How Private Sector Balance Sheets Changed Recessions

The only question is timing, which is kind of always true, I guess, but it definitely feels like the chorus of people talking about a potential recession is getting louder. Yeah, between the trade war, the curve and version which as of right now is actually uninverted. Uh, some we data in the US. Uh, there's clearly we're back on recession watch. There's no real doubt about that. But as you point out, we're always heading for recession, and Jamie Diamond point out,

it's only it's only a matter of time. At some point we'll have another one. So to say we're headed for one but we don't know why, it's kind of obvious, right, And I think we're still in the longest economic recovery on on record now, right, So we're kind of do for something to happen. But I think there's a more perhaps interesting and consequential question for investors in the economy

than merely when will the recession happen? What's that? Well, I think the bigger question is when the recession hits, what's it going to look like? Because we've been scarred recently or recent recessions have all been pretty brutal in

some sense. So if you think about the recession that started in two thousand seven, the financial crisis that was horrible, the recession that came after the dot com boom, it wasn't really devastating overall, and it was kind of quick, but you know, it was a tremendous loss of wealth due to the crash in the stock market. And prior to that, we had a recession, uh, following the savings and loan crisis. So we don't have we don't seem

to have these sort of old style recessions anymore. They always seem to be accompanied by something big in systemic Well, people who talk about recession now do seem sort of oddly hopeful that the next one is going to be what they call a shallow recession. Right. You hear people who talk about it every once in a while and say, just because it's a recession, that doesn't mean it's going to be like two thousand eight all over again. We can have a contraction in economic growth without a huge

crisis in the financial sector. But I think what you're getting at is whether or not that's true, and whether the examples of recession slash financial crises that we've seen over the nearest past decades suggests that that maybe that can't happen anymore. Yeah, this really is the big question. Like we don't want to be too um, I guess scarred by recent events to say, oh, every recession now

is going to be a crisis. But on the other hand, we don't want to dismiss the fact that, uh, the sort of old business cycles is we know them have given way to financial market cycles, and that sort of is seemed to seeming to be the main driver, and

in fact, you know, there's not novel concept. Jerome Powell at Jackson Hole two summers ago kind of said the same thing that whereas the FED on our traditional models think about trade offs of inflation and jobs and the sort of very sort of standard view of the economy overheating and then slowing down. The real game in town is what happens with asset prices and how it declined.

An asset prices uh spills over into real economic activity. Right, So if you think that the economy has become financialized, which a lot of people do seem to think nowadays, then it would stand to reason that when we get recessions, they're going to be financialized as well. I like this topic, joke. I like this topic too, and we have the perfect guest for it today. Today we're going to be speaking

with David Levy. He is the chairman of the Jerome Levy Forecasting Center, and you recently came out with a very interesting report called Bubble or Nothing, and it talks about how the private sector swelling balance sheets compel increasingly risky financial behavior and it really addresses the role, the growing role that financial assets themselves play in the economy

and in economic cycle. And so maybe in this conversation we'll get an answer to can we have old fashioned recessions or we doomed to have big crises or many crises that are a result in swings and prices. So without further Ado, I want to bring in David Leaving. Thank you Joe, and Hi Tracy, and thanks for both of you for having me here. These podcasts are just such a refreshing change from the SoundBite world. We spend too much time and I'm really excited to think this

is a great topic. Hand you on TV a couple of weeks ago and we talked for like six minutes, but it's so deep. I was like, we gotta have them back and actually do something really deep because it's such an important topic. But just to start off, would you say that our sort of characterization of the evolving nature of recessions is correct. Whereas in the old days you think about the economy overheating, maybe factories built too many widgets, there wasn't demand for widgets, the factory had

to lay off some workers for a few quarters. They draw down the inventory of widgets than they build up them up and everything is back again. That just doesn't seem to be the way cycles work. I agree very much with with with the thrust. What you're saying, I'm going to try to paraphrase a little bit by saying what has changed is that as private sector balance sheets have become larger and larger relative to GDP, relative to personal income and in which sector are we're looking at. Uh,

they have increasingly dominated the cycle. So things like balance sheet effects such as wealth effects when the stock marker goes up or down a lot, major refinancing effects when there's vast amounts of debt they get refinanced at lower rates and people pull cash. These things have started to play a much bigger role. But also, you know, it's important to realize balance sheets have been involved in the economy. Their expansion is an essential part of how economies works.

