Judging the Old Bailey

Richard Kramer:

Welcome back to Bubble Trouble and to all those who've discovered us through Will Page's appearance on the BBC World Tonight, which gave no less than three shout-outs to Bubble Trouble. Ironically on the topic of Spotify's podcast Bubble Bursting and their defenestration of Harry and Meghan. It's myself, the independent analyst, Richard Kramer, and the economist and author, Will Page, hurdling towards our 100th episode laying out inconvenient truths about how business and financial markets really work.

This week, we want to give a hat tip to the Financial Times reporting on how the Bank of England is going to review its use of economic forecasts. As so often happens with the FT, the comments were even better than the article, which like us, have been despairing for years about central bank economic models constantly getting wrong footed by the real world. Asleep at the wheel or making the best of an impossible job, a second helping of Bank of England Governor Andrew Bailey's many shortcomings we saw as the head of the regulator, the FCA, or a victim of circumstance, stand by while we put Bailey in the dock, not at the Old Bailey, but on Bubble Trouble. Looking at how economics and forecasting at the Bank of England simply aren't fit for purpose. And we'll see how many more bubbles they might be causing and not popping. Back in a moment.

Will Page:

Thanks for the introduction, Richard. And maybe for our audience's benefit, we should spell out the acronyms. What does the FCA stand for in your personal opinion?

Richard Kramer:

Well, it means the Financial Conduct Authority, but there's a famous satirical journal in the UK called Private Eye, which calls them the fundamentally complicit authority because of all the times they've sided with large banks or financial institutions and left individual savers or pension plans high and dry.

Will Page:

Very suitable, very suitable. For this podcast, it's just me and you and I wanted to give us an answer story. As we sort of ramble our way through this very relevant subject matter, especially for those who are on fixed rate mortgage deals, which are due to end soon, I want to produce these kinds of three Ts, I'm going to call it, that we can visit the end of the half hour show. And the T's I want to discuss here are taught, tools, and trade. That is I'm going to offer an axiom for this discussion about central bankers. And before I even begin, maybe just to quote that famous line from the film, All The President's Men where Deep Throat says Robert Redford, "You know these guys in the White House, they weren't that smart, but things got a little out of hand." But one thing I think we can achieve in this podcast is just to dispel the myth that central bankers walk on water, that they're the brightest and the best.

My first T is taught. I would argue no. The way that theory is taught today has not kept pace with reality. Whatever you are taught when you got your PhD or Masters in economics is not going to be that relevant to today's society. Secondly on tools, I think the data that they have to work with today lags behind most tech companies. That is the tools that are largely redundant. There are surveys of manufacturing firms in Soly Hall. They're not data scientists. And then finally trade. It is impossible for a rational economist to want to be a central banker because that's not where the brightest and best are in the biggest box. Just to repeat, the way it's taught has not kept pace. The tools they've got are not fit for purpose and in terms of trade, the brightest and the best aren't going to be working in Thread Needle Street. They're going to be working around Thread Needle Street trying to gain their next decisions. That's my kind of hunch of where we're going to find here.

At the end of the conversation, let's visit these three T's and see where we end up. But Rich, just back to you, sir, when you talked about the FT piece, you're always a big fan of the comments. Was there any of the comments, I mean I think there were 80 comments to that article, but any stand out to you as being exceptional or worth raising for our audience?

Richard Kramer:

Well look, I don't want to go over all of them because we don't want to just reprise the piece, but I'd like to pull out one of those issues you raised, which is the trade. And I had always thought that working at one of these central bank jobs at the Fed or the Bank of England was the height of prestige, was where the best in the brightest would go maybe before they went through the revolving door and then went to lucrative jobs at hedge funds or other financial institutions. And I also thought, silly me, that these would be the folks who would have access to the best data. After all, they're sitting atop the government, they're sitting at the nexus of the UK economy controlling monetary policy. How is it that these guys don't have access to fantastic data sets that have the finger on the pulse of what the real economy is doing?

Will Page:

No, let's just hold up there a second. I remember the treasury came to visit me at Spotify and they were asking about data science. Explaining about Google BigQuery, Google Studio, Tableau dashboards, automating incredibly large data sets. And they said, oh, well the model of the UK economy sits on one Excel spreadsheet. What if you lost a USB stick? Let's just have a slight cold shower reality check as to quality of the data these institutions, as opposed to companies, are using. And then secondly, if I can attack it in terms of just are these the brightest and the best? No, they're civil servants. But to get to becoming governor of the Bank of England, you've got to toy the party line for 20, 25 years. Now toying the party line doesn't make you a brilliant economist who can steer this economy away from a mortgage default crisis, can get our interest rates above the rate of inflation, which hasn't happened for 14 years. We're looking at epic failure of a scorecard and life serving civil servants steering the ship. I wonder if those two points are connected, Richard. I just wonder if those two points are connected.

