Can the New Fed Boss Shrink QE Without Crashing Everything?

0:00On the podcast today, who controls money? Central bankers? Are the market? Is it push? Is it pull? And ultimately, will the new Federal Reserve Governor in the United States achieve what he wants to achieve? That's all coming up in a couple of minutes.

0:46And send it back to you to get your results. The Cologuard is an option with a recital to detect the colon cancer in people of 45 years or more with average risk. Resultados positive can be followed by a colonoscopy. They can give results false positive and false negative. The Cologuard does not replace the colonoscopy in high risk patients. No use Cologuard if you have a disease, if you have an inflammatory intestinal, or certain symptoms of a person or family of cancer. Pide la prueba de Cologuard a tu médico. Para más información en español, visita Cologuard.com-prueba.

1:43for three-month plan, equivalent to$15 per month required. Intro rate first three months only, then full price plan options available. Taxes and fees extra. Default terms at mintmobile.com.

1:55Just a quick note before we start. Why don't you join the crew? That's the David McWilliams Podcast crew. It's davidmcwilliams.ie forward slash crew. Now, what you're going to get from joining the gang is every episode will be ad-free. There'll be a full archive of past premium episodes. There's going to be access to the macroeconomic audio course, which is every Friday, fresh new lecture every Friday. And we're going to have a Q &A once a month where I'm going to be available to answer all your questions. You'll have pre-sale access to live shows, podcast shows, priority access to Kilkenomics and Dalky Book Festival tickets.

2:34And you will be in the mix for signed book giveaways. That's all, davidmcwilliams.ie forward slash crew. Join the crew. To understand the economy, you have to understand human nature. This podcast is powered by Acast. How are you doing there? It is podcast time. And as this podcast is going out on a Thursday, we're going to really pick up where we left off on Tuesday. We were talking on Tuesday about not necessarily just cryptocurrencies and Bitcoin. And actually, we're doing Archimedes. We were doing Newton. We were doing Dante. We were all over the shop. It got very scientific. It got very, very scientific.

3:20For real, John's head was melted. I love all that stuff. But what we're going to do this time around is we're going to, John, look at central banking. Yes. And we're going to, it's going to be a little bit wonkish, this particular podcast. But I think it's important. More wonkish. More wonkish. No, but I think it's important, right? Because there's a lot of talk about economics, finance, monetary economics, currencies, rates of inflation, rates of interest, open market operations. We talked about that last week. Central banking. There's a new central banker, top of the Fed, coming in. We're going to talk about him.

3:53But what I want to talk about is actually what do central banks do? Yes. Before you yawn, right? Yeah, you know. Switch off, okay? It's absolutely crucial because central banks control money. Yeah. And as Nathan Rothschild said, I don't care for the man who controls the army. Give me the man who controls the money and I'll tell you who controls the society. Right. So what he meant by that is we need to understand what do central banks actually do? When you say they print money, what does that mean? When you say that they negotiate and determine the price of interest, What does that mean? When you say that they absorb in treasuries, what does that mean?

4:36When you hear the new central bank governor, Kevin... Warsh. Warsh. Let's go for Warsh. Warsh. Okay. Yeah. Says, I want to reduce the Federal Reserve's balance sheet. Most people are like, what the fuck? Yeah. Yeah. Yeah, yeah. Me included. And yet, that one utterance sent the price of gold and silver tanking the back end of last week. Right. It changed perceptions of the dollar. It changed perceptions of interest rates. So we're going to talk about what do central banks actually do? That's the first thing. The second thing that I will talk about is, because I know you're always concerned, John, about the end of the dollar.

5:15Dear listener, John loves a story. Well, the end of everything, right? The end is nigh. The end is nigh. John is an Armageddonist, really, deep down. He believes in... I just want to see what an Armageddon would look like, really. You don't want to be involved in Armageddon. No, no, I want to be a voyeur. Yeah, okay, the boy and the rapture, John. You know when we talk about the rapture, the end of days, right? That if you're an evangelical in America, you believe that there is a great day of reckoning that is going to come upon us. That day of reckoning will involve all the sinners, who typically are people like you and me, who have overdrafts rather than large spending accounts, are going to pay for our sins, right?

5:54But we'll talk about that. But the basic idea, what I want to start off, John, is what... Does the central bank do? Who are the people behind it? Why are they regarded in this sort of conspiratorial world as being an unwashed, unelected elite who are making policy? They go to a place called Jackson's Hole, John, which is not exactly what you think it is, right? It is a place in Wyoming every year, right? Yeah. Okay, and we'll talk about that. So that's what we're going to talk about. And they do a bit of fishing there. They like a bit of fishing. So come here to me. Last podcast, we talked about Bitcoin.

