The Debt Crisis No One’s Talking About - Sir Niall Ferguson

28:07Francis Foster:But you were talking about the way that Renaissance Europe made adaptations that took finance, created modern finance or the beginnings of modern finance. and you were talking about why they were able to do that. I think it's a very striking feature of world history that these things happen in Europe. They do not happen, say, in China, which has a much simpler monetary system, which has a system of coinage, no real system of public debt, fairly basic and rather low-yield system of taxation. China's empire runs on different rails. Why is that? And the, I think, most plausible answer, which I also try to explore in a book called Civilization, is that Europe is divided into a lot of relatively same-sized polities.

29:04And these polities are in aggressive competition with one another. They regularly make war on one another. Periodically, one of them will try to create a European-wide empire, and the others then band together to stop that. And war is, in many ways, the driver of financial innovation in Europe. And it just takes a very different form from the geopolitics of East Asia, which is characterized by one fairly large and more or less homogenous empire with a relatively low level financial system with taxes as a share of GDP much smaller. So one of the lessons of financial history is that you need to have the kind of stress of regular warfare to propel financial innovation forwards as well as to propel scientific innovation, exploration.

29:59People are motivated by a sense that there isn't enough money for the needs of the state. And that's why you set sail for the Americas, thinking you're going to the Indies, you're looking for precious metal. That's why you sit down, come up with the idea of public debt. Hey, wouldn't it be a good idea if the rich people lent the government money to fight the war? These innovations, I think, are propelled by the imperatives of geopolitical conflict in Europe. But in a way that we talk about the borrowing and the attitudes to people who lent us money, Is that why Shakespeare talked about a pound of flesh when it came to Shylock?

30:40Well, if you think about the Merchant of Venice, Chiloc is trying to collect on a debt but decides when it's clear that he can't be paid, that he will take full advantage of what he thinks is his power as a creditor and demand the death of the debtor. And that leads, of course, to his coming a cropper because, as Shakespeare makes clear that's actually a wicked thing to do. Absolutely. And but it's also there's a hypocrisy there, because as we've alluded to, without borrowing, without taking essentially financial risk, innovation can't happen. And that's innovation, whether it comes to exploration, whether it comes to setting up a business, whether it comes to, you know, a government, for instance, building infrastructure, we need to borrow.

31:38This is essential, isn't it? Well, it's very risky. I mean, Shylock's been asked to finance oceanic trade, and ships sink quite regularly in those days. So there's quite a substantial risk in financing any maritime trade. That's, of course, the side of things which would make you sympathetic to Shylock before he decides to go for the pound of flesh. But I mean, I think the point you make is a really critical one. Just as there's a cost to my borrowing a car for a year, or for that matter, a tractor, so there's a cost to my borrowing£100 ,000 to start a business. And anybody who's going to bet on my business being successful will need to be compensated for the risk.

32:28And that's at the heart of almost all financial transactions. What's the appropriate compensation? Because there are risks. One risk is the default risk, which Sherlock encounters. Ah, sorry, I can't pay. The ship's all sank. What can I do? It was the weather. But there's other risk too. Suppose that we contract this debt in pounds, but we do it in the 1970s. and in the period of the loan, the inflation rate rockets up, as it did when I was a kid, into above 20%. And so the debtor gets to pay back in these depreciated patents, the purchasing power of which has been reduced in a year by 20%. There's also a risk there.

33:10So if you're lending, you ask yourself, what's the default risk and what's the depreciation or inflation risk that I am running? And efficient financial markets, to use a term that's been much abused over the years, deliver, if there's sufficient information and sufficient liquidity, they deliver a reasonable price for those risks. and we're talking about risks and one of the stories that you tell in the book which was fascinating which is all about risk is the story of nathan rothschild which every every look people know it's a famous name but particularly uh the anti-semites who will be you know the moment they hear the word rothschild they're immediately they're kind of the light bulbs start pinging so let's talk about the story of nathan rothschild because that's a story about financial risk lending, but also vast amounts of wealth that come as a result of that.

