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Europe’s economic recovery: More like Japan, China or the US?

We have a first-time QuickHit guest for this episode, Daniel Lacalle, a well-respected economist, author and commentator. Daniel shares his expertise on the eurozone and European Union. What is happening there in terms of Covid recovery? How does the region compare to other economies like Japan, China, or the USA? Will the ECB follow what the BOJ did? Will there be talks of deflation or inflation in Europe? How about the quantitative easing especially with a possibility of a more conservative ECB chair? Also, will Europe suffer the same power crisis as China and will Europeans be able to absorb inflation?

 

Daniel Lacalle started his career in the energy business and then moved on to investment banking and asset management. Right now, he’s into consulting and also macroeconomic analysis and teaches in two business schools.

 

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This QuickHit episode was recorded on November 18, 2021.

 

The views and opinions expressed in this Europe’s economic recovery: More like Japan, China or the US? Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

 

Show Notes

 

TN: We spoke a few weeks ago on your podcast, and I’ve really been thinking about that since we spoke, and I wanted to circle back with you and talk about Europe. There’s a lot happening in Europe right now, and I think on some level, the US and China get a lot of the economic commentary. But really, Europe is where a lot of things are happening right now. And I’d like to generally talk about what is the near term future for Europe. But I guess more importantly, in the near term, what are some of Europe’s biggest economic impediments right now? I’m really curious about that. So what do you see as some of their biggest economic impediments.

 

DL: When we look at Europe, what we have to see from the positive side is that countries that have been at war with each other for centuries get along and they get along with lots of headlines. But they’re getting along sort of in a not too bad way. Good. Yeah, that’s agreed. But it is true that the eurozone is a very complex and a very unique proposition in terms of it’s, not the United States, and it’s not unified nation like China. It’s a group of countries that basically get together under the common denominator of a very strong welfare state. So unlike China or the United States, which were built from different perspectives. In the case of the eurozone, it’s all about the welfare state as the pillar.

 

DL: From there, obviously, productivity growth, job creation, enterprises, et cetera, are all, let’s say, second derivative of something that is a unique feature of the European Union. No, the European Union is about 20% of the world’s GDP, about 7% of the population, probably. And it’s about 55% of the social spending of the world. So that is the big driver, 7% of the population, 20% GDP, 55% of the government spending in social entitlements.

 

So that makes it a very different proposition economically than the United States or China. Where is the eurozone right now? The eurozone and the European Union in particular were not created for crisis. It’s a bull market concept. It’s a Bull market agreement. When things go swimmingly, there’s a lot of agreement. But we’ve lived now two crisis. And what we see is that the disparities between countries become wider when there is a crisis, because not everybody behaves in the same manner. Cultures are different. Fiscal views are different. So that is a big challenge. The situation now is a situation that is a bit of an experiment because the Euro has been an incredible success. When I started.

 

DL: When I started in the buy side, everybody said the Euro is not going to last. And there it is. And it’s the second world reserve currency in terms of utilization, significantly behind the United States. So it’s been a big success. But with that big success comes also a lot of hidden weaknesses. And the hidden weaknesses are fundamentally a very elevated level of debt, a very stubborn government spending environment that makes it very difficult for the European Union and the eurozone to grow as much as it probably could. And it also makes it very difficult to unify fiscal systems because we don’t have a federal system. We don’t have like the United States is.

 

The situation now is the eurozone is recovering. It’s recovering slowly. But some of those burdens to growth are obviously being very clear. Think about this. When Covid19 started, estimates from all global entities expected China to get out of the crisis first, the eurozone to get out of the crisis second, and the United States to be a distant third. It’s… the United States has surpassed its 2019 GDP levels. The eurozone is still behind. So it’s interesting to see how the expectations of recovery of the eurozone have been downgraded consistently all of the time. And therefore, what we find ourselves in is in a situation in which there’s almost a resignation to the fact that the eurozone in particular, but also the European Union. The eurozone is a small number of countries. The European Union is larger, for the people that are watching. It’s going to recover in a sort of almost L shape. It was going to recover with very low levels of growth, with much weaker levels of job creation and with a very significant and elevated level of debt. So that’s basically where we are right now.

 

Obviously, the positives remain. But it’s almost become custom to accept low growth, low job creation, low wage growth and low productivity.

 

TN: It seems to me that if we switch to say, looking at the ECB in that environment, how does the ECB deal with that in terms of higher inflation, lower growth, a weakening Euro? Now, I want to be careful about saying weakening Euro. I don’t necessarily think the bottom is going to fall out. I know there are people out there saying that’s going to happen. But we’ve seen over the past, particularly three weeks, we’ve seen some weakness in the Euro. What does that look like? Do we see kind of BOJ circuit 2012 type of activity happening? Or is there some other type of roadmap that the ECB has?

