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Welcome back to another episode of Forward Guidance. And joining me today is Warren Mosler, who is the renowned economist and originator, pioneer, and the father of modern monetary theory. Warren, we had you on the show about a year ago.
during that time was when we saw, you know, higher interest rates than we're at right now in terms of Fed funds. And during that time, there's a lot of discussion of, okay, you know, the Fed has increased rates significantly, one of the fastest basis that we've seen. And there was concern about recession and these ideas.
And you're on the opposite side of a lot of those mainstream discussions and had the view that effectively the opposite was occurring and that it was actually somewhat stimulative. Excited to get you on the show. I want to open it up.
to you and just hear about how you think about the context of things these days. We've had about 75 bps of interest rate cuts so far and looks like another 25 coming up soon. And just wanted to get an overall perspective on how you think about things today. You know, a year ago, the forecasts were for probably recession.
I don't even remember, but certainly weakness, rising unemployment, that type of thing. Figuring that the monetary policy worked with this long and variable lag or whatever, and it just hasn't happened. And we went into why It hadn't happened and why it wasn't going to happen and why you could just say the Fed had it backwards along with the rest of the financial community. And that is the fiscal impact of the higher interest rates was dominating anything that might be happening on the monetary side. The budget deficit was up to six or so percent of GDP, and that's continued to be the case.
And a large component of that was the interest expense, maybe more than half, 60%. We're now running at an annual rate of maybe $1.2 trillion in interest expense, and that's going to keep going up. Even though there have been rate cuts, the interest expense, the increases in expense are a little bit gradual because treasury securities take a while to mature and the interest rate's still higher than most of the maturities that are maturing and getting refinanced at maybe a little bit lower rate than they might have, but still higher than what's maturing.
So we... The interest expense continues to climb. And of course, the size of the deficit is larger. So there's more interest paid on that. And the Fed still has a substantial amount of excess reserves.
That component of the public debt pays at the current rate, interest rate. OK, so I brought us up to date. On a looking forward now, on a forward look here at what's going on, it's more the same.
As the average yield on the Treasury's outstanding continues to creep up, it's now close to 3.5%. Even though Fed funds are over 4% now, just like I said, it takes a while for that to go up. And it'll continue to go up until it gets to the funds rate. Now, if the Fed funds rate roughly gets down to the 3.5% or whatever, then it'll be kind of neutral. We'll stay where we are and the size of the public debt won't.
be accelerating or growing relative to GDP. It'll be more constant. Okay.
But we've also got a lot of other government programs that are involved in public debt. We've got all the other expenditures that government has, and there's no sign of any of them slowing yet. There's a lot of talk about it next year with the new administration. But so far, if anything, we see people who are there now want to make sure they get their money before it's taken away type of an attitude.
And so it looks to me like things are going to continue strong until there's, you know, it's like you don't shoot until you see the whites of their eyes. You know, we'll see what. You know, wait for something to actually change.
Again, we can't reliably say what will happen in the next administration. We can say what they've wanted to do, but it's still, at least as of now, has to get through Congress. And, you know, we have to see what comes out. OK, yeah. I want to double click on a concept there that you brought up in terms of the weighted average maturity of Treasury debt.
And you had said that, you know, it's the long term weighted average maturity is about, you know, it's about 3.5 percent versus. the Fed funds is at 4.5%. For those that aren't aware of how you look at the economy and markets and policy overall, is that how you derive what the neutral rate or inflation should be? It's based on that? What you said is interesting, the neutral rate.
So what is that? So right now, the Fed will say that's the rate at which some spread above the inflation rate, the CPI, maybe 1%, maybe 2%, maybe a little more. And at that rate, it's neither expansionary nor contractionary.
So if the rate's too low, it's expansionary, and that's pushing the economy, making the economy stronger. If the rate's too high, it's restrictive. And the Fed has at least stated at the last few meetings that they feel that the interest rate that they've set has been restrictive, and they want to reduce it back to some neutral level. So where do they get the idea that there is a neutral level, that the policy rate is restrictive or not restrictive based on a spread to inflation. Where does that whole thing even come from?
What are the foundations, the theoretical foundations for it? And as it turns out, there aren't any. It's an anachronism.
All the foundations for that, the theoretical foundations, which were excellent, came from the gold standard, which applies to the gold standard and other fixed exchange rates, where there is, in fact, a neutral rate. And that's the rate at which the government doesn't gain or lose gold reserves. The reserves are stable. So if you set the rate too low, you're going to have reserves flowing out.
And if you set the rate too high, reserves will be flowing in. And it's based on all kinds of mathematical constructs and everything else. The important thing to understand is that when you're on a gold standard, the money the government spends.
can be converted into gold if the recipient of the money wants to. He has that option to convert it into gold. And so if they engage in deficit spending like we are today and flooding the market with almost $2 trillion a year of deficit spending, and those people can all convert it into gold, there's a risk that the Treasury runs out or the Federal Reserve, the government runs out of gold and can't maintain the gold standard, can't maintain convertibility. So what they do is they offer Treasury securities. Because if I take my convertible money, And instead, I buy a five-year treasury security.
I can't convert it to gold for five years. I have to wait for it to mature. So I deferring my option. So the treasury is competing with the option to convert. The treasury is competing for my convertible currency, and they're competing with my option to convert it into gold.
And there is an interest rate where the market clears. And that might be 3%, 4%, 5%. And at that rate, I take my money and I buy treasury securities.
Because I'd rather have the securities than the gold based on that interest rate. And that's not a rate determined by the Fed or the FOMC or meetings or anything else. That's purely market determined. And it's the entire term structure of rates. It's not just a short-term rate.
Because there is a term structure of rates where people with the ability to convert are saying, no, I'd rather have treasury securities rather than the gold. Okay. And out of that comes the concept of a neutral rate.
And if the treasury, again, tries to set a higher or lower rate, it's going to have consequences on the gold supply, on the economy, on inflation. Now, they also defined inflation differently than we do today with a fixed exchange rate, with a gold standard. It's defined as the price of everything relative to the price of gold.
And- simply by doubling the gold supply, for example. Let's say... A lot of gold mines, gold was discovered in San Francisco and suddenly the treasury is buying all this gold and paying for it with convertible currency and they have the gold to back it, but there's still twice as much of that currency out there.
