The Next Age of Uncertainty: An Interview with Former Bank of Canada Governor Stephen Poloz
Episode Summary
This week we are delighted to have Stephen Poloz the former Governor of the Bank of Canada. Stephen was the Bank’s Governor from June 2013 to June 2020 and was at the helm during the early days of the COVID-19 pandemic. Stephen just released a new book titled “The Next Age of Uncertainty” that outlines five tectonic forces that, when they interact together, will create more volatility and risk than in the past era. Here are some of the questions that Peter and Jackie asked Stephen: How would you compare the inflation we face today to the period in the 1970s? How do higher interest rates work to reduce inflation? Are there other tools the central bank can use to control inflation? During the early 1980s high-interest rates used to fight inflation caused a double-dip recession, is that a concern now? What actions were taken by the central bank during the early days of the pandemic? How concerned are you about Canadian housing prices? Why do you view the future to be more uncertain and volatile?
Are you carrying cash on you right now? In your pocket, wallet, or purse. Do you even have a five-dollar bill? If you do, that’s probably all you have… just in case.
How we think about and spend money has changed dramatically in the last 20 years but have economic strategies, at the highest levels, really changed? Do we handle inflation differently? Are interest rate strategies changing? And the awkward question – what role does the government actually play in setting those strategies?
In this episode, Jackie and Peter talk with former Bank of Canada Governor Stephen Poloz as he shares insights from his new book “The Next Age of Uncertainty.
If the past is prologue, to what extent can monetary policy of the past influence policy of today?
“Well, the most important similarity is that most of the inflation, the source of the inflation is coming from outside. It’s coming in this case same as in the early ’70s from an exogenous increase in oil prices or other commodities,” says Poloz.
“The differences are probably more important because back then, monetary policy around the world was framed around what we called the Bretton Woods system, the post-war system, which is the U.S. dollar was anchored on the gold price and the rest of us were anchored to the U.S. through an exchange rate mechanism called Bretton Woods. Well, so if you have that situation, it means that basically all the inflation for everybody is being decided back in the United States, every… It’s tied together.
Then the great inflation in the ’70s emerged, that’s what blew up the Bretton Woods system and the U.S. was forced to drop the gold standard. And from then on, there was no framework to anchor the system and that’s why the great inflation could happen. And today, that’s completely the opposite.”
“Nobody wrote any articles about the deflation in the first year of the pandemic, but there was lots of it. Well, when they recover, it looks like inflation, but once they’re recovered, it’s not inflation anymore. They stop rising. And on top of that, the energy pricing and food pricing that has gone up.”
“The Next Age of Uncertainty” is available for purchase from numerous retailers including digital and audio. You can purchase your hardcover copy on Amazon.ca.
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Episode Transcript
Disclosure:
The information and opinions presented in this ARC Energy Ideas podcast are provided for informational purposes only and are subject to the disclaimer link in the show notes.
Announcer:
This is the ARC Energy Ideas podcast with Peter Tertzakian and Jackie Forrest. Exploring trends that influence the energy business.
Jackie Forrest:
Welcome to the ARC Energy Ideas podcast, I’m Jackie Forrest.
Peter Tertzakian:
And I’m Peter Tertzakian. Welcome back.
Peter Tertzakian:
You know I was in Vancouver last week at a hotel and I checked my luggage in with the bell person for a while. And when I got my bag back, I felt like giving him a tip as I usually do, but I realized I don’t carry cash anymore. And everything is digital. I mean, when was the last time you had cash in your wallet?
Jackie Forrest:
Well, I typically do carry a little bit with me, but I haven’t used it in a long time. Yeah.
Peter Tertzakian:
Yeah, no, I realize, I mean, I don’t think I’ve used cash since before the pandemic like many people. It’s either a couple clicks on my phone or my watch and just pay for everything digitally. But I did bring into the studio today a $5 bill.
Jackie Forrest:
I see that. And it’s nicely framed too.
Peter Tertzakian:
It’s nicely framed. And all Canadian paper currency is signed by the Bank of Canada’s governor. And you can have Mark Carney bill or our current governor, Tiff Macklem. This one is a Stephen Poloz signed, not only signed in print, but personally signed.
Peter Tertzakian:
And I bet you can guess who our guest today is in person here in our Calgary studio. I am delighted to introduce Stephen Poloz, former Bank of Canada governor, and who better to talk to us about all the pressing economic issues in front of us?
Stephen Poloz:
Well, thanks very much. Great to be here.
Peter Tertzakian:
We’ve got a lot to talk about including inflation and the economy and all sorts of interesting things, things out of your most recent book, which we want to talk about. So yeah, just delighted to have you and welcome.
Jackie Forrest:
Yeah. And we’re excited to have you. Congrats on your new book, The Next Age of Uncertainty, the title certainly fits with how many of us are feeling these days. So we have lots of questions for you around the economy, inflation, interest rates, and about the themes from your book that are more the longer term trends to watch for.
Peter Tertzakian:
Well, we always like to start out our podcasts with guests to sort of get to know them a little bit, tell our audience a little bit about themselves. So your book is just great. It’s got a lot of personal anecdotes as well.
