Etienne de Marsac, former European Central Bank Insider
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Transcript00:01ROGER HIRST: Etienne, a very warm welcome to Real Vision.00:04ETIENNE DE MARSAC: Hi, Roger.00:05Thank you for inviting me.00:06ROGER HIRST: Not at all.00:07I think this is your first time.00:09So maybe if you could just give us a little bit of background, because you’ve been in00:12this business for over 20 years in hedge funds, investments, even in some of the European00:17institutions.00:18So maybe give us a little bit of color about this career that you had.00:21ETIENNE DE MARSAC: Well, indeed, I started already 20 years ago.00:25The financial environment was totally different.00:29I spent so 20 years in the fixed income market as a global fixed income and currency trader,00:36or investment manager.00:37And indeed, I had the opportunity to move or to come across many various institutions,00:44some of them quite small, some of them quite big.00:48And as you said, my last two principal or serious experiences were in Luxembourg in00:55a hedge firm before joining the EIB, the European Investment Bank, which is basically one of01:01the biggest European banks in the European universe.01:05People basically don’t know in general, but the balance sheet of the bank is roughly 60001:11billion euros, and the role of this Development Bank is to provide credit to the whole Europe,01:19but also the rest of the world.01:21So it was these last two experiences were extremely interesting, extremely unusual.01:27The hedge fund, because it was very technical– a cross-asset hedge fund.01:31So where we were trading equity, derivatives, commodities, fixed income, credits, globally01:38all assets, with an overlay on the top of it.01:42And then, the EIB, when I was in charge of investing the long-term liquidity buffers01:49of the banks.01:50So roughly 10 billion euros that needs to be invested for regulatory reasons.01:55And before coming into this universe, this European universe, I had no idea about how02:02regulation can distort prices.02:05And I think this is pretty much the biggest thing that I’ve been taught and that I will02:12remember.02:13ROGER HIRST: And so bringing in all of that, I guess in some ways, the key thing here now02:16as you’re running money again is the state of the market.02:20Because we have this incredible– so to some people, it’s an incredible world where the02:24S&P has been marching higher, and although we’re not at the lows in yields, it feels02:29distorted.02:30Valuation feels distorted.02:31And yet, central banks are behind it.02:33How do you perceive the state of the market right now?02:35ETIENNE DE MARSAC: That’s a key question.02:37I’m a little bit suspicious right now.02:41Either I’ve been participating to this very risk-on environment for many years, except02:47to 2018, which was a little bit different, a different context, where or when the United02:54States and, namely, the Fed tried to escape from the quantitative limiting but did not03:01manage to do it.03:04I’ve been participating to the risk-on environment for a long time.03:08But right now, I have the feeling, indeed, that the valuations have been too far, are03:13too much stretched.03:16And even if you cannot short right away the market, which would be completely foolish,03:21I am tempted to have a lower participation to this risk-on environment.03:27So I qualify the environment as being greedy.03:31I can feel some greed in the market.03:34I can see some hubris within market participants.03:39I can see a quite non-irrational exuberance, if I may say so.03:46That is to say, a logical one that is explained by, mainly, three factors, three features–03:53first one being the American president very frequently referring to the levels of the04:00stock markets as a key feature or as a key measure to qualify the efficiency of his policies.04:08So this is very unusual.04:10We had an example very recently last week when, during the conference following the04:16signature of the phase one deal, Mr. Trump referred two times to the level of the S&P04:22500 and the Dow Jones as a key measure of the efficiency of his policies.04:28And I think this is slowly and surely introducing a misperception of reality that price on the04:37equity markets can go on upper and upper unless– until Mr. Trump– or, while Mr. Trump is still04:44in power.04:45So this is the first one.04:47The second point, of course, has been induced by the omnipotence of central banks, or at04:53least the perception that they will be here forever.04:56I must admit that they have been extremely efficient, really good, at addressing liquidity05:02issues as well as solvency issues, the latest example being the way the Fed addressed the05:09repo issue in the repo market last year, beginning of last year, by injecting very precisely05:15between $60 billion to $120 billion per day of liquidity exactly where the liquidity was05:21required.05:22I’ve been extremely surprised by this efficiency in the securities.05:26So I must admit central banks, and particularly the Fed, has been quite efficient.05:31The ECB is also part of the story.05:36That the money supply impulse– so that the year-over-year difference between the net05:43asset purchases of the previous year relative to the new year– the net impulse has increased05:49by $3 trillion, not to mention the money supplied by China.05:56So the central banks have been extremely successful in injecting liquidity.06:02And so it would be absurd to not to participate to this party.06:10But I have the feeling that we may be slowly but surely going into the end of these bubbles,06:18on the end of this everything bubbles, that it is right now jeopardizing the equilibrium06:25of financial assets.06:28And yes, I think we need to pay