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Dear listeners, here is a riddle for you.
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Like oxygen, I am something you cannot live without.
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And yet, you take me for granted.
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Over the centuries, I have been made of salt, butter, coconut, tea, rice, tobacco, seashells,
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animal skin, almonds, gold, silver, iron and even paper.
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You cannot live without me.
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And sometimes, it seems that you cannot live with me.
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Welcome to The Scene and the Unseen, our weekly podcast on economics, politics and behavioral
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Please welcome your host, Amit Barma.
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Welcome to The Scene and the Unseen.
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Before I reveal the answer to my riddle, I'll tell you what the answer is not.
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Sadly, art is not a constant presence in our lives, and most of us can only admire it from
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Our sponsors for this episode, a company called Indian Colors, has made it its mission to
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make the best fine art easily accessible to art lovers everywhere.
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Indian Colors licenses images from top Indian artists and adapts it into beautiful objects
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They have home decor, like cushion covers and table runners.
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They have accessories, like tote bags.
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And what I particularly like is their wearables, their kaftans, shrugs and stoles.
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On languid summer afternoons, I recline by the lake wearing nothing but a soothing stole
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Artists get royalties on each product sold, just like authors do for books.
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Use the code IVM20, IVM for Indus Fox Media 20, for a 20% discount.
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IVM20 is the code at IndianColors.com, Colors with an OU.
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And now, moving on from art to money.
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Yes, the answer to the riddle is money, which is all around us, almost as essential as oxygen.
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And it's been made through the centuries of salt, butter, coconut, tea, rice, tobacco,
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seashells, animal skin, almonds, gold, silver and iron, and is now usually made either of
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paper, which is easy to print, or of bits and bytes, which are easy to replicate.
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That makes it easy money.
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And my guest today is a columnist and author, who has written an entire trilogy of books
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called the Easy Money Trilogy.
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Vivek Kaul, welcome to the scene in the on scene.
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Thanks Amit for having me.
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Vivek, your trilogy came out a few years back, but you've been writing about easy money even
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recently in the context of recent events.
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Before we get to that, can you explain to me what the concept of easy money is?
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So basically, I mean, there is, you know, it's more of a journalistic term, which was
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created in the aftermath of the financial crisis, which started in September 2008, when
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Lehman Brothers, which was the fourth largest investment bank on Wall Street, went bankrupt.
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In the, you know, Lehman Brothers went bankrupt on September 15th, 2008.
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In and around then, many other financial institutions had to be rescued by governments.
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This included the American Insurance Group, AIG, which was built out by the American government
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on September 16th, 2008, a day after Lehman Brothers went bust, because if AIG had been
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allowed to fail, many other financial institutions, including Goldman Sachs, which is by far the
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biggest investment bank on Wall Street, would have failed as well.
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So to prevent that, a lot of, you know, these financial institutions were rescued.
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And this essentially goes against the entire idea of free market capitalism, where if something
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is failing, it needs to be allowed to be failed.
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But I mean, that did not happen.
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And then in the months, you know, after September 2008, the Federal Reserve of the United States,
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which is the American Central Bank, and other Western Central Banks, including the Bank
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of England, decided to print money.
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And the idea was to sort of flood the financial system with a lot of money so that interest
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rates fall and people and companies borrow and spend more.
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And because of that, the economy would recover and everybody would live happily ever after.
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So that was basically the concept of easy money.
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Now, what happens is, you know, when a central bank, which includes the Federal Reserve also,
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prints money, it cannot like load that money onto a helicopter and, you know, then go out
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there and throw that money into the economy, right?
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So what it does instead is the money that it prints or rather creates digitally these
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days, it uses it to buy bonds.
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And when it buys those bonds, the money gets into the financial system.
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And once the money, there is a lot of money going around in the financial system, then
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interest rates start to fall.
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So what the American Central Bank, the Federal Reserve decided to do was it decided to print
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money and buy two kinds of bonds.
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One was the American Treasury bond, which is basically the, you know, bonds issued by
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the American government to finance its fiscal deficit.
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And the second kind of bonds were called the mortgage-backed securities.
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Now, mortgage-backed securities were essentially securitized financial securities, which had
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been derived from mortgages, which in India we call homelands.
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So they bought these two securities and the reason they did that was because a lot of
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these financial institutions had these bonds, but nobody was willing to buy them.
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Now what happens is, you know, when, when any financial crisis starts, people who have
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cash institutions, which have cash, try and hold onto that cash.
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Nobody wants to, you know, go out into the market and trade.
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Now in order to sort of untangle that the Federal Reserve had to step in and they had
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Now a central bank buying and selling government bonds is, you know, well known.
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They do that to, you know, carry out what are known as open market operations.
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But a central bank buying private financial securities, like the Federal Reserve did by
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buying mortgage-backed securities is not something which was very well known till that point
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So, as I said, the entire idea was to buy these securities, pump money into the financial
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system, hope that the interest rates fall, hope that people borrow more, companies borrow
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more, the wealth effect kicks in, so on and so forth.
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And you know, the economy sort of comes out of trouble.
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But what happened was, you know, all of this and a lot more.
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And so we are sort of, you know, still seeing the effects of the easy money policy, which
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was initiated by the American Federal Reserve nearly 10 years back.
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And before I, you know, ask you to elaborate on the easy money aspect of it, and I'm going
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to take you both back in time and forward in time from where you just left off, it's,
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I'll just point out that, you know, people often think of it as capitalism gone wrong.
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But if you think of the bailouts themselves, they're what economists call moral hazard.
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When a company bails out banks, what it does is it creates incentive for them to continue
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being irresponsible in future, because they know that taxpayers' money will be there to
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This is sort of a way of privatizing profits, but socializing losses.
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If the company does well, it keeps the profits, but if it does badly, we the taxpayers have
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And this is contrary to all principles of free market capitalism.
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And cronyism is really the only acceptable term for it, but that detour aside.
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So I just wanted to add to what you were saying.
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You know, one of the economists in the 20th century who was by far, I mean, the most red
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economist in the sense that he used to write the most in the popular media was John Kenneth
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Galbraith and Galbraith had to say this.
