Debt Deflation Holy Grail (RE-RELEASE)

Published on
December 29th, 2020
Duration
53 minutes

Jeffrey Gundlach — Waiting for the Next Big Trade (RE-RELEASE)


Debt Deflation Holy Grail (RE-RELEASE)

The Interview ·
Featuring Richard Koo and Ed Harrison

Published on: December 29th, 2020 • Duration: 53 minutes

Real Vision Managing Editor Ed Harrison talks to Richard Koo, Chief Economist at Nomura Research Institute. Koo is famous for his work on balance sheet recessions, a rare type of recession where drastic liquidity injections fail to increase the money supply because they remain trapped in the financial system, as there's no low demand for loans since companies focus on minimizing debt rather than maximizing profits. He and Harrison discuss this framework in detail, and use it to analyze our current economic crisis the world faces. Koo draws a contrast between the traditional balance sheet recession, where a bursting of a debt-financed bubble causes a collapse in asset prices and an emergence of debt overhang, with what he refers to as a "pandemic recession," where an exogenous collapse of economic activity leads to disappearing income and a tightening of financial conditions. Koo and Harrison also discuss the various toolkits available to central banks and fiscal authorities worldwide, and Koo shares what he thinks what a sound policy response might look like. Filmed on May 7, 2020, over Skype. To view more of Koo's charts, click here: https://rvtv.io/Koo

