Mark Blyth and Nicolò Fraccaroli - Inflation

23:17And by blinders reading, by the time you get to 81 and you really jack this stuff up, it's kind of on its way out. So what Paul did was massive overkill and probably didn't need to do it. Now, when I first came to that sort of conclusion through reading this stuff, I thought, well, is that right? I mean, it's a very, very different history, right? But then I thought about what happens next, right? You get this period of, like, basically relatively high interest rates while you're basically privatizing the banking system and integrating capital markets globally. And that spread is what everybody rides down until 2008.

23:49Then you build up a huge amount of leverage. Bang, it all goes to the central banks. Then you go through the QE period, et cetera, et cetera. And at that point, you've kind of made the central banks the monetary gods, right? They are. What was Del Arion's book? The only game in town, right? I was going to say, or an omnipotent ship captain is how I think about that. Oh, brilliant way of putting it. Exactly, right? So then we're like, well, you guys have got this, And ultimately, they have two things, short-term interest rates, raise and lower the price of money, buy and sell assets, give it a fancy name, quantitative easing, quantitative tightening.

24:18So they do what they do, and blah, blah, blah. And then we get to the next period of inflation. The next period of inflation is like literally Germany lost its gas station, and America lost its parts supplier. You can look for spikes in M2 because of COVID spending, but there was 30 countries hit by inflation. Only one of them had the Biden stimulus check. So where do we go with that? That's not causally right. So this whole thing has really just made me go, yeah, the Volcker story, there may be something more to it than that. Maybe the timing was off. Now, if we do the counterfactual, that gets super interesting.

24:54What would have happened if he hadn't have done it? There wouldn't have been a big bust. There wouldn't have been a rise in unemployment. There wouldn't have been a structural shift in the United States business model, if you want to put it that way. It would have been a more gradual deflation. Would that have actually been sustainable? Would inflation have then picked up again if those expectations had to become unhedged? I don't think there's any way of knowing. Well, I mean, as we know, the tenure is set by the market, supposedly. Right. Right? Yeah. So wouldn't the market or what we used to call the bond vigilantes just wake up one day and say, I'm not buying.

25:27I'm done. Yeah. I'm tapping out. This is not the risk I want to take. And I think back in the 70s and 80s, you can do that because, in a sense, the bond vigilantes are much more powerful. But these days, there's loads of other people in the market. There's basically dumb money from every pension fund in the world coming every month that's looking for a safe place to hide. You've got every exporter in the world who doesn't want the dollar circulating the domestic economy, so they sterilize it by buying treasuries. China sits on a trillion and a half at any given point in time simply because it's such a volume exporter.

25:58So there's so much buy pressure now in the treasury market that, in a sense, that gives it a bit of sort of idiot proofing. that you might be the bond vigilante who wants to come and send that signal. There's a lot of other people you've got to convince of that signal as well. So I don't think it works quite that way now. Sure. Let's talk about taxes because you mentioned how even in taxes, the government can pick a winner or loser situation based on how they want to calculate CPI, for example. Can you explain how they might rig the system for themselves in taxes? You're going to have to remind me of that bit of the book.

26:33That might have been one of Nicholas passages. I think you guys talked about harmonized CPI as the way to look at tax brackets, for example. Oh, yeah. That was just the 70s stuff about basically you get pushed into different tax brackets as your nominal income goes up because of inflation, but your real ability to pay back doesn't. I mean, that was one of the classic sort of complaints about inflation in the 1970s that really gelled with people. It's like they're getting shoved into different tax brackets. They're actually taking more. But in real terms, they have less rather than more. It's only in notional terms they've got it.

27:03I mean, the bigger story here is sort of does inflation actually benefit governments? So there's the whole sort of Fisher channel of like, it benefits debtors. There is the fact that the last time the United States had debt to GDP ratio, like this is after World War II, and the way that they dealt with it was a healthy dose of financial repression, capping interest rates. Yeah, from 46 to 52. Yeah. Yeah, and even beyond that, way into the 60s, basically running a positive rate of inflation with a slightly higher rate of growth, and then you're getting people like McChesney Martin to basically use the bond market as kind of a regulator for the economy, taking money in and out of Q institutions in the 50s and the 60s.

27:42And by the time you get to 64, you're down to like 60 % debt to GDP or something. Inflation cures debt. As a finance friend of mine put it once, inflation is defaulting softly, one heartbeat at a time. I totally agree. Isn't that brilliant? It's your point. I mean, because when I study like the South Seas bubble, The Southeast bubble came out of getting rid of government payments, right? Yeah, totally. They took and swapped their annuities for the Southeast Corporation, okay? And so I point that out because, to your point, if I'm the government and I made bad decisions in malinvestment, inflation is the easiest way out of my prior bad decisions.

28:22Yeah, it is. You're absolutely right. I mean, the thing is, though, do they have the wherewithal and timing to do that? because there's a timing problem with that. And then as a kind of, do I get lucky in my asset class question as well by doing that? I mean, in a sense, if they knew that they could do that, they would know the bust would come in. So the better thing to do would be to short the asset rather than take a long position to hope inflation cures it. Well, or, I mean, this is just hitting my head right now. What gives people more hope depending on the path I take? So for example, you've watched this, you know, wrenching inflation of the 70s.

28:54And if you go to people and say, hey, if we bring inflation down, financial assets would be worth a lot more, and business will be worth more, and we will prosper through trickle-down economics. Well, you might say, gosh, this has been miserable. That seems like it's pretty hopeful. Now, in today's position, you go to people and say, hey, listen, here's the deal. We're going to keep inflation low. Asset prices are going to continue to rise because, to Mark Blythe's point, there's an idiot out there willing to always fund the treasury market for some reason, for some ungodly reason. and therefore, you know, we're going to have this hopeful future of just being really rich.

29:27Well, if you're someone that doesn't have any assets, that's not very hopeful. And that's not a big sea change compared to the past. So I also think of it as like, what causes a big change that benefits most people? And the question is, keeping status quo for what we've seen much the last 20 years, does that really help most people? No, and that's it. I mean, you know, the point about trickle down, one of my favorite papers from a few years ago is the Rand Corporation's paper. not exactly a lefty think tank. MARK BLYTHERSON, Yeah, exactly. MARK BLYTHERSON, And they have this piece. And it's got a brilliantly anodyne title.

