Federal Reserve Chair Jerome Powell’s perceived dovish stance is critiqued for potentially leading to increased inflation and discontent among voters.
Market reactions to the Federal Reserve meeting were positive, resulting in a broad rally across various asset classes.
Concerns are expressed about the impact of new legislation in Hong Kong, particularly on foreign investors and the perceived shift towards authoritarianism.
The potential implications of stricter laws on data privacy and state secrets in Hong Kong are discussed, raising concerns about its impact on the region’s business environment.
Transcript
Peter Lewis
Tony, what are your thoughts? I mean, it’s interesting, isn’t it, because he’s raised the inflation forecast. He’s raised his growth forecast quite considerably, but no change to the number of rate cuts this year, although we did get one taken off for next year, didn’t we? There was going to be four next year. Now they’re only talking about three year. So I suppose one of the rate cuts has come out for next year. But what are your thoughts?
Tony Nash
I think it’s silly, Peter. We can’t be raising our economic expectations, seeing wages rise, seeing prices rise, raising our inflation expectations and saying, oh, yeah, we’re going to make money easier. Right. And he even said during the meeting that they were going to slow the pace of the offtake from the fed balance sheet. They’re cultivating an environment for pretty easy money where demand seems to be right now. And that’s how markets took it. Markets took it after the meeting and they just ran with it because he came across as very dovish. In fact, Powell has a way of coming across either way too hawkish or way too dovish. And then other Fed speakers have to course correct in the following days. So I think he probably came off way too dovish. And I think we’re going to see fed speakers over the next week. Correct. More on the hawkish side to say, whoa, that’s not really what we meant. And I really think that that’s what’s going to happen is they’ll make the three interest rate cuts seem more questionable than they are. Although the vote was unanimous, we did see a slightly more hawkish trend in the dots.
Tony Nash
Not a lot, but slightly more hawkish.
Peter Lewis
And what was also interesting was out of the 19 FOMC members, nine of them, so a minority, but a substantial minority, actually think the Fed is going to cut less than three times this year. So I think that’s maybe Jerome Powell is sort of out on a bit of a limb there, isn’t he?
Tony Nash
Yeah, I think you’re right. I do think that he does over calibrate either hawkish or dovish, depending on the direction, and I think he’s trying to signal the direction, but I think he always overdoes it just a little bit. He doesn’t have an easy job. Everyone reads everything into the way he holds his papers, the way he clears his throat or whatever. Right. I mean, everything is overly analyzed with him. But again, we have seen this where he comes out and he’s overly one way or the other. And I think, yeah, seeing those nine voters say hey, we’re not going to have three this year. I think as we’ve been talking about, my team has been talking about a resurgence in inflation for over a year, and we’ve seen it over the past couple of months, and we’re going to see that accelerate. They try to present Jan, Feb as just an aberration, but it’s not. And so it’s going to accelerate. Their expectations are going to be probably even exceeded. And it’s very difficult to have an interest rate cutting environment when you have inflation rising because it’s an election year.
Tony Nash
And consumers love, and voters love to complain justifiably about prices and prices keep rising. What did we see after the Fed meeting? We saw commodity prices soar. A lot of commodity prices soared after the Fed meeting, and that’s going to hit consumers within two. You know, this very unnecessarily dovish talk out of Powell has resulted in inflation definitely being locked in for at least two months.
Peter Lewis
Tony, I’m wondering what you think about this. Is the Fed taking a risk here? Because they basically seem to be saying the economy can run faster without generating significant overheating pressures and they’re willing to cut even while they’re still away from their target.
Tony Nash
Well, this is very similar to like a 2020 2021 argument when things were actually doing okay in the middle of COVID at least in the US, and people kept saying, hey, let it run hot. Let it run hot. Right. And it seems like we’re replaying that again, where, although people may not be using those words, the subtext is let it run hot. And I think the problem is, as Andrew was talking about GDP, the quality of that GDP is not great. It’s overwhelmingly government spending in terms of the growth areas. Okay, so we’re not having private sector growth as a contribution of GDP in the US. We’re having government spending as a growth area in GDP. And so what we’re seeing is heavy fiscal and we’re seeing dovish monetary. And so that’s great, but it just means that we’re going to see more inflation. Inflation is going to come back. Well, it already has, but it’s going to continue to accelerate. If this is the world that policymakers are comfortable with and if this is the world that policymakers are comfortable with, it makes us voters very unhappy because their pay rises are not keeping up with inflation.
Tony Nash
Now, what’s interesting, public sector pay rises are something like twice the size of private sector pay rises. So public sector wages are keeping up with inflation, but private sector wages aren’t and so this is the problem with an election year. American voters are really tired of it and inflation comes up in almost every discussion I have.
Peter Lewis
And I wonder what American voters also think about what he said about labor supply. He sort of mentioned the strength of the data on labor supply, but then he pointed to the strong pace of immigration as helping on that front. That’s rather a hot political topic to.
Tony Nash
It’s a lightning rod, and it’s not a very positive discussion in most parts of the US, even in very heavily democratic parts of the US, which favor inflation in state Massachusetts, New York, it is just a sour topic for people and it’s a very sensitive topic. So when the Fed chair gets up and says immigration is helping the labor market, it makes Americans very uncomfortable and it makes them not really like him.
Peter Lewis
Tony, what do you make of the market reaction to this? Jerome Powell didn’t talk down the rally at all, did he? In his press conference in either stocks or risk assets. He didn’t even acknowledge that this is easing financial conditions and maybe making their job a bit harder.
Tony Nash
He did not. And I think he turned it from a tech rally to an everything rally. If you look across markets at the close in the US today, and as you mentioned at the top of the program with Hong Kong was coming on strong this morning, international markets coming on strong this morning. I think with this, I think overly dovish Fed meeting, he turned the rally from a tech rally to an everything rally.
Peter Lewis
Do you think this is going to continue?
Tony Nash
It’s possible. I think we have to see how things go into the end of the week. If things stay strong into the end of the week, then look out. But I think if we start to see things stall out Thursday and Friday in the US, then we could see things settle back to the levels we had seen a few days ago.
Peter Lewis
Tony, if you look at the reaction of the yen to this, clearly the currency traders don’t think that this is the start of a sustained period of rate increases in Japan. And there’s still going to be that wide yield differential between US rates and Japanese rates.
Tony Nash
Yeah, it wasn’t a big statement. ET seems to be very conservative. He doesn’t want to be seen as shaking things up at the BOJ. He almost acts like a caretaker. And so I think currency traders expected something a little bit more. They want a little bit more in the end, want a little bit more. In terms of markets being slightly tighter, he’s not a big bold move maker and this just wasn’t it. So to see the end continue to weaken on this was just really interesting for me to watch this.
Peter Lewis
Okay. Okay, Tony, what are your thoughts? You’re obviously looking at this from overseas. As Andrew says, it’s no surprise it passed, and it passed with unanimous vote in ledge coat. But now that it has passed, and foreign investors are going to have a chance to scrutinize it and see the impact of it, is there anything to worry them?
Tony Nash
Oh, sure there is. I think the law allows trials without a jury. It allows trials behind closed doors. It allows handpicked judges. So anybody forming a company, anybody who’s a board member, anybody who’s an officer in a company, in a jurisdiction like Hong Kong, you have to worry. Why don’t you have a lot of international companies centered in Beijing because of laws like this, right? So Hong Kong, which 1020 years ago, 30 years ago, was the place to have a company because it was the most business friendly city in the world. Today it’s not that way. And if you’re an officer or director in a company, it’s got to be a little know, give you second. You know, one of the attractors for Hong Kong for a few decades has been media. There is great media in Hong Kong, but it’s no longer a media center, it’s no longer an arts center. And the sad part about that is a lot of that stuff is moving, or has moved to Singapore, which is a pretty strong state in terms of control of messages. So people are so worried about the impact of this new law on Hong Kong that they’re moving to Singapore and seeing it as a freer place than Hong Kong, completely 180 degrees from the way things were ten years ago?
Peter Lewis
John Lee and the government will say, what this Article 23 legislation does is it brings stability to Hong Kong. So will foreign investors look at that and say, yes, Hong Kong is more stable as a result of that, and that’s a positive.
Tony Nash
No, it brings opacity and it brings authoritarianism, in truth. And authoritarianism generally is stable until it. And so, you know, Singapore is an authoritarian place and it’s stable. It’s marginally freer than Hong Kong now, I guess. But no, authoritarianism doesn’t bring stability necessarily, or the stability it does bring is short lived. And again, Hong Kong was very vibrant, very creative, very interesting business hub. And I don’t think it’s totally gone, but I think the risks to officers, investors, board members and so on are much, much higher than they were before.
Peter Lewis
Tony, you are a financial analyst. If you were based in Hong Kong, would you be worried about this state secrets legislation or this state street secrets article that includes economic information, technological information on Hong Kong?
Tony Nash
Yeah, absolutely. So I used to be with a company called IHS, and it’s since been bought by S and P. But twelve or 15 years ago, there was an IHS analyst who lived in China who had some information on crude output or something like that, crude storage. And this person, from what I understand, got it from an industry association or something because they used it in a business environment. The chinese authorities prosecuted him and put him in jail for a long, long time. And at the time, I was working with the economist, but we were shocked at what was happening, because you used to be able to do research, find information, and if you could find information, you could use it to your advantage. And part of using things to your advantage is to trade on it. Right. And so if Hong Kong is to remain a vibrant financial center and a vibrant trading hub, you have to be able to dig for information. But if the Chinese authorities are going to prosecute people for finding information, then Hong Kong as a competitive center is no more. It just isn’t.
Peter Lewis
I mean, that’s what some people are worried about is that Hong Kong is becoming more like mainland China in terms of things like data privacy, state secrets, and what constitutes state secrets?
Tony Nash
Well, there are huge data centers in Hong Kong, right? I mean, there have been for 30 years. And so those data centers, I don’t know, a lot of foreign companies that people have their servers outside of China for a reason, and they have their data stored outside of China for a reason. These new laws allow the government to look into whatever they. So, you know, that stuff that has remained in Hong Kong, I’m sure at some point will move elsewhere if it’s remotely confidential.
Peter Lewis
Okay, well, thank you very much for your thoughts this morning. Great to hear you. That’s Tony Nash over in Texas, USA, who is the founder of Complete Intelligence.
This “Futures Edge Ep 55 : The AI Episode with Tony Nash” video discussion is originally published on https://youtu.be/ugFUvz_DYEY
Transcript
Jim
Welcome to the Future Edge podcast. I’m Jim Iuorio, always the assistant to nobody, executive producer, brains behind the operation, and co-host Bob. Today we have our friend, Tony Nash, the founder of the AI firm Complete Intelligence, who also has a kick-ass podcast called The Week Ahead, on which I was fortunate enough to be a guest and really enjoyed the conversation. You generally host it with Tracy and Albert, correct?
Tony
Yeah, quite a lot. We do it with Tracy and Albert about two-thirds of the time. Thank you for that, by the way. I really appreciate it, Jim.
Jim
Oh, no, I loved it. First of all, let’s get the nonsense out of the way. What’s your favorite drink?
Tony
Oh, coffee.
Jim
No, you don’t drink?
Bob
Not what he meant.
Tony
No, coffee. Coffee is it. I write about coffee, post about coffee, and coffee is my favorite drink.
Bob
Well, you are a fucking nerd dude, by the way.
Jim
Coffee. I think if I had to quit either coffee or booze, I think booze would be harder, but I think coffee would be damn close. I think coffee is something that I rely on.
Bob
Coffee would be much harder for me.
Jim
Yeah. How many cups of coffee do you drink a day, Tony?
Tony
Only four.
Jim
Okay, I drink about four cups a day too. I was about to ask you what your favorite show that you have watched recently was. Have you guys seen the show Shrinking with Harrison Ford and Jason Siegel?
Tony
No.
Jim
That’s your assignment for the week. It’s pretty damn funny. Harrison Ford in a comedic role was really interesting, and he killed it, I thought.
Bob
Can I throw something out here before Tony tells us his favorite show? Is it a cliche that I love Sylvester Stallone and Tulsa King? Is that a cliche?
Jim
Yeah, it’s a dago cliche.
Bob
I’m stereotyping myself, right? Is that what I’m doing?
Jim
No doubt about it.
Bob
The mobster now in Tulsa, Oklahoma. I’m down here in Southwest Florida, pretty.
Jim
Tony, before you answer the question, speaking of mobsters, you should read the Bill O’Reilly book, Killing the Mob, particularly if you’re from Chicago. It was amazing. Did you read it, Tony?
Tony
No, I did not. But it sounds great. We should read it.
Bob
Shut up and let him answer questions.
Tony
Staying on The Mob, the best show that I’ve seen over the past year. It was on Paramount Plus, and it’s about the making of The Godfather. I can’t remember the…
Bob
Offer. It’s called The Offer.
Tony
The Offer. Yeah. It was fantastic. Really?
Jim
I want to watch that. Particularly because they talk in Bill O’Reilly’s book, they talk a lot about Sidney Korsak, who was basically the biggest guy in the Mob. He was in LA and he was the Mob accountant for all the outfits. So he was the fixer, they call them. And he’s the one who hired David Evans, who made the Godfather. Right. The Mafia hated it at first, and then they loved it after it was made, which is so funny, and started adopting some of the traditions that were brought back from the movie The Godfather.
Tony
They talked through some of that in this movie about how they negotiated with the mob to allow the movie to be made. It was really well done, actually, if…
Bob
You guys want to read something good called Family Secrets. Okay, Jimmy, since you’re a restaurateur and you’re both very familiar with the Chicagoland area, you will recognize 90% of the restaurants and places that they mentioned in that book because it’s all about the Chicago outfit and the Calabrese brothers and the Kid and all that. It’s fantastic.
Jim
What was the name of the mob joint in Norwich or Norwood Park? It was an Italian restaurant that was all like my buddy who worked for the state’s attorney, they had files on these mob guys and they had like, hangouts and there was all it was the same restaurant. I used to go there occasionally. You guys don’t remember the name of it?
Bob
Talking about Capri or Sicily Restaurant?
Jim
Neither of those sound familiar. If you said it, I’d know it. But it was so funny because now there’s a place in Arlington Heights now which I think is a bunch of mob wannabes. It’s like a bunch of 80-year-olds, maybe they were back in time. But it’s a pretty funny place called Palm Court. We go there, and they have like a guy singing Lou Rawls and Dean Martin and a bunch of old Dagos dancing. It’s fantastic. Okay, let’s get to Tony. By the way, remember Tony’s here we have his brain, his knowledge, and we could talk about mob stuff the whole time. So we had a series of numbers over the last week that are beginning to suggest some level of stagflation. My opinion is that until strength in the labor market is obviously not part of stagflation, is it too early to start worrying about it? Tony, what are your thoughts?
Tony
I think it is. I think you saw some really strong quarterly reports this past week. I think banking is not as bad as people had feared. There’s some strength in tech. You see some of the services company restaurants and even some of the consumer goods companies that are still reporting price hikes. So the price hikes would be inflation. But there is a very small slowdown in their volume, right? And so they’re still growing the top line. And so it’s not as if people can’t buy because they can’t afford it. You’re also seeing service wages, especially in the middle of the country, still be very strong. And so people in the middle of the country are making more money and they’re spending it, right?
And what’s also happening is you saw, I think, eight or 9% rise in Social Security earlier this year. And so you have a bunch of old people, they’re not saving the money, right? They got a 9% pay rise and they’re going out and spending it. So we do have more money coming in. I don’t necessarily see that we’re kind of entering a recession. I do think that we’re going to have a slower Q Two and a slower Q Three. Our forecast indicate that we’ll see kind of a 0.2.3 growth rate in those quarters, and then we’ll take back up in Q Four. So we have a lot of economists talk about, well, we’re going to have a recession in the back half. I don’t think it’s the back half. I think it’s the middle part of the year that we should really worry about. And when we get to the last quarter, I think we’re going to be in much better shape. Okay.
Jim
Now, the stock market seems to be relatively buoyant. I point to the fact $7 trillion was injected into the economy over a relatively short amount of time. But there’s something to me that looks kind of ominous. If you look at the Russell compared to the Nasdaq, or let’s just say if you did equal weighted in the SP, it be down for the year. But cap weighted is up for the year, meaning the big companies, people are buying their shares. To me, it almost kind of smacks a flight to quality. Do you think that I’m reading too much into it or no, no, I.
Tony
Don’t necessarily think you’re like flight to quality right now, as people are spooked, it’s a natural thing to do, right. And you have the Fed start to dial down on or start to increase the rate of QT up until the banking scare a month ago. And so some of that money was being taken off the table and other things. So I think as that money is taken off the table, people want to move to quality because the smaller companies they’re just not sure about. But I think what we’re seeing in some of these earnings that there are some companies that are actually doing okay. People have kind of figured some of this stuff out. They’re getting more efficient with staff, especially in tech. They’re getting more efficient with staff, and they’re really learning how to pass their costs on to their customers.
Bob
Bobby Gany yeah, so I want to push back a little bit on the stack inflation thing, which you might have guessed. Tony Tweeted today, jimmy, we tagged you in. I don’t know if you got a chance to see it, but Tony said with the strong earnings, are we still talking about stagflation? And I jumped in with a yup, and I said, okay, let’s talk about that. And then, Jimmy, I actually have a question for you because one of our members on the Path Trading partners, YouTube, asked a question and asked me to ask you. So when you give me an opportunity to do that, I will. So I maintain that stagflation is the worst possible economic situation. Some people, like Charles Payne from Fox News thinks deflation is worse than stagflation. I can understand that argument. It’s it’s kind of tougher to get out of. The stagflation argument to me, sort of plays out like this. We had GDP go from 2.6% to 1.1%. So there is a slowing economy, still growth, actually still respectable versus the last 20 years. Right, guys? But versus the last 20 years, I wouldn’t call it generally respectable. And then you had both PCE numbers surprised to the upside in some forms.
Now, I would argue, and Jimmy’s been correct about this, the supply chain part of the inflation has virtually gone away, but the wage part is still biting. And that’s where we saw in the ECI numbers, the employment cost index numbers, also surprised to the upside. So my fear is this. And one of the things I said to our members is, you guys stop spending because the economy is slowing down. I really don’t want stagflation to happen. Okay? Quit our service. Do whatever you have to do. Just stop spending.
Jim
Right?
Bob
Well, some of the things like wage salesman I know, I’m awful. I am awful at this shit. Anyway, some of the things in terms of the wage growth and the increased Social Security stuff, to me smack a little bit inflationary. And it bothers me because when you look at the labor numbers, which is what a lot of economists and analysts and guys we had on the show point to as a strong part of the economy, every Fed hike cycle has ended in a recession except 1994. And every single time after the recession started, the unemployment rate rose by a lot and fast. But it was after the recession started. So my fear is that I think where we get lost in the argument is are we in a recession now? No. Are we going into one?
Jim
I think yes.
Bob
So where am I crazy?
Tony
Well, I don’t think you’re necessarily crazy. I think there is not 0% chance of a recession. There is not 0% chance of stagulation. So everything I say is just kind of and we all have recency bias whenever we analyze generally. Right. I think what Jim said is we had $7 trillion or $8 trillion pushed into markets very quickly. Right, okay.
Tony
And so that’s the sugar high that we saw, particularly in 21. Right. And we kind of weaned off it a little bit in 22. And right now we’re facing those hard trade-offs. Right.
But with that much money pushed into the market and the supply chain constraints we saw from COVID we saw goods inflation just a rocket ship. Right, right.
And then what happened? People couldn’t necessarily buy all the stuff they wanted to buy, so they demanded higher wages. So there’s a delay between goods inflation and wage inflation. Right.
And so now that goods inflation has generally subsided, wage inflation, there’s going to be a lag because we saw Walmart give that big raise to all their staff in January and then that kind of cascaded to everyone else. And we saw Social Security and all these different wage rises come around. It’s going to take a while for that to cascade through. And then will we completely normalize? It depends on how we normalize is normalizing back to 2019 levels? Unfortunately, I don’t think we’re going to do that right now without serious economic damage. So I think all we’re looking for is some sort of balance point where we have this kind of sugar in the economy that has kind of diffused through the economy. Right.
It’s had all of its effects on the cost of goods and wages. And now that it’s diffused through the economy, we have to start figuring how to normalize how do we take it out? Right.
And we have to be really careful about that with higher wages. So will wages get high to a point where people start coming into the economy, people who haven’t been in the economy for a while? Right.
Because in 2020 we saw a lot of people check out of the economy, but we also have baby boomers who are retiring at an accelerating rate. So we may have a point where we have people who are out for either voluntary reasons or maybe they’re not necessarily don’t necessarily have the best skills or something like that. We may see people come back into the economy that might put wage downward pressure on wages, but I think it’s going to be maybe a year before we start to see that we’ve really got to see wages continue to rise.
Bob
I think you definitely make a compelling case that this could be different, that there could be a soft landing built in the year. I hadn’t thought of it from a perspective, even though Jimmy has said it over and over again, but I tune them out. I hadn’t thought of it from a perspective of, okay, so the sugar high is out now and there’s actually time to normalize the rate rises with the price rises where it can actually come down. And by the way, to your point, Tony, people who say there’s never been a soft landing are wrong. I mean, 1994, the Fed did engineer, quote, unquote, a soft landing.
Tony
It did happen, yeah. But I think it’s going to be a hard landing for some people. For those people who’ve been laid off from tech companies or whatever. Right. It’s already been a hard landing for them. Right. And so it just depends on how broad that hard landing is. Right.
And so can those guys get other jobs? Maybe. Is it going to be 300 grand a year checking in for 2 hours a day? Probably not. But will they be able to get other jobs that’ll soften their landing? So it depends on how broad that landing is.
I remember in the early 90s there was a recession that nobody else talks about anymore. Okay, my parents were both laid off from their job. Actually, they weren’t laid off from their job. They were at a company, they both worked for the same company, where every three months, they had to reinterview for their same job. Okay.
And so they had kind of this rolling rehiring within the company. It was terrifying for them, right, that you couldn’t make long-term plans. But at that point, in that recession, employment in places like New Jersey was 18%. Okay, so again, we talk about the 2000 recession, we talk about 2008, but 1991 was really bad, and they had to reinterview every three months, and that lasted, I think, two years or something like that.
That’s not there right now. Like, everyone is kind of complaining about having to end work from home or whatever, and complaining about not getting whatever kind of benefits with their job, rather than just having a job, period, right. So we still have so much workforce demand, so much lack of supply, that I don’t think we’re anywhere near how difficult things were in 1991. And until we get there, I really don’t think we see a really hard landing. And again, it’s a relative kind of perception. The smallest hiccup will be portrayed in media as a hard landing because somebody’s having a hard day, and it sucks. It sucks for them. And I’m really sorry that people have to go through this, but it’s all relative, and we really haven’t seen a hard landing for at least a decade. I mean, 2009 would be the last time.
Jim
So tell me this, Tony, because you look at and I like what you’re saying here. I’m not convinced of soft landing yet, but I like the word you’re saying. The money supply, m two money supply, there’s been four times in history, independent, this one, that the m two money supply contracted by more than 2%. Three of those times were a depression. 18, 70, 19, 20, 19, 29. The fourth time, I think it was a panic of some sort in like the 1890s. Right now, our m two money supply has come down two and a half percent, more than two and a half percent. Why is it different than them? Actually, I have an answer. I’m curious what your answer is, because I have an answer, too, that it is different. Why do you think it’s different?
Tony
I think it’s different because a lot of that was one-time government spending. And so people understood that PPP was one time. People understood a lot of these payouts were kind of one-time payouts. And so it’s like, okay, let’s back up the truck, take the handout. We took PPE in my company, and I’m not embarrassed about it at all, because not even more, we took the PPP, and we knew that it was one time. Right.
And so you take it, you survive, and then you live to continue the business or continue a household or whatever. So I think people are mentally prepared for the fact that this cut government spending was a one-time deal. Right.
Jim
That’s my opinion as well, by the way, too. I thought the fact that we inject the 7 trillion, 8 trillion, whatever we’re talking about here, to expect a little bit of a mean reversion, I think is relatively reasonable. So I do genuinely believe it’s different this time and again. I’m not saying I think it’s soft landing because I do think there’s a bifurcation in the economic condition. I think there was a big wealth transfer of that money we were talking about. A lot of it went to the higher end. I think people are struggling on the lower end. Tyson Foods just announced a 10% reduction of workforce. So this is different now than tech companies that were bloated and hired a shit ton of people over two years. Tyson Foods didn’t hire people. So I like what you’re saying about the soft landing. You can justify those things and still see those layoffs coming and think it’s going to be okay.
Tony
Yeah, I think, well, here’s where it’s going to be different, okay? It’s going to be different over the next two years with white-collar jobs. Okay?
And this is where kind of you roll your eyes and go, okay, he’s going to start talking about AI. But I think we will really start to see a reduction of white-collar jobs because of technology. It’s not going to happen immediately. It started a little bit, but I think we don’t really start to get traction on there for probably two years. Okay, so when we see Tyson Foods cut jobs, that’s different. Maybe part of that is automation, part of that is demand induced, but we’ll really start to see your finance people, your accounting people, your marketing people, people who say make really good money are educated, but let’s say they live their whole day or a good portion of their day in Excel. Anything that any of us do in Excel can be automated. Anything. And so these jobs where people went to school, say in the 90s or 2000s and got an MBA, got a corporate job, all that stuff, what we’re going to start seeing in two, three years time is initially there will be an augmentation of their jobs using AI, ML, whatever you want to call it. Over time, what management and boards will realize is that a lot of the time that these white-collar professionals are spending is on relatively mundane tasks, okay? And so they can’t necessarily be outsourced somewhere because it’s sensitive information. But they’re repeatable mundane tasks and ask anybody who’s white collar if they’re really honest with you, they’ll tell you a good portion of their job is kind of routine, boring stuff, right? Not just in meetings on the phone. It’s kind of reports they have to make or data they have to analyze or things that have to be written or whatever, right? And so we’ll start to see some of those structural adjustments in white-collar jobs in a couple of years’ time. That’s when we’ll hear a lot of screaming and a lot of pain from that class of worker that we haven’t really heard from in a couple of decades at least. Right.
But going back to kind of the softish landing, of course, there will be turbulence. Right.
But I think it’s possible that as long as that supercore inflation is persistent, the Fed doesn’t really have a choice. They have to continue pulling back because that supercore inflation is hitting everybody because these are services jobs, right? So everyone is hit by services jobs inflation. People who go to Walmart to shop, people who go to McDonald’s. McDonald’s pushed their price by almost 9%, I think, over the last quarter or last year. I mean, everyone’s hit by this stuff, and it’s largely on job costs and wages. Everyone is hit. And so the Fed has to move on it. So we’ll see more investment in productivity. We’ll see more focus on productivity because people just can’t continue to be pushed on price. We’re not there yet, but people just can’t continue to be pushed on price. It’s just unaffordable at some point.
Jim
Okay, you’ve mentioned AI before, too, and I like a lot of things you’re saying. Another that one company, that MCD company, I’m not allowed to talk about it. My daughter may or may not be an exec at that company, but whatever. Let’s not talk about that. Anyway, so how far are we from AI, where we could have seamlessly had one of us on this call be AI-generated and people won’t know? Are we years away from that, or no?
Tony
Oh, no, I don’t think we’re far from that. Let me give you a very tangible example of what we do. And for your watch. I don’t intend this to be a sales pitch, but this just can help you understand what’s possible. Okay?
So we do really boring stuff at Complete Intelligence. We’re an AI company. And so what we do is we help companies to augment and automate their budgeting process and their forecasting process. Okay?
So we have a customer. Their annual revenue is about $12 billion. They have, on an annual basis, about 400 people working on their annual budget. Okay?
It takes them three months, so that takes them three months to do. It cost them maybe six million dollars, five to six million dollars to go through that process. Okay?
When we worked with that company, the first time we did their budget, it took us 48 hours. We were 0.3% off of what those 400 people took three months to do. Okay?
Now, a year later, we circled back with the finance executive who we worked with, and he said, you guys absolutely nailed our budget number. At the beginning of the year, not only did you nail it. You did it for six layers deep within the general ledger. Okay.
The people that they have working on their budget do it three layers deep within their general ledger. Okay.
And these are relatively highly paid white-collar professionals who are doing this stuff. Okay.
There are 400 of them. I’m not saying we would replace them, but we certainly take a huge load off of their workload for three months of the year. Right.
And so can they do different activities? Can they do with fewer people, those sorts of things? Right.
And so these are the kind of things it’s not super sexy, it’s not Palantir doing CIA stuff or whatever. It’s really mundane stuff that really impacts the bottom line and headcount of a company. Right.
And so this is where I think the really interesting stuff in AI is, is ChatGPT interesting? Yeah, absolutely. I don’t have to hire an entry-level analyst anymore and have them take six months to come up to speed. Right.
I can actually go into ChatGPT and have something written up that it would take four to six months for an entry-level analyst to learn how to write. It takes me 15 minutes. Right.
So these things but just to let you know, kind of when I talk about white collar jobs and AI starting to be augmented or automated, I’m talking about the really boring stuff that, quite honestly, people really don’t like to do. Right.
And so we help those things to those roles to be much more productive, and we help those executives to get a much more accurate view on their business.
Bob
So, first of all, Tony, you’re a pretty ethical, honorable guy. I was on your podcast as well, and you couldn’t have been nicer or kinder. So I want you to tell people how they can get a hold of you. We have some pretty high net-worth listeners.
Tony
Okay.
Bob
You’re not on here to pitch your company. I want you to tell people in the middle of the podcast rather than the end where people might have kind of drifted off already since Jim and I are so freaking boring, where you can.
Jim
I’m excited as hell.
Bob
He never moves from that position in the chair. He literally sits like this.
Tony
He’s got a long day.
Bob
He’s actually AI. He’s not a real person. Tell me where they can reach you, Tony, before I ask you the question.
Tony
Sure. I’m on Twitter. @TonyNashnerd. T-O-N-Y-N-A-S-H nerd. My email tn@completeintel.com so I own the nerd thing. I’m not afraid of it. I get it. But, yeah, contact me. I’m happy to talk to any of your viewers.
Bob
Okay, so another thing, by the way, right now, being a nerd is cool, so don’t act like you’re admitting something that’s embarrassing right now.
Jim
It’s a flex. It’s not enough.
Bob
Yeah. All of a sudden it’s a flex these days where I don’t know who even made it a flex. I used to flex in front of nerds and try and scare them off.
Jim
It’s the Big bang theory.
Bob
That’s what it is. Big bang theory.
Jim
A long way in normalizing, which I think was very interesting. Yeah.
Jim
Big bang culture thing.
Bob
So here’s my question, Tony. Good. So I actually have very recently and I don’t think there’s any problem with me talking about this I used to have to call an attorney for every little thing, and it got so ungodly expensive that I started just kind of looking for templates online. And in simple agreements, I would just write my own and take my chances, because in a worst-case scenario with a client, like we do in Pat trading partners, we do like, boutique analysis for smaller firms. So I would just write simple documents and be like, what’s the worst that could happen? They don’t pay me for a month. It’s probably still less than I would add to pay a lawyer to write up this document. I recently used Chat GPT 4.0 to create an easement between myself and my neighbor so that our fences could connect. That goes into perpetuity. So number one, are certain white collar managers going to be slightly timid to hire you? Because obviously some of the mundane tasks they do make them valuable? And number two, do you think there’s a larger economic effect on white collar jobs? For example, my easement that I’m not going to be paying a lawyer for that comes with AI.
Tony
Yeah, absolutely. We see this all the time. When people realize what we can do. There’s kind of that holy crap moment where people realize, oh, my gosh, we have 400 people working on this stuff and these guys can process it in 48 hours. When people realize that, it’s impressive, but it’s kind of scary, right? When I think about how are you using a lawyer? You’re using a lawyer to manage risk, right? And so why do you call a lawyer? Because you want someone else you can call and say, hey, that guy told me that this was the right thing to do. So you’re basically outsourcing your risk to them, right, so that they can create a document for you. In what we do, when a CFO walks out of their office and they see 50 people or 100 people, those people are effectively managing risk for them, right? And so nobody really thinks of AI in terms of risk management, but actually those people are managing risk for a CFO. Okay?
And so when we do what we do, we’re automating that risk element and we’re making it much more consistent. Right.
How risky is it for you to forecast your budget for the next year? Right?
If you get it wrong and you give the street the wrong number or the wrong guidance or whatever, it can be really bad. Right.
But for everything we do and ChatGPT and other AI tools work the same way. We have a statistical basis for everything we do. So everything we do, we tell our customers our error rates for every single line item for every month. Okay?
And we actually have a publicly facing platform called CI Futures that people can subscribe to to see the S&P 500 stock forecasts. They can see equity markets, they can see currency forecasts, they can see commodity forecasts, and they can see global economics. It’s $20 a month. So really cheap, right? But we disclose our error rates on that platform so that people can understand the risk associated with what we do. Right?