And so relative value shifts, prices go up to adjust for the new level of gold. That's a one-time adjustment. And they would say that the value of gold has fallen relative to everything else.
It now takes twice as much gold to buy the same amount of stuff because the gold supply doubled. So the gold supply itself is their measurement of inflation and the price level. If a Spanish galleon sinks and all that gold is lost, it becomes a big deflationary event. Gold's a lot more valuable.
And so the money's more valuable. Prices are lower. Express is more valuable. So, OK, now today we're not on the gold standard. Officially, we went off at 1971. internationally, totally, but we've been off it functionally since really 1933 when during the depression, we went off the gold standard to try and get out of it.
But anyway, either way, we're off the gold standard. And so the money is not convertible into gold anymore. You can't take your dollars to go to the Fed and say, hey, there's a fixed price of $35 per ounce. I want my gold or any price. They'll just tell you, go out and buy it from somebody else.
We're not involved in this anymore. And so The treasury securities are not competing with my option to convert because there isn't one. And so there isn't any. The whole idea that there's some neutral rate where the gold supply is stable just doesn't apply. It's not applicable.
So all that math, all that arithmetic that's applicable to a gold standard is not applicable to floating exchange rates, flexible exchange rate policy, which we have now. And to come up with a theory that where you arrive at something. called a neutral rate.
Nobody's done that. All they've said is, if you ask them what the neutral rate is, they give you the definition. It's the rate at which it's neither expansionary nor contractionary. But there is no calculation to determine what that rate is. And they'll tell you, we don't know what it is.
So we just try different rates until we think we found it. Well, there's nothing to find there. It doesn't have any basis in theory or fact with floating exchange rates.
They've changed the channel on the television set and they're using... information from the previous channel to guide themselves through the next show that they're watching. And there's just no connection.
And it's kind of like, I don't know, astounding that you'd have a Federal Reserve and hundreds of PhDs and they had central banks all over the world all doing this and not having even asked the question of like, how did we get here to this place? And they have this enormous confirmation bias. do these regression analysis, they call them, which they say, okay, over the last 20 years, as rates have changed, how much has inflation changed?
How much has the economy changed? Can we detect where a neutral rate might be? And they can't.
They keep looking for it. They have probabilities and they're slim because they've got the wrong map for the city they're living in. Okay.
And it doesn't quite fit, you know, there's buildings and gas stations, but this is not overlapping. And there's about a, maybe some of it overlaps. And so right now we're in the midst of policymakers doing this. And I did a cartoon on this back in 1996 where I had a car driving over a cliff, and the guy behind the steering wheel was labeled Congress, and his steering wheel is fiscal policy, raising taxes, cutting spending, increasing spending.
Those have real effects. Then there was a kid in the car seat, which at the time was a Fed chairman, with his toy steering wheel. And he's playing with the steering wheel. He's got his hands on the wheel, and the car's going over the cliff, and everybody's... It was Alan Greenspan at the time.
He was a Fed chairman. And everybody's going, nice driving, Alan. You just took the car over the cliff. You made the wrong decision on monetary policy.
Well, that steering wheel is not connected to the economy. Now, at the time, there wasn't a lot of data to back me up. But 30 years later, the data's more than 100% backed me up. And in the last three years in particular, it's... entirely backed it up.
There's no other explanation, of course. Yeah. I'm interested to hear a bit about over the past three years and using a case study of what the Fed has done over the last four years. So if we think about it, obviously, the Fed has brought the Fed funds from zero to over five.
And during that time, we have seen inflation come down. So I want to ask you, is that more so just a spurious correlation and they got lucky and there was other causal factors? Because at the same time, we've seen nominal GDP.
quite a bit above most people's forecasts during the same time. So is it just a spurious correlation and that's it? No. So a couple of things happened. They voted to raise rates, and they did.
They started raising rates. And at the same time, the Ukraine war hit. And the Saudis decided to allow the price of oil to go up for a while. And it got up to $120 in July of 22. And if you look, that retraced the path of oil prices. It's identical to the prices going up around the world globally at the same time.
The whole inflation thing was a global thing that happened. And at the same time, you had all the supply side things people talked about. You had excess demand from all the stimulus checks, all the large deficit spending, which the Fed attributed about, I think, a half a percent or something like that of increase each year annual in CPI, which is something, you know.
So there was excess demand, but it was largely the oil prices. And then after President Biden made some kind of deal with Saudi Arabia, he went over there and talked to the prince and immediately agreed not to. prosecute them for the murder of the journalist and replace their Russian weapons with US weapons, and they came up with something. And all of a sudden, the price of oil starts going down again. It came back to about where it was before, which is what the inflation rate did.
So there was this bulge, and then it came down as supplies side issues eased. It came down. And the pattern's identical for every country in the world, regardless of monetary policy, including Japan, where they left interest rates at zero the entire time. Now, Just anecdotally, Japan's inflation only got up maybe half as high as ours did. They had zero rates the whole time.
They didn't do anything. And others were somewhere in between. And so you can look and see how they did it and kind of figure out, take a guess at how much of whatever they did had, you know, how much interest rates contributed. It comes out, it's very hard to find that any of this is a function of interest rates. Okay, but it did happen at the same time.
It was coincidental. And, you know, I'm, you know. That's true.
So what do the interest rates do? So let's look at what our inflation indicators have done. And I'll call them inflation indicators because that's all they are really.
They're not actually inflation. Inflation is the change in the general price level. We can't even measure that.
We just have CPI, which is an abstract index designed for political purpose, whether people are hurting or not and things like that. It's a cost of living. It's not an inflation. But anyway, so...
It went up high, I don't know, 9% or something like that. Then when things collapsed, it came back down over a shot or not really, just came back down and then leveled off. And our core CPI has leveled off at something just shy of 3.5% since July. And it's gone not only sideways, it's been going higher.
And I'll say it's been approaching the Fed funds rate. And that... plateau it's been for the last four or five months is higher than it was before the whole COVID thing, before the oil price spike, where it was maybe around 2%. And you heard up to mid-year that inflation is coming down towards our target.
And so we're going to be cutting rates as it does it because we think rates are restrictive and we don't want to overshoot because rates are too high and cause a depression because we left rates too high and they're relying. entirely on their model of this neutral rate model. But the inflation indicators have not continued to come down.