29:59It's called something like Trends in Income, 1945 to 1980. You can find it. And it's this kind of random forest model, complex calculation that basically does a counterfactual and says, if we had the economy of 1980 and didn't change anything, what would it have done to the income distribution now if we project it forward? And what their estimate is that$36 trillion went up, and practically nothing came down. Yeah. Wow. $36 trillion, right? Now, you know, one of the ways that you see this is in stock buybacks. Now, I know on a corporate balance sheet perspective, it's totally fine. It's neutral, whatever, right?

30:35But if you're a company, you get the license to do investment in society because we don't get the government to do this. We've got loads of different companies to do this because you'll like failure. We like variation. They'll think of things we'll never think of. That's all the justification. If at the end of the day, you've got a big moat and castle, and you basically sit there and you can set prices, as they can in many sectors, and you don't innovate, you buy the competition just to keep the moat and castle up, and then you've got a huge cash pile, and all you do is you buy back your shares because it juices earnings per share, and that rewards the C-suite, people downstream have every right to question that, and every right to say that this is not how the system's meant to perform.

31:15We're all meant to benefit from this. And if we're not all benefiting from it, there's a problem. And that's where we are in the world today. Sure. I'm going to come back to that because I got another theory I'm going to throw to you. But I want to go to your price controls. You talk a lot about price controls. You actually talk about them in some cases in a good light. But some cases in a poor light, we're very even-minded. Correct. You're very even-minded. So I guess, how do you personally think about price controls? Where do you think the weight of data? In other words, you do point out that they do occasionally work.

31:45Yeah. But it seems to be that the preponderance of data argues against it because no one's that lucky often enough. I think that's a fair thing. I'm not suggesting that we swap out interest rates wholly for price controls, right? Part of the problem is another way you could do this is buffer stocks. And that sounds kind of like, you know, sanguine. Apart from the fact you need to know what you're buying and then there's the opportunity cost of the buy. It's like the SPR is a buffer stock. Exactly, right, exactly. So basically, you know, there's always a cost with it even though it's just maybe a buffer.

32:13Now, to go to price controls, it's dead simple. And you put it very well. I put it slightly different, which is the following. Ex ante, right, before the fact, it's really hard to know if this thing's going to work because people will react to it. The worst thing you can do in economics and policy is take the Cateris Paribus clause seriously. Because the minute you try and do something, everybody changes their behavior, right? Nothing remains equal. So ex ante, it's hard to know if it's going to work, even if it's well designed. Ex post, even if it seems to work, you have an identification problem.

32:50You don't know if things went well because of that. It might have been other things that you're not paying attention to, and then you ascribe victory to the policy, right? So this is a general thing with policies, not just price controls. I'll just give two simple things, a way to think about it, right? Spain didn't try to control prices. But what it did, it said, was we got 40 % of the income distribution that's getting hammered here. Spain's above middle income country by far. It's a developed economy. It's got a fairly high income skew. What do we do for the 40 % of Spaniards that really are having trouble here?

33:22Well, we could do what Hungary did and basically say to the supermarkets, no more price rises. And exactly as any economist would tell you, there's no bread on the shelves. It's all been sold somewhere else, right? They didn't do that. They basically said, how about we give you guys subsidies on electricity and public transport? because we're not going to try and solve the inflation problem through a price control. We're going to just take what you're getting hit and try and offset some of those costs by making these things cheaper in this moment. Which is more of a Friedman argument because he thought you should always subsidize the consumer or the buyer, not the supply.

33:56Yeah, and I think I would wholly agree with that. I think that's a totally reasonable way of looking at it. Now, let's be fair to controls on the other side of this, right? This country is filled with price controls. You know, electricity markets, the levelized cost of electricity, regional differentiations. I mean, we have regulations controlling these things all the time. We have controls on what you can sell internet services for. We have control. The entire medical market is made up. Yeah. There's no market. It's all negotiated prices. So the idea that we don't do this, and we never do this, and it's anathema to what we do, no.

34:31We need to have a look in the mirror. We do this all the time. And we need to learn from places where we do it, where it kind of works and then not do dumb shit, right? It's really that simple. Yeah. This is going to be a bigger picture question, but since you're talking about price controls and we did kind of make fun of monetary policy, I think a bigger question that we have to ask ourselves just as rational human beings is can we control things? I only say it because I have two teenage daughters right now and if control of teenage girls or young children is not possible. Is it really possible for us to take these big markets and economies and produce some level of control over them?

35:13So in a sense, we have no choice but to try and do so because we have a political system and it's not reducible to democracy. This is true of authoritarian states as well. It's basically our job is to make sure things don't get too out of whack. So in a sense, you have to intervene, right? At the same time, I'm a huge fan of Nassim Taleb's view of this, that this is iartigenics. This is the cost of intervention. And the cost of intervention tend to be asymmetric, if not sort of like damn-wrecked convex in unexpected ways. And you can intervene in certain ways and end up in a very different place from what you intend.

35:48Now, is that an argument against all intervention? Some people will make that argument quite cogently. But given the complexities of the world and given the demands that citizens place upon their governments, we don't have the luxury of ever doing that. Sure. So to me, this is a finance story as well. I think the best rules in finance are broad, dumb, simple rules. Ones that are basically dead obvious, like here's a leverage ratio cap, 15 to 1. Go beyond, it'll fine you. Simple as that. Now, it might not say that that's the best thing or this is whatever, right? But it's simple, right? If you start doing like, well, you can have these tier one and these tier two and this one counts and this is a base.

36:26You've seen the basal regulations? It's like it's a bit as bad as the tax code, right? This is just a license to game shit out. So if you think of intervention as like micro-tuning things, then yeah, I'm not a fan. If it's a case of like keeping the damn train on the rails with certain broad rules, I think that's kind of how markets and societies work. Sure. Let's pivot to windfall taxes. The one thing I loved about your windfall tax discussion is it's more of an honest discussion about the effects of rising prices, which is, let's pick a loser. Let's pick a loser, and we're just going to tax them because they're winning too much.

37:07Yes. Is that a fair way of thinking about windfall taxes? I wouldn't call them losers. I would call them unfortunate winners, right? So I'll give you two examples, right? Or punished winners, maybe. Yeah, but they're winners in a weird way. I mean, the whole rationale of windfall taxes is they didn't do anything to earn it. They were just in the right place at the right time. So therefore, if they are earning it, and that's actually coming at the cost of other members of your society, then you should redistribute the windfall, right? It becomes a lot, not a lottery, it becomes a more general one.