And so I think we have a more educated society. You have more confidence in using GPT 4.0 because you’re confident in the underlying tech, the broad based adoption of it, and the kind of statistical, although you’re probably not too aware of it, the statistical underpinnings of it, right. Because all it’s doing is, all GPT is doing is going out and doing a bunch of, say, Google searches all at one time, looking at the incidence of a topic or a word, and then putting that together for you on an incidence basis. Right?
So you want a legal agreement for an easement, and it goes out and says, okay, legal agreement for easement. What are the words that are used in those agreements? How are they structured? And what’s the incidence of the order of that stuff? And it’s summarizing it up and it’s putting it together for you. Right?
And so that’s just a statistical analysis that is reducing your risk because it’s looking at what most people do, right? What do most of those agreements say? And so what we’re doing when we forecast, say, a supply chain cost or an expense budget or a revenue budget or something, is we’re looking at a lot of data. We do trillions of calculations to do this stuff. And we’re telling people, you know what, statistically this is likely what’s going to happen in that very deep line item within your budget in September of 2023, something like that. Right.
And so they have a higher degree of confidence in what we’re doing. It’s faster, higher degree of confidence, and it’s better. Right.
And your question about people who are nervous about it yes, they are. And you know what, I’m an investor in companies, in publicly traded companies. Do I want to know that they hire 5000 people in their finance team and it could be taken down to, I don’t know, 3500? I would want to know that. Right.
And so is there inefficiency, in these finance teams or marketing or other teams? Absolutely. Right. So that’s what this technology is doing. It’s allowing investors to look at the companies they invest in and go, hey, company A, why are you not looking at this technology to deploy in your company to actually make your workers more productive? That’s really what it’s all about.
Bob
You’re the boogeyman to a lot of middle managers, Tony. Go ahead, Jimmy.
Jim
Absolutely. Can we flip back to markets for a second? Because I do want to talk about the buoyancy in the stock market, particularly the last couple of days. I’m having a difficult time understanding it, particularly after we saw that the GDP number, which, like we said earlier, showed both slowing economy and inflation, that’s being persistent. What do you make of it? Why do you think the market is going higher?
Tony
We had nominal GDP at 7-8%. I don’t remember the exact number, but you have a nominal GDP number that is the same as it’s been for the past couple of years with all of the government stimulus. Okay. Real GDP is different, of course, because it factors in inflation. Right?
And so we have inflation at five to six or whatever. So that’s discounted to one point whatever percent it came out at. Right. You’re still growing nominally at the same rate you’ve been with all of the COVID stimulus. I think that’s part of the reason that people are looking at this economy and going, yeah, we really thought that pullback was coming. We really thought the economy was slowing. But in fact, statistically, on a nominal basis, it’s still running at the same rate. If we factor in inflation, then it pulls down, then it looks like it’s slowing. Right.
So as you deconstruct the data that come out, it’s not really bad. And if you look at that nominal run rate and you say, okay, if we could get inflation down, then that nominal rate actually looks really good. Right.
And so it’s possible I’m not saying this is probable, because it’s not in our outlook, but it’s possible that if the Fed can actually get inflation down while keeping nominal growth, maybe not at seven plus, but let’s say it’s at five plus, then we’re in amazing shape as an economy, right? Is that likely? Again, I don’t think it’s likely, but it’s possible. Again, here’s what I always say for people with economic data, okay? And if you see me on Twitter, I always say, Wait for the revision. Always wait for the revision. Because this first release that you see is really a bunch of government statisticians doing a best guess, with very little data, actually. Okay?
And so when we see retail sales, when we see CPI, when we see GDP, whatever, we see it’s government statisticians basically doing a sample of a sample of a sample and getting a quick number out to us to give us an indication of what’s actually happening in markets. But there’s three or four revisions to a bunch of these numbers, so we won’t know for two years what the GDP number really was.
Jim
That’s a good takeaway, by the way, from the show, because I think that’s interesting and something I don’t think about quite enough.
Tony
Nobody does.
Jim
Yeah, nobody does. Right. When you look at how gold, bitcoin, silver have performed so well over the last few months. Put a fine point on that. How do you explain it?
Tony
I think it’s just a function of the dollar coming down. I think it’s kind of the reverse of that. I think it’s people pushing a recession narrative and wanting to kind of look for a safe asset. And so that’s really, I think, all it is. I don’t hate gold. I don’t love gold. I’ve been in and out of gold over the past year or so. Not on a regular basis, but I’m not in it now. But I think it’s useful when it’s useful, but it’s not something that I’m looking at. I did have a crypto investment a couple of years ago. I was in doge for like, six weeks, and I got in at got out at $0.76. So I did okay on that. But it’s a bigger suckers market in crypto, I believe. It’s not money. It’s an asset. Okay?
Crypto is an asset. It’s not money. And so I saw it as an opportunistic asset. I got in and out. I didn’t make a huge amount of money. I just wanted to see what could happen. Did a lot better than I thought it would do. And I’m just not a huge crypto fan because I just don’t see where it’s going, especially when we’re talking about central bank digital currencies and other things. It’s just what are you going to do? If every investor in the US. Can’t fight the fed in their trading every day, then how is a cryptocurrency going to fight the fed with a central bank digital currency?
Jim
Bobby, do you agree with that? Do you think that there’s no use case scenario for crypto going forward?
Bob
What bothers me about crypto, I don’t think there’s no use case, but I agree when Tony says it’s not money. I think it could become money, but to me it’s very strange because nothing is technically money unless we get rid of income taxes, because the only thing that gives the fiat currency value is that it’s an acceptable form of payment for your taxes. Otherwise nobody would trade that paper. Why would anybody hold just pieces of paper that’s backed by nothing? Which is and Jimmy and I, you and I have talked about this both privately. And last week I did a WGN radio show where the guy said to me, bitcoin is favored by drug dealers. And I said to him, I was in studio down on Michigan avenue, and he said, favored by drug dealers? I said, pull out whatever you got in your pocket. He pulled out a bunch of cash. I go, so is that and so is that not backed by anything except that you can pay your taxes with it. You can’t pay your taxes with bitcoin. But I’ve had private arguments with people. I wish I could remember this woman’s name.
I watched this young woman who’s a Bitcoin fan, and she was arguing with Peter Schiff, right? And she said, Bitcoin is money. And he said, no, it’s not. And she said, yes, it is. No, it’s not. And she says, yes, it is. Because I pay people Bitcoin and they pay me in Bitcoin. And I said, okay, that’s fine, fair enough. But I just gave a 15 year old kid a pair of Jordans I don’t wear anymore to come and cut up a bunch of boxes for me and put them into my recycle bin. That doesn’t make Michael Jordan’s shoes money, just that he was willing to accept it to do the work. Right.
What makes it money is the ability for everyone. Or I shouldn’t say the ability the willingness for, let’s just call it the majority of the population to accept it in a transaction. We’re nowhere near that.
Tony
Yeah. I want to be clear. I don’t hate crypto. I don’t think it’s bad or anything. I’m not making a moral judgment call on it.
Bob
I didn’t take it that way, Tony.
Tony
And if people want to invest in it, I really don’t care. But it’s changing the topic just a little bit. I’ll make an analogy. It’s like Argentina using the CNY for trade settlement, right? All they’re going to do is two currency transactions when they pay in CNY, okay? Because everything in trade is either in dollars or euros, everything in international markets. So they may pay in CNY, but really they’re going to be checking what the dollar value of that trade transaction is, right? You can say the same thing for crypto. Does your brain work in I’m going to go buy a banana in crypto? No, you think of it in dollars, right. Or euros or whatever, right? And so, sure, you may transact in crypto, but it’s just circumvention of the dollar system because that’s what the ultimate nomination of that value is, right? And so until we start thinking about things valued in crypto, right, until I can go to the gas station and they say, oh, this is however many Bitcoin or whatever, I have no idea what their numbering scheme is. I just don’t see it as currency. I spent most of my life in Asia.
I worked with a lot of currencies like Sri Lankan Rupee and Vietnam dong and all that kind of stuff. Those are currencies. They’re nationally traded. They’re traded every day, all that stuff. So you don’t have to be the US dollar or the Euro or CNY to be a currency. There are minor currencies all around the world.
Jim
So why don’t we outline something real quick? Because I got a question to you about the de dollarization, but I want it to be known that I can hear the name of the Vietnam currency now and not snicker and laugh. This is growth.
Tony
Congratulations.
Jim
Okay, very good. So the de dollarization thing, I did think that it was a big mistake what the Russia freezing assets kind of weaponizing the financial system. I still am of the camp that I’m not particularly concerned of any sort of global de dollarization thing. I mean, the reserves are still there just does not seem to be a suitable substitution. Are you on the same camp or.
Tony
Are you concerned China still pegs the CNY to the dollar? Every day. They announce every day what their USD CNY conversion rate is. Every day. Okay, so does that tell you that there’s de dollarization? Whenever people talk about CNY, I would say you do realize that the PBOC literally uses numerology to decide their interest rate. They literally use numerology.
Jim
Okay, what does that mean?
Tony
It means it has to be a pleasing number that ends in an eight. Okay.
I’m not kidding. It’s not the only factor, but it is one of their considerations. And so you can’t have a central bank that is setting their rates, whether it’s a repo rate or an interest rate or whatever, using numerology. I mean, that’s just not credible. And if people would look into the inner workings of the PBOC, they would understand that CNY is just not a credible international currency. Regardless of what Xi Jinping wants you to believe, and regardless of what all of the kind of anti dollar people want you to believe, it’s just not practical. The other part is this Belt and Road initiative, which is kind of more of a joke than a reality. It’s all nominated in dollars. It’s all nominated in dollars. A Chinese national program now, okay, so the part outside of China I’ll say is all nominated in dollars. So if there really was a de dollarization underway, why would the Chinese government be funding trillions of dollars of infrastructure in US. Dollars and not in CNY. Those loan agreements, those equity agreements, they’re all in USD.
Jim
By the way, I agree with you 100%. I am not particularly concerned about de dollarization, but I will going to push back for a tiny bit on something. Six, seven years ago, I would have said the notion of a dollar collapsing was a .1 percentage. And I think that’s changed and I think now it’s a 1% possibility, which I think is ridiculous for us to be making these moves. Poor stewardship of the currency, what we did in Russia, it’s at least something to be concerned about. Or you have no concern over it.
Tony
What’s the alternative? Like we’re all going to trust in the ECB? I’m sorry, it’s not the currency we want, but it’s the currency we have. Right? Right.
So if you look at the Fed’s behavior, the central bank itself matters a lot. It matters more than the currency itself. Okay?
And so if you look at the Fed’s behavior, they have meetings, they have notes, they respond to media and so on and so forth. Are they as transparent as we want them to be? No. Do they do the things we want them to do? No. Do they have a bunch of bureaucrats working with them? Yes, but when you look at other central banks on a relative basis, it’s actually better. Right, right. Sorry. Go ahead.
Jim
I tweeted something about a week ago, and I said, we don’t have to have a good currency. We can even have a shitty currency. We just have to have the best currency. Right? That’s what you’re saying, right?
Tony
Right.
Bob
It’s that best house on a bad block thing.
Tony
And I don’t say this to be dismissive at all. I take the dollar as the kind of US holder of value very seriously, but I’m just not sure what that other vehicle would be. Look at the structure of the European economy. It can’t be the euro. Right?
Look at the UK and some of the policy decisions they’ve made. It can’t be the pound. Look at China. I was talking with Michael Ncolettos about a month ago, and he was saying M two in China, the amount of M two issued in China is something like three times the value of their GDP. Okay?
Now, M two in the US is something like 90% of the value of GDP. Right?
So China has three to four times the amount of money in circulation compared to GDP when we make it relative to the US. Right.
So how can that be seen as a credible currency? They just are not managing the number of fund tickets that’s in their economy. Right.
And then again, when you look at Japan, look at their central bank policies, look at their demographic structure, the Japanese yen is just not a credible currency. So I just want to understand, first of all, what is a real currency that we can use? Not crypto, which is an asset. Okay.
And what is a central bank that we can trust, that has sufficient money in circulation, that is usable? And I think I don’t know of another solution right now. Again, as an American, I don’t want the dollar debased. I don’t want it abused. I don’t want all that stuff. I want solid money policy. Right.
Have we had it for a while? Actually, we haven’t. Right.
And so things need to change, and we need a more responsible, certainly more responsible spending in DC. And we need a more responsible Fed. But I think on a relative basis, it’s kind of the best we got.
Bob
So, Tony, I want to say this correctly. We have a responsible Fed, relatively speaking. Is that correct?
Jim
You guys agree with me, by the way.
Bob
I know again, that’s the worst house. What is that? The best house in the bed? I don’t know. They saw, but they’re the best one out there. So from a perspective of that, you think a soft landing is possible? Stop me anywhere where I misrepresent you. Okay? You think a soft landing is possible? Am I wrong on that?
Tony
I’ll say uncomfortably soft landing because we’re going to have chop at points, right? So, yeah, we can have an uncomfortably soft landing.
Bob
So I have come around to the idea that the Fed might be cutting rates. I don’t think this year the CME Fed watch tool has the first rate cut pricing in September if things are okay. So if things are okay, why the hell would they do that? And this is why. There seems to be this sort of mismatch between what people are trading and I want to stress the equity markets is not GDP, the economy is not stocks. Right. There’s been several times in history well, not several, but there have been times in history, 73, 74 in the US. Where GDP was strong and stocks were negative. Same thing with Japan in the 90s. They had good GDP, but their stock market couldn’t recover. So these things are detached. They’re not as correlated as people think. But if we actually have good earnings, which no one can argue, we had good tech earnings. Right. We have terrible market breadth still, but we had good tech earnings. May continue next week. We have 709 companies reporting next week.
Tony
With market exxon Chevron reporting really well. There are some parts of the economy that are doing corporate green. Corporate green.
Jim
Go on, Bob.
Bob
Why would they cut rates? Why would they if things are going to be semi? Okay, and Jimmy, this leads me I want to ask Tony respond to that, and then I have to get this question out because it was asked of me. You said in the last podcast that you think we’re going to have a nontraditional recession. What does that mean? So go ahead, Tony.
Tony
Okay, so I’ll just parrot what somebody said to me earlier today. They said bond investors are the worst investors over the last three years. Okay.
Bob
Small data set.
Tony
Sure. What’s that?
Bob
Small data set, right? Relatively speaking, yeah.
Tony
But they haven’t performed very well at all over the last three years. Right. And it’s largely bond investors who are looking at that because it affects their bonds. There is this persistent desire among bond investors to have a recession that’s just baked into the pessimism of being a bond investor, I guess. Right. And I think if we look at earnings, certainly, especially those reported over last week, but also when we have the globally systemic banks report a week and a half ago, those were not bad earnings at all. Right.
And are they telling us that we’re entering a recession? I just don’t see it. So I think September, like, again, I don’t want a recession by September, but I actually don’t think there will be a recession by September. I actually think that things are persistently strong again, because we have that strong nominal GDP growth with relatively high inflation. So if we had stagflation, we would have high inflation and a smaller GDP number than inflation. Right.
Tony
But I think with where we are now. I don’t see us kind of on the precipice going into Q Two, going to Q Three and saying, oh gosh, we’re going to fall off a cliff, right. I just don’t see that. And again, I think part of it is because people saw those government payments as one time or limited time, right? And people have kind of buckled down and said, this is over. We have to figure something else out, and they’ve just continued to spend.
Jim
So, Bobby, to answer the question that the viewer asked, and it kind of relates to what Tony just said too, about the payments, I think that there’s a massive change in our economic condition. I think there was massive wealth transferred from the bottom 60% to the upper 20%. I think those two people still have a shit ton of money. I ride the L. I ride public transportation in Chicago. The amount of people who appear to be living on the fringes has exploded to me, even when it was going on, I was saying to people, no, you’re going to get two $400 checks, and I’m going to get massive appreciation in the four homes I own and the stock market portfolios I own. This is favoring me, not you. And I think that that’s happened in a big, big way, and I think we don’t have the tools to calibrate and figure out we can do Ginny coefficients to measure wealth inequality, but I think there’s this massive wealth inequality, and I think the government then gets involved and tries to support the lower end. Makes it even worse. It’s a yoke, it’s not a gift. And I think we’re in kind of a fucked up way right now in our economic condition. Do either of you guys agree with me on that?
Tony
Tony, I don’t disagree with you, but when we see things like supercore inflation rising, that tells me that those wages for service workers are rising in a persistent manner. And I don’t think that’s all bad. Right.
I think that’s helping the folks at Walmart, the folks in the service sector, get better wages. And they’re not getting it through government regulation. They’re getting it through the market working. Right.
And so employers have realized they have to pay more. It’s not some local city government saying you have to pay $20 an hour or whatever. It’s the market working. Does it take a long time? It does, and that sucks, but the market is working. People who work at the lower end are getting more money. People who work in the middle are getting more money, and people in the middle of the US. Who have typically lagged pay rises on the coasts are getting more money now. Okay. And so we’re seeing that makes me feel better.
Jim
Yeah.
Tony
So markets are working again. Markets sometimes take a long time to work. Right. When it comes to pay, I do.
Jim
Worry that the government is going to see what I have identified, like I’m coming in to fix it. And we all know what happens when they fix it. Bobby, do you got another question before we go?
Bob
Well, no, I just want to add on to what you guys are talking about here. What you just said, Jimmy, and what Tony explained just as clearly is why I fear Stagflation so much, why I actually said to the people who pay us, stop paying us for a little while. Because in my opinion, by the way, if you join, if you hire complete intelligence, we will not be getting paid for that. So don’t worry, there’s no discount code here that’s coming out after the show. No, but what the government will do to try and fix Stagflation is the Fed ill advisedly, so fears a recession more than inflation? I think they should fear inflation more because inflation hurts the poor and it’s a tax on the poor. And the government, because they’ll be in election close by, will send out checks to help people deal with the inflation that’s still there while the economy is slowing down, which will just spark an even worse situation. So my fear is that if we get Stagflation, not only is Stagflation bad in and of itself, but the government’s response, and including the Fed in, that will be awful for 2025 and 2026, and for the lower middle class and the poor, it will be hell on earth.
If they do that in the next five or six years, they’ll crush people. And that’s my biggest fear about Stagflation, why I hope I’m wrong about it coming?
Tony
Well, we see what’s happening in Europe with the payment for energy.
Jim
So here, both of you, lightning round real quick. I’m sorry, Tony, I didn’t mean to talk over you. I just have one quick question. I do it all the time. Yeah, it’s a shortcut thing. Can we have stagflation if we don’t have high energy prices? Tony?
Tony
Yeah, of course. We can have all kinds of we can have high food prices and have stagflation. So I think having high energy prices would certainly make it easier. But sure, high food prices or high rents or high housing, that sort of thing, I mean, major components. Yeah, absolutely. We could do that.
Bob
My answer is very similar. Yes. But it would be a hell of a lot harder with low energy. Yes.
Jim
I just think of the cost push and the energy embargoes made it a lot easier. Let’s wrap it. Unless anyone’s got something real pressing that’s going to set everyone on their ear. Guys. Good.
Tony
Thank you so much.
Jim
Yes, it’s a lot of fun. I love to do a deep dive, particularly get to know you a little bit better. This is awesome. And thanks for plugging your AI. I think that’s a really cool thing. Have a great weekend. What are you doing tonight?
Tony
Tonight I’m just resting. It has been a dramatic week. So I’m just going to shut it down tonight as a Nerd dragons. That’s right.
Jim
I’m going to a figure skating competition that’s going to be 3 hours long for my niece. She’s not even my daughter. She’s not even blood to me. She’s my wife’s niece. And I’m going to a three goddamn hour figure skating competition.
Bob
You saved yourself by saying you’re going for a relative, so that way take.
Tony
It for the team. Jim exactly. Dads and uncles everywhere. I appreciate you.
Jim
She’s one of my favorite nieces, even though she’s not blood to me. But I really like her, so I’m glad to support her.
In the latest episode of The Week Ahead, Tony Nash is joined by Michael Nicoletos, Tracy Shuchart, and Albert Marko. The panel first explores Russia’s recent announcement that it would use CNY for trade settlement outside of the US and Europe. Michael Nicoletos explains that this move could be viable, but it would depend on whether all countries would accept the terms of trade.
Albert Marko believes that the recent rate hike was the right thing to do and predicted that the Fed would raise rates twice more. He also criticizes the lack of depth in the economics department of some central banks, citing examples from the RBNZ and the ECB.
The panel also analyzes the energy market and predicted when we might see an uptrend. Tracy Shuchart updates the chart and pointed out that crude seemed to break the down cycle a bit, leading to a good week for the commodity. The team answers a viewer’s question about the possibility of energy prices remaining low for a long time and offered their perspectives on the matter.
Finally, the panel discusses what they expected for the Week Ahead. Michael Nicoletos predicts that the energy market would remain volatile, and Tracy Shuchart believes that the focus would be on the stock market, particularly the Nasdaq. Albert Marko highlights the importance of watching the inflation data and suggests that investors should keep an eye on the bond market.
Key themes: 1. Russia ❤️ $CNY. Why? 2. Where does the Fed (and other central banks) go from here? 3. When will we see an uptrend in energy?
This is the 58th 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 Michael Nicoletos. Michael is the founder and CEO of DeFi Advisors based in Athens. We’re also joined by Tracy Shuchart of Hilltower Resource Advisors and Albert Marko. Guys, thanks so much for joining us. We have a couple of key themes and I was really in questioning mood when I put these together. The first one is around Russia and the CNY. There was an announcement this week. My question really is why? What’s the point of that? Next is where does the Fed go from here? And really where do all central banks go from here, but mainly the Fed, ECB. Albert is going to lead on that and I know Michael has some views on that as well. That’ll be really exciting to talk through. And then we’ll talk to Tracy about energy. For the first part of this week, we saw energy on an uptrend and we’ve seen a little bit of turbulence on Friday. So when do we expect to see an uptrend in energy? So again, guys, thanks for joining us. Michael, I really appreciate you taking the time from Athens to get involved with us today. Thanks so much.
Michael
Thank you. Happy to be here. Great, love to talk to you guys.
Tony
Great. So first, Michael, I know that you know a lot about China and you follow a lot of their economic activity. And I saw you commenting on this Russia announcement about CNY. Of course, they announced that they’ll use CNY for trade settlement outside of the US and Europe, which is Latin America, Africa and Asia is what they said in their announcement. So that’s about 37% of Russia’s exports. So I put a little chart together. I used UN ComTrade data.
This is 2021 data, which is the latest data that UN ComTrade has. So if they’re really doing that, Latin America is 2% of Russia’s trade, Africa is 3% of Russia’s trade. China is 14%. Okay? And so I guess is all of their trade with China settled in CNY? I seriously doubt it. And then Asia is rest of Asia is 18%. And of that about 1%, just under 1% is Taiwan. So I seriously doubt Taiwan would settle in CNY. But what’s obvious from looking at this chart is Europe is more than half of Russia’s trade. So it’s not as if this is necessarily a massive bold announcement that everything is going to be in CNY from here on out.
Tony
It really is just kind of putting a stake in the ground saying I think it’s almost a best efforts thing. So I guess is this viable? That’s really the question. And Michael, you put out this thought-provoking tweet.
You said if that were the case, China would have no issues running out of USDs. Let’s take that on and help me understand why is China trying to do this and what is the US dollar question that you have around this arrangement?
Michael
Well, first of all, again, thank you for having me. It’s great to be here. Now we need to segregate two things: wanting to do something and being able to do something. It’s clear that a lot of countries which are highly dependent on the US dollar for trading would rather be on something else and not be dependent on the dollar. We saw what happened with Russian FX Reserve when the war started. So clearly this was a warning shot or a lot of countries said we could be next if we go into a fight with the US. So clearly there is a tendency and China wants this to happen as soon as possible. Now, for this to happen, there are a lot of things that need to happen first. I’ll give just an anecdotal example because we get all this news flow and all these headlines where one signs an agreement with another and then two people or two prime ministers come up and say we’re going to do it, and everyone takes it for granted, especially on Twitter. It’s either a fanatic from one side or a fanatic from the other side. So again, I agree with everyone who is afraid of this happening in the sense that a lot of people are saying that the end of the dollar is close and that everyone’s going to go to something different.
Michael
I agree there is the willingness. I’m not sure this can happen soon, and I don’t think it can happen without some conflict occurring somewhere. So an example is that in 2018, Iran signed an agreement with China to sell oil in Yuan. Still, after four or five years, the volumes are ridiculously low. So again, there are agreements, but in order to enforce them and in order for them to happen, they take a lot more time than one would want. So Russia had no option. So because of the sanctions, they still sell to Europe, a few things, but they’re trying to outweigh it by selling more to China. And China and Russia are trying to make these agreements where they will be settling in Rubles or in Yuan. And they try to make these agreements. They want to expand them to other countries as well. However, you see, for example, India. India doesn’t want to settle in Yuan or doesn’t want to settle in ruble. They want to settle in Dirhams, which is back to the dollar. So you get all this information and the data, at least until now, does not support that there is a threat to the dollar.
Michael
There is a threat to the dollar in terms of willingness. There is no threat to the dollar in terms of data which says that this is going to happen tomorrow. So I think that this will eventually happen, but I don’t think it will happen soon. I think until it happens, we’re going to see a few episodes. And these episodes are not straightforward, how they will evolve.
Michael
Now, regarding China and its macro, the reason I’m saying what I’m saying and I’m saying that China needs dollars. China has been dependent, first of all, on its real estate, which was like 30% of its GDP. We saw what happened to the real estate. The second leg was it was highly dependent on exports. There’s a global slowdown. So these exports will have some issues. And now, how has China managed to keep this economy running? I’ll give you a few metrics to understand. The US is an economy which is like 26, I think 26 trillion of GDP. And if I’m not mistaken, its M2 is around 21 trillion. In China, the GDP is around 17 trillion, all in dollars. Okay? And M2 is $40 trillion. 40. Four, zero. So what does that mean?
Michael
The China government prints money. Prints money. Prints money. Because there are capital controls, the balloon gets bigger and bigger and bigger, but the money can’t leave, or it can leave for selected few, and I’ll explain how it leaves. And for the rest, because our capital control, the money can’t leave. So it stays in. But this is in one. Some try to buy gold, some try to invoice over invoice to Hong Kong and take it out of Hong Kong. But when the disparity is so big, clearly there is a problem. There’s an NPL problem. Chinese banks are like four times China’s GDP.
Tony
Sorry, NPL is non performing loans.
Michael
Non performing loans. Sorry. Sometimes they’re non performing. You cannot have an M2 of 40 trillion and a GDP of 17 trillion and not have non performing loans. Chinese banking system.
Tony
Sorry, I just want to go back and I don’t mean to interrupt you, but I just want to make sure that people understand. China has currency in circulation of $40 trillion, and they have a GDP of $17 trillion. Whereas the US has a GDP of what you say 24 trillion. I don’t remember what number you’re… 26 trillion. And they have 21 trillion in circulation. Right. So for all of these people who talk about China being this economic model for other people, why does it matter that their M2 is more than double the size of their economy?
Michael
Let me say something. First of all, let’s put something that the US. Is also the global reserve currency. So everyone in the world wants dollars. It’s not like only the US wants dollars. At this stage, less than 10% of the world wants Yuan. So it’s not like everyone wants to get.
Tony
I think it’s 2.1% of transactions or something like that.
Tracy
2.8%?
Tony
2.8, yeah, transactions.
Michael
Okay. I saw a number which was around 6%. Maybe I’m wrong. Okay. But again, it’s a number which is very small.
Michael
All this money that is in the economy, if Chinese people were given the choice, they would be able to take it out. The economy is growing at a faster pace than its potential. I’ll give you a number. Right now, Chinese banks are more than 50% of global GDP in terms of size. The US, I think its peak was 32% in 1985 and Japan’s 27% in 1994. So we’ve passed all metrics in terms of the world dominant power or the dominant economy, if you want to put it this way, being a percentage of GDP in terms of banking assets. So the banking assets clearly have a lot of bad debts in there, which we cannot know what they are because the Chinese economy wants the Chinese government wants to control that. Now, there was a special committee put in place this month, I think, in order to oversee the financial situation in China. So I’m pretty sure they’re a bit worried about it. They want to switch from an export oriented economy to a consumption driven economy. But this is still less than 40% of GDP and this takes a lot of time to go like the US is around 70%, but it takes a lot of time to go for 40%, 70%.
Michael
Now, all this money stays in China. They have no option, they can’t do anything. So it’s an issue. And I’ll give you a ratio. If you take their FX reserve, it’s around 3 point something trillion. If you divide FX to M2, it’s around 7%. So if that money were to want if that money wanted to leave, in theory, only 7% can be covered by FX reserves, the fixed reserves of the government. Just to clarify, the Asian tiger crisis in 97, the tigers collapsed when the ratio went below 25%. So they didn’t have that support to keep it up.
Tony
And just be clear for the US that’s 100%, right?
Michael
The US doesn’t have any problems. So this is something that needs to be addressed and I don’t know how they will address it. They try to make all these agreements so that the one becomes a tradable currency and they can invoicing one. So if the Yuan, in theory was to become the global reserve currency tomorrow morning, their debt would become the world’s problem. Now, they haven’t managed to export that, so they need these dollars to keep that balloon, let’s say, from all the area in the balloon to be taken up. They need these FX reserves to keep the money in and they need to build confidence, and they try to build confidence with narratives and not with data. But again, they don’t have a choice right now, in my opinion.
Tony
CI Futures is our subscription platform for global markets and economics. We forecast hundreds of assets across currencies, commodities, equity indices and economics. We have new forecasts for currencies, commodities and equity indices every Monday morning. We do new economics forecasts for 50 countries once a month. Within CI Futures, we show you our error rates. So every forecast every month, we give you the one- and three-month error rates for our previous forecast. We also show you the top correlations and allow you to download charts and data. CI Futures is available for $50 a month, $75 a month or $99 a month. You can find out more or get a demo on completeintel.com. Thank you.
https://youtu.be/yYom7Zqezio
Tony
The difference between, say, the onshore and offshore CNY or CNH or whatever, there is a huge difference in perceived value. I would think you can’t change the perceived value of CNY onshore, but offshore, if people are nominating contracts in, say, I’ll say “CNY” in quotes, there is an exchange right there. But again, this M2 issue, which I can’t stress how important that is, I haven’t heard anybody else talking about this. And it’s so critical to understand the fiat value of CNY itself, right, because it’s not limited, and the government because they’re effectively fun tickets with Mao’s face on it.
Tony
Right. And that’s how the PBOC was treating it. And again, when people talk about CNY as a global reserve currency, nobody is looking at the integrity of the PBOC and nobody is looking at how the PBOC manages monetary policy in China.
Michael
I’ll give you anecdotal information. I haven’t checked the number for a few years, but the last time I checked, if you look at the import-export numbers from Hong Kong to China, and you look at the PBOC, and then you go and see the same numbers in the HKMA, you would assume that these four numbers should be the same, not the same. Import should be export and export should be imports. The numbers should be very close. The discrepancy is huge. These numbers do not reconciliate, which means that in some form there is some over invoicing to Hong Kong.
Tony
And you’re not talking about 30%, you’re talking about multiples.
Michael
You’re talking about a lot. It’s ridiculous. So I think if you see the Hong Kong peg has been stable to the upper bound lately because I guess because of the interest rate differential, a lot of money is leaving. So it’s putting pressure on Hong Kong as well. So it remains to be seen what happens there.
Tony
So let me go to Tracy. Tracy, in terms of Russia using CNY, okay? And I know you look at a lot of their energy exports, and of course there’s all this official dumb around sanctions and stuff, but what’s your kind of guess on Russia using either USD or proxy USD, Dirhams or something else as currencies for collecting on energy exports or commodity exports more broadly?
Tracy
Well, first, I think that they prefer dollars no matter what this kind of China saying we want to trade a Yuan. And Russia said, okay, but that was a suggestion. That does not mean that it’s necessarily happening. But what is really interesting is earlier this week, on Monday, Russia laid out conditions for extending the grain, the black seed grain deal, right? Because it was supposed to be for 90 days, but they cut it to 60 days because they’re trying to use that as leverage. And one of the things that they are trying to use as a leverage is they will extend the deal or they’ll give or the other part is they’ll give African countries just free grain instead of selling it. But one of the big conditions for that was for the removal of some Western sanction, specifically to get them back on Swift. And so if that happens, forget it. Everything’s going to be all the trade will be all euros and dollars.
Tony
I thought Swift was terrible and everybody wanted on Swift.
Tracy
I just thought it was important to point out because if they get back on Swift, obviously that’s going to make trading in dollars easy for everything, all commodities across the board.
Tony
Right. And so that goes back to what Michael said initially about kind of these guys really want dollars and all this other stuff. There’s the official dumb of the prime ministers meeting each other, right. And then there’s the factual activities they undertake based on the reality of their position in the world economy. Right. What are your thoughts here?
