FRA: Hi welcome to as far as The Roundtable Insight .. Today we have Daniel Lacalle. He’s a Spanish economist. He’s the chief economist at Tressel’s and the author of several books including “Escape from the Central Bank Trap” and he’s also done work and in energy and finance sectors more than 24 years’ experience in those sectors in North Africa, Latin America and the Middle East. And he’s also the president of Mrs Institute in Spain. Welcome Daniel.
Daniel Lacalle: Thank you. Thanks for having me.
FRA: Great. With that today we’ll talk about an interesting article that you wrote recently and that is on the nationalization by central banks of the economy. So this sort of applies in general a lot of of central banks appear to be doing this sort of pie’s the different economies. First your general thoughts.
Daniel Lacalle: Well the first is is we’re living in probably one of the most incredible moments in history in terms of monetary policy. We have seen all sorts of monetary policy globally, but I think this is the first time ever in which central banks are issuing so much credit by print what we call printing money, increasing money supply. We’re talking about more than two hundred billion a month globally. And there’s no recession, there’s no crisis, it’s not because there is a big turmoil in financial markets. So you know one of the one of the risks that we’re seeing is that the entire economy is so dependent on central banks lowering rates and increasing money supply that is close to what I mentioned in that article which is the risk of nationalization from central banks. Think about Japan. The Japanese Central Bank currently owns about 60 percent of the ETF of the country, their equity traded funds. So you know that is one of the reasons why I wrote that article.
FRA: And also Bank of Japan is a top 10 shareholder, 90 percent of the Nikkei I think of you mentioned. So that’s that’s just fascinating. You list a number of fascinating facts as well in terms of like the ECB and the Bank of Japan balance sheets exceed 35 percent and 70 percent of their GDP. The Federal Reserve owns more than 14 percent of the U.S. total public debt. The ECB owns 9.2 percent of the European corporate bond market and more than 10 percent of the main European countries total sovereign debt. So these are some fascinating facts, so what is the driving force of this is it. Is it the need by central banks to implement their monetary policies? And then what’s driving that.
Daniel Lacalle: Well I think that at the forefront of all of this is the endless quest from central banks to create inflation by decree. So they they are trying at any at any cost to make savers to make investors take more risk and to sort of put more money into into the real economy. So if you as a central bank push bond yields to historical lows, the expected outcome is that investors will decide not to be invested in such highly liquid assets and move into a sort of long term real economy type of type of investments. However obviously that doesn’t happen now. It creates a perverse incentive. So basically the lower bond yields are higher that valuations of the stock market become what you see is that investors go where the money is created. So central banks are basically in a sort of catch 22 situation by which they try to push investors and savers to take more risk and to and to drive the economy. Strength to a stronger level by investing in the real economy, but what investors do obviously is to increase their exposure to short term liquid financial assets at the forefront of it all is a magical idea that by increasing money supply, the transmission mechanism of monetary policy will end up reaching the real economy in some form and and driving growth higher employment higher and obviously with that inflation.
FRA: And also the Swiss National Bank has a sort of program to buy equities as well right. Can you can you speak to that in terms of why they’re doing that.
Daniel Lacalle: Well you see one of the one of the problems that central banks face is that when they start these programs read repurchase programs is that there is a point at which they run out of things to buy. But at the same time there is a point in which their position is very dangerous because if they run out of things to buy and obviously if you run out of things to buy you basically just stop buying. But if you stop buying you can create a financial crisis because valuations have gone through the roof and therefore you know they become what I call in my book an escape from the Central Bank trap the pyromaniacs firefighter is that they basically have to they have to do more to prevent a crisis happening because of that policy. And therefore that’s why they buy equities or why they buy corporate bonds of companies that have never had problems and financing themselves is because they need to continue to push valuations higher.
FRA: And what about the ECB. Do you see the potential for that central bank in buying for example German equities because maybe running out of bonds or you know sort of certain types of assets in their Asset Purchase program? Do you see the possibility?
Daniel Lacalle: I mean the possibility is obviously there. I think that it’s a long way ahead because extremely loose monetary policy is relatively new in the European Union. However, it is extremely likely. Why? Because the European Union and the European Central Bank itself are actually moving in the same direction as Japan did in the in the late 90s. So one of the reasons why I believe that there is a strong possibility that the European Central Bank will move to, at some point, buy equities is that the same way that it moved from buying you know toxic or high risk sovereign bombs. It is now in a situation in which it needs to buy high quality corporate bonds. So the problem for the European Central Bank is exactly what I was mentioning, is that they are unable to get into a situation in which they they create that level of inflation that they’re looking for. And at the same time they run out of options. So the possibility of buying equities is not small. It is actually quite relevant because if you think about what happened in Japan it is pretty much the same. It started buying the Central Bank of Japan started buying exclusively sovereign bonds. Then it moved to corporate bonds and then as it is doing now it is buying Japanese equities. So if the European Central Bank, as I believe finds itself trapped in a similar situation to which the Japanese Central Bank found itself it will probably also move forward with with purchases of equities.
FRA: So how long do you think these trends will last for like. What is the end game on you know will there be continued buying of corporate bonds in equities by central banks?