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He said in America, there is only one kind of socialism and that is socialism for the
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So this is a very, you know, the bailing out of, you know, the likes of AIG and Goldman
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I mean, Goldman Sachs was not technically bailed out, but you know, the moment they
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bailed out AIG, they also bailed out Goldman Sachs was obviously, you know, a very good
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example of what Galbraith said.
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And you know, in 2008, when the entire, you know, thing was breaking out, the American
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treasury secretary, Henry Paulson was a former chairman of Goldman Sachs.
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So you know, I mean, the links are between Wall Street and the American government are
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so deep that, you know, whenever a crisis occurs, the government by default will have
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No, and the thing to note here is that this was bipartisan, that there was a consensus
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across both the major parties, the Republicans and the Democrats that the bailout is necessary.
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Because, you know, what really happened was that between Ben Bernanke and Henry Paulson,
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you know, both of them, you know, really shared the shit out of these, you know, congressmen
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So they really did not have an option, you know, when there are books, I think one of
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these books was written by Andrew Ross Sorkin, in which-
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In which I think either Bernanke, I think it was Bernanke who said that we may not have
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our economy on Monday morning when they were, you know, negotiating these things.
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No, the fascinating thing is that a lot of those congressmen and senators won't have
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the expertise to evaluate that for themselves.
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So you have to take the word of the expert who's giving it to you.
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And that word of the expert has a lot of perverse incentives, like all the political parties
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essentially get funded by special interest groups, which are basically big lobbies and
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So that's, I mean, what do you do about that?
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But let's get back to sort of easy money.
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And before I ask you to sort of come forward and talk about the consequence of the pumping
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of this easy money into the system, one of the observations that you've made in your
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book is that to some extent, 2008, the financial crisis, its roots lie in something that happened
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Can you elaborate on that?
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So that's a tricky question given that I wrote the book a while back.
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So until, up until 1971, paper money was linked to gold and can you explain what you mean
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So you know, what happened was that as over the years, different kinds of commodities
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And you know, as you said at the beginning of the show, right from everything from, you
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know, butter to gold and silver.
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Now somewhere along the line, paper started to be used as money.
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And I mean, without really getting into the details of it, this paper was always backed
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In United States, tobacco receipts in the state of Virginia, Virginia tobacco we all
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know about was used as money for a very long time.
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In fact, it was used as money longer than gold was.
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So these receipts could be used to settle, you know, accounts and they had the backing
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of some other commodity.
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So similarly over a period of time, you know, I think the Bank of England paper money was
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backed by gold and the master of the mint of the Bank of England was a gentleman called
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Isaac Newton, who we all know, I mean, which is where he, you know, he made his money being
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the master of the mint of Bank of England and not doing all the science and the math
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Man's got to own a living.
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So there is something about all this in the first volume of Easy Money and how, you know,
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Newton did something, I mean, as a matter of chance rather than, you know, thinking
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through it, the entire consequences that gold essentially became the currency of choice
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The Bank of England used to issue paper notes and these paper notes were backed by gold.
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Now once, you know, the English sort of started ruling the world, other countries like Germany
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also thought that, you know, gold and the fact that their paper money was backed by
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gold had some part to play in it.
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So just to clarify what you mean when you say backed by gold, is that a specific value
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was said that so many notes or so many whatever.
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So this was like, I mean, I don't remember the exact value right now, but you know, one
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pound was worth a certain amount in gold.
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The amount of money in the world was therefore limited by the amount of gold.
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So what you have to do is essentially at any point of time, you could take those paper
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notes and, you know, go to the mint and exchange them for gold.
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And at any point of time, you could take gold and exchange them for paper money.
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And what this also therefore means is that because it's the amount of money is restricted
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by the amount of gold that there is, that the government can't just like print money.
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I mean, they couldn't sort of print their way out of, you know, any problems that they
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So basically the success of great Britain essentially led to a situation where many
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more countries in Western Europe started moving towards gold as their currency.
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And this went on till around 1914 when the first world war started.
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And at this point of time, you know, the countries which were a part of this war suspended their
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standards so that they could print as much money was required in order to fight the war.
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Now one country which sort of stayed away from the war for a very long period of time
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was United States and United States from what I remember did not have to suspend the gold
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standard during the first world war.
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Now what happened was in the, you know, what happened was all these countries had printed
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a lot of money to fight the first world war and there was suddenly a lot more money in
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the financial system than gold backing it.
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After the war ended and this, because of this, a lot of, you know, problems were created
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and by the time the second world war started, a lot of these countries, which had gone back
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to the gold standard, never really sort of recovered from the economic catastrophe that
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followed the first world war.
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And obviously during the second world war, also the gold standard was...
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And what were some of the consequences of sort of deviating from the gold standard during
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Like I would imagine inflation would be...
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One is a, you know, classic example of, you know, the German hyperinflation of 1923, which
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is still date, you know, the highest inflation in economy has an economy of substantial size.
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I mean, if you leave out the hyperinflation of 2008 in Zimbabwe.
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So you know, there were these, I don't know, if you Google, you'll see all these people,
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you know, taking money in a wheelbarrow to buy bread, or there is money being used as
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wallpaper and you'll get all those kinds of pictures.
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There's a great story about, which I read many years back in a book authored by a gentleman
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called Adam Smith, who wasn't the Adam Smith, but someone in the US writing under the pseudonym
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So this Adam Smith writes a story about another guy called Walter Levy, who was an oil consultant
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or something like that.
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And Walter Levy's father, it seems, had bought an insurance policy in 1903, 1903, which matured
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in 1923, right at the point when the German hyperinflation was on.
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And that the money that that policy gave out was just good enough to buy a loaf of bread
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or something like that.
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So I mean, you can very well imagine, you know, what happens to, you know, when money
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loses value dramatically over a very short period of time.
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In fact, I'll take a slight detour for my listeners, you know, because a few days back,
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a young person asked me the question that, you know, if a government doesn't have enough
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money to spend on schools or whatever, why don't they just print more money?
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And what happens is that because you have the ability to print money, what happens when
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you print more money is that the amount of money goes up, but the goods and services
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at that point in time remain the same.
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Now, it's supply and demand.
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When that happens, automatically everything becomes more expensive because it's a greater
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amount of money chasing the same number of goods.