attention to various signals of excess leverage, excess06:36liquidity, absence of notion of risk, greed, and, yeah, pretty much, that’s all.06:43ROGER HIRST: And do you think– I think what a key area is here is that it feels like we06:48deserve a pullback, but the pullback that you expect, is going to be a correction–06:535% to 10%– which takes out the exuberance.06:56Because in many ways, this is not a euphoric top that we are seeing, if it is a top at07:00all.07:01it’s not a euphoria of mass participation by the man on the street, which is one of07:05the reasons, in some ways, where this valuation story, which has been there for a few years07:09now, has been ignored because it’s a liquidity story.07:11So do you think that the next chip phase, or the next downleg that we have, is a correction,07:18or it’s the beginning of a financial crisis?07:21Or do you think that at financial crisis, potentially, is still quite a long way down07:25the road because the liquidity, it might come out a little bit, but every time we’ve seen07:31initial return, the liquidity comes back even faster.07:35ETIENNE DE MARSAC: An easy question.07:39If I’m honest I must admit that I don’t really know the answer the party can goes on again07:46and again and quite longer so that there has been a tremendous effort done by the regulations07:55and the regulators around the world to avoid the same type of financial crisis.08:01So basically, these acronyms like BRRD– so bank resolution– BRR, so bank resolution08:07regime, LCR ratios, these type of acronyms, they all provide support to the idea that08:16the next financial crisis won’t happen within the banking sector that had been extremely08:22recapitalized these last years.08:26If we step back a little bit and we focus on the European sector, the recapitalization08:31effort is of about 6 trillion euros in 20 years.08:36That’s huge.08:37That’s even bigger than the impact of the balance sheets of the ECB.08:44So the solvency issue has been addressed within the banking sector, either in the US or in08:51Europe, but it is also having an amplificating effect on these euphoria that we were discussing.09:02The liquidity buffers, they need to be invested.09:05As an example within the EIB, one of my last missions were to invest between 5 and 10 billion09:14euros or dollars on sovereign bonds.09:17Care less the level of the prices, of the level of risk, of the level of rates, because09:24the cost of being non-compliant to regulation is even bigger than the cost of being of having09:31a negative carry on your holdings.09:33So the banking sector is in a better shape, but you can still see some fragilities in09:40some areas.09:41And the socalled doom loop, which is a way the banking sector is being forced to buy09:49sovereign debt at ridiculous levels because they are AAA and because they consume very09:56low level of risk-weighted assets could be a factor or a trigger of a bigger meltdown.10:05We had the example quite recently in Italy with– when the blowup of the Italian sovereign10:13bonds is having a direct effect on the sovereign spreads.10:17To answer a little bit more specifically to your question, I think we are not– we are10:25living in a big bubble that is made of small bubbles, and these bubbles will deflate–10:33either naturally, when suddenly people come back to reason, or either because the regulator10:40or the central banks will start to be– or will start to focus on them.10:48And last week, Robert Kaplan, for instance, made a speech about the financial instability10:54that needs to be tackled.10:55And I have the feeling that probably, if a crisis emerges, it will be internal.11:01It will come from the central bank themselves.11:07They were the ones who inflated the bubbles, and they could be the ones who will try to11:11deflate it.11:13Not a very long time ago, one year, one year ago, Mr. Powell, through the quantitative11:21tightening, was exactly trying to get out of this mess and trying to exit the balance11:29sheet of the Fed, assuming it would create some bout of volatility.11:35He went a little bit too far– much too far– with a very clumsy communication that the11:43financial market could not really understand.11:46But this is how I see the world.11:49Either it will correct because of a doom loop within the banking sector– either it will11:58be directly due to a change of focus of central bankers trying to address the global imbalances12:09that they have created for all the reasons that we know– inflation targeting, et cetera.12:13ROGER HIRST: Well, how do you think we move from this?12:15Because we currently have is almost a virtuous circle.12:18How does the virtuous circle turn into the doom loop?12:21Because if anything, the central bankers themselves, I think, have learned a few things.12:24One is in the 2000s, they cut rates, and the equity market fell in 2000 to 2003 and 2008.12:32So now, gone, it’s not the price of capital.12:34It’s the availability of capital.12:36Hence QE, and hence, during last quarter’s repo issues, the capital went in.12:41It was– that was more important than the cost of capital.12:43So the central banks, haven’t they– in some ways, they’re now saying, OK we will put–12:50rather than a put under the equity market or the bond market, we’re going to put a cap12:53on volatility until we stabilize everything.12:56We continue to provide that liquidity.12:58In some ways it’s not that we’ve got asset bubbles everywhere.13:01We’ve got extremes but no euphoria.13:03But we might have a bubble in central banks.13:05But why don’t we just keep on doing this?13:08Because at the moment, there’s no inflation.13:09At the moment, there’s no– at the moment, as we saw with Powell’s misstep with the rate13:14hike in 2018 at the end and the final move down, they know