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Will The Rally Sustain?

Will The Rally Sustain?

Tony Nash from Complete Intelligence explains whether the US market’s biggest 4-day rally since November can sustain?

This podcast first appeared and originally published at https://www.bfm.my/podcast/morning-run/market-watch/will-the-rally-sustain on February 3, 2022.

Show Notes

SM: BFM 89.9. Good morning. You are listening to the Morning Run. I’m Shazana Mokhtar together with Wong Shou Ning and Philip See. It 7:05am on Thursday 3rd of February. But first, let’s recap how global markets closed yesterday.

WSN: Well, the US had a pretty good day. That was up 0.7%, SP 500 up 0.9% while Nasdaq was up 0.4%. And for Asia, the only market that was really open with the Niki, and it was up 1.7%. Hong Sung, Shanghai, Singapore and our very own FPM KLCI.

SM: We were all closed for celebrating the Year of the Tiger. Speaking of meta, I think the results came out and they were not within forecast essentially.

WSN: Well, actually after hours, right. The trade actually the share actually tumbled more than 20% in extended trading earlier. And I think it’s on the back of like what you say, Charles. It’s disappointing earning results. And added to that, they are giving weak guidance and said that user growth has stagnated. Now that’s kind of scary for a company the size of matter.

PS: Yeah.

Just to break down the numbers, earnings per share was at $367 versus the expected 384. Revenue was at $33.67 billion. The expected was 33.4, which wasn’t so bad. But Facebook also missed estimates with user numbers with his daily active users at one point 93 billion versus the expected one point 95 billion.

WSN: Now, I think why the markets are nervous is because when you think about it. Right, this company is at a critical juncture at this point. It’s fighting a regulatory battle on multiple France. And it’s also, remember, guys, it’s trying to shift into the Metaverse. And this shift is costing them an extremely a lot of money. So whether they can translate these KPCS that they’ve already kind of agreed to in terms of $2 and cents, that’s the question mark when your core business is not growing.

PS: I guess a big question of how do you monetize from meta and that pathway has not been articulated very carefully, isn’t it? But that’s a long term expectation. As you said, Shannon, there’s so much regulatory pressure on them. And I wonder with the whole discussion about your revenue source, whether you can rely on advertising revenue now going forward. That’s a big challenge for Facebook going forward and better.

SM: I mean, that’s going to be one of the major headwinds to them. I mean, Apple’s iOS changes affected ad targeting and measurements. That’s already a headwind. There’s also the fact that a lot of people are sort of flocking to other options when it comes to social media TikTok, YouTube. I think the advertising rates for Metsa’s own Reals on Instagram, that’s a lot lower than what’s available on other unfeeding stories.

WSN: No rewind, a few earning season rewind. Let’s go back a few quarters. And I think what has happened is that 18 year olds to 29 year olds were flocking to Facebook. Right. So the question is better, is it going to attract them? And what progress are they going to make? So that’s another thing that the markets are looking at.

SM: Joining us on the line now for analysis on what’s moving global markets, we have Tony Nash, CEO of Complete Intelligence. Tony, good morning. Thanks so much for speaking with us today. Can we get a quick reaction from you then on the disappointing results from Meta and Spotify? Does this mean something for tech bargain hunters?

TN: Well, I’d be really careful here because tech is really a deflation play. It’s not an inflation play. And so as we’re in the midst of the inflation cycle, there’s more movement to other sectors. So I don’t necessarily maybe it’s a short term opportunity, but again, if I was investing, I’d be really careful here with the Spotify and other misses.

PS: And can we get your perspective on the energy and financial sector? They helped the US Equities stage a mini rally over the last few days. Why are these economic sectors being buoyant while others like tech creating?

TN: Yeah, well, energy, commodities, finance, those are deflation plays or those are inflation plays. I’m sorry. And so that’s why more money is moving into commodities and energy and so on and so forth. So the market seems to be indicating that it doesn’t believe at least the equity market seems to be indicating that it doesn’t believe the Fed will fight inflation effectively. So they seem to be indicating that we’ll keep ripping on inflation.

WSN: So, Tony, how should we allocate our cash? Let’s say we have cash. Where would you be putting your money?

TN: Oh, gosh. Well, you really have to that’s an individual question. I just want to be really careful. So there’s a lot of money moving into commodities because there’s a belief that inflation is here to stay for a while. So if I were looking around, that’s really where I would look, of course, you have to have a risk allocation and you have to have some money and things like tech. But I would focus on companies that actually make physical stuff rather than, say, the work from home plays that we had over the last two years.

SM: And, Tony, let’s take a look at the US yield curve. It’s flattening even before the Fed has fired the first shot on rate hikes. What could possibly be causing this to happen? And do you see a short or long cycle of rate increases?

TN: Yes, I think to answer your last question first, I think what would be best is a short and abrupt cycle because it would really put a stop on the threat of inflation and so on and so forth. So like a 50 basis point hike in March would probably be the best solution we could find. But when we look at the yield curve flattening first, it is a traditional signal of a looming recession. So if you look at today’s employment data in the US, there was a loss of 300,000 jobs. So we’re in this weird place where we have booming inflation and a loss of 300,000 jobs. So it’s like the late 1970 stagflation. I’m not going to say we’re necessarily there, but if you just look at today, it seems like right. So what the yield curve flattening means is bond traders are pretty nervous and stagnation is ugly. So they seem to be saying that they don’t believe that the Fed will take the necessary action on inflation in the short term. So JPOW is not Volker is really what they’re saying. Paul Volcker from the 1980s. So bond traders can really make things difficult on both the Fed and equity markets.

So the Fed has a real balancing act to do. They don’t want equity markets to crater, but they don’t want bond traders to kind of extract their vengeance on the Fed and equity market. So if we don’t see rates rise, if we don’t see the balance sheet reduced, then bond traders are not going to be happy and it could get ugly in safety, too.

PS: I wonder what all this means for the US dollar. Where does the US dollar hit going forward and how do you see Euro and Yen perform against the greenback?

TN: Yes, again, that depends on which direction the Fed takes. If the Fed’s approach is weak and if fiscal support from Congress is weak or it doesn’t come, as many in equity markets seem to be implying, then the dollar will likely level out or even depreciate a bit. That would mean a stronger Euro and yen versus the dollar in a relative sense. And currencies are all relative. If the Fed resumes the hawkish talk that they started last week in Jpow’s comments and then on Sunday and Monday through some of the regional presence, then the dollar will strengthen and the Euro and the yen will weaken. Obviously on a relative basis. There’s not a lot of strength in Europe. And especially when you look at some of the geopolitical issues around, say, Ukraine and Russia, there’s a lot of risk in Europe. So people are really nervous about Europe and then Japan. Yeah, it’s stronger than Europe, but that’s really not saying a lot. So the yen will strengthen on a relative basis, but it’s not necessarily an endorsement of the strength of the economy.

SM: Tony, thanks so much for speaking with us this morning. That was Tony Nash, CEO of Complete Intelligence, talking to us about some of the trends that will be moving markets in the weeks and months ahead.

WSN: Yeah, it looks like markets are headed towards a very volatile period for the moment. So the Nest did really well. But what we do know is the results of Spotify and also Meta were disappointing. And after hours trading, these stocks took a huge hitting. Even PayPal, which results came out the night before, also is down 20 over percent. It looks like markets are seeing this glass as half empty rather than half full so the minute you disappoint right you really get whacked down because everyone basically was already making money the year before so their patience in terms of like writing out this maybe dip in earnings is just not there.

PS: It’s a consequence of so many issues, isn’t it? Because we saw this dip even before the real earnings came out, isn’t it? Because that was when JPY in the earlier minutes said that they were going to raise interest rates and also accelerate tapering and then I think these really disappointing earnings I think just compounded the matters worse but you do see some pickup going forward so whether they’re selective opportunities you don’t play the sector, you don’t play the themes but you really go stock by stock now, isn’t it?

WSN: Yeah, you have to take a very bottom up approach. The easy money is clearly made but you can see a shift of money and this is what Tony is saying is there’s a shift towards commodity prices right? So brand crew this morning is close to $90 barrel. It’s close to seven year high. This is despite the fact that OPEC has said that they are going to raise output but there’s a lot of judges because of the geopolitical tensions that we’re seeing coming out of Ukraine but maybe it’s also due to the fact that oil is truly an inflation play and inflation is here. It’s not transitory at all.

PS: Yeah, and I just think I do see some improvement also in Bitcoin right? If you can see across ECM and Bitcoin up actually marginally just one and a half percent you see some good news there but I wonder if this is a sign of whether that the pressure is really on the equities market going forward but the rest are still holding resilient.

Categories
QuickHit

What happens to markets if China invades Taiwan? (Part 1)

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In this QuickHit episode, we’re joined by Mike Green to talk about what will happen if China invades Taiwan? We’re not saying that China is going to invade Taiwan, but what if it is to happen? What will be the impact to markets?

Mike Green is the chief strategist and portfolio manager for an ETF firm called Simplify Asset Management. They specialize in derivative overlays and derivative structures that modify the traditional market exposures. Their flagship products are things like US equities with downside protection.

His background prior to Simplify, has been in hedge funds for about 15 years and have built an expertise or a degree of renowned for the work that he does in primarily the derivatives and volatility space and have managed traditionally in what’s referred to as a discretionary global macro style. The assets that he purchases or that he monitors exist around the world, including places like China, Taiwan, et cetera.

A lot of the discussions Tony and Mike have had around Taiwan are tied to some geopolitical observations and some dynamics that exist in which Mike played a role less under the Biden administration. But in the prior administration had an advisory capacity to some components of the Department of State and Department of Defense.

📊 Forward-looking companies become more profitable with Complete Intelligence. The only fully automated and globally integrated AI platform for smarter cost and revenue planning. Book a demo here.

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This QuickHit episode was recorded on December 2, 2021.

The views and opinions expressed in this What happens to markets if China invades Taiwan? Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

Show Notes

TN: So today we hear or any day, pick a day. We hear that China is invading Taiwan. What are the first things that come to your mind as the news crosses the wires?

MG: Well, I think there’s a couple of things that are really important about the question of is China invading Taiwan, right. And so what we have seen very clearly, and this is fact, not speculation, is a dramatic escalation of China’s incursion on what would traditionally be thought of as Taiwan sovereignty or independence. Right.

We’ve seen a dramatic increase in boats transitioning across the international marine borders. We have seen a dramatic increase in incursion of both fighter jets and bombers into Taiwanese airspace. And in general, the strategy that you see China engaged in is what is typically thought of as a precursor to an invasion. They’re effectively forcing Taiwan to maintain alertness and readiness, which slowly degrades the quality of defenses.

If you have to constantly scramble jets, there’s only so many hours that you can actually have them in the air. There’s only so many hours you can have pilots operating before their capability deteriorates. That is very clearly what is in play here.

Now, it’s an unknown question whether they go to the next step, whether they take what is currently a largely psychological and relative resource advantage to degrade Taiwan’s capabilities, whether they turn that kinetic as compared to hoping for a psychological collapse where Taiwan effectively decides to sue for the best possible deal they can get is unclear.

And I think that’s really what we’re all debating. I mean, China has come out very clearly. Others have made this observation, and it’s not dissimilar to my former employer, Peter Thiel’s observation about Donald Trump, right. That everyone takes him literally, but not seriously. I would flip that on its head. And everyone say everyone takes Xi seriously, but not literally when he says we will reunify with Taiwan in one form or another within the next five years.