34:07Yes, the story of how the Rothschilds made their first million is a famous one. It's even been made in two movies a couple of times, once by the Nazis. And that gets to your point that this story has often been used by anti-Semitic writers. I wrote a history of the Rothschilds back in the 1990s based on the archives of the bank here in London and tried to tease out what had really happened. And it's important to tell these stories with historical documentation and as much accuracy as you can muster, because it's really the only possible antidote to the anti-Semitic myths. The myth says that in a somewhat illicit way, the Rothschilds make money from the outcome of the Battle of Waterloo, while heroic Frenchmen and Britons, not to mention Germans, are perishing in the battle.

35:11They're profiting. So what really was going on? What was going on was that Britain, other European countries fought recurrent wars with France from the 1790s, from the period after the French Revolution, right up until the Battle of Waterloo in 1815. And a variety of different instruments were used to finance these wars, including bonds, which the British government was able to issue in substantial quantities, and bankers. And the Rothschilds were one of a very significant number of bankers who contributed to financing the war effort against revolutionary and then Napoleonic France. One of the most important things that the Rothschild brothers did, there were five in the course of the period prior to 1815, they left Frankfurt and established themselves in five different financial locations.

36:07There was the original base in Frankfurt, There was a house in Vienna, a house in Naples, a house in Paris, and a house in London. These five houses of Rothschild contributed primarily by advancing gold to the armies in the field. If you're an armed force marching your way, say, up from Spain towards France, you really can't pay with paper. The locals want to have hard currency. So part of the challenge was getting the gold to where it was needed, ultimately, by the Duke of Wellington's army. And the Rothschilds had been involved in those transactions, as well as other transactions, occasioned by the Napoleonic Wars.

36:51OK, this is where it gets exciting. So the Napoleonic Wars appeared to be over before 1815. It appeared that Napoleon had been defeated and he had been sent into exile on the Isle of Elba and peace had arrived. And when peace arrived, there was significantly less need for the gold that had been used to finance his ultimate defeat. When Napoleon makes a comeback for 100 days in 1815, culminate at the Battle of Waterloo, The Rothschilds, of course, are scrambled into action again to help finance another campaign against Napoleon. But nobody knows how long it's going to last. And indeed, it's reasonable to expect a long time because Napoleon has an incredible record of military success.

37:40And he's back. The emperor is back. He appears to be back in control of France. When the news breaks that he's been defeated in the Battle of Waterloo, it takes a while for that news to spread. No internet, no telegraphs. The only way you can actually get news around Europe in 1815 is to have guys on horseback riding to the Channel Coast, handing the message to somebody in a boat, gets across the Channel, hands the message to another guy on a horse, horse gallops to London, news is delivered. The Rothschilds clearly got the news before the British government that Napoleon had been defeated. So their couriers were faster.

38:22And this certainly was part of the reason that they were able to make a significant amount of money. But as I showed in the book, the House of Rothschild, also known as the world's banker in all good bookshops, there was a terrible moment when they thought they had actually blown up because they didn't expect Napoleon to lose. They'd expected a protracted campaign and they'd accumulated a lot of gold in the expectation of that continued campaign. When they heard the news that it was all over and he'd lost again, there's a moment of panic within the brotherhood. They're writing to one another, who has the money?

39:00I thought you had the money. Wait, where's the money? They really thought they'd overextended themselves and were about to come a cropper. Now, Nathan Rothschild was not the eldest brother, but he was the smartest brother. He was the one in London. And Nathan was one of these people who can, as they say in New York, turn on a dime. As soon as he realises what's happened, Nathan radically shifts the position and goes long British government bonds, known to this day as gilts. He goes long British bonds because he thinks peace is now here, it's all over, these bonds are going to rally, in other words, interest rates are going to come down, we're going to peacetime economy, and it's that trade, buying bonds before the rest of the market knew that Napoleon had been defeated that made them a million pounds, which at that time was a lot of money.

39:51That's what really happened. And it then becomes part of the mythology of the Rothschilds right down to the present day.

39:59Francis Foster:Where is the allegation of cynicism or sinister behavior within that? Where is the divergence between what you're telling, which is what happened and the myths. Beginning really not long afterwards in the 1820s, particularly in France, critics of the Rothschilds, who certainly included people sympathetic to Bonaparte, who were hostile to the restored royal regime, began to portray all of this in a somewhat scurrilous light. And there are two kind of pieces to this. One is, well, you know, heroic people are laying down their lives and they're sitting in London making money. And the second one is, well, there's some kind of insider knowledge.

