How Demographics Will Break the Bond Market | Manoj Pradhan

24:23I think you're quite right. There's a lot it doesn't capture. It's a very simple way of thinking about one of the dimensions of healthcare and healthcare spending that we have to deal with. It's just very interesting because we continue to remain in an economy where productivity in some sectors is far outstripping others, and it hasn't yet come to healthcare. In the book, we make a point about education, but we are at a really critical point with AI and education where we don't know what the future of the education sector looks like. So your point right there is that the sector itself can change.

24:55The demand and supply of workers can certainly change. The second thing I think Bommel's healthcare disease, sorry, cause disease doesn't capture also is the changing nature of the population. So as the population ages over a period of time, what we've made a particular point of addressing in our first and second book, and something that we're both very proud of, given that both our families have personal history of neurodegenerative diseases, is that the need for caring can also rise exponentially. So a lot of medical research shows that medical dependency, not demographic dependency, where you actually need people to look after you, rises exponentially from the 60s to the 70s to the 80s to the 90s when it comes to aging, because the incidence of neurodegenerative diseases increases exponentially.

25:44And that's a very particular task because when you're afflicted with one of these neurodegenerative diseases, you can't really look after yourself or you can't perform the same task, which means you do need carers. So answering your question in one way, I think the need for carers is still underestimated. That's number one. Number two is because these needs are going to rise over a period of time in a way that we can't yet see, we can see at a micro level, but we can't visualize it yet at a macro level. We need some jobs to be destroyed in other sectors. If jobs were not destroyed in other sectors, I think there would be a problem because the demand for labor would far exceeded supply.

26:23And a couple of other things to add in there, that model doesn't also incorporate the political climate we're in. So most of the solutions that people have found for healthcare problems over a period of time have tended to include immigration. But so strong is the political desire to curb immigration at the moment that that's a source we can't rely on. And finally, if you look at the political climate and you look at these budgets and budget deficits that we're looking at, what's adding to the complications also is the need to get reelected. And that is creating a political desire behind fiscal spending, which that model also doesn't capture.

27:01So it's a shorter, briefer model, which is not quite as rich as what we would like it to be.

27:06Demetri Kofinas:I'm so glad that you brought up immigration because that's another example of a trend that isn't just a headwind, but was previously a tailwind. So that's the other thing. We've got a series of tailwinds that have turned into headwinds, which exacerbates the scale where the move from one extreme to another. I'm sure a lot of people who heard you talk just now might've thought to themselves, well, what about robotics? The Japanese are introducing robotic helpers and companions in their economy. How could that possibly drive down the costs of labor and increase productivity in the healthcare sector?

27:38Demetri Kofinas:We're going to have a chance to talk about that when we get into AI in more detail, but I want to switch back to the conversation about fiscal spending and the role of the government in all of this. Because in the 30 years or so between the end of World War II and the mid to late 1970s, the cost of borrowing on average for the government was lower than economic growth adjusted for inflation, something that you write about quite a bit in the book. And in other words, it means that the economy was growing faster than its borrowing costs, which along with the use of financial repression helped to reduce the debt to GDP ratio for the government.

28:11Demetri Kofinas:Since roughly the late 1970s to early 1980s, that relationship has operated in reverse. In other words, real interest rates have exceeded rates of growth. And this has contributed to a rise in the debt to GDP ratio for the government, with some notable exceptions being the mid 2000s housing boom and the post GFC period. Your thesis, as I understand it, is that we are entering a new phase within this larger trend that has been in place for the last 40 years, where demographic pressures continue to keep real interest rates elevated while simultaneously slowing economic growth, therefore putting further pressure on government finances.

28:50Demetri Kofinas:If you're right, and we are entering this new phase, what does this mean for the government's finances, for the fiscal deficit, for the government debt, the economy, and inflation? Spell that out for us. First, I'm really glad you took that time series that you did, because there's a lot of rich information in that where comparability really matters, right? So let's start by fleshing out some of those comparative statics, as economists would like to call them, right? A snapshot of the 70s and 80s and a snapshot of where we are today and the critical differences. There are some similarities, but let me start with the differences first.

