Podcast Transcript: Jeff Snider on Deflation, Central Bank Failure, and Understanding Money

This is an edited transcript of our podcast episode with Jeff Snider, Head of Global Investment Research for Alhambra Investment Partners. We discussed the lack of inflation after the GFC, the importance of banks, why fiscal stimulus won’t work and what could generate inflation. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Jeff’s Background and Career Path

Bilal Hafeez (02:19):

Now onto this episodes guest, we have Jeff Snider. He’s the head of Global Investment Research for Alhambra Investment Partners. He started his career in portfolio management and equity research before focusing on broader investment research since the 2000s. He’s a true alternative, out-of-the-box thinker. So I’m sure you will enjoy the conversation I had with him. So onto our conversation.

So welcome Jeff. It’s great to have you on this podcast. And I must say, I feel as though I know you because I’ve been listening to your weekly podcasts for the past few months or so. You might not know me, but I know you, it seems.

Jeff Snider (02:54):

Well, I thank you for that and thank you for having me on, it’s always great to have an opportunity to talk with intelligent people who are deeply interested in the minutiae and the details of the world and not willing to just sit back and accept shorthand the mainstream explanation for everything. You know what? People who want to talk about these things and really get into them in a serious fashion, always happy to do that.

Bilal Hafeez (03:17):

That’s great. No, I appreciate that Jeff. And before we get into sort of the meat of our conversation, I always like to ask our guests something about their background, their origin story, so to speak. So it’d be good to learn about what you studied at university or college, as you guys call it. And then was it inevitable? You were going to enter finance and how did you end up where you are today?

Jeff Snider (03:36):

I have a very, very boring background, indistinct in every way. I went to a small college in Buffalo, New York called Canisius College. I have bachelor’s degree in finance and I had intended to do what most people did in the early to middle 1990s to enter the finance industry, to be a portfolio manager, to manage stocks. Dot coms were on fire. Everybody wanted to be in equity – that was the place to be. And so that’s what I started out doing as a small registered investment advisor in Buffalo, New York.

And in order to be what I thought was a good portfolio manager, I had to get involved in equity research. And doing some equity research, I started to look at, of course, the banking system, the financial system. And taking it from an equity perspective, you start taking apart balance sheets. You’re looking at what banks are actually doing.

And what I started noticing was that, what the banks were doing and what they were reporting, even if you get into the footnotes, it wasn’t like what they taught you in school. It was like, wait a minute here, there’s lots of other stuff going on that I haven’t heard of. I mean, what the hell is a Eurodollar? What is repo? What is a repurchase agreement? What are these things? It’s not like these are trivialities, some small things here, there. There were all sorts of weird stuff going on, derivatives. What are these things for? Why are there tens of billions, not hundreds of trillions? I mean, all this stuff that happened, they didn’t really teach about in college and started to ask around other people in the industry. They didn’t have any answers either. And to be frank, a lot of their answers were, why are you asking? Why do you care?

Wait a minute, I’m trying to make a career out of a being portfolio manager and what I’m hearing is that more questions, more knowledge is a bad thing. Whoa, okay. So that had set in motion my transition later in life after being a portfolio manager for a number of years to do more research-oriented stuff, more writing, more deep investigations and things like that.

So, over the last 25 years, I had intended to be a conventional portfolio manager and have become something completely different, which is basically all research, all writing, doing podcast appearances and things like that to tell people what I’ve been doing for the last 20 years, which isn’t really conventional portfolio management.

Do Central Banks Believe in QE?

Bilal Hafeez (05:41):

Okay. Yeah. Understood. Okay. That sounds good. But nice journey there. I guess maybe we can start with the global financial crisis because that’s really where we’ve seen widespread use of quantitative easing and the narrative around then. And we’re hearing similar things today, which is that central banks have kind of crossed the Rubicon. They’re doing something they’ve never done before. They’re printing huge amounts of money. This is going to lead to rampant inflation. And that was kind of the narrative. Now these central bankers themselves didn’t articulate it in quite such an aggressive fashion, but there was this expectation that-

Jeff Snider (06:17):

Well, they couldn’t. I think that’s an important point I don’t think most people are aware of. Quantitative easing has turned 20. It started in 2001 in Japan. And even before the financial crisis, central bankers knew quantitative easing didn’t work. Let me say that again. Before the financial crisis, central bankers knew that quantitative easing didn’t work. They’ve had any number of discussions about it, there have been any number of studies produced in and out of Japan that said this stuff isn’t working.

June 2003 is a time period that comes up for a lot of reasons in the United States. The FOMC, because they were debating lowering the federal funds rate to 1% for the first time in American history, they started to have a whole bunch of staff discussions and presentations prepared. They talked about, okay, if we’re at 1%, we’re in range of Japan, zero interest rates and maybe quantitative easing. So, in June 2003, the FOMC’s regular policy meeting was all about, or much of it was about, Japan’s experience with quantitative easing. And you got to read what they were saying. They knew it didn’t work back then. Now what they came up with, what they decided had happened was, “QE as a theory is good. The way the Japanese carried it out must have been wrong.” And it’s not the stuff that you think about.

If you go back to the first Bank of Japan discussions about quantitative easing, all the way back in March of 2001, they knew that this was not money printing. They knew they were raising the level of bank reserves, but that’s not the same thing. In fact, Eiko Shinotsuka was the one dissenting member of March 2001 vote for QE. She said, “Why are we doing quantitative stuff here? We don’t do quantitative stuff here. And the reason we don’t do quantitative stuff here is because we can’t define money. We don’t know what money is.”

