Live from Kilkenomics: financial mistakes

0:09Hello and welcome to the first ever live recording of the Unhedged podcast with a live audience Live audience, please cheer. I'm Katie Martin, a markets columnist at the Financial Times in London, and I have ventured out of my cosy but slightly grey studio in the basement of FT Towers into a pub, well, a room around the back of a pub in Kilkenny, part of the Kilkenomics Festival. It's really great to be here. And in the run-up to the Kilkenomics Festival, we thought to ourselves, would it be a good idea to record the podcast with a live audience? And the answer is, we don't know. But we're going to try it.

0:50It's a big experiment. And experiments are the theme of this recording that we've got going on now. So please welcome my special guests, Russell Napier, who is a former analyst and from the Library of Mistakes, which is fittingly about economics. And Martín Lustó, who's a former economy minister from Argentina and now a senator for Buenos Aires.

1:14I'm going to sit down now. So we're going to do a bit of a kind of global tour of economic experiments and train wrecks and stuff that's gone right, stuff that's gone wrong, and whether we ever learn anything from the stuff that does go wrong. Hello, latecomers. Hi. So, Martin, you are living through your very own live radical economic experiment in Argentina right now. you have a president who, tell me if I get this wrong, he's like a radical libertarian, runs around with lots of chainsaws, takes his policy advice from his dogs, some of which are not alive. Have I got this right? Yeah, partly so, yeah.

1:59He speaks to his dead dog. Yeah. He's an Austrian school economist and he's quite savage, yeah. Yeah, he's pretty savage. So when he speaks to journalists and when he kind of gives his big pronouncements, he talks about how he is leading a regime of freedom and he's going to put the country on the right track. What is he actually doing? OK, first, the good thing is that he's not doing what he told us he was going to do during the campaign. So he said he was going to close down the central bank and dollarize the Argentinian economy. So he didn't do that. he said that he was going to fine-tune or slash expenditure in a sensitive way.

2:40And he didn't do that. He just used inflation to slash expenditure. He's trying to recover Argentina's reputation. The issue with Argentina is not that he has 100 % inflation a year or high debt to GDP and pays high interest rates. It's that our reputation is zero. So whatever you want to do with any tools, we all envision that that's going to end up in disaster so anticipate things but it's not so easy to rebuild reputation so it's what he's been doing at the moment first he had a huge devaluation and 118 percent devaluation that step up inflation from around 10 per cent per month to 25 in december that's 10 a month like this is quite hard for people outside of argentina to get their head around yes so it's like 25 a month it's like slashing your 100 dollar bill in fifths and take one fifth out of your purchasing power in a month so he did that we had 25 inflation in december 20 in january 13 in in february so he used inflation in order to slash expenditure pensions, public salaries, and it also happened with your own salary in the private sector.

3:59At the same time, he fixed the exchange rate. So we have what is called a crawling peg, which is an experiment that Argentina did in the 80s and ended up very badly. And he also managed the interest rate. So even your savings went down in real purchasing power. So either whether you had dollars before or a savings account that went down in terms of purchasing power. So what that did is it put the fiscal economy or the fiscal figures in the right track, but the real economy in a real hard recession. And that's what we're experiencing at the moment. So now the inflation rate came down to around 3 % per month, but the economy sank almost 4 % year against year.

4:52So the IMF is praising his resolute action, right? And markets do as well. And markets do as well. And so that's what I want to ask you about, Russell. It's like, what is an economic mistake? And is it a mistake on our part to measure these things through market reactions? Maybe we should just say, screw markets. This stuff doesn't matter. Policy and markets have got to be separate beasts. What do you think? Have you told Quasi Quarteng that? Markets discipline governments until governments abolish markets. So I think it is a reasonable point. I think across the world, not just in Argentina, governments can't live with the consequences of markets.