And that’s the core of the question. Are they going to do this in a peaceful fashion? Are they going to do it in a kinetic military fashion? What are the ramifications of each of those two strategies and what’s the state of gameplay that is in place right now, as each side including the allies of Taiwan in the form of Japan, the United States, et cetera, evaluates how they want to respond to it.

TN: Right. What is that? What are those initial responses that you think happen, setting aside battle plans, of course. Honestly, I don’t believe that Min Def or DoD know 100% of whether this will happen or not. I think everything is a potential.

What do you think those reactions are initially in terms of, say, markets, investments, even things like trade? Those are like, what do you think happens right away?

MG: Well, I think there’s a couple of things that are worth hitting on. Right. So the first is why does China want Taiwan or why does it matter? Right. So one component is just the psychological final victory over the Republic, the Taiwanese Republic, what is known as the Republic of China outside of the area.

When you think about that dynamic, this is a final victory that would allow Xi to place himself permanently on par with the founders of the Chinese Communist state. Right. The Mao’s, et cetera, of the world. So this is a huge accomplishment.

I think there’s a huge misunderstanding that the objective is to obtain the semiconductor resources, right. To me that feels, one, extremely unlikely to expect that they could do that successfully, and two, I’m not sure it’s actually entirely relevant. Right. But that does then speak to the indications that the game is being taken much more seriously.

And so one of the things that I would point to people is the dramatic expansion of capabilities and investment that Taiwan is making in Arizona, where they’ve effectively doubled on a nameplate capacity and potentially up to 5x the capacity of TSMC in Taiwan. Now, that’s a huge implication.

If we were to put ourselves back into the 17th century, it would be the akin of a European sovereign entity, a small Principality, taking the Crown jewels and shipping them for safekeeping somewhere further away when they were faced with a threat, taking the error apparent and shipping them abroad so that there’s a base of operations. If you think about TSMC’s investment in Arizona, that can be very easily thought of as a base of operations and a source of income for a government in exile. Right. So I don’t think Taiwan is planning on going away.

It also opens up kind of the interesting angle of how effective is China’s strategy, because I think that China broadly looks at it and says, we can wear them down and I would point to it and say, yeah, your best opportunity was actually probably a year ago to use the element of surprise. Now you’ve pretty well telegraphed it. Taiwan has made significant advances. The US Department of Defense, in particular, I would argue, would have been caught very much off guard a year to a year and a half ago. Today they’re pretty much on top of this, right.

The Pacific Theater has been opened pretty widely. You’re actively hearing expressions of support from South Korea, Japan, et cetera. So to me, it feels like the element of surprise has been lost, and now it just becomes a question of, is this ultimately going to happen? It seems extremely unlikely to me that it will be a long term successful component.

Then you have to ask yourself the last question, which is, why does China care beyond simply the moral victory or the desire for that? And that’s where you and I have been through these maps. And I don’t know if we’re doing this in a visual format, but I could share it if you wanted to.

The way the world looks at China is not the way China looks at itself. Right. So the traditional map that we think of with China when we look at it, we see this large access into the Philippines and in the Pacific Ocean. It looks like China has a coastline that is similar to the rest of the similar to the other great powers like the United States. The reality is that their entire access to the Pacific Ocean is framed and blocked by barrier Islands, Taiwan being the most prominent of those. Japan to the north, being another equally important one. The Philippines come into play. Okinawa comes into play there, et cetera. Right. What they’re really trying to do in terms of expressing a desire to take over Taiwan is to break into the Pacific Ocean and pick up that Deepwater Navy capability that is absolutely mandatory for an “Empire to express power.”

Map of China and countries surrounding it. Image from Google Maps.

So I think we’re at kind of a point of maximum uncertainty where it feels like they may have missed the best opportunity to do so. But as you and I have talked about, I’m not sure that China is actually as good at this game as everybody thinks.

TN: I’m with you on that. Yeah, I don’t think they are, either. And one of the things that I’m seeing more and more of two years ago, a year and a half ago, as you mentioned, China was winning diplomatically, not everything. But there was more of a positive bias toward China.

Today, they’re just annoying people. And so if they take an action like that, it seems like they start from a negative position, and it’s hard for them to get to a positive position out of that when Xi Jinping was going to the left to talk and all this other stuff, he had a lot of positive momentum behind him, and he actually could have done a lot of really terrible things, which, if you look at what’s happening in Xinjiang and other things, he did a lot of terrible things. He could have done more, actually. And I think the world would have turned the other way. But now I think it’s really hard for them to turn the other way. Does that make sense to you?

MG: No. I actually think that’s true. I think that they may have gained a degree of false confidence off of the failure to react to Hong Kong. But absolutely, with the exception of… Australia has clearly turned. The UK has recognized that it has to turn. Europe continues to enjoy the schadenfreude of the US’s relative standing having deteriorated. I think Europe is slowly waking up to the risks of their reliance on Russia, particularly for energy supplies.

And an interesting angle, and again, you and I have talked about this offline, would be the dynamic of a simultaneous move in both directions by Russia to expand into Ukraine and China, to expand into Taiwan and the immediate aftermath of the Chinese Olympics in Beijing this winter, which is February. From a purely mechanical standpoint, it’s almost impossible to mount any form of attack on Taiwan until May due to weather conditions, and an amphibious assault would make no sense, you could certainly see an airborne one.

I think there’s a very real chance that we see at least an increase in the drumbeats associated with that to test it out. But Europe will eventually turn, right. They have to understand at their core that they are an exposed peninsula on the Eurasian continent, and they really can’t allow China and Russia to become as dominant as they are expressing at least their interest of becoming.

TN: That’s right. Okay. So you bring up an interesting analog when you mentioned Hong Kong. Okay. So Hong Kong and Taiwan used to be this kind of holdouts from the mainland, and people looked at them as these democracies-ish, although Hong Kong, whether it was a democracy or not as questionable. But the takeover of Hong Kong is one that happened.

I was telling people in 2014 that it was already done. That this was going to happen. And for five years that I talked about it, people said, no, you’re crazy. It’s not going to happen. There’s too much money that goes through Hong Kong and so on and so forth. But it happened. And now in the wake of it, people just kind of shrug their shoulders like, okay, whatever it happened. Do you think that a takeover of Taiwan would be similar? Do you think people would just kind of shrug shoulders and say, “they invaded Taiwan. It was going to happen anyway, let’s just move on.?”

MG: No, I think it’s much harder for people to look at it in that context. Now, I would frame it, if we’re going to use a World War 2 analogy. And you always got to be careful with Godwin’s law about this, but it would be the analog to Nazi invasion or the German invasion, more accurate of the Sudettan land, which ostensibly was done in a manner very similar to Russia’s invasion of Crimea and the Dunbas region, were there to protect the Russian speakers.

We’re not actually there to have any form of substantive gain, and the world has broadly moved on from it. Right. Same thing I would argue with Hong Kong. Well, of course it was ours, right? You didn’t actually expect us to sit around 2047 and wait for this. There had to be a gradual progression in that direction.

Now, if this is the definition of gradual, I’d hate to see the definition of sudden. But again, the world has largely ignored it and moved on because for the most part, those outside the region have not experienced a significant shift. And again, if you were to look at foreigners in Berlin around the invasion of Sudetenland, they wouldn’t have seen anything different either. Right. Maybe they would have seen the riding on the wall and gotten out. But as we know, many didn’t.

There’s the risk that this is similar because the reality is if China were to decide to invade Taiwan, and now we can kind of get into the market impact, I don’t think the west can do anything about it. Right. Remember, this is 100 miles, give or take off the 100 km. I’m sorry. Off the coast of China. The US cannot Mount a credible defense and certainly not the ability to take back that region once China has taken it.

And I think that’s kind of the interesting feature associated with this is that like the actions of Germany and Sudetenland or the Blitzkrieg into Paris or any of these components, it’s going to be very hard to undo this. And so the minute it happens, it becomes a much longer protracted extended dynamic. And that’s the reason we care. It’s not so much that are we going to win or lose? Right. Almost any credible analysis of it says that China can indeed take Taiwan.

Taiwan is unique and in terms of its mountainous dynamics, et cetera. It’s uniquely suited in a lot of ways for guerrilla warfare. So my guess is they will be playing an Afghanistan type dynamic for decades if they take it. And the US would certainly be working in ways to resupply that and create harassment and everything else. But it is unrealistic to think that it can be stopped if they truly decide that they’re going to do that.

And that’s kind of the thing that, to me is more interesting is that how do the pieces start to fall together in a puzzle if they were to do that and what is properly priced under those scenarios? And I think, Ironically, people will point to US equity markets and say, oh, they’re going to fall or the dollar would be affected, et cetera.

I think there’s some truth to that certainly on a short term basis. But as you know, I don’t really think that the fundamentals matter all that much in the US equity markets right now. Are Americans going to lose their jobs and stop contributing to their 401k plans? And is the Federal Reserve suddenly going to step away from markets and stop engaging in supportive activity? To me, that seems very low probability. And so while there could very well be a correction, I’d be surprised if it moved in that direction. But I do think there’s other trades that are particularly interesting. Right.

So we mentioned Hong Kong. The Hong Kong dollar has been completely unaffected, both in terms of the absolute level of the dollar and its relationship with the US dollar. In other words, they continue to trade, basically a parody with very minor exception. But also the volatility associated with that. So taking bets against that relationship have retreated to near the lowest levels in years.

TN: Sure.

MG: If China were to make a play for Taiwan, it would be almost impossible for me to imagine a scenario in which that relationship didn’t fray violently. Same thing becomes true for Japan, right. Because Japan has two separate issues. One is they are a client state of the United States, and now they are directly in the face of a kinetic war that requires them to rapidly increase their government spending and to do so under somewhat existential risk. And at the same time, they have to write off, basically the minute they do that, they have to write off all of the collateral that most of their corporates have invested in China, which has become the single largest source of their external investment. Right.

So those to me, the area across Asia feels mispriced for this risk. Even if we’re just talking about a volatility spike, it feels that that area is much more mispriced than the US equity markets, for example.

TN: Interesting. So what you say about Japanese companies riding off their investments in China with the same go you think for, say, Korean companies as well?

MG: Oh, absolutely. You’re effectively placing them in a very difficult situation for sovereign reasons and for very obvious political reasons. Those are regions: South Korea, Philippines, Japan that really can’t get on board the China train. Right. Because it creates too powerful of an entity, and one that you point out is increasingly unliked. It places too powerful of an entity in their backyard.

TN: Okay. So something like 37, we all kind of know this 37% or something of global manufactured goods are made in northeast Asia. Right.

MG: Right.

TN: And if you look at electronics, it’s a lot more than that. I don’t know the number a lot more than that. So you have a manufacturing base, and especially in electronics, you have a manufacturing location where risk all of a sudden is amped up. Okay. What does that do? I know this is kind of an obvious question, but I want to get a little bit into details. What does that do to supply chains, especially around electronics?

MG: Yeah. Well, the quick answer is obviously it throws them into chaos. Right. And the most important point on the electronics that I would make is that while China holds a fraction of the world’s IP on electronics, again, the commentary around semiconductors, they are massive in the assembly process. Right. They’re basically the assembly line or the finishing stop. And so you have a ton of semiconductors that get shipped into China and then shipped out in the form of flat panel TVs, computers, iphones, et cetera.