Economy cannot generate profits without balance sheets expanding. This gets into the flows of funds that give us profits. It's what we call the sources of profits um. And it's it's a process that is is perfectly natural and normal. The problem is balance sheets having grown faster than income for really since the end of World War two, a little bit on and off, but but pretty much, uh,

most of the time. We've got to the point eventually by the eighties where these balance sheet effects were starting to be distorting, and that has become more and more extreme, and that is why we see a lot of the distorces It's why interest rates were forced down is by the supporting these top heavy financially top heavy economies. It's why rates of return were forced down. It's why, Uh, there's a massive amouss of wealth that swings of which

are have huge influence on on people's behavior. And and that's really, uh, the new world where and it's not when we're gonna be in forever, but that is the one we're in now. So, David, you're saying that these big balance sheets basically mean that wealth has become more important and sort of bigger relative to income, and that means that wealth slash balance sheets have an outsized effect on the economy. But how did we actually get to that place? Why in the nineteen eighties did balance sheets

start growing in this way? If we go back to the end of World War Two, we've just been through fifteen years of depression and war, and balance sheets were extremely low. There was no one had done much investing, they hadn't been really been, They hadn't wanted to in the depression, they hadn't been allowed to during the war. Uh, there was a huge pent up cash. All the debt had been pretty much paid off or going bad by then. And at the end of the war, we had this

tremendous boom rebuilding, and this meant expanding balance sheets. We had asset prices that were depressed by all the fears brought about by depression and then war, and gradually people became more comfortable, so we had a normalization that went on maybe for up let's say into the seventies somewhere. There's no way to draw a precise line, but the problem is that there's a certain shore there and this

this this kept going. I don't have you know, we don't try to explain exactly why it had to go. We we could have a long discussion about that, and there are a lot of reasons to believe that there were some forces behind it. But the important thing is we know what did happen. And once you get to the point where you start to uh, balances are so big that to support them, the FED is forced to

lower interest rates. That it's not you know, housing uh just weakening or or or or car sales going down, but it's actually you have an asset market that's having a negative wealth effect or there are debt problems of financial crisis that comes when interest rates go too high. Those are the balances now start to take over interest rates. I want to talk a little bit about the sort of necessary FED response when asset prices go down. But before we do, I just want to back up the

germ Levy Forecasting Center. You talked about how you use a sort of sources of profit, sectoral balances or balance sheet approach to under ending the economy. Can you just sort of talk a little bit more about what makes your approach to analyzing the economy distinct? Because when I read a lot of like self side research, I typically don't see a lot about sources of profits analysis. No, No, this is this is There are more people starting to

pay attention to this. In fact, a piece which we give out a complimentary I don't know if I mentioned where profits come from. It's just an educational too. I know is used by a number of big investment houses. They've started to get interested in it. It was introduced to the discipline UH in the nineteen thirties by UH. To most people an obscure Polish economist who was a contemporary of Canes at at Cambridge, but it was that was Michael Koletsky. But he had a very left wing

view of about a lot of things. There's nothing left wing about the profits identity. Profits identity of profits equation is just a cousin of the very well known savor investment identity. You just rearrange the terms because business saving is profits after taxes and dividend, so you can turn it into a profits equation and that is a much better causal way to understand what happens in the econic when investment takes place and people decide not to save

too much. A lot of that the wealth created investment that isn't saved by households or governments ends up necessarily flowing to business and it becomes profits. So this way of thinking, it naturally ties into finance. You don't look at real concept. You're looking at financial flows because of the importance of investment or saving flows. It ties into balancing changes in a very direct way. Just to say,

how does this different? There are people who are told you mentioned sectoral um analysis, where people there's a there's a strong tendency among a lot of people to say to look at the private sector as a whole, look at what is the net balance the private sector. I believe it is absolutely essential to separate the corporate sector from households because if if household saving goes down, that's

good for profits, Yet the total may not change. The households save and profits go down the total maybe you know you're missing critical asset because business is going to make the decisions about employment, about investment, and so forth when it comes to you know, you argue that basically the rising value of assets relative to income pushes down interest rates over the long run. Can you walk us

through why exactly that happens? Is it because of the central bank is forced to lower rates to support an increasingly financialized economy every time there's a sign of trouble, Or is it because the actual rising value of assets somehow exerts some sort of force on interest rates itself. Um, it's it's it's really what it compels the central bank to do. You know, the general story told by probably the majority of economists for many years. I don't know