Comments

Transcript

  • JS
    Juraj S.
    1 January 2021 @ 11:38
    Koo greatly underestimates the risk of moral hazard and long term economic damage when he discounts State spending effects. What he suggests leads precisely to more and more of the same with ever increasing absolute numbers but lower and lower effects in each cycle. I think you have the let the prices do the cleaning, restructure, let the companies go bust.
    • JS
      Juraj S.
      1 January 2021 @ 11:43
      "It required Japanese attack on Pearl Harbor." Ah, he's one of the "WW2 got us out of the depression" folks. Charming.
    • JL
      J L.
      1 January 2021 @ 20:47
      That was also the view of Herbert Hoover (POTUS 1929-1932) and Andrew Mellon (his treasury secretary).
  • RM
    Russell M.
    29 December 2020 @ 19:13
    This was a fantastic interview. This was the first time I heard someone provide a sound solution to EU woes.
    • JL
      J L.
      29 December 2020 @ 20:07
      It's an intriguing idea, but not a sound solution. Limiting the purchase of government bonds to citizens only, while borrowing in a currency that someone else issues, would be a recipe for disaster. If Spain issues Spanish-only bonds in euros, and then runs out of euros to cover the debt service payments, it is game over. Koo's implied point was that "fiscal disunion" could provide a means of getting around the Maastricht Treaty. If Spain's woes were contained to only Spain, Italy's only to Italy, and so on, then each country could run larger fiscal deficits, on the ground that a financial implosion would not leak over the border into other EU member bond markets. But that doesn't really work, of course, because if Spain or Italy went ahead and imploded, they would then want to leave the eurozone to go back to their own currencies -- why be saddled with the monetary policy of the euro when your economy just got blown up -- so again, it isn't really a solution, just an idea. With that said, Europe successfully managed to beat the German court problem, and issued a 750 billion euro recovery fund in a big and powerful step toward debt mutualization, two months after this interview was recorded. So Harrison's fears were unfounded and Europe pulled it together.
    • DS
      David S.
      30 December 2020 @ 17:59
      J. L. - Europe pulled together for now. Germany is working very hard to keep the Euro together. Eventually this may not work, IMO, as holding up a political currency without a sovereign is still an experiment- Mr. Napier. The alternative is to put Brussels in total sovereign control of the EU countries. This also seems to have a low probability, although the original intent of the political currency. There are many steps before either extreme. Time will tell. DLS
    • JL
      J L.
      30 December 2020 @ 18:53
      @ David S. Indeed the jury is still out, but the scales have tipped in favor of the euro's survival as opposed to its demise (meaning odds are now higher the euro it succeeds than fails) for multiple reasons: -- The longer the euro exists, the harder it becomes for any EU member country to logically break away from it (as a huge suite of trade and access advantages is immediately lost upon exit) -- Breaking up with Britain may wind up being a surprise long-term win for the EU, particularly if Scotland leaves the U.K. to join the E.U. (more likely by the day, a matter of time), Northern Ireland also joins the EU (in a de facto way by rejoining Ireland), and Paris and Frankfurt "take back control" from London in terms of the EU reclaiming its financial center activity from London -- all of these would make the EU stronger -- Not having the U.K. to stir up trouble and dissent in future policy decisions will make the EU run significantly more smoothly (to some extent the Nigel Farages were more trouble than they are worth) -- The world is moving very firmly in the direction of big players and big trading blocs, e.g. away from the "Global Britain" scenario and towards a configuration where size, power, and clout are key (favoring EU membership) -- Crossing the debt mutualization threshold in 2020 will be seen by history as a huge obstacle that was overcome and a major victory (consider Ed Harrison's pessimistic comments about whether it could even happen, before it did happen) and all further forms of debt mutualization will get easier moving forward -- The euro will have added strength in the coming years as a reflection of the US dollar's unwinding as a world reserve currency (the USD will still dominate trade flows, but maybe fall to something like 40% instead of 60%, which will be a very big shift) -- China and Russia are jointly making a legitimate and concerted effort to do more energy trade in euros versus dollars (this will stabilize the euro further, support euro based debt markets, and make it easier for other CBs to add more euros to their reserve currency mix) -- The added strength the euro will have vis a vis USD decline and world reserve currency twilight (as the dollar backs off its global role, ceding some ground) will make it easier for the EU to issue significant amounts of mutualized debt (which it is logical to do anyway) to help stabilize weaker areas of the euro zone without seeing currency-based inflation -- 2020 was a huge test for the euro, and also the euro's 21st year as a tradable currency -- the fact it has passed that test, with flying colors, greatly increases the odds it will survive whatever is next I am agnostic on all currencies and have never been a champion for Europe (I live in the USA). I was also a euroskeptic even before the euro started trading (in early 1999). But with that said the objective facts and data make it very clear that the euro is on a stronger footing than it has ever been before. The euro has overcome a highly improbably series of obstacles and dangers already, and its odds of survival are now greatly enhanced (with a successful Brexit and a successful debt mutualization launch increasing those odds).
    • JL
      J L.
      30 December 2020 @ 18:58
      p.s. correction, 2020 was the euro's 22nd full year as a tradable currency (it launched on Jan 1, 1999)
    • DS
      David S.
      30 December 2020 @ 22:50
      J L. - I look forward to the day that their is no reserve currency. The value of currencies should be determined by the huge FX market with skin in the game. The FX market will have many problems too. It will be distorted by huge sovereign wealth funds at times. I think the market is being distorted now by CBs lowering their percentage of $US reserves. We will see how well this goes. IMO it is a reaction to the $US being weaponized. This too shall pass. Eventually a new equilibrium will be established by the FX market makers each day.. DLS
    • JL
      J L.
      31 December 2020 @ 07:45