29:27You know, it's very widely and popularly known that Paul Volcker, when he came in, saw inflation numbers that were just unrealistic to think is sustainable for the future. And he raised interest rates very sharply and generated two recessions, one smaller one, one larger one, which is widely credited with bringing inflation down and helping to solve a credibility problem that the Federal Reserve may have had. Now, one important difference between that period and where we are today is the stock of debt. If you look at any measures of the stock of debt, the Congressional Budget Office usually comes out with wonderful statistics and outlooks for where we were and where we are going.

30:06You'll see it very clearly that the stock of debt or the debt to GDP ratio at that time was low enough that Volcker and the Federal Reserve could raise interest rates aggressively without really damaging the economy. In other words, they could focus almost single-mindedly. I don't want to say purely single-mindedly because there's a lot going on in the impact on unemployment, but they could focus almost single-mindedly on bringing inflation down. If you follow that strategy today, let's say there's a shock that comes our way and raises inflation close to double digits, and the Federal Reserve thinks, well, we are really going to have to solve this problem.

30:47Now there's an inherent tension because the stock of debt is so high. Famously, just a few weeks ago, the US debt to GDP ratio has passed 100%. If you now raise rates as aggressively as you did in the past, what would change is the borrowing cost of financing that stock of debt. And that would raise the interest expense component of the deficit, which would be added to the stock of debt and would have to be financed again next year. So maybe you get a downturn today and that downturn today brings inflation down and the Federal Reserve has, quote unquote, succeeded in the near term. But what you have done is you have added significantly to the stock of debt that has to be financed.

31:29And in order to finance that enhanced stock of debt sometime in the future, you're going to have to start running higher inflation. So in a highly indebted society, the ability of the central banker to really tackle inflation is significantly lower, and it has to be balanced against a counter-objective, which is to maintain financial stability. Paul Volcker did not have that particular problem, but central bankers of today are going to have that problem already. So when you add demographic layer onto what the debt profile will look like, particularly given all these things that we have discussed, you can see why the need for AI is so high or the need for some fiscal control is so high.

32:11But how do you do it when your population is aging? One small thing I would add is an interesting similarity and an interesting lesson for financial markets out of the 70s and today is the way interest rates behaved. So another thing that we mentioned in the book is that part of the reason that inflation started rising, not only in the 70s, but also starting from the 60s, is that policymakers wanted to run the economy hot. They wanted to get labor markets to be vibrant. They wanted them to be tight in order to give some relief back to workers who had suffered since the Second World War. And what that led to was an uptrend in inflation already in the 60s.

32:49Now, in that first inflation spike of the mid-60s, if you look at the one-year and the 10-year yields, they're actually flat, which means the yield curve says, okay, inflation went up. I don't think that's a problem. It's a one-time deal. I'm not going to punish anyone for this. Then the 70s shock comes in. And at that point, the bond market does two really interesting things. Number one, it demands action from the central bank. So the one-year yield then climbs higher than the 10-year yield, which means the yield curve inverts. But really interestingly, after that recession, the 10-year bond deal does not go back down to where it was before.

33:24And then comes the bigger shock of inflation. And you see the same dynamics happening until it is convinced that you take decisive action by creating a recession, bond yields don't fall. I think we're in a very different scenario right now where the central bank simply cannot afford to act that way.

33:40Demetri Kofinas:So I feel like now is probably a good time to bring up what is a core, I would say, a core intellectual innovation of the book, which is your argument that there are two Phillips curves. Now, remind me, did Bill Phillips introduce the Phillips curve before we began to see evidence of cost push inflation driving prices higher in the economy, or had it already been developed as a theory, and then it was just adopted because the environment seemed to confirm what the theory already suggested to be true about the sources of inflation? No, I think that concept was around for a very long period of time because we had had supply shocks in the past.

34:16We had had wars in the past. So I think it was well incorporated. But this one worked as a relationship in normal times. In normal times, when you had a very little economic slack and very little labor market slack, the demand for workers would be higher and obviously push wage growth up. But they did have a very clear understanding what cost pressures and supply side shocks could do. It's just never been the norm in the past. So supply shocks were more rare. They were more associated with random events that lasted for a period of time, and therefore not the way to construct conventional thinking for 90 % of what our life used to be back then, which is a demand-led world, not a really supply-dominated story.

