bank giving out that mortgage must demand a very, very high interest rate knowing that inflation is part of the system because 30 years down the track the money that the bank would be getting back is worth almost nothing.

Steve

Yeah, so I’ll take the second part of that question first. If you look at the rate of interest that the banks charge, there pretty much is a reserve rate plus the inflation rate, or close to it, plus their cost of funds (about 3%). So, the real rate of interest tends to be of the order of 2% to 3%. They buffer the nominal rate that they charge to cover that inflationary difference.

If you look at periods of high inflation. If you go back to the late ’70s, early ’80s, when you did have a high inflation rate, you had high interest rates as well. Now, what we’ve seen since then is the crushing of that inflation level and the crushing of interest rates as well. So, the real rates haven’t changed all that much but the nominal rates have fallen from 20% to 3%. So, the private financial sector tends to cope with that by varying the nominal rate of interest that it charges.

I can understand the Weimar fear. The element about that is what should you fear is being defeated by the French.

Moritz

(Laughter)

Steve

Because the whole intention of the treaty of Versailles was to cripple Germany permanently. That’s one reason even people who are outright critics of Keynes, I highly recommend they read The Economic Consequences of the Peace, which was his absolutely disgruntled, personal reflection on that treaty and the extent to which the French came in there and tried to crucify the Germans and destroy their long-term enemy once and for all with a tactic that would have worked in a feudal system and Keynes said will fail in a capitalist one.

Moritz

Yeah, and it produced Hitler.

Steve

And it produced Hitler, yeah.

Moritz

Because he was using the Versailles Treaty, after WWI to rally his troops.

Rob

I don’t know where you are Moritz, but you know that there’s this French lady in charge of the ECB now, right? Don’t know if you noticed.

Moritz

Yeah, it’s terrible. (laughter)

Steve

But the real thing that produced Hitler was austerity because the Weimar, in its own weird way, was a way of wiping out the reparation payments. You then had Germany getting caught up in austerity during the 1930s in response to the Great Depression. Hitler was actually an anti-austerity campaigner. One of the weird things that happened to me in my history, being a renegade economist, is that somebody out of the blue said, “You don’t acknowledge your forbearers. Why don’t you ever acknowledge Henry Ford?”

What?

And they sent me a copy of Henry Ford’s writings in a thing called The Dearborn Chronicle. Now, I suggest you brace yourselves before you read the damn thing because it’s actually Hitler’s play script. Henry Ford, he was an anti-Semite, and you might have been reading Hitler when you’re reading the Dearborn Chronicle. But, he also understood the monetary system.

I wonder these days (I do intend on reading Mein Kampf) that, apparently, the only person Hitler acknowledged in Mein Kampf was Henry Ford. What you find him saying is he’s saying there’s no problem about the government creating money. It can create as much as it likes, etc., etc. There’s no need for austerity, fundamentally. That’s the message that Hitler used to become successful in his campaign with the German people in the early 1930s.

So, we often think that it’s the Weimar republic that led to Hitler. It’s actually austerity that led to him. That’s what scares me about the current circumstance where, without the same level of awareness that Henry Ford had and Hitler required about the capacity for the state to create its own money and finance its own activities, we’re setting up the same sort of right-wing, demigod possibilities with austerity, first of all in the aftermath of the Financial Crisis and now in the middle of, in some ways, the Coronavirus crisis.

Niels

Just staying on that, you talk about the similarities you see, now, and worry about from the ’30s and all of that. I can’t help trying to bring it back a little bit to… I don’t know if you’re familiar with the work of Neil Howe and the Fourth Turning that, just from a cycle point of view, we are in a period where they predict it to be a really, really, serious crisis because it fits with that fourth turning. That fourth turning always gets resolved in war, real war, hot war. So, I don’t know whether you think about that as well in terms of your work, the possibility of all of this having to go through what we saw ninety years ago, so to speak.

Steve

Yeah, what do they say that I intend on writing a little book? What’s the worst that could happen? I think the worst will happen.

Climate change is, by far, the major factor I’m thinking about, not the Corona. The Coronavirus was part of it, but certainly, climate change is, by far, the major fact I’m considering. Yes, I think we will face global conflict.