40:45There's something disreputable about the fact that they front run the market before even the British government knows the story. But that's sort of not enough for a conspiracy theory to have legs. And so quite quickly, what you get is this elements of the supernatural, that there's something really not quite right about the fact that they can know this so early. And so you get the legend of a kind of talisman that protects the family and makes the success of the business. And this idea that there's a secret power at work is interesting because it exists in the anti-Semitic literature or the anti-Rothschild literature.

41:27And it exists in Jewish literature, including in Russia, with the notion that there's something magical about this family. They're kind of the super Jews. And Rothschild refers to

41:38Francis Foster:themselves as, you know, the royal family of Judaism. And so this idea that there's something kind of more to it than just business acumen, I think, is part of what fuels this really powerful conspiracy theory. I mean, I think what's interesting is it morphs into a series of apocryphal sayings along the lines of, you know, the time to invest is when there's blood in the streets, or the, you know, the sound of guns or of cannon fire is a chance to make money. Those apocryphal sayings arise in the course of this story morphing into a myth. At the start of a new year, everyone talks about resolutions, but most people try to brute force change with willpower alone and burnout by February.

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43:40Francis Foster:Of course if I'm the king and I want to fight a war against France, I'm going to borrow money from whoever's going to lend it to me. It would be very, very strange in that situation to blame the lender for the war. That doesn't make any sense. But as you inch towards slightly less obviously visible people borrowing money, the government, whatever that is, not saying that necessarily happened with the Napoleonic Wars, but just as you start to head towards democracy, you can see why it's almost like, well, who is responsible for this? And of course, this modern narrative exists all the way through to, you know, the military industrial complex and so on.

44:17Francis Foster:There's always this narrative that wars aren't being fought by people in charge of governments who either have real geopolitical, geostrategic concerns, or they want to show that they've got a bigger penis than the other guy or whatever it might be. It really is, you know, the shadowy figures in the background who just want to make money from it. I think that's right. In the course of the 19th century, which is over time an increasingly democratic age, where more or less everywhere there are widening of the franchise, politics changes. and one of the targets of the more democratic politics is the relationships between bankers and politicians and you get this in in most countries in the United States there was always a skepticism about financial power it was right at the earliest stages of the republic that you had the debate over whether there should even be a central bank the decision not to allow New York to have too much political power to create Washington, D.C., is part of resistance, particularly by the Southern founders, to Alexander Hamilton's vision of a quite British form of United States in which all power, financial and political, would be concentrated in New York.

45:38So the 19th century debate evolves in interesting ways to offer a critique of those who run the financial markets, and the Rothschilds were the dominant financial family for most of the 19th century, far bigger than, say, J.P. Morgan, who was a newcomer, new on the block in the late 19th century. The Rothschilds and finance become almost synonymous with one another. The relationship between that financial world and the political world of kings and of ministers, prime ministers and finance ministers. Now, those relationships existed. Of course they existed because the Governments are consistently encountering the problem.

46:18You seem to have a deficit, Your Majesty, and here's the choice. Raise taxes or cull the Rothschilds. Obviously, politically more convenient to go down the borrowing route. These relationships exist. They're documented. There's correspondence. I spent a great deal of my time in the 90s piecing all that together. The critique that comes from democratic political figures is, Well, there's something not quite right about this. I mean, A, aren't they making a crazy amount of money? And surely that's ultimately taxpayers' money. And B, isn't it a little bit cosy that the prime minister is so close to Rothschild that, oh, his daughter's just married a member of the family?

47:00Those are the critiques, but they come from both the left and the right. And this is a really important thing. The critique of finance or finance capitalism is a socialist critique. It's there in Marx, but it also becomes a critique on the far right. And in the 1820s, those distinctions aren't yet clear. They're just radicals, and radicals don't like this. They don't like the Rothschilds. They don't like the restored monarchy. by the time you get to the 1840s, 1850s, there are two flavors. You can be a Marxist, a social Democrat, you can be for the workers and against the capitalists. But that's not quite strong enough drink for you.

