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In the latest “Week Ahead” discussion, three experts delve into three crucial topics: synchronized global risks, the spending patterns of the US consumer, and the copper gap in the energy transition.
Keith Dicker of IceCap Asset Management and Loonie Hour Podcast takes the lead on synchronized global risks, highlighting how a banking crisis in Silicon Valley has led to crises at other regional banks in the US and abroad. He also discusses the potential risks of the Hong Kong dollar breaking its peg and its impact on the Canadian dollar.
Albert Marko shares his insights on the spending patterns of US consumers, presenting surprising findings on mainstream companies like Carnival Cruise Lines and McCormick, which have been able to raise prices despite the economic recession. These findings challenge the notion of the Federal Reserve’s ability to pivot or pause.
Tracy Shuchart from Hilltower Resource Advisors warns about the copper gap in the energy transition, which is emerging just as the energy transition gains speed. She provides insights into what this means for copper prices in 2023 and how it will impact the energy transition.
The episode concludes with the experts’ predictions for the week ahead.
Key themes: 1. Synchronized global risks 2. The US consumer isn’t slowing down 3. Copper gap & energy transition
This is the 59th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash, and today we’re joined by Keith Dicker. You’ll know Keith on Twitter as @IceCapGlobal. He’s with Ice Cap Asset Management. He also hosts the Looney Hour Podcast, which is one of the most popular business podcasts in Canada. So we’re really lucky to have them today. We’ve also got Tracy Shuchart from Hilltower Resource Advisors and Sam Rines from Corbu. Sam Rines will be joining us a little bit later.
Tony
So let’s get started, guys. We’ve got a few key themes this week. First is synchronized global risks. And we saw that recently with the banking issues, and we’ll get that into a little bit into that a little bit deeper with Keith. With Sam, we’ll talk about the US consumer and how it really isn’t slowing down. And we’ll go into some detail on company annual reports and quarterly reports on that. And then with Tracy, we’ll talk about the copper gap and the energy transition and a message that she’s been talking about for maybe about a year, but is really kind of coming to the forefront now. So, guys, welcome. And Keith, thanks again for joining us for the first time. We really appreciate it.
Keith
Yeah, thank you for having me here. And I think with Tracy, I consider you like half Canadian, sort of with the Quebec ties, but still like one and a half Canadian against one guy from Texas. We’re still not winning, are we?
Tony
Yeah, you’re welcome here anytime.
Keith
So I’ll just talk a little bit about how we do things. We manage money for individuals and family offices, basically across Canada, as well as some European clients, in the US, and Asia. And so we’ve had a lot of success with our strategy and just a couple of things to get the view started, which I think is important. We’re Canadian. I founded Ice Cap back in 2010-2011ish around then, but prior to that, I was offshore in Bermuda for over a decade. And then before that, I was with one of the big bad Canadian banks. But I like to share this Bermuda story because I think it’s really important today because I think a lot of people today get so focused on the day-to-day and short-term factors, what’s happening. And the other challenge a lot of investors have, we tend to see the world through the eyes and minds of where you live and where you’re from. And our view, the financial world does revolve around the US. That’s just the way it’s put together. But being offshore, you don’t really belong to any country. You’re living in between the seams.
Keith
So you get to see and feel and live the world from the perspective of all these other ex-pats you hang out with and so forth. So I just share that with you because, like up here in Canada, if you know the Canadian environment or not, Tony, you should head up when it’s a bit warmer. Maybe for you, I know, but Canadians have this very insular view of our banking system and our housing market. Everyone around the world should behave and act and walk the way Canadians do and so forth. As we all know, that’s not the case at all. It’s a very bigger world out there. With just that in mind, just before I go into the immediate view that we have with the world, it’s our view that long-term interest rates, looking at the ten or 30 years, really did peak in 1982. That’s when it peaked. Back then, rates were called 20%. So from the early 80s right up to eight nine, they went to 0%. And everybody makes money when that’s happening, especially the bond managers. And when that hit zero in 809, policymakers should have let the world reset.
Keith
But we know, of course, that wasn’t permitted, and some jurisdictions did a better and worse job than others that trying to protect that. But effectively, what happened then, for the next decade-plus, we’ve been living in this world with zero rates, negative rates, unbelievable re-escalation of borrowing at both the sovereign debt level households and companies, and so forth. And the other part I like to add to it a bit of a joking way, but it’s also factual. We now have basically two generations of university kids coming out for their entire university academic careers. And now ten years of working in, say, the investment world has been in this period that just doesn’t exist. It’s zero rates. Nothing exists, because as we know, Tony, you put a zero in your denominator for any number. You’re calculating what happens. It doesn’t work. Right. So what we see now today in response to all the policies we have with the Pandemic and COVID, for better or worse, all of the economies and central banks in the world, now they’ve all synchronized. So risk has been synchronized in the US. Canada, Australia, Asia, Europe, you name it.
Keith
And now we’ve gone from this period with zero negative rates. Short term rates are now they exploded higher, and it’s created this moment where increasingly we’re starting to see these risk just come out of the blue.
Tony
Just to clarify something, and I want to make sure that I understand correctly, when you have a zero or negative interest rate, the cost of risk is only the nominal cost of the money that you put at stake. But with an actual interest rate, you have a multiplier on that risk. It may be just a small portion of the multiplier, but there is an accelerator on that risk, right? And so I think this is what it’s been really hard for people well, really easy for people to fall in love with, with zero risk, I think, is that if I risk $100 and I lose it, the value of it is only $100. But if I’ve got a 10% interest rate, then I’m not just losing $100, I’m losing $110. Right. So as we transition back into a positive interest rate environment, the financial planning and the investment planning for people, as you mentioned, say, two generations of people coming out of school, this is an environment people have never had to deal with before. Right. And at the same time, we have BOJ, ECB, and the Fed, who to varying degrees, have had zero or nerp environments where nobody’s had to deal with that.
Tony
And it’s crazy. So I know that is just some basic, basic stuff compared to the advanced calculus you’re talking about, but I think we really kind of need to highlight that that there is an actual cost to risk now that we have real interest rates.
Keith
Yeah. And it’s something we haven’t experienced for a long time. So people tend to forget that. In school, and these CFA studies that we all went through, we call that the risk free rate of return. And it’s been zero for a long time, and it’s been reset. I think this is the greatest global macro setup that we’ll ever see in our lifetime. I mean, if you’re a money manager and you’re not enjoying this right now, then I think you should get a different career, move along somewhere else. But if you think about, for example, over the last five or six months, the Brits had their crisis in their pension fund and guilt market. Of course, then we had Silicon Valley Bank just recently, and then right behind that, Credit Suisse was there. So one good result about that, policymakers, which is mostly the Fed Reserve, of course, were able to react very quickly to prevent contagion. And so they should be complemented for that. I know it’s not nice to compliment or it’s not cool to compliment Central Bank. Yeah, definitely not cool. But that’s something that is a result that did happen. However, it’s also telling us here at Ice Cap that if you went back six months ago and I said, hey, I want you to list ten things that could blow up over the next six months, you wouldn’t have had those three events on your bingo card.
Keith
Maybe the Credit Suisse story, maybe, but the other two were pretty hard to find. So that tells us that, hey, there’s other events that are out there lurking around. And because they’re out there, it doesn’t mean they have to occur. It just means that the probability of them occurring, in our opinion, it’s a lot higher than it normally would. It normally would be your normal distribution chart or graph. So we have that happening, and it seems like every day there’s increasingly more data coming out. We just say, wow, I can’t believe that’s still going down that path. But these are the things that we look at. And again, we find it’s incredibly interesting. It means it does create a lot of opportunities coming up for people managing the portfolios. But you have to be aware of these fattail events that are out there because they could happen and maybe the next one is central banks are not able to save us.
Tony
So let me ask you on the, on the kind of synchronized risk part, seems to me that developed markets are highly calibrated to these risks. A small issue causes a huge reaction in developed markets. I spent a lot of my life in emerging markets, China, Sri Lanka, India, Southeast Asia, Eastern Europe, all over the place. And so it seems to me that emerging markets can bounce around a lot and the perception of risk is a bit lower. I know that there’s a perception that if the US or if developing markets have problems they’re going to be felt even more in emerging markets. But is that true when you talk about these synchronized risks? Do they necessarily feel worse in emerging markets?
Keith
I think in a normal cycle that is the case. You just go with it because from a fundamental perspective, emerging markets look awesome. You know, they have lower debt, faster growth rates, younger, you know, younger demographics and, and things like that. However, again because we’re in this world again I call it synchronized risk. And a quick example is housing markets, real estate markets like Canada and Australia as an example. Again it’s our view that if risk does re escalate, so it happens rapidly. Then because the world.. It operates on the US dollar, that’s just a fact. That’s the way it works. All of a sudden liquidity dries up and liquidity comes out of those markets. So then it doesn’t matter how strong or weak the fundamentals are. If you don’t have dollars to operate, you have US dollar tax revenues coming in or economic gross domestic product revenues, all that stuff, then it’s going to push someone off sides. I think back prior to the 809 housing crisis it would have been hey yeah, just ride it out and you’ll be fine. But these days for example, we’re avoiding these markets. We’re not in the EM markets at all.
Keith
And sometimes that’s great, other times it’s oh wow, you missed one there Ice Cap. The main goal with investment management that we look at is if you avoid the large drawdowns for your primary portfolios then the return side will take care of itself. But if you get these big chops in value and I mean we know the numbers, if you’re down 50% you need a 100% return to get back to where you started. Again it’s being cognizant of these risks that are out there and we keep going back to this US dollar wheel that’s greasing the world.
Tony
Yeah. Speaking of currencies, Keith, you had posted this tweet earlier this week responding to a message from Kyle Bass about the Hong Kong dollar breaking and you said if the Hong Kong dollar breaks, the CAD also breaks. Can you talk us through that a little bit?
Keith
Yeah, because obviously we’re Canadian up here and the challenge that most Canadian investors have is that they don’t appreciate that the Canadian dollar and the Canadian economy and the yield curve up here in Canada, it can be significantly influenced by an external factor and that’s lost on most investors up here. So if you’re reading, like, big bank research, like, they’ll never. Sorry, they’ll rarely talk about these outside events. It could be something within the eurozone, for example, like the Italians or something. We know China is struggling quite a bit, but I will frequently talk and write and chat about these events and that if they happen, it is going to affect Canada. So the comment this week sort of stems back to… So we know the Fed opened their USD swap lines with all their friendly central banks that are set up for it and everyone drew on it. Everyone immediately. “Hey, yeah, we need the dollars.” But they also have this other repo line set up. It’s FIMA. I think it’s Foreign International Monetary Authorities. I think it is that stands for. So basically it’s a repo facility for central banks that are not attached to the swap line option.
Keith
That’s my understanding of it. And at some point, it was one week ago Friday, someone out there borrowed 60 billion USD for that. And if I think of people if you’re not aware how the repo facility works, Tracy, if I’m giving you $60 billion, you have to exchange with me at least 60 billion plus in US Treasuries to act as collateral for it. Even though you have Treasuries, you don’t have US dollars. We like to joke about if you go to a restaurant, you get your bill at the end of the night. You can’t pay it with a T bill. They’ll laugh at you. You need US dollars for it. So someone needed US dollars last week. And because of the size, and because they’re not one of the USD swap line friendly nations, you’re looking around who has that much in Treasuries that they can use for a repo? It really looks like it was or is China. And Hong Kong is the conduit for capital flows coming out of China. And it happened on a Friday afternoon. And as you know, if anyone here is running a bank, your goal is to last Friday afternoon and then you try to sort it out to get through to the weekend.
Keith
And then with that then 60 billion, it went to the Chinese, supposedly. And then every day this week we’ve had the Hong Kong dollar peg. It’s been up against its upper range, so it’s been sitting at 785, basically. And when it did open on Sunday evening, it actually broke through the range. So for this brief moment in time, it was up there. And so when I referenced that tweet, I’m more or less just pointing out to Canadians that, hey, if this peg was going to break, it is definitely going to affect world capital flows. Money will flow into the dollar, which means it’s coming out of the Canadian dollar. I like to poke Canadians sometimes with these things because they know we all feel we’re the best in the world at a lot of things, but that was the message with that.
Tony
Okay, so just staying on the Canadian dollar for a second, do you think the sensitivity with CAD, where outflows from CAD is as sensitive as, say, Hong Kong dollar could be? Especially given that CAD is so resource driven, do you think that would have an impact on it?
Keith
Yeah. So just be clear, if the Hong Kong dollar peg broke, this would be a once in two lifetime financial economic event. It will reverberate around the world several times over. If it doesn’t, and we’re just having a normal economic cycle, Canadian dollar is just going to ebb and flow with the demand for commodities and something else. But up here in Canada right now, we have a very tightly wound housing market. Everyone is familiar with that. There’s lots of reasons to support why it is strong. Our population growth has been unbelievable. We’ve had a million immigrants come in. In Californians, too. I don’t think they would last with the weather.
Tony
Albert’s got the New Yorkers. Albert and Tracy have the New Yorkers. We have the Californians.
Keith
So Albert and I met a few years back. I’ll give you guys one guess where we met in a location.
Tony
I don’t know if we can talk about that publicly.
Albert
It was actually Orlando. It was actually Orlando. I do like the Canadian dollar short term, anyways. But speaking about the population, I mean, the demographics for Canada is excellent. Probably the best they’ve had in a generation. The housing market is interesting, though, because I saw a statistic where in 2003, the average income for Canada was $60,000, yet the average home was 213. Now it’s $64,000 and $612,000 for a home. So the housing market is quite an anomaly in Canada. It’s over my head, but it’s something that I definitely should pay attention to.
Tony
I don’t mean this to sound stupid, but do you have the generational loans like they did in Japan back in the day? Do you guys do that up there?
Keith
What do you mean? No, our mortgage is…
Tony
One generation to nother to pay off a house.
Keith
No, we have 25 year amortization periods. The banks now have to do a few funny things to keep these loans from being impaired. So they’re extending to amortization period. But just a couple of quick things with Canada to be aware of right now. We have basically five major banks up here, and their loan portfolios are homogenous. They will tell you, no, we’re a little bit different than the next guy, but they’re all the same. So if we were to experience some kind of crisis in our economy or in the housing market, it will affect all banks at the same time. So we also have our term deposit insurance up here. It’s $100,000 canadian. It’s highly likely they’re going to need to increase that, but they’re not able to increase it to any level. That would actually be helpful if we were to experience a crisis because if one bank ran into trouble and they had to go to the CDIC to make a claim, all the banks are going at the same time. That’s just a function of what it is. But we are in this sort of precarious moment right now. We just had a budget came out yesterday, or the day before, I think it was.
Keith
And again, it’s like deficits forever, debt is going to grow forever, there will never be a recession. All these perfect scenarios are lining up. Again, we just like to highlight that we are in this global world and some kind of event can happen outside of your country. It doesn’t matter if it’s Canadian or Australian or British, something can happen that will trigger most likely would be a shift in your yield curve in some way where the credit spreads are hit or the long end of the curve gets hit, or banks have to take actual losses and things like that. And that’s when things get a bit funny out there. But that’s the story on what we see. Again, we think it’s incredibly interesting. There are great opportunities coming up, especially in the commodity world. We’ve been adding that space over the last three to four weeks. And the path that we like to talk about, not journey. The path, and it seems to be going where we’re expecting this year.
Tony
Perfect. We’ll talk about Canadians or commodities with Tracy in a little bit. But first, how is the Canadian consumer doing? We’re going to talk about the US consumer in a second with Albert, but how is the Canadian consumer doing?
Keith
You look everywhere, everyone is over levered. So you have that happening. Employment growth is fine, but if you look under the hood, it’s really in the service sector. One person might have they’re running three jobs, they’re an Uber driver, they’re running Uber food or DoorDash, whatever they call it, and maybe something else at the same time, because it’s kind of interesting in that we’re all expecting a recession to hit up here, but the data is still not showing that it’s going to happen. And the most important contributor, the positive contributor again, is population growth. So again, we’ve taken in over a million immigrants this year and I think that works out to about two and a half percent population. So our GDP per capita is actually declining, right? So if you take out the population growth, then we are struggling a bit. But Canadians right now, and banks are tightening their standards on lending. There’s increasing evidence that if we do start to see job losses, then it could be a bit rough. A lot of Canadians have bought houses over the last three years. They went with variable overnight mortgages, and all of a sudden, they’ve been resetting lock and step with the Bank of Canada.
Keith
So the good news is the Bank of Canada is done. They ain’t hiking anymore. Yeah, maybe we’ll get some relief with that. But the Canadian story, if something bad happened in Canada, it’s not going to affect the rest of the world. If something outside of the rest of the world happened, it will affect Canada. So we have this bit of a challenge here.
Tony
Okay, great. Keith has been it’s been really helpful to I mean, for people outside of the US and Canada. We’re different. The US and Canada are different. And Americans, I’m sorry to say, don’t really pay a whole lot of attention to what happens in Canada. So this really is helpful for us to understand this stuff. It is America’s largest trading partner, but we are a little bit selfish. And I’m sorry to say it, but it’s true. So it’s helpful for us to learn this stuff.
Tony
So let’s move on to the US consumer and little programming note. Sam Rines does not look like Albert. This is actually Albert. And so Sam Rines is ill. So Albert has so very graciously jumped in to this spot. And so, Albert, thank you so much. So I want to ask about the health of the US consumer. And Sam had done this newsletter earlier this week, and this is very much in line with things that you have been saying about inflation, Albert. And so let me just bring up a couple of things. And Sam brought up Carnival Cruise Lines earnings. And the highlighted part of this thing on screen says the company experienced the highest booking volumes for any quarter in its history, breaking booking records for both North America and Australia and Europe segments.
Tony
Okay, so Carnival Cruise Lines is not exactly a high end cruise line. This is a middle America cruise line. And they’re seeing bookings that are far beyond what they’ve ever seen. And next, Sam looked at the earnings for McCormick, a spices company, and McCormick talked about 11% growth from their pricing actions while they saw a 3% decline in volumes.
So this goes along with this concept that Sam has been talking about for about nine months called price over volume, where companies have been passing on their costs through their prices to their consumers while accepting a small volume decline. And so we’re definitely seeing the broad basis of prices continuing to rise in the US. And Keith mentioned this, that there is some broad expectation that we’re going to see a recession in the US. But Albert, we still see hiring relatively strong. We still see service wages strong. We still see price rises coming. What’s happening? How are we going to see a recession? First of all, what is your view of the US consumer. And second of all, how are we going to have a US recession while all this stuff is happening?
Albert
Well, the US consumer has been surging. It’s been relentless. I mean, wage inflation is at the core of it. I mean, people are finally the public is getting a 20-30% jump in their wages after 40 years of stagnation basically. It’s become such a problem for the Fed that they’re resorting to bank crises now to stop lending and credit from the banks. It’s just the reality of what’s happened. I don’t see it lighten up. They want the market up. That’s providing liquidity. Consumers are getting liquidity from all over the place. Certain states still have stimulus. It’s just relentless. And it’s really problematic for the Fed.
Tony
Wait, certain states still have stimulus?
Albert
Yeah, they still have stimulus programs. California has inflation checks and certain unemployment benefits are still rolled on. I think it’s 16 or 22 states still have some sort of stimulus programs kicked in for unemployment.
Tony
Okay, so one of the things that I’ve said today actually on Twitter about trying to pull back on the consumer is that we’re going to have to see some change in the housing market in order for the consumer to stop spending in the US. Because the perception of wealth in the US. Comes more from the perceived value of your house than it does from equity markets. There is this belief that as equity markets rally, there’s this broad basis of spending that comes from consumers. And while that’s certainly true for a portion of them, the value of someone’s house is so much more a part of their spending habits in practice. So does that make sense to you?
Albert
It does, but it creates another problem politically. Washington wants housing more affordable for their constituents. But on the flip end, the boomers don’t want to give up their increased prices of their homes. And on top of that, people are taking out Helocs and buying secondary and third homes for rental income. So this problem is just simply not going to end in the near term. And on top of that, thinking about jobs, when you talk about layoffs, it’s only tech. There’s not any construction jobs that are being laid off. I don’t know one company in the housing or construction field that’s dropped workers, the significant amount of workers, zero.
Tony
Right. Well, because there’s supposedly an undersupply of housing. That’s what we keep hearing. But when we hear about people taking home equity loans to buy a second house to rent out, how real is that housing shortage? I just don’t know. I mean, you can see all kinds of different data showing that there’s a shortage or not a shortage. But when we have a synthetically low interest rate and we have the Fed holding a lot of mortgage backed securities, we do have an interest rate that’s lower than it naturally would be.
Albert
Of course, there is. But when it comes to the housing shortages or oversupply or whatnot, you can’t even look at it at a national level. You have to take it state by state or even city by city. I mean, Florida and Texas are absolutely booming, but the same can’t be said for Pennsylvania. So I think we have to look at it from that aspect. It’s really hard to look at the housing.
Tony
We’re still seeing wages surge in the middle of the country, although they may not be surging on the coast. We’re still seeing prices rise and price and margins expand. With a lot of these consumer companies and services companies. We’re seeing patchy housing values rise or stagnate. What does the Fed do? Will we see a pause this year? Will we see a pivot this year?
Albert
I don’t think pivots even in the cards at the moment. A pause certainly is in the cards. The problem that the Fed faces is super core inflation. It’s just services like, even in Canada, like Keith was saying, is just sky high, rocketing up. It’s just not stopping. This is the biggest roadblock that the Fed has for combating inflation at the moment.
Tony
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Tony
Right, so we expect to see, I think you said before, at least a couple more 25.
Albert
I think two more before a pause hits.
Tony
Is it possible they could take some action on QT for MBS to hit the housing sector a little bit?
Albert
They could, but again, they’re facing headwinds from the boomers that are up there with Hank Paulson and Larry Summers and their crews. They certainly don’t want to hear from them that the housing market is crashing and their wealth being erased slowly. So that’s just again, there’s two dynamics. You have the middle class voters that can’t afford houses, and then you have the boomers that don’t want to lose their value and their wealth. So that’s what we’re stuck between.
Tony
I suspect that at some point that might be one of the only levers they have to pull to slow things down.
Albert
It’s a dangerous level to pull.
Tony
It is, but I don’t know.
Albert
I don’t even know if the banking sector can absorb too much of that kind of pain. I don’t know. I haven’t really analyzed that in any way. But theoretically, you start dropping housing prices 20, 30%, and I don’t even know what. That does to loans for people and the banks.
Tony
Keith, what do you think about that?
Keith
Just to add to that, back to the Fed comment, Albert. If you have the Fed hiking another 50 basis points and everyone else has effectively stopped, I think the ECB has stopped or they’re pretty well close to that. You could have this environment where maybe the economy does slow somewhat in the US. Yet the dollar is surging. Like it’s continually gets stronger and you just get this vicious cycle going back and forth with it. But it’s funny because everyone has been watching the Fed now since Jackson Hole back in August, expecting that they’re going to pivot. They’re going to pivot. And in my mind, I think the Powell has been very clear with which direction they want to go. And somehow they dodged that there at their last meeting, they had every opportunity to pause if they wanted to because of the banking crisis, and they just plowed straight through. So I agree with Albert. They want to continue hiking until they’re told they’re not able to do it anymore. And if they can get through several banks basically going under within a few days of each other and to continue hiking, then maybe there’s a world to get more than 50.
Keith
And again, if that happens, it’s going to push someone off sides out there. But that goes back to the whole global macro view.
Tony
Right? Well, we used to talk about how the Fed is going to push until something breaks. And so we saw some banks break and they’re continuing to push. So something else has to break. Right.
Albert
Something bigger.
Tony
What’s that?
Albert
Something bigger has to break. Something with more gusto to limit to help out the Fed right now. I mean, they unwound six months or nine months of QT in a week. Exactly. We’re back to square one now.
Tony
Right. And so banks failed, didn’t break enough. They want something else to break.
Albert
Joke. This bank failure thing is an entire joke.
Tony
Of course it is.
Albert
It’s a pre planned event. I mean, when First Republic loses 90% or 60% of their deposits and the founder is pushing back on the FDIC about a plan for salvaging the bank, it’s a joke. It really is.
Tony
Okay, so, Keith, you mentioned Fed continues to rise, stronger dollar. That seems to me to put pressure on downward pressure on commodity prices. Not necessarily everything, but it seems to put some serious pressure on commodity prices if we have a rising dollar, is that fair?
Keith
Yeah. I mean, our expected path this year with commodities prices that we go lower Q1 into Q2, and that’s exactly where we are. We start to see slower economic data coming out, Q2, Q3. They should bottom before any recession actually hits. So in that world, unless there’s a major supply disruption or discovery or something like that, we’re using this as an opportunity to start building small positions in that space, but you keep going back to like, is it a normal cycle or is there something else that may happen here at this point.
Keith
I think everyone’s been calling out for a recession. Say, hey, if you go from zero to five with overnight rates and the yield curve gets inverted so much, no matter which way you want to look at it, the recession is here and people have been looking for this back in Q4. Here we are, like five months into it and still no sign of it coming. Again, something is a bit odd out there. Maybe it’s just delaying the inevitable or maybe it’s as, you know, a bubble. You keep blowing into a bubble. I don’t mean that the economy is in a bubble or anything like that.
Keith
It just means that, again, everything has been synchronized around the world that it is giving the opportunity for something to go off sides. And when that happens, because everyone has so much risk on the table, people can start running around. And again, that doesn’t mean that you go all into cash or whatever your favorite overnight holding is. It just means you had to be aware of it and be positioned for it. And then when it does happen, it’s funny how nobody buys low and sells high anymore and most people do the opposite. So I think, though, maybe you can be a bit traditional, that opportunity will come up.
Tony
A recession is whatever we call it. So we had two quarters negative growth last year with strong employment. Right. So will we see the opposite of that this year with employment weakening but continuing GDP growth and maybe call that a recession? I have no idea.
Keith
Yeah, I think one of the main contributors to recession coming up is when banks stop providing credit to the economy or they slow the growth of credit. That’s the main thing to look for. And just using the Canadian economy as an example, that is happening. It’s now more difficult to get a mortgage. If you need credit, you’re using credit cards or stuff like that. I know the boomers are doing well. We always have access.
Tony
Boomers have always done well. It’s been good for boomers since they were 18 years old. They’re never going to suffer until they die.
Albert
That’s exactly what Keith is saying, is until the banks stop lending out, this is just going to continue. And this is most likely why this bank crisis was preempted, to stop the banks from lending.
Tony
Okay, so, Tracy, we started going down the path of commodities and with Albert and Keith, Albert thinks we’re going to see at least two more rate rises. If that strengthens the dollar. What’s your view on that in terms of general commodity prices? Does that push commodity prices down or do we start to see growth toward the end of the year pick back up and that helps commodity prices?
Tony
Sorry, you’re muted.
Tracy
Sorry. I think that it’s really going to depend on multitude of factors. The thing is that if you’re looking at some of these base metals, battery metals and things of that nature between energy transition and in Europe and North America have committed to this at all costs, even asking central banks to look past inflation in these areas. And so I think that demand particularly, and if we see pickup in China, which is also one of the largest EV makers in the world, I think that we’re going to have a problem where we’re going to have these metals go higher even in conjunction with a higher dollar. I think it’s very possible.
Tony
Okay, so let’s look at a comment you put out on Twitter earlier this week about copper.
Copper is critical to the clean energy transition. Europe and North America have committed to the transition. After 2023, incremental copper supply decelerates into 2030. And then you actually sent out a chart in November of ’22 showing kind of the copper supply gap. So can you talk us through why is there a copper supply gap? It looks like the supply just kind of flattens after growing. Why is the supply flattening out as demand is rising?
Tracy
Because we don’t have, because nobody’s mining it, really. We have about 1.1 million tons being added this year to supply as far as supply growth is concerned, and new supply coming online from new mining. But after that it levels off. And I actually sent you those charts so that you can show everybody, but you can see where supply growth literally goes from 1.1 million tons to literally nothing from here to out to 2030.
And then you have this incremental supply growth. When you’re looking at just take for example, an EV, right, it requires four and a half times the amount of copper as an ice vehicle. And when you start talking about buses, that’s twelve times as much. This doesn’t even include solar, wind, charging infrastructure and stationary energy storage that also require huge amount of copper.
And you have the green plan in the United States, and you have Europe’s rendition of a green plan, right? And so they’re planning to build all this out, and we just don’t have the supply available, and we’re just not going to have it. And if you add into this, for the past seven years, the mining industry suffered from the same problem that the oil industry has. Lack of capex.
Tracy
So you’re coming from already seven years of no cap, barely any capex, declining capex. So you’re not having supply really come haven’t had supply really come on in any notable amounts in the last seven years. And then moving forward to 2030, we’re not seeing that increase at all either.
Tony
Do you know that Simpsons meme, where they’re like barts in class and they say, say the line, say the line.
Tony
We’re going to think about that there when I say why has there been a lack of capex in mining?
Tracy
Because it’s dirty.
Tracy
Right? Is the reason.
Tracy
And nobody wants mining. Same with the oil sector. Nobody wants oil to drill for oil either. It’s dirty. Right? ESG these things are dirty, but yeah, we need them. So here’s our conundrum, and it’s not going to I think that not get any better. Regardless if we’re in a recession and regardless if we see the dollar spike. I mean, we’re already seeing copper prices are still holding up very well through this banking crisis, where we have seen oil wobble a little bit and the dollar has been over 100 and we’re still seeing these metals. We did see a pullback from the summer high when we had the electricity crisis or the natural gas crisis, right. So we did see those metals pull back from 2022 highs, but we’re starting to see them all spike again because again, we have these green programs that are coming to light now, particularly in the United States, and then again with Europe having their own kind of rendition of the IRA plan.
Tony
What will win? If you look five years out? Okay. And we have these ESG constraints on upstream development and mining and other things, and it almost seems like we’re going to have to continue to have some sort of subsidy for energy in places or some of that ESG regulation or legislation can change what will happen? Will ESG loosen or will we just continue to subsidize these things until we’ve kind of finished the transition, whatever that means?
Tracy
I don’t think just to reach 2035 goals right now, we need $35 trillion, right?
Tony
Because we’re just making money up now, right? So what is that $35 trillion spent on?
Tracy
And that’s just to get us to where the countries have their 2035 goals. So really, that’s not going to happen. You know, that’s not going to… Europe is not going to cough that up. United States is going to cough that. Canada is not going to cough that up.
Tony
Remember the Kyoto Protocol from the UN talking about green goals? It was done in 1992 or whatever. And I think the only country that did it was I think there were only two countries that did it, maybe three, like Canada, the US, and Iceland or something like that, right? So everyone signed this deal. These were all aspirational the goals were far enough advanced that nobody who signed the treaty was going to be in office when the accountability was made.
Tracy
Exactly. And that’s where it gets me to. My next thing is that they’re going to have to push these goals out. You know that, right. Because everybody decided these 2035 goals, whoever’s in office, we have the UK, and all these people are going to be gone, right?
Tony
Whoever is the chancellor in Germany will still be there because they keep those guys.
Tracy
That’s true. So my opinion is we’re not going to have enough money. You still aren’t getting these mining companies excited enough to you can’t get oil companies excited enough to drill right now. Right. They’re all focused on investor returns, paying down debts, capital discipline. It’s no different in the mining industry. Right. So we’re going to have a problem. So you’re going to have to pull just by pure logistics. You’re going to have to push those out. I mean, it’s just logistically impossible. We just don’t have enough metals, period. And you can’t just wish that into existence.
Tony
I don’t necessarily need to get into company names. And Keith, I know you want to comment. I just come to you in just a second. But I’ve been trying to think of how do you play this ultimately, because all of these green things plug into a grid. So is the ultimate play for the energy transition power companies or the companies that provide hardware for the power grids? What is the real play here?
Tracy
I think that it’s infrastructure to build all this stuff out. Right. So I like things like heavy machinery, steel, things that make infrastructure to actually build this out or to mine, right. Not necessarily the actual metals themselves because those tend to be very volatile. So I would look at what goes into making these metals, what goes into making these grids. That’s where you’re playing. Utility companies are, I think, going for the utility companies, they always get screwed in the end. That wouldn’t be my go to for an investment longer term, looking at this sector. So I was more into kind of the infrastructure again.