Now, the internals that some of them have, they'll say, oh, the housing last month is only 4% or 3.8. It's down from 5.8. That's fine. And services have been higher and goods came down.
And now services have come down, but goods are back up. You know, when you've got a general price level increase going, it's If it's not one thing, it's another, right? And so you can go to any number any month and point to one that went up or one that didn't or owner equivalent rents or something like that.
But we used to include mortgage payments as part of the consumer price index, and we don't even count those anymore. We substituted this owner equivalent rent. And what they're not saying is if we hadn't done that, the spike in mortgage rates would have shown up as a huge increase in CPI. It's actually quite interesting. I'm Canadian, so up here we do have that in the index here.
So. So they've been lowering rates and we've been seeing because of mortgage costs coming down, inflation has been coming down. Right, right, right.
And now I see tobacco as part of it. Tobacco has gone up by 7%, so maybe they shouldn't include tobacco or whatever. And I always said, look, I'll give you any inflation rate you want. If you make me Fed chairman, well, how are you going to do that? I'll just change the tobacco tax.
If I add to the tobacco tax, we'll have more inflation. If I eliminate it, we'll have less. If we pay people to smoke, inflation will go way down. So it's all.
You've got to decide what you're going to do, what your tools are, why you're doing it, and use the indicators you have and make sense of them. And I'm not saying we shouldn't have these indicators, but you have to understand what they mean. and act accordingly.
So, you know, it's not about being critical of the index. I've talked to the people who've done that, made the indexes, and they're very, very good. They're very good at it. I'm not at all critical about what they've done. They've got very good reasons for doing it.
And it's always some further purpose for doing it. And they've always had really, I'd say, Admiral, you know, I support their purposes for the changes they've made. You know, they're constructive. They've always been constructive.
So if you just overlay the price of oil against the changes in CPI, it's pretty close, except oil has come back down to where it was. CPI hasn't come all the way back. And underneath it, we have it gravitating up towards the Fed funds rate, being supported by this deficit spending for interest, being supported by forward prices that are a function of interest rates, right?
And so I think it'll continue to gravitate towards the Fed funds rate. If the Fed funds rate comes down. to three and a half, then that'll no longer be a upward bias on the inflation rate, but it won't be pushing it. It's not going to be pushing it higher. They think the rate cuts are pushing it higher.
I think the rate cuts are lowering the ceiling. So we had maybe a 5%, 5.5% Fed funds rate if they had left the rate there, you know, and not voted to lower it. And so the inflation indicators, I was saying, were drifting up towards five and a half. So now they're drifting up towards four and a quarter were the latest. So if we if we extrapolate that assumption that, you know, if we if we lowered, you know, Fed funds, it'll lower the ceiling of inflation.
Would you surmise that they are actually taking control of inflation right now by cutting? Or is it more so the power of the fiscal impulse that has just been? Do you mean deliberately? Do you mean deliberately?
Or do you mean it's what's. I think I think it's more just it's happening. I don't know if I'd call it deliberate. Yeah, I wouldn't. I wouldn't call it at all deliberate unless.
No, no. Yeah. Okay. I think they've still got it backwards if you take them at their word.
And not that maybe, look, maybe they've seen my interviews and they've decided they're going to have to lower rates, but they don't want to talk about it. So they're given a cover story, but they're going to go to zero because that would be the eliminate that source of inflation, which is what I would do. Eliminate 1.2 trillion a year, ultimately of government deficit spending, which is much larger than the doggy commission is supposed to be cutting.
And it's the low hanging fruit. And. You know, it's much stronger fiscal consolidation than any of this cutting soup kitchens or whatever they're talking about doing, extending the Social Security retirement.
That's all whatever it is. But here's some big fat $1.2 trillion per year. The CBO would score it probably as a $20 trillion reduction over 20 years of deficit spending. Okay, but I don't think they're going, they're not saying that that's what they're going for.
But it seems to be like that's what could actually occur. Yeah, and that could happen. And that could happen.
And I'm hoping that it happens. But, you know, it would be one of those better lucky than good type of things. But yeah, it would be nice if we get there like that.
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On this point about basically... interest expense being stimulative. This is something I've been trying to figure out. I haven't tried to quantify or model it or anything.
But obviously, the traditional side of the equation is when you increase Fed funds, which is SOFRs priced off that, and then floating rate loans are priced off that. So as the interest rates, borrowing costs do increase. But the assumption is that it is offset more than enough by the interest payments that come from from the government towards individuals. In a private sector, those increased costs you talked about get paid to somebody in a private sector. So it's a transfer of income.
The borrowers pay more, savers get more. The lender gets more. OK, now the argument is that the lenders don't spend the money. So all we have is borrowers paying more and money is just turning dead, dying and not getting spent sitting in savings accounts, which could be the case.
So you have to. investigate that. But on top of that, the government is a net payer of interest of $1.2 trillion a year.
And it's interesting. So I think what happened was, maybe until recently, the Fed's models have assumed that interest income doesn't get spent. Because they know one person's getting it and another person's losing it.
So they just say the borrowers are paying more, but the savers are pension funds, foreigners, I don't know, Social Security, somebody, they're not spending it. And when they did that, they got their forecast that said we're going to be going into recession. And so if interest was not getting spent, I would have been wrong. My forecast would have been wrong.
And then we would have gone into recession because that money's not getting spent. It was just being drained out of the active economy. It's dead money, savings. The fact that we've gotten 3% of GDP, real GDP growth, tells me.
Okay, the interest is getting spent. Now, is it getting spent as fast as a $500 stimulus check going to somebody who's out of work? Probably not.
But maybe the propensity to spend is 60%. Maybe it's 40. I don't know what it is, but it's enough to support this. And if I had 200 PhDs working for me, I'd have them do a regression and tell me what percent is getting spent. Because they've got all the numbers in and the numbers out. Okay, but I don't have those people working for me.
But there's some percentage. getting spent. And it's substantial.
And it's enough to support the economy at current levels. Otherwise, we wouldn't be at current levels. Is interest payments money printing?
Because when I think about it, how does that money come in? Well, the deficit spending. All government spending is done.
