The Last Gasps of the Central Bank Experiment (w/ Brent Johnson and William White)

Although governments are technically insolvent, markets have been very patient with the big countries and believe they'll sort things out noninflationally over time, so they continue lending—but this patience is not infinite, and when it runs out, it will be a significant crisis.

“the governments are all insolvent, but the markets, okay, have actually been very patient with virtually all of the big guys, and they basically said, I can do the math, the technical stuff, but I think you'll sort this thing out in the fullness of time in a noninflationary way and therefore, I'm prepared to give you the money. I think the markets will continue to be patient the for the big guys at least for a significant period of time...the markets patient is not infinite.”

Following the pandemic and even before it, there has been growing agreement in the academic and central banking community that monetary expansion has reached its limits due to hitting the zero lower bound and uncertainty about non-conventional instrument effectiveness, and therefore fiscal expansion must be used much more than it was after the Great Financial Crisis.

“there has been a general agreement that fiscal expansion has got to be used much more than it was after the Great Financial Crisis. I think that general view had been building in the academic in the central banking community, even before the pandemic and more and more talk about look, monetary expansion has reached its limits mostly in the context of having hit the zero lower bound and not being so sure about whether the effectiveness of the non-conventional instruments. Now, there's much more of a willingness to say, it's got to be fiscal.”

During COVID crisis shutdowns, money stopped moving in the system and no new collateral was added to compensate, exacerbating an already very large problem into a critical one.

“The money's not moving because people aren't moving with the pandemic shutdowns. It made a problem that was already very large and exacerbated it.”

Only recently since the Trump administration, with its exaggerated use of the dollar as a geopolitical weapon, have Russians, Chinese, and to a lesser extent Europeans begun to push back against dollar dominance.

“It's only recently since, I would say, since the Trump administration, and the-- what's the word, they aggravate it. The US have been doing this for a long period time but the exaggerated or aggravated use of the dollar as a geopolitical weapon, that you've started to see some pushback particularly from the Russians and the Chinese, to a lesser degree, by the Europeans, and one can't blame them.”

The expansion of private sector debt through monetary expansion has been used repeatedly by central banks, and although White's biggest professional mistake was underestimating how well central bankers could pull crises from the fire, he believes this time it won't work and they're much closer to the endgame.

“The expansion of private sector debt and credit through monetary expansion, and I really just talked about that, it's been used over and over. I'll tell you, honestly, Brent, the biggest mistake I've ever made in my professional career was underestimating how frequent how well central bankers could actually pull the iron out of the fire. They've done this repeatedly. I guess I'm going out in a limp and saying, I think this time it won't work. Certainly, we're getting much, much closer to the endgame.”

Central banks are typically reactive agencies rather than proactive ones; they wait for crises to happen and try to solve them rather than getting ahead of the problem.

“Aren't central banks for the most part reactive agencies rather than proactive agencies? Don't they typically wait for the crisis to happen, and then try to solve it as opposed to getting ahead of it?...Well, I think you're right.”

The IMF, OECD, and Group of 30 have repeatedly called out inadequacies in legal and administrative frameworks for handling insolvencies and restructuring, but inadequate effort has been put into addressing these, despite the fact that restructuring is coming down the road.

“There's been repeated calls from the IMF, from the OECD, from the group of 30 pointing out the inadequacies in our legal and administrative framework. We should be putting a lot more effort into that because it's coming down the road.”

There are at least half a dozen provisions in Dodd-Frank that will tie the Fed's hands behind their back, and Federal Reserve Chair Janet Yellen has stated she is worried that the Fed may not be able to respond in the next crisis the way they did in the last crisis.

“There's at least half a dozen provisions in Dodd Frank that basically are going to tie the Fed's hands behind their back, and Janet Yellen has said she's worried that the Fed may not be able to respond in the next crisis the way they did in the last crisis.”

Jean-Claude Trichet lamented in 2009 that central banks had relied on models that proved palpably wrong because they assumed big crises can't occur or will self-equilibrate quickly, so when the crisis occurred the first proposition was wrong and the analytical apparatus was flawed.