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Things becoming more expensive, and I'm being kind of simplistic here, but this is broadly
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how it works, that when the money supply goes up and there's more money chasing the same
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number of goods and services, things become more expensive, that's inflation.
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And inflation always hurts the poor the most, therefore, they are the people for whom a
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bag of rice will go from 20 rupees to 40 rupees, and, you know, just making that daily meal
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becomes a burden, which is why libertarians often call inflation a tax on the poor.
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And which is why it's a very dangerous thing that requires a lot of oversight when a government
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has its hands on the money supply, because it's very tempting for the government of any
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day with short-term interests in mind, like the next elections, to just print their way
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out of trouble, just print more money, you know, forget about the consequences to the
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common man, especially the poor, remember, it's not the rich, but the poor who get hurt
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Sorry for that, you know, that typical libertarian digression I had to make.
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So let's get back to your story.
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We were moving towards 71.
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So, we were in the Second World War, and, you know, right towards the end of the Second
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World War, the countries realized that the monetary system of the world is screwed up
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and they need to fix it.
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This was towards the end of 1944 when the World War really hadn't ended.
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But it was more or less clear by then that the allied forces would beat Hitler and company.
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So they met at this hotel in this place called Bretton Woods in the state of New Hampshire
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And this is where the new global monetary system, so to say, was unveiled.
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And in this system, you know, the United States was at the heart of this system and it sort
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of promised to, you know, exchange paper money for gold at the rate of $35 for an ounce of
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One ounce is around 31.1 grams.
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So this is how, you know, the new global financial system or global monetary system was unveiled
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in the aftermath of the Second World War.
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And what was the purpose of this?
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The purpose was basically, you know, what had happened was that during the course of
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the war, the only country which had any gold, substantial amount of gold left was United
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Every other country was essentially buying stuff from United States.
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So when you were buying stuff from United States, you know, you were basically, you
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know, in the end, all the settlement happened in the form of gold.
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So if your imports from United States were greater than your exports to the United States,
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you ended up shifting gold to the United States, right?
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So what happened was because of that, you know, countries like Britain, Germany had
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very little amount of gold and United States was the only country which had a substantial
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amount of gold left and was a currency of all these countries still backed by gold.
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So basically everything was, so it was like one pound was worth around four point eight
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So if they had very little gold left, is that the same as saying they were very poor at
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Government wise, government wise, the government said very little gold left.
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So anyway, so this new financial system was unveiled and in this system, you know, the
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U.S. had to essentially promise that it would exchange dollars for gold.
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Now this, what this did was this gave U.S. an exorbitant privilege, which essentially
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meant that the U.S. could print all the dollars that it needed, whereas the other countries
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in order to ensure that they had those dollars needed to earn them.
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So what the other thing that happened was that, you know, because of this, because dollar
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was exchangeable into gold, dollar became the international financial currency, okay,
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which it made sense for countries all over the world to hold their foreign exchange in
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the, you know, in terms of dollars, which is something which continues till this day.
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And before that, the British pound was the international financial currency.
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And so this gradually moved towards the dollar.
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Now what happened in the late, you know, mid to late 1960s was that France under Charles
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de Gaulle started to do very well and they started earning dollars and they started converting
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these dollars into gold.
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And gradually this caught on and a lot of other European countries started doing this.
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And in the end, you know, you reached a, U.S. reached a stage where it had very little dollars
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left in order to continue exchanging them for gold.
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The final nail in the coffin came from Great Britain on August 13, 1971, when Britain also
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demanded that the dollars be converted into gold.
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On August 15, 1971, Richard Nixon, who was the then president of United States, interrupted
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a very famous show whose name I can't recall right now.
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It was in its 12th season and it was really followed quite a lot back then.
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And he interrupted that show, went live on television and told the world that, I mean,
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he said a lot of things and within those lot of things, he also told the world that the
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gold window, the dollar gold window has been shut down.
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So suddenly what happened was that, you know, up until then the entire currency system had
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some sort of, you know, commodity backing it.
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Now in, on August 15, 1971, that, you know, sort of that arrangement broke down and that
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essentially freed governments all over the world to print as much money as they wanted
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I mean, in fact, this had already started in a way after the end of the first world
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war, but the real break came on August 15, 1971.
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So the shift had gradually happened and with the final blow on 71 was really a shift from
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money being backed by gold to money being backed by trust, so to say.
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Money being backed by the government fee act.
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I mean, all right, so it depends on how much it's like, you know, a 10 rupee note is not
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much different from a 2000 rupee note, except for the fact that, you know, the government
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says that, you know, the 2000 rupee note is worth 2000 rupees and a 10 rupee note is worth
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The real difference between them is not 1990 rupees.
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So in a sense, as Yuval Noah Harari says in the book Sapiens, it's a story.
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It's a story we chose to believe.
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I mean, the only reason people continue to sort of use paper money to carry out economic
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transactions is because they believe it is money in the first place.
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The moment they stop believing it is money, they'll stop using it.
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I mean, look at something like bitcoins, which have, you know, taken the world by storm.
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I mean, bitcoins don't have anything backing them, but then a lot of people do believe
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And because they believe that Bitcoin is money, Bitcoin is money.
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And governments typically inspire a lot more belief, so government backed currency obviously
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is the default currency.
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But see what has happened is, okay, but we leave it, I mean, I'll be jumping the gun
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here because easy money is also linked to the rise of bitcoins.
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So let's go back to 71, when Nixon delinked the dollar from gold, what were the dangers
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of that and what were the consequences?
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So I mean, so the first thing that, you know, a lot of people said was now that, you know,
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the monetary system would collapse and, but nothing like that really happened.
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I mean, there was this chairman of the Federal Reserve of United States called Paul Volcker,
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who was the chairman between 1979 and 1987, and he said something to the effect of that,
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you know, the belief in dollar as the global financial sort of currency became even more
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after the, you know, gold standard was broken.
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So I mean, rather ironically, this happened.
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But you know, one thing that needs to be sort of also said here as to, which is something
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that not many people know, that the rise of the dollar as international financial currency
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was also thanks to Saudi Arabia, which sometime in 1945 got into a sort of an agreement with
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the United States, not Saudi Arabia, but the Al Saud, the Al Saud family got into an arrangement
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with Roosevelt, who was the president of US at that point of time, that they will sell
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oil in terms of dollars.