Albert
I agree with Michael and Tracy to talk about the reserve currency. Switching from the dollar to the Yuan is a joke, to be honest with you. You do have some people in other countries in the Middle East and China and whatnot talking about the death of the dollar and actual serious tone. But anyone with even like a shred of financial backing and insight knows that it’s just an impossible thing. From what it sounds like, it’s more of like a barter system. But that introduces even bigger problems. I mean, you can’t scale it up. There’s no standardization. How do you value things to begin with?
Tony
That’s it.
Albert
Valuing goods and services without using the dollar right now is just an impossibility. And on top of that, you have the political problems that come along with it. I mean, like the Saudis, they want dollars for their oil. They need defense assistance. The Greeks needed US defense assistance. The Turks, as much as they want to make noise again, they’re reliant on the US and NATO for defense and whatnot. These components not just financially, what Michael talked about and decided much more eloquently than I would ever would, but there’s also political components that you just can’t get around in the near term.
Tony
But even if they had a barter system, they would reference the price in dollars, right?
Albert
Well, yeah.
Tony
10 billion.
Tracy
Your chocolate is back to iran did that when they were first sanctioned over a decade ago. They were trading oil for gold, but it was still referencing dollars.
Albert
On top of that, you run the risk of hyperinflation eliminating dollars from your FX reserves and starting to trade away from the dollar. You’re going to end up in a hyperinflation event.
Tony
Right.
Michael
Can I say something? Can I say something? About all these points? I agree with all these points. There’s one more thing. Let’s say you trade in rubles and you trade in Yuan, okay? It means that you’re going to keep FX reserves in rubles or in Yuan. So you feel more comfortable keeping a currency from an authoritarian regime than holding the US. Dollar, which is fully liquid, fully tradable, and anyone in the street will take it at a split of a second. You need many years of track record to build that trust. There are a lot of bad things about the dollar. We agree that I don’t think anyone will say that it’s a perfect mechanism, but right now, it’s very functional, it’s very liquid. And if you want to keep your reserves in US Treasuries, you can sell them at the split of a second. You don’t have any issues with that. If you have Yuan, you’re going to do what? You’re going to buy Chinese government bonds? And how will you sell them if the PBOC calls you and says, it’s not a good idea to sell your Chinese bonds this week? We would prefer you didn’t.
Tony
Bet on the central bank, right? If you’re holding rubles, you’re betting that the Russian central bank is trustworthy. If you’re holding CNY, you’re betting that the Chinese center. So what central banks are out there that you could potentially trust? You have the Fed, you have the ECB, you have BOJ, right? Those are really the only three that are visible enough that have the scale and transparency to manage a currency. And look what the BOJ has done since Abenomics. And on and on and on. Do you trust the ECB? I don’t know. And it becomes, do you trust the ECB or the Fed more? I mean, sorry, but I just don’t trust the ECB.
Michael
I don’t trust ECB. But it’s relative. I mean, you don’t have a problem keeping Euros. Maybe it’s not your preferred choice, but you don’t lose your sleep on holding Euros. Let me put it at this stage.
Tony
That’s exactly right. That’s exactly right. Okay, guys, this is great. Let’s move on to the next thing, because I think we all agreed violently here, but I think we’re going to not agree on the next one, which I’m really excited about. So let’s talk about central banks. And where does the Fed and where do other central banks go from here? So, of course, we saw the Fed raise this week. I think it was the right thing to do. Albert, I know you think it’s the right thing to do. Markets have been up and down since then. And Albert, you’ve said that you expect the Fed to raise two more times, and I want to talk about kind of what’s behind that assertion. And then we get silly statements like this one from the RBNZ in New Zealand, where the chief economist basically says, if inflation expectations don’t fall, we’ll be forced to do more regarding interest rates.
Well, of course. Why wouldn’t you do that. So can you walk us through a little bit, kind of just very quick, because there have been thousands of hours of Fed analysis this week. But why do you think the Fed is going to raise two more times?
Albert
Supercore is trending up and it continues to trend up. Services are on fire. Real estate numbers have been on fire. There’s no slowdown in reality. I mean, even the layoffs have been slow. They’ve come from the tech sector. They haven’t come from construction or any other blue collar jobs at the moment. So until we see that, the economy is going to be red hot and it’s a problem for the Fed, inflation overall.
Tony
Okay, so play devil’s advocate here. Banking crisis, Fed had to bail out banks, all this other stuff. So why isn’t the Fed saying, let’s pause on the banking crisis worries?
Albert
Because banks are fully liquid. The big banks have no problem whatsoever. Some of these smaller banks that have no risk protocols are getting exposed. The tech heavy investments are getting exposed. Everyone knows that higher rates hurts the tech sector the most. And those banks were at fault. They didn’t hedge properly.
Tony
Now you have duration risk. I just want to be clear. I just want to make sure that people understand. You’re not saying that they failed necessarily because they’re tech, but they failed because of duration risk and then their tech depositors took their money out. Right?
Albert
Absolutely. But the banking system overall is not really at risk. They’re just shaking out some of the weaker players. But that was inevitable as interest rates have risen. A lot of the problems stem from the Fed and them guaranteeing four, five, 6% deposits, while the banks only do 1%. They can’t compete with that.
Tony
Right. Michael, I know that you think this wasn’t the right action. So what’s your perspective?
Michael
Well, let me say something first. I believe that it was a mistake, and I’ll say why it was a mistake. I think it’s a mistake when you raise interest rates as a central bank and the banks follow by raising rates on the loan side and on the deposit side, what do you do? You make debt more expensive and then you make people because you have, let’s say, a 5% interest rate on your bank, you create an opportunity cost so people want to save. So you reduce liquidity from the deposit side, and also you reduce loan demand because it’s more expensive, and that creates a slowdown. What happened now, because we had ten years of QE, everyone forgot that there was an interest rate on the deposit side. So the Fed, MDCB and all the central banks raised the interest rate. So the loan side adjusted. That became more expensive, but the deposit side stayed zero at 1%. I don’t know where this is in the US. But it’s really low. At some point, people started waking up when it arrived at 4% and they suddenly started saying, okay, I don’t have any interest on my deposit.
Michael
Let me put my money in the money market fund. How much does it give? Three, four, 5%? I don’t know. It’s a much higher rate. So I think I saw somewhere today that around 5 trillion have gone into money market funds. The numbers close to that. So when you take your money out of the deposit and you take it to a money market fund, this is the equivalent of a bank run for the bank that you’re taking the money, it’s a deposit living. It might not feel like a bank run, but on the balance sheet of a bank, it’s a bank run. So this started happening, and again, because of what you mentioned, they had invested in Treasuries and the duration risk was a mismatch. They didn’t do some of them at least hadn’t done appropriate hedging. They started losing money and they started selling this bond at a loss, although they had them at the Healthy Maturity portfolio where you don’t need to take a mark to market loss. And suddenly both sides of the balance sheet were screwed. Let me put it this way. So a few banks started going under. Now, I know that the central bank has come up and I know a lot of people come up.
Michael
And I do agree that there’s no systemic risk. And I mean that I don’t see a cascade of people losing their deposits. But nevertheless, people feel uncomfortable and try to do something about it. Either take them more money market funds or take their money from a regional bank, if they can. To JP morgan or one of the big guys. This creates a big problem for the economy. Yes, there are some signs which show that the economy is still robust. But I think a lot of leading indicators suggest that the economy is slowing down and most of the metrics coming from the inflation side have collapsed. Yes, core CPI is still high and it’s a lagging indicator, so it will take time for it to come down. But I think that given the stress we saw this week and why do I say that? Because we look at the US as a closed system. It’s not. When you raise interest rates as the Fed and you are the global reserve currency, you create a global credit crunch. You saw that last week. The Fed had come out with swap lines for everyone. You saw today that foreign banks borrowed 60 billion in liquidity, the ones that didn’t have a swap line.
Michael
And we see today Deutsche Bank being in the headlines and Commerce Bank being in the gate. So you might think that the US system is okay, but it creates a domino effect, which we’re starting to see. We saw Credit Suisse going under in a deal, which was not, I’d say, what we would think of. I believe that that deal in combination with the high rates is probably the root of the problem in the sense that they destroyed the capital structure, they wiped out all the 80 ones without wiping out the equity holders. Which means now that in Europe everyone’s wondering if my 81 is of any value. And that creates another uncertainty in combination with the higher interest rates and the stress that has started to build up. I think we’ve passed the moment where, okay, it could be debatable if they did right or if they did wrong. The US bond market is saying that it was wrong. It was a mistake. The two years at 370. And so the bond market went from the one side and the Fed went on the other side.
Tony
Why? The two year at 270 is important.
Michael
373, 70. Sorry, yeah. Three seven. Because if in two years you’re getting 3.7% and the Fed fund rate is five someone, it means that someone is buying a two year bond getting much less. Which means what? It means that the market is saying rate cuts are coming soon. So the market is saying there’s no way we can keep it this way. And the Fed is saying the opposite. Historically speaking, the bond market has been right. If you take it into context, it could be this time that they are wrong. It feels to me, at least from the stress I look in global markets and not in US. Only, that things are getting a bit out of hand. And having a bank like Credit Suisse go under, which is a big bank, and having all the central banks come in together on a Sunday night to give up swap lines, it means that the stress in the system, it’s much bigger than with yeah, but Sunday night.
Tony
Is the best time to get swap lines. Okay, so you talk about European banks, but we had Mueller from the ECB out this week saying, I wouldn’t worry about a financial crisis in Europe.
So we have ECB guys out there going, yeah, Credit Suisse happened and we know Deutsche is an issue, but I wouldn’t worry about that in Europe. So I think we’re seeing statements from Yellen, the Fed, the ECB, other guys who are saying, no, there’s nothing to see here, but then we see things kind of blowing up all over the place. Right, and then we have a question especially specifically for you, Michael, from a viewer who said, I’d like Michael’s thoughts on the EU, particularly banks, pensions and future growth prospects. So can you talk us through? How do these banking issues in Europe flow through to European pensions?
Michael
First of all, let’s say something. We’re talking about the US and.
Albert
Duration.
Michael
Risk on the bond losses. Let’s remind everyone that at the peak of QE 18 1818 trillion worth of bonds had negative yield, and these were mostly Europe and Asia. So pension funds and banks in Europe which are forced to buy these bonds were buying bonds. With a negative yield. So they were losing on day one these bonds from -50 basis bonds have gone to two and 3%, the losses on these are much greater and pension funds will have much bigger issues than the ones that have in the US we were talking about a pension crisis in the US. But the European one is pretty bad too. Just look at in France, they raised this week the year that you take your pension from 62 years old to 64 and the country is burning to the ground. Now, you understand that it’s 62 to 64. It’s not like they made 62 to 70 years old. So it’s very delicate. And the situation in Europe, given the negative bonds, given the interest rate hikes and given one more thing in Europe, given that Europe doesn’t have the dollar and it has the Euro was mostly a supply driven issue.
Michael
It means that we were importing oil and energy from Russia and from everywhere and all these commodities were priced in dollars. So as a Europe tell, the price of these commodities were more expensive. So inflation was a supply driven problem. I think there’s a report, I think from the San Francisco Fed two thirds of the inflation was supply driven in Europe. So when inflation is supply driven and you raise rates to stop it, you’re using the wrong medicine to stop the problem. You need to crash the economy in order for this to stop. This is not really efficient. Now, in the meantime, you have yields going higher and now the yields that we see on our screen on Bloomberg or anywhere are not the yield real yields because the ECB is in and tries to contain the spreads. If you left the market low, I’m pretty sure the spreads would be much, much wider. And you have the new thing which came up this week when the Swiss National Bank decided that tier one, additional tier ones would be written off and equity holder, an equity holder would be saved. Now, imagine what happened. You probably saw what happened this week, all the 80 ones in Europe got smashed because everyone says I don’t trust this instrument.
Michael
I don’t know. Yes, central bankers will come out.
Tony
These are the cocoa bonds that came out in I think, 2013, right?
Michael
Yeah, there are a few of them, yeah, but it’s a cocoa, it’s contingent convertible. It means that they’re convertible be converted to equity if something happens. Let me put it as simple as it is, but these are supposed to be wiped out before the equity. So the question is what prevents for something else similar to happen again, the ECB came out, BoE came out, they said this is not accepted. But the fear and the is now everywhere. So you have a combination of factors. You have a factor that this ECB has been raising rates when I don’t think it’s a proper mechanism to address inflation in europe, they’ve created a slowdown. If you see Germany’s numbers and everywhere’s numbers in Europe, the economy is slowing down fast. You have a discussion on the capital structure of lending, which is very critical in the way companies and banks go and borrow themselves and all this at the same time and when the US. Is draining liquidity from the global system. I think the situation in Europe is very tough. Again, after 2008, I don’t think we have a systemic risk on our hands and the risks never materialize in the same place.
Michael
But I think things are about to get tough and it’s going to be much worse before it gets any better.
Tony
So what I would offer back, and I think everything you’re saying is valid and Albert Tracy, let me know if you want to think about this, but in the US. We have a presidential election next year. There is almost no way that we will see the US economy crash in the next 24 months because Janet Yellen won’t let that happen. And so we may see issues in Europe and we may see Europe and the rest of the world suffer based on US interest rate and monetary policy. But the US. Will do everything, the current administration will do everything they can to keep the US. From crashing in that time. And I’m not just saying this because they’re Democrats, Republicans would do the same thing to keep the economy afloat in the year before an election.
Albert
Albert, what do you think about that? It depends on what is happening specifically with debt ceiling, right? I mean, Janet Yellen and the Biden administration would gladly let the economy sink, the market sink anyways if they could blame it on escape both the GOP on the debt ceiling not getting hyped. So that’s definitely something you need to watch over the next six months because it is campaign fundraising season and they can’t really agitate their voters all that much, to be honest with you. Certainly the political component is going to be high over the next twelve months.
Tony
Okay, great. Let’s move on. Thank you for that, guys. Let’s move on to energy.
Michael
Can I say something?
Tony
Absolutely. Yes, please.
Michael
What appears to be happening right now, at least in my eyes, is that the Fed is using interest rates to attack inflation and it’s using the balance sheet to give liquidity. So these two do not go in the same direction at this point. The question is if they can do this for a long time. It doesn’t feel to me that they can. But at least right now they’re giving liquidity on the one side and they’re raising rates on the other side. I’m not sure they can do this for us.
Albert
We’ve actually talked about that at length here. But it’s not the Fed. It’s really the treasury. Sterilizing QT They’re coordinating.
Michael
They’re coordinating.
Albert
Of course they coordinate for the most part, but sometimes in the last six months or the last twelve months. Powell and Yellen have been at odds with each other in policy. So this is a lot of the reasons why the markets has just been topsy turbine. Don’t understand which way it’s going because you have conflicting policy and agendas from the treasury and the Fed.
Michael
So you feel it’s conflicting or do you think it’s coordinating? They’re doing it on purpose. That’s what I haven’t figured out yet.
Albert
I think the want to eliminate excess cash in the system is coordinated but I think the policy of how they’re doing that is conflicting and that’s going to be a bigger problem, say second half of this year.
Michael
Okay, sounds logical, but it’s one of these things that pass on me. I don’t know if they’re doing it on purpose or if they do any as you say, because they’re using other tools and they step on each other doing so.
Albert
My rule of thumb is to side with incompetence rather than conspiracy.
Tony
Okay.
Michael
It’s not conspiracy when the Fed chairman talks with the treasury guy?
Albert
No, I am absolutely in your corner on this one. I absolutely believe that they talk and coordinate things for sure. I just think that their agenda at the moment doesn’t line up 100% of the time.
Michael
Okay.
Tony
Very good. Okay, thanks for that guys. Tracy, let’s talk about energy for a while. Up until Friday we had a pretty good week for crude. I thought we were breaking that down cycle a bit, but we’re seeing some chop in energy markets. And so we had a question for you from a viewer saying when do you see oil and natty in a sustainable uptrend?
Tracy
Yeah, nat gas is a whole other issue. I think it’s going to be very difficult really. We’re trading in the range that we’ve been trading in most of the time for the last 20 years or so. That $2, $3 range has been very comfortable for nat gas. We produce a lot of nat gas. Yes, we are building out LNG facilities and yes, we have had problems with freeport and such. I just think that we probably won’t really see a big spike in prices unless we see another energy crisis in Europe, do you know what I’m saying? And then we’re going to have to force to sell even more. So for right now I would kind of get comfortable with nat gas about that range. But if it starts breaking above like 375 or so I would start getting bullish. But for right now, just kind of in that area where it’s been comfortable most of the time. Right. So I think it’s going to be a while for that. So we got to kind of assess the situation in Europe as we get to summer air conditioning use and to next winter if they have a bad winter, I think it’s going to be a few more months at least down the line for natural gas as far as oil is concerned.
Tracy
Brent said about $75 right now, saudi Arabia would like it around 80, 90 range is where they’re really comfortable. I think right now what we’re going to have to get through is we’re going to have to really assess we need more time to assess Russia’s situation. They just extended that 500,000 barrel a day cut out until June. The latest records do show that they actually have cut that much so far in March. So the cut is happening, which also means that they’re experiencing kind of a pullback in demand, even though they have really it’s more on the product end rather than, I should say, rather than the crude oil end, because they have floating storage, they have ships piling up everywhere with product. And so I think that will help clear their excess product a little more. So it’s really on the product end and that we also have to see everybody’s freaking if the Fed again decides to stop raising rates or pause. I think commodities really like that situation just because of the cost of carry and transportation and storage for all these commodities is very expensive. Right.
Tony
Because.
Tracy
You get bank credit lines for that. Right. And so I think that’s putting downward pressure on markets right now. And then obviously fear of recession is kind of kicking in again after the recent bank crisis in the US. And in Europe. And so I really don’t think that we’ll see higher prices. I mean, typically this is the time of year we do start seeing higher prices heading into high summer demand season. But we’ve also been seeing, I think everybody expected China. China demanded to shoot up right away. That’s taking longer than anticipated, which I kind of have been saying that on this show for quite a few months.
Tony
Long time. Exactly.
Tracy
So I think that there’s a lot of factors involved right now. I do think, again, it’s higher for longer. Historically still, prices at $70 is high for oil. The market is crashing by any means, just coming down from geopolitically induced spike last year. I think it’s higher for longer. And definitely I could see prices go into that $110 range, but likely into 2024. Not really this year, obviously, unless something happens. Okay.
Michael
Do you think if the Fed poses or whatever reason, or if they do a rate cut, do you think that commodities will explode or do you think.
Tracy
I think if they cut, commodities would get really excited. I think if they pause, they would get excited. Right. I think we would see a rebound in a lot of these commodities, grains, things of that base metals and industrial metals and oil. But if they start cutting, then I think that they’ll really like that because then they don’t have to throw product at the market because they can’t afford to store it.
Michael
Thank you.
Albert
I’m actually quite bullish for oil in the near term. One of the reasons is I’ve heard through the grapevine that the Chicanery and the futures market and I’m reading that hedge funds and other money managers sold the equivalent of 139,000,000 barrels of oil in futures over seven days a week and a half ago. So, I mean, to me, it’s like they’re almost out of ammo when it comes to suppressing oil at the moment. And any little flare up or anything is probably going to be bullish for oil and probably shoot right back up to 80.
Tony
So what could that be, Albert?
Albert
It could be a natural event. It could be weather, I mean, some kind of economic policy stimulus from Europe coming out there, or even the United States going into, like Tracy was saying, the travel season and whatnot. It could be anything, really. I mean, I think the market is just begging for some kind of bullish signal for them to run it up.
Tony
Okay. And Tracy, if you’re sitting in Europe because energy prices were such a factor in 2022, what are the main things that you’re worried about? Their nat gas storage. Has that been depleted much over the winter?
Tracy
No, it wasn’t depleted. They just had to start injections again because what we are seeing is that this really started in fall of 2021. Everybody kind of forgets that the crisis started before the Ukraine invasion, but what we saw is industry start to shut down, especially industry like smelting and glass blowing and things of that nature that require a lot of energy. Right when nat gas prices started spiking, and that was well before that summer of 2022 spike, they didn’t need to spike much where we saw a lot of those industries shut down. So what we’re seeing now is that since prices have been muted for long enough now, now we are seeing manufacturing and whatnot pick up with the numbers came in overnight for Europe. We’re seeing manufacturing pick up again. We’re starting to see some drawdowns finally in storage. Spain in particular has really ramped up a lot of their industry that had shut down prior. I have to say, natural gas prices are still more expensive than they typically are in Europe. Even at this price, right, they’re still higher than normal. So this is also why we’re not seeing a flurry of activity.
Tracy
As soon as prices came down, you have to realize that relative to where they were, they’re still generally high. But we are seeing, I think people are getting used to kind of this price range for Ttf, which is Dutchnet gas. And so we are seeing in manufacturing and industry pick up again in some of these traditional industries that require a lot of energy. So we’ll have to see, and if that really picks up, companies are going back to where they went to fuel instead of gas. We’re seeing them go back to gas now. And so that’s really what I’m watching on the energy end. Is this just one off, kind of, or does this continue throughout the summer?
Michael
Okay.
Tracy
Sorry.
Tony
And then everybody’s favorite energy secretary, Jennifer Grandholm, had some comments about refilling the Spr this week. Can you fill us in on that? And what does that mean for markets?
Tracy
Basically, she said we’re not filling in the Spr, refilling the Spr anytime soon.
Michael
Sorry.
Tracy
She said a few years, which means a lot more years unless there’s a change of administration and a policy change. But I would say from until the election not going to see an Sbr, which makes sense because they know that if they fill the Spr, what’s going to happen? Oil prices are likely going to go higher, and they can’t afford that going heading into an election year. And so I think that’s really why they kind of pushed that off. That’s kind of what’s going on with that.
Michael
Can they be saying something and doing something else?
Tracy
Yeah, but we would know if they’re actually filling the Spr or not because it’s a public auction.
Tony
Okay, why don’t we just stop calling it the Strategic Petroleum Reserve and just call it the Petroleum Reserve? Nothing strategic about the way they’re using the Tactical Petroleum Reserve.
Tracy
They’re using it as a piggy bank. Right.
Albert
Instead of strategic, you use slush fund, petroleum reserve.
Tony
Right, exactly. Okay, guys, one last question, I guess. What are you looking for in the week ahead? We’ve had a lot of volatility over the past couple of weeks. Michael, what are you looking for in the week ahead?
Michael
I’m focusing on central banks and interest rates. I think the issue will be banks. Again, I think the big stress in the economy is private markets and not public markets. BCS, private equity, all these investments need to do write downs. It will take a bit more time for them to do that. It doesn’t happen that fast. They don’t adjust as fast as public market. I believe that bank we will see that stress mostly on banking stocks. A because the cost of funding goes up, b because the capital structure is put into a discussion. C because they continue to raise interest rates. And there is a stress within, I think, focusing on what happens to the banks and to the two central banks. Again, we’re looking at the same thing, unfortunately, but the problem is not in the same place. But these are the indicators you need to look. I believe that you’re going to see inflation coming down fast. That’s my expectation. Maybe I’m wrong, but if you see inflation coming down, it’ll make the life much easier for central bank. Yeah.
Tony
And for all of us. Do you expect to see, like VCs, for example, some VCs close up because of the cost of funds and a lot of these banking issues, or do you think it really doesn’t impact them much?
Michael
I don’t know if they’re going to close down because it’s a 510 year investment. It depends if they can reinvest or if they have to liquidate. But I think funds that are coming up to their maturity, they need to liquidate or they need to roll over. It’s going to happen at a much lower price than they thought, or they’ll have to wait one or two years more. So I think that stress is going to show up somewhere.
Tony
Tracy, what do you see over the next week?
Tracy
I think it’s type based markets. There’s not really a lot coming up as far as oil is concerned. OPEC meeting is the following week, which we already know they’re going to do nothing. So really, next week, end of month stuff, there’s not a whole lot going on in the commodities world, really newswise next week. So I think probably see the same sideways action.
Tony
Okay, great. Robert, what are you looking for? Let me ask a little bit of a kind of loaded question with that. As springtime is coming in in Ukraine, do we expect that to heat up at all as things warm a bit there?
Albert
Well, yeah, I would say yes. Geopolitically? I think it would be advantageous for Russia to do something to stay face. Absolutely. But for the week ahead, I think the narrative shift I’m watching for the narrative shift of interest rates to banking, like Michael was talking about, I think Yellen is most likely going to come out and try to guarantee 500,000 in deposits and even talk about 750 and get it up there and just get the crisis over and done with. So that’s what I’m looking for.
Michael
Okay.
Tony
Wow. Would that require congressional no, they can use emergency powers. Everything’s. Emergency power is great. Perfect. Okay, thanks, guys. Thank you very much. Really appreciate your time and all your insight, and have a great week ahead.
In this episode of The Week Ahead, the hosts discuss three key themes: Silicon Valley Bankruptcy, the Federal Reserve’s Quantitative Tightening (QT) and systemic risks, and America’s energy policy.
The discussion begins with a focus on Silicon Valley Bank (SIVB), which had a major issue raising capital and faced a bank run on Thursday. On Friday, the California bank regulator shut the bank down. SIVB had $175 billion in deposits, $151 billion of which were uninsured. One of the discussions surrounding the SIVB collapse is how venture capitalists have been affected.
The hosts then move on to discuss the Federal Reserve’s QT and systemic risks. They note that the US has been experiencing strong data and inflation, and Fed Chairman Powell hinted at a 50 basis point increase this month. The hosts discuss whether the Fed will accelerate QT in this environment, what that could look like, and what risks it would pose to the US financial system.
The third theme discussed is America’s energy policy. Host Tracy Shuchart mentions a speech given by US Energy Secretary Jennifer Granholm, which didn’t seem to give her more confidence in Granholm’s competence as an energy secretary. The discussion touches on the problems with America’s energy policy and how it affects the country’s overall economic outlook.
Finally, the hosts share their expectations for the week ahead.
Overall, this episode offers a comprehensive analysis of current events and trends in finance and policy, with a particular focus on the implications of SIVB’s bankruptcy and the Federal Reserve’s actions. The hosts provide insightful commentary and thought-provoking questions that will be of interest to anyone following these issues.
Key themes: 1. Silicon Valley Bank(ruptcy) 2. Fed’s QT & systemic risks 3. America’s feckless energy policy
This is the 56th 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. Today we’re joined by Joseph Wang. You may know him as @FedGuy12 on Twitter. He’s a CIO at Monetary Macro and a former senior trader at the New York Fed. Joseph, we’re really happy to have you here. Thanks so much for joining us. We also have Albert Marko and Tracy Shuchart will be joining us during the show. There are some key things we want to talk about. First is a hawkish Fed of course we can’t talk about that without the Silicon Valley Bank things, events that happened today. So we’ll cover that a bit. We’ll get into the systemic risk of quantitative tightening and the likelihood of that happening, as well as America’s rudderless energy policy. And we’ll talk to Tracy about that in detail.
So guys, thanks very much. There’s been a lot going on this week. Albert, I know you’ve been on the road. Joseph, it’s your first time here, so I’m really glad we can have this conversation. Guys, let’s start out with Silicon Valley Bank. I mean, this is something that just kind of happened yesterday. It actually happened with a communications announcement on Wednesday coming in the wake of another bank failure.
And it was really bad timing, it was really bad advice for them to do this. And we’ve just seen a bank explode right, or implode. So can you help us walk through what actually happened from your perspective?
Joseph
Yeah, well, first of all, thanks for having me on the show, guys. I love your show and I do listen to it. So it’s real honor to be here today.
Silicon Valley Bank. So as of recording today, it looks like they’ve been taken into receivership by the FDIC. So basically it’s bankrupt. Now, Silicon Valley Bank over the past couple of years, if you look at their equity prices, they soared really high, especially during the crypto boom. They were known as a bank that would lend a lot to the financial tech sector. And as the financial tech sector imploded, it seemed like that kind of hurt them as well. These past few days you saw it stock price steadily decrease. So if you’re a bank, you have two big concerns. The one is solvency. Are your assets worth more than your liabilities? And the second is liquidity. Do you have enough cash on hand to meet investor withdrawals. When I put money in a bank, so I am an investor in that bank, right. So I eventually lent money to local bank and local bank bought from me and I can go and get that money back anytime I want. And that is part of the problem of a bank. Your liabilities, they are short term, so they can disappear anytime you want. But your assets tend to be longer dated, things like loans, let’s say a five year, ten year loan.
So I can’t really comment on the solvency situation of Silicon Valley Bank. I suspect that they are insolvent simply because I read that they’ve been making a lot of loans to these fintech companies and we all know how that turned out. But you can actually get pretty good insight on their liquidity situation by looking at their regulatory filings. If you want to study a bank and I study bank, so you want to look at something like this.
That’s all this is a call report. A call report is a financial report that banks file. It’s literally 100 page reporting form, and it comes with instruction manual that’s 800 pages in leads. So that’s why I can actually keep a reference here. So if you look at Silicon Valley’s financials, you’ll see that it’s a bank that is vulnerable to liquidity runs. It might not seem so on the surface, but so just for the audience, Silicon Valley Bank has about $210 billion worth of assets. It’s largely funded by deposits. Now let’s look at their asset side first. Now if you’re a bank, you got to keep liquidity on hand because what if everyone starts to ask for their money back? You want to have some liquidity on hand to meet those redemptions. So Silicon Valley Bank has actually a pretty good portfolio of liquid assets. Of the 210 billion in assets, about 120 billion are securities. Securities are good because you can sell them. That’s what a security is. If you have a loan to local company, you can sell them. That’s illiquid. Of the 120 billion, 80 billion are high quality liquid assets. So in the banking world, you want to have high quality liquid assets because you can sell them easily to raise cash.
These are Treasuries and Agency MBS. So so far, $80 billion of high quality liquid assets. Sounds like a great liquid bank. You dig down a little bit more, you find out they’ve already pledged about 50 billion of those away. So they’re already using that to either to secure borrowings. For example, let’s say you are a huge investor. You’re putting money into Silicon Valley Bank, but you don’t really know if you want to take that risk. So you could ask for some collateral. So that could be a possibility as well. So the bottom line is they don’t actually have that much liquid assets, even though they look like they do. Now let’s look at their liabilities. It doesn’t look good either. So normally if you and I okay, I don’t know about you guys, but when I put money in a bank, I have less than 250,000. So it’s within secured by the FDIC. But if you have a lot of money more than 250,000, then it’s not secured by the FDIC. Then you have credit risk. When you look at the depositor profile of Silicon Valley Bank, you can see that they have $150 billion unsecured deposits.
So those are institutional investors who basically lent maybe unsecured, maybe definitely uninsured to Silicon Valley Bank and they could lose everything. If Silicon Valley Bank goes bad, down really badly, they probably will, they’ll get something back. But it’s not good to lose money when we put it in the bank. So they have liabilities that are runnable and they began to run. Now I’ve been hearing anecdotally that everyone was like, get your money out of Silicon Valley Bank. So I’m sure they were. Now you have if you’re a Silicon Valley Bank, that’s a huge, huge problem. You have no liquidity. Everyone is asking for their money back. Your last lifeline is to borrow from, let’s say, the Fed or a Federal Home Loan Bank. It looks like they’re already borrowing from the Federal Home Loan Banks and I don’t know if they can borrow even more. A Federal Home Loan Bank is basically a government sponsored agency whose job is to provide cheap loans to the commercial banks they’re already lending to to the Silicon Valley Bank. In theory they could lend more, but they have a lot of exposure to Silicon Valley Bank. So the Federal Reserve Bank of San Francisco, which is the bank that’s lending to Silicon Valley Bank, 20% of their loan book is to Silicon Valley Bank.
So if you’re a CFO there, do you want to increase your exposure to this bank that’s probably going bankrupt? So yeah, it’s over for them, which is why the FDIC souped in.
Tony
Those are amazing details and it’s exactly what I wanted to hear. Now what I had read earlier was that there are $171 billion of deposits at Silicon Valley Bank and 175 billion but 151 billion of that is uninsured. So basically $24 billion people can pull $24 billion out, but there’s $151 billion that they may or may not get back. Right. So for a lot of these VCs, early stage tech companies and so on, I don’t know if private equity firms or investment funds bank there, but certainly it seems to me to be a systemic risk, especially in the venture capital community. Is that a fair assumption to make?
Joseph
I don’t think it’s systemic to the banking sector and we can talk about that. But these guys who in that community for sure, Tony, I imagine that a lot of people in that community are banking with Silicon Valley Bank. And if Silicon Valley Bank goes under, they’re going to have to have haircuts and maybe it’s a lengthy process. Maybe they get tied up in bankruptcy court or something. So that’s a liquidity problem for them. And so for that community, yeah, I agree, it could be a big problem.
Tony
So if I’m a limited partner in a venture fund today, I’m checking with that venture fund to make sure that my cash is okay. Is that the process that people would be doing? For people who don’t know, limited partners are the investors who put money into a venture capital fund. And my assumption is a venture capital fund would likely store that money in Silicon Valley Bank. And if they can’t access all of well, they could take the first $150,000 of that. But if they can’t get beyond that, then it’s not just the VC that’s hurt, it’s that limited partner. Is that correct?