37:37The word is escaping me. You get what I'm talking about. So let me give you an example of this, right? So Saudi Arabia has a premier league for football. Just stop there, right? They have Cristiano Ronaldo and every big player from five years ago playing in stadiums, which I'm sure people show up to, but nobody else seems to give a shit. And they're able to do this because of a windfall that basically oil prices went through the roof, and they are this marginal producer, the swing producer. I mean, come on. It's just ridiculous, right? Here's an interesting one. We just managed to get this and put it in the book.

38:14Team of economists at Amherst basically did a profits calculation and basically just looked at it. It was like five-year moving average of profits and basically what happens to the spike afterwards, right? And you can calculate, back out inflation, figure out whether it is or whatever. Anyway, according to this estimate, American oil companies basically got 220 billion above normal, just call it above normal profits, in the 2022, just in 2022, right? So everything's 22222, right? Now, think about the fact that the top 1 % of America, of 3.3 million people own 51 % of all shares. Now, let's think that that$220 billion of those oil companies is going to be probably half of it is going to go in share appreciation and dividends, right?

39:03So 3.3 million people got$100 billion just by having to own those shares just because oil prices went up, just because we had a pandemic plus a war in Ukraine, and we had to ship LNG around the place. pure windfall and more than offsets any inflationary cost that you would have if you're up there. Well, by the way, I agree. So that's a windfall. I agree. Well, here's the funny part. It's crazy to say this. 220 billion sounds big, but let's call a spade a spade. That group at the beginning of the pandemic was like 2 % of the entire stock exchange. Right? So it's a big number, but relative to assets in general.

39:47Yeah, that's right. It's the smallest, the capitalization of those profits it had been in decades. Absolutely. But the capitalization is less important in the story, I would say, than the fact that that huge amount of profit is then distributed amongst a very small group of people. Not because they're not good people, not because they think it's bad, right? But it's just because it was a windfall. That's it. It was pure. Nobody did anything to make this happen, right? If you turned around and said, I've invented super fuel, it's twice as efficient, and it gives off no CO2, and you've got stock in it, you're a genius.

40:18I love you. And you're doing everything for the world, right? But if you just sat there and got lucky, you know, don't, you know. I love this about Talib's first book, Fooled by Randomness, the confusion between luck and skill, right? A lot of things that happen is just luck and we ascribe it to skill. And that's why we don't want you to touch it. We hope you're enjoying the podcast. You know, we work hard putting together this show. But we work even harder for our investors at Smead Capital Management. At Smead, we believe in disciplined investing, which is why the Smead funds have a proven track record of long-term outperformance.

40:53If you're an investor who plays the long game and want to invest in wonderful companies to build wealth, we invite you to visit SmeadCap.com. Past performance is not indicative of future results. Investing involves risks, including loss of principle. Please refer to the prospectus for important information about the investment company, including objectives, risks, charges, and expenses. Read and consider it carefully before investing. Smead funds distributed by Smead Funds Distributors, LLC, not affiliated. On that subject, and I'm totally biased. We are folks, just so you know, Mark, that we didn't touch the oil market for the 2010s.

41:31Because to your point, they lost a lot of money in the 2010s. That's what no one says. The 220 doesn't get anywhere near the amount of money they wasted. No, absolutely. If you're a long-term investor in that, you're just getting a little bit of payback. But as a windfall in that window. All right, let's shift it to another one, right? I was going to say, let's shift it to Italy because I love this. And most people don't understand this at all because it's kind of like Munger says, you show me the incentive and I'll show you the outcome. And I think Italy does that. Yeah, so basically it's another example of a windfall.

42:06And Italy basically got on top of what happened everywhere. and most of our politicians were asleep at the wheel. Yeah. So everyone listening to this podcast knows that basically we don't do fractional reserve banking and we don't have loanable funds. You basically do endogenous money creation. Wholesale markets are important. It's blah, blah. It's a totally different world from what's in the textbook. So with that in mind, how do these people make money? Well, there's meant to be this model that we still got in our heads whereby grandma shows up at the savings bank and then the savings bank's very clever and lends it out to an engineering firm.

42:39So they borrow at three, they lend at six, and they get the three. And we call that net interest margin, right? Yes, net interest margin. And then you've got to basically give something back to grandma in order for grandma to put the deposit in or the whole machine breaks down, right? Yep. You have depositors because it gives you a banking license and in many countries insurance. That's not where you get your cash. You just invent it from basically making loans. Now, with that in mind, what happens when central banks raise interest rates? Well, suddenly, those banks become a lot more profitable.

43:10Are they passing that back to depositors? Absolutely not. They are taking the net interest margin to themselves. And the Italian government went, hang on a minute. Because Italy is a place that's got loads and loads of small savers. That's actually an incredibly important constituency. And they're all old. They all put tons of money in the banks. And none of it's growing because the economy is incredibly slurotic. And interest rates have been on the floor for ages. So suddenly, European central banks banking things up to 4%. They're still getting the negative 7. No, not really. But you know what I mean.

43:43They're basically getting negative bupkis on their deposits. Yeah. So the Italian government went along and calculated how much they made and said, you guys are going to pay us a tax. And the banks were like, what? Yeah, yeah, yeah. Literally, it's a windfall. We're going to take it. And we're going to redistribute it back out to the people you should be doing it because you're not passing it on. Now, the whole thing got held up in court. And basically, the banks kind of won. And then everyone stopped caring. but it was an interesting example of thinking how to think about windfalls when also how models can't be applied so for example to your point i'm going to follow on that because i i'll give you an example like i love this in your book because i you know like i love being an american but we obtusely use what happens here to many other places in the world and it doesn't apply so in america if we have a better deposit rate at one bank versus another what do we do we're loud mouth people.

44:31We tell everybody about it. Oh, by the way, we can get you an extra 50 basis points over here. God bless you. Come to our bank. But that's not how it works in Italy. In Italy, they do not advertise their deposit rates on the window because they're actually afraid of people moving deposits. Correct. So what does grandma have to do to use your analogy? She has to go in and sit down with the banker and say, sir, I have been told by other people that deposit rates are higher for them. I'd like to renegotiate my deposit rate. And the person would say, great, what would you like? And they would tell them and they'd say, no, we're not going to give that to you.

