The Munk Debates Podcast - Munk Members-Only Pod: Season 2, Episode 26

Episode Date: June 17, 2022

This program provides listeners with a focused, half-hour masterclass on the big issues, events and trends driving 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 Munk Members podcast explores a wild week in financial markets brought on by central banks around the world aggressively raising interest rates to fight surging inflation. Are witnessing more than just a regular market sell off? The last decade and a half saw the normalization of new monetary policy tools by central banks such as ultra low interest rates and fueled record levels of indebtedness on the part of governments, consumers and corporations. The recent surge in inflation and the response by central banks to rapidly raise interest rates looks set to upend this status quo ante with big consequences for the economy, growth and economic inequality. Janice and Rudyard discuss what could come next and the important lessons that policy makers should take away from the economic turmoil effecting everything from equity and bond markets to currencies, housing and crypto. To access the full-length episode, consider becoming a Munk Member. Membership is free. Simply log on to www.munkdebates.com/membership to register. Under your membership profile page, you will find a link to listen to the full-length editions of the Munk Members Podcast. If you like what the Munk Debates is all about, consider becoming a Supporting Member. For as little as $9.99 monthly, you receive unlimited access to our 10+ year library of great debates in HD video, a free Munk Debates book, monthly newsletter, ticketing privileges at our live and online events and a charitable tax receipt (for Canadian residents). To explore your Munk Membership options, visit www.munkdebates.com/membership. 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.

Hi, Monk Podcast listeners. The following is a sample of the Monk members-only podcast. To access the full-length edition of this episode and all of our regular Monk members-only podcasts, go to our website, www.W.Munk Debates.com and register for membership. Membership is free, and it's available for you right now at www.munkdebates.com. Hope you enjoy the program. Hello, Monk members. Rudyard Griffiths here, your host and moderator. Welcome to this. our regular Monk members-only podcast. This is the program where we dig into the big issues and

ideas and the news, hopefully leaving you with some new analysis and insights. We do this each and every week with Janice Gross Stein, the founding director of the Monk School of Global Affairs, an internationally renowned scholar and author. Janice, great to be in dialogue with you on this Friday. What is it today? It is the 17th of June. Great to be with you, Richard. after a brutal week in the markets that you predicted months ago, you put on the table in these monk podcasts, how worried you were about a recession and about inflation when nobody else was really talking about it.

Well, I wish I could claim some persipacity, Janice. But honestly, it's following, you know, people like Larry Summers, Muhammad, Lerian, there were others out there, you know, that had a contrarian view, but who I believe had a well-reasoned argument. It's just too bad I didn't short. The NASDAQ or Kathy Orks, Kathy Woods Arc Fund. I did not do that.

So next time you've got to cajole me into putting up some hard, cold cash on my predictions. I'm a bit of a coward now when it comes to that. But Janice, that's where I want to start this week, which is this. significant sell-off in U.S. markets less so in the TS.X. We can talk a little bit maybe about why that's happening. But U.S. markets, the S&P 500, the biggest and since exchange, is down now into bare market territory, correcting over 20 percent. Nasdaq, the tech kind of market in the U.S. that had those incredible highs last year, firmly in bare.

market territory down almost 30% the Dow following. Two, you have a sense, Janus, that two things are interesting here. One, obviously, the scale of the correction. I mean, you're talking about trillions in wealth now that's been wiped out from crypto to stocks to this bizarre scenario, this unfortunate scenario where we're seeing the bond market sell off so that traditionally balanced portfolios that would have had a mix of stocks and bonds are also. not getting any love, any protection from their bond holdings. But it's also the rate of change, isn't it, Janice? Just how fast this is happening this time and the sense of kind of disorientation.

And I feel in the ether out there, you know, I turned on the CBC yesterday in the car. And, you know, it was the second maybe story on the 7 o'clock newscast. And I thought to myself, that's interesting. You know, when the public starts to become conscious of this and journalists, are making editorial decisions to really raise what should be kind of boring market functions to a lead item in the news, you know you're in different territory. Absolutely. I think you put your figure on it, Rudyard.

It's the pace of the drop. Now, it reminds people of the 2000, 7, 8, 9, volatile period where it was the pace that was so stunning. There's nothing gradual anymore about anything in our world. This is a speeded up world, and that's what we're seeing in the markets, too, that it is moving at such a fast pace that the kind of adjustment decisions that both policymakers, so are governors of central banks all around the world, not only the Canadian one, they're having trouble keeping up with the pace.

They move too slowly in, they're out of sync with the racing markets in a way they were not before. Also really tough on individuals who believe that they have some control and can make decisions in fast moving markets. They probably couldn't anyway, but these last few weeks have really driven that home for me. And you just think, you know, this is going to be a tumultuous summer because, you know, you've got inflation prints in Canada above 6%, the United States, above 8%. And just to remind people, central banks targeting 2% inflation.