Richard Kramer:

Yeah. And I guess then you'd have to reflect on this notion of independence of central bank. This was thankfully put into practice in the UK some 20 or so years ago, put into practice in the US a long time ago, but we talked in previous podcasts about who owns the Fed and we found out it's indeed owned by the clearing banks. We talked in the past about the room for political interference in these central bank decisions and does that sufficiently explain why their models are so bad? Because frankly they're not even asked to look at them. They're being told we need to keep interest rates low because it benefits, as we talked about in our boom and bust podcast, homeowners and homeowners vote and they're an important constituency behind the governing party.

Will Page:

Well, let's just think about that for a second. If I go back to that great podcast we did with Chris Leonard, wonderful journalist, great guest, we should definitely bring him back on. And I asked him about inflation targeting, sold to me when I was a student in the late nineties, early [inaudible 00:06:51] as the saving grace of central banking, just target inflation and everything else falls into place. Target 2% inflation with no evidence to justify 2% inflation and everything else falls into place. And I asked Chris, well what's the scorecard on inflation targeting given everything hasn't fallen into place, we have seen boom and bust cycles on multiple occasions since adopting inflation targeting? And his gut reaction was, why is nobody asked that question? In fact, who's been held accountable to inflation targeting? Just give me a box ticking policy, target inflation and you get to keep your job.

This political economy interference in the way that central bankers behave to keep their jobs, but equally what I think we can also explore here is there's direct interference from the government. Let's say I'm the prime minister of country X, you're the central bank of country X and I phone you up on your personal cell phone and say, I got to get elected in three months time. Get those interest rates down. That's direct interference. But equally we can explore indirect interference, an induced interference that is if you hold up a low interest rate policy and I cook up a big housing market on this side of the fence, then I know that my housing market situation, I got 30 million homeowners in the UK mortgaged to The Hill, is going to influence your decisions to keep interest rates lower than they might have otherwise been. I think you can bifurcate it, direct interference, text messages, cell phone calls, meetings in smoke-filled rooms, I get that. And inflation targeting and central bank independence has probably cooled that down. But that doesn't stop the indirect interference of when the right hand is behaving like just control inflation and the left hand says, well let's cook up housing boom like we've never seen before. Then we've got another problem to solve and ultimately it's going to be for that central banker to solve as well. It can work in both ways.

Richard Kramer:

Well look, I do not want to excuse the Bank of England or the Fed for mismanaging the wider economy because it's clear there's a cost of living crisis in the UK right now. We have held artificially low interest rates for such a long time that it has led to tremendous levels of inequality. There're clearly structural issues, but can you say it's the external factors? It was impossible for the Central Bank governor to realize just what an impact on wage inflation you'd have when you cut off the supply of workers from the EU with Brexit. You could not have forecast what happened to energy prices in the past 12 months when you had a war in Ukraine. Do we let these guys off the hook for the fact that their models didn't anticipate some of these shocks to the system or aren't those shocks to the system exactly what they should be modeling and capturing? Shouldn't they be thinking how many standard deviations, how many black swan events we need to put into our model every bloody year because we seem to keep having them just like the bubbles bursting?

Will Page:

Mm-hmm. This one frustrates me, Richard. It frustrates me a lot. My personal stance on this is no. In many ways the bank should be ignorant of these asymmetric shots 'cause they've hit the economy. I mean we've had Brexit, juries still out. You can have the woe is me people who are like, it's such a terrible thing telling us how all the wells ills are down to Brexit. And the other extreme, you can look at what's happened behind Kingswell Station London since 2016 where international tech companies with international workforces have flooded into London post Brexit, investment decisions made post Brexit involving international companies and international workforces. There's many examples of pros and cons on Brexit, but park that one to the side for a second. We've had two shocks. One we've had COVID, which was hopefully a never again shock. And two, we've had a war in Ukraine, which hopefully is a never again shock.

These shocks hit the economy and then they dissolve themselves into the mix. It's a temporary shock and we've seen that with the rate of inflation and energy prices as a result of the war in the Ukraine, it spiked and then it settled back down again. Now, you've got to step back and say, well what is the bank's theory of inflation when dealing with these one-off shocks? Is it that this spike in energy prices leads to way spiraling effects as taught in the textbooks in the 1970s, eighties and nineties? No, the world is far more open, far less unionized. It doesn't function like that anymore. There's no evidence to suggest that nurses wages are going to drive inflation. I haven't seen anything to justify this, but the central bank theorists, the textbooks, one of the three T's I talked about at the start of the show, suggests you have to respond this way. I don't understand the response mechanism. How, if the cause of inflation is a war in Ukraine, does raising interest rates reduce the war in Ukraine? Well that's not the job of a central, no, hold on. We have causality here.