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Now oil is a commodity which every country in the world needs and not every country sort
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of produces it, you know, not every country has oil.
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I mean, like India almost imports 80% of the oil that it needs.
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Now what that did was once Saudi Arabia and then the OPEC started buying and selling oil
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in terms of dollars, every country in the world needed dollars.
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So when every country needed dollars, what they also had to do was when they sold their
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exports, they had to price them in dollars.
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So Saudi Arabia played a very important part in ensuring that dollar became the global
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In fact, if you, if you remember a few years back, Barack Obama was, you know, had come
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to India and he had to suddenly leave because the Saudi Arabian king died.
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And I mean, so this is all about oil.
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I mean, the only reason why-
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Maybe he got a bad tummy.
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He went to Saudi Arabia.
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So no, what I'm saying is the only reason why the United States puts up with a lot of
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shenanigans of, you know, Saudi Arabia in the Middle East is because Saudi Arabia has
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So you're saying Saudi Arabia was one of the reasons for their preeminence.
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So there were, you know, there was some talk, in fact, in the late seventies, and I mean,
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I discussed this in great detail in the book.
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One of the foreign ministers of Iran had put a proposal to the OPEC, which is the oil cartel
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to sell oil in a basket of currencies, which would also include the dollar.
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But that somehow never really got pushed through because Saudi Arabia was always against it.
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And Saudi Arabia has been always against it, primarily because the Al Saud family, which
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rules Saudi Arabia, has military support of the United States.
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So let's get back to linking 71 and what Nixon did there with 2008.
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So basically, you know, Nixon did in a way was that he initiated the entire easy money
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And sometime, by which you mean any time the government wanted more money, it just printed
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In 1987, a gentleman called Alan Greenspan took over as the chairman of the Federal Reserve
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of the United States, and Mr. Greenspan took forward this easy money era wherein he sort
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of ensured that, you know, low interest rates prevailed and people borrowed and spent.
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And because of that, the American stock markets did very well, even though there was a bubble,
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a dotcom bubble, which ran up till the year 2000 and then burst.
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After that, because of low interest rates, a housing bubble started and the stock markets
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also started to do well.
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So essentially remember, I mean, correct me if I'm wrong, but when there was inflation
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in the US during the last years of Carter's presidency in the 1970s, I think Paul Walker
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raised the interest rates.
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So Paul Walker raised, Paul Walker was the, you know, the last, you know, good guy in
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the American financial system, as a lot of Austrian school economists like to believe.
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So Paul Walker took over as the chairman of the Federal Reserve in 1979 and he started
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pushing up interest rates in the hope of killing inflation, which in, you know, which in the
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post, you know, 1971 era had reached double digits in the US.
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So he finally, over four years of raising interest rates and which obviously also led
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to Jimmy Carter losing his presidency and a lot of ill will was generated towards the
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Federal Reserve during those years between 79 and 82, Paul Walker managed to kill inflation.
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And to clarify how that would be, high interest rates would have led to less people borrowing
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money and therefore less money out in the system.
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And because there would be less money chasing the same number of goods and services, prices
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Prices, even if prices don't come down, they may not rise at the same rate as they were
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And in the Greenspan era, the low interest rates, what they did was they prompted people
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to borrow more and more money and the money had to go somewhere.
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But that did not lead to inflation, primarily because the world by then had discovered China
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as the factory of the world.
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So, you know, so essentially the, the way it sort of, so the surplus money went into
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So there is a sort of a circular arrangement, which I sort of discuss in my, I think it's
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there in the third easy money book, wherein what happens is that, you know, America spent,
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China earned dollars, okay.
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Then China invested those dollars into American financial securities, including the treasury
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bonds of the United States and a lot of other private financial securities.
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So when the Chinese invested in the American financial securities, the demand for those
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securities went up and hence, you know, the bond yields came down.
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And because of that interest rates were low in the U S so when interest rates were low,
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the U S consumer, American consumer could borrow at low rates and then he could use
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a lot of that money to ultimately buy Chinese goods.
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So it was a very, you know, so what seemed like a virtuous circle then might even be
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a virtuous circle, basically a Ponzi scheme if you look at it in the sense that as long
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as, you know, the American consumer borrowed and the Chinese reinvested, I mean, as long
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as the Chinese keep reinvesting in the U S treasuries and the interest rates stayed
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low, the American consumer kept borrowing and the American economy kept doing well.
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I mean, obviously I'm simplifying it a lot.
#
I mean, you know, the real world really doesn't work as, you know, simplistically as this,
#
but so getting back, so this is how, you know, Alan Wainspan and the entire era of easy money
#
Now what has also happened in the U S very, very interestingly is that since the, I think
#
mid seventies or early seventies, the median incomes have not really moved.
#
So which has led to a situation where in, you know, the politicians like low interest
#
rates because that, you know, people can borrow again at low interest rates, housing prices
#
So even though the salaries of people are not going up because the home prices keep
#
going up, people tend to feel a little wealthy, okay.
#
And which is something that politicians like.
#
So this is, you know, another angle to it wherein because the U S over the years has
#
stopped manufacturing, stopped making things, you know, the median income hasn't really
#
gone anywhere, but that's a different debate for a different day.
#
So obviously after the dot-com bubble went burst in 2000, a new bubble in the form of
#
the housing bubble came to the fore.
#
And in this housing bubble, there was something known as the subprime loans, which came to
#
Now what had happened was because, you know, the banks were ultimately running out of people
#
to lend money to banks and other financial institutions.
#
So they had to create a new level of borrowers.
#
Now prime borrowers were good borrowers to whom you lent money because you felt that
#
they were in a position to return it.
#
The subprime borrowers basically were the borrowers below the prime borrowers who normally
#
would not have gotten a home loan or any other kind of loan for that matter.
#
But given the fact that there were just too much money sloshing around in the system and
#
So a subprime category was created.
#
I'll just interrupt you here and talk about, you know, earlier you mentioned politics and
#
how politics drove a lot of this earlier on political incentives.