34:56Demetri Kofinas:Great. So since I think you've already pretty much defined what the Phillips curve was, what I think is a core innovation of the book is, as I mentioned, the separation of the Phillips curve into two curves, one being a domestic services curve and the other being a goods curve. And your argument, at least as I understand it, is essentially that the two have decoupled as a result of this period in which China became the world's factory floor. And you argue furthermore that conflating the two has led to decades of macroeconomic misdiagnosis by central banks, much of which people will be familiar with, though, maybe not in this particular model that you described, but certainly as a result of conversation we've had on this podcast for years.

35:38Demetri Kofinas:Why is your decomposition into two curves important for understanding not just what's happened in the economy with inflation, but also what could happen going forward? Okay. Let me start with the question you asked, because that's really the crux of the matter. If that's not relevant, I don't think that decomposition matters at all. So I think it's relevant because separating inflation into what drives goods price inflation and services price inflation is almost a kind of separation of history. So the separation of history element comes in thinking that when we look backwards at the last decade since the 1990s, the dominance of goods inflation in determining the overall path of inflation has been critical.

36:24And that coincides with the time that China has seen both a real benign disinflation and a malign disinflation. In the future, we feel China's role is going to be a little bit more normalized. They won't really be able to exert the same kind of disinflationary pressure. Maybe it lasts for a year or two more, maybe a little bit beyond that because it's very uncertain times in China at the moment. But what changes over the coming decades is that the role of services inflation, which is domestically generated, which is linked to the labor market, becomes far more dominant. And a critical aspect of that is if the labor market becomes tighter, faster in the cycle, excuse me, because of demography, because of a shortage of workers, because of immigration restrictions, then what you will see is that wage growth starts picking up perhaps earlier in the cycle than would have been the case in the decades past.

37:22So really, the way goods inflation has influenced overall inflation and the way services inflation will influence the future is changing. And that's why that decomposition is important. So let me take a step back and talk about why that decomposition has been misunderstood, even though it is well-defined. For example, again, I had mentioned President Lagarde. She has been very clear in calling services inflation domestically generated. Every central bank in the advanced economies and many in emerging market economies, separate goods inflation and services inflation, and they've got many refinements on this.

37:57So we're not pretending that we've come up with some novel concept. We argue, however, that the genesis of these two parts of inflation have not been clearly defined by central banks. So let me work this through with a simple example, right? I was having this conversation with the head of the European Central Bank, and they were mentioning that, look, their job is to control inflation. Why does it matter whether it comes from goods and services? They've delivered stable inflation. And it's absolutely right. I don't think that's something that can be contested. I think that's a spot on point. The difference, I think, however, is that how you've developed that inflation profile changes.

38:37So for example, let's say you're the CEO of Starbucks and you want to deliver the best priced coffee that you can in a cup to a customer. What you've already done is you've cut down as much as you can the cost of those barista machines, the cups that you buy, the coffee that you source, because that's your bargaining power. And you've really managed to squeeze every last bit of cost savings that you can. Now, if you get a cost shock and you want to keep your coffee costs low, you're going to have to start closing down branches or reducing the number of workers you have. And just recently, I think Starbucks also had count reduction in executives.

39:13That's the difference between goods and services inflation. Goods inflation has delivered to us already. In the future, if you really want to deal with services inflation, you're going to have to take very, very, very difficult steps. That's what we believe central banks haven't quite grappled with. They've looked at the past. They've looked at the way core inflation has behaved. And whether they are fully right or not, they can take some credit for controlling inflation, but not as much as they assume. Falling goods inflation has done most of the heavy lifting before the great financial crisis, afterwards, and even after the pandemic.

39:48The choices in the future are going to be much harder.

39:51Demetri Kofinas:So you mentioned that there's a faster transmission mechanism for services versus goods inflation. And as your Starbucks example just now illustrates, because labor costs as a percentage of inputs are higher for services relative to goods manufacturing, this also means that services inflation is stickier. And that in order to get those costs down, businesses will have to make more difficult decisions with potential political ramifications for companies as well. This also seems consequential when we're talking about the prospects for the durability of inflation, no? I think so. It'll be very difficult to control that for two reasons.

40:30Number one is depending on where you're talking about in the services sector, if it's in the lower income part or the lower productivity part of the services sector that you're talking about wage pressures, those jobs tend to be much more fungible. I don't think anyone with higher education can switch jobs relatively easily. People with lower skill, who are very essential for the economy, can switch jobs far more easily. So you see wages transmitting from one sector to the other far faster in lower skilled, lower wage sectors. That's a critical point. I think it will also be the case that once the persistence sets in, it's very difficult to get rid of.