That would unquestionably be disrupted. Right. And it creates an interesting, there’s an interesting game theory associated with it, which is you’re effectively talking about splitting the world in two at that point in a manner that is very similar to the breakdown of the alliance between the Soviet Union and the United States following World War II. Right.

TN: Right. This is what I’m not sure a lot of people, especially in the corporate world, understand, is how acute and how distinct that break could be if this happens.

MG: Yeah. I agree with you broadly. Now, the irony, of course, is part of the reason that they can’t embrace that is that redundancy costs money.

If I’m going to build a diversified supply chain, it places me at a disadvantage to competitors that do not do so in the interim. It potentially positions me for a knockout punch for a true winning of the game. But even there, you start to have to ask yourself questions. Would it be politically feasible given the likely response in terms of price controls and everything else that would kick in? Right.

I mean, I find it highly likely that a Biden administration or a Republican administration. Remember, the price controls were instituted by Nixon, not by Johnson. When you start talking about those types of dynamics, the game theory doesn’t really support the desire to fully diversify your resources. It places you at a disadvantage to your peers in the immediate future, and the potential rewards associated with it are somewhat in doubt as well because it becomes politically unacceptable to raise prices in response to that type of event.

TN: Right. Everyone else is going to be knocked out. I’ll be knocked out, too. So there’s no advantage or disadvantage to me to have a redundant supply chain.

MG: Correct. There’s a disadvantage if it doesn’t happen, right? You’re maintaining something more expensive.

So it’s hard to look at those who would be most impacted and say that they’re behaving in an irrational way. Right. Like the game theory is actually very much. Don’t do anything. Don’t do anything. Don’t do anything. Panic.

TN: Right. Okay. So we have a lot of risk in, say, Northeast Asian markets. We have a lot of risk to the electronic supply chain. I know this may seem like a secondary consideration, but maybe it’s not. What about Europe? Does Europe just kind of stand by and watch this happen, or are they any less, say risky than any place else? Are they insulated somehow?

Categories
QuickHit

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

Europe's economic recovery like Japan, China, or US?

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

 

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

 

📊 Forward-looking companies become more profitable with Complete Intelligence. The only fully automated and globally integrated AI platform for smarter cost and revenue planning. Book a demo here.

📈 Check out the CI Futures platform to forecast currencies, commodities, and equity indices

 

This QuickHit episode was recorded on November 18, 2021.

 

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

 

 

Show Notes

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

DL: Thank you very much.

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China’s Belt And Road Has Failed. TONY NASH In Conversation With Daniel Lacalle

Tony Nash joins Daniel Lacalle in a discussion on the rise of the machines in a form of AI and machine learning and how Complete Intelligence helps clients automate budgeting with better accuracy using newer technologies like now casts. How GDP predictions are actually very erroneous yet nobody gets fired? And how about China’s GDP as well, and why it’s different from other economies? All these and so much more in markets in this fun discussion.

 

The video above is published by Daniel Lacalle – In English.

 

Show Notes

 

DL: Hello everyone and welcome to this podcast. It is a great pleasure to have somebody that you should actually follow in social media on Twitter, Tony Nash. He is somebody that you definitely need to need to look for because it has very very interesting ideas. Tony, how are you?

 

TN: Great, thanks Daniel. Thanks so much for having me today.

 

DL: It’s a tremendous pleasure as I said I was very much looking forward to to have a chat with you. Please introduce a little bit yourself. A little bit to our audience and let us know what is it that you do.

 

TN: Sure, thanks Daniel. My name is Tony Nash. I live in Houston, Texas. I’ve spent actually most of my life outside of the U.S. I spent most of my 20s in Europe, North Europe, the UK, Southern Europe and from my 30s to almost the end of my 40s I was in Asia. And so you know being in the U.S., Europe and Asia has really given me personally an interesting view on things like trade economics markets and so on and so forth.

 

During that time I was the global head of research for the economist out of London, I was based in Singapore at the time. Led the global research business. I moved from there to lead Asia consulting for a firm called IHS Markit which is owned by S&P now.

 

And after that I started my current firm Complete Intelligence which is a machine learning platform. We do global markets currencies, commodities, equity indices, economic concepts. We also do corporate revenue and expense forecasting so we’ll automate budgeting for large multinational firms.

 

DL: Wow! amazing. Truly amazing. You probably have a very interesting viewpoint on something that a lot of the people that follow us have probably diverging views. Know the situation about the impact of algorithms in the market the impact of high frequency trading and machines in markets.

 

We had a chat a few months ago with a professor at the London School of Economics that he used to invite me to his year-end lectures to to give a master class. And he mentioned that he was extremely concerned about the almost the rise of the machines. What is your view on this?

 

TN: I think so an Algo is not an Algo, right? I mean, I think a lot of the firms that are using Algo’s to trade are using extremely short-term algorithmic trading say horizons. Okay? So they’re looking at very short-term momentum and so on and so forth. And that stuff has been around for 10 plus years, it continues to improve. That’s not at all what we do we do monthly interval forecasts, Okay?

 

Now, when you talk to say an economist they’re looking at traditional say univariate and multivariate statistical approaches, which are kind of long-term trendy stuff. It’s not necessarily exclusively regression, it gets more sophisticated than that.

 

When we talk to people about machine learning, they assume we’re using exclusively those kind of algorithms. It’s not the case. There’s a mix we run what’s called an ensemble approach. We have some very short-term approaches. We have some longer-term traditional say econometric approaches. And then we use a configuration of which approach works best for that asset or that revenue line in a company or that cost line or whatever for that time.

 

So we don’t have let’s say, a fixed Algo for gold, Okay? Our algorithm for the gold price is continually changing based upon what’s happening in the market. Markets are not static, right? Trade flows economics, you know, money flows whatever they’re not static. So we’re taking all of that context data in. We’re using all of that to understand what’s happening in currencies, commodities and so on, as well as how that’s impacting company sales. Down to say the department or sub department level.

 

So what we can do with machine learning now. And this is you know when you mentioned should we fear the rise of the machines. We have a very large client right now who has hundreds of people involved in their budgeting process and it takes them three to four months to do their budgeting process. We’ve automated that process it now takes them 72 hours to run their annual budgeting process, okay? So it was millions of dollars of time and resources and that sort of thing. We’ve taken them now to do a continuous budgeting process to where we churn it out every month. So the CFO, the Head of FP&A and the rest of the say business leadership, see a refresh forecast every month.

 

Here’s the difference with what we do, compared to what a lot of traditional forecasters and machine learning people do, we track our error, okay? So we will as of next month have our error rates for everything we forecast on our platform. You want to know the error for our gold price forecast, it’ll be on there. You’ll know the error for our Corn, Crude, you know, JPY whatever, it’s on there. So many of our clients use our data for their kind of medium term trades so they have to know how to hedge that trade, right? And so if we have our one, three month error rates on there, something like that it really helps them understand the risk for the time horizon around which they’re trading. And so we do the same for enterprises. We let them know down to a very detailed level to error rates in our forecast because they’re taking the risk on what’s happening, right? So we want them to know the error associated with what they’re doing with what we’re doing.

 

So coming out of my past at the economist and and IHS and so on and so forth. I don’t know of anybody else who is being transparent enough to disclose their error rates to the public on a regular basis. So my hope is that the bigger guys take a cue from what we’re doing. That customers demand it from what we’re doing. And demand that the larger firms disclose their error rates because I think what the people who use information services will find is that the error rates for the large firms are pretty terrible. We know that they’re three to seven times our error rates in many cases but we can’t talk about that.

 

DL: But it’s an important thing. What you’ve just mentioned is an important thing because one of the things that is repeated over and over in social media and amongst the people that follow us is well, all these predictions from the IMF, from the different international bodies not to the IMF. Actually the IMF is probably one of the one that makes smaller mistakes but all of these predictions end up being so aggressively revised and that it’s very difficult for people to trust those, particularly the predictions.

 

TN: Right. That’s right.

 

DL: And one of the things that, for example when we do now casts in our firm or when with your clients. That’s one of the things that very few people talk about, is the margin of error is what has been the mistake that we have made in the in that previous prediction. And what have we done to correct it because one might probably you may want to expand on this. Why do you think that the models that are driving these now cast predictions from investment banks in some cases from international bodies and others? Are very rarely revised to improve the prediction and the predictability of the of the figures and the data that is being used in the model.

 

TN: It’s because the forecasters are not accountable to the traders, okay? One of the things I love about traders is they are accountable every single day for their PNO.

 

DL: Yeah, right.

 

TN: Every single day, every minute of every day they’re accountable for their PNO. Forecasters are not accountable to a PNO so they put together some really interesting sophisticated model that may not actually work in the real world, right? And you look at the forward curves or something like that, I mean all that stuff is great but that’s not a forecast, okay? So I love traders. I love talking to traders because they are accountable every single day. They make public mistakes. And again this is part of what I love about social media is traders will put their hypothesis out there and if they’re wrong people will somewhat respectfully make fun of them, okay?

 

DL: Not necessarily respectfully but they will.

 

TN: In some cases different but this is great and you know what economists and industry forecasts, commodity forecasters these guys have to be accountable as well. I would love it if traders would put forecasters up to the same level of criticism that they do other traders but they don’t.

 

DL: Don’t you find it interesting? I mean one of the things that I find more intellectually dishonest sometimes is to hear some of the forecasters say, well we’ve only made a downgrade of one point of one percentage point of GDP only.

 

TN: Only, right. It’s okay.

 

DL: So that is that we’ve grown accustomed to this idea that you start the year with a prediction of say, I don’t know three percent growth, which goes down to below two. And that doesn’t get anybody fired, it’s sort of like pretty much average but I think it’s very important because one of the things. And I want to gather your thoughts about this. One of the things that we get from this is that there is absolutely no analysis of the impact of stimulus packages for example, when you have somebody is announcing a trillion dollar stimulus package that’s going to generate one percent increase in trendline GDP growth it doesn’t. And everybody forgets about it but the trillion dollars are gone. What is your thoughts on this?

 

TN: Well, I think those are related in as much as… let’s say somebody downgraded GDP by one percent. What they’re not accounting for, What I think they’re not accounting for is let’s say the economic impact kind of multiplier. And I say that in quotes for that government spending, right? So in the old days you would have a government spending of say you know 500 billion dollars and let’s say that was on infrastructure. Traditionally you have a 1.6 multiplier for infrastructure spend so over the next say five years that seeps into the economy in a 1.6 times outs. So you get a double bang right you get the government spending say one-to-one impact on the economy. Then you get a point six times that in other industries but what’s actually happened.

 

And Michael Nicoletos does some really good analysis on this for China, for example. He says that for every unit of say debt that’s taken out in China, which is government debt. It takes eight something like eight units of debt to create one unit of GDP. So in China for example you don’t have an economic multiplier you have an economic divisor, right?

 

DL: Exactly.

 

TN: So the more the Chinese government spends actually the less GDP growth which is weird, right? But it tells me that China is an economy that is begging for a market. A real market, okay? Rather than kind of central planning and you and Europe. I’m sure you’re very familiar with the Soviet Union. I studied a lot of that in my undergrad days very familiar with the impact of central planning. China there’s this illusion that there is no central planning in China but we’re seeing with the kind of blow-ups in the financial sector that there is actually central planning in China.