“Jean-Claude Trichet lamenting the fact that they'd relied on all of these models and that the models had proved palpably wrong because they started off with a fundamental assumption that really, big crises can't occur. If they do occur, they'll selfequilibrate in a short period of time. Well, when the crisis occurred, the first of those propositions is wrong. Jean Claude immediately stated that he could see there was a problem with the analytical apparatus here.”

Easy money used to stimulate demand in downturns induces people to bring spending forward through debt, which works temporarily but the resulting increased debt then acts as headwinds, like using one credit card to pay another—debts get bigger until you can't get more credit, making the system fundamentally unsustainable.

“when you basically use easy money, think about it in the downturn, to get out of a situation, you induce people to bring spending forward from the future by taking out debts by credit, debt, spend the money, and it works. The problem is that the debt, unless we can go into how you might get out of this, but generally speaking, what's happening is that that increased debt then acts as headwinds in exactly the same way as if you're using your credit card, that you use one credit card to pay off another credit card, the debts are getting bigger and bigger, eventually you can't get any more credit cards and you know that in a certain sense, it's got to come to a stop. It's unsustainable.”

When looking at intergenerational accounting including off-balance sheet liabilities (Medicare, Medicaid, pension funds, contingent liabilities), most governments are technically insolvent in that they cannot meet the intertemporal budget constraint without very significant increases in taxes.

“For example, at some of the work that Larry Kotlikoff did, the intergenerational accounting stuff, where you basically look not just at the on balance sheet stuff of governments, there are contractual obligations like bonds, but you add in all the off balance sheet stuff, which is the Medicare, the Medicaid, the pension funds, the contingent liabilities, the numbers get to be very, very large very quickly. For all practical purposes, if you do the numbers, most governments are from that technical perspective insolvent in the sense that they can't meet the intertemporal budget constraint without very significant increases in taxes.”

In 2008, the crisis epicenter was in the US (subprime), but the dollar went up rather than down, supporting the hypothesis that a stronger dollar is a flight-to-safety response to crisis rather than a sign of weakness—so if the epicenter shifts to outside the US, dollar appreciation would be even more likely.

“in 2008, the trigger for the crisis and the epicenter really was excesses in the United States. Subprime and all that stuff, and yet, even though the US was in some sense, the trigger for the problem, the dollar went up, not down. That flow makes some people like Nouriel Roubini and others who have basically been saying-- so if the dollar was the epicenter of the problem, and yet when the problem emerged, the dollar went up, how much more likely is if the epicenter of the problem turns out to be outside the United States at the moment? Then there'll be this flight back into dollars for safety.”

White thinks central banks are a long way from forcing banks to make more loans because people are increasingly aware that many past loans were made to unqualified borrowers, and there is growing suspicion that many loans especially in Japan cannot be serviced for principal or interest.

“I think we're a long way from that world. Not least, I think, because people are increasingly aware that many of the loans that were made in the past were made to people who ought not to have received them in the first place. Secondly, growing suspicion that starting in Japan, going back a long time, suspicion that a lot of the loans are really loans have been extended to people who can't pay back the principal, and for that matter, can't even pay the interest.”

What's much more likely than forced loan expansion is recognition that many loans won't be serviced and that bad debts need to be restructured more aggressively than has been done, which was even suggested in recent Financial Times editorial.

“I think what's much more likely is that there will be a recognition, as I said earlier, that there are a lot of loans that will not, in fact, be serviced and that we have got to face up to the fact that some of these debts or bad debts. We're going to have to restructure them in a much more aggressive way than we've been doing up until now. I've noticed just in the course of the last few days, I think there was an editorial in the- - in fact, I think it was this morning in the FT. The FT suggesting that we've got to prepare ourselves for that.”

The fundamental problem is the financial cycle driven by credit expansion, not the business cycle or inflation cycle, and this has been the core issue over the last 30 years rather than out-of-control inflation.

“the most fundamental problem is not the business cycle. The fundamental problem is the financial cycle. The financial cycle is basically fueled by credit expansion. It's the boom bust thing. If you look back over the course of the last 30 years or so, that really has been the problem. It's been boom bust as opposed to oh, my God, inflation is out of control, and we have to tighten up and control it. That has not been the case really since the early 1980s.”