41:09Here in the UK, during the pandemic and after, some of the wage settlements that were given by both the Conservative and the Labour governments have been quite large wage settlements. And whether those settlements were justified or not, I think it sets the trend for the private sector to then go and demand higher wages. You're seeing similar stories play out in Japan with wage negotiations. There's a certain inertia in price and weight setting when you can see it changing in front of your eyes right in your domestic economy. That inertia is hard to get rid of.

41:41Demetri Kofinas:So in the book, and you also address this a bit so far in our conversation, you express strong skepticism about whether China will continue to export disinflation. but you also acknowledge near-term uncertainty around the forecast. This seems like a common sense position in my view, and I would say even consensus position. But regardless, can you walk me through your thinking on this anyway, just so we understand why you feel this way? And then let's dig into some of the assumptions behind it. I'd be happy to. It's a really, really interesting topic and an incredibly difficult juncture at which to separate these forces.

42:14So I'm glad we have a chance to talk about it. Let me start with the conventional way of thinking and the problems very briefly within China. The conventional thinking around China is that if you look at the way those exports and current account surpluses have moved recently, you've seen a significant rise in the current account surplus. And commensurate with that, you have seen a fall in export prices, particularly in electric vehicles, in solar panels. And that has created knock-on effects in many other economies, in internal combustion engines and electric vehicle industries across the world.

42:49Germany has felt that. I think Detroit has felt that. And obviously, solar panels have made either production cheaper or impossible for others to compete with. And so I think the problem that many people see with China is that there appears to be a strategy of deflating export prices in order to raise the level of exports, therefore raise the domestic manufacturing footprint within China and create greater employment. That's a problem. If that continues, that can have a significant disinflationary, deflationary impact on the world, which is almost a mercantilist policy that there's a small cake and I'm going to try and take as big a share as I can.

43:33Where we disagree with that story is on both of its components. First, demography. We don't think the current account surplus is here to stay forever. We feel that, as we had discussed right in the beginning with perhaps your first question, aging societies will start seeing greater spending. In this case, particularly within China, I think that story is going to move much faster. The government will have to provide much higher protection for an elderly population. Families themselves have been saving because they can see what's coming in front of them. And the combination of the two, I think, is going to move spending higher and therefore the current account into deficit.

44:13So part of the problem that conventional economists see is not going to last forever. Second, and I think a more tangible part of that problem is that there's almost an argument that export prices have been deflated as a strategy. I don't think that's right at all for two reasons. Number one, deflation in the Chinese economy comes from three broad sources. Number one, it comes from a vicious fight in electric vehicle and battery makers that has lasted three to four years because the government has provided a subsidy to get those vehicles and batteries fast-tracked. Similarly, it comes from solar panels, which have deflated and prices have fallen by about 70-75 % over the last three or four years.

44:59Both those industries are now going through a vicious consolidation, which is really biting into profitability. It's making it impossible for entrants to come in. And Chinese policymakers don't like it. So they have tried to introduce explicit policies to try and get over that deflation. The other source that is driving deflation is the housing market. And obviously, that was something that policymakers wanted because it was a continuation of a past adjustment that hadn't yet gone through full completion. But now I think you can see that there is a desire to draw a line under the housing problem, not in a way that brings up another housing bubble, but just to make sure it doesn't get any worse and the improvements are slow and steady.

45:41So Chinese policymakers are fighting the deflation that many people believe is a strategy of the policy machine. And the current account surplus that many are worried about over a period of time will turn into a current account deficit. So we don't see China as a lasting problem. It's uncertain because we don't know how the electric vehicle companies or the solar panel industry or the housing market are all going to react over the next year to two to three. But that's not a sustainable strategy. And I don't think China sees it that way either.

46:12Demetri Kofinas:So I want to address a few of your points, one of which is the uncertainty around the near-term forecast. How can we tell if a deflationary or disinflationary wave coming out of China is temporary or not? I think you can in a few ways. Number one, the consolidation process within the auto industry, for example, at home is quite advanced now. There are four or five companies, main companies, which includes BYD, obviously, have gained a large share of the market. So any industry that opens up new goes through a period of what we would have all learned in economics textbook called supernormal profits, which is that there's a new market, it opens up, everyone rushes in because there's money for everyone.