47:43Then you can join the nascent radical right, which ultimately evolves through populism into fascism. And you say, you know what? The real story here is the Jews are taking the money of the Christians. And that's, I think, the kind of bifurcation that you see in the democratic politics of the 19th century. Doesn't a lot of this anger, resentment, frustration come from people who don't really understand money? They don't understand finance. They don't understand the bond market. So where you have this absence of knowledge, what then gets fed into it is conspiracy theories. Anger, resentment, which then leads to anti-Semitism, resentment, which then leads to movements like communism, socialism, etc., fascism.

48:33I think one of the odd things about the way education evolves in the course of the 19th century is that while we generally agree that it's a good idea to teach people literacy and numeracy, not to mention some history and maybe a foreign language, We never really sit down and teach them about finance. And indeed, financial illiteracy is a very striking feature of our world today. It's a very complex financial world. Everybody is expected soon after they leave education and perhaps even before then to understand how a loan works, even if it's just a student loan. We expect people intuitively to know how interest rates work.

49:19when they've probably only encountered the concept in a mathematics class. So we have that problem that nobody really quite understands what a bond yield is. That is still true. I read just the other day in the newspaper that some British political figure didn't actually understand what a bond yield was. I remember noticing at Harvard when I was teaching a financial history course, which was a popular course, that quite a few of the teaching fellows, the graduate students, couldn't in fact explain very well to the undergraduates what bond yields were. So I think it's true that ignorance is one of the precursors to conspiracy theories.

49:58When you actually explain what an interest rate is and what risk is, the kind of risk that you run if you're a lender, why being a banker can give you sleepless nights, I think it becomes a little less mysterious why the Rothschilds became wealthy. From the very outset, they ran colossal risk, not only in 1814-15, but recurrently through the 19th century. They take on the risk, for example, of financing railways. They're very early to see the potential. And railways are the big capital expenditure. They're the data centres of the 19th century. But to a large extent, these railroads in Britain and Western Europe are built by private finance.

50:41Further east, it's the government that does it. There's enormous risk involved in building a railroad. It's an extremely expensive undertaking. It's a pretty unregulated market. And a lot of companies that built railroads did not make money and indeed went bust. So I think people don't have a good understanding of risk, nor do they have a good understanding of the difference between risk and uncertainty. Something I try to explain in The Ascent of Money goes back to a distinction the Chicago economist Frank Knight drew about 100 years ago. Risk is calculable. I mean, I roughly know the probability that each one of us will experience a car accident in the next year.

51:19We can kind of put a number on that because it's fairly normally distributed. We all can figure out what our risk of being diagnosed with cancer is. Mine's higher than yours because I'm older than you. All that's calculable. And so when we're calculating how much we should pay in health insurance, That isn't actually tremendously difficult to figure out. But what is the probability of war breaking out that involves Britain? Actually, that's impossible to say. What's the probability there'll be another pandemic? Nobody knows. When will there be a huge earthquake in San Francisco that completely ends Silicon Valley?

51:56Nobody knows. So that's the domain of uncertainty. So anybody who's embarking on a large-scale investment, whether they're lending the money or buying the equity, we'll come to that in a minute, is taking on risk. Some of it's calculable and some of it's not. And that is ultimately at the heart of capitalism, the cost of risk and uncertainty.

52:20Francis Foster:And one of the things to pick up on there is you corrected me, and I'm grateful for your correction, that you wrote your book before the financial crisis. I didn't know about that because I became aware of it shortly after.

52:32Francis Foster:What did you see that other people didn't see? So in 2006, there were a couple of red lights that were flashing on the dashboard, and I wrote about it at the time. There was a lot of debt accumulating the financial system. Household debt, particularly the famous subprime mortgages, loans that were taken out by relatively low-income families to buy homes. But there was also a lot of debt on bank balance sheets. And then there was debt that was not on their balance sheets in various off-balance sheet vehicles, part one. Part two, the cost of debt, interest rates, were rising. And therefore, there was going to be a steady and sustained squeeze on any vulnerable borrowers, anybody who had overextended or any institution that was undercapitalized.