Tony
Good. Okay, Keith, you had a couple of things you wanted to say.
Keith
Yeah, I just love this conversation. And maybe one thing for us to think about is that maybe the current path we’re on, it changes. So we get the pendulum swinging to the other side where it’s no longer whether it’s socially or politically, you don’t have that huge push towards green technology and so forth. It doesn’t mean that people don’t want it, but it’s not going to be pushed by the public sector. Instead, it’s going to be into the private sector. And that could change a lot of things. I do think that a lot of countries are going to be prohibited from doing a lot of these investments because they just won’t be able to raise the capital in their bond markets. And there’s also going to be other needs coming up. Again, I go back to here in Canada right now with their budget that just came out. 10% of our at the federal level of our tax revenues are now going to interest expense on the federal debt. Again, I suspect everyone is in that kind of position. So what worth goes. I love the concept of stranded assets in the energy and commodity space.
Keith
I’m incredibly bullish on this space and maybe the dirtier that the commodity is is probably the better opportunity for return. And again we’re just in this world now, we’re even having this conversation. It’s not acceptable by some sides but I think we have to be realistic that we live in a period of extremes and I think if we’re using linear thinking that that’s going to be wrong. Like something will swing back to the other side.
Tony
Extrapolate today until forever.
Tracy
I actually tweeted out a German survey today. So only 10% of Germans believe that renewable energies will be able to meet energy needs for the foreseeable future. Even among the Green voters, that figures only 18%. Instead citizens want natural gas 59% and nuclear power 57%. And that’s across all parties in Germany. So the citizens wants, needs, likes are not necessarily coinciding with our government overlords. Right.
Tony
Because they’ve lived over the past year. Right. They’ve seen how this stuff can’t meet their needs.
Tracy
Swinging.
Albert
Well, the wall of reality is starting to hit these governments. Like what do you do here? You got a budget, you have to increase your defense. Specifically for the Europeans, you have to increase your defense budget. You still have to maintain your social programs. You still want to push these subsidies for renewables. There’s no money for that.
Tony
It also comes at a time where you have a lot of baby boomers retiring so you don’t have the income taxes on those guys going into your budgets. Right. So you’ve got a gap of say ten years until millennials hit that income level. And so there is a revenue issue and a spending issue and yeah, I think there are so many things in this calculation that it’s just a very.
Albert
These renewable programs are nothing more than tax schemes by the government. They see their budgets dwindling so they know that they can tax and spend a little bit more by throwing out these beautiful narratives like the Paris Accords where nobody but the United States had haired to.
Tony
So whatever we’ll go from there just a little fact and I’m sure I’m not going to become anybody’s friend from this, but I actually co authored a couple of papers with my friend David who was the person who pulled the US out of the Paris Accords in 2017 on behalf of the Trump administration.
Albert
Good. Exactly what they should have done. If people are going to make up their own numbers and have no mechanism for enforcement, then what do we do?
Tony
Exactly. So that’s where I sit in that anyway. Okay guys, really quickly to wrap up. Keith, your first. If we look at the week ahead, what are you looking for in the week ahead? I’m not looking for companies or anything here, but what are you looking for in terms of issues whether in Canada or globally or the US or something? What do you see in the week ahead?
Keith
I mean for one week ignoring any economic data points coming up, we’re finishing quarter end today it’s been risk on for the last ten days. I suspect on Monday morning we might see a bit of a shift in that stance, but that’s it. We continue on this. I keep going back to this path and where’s the next kind of crisis going to escalate from.
Tony
Good call. Great. Tracy, what are you looking for?
Tracy
Well, OPEC meetings this week. I expect no change, so nothing really to get that excited about in the oil sector.
Tony
Even with crude prices continuing to wait.
Tracy
No, I think they’ll stay the course right now because I still think that we did have Russia come out and say they’re cutting 500,000 barrels per day. It was just supposed to be just for March. They pushed that out to June. So I think that OPEC will kind of look at that and want to see how that is factoring into everything as it is.
Tony
Very good. Albert?
Albert
Specifically grains. I’m very curious to see how grains are in the commodities market, and whether food inflation starts to go up because wheat starts going up also. The Ukrainians said that they’re 10% lower on their crop yields. The Russians have been starting to make noise about Cargill. So I’m going to be very curious to see if we can catch a bid and drive itself up into the 800s.
Tony
Okay, very good, guys. Thank you so much. Thank you so much for your time. Have a great weekend, and have a great week ahead.
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This Week Ahead features a discussion on banking systemic risk versus inflation with Hugh Hendry, Tracy Shuchart, and Albert Marko. The group covers recent events in the banking sector, including Credit Suisse and the potential risks posed to the global economy, the impact of higher interest rates on crude prices, and China’s growing diplomatic role.
To start, Hugh expresses concern over the lack of GDP per capita growth since the Great Financial Crisis and the failure of the remedial work undertaken since then, labeling the current environment as “The Great, Great Depression”. He warns that raising interest rates in this environment could be disastrous and discusses the creation of credit and the muted credit cap, as well as the contraction of the M2 series.
Hugh questions the need for central bankers and believes that the totality of credit creation should be examined. He suggests that the bond market has been more accurate in predicting rates than central banks and he notes that there are persistent trade surplus nations that create surplus capital, which is being invested in the United States, resulting in asset price inflation. He argues that the problem lies in the flow of capital rather than the currency (the US Dollar) itself.
Next, Tracy highlights how rising rates are affecting the prices of commodity cargoes. The discussion digs into the possible impact of falling cargo rates on the supply and pricing of commodities. Meanwhile, the discussion anticipates that the upcoming CPI report could inform the Fed’s expected raise of another 25bps at this month’s meeting. They also discuss the ECB’s recent 50bps raise to offset European inflation.
Finally, Albert leads a discussion about China’s shift from an aggressive “wolf warrior” foreign policy to one of a peace negotiator. The discussion explores the motivations behind China’s recent diplomatic efforts to negotiate a Saudi-Iran agreement and facilitate a Russia-Ukraine peace agreement. They also explore the position and potential level of involvement in these discussions by the United States.
Key themes: 1. Banking systemic risk vs inflation 2. Higher rates & commodity cargoes 3. China: From wolf warrior to peace negotiator?
This is the 57th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. My name is Tony Nash. Today we’re joined by Hugh Hendry. I don’t think he needs an introduction, but Hugh is a founder of Eclectical and Macro, as well as being a hotelier in St. Bart’s and a lot of other things. We’ve also got Tracy Shuchart with Hilltower Resource Advisors. And we’ve got Albert Marko. Guys, thank you so much for joining us. So much has happened over the last two weeks in the banking sector and especially over the weekend with Credit Suisse. So looking forward to a lot of this discussion.
We’ve got some key themes today. The first is banking systemic risk versus inflation. As the Fed meets, and as we sort out a lot of these banking backstops, I think there’s a lot of discussion about which is more important right now. I think a lot of it is focusing on banking systemic risk panic, but we’ll talk through that with Hugh. We also want to talk about higher rates and commodity cargo prices. Tracy brought some thoughts about that earlier, I guess, over the weekend. So we want to talk through that today. And then we’ve seen China kind of come forward as kind of a negotiator for the Middle East and Russia, Ukraine and other things. And I want to talk to Albert about kind of how real is that, how much of a good faith negotiator is China in those areas?
So, Hugh, first of all, thank you so much for joining us. Hasn’t been easy to get you, and we’re really glad to have you. So we really appreciate having you here. Great. So first off, banking systemic risk versus inflation. Everybody knows the Silicon Valley Bank and First Republic and the BTFP stuff here in the US. All the Credit Suisse and UBS stuff happened over the weekend. What are you watching there? Like, what’s your biggest worry? Is it these 81 bonds? What are you focused on there?
Hugh
Well, I have been focused for some time. My focus has been this impending car crash, which is now becoming more apparent perhaps to the many. And my concern had been Fed by my observation, my belief that we’ve been operating in a silent form of depression ever since the remedial work undertaken since the great financial crisis. Let’s date that to March 2009. It has been a spectacular failure. I will share with you a chart. Maybe we’ll be looking at it now. And it comes from who does it come from? I want to say I always get these names mixed up. Michael Klein. I think the wonderful economist academic works of Michael Barr, doesn’t work with Michael Pettis, but collaborated on trade wars, of political class wars. And he shows the indexing of US GDP per capita from the starting point of the Great Depression. And likewise, he superimposes a similar series for now, if you will, from that March 2009 and over the period spanning to almost 15 years us. Per capita GDP in the Great Depression went from 100 to almost 190. And this time around we’ve gone from 100 to 115. So I said silent.
We should call it the Great Great Depression that no one is allowed to speak of. We went through the pandemic environment to realize that there are some terms where there’s almost a censorship and it would seem that in US financial literature the word depression has been assigned to the past and not to the present. So raising interest rates in a Great Depression has filled me with dread and I think that is what has come to light in the last ten days or so.
Tony
So when we look at the amount of credit that’s been created since the financial crisis and kind of the payoff in terms of GDP per capita, is that one of the variables that concerns you most? I know it’s everything and I think we’re all looking at everything, but it seems to me that the payoff for every dollar of debt incurred by the government and by individuals is rapidly kind of falling down.
Hugh
Yeah, I would say that the credit cap has been muted. And again, I make a distinction between sovereign dollar creation and by that I mean the dollar creation from onshore domestic US banks entering into new loan agreements and if you will, printing dollars versus the dollar creation. I would call it non sovereign, which is the Euro dollar which is taking place offshore and where with the ability to provide collateral, new dollars will be created. Now, the Fed I believe, is less interested in the latter and I believe over the last 40 years the latter, these non sovereign dollar creation have come to be really much greater than the sovereign onshore and the credit provision there has been really to fund assets and it’s funded asset price inflation. And I think market participants have been very aware that that credit spigot got turned off, let’s say 18 months ago very dramatically. So I would say it’s been contracting. And now we’re seeing I don’t like discussing the M two series because I think it takes away from this non sovereign creation, but we’re seeing that the onshore M Two series is now contracting as well. We don’t have much per capita GDP augmentation to show for for that.
Tony
Right. So so wouldn’t, after all of the creation of money in and I would say through, largely through government spending and obviously Fed balance sheet in 2000 and 22,021, isn’t this kind of a normal reaction, kind of a normal medium term reaction to that much creation and distribution of money into economies?
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Hugh
Well, again, it’s kind of crossing my arms. It’s a funny money conversation.
I keep saying, I go to Starbucks and ask for a caffeine latte, and I promise to pay it in bank reserves, and they kick me out. The Silicon Valley Bank was acutely sensitive because their corporate customers are startup businesses, which are very much at the riskier end of the spectrum. And typically that bank would be funding between the last six to three months. Your cash is disappointing. You need another fundraise.
But the bank steps in and it holds you over. There was no prospect of more fundraising, so it was kind of exaggerated. But I think with the other banks, what you’re seeing is that and with Silicon, you were seeing that their assumptions with regard to operating cash flow from their client, from their clients, just was not being met. That actually the economy is weaker. That we’ve we’ve, again, within this kind of silent depression, we’ve imposed I mean, I don’t dispute we’ve imposed structurally higher prices, but without again, without the legacy of a dynamic of credit creation, which left, like, a really strong economy, which was to be tamed and to be tempered by the Federal Reserve’s oversight. To my mind, it’s been a muted economy for the real folk. If we move a kilometer or so outside the financial centers of the world, the real world just seems rather grim. And that real world is being hammered by higher rates. And again, with the prevalence of debt, I keep saying, if debt was one X GDP in the so we’re taking out decimal points, then I’d say we’re four X today. And so the Fed at 5% rates is really the Fed at 20% rates in the 70s.
If I can get away with that kind of leap and you break things and we’re breaking things, that’s been my concern. My concern is, I believe, that the depression has been fueled by Bernanke. Back in was it 2013 when we had the taper tantrum, where he encouraged the private sector to raise rates on his behalf? We had seven and a half percent adult unemployment. He was saying, Heavens, I’m beginning to worry that the economy is getting overcooked. The market doubled ten year rates. You know what? The economy hit a wall. Then we had John Yellen, tentatively, in 2015, trying to raise rates again. Why? There was never this economy which was running away. And then you had Jay, and Jay is just being determined from his first day in office to kind of be some kind of volcker guy, what was it called? The Duke of York. He marched them up to the top in 2018 and promptly had to take them down and then he came back again and finally I think I feel like particularly the American economy has been crucified on the cross of Jay’s miscommunication. During the pandemic, he explicitly said on daytime television that they were printing money.
I get why he said it. He was saying it to alleviate the real fear of that time. But it was I mean, I’m going to say it, it was a lie. And so he now owns the price, I would say. Is it causality? Is it something I don’t think the inflation that we saw is monetary. I say it was a supply side thing. I think it will abate because the monetary power will not be there to perpetuate it. But Jay couldn’t escape that. He was the guy who said I’m printing money and then you had an explosion in prices. And so they’re fighting desperately to kind of preserve or reign back their reputation. But it’s the economy and these banks and other actors which are feeling that.
Tony
Yeah, I guess so if the Fed is kind of trying to bring back in their reputation I know this seems a little bit random, but who has a better reputation? Like all central banks have terrible reputations right now. No. So are they in fact the best of the major central banks or are there other people that are more credible? ECB raised 50 basis points last meeting. So is that a credible trajectory?
Hugh
There’s only one thing we know for certain that the ECB will raise rates at the wrong time.
And again, it’s like the pushback I also have is just tell me the last time any central bank made a glorious decision, you thought, gee, these guys, they got it, they got it. Maybe it was 1994 and there was a kind of preemptive hike by Greenspan maybe, but 1994 is a long time ago. So in terms of do we need central bankers? Given I mean the American central bank is the regulator of the onshore banking sector and I maintain that we should be investigating and spending a close amount of money to examine the totality of dollar creation, credit creation because I believe it’s tremendously larger outside the review of the central bank. And then finally, who does it better? Well, the inversion of the treasury curves, not just the US treasury, but it’s a global phenomenon. If you’ve seen what the German curve has been doing, especially the last really if following that huge eruption in the UK pension market when we had the fake budget or whatever, when you have an inversion, it is not the bond market telling you it’s best guess of where rates will be. They create the inversion via a desire to hedge against the expectation of negative consequences like unforeseen consequences of Federal Reserve tightening in a world of tepid demand.
And in a world of great leverage, the bond market has been spot on. Those inversions are at record levels. And again, we are seeing a record form of banks going wrong and needing record forms of financial intermediation from the central bank to fix it.
Tony
Right. So it’s interesting when you say do we need central banks? I know that’s a hypothetical question, but especially over the past week and a half, as we’ve seen the Fed come in to backstop bank runs, that’s precisely the reason why central banks were created. Is that right?
So they kind of are with this BTFD, they’re kind of doing what they were created to do. And I guess with the Swiss central bank, what they did over the weekend, they’re kind of doing what they were created to do. Although nobody loves the fact the kind of bank bailout discussion nobody loves that, but they’re kind of doing in the purest form what central banks were created to do. Is that a fair categorization.
Hugh
At the tail end of the process? Yes. I don’t dispute what they’re doing. I wouldn’t ask them not to do it. Right. But I feel that especially this time around, they are the malignant force that is causing the failure in the host banks. I mean, Credit Suisse credit Suisse has been a problem that should have been addressed at least a year ago. Oh, yeah.
Tony
It surprises nobody. I mean, the fact that anybody’s surprised is surprising.
Hugh
And there’s no bailout. Even if you bought the equity on Friday, I think you lost 60%. The equity lost just about everything. And of course, that spread into one of the tiers of the kind of quasi debt debt structure. So again, we accept that. The wider question is just why is it happening and why is it caught out the central banks? There’s no dispute that the central banks are responding. And I don’t take huge exception to how they’re responding. I take exception to the fact that they’ve been the custodians of a if you were to accumulate the myths in potential GDP you know this, Tony, that in the 30 years up to 2007, most kind of g seven. Economies outside the phenomenon of China were kind of compounding like 2.7%. And it’s been more like one and a half in those years since then. So the miss is now the equivalent of the entirety of the Chinese economy. It’s a big mess. I think it stems from a change in the risk seeking behavior of the horse bank supporting the euro dollar system. They had a near death experience and they’ve been regulated to bring it down.
Okay. And secondly, it’s been periodic preemptive hiking by the central bank, maybe with a noble cause, but actually ending up doing wrong. Those those two functions. I actually believe at the end of this, I think we’re I think the generational time clock where you get profound, you know, like ray Dalio talks about these things, you know, 75 years. He has different clocks, and they all have like, a variation of 25 years, give or take. But we’re in one of those variations in terms of where we look at the underlying monetary system. We had a gold standard. It failed. Great Depression. People talk about bread and woods. I think bread and woods was a kind of in between. It didn’t really work. Private banks went, this doesn’t work. Let’s work it to our ends. And I think that Eurodollar system from was it NatWest Bank in London in 1956 or something, I think that system is near its death as well. I think we’re getting to the point where we’ll have to invent a better way now that’s not to kind of come back and see the dollar is doomed. It’s actually that the system that America accepts is really no longer doing it.
It’s not an unfair advantage. It’s the opposite. You have to really question why they support it. What do I mean by that? Why they support being the recipient of the world’s surplus capital inflows? Why are the world’s capital inflows going into the US. Where they have absolutely no desire for investment beyond the domestic pool of savings? Okay? And so the result of that is we get profound asset price inflation. We turn an economy famed for its entrepreneurial ship, and we turn it into an economy of speculation. That speculation is being unwound with the advent of GDP. When debt accumulates or debt to GDP rises, then you end up there’s a danger that you’re overstating the current GDP at the expense of future GDP. And as you overstate growth, you kind of create a fictional wealth in terms of the price of property, the price of price of stock market, the price of private equity. And it’s not done through kind of sinister means. It’s a miscalculation. And the US. Now, for the last heavens, the last 25 years, we’ve had, what, three or four events within 25 years that in a normal distribution, if there is such a thing, you’d expect these things to be spread out over 70.
We got four events that you would expect to kind of come to bear over maybe 100 and 5200 years. And yet we’ve seen it within 25. It’s no longer doing the US. Any favors. And so I think ultimately the US. Will have to look to perhaps mimic China and say and put up barriers whereby you cannot be the recipient of all these surplus capital flows. I think there would be a better place for that, but that’s perhaps for another time.
Tony
That’s really interesting.
Albert
I’d like Tony. I don’t want to be the one to defend central bankers, by all means, but how much of it is political influence for central bankers to combat supply side inflation? I mean, voters in each of these countries are facing 2020 5% inflation on goods and services and the way I look at it is those politicians need to get reelected. And for them to push back on the central banks to try to do something to combat inflation is the way that I would work it.
Hugh
I agree. It’s an agency to my mind, this is an agency problem and not an economics problem. I mean, it’s creating an economics problem, but it’s the agency of government. It’s the government being the principal and turning to its agent, the Federal Reserve, and saying, you guys messed up and messing up. You affect me, okay? And if you affect me, I’m really going to affect you. So do something about it. It’s mafioza. But my point is this is not an economics problem. Inflation I was saying she was going to have all my tombstone. Inflation is a monetary phenomenon, okay?
Tony
Many tombstones, not just yours. Yeah. So, Albert, what you brought up about the euro dollar kind of out kind of outlasting its use. What are your thoughts on that? I know you know the euro dollar inside and out. Can you talk us through your view on that?
Albert
The problem that I have with that argument is there’s just no alternative at the moment. And I understand what she was talking about is, yeah, maybe we should look at a different alternative. And I think I was on this podcast maybe two weeks ago where saying that theoretically the Anglo sphere could come up with a digital currency founded by the dollar and whatnot to come up with a new system. But these are all theoretical policies that I don’t know how would they work. I don’t know what it would do to the economies, how things would even transpire at that point. There’s a lot of unknowns, in my opinion. But I don’t think that the euro dollar I don’t think even Hugh believes that the euro dollar is in any danger of going away in the foreseeable future.
Tony
Right now, the Euro, if we go back 20 some years, the Euro was supposed to kind of be that offshore mechanism, but it never really worked that way. Partly because the Dutch and the German.
Albert
Different national interests tony the different national interests, different financial policies, different political interests. It just doesn’t work right.
Hugh
But it’s also tony but it’s this point that Europe is founded still upon the rock of Germany, Holland, et cetera. And these are persistent trade surplus nations that create surplus capital, and that surplus capital is invested in the United States. The housing crash of 2007, 2008, the majority of mortgage credit was provided by European banks, not American banks. So again, Europe and China, Asia are less open to the flow of capital than principally the US. And the United Kingdom. I don’t believe to Alba’s point, that we have to invent a new currency. I don’t believe it has to be digital or physical or, God forbid, commodity. There just has to be a greater regulation in the conduct and behavior of trading blocks with regard to each other.
Albert
I agree. There’s a problem where Yellen is the one she’s done this before in 2013, where she drives up US. Dollar policy and hoping that capital comes back into the United States to keep asset prices elevated just purely for her own labor ideas and political leanings. So that’s something like for me, if you don’t put any controls to stop yelling and others from doing this, they’re going to just keep doing it over and over again. We’re going to be stuck in a doom loop of capital flows coming into the United States.
Tony
Okay, but that’s interesting. What you said, Albert and Hewitt, you said about almost trade flow. So it’s the flow that is the problem. It’s not necessarily the currency is that my point.
Hugh
And again, there are achievable. Here we are, and we want to talk about Greta’s recent Silicon Valley, but it’s buried so deeply the underlying problem, which has been with us for at least 25 years. I want to say that the last time the kind of Charles Kindleberger handbook to a currency crisis actually worked out with the great logic of his orthodoxy, where you could monetize it was the Thai bat. And since then and what was the change, because it was the specter of China et al. Seeing the vulnerability to those Asian currencies from being so open and so those bolt fast to being effectively closed or very much controlling the money coming in. So in return, the US. Has had profound asset price inflation. Now, if you wanted to discourage that, you could put a withholding tax on treasury holdings by central banks, by foreign central bank. They already have it at custody with the New York Fed. And and I don’t believe that these institutions are like hedge funds, that they are profit seeking. They are working to a political goal and they will pay it. And if you squeeze it enough, you may actually discourage them, but at least you could impose a rent on their behavior and the disturbances that that behavior is, as we see the disturbances today, play out again.
Tony
Okay, very interesting. Okay, so we’ve gone into kind of the core of the problem. But if we go very short term because we have a Fed meeting coming up, everyone’s nervous about the systemic banking crisis or inflation, what do you think takes the priority in the next Fed meeting? Do you think the Fed stays on its trajectory? And all you guys, Tracy, Albert, Hugh, what are you guys views on this? Do you think the Fed says, hey, this banking thing scared us. We’re going to stamp pad on zero for a meeting and then we’re going to see what happens? Or do you think they proceed with 25s as they’ve been talking about and saying, hey, we put the backstop up. The Swiss central bank came in and put their backstop up. All is good with the banking crisis. Nothing to see here. We’re going to keep fighting inflation. What scenarios do you see them coming through again with a very short term mindset.
Hugh
Or Tracy, forgive me, Tracy, we haven’t heard from you. Why don’t you contribute?
Tracy
That’s fine. I hate having an opinion. Because everybody has an opinion.
Tony
Yes, that’s why you’re here.
Tracy
Everybody’s talking. I would think they stay at 25. That said, I think that if they decided to hold, that would be great news for commodities, and the commodity markets would react very positively towards that. But I think that they’re going to stay with the 25 because they’re going to say everything’s contained, just like we’ve heard a million times before. But we’ll see.
Tony
I remember in 2007, at the beginning of the financial crisis, the early indication said, it’s a 200 billion dollar loss. We’ve got it contained. Nobody talks about this today, but it’s $200 billion. Don’t worry about it. It’s all fine. We’ve got it contained. Is it possible that we’re in one of those scenarios now where 2007, $200 billion, it’s all fine, and we just kind of keep kind of raising into this when there’s a bigger specter living out there, or do you think it’s done? Tracy?
Tracy
I feel like this is not a repeat of 2008. I think it’s completely different. So I don’t want to equate it with 2008 exactly, but I feel like the rhetoric is kind of the same where everything’s contained. It’s okay. We took care of it.
Tony
Yes. Okay. Very good. Albert, what’s your view on the next Fed meeting?
Albert
You think they’re going to do 25? I don’t know what they’re going to do, but I think they should do 25. Going to zero. Pausing is, I think, a bad sign for the market. I mean, it might be bullish for a few days, but realistically, it’s not going to help solve anything to do with inflation, specifically supercore, which is what I think the Fed is. Powell has said himself is what he’s been watching, and its trajectory is going up. So I think they have to stay the course and do 25. That said, they could do zero just because this banking issue has gotten, at least in the press, out of hand, with a lot of bazookas being sent out by central banks to squash it. So we’ll see. But I hope they do 25.
Tony
So if they do zero, do you think it indirectly confirms everyone to worst fear? It’s like, oh, my gosh, they did zero.
Tracy
It must be worth really bad.
Albert
Yeah. Narrative wise, that’s exactly what I would be thinking. It’s like, what’s going on? Why are they overreacting like this? So that’s exactly what I think the sentiment would be. Definitely negative over the long run.
Tony
Right, Hugh?
Hugh
You’re all blinking crazy. May I remind you, for the last 15 years, the growth in per capita GDP for the average American has been catastrophic. It’s been one 6th that experienced during the Great Depression. And we’re talking about the Fed hiking rates further. I recall my trading experience, Tony, you mentioned 2007, and I always sat on big dumb leverage positions and we had northern rock go under. We had some French banks kind of have closures, but it was still modest. It wasn’t really what we’ve seen of late. And the Fed cut rate and the S and P was like pretty much at his all time high. And they won’t do anything. They’ll talk about it. They’ll express concern, boom, cut interest rates. The question is, is that an old Fed? And that may be relevant in the sense that I think the Fed should have been cutting rates six months ago. I think that the sovereign curves have been telling you that. But they’re kind of trapped again to the agency point and to the assumption, as Tracy said, hey, if they hold, can you imagine they cut, your commodities would be off to the stars and risk assets would explode.
And I think the Fed is very conscious of that. And so a Fed that should be, I think, should be cutting. Can I just say, banks have discovered that they have funding deficits. These regional banks, they’re not money center banks. They don’t have colossal sums of other instruments that they can sell off to meet liquidity needs. They have illiquid pools of mortgages to corporate America. And what you can do with that is you can package them like a CDO, these illiquid tranches, and you can offer it to the big money center banks and they’ll give you Treasuries. And then with the treasury, you into the eurodollar system and then they’ll address your funding. Now, the funding is coming I believe the funding is coming from the inflation in that everything is 15% or more expensive, but the underlying business health and revenue isn’t there. And so the corporate customers are their cash balances are coming down and down and down, creating the deficit which these banks can’t fund. Like I say, we’re in a depression. And the preoccupation is how far will the Feds raise rates? It’s going to get worse. The economic fallout, the consequences of this, like finding you remember, we have what percentage of the economy is the Frankenstein businesses that were supported by the fact that the carry was so low?
How much of the economy is the conceitful economy, which hasn’t marked the market, is I am full of angst.
Tony
But are we here partly because interest rates were kept so low for so long? I mean, that was really on some level, what was behind Silicon Valley Bank is they were holding this debt that was so far underneath the market that they couldn’t keep up with their cash needs. So is that part of the problem? If they cut rates, it puts us back into that environment?
Hugh
Yeah, that is the problem. But the deeper problem again, is beg of thy neighbor policy. We’re. Missing, like I say, $15 trillion of global economic demand. And I think that’s because China et al, pures a policy of making things cheap and keeping its current. Imagine if where are we on the remembri? We’re six.
Tony
Nine.
Hugh
Yeah. Seven. Eight. They call it seven. It was at nine when we created NAFTA many years ago. So nine to seven in terms of appreciation, the damn thing should be at four. The Chinese should be the citizens in the household sector should be really rich, they should be buying tons of overseas products and we wouldn’t have that deficit. But again, owing to the Thai pad episode and how we’ve organized trade flows, that hasn’t happened. And so, again, that’s why the per capita GDP for the ordinary folk in the States has barely budged, which is why we’ve had to keep rates on life support. But of course, the consequence is you blow up asset prices and trying to get the two balance between the two. I don’t envy anyone that decision.
Tony
No, it’s painful. And as we see housing prices come down to earth, if that happens here in the States, that’s where most people’s wealth is based. Right. So if their portfolio is coming down a bit, if their house price is coming down a bit, there are a lot of delicate balances, delicate, say, household balances, that will be upset here in the States, if not globally. So I think you have a great point. I think it’s a really difficult dilemma. I hear people all the time talk about how dumb the guys of the Fed are. They’re not stupid people. I don’t think they’re stupid people. I think they understand the problem. I think it’s a very complex issue that they have to get out of.
Hugh
Right. Yeah. Can we ask Tracy? But on oil, why is oil so weaker? And where that huge surplus has come and it’s changed the shape of the curve, there’s no demand for it. Can you speak to that?
Tracy
Yeah. I think part of the problem is a lot of Russian oil is still on the market that most were anticipating. It not be. We are seeing China demand come back, but not as fast and furious as everybody had anticipated, and still kind of very soft, even though mobility data has improved significantly. Still, their demand for oil is because they were stocking it for a year in their surplus. So they have a lot of surplus. So obviously they’re going to drain that first, while oil prices are high and making deals with Russia for cheap oil. And the other part of it is that interest rates are high, and that is because when you’re talking natural resources, they’re particularly exposed to rising rates, right. Because trading houses rely on bank credit to buy, transport and store these commodities. So with higher rates, what is happening is these companies are either having to sell right away at any price because they can’t hold it like they used to and wait for a better time to sell when the price was higher or the opportunity was better. So they’re having to sell it right away for whatever price that means, which is also causing downward pressure on prices right now, realistically speaking and hearing from some of the big trading houses that they’re having to forego some trades.
Tracy
Right. And so that’s stranding product with the producers. So I think that’s why we’re seeing weaker commodity prices pretty much overall.
Hugh
Do you have data on the driving statistics in the continent of North America?
Tracy
Yes, I do.
Hugh
Am I making it up to say that here we are, so many years after the pandemic when we know that everyone was kept at home and that the mileage is not really changed much?
Tracy
It really depends on the area, I think. Right. So we’re kind of still seeing more limited in, say, some of the blue states where you’re seeing a lot of uptake in some of the red states. Obviously, in the south there’s a lot more mobility, or the mobility data is a lot better. If we go and we look at TSA, I mean, TSA, we’ve been wobbling, like just above 2019, just dipping just below and then just above. So that data is still pretty strong. So that looks good. But mobility data is very regional in the United States.
Hugh
And I guess with anyone shouting at the screen saying it’s the adoption of Teslas and electrical vehicles, I hear you. But the whole notion of this curse of inflation, that it doesn’t persist, or a sign that it’s unlikely to persist, is when you see changes in economic behavior where you have discretion. You cut back because you just don’t. Have the financial wherewithal to support a wallet which your wallet is not 15% higher. But the price of goods and services are 15% higher. And so maybe driving would be discretion in that sense. Anyway, thank you for that.
Albert
Yeah. On top of that, I’ve talked a lot about Spr releases timed with the Fed selling oil futures to bring down the price of oil in their mind to help combat inflation. I mean, that’s something that’s happening.
Tony
Happened.
Albert
Last year for a little while. And I know that they’ve been doing it again this year. And, I mean, I heard through the grapevine that it was up to $800 million worth.
Hugh
Really? So, Tracy, I thought that had come to an end. The biden policy of selling the reserves, the oil reserves.
Tracy
We have the last little bit sold in December of 22, and that was from that 180,000,000 barrel release that was released throughout the year. There’s about 26 million barrels to release this year. That was scheduled back in 2015. That’s part of a whole different deal. It was part of the upgrading of the Spr, paying for the upgrades of the Spr. So that release will still happen. The thing is, traders were looking at at these prices the government was going to rebuy. Right? And so they did hold an auction on in January and they didn’t get any offers. They didn’t get any bids so they decided not to do that. And people are definitely looking at prices this low because really their target area was $68 to $72. So at these prices they were looking for the government but it looks like that’s just not going to happen because I think they are very happy with prices this low and they know if they start reflecting the spr that’s going to raise prices.
