Speaker 1: I was trying to impress my daughter by telling her I was going to give a TEDx talk, and she said, ah, that's interesting, Dad. And what's your subject? I said, how can we avoid the next financial crisis? And she went, Dad, are you serious? Yeah. I mean, come on. That's so easy. You just go there and say, can we avoid the next financial crisis? Of course not. And you walk away. End of talk. I said, hey, hey, hey, hang on a minute. Take a look at this chart. And she went, no, what is this chart? It shows you the performance of the stock market worldwide. And she said, ah, stock market, that's your stuff. I don't invest in the stock market. That's your game in town. I said, yes, you do. You're working. If you're not investing in equities in the stock market, your pension fund does it for you. And believe me, quite heavily so. So this is a takeaway for you tonight. If you think you are not concerned by the stock market, actually you are. Three things to notice on this chart. Financial crisis happen when the bars go down. And look at the numbers here. They increase. Financial crisis get worse and worse. Fact number two, there's a recurrence in these financial crisis. It happens on average every 10 years. Now, I'm not saying it's going to happen every 10 years, but there's a recurrence in financial crisis. But more importantly, there's almost always a feeling of deja vu when we get into a financial crisis. And you want to know why? Because since 1472, 1472, financial crisis almost always occur for the same reason. 1472, does that ring a bell to anyone? 1472 was the year the first bank ever was created. Not here in Switzerland, as some private bankers would claim. In Italy, in Tuscany. La Monte dei Paschi di Siena. 1472. And what is the single mistake which we have been doing? Mistake, not mistakes. Mistake. That's the one. Excessive debt. Be it in the government sector, in the corporate sector, or in the household sector, there's almost always a problem with too much debt in the system. Now, how can we avoid the next financial crisis? We need somebody to tell us there's too much debt in the system. This could be this man here. Now, who is this man? This is Dr. Alan Greenspan. And for 20 years, he was at the helm of the most powerful institution that impacts financial markets, the US Central Bank, the Federal Reserve. And look here what this man says. Him, and then his successor, because he's no longer chairman of the Fed. He says, you can only detect a bubble when it bursts. With that, you understand why we get financial crisis since 1472. Because nobody acts before they come. Now, we need to define what the bubble here is. Let's talk about bubbles. Sparkling wine or champagne? Can you tell which is which? Okay. So now, when I show these slides to my students, I tell them the following. Imagine that sparkling wine is government bonds and champagne is the stock market. Government bonds is a bit of a boring investment. You give some money to the government, and in exchange, they give you an annual income, a coupon. And in the end, eventually, at maturity, if everything goes well, you get your money back. The equities is more for the kind of people who are looking for growth of your capital, right? But it's much more volatile, that's champagne. Just think of that. Government bonds, sparkling wine, champagne, equities. Now, imagine the following. After this talk, you're invited to a party, to have a friend of a friend, and he tells you, bring a bottle with bubbles. And you have the choice of buying sparkling wine at $20 a bottle, or champagne at $40 a bottle. When I show this slide to my students, what they usually say, ah, I'm a bit short of cash right now, so I go for the sparkling wine. You know, it'd be dark, it'd be late at evening, nobody would notice, I'd take the sparkling wine. Okay, now, next question. In one year's time, same type of, same kind of invitation, also a different friend of a friend. And here, you're confronted with the following choice. The price of champagne has tripled to $120. The price of sparkling wine has quintupled, has gone to $100. Now, what would you do? Show of hands, who would buy champagne? Quite a few of them. Who would buy sparkling wine? Fewer. Who would buy none? Ah, now you're talking. This is very interesting, because this is precisely what I'm aiming at with this example, is to show that this is a bubble. We're buying today equities, not because they're cheap, because we're comparing them to something which is outrageously expensive, government bonds. And we say, $120 for a bottle of champagne, that's cheap, compared to $100 for sparkling wine. But I tell you what, when you see this kind of prices, just imagine one thing. Just imagine I add a zero to both numbers. Would you buy champagne at $1,200, just because sparkling wine is at $1,000? So, there you go. This is a bubble. This is when you get a bubble, and it pricks, it bursts, and you get a recession. This is when prices are insane. And when you look at these prices, you feel like laughing. And you say, ha, you must be kidding. For that kind of prices, I bring a bottle of sparkling water to the party. Okay. So, Dr. Greenspan and his successor are telling us, we cannot know ahead of the bubble if champagne