if it's still people still even be interested. It was that the reason interest rates came down under the eighties and nineties was because of falling inflation expectations. The Fed succeeded in lowering people's expectations, Therefore there was less inflation

interest rates didn't have to be as high. If we look at when the FED made decisions, it was they always were raising rates until the when they thought the economy was strong and there an inflation was harder they wanted to be and they all but they stopped and reversed when the economy got into trouble and increasingly that trouble was financially related. Now, but the real interesting part is what happens when you get into a recession or financial crisis. Each time the Fed had to lower rates

further in order to UH stabilize financial problems. If we go back to the UH ninety nineties, when we had the underwinding of the commercial real estate bubble, we had

bicoastal housing bubbles. We also had we had a lot of LBO excesses, We were still working through the problems from the savings and loan system, and we had a lot of of fall out, a lot of balance sheet problems over capacity, things that led the Fed to to cut rates and not just through the recession, but to continue to cut them for another almost another two years before the economy finally showed some life. If we go back to them going to the next cycle, when the

tech bubble burst. Instead of going down to three percent with the FED funds right, the FED had to go all the way down to one percent, again, continuing to cut after the recession ended because the economy wasn't responded, because the balancie problems, and in the latest case, it was clear that they were going to have to go lower. And I say it was clear when I When I say that, I mean we went out and I did something never done before and probably will never do again.

I started a small hedge fund to do nothing but play the the eventual collapse in interest rate, because you the FED would have to go to the floor. Now we are timing wasn't perfect. Fortunately we ended up doing very well. But we I don't want to make sound like I'm too clever, because we we We certainly didn't do you know time everything thinks lasted loaning, we thought.

But the point is it was clear that the next time there would be even more debt, there would be even more asset value of losing it that the FED would and the consequences will require even lower rates, And the FED was going to run out of room, and therefore we had The FED had to keep rates low

for a long time. So sometimes when the stock market starts to fall and suddenly the chatter picks up among various ef I see people about rate cuts, and people say, ah, there's a FED put under the market and the Federal he cares about asset prices, and kind of what you're saying is like, that's not even a conspiracy, that's not even that's just how the world has to work these days with unfortunately or fortunately, and we don't have to

make any judgments per se. But that is just kind of like the required mechanical operations because the consequences of falling asset prices in a world of gigantic balance sheets more or less leaves the FED. We have to remember the FED is is in a in a politic environment. And uh, I remember my father, who was in this

business before me. Uh met with William at Chesty Martin and when he was in the FED chair, and he said, look, as long as the White House and the Congress disagree about what we should do, we can do anything we want. Implication being obviously, if everybody thinks you're not doing enough, you better do something. When if we think back to earlier in this this expansion, why why were people pushing for for zero race, Why were they pushing for qui?

Why were they pushing for more? Because the economy was not behavior in a satisfactory way and people were We had fiscal stimus, but it wasn't enough and people were reluctant to use more. So the pressure was on the FED, and the FED was their Their objective is helped get the economy going, so that's what they tried to do. The problem is the FED, really and I'm really sympathetic to the FED because they really face an impossible task.

Although I'm not sure they always realize it, or all all members of the of the Open Market Committee always realized it. And that is that on the one hand, you know they in order to get the economy going, you need to have balance sheets expand rapidly, especially when they're already this big, and we can talk about why that is. But at the same time, in doing that, they're making the balance she's even bigger, creating more pressures that are gonna make things worse. We see this very acutely.

We happened in a very rapid time in China where we saw they would constantly turn to opening the credits big it's af tremendous debt growth as the economy started to need boost here and there. Uh, and then they began to realize they were creating something that was completely unsustainable. And now they've been back and forth trying to figure out how do they stimulate the economy but not create too big a bubble, and they're they're not doing a

really great job of it. So our negative yields on debts or securities are those the ultimate expression of this lower interest rate dynamic that you're describing, Because when you think about negative yielding debt, that's something where the only way you're really making money is either through you know, some sort of currency hedging or conversion, or by selling it onto someone else, in which case it's capital gains

and not income. So is that basically what the world is going to look like if if we keep going down this road. Let's start to first talking about the negative policy rates, because that that has huge impact. That is critical to having negative yields on bonds. If you are going to lower interest rates and negative rates, now you create a situation where depositors ultimately can be either paying fees on their checking accounts or they're can be