The Treasury instructs the Federal Reserve to credit an appropriate account at the Fed. Now, when you credit an account, all you're doing is changing a number from a lower number to a higher number. You're not taking somebody's tax money and jamming it into the computer and it comes out the other end or anything. It's just changing a number up.
So in that sense, all spending is printing money. They're not printing it, but they're crediting accounts. So to use the same language, you could say all government spending is printing money. Now, when you tax, you're debiting accounts.
You're reducing the balance in somebody's account when they pay a tax. You're not getting anything. There's nothing that, there's no bag full of money coming out that gets walked over to the treasury. You just. lowering the number of someone's account when they taxes get paid so you could call that unprinting money right yeah that's what i was going to ask is like okay so if tax receipts come in but then it gets redistributed as interest payment well it doesn't get new money it's separate they when taxes come in they don't come in when when your account money if you have an account with five thousand dollars in it you pay three thousand dollar tax either five turns into a two okay nothing went in or out and That three, it just got reduced.
That's unprinting money. That $3,000 was unprinted. Now when they credit somebody's Social Security with $3,000 or they credit interest payment of $3,000, that's printing. So you have to look at the difference.
And the difference is the deficit spending. That makes sense. More crediting accounts than debiting accounts. And they credit the accounts first and then they debit them.
Now, it has the appearance to most people that first they subtract money from your account, and then they can go spend that money with somebody else. Well, it doesn't work that way. You cannot debit an account at the Fed unless there's been a prior credit to that account.
You can't take anything out of a bag until after you put something in, okay? So the Federal Reserve Bank is a bank. All the member banks have accounts there. The only way dollars get in their accounts collectively is if they come from the Fed adding dollar balances to their accounts.
It's called reserve add. They add balances. And that's what treasury spending does. It adds balances.
And then taxes subtracts balances. Buying securities subtracts balances. Well, you have to add them before you can take them out.
Look, nobody thinks the football stadium has to collect the tickets before it spends them. I mean, before it sells them. It has to sell the ticket first before it can collect it.
You can't collect the tickets first and then sell them. The movie theater doesn't collect tickets first and then sell them. They sell the ticket first and then collect them. The source of the tickets has to provide them. to whoever is going to like then use them, right?
The issuer has to provide them to the user so the user can pay them back to the issuer. And so the sequences of events is the spending comes first before the taxes are paid. Now, that spending can only take place if something's offered for sale. If there was never anything for sale, the government couldn't spend. So how do things get offered for sale?
Well, that's where... tax liabilities come in, tax requirements. So the very first step is the government puts a tax requirement. And for this example, let's say it's a retirement requirement on your property, your house. So now you need governments, you need dollars to be able to pay the taxes so you don't lose your house.
The government's the only source of dollars that can pay taxes. They have to spend them first and credit the accounts on their books. Those are the accounts that taxes get paid out of. Once they've spent the money. Those accounts have positive balances.
Now people can spend the money and pay their taxes. That's the sequence of events. So when you understand that sequence, it's much easier.
If you try to understand what was going on in a football game by saying, first the stadium collects the tickets and then they sell them to people, it's going to get hard to understand and confusing. That's why nobody can understand how the government finance works. They have the sequence backwards.
You have the right way around, but you can understand it, you know, three-year-old times. To that end, while we're on this note, it feels like, you know, the broad financial world is obsessed with monetary acronyms, you know, QE, QT, reverse repo, all these acronyms. When you take into consideration the framework you just articulated, setting aside psychological impact, is there any effect on the economy from these inflows, outflows or whatever you want to call them of these monetary acronyms?
You know, so the short answer is no. But to the extent spending is an acronym, yeah. Yeah. When you spend and buy something from somebody, you've established a price.
Okay, if government spends and doesn't, and can buy everything at the same price as it paid last year, then there's no inflation, there's no price level going up. If it looks out and has to pay more, so it pays more, well now it's established prices at a higher level. So prices paid is actually the key factor in the price level and not the quantity it spends.
It can spend as much as it wants as long as it's not enough to drive up prices. And nobody would particularly care about inflation or anything else because there wouldn't be any. When their activity is causing the government to pay ever higher prices, and that's showing up as everybody else's costs as well, then it becomes a political problem, right? And you lose your job and get thrown out of office, which you could, you know, it's not wrong to say that was one of the reasons we had a change of regime here was because of the price increases, right? People.
A lot of people got desperate because there's a lot of distributional issues that go with price increases. On average, everybody did fine except people on top who received interest income. Now, who received all the interest income, by the way?
People who already have money. If you don't have money, you don't get interest. And they got it in proportion to how much they already have. So you're talking about $1.2 trillion, more than all the stimulus checks that went out, were just given out in new money, new printing money, deficit spending. spending more than was being debited for taxes, only to people who had money.
And then you say, well, look, on average, everybody did well. Well, yeah, Rolls Royce sales were through the roof, but sales of the lower end cars were not. And, you know, when food prices go up 30 or 40 percent, the people, the high end people have no problem because they were getting all the income.
And the traditional assumption was that. Those asset owners, their marginal propensity to consume was lower, but we're seeing that it's actually not as low as we thought. They are still spending. Yeah, yeah. And so I had Charles Goodhart, who I got to know from the Bank of England.
I was over there visiting once, and I stayed at one of the hotels, and they have a separate faucet for hot and cold. I don't know if you've ever been to England. So you go to wash your hands, and you turn on the hot and the cold, and I'm like, you know, what do you do? You're going to burn yourself for free.
I said, Charles, what's this all about? He says, oh, well, we're just trying to make the point about what averaging actually means. So that's what we did with this economy, okay? And people are getting burned and, you know, and enough to maybe cost the regime the election. So employment's high, but there were a lot of people not making enough money and struggling to weren't happy, even though they had jobs.
They weren't they were a lot worse off than they were before. And so so it's important. OK, so, yes, it was one of the best economies on average that we ever had. But, you know, the interest rate policy is. obscenely regressive to pay out that much money, 4% of GDP, only to people who already have money, presumably to fight inflation.
What kind of a way to fight inflation is that? To print up 1.2 trillion of new money and credit the accounts of people who already have money. But, you know, the Federal Reserve does that unilaterally because they think they're fighting inflation. The Democrats and the Republicans in Congress, nobody pointed that out and said, like, what are we doing? This is not what our constituency wants.