45:08And then she would have to move their deposits to someone that would give that to her. It's a negotiated deposit market versus an advertised and regulated. The UK regulates their deposits a lot more, for example. So naturally, banks have to give a de minimis level that's higher. And that's what I love about this. As you go around the world, these frameworks are different, and you can find profit arbitrages depending on where you go. And also, the structure of banks is so important. I mean, the Italian banking system still looks like it did in the Medici period to a large extent, right? It might have been better then, by the way.

45:39It might have been better then, right? But then when you look at French banks, I mean, this is going back to my austerity book. One of the things I was looking at was, essentially, the American story was too big to fail. When you start to look at the asset footprint qua possible losses of European banks. They're two to three times the size. Three French banks at the time of the crisis were 245 % of French GDP. And these people are in the euro and don't have a printing press. Wow, that's too big to bail. I mean, literally, that's it. So the structure of the things can vary so much, even within one monetary union.

46:15So you mentioned a couple of different factors that you touch on. And these are like the factors of the multi-factor model. And I think you really do a good job of explaining that people get too fixated on one thing standalone. OK? So you mentioned too much money. OK? Yeah. Would you say that stimulus checks were a pretty good example of this? The best estimate that we were able to find in the research on this was it could have contributed a third of the inflation that the United States felt. OK. But the error bars on the estimates were so wide, it could have went from negative 1 to, you know, from one third to minus 0.1.

46:54OK. So you don't know, right? Common sense tells you it does, except you have to think about two things. These checks were given at a time when we shut down a very, very large proportion of the labor market in an economy where lots of people live paycheck to paycheck. So what did they do? They ran up their credit cards. So what we did was we went to the New York Fed Survey of consumer finances and just found the issue where the paychecks were spent and what did they spend it on. A huge amount of that was the largest increase ever in credit card receivables. So they paid down their debt, which is inherently non-stimulatory.

47:29So even if the money was in principle stimulatory, and we can argue about the context in which it was paid, calling it stimulus checks was dumb. They should have just called it emergency cash or whatever, right? But nonetheless, you take that money and then you put it on a credit card, you spend it, Absolutely, particularly in a moment when supplies are constrained, probably going to have an inflationary effect. But the act of paying back the credit card, first of all, destroys money. But secondly, it's not inflationary. So you've got to work hard to make that one work. Now, again, let me say this.

48:00I mean, a lot of monetarists are very cross with me. I was surprised so many of them are still around. But nonetheless, it's a 70s argument, right? Sorry, that's a deep economics humor that I'm bringing there and listening to you on. It is. It's all in the timing, right? But, you know, I mean, again, that sort of model, to go back to what we're saying, really relies on kind of deposit funding. It relies on loanable funds. It relies on the central bank pushing money into the system, kind of none of which actually applies to the way that we really do these things anymore. But, you know, do I think that money on its own can cause inflation?

48:34Shit, yes. Are there examples throughout history where governments have just went, wah! And yes, it's, of course, right? Yeah. But you know when you look through even the big cases of hyperinflation, that's not what's.. The hyperinflation is everything is broken, and the last thing you've got is the printing press. So you might as well go for it. It's a sign that you're already dead. That's pretty much it. And the classic case on this, Latin America, can you find evidence of populist spending insane amounts of money and vote buying and the economy blowing up? Absolutely, right? Look no further than Venezuela.

49:09Yeah. But, you know, the Argentine case is super interesting because a very simple way of telling the Argentine case is there was Perón. Perón steps into the breach after the 30s when everything goes to shit. And basically it does so because they're dependent on exports. Exports collapse in the 30s. They try and rebuild in the 50s. They've also got to industrialize simultaneously. Because labor is part of the Perónist coalition, you can't do the East Asian trick and essentially suppress wages to build savings to do the capital imports. you become very much dependent on foreign people's money. And then when that starts to go awry, you just print money and you try and build flavors that way.

49:45I think so much of that is true. Malay in Argentina is a reaction to, if you will, the denouement and end and collapse of that system. So 100 % sign me up, right? But there's another one that goes like this. You export six things of value and import 20 ,000 things you need that you don't make. Your exchange rate is a proxy for a commodity or a basket of commodities. Yeah. When that's doing well, you don't have a current account constraint. And you can import what the hell you like. And your bond market's great. And everybody loves it. But like all commodities, you end up making too much of it.

50:17And demand shifts. And you get the other side of the cycle. Your exchange rate collapses in real terms. You can't import everything that you need now at the same price. Moreover, nobody wants your currency anymore. They want dollars. So that spread's got to be filled in. So either you say to your population, no drugs, no food, no fun. and we're just going to set this one out. Or you're on the printing presses. And that's what you do. So what's driving it here? There's a phrase that we picked up from a Fed thing from years ago, which is, it's always and everywhere a monetary phenomena. Ballistics are always and everywhere.

50:50No, shootings are always and everywhere a ballistic phenomena. Bullets are involved, but it doesn't tell you about the direction of causality or who got shot or why. And I think that that Latin American model really shows, absolutely, is buckets of populist money involved in this? Yes. Are they running the print best? Yes. But it's because they're Latin America, and they're structurally dependent on exports, have a soft currency, and have a volatile exchange rate. MARK BLYTHSCHER Sure. Because the other thing that, again, back to your stimulus check. So I can't get over this. And we've been coming to this data point since the bottom in 09.

51:25If I look back at household debt service ratios, right? So separate from government, right, here in America. So we know our government's levered. We know that looks problematic. You got Neil Ferguson out there arguing we're spending more on interest costs and defense spending. Not a good picture for America. And I agree with Neil on that. But that's the government's problem. They could be the loser, and I could still win maybe. So if you look at the household debt service ratio, we're not at the lowest we've ever been. That was actually peak pandemic. It was the lowest we ever got on that when the stimulus checks were going out because it brought it even lower to your point because we paid off debt.

51:59But it's still at one of the lowest levels since 1980. And I always point out to people, yeah, yeah, I mean, that helped us. But what it does is it buys time. It buys time to the next recession. I mean, so let me throw out another idea to you. Just think of this year. I just think of this year a lot. And this kind of is kind of a question on the too much money argument. We have never, outside of a war, done this kind of spending in deficit, you know, 7 % for four to five years. We're into this, okay? And so I hear, I mean, the dumbest thing, and Mark, I just, I love your writing and your thoughts on this, because a lot of times you're stepping back and saying, wait, wait, like, let's not be in the weeds on this.