Peter Tertzakian:
And what struck us as we read the book was that you actually wanted the job as a governor of Bank of Canada from the time you were a university student earlier. So tell us a little bit about that and what led you to become the governor of the Bank of Canada?
Stephen Poloz:
Well, how long is this podcast? No, but yeah, it’s an interesting question. Because I set out as a young lad to become a doctor, I went to Queens and took all the pre-med courses, but you get to take one option. And somebody talked me into taking economics. I knew nothing about it. As soon as I started learning about it, I got really hooked.
Stephen Poloz:
And then when I learned what the Bank of Canada was and what it does, I thought now that’s a powerful tool. That’s a sort of place where you can help lots of people as opposed to one person at a time. And that’s kind of motivated me and I decided that’s where I wanted to work.
Stephen Poloz:
Now that was in 1974. Okay. So that is a long time ago and yeah, it took until 2013. So it took a long time to achieve that vision. But yeah, it’s very rare I think for somebody to think about something that long ahead and to actually have it come true, but I got lucky.
Peter Tertzakian:
Yeah. I almost flunked out of English and I ended up becoming a writer. So you never know what happens in your career. I certainly didn’t plan that one. But well, maybe talk about once you were in the seat as the governor of the Bank of Canada, talk about that role and what the Bank of Canada’s role more broadly is.
Stephen Poloz:
Well, the role itself is very meaningful. You feel every conversation, every decision has so much weighing on it. You never want to make the mistake of course, but you’re always in the fog of data where it well, [crosstalk 00:04:18] it’s nothing is definitive. And what the bank is trying to do is to use its tools, its interest rate mainly, in order to smooth out fluctuations in the economy.
Stephen Poloz:
So if unemployment is rising, will you cut interest rates in order to cause it to rise less? And so fewer people lose their jobs. You’ve moderated what’s happened to the economy, for whatever reason it’s doing that. And inflation has been used for over 30 years now as the guide to the sort of beacon that you aim for. And this worked out quite well over time.
Stephen Poloz:
But you also make sure people have the cash they want to carry in their pockets. You say you don’t have much or any even, you frame it on the wall, you use it so little. But I think most people still keep a few bucks in their pocket. I mean, it’s like, you’re right. I still have probably the same $100 that I had around the beginning of the pandemic.
Stephen Poloz:
Haven’t used much except in parking garages or places like that. But anyway, that, and you’re also the banker for the government. So in other words, manage their debt program, and advise them. And of course, you’re their bank. So you’re settling all their transactions. So it’s a real bank. Right? But it also does the interest rates, which is the part that most people see.
Jackie Forrest:
Well and how independent is it from the government? Politicians may want to affect the next election by having low interest rates. Are they able to put pressure on the governor to make changes?
Stephen Poloz:
Well generally, no, that’s every government that I’ve been acquainted with, treats that as almost a religion, that the separation is clear. Of course, in a crisis like what we had in the 2008 or the crisis we had in the pandemic, what you see is the Bank of Canada working very closely with the minister of finance in order to bring all the tools to the table, to keep things on as even a keel as possible.
Stephen Poloz:
But that’s not the same as foregoing independence. The way it works in Canada there’s no statute that says the Bank of Canada’s independent per se. But the convention that we’ve followed certainly for over 30 years is that every five years we establish an inflation target, the government agrees to that inflation target with the Bank of Canada, and then the Bank of Canada has operational independence for that five years to follow that.
Stephen Poloz:
And it would be really taboo for a government to try to lean on their central bank. But in history, there’s lots of times where that’s happened. Not here, but the Fed got leaned on in the late ’60s. And that, as I describe in the book is one of the big reason why we had the great inflation of the 1970s.
Stephen Poloz:
And you can see in Turkey today the evidence of how, if a government leans on their central bank to keep rates low when they should be keeping inflation at an even keel of inflation in Turkey is now over 60% per year. That’s inflation.
Jackie Forrest:
Wow.
Peter Tertzakian:
Yeah. Well, let’s talk about the interest rate tool or lever as it’s sometimes called and the inflationary situation today. I think as of today, May 4th, the US just raised its interest rates by half a point. And we’ve raised them here in Canada.
Peter Tertzakian:
And you have studied the 1970s, which was the last time we had really serious inflations, you’ve studied that in depth, in fact, did your masters and PhD in it so you’re the guy to talk to. Tell us about the similarities between today and the ’70s?
Stephen Poloz:
Well, the most important similarity is that most of the inflation, the source of the inflation is coming from outside. It’s coming in this case same as in the early ’70s from an exogenous increase in oil prices or other commodities. And that’s of course the most important similarity.
Stephen Poloz:
The differences are probably more important because back then, monetary policy around the world was framed around what we called the Bretton Woods system, the post-war system, which is the US dollar was anchored on gold price-
Peter Tertzakian:
Gold. Yeah.
Stephen Poloz:
… and the rest of us were anchored to the US through an exchange rate mechanism called Bretton Woods. Well, so if you have that situation, it means that basically all the inflation for everybody is being decided back in the United States, every… It’s tied together.