So this is, yeah, this is the driver of the K-shaped economy that everybody's talking about. Yeah, yeah, yeah. It's certainly a contributing factor.
There are other things in there, but that's a large contributing factor that's just gone unnoticed. Yeah, and there's huge political ramifications, like you said, that are occurring. So how do we reverse that?
Is it just setting rates at zero again? Yes, but of course, right now they're looking at inflation numbers. You know, they thought they would.
going towards their target. Now for four months, they've been going the wrong way. Now some of the internals are going towards their targets. Internals, I mean individual categories, but overall it's not.
And so we've got a meeting coming up next week. They're expected to cut rates again, even though inflation is not coming down. And even though we have a three and a half percent, 3.4% GDP forecast for this quarter, where they had been forecasting something like 2% trend.
So they're wrong again, of course. And I think they're going to be very wrong on unemployment. They thought, I think I read.
The last forecast from November was 4.4. It's not. But it's because this weakness they all thought was going to happen. And of course, even the unemployment number has only gone up because of new people entering the labor force, not because of people losing jobs.
So it's not a sign of weakness as you'd normally have. And you can look at the household survey, which is problematic, which normally gets dismissed, but now it's confirmation bias to people who want to claim that employment's weak or something. We've been hearing this for years.
As opposed to the establishment survey. Yeah. And then the last time around, it got revised off.
Anyway. I know. Yeah, they're quiet when the revisions are higher.
So, you know, obviously the criticism of that approach is that, okay, you know, if we set rates at zero, we're going to blow up an asset bubble, right? That's what people say is the concern of that. What do you say to that?
Japan had zero rates for 30 years and they didn't have an asset bubble. They were still trying to fight deflation. So, yeah, you can have asset bubbles, but they're coming from something else.
We have other institutional structure that does that and you'd have to get more specific as to what's doing it. Europe had zero rates for about 10 years, I think, and even negative rates from the ECB. They didn't have an asset bubble.
And we didn't have an asset bubble after we cut rates to zero either. And those Obama years with zero rates, things languished. We didn't have that kind of thing. And so that's what I said.
They go back and do these regression analysis trying to see, well, what happened with rates at this level, that level, the other level? Maybe we can find a pattern. and set rates at the level that works as if rates were causing any of that. But they're not causing any of that is what I'm saying. They have no theoretical reason to assume rates cause any of that except for what you touched on was a zero propensity to spend interest income.
And we've seen in the last three years that can't possibly be the case or those recession forecasts would have been spot on and we would have been in serious trouble. Right. So once again, getting into this. notion of these coincidental impacts.
If you look at the COVID response over the last few years, people look at 2021 and say, oh, there was an asset bubble because we cut rates to zero and did a whole bunch of QE. But it sounds like your argument would be it's actually because of the fiscal impulse, not the monetary. Yeah. Fiscal impulse combined with the Saudis raising oil prices in the Ukraine war when they were working with Russia to make sure they had enough money to pay for it.
Then Biden outbid them somehow. I don't know what he said. And the prices came down.
Now that he's gone, we'll see what happens next. You know, if we're going to have a policy for more oil drilling, the last time that happened, we had President Trump threatening the Saudis with all kinds of nasty things if they didn't cut production to get the price of oil up because it had dropped during COVID. And it had gotten so low that our oil industry was threatened.
Our shale producers were shutting down. And he wanted to price up to support the American business. They...
went for the deal, whatever was offered them at the time, and supported higher prices and prices went back up. You know, then when COVID hit, they went even higher. So, but I'm saying looking ahead.
The way to get more drilling traditionally of your market type oriented policy makers is to get the price up. You get oil up to 100, you're going to have a lot more drilling and a lot more production. You let the price go down to 40 or 50, everybody's going to be shutting down, right? So unless they've got some other way to do this, right now we don't know what they're going to do.
We don't know what the price is, but if they use price and decide 70 or 80 dollars is what we need for new drilling and the price goes up to 70 or 80 dollars, well it's 70 today actually, goes up another... to $80, we're going to see CPI headline creeping up and then everything gets traced back to oil. And you'll see lots of other things, fertilizer and food and all kinds of things gravitating up towards this new price of oil if that happens.
So right now, I can't say, I can't forecast what's going to happen. You have to give me some of these data points, what's going to happen to the price of oil, which are political decisions. You've got to tell me if the politicians do this, what might happen to them.
I just can't second guess them right now. I don't know what they're going to do. I mean, we don't, we'll have to wait to see if there's ever going to be another election after January, because it's been certainly strongly suggested that there might not be, you know, including telling voters, this is the last time you're going to have to vote. Now, maybe it was just campaign rhetoric, but you just don't know until it happens.
So we'll have to see what happens. Yeah, hopefully it was just campaign talk. Well, speaking of campaign rhetoric, obviously a big one is tariff talk. In your paper of like the seven innocent frauds of economics, one of them had to do with the trade deficits and how there's a misconception about them being a bad thing. You think they're a net benefit.
Trump has fixated quite significantly on this idea of the U.S. trade deficit being a bad thing. I want to get your take on how you're starting to think about that at the moment. Yeah, well, look, it's bipartisan. And he calls us suckers for running a trade deficit because they're getting all our money.
And we're getting their stuff, but they're getting all our money. And so we're losing. Now, what is all our money? They have $1.2 trillion of treasury securities.
What do they get for that? They get a bank statement that says they have treasury securities. And we get the things that we're driving around, the cars and the tennis rackets and everything else, and whatever else we're importing. materials. And so in economics, I like to say it's the opposite of religion.
In economics, it's better to receive than to give. And I like to use the extremes to make the point. And so let's say we export. If exports are so good and the money is so good, let's say we exported everything and got paid for it. And we got credits on central banks all over the world in their currency.
So we had all their money and we exported everything we had. What would happen to us? And the answer is we'd all die because we've exported all our food, all our clothing, all our everything we built. You know, there's nothing left. We all die.
Okay, now let's say we imported everything and didn't export anything. Then what happens? Well, we have everything.
We don't have to work. Okay, so in the first instance, we have to go to work, produce everything, food, clothing, shelter, and export it all. We have nothing and we die.