#
And one of the things that came out of that was something called the community reinvestment
#
I don't know if this was in the late sixties or the late seventies.
#
I can't, can't quite remember.
#
But the community reinvestment act basically mandated that lenders have to give a certain
#
percentage of their loans to people who would not otherwise be credit worthy.
#
So they were basically, you know, quotas depending on areas, quotas depending on income and all
#
those kinds of things were there.
#
What also happened was that the American financial sector discovered something known as securitization.
#
Now securitization added to this entire easy money bubble.
#
You know, what happens is typically when a bank gives a loan, it, you know, keeps that
#
loan on its books and over the years as the AMIs get paid, a part of the principal is
#
returned and interest is also paid on that loan.
#
In case of securitization, what the banks and other financial institutions did was,
#
you know, let's say they had, you know, given a home loan at the rate of 8%.
#
Now they issued financial securities against that home loan, which paid, let's say an
#
interest of 7% and those financial securities were then sold off to other investors.
#
So what it did was that the bank, instead of holding the money on to its balance sheet,
#
got the money back upfront and it could then lend the money all over again.
#
And not just that it bundled bunches of loans together.
#
What also happened was because, you know, the interest in case of the investors was
#
because a lot of these loans were subprime loans.
#
So they were essentially giving a rate of return, which was better than a lot of other
#
And, you know, these were triple rated securities.
#
Which is another thing to point out.
#
The rating agencies were actually paid, I mean, I mean, their money came from the companies.
#
So what happened was this is, you know, very interesting that the amount of money that
#
rating agencies made on, I mean, I remember this vaguely, they made at least three times
#
the money rating a subprime loan than a normal loan.
#
So hence, you know, it was in their interest to keep anyone who was issuing those securities
#
happy because there were three, I think government approved rating agencies in the US.
#
So instead of going to one, instead of, let's say, going to S&P, the guy could have gone
#
So there is a fundamental problem in the entire rating game.
#
So because of that, so banks got their money back because of securitization, the bank no
#
longer had to hold on to the loan on its books.
#
Now, what that did was that, you know, the entire structure, which was in place in order
#
to ensure that you give loans to only people who returned those loans, I mean, you had
#
loan officers who did that sort of thing, that went out of the window because the moment
#
you did not have the loans on your book, you know, it did not matter, you know, any, anyone
#
else, your incentive change, so all those loan officers were fired and all that's there
#
So, so ultimately, because all this money was being lent, there was a huge bubble in
#
the American housing market.
#
Now, this is just one part of this story.
#
The other part of the story.
#
So the bubble was because banks kept lending to subprime customers because they could easily
#
get the loans off their books because of high ratings given by rating agencies they were
#
And part of the reason that they could give so many loans was because of low interest
#
rates and the easy money in the system.
#
So, you know, in the US, other than home loans, there is another kind of loan called the home
#
So what that does is, let's say you bought a house for let's say $100,000.
#
And over a period of time, the value of the house has increased to $150,000.
#
So you have something known as a home equity, which is the difference between the current
#
value of the house and the home loan outstanding on it.
#
So let's say a home loan outstanding on that $150,000 house is $80,000.
#
So your home equity is $70,000.
#
So you can borrow against that home equity also.
#
To pay off the original amount.
#
No, I mean, you can do it anyway.
#
That's just a normal, you can go buy, you know, consumer goods or whatever.
#
So what this entire bubble did, so it was a bubble at two levels, you know, one was
#
the home loan bubble, then the other was the home equity loan bubble.
#
So a lot of people took on these home equity loans and, and then, you know, bought consumer
#
goods or goods that were being imported from China and so on and so forth.
#
So that all of this essentially, you know, ensured that the US economy kept chugging
#
along and it did not have to sort of face the negative consequences of the.com bubble
#
So all this went along very, very final, you know, and, but then as, you know, is the case
#
with any bubble, you know, people ultimately, if you give them more money than they have
#
the ability to repay started to default.
#
And once they started to default, you know, a lot of these investors who had also borrowed
#
money to buy all these securitized financial securities started getting into trouble.
#
And the first, you know, two hedge funds of investment bank called Bear Stearns, which
#
was the fifth largest investment bank on Wall Street, went bust sometime in 2007.
#
And Bear Stearns was finally sold to JP Morgan in March, 2008.
#
This was the first sort of big thing that happened.
#
And I think as Andrew Ross Sorkin describes in too big to fail, it was basically all the
#
banks coming together saying, Hey, what do we do when we need to do something about these
#
And that's how the deal happened.
#
So another, so over the next six, seven months, you know, so obviously once the fifth largest
#
bank went was sold off, the next guy on the line was Lehman Brothers.
#
But you know, from what I can understand having read up about the entire era, the CEO of Lehman
#
Brothers, a gentleman called Richard Fuld, F-U-L-D, I don't know how to pronounce it,
#
was always of the belief that given that the Fed had rescued or at least initiated the
#
rescue of Bear Stearns, they would rescue Lehman Brothers also.
#
But for some funny reason, I've tried really sort of understanding as to why they led Lehman
#
Brothers go given that they rescued almost everyone else.
#
I really haven't been able to come to a conclusion, but I mean, long story short, next Lehman
#
Brothers went bust and everything started to go haywire.
#
And then the Federal Reserve decided to sort of start printing money in order to ensure
#
that the American economic recovery is faster.
#
So now before I ask you to continue the story from here, I'll just try and sum up this
#
period very briefly and tell me if I've made a mistake.
#
The housing bubble happened because a lot of loans, both in terms of home loans and
#
home equity loans, as you explained, were made that wouldn't otherwise have been made
#
if you went purely by credit worthiness.
#
Now the reasons they were made were manifold.
#
One of them, as I pointed out, were perverse incentives put in place by the government.
#
So basically because the median income wasn't really rising, so the government had to do
#
So the government had to do something.
#
So number one, there was a community reinvestment act which mandated that a lot of these people
#
make these kinds of loans to people they otherwise would not make these loans to and which were
#
also Fannie and Freddie, which are government bank institutions.
#
So Fannie and Freddie Mac were essentially, what their role was, that largely they bought
#
out these securitized loans from all these guys who were making these loans.
