The MOST Important INSIGHT World-class investing ideas in just 15 minutes.

 Welcome to The MOST Important INSIGHT—the companion series to The MOST Important Thing podcast. Every week I take a one-hour conversation with one of the world's leading economists, investors or business thinkers and distil it into the most important ideas and insights you need to know. If you're short on time but still want world-class insights, you're in exactly the right place.

What a start??? Only the Chief Strategist with JP Morgan

Dr David Kelly CFA

You're Welcome

Transcript

SPEAKER_00 0:00

So over the past year I spent some time the best and the brightest across finance, economics, investments, markets, policy. And it's really been a fascinating journey for me. What I've done, I have a summer intern, Craig Evans, helping me with this, which is great because I get the perspective of his generation, I suppose. And he has been curating some of these interviews with me and highlighting some of the areas that he has struggled to understand, and he's been a great barometer for me to pinpoint some of the parts of the episode that perhaps I need to explain a little bit better. What we've done in this shorter series, I'm gonna go step by step, maybe four or five key insights from Dr. David Kelly's interview with me. I hope this is useful. So let's jump to the first insight. And the key question is have central banks lost their way? For much of modern economic history, central banks have had a relatively straightforward mandate to preserve price stability and maintain confidence in the financial system. But over the last two decades, their role has expanded dramatically from quantitative easing and negative interest rates to climate policy and inequality. Increasingly been asked or have chosen to solve problems that arguably sit well beyond monetary policy. So have central banks become too ambitious and in trying to do more, have they actually become less effective? Here's David Kelly's perspective.

SPEAKER_01 1:33

Well, I think that they have become more ambitious in terms of what they can do. But they felt like they could do QE1 or quantitative easing and do other things to keep rates low. The ECB decided to have negative interest rates. All these things were supposed to promote economic growth, to promote greater demand. It didn't actually work. Then when we had inflation in the early part of this decade, uh in the United States, the inflation rate got up to 9.1%. Everybody blamed the Federal Reserve for it. It wasn't their fault. The Fed felt they had to fix it. Well, they didn't, it fixed itself. But I think they I think the problem is that central banks think that they can do all these things because there's no proof. A lot of these problems resolve themselves. Um and but if they're taking some action and it resolves, they say, well, hey, we fixed it. No, they didn't. But I I think that over time, central banks have gone from just keeping a f stable financial system or facilitating a stable orderly financial system to trying to promote stronger economic growth or moderate inflation. That's one thing, or or to remove the inflation rate. And then also sometimes they take on other roles which they're they're absolutely incapable of dealing with, such as controlling global warming or achieving ESG targets or helping out this group or that group in society. They can't do these things. These things are the responsibility of governments and central banks just shouldn't try.

SPEAKER_00 3:10

Should preventing asset bubbles be part of a central bank's job? When we think about central banks, we usually think about inflation and interest rates, but what if their greatest economic impact has been somewhere else entirely? Over the past few decades we've experienced repeated booms and busts in housing and equities and other asset markets. David argues that while central banks have focused on stabilizing inflation, they've often overlooked the build-up of asset bubbles, despite the enormous economic and social consequences when those bubbles eventually do burst. It's a fascinating perspective that challenges what many people believe should be at the heart of monetary policy.

SPEAKER_01 3:55

Well, first of all, I think that I think that is reasonable to give them a that sort of mandate, but but they should still recognize their limitations in achieving that. The other thing, though, that isn't in their mandate that ought to be in their mandate is uh to try to prevent asset bubbles. Because if you look at the history of this century, it's really been and indeed the last few decades, it's been one bubble after another which has really caused the problem. And central uh central banks, when they add too much liquidity to the economy, tend to cause a bubble, such as you know, home prices shooting up. I mean, there's a reason why home prices in Europe and in the United States are astronomically high and so very difficult for younger people trying to buy a house. It's partly because the blasted central banks kept mortgage rates so low, I mean just ridiculously low. So that, you know, that pushed these prices up because what how much house can you afford? Well, at a mortgage rate of this rate, I guess I can afford a lot of house. So you actually, you know, they caused housing bubbles, they've caused financial bubbles. Um I think that I think they ought to be part of their mandate ought to be to try to prevent asset bubbles from So did central banks really defeat inflation in 2022?

SPEAKER_00 5:05

One of the dominant narratives over the past few years has been the central banks successfully brought inflation under control through aggressive interest rate increases. But what if that story isn't entirely accurate? Ivett Kelly believes both the cause of inflation and the reason it eventually subsided have been widely misunderstood. In his view, fiscal policy, supply disruptions, and geopolitical events played a far greater role than monetary policy, raising an important question about how much influence central banks really have. Here's his take.

