The Munk Debates Podcast - Friday Focus: Financial Turmoil – Robert Kaplan

Episode Date: September 30, 2022

Friday Focus provides listeners with a focused, half-hour masterclass on the big issues, events and trends driving the news and current events. The show features Janice Gross Stein, the founding director of the Munk School of Global Affairs and bestselling author, in conversation with Rudyard Griffiths, Chair and moderator of the Munk Debates. This week’s edition of Friday Focus begins with a look at the forces and factors driving the current global sell of in financial assets. Currencies, bonds and equities were all pressured by the Bank of England’s surprise move to stabilize the UK’s long-duration government debt market and bail out pension funds that were at the risk of liquidation. Are we starting to see real stresses emerging in international markets as geopolitical risks grow and central banks continue the relentless hike of interest rates? What could this lead to in the weeks to come? The program concludes with Janice’s thoughts on a recent talk given in Toronto by big geopolitical thinker Robert Kaplan. Friday Focus subscribers can access an audio version of Kaplan’s Q&A with Rudyard on the Munk Debates website here. This podcast is a project of the Munk Debates, a Canadian charitable organization dedicated to fostering civil and substantive public dialogue. More information at www.munkdebates.com.Become a Munk Donor ($50 annually) to get 72-hour advanced access to the full length editions of Friday Focus and Munk Dialogues. Go to www.munkdebates.com to sign up. Hosted on Acast. See acast.com/privacy for more information.

These statues have to come down. It's always been a pandemic of the unvaccinated. The problem now is it's a pandemic of the willfully unvaccinated. Falling birth rates are good. They're good for our planet. They're good for our societies. We're not responsible for the escalation with Russia. We're not the ones who invaded Ukraine.

I don't think it's fair to portray people of color as victims. It is a very dangerous time in American politics. Hello, Friday focused listeners. Bradge Greas here, your host and moderator. Welcome to this, our regular half-hour program, exploring the big issues and ideas in the news with Janice Gross Stein, founding director of the Monk School of Global Affairs, an internationally renowned scholar and author. Janice, great to be in conversation with you on this. The 30th, the last day of September. Fall feels like it's stalking us. The temperatures are getting colder at night. I even had a sweater on this week.

Changes happening. Personally, these are not changes that I look forward to, but just one thing that is worth mentioning right there, Blue Jays are in the Wildcard series. That makes fall exciting. Something to look forward to. Here's what I want to do on today's show, Janice. The first half, you know, it's just been a, the only way to put it is just a wild week. And I want to get your thoughts on some of the key aspects of that week, maybe with a little bit more of a

kind of financial focus, because I think we're all kind of looking nervously at markets and seeming increasing kind of financial instability in various parts of the world. And then the back half of the show, you and I had an opportunity this week to attend a talk that I was kind of serving as moderator with an individual called Robert Kaplan, a really thought-provoking geopolitical thinker. Many people would know his books, Balkan Ghosts, The Coming Anarchy. And we're releasing right now on this podcast feed of some bonus content. We're going to do this as part of our kind of commitment to a revamped and expanded Friday Focus podcast, getting used some exclusive access to content that we think really helps people, at least help me think through some of the big issues and ideas transforming our world. So that bonus content is in your podcast feed right now for Friday Focus.

a full length, a 45-minute conversation between Robert Kaplan and myself and Janice and I will give you the highlights and unpack it in the back half of the show. But Janice, let's start with this week that wasn't. Instead of going into specifics, I want to get your advice on something. You know, I look at this week, massive hurricane, devastating Southwest Florida. Putin on Friday, the day we're recording, annexing these old. Oblast in eastern Ukraine, eerily kind of reminiscent of Hitler's annexation of the Sudaten lands and the other events that triggered in no small way the Second World War.

Chaos in financial markets reports this week that major British pension funds were within hours of insolvency because they were on the wrong side of trades around long-duration UK debt and were potentially experiencing devastating margin calls. an unprecedented intervention by the Bank of England. And then today also Friday, record inflation numbers out of the Eurozone, double-digit inflation across the Eurozone as the region stares into an energy crisis and a winter of discontempt. Janice, what I need your help with this?