Stephen Poloz:
One of the great inflation in the ’70s emerged, that’s what blew up the Bretton Woods system and the US was forced to drop the gold standard. And from then on, there was no framework to anchor the system and that’s why the great inflation could happen. And today, that’s completely the opposite.
Stephen Poloz:
Almost every central bank of note has an inflation target. Has been adhering to it for years. In some cases maybe it came up short. So there’s lots of times over the less. Right now, of course, as you know, inflation has kind of gone up pretty well everywhere, which is we haven’t seen that for about 30 years.
Peter Tertzakian:
So given this lack of anchor in the gold standard today, are you more optimistic that raising interest rates will control the situation as compared to the past?
Stephen Poloz:
Yes, really what the anchor is people like you and me, we have expectations and guide our lives, make our economic decisions based on those expectations. I think if you just went out in the street and asked somebody randomly, “What do you think inflation’s going to be, say a year or two from now?” They’d probably say, “Well, it’ll probably go back to 2%.”
Stephen Poloz:
That’s what we mean by an anchor. So they’re not thinking that somehow inflation has become de-anchored and it’s just going to spiral up enough as it did in the ’70s. That of course is a fragile thing, those expectations. If people experience inflation for a prolonged period, they could lose faith in that 2%.
Stephen Poloz:
And that’s why you’re seeing the central banks reacting now. And the trick is though that most of the inflation we’re seeing has come from things that they’re beyond their control. Part of it is just because prices went down during the pandemic. And then when they come up, it looks like inflation.
Stephen Poloz:
Nobody wrote any articles about the deflation in the first year of the pandemic, but there was lots of it. Well, when they recover, it looks like inflation, but once they’re recovered, it’s not inflation anymore. They stop rising. And on top of that, the energy pricing and food pricing that has gone up.
Stephen Poloz:
So what we try to distinguish is between outside inflation and inflation which is homegrown through a tight labor market, and rising wages, and costs, that sort of inflation spiral. So if we get into that, well, then that’s a whole other story. And right now we’ve got all the ingredients. So the central banks are clearly on their guard.
Jackie Forrest:
Well maybe it’s worth explaining how high interest rates are going to tame inflation, because you say as a lot of these things are happening outside of the Canadian economy. Is it to slow the economy? Or what’s the end goal of it? And is there other tools that a central bank can use outside of just interest rates?
Stephen Poloz:
Yeah. So right now many economies, US, Canada, they’re actually a little too hot. The recovery from the pandemic have been very robust. That’s surprised a lot of economists that it’s been so rapid, but it’s just an example of really excellent fiscal policy. Really fiscal authorities did a great job of stabilizing economies.
Stephen Poloz:
So setting that aside, what we have now is Canada for in particular 40 year low in unemployment, plus almost 1 million jobs vacant. That’s a tight labor market. The good news is that immigration now is picking up strongly. The government put extra resources in the immigration department to try to speed up those processes. Allowed more expansion on the temporary foreign worker program.
Stephen Poloz:
So there’s a lot of people that can show up and pick up those job vacancies. And that’ll take that excess demand out of the economy. That and of course interest rates are normalizing. You say raising, it’s not quite the same. Nobody thought interest rates are going to stay at zero forever. At least I hope they didn’t.
Stephen Poloz:
Something more normal would be 2, or 2 1/2 or perhaps 3% for the short term interest rates. And that’s where we’re headed back to. And that would be like taking your foot off the gas pedal in your car. It gradually moderates and gets down to a coasting speed. And that’s where we want the economy to end up.
Jackie Forrest:
And are there other tools that the central bank can use? Or is it mainly interest rates?
Stephen Poloz:
Well, we have supplementary tools. It’s kind of they’re used at times to try and bring a little more oomph to the interest rate tool, but really interest rate is the tool. During a crisis, we’ll use something called quantitative easing, which is just a matter of buying government bonds in the open market in order to squeeze a little bit more longer term interest rates.
Stephen Poloz:
Because of course the central bank rate is the very shortest rate. It’s the overnight rate. So what matters to you maybe is the mortgage rate, and that’s a five year rate for example. Well, you have to be able to push down five year rates a little more.
Stephen Poloz:
And if you do that, then the quantitative easing helps to get a little more juice out of the lemon, but it is not the tool. It’s just sort of a supplementary tool.
Peter Tertzakian:
But related to raising rates is also in terms of tightening up the money supply is not issuing as many bonds.
Stephen Poloz:
Well, the government is an independent source of stimulus in the economy. So for instance, right now, even though the economy is at full employment, the government budget still is stimulating. Okay. There is continued deficits. So there is extra demand going into the economy from that source. And that of course is financed by issuing bonds.
Stephen Poloz:
But those bonds would normally be bought in the open market as normal as investors do. But is during the crisis, all central banks pretty well began buying government debt off the open market to cause interest rates to go down even further at the longer end of the term.
Peter Tertzakian:
Let’s talk about that word you just used debt because a lot of people-
Stephen Poloz:
Sure.
Peter Tertzakian:
… get excited when you mention the level of government debt, especially that has accumulated over the course of the pandemic. And so how worried should people be about the level of Canadian debt right now?