Joseph
Yeah. So that losses, like you mentioned, partnership losses flow through from the entity to the partnership. That’s what being a partner is about. I imagine there are some rules depending on your general partner, limited partner, things like that, but yeah, it’s investors that get hurt.
Tony
And so the allocation just both of you guys probably know more about this than I do, but the allocation of, say, venture capital from, say, a pension fund is a relatively small allocation of all of the allocations of, say, a pension fund. So I would suspect that this probably isn’t a systemic risk back to, say, pension funds and other investment funds like we had maybe in 2007-8. Right. It’s probably less of a systemic risk than that was.
Joseph
Yeah, I totally agree. I don’t view this as a systemic risk.
Albert
I agree with that. Tony. I don’t think anything systemic is going to happen because SVB Bank goes under. I mean, SVB Bank is the FTX of the fintech banking world. I mean, everything on there, everything that they invested in, is based on trust, and not very much for the fundamentals at A. So it’s not a surprise that it went under as the Fed has been raising rates. Everyone knows that if the rates rise, the tech sector is one that gets hit the most. So it’s not really a surprise that this happened now.
Joseph
Yeah, I totally agree. When the Fed is raising rates, it’s trying to slow down the economy through sectors that are interest rate sensitive. I think the great irony here is that we all expected that to be real estate, right? But real estate is fine, but we miss the fact that the other really interest rate sensitive sectors is tech. And we see big layoffs in tech. So it’s actually all the well paid people who complete on Twitter who are having a bad problem, but the more blue collar industries seem to be doing fine.
Albert
Yeah. Housing got a boost because there’s a lot of cash buyers. People were cashing out at the behest of bloodstone, buying everything, but they were cashing out three and four times the value of the homes that they had a mortgage on. So they go and buy other homes, pure cash. There’s no mortgage risk in the system for the rate. Just like you were saying, the housing sector is not really affected by rates at the moment. You can see that because the houses are still going up and still a little bit of a shortage. But the tech sector was always the biggest loser of the hawks.
Joseph
One of the things that I hear is that there’s the fiscal stimulus from all the construction stuff, like is flowing into the state and local governments. And so that kind of construction spending seems to be supportive of employment, at least in the construction sector. So the guys who, if they’re building residential houses, maybe they can go and do something that’s benefiting from fiscal stimulus.
Tony
Sure. Here in Texas and probably in Florida, where Albert lives, there is construction all over the place, and it’s helping the tax base, it’s helping the overall impact of related jobs and other things. So it is still very strong, at least in the south.
Albert
Well, look at the layoffs. It’s all been tech and no construction. Construction has a shortage of workers at the moment, that’s the best indicator that you can have at the moment.
Tony
CI Futures is our subscription platform for global markets and economics, we forecast hundreds of assets across currencies, commodities, equity indices, and economics. We have new forecasts for currencies, commodities and equity indices every Monday morning. We do new economics forecast for 50 countries once a month. Within CI Futures, we show you our error rates. So every forecast every month, we give you the one- and three-month error rates for our previous forecast. We also show you the top correlations and allow you to download charts and data. CI Futures is available for $50 a month, $75 a month or $99 a month. You can find out more or get a demo on completeintel.com. Thank you.
Tony
Right. Okay, in talking about that strength, let’s talk about the Fed a little bit. Okay. If we were talking two days ago, there would probably be a bias toward the Fed becoming more hawkish. Right.
All the buzz two days ago was, well, we’re going 50. Fed is going to be more hawkish. It’s going to be tough. But over the last 24 hours, things have really started to lean away from that. So what do you see as drivers of the Fed being hawkish and drivers of the Fed being less? So we can’t say that they’re dovish. Right. But it’s more the degree of the rate rise. So what do you see in the calculus that they’re thinking through?
Joseph
Yeah, so let’s level that a little bit. So at the last FOMC conference, Chair Powell basically said that from now on, we’re going to do 25 basis points. He said that through his statement. So the language was that rather than talk about the pace of the hikes, we’re going to talk about the extent. So that’s kind of a that would seem like a done deal. And from my experience with the Fed, very slow, very conservative organization. 75-50-25-25-25, you know, you don’t go from 25 to 50. Now, that’s what everyone assumed. And also corroborated by, let’s say, President Mester. And then Chair Powell kind of threw that whole thing upside down this past week when he was testifying before the House and Senate. He was basically suggesting that, you know, if the data is still strong, we’re going to do 50 until the market began to price that in. So the question ultimately is, is data strong? And that has to do with what happened today with the non farm payrolls and what happens with the CPI report next week. Now, when you’re looking at market pricing, like you suggested, Tony, they seem to be taking out that 50 basis point hike today, Friday, and that could be in part because of fear contagion in the banking sector, I don’t know.
Now, looking at the non farm payroll itself, it looks like the jobs number over 300,000 was comfortably above Bloomberg expectations of about 200 some thousand dollars. But there was a little bit of a mix in it as well because of the unemployment rate increased. I think the pace of a wage increase is also moderated as well. So it seems to be on the stronger side, but not unambiguously. So my perception from this is if the Chair Powell is basically upending everyone’s expectations and putting 50 on the table, the presumption is 50. And this was not clearly weak. We got to watch CPI next week as well. As long as CPI is not like super, like a big disaster, I think the presumption should be about 50 basis points for the March hike.
Tony
So you think the presumption is 50 now?
Joseph
I think today’s headline employment was pretty strong. It’s not something that is weak enough, I think, to take away the presumption. Again. Everything could change with CPI next week, but we’ll see.
Tony
Thank you very much. That’s okay. We know you’re busy, so thank you so much. So Joseph, with the jobs data, there were 50,000 department store jobs in that jobs data. And to me that seems like a statistical extrapolation from an old model or something. I mean, I don’t know of any department store that’s hiring. So when these things come out, what are we supposed to think about that type of data?
Joseph
Yeah, so a lot of people get into the guts of the report and the Fed actually, internally, they have their own model for stuff like this. I would be hesitant to be looking into too much into these adjustments. As you mentioned, they matter. But then you can look at every single job report and say, oh, it’s actually not as strong as it is, or not as weak as it is. For all these little idiosyncratic reasons. I would just take it as it’s presented and knowing of full well, of course, that it is a statistical abstraction of what reality is.
Tony
So is it fair to say you see it more as a kind of a direction than something that’s more specific?
Joseph
Yes. And also if you just average this one with the past few months, it does seem like the labor market not slowing, has decent momentum and there could be revisions going forward. I mean, January was revised slightly, slightly weaker. So it’s just not obvious evidence that data is weak from my reading.
Albert
Tony, for a long time I’ve been saying the Fed should have been doing 50 basis points months ago, but here we are now talking about 50 after doing 25 a few times. I don’t think that they’re going to do 50. I think more that what they’re going to end up doing is talking about QT and doing QT for longer rather than rates at the moment, just because I think Powell and Yellen and the entire crew over there is a little bit worried about the economy, especially after the bank failed. And looking at the jobs numbers, I just can’t see more than that’s. I just think that things will start breaking. If we go 50, we’ll be down 200 points on the S&P, and things will start breaking. And you start wandering down to 3500 on the S&P, you actually make it a financial crisis.
Tony
Isn’t that kind of what they like? They kind of want some things to start breaking. Right. Not that they don’t bankrupt people, but they do want some things to start breaking.
Albert
They keep talking about a soft landing, and that’s the plan at the moment.
Joseph
I agree with Albert. I think the right policy would just be emphasized QT a bit more. It makes perfect sense. I guess we’ll talk about QT in a bit, but it’s a good policy from my perspective, because when you do QT, you’re putting upward pressure on the rates that actually matter to the economy. You hike the Fed funds up and down. Nobody really cares about the overnight rate. When you’re talking about economically sensitive rates, like mortgage rates or like your auto loan rates, those are like the five year, ten year sector, and that can be influenced by QT. So you want to slow the economy down, you want those rates to go higher. But I think the Fed is pretty stubborn when it comes to QT, in part because they don’t really understand they don’t feel like they understand it well. They feel that they understand the overnight rate a bit better.
Tony
Okay, so let’s talk about that. QT is on our agenda, so let’s move to that. So in terms of rates, Joseph, you’re the 50 camp. Albert, you’re the 25 camp. Let’s move to QT. We have been undertaking QT for, what, ten months now or something, and it’s been gradual. Albert, you smile when I say that. What’s your thought?
Albert
Well, I mean, we’ve been doing QT, but then it’s been offset by Yellen’s TGA activity.
Tony
Yeah. Now what are you hearing about the TGA? Has that slowed down?
Albert
It slowed down now, but once the tax revenue comes in late April, she’ll have that again in May.
Tony
Okay. So if we have quantitative tightening, which means the Fed is selling things from their balance sheet into the market, probably at a discounted rate, which takes money out of the out of circulation and it tightens the money supply. Right, but if we have the Treasury issuing funds from the general account, it’s offsetting those QT efforts. Right?
Albert
Yeah, that’s exactly what it’s doing. She’s actually, right now, as we speak, being questioned by the TGA from the House Ways and Means Committee. That’s exactly what she’s been doing, and I think it’s more like why she’s doing it politically rather than anything with economic policy in mind.
Tony
Okay, so what are the politicians generally asking her about, Albert?
Albert
Well, they’re asking her about her sterilization of QT by using the TGA and the effects of inflation because of it at the moment. I have a list of the questions that I can definitely give you guys for afterwards if you want to post them up here. But that’s what they’re asking her about. Why is her action why is she talking about rates when she is a CFO of the country? She is the Treasury Secretary. She’s not the Fed chair. She should be talking about rates one day after Powell comes out being hawkish.
Tony
Right. It’s hard to quit the Fed, I guess. Okay, moving on.
Joseph
I have a question, Albert. Do you have any views on who might be the next vice chair? I mean, right now the frontrunner seems to be Janet Everley, this academic in Northwestern, but I watched the hearings and everyone there was like, from the Democratic side was like, “”oh, we got to have an Hispanic vice chair. We got to have an Hispanic vice chair. And Janet Everley, maybe she has distant relatives or maybe she’s going to write a cookbook about tacos or something like that, but she doesn’t appear to be Hispanic to me.
Albert
Yeah, I don’t know. That decision is going to be made by Brainard who they want is the vice chair. That goes with their liberal policies and enacting and using the Fed to push those political agendas. That’s what they’re looking for. I mean, it could be Hispanic or black or white or whatever, but the base case is that they need someone with a liberal slant in their view to help them out.
Joseph
Yeah. Janet Everly definitely has a liberal slant. For you guys who are not aware, she thought it was a good idea to have a higher inflation target. Maybe that will be in the future, not with Jay Powell, but maybe in the future, maybe like 3%, maybe 4%. Who knows?
Albert
I think 3% is definitely coming no matter what. I don’t think it’s realistic for us to get back down to 2%, especially with the Fed members being former liberal than they were a few years ago.
Tony
Okay, let’s talk about the three 4% rate at some point.
Tony
But let’s get back to QT. Joseph, can you talk us through some of the if the Fed were to accelerate QT, which seems to be something that you’d like to see them do, more of what forms would that take?
Joseph
They could just simply raise the cap for Treasury. So right now the Treasuries can match. The QT pays for Treasuries is a maximum $60 billion a month. They could raise that. So what happens mechanically is that you can think of it as the private sector having to hold more Treasuries. You’re increasing the supply of Treasury debt that must be held by the private sector. So basic supply and demand, increasing supply prices for Treasuries decline and so yields go higher. So that’s a way that they could try to tighten policy by making, let’s say, longer dated interest rates higher. And I think it’s helpful, especially in today’s context. So investors look at the world, look at the future based on their experience in the past. And our experience over the past decade was a Fed who would just cut rates at the drop of a hat. And so because the investor community believes that you have a very, very deeply inverted curve and that’s a big problem because as the Fed is hiking rates on the front end, you don’t see that as much in the ten year. And so you can see, for example, mortgage rates continue to go down as they did in January, thus essentially undoing all the hiking the Fed is doing in the frontend.
Joseph
So you really need the market to either believe that the Fed is higher for longer, or you could have the Fed engineer it by just boosting the supply of longer dated Treasuries. And it’s hard to convince the market of something and the market has a reason to believe that JPowell and his committee of largely dovish committee is just going to cut rates. So it’d be easier to just boost the supply of Treasuries through QT.
Albert
Okay, that’s something that nobody talks about, is durational liquidity. Nobody speaks about that right now with the Fed and the Treasury. I haven’t seen one analyst talk about duration liquidity.
Tony
Okay, so can you guys talk about that? How would they change? Well, first of all, if we focus more on QT, would that potentially pose a threat to, say, banking systems or there are other potential systemic threats that QT could pose for the US.
Joseph
Yeah, it could blow up the Treasury market.
Tony
Okay, tell us how that wouldn’t tell us.
Joseph
So I think there’s huge the great systemic risk today is not in the banks or the private sector. It’s in the public sector. It’s in the Treasury market. And we saw kind of a prelude to that with what happened with the gilt market in the Bank of England last year. For those of you who don’t remember, last year we saw gilt yields basically 30 year long good data gilt yields basically explode higher late last year, and in part because, one, the Bank of England announced that they were doing quantitative tightening and also because the government announced that they were going to issue a whole bunch of gilts. Now there are some levered players in that market who basically blew up. Now if you recall throughout late last year, okay, the summer of last year, there’s a lot of articles about Treasury market liquidity. This is something that I’ve been writing about since last January. And Treasury market liquidity is not really strong, in part because the size of the Treasury market is just growing so quickly. It’s not growing in proportion to the underlying market. So I think about this as like a stadium that gets bigger and bigger, but the exits don’t get any bigger.
Joseph
So 20 years ago we had about $7 trillion in Treasuries outstanding. Today we got about 25. And Biden is going to promise that he’s going to issue even more through his spending. And the underlying market liquidity in the market hasn’t scaled in the same way. 20 years ago we were doing $400 billion a day in cash transactions. Today it’s 600. So again, there is some potential for fragility. Now the market got was looking pretty dicey in the summer last summer, but it got bailed out when recession fears predominated and people began to think that Fed is going to cut rates. Recession, you got to buy Treasuries. But in the event that those recession concerns go away or inflation stays persistent, you can have, I think, some real discontinuous event there where yields spike higher like they did in the UK, which of course wouldn’t lead the Fed to respond. Yeah. So that’s what I view as I’m not really worried about banking or anything like that. So one thing that people have to be aware of is that the banking system has really changed a lot over this past decade. So an easy way to look at that is just Fed QE, right?
Joseph
So now banks have $3 trillion of basically liquidity from QE on their balance sheet. They didn’t have that preg. There’s also a lot more regulation. Now banks are really, really boring businesses. Back then it was exciting. Everyone is making huge bonuses and so forth. But now that’s all in the tech sector.
Tony
Okay, so you say that the gilt blow up happened because of long dated yields. Is there anything, if we move into QT, is there anything the Treasuries could do? Could they move that to the shorter end of the curve to avoid that?
Joseph
I think that would be a great idea. So one of the things that they floated is a buyback operation. So what they would do is they would issue bonds and use that proceeds to buy old bonds. Now I think it would be a good idea to issue shorter dated bonds and buy longer dated bonds. They basically change the duration profile. I don’t think that’s what they want to do. So far they’ve been pretty adamant that they want to make it a maturity bond. Now I’ll give you an example. Let’s say you issued a 30 year bond and. After ten years, it rolls down to a 20 year bond. Now it’s an off the run bond. So an off the run is something that was issued, not recent, and that off the run market is very, very illiquid. So what you could do is you could issue a new on the run 20 year on the runs are very liquid because they’re the recent vintage. Take that money and buy back the old 30 year, which became a 20 year. So you don’t really change the duration of the debt outstanding, just the liquidity profile. That’s what they’re floating.
And maybe that’s something they’ll do. I suspect that it’s not going to be enough. If they want to do something like that, they probably will need to rely well, it’s not going to work, so they’re going to have to rely on the Fed. Just like in the UK, they relied on the Bank of England.
Tony
In Japan. What they’ve been doing particularly kind of seven to ten years ago, the Ministry of Finance was issuing shorter duration debt to buy longer duration debt, and the BOJ was buying that shorter duration debt and letting it expire at maturity. Is that something that we could do here? Where the Treasury would issue shorter duration debt, the Fed would buy it, they would pay off the longer duration debt, and then it would just go into nowhere?
Joseph
They could totally change the maturity structure of Treasury debt. It’d be a really good idea if they did that. They don’t actually need the Fed to buy it. There’s a ton of demand for cash at the front end in the US financial system right now. There’s so much demand that people are putting it into the Fed’s reverse repo facility, which is about $2 trillion. So that means that the Treasury could issue $2 trillion worth of Treasury bills, and the market would just lap it up like that. So they don’t need the Fed to buy it.
Tony
Okay, while we’re here, while we’re talking about people buying Treasuries, I saw some notes over the past week or so where people are saying China is selling their Treasuries, everyone needs to worry. Can you talk to us about that? Joseph Albert, can you talk to us about that? To me, that seems laughable, but it is laughable.
Albert
They need dollars to keep even if you look at if you look at over the long run, I think over the last, like, five years, yeah, sure, they had bought a lot of Treasuries and now they’re selling Treasuries. But it’s pretty even at the moment, if you look going back five years, I don’t even take that kind of argument seriously. When people say that China is going to sell Treasuries and dollars going to crash and blah, blah, blah, buy my crypto, buy my gold, it’s what it usually is. So I personally don’t see it as a big deal. I mean, you know, that’s just the way I think about it, so pretty pretty explicit about it.
Tony
Joseph, what do you think?
Joseph
Yeah, it’s hard for China to find a substitute for Treasuries. So Brad sets there at the Council of Foreign Relations, he’s an expert on this and he has done some pretty interesting detective work. And one of the things that seems interesting is that the China foreign reserves actually hasn’t changed all that much over the past several years. So based on their publicly disclosed data, it stayed around, let’s say three, three and a half trillion over the past few years. But if you recall, China has been making a lot of money through exports. During COVID for example, they were exporting like trades to the US trade deficit with China between US exploded higher. Right. So where is all that money going? It’s not going to the sovereign fund. It must be going somewhere else. I think part of it is going to the commercial banks, but I don’t really know how their data works out. I think they definitely have a huge problem in that they have a lot of exposure to the US. That kind of gives the US political power over them, just like the US could seize Russia’s sovereign reserves. It’s a problem for them.
I don’t know how they can solve it. I’m sure they want to solve it, but so far it seems like they’re stuck, at least for the moment, in Treasury.
Albert
It is a big problem for China because when Yelling calls them up and said, you got to help us out in inflation and crush commodities, you’re going to have to do what Yellen and the Fed say just because of how much they’re held off. I absolutely agree with you on that one.
Tony
Let me bring Tracy in here because I don’t like it when she’s quiet. So, Tracy, what do you think about the issue about Chinese selling US treasuries? Do you see that as an issue from your perspective? Does China have other options? What do you think they’re doing with the money they’re making on US. Export, on exports to the US?
Tracy
Well, I think if we look at the big picture, right, we have seen increased central banks buying gold and selling US treasuries, but we have to look at the bigger picture. More people own US debt than any other country in the entire world, so that’s not going away soon. So I hate to cater to these people and say, yeah, central banks are wearing a lot of gold, but that means that they’re shutting us right? Because it’s simply not true. You still look at the highest countries that own US debt still continue to be the same one china, Japan, et cetera. That’s not going away anytime soon. It is notable in the fact that looking at the gold market, which has been particularly lagging, I think it’s very interesting if we’re looking at the commodity side of things because we’ve seen last year particularly we saw outflows of gold flows, people investing in gold, whether it’s physical, ETF, et cetera, literally for eight months straight. I think that kind of makes this market interesting. But again, I don’t want to conflate that with central banks are buying gold, digging US. Treasuries. That means nobody likes us.
Tracy
Debt anymore.
Albert
That’s an important fact that, yeah, whenever they sell gold or Treasuries, they’re just raising my opinion. They’re just arbitraging for dollars later on. It’s nothing systemic that’s a threat to the US dollar by any means.
Tracy
That was my point. Let’s not make this a bigger issue than it needs to be that we have often seen, yeah, central banks can.
Tony
Walk and chew gum and spin plates and all that stuff at the same time. I think they’re capable. They’re very smart people are capable of doing all this stuff. So okay, just before we move on from QT, albert, is there anything else on QT that you wanted to bring up that you’re watching?
Albert
No, Joseph pretty much talked about it extensively, and there’s not really much I can add. I just think that the proper thing for power to do right now is to accelerate QT and keep rates as they are at the moment.
Tony
Okay, so with housing remaining relatively strong, do you think that they’ll sell off more MBS as a part of their QT portfolio, or do you think they’ll just keep it in the same proportion that it’s been now?
Albert
I think they’ll just keep it in the same proportion right now. I mean, housing at the moment is a big political problem because homes are unaffordable at 70% mortgage rate. So they’re going to have to do something they’re keeping an eye on. That I can guarantee.
Joseph
Yeah. I also note that Powell has been asked his point, Blake, and just said no. He can always change his mind. Powell has a reputation for being a pivotal like he just did. But to Albert’s point, mortgage rates are 7%. That’s kind of already a big drag on housing. If it went to 8%, would that really make that much of a difference? It’s already very high, and you’ve already.
Tracy
Seen housing prices come down extensively, right? Redfin just came out and said 45% decrease in luxury homes and 37.5% decrease. So I think what we’re seeing is housing prices decrease in response to the increase in mortgage rates.
Tony
Okay, very good. Okay, let’s move on. Since we’ve been talking about the US. Government for the first two segments, let’s move on to the US. Government for the third segment and talk about America’s rudderless energy policy. So, Tracy, you were tweeting about a speech that Jennifer Granholm, U. S. Energy Secretary, made earlier this week, and I want to kind of parse that through with you because she is the spokesperson for US. Government’s energy policy.
And there just seems to be a lot of mixed messages. And I’ve got a tweet on the screen about the grand home speech where you said she said, we’ll still need fossil fuels in 30 to 40 years, then to send it into how the Inflation Reduction Act makes the US. Irresistible for new energy. So can you talk us through kind of what were you thinking of as you heard her, and what were your big takeaways?
Tracy
Well, the first thing I want to note in that speech is that for the last two years, this administration has been pushing on the energy industry, right. And has been talking about how they have all these profits and they’re not.
Tony
Producing greeny energy companies. Greedy.
Tracy
That’s been the mo, right. For the last two years. And then in this speech, she did like, 180 when asked the question.
Tony
How.
Tracy
Do you think oil companies, oil and gas companies are responding? She said, we’re very happy how oil and gas companies are responding to our request for like, she gave them props, which is literally 180 degree. So to me that I was like, what? Because really our production has not really increased at all. But suddenly she’s at Fair a week giving props to the energy companies because.
Tony
The CEOs were there.
Tracy
Well, right. So it’s a huge mixed message. The other important thing, I think, to take away from that particular speech was that the US. Wants to move on to energy transition. We want to move away from China. We want to be able to mine our own metals and minerals in the US. For this energy transition. But she was quick to add that the permitting process is a nightmare. It takes ten years just to get a permit. And then if you get lawsuits on top of that, to get to an idea from, I want to build this mine in the US. To actual fruition is a ten year permitting process, and then it’s then plus however many lawsuits you have. I thought that was really interesting and that she actually admitted that the permitting process was completely horrible. Since her administration, or the administration that she works for, has said, what we want to do is streamline this permitting process. We’re going to give people all these incentives to build mines, et cetera. Basically, what she did I take away from the speech is basically what she said was completely opposite of what this administration has been telling us, and that is we have all these incentives.
Tracy
We can build all these mines, no problem. And we love the fact that the US. Oil and gas companies have responded to us and are producing more, which is outright not true. Sorry.
Tony
Okay.
Albert
These are political pipe dreams by the Biden administration. As long as the EPA is there and staff with environmental Nazis, there’s no way that manufacturing and mining is going to propel to the next level in the United States.
Tony
Biden budget proposes 17,000 more EPA staff.
Albert
Oh, yeah, that’s a great sign. That’s a great sign.
Tony
But what they’re saying, tracy, tell me if I’m wrong. They’ve already pushed all this money or they’re already planning to push all this money out into the market. Okay. And this week, the EU developed a proposal to kind of complement the US. And compete with the US. So there’s dump trucks of cash now out there to develop alternative energy. But both the US. And Europe have very restrictive policies on getting those mines together. So out of one side of the mouth, they’re saying they want alternative energy for a safe future. But the reality is they’re paying companies to have Congolese children mind cobalt. I mean, that’s the reality of the situation, right.
Tracy
Situation is it’s not in my backyard. Right, right. That’s the reality situation.
Tony
We want cars that plug in, and we don’t want people to know that Congolese children are mining cobalt. But that’s the crude, stark, horrific reality of these policies today.
Albert
Absolutely, yeah. If you want an American built iPhone or American built Tesla, from the battery on all the way up, it’s going to cost you $5,000 for an iPhone and $190,000 for a little smallest Tesla you can possibly buy.
Tracy
Yeah, it doesn’t matter because it’s never going to be enough, but it doesn’t matter. You think Yellen went to Africa, right? Her trick on Africa, all we heard was she went into Africa to join the renewable generator. That is not why she went. She went to go make deals for mining in Africa. It’s really the back of that situation.
Tony
Wow, that’s terrible. I mean, it’s just the rainbows and unicorns of the policy as it’s portrayed versus the reality, the ugly reality of this industry is pretty horrific. So, Tracy, as you watched Grand Home, what did you think about the oil and gas sector? Did you think, okay, everything’s fine, I don’t have to worry about all this restrictive stuff for 510 years, they’re just going to keep on with status quo?
Tracy
No, I think once you’re looking at the oil and gas sector and you have to look at what actual oil companies said. So you had Scott Sheffield, a pioneer, say there’s five good years left of the permian. That’s a scary thought. Right. And there’s no incentive to drill more because the government’s telling you that in ten years, we want you totally phase out. And so we are going to have a serious problem. And I have said repeatedly, I think that the 13.1 million barrels per day the US. Produced at the end of 2019 in December is probably the height of that’s. It that’s the height of shell, unless something drastically changes within policy.
Tony
Okay, so it sounds to me, since there’s five good years left to the permian, since the US. Government wants this phased out in ten years, there is no ability for oil and gas and money firms actually to have a capital planning cycle. Right. Anything that has longer than a five year payback just is not worth investing in, is that fair to say?
Tracy
I would say that’s fair to say in the United States. Now, if we look offshore, which is really interesting, and that’s where we’re seeing a lot of investment in, say, Guyana or Namibia or a lot of offshore sector kind of seems to be the focus right now in other countries because they just don’t have the same policy hurdles that the United States does.
Tony
Okay.
Albert
Yeah. All places where the EPA is not at.
Tony
Right. So the entire US energy policy and renewables policy is just a big Nimby policy, like you said, just not in my backyard.
Tracy
It is right now. We’ll see what happens. There’s a project going on in Alaska right now which people should be paying attention to their policymakers want this to go through. I sincerely doubt that it’s going to go through because no majors want to invest up there because they run into a bunch of lawsuits. Right. And so why would you knowingly, even if you bought the land rights or the leases, it’s a horrible place because you know that you’re going to be faced with a million lawsuits and give me a million hurdles and whatever. Even if you look at the recent Gom auction, now, you have environmentalists suing anybody that bought leases. It’s a lose lose situation if you’re really trying to explore more gas in the United States right now.
Tony
Okay, so when you say it’s a horrible place, do you mean specifically that Alaska is a horrible place? Because I think we have, like, three there.
Tracy
Alaska is amazing place. I have friends from Alaska.
Tony
Okay.
Tracy
I’m just saying the problem is that you run into a whole lot of regulatory issues, and then you run into a whole lot of lawsuits that are going to take place. And really, that’s a whole separate issue. Now, I really wrote about this in 2020 was the land that they auctioned off is part of a reserve?
Tony
That’s always a good idea.
Tracy
Probably should have never been. Right? And that’s why it really got no interest. It did get a bid from Chevron again, but I don’t see that project going forward ever.
Tony
Okay. Yeah, it’s crazy. And as I try to figure out the policy and I talk to you and I talk to other people, I just can’t figure out what we’re going to look like in five years. And if I was in charge of capex budgets with upstream, downstream, midstream, I honestly wouldn’t know what to do.
Tracy
Because there’s that’s why we continue to look at these companies, continue to focus on dividends, capital, discipline, and paying down debt. I mean, you have to remember, these studies were not making money for years.
Tony
That’s an important point. So when the President of the United States says that Chevron is a terrible company for giving large dividends and doing large share buybacks, they’re doing that because they cannot spend that money on capex. Because they don’t know what the environment is going to be like in five or ten years, is that correct?
Tracy
Yes, exactly. And that’s the point. And they’re trying to gain shareholders. You have to look, two decades ago the oil and gas sector was 20% of the SF 500 weighting wise. Right. And at the lowest in 2020 we were a little bit below 2%. We’re now at about 4%. But you can see where that market has fared fairly poorly.
Tony
Yeah, but Tracy, it’s all going to be AI software forward, so just complete intelligence.
Tracy
It’s going to be chevron AI.
Albert
Yeah, I’ll fund it by a new Silicon Valley bank.
Tracy
That’s right.
Tony
Okay guys, we have a big week ahead going into leading up to the Fed meeting. So what are you all expecting? Joseph, what do you expect to see next week with the various prints coming up?
Joseph
It’s all about the CPI. I mean, I want to know if it’s actually strong. If it’s strong, then we got 50 basis points blocked in right now. Like you mentioned, Tony, that’s been taken out of the market. It could be a violent repricing. So that’s what we want to focus. So I’m suspecting that a lot of people are pricing in rate cuts in part because of what they perceive to be some risk in the banking sector. I just don’t see that. And so when we see that come out of the market, we could have rates go back to expecting a more higher for longer stance by the Fed.
Tony
Okay, great. What is a high CPI to you?
Joseph
I haven’t checked this expectations yet, but whatever is higher than expectations.
Tony
Okay, so literally higher than expectations, if it’s higher than the consensus, then that’s a high CPI.
Joseph
Yeah. If you think back a couple of months, we’re seeing CPI go down. Right. Deceleration, I want to know if it really just did reaccelerate or if it just kind of gave back. What the increase from last month?
Tony
Okay, great. That’s perfect. Albert, what are you looking for next week?
Albert
Same thing CPI is to make a break for the Fed on 25 verse 50. I’m hoping somehow they’ve managed to manipulate the CPI number to make it somewhat in line with the consensus. Hoping for a nothing burger probably be the best option at the moment. Something meaning consensus. If core CPI is hot, like Joseph said, fifty S, fifty S locked in.
Tony
And if super core CPI is hot, that just reinforces wage expectations and it’s all this super circular situation. Right? Okay, so if we do see a 50, do you see an impact on equities? Like a negative impact on equities? Do you think it’d be sideways?
Albert
Without a doubt. Without a doubt. I think if they go out and do 50, I think we’re down 200 points in the S and P pretty quickly in a week. If they do 25, we might even rally 100 points. You know how it is, we’re in bitcoin world now in the S and P. Right?
Tony
Exactly. Okay, that’s good to know. Tracy. We’ve seen oil kind of move sideways. We see energy kind of move sideways lately. What’s happening and what do you expect to see?
Tracy
You know what? I think we talked about this the other week. I continue to think it’ll move sideways. I think we’re in a range. OPEC is very comfortable with that $80 to $90 range for Brent crude oil. And so I see no reason for much to change in that. I think as we head into high demand season right, june, July, August, we could see an uptick in prices. But for right now, the market is very comfortable.
Tony
Okay. And then this Saudi Iran peace agreement that was announced today, do you think that has an impact on crude supply? Do you think that could push crude prices down?
Tracy
I don’t think that, no. Because OPEC has existed for a very long time. Iran is an original member of OPEC.
Tony
They were the founding member. Right.
Tracy
So that relationship has existed cohesively beyond any of the other geopolitical problems that they have had. And Saudi Arabia has always said that this relationship will exist beyond whatever other problems we are having. So I don’t think within the oil market, it really changes any dynamic because that relationship was already solid.
Tony
That’s good to know. Okay. Thank you so much. Thanks for your time. Thanks for all your knowledge. Have a great weekend. And have a great weekend. Thank you.
In this BFM 89.9 podcast, CEO of Complete Intelligence, Tony Nash, discusses the February US equities market and gives his predictions for March. Nash predicts another down month for US markets, albeit not as much as February, with China also being down markedly. He also expects Malaysia to do well and increase by about 1%. Nash also comments on US earnings season, stating that the quality of earnings reported so far is not great and that only $0.88 was matched by cash flows for every dollar of profit, with some companies passing along price hikes successfully but for how long can they keep it up. Nash also discusses interest rates and a more hawkish Fed, which could lead to the dollar rising. He also comments on a newly formed House committee aimed at examining economic competition between the US and China.