6:32And Bitcoin in the last couple of weeks has collapsed or certainly down. Has fallen. Has fallen a lot. 40-something percent anyway. In the last, certainly in the last, yeah, last couple of weeks. Yeah, right. A few weeks. Also, the dollar is down massively and has been continually weakening since Trump actually got into power. Yes. So here's my question then. This new head of the Fed, Kevin Warsh. Yes. What is he going to do? But more to the point, what can he do? And is he, you know, are they going to strengthen the dollar? Is that the plan? Is that the strategy? No, I think. Talk me through it.

7:13So the first of all you have to understand is what is money? Money is divided by two things. It's not Bitcoin. We've solved that one. There's two parts of money. One is currency and the other is finance. And this is a very important thing to get your head around, right? So currency is the money in your pocket, the money on your card, the money in your account, basically your deposit account, okay? And that money is about 10 % of the global money supply. So 90 % of what we know to be money is what we call finance. And finance is the alchemy of money. It's where money really comes alive because in effect, currency is inert, whereas finance is dynamic.

7:58So finance is this amazing inherited system of debts, obligations, of legal systems, of reputations, of everything. The best way to look at it is mortgages. Mortgages are finance, right? where you go into a bank and you say to the bank, I'd like 200 grand to buy, not a billion like Michael Saylor, maybe 200 grand, maybe 300 grand to buy a house. Yeah. Right? And the banks say, okay, fine. They look at your credit rating. They look at your income. They look at your previous defaults. They look at anything they should be worried about. And somebody says yes. Yeah. And then suddenly what happens is money is magicked up by the commercial bank.

8:46Right? So that's basic finance because they make it up. So basically, the 300 grand that you looked for today didn't exist yesterday. Right. And tomorrow it's in your account. And they just transfer it. They just tap it in. It's just a number, right? So I'm going to explain that because this is the alchemy of money. Yeah. And finance is everything that gets financed. Whether it's bonds, whether it's currencies, whether it's stocks, whether it's lending. But most of the time, it's not financial markets. It's just punters and companies buying from each other into the future. I pay you back in 10 years' time.

9:24Then you have to think of the rate of interest. The reason the rate of interest is so important is the rate of interest is the price that we decide I'm going to borrow from you and you're going to willingly lend from me. So the willingly is the key thing. So in that one price, the rate of interest is a phenomenal amount of information. It's an information about you, about your income, whether you've defaulted before, what sector you're in. You know, if it comes to you and I, it's how's your health? All these sort of things. No, seriously. Not good. Not good. So look at the rate of interest as an encyclopedic piece of information about everybody.

10:04Yeah, yeah. Because it carries. So if you say the rate of interest in a country is 10%, what that signals to you in the country is the country is corrupt, the country is unstable. It is probably going to default. Whereas if you see the rate of interest is 2 % in that country, then you probably think, okay, that tells me that the savings infrastructure is very strong. It tells me that the population is probably quite old. It tells me the population is quite stable. It tells me the rate of inflation is very, very low. It probably tells me the currency is very, very strong. It also probably tells me...

10:37It's like a health check. Exactly. It's an MRI. the rate of interest is an MRI for the financial health of an individual and or a country. Right. So look at that. You go into the MRI and you and I have gone into it before. Yeah, yeah. And you know, and you come out the far side, right? So it's an MRI for the financial health, right? Yeah. So then the question is, who controls money? Yeah. We know the central banks control currency, but who actually controls finance? and this finance is 90 % of what goes on in the financial markets. And as I said, it's not just about stock markets, it's about everything we do, right?

11:16The question is, who does it? Now, the story you learn in university and the story that monetary economists tell the world about money is actually wrong. Here's the big reveal, John. Here's the spoiler alert, that the central bankers who swanning around Jackson Hole and all those places, and Davos last week. Yeah. Pretend they're in control, but they're not. This is a very interesting, slightly alarming piece of information. Yeah, yeah. So here's the thing, right? As finance is 90 % of the money supply, maybe 80 % in most countries, right? Yeah. Currency is controlled by central bankers. the amount of money into deposits, right?

12:08But finance is not. And the reason is the following. Sorry, you're just saying like nobody in general is in control. That's why we have crises. That's why we have recurrent financial crises. That's why some poor agents... It doesn't sound like a great system then. Well, it is an evolutionary and organic system. But I'll explain it to you, right? Yeah, go on. So the story that if you learn monetary economics in university, you go in and there is two stories. There's the push and pull factor, story. The push and pull story, right? The one that central bankers teach the world is the following, that the central bankers determine how much money the economy requires dependent on or predicated by the rate of growth, the rate of housing formation, the rate of employment, the rate of demand, all that sort of stuff.