Central bankers in the 2009-2010 period were caught between wanting to normalize policy but realizing that other aspects of public policy (tightening fiscal policy, tightening regulatory mechanisms) were moving in the opposite direction of higher aggregate demand, so they were left as the only game in town and forced to continue ease.

“Then just as they might otherwise have been thinking about renormalizing, every other aspect of public policy basically went into the opposite direction. Regulatory mechanisms got tighter and tighter, fiscal policy, whereas it had been very expansionary in 2009 and 2010, went sharply into reverse, and so there was this community of people wanting to renormalize on the one hand, but realizing that all of the other forces were moving in the direction of lower aggregate demand, not higher, and yet underlying it all was the desire to have higher aggregate demand. This was the line, they were left as the only game in town, and basically, were almost forced to do what they did.”

Providing swap lines to different countries creates political complications—if Powell gives a swap line to the ECB, which gives one to France, which gives one to Airbus while trying to bail out Boeing, it creates political issues that may supersede what the financial system desires.

“it gets tough for Powell to give a swap line to the ECB who gives a swap line to France who gives a swap line to Airbus if we're also trying to bail out Boeing, issues like that. There becomes political issues that I think maybe supersede what the financial system is desiring.”

Creating an alternative to the current dollar system is extremely difficult because of enormous network effects, and it will probably take an aggravation of the current crisis before people fundamentally rethink the international monetary system.

“To try to come up with an alternative to the current system is going to be very difficult because you do have all of these network effects that are out there and we are where we are, we always start from here, something about these complex adaptive systems that they're all past dependent. The old joke, if I were you, I wouldn't start from here, but we are where we are. I personally think that it will take an aggravation of the current crisis before people do start to fundamentally rethink the question of the international monetary system.”

Johnson changed his view 180 degrees from believing the dollar would go lower due to unsustainable debts being inflated away, to believing the dollar will go much higher before any ultimate reemergence of gold, with the penultimate chapter before gold's return being a dollar crisis.

“I initially thought that and over the last several years, I've changed my view 180 on that, to your point of the, it's not what you don't know that gets you trouble, it's what you believe that just ain't so. For several years, I believed that the dollar was headed lower and when I finally came to the realization or the belief, because I could be wrong, but the belief that before that happens, the dollar is going to go much higher, and I think that's the crisis that's coming down the pike.”

Trump's trade policy and attempts to renegotiate the global order shifted supply chains from unipolar to dual configurations, creating a situation where allied countries might receive swap lines and supply chain access while non-allied countries do not, making monetary and fiscal policy increasingly driven by geopolitical considerations.

“over the last couple years with the way that Donald Trump has tried to renegotiate trade in the global order and we've gone from a unipolar global supply chain, they're now talking about dual supply chains and countries that are friendly with us maybe get these swap lines and those who don't maybe don't get the supply chains and because we are in this crisis now with COVID, you could almost think of it as like a-- not a warlike situation but a crisis situation and government and monetary policy and fiscal policy could be driven in a crisis type situation or a warlike situation.”

The congressional pushback to Fed swap lines is likely to increase the longer they continue, especially given that swap lines are now being offered to countries like China that weren't traditional allies like Europe and Japan were in the GFC.

“the more they do it and the longer it continues, the more likely it is that there will be a congressional pushback. Now, I don't profess to be any expert about that thing but certainly raising it has an issue, how far can we go here? It's an important question to ask. One of the big differences is that the last time, in Great Financial Crisis, the swap lines were basically with people who were largely European and the Japanese, not totally but largely, who were friends and neighbors. Now, the situation is a bit different because there's a lot of people, not least of whom the Chinese who are in this position. It's not at all clear that the political road to the Fed being able to help them, that that road is going to be open to them.”

Fed swap lines are temporary solutions at best, and while theoretically possible for the Fed to bail out the world, it is politically impossible or at least not as easy in reality as in theory.