Tony
Okay great, thanks for that and Tracy, I appreciate the cargoes or the pricing and the urgency of the finance of commodity sales. How long do you expect that to last? Do you expect that to continue to last for the next couple of months or is that something that we’re just kind of in this period where things are changing really fast and it’s a relatively temporary issue?
Tracy
Yeah, I think it’s a relatively temporary issue. I think really what we’re going to I still think we need a few more months to really see what Russian oil is or is not off the market. And by the way that is getting very difficult to track these days because they have their own fleets and you have a whole gray market there. But from whatever Sts satellite information that those people gather they are seeing a lot of product build up on water that’s not going to be able to be sold because February 5 is when that policy enacted with the ban on products. So I think we still need a few more months to see where that goes. I still think we need a few more months and I’ve said this for months now when China started to reopen I said I think this is not going to be like it’s going to cause commodities to skyrocket. I think it’s going to be very bumpy. I think particularly the property sector is still a mess. They’re not building anything there’s not really creating a lot of stimulus right now and they have a lot of oil stored.
Tracy
So I think they’ll need to kind of work through those issues a little bit before we really see China demand take off. Maybe an H, two of the share if the whole world is not in a global depression.
Tony
Yeah I remember a few months ago I remember a few months ago talking about that when China was kind of supposed to open in Q One and there were a lot of cheerleaders saying it’s going to be a rocket ship, it’s going to take off really quickly. And I think what we talked about here was it’ll be slower than most people think and that’s come to pass right?
Albert
Yeah they’re pragmatic, they staggered their reopening. They’re making moves for the next six to twelve months on commodities. Which leads me into my section today is what they’ve done in the Middle East with brokering a deal between Iran and the Saudis. I mean, this is specifically done because the Chinese are the biggest clients of both parties. So you’re going to have to appease your biggest client and come up with some sort of truce. But it’s a short lived truce. As the Russians, the Iranians and Saudis start competing for more Chinese market share, since they are the biggest buyers on the Earth at the moment, tensions will inevitably come back up. They’ll bubble up again and this truce just doesn’t have any legs to it.
Tony
The most surprising part to me is that China just a few months ago was still under this kind of wolf warrior diplomacy kind of theme, right? Very aggressive, very direct, very unlike what I’d seen in China for decades before. And now they’ve changed really quickly to this dove policy of we’re going to negotiate peace in the Middle East, we’re going to negotiate peace between Russia and Ukraine. What happened there? Why is it just easier to sell stuff in a peaceful environment than it is in war environment? Or what is it? Because they’ve been the biggest buyer of tiny crude for a while, so that’s.
Albert
Not necessarily it’s mainly to do. The United States is leaving vacuum, their newest foreign policy, leaving vacuum in the Middle East. They’ve just basically abandoned it. We abandoned Afghanistan, we’ve pretty much abandoned Africa at the moment. And the Middle East is we’re not visible at the moment. So inevitably people like China and Russia are going to sit there and go and fill the vacuum. And it’s very easy for them to leverage their purchasing power on Iran and the Saudis and say, hey, cut a deal between you two so we can keep these trade deals going. Now I think also the Saudis are leveraging their oil reserves versus the United States and say, hey, if you don’t become a little bit more friendly with us in the defense sector and start pushing back on the Iranian nuclear aspirations, we’re going to cut deals with China. And I mean, I would do the same thing, to be honest with you.
Tony
So why this may sound like a stupid question, but why doesn’t the US come alongside these discussions and say, hey, it’s peace, let’s negotiate. Let’s get involved with this and support it? Why would the US. Not do that?
Albert
Well, it’s much more complex to say, let’s just have peace. I mean, the Iranians and the Saudis absolutely despise each other. The Israelis are also a major lobbying group in the United States. They certainly don’t want to see Iran benefit financially over this and push that right into their nuclear program. So there’s a lot of moving parts at the moment. And specifically when you talked about Russia and the Ukraine brokering peace there, the reality is the Russians are not going to leave their annexed areas and the Ukrainians are not going to accept that at best, you can get to a status quo, as we were a few years ago. But in terms of peace deals, it’s just not realistic.
Tony
But over the weekend, didn’t the White House come out and say, ukraine is a sovereign nation, but basically we won’t let them negotiate a peace deal with Russia right now? There was something like that that came out over the weekend. So how can the White House supposedly recognize Ukraine as a sovereign nation, but also not allow Ukraine to negotiate a peace deal? That doesn’t really make sense.
Albert
Ukraine’s defense is completely based on US. Armaments at the moment. So of course they can use that as leverage. And, I mean, the United States loves specifically the Biden administration loves to have Putin as a scapegoat for inflation. The moment the Russians marched in there, the term Putin price hikes came out and all over the news. It’s just one of those things where politics has reared its ugly head trying to influence economics. And here we are.
Tony
Great. Okay, so let’s take a quick look at what we expect, say, this week or the week ahead. What are you guys looking for? Tracy, we’ve seen crude way down over the past two sessions. What do you expect to happen in energy? Is this likely to continue with crude continuing downward, or is this very temporary?
Tracy
I think it is a temporary move. I mean, if you look at this, even though we have some softer demand, we are heading into higher demand season. Right. And so, again, there’s a lot of recession fears right now, too.
Tony
Right.
Tracy
So that reared its ugly head again, because of all of the banking crisis. And you also had a lot of what we saw, too, is when US treasuries spiked, right? Because everybody was short spiked. There were a lot of margin calls. And so it was kind of sell what you have to. Oil been sideways for three months, and so sell what you have to. And so I think that was part of that initial push down just from the price action, because we’ve seen that before. But I think it’s going to take a couple of months to digest all of this, to see where we’re at. Let’s see what the Fed does decide to do. Again, if the Fed decides to do nothing, commodities would love that, right? Yeah, they could.
Tony
Love it. Everyone would love it.
Hugh
I’m not sure I’d love it. I’m not sure I’d love it. And I’m not sure commodities would fly. When you say the Fed does nothing, the Fed sits at 5% rates. Or if we’re in the 1970s, the Fed sits there content with rates at 20%. I think oil has done something extraordinary. I mean, from the high tick with the Ukrainian invasion. I mean, oil the oil price is halved. I mean, oil is trading at levels prevailing 2004. That’s extraordinary. And it speaks more, I think, again, to my notion of this silent depression, an aggressive tightening of policy which is appropriate for asset price inflation, but is sheer misery for the ordinary folk.
Albert
I’m actually looking for a 25 basis point rate hike just to agitate you. But I agree with actually, I agree with you. I think that the Fed needs to actually cut rates if you want to see commodities start going these sky high parabolic moves again. And I don’t think we’re close to that at the moment. I do think that a pause would push commodity prices up, but I don’t think it would go parabolic like it did before.
Tracy
Oh, yeah, definitely it would be parabolic.
Albert
Yeah.
Hugh
Of course, if I was to talk my book, I want the Fed I want them being ECB. Like, I have to be cautious of how I say this because I don’t want them doing malevolent things to ordinary folk. But if I was to top my book, I’m really very enamored, very long of the very long end of the treasury curve. Because, again, to repeat myself, broken record depression in terms of price, if we ignore the Carry On Treasuries, which is, again, you could say fanciful, but we’ve wiped out 20 years of price performance, which is to say you’ve had profound mean reversion. And so I do like mean reversion events in terms of global asset. I don’t like mean reversion for individual stocks or individual kind of eclectic risk positions. But the generic give me something trading at the 20 years. So to my mind, where the treasury bond trades, where the inversions are trading, is that most likely we have for the curves to be correct? They’re really imagining a situation where the Fed could rapidly unwind like it did from September 2007 from five and a quarters to terminal of zero. Not a terminal five and a half, six or terminal of zero.
Hugh
And so you’ve got to think, how do you get to a terminal of zero? Well, you get there by inflicting, again, just a colossal deadweight cost of economic pain on the economy. So you can conspire how that would come about from this intellectual reputation or agency trap where they’re just forced to continue with hiking.
Tony
Yes. Over the next week. What are you looking at here? What are you looking in the very short term? What are you paying attention to in the very short term?
Hugh
You don’t want to know.
Tony
Oh, I do.
Hugh
My insights for these markets come from not watching them a great deal. I mean, I’m heading to the most outrageous party in Paris on Wednesday, thursday night. I’ll restock maybe Monday on the West Coast, next week in the US, and we’ll see what’s happened. If I had to guess, I’d expect there’s a huge desire to buy the markets here. The fed’s done something. We’ve even resolved the long standing corpse of Credit Suisse. You look at the equity market, it’s not really indicative of any great danger. The commodities. I mean, yes, I was talking about oil, but the commodity complex, it’s not kind of signaling any profound falling off a cliff. There’s just been a profound revision, I think, coming from hedging activities at the very short end of the treasury curve. Even the long end of treasury curve, it’s not really done anything. So the notion, I think and I was speaking to friends who manage risk, and they’re all agitating, and we were looking at banks. If you look at Irish listed banking securities, they’re way above where they were trading september, October last year. They’ve had a pullback for certain, but they don’t look whole.
Hugh
So I think the presumption is still going to be to feed and come back and try and chase a rally higher. That would be my guess.
Tony
Very good, guys. Thank you so much. This has been a fantastic discussion. Hugh, I’m glad we can keep up with you. Really good kind of long term views, and I really appreciate your perspective. Tracy, Albert, as always, thank you so much for your time, guys. Really appreciate it. Have a great weekend. And you have a great time at that party in there, right?
In the latest episode of “The Week Ahead”, Tony Nash, Michael Kao, Albert Marko, and Ralph Schoellhammer discussed the current market trends and key themes in the world of finance. The discussion revolved around three main topics – “What kills the US dollar?”, “DXY to 112? Turbulence Incoming”, and “Inflation’s hold on Europe”.
Mike started the discussion by talking about the symposium on the Great Power Competition with China and the US Dollar’s primacy in an era of economic warfare. He emphasized that the US dollar’s status as the world’s reserve currency is at risk due to the rise of other currencies such as the Chinese Yuan. Mike further elaborated on the factors that could potentially kill the US dollar, such as a shift towards a new reserve currency or the decline of the US economy.
Moving on to the next topic, Albert spoke about the DXY, which he expects to reach 112 in the near future. He explained that this is due to the strengthening of the US economy, coupled with rising interest rates and the anticipation of the Fed’s monetary tightening. However, he also cautioned that the markets are likely to experience turbulence due to the uncertainties surrounding the central bank policy and the geopolitical risks.
Ralph then focused on the impact of inflation on Europe. He pointed out that inflation in Europe has been rising at an alarming rate, with Austria’s inflation rate being 0.9% m/m and 11.2% on year. Ralph also tweeted about the rapid increase in bankruptcies, and how this could lead to a domino effect on the European economy. He predicted that the European Central Bank’s (ECB) decision to tighten monetary policy would lead to further economic challenges, especially in Q2 of this year.
Key themes: 1. What kills the US dollar? 2. DXY to 112? Turbulence Incoming 3. Inflation’s hold on Europe
This is the 54th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Michael Kao. Michael is @urbankaoboy on Twitter. He’s an ex-hedge fund manager and now he’s a private investor. We’re also joined by Albert Marko, who you’re well familiar with, and Ralph Schoellhammer, who is at Webster University in Vienna and he’s a political economics expert.
Tony
So before we get started, I want to talk about our Friends of Tony promo. So I have more than one friend. So it’s plural. Friends of Tony Promo. So, CI Futures is our markets forecasting platform where we forecast about 800 items every month. We do currencies, commodities and equities every week, every Monday morning. And we do the top 50 economies economic variables once a month where we do show our error rates there. So that is what distinguishes us from other folks. There is accountability. And you don’t have to guess about our previous performance. We’re having a promo. The coupon code is friends of Tony. Plural friends. It’s $19.99 per month for a twelve-month subscription. It’s for new subscribers only. We’re only doing it for the first 25 people who come in. So please make sure you get on this right away. Please go to completeintel.com/pricing and we hope you subscribe.
So guys, thank you for joining us. We have a few key themes this week. First, Michael has written quite a bit about the dollar and about the kind of economic warfare happening now between the US. And China. So we’re going to take the other side of his typical argument and look at what kills the US dollar. We’re going to talk to Albert about dollar strength. He made a statement about the dollar going to 112 with some turbulence. So we’re going to dig into that. And then Ralph is going to talk us through inflation’s hold on Europe. So, should be a really broad macro conversation for us today, which I’m really looking forward to. Mike, you did recently attend this symposium on the Great Power competition with China, I think it was at West Point. And you spoke about US dollar primacy and an area of economic warfare, which must have been great. I missed my invite, but it must have been a great discussion and I think we’re all pretty jealous. I assume that much of the presumption or fears about the Chinese Yan, right.
Is that kind of what the basis was of this?
Michael
Yeah, I think generally when people are talking about threats to the US dollar system right. The most glaring contender is the Chinese Yuan, given all the scaffolding that they’re setting up with 60 plus odd bilateral swaps around the world and one belt, one road and all this stuff. Right. But anyways, if you want I can go. First of all, I love the fact that you’re forcing me to steal, man, the counter argument against my own thesis. Good. Which is great. Yes.
Tony
You’ve talked about the US dollar wrecking ball. Right. And you’ve really talked a lot about how the dollar has really kind of hurt some emerging markets. So I do have a chart of USD CNY, and we’ve seen the volatility of the CNY over the past really five years, ten years. And you know, part of my concern about the CNY is the PBOC.
And you know, we can talk about that in detail, but I’d really like to hear, what do you think? If the dollar was displaced, how would that happen? And we could spend days talking about this, but I guess in a summary conversation, how would that happen and what would be a potential other store of value that would be accepted globally?
Michael
Okay, so I was going to answer this question on different time scales, right? There’s short term and there’s longer term, but I believe where you’re going with this is a longer term time scale. Like what ultimately displaces the dollar as the global reserve currency. Right.
Tony
We can talk different timescales. I actually think that’s very interesting.
Michael
Right, well, look, let me dispense with the easy part first, which is the shorter time scale. I’ve been saying for a while now that I don’t necessarily think that we’ve seen the cyclical top in the US dollar in the short term just because I don’t think any of the competing regional blocks can outhawk the Fed. Or conversely, I don’t think the Fed is going to be in a position where it’s going to outdove the rest of the world either. Right. So either of those scenarios tell me that I think the US dollar is probably going to resurge. And so obviously the counter to that, what would have to happen for that not to happen? Well, I think that the US economy would have to suddenly take a turn for the worst and be in a much worse spot than the rest of the world. And the rest of the world would basically be able to become a much more hawkish visa vis the Fed. I see the exact opposite playing out in the short term. Okay, so now longer term and this is basically the topic of my paper, right? So I think the premise of my paper is that this notion that Breton Woods was basically this top down construct that it foisted a Trojan horse mechanism on the world where, hey, everybody, come use the US dollar because we’re going to be convertible to gold.
Michael
And then all of a sudden in 1971, nixon shocks the world and takes that gold tether away. But it’s too late. Everybody is stuck using a dollar. I call bullshit on that thesis because if you look at the Euro dollar, the rise of the Euro dollar banking system, it started happening probably 15 years before that.
Tony
And he was actually very popular when he did that.
Michael
Right? Yeah, well, it’s started happening by the way. It started happening the real catalyst to it first it was the failure of the tripartite agreement after World War II, which tried to stabilize the frank and the pound and the dollar exchange rates. But then in 1957, when Britain basically in a domestic flight against inflation, surprise, surprise, they they basically instituted capital controls. So there was a there was a tremendous global need for a liquid reserve alternative. And so the world actors on the world stage organically flocked to the US. Dollar. So the premise of my paper delves into what are if trust in the dollar already went well beyond its gold backing back then, right? What lent that trust? And so our paper posits that it rests upon national power. It’s a bedrock of national power. And I focus on three economic pillars of national power geography, which informs everything. But then geography also informs a country’s access to its natural resources and its industrial capacity. So in our paper, we talk about how, look, the US. It’s well known that the US. Is very, very naturally bowed with geographic assets that are really unparalleled in many ways.
Michael
And China is short a lot of those assets. However, because we have a federalist capitalist system, china is using essentially economic warfare to target that as a vulnerability, right? So they have unfairly competed and stolen IP in the world of semiconductors. Right. They’re trying very hard to replicate Taiwan success with TSMC. Fortunately the US. Controls critical choke points in that industry still. But yet, in that area at least, the US. Is finally starting to come around and make some very specific targeted export controls as well as changes to its industrial policy. The point here is that in that area alone, the US. Is starting to recognize the importance of reshoring and defending our flank from an industrial policy perspective. But when you compare and contrast that to oil and gas, which is the other critical supply chain where the US. Is currently the leading oil supplier in the world, and we are naturally long that natural resource, but because of blind devotion to ESG adoption and this erroneous assumption that an energy transition is going to follow Moore’s Law dynamic when it won’t right. Is going to leave us in a very dangerous lurch. I point out that there’s a real inconsistency there where we’re kind of shooting ourselves in our own foot when it comes to energy policy.
Michael
To answer your question, what has to happen for the US. To really lose its status? I started thinking. I said, well, number one, okay. Oh, the other thing is much ado has been made of the US. Weaponization and the criminal west seizure of Russian reserve assets and whatnot. Okay, well, look, I also point out in my paper that, yes, that should be a shot across the bow for US. Policymakers because, like the situation in the 1950s, right, it certainly creates an incentive for our adversaries to look for an alternative. But what are the alternatives? Because if you look at the eurozone, the yen, the pound. The euro is, frankly, the most successful challenger to the dollar to date. And yet, since its inception in 1999, us share of FX reserves has stayed constant 60%. It’s the euro that’s actually lost share. Now, the Chinese yuan. Here’s the problem. What has to happen for the yuan to supplant? The US number one, china would have to prove that it will be a better benefactor and more trustworthy sort of steward of the global commons than the US. I don’t see that happening in almost any circumstance.
Tony
So let me ask you just in that what allies does China have? Like, if China were to say, okay, boys, we’re going to war. Line up and let’s form a coalition, who would China’s allies be?
Tony
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Michael
Well, that’s that’s a really good question, because right now right now well, yeah, those those are the those are the two, right? And perhaps, perhaps Iran. Right? But, like, Russia is interesting because China’s relationship with Russia over decades and centuries and even centuries, certainly, right. Has been kind of a storied one. Right. I wouldn’t say that this dragon bear romance is necessarily that chummy, because, look, China is really happy that it’s getting big discounts to Russian euros, right. And that’s directly countered to Russia’s interest, I think this whole notion that right now they share a common interest in wanting to counter the US’s. Hegemony, but that is a very fragile bromance, to say the least. The other thing I was going to say is that the other thing that would have to happen for the US. To see dominance, I think, would be that the US. Willingly essentially becomes a vassal state to China and allows China to roll over. Basically, our interest in the Indopacific, that the US. Allows China to take over Taiwan and we just roll over and do nothing. I guess in a parallel universe, that could happen. I’m not seeing that happening.
Michael
I think that China’s significance alone, not just as an unthinkable aircraft carrier, potentially for China if seized, given its geostrategic position in the first island chain, but obviously Taiwan semiconductor alone is of critical significance.
Tony
Just to take the other side of that for a minute, you know, let’s also be very aware that, you know, the wars that the US. Has lost over the last 80 years have really been to China in Korea, to China in Vietnam. Right.
Albert
We didn’t lose those wars, Tony. Our military objectives were all met. We’re confusing the political opponent.
Tony
We lost those two wars. I mean, we had to negotiate the settlement, and the US lost those two wars. So the only people the US has really lost to over the last, you know, hundred years is the Chinese. And so, you know, I do sit with you and with Albert in terms of if things were to happen, you know, with the US prevail, I actually think they would I don’t think it would be a cakewalk, and I do think there are some scars there in Asia. Right.
Michael
I think you have to compare and contrast that to where the US. Was in World War II, like when Britain lost its hegemony, where the pound lost its hegemony is because the UK was in a very tough spot. It had essentially bankrupted itself after World War II and was completely beholden to the US. The US’s lend Lease program. Right. So the US essentially had all the cards. Now, here the two wars that you talk about. I agree with Albert. It’s not even close to the same thing. We withdrew, and it wasn’t a great withdrawal, but it wasn’t a situation where we had essentially bankrupted ourselves and we were completely dependent on the largess of somebody else. Right.
Albert
If I can interject Michael, we can.
Michael
Go on and on.
Albert
About to go back to Tony’s question, what would come next? I mean, theoretically, the United States would have to have some sort of societal breakdown. Our rule of law would have to break down, and we’d have to become a nonintervationalist nation. We wouldn’t be able to protect our interests globally at that point. Something could come along to dethrone the dollar. But even if we’re at that point, I think the next logical step of removing the dollar as a reserve currency would be an Anglosphere plus Japan digital currency, where regional players would secure their own interests in those regions and have a collective I mean, this is just theoretical and way out of our lifetimes, in my opinion. But I think it would be a step down to that first where our allies and the US. Would jointly have a currency block yeah. Running through all the scenarios, in my opinion, that would be the only thing that would take the dollar. That would be I mean, the dollar would still be a part of it, but it wouldn’t be the main part of it. It would be the sole unit polar one. But you could have an angle sphere plus Japan digital currency for just for trade settlement.
Michael
Now, you know what I think the highest probability sort of gray rhino would be out of all this. It would be that if China made overtures toward Taiwan and Taiwan willingly just say, Here, take me. Because I think last year, or maybe two years ago, I wrote a thread about this, how some of the older guard in Taiwan and you know this, Tony some of the older guards that are with the KMT, they really don’t like the DPP because the DPP wants to get away from the Chinese ancestral roots of the Taiwanese. So the old God doesn’t like that. And so what if China says, hey, we’re going to take you? And then what if Taiwan says, Here, take me to me? That is much more worrisome than an amphibious takeover of Taiwan, which I see is very low probability.
Albert
Yeah, exactly.
Tony
Yeah. I think that is the most likely scenario of the scenarios of China taking over Taiwan. Right. It’s a mutual but with the DPP in power and with DPP as a sizable political party there, it’s a north versus south issue for people don’t really understand. KMT is largely North, DPP is largely south, and DPP comes to power when their policies really align with people in the north from time to time. Right. And so that’s how the DPP gets into power. The DPP is much more nationalistic and independent than the KMT.
Albert
That would be pretty risky, I mean, for the United States if it didn’t intervene in some which way, because then you could talk about North Korea and South Korea unification and siding with the Chinese at some point, which is not out of the realm of possibility, in my opinion.
Tony
Right, okay. Can we agree? Is it eliminated for the next probably 2030 years?
Albert
Yes.
Tony
Do you think it’s eliminated, Michael?
Michael
I think so. I think so as well. I was on a different podcast earlier this week, and I keep alluding to this interesting podcast that Andrew Hunt out of the UK did, where he did analysis on 36 Chinese private banks. And his assessment is that there’s four there’s a $4 trillion liability gap that’s not captured in the in the balance of payments. China is much china is much, much more levered than the US.
Tony
Absolutely.
Michael
But but it’s but it’s hidden. It’s just pin behind the Opacity curtain. That’s exactly right.
Tony
Doesn’t look good. So if we if we push China out, say, 30, 40 years before they’re a contender, and they may not even be they may be too old by that time, because there really isn’t immigration to China right. Except for from North Korea and maybe a couple of other places. So we pushed China out. What about Europe? Will we have European decide for morale in 30 years? Will we have the demographic age of people who can actually work and contribute to the economy?
Albert
They don’t have a functioning military and solely reliant. Their banks are solely reliant on the US. At the moment. They’re insolvent, in my opinion.
Tony
So, yeah, that’s a good point. If you can’t defend yourself and if the demographics continue to get worse, they won’t have people that will defend the area. So if you can’t defend yourself, you can’t have a functional currency. Right.
Ralph
I guess that was a little bit an unintended consequence. And this is something Europeans hate to admit, but of course a lot of EU policy was kind of this dirty secret. The United States were constraining China and Russia, and the Europeans were trying to make deals with them. If you think back them in the entire Russian pipeline network to Europe, and I think with all of it also mentioned, kind of psychological effect was a certain form of infantilization. Right. This idea that military conflicts simply are a thing of the past in many ways, I see the biggest security risk for the United States. I don’t want to over dramatize it, but I see it almost more in Europe than in China or elsewhere, but not because of an actual military conflict, but the commitments to Europe for cultural and historical reasons that this is going to drag down American capacities. This is going to work out. But the European idea and we hear it again europe will now rearment the Titan vendors. They talked about the Germany. If you look at what’s actually happening, it’s just not happening because they know that the populations don’t really have an interest in that.
Tony
Yeah. Okay, so it’s not CNY. It’s not Euro. What else is a viable it’s not Japan.
Michael
Right.
Albert
This is what’s making me allude to the fact that I think that anglosphered plus Japan digital currency would be the only logical step. Next logical step. Just in my opinion. I just can’t see anything else out there. The Swiss francs is not big enough. The pound is not a relic of what it was without any actual alternatives that we can discuss. What’s out there? Nothing’s out there.
Michael
And by the way, all these, like, newfangled ideas of having some sort of pan global currency backed by commodities. But you know what? John made her. Cain’s backed the Bancorp during the battle for Bretton Woods. Harry Dexter White backed the unit. The SDR was tried and failed. The US. Dollar. Is that pan global currency?
Tony
Sure.
Albert
Yeah, it is. I keep arguing with these gold back currency people, and I’m like, what would stop me being the dictator of Albania, of spray paying some lead and saying, there’s my gold? But you can’t really look at it. You know what I mean? No nation gives you a transparent audit. So how could you even have a currency based on such a thing? It’s just silly to me, in my opinion.
Tony
Ralph, jump in.
Michael
Yeah.
Ralph
And I think one of the things this is what Mike did so well, I think in his paper that he presented at Westbourne, I think we have to look at kind of the structural conditions. And in many ways the United States has the occasional incompetent administration, but their structural is still more sound than any potential competitor, definitely more than Europe. And I think if one takes a closer look, they’re all structurally, at the moment, more sound than China. And in the case of a real conflict, I mean, these things really, really matter. And besides the rhetoric in America, we.
Tony
Expect our politicians to be dumb, and we just work around that.
Albert
Yeah, I mean, in a perfect world, the Pentagon would be working with the treasury to weaponize the dollar. I guess in the adversaries, I mean, that’s something the Pentagon has never really understood or really looked at, is like, you can place your adversaries in a certain position, being short commodities, short food, and you can really strain bingo, bingo.
Michael
By the way, that is the premise of our paper. Our paper is literally saying is literally saying that rather than rely on overt sanctions, that basically cause everybody to look for alternatives to the dollar. We’re at this really interesting macroeconomic window where a strong dollar policy inflicts asymmetric pain in our largest geopolitical adversary.
Albert
Yeah, it’s an absolute logical thing to do. And on top of that, not only can you use the dollar, but you can now use derivatives of the dollars, specifically grains. I mean, there’s only five companies in America that control the world’s grain. You can call them up and cause problems for the world or for China, for Russia, for any nation you really want to target if you really want to get down to that level.
Michael
And by the way, it also kills two birds with 1 st, right. Because it basically export our inflation problem because we are in a domestic fight against inflation.
Tony
Okay, that’s a great idea. Let’s do that. Great. Okay, so let’s just call this new currency TBD. How about that? Because I’m not really sure what to put in there. There are a lot of cheerleaders, as you guys have pointed out, trying to push other things forward, but I just don’t see the case for them. And outside of just suspending reality, I just don’t see the case for something else right now. I don’t say that as an American. I like, I’m not necessarily trying to kind of represent for the dollar. I just don’t see the viability of other options right now.
Michael
Yep.
Albert
I would be I would be the first one waving the red flags if there was an actual alternative out there.
Michael
Oh, there was one thing I was going to riff on. Albert, what what you were saying, or Tony, what you were saying in terms of, you know, our politicians being idiots and whatnot. So so my my view on that is that it’s because of the geographic endowments that the US. Has that’s enabled our federalist free market system to arrive and to survive. Because if you think about it, right, if you’re China or Russia with unbelievably shitty geography, it takes an autocratic system to try to hold that bucket of bolts together. To paraphrase Han Solo, why would you.
Tony
Want to own all that land if you’re Russia, why do you want to own the east? I don’t get it. It’s just hard to keep it all together. So that’s a great point, Mike. Okay, great. Hey, let’s go from talking to the dollar to talking about the dollar. Okay. You put a Tweet up earlier this week saying when the dollar started breaking upward, you talked about expecting Dxy to hit 112.
So it’s kind of we’re, we’re heading back to where we were last year, I guess. So can you walk us through that reasoning? And you talked about turbulence. Incoming. Can you, can you talk about what that turbulence is?
Albert
Inflation. It’s back again. And as much as the Fed doesn’t want to admit a mistake, they’ve absolutely created policies of mistakes and allowed inflation to rear its ugly head. I don’t want to leave it all on, all on the Fed. A lot of it has to do with Yellen’s actions and what she’s done with the dollar and then bringing it up and bringing it down. I mean, this goes to Michael’s point of the weaponization of the dollar is, you know, Yellen takes the TGA and she’s in charge of dollar policy. She can take the dollar up. And what she did, and it drove all the liquidity in Europe, back in Asia, back into the United States, which kept our markets propped up.
Tony
For people who haven’t watched this word, can you talk about what the TGA is?
Albert
And then if the treasury general account, she can use it in many ways, but basically it’s injecting liquidity into the economy.
Tony
And how much at what scale has she done over the past, say, nine months or something?
Albert
Prior to the midterms, she was doing about 160,000,000,000 a month.
Michael
Wow.
Tony
Okay, that’s a lot. When you say injecting, where was that going?
Albert
Well, I don’t know exactly where it was going. That’s not really clear. But she was absolutely using it and I’m sure it’s been dispersed throughout the economy and whatever sectors that she needed to send it out to to rally the markets. And she did a good job. I mean, the markets have stayed up here over 4000 for quite a long time and we don’t really deserve to be here at the moment. The problem that we’re having here now is as you rally the markets now, commodities start to rally. I mean, Europe was in a zombie status. China has been in lockdown for the most part. Yeah, I mean, they’re doing this, but as they reopen, inevitably inflation is going to come back. Wage inflation has been persistent. That’s not going to wave. I mean, I mean, honestly, the workers probably deserve wage inflation after 40 years of getting nothing. So, you know, I can’t really blame them on that aspect. But again, we’re, we’re sitting here with a hot PC PCE number today. You know, it looks like CPI is probably going to be sticky again next, next time around. And the Fed is going to be talking about 50 basis points when they, you know, previously the markets were calculating that we’re going to do a pause or a pivot in a later in the year.
Tony
That’s just not happening. A couple of meetings.
Michael
No. So I mean, this honestly feels like Q one of 22 to me. The whole setup right now feels like Q one of 22.
Albert
We’re right back where we started, Michael. Right back where we started. Because of Fed policies, they’ve done nothing to correct the situation with inflation.
Tony
Okay, so what’s going to happen to drive the dollar up? Yellen stops spending out of the TGA or doesn’t spend as much, or Fed policy, all the above. What happens to contribute to that?
Albert
I think it’s going to be a combination of Fed policy and then the ECB, the Europeans being hawkish themselves. But I think that we’re looking at 75 basis points, probably going up to five and 5.75 on the Fed funds rate by the end of the year, maybe even six. I don’t think they can go over that. But I mean, that alone should take the dollar up to 112. I’m sure they can, but taking the dollar over 115 to 120, you’re going to start causing massive problems. Rest of the world, you just start breaking things.
Michael
Can I ask Ralph a question?
Tony
Absolutely, sure.
Michael
So Ralph, I’m curious. I agree with Albert’s thesis. When I look at the inflation prints in Europe and in the UK, still so high, that gives me a little bit of pause right again on betting on the dollar continuing to rise, except when you look at the state of the economy. And so I’m curious how you see that, because I believe the last UK GDP print was very close to skirting the zero bound. So how much more can the BoE or the ECB really do?
Tony
Sorry, before we do that, let’s move into rough section, which is inflation hold on Europe, right? Which is exactly what you’re talking about. And so we saw Austrian CPI committed 11.2% year on year. When was the last time that happened, Ralph? I mean, what we’ve seen over the past few months maybe, I don’t know, 40 years ago or something.
