 This is Mises Weekends with your host Jeff Deist. All right, ladies and gentlemen, welcome back. Once again, we're joined by my good friend, Daniel Achaia. He's been on the show before. He's one of our favorite economists, but more importantly, a fund manager, somebody who really keeps an eye on markets. You need to be following him on social media. He was actually just announced by Rich Topia as one of the top 100 most influential economists based on, among other things, social media presence. So congratulations, Daniel. You're making a splash. Thank you very much. Thank you very much, Jeff. Thanks for having me, as always, always a pleasure. Yeah, well, one of the reasons we like to talk to you is because you have Austrian influences, you understand Austrian economics, but you're also really involved in the markets and you're not blinded, let's say, which is a criticism that's often leveled against Austrian theorists. In other words, you're not a perma bear. Mm-hmm. Yes, well, you have to be very aware of trends and very aware that one of the things that we make the mistake with as Austrian economists is to think that, for example, monetary policy is always going to generate negative effects on markets. And on economies. And trends are different. And the cycles are more complex than sometimes we think. So there are different levels of cycles that we see. And the market is not looking mostly at one single variable, but of many different variables. And it's always more about expectations rather than whether something is positive or negative in the long run in which we, as Austrian economists, are more right than wrong. Well, I want to talk about a recent article you have entitled, The US Ten Years Shows the Extent of the Bond Bubble. We'll post a link to this on our site. But one of the things you say here is that the single biggest bubble out there is in sovereign debt, in sovereign bond issuings. And you mentioned, like, nobody would be buying Italian or Portuguese or Greek sovereign debt if the ECB wasn't there to backstop it and buy it. So talk about the sovereign bond bubble. And why should we care about it as ordinary people? Why do we care about the sovereign bond bubble? And why should we be more concerned than, for example, the tech bubble or the housing bubble? The first is because the tech bubble, the housing bubble, even the cryptocurrency bubble, if you want to talk about it, to a certain extent, they do create ripple effects into the real economy. But they're easily adjustable and, at least, definable. The problem with sovereign debt bubbles is that, first and foremost, governments are not going to pay for them. So if you had a tech company that went bust, hey, you as a shareholder or you as a CEO of that company, you're going to suffer from it. But it doesn't generate a problem, for example, in the, I don't know, mining sector. However, a sovereign bond bubble does. And it does because it is allegedly the safest and lowest risk asset. So when the central bank makes the lowest risk asset massively expensive, it, by definition, is also making every other asset extremely expensive. And the reason why we need to care about it is because when it bursts, it doesn't burst by making some shareholders lose some money or some bondholders lose some money. It makes citizens lose money because it comes via either stagnation or a financial, a very large financial crisis, or more importantly, stack flation, which is a risk that very few people in the media are talking about, which is more, let's, I would say, more evident as a risk, rather than, for example, hyperinflation or deflation. So does the US have a sovereign debt bubble? To a certain, not so much as the eurozone. Remember one thing, at the peak of QE, at the very, very most aggressive part of the quantitative easing process, the Federal Reserve was never 100% of the net issuances of sovereign bonds. This is very important because the Fed always keeps an eye on the market. It does manipulate the market, but it keeps an eye on the market. There is always a secondary market. I actually had the opportunity of talking about this with Dr. Bernanke last Tuesday in a breakfast. And he actually agreed. He actually said it is absolutely true. There is always a certain level of trying to understand what the market demands are and to be sort of in line, despite I was obviously more critical about the Fed's actions than what he thought, that he thought that there were no negative consequences of monetary policy. However, the problem is so at the peak of QE, the Fed was never all of the demand for treasuries. Therefore, there was a secondary market. Right now, in Europe, there are no there is no secondary market demand for sovereign bonds at these yields. Not at all. So the problem that the ECB finds itself with is that if the ECB stops purchasing bonds, or even worse, raises rates, there is not going to be any investor that is going to buy Italian bonds at 3.5%, 3.4%, 10-year bonds, Greek bonds at 4.3%, Spanish bonds at 1.5%, 1.6%. It makes absolutely no sense. Therefore, that is a much bigger problem. In the United States, it could be a problem of maybe we could debate about half a point, or whether the Federal Reserve or treasuries were discounting a level of inflation that was correct or incorrect. But it's a debate on 70 basic points. Here we're talking about twice, three times. The real yield relative to the market. And that is monstrous. Because if you think about it, that also, as I said before, affects the highest risk part of the market. And if you look