The modern banking system has created all sorts of different forms of money. And so, if we’re going to claim to do quantitative monetary theory or practice, we don’t know what we’re doing. And remember what the original thesis was – the Bank of Japan in March 2001 was going to target a trillion yen increase in bank reserves. Reserves were supposed to go from four trillion or so to about five trillion, which at the time, everybody was like, “Whoa, a trillion yen, oh my God, this is huge.” And the Japanese discussion was, “We don’t really know if this is…we have to do something. Interest rates have dropped to zero, and we can’t go any lower than zero so we got to do something.”

So, they kind of just threw quantitative easing at the wall to hope and see if it sticks. By June 2003, when the Federal Reserve was evaluating their performance, they’re like, “it was always supposed to be a trillion yen and yet bank reserves in Japan went from 4 trillion to 20 some trillion, and it still didn’t have much of an effect.” And it wasn’t just the Fed. The Bank of Japan produced any number of studies in that middle 2000s period that said, “We think in theory, quantitative easing is supposed to work through three different channels. The first channel is the portfolio effect channel, which is buying bonds from the market, which removes those typically safe government bonds from the market. And that’s going to force the banking system to go do some risky stuff. I take the Japanese government bond from you, and you have to lend into the real economy. I mean, it sounds perfectly reasonable and that’s a reasonable expectation.

The second channel is interest rates. If I’m a central bank and I’m buying a bond, it’s a non-economic reason to buy a bond that should increase the price of that bond, therefore lower the yields, lower interest rates. So again, it sounds pretty intuitive, makes perfect sense.

And the third channel is sort of their bread-and-butter channel, which is nothing more than signaling. For example, I’m a regular Joe on the street, I am a consumer, I’m a worker, maybe I’m an employer too. And the central bank is doing something. It’s doing something big. I don’t know what it is. I don’t really care to know what it is. All I know is that these guys, they know what they’re doing, they’re the ideal monetary technocrats and so we assume they know what they’re doing. And if they’re doing something big that’s going to be positive and good. So, I’m going to spend more money, I’m not going to be as risk-averse; I’m going to hire more people because I’m going to become optimistic. And so that’s the signal channel. The central bank is doing something, it’s doing something big. I don’t need to know what it is because I trust these people. They say, they know what they’re doing. The media tells me they know what they’re doing, so I don’t need to know what they’re doing, they’re doing something.

The study said that through all of those three channels by 2004-2005, they didn’t see any effect in any of them. The most that they could say about the portfolio effect was nothing – didn’t happen at all. The banks ended up selling their bonds to the Bank of Japan under quantitative easing, and then buying other bonds back. They just traded one safety instrument for another. There was no portfolio rebalancing whatsoever.

For the second channel of interest rates, studies have shown conclusively time and time again, not just in Japan, and that’s just in the early part of the QE period, but for the entire 20 years in every place QE has been tried, it doesn’t lower interest rates, the market does. And that was true in Japan from the very beginning, which was that investors and the banking system were buying safe and liquid assets long before quantitative easing happened. So, by the time QE comes along, interest rates had already been lowered. It’s the market that lowers interest rates even when QE is in place or not. So the effects of QE on interest rates are negligible. So that channel didn’t really work either.

And then that just leaves the pop psychology signaling stuff. I’m making people optimistic for reasons they don’t even understand. That’s really what it comes down to. And that’s supposed to raise inflation expectations and all sorts of econometric types of processes. What we find again is that that doesn’t happen either. So, for all of these three channels where QE was supposed to work, even before we get to the Global Financial Crisis in 2008, there was already all sorts of evidence from the Japanese experience that said, this stuff doesn’t work.

Why QE Didn’t Generate Inflation After GFC

Bilal Hafeez (12:04):

Yeah. I kind of wonder, listening to it kind of makes me think – I mean, this is always treacherous waters to go into, when you say, let’s look at the counterfactual. But surely, them doing whatever they did must have had some kind of expansionary effect.

Jeff Snider (12:18):

Yeah. You get into jobs saved, right? Well, we didn’t create any job, but it would have been worse if we hadn’t done that. And yeah. And it’s impossible to say, I don’t believe it, but if you want to believe it, I have no way of arguing against it. I can’t say that, “Well, if they had done nothing, it might’ve gotten worse.” When you look at the QE experience and of course, obviously in 2008 and 2009, it’s hard to argue that it had much of a positive impact in that way, because it already got worse. It already got really bad. And it already got really bad despite the fact that though the Fed didn’t call it quantitative easing in the fall of 2008, it undertook much of the same stuff anyway.

It expanded its balance sheet. Bank reserves increased by a tremendous amount, $700 billion at one point, which back then was an enormous change. So, it wasn’t quantitative easing, but it was the same sort of principles, especially through the three major channels that economists and central bankers thought they worked through. And yet from October 2008 until March 2009, which was a half-year period, the crisis continued anyways. So, I have a hard time thinking that the Fed kept it from becoming worse because it got worse despite the Fed’s best efforts anyway.

Bilal Hafeez (13:33):

Yeah. No, I hear you. And you mentioned that when the Fed looked at the Japan experience in those papers, you mentioned in 2003, they said, in theory, it could work, but in practice the way the Japanese had done it wasn’t the right way or something. Did that mean that they had learnt something about how to implement it and that’s what they did in 2009 onwards?