Transcript
BFM: BFM 89.9. Good morning. You’re listening to the Morning Run at 7:07 on Thursday the 2nd of March. I’m Shazana Mokhtar with Chong Tjen San and Wong Shou Ning. Now, in half an hour, we’re going to discuss Malaysia’s bilateral ties with the Philippines in light of our Prime Minister currently on a visit there. But as always, we’re going to kick-start this morning with a recap on how global markets closed.
Overnight, US markets were mixed. The Dow was up marginally by 0.2%, the S&P 500 down 0.5%, NASDAQ down 0.7%. Asian markets were also mixed. The Nikkei was up by 0.3%, Hang Seng popped it up and was up by 4.2%, Shanghai Composite up by 1%, Straits Times Index down by 0.2% and the FBMKLCI was down by 0.3%.
It’s everywhere.
That’s right. Well, we’re going to try and kind of peel some trends with Tony Nash, CEO of Complete Intelligence. Tony, good morning. Let’s review what happened back in February. It wasn’t such a great month for US equities. We did see the Dow and SP 500 both lose 4% and 2.6%, respectively. Where do you see the stock market heading in March? Is it going to be more volatility or perhaps brighter skies on the horizon?
Tony: Oh, yeah, it’s going to be pretty choppy. Generally, we expect US markets to have a down month, not down as much as it had been in Feb, but we do expect another down month. Obviously, if the Fed comes in with a very hawkish meeting, then we could see more chop there. We do expect China to be down this month as well. That kind of goes against what we’ve seen in News early this month, but we are seeing China down markedly, say more than 2% this month as well. Good news is we expect Birth of Malaysia to be up about 1%. So while we see chop in others, we may see Malaysia do squeak out a good positive month.
BFM: And Tony, as the US earnings season starts to taper off, what is your assessment of the results that have been released so far? In particular, the most cyclical consumer-facing companies?
Tony: Yes, so the quality of earnings reported so far is not great. So for every dollar of profits, only about $0.88 was matched by cash flows. That’s the largest discrepancy since at least 1990. So that means 12% are from kind of non-cash earnings. So it’s really accounting and other things. So what we’re seeing, especially on the consumer side, is some companies are passing along price hikes, and we see some of them doing that really successfully. I think we’ve talked about that here before, where they’ll hike between eight and say 15% and their sales volume will be down maybe 5%, something like that. That’s really helped the top line and margin expansion. But the real question is for how long can they keep raising those prices and kind of sacrificing transaction volume. So there’s a real question there. But many of those companies have said they’re going to continue to raise prices into later in ’23. The problem is when we run into a company like Coals, which is a retailer here in the US that reported today, and it was all bad, they’re losing customers they’re not able to keep with their costs and other things.
For those companies that cannot pass along price hikes, for whatever reason, it’s really bad news for them. The inflation they’re importing from their vendors is just squeezing their margins, and in some cases, they’re losing money. So, I don’t think the quality of earnings improves from here for at least two quarters. That’s just something to think about as we go into the next Q1 and Q2 earnings.
BFM: Okay, I want to come back to interest rates, Tony, because I’m reading Bloomberg and it seems like the Street is now expecting a terminal rate of 5.6%. Honestly, this changes every day. It was 5.4% not too long ago. But what does this mean for the US dollar? Are we back to the reign of King Dollar again?
Tony: Well, if we see a more hawkish Fed, then I would say yes, that’s probably the case. So, what we would likely see are things like 25 basis points, at least for the next three meetings, if not longer. If we continue to see hot inflation, as we have over the past couple of days, they could do a surprise 50. I don’t think that’s what they’re going to do, but we can’t rule it out. We could also see quantitative tightening, meaning the Fed could unload more mortgage-backed securities or other things, accelerating that from their balance sheet. Because housing is still pretty hot, actually. Prices aren’t moving that much, so we could see the Fed move on MBS or some other things to accelerate that off of their balance sheet. I don’t think that’s highly likely, but it’s a possibility. All of those bode well for the dollar and dollar strength. If that happens, we would definitely see the dollar rise generally.
BFM: Can we take a look at what’s happening over in the US Congress, Tony? There’s a newly formed House committee aimed at examining economic competition between the US and China. I think they held their first hearing earlier this week. What was the outcome? And do you think, as a result, we’re just going to see more trade conflicts between these two superpowers?
Tony: Yeah, so there’s a lot of focus on decoupling from China. There will never be a full decoupling from China. I don’t think we’ll even have a majority decoupling from China. But there are some key industries, like semiconductors and pharmaceuticals, some healthcare aspects that people really do want to decouple from China because we saw through the pandemic that supply chains are very, very dependent on China. Americans want many of those core things closer to home. They’re focused on decoupling. For some reason, people in Congress are just becoming aware that the CCP is in charge of everything in China. So they’ve underestimated the influence of the CCP and they’re waking up to the fact that they’re central in China. We had a couple of former national security advisors suggesting things like accelerating the arming of Taiwan and helping Chinese circumvent the Great Firewall, those sorts of things. And then, of course, human rights. They talked about CCP police outposts that are in US cities where there are actually these CCP outposts that will pursue Chinese nationals within the US, among other things. It’s taking a pretty tough stance on China. I’m not sure to what extreme that will go and what policies will be adopted yet, but I think it’s definitely trying to at least uncover some of the things that Americans haven’t been aware of.
Keep in mind, a little bit of this is theater, right? It’s people in Congress holding hearings to publicize some of their agenda. So, I think it’s a little bit of that so that they can then move into legislation and move the needle just a little bit. I don’t think we’ll see anything extreme, but you will certainly hear some extreme talk over the next couple of months.
BFM: Yeah, but does this change the way fund managers invest? You’ve got this continuing geopolitical tension between the US and China. Is it going to stop, for example, American fund managers from buying Chinese stocks?
Tony: I think it definitely puts China as a higher risk for US portfolio managers. And certainly over the past couple of years, more US portfolio managers have become aware of the risks of investing in China as supply chains close down, among other things. So, I think you will see more of a tighter risk calibration and more weighting of risk for Chinese equities. So, it could potentially not be good for American money investing in Chinese exchanges. Absolutely.
BFM: Tony, thanks very much for speaking with us. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead. As he was talking about how March is possibly going to be down, although not as down as February, I couldn’t help but think, ‘Oh, beware the eyes of March.’ But, yes, it’s still choppy out there, especially as the FOMC will be having their meeting this month. I think everyone’s going to wait and see how much they’re going to hike those rates.
Yeah, he gave some predictions on Malaysia as well. He thinks the market will possibly be up by about 1% in March, but the market has been quite disappointing in Malaysia. And he also expects the China market to be down in March by about 2%. And we spoke about the geopolitical risk which may impact US fund managers as well.
In this episode of “The Week Ahead,” host Tony Nash is joined by Brent Johnson, CEO of Santiago Capital, and Tracy Shuchart, a commodities trader at Hilltower Resource Advisors, to discuss the most pressing economic themes for the upcoming week.
One of the key topics of discussion is the Federal Reserve’s “Q2 Danger Zone,” which Brent believes could be a potentially scary time for the economy. He notes that we are still less than a year away from the first rate hike, and it often takes 12-18 months for rate hikes to show up in the economy. By the summer of 2022, we will be right in the heart of that time period, coinciding with YoY inflation numbers that should come down due to the crazy comparisons from the previous year. Brent warns that even if inflation remains somewhat sticky, we could see a bunch of disinflationary prints at the same time, which will make it challenging for the Fed. Moreover, by that time, Owner Equivalent Rents are expected to fall, adding to the Fed’s challenges.
Tracy then delves into the topic of oil production and cuts, specifically Russia’s decision to cut 500k barrels. She explains what this means for the market, how it could impact crude prices, and who will be hurt the most – Asia or the West. Tracy also raises an interesting point about Russia’s decision to smuggle oil through Albania despite the cuts, leaving us with questions about their motivations.
Finally, the discussion turns to commercial and industrial loan growth, which saw a sharp rise after rate hikes started. Tracy explores why this is happening, and what it means for the economy. She believes that companies are taking out loans to fund capital expenditures, which is good news for the economy as it indicates that businesses are investing in themselves and their future growth.
Key themes: 1. The Fed’s Q2 Danger Zone 2. Capex & C&I Loan Growth 3. 500k fewer Russian barrels
This is the 55th 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. Today we’re joined by Brent Johnson and Tracy Shuchart. We may be joined by Albert Marko at some time, but we’re just going to focus on Brent and Tracy right now. Guys, thanks so much for taking the time to join us. I really appreciate it.
https://youtu.be/yYom7Zqezio
CI Futures is our subscription platform for global markets and economics. We forecast hundreds of assets across currencies, commodities, equity indices, and economics. We have new forecasts for currencies, commodities and equity indices every Monday morning. We do new economics forecasts for 50 countries once a month. Within CI Futures, we show you our error rates. So every forecast, every month, we give you the one- and three-month error rates for our previous forecast. We also show you the top correlations and allow you to download charts and data.
CI Futures is available for $50 a month, $75 a month, or $99 a month. You can find out more or get a demo on completeintel.com. Thank you.
We’ve got a few key things, themes we’re going to cover today. First is the Fed’s second quarter danger zone. There’s a lot setting up for Q2, and Brent’s going to talk us through that. Then we’re going to get into Capex and CNI, commercial and industrial loan growth. And then finally, we’re going to talk about those Russian barrels that are coming off the market this month, and Tracy will talk us through the impact there.
Okay. Guys, thanks a lot for taking the time. Brent, when I asked you what you want to talk about, you really want to talk about this kind of Q2, potentially Q3, these issues that we may see in markets in that time. Can you help me understand or help us understand what are you looking for there? Because there’s a lot going on, of course, and you can talk us through a number of items. But I have a tweet from Daniel Lacalle, who’s joined us a few times talking about the ECB under pressure for faster rate hikes.
We’re seeing similar stuff in the US. But markets keep going up. What are you thinking?
Brent
Well, I think there’s a couple of very, I guess, poignant and competing narratives fighting each other right now. And they’ve been fighting each other for a while. And I’ll explain why I think they’re fighting each other. But I’ll also explain a little bit about why I think Q2 and Q3 have the potential, again, there’s no guarantee. We’re all speculating here. But has the potential for one of these narratives to kind of come to the fore or something to change dramatically in Q2 or Q3. So I think the first narrative that has been around for a year now, so we’re almost still not yet, but very close to now, the one year anniversary from the first rate hike. And I think a lot of people forget that it hasn’t even been a year yet since they started raising rates. And typically when you raise rates, it doesn’t have an immediate impact in the economy. Sometimes it takes nine months, twelve months, 18 months for those rate hikes actually kind of work there through the economy and have the full effect of them show up. So we’re not even to a year yet, but in another three or four months we’ll be in the 12- to 18-month range when they typically start to show up.
Now, in the meantime, we continue to have inflationary prints that are stickier than some people have expected. Again, part of the reason markets have been pretty favorable for the last two, three, four months is the expectation that rate hikes would slow and potentially even reverse and maybe we even get to a cutting cycle. And as a result, the markets are front running that. But now in the last couple of weeks and so at the beginning of the year, we had a big rush up in bond prices as rate hike expectations came down, and stock prices and commodity prices. But for the last month, let’s call it since the, to the last week of January, 1 week of February, I’ve kind of turned it violently sideways. We’ve gone up and down and up and down and up and down, but kind of just treaded water. And actually if you look back two years, we’re kind of where we were a couple of years ago. We’ve gone up and we’ve gone down, but we’re kind of where we were two years ago. But because of the stickiness, the relative stickiness of the inflationary prints, this idea that rate hikes are now going to go the other way is starting to get a little queasy.
And maybe they’re going to have to go back to 50, maybe they’re going to have to go longer, maybe they’re going to have to go higher for longer. And so now markets are trying to figure this all out. And so the reason I think once we get into Q2 and Q3, it gets very important is for two reasons. One, if things stay sticky in the meantime, the Fed may have to either keep hiking or continue to message higher for longer. And then if at the same time all of the previous interest rate hikes start to show up in the economy and then at that point we are going to be in the heart of the year-over-year inflationary prints. And those will most likely show negative. Even if inflation is still high, it’s probably, you know, I think was it last June or last July we had the 9% print in inflation. So even if this year it comes in at 7%, it’s going to show a negative two year-over-year. And so that puts the Fed in the position, okay, inflation is starting to come down, we’re making progress. But you still have high inflation.
So does that mean that they stop or do they start? And it’s going to be at the same time where all the previous rate hikes are going to be showing up in the economy. Right.
Tony
Sorry, go ahead.
Brent
No, but my point is we’re getting to the point where a lot of the decisions that have already been made would naturally start showing up in the economy, but we’re not quite there yet. In the meantime, the Fed is in a tough spot as to whether to continue rate hikes or to slow them down because we are seeing some disinflationary pressures. Right. And so they’re in a tough spot right now.
Tony
Yeah. When Powell spoke, gosh, I think it was in the last meeting, he talked about the lag effects of Fed policy, and it was almost in a defensive way, saying, hey, it may not look like much is going on, but there are serious lag effects to our policies and you better watch out. And I think that’s when they rolled out the 25s or they started rolling out the 25s.
I’m not sure that at this point I see an end to 25s. Sam Rine’s on the show talks several times about how it’s at least 25s until mid-summer. Right.
Brent
I think so.
Tony
And I think we’re starting to get some nervousness from the pace of inflation in Europe. And I think that’s kind of bleeding over here a little bit because people are seeing the prints in Europe and saying, gosh, is that coming our way too? The ECB is going to have to hike faster. And so what’s that going to do to say, the dollar and other things as well? And when we have a relatively strong dollar, the impact that’s having on commodity prices, it mutes them. Right?
Brent
So now you just touched on something else that’s very important to understand. Okay. So if Europe is pressured to keep hiking, or at least hiking more than expected, that has the potential, again, no guarantee. Not everything trades on rates, but it has the potential for the dollar to fall more. That’s why the dollar has fallen for the last four months, is the pace of rate hike expectations. So if we already have sticky inflationary data and then the dollar starts to fall in price again, that can actually provide a tailwind for the inflation that the Fed is trying to counteract. Right. So again, it puts them in this tough spot. The other part that you just mentioned is, and this is where it gets tricky as well, is if you look over the last year, but not just last year, if you look over the last ten years, oil is about where it was a year ago and about where it was ten years ago. Natural gas is below where it was a year a you go. Huge drop off in about where it was ten years ago. Corn is about where it was ten years ago.
Wheat’s about where it would… Copper? You look at all these commodities, they’ve actually come down quite a bit from a year ago. But what has remained the stickiest is the wage data or sorry, wage inflation. Those costs, I know we’re going to talk about that at some point as well. And that could be more to do with a structural issue that the Fed has really no control over. Right. If people have, they’re retiring, they’re moving out of the workplace and they’re just not coming back. And so you have a demographic issue where there’s just not enough supply of labor. It pushes up the price of labor. That is something the Fed could influence, but not as easily as they can influence asset prices. And so, again, you get into this situation where I think everybody knows the further down the road we go, the higher the likelihood we have some kind of an event, right? Whether that’s a crash or just a volatility explosion or whatever it is, I think everybody knows that something down the road is not going to be good. Now, whether that’s six days or six months or six years from now, that’s the debate.
But I think we all know that there’s the potential for this great event. And again, if we get into Q2 or Q3 and it hasn’t happened yet, and you have this confluence of all these events that I’m talking about and in the meantime, asset prices have gone higher or at least held where they’re at, you have the potential for this bursting of this bubble, for lack of a better word.
Tony
Right? Go ahead, Tracy.
Tracy
Sorry, I had a question. So we’re seeing that two-year and five-year inflation expectations start to rise again. So what do you make of that? And what does that mean for the Fed and the Fed’s decision? Right?
Brent
Yeah. Well, I think this gets to everything we’ve just been taught it puts them in a tough spot because they’ve already… They have very clearly started to slow, right? Now, they have said we’re going to maintain and we’re not cutting and we could be higher for longer. But there’s no question that they have, at least for the last four months, have not been hiking at the same pace that they were last summer. But the worst thing for the Fed is if they’re back at 25 basis points now, or if they were to indicate that maybe we’ll have one more hike of 25 and then we’ll be done. But then you get inflation starting to rise again. I mean, that’s horrible for that. That’s the worst possible thing for the Fed and it throws their whole object not objectivity. It’s not that their repu… Not that their reputation is great anyway, right? But after getting the last couple of years so wrong, for their credibility to be challenged again is a really tough thing. And I’ve mentioned this before, you cannot underestimate, in my opinion, you cannot underestimate the influence of getting it wrong would have on Powell’s legacy. And I think he’s been very clear that he doesn’t mind having asset prices lower.
In fact, I think he wants asset prices lower. And so while I completely understand the argument for they’re going to have to cut, I don’t think he can personally take the risk of stopping hikes too soon because the risk of stopping too soon is extremely high for him personally.
Tony
I want to go back to your wages point for a minute. So, you know, when we have a company like Walmart make their minimum wage $15 and then that cascades through the economy because it doesn’t hit everyone immediately, you know, there’s a lag to that hitting the economy too, right. What you talk about? And it doesn’t just hit people making below $15. Those people who are making $15 are like, wait, I was making 15. Now everyone’s making $15. So it cascades up a little bit, right. And it cascades out. And so that takes months to hit also. Right. So that just happened in January, this impact on wages, at least for the next couple of months, right, or do you think it happens?
Brent
I think so. And again, when we get to an event, let’s call it either a credit event or a contraction in the money supply or a bursting of an asset, whatever, when we get to an event and things turn the other way quickly, then that stuff can change quickly. But until that happens, there is a tailwind for them to get worse or for the structural wage inflation for them to work themselves through the economy. And the other thing that I think many people forget this is that and I got to be careful how I say this because… I don’t want to confuse people and I don’t want people to think that I’m just absolutely bullish, because I’m not. I do think we’re going to have one of these credit events, and I do think disinflation is more likely than runaway inflation. But until we get that event, there is an inflationary tailwind, not just because of the things we’ve already talked about, but because of the higher rates. And what I mean by that is, as long as the banking system doesn’t contract and there’s not a deflationary crash, the higher rates are actually pumping more money into the economy.
Right. It wasn’t that long ago you had to go out ten years on the yield curve to get anywhere close to 4% return on your money. Now you can put your money in the closest thing to cash and get 4% on your money. So the people who have the money in their accounts are getting more money pushed into it because the Treasury has to pay higher rates. And that’s just now, kind of, again, the federal funds rate has been slowly ticking up, but some of those rates that people receive are just now resetting higher or have just started to reset higher in the last couple of months. And the further we go along without this “event”, more money gets put into their account in the form of interest payments. And that’s a tailwind because now you have more money to spend.
Right. No, the point that I just want to make is that I believe that we’re going to have this event and I think we’re going to have it sometime this year. But until we have it, there’s a tailwind. So it’s almost like it’s going to be speeding up into the wall.
Tony
How much of that tailwind, Brent, is… People have put on pretty easy trades for the past few years? And how much of that tailwind is people who have a little extra money in their account who just want to make that one last trade, right?
Brent
I think there’s a lot of that. I think there’s a lot of that. And that’s typically why it ends badly, right. If you think about an exponential curve, it goes up and up and up and up and up and up, and then it crashes and it’s because those last people are trying to get that last little trade in. And the other thing that I’ll say is I think this is really important to understand and we were talking about it a little bit before, so it’s repetitive but for the people on the show. It was last summer Q3 of last year where the yield curve inverted. Actually, it inverted just slightly in Q2 of last year. But then the real inversion took place in Q3. And at the end of Q3, we had a point where the stocks were at their lowest level in two years. The VIX was at its highest level in two years. The dollar was at its highest level in two years. And I actually at that point, I even sent out a tweet that said to probably do for the dollar to pull back. And I bought, I took off all my equity hedges and I actually bought equity calls and people were like, why the hell are you doing this?
And I said, Because the yield curve is inverted. And they said, that means there’s going to be a recession. And I said, yeah, but usually that takes twelve to 24 months to show up. And historically in that twelve to 24 months, between the time the inversion happens and the recession arrives, you typically get a run in equities. And so that it kind of goes counter. Everybody thinks higher rates, you don’t want to own equities that’s bad for growth, but in actuality it ends up that way. But in the short term it’s actually typically, historically good for stocks. And so to be honest, and I fully admit it, that trade worked, but I sold it way too soon. I chickened out because I see this wall coming, right? But had I held it for this last six months. It would have been a monster trade, but I sold it after, like, one month because I chickened out on it, to be quite honest. But that’s something that’s very important to understand. And here’s the other thing, and I’ll give you some historical context and it’ll explain two things. It’ll explain the magnitude of the run that can happen, and it’ll also explain the horrendous result that can come up afterwards.
And that is it. From 1926 to 1929… Let’s call it, from 1920 to 1926, you had seen stock prices run very high. It was like the Roaring 20s, right? And then in 1926, the yield curve inverted and it stayed inverted until 1929. And in that time period, from 1926 to 1929, the long-term US Treasury fell 30%. So if you were invested in bonds during that yield curve inversion, you lost a lot of money, just like last year, right? But guess what stocks did over that three-year period? They more than doubled. They went up 150% with the yield curve inverted for three years. And now we all know what came after 1929, right? After that last trade, to your point, pushing that last trade into the market, then you had the huge fall. We could very easily have something like that again. Now, I personally am not in the camp that we’re going to go into another Great Depression. I don’t think it’s going to play out that way, but I can’t rule it out. But it’s all of these cross currents.
It’s because I understand the tailwinds and it’s because I see this massive wall that we’re racing towards that I think right now is the hardest environment I’ve ever seen to be an investor, or at least to be an investor with conviction, I think it’s very hard. The good news, and I would encourage people to think about this, the good news is that in the last ten years, if you didn’t have conviction, it was very hard to sit on the sidelines because you got no return in your account. Interest rates were zero, but you can now sit on the sidelines, wait for clarity and get paid 4 to 5%. That’s not a horrible idea. Right. So, anyway, that’s kind of my soapbox moment.
Tony
These are all great points for it. I guess it’s just time for people to be careful. I don’t think you’re saying the sky is falling today. I think you’re saying, just don’t hold the bag. Yeah.
Brent
And I’m not saying you can’t make money. I’ve used this analogy with clients a few times to explain what I mean, because I said, Couldn’t stocks run another 15 or 20%? And I say, yeah, absolutely they can. I said, It’s like when Evel Knievel jumps over the fountains at Caesars Palace and then his son does the same thing. Well, Evel Knievel crashed and broke every bone in his body. Robbie Knievel landed the jump and was fine. Got a lot huge glory, but they did the same jump. So whether you landed well or land poorly, if you took the same amount of risk. So I’m not saying you can’t make money over the next six months by being in the stock market. I’m just saying you’re taking a lot of risk in order to do it. And if you don’t want to take that level of risk, you can sit in T bills and get 4.5%. That’s not a horrible that’s not a horrible sideshow. Right?
Tony
Right. Yeah. And just for people who aren’t familiar with Brent, I don’t know who isn’t? But he’s not a total doomer. Right. You’re not this, you know, permabear.
Brent
And I try not to be.
Tony
I just don’t want people to think you’re kind of a permabear coming on and try to spread kind of the permabear gospel. You do change your views as markets change, and this is just kind of a sober view on kind of where we are.
Brent
I own a lot of equities for my clients right now. We have participated in the run, but we have not been levered on it. And I’m not all in on that trade, but we own stocks in our portfolio. We think it’s time to be careful. We think you should have some hedges, we think you should have some cash. But we’re not sitting in our bunker just waiting for the sky to fall.
Tony
Great. Okay, that’s all good to know. Time to be very, very sober about things. You mentioned loans and interest rates, and Brent, you were mentioning some things about commercial and industrial loans. And Tracy, you’ve talked about capex, especially in energy, pretty regularly. And Brent, you were saying something about the CNI loans have risen over the past year, even as interest rates have gone up. Can you talk us through that?
Brent
Yeah. So this is kind of another part of the narrative. The combating narratives that I think people forget is many people didn’t think the Fed would ever be able to raise rates. But not only did they raise once, they’ve been raising them for a year now, and they’ve raised them aggressively. And the markets have not collapsed, to many people’s chagrin and many people said, well, as soon as the Fed starts raising rates, they’re no longer going to be increasing the money supply. Okay, that’s fair. And I know a lot of people think that the central banks just print money and flood the market with money. But where the real printing of money comes from, where the real creation of money comes from is when banks loan money. When you go down to your bank and you take out a loan, they don’t and let’s say you take out a million dollar loan, they don’t take somebody else’s million dollars and give it to you. They create it out of thin air. That’s rational.
Tony
Million dollars?
Brent
That’s right. That that’s a new million dollars that’s now in the economy that wasn’t there before. And so a year ago, loans had been coming down aggressively since COVID so they’ve been ramping up, I want to say, like in 2020, it was around $2.4 trillion. And then after COVID, they did all these PPP loans and it spiked to like $3 trillion. And then since the PPP loans, it’s just been steadily every month down, down, down. But I think it was last March or April, it stopped going down and it actually started to tick up. And now it’s been going up for a year, and so it’s up about 10% or 15% from the bottom. So that’s the creation of new money. And despite the fact that the higher rates have not yet caused anybody to go bankrupt, it’s starting to happen. And BlackRock had this happen to them with one of their funds recently. But despite the raising rates, you haven’t seen mass bankruptcies yet. And not only that, you see new loans being taken out. The existing supply of money is still there because we’re not getting the big credit contraction, and new money is being created through new loans.
And so again, you have this tailwind that’s actually speeding things up towards this wall that I believe we’re heading towards. It’s kind of part of the same thing we’ve already been talking about, but it’s just another facet of it.
Tony
No, it’s good. Some economists are going to ride in and say “that’s not technically new money.” But it is new money, right, because it’s circulating in the system and people are using it. Okay, so what drives that? I mean, it seems to me that when you have interest rates kind of steady for a long period of time, people tend to say, well, I can always put that investment off until tomorrow. But then when you see interest rates start to rise, people wake up and go, whoa, wait a minute, I better make that investment before it rises even more. Is that what’s happening?
Brent
I’m actually not an expert on this, and I don’t know for sure, but here’s my theory on it. And so I’m sure we’ll get a lot of people that tell me I’m wrong, but this is kind of how I think about it. I’ve been on record in the past as saying low rates are deflationary for the reason you just explained. If the market condition is so bad that the Federal Reserve has to resort to these extraordinary measures and pull interest rates to zero, is that really an environment where you want to go borrow a million bucks? Maybe, but that’s kind of scary, right? And so I kind of feel like low rates keep people from borrowing money and keep people and it’s borne out, if you look at these reports, that’s typically what’s happened. But if you are in an industry and you are competitive in that industry, and you want to remain in that industry, and you have not taken out that loan. But then let’s pretend as an example, you own a shoe store in Dallas, right? And you compete with a couple of the malls and a couple of the other independent sellers.
And a year ago, they took out a loan and bought more inventory and increased the size of their showroom or whatever it is. And you didn’t. But now we’re a year ahead. Market is holding up. Everybody’s going to those new stores to buy shoes. They’re not coming into your store as much. And in order for you to compete with them, you need to build a bigger showroom. You need to buy more, whatever it is. Well, now your loan costs two or 3% more than it did a year ago. And so now your question is, if I want to remain in this business and the crash doesn’t come in the next two months, if I wait another three or four months, our rate is going to be 2% higher? And so they’re kind of behind the eight ball. And so what I think happens is, as interest rates start to rise, if you need the money, you will borrow it. And we get into…
Tony
A friend who is doing a restaurant franchise who’s going who went through that exact process in terms of deciding when to take out money. It was extremely low. Interest rates started to rise and he felt urgency to get his loan locked in and got it locked in because of the change of rate, right? And the perception of the future change of rate made him so those expectations play.
Brent
I did the same thing. I bought a place in Puerto Rico last summer, and I think our mortgage is around 5%. It had been like 3%. If I’d have done it three years ago, we did it at five, and now I think they’re at six or seven. But that was part of my calendar calculation. It’s possible that rates will go higher. Now, it’s also possible that they’ll crash the three, in which case I refinance and I’ll be fine. But the point is, as money gets more expensive, if you’re going to stay in business, you need money. And so we get into this other theoretical thing where money is a gift. And I say money is a gift and good. And a gift and good is something that typically when something rises in price, the demand falls. But not with a gift and good, with a gift and good is as demand rises, price rises. Or as price rises, demand rises as well. And it’s because you just need it. It’s like this drug you just have to have. And as interest rates start to rise, you will pay more and more and more. And people say, well, if it gets too high, they won’t pay.
And I always say, okay, maybe but if high interest rates keep people from borrowing, then explain to me why Visa is in business and why loan sharks exist. They exist because even though they have rates, people need money and they will borrow at high rates. And so I think that’s kind of what we’ve seen as well. Again, I think this is all going to end, but all of this contributes to where we see markets at today.
Tony
Yeah, I think you’re exactly right. Tracy, can we change this focus of capex to energy? Because it’s pretty well known and you’ve talked about several times that energy hasn’t invested in the upstream since 2014 or something, right? So do you think that rising interest rates and there is some change in the tone of ESG speak in the US over the past couple of months? Do you think the rising interest rates may push some of these companies to start investing in the upstream, or is that just completely ridiculous?
Tracy
I’d be hesitant to say, yeah, I think oil companies are going to jump on board with this because we still have this rhetoric in the west saying that we’re phasing you out in ten years. We want you gone. And so oil companies are therefore they just don’t want to spend the money. And it doesn’t really matter what rate it is at. It’s good news. We’ve seen Vanguard leave the Zero Alliance, and we’ve kind of seen a lot of these banks kind of push back and a lot of these investment funds kind of push back on this ESG narrative. But I just don’t think that’s quite enough until we see governments really focus more on ESG. And even though, say, for example, and it seems hypocritical, we’ve seen Germany, for example, their coal usage skyrocketed in 2022 as they’re closing nuclear plants. Meanwhile, they’re pushing this green initiative. The problem is that since natural gas prices have come back down to prices that they were pre-summer of 2022, I think that they’ve become very complacent. This is how natural gas prices will stay, and natural gas prices are going to stay low.
But that’s looking at the European economy, on the other hand, the damage has already been done. We’re already seeing some deindustrialization in Germany. You have BASF leaving forever. You have a lot of smelters across the whole of EU that are just not going to come back online when they had to. In fact, a lot of them started shutting down in fall of 2021 before the Ukraine invasion. And the thing is, you can’t just reignite those glass furnaces. It takes a lot of money. You have to keep them running 24 hours, 24/7. You know, we’re just not seeing that industry come back, unfortunately. And the ironic thing is if we go back to BASF in particular, they are moving to China, who is buying cheap Russian oil.
Brent
Crazy, right?
Tracy
Because it’s cheaper to do business over there in general. But so I think at this point and we’ve also at one of that, we’re also seeing companies, oil and gas companies, in the UK, sort of because of their windfall taxes. That’s affecting business as well. And so they have decided to either leave the UK altogether we just had Suncor in Canada sell all their assets in their joint venture to BP. And we heard from Shell, Equinor, and BP all said that whatever we wanted to invest in UK, we’re not going to do that anymore because of these windfall taxes. I think that we’re running up against a lot of problems here that are more government-oriented, bureaucratic-oriented than our state central bank oriented, rates oriented.
Tony
We have had some state governments in the US push back on ESG. Right. And we did have a bill in Congress that passed that was pushing back on ESG, but there’s a veto coming or something on that bill, is that right? Governments are getting involved to some level.
Tracy
Absolutely. We have 20 states right now, basically, that are pushing back on the ESG narrative, saying, we do not want our pension funds investing based on ESG. We want our pension fund, our state pension funds, investing on what we think is going to make us money.
Brent
That’s going to make money. Imagine that. Right?
Tony
That would be a good focus.
Tracy
So there are 20 states involved in that. Texas is one of them. Florida is one of them. So that’s still kind of going through the court system at this point. And as far as this new, the amazing thing is this ESG legislation that will likely get vetoed was that it passed the House and the Senate. That’s huge. That’s a huge shift, right? Not by a small margin, I mean, relatively speaking, when we’re talking about other pieces of legislation. So the narrative is shifting in the US. So I think it’s too early to say where this is going to go, but it is definitely something worth keeping your eye on.
Tony
Great. Okay. All right, that’s good. Let’s talk about the Russian supply cuts going into this month. They’re going into this month, Tracy, what does that mean? Can you kind of put that in perspective of their overall supplies?
Tracy
Yeah, I think in general, what people expected was when they announced this and they announced this in a month ago, that oil prices were going to skyrocket. But I don’t think they were doing that to raise oil prices and stick it to the west, right. And raise oil prices that they wanted to see. What they wanted to do is narrow that spread between urals and ESPO, which are their two main crude grades with respect to Brent, because that’s how the prices quoted, European oil prices are quoted in Brent minus whatever the spread is. Right. So what they wanted to do is they wanted, after the price caps and all of the sanctions, et cetera, they wanted to, we saw those prices, those front month prices in those particular grades fall dramatically. And so I think what they want to do is narrow the spreads. And so really, that’s what I think that whole thing, that whole decision was aired for.