SPEAKER_01 5:42

The problem is that central banks and central bankers tend to uh have an overinflated sense of their importance. Let's be clear, central banks did not cause the inflation that occurred in the first part of this uh decade. If they had, that inflation would have bubbled up a lot more earlier after the great financial crisis in 2014 or 2015 or 2016. That's when we would have seen bubbly inflation because the central banks were pouring money into the economy. What happened is we had a pandemic, and then we had a policy response in the United States and a similar one in Europe, where governments gave money to lower and middle income households who lived paycheck to paycheck. Now, if you give a pay a household that lives paycheck to paycheck an extra paycheck, they'll spend it. And so what happened is you had an enormous clearing of the shelves in the United States where every you know everybody's freezer is still has stakes that are five years old right now at the bottom of them, gathering it with ice crystals on it, because they just uh they went out and spent the money. And and we've we've discovered this. It's rather it's a rather alarming thing. If you ever want to stimulate an economy, just send out six hundred dollar checks to to everybody, regardless of income, and they will spend it, and that will get you extra aggregate demand. But that's what happened on the one one side. And the other side, of course, the pandemic did disrupt supply chains, but it's mainly just excess demand coming from fiscal policy. That was extended by Putin's horrendous invasion of Ukraine and uh and all those issues. And that's why the inflation rate kept high and got up to, in the United States, 9.1%. But then it came down. And the thing is, you know, you say, you know, the question was, well, what can central banks do to control inflation? There's only one thing they can do to control inflation, and that is killing aggregate demand. They have to kill demand. They push up interest rates in the hope of killing demand. That slows the economy down. If it slows the economy down enough and people feel poor enough, they don't buy stuff. That's how it works. Nobody wants to say it that way, but there is no other mechanism. But if that is the mechanism, then we know they're not g they they're not responsible for inflation coming down either, because the US did not go into recession, didn't come close to going into recession. And if the if the US economy is still going two, two, two and a half percent, which is basically in line with its potential, if it's still growing at that pace and inflation comes down, then all that happened really was you know, commodity prices got very high. And if you've got high enough commodity prices, then people will find a way of getting the oil to market. If the pandemic ends, the supply chains will you know figure themselves out. And that's what happened. The inflation basically went away of its own accord, but it w the central banks didn't cause it and they didn't fix it. But they're they're an easy scapegoat, and and that's why people sort of blame them for it.

SPEAKER_00 8:13

Why didn't interest rates cause a recession? For much of 2022 and 2023, a consensus expectation was that sharply higher interest rates would inevitably push economies into recession. Yet, particularly in the United States, that recession never materialized. So what did economists get wrong? David argues that many of the traditional assumptions about how interest rates affect the economy no longer hold in a world of fixed rate mortgages, particularly in the US, aging populations with savings, income, and service-led economic growth. It's a compelling explanation for one of the biggest forecasting errors in recent years.

SPEAKER_01 8:59

I think that people thought these higher rates were going to kill the economy, but why don't they? Well, let's talk about it. First of all, and again, all this has changed over history, but a lot of Americans, and I think this is true also in Europe, have money in savings accounts or money market funds where you get short-term interest rates give you more income. And so there are millions of retirees in America who got an income uh boost because of higher short-term interest rates. Second of all, in the United States, mortgages, and over 90% of them are fixed-rate mortgages, you push up interest rates, doesn't hurt people at all in terms of that spending. Credit card debt people talk about it a lot, but it's a much smaller part of debt. Third, when the Federal Reserve raises interest rates, people want to borrow money ahead of because rates might go up or more. So let's let's borrow money now. And also the Federal Reserve must think the economy's okay or they wouldn't be raising interest rates. The opposite happens when the Fed cuts rates. If the Fed cuts rates aggressively, everybody says, well, they're going to cut some more, so let's now wait and see, and that slows the economy down, or that they're scared that it's a that it's a that the economy's headed for a recession, or um you or it's it and it is a reduction in income for for people who've got money in savings accounts. All of this change over time. It used to be. You know, again, if you sort of go back a hundred years, you have this big connection between interest rates and capital spending, investment spending. You know, they'd want to build a factory, but we can't afford the factory doesn't work. It doesn't work at f at 8% interest rates, it might work at 4% interest rates. That's not really the economy we have. The economy today is much more about payroll and about hiring experts to make this or to build and build that. It's not about long-term capital spending, and therefore it doesn't depend as much on interest rates. In the United States, home building is 4% of GDP. That's it. I will admit that the home building industry is affected by mortgage rates, but the other 96% of the economy isn't really affected by interest rates. So it's just not that sensitive, and he and even to the extent that I think that in some cases cutting interest rates uh actually slows the economy and raising interest rates speeds it up.