46:55And then over a period of time, that story becomes a lot harder because some have an intrinsic superiority in that market, and they start to gain a larger and larger share. And that drives out new entrants. Unless you're really innovative, you can't really enter that market again. So we are seeing consolidation, which is quite mature in that industry, which means that the fight to really cut prices and get a larger share should abate to some extent. Second, you are seeing some pushback, right? Tariffs are coming into play. Quantity restrictions are coming into play. And that means the ease with which some of these advantages can be driven may not transmit globally as quickly.

47:33On the housing market side, I think things are also showing some promise. One of the main reasons that policymakers did want to change the way housing is sold in China is because it was sold almost as a Ponzi scheme, where property developers would ask buyers to stump up a bunch of cash, and then that cash would be used as revolving capital for other projects. And then if one of them went belly up, a lot of them would go belly up and some projects were never delivered. And it's really a burden on consumers in every sense. And it's a problem to financial stability. So they did want to change that system.

48:08But now what you're seeing is the policy machine has begun to hum the other way. The hooker population, which is a type of passport that you need if you're a rural resident to stay within urban areas, they had significant restrictions on what property they could buy and other social amenities they could use. And those property restrictions in particular have been dissolving very, very, very quickly. And that's a clear signal that China's policymakers want new buyers or understand that the housing market requires some support. And I think things are beginning to show, even in the housing sector, some signs of lifting.

48:44It's a deep shock. So I don't think it can dissipate. And there may be unintended shocks or unintended consequences of that over the next year or two. But I think the delta of both of those things in the consolidation in some of these high-tech sectors and within the housing market, which looks quite mature, it's impossible to say, I think both of those suggest that you won't change this overnight, but the process is fairly mature in terms of getting rid of disinflation or outright deflation in both parts.

49:12Demetri Kofinas:So you referenced the consolidation of the auto sector at the beginning of your answer, and this would be an example of where Beijing sees ruinous competition in sectors of the economy that have benefited enormously from the productivity gains and gains in market share abroad over the years, but which at the same time risk accelerating debt deflation domestically, given how much regional governments and Chinese banks have invested in many of these companies and projects. My question for you is, and this is a pushback or a counterargument, even if Beijing succeeds in this effort, doesn't the sheer volume of Chinese EVs and solar capacity and battery capacity represent a deflationary overhang internationally for years to come?

50:02Demetri Kofinas:And isn't it possible to argue that in fact, what this policy does is it makes the deflationary overhang worse because it's propping up domestic prices and preventing the market from clearing, which importantly preserves capacity that would otherwise have been wiped out? I think it does. I don't think that's a question. Just because you've made it difficult for them to export it doesn't mean that technology won't have a depressing effect on prices, but it's a sectoral price shift. I think if it was something that was happening in every sphere of the economy and every good that was being produced, I think the story might have been different.

50:39But we've seen that kind of a shock over the last decades. In fact, your question on the two Phillips curve was grounded precisely on that, that a very broad range of goods had not found a new equilibrium price given that China was producing it. So if you thought of the price before China as being up here and the price after China's entry for a washing machine being down here, it took quite a few years for that equilibrium price to globally drop and drop and drop. And I think we're fairly close to a situation where you have extracted a lot of that disinflationary pressure for a broad variety of goods already.

51:18And China's labor costs themselves, not least because their demography is changing, are beginning to slowly rise so that the equilibrium cost of producing goods is a little bit more settled. So if you look at goods inflation, it drops very quickly when China has a problem, which means that it's not necessarily a structural force from here on. Prices will remain low, but I don't think it's the kind of new disinflationary pressure that we saw in the 90s or even the collapse of the housing bubble created after the GFC. Some of those sectoral stories, I think, will be dominant, and they will take a toll on the counterparts in other economies, which they already have.

51:56But it's not the broad-based deflation that was a shock to the global economy, whether benign or malign.

52:03Demetri Kofinas:So one more point of pushback, though. I'm not even convinced by this question, but I'm just going to raise it because some people are going to ask about it. So China maintains an onshore and offshore renminbi. the impossible trinity suggests that with capital controls in place, China could, in theory, inflate domestically while deflating export prices through currency management. How much room does Beijing have to do this? Or it does not really matter because to your larger point, there are political forces at work. Because it seems to me that besides the demographics being an underlying structural force, from a policy standpoint, you're also making a statement about what you think Beijing is intending to want to accomplish so that therefore the fact that they have the ability technically or theoretically to do this isn't really relevant.