5:32And the crucial one is the yield on government bonds. So what we see, and I think what we'll continue to see, is the government's picking up your point exactly and saying, well, wait a minute, we have a perfect answer to this. Because we have all these savings in the economy, and if we're paying too much for government debt, if that's the market disciplining us, we can easily discipline this market. Because we can force the people of our country to buy government bonds at a yield that we want to borrow at. Now, that's called financial repression, but it goes to the crux of the question. if society concludes that it doesn't want to be disciplined by markets, that we want to ignore markets, then effectively abolish them through compulsion.

6:08And I'm sure you're aware the word in the UK now is mandation. And we're going to hear a lot more about that at the Mansion House speech. So yeah, I think we've got to that turning point in society where the politicians and the people potentially can't cope with the consequences of market prices. So we effectively abolish them. This is a long, long cyclical structural swing. And I think the rest of us, I can't speak for Argentina, but the rest may be going a different way in Argentina. But in the developed world, that's the world we're going to move into. Yeah, so you mentioned mandation. This is a kind of debate in the UK around the idea that UK stock markets are kind of pretty rubbish, have been for a really long time.

6:46And what we should do is in some way force the UK pension system to buy UK equities. Now, this will be a kind of carrot and stick thing. You can't put a gun to people's heads and say, you must go and buy these stocks. You can put a gun to people's heads. In what way? Well, if you're the government, of course you can do that. I mean, we could simply pass a law tomorrow morning, and I think Argentina's done this in the past. We still live in financial repression in Argentina. We have capital control. It says if you receive a tax break for the pension, 50 % has to be in UK assets. And if it isn't, use your tax break.

7:20That's not quite a gun to the head. You could actually just, and what we did after, during World War II, usually it's during warfare that you put a gun to people's head and you say you are buying government bonds. So, yeah, you can put it on the people's head. You're the government. You can do whatever the hell you like. Yes, in Argentina, you use that to finance the treasury. So, for example, if you buy a certain type of bonds, that counts. It's got a special accounting for minimum capital requirement in banks. So you provide an incentive for capital to go to finance the treasury. Yes. So this brings me on to kind of probably the biggest experiment of all, which is, you know, around government borrowing writ large, right?

8:00There's a load of stuff that governments need to spend money on, like defence, particularly in the UK and Europe, particularly after the election of Donald Trump, the green transition because the climate is not going to fix itself. Where, at what point does the market say, okay, enough, Russell? Because this is one of these debates that every time bond yields are picking up for whatever reason, right? So prices are sinking, the yields are picking up, bond markets aren't very happy. And people say, ah, well, now's the time. This is the market's way of saying that, you know, so far and no further.

8:32How close are we to that point? Well, as you've sort of alluded to, for 40 years, debt to GDP has been going up. And for 40 years, yields and government bonds have been coming down. So everybody, anybody who ever stood up and said enough is enough has been completely, totally and utterly wrong. So I'm here to tell you that enough is enough. So what we're witnessing really across the developed world is no growth in broad money. And this is an argument for a certain type of economist, I suppose. and we're watching bond yields going up. And of course, the market narrative is those bond yields are going up to reflect a coming inflation.

9:02But it is highly unlikely that we've got a coming inflation when there's virtually no growth in the money supply across the entire developed world. So it may be that we've already lived through the first four months of this where we're beginning to realise that the market is beginning to price in a little thing for the unsustainability of this. Now, to be clear, the unsustainability is not the government defaulting an interest in principle. The unsustainability is generating a level of inflation that gives you a very poor real return on fixed interest securities. So I'm going to say to you that the market's already beginning to price it in.

9:31And that means I can be wrong by Christmas. Yeah, because these things have a habit of going wrong, you know, slowly and then quickly. So what's Argentina's little dance been with global markets in terms of keeping the money coming in? Well, first, Argentina has something that's called the regional scene. So it's not the same as developed countries. So it's very hard for you to get a loan in your own currency. So then it means that in order to repay the loan, you need to have a proper exchange rate in order to build up reserves or attract capital. Otherwise, you're not able to finance yourself whenever you need to repay the loans.

