 This is Mises Weekends with your host, Jeff Deist. All right, ladies and gentlemen, welcome back once again to Mises Weekends. I hope you all had a very merry Christmas this past week and I'd like to wish you all a very happy New Year as we go into 2019. And we do so with one of my favorite guests, the great economist, Daniel Lacalle. Many of you know him as somebody who's been on the show before. He's been sort of back and forth between London and his home in Madrid over the past few years and very active on all the talking head shows but perhaps more importantly for our purposes, author of a great book called Escape from the Central Bank Trap. Daniel, great to see you. Great to talk to you as well, always a pleasure. Well, I have to start with this dog and pony show of a week or so ago when Jerome Powell made his dreary announcement that we're gonna have another quarter point interest rate. What kind of economy is so terrified of two and a half or 3% interest rates? It seems absurd to me. It is, it is completely absurd and it shows what type of bubble we live in that an economy with almost 3% unemployment, 3% inflation is not going to take a rate hike of 25 basic points, sounds absurd. It is completely absurd. If you think about it from the real economy perspective because we're talking about a rate hike that has very little sort of effect in the real economy the investment decisions in everything that should be you know, a really strong economy, you know and to think that there are people out there sort of implying that that's such a completely tiny minuscule rate hike. More importantly, announced, I don't even wanna know how many times I don't even wanna know, want to remember how many times have they said that rate hikes are going to follow this path announcing it over and over and over again precisely for the real economy to get used to it. But, ah, here's the problem is that the financial asset led economy is very much based on one single trade which is the Fed will not do what they said they will do. And as such, we have the tantrum that we have seen in the markets. But the economy can, should and must take a rate hike that by the way continues to place the Fed below the curve. Yeah, well, it's interesting. Austrians get a lot of heat sometimes for their obsession with central banking. Do you think we put too much into central bank that it has a smaller effect on the economy than we imagine? No, I think we rightly place the blame and the headline and the impact of the central bank is enormous. The impact of the central banks is enormous because at the end of the day in the last 10 years, what we have seen is unprecedented. We have seen an unprecedented increase in money supply and unprecedented monetary stimulus. We have never seen anything like what we have seen with all central banks almost in tandem raising their balance sheet to above 20% of GDP in the case of the United States, but 100% of GDP, 40% of GDP in the case of the Eurozone and at the same time massively distorting the price of money. So at the end of the day, obviously, we are doing the right thing, which is to show that the one single factor that has the biggest impact on the economy is a central bank that is distorting the amount and the price of money. You think Jerome Powell is well read. Do you think he would accept the broad parameters of business cycle that banks are too expansionary, the malinvestment occurs as a result and then there's a bust later? Do you think he'd accept that, just conceptually? To a certain extent, yes. I don't think that he sees it from the perspective that we see it. I've had the pleasure of speaking with him and I don't think that he sees it from the perspective that we see it of incentivizing malinvestment by lowering interest rates to unsustainable levels. And I don't think that he sees it either from the perspective of banks having a perverse incentive to create these bubbles that we talk about. But I do think that he does understand that there is a point in which further stimulus is not going to help the economy, rather it's going to harm the economy. And I think that he understands that if he believes in the central bank as a factor that sort of smooths out economic cycles if interest rates are not hiked right now and the quantity and the balance sheet of the central bank is not reduced right now, then it is going to create a much larger and very important problem once the cycle truly changes. So you mentioned the extraordinary monetary policy the last 10 years. Does that mean we'll never see 10 or 15% Fed's fund rate again in the US like we saw in the 70s? Are those days simply over in America? I think that they are. I think that they are over. I mean, obviously never, I wouldn't dare to say never as Janet Yellen said that we would never see a crisis in our lifetime. It's very difficult that we see interest rates of 10, 15% because it's also extremely difficult that in a globalized economy in which the level of debt is as high as it is right now and will likely continue to rise, it is very unlikely that we will see the levels of inflation that those 10, 15% rates implied as well. So it's very, very unlikely. We have to understand that technology, high debt, many of these factors basically erode inflationary pressures and some of those factors are truly fantastic like globalization, like the improvement in worldwide commerce, the increase of technology, efficiency, all those factors are very