13:00So basically, the story central bankers tell us is that in the central bank, there's a bunch of boffins, of which I used to be one. Okay, right? And these boffins have a great insight into the economy because they're all trained economists. They can come up with really accurate macroeconomic forecasts. And as a result of that, they say, well, the economy is going to grow by 5 % next year. So then at the central bank monetary committee, we say, okay, well, if the economy is going to grow by 5%, the money supply should grow by 8 % because there might be 3 % inflation. Right, okay. Okay, and then once we've decided that as the boffins in the central bank, we then in effect make 8 % more money available to the banking system.

13:44Okay. And we ring up the banking system and we say, lads, there's a whole load of money here. Who wants it? And the banking system says, oh, I wouldn't mind that. I'll get that and I'll lend that to somebody. and the central bank sets the rate of interest at the top and they push the money into the system. Okay. And the finance part of it is the commercial banks take that money and then they push that money onto people. Yeah. And that is the push story of how money is created. It sounds good because it gives you the sense that somebody at the top is in control, number one. Yeah, yeah, yeah. And that in control is informed by economic knowledge and wisdom and all that good stuff, right?

14:25And it sounds really good. Yeah. But it's wrong. Right. How so? Because what actually happens is something quite different, is that the way money is created in an economy, the push system says it's a top-down system and everything goes to the top and it's pushed down into the thing. What actually happens is the following. You decide that you want to buy a card. tomorrow. John Davis wants to buy a car and the old banger outside, it actually isn't a bit of an old banger, right? Outside. Who dare you? Okay. Okay. But John's banger outside needs to. Yes. Be. Indeed it does. To migrate to banger heaven, right?

15:09And then you go into Bank of Ireland or AIB or whoever your banker is. And you say, I'd like 40 grand to buy a car. And the bank says, okay, John, that's grand. Come back to us tomorrow and we will put your application into what we call the lending committee. The lending committee are little fellas in probably quite bad suits these days and they assess John's creditworthiness and they think he's a bit dodgy but you know what? We'll give him 40 grand. Yeah, I come out of the MRI, all right. You come out of the MRI, all right. Exactly. They've had the MRI, little bit, little fatty liver, Use your stuff at our age.

15:50But you know what? You're okay, right? Yes, yeah, yeah, yeah. And then all that money goes into the lending committee and the lending committee say, John, there you go. Yeah. Right? Now, there is a bizarre thing that happens then. The bank then push a little button and in that little button goes 40 grand into your account. That money didn't exist yesterday. It is created out of nothing by the banking system. It is not covered by deposits. It is not covered by anything. The banks have this extraordinary money-creating capacity, and they are given a license, i.e. a guardrail, by the central banks to do their business.

16:34But the problem with that is there's always an incentive in the banking system to create more and more money. But there is a limit, though, right? There is not a limit. There's not a limit. There's not a limit. This is the whole thing, right? There are many, many guardrails because if you think the central bank as the issuer of money is a monopolist. Yeah. A monopolist, in the definition of monopolist, it's the monopoly issuer of currency, right? Is a monopolist can, and this is a very basic economic idea, set either the price or the quantity, but they can set both. Okay, right, right. So they set the price.

17:11So what they will say is the rate of interest is 5 % And at 5%, we'll see what the market decides, right? Yeah. So therefore, the market, i.e. you, decides, well, if it's 5 % from my overdraft or whatever it happens to be, fair enough, I'll go for it. And the banks then expand the quantity. Now, there are some limits, and I'll go into the limits in a second, right? Yeah, yeah. There are some limits to what the banks can do. But in a world, derivatives and all sorts of things, there really are no real limits until things get too... That's a bit scary. It is scary, yes. I mean, there's capital adequacy ratios and all those sort of things.

17:46They sound great, but in effect, what you have is a system that is about discretion rather than rules. So in effect, John, basically, you know, the central bank thinks that it's pushing money in, but it's actually been pulled around by the commercial banks and the commercial banks always have this almost built-in danger point where the commercial banks will always lend too much. So the commercial banks are more in control than the central banks? They are much more in control in the sense that they create the money. The central bank doesn't create the money. The central bank determines the price of money, which is the rate of interest, but it doesn't determine the quantity of money, which is determined by the commercial banks.

