What Negative Interest Rates Mean for the World

including some songs by yours truly. So keep listening to odd Lots all this month to find out more details about the live show, but for now, mark your calendars for Thursday September for the first ever Odd Lots variety show. Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My co host Joe Eisenthal is away. But I was thinking the other day and I realized that Joe and I have never really done an episode

on negative interest rates. And while we've had instances of negative yielding bonds before, over the course of the summer this has actually become a really big topic. By some estimates, the world has I think seventeen trillion dollars worth of negative yielding debt now, and that includes things that you

wouldn't really expect, like corporates, some emerging market governments. And I think the reason this gets so much attention is that there's something fundamentally kind of unsettling about negative rates. It just doesn't really sit well with our idea of how capitalism is supposed to function. I mean, if you have money and you put it to work by investing in a company or a government, then you are supposed

to be rewarded for that. And that's one reason I think that we're really starting to see p question the foundations of the global economy. And we're also starting to see people look at new ideas for fixing it, such as modern monetary theory or MMT, which is something that

we have discussed on odd lots before. Now, in any case, it doesn't seem like negative rates are going to go away anytime soon, given that central bankers around the world are pushing benchmark rates even lower by embarking on another easing cycle. So on today's all thoughts will be asking why exactly is this happening. Why is it that more than ten years after the financial crisis, yields are trending even lower and what is this say about the economy and how we think about it and how can we

actually fix it? And I'm really happy to say that our guest for this episode is one of my favorite analysts. I've been reading his research notes for many years now, and I think he's really one of the few on the cell side that thinks about these kind of issues on a big picture basis. He's certainly the only analyst I've read who seems to be taking M M T very seriously. And you'll see what I mean in just a minute. So, without further ado, I'd like to bring

on Victor Schutz. He is a Global markets head of Asia strategy over at McQuary. Victor, so nice to have you on the show. Thank you, thank you for having me a Jersey. Let's start with that number that I threw out earlier, seventeen trillion of corporate and sovereign debt with negative yields. How exactly did we get here? Well, that's uh, that's a great question. You're absolutely correct. The question is why we cannot tolerate things like obility. Said

more when I was a younger man. Quite often spreads will move fifty sixty bits very easily today when we have thirty five spreads suddenly moving and you almost need ambulances at the exits. Why can't we have prime discoveries. Why can't we have time value of money? The answer to me is leveraging. In other words, our solution to low productivitory over the last twenties that years was the

brand future consumption. To the present, our solution was a surprises and leveraging will don't but to you what wages no longer capable of giving you. And therefore, yes, your real incomes might not grow, but we will allow you to grow well in different ways. And initially it's incredibly stimulating, it improves wealth, It does also some wonderful things. It also works together with globalization. You can't really have that sort of leveraging unless you also globalize the product and

labor market. So it's really the next of triple package of globalization, product market, labor market, and financial market, where our well being, our pensions and everything else depends on enterprices. But the challenge with that is that the more you financialize, the less effective it becomes. You got twenty years ago, you needed maybe a dollar dollar fifty of debt to generate one dollar of GDP. In most countries today, you need three to five dollars of debt for every dollar

of GDP. So the more you do it, the more incremental impact diminish it. And that implies that you have to spur or you have to motivate it to multiply even higher. To do that, you need to issue more and more of that debt. And the more capital you create compared to what you need, the more cost of apple has to go down. And that's why interest rates have to continuously go down to a lower and lower level.

And the more you rely on assets and debt, the less comfortable you are with volatility, the less you can tolerate volatilities, particularly in asset classes. So where is the stage that it's like a squirrel in the wheel. You can't stop running because if you do, the whole house of gods collapses theory very quickly. And so if you

if you sort of take that, you do that. Any inoculation that central banks might want to do in terms of lowering rates not to spur a little bit more growth makes it worse, and interest rates have to go even lower over the longer term. Of course, what it means if you continue to use monetary levels, interest rates will have to go with negative everywhere, not just in Europe, not just in Japan, but also names of such countries and eventually all across the world. A lot of people

will say what is wrong with that? But but traceday as you correctly said, that's not the way capitalism is supposed to function. That's not the way corporate finds theory is supposed to function. So Victor, on that note, you talked about central banks driving down the cost of capital in order to boost growth, and this is where we start to to see the impact on both our theory

of capitalism and also the value of money. You mentioned this already, the time value of money, So this is the idea that you know, money available right now is worth more than that same money in the future due to its earning capacity. So basically, you know, it's a core principle of investing that your money can earn interest or a return, and so it's it's worth something. And that seems to be what makes people so uncomfortable about