 

DL: It’s a very good comparison. The ECB is following the footsteps of the Bank of Japan. In my opinion, in an incorrect analysis of how the ECB the European Central Bank behaved in the 2008 crisis. There is a widespread of mainstream view that the ECB was too tight and too aggressive in its monetary policy. Aggressive in terms of hawkishness in the previous crisis. And if it had implemented the aggressive quantitative easing programs that the Federal Reserve implemented, everything would have gone much better. Unfortunately, I disagree. I completely disagree.

 

The problems of the eurozone have never been problems of liquidity and have never been problems of monetary policy. In fact, very loose monetary policy led to the crisis. Bringing interest rates from 5% to 1%. Massively increasing liquidity via the banking channel, but increasing liquidity nonetheless. And so the idea that a massive quantitative easing would have allowed the eurozone to get out of the crisis faster and better has been also denied by the reality of what has happened once quantitative easing has been implemented aggressively.

 

So now what the ECB is doing is pretty much what the Bank of Japan does, which is to monetize as much government debt as possible with a view that you need to have a little bit of inflation, but it cannot be high inflation because in the United States, with 4% unemployment, 4.6% unemployment, you may tolerate 6% inflation. For a while. But I can guarantee you that in the European Union, in the Eurozone with elevated levels of unemployment and with an aging population, very different from the United States. Very different in the European Union almost 20% of the population is going to be above 60 years of age pretty soon. Aging population and low wages with high unemployment or higher unemployment than in the United States. A very difficult combination for a very loose monetary policy.

 

The Bank of Japan can sort of get away with being massively doveish because it always has around 3% unemployment. So structural levels of unemployment. But that’s not the situation of the eurozone. So I think that the experiment that the ECB is undertaken right now is to be very aggressive despite the fact that the level of inflation is significantly higher than what European citizens are able to tolerate. Obviously, you say, well, it’s 4% inflation. That’s not that high. Well, 4% inflation means that electricity bills are up 20%, that gasoline bills are up another 20%, that food price are up 10% so we need to be careful about that.

 

So very dangerous experiment. We don’t know how it’s going to go. But they will continue to be extremely doveish with very low rates. That’s why the Euro is weaker, coming back to your point. Extremely dovish despite inflationary pressure.

 

TN: So it’s interesting central banks always act late and they always overcompensate because they act late. So do you think that maybe a year from now because of base effects, we’ll be talking about deflation instead of inflation like, is that plausible in Europe, in the US and other places, or is that just nonsensical?

 

DL: Well, we will not have deflation, but they will most certainly talk about the risk of deflation, because let’s start from the fact that the eurozone has had an average of 2% inflation. In any case, most of the time. There’s been a very small period of time in which there was sort of flat inflation. Right. So will they talk about the risk of deflation? Absolutely they will. I remember the first time I visited Japan. I remember talking to a Japanese asset manager and saying, “well, the problem of Japan is deflation, isn’t it?” And he said to me, you obviously don’t live in this country. So will they talk about deflationary pressures? Maybe. Yes.

 

Think about this. If you have 5% inflation in 2021 and you have 3% inflation in 2022, that is 8.1% inflation accumulative. But falling inflation.

 

TN: Right. Exactly. Yeah. And it could be a way to justify central banks continuing to ease and continuing to intervene. And so Japan’s found itself in a really awkward position after eight, nine years of really aggressive activity. It’s just really hard to get out once you stop, right? So I do worry, especially about the heritage of the ECB, with kind of the Dutch and German chairs being very conservative. This is a pretty dramatic change for them, right?

 

DL: Huge. Because you’ve mentioned the key part is that everybody says, well, the ECB will do this. The ECB will do that. But the problem is that the ECB cannot do most of what they would consider normalizing. Because Spain, Portugal, Greece, Italy, it would be an absolute train wreck if the ECB stops purchasing sovereign bonds of those countries. Because the ECB is… This is something that you don’t see in the United States. The ECB is purchasing 100% of net issuances of these countries.

 

So what’s the problem? Is that? Think about this. Who would buy Spanish or Portuguese government bonds at the current yields if the ECB wasn’t buying them? Nobody. Okay. Let’s think of where we would start to think of purchasing them. We would probably be thinking about a 300-400% increase in yields to start thinking whether we would purchase Portuguese, Greek, Italian, French bonds? Not just the Southern European, but also France, et cetera.

 

So I think that is a very dangerous situation for the ECB because it’s caught between a rock and a heart place. Very much so. On the one hand, if it normalizes policy, governments with huge deficit appetite are going to have very significant problems. And if it doesn’t normalize, sticky inflation in consumer goods and nonreplicable goods and services is going to generate because it already did in 2019, protests. Because we tend to forget that in 2018 and 2019, we had the gilets jaunes, you probably remember the Yellow Vests in France. You probably remember the protest in Germany about the rising cost of living. The protests in the north of Spain. So it’s not like everybody is living happily. It’s that there were already significant tensions.

 

TN: Right? Yeah. I think the pressure is, the inflationary pressures that say consumers are feeling here in the US and Europe and parts of Asia, definitely acute, and people are talking more and more about it.