18:34And that is the flaw endemic in the system that most economists and central bankers care not to explain to people. Right. Right. So that's the first thing. The second thing is then, how does the central bank do what you're talking about, at least oversee the commercial banks? Yeah. And that's where treasuries come in. So imagine that the central bank is the banker's bank. Yeah. So in the same way as you have deposits in the bank, and you basically say to the bank, here's my wages, can this be on deposit, etc. Banks also have deposits with the central bank. So what are those deposits? This is the key, and this is why the treasury rate is so important.

19:23The deposits that the banks have with the central bank, which gives them the license to create more money, are government bonds. So this is how the system is all integrated. This is how the government system, the banking system, the central banks are all part of the one big, what I would call financial establishment. Yeah. So what happens? So hang on a second, Mac. So that is the very reason why the independence of central banks is really important. It is. But again, I think it's Mickey Mouse. Oh, okay. This is, you know, I'm a skeptic. Yeah, yeah, yeah. I am. I am. But you're the inside man. I was the priest who kind of realized, you know what?

20:06The body and blood of Christ isn't in the communion. It's only makey-uppy, right? Okay. When you do the hocus-pocus over the tabernacle, it doesn't really... Anyway, so, but I do, I think it's a religious image I have in my head of this. So, central bank independence was supposed... Now, you've asked me the question a little bit sidelined, but dear listener, central bank independence was a function of the 1970s, in effect. In the 1970s, the world experienced rapid increases in a character and a creature that we hadn't met for a long time called inflation. Right. And inflation freaked everyone out.

20:45And ideologically, there was a thing called monetarism. And monetarism said, under the auspices of Milton Friedman, that inflation is always and everywhere a monetary phenomenon. So if we can limit the money supply, limit the amount of money in circulation, we will ultimately limit the amount of price increases in the economy. So less money in circulation, less price inflation, less inflation, less money in circulation. And that's what you had a whole period in the 1980s of what they called money supply targeting in the 1980s. Part of that was an ideological article of faith that if we separate the central bank from the government, central bank will not be obliged to finance government deficits.

21:33Now, what does that actually mean in reality? It meant that in the 1970s, the governments were saying, the economy is stalling, unemployment is rising, welfare payments have to rise, we need money, we need to borrow. Yeah. So typically you can borrow from two areas. One is you're going to borrow from punters, our institutions, and the private sector, or you can actually borrow from the central bank. So you go into the central bank with a whole bunch of IOUs, and you say, here's an IOU, here's a piece of paper, you give me$100 million. Right. And on that piece of paper says, I owe the central bank$100 million at a rate of interest of 5 % to be paid back over the next 20 years.

22:17Right. So. I'm going to try this. This is a great scam. This is a great scam. So basically in the 1980s, they said, look, hold on a second. As long as central banks are part of the state, they are obliged to do this. We will never be able to stop the rate of inflation because governments will be the creators of inflation. Why? Because they are issuing the debt to the central bank. The central bank's then giving them the money and they're spending the money. So the money supply will continue to expand. So it was meant to be this incredibly elegant way of which we're going to change the world. But it didn't work out that way.

22:53I was afraid you were going to say that. It didn't work out that way, right? So if independent central banking, which is now an article of faith, had delivered the discipline on governments that it said it was going to deliver, why do we now have higher government deficits and debt than we've ever had in our lives? Yeah. Because it doesn't work. Yeah. Okay, so that's the first thing. Yeah, yeah, yeah. Okay, I'm getting this. This is about, you know, the Shibboleths. This is about destroying the Shibboleths, right? So Shibboleths were a tribe in the Bible, John. Yeah. So around Jesus Christ's time in the Bible, there were loads and loads of little tribes, all of whom were saying that they were the Messiah.

23:32Yes. There was the Judea's people's front, and then the people's front of Judea. Exactly, all those things. And Christianity and all these things, right? All these off-shirts, right? Exactly. So think of the life of Brian. And one crowd in Galilee were called the Shibboleths. And they were a particular sect. And to prove that you were a member of the Shibbolithic sect, you had to be able to pronounce Shibboleth properly. Right. Okay. Which is how? Shibboleth. All right. So you're part of them. I learned it. Right. It's like in the Second World War, how Dutch people used to try and identify who was German and who was not.

24:11Who was a German spy. they used to ask me to say Groningen, the town, properly, with a Dutch accent, and most Germans can't do it. There you go. Shibboleth, right. Right, okay. So a shibboleth has come to, so basically to be part of the shibboleth, you just had to know the code. Yeah. So in economic shibbolethism has actually become a byword for not thinking for yourself. Okay, yeah. So shibboleths replace hard thinking. And one of the shibboleths of central banking was that independent central banking would cause the rate of inflation to fall and the rate of government expenditure to fall too.