And then you also have to understand that Russia includes condensates, which is those lighter oils within their total oil production, whereas the rest of the world does not. And so we don’t really know exactly where that 500K is coming from. Are they those like NAFTA, or is it pure crude? And where that really remains, just so people kind of understand the market over there.
Brent
I think Tracy and I might be wrong, but you’re the expert here, but I think another contributing reason that they cut production is, to your point, in order to get that spread closer, right? Because the discount was pretty significant. Right. And a month ago, I think they announced the production cuts, and a month ago, they announced that tax revenues were falling and as a result, they were going to have a budget deficit this year. But what I didn’t see until kind of a couple of weeks ago was that as a result of the production cuts and as a result of the tax revenues falling so severely in Russia that they are changing the way taxes are calculated on Russian producers.
Tracy
Exactly. Exactly.
Brent
And they are doing and this is not going to be in favor of the Russian producers, they’re going to increase the taxes on the Russian producers to try to alleviate that budget deficit. So I don’t know that they were 100% correlated, but I don’t think that they’re unrelated. Right? In other words, if they’re going to tax Russian producers at a higher rate, and it is taxed on the difference of the spread between the west and Europe, they not only want to get the spread closer or the price higher, the discounted price higher, and then tax at a higher rate. So it’s kind of a double whammy on the producers.
Tracy
It’s a double whammy on the producers, but it’s income for the government.
Brent
Right, exactly. No, exactly.
Tracy
You know what I mean? And this is the same thing I was kind of talking about earlier on another podcast. What is interesting is that Russia is suddenly buying this huge fleet of vessels, right? So they own the vessels and they’re now insuring themselves. So the government’s making money no matter what. They’re just paying themselves. So Russia is not really losing money on this, even with the price cap and with that spread being lower. Now, if you look at and moving on to that, there was just an independent study done that assessed the international sanctions impact on Russian oil imports. And I think it was researchers from Columbia University, University of California, and the International Institute of Finance. And what they discovered is really that Russian crude oil is really selling for $74 right now, all is said and done, which is well above the $60 price cap. All we hear from mainstream media is they’re losing money, they’re losing money. But in reality and I read this paper, and I’ll post it on Twitter later if anybody wants to read this paper. It’s very interesting and it’s very well done. They essentially are selling oil above the price cap, and there’s no way to stop. There’s no way to stop.
Tony
Yeah, sanctions are great, but if there’s no enforcement mechanism, they don’t mean anything. And the Russians know that. Russia, Iran, China, they all know how to circumvent.
Tracy
Iran is the most sanctioned country in the entire world as far as the oil industry is concerned, and they’re still making money, and they’re still able to export, so.
Brent
Shows you how powerful oil is.
Tony
Right, exactly. So, Tracy, who does the 500,000 cut hurt? Is it hurting Asia more, or does it hurt markets generally, globally, just because it’s crude oil?
Tracy
Well, I think, again, it’s very hard to decipher because we don’t know what 100% is being cut. Is it all oil, or is it just these light condensates? And so I think in general, I don’t think it hurts anybody in particular, because if the markets were that worried about it, well, it would be at $100 right now, easy. Right? And so I don’t think markets are that worried about it. I also think markets are kind of let’s wait and see what this actually is. And that brings to a second point, is that right now what’s happening is that we’re having a bifurcated market, right? So the oil market, which did its thing for 30 years, 40, 30 years very nicely, trade routes were settled. We were in this crew. Now we have literally a gray market. I mean, we always had a black market in the gray market, but, I mean, now we’re talking 10 million barrels a day in the gray market, not a few million barrels wherever else. So we’re talking about a large 10 million barrels, which is approximately Russia. And this is a gray market right now, right, because they have their own vessels again, their own insurance. They’re doing ship-to-ship transfers. They’re doing all these shady stuff offline to kind of mitigate and get around Western sanctions in any way possible. And so we really are seeing this market where it’s going to be harder and harder if you’re a barrel comes here, it’s going to be harder and harder to actually track these barrels because that gray market has exploded in volume.
Tony
Interesting, you tweeted a story about some Russian crude being seized in Albania. So that’s one of the, I guess, paths to circumvent. Can you talk us through that and why that’s important?
Tracy
Well, I think that it was interesting because this is not something that, you know, again, there are offshore ship-to-ship transfers going everywhere. You know, particularly if you look off, Spain is a very big on ship-to-ship transfers, right, in Greece. I just thought that was interesting because my first thought was five minutes later, it’s going to be on the black market via the Albanians.
Tony
Sure.
Tracy
But yeah, I mean, they just happened to get caught and too bad that Albert’s not here. He could probably better explain the Albanian relationship.
Brent
It was probably him.
Tony
Okay. I guess the message that I’m getting pretty consistently and tell me if I’m wrong, these are sanctions put on by Europeans, but through Albania, through Greece, through Spain and other places, they’re circumventing the sanctions. When I say “they”, I mean people in Europe are circumventing the sanctions that their own governments put on. Have I misread that?
Tracy
No. I mean, I think that everybody’s trying to kind of find a way around the sanctions right now. And you have to remember, this only applies to seaborne Russian crude. I mean, we still have gas pipes into Europe and we still have oil pipes into Europe right now. So it’s really only seaborne crude.
Tony
So when it’s piped, it’s fine.
Tracy
Yes.
Tony
That’s amazing. Really amazing. Okay, great. Hey, guys, listen, let’s just take a quick look at what you guys are expecting in the near term. What are you guys looking for, say, for the next week? What’s ahead? Tracy it sounds like energy markets are kind of sideways for a while.
Tracy
I think we’re kind of stuck in this $70-80 range right now in WTI. OPEC is very comfortable at $80-90 range for right now in Brent. And so, you know, I think that as we move closer to, say, high demand season and we get more clarity on China and what their domestic demand is going to really look like, I think we could definitely see a push to the upside. But for right now, I think markets are very comfortable where they are, and I think OPEC is very satisfied where markets are right now.
Tony
Okay, great. That’s what events happen, though, right?
Tracy
When everyone’s coming, right? Exactly. You never know what could happen. You had what the story this morning from The Wall Street Journal say EU is leaving. I was like, what? No, they’re not. And they retracted the statement.
Tony
You leaving OPEC and all that stuff? Yeah. Crazy. Brent, what are you looking for in the next week or so?
Brent
I kind of think we’re going to continually have this violent sideways. I think markets are going to go up one day and they’re going to go down the next. And I think in general, I don’t think we’re going to get real clarity in one direction or the other until at least the Fed meeting. Possibly. We do have CPI that comes out a week before the Fed, so that will have a big impact, no doubt, unless it comes in right on the number, which in which case it will be violent sideways again. But I’m trying to just be nimble right now. Again, I don’t have any huge convictions either way right now. I kind of have my long term view while I understand the short term tailwinds, but I think it’s a time to be prudent rather than a time to try to be brave. So that’s kind of a cop out answer, but that’s kind of the truth right now.
Tony
No, I think that’s a great way to put it. Time to be prudent rather than time to be brave. I love it. Okay, guys, thank you so much for your time. I really appreciate it. This is great, great insights. So I appreciate it. Have a great weekend. And have a great weekend. Thank you, thank you.
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
CI Futures is our subscription platform for global markets and economics, who forecast hundreds of assets across currencies, commodities, equity indices, and economics. We have new forecasts for currencies, commodities and equity indices. Every Monday morning, we do new economics forecasts for 50 countries once a month. Within CI Futures, we show you our error rates. So every forecast every month, we give you the one in three months error rates for our previous forecast. We also show you the top correlations and allow you to download charts and data. CI Futures is available for $50 a month, $75 a month or $99 a month. You can find out more or get a demo on completeintel.com. Thank you.
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 episode of the Week Ahead, Tony Nash is joined by Mike Green, Tracy Shuchart, and Sam Rines to discuss key themes including Productivity, Inflation & Secular Stagnation, Fed Outlook, and German Gas Issues.
Mike begins the discussion on Productivity, Inflation & Secular Stagnation by referring to his newsletter “ProcrastiNation” and explains the concept of Total Factor Productivity growing by constant amounts instead of constant rates, which may lead to secular stagnation. The team also reviews a chart from Natixis, which shows a bump in per capita productivity, followed by a sharp fall. The team discusses whether this productivity rise/fall is due to the boost of government spending and the blurry visibility of hours worked during the pandemic. The discussion also touches on how this impacts inflation and what measures could be taken to fight it.
Moving on to the Fed Outlook, Sam notes that the Fed isn’t letting up on inflation fighting and has been working on a delicate trajectory to achieve it. Sam talks about what he’s currently looking at and what’s changed since he first spotted this in Q2 of last year.
Tracy leads the discussion on German Gas Issues, highlighting that Natgas in Germany has been a significant topic since Russia invaded Ukraine. Tracy refers to a chart that shows how industry in Germany started curbing production during the first spike of TTF nat gas. The team also notes that capacity utilization has not come back at all, not just in Germany, but also in the Euro area as a whole.
Finally, the team discusses their expectations for the week ahead. Overall, the episode provides a comprehensive and insightful analysis of the key themes in the week ahead.
Key themes: 1. Productivity, Inflation & Secular Stagnation 2. Fed Outlook: What’s changed? 3. German Gas Issues
This is the 53rd 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 Mike Green, who is the chief strategist at Simplify Asset Management, and Tracy Shuchart from Hilltower Resource Advisors. And Sam Rines from Corbu. So we’re going to start off today getting a little bit nerdy. We’re going to talk about productivity, inflation and secular stagnation. There’s a great piece that Mike wrote a week ago and I want to dive into that a little bit. Next, we’re going to jump into the Fed outlook with Sam. He’s been very consistent with his view on the Fed for the past probably nine months. And so I want to really see what’s changed with the Fed outlook. And then we’re going to look at German natgas issues with Tracy and kind of how that story is evolving. So guys, thanks so much for joining us today. I really appreciate the time you’ve taken to talk with us.
Tracy
Thank you.
Tony
CI Futures is our subscription platform for global markets and economics. We forecast hundreds of assets across currencies, commodities, equity indices, and economics. We have new forecasts for currencies, commodities and equity indices every Monday morning. We do new economics forecasts for 50 countries once a month. Within CI Futures, we show you our error rates. So every forecast, every month we give you the one- and three-months error rates for our previous forecast. We also show you the top correlations and allow you to download charts and data. CI Futures is available for $50 a month, $75 a month or $99 a month. You can find out more or get a demo on completeintel.com. Thank you.
So Mike, I want to talk about your newsletter, really stellar newsletter on productivity and inflation. You called it ProcrastiNation. For anybody who hasn’t signed up for Mike’s newsletter, I would definitely recommend it. Do you mind walking us through that kind of at a high level? And why is that important, particularly right now?
Mike
So this is going to be an interesting part of the discussion. I’m obviously interested in Sam’s take on it as well. And can you guys hear me clearly? I just realized I took off my headset. So as long as you can hear me clearly, we’re good. The dynamics of what is actually going on, are we experiencing a slowdown in productivity growth or is our model of productivity broken?
And therefore we’re effectively trying to push on a string to get all sorts of things fixed that may actually be we may be damaging them in the process of fixing them is really kind of the core point that I was making. And there’s this question about how do we measure productivity growth? How do we think about it? The traditional model of what’s called the Solo swan framework is that productivity growth is a compounding feature.
I able to produce 1000 this year. Next year I’m able to produce 10% more. So 1100 the year after that, 10% more twelve whatever it is, 1221, et cetera. We can continue that process as we go through an exponential series that grows in a manner and suggests that we should be experiencing something along those dynamics. That model is increasing. And what we have seen against that is a slowing of the rate of growth that we measure as productivity or as total factor productivity. Effectively, the inputs that we’re putting in are separated. Let’s ignore the inputs and we’re looking at how much more effectively we’re using those inputs in each period.
It’s generally thought of as the technology component. The evidence is growing that our models for how to measure this and how to think about this are flawed. In other words, it’s not a compounding feature in the sense of multiplicative. It’s actually an additive feature. In other words, if executed properly, we can see our wealth or our income levels grow by a fixed amount each year, right? So if we start at 1000, the next year we grow by 100. The year after that we grow by another hundred. Year after that we grow by another hundred, et cetera. And every once in a while, technological innovations emerge that combinatorially change that and can lead to a step function increase in that. So wealth can begin growing by a differential amount. If you measure those data series, one that is compounding exponentially, one that is compounding in what’s called an additive fashion, at least initially, they’re going to look very similar, right? So 1000 plus 100 plus 100 plus 100 looks an awful lot like 1000 times 1.1 times 1.1 times 1.1 for a certain number of periods. But they very rapidly begin to diverge. If the model that you’re trying to pursue is this multiplicative one right, and this is hyper nerdy, I understand all this, then it means you’re going to try to force all sorts of things through and more importantly, you’re going to actually start budgeting around that dynamic, right?
Well, we expect to be this much wealthier in the future, right? We’re going to see this dynamic. Anyone who’s gone through life, and we all have to do that. You’ve gotten your first job. Your very first job leads to raises that are very rapid as you demonstrate competence. And then you can kind of budget off of that. You can budget off of, okay, well, my income is going to grow at 10% a year. But you rapidly discover somewhere in your 30s that that starts to slow down, right. And you suddenly discover that things stagnate. Well, the whole point is that you’re supposed to live within your means and slowly accumulate savings till that you end up okay. But if you budgeted off the constant increases in income, you’re going to really struggle.
That’s effectively what we’re experiencing as a nation. We budgeted off the idea of nearly unlimited and trend growth. And now it actually appears that that model was wrong. And so the answer is, do we try to bang our heads and do more of the same or do we actually start to embrace that maybe a different model is operating this and what are the implications for that? The most important one is if we try to believe in a multiplicative model and the reality is an additive model, then things like inequality really begin to matter. Because if you have the upper income classes or the elites of society taking a higher share, eventually it means that the absolute numbers that are available for everybody else begin to fall. I think there’s a tremendous amount of evidence that’s what we’re seeing we’re seeing genuine dissatisfaction rising amongst the lower income communities. Or more accurately, if I really want to address it, it’s the center of the distribution that’s really being hammered to this framework. We’re more than happy to basically buy off the very low end. We’re more than happy to encourage the very high end and say, boy, you guys are really a gift to society.
It’s those in the middle that are increasingly getting hammered by this situation and by this philosophy.
Tony
Okay, so let me ask you a quick question on that. When you say a constant rate of growth or relatively constant rate of growth, you’re talking about a real rate of growth, not a nominal rate of growth, is that right?
Mike
So I just want to be very clear. We’re actually not talking about a rate. We’re actually talking about a quantity.
Tony
Quantity.
Mike
So instead of our income growing by 5% a year, you should think about our income growing by $500 or $1,000 a year. And that’s going to continue. Now, naturally that leads to slower rates of individual growth, exactly as I described for an individual.
I start off my career, I get a 10% raise off my $35,000 1st starting salary. Wow, that’s fantastic. I make $3,500 more. By the time I’m 50, I’m making $150,000. I don’t get a 10% raise, but I get a $5,000 raise. Should I be unhappy with that 5000 versus the 3500? No, the 5000 by definition is more, but it’s still a slower rate of growth.
Tony
Okay, so let me kind of try to take this a little bit more. I don’t know, I guess theoretical when we have more theoretical than me, let me try a hypothetical situation here. If we have an inflation rate 7%, okay, and that’s goods, that’s services and so on, and then we have a super core inflation rate that takes out energy and food and a lot of other things that supercore is really telling us the price of services, wages, if we really boil it down. Is that right, Sam? What is supercore telling us?
Sam
Supercore is sticky, right? And it’s sticky because wages tend to be sticky.
Tony
Right.
Sam
You don’t give to the point Michael made, you tend not to give somebody a $350 raise and then take that raise away. You leave them at that and then you slowly pick them up higher or you fire them.
There’s kind of two options. You either keep giving them pay raises or you get rid of them.
Mike
The problem with trying to cut pay, right, except under extraordinary circumstances, is it’s a signal to the employee that they’re less valuable.
Nobody wants to hear that and then show up at work the next day.
Tony
So if we’re not seeing productivity raise, say, multiplicatively or on a percentage basis, then when we see excess inflation like we do today, there really isn’t a way for people in the middle, as you say, the top end keeps what they have. The bottom end is subsidized, but there really isn’t a way for people in the middle to keep up. Is that what you’re saying? Since that super core is constant.
Mike
Correct. This is actually really kind of the key component that I would highlight, and it’s why inflation feels so bad to those in the center.
Again, at the low end, we subsidize it, we inflation adjust, and we say it’s going to rise at a rate. The inflation rate is 5%. We’re going to adjust Social Security by 5%. We’re going to adjust Snap by 5%. That person in the middle, though, can only if they’re subject to these rules, which, as I said, increasingly appear to be true. Their increment of productivity is not a percentage. Just imagine yourself on an assembly line. It is implausible that you are going to become 5% more productive every single year, your entire career. That’s just a simple reality. And I produce 10,000 tubes of toothpaste as a single worker today. As I go through my career, I get more productive, but I don’t get 5% more productive every single year. Otherwise I’d be producing basically all the toothpaste in the world as a single worker by the end of my career.
It’s not entirely true, but you understand the illustration. What is entirely plausible is, is that I’m able to produce 100 more tubes of toothpaste each year because I figure out new ways of doing it. That’s a decreasing rate of growth perfectly matched by the data series we have in terms of things like productivity over time in a career. My initial steps into my career, my productivity rises very rapidly. Later in my career, my productivity growth slows down even though my absolute productivity is higher.
When you have a rate like inflation, that’s hammering. That because it is a rate that is being reduced. It means that I’m experiencing a real loss of income and purchasing power. My productivity is less valuable. Under that framework, my living standards fall. It matches perfectly. If we had a rate based dynamic, we really wouldn’t care.
Theoretically, we could just say, well, inflation is a truly pass through experience, but it’s not.
Sam
Thank you.
Tony
Okay, great. So let’s take this a little bit to kind of productivity. I saw this chart this week from Natixis, which is a European research firm. They’re a great team of smart economists. And so I’ve got it up on the screen. It’s in your packet, Mike. Looking at per capita productivity, which is economic output divided by hours, worked as a basic rough formula for productivity, right. So we see a bump in productivity than a sharp fall. Is this a real productivity rise or fall? Is it more of a boost of government spending and blurry visibility on hours work during the pandemic? What does this mean and how does this fit within the kind of constant rates discussion that you’re observing?
Mike
Well, I would actually highlight that this is almost a perfect illustration of that type of phenomenon. It’s something that we’ve seen since the 1990s, which is the reality is that adding additional workers to the process doesn’t simply increase the output by the number of workers.
The production process is inherently limited in finance terms. Effectively, the beta of an additional worker is always going to be less than one.
So when I add new workers, I’m going to end up lowering my productivity. When I add hours to the day, I’m going to end up lowering productivity. When I remove them, I’m going to raise productivity if the system does not operate under this phenomenon in which each incremental worker or each incremental hour has the same contribution.
It’s a great description of what’s going on. And by and large, what we’ve seen in 22 is no tangible increase in outputs relative to an increase in the inputs, which is what you’re showing on. And it takes this dynamic.
Part of that, by the way, I do think is actually measurement. How do we properly measure how many hours somebody working from home is working?
Am I spending my time working? Am I spending my time running the vacuum cleaner? Am I spending my time experimenting with keto recipes?
You all know the answer for me on that last one. So that has been a consistent pattern. I’m not entirely sure I completely agree with the way that natixis frames it, although I do think that that is the direction that we’re headed in. The Fed is on this path that I think is fundamentally flawed, where they’re effectively saying, okay, let’s really raise the costs of increasing production. Let’s really raise the costs of holding incremental inventory. Let’s make it increasingly difficult for companies to finance themselves. And off the back of that, we should expect to see a dramatic increase in production and a fall in inflation. Makes zero sense to me. But they’re doing what they’re doing.
Tony
So they’re effectively trying to force productivity improvement, at least in theory, by making the cost of that worker higher.
Mike
What they’re attempting to do, that’s a way of thinking about it, right. They’re trying to force a reorganization of society so that it is, at its core, more productive. That would be great if human beings were widgets. But one of the most interesting things about what’s going on right now is that this recession looks radically different than prior recessions that we’ve had. Traditional recessions target the cyclical worker, the person on the assembly line, et cetera. We’re still recovering from the depths of the Cobin crisis. On the production front, we’re producing less than 15 million vehicles. On the automotive side, we still have shortages of houses, we still have homes that are currently under construction from the last boom, et cetera. We haven’t seen the impact of those falling off yet. This cycle is very different. We’re firing people that have college degrees for the first time almost in history, without a meaningful slowdown in the rest of the economy, we all experience this. There’s shortages of housekeepers and low end workers, people that are willing to change bedpans in an environment of COVID In a nursing home, you can’t find those people, right? But you can find plenty of college educated French medieval literature majors.
Now, what good are French medieval literature majors? I’m not entirely sure, but we stole those signals from the market a long time ago through our system of student loans. And now, of course, we’re dealing with the ramifications of it in the Silicon Valley environment, where Google basically was trying desperately to hire anybody to conceal their innate levels of profitability and avoid things like antitrust actions. They brought in all sorts of workers who are very marginal contributors, primarily contributing of various TikTok memes in terms of how their pictures are taken. But the workers being laid off at Google make $275,000 a year on average. Stop and think about that. That’s a lot of money. That’s a great job, right? You know what the unemployment benefit is in California? The maximum unemployment benefit? I’m guessing Sam knows this off the.
Tony
Top of his head, like $1,500 a month or something?
Mike
No, it’s $13,000 total. Okay, so somebody who gets fired from a $275,000 a year job is supposed to immediately go and file unemployment claims so they can generate a $13,000 benefit over 26 weeks. When, by the way, if they just wait a year, they could actually file in arrears and get it as a lump sum payment that would help to pay for a flight to Hawaii. A vacation in Hawaii. They don’t know how to do this. They don’t know how to tap into the market. They have no idea how those systems work. In contrast to the traditional cyclical employees, when they lose their jobs, have the number taped to their refrigerator.
Tony
So I had dinner with a technology recruiter last night. He told me that for tech jobs in New York, for every tech job that he sees, there are 3000 resumes. For every tech job. He said it’s terrible in New York. I can’t imagine. Silicon Valley is much different. But he said there’s so much slack in the tech workforce in New York. That they get 3000 applications for every job that’s posted. He said, Honestly, I can’t go through all of them. I go through about 800 of them. I can’t look at it anymore.
Mike
Your brain fries on that.
But now the flip side of that is, of course, what we’re supposedly receiving from the Fed surveys of job openings and labor turnover of the jolt surveys and suggest, wait a second, there’s two jobs available for every unemployed worker. How do we possibly get to the 3000 applicants for every job if there’s two jobs for every unemployed worker? It’s just the data is a mess.
Tony
It’s a mess.
Mike
Yes.
Tony
Ba is not going to get that accurately. They’re working on a methodology that’s probably two decades old. I haven’t looked into it for a long time, but you guys would know more about that than I would. But I assume that their methodology is.
Mike
They took a terrible methodology and they made it much worse with the introduction of the birth death adjustments in 2012. So now they basically just assume that jobs are being created.
Tony
That’s good. Okay.
Mike
Yeah, I know. It’s great.
Tony
We have an economy based on assumptions, okay?
Sam
It’s why you just jump to the Indeed data and call it a day. That’s what I do.
Mike
You do what? I’m sorry.
Sam
I just look at the indeed.com data. That’s the only one I use.
Mike
Even the Indeed data, though, you have to recognize the dynamics of share gain.
Mike
So you have to make some adjustment for the fact that increasingly people are finding their jobs on Indeed.
Sam
Exactly. Yeah, you do. But it’s at least a little bit better because it’s at least real jobs being posted.
Mike
And the response rates, by the way, to the jolts data is like, it’s just so bad at this point. It’s fallen from Sam again, sam probably knows the data better than I do, but I believe the response rates for the jolt going into the global financial crisis were north of 65%. Today it’s below 30.
Sam
Yeah, it’s gone down about 50%, give or take count.
Tony
So the response rate to the jolts data you mean the companies who are responding to the surveys for jolts data?
Mike
The companies that are responding to the surveys for jolts data has fallen by around 50%, among other things. That’s because the bls continues to rely and this is true for the household survey as well.
They continue to rely on things like landline surveys. You will not get a call from the bls on your cell phone. This is a legacy from the dynamics of cell phone calls used to cost the receiver, so you used to have to pay if somebody called you. Therefore, they would never call a cell phone because people would be like, hey, there’s a survey. They hang up. Now we don’t have anybody with landlines anymore.
Tony
So, Sam, does your company have a physical landline?
Sam
I have never had a landline in my life.
Tony
Tracy, does your company have a physical landline?
Tracy
That would be no.
Tony
Mike, does your company have a physical landline?
Mike
We do not.
Tony
Neither does mine. So I know we’re probably outliers, but still, we’re in small, mid size companies, and none of our companies have a landline. So blsba would never survey us.
Mike
They would never survey us. And the methodology is that we are presumed to have the same behavior as those who answer their phones.
Tony
Yeah.
Mike
It’s just a mess. That is a technical term for what happens when you go through transitions and you have far too much dependence on accuracy of data.
We’ve tried to fine tune the system to the point that it’s not meaningful anymore, using that system to establish monetary policy of unprecedented levels of intervention.
Tony
Okay, so, Mike, let’s go to the conclusions of your newsletter. What does this mean for inflation? What does this mean for how you view our ability to fight it?
Mike
Well, again, I was saying this I say this over and over and over again. We’re a narrative based species. We have to explain everything. One of the narratives that we have deeply accepted is the idea that anything the government does is bad.
And so we basically have gotten to the point where our conclusion is, elon Musk is a more talented individual than Mike Green, therefore, he should pay less taxes, or certainly shouldn’t have to pay taxes on surplus through a higher progressive rate, et cetera. We want to keep the money with those who have demonstrated productivity. It’s not working. It’s the easiest way to put it.
What we actually know is that any one individual has a combination of luck and skill in their individual career. How that gets compensated, how that gets rewarded, is completely context dependent. If the world was back in the 19th century and we were reliant upon various forms of 18th century, we were reliant on various forms of physical strength, tracy’s role in the economy would be radically different today. Radically different than it is today.
Mine as well. Instead of being a giant forehead on a TV screen, I’d probably be slaving away in a coal mine somewhere. Our ability to raise individuals to that capability and to allow them to participate in the system is really what’s a question. And we’re just doing a terrible job of incorporating people into that system. We’re increasingly saying the only people that matter are the Elon Musk, peter thiels, sergey brin’s of the world, and we should want them to continue to bestow their capabilities upon us. Again, that’s part of the reason for highlighting the productivity dynamics. There’s no evidence that that’s actually true. So what we’re doing is we’re taking away from people who could be contributing to society at a lower level, but their aggregate contribution is like a bunch of ants.
I mean, each individual ant can bring something to the table. Even if they don’t get to be the queen, we’re disregarding them, saying that they don’t matter, reducing their role and their compensation in society, encouraging them not to participate. I think that sits at the core of the challenges that we face right now.
Tony
That’s a tough one, especially given where our infrastructure is today. Sam, what thoughts do you have on that?
Sam
I’m pretty much right there with it. I do think that there’s a significant amount of problems and it’s very problematic when the call it the lower quartile of the income spectrum and the middle in particular begins to see a real wage go negative and go negative in a meaningful way and they generally don’t see a way out of it. What’s also interesting is that we’re relying on cpi numbers. We talk about supercore, we talk about core services, ex shelter, et cetera, et cetera. But when the middle is actually looking at what their wages are going to, it’s predominantly the things we cut out, right? It’s shelter, oil and food that’s a significant portion of their income. So while it’s always entertaining and it’s always kind of a good thing to look at the underlying metrics on inflation, it is not the real world experience. The easiest way for me to feel good or bad in the morning. Well, not necessarily me because I’m in Texas. So the bigger the number on the gasoline board, the better off I am. But for the vast majority of Americans, that’s not true to me. There’s a significant longer term issue here when the consumption metrics are highly reliant on the bottom 50% and the bottom 50% is getting eaten away.
Tony
Yeah, sounds pretty dire. I hope it’s not really that dire. And Mike san Francisco Fed. I think you should go. Sam, Dallas Fed, I think you should be there and you guys should solve these problems.
Mike
I will tell you, I spent a significant amount of time last two weeks ago at the New York Fed and the answer is really quite straightforward. It is an orthodox institution that is extremely captured by the idea that the cost of money is ultimately the determinant of inflation and they’re not prepared to consider anything else. So the solution is the beating shall continue until morale improves.
Tony
Great. And I guess the real question to be a realist is how do you game that?
Mike
Right?
Tony
I mean, that’s the question for all of us and that’s why we talk about this every week, is how do you take that view and how do you game that to make the best of your income?
Mike
So the quick answer is that you do the best you possibly can to engage in the equivalent of Dumer prep. It’s not to stockpile canned food and pasta, it’s to basically remove yourself from a situation in which you are dependent upon the impact of the Federal Reserve. So the Fed is pursuing a model that is going to raise inflationary pressures that is going to lower economic activity. We’re all caught in the crossfire of that. That means that our incomes are going to be negatively affected in real terms. Our capacity to service debt is going to fall in the future. And therefore you want to reduce as much debt as you basically do the exact opposite of what we’ve been encouraged to do for the past 40 years. 40 years. You do everything in your power to reduce debt, reduce dependence on the system, and create put yourself into a situation in which you’re effectively benefiting from the higher interest rates. Meaning you’re holding cash.
Tony
Yeah. Very good.
Sam
Okay.
Tony
Thanks, Mike. There’s a lot to think about there. And again, anybody who doesn’t get mike’s newsletter, I would encourage them to look for his substac and subscribe his. So thank you for that, Sam. Let’s look at the Fed outlook. Given the kind of doomer Fed close out that Mike just gave us, let’s look at the Fed outlook and look at what’s changed. So back in July of 2022, you presented in your newsletter, you said peak inflation and peak hawkishness dominate the narrative. Following the fomc meeting. This was the Fed meeting in, I think it was late June, early July. But it’s you said that the fmc has tunnel vision on inflation, and the end of the tunnel is not visible. So this was, you know, almost a year ago, nine months ago this past week, you said very similar, you said until price over volume and the consumer breaks, it is still 25s for life.
So you’ve presented a very hawkish outlook for the Fed over that period. Well, not very relatively. I’ll say hawkish. So as far as I know, I don’t know, you’re the only person who’s got it consistently right. And you’ve been pretty flawless.
So the Fed isn’t letting up on inflation, and they’ve been working a pretty delicate trajectory.
Mike
Right.
Tony
I mean, they really went hard on seventy five s, and then they pulled back to 25s. What are you looking at now? And what has changed since Q 222 since you spotted this last year?
Sam
Yeah. So not much has changed. We can start there. Okay, good. Not much has changed relative to what we were thinking, that we were well above where the street was at that point for the terminal rate. And we continue to see twenty five s and those 25s continuing for the foreseeable future.
Mike
Right.
Sam
And I do think that it’s highly dependent on two things. It’s highly dependent on where inflation actually comes in, and it’s highly dependent on where wages and the consumer end up. And when you look at the data and to michael’s point, looking at the data that’s being printed off, the inflation report, the employment report, et cetera, there’s a lot of noise in those systems. So instead of doing that, I basically just go through earnings reports constantly as they’re released and take it as. These management teams tend to have a pretty good idea of where they’re going to set price, where they’re going to set wages, and what their input costs are going to be. When you look at companies from pepsi to coca cola, nestle, hershey, all of their pricing is going up and they’re going up significantly.
Tony
What’s the magnitude on average?
Sam
810 percent, 12% on average. It’s low teens in terms of year over year pricing. pepsi said they were mostly done pushing price, but that means that they’re still pushing price to date. Texas roadhouse, of all places, said they were increasing their menu pricing 2.2% in March. They saw their commodity prices increasing for the year 5% and their wages going up 5%. So that’s kind of one little I call it a cog in the system.
Tony
It’s interesting you mentioned Texas roadhouse. So we had retail sales, restaurants went up 25% year on year, right. How does that stop? I just don’t understand. How does that rate of growth stop? What does it look like from your.
Sam
Perspective in terms of the year over year numbers? I mean, the year over year numbers were somewhat skewed because of omacon last year, right. So you had some audies in the data going in to the retail sales report on a year over year basis, but on a month over month basis, they were very, very strong. And one of the things that another one of the great points that Michael made a moment ago, it’s really interesting when you look at the dynamics of income to start 2023, social Security payments increased by 8.7. That’s 70 million people that just got in a nearly 9% raise in January.
Mike
Right.