Stephen Poloz:
Well, everybody should be concerned about debt. We have borrowed quite a lot in order to finance the government spending that supported the economy globally. Well, more than 20 percentage points of global GDP was borrowed during the pandemic by governments.
Stephen Poloz:
And that has brought global indebtedness by governments to about the same level was just after the Second World War. One more response to that is, well, we’ve been there and done that. We know that somehow we grew our way out of that, but those were a little different back then. Nowadays there’s less population growth and all that to help us grow out of it.
Stephen Poloz:
But here in Canada, we started off in the best position of any of the major economies, around 30% of GDP as the government debt level. And at the time of the pandemic, we imagined that it could go as high as 60% and it could have doubled, but [inaudible 00:15:28] in the latest budget you see the peak that’s laid out there it’s 46%.
Stephen Poloz:
So that’s far less debt than we imagined would accumulate because the economy is outperformed all those expectations. So still though you might ask, well, is that good enough? Or are we prepared for the next crisis? All right, then the answer is, well not really. And the debt is falling in the budget.
Stephen Poloz:
Some would argue it should fall faster, and it might be better if it did, could give our resilience a bit of a boost in case there’s another crisis around the corner. But still get all that considered, I think that pretty good balance was struck, especially given the political environment we’re in. So some of the funding was definitely put to having a faster decline in the debt ratio for the government.
Stephen Poloz:
It’s not really reducing the debt, it’s reducing the ratio of debt to the economy. That’s an important distinction.
Peter Tertzakian:
Yeah. So the debt to GDP.
Stephen Poloz:
That’s right.
Jackie Forrest:
Well, let’s talk a little bit about the interest rates kind of related to debt, right? A lot of individuals have more debt than they used to because of housing prices government has more debt. We go back to that period in ’70s and early ’80s, at the time the central banks had extremely high interest rates.
Jackie Forrest:
You were saying getting back to a normal level of 2 or 3%, they at times the interest rates touched on 20% in the US and this actually caused a double dip recession in the US and a lot of hardship in a lot of developed economies around the world.
Stephen Poloz:
That’s right.
Jackie Forrest:
So how high do you think interest rates can get today? I can’t imagine they could get as high as back then only because the levels of debt that people have are so much higher.
Stephen Poloz:
Well, I think you’re right, but there are more fundamental reasons why it wouldn’t happen like that. I mean, back in the ’70s, inflation was double digits, and there was nothing to anchor people’s expectations. So they had a belief that it could just continue to go higher like the situation we see in Turkey. So if expectations have nowhere to anchor themselves, well, they just assume next year it’ll be even higher.
Stephen Poloz:
That’s the natural thing, extrapolate, that’s what people do without any other anchor to explain it for them. And so in order to get those expectations down to a low level, which is the purpose of the original inflation targets, break the back of that spiral, that took basically a major disruption in the economy. That was led by Paul Volcker at the US Federal Reserve and was basically followed by other countries to the extent that they needed to.
Stephen Poloz:
And that did cause a really big recession in 1981, 82. And then that, of course the rise in unemployment meant that nobody could bid for wage increases of 10% or whatever in order to keep up with inflation because they were unemployed. So then the thing all slowed down and by the mid ’80s we were more on track.
Stephen Poloz:
By the end of the ’80s, say 1990 pretty well everybody was starting to adopt something like a 2% inflation target to anchor the system. So again, what matters now is that everything is done to protect that legacy of stable inflation to defend it so that as we go forward, people have confidence in that, they maintain their confidence in that. And that’s where we’ll go back to, that’s the key. And that’s what the central banks are up to now.
Peter Tertzakian:
So as you pull on the lever and you start ratcheting up the interest rates to meet those expectations that you’re talking about, there is a risk you go too high and given what Jackie just said, the levels of debt, and of course there’s different levels of income in the country. And obviously the lower income brackets are more affected than the higher income brackets. So how much more interest rate ratcheting up do you think we can take?
Stephen Poloz:
Well, that’s a very hard question to answer. It depends on the state of the economy. That’s why we use the term data dependent. When I was governor that we called it decidedly data dependent, triple D. So they made me a mug that said DDD. And, but the idea is that you have to move in such a way that and you’re feeling your way. You’re seeing how is the economy reacting?
Stephen Poloz:
And one of the big issues that we can’t really put our finger on is how will those indebted Canadians react to that? You can do the arithmetic around it. You can do the arithmetic around how much is the average mortgage? Or what’s the distribution of mortgages? And how much will the rates go up? How much will payments go up? Well, you do the analysis of that well, most people take five years.
Stephen Poloz:
So every one fifth of them renew each year. So you can see, do a lot of arithmetic around that to see. And so what happens is if your mortgage rate goes up, you renew and you have a higher mortgage payment so well you have less money to spend on other things. So the economy slows down. And other people who were thinking of buying a home, put it off until rates would come down.
Stephen Poloz:
So that’s exactly what’s supposed to happen. When we cut interest rates, the idea was to stimulate those kind of spending. So when you renew your mortgage, you have more money left over, you spend it on other things. And if you are thinking of buying a house, you buy it. And that boosts the housing. That’s the main mechanism by which monetary policy stabilizes the economy.