We have the cause of inflation and the response, but the response is not connected to the cause and I think that's where central banks have to be held accountable. In fact, it's not even clear to me that the bank has a theory of inflation. Indeed, when Reverend King asked him, Andrew Bailey, he couldn't provide one.

Richard Kramer:

Yeah. Look, I would take issue with quite a few of the things you just said there and I don't want to get into deep arguments on Brexit, but nearly every independent economic analysis I've seen has shown that Brexit has deflated or depressed the UK's growth rate materially. And whether it's farmers having crops rot in the field or restaurant owners that tell me they simply can't get staff that used to be coming from the continent, well, let's not litigate that one. I'd like to get-

Will Page:

Well, no, just one caveat there. There's a lot of European countries experiencing labor market shortages as well. Again, and with every criticism on Brexit, there's a count of you to say correlation causation, it's just not clear to me it is a Brexit caused problem.

Richard Kramer:

Yeah. The wider issue that you can look at beyond Brexit is an immigration crisis and you're just not importing enough surplus labor to do all of the jobs that are out there in the economy.

Will Page:

That I can agree with you on. But you can change immigration policy post Brexit in many different directions. I mean it's a problem, but there is a solution there, which doesn't necessarily mean Brexit is the cause. I just want to separate out those two events.

Richard Kramer:

But let's get back to Mr. Bailey and the Central Bank.

Will Page:

Mm-hmm.

Richard Kramer:

One thing I will dramatically disagree with you on, and I'll just call you out because it's flat out wrong, is that we had a year of 10% inflation and now we're lapping that with 6% inflation. We didn't see wave that crested, peaked, whatever you want to call it, and then receded. We saw a wave that led to the water level being higher and then another wave come through. Now we have that pernicious issue of instead of the 2% classic inflation theory per year that you would expect and prices gradually go up, you saw a big step-up in prices and then they're still rising as they've lapped that step up. That creates a real problem and I personally see it when I go and buy food for my family. I see the way things that I knew what the price of the item was and how much it's gone up and I've been seeing that now for well over a year. You are lapping and baking in these structurally higher prices into the economy and they have to be inputs to the overall health of the economy.

And I just don't think the central bank with its mandate of tackling inflation has a grip on this.

Will Page:

I don't think we have a grip, but I would ask how well can markets solve the problem themselves post pandemic, post-war Ukraine, peak effects? Is it a bit like the train system in the UK, every morning the trains run in this country and they all have their great starting points. I think post those two shocks, a lot of those trains start their day in the morning in the wrong starting point, editor's dislocation in the supply chain, and that could take a while to solve itself out before markets can bring prices back down. I think there's some supply chain issues there, which markets may resolve irrespective of what a central bank does. On the other side of the fence, let's take a look at the labor market and I think this is where you can get into some of the more technical issues with what the central bank is doing wrong.

Central bankers and economists will typically look at the vacancy rate and the unemployment rate. That's what's inside their models. Their two indicators are vacancies and unemployment rate, the Phillips curve, unemployment and stable inflation. What's my relationship between those two points? If there's bottlenecks to labor market, inflation goes up. The slack in labor market, inflation goes down, it's measured using unemployment. What's not in a lot of these people's models is labor market participation. And remember that's not the same thing as a vacancy rate or an unemployment rate. That's a completely different thing. If you look at labor market participation, there's actually a lot of slack in the UK economy. If you look at the unemployment rate, there's no slack at all. We're all at bottlenecks. Then should policy, government policy, not necessarily central bank policy, address labor market participation issues to resolve the slack that we're seeing? Now that's a bit of a rabbit hole to go down in the first half of this show, but what I want to come up for air and say is, are the tools one of the two second of the three T's we set up at the start of the show, just not fit for purpose?

Are they targeting the wrong variables? If you targeted labor market participation, what would you have done with the economic policy versus had you targeted the unemployment rate?

Richard Kramer:

Well, it oddly sounds like Will Page is about to let the governor of the Bank of England off the hook, even the previous governor of the Bank of England, who said three years ago that structurally low interest rates were here to stay in a feature of the economy and now three years later, Mark Harney is saying structurally high interest rates are here to stay and they're a feature of the economy. You just have to wonder how many hands do these economists have? What is it about these policy pronouncers of central banks that they seem to be so often wrong-footed?