In terms of the Coronavirus itself, that’s going to give us a fractured planet. International travel is out the window unless you live in Covid-free economies. That’s going to be China, Southeast Asia, Australia, and New Zealand and, by the looks of it, maybe Norway and a couple of other countries in Europe. The rest of the world you won’t be able to travel freely because of the capacity to pick up the disease on the way through, on planes, and stuff like that. So, goodbye tourism, goodbye international airline industry. You’re looking at 15% to 20% of GDP that could disappear that way.

Then, in that situation, if you then have governments imposing austerity in response to it, well, the little bloke with the funny mustache becomes a possibility, again, domestically. But, with the global warming impact the type of breakdown of production systems that is feasible to come out of that, and breakdown of food systems; that could lead to conflict between India and Pakistan, for example. It, equally, could lead to cooperation between India and Pakistan to decide to invest in and produce high altitude jets that can save the atmosphere with sulfur dioxide and drive the temperature of the planet down five degrees. Then you might get a rather different response back from the West about that. So, I can see a huge amount of human conflict coming our way.

If we hadn’t overshot the planetary limits thirty-something years ago, then we could have avoided that crisis. But I think we’ve overshot them so badly, and economists have helped us overshoot that; Bjorn Lomborg being the latest jerk who is helping to promote their views forward. In the aftermath of having pulled back our consumption levels on the planet, dramatically, perhaps by a factor of two or three, then we’re going to be fighting over resources and that just means massive human political conflict.

Niels

Just staying on the point about cycles, like Neil Howe’s work where it’s more demographic cycles. do you have any sympathy for people who say, “Well, actually from a… (and again, I don’t know much about the climate compared to you at all) I do hear people who are saying, “The climate goes in cycles as well.” So, what’s happening in terms of global warming is part of… (I don’t know how long these cycles are but they’re probably hundreds of years, right) We are at a point where it’s meant to be warm and it will get cooler again.

Is there any sympathy in your work for general climate cycles that are not really impacted by whether we travel by air or whether we drive too many cars or anything like that?

Steve

Pardon me, can I share my screen here? Is it possible to share my screen with this?

Niels

You can, you can share it. We don’t record screens, so it will just be the audio.

Steve

I’m going to give you some correlations instead, in that case, and see if you want to maintain the same argument.

What is actually causing the increase in GDP is increase in energy. We have a high level of GDP because we use more energy. The correlation coefficient between energy consumption and GDP, at the global level, is .997. So, I think I have reasonable grounds to say (I’ll make my closing argument as well of course), a correlation of close to 1 in energy causes GDP. Fair enough?

The second one is the correlation between GDP and carbon dioxide, what do you reckon, is it higher or lower than the number I just gave you for the correlation between GDP and energy?

Niels

I have a feeling it’s higher.

Steve

Yes, .998. Then the correlation between CO2 and temperature, do you want to have a guess at that one?

Niels

I’m going to stick with higher, again.

Steve

No, you’re lucky, it’s lower, .992. That’s using smooth data. If I used the actual data which, of course, includes the cyclical factors, it’s .958. But if I leave out things like El Nino, which is short term cycles, we know, it’s .992. Now, pardon me for being a bit dramatic, I’m going to say .999 to your comments. There is absolutely no way that this is cyclical. There’s absolutely no way we can say that it’s something in the natural variation. We are caught in the middle of it. We are driving this.

Now, I’ve given you three correlations north of .99 and I don’t even need to talk about what causes carbon dioxide; what causes .99 times 3.

Niels

So, the only way to save the world, to speak, (and again I don’t really want to necessarily make this a climate discussion because I don’t know much about it) but would be to take production off the planet, right?

Steve

Yeah, fundamentally, that’s the only way to, in the long term (and I mean the next hundred years to two hundred years) the only way we’re going to be able to sustain human society on this planet is to take production off-planet. We are on the verge of that. That’s one reason I’m a great fan of Elon Musk. I’m even a fan of…

Thank God these billionaires are spending their money on rockets rather than mansions. I’m sure their houses are pretty grand as well, but we’re getting to the stage where private exploitation of outer space … Who cares about waste in outer space? it’s feasible, but of course, that completely changes the type of income distribution system that we have. We can’t have an income distribution based on wage labor in that world. We’ve got to prepare ourselves for that eventuality otherwise we face a Hunger Games future, in my opinion.