 

And if you look at the steel sector you look at commodity consumption, these sorts of things it’s a big factor of china still, right? So but it’s incredibly inefficient spending. It’s an incredibly inefficient way and again it’s a market that is begging for an open economy because they could really grow if they were open but they’re not. They have a captive currency they have central planning and so on and so forth.

 

Now I know some of the people watching, you’re going to say you’ve never been to China, you don’t understand. Actually I have spent a lot of time in China, okay? I actually advise China’s Economic Planners for about a year and a half, almost two years on the belt and road initiative. So I’ve been inside the bureaucracy not at the high levels where they throw nice dinners. I’ve been in the offices of middle managers for a long time within the Chinese Central Government so I understand how it works and I understand the impact on the economy.

 

DL: Don’t you think it’s interesting though that despite the evidence of what you just mentioned. And how brutal it has been because it’s multiplied by 10. How many units of debt are required to generate one unit of GDP in a little bit more than a decade? Don’t you find it frustrating to read and hear that what for example the United States needs is some sort of central planning like the Chinese one. And that in fact the the developed economies would be much better off if they had the type of intervention from from the government that China has?

 

TN: Sure, well it’s it’s kind of the fair complete that central bankers bring to the table. I have a solution. We need to use this solution to bring fill in the blank on desired outcome, okay? And so when central bankers come to the table they have there’s an inevitability to the solution that they’re going to bring. And the more we rely on central bankers the more we rely on centralized planning. And so I’ve had so many questions over the last several years, should the us put forward a program like China’s belt and road program, okay?

 

We know the US, Europe, the G20 nobody needs that, okay? Why? Because Europe has an open market and great companies that build great infrastructure. The US has an open market and although European infrastructure companies are better. The US has some pretty good companies that build infrastructure in an open market. So why do we need a belt and road program? Why do we need central planning around that? And we can go into a lot of detail about what’s wrong with the belton road and why it’s not real, okay? But that type of central planning typically comes with money as the as kind of the bait to get people to move things. And so we’re already doing that with the FED and we’re already doing that with treasure with money from the treasury, right?

 

And if you look at Europe you’re doing it with the ECB. You’re doing it with money from finance ministries. The next question is, does the government start actually taking over industries again? And you know maybe not and effectively in some ways they kind of are in some cases. And the real question is what are the results and I would argue the results are not a multiplier result they are a divisor result.

 

DL: Absolutely. Absolutely it is we saw it for example. I think it’s, I mean painfully evident in the junk plan in Europe or the growth and jobs plan of 2009 that destroyed four and a half million jobs. It’s not easy to to achieve this.

 

TN: You have to try to do that.

 

DL: You have to really really try it, really try.

 

I think that you mentioned a very important factor which is that central banking brings central planning because central banks present a program of monetary easing of monetary policy. And they say well we don’t do fiscal policy but they’re basically telling you what fiscal policy has to be implemented to the point that their excuse for the lack of results of monetary policy tends to be that the that the transmission mechanism of monetary policy is not working as it should. Therefore because the demand for credit is not as much as the supply of money that have invented. They say, well how do we fill in the blank? Oh it has to be government spending. It has to be for planning. It has to be so-called infrastructure spending from government.

 

You just mentioned a very important point there is absolutely no problem to invest in infrastructure. There’s never been more demand for a good quality infrastructure projects from private equity, from businesses. But I come back to the point of of central banks and a little bit about your view. How does prolonging easing measures and maintaining extremely low rates affect these trends in growth and in these trends in in productivity?

 

TN: Well, okay, so what you brought up about central banks and the government as the transmission mechanism is really important. So low interest rates Zerp and Nerp really bring about an environment where central banks have forced private sector banks to fail as the transmission mechanism. Central banks make money on holding money overnight, that’s it. They’re not making money necessarily or they’re not doing it to successfully to impact economies. They’re not successfully lending out loans because they say it’s less risky buying bonds. It’s less risky having our money sit with the Fed. It’s less risky to do this stuff than it is to loan out money. Of course it’s less risky, right? That’s goes without saying.

 

So you know I think where we need to go with that is getting central banks out of that cycle is going to hurt. We cannot it… cannot hurt, well I would say baby boomers in the West and and in Northeast Asia which has a huge baby boomer cohort. Until those guys are retired and until their incomes are set central banks cannot take their foot off the gas because at least in the west those folks are voters. And if you take away from the income of that large cohort of voters then you’ll have, I guess I think from their perspective you’ll have chaos for years.

 

So you know we need to wait until something happens with baby boomers. You tell central banks and finance ministries or treasuries will kind of get religion and what will happen is behind baby boomers is a small cohort generally, okay? So it’s that small cohort who will suffer. It’s not Baby Boomers who will suffer. It’s that small cohort who will suffer. It’s the wealth of that next generation that Gen x that will suffer when central banks and finance ministries get religion.

 

So we’re probably looking at ten more years five more years of this and then you’ll see kind of… you remember what a rousing success Jeff Sax’s shock therapy was, right?

 

DL: Yeah.

 

TN: So of course it wasn’t and it’s you know but it’s gonna hurt and it’s gonna hurt in developed countries in a way that it hasn’t hurt for a long time. So that kind of brings to the discussion things like soundness of the dollar, status of the Euro that sort of thing. I think there are a lot of people out there who have this thesis. I think they’re a little early on it.

 

DL: Yeah, I agree.

 

TN: So economists you know these insurance people see it from a macro perspective but often they come to the conclusion too early. So I think it’s a generational type of change that’ll happen and then we start to see if the US wants the dollar to remain preeminent. They’re going to have to get religion at the central bank level. They’re going to have to get religion at the fiscal level and really start ratcheting down some of the kind of free spending disciplines they’ve had in the past.

 

DL: Yeah, it’s almost inevitable that you’re in a society that is aging. The net prison value of bad decisions for the future is too positive for the voters that are right now with the middle age, in a certain uh bracket of of age. Me, I tried the other day my students I see you more as the guys that are going to pay my pension than my students. So yeah…

 

TN: But it’s you and me who will be in that age bracket who will pay for it. It’s the people who are 60 plus right now who will not pay for it. So they’ll go through their lives as they have with governments catering to their every need, where it’s our age that will end up paying for it. So people our age we need to have hard assets.

 

DL: Absolutely.

 

TN: You know when the time comes we have to have hard assets because it’s going to be…

 

DL: That is one of one of the mistakes that a lot of the people that follow us around. They they feel that so many of the valuations are so elevated that maybe it’s a good time to cash in and simply get rid of hard assets, I say absolutely the opposite because you’ve mentioned a very important thing which is this religious aspect that we’ve that we’ve gotten into. And I for just for clarity would you care to explain for people what that means because…

 

TN: I say get religion? I mean to become disciplined.

 

DL: I know like you because that is an important thing.

 

TN: Yes, sorry I mean if anybody but to become disciplined about the financial environment and about the monetary environment.

 

DL: Absolutely because one of the things that people tend to believe when you talk about religion and the the state planners religion and and central bank’s religion is actually the opposite. So I wanted to write for you to very make it very clear. That what you’re talking about is discipline you’re not talking about the idea of going full-blown MMT and that kind of thing.

 

TN: No. I think if there is if there is kind of an MMT period, I think it’s a I don’t think it’s an extended period. I think it’s an experiment that a couple of countries undertake. I think it’s problematic for them. And I think they try to find a way to come back but…

 

DL: How do you come back from that because one of the problems that I find when people bring the idea of well,  why not try. I always, I’m very aware and very concerned about that thought process because you know I’ve been very involved in analyzing and in helping businesses in Argentina, in Hawaii, in Brazil and it’s very difficult to come back. I had a discussion yesterday with the ex-minister of economy of Uruguay and Ignacio was telling me we started with a 133 percent inflation. And we were successful in bringing it down to 40 and that was nine years.

 

TN: Right. So, yeah I get how do you come back from it look at Argentina. look at Zimbabwe. I think of course they’re not the Fed. They’re not you know the EU but they are very interesting experiments when people said we’re going to get unhinged with our spending. And we’re going to completely disregard fundamentals. Which I would say I would argue we are on some level disregarding fundamentals today but it’s completely you know divorced from reality. And if you take a large economy like the US and go MMT it would take a very long time to come back.

 

DL: Absolutely.

 

TN: So let’s let’s look at a place like China, okay? So has China gone MMT? Actually, not really but their bank lending is has grown five times faster than the US, okay? So these guys are not lending on anything near fundamentals. Sorry when I say five times faster what I mean is this it grew five times larger than the bank lending in the US, okay? So China is a smaller economy and banks have balance sheets that are five times larger than banks in the US. And that is that should be distressing followers.

 

DL: Everybody say that the example of China doesn’t work because more debt because it’s growing faster what you’ve just said is absolutely critical for for some of our followers.

 

TN: Right, the other part about China is they don’t have a convertible currency. So they can do whatever they want to control their currency value while they grow their bank balance sheets. And it’s just wonderland, it’s not reality so if that were to happen there are guys out there like Mike Green and others who look at a severe devaluation of CNY. And I think that’s more likely than not.

 

DL: Yeah, obviously as well. I think that the the Chinese government is trying to postpone as much as it can the devaluation of the currency based on a view that the imbalances of the economy can be sort of managed through central planning but what ends up happening is that you’re basically just postponing the inevitable. And getting a situation in which the actual devaluation when it happens is much larger. It reminds me very much. I come back to the point of Argentina with the fake peg of the peso to the dollar that prolonging it created a devastation from which they have not returned yet.

 

TN: Right. And if you look at China right now they need commodities desperately, okay? Metals, they need energy desperately and so on and so forth. So they’ve known this for months. So they’ve had CNY at about six three, six four to the dollar which is very strong. And it was trading a year ago around seven or something like that. So they’ve appreciated it dramatically and the longer they keep it at this level. The more difficult it’s going to be on the other side. And they know it these are not stupid people but they understand that that buying commodities is more important for their economy today because if people in China are cold this winter and they don’t have enough nat gas and coal then it’s going to be a very difficult time in the spring for the government.

 

DL: And when you and coming back to that point there’s a double-edged sword. On the one side you have a currency that is out to free sheet are artificially appreciated. On the other side you also have price controls because coal prices are limited by the government. And therefore you’re creating on the one hand a very big monetary hole and on the other hand a very big financial hole in the companies that are selling at a loss.

 

TN: That’s true but I would say one slight adjustment to that things like electricity prices are controls. When power generators buy coal, they buy that in a spot market, okay? So coal prices have been rising where electricity prices are highly regulated by the government this is why we’ve seen blackouts and brownouts and power outages in China. And why it’s impacted their manufacturing base because they’re buying coal in a spot market and then they’re having to sell it at a much lower price in the retail market.

 

And so again this is the problem with central planning this is the problem with kind of partial liberalization of markets. You liberalize the coal price but you keep the electricity price regulated and if you don’t have the central government supporting those power plants they just blow up all over the place. And we’ve seen the power generators in the UK go bankrupt. We saw some here in Texas go bankrupt a couple years ago because of disparities like that and those power generators in the UK going bankrupt that’s the market working, right? So we need to see that in China as well.