52:44Can we step back for one second? Does this make any sense to an average person, or is it just total, like, economics hubbub, right? And so what doesn't make sense to me is I feel like Wall Street's primary obsession is not to find the next bear market in stocks or assets, because they suck at that already. We know that. but it's to sit around and be like, where's the recession coming? We're recession hunting. We're going to, oh, that might be a recession. Oh, nope, it's not. Never mind. And we've been doing that for four to five years, right? Like 22, we were supposed to have a recession. Where did it go?

53:16And the answer is it scurried off because ultimately I would invert it. Munger says always invert. Can we go back in any point in history and find a period where in the American economy, I mean, the government was spending 7 % of GDP in deficit, and we went into a recession. Normally, we use that in deep recessions to get out. So it's like dumb sport, recession, honey. You're never going to be successful. It's like fly fishing for me. It's just not going to work. Is that a fair way of looking at this? I think it's a fair way of looking at it. I mean, a very simple way to look at it is you want to be as simple as possible.

53:53And I'm not a card-carrying MMT person by any means, but they make a simple point. If the public sector is running a deficit, that has to show up as a private sector surplus. And if the private sector has a surplus, they're going to spend it, or they're going to save it. It doesn't look like they're saving it. It looks like they're spending it. If you then add to that a skewed income distribution, then what you're doing is you're filling in for the lack of demand generated at the bottom, or wage growth at the bottom, with essentially consumption at the top. So this is why we have these consumer reports that basically say the top 20 % of American consumers are powering 80 % of the economy.

54:27Yeah. Because that's where the money is. So I think, yeah, it's a very simple story. And the counterfactual is, right, OK, so if you were to balance the budget, what would happen? Well, I guess that that would mean that there would then be, or if you reversed it, there would be less of a private sector surplus, which would mean that demand generated in the private sector would fall, which would mean that if the government's saving at the same time, the economy would shrink. Now, that might then lead to a focus on reducing spending and so on and so forth. and that might in the long term lead to lower debt.

54:59But the experience of the 2010s in Europe was, if you have 100 over 100, and it's 100 % debt to GDP, and you cut your GDP by 20 % through saving, your debt to GDP ratio just went up to 120. Yeah. Right? So there's no easy answer on this one. And once you get kind of addicted to the permadeficit, it's hard to wean off that. Now, if you're the US, you print the global savings asset, There's an insatiable demand for treasuries, et cetera, et cetera. You have a license to print that other people don't. Yeah. You don't have a current account constraint, right? But the interesting thing about the Trump administration, for me, is they are aware of this.

55:35This is what they think has hollowed out American capacity for manufacturing, amongst other things. Yeah. And they really want to do something about it. And this is why you see, like, Mirren and others talking about, maybe we should have a transactions tax on foreign holdership of dollar assets. Yeah, we still believe in a strong dollar. No, you don't. you actually want it down because if you want mine exporting, you want to have a cheaper dollar. No one's saying that though. I mean, to your point. Nobody's saying that. Because there's two places. The markets are pricing that in two places. A, the dollar.

56:01I agree with you. And by we're hearing from investors, they're starting to ask the question of like, hey, do you provide a hedge share class for US assets? Why? Because they're beginning to think of that in their mind. That's one. But secondly is, markets are trying to make profits on this policy. And the other way you could see that is gold. Yeah, and you do see that. I mean, admittedly, from my reading of this, a lot of this is even more interesting. It's basically German and Chinese central banks going, give me the gold, give me the gold. So if it's a lot of demand that's there rather than sort of in the investor space, they're more likely to buy an ETF of the thing rather than the real thing.

56:42The physical shipments of gold in the past few years to central banks are actually quite spectacular. So yeah, there is that. This is also the build-out of crypto. This is the interest in stablecoins, which is kind of weird, because if you want to do a treasury market, then why would it be stable and an alternative to the treasury? Because that's already stable. That makes no sense. Yeah, exactly. And also, if it's unstable, then why would that be the hedge that you're using to issue the coin, right? But park that for a minute. But absolutely, people are looking to domestic investors, international investors, but also countries are looking to disintermediate and get out of the system.

57:15Because think about, let's say you're the Russians, right? So in the newspaper today, in the FT, the Germans have decided that, seeing as they're the ones that are bankrolling most of the expenditure for Ukraine, they're basically going to seize the profits of Russian assets and use that to fund it. Sure. You've just ended any attempt by the euro to become a global currency. Yeah. Because what you've just told everyone right there is, it's your money, but we can steal it. Yeah. Well, why would I want to do that? Now, if you've done that to the euro, right, we've got a government here that basically is telling the treasury market, maybe you should just swap everything for a console with a low interest rate in exchange for military protection.

57:54Yeah. Are you serious? People are looking for alternatives. Absolutely. And then you've got the whole BRICS thing, right, trying to build a digital bridge, et cetera. Yeah. There's all this stuff going on. Well, I mean, even the drug dealers know what the currency you want to hold is. I mean, that's the crazy part to this is they don't want euros. That's for sure. Right. Absolutely. Hey, I want to give a big shout out to everyone who's been working so hard on this show. You know, we recently hit the top 10 in investing podcasts on Apple Podcasts and even number one in the business category in several countries.

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59:01Smead funds distributed by Smead Funds Distributors, LLC, not affiliated. I want to pivot the discussion a little bit. But I will say this to our listeners. I'm not going to go into your hyperinflation definitions, but they're really good. And I just like walking through history and asking what's similar, what's different, things like that. Also, you talk about how the Japanese model of cheap labor, high savings that worked in other parts of Asia failed miserably in Latin America. So let's go to the queen. The queen asked after 08-09, why didn't we see this coming? That was her question. Okay.

59:40Now, isn't the kind of point that we can't in aggregate, but in small groups, profit can be made from seeing things like, for example, you know, you know, the Fed just lowered short-term rates. And so people look and said, well, that's weird. Why is the treasury, 10-year treasury upticking and why are mortgages upticking? And like I tell people, it's not what happens. it's the expectations of what happens because there were arbitrageurs and profit seekers who were already anticipating that move months in advance that had already priced in such a way that once they got their profits they needed to get out and what does that do they have to give up some profit for liquidity and therefore rates move higher marginally that's the nature of that's markets.