Yes, that’s the long-term thing. In the short term, if we could pull back on the level of carbon generated energy, then we might be able to get out of the crisis. But if you’re looking at the speed at which we’re making that transition, even if we ramp up nuclear massively in the next ten to twenty years, we’re still at the stage where, if we’re forced to drastically cut back our energy consumption because of the impact on the climate and other impacts of waste as well, then we could see GDP having to be reduced by 50%, if we’re lucky.

Niels

So, I’m curious (if we can stay on this topic a little bit but in a different way), part of the solution, yeah, we can talk about taking production off the planet, that’s fine, but another part of the solution would be to say, “Well, what if there were fewer people on the planet in the first place?” So, I’m just curious where this is another kind of test of these things that you hear out there, that is whether you subscribe to any of these conspiracy theories that actually what’s happening with the Coronavirus, the way it’s set up, it’s really controlled or designed by a very small group of people to, at the end of the day, end up in some kind of technocratic environment where they control everything so to speak.

Steve

Have you met any of those people? I have, some of the people, the people that are fantasizing about the level of conspiracy theory, you need to have multigenerational Einsteins to pull of that sort of conspiracy. I’ve met enough of the people at the top level of this planet that they’re not Einsteins. They’re living deluded theories. I read Federal Reserve minutes. Anybody who can spout the garbage that I have heard coming out of the Federal Reserve is not going to ever have a conspiracy to hide ice cream from their children in the frig. The level of intelligence that it implies, for a successful conspiracy like that, is simply off the scale.

I can certainly allow for the potential that there was an accidental release of COVID, maybe it’s something which is biologically engineered and got out by accident. I think it’s more likely that it’s evolved naturally. In terms of a conspiracy over that sort of stuff, I’m sorry, the people who are running this stuff are nowhere near smart enough.

They’re conspiring all the damn time. Their conspiracies don’t work and will have unintended consequences that they weren’t expecting. There’s no way that this is conspiracy driven. They know as much about the planet as the people who run a place called Teotihuacan. If you’ve ever been to Mexico and checked out the pyramids in Teotihuacan and seen the burnt walls of the elites there, when the peasants realized that the elite didn’t have a damn clue and they were all starving to death, the first thing they did was burn the elites alive. It’s not a conspiracy of guile, it’s a conspiracy of stupidity.

Rob

Steve, I agree with you on a lot of stuff. It’s fair to say that I agree with you on the amount of money being put into the system probably not being inflationary. I agree with you on things like basic income, I think, which we haven’t even discussed today. I definitely agree with you on the climate. There is one issue, though, which we differ on. I hate to be parochial and bring it up, and that is Brexit.

Steve

(Laughter)

Rob

So, I think you’re on the other side of the fence and I’m sure you have your reasons. So, maybe, just very briefly, because we haven’t got much time, very briefly just talk about why you think Brexit was a good thing for both the U.K. and the E.U., I guess. Also, perhaps, whether you think it’s going well because I think, in this country, most people think that the way it has been handled, the outcome is, perhaps, not looking as rosy as we were lead to believe when the vote happened.

Steve

I voted for Brexit because I don’t like the European Union. I wasn’t voting on whether it would be good or bad for the U.K. If I had known how badly it was going to be stuffed around by the Tories, the whole thing has been a total circus, I would have stayed in bed rather than getting out to vote.

So, I think it has been a catastrophe, and what I hoped was that it would be a wakeup call for Brussels to say, “You’d better change some of your rules. Change the Maastricht Treaty, take the screws off the countries that are running deficits, particularly Greece, obviously, and even Italy. I think Italy is the country that has suffered the most courtesy of the Euro. So, I saw it as a gentle wakeup call to Brussels.

Well, the Brussels bureaucrats have given the Tories a complete runaround. Yanis, for a fact, has given the best advice way, way back in the early days when he said, “Don’t even negotiate. Put forward a Norway plus deal and simply put it on the table and don’t bargain. You’ll get the Brussels runaround if you try to bargain with them.” Well, they got the Brussels runaround for the last, what, three or four years. It has been a total travesty.

Seriously, I wouldn’t vote against Brexit, because I believe in the European Union. I wouldn’t bother voting if I got a chance again because it has been so badly mishandled by the British, to begin with. Now you’re going to get all of the complications of the customs checks and so on, which didn’t need to happen. If the European Union had been agreeable about it, they could have agreed to just maintain the free trade zone. But they haven’t done that. So, it’s been a total catastrophe.

If I could see what was going to come without the Tories mishandling it, I wouldn’t have voted for it in the first place.