Ralph
Oh, yeah, before I was born. And so this has been significantly long time ago. The problem is, despite what the ECB does for European politicians, it’s always the 1930s. So the answer, the economic problem is that it must be a demand side problem. So every time the ECB hikes rates, the government comes in with fiscal expansion. And Australia is the best example for this. Pretty much everything that would have been caused by higher rates has been softened by government spending and now expected government spending to happen in the future, which is they very slowly or not at all changed their behavior. So the, the idea to. Kind of, you know, pull money out of the system due to high interest rates is not working as as expected. I mean, we we saw it in Germany. It was when we met the last time, right? They said that there was actually slow growth in Germany in Q four 2022. Then they said that was a slight contraction of 0.2. Today we got the second revision. That actually it’s a contraction of 0.4. And that’s mostly because there was government spending. Otherwise it would have been significantly worse.
Ralph
And I think this is really the problem we are running into. So every time the ECB tries to high grade, governments will jump in with their own fiscal policies, trying to soften it. And what, of course, happens as a consequence, europe is losing its industrial base. So supply side politics, which would be necessary, they become more and more difficult. I mean, Tracy on the last weekend did a great job in kind of just listing all the aluminum smelters and all the heavy industry that has been closed down. We heard today that Germany’s chemical giant BASF is shrinking operations all over Europe. So at some point, you cannot just turn this back on again. So I’m very worried about the structural health of Europe, or even if we look at R and D and spending, right out of the top ten R and D spenders, there is one European company, which is Volkswagen, but all the other companies, most of them are American and some of them are Asian. But Europe is losing kind of connection to all of this just as a challenge to you guys. I mean, name one groundbreaking innovation or one groundbreaking area, and let’s say the high tech area where Europe or European nation was on the forefront in the last 20 years.
Ralph
Nothing comes to my mind.
Michael
Well, ASM Lithography.
Albert
Ralph brings up a great point, and one I usually harp on a lot is whenever you have political policies intermixing with economic policies, you have a problem because politicians want to get elected and their terms are a lot shorter than economic policies need. You know what I mean? That’s just the reality of it. I mean, the Germans, they say they’re tightening things up, but then they give 80% of their population, 80% of their paycheck to stay home. That’s not going to help.
Michael
And by the way, all this, right, all the slowdown in BASF and all that that you’re talking about, Ralph, this is with an extremely benign weather backdrop this year that enabled Ttf and NBP to collapse.
Tony
So huge benefit.
Ralph
I think there are two other very important issues that particular European politicians don’t get and that you and Mike had also talked a lot about, which is there is this weird idea that if Europeans and Americans stop drilling and supplying the world with fossil fuels, that somehow the prices will go down. But exactly the opposite is going to happen because we’re still going to consume it, we just no longer produce it, which is great for all the non European and non American producers. And the second part, what I think Europeans still don’t understand, is there is still this idea that the world will go back to as it was, let’s say ten years ago, like very early on. But even if there were, new should stop. Right? It’s obvious that there is a new kind of industrial policy happening that French showing that reassuring is going to happen and that will push upwards pressure on prices. And Europeans, at some point, they’re going to feel this. I mean, we see. With Germany, Europe is increasingly becoming a continent that has to import more and more, but everything we can export is becoming less and less.
Ralph
That is not a sustainable model unless we say we just become the world’s biggest retirement home tourist destination. But other than that, it’s really problematic.
Albert
That’s interesting because I remember Belina and I were talking about what Europe should do and it was definitely bring black your supply chains to Eastern Europe, north Africa, closer to home, something Europe can drive in investments and actually hold it close to close to their hand there. But they just have not done anything. They want to rely back on the old guard of let’s go to China and grab their market share. Meanwhile, Africa is sitting right there. That’s going to have a bigger population in the next 25 years than China and Younger and Hungary for innovation and products, but they haven’t capitalized on that.
Ralph
It’s like an inversion of the 19th century, right, when there was once a time where Europeans looked at the map and so everything is a potential part of the empire, not like they barely looked at the map at all. And I think it shows in their economic policies.
Tony
Yeah. Just going back over to what you were saying about the short termism of governments, and we see this, at least in the west, the bureaucracy is supposed to be the part of government that helps the office holders to see the longer term. But the quality of our bureaucracy has deteriorated so much over the last 2030 years that they just don’t care.
Albert
They don’t care. I put a lot of blame on social media right now. I mean, all these politicians get on social media and do catch phrases and this and that, and everything is in the real and now and immediate and so on and so forth, six months down the road. They don’t care. Simply, they don’t care.
Tony
Yeah. Ralph, one of the things that you tweeted out earlier, and I know Michael found this really interesting, was the bankruptcies in Europe. This was a Eurostat chart that came out looking at the rate of acceleration of bankruptcies across industries. Can you talk to us about that a little bit?
Ralph
Yeah, I mean, there’s a couple of factors not work. I mean, one is that a lot of these companies it’s kind of what happened in the financial sector during the Great Recession where you had these zombie banks. I think a lot of this is now also happening in the real economy and the industrial economy where many companies have been propped up during Cobit, they have been propped up by very low interest rates and this is now coming to an end. I can only speak for Austria, but there are many companies, of course, also have loans, some of them with not fixed interest rates. And of course they are squeezed now, so they have huge problems in refinancing themselves. And I think this is just the beginning. I don’t share the optimist. I’m kind of a little bit Albert here. Everybody who says that either inflation is going to be over, there’s no trustworthy indicator for me that inflation is ending anytime soon. And the second one is this idea and you mentioned this also, Tony, one of your tweets. I think the IMF forecast for growth in the Eurozone are too optimistic. I think that factors that are not yet calculated.
Ralph
Absolutely. And of course the big elephant in the room comes and go to mike, did you mention, is of course, energy. Like, everybody is like, oh, the energy crisis is over. But that’s only because elasticities in the energy sector are very low. So yes, if there is a lot available right now, it immediately affects the price. But there is no guarantee that it’s going to stay like this in the medium and long term. And if I look at European policy, I think that it’s going to get worse before it gets better seems more likely. And you see gradually signals like this coming from the International Energy Agency and from Goldman Sachs. So all of a sudden the optimists of two months ago say, well, it might be more problematic than we anticipated it to be. And one part of the story is something that also Mike mentioned. At some point, I think we have to say this also openly is this obsession with ESG and an energy transition that makes the promise that by 2030, 2035 the European economy is going to run entirely on renewables, which is an unrealistic. And we want to be more outspoken about it, which I think is a ludicrous proposal that cannot be fulfilled.
Michael
I call that the grativerse.
Tony
Yeah, we’ll all be driving.
Ralph
As a quick last point if we want to put real numbers on it. I mean, the German government alone, the Europeans spent almost a trillion dollars on energy last year. The Germans spent about $465,000,000,000 only on energy and all it got them was the declining economy by 0.4% in the first quarter. So what is their strategy if they want to do this again next year and we see it in the spread? At some point markets are going to look at Germany and say, listen, your reputation has been great for the last 40 years, but can you really still.
Tony
Deliver what what you germany’s got a lot of they’ve got a lot of capacity for fiscal spending. I just think they haven’t opened up as much as they need to yet. I mean, I think that’s part of.
Albert
Their they can’t they go into a doom loop of inflation.
Michael
What happens when Mother Nature doesn’t cooperate next time around?
Albert
Right?
Ralph
I think all of you are right. Tony’s right. I think there is still wiggle room. But what are they doing with the money? Right? Instead of making capital investment and saying, okay, we solve the problem, to do something they pretty much put it all into welfare checks, energy subsidies, but exactly. Encourage people to spend more and more products that are less and less available. So what’s the only thing you get? It’s inflation. I don’t know what the politicians are looking at.
Tony
Speaking of that, let’s talk about everyone’s favorite central banker, Madam Lagarde, and the choice that she has at the next meeting. She said earlier this week that they’re likely to raise by 50 basis points at the next meeting.
So what we’ve seen, the last two rate hikes were 50. We saw a couple of 75s in September and October. So there had been a hope like there was in the US. That things would not loosen or ease, but at least slow down on the rate hiking front in Europe. But with the pace of inflation, it almost seems like they don’t really have a choice, right?
Ralph
I would agree. Yeah, I think they don’t have a choice.
Tony
Okay, well, that’s it.
Michael
Well, I think they’re going to try. But what I really think reading between the lines of all the tough talk with all the world central bankers what I think everybody if you look through to their actions so far, I think everybody has been holding their breath, hoping that the Fed is going to engineer a global recession so that they don’t need to be the ones to have to administer the medicine. But the problem is, and I alluded to this in a thread a couple of months ago called geopolitical mosh pits, right? We’re in this every man for himself world where everybody’s got a domestic inflation problem. And so what the Fed does needs to sorry, the United States interests need to take precedence over necessarily worrying about other central banking interests and vice versa. But the problem is that right now the US economy is still humming along whereas the rest of the world’s economies are faltering pretty badly already. Your guess is as good as mine. I just think that Lagarde’s job is really tough because there’s no panned global bond market. Really. So she’s got this ridiculous Tpi mechanism where she’s trying to hold together sovereign spreads and the ECB’s sort of bond purchases as a percentage of GDP already at like 60% compared to the Fed at like 34% compared to japan at 120%.
Tony
Right.
Albert
I’m glad you mentioned that Michael, about nation states interest because it’s one of the things I harp on, especially when I talk to younger people and they ask me about geopolitics. The first thing you have to look at is a nation’s self interest and there’s no better time than right now to prove that example and you’re seeing it firsthand. All these nations, they have to have their own self interest that are before anything else at the moment.
Tony
And that’s normal, right?
Michael
That’s healthy.
Tony
I think that it’s so silly when we have to consider other people. Of course there’s a time for that, but it’s not right now. You have to really look after your own country, whether it’s India, Germany, US, China, whatever, it doesn’t matter. You have to look after your country first. Rough.
Ralph
But that’s the thing. Exactly what Albert just said and this I think makes it an even bigger ticking time bomb for Europe. You have notice absurd situation that politicians of member states of the EU, they want to continue to do populist economic policies while when they fail they can put blame on the Europe, on the ECB. So technically what probably should do before the next and out sort of a rate hike is to go out and say listen, cannot clean up the mess that you guys make in the domestic economic policies. And of course that’s not something that she’s probably going to say, but that’s really the dilemma. Data us almost have an advantage with the somewhat something that Albert is criticizing all the time, justifiably so with the kind of the chummy relationship between the Fed and the government. But at least it all happens within one state, right? It all happens within one country. And also going back to what Mike said about the federal structure. But in Europe, it’s kind of the worst of two worlds because the ECB tries to fine tune the economic problems via interest rates and the politicians that just go out and say, oh, I know you have to pay more on your loan, but here is an extra check for you.
Ralph
So you could almost say it’s like the nation states are mocking in the sense what DCP is trying to do.
Tony
Yeah, Mike, you said that Lagarde has a very hard job. I actually think it’s very hard because it’s very easy. There really isn’t a lot of choice there. It’s hard having the wherewithal I guess to go through with these things that are probably going to end up being.
Michael
Pretty painful, by the way, to steal man the other side a little bit. Okay, there are some that say that okay, well the Fed, because we have all these bilateral currency swaps, the Fed is going to take care of all its friends. Right. And so we actually saw a little bit about that. I wrote a thread last year about how, when the Yen, for instance, started its first approach towards 145 ish 140 ish I got some talk from a very well placed source that basically the Fed, in conjunction with the DOJ was allowing the BOJ to essentially buy us ten years to basically kind of paint a picture to stymie the depreciation and the yen. Okay? So then we saw this big risk rally. Remember when that happened and the yen corrected back? Well, then I get a call from the same source saying, you know what my people are telling me? My people at the Fed are telling me that, you know what? They can’t hold the line anymore. They’re going to basically stop. That’s when you saw the yen go to 150. Right now we’re in this sort of everybody calls it the transitory boldilocks, where things kind of came down and you’ve got Yellen’s games with the TGA, et cetera.
Michael
But I really think, and I think I agree with everybody on on this call, that all hell is going to break loose again when the dollar starts approaching 110 again. And this time maybe there won’t be that sort of bilateral help.
Albert
Yeah, michael is absolutely right. I heard the same thing about the Fed and the BOJ on top of that.
Tony
I thought you were a source, Albert.
Albert
Right, because I talked to you about.
Ralph
It a couple of times.
Albert
But they do the same thing with the Aussies and New Zealand and Canada. They give them marching orders, say, hey, we’re going to paint a picture over here, so gives us room to do something over here, so on and so forth. But like I said, that’s the Anglosphere and plus Japan. That’s why one of the things that led me to believe is like, next thing for a currency would probably be them. But they already work together as it is, whether the market knows it or not, they talk and they work together. Yeah.
Ralph
I think it very often comes back to this very point that this is something that Michael’s and I said before it’s that, of course, what underwrites the dollar as the global reserve currency and the most powerful currency is because the United States have the most powerful economy. Whatever problems they have otherwise, their economy in many ways is still the most dynamic and the most innovative. And this is what I interfere about. The European situation is we can criticize politics, we can criticize the ECB, but I think we also have to criticize European industry itself. Because like in Germany with heavy industry, they never say anything. Right? They could get together and say this. You hear occasionally a voice there and occasionally a voice there, but there is no concerted actions by representatives of the industry to do something about it. And my suspicion is because they kind of made it comfortable for themselves because they know they get government subsidies, they might have to produce less, but I’d rather depend on the biggest monopoly there is. The state than on those pesky customers or those potentially unsecured international markets. But that’s a very short time perspective.
Ralph
I mean, this is not something it can do forever. And again, the only reason why Europe could do what it did was because they could rely on the United States to provide with the bluewater navy to everything else. They provided the framework in which Europe could do what it did. But as this framework is changing, because Albert would never talk to me again, I’m not going to move all multipolar because you would because I don’t agree with that idea either. But it’s definitely changing, I think. I think Americans are becoming more sensitive to listen, guys, you have been pre writing for 60 years. It’s time to do something yourself.
Tony
Yeah, go ahead, Mike.
Michael
So, Ralph, you touch upon another theme that we raised in our paper, which was, again, it goes back to geography, right. Because the US has had these geographical advantages. It’s allowed its military strategy to focus outward on force projection and develop that blue water navy. Right? So when you compare that and compare and contrast that to China, right, where you could argue that they’ve got greenwater superiority within the first island chain by virtue of 350 vessels versus our 270, but the gross tonnage is one third that of the US. Navy. They cannot force project. And so if you talk about real force projection and geopolitical power right. Again, to steal man the other side, what would cause the US. To see the T hegemony? Well, it would be that scenario where China somehow decides that, hey, you know what? We are going to subsidize global maritime security for the good of the global commons. Do you see China doing that? I sure don’t.
Albert
Not for all of us to century. And it takes a lot of money to build up a navy. And then you need combat experience. And then on top of that, any kind of conflict in Taiwan or the South China Seas shuts down their ports. China cannot afford to shut down their ports. I was going back and forth with Elbridge Colby about this. He’s a military guy, and I love the guy. Right. But when you have to look at the economic aspects of it concerning the dollar and China’s food insecurity problems and their economy in general, if they invaded Taiwan and shut down those ports and their economy collapsed, she would be dead in 30 days.
Michael
There’s a little issue of China having to import 80% to 90% of its crude, all of which pretty much come through the Strait of Malacca.
Tony
Yeah.
Albert
I mean, so but this is this is something that it’s really important for you to talk to the military and get that USD thing out there and talk about commodities and talk about the economic ramifications and say this is a significant deterrence for China to invade. This is a significant deterrence for any nation to really go after because there’s just no money around. The economies are really weak. So it’s a great thing that you’ve done.
Michael
Thank you. I hope you guys enjoy the paper. Yeah, sorry.
Tony
Just going back to what you said, Mike, about China not having the blue water navy, really, to protect trade and waterways. They have tried that with the Belt and Road. It’s been less than a decade, but it’s kind of been a failure since the start of it.
Michael
The thing with belt and road, right? If you think about what it is, they are expending tremendous amounts of national treasure to recreate what the US. Is naturally endowed with.
Tony
Right. Yeah. It’s very inefficient.
Michael
It’s very corrupt, and they’re failing at that.
Tony
I start with those. When I was trying to put in a tendering system for the Belt and Road transparency, I asked them, how much are you comfortable losing to corruption? 20%, 30%, 50%? People just shrug shoulders. Nobody wants to even look at those basic transparency issues, much less understand that that spending is incredibly wasteful just for some sort of desperately seeking some sort of relevance with third tier countries. Right. I mean, no offense, they’re great people and all that stuff, but they are not necessarily economic powerhouses, and they’re not necessarily strategically placed. So it’s a big problem, and corruption is a big problem in those places. So not only are they going to have to buy off Chinese industry to go in these places to build, they’re going to have to buy off the officials in those countries to get the infrastructure done. Okay, guys, let’s bring this back to Europe. Since Europe is kind of our last group. Ralph, I get the sad sense that when Mike talks about dollar resurgence and Albert talk about dollar resurgence and inflation is pushed on the rest of the world and these sorts of things, europe and European industries show this as well.
Tony
Europe isn’t really a growth engine, of course. Right. So is Europe the worst place of the regions in the world generally, when we see a dollar resurgence and inflation and kind of these coming headwinds? Probably not.
Ralph
I mean, I remember I asked all about this, I think almost a year ago, once on Twitter. I think that the ties between the US. And Europe are still so strong that I could imagine that the US. Would be willing to adapt their policies in a way to protect Europeans from the fallout that will find some ways to support them. Okay, I think that, again, maybe I’m putting too much hope in the US. Maybe this is wishful thinking on my part, but I think that these ties are still strong. I think this is the US. I think they still view Europe as part of the national interest. But spoke to be very clear, I’m glad of I mean, something that bothers me, really, is I think the best thing Europe could do would be to place itself as Athens to America’s wrong kind of place I can feel to the strongest player on the block. But don’t try to be as again, Albert, we’ve discussed it many times to participate in this fantasy of the new multipolar world where you will balance the US in a quasi agreement with India and China. This is all fantasy.
Ralph
None of this is real. When push comes to Sharp, I think the US are still the best bet for the Europeans. But to be kind of a psychological problem in Western Europe, I think this is another thing.
Tony
Of course.
Ralph
I think the Eastern Europeans, particularly Poland and others I think are much more willing to attach themselves or kind of align themselves with the US. I think Western Europe and it’s mostly cultural, psychological that they still wish to be kind of a counterweight potentially to the rude Americans and the alcohol.
Tony
We’re definitely rude. We’ll take that. Okay, guys, we’ve been an hour, so I appreciate all of the thought you put into today. For everyone watching, please don’t forget about the promo. The Friends of Tony for promo promo 1st 25 subscribers. Guys, I really appreciate your time. Time. Have a great weekend. Have a great weekend. Thank you very much.
In this video, our first-time guest Jim Iuorio leads the discussion on the topic of whether markets are too good for the Fed. With speculation around CPI, layoffs, and interest rates, the question of the Fed’s direction and potential pivots later in the year is raised.
Jim also delves into the recent success of the metals market and offers insight into where the market may go in the future. He also offers his thoughts on the potential impact on equities if the S&P hits his target of 4060.
Next, Tracy takes the lead in discussing cracks and Freeport. She explains the significance of rising crack spreads and its impact on the market. She also shares her insights on the recent opening of the Freeport facility and its effect on US natural gas prices.
Albert then discusses the risks associated with Ukraine’s new hardware. He addresses the classification of “direct involvement” and its potential impact on European countries. He also offers insight into what actions Russia may take to further complicate the situation and the potential impact on markets such as wheat.
Finally, the team gives their expectations for the upcoming Fed meeting and what to look for in the week ahead.
This is the 51st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Jim Urio. Jim is at TJM Institutional and he’s with the Futuresedge podcast. Or is it on the Futuresddge podcast, right? Yes. Also with Albert Marko and Tracy Shuchart with Hightower Resources Advisors.
We’ve got a couple of key themes. Obviously, it’s the week before the Fed and we’ve had a really good week in markets. So one of our key themes is our market is too good for the Fed. Second I think Tracy is going to talk about crack spreads and Freeport and what’s happening there. And then we’re going to look at the risk with Ukraine’s new hardware. There’s been a lot of talk about tanks going to Ukraine this week, so we’re going to talk about some geopolitical risks with Albert.
So Jim, first, thanks again for joining us and watching some of your comments through the week with markets breaking through some of the key levels that you were looking at, the Fed’s direction is obviously a big factor in markets and there’s a lot of conjecture around CPI, layoffs, rates going lower or pause or pivot or whatever you want to call it, and people saying the Fed may do 25 and then pause.
What’s your view on that? You’ve been obviously speaking about this several times this week. So I’m curious, what’s your view after seeing a whole week, where do you think we go from here?
Jim
Well, I’ve been somewhat more of a bull, I think, than most over the last few months. And I’m not trying to take a victory lap or anything, it’s just a fact. And my reasoning was that every one of us knows that these Fed rate hikes have a huge lag period before we feel the efficacy. Fed knows that too. As stupid as the Fed is, this is something that’s so fundamental, but I think they genuinely do know that. So now we’re starting to see things happen. We saw a pretty good PCE report today. CPI has been trending lower too. The only things in CPI that are stubbornly high, consistently, are food and energy, which are the two things that are least rate sensitive. The yield curve is still wildly inverted, signaling to them that they still are in a financially tight market. I believe that the Fed is getting close to having some sort of gentler language. Now, whether they go 25 basis points this time and then 25 basis points again, that’s fine to me. Now, the one thing I do have a problem with is that the Fed Funds futures curve says 50 basis points over the next two meetings.
And then toward the end of ’23, there’s going to be an ease. But they say it’s only going to be a quarter, two and a half point ease. And that I say “no way.” If they’re ever going to actually pivot and start easing, it’s only going to be as if something is burning and something is falling down and then it’s not going to be a quarter point ease. That being said, I still like risk assets. And I have because I think we are nearing the end of the Fed tightening cycle. I believed, I’ve been doing my podcast for the last hour. I wanted the market to settle above 4070. It certainly did, right? We went into the closed pretty strong, I thought. And I think that that green lights the next move higher. I particularly like the metals market, and I’ll shut up in 1 second, I swear to God. I particularly like the metals market because I think that… I don’t mean to talk for so long. I thought copper was being held down by China news, by the Fed, by the strength of the dollar, and all those things have seemed disappeared. And I’ve made good money on that so far, and I plan on keeping those lumps.
Tony
So it’s a good question about metals. What are you looking at? You said China and you said China reopening other things. What are you looking at in metals? Are you looking at industrial metals, copper and so on? Are you looking at precious metals or kind of all of the above?
Jim
Copper is number one and that’s my biggest position. Silver and then go down from base industrial all the way to just gold being pressured. And the gold thesis for me is different than the copper one in that I believed at the time when I started buying more gold, that Bitcoin and Etherium in the crypto market and all that dollar safety hedge or whatever the hell it is, if that was disappearing, then money would go back into gold. Well, that didn’t disappear. Bitcoin is butting up against new cycle highs now, but gold is still doing well. So in that I was kind of wrong on the thesis. The thesis was also the dollar weakening, which happened as well. Once the Pound of the Euro started really bouncing off those October lows, I thought, okay, the green light is on for all these metals. So I’ve done okay in gold, even though my thesis about crypto was wrong.
Tony
Okay, but was your thesis wrong? Do you see crypto and gold as substitutional somewhat at the margin still?
Jim
I don’t know. I was going to ask you that same question. I always did. And I thought that the $3 trillion crypto market was sucking away some of the gold. And I thought that that was a big deal. But then it doesn’t seem to be now, so I guess I can’t answer that. I’m confused, I guess.
Tony
Yeah. I’m curious. What do you think about that, Tracy, in terms of crypto and gold? Do you think there’s a trade off there?
Tracy
This is not really my… Crypto market, is not really my market.
Tony
Internet, say whatever you want.
Tracy
Albert knows way more about this than I do, to be honest, because I’ve never traded crypto, and he’s traded a lot in the past. So I’m going to defer this to Albert.
Albert
Before I do think that there was a correlation between how much money was flying into crypto versus taken away from gold, I think there is no doubt that gold suffered because of that. I don’t think that as the case right now, simply because there’s been too many blow ups in the crypto world at the moment. I don’t really know how liquid it really is. There’s certainly no retail left in the crypto market, so it looks like it’s all institutional. So I don’t know. You can’t really make a fundamental call on crypto at the moment.
Tony
Could you ever make a fundamental call on crypto?
Albert
You could at some point, because institutional money was flying in there because their clients were forcing them to get into the space. So you could make a little bit of a fundamental case for crypto, but as all these ponzi schemes blew up, like FTX and everything, that’s just gone completely out the window at the moment.
Jim
Sure, Tony, I can make a slight fundamental argument of it. When they were adding an additional $7 trillion, throwing it into the money supply, and really being poor stewards of the dollar, that was somewhat of a fundamental argument for crypto, I guess, right?
Tony
Yeah. Okay. Are markets too good for the Fed. As we’re going into next week, are these levels too good for the fed? Is Powell going to come out and really, you know, say, look, this is irrational or whatever, and it’s too much, and is he going to pour out, say, 50 basis points and disappoint a lot of people?
Jim
Just to punish me a rug pull? I mean, I think he’s capable of that. He certainly did at the Jackson Hole meeting a while back. So you have identified, I think, the major risk, and it’ll probably go into that somewhat hedged. And again, hedging is probably going to be expensive going into it because people realize that that’s where the risk is. So on balance, I will say, no, I don’t believe he is. I think he believes that going too far this way. And again, I think he thinks going not far enough in this direction is the worst possible thing. But I also think he’s starting to realize going too far and what that looks like. He sits around and talks about creating slack in the job market, and to him, it’s just an equation on a whiteboard where the reality is talking about people losing their jobs. I think he balances a lot of realities. I think he’s incompetent. His entire tenure has been mostly incompetent, but I think he’s done a pretty good job trying to clean up the mess that he made over the last year and a half, and I don’t think he’s going to do something stupid like that. But, yes, to your point, it is a risk.
Albert
I actually disagree with Jim on this.
I think it’s going to really matter about what the market does. If we start flying into the 4200 before Tuesday on the SPX and whatnot. I think that Powell will come out. I don’t know if he’ll do 50. I don’t think he’ll do 50, but he might come out with a 25 basis point rate hike and then start talking extremely hawkish and dismiss all the rate cuts that everybody’s been talking about, which would be essentially the same thing as doing 50 to the market. If the market says that. If the market here is that we’re not getting rate cuts till 2024, I don’t see that as positive whatsoever.
Jim
I certainly hope you’re right in the near term, too, because I’m short some of those 4200 calls, like, too many. That’s the position I keep checking in my bold position was like, oh, sh*t, they’re getting too expensive. So I actually like what you’re saying a little bit in the short term.
Albert
Yeah, I have a problem because of this is falling liquidity right now and tightness at the same time. I look at the market and I’m like, well, money is starting to fly out into Asia, which we talked about Tony, repetitively for months now. Where are we going to get that $5 trillion incremental money coming into the market to keep this thing afloat? For me, it’s like I don’t see the math adding up to 4300 on the S&P and anytime soon. And on top of that, if you calculate rate hikes and everything you’re looking at the market, 4150 or 4200 is more expensive than 4800 was. It’s technically even higher valuation. So for these things, I’m just like I think we’re probably going to retrace the 3850 on some kind of ridiculous Powell talk. And on top of that, Brainard is talking about leaving. She’s not leaving if Powell is talking about being dovish. She wouldn’t be doing that, in my opinion.
Tracy
I asked a question. I was just saying and that’s for both of you. I mean, considering that the Fed has hiked so quickly, do we even think, and the data has remained pretty good, considering right, so do we think that the rate hikes have actually even been able to filter down into the economy at?
Jim
I don’t, Tracy. I think that that’s the point. I think when you look, just take the real estate market. How in the world is it not going to be a major hurdle for the real estate market to take mortgage rates from 2.8% to 7%? I think that it’s silly to think that if they just left things the way it is, I believe that we would certainly go in recession at some point in time with money being restrictive as it is compared to… I’ve argued for 30 years that rates had to be inorganically low to make up for the fact that we have all these crappy regulations and punitive taxes on companies. They need low rates to function. I think rates are to point now where eventually they would drag on us too much. Albert, do you agree with that?
Albert
I do. But the flip side of that is, like, if Powell doesn’t stay the course, Yellen is using the TGA, in my opinion, from what I heard, to offset quantitative tightening. This could set off another round of inflation if China comes on too fast, or even Europe starts to gear up a little bit and reset their manufacturing sectors with stimulus. The fear I have is a second half inflationary run again, and then we’re going to be talking no more pauses, but another round of 50-75 basis point rate hikes.
Tony
Second half of Q2. I don’t think it’s a second half inflation run. I think it’s Q2. I think it happens a little bit sooner than that.
Albert
Yeah, it could. I mean, you could have any kind of geopolitical event like Russia re-invading Ukraine with some gusto this time.
Tony
Okay, guys, here’s my question, though. We’re talking all this potential dovishness, but all we’ve seen is the rate of inflation slow. We haven’t seen prices come down. Okay, so why would he go to zero? Or why would he just do 25? I’m not seeing it. When you look at the job market, sure, you’ve lost 70,000 tech jobs, but they hired 2 million since 2020 or something like that, right? So it’s nothing. It’s dropping the bucket.
Tracy
Chipotle hiring 15,000 so those people can get a job.
Tony
Exactly. What is it that would tell us that he’s going to go 25 or pivot or whatever? I’m just not seeing that thing because the job market is still really strong.
Jim
So here’s what I would say to that, is that the job market is going to be strong and tighten. It’s a weird kind of anomaly that happened with 3 million boomers leaving the job market prematurely over the last three years. To your point about why would he not stay the course if prices aren’t coming down? Because, remember, ultimately, the end of the day, the inflation was intentional and it was done because of this wild indebtedness all over the board. But I always focus on the five states that could not possibly have paid their bills under any possible scenario. And that’s why for ten years, they kept telling us that they needed inflation. So I think in Powell’s mind, he tells us 2%. I think he’d be perfectly happy with three and a half.
Albert
And they’ll get three and a half because they’re starting to change the way CPI has waited starting 2023.
Jim
Just like when Nixon changed the definition of unemployment back in the 70s.
Albert
The BLS have done that in the past. They changed the way unemployment is calculated. Now they changed the way the CPI is calculated.
Tracy
They changed the way inflation is calculated.
Albert
Perception is reality in the market. We can sit there and b*tch about fake data from China and fake data from the Europe and the US. But perception is reality in the markets.
Tony
Yes. So we’re going to change the rules to win.
Albert
Well, yeah, of course.
Tony
And the CPAC calculation changes this month, right?
Albert
Yeah, January 2023.
Tony
Fantastic. Okay, so you guys are in the 25 basis point camp for next week, right? 25 and very hawkish. 25 and very hawkish.
Jim
Okay, I don’t I like what Albert saying. I say 25 and mildly hawkish.
Tony
All right, we’ll see. I think it might be a little harder than that. So we’ll see. That’s good, though. I appreciate that.
Tony
Okay, Tracy, I want to talk a little bit about refineries and crack spread. You sent out a tweet on Monday about diesel prices.
Can you help us, help us understand what’s happening at refineries and what’s happening with diesel and gasoline and other refined products prices?
Tracy
Well, this is actually the perfect segue because I tweeted out a chart of ULSD, which is diesel, basically. And so we’re seeing those refinery margins explode again. And most people say, well, that’s anticipation of the diesel embargo in Russia and refineries across the world that are not part of Russia are seeing these increases. But that’s not just happening in the diesel market, that’s also happening in gasoline cracks. And so higher refining, basically the long and short, higher refining margins mean higher prices for consumers. Right. So Tuesday we just hit a three month high of $42. And when oil was at its highest price, those crack spreads were at $60. So this should start ringing alarm bells a little bit about inflation. This is why it kind of correlates to what we were just talking about. And so CBs, even though they don’t count energy in the CPI as part of inflation, they should be keeping an eye on these indicators because it kind of indicates that we’re going to see higher gasoline, diesel costs, jet fuel, et cetera. And that could add to inflationary pressures across the board, not only for just the consumer, you and I, but for companies that are heavily dependent on these products.