Jeff Snider (13:54):

No. You would think they would say that, okay, they did the wrong money, or they did the wrong time or the wrong… No, that’s not what they focused on. They focused on exclusively on the signaling channel. They’ve criticized the Bank of Japan because they said, “Well, they were being too realistic about it. [The BOJ] would up to QE quota. They would raise the level of bank reserves targeted. But then, they’d tell the public that they were doing so because of a bad reason. You can’t do that, you got to be happy all the time.”

And so, what they were saying is that the Bank of Japan was undermining its own psychology by being realistic about why they were doing these things. They kept saying, “Things are improving, so we got to do more QE.” In the Fed’s viewpoint, in a psychological expectations manipulation regime, you don’t do that, you can’t do that. You have to say, “This stuff is powerful. It works. Just go with it. Don’t question it, just go with it.”

And so, their answer to why QE didn’t work in Japan was that the Bank of Japan didn’t project a sufficient amount of confidence. And they didn’t come across to public as saying, “This crap, you won’t even question it, it’s awesome. You will never have a doubt. You’ll never need to doubt what we’re doing.” And so that was sort of the idea that QE could work elsewhere as if you always say it always works. And so that’s kind of what we saw, especially in 2009, 2010. As early as 2010, Ben Bernanke had to do a second round of QE. And why didn’t people stop and say, “Well, wait a minute, we’ve got all this experience in Japan, now you’re telling me this stuff will always work. That’s what you said in 2009, that it saved a bunch of jobs and it saved the system from being Great Depression Part Two. But here we are in 2010, you’re telling me you’ve got to do more?”

We’re already starting to see the similarities with Japan because they focused on the psychological aspect, what they thought is the most powerful aspect of QE. And it all goes back to what Eiko Shinotsuka said in 2001, which is, we can’t define money. We don’t do quantity money because we can’t – we have no idea what the money is in the monetary system. So, we’re sort of pretending. We’re hoping that pretending and people not asking questions will be enough of a psychological boost to have an impact in the same way that lowering the Federal Funds rate have. When you think about it that way, it really makes sense why it didn’t work.

What is Money and Can Central Banks Control It?

Bilal Hafeez (16:07):

Yeah. And I guess, targeting money supply sort of fell out of favour decades ago yet we’ve kind of resurrected it in some form or another. But let’s kind of go to that question of what is money then? So I know you’ve written a lot about the Eurodollar system. And so maybe you could kind of talk about the types of money that are there and types of money that you think a central bank can control and the types of money they can’t control.

Jeff Snider (16:32):

Look, their predicament in the 2000s and really before that is understandable. We don’t have to be sympathetic to their position, but we understand why she was saying you can’t do quantity money. Go back decades before that, to the 1950s and the 1960s. We had a massive monetary and banking revolution in the way things were done – not just Eurodollar, but the different ways banks traded liabilities back and forth that created this monetary system unrecognizable to most of the traditional systems printed in the textbook.

Getting back to what I said about the outset of my own journey of discovery, I found these monetary revolutions in the ’90s and was like, what the hell is going on here? And I realized that this had been going on for decades before that. If you listen to the people like Alan Greenspan in the ’90s, he was telling you this. In his famous “Irrational Exuberance” speech in 1996, if you really heard him, what he was saying was that they had no idea what money was because they couldn’t define money. They said money supply trends had veered off several years ago. Well, that’s what he really meant because we couldn’t define money in the modern system, how would we know if the stock market’s behaving rationally or not? That’s what the irrational exuberance he was talking about, which is – we don’t know. We can’t look at the monetary system and say it’s doing this because we don’t know how to define it. So, you’ve had this massive evolution in money.

So, what central banks decided to do, again, getting back to Eiko Shinotsuka, was to say, “we’ll manage people’s expectations. In other words, we’ll signal to people that we’re doing this or that. And we’ll give off the impression that we’re in charge here. And in one sense, we’re going to let the banking system take care of the details of money. We don’t know how to define it, but they must do. They must because the global banking systems is trading stuff back and forth all over the place. We can’t keep up with it. But if we sort of influenced bank behaviour, that will allow us to influence the money system without having to actually understand how it works.”

So that was the policy that Shinotsuka was talking about, sort of the expectations, interest rate targeting policy that’s more about behaviour than the actual money. Except, when you’re running counter to the zero lower-bound, you can no longer influence behaviour by raising or lowering interest rates. What do you do? That’s where we get to the point – what does the central bank actually do in its day-to-day operations? And it’s really just bank reserves and bankers are nothing more than an accounting remainder after they undertake this quantitative easing asset swap.

And it sounds like it should be money. To begin with, it’s a bank reserve. It’s something the central bank comes up with in its accounting. It’s a deposit balance that a bank holds at the central bank. So how can that not be money? And the answer is, when you look at the evolution of banking throughout the ’50s and ’60s on into the ’70s, ’80s and ’90s, it’s really whatever banks decided was money that became money. And if there’s no real purpose or reason for bank reserves in this new system, then the central bank increasing the level of what are largely outside of the monetary system – increasing the level of the balance of bank reserves systemically – isn’t necessarily effective in the actual monetary system.