Stephen Poloz:
And so now we’re going into the opposite phase of that. So no one should be surprised to see those kinds of effects. But how big and how fast, that’s a lot of judgment that goes into that models and all that. And so I won’t second guess that, I’ll be a spectator like you.
Jackie Forrest:
Well, I think something that’s on a lot of people’s minds is you talk about, you want to increase it enough to slow the economy but not contract the economy and create a recession. And we just saw last week that the US had a contraction in their economy in the first quarter of this year.
Jackie Forrest:
So how concerned should we be that these interest rate hikes will actually kick off a recession? And do you think that’s a remote possibility? Or something that people should be thinking about?
Stephen Poloz:
Well, again, it would be… This is a very difficult judgment to make in advance. And now that the economy and on average grows more slowly than it did back in the old days, you’re never really that far technically away from having a recession. Recession just means that the economy like you saw in the first quarter of the US, I think it was a bit of an anomalous number.
Stephen Poloz:
The economy is actually really strong, but the fact is it’s not that hard for it to happen. We shouldn’t think of it as a huge problem. If there was one, we’d be preferred to avoid it. All you’re really trying to do is buttress those inflation expectations so that people understand, well, we’re not going to have persistent 4, 5 or 6% inflation.
Stephen Poloz:
But the good news is that even if oil prices stay at say above $100 to stay there, well, after 12 months of that, it’s no longer adding to inflation. It’s just-
Jackie Forrest:
It’s become the base.
Stephen Poloz:
… it becomes the base. And that’s true for the other things I mentioned before, which was prices that recovered after the pandemic. That I would guess that actually once that stuff washes out, which will be over the next four to six months, those things, those re-basing effects will happen.
Stephen Poloz:
Well, as that happens, then inflation is going to subside down to perhaps 3% or maybe 3 1/2%. So people will be a little less alarmed. Right. And then, so if that happens, then I think the expectations can kind of re-anchor themselves on a lower level.
Peter Tertzakian:
Let’s talk about that $100 a barrel plus and actually now as of today, I mean the price of natural gas it’s not as well publicized, but I think it’s $8 or something like that, which was just, it’s moved up very rapidly.
Peter Tertzakian:
But let’s just talk about oil and gas revenue, the exports, because oil and gas are dominantly exported to the United States. This year are going to be over $200 billion. I mean, it’s, by far the biggest export, my estimates are roughly that it’s going to be about 40% of the trade balance, which is huge.
Peter Tertzakian:
So there’s a whole bunch of things we can talk about, but the one thing I want to talk about is why is the Canadian dollar sort of hanging around 79 cents and not moving? We used to be called the Petro dollar.
Stephen Poloz:
That’s right. It’s a good question. It used to be quite a reliable relationship between oil prices and CAD. And it has not really emerged, but of course we’re in a really unusual situation. And most importantly, I think all economies are in the same boat. We all are, everybody’s dealing with COVID.
Stephen Poloz:
Now of course, everybody’s dealing with the shocks related to the conflict in Ukraine. And so all those things are happening to everybody at the same time. When normally when we think of the relationship between oil and the Canadian dollar everything’s normal and then suddenly oil prices go up.
Stephen Poloz:
Well, that’s going to benefit Canada because as you say, income in Canada rises and the Canadian dollar rises in sympathy with that. And of course it’s actually the opposite effect in the US, even though they’re a big oil producer, they’re a net user. And therefore, as a result, it tends to be… It’s one of the equilibrating mechanisms is the Canadian dollar.
Stephen Poloz:
Well, so I think why would it be a little different now there’s reason I just said, everybody’s kind of in the same uncertainty boat. And so Forex markets aren’t really doing much with a couple of exceptions like GEN. And secondly, there’s a lot of backwardation in the curve. So markets may be not really convinced that oil prices are going to stay at this kind of level.
Stephen Poloz:
So that would be one reason why you wouldn’t get the usual follow through with higher investment, more drilling rates and all that kind of stuff. And there’s other things contributing to that, like the uncertainty about the future of the oil business, right?
Stephen Poloz:
So that mechanism may be a little less firm or reliable than in the past. And for that reason, I think that’s enough reasons why the Canadian dollar’s kind of lagging [crosstalk 00:25:31]-
Peter Tertzakian:
Yeah. That whole end of oil narrative is still fairly prevalent.
Stephen Poloz:
It’s still there. I don’t happen to subscribe to it, but that doesn’t matter. The uncertainty is there. And so you don’t get the same follow through we used to get.
Jackie Forrest:
Well, hey, let’s go back in time when you were at the Bank of Canada and COVID was happening. And in your book, you talk about those first few months of COVID and that was a really difficult and uncertain time, probably feels more certain, even though we talk about today being uncertain, I’m sure that felt way worse.
Jackie Forrest:
So just walk us through what it was like at that time, what the concerns of the central banks around the world were, and the actions that were taken and how you think that worked out.
Stephen Poloz:
Right. When something like that happens that, you know that you’re basically shutting down large segments of the economy. You immediately think of basically picture the bottom falling out of the economy. And literally prices started to fall, prices of lots of things started to fall.