24:46That hasn't happened. But there's still, loads of them are still talking about it. If you listen to them at Jackson Hole, they're still talking about it. Yeah, yeah. It hasn't actually happened. So let's go back to finance and money. How the central bank controls the money market is they require the banks who have the license, this is to your question of is there anybody in control? Yeah. They require the banks who have the license to every day deposit a certain amount of treasuries, government bonds with them as collateral, as security. Okay. Right? Yeah. But it isn't a one for one relationship.

25:26It isn't like you give me 100 million of government bonds and you can now lend out 200 million of dollars. It's just you give me this collateral and we will then oversee at arm's length what you are doing. And the problem for that, it's a very simple thing, is that in banking crises, bank crises, very simply, the easiest way to rob a bank is to run it. Right, yeah. If you look at the modern world, you know, bank robbers don't come over the wall with a bag of swag and blow off the doors. That's a big thing on your eyes. Okay, that's not how banks go bad. Banks go bad from the inside out. And they are robbed usually by their own people.

26:10Now, by that I mean what happens in the banking system is because the oversight is at arm's length, because the way in which a bank gets the permission to lend is by buying government bonds. If they buy up lots of government bonds and deposit those bonds at the central bank, The central bank tends to look the other way, right? Is this the kind of Anglo-Irish kind of vibe? All that sort of stuff. But Anglo-Irish is even, that's even better a crack than that because they actually ran out of money completely. Right. They ran out of all deposits. And then they started borrowing from everywhere, which is why at the end Anglo-Irish was issuing a three-month paper saying we'll pay you back in three months at 12 % from the rate of interest is two.

26:55That's always a very bad sign. Right. If somebody says I'll pay you 12 % from the rate of interest is two, you know they're bankrupt. And that was the Shawnee Fitz thing at the time. But to come back. But again, Anglo-Irish was robbed by its own executives. But that's what I mean. And why is that? Because the executive pay was linked to profitability. Profitability in banking is linked to the quantity of loans you make. Why? Because you make a loan at 5%. You pay deposits at 2%. you are making a 3 % margin. The more loans you make, the more percentage you get. If that then drives up the share price, and if your pay is your salary plus a bonus in shares of the bank, there is always an internal mechanism to drive the bank over the hill.

27:49And that is the absolute weakness of banks. And there's one last thing that banks have. It's what's called a time mismatch. which is the following their deposits i.e your deposits you can withdraw those deposits if you go to AIB tomorrow you say I want my deposits back they probably have to give you them back either straight away or over the period of a month they might say well we've got to hold on to a month or whatever right yeah yeah yeah yeah so their deposits which are their liabilities because they're losing money on the deposits they are very short term their assets which is the mortgage you just got is a 30-year liability.

28:30So it means there's a mismatch between their assets, which are for 30 years, and their deposits. So basically what they're doing is they are claiming that the deposits are collateral, which they're not really. But they have a financing mismatch that if everybody wants to take their money away today, they can't sell the house that you are in to get their money back. So a bank run occurs, which is why it's called, as I've always said, a bank run, not a bank amble or a bank stroll. It happens very, very quickly. So now to come back to your question, are central banks in control? No, not really. What they are is they have guardrails for the banking system.

29:15And rules like fractional banking and... Fractional reserve banking, again. Fractional reserve banking is the key to understanding this, which is that banks only have to keep a fraction of their reserves in liquid assets, and they can lend out as much as they want after that. And that is the weakness at the core of banking. That is why we have banking crises. That is why we have periodical banking crises and financial crises. And that is why, ludicrously, some poor old central bank Egypt is wheeled out on prime time after the crisis to explain what happened when they weren't in control at all.

29:57Okay, I understand all that. And it's alarming that... It's terrifying. Yeah, it is. It is. But, okay, if you were in charge now, how would you change that system? Is there a system that would work and would work better? No, you see, the interesting thing is that, you know, I believe the economy is an evolutionary mechanism. Yeah. And I believe that in most periods, things mooch along quite nicely. Like we don't have financial crisis every week. We have them once a generation, right? Yeah. So what you would find is that the asset, typically it's an asset that causes a financial crisis, whether it's AI in America now, whether it's housing in Ireland 10 or almost 20 years ago now.