53:25You could see that. I could see that from late 2006. and I think the moment of truth for me was when one of my friends, Jim Tisch of Lowe's Corporation, sat me down with his mortgage specialist and she showed me a chart of when the subprime mortgages would reset because the way the subprime mortgages worked was that you had a sweetener period when the payments that you had to make per month were relatively low, artificially low, but they reset after a certain period of time to a much higher market rate. And those resets were pretty much pre-programmed to happen in the course of 07. And so you could see that the trouble would start to build in the course of 2007.

54:11And then finally would spill over in the full-blown crisis that we saw in 2008, first Bear Stearns, then Lehman Brothers, because the overextended investment banks were really the weak link. The interesting thing looking back on it is how few people saw that. That was partly because if you were making money in the market, you were incentivized not to see it. If the music is still playing, we'll keep dancing. That was what Chuck Prince, one of the bank's CEOs, famously said. But I think there was also a kind of failure on the part of some economists for me to understand the precariousness of the debt dynamics.

54:51and in some ways it's an advantage to be an economic historian because you don't have some fancy mathematical model that you have to focus on. You're really just looking to spot pattern recognition, do pattern recognition to see, well, we've seen this kind of debt dynamic before. I think it's important to bring into the conversation something we haven't talked about yet, which is the equity market. Because we've talked about banks, we've talked about bonds, but we haven't talked about the stock market. And that's funny because actually people typically focus a lot more on the stock market than they do on the bond market.

55:27And certainly in the United States, most conversations about Wall Street are really conversations about the stock market. And it's worth just understanding that because it was collateral damage in the financial crisis. I mean, equity markets tanked in the wake of the Lehman Brothers bankruptcy. But it wasn't really at the heart of the crisis. So let's just quickly do a refresher on that, because stocks or equities are just a way in which we can own a piece of a business, a piece of a company. Whether it's Apple or Alphabet or a much smaller company, if it's a publicly traded company, you can go and buy a little piece of its equity, of its capital.

56:15There's more risk involved because the company can go bust and you get nothing if that happens. But there's more upside because if the company is NVIDIA and you were smart enough to buy NVIDIA stock on the eve of the launch of ChatGPT, then your upside is massively bigger than in any other asset class. I wanted to throw that in because if you want to understand how the financial system works, you've got it populated with all the different components. Of course. And they kind of, they accumulate over time. There's no equity market prior to the 18th century. That's essentially when you start to see something like a modern stock market emerge.

56:54Similarly, there isn't really much of an insurance market in the modern sense until the 18th century and the 19th century.

57:01Francis Foster:And that brings us perfectly to where we are today because one of the ingredients, Francis mentioned ignorance, but another ingredient I think is pain. another ingredient is terrible economic times another ingredient is war another ingredient basically times when people feel that something has gone wrong and the rise of the radical left and the radical right is something that I think is happening in our society today I think it's undeniable you know here in the UK the Zach Polanski's of the world in the US you have both the radical left and the radical right. And, you know, we've spoken to people on both sides of that.

57:42Francis Foster:It's happening. I don't know how you feel about it. I mean, you've talked a lot about the indebtedness levels, and it's obvious that's a huge problem. Are we headed in a sort of 1920s direction, 1930s direction? Well, it's a good question, because the ideologies are the same old, same old. Yeah. I mean, it's sort of depressing that we can't come up with new material, but It's like the writers have just gone home and we're stuck with, oh, I'm really disillusioned. What can I have for my disillusionment? It's like, well, sir, we can offer you Marxism if you'd like that. Or if you'd rather something stronger, we've got some anti-Semitism.

58:25So it's essentially Zoran Mamdani or Nick Fuentes. And that's like, really? We've got 100 years on the clock and it's those guys again? That's somewhat disappointing. I feel we could be more creative. Maybe we're not reading enough manga. You know, we're short of new ideas. So the question is, do we get the macroeconomic context in which those ideas come in from the margins and become very popular? Because right now, the people attracted to the extreme ideas are still clearly a minority. I think...

58:57Francis Foster:I mean, sorry to interrupt, Neil, but Mamdani's mayor of New York. Yeah, but he's not going to be president of the United States. I mean, remember, New York politics is not at all representative of US politics. I'm just making the point. They are making Inbroke. Oh, unquestionably. But the key question is, you know, do we have enough economic volatility of the kind they had in the 20s and 30s to propel today's wannabe Hitler into a position of political power? And lots of so-called far-right populists aspiring to power. And the question is how many get there and obviously how radical are they when they get there.