“these are temporary solutions at best, and I think the idea that the Fed can bail out the rest of the world by via swap lines while in theory possible, is politically impossible, or not impossible, but not as easy to do in reality as it is in theory.”

The Fed has gone beyond its legal mandate in some of its emergency actions including ETF purchases, and concerns have been raised by others about whether this is actually legal, even though White hasn't raised the issue himself.

“there's been a lot of worries about the legality, as you know, about the legality of I'm not raising this issue, but other people have raised the question of whether what the Fed is doing, the ETFs and whatever is actually going beyond their legal mandate.”

The current system is referred to as an international monetary nonsystem because there are no rules; a true system would be like a club where membership requires following binding rules, but currently the US doesn't believe cooperative rule-based systems benefit it.

“At the moment, it's often referred to as an international monetary nonsystem, because there are no rules. A system is based on-- it's a bit like a club. You choose to become a member of the club, but you know if you're a member of the club, there's certain rules you have to follow...it really does demand that the US, of course, becomes convinced that somehow the current non-system is not good for it, that it would be better for the US if it, the US, were subject to certain rules that also were binding on other people. That would be better for everybody, but clearly, we're not there yet and as you're well aware in the context of the current administration, the idea that there is solidarity in the system and that working cooperatively will bring benefits to everybody, that mentality has been replaced...by, I only win if you lose”

When adding in all the swaps and derivatives, there is implicitly still more borrowing going on in dollars beyond the reported $12 trillion that have to be repaid, increasing the true exposure.

“There will be a dollar shortage. Claudio Borio, and others at the BIS have pointed out to that when you add in all the swaps and the derivatives, that there's implicitly still more borrowing going on in dollars, that have to be repaid.”

Decisions in regulatory matters are taken by committees made up of national experts at the BIS, not by the BIS secretariat, and on monetary policy matters, no decisions are taken—the BIS is just a place for central banks to exchange views without taking collective action.

“All of the decisions, whether on the regulatory side or in the monetary policy side-- well, on the regulatory side, there are decisions taken at the BIS, but they're taken by committees made up of the national experts. It's not the secretariat of the BIS that's making the decision, it's the regulatory people meeting there. In so far as the monetary policy side is concerned, there are no decisions taken at any of those meetings. It's just a place for exchanging views”

The popular narrative that the Bank for International Settlements is the central bank for central banks and controls them is a total misunderstanding; the BIS is actually a host for meetings providing secretariat support, similar to the OECD, with no independent decision-making authority.

“that popular understanding is a total misunderstanding. I remember when I first arrived at the BIS thinking I was going to another central bank, and it took me about two weeks to realize I was no longer in the central banking business. I was in the tourist business. The BIS is a bit like the OECD. It's a host for meetings. That's all it does. It's a host meetings.”

The IMF estimates that about 40% of all low-income countries were either in a debt crisis or on the verge of one, even before the pandemic hit (as of October 2019 global financial stability report).

“the IMF estimates now that something like 40% of all the low income countries are either in a debt crisis or on the verge of a debt crisis, and that was before the pandemic hit. That was the October global financial stability report of the IMF.”

Global debt as a proportion of GDP increased from 280% in 2008 to 320% by the end of 2019, with almost all of the increase occurring outside the US and in emerging markets, meaning the 2008 crisis was not a time of deleveraging despite common perception.

“global debt as a proportion of global GDP was 280% in 2008. At the end of 2019, it was 320%. If you thought the global financial crisis was a time of deleveraging, think again. Now, what was interesting about that increase, it was almost wholly outside of the United States and in very large part, in emerging markets.”

Central bankers may have genuinely believed that ultra-easy monetary policy would be effective without serious side effects, partly due to shared education, models, and community reinforcement—a Keynesian point about how 'astonishing' beliefs become possible when people think alone in similar intellectual contexts.

“I think to some degree, they did, although clearly, there were doubts being raised in various corners of the community. Keynes, what is the line that he uses, it's astonishing the things that a man can believe if he thinks too long alone, and that's in the Intro to the General Theory, I think, but if you have a community that went to the same schools, they basically got the same models, so there's an element of that.”