1:00:29Yep, that's it. But not everyone can make that money because you would have to anticipate that and put capital at risk. Right. Can we get it right ever is the question. All right, but what was your original question though? In aggregate, in other words, like we're trying to make these cases that like, you know, the central bank in aggregate for society. Oh, right. Can they see it coming? Yeah, yeah, yeah, absolutely. Sorry, I know where we're going, right? Yeah. So I would put this as a micro-macro split, right, which are always more analytic than real. But allow me the indulgence, right? So can we expect them to see what, right?

1:01:04Can we expect people who are micro-focused profit seekers to have a macro view of a system, and even if they did, act upon it, given the incentives and given what they do, right? Yeah. 2008, no, right? But here's the question. The entire central edifice of modern central banking independence is based upon, trust us, we've got this. Yeah. Right? We are uniquely qualified to see the world as it is. We have our star. We have Y star. We have U star. We have the astrology that allows us to set these models up. We know the speed limits in the economy. We can tell you when you're heading for inflation.

1:01:41We can tell you what an excessive deficit looks like. We understand the whole thing. Great. In that case, why didn't you see it coming? Yep. And the argument and the answer is because, in a sense, they were looking in the wrong place. They were looking at labor markets, because that's where they always look for inflationary forces. And we spend a bit of time saying, that hasn't happened for a long time, because we destroyed trade unions, and we internationalized capital and supply chains. So they simply have no push force to do that type of stuff anymore, right? And if you stop looking at the labor market, where else do you look?

1:02:13You look towards money. So governments don't spend money, politicians shouldn't spend money, politicians are time inconsistent. If you leave them alone and for five minutes, they'll spend you in Tempecuny. The Germans have been balancing the budget for the past 12 years, and it's basically meant that the economy is falling apart through a lack of investment. So no on this stuff, basically no. So our sort of thing was, well, you couldn't see it coming because you were focused on labor markets and money. What about just big things like you've extended all these supply chains that are equivalent to a financial crisis screw up, which was the financial crisis grew up in a way was you're a British bank that lends mortgages.

1:02:55You go into the repo market, and you're borrowing overnight, and you're refinancing this mortgage every day for 30 years on a mortgage. So you're making an assumption that there's infinite perfect non-volatile liquidity available at any given point in time. That is a hell of a bet when you phrase it that way. When you build a global supply chains, you're basically making a bet that geopolitics has disappeared. Everyone always likes each other, and there's no such thing as exogenous shocks. That's a hell of a bet as well, isn't it? I agree. What they have in common, to your point, the reason why they are the same, is because if I go out and seek liquidity today and it's there, great.

1:03:32It didn't require any time, and the price for little time is low. Right. But if it takes me 30 days, the price is going to be higher because the marginal buyer for 30 days later that says I'll do it means I'm paying more money. Same thing is true in supply chains. The more time it takes, the higher the cost is. MARK BLYTHERSON, Ph.D.: Exactly. And now, arbitrageurs can exploit that on the one side. But to go back to central banks in this example, this is why they are so important. Because apart from having that rise and lower the price of money buying and sell assets, there is one more thing they've got going for them, the price insensitivity of the buyer.

1:04:06They don't have to care because they've got the keys to the print and press. That's why they are genuinely the only outside money in the system. and that's actually where the real power lies in that side and that's something we really don't focus on enough. Sure, so I'm gonna, I think I got two kind of final questions that I wanna walk you through and I wanna set up a scenario because we talked about this before and I'm just, I'm totally consumed by this right now. And by the way, I am a profiteur, I am an arbitrageur, I wanna make money on this and my biggest concern is, like I've said numerous times in my audience, Like I'm your classic right-wing evangelical type of person politically, and I believe in a lot of the economics I've learned, but my job is pragmatically to make money.

1:04:53That's plain and simple what my job is. Okay? And so let me just kind of give a backdrop, and if there's any of this that you disagree, but I'm going to start with 20 to 22. Okay. Because I think it's a very prescriptive period of time to think about for even some of the circumstances and factors at play now with some differences. Okay? So, you know, we talked a little bit about there's a lot of largesse coming into the economy tied to the government then. There still is now. Okay. You know, what we had going on then is we actually did have some people leave the labor force. I'll call those boomers.

1:05:26But what we had was these imbalances in supply chains. We don't have those today. But really, there was a near-term demand for labor to get things done coming out of the pandemic. And in the overnight period, you just couldn't replace people that weren't there. Right? Now, we could do that over time. By 22, 23, we began to. But we also, differently than today, we had millions of people coming across the US border. And the reason why I point that out is because if I look back at the data, if I look back at the Federal Reserve Bank of Atlanta data, for example, they do a great job of breaking out the wage quintiles, right?

1:06:05And you'll see the highest wage growth during the 20 to 22 period was actually the lowest wage. Yeah, the bottom. It was the bottom, which means that the raw commodity of just someone showing up to use their time to serve someone for entry wages was actually our biggest need, our scarcest asset at that time in the wage market. So I just think about all the factors, low short-term rates, strong economic growth on the back of government stimulus, etc. Okay, now in real terms from 20 to 22 stocks lost money real. Okay, now let's fast forward to today. So what we've seen since then has been lower inflation, labor markets have backed off.

1:06:56Oh, by the way, the thing I didn't mention on 2022 housing was very strong during then. We've kind of seen the inverse of that. Cooler housing, not bad, but cooler. You've seen labor back off in prices. You've seen inflation back off. And in comparison, real stock returns are higher. Right. Okay? Now, when Mirren, to your point, is saying, no, we should be shorter, like, shorter rates should be lower. And they say, you know, they keep on with this idea of, like, we want Main Street to win. Well, in my mind, there's two ways that Main Street or what I'll call the bottom three income quintiles win is that labor inflation runs hot.

1:07:36Secondly, housing inflation runs hot because most of the wealth of the bottom three income quintiles is more often than not tied to their house. There's many Americans. There's a good portion of America that the day they retire, their biggest asset is their house. Okay? And I think what most people in the stock market is forget that there's people like that. Yeah, that's certainly true. Okay? So here's why I say it. I think we're going to wake up in a world where the short end of the curve is 2.5 % to 3%. I think we're going to wake up in a world where in two years we're going to have 4 % inflation.