52:47I do tend to agree with you in your first reading of that particular question. I think you can always devise mechanisms in theory that could work. Practically speaking, I think that's incredibly hard to do. I think there have been many instances in which offshore investors have attacked offshore Renminbi and then authorities have had to really aggressively raise the offshore costs of borrowing to try and prevent that. Thinking of that as a structural solution to separate the two worlds, I think is very difficult. I think if it was that successful, other countries would have tried it and succeeded.

53:22I don't think anyone has. You could make an argument that China is different because of their clout in the global economy. If this decided to do something, they might be able to just do something that others have not been able to do. But it seems very hard in the day of Bitcoin and digital currencies and the leakages that you've seen in export invoicing in China, that you're able to sustain two vastly different exchange rates and interest rate regimes. And no one in China is able to find loopholes to get their money in or out. I think it sounds very difficult. Is it possible? Yeah, sure, in theory.

53:54But I think practicality is really make it, you could do it for a few months, But I think stretching it beyond that would make life very difficult for everyone involved in such a strategy.

54:05Demetri Kofinas:So I have a few more questions for you before we move to the second hour, Manoj. And one of those has to do with social security, which faces a very well-documented funding cliff around 2033. By the way, it's also interesting. I don't know if you feel this way, but I do. It's interesting to look back on the discussions that I heard as a young person around the the unsustainability of social security and some of these other unfunded liabilities. Because at the time, these were presented as long-term problems, and they were. That if we were smart and proactive and responsible, we could get ahead of them.

54:43Demetri Kofinas:And I feel like so much of what we're experiencing today and we're talking about even in this conversation are the chickens that we were once talking about then finally coming home to roost today. You know, that in other words, these aren't new concerns. They've just moved from the theoretical of the remote to the here and now. So I just want to throw that out there because it's so often in the back of my mind during conversations like this, and I wonder if other people feel the same way. But in the book, you suggest that politicians will bail out social security rather than cut benefits of the elderly voting bloc that has traditionally been more easily mobilized.

55:22Demetri Kofinas:And of course, politicians respond to incentives, and that's a powerful incentive. What does that bailout look like? And what do you think it's going to ultimately cost in practice? Well, first, let me say thank you really for bringing that question in that particular way up, because as you will clearly recognize, that is a problem that pertains to the horizon of thinking around demography as well, right? People are really concerned and interested about demography. But the reason I think they tend to downgrade its impact is because they feel that's something that's going to happen in 10 years, 15 years, 20 years.

55:58We've got plenty of time to deal with that. But the manifestation that you discuss is the very thing that brings it to today. The fact that social security pressures are only going to get worse because, as you mentioned, the way the social security system works is that you collect payroll taxes, and that is the majority of the receipts. And you have to give social security benefits to a larger share of the population, while the share of workers in that population is becoming smaller. So you're getting smaller revenues, and you have to give larger receipts. And right now, it's being funded through that reserve fund, which runs out in 2033.

56:34Those population pressures are only going to get larger. And what's going to be more interesting is that elections are going to be determined by the way people view these particular challenges and solutions. And politicians who stand are going to find it incredibly hard to say before they're elected, well, bite the bullet. I'm sorry, this is what we need to do. Those kinds of solutions are usually implemented only after a crisis. In a slow burn, if you will, which probably is what we're seeing right now, I don't think any politician gets elected by going up to the population and saying, I'm going to get elected and I'm going to cut the money that you receive because this is what's needed 15 years or 20 years down the line.

57:17It just doesn't happen. And I think the solution that most political parties will find when they stand for election is to probably not mention it at all, because both sides of that political divide have a inclination to not discuss solutions to problems that they both know they cannot solve. And when it comes to that impending problem, let's say we are on the eve of a fiscal cliff for the social security system, and whoever is in charge, whether you're left-leaning or right-leaning, has to solve it. The chances that they really let it fall off the cliff are high only if there has been a preceding panic in the bond market that says, if you bail it out, I will raise interest rates as a risk premium on you by tens of basis points or hundreds of basis points, and that's a crisis.