Stephen Poloz:
And so what you saw from many economists were forecasting things like I remember one of the headlines being, this will be the worst recession since the great depression. Well, what does that conjure up? The comparisons there were… That was pretty scary. And what happened in the great depression was the price level fell by like a third, it was huge.
Stephen Poloz:
And when you have falling prices in the economy, you also will get falling wages because you’re going to do a lot of unemployment. And when that happens, anybody with debt, whether you’re a company or a household, anybody with debt, the size of that debt is actually magnifying, right?
Stephen Poloz:
The bank doesn’t come along and say, oh, I realize you’ve got a 30% lower wage rate so I’m going to cut your debt by 30%. You still have that. And as a company, you’re getting fewer revenues, but you still have to service the high debt. It’s that interaction. And so this is one of the major interactions that I describe in the book.
Stephen Poloz:
That’s gives rise to a depression. You get locked into that, deflation interacting with debt, though that’s what gives you depressions. And it’s really hard to get out of. So that was what we were concerned about. That if we went down that path, we could have all the ingredients of the second great depression.
Stephen Poloz:
And so of course, all the tools were deployed to avoid exactly that. And we look on it now we say, wow, that’s a pretty big success. Hard for people to imagine the counterfactual now, but at the time, the economists were screaming that that’s a very real possibility. So that was our major concern.
Stephen Poloz:
And so, like on Star Trek when they say, let’s get the photon torpedoes, nobody says, how many? 5? 6? 10? They just say load photon torpedoes. And then they get the job done. Right? And at the time I said a firefighter never gets criticized for using too much water. Right?
Stephen Poloz:
You get the fire out; you mop up afterwards. And I think we should be happy that we avoided the second great depression. It’s okay to criticize the fine points. There are lots of things you could dwell on, but they’re not the big picture.
Peter Tertzakian:
Right. Well, let’s move on to the future here and The Next Age of Uncertainty, which is the title of your book. And before we really get into that, we would be remiss not to mention the war in Ukraine and your ancestry is Ukrainian Poloz. And maybe talk about how that is affecting your thinking about economy east versus west return to the Cold War, all that kind of stuff.
Stephen Poloz:
Gosh, I mean, it’s just dreadful what’s going on over there, but right now it feels like economically we’re entering a period that has a lot of similarities with the early 1970s. But on top of that, we have this intense uncertainty, geopolitical uncertainty, which at least was not really a feature. Then we had a Cold War but doesn’t seem the same as what we’re seeing overtly now.
Stephen Poloz:
So, the way I try to think of this is to try to be objective about it. As we move in the future, I expect to see lots of volatility as economic and financial, much more than we’ve become used to in our time as economists. I think what that means is that almost anything can touch it off.
Stephen Poloz:
It could be a bat from Wuhan, or it could be a lunatic in Moscow would… What these episodes show us is that frankly, we’re not all that well prepared for big bouts of instability. Whether medically, if you want to talk about, did we have the buffering in our medical care system? No, we’re basically running it as close as we can to what we think we need in the medical system.
Stephen Poloz:
And that’s why we had to shut down a lot of stuff in order to deal with COVID. And it’s the same fiscally, it’s the same on all in many fronts where we don’t have buffering, or margin to maneuver. And so, I think the lesson from that is we’re going to have to invest more, whether we’re households, whether we’re companies or governments, invest more in our resilience in the future, because we won’t be able to predict things like what’s going on right now.
Stephen Poloz:
We shouldn’t pretend that we can predict how that’s all going to turn out, or how the economy will behave. I don’t know the answer to that question, but I do know we need to be prepared for both upside and downside risk, more prepared than we have been in the past.
Jackie Forrest:
You talk about five long term forces that when they interact together, we’re going to create more volatility and risk. And this was even before the Ukraine situation.
Stephen Poloz:
That’s correct.
Jackie Forrest:
Can you just really quickly just list off those five forces and just a little description of each?
Stephen Poloz:
Sure. Well, these are things that economists often just assume are constant. When you’re doing a forecast for next year or two years, you don’t think about, well, what about demographics? Well, that’s boost was slow. It just doesn’t factor in, but over a horizon that matters, every once in a while, it’s moving a lot. And that’s right now.
Stephen Poloz:
So population aging that’s happening rapidly now because folks like me from the baby boom generation are exiting the workforce. For 50 years we’ve been there and now we’re falling out of it. So normal is being redefined, and that’s a really important force.
Stephen Poloz:
Secondly, technological progress, we have that every day, but in history there’s only been three industrial revolutions, the steam engine, electrification. And of course, the computer chip. And now we have the fourth, which is digitalization. So, another big woosh in technology, huge displacement of workers, perhaps 15% of the global workforce will be disrupted.
Stephen Poloz:
That’s a major factor. The third one is rising inequality that usually comes with industrial revolutions because you get displaced while you’re on the short end of that stick. If you’re the employer that’s deploying the tech, you make the profits. So rising inequality and we can see the evidence of that all around.
Stephen Poloz:
And rising indebtedness one we’ve already discussed. I mean, there’s huge amount of debt, households, firms, and governments. And finally, climate change, or more specifically the force transition to net zero by 2050, that puts a whole new layer of uncertainty on top of this, because we don’t really know what path will take to get to 2050.