paying negative interests themselves. Uh, And certainly for large depositors, this becomes a big issue. So at some point they say, all right, uh, or even if we're not being charged a feast, now, if these negative rates become more negative, we will be. So let's lock in a negative rate. So at least we won't we know how much we're losing. We won't lose as much as we might lose if

something else happens. So the expectation of negative short term interest rates is critical to having negative views and bonds. If you look at the Great Suppression US, we had deflation everything else. Yields did not go negative. The couple of tining caveats in that which were special circumstances did not go negative. Un bonds because people wouldn't take less than zero. They've just hold cash otherwise. So the title of your of this paper and you talk about is

bubble or Nothing. The paper details how private sector swelling balance sheet compel increasingly risky financial behavior. So private sector actors are aware, either directly or implicitly, that we live in this balance sheet denominated world in which the only thing that sort of drives the cycle is the direction that asset prices are going in How does that change the behavior of households and firms when we when this is what drives the cycle, and how does it compel

increasingly risky behavior? All right, we we identify nine ways where in which the expansion of balance sheet ratios has a higher debt to income and higher asset to income ratios actually change parameters in the economy that affect decisions. But I'll give you a very graphic illustration of what it looks like. First, uh I won't take you throw on nine. Don't worry, but the the don't check out

the paper if you're listening. We've tried in the In the paper data from the uh I forget the of the organization, which the Pension Fund Association, and they show that the average target, that is what what the manager of that fund is supposed to be achieving on an average over the years, was just about just over eight percent. At that point, you could get almost a percent, about seven point eight percent on a thirty year Treasury didn't have to be very imaginative, taken a lot of risk

in order to hit his target. Now, twenty years later, two thousand twelve, that target had barely moved was down slightly still about eight percent, Yet the yield on the third year bond was so Now how is he he can't just say, well, we'll buy some corporate or investment a little bit higher yield. Now now he has to they have to think of a whole different set of choices.

There was quoting the I. M. F Uh making statement that we're having a problem with low interest rates because too many people are investing in in items, in assets that are too risky or too a liquid and this is going to lead to problems. This is exactly the dilemma that comes from balancing. Now again, we talked a little bit about interest racing forced down as balances get bigger and bigger, that the crises forced the Fed to

lower rates to keep things stable. And we all also one of the things that happens as as as rates go lower, asset prices go higher. But what's the flip side of that low operating rates of return? If you have a low operator rates return, the rent on the building relative to the cost of building is low. The the dividends are stocks are you know, at a low rate.

If you're looking to invest for conservatively for income, and maybe you'd have a little bit of blue chip equities paying paying UH dividends in the past with some investment create bonds. Now you can't do it that where you have to depend more on capital gains. So one of the things this does is it puts a lot of people investing in equities who really want UH steady income.

And that's I think the origin of a lot of the pressure on on business managers to meet their quarterly objective for earnings and to put the emphasis there rather than what is good strategically for the long run. Right, I have a question how do people and I guess companies actually convert capital gains into you know, wealth or income or something they can use well for companies. First of all, companies will will sometimes have capital gates if

they sell assets. In fact, it it's UH if we look at the period UH starting the nine we we've seen a lot of major capital gains by businesses that they've they've it's been a significant part of profits based on I r S data over over the decades. But you know, the most important capital gains are really the ones that are secured by the household sector. UH. And because how and and those capital gains have become larger

and larger relative to income. We've also seen bigger and bigger cyclical swings in in the in assets, so that in other ways, the the the gains the wealth gain of relative to your income over a business cycle has become greater than it was in the past. And your wealth losses during the recession crisis have also become greater. So now you know we have another form of instability

that that's that's uh imposed itself. But wealth effects also affect colleges and private private endowed entities where they have their own investments, where they have their own capital games, but also their donations are largely going to reflect the capital gains of of of So yeah, So on that note, how does asset price inflation um actually impact the balance sheet?