 

If we move on to say specifically to energy, since that’s where you came out of, right? So we’re seeing some real energy issues globally and energy prices globally. But when we look at gas, natural gas, specifically in Europe, do you expect to see a crisis in Europe like we’ve seen in China over the last three months where there are power outages, brownouts, hurling blackouts, that sort of thing? Or do you think there’ll be a continuity of power across Europe?

 

DL: In my opinion, what has happened in China is very specific to China because it’s not just a problem of outages because of lack of supply. Most of the lack of supply problem comes from a shortage of dollars. So many companies in China have been unable to purchase the quantities of coal that they required in a rising demand environment because they had price controls and therefore they were losing money.

 

They would have to purchase at higher prices and generate at a loss. That is not the case in Europe. In Europe, the problem of gas prices is a problem of price definitely, obviously. It’s very high and it’s also feeding to our prices because of the merit order. But it’s not a problem of supply in the sense that getting into an agreement with Russia to increase 40% their supplies of natural gas into the European Union was extremely quick. From the 1st November to beginning of this week, gas form has increased exports to Europe by 40%.

 

Problem? Prices have not fallen as much as they went up before. For the south of Europe, it’s a problem fundamentally, of access to ships because LNG obviously is very tight. Vessels are not available as they used to be. There might be a certain tightness in terms of supplies, but I find it very difficult to see, let’s say, a Chinese type of shortage of supply because it’s a matter of price. Will we have to pay significantly more for natural gas and significantly more for power, but not necessarily feel the problem that the Chinese did because they had lost making generation in coal.

 

TN: Great. Okay, that’s very good. That’s what I’d hoped you say, but it’s great to hear that. Let’s switch just a little bit and talk about kind of European companies because we talked about rising prices, like energy. We talked about inflation and consumers say bearing inflationary pressures.

 

In European companies, we’ve seen that American companies have been able to raise prices in America quite a lot, actually. And consumers have borne that. Chinese companies haven’t really been able to do that. Their margins are really compressed because consumers there haven’t been able to bear the price rises. What are you seeing in Europe, and how do you think that impacts in general European companies, their ability to absorb price rises or pass them on to consumers? And how long can they continue to bear that?

 

DL: Yeah. One of the things that is very distinct about Europe is the concept of the so called, horrible name, “National Champions.” In power, in telecommunications, in banking, in oil and gas, etc. Etc. We tend to have each country a couple of dinosaurs, most of them, that are so called National Champions. These cannot pass increases of inputs to final prices because they receive a call from the red phone from the Minister in the country. And no my friend, the prices are not going up as they probably should.

 

So the automotive sector? Very difficult because there’s a lot of over capacity and at the same time, tremendous cost pressure that you cannot pass because of the lack of demand as well, or the lack of demand relative to supply. The airline sector? Cannot pass the entire increase of cost to consumers. The power sector? Very difficult, big companies, very close to governments. They’re suffering immensely from regulatory risk. So very difficult. So you have those.

 

However you would say, okay, so that sort of shields inflationary pressures out of consumers. Unfortunately, it doesn’t because those are very large companies, but they’re very small in terms of how much they mean, for example, the prices of food or the prices of delivered natural gas. Even though you purchase natural gas, there’s a strict pass through in those, for example. You might not increase your margins. You might lose a little bit, but the pass through happens. It goes with a delay. In the United States, everything happens quickly. In the United States, shut down the economy, unemployment goes to the roof, then it comes down dramatically like V shape, opposite V shape. In the Eurozone, things happen slower. And that’s why it’s a bigger risk, because the domino effect, instead of being very quick and painful and quickly absorbed is very slow.

 

TN: Interesting. Okay. Very good. Well, Daniel, thank you for your time. Before we go, I’d like to ask everyone watching. If you don’t mind, please follow us on our YouTube channel. That helps us a lot in terms of adding features to our podcast.

 

Daniel, thank you. As always, this has been fantastic, and I hope we can come back and speak to you sometime in the future. It will be a great pleasure. Always a fantastic chat. Thank you very much.

 

DL: Thank you very much.

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QuickHit

EM Meltdown: China, Turkey & Russia (Part 2)

In this second part, emerging markets expert Michael Nicoletos discussed Turkey and Russia. What are the major issues that Turkey is facing, specially around its FX reserves? They have an energy problem as well, and will soon need to choose between the US and Russia. And how about Russia’s love-hate relationship with Europe? How does Nicoletos see it will end up?

 

Please watch Part 1 first, if you have not already. Michael talked about China’s household debt and how much is that? Can they ever recover from the Evergrande disaster? And how they got into it in the first place? Is CNY still valuable? How do the Chinese get dollars now with their very limited FX reserve? Should you use the digital Yuan? How much is China spending right now to up its GDP?

 

Michael Nicoletos have spent most of his life around markets, and I used to run a hedge fund for more than 10 years on emerging markets. He shut it down in 2019 to take a sabbatical and Covid 19 hit the world. Now, he is doing a lot of research on emerging markets and trying to see what the next steps will be in terms of the investment world. But in the meantime, he is also advising a few firms on their investment.