Stephen Poloz:
So the idea is that actually… And even one of those things, you could analyze them by itself. As an economist, you could think about, oh, this is what it’s going to mean, but when they can interact with each other, what this gives rise to essentially in mathematical models is chaos theory. That’s where the butterfly effect comes from.
Stephen Poloz:
Nonlinear forces that bump into each other and magnify each other. So that’s the basis for the call that we’ll have higher boats of volatility, because these forces are all getting bigger, and being more meaningful right now for the first time since probably the early 1970s, by the way.
Peter Tertzakian:
I’m going to tie that to the word you used a couple minutes ago, which was resiliency. So, one way of dealing with the expectations of more uncertainty as your book suggests, and I certainly agree, we’re entering a volatile period.
Peter Tertzakian:
Again, resiliency, do you feel our country Canada is putting in place the necessary policies and thinking to become more resilient in a de-globalizing world when supply chains are geopolitically or otherwise being repatriated. And then we have all this uncertainty in terms of workforce and technology and everything. Are we doing enough here to understand that?
Stephen Poloz:
Well, look, here in Canada we do have a very sophisticated, well-designed set of safety nets, let’s call them, at more than one level of government. So, we do have a lot of advantages in that front. And certainly, we’ve just come through a period where governments did a fantastic job to regularize our daily lives, despite what we were being hit with.
Stephen Poloz:
So, it’s easy for people to think, well, yes, maybe it’ll be more volatility, but I bet the government will take care of it for me. But I think that’s a bit off base. Fiscally, well, as you know we’ve got all that debt that gives us less room to maneuver in future. We’re not having built up those buffers yet. And the demand’s being put on governments because of aging population or just something we haven’t really contemplated.
Stephen Poloz:
That’s going to be a big draw. And central banks are kind to dealing with relatively low interest rates, very little room to maneuver, to stabilize economies. So, I think in the end, governments will not be able to keep us from getting hit by this volatility. That’ll be up to us as ordinary individuals or our employers to help cushion the blow. Because the risk that I’m talking about has to land somewhere. It’s a zero-sum game. It has to show up someplace
Peter Tertzakian:
That’s kind of an interesting philosophical question maybe even more pragmatic than philosophical. I mean, as Canadians, we’re a very privileged lot in this world, in this land of plenty. And I kind of get the sense that there’s sort of this, it’s not my problem.
Peter Tertzakian:
The government has to deal with it for me, sort of all sense of entitlements. Do you really feel that we as a people are ready to take on more responsibility at an individual level to shield ourselves from such volatility?
Stephen Poloz:
Well, I think having gone through what we just have, as economists we know that there’s a lot higher level of savings in the banking system than we had before the pandemic. Economists are debating right now, how much of that savings stock will get spent during this recovery period when you start traveling again and so on?
Stephen Poloz:
And my guess is having been through all this, people will keep more savings than before. That’s an example of being a little more conservative. And if you’re dealing with more volatility in future, maybe every year you end up losing your job for three or six months, but you get another one not too long after, but you never really know. And El only covers so much.
Stephen Poloz:
Well, then that uncertainty is the sort of thing that would cause people maybe not to buy the biggest house they can afford or get the biggest mortgage that they can qualify for, kind of build a buffer into their standard arrangements and companies, same thing. And I think also companies will look, they’re going to face a major shortage of workers.
Stephen Poloz:
They’re going to find that as this demographic thing we talked about happens, they’re not going to have all the workers they want, certainly not the ones with the skills they’re looking for. So, they’re going to work harder to attract and retain. And part of that value proposition will be to help people manage risks more. So, I think you’ll see things like the return of defined benefit plans.
Stephen Poloz:
Pension plans, for example, have kind of gone away as a cost saver. But I think it’ll be one of the ways you can reduce risk during a lifetime and build loyalty to the company. Those kinds of things. And companies will have to deal with risk every day in order to turn risk into value. So, I think it’ll be natural, Peter. I think it’ll be like Mother Nature at work because the residual uncertainty will have to be managed somehow.
Jackie Forrest:
All right. I wanted to come back to climate change and maybe just a little more details on how it can create uncertainty. Is it just in the price of energy and we just don’t know how much that’ll cost? Or can there be other overlays like political instability that can come from it?
Stephen Poloz:
Yeah, no, I think it’s, for me, it’s mainly so much agreement on this 2050 goal. And you see companies all laying out their plan, this is how we are going to get to net zero. And by the way, taking the word net very seriously, net zero, not same as zero, is it?
Peter Tertzakian:
Mm-hmm (affirmative).
Stephen Poloz:
And so, when you have that, and basically shareholders forcing that, and of course by the way your bank, your bank has subscribed to the same philosophy. So, everybody’s saying to a company, well, I need to see the evidence that you’re going to get to net zero. Well, that’s all great, but that’s a different path for every company.
Stephen Poloz:
What we don’t know is what the government will do or support that. Well, will the policies be a very clear path? Or will it be more sporadic? Let’s mandate electric cars, maybe half electric cars, maybe hybrid cars will be okay. I don’t know. Imagine if you’re trying to make an investment in the energy business right now, you don’t know if you’re going to be told, “Just leave it in the ground,” or, “Oh, energy security matters now so we need more.”