what will cause things to13:20blow up, so they know what they can do.13:22So why don’t they just keep it going?13:24ETIENNE DE MARSAC: Just because at some stage, the targeting financial stability and targeting13:35price stability is becoming two different goals, two orthogonal goals, that will hurt,13:44themselves, each other.13:46The world of the central bank, they have chosen to privilege the inflation targeting, despite13:53the bubbles that they may have created all around.14:00They perfectly know this.14:02They are perfectly aware of the bubble created within the fixed income market, within the14:06corporate market, or within the equity market.14:09But it will only require a change of focus.14:15And I think this is where we are slowly coming right now.14:21The ongoing valuation of the tools that the Federal Reserve is using and also the ECB14:31is using is an ongoing valuation that will last some months.14:36But maybe– and I will discuss this after at the end of your interview– but there are14:41probably some surprises to expect from the review of the tools, the review of the CPI14:48figures, the review of the methodologies, and globally, the review of this inflation14:55targeting and the level of inflation.14:56Is the level of inflation of 2% still relevant in an environment of pressurized prices, in15:06an environment where the quality effort is pushing the prices to the downside?15:12Have a look at your iPhone, for instance.15:16Your iPhone, the price of your iPhone is the same than what it was five years ago, basically,15:22but there is much more technology inside it.15:24So how is this technological aspect being taken into this inflation reflection or this15:35inflation target that the central bank are having?15:38Is the CPI computed 50 years ago still relevant in this new environment?15:44Our grandmothers, they were not buying phones, or they could not use so many services that15:51are free from the moment.15:53On your telephone, you have a WhatsApp application that is totally free.15:56It used to be– it used to eat used to consume a lot of wealth before, so you used to pay16:03for it before.16:04So how do you account for this new environment?16:06And this ongoing debate within the central bank, I’m sure, is going to lead to some surprises16:15that we will face next year.16:19Still, the amount of risk in the financial market is much too high.16:25Coming back to the 1999 years, the global level of debt was of $80 billion.16:32Right now, it is of roughly $270 billion.16:35So it multiplied by three.16:38Meanwhile, I don’t need to say that the growth of the earnings did not follow the same train.16:48So we have a big issue of loss of efficiency in the allocation of capital.16:59More and more debt is explaining or is leading to less and less growth.17:04So the capital efficiency is a big issue.17:08So globally, what I’m discussing here is the liquidity trap, so the Keynesian, the very17:13basic Keynesian liquidity trap, when providing liquidity, even providing debt and more and17:19more debt, you favor zombie bonds or zombie corporates that are less and less efficient17:25and that, at some stage, are going to blow up.17:29So either you let them blow up themselves– and WeWork is a perfect example, for instance–17:36or either you raise interest rates in order to increase the debt servicing so that these17:46zombie corporate dodge themselves.17:50What is a zombie corporate, if I may open a parentheses?17:56It’s a company that is not able to pay its debt or more than one year of debt servicing,18:07or more than two years of debt servicing.18:10So its revenues are less than two year of debt servicing.18:13If you have a look at the environment, you will see– you see that in Canada, the number18:18of zombie corporates is increasing to 30%.18:23So 30% of the corporate world is made of zombie corporates.18:30In the United States, it’s 20%.18:32In China, it’s 25%, and so on.18:35And these figures have doubled in 10 years.18:40And I think it’s not healthy.18:42They shouldn’t be kept above the level of the water, and they are posing, probably,18:52crippling effects, or they could have cripple effects on the rest of the financial world–18:58namely, insurance companies, pension funds who were made to invest in these extremely19:06risky corporates to increase their revenues, but at the end, you can fear some domino effects.19:15ROGER HIRST: But in many ways, isn’t this just a rinse and repeat of what we’ve already19:19had?19:202000 was, in some ways, the beginning.19:21We got a verifiable bubble.19:24It deflated, and they used the same tools to inflate, reflate the bubble.19:28Deflate– they used pretty much the same tools with a bit of a turbocharge on to reflate19:33the bubble again.19:35It would seem very strange that, having done this for the third time, here we are with19:39everything near the tops of the range.19:41As the price is riding high, the central banks will go, now is the time to change, and bring19:47the whole system crashing down?19:49Aren’t they just going to keep trying and trying to move this forward?19:54And the question really comes from this line– and I know we’re going to talk about the US–19:57is that outside of the central banks maybe doing something, which we’ll come to at the20:01end, what are the potential catalysts?20:03Because we always look at the US as a potential catalyst.20:06Is there an issue there?20:07Or is it going to be the European debt crisis?20:11What is the thing which is beyond the control of central banks printing yet more money to20:19stop this thing becoming worse than 2008?20:23ETIENNE DE MARSAC: So indeed, the increasing amount of debt is not a purely US phenomenon,20:29of course.20:30Obviously, it is also a European one.20:32It is also a Chinese issue where