30:43And if those assets are rising very rapidly in price, then what the central bank should do in that case is specifically target those assets and say you cannot lend against those assets anymore to the banking system. Right. Be aggressive with it. Yeah. And so you look at asset management as your, in effect, leading indicator for bubbles. But you would be accused then of putting the kibosh and the brakes on economic growth. Or the housing market, for example. Yeah. Yeah, and you would say, well, look, economic growth comes from all other different areas. Yeah. But the problem is, in our Western society, that wealth accumulation through housing in a country like Ireland is regarded as almost a rite of passage for a generation, our generation in particular.

31:41Yeah. And very, very few politicians will stand over that, which is why the central bank independence should count. Yeah. And they should act, but you rarely see them acting. And that's where I think it's a bit of a shimmer. I think it's a bit of a smoke and mirrors operation. But just to come back to you, that's how a central bank works or doesn't work, as the case may be. Yeah, yeah, yeah. Right? And the reason then that long-term interest rates are so pivotal is because long-term interest rates in the American 10 or 30-year bond is the price of the collateral that the commercial banks give to the central bank.

32:22And as a result of that, it sets the price of all their other lending. Gotcha. Because they have to make a margin over and above that, which is why people agonize about and fret about the treasury yield. It's not that the treasury yield only reflects the risk on the American government, whether it's going to default or not, what the treasury real actually is, it is the price at which the financial system reinvents itself every day. Can I ask you a question then? I told you it's going to be wonky. It's wonky, all right. Dear listener, I told you we're getting the weeds here, but it's good to get in the weeds.

32:58So in the EU context, it's the ECB that sets the interest rate. Yes. So the Irish Central Bank doesn't even do that. They just implement the ECB's rules. The Irish Central Bank is like the post office in Mayo. Right? Right, okay. Okay? Imagine you're the postmistress in a post office in Mayo. Yeah. Right? Yeah. And you go from where the letters go in Mayo, you have savings accounts, post office savings accounts. You probably engage a lot of delivery vans in Mayo. Yeah. Well, you don't set the price of anything in Mayo. Yeah. Right? Yeah, yeah, yeah. So the Irish Central Bank, but the dilemma...

33:39It's not against Mayo, by the way. Not against Mayo. We can call Galway. Yeah. Call Sligo. Or Dunleary. What the Irish Central Bank can do is they can stymie innovation. So what has happened, I believe, from talking to a lot of people, is that the Irish Central Bank were so traumatized by having missed the 2008 crisis, where they basically said to the banks, you can do whatever you like, and they were all playing golf together, and they were all mates, right? And there was a revolving door from the central bank into the banking system, etc. After that, when the whole top brass had to resign, the new lads who came in have done, I think it's kind of human nature.

34:23You are over generous and lax in one market when you should be a little bit more prudential. You end up being too prudential in the market now. So we have a strange situation in Ireland where it's very, very difficult for anyone to get a license to do anything in financial markets. You've talked to anybody who's tried to own banks, to open banks here. And as a result of that, Ireland is what they would call underbanked. We've only got two banks here. Yeah, yeah. You know, I'm not saying that Celtic Tiger was great, but we had about 15. There were options. And there is, bizarrely, about 160 billion euros on deposit here.

35:03Right. Right. That's Irish savings. It's a huge amount, right? So the banking system is almost like a safe deposit box rather than a generator of loans, et cetera. So what we have is a very dysfunctional banking system. And at the top of that, we have a dysfunctional central bank that doesn't seem to me to be aware of or cognizant of its responsibilities to the economy, which is to make sure the financial system works for everybody. Okay, Mac, so just to come back to what we're talking about at the very top, which is the Fed and the new boy, Kevin Warsh. He said that he wanted to reduce the Fed's balance sheet.

35:48Yes. What does that mean? Okay, I'll tell you about that after the break. Good idea.

36:03Happy birthday, Rafa. Sopla, sopla. Traiga la manguera que son 45. Cuando cumples 45, te toca soplar muchas velas y examinarte contra el cáncer de colon, ya que al detectarse temprano es más tratable en 9 de cada 10 personas. Usa la prueba de Cologuard en la privacidad de tu casa y envíala de regreso para obtener tus resultados. The test is a option with a recital to detect the colon cancer in people of 45 years or more with a high risk. The positive results can be followed by a colonoscopy. They can be positive results and negative results. The test is not replacing the colonoscopy in high risk patients.

36:43No use Cologuard if you have an endometriosis, if you have an inflammatory intestinal, or a certain disease of a family or a family of cancer.