Stephen Poloz:
I mean, that’s just too much uncertainty to deal with, with a 20- or 30-year investment. And so, if we get more clarity there, then that uncertainty can be reduced. But right now, it looks like a highly uncertain path. And that’s an important source of business uncertainty to the future.
Jackie Forrest:
So, it may just slow down investment because of all that uncertainty.
Stephen Poloz:
Exactly.
Jackie Forrest:
Yeah. And slow down the economy and things like that.
Stephen Poloz:
That’s right. And so, a little clarity on that, for example, when they did the carbon capture thing in the budget and it included the energy sector, well, that was an important slice of clarity, right? So that just means, well, okay, that’s taking net seriously.
Stephen Poloz:
If we can do carbon capture, we can continue to produce the energy people need. And we do walk and chew gum at the same time. That’s what net looks like. Right? So that’s a bit of clarity and that’s been helpful. We’ll see.
Peter Tertzakian:
Well, we’re certainly not net zero in people’s wallets when it comes to housing. And I don’t think we can have a complete conversation about Canadian economy without talking about housing, unaffordable for the younger generation and most of our big cities. What does the Bank of Canada think in these sorts of situations? What do you think we need to be doing?
Stephen Poloz:
Well, I won’t speak for the Bank of Canada Peter, but I’ll say that housing prices are a function of so many things. If I was to say something definitive right now, I’d be making it up. The fact is that prices are likely, I think over time to continue to rise. And the simple reason is because we’re going continue to have high levels of immigration in Canada.
Stephen Poloz:
We know statistically, we’re not building enough roofs to put over the heads of the people who are showing up here and that’s going to lead to higher prices. Even if we built the right number of houses or dwellings I should say, for everybody who’s a new arrival, that would still mean our cities would get geographically larger, expand out. So, in every city, large cities in the world, the prices of the housing look like an Eiffel Tower from the outside coming up.
Stephen Poloz:
And so well, that just means the bigger the base, the higher the peak. Existing homes go up in price because the city’s getting bigger. Because people would rather work or be a little closer in, they’ll pay a little more to do that. And so that’s a phenomenon that we need to understand and realize that what we really need is more supply to stop that spiral.
Stephen Poloz:
And the speculation that comes into it, interest rate normalization is going to have an effect. That’s an asset that you set the discount rate to a really low number; the present value will be a really big number that’s boost housing prices. So, the normalization of interest rates will cause things to calm down to some degree, that’s for sure. We see some evidence of that already emerging.
Stephen Poloz:
And finally, I think what really matters is that in order to address the accessibility problem, what we should be encouraging is more financial innovation. I mean, we still using the standard mortgage with the 30 year or 25 years. That is right out of the depression. That’s that depression anti debt mentality.
Stephen Poloz:
But you know why? If you’re going to buy yourself, I don’t know what city you might be living in, but if it’s a $1.5 million for a home in one city and it’s $500,000 in another Canadian city, well, why can’t we replicate the experience in both cities for someone with the same family income? So, in one city, maybe you end up owning the entire thing by the time you retire, the $500,000 one.
Stephen Poloz:
The other one you end up owning a third of it. And all there is on the other side of that trade is an investor who is interested in having-
Peter Tertzakian:
Sure.
Stephen Poloz:
… more real estate in their portfolio. So, they own two thirds of your house. When you retire, you can sell your share, which is one third of, and off you go and you do your retirement how you like.
Peter Tertzakian:
Sure. I mean, after all it’s all equity.
Stephen Poloz:
Is all equity.
Peter Tertzakian:
It’s all equity.
Stephen Poloz:
Describing as a form of co-ownership or more sophisticated models of intermediation, which there hasn’t been an innovation except the HELOC in the mortgage space in my whole adult life.
Peter Tertzakian:
Well, yeah, I mean, it’s often thought of innovation as being everything with test tubes, and technology, and computer chips, but innovation extends into thinking differently about policy, thinking differently about financial instruments. So yeah, that’s fascinating. In fact, this whole discussion has been fascinating and we’re delighted to have you, and we could spend certainly another 45 minutes or more, but time is up.
Peter Tertzakian:
We are delighted Stephen Poloz that you could join us. And we started the conversation by talking about my framed and personally signed $5 bill on the wall, and that we are now captive to digital currencies. So I think it’s only appropriate Jackie, that we put the link to Stephen’s book, The Next Stage of Uncertainty on the website, along with this podcast. And our audience can choose to either download it as an ebook or in paper.
Jackie Forrest:
Mm-hmm (affirmative).
Peter Tertzakian:
But I’ll say thanks so much for coming in person to our studio here in Calgary. And it’s been wonderful having you and seeing you again.
Stephen Poloz:
It was my pleasure. I never need a good excuse to come to Calgary. I love the place.
Jackie Forrest:
Yeah. I really enjoyed the conversation. Thanks so much. And thanks to our listeners. If you enjoyed this podcast, please rate us on the app that you listen to, and tell someone else about us.
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