Tony
And when there’s inflation in energy, there’s inflation in everything.
Tracy
Right, right.
Tony
Second or two tier impacts.
Tracy
Exactly, yeah.
Albert
One of my oil friends was telling me that normally January, February, they’re running at minimum rates, trying not to lose money. But this has been like absolutely insane, where they’re just making money hand over fist right now because the demand is so high.
Jim
Tracy, I have a quick question for tracy, by the way. Is that okay?
Tony
Yes.
Jim
So, Tracy, just last week, I don’t know if it was Chevron or Conical Phillips, where they announced raising the dividend or whatever, paying bonuses and not investing in it. Was that an indication that they still feel that the government is not smiling upon fossil fuel companies expanding their operation?
Tracy
Oh, 100%. Right. For over a year now, we’ve seen elevated energy prices in that seventy dollars to eighty dollars range. Negating, the spikes that we saw from the Ukraine invasion. But so after a year of pretty much stable higher energy prices, we are still not seeing anybody want to invest in this sector. Right. They still want to cater to the investor. They still want to pay down debts. They still want to do higher dividends. They still want to engage in stock buybacks. All to placate the investor. And so that is very telling that after a year, they’re still not willing to reinvest into capex, particularly in shale.
Tony
It’s nothing but downside to invest, right?
Jim
No doubt.
Tracy
Yeah, absolutely.
Jim
It’s maddening when you think about it. Everything seems like it’s such a self inflicted wound. And this is the kind of thing that keeps me up at night. It seems like a government that’s working against us. And I’m not trying to be that guy. I’m not political. I just see policies and they’re asinine.
Tracy
Who wants to invest when they say, we want to phase you out, we want to kill you?
Jim
Right? Yeah.
Albert
Well, this is the problem when politics gets mixed up in economic policy, it starts muddying things up and mistakes become exponential at this point.
Tony
But politics is always mixed up in economic policy everywhere. You know that. I’m not telling you you don’t know, but it’s always there. When I hear you talk about refineries, and it’s been how many decades since we built refineries in the US, Tracy? The 70s was the last time we built refinery?
Tracy
70s was the last major. We’ve had a lot of brown projects, which means we’ve added refinery capacity to already existing refineries, but we haven’t had any new green projects, which means building new refineries. And we were talking about, I think, last week or the week before the expansion that we’re having in Texas. But the problem is that the amount of refining that is coming offline is more than the refining capacity that is coming online.
Tony
Right. So what’s our capacity utilization right now in refineries?
Tracy
Well, we’re down right now because we’re in the middle of maintenance. And we also had Elliot storm, which some refineries, for instance, Baytown, is just coming back up this week from the storm in December. So utilization rates right now at about 89.5%. But, you know, you have to realize that, you know, we’ve been over, well over 90%.
Tony
Yeah, 94 or something like that. Right?
Tracy
Yeah. And we have aging refineries. And so what does that mean? Those refineries are more prone to breakdown because we’re running them at, like, ridiculous max capacity. Right, exactly.
Tony
Okay, so since you mentioned Texas, let’s look at this tweet that you put out a couple of days ago saying that Freeport gets approval.
So USLNG, the Freeport terminal has been approved and reopened. So can you talk us through what that means for European nat gas and what that means for US nat gas prices?
Tracy
Well, for US natural prices, that is positive. And I know that all nat gas prices have tumbled 35% to 45%. Regardless, we’re back into that two area that is pretty much where we’ve been for several years. But it is a good thing. I think the market, I think, spiked 15% or 15% $0.15 sorry, on that move. And they kind of retraced it. I think the market is a very Freeport is an export place. So what that means is that if Freeport being closed basically landlocks US nat gas, which is obviously a negative because we have a lot of it. But I think that the market in general is a little bit skeptical. But as soon as we actually start seeing export capacity increase from that facility, then I think that the markets will be more enthusiastic about the success of that because it’s really been since August since that facility is shut down.
Tony
So you’re saying we should see US nat gas prices rise as we have more export volumes from Freeport?
Tracy
Absolutely. And even this week, Semper Energy announced that their new Port Arthur facility has already been booked. And that facility isn’t even all the way built yet. And that’s another export facility. So there’s a lot coming online and a lot being built out that we will be able to see. I think that just market participants have become a little bit placated because they look at European stocks and European stocks, of course they’re still full. They’ve had a mild winter, but everybody kind of forgets that last year 50% of their storage capacity came from cheap Russian pipeline. And that’s not going to happen this year.
Tony
Yeah. So all of those new roads that are being built in Texas, it may have been started with other money, but it’s going to be finished with European money. Right. So I just want to take this moment to thank our European friends for finishing our transportation.
Albert
About time they give back.
Tony
That’s right.
Jim
Finally, their currency has come back a little bit, so now they can actually buy stuff here.
Tony
Perfect. Okay, very good, Tracy. Anything else on nat gas? Are you still keeping eye on fertilizer for kind of late spring time period?
Tracy
Yes, absolutely. I think that’ll still come into play. I mean, nat gas prices are extremely low right now, which is great news for fertilizer prices. That will give farmers a break. This is all good news in that respect, but I still think we need to keep an eye on this going forward and keep an eye on that gas prices because obviously that’s going to affect fertilizer prices and farming in general.
Tony
Jim?
Jim
Tracy, you talked about diesel before, and I don’t trade diesel. Is the spread between diesel and regular WTI still blown out? And what could possibly get diesel back in line?
Tracy
Well, I think that there’s been a shortage for a very long time. That spreads come in a lot, comparatively speaking. But now it’s starting to blow out again because again, you have the EU embargo of diesel, and they got literally like 95% of their diesel came from Russia. Another dependent project. And I’m sure Russian diesel will go somewhere else. It’s not more about that, but it’s more about really boils down to refining capacity as well. Because even in the United States, we can’t refine. If Europe wants to buy from us, we can’t even refine enough. We’re sending what we have over there as well as our domestic needs. So really, diesel to me comes down to refining capacity altogether.
Jim
That’s an unfixable problem, right?
Tony
Until Russia’s solved, right?
Albert
What about the Jones Act waivers for sending diesel up to these coast cheaper?
Tracy
Yes, they could do that, but they haven’t done that. They’ve done that in the past for Puerto Rico after the hurricane and all of that, but they still haven’t given waivers. Even when prices were extremely high in the United States, when we were at the height back in June, July, when prices, gas prices were highest, diesel prices were highest, they still wouldn’t give Jones Act waivers. You have to understand that the Jones Act came into play into 1920 when we had a fleet of over 1000 vessels, and we now have under 100 vessels that can transport that. So, you know, it’s the government could do it. They’ve chosen not to. Why? I’m not sure, but…
Jim
We can come up with some guesses. They’re either stupid or they’re nefarious. I believe at some point in time you’re going to have to say some of it’s nefarious, where they keep making the wrong decision at every turn. And I apologize for that.
Tony
No, don’t apologize. Look, it’s making it more expensive for people on the East Coast to get diesel. It’s not good.
Tony
Okay, great. Speaking of Russia, Albert, we saw a lot of news over last week about tanks going to Ukraine. And there’s a tweet from Max Abrams, who’s a great geopolitical professor talking about Russia, says that tanks from the west count as, quote, “direct involvement in the war”.
So I wanted to get your… Jim said what would solve the diesel problem. Obviously, Russia coming back into the market would solve the diesel problem. Now with a lot of Western countries sending tanks to Ukraine, that doesn’t sound like we’re coming closer to a solution on that. So first of all, why are they sending them if they don’t have the people to operate them? Second, tanks are to take land. Right? So what do you think is being planned? And third, how risky is it? Do you think it really implicates these kind of donor countries as direct participants in the war?
Albert
I don’t really buy into the whole direct participants of the war. The rhetoric coming out of Russia is a little bit bombastic in that respect. Referring to those tanks, there’s only going to be about 100 of them, right? They’re not going to be able to push out the Russians with those tanks. On top of that, they’re going to be about six months out until they’re actually even deliver, and then you still have to train these guys and they need supplies, and the Ukrainians don’t really have all that. So the best guess that I have is that they’re forcing Russia to come into a ceasefire in about six to eight months time, which gives them a window now to try to take Dambus and have some kind of wind before these tanks get delivered. Listen, they’re no joke. The Leopard tanks and the Abrams are better than what the Russians have. But in terms of the Ukrainians using them to push Russians out of all Ukrainian territories, that’s just not happening.
Tony
Right. So are these just old tanks or is it a quality kit that they’re getting?
Albert
Well, I think they’re getting like the second tier tanks of what the west has, but that’s still better than what the Russians have or even willing to use for Ukraine. So, like I said, this is more of a measure to force the ceasefire later on in the year.
Tony
Okay. Yeah, Jim?
Jim
Albert, a couple of days ago, when this escalation started in Germany, we announced I immediately put on my screens, looked at oil, wheat, even the defense sector ETF, and nothing really budged. Do you think the market was looking at it like it wasn’t a big deal? Or do you think the market was looking at it as somewhat balanced, perhaps a quicker end of the war and not an escalation, or perhaps an escalation, the two things come around?
Albert
Oh, man, that’s a good one, Jim. I honestly think that the market’s probably in a wait and see position at the moment.
Jim
Numb to the shit kind of. Right?
Albert
Yeah. You got to wait and see what Moscow is going to do. I certainly think they’re going to use wheat and grains and other grains asymmetrical responses to the west to push inflation out over there, make it hurt. That’s the only thing they have. They don’t really have anything else to go after. I mean, the oil that they’re selling to India and China is enough to sustain their pocketbooks for a little while until this gets sorted out. But until there’s some sort of major upheaval in Ukraine, I don’t think the defense stocks will take off or wheat yet. But they will. I think they will. They haven’t moved.
Tony
The defense stocks haven’t moved for a while. If it is we and other AG stuff that is going to be their lever, that probably means the Turks will get more involved in the discussion because they’re the ones who arbitrated the discussion earlier. Is that right?
Albert
Well, they’re trying to get into the discussion. I actually have really good connections with the Turks and their main thing is to distract the West and the Russians into Ukraine while they push their trade deals out into Africa at the moment. You know, the Turks have a great drone, the TB Two, which they sell to pretty much everybody. So that’s as far as they’ll actually get into the war besides making media comments.
Tony
Right, okay. And so what risk do you think there is on wheat? Do you think we see more wheat risks, say, in Q2 – Q3 this year?
Albert
I absolutely do. The Ukrainians, they’re planting a lot less. I think 40% less is what they’re reporting, is probably even more than that.
Tony
Right.
Albert
And on top of that, if the Russians decide to blow up a port or blow up a few ships that are trying to get out with wheat, and all of a sudden, wheat, you know, takes off back to the 900 or $1,000 mark again. So I definitely see that happening in Q2 Q3.
Tony
Okay. That could be exciting. All right, guys, let’s close it up. We’re in that quiet period for the Fed. We have that Fed discussion next week. So what are you keeping an eye on next week aside from the Fed, of course, but what are you keeping an eye on in markets? Tracy, why don’t you get us started.
Tracy
Well, I know that most people are looking forward to OPEC is next week at the beginning of February. My personal stance on that is that I think they will keep everything as is. Right. They made that 2 million cut, even though it’s technically not 2 million, because they were under quota anyway. They said they were going to carry that through 2023 unless something came up that they really needed to address. And I just don’t see anything coming. I don’t see any reason they would need to change this policy stance right now. We have Russian barrels still on the market. We have China is still kind of an unknown because they haven’t really opened up yet. So that’s what I’m looking forward to, or at least that’s what my feeling is about the data.
Tony
Great. Okay. Albert, what are you looking at next week?
Albert
Well, obviously the Fed. I think, is in order with a hawkish tone, but honestly, I want to see how the dollar reacts to all this. And the VIX. The VIX at 17, start looking at some good old put options and call options with the 17 VIX is fantastic. But, yeah, basically what the dollar is going to do. I really want to see if the dollar breaks into the 90s with some kind of bull market talk.
Tony
Excellent. Okay. And Jim. Wrap us up. What are you looking at?
Jim
The unemployment numbers on Friday. Big deal. The last shooter drop is going to be the slack in the labor market that they want. Albert mentioned that level on the dollar. I call it like 101 to 100. As soon as it goes below that, as soon as we get a nine handle on the dollar, I think it greenlights a lot of risk assets. But the thing I’m mostly focused on is unemployment and then the week after that my trip to South Florida. Because every time I leave these damn markets, something crazy happened. So you guys can count on that. I’ll tell you when I’m on my flight. Something weird is going to happen.
Tony
When is that?
Jim
I don’t know. My wife makes the arrangements. I think it’s the next, like a week from next Thursday. I think we’re going on vacation.
Tony
Keep an eye on. Jim, thanks so much for joining us, Jim. Guys, this has been great. Thanks very much everyone have a great weekend. Thanks Jim.
The last couple of weeks has seen rising levels of unrest in China. This seemingly started in a Zhengzhou iPhone factory after the deaths of seven workers and has rapidly spread after Covid lockdowns contributed to the deaths of a family of 12 in Urumqi. Some are even saying the World Cup contributed to domestic unrest. But there’s no getting around the fact that people are just tired of lockdowns.
There’s an old Chinese saying – often attributed to Mao Zedong: “A single spark can start a prairie fire.”
What started this prairie fire and what does it mean for China and the world? We discuss that in this special episode with Dexter Roberts, Isaac Stone Fish, and Albert Marko.
Dexter talks about his retweet of a note from Lingling Wei.
Isaac talks more about this unrest potentially leading to the downfall of Xi Jinping. That seems optimistic, especially for the West. What are some of the probable outcomes?
And on the ongoing risks and market impact, Albert shares his knowledge on the issue. We’ve talked a lot about Chinese markets and the CNY. How will the markets react in the coming weeks? And how Western companies will respond to these protests and the aftermath?
Key themes: 1. Protest Context – Spark and prairie fire 2. Will anything change? “ 3. Risks and market impact
This is the 43rd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi everyone, and welcome to the Week Ahead. This Special Week Ahead, talking about China protests.
I’m Tony Nash, and today we’re joined by Dexter Roberts. Dexter is an author. He’s member of the Atlantic Council, the Mansfield Center. He’s a former Bloomberg Business Week China bureau chief, among many, many other things. Dexter, this is your first time. We really appreciate that you joined us. Isaac Stone Fish is also joining us again. Isaac is a CEO of strategy risks. He’s also Atlanta council member. He’s a China-based journalist for Newsweek and has was there for a lot of years. And we’re also joined by Albert Marco, who is a geopolitical maven and knower of all things. So guys, thanks for joining us today.
The key themes today is really what’s the context of the protest? There’s the old saying of a “spark and a prairie fire,” which we’ll go into. Really want to understand that context. Want to understand will anything change? And also what will be the impact on markets? That’s kind of hard to tell, but we’ll walk through that the last couple of weeks.
Obviously, we’ve seen rising levels of unrest in China, particularly over the weekend we started seeing quite a lot more. This seemingly started in a Zhengzhou iPhone factory after the deaths of seven workers. There’s a long story. There are a lot of videos on the internet about that, and you can do a little background on that if you want. And it spread rapidly about a week ago after there were deaths of a family of twelve in Ürümqi in an apartment fire. Again, there’s a lot of background on the internet that I’m sure you guys have seen. Some people are even saying that the World Cup contributed to the domestic unrest as Chinese families saw other people in other parts of the world out celebrating.
But there’s no getting around the fact that people are just tired of Covid lockdowns. There’s an old Chinese saying, it’s often attributed to Mao because it was a title of one of his essays called a Single Spark Can Start a Prairie Fire. And we’re trying to figure out what started the prairie fire and what does it mean to China and the world. I want to look at that with some experts, which is why we have this amazing panel today.
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So, Dexter, welcome. I really appreciate that you joined us. Thank you. You’ve retweeted quite a bit this week about the protests, and you retweeted this one from Ling Ling Wei, talking about kind of some of the origins of the protests.
Can you talk to us a little bit about kind of what are the sparks? Are there things that we’re not seeing on this side of the world that have led to this in China?
Dexter
Yeah. Well, thanks so much for having me and really appreciate it. Great to be in such a great company here.
So, obviously, we all know that there’s tremendous frustration about Covid Zero, the intermittent lockdowns, the unpredictability of life for so many people in China today. And that’s very real, and it’s a huge part of the spark, if you will, that caused the protests. I do think that less remarked upon is the very, very deep economic malaise, which is also a really important cause of this.
In particular, we’re seeing for young people a far less rosy future, if you will, and they are starting to realize that. So we’ve got the obvious economic indicators that are very bad, like the 18% plus youth unemployment rate. And then you look further than that, and I think there’s this sense, particularly amongst young people, probably amongst everyone but the young people that have taken to the streets protesting that the future is simply just not going to be what they had expected it to be.
I’d actually go one step further and say that for them, they feel like the social contract that they grew up under that really has been in place since Dung Xiaoping launched reform and opening in the late 70s.
This idea that your life will always get better, your children’s life will be better than yours, you’ll make money, you can pull yourself up by the bootstraps and do better in China if you work hard. I don’t think people feel that’s necessarily the equation anymore.
Some of the things if you just look at what’s happened in the property sector, that people have become very used to rising values in the property sector, going up and up and up, making a good career, including in the private sector, in the big tech companies, all these things are really in question in Xi’s China.
Xi has shown an attitude that is very, very different from his predecessors about the private economy. And I think this is sort of starting to become something that young people are very aware about. Then you have, of course, you have the isolation of the country, which I think is deeply distressing to a lot of young people as well. It’s a much, much different social contract that they’re being told that they need to be part of if they want to be important in the future of China.
Tony
It’s interesting you mentioned the social contract under Dong. I think it was in 1980. He talked about unifying China because there were all the fractions after the Cultural Revolution. Do you feel like Xi Jinping has continued to unify China? Has he done things to really break that up?
Dexter
I think his idea of how to unify China, he has a very ambitious idea of how to do that. It has a lot to do with nationalism. It has to do with taking pride in the ancient traditions of China. It has to do with taking pride in the earlier communist, the Mao era as well. Look where Xi Jinping took his new standing committee of the Polit Bureau right after the 20th party Congress. He took them out to Yenan, which is all about emphasizing frugality and sacrifice, self-reliance, as Xi Jinping likes to say, the old Mao expression.
So I think he believes that those can be unifying in some way. I don’t think the young people of China feel that that’s very unifying at all. It’s much more collectivist. Anti-individualistic has an almost negative attitude towards making money towards the private sector. And these are all, I think, a bit of a shock for young people in China today.
Albert
Tony, it’s interesting because trying to unify a billion people is not going to be an easy task under any system, whether it’s socialist, communist, capitalist, whatever you want to throw out there. But Xi moving into a more nationalistic arena, specifically with the private sector, has just taken the Western companies out of the equation. They’re all leaving out of China. And what Dexter is saying, what future did they possibly see with everyone leaving, especially the tech sector and the manufacturing sector? They’re just leaving. This is something Isaac can talk about, because I believe this is…
Tony
Yeah, Isaac, what are you saying about that? Are you seeing young Chinese kind of giving up on their careers? Are they frustrated by that?
Isaac
There’s such a wide range of views. And I think one of the things these protests are showing is that you can’t, nor should you try to unify any large population, because then you just squelch out the diversity of opinions. I think the protests are a real sign that a lot of people have been a lot more frustrated with communism in the Communist Party and China’s economic situation and COVID than we had thought. There’s no good polling on any of these issues. There never will be until the party relinquishes. The question of foreign businesses. It’s definitely a trend moving in the direction of reducing exposure to China. However, your average Fortune 500 company is still incredibly exposed to China and to the Chinese market.
Tony
And dependent, right?
Isaac
Yes. Especially dependent both on a revenue perspective, but also a supply chain perspective or regulatory perspective for some of the investors.
And one of the things companies are very slowly waking up to is that, on the one hand, China is not Russia. There’s so many differences between the two countries. On the other hand, there’s a lot of things that have happened in Russia that could be templates for how the future unfolds with China. Most noticeably, the situation in Taiwan.
So, three years ago, US traded 25 times more with China than we did with Russia. The numbers are starker today, but if China invades Taiwan and the US gets involved militarily, companies better have a plan for what they’re going to do with the immediate cessation of their business or the nationalization of their assets, and frankly, how they’re going to protect their Chinese and American staff.
Tony
Yeah, I’m curious about with protests like this, could it become nationalistic like it was against Japanese companies in 2012? Could we see the central government try to pivot to that type of venting?
Isaac
It’s tough to say because the party wants things to be at lower levels where you can be very nationalist because you’re cleaning up the party. And probably the most worrying thing are the calls for the downfall of the party and the calls, the rare for the downfall of Xi. And the strategy seems to be, hey, the center, Beijing is taking care of you. It’s just some local officials or some local jurisdictions are having the problem. So you can be pro-China, but anticorruption or anti what’s happening in HubeiNanchang or nonchang or wherever they decide.
Tony
Right. So let’s go to the next section, which is really looking at what are likely impacts. You talked about people calling for the downfall of Xi Jinping. I think Westerners are making a lot more of that than is on the ground. Is that what you’re seeing as well?
Isaac
I think and I’m really curious to your thoughts on this too. It’s so hard to know fully what’s happening on the ground. There’s so many fewer journalists. Even with the videos that we’re seeing on the Internet, it’s hard to know always how accurate those are and what we’re missing. And it does feel like a small, small number of people calling for the downfall of Xi Jinping is incredibly significant. And at the same time, it doesn’t mean that there’s going to be any sort of downfall of said man.
Dexter
Yeah, no, I think you’re absolutely right. It is very significant that right there in the heart of Beijing, right next to where I used to live, actually in the Taiyuan diplomatic compound, you had those protests. I guess the calls for Xi to step down were down in Shanghai. But having those kinds of very angry people and in some cases saying something from the Chinese Communist Party perspective as extreme as the leader should step down. I think is very notable.
Yeah, I don’t think that’s a widespread sentiment. I think it more has to do with a sense amongst young people that the party and Beijing is less fallible. It’s not infallible that they’re not quite as competent as people thought. And I think Covid Zero has really demonstrated that to people that the economy is a mess. The IMF is now saying, I guess, 3.2% growth for the year. It’s just almost as bad as we saw in 2020.
The script, they’ve gone badly off script. There was this great stirring narrative of how China survived the initial COVID outbreak, struggled when the rest of the world was still doing okay, and then emerged victorious and kept society, the economy recovered.
Only major economy to see, significant growth, I think a year later. Well, everything’s gone wrong now. So I think this sense amongst and again, it’s so hard, as Isaac says, to know actually what people are thinking. But from what I hear and from some conversations I’ve had, it seems as if there’s this feeling that the Party has really badly screwed up and they need to take some responsibility for it.
I think also it’s notable that they’re saying Beijing because as we were saying earlier, for years the party has got by on the argument that we’re good here in Beijing. There’s all these evil local officials, they’re abusing workers, they’re creating polluting factories. All we got to do is appeal to the right people in Beijing and they’ll solve our problems because ultimately the party has our interests in hand.
Now, if we are starting to see, and I think we are, this feeling that the Party, even at the center, has screwed up badly. And of course, the gentleman who’s in charge of everything but the chairman of everything, Xi Jinping, then that is very notable.
Tony
Yeah. So first of all, I don’t believe it’s possible for one guy to control all that stuff. So in the west, people way oversimplify and act like China is a monolithic government and there’s one guy at the center, it’s just not possible for one guy to control all that stuff. Do you guys think he really is the only guy making decisions, the only guy making policy?
Albert
No. I have a contrarian point, though. For my take of this, the question has to be why is China even allowing these videos to leak? Why are they even allowing these protests to get this big? In my opinion is they want to show the world that they are done with this COVID they need a reason to be done with COVID Zero. It’s been hampering their economy and they need to move on. They’re done working with the United States on combating inflation and this is their signal to the rest of the world saying, look, we can’t do this anymore.
Tony
So when you say “they,” who is they?
Albert
When you say they and his cohorts on the CCP, they’re done with this, they’re done with helping the Fed and Yellen combat inflation globally.
Dexter
I have to just push back a little bit. I think they are aware, and I think it’s the reality that if they do, they’re in a really difficult spot, because if they were to actually pull away and all controls, they’re just not prepared, I think, for the outbreak of the pandemic that China would see. They have very little herd immunity. They’re victims of their own success to a degree there. As we all know, and we’ve heard a lot about the there’s low levels of vaccination for the elderly. They have a very fragmented healthcare system. I think ending COVID Zero with one stroke is a recipe for huge problems in China and I think that the leadership knows that, or at least they fear that. I think they’re in a very difficult spot. They do want to move beyond it. I agree. It’s not easy.
Albert
Yeah, I don’t think they’re going to move as the one full stroke and just open up everything. I do think it’s going to be a staged open, but from what I heard, my contacts there said March was the date that they’re going to end COVID Zero, whether it be stages or one full stroke as a debatable thing. But at this point, I don’t think they can last that long. I think now it’s looking more like end of January, early February.
Dexter
I’m going to say really quickly, I mean, the other huge issue is Xi Jinping has associated himself so much with what he sees as a successful, I mean, what had been until not too long ago, it seemed like a successful COVID Zero policy. It turned out it wasn’t successful at all. We know in hindsight, but they have really defined themselves in opposition or in contrast to the rest of the world. So if you watch the Chinese media, the staterun media, every time we’ve reached a new level of mortality, more than a million people have died. These things are top of the news in China and I think the party has tried to tell the Chinese people, you’re safe here, in contrast to the chaotic rest of the world and particularly chaotic America. This is their argument. And if they lift Covid Zero now and they do have the pandemic rips through the population and they do have high mortality, there goes out the window Xi Jinping’s narrative of the grand success of the CCP with COVID Zero.
Isaac
The Spring festival in January, February, where hundreds of millions of people normally travel, would be a super spreader event, like nothing we’ve ever seen before. So one imagines if they do loosen, it’ll be after that. And the record, I do want them to loosen up, and the draconian and arbitrary lockdowns have such a massive toll, but I think Spring Festival will be a big piece of their consideration.
Tony
Okay, that’s a great point. I think you and Albert kind of agree on that generally, in terms of the time frame. So let me ask you, what else will change? Will we see, say, some local leaders go down saying they overly aggressively enforced it or something like that? There is typically some sort of accountability, whether it’s well placed or misplaced in China. So will we see somebody or a group of people or many, many people go down? And I’ll tell you why I asked that.
I referred to this on social media. This reminds me of the April 5 incident in 1976, when Zhou Enlai died and Mao didn’t attend a funeral and didn’t want people to recognize that Zhou Enlai died. So people started protesting and expressing their, you know, their sadness that Zhou Enlai died. Thousands of people went to jail. Right. And somebody had to pay. It was an outburst like we’re seeing now across China, and it really took two or three years for those people to be let out of jail. Right. So it seems to me a discreet event like that, and it seems to me that the response back then was thousands of people going to jail, and then a few years later, under new leadership, saying, “oops, that was a mistake, let everyone out.” Will it be something like that?
Isaac
I don’t think so. I’d say the base case is quiet arrests and harassment where people disappear or people aren’t seen for a brief period of time, and there’s not enough that people can hang their hat on. I think one of the easiest ways to make this into a movement is to create martyrs. So if a local policeman screws up and shoots into a crowd of protesters, this could really, really spiral. It’s so hard to know. I mean, it’s impossible to predict whether or not that’s going to happen. That could be a history changing moment. I think right now we are before the tipping point, and I think the most likely outcome is these protests subside. We see some more of them this weekend, but they’re not as well attended. And this is basically the high point of that. And there’s probably a couple hundred arrests, but we don’t really know. There’s no good statistics on it. And COVID slowly opens up, and several provincial level officials lose their job in ways that people loosely tied to this event.
Tony
Yeah, I think that’s fair. Dexter, does that make sense to you generally?
Dexter
Yeah, it does. It reminds me of I covered the labor movement before Xi Jinping ultimately destroyed it around 2013, and going back to even the first big labor protest in the northeast of China in places like Dai Qing and Lio Yang. And back then, what they would always do is they would arrest or maybe they would create the ringleaders of the protests. So they put a couple of highprofile people in jail as a warning to the others and then they would do a lot to try to meet the frustrations of the protesters. So then it was about local corrupt officials or corrupt factory managers stealing the pensions or whatever it might have been, and they would announce that. I see sort of yeah, something like, as Isaac was saying, well, they’ll do more. They will loosen on COVID Zero when they can. You already had a statement. I’m trying to remember if it was the Health Ministry or something that seemed to be sort of it didn’t go very far, but it seemed to be sort of saying, we understand the frustrations of the people just in the last day or so. I think they’ll do that.
Dexter
The arrests, of course, they’ve already started talking about the hostile foreign forces that are involved, which is not a surprise. They’ll probably heat that up a bit and blame. They’ll try to make the argument that the young people have been misled by bad people overseas, which they always do. And they did that in Hong Kong and they’ve done that in Xinjiang and so on. But, yeah, I think I do agree with Isaac. I think that’s probably most likely. They definitely don’t want to make martyrs.
Tony
Great. Okay, then let’s move on to kind of the markets impact. So it sounds to me like the general consensus is not a lot. This is not a revolutionary event. We’re not going to see the deposing of Chinese leadership, despite the kind of Western sharing, all that sort of thing. So in terms of the risks and the market impact, Albert, can you just start us on that? Do you see markets impact? Do you see Chinese markets rallying or falling? Do you see CNY devaluing or appreciating? What do you generally expect?
Albert
Well, as I said before, I think this is a signal to say that China is definitely going to be moving beyond COVID Zero. Data is debatable, but they have just an enormous amount of stimulus to unleash. They just did a little bit overnight talking about helping out the property sector and KWEB and Baba and everything is up 7%. It’s uncanny. So, yeah, this is definitely a signal to the US or Europe and say, hey, we’re almost about to open for business. Get your stuff in gear, because when it does, it’ll be a tsunami of money coming in and the markets will rally on it, for sure it will.
Tony
So this is generally could be good for Western markets and Asian markets because China’s lockdown is really I mean, I don’t I don’t mean to be overly simplistic, but I’m going to do it. Ending China’s lockdown is really the most important issue in Asia right now, I think. And it’s the most important issue in markets right now.
Albert
But it’s not good for the west. It’s not good for the United States specifically because it’s going to take inflation back up to where was six months to eight months ago. When China starts moving, commodities start rallying.
Tony
Which is at 78 right now, or something up to?
Albert
110 or 120 easy. That point. On top of that, money from the United States will end up flowing out back into China, in Asia, Singapore, Japan, South Korea. Name your manufacturing sector, but that’s the reality of it. The Fed right now has 60 days to get things sorted out with two Fed meetings coming up.
Tony
Okay, Isaac, what do you see on the risk side as this plays out? Is it just going back to business as usual, no problem, everything’s great, or do you see are there some risks that we’re not kind of aware of?
Isaac
Geopolitical tensions are so much higher than they were preCovid lockdowns in China, and the looming specter of a Chinese invasion of Taiwan still not the base case, but still very likely increased tensions with Japan or India or in the South Sea or the East Sea. These protests, I think really the right assumption is that they don’t lead to further instability, but they certainly could, or certain other areas of disturbance or frustration with the leadership could really bubble up, and that could have very severe economic consequences.
I think there’s also the really important point of the strong leftward turn that China’s economy is taking. It’s becoming a lot more statist and with more investments, more JVs, a flowing of capital into China. This is going to be done under different rules than it was under Hu Jintao or under early Xi Jinping. It’s going to be with a much heavier state footprint, and that’s going to make things a lot more complicated. It’s going to be a different set of rules, even for companies that have been doing this for a very long time.
Tony
So what you’re saying is we are who they thought we were a few weeks ago in the part of Congress, right? There was this ominous feeling coming out of that. And then there was this event, I think, last week in ASEAN where it felt like there was some shine put back on Xi Jinping. And now it feels like that it’s coming back to be kind of who we thought they were.
Isaac
And the narratives keep shifting so rapidly, and they’re going to continue to shift and evolve. I think people need to understand. There’s an old saying, if you’re going to have to remind me how this went, but it’s something that in China, the only thing you know about the impossible is that it happens all the time, and it’s very difficult to know what we’re going to see. But we do have I think Taiwan is the best example of that. We do have a very clear possibility that China invades Taiwan, and that may start World War Three. And we can predict that now, so people can plan not, hey, this is definitely going to happen, but, hey, this is a very real risk, so how do I plan accordingly?