the money supply has increased by– I think it’s 3320:39US trillion in 10 years.20:42So obviously, there is a money supply bubble in China as well as a global debt bubble in20:53the US, but also in Europe.20:54The thing is, while the amount of debt is increasing, the sensitivity of stock markets21:03and of the financial community to even a very tiny move in the interest rates or in the21:12dispersion of interest rates or in the past of interest rates, the sensitivity is also21:18increasing.21:19It did not require a lot of misguided communication from Mr. Powell last year or at the end of21:28the 2018– during the Q4 quarter– to prop up a fantastic meltdown of, say, minus 30%21:39on the US equities.21:40ROGER HIRST: So I think it’s 20, 20% from– ETIENNE DE MARSAC: 20, 20%.21:44ROGER HIRST: Average, 25% average.21:46ETIENNE DE MARSAC: So here, we have a big, big issue– how to address such a sensitivity21:54to a very tiny level of a really tiny movement in interest rates?22:00And the key issue is how the central banks are going to communicate to the market when22:08tackling or addressing the stability issue.22:11There is a paradox.22:12Right now, the central banks are injecting liquidity, injecting money, purchasing directly22:23assets in the primary and the secondary market in the name of the financial stability.22:28But at the end, the paradox is also that in the name of this financial stability, they22:34are provoking what they want to avoid– that is to say, financial instability everywhere–22:41excess of capital, misallocation of capital, zombie corporates, zombie banks.22:49So how do you reconciliate these, the same objective?22:55Then how do you reconciliate this paradox?22:57So I think there’s no way out, apart from extremely precisely addressing some parts23:09of the bubble.23:10So by communicating very softly, which is probably what Mr. Kaplan has started last23:18week, by changing the expectations into the passive rates so that many companies understand23:29that the party is over.23:30I can feel that the message has been pretty well received, because back to the first week23:37of this year, there has been a record in issuance in the European corporate market.23:43100 billion of issuances have been launched.23:49By the way, they were oversubscribed three times.23:52And this represents 20% of 2019 issuance.23:57So 20% of the 2019 issuances have been launched in one week at the beginning of this year.24:05So isn’t it because the financial community is aware that the party is not going to last24:13that long, or will not last for a year, and that they should try to refinance at these24:20very low levels their debt in order to survive as long as possible?24:24But it’s also a sign that maybe I’m not going to talk about a hybrid because I think it’s24:30much too premature, it.24:32But by changing the inflation target, for instance, this will send a huge message to24:37the financial community.24:41If the inflation target of the ECB is revised– ROGER HIRST: And what will they– what are24:46they going to do there?24:47Because at the moment, it’s, what, 2% on HICP, so– ETIENNE DE MARSAC: Yeah.24:49ROGER HIRST: And they can’t get anywhere near it.24:51So what are they going to do?24:53Because they can change a target, but isn’t it irrelevant if they could never get to whatever24:57target they set?24:58ETIENNE DE MARSAC: Well, if you admit that the new environment where the output gap is25:06being filled with a 1.5 percent of inflation, then shouldn’t it be logical that the target25:13is 1.5% instead of 2%.25:16So there is a debate inside the ECB, right?25:18There are some people advocating for, OK, let’s push up the target to 5% so that the25:24people really get aware that we are going to wait a large amount of time before raising25:30rates.25:31So enjoy the party, and let’s reflate the whole economy.25:34But there is also the opposite argument, where some other people, in Banque de France, for25:41instance, they advocate for a lower inflation targeting so that it would recon that they25:48stole too much accommodation, that the right level of inflation has been achieved, paradoxically25:55speaking, and that maybe the last bout of quantitative easing is no longer warranted.26:02ROGER HIRST: Doesn’t that mean that– we saw it in the US in some ways at the end of 2018,26:07where we got I think it was 3.25% on the 10-year, which rang the bell for the equity market.26:13And every time we get a move in yields in Europe from negative to positive, we all get26:18excited because we’ve got growth.26:19But then, everyone scratched their beards and goes, well, hang on a minute.26:23That whole pile of debt that every bank owns is just about to fall in value.26:28Everyone’s now bankrupt.26:29So you have a choice.26:30And isn’t this– for the ECB, in particular, you’ve got the rock and a hard place.26:35You either have no growth, negative rates, you kill savers, you have a flat yield curve,26:40or you try and raise rates, and you kill the very banks you were trying to say by doing26:44QE in the first place.26:45So you either collapse the system, or you have the death by 1,000 cuts.26:51How do you get that for Europe, between what we currently have, and saying we want growth,26:57but then the balance sheets get distorted?26:59How?27:00What do you think they’re going to do there?27:01ETIENNE DE MARSAC: The direct link between high rates and the destruction of value inside27:08the banking sector is questionable.27:09If the yield curve’s steeper than the way the banking sector is making money through27:18the transformation, the so-called transformation operations.27:22So that’s basically lending at a higher rate that- – your funding rate, than you you’re27:27making money.27:28And then, basically, the banking system remains