59:34Same question for the left. New York can take a kind of punt on socialism. Maybe Minneapolis might do it too, but I'm not sure that many other cities are going to do it. But remember, all this is happening after a period of sustained economic expansion where economists have predicted several of the last zero recessions, apart from the shock of the March 2020 onset of COVID, the economy has essentially been on expansion mode, certainly in the US, since the financial crisis. There hasn't been that much in the way of volatility by the standards of the 20th century. So when Andrew Ross Sorkin publishes his new book, 1929, we're all supposed to read it looking for traces of the 1920s in the 2020s.

1:00:30And of course, there are some because there are 1920s people offering projects of implausible economic viability. Step forward, Sam Altman of OpenAI. There's margin credit. There are traders who buy stocks on the YOLO principle. You only live once. Or on the FOMO principle because they have fear of missing out. That's all quite 1920s. So what's the probability that we get the great shock of 29 followed by a decade of depression as we did in the 1930s? That is very low probability because we're unlikely to make the policy mistakes that were made back then. Which were what? Well, the key lesson of the Great Depression is that the Federal Reserve did almost everything wrong, everything to make matters worse.

1:01:24And when I was trying to navigate through the financial crisis, after I published the book, I did a lot of talks in a lot of institutions, the question was always, is it the Great Depression? And I would say, well, no, because Ben Bernanke, who was then the Fed chair, knows the financial history of the Great Depression, and he's not going to do what the Fed did then, which was actually to tighten monetary policy. And that had the effect of causing multiple bank failures persistently right the way through from late 29 all the way until Franklin Roosevelt is sworn in and finally shuts down all the banks in the famous Roosevelt bank holiday.

1:02:01We're not going to do that again. No central banker would make those mistakes again. And in a sense, we've run the experiment because when the financial crisis happened, the Fed and other central banks did what came to be euphemistically called quantitative easing, i.e. they expanded the balance sheet, they bought lots of stuff that was otherwise going to tank in price, they bailed out key financial players, and we didn't have a Great Depression. I think therefore it's reasonable to assume that we're not going to have a Great Depression when the next recession hits, which eventually it will. My student Tyler Goodspeed has a brilliant book coming out early next year called Recession, which everyone will have to read, showing what it takes to cause a recession.

1:02:46And it's usually more than one thing that goes wrong. I think we will get at some point enough bad news to check the CapEx boom in AI. We'll get enough bad news, maybe geopolitical bad news, to make investors much more worried than they currently are about Taiwan. At some point, I'll be sitting here with you guys talking about how we got into the latest financial mess. But I doubt very much that that financial mess will lead to the kind of economic pain that we saw in the 1930s, without which it's hard to believe so many authoritarian leaders would have come to power. It's very hard to imagine the collapse of German democracy and the advent of Hitler without the huge shocks of hyperinflation in 1923 and then a crash where, I mean, unemployment is like north of 25 % in Germany by 1932.

1:03:46I can't see us going there again. So the bad ideologies, they're back. They never really went away. They're just back and somewhat attractive. To me, the weird thing is that they're attractive at a time of relative of economic prosperity when there really isn't that much pain. You mentioned pain. Well, we ain't seen pain.

1:04:06Francis Foster:Mass immigration, mass illegal immigration is probably a big driver of it. And I think maybe that's where some of the appeals have come. Of course. Unquestionably. But the interesting thing about that is that if you cut it off, which is happening in both the US and the UK... You're going to get economic depression. Well, there'll be economic depression. Not depression, but you'll have some... There's some economic cost to that. Yes, yeah, yeah. it's hard to run the NHS with immigrants. I would assume it's the US economy without cheap labour from the south runs in a very different way. And so all of the changes that are currently being made in response to disillusionment about immigration will have some kind of as yet unclear economic consequences.

1:04:46Francis Foster:Yeah, it's got to be calibrated correctly. I certainly feel that in the UK, I don't know how reliant Britain is on boat crossings from France. No. I don't think we are reliant on that at all. In fact, I think it's a massive cost and drain on the economy. Yeah, absolutely. But there's one other thing on economics and finance that I think is a giant problem. And I wonder if you know how it's ever going to get solved, which is we don't seem to be able to live within our means. And this is where, you know, Francis did, I think, as good a job as anyone can do of making the case why borrowing can be a really useful tool.