So there is a huge gap here between where, stated policy is and the reality of inflation, which has, as we saw in the latest CPI print the United States, and here in Canada, too, it's broadening, Janice. We're seeing inflation creep out of these transitory elements like, you know, energy prices, food prices. It's getting into wages. We have a major rail strike underway in the UK. You have construction workers that have walked off sites throughout the GTA in Toronto. You're starting to see these wage demands now, rightly so, because if you're a worker, you know, yeah, I guess through your pension, maybe your union, you're somewhat invested in markets, but you certainly haven't benefited in the same way that

the 1% have over the last decade in terms of the massive run up in asset prices. So it's very legitimate. I think you show up at the pump, you show up at the grocery store, you're feeling inflation's pressure. The only way to solve for that is wages. And I don't know, Janice, I don't like to make, you know, bold predictions, but I worry here about maybe some complacency that people have, that this is going to be, they don't like to use that word anymore, transitory, but that this can all resolve itself in the coming quarters, that by, you know, this fall heading into 2023, inflation will come down, the economy will have this, quote, soft landing. I don't know. I have a feeling that this is, getting more entrenched and the fight is getting harder for the very reason you said that central banks were so late to act. They were still stimulating right up until this spring when they should have been conscious of the inflation threat, raising rates, taking stimulus away from the economy, and boy, are we paying the price now. I think you're absolutely right.

So let's talk just for a moment about central banks and how blunt their instrument is. And that's really the problem here. Central banks raise rates on a schedule. They can push it up to monthly rates, which would signal, frankly, dread inside the central banks if they did that. But they raise rates on predictable schedules. and really to send market signals. That's really what they're doing. Forward guidance, in a sense, of what they think is coming.

It is naive to the extreme, I think, right? For people to believe that a blunt instrument like that can engineer a soft landing. It's not, if they get really lucky, that can happen. But that's what we're relying on is luck, because the policy instruments we have can't keep up in a sense with what makes this to me, and it's never different. That's what our economist's friend, Ken Rogoff, got so right. It's never different.

But we are seeing a convergence here, which is what is going to make this so hard. There are these repeated supply shocks that are still continuing to come at us in big ways. At the same time as people are suffering, they're going to the grocery store, food is astronomical. I went to buy cherries in June, which is one of my favorite fruits, $16 for half a bag. $16. I stood back. I look at this and said, no, I'm going to walk right on buy those. But then you want higher wages.

And that's when the expectations get baked in and they are so hard to reverse. So I think we're close to that territory where people are starting to say, raise my salary. No, you can see that in the data. The inflation expectations are getting unanchored. I think that's why we saw the big 75 basis. I could move it out of the U.S. We're going to see that in Canada. My little inflation sticker shock story was in the gas station yesterday.

Windshield wiper fluid $8. I thought to myself, how can I mix my own windshield wiper fluid? I'm sure Google and YouTube has a video for this because I'm not paying $8 bucks to squirt, you know, something on my windshields for the next couple weeks. Two, a question for you. And then I've got a final comment to wrap up this section. And the question of you, Janice, is, are we looking at another elite failure here? You know, Larry Summers was out with some controversial analysis saying in effect that the

January Sixers, the people that are part of this conspiracy that the U.S. election was stolen, in some ways are contributing to inflation. His argument was that, in a sense, the distrusting government, the extent to which broad swaths of the American public no longer believe what they hear from government has created uncertainty about Ford guidance, about what central banks say, hey, talk about the elite. they're the ultimate elite of the elite. Is there a challenge in all this, Janice, about not simply the effects of inflation on popular opinion and anger towards government institutions, but just the

extent to which all this is now happening, all this fight against inflation is happening in a very different and uncertain political environment. I worry about the feedback loops here between inflation, central banks, populism, Donald Trump, the war in Ukraine, the uncertainty in Asia, that's really, I think, what is making this so dangerous. Most of the structural pillars that put some shape in managing risk, inflation risk, recession risk, are bending under the weight of these geostrategic shocks that we're seeing, Reddard. And that, and these are, as you put it rightly, these are all interconnected. They're feedback loops.

And that's what makes this so hard. You've talked about asset bubbles. And what we're seeing across a wide swat, whether it's stock markets, whether it's crypto markets, the real estate markets in Canada, which is a particular concern because there's such a big part of our economy. Energy is being affected by shocks. You look across the economy and either you're reeling from supply shocks or you're reeling because asset bubbles are being pricked or you're reeling because you're building in expectations that are in a feedback loop that they themselves are inflationary. This is a really tough one.

to manage. Now, just to say, I disagree with Larry Summers that the January 6ers are at fault here. Let's take this a little bit backward. How did we get to the point where people distrust government to the extent that they do? That's the more important question. Well, and the Fed certainly isn't helping being so late to the inflation fight. I always try to think of, you know, what's the silver lining here. And I think there is one. It could result in some pain, but what comes out the other side could be positive. As you said earlier in this, our conversation today, Janice is so right. We are exiting a period here. And I really think people have to understand what's going on now. It's not simply a blip between, let's say, 2020 and the start of COVID and now and a bunch of

actions that central banks and governments took that are now having their opposite and equal reaction, a kind of Newtonian universe. This is much bigger. I think it goes back to the great financial crisis. I think it goes back to a whole strategy that emerged after the GFC about how to run our economy. And that strategy, initially out of the great financial crisis, was one of necessity. It was ultra-low rates. It was central banks expanding their balance sheets to buy assets to suppress the cost of mortgages, corporate debt, you name it. They did it all again during COVID. And what that's done, Jen, is it's destroyed the price signal in our economy.