Will Page:

I think that's a question of accountability. Now he is the ex-governor of the Bank of England. He can completely wash his hands for what he said and say something completely different. But yeah, that must frustrate those people who are looking at their mortgages going up by two, 3,000 pounds a year next year when their fixed rates expire for sure.

Richard Kramer:

And I guess one to wrap up the first half. I get the Winston Churchill, it's events my boy. And of course no central banker would expect the COVID pandemic, Brexit, the war in Ukraine, all of these external shocks, but do they have any tools in the toolbox that really can address these external shocks short of what has been done since 2008, which is just to print more money and buy bad loans off the books of struggling, poor, oh woe is me investment banks?

Will Page:

Well, on tools, and if I can join two moments in history, the pandemic and our current central banking crisis together here, I think there's a need for more transparency. I really do. When we had the pandemic saying the COVID infection rate is going up, and I kept saying, but the rate of testing has gone up. It's a one for one. You test more, you get more incidents of COVID. Supply of tests creates demand of the virus. I wish we could have got more transparency on those expert models to see what variables weren't being included. What about density of living, what about the presence of air conditioning? Which one has got more explanatory factors? Could we get our hands dirty with these models? Is central banking the same thing? I mean just if we get towards a break here, let's just think about one example about the wage spiral thesis.

I can't give the nurses who got us through the pandemic a pay rise because it could lead to wage spirals. Nothing. Nothing to justify that claim other than out of date textbooks. But why don't we reverse causality, that's what a good economist should do. Here's my line of causation, then let me test for reverse causality. Perhaps if I raised the interest rates in the country of Kramer and a load of Kramer suddenly realize their mortgage is going to get more expensive and they then go to their bosses and say, hey, my mortgage has gone up by 500 quid a month, I need a pay rise. And that sets in a wage spiral, that's plausible. It goes completely against the grain of central bank logic, but that's entirely plausible. I wish us, the public, could go into these expert models and be able to challenge them ourselves. You give me a line of causation, let me test reverse causality and we see who comes out best in the wash. I think that'd be a great way of improving the credibility. And just remember, Richard, before we wrap it up with part one, confidence in our central bank in this country is that a record low hasn't been lower since 1999. Confidence is something we should explore in part two.

Richard Kramer:

Well I have a number of shreds I'd like to pick up on, but let's park that for now. We'll come back in part two and I definitely want to pick up on confidence and also what the common person might be able to glean looking at those models and why they should be opened up. Back in a moment. Welcome back to part two. Will, I want to bring up a quote from September 2019 about the current Bank of England governor, Andrew Bailey, who was accused of falling asleep during a meeting between campaigners, which were acting on behalf of the then defunct British Steel Pension Scheme, and the financial conduct authority that he was chairing. Is this an app metaphor for what the Bank of England has been doing for the past few years, asleep at the wheel with low interest rates through a turbulent time leading to record busting inflation in the UK? Is that the right metaphor or has it just been overtaken by events, my dear boy, events?

Will Page:

Asleep at the wheel, asleep at a meeting with an important pension scheme. Pretty bizarre quote you pulled up there, a bit worrying actually. And I think the weight of evidence is yes, Andrew Bailey has been asleep at the wheel. And I learned a very interesting thing about the way that he models the economy, which helps justify this. Now just remember, it is possible for a child to be doing GCSE economics this year who has not lived in a world where essentially interest rates were above the rate of inflation. When I was at university, that was taught to you as a weird outlier that happened once in history and it'll never happen again. We are 14, 15 years into this bizarre position where interest rates sit below the rate of inflation. Now the spread is even more than ever before. But what I think is fascinating and what I think helps justify the argument that the bank and the bank's governor have been asleep at the wheel, is the way the models that the bank use work. They have what an economist call mean reverting properties.

You have a shock and it sends inflation down, perhaps below 0%. You've got deflation in economy. Don't worry because after the shock works its way out, it'll just revert back to the target 2%. Now you have a shock which sends inflation up or maybe up to six, 10% like we've just seen. Don't worry because the model tells you in two or three years it's just going to fall back to 2%. Now that might be a good model. I don't think it's proven itself correct, to be frank, but that could be a good way of modeling. But let's just attack this for a minute. If you have that sense of, how would you say, what's the word I'm looking for? That convenient logic that the well just works its way out in the end, then you would be tempted to go fall asleep at the wheel. You've almost got a cruise control on your model, which says don't worry about what happens, inflation's going to get back to 2%.