 

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This QuickHit episode was recorded on October 20, 2021.

 

The views and opinions expressed in this EM Meltdown: China, Turkey and Russia (Part 1) Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TN: Talking about EMs, and we talked about reserves, and you mentioned Turkey. Let’s talk about Turkey for a minute because you’ve made some really interesting statements about Turkey, and I’d like to really understand your perspective.

 

MN: Turkey faces some other issues. Turkey faces high inflation. More than 20% rates are around 19% of negative yields. The Lira has fallen more than 50% in the past few years. So you might see nominal GDP in Turkish Lira going up. But if you put it in dollar terms, it’s actually flat for the last ten years. It’s not flat, it’s flat-ish. So in Turkish Lira, the last ten years, the Turkish GDP has gone up 350%, which is a wow. But if you put it in dollars, it’s not flat, but it’s not something meaningful.

 

Turkey GDP in Lira and USD

Now, if you look at Turkey and the devaluation, the President of Turkey, Tayyip Erdoğan, has tried to stop the Lira from falling. Right now, it’s I think at its all-time lows around 920 versus a dollar. But if you look at the FX reserve, which is very tricky and this is very interesting for Turkey, you’ll see that, okay, the number is ambiguous because depending on what source you see, you’re going to see another number. But let’s say it’s around $18 billion. Now, this is the gross number. If we deduct gold and all the other stuff and we also deduct the swap lines, and I will explain what the swap line is, this number falls around to $20 billion. And this could be negative according to some sources because the dollars are not there.

 

What has Turkey done? Instead of using its dollars to protect the Lira from falling, I’m not an advocate that you should do that, but that’s what they’ve been doing. They went to the banks and did swap lines with the banks. And the banks are using depositors dollars to buy back the Lira. So depositors right now don’t actually have those dollars in their account.

 

Turkey FX Reserves

 

MN: Because the Turkish banks have made agreements with the central bank with swap lines, which okay, when your central bank gives you a swap line, it’s a guarantee if you’re a bank. And instead of, if you go and you see the headline number of the Turkey central bank, you won’t see it falling. But if you understand that they’ve been using depositors’ dollars to cover for it, you need to subtract that. So the number could be close to 20, maybe there are some allegations that it could even be negative. So if it’s negative, imagine. FX reserves in Turkey are pretty horrible.

 

You have, let’s say, $18 billion of gross FX reserve, and you have $130 billion of short term liabilities, within the next twelve months, Turkey has 130 billion of foreign claims. So again, this metric is not really good. Now, Turkey is estimated to grow around 8 or 9% this year. Again in Turkish Lira.

 

MN: If we take the Lira is down 25% this year. So this is an issue. Another issue is in Turkey, 60% of its current account is energy. They don’t have domestic energy, so they need to import energy and we know what’s been going on with the energy crisis and natural gas and oil going higher. So all these are main problems for Turkey right now, which I think will be forced to find a drastic way to… They don’t want to go to the IMF or the World Bank, but I think at some point they’ll have to go. And again here geopolitics come to play why they say geopolitics is because Turkey is in NATO. It’s the second biggest force in NATO. The US wants to keep it in NATO because wherever US doesn’t send military, Turkey does. Not many NATO allies send military forces wherever they go.

 

So Turkey is trying to play both sides right now. Trying to be the good guy with Russia, good guy with NATO. Trying to get the most out of both sides. But I think time is ticking and they will be forced to take some form of decision on what they want to do in the future because they’re running out of time in terms of their FX reserves.

 

TN: Yeah, it sounds like it’s pretty short time. Wow. Okay. So looking at the energy issues, not just what Turkey faces, but that Europe faces, I want to spend a little bit of time talking about the Russia-Europe relationship and what you’re seeing there. Will Russia provide sufficient gas to Europe this winter? And, from a financial perspective, how much will Russia benefit from that? Just generally.

 

MN: Yeah. Okay. But the thing is here the following: Europe trying to transition to a more green related economy. The planning was pretty horrible. I would say they wanted to do it fast and they wanted to say “blackmail” corporations to go to more green energy. What did they do then? They created the CO2 emissions credits. So if you were polluting above a level, you were forced to buy CO2 credits in order to cover for that. And that was like an indirect tax, making it less efficient for corporations to use that form of energy so they would be forced to go to other forms of energy.

 

Now, from going to coal to, let’s say, totally green. It takes some time to create the wind turbines and the sun. And actually Germany shut down all its nuclear reactors because of Fukushima.

 

TN: They have a lot of low-end Taiwanese fabs transition to photovoltaics with all of the incentives they were providing. I mean, for a long time, low-end fabs across Asia were just doing a very quick transition to a PV, and it was just a kind of back up the truck moment where they were just taking all the dollars they earned or Euros or whatever currency they could because Germany and all these other places were incentivizing them to do it. And they were low-end PVs. They weren’t high-end. They were just bog standard photovoltaics.