So, the central bank creates bank reserves that don’t have an easy, direct way to be deployed in the actual monetary and banking system. So, if you have a banking problem – that means you also have an effective money problem. And the modern central bank doesn’t do modern money. So all it does is bank reserves. So again, we come back to the question of why didn’t quantitative easing work in Japan and everywhere else it was adopted – it’s is because it isn’t actually money printing. It’s just the creation of bank reserves through this asset swap that doesn’t work through the other two channels either.

The Importance of Banks

Bilal Hafeez (20:14):

Well, I guess this also goes then to the point of perhaps why QE didn’t work after the Global Financial Crisis, which was that banks were in bad shape. One is, they were in bad shape and so they became risk-averse. And then the regulation changed as well, which constrained their balance sheet. Now, do you think that was a factor of why modern money, so to speak, didn’t expand?

Jeff Snider (20:36):

Oh, you mean talking about regulations?

Bilal Hafeez (20:37):

Regulation, yeah.

Jeff Snider (20:38):

No. I think regulation did play a part, but what you just said before is the bigger part, which is that banks became risk-averse. For several decades it had been from the ’60s, ’70s, ’80s, ’90s, and middle 2000s, before August of 2007, it had been believed by the banking system that there was very little risk because history said, look, there doesn’t seem to be a downside here. Everything works no matter what we do. Bigger is always better, more and more and more and more and more, no matter how ridiculous and insane. And part of that was this lore and this legend of Alan Greenspan and the Greenspan put – that if push comes to shove, the Fed will come in and bail us out without realizing the fact that the Fed actually has no way to do that. It was one of those shorthand myths that got perpetuated for a long time, because it was never tested. And so, you have recency bias and confirmation bias. All of these things worked before 2007. And then when things started to go wrong, it became, “Oh, wait a minute, all that stuff that we thought for decades, it’s all falling apart really fast. And oh, by the way, I’m on the hook here.”

The Fed looks at Bear Stearns as a success when the rest of the banking system looked at Bear Stearns like, “Oh my God, I don’t want to be the next Bear. My equity is wiped out. I’m no longer a manager of a bank. My cushy job where I get paid millions of dollars disappeared. I don’t want to be Bear Stearns.” So, the banking system looked at that the early crisis period and said the risks that we thought didn’t exist were actually there. And worse than that, some of the things that we thought were redundant, structural reinforcements actually turned out to be bottlenecks that made the situation worse.

And so, we have this asymmetry that we didn’t appreciate. Suddenly, it creates the potential for the worst of the worst case, which is a failure, which is I’m out of business. And that’s started changing behaviour long before we got to Dodd-Frank and Basel III and all the other stuff. The banks had already constrained their own balance sheet. You can talk to any number of bankers in the industry. And they’ll tell you – the way things operated before 2008 was completely different. If you wanted to do some cowboy stuff, all you had to do is call up your boss and say, I’m going to make you money. And they would go, yeah, whatever you want to do, you go ahead. Bigger is better, there’s no risk.

Nowadays, you want to do cowboy stuff, you’ve got eight different committees, you’ve got lawyers, you’ve got management. Banks operate completely differently. And Dodd-Frank and Basel III only made it worse. They’ve only hardened those tendencies to say, you need to be risk-averse because if you’re not risk-averse, we’re going to see it in your numbers and then we’re going to tell everybody about it.

So, it reinforced some of the worst kinds of behaviours. And I say worst kinds of behaviour, not in the sense that we want the banking system to operate like it did before the crisis, but monetarily speaking, we need risk-taking banks to generate monetary growth. That’s where the money growth came from – not from central bank policy, but from banks saying, “We’re going to take on risks often in really ridiculous ways and that’s how we’ll perpetuate this monetary system, which creates the necessary monetary and financial credit resources for an expanding global economy.”

What Caused the 1970s Inflation

Bilal Hafeez (23:33):

Yeah. And there’s a couple of follow-up questions here. One is, what happened in the 1970s? We had rampant inflation in the ’70s. What’s you take on that in the context of what we’re talking about here of money and so on?

Jeff Snider (23:46):

I use the term that economist Paul Samuelson came up with, I think it was in 1971. He said it was “benign neglect.” What benign neglect actually referred to was Triffin’s Paradox. Now Robert Triffin’s paradox described the situation after Bretton Woods in 1944, where the US dollar and the British pound were linked to their respective domestic reserves of gold. What Robert Triffin observed by the late 1950s was this monetary evolution starting to really take hold. Triffin said, “Look, you can’t have a national currency be an international reserve currency when it’s tied to a national store of reserves because you need more currency throughout the rest of the world to perform the roles of a global reserve currency than are available to be redeemed in the national currencies’ reserves.” That simply meant that you have to have more dollars outside the United States. The risk under the Bretton Woods system is that those dollars are going to be converted into American gold, which is exactly what happened in the late 1950s.

And so, as this monetary evolution was taking place, this Eurodollar system start to develop. What happened was they began to solve Triffin’s paradox in an ad hoc way, organic way where the banking system started to maintain the functions as a global reserve currency, without any administration, regulation or intervention of authorities.

The Rise of the Offshore Dollar (Euro-Dollar) System

Bilal Hafeez (25:01):

And just for clarity, just in case listeners get confused, Eurodollar, we mean here offshore dollars, dollars traded outside of the US system.