at $120 is too expensive or not. Hence, we don't do anything. But when we get the financial crisis, that's when we come in play. That's when we get into action. But you know what? We get a problem. And that's a problem here, illustrated. I say, what is this? A central bank can bring the donkey to the fountain, but it cannot make him drink. This allegory, fantastic allegory, was given to me by Professor Jean-Pierre Dantin, who taught economics at University of Lausanne, before he became vice chairman of the Swiss National Bank. And he told me, Michel, remember, a central bank can bring the donkey to the fountain, but it cannot make him drink. Actually, this is the French version. In English, you can lead a horse to water, but you cannot make him drink. No matter how hard you try to show him how to do it. Now, what do we mean by that? What we mean is the central bank, once we get into a financial crisis, they open the liquidity tab and they tell the horses, come and drink my water. Who are the horses? The commercial banks. They must take all that liquidity from the central bank and inject it into the real economy to make the economy grow again out of recession. But if central banks do that, they are praying for commercial banks to follow their advice. But if commercial banks, they don't want to play the credit game, the economy goes nowhere and we get this. Japan is the textbook case for a total disconnect between monetary policy and the real economy. There's no guarantee whatsoever that the current policies of the central banks injecting liquidity after the financial crisis is going to work because it depends on what commercial banks are going to do. Japanese horses have not been thirsty for the last 30 years. Why? Because they drank too much water before the financial crisis. They were providing loans to whoever asked for them. So they were full of non-performing loans in their balance sheets. So when the central bank comes and injects that liquidity, that liquidity, you know what it does instead of going into the real economy? It goes into financial markets. The banks in Japan, they were buying government bonds instead of providing loans to the real economy. The Americans have found a way to force the horses to drink. Yeah, it's true. It's called TARP. TARP is Trouble Asset Relief Program. This was implemented right after the last crisis we had in 2008. What you do is you go to the banks and you tell them, show us all your bad assets, all your non-performing loans, which is a polite way of saying these loans will never be paid back, non-performing loans. Show us. Then you take them all and you dump them in a bad bank. Is that the policy? Would that be just the solution to just take all the dirt and dump it somewhere? Of course it worked when you inject monetary policy, we inject liquidity thereafter. Then banks play the credit game and the economy grew. It did grow faster in the US than in Europe and other emerging countries. But that's clearly not the solution. Would it be that easy? We wouldn't know. Rather than just doing such extreme solutions, I believe it's much better to try and identify speculative bubble before they come. Here is one indicator I look at. When you want to assess whether debt is too high, instead of asking yourself, is it excessive or not? What you do is you ask yourself, is it sustainable? Look here. This shows the evolution of the US household debt in relation to GDP. Is it a good indicator of the recessions which are indicated by these vertical bars? No. But if you look at this line here, it's the debt cost. Can we afford for this debt? Can we pay for it? Then it's a much better indicator. Look here. If the debt cost is 6% or more of GDP, then we get into a recession. The indicator works pretty well. Another indicator I'm looking for is global inflation. The problem we have today is that central banks are looking into the basket of consumer goods to find for inflation. There's none there. There's hardly any inflation in the consumer basket. There's a lot of inflation in the financial assets. Central banks need to include those financial assets into their measure of inflation. This is what I do here. You get these bars. When they go down, you get a stock market crash in the US, a financial crisis. What I've noticed is that whenever that global inflation measure exceeds 4%, boom, soon after we get a financial crisis. These are some examples of things you can do to identify the bubbles before they explode. I believe it's relatively easy to make the horses drink. For that to happen, you just have to make sure they don't drink too much before we get into a financial crisis. You have to make sure that commercial banks are not providing too many loans to the households, to the corporates, to the governments for buying champagne at whatever price for doing crazy and wild things. This is what you need to do. Just restrict credit when you think it's becoming excessive. That's the best way to ensure that we avoid the next financial crisis. Avoiding the next financial crisis is like fighting global warming. It's not because we don't know exactly by how many degrees the temperature on this earth is going to increase over the next 50 years that we should stand there and do nothing.