It's not destroyed. It's a bit over the top. It has degraded the price signal in our economies so that there's been an incredible amount of malinvestment. When money is basically free and volatility in markets is suppressed by central banks because they're endlessly bathing the market in liquidity through programs like quantitative easing, you end up with crypto. You end up with meme stocks.

You end up with nonprofit, you know, tech companies like Zoom or Peloton or Rivian, the truck maker, that's never built a truck and doesn't have a factory, but, you know, has valuations and the multiple, multiple billions of dollars. All of this Janus created a kind of model of growth fueled by debt that unfortunately, you know, cause this, I think a bit of a crisis of capitalism where it's, it doesn't work if you don't have price signals. If you don't have the ability for investors to make predictions about how, you know, a dollar in company X or a bond Y is. going to lead to a return of a certain amount. If that's always being modulated, controlled, manipulated, you end up with asset bubbles. And I think, Janice, I hope, once we come through the pain of this, that we learn that let's not go back to that. Let's not do what would be really easy

in the face of a recession, which is to say, whoa, let's cut interest rates, let's ramp up our balance sheets again, let's suppress volatility, because I worry we're just going to end up blowing an even bigger bubble three to five to ten years out. You look back from 2005 on, if you look back on 15 years, certainly, Roger, and more. It's been one asset bubble after the other. It's just the bubbles have moved, but there have been bubbles in the economy. So everybody who thought, we've solved the problem. We've smoothed the waves of capitalism. There was that hubris, right?

We don't have these problems anymore. You look at these last 15 years, and you see repeated housing bubbles, not one, but repeated housing. And getting bigger and bigger. And bigger is part of economies. So that wealth is stored. And by the way, they're dropping at the same time as everything else is dropping. non-fungible tokens, astronomical markets for non-fungible tokens.

When you see that, you know you're in a period where market signals don't really mean anything. And it's a tough road ahead, frankly, to begin to tamp down the expectations that you can pump liquidity into an economy, creating bubbles. It's just not possible. It's very interesting, just as an aside for a minute here. One of the things we look at in China's economy is, in fact, one of the areas of growth, because China's productivity has really dropped, stunningly, in fact, over the last few years. One of the reasons it's so difficult to know, Richard, it inefficiently allocates capital.

huge amounts of government spending going to really critical things. But it's so inefficient along the way because it doesn't get any feedback in a timely way. And that comes at a very large premium. And Janice, I would come back to you and say, well, guess why our productivity has been so low? Well, you know, if you are as in Canada, you've taken real estate from, you know, 4 to 5% of GDP up in to the high teens over the last decade and a half. You know, and you've done that through ultra low rates. In case of COVID, the bank of Canada going in and suppressing rates by buying mortgage bonds to make boring costs even lower, you allow regulators like OSFI to allow the banks to

aggressively promote, you know, people taking equity out of their homes. What do you end up with, you end up with an economy that's over indexed to real estate? Real estate is not, a particularly productive place for an economy to devote its capital. I mean, it does produce short-term returns or employment. I get all that. But you are not innovating in ways that create new technology, new systems of knowledge, new deployment of your human capital when you're erecting skyscrapers and condo buildings. These are actually very conventional, well-understood processes.

that are just borrowing and copying the designs and innovation of, of frankly, previous generations. I mean, a lot of the skyscraper technology goes back almost 100 years. Canada needs to move away again from an economy that is over indexed to the unproductive in terms of the generation of productive capacity in its economy, like real estate to harder stuff like figuring out how to create, I don't know, new food processing systems, new approaches to, you know, energy, hydrocarbon energy utilization.

Tech, you know, the things that are really going to create a growing economy, we've ignored them for the last decade and a half because it's just been so easy to frankly be wealthier than in the past by borrowing more money, by participating these bubbles, and by having all of that feel as if we were making some really fundamental process as an economy as a nation. It's a chimera, Janus, and it's falling to pieces before our eyes. You've been listening to a sample of the Monk Members Only podcast. To access the rest of the episode, consider becoming a member. Membership is free and available at www.w monkdebates.com.

Once you've joined as a member, go to your membership, profile to access the rest of this episode and all of our monk members podcast. Thanks for listening.