You can go back to sleep now. I think that type of thinking, Richard, worries me. I wasn't the one who built a model, I haven't got my hands dirty in the model, but in econometrics you have an error term at the end where you preach stuff that you don't understand. To have something like that going on in the way that we model society, that don't worry, everything just reverts back to our target policy, which by the way had no justification. I have not seen one piece of economic literature which says 2% is the right target. Seems reasonable, I just don't know understand why it's two. Maybe it's an even number, that's why they picked it. But to have that type of logic in your modeling, which is don't worry about anything, it's just going to fall back into place and we can cruise along aimlessly. That means there's a higher probability that the governor's going to be asleep at the wheel.

Richard Kramer:

But we're now 18 months into runaway inflation. And I know it's cooling somewhat in the US, but it's certainly not cooling in the UK and it has moved into areas that really affect the entire populace. For example, in food price inflation, which is running as high as 20%, which is a staggering number. And how can one still hold out hope for a mean reversion that thinks we're going to go back to a trend line of 2% when we've seen periods of 20% growth? We would have to see massive food price deflation, which means a substantial increase or the same in production, the loosening of the labor markets such that all of the crops that are withering in the field and the failure to bring sensible prices for fishermen or farmers or whomever, that gets reversed. How are you going to see that mean reversion take place? I just don't get the economic logic of it. Can you walk me through what the forecasters must be thinking to stick to that mean reversion trope?

Will Page:

Well, let's try and join two points, one from the first part of the show, just second from what you've just said there. One-off shocks such as a pandemic that turned the world upside down, such as a war in Ukraine which sent energy and food prices through the roof, how can you not revisit your model's assumptions in the face of these one-off shocks? That's where it could get interesting. Let's go back to the political economy because it's my model and I'm a lifer at the Bank of England. My model is what served as Bank of England well for the past 20 years. I like these mean reverting properties because it means I've got a sense of assurance that when I give my estimates to the market or I tell the government ministers what we're looking forward to, we have this property in our model which suggests don't worry, risk off, things get back to normal. I wonder whether it's a combination of the bank being asleep at the wheel and not revisiting their assumptions in the face of these huge one-off shocks. What did you change in your model after the war in Ukraine? Nothing.

Okay. The well carries on as normal and we carry on getting back to 2%. Is that the story that we're being asked to believe? And that goes back to what we discussed at the end of the first half, which is credibility and confidence.

Richard Kramer:

But are we asking too much of these central banks to be omniscient and indeed neutral observers of society and the economy? Because what we saw when energy prices spiked is the politicians said, let's incur some more debt so that we can give an energy price subsidy to those who need it and fair enough. But that changes the economic picture for the Bank of England, especially when it comes to their principle client, the government and the debt that they're piling up and will need to pay interest on. Now, won't a career civil servant type, like the Bank of England governor is not going to notice a real terms wage cut for the majority of workers in the country.

Will Page:

The bank, as it currently stands, as it's currently mandated has blinkered. Just hit that inflation target and you're good to go. Which as we know, it's failed to do for many quarters at a turn. What if the bank had a different mandate? Economic growth or prosperity. Raising interest rates takes a cost of living squeeze and squeezes it even harder. Is the bank's job to choke this economy for the sake of one simple inflation target?

Richard Kramer:

Well and equally, when you talk about shifting the mandate to prosperity, my question is prosperity for whom?

Will Page:

Right.

Richard Kramer:

Because what we've seen since 2008, and we've had multiple bubble trouble episodes on this, whether it was Chris Leonard or Jesse Eisinger or many of our wonderful guests have made it clear that making money free has principally benefited the elites. The those who have money can borrow more money and benefit from it. It has also secondarily benefited others for whom costs were kept lower than otherwise they might have been. But principally, it's allowed people who could borrow large amounts of money at no or deminimus interest costs to pile up more wealth. And you have to ask the question, prosperity for whom? If the overall GDP grows, but it's increasingly skewed towards the top end, is that the Bank of England's mandate or should they seek to have broader participation in the economy? Should they be pushing for wage inflation, keeping in pace with normal inflation for all of those civil service functions that we desperately need to enjoy our normal lives in the UK?

Will Page:

And it gets worrying at that point. Let me just add some of the critics to the bank's QE policy, not just those external fine minds that you quoted, but also many people inside the bank that didn't get the top job have come out and said quantitative easing had a purpose initially, but after a period of time, the cost outweighed the benefits. And that the only benefactors, like you say, were those at the upper ends of the higher income curve and it's actually punishing those at the lower. We've had people inside the bank come out and criticize this policy as well. But I wonder again, whether it's just blinkered vision, don't rock the ship and hold the party line constant and perhaps for too long. I mean that's crazy when you reflect on just inflation above the rate of interest and quantity fees going on for the best power of a decade and a half now. It's a long time to assume nothing's going to go wrong further down the pipe.