1:05:22Francis Foster:And it has been. It allows civilization to grow fast. that allows us to do things before we otherwise would have been take risks, etc. But when you become addicted to it in the way that we have, I mean, we really are in trouble in that aspect of things, are we not? A mate of mine tries to quit vaping every new year, every time he fails for the same reason. He removes the habit, but never replaces a ritual. That sounds like you. This will help. If you're part of the 50 % of people who attempt to quit vaping every year, you need to equip yourselves with the right tools for the job. And there's no better tool to break up with vaping or smoking than this episode's sponsor, FUME.

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1:07:11Francis Foster:I mean, we really are in trouble in that aspect of things, are we not? Yes, deep trouble. If you borrow to invest and you acquire some productive asset, then what's not to like? It'll probably help you repay the debt. But if you borrow to consume, well, that way lies trouble. And that's what we've been doing. Let's put it really simply. The systems of public debt that evolved in the 20th century to finance wars, particularly the World Wars, after the 1945 Allied victory, began to transition to financing welfare. So we went from warfare to welfare states. Those welfare states, which evolved in the 40s and then got another expansion in the 60s, assumed certain demographic features about fertility and longevity, which have completely changed.

1:08:07So we now don't have really any countries outside of sub-Saharan Africa, where fertility is above the replacement rate, 2.1 children on average per woman. And we have, in most countries, retirement ages that were kind of devised in the mid-20th century, while life expectancy is steadily increased and people can expect, therefore, to spend substantial parts of their lives retired. Our welfare states can cope with that on either side of the Atlantic. In the US, the real driver of the debt and the deficit is Social Security, the retirement program, and Medicare, free health care for the elderly. In the UK, you have a whole system of benefits that can trace back to the Attlee government after 1945.

1:08:51It's all anachronistic, and it's really hard to reform. Why is it hard to reform? Because there's a very, very powerful constituency that likes the status quo called the elderly, and they're a huge proportion of the electorate and dependably vote. I think I read the other day that 40 % of the German electorate, more than 40%, is now above retirement age. So you can't get radical reforms through with that basic obstacle. Nobody who tries to reform these welfare states survives politically. Emmanuel Macron has been dead in the water since France. Why? Because he tried to make a microscopic increase in the French retirement age and he's been twisting in the wind ever since.

1:09:33This is the problem. What does it lead to? It leads to there being deficits every year and not just in the bad years, which is wrong. The deficit every year, in the US, 6 plus percent of GDP every year, as far as the eye can see. Gross debt, now above 120 % of GDP, higher than it was at the end of World War II. This is not sustainable. Ferguson's law, which I promulgated in January, because everybody should have a law. And I decided I would have. So I said, Ferguson's law states that any great power that spends more interest payments on its debt than on defence won't be great for much longer. Well, the UK stopped being a great power a long time ago, been in violation of Ferguson's law for many years.

1:10:18But the US only crossed this threshold last year, and it's going to stay well above it for the foreseeable future until by about 2040, I think I worked it out, The US will spend twice as much on debt service, on debt interest, as it spends on defence. These are completely unsustainable trends. Problem is, politically, nobody wants or dares to go there. And so your next question is going to be, so how does this end, Neil? How does it end? And that's the big question. And there are a finite number of options, very, very limited range of options. Happy ever after option, OK? It has been done. You can have a really large debt and you can grow your way out of it.

1:11:02That's what Britain did after the Napoleonic Wars, going back to the time of the Rothschilds. Britain just ran primary budget surplus and grew thanks to the Industrial Revolution. So that's the good way out. If that's to happen here in the 2020s, we need AI to be every bit as good as Sam Alton says it is, and the productivity growth to be so great that in a couple of years time, this podcast will be generated by GPT-6 and you guys will be out of a job. So that's the good news, that productivity gains will get you out of jail. Do I think that's likely? No. I think it's quite unlikely. I think it's unlikely.