stable.27:34Clearly, from one way or another, the deflating the bubble will have a cost.27:41So the question is, who is going to take these costs?27:44Indeed, there is some social costs.27:46Probably, it’s not right now a big– the good moment in France, for instance, to start this27:55process.27:56And that’s particularly why the last round’s run of quantitative easing was lost.28:02It was a social QE, right?28:04It was particularly a QE addressed to the Italian people and to the Italian banking28:10sector so that they could present, at the end of the year, some key ratios, such as28:16the liquidity stable rates, the net stable funding ratios, and liquidity coverage ratios28:21at the end of the year.28:22So the quantitative easing at end of last year has been addressed, particularly for28:27social reasons, and also for geographical imbalances.28:32So back to your question.28:34Hi, how do you reasonably deflate the bubble?28:38Well, you just leave the bonds that you’ve been purchasing within the balance sheet of28:47the ECB or of the central bank you leave them slowly but surely.28:52Decrees are being reimbursed and paying their coupon.28:55And if they have some default, you’ll absorb the default inside the balance sheet, which29:01will create a debasement, basically, of the currency, which is exactly what all these29:09central banks are looking for.29:11QE’s aim is– these they will never say, but it is targeting explicitly, implicitly, debasement–29:20so lower currencies.29:22So in case you have defaults within the balance sheets of these central banks, then, it will29:30achieve exactly the same target, which is lowering the cost of capital, lowering the29:36currencies, gaining in competitivity relative to the other partners, et cetera.29:42ROGER HIRST: With that, because one of the fantastic things about currencies in a way29:47and also the demand for inflation is that Japan debases its currency– so the yen falls.29:54So Europe does it, so the euro falls.29:56And then the US does a bit more QE, and so the dollar falls.29:59So if everything falls, nothing has fallen.30:01They’re all on the same level.30:03And so in some ways, let’s say Europe does that.30:05And if Swan said, oh, you’re going to debase the currency in Europe, I would run a mile.30:10I would sell everything in Europe, because the euro’s going down.30:14So that they get penalized for doing that.30:17And this has been this bizarre world where each central bank has been trying and nobody’s30:22actually succeeded because everybody’s done it together.30:24So all that’s happened is that capital has gone in with a lot of capital going in with30:28a low cost, and no one’s currency has really moved that much.30:31Obviously, the dollar has strengthened a bit.30:32ETIENNE DE MARSAC: Yes.30:33ROGER HIRST: How do we break out of that?30:34And how does one break it without being a manipulator?30:37ETIENNE DE MARSAC: Well, as you said, except versus the dollar.30:4210 years ago, I think the value of the euro was something like 1.45.30:48We are at 1.10 or 1.11.30:51So the euro has deteriorated with quite a high level of efficiency versus, at least,30:58the US dollar.30:59So the US dollar is the loser in this equation, and Europe is quite a winner.31:06So I tend to disagree with the idea that it is a zero-sum game, because from time to time,31:15you have big devaluation effects before your other partner starts a devaluation process.31:20ROGER HIRST: And do you think that the US– because you talked about the dollar’s strong.31:24But the US has lots of debt– lots of corporate debt, lots of buybacks.31:30If there’s any equity bubble out there, you’d probably say it was the S&P and bits of the31:33NASDAQ.31:35So in some ways, that, the most exaggerated part of the market, is also where some of31:40the most aggressive junk and triple B volume is as well.31:43Do you see that as a risk that actually– when I say “risk,” it sounds like it might31:46be a positive risk for the US.31:48The US might be the one that comes unstuck but which, therefore, may be able to rebalance31:54first?31:55Just how do you see the US versus Europe?31:56Because everyone’s looking for, which region is going to blow first?31:59And how does that come into the framework?32:01ETIENNE DE MARSAC: Well I think right now, the US are the hottest emerging market for32:062020.32:08I think- – ROGER HIRST: And can you explain what you mean by that?32:11Because that, to me, is like– ETIENNE DE MARSAC: Yes, it’s a little bit controversial.32:14I apologize for your American audience.32:17I agree, it’s pretty much controversial.32:20But when you apply an emerging country risk matrix to the US, well, you have the feeling32:28that it takes– the years are ticking a lot of boxes for a potential downgrade.32:35And we’re not discussing about something that is seen as super or not natural.32:41The US had been downgraded already in the past by S&P.32:45I think it was in 2011.32:49And it could pretty much happen again.32:52So for many reasons, so the way I look at the US right now is by applying exactly the33:01same metrics that I apply to a country analysis in South America, for instance.33:08I see challenged institutions.33:10And everybody would agree with this, that probably– most Americans will agree with33:18this, too, that we are in a very precise moment in history where the institution the various33:25institutions of the United States are being challenged by the White House, typically.33:31So the Mueller report, the Hungarian affair, or the two procedures of impeachment that33:42have been submitted to the Senate, very recently, they all accounts for this fragility that33:50I see in this political landscape.33:53So I think ultimately, the institutions will remain strong and robust enough to absorb34:02these ongoing