In the second one, we have everything. We don't even have to work. We just get to use it and play with it.
So clearly exports are... In economic terms, real costs and imports are real benefits. Now, there are strategic considerations, and those are critical considerations. We don't want to import, you know, critical vaccines from people who might cut us off if we need them.
That's just plain stupid. We don't want to import critical products for our military if people are going to go to war with, you know, if we're importing from them because we might need them and then we lose the war. So you have to be strategic.
considerations are critical. They're not just a side thought, a passing thought, incidental thought. These are real. And so, yes, we have to look at what we're importing and maybe we should produce it domestically, not because they're getting our money or anything like that, which are just tax credits really on our central bank's books, but because these have strategic importance and we're putting ourselves at risk by not building it ourselves. And it's going to cost us to do that.
because there's something out there called productivity, right? And the idea that, oh, well, we're losing jobs when we import. Well, we are, but those jobs are getting replaced. Otherwise, the unemployment rate would be at 50-year lows, at or near 50-year lows.
It would be much higher. There was a time where we all had to, like, go out and grow food. Ninety percent of the people were in agriculture or else we'd starve.
We couldn't have this conversation because we'd have to go out to harvest, bringing in a... you know, or be canning food or something. And today, 1% of the population, you know, produces like 8,000 calories a day per capita. So we can do other things like sit around on talk shows, right? And pretend we're intellectuals.
Okay. So, but we couldn't, that's, we can only do this because the productivity is so high. It takes a fairly small amount of the population to take care of all our needs.
We have 7% in manufacturing, jobs, something like that. If we went to 8% or 9%, the rooms we're sitting in would be filled to the ceiling with junk and we couldn't talk either. We'd be... choked out, okay? Because our productivity is so high, we don't, you know, we can do other things.
So you want to make sure you don't undermine your productivity. You always want to keep that as high as possible. And in trade, those are called your real terms of trade, okay?
So, and what we're looking at, and again, I'll give you the easiest way to understand this and the most, this is a model you should always call on when people talk about trade. What is our real wealth as a country? What is it? Okay, it's our pile of stuff. Think of it as pile of stuff, goods and services, but let's call it a pile of stuff for short.
Everything we produce domestically makes our pile of stuff larger. The more people working, our pile of stuff is larger. So if we have 10% unemployment, our pile of stuff is roughly 10% less than it would have been if we had everybody working. Now, they're not all the most productive people. I understand that.
So maybe it's... It would only be 8% larger, but it's going to be a lot larger, a huge amount, 8% of GDP. It's huge with everybody working.
So number one, your pile of stuff is your real wealth. Imports, when you bring something into your country, it makes your pile larger. You have more stuff. You now take whatever you're producing domestically and you add all the cars and tennis rackets and whatever else we're importing to that pile of stuff. Exports.
Make your pile of stuff smaller. You're sending something off your pile to somebody else. What's called your real terms of trade is how much stuff do I have to send to everybody else and how much am I getting back for it?
How much am I making my pile smaller by exports? How much am I making my pile larger by imports? What's my real benefit from that?
That benefit, that differential are your real terms of trade. And you want to optimize that. You want to be able to import the most for a given amount of exports.
And what that comes down to simply is you want to get the highest price possible for your exports, and you want to pay the lowest price for your imports. And so what we had was President Trump, his first time around, decided that Canada wasn't charging us enough for lumber, okay? And so they're bad people.
They're taking advantage of us by not charging us for lumber. Do you want to send this guy out shopping for you? I don't think so, right? And so what are we going to do?
We're going to put tariffs on Canadian lumber. President Biden comes in, they're still not charging us enough. So he increases the tariffs. So I'm not like forcing this apolitical thing. This is apolitical.
There is bipartisan consensus that if Canada doesn't charge us enough for lumber, they're bad people. It's like, no, this is nuts. Well, what are all the people going to do who are cutting down trees? Well, what are all the people do who are growing food, which used to be 80% of us who are 90% who don't need to do that anymore? Well, we're doing.
Medical research, we're doctors, we're nurses, we're teaching school, we're public services, we're public safety, we're public health. You can't have all that and have everybody growing food at the same time. You have to, labor is a scarce resource. There's always more to do than there are people to do it. You've got to free up labor to do the other things or else you don't go anywhere.
How many research assistants would all these medical researchers like to be able to find new cures and new treatments? A lot. What's limiting them? Well, funding, right? But even with funding, you can't have everybody doing medical research.
There are other things in the country that need to be done. Unless you can get non-residents, that's what I call foreigners, they're just people who don't live here, non-residents to do it for us. So with non-residents net sending us a trillion dollars a year of imports on net, we import more than we export.
We don't have to do all that stuff. We can have all these other high quality jobs. Of course, you have to organize yourself to do it. If we just let unemployment go up to 20%, yeah, okay, that's just plain stupid. But we don't.
We redeploy these people into high-quality software jobs and high-quality other stuff. That's why we're the richest country in the world. We've got a trillion dollars of imports adding to our pile of stuff. Right. And so correct me if I'm wrong, but the underlying assumption there is, okay, so the goal is to have, you know, to create wealth, you have to have more stuff and amass more stuff.
The traditional. school of thought would be okay the trade-off for that is we have to unless productivity increases we have to borrow more money to do that we have to increase our debt but the underlying assumption is as you've explained in through MMT is that that's not the concern it should be. So it's worth it to pursue the goal of more stuff, right?
Yeah. Now, you know, there are other issues with more stuff. If we're doing more stuff and we're going to, you know, boil over as a planet in 20 years and you're not really getting, you're being pretty short-sighted about it.
So you want to do it, you know, you have other strategic considerations. So I don't want to like. I said that before, I emphasize, I just want to reemphasize it because more stuff all of a sudden means we really don't want more stuff.
But do we want more performances for theaters? Do we want smaller classrooms so children can be more and more? Do we want, you know, longer education for people so everybody can go to college?
This is all part of more stuff. It doesn't need to be at all energy intensive. OK, and now in terms of the financing of that.
So now we have to look at. to make sure we separate the idea of government finance from private finance. Okay, as individuals, we all know our constraints.
We have to get money first before we can spend it. We either have to have income from earning it, income from dividends, or we have to borrow to be able to spend. If we borrow, we have debt service and we have to pay it back and we have limits to what we can borrow.