#
So ultimately what used to happen, let's say I'm a small subprime lender and I was like,
#
I always had the option of selling off these subprime loans to Fannie Mae and Freddie Mac.
#
Who would buy them and they were explicitly backed by the government.
#
So what really happened here was, again to summarize, you had a whole bunch of loans
#
which were made which shouldn't have been made.
#
Number one, for political reasons, the government put in place a community reinvestment act
#
which mandated that these people have to lend to people who were otherwise not credit worthy.
#
Number two, you had easy money flooding the system, which was enabled by the US going
#
off the gold standard and Nixon's decision in 71.
#
And what that easy money did was that because of low interest rates, people had access to
#
a lot of money, banks and financial institutions, which they used to merrily make more of these
#
And number three, what also enabled them to make all of these loans was the fact that
#
they were able to bundle them into these securities and sell them off further down the road to
#
I mean, it was really like a series of Chinese boxes.
#
You open one Chinese box and there's another smaller one inside and so on and so forth.
#
The number four, because of Fanny and Freddie would buy all these subprime loans whenever
#
you wanted to sell it to them and they were essentially backed by the government.
#
What eventually happened later, the bailout, which was an example of profits being privatized
#
and in that case, losses being socialized, was something that all these companies essentially
#
And you could say that Lehman Brothers for not being bailed out was simply just unlucky,
#
but it was implicitly there as part of the system that, hey, if something goes wrong,
#
the taxpayers are there.
#
In fact, the funny thing is Fanny Mae and Freddie Mac were not government-owned.
#
I mean, a lot of people tend to- Right, but there was an explicit backing.
#
They had an implicit guarantee, which was- I thought it was explicit.
#
There was never an explicit guarantee as to- But it was taken for granted that they will
#
They will always be backed up.
#
They will be backed by the government because it was the government which has started both
#
And then they had privatized it.
#
But the funny thing now is the easy money caused a crisis and the response to that crisis,
#
as you pointed out, was more easy money.
#
Was more easy money, yes.
#
And so basically, if you study the financial history of the United States, they have always
#
managed to come out of an economic crisis by spending their way out of it, which is
#
precisely what they wanted to do this time around as well.
#
So what happened was that the economic policies which were initiated had some hope of that
#
this was what they hoped to achieve.
#
But the economic incentives they created led to something else.
#
Now when all this money was printed and interest rates were driven down, the hope was that
#
American companies would borrow at low interest rates, they would expand, create jobs, pay
#
people money, and so on and so forth.
#
And all that multiplier effect would kick in.
#
Which is a Keynesian way of thinking, which is a sort of, I mean, Keynesian is government
#
It's more about spending.
#
This is more from the point of view.
#
This is the point of view from what Milton Friedman basically, so essentially a lot of
#
the way the US central bank operates comes from what Milton Friedman thought of what
#
went wrong during the Great Depression.
#
So Ben Bernanke was essentially a scholar of the Great Depression, and which was one
#
of the reasons why he became the Federal Reserve Chairman.
#
And a lot of the thinking of these economists is influenced by Milton Friedman's writing
#
on the Great Depression, and yes, so his thing was, his basic thesis was that because so
#
many banks went bust, the money supply in the system contracted, and because of that,
#
you know, everything went haywire, I mean, to put it very, very simplistically.
#
So basically when Ben Bernanke initiated what he did, his thinking was coming from what
#
he thought was the right thing to do given what Milton Friedman had written about the
#
Not that Friedman would have approved of easy money, but simply Friedman's insight that
#
the interest rate can be used as a lever to manipulate the economy.
#
In the sense he didn't, nowhere did Friedman, Friedman would obviously have balked at rescuing
#
so many, so many of these private enterprises.
#
So anyway, so to get back to the point, so when these, so the hope was that these companies
#
would expand and borrow and expand, but what happened was the companies did borrow because
#
the interest rates were low, but they borrowed in order to buy back their shares.
#
Now what happens is when a company buys back their shares from the stock market.
#
So when the company buys back shares, the total number of outstanding shares in the
#
stock market goes down, which basically pushes up the earnings per share.
#
And because the earnings per share goes up, the stock price also goes up because the stock
#
price ultimately is a reflection of, you know, if the supply of shares in the open market
#
goes down, then again, that's another reason for the price to go up.
#
So basically, and you know, the incentive here was that a lot of the top management
#
of US companies had a lot of stock options.
#
So they saw this as a very good opportunity to drive up, you know, their wealth by borrowing
#
at the cost of shareholders at a very low interest rate.
#
And through easy money pumped into the system, ultimately taxpayers money.
#
So this is essentially a perverse incentive, which was theft is another word for it.
#
Now the problem is even though the stock prices went up and the stock market went up, but
#
buyback does not create jobs, right?
#
So the entire idea of companies expanding and creating jobs and so on and so forth went
#
Because they weren't investing.
#
Yes, they weren't investing.
#
That's one perverse incentive, which was created.
#
The other hope was that people would borrow and spend more, but people had already done
#
their round of borrowing.
#
And in the aftermath of the financial crisis, the American household debt actually came
#
down for a few years till it started going up again.
#
And if you look at the household debt to GDP ratio, it is still, you know, lower than where
#
it was when the financial crisis started in 2008.
#
So the households did not want to borrow.
#
Now what happened was that these big financial institutions saw this as a great opportunity
#
to borrow money at low interest rates and invest them in financial markets all over
#
And a lot of this money kept, you know, came into the Indian stock market and into the
#
So is our stock market boom?
#
It is largely because of, if you look at data, I mean...
#
So American taxpayers have funded our stock market boom.
#
So a lot of the money that came in between 2011, 2012, 2014 was a lot of the foreign
#
institutional investors, as we call them investing in India, 2015 was a negative year for them
#
and then they turned positive in 2016-17.
#
Now if you look at conversely at the domestic financial institutions, they were selling
#
all along between 2011 and 2015 and they've been buying in the last two years when the
#
markets have peaked, sort of.
#
So in the sense that, you know, a lot of this easy money found its way into financial markets
#
all over the world and it drove up, you know, stock prices and then stock markets.
#
And then the crazy venture capital that's also been floating around.