the negative interest rate environment. So my question is what is that going to do to the overall economy and to investment. Central banks that what they're doing because they're scared of deflation. Now why they're scared of deflation, Well, because we've accumulated so much dead that nobody will ever be able to repay it. I mean, globally, we have

two hundred trillion dollars of death. If you look at all of the real instruments that we haven't told that really the cloud of finances at least four or five hundred trillion dollars. That's around five times nominal GDP. So instead of repaying the death, society is built around the concept of a very gradual and slow default. So we're slowly defaulting on our death, and the way we're default it is to inflation. That's why central banks are so

scared of deflation. The more you relign monitor delivers, the more you drive the cost of capital down, the more you create deflation. So you're trying to eliminate it, but you're actually making it worse. Now why is it's a well a couple of reasons. The reason number one is that the low cost of capital means zombie companies survived, so you don't actually have clearances which are normal capitalist system or have. Now that's a highly deflationary element. The

other thing that is happening. The lower cost of capital implies that any unicorn, any brand new idea can be funded, and so technology is actually progressing much quicker than otherwise it would be the case. We've actually pour in Harrison on the fire, and as technology explodes, companies get decent mediated from their products, their brands, labor gets disintermediated from

their wages, and that's also highly disinflationary. So the first side effects of using sort of monetary levels that aggressively is that you're trying to avoid deflation, but in fact

you're creating a stronger and stronger dec inflation. So, actually, Victor, you just mentioned tech investment in particular, and I wanted to press you on this topic because it does feel like nowadays, with the cost of capital so low and people chasing future asset price growth rather than value, right now, it does feel like we've seen a lot of money go into the sector, whether it's through the private market and unicorns, or through the public markets through thingstocks like

Amazon and Apple. What is the tech investment in particular do for global economies and for society? Tech investment actually has clearly multifact de fact some of it is very very good, but a lot of it is highly deflationary. So in other words, tech has a tendency of eroding cost of everything we consume and we produce. So when marginal costs decline of a time, the prices also dropped.

That's part of the reason it's so hard to prosecute technology company for antitrust violations because they're not actually gouging consumers. On the contrary, they're reducing prices. It's not the depriving consumers of a good product. Product is actually good. The problem with tech is not so much gouging or depriving people of value, but rather the fact that tax is money tizing people than powers uh and the creating scale of business that includes other businesses going into into this

particular area. But from a macro perspective, if you keep the cost of capital too low, technology propagates much faster. Technology is really human spirit, it's human ingenuity, but the speed with which it progresses depends on the cost of capital. The lower your cost of capital, the faster it goes. As a set of setting that it's like pouring rising on the fire. And when tech progresses, it basically disintermediates companies from their products and their brand. It disintermediates employees

from their wages. So it contributes more disinflation to the system. I mean, I'm curious you've alluded to this already, but rampant disinflation. Uh, disintermediateation through technology, the financialization of assets, and a bunch of investors basically pursuing speculative wealth. What does that due to political society. One of the things it does is that it increases income and wealth inequalities. Again,

income in weals inequalities, right, variety of reasons. But financialization, relying on assets, relying on leverage, magnifies those income and wealth inequalities significantly. Even the central banks increasingly starting to realize that aggressive prolonged usage of money to relevers is not good for inequalities. Now that by itself is starting to create political friction. So but from a societal perspective, couple of impacts. Number one, the marginal pricing power of

labor declines. In other words, technology and financial sization reduces your marginal pricing power, reduces your wages effectively that you otherwise would be able to command. And the second thing it does if you're a person with a lot of assets, particularly financial assets, your your wealth, your networks is growing very fast. If you're relying on wages and household chapels like houses or refrigerators, your relative wells actually goes down.

Um and financialization and dead increase the speed with which those two parties go apart. That's your top one versus the rest of the population. So if we continue to rely on monetary levels, implications are At first of all, disinflation is likely to get stronger. Number two, the pockets of growth in economy will get smaller and narrower. Number three, that will be less productive investment, a lot more speculation occurring. Number four, income in wealth inequalities are going to increase.