37:00Hey, this is Adam Grant, host of TED's podcast, Rethinking with Adam Grant. Have you heard of Bill? It's the intelligent finance platform that uses AI to help you avoid costly errors and optimize cash flow. In fact, Bill reports that over 90 of the top 100 US accounting firms trust them to manage, move, and maximize money, proven by over a trillion dollars in secure transactions. Eliminate the friction and start scaling with the proven choice. Visit bill.com slash proven to talk with an expert about automating your business finances and get a$250 gift card as a thank you. That's bill.com slash proven.

37:34Terms and conditions apply. See offer page for details. Parles-tu français? Hablas espanol? Parli italiano? If you've used Babbel, you would. Babbel's conversation-based technique teaches you useful words and phrases to get you speaking quickly about the things you actually talk about in the real world. With lessons handcrafted by over 200 language experts and voiced by real native speakers, Babbel is like having a private tutor in your pocket. Start speaking with Babbel today. Get up to 55 % off your Babbel subscription right now at babbel.com slash acast. Spelled B-A-B-B-E-L dot com slash acast.

38:13Rules and restrictions may apply. Okay, Mac, as we're talking about how central banks work, which is quite an eye-opener, but we started with talking about the Fed's new head, which is Kevin Warsh. And he was talking about what he wants to do, his main thing is to reduce the Fed's balance sheet. What does that mean? Okay. And how do you go about doing stuff like that? Okay, very interesting question, John. Well, I think we will conclude the podcast. So we've explained why I believe that central bankers are half in control and not particularly in control. Yeah. Who's depositing what and all that sort of thing.

38:56So Kevin Warsh came in and he is regarded as somebody who will reduce the size of the central bank in financial markets. Now, what does that mean? So there's a thing called QE, quantitative easing. So one of the roles of the central bank is to be the lender of last resort. So when the financial system gums up, when there's a banking crisis, and when liquidity dries up, i.e. banks don't lend to each other because they're worried that each other's balance sheet is really ruined, the central bank is obliged to come in and be the lender of last resort. Now, how does it do that? What it does is it brings up all the banks, says, listen, guys, you have a liquidity problem.

39:40But you have on your balance sheet lots of assets. those assets we will make liquid if you turn up at what's called the discount window. This is, right? Or is it around the back? Yeah, it's around the back. Yeah, it's the tradesman's entrance. You arrive up with your, you know, a pawn shop. It's the same basic principle as a pawn shop. Right, okay. Like, don't get away from this. This is not that complicated. How much can you give me from a watch? Exactly. That's exactly what they're saying. I've got my watch. I've got an old overcoat. I've got a pair of runners. I've got a pair of sneakers, you know, in your case, lingerie.

40:14you know whatever and um then yeah and you give over your your goods and they give you cash so keep that in mind that's exactly what's happening you're absolutely right right it's like a pawn shop right so what they what the center bank says look all your government securities that you have that your treasury has bought that your your actual bank has bought give us them all and we'll give you cash okay and then they say to the government this is qe look, what we'll do is we'll take your securities too for cash, right? So what they say to the government is you sell your IOUs to the banks and the banks will turn up at the discount window and we will take all of those IOUs and we will give them crisp new dollars.

41:04So what does that do then? That expands the money supply very, very quickly. And inflation. But if you're in the case of 2011 and 12, you're in what Keynes would call a liquidity trap, where companies and people have too much bad debt and they don't want to borrow no matter what the rate of interest is. And banks have too much bad debt and they don't want to lend. So if you inject money in that sort of situation, you won't get inflation. You will tend to get economic activity. That's what QE is. It was meant to be emergency. But the problem is it's very difficult to unwind these situations. So what Warsh is saying is we are now going to taper the QE.

41:49We are going to stop buying at the pawn shop, keep this idea in your head, old watches. We are going to stop doing that or we're going to give you a massive premium. So in the past we would have given you, let's say the watch is worth 100 quid. We'll give you 80. now we're going to give you 60 right okay so the amount of money consistent with that collateral begins to diminish now the problem with our friend warsh so that's the reason that's where he says so reducing the balance sheet is in effect saying the pawn shop discount window is closed yes right okay you can all fuck off okay but the problem with telling people to fuck off is if the financial system is highly leveraged and everything is borrowed against everything else because the discount window was open for so long so cheaply money flowing in it's a hugely fragile balancing act to reduce the amount of central bank purchasing of collateral yeah while at the same time not risking an implosion of the entire system which in itself is built on leverage.