And I'm actually thinking about corporates here, but there's been a lot of talk that that corporates borrowing from the bond market to fund dividend payouts and also share buybacks has inflated the value of equities. Is that something that you would buy into based on your thesis here, well, so, I mean that it was clearly happening the way that we see actually on the corporation's own balance sheet in

terms of its own assets. Uh. That we see um asset inflation is usually in the form of goodwill, which comes about when they take over. They do a takeover. They they buy a company whose book value is five dollars and they pay two billion. Well, the access goes on as book value, uh sorry, as good will. The most acute places where we see these the acid of appreciation is I think in the household sector. It's also in in in the real estate commercial real estate sector,

depending again which would cycle we're in. So let's get back to the original question. I mean, I remember like the first few years after the financial crisis two dozen ten or so, and my thinking, and arguably I would still say it is it's like, wow, that was really bad. But these things come along maybe twice in a century or once in a century, and then typically recessions are

nothing like that. But we set up the whole discussion of like, well, can we actually just have this sort of shallow, short, not that bad recessions where there's not really a financial crisis and employment only rises a modest degree given what you've said, and ignoring about whether we're going to be in recession this year, next year or the year after that, because that seems hard to predict. How bad could it be? And are we naive to think that it could just be like a good old

fashioned recession. Well, you know, moving from the principles that are illustrating this paper to put on a hat as my day, my normal day job, which is analyzing and forecasting the economy and looking at the world and trying to give opinions about it. What we see is in the United States. The United States was the epicenter of the last financial crisis. It was our housing bubble and the enormous um mortgage finance derivative monster sausage machine that

we we generated and that had global implications. They were reflections. There were bubbles in other countries, but we were the center of it this time around. Uh, the United States is arguably no worse off and in some ways better off than it was going to the last secho. But the rest the world is in much worse condition. And I would say if we had there's no perfect analogy, but if I had to pick one thing to say it's this is this sector's housing bubble, I would say

it is the emerging market sector. The emerging market sector has basically their their their boom over the past generation was largely based on tremendous growth and exports uh and also tremendous investment in their exporting capacity and infrastructures to support it. These countries were doing wonderful until they got to be too big a part of the global economy and the developed market economies started to slow down, and

suddenly they couldn't keep doing this. So we've seen their investment weakening, their exports weakening, and increasingly they've they've been depending on incurring debt and basically being kept kept afloat by the tremendous search for yield that keeps money flowing into risky places. So we think in the next recession there could be serious problems in emerging markets, flights of capital, and its gonna be a real nasty mess. I think

that will affect the world. So you say that in your view that you know, perhaps the best analogy to the housing bubble is what's going on in e M. One difference that really jumps out to me, however, is that people were bullish and enthusiastic about housing. Certainly still in two thousands six, maybe even it's still two thousands seven and then suddenly the entire edifice surrounding house they

finance seemed to collapse overnight. Whereas with e M, e M sets have been under performing world markets for I don't know, close to a decade now. I think they peaked relative to global markets and have been under performing. It's extremely hard to find an e M bowl anywhere right now. They'll always say, you look at specific countries or you know, come up with some other thing, they say, and so should this be I don't know, give us

a modicum of comfort. I mean, I'm not looking for comfort, but is it one that there is not a particularly high consensus that these countries are in great It's clearly not a perfect parallel. But I would say that what we've had in in terms of the underperformance, but we had the US, UH and Europe, the US with severe problems, and then the the the rest of the world. I sorry, Europe in particular with its crisis that it came out

of at least largely came out of UM. So we had very rapid recoveries from those things UH and and and the long term problems I mentioned start to become more and more evident and weigh in the profit growth of those countries. So but I would maintain that there is still I mean, even even now there are plenty of people saying this is the time to rotate it

to the MS just because they've underperformed. Uh. But the main place where the excesses, I would say, is the dead side, the number, the amount of death that's you know, the spreads are are still historically quite narrow as if there wasn't that much risk there. And yet there's another private sector hard money that mostly concerns you you mean the uh, the m private sector, private sector, and there's

but there's also there's also a government. These governments because of the condition a lot of them being able to run deficit spending that they wouldn't be able to otherwise without worry about capital flight or having to raise interest rates or anything else. But also it's I want to emphasize. Look, we look at Europe. Their their debt ratio did not come down the way ours did in the last and it's higher than ours. So we look at Canada, they have the highest debt income ratio in the in the

in the world. China very close, Australia close, South Korea is close, you know, so we have a lot of countries that have excessive balance sheets in one way or the other. It's it's more mixed. It's not like in some sense the housing bubble in the US was like it was a kind of a pinnacle. But but there are plenty of problems and and the thing is the United States has the institutions to u contain the damage, to stabilize this banking system when we have a crisis.