And then on that point, Richard, that is at the heart of it, which let me ask you from economics to finance here, the bank creates an action, it raises an interest rate. How long does that take to filter through to the financial economy and the real economy? Because it doesn't happen overnight. In fact, it doesn't happen over the next three to six months. You have this time lag, this transmission mechanism between the actions of a central banker and the impact on the real economy and a lot can happen in between, right? I'm going to raise interest rates and the war's solved. Look, raising my interest rates curved inflation. No, the war was solved, that curved inflation. Your actions had nothing to do do with the inflation rate. I want to hear you riff on that topic because you deal with the financial markets, that lags got to be relevant.

Richard Kramer:

Well I'm not sure there is so much of a lag because the markets price in those rate rises very quickly and they price in an expectation of those rate rises. Now, one thing you saw with frightening rapidity since the start of the year was the failure of multiple regional banks in the US. SVB was only the first of them and then several others went down. And that's because they had baked in an operating model which said we can collect deposits and only pay out the prevailing rate of interest, which we presume will stay low, and we can lock in our capital that we've collected in those deposits into treasury rates, which hey, it just went up from zero to 1% or 2%. That's a huge increase. We'll lock in 2% and all of a sudden they were caught, as we talked about in our SVB Dam by Duration podcast, they were caught with having to pay out four or 5% to savers to keep them on board, but being locked into only generating 2%, all of a sudden they had these unrecognized mark to market losses on their books which led to their collapse.

Now it just shows you how quickly those rate rises can filter through to some segments of the economy that are directly exposed. Whereas other segments that are still contemplating capital purchases or business expansions, they have to reset their models to higher interest rates. There the effect will be felt down the road.

Will Page:

Right, but you are talking about the finance economy. Popular tech bank goes bankrupt, how does that affect your average Joe Blow in Middlesboro? Not clear to me. Just on Silicon Valley Bank, I learned on Friday afternoon, there was a bank run on the SVB, which is Peter Thiel, quite interestingly, who was very involved in how that scenario unfolded. But let's just go back a bit. The language that you hear a central bank use is we're going to raise interest rates to curb the money that's flowing in the economy to slow down, or an overheating economy to suck a little bit of cash out the economy. Do you see a link between the base rate of the Bank of England and the amount of money that's in flowing the economy or is that just retarded monetarist logic which realized never woke up to the inconvenient truth, which is you can't measure and you can't control money supply?

Richard Kramer:

The sad fact of all of these individual central banks, with maybe the Fed as an exception, is that they have a purview over a territory. But capital is transnational and liquid in all its forms. What do we see all around cycling through Central London? For me, constantly I see reminders of the way in which the UK has imported capital from overseas to pump up its economy in the form of the safety deposit boxes, also known as London flats. And there are endless numbers of new builds going up, and who's buying this stuff? Not your average teacher or nurse on 30,000 pounds a year, but some overseas capital pool which comes in, maybe sets up an offshore Cayman Islands registered company to buy the flat. And while they have to pay a bit of council tax, certainly aren't tasked with or taxed with the occupancy of that flat. And they're not generating any income after that flat gets sold. It's only a one and done type of purchase that sits there as an underutilized asset. And that's quite sad. It can inflate GDP numbers because you look like you sector, but it's building houses for people who don't really need them and as an opportunity cost, not building houses for the normal workforce that absolutely has a housing crisis right now in the UK.

Will Page:

Yeah. And don't get me started on the swiz of the student union apartments. These student apartments are going up and down the country.

Richard Kramer:

Awful, awful.

Will Page:

That's where you can securitize against 300 assets as opposed to just one because each one's an independent apartment. You see how it works?

Richard Kramer:

Oh.

Will Page:

Yeah, yeah. That, for me, is where you highlight an interesting point about what these interest rate rises are going to do to our mortgage market and our property market. You introduced me to a lovely term a while back, which went getting ahead of your skis.

Richard Kramer:

Yeah.

Will Page:

The property developers, be it somebody who just happens to go for a second or a third property or somebody who's actually in the full-time profession of building and flipping properties, have got ahead of their skis and they can't afford that second or third property. Is that a crisis, or is that just people who just got a little bit exuberant when those interest rates, inflation conditions were so abnormal for so long that they're just going to have to wheel back on their exuberance? That's one thing. Whether it's family of four with half a million of mortgage debt and it looks like they can't afford the bills when their fixed rate expires, that's another problem. But I think we should be very wary about what the finance economy has created, which is a bubble in real estate, versus what the real economy could be suffering, which is a huge jump in the cost of living in that house that is compulsory that they have to live in as well. How's that going to play out? Forget the property developers who've got ahead of their skis, come back to the family of four who could be looking at bankruptcy. What happens, Richard?