1:08:11That might be small, but again, I think it's 4%. It's kind of a number I think about. The question is what's the market deciding on the 10-year? I would say it has as much to do with how much people lost or won in the stock market at that point to determine whether they like bonds or not ultimately. But let's just say it's five. And then the other question would be like you're in a hot housing economy with hot labor inflation. What's the price of a mortgage? Now, back to fractional banking. if the government is lending to me at two and a half to three percent uh normal spreads on mortgages the 30-year story says one and a half percent 10-year to 30-year fixed today it's been more like 200 to 250 base points more on the 250 side i don't think there's a chance in god's name that long-term with short-term rates are two and a half three percent that you're going to find banks sitting out at seven percent on mortgages because in fractional banking that's too much margin, right?

1:09:10If I can borrow it two and a half or three, and I give you a mortgage mark at seven, I mean, that's better than asset management, right? No, no, absolutely. Okay. So I say that because I can actually see a world where what Mirren's advocating for is, and I'm going to get, I'm going to, I totally thought about this during your discussion. It's two pedals of a bike. Okay. In some eras, we do the, let's keep inflation low and let's keep asset prices higher because we want to create a lot of surety around capital. But if we go too far on that one pedal, the bike's going to stall out because it loses momentum.

1:09:47So the second pedal of the bike is, okay, we've done that for a while and a long time. We now have to reinvest that capital back into income and thus the real economy to make sure that at a later date, when we come back to the capital pedal, people believe in the system that we're using. That's pretty long-sighted stuff. I mean, I would like to think people would take that type of view. Well, I'm not saying they are. I'm not saying they are. I'm saying that that's the natural – like Buffett talked a lot about 64 to 81 as a very unique period. That's where the real economy, according to Buffett, won.

1:10:27Yeah. And all I'm really saying is it's going to be something closer to like 64 to 81 because you need that to fire the next era of assets. many years later. MARK BLYTHERSON, Yeah, whether it's deliberately to fire the assets or not. I mean, there's an open question. I agree with Vip. That's all you said there, right? I would look at slightly different factors. One would be sort of like, well, who's sitting the 10-year? Because you still have those fiscal pressures we spoke about. We still have a lot of people who are investors saying, I'd like to have an alternative. If credible alternatives do pop up over time, technologically or geopolitically, that affects this one.

1:11:01I'm not quite clear why if they're at 3%, If you got 4 % inflation, 2.3%, 2.5%, the mortgage would be 7%. Like, why wouldn't the mortgage be 5 %? Oh, I agree. I agree. The spreads will come in. And by the way, think about what that does to housing. We're like, wait. I mean, I'm back right in 5%. I agree with you. So basically, I'm juicing the housing market again. Correct. The other thing is, yeah, the housing residual on wealth is definitely there. But when you get to the bottom 20%, nobody has it. I mean, it really starts around the 35th percentile. Well, I agree. But here's the funny thing.

1:11:33Exactly, getting housing. I agree. But so here's the funny part. Phil Graham's book, The Myth of American Equality, he says that if you go, this is crazy to say, this is like how blessed I feel to be an American. If you look at the lowest income quintiles house, it's actually nicer than the average house in the UK. And that, I mean, also just in terms of the quality of building. Correct, exactly. I think that's true, right. But in terms of actual home ownership, I mean, we are down, we're back to where we were in 2008. It's high, but it's only 54 % or something like that that actually own houses.

1:12:07So half the country actually rents. So I mean, that story is true. So it's a bit like saying the following, right? If you've got a car, it's probably a better car than that guy's car because we both have cars. We're doing an inter-car comparison, right? If I've got Uber and you've got a car, and you're saying my car, it's just irrelevant, right? So yine on that one. I mean, I don't dispute your picture, where you're getting to. I mean, I'd look to different factors on it. But I don't dispute it. I can totally see a world of like, you know, four, three on growth, four on inflation, and then six, five on mortgages.

1:12:41Now, if you do that, interestingly, you're saying 64 to 81. I did it slightly differently, but it's more or less ballpark. I think that's what we had then. I agree. And it wasn't the worst of all possible times. I can debate the time frames. I agree. By the market peak, relative returns of stocks really ended in 66. Yeah, totally. Right? So they made higher highs, but not in real terms. Yeah, no, absolutely. No, and it was a very, it was an inverse. It was the other side of the pedal, right? And yeah, I mean, I think over sort of, I mean, I look at it this way. You can do that story on a macro level with basically the rise and fall of the gold standard and then the rise and fall of Bretton Woods.

1:13:18And what we're seeing now is the rise and fall of what you might call neoliberal globalization, only that's a hell of a mouthful and I can't find a better descriptor. But, you know, these things do sort of pivot over 40-year cycles. They exhaust themselves. Correct. Right? The bug in the software, as I've described it before in agronomics, the gold standard was systemic deflation, basically constantly falling prices. The bug in the software for the Bretton Woods system was constantly rising inflation. And then we solved the inflation problem again, this time with central bank rather than gold.

1:13:47But what that did, the bug in the software, was leveraging the banking system and asset inequality. And we're going to correct for it. So in that, I think we're exactly on the same page. Atone for it. Atone for it. We have to atone. I'm a lapsed Catholic. I can't do atonement. It brings me back too many memories. Lapsed Catholic is a term one of my colleagues uses. So that's funny you use that. So I'm going to throw two things you talk about. Demographics, I think, are way understated in the policy realm. Like I think they're, you know, we were going to have deflation because there were 25 % less Gen Xers than boomers, for example, in America.

1:14:24That's deflationary. Now, that was then. also globalization, right? That caused deflation. Now, if I use those two factors, and you guys touch on this, I think, those two factors argue inflation now, not deflation. That's exactly. So at the end of the book, what we do is, we mentioned the Golf GTI, so I'll just let the listeners know why. So my favorite car, in many ways, one of the first cars I ever had, and the 1978 model cost, in$78, about$10 ,000. If you buy the new one today, The engine's twice as powerful. It's got ABS, a computer, the whole lot. I mean, it's a far superior car. And in$1976, it's a third cheaper.