Our income limits what we borrow. We are revenue constrained. We have to look at our revenue, what's coming in, we're income constrained, okay? The government is the other way around, okay?
They start off with a tax liability, okay? But now everybody needs their money to pay the tax and it comes from the government. So they are constrained by what is offered for sale, okay?
They can buy it if it's offered for sale. If somebody's trying to sell them a banana for a dollar, they can buy it. a banana, but it has to be offered for a dollar.
If everybody has a bananas and the government says, I want to buy them, how many dollars? It's like, we don't want your dollars. They're not for sale.
The government can't buy it no matter how many dollars they have. So the government's constrained not by how much you can credit your account. There's no limit to that, but by how much it can create that's offered for sale.
It does that with tax requirements. So taxing is critical, but not the revenue, not the money. The taxing has to cause things to be offered for sale.
or the government can't buy them. So when we're in an economy and we see unemployment, what is unemployment? That's people for sale, people willing to work for $1,000 a week, $800 a week, $1,500, whatever it is.
They're for sale. The government can buy those. It can employ those people.
And if they're unemployed and not productive, our pile of stuff gets larger if they're employed productively. whether it's in public services to make the legal system faster so we don't have to wait in line so long for government services, for legal services, or if it's to cut taxes or increase transfer payments so that the private sector can now hire these people. OK, so if we can get these people out of unemployment, employed, OK, now we have a chance for a pile of stuff to go higher. If we don't.
You know, we can't do that. Now, why could they possibly be unemployed? How does that, where does that come from? That, so the government puts tax liabilities on right now, let's say it's $5 trillion or what the economy generates in tax liabilities.
A lot of them are transactions taxes, which are much more complicated, but we won't go into that now. Economy needs $5 trillion to pay the tax. How do we know the economy needs any dollars to pay the tax?
Because it's selling things to get dollars. There's no other use for the dollar either to pay your tax or not pay your tax and just save it. There's only two reasons the economy would want dollars, pay the tax or to not pay it and just hold the money. There's only two things you can do once you've earned it. If they're willing to sell something to pay the tax, yes.
If they're willing to sell something to just hold the money, okay, that's a conscious decision to save. There are savings desires out there. We don't know how large they are. So when we see unemployment, we see people for sale, right?
And we know the money we pay them is either going to be used to pay taxes or to save, because it can't go anywhere else. That's where government money goes. Tickets from the movie theater are used to go to the movie, or they're held in savings. They can't do anything else. Tickets from the football stadium go to the game, but they can't, you know, stadiums, nothing, can't do anything else with the stadium.
Okay, for the government, once it spends its dollars, it credits your account, you're either going to use them to pay taxes. get subtracted from the account or you're not, and they're going to stay in your account. That's called the public debt, right?
Okay, so unemployment is the evidence that the government's spending hasn't been high enough. cover the need to pay taxes and the desires to save that are created by government tax liabilities. Okay, the unemployed are there because the government put a tax liability on, which created unemployment, created people who need paid work in dollars to pay taxes or to save, and then it didn't spend enough to hire them. The unemployed are created by the government tax liability. So the answer is either to cut taxes or to increase public spending, make a fiscal adjustment, depending on your politics, get them back in the private sector by cutting taxes, get them in the public sector if you think we need more public services, which is, I guess, the country's split 50-50 on that, so I won't take sides right now.
Okay, but those are your two rational, constructive choices. Not be against deficit spending because you don't understand, you got the sequence backwards. Leave people unemployed, leave your pile of stuff smaller than it would have otherwise would have been.
You know, destroy 10 or 15 million lives with the anxiety and agony of being unemployed and family breakups, crime and everything else. You know, over. So anyway, the only thing that's preventing a smooth operation of the system, whether it's for, you know, one partisan group or the other, they're all in favor of. you know, having everybody working.
Just one of them would like them in the private sector, one in the public sector. But, you know, whoever wins gets their choice. Neither of them want the unemployment, okay? It's the space between our ears that's causing neither one of them to be successful at their own agenda.
Right. So with that as context, like when somebody like Scott Besson is coming in to be Treasury Secretary, he's talking about bringing deficits from 7% to, say, 3% of GDP. How do you think about that?
Does that concern you from that? Well, first of all, I'll say why. I'll say why.
Right. One of the reasons why is, well, we've got to pay all this interest. Let's say you cut rates to zero like Japan has done for 30 years, like the U.S. did for 10, like Europe did.
It doesn't cause any inflation or anything. Well, then there's no interest payments. Now, why do you care if the deficit's at 3% or 6%?
Why does it matter? It's just to assume that it matters. It's just to assume there's a neutral rate that the Fed's looking for.
They've got all these built-in assumptions and the rhetoric, all these starting points that have no... foundation in today's reality of a floating exchange rate currency, fiat currency. They might have had application on the gold standard.
We have to bring this deficit down, otherwise we're going to lose our gold supply. But that's not applicable anymore. All the reasons they wanted to bring it down, if he's thinking unemployment needs to go higher and we want less inflation and somehow the unemployment's the cause of the inflation, okay, he'd have a coherent argument, but he doesn't have that either. It's just the deficit per se is bad. It's a DE word, the devil word.
It's evil, and it has to go. And once you're at a zero rate policy like Japan has been, they've run much larger deficits than we have. Their debt to GDP is, what, 260%, maybe 180 after intergovernmental transfers or something like that. And their inflation rate's lower.
It was lower through the whole crisis, never got over for something. With a deficit that was roughly double ours, something like that. Okay, so the deficit doesn't, you don't even need to publish the number if you're at a zero rate policy.
It's of no consequence. Okay, what's the trade balance between New York and Connecticut? It's like nobody knows.
But if they publish a number, I'm sure there'd be a deficit on one side and somebody went off to do something about it. Because we all know deficits are bad. Warren, on that point, earlier in the show, you provided an anecdote about how. you know, bonds and government bonds are this hang up from the gold, you know, the gold anchor era that isn't quite as relevant these days. You ran a fund for many years where you were trading fixed income securities.