shocks that they are facing.34:06But yes, globally, there is a feeling of, maybe, slight corruption that we are also34:14facing in Europe- – that is slowly spreading like a disease within the US institution.34:22I totally trust the institutions to resist, but still, they are much more fragile under34:31this administration than the independence of the monetary institutions such as the Fed34:40is being questioned.34:43So many times in recent years, last year on and on year before, did we hear Mr. Trump34:50voicing against Powell– he doesn’t have a clue.34:54They don’t have a clue.34:56They should lower rates.34:57I could fire him if I want.35:02They don’t understand a single thing.35:03They don’t know what they are doing.35:05These are what we’ve been used to hear from Mr. Trump, and it’s very– and even if theFed resisted to the White House pressure, it’s very possible that by resisting, it mayhave altered the reaction function of the Fed.35:23If Mr. Powell had delayed his reaction in order to show his independence vis-a-vis the35:32White House, isn’t it a loss of independence per se?35:36So this is a question.35:40I think there is a decent loss of skills within the Fed, the Federal Reserves, and within35:49the triggering.35:52The fantastic team made of former MIT guys– so Bernanke, Yellen, Dudley, Fisher– they36:02are all gone.36:04And they were– they all had an extremely high economic mindset, much more able to tackle36:12these difficulties than Mr. Powell has right now.36:15ROGER HIRST: But aren’t they the architects of the doom loop?36:17Aren’t they collectively the ones who created the very framework that, in some ways, Powell,36:22with his pragmatic hat, tried to address?36:25The markets told him, though, stop in 2018.36:29Yet in some ways, it’s that whole fragility that we’ve got was created by the Chicago36:37School and the MIT School, and all those guys who have spread their wings across the whole36:41world?36:43Is that maybe, we actually need a practical mind?36:46We need a Volcker type mentality to accept the reverse, Volcker, obviously in, inflation.36:51Now this world, we need somebody who attacks the system and creates pain.36:57But I don’t think Trump will allow that.36:59And then, just finally on that, we did have a downgrade in the US, and you said to fail37:04early 2010, ’10, ’11, it they didn’t have much of an, impact.37:08And in fact, as an investor, if US yields moved up 10, 15, 20 basis points relative37:14to everybody else, I’d actually go more get more excited about US bonds, and I’d put money37:19in.37:20So wouldn’t it be self-correcting for the US?37:22Because Europe doesn’t look great.37:25Japan doesn’t– has never looked great.37:27China doesn’t look great.37:28So in this relative game, It will take a lot to destroy or undermine the US, won’t it?37:33ETIENNE DE MARSAC: Three questions in your “Big Questions.”37:38I disagree.37:39I think there’s I thing that you are softly inverting causes and consequences.37:47I don’t think that what we are– the world in which we are living right now, which is37:53the liquidity trap, the Canadian liquidity trap, is the product of this MIT team.38:00On the contrary, I think that Ben Bernanke, for instance in his helicopter money speech38:06in 2002 was extremely accurate, and was able to foresee the deflation coming , and was38:15able to design exactly what should be the reaction of a central bank in case we reach38:21a lower burn.38:23And probably, the failure that, if the Fed was exposed to this situation, would have38:30to lower even lower.38:33So decisively, enter into a period of negative interest policies.38:41So this has been extremely well written and foreseen by Ben Bernanke, 20 years ago.38:50I would argue that the way Mr. Powell implemented the reverse of this policies is extremely38:58questionable.39:00If QE is an empirical experience, it’s not something that is automatic.39:06So you can’t say in front of the world that the balance sheet of the Fed is on automatic39:14pilot it’s a misunderstanding of, what is QE?39:18It’s typically an experience made of faces.39:21Exactly the same apply for the European QE– that started with lower rates.39:27Then you stop.39:28You see what happened.39:30Negative rates.39:31You stopped to see what will happen.39:33Direct asset purchases– you increase if it’s not significant enough.39:39Direct loans to the private sector through TLTROs, et cetera, you need to be pragmatic.39:45And I think by using this very unusual wording like “automatic pilot,” or by using concepts39:52that Mr. Powell does not fully understand, such as natural rate, natural rate of inflation,40:01or “far away from natural rate,” if I make quote him, was a mistake– extremely messy–40:10and directly accounts for the equity meltdown of Q4 to 2018.40:21So first of all, I am saying that the US are going to be downgraded in the coming weeks40:28or in the coming months.40:29But it will probably– what will probably happen is first of all, a downgrade of the40:34outlook.40:35And if you have a look at what Moody’s is actually saying and reporting, it’s in his40:43annual report published in December 2019, it’s exactly this.40:47On a long-term basis, the strengths of the US are weakening, and the weaknesses are strengthening,40:53or are rising.40:54So I fear not a downgrade, per se, but a downgrade of the outlook that would be the start of41:02a long series, maybe, of various downgrades.41:07And so it all depends on, if we have a downgrade, is it associated with, still, a negative outlook.41:14So if the US were to be downgraded plus a negative outlook it could have ripple effects41:19in the banking system, since the sovereign debt is owned by the banking sector itself,41:26and if you have the feeling that in some months or some years, the US are