But another thing it does because every time you use debt, marginal utility of that debt goes down, and other words, every time you need more and more of it. What it does make countries want to do is to steal from their neighbors. So, in other words, countries and start competing very aggressively to start running current accounts surfluces, to try to steal business from another country, and that's what leads you into potential currency evaluations. That's what leads you

into trade wars. So if we continue using monitory levels as we have done over the last thirty forty years, if we continue over the next fiveteen years, societies could

just blow up. Okay, So here's my question. In two thousand nineteen, we are about to embark on another round of easing by tra banks around the world, and even though we've had ten years of evidence to the contrary, they think that doing the same thing over and over and over again, which is lowering rates, is somehow going to lead to a different outcome, which would be inflation. So what exactly is going to be the point at

which policymakers realize that this monetary strategy is not working. Essentially, the problem is you can throw away the system until you build a new system. I do believe that, whether it's central banks, whether it's treasury departments where most of the banks they do understand that you can't just keep going. But the problem is you kind of abandon the system that you already have before you've decided what else you're

going to do. Now, there are alternative ideas, and the interesting thing that I find how quickly they're becoming popular. If you think of what monetary theory. It's not a new idea. It's been around for a long long time, and there were books published, articles published for decades. It's amazing how popular there is suddenly becoming. I mean, Financial Times only a couple of weeks ago devoted the entire page discussing MMT. Only twelve months ago, I can't believe

that ever would have happened. The same applies to Neil Kinsians. If you think of a growing popularity of people like Paul Krugman, uh, what you're seeing that in massive intellectual shift is already underway. Recognizing that fiscal neo Kinsian and m m T solutions might have lower side effects. It's still a drug, but it's a drug which will have lower side effects than continue to use minetary levers. But I'm not suggesting for a second we're going to abundant

monetary policies where no we're not. It's just what you prioritize as you go forward. I personally think probably is going to be the last year when monetary policy is used as a primary instrument, and the breakpoint to me will be when we have to do something every two or three months. Every two or three months, think about it. We had a small heart attack in December two thousand eighteen.

I don't know what January two thousand nineteen would have looked like if Jerrem Powell did not surrender on a third of January two thousand nineteen. Then we had another mini heart attack in May two thousand nineteen. This time

around it was better reserve and ECB. So the windows getting shorter and shorter, the period of stimulation or the beneficial impact are getting shorter and shorter, and so so to me, it's those mini heart attacks that will continue rolling over the next twelve eighteen months that will have to come to a stage that people will start shifting priorities. I do not believe anybody will call it neo Kanzian

immediately or anybody will call it m MP immediately. Rather, we're going to stumble around and gradually it will be fiscal policy. It's going to be neo Keynsian policies that

that are going to drive them. So what about political opposition to fiscal solutions, because it does seem that basically what you're talking about is rethinking the way the financial system has been working, and governments in the developed world really have seemed reluctant to do that so far, and certainly it feels like there are interest groups or politicians out there who basically I can't see them and diving head first into m m T for instance. So what

would allow it to happen? Now? You you argue that in some of your research that Japan is actually the closest example we have to a sort of m MT or fiscally driven society. But you know, as someone who grew up in Japan, I can argue that that society is very, very different to the one in the US. For instance, when we talk about using monetary levels, we're predominantly talking about the rest of the world outside of Japan, and outside of China. China is actually using all three instruments.

They're using monetary policy, they're using fiscal policy, they're using neo kains in Ism, and they're using straight MMT Japan practices. Elements of all of this, all of this societies are are different. But one thing, Tracy, absolutely you're right to say that a dogmark developed since I guess late ninety seventies, which basically argued that private sector is always better at allocating capital than a public sector. If you go back

to nineteen fifties. In nineteen sixties, that document didn't exist. People didn't think at the time that public sector is necessarily inferior to private sector investment. And the reason why they didn't think public sector was inferior because in their memory they remembered in nineteen twenties and nineteen thirties how badly private sector a misallocated resources. It was, really, I said,

late in nineteen seventies. So the problem we have the entire system is structured around the idea that private sector is dominant, private sector is in a driving seat, and around the idea that public sector is wasteful and private sector is much better dellocating capital. Now, I think what new King's in and M. M. T would argue that is not strictly true always, and in fact, there has

been spectacular misallocation of capital occurring in the private sector itself. Now, to surrender the dogma requires a very long time, So from an academic point of view, you're looking at decades before a new system will actually emerge. But from a practical perspective, from a political perspective, I do not believe for a second we're going straight into m MPT. What we're going to do, We're going to de emphasize monetary

and emphasize more fiscal and Kinsian solutions. Eventually, we probably will end up with a version of MT, but that could be a decade away or longer. So it's not going to be a one soft switch that we go from one policy, one set of tools to another set of tool. Instead, what we're going to do is just gradually shift towards it. A classic example of that all the antitrust and investigation that is starting right now in various countries on techno oology. In many ways, that's a

Neil Kinziean answer. When we have management team has been criticized for very high pension payments or salaries, that's a Neil Kinziean answer. And so what you're seeing is that neo kinson is, if actively, already intruding into the today's world. It's already starting to impact, but its impact is still small.