      Not sure what it means to say the USD is being weaponized. The trade-weighted value of the dollar saw a historic decline in 2020, from the spike of the March high to the present multi-year lows. A weaker dollar is good for global recovery, as a lower-cost dollar boosts the value of commodity exports (which helps EM countries) and also helps US exporters. Where is the weaponization in that? Unless the accusation is to say the US is waging a currency war by intentionally weakening the value of its currency? But that doesn't work, because the world reserve currency is uniquely beneficial to ROW (the rest of the world) when it is lower cost. I suspect that the "dollar is being weaponized" argument is incoherent. I say that because I have a solid grasp of how capital flows work, and nobody has been able to cogently explain what they mean in saying the dollar is being weaponized. I also suspect that the Snider-led focus on the plumbing of monetary policy issues is being overwhelmed by fiscal activity, but they don't want to admit it. When the government spends $900 billion, much of which is direct stimulus, the Sniderians do recognize that involves a mass influx of dollars going into people's hands, right? And yet they talk as if this isn't a factor. As for reserve currencies and the FX market -- they are much the same as far as I can tell, especially if one considers gold and Bitcoin two forms of alternative sovereign currency. Countries that lack a large internal domestic economy -- as defined by a large percentage of revenues coming from exports -- will always need some type of "reserves" on hand to buffer against volatile periods. This is like being an exporter who mainly deals in a currency other than your own; you will always have "reserves" as some form of back-up. In this sense there will always be reserve currencies, or reserve assets, with a ranking of certain reserve assets at the top of the list. The dollar will probably remain very high on that list for a long time. Rather than seeing the dollar disappear from the reserve currency list, the dollar is more likely to lose its super-dominant number one position, with, say, the euro becoming a more robust number two, the yuan stepping up as number three, and gold and Bitcoin occupying the three and four slots. Point being, as long as you have export-dominant nations you will have reserve assets, which in turn means reserve currencies -- the question is just making the mix less lopsided, as such that the USD is not so far out ahead. One could argue that, say, Bitcoin or gold will one day own the #1 and #2 slots or vice versa, but even if that happens, there will still be reserve currencies, in the sense that there will always be reserve assets and there will always be a top five, and the currencies of large nations that buy a lot of imports will always be popular to hold for insurance purposes.
    • JL
      J L.
      1 January 2021 @ 20:44
      p.s. I stand corrected on the dollar weaponization comment. Via reposting of the Melkman interview, I realized what that was referring to: A hawkish US administration denying "bad actor" regimes (Russia, Iran, etc) access to asset holdings that are denominated in dollars. Using world reserve currency privileges as a means of inflicting punishment for perceived geopolitical misdeeds, in other words. I had heard some other explanations of USD weaponization that didn't make sense to me -- along the lines of withholding dollars from global users who want them generally, not for geopolitical reasons -- but that explanation actually clicks and is fully cogent (an arrogant US gov using SWIFT, and dollar demand, to hurt its perceived enemies on a case-by-case basis). Funny enough, though, the weaponization problem as described in that manner (the US abusing its world reserve currency issuance privileges as an inappropriate policy tool for punishing bad actors) further contributes to a bearish USD outlook. It accelerates the sense of urgency in de-risking reserve asset baskets by shedding dollar-denominated holdings.
  • DS
    David S.
    30 December 2020 @ 19:11
    For centuries Europe had monetary disunity i.e., each country had its own currency. The European Economic Union - trade union - would have worked brilliantly without the Euro. Politicians as usual took over the idea and killed it. A good econmic idea destroyed by politicians seeking power and reelection. This is what history will record. DLS
    • JL
      J L.
      30 December 2020 @ 20:22
      I have bad news for you. We have to get the politics right or human civilization will fail. An assumption that political projects are inherently bad is illogical because, if all political projects are doomed to fail, then so is humanity as a species, because our technological power will eventually lead to a war that wipes out all life on earth. Tired conventional wisdom as to what will happen to Europe should be tempered with a more creative open mindedness to future possibilities. Look at what the United States had to go through to hang together as the United States. The Civil War was one of the bloodiest and deadliest conflicts in history. If one were to bet on the U.S. hanging together, the logical bet would have been that no, the U.S. would fail. As it stands, the U.S. would not have survived had Lincoln lost re-election in 1864. This is not to suggest Europe needs a civil war. It has already had two world wars to spur the motivation to come together and stay together. The point is rather that all political projects are rife with challenges and strife, just as America's was (and is). And we should root for grand political projects of logical cooperation to succeed, not automatically assume they will fail, because if that automatic failure assumption is true, there is no hope for human civilization, and it is just a matter of time until mankind wipes himself out.
    • DS
      David S.
      30 December 2020 @ 22:15
      J. L. - Thanks. I agree that all political projects are not inherently bad. My emotions erupted from all the pain this political program has caused thousands of Europeans. In my defense I was and am in favor of the EU as mentioned aboved. The Euro is not logical on an economic basis. It is a political fiat currency without a sovereign. If the US tried to unify today instead of a couple hundred years ago, it would not work politically ; economically probably; fiat currency no way. DLS
    • DT
      David T.
      30 December 2020 @ 22:39
      They day fiscal or any union falls apart in the Europe, the very next day Russia will cause wars in Europe. EURO currency will survive. They have been predicting demise of Euro from the day one but, so far so strong compare to USD. Sovereignty is the pressure valve in EU and countries will give it up in favor of unity. The states did the same to create the USA.
  • DS
    David S.
    30 December 2020 @ 18:32
    Great Release choice from RV library. I greatly respect Mr. Koo and his analysis of the Japanese balance sheet rebuild during a good economy in the rest of the world. Now the whole world is in economic turmoil. COVID Times show major differences between a more cohesive Japanese culture and a divided Western Cultures. This recovery is going to be most difficult. As we see good GDP expansion over a lower base, it will be difficult to help those left behind. Polarized US workers on the left and right will continue to fight each other instead of looking for common ground. For political power media will continue to exacerbate this divide to obfuscate their common interest. As long as the stock market is up Congress will not work on solutions. Congress will work diligently on power and reelection. DLS