 

DL: Yeah, it’s a very very fascinating conversation because on the other hand for example in Europe right now with the energy shortage we’re seeing that a few countries Spain, France, etc. are actually trying to convince the European Union, the European Commission to try to get into a sort of intervened market price in the in the generation business. Which would be just like you’ve mentioned an absolute atrocity very very dangerous.

 

TN: This creates a huge liability for the government.

 

DL: It creates a massive liability for the government. This is a key point that people fail to understand the debate in the European union is that, oh it’s a great idea because France has this massive utility company that is public. And therefore there’s no risk it had to be bailed out twice by the taxpayers. People tend to forget that you’re paying for that.

 

TN: But again this is what’s that block of voters who doesn’t really care about the impact 10 or 20 years down the road. That’s the problem. There’s a huge block of voters who don’t really care what the cost is because the government’s going to borrow money long-term debt. And it’s going to be paid back in 10 or 20 years and the biggest beneficiaries of this and the people on fixed incomes they actually don’t care what the cost is.

 

DL: Yeah, yeah exactly, exactly. There’s this fantastic perverse incentive to pass the bill to the next generation. And that obviously is where we are right now. Coming back to the point of the infrastructure plans and the belt and road plan. What in your view are the the lessons that we must have learned or that we should be learning from the Belgian road initiative?

 

TN: So here’s a problem with the Belton road and I had a very candid discussion with a senior official within China’s NDRC in probably 2015 which was early on, okay? And this person told me the following they said the Belgian road was designed to be a debt financed plan. What’s happening now, and again this was six or seven years ago, very early on in the in the belts and road dates. They said the beneficiary countries are pushing back and forcing us to take equity in this infrastructure, okay?

 

Now why does that matter well the initial build out of infrastructure is about five percent of the lifetime cost of that asset, okay? So if you’re if China is only involved in the initial build out they’re taking their five percent, it’s a loan and they get out. If they’re equity holders in that let’s say they’re 49 equity holders in an Indonesian high-speed rail then they become accountable for part of that build-out. And then they have to maintain the other 95 of the cost for the next 30 to 50 years. So they thought they were going to be one and done in and out. We do this infrastructure we get out they owe us money and it’s really clean what’s happened is they’ve had to get involved in the equity of those assets.

 

And so I’ve since had some uh government officials from say Africa ask me what do we do with the Belton road with china? Very simple answer force them to convert the debt to equity, okay? They become long-term involved on a long-term basis. They become involved in those assets and then they’re have a different level of interest in them in the quality maintenance and everything else but they’re also on the long-term basis accountable for the costs.

 

So they don’t just build a pretty airport that and I’m not saying this necessarily happens but they don’t just build a pretty airport that falls apart in five years, okay? They then have to think about the long-term impacts and long-term maintenance costs of that airport, right? And so but you know the original design of the Belton road was debt financing. Mobilizing workers and so on and so forth what it’s become is a mix of debt and equity financing. And that’s not what the Chinese government has wanted.

 

So I’ve been telling people for three or four years the Belton road is dead, okay? And people push back me and say no it’s not, you know think tank people or whatever. But they don’t understand the fundamental fact of how the Belton road was designed it was designed as a one-and-done debt financed infrastructure build out it’s become a long-term investment all around the world. So it’s a different program. It’s failed, okay?

 

They’re not going to make the money they thought yes they’ll keep some workers busy but they’re not going to make the money they thought. All of those assets, almost all those assets are financed in US dollars, okay? So they’re not getting their currency out. It’s not becoming an international unit like they had hoped. They’re it’s not they’re not clean transactions and so on and so forth. So this is what’s happened with the Belgian road. So the lesson learned is they should have planned better. And they should have had a better answer to you become an equity owner. And uh

 

I think you know if any western governments want to have kind of a belt and road type of initiative. They’re going to have to contend with the demand from some of these countries that they become equity owners. And I think that’s a bad idea for western governments to be equity owners in infrastructure assets so you know this is this is the problem.

 

Japanese have taken a little bit different because of where the Yen is and because of where interest rates are in Japan. Japanese have basically had kind of zero interest or close to zero interest on the infrastructure they’ve built out. And so they haven’t gone after it as aggressively as China has. They’ve had a much cleaner um structure to those agreements. And so they’ve been, I think pretty successful in staying out of the equity game and staying more focused on the debt financing for their infrastructure initiatives.

 

DL: Oh, absolutely big lesson, big lesson there because the we see now that the vast majority of those projects are impossible to the debt is impossible to be repaid. There’s about 600 billion dollars of unpayable debt out there. And we also have the example from from the internationalization of the French, Spanish, Italian companies into Latin America that they fell into the same trap. They started with a with a debt-financed infrastructure build type of clean slate program that ended up owning equity. And in some cases with nationalizations hopefully that will not…

 

TN: And watch for debt to equity conversions in these things. It’s good. There’s going to be huge pressure because the Chinese say the exit bank the CDB. A lot of these organizations are going to be forced to convert that debt to equity and then unload it on operating companies in China. They’re not going to want to do it but we’re going to start to see more and more pressure there over the next couple of years.

 

DL: Great! Well I’m absolutely convinced that will happen. Tony, we’ve run out of time so it’s been an incredible conversation lots of things that are very very interesting for our followers. We will give all the details to follow you and to get more information about your company in the details of the of the video. And thank you so much for your time. I hope that that we will be able to talk again in a not too distant future.

 

TN: Thank you Daniel. Anytime. Thank you so much.

Categories
QuickHit

EM Meltdown: China, Turkey & Russia (Part 1)

EM Meltdown: China, Turkey & Russia (Part 1)

The emerging markets expert Michael Nicoletos shares his insights into the Chinese economy and why it’s in a very big trouble?

 

This is the first part of the discussion. Subscribe to our channel to get notified when Part 2 is out.

 

In this first part, Michael talked about China’s household debt and how much is that? Can they ever recover from the Evergrande disaster? And how they got into it in the first place? Is CNY still valuable? How do the Chinese get dollars now with their very limited FX reserve? Should you use the digital Yuan? How much is China spending right now to up its GDP?

 

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

 

Tony Nash met Michael at a Real Vision event in 2019, when he was giving a presentation on China, and he had a chart in there that was actually Michael’s chart. They had a conversation after that and have stayed in touch occasionally since then.

 

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This QuickHit episode was recorded on October 20, 2021.

 

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

Show Notes

 

TN: So on China. Michael, I wanted to ask you, you sent out a tweet. I think it was last week talking about China’s household debt and it’s on the screen now. So it’s talking about how China’s household debt is at $10 trillion and looking at the ratio of China’s household debt to say, Hong Kong and the US. So can you talk to us a little bit about China’s household debt loads and what that really means for the Chinese economy?

 

Banking bubble in China and Hong Kong

 

MN: Well, as we all know, it’s been in the news lately. The Evergrande imminent. I don’t know if it’s going to be a default because there are some discussions right now to find a solution. But either way, it’s very hard for it to be repaid at its face value.

 

Now, the problem here is twofold. One problem is that China is highly levered as a whole, approximately more than 270% of GDP. The other thing is that real estate is approximately 62 trillion, I’d say the property market, which includes also home prices and everything. It’s about 62 trillion, of which around 10 trillion around sold properties. So it’s a very big backlog. The real estate crisis has started with Evergrande, and we’ve seen actually bond yield spiking in China real estate bond prices. And the big issue here is that banks are the ones who lend obviously to the real estates. So right now, banking assets in China are around 400% of GDP. And in Hong Kong, which is a proxy to China is around 900% of GDP. Just to put it in perspective.

 

In 2007, the relevant numbers for the US was 230%. And Ireland where the crisis started was like 700%. So we’re past both those levels. So we see that there’s a very big debt problem within China. Now, because China has capital controls in place, money cannot leave the country. So the bubble grows, grows, grows. But the money stays in the system.

 

So people now are starting to be afraid. And it’s the first month after six years that retail prices started falling in China. So this is creating a vicious loop. That fear that the contractor will not deliver your house. It means that you’re not going to purchase a new house. So you’re afraid. People in China have stopped buying, which creates a negative, vicious look.

 

So China has tried to avert this at least three or four times in the past ten years. Every time China is trying to stem back from giving you debt, we see such a small crisis, and then China is forced to reverse immediately because it cannot afford. It’s too big of an economy. Real estate is approximately 29% of China’s GDP. So you understand that something like that is very hard to control.

 

Now, China has been a rock in a hard place because I’ve been trying to shift from an investment, let’s say, investment intensive economy to a more consumption driven economy.

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TN: This has been a 20-year transition, right? It’s not something they started two years ago. They’ve been trying to do this for, like, 20 years, right?

 

MN: They’ve been trying to do this, say ten years. But let’s see, consumption as a percentage of GDP is around 38%. When in the US, it’s around 70%. It’s very hard to get that number higher. And given that all the wealth or most of the wealth by Chinese people, is linked directly or indirectly to real estate, you understand that this is a chicken and egg problem. If you try to stop one problem, you’ll create the other problem.

 

TN: Sure.

 

MN: So there are these problems right now in China. I think China will be forced to reverse course again. I don’t think you can afford to create a real estate crisis. I don’t think there would be a world contagion, by the way. But I think it could create a spillover effect with other real estate entities. Evergrande, the size was around 300 billion. It’s actually the biggest one. So we’ve seen the biggest one. And the thing is this could spill over to the whole industry.

 

Now, what’s the problem here, besides that? The problem is that China has been trying to convince banks and actually all the regions to stop giving loans, which are unproductive. Now, because GDP in China is an input number and not an output number like it’s in the Western countries, whatever the number the government sets, that’s what everyone tries to achieve and they can achieve it by giving more money.

 

TN: I just want to stop you there because I don’t think that point is well understood. When you say GDP is an input number in China and it’s an output number everywhere else. I’ve been trying to make this point for years to people, and you say… Help me understand, when you say it’s an input number. What do you mean in simple terms?

 

MN: In simple terms is the government wants 7% growth, so everyone will do the best they can to achieve that 7% growth, no matter what. So it means if I’m a bank or if I’m a region in China and I need to do more, I need to produce more growth. I’ll give out loans, which could be unproductive.

 

What do I mean? If I build a bridge, this is the most common example. If I build a bridge, when I build a bridge, this is counted in the GDP growth. Now, if I destroy the bridge, that is not deducted by the GDP. Right? If I rebuild the bridge, it’s added again. So in theory, you could make one bridge, build it, destroy it, build it, destroy it. And you would only have growth. So when China wants an input number, it will create bridges. The bridges could be, as we say, the usual “bridges to nowhere.” The famous quote. Or it could be bridges, which are useful. So all these unproductive debt went mostly to properties. And that’s why we see all these vacancies and all these ghost towns around China which actually were built and this was added in the GDP growth numbers. But then no one went to live there and the towns are there, and now they have to bring them down.

 

TN: Right. Now, you’re famous for kind of calculating for every say CNY spent by the Chinese government, it results in X amount of GDP, right? There used to be a multiplier effect to CNY spent and GDP. But you started seeing as that was diluted. So when you last calculated that, what was that number? For every say Chinese Yuan spent how much GDP was created?

China credit to GDP ratio

 

MN: So your viewers can understand because it’s a bit technical. So let’s assume you’re an economy and you create debt. You want that debt to create more GDP than the debt you’re giving. So if you’re giving one unit of debt, you want that one unit of debt to create one point, something of GDP.