positive. Obviously, unfortunately, the massive increase in debt is not a positive, but all of those factors are disinflationary. So it is very unlikely that we will see the levels of inflation that we saw in those years and with that price of money, those interest rates. But if we look at the West, we look at this huge increase in debt. We have sovereign debt exploding, we have corporate debt exploding, personal and household debt, mortgages, credit cards, student loans, the amount of debt today versus 2008, the last crisis is almost unfathomable. So doesn't this mean that raising interest rates is today by central bankers, is very different than raising them 30 or 40 or 50 years ago? It is. It's a different animal today. It is a completely different animal, absolutely it is, but that is precisely why communication and the way in which interest rates are set is so important. From the, I'm placing myself in the position of how central banks think. It is so important that they constantly give guidance about what the rate hike path will be and that they adhere to it. Because when they don't, is when you create the massive perverse incentives that lead to bubbles. If you say I'm going to increase rates next year two times, you don't increase them, then there's a massive buy the junk type of, and get more into more debt type of situation. I think that what happens is that on one side, you want to have interest rates that disincentivize the malinvestment that we were talking about before and that prevent the creation of large bubbles, but at the same time, we want interest rates that are low enough for governments to sort of absorb this kind of debt. And it's an impossible scenario to contemplate. You cannot have interest rates that are low enough for governments, which are the first recipients of money and obviously the ones more incentivized to increase debt because they don't suffer any of the negatives of increasing debt. And at the same time, prevent the creation of bubbles and the creation of large financial asset imbalances. Well, here's a point I'd like to make, which is at least speaking to America, there are still poor people in America who might go into a rental center to rent some furniture or a TV or might obtain a credit card. They're still paying 22% interest on these things. In other words, ultra low interest rates haven't necessarily helped people at the very bottom much at all. Low interest rates never help people at the bottom because low interest rates and high liquidity always benefit the ones that are already indebted and that are the first recipients of money. Therefore, governments, the very wealthy and the extremely high intensive asset wealth, no? Sectors. So obviously, who suffers from money creation and from very low interest rates? Savers and salaries and as you very well say, the poor, if they have to use a credit card to finance some of their purchases, they're going to be paying 22%. Who pays 2.5%? The extremely indebted and the government. That's basically the... So that's why, funnily enough, these monetary policies that are allegedly made to sort of help redistribution of wealth what they create is actually more inequality because the sectors that do not access debt and do not access stock markets or financial assets, those are not just not benefited. They are the ones that are actually suffering from it because they see the inflation that we believe is low but is high for them, no? And they see that the cost of borrowing a little bit for tiny purchases is actually very, very high. Well, you talk a lot about the effects of QE both in the US and in Europe. I'd like to touch on that. First of all, your argument is not that all the growth in the US since the crisis of 2008 in equity markets, in housing, in jobs, in consumer confidence, et cetera. You would not argue that all of that has been artificial and purely result of Fed stimulus. You would argue there is some organic growth in the United States economy. Yeah, there is, there is obviously. The US economy is completely different to the Japanese or the European one because the real economy is barely financed by the financial system, by the banks. So it's about 20% of the real economy is financed by the banks and as such, artificial money creation does obviously lead to pockets of bubbles here and there but it's a much more dynamic and much more real economy than economies that are sort of very clustered around government spending like the Japanese or the Eurozone one. Now it's part of that just because the US economy is so vast in size and scope. When you say only about 20% of it is directly financed by banks, just explain a little bit more what you mean and does that help us understand why QE hasn't led to huge CPI increases? Yeah, well, if you think about the real economy, when the real economy is extremely dependent on bank financing, very large changes in interest rates and in money supply coming from central banks create a very quick domino effect into the economy. Why? Because banks basically are penalized for holding assets and they are incentivized to lend almost at any cost. This is what happened in the stimulus of the Eurozone of 2008. This is what happened. Actually, the Eurozone has been a chain of stimuli since its creation, but in the case of the United States it is true that there is a very large sort of financial asset based economy but the real economy is mostly financed via equity and we talk a lot about the debt of the S&P 500 