    • JL
      J L.
      30 December 2020 @ 19:06
      I would question your assumption about U.S. congress. The days of robotic support for the stock market over the real economy are probably gone. Just look around right now, at the level of support for $2,000 stimulus checks on both sides of the aisle. That is happening in part because Bernie Sanders is partnered with senator Josh Hawley of Missouri on this issue. That is interesting because Hawley is a hardcore Republican taking a pro-worker populist line. On the left, corporatist Democrats have ceded power to progressive Democrats who are far more vocal about workers' rights (and anti-stock market). On the right, the GOP finds itself tempted to shift in a pro-worker populist direction, as shown by Hawley and others who want to inherent the pro-worker aspect of the Trump mantle. This is also reinforced by voices in conservative media -- Tucker Carlson often talks like a pro-worker populist -- and as as also shown by glimmers of possibility in the GOP making real inroads with Hispanics (a culturally conservative ethnic group). Long story short, pro-worker policies -- which are inherently anti-stock market in that they favor things like direct stimulus, larger benefits, higher wages, and so on, all of which add to the deficit and reduce corporate profits -- are going to be increasingly popular on both sides of the aisle moving forward. This doesn't mean the K-shaped recovery dynamic will change overnight, but the political landscape has already changed, possibly by a lot.
    • DS
      David S.
      30 December 2020 @ 22:22
      J L. - I hope you are correct. There is always hope. DLS
  • KT
    Kevin T.
    30 December 2020 @ 03:07
    Great observations in this vid. Low rates only go so far as an incentive for individuals because they still have to service the debt. I wouldn't borrow (say for a home) at low rates if i think rates will go higher, because if rates rise, and incomes don't rise, I'd lose equity. I'd need to see peoples' incomes rise too. It's also a CF problem.
  • JC
    Jason C.
    29 December 2020 @ 21:27
    This interview made me feel less like central banks come from the devil.
  • JL
    J L.
    29 December 2020 @ 11:56
    Koo is brilliant. His critique of negative interest rates is very on point: "An act of desperation of those people… clinging to this idea that monetary policy is the key tool." Monetary policy has efficacy limits. Fiscal policy — where the government spends directly — can pick up where monetary policy leaves off, because politicians have the power of the purse. They can spend, and in so doing leverage the government's own balance sheet. And a sovereign government's balance sheet is different than any other balance sheet, because sovereign governments are effectively immortal (they don't die), perfectly diversified (they benefit from all economic activity in aggregate), and free of technical default risk (the only path to default is through inflation). With that said, in retrospect this May 2020 interview looks to have gotten one big point very wrong — not in terms of theory, but in terms of how the pandemic has played out. At one point Koo says: "The Americans who lived through the Great Depression never borrowed money until they died. This experience was so bad. We're going to have a similar situation with many people who went through the 2008 experience and maybe the pandemic recession experience as well." I would argue something like the opposite of the caution model is true. Those who didn't have money in the first place — service workers, the lower-middle-class, and the poor — were indeed hit hard. But knowledge workers and the upper middle class were emboldened and enriched on net. The pandemic was brutal, and Great-Depression-like, for the bottom one-third to one-half of the U.S. economy. But for the top half, or top third, of the U.S. economy, the pandemic has actually been a positive financial experience. You see home values going up. 401Ks going up. Excess funds from stimulus checks (for the millions who don't need the funding) getting punted into stock market bets. If anything, the pandemic may have inspired the top third of consumers to feel FOMO for not having invested more of their life savings in FANGs and meme stocks. The same split will hold true for public companies. The pandemic has been a near-death experience, or a full-on wipe-out, for millions of small businesses. But the expansion opportunities for strong companies in the aftermath, backed by lending funds from banks eager to resume profitable activity in the future expansion, will be like manna from heaven. For every 10,000 restaurant owners who shut their doors forever, there is a Cheesecake Factory or Yum Brands rubbing its hands. On net, one of the deep tidal trends the pandemic has revealed, and will continue to reveal in 2021, is the incredible divergence between "haves and have nots" in the American system, as the inequality gulf grows wider than ever. The pandemic was a catastrophe for physical laborers, those with hourly jobs in the vicinity of a living wage or below, and those who lacked savings and fallbacks. But for those who were already doing well, all through the pandemic they by and large continued to do well — and efforts to lift the economy in aggregate will help them continue to do well in 2021 (as fiscal stimulus efforts further prime the pump). This is a kind of "roaring 20s" recipe in which the next big disruptive event for the U.S. economy comes when the K-shaped recovery deepens the divide to the point of the gulf becoming a chasm, with the top third and the bottom third living in such drastically different conditions they might as well be in different worlds. But Americans are comfortable with the K, so it will take a whole lot before the poor truly rise up with pitchforks (if they ever do). And asset prices can continue to boom in this super-K divergence scenario, because Wall Street has never given a crap about the lower half of the US economy (as it was never a spending and lending driver in the first place).
    • AB
      Alastair B.
      29 December 2020 @ 13:37
      Outstanding. One needs only to read about the socialist/nationalist battles in Germany after WW1 (Freikorps and Spartacists etc.) and look at the USA to see the similar effects of such a drastic split between those that suffer and those that benefit from the crisis. Of course, the USA has institutions far more robust than the birth pangs of the German Republic, but there are enough similarities to herald a clear warning for the future. I have both feet planted firmly in the part of the economy that has benefitted tremendously from the pandemic but many friends and family are not so lucky, and it’s starting to get obvious that something is deeply amiss with the recovery, and terrible omens abound.
    • JL
      J L.
      29 December 2020 @ 20:18
      @ Alastair B Same here. Between my wife and I, half our colleagues / friends / family are doing fantastically well (largely based on industry and education level) while the other half face economic oblivion.