Jeff Snider (25:09):

Right. It has nothing to do with the Euro, the European common currency. The term “Eurodollar” was coined in 1960 by, I forget the guy’s name from the Financial Times, because he stumbled across the phenomenon by accident. And when he realized that there were all of these dollars being traded outside the US – primarily in London, but also throughout mostly Europe, and not just Europe. And so that was the shorthand. It became the Eurodollar because it was a European or continental dollar. There was robust Eurodollar market in Japan too, as well as Canada in Montreal. Really, all over the world. But yes, Eurodollar, when you hear the term Euro or anything following it, it just means offshore.

So, there’s actually a Euroeuro. There’s a Euroyen. It just means offshore yen or offshore dollar. But this monetary system is primarily US dollar-denominated and it takes place offshore. Because it takes place offshore, outside the US jurisdiction, so it’s outside of the control of the Federal Reserve. And getting back to what we’re talking about with Triffin’s paradox, you now have a US dollar that’s a dollar technically, but it’s de-linked from the stores of US reserves. And effectively in the 1960s, we had the Eurodollar take over the role of global reserve currency. Authorities became increasingly aware that was taking place and love the fact that it was happening, because it took a huge problem off their hands.

By August 1971, when president Nixon closed the gold window, the Eurodollar system had already taken over the functions of global reserve currencies in the post-Bretton Wood’s era, which began much, much earlier than 1971. And what happened was, it simply got out of control, right? You have monetary evolution throughout. I mean, these dollars flowing throughout the entire world. Not just ours, but all sorts of currencies – this offshore monetary system of going absolutely crazy because, I mean, nobody had any idea what’s really going on there and that’s what led to and what created a good chunk of what became known as The Great Inflation.

Why Fiscal Stimulus Won’t Work

Bilal Hafeez (26:58):

Yeah. And if we kind of fast forward to today, we’re jumping around lots different time horizons. There is a viewpoint today that says, “Look, banks are in a healthier position today than they were in 2009. So, they should be less risk-averse than before. Plus on top of that, you have the fiscal side the government has stepped up its balance sheet and it’s spending lots of money and giving people checks and so on. And in some ways, you’ve ended up in a kind of a crazy MMT situation, where what the central bank printed in the past that didn’t enter the real economy, but now they’re printing and the government is taking that printed money and now giving it to people. And as a result, this time is different and this time it will work.”

Jeff Snider (27:41):

Well, let me take the first part of that first, which is banks. Yes, it is true that the big banks around the world are in no danger whatsoever. Their balance sheets have been reinforced. But I would argue, I think that their data, you can just look at their balance sheets themselves, that they have become so because they are risk-averse.

Yes, they’re healthy, they’re not in any danger of failing, and they would say, it’s because we don’t take risk, we do the opposite. Look at what most bank assets are comprised of nowadays, bank reserves and government bonds. There’s no lending, practically no lending. There’s no lending growth, I should say – lending growth has been practically zero. I mean, even the last year or so, despite the Fed’s best efforts, banks are not lending, they are not lending. So I would say that no, the banking problem remains, which is balance sheet constraints for the reasons we’ve discussed before. So they are risk-averse, even though they are very well fortified. You’re not going to see another Lehman brothers. That’s just not right.

Bilal Hafeez (28:31):

Again, that’s a fair point. They’re safe because they’re risk-averse and so they’re going to remain safe by remaining risk-averse in essence.

Jeff Snider (28:39):

It sounds ridiculous but in the context of the banking system, in the world that we live in, it makes perfect sense. Because we don’t want to be that Bear Stearns, we don’t want to be Lehman brothers, we are not going to take that much in risk because we appreciate the fact that the Fed doesn’t do money. The monetary system is broken and if something does go really wrong, we could find ourselves in a lot of trouble. There is still that belief out there and I think it’s only been hardened by practical experience over the last 15 years, which says, you can’t depend on the Fed, you can’t depend on the system. It’s still kind of breaking down every once in a while. And so the risks are continually large. Even if the rest of the public doesn’t see it on our balance sheet, we appreciate it in the way that we actually construct it, which is safe, risk-averse, liquid assets – those are always preferred. It’s always about, do I survive tomorrow if something goes wrong?

So, the other side of that is, quite naturally, if you’re a policymaker, knowing the Japan experience and knowing the American experience immediately after and the European experience as well, where the banking system becomes this huge block. They call it the clog transmission mechanism, which gives themselves a little bit too much credit, but that’s what they call it. They’re essentially saying that they try to do monetary policy and then it’s like banging our heads against the wall because the banks keep saying no. No matter what you do, ECB negative, you can punish us with negative rates, we’re not going to lend, we’re not going to do risky behaviour.

And so, it makes sense. If the banking system is your problem, I’ll go around it. So instead of trying to influence bank behaviour, even giving banks reserves that they don’t need, I’ll just give cash to the public. I’ll give cash to businesses, I’ll go right out. The government can borrow all the bonds it wants for… It doesn’t matter about QE because banks are risk-averse, they’ll buy safe liquid instruments, which is what governments offer. You don’t even need the central bank to finance the debt, the banking system will quite naturally do it for you. And so, we’ll funnel all of this borrowed debt from banks who want to hold safe paper and then the government will redistribute it into the real economy instead of going through the banking system. And it sounds like, well, there’s your answer? That’s the magic right there. Except the Japanese thought the same thing in the 1990s.