I how do we process this I you know that just stuff they're feeling of being overwhelmed here a feeling that something is just slipping away I don't know order stability normalcy like how do you just personally kind of process this and remain sane in the face of the insanity that we are seeing on almost every vertical and segment and slice that you want to take of the world stage at this moment. Roger, the way you told that story in that minute tells the story. And that's why I really think that we are leaving the old world behind and moving into uncertain territory.

It's not because of any one of the verticals, of the factors that you mentioned. it's because they are converging and are interrelated and are all happening at the same time. So we have this unprecedented action by Russia, which frankly is eerily reminiscent of very terrible earlier times, not to say that that's where we are, but this is unabashed annexation of territory that he, you know, conquered, Let's call it what it is through aggression. And then you look at England this week. Oh, my, it's all I can say. Oh, my, you get a neophyte prime minister who releases ill thought is way too complimentary.

Mini budget, which is not really even a mini budget, so there's no information. And tax cuts, which reduce the top levels of taxation. you know, for the very top earners. Why would you do this in the midst of a financial crisis is just beyond me to the point where, as you say, big British pension fund, solid financial players were, there was a run, frankly, and they could not finance their payment. And the Bank of England, this, I mean, you hear in my voice, the Bank of England steps in and makes a move that runs counter to what the Prime

Minister of England and her finance minister had just announced. So if people are not concerned, they're not paying attention. Now, we put this all in a frame. I think Ian Bremmer said it best three or four months ago. We are in a geopolitical crisis. That's what's driving this. the financial crises that you were talking about are really a product of a much larger geopolitical crisis. So at the heart of this, the old rules are broken. There are huge financial consequences not only because of what Russia did, but because of the way we responded to Russia, too. There are huge energy crisis, and you see it's almost like those pictures of the hurricane that we saw in the last three days. pressure, pressure, pressure on the existing walls and existing structures.

And you have to think, you know, Britain is particularly vulnerable and how sad is this, frankly, to watch Britain performing this way. Something's going to crack, so you're right to be concerned. Where that crack comes first, but we have these convergent pressures pounding against the remaining structures that we have. Yeah, I like that analogy. It's kind of like a geopolitical. political storm surge that is, you know, the proverbial 12 to 18 feet high that slammed into

the southwest coast of Florida rendering horrific devastation. And, you know, many times I think people say, well, you know, why do you on this podcast focus on everything that's going wrong in the world? There are a lot of good things that have in the world. And I agree, and maybe we should try to spend more time occasionally pointing those out. But I'd be honest with you, it's you kind of, it's almost talk therapy. You have to speak about this stuff because if you don't talk it through, to me, understanding, and maybe this is just the way I'm wired. I'm curious if you're wired this way, to me,

understanding is the first step to kind of dialing down my anxiety. So if I can start to wrap some kind of structures of thought, some ways of processing all this, then what maybe is at times very irrational, chaotic, I can at least, at least have some semblance of, okay, here's a pattern that I can see, or here's a way of kind of thinking about this that allows me to understand that it isn't just chaos and insanity, that there are issues here that we can think through. And ultimately, there are decisions that we can or won't make that will matter. Yeah, I think that's absolutely right, Rudyard. And let's just run with this story for a minute of a geopolitical storm surge that's pounding against the walls here, the sea walls.

Well, the Bank of England stepped up. It stepped up. There's the positive in this story. You could argue that the Bank of England, you know, we can have a big argument. And Mark Carney, by the way, the ex-governor, the former governor, got right in the middle of this this week with some with some advice. advice that was probably not welcomed either by the bank or by the prime minister, frankly. But you could argue here's an institution, the Bank of England, not within its remit to do this kind of stuff, really, especially to counter, you know, government policy. Steps up into the breach, the institution stabilized. So I think there is a message here that we are watching this unfold, but the end is not determine. Sea walls hold or they crack, right? And we just, frankly, none of us know as we're watching

this. The bank stepped up. Russia's annexation universally condemned, of course, by the Secretary General of the United Nations, but the Chinese, the Indians, the Czechs, by the way, who were in the street this week, you know, by their thousands complaining about the high energy costs, the government sympathetic to that, but boy, when the annexation comes out, back comes memories of the Sudatenland from 1938. They're alive and well again, unequivocal condemnation of Russia. So Russia is now more isolated than it's been literally at any time in its history, frankly. Well, and we haven't even talked about Italy and Georgia Maloney. I mean, it's just, it seems like, as you say, one thing after another, one kind of geopolitical, uh, cold front at,

at minimum, sometimes seemingly a hurricane blowing through, but just to circle back on the, on the bank of being a little bit. Because to me, that was an interesting moment this weekend. You can say they stepped up, Janice. And it's true in some ways they have to, uh, central banks have a mandate to ensure the, uh, functioning of markets and in long duration of government debt was, you know, yields were surging. Yeah.