companies. We talk a lot about the debt of the large companies that are quoted, but that is a very, actually it's a very small proportion of the economy. And it's not just because it's very large, it's because it is very independent from government, the US economy. The US economy, small and medium enterprises, the households, et cetera, depend very, very little on government spending. Obviously the public sector workforce is significantly lower than in the Eurozone countries, for example. So it's a much more dynamic economy and it is also an economy in which there is a very quick process of penalization of mistakes that creates the positive effect of creative destruction. So yes, you do get pockets of bubbles, you get the tech bubble, those companies go bust. Certainly, hey, you have this massive investment that has already happened and you have other companies that take over and that generate higher returns. That's why it is an economy that tends to avoid the risk of zombification, that economies that depend too much on the sort of circle of government and crony sector type of, let's say, base depends. So if you look at, for example, in the crisis of 2008, one of the reasons why the US economy recovered very, very quickly was because you had a very quick process of creative destruction. You had, yes, you had numerous bankruptcies, you had foreclosures, you had all those things, but quickly you have people buying those assets, people restructuring those companies, people making big, big changes into that. You don't have sort of a subsidy system that would zombify the incompetent sectors. You do have it in some parts in the United States economy, but it is much, much more dynamic and much more, let's say, price and profit-driven. This is the key. The key is that the US is a profit-driven economy, whilst that is not the case of Japan or the Eurozone, for example. Well, you point out that Europe is actually not doing nearly as well as I think a lot of Americans might believe. So ECB QE has not been a resounding success. I was interested where you point out not only is government spending as a percentage of GDP up, but I didn't realize that unemployment in Europe in the Eurozone is maybe twice that of the United States. So why isn't this seen as a refutation of QE? I find it very interesting. I think that there is, you know what happens when you travel a lot, like I have the great opportunity to do, is that you see how when you travel to the United States, most people have a very negative perception of what is happening in the United States. Why? Because everything that you read every day is negative. And you think that everybody else is doing phenomenally in the Eurozone, no? And obviously, when you travel, you tend to travel on holidays and on holidays, beautiful cities, lovely restaurants, great things. But at the end of the day, when you're thinking about the economy, the reality of the Eurozone is very, very challenging because we took, yes, first, the Eurozone unemployment is double, not only the United States rate, but also the Japan and other comparable economies rate. So that is a very big problem. Youth unemployment is also a dramatic problem in the Eurozone because it has a system that is allegedly a protection system that doesn't protect, that basically just keeps a very high level of unemployment. And this is not a fixture that has always been that way. Olivier Blanchard and many other economists have pointed out how the Eurozone, the European Union and the United States had very similar rates of unemployment about 20, 25 years ago. It's just moved dramatically, dramatically in different directions since the implementation of this directed economy. And it's very easy for some economists to blame it on the Euro or to blame it on the currency. Oh, it's because of the currency, they can't print money. And therefore, if countries cannot print money, well, it didn't work either before. It didn't work for Italy or for Spain before when they had their own currencies. So unemployment is a very big problem. The other big problem is how quickly industrial production, credit growth, direct financial investment, hiring decisions, consumer confidence deteriorate after the stimulus has happened. It's been staggering to see how quickly, even the allegedly strongest economy of the Eurozone Germany, how quickly it has deteriorated in 2018. But the case of France, which has never had any austerity, is also quite staggering. And it's not because of the monetary policy. It is not because of the not being able to print the currency by each of the countries. It is because it has implemented a completely directed economy model copied from the French. Do you think we'll ever see a day where there aren't sovereign bonds among Eurozone countries that they'll just be Euro bonds? In other words, to have a single currency, but to have all of these countries still issuing their own debt seems unsustainable long-term. It is, to a certain point, unsustainable, but it is very difficult to, you have to change the structure of the Eurozone in order to have Euro bonds. You cannot have Euro bonds when you don't have credit responsibility, because if you have Euro bonds today, in essence, what, I don't know, France or Italy or Spain or Portugal or Greece would be doing to issue a lot of debt underwritten by Germany. You know, think about it from the perspective of the United States. The reason why the United States has a fiscal union and has the