going to lost their41:36AAA or lost or even lost their AA or could be single A. Then, at some stage, it will41:43require, for the banking sector, a recapitalization and much more riskweighted assets than what41:50is computed right now on the basis of a single AAA.41:53So this is where the doom loop can start— force, force sailors from the US banking sector,42:02and also the European one, of bones that you expect are going to be downgraded, until it42:08reaches a level of return that is more compatible or more in line with the risk that you take42:18right now the baby the levels of rates and as I’m fixed income terms extremely cautious42:25about valuations.42:27You’re not totally– you’re not rewarded for the risk that is slowly, that is slowly rising,42:36particularly if the US are losing their statutes of buyer of last resort, of funder, your cheap42:46US funder of last resort, which is basically the contract that was contracted after the42:54World War II where the US agreed to found cheap dollar versus, OK, the rest of the world,43:01you agreed to fund, to use your savings glut, and you’d fund our deficits.43:07But if the contract is stirred, then the US should lose their very particular status within43:19the way the agencies are rating the US.43:23And so I think the two play could be in danger.43:26ROGER HIRST: Sounds like that’s a very, very deflationary environment where basically you’re43:29saying here is there’s going to be an almighty re-balancing which means that any asset allocation43:36is done en masse is actually a capital destruction before you actually have an allocation.43:40So it’s never a nice, simple transaction.43:44So that sounds like the– it sounds like a very risky type of environment.43:50Which, again, in some ways goes back to showing that’s the last thing the central banks and43:56policymakers want, who spent the last 10 years effectively putting a cap on volatility as44:00their means of putting a put on their asset prices.44:04Are they going to avoid– yeah, no one want to be the wall who in history is the one that44:09burst the bubble, so why not just keep it going, and going, and going.44:14ETIENNE DE MARSAC: Well, the time when the Fed was trying to exit wasn’t very far, isn’t44:19very far away from us.44:21It was in 2018.44:22The time when the ECB was also thinking about exiting and was not at all engaging to a new44:31series of quantitative easing– this is only 12 months away from here.44:35So have they forgotten this objective?44:40Have they put it– had they put it aside I don’t think so.44:44I think that it’s still pretty much present in their mind and just waiting for the occasion44:51to softly try– if they can– Softly try to deflate these bubbles.44:57I agree that an excess cannot be corrected without another excess, all right?45:03This is how it works.45:05This is based on emotions.45:06This is based on perceptions and a misguided perception of reality conducts to another45:14misperception.45:15And there is no — it’s extremely difficult to find an average pass between these two45:21extremes and this is why the central banks community is in advance thinking about it45:29in case we are much too excessive in the way we fight these bubbles, in case it leads to45:37a new financial, crisis how what will be the new instruments that will increase the sensitivity45:47of markets to interest rates?45:49Right now, as you know in this, liquidity trap, the money velocity is extremely low.45:57So are there new instruments that they will use or be able to use in trying times when46:03the bubble will have exploded?46:05This is what they are, in anticipation, working on right now.46:08So with that, really– ROGER HIRST: So with that, we can move from what we saw, I think,46:14in the US when Powell made his misstep.46:16The markets spoke and said, no, and then, he reversed.46:18ETIENNE DE MARSAC: Exactly.46:19ROGER HIRST: And then– and then, in Europe, you had– in Europe, we saw bond yields back46:22at minus 75 basis points the.46:24Markets spoke.46:25And Draghi went, OK, well we’ll go back to it?46:28So we got Lagarde, And everybody is saying, the last thing Draghi said was, we’ll buy46:33everything.46:34And people say well, they’ve run out of stuff to buy.46:36But Draghi basically said, no spend loads of money, print loads of bonds, we’ll buy46:41them.46:42What is it that you’re seeking in the ECB?46:43ETIENNE DE MARSAC: Yes.46:44ROGER HIRST: You just mentioned, you’ve just touched on it, but one of the very clear signs46:47over the next 12 months we’ve seen from the ECB that will be changes and maybe that could46:51impact things like inflation.46:52ETIENNE DE MARSAC: Yes.46:53ROGER HIRST: Which might ultimately be the thing that brings it all down, what is that,46:57if you can just give us that ECB view?47:00ETIENNE DE MARSAC: So having worked for the Us– port for European institutions, namely47:08the EIB, and quite closely, with the ECB and, also, the European Commissions, I try to stay47:16quite tuned with that universe, And I try to maintain my network within these institutions.47:24The first, first point, we need to, if we come back to September and October, 2018,47:34the new set of QE has been extremely powerful from a certain block standpoint.47:46Think about it.47:47They lower rates by 10 basis point.47:50They were able to surprise the market.47:51They lower rates by 10 basis point.47:54They lengthen the forward guidance by saying what you just quoted– that is to say, we’re47:58not going to raise rates until inflation definitely rises to a sustainable levels.48:05They relaunched direct loans to the banking sector– namely TLTROs so long-term loans–48:13at a very low price at a very low level of rate.48:19They made the case for negative rates exemptions towards the banking