And I want to ask you about some of the, you know, points of consideration that have been out for the last few years, this idea of, you know, what Janet Yellen has been doing in terms of changing them, like shifting the maturity structure of the government debt and how that's, you know, potentially. form of QE or just manipulating liquidity in these ideas. How do you think about just those priorities of maturity structure in government bonds, which are a hang up for this gold era?
Yeah. Well, look, if you had a zero rate, it's kind of moot because the rates are zero in all of them anyway, so it doesn't matter. You might as well just leave it at three-month bills and go home and do something else. Put more whatever else treasury does, run the secret service or something.
Sign the money. Look, I was at Treasury years ago, and they said, yeah, we understand what you're talking about, but we're worried about being downgraded by the rating agencies, and our job is to not get downgraded. They wanted a maturity of 4.2 years or something.
We're 3.8, so we're going to have to do longer term. So there's always these. you know, inapplicable reasons for doing what they're doing behind it. And it's the same thing.
You know, QE shortened the duration dramatically, right? Because all the QE just changed it to zero duration. It's like, so what?
Well, when rates were zero, everybody was happy with it. Then rates went up and they say, oh, we should have termed it out and everything. Just leave rates at zero.
That whole argument discussion goes away. You know, and why? a rate's not at zero. It's not like the market or inflation or anything else will cause you to raise rates, okay? Especially when you know that when you raise rates, it makes inflation worse.
Once you understand that, now if you want to do something about inflation, you got to do something else because you know it doesn't work. By the way, that's in the new Keynesian model. They have all these cash flows in there. They know that when the debt gets too high and as you raise rates, it becomes inflationary.
It's not a surprise for them. They were talking about that several years ago. when they were warning about the debt getting too high, once it got to those levels, they stopped talking about it.
So I don't know what's going on there, but I assure you it's already in their models. Yeah. So, I mean, like, as you say, the solution, like you say, is, yeah, just high rates of zero.
But since we're not in that world right now, how do you see the material impact of changes of duration of bond issuance on markets? Because, you know, sometimes you see where we get the QRA announcement, right, every quarter, and it's like, okay, the percentage of coupons versus bills is increasing, more duration on the market, that might compress equity premiums. Do you think that's a valid line of thinking or is it invalid?
Yeah. It is valid, but it's small. I remember when there were no 20-year bonds and they introduced a 20-year bond in that sector to yield, or the 15-year actually first, and it got 20 basis points cheaper. So there was a big gap in the yield curve, but it was 20 basis points. That was important to us trading.
It was a lot of money and we could make good returns for our investors betting on that and doing the math around that kind of a structure. But in the scheme of things for public policy, if the 20 years, 20 basis points, two-tenths of a percent higher in yield, it's not that big a deal. What happens is I think they all worry that now that they have to term it out, as they call it, go from bills out to in what?
the portfolio runoff, the Fed's doing QT, that all these long bonds are going to cause the long end to go up in yield. It's going to affect mortgages and everything else. I have never seen that happen. What I've observed, this is all anybody can say, is that the bid for duration has always been a lot larger than anybody's always imagined.
It's like, who are going to buy all these long bonds? And they sell off 10 or 15 basis points and there's a big tail in the orchard. Then two weeks later, they're 10 basis points rich and has any idea what happened, right?
But, you know, the bid for duration is enormous out there. And long zeros, 100-year bonds, who's going to invest 100 years? Well, for one thing, if you look at the convexity out there, it's, you know, at the long end, you get, you know, positive convexity relative to the shorter stuff. And so the astute buyers, it's a huge boondock, you know, it's a big, what do you call it, a benefit to them to have, you know, these cheaper. The long bonds are even cheaper than they look just on the curve when you convexly adjust them.
But anyway, the bid is huge and they always wind up getting richer. Will it happen this time? I think so.
I think it's because of our retirement fund structures where people, you know, the client, I was a bankers trust for a while in the 70s and all the major accounts, state of New York, teachers retirement, PIMCO, all these guys, they would buy long bonds because it was Tuesday and they'd get their balances at the end of Monday and they had 10. you know, million dollars to buy long bonds. And Tuesday morning, they'd call up to buy long bonds. You could talk to them about the Fed or rates or inflation. They really didn't care.
It was Tuesday and they're buying 10 million long, which is a lot back then, right? I'm sure it's continuing today because so people are buying because of the cash flows in. And anytime somebody has money withheld from their paycheck, you know, $100, it goes into some fund, you know, 40% goes to bonds, 60%.
20% goes to liquidity, 40 goes to stocks. Now the bonds, they've got a maturity ladder that they've dreamed up, right? And so much is going to go into 30-year bonds.
They don't even know what they are. The guy whose paycheck just deducted, you know, had his paycheck deducted from his own. And that bid for that duration is like absolutely staggering to me. And it's, you know, I'm always like, you know, relieved, but can, you know, just like, wow.
Look at all the, look at how, look at how. How's that login go into a premium all the time? How does it go? How does it do that? Yeah.
So when you trade bonds, do you just set aside your philosophical views that rate should be at zero and just play the game as you see it? Or like, how do you square those two sides? Yeah. And so I can't, I don't directional trade. I just can't do it because if I see the forces at work, I think the Fed's going to see this inflation number and it's going to raise rates.
And I bet on that. And then behind the scenes, the Fed has been reading my stuff and they cut rates to zero and I lose money. I just don't want to be there. I don't want to be there.
So I just can't do it because I can't bet on them doing the wrong thing. And I just never been able to do that. So from the beginning, I always did relative value, zero duration investing.
And in fact, I think I kind of invented that space back in the early 1980s when we started our fund. I don't remember going to accounts to having anybody competing for that space. It was just a small portion of their assets, but there were enough assets. So we grew nicely.
And we had about $3.5 billion in 1970, 1998, the end of 1997 when I turned it over to my partners. So I've been out of it for over 25 years. Yeah. You're still racing cars too?
I stopped racing when I turned 50, but I'm still into it. My son's in, I'm in his shop right now. So he's got all the cars. I sold the company, the pile of junk that was left in 2013, but he's got all the good stuff here. I love it.
Yeah. 10 out of 10 background. Well, look, Warren, that was a ton of fun.
It was an honor to get you on the show and hear about how you're thinking about things. Anytime. Appreciate it. Looking for a blockchain that combines high performance with zero headaches? Scale is your answer.
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