Richard Kramer:

Well, you go back to the political solution. Whatever well-designed plans the central bank might have for controlling inflation, increasing the participation rate in the workforce, et cetera, it all comes down to what the politicians are prepared to do and who they serve. Whether they serve the broader public, whether they see homeowners as an important constituents. They provide some mortgage relief in the US, you get a tax credit on your mortgage payments. And we've had previous podcasts on Bubble Trouble where we talked about that original sin of deductibility of interest payments on your debt.

Will Page:

The laws of private equity apply to the public then.

Richard Kramer:

Absolutely. And the idea that the more leveraged you can get, the more you can write off against your taxes. We actually have a very low participation rate of many wealthy sectors of the economy in the tax pool. A lot of the tax pool gets absorbed by payroll taxes and value added taxes and not by the 1% of the 1% that can afford clever schemes to avoid paying taxes or have offshore income. Who owns a lot of those London properties? Well, it's not UK taxpayers. It's either non-domiciled or offshore companies. And that erodes that ever so important word you mentioned, confidence, in getting a fair set of public services for a fair burden of taxes.

Will Page:

And on confidence, we may have some time for smoke signals in a second, but on confidence, I always like to quote Mario Draghi, for a long time the president of the European Central Bank. When at the heart of the credit crisis and everybody was wondering about will the Euro survive, are we going to see the Deutsche Mark and the Gilda and the Lyra reappear? He said, I'll do whatever it takes. I'll do whatever it takes. Five words to instill confidence in the market and then proceeded to do nothing. I'll do whatever it takes. And if you look at his track record, he did nothing. He just said five words and that was enough. But the confidence worked. My point is, you might not need a PhD in economics. You might not need the training of 30 years at the Bank of England, a life for civil servant there. You might just need to instill confidence. Now, Richard, when we look at our current central banker on today's podcast, it's putting the old Billy back in the dock, does he instill you with confidence? Could he say five words that makes you feel the guy's steering the ship, the guy's on top of things, worry about something else?

Richard Kramer:

I don't have a lot of confidence given that as I understand it, the politicians now demanding that the Bank of England revisit its forecasts and the way it approaches modeling the economy was something they were already doing by already recognizing how many times they'd got it wrong. And what I don't quite understand is this notion of, isn't this Scottish proverb? It must be. Fool me once, shame on you, fool me twice, shame on me. And how can it be that they are so consistently getting things wrong without revisiting it as growth mindset professionals, if you want to call them that?

Will Page:

It's group thinkers. It wasn't our problem, it's someone else's problem. No, it has to be your problem. You're the bloody governor of the Bank of England.

Richard Kramer:

Absolutely. And someone has to take responsibility. Will, I want to move to a bit of smoking for Sunday afternoon and I want to put you on the spot. Economists and forecasters, they're getting it wrong all the time. What are the things to look out for when you see headlines, you see them almost every day about forecast for the Eurozone or for the US economy or for the global economy or the OECD or... What gets your hackles up when you hear this verbiage about forecasts and you just know they're going to be off the mark?

Will Page:

My two drawers on that herbal monetary spliff that you've passed me would fall into the buckets of just questioning the actual source data for how this is constructed. And I've covered this in large details in my book, Charts and Economics, published a paperback under the title Pivot. And I want to pick up on a couple of fresh thinking examples of this as well. The jockey is only as good as a horse. The policymaker is only as good as the data they got to work with. Junk data in, junk policy out. Fairly simple rule, one, when you hear people obsess about the productivity crisis in the UK or elsewhere, just be careful about what we're actually measuring here. If you have two countries, and let's just paraphrase this as a UK and France. And UK's got high labor market participation, France has low labor market participation.

UK's got high inward migration, France has got high outward migration. Here in London where the six borough of Paris is about 300,000 Persians, high earning individuals working in a city. Then by that arithmetic alone, productivity should be lower in Britain than it should be in France. For example, I might employ somebody to sell me a coffee at minimum wage at a train station. Whereas in France, that person might go to the office, make coffee themselves. I just want to remind the audience by the arithmetic behind productivity, 'cause I think that's super important here is to not get too hung up on this word productivity. I think there's better problems to solve, which in turn will help solve productivity. Don't obsess about productivity itself. There's too much going to the numerator and the denominator to make sense.