Tony
Okay, so protest not a big deal, but World War Three possible? That’s kind of what
Isaac
That’s the summary. Yeah, put that on my tombstones.
Tony
Very good. Any other thoughts?
Dexter
Yeah, well, Isaac just brought up a big one, which is this increasing status nature of the economy. I think as multinationals going forward, they’re going to do business in a very different environment. We heard that, of course, with Xi Jinping’s 20th Party Congress speech, which, as we all know, mentioned security, whatever it was, 91 times, and market a small fraction of that. There’s a new emphasis. Xi Jinping has made it very clear that he’s willing to make economic sacrifices, productivity growth sacrifices, in order to make sure that the party is secure and China is secure and is on a path that he thinks is correct. He’s got that whole line about that. He’s been saying for years about how we can’t use the second 30 years of China’s history to negate the first 30 years. Meaning we moved too far in saying that reform and opening was the end all to be all and negating the earlier the historical neolism that Y’all talks about, which is negating the Mao era. He thinks there’s important lessons for the Mao era. He’s not a Maoist at all, and he certainly doesn’t believe in bottom up revolution. He’s a very top down sort of guy.
But I do think he has a very different vision for the economy. I do think he’s willing. We saw with the private education sector, he seemingly didn’t lose much sleep over completely wiping out a major industry, forcing markets around the world to shed tens of billions of dollars and sending huge numbers of young Chinese into unemployment with this crackdown on private education and tech. And I think ultimately that’s cheap. I don’t believe I think he’s a very different breed. When I showed up in China, it was Zhang Zumin and obviously Jung Zumin and Zhu Rong Xi.
Very different than Hujing Tao and Win jabao. And then today, and I myself was astonished by who Xi Jinping is. I think he’s deeply ambitious and has very different ideas about where China will go, how it will get there, and those have very big economic implications.
Tony
Wow. I’d love to have a two hour conversation with you guys. Let’s just keep it quick. Thank you so much for this time. I think we can maybe do, if things take a different turn, let’s do another conversation in a couple of weeks or something. But I really appreciate your time and thanks, guys. Really. Thank you very much.
This Week Ahead, we’re joined by Daniel Lacalle, Tracy Shuchart, and Sam Rines.
First discussion is on liquidity drain and quantitative tightening (QT). How difficult is it?
Rate hikes get a lot of the headlines, but QT peaked at just under $9 trillion in April of this year. The Fed has pulled just over $200 billion from the balance sheet since then, which isn’t nothing, but it’s not much compared to the total.
Where do we go from here? Most of the Fed’s balance sheet is in Treasuries, followed by Mortgage-backed securities. What does the path ahead look like – and where is the pain felt most acutely? Daniel leads on this discussion.
We also look at the copper gap with Tracy. We don’t really have enough copper over the next ten years to fill the demand. Despite that, we’ve seen copper prices fall this year – and Complete Intelligence doesn’t expect them to rise in the coming months. Tracy helps us understand why we’re seeing this and what’s the reason for the more recent fall in the copper price. Is it just recession? Will we see prices snap upward to fill the gap or will it be a gradual upward price trend?
We’ve had some earnings reports for retail over the past couple of weeks and Sam had a fantastic newsletter on that. On previous shows, we’ve talked about how successful US retailers have pushed price (because of inflation) over volume.
Costco and Home Depot have done this successfully. Walmart had serious inventory problems earlier this year, but their grocery has really saved them. Target has problems, but as Sam showed in his newsletter, general merchandise retailers have had a harder time pushing price. What does this mean? Is Target an early indicator that the US consumer is dead?
Key themes: 1. Liquidity drain and QT 2. Copper Gap 3. Retail and the US Consumer 4. What’s up for the Week Ahead?
This is the 42nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to The Week Ahead. I am Tony Nash. And this week we’re joined by Dr. Daniel Lacalle or Daniel Lacalle. Daniel is a chief economist, he is a fund manager, he’s an author, he’s a professor. Kind of everything under the sun, Daniel does.
Daniel, thank you so much for joining us today. I know you have a very busy schedule. I appreciate you taking the time to join us. We’re also joined by Tracy Shuart. Tracy is the president at Hightower Resources, a brand-new firm. So pop over and see Tracy’s new firm and subscribe. We’re also joined by Sam Rines of Corbu. Thanks all of you guys for taking the time out of today.
Before we get started. I’m going to take 30 seconds on CI Futures, our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies commodities, equity indices.
Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast error.
We also forecast about two thousand economic variables for the top 50 economies globally, and that is reforcast every month.
There are a few key themes we’re going to look at today. First is liquidity drain and quantitative tightening, or QT. Daniel will lead on that and I think everyone will have a little bit to join in on that.
We’ll then look at copper gap, meaning we don’t really have enough copper over the next, say, ten years to fill the needs of EVs and other things. So Tracy will dig into that a little bit.
We’ve had some earnings reports for retail over the past couple weeks and Sam had a fantastic newsletter on that this week. So we’ll dig into that as well. Then we’ll look at what we expect for the week ahead.
So Daniel, thanks again for joining us. It’s fantastic. You’ve spoken to our group about a year ago or so. It was amazing.
So you tweeted out this item on screen right now about the liquidity drain.
You sent that out earlier this week and it really got me thinking about the complexities of draining liquidity from global markets, especially the US. Since I guess global markets are hypersensitive to draining in the US.
Of course, rate hikes get a lot of headlines, but you mentioned QT, so it’s a bit more complicated. Obviously, QT peaked in April of this year. There’s a chart on the screen right now at just under $9 trillion.
And the Fed’s put about $200 billion back from their balance sheet, back in the market from their balance sheet, which isn’t nothing, but it’s really not much compared to the total.
So I guess my question is, where do we go from here? Most of the Fed’s balance sheet is in Treasuries as we’re showing on the screen right now, followed by mortgage backed securities.
So what does this say about the path ahead? What do you expect? How quickly do you expect? Does it matter that much?
Daniel
Thank you very much, Tony. I think that it’s very important for the following reason. When people talk about liquidity, they tend to think of liquidity as something is static, as something that is simply there. And when central banks inject liquidity, it’s an added. And when they take liquidity away from the system, that simply balances the whole thing. And it doesn’t work that way.
Capital is either created or destroyed. Capital is not static. So when quantitative easing happens, what basically happens is the equivalent of a tsunami. Now, you basically add into the balance sheet of central banks trillion, whatever it is, of assets, though, by taking those assets away from the market, you generate an increased leverage that makes every unit of money that is created from the balance sheet of the central bank basically multiplied by five, six, we don’t know how many times. And it also depends on the transmission mechanism of monetary policy, which is at the end of the day, what the reason why central banks do QE is precisely to free up the balance sheet commercial banks so that they can lend more.
Tony
Let me stop you there. Just to dig into so people understand what you’re talking about. When you talk about transmission mechanism, and the Fed holds mortgage backed securities, the transmission mechanism would be through mortgages taken out by people because mortgages are cheaper, because the Fed is buying MBS. Is that fair to say?
Daniel
Not cheaper. They don’t necessarily have to be cheaper. They have to be more abundant. Ultimately…
Tony
That’s fair. Yeah. Okay.
Daniel
Ultimately, this is why when people talk so much about rate hikes, rate hikes or rate cuts are not that important. But liquidity injections and liquidity training are incredibly important for markets because rate hikes or rate cuts do not generate multiple expansions. Yet liquidity injections do create multiple expansion, and liquidity draining is much more severe than the impact of the rate hike.
Tony
Okay, so when you say multiple expansion, you’re talking in the equity markets?
Daniel
In equity markets or in the valuation of bonds price. That means lower bond yields or in the valuation of private equity. We saw, for example, in the period of quantitative easing, how the multiples of private equity transactions went from ten times EV to even to 15 times easily without any problem.
So what quantitative tightening does is much worse than what quantitative easing does, because the market can absorb an increase of liquidity through all these multiple assets. However, when quantitative tightening happens, the process is the reverse. Is that the first thing that happens, obviously, is that the treasury, the allegedly lowest risk asset, becomes more cheap, ie, the bond yield goes up, the price goes down, the bond yield goes up, and in turn it creates the same multiplier effect, but a larger dividing effect on the way out.
Tony
So the divisor is greater than the multiplier.
Daniel
The divisor is greater. And I tell you why. In the process of capital creation, there is always misinformation that leads to multiple expansion. Okay? So one unit of capital adds two more units of capital plus a certain excess valuation, et cetera. Now from that point, if you reduce one unit of the balance yield of the central bank, the impact down is much larger. So where it goes to, this is the problem that we as investors find it very difficult to analyze is where is the multiple at which equities, bonds, certain assets are going to stop because it is very likely to be below the level where they started.
The challenge of quantitative tightening is even worse when the process of quantitative easing has been prolonged, not just in period of compression of economic activity or recessions, but also in the periods of growth.
Tony
Okay?
Daniel
Because the level of risk that investors take becomes not just larger but exponential under QE. Under QT. Under QE, you get Bitcoin going from 20 to 60 under QT, you get bitcoin going from 60 to maybe zero.
I don’t know. I don’t know.
Tony
The comments are going to be full of angry bitcoin people.
Daniel
I just want people to understand that just like on the way up in a roller coaster, you go slowly and it seems that everything is going relatively smoothly. When you start to go down, you go down really fast and it’s truly scary.
Tony
Okay, so let me ask you this, because when you talk about multiple expansion, I’m sure we’re going to get some comments back about tech firms because we’ve seen tech firms multiple expansion decline pretty dramatically in the past, say six months, certainly past year, for companies like Meta. So although we’ve only seen $200 billion in quantitative tightening, how does that reconcile with your statement about interest rates not necessarily impacting valuations.
Daniel
No, interest rates impact valuations, but not as aggressive as quantitative tightenint. They do, particularly in tech for a very simple reason. I think that all of us can understand that a technology company is in the process of money creation. A technology company is one of the first recipients of newly created money because it absorbs capital quicker and it obviously benefits enormously from low interest rates, obviously.
But the process of multiple expansion tends to happen in the early stages of those companies. Now the process of multiple compression is much more viscious because I would be genuinely interested to have a discussion with, I don’t know, with people that invest in nonprofitable tech, but I would really like to understand how they get to the current levels of valuation comfortably.
The biggest problem I see of quantitative tightening is the same problem I see of the hidden risks of quantitative easing is that central banks cannot discern which part of the wealth effect comes from the improvement in the real economy or simply from bubbles. And the creation of bubbles obviously, we can imagine that something is a bubble, but we don’t really know until it bursts.
So it’s going to be very problematic for a central bank to achieve almost one thing and the opposite, which is what they’re trying to do. What they’re trying to do is to say, okay, we’re going to reduce the balance sheet. Hey, we’re going to reduce the balance sheet by 95 billion a month and think that that will have no impact on the bond market, on the equity market, and on the housing market. The housing market is already showing.
Tony
Yeah, I don’t necessarily think they’re saying that will have no impact on that stuff. Sam, from your point of view, is that their expectation that QT would have no impact on asset prices?
Sam
I wouldn’t say it’s their expectation that it wouldn’t have an impact on asset prices. I think they understand that there’s an impact on asset prices from just the narrative of tightening generally. But to the point, I think it is very difficult to parse what portion of their tightening is doing what particularly for them.
You look at some of the research on coming out of the Fed, on what QT is expected to do and what QT does, and you come out of it thinking they have no idea. I think that they would probably say that quietly behind closed doors, without microphones. But to the point, I would agree that there is an effect and that the Fed likes to say set it and forget it, because they don’t really understand what the actual impact is on either the real economy or the financial economy. Come up with our star-star, which is some stupid concept that they decided to come up with to rationalize some of their ideas. But I would say no, that makes perfect sense, that they really don’t understand exactly how much it is. Which is why they say we’re just going to set it, forget it, and we’re not really going to talk about it.
Because if you listen to the Fed, their concentration is on the path to the terminal rate and the length of holding the terminal rate there. And if you Google or try to find any sort of commentary about quantitative tightening within their speeches and their statements, it’s actually pretty hard to find.
Daniel
Yeah. So just to clarify one thing, just to clarify. In the messages from, for example, of the ECB and the Bank of Japan, less so of the Fed. And I would absolutely agree with that because the Fed is not so worried because they know that they have the world reserve currency, but the ECB and the Bank of Japan certainly expect very little impact on asset prices. For example, the ECB are just saying right now that they’re expecting to reduce the balance sheet in the next two years by almost a trillion euros without seeing spreads widening in the sovereign market. That is insane to be fairly honest. So that is what I’m trying to put together is that the same… A central bank that is unable to see that negative bond yield and that compressed spreads of sovereign nations relative to Germany is a bubble. It’s certainly not going to see the risk of tightening.
Sam
I would start with saying that if the ECB thinks they are going to take a trillion off the books in a couple of years, that’s the first insane part of that statement.
Tony
Good. Okay. So what I’m getting from this is taking liquidity out of markets can be really damaging and the guys who are doing it don’t really know the impact of their actions. Is that good top level summary?
Daniel
Absolutely. That is the summary.
Tony
Okay, so since they’ve only taken 200 billion off, I say “only,” but compared to 9 trillion, it’s not much. Since they’re pulling the interest rate lever now at the Fed and they’re kind of tepidly moving forward on the balance sheet, do we expect them to finish the interest rate activities before they aggressively go after the balance sheet or are they just going to go march forward with everything?
Daniel
No, I think that’s.. They want to see the impact of interest rates first before they make a drastic action on the balance sheet. Particularly in the case of the Fed with mortgage backed securities, and the case of the Bank of Japan with ETFs because the Bank of Japan is going to kill the Nikkei if it starts to get rid of ETFs. And certainly the Fed is going to kill the housing market with mortgage backed securities are warranted.
Tony
Yup.
Sam
And then it’s kind of interesting because there’s two dynamics that I think are intriguing here. One is that the Fed’s balance sheet is getting longer in duration as interest rates rise because those mortgage backs are just blowing out to the right because you’re not going to have to have the roll down and you’re not going to have the prepays on those mortgages anytime soon. So the Fed is putting themselves in a position where hitting those caps on mortgage backs is just simply not going to happen on a mechanical basis. And they’re either going to have to sell or they’re going to have to say, we’re just not going to hit we’re not going to hit our cap on mortgage backed securities for the next 20 years.
Tony
Yup. So I get to put those to maturity like they’re doing with all the treasury debt.
Sam
Yeah, they’re just letting them roll off, which means they’re not going to have mortgage backs rolling off with a six and a half percent refi rate.
Daniel
Yeah, I agree with that.
Tony
Wow. It’s almost as if QT potentially is a non issue for the longer duration debt? Are you saying they’ll continue holding? Sam you’re saying , “No.” So what am I missing? What I’m hearing is they may just hold the longer duration stuff. So if that’s the case, is it kind of a non issue if they just hold it?
Daniel
It’s not a non issue. They are in conversations all the time with the Bank of Japan to do this composite yield curve management, which in a sense means playing with duration here and there on the asset base. But it doesn’t work when the yield curve is flattening all over the place and when you have a negative yield curve in almost every part of the structure.
So the point is that by the time that markets realize the difficulty of unwinding the balance sheet, the way that central banks have said, probably the impact on asset prices has already happened because commercial banks need to end margin calls, et cetera, margin calls become more expensive. Commercial banks cannot lend with the same amount of leverage that they did before. Capital is already being destroyed as we speak.
Sam
Into the point. As soon as you had the Bank of England announce that they were going to have an outright sale of Gilts, you saw what happened to their market. They broke themselves in two minutes.
Tony
Right. Okay. So that’s what I’m looking for. So it’s a little muddy. We’re not exactly sure. Right. QT is complicated. It’s really complicated. And liquidity is dangerous, as you say, Daniel. It’s easy on the way up. It’s really hard coming down from it. And that’s where…
Daniel
I think it was Jim Grant recently who said how easy it is to become a heroin addict and how difficult it is to get out of it.
Tony
Sure, yeah. I mean, not that I know, but I can see that.
Daniel
We don’t know it, obviously. None of us do. But it’s a very visual way of understanding how you build risk in the system and how difficult it is to reduce that risk from the system.
Tony
Yeah, just stopping adding liquidity is a good first step, and then figuring out what to do after that is I think they’re right. A lot of people like to knock on the Fed, but doing one thing at a time is, I think, better than trying to reconcile everything at once.
Okay, great. Since we’re taking a little bit of longer term view on things with some of that mortgage backed security debt, I just also was in a longer term mood this week and saw something that Tracy tweeted out about copper consumption and demand.
This was looking at long term demand, say, by 2030, and there’s a gap of what, 20 no, sorry, 10 million tons. Is that right, Tracy?
Tracy
8.1 million tons.
Tony
8.1 million tons. Okay. Now, when we look at copper prices right now, we’ve seen copper prices fall. We don’t really have an expectation of them rising on the screen as our Complete Intelligence forecast of them rising in the next few months.
So why the mismatch, Tracy? What’s going on there? And why aren’t we seeing the impact on copper prices right now?
Tracy
Well, I think if we look at basic industrial metals really as a whole, except for, say, lithium, really, we’ve seen a very large pullback in all these prices in these specific metals that we are going to need for this green transition.
Now, part of that is, I think, part of that is QT, we’re just saying money liquidity drained from the system. But I also think that we have overriding fears of a global recession. We also have seen people are worried about Europe because with high natural gas prices, a lot of their smelting capacity went offline.
And one would think that would be bullish metals, but it’s scaring the market as far as global recession fears. And then, of course, you always have China, which is obviously a major buyer of industrial base and industrial metals. They’re huge consumer as well as producer of the solar panels. Wind turbines and things of that nature.
So I think that’s really the overriding fears and what I’ve been talking about even for the last couple of years, that I think metals is really going to be more of H2 2023 into 2024 story. I didn’t really expect this year for that to be the real story.
I know you thought that energy was still going to be the focus. And I think even though we’ve seen prices come off, energy prices are still very high. And I think energy prices we’re going to see a resurgence of natural gas prices again in Europe as soon as we kind of get past March, when that storage is kind of done. Because we have to realize that even though the storage is still this year, 50% of that did still come from piped in natural gas from Russia.
I think we’ll start to see natural gas prices higher. Oil prices are still high. Even at $75, $80, it’s still traditionally high. So the input cost going into metals to bring it all together, the input cost going in metals, we are going to need a lot of fossil fuels. It’s very expensive. We also see mining capex suffers from the same problem that oil does is that over the last seven years, we’ve seen huge declines. And then when we look at copper in particular, we really haven’t had any new discoveries since 2015. So all of those are contributing factors. But again, I don’t think that’s really a story until last half of 2023 and 2024 going forward.
Tony
Okay, so to me, the copper price tells me, and I could be, tell me if I’m wrong here. Copper rise tells me that markets don’t believe China is going to open up fully anytime soon, and they don’t believe China is going to stimulate anytime soon. Is that a fair assessment?
Tracy
Yes, absolutely. I think we kind of saw metal prices. We’re bouncing on some of the headlines back and forth, but really we haven’t seen anything come to fruition, and I think most people are not looking until probably spring for them to open up. And I think China really hasn’t changed its stance, right. As far as. There Zero Covid policy, they’re still on that. So I think markets have been digesting that over the last couple of weeks or so. And that’s also another contributor to seeing a pullback in some of these metals in the energy sector.
Tony
Yeah, if you look at the headlines over the past week, you definitely see a softer tone towards China, with Xi Jinping coming out in the APEC meeting sorry, not the APEC meeting, the ASEAN meeting. And he’s a real human being and all this stuff, and he’s talking with Biden and he’s talking with European leaders and Southeast Asian leaders.
So I think there’s been a softer tone toward China and this belief that good things can happen in the near term, but I don’t think most investors will believe it until they see it, first of all. And I think places like Japan, Korea, Taiwan, US. Other places, maybe not. The Germans are also a little bit worried about short term sentiment in China. Things could turn pretty quickly. So, like you say, I think base metals prices are down on that. But over the long term, obviously, it doesn’t seem like there’s enough capacity right now. So, anyway, we’ll see. So for bringing that up. Sorry. Go ahead, Sam.
Sam
Yeah, I think there’s just two things to add there. One, if you didn’t have investment in base metals and energy at zero interest rates, you’re not going to get it at five. Let’s be honest. That’s point number one, this isn’t a short term thing. This is a much longer term thing. And you need to have much higher prices for commodities broadly in order to incentivize any sort of investment, because they’re, one, very capital intensive, and two, capital is very expensive right now. So I think that’s also something to keep in mind over the medium term, is we’re not solving this problem at five and a half percent interest rates here. That’s clearly not going to happen. And the other thing is you haven’t seen the Aussie dollar react in a positive way. So if the Aussie dollar is reacting, China is not reopening. It’s just that simple.
Tony
Yeah, that’s a very point.
Daniel
If I may, I would also like to point out that the bullish story for copper, lithium, cobalt is so evident from the energy transition and from the disparity between the available capacity and the demand. But when the gap is so wide between what would be the demand and the available supply, what tends to happen is that the market, rightly so, sees that it’s such an impossibility that you don’t even consider, at least as a net present value view, that bullish signal as Tracy was mentioning until 2023 or 2024, when it starts to manifest itself.
Right now, it’s so far between the reality of the available supply and the expectation of demand that it looks a little bit like what happened with Solar in 2007, 2008. We just saw bankruptcy after bankruptcy because you didn’t match the two. And on top of it, Tracy correct me. But this is the first year in which you had a massive bullish signal on prices, in energy and in metals, yet you’ve seen no response from a capping.
Tracy
Exactly. Nobody’s prepared, nobody wants to really still spend that kind of money, particularly not the oil industry when they’re being demonized by everybody in the west in particular. So you know, you’re not going to see a lot of, nobody wants to invest in a project when they’re saying we want to phase you out in ten years.
Tony
What’s really interesting though also is BHP bought a small midsized copper miner in Australia this week, so I forget their name, but the miners are seeing opportunities, but they’re just not seeing the demand there yet. So we’ll see what happens there. So anyway, thanks guys for that. That’s hugely valuable.
Sam, you wrote on retail this week and you have really brought out some interesting dynamics around pushing price versus volume within stores over the past several months. And your newsletter looked at Target, Walmart, Costco, Home Depot. Earnings across retail sectors.
So Costco and Home Depot seem to have pushed price successfully. Walmart, as you say, had serious inventory problems earlier in the year, but their grocery business seemed to have really saved them. But Target really has problems and their earnings report this week was a mess. So we’ve got on screen a table that you took out of some government data looking at, has made a change of sales for different types of retail firms, building materials, general merchandise and food services. And things seem to be going very well for everyone except general merchandise stores like Target.
So can you help us understand why is that the case for, I mean, maybe Target is just terribly wrong, but why is that the case for general merchandise specifically and what does this say about the US consumer? Is the US consumer kind of dead in some areas?
Sam
No. US consumers is not dead, which is the strangest part about this earning season to me is everybody kind of read into Targets reporting was like, wow, this is horrible. It’s bad, it’s bad. Target is its own problem. Their merchandising, horrible. Their executive team, horrible. I mean, I don’t know how you survive this. With Walmart putting up huge comp numbers on a relative basis. I mean, they pounded Target and to me that was single number one. That’s Target’s issue.
The general merchandise store. We bought a whole bunch of stuff during COVID that we don’t really need to buy at 17 of right? We bought it during COVID You could get Walmart and Target delivered to you, that was a boom for their business and that’s just not being repeated. Same thing with if you look at Best Buy and electronic stores not doing great because we all bought TVs during COVID and computers, we needed them at home. These are just pivots. When you look at the numbers for restaurants, when you look at it for grocery, I mean, again, a lot of it is pushing price onto the consumer, but the consumer is taking it.
And those are pushing revenues higher. Look at something, the company that controls Popeyes and Burger King, absolute blowout, same store numbers. I mean, these are restaurants that are pushing price. They’re still having traffic and they’re not getting enough pushback.
Home Depot pushed 8% pricing, well, almost 9% pricing in the quarter. They didn’t care about foot traffic, but traffic was down mid 4%. They didn’t care about the foot traffic. They got to push the price and they, guess what, blew it out? Loads had a decent quarter. These are housing companies, at least home exposed companies and building exposed companies that had great third quarters that were supposed to be getting smashed, right? The housing is not supposed to be the place that you’re going to right now. And somehow these companies could push in a price.
There’s something of a tailwind to the consumer where the consumer is kind of learning to take it in certain areas and just saying, no, I don’t need another Tshirt or I don’t need to make another trip to Target. I think that it’s pretty much a story of where the consumer spending not if the consumer spending.
That retail sales report, it will get revised, who knows by how much, but the retail sales report, even if it gets knocked down by a few bips called 20 basis points, 0.2%, it’s not going to be a big deal. It’s still blowing number. These are not things you want to see.
If you’re the Fed thinking about going from 75 to 50, 2 reasons there. One is that pricing little too much. And if it begins to become embedded, not necessarily in the consumer’s mind, but also in the business’s mind, I can push price. I can push price. I can push price. That’s a twosided coin where the consumer’s willing to take it and businesses are willing to push it. That is the embedding of inflation expectations moving forward.
Going back to I think it was last quarter, Cracker Barrel announced during like, yeah, we’re seeing some traffic flow, but we’re going to push price next year, and here’s how much we’re going to push it by. These companies aren’t slowing down their price increases, and they’re not seeing enough of a pushback from consumers.
Tony
Cracker Barrel and Walmart are not topend market companies. They’re midmarket companies. And if they’re able to push price at the mid market, then it says that your average consumer is kind of taking it. But the volume is down. So fewer people are buying things, but the ones who are buying are paying more. Is that fair to say?
Sam
It’s fair to say. Fewer trips, more expensive. It’s fair to say. But there’s also something to point out where Macy’s, their flagship brand, kind of had a meh quarter. Bloomingdale’s, heirt luxury? Blew it out.
Tony
Okay.
Sam
So you’re seeing even within general merchandise stores, you’re seeing a significant difference between, call it luxury, middle, and low.
Tony
Okay. So what is it about, say, Target and Macy’s? I’ll say Target more than Macy’s, but is it just the management, or is it the mech?
Sam
It’s merchandising and it’s the Mexican.
Tony
Right, okay.
Sam
And if you don’t have the right stuff that you can push price on, you’re not going to make it.
Tony
So will we see some of these general merchandisers move into other sectors? Grocery or whatever?
Sam
I mean, Target has grocery. TVs closed. They have everything. It’s a question of do you have the right thing to sell right now in terms of that? So I don’t really think you’ll see many big moves, mostly because they already have too much inventory. So their ability to pivot is zero at this point. So it’s going to be a tough holiday season. I think it’s going to be a pretty tough holiday season to Target. But I didn’t see Walmart taking down numbers for the Christmas season. We’ll see with Amazon, but cool.
Tony
It seems healthy. Just observationally. They seem pretty healthy.
Sam
Yeah. And the other thing to mention, just as a side note, there’s a lot of this consternation around FedEx and UPS and their estimated deliveries for Christmas. This is the first year that Amazon has had a very, very large fleet going into the Christmas holiday season where they don’t have to send packages through FedEx and UPS only. They have a very, very large in house fleet of vehicles to do so with, and they built that out massively over the past 18 months. So I would read a lot less into that for the Christmas season, et cetera, than people are. That’s something I think it’s kind of taking the big picture and missing the finer points.
Tracy
I had a question really just on that same vein. I’ve seen a lot of the freight companies that report on freight, like Freight Waves, have been screaming at the top of their lungs, loadings are falling. People are going out of work. They’re firing everybody. Nobody’s delivering anything. Nobody’s delivering any goods. Do you think that’s sort of cyclical or because it seems like there’s a mismatch right now. There’s a lot of goods out there to be delivered, but for some reason, these guys can’t get loading.
Sam
I think it’s two things. One, everybody double ordered in spring and summer. So I think Freight Waves and a lot of other companies saw a lot of livings that they wouldn’t have seen otherwise. And you spread those out, and I think that’s point number one. Point number two is these retailers are stuffed with inventory. Target, even Walmart is somewhat elevated. They don’t have that big problem. They have the inventory. I would say it’s much more of a timing issue. You’ll probably see Freight Waves have too many loadings, called it in the spring and summer of next year because people are playing catch up and trying to get the right merchandise, et cetera, et cetera. So I think it’s just more of a Covid whipsaw than anything else.
Tracy
Makes sense, right?
Tony
Okay, so bottom line, us. Consumer is still taking it, right? They’re still spending, they’re still okay. Despite what bank deposits and other things tell us, things are still moving. And is that largely accumulating credit or how is the US consumer still spending? They’re accumulating credit?
Sam
A couple of things. One, they have their bank deposits are fine, particularly at the middle and upper levels. They’re still relatively elevated. Two, you’re getting a much higher wage. So your marginal propensity to consume when you see a significant pay raise, even if prices are higher, is higher, right. So you’re going to spend that dollar.
So you’re getting paid more. You’re switching jobs a lot more. Your switchers are getting something like a double digit pay increase. These are rather large chefs, so I would say the consumer feels a lot more comfortable with taking the inflation because they’re getting paid a lot more. Unemployment is sub 4%, so they’re not afraid of losing their job unless they’re at Twitter. So the consumer is sitting there like, all right, I’m not losing my job. I’m getting paid increases. Why would I stop spending? I think it’s that simple.
Tony
Great.
Sam
Yeah, they have credit cards.
Daniel
That is a very important point. What you just mentioned, employment. Employment makes all the difference. The pain threshold of consumers is always being tested. Companies raise prices. Volumes are pretty much okay. So they continue to raise prices to maintain their margins. And that works for a period of time.
I think that what is happening both in the Eurozone and in the United States is that after a prolonged period of very low inflation, consumers also feel comfortable about the idea that inflation is temporary. Basically everybody and actually I have this on TV this morning, we’re talking about everybody is saying, okay, so prices are rising a lot, but when are they coming down? But I’m still buying.
The problem, the pain threshold starts to appear when employment growth, wage growth, starts to stop, and at the same time, prices go up. And obviously the companies that feel comfortable about raising prices start to see their inflation rate, rise. So it’s always difficult because we never know. There’s a variable there that we’re very unsure of, which is credits. How much credit are we willing to take to continue to consume the same number of goods and services at a higher price?
But it is absolutely key what you’re saying, which is as long as even though wage growth in real terms might be negative, but you’re getting a pay rise and you still feel comfortable about your job, you feel comfortable about your wealth to a certain extent and credit keeps you safe, consumption in the United States is not going to crack.
However, where do you see it cracking? And we’re seeing it cracking in the eurozone. In Germany, where you don’t get the pay rise, you don’t get the benefit of taking expensive credit from numerous different sources or cheap credit from different numerous sources and at the same time you get elevated inflation. Consumption is actually going down the drain. The way that I see it is that the problem, the consumption, not collapsed, but certainly the consumption crack is very likely to happen more north to south in the eurozone than in the United States at the rate at which the economy is growing.
Tony
Yes, yes, very good. Thanks for that, until on Europe, Daniel, that was really helpful.
Okay, let’s do it very quick. What do you expect for the same week or two weeks ahead? We have a Thanksgiving holiday here in the US, so things are going to be kind of slow. But Tracy, what are you looking for, especially in energy markets for the next couple weeks? We’ve seen energy really come off a little bit this week. So what’s happening there?
Tracy
Yeah, absolutely. Part of the reason of that, besides all the global factors involved, the recession didn’t help UK him out and said they were already in the recession. That then sparked fears. We have pipeline at reduced capacity right now, which means that’s going to funnel some more crude into cushion, TWI contract is actually cushing. So that’s putting a little bit of pressure. I think holidays, obviously I think this next week we’re not really going to see much action as usual. So really looking forward to the following week is we have the Russian oil embargo by the EU and we also have the OPEC meeting and I would suspect that at these lower prices they would probably, they might be considering cutting again. So that’s definitely those two things. I’m looking forward to in that first week in December.
Tony
Great, thanks. Daniel, what are you looking for in the next week or two?