#
Yeah, I mean, which is also another...
#
So if you look at, you know, the example that I like to give is that Blackstone is the biggest
#
owner of real estate in India, which is very crazy.
#
The second biggest after the government obviously.
#
I mean, I'm just talking about generally, I mean, if you look at the, so, I mean, stuff
#
which is there on paper.
#
I mean, there might be some guy who might own more than Blackstone, but we don't know.
#
So all this money that, you know, coming into the Flipkarts of the world and, you know,
#
we getting huge discounts is also a function of the era of easy money.
#
So the American taxpayer has funded the discount I got yesterday when I bought from Flipkart.
#
I don't buy from Flipkart by the way.
#
That was a hypothetical example.
#
So, yeah, so if you look at the valuations, the price to earnings ratios of the Indian
#
stocks and the Indian stock market, you know, it's gone up dramatically in the last couple
#
So which basically means that even though the stock prices are going up, the earnings
#
of companies are not going up at the same place.
#
So something's got to give at some point.
#
So which is how, you know, so ultimately, you know, all this sort of has been happening
#
And in June last year, the Federal Reserve essentially said that they will gradually
#
start withdrawing all this money that they have pumped into the financial system.
#
And they started doing it sometime in October.
#
Now between October 3rd, 2017 and January 29, 2018, the Federal Reserve has sort of
#
pumped out around 40 billion dollars, which is less than 1% of the size of the balance
#
The balance sheet now is peaked at around 4.5 trillion dollars in December 2016.
#
When they started off in September 2008, the balance sheet size was around 905 billion
#
So it went up by almost five times.
#
So ultimately, you know, you have to understand that any central bank does not have any money
#
So if the size of its balance sheet is going up, it basically means it's acquiring assets.
#
How is it acquiring assets?
#
So their balance sheet size went up from around 900 billion dollars to 4.5 trillion dollars.
#
Now this is something that the Federal Reserve is now trying to contract.
#
And it is between September, sorry, between October and January, it has managed to contract
#
And so obviously, the plan is to contract the balance sheet by around 420 billion dollars
#
this year and 600 billion dollars there on.
#
So if everything goes as it is supposed to, then by the end of this year, the Federal
#
Reserve balance sheet will be down by around 10%.
#
And what's the impact of that?
#
The impact is basically, you know, when the money in the financial system comes, starts
#
being sucked out by the, pulled out by the Federal Reserve, the total amount of money
#
And when the money goes, supply goes down, interest rates start to go up.
#
The other issue here is that the American government under Donald Trump is supposed
#
to borrow more than 3 trillion dollars between 2018 and 2020.
#
So what is happening here is that you have the Federal Reserve at, you know, pulling
#
out money and between 2018 and 2020 they would have pulled out around 1.6 trillion dollars
#
if they keep doing what, you know, they are saying right now.
#
And at the same time, you have the US government wanting to borrow 3 trillion dollars.
#
So a government wanting to borrow in a financial system where the money supply is actually
#
contracting is not, you know, the best thing that will happen because all governments like
#
to borrow at low interest rates.
#
So at some point of time, you know, I think the US Federal Reserve will end up in a confrontation
#
with Donald Trump if it continues to do what it is saying it will do.
#
That whether they'll continue to do it is a, you know, is a big question mark.
#
What's the potential impact of this on A, the world economy and B, on India because
#
So what will happen basically is, you know, if these interest rates start to go up, all
#
the money which these big financial institutions have borrowed and invested in India will start
#
to go out gradually, primarily because, you know, as interest rates go up, the trades
#
that have been made will start to become unviable.
#
So it will make more sense for them to sort of withdraw money from India and take it back
#
Which is not something you'd lament, right?
#
Because it means, you know, the stock prices will again be more or less sensible.
#
Yes, but then, you know, what happens is, you know, when stock prices fall, falling
#
stock prices have a huge nuisance value.
#
Because, you know, people who invest in the stock market are heard much louder by the
#
government than, you know, people who invest in fixed deposits, so to say.
#
So the other big, the bigger threat as for me is that, you know, if money, foreign money
#
starts to go out of the Indian bond market, then the bond yields will start to go up and
#
interest rates will start to go up and interest rates going up will mean EMIs will start to
#
go up, which will hurt more Indians than money going out of the stock market.
#
So and when the mood around the economy goes down, it's a government of the day, which
#
inevitably bears a brunt.
#
So Modi may actually be unlucky going towards 2019 for factors outside his control.
#
But the point is, you know, the question is whether this will happen or not.
#
Now, you know, the beauty of the American system, so to say, is that they have a sense
#
Now even though you have a federal reserve chairman, the real decisions are essentially
#
made by the Federal Open Market Committee, which decides on the monetary policy of the
#
Like, you know, in India also, we have recently moved towards the Monetary Policy Committee.
#
So if the, as interest rates start to go up and if those rise in interest rates starts
#
to hurt the American economy, then the FOMC might very well take a decision without running
#
into a confrontation with Donald Trump that we do not need, you know, high interest rates
#
So they can go slow on sucking out money from the financial system.
#
Now why I say this is because, you know, the median income in the U.S. started to fall
#
from 2008 onwards and only in 2016 has it crossed the level that it was in 2008.
#
So the American system, economic system, so to say, is at a very nascent stage of a economic
#
Now, whether the Federal Reserve will, you know, risk sort of sabotaging that recovery,
#
I mean, I don't think so, which is why I feel that, you know, somewhere towards the
#
second half of this year, when the impact of higher interest rates becomes a little
#
more clear than it is as of now, the Federal Reserve will have to sort of go slow on taking
#
the money out, you know, all this money, printed money that they have put into the financial
#
system, taking that out, they'll have to go slow on it.
#
And to be clear, it's an autonomous body.
#
So they don't have to listen to Trump.
#
What also happens is that, so the theory going around now is that the new Federal Reserve
#
chairman has been appointed by Donald Trump and he is not an economist.
#
So he is a lawyer and an investment banker.
#
So yeah, so you have to take that into account.
#
But then again, having said that, he's just one guy in a committee of 30.
#
He doesn't make a decision by himself.
#
He can't make a decision by himself.