We're predominantly in a monetary system. All I'm saying over the next couple of years that impact will grow and the state role, the role of the state is going to increase, and that role will be welcomed, particularly by millennium and Generation Z. And you have to remember one third of the US electorate is already millenniums and Generation Z. Uh. Within five years or six years, there will be the majority electoral majority. The same way as Biby boomers brought

on their shoulders Ronald Reagan and Maggief. Millenniums Z generations will change how the role of the status perceived. I said, what we're going to see is increasing influence of those ideas and those policies. Now that's a major problem for investment. Victor. I take the point that this is going to be

a sort of long running transition. But whenever we talk about m m T on the show, I always have the question of whether or not MMT can work everywhere because to me, it feels like it's basically the purview of a few developed economies who you know, probably have an advantage in the form of currencies that are either you know, global reserve currencies or considered safe haven. So can everyone around the world embark on significant fiscal stimulus or MMT uh? No, absolutely not. It's going to be

a reserve of only some countries. I think both New kangents and m m T. People who propagate these ideas will agree on a couple of aspects. Number One, they will all agree that if private sector doesn't multiply aggregate demand and liquidity at a pace that society requires, a society believes is appropriate, then it's responsibility of public sector to do that. Secondly, they agree that it's not necessarily proven that public sector necessarily worse at allocating capital than

private sector. But the other thing, they would argue that under certain circumstances, government can do almost anything they want to, and prerequisites are quite tight. Number one, you have to have monetary sovereignty. So in other words, you have to be issuing your own currency and you have to be

borrowing in your own currency. Now, that applies to United States, that applies to Canada, to Australia, that applies the UK, That applies to Japan, that applies to parts of euro But it doesn't apply to a lot of emerging markets in emerging market space. For example, it does apply to China, it does apply to Korea, but a lot of weaker

emerging markets, um, they do not have monetary sovereignty. The second argument, I think correctly they will They will say that you need to have proper institutions of state, so that the country borrowing and or using central bank cannot be as Imbubwe or Democratic Republic of Congo Venezuela, that that they have solid institutions of space. Again, that applies to a lot of the world, but some of the

emerging markets it does not apply. And a third argument, they will say that you need to live in a relatively disinflation re climate. Again that applies to a lot of developed countries. That applies to some emerging markets, but it doesn't apply to others. So you're absolutely right, there are some strict criteria. It's good to be of some size as well, that there are greateria and not rebody

will be able to do this. But if you think of the world, the countries we mentioned represent about of global GDP, what happens to the countries or economies that can't make the transition to fiscal spending? And on that note, are are we basically going to be trading inequality within countries or within societies for inequality between countries. That's exactly what's going to happen. We're going to become much more localized. Effectively,

we're going to sort of nineteen fifties nineteen sixties. It's not going to be, of course, as field countries as they were back then, but nevertheless the shades of fifties and sixties will be there. You know, there's much more localized, much more protective. The freedom of movement of people will be much more restricted, the freedom of moment of capital will be much more restricted. You'll find the government will be the major driver of a want to miss an investment.

Many people will welcome that also because in this system you don't have a lot of access capital just looking for something to do. You might end up with a little bit less speculation. You will will end up with a little bit more productivity growth rates, at least for a period of time, and that in turn would lower

inequalities in your country. But what about iglobalization that it implies, what about the vocanization that it implies, Well, you absolutely right, a lot of emerging markets probably will go back to being just under developed countries the way they were quality classified not that long ago, when I just needs to

be young men that were called underdeveloped countries. So in other way, some of the trade and capital flows that really enable the emerging markets to prosper and develop will become much scarcer, and some of those countries might not be able to make it, so disparities between the country

is I think will will increase. Okay, and you touched on this earlier, But if you're an investor in the current climate, you are still living um, you know, in the current construct of capitalism, and it's basically one where markets are sort of driven by flows of money rather than um sort of outright value or productivity. So what are investors supposed to do as they still continue to grapple with the current environment, which is one of you know,

lower rates and negative yields. It's interesting if we just continue doing what we're doing. Let's assume no change in policies, as you correctly said, it might take a long time for politics to change. If we continue to rely on monitory levels, then investment styles become quite clear. First, bombs are always good investment. This idea that it's the end of the tar bullmarket run and bonds is just absolute nonsense because interest rates eventually will have to go negative everywhere.