Daniel Lacalle: What is the end game? Unfortunately, as it has always been it is no coincidence. It will be a financial crisis. It will be a financial crisis because the excess risk taken will end up you know generating turmoil in financial markets and central banks are never, have never ever been able to predict a crisis let alone see a bubble. So they simply go on and then just because there is no relevant increase in inflation they continue to go on. And then when it bursts then they do it again which is what we have seen over and over again. If you think about the past crisis it is always the same pattern. First central banks try to devalue the currency like there’s no tomorrow by issuing as much pay cuts or by increasing money supply as much as they can. Second they lower rates immensely. That leads investors to take extraordinary levels of risk in financial markets and when valuations are simply you know unjustifiable when those bubbles burst then central banks lower interest rates again and they increase money supply yet again. That was you know those were the origins of the tech bubble, housing bubble, etc. Now the problem next time is that in the past the past crisis that we have analyzed in escape from the central trap when there were a number of tools that central banks can actually use because you can actually lower interest rates from say 65 percent or from 5 to 4, etc. The problem is that right now we’ll live in a world of zero interest rates and in which the balance sheet of central banks is not small is actually very elevated, hence the risk of a much more abrupt crisis in the future because they will run out of options or tools to manage the situation in the way in which they they’ve them the past.
FRA: And do you have any idea of the timeframe for the next financial crisis.
Daniel Lacalle: Yeah that is the problem, that there is always a problem. Financial Crisis always happen in assets and in where the general consensus is that there is no risk. The bubble happened because everybody believed that we were living in a new paradigm and that technology could not be used as stocks or as companies the same way that we used to value traditional companies. The housing bubble happened because in the past the vast majority of population thought that house prices could never go down and therefore you know you could leverage your home or your real estate asset as much as you wanted, etc. But like those bubbles in the past they test even the most astute investor and the best analyst because that’s why their bubbles is that they take longer to create than what many expect and when they burst they burst abruptly. If you think about I don’t know if you’ve been able to read the book or watch The Big Short Movie. If you think about it the guys that predicted the housing bubble from the moment that they saw the immense bubble that had been created until it actually burst. Yeah it was it was a good three and a half or four years. So predicting the timeframe is very challenging particularly when unlike in those previous financial crisis in this one. On top of it you have a number of central banks that are working in a in a sort of coordinated way. So when when the Federal Reserve starts to normalize a little bit its financial policy Japan you know does it a little bit more aggressively then when the European Central Bank goes further than the others reduce a little bit. So there is a lot of manipulation coming from the central planners. But the end game is always the same is it has always been the same. And it will not be different this time.
FRA: Interesting. And so in terms of the nationalization process what are the negatives of this two economy I guess you can consider. Central banks picking picking winners versus not not allowing new entrants into the market like smaller companies perhaps like with like. Is there sort of a hazard of that to the economy. Moral hazard What are your thoughts?
Daniel Lacalle: Yeah it is that is a good point that at the end of the day it generates the same negatives as any level of central planning the economy gets. It’s a decision by a group, by a small group of people of who and how the winners will be created within the economy now. And but more importantly I think that the biggest risk is that it does three things. The first thing is that if you’re a very leveraged very you know a dinosaur type obsolete company it basically perpetuates obsolescence. It also perpetuates overcapacity and it gives the impression that there is no risk in areas where there is a lot of risk. So the biggest risk for the economy is that, as we are seeing way is that despite all this activity on the average citizen you know the middle class, etc. fail to see any improvement in their lives while at the same time in their disposable income, in the kids in their wealth, which is mostly deposits. When they stop they suffer. So the biggest problem is that you’re gradually eroding the middle class which is the most important part of the economy in order to perpetuate sectors that have access to too much debt and that invest in overcapacity.
FRA: Yes. And as you mentioned the private sector suffers the crowding out effect in crisis times and the taxation of wealth confiscation effect and expansion times.
Daniel Lacalle: Exactly. Exactly. When when you see it and we know in America right now, we have seen it in the in particular in the past eight years. The largest transfer of wealth from savers to government in history 1.5 trillion of new taxes with an added 10 trillion of new debt and 4.7 trillion of our money supply increased. So the average citizen basically is in. Throughout the crisis it doesn’t benefit. And an expansion times it gets taxed away from the ability to climb the ladder. So the everything that we’re striving to achieve from the perspective of a family from the perspective of a normal economy. Where you know what you’re basically trying to save a little bit for the future so that your children are able to achieve a better standard and then with that get to a better position in the future. All of those things that get created the developed economies are basically subverted. And what the governments and central banks are doing is literally taking from the pocket of the middle class and giving it to the sectors that are close to government and the sectors that are close to them.
FRA: And as you mentioned also the public sector comes out from these crises more powerful and more indebted.
Daniel Lacalle: Exactly. So from every crisis the mainstream economists will tell you that it is the public sector that has to spend; the public sector that has to borrow. Obviously the private the public sector has an incentive to spend in a manner that is completely different from the private sector; is not looking at profits, is looking at maximizing budgets. Then what happens is that obviously the level of growth, the level of jobs, and the level of salaries that were expected are not created. But the bill of the mistakes of that investment or that spending are passed to the middle class. So if you start doing that in the 50s, you basically achieved some level of, I would say, a cushion in disposable income from families. What you see right now is actually the opposite, is that the ability of families to improve after a crisis is really really limited.
FRA: Well that’s fascinating insight to help our understanding of the macro. Daniel how can our listeners learn more about your work?
Daniel Lacalle: Well I think that the best way obviously is they can follow me on Twitter. I have an international account. And just when all the news and my opinions about what’s going on obviously my books “Escape from the Central Bank Trap”, “The Energy World is Flat” and “Life in the Financial Markets”, which I mentioned all these things about what’s happening in the financial markets and in my website, which is delacounty.com, that is a-d-l-a-a-L-L-e-dot-com.
FRA: Thank you very much Daniel for being on the program show.
Daniel Lacalle: It’s an absolute pleasure Richard. Thank you so much for having me.
Summary written by Boheira Manochehrzadeh