SPEAKER_00 10:57

Is AI developing faster than we appreciate? Artificial intelligence has become one of the defining investment themes of our time. But beyond the excitement lies a more fundamental question. How quickly will AI reshape the economy and the labor market? David believes we're underestimating the pace of change. Rather than evolving gradually, he argues that AI's impact is likely to be exponential, with each technological advance accelerating the next and transforming employment far more rapidly than many expect. It's a thought-provoking discussion about one of the most important structural shifts investors will face over the coming decade. Let's see what he thinks.

SPEAKER_01 11:41

Well, I think the exponential character of it is probably correct, which is really interesting. I mean I remember I remember my my most recent encounter with exponential curves was watching the spread of COVID. And once you watched it for a few weeks and did the math, you realized, oops, we have a problem. But that's true with AI. And the reason it's true with AI is because AI is getting smarter. Every new addition is smarter. Every new addition means that there are more workers that this thing could replace. Every time that happens, it encourages more capital spending. It also encourages more innovations in complementary technology such as robotics that could use AI. And so what I think is going to happen is, you know, AI is going to impact the environment over the next five years, but it's going to impact the environment far more over the following five years, and far more than that over the five years after that. There are negatives, potential negatives because of what it does, its potential for misuse and implications of democracy and so forth, and I suppose the misuse of it and things like computer viruses. But overall, I expect that a combination of AI and robotics will each year make more and more workers obsolete. And that's quite dangerous if you have a recession. Because if you have a what happens is if you have an expansion, companies say, oh well, you know, maybe we'll keep we'll keep Joe working. I mean, he's a nice guy, we you know, we don't want to cause any misery here, and we can we can get by okay. And then when the recession comes, look, we're gonna have to make tough decisions and and out Joe goes, and and all the people that could be replaced by AI suddenly find themselves looking for a job. So I think it could lead to a significant reduction in workforce come the next recession, as people say, well, you know, honestly I could do that job better with with uh with a machine. So I think over time it's gonna make more and more workers obsolete. Economists always say, and I I still kind of believe that technology tends to create new jobs as the technology comes in. But this this is going to be an interesting challenge because its impact is not going to be meandering. I think it's going to be exponential. Every year, the impact it has on labor demand is going to be greater. And so there'll be a greater need to find other things for people to do usefully, but AI can't do faster and cheaper than them. It will it'll be interesting to live through this. But I also think, you know, for younger people, people always ask me about you know technology skills and the spreadsheets. I love nineteenth century skills. I love somebody who can pick up a pen and write and think as they write. I love people who exercise their human intelligence. I love people who read uh I love the idea of reading books rather than reading scrolling uh messages on phones because it's you know, I feel like I was a beneficiary, I'm sure you felt like you were you're a beneficiary too, of of growing up in an era where you didn't have to be attached to a phone or a computer. You you did actually have to think for yourself, but you have the time and the leisure to think for yourself, uh to read the thought uh read things in books and then think about how people uh wrote stuff. So I you know, I'd say, you know, I mean, I th you know I often do give advice to young people. And my advice is you know, take your cell phone, stick it in a jug of water, go get yourself a book, and it doesn't it almost doesn't matter what book because it's what's going on between your ears that matters. It's not necessarily what the what's on the on the page in front of you, but it's a book, even if it's a nineteenth century book like you know Dickens or somebody, it it forces you to think. And that's what I think is is really important.

SPEAKER_00 14:53

So what is the most valuable skill in an AI world? As artificial intelligence becomes increasingly capable, it's easy to assume that the most valuable skills will be technical ones. But David Kelly takes a very different view. He believes that the qualities which distinguish people clear thinking, curiosity, deep reading, and the ability to communicate may become even more valuable in an age where machines can process information almost instantly. It's a refreshing reminder that while technology continues to evolve, some of the most enduring human skills never go out of fashion. So there ends the first most important insight from our very first interview with Dr. David Kelly, CFA, global head of strategy with JP Morgan. David is a fellow Irishman and was very generous with his time, and I continue to follow his work. His Notes of the Week podcast is something every serious investor should listen to. He just speaks into the camera every Monday and is free, and I would highly recommend people download that and follow David on LinkedIn. Again, he's very generous with his thoughts and insights. So I hope you found that useful. Stay tuned. We're going to keep this short series going as a compendium to the Most Important Thing podcast, which was released every Tuesday or Wednesday, with a long form interview with the best and the brightest, and I've got some great guests coming up, so stay tuned for those. If you want to listen more to David Kelly's interview, go back and listen to the full interview. Fascinating. I've had thousands of streams on Spotify, Apple, and all major podcasts. Thanks for tuning in. Thanks for supporting the show. We would appreciate a review if you find the show is useful. And you can email your suggestions to the mitpodcast.com. There's a dedicated website where we've lots of additional educational material. Okay, talk soon. Thank you.