Daniel
The next week or two are going to be pretty uneventful, to be fairly honest. We will see very little action or messages that make a real difference from Fed officials or from the ECB. On the energy front, there’s plenty of news that we pay attention to Tracy’s Twitter account. But in Europe we will get quite a lot of data, quite a lot of data that is likely to show again this slow grind into recession that we’ve been talking and very little help. I think that from here to December, most of the news are not going to change where investors are and that will probably start to reconfigure our views into the end of the trading season, 27 to 28.
Tony
Okay, very good. And Sam, what do you see next week? The week after?
Sam
I’ll just be watching Black Friday sales that are coming in. Honestly, I think that will be a pretty important sign as to how things are developing into the holiday season and begin to set the narrative as we enter in December. Again, there’s no real interesting Fed talk coming out next week, but we’ll begin to have some pretty good data coming from a number of sources on Black Friday, foot traffic, internet traffic, etc. Tuesday and Wednesday.
Tony
Very good.
Sam
The following week. That’s all I care about.
Tony
Excellent. Really appreciate that. For those of you guys in the States, have a great Thanksgiving next week. Daniel, thank you so much. Have a fantastic weekend. Always value your time, guys. Thank you so much. Have a great weekend.
In this episode, we’re joined by Isaac Stone Fish, who is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years.
We talk about how are foreign companies dealing with the political changes in China? Or what should they be paying attention to? We’ve seen changes in Xi’s team that, to be honest, weren’t all that unexpected, but seems unexpected anyway. It’s certainly a hard turn to the CCP’s commie roots. This tweet really underscores how desperate Xi is to set an old school tone.
Markets have seemed a little spooked this week, so we saw orders from Beijing to prop up the CNY and Chinese equities, which didn’t work all that well. But with all the political and market backdrop, what does all of this mean for US and other foreign businesses? Are foreign employees at risk? Do we expect direct investment to slow down?
On the risk side, we look at tech earnings, which are super bad. Hiring is a huge issue and tech firms seem to have been hiring based on their valuation not based on their revenues. When will we see headcount reduction announcements? One of Meta’s investors was saying they should cut 20%. Albert shares his views on this.
And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages. We saw another draw on global inventories this week. As OPEC supply is contracting ~1.2m bpd. Russian crude sanctions start soon. And US exported 5.12m bpd last week, making it the 3rd largest crude exporter. We know global inventories are low, but when will it start to bite? Tracy shares to us what’s going in.
Key themes
1. China risk for Western companies 2. Tech earnings & China 3. Crude inventories & Asia stockpiling
This is the 39th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
0:00 Start 1:00 Key themes for this Week Ahead 2:52 What the news about China means to Western businesses 6:38 What has changed around the concept of Communist Party membership over the last ten or 15 years? 8:20 Anybody who’s overseeing a business in China has to understand modern Chinese history 9:31 Risks for foreign staff in China 12:34 Congress does not want US companies to do business with China 14:14 Danger of a rush to the exits in twelve months 17:58 Tech earnings are super bad – how bad will layoffs be? 21:10 Is it possible to cut 20% of Meta’s workforce? 22:44 China and US competition in India and other countries 24:52 Crude inventories – when will this start to bite? 28:31 Japan is stockpiling crude – is it because of geopolitical concerns? 29:47 China stimulus – will they do it in February? 31:55 What happens to the crude demand of Covid Zero ends? 34:27 Will oil prices raise by 30% before 2022 ends?
Transcript
Tony Nash: Hi, everybody, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Isaac Stone Fish. Isaac is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years as the New York Times in New York Times bureau. So we’re really lucky to have Isaac with us. We have Albert Marko, of course. And Tracy Shuchart. We’re very fortunate to have them again today with us.
So, Isaac, welcome and we’re really happy to have you.
Our theme today that we’re going to talk through first is how are foreign companies dealing with the political changes in China? Or what should they be paying attention to?
On the risk side, we’re looking at tech earnings and the impact that tech earnings will have on other earnings and headcount reductions and other things over the next few months. And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages.
And we want to hear from Tracy as to what’s going on.
Please take a look at our product, CI Futures. It’s a forecast subscription product. It’s $99 a month. We cover a few thousand assets over a twelve month horizon. Economics, currencies, commodities, equity indices. So please take a look at that. The URL is on the screen. Thanks a lot for that.
So, Isaac, welcome. Would you give us a quick overview of what Strategy Risks does?
Issac Stone Fish: Strategy Risks works with corporations and investors to help them manage and reduce their China risk. And with increased tensions between the United States and China, and growing awareness of the liabilities in both China and the United States of working with the People’s Liberation Army or the United Front or the Ministry of State Security or the Chinese Communist Party more broadly, it’s been a good couple of months for us.
And so excited to be joining you and chatting with you on these issues.
TN: You must be working 24 hours a day. I have no idea how you stay, how you get any rest right now with all the stuff that’s going on in China.
ISF: Under drugs right here.
TN: Isaac, I’m curious, with all of the political changes announced this week, of course, that’s been way analyzed, a lot of different perspectives on things. I would warn people as they read through that analysis, just be careful of kind of some anti China bias, but we have to kind of read things for what they are too.
We saw changes in Xi’s team that, to be honest, weren’t all that unexpected. People have talked about this for months, but the fact that he actually carried through with it, I think made people feel like it was a little bit unexpected.
But it’s certainly a hard turn to the CCP’s communist roots. I’m showing a Tweet right now looking at Xi taking his team to pilgrimage where the long march ended during the Communist revolution. And so he’s just the optics around the hard turn to the party’s communist roots are front and center.
So Isaac, markets were spooked this week. Of course, we saw orders from Beijing to prop up CNY and prop up Chinese equities. Obviously didn’t work very well. But with that backdrop, what does all this mean for US and other foreign businesses? I know it means a million things, but if you had some top level takeaways, what are the things that you’re seeing that it means for, say, US and other foreign businesses in China?
ISF: Have a really good understanding of leftist ideology. If you decide that you want to stay, which oftentimes we discourage, and if you decide that you don’t want to reduce your exposure, which we always discourage. Have a really good understanding of how Communism works, and read the tea leaves. Spend a lot of time on analysis. Understand that every Chinese company or every company in China that has at least three party members has to have a party cell. And for a long time people overlook that law.
But companies like Alibaba have tens of thousands of party members. So understanding that you’re partnering with the Chinese Communist Party and things that you used to be able to get away with, you can’t anymore. I think the other high level take away is with increased media, consumer and congressional scrutiny on China.
What happens in China doesn’t stay in China. So the work that you do with a major Chinese charity which does say party building exercises in Chinese orphanages, aka Brainwashing Chinese Children on Party ideology, we can get that information here. Congressional staffers can read that, journalists can pick that up, and you’re going to have to start dealing with the liability of that from a PR perspective. The final highlevel takeaway, the more Xi marches to the left, the more draconian things get. And the more saber rattling we see with Taiwan, the more likely it is that the US and China go to war over Taiwan.
Right now, I would say that’s still not the base case. War is very avoidable. It probably won’t happen. But it’s a very concrete risk and investors and I would argue especially boards of major corporations, need to be discussing this risk. And perhaps the best thing to do with the risk is to say, okay, we know this, we’re not going to change.
But I think if there is a war, companies are going to have to face some pretty serious shareholder lawsuits because it’s a viewable risk and you didn’t do anything about it.
TN: Right. So let me ask you, take two questions. First is, in 2010 or ’11, I spoke at the Central Party School in Beijing, and the person who drove. I was giving an economic update. I was working with the Economist at the time, and it was so surreal for me. The person who drove me to that event was a venture capitalist. And so I think the view that many people have of Communist Party members is, oh, you know, they’re these soft guys, they’re capitalists like us too, you know, that sort of thing. What has changed around the concept of Communist Party membership over the last ten or 15 years?
ISF: Think of the perception. So when Rupert Murdoch in early 2000s was going into business in China, he would downplay the importance of the Communist Party and say things like, oh, they’re just like us, there’s really no difference. And some people just join the party for opportunistic reasons, and some people do it because they believe, but they’re fairly soft spoken and gentle. And then there’s the very hard security element of the party.
And I think people are realizing that for every venture capitalist, there’s also the PLA secret agent or the MSS agent or the public security agent in that these people are increasingly important in the Chinese system.
And the other piece of it is that it used to be seen from a Western context, both PR and regulatory, relatively benign to be working with party members in the Communist Party. But after the genocide in Xinjiang, after Xi’s increasing authoritarianism, people are not getting the pass that they had before when you and I were out there.
TN: Right. And so I think it’s really critical. Anybody who’s overseeing a business in China has to understand modern Chinese history. You have to start from the great famine, really. I mean, start from the revolution, but really the great famine through the Cultural Revolution, through the 70s, through Deng Xiaoping, through… That era is really critical to understand what’s happening today. Right. Because that’s when Xi Jinping grew up and that’s when his ideologies were formed. Is that safe to say?
ISF: Good is safe to say. I think the other thing that we have to understand is we do have to be incredibly humble about our ability to understand what’s going on at the top of the party. We have very little idea. People are going to keep speculating about that crazy video with former Chairman Hujing Tao. We probably won’t know what happened there for decades, I would guess.
And I think when we talk about war with Taiwan, we talk about what’s going to happen between the US and China, we have a lot of insight into how Biden thinks and almost none into how Xi Jinping thinks. We just need to bake that into our predictions.
TN: Yeah, that’s absolutely right. And I cautioned on that earlier this week about the Hoojin Tao exit. It could be health, you don’t know. Right? It could be intrigue. You don’t know. So none of us know.
So let me also ask you, when you talk about you had a tweet about potential China-Taiwan war earlier this week, and you talked about Chinese staff for American companies or Western companies, sorry, and you talked about Western staff in China. So can we talk about some of those risks, like the real people risks for multinational companies who hire Chinese employees. And none of this is intended to be Xenophobic.
This is intended to be purely practical in understanding really what the risks are. And also with those foreign staff in China. Can you help us understand some of those risks?
Tracy Shuchart: Yeah, I was going to ask something along that line, if I can just tag on my question to that one. We saw a bunch of people who are Americans pulling their staff from Chinese chip companies right, lately. So I was wondering if you saw that, see that trend continuing and bleeding into other sectors besides just the tech sector.
ISF: I very much do, and I think there’s two ways to think about this. One is the economic and regulatory so increasing difficulty doing business in China, desire for localization of staff, Biden regulations that restrict the ability of Americans to work at certain Chinese chip companies. And then you have the potential for war.
And the idea is that if the US and China go to war, American staff in China and also Chinese staff for certain American companies could be seen as enemy combatants. And we saw this with Afghanistan, we saw this with Ukraine. There’s orders of magnitude, more staff for Western companies in China than in these places. I mean, it’s not even comparable, the numbers.
And I think from an ethical perspective, I get really worried that people don’t talk about war because then war could just be on us. And the United States has a terrible history of interning Japanese during World War II and harassing Germans during World War I. I think with the dynamic with Chinese people here, we need to have a concrete conversation about it so that we can defend the rights of Chinese and Chinese Americans in America if we go to war.
And from a corporate perspective and from a risk perspective, companies need to have exit plans for their staff in China because they’re going to be dealing with major, major ethical and insurance risk issues if this happens. And they can’t just take the foreign staff out to Hong Kong anymore. Because that’s not like a free zone anymore. And you hear stories of people being smuggled out now, and I think we’re going to hear a lot more of those, and that’s going to be more and more common.
TN: So, Isaac, what are we missing when you see the discussion about China right now and with American businesses, what are we missing? What’s not being discussed that you’re like, Gosh, I can’t believe people don’t see this.
ISF: Congress does not want American companies to do business in China. And with the UFLPA, the Uighur Forced Labor Prevention Act, we talked to a lot of corporates about that, and they don’t seem to understand how to comply with the law. And that’s the point. It’s a law that’s meant to deter behavior as opposed to shape behavior.
So it’s okay, we can’t invest in Xinjiang, but this company that we work with, has a branch of Xinjiang. Well, don’t work with that company. And I think the American political calculus of this too.
People don’t really get Pelosi’s trip, I think didn’t really bake into corporate behavior in the way that it should have because people think this is a Republican issue. They hear Marco Rubio, they hear Ted Cruz, they hear some of the awful remarks that Trump made, and they don’t realize that Nancy Pelosi and Chuck Schumer sound almost exactly like Rubio and Cruz on these issues. They think it’s a Republican issue. It’s not a Republican issue. There are holdouts on the progressive left, there are holdouts on the libertarian right. But the US is pretty united about this from a government perspective.
It’s just not from a business perspective. And that’s fine. You can have that discordance. But businesses need to understand main street and Congress feel very differently about these issues than they do.
TN: Yeah. So one last question on this. Unless Albert, Tracy, you guys were going to come in, but do you think we’ll see publicly traded American companies disposing of their China units with say a Hong Kong IPO?
I mean, I know this is an old idea, but better than nationalization, at least they can get some value of it. And I think of like a GM or something like that, right? It’s a huge business for them. So they could potentially either have that nationalized or they could make it public on the Hong Kong stock exchange or something.
So do you think we’ll see more of this? Young Brands is the one that everyone knows about from ten years ago or whatever, but do you think we’ll see more of this? And if people don’t do it now, is there a danger of a rush to the exits in say twelve months?
ISF: I think that’s an excellent point. Ping on, which is a major shareholder of HSBC, suggested HSBC break up into two different banks, one headquartered in Hong Kong to focus on China market and one of the rest of the world.
And companies like Boeing, which has an airplane business that I think it’s something like 14% to 18%, goes to China, specifically the Chinese Communist Party and then has a very important government contracting business which is increasingly at odds with its relationship with the Chinese Communist Party and need to start considering these issues.
I think you’re right also on the timing, these things take a lot of time and companies are very private with them for obvious reasons. So if they’re considering them now and we’re going to see announcements on it and it doesn’t require that much scrutiny from Cyphius or the Beijing’s regulatory Agency or other Beijing other Chinese agencies, I can see these things happening.
I think if companies are starting to think about it now, it’s probably too late. I think years process. But in the same way that nobody wants to talk about war, nobody wants to talk about spinning off their China assets.
TN: Right. But you either do it now or it gets nationalized. Or you do it for $0.10 on the dollar in a year or two years.
ISF: I think you’re exactly right. And Tony, we should write something on this, and I think this is a good time to talk about this issue.
Albert Marko: Okay. There are other issues. Capital flight out of China, even if you decide to list in Hong Kong, is like, where’s the money going to come from? It’s not going to come from the west. Even the Chinese are starting to take their money out into Singapore and Macau and anywhere else they can get it out of at the moment.
But I agree with Isaac on 90% of what he’s saying. I don’t think that war, Taiwan is even a remote possibility in the next ten years, to be honest with you. The pilot bureau, Xi is inspired politburo. It looks scary. There’s no question about that. And the Western companies need to take a look at that because it reminds me of the Nazis from the 1930s.
Now, I’m not talking about what the Nazi crimes were, but just the mobilization of the country and the nationalization of corporations and then starting to boost the economy internally. It’s most likely going to start happening, and they will nationalize companies that they see are instrumental for their vision going forward.
TN: Yes. I mean, honestly, I don’t know why anybody related to SAIC Shanghai automotive. Why would that not become the property of SAIC? If they’re really taking this nationalist bent, that’s a real risk, right? I think so. Any of these guys really need to pay attention and really start to evaluate what is their path going forward? What is their path for Chinese staff? What is their path for foreign staff there? What is their path for IP that’s shared between those units? These are real head scratcher questions.
Okay, Isaac, thank you so much for that. This is so insightful. I’d love to spend 2 hours with you on this, but we’ve got to talk about tech earnings.
So, Albert, tech earnings are super bad, right? Super bad.
AM: Super bad is an understatement.
TN: Yeah. Horrific. It’s a tech wreck, all that stuff. So we can talk about what missed and kind of we all know what’s missed. That’s been analyzed over the last 24 hours or say a few days or whatever. But I guess what I’m most interested in tech is staffing.
So the vacancies in the US. Workforce has been a big issue for the Fed. Okay. And I’m showing right now on the screen that the Meta’s stock price from $350 all the way down to I think it was $97 yesterday, just over one year. It’s incredible, right?
So a lot of these tech firms have been over hiring. They’ve been putting out job wrecks for things that they where they just want to target one person and they don’t really want to target the job and all this stuff. They’ve almost been hiring based on their valuation rather than their revenues. So in terms of those productivity metrics, do you think we’ll start to see headcount reduction in tech? Or they’ve been saying, hey, we’re just going to slow down our hiring.
So do you think they’re going to stick to only slowing down their hiring? Or do you think we’re going to see this kind of tech halt and kind of shrink the tech workforce?
AM: Oh, absolutely. You got to shrink the tech workforce. But that’s not going to come till after midterms. I mean, nobody wants to be in the line of sight of Biden’s firing squad over firing 10 thousand people just before midterms happen. But afterwards you will. Probably after Christmas, you’ll actually start seeing quite the number of job layoffs in the tech industry.
TN: Every time I’ve worked with a tech related firm, the pink slips come literally the week before Christmas.
AM: Yeah, you know what I mean? I don’t think that people understand how bad these tech earnings are. Right. We can note Facebook and Amazon and whatnot, but they had tailwinds of inflation of an extra 10% because CPI, they say 8%. It’s really like 20%. So they had an extra 10% baked into their earnings that people don’t really catch. Right? And even with that, they’re down 30, 40%.
Amazon lost 25% in two days. Amazon. These are just astronomical. Which is a solid company. I love Amazon. I don’t have any… Company. Yeah, it is a solid company. And I like Amazon, I like the tech, I like the delivery service. And everything they do is correct. But I mean, realistically, they were, them and along with another dozen tech names were so over inflated for the last two years because the market just kept pumping up to just the high heavens that this was just I mean, it was an easy call that tech had to come down.
And on top of that, tech is based on zero rates. We’re not going to see zero rates for years.
TN: Right, that’s fair. Okay, so, you know, one of the hedge funds, I can’t remember who, was pushing Meta or Facebook now, I guess, again, to cut 20% of their workforce. Do you think something like that is possible?
AM: And it sounds like a lot, but given what’s happened with their valuations, do you think a 20% cut is possible? Do you think more or less is possible? And 20% is a lot. Usually when you have over 12%, you start looking at a company as going into bankruptcy. That’s one of the signs that you look at. So 20% is way too much. I don’t think that’s going to happen. Maybe seven to 10% staggered over the next few years.
TN: Okay, that’s fair. But I mean, they hire a huge number of people. What that would do to wages in tech would be immediate, right? $300,000, 22-year-old dev, that would be gone.
AM: Well, yeah, that cuts into the state’s budgets also because they take those tax revenue and whatnot. The other thing that we should talk about is China’s mix with the tech industry. I mean, now that the US congress, like Isaac was saying, is actively trying to prevent companies to go over there, I don’t know where tech earnings are going to come from. I just don’t see it. They’re taking away massive market share. They’re taking away supply chains and semiconductors and everything. I don’t see any silver lining in tech for the next two, three years.
I think they need to run size their organizations and really focus. Plus there’s more competition in the ad market, so you’re not going to see ad rates necessarily rise from here for some time.
So, yeah, I think there’s a lot of headwinds. I actually have to get Isaac’s opinion on this one is no one is talking about the tech industry in China competition with American companies in countries like India. Right? Because you have Chin Data and a couple of other countries that are massive and makes generate a ton of cash out of there.
And nobody’s talking about the competition level in India between the two. And I don’t know if you’ve heard anything, Isaac, but like, that’s something that I wanted to start looking into.
ISF: I think that’s an excellent point, is it doesn’t get nearly enough attention. And the market for the rest of the world for most of these companies is larger than the market for the US and China combined. There are a lot of contested spaces, especially in countries like India, Brazil, Indonesia.
And I think the lens through which we should see it is the political battle between the US and China because both countries are really pushing all of these third countries to be more sympathetic towards their way of view because so many of these tech companies can be hobbled by regulations. We see that with Huawei. We see that a lot in India where there’s a lot of distrust for Chinese tech companies, a lot of restrictions on the ability of Chinese tech companies to operate.
And so it’s protectionist, but it’s good political warfare for both sides to be making these arguments in countries around the world. And it is good business for these companies to be spending heavily on government affairs in all of these companies, in all of these countries and figuring out how they position their relationship with the government, whether it be the Chinese government or the US.
AM: Yeah, and that’s something I actually criticized the Biden administration that they’ve been so hard on India about using Russian tech and Russian oil. It’s like, come on, you guys got to be a little bit pragmatic here. You know what I mean? They’re stuck between a rock and a hard place with China and Pakistan.
TN: True.
ISF: I think that’s a great I mean, they buy huge amount of weapons from Russia, and they buy those in large part to defend against China.
TN: Yeah, very good. Okay, great. Thanks for that, Albert.
Now, Tracy, let’s move on to crude inventories. I’ve got a Tweet up where you talk about there was another draw this week.
And we saw a draw on global inventories. As we have inventory drawdowns, we have OPEC supply contracting by what, about 1.2 million barrels per day, something like that. Russian crude sanctions starting. We also have with the SPR, it was interesting to see the US became the third largest exporter of crude, I think last week or something, with over 5 million barrels per day because of the SPR draw.
So we know global industries are low, but when does that start to bite? I feel like the easy answer is well, after the SPR stops, right? What more to the story is there?
TS: I mean, I think it really depends on where you are. I mean, we’re already seeing the SPR. Those draws are kind of dwindling down, right? We’ve gone from about seven, 8 million barrels per week to 3.5 million. Even though that’s still a lot. That’s been part of the reason why we’re exporting, because we kind of, first, we were drawing down sour crude because that’s really what US refiners need. But at some point, that’s almost gone, so we had to start releasing sweet crude, and we can’t do anything with those barrels. And so they are making their way to China, they are making their way overseas.
And that’s why our exports have increased over the last few months there. In particular, we’re kind of seeing an uneven balance where we’re seeing global inventories are drawing, still drawing, right? US inventories are drawing, by all intents and purposes. I mean, we had, what, a 2.8 million build, but we also had a 3.5 million SPR release and an adjustment factor of 15.8 million barrels. Technically, we are drawing. And really, if you include the SPR, we had a draw of 5.9 million barrels total crude plus products this week.
But we are seeing what’s interesting is we are seeing Japan. Their stocks are actually going up because they’re stockpiling mad right now. So they’re buying everything from everybody. It’s stockpiling, and they were giving subsidies for companies to buy that in their SPR. So Japan kind of had a different kind of way of looking at things and the rest worlds just dumping. But they’re literally stockpiling.
China did stockpile for a while, but really their SPR is down, obviously, from the 2020 highs. They’re not stockpiling as much. But with China, I know that there are many problems going on there, but if they increase those import quotas for the Teapots, then we’re going to start seeing them by a lot.
TN: By Teapots, you mean the small refinery?
TS: Is just correct, because they’re talking about possibly raising those import quotas. But we won’t really find that out until December, and that’ll be for into 2023.
TN: Okay, so just a question on both, well, in Japan, first of all. With the yen at these dramatic lows, they’re stockpiling and it’s hugely expensive for them. It’s not just kind of incidental decision, this is a really intentional decision for them to stockpile. So are they partly, do you know, are they partly stockpiling
on geopolitical concerns?
TS: Yes, absolutely. I believe so. And all around, because we really saw them that sort of started to kick off in March after Ukraine invasions. Same with LNG, right? They’ve always been huge importers of LNG, the world’s largest, but they’re importing even more because they’re kind of seeing what’s happening in Europe right now and they don’t want that to happen to them.
AM: I think it’s a little bit more than that. Also, I think that they see that we’re probably even got cues from the US that Japan is going to be a manufacturing hub to try to pick up the slack from China. So I think they’re preparing for that in 2023, 2024. And on top of that, the price of oil right now, that’s still discounting China not stimulating because once China stimulates, the demand is just going to skyrocket.
TN: Okay, all three of you guys want to ask about that China stimulus. So you guys all know China Beige Book, and they’ve been saying everyone’s really foolish for thinking China is going to stimulate, and they’ve been saying that for something like six months. Right? And I hear a lot of people say, oh, they’ll stimulate after the Party Congress. I said that too, and we still haven’t seen that. Do we think that we’re going to see stimulus in China, say, before Chinese New Year, which is what, February?
ISF: I would say absolutely not. I think the real stimulus for the Chinese economy, too, will be less a government led infusion of capital and more a relaxation of COVID concerns.
And I think that’s going to be a lot more likely after Spring Festival than after the March Congress because, A, you have the appointment of the premiere, you have some important events there, but you also don’t have to worry about mass contagion with hundreds of millions of people wanting to travel.
So I think the base case for the opening of the economy and then potentially economic inflation is after the Congress, after Spring Festival. And who knows, it’s very hard to predict, but that would be my best guess for that.
TN: I think that’s really solid. What do you think about that?
AM: Yeah, I think COVID Zero policies are going to be still in place until March. There’s no question about that. I think stimulus happens around the same time that they think that inflation is under control. I think that’s pretty much their driver at the moment, because if they stimulate price of copper and oil and everything in the country is going to go to the moon and they know this. So I think it really depends on inflation. What the US can do to tame it.
TN: So when do you think they’ll think that inflation is under control?
AM: I think close around March after the US. And also the end of quantitative tightening and whatnot. So it’ll probably be a coordinated effort.
TN: Okay, so Tracy, if they just let go of the lockdowns, what does that do to crude demand?
TS: Well, definitely we obviously start to see that rise because they’re locking down millions of people at a time, you know what I’m saying? An entire city, and not for a couple of days. We’ve seen some cities lock down as long as two months.
So I think as soon as they start relaxing that we’re definitely going to see demand come flooding into the market.
And again, China hasn’t really been stockpiling this whole time during this, which they have a little bit from their lows, if you look at their SPR, but not a lot. Not as much as everybody thinks they are. Everybody thinks they are because oil prices are lower and they like lower oil prices. But really, comparatively speaking to how they purchased in the past, the SPR hasn’t been as much as most people think.
AM: Okay, do you think that they could be? First of all, I don’t trust the data of China. I don’t have anything.
TS: Well, what we can see from satellite systems, right? We have no idea what their underground storage looks like or anything of that nature. But what we can tell and what we can track, what’s actually going into the country.
AM: Do you think that they can hide that in tankers on the sea for a while?
TS: Yeah, absolutely. I mean, they’ve been known to do that before. Absolutely. They’ve used Myanmar,
AM: Singapore also, I believe.
TS: Well, Singapore is a little bit harder to hide just because it’s so huge and so many people are tracking vessels there. So they kind of like to kind of stay away from there when they’re kind of trying to hide stuff.
But definitely, I mean, they’ve, you know, hidden purchases from Venezuela through Singapore, through other ports in that area. From what you can see from the best guess. From the best guess, what you can see, what you can tell what satellite services have picked up, like Kepler or whatever.
TN: OK, let me kind of close up with this question. So I just filled up with gas in the US last night and I posted this price in Texas is $2.95. So I’m sure you’re all jealous. I said, will this be 30% higher by the end of the year? Because post election, SPR releases stop, other things? Do you expect gasoline to rise, say, as much as 30% before the end of the year since SPR release and other things are stopping? Or do you think we’re kind of in this zone that we’re going to be in for a little while?
TS: Well, I think that generally this is kind of lower demand season anyway, right? I mean, usually typically we don’t see prices really start to rise again until about mid December, just seasonally speaking, right before the holidays. Christmas in particular, and everybody goes on vacation, et cetera, et cetera.
But I think, I don’t know. 30% might be a lot for this year, but definitely for next year we’re going to have some problems because they took that last 10-15 million barrels and they pushed that out for December, so we’ll still have some releases then.
So I think they did that it was actually 14 million barrels that are left and so they did push those out until December. So they’re kind of going to triple it out in order to kind of control prices.
TN: Okay, so the selection bias for people telling me that I was right is wrong.
TS: I think it’ll probably depend on where you are in the country, you know, depending on the state. Yeah, absolutely. I mean, if you’re in the Northeast, you’re going to have a huge problem, right, because they have the same issues going on that Europe. They don’t have any pipelines, they don’t have any storage, and they don’t have any refining capacity.
So this winter, especially with the diesel shortage, you’ll probably see the highest gasoline prices, obviously in California and then the Northeast will be the next higher.
TN: And I just want to say to everybody, I’m not promoting the gasoline price as a reason to move to Texas. I mean, it’s all scorpions and rattlesnakes and really terrible bagels here, so please don’t move here. It’s just an incidental benefit of living in a place that’s a pretty rough place to survive.
So anyway, guys, thank you so much. Isaac, really invaluable. I don’t think we’re going to gotten this perspective from anybody else on earth, so I really appreciate the time that you spent with us.
Albert. Tracy. Thank you, guys. I always appreciate your point of view. So thanks very much. Have a great weekend. Thank you.
It has been a terrible week in markets. It is not looking good for anybody, at least on the long side. A lot of that seemed to change when the CPI number came out. It’s like people woke up and terminal rate is going to be higher and just everything flushes out.
We talked through why the dollar is where it is and how long we expect it to stay there. Brent Johnson recently said that the USD & equities will both rise. And so we dived a little bit deep into that. We also looked at crude.
Crude’s obviously been falling. Tracy discussed how long is that going to last.
We also did a little bit of Fed talk because the Fed meets this week. And we want to really understand when does the Fed stop? After last week’s US CPI print, the terminal rate rose from 4% pretty dramatically. Does QT accelerate?
Key themes: 1. $USD 🚀 2. How low will crude oil go? 3. When does the Fed stop? 4. The Week Ahead
This is the 34th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Time Stamps 0:00 Start 1:20 Key themes for this episode 2:24 What got us to stronger USD and will it continue to rise? 8:29 Dedollarization 10:23 Intervention in the dollar if it gets too strong? 12:22 Both the USD and US equities will be rising? 14:18 Crude: how low can it go? 18:03 Look at the curves for crude 19:17 Slingshot in December? 20:18 How India and China buys Russian oil and resell 21:33 Restock the SPR at $80?? 22:57 When does the Fed stop raising rates? 29:33 What if Russia, Ukraine, and China don’t lock down anymore? 32:08 What’s for the week ahead?
Listen to the podcast version on Spotify here:
Transcript
Tony Nash: Hi everybody, and welcome to The Week Ahead. My name is Tony Nash. We’re joined today by Tracy Shuchart and Brent Johnson. So thanks guys for joining us, really appreciate the time to talk about what’s going on in markets this week and next week.
Before we get started, I want to remind you of our $50 promo for CI Futures. CI Futures is a subscription platform to get forecast for thousands of items: currencies commodities, equity indices and economics. The currencies commodities equities are refreshed every week. So every Monday you come in for a new forecast, economics forecast every month. That $50 a month promo ends on September 21. So please take a look now go in and check it out and if you have any questions, let us know, we’re happy to answer them. So thanks for taking the time to do that.
So, Brent and Tracy, it has been a terrible week in markets. It is not looking good for really anybody, at least on the long side. And so a lot of that seemed to change when the CPI number came out. It’s like people woke up and we’re like, oh no, the term rate is going to be higher and just everything flushes out, right. And earnings and a bunch of other stuff. So we can go into a lot of specifics. But one of the items that I’ve been really curious about for weeks, if not years, ever since I met Brent in 2018, 19, is the dollar. So we’re going to go a little bit deep into the dollar today.
We’re also going to look at crude. Crude’s obviously been falling. So we’re going to ask Tracy kind of how long is that going to last? And then we’re going to do a little bit of Fed talk because the Fed meets in the week ahead. And I want to really understand kind of when does the Fed stop.
So those are our key themes today.
So, Brent, welcome. Thanks again for joining us. I’d really like to talk through the dollar and we are where we are, which is amazing. And you have seen this years ago. On the screen, I’ve got a chart of our CI Futures forecast which shows a dollar continuing to rise over the next year. We’ve got some bumps in there, but for the most part we see a persistently strong dollar.
CI Futures provides highly accurate commodity, equity, currency and economics forecasts using advanced AI. Learn more about CI Futures here.
So I’m curious what got us here and what will continue to push the dollar higher?
Brent Johnson: Sure. Well, first of all, thanks for having me. I always enjoy talking to you, Tony. The reason I like talking to you is you’ll talk a lot about Asia, but you’ve actually lived there and you actually know what you’re talking about rather than people who’ve just read it in a book. And same with Tracy. So I’m happy to do this and happy to do it anytime you invite me.