ability to sort of have that system is because at least so far, there is credit responsibility. So when California goes bankrupt, it doesn't get bailed out by, I don't know, by Texas, although the Texans believe that they do, but it's not true. So the problem of the Eurozone is that it's a system that from the fiscal perspective, it is based on credit irresponsibility. So you get penalized if you do well. If you do well, the ECB is gonna buy less bonds from you. If you do well, your savings are going to be used to finance the excess spending of other countries. So it becomes, it is a fiscal system that is the equivalent of a classroom in which you get penalized if you get A's, no? So you have all the incentives to have lots of D's and be bailed out. And that is, so you cannot have Euro bonds in that environment. You need to have some level of fiscal responsibility that is not based on, oh, yes, we have a deficit target of 2%, whoops, it went to four. Guess what, no problem. You have to have some level of real credit responsibility. That is very, very difficult in a Eurozone in which the main target, the main objective of all of the governments is to avoid the pain. And avoid the pain means that you don't penalize the ones that do things very incorrectly and you don't reward the ones that do very well. Well, Daniel, final question for you. We live in the world we live in, central banks are as they are. If you could sit down and advise people at the Fed or the ECB today, what would be your real world advice given the situation we're in today? I think that my real world advice would be to say first you need to stop looking only at CPI for a consumer price index for your analysis of what monetary policy is doing. You need to look at financial assets. You need to pay attention to financial assets because financial assets lead the bubble but the burst of financial assets hurts the real economy. So you need to look at that and you need to really from a serious perspective look at whether valuations are aggressively heated or so that is one of the key factors that I would say. The other is that central banks only rely on one thing which is faith. If they lose the confidence of citizens and they're very close and they are extremely close to that, then it's going to be a big, big, big disaster. So what they want is to sort of continue to be moderators of liquidity and improvements in the economy, et cetera. What they definitely need to do is three things. One is that they need to be data dependent that they need to say, look, this is the way in which we will set rates. This is the way in which liquidity is going to be injected and it's going to be based on these parameters. So that me or any other financial investor doesn't go out and say, ha ha ha opportunity to buy the junk. So that is one, so data dependent. The second is communication. Do what you say. If you don't do what you say, you create the perverse incentive that you're seeing in the Eurozone, that you're seeing in so many countries in which governments in the Eurozone are saying, no, we don't care that the ECB is not going to buy bonds anymore because we're going to continue spending. They will have to buy them. So do what you say you do because if you don't, you are basically generating the next crisis. The third, and I think that is an important factor is you cannot just look at CPI, you cannot end unemployment. You need to add other factors and other factors that are extremely important here is not just credit growth per se, money supply growth but quality of that credit growth. So they need to be more detailed, for example, about analyzing what type of credit growth is happening in the economies that they are sort of directing. Think about this for example, when I visited the ECB recently, I told them that one of the things that worried me was that 80% of investment growth in the Eurozone of investment growth was recycling of capital. Guess what? Very few, first, knew that piece of information. Secondly, very few thought of that as a problem. It is a problem because it's part of this massive illusion of multiple expansion. So those three factors I think would be very important. I think that there's a, I'm not going to defend it but I sort of understand the new school of urban fisher followers that basically believe that it is interest rates going higher what will actually drive better and stronger growth and better growth of capital expenditure instead of low rates and high liquidity. But those three factors pay attention to financial assets, communication, do what you say, third, pay a lot of attention about the quality of credit growth. Well, Daniel, that's all really fascinating stuff. We'll see what Powell does. He certainly claims to be data driven. So far, he's stuck to his guns on these interest rate hikes we'll see. But what I like about him is he's by all accounts, not a walk, he's not a PhD academic, he's a lawyer and we're going to see just how data driven he is. That said, Daniel, thanks for your time, ladies and gentlemen. The easiest way to follow Daniel and his work and catch up on his appearances on the Talking Headshows is via Twitter on his Twitter feed. It is at dlekiae underscore IA. And Daniel, we thank you for your time, ladies and gentlemen. Have a great New Year's Eve. Thank you so much. Happy New Year to everyone and thanks for having me. Subscribe to Mises Weekends via iTunes U, Stitcher and SoundCloud or listen on Mises.org and YouTube.