at high yield in Europe, it has a spread of about 290 basic points over the sovereign. So the sovereign is expensive. High yield has very low spread relative to the sovereign. High yield is monstrously expensive. Right. So is there any scenario, fiscal or otherwise, a deep recession, a stock market crash, where the Fed becomes virtually the only buyer of US Treasury debt? In other words, the whole world wakes up and says, the US government's never going to get its fiscal house in order. I mean, that's the kind of apocalyptic scenario that Austrians think about. No, I think that where we Austrians sometimes make a mistake is not understanding that the world for a bond holder, for a saver, for an investor is a world of relatives. So when you get close to that scenario, which is possible, when you get close to that scenario, what happens is that the lowest risk asset becomes more attractive. So in essence, the US 10 year or the German Bund becomes the asset that everybody buys. So as the 10 year US bond goes to 3.2%, more capital flies out of the riskier assets. You buy that one, therefore you don't have that risk. Why? Because you can maintain the status of lowest risk asset and world reserve currency. Now, you would say, obviously, well, the Germans don't have a world reserve currency and they don't have that status. However, think about this. If you think that there is a risk of the eurozone breaking or the euro collapsing, what would you buy? Something that is going to be re-denominated in Deutschmarks. So obviously, you prefer something that is going to be re-denominated in Deutschmarks, which is a government bond, rather than something that is going to be re-denominated in Italian lira, which obviously will be worth between zero and nothing. Well, it turns out, even today, there's still a lot of physical Deutschmarks under people's mattresses in the hopes of such a scenario, maybe. I want to talk to you a little bit about Powell, the new-ish Fed chairman. As you mentioned in your article, he has talked about a series of interest rate raises. You think he's going to hold to these and that a lot of governments and investors are kind of acting like he won't, that the Fed will bail them out against low interest rates, where in fact, he appears to really be serious about unwinding, at least to an extent. Yeah. I had the pleasure of meeting Mr. Powell. And I found that it was very refreshing to meet somebody whose chair of the Fed and is aware of the risks of keeping the bubble inflated. He is aware of the risk of equity markets, but he's also aware of the fact that the Federal Reserve lost precious time in the tenure of Dr. Yellen because what should have been a very easy and smooth process of raising rates was missed because of fears of whatever was happening in China, the elections. I don't even want to think about it. But different factors that sort of kept the Fed way behind the curve. More importantly, I think that Mr. Powell is very aware of the risk that if the Fed doesn't do what it has said it will do, what ends up happening is that the signal that it sends to investors is much worse than whatever ripple effects a small rate hike will have. For example, imagine that you're the Fed chair and you go in December and you say, I'm not going to raise rates because the markets are a little bit volatile and the data in the economy is okay, but we're not going to raise rates. I as an investor will be thinking, hey, these guys know something that I don't know because the economy is growing at 3.3%. I think that's the latest data for the third quarter. Unemployment is at 75-year lows. Wages are growing at 3%. And you're telling me that you cannot raise rates by 25 basic points. There is something really bad going on here. So the diminishing placebo effects of monetary policy is something that is also very important. And Bernanke mentioned numerous times the importance of communication. So I personally think that he is going to hold on, particularly because he knows that not doing it is not going to generate any positive effect from the side of, let's say, making people happier about investing or spending or doing whatever they have to do to keep the economy afloat. But as you mentioned, he also needs some potential tools if there's another recession, right? He needs to be someplace where he can cut rates. Absolutely. I mean, again, coming back to the point of what I say, what I call the mistakes of the yell and tell you, no? Being too cautious makes you miss all of the optimism in a period of robust economic growth and strong capital markets. So if you don't build some tools in that period, what you find yourself in is that when the cycle turns and many people are talking 2020 for the US, I don't know. These things are more complex than sort of putting a date on it. But whatever it is, it'll be in the next five years. And you definitely need, because central banks are not going to change the way that they act. So they are going to need to have a balance sheet that is strong enough to take some measures and they're going to need to have some room to reduce rates. So you cannot keep basically the balance sheet at the levels, for example, that the European Union has. The ECB is 41% of GDP of the eurozone is insane. Because then, even if you decide to do an operation twist or to do some QE, what is it going to do to take it from 40% to 50%? It's Japan again, no? Right. Well, earlier you mentioned Mr. Powell versus Dr. Powell. This is a very different guy. He's not a PhD economist like Yellen, Bernanke, Greenspan