 

So in theory, you would want it to be two, three, four. Okay, that’s not very easy. But if it’s a plus, it means that your debt was accredited. So it helped the economy. The problem here is, since 2008, China from using approximately let’s say, two units of debt to create one unit of GDP. So we’re already negative, because when you have two units of debt to create one unit of GDP, it means that that one unit will end up as a bad debt at some point. It’s not imminent, but at some point it will add up. So we went from 1 to 2.2 units of debt to create one unit of GDP. And right now we’re approximately between eight and nine units of debt to create that same one unit of GDP. So China needs more and more debt to sustain the same rate of growth.

 

TN: Right. So instead of a multiplier effect, which is what kind of economic impacts people usually talk about, there’s almost a divisor effect in China.

 

MN: You could say that. But because it’s a closed economy, that money can’t leave the system. So in theory, if you had a free account or if you had an open capital account, the Chinese will say, oh, my God, my currency is overvalued. Or let me take some money out of China and make a dollar. Now, this is not possible because Chinese have, I think, a quota of $50,000 a year they can take out? Something like that. Now, obviously, there are ways to take money out, but it’s not the easiest thing, and it’s not for everyone.

 

TN: I guess. It’s jewelry and watches the latest.

 

MN: Right. Okay. It was also Bitcoin. They try to be creative. Well, there’s a good ratio here, which is pretty interesting, and people forget. Now, if you devise the M2, the FX reserves to M2, why do I do that? Because let’s assume money is the money supply within the system. The ratio goes to 9%. Now, the Tiger countries in the Asia crisis in ’97 had the same ratio of approximately 25% to 30%. When it dropped below the 25%, you had the big devaluation.

 

Now, China doesn’t have a big external debt. So since it doesn’t have a big external debt, there is no trigger from that side of the equation for China to be forced to liquidate that fixed reserves to cover for it. But even though they have approximately $3.2 trillion of FX reserves and maybe another trillion from the banks and everything. I’d say 4 trillion. The M2 is approximately around $36 trillion right now. So these numbers… Imagine a hot balloon that you put air. At some point it’s going to blow. We don’t know what that level is. Okay. It could be like ten years before that happened. Or we could see, in my view, the Japan-like model where for ten years, you have an anemic growth. But you don’t see anything really, not a substantial bust. Because one thing.

 

TN: You also just destroyed the idea of China becoming a global currency, of the CNY becoming a global currency. Right. Because if they do have to trade on an open basis, then it’s way overvalued. Right. It’s like monopoly money.

 

MN: Well, China tried or is trying, at least. And it appears through Alipay and WeChat to create a digital Yuan. Why does he want to create a digital Yuan. It’s pretty simple. If the world is using a digital Yuan outside China, it means that the CNY or Yuan or Renminbi or whatever you want to call it, will be used abroad. So this means that it’s usage outside China will increase.

 

We’ve seen, however, that during the last two years, and I’m sure you have the guests, which are better to talk about this, know this subject a bit better than me. The dollar usage has gone up. The dollar is around 87% of global transactions. It actually went up. So there’s a discussion where everyone says the dollar is dying. The dollar is dying, the dollar is dying. Okay. And I understand where it’s coming from because of the policies. But monetary policies are relative. They’re not absolute. Maybe US is doing something bad, but the rest of the world is not doing something better.

 

So right now, the US dollar dominance increases. Now. I’m pretty sure I understand that this cannot stay at current levels. But going from 87% to being to 5%, it’s not something that’s going to happen in the next 2 years.

 

TN: I think the dollar had been down to like 82% six to seven years ago. And seeing it go up to 87%, that’s not a small amount. But the Fed does not want to be the World Central Bank. The US Treasury does not want to be the world’s treasury. So there’s this belief that the US wants to be the dominant global currency. I don’t necessarily believe that’s true. I think there are advantages to having a large portion of global currency usage, but I think 87% is just way too much. It’s way too much concentration of risk, actually, for the Fed and for US monetary officials. Go ahead. Sorry.

 

MN: No, you’re absolutely right. I think you’re right. However, the US, I think would like to remain the number one. Now, I don’t know what the percentage, the optimal percentage would be. But I’m pretty sure they prefer being the dominant than not being the dominant.

 

TN: Oh, yeah, absolutely. They want to say number one, but 87% is just too much.

 

MN: Since we’re talking about the dollar. The important thing about the dollar is that if the dollar strengthens, okay. And I don’t have a strong view here, I think it’s going to strengthen, but I understand if it doesn’t. If the dollar strengthened, this puts the pressure on emerging markets as a whole, because usually emerging markets tend to borrow in foreign currency because the foreign currency interest rate is much lower than the local currency.

 

For example, in Turkey, it’s 20%. The dollar is 0%. So if there’s a Turkish corporate wants to launch a bond, it will borrow on dollars at five 6% instead of borrowing at 20%. So they try to do that.

 

Now, as the dollar strengthens, especially for emerging markets, this puts pressure to repay the debt and it becomes harder and harder. So if the dollar were to strengthen, that would create a very, very big problem. I think the Goldman Sachs issued a report where it showed that the growth divergence between emerging markets and developed markets is at its lowest point. If you look at the cycles and it leaves that it could expand and right now, I think it discounts like a 4% growth for EM as a total.

 

So if the dollar strengthens, I don’t think we’ll see these numbers. I think you’ll see pressure on EM. Huge.

 

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

Categories
QuickHit

Quick Hit Cage Match: Van Metre vs Boockvar on Inflation (Part 2)

Van Metre vs Boockvar on Inflation (Part 2)

This is Part 2 of the inflation discussion with Steven van Metre and Peter Boockvar with your host Tracy Shuchart. In this second part, they talked about the possibility of the Fed tapering this year or early in 2022. How about the possible rate hike and what will possibly happen in other parts of the world like Bank of Japan and Bank of England if ever this happens? What is Powell doing exactly and why? Is there a possibility of a new Fed chair next year? And what do they think about stagflation?

 

For Part 1 of this QuickHit Cage Match episode, please go here. 

 

Steven van Metre is a money manager who have invented a strategy called Portfolio Shield. He also has a YouTube show that discusses economic data and the news three days a week.

 

Peter Boockvar is the Chief Investment Officer and portfolio manager at Bleakley Advisory Group. He has a daily macromarket economic newsletter called The Boock Report.

 

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This QuickHit episode was recorded on October 14, 2021.

 

The views and opinions expressed in this Quick Hit Cage Match: Van Metre vs Boockvar on Inflation Part 2 episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TS: Do you see the Fed tapering? And if they do, how much is this going to affect inflation? And also, I know the market is saying the Fed is going to raise rates in ’22, 2023. But is this a reality at all?

 

But before we jump into that, I just wanted to remind you to please subscribe to our YouTube channel.

 

PB: I think the Fed will at least start the taper and see how it goes. The thing that is different with this taper is that it’s coinciding with central banks around the world that are also beginning to remove accommodation. However slow, however glacial that process is, they’re all outside of the BOJ. They’re all doing it at once.

 

So if the Fed starts to taper in December, which they basically told you that they will, well, the Bank of England could be raising rates in December. We recently got a rate hike from Norway a month or two ago from South Korea. We’ve had Canada and Australia trimmed QE. Even the ECB has trimmed QE. So there’s a global shift to tightening. And I do believe tapering is tightening to define that. Just as we saw last year, the past 18 months obviously massive global easing.

 

Now I can’t even discuss the rate hike situation because I’m not even sure that they’re going to be able to get through the tapering. If you look back to 2010, every single notable market correction in equities and also fixed income markets outside of Covid and the one evaluation in August 2015 coincided with the end of QE, where it was a hard stop QE1 and QE2. And then obviously you had the taper 2013 and then obviously around rate hikes. Every single one coincided with a tightening of policy. And even again, it was gradual. It still affected markets. And we’re going to have it again to think that we’re going to somehow get through tapering without any accidents, I think, is delusional. And you believe that there’s a free lunch and it’s a matter of what kind of accident occurs by this.

 

Now QE itself essentially, at the end of the day, it’s an asset swap. And yeah, does some of that money sort of filter into markets? Yeah, maybe, I guess. But a lot of it’s psychological, but it also does help to, at least on the short end, suppress interest rates to where they would be otherwise. That said, when QE has been on, you’ve been paid to steepen the curve when QE is off, it pays to flatten it. And I think we’ve seen some recent flattening in the yield curve. And I think that that has been the right trade to do when QE is about to turn off.

 

But to Steve’s point about the bottom 50%. Well, if you get a short equity market correction, well, the top 50% is going to feel that as well. And yeah, can that filter into how they spend for sure? But that doesn’t necessarily resolve the supply issues.

 

That’s how this inflation story is going to recalibrate. The supply side is going to take a couple of years, and it’s going to be less demand. That is going to recalibrate this inflation story. And I think that is. No central bank wants to preside over a declining economy. But unfortunately, you’re going to have to have a trade off. You want lower inflation and a slower economy or an economy, as is but fast inflation, that’s going to hurt the people that can least afford it.

 

SVM: Yeah, this balance sheet taper thing is really interesting because I will be on record. I’ll hold on record still, and I don’t think the Fed’s going to do it. Although, as Peter mentioned, you just said that you think that the Fed is going to start and then quit. I’ve had to come to your side of the fence on that deal, mainly because when Powell spoke at Jackson Hole, it seemed like he was saying, we can’t make this mistake. We got to keep easing because we could let off the gas too soon.

 

And then for whatever reason, there’s this massive pivot between that and the last meeting. And he’s going to have a disadvantage going into the November F-O-M-C. And not have the non farm payroll report because he concludes me on Wednesday. Nonfarm payroll is out on Friday. Maybe he’s got some early access, who knows? But it seems like all of a sudden he’s in a panic to start tapering.

 

Now, could this be because we know the treasury is going to reduce their issuance of notes and bonds as we borrow less money, and he doesn’t want to be over purchasing? Sure. Could it be, as Peter mentioned, that the other central banks are tapering and starting to raise hike rates. And that’s interesting, because the way I look at it is that would be a catalyst if the Fed doesn’t start tapering, that the dollar goes higher.

 

Well, there’s part of the inflation story that almost nobody is looking at. What if the dollar gets up into 96, 97, maybe even close to 100? I mean, we’re talking about destroying the inflation story just from the dollar alone. And is this one of those things where we had coordinated easing? So now we need to have coordinated tapering to keep the dollar from going up too much? I’m not sure what his motivation is, but I will say this. There’s no way that they get to the end of that taper. There’s a 0% chance they’re going to raise rates. And even if they did, it doesn’t matter. They’ve effectively given the banks a pass by saying, look, there’s no reserve requirement because, well, you’ve got all these QE reserves you don’t need anymore.

 

The whole idea that we’re going to get this balance sheet unwound. I think the bond market is telling us the Fed’s making a mistake. I think, Peter, you and I agree that we don’t know how many months they’re going to go? The only question is, at what point is there a payroll report or some data that comes out that the Fed goes, “Oh, my God, we made a big mistake.”

 

PB: I’ll tell you why he’s doing this. Well, first of all, the whole purpose of monetary policy, as we know, is to push the demand side. And if you look at what are the two most interest rate sensitive parts of the economy — it’s housing and autos. So is Powell with a straight face going to say, I need to pedal to the metal, continue to stimulate the demand for housing and autos, when you can’t find an auto and the price of the home is worth 20% more than last year? They need to take their foot off that demand pedal. And he does not want to be Arthur Burns. He does not want to be Arthur Burns. And right now he is headed towards being Arthur Burns.