Niels

Staying on that topic for a little bit, I saw an old interview you did with Hard Talk on BBC, I think probably four or five years ago. I have to say you held up really well. He was pretty hard-talking, the guy that interviewed you.

I agree with you in terms of Europe. I’m not a big fan of the E.U., personally. But I’d like to hear your reasoning and also will Europe actually survive, or the E.U. (I should say) will it survive? If not, what’s going to cause the downfall do you think?

Steve

These things last far longer than they ever should and then they fall apart faster than you expect at some point. I think the Euro has been a tragic mistake right from the very outset. If you haven’t read it I recommend finding an article called Maastricht and All That by Wynne Godley, published in 1992, well before the Euro came into existence. His reaction in the London Review of Books told why it was a bad idea to have the Euro. The idea was, first of all, you lose capacity to create your own money, which leads to all sorts of dilemmas that European economies have suffered with ever since. Then he said, “When a crisis comes along, because of these rules, countries which have got an economic downturn, again, make it worse by having to run a government surplus.” So, he’s quite right about it.

The trouble is there’s such a level of… The Euro, itself, has become part of a symbol of Europe, and people like the fact that they can travel between one country and another and not have to change their bank accounts, or their banknotes, and so on. So, even the Italians, who I have said have economically suffered more than anybody, because they couldn’t readjust their inflation rate to the German inflation rate anymore, and they have been forced into austerity when they should have been doing stimulus. Even the Italians are being wedded to it.

So, it could go on much, much longer. I just would like to see it disappear. I would like to see a country like Italy say, “That’s it, all accounts are now in Italian Lira. One Lira is worth one Euro. International debts we’re now going to abolish and we won’t pay back the T3s and all that jazz, the target balances, and so on. We’ll just write out debts off and cause a crisis to cause the E.U. to be shut down, generally, and go back to national currencies.”

That’s what I would like to see. It would be an absolute mess in the process but better than the depressing impact of the owe indefinitely. It’s quite possible that it could go in the opposite direction. The Euro could realize it’s got to provide cash flows regardless of what the Maastricht Treaty says, and give the money to keep the economies from failing when all the banks start to fail because people can’t pay their mortgages anymore in the middle of the Coronavirus crisis.

In that sense, look at the travesty, the mismanagement of the Brussel’s level of the whole crisis over Covid19. There’s another side of how ineffective this supranational bureaucracy has been. When Italy said it needed help it didn’t get any because the memos went nowhere. So, it’s utterly ineffective. Its only effect is to slow down the speed of responses to crises. I’d like to see it disappear but it could go on for another ten or twenty years.

Niels

Sure, sure, sure, Moritz, in terms of the last question, we need to be respectful of Steve’s time, so, anything?

Moritz

Yeah, I mean that’s been great. Obviously, you know, I live in the Euro Zone and I deal with that currency on a daily basis. The way I see it, and this may be completely wrong, is we either abolish the thing and we go back to national currencies and give countries their freedom to do whatever they want. That is option ‘A’. Option ‘B’ is that we get out sh** together and the only solution there is to have a common physical, common tax, common everything type of system. Maybe you turn in your German passport and you get a European passport and it becomes like this one thing like the United States. Maybe then it will have a chance. But, other than that, it’s going to be difficult.

Steve

Yeah, and I think the potential was there for that if you go back 50, 60, years, in the early aftermath of the WWII, you could have had the United States in the European form. The overall intention was to have a continental economy to rival America. Ok, that was the real intention behind it.

I think they stuffed it politically. They could have done it 50, 60 years ago. Instead, by trying to do it the way that they did, and certainly by going to the monetary union first before a physical union of any sort, the chances of that, I think, are zero now. COVID is a total wild card. It’s possible, for example, France and Italy might well end up being Covid-free. They seem to be turning the right way. Maybe Germany as well, but other parts of the European Union aren’t going to get there. So, you’ve got a fissure right down the middle of the Union.

So, what I’d prefer to see, if you actually do it, is to go back to national currencies but have the ECB being a seamless international currency conversion system. So, when you go from Italy to the Netherlands, on your Amsterdam holiday, you turn up with your Lira, and they get converted into, I don’t know what the Netherlands currency is called, Guilders I imagine, at zero cost to you and zero inconvenience as well and that sort of thing, meaning that you get the fluency within one country.