But anyway, what’s really going on with the dollar is a function of the fact that it’s not only the Fed and it’s not only the US that has, for lack of a better word, idiotic leaders. The rest of the world does, too.
And I think over the last several years. At least in the retail investment world. There’s been this theme that the Fed is out of control. The government’s out of control. They’re going to spend all this money. The dollar is going to pay the price. And it’s going to get inflated away and go to zero. And the rest of the world is going to do great and we’re going to do poor.
And I understand that view if you just analyze the United States. But the problem is you can’t just analyze the United States because it’s a big world and everything is interconnected. And all of the problems that people have forecast to fall upon the US.
Dollar are currently happening to a greater extent in Europe and Asia. And the budget deficits, the printing of the money, the central bank support, the holding down of rates, all of that applies even more so to Japan and Europe than it does the United States. And that’s really what you’re seeing.
Over the last, let’s just call a year, you’ve seen the yen fall 20% versus the dollar. That is an incredible move for any currency, but it is an absolutely astonishing move for a major currency, specifically the third biggest currency in the world, or some would even argue the second biggest currency in the world. And then you’ve seen the euro over the last year is down 10% or 15%.
So these are very big moves. Again, the reason is because the Fed is raising rates. So on a relative basis, we have higher rates than those two big competitors. And on a relative basis, those two big competitors are doing more monetary stimulus or QE or extraordinary measures, however you want to define that central bank activity.
And you always because the globe runs on the dollar, there is a persistent and consistent bid for the dollar globally. And so it’s really a supply versus the demand issue. Now, everybody always focuses on the supply. Central banks are increasing the currency in circulation. They’re going to print all this money and so therefore the dollar falls or the currency falls. Well, that’s just focusing on the supply side.
But again, you have to remember that all central banks are increasing supply, but the demand is what makes the difference and that there is global demand for the dollar. Now, whether you think there should be, whether you think it’s the right thing, it doesn’t really matter. It just is. That’s the way the system works.
But there is not that same global demand for yen. There’s not that same global demand for yuan, there’s not the same global demand for euros or Reals or Florence or Liras or anything.
And so what you’re really seeing play out is Trifan’s dilemma. And so I’ve spoken about this before. But Trifon’s dilemma is an economic theory that states that if you have a single country’s currency that also serves as the global reserve currency, at some point the needs of the domestic economy for that global reserve currency will come into conflict with the needs of the global economy. And that’s what we have.
We have an inflationary pressure problem in the United States. The Fed is very embarrassed about it. They got it wrong and now they need to do something about it. And they’re bound and determined to try to bring it under control. And so they’re raising rates to counteract that. Well, when you raise rates, you’re tightening the monetary supply. And that’s happening. That’s fine for the US. But there’s many countries around the world that cannot handle that right now.
But that’s what’s happening. And so the needs of the domestic economy are in conflict with the needs of the global economy. And it’s going to be the global economy that suffers more than the domestic economy as a result. It doesn’t mean that the domestic economy won’t be hurt. It just means on a relative basis, you want to be closer to the money than far away from the money. And because we have the global reserve currency, we’re closer to the money.
TN: So it’s interesting when you talk about the dollar versus other currencies, and we often hear people say, oh, CNY is rising as a share of spend, which that’s debatable. But from my perspective, it’s not the dollar that’s kind of in the gladiator ring of currencies. It’s the yen, it’s the euro, it’s the British pound, it’s the aussie dollar, it’s these secondary currencies. They’re going to lose share before the dollar does. Is that wrong?
BJ: No, I think that’s absolutely right. And again, that’s a very good way to put it. I know gladiator walks into the ring and thinks, I’m not going to at least get a few scratches. It’s going to hurt. That’s just the nature of being a gladiator. But what matters is who’s standing at the end of the day, right? And so I think it’s these other currencies are getting hurt by the battle more so than the dollar. It doesn’t mean that we’re not getting hurt. It doesn’t mean it doesn’t sting. It doesn’t mean there isn’t going to be any pain involved. But at the end of the day, if you’re at war, you want to be the last man standing because of the way the system is designed, I believe that that will be the US dollar.
The other thing that I would just quickly point out is a lot of people say, why can’t you see it? It’s very obvious. The rest of the world wants to de-dollarize. They’re putting all of these trade deals in place, the dollars falling as a percent of reserves, etc. And the point I would make is, yes, I do see it. I agree with you the world would like to dedollarize, but it’s much harder to dedollarize than just saying, just because you put an announcement out there doesn’t mean you’re actually going to be able to do it.
I’d like to make the analogy that I’ve said I want to lose weight and get in great shape for 20 years. It doesn’t mean it’s going to happen. It hasn’t happened yet.
But that’s the headline versus reality, right? I just think that’s where we’re at. And the dollar, for better or worse, it’s a rigged game in favor of the dollar. And the US set it up that way is the global hegemon. They set it up that way. Now, it doesn’t mean they’re not trying. It doesn’t mean that the world doesn’t want to get away from it. It’s just very hard to do it.
The last thing I’ll say and I’ll shut up, but the other thing I would say is the process of de-dollarization, even if it is successful, will not be a calm transition. And the process of dedollarization is not necessarily, and in my opinion, not probable to be negative for the price of the dollar. I think the volatility and the lack of liquidity in dollars that would go along with de-dollarization would actually squeeze the price of the dollar higher.
And so it doesn’t matter to me whether de-dollarization happens or not. I think the dollar is going higher for all of these reasons.
TN: I think what’s funny there is people always put de-dollarization in this almost moralistic language. It’s a good or a bad thing. And it’s just not. It just is.
Tracy Shuchart: I just had a question for Brent. I mean, do you see at any point that there’s some kind of intervention on the dollar? The dollar gets too strong because it’s going to crush emerging markets? Do you think there’s any point in which Yellen kind of backs up?
BJ: I do think they will. And that’s why I think the dollar is going to go back to all-time highs before this is all said and done. I don’t think it’s going to be a straight line. It can’t be a straight line without absolute devastation. Doesn’t mean it can’t happen. But I think this is going to play out over several years rather than several weeks. It could play out over several weeks, but I think it will take longer. And the reason I think it will take longer is I think that they will interact or they will get involved, as you’re suggesting, Tracy.
I actually think right now the Fed and the Treasury want the dollar strong. I think they’re using it as a weapon or as a tool. It’s something that can be used very effectively. Again, whether you think it should be used or not, I don’t care. I just think it will be, and I think it is being and so I think that will continue.
But I think the Fed and the treasury, they want the dollar higher, but they want it done in a measured fashion that they can control. If it starts to get out of control, I think that they will rein it in. I think they want some of the other parts of the world to be an economic pain, but I don’t think they want the whole system to collapse. And so my guess is that we’ll get the dollar higher, maybe it goes to 115, 120, and then they’ll do something, it’ll pull back for six months, three months, whatever, and then it’ll get higher again and they’ll come out and do something.
So I think this will be a process, a little bit of a roller coaster, up and down, but I think that the general trend is higher and I think there’s more pain to come for the global economy as a result.
TN: Brent, real quick, before we get onto oil. You sent out a tweet earlier this week that said you think that we’re going to come to a point where both the dollar and equities and US equities are rising. Can you walk us through that just real quickly? I know there’s a very detailed thesis behind that, but can you walk us through that very quickly so we understand kind of what you’re talking about there?
BJ: Yeah, so the first thing I’ll say for anybody who’s just kind of passing through this conversation is that I don’t think this is happening right now. It could happen right now. In the short term, I expect US equities to go lower. I think that’s just kind of where markets are headed.
But as the pain develops throughout the global economy, I think we are going to experience a global sovereign debt crisis. And when the world, the US included, starts selling sovereign debt rather than buying sovereign debt, I think that money will have to go.
Now, some of the money will just be, it’ll just go poof. It’ll be gone. And so that money won’t have anywhere to go but the people who start selling the bonds looking for another place to go, I think the next best place to go will eventually be US equities. And I think US equities will be seen as the new… I don’t want to say new Treasuries.
That’s a little bit hard to say. But on a relative basis, the place where big global capital can go, that is the most advantageous to them. And so I think we will get into a point in the sovereign debt crisis where US equities will get safe haven flows and I think the whole world will potentially be printing more money, right.
So be sending more liquidity out there. And so I think that liquidity that is generated with little liquidity there is, I think we’ll find its way into the US and the US Dow, big blue chip stocks and I think they’ll go higher. I might be wrong on that, but that’s my working thesis as of right now.
TN: Let’s move on to crude oil. Obviously we’ve seen crude take some hits over the past few weeks and we’ve got a WTI chart on the screen right now.
So how low will crude go? Are we almost there? Are we headed to 65 where it was for a while? And what then pushes it higher?
TS: I don’t really want to forecast exactly where crude is going to go. I definitely think that we could see some more downside, but we have to look at what is weighing on price and sentiment right now. One, there’s more Russian barrels on the market than everybody anticipated.
Two, you’ve got never ending zero Covid China lockdown that haven’t seemed to let up yet. We also have EU recession, right? And then we had 160 million barrels of SPR thrown on the market. And so that’s really weighing kind of on the front end of the curve. Those are the things kind of weighing on sentiment right now. That’s why we’re seeing a lot of weakness.
That said, if we look at the fundamentals of the market, the market is still very tight. We’re still drawing globally. We definitely have a diesel problem that is global. And I think where we start to see kind of a change in this, I think when it comes to the end of October, when the SPR is done this with kind of been looking over the last couple of weeks, had we not had such large SPRs, we would have actually been drawing a regular stock.
So it’s not as if that oil is going piling up anywhere. So I think as soon as the SPR stops, I think after Midterms, because I think this administration is trying to do whatever they can to suppress the price of oil, thus, gasoline. And I also think that we have to see kind of what happens in China after the People’s Party Congress in the middle of October and trying to see what their policy is going to be moving forward.
Are they going to open up? I mean, they’re looking at they want 5.5% YoY GDP by the end of the year,
which…
TN: They’ll hit it. On the nose, we can guarantee that.
TS: But I think they’re going to have to start stimulating the economy a little bit more. And we kind of saw announcement Evergrande is going to start financing more inspection projects and whatnot going into starting at the end of September. So I think we’ll probably see the last quarter if we get a little stimulus and if they back on their policy because, that’s the big thing for oil right now, is that if that demand comes back because they’re down about 2.7% on the year and as far as consumption is concerned.
So I think if that demand comes rushing back, know that’s going to be a huge upside surprise for the market. I think over the long run, oil is going higher, but out looking out into 2023, I just think that’s just the trajectory of it. I’m not calling for $200 oil, anything crazy like that. I just think that we will see higher oil, and I think we’re poised to see higher for longer than the functionality of the market and the fact that we have no capex for the last seven years.
TN: So last month you said to look three to four months out, look at the curves three to four months out to understand kind of what the real oil price was or is going to be. And so that would be two to three months now. So that’s November. December.
TS: Look at those spreads are widening out or not, right. You want to see if we’re moving into more backwardation and even more backward dated market, right? So you kind of want to look at that.
TN: Okay, so I paid $2.88 a gallon for gas at my local last night. We’re the energy capital in the world. Yeah, I’m going to show it off. Anyway, that is kind of coming down. And energy has been the biggest upward factor in some of the inflation issues. That’s good news, at least until the election. Hey, I’ll take it while I can get it, right? And if it heads back up after the election, I think we’re all prepared for that on some level.
So I guess SPR, as he said, election happens, there’s no political reason necessarily to suppress these prices and so on and so forth. So do you expect to see almost a slingshot in, say, December, where things trend higher pretty quickly?
TS: I don’t think we’ll have… I don’t want to call it a slingshot because anything can happen in the oil market. I mean, we’ve seen $7 to $10 in a day before, so that’s not unheard of. But I do think we go higher, especially if you’re looking into the market, is going to get even tighter in December because of tax reasons. December 31 is the tax assessment date for the barrels that you have on hand. So they tend to pull back on production so they can move out inventory as much as they can, so they’re not taxed at the end of the year.
Usually we see a little decline in production anyway in December and the second half of December, we do see prices start to rebound off the seasonal for regular seasonal trend low. Okay, so that would be normal.
TN: Brent, I think you had a question for Tracy on crude markets as well.
BJ: Yeah, I actually had two quick questions. One, I wanted to get your thoughts on the fact that India and China are buying oil at a discount from Russia. And then there’s lots of stories about them selling that oil
on to Europe or other places. And so they’re making that spread. I just wanted to get your thoughts on that and logistically how that actually takes place.
TS: So if you’re looking at India, definitely they are buying discounted crude. What they do is they don’t
resell that to Europe. What they do is they blend it and they sell fuel. So that’s refined. So it’s really hard to trace what’s in… They don’t trace those barrels that way.
So that’s how that oil is kind of emerging back in Europe. It’s really by way of refined products. Now when we talk about China with the gas, really what they’re doing is they’re buying gas right now, literally half off from Russia, and they’re turning around and selling their own gas to Europe for the higher marked up. The gas they already have. So they’re selling the gas they already have? So that’s kind of how that’s working.
BJ: And then the other question I have for you quickly is I was surprised this week when the rumor was floated by whoever floated that they would restock the SPR at $80. It seems like they’re doing everything they can to get the price lower. And then to have that rumor come out and put kind of a floor under it was kind of surprising to me. So maybe nothing more than just the speculation, but did you have any thoughts on that?
TS: Yeah, I mean, basically they put a floor on it. Everybody’s calling it, the Biden put now. But the thing is that it’s all nice and well if they want to do that, they still got enough 60 million barrels that they need to release. And then by the time those contracts go through and you want to refill the SPR, I mean, that’s months away. We’re looking at months and months down the road. And who knows what oil price would be? To me, it was just another try to jaw bone market down lower.
BJ: It kind of reminded me of the ECB where they’re raising rates on one hand, but they’re buying bonds with the other. Biden wants his cap. He’s like got a collar on it. He’s trying to put a cap on it and a foot on it.
TN: Strategy. Let’s move on to a little bit more of kind of the Fed kind of Fed talk. There’s a Fed meeting next week, and when CPI came out this week, the terminal rate really rose very quickly. And that’s when we started to see equities fall pretty dramatically. And we’ve got on the screen right now expectations for the rates coming out of each meeting. So 75 in September, 75 in November, and another 50 in December. That has accelerated the expectations for the Fed by about 25-50 basis points?
When does the Fed stop, basically from where you are now, do you think this continues to accelerate in 2023 or given, let’s say, CPI? Of course on a year-on-year basis it looks terrible. But once we get to November, when CPI really started to accelerate, November 21, do we start to see some of those base effects in a year-on-year basis and the Fed starts to pull back a little bit and go, okay, wait a minute, maybe we’re okay with the plan we have when we stop at say 450 or whatever as a terminal rate.
The other complicating factor will add in there is University of Michigan came out, University of Michigan survey came out on Friday and it’s a bit lower than what was expected. And the Fed has really been looking to University of Michigan, which is kind of a semi-serious survey, but they’ve really used that to justify some of their decisions.
So we obviously have a mixed environment. But I’m wondering, with all of this stuff coming out this week, do we expect the Fed to keep marching pretty aggressively into 2023?
BJ: I’ll take that first. So I actually do expect them to keep marching higher into 2023. And I say that for a couple of reasons, and I’m going to qualify this and say that they will pivot when they have to pivot, but I don’t think they’re going to pivot until they have to pivot. And so I think a lot of people that are predicting the pivot are misunderstanding the Fed’s intentions and perhaps for a good reason. They’ve done a fantastic job of ruining their credibility. So it’s understandable not to believe them.
But in this case, I think you kind of have to believe them. And I’ll tell you why I think you have to believe them. Number one, I think they don’t mind the dollar being stronger. Again, I think that’s kind of policy that I spoke of earlier in conjunction with the treasury.
Number two, I think they want asset prices lower. So the fact that the stock market goes down I don’t think would bother them. I think if the Dow was at 28,000 and the S&P was at 3600, I think they’d say that’s totally fine. I don’t think they have a problem with that as long as it’s not collapsing. Right? Now, if it collapses, then they have to come in. And they will come in, but I don’t think they mind if the stock market is 10% or 20% lower than here.
The third thing I’d say is the Fed central banks in general, they’re always lagging. They’re a reactionary agency. They’re not a predictive agency. We all know that. They can’t predict anything anyway. I’m not sure I want them predicting things, but to me they’re always behind the curve because they always wait until they see it and then they react, right? They come in and they try to save the day. So when things get really bad, then they’ll eventually come in and provide support.
And when things are always too late to tighten as they are now, and then they try to make up for it. So I think they’re going to despite, like you said, the Michigan number starting to come down, Atlanta Feds already slash their GDP. So even though they’re getting these signals that things are slowing down, they’re not reacting to it yet. They will react to it late.
And then the fourth thing I’d say is that I think Powell is mad and he’s pouting, right? Not just Powell, but mainly Powell, but he got all this advice from all his staff and however many staff, PhD staffers they have at the Fed, and they all said inflation is transitory and it’s going to be fine. And then it wasn’t. Right? Now he’s mad.
TN: He’s a lawyer, not an economist.
BJ: And I’m going to do something about it. And if you don’t think that I can bring inflation down, well, then you just watch me, right? And I’ll take my ball and go home. And his ball is interest rate. So he’s taking them higher, and he’s taking them home, he’s taking them higher. And so it come hell or high water, and after the, I don’t know, the chink in their armor or the threat to their credibility that they’ve had over the last year or two, I think the last thing in the world that Powell wants to deal with is the fact that he slowed down or, God forbid, cut rates and then inflation kept going higher.
That would look even worse than waiting for it to crumble, right? So I think for all of those reasons, you kind of have to take them at their word. Again, I’m not saying not unless the markets force them to do it
and the markets might force them to do it. I’m not saying that that’s out of the possibility. The only thing I don’t like saying about this is this is the hole they’re going to hike until it breaks theory, right?
And I agree with that. The thing I don’t like about it is everybody else seems to agree with it now, too. That seems to be the common refrain, is that they’re going to hike until something breaks, and everybody says, yeah, that’s kind of what’s going to happen. Usually when everybody thinks something, it doesn’t happen that way. But as long as equity prices are higher and as long as inflationary prints keep coming in high, I think they continue hiking.
And think about it, inflation could fall by 30%, and it’s still at five or six, which is still two or three times higher than their goal. So is there a path to a pivot? Yes, I think there’s a path to a pivot, but every week, when people come out every week and, oh, they’re going to pivot, they’re going to pivot. I don’t think they’re pivoting next week, and I don’t think they’re pivoting in October unless they have to.
TN: Okay, Tracy, what do you think of that?
TS: Yeah, I absolutely agree. All the data coming in, there’s no way they’re not doing 75 next week. In my opinion. I could be wrong. Somebody will come back. I think that’s pretty much a lock.
TN: Yeah, I think short of, let’s say sometime in Q4, Russia, Ukraine ends, and China says we’re not going to lock down anymore, that would fundamentally change the Feds calculations, right?
BJ: Well, if they weren’t locked down anymore and it pushed demand higher and it pushed prices higher as a result of demand increasing, then to me, that would keep them on their path to hiking. The flip side. And the flip side is that if something breaks in China, and China has to devalue or revalue the yuan in order to deal with the real estate collapse or the internal problems, whatever it is, that could send a deflationary wave to the rest of the world.
So I’m not going to sit here and deny the inflationary pressures that we’re seeing, but I think to a certain extent, people have again dumped themselves into the inflation camp or the deflation camp, and I think we’re going to have periods of both.
I think if you fundamentally understand the design of the monetary system, the threat of a deflationary
wave is always there. But if you don’t admit that the inflationary pressures are here, I think you’ve also got your head in the sand. I’ve said this several times, but I will admit to a big mistake, and that is, for several years, I hated the term stagflation. I thought it was a cop out. I thought it was for people who just couldn’t decide if they were in the inflation or deflation camp. But I think that’s what we have, and I think we have it in spades. I think some assets and some prices are going to continue to rise and be higher, and I think others are going to collapse, and that’s what makes it so hard to deal with.
So to anybody I ever took a shot at for them using stagflation as a cop out, I apologize. I’m with you now. I got that part wrong.
TN: Brent, one of the things I admire about you is you’re not afraid to say you were wrong, right?
BJ: No. I mean, do you mind if I just make a comment on this really quick? I think too often in our business, people will make a call and then they’re just so afraid to change it. Or you’ll make a call, and then somebody else will call you out on it if you got it wrong. At the end of the day, our job is sort of to predict the future. And so anybody who thinks that they can accurately predict the future 100% of the time has the biggest ego in the history of the world.
The reason I don’t mind making predictions is number one. I don’t mind being wrong because I don’t think I’m the smartest guy in history. And if I get something wrong, then I’ll have to deal with it. But this idea that we’re always going to be right and we know everything, it’s ridiculous. So anyway, we’re all speculating at the end of the day.
TN: That’s right. Okay, real quickly, guys, what are you looking for in the week ahead? More the same. More the same disappointment, difficulties, headwind, all that stuff. Until the Fed meeting? Is that what we’re looking for until the press conference?
TS: Yeah, I think we’re the markets will be in limbo, definitely until the Fed. I mean, everybody expects 75. We get 75. Maybe we see a bounce in equity, actually, because it’s already done with, right. There’s no question anymore. So maybe we get a bounce after that.
TN: Slightly less hawkish language than is expected, right?
BJ: I think that’s right. Now we’ve got the potential of maybe 100 basis points, right. So if they come in a couple of weeks ago, although now there’s a path to pivot, they’re probably only going to do 50 basis points in September.
Well, then we got the CPI print and it’s 75. That’s 75 is going to happen. Then a couple of people go hundreds now on the table, right? So now if they only come out and do 75, maybe the market kind of breathes a little bit. At least it wasn’t 100. So my guess is that we would have some volatility leading up to the meeting. Maybe they do 75. Perhaps things get a little bit of a bounce as a breather.
But I don’t think markets are going to change a whole lot between now and the election. I think they’re going to be volatile. I think the Feds are going to keep hiking. And I think Market Powell said it himself. We had the boom and now we have to deal with the pain. This is the unfortunate side effect of what we have to do. So he’s telling you he’s going to cause pain. He just doesn’t want to collapse. So if it starts to collapse, it’s the sad truth.
TN: Guys, thank you so much for your time. Thank you so much. Have a great weekend and have a great week ahead.
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UK Prime Minister Liz Truss is expected to announce a package of support to deal with rising energy bills in the coming days. It’s understood the government could spend $115 million on plans to subsidise bills. We weigh up the pros and cons of subsidies and windfall taxes with Caroline Meyer, energy analyst and CEO of Meyer Resources.
US e-cigarette maker Juul is to pay a $438.5 million settlement, following a lengthy investigation that found it had marketed its products to underage teenagers. Rachel Butt from Bloomberg in New York explains the background and implications of the story.
Rahul Tandon is joined from Austin, Texas by Tony Nash, CEO and founder of Complete Intelligence, and from Freetown, Sierra Leone by media entrepreneur and TV presenter Stella Bangura.
Transcript
BBC
Hello, there. How are you? This, of course, is Business Matters here on the BBC World Service. I’m Rahul Tandon as always, coming up on the program, we’re talking about changing your leaders. Does it work? That’s happened here in the UK. Liz Truss was sworn in into her new job. We’re going to be looking at the energy challenges that many countries, many of you listeners, are facing at the moment.
BBC
It’s going to be a terrible winter and in many countries, it will be for some of the lower income households. It will literally be a question, do I heat or do I eat?
BBC
There we go. That is a question I think that many people, unfortunately, across the world, will be facing. A lot of tough questions that are going to face businesses here in the UK. Tony Nash joins us as well this evening from Complete Intelligence. Hello, Tony. Always a pleasure to have you on the program. Our new Prime Minister here is going to need a lot of intelligence. Can I ask you, Tony, sometimes when we’re faced with big problems, we think, let’s just change the leader. That doesn’t always work, does it? Just putting a new person in charge. The problems are still there.
TN
The problems are still there. And the problems that we have right now are very hard problems to solve. So Liz Truss is going to really need a lot of help and a lot of deep thought to solving these problems.
BBC
Let’s switch it on its head, though, sometimes, having that new leadership in place, new ideas, new thoughts. She announced her new team a short while ago, Tony, that can make a difference. A fresh look at difficult problems that people are facing, whether it’s countries or businesses as well.
TN
Sure it can. I think some of the problems she’s facing right now, though, are they’re global problems. It’s the energy supply chain, right? It’s the cost of energy, it’s the downstream costs of energy. It’s the cost of things like fertilizer and food into next year. So these are not problems that the head of the UK, the leader of the UK, can solve on their own. This is something that really takes some deep thought to solve, say, the domestic symptoms of those problems, or not the symptoms, but the domestic impacts of those problems, as well as the global sources of those problems. It takes a lot of effort, especially for a new leader, to come in, set up their team and get going.
BBC
Yeah, that’s a good point. Tony, last question to you on this particular issue. Sometimes with leadership, the key is knowing when to take over. This is not the best time for any leader to take over in the country because of those problems you outlined there, which we’re going to be talking about in the program in a lot more detail a bit later.
TN
No, you’re exactly right, but I think there’s a certain kind of leader that’s attracted to taking over in a very difficult time. So I’ve done a turnaround and a couple of startups in my day, and it takes a different kind of person who to want to take a leadership position in that situation. And hopefully she’s a person who is focused. Hopefully she’s a person who can take criticism really well. Hopefully she’s a person who can get people on her team and build trust. And if she can do those things and all of the other things that a leader is supposed to do, she may actually do really well.
BBC
Stella, you were talking about the elections in Sierra Leone, which are coming up by the beginning of next year. I wonder we’re talking about leadership. I suppose the true test of a leader or somebody who wants to be a leader is taking over in difficult circumstances. Not when it’s easy, but when it’s tough. Against your labs. Tony, when you go around Texas, are you seeing a lot of youngsters vaping nowadays?
TN
I have two kids in university and one in junior high. And my kids who are in university were part of that initial group that was marketed to. And so when they were in high school, there was a lot of vaping in high school, and there still is. And even now the kids in junior high are being marketed. And so when I say junior high, that’s kind of 12, 13, 14 years old.
TN
So are they being directly marketed to? Probably not. But the problem here yes, that’s right. And the influencers and the way that they get to these kids, and there are efforts in the schools here to counter that. A lot of the messaging in the schools is countering, and again, I’m talking 12, 13, 14 years old is countering vaping and trying to get the kids to not start vaping. So it is something that’s very common even at a young age, and there are a lot of efforts to really stop it.
BBC
Yeah, go on, Tony.
TN
Yeah, the appeal here for the kids, there are a couple of appeals. First of all, they don’t smell like tobacco, right? So it’s a lot easier to do and conceal. But the other part that’s pretty common is to get vape use that has THC in it. And kids in, say, public schools will smoke in the bathroom between classes or something like that. But it’s the THC juice for their vape.
BBC
Because I’m listed, I know what that is.
TN
It’s basically smoking marijuana, right? It’s the THC is the active ingredient in marijuana. And so it’s a very easy and pretty inconspicuous way to distribute this to schools, to kids in schools. And so it’s not necessarily nicotine, it’s the THC. I’m not saying every kid who vapes has THC in their vape juice, but it’s both. And it’s balancing both out that we see a lot in the junior highs and high schools here.
BBC
I want to bring in Tony here very quickly, because I remember being in India when the government had demonetization completely changed the currency. It’s not that easy, is it? Sometimes?
TN
No, it’s not easy. It’s a shock. And I think that it’s a little bit of a shock by design so that people understand the new value. But when it doesn’t hold, then that’s a real problem. So I’m not laughing at this specific situation now, but with demonetization in India, obviously, that had an organized crime drive, right? Like they wanted to take out the large bills to take the power out of some of the organized crime transactions. Is that fair?
BBC
Yeah, it was. It was also about removing some black money from the economy. Did it work? It’s an interesting discussion that’s still going on in India. Lots more interesting discussions coming up here on Business Matters after the latest news.
BBC
What about where you are in Texas? That’s a part of the world that is known, isn’t it, for its energy resources? It’s fossil fuels, also renewables. Now we’re heading towards Midterms. How big an issue is energy there? Not quite as big maybe as it is in Europe, I suppose.
TN
Well, I live in Houston, Texas, the energy capital of the world. So you should know that everyone in my neighborhood has put in a new swimming pool except me over the past year. So the energy companies are doing well and my neighbors are benefiting. And so I don’t say that to be horrible, but these times part of the problem with times like this is people realize that there is actually under investment in energy.
TN
And so whether it’s electric, power companies or storage or transmission, other things, so what comes out of Texas is natural gas, which goes to Europe to kind of fill the gap that isn’t coming from Russia. Okay. And so because there’s not as much supply, those prices go up, and that benefits the people who take things out. But the under investment happens in two places. It happens kind of on the electricity side, but also on the extraction side. So things here actually in Texas pretty good, and we’re not seeing a lot of the downsides that Europe is seeing.
BBC
Yeah, very much. And I suppose the price of the gas at the moment, a lot of that liquefied gas coming into Europe at the moment means that a lot of those companies in Texas will be doing very well. We were talking about Liz Truss earlier in the program, the new British Prime Minister, because she’s unveiling her energy plan a little bit later this week, on Thursday. But it’s quite clear now that her government’s going to borrow hugely to keep bills low. In the EU, though, Brussels are going to propose levies on energy companies that would channel sky high earnings back to vulnerable households and businesses.
BBC
This is going to cost Europe a huge amount of money because they’re going to have to bail out a lot of people because of the rising cost of energy here and that’s going to have long term economic consequences for the continent.
TN
Sure, yeah and I think that whenever you get a governor estimate, it’s always a little bit low. So whatever the governments are putting out to spend, you can probably count on two times that or more maybe then. Sure, yeah. The government estimates are intentionally low and they always are because they underestimate probably supply constraints in this case.
TN
If you look at things like gas storage. So I’m not of the belief that we’re going to have like a horrific event in Europe this year or this winter because if you look at gas storage, for example, Germany has a natural gas storage, it’s something like 84% of reserves and their target is 95% and they’ll fill that 95% by probably November. So there will be supplies of gas in Europe. It will be expensive.
TN
So as your guest said, people will have to choose between food and heating. I don’t necessarily think that’s the case. If you look at the German government, they have the capacity to issue a massive amount of debt to pay their people to survive through the winter. So not every government in Europe has that luxury, but Germany certainly does and a lot of northern European governments too.
BBC
Well, we did see, didn’t we, earlier this week, the Chancellor of Germany outlining plans to help people will have Liz Truss do that as well. Texas, California, two rivals. I think a lot of our listeners across the world will be surprised to hear about blackouts in a state like California, one of the wealthiest in the US.
TN
Well, yes, in California needs a lot of investment in its power grid. That’s really something that’s long overdue and they haven’t necessarily put the investment in. It’s got a creaking power grid and so this is why power is so inefficiently distributed in California. And until they do that they’re going to continue to have these brownouts and blackouts and power distribution problems.
BBC
And do you think that’s one of the reasons why we’ve seen a movement of quite a lot of businesses, haven’t we? It’s not just about taxation from California to your part of the world.
TN
Yes, absolutely. It’s about regulation, it’s about the continuity of power and it’s about education. And the students that come out of Texas institutions are very good, very hard working students. So there are a lot of factors related to it. And land, there’s a lot of land in Texas that can be built on for things like Tesla and other places.
BBC
Stella well, that’s very similar to the situation in Bangalore, a city that you know well. As you Tony know very well, yes.
TN
Gosh, I spent a lot of time in Bangalore about 20 years ago, before the new airport, before the second ring road, all of that stuff. So it was the same town, but it was a little bit different, not quite the scale that it has today, but the disasters there, it’s heartbreaking.
TN
I moved to Texas in 2017 when we had a Hurricane Harvey, and one of the things your guest was talking about is how people would help each other out in Bangalore with the floods. And that’s exactly what we saw here where we went and helped ten or 20 people take all of their belongings out of their house and started new life. It’s heartbreaking.
BBC
It is indeed. And it has been a sad end to the program, talking about the city I know very well in Bangalore. Hopefully, I’ll get on its feet. Thanks to Tony. Thanks to Stella. We’ll be back same time, same place tomorrow.