Actually our currency strengthens, that's not it'll be a very different situation I think for merging markets. And that's that's why that's concerned. I have a step back question. I guess our Our previous guest on odd lots was Richard Coup from the Nomura Research Institute, and he's famous for coming up with the balance sheet recession idea, which is that basically, after you know, we get big recessions, it's very, very hard to get the private sector to lend again.

People are sort of scarred by the experience, and even if interest rates go lower, they're not necessarily willing to go out and borrow. But you're sort of saying the opposite here. You're sort of saying that the reflexive reaction um is to continuously go out and expand your balance sheet. Why why do you think how do you account for that difference? Well, first of all, let's talk about who who's expanding their balance sheets. We're not seeing businesses go

out to invest to expand capacity. The economy is not really the private sector is not investing in the profit sources are staying depressed. Where the money is being borrowed is in the financial sector, in people are trying to leverage positions to try to get more returns. I mean, there's always you know, there's borrowing in parts of the world going on their emerging markets. There their corporations who are in trouble who would be cutting back, but they

keep borrowing to keep themselves afloat. Let me also just say generally, because you know Richard who really did a brilliant thing. I mean, coming from a conventional background, uh, he looked at the situation and in Japan and said, wait a minute, there's something going on here that that

is not being accounted for. And he very properly identified the bubble in as having created over extended balance sheets and the process of bringing those balance sheets down was having all kinds of economic as well as just pure financial market of effects and a lot of his policy prescriptions.

I I agree with that perfectly but large extent, but some point of thing that the balance sheets play a role in their expansion to contraction, plays a role in the economy throughout history, and that the balance sheets have had there's a long story here. This growth and balance sheets relative to income has made it possible, not only made it possible we get the point where we have these bubbles, but it started to generate its own pressures once you get to certain points of great, bigger and

bigger bubbles each time until the whole thing breaks down. So, whether it's Richard Coop, many of the sort of MMT post Caynesians, Leftish economics types, and increasingly mainstream New Canesian types like Larry Summers, there is this growing consensus that well, to break this cycle that you described of lower and lower rates and more and more bloated private sector balance sheets and mediocre growth, what we really need is for all the developed market UH governments to step up and

do true fiscal stimulus, really unleashed fiscal firepower. And of course we know that it's politically difficult because of politics, but in theory that's what could break this cycle? Is that?

Do you agree with that? Is that? Ultimately what breaks what could break this cycle of larger and larger, riskier balance She's is if essentially more and more of the debt we're not at the household sector, not at the corporate sector, not in financial leverage, but in direct government spending, which is largely risk free, so that the debt swapped from risky private debt to largely risk free government sector

debt um which is basically a safe asset. And if that were done in a concerted, large scale, sustained manner, would that break this sort of the bubble or nothing cycle. Here's the tricky part about it. The tricky part is if if, if you're the vision is that we get the whole global economy to be growing in a lovely manner supported by fiscal policy, and somehow these balancy successes

will just fade away. No, they won't. You don't. As long as the economy as proceress, people are going to try to figure out how do we get higher returns. And if they're not there now, one of the things that happens if you raise interest rates, you tend to bring the asse advice down, but the negative wealth effects will be very powerful. The reality is governments are reactive. They're not you know, they're not gonna come up with a you know, a great, great move ahead of time.

And I think what what we're likely to see is in the next recession we will see reliance on fiscal stimulus too, and hopefully associated with with long term investment and doing things that government has been neglecting in many places. Anyway, we have a whole lot of technology trend changes to make. We have to adapt to changes in how we use and create energy. So there's a lot of positive things that can lead to to a boom down the down

the road. But I think you cannot escape the fact that the correction it's gonna it's not gonna be easy. People don't like to have their wealth go down. And in some sense, you know, we have created a fantasy with with with a great market enthusiasm and extremely low interest rates that somehow assets have an enormous value relative to the income they produce, which is just not really going to be sustainable. No, look, we're not This is

not the end of the world. But I you know, I think we're gonna go through some some bumpy cycles, and and there will be I think I am worried about certain parts of the world that do not have the ability to to stabilize themselves. But but I think for the for the US, um hopefully we won't go through a recessions bad as the last one, but they're gonna be some bumps. So just just to be clear, though, can we ever go back to a ninety and fifties world in which the economy cycles are not driven by

asset prices but are driven by income and production. I think I think we we are are, in all probability headed exactly to that, but I think we have to go through the corrector process. That corrected process means that we need to go through up here where asset prices are going to come down. Home prices have to come down. You know, if you look at Robert Schiller's UH chart on on the very long term UH real home prices, you see that we had a lot of stability for