58:08If you don't have a crisis and you're approaching that cliff, I think chances are that you create an emergency solution for the next four years, or you have a path that reduces that spending over a period of time. There have been periods in which governments have come up and slowly reduced those obligations. For example, in the pension system, we move from defined benefits to a defined contribution. That was a watering down of obligations. Slowly over time, that will happen. But I think letting it collapse as a fiscal cliff is difficult. The solution you find will be equally slow. You may be able to water down some of those obligations and therefore create a smaller increase in interest rates, but you will raise debt.

58:52And if you don't raise debt, what the implications on the private sector will be also interesting. So I'm not inclined to save much because I know I'm going to get a social security transfer in the future. If I don't get that social security transfer in the future, maybe I raise my savings. Maybe I work a little bit longer. Those could be offsets. But our point is all of those are solutions. We don't think people will work less or they won't save more if the government doesn't bail them out. But you have to get to a point where the government has the political capital to say, no, we are going to let this thing expire and you are going to have to take care of it and still get reelected.

59:31That's the tricky part.

59:32Demetri Kofinas:Great. So to your point, we've already seen evidence of bond market stress in the UK under Liz Trust in 2022. We've seen a significant repricing in Japanese bond yields. In fact, I think we're at roughly 30-year highs. I think where Japanese bond yields are today on the 10-year, which last I checked was something like 2.73 or 2.75, are roughly where they were in 1997. And there's ongoing stress of the bond market for French government debt that could produce another sovereign debt crisis in Europe's largest economy. Are these early signals of the regime change that you've been predicting? I think the answer is an unambiguous yes.

1:00:12Along with the US debt story, which we've already been discussing, the three examples that you use are unimaginable a decade ago. Unimaginable. This is the kind of stuff that emerging markets get penalized for almost all the time. If you show an unfunded increase in public spending in emerging markets, the currency takes a beating. That raises the inflation profile. Central banks are forced to defend the currency and that forces the government back into its pen or back into a more conservative position. In the past, the advanced economies have never, ever had to deal with such problems where the market says, no, you can't raise fiscal spending in an unfunded, unsustainable way while the economy's productivity profile doesn't rise.

1:00:58I think it's a clear signal, even though many of those situations, we've been able to get bond deals under control. For example, in the trust administration, the Bank of England stepped in and did a one-time QE. We've had all kinds now. This is a one-time QE for financial stability, which goes to our earlier discussion about what central banks can and cannot do in a highly indebted economy. I think it's a clear signal that markets are saying we have reached a point where the future of debt and current debt to GDP stock is so high that without lower interest rates and lower borrowing costs, you can't sustain it.

1:01:36And we won't allow unfunded debt to really be forced down our throats. I think that's an entirely different world that governments are living in now.

1:01:46Demetri Kofinas:And I didn't even mention the fact that 30-year treasury yields are now at levels that we haven't seen since before the great financial crisis. So again, to your point, there may already be signs of your thesis playing out here in the United States as well. I'm going to move us to the second hour, Manoj, and I'd like to start that part of the conversation with a discussion about the housing market, which we spoke a little bit about, but which I'd like to dig into in more detail as it pertains to mortgage rates, investment in new housing construction, intergenerational wealth transfer, and whether or not this may actually become a hot button political issue, as well as a lever on which governments can pull to make up shortfalls in their revenues through things like land taxes or floor space taxes, which you write about in the book.

1:02:36Demetri Kofinas:We're also going to have time to discuss the effect AI could have on the labor market, ways in which it could both mitigate and exacerbate some of the underlying structural forces that we've described so far, and that you go into much more detail about in the book, as well as implications for central banks if and when we enter into a regime of fiscal dominance, and what this means for central bank independence, and if and when we enter into a regime of fiscal dominance, and what this means for central bank independence, implications for investors, and much more. For anyone new to the program, Hidden Forces is listener supported.

1:03:12Demetri Kofinas:We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want to access the second hour of today's conversation with Manoj, head over to hiddenforces.io slash subscribe and sign up to one of our three content tiers. All subscribers gain access to our premium feed, which you can use to listen to the rest of today's conversation on your mobile device, using your favorite podcast app, just like you're listening to this episode right now. Manoj, stick around. We're going to move the second hour of our conversation onto the premium feed.

1:03:46Demetri Kofinas:If you want to listen in on the rest of today's conversation, head over to hiddenforces.io slash subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Stylianos Nicolaou. For more episodes, you can check out our website at hiddenforces.io. You You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.