And they did all the same stuff, and guess what, no inflation, no growth. And the reason is, the government redistributing money into the real economy is not the same thing as the banking system intermitting, which mediates real economic processes that create sustainable wealth. The government creates lumps in the economy. It creates artificial intrusions that are often wasteful and harmful in the long-run. It’s inefficient and ineffective. Yes, the Keynesians would argue that you’re raising aggregate demand and that’s true in the short-run. But as we’ve seen from Japanese experience, as well as a lot of historical experience elsewhere, government interventions in this fashion, even if they’re giving grants into the direct economy from monetary sources, tends to have an intermediate and longer-term deflationary impact because it’s wasteful and inefficient.

Think about UBI in this context, for example. What is UBI? It’s paying people not to work. So what is more harmful to an economy? Locking up a significant amount of the labour pool and saying, we’re not going to use it. An economy depends upon efficient use of resources. And if the government comes along and says, for non-economic political reasons, we’re going to take a chunk out of the labour pool so that you can’t use it, or they don’t want to work at the rates that you want to pay that are profitable for you to pay, it becomes a deflationary position.

There are any number of reasons like that. And again, we see this in Japan in the ’90s and 2000s, where they try to get around the banking system, thinking that that was their primary monetary impediment, and it didn’t create inflation, and it didn’t create economic growth. In fact, you could argue (and this is a debatable point) that increased government intervention actually made it worse, made the lack of growth, lack of everything.

The Problem With Market Fragility and Illiquidity

Bilal Hafeez (32:25):

I guess when we talk about risk, one thing that has been very evident in recent years has been all the odd kind of flash crash dynamics we’ve been seeing in markets. Whether that’s flash crashes in equity markets or whether it’s a repo blow outs and so on. We’ve seen some this year as well. We obviously saw some in March last year, we saw the repo blow up a couple of years before. I mean, what are your thoughts on those sorts of things that are coming up?

Jeff Snider (32:50):

It’s a symptom of the big problem, the major problem, which is the dealer. The banks that we’re talking about, they’re dealers. They also have money-dealing activities embedded within them. And for some of them, that’s their core business, especially some of the bigger businesses. That’s what we’re really talking about when we see these types of market breaks or illiquidity events.

September 2019 is a perfect example in the repo market. It really was a small technical thing. It wasn’t a big deal, but it became a big deal because the dealer stepped out. They said, “You know what, we’re-risk averse, we’re balance sheet constrained.” Whatever the reason was, as this illiquidity started to build in the repo market and where you would expect dealers to step in (because as the repo rate went up and up and up, a dealer could have made his entire year on that one day alone – there was so much profit opportunity to step into the repo market) the opposite happened. The higher the repo rate went, the less dealers were involved in the market place because they viewed that rising repo rate and they look at liquidity as a danger. So, it’s a symptom of the fact that dealers become risk-averse at the first sign of something wrong when the system depends upon dealers becoming risk-takers when these things go on. That’s what a dealer supposed to do.

And the reasons are, well, we just discussed, balance sheet constraint and everything else that’s going on. So that was a very poignant example of these. They’re not really anomalies because they happen more often than not and they happen quite regularly. And time and time again, we see that the dealers are very shy and very averse, which presents all sorts of systemic implications, including that the rest of the system becomes risk-averse because it realizes that if something goes wrong. They think, “I can’t count on the Fed, I can’t count on dealers. These markets go illiquid at a moment’s notice. I’ve got to be very cautious and careful” It becomes a systemic issue from that point forward. They’re just reinforced because it’s already been the way things are looked at.

Bilal Hafeez (34:47):

That’s a good point. Yeah. So actually, it reinforces the banks risk-aversion in general, because of this sort of the fragility of the system.

Jeff Snider (34:53):

Yeah. We focus on the banks a lot but I also think it spills over to the huge non-bank sector and that contributes to this too. And it spills over to them because they don’t have any recourse to anything. If a non-bank is overextended and it depends upon the repo market for its funding or its backstop funding, you’re really dependent on dealers to lend you collateral. And so, if dealers becoming risk-averse on these types of abnormal events, you have to think, well, my collateral position isn’t very good either. And you have to become risk-averse for the same reasons.

It really becomes a systemic thing. And the only way that the central banks try to circumvent or combat it is through this pop psychology crap. Let’s say, I’m doing a bunch of stuff. I’m creating trillions of bank reserves and everybody’s supposed to be happy about it. Well, that’s not going to solve the problem. It’s not going to help either the banks or the non-banks. So it’s not really a clog transmission channel, it’s that central banks are not central. That’s really the case here.

Central Banks Care About Equity Markets

Bilal Hafeez (35:50):

And what are the market or investment implications of all of this? I mean, from the sounds of things, it seems like we won’t really see much if any inflation, so that suggests that bond yields will probably remain on the low side. Does this have any implications for equities or how does all of this fit into equities? Obviously equities in general have performed quite well over this period of time. I mean, is that linked somehow to QE and all of these things, or is that just a separate set of behaviours?

Jeff Snider (36:18):

We’ll take the equity side first. That’s really what quantitative easing has… Its primary audience, the psychology I’m talking about is portfolio managers buying equities. The primary channel for signalling is through the stock market because academically, economists and central bankers believe that consumers and businesses get their information on the economy from the New York Stock Exchange. So if you could influence the price of shares, believing that consumers follow the stock market more than they follow GDP reports and payrolls and things like that, then you’ve kind of accomplished your primary task, which is you think higher share prices will allow more risk-taking in the real economy, regardless of the banking system. So QE’s primary psychological audience is the financial services industry, which is only too happy to buy stocks anyway. And of course, there’s also passive investing you have to take into account. I don’t know if you know, Mike Green, who’s done a lot of work on passive investing.