Richard Kramer:

But I need to boil down a little bit more here, buddy. Smoke signal. What should I look out for? One, is clearly you're saying when people talk about productivity, it's a relative thing.

Will Page:

Mm-hmm.

Richard Kramer:

'Cause you can be productive to different levels with the same assets in country to country. What's the second one for me?

Will Page:

The second one is a big one, which is inflation. Just remember inflations are series of judgments. We judge what goes into our basket of goods. Maybe it's this brand of shampoo, not that brand of shampoo. Maybe this person doesn't have any hair, so doesn't need to buy shampoo. That's the simplest example I can give you. Okay. But it's a judgment. That bottle of shampoo is going to be in the basket of goods and affects the inflation rate, which inflects the bond market, et cetera, et cetera. And then there's a judgment in terms of how to weight these baskets of goods. How much of your monthly spend goes on shampoo and how much of your monthly spend goes on transportation? And those are our judgements, question how those judgments are arrived because we know it's not a taboo subject. They are judgments. I'm the type of person, I'm like a dog on heat with this type of stuff.

How did you judge shampoo is in there, how did you judge in the UK that a Spotify subscription price was in there and CDs were out? CDs didn't disappear, but Spotify became more popular. They judged to add Spotify in and they judged take CDs out. My big bone of contention with inflation is I don't think we've captured all the deflationary effects of the pandemic. And my example I give in the paperback of Pivot is somebody who spends 5,996 pounds on an annual season ticket from Redding to London, that is compulsory travel. They haven't got a choice in the matter, they've got to go in and work and is then told to work from home. Outside of a mortgage and potentially private school education fees, wiping 6,000 pounds off your family budget is hugely deflationary. Forget a price of beer going from four to six.

You're up 6,000 pounds. You can drink lots more beer now. Back to weight, back to judgment calls. But what I did see recently is very clear evidence that the idea of our Monday to Friday work week train ticket is dying in this country. Now it's trivial, it's not trivial. We don't actually have commuting in the judgment of the basket of goods in inflation, which is a scandal in itself. And weights that we use for judging that basket of goods are two years at a date, which is another scandal in itself. But if Monday to Friday or monthly season tickets are dying because people can work from home three days a week, that means they are saving money on transportation. And that is deflationary on the basket of goods. And I really want to stress, and I've been at this for a while now, I don't think this country has truly captured the deflationary forces that happened during the pandemic and continue to happen to this day. And we've now got some evidence to justify my claim.

Richard Kramer:

Fascinating. And let's hope that person out in Redding will not drink 6,000 beers with that or 1,000 beers, sorry, with that 6,000 pounds.

Will Page:

Your arithmetic let you down, Richard.

Richard Kramer:

Yeah, sorry. An extra 1,000 beers. But will save up because their mortgage, whenever it comes off that fixed rate deal they might have had five years ago at one or 2% is going to go up a lot to, and some banks are not even writing mortgages. And I want to close out on one point, which you mentioned about transparency and allowing people to look into those numbers. And there's a very famous statement by the American political theorist, Nome Chomsky, which whatever you think of his politics, he made a fascinating point about the common person, oh, not being able to understand all these detailed economic statistics. And he said, well ask how many people can read a baseball box score or look at the analytics from a football match and there's no problem with individuals being presented with extremely complex statistical data. It makes sense to them.

Will Page:

Or understanding the rules of cricket. I mean, come on.

Richard Kramer:

I still don't understand those after 30 years in the UK.

Will Page:

Scotts and Americans, we don't get it. Okay. Fair to use.

Richard Kramer:

But I certainly have seen many examples where your average person in the street is incredibly well-versed in deep statistical thinking about sports.

Will Page:

Yeah.

Richard Kramer:

But somehow this magical world of the economy and the interrelationship of prices, wages, inflation, capital flows, et cetera, is all beyond them. I think that's nonsense. I'm all for adding another T to your what's taught, the tools and the trade. And that is transparency. Let's get a little bit more transparency into what goes into these Fed, Bank of England and ECB decisions and let's let the public weigh in and understand one final T we can close out on, which is the trade-offs because there are always trade-offs. Do that? We'll wrap up another episode of Bubble Trouble with my guest, Will Page, talking about the Bank of England where we put its head, Andrew Bailey, in the dock, maybe not at the old Bailey. See you next week.

Will Page:

If you're new to Bubble Trouble, we hope you'll follow the show wherever you listen to podcasts. And please share it on your socials. Bubble Trouble is produced by Eric Newsom, Jesse Baker, and Julia Annette at Magnificent Noise. You can learn more at bubbletroublepodcast.com. Until next time, for my co-host Richard Kramer, I'm Will Page.