for throughout history. This enormous spike in the last cycle, we came down just back to the old highs, and we went up, not as big as spike, but they're still just too high. We need to adjust that equity evaluations have to be adjusted. That's gonna be difficult. But by the time we come out of this and this long period of week investment, the need to reinvest, the new technologies, the pressures, I think we're we're gonna, We're gonna come out of it, you know, but we probably

have to be a little bit like the phoenix. We may have to catch fire a little bit before we we we we re birth. But not that's that's probably the right analogy. That's too extreme. I think in Japan, although it took them longer and they didn't do everything right, they did avoid a great depression, and I think they've

they've healed a lot of their problems. What's your one recommendation to either politicians or policymakers about how to handle the big balance sheet issue and actually manage us into a place that is more similar to, you know, the nineteen fifties style of recession. Well, number one, there's no easy, clear roadmap, but here are four very quick rules. Number One, when you need to stimulate the economy, rely more on fiscal policy, hopefully for public investment. Number two, don't let

the banking system break down. I think most of them get that, but but keep it functions. You can, you know, make the manage, the stockholders and the manager. You can punish them, but keep the banking system functioning. Number three is encourage orderly working out of problems when they're there. Resolution Trust Corporation for the same as loans a great example.

And the final one is try to avoid and this is the real tricky when doing things like extreme monetary policies that that might lead to reinflating asset bubbles at a time you don't really want to be doing that. David Levy, this was a fascinating in conversation, and even though it's kind of depressing because you would have hoped that maybe two thousand two nine would have been that Phoenix moment, I am. I do appreciate that you left us on a little bit of hope that we're not

all going to die. I think of the next generation, we're gonna see wonderful revival. I could go a whole laundry list of reasons why I think the US has got a very bright future. Uh, manufacturing coming back, all sorts of things having nothing, a trend that's already begun actually long ago. So it's not it's not all doom in globe but but but but the time for being a little cautious. Definitely. All right, Well, I really appreciate

you joining on. I highly recommend everyone read your report, or if you don't read it, just check out the charts. They're great. Thank you very much, Thank you, Joe. Thanks David, Joe. I've on that conversation really really fascinating, not least because I personally have been thinking a lot about the financialization of the economy, though I think about it mostly in relation to corporates and UM I sort of alluded to it in the conversation, but M and A and buy

backs and how that's interacted with asset valuations. But I really liked David's separate separation of corporate versus household versus government leverage, Like we tend to think of leverage as this one big, cohesive concept, but it actually has different effects on the economy. Of course. Yeah, I think financial media can often get extremely lazy about using the word debt, and it's like, oh, there's a lot of debt out there without we are the financial media, No, not using

other people, but other people. And it is really important to distinguish between different kinds of debt, what's risky, what's productive, what is going to be a burden on the economy.

And I just want to say, like I really, I don't think we intended it, but some of these last few episodes, I'm really into this balance sheet theme because we're of course talking to Michael Pettis and the structure of Chinese balance sheets, Richard Coude talking about the balance sheet recession where he sees it today, and then obviously getting more granular with David about different aspects of private sector balance sheets and this sort of ever inflating bubble.

This feels like a really meadia topic and one that the mainstream UH is only now just starting to really come around and appreciate it. And like I said, you know, it's not totally outside the main stream. I think Jerome Powell hit on a couple of these things, and Jackson the whole a couple of years ago. But I'm I'm bullish on this is the topic. Well, a lot of these ideas sort of exist in the public sphere. I mean, David mentioned the I m F Report talking about you know,

risky practices UH spurred on by low interest rates. They're all sort of out there. But what's nice about David's paper and his these this is that it all kind of pulls it together in a really tangible way. And we've actually inadvertently created a balance sheet series, which is quite cool. We have we have three three's a trend, yea trend. Alright, on that note, Alright, this has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway.

You can follow me on Twitter at Tracy Alloway, and I'm Joe Wisenthal. You could follow me on Twitter at the Stalwart. And you should definitely check out David's paper, The Bubble or Nothing, how private sector swelling balance sheets compelling increasingly risky financial behavior, really fascinating stuff. And be sure to follow our producer on Twitter, Laura Carlson at Laura M. Carlson and all the Bloomberg podcasts under the handle at podcasts. Thanks for listening,