And so, the stock market takes these signals from QE and it just reinforces behaviour it already takes anyway. So regardless of economic fundamentals, we’re not discounting actual economic behaviour. We’re taking QE signals and saying, there’s no risk in history certainly since go back to 2011, the last time we really had a really big sustained sell-off other than last year. It seems to be that there’s no risk in stocks. Apart from these periodic liquidations like March 2020, where the monetary shortage gets so bad that even stocks have to be liquidated, it appears to be that Greenspan’s put is alive and well, even though there’s no money in it – it’s all psychology.

So that’s the stock part of it. And then you have the bond side of it, which is saying, wait a minute, this is all junk. There’s no economic growth, there are only risks. Banks are the ones buying these bonds. The banks, the non-banks, and the monetary system, the like, are the ones that are saying, “Look, we only want safe liquid instruments because we’re concerned about safety and liquidity.” Which is the opposite interpretation of stocks. And this is, I’d say that I tell people this all the time, this is the interest rate fallacy personified.

The interest rate fallacy is another one of those things that the textbook gets wrong. We’re conditioned to believe that low interest rates are stimulus. And that makes sense. It seems to make sense, right? I mean, if we have lower interest rates, it’s cheaper to borrow, so that should be stimulative. As Milton Friedman said in 1967, no historical experience runs exactly contrary to that.

Low interest rates are a sign of tight money in the real economy. Low interest rates are tight money. Think about the 1930s in the United States, the Great Depression. What were interest rates in the ’30s? They were low, not high. Today, even after the sell-off this year, rates are still really low. They’re extremely low. And what that says is the market is saying tight money, low inflation. And that includes taking into account Joe Biden’s stimulus and infrastructure. The bond market is saying even with everything (the fiscal and run-around the banking system block, all of this stuff), the economy does not come out to be inflationary. At least we don’t think so right now. Nothing has changed. Yes, there’s lots of big stuff going on in the short-run, but the intermediate and longer-term picture, it remains the same ugliness, but even a touch uglier.

What Could Generate Inflation?

Bilal Hafeez (39:30):

Okay. And if we kind of stepped back then, I mean, so what do you think could cause inflation? I mean, what types of things would you want to see to make you think, hang on, things have changed now we are going to see inflation.

Jeff Snider (39:44):

Well, I think we have to define inflation first because it means different things to different people. What are we talking about in the traditional economic context? Inflation is a broad-based and sustained increase in consumer price. So it’s not food prices going up or college going up or my medical expenses are going, health insurance is going up, it’s everything going up.

Okay, so it’s broad-based increase in consumer prices and it’s not just everything going up this year, it’s everything going up this year, next year, the year after, and the year after that year, etc. Going back to the 1970s, it wasn’t just gasoline prices that got outrageous, it was the price of everything. Everything went up for year after year after year, that’s inflation.

Jeff Snider (40:25):

Now, what central bankers shoot for and what they tell you that they’re looking for is a very small amount of that. And that’s a good thing because they think it gives them a margin of error between inflation and deflation. So that’s why they have this inflation target of 2%. You would think the ideal price stability is zero. And what they would argue is that broad-based sustained consumer prices at a low level is what we should target for, because it gives the economy some margin of error from deflation.

So, when we’re talking about inflation, that’s what we’re really talking about. We’re talking about broad-based sustained inflation. So yes, we will see spikes in food prices for example. Over the last year, that’s obviously been the case. But that doesn’t necessarily equate to inflation. And I believe in the monetary explanation, Milton Friedman’s explanation, everybody else, Alan Greenspan, anybody else you want to talk about – that inflation is a monetary phenomenon. I mean, that’s why central banks target it, right? It’s a money thing. We’ve been a disinflation because of the interest rate fallacy – the market’s telling us money has been tight. We’ve we just talked about the Eurodollar system has been broken for 14 years almost, in the sense that it doesn’t grow in the way that we need it to; it doesn’t offer enough money to the system that needs it to grow.

It doesn’t mean it’s been shrinking and contracting. It’s not 1930 all over again. It just means that it’s growing at a rate that’s insufficient to continue to keep the system operating at its best level. So what we would expect if we think that inflation is going to come, the paradigm has shifted out of this dis-inflationary low-growth rut into something better, more consistent. It all comes back to the banking system. It really is that simple, because banks are money. Money is inflation. Without fixing the banking problem, you don’t fix the money problem, you can’t get the inflation. It is really that simple. And I think that’s what the market is telling you, that despite the trillions in the US and the trillions of euros in Europe, everything Japan has done, everything China has been done. Everything that governments and central banks are doing around the world, we’re still not buying it.

In 2021, interest rates have come back a little bit from their lows last year, but why haven’t they come back a lot more? And the answer is because more and more it’s becoming: hey, this isn’t really different. Governments are doing more, but it’s more of the same types of things. It’s not fixing the underlying structural issues that had been this way for a very long time.

Bilal Hafeez (42:42):

Okay. No, that’s great. No. I think that’s a very compelling argument. I mean, listening to you, it does sound like that the one area of inflation is probably the size of central bank and fiscal programs themselves. They seem to have gone from hundreds of billions to trillions. So we’re definitely seeing inflation there. That’s one area we are seeing inflation.