#
So typically what happens is that, you know, at least in the Ben Bernanke and the Janet
#
Yellen era, the chairman used to have some point of view and then he used to try and
#
get the committee to subscribe to his point of view.
#
So I'll take the opportunity to bring you to India.
#
But before I ask about India's approach towards monetary policy and towards easy money, final
#
sort of question on the US that what do you think the responsible approach would have
#
You've shown us through your narrative of how easy money caused the 2008 crisis and
#
the response to it was more easy money, which doesn't make any sense.
#
What should have been done?
#
So, you know, a good example that I discuss in my book is that of Iceland.
#
When the three biggest banks of Iceland went bust in the aftermath of the financial crisis,
#
the government decided to let them go bust.
#
And Iceland is one of the few economies in Europe which has managed to recover.
#
A good counter example to Iceland is Ireland, where the government decided to sort of take
#
over the, you know, the liabilities of the banks going bust.
#
And because of that, you know, the Irish economy has been in the dumps for a while now.
#
So, you know, the point is that, you know, in economics, there are no experiments.
#
Now, if the Federal Reserve had let all these banks go, I mean, would that have meant that,
#
you know, as Ben Bernanke put it, there would be no financial system on Monday.
#
You know, we really don't know.
#
But you know, what this has done is that it, as you said, you know, it has sort of created
#
And the next time any of these banks are in trouble, you know, the market expects them
#
It's practically a guarantee of irresponsible behavior because, you know, they get the upside
#
of the risk, but not the downside.
#
Exactly, so which is, I mean, see, what also happens is, you know, when you are, you know,
#
people who are in these decision making positions are much more closer to the guy who's getting
#
whacked at that point of time.
#
And you know, guys who are not getting whacked are really not organized to sort of push their
#
Concentrated benefit defuse cost.
#
So, which is how it is.
#
But then as I said, you know, Iceland again is a very small economy, but it is a good
#
example of how a country which sort of let its financial, you know, sector go, actually
#
was able to come out of the crisis much faster than other countries.
#
But then, you know, in economics, as you know, I mean, many years back, I had, I happened
#
to meet Mr. Y.V. Reddy, who was the governor of RBI between 2003 and 2008.
#
And he told me, and this was at the point when the financial crisis was just starting.
#
And he told me something very interesting.
#
He said, Vivek, you know, not doing anything is not something a central bank can do.
#
They have to do something.
#
They feel compelled to act in a crisis.
#
So, and this is, you know, it's like, it's an example that I sort of, and I then wrote
#
a piece around this phenomenon a few years later, which Dr. Doori Subbarao, you know,
#
used in his book and he, who moved by interest rate.
#
So the example was very simple.
#
You know, in football, the statistics show that, you know, when a penalty is being taken,
#
it makes sense for the goalkeeper not to jump and stand where he is because his chances
#
of based on past data, his chances of stopping the goal are best if he doesn't jump.
#
But the problem is if he doesn't jump, you know, for the, for every time the ball, you
#
know, when the ball goes towards his right or towards his left, he ends up looking very,
#
So if you take the same analogy and, you know, sort of plonk it onto a central bank, they
#
So not doing anything is not an option.
#
So since, since you mentioned Reddy and Subbarao, quick comments on how over the years India
#
has historically looked at monetary policy, has our central bank been autonomous and given
#
the independence it should have, has the temptation to create easy money, something that governments
#
And I mean, after the Modi government took over, there were fears from some quarters
#
that they would lower interest rates and get more money out of the system.
#
This is what, what typically didn't happen.
#
No, I mean, see what, what also happens is, you know, lower interest rates do not automatically
#
lead to more borrowing.
#
I mean, there is, you know, a general misconception that, you know, almost everyone has now in
#
an Indian context, if you, if you look at the post demonetization era, interest rates
#
have come down on fixed deposits on loans, but the borrowing hasn't gone up proportionately
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for the simple reason that, you know, demonetization has hit people badly and it has hit the capacity
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of people to go out there and, you know, take loans and be able to pay those EMIs.
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In fact, just to digress, we were discussing at the start of the episode, how one of the
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key features of money, which is backed by the government is trust in the money.
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And among the many disastrous thing demonetization did, one was that it affected their trust,
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If you have a thousand rupee note, are you actually going to get a thousand rupees for
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One thing we didn't talk about was bitcoins, you know, the rise of easy money and the rise
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of bitcoins are very intricately linked because people who, I mean, I'm talking about the
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guys who are passionate about bitcoins, not the speculators who've just put money to sort
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of make money out of it.
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Those who are using it as a medium of exchange rather than as a speculative asset.
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People who are passionate about bitcoins are passionate about it because they want control
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They don't want the government to interfere.
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And you know, there is a great belief that Bitcoin cannot be cracked by the government.
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Vivek, I want to talk about bitcoins.
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I want to have a full episode on it.
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So let's leave that for another day.
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In any case, I mean, talking to you was extremely enlightening.
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And if you've listened to this episode so long, you found it as interesting as I did.
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So do go out and buy Vivek's books.
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And actually, Vivek's books do pretty much what my podcast sets out to do.
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Look beyond the scene effects and see the unseen effects.
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Vivek, thanks so much for being on the show, man.
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Thanks, Amit, for having me.
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In case you enjoyed listening to the show, you can follow Vivek on Twitter at call underscore
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Go to Amazon and check out the Easy Money Trilogy right away.
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And also his latest book, India's Big Government.
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You can follow me on Twitter at Amit Verma, A-M-I-T-V-A-R-M-A.
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Our past episodes, including a few featuring Vivek, are available on sceneunseen.in.
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And for more great, cutting-edge Indian shows, do download the IVM Podcasts app and follow
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IVM Podcasts on Twitter and Facebook.
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If you enjoyed listening to the scene and the unseen, check out another hit show from
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Indusworks Media Network's Cyrus Says, which is hosted by my old colleague from MTV, Cyrus
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You can download it on any podcasting network.
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There she stands, a podcast addict, outside the bank, having travelled several miles to
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get in with other poor souls like her.
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The journey, though daunting for this youngling, will have some comfort because she has downloaded
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You can see more of her species on ivmpodcasts.com, your one-stop destination where you can check
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out the coolest Indian podcasts.