The difficulty in pushing the BIS message to central bankers was that doing so would require effectively challenging 1000s of PhDs employed by central banks and their methodological approach, an inherent power imbalance that prevented stronger advocacy.

“The real problem was that I think we pushed it as far as we could without getting the central bankers who, I remind you, were the chief shareholders, without pushing back and saying well, no. I've got 1000 PhDs working for me and they tell me that my way of looking at the world is right and your way of looking at the world is wrong, and who are you guys in Basel anyway?”

George Freeman, a mentor to White at the Bank of Canada, taught him that regardless of rank or position, there is always someone else whose opinion you must consider, and that one should always be humble because one's beliefs might be wrong.

“That just taught me a huge lesson. That it doesn't matter how senior you are, that there's always somebody else whose opinion you have to take into account, and that's just the way the world works...you should be very humble always. Because it could well be that what you believe is actually wrong.”

White would most like to interview John Maynard Keynes because Keynes had the self-confidence to publicly say he was wrong when facts changed, as evidenced by the dramatic reversal between his 1931 Treatise (which said easy money was the answer) and his 1936 General Theory (which rejected this).

“Oh, I think the Master Keynes, and the reason why, it goes back to something that you mentioned before, is most people don't have the courage to say I was wrong. That's happened to have a think, whereas Keynes was absolute master at this. He wrote the General Theory in 1936 which, as far as I can tell, completely, went in the opposite direction of the treatise that he wrote 1931, where the treatise basically said, easy money is the answer to all our problems. By 1936, Keynes said is not true, and my question would be how did you have the self-confidence, and he did this in a number of occasions, to basically say, I got it wrong?”

Central bankers were always respectful of the BIS analysis and never attacked the house view, they simply chose not to accept it—a polite rejection that still constituted a complete dismissal of the warning.

“Everybody was always respectful. No question about it. Nobody ever turned on this and said bad things about the house view. They just chose not to accept it.”

The financial cycle and credit cycle, not the business cycle and inflation cycle, is White's most controversial professional view, which he's been fighting for about 20 years despite lack of acceptance.

“the one we've been talking about for most of this interview, which is that the fundamental problem is the financial cycle and the credit cycle, and it's not the business cycle and the inflation cycle. I've been fighting that battle for 20 odd years, and all I can say is I continue to do it.”

Current geopolitical and economic climate shows people 'turning in on themselves' with populism, nationalism, and right-wing movements, which is concerning because when things get rough, people blame foreigners and others rather than addressing systemic problems.

“the current climate seems to me to be people turning in on themselves, populism, nationalism, the right wing, and it bothers me. That one part of that, of course, is when things start to get rough, you blame the foreigners, you blame the others.”

White was discouraged when presenting a BIS paper about credit expansion and global liquidity as a real problem at a Global Meeting, but the discussion got bogged down in definitional debates about liquidity and money demand, losing the fundamental message that credit expansion was dangerous.

“We'd written a paper that was being discussed at a meeting, I think it was called the Global Meeting. It was basically a statement that credit expansion was a real problem and the growth of global liquidity, and the whole discussion got bogged, totally bogged down in a discussion of what is it-- how do you define liquidity and shifts in demand for money functions and all this stuff? The basic messaging seemed to me to just have been lost.”

White felt like he was watching a Greek tragedy where the problem could be seen coming down the road but nothing could be done about it, reflecting the BIS's inability to push harder without risking pushback from central bankers who were the chief shareholders.

“I can remember coming back to my office with my colleague, and saying it's like, what's the word? It's like, a Greek tragedy. You can see this thing coming down the road and you don't seem to be able to do anything about it. One of the questions that I remember putting to myself was, maybe we should have been much, much clearer in terms of our cries about we're going down a bad path, but the real problem was that I think we pushed it as far as we could without getting the central bankers who, I remind you, were the chief shareholders, without pushing back and saying well, no.”

White did not see appetite among central bankers to return to gold as part of the monetary system during his time at the BIS and OECD.

“I know, in a previous interview that you did with Grant, you mentioned that in all of your dealings with the various central banks and monetary authorities, you didn't see much of an appetite to return to gold or have gold be part of the system.”