Jeff Snider (43:01):

Yeah. And that’s the easy thing, right? You can look that up on the Fed’s website and you can see its balance sheet rising; you see level bank reserves rising. I mean, you’re getting checks from a government for… In Europe, I know they do it a little differently, but people in America are getting checks from the government. They’ve never, (oh, they did in 2008) but now they’ve gotten much bigger and they’ve become much more regular.

So, I mean, this is the stuff you see, you see this stuff and you think, well, how can this not be inflationary? But it’s the stuff you don’t see that actually matters. And that’s why I spent spend most of my time on these bond market signals. And to be clear, when I say bond market, I don’t just mean US Treasuries. There are all sorts of different aspects of the bond market system. There’s the Eurodollar futures, there’s interest rates swaps, there’s currency swaps, and all sorts of things that go on in these global offshore money shadows that you don’t see; you have to depend upon these market signals to tell you what’s going on in them.

And it’s the stuff you don’t see that ends up being most important. Think back to our experience in 2009, 2010. We saw the Fed’s balance sheet go way up and everybody said it was going to kill the dollar – the dollar is going to zero and inflation is going to go through the roof with all this money printing. And what happened? The dollar went up and inflation went down. It was the opposite. And the reason was because it’s what you didn’t see in the shadows that forced Ben Bernanke to do a second quantitative easing, and then the third and then a fourth. It’s the same exact experience as Japan because banks do money, not the central bank.

This offshore bank-centred shadow Eurodollar system said, no, there’s no money, there’s no growth, there’s no inflation here. There are only risks. We’re only risk-averse. It includes M2, for example, M2 has gone crazy in the last year yet there’s still low inflation and interest rates are still low. It’s because it’s the stuff you don’t see, that’s what really matters.

Jeff’s Productivity Hacks and Book Picks

Bilal Hafeez (44:47):

Yeah. No, that’s just kind of an apt way to end our sort of discussion on the macro side of things. I want to change tack now and just get more personal and I can tell you consume a lot of content and analysis and so on. I mean, what are your tactics and how do you manage your information research flow? It’s quite easy to get overwhelmed.

Jeff Snider (45:05):

All over my desk, I’ve got papers everywhere, just notes and things. But I manage my own information flow because a lot of it is just regular, it’s habitual. I need to check this, I need to check that, I need to see this, I need to see that. And when I have spare time, I’ll do a lot of primary source research. I’m sort of well-known for being the most boring human on earth. In my spare time, I read transcripts of central bank discussions from the 1950s, things like that. And it’s good because using primary source material, you can fit what people were saying back then into this worldview that I’ve developed: the Eurodollar system, this modern monetary shadow money system and see how it got to be that way. And that helps you appreciate what’s going on right now. Again, why do we need to pay attention to the shadows? Well, there’s all sorts of answers to that from the ’60s and ’70s and things like that.

So it’s really about matching the scholarship you do, and the work that you do about past history and understanding the way things work with how things are developing in the real world in real time. And it’s a bit of a chore, but once you get into that world and understand things, it become second nature. It’s not so difficult.

Bilal Hafeez (46:15):

You mentioned reading of course. And so are there any books that have influenced you over your career?

Jeff Snider (46:21):

The book that I use the most actually is A Monetary History, which is Milton Friedman and Anna Schwartz’s seminal work from 1963. You can see my copy of it, it’s completely torn apart. There’s a lot to like about what they talked about. And really, the book is about monetary evolution, except in an age before the Eurodollar system. What they’re talking about is depository bank evolution. So, when I first read it a long time ago, I thought, wow, this is really good because it’s out-of-the-box. It’s certainly original thinking. It’s a different way of looking at things. And I think a lot of it stands the test of time.

And in addition to that, if you want to know what a central banker is thinking, all you’ve got to do is read that book. I mean, quantitative easing is in there, zero interest rate policy is in there. All that stuff is in the book. So it tells you a lot about how things are today. And to me, it sort of represents an endpoint where monetary scholarship had developed in the post-Great Depression era, only up until the 1960s. And then they said, oh, Milton Friedman wrote this book, we don’t have to study money anymore. It’s sort of like, okay, we’ve left off here and now we need to fill in all the rest of the blanks over the last 50 years.

Bilal Hafeez (47:24):

Yeah. That makes sense. Okay. No, that’s all great. And if people wanted to follow your work or your thoughts, what’s the best way for them to do that?

Jeff Snider (47:31):

I post regularly at my company’s blog, which is alhambrapartners.com. We also do a podcast as you referenced with my co-host Emil Kalinowski, who is offshore in the Cayman Islands, which makes it very appropriate. We talk about Eurodollars and shadow money. That’s called Eurodollar University Making Sense. And we do that regularly every week. Usually, we’re talking about what’s going on in the world. Also, we always try to take some of these more intricate and complex topics of pardon in a way that we hope even a novice audience would understand. For example, a couple of weeks ago, we looked at how collateral works in the offshore framework – where it comes from, how it goes around, and why banks do some of this interbank stuff that they do in the repo market.

Bilal Hafeez (48:12):

Yeah. That’s great. And I’ll include links in the show notes. So with that, I’d just like to thank you. You’ve been an excellent guest. I’ve learned a lot in our conversation and yeah, is excellent.

Jeff Snider (48:20):

Thank you very much for having me. Like I said, I’ve always loved having these conversations with people who are interested in a different perspective, for sure. What I hope is a compelling perspective, at least one that makes some kind of sense.