 

And the Fed is going to reach a pivot point, where if inflation still remains sticky and persistent, but growth is really decelerating to a greater extent than it already is. And we know that the Atlanta Fed third quarter GDP number has one handle on it. He’s going to have to reach a point, do I try to come inflation, but then risk further weakness in the economy and a fall in asset prices, which JPowell obviously inflated. Where is he going to just not really respond quick enough. And being in Washington, we can be sure he probably leans towards trying to save the economy, but then that creates its own problems.

 

The one thing in the dollar, the dollar is going to get tied into this, too, because if he remains too easy for too long, well, that may sacrifice the dollar. If he is more aggressive at dealing with inflation, well, then you can see a faster move in the dollar. So he’s just been an absolutely no win situation here. But there is going to be a pivot point where he’s going to reach that we’ll have to see, does he go down the Paul Volcker route, or is he going to go continue down the Arthur Burns route?

 

SVM: See, Peter, you just said it best. He didn’t know what his situation. And all we’re debating is, at what point does he back off and quit because he realizes it’s not working? I mean, we can look at the velocity of money and see the monetary policy is not functioning properly.

 

I mean, there was a lot of people that predicted at the end of the last quarter that as economy reopen, velocity would pop. But it didn’t because of the fact that monetary policy is not transmitting into the economy. And so now the real issue is if he starts tapering and it does do what it’s supposed to do, does he inadvertently tighten financial conditions? I mean, this is such a mess of what he’s got to deal with. And I don’t know if you’ll agree with me honest, but I don’t think they have a clue what they’re doing.

 

I think they’re just betting that this is all going to work out, that Powell, as himself, is going to get renominated. And somehow, in the end, either he’s going to look like a superhero and say, look, see, I did it and go out as one of the most celebrated Fed chairs ever. Or he’s going to find someone else to blame this on when it doesn’t work.

 

PB: The Fed has been winging it for decades, and this all goes back to Greenspan. In 1994, he raised rates aggressively. We know he blew up Mexico, he blew up Orange County, California, and he took that at heart. He learned a lesson. And so you go into the late 90s when everything is on fire. Stock market bubble. We know he was very slow to raise interest rates because he didn’t want to repeat 1994.

 

And then, of course, you have the blow up. And he’s obviously quick to raise interest rates. But remember the mid 2000s, every single. When he started raising interest rates, he did it every single meeting, and in every single statement, it said, we are doing this at a measure pace, because he didn’t want to repeat 1994.

 

And then what we have, obviously, the housing bubble and so on and so on. And then now you take Powell. We know Janet Yellen was afraid to raise interest rates. Took them seven years to get off zero. And then after finally raising, took them another twelve months to finally raise rates again. And then Powell started to pick up the pace. And then he blew himself up in the fourth quarter of 2018. And then that helps to explain why they’re going so slow now.

 

Then you throw in, of course, the whole social justice. The Feds become the Ministry of Social Justice now and how they view monetary policy. But yeah, to your point, they are winging it. And they’ve been winging it for decades.

 

SVM: And you bring up an interesting point about 2018. I’m really glad you did, because a lot of people forgot that we started easy to the point that it didn’t really make a lot of sense from the outside look in it. And so now this whole notion, and I don’t know what your reaction was, but I remember hearing the press conference when he’s like, okay, when Powell said, “We’re going to gradually unwind the balance sheet by mid 2022.” I’m like, since when is “gradual” six months. There’s no way this is going to work for you, buddy, but good luck if you’re going to pull it off.

 

PB: Yeah. And the Fed got lucky for a period of time. They got lucky in 2017 because the markets rallied and ignored Fed rate hikes and the beginning of the shrinking of their balance sheet. They were double tightening and they got bailed out because everyone focused on the corporate income tax cut. That obviously happened at the end of 2017. But that entire year, the Vix got down to eight. Every dip was bought because everyone was pricing in that tax cut. But once that tax cut was in place, the Fed then raised interest rates again in January 2018. And then we immediately shift back to the Fed is double tightening here between the balance sheet and rates. And that obviously coincided with the fourth quarter of 2018.

 

So we know in the Fed tapering, the Fed tightens until they hit a wall. The Fed tightens until something breaks, and you can be sure something will break in 2022. It’s just a matter of how deep they get. And also one last point here is that having low inflation gives central banks that Wayne’s World Concert pass that all access to do anything they want for how long as they want, when there’s no inflation. But once you get inflation into the numbers, into the economy, their flexibility is greatly diminished. And that will be an interesting sort of tug of war as they get further into the tapering and something eventually breaks.

 

TS: One last question, a couple of last question. How do you feel about Stagflation? I kind of amend the Stagflation camp. Do you think that’s a cop out or how do you feel about that?

 

SVM: I think it’s temporary. I mean, we’re supposed to be rising unemployment. I mean, I guess with people coming off the ranks, I don’t know. Maybe it’ll go back up. I don’t think that’s likely to happen. And then you tend to get that with higher prices. But when we start looking at the bond market. The bond market is starting to tell us that, hey, this Stagflation is going to be transitory. And then the risk that I see is that we get into outright deflation from here.

 

PB: To me, I just look at stagflation as just slower growth and higher inflation. And in an economist textbook, they think that slow growth means lower prices. Faster growth means higher prices. I’m just looking at the Bank of Japan. The Bank of Japan said we need to get inflation at 2%, and somehow that will then generate faster growth. To me, they’ve got that backwards. You need stable prices in order to develop and sustain healthier growth.

 

So right now. But the Stagflation it’s sort of intertwined in the sense that it’s the inflation and what is driving it. So it’s the inflation itself that is beginning to impact consumer spending. And it’s the factors that are creating the inflation, like the supply bottlenecks that in itself, are also creating slower growth.

 

TS: Excellent. One last question, just for a thought experiment. I mean, say Powell does leave the Fed next year and we have find a Dove, right. So what does the Fed look like at that point if we have a dove as a Fed chair?

 

PB: Well, 2022 becomes completely politicized. The Fed’s already politicized, but it becomes Uber politicized in 2022 because of the elections in November. And if a Lael Brainard becomes the next Fed chair in February, 2022, you can be sure that Steve and I are right, that there’s no chance in hell they’re going to finish this taper because the second something breaks, you know, they’re going to back off and they’re going to do their best to, or at least the Democrats headed by the Lael Branard will do their best to maintain control of Congress.

 

SVM: Yeah. I’ll put that as a low probability chance that Powell is out. If he does, I’m 100% agree.

 

PB: I agree. I think he stays as well.

 

SVM: Yeah, 100% agree. I think it’s a big risk for the Biden administration to pull him. He hasn’t really done anything wrong. But if he does, again, I think Peter is spot on. I mean, now it becomes even more political than the Fed is supposed to be. And he’s right, as soon as something goes wrong, I mean, we’re going to 120 billion a month. Yeah, right. It’ll be multiples of that in a second.

 

TS: All right. Well, I want to thank you both again for everything you shared with us today. Can you each tell us where we can find you on social media or otherwise?

 

PB: Well, I just want to say thank you to Tracy and Steve. Thank you for having me in this debate and discuss this with you. It was definitely a fun time. If you want to read my daily readings, you can subscribe to boockreport.com. boockreport.com And our wealth management business is at bleakley.com.

 

TS: Excellent.

 

SVM: I want to thank you as well. Peter, you and I know this has been a long time coming for us to be on the same screen together. I had a blast. Totally looking forward to the next time. If you want to find more about me, you could go to my website. stevenvanmetre.com On Twitter @MetreSteven. On YouTube at @stevenvanmetrefinancial.

 

TS: Great. And for everyone watching, please don’t forget to subscribe to our YouTube channel and we look forward to seeing you on the next QuickHit.

Categories
QuickHit

Cause and Effect: Are you a deflationist or an inflationist?

Are you a deflationist or an inflationist?

This QuickHit episode is joined by central bank and monetary policy expert Brent Johnson. He talks about inflationists versus deflationists and what makes these camps different in a time of a pandemic. What’s monetary velocity? And why banks are failing at their job, and why they’re not lending anymore money? Also discussed China and when supply chain issues will be resolved.

 

Brent Johnson is the CEO and founder of Santiago Capital, a wealth management firm. He works with about a dozen different families and individuals customizing wealth management solutions for them. He does that through a combination of separately managed accounts and private funds, also invest in outside deals, private deals, venture capital funds, and others. Brent have a focus on macro and loves the big picture.

 

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This QuickHit episode was recorded on September 28, 2021.

 

The views and opinions expressed in this Cause and Effect: Are you a deflationist or an inflationist? QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TN: Part of the reason we’re having this discussion. And is you posted something on Twitter a few weeks ago and I’m going to quote it and we’re going to put it up on screen. You said if you believe an additional QE is on the way, you are secretly a deflationist. If you believe in the taper, you are secretly in the inflation camp. Cause and effect. And I thought it was super interesting. Can you kind of talk through that with us and help us understand what you mean by that?

 

Inflation, deflation tweet

 

BJ: Sure. And before I get into that, I’m just going to take a step back because a lot of work I’ve done, a lot of the work I’ve done publicly and put out publicly over the last 10 to 12 years has really been about the design of the monetary system, how it works, how fund flows, you know, this currency versus that currency, what central banks do, etc. Etc.

 

And this is really a follow on from that and what I was, the point I was trying to get across in this particular tweet is that central banks are a reactive agency. They are not the cause. They are the effect. Now their policies can cause things to happen, but they are reacting to what they see in the market.

 

And so my point was if you think more QE is coming, then you believe they are going to be reacting to the deflationary forces that still exist in the economy. And so if they were to step back and do nothing, you would have massive deflation.

 

Now, the flip side of that is if you think that they’re going to taper and you think they’re going to pull away stimulus, then you’re actually an inflationist because you believe inflation is here, it’s going to remain. Prices are going to continue to rise. And the Fed is going to have to step back in reaction to those steadily higher prices.

 

And so I really get this across because I think there’s a huge battle between the people who believe deflation is next and the people who believe inflation is next. And I think it’s a fantastic debate because I’m not certain which one to come. I kind of get labeled into the deflationary camp, which I don’t mind for a few reasons. But I actually understand all the reasons that the inflationary arguments are being made. And I believe it was a few additional things happen. Then we could get into this sustained inflation. But until those things happen, I’m happy to be labeled into the deflationary camp. So I hope that makes sense.

 

TN: Yeah. So pull this apart for me. Inflation is ever and always a monetary function. Right. We hear that all the time. Of course, it’s hard to say something “always” is. But people love to quote that. And I think they misapply it in many cases. And I’ve seen that you’ve kind of pushed back on some people in some cases. So can you talk us through that and is this time different? Like, what are the considerations around inflation this time?

 

BJ: Yeah. So is this a perfect way to set this up because again, I understand the argument that those in the inflationary camp are making. And it would be hard to sit here and say we haven’t seen inflationary effects for the last twelve months. Prices have risen. Regardless of why or whatever prices have gone up. So I’m not going to sit here and deny that we’ve had inflationary pressures.