 

MN: No, no. Okay, but besides that, what did the European Commission do? There are auctions every now and then of CO2 credits. But the auctions are arbitrary. So the Commission, whenever it wanted the prices to go up, they did not do the auctions. So then the supply of credits was less and less. CO2 credit emissions went through the roof. So suddenly, if you use natural gas as an energy, it went even higher. And this created the viscious loop, creating the natural gas prices to go even higher.

 

In the meantime, Europe was negotiating with Russia about Nordstream, too. So Russia, which is a pretty good strategic and geopolitical player, realized that Europe was going back as being back in the corner and said, unless you sign whatever I want, let me put it in layman’s terms. I’m not going to pump anymore natural gas. Europe says, no, we have to sit down. We have to discuss. Okay, I’m not pumping. So one brings to another. And every time that Europe trying to play hardball, Russia says, okay, there’s no such a problem. I’m not going to be pumping and prices go higher and higher.

 

So I guess that at some point Europe will need to sign anything Russia wants at this moment. And will try to negotiate some form of an agreement which will be obviously not, it won’t be good. But it will be much better than the current prices that we’re seeing now. And because of the energy prices going higher, Russia is benefiting on a macro level, benefiting on a geopolitical level, and it’s gaining a lot of strength in the region.

 

TN: Hugely. Yeah. Hugely.

 

MN: So the two are interconnected. It’s not one or the other. So the energy crisis has helped Russia, and Russia has exploited Europe’s inability to act smoothly and fast.

 

TN: It’s very interesting. Okay. Just to close this out because I know we’ve been going on for a while. I’m just curious about Russia’s position with Europe, say, over the medium term. Do you see Russia and Europe growing closer? Do you see that relationship becoming tighter, or do you see that eventually becoming an antagonistic relationship? Are there substitutional energy sources that Europe can utilize and that eventually becomes an antagonistic relationship again? Just in general terms. I don’t necessarily political specifics. But how do you think that plays out?

 

MN: Well, I’ll use Henry Kissinger’s famous quote that was back, like 40 years ago. He said, “When I called Europe, who do I call?” So right now, you have, in Germany you just had elections. They haven’t formed the government. It might take months before they form a government.

 

In France, there are elections in April. It seems that the right could be a threat to Macron. And we don’t know what the “right’ means in France. It could be Le Pen or it could be someone else, but it could be anything right now. So right now, I don’t see a leader. If Macron wins, he could be the next leader of Europe. But right now, there’s a leadership problem within Europe.

 

So as long as there’s a leadership problem within Europe, in my view, there’s a vacuum. And I think Russia will exploit it to gate as much influence as it can. And I cannot foresee the future. But in the next six to eight months, I think Russia will try and get as much influence as it can and try to exploit that vacuum.

 

TN: I think you’re right. They’re very smart. They’re very smart political players.

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QuickHit

QuickHit: What China is thinking right now?

China expert Chris Balding joins us this week for #QuickHit to discuss “What China is thinking right now?” What is the state of the Chinese economy? Are they really doing well in Covid? How about the deleveraging process, is that even real? And what’s happening to CNY? Also talked about are the politics around China especially how it relates to Afghanistan.

 

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This QuickHit episode was recorded on August 24, 2021.

 

The views and opinions expressed in this Sentiment has soured: How will governments and companies respond? (Part 1) QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TN: Hi, everyone. Thanks for joining us for another QuickHit. My name is Tony Nash with Complete Intelligence. Today we’re talking with Christopher Balding about what is China thinking now.

 

Chris, thanks for joining us. Can you let us know a few things about yourself? Give us a little background?

 

CB: Sure. I was a professor at Peking University in China for nine years and then two years in Vietnam at the Fulbright University Vietnam. And today I am a super genius in the United States.

 

TN: Yes, you are. Thanks for taking the time, Chris. You’re one of the very few people I know who’ve actually had on the ground experience in China with a Chinese government organization.

 

So I think it’s really important to go to people like you, who had experience like you to understand what kind of China or the Chinese government is thinking now. Of course, it’s not monolithic. There are a lot of different opinions, but it’s good to have that insider’s view.

 

So I want to start off as we look at where we are in COVID, we’re a year and a half into it, depending on the school of thought, maybe it did or didn’t start in China, but we hear that Chinese economy is doing great and they’ve come out of COVID really well, all these other things. I’m really curious your view on the state of the Chinese economy right now. And what are Chinese economic planners thinking right now as they kind of potentially go into year two of Covid.

 

CB: So I think there is a couple of highlights out of the Chinese economy. First of all is that they’ve resorted to the pretty similar playbook that they go back to every year, which is pump credit, pump construction and infrastructure type spending.

 

In the early part of this year, we saw a significant amounts of credit growth. That’s softened as we’ve moved into summertime. That’s primarily due to because there’s a very clear summer and fall building season that allows builders in China to do things because the weather becomes inclement in significant parts of the year. And then if you add in the Corona backlog, that kind of is essentially almost trying to put two years of expected growth into one year.