You don’t have an international currency but you have international fluency between national currencies to give you the same overall effect. Then you can run different fiscal policies and different inflation rates and not have the type of destruction of industry that has happened with Italy courtesy of the Euro. Whether that will happen or not, COVID has made every potential forecast of the future a total crapshoot. So, I won’t speculate what’s going to happen on that front.

Niels

Yeah, sure, I wanted to finish off with a slightly different question for you, Steve. It’s maybe more of a piece of advice we might get from you, the three of us. We are kind of a little bit like you meaning that you hold some very different views than many of your colleagues. A lot of people look at trend followers a little bit in the same way because we believe that you don’t have to make any predictions what so ever to make money in the markets, you just have to follow the price. So, to some extent, we’re kind of the black sheep of the family.

So, I was just wondering if you have found a good process for getting people to stop in their preconceived tracks and actually listen to what you have to say with an open mind, and obviously, ideally, being swayed by your arguments. Is there anything that you can give us in terms of advice for doing that?

Steve

Well, I think I have been less effective than I’d like to be because mainstream economics still dominates everything. So, I certainly haven’t won the argument, although at least I get listened to. I suppose that’s the positive here.

I think, partially, it involves working out, with the people that you’re trying to change their minds, what is the basis of their thinking and then saying, “OK, I’m going to take that basis and show why that’s a fallacy.” So, that’s one reason that I’m working on my Minsky software right now to build models of modern monetary to show that the government running a deficit actually gives money to the private sector, not takes it away (which is the mainstream way of thinking).

So, you’ve got to find a way to be able to pose the problems that the other way of thinking people have puts for you and then show why this is false. Now, a few people, a few approaches just follow the prices and that sort of thing. Then one thing you can do is say, “Oh, let’s take a look at past historical events, how much did they move the markets?” The answer is, “Well, bugger all,” might be the initial reaction, but then that gets washed out over a day. So, you’ve got a strong case for a follow the price signal.

On that front, if you haven’t seen it, I recommend finding three books by a now-deceased author called Bob Haugen. Haugen was a professor of finance who had a lot of typical mainstream finance textbooks but always had strong appendices where the data and the analysis would contradict what was in the body. When he left the academic sector he made me look like a wallflower and just blasted the mainstream with three books, one called The Inefficient Markets Hypothesis; another called The Beast on Wall Street; and a third one called The New Finance.

In those he did exactly what I’m talking about, he went and said just how much this historical data moved the market. The answer was, “Bugger all”; major events. The market is a self-referential system. So, the sort of thing you people are doing, I think, has got more validity within the market that people who think they can pick macro trends. There are macro issues of which credit is a major factor there. I’d include credit and credit dynamics in what you analyze. People looking at the market as being driven by news? Forget it, they’re wasting their time. News is the stimulus you throw into the pit that then gives you the pit’s reactions which will and truly overwhelm the original trigger.

It has been a long time since I actually looked in this area, but I always liked the work of J. Edgar Peters, The Fractal Markets Hypothesis. He has also done a similar thing about the extent to which markets are not moved by news but moved by their own internal chaotic dynamics. So, learn how your opponent thinks and try to find ways that they will say, “X should lead to Y, and X leads to Y instead,” then you say, “Well, there’s something wrong with the thinking.

Niels

Yeah, and I think that’s a great way to end because, although we didn’t get to it this time, hopefully, there will be another opportunity, and that is your Minsky Project which I think is about visualization. That’s actually something that I found, also, in my work and I’m sure that Rob and Moritz are the same. When you can visualize the impact of what our type of investment strategy does to a portfolio, people really do stop and say, “Wow! I didn’t realize it was that powerful.”

So, for that, thanks very much. Thank you so much for spending some of your time with us because what we heard today was super interesting and I know that all of our listeners will feel that way. By the way, make sure that you follow; make sure that you subscribe and you support Steve’s work via his patron account. As you can tell from today’s conversation, we are living in a true global macro-driven world and it is, perhaps, more important than ever before to stay well informed. From Rob, Moritz, and me thanks so much for listening and we look forward to being back with you as we continue our Global Macro Miniseries. In the meantime be well.

Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today’s episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you’ll be sure to get all the new episodes as they’re released.

We have some amazing guests lined up for you, and to ensure our show continues to grow; please leave us an honest rating and review on iTunes. It only takes a minute, and it’s the best way to show us you love the podcast.

We’ll see you next time on Top Traders Unplugged!