10:09And that's been happening in Argentina for quite some time. So when you were asking whether markets would say enough is enough for Argentina, they said many times enough is enough. So we end up having no credit at all. So for example, now country risk for Argentina is around 900 basis points. So we pay 9 % above what treasury bills pay. Can I ask you what the people of Argentina hold a large percentage of their savings in somebody else's currency? Have you any idea what percentage of the savings? I mean, this is a double problem, even your own people. Yes. So how much of the savings of Argentina do you think rest in effect of the US dollars?

10:47The national accounts say that we hold around$280 billion. So it's roughly half of what we owe or a little bit above what we owe. And it's a country in the world, after Russia, I think, that has the largest amount of dollar bills per person. It's amazing. Because whenever you have a country, for example, in my lifetime, I started studying economics in 1989. 1989, I lived through two hyperinflations, one big depression, devaluations and recessions almost half of my life. The tequila effect, the tequila effect, the great financial crisis. So every four or five years we live through a crisis. And the only way to get something, an instrument to avoid losing purchasing power is to hold someone else's currency.

11:46That's one of the reasons why even in the 90s Argentina adopted a currency board to stabilize and to say, OK, let's go directly for a different currency. And in that moment backing our currency with dollars, with hard dollars. And it ended up very badly. Can I suggest that this is the man who should be looking after your money? I mean, he's seen everything there is to see. We, I mean, the people of Ireland have seen more than most people, but we think we haven't seen this. We think we'll never see it. Well, we'll see some of it. But the professional people who manage our money, who are business school educated, been in the business for 20 years, have no comprehension of what a structural change is where the government has to get more involved in the marketplace.

12:29So we've got all the wrong people running all your money at exactly the wrong time. So you should set up a fund management company. It's impossible to survive in Argentina unless you understand something about economics. A taxi driver knows that. Yeah. So when we have inflation, nobody's leaving their money in their checking account. We know that for sure. We know that we're losing time every single day that passes by. Argentina is an extreme case, right? But again, on top of the kind of extra kind of government borrowing that we're likely to demand around the world, we do have a more inflationary world, right?

13:04we have supply chains that got horribly disrupted during COVID and made everyone think, OK, let's be less reliant on China. Let's bring manufacturing back home. On the margins, that just means that, you know, that big disinflationary impulse that we had from China joining the WTO in 2005 has gone away. So the sort of the low level kind of simmering inflation is there in the global economy all the time. And as Russell, as you were suggesting, policymakers just haven't grasped that yet because they just think okay we need some money let's either print it or borrow it it'll be fine it's been fine for like the past you know 20 years or something so it will continue to be fine but what if it's not well it's interesting but what mandation is is really is really a different approach because as you say either you borrow more at the government level or you print more but there's a third way and mandation is the third way you take people's savings and use them for what you want to do your government debt to gdp doesn't go up.

13:57This is a contingent liability. You're forcing people into this government bonds. You're forcing them into what you want funded. And, you know, the reason that Argentina does, unfortunately, slip into hyperinflation is because people keep their savings outside of the country. You can't mobilize the savings of the people of Argentina. It's difficult to get confidence to do that. But all our savings rest really in our kind of domestic currency. And if you want to utilize that through mandation, then you don't need to borrow any more money at the government level. You don't need to unnecessarily print lots of money.

14:26So in the ways you deal with excessive debt, long before you get to hyperinflation, they're stealing people's savings. So theft comes in all shapes and forms, but I don't hesitate to call it stealing people's savings, but it's giving them a positive nominal return and a negative real return. We did it after World War II, and there are lots of UK policymakers who think this is a brilliant template for what we should do. Now, if you held British government bonds from 1945 to 82, I think you lost 80 % of your purchasing power. And yet by many people, it's seen as a tremendous triumph. And so that's what we're back in again.

14:57That's the way we're going to do that. And government debt to GDP comes down. It doesn't go up over the long term. You presumably get the counter argument though, right? Which is like the UK in particular is massively underinvested in domestic equities relative to its peers. We've got to do something to turn this around. Buying begets buying. You know, this is just a kind of first step. This is turning it all around. I mean, first of all, it's turning it around because you're mandating people to buy the equities. So you're turning it down quite bluntly. But you've pointed out we're having this dissociation from China.