And they were surging because there were no buyers. And why were there no buyers was because the government had announced these massive tax cuts that were unfunded. They were, in a sense, going to be funded through more borrowing. The United Kingdom already heavily indebted. And in a sense, you have a government that is facing high rates of inflation, eating away at the returns of bondholders, because they're going to get paid back in pounds that are worth less in the future than they are today. and then the threat in a sense of a currency that's losing its value. So what happens?

The market demands a higher yield. It wants to be paid more to take on the risk, the duration risks of currency and inflation to hold British debt. Instead of allowing, and I agree, maybe in this case it really was a crisis, instead of allowing the market signal to price debt at what the market wanted, thereby arguably forcing the trust government to reverse these policies, instead what happens. is the same muscle memory of the last 15 years, the central bank steps in. And in this case, bails out what sounds like, according to reports, pension funds that

were engaged in highly risky, highly leveraged strategies because they'd spent the last decade and a half searching for yield. And in order to get yield, a higher return in a low interest rate environment, they went up the risk ladder into derivatives and credit default swathes. and credit default swaps and other complex financial engineering, the result was some of them risked insolvency. Others didn't. Others were able to make their margin calls.

But at the end of the day, what do we have here, Janice? We have a bank that has, in a sense, reaffirmed moral hazard. So, hey, take whatever risk you want because the end of the day, we'll bail you out. And then a bank, in a sense, that is doing something that is stimulative. So they are reducing long-term borrowing costs, which lead to a stimulation, a monetary stimulation of the economy and borrowing at a moment when inflation is high and they need to be raising rates on the short end, on the overnight rate. So they're literally, what's that nose cutting? What's that expression cutting off? Their nose to spite their face.

So look, I look at this. I don't really see some great institutional success, some, you know, it is. It's a kind of, you're getting to the point of the least best option. The best best option is gone. And we're now seeing institutions struggle to find a scenario where they don't end up being forced into the least best option. Yeah. You know, the version of the story of the Bank of England that you told is a really compelling one, Rudyard. And when I watch the bank make that move, I thought, I must say my jaw dropped, right?

My jaw dropped up because you are right that this reaffirms too big to fail. We saw it in the United States. We're big institutions. After the first big failure, too big to fail. And what does that really mean? You privatize the upside and you socialize the downside. And that is not a good foundation. frankly, for financial stability over the long term. But I watched that story from a slightly different, I was just, you know, banks, central banks have independent mandates. And they, as you say, their mandate is, they have a mandate to control inflation in many cases,

but it's fundamentally to assure the orderly working of markets, right? And here this prime minister comes out and passes, announces, a stimulant, but that was a stimulatory financial statement. That's what she did. Or he did. You know, they cut the house. It's inflationary. It's inflationary. A moment when the UK is facing 10% double digit inflation, they come out and do a trickle down reganomic style mini budget that causes, in a sense, what we just talked about it rationally, the bond market says, okay, the IMF is saying you may need a bailout. So why am I going to accept 3% yield on 10-year money? I want 6% because there's real risks here. Exactly. But what does the bank do then? You know, independently, you know,

there must have been conversations that went on, but independently, it takes the action that it does, which as you point out is also stimulative, right? It's also inflationary. So it gets that government pulls them back from the edge of the cliff. You can say that. So that's why

I said, well, the institution held. Because I actually think what the bank did is astounding.