before him. From what I'm told by some people who have worked with him in the past, he's not an egghead. He's a lawyer, a pragmatic guy. I mean, what's your take on him? Brilliant guy? I mean, obviously, we need to see what he's going. I think that the key thing about Mr. Powell is that he's very data dependent. And this has been a key driver of this horrific. The reason why markets became so over complacent and at the same time, investors are doing things like betting against what the Fed is saying that they're going to do and things like that is because, historically, it did work. It's because, historically, the buy the junk policy by so many people of buying the worst and most aggressive and most risky assets because the Fed, the ECB, et cetera, will not do what it is supposed to be doing in a period of good economic data actually happened. So I think that being data dependent is very important in order to avoid that perverse incentive in the market is that Mr. Powell is looking at the data and is saying, look, unemployment is 75 year low, wage growth. However, there is still some slack in the economy. Labor participation rate remains weak. So there needs to be a lot of things that have to improve. But the economy can take 25 basic points higher rates. More importantly, it needs. This is a critical part of what he mentions. It needs to take 25 basic points because the risk of promoting malinvestment is very high. And he is aware of those things. Now, I think that what I like about his approach is that it is not driven by hearsay or about whatever is happening in the equity markets in China or in emerging markets because that is not his mandate. The mandate is unemployment and inflation. Those things are working in a way in which rates have to be increased. If they don't, the US economy is going to be in a much worse position in five years' time. I'm sorry to contradict President Trump on this, but if the economy doesn't build some tools in these years in which growth is well above consensus estimates, when the cycle turns, it's going to be dramatic. And I don't want things to be dramatic in the United States or elsewhere. Well, speaking of Powell, he talks about the Fed's balance sheet. And for years and years since the crash of 08, we're told it doesn't really matter. The Fed's balance sheet roughly quadrupled between the crash of 08 and today. So in a similar vein, why should the average person care about the Fed's balance sheet? A lot of Mises Org readers and listeners they understand the difference between the monetary base and the broader measures, the outright money supply M4. So people understand the difference. Why should we care about the size of the Fed's balance sheet as ordinary people, ordinary investors? An ordinary citizen or investor should think about the balance sheet of the central bank, not as printing money because it's not printing money. You have to think about it as increased leverage in the economy. It's a loan. It is a loan. It is exactly the same as seeing banks multiply their balance sheet. And the same way that you as an ordinary citizen would be concerned about seeing the balance sheet or reading in the papers of the balance sheet of your banks, where you have your money, where you go to get some credit for your business. Those balance sheets are way too aggressive. You should care as well about the central bank balance sheet because the asset on the other side is you. The balance sheet of the central bank is based on a prom, is a promissory note on the future. And therefore, you don't want that balance sheet to be bloated because it is exactly the same. It is building the exact same risk that we can understand from the financial crisis happened with commercial banks and investment banks. But it's more dangerous because it is endless. Because it can be endless. But endless doesn't mean that it's endless benefits for you and for me or for the government. It means that it's going to be a burden on potential growth, a burden on potential improvements and wages and obviously a burden in your real income and on the purchase and power of your money. So that's why you have to worry. In fact, what you have to think about it is that the higher the balance sheet of the central bank is, the more possible it is that the future that your children and your grandchildren will live is that of stagnation. Well, I think that's well put. It's a loan on us. But what about when central banks go even farther with Bank of Japan, Swiss National Bank? They buy equities. Would Powell ever go this crazy if we had a bad recession? Would he ever buy fang stocks? Will the Fed ever buy equities? Let's think why the Bank of Japan, for example, buys equities. Now, the reason why the Bank of Japan buys equities is because the citizen in Japan knows that by that investing in the Nikkei or the topics is not a good idea. And the reason why they know is because their father and their grandfather lost so much money in that that they do anything else except investing in equity markets. So what the Bank of Japan is trying to do is to do exactly what it does with sovereign bonds is to make the market very expensive in order to force people to feel the wealth factor, this completely horrific concept that you and I debunk so many times a wealth effect is a ludicrous effect in a citizenship that has less than 8% of its wealth in the stock market. But it's trying to build that sort of feel-good factor. In the case of Japan, it also has another effect. The companies in Japan, as you very well know, the Keiretsus and the