1:11:42Francis Foster:There are some social consequences to that out. I think you would not be the only aggrieved people in this scenario. There'd be an entire generation of people with university degrees who wouldn't even be Uber drivers because the cars would also be driving themselves. Plan B. So then you kind of default. You say, go back to the medieval monarch approach. You know that money that we owe you? I don't know, but I'm really sorry about this. I'm not going to pay you. Defaulting on the bondholders is something that used to be more or less a recurrent every decade experience in Latin America. But if you default on the people who receive benefits, particularly old age benefits, I don't know.

1:12:25I'm just thinking you better have a plan for the private sector because your political career will be cut very short. What about plan C? How about we inflate it all away? How about we do what we did repeatedly after World War II and we just reduce the real value of all these liabilities with a big, sudden, unexpected increase in inflation? Yeah, that's going to be pretty unpopular too. The other problem is that a lot of the liabilities these days are index linked. Because we went through this once before, and then the decision was, let's not do that again. Let's make sure that we can't inflate away the debt.

1:13:04So the number of ways out of this problem is pretty small. I think what ends up happening is some combination of default, where in practice we reduce what we said we would pay out and some element of inflation. We inflate away or use financial repression, some of the liabilities, none of which is going to be fun, particularly for the people who've got significant amounts of money they expect to receive from government or the people who've accumulated lots of pounds or dollars in savings. But I don't see any other way out. And it's not just the Western world. I was reading about this. China's got a debt of 17.8 trillion.

1:13:52Chinese debt's interesting because it's mostly at the local level. And it tends to kind of get passed over by people who are taken in by Xi Jinping is awesome. But actually, Xi Jinping is not awesome. The public finances of China, if you drill down, are about as bad as those of the United States. It's just that it's mostly local government debt. If you add up the liabilities of the public sector, they're about the same relative to GDP. And the deficit, the Chinese deficit might be even larger. The IMF did a study, I think a couple of years ago now, where they calculated that the real deficit of the entire public sector was more like 15, 16 % of GDP.

1:14:29So China has this problem. Of course it does, because it has a very rapidly aging population and its fertility rate has collapsed. So the demographics are the real driver here. If you leave your system unadjusted, it's just going to go insolvent unless you have a miracle rise in fertility. That's vanishingly improbable, very, very unlikely. Or you might have a pandemic that really kills the elderly rather than just kind of half-heartedly does the way COVID did. So those seem like pretty unlikely solutions. you're finally going to be forced, whether you're China, Europe, the UK, the United States, to do something radical.

1:15:14And this is where Mr. Millet is interesting. The Argentine president is the only really fiscally radical leader in the world. He's the only one who's serious about this, who in his first year as president said, I'm reducing the deficit from 5 % of GDP to zero. And he did it. So, you know, Malay has shown that you can be radical. But what's really interesting is you have to be, as the Argentines were, staring at 200, 300 percent inflation. You have to have your economy just flat face down in the ground to get the votes to do the radical stuff.

1:15:51Francis Foster:Well, look on the bright side, Neil. That's probably going to happen. I console myself that in the end, everybody is Argentine. Eventually, they all get there. And then everybody needs Malay. Neil, what a pleasure. We could carry on this conversation for many, many hours. It's always a fascinating insight. Final question is always the same. What's the one thing that we're not talking about that we really should be? Well, maybe we have been talking about it. I'm always struck by how much less fun these conversations are. Conversations about money. Thanks, mate. conversations about sex or political extremism.

1:16:33And I actually think we've just had the conversation that a lot of people would rather not have. Because culture war is more fun. I mean, the culture war is just much more fun. Is it really a woman? My message is right. You see, already we have laughed. But I think we're talking right now, what we've just done is we talked about the difficult, nasty, gnarly stuff that isn't going to go away. I mean, you may not be interested in financial history. Financial history is interested in you. And those who don't understand debt dynamics, those who enter adulthood without a clue about how interest rates work, who don't know what a bond yield is, who've never made an investment in the stock market and never will, those people will have worse lives than the people who get informed.

1:17:22So the thing about the stuff I do at core, it's boring. but important. And if you can't get your head around the stuff that's boring but important, if you can't bear to get through the ascent of money because you'd just rather watch Nick Fuentes on YouTube, you will be poor and I will laugh. There we go.

1:17:46Francis Foster:Fantastic. Neil, fantastic. Thank you very much.

1:17:55Thank you.