 

We actually saw a lot of that. And that front loaded a lot of the credit and demand for things like commodities. This is why you’ve seen such demand for things like coal and steel, which were quite high. We’ve seen that soften as firms built their inventory and really ramped up during the summer building season as the demand for credit has softened and some of the building has actually been undertaken. You’ve seen a softening of that which has caused you’ve already seen talk of maybe there’s going to be unleashing or the economy is a little bit softer than the planners would like. So there’s talk of unleashing some additional credit growth trying to stimulate different parts of the economy. We’ll have to wait and see if that happens.

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Generally speaking, the rule is, if there’s a debate about whether or not they’re going to unleash credit growth, I would definitely take the over.

 

TN: By about three times. Right. So one of the interesting things you mentioned is that you said that they expended credit in the early part of this year. But what I read from investment banks and what I’ve read from other people who look at China is that China just underwent this big deleveraging process. Is that real? I’m just not sure, because I see on one side that there’s this talk about deleveraging, but my gut tells me it may not necessarily be happening. Is it happening, or is it something that’s just happening on paper or what’s your view?

 

CB: It’s tough to understand the Chinese National Bureau of Statistics and PBOC’s math as to how they arrived at that, because if you’re just running more generalized numbers, it’s very clear that debt at all levels has continued to outpace GDP. So it’s very difficult to understand how they’re estimating a leveraging. And it’s important to note that we did not see, let’s say, the rapid, rapid expansion of economic growth that you saw, for instance, in the United States.

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And what I mean by that is, whereas any United States, maybe growth went from two or three to 5% relative, almost doubling, you know. You probably saw Chinese growth go for maybe like 5% last year to seven or 8% with the Corona boost where you have that base effect. And so you didn’t see it go to, like, 10, 12, 15% that you might have seen if it had really in relative terms, they doubled from the previous year.

 

And so it’s very difficult to understand how they arrive at those deleveraging numbers. And as we all know, China is famous for fudging their numbers. So it’s very difficult to understand how they’re arriving at those numbers.

 

TN: Right. No, I agree. I haven’t believed it when I’ve heard it, but I kind of nod along as if it’s real. But I think, you know, the Chinese economic data a lot more intimately than I do, but I just don’t see where it’s happening, where it’s actually materializing instead of just being debt transfers.

 

Okay. So earlier you said that Chinese economy is slowing. Now, from my perspective, that’s worrisome partly because you’re going into a big export season, and we’ve got some ports that are stopped up. We’ve also got an election next year with Xi Jinping being reelected, whether that’s in square quotes or not, but Xi Jinping being reelected next year.

 

In terms of the resources put towards stimulus this time around, do you expect that to be more intensive than normal?

 

CB: Typically, what you see. And you saw this the first time Xi was elected, you saw this second time Xi was elected. What you typically see is a pretty significant boost to fiscal outlays. And so I think if history is any guide, I think you’re probably going to see going in the fall and the first of year, it’s very, very likely you’re going to see some type of significant boost to fiscal outlays. And this pattern goes back many, many years well before Xi that when there are these elections. And I’m not sure if it’s a scare quotes or air quotes, but both seem to…

 

TN: Yeah.

 

CB: So I think it is very, very likely that you’re likely to see that. And one of the things I think that a lot of people have missed out on is yes, there were absolutely corporate, let’s say, bailouts or corporate funds for Corona. But one of the things is that in the United States, there were the large amounts of transfers directly to households. China has not enjoyed those transfers directly to households.

 

And so actually, consumer spending in China is actually pretty soft. And those are buying inflated data standards. And so I think that is something that is very important to note when we’re talking about the health of the Chinese consumer.

 

TN: Yep. That’s great. Okay. So I also want to talk about the supply chain issues. And I was just reading a story today about how Pudong Airport has been shut down. Cargo on Pudong Airport is going to be much slower for a period of time because of anothe Covid outbreak. This sort of thing. Do you see ongoing port capacity issues related to COVID? Is that something that you’re kind of concerned about?

 

CB: I think that is something that you’re going to be seeing for definitely the foreseeable future. And I should say it’s not just China. You’re seeing a lot of this in other parts of the world that I know, specifically Vietnam, the Middle East. I’ve heard of similar things in Europe where they are just straining at capacity. Sometimes it’s due to COVID shut down. Sometimes it’s due to other issues. But absolutely, these are issues that I think are not going away anytime soon.

 

And it is, I mean one of the debates in the United States right now is transitory or structural inflation. And I think, not to be capping out on the issue, but I do think it is kind of a mix of both. And I think the supply chain issues don’t be surprised if we’re looking at very likely two years before all these issues are really worked through, because when people went to, let’s say, just in time or contract manufacturing, what that did is that gave you less wiggle room. So you did not just have a massive warehouse of supply that you inventory, and then you could draw down as necessary where it would give you three months to make a mistake. Now people were essentially saying, I got one week of inventory, and if that one week gets shot, I’m in deep trouble.