15:27So you then get this massive investment, but I'm funded by the Mandation, as you have new securities from Mandation. So you get a really elevated growth rate for the United Kingdom, not just the United Kingdom, for kind of everybody, as we retool ex-China. So, you know, as you can tell, I'm really quite optimistic about all of this. But not for people who save. This is the problem. So when we did it after World War II, the Prime Minister could say in 57, you've never had it so good. Well, if you're a bondholder, you'd lost 30 % of your purchasing power. But if you're the average guy in the street who was getting involved in all these new businesses and industrial production.

15:59So there's a kind of industrial renaissance coming for the developed world. It could be Ireland, could be the UK, could be anywhere else except France. And possibly Germany. So let's not be, you know, there are reasons to be pessimistic about this, you know, stealing money from savers. But there's another side to it. More investment, more economic growth, more blue collar jobs. And markets at least temporarily would like it, so it won't look like a mistake early on. Yeah, I call it stealing money from old people slowly. And if you do it slowly enough, they don't really notice. It's already happened.

16:32I mean, if you've held a British government bond since 2021, you've lost a fortune in nominal terms and real terms. So we're already stealing money from people. This is really cheerful. Let's talk about something else really cheerful. Donald Trump. huge experiment coming down the tracks here economically from him what on earth like martin i'll start with you what what on earth do you make of the kind of tariff policies that he says he's going to bring in whether he does or not we don't know okay when i was the ambassador when of argentina to this when trump won the first time and there was you never know whether he has intuitions or a team behind him that it's like feeding him stuff he's not talking to dead dogs that's now that yeah yeah that's right he likes dogs but but at the beginning the first term he was he was saying oh his people were saying okay we cannot rely on europe anymore because we cannot rely on american companies anymore because they are not american anymore and we cannot rely on the wto and multilateralism and i think that part of those intuitions were okay for what he wanted to do so and now he's facing a world in which there are certain threats and certain trends and the French shoring and the short shoring.

17:48And I think that he's building on what he did before and giving it even more fuel. So this is the tariff thing, reshoring and bringing some production back to the U.S. But as Russell was saying, that would only add to inflation. and if you also are going to send workers abroad because that will add to inflation as well. And so if we are seeing a world in which inflation is starting to be the tool to solve the issue of over-indebtedness, then that will only add to the toolkit. Yeah. If there's one thing he loves, it's when stocks go up under his watch, right? Right. And stocks like US stocks have had a really good run after he got elected.

18:40So he will see this as an immediate kind of, you know, welcoming from global investors. But at the same time, the bond market did puke quite a bit. And that's the market's way of saying, I'm not sure about this fiscal policy. I'm not sure about this deportation policy. So, you know, again, how seriously do you think we should take that warning sign? I think we should take it very seriously. What you've described and what I call this is national capitalism. This is using the savings of America for jobs for America. That the capital is not free to go wherever it wants. It's national capitalists.

19:13Now, Trump's got a problem with that. Foreigners own$57 trillion worth of his own assets. That's the gross number. If you take the net, you know, net off what America owns overseas, it's still$22 trillion on a negative basis. Now, if, let's take the UK, the UK begins with mandation. What are people going to sell to buy all the stuff that the British government wants them to sell? What if it's the S &P 500? President Macron is very keen on the same thing. He's got a tremendous speech at the Sorbonne. He said, Europeans put 300 billion a year into America. This is absurd. Now, if Europe begins to repatriate capital, he's actually short.

19:47I mean, he thinks he's got the strongest economy in the world. He has. But it's incredibly reliant upon sourcing foreign savings into the S &P 500, the Treasury market. So what we're maybe beginning to see, he thinks he wins that particular war. He's a flow guy. He's not really looking at stocks. He doesn't win that war. Because if Japan in particular, if Japan was to begin to repatriate capital to fund its own government, they'd be selling hundreds of billions of US securities every year. So I think that's the flaw that's beginning to be priced into his bond market in particular. That's been the kind of dog that hasn't barked for so long, hasn't it?