Saibatsus are actually very government dependent, very interlinked with government. It's a very almost organic symbiosis between government and the corporate sector. Therefore, it is a way also of, let's say, aligning the interests of companies with that of government. And it's not particularly, let's say, I wouldn't say very appealing of a concept in a country in which special interests continue to be a burden on growth and on productivity. In the case of the Swiss National Bank, it is more the evidence of understanding that what central banks do is inflate a bubble. And what you do therefore is, being a smaller economy, you leverage on that bubble. And then you end up being a massive investor, the Swiss National Bank, massive investor in tech companies in the US. Obviously, a Swiss citizen will think, well, why would you do that? And the only reason why you do that is because you say, well, central banks are not creating inflation in the real economy, they are creating inflation in financial assets. So we are leveraging on that via an economy that is massively savings oriented. And I think both sides, what they're showing, is that the role of central banks is actually not for, let's say, the average citizens for Main Street, as Bernanke says, but is actually to inflate financial assets. Last question for you, Daniel. Assuming Powell is correct and interest rates continue to rise, is it going to kill the overheated US housing market? I think Americans, maybe more than any other country on earth, have a psychological attachment to their houses and to the housing market and to the prices of it. The last housing crash in 07 really caused a tailspin for a lot of people's lives because they were upside down in their mortgages, they couldn't move, they couldn't sell, they'd have to bring a check with them to closing. Or 5, 6, 7, 8% interest rates going to be the death knell of our housing bubble. Let's differentiate the bubbles. Bubbles are not always the same. The housing bubble of 2000 that was building, I remember I was living in the US in that period, I was at Citadel at the time, it was insane. Everybody, I remember in Chicago, house prices went from, the average house prices that my colleagues were buying, went quickly from 1.3 to 1.5 to 1.7 to 2 million dollars. And above. I think that the difference now is that everybody has that fear in their minds. I love that. It's the same in Sweden, same in Spain that also lived the house and bubble. Therefore the average home buyer is a completely different person. The way in which loans are structured is completely different. I was reading the other day that one of the best performing assets in 2017 and 18 had been subprime mortgages, absolutely. But look at what subprime mortgages are today relative to what they were in 2005, 2006. So the point that I'm trying to make is that there might be an overheating in house prices. House prices may come down as we are seeing now in the UK, but not a crash that leads to the rest of the economy falling because you don't have an entire economy leveraging on that. I think that the mentality has changed. The next bubble is different. The next crisis is different. The next crisis only happened in the assets that we as a collective perceive have no risk. You cannot have a crisis or a bubble built on something in which we are discussing that there is a lot of risk because that already means that we are more prudent than what we think we are. So where is that bubble? That bubble is in sovereign bonds. That bubble is in sovereign bonds. That's the bubble that you go to Brazil today and the government completely believes who whatever the government is that they will be able to finance themselves at eight, seven percent forever. That is the kind of risk where I think that this one, housing, of course you might see cycles and corrections, but it is not going to be the same and definitely not have the same effects on the economy. I don't have colleagues anymore that come to me and say, hey, you know, I remember the first, I always say this to my colleagues, the first call I got when I joined ABNMRO in the city in London, first call I got in my office was from a mortgage broker. A mortgage broker, already something that you should be very aware of. And the mortgage broker called me and said, we're offering you a two million pound, not dollar, a two million pound mortgage from these three, four, five different suppliers. And I said, I don't even have, I don't even have my first salary with me. You know, I just arrived in this country, you're offering me a two million pound mortgage that I don't see anymore. That I'm not seeing. I'm not saying that there is, that prices are not overheated, which is quite possible like so many other assets, but that doesn't mean that that it's the equivalent of the bubble of 2005-06. Well, all I can say is from the perspective of the Southeastern U.S., there are construction cranes everywhere. If you were watching any of the hurricane coverage the last couple days of Panama City, Florida, you saw how many construction cranes were flapping in the breeze. That said, Daniel Lacalle, great to talk to you. Thank you so much. Ladies and gentlemen, follow him on Twitter. It's L-A-C-A-L-L-E. Lacalle is, you'll find him on Twitter, but more importantly, check out his most recent book. You can find it on Amazon. It's called Escape from the Central Bank Trap and it talks in a more bigger picture about some of the very topics we were discussing today. So, Daniel, great seeing you. Ladies and gentlemen, have a great weekend.