 

So the chips are, there’s chips, there’s car, there’s Corona shutdowns, there’s capacity issues at some ports. And so it’s going to take a couple of years, probably to work through all these issues to return to what we think of as some degree of normalcy.

 

TN: Right. What’s interesting to me about that is the previous administration of the US tried to bring manufacturing businesses back to the US.

 

Now, with COVID because of the global supply chain issues and the intermittent supply issues, there’s more of a move to bring things back, at least to North America. I know lots going into Mexico right now. Some’s going into the US to minimize the disruption of things, especially in electronic supply chain.

 

So it seems like regardless of the kind of official policy, whether it’s trade policy or just say public health policy, it looks like more of this regionalization is happening. Does that make sense to you?

 

CB: Yeah, absolutely. I mean, look, nobody is going to announce that they’re leaving China for many reasons. But nobody’s going to announce that they’re leaving China. But you do absolutely see a spread of manufacturing capabilities.

 

Whether that is because they want to have multiple manufacturing bases, they want to be more diversified, whether it’s because of IT issues, whether it’s because of Corona risks, tariffs, all of these issues, there is absolutely increasing diversification of manufacturing capabilities, whether it’s Mexico, India, Malaysia, all of these different places. You’ve even seen Africa doing relatively well in certain areas. So it has absolutely happened.

 

TN: Okay. One last question on the economy then we’ll move to kind of politics and China’s place in the world. What’s the thought behind the elevated CNY? We’re trading much higher than we have for a long time, and it stayed there, right? It’s pegged right around 6.4 something, and it’s been there since Q1, I think. Why the persistent strength in CNY?

 

CB: Well, I mean, I think first of all, they have been running during Corona pretty significant surpluses. The United States has exports to China and other parts of the world have declined, not insignificantly or remained flat as we’re importing a lot more. That’s number one.

 

I think also the dollar has gone into a specific range. And the way that I think of the CNY is it’s basically just a reverse USB tracker, which I think explains most of what we’re seeing. I think what they’re trying to do and the reason that China has been buying some dollars, not in major amounts, but I think they kind of have, like, ICBC and CCB, those types of banks acting as dollar cushions for lack of a better term, is that they don’t want it to appreciate too much for a number of reasons, because they know they’ve become more expensive and that would just make it that much more expensive. So in a way, I think they’re trying to manage that, manage that flow. But I think it’s still generally within a range where it’s like you can say they’re within spitting distance of what their index say they should be. Okay, that’s fair.

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TN: Okay. Now let’s move on to politics. Let’s move on to kind of China’s big, long term, multi hundred year plan to rule the world, which I think is not real.

 

So let’s talk about Afghanistan. This just happened over the last couple of weeks, and there’s a few that China is going to be the master winner of the US withdrawal from Afghanistan. I think there are multiple perspectives on that, but the consensus view seems to be that the US really did had to job on the withdrawal. And the ultimate winner of this is China. Can you kind of walk me through some of your views on that? What are some of the possibilities there with China and Afghanistan?

 

CB: Sure. So I think it is very fair to say that the United States has pretty badly bungled the withdrawal. You know, why, you know, we should have waited until we’d already evacuated all the army to say we’re going to start evacuating US citizens and Afghani translators and people like that.

 

One of the things I do think is absolutely happening. And this is not just China. And you’ve heard this from country after country. Taiwan, Germany, UK on down is they are saying we need to go back to the drawing board and re evaluate everything we think we know.

 

Okay. And somebody that I was talking to, I think, expressed it very well is the United States still has credibility because we can move large amounts of assets, whether it’s military, governmental, other private sector, we can bring significant assets and influence to the table. What, this has really changed in a lot of people’s minds is confidence.

 

TN: Yes. That’s fair.

 

CB: That has changed a lot of people’s mind. So you have a lot of people going back to the drawing board. One of the things I’m going to be a little bit hesitant to do is start pronouncing winners, losers, and this is what XYZ country is going to do in ABC country is going to do. And the reason I say that is it’s very, very plausible to construct a scenario where the Taliban and the CCP become BFFs. Okay?

 

TN: Sure.

 

CB: I mean, if China is shipping large amounts of fentanyl out of northeast China, it’s not a crazy scenario to say they partner with the Taliban to start shipping large amounts of opium into the United States at the same time.

 

TN: Sure.

 

CB: Not a crazy scenario. It’s also not a crazy scenario for the Taliban to start bombing China within a year or two. Okay. You could very easily construct those types of scenarios that lead to that. Okay. So it’s very, very difficult to construct those types of scenarios with any what I would consider a degree of certainty. Okay?

 

TN: Sure. So what about the, the China-Pakistan relationship? $46 billion of investment, supposedly, supposedly a tight relationship there. That’s arguable. Do you think that pays dividends in Afghanistan, or is that kind of something that’s a little bit, I wouldn’t say irrelevant, but a little bit less directly connected.