43:03So he's got an incredibly difficult balancing act. Now, the reason the dollar has rallied, the reason silver and gold have fallen is because people think he will try to do this. And they will tighten monetary policy. They will make the amount of money in the economy reduce. They will hold in the banks and they will be able to do this all without a financial crisis. And that is the big gamble, John. And do you think that this will work? I mean, what will that do to say, you know, for the average guy in the street, you know, the affordability crisis that they deny is actually happening? But what will that do?

43:48They deny. It's all about them. Those people. So what that means... They know who they are. They know who they are. We know who they are. They don't know that we know who they are. Okay. What it will do is it will reduce the availability of credit in the economy. Right. Now, what Warsh is saying, and that's quite interesting. Remember we did an interview with a guy who wrote a book called The Lords of Easy Money about three years ago. Yeah. But what Warsh is saying is the main recipients of all that excess money have been financial markets, have been assets has been Wall Street rather than Main Street.

44:29And what he's gambling on is that asset prices will fall quicker than the amount of credit available on the street will fall. That's an absolute imponderable in the sense that there's no reason to believe he can do it. There's also no reason to believe he can't do it. Right. I'm none the wiser. I'm none the wiser, exactly. But you'd pay millions for that sort of advice, wouldn't you? That's what the fellas on Wall Street say. Things like this. Yeah, yeah, yeah. But it means that America is going into, this is maybe the pressure on the dollar or whatever, that America now is going into really uncharted waters financially.

45:12Because in the past, the level of debt in the system was kind of manageable. Yeah. And the aspirations of the central banks were kind of modest. This guy is coming in and saying, you know what, we will need to change the way we do business. And if needs be, the rate of interest will probably have to rise. Donald Trump, who appointed him, is saying, I want the rate of interest to be at 1 % for my re-election. And that, I think, is why financial markets are very nervous because two things cannot be true at the same time. It is almost impossible, and we leave it here, John, to reduce the central bank's balance sheet while at the same time reduce the rate of interest.

46:05Warsh believes this. He's a kind of a conviction guy. He's convinced that this is happening or this can happen. He's got many years' experience in financial markets. But, you know, what happens is the United States has been on a borrowing binge since 2008. And these borrowing binges tend to come to a shuddering halt. And all the indicators are is that Americans are overspending. Government debt, current account, deficit, all these things. So I wouldn't be too confident. Sounds like quantum mechanics of banking. But the difference by quantum mechanics, John, is it's measurable. This is not measurable.

46:53Schrodinger's kitten. Yeah, this is all the kittens. These bag of cats, right? Quantum mechanics is measurable. Yeah. This is not. Why? Because at the centre of the whole thing is the bizarre creature called the human being. And he is, she is, unpredictable, irrational, splendid, mad, chaotic, mendacious and ultimately unforecastable. So we'll leave it there. And fun. And lots of crack.

47:43¡Feliz cumpleaños, Rafa! ¡Sopla, sopla! ¡Traigan la manguera, que son 45! Cuando cumples 45, te toca soplar muchas velas y examinarte contra el cáncer de colon, ya que al detectarse temprano, es más tratable en 9 de cada 10 personas. Usa la prueba de Cologuard en la privacidad de tu casa y envíala de regreso para obtener tus resultados. The test is a option with a recital to detect the colon cancer in people of 45 years or more with a high risk. The positive positive results can be followed by a colonoscopy. They can give results false positive and false negative. The test is not replaced by colonoscopy patients with high risk.

48:23No use Cologuard if you have an adenomas, if you have an inflammatory intestinal, or a certain disease of a person or family of colon cancer. de colon. Pide la prueba de Cologuard a tu médico. Para más información en español, visita Cologuard.com diagonal prueba.

48:41Shipping, billing, admin, payroll, marketing. You're managing all the things. So why waste time sending important documents the old-fashioned way? Mail and ship when you want, how you want, with stamps.com. Print postage on demand 24-7 and schedule pickups from your office or home. save up to 90 % with automated rate shopping. That's why over 1 million small businesses trust Stamps.com. Go to Stamps.com and use code PODCAST to try Stamps.com risk-free for 60 days.

49:37Cologuard. And send it back to your results. The test of ColorGuard is an option with a recital to detect the colon cancer in people of 45 years or more with a high risk. Resultados positive can be followed by a colonoscopy. They can give results positive and negative positive. The test of ColorGuard is a test of the colonoscopy in high risk. No use ColorGuard if you have an adenomas, if you have an inflammatory intestinal, and certain symptoms of hereditary or a family of cancer.

50:15With almost half a million customers and over a trillion dollars of secure payments, Bill isn't new to intelligent finance. It's the proven way to simplify Bill pay and maximize cash flow. Want to learn more? Visit bill.com slash proven for a special offer.