1:15:04Why? Because everybody else makes these cars as well now. And it's called competition. It drives down prices. It increases supply. It does all the things. That's why we think capitalism is the system that dominates the world, because that's what it does. The problem with it is if you have constant deflation across all sectors, then you end up squeezing labor beyond to maintain profits. And then the whole thing goes to hell in a handbasket, which was the gold standard story, right? So there's inherent deflationary tendencies, good ones, in the system. But on the other side, you've got what was demography?

1:15:34It was the baby boomers exes you mentioned, right? But a simple one was 500 million Chinese workers joined the labor force in an integrated supply chain that had massive deflationary effects on prices and wages everywhere else. Simples. That's done. They're no longer a low-cost economy, and there's nobody else waiting in the wings that can perform that function, nor with 4.0 manufacturing, do you need that? So that's gone, 100%. The other one we mentioned is climate change. You already get the numbers on this. The Potsdam Institute for Climate Research has done a lot of work on this. They already estimate that basically about a third of the inflation that we're seeing showing up every season across Europe and so on and so forth is basically the Po Valley drying out.

1:16:16Spain has basically drained 30 % of its aquifers, so strawberries could be in Britain year round. these sorts of like let's say supply shocks will become more common so there's these two things fighting against each other one is kind of the inherent deflationary tendencies of competitive capitalism and the other one is demography climate change and you could add other supply pressures to that so let's see uh two things off that uh we have the west not having babies yeah do you have any hot takes on, because I would say that means no new labor coming into the workforce relative to the size of the economy.

1:16:55Particularly if you no longer want immigrants, you've got a problem. Let me do a Mike Green thing here for me, because I was the first person I ever heard. He sort of, this is how you basically, I'll just do it. It's wonderful. He goes, what's an economy? It's the number of people, the number of hours worked, and the quality and quantity of capital that they work with. That's it. So if a variable one goes down, variable two has to go up. And if you're not going to work any longer hours, the solution is robots or immigrants. It's that simple. So how do you want to play it? I think it's just a great way of framing the problem.

1:17:29Well, now, but there's also one other factor in capital. Let's use the deflation of the internet era with Chinese and also Chinese workers and also really the demographic change. Yep. The internet era was dominated by software, which requires very little investment and produced a big return. Yep. If AI is going to play that robotic opportunity, what do we know? It requires massive investment. Massive Carpex, and we don't even know what the Opex is going to be. Which argues that means the incremental return in that economy to automate is actually far more expensive than the past. Which is why it has to be super concentrated and one firm has to win, which is why you get the CapEx build that we've got.

1:18:16Well, except that there's like eight of them competing with billions, hundreds of billions of dollars as of this date. So it's - I mean, it's super fascinating. I agree. Okay, last question. Oil investment looks like it's literally going off a cliff here in the United States. And the marginal supplier right now is effectively countries that don't have to do much to bring on oil over the next 6 to 12 months, but they're using all their excess capacity. Is our next big inflation pressure like the past just going to end up being energy prices? It depends. You've got two forces. One is people are no longer need oil.

1:18:55Pakistan's given up on gas firing its grid. You've got a micro build out that has basically shut down large parts of the Pakistani grid because we were slated for Qatar's LNG and they sold it to Europe and And they said, screw you guys. We're going to take Chinese panels. This is also what's happening in Africa. It's happening in southern India. One part of the world is basically saying, you know what? Oil is a huge balance of payments, constraint, a pain in the ass. We're done with it. Don't want to do it. We'll just take the panels, please. And then you've got the other side of it, which is primarily us saying, if you don't want to get tariffed, why don't you buy 100 billion of our carbon exports?

1:19:28So you've got carbon locking on the other side. And it's these two forces competing together that's going to dominate the next decade. Now, one final thought on this one, right? Who else is coming online? Argentina, Guyana, Brazil, Indonesia. We are going to have so much of this stuff at the same time that you will basically hit peak oil for gasoline, at least, in the 2030s. What has to happen is a massive price crash in oil. So short term, yeah, you may see some kind of price pressures. Longer term, that baby is going to go down. We couldn't disagree more on that. I'm sure, but that's my view Well no, I don't disagree, but here's my rough math I'll give you a really simple way You know, humans are going to flourish I truly believe in that, the future's bright We need about a million barrels a day Each of the next 10 years So in 10 years you'll be doing 10 more million barrels And even with those things coming online They don't meet that They get at best about 70 % Of the 10 million barrels, which way 10 million barrels is a lot, we're the largest producer in the world At 9 million barrels a day And so I just say that because you're right, we have to grow supply, but this is the smallest supply growth ever of the last 20 years.

1:20:41And yeah, absolutely. Over the past seven years, eight years plus, I mean, you get to the point where your North Decor and fracker can survive at about 55. But if it goes down below that, then you're really in trouble. In the Dallas Fed survey, someone said, yeah, no, there's abundant oil. We're just running out of the$60 stuff. Yeah, exactly. And I think that there's actually, it's not a price floor. It's a kind of price ledge. I think that the incremental effect, particularly of foreign buyers turning away over the next several years, really will make that edge a lot steeper. So we're running an experiment.

1:21:19We'll see which one of us is right. I agree. Well, let's see, Mark. I've had a ton of fun. And, you know, I just got to say, and by the way, it sucks that Niccolo couldn't join me because I'm sure your accent plus his would have been a lot better. Yeah, it would have been truly cosmopolitan. It would make me feel smarter. Your book, Inflation, A Guide for Users and Losers, should remind our audience that understanding inflation is like we're talking about. It's a multi-factor model. Simple rules, in my opinion, are simply stupid. I think we should focus our time understanding who the winners and losers are, and your book does a wonderful job of this.

1:21:55This can change faster also than we think over a five to ten year period. If you enjoyed this podcast, go to Apple, Spotify, YouTube, or wherever you listen to a book with legs podcast. Give us a review and tell others about the books and great authors like Mark Blythe and Niccolo that we have the opportunity to understand and study the world with and through. For our tribe, if you have a great book that you'd like to recommend, email podcast at smeedcap.com. That's podcast at smeedcap.com. You can also send your suggestions to us on X. Our handle is at smeedcap. Thank you for joining us for a Book With Legs podcast.

1:22:31We look forward to the next episode. Thank you for listening to A Book With Legs, a podcast brought to you by Smeed Capital Management. The material provided in this podcast is for informational use only and should not be construed as investment advice. You can learn more about Smeet Capital Management and its products at SmeetCap.com or by calling your financial advisor.