sector.48:26So that excess reserves are no longer being taxed, so that the cheering system and the48:33relaunch started as a direct asset purchases at a resume of $20 billion per month.48:41So the package has been extremely powerful.48:45So since it just started, even if there were so many voices inside the ECB against the48:54package, expect the end of the ongoing review to come to the end before the ECB comebacks49:03or comes out with a surprise.49:05So right now, indeed, Mrs. Lagarde launched an assessment of the instruments that are49:11being used.49:12What are the main instruments?49:14What are their efficiencies?49:16Are they still relevant in the environment or not?49:19Should we suppress some of them?49:21Should we increase some of the others?49:23During the next six months, and Christine Lagarde has been extremely strong with, some49:27reporting against any information being displayed in newspapers.49:32I think we will not hear, on many conclusions, about this rear view, But we still have some49:40flavor about it.49:41So as I said the inflation targeting is, obviously, a point of interest.49:48They will come with something else.49:51Is it a different level?49:53Is it, by stressing the fact that the target is a symmetrical, that as the Fed is doing,50:02they will be happy with living a much higher degree of inflation if ever it happens?50:09Is it by level targeting?50:11That is to say, suppose that you should be at a level of 150 in terms of prices.50:19Because inflation was so low, you were only at 110 because there is a gap of 30 of prices50:24that you need to bridge before being at the target.50:29So it’s not just a target it’s also about the accumulated deflation that you are, on50:36an historical basis, wearing upon yourself.50:41Expect also the new music that we’re starting to hear about digital currency to gain traction.50:51And digital currency is– I’m just back from Frankfurt, where we were discussing about50:57that in a year in an ECB symposium.51:00And digital currencies will probably be the way that helicopter money– money, so back51:06to the Ben Bernanke speech– helicopter money will be implemented using the blockchain for51:14security reasons.51:16For money velocity reasons, because it will be extremely efficient, and this subject,51:25I think, is clearly gaining traction in the US, in Europe, in Canada, et cetera, and deserves51:35all our attention.51:36ROGER HIRST: And so just to finish off, if you could just– because it must be– what51:40is in your portfolio?51:43What are, maybe, the two trades that you think is the best?51:45Way to play this environment because you say that there’s so much uncertainty, but it sounds51:51like it’s a structural change that could be coming.51:54So how do you play that?51:55Do you have any long-term trades on, or are you waiting?51:57ETIENNE DE MARSAC: No, no, no, no, being at awaited is not an option, because your cash52:03is being taxed.52:04So you’re losing money when you are not Invested.52:08So we like selective, high-yield names within the European sector or the European sector,52:16or the American one.52:18So the idea here is to build a book full of carry, but a quite short-term carry with quite52:27a high level of visibility.52:29So if you have visibility of cash flows on a very specific corporate bond, or a specific52:34culprit, then you can gain some carry.52:38I like the idea of the reflation narrative, even if I am perfectly aware that it’s still52:45a narrative that deserves to gain traction.52:49But using– so through some high return currencies such as Aussie, for instance, allows you to52:56catch up a little bit of this narrative.52:58Now, the risk aspect that we’ve been discussing is of the hedges against these quite risky53:06environment.53:07They are quite, indeed, concentrated in my fund.53:10So basically I’m buying gold for debasement reasons, for low real rates reasons, for this53:18pursuit of debasement.53:21I think the environment is extremely favorable for gold and for precious metals globally.53:27Then, I have [indiscernible] against inflation, even if I don’t really believe it– believe53:35about it.53:36But, who knows?53:37Maybe it’s just a genie that is going to be to get out of the bottle, even if it’s for53:41a very long period of time.53:44So steep news on the UK, US yield curve, the European yield curve, too.53:50530, for instance, and that’s pretty much my book right now.53:54ROGER HIRST: Volatility, long or short?53:57ETIENNE DE MARSAC: Volatility, well, it has a negative carry impact, right?54:03So I’d prefer you need to be extremely good in timing when it comes to vol options.54:10So as a hedge trying to build up some– it’s counter-intuitive, but I do believe that in54:20case– and we’ve been discussing about that– in case a proper liquidity meltdown happens,54:26then the Fed will have no choice than lowering the Fed rates.54:32So I’m wearing, or holding Eurodollar options, so Eurodollar call options.54:38ROGER HIRST: What strike?54:40100?54:4199.75?54:42What level are you?54:43ETIENNE DE MARSAC: 98.50.54:44Right, two years.54:45ROGER HIRST: So if take calls, and I’m selling at out-of-the-money calls.54:49So 75 and 99.54:51Or so basically, 87– no.54:53Basically, 85, 87, 90 are profiling you now in December.54:58ETIENNE DE MARSAC: Excellent, good.55:01ROGER HIRST: Well, thanks for those trades.55:04Thanks very much for the views on the market and the world, and the inside ideas on the55:09ECB.55:11It sounds like it’s going to be– second half of the year could be very interesting.55:14ETIENNE DE MARSAC: Yes, exactly.55:15ROGER HIRST: Good.55:16Thank you very much for your time.55:17ETIENNE DE MARSAC: Thank you so much.55:18ROGER HIRST: Good to see that, and thank you very much.55:19ETIENNE DE MARSAC: Thank you very much.