Sam
So that money is hitting the system. That’s somewhere around $120,000,000,000, and the marginal propensity to consume on that is extraordinarily high. The average dollar coming in the door on Social Security is going to the bottom half the income spectrum and mostly skewed towards the lower half of that half. That tends to get spent, and it tends to get spent very quickly. So that’s high powered automobiles directly into the system. Well, it’s a lot of eating out at restaurants, right? It’s a lot of cracker Barrel. You look at cracker Barrels earnings, their wages, et cetera, walmart raising their wage, a lot of middle America, particularly at the bottom, is beginning to see some pretty significant pay raises. And those pay raises go straight into the economy. They don’t go into savings, they don’t go into 401k, they don’t go into the stock market. They go straight into spending. And they tend to spend on, well, gasoline, groceries, eating food out, and to a certain degree, shelter.
Mike
Right?
Sam
So these these numbers are more than likely not one off type deals, right? We’re more than likely going to continue to see significant surprises to the upside. I mean, there’s, there’s some I think it was Texas roadhouse as well that said that their January was up in the mid 20s on a year over year basis. This type of dynamic, and I think it’s really interesting following on from mike’s portion, it’s a really interesting dynamic because if you don’t have inflation crack, the Fed is going to continue with these 25s for the foreseeable future. And right now we’re sitting at a terminal rate that’s 5.25 to 55. And they’re going to continue pushing those further. If you continue to have these data points, and it’s really hard to see when the data points are going to crack, you can kind of moving away from the restaurant and retail for a moment. John deere is mid teens on pricing for the year. Those prices aren’t going down so that’s farmers are going to see their equipment become more expensive. You’re going to have food becoming more expensive when you eat out. You have food at grocery stores becoming more expensive.
To michael’s point, it’s probably not going to solve the problem by increasing interest rates immediately. And you haven’t seen a crack in construction because of the massive backlog, because we didn’t have lumber and we didn’t have piping and we didn’t have concrete, et cetera. You still have construction jobs, you still have oil field jobs, you still have all of the stuff in the middle of America, and you’ve had a few thousand people get laid off in tech.
And they all got six to twelve months giant packages to go find another job. So they’re not going to hit the jobless claims for at least six to twelve months from when they got laid off. They’re all sitting pretty, they’re all going on vacations, they’re all spending money. So again, it’s one of those where the economy still hasn’t cracked and the Fed is going further.
Tony
Yeah. I just want to be clear. I know we’ve talked about this before, but I want to make sure that my understanding is still correct. The Fed is not trying to get pricing levels back to 2019. No, we’re just trying to get them to stop rising.
Sam
Correct. Yes. Well, they would prefer to have disinflation. Right. They want to get back to a 2% run rate, but no, they’re not trying to get back. They’re not trying to go deflationary.
Mike
Trying can I just toss something into sam’s point picture of North American tractor sales?
The really critical point is that we’re talking about price increases, dramatic price increases in tractor sales, even as tractor sales themselves are, give or take, 40% below the levels from 2008.
This is insane. This is clearly market power that is going through. The tractor industry is basically divided into two players, deer and agco, neither one of which, both of which have signaled we’re no longer going to compete on price. We’re going to basically try to load everything up and produce at a minimum level. These are monopoly and you know what I mean? oligopolistic. I’m sorry. Pricing patterns where you produce well below the marginal demand because you’re effectively trying to maximize your margins.
So we’re seeing this over and over and over again. That’s why we have the ftc. That’s what we should be going after in terms of the behavior of individual companies. We should be penalizing them. We should be working to introduce new competition into these spaces, et cetera, and we just refuse to do it. We’re terrified that in the process of harming these individual national champions like deer, that somehow we’re going to create conditions under which we all collapse into the proverbial flames of hell.
The second component is that Sam hit on this dynamic of somebody who has Social Security just experienced a 9% raise. They actually experienced far more than that because remember that those who are collecting Social Security tend to be amongst the class of individuals who have accumulated a degree of savings that they had anticipated living off of for the rest of their lives. Suddenly, their checking accounts or bank accounts have gone from yielding or their money market funds have gone from yielding zero to yielding four and a half to 5%.
If I have $100,000, that’s $5,000 of incremental savings that I’m receiving. I have a million dollars. That’s $50,000 that I’m receiving. And by the way, my propensity to spend that is dramatically higher because it’s income, not principal. Now, I actually am much more comfortable spending that than I would have been spending $50,000 before.
So everything that we’re doing in, like, the last desperate act of the boomers to totally screw us all is basically handing money to old people at the expense of young people who are going to lose their jobs.
Tony
I think that’s worth repeating. And we’ve talked about that in a couple of other shows. Not that directly, but say that again. So the government is handing out money to old people at the expense of younger, more productive workers who are losing their jobs.
Mike
Correct. It’s just that straightforward.
Tony
Yeah. Okay, great. Okay, so, Sam there’s a lot to digest here, guys. It’s not pretty. It’s not a pretty episode. So, Sam, tell us about what does the Fed look like over the next three or four months? It’s 25, as far as you can see. But it’s that simple.
Sam
It’s that simple. And it’s that simple. It really you only have a couple more prints of data before of data that matters before the Fed meets and redesign plot. I mean, that’s it’s. It’s 25s for the next four for the next three meetings. Okay. Then there’s the possibility of a pause, but I would be short the possibility of a pause there simply because, to reiterate what Mike said, again, it’s a pretty orthodox place.
Mike
Right.
Sam
They’re going to continue raising rates until inflation breaks because that’s what they believe will occur.
Tony
But I think June by June will have had the base effect of crude being in $130 a barrel, right?
Sam
Core Services, Ex Shelter doesn’t have oil in it. They don’t care.
Mike
They don’t care about that. But that actually is a really critical point. And forget the year over year comparisons because nobody actually does that, right? Nobody sits down and does their budget and says, gosh, oil was $130 this time last year. Now it’s only $80. Therefore I have more money to spend. They experience it immediately when they go to the gas tank and they go to fill up their gas. Their gas tank. A year ago, they were filling it up for $100. Now they’re filling it up for $60, money that has gone back into the economy from the period of June and contributed to the perception of rebound. That, in turn, is now theoretically feeding the inflationary concerns. We see this in consumer sentiment surveys that are heavily dependent upon gasoline prices, like the Michigan survey, et cetera. The minute gasoline prices bottomed or peaked, they began to experience improvements in sentiment even as the underlying conditions have deteriorated.
Tony
Okay, tracy, I want to bring you in here because I always get complaints when you speak last. So tell me your thoughts on that in terms of oil consumption, as far.
Tracy
As oil consumption in the United States.
Tony
And the impact on inflation, how do people experience that and what impact do you think that has on how the Fed acts?
Tracy
Yeah, absolutely. I completely agree with Mike. What it comes down to is what are the prices at the pump for the actual consumer, right? And that gives you extra, theoretically, or what’s envisioned is extra spending, right, extra spending money. Because you’re not paying $100 anymore, as he said, for that example, you’re paying $60. So now you have more excess cash to, I don’t know, go out to dinner. But that’s kind of like a theoretical situation. And the thing is that I think that when we are talking about gas prices and when we are talking, we really need to see longer term results for this. I think it’s premature to say we’re seeing excess spending in this area because gas prices are down this month because they fluctuate so much because gas has been very volatile since 2020. And so I think there needs to be a lot more long term data that is focused on this, which we’re probably not going to get from the government. But I think that would be beneficial into seeing how exactly does this over the long term reflect consumer spending habits.
Tony
Great. Okay, that’s hugely useful. Sam, back to you just to wrap this up. And you’ve had this concept of hawk grackledove, right? And for those who don’t understand, a hawk is obviously hawkish Fed. A gracklish fed. And Sam, correct me if I’m wrong, is one that kind of is talking out of both sides of its mouth, just making a lot of noise where they’re not entirely sure which direction they’re going to go. And then you have a dovish Fed, which is obviously dovish. Right. What data are you looking for or what behavior are you looking for? For the Fed to really swing kind of gracklish.
Sam
I do think the Fed is gracklish at the moment. The Fed went grackle when it went to 25 because that gives them wiggle room on both sides. It gives them the ability to both push the terminal rate higher, push terminal rate lower, much more data dependent. In terms of every you put in another 25 if you put up 400,000 jobs. If inflation comes in high, you put up another 25 basis point hike. If it comes in low, you take it out. That’s really what the Grackle is.
Sam
It’s when they talk a lot and don’t really give you any incremental information. Right. Last year, they were just pure hawk. It was every single time they open their mouth, they seem to just be hawk. Now it’s, well, maybe we wanted to go 50, but we went 25, but maybe we don’t have to go any further, which is what we’ve seen over the last week. Yeah, they’re grackles.
Sam
To reiterate this, and I think I said it here, I might not have the Grackle is the most annoying bird in the world. They are loud, they fly in groups, and they scream all the time. And at least in Texas, you can’t park your car under a tree for a long time. It’s just the worst thing ever. And it’s pretty easy to understand a Dubbish Fed. It’s pretty easy to understand a hawkish Fed. It’s very difficult to understand a Grackleish Fed. And that’s where I think we’re at right now.
Tony
Okay, great. So just more to come there. We’re waiting and seeing we’re going to see at least three more, then more to come. Yeah, that’s the story. Okay, thank you, guys. That’s great. Let’s move on to tracy, who everyone’s been waiting for, of course. And so, tracy, I’m responding to, we sent out a tweet asking for questions, and one of our regular viewers, Daniel Cook, said, how is industry in Germany coping with the nat gas situation today? So I want to bring in some of those questions pretty regularly.
And you sent me a couple of charts. The first one is on ttf netgas, so can you talk us through that and what’s happening in markets with ttf natgas?
Tracy
All right, so I feel like this is a total switch from what we’ve been talking about.
Tony
Absolutely, it is.
Tracy
We’re switching to Europe right now. Right. I hate to add to the non pretty situation, but this episode is going to continue with the non pretty situation.
Tony
That’s okay.
Tracy
I think that there has been irreparable damage to industry, and not only Germany, but in the Euro area as a whole. I sent you that ptf chart because I wanted to point out that in fall of 2021 is when we had that very first spike, right? And that’s when we really started seeing industry having to pull that. That is in particular in smelters glass companies and chemical companies. I just want to run through very quickly kind of a timeline of the biggies that happened. And this will make more sense later. Why wouldn’t do this? But so in October of 2021, nystar, which is one of the largest zinc companies in the world, they cut zinc smelting production by 50% in three top European smelters. December of 2021 started the aluminum smelting horrible problem, which dunker K Industries in France. My French is terrible. So I know a million people will say that’s not how you pronounce it. But anyway, which is the largest aluminum smelter in France, curved output. Then you had followed by romanian aluminum producer alto slatina. They started a program of total closure due to high energy prices. By May of 2022, aluminum production flies more.
July of 2022, almost all of European smelting production is offline. September 2022, that starts the glass industry. So you have French glass maker derelict stops production entirely.
Tony
Sorry, let me stop you. So with the aluminum smelting so if it’s not being done in Europe, where is it being done?
Tracy
Tell me. I was getting to that. Well, since you asked, ironically, it’s Russia. Of course it is, because ironically it’s Russian. What happened is that the EU actually sanctioned Russia aluminum imports in April of 2022. But there was a clause in that particular sanction agreement that said you can get an exemption of products from Russian origin to be imported if you can get a special permit.
Tony
Of course, europeans always circumvent their own sanctions.
Sam
Always.
Tracy
So long and short of that is, within six months, EU imports, Russian aluminum surged over 70%. So that happened back to my timeline. So Bass, after cutting production throughout the entire year, in October of 22, they announced permanently they were downsizing their factory in Germany as far as production and labor is concerned. And then in November 2022, they announced their largest service treatment treatment site in China. So long and short of this is that when you look at these industries, right, you have to look at especially smilting and glass in particular, these blast furnaces. You just can’t turn them back on, right? They take months and months to get them the proper temperature again. And if you look at if you revisit that ttf graph, you can see there’s been no relief for these industries to be able to get back online. So you can assume that’s gone because now it’s been over a year, right? And so people have already I mean, even Europe has already sourced other people outside of Europe. So these industries are not coming back.
Tony
So can you talk us through capacity utilization and how the industry is not going back has impacted capacity utilization? Because the capacity utilization is a measure of the capacity that is still there, right? Not the capacity that’s online.
Tracy
Right. What is still there. And so what we see in the graph that I sent you is Germany. But really, if you look at the Euro area as a whole, that graph looks exactly the same. And what we’re seeing is that even though Nat Gas prices has limited I can’t speak to that either. It’s limited over the last six months. We’re still seeing utilization down. These industries are not coming back.
Tony
In other words, where are they going?
Tracy
They’re being outsourced everywhere else. In fact, Europe has a big problem with regulations and red tape, which has been a huge pitfall for companies. And so oh, you know, companies have been looking elsewhere, for example, China, the Us. Mexico, South America, and realize they’ve been dealing with this since the first spike in fall of 2021. And so they’ve had plenty of time. And now, I know the EU has been very vocal about the Us. Inflation Reduction Act and worried that it’s going to incentivize business to leave the EU for the Us. Which is a concern. I understand that. But I guess I would say the essence of the debate has been this in face of the $369,000,000,000 worth of tax breaks and subsidies set aside to boost green technology and energy security in the Us. How can the EU maintain a leading position in clean tech industries moving forward? The problem is that they’ve taken six months to talk about this without doing anything. It’s all been talked. And so companies have already been looking elsewhere outside of Europe. So, unfortunately, I think what this is going to lead to is kind of a deindustrialization of not only Germany, but the Euro area as a whole.
Tony
Well, that’s pretty dire. So you say it’s going to China, Us, mexico and parts of South America. I assume that’s Brazil? Maybe.
Tracy
Yeah.
Tony
So that’s a net positive, I guess, for North America.
Tracy
At least it is for North America. Europe is running very scared right now. Right. Again, they’ve been having meetings for the last six months, but the problem is that they continuously drag their feet on making decisions. And when you drag your feet that long, you give companies ample time to make other plans.
Tony
Right. Okay. So how does this end? If if we had Nat Gas stay at low levels for three years, do you think that manufacturer would would come back?
Tracy
No. Back to Europe? No, I think they’ve already made once you’ve already made other plans, and you already left. And we’re talking about companies that have literally shut down things permanently.
Tony
So parts of Germany become western Pennsylvania.
Tracy
Yes, but again, I don’t want to be a doom and gloomer and say it’s totally in German manufacturing, but I will say that I would keep a close eye on that, because I think that you’re going to see, I think Germany as an industrial powerhouse is going to not be over the next ten years wow.
Mike
Tracy, when you say over the next ten years it’s not going to be a powerhouse, is that because the cost of producing, you’re saying effectively is so high that they’re no longer going to be able to compete?
Tracy
Correct.
Mike
Is the flip side of that just that the cost will go up because the world needs their supply?
Tracy
Well, that’s a twofold question. First of all, we’ve already seen industry already close there permanently, such as basf, just the largest chemical manufacturing company in the world, basically has already decided to leave Germany. Not entirely, but they have decided to pare down their manufacturing process and their labor in Germany and look elsewhere. And I think that it’s going to continue to happen because I think if you look at Germany or EU in particular, there is a lot of bureaucratic red tape there and a lot of things. And until I think that Europe really addresses that issue, more and more companies are going to be encouraged to go other places where perhaps that rig tape is not so difficult. In addition, it’s a lot cheaper as far as labor, et cetera.
Tony
Wow. Okay, so how does the German market what can they do to cope with nat gas prices just in terms of the day to day consumer?
Tracy
Well, obviously nat gas prices have come way down since the peak in July of 2022. But I don’t think that is completely over with. I think the market is a little complacent right now because prices have come down so much because the German government has been asking for people to cut their consumption not only on the consumer side, but on the industry side as well. And so we’ve seen a 30% decrease in consumer industry consumption due to a lot of initiatives that they’ve asked for.
Tony
While increasing their coal consumption and shutting nuclear.
Tracy
Yes, I think it’s a difficult road. I don’t think Europe as a whole is out of the woods yet as far as natural gas is concerned. We talked about that last week a little bit. But as far as industry is concerned, I am really worried because I think the signs are all there, that we are at least starting to see the deindustrialization process of airport, which would be mark a significant change in industry, particularly for Germany.
Tony
Wow. Okay. That’s something to really think about, something we want to keep an eye on because I’m very curious about that. Okay, guys, thanks for a real downer of a show. That’s awesome.
Sam
Wages were going up. That’s not all bad.
Tony
This has been great. Look, we’ve been a little more thoughtful today, I think, a little more kind of looking at kind of the whole context rather than just the markets. And I think that’s great. And I think what’s interesting to me is there’s not a lot of focus on this in the day to day hype cycle that we see. Of course. Right. But these are things that we have to look at within the context, not necessarily within the decisions that we’re making every day. And so I really appreciate this Mike, I really appreciate between you and Sam, your newsletters have such deep thought in them and application to what’s going on today as well as say the medium or longer term. It’s just fantastic to get that. Having said all that guys, what’s on your mind for the next week? So tracy, let’s start with you the week ahead, what do you have coming up next week?
Tracy
What do we have coming up next week? I think next week, I think honestly it’s going to be more of the same. I think we’re going to see a lot of volatility in markets, especially looking at obviously commodity markets are kind of my focus. I think that you are going to see that. I think everybody should keep an eye on the dollar, particularly if you are trading commodities because we are sort of seeing a technical breakout of some sorts looking at the daily charts. So keep an eye on the dollar and then again I still expect volatility to continue in the commodity markets. With conflicting news on a higher dollar, china reopening Russia export. They said they were cutting five hundred K million barrels per day starting in March. But then they just said this morning that their butt they’re keeping exports the same. Crude oil markets didn’t really like that.
Tony
Their natural production is down 20%. So of course they’re going to cut $500,000 for domestic consumption. Are you still there tracy? Okay, Sam, what are you looking for in the week ahead?
Sam
I’m basically just kind of listening to whatever. I don’t really think there’s that much that’s all that interesting coming out next week. Maybe jobless claims will be interesting, unlikely, I don’t know. Honestly, it’s just a lot of chop. It’s all about waiting. It’s kind of like waiting on godot except you just sub in China for godot, wait for them to reopen, wait for them to actually make a move on the stimulus. Some announcements that actually makes sense in terms of how they’re going to stimulate, et cetera, et cetera. So right now I think it’s a waiting game and sitting on your hands is probably the most intelligent thing to do through the job.
Tony
Yeah. China is going to announce rail stimulus like they have for the last 30 years. I can guarantee that’s part of the mix. Okay, thanks for that. And Mike, how about you? What are you looking at for the week ahead?
Mike
Well, we have the traditional data dynamics like tracy, I’m very closely watching the Us dollar, but more importantly I’m starting to watch the credit events that are beginning to pile up. So you had brookfield walk away from two buildings last week. You had Standing file for bankruptcy today as fuel pump manufacturer has been in business continuously for 150 years citing unsustainable levels of debt repayment from buyout done with cerberus. This is the waiting the higher for longer framework. The continued tightening of liquidity is the equivalent of a distributive top in equity terms. Right. You have to wait and it’s going to happen. You’re going to see the distress begin to mount and the Fed will ultimately manage to crush demand because they’re creating an incredibly compelling reason for those at the high end with true discretion, right? I mean, remember the low end, that bottom 50 percentile that Sam and I are highlighting in terms of the consumer, they don’t really have a choice about discretionary spending. They basically don’t really have any savings. And so when they’re faced with a loss of real purchasing power, as we’ve seen over the last year, they originally kind of that second quartile turns to credit cards and other mechanisms to allow them to continue to purchase goods and services in the hopes that things are ultimately going to get better.
Mike
We’re now seeing those hopes begin to run out. The additional space on their credit cards is becoming exhausted. Unlike the old and the extremely wealthy, they don’t have significant quantities of cash in bank accounts or in money market funds. So they’re not benefiting from the increasing purchasing power. They’re beginning to falter. We’ll see the signs of that. My expectation is sometime in the next quarter.
But it is a waiting game right now, right? And until the Fed begins to see the evidence that it’s mission accomplished in hammering the demand side of the equation as compared to the supply side, which is really what they’ve hit so far, my guess is that they’re going to continue to proceed. The words we’re getting are the equivalent of subprime is contained, even as those of us who are following it closely fully understand that sub prime is a critical part of the stack and was never really the problem to begin with.
Tony
So what you’re all saying is kind of take a deep breath for now.
Mike
Take a deep breath and be prepared to hold it as we submerge. My advice.
Tony
Okay, it’s good to know. Guys, thank you so much. This has been a real kind of wake up. So thanks very much. I really appreciate this. Have a great weekend and have a great week ahead. Thank you.
I have adopted the position that when a central bank allows its government to overspend and abuse its currency, something has to give. You could say this is one of the unwritten laws of fiat currencies. Time and time again history has proven this to be true and it is the reason many people claim gold is the only true form of money that cannot be corrupted. In a world where everything seems subject to manipulation, this claim about gold is still up for debate.
The overspending by governments coupled with inflation has really started to affect the perceived value of currencies in relation to other currencies. As these relationships break the losers are the people holding the de-valuated currency. Of course, many factors feed into how we value a currency but the crux of this article is not about whether a currency is over or undervalued but rather what a country must do to defend its value if it comes under attack.
Brent Johnson of Santiago Capital is credited with coining the term the “Dollar Milkshake Theory.” It explains how our debt-based monetary system can cause the US Dollar to rise despite the increasing liquidity injections around the world. Whether this was a “grand master plan” or a situation that just developed over time, it is something that may bode well for the dollar. Johnson recently took part in a discussion that included subjects such as the future price of oil, housing, and the probability of a huge global huge recession.
Johnson conveys what many of us see as a truth that haunts fiat currencies. This is rooted in the fact that when the value of a currency falls, a country and its central bank cannot save both its currency and its bonds. In his “slightly edited” words;
“The problem is you cannot, and this is for every country, the US included, again, there’s a progression in how it’ll go, but you cannot save both the bond market and the currency market because they work at cross purposes. Whatever you do to save the bond market hurts the currency. Whatever you do to save the currency hurts the bond market. And every central bank in history has promised they won’t sacrifice the currency, and every central bank in history has ultimately sacrificed the currency.
And the reason they always choose the currency over the bond or the reason they always choose to sacrifice the currency over the bond market is for two reasons. One, the currency affects the citizens more than the government, and the bond market affects the government more than citizens. So they’re going to bail themselves out before they bail the citizens out. And the second thing is if the bond market blows up and the banking system blows up, there is no longer a distribution system for the government to raise money.
So they can’t let the bond market blow up because then they can’t get money anymore. And then if they can’t get money, they can’t operate. So this is a very long way of saying that I understand why the market moved the way it did. I think maybe in the short term it makes sense, but in the medium to long term, it doesn’t make any sense to me at all. Again, kind of watch what they do, not what they say.”
He later added “The problem, as we’ve kind of figured out and found out that it’s very hard to just get four for four or 5% inflation. It goes from 2% to 12% pretty quickly. They don’t have as much control as they think they do, right? And the problem with four or 5% inflation, you can kind of get away with it because it’s annoying and it is frustrating, but it’s not totally ruining your life. But with 8, 9, 10, 12, 15, 80% inflation, that starts to ruin the pledge life, as you mentioned. And that’s when they start to push back from a political perspective. And that’s what central banks and governments don’t want. They don’t want the populace revolting”
When you think about the true motivators driving this “system,” it is logical the government and central banks would throw the populace under the bus. This is about their survival. As to the question of equal pain, those in power justify taking raises to offset the impact of inflation under the idea we “need them” to steer things forward for the “greater good.”
While Johnson’s remarks were aimed at what is most apparent in the actions of Japan, this truth is problematic to all fiat currencies. For more on the Dollar Milkshake Theory see;
In this episode, Ross Kennedy of Fortis Analysis, Ralph Schoellhammer of Webster Vienna Private University and Albert Marko joined Tony to discuss three main themes: supply chains in 2023, the existence of China in 10 years and Germany’s dependence on Russian gas.
Ross Kennedy led the discussion on supply chains in 2023, and he explained that although supply chain issues have appeared to normalize over the last 4 months, with trans-Pacific shipping rates falling to levels at the start of the Covid pandemic, there are still things to watch out for in the upcoming year.
Albert Marko led the discussion on the prediction that China will not exist in 10 years. This claim was made by Peter Zeihan, a geopolitical analyst, during his appearance on Joe Rogan’s podcast. He went on to say that some of Zeihan’s predictions sound impressive, but he and Ross Kennedy both have doubts about the validity of this claim.
Tony pointed out that similar predictions were made by George Friedman in his book “The Next 100 Years” (2009), where he said that China would split into 5 countries. However, both Albert and Ross argue that China’s economy, military, and political power are too strong for this to happen in the near future. They also highlighted the fact that China’s growth and development have been hindered by the pandemic, but the country has managed to recover quickly and is still a major player in the global economy.
Ralph Schoellhammer led the discussion on Germany’s ongoing dependence on Russian gas. He wrote about how the green push in Germany has led to a decrease in the country’s dependence on Russian gas, but there are other considerations. He explained that the Russia-Ukraine War had a major impact on Germany’s dependence on Russian gas and that when the war stops, it is likely that Germany will welcome Russian gas again. He also highlighted the fact that Germany’s dependence on Russian gas is not just a matter of energy security, but also a matter of economic and political considerations.
Key themes: 1. Supply Chains in 2023 2. Will China exist in 10 years? 3. Germany can’t quit Russian gas
This is the 49th 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. Today we’re joined by two new guests. We’ve got Ross Kennedy. You may know Ross as Huntsman on Twitter. He’s with Fortis Analysis. And we’ve got Ralph Schoellhammer. Ralph is at Webster Vienna Private University. And we have the honor of having Albert Marko with us again today. So there’s a lot that’s happened really over the past couple of years around supply chains. And we’re going to kick off talking about supply chains in 2023, and Ross is going to lead us on that. But next we’re going to look at China. There have been some claims made about kind of existential claims made about China over the past couple of weeks, and Albert is going to walk us through those. And then finally, Ralph is going to help us talk about Russian or sorry, German energy and German dependence on Russian gas. So let’s get into it, guys. Thanks for joining us. Ross, you know, I’ve seen a lot on Twitter. You’re you’re talking quite a lot about supply chains. And in 20 and 21, you really opened a lot of our eyes to some of those issues.
So I’ve wanted to have you on the show for a long time. On the screen right now, I’ve got a chart of shipping rates, Asia to us, west coast seafood rates, and those obviously ballooned up in 21, came back down in 22. And we’re kind of now down to about where we were in Q, one of 20. So the last four months, things have really started to calm down in terms of the costs.
But I guess really what I want to get into with you is, are supply chain risks a thing of the past? You know, what should be we be looking for in 2023? I guess that’s let’s just start with that. Are they a thing of the past? And what should we be looking for in supply chains in 23?
Ross
Yeah, I think supply chains have changed in terms of the scope of risk. Certainly it shifted from one to the other. We had a short term risk that was very systemic as far as manufacturing in China being completely disrupted, the ability to ship out. And then we had the entire issue of people changing their buying habits basically by force as far as lockdowns from a lot of events, a lot of entertainment, a lot of things where their dollars are being spent on, not physical things that actually have to be chipped. And all of a sudden, everybody took that spending, they took the stimulus money, and they just began buying things that were feathering their nest or occupying their attention. And so you had the disruption not only of lockdowns, not only of that, but you had this very enormous shift in purchasing from experiences or non tangible things to physical things that have to be shipped. That’s why you saw the run up in stock for Amazon and numerous others, it was because people were doing that right. So we had this enormous crunch that was driven by that fundamentally. And now we’ve seen we have the bullet effect.
Ross
Inventories were dramatically over ordered and now we’ve got inflation happening. So inventories are full and demand is down, particularly on the transpacific trade to the West Coast, the US. China. What we have seen, though, is that there has been container volume shifted to the Gulf. It’s also shifted to the East Coast because we’ve had the risk really since July of last year of longshoreman strikes. And then you have the concurrent risk of rail strikes coming off the West Coast. So we have seen some volume that’s still in place shift. But depending on who you are as a company, we’ll determine if that has actually your supply chain problems have begin to unwind a little bit or if they have really only begun or if they’ve just changed as far as what they are. If you’re a retailer in the US, you really just started shipping over the East Coast if you’re concerned about West Coast risk and you still have to move inventory. But that’s assuming that now the lockdown, lockdown, lockdown, no lockdown, back to lockdown and now no lockdown again with people out sick right in front of the Chinese New Year, if that hasn’t dramatically impacted your business.
Ross
There are some sectors that have been heavily hit by that hard. The impact is less to China in some ways because they’re heavily subsidized in a lot of their industries. The impact is more so, I think, felt by the US. And I know Albert will talk about the China side of that factor. But what we’ve seen now is a dramatic disruption, really, to the way things are. Not in a foreseeable way, not in a way that a lot of people know how to forecast. In a very I would say very unexpected way where you’ve got this sort of well, not unexpected to this group, but unexpected through a lot of supply chain and planners and executives of. They went from huge amounts of demand to very little demand due to inflation here in the US. And then you also have the supply side disruption in Asia. So that’s sort of the twin monsters that a lot of North American companies and European companies are dealing with related to planning this.
Tony
It sounds to me like we have a couple of things in general that are helping to alleviate this. First is price, right? Things are more expensive and so that’s pushing down demand on a volume basis. But we also have China opening up and so that is alleviating supply chains on the supply side. So those two dynamics seem to be really helping us into 23. Have we also seen I know there’s been a lot of talk about this, but to what extent are we seeing rotation of manufacturing locations? Is that a major effect or are we in the early stages of that?
Ross
I think we’re in the very early stages of it. It takes multiple years if you’re going to uproot a semiconductor foundry, for example, which everybody’s made a big deal about, the chips act and all that. And I think Nancy Pelosi had a great run financially because of that for a while. But it takes three to four years, even five years, from soup to nuts, be able to get the process of moving something halfway around the world from one location to another. You have to make a lot of things before you install them and then begin making chips. Other things that are able to transition very quickly are doing so. Things that are fungible, where you’re essentially reprogramming a machine to print a T shirt in China versus Vietnam, that stuff is already shifting. You’re already seeing demand pick up for things like garments and textiles in Southeast Asia and India and Bangladesh. Pakistan also has gained a little bit on the textile side, but things that are energy intensive to manufacture, things that require critical raw materials or certain types of inputs that China does very well. We’ll probably talk a little bit about Zahance hypothesis with regards to China, but China is very dominant in a lot of raw material sectors, and assuming they continue to have the energy and labor available, it’s going to be a lot slower to ship that type of stuff away from China.
Ross
But things that can shift. Are you’re seeing more tires produced outside of China again, for example? So, again, it’s very sector dependent, and a lot of people want to make projections or economic plans or suggestions about the way things are on a macro scale without really understanding that in certain ways, china still very much holds the whip hand. And you won’t see manufacturing shift in other ways. You’re seeing it shift very rapidly away from China and that’ll have an impact on them as well.
Tony
Okay, so let’s take a step back to, say, 2019. Okay? We had Trump, who was trying to get different things out of China and bring things to the US. And reduce China’s centrality or centricity to supply chains. And then we have COVID come in, and that really disrupts supply chains. And then there’s this wake up call for people to kind of regionalize manufacturing, right? So this reminds me a lot of, say, 2007 eight, when it started with Japanese companies doing a China plus one, china plus two, China plus three strategy, right? That’s happening again. But after we got through the financial crisis, everyone just was like, China is easy. Let’s just go back and do that. Are we going to see that again? Are people just going to kind of shrug shoulders at the end of the day and go, people are inherently lazy. I don’t want to have to do the work to have three different sites to manufacture this stuff. So let’s just put it back in China. Is that likely to happen? Or was this wake up call the one that really pushes people to have resiliency in their supply chain?
Ross
I think, again, from a sector dependent standpoint, it’s yes and no. To the extent that if the stakeholder, if the primary stakeholder of a company is the US. Let’s say a Honeywell, for example, they will have to pull out US policies. We have reached a point that even if the US has a company is US based and they’re like, we’re going to still try to manufacture there for whatever reason, it is too much of a lift to pull out of there. In a lot of respects, xi Jinping has a vote on that too. If he wants a company out, or if he wants to just see that company’s manufacturing capacity or whatever, he’ll do it. Right. So the bad guy always has a vote on how the fight goes too. So that is one group of companies that very much can be expected to either leave on their own or be forced out in other sectors where a company can be co opted or the US. Isn’t really paying attention. Yeah, I think you’ll see the impetus to just kind of try to hunker down and ride out this ten year sort of economic cold war, if you will.
Ross
In their mind, they’ll do that as well. But again, so many of the unknowns that are driven here are the fact that China has a vast ability, if it chooses to, to leverage its own strategic advantages to push us around the anchor companies there if they want to, to kick them out if they choose to. And for whatever reason, really, outside of a relatively small group of Natsych types and people that do analysis really well, they’re not discussing what the calculus is on the other side. They’re just discussing what the US. May or may not be able to do through our own policy. At the end of the day, particularly when it comes to energy, anything that’s super energy intensive to manufacture, it’s not attractive to restore to the US right now because the Biden Administration, the Department of Energy, particularly FERC, they’re not going to get out of the way, and they have not proven to do that. So we’re not going to be able to make the fertilizers and fuels that we need to if we are continuing to drive them away with terrible energy policy and drive the price of energy sky high.