And Liz trust today Friday, the 30th of September, is out reaffirming and defending

her every intention to continue with these unfunded tax cuts, you know, finance through more deficit

spending. So again, the market check wasn't allowed to happen. And that's why I think we all have to be eyes on Jay Powell and the U.S. Federal Reserve because up to this point, really since his Jackson Hole speech in August, Powell has been resolute in his communication around the fight against inflation. And in some ways, that's why we're seeing, I think, this incredibly strong U.S. dollar because at this moment, the United States and the U.S. Federal Central Bank,

looks like the only adult in the room. It's the last remaining major central bank, which so far hasn't blinked, hasn't pivoted, hasn't pervaricated in its fighting against inflation. That could come. I don't under, I don't rule out at the moment, you know, when the S&P falls below some certain magical benchmark and suddenly it's much more about bond yields, as you know, because those those yields get passed down to mortgages and to people who are renewing mortgages. And that's when the real political pressure comes to both the bank and on the government. The pace of hikes are the fastest ever, but we're only approaching yields on short and longer duration debt, which approximate the pre-great financial crisis era. And they're at the bottom

range of that pre-GFC era. And that's what people need to understand is that in an era of inflation, rates are normalizing because bondholders are demanding additional yield to counteract or internalize the risk of inflation on their returns. But I look at the Bank of Japan. I look at the bank in Europe. Again, European inflation numbers out today, double digit. Yeah. Astonishing. Their overnight lending rate is a little over 1%. So deeply negative, real yields. I just hope that the Bank of Canada, North America right now seems like this oasis of rationality in the fight against inflation because the rest of the world seems to be already capitulating, already trying to have its cake and eat it too. And as we know from

the 1970s, Janice, you were there. You had a front row seat to what was your mortgage? What was your mortgage? 18%. Okay. If you don't deal with it. with inflation now, you are just going to have a more destructive, more damaging fight against inflation in the future. It's not going away. So let me add, let me add that overlay here, Redyard, of the big geo-strategic forces that are driving inflation. So this is not just governments poorly managing and banks that can't hold the line. There are long, and so it becomes even more important, right, that we think this through in the moment and not hope for better times.

Hoping is not a strategy. I can't remember which political leader said that, but I thought, oh, boy, is that right? There are long-term underlying drivers now, chief among them, an aging population, virtually all over the world, except for Africa, and some small parts of the Middle East, which are driving labor shortages, which have two effects. One, as the workforce gets smaller because they're just fewer young people coming into the market, demand is depressed. But at the upper end, the price of labor goes up, which is in itself a great thing after three decades of inequality, but is inflationary. So governments and banks are already pushing against structural

forces that are inflationary and inflation will be with us for a decade. It's a question of managing it without the most, and I'm going to say it explicitly, not only economically destabilizing, but politically destabilizing fallout, because that's what we're seeing in Italy, in Germany, in the Czech Republic. And frankly, you know, to some degree, wherever populist movements are strong, that's a part of the bigger story here. Being, you know, let me just say this, being a governor of a central bank right now,

don't apply for that job, Roger. Don't, and if you're offered it, don't take it. But on the other side, what a great time to go to Britain. With a pound, inconceivable. You know, again, think back two decades, $2.40. When I was a university there, $2.60. And it's now like half that.

Yeah, parody. It's frankly a parity. Unbelievable, the euro. Yeah. You know, came out of the gate below the dollar, but soared now a parody. And there's an upside to the U.S. dollar murders, but boys, there are a downside.

Yeah. I know, and that's an important, maybe a point we wrap this segment on because it's a good kind of data point to leave our listeners with, you know, watch currencies because currency markets in some ways are the last, unmanipulated markets in the world.

Yes, central banks can intervene, but it's usually temporary and it's not very effective. So when you're seeing currencies falling, it is in a sense a, it's the market working out just what in a sense the risk is of any one geography in the world, what their policy failure is adding up to at any one moment vis-a-vis their other pure nations. So right now, I think the verdict is that the United States is committed. to the fight against inflation. It's committed to ensuring that the U.S. dollar is a store of value. And other currencies and other central banks, frankly, don't seem as committed to that fight. And it's being reflected directly in a plunging pound, a plunging yen, and a plunging euro.

Well, let's take a quick break, Janice. When we come back on the other side, let's stick into Robert DeCaplin's talk that you and I both attended this week. And just touch on a couple of the big geopolitical issues that Robert, brought to our attention and maybe more particularly how he chose to analyze them and the risks involved. And again, we have that entire interview with Robert D. Kaplan as an additional bonus episode in your podcast feed right now for Friday Focus. So back after this short break. You've been listening to a sample of the regular Friday Focus podcast of the Monk Debates. To access the full-length editions of each episode, simply go to our website, Triple W, The Month.

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