 

The question is what comes next. And I think what I would say with regard to the quote that you were just making, I think that was, I can’t remember who said it now, but it’s 50 or 60 years ago. And what I think was assumed in that quote was that monetary velocity is constant. And so you’ve seen these huge rises in the monetary base. But not just the United States, but Canada, Europe, South America, China and Japan.

 

And so the thought is that with that new money in the system, you’re naturally going to have inflation. But I think Lacy Hunt, who a fellow Texan of yours, does a fantastic job of showing, had the rate of monetary velocity stay the same. That is absolutely the case. But the reality is monetary velocity kind of took a nose dive starting about 20 years ago, and it just continued to lower and lower and lower.

 

TN: And it’s been negative, right, for the past couple years?

 

BJ: Yeah. It just continues to fall. And I think the rule is…

 

TN: Let me just stop you right there. “Negative velocity of money.” What does that mean?

 

BJ: What it essentially means is that new credit is not being created. And so the system is contracting. And this is really the key to it all. It’s the key to the way the monetary system is designed. It’s the key to the way it functions. And it’s the key to whether we’re going to have inflation or deflation next.

 

Because I do agree with the money, the inflation is always and everywhere, a monetary phenomenon, assuming that velocity is constant. But velocity isn’t constant. And it’s because of the way the monetary system is designed. And it’s because of the way that the Fed and other central banks have been providing stimulus.

 

Probably don’t have time to get into all the details of what a bank reserve is and whether it is or whether it isn’t money. But essentially what the central banks have been doing, especially the Fed, is re collateralizing the system. Now re collateralizing the system isn’t exactly the same thing as actually handing somebody else physical money. It sort of is, but it sort of isn’t. And it leads to this big debate on whether they’re actually printing money or not. It’s my argument that the Fed has been re collateralized the system and that has kept prices from continue to fall.

 

But in order to get this sustained inflation, I keep saying sustained inflation because I don’t want to deny, but we’ve had it. But to have it continue going higher, especially at the rate we’ve seen would require one of two things. Either the Congress has to come out and agree to spend another seven or $8 trillion, which this week is showing, it’s very hard to get them to agree to do that. They can’t even agree on 3.5 trillion and let alone another 6 to 7. Or the banks have to start lending. And the banks simply are not lending.

 

They lent last year because the loans that the banks made were guaranteed by the government. These were the PPP loans that everybody got.

 

TN: So. What you’re saying, it sounds to me, and correct me, what you’re essentially saying is that banks are failing as a transmission mechanism. So the government has had to become the transmission mechanism because banks aren’t doing what their job should be. Is that true?

 

BJ: That’s a very good way of putting it.

 

TN: Why? Why are banks not the transmission mechanism that they should be?

 

BJ: Well, they have the potential to be. And that’s what I say. The Fed has provided the banks all the kindling for lack of a better word, all the starter fuel to create this inflationary storm. But the banks haven’t done it. I would argue. Now there’s people to disagree with me. But I would argue that they don’t want to make a loan because believe it or not, banks don’t want to rely on getting bailed out, and they don’t want to make a loan where they are not going to get their money back.

 

Now, if you’re in an environment where businesses have been shut down either because of the pandemic or because of other laws or because of regulations that can’t afford all the regulations, whatever it is, you know, it’s hard to loan somebody a million dollars if you don’t know that their business is even going to be open the next day. Right.

 

So banks aren’t in the business of going out and making a loan and having and default on them. They want to get their money back. And I think that they would rather go out and buy a treasury bond that’s yielded one and a half percentage, than make a loan that pays them, three or four of them might go bad. Right.

 

TN: Okay.

 

BJ: So to me, that’s indicative of the deflationary forces that the banks who are closer to the money than anybody else, and typically the people that are close to money understand the money or benefit from the money the most, they are telling me from by their actions, maybe not their words, but their actions are telling me they don’t think this is a great investment.

 

TN: Yeah. I think we could talk about that point for, like, 20 minutes. So let’s switch to something else. So what you didn’t really mention is the supply side of the market in terms of inflation, meaning supply chain issues, these sorts of things. Right.

 

And so I want to focus a little bit on China. Now, there’s a lot happening in China, and I want to understand how that impacts your worldview.

 

In China, we’ve got the crypto regulation that’s come in. And the clampdown in crypto. We have a strong CNY, like an unusually strong CNY over the last six or nine months. We have the power supply issues. We have the supply chain issues. That’s a lot happening all at one time, at a time when a lot of people believe there’s kind of China has this clear path to ascendency, but I think they have a lot of headwinds, right. Of those kind of how are you thinking about those factors? The crypto factor, the supply chain factor, the power factor? How are you thinking about that stuff?

 

BJ: So I think about this a lot first of all. I mean, this is a probably, like it or not, for better force, the China-United States dynamic is probably one of the biggest macro drivers for the next ten or 20 years. It most likely will be. There’s nothing is guaranteed. But that’s probably a pretty safe bet that that’s going to be one of the main drivers. And so I think what you’re touching on as far as the supply chain, in my opinion, that is as big a driver as the “money printing” for the inflationary effects that we’ve seen for the last year.

 

You know, if you look at the efficiency with which the single global supply chain that Xi call it from 1990 to 2018 or 19, it’s pretty amazing, right. There’s one global supply chain, just in time inventory, you can predict with a very high level of certainty when you would get those things you ordered and at what price. But then with a combination of the US and Chinese antagonism and COVID, the supply chains are broke. And that makes it harder to get those supplies. And the timing of when you get them in the price, which you get to miss completely unknown or its delay, and the prices are higher.

 

And so I think that has led to a lot of the price pressure on commodities. Now, part of the reason that the decreasing supply push prices up was that demand stayed flat or went up it a little bit. And I think the reason it went up is a lot of people believe that the Fed would print enough money to cause demand to stay, solid and that China was growing and that they would continue. China has been the growth driver for the global economy for years and years. And I think a lot of people thought that China would continue to be that growth driver for these commodities and these other goods that were needed. And so if demand stays flat arise and supply gets cut, then price rises.

 

Now, I don’t think that China growing and ascending to economic hegemony or however you want to describe it is a given. I think they have more troubles internally than they would like to admit. And I think we’re starting to see that, with the Evergrande, real estate daisy chain of credit extension. You know, if you think that the US has a credit problem, take a look at China, they do as well. And it’s manifested itself nowhere more visibly than in the real estate market there and Evergrande.

 

Now, the problem is if they cannot send that credit contraction that is currently taking place in the Chinese market from a real estate perspective, then demand is not going to stay cloud. Demand is must start to fall, and demand starts to fall and some of those supply chain logistics start to get ironed out. Now, they’re not going to get fixed overnight. It’s not going to go back to the way it was 18 months ago. But if it even gets a little bit better and demand starts to fall, well, then you could have a move down in commodity prices and then move down in growth expectations.

 

And that is the way deflationary pressures could take whole. And as those prices start to come down, then you get more credit contraction. It becomes a vicious cycle both to the upside and to the downside. But based on the design of the monetary and I don’t need to keep harping on this. But based on the design of the monetary system, it is literally the stair step up in the elevator shut down. That’s just the way it’s designed. It’s an inherently inflationary system that it has to grow. Or if it doesn’t grow, then it crashes. And crash has always happened faster and steeper than the stairstep higher.

 

TN: They take longer, but steeper on the way up. Right.

 

BJ: That’s right. That’s right.

 

TN: Okay. So in terms of the supply chain issues, okay. I’m just curious, is this something that you think is going to resolve itself in three or six months? Do you think it’s something that’s with us for three years or what was I feeling out of this?

 

BJ: Some of it is gonna resolve itself in three or six months? And I think that will be a combination of just working out the kinks and demand falling. Right. I think that will help. But I don’t think it’s all going to get fixed in three to six months, and I think it might take three to six years to get the other part of it. And this is where I have to actually say that in the past, I’ve been somewhat critical of the people who called for stagflation because I kind of felt the top out, right? You couldn’t decide. So you just go down the middle.

 

But I actually think that that’s a very likely scenario. I think some things are going to inflate and some things are going to deflate and we’re going to have this kind of the stagflationary environment. I think the central banks are going to do everything they can to kind of offset those deflationary pressures. And in some cases, it will work. In some cases, they won’t. But the global debt, the amount of global debt and the global dollar… Is so big that deflationary scare, in my opinion, is always going to be there. And in my opinion, you can’t ignore it.

 

A lot of people just think, oh, don’t worry about it. Central banks, have you back. There’s a Fed put, don’t need to worry about it. I understand that argument, but I don’t think it’s correct. I think you do have to worry about it.

 

TN: Yes, I think that’s right. Brent, I would love to talk to you for another couple of hours. I think we could do it. And I’d love to revisit this in a few months. Thank you so much for your time for everyone watching. If you wouldn’t mind following us on YouTube and subscribing, we’d really appreciate that. That helps us get up to where we can promote more and other things. And, Brent, I really appreciate your time and really appreciate this conversation. Thank you very much.

Categories
QuickHit

QuickHit: What China is thinking right now?

What China is thinking right now?

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

 

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This QuickHit episode was recorded on August 24, 2021.

 

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

Show Notes

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

TN: Yeah.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

TN: Yes. That’s fair.

 

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

 

TN: Sure.

 

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

 

TN: Sure.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

TN: Sure.

 

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

 

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

 

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

 

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

 

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

Categories
QuickHit

QuickHit Cage Match: Time to Taper?

QuickHit Cage Match: Time to Taper?

This is a special QuickHit Cage Match edition with returning guest Albert Marko, and joining us for the very first time Andreas Steno Larsen to talk about tapering. Will the Fed taper this year? If yes, when, how, and why? If no, why not? Also discussed are the housing market, China GDP, and corporate earnings.

 

Andreas is the chief global strategist at Nordea Bank, which is mostly a Nordic bank, but has a presence in large parts of Europe, but also in the US. He speaks on behalf of the bank on topics surrounding global markets and in particular bond markets.

 

Albert Marko is a consultant for financial firms and high net worth individuals trying to navigate Washington, DC and what the Fed and Congress are up to.

 


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This QuickHit episode was recorded on August 16, 2021.

 

The views and opinions expressed in this QuickHit Cage Match: Time to Taper? QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

Show Notes

 

TN: So Andreas, I noticed you guys, you and Albert kind of in a Twitter fight last week about tapering, and that’s what really drew me to this discussion. I wanted to give you guys a platform to talk through this. So help me understand, you know. So what is your position? Why do you think it’s going to happen? When do you think it’s going to happen?

 

ASL:  Well, I think tapering is right around the corner, and the basic reason is that I expect marked sequential improvements in the labor market in the US over the coming two or three quarters. If you look at it, very simply speaking, right now, there are more job openings than unemployed in the US. I know I disagree with Albert on this as well. But in the old world, that would at least have let the Fed to turn very, very hawkish when they can see such a rate between job openings and unemployed as we have right now.

 

I basically have a case that once these extraordinary benefits, they will end across the US during September. Then we will have an explosion in a positive sense in the US Labor market. And that is exactly what is needed to convince the Fed of tapering.

 

So my base case is a decision taken in September and then an implementation starting already in December this year. And I expect them to be done already during the first half of next year with the tapering process. So it’s fairly aggressive compared to the scenarios I’ve seen painted by by other analysts.

 

TN: That’s really interesting. I just want to clarify one thing. When you say explosion the labor market, you mean more people coming into the market?

 

ASL: Yeah. And they come into the market and fill these job openings right