The number one, bonds are always good. Number two financial speculation always good. As you correctly set private equity unicorns flatly thing any financial speculation is good. Number three because this inflation is likely to get stronger and it grows will become narrower. In the narrow pockets, Investing in companies that are capable of growing despite the headwinds are going to become even more popular as you go forward. That's sort of the essence of your quality and grows portfolios

that a lot of people are really like. One investment style that will never work in the system is a traditional value investing occasionally valuable pick up, but essentially it doesn't work in that system at all. If we switch across the Neo Kansian world, the circumstances are somewhat different. I don't believe interest streates can really go up that much, but it will be an environment which will have a

bit more inflation and grows in it. So first, the bonds are not going to be a one way street anymore. I don't think people are going to lose necessarily a lot of money because the interest rates cannot really go up a lot. But nevertheless, it's not a one way street. Number two, because there ought to be a little bit more productivity, a little bit more inflation, at least for

a while. You're going to have more gross opportunities available to you, So the excessive price you will place on the companies that are capable of growing despite all the headwinds will become less pronounced, and in fact some of

those companies might get somewhat derated. As you go a forward, there will be times when the value will really run up because the governments will be spending more money on infrastructure, that will be spending more money on various facilities and things to do capital investment, so some of the value will really run up and could actually be a prime in them for years rather than just for you know,

two or three months. But the thing that really will work in that sort of environment is whatever the government wants to do, which is not similar if you think of China today, That's exactly what Chinese analysts are doing. They're basically asking what would the government do and how does it work through my system? And what do they buy? That's pretty much the way in in sort of neo king and fil world is going to work that you would need to ask yourself a question, what does the

government wants to do? If it's infrastructure fine, and if it's support of consumption through about a minimum in can get in his find That's that's what you're going to do. Investment styles are quite different. But because we're living between the two worlds, a monetary world is still with us. It's still the most powerful force that we have right now. But now the world is gradually intruding, and as it intrudes, it creates cross currents, and so investors right now have

difficulties seeing how they should be investing. That's why Aliot just continue to get crushed by growths. That's why at the times of uncertainties, declining interest rates, even sometimes they've been in yielding stocks don't do well, and and and so the reason for that is there a cross currents. If we stay was one system, it's pretty clear what to do. If we move to another system, it's pretty clear what to do. If we staying in between, investors

are confused. What they're all hoping for, and central banks also hoping for, is a private sector will returned back to growth, and therefore central banks and fiscal authorities will simply pull back and every single returns back to normal to meet the probability of that occurring is close to zero. So I have one more question for you, and it's sort of a step back question on on everything we've

been discussing. But you know, if you read your research, it feels like a lot of the problems that you identify with the current system are that we are overindebted and we're not going to be able to reflate our way out of that debt using existing monetary methods. And yet you're also advocating for fiscal stimulus in the form of m M T or neo kanesiasm, and I think you know that's the policy that basically says, don't worry about the deficit um, So how do you square those

two ideas? Can Can indebtedness be both the problem and the solution? That's exactly what it is. But but the most I guess basic principle is returning back to normality is not on the cause. So we need to choose our poison for the lasts. The West was taking one poison.

It's called monetoring. It indirectly tries to influence the behavior of private sector, and the facts of that policy for the lost tent tift is is becoming so toxic that neither people, nor political classes, nor anybody else has prepared to just carry on with the other poison we have is what we have discussed. It doesn't necessarily solve the problem. We're not returning back to equilibrium, whatever that equilibrium is.

We're not returning back to our reality. But instead we're thinking another poison that has less side effects right now. Because remember, only China practice Ball three. They know the side effects of the other two. We in the West have not really used the other two poisons since nineteen fifty six, so nobody really remembers. So from my point

of view, what new Kinson and m MT does. They give us another way of keeping society is intact, keeping economies intact with a lower degree of side effects, oring the pressure, not the similar to what Iron Chancellor Bismarck did in Germany in eighteen eighties when in producing welfare benefits that reduced some of the pressure that arose out of industrial revolutions. We need to do something similar to reduce the pressure on societies. It doesn't solve the problem.

I mean not suggesting it solves a problem. All it does it provides another draft to keep going with the lower side effects and reducing some of the geopolitical and social pressures that we are experiencing in the next several decades, a different world will emerge. It's going to be something completely different. I don't not believe it's going to be a conventional capitalism, but we need to go through decades to get there, and so I think we need to

switch the draft. That's Victor Schwetz, the only sell side analyst I know who can reference Bismarck on a podcast and quote marks in his research. Thank you so much for being on our thoughts. Thank you, thank you. Drakey. Yeah, so this has been another episode of the Odd Lots podcast. You can follow me on Twitter at Tracy Alloway. You can follow my Missing an Action co host Joe Wisenthal at The Stalwart, and you should definitely follow our producer

Laura Carlson at Laura M. Carlson. You should follow the Bloomberg podcast team at podcast. Thanks for listening.