 

CB: So I think Pakistan is actually very pretty directly involved in all of this. But again, it’s very difficult to say with a high degree of certainty what’s happening there because Pakistan has very direct connections into both the Taliban, Al Qaeda. Some would even say that they were a Pakistani security service creation. At the same time, it’s well known that there are blood feuds between groups within each of those organizations.

 

So it’s very difficult to get to say exactly who the winner, loser there. With regards to China and Pakistan, one of the things that you’ve seen very clearly is that pretty much the Pakistani government and the Pakistani elites are effectively compromised by China. They will say nothing about wingers and other issues.

 

At the same time, everything, I think indicative on the ground and of the mass population is that there is maybe not extreme, but I would say broad discontent with the Pakistani relationship with China for many reasons.

 

TN: From who and Pakistan? Is it from the armed forces? Is it from other parts of the government, from regular folks who isn’t happy with that relationship?

 

CB: I think a lot of folks broadly. The business community. I think there’s a growing sense that they are effectively a Chinese colony. One Pakistani I know who described it as such. So I think there is very broad discontent. And as we all know, Pakistan has quite the lengthy history of governmental instability.

 

So similar to what you’ve seen in other countries in the region, it’s very easy to paint a picture, a scenario where the current government remains compromised and under the thumb of the CCP for years to come. I think it’s also plausible that a new government or some type of political instability happens in Pakistan. And all of a sudden, there’s an about face on how to manage relationships with China.

 

Generally speaking, though, I think there is going to be very tight coordination between Beijing, Islamabad and Kabul because those… Pakistan, I mean, almost anything that happens in Afghanistan is going to be maybe not controlled by Pakistan. I think that overstate it. But there’s going to be large amounts of information flows and influence back and forth happens over what happens in Afghanistan.

 

TN: Yeah. Okay. That’s all really interesting. I think we could spend a long time talking about China, Pakistan, Afghanistan, India, Russia, kind of where all those countries come together, Central Asia. But I want to end on this.

 

We’ve seen, a lot really changed with US standing in the world over the past couple of weeks over Afghanistan. We’ve seen a lot change in the US China relationship over the past year with the new administration. And so let’s talk for a minute about the overall US China relationship. What’s your thought there? Are they getting along? Is there a constructive dialogue? How do issues like Taiwan fit within that discussion? Can you just help me think about some of your thoughts there?

 

CB: So I was talking to someone, and I think they put succinctly the way that I would characterize the Biden administration’s record on China. You can’t criticize them for what they’ve done on China because they really haven’t done anything at all. Okay. Other than adding a couple of names to the Sanctiosn books, there really has not anything taken place.

 

They promised that they were going to get out their China strategy plan in June. Then there were rumblings that might happen in July, where now at almost rapidly approaching September 1. And now there’s not even talk of when it might be released. So really, nothing has been happened except for the Alaska meeting, which apparently went over like a lead balloon.

 

Everything right now just seems to be a stalemate. And the Biden administration is worrying, and that China is still moving forward, and the Biden administration is basically doing nothing.

 

The most telling point to me about the by administration approach, and I think this is something I think you should fault in. In fairness, Trump for is look, we can talk about values and do the right thing and all this kind of good stuff. But the United States, at some point has to actually put resources into this effort.

 

And the Trump administration, other than political capital with allies or other countries, never put any real hard resources or assets into these issues. And the point I would make is the Biden administration has made a point of spending literally trillions of dollars. And to the best of my knowledge, there has been almost zero spending passed that has really anything to do with China. Okay.

 

We cannot continue to talk to countries like Vietnam, Malaysia, South Korea, Japan. You cannot talk about the threat China poses and never spend any money on the issue.

 

TN: Sure.

 

CB: Okay. And look, this doesn’t have to mean we go out and increase military spending by 20%. This could simply mean we’re going to go into Vietnam and say, we want to have a development program and, you know, help solve issues. This can mean capitalizing the Development Finance Corporation to help countries like India and Malaysia and say, look, there is a real opportunity that does not involve the Belt and Road, where there’s going to be green standards or these non-corrupt standards and things like this to make sure that this money is really helping your country. You know, and it was probably something that was negotiated could be all the way back to the Obama administration.

 

There was some type of military center opened in, I believe, Jakarta with the Indonesian government that was supposed to have other governments. It’s a small center. Even those types of things. There’s simply not the resources being dedicated. And I think that’s indicative of where this ranks within the Biden administration priorities.

 

TN: I’ll be honest, Chris, it sounds like a mess. It sounds pretty bleak to me.

 

So great. I really appreciate this. I think if anybody knows has an idea of what China is thinking, I think you’re the guy. And I really, really appreciate your time.

 

Everyone watching. Please please subscribe to our YouTube channel. The more we have, the more we can bring to you as a part of our videos. And, Chris, thank you so much. And thanks to everyone. We’ll see you on the next interview. Thanks.

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