Tony
And as a Texan, I will tell you, we have all the raw materials here, right? There’s no reason for us not to do that. A lot of Americans may not like Texans, but generating wealth here really does help all of America, right?
Ross
So in my view, particularly when you talk about the Gulf, the raw capacity is there from a transportation side, from a labor side, from a raw material side, particularly energy, to to turn the south MidSouth all the way down to the Gulf into a manufacturing mega region. That that would be one of the great economic success stories of all time anywhere in the world. And that’s a policy issue. It’s certainly not a capability or capacity issue.
Albert
Yeah, the problem with that is the EPA makes a lot of manufacturing in the United States inefficient and uneconomical, just something yeah, we can’t get around it. It’s the problem.
Tony
Okay.
Ross
And Europe has done very well with a lot of that stuff as well, too. But again, it’s subsidized in Europe, some of those offsets, if you will, they’re heavily subsidized. And so the companies don’t bear that burden to the extent that they would in the US. Where that type of thing is just as heavily regulated and penalized with zero subsidy.
Tony
Right. So since we’re talking about supply chains mostly into the US. Since we’re often here, let’s talk a little bit about Germany. We’ve seen German politicians go to China over the past couple of months, and German heads of industry go to China and kind of almost double down on their commitment to China and double down on their dependency. And it almost feels like Germany is having the opposite conversation from a policy perspective that the US. Is in terms of the US. Is trying to reduce its dependence on China. It seems like Germany is just going all in. Is that a misread, what’s going on there?
Ralph
Well, yes and no. There have been voices in Germany getting louder, particularly when it came, for example, to the Chinese buying parts of the harbor in Hamburg or a German Chip producer. So there are some voices that are getting more critical, but overall, the Chinese market is still crucial for German exports. So kind of when the German Foreign Minister, Angelina Bieberk was in Asia a couple of months ago and she said, we will stand side by side with Taiwan in the case of a conflict. That kind of was immediately backpedaled by other German parliamentarians who said, well, the Taiwanese didn’t ask moral support, so we have no intention to give tomorrow support. So I guess it would be very similar to the Russia Ukraine thing. I mean, in a sense, I think what’s always very important when we look at particular German foreign policy, they are not really for or against someone. They primarily want to maintain the status quo. So they want to maintain as much as they can the 1990s early 2000s status quo. That is true in the Asian case. It’s also true in the case with Russia and Ukraine. Right. Because some people say, why are the Germans not more supportive of Ukraine?
Ralph
Or are they all in the pockets of the Russians? I don’t think that’s the case. I think German policy is to maintain a status quo when it comes to exports in China, when it comes to energy with Russia and everything that quote unquote disturbs the peace is seen as a nuisance, and they usually kind of bet on the party that they hope can end that nuisance as quick as possible. And then I think was a little bit the miscalculation in the Russia case that they originally believed that this is going to be a war like Georgia, like other earlier conflicts, that this is going to end very quickly.
Tony
And we can all pretend it didn’t happen, right? If it ends quick, it didn’t happen.
Ralph
Precisely.
Ross
And that didn’t happen too, that are like leading indicators of German behavior with regards to China. BASF is one of them. Not only is BASF not recognizing its potential position of dominance on the vitamin and specialty chemical side, it’s actually doubling down on China and expanding its manufacturing operations there, not retracing from it. And if you look at Mercedes, for example, I love Mercedes Benz as a company, and I think they make some of the most amazing machines in the world. But you’re not going to tell Mercedes, get the hell out of China. They’ll do, and they can.
Tony
But they have got Volkswagen cans. Mercedes can.
Ross
Volkswagen can.
Ralph
And as a quick second point of this, the German energy planet, we’re going to talk about this a little later in more detail, but they still want to double down, particularly on solar and wind. And they need China as a partner to have good relations with China because they control most of the supply chains in these areas. So as long as Germany doesn’t really have this often announced but never actually materialized u turn in their foreign and domestic policy, this is not going to change. So I think, as you guys correctly point out, whatever the headlines say, whatever the Sunday speeches by politicians are, I think the underlying indicators still strongly point towards not just Germany, I would say all of Europe kind of being at least economically very benevolent towards China. And I think sooner or later, with the exception of some Eastern and Central European countries, I think many Europeans would be more than happy to renormalize relations with Russia as much as possible.
Tony
Let’s get on that later.
Ralph
Okay.
Tony
Before we move on, what do you see in supply chains that people aren’t talking about, that we need to know about? What is a thing where you’re just like, gosh, why don’t people see this? What is that? What’s supply chains?
Ross
It’s food. Probably the biggest and most obvious one that comes to mind. Everyone’s talking about semiconductors. That’s an obvious one too. But that gets beat to death. And frankly, the US. Really holds some major strategic advantages with that as well that don’t get discussed enough when we talk about that issue. On the food side, though, particularly with regards to China and Russia, russia is an enormous manufacturer of certain fertilizers. That’s very true. Now. The US. Has tremendous optionality with Canada next door. We make a tremendous amount of nitrogen. We have the ability to make more. We do find for ourselves on phosphates. We have significant phosphate reserves on the potash side. Canada has the far and away the most reserves in the world and an untapped capacity to move more to the US. So I don’t subscribe at least as far as like Europe and the US are concerned to the macro nutrient issue of NP and K that you’ve heard recently and for a long term elsewhere, that Russia and China control the world on it. They don’t. We do find out fertilizers amino acids are an enormous issue. Vitamins and micronutrients. And those are the ones where, when you’re talking about there’s roughly ten major vitamins that go into animal and human nutrition, but particularly into animal feed to keep them alive, to help them grow faster, to help them produce higher quality meat and eggs and milk.
Ross
Almost all of those vitamins are 90% or more manufactured in China, most of them at 100%. When you talk about key minerals that needs to go into their diets, whether it’s a zinc, calcium, or you see sometimes manganese and magnesium added in as well. Other than Turkey, India and Brazil, most of that stuff comes from China, too. And then you talk about the big amino acids. The US. Is far and away the largest meat producer in the world per capita, even more so than China. But we make about 40% of the amino acids needed in the diet. So we make far and away adequate supplies of DDGs or soybean meal that we use as the crude protein and the crude fiber. But the other 20% of that is completely, almost completely controlled by China. And then BASF and one other company based in Switzerland. And so if they turned off the tap on that, I hope you got it, that she’s not watching this, they turn off the tap on that, it would be crushing for our food sector.
Tony
So is there anybody who’s talking about rotating that production elsewhere? Any company is making that?
Ross
Adm and Cargill talk about it because they’re the only ones that actually make the stuff in the US. In ADM’s case, they manufacture in house. In Cargill’s case, they’re actually the glucose or dextro stream that gets fed into that fermentation cycle to make aminos. You have Ivana and Blair, Nebraska. You’ve got two companies in Iowa, korean and Japanese. And that’s CJ and International and Naji Namoto. They are also an over the fence agreement with an extra cargo, corn mills. That’s it, really, as far as that type of product in the US. We could expand that capacity relatively rapidly. But we have seen amino acids in particular go through so many expansion contraction, volatility cycles that to an American company, particularly one that’s publicly owned, one like Adm, the juice isn’t there for them. They’re not going to take a 20 year investment risk on something that on a year to year basis could lose a lot of money.
Tony
Okay, but if they had to, how long would it take to get that up and running?
Ross
It takes less than two years to build a wet corn mill. But if you were to expand fermentation capacity at any of the already existing wet corn mills in the US that are making, let’s say, high fructose corn syrup, I think of Golden Growers, which is a 50% joint venture with Cargill up in the southeastern corner of North Dakota. All they’re making up there is high fructose corn syrup for food. They can easily convert that stream into fermentation inside twelve months or less. So we do have a dormant quick to market capacity, relatively speaking, the faster we could get that type of thing online, you could do it with subsidies, you could do it with some market protections, you can do it in the food bill and just add certain things in there that favor that type of production. So these are not unsolvable problems. Vitamins. We are, pardon the language, if China really does decide to cut us off on that, that becomes very problematic in a hurry because it’s three to five years to get vitamin production online. If you’re talking synthetic vitamin production, all of that is adjacent and utilizes coproduct from the petrochemical industry.
Tony
Okay. So when I hear this stuff, it makes me wonder, with all of the money that the federal government puked out in 20 and 21 and early 22, this seems like a relatively small investment.
Ross
And it’s very small. A couple years to build a massive vitamin plant? Yeah, you could co locate a vitamin plant right next to Port Arthur, any of the places that are along the Gulf that are very dense and natural gas, and within 24 to 36 months, depending on permitting, if you put a fast lane in place, you could do it in 24 months. And the expertise exists in the US. To build that.
Tony
Okay, thanks for that frustrating example, but it’s something we need to talk about, right? And people need to know about it.
Ross
Albert will tell you this. It’s not talked about much in DC. I’ve briefed numerous Senate committees over the last year on this. A couple of House committees, a whole lot of staff members and Congressmen to their faces. And I show them the charts, I show them the numbers. And it’s really outside of anybody who’s part of the Midwestern congressional delegations. They have no idea. It’s completely foreign to them, and it’s really one of our pacing. Strategic risk.
Albert
Yeah, there’s like deer in headlights when you start bringing up these complex issues, supply chains and asymmetrical responses that the Chinese hold against us, it’s just nothing. It just doesn’t register.
Tony
Yeah, it’s terrible. Okay. Thank you, Ross. Sober, let’s move over to you. And I want to since we are talking about China, let’s talk about, I guess, a Twitter discussion that you and Ross had last week where you invited him on the podcast to talk about some of Peter Zaan’s comments about China.
So, just so everyone knows, I tried to connect with Peter Zion on Twitter and invite him to come on, but he’s very popular and we’re really small time for him, so I don’t blame him for not coming on.
Ross
But anyway, he just doesn’t want to be challenged, maybe.
Tony
Well, possibly. Look, the guy is a great speaker. When I watch him speak, I wish I could speak that well. Right. He’s obviously very smart and he says some stuff that sounds really impressive. Big old predictions, all that stuff. So, having said all of that, he was on Joe Rogan last week and talked about China and basically said that China won’t exist in ten years. Right. Now, this, to be honest, is a derivative of George Friedman’s hypothesis in a book called The Next Hundred Years that was published in 2009, where Friedman said that China would split into, I think, five countries. You know, part of it owned by Japan, part of it, you know, whatever. It’s it’s a really interesting book where he talks about a research in Turkey, a stronger Mexico, all that stuff. I definitely recommend that to people. Some of the stuff doesn’t sound real, but directionally it’s interesting. But Albert, both you and Ross have opinions on this, and you can talk about any of the stuff that Peter Town said. But I guess, broadly, do you see China as a nation state by 2033?
Ross
Of course I do.
Albert
It’s an absurd comment to say that it’s going to break apart within ten years. I mean, you’d have to have something cataclysmic to break up some major industrial nation into ceasing to exist. I don’t understand how that could possibly even come to come to fruition. I mean, China has a strong economic growth. They’ve brought up a middle class, they have a CCP that’s a centralized government that can initiate policies and stimulate the economy at will. They have a grasp on the country, they have a good grasp on the population. Everything that you see that comes out of these protests or whatnot, that’s something that the politicians in China allow you to see. And it’s a messaging thing. I was on here what is it, like, a month ago with Atlantic Council guys, and they’re about the COVID lockdowns and whatnot, and I said, this is your signal that China is opening. And literally, I think it was like a week later, they opened. The thing is, people look at China and they take things at face value with politicians and with data that comes out of China at face value, and you simply cannot do that.
Albert
As much as we blast the Chinese for their belt and road initiative, the key component of that is they have food security coming through that. They have farmlands in Africa, they have meat coming through the South American border. And even if we were to cut off their meat supply, by some measure or another, they still can fish the Sea of Japan, that has 5% of the world’s fish. So they have options for feeding their population in a pinch, and they have the stability and the military and the police force to keep people aligned. So I don’t see how, barring a meteor hitting the place or barring some kind of like, supercharged COVID starting to kill millions and millions of Chinese people, I don’t see how it’s even possible, even logical, to say that it can end up ceasing to exist in ten years. Just the asymmetrical challenges that the world would have to bring China down if they tried to would be devastating for the global economy.
Tony
Yeah. Ross, what do you think there?
Ross
Yeah, I think almost every discussion about the demise of China ignores one simple thing, and that’s not unique to Communists. Will to power is certainly very baked into the cake when you’re talking about communism. But in terms of strategic optionality, china has done a better job than any communist country ever at reinforcing their flanks strategically in a lot of different ways. And so you have to account for that. You have to account for the agency, again, of the adversary, which I think a lot of the discussions about the decline of China do not account for. It at least makes it incredibly complex and certainly is by no means is anything certain one way or the other. On the demographic time bomb issue. I have a very cold hearted way to say this. I don’t think they care. I don’t think they care. When you look at an enormous number of people that are, on the one hand, potentially would die off in some sort of food shortage, certainly with the reopening the percentage of people that at least from the people I talk to and deal with in China on a daily basis. It’s not a lot of young people, it’s not a lot of the productive workforce.
Ross
Again, just like in the US. It’s a lot of people that are unhealthy or older or both. And so you’re talking about people that already have significant respiratory issues in the cities, then getting hit with any sort of cold that’s beyond a basic cold, it’s going to be a problem for them. Right. So even if they survive, you’re still talking about a percentage of the population that in the communist mentality are viewed as less productive or drains on the state’s resources. They don’t really care if a lot of these people die. They truly don’t. And some level of very minor famine where they have the ability to begin to marshal resources and shepherd them a certain way where they can even target who wins and who dies, that type of thing, we will see in that sort of scenario. And they will be able to almost indefinitely put on not indefinitely, but for a much longer. Period of time be able to put off the more severe impacts of a demographic time bomb. And the other issue is, of course, too, they’re atheistic, right? They don’t recognize Christianity or a Jewish god or an Islamic god or whatever.
Ross
So they’re really unbound by any sort of traditional moral or ethical constraints that we have in the west. And so who knows what sorts of technology, what sorts of medical procedures and things they’re pursuing that will in addition to things like automation, they’re now one of the top 15 most automated manufacturing economies. A lot of the robots in the world have shifted production to China from Europe. So they’re dealing with things in a way that all these other models talk about the demographic time bomb don’t account for. They’re going to be a smaller population, but I think long term that also may be baked into their calculus or even serve the interests of what they’re looking towards. Absolutely.
Albert
Yeah, I could have said it better myself for us, I mean, the Chinese are pragmatic. They don’t make foolish mistakes when it comes to their existence. They went out and bought grains for a year and a half. They went out and secured meat for a year and a half. They took advantage of the Ukraine war and secured energy supplies for a year and a half. I mean, they’re not some kind of blind entity that’s going to be taken by surprise. They know their challenges. They understand these problems. There’s something that it’s not as simple. The population goes down, they’re in trouble, they cease to exist. Those dots I just can’t connect.
Tony
Sorry, Ralph, you had some comments.
Ralph
Yeah, just that I fully agree with Albert and Ross said, and I think the demographic part what is often overlooked. I mean, imagine you as a dictator, right? What kind of population would you like to have? One that is on average in the early 20s, or one that’s, on average in the late 30s or early forty s? I think an older population is easier to control because we see this in the Middle East and in Palestine. In these areas, it’s young men who are the biggest problem for social stability. If you can find this golden middle ground of late 30s, early forty s, I think that actually could be to the advantage of the stability of the political system. The only thing because Ross, you mentioned the religion part. I mean, I don’t know if this is still true. It was definitely true a couple of years ago, right, that China had the fastest growing Christian minority in the world. So that doesn’t matter if it doesn’t penetrate the political system or the political leadership. I’d be curious. That’s kind of the only scenario where I would see major changes if all of a sudden kind of these ideas, for whatever reason, start to penetrate the inner circle of Chinese leadership in a kind of ancient Roman scenario.
Ralph
Where all of a sudden the Roman Empire became Christian in an exaggerated fashion. But otherwise, I think you guys are completely right. The I think the the rumors of China’s immediate demise are strongly, strongly exaggerated.
Tony
Yeah. Let me let me add a couple things here. I think when when people make comments about the demise of China, I don’t think they understand modern Chinese history. If you look from, say, the mid 50s until today, certainly well, I guess the 19 teens until today, right. The the volatility that you’ve seen in China’s social structures, the conflict you’ve seen, the famines you’ve seen, the deaths you’ve seen. And certainly in the CCP area, the tolerance that the population has had for leadership, whether that’s coercive tolerance or whether that’s genuine tolerance, they have tolerated a lot. Okay? Now, when we look at, I think, part of the pressure on the CCP, maybe not China as a nation state, but the CCP as a ruling party is through much of the CCP’s existence. The population was very poor and not very educated. And this was Deng Xiaoping was really the one to say, hey, we need an educated leadership. Because until then, most of the people kind of dumb and not really well educated. And a lot of the universities were closed down in the 60s. Right. And so they really started having this educated leadership in the an educated business class starting in the 90s.
Tony
Right. And so you now have a very widespread level of education, and you have a pretty widespread communications platform where people can understand what life is like in other parts of the world. And so I do think that there will be more pressure put onto the CCP to open up and to do things like respect individual rights, whether that’s Christian or not. It’s something that with wealth comes an expectation that individual rights are respected. Right? And so if somehow there was some sort of economic regression where people were poor again, fine, but that would make people really angry. But as people get more wealthy and as they get more educated, I think that does put more pressure on the CCP to be more responsive to the population. Because in the past, people would go into their government guy or woman and they didn’t really have any ability to push back, say, intellectually necessarily. Right now they can go into their government representative and go, oh, that person’s stupid. They don’t know what they’re talking about. And we do that in the US. And we do that in Europe, and we go, our politicians are stupid.
Tony
Right. And so that’s happening more and more in China. And so I don’t think that it leads to the demise of China as a nation state. I think it leads to heavy pressure to the CCP to evolve into something different. And I’m not sure what that is, but I think the pressure on the CCP to evolve will become immense over the next five to six years. And maybe that’s what Dion meant and he just kind of simplified language.
Albert
I don’t know. The CCP morphing into something slightly more liberal is obviously going to happen. I mean, they’ve used actually done quite a good job of promoting national unity. If you want to give them any sort of praise, you know, national unity within China has risen over the past five to ten years. The CCP, like I said, they’ve been around for 70 years. Tony, you said that they’ve got a grip on the country, and I just don’t see it releasing anytime soon under any circumstances.
Tony
Let me just go back and say one thing. We’re all disagree with you. It’s a rare moment of disagreement, Albert, but I actually think the CCP are terrible planners. They’re terrible, yes, they bought things for a year and a half at a time, but they’re just terrible planners. And because they have such a heavy current account surplus, they have the money to make up for their mistakes. And that’s been their situation for the past 30 years. But I think in general, central planning is horrific, and I think Chinese central planners are incredibly awful. So the belief and I’m not accusing you of having this belief, but I think there is among kind of Western intellectuals, there is a belief that Chinese are amazing planners. And central planners, they’re really thoughtful, and I think that’s garbage because it’s just not true. They make a lot of mistakes.
Albert
Oh, no question about that. When you start talking about, like, central piloting and strategic moves, the Chinese have not been historically not been good. You’re right. But those are like 2030 years out, right? I’m talking about four or five years out. They usually don’t make mistakes when it comes to their own domestic politics within the country itself. I mean, they’re they’re still around 70 years. Nothing’s, you know, nothing’s changed, really, in 70 years. So in that respect, I would give them credit to, hey, for national unity’s sake, if they keep themselves in power, they’re done a good job for everything else.
Tony
They do a terrible job. Yeah.
Ross
Again, the dog not barking so much for China when they talk about this stuff. This is the first time we’ve ever seen any sort of synergy between the PLA and the CPC leadership. There has historically been a significant externally, people don’t realize it, but if you’re in the game, you give it. There has always been a historical significant antagonism in a lot of ways between PLA senior leadership and the CPC, the civilian Mandarins, if you will. And this is the first time that we’ve ever seen. And going all the way back to Mao and before him, any sort of cohesion, whether it’s enforced at the barrel of a gun or not, but cohesion because of all these corruption purges that she’s been on since he took power in 2012, going all the way now to today. We’re seeing for the first time, really, the output of a unified PLA CPC kind of mega deep state, if you will. And that gives for the first time, the civilian side a lot more control over what has historically been a multi trillion dollar dark economy and revenue engine of China. And that’s that massive network of shell companies and enterprises that the PLA owns through everything that they’ve got.
Ross
And I’m not saying necessarily we can predict yet what this means, but if that cohesion, if that’s some sort of maybe for the first time unity, if you will, from a political side and from a commercial side, the more that’s.
Tony
Going to look like, the more that happens, the more fragile that whole infrastructure becomes. It becomes so inflexible. And I think for the adversaries of China, that’s a great thing. So go down that path as fast as they can because it creates a very fragile infrastructure within the Chinese government.
Albert
I’m glad that Ross brought that up because I actually had a Tweet thread today about something similar where Xi has been messing with the CMC, which is the PLA Navy’s group that kind of operated away from the CCP and was instrumental in dialogue with the US navy. He’s like, pretty much eliminated those leadership and starting to put his own people in there. So there’s room for error. When you put civilians inside of a military complex.
Ross
That’s a path that I would say if we see a decline of China as an actual aspiring global head of mine, if you will, I think it’s more likely to come from that vector than it would be any sort of demographic time bomb considerations.
Tony
Yeah, I don’t disagree with you. Okay, guys, let’s move on to Germany. Ralph, you had sent a Tweet earlier, I think you sent it a couple of days ago talking about the German energy mix and the push for clean energy in Germany and how ultimately that will lead to more demand for Russian gas.
Can you talk us through that hypothesis? I know you wrote a detailed thought piece about it. Can you talk us through that and then help us understand when the Russia Ukraine war stops, how long before Germany goes kind of rushing into Russian gas again?
Ralph
Yeah, I think the first and most important takeaway is that the underlying German energy strategy has not changed despite the war in Ukraine. And maybe just to sum it up a little bit, in 2021, where we have the most recent numbers, right, about 40% of German electricity production came from coal and nuclear, all kinds of coal. So lignite and black coal. And they want to phase that out in the next ten years. Actually coal, they want to phase out now faster than originally planned. So that means they have to replace 40% of their electricity production. But at the same time, until 2030, the expectation is by German industry that they will have an increase in 20% of demand. And what is the German plan to kind of meet replacing the lost coal and nuclear and meeting this new demand of 20%? The plan was always gas fired power plants and that plan is still in place. So they still want to double their gas fired power plants. And of course the question is where’s the gas going to come from? Now, the quick answer is always it’s going to be US LNG, but I think this is just going to be an affordability problem at some point.
Ralph
The Germans spent $440,000,000,000 only for energy related matters this year, just to give you a comparison, the entire EU spent $700 billion as the so called relief package for COVID. So just to give you a dimension, we are just talking about Germany here, so this is not sustainable. That’s 12% of their domestic industrial output, so they cannot do this forever. And secondly, kind of the more geopolitical thing, I think they prefer close cooperation with Russia than being dependent either on the US or being dependent on Italy or Spain and these areas where LNG would also come through. So I think that on the medium to long run, if there isn’t a window of opportunity to reopen the gas flow from Russia, which is of course still going on, to other pipelines, I think they will jump on it. And the last point, which I find quite intriguing, because everybody says Nordstream Two, Nordstream One, that was sabotaged by the Americans, but apparently, if you look at it, one pipeline of the Nord Stream Two net is still operational. So to me this looks more if I would speculate, but of course I’m speculating here is that the Russians say, no, we cannot destroy Nordstream One.
Ralph
We leave a bit of Nordstream Two in place because then we have to start at some point Nordstream Two and then kind of when this is already happening, we just also start Nordstream One again once it’s repetitive because that was always in place. So I think the underlying energy outlook is still the same and I think as soon as there is a ceasefire or something, this is going to happen. At the very last point, we talk a lot about gas, but of course there’s still the unanswered diesel question when it comes to energy between Russia and Europe. So, as I said, I think if there is a chance to re engage in the energy market with the Russians, I think Germany primarily, but I think other Europeans as well would be very happy if they could re engage in this area with Russia.
Tony
Perfect. I’m going to stop you real quick and I know Ross has to jump in a couple of minutes. Ross, what thoughts do you have on that, on Germany’s dependence on Russian gas?
Ross
I think it’s obvious if you work in the commercial world, if you deal with German companies, whether it’s a buyer or a seller or supplier, whatever it may be. I do think you’re seeing a play out the clock scenario here. There is obviously positive alignment at a global scale between Russia and China. And there’s disagreements or things where maybe one surprises the other with some of their behaviors, but in general they’re positively aligned. Major German manufacturers doubling down in China is actually an adjacent indicator. Russia is still the cheapest source of natural gas that Germany itself can get its hands on. And it’s not I say this somewhat facetiously, but also sincerely, it’s not like the Germans and the Russians don’t have a history of secret relationships or conflict benefit maybe them or conflict. So I do think that as long as there is a strategic alignment on a long term basis of Germany and through infrastructure and through relationships that have really been built deeply since the end of the cold war connection to Russia, I think it would take a lot to really completely sever that completely. Because on a long term basis, if they don’t have replacement energy capacity, which they don’t not at this point, germany would stand to be tremendously disrupted by that.
Ross
I don’t think they’re going to let it happen, not for NATO, not for the EU.
Ralph
And maybe to add something, since Ross is still here as a supply guy, the other thing is even the idea they would have to double their renewables, including wind and solar. And the problem is, wherever they can build those wind turbines, they cannot get those transmission lines built basically from the north to the industrial heart or in Bavaria, for example. On one hand is because the lines are too expensive and too long at the moment. And the other thing is nobody wants them in their neighborhood, right? Nobody talks about this. So on paper it’s easy to build them, but every little municipality, every local politician says, sure, you can make those transition lines, but not here. And then this has basically been on ice for a long time now. So as Ross also says, I think at some point it’s either continue spending oodles of money, which at some point I think will just get too expensive, or find ways either openly or secretly, to increase imports in the energy sector from Russia.
Tony
Ross, I know you have to jump. I just want to thank you for your time. We’re going to continue the conversation, but I look forward to having you on again. Thank you so much. Thank you very much.
Ross
Thanks gentlemen.
Ralph
Thanks Ross.
Tony
Ross, one of the things you said was that Germany would rather source gas from Russia than from southern Europe. Can you help us understand why that’s the case?
Ralph
Yeah, because I think this is one thing that has been overlooked in the entire debate when it comes to the Russian position. Let’s also Twitter a little bit for the French position that a shift towards the east in focus both economically and politically is not in Germany’s interest. So as many I say now fantasizing. But I don’t mean it in a disrespectful way of a new kind of Baltic Polish Ukrainian alliance under the military protection, let’s say your military cooperation with the UK and the US. That is not something that Germany is particularly interested in because they want to remain the major power in Central and Eastern Europe and a new formed bloc with 44 million Ukrainians is not something that they are particularly interested in. And the same is true with kind of shifting the energy focus, let’s say towards Italy or towards southern Europe. It’s the same thing. I think this is not the kind of power shift that they want to see. And just as a quick add on to this is often forgotten, germany together with the Czech Republic as a smaller player, particularly France, they have been the major electricity exporter in Europe.
Ralph
They in some cases quite literally had the hand on the light switch and I think this is also something that Germany doesn’t want to lose. Now, I don’t know to what extent they are aware of this themselves, but I think if you look at German behavior towards Ukraine, towards Russia in this entire conflict, even now, at the moment, right, where they say, yeah. We might deliver Main Battle tanks if the US delivers them first. And if the Polish deliver them first, then maybe we’ll do it as well. I think this hesitancy is not just facetiousness on part of the Germans. I think it is kind of being concerned that the power could shift further towards the east into this kind of Polish Baltic Ukrainian new power center and it would be economically weaker but it’s already militarily potentially significantly stronger. So I think Germany is playing a kind of geopolitical game here that is not we can have a moral debate whether we agree or disagree but I think from what they are trying to accomplish it’s at least partially understandable and it’s a truly last point. There was a moment if they would have really kind of switched entirely their energy policy in February continuing the nuclear power plants and shifting other areas, I think then it would have been credible that they say they want to kind of emancipate from Russian energy, from Russian gas but they didn’t do anything of that kind.
Ralph
So this is why I think that on the long run, on the medium to long run relations between Russia and Germany will improve, whatever that means for other players.
Tony
I think it’s so interesting that the Polish Baltic Ukrainian that is such an ancient political entity from centuries ago, right? And so it’s just interesting that these things are coming back. But I want to push a little bit harder on that. As much as you say they would rather source from Russia than from southern Europe, why are they so hesitant to source gas from southern Europe? Because it’s a part of the EU, it wouldn’t be a political kind of lever that the south would pull.
Albert
It would be Tony. It would be because the Germans have Spain, and Italy is indebted to Germany a significant amount of money. Right. So that upsets the political dynamic from the Germans being able to counter the French and what are they doing within the EU? So you have a political economic dynamic here where Germany just does not want to give money back to the Italians in the space.
Tony
Okay, so what you’re saying is Germany would rather empower a hostile Russia. I would rather enrich a hostile Russia than give up the political power that they have over the south by giving them money. They would rather have the thumb on southern Europe and control them politically than actually help enrich their fellow Europeans. I wasn’t aware of this.
Ralph
I used to do this 20 years ago.
Tony
I don’t as much anymore.
Albert
I would do the same thing because Russia is not in my political sphere, and there is little to zero chance that the Russians are going to attack NATO lands. So from the German perspective, I get cheap power from Party A, and I still control Party B and C over here under my thumb. Why would I change that dynamic? I would never do that.
Ralph
The German area or the German sphere of interest that they are interested in is central. It’s Europe. Whether it’s the European Union, they don’t really care what’s going on in further to the east or, for example, between Russia and Ukraine, which they have shown quite openly up until February. I think Albert is precisely on the money here. So this was a very good deal for Germany.
Tony
Wow. Just another reason for me to think that the EU, as I’ve thought for the last 30 years, is just a cynical political grouping rather than a functional union.
Albert
It’s very nation states have their own interests at heart. Always first and foremost, before you want to talk about globalist or community.
Tony
Sure, yeah, absolutely. Okay, guys, this has been great. Can you just before we kind of end this, can you guys help us think? What are you looking at, let’s say for the rest of January, kind of the week ahead, the next couple of weeks ahead? What are you guys looking at with, say, ECB or Fed or markets? What are the things that are on your mind right now that you’re looking at for the next week?
Albert
I don’t know about the next week. I think Opex is next week, so it’ll probably be pretty muted before the Fed in February. But honestly, I’m looking at Russia whether or not they desire to have a new surge into Ukraine, albeit a smaller one, more tactical. But they need a win for the PR before they actually try to come into actual peace negotiations, because it’s just not sustainable, what they’re doing right there right now.
Tony
So do you think there will be peace negotiations, say, in March, April, something.
Albert
Like that, as plausible at least June, July, maybe?
Ralph
June, July.
Tony
Okay, ross?
Ralph
I’m kind of looking at the German economic numbers at the moment because they have all been very celebratory, because in the fourth quarter, apparently it grew by 1.9%. My suspicion is that these numbers were particularly pushed because Germany was simply pumping so much money into the economy. This is something oliver, you mentioned this a couple of times on your Twitter feed as well. This is something I don’t think enough people talk about that whatever the ECB does, a lot of this is going to be offset by European programs of pumping money into the system via alternative means. So kind of the celebratory mood that now it’s, I think, just 7.7% inflation and not 10% inflation, I think that’s just going to be temporary. And the same is about economic growth. So this idea that there will not be, as I think Goldman Sachs said, and a couple of other economists as well, that there will not be a recession in Europe next year, I’ll be very surprised. I prefer not to be that one, but at some point I know Albert has said something similar ones, but I’m growing increasingly suspicious of these numbers because they don’t add up with anything.
Ralph
When you talk to people in the industry, when you talk to the banking sector, they tell you it’s not all doom and gloom, but it’s definitely not. That all. Next year we’re going to grow beyond our expectations.
Albert
The celebratory chance for the Europeans right now completely missed the fact that they are dormant. They’re in a zombie state. There’s nothing going on in Europe at the moment. So once they start kicking things back up and manufacturing and demand inflation is going to go right back up to where it was a year ago.
Tony
I never trust a preliminary economic data release. Never. Always wait for the second or third revision. So when markets move on a preliminary release, it’s moving on the belief that other people have expectations around it. Right? And so it’s just this reflective, expectations based move rather than based on the numbers themselves. And I always will often say this on my Twitter feed wait for the revision. Don’t trust the initial preliminary data release because it is PR. It’s nothing more than PR. Maybe it’s directionally correct, maybe, but those preliminary releases are PR. So on that optimistic note, guys, I want to thank you for your time. This has been fantastic. We’ve had such a great, deep discussion. So thanks very much. Have a great weekend and have a great week ahead. Thank you.