20:24Any day now, China's going to say enough and start selling down its treasuries, and so is Japan. We've talked about whether that point is getting nearer, but how does that relate to the economic situation, particularly in China, where the potted history of the past couple of years is that the property sector went down the tubes. And the idea among investors was, well, as soon as they pump enough money back into property, this is all going to sort itself out. We're going to be able to invest in Chinese stocks again. It's been horrible. There have been some big pickups along the way, but it's been pretty horrible.

20:53We've talked about inflating away debt. So just give you the debt number. So America's debt to GDP ratio, which is public and private, is 255 percent of GDP. grossly over indebted United Kingdom's 234 percent they're 290 percent and it's going straight up with China China so now they have to inflate away their debts if we go back 15 years ago they were about 130 they've gone from 130 to there's been nothing like it in human history so now as you've already alluded to what is the consequence for the world of China has to inflate away its debts well it can't be a stable currency and the reason they've been buying so many treasuries is that exchange rate intervention to secure the level of the currency so the whole global monetary system blows apart because at the cornerstone of it was that link between the renin and b and the dollar and it cannot continue if they have to inflate away their debt so we have a huge structural change and I don't have time to go into all of the distortions that the old system caused but if you think why do we have so much gearing in the world why are asset prices so high it's because the Chinese linked their currency to the dollar and I have a sort of 90 minute lecture on that so I'll not go through it but that you know every 30 or 40 years monetary systems collapse collapse.

22:00This one is collapsing in front of our very eyes and the front page of the FT will still be talking about next quarter's GDP growth. It's shocking. I mean, that's not a reflection of the FT because that's what everyone's doing. It's the same in the industry as well. We're not talking about the thing that's staring us in the face. There's a new global monetary system coming. And it's because the old one didn't have a name. It's almost like it didn't exist. Right. But of course it existed. So what are you calling the new one? So the new one I'll call national capitalism. Okay. It's not a good thing.

22:27Well, if you're a saver, it's not a good thing. But as I said, if you're a blue-collar worker, maybe it's not a bad thing. Yeah. Having your debts inflated away with new opportunities in the manufacturing sector. Mr. Piketty might call it a redistribution of wealth. But so the latest salvo from China was to announce it's going to pump another$1.4 trillion of stimulus into the market. Is this just kind of pissing in the wind? No. Governments, this does not apply to Ireland, obviously, because it doesn't have an independent central bank, but countries with an independent central bank that begin the road to reflation always succeed.

23:01Yes. Always. Now, they may stumble. Maybe it'll take a second, a third or a fourth. I can't think, when you have an independent central bank and an independent fiscal policy, can't think of anybody who's ever failed. So, of course, it's going to succeed. It may meet another round two and a round three, but, yeah, of course it will succeed. Well, this has been much more miserable than I was expecting. This is a bad way to start the day. But what we're going to do now is move on to like a little kind of feature that we have on the podcast, which is called Long Short.

23:49what we're going to do now is is move on to like a little uh kind of feature that we have on the podcast which is called long short that part of the show where you go long a thing you love or short a thing you hate. It can be anything. I told you to prepare something and I don't think you've done it. No.

24:09You're going to have to come up with something. I'll short anger in politics because it prevents us from thinking. It's just politics generally. Anger in politics. Yeah, I think you're right on that one. Russell? France.

24:30I don't know, why is everybody laughing? If I'd said Argentina, nobody would laugh. No, seriously. I just feel like we should have carved out 10 minutes to talk about that. Well, what's so funny about France, so I think not just France, all French assets, but go out and take a bet that there'll be a sixth republic within five years. I think they're on their fifth republic, aren't they? Yes. I think you'd get pretty good odds on that, so bet on a French sixth republic within the next five years. Stop being so miserable. Ladbrokes is out the front door, to the right. Yeah, just down the road. Whether Kilkenny Ladbrokes has ever had such a bet, I do not know.

25:04I don't know if they're taking odds on that sort of thing. I am going to be long. You guys in the audience, I had no idea if anyone was going to turn up to this. And you did. And you've been good fun. So thank you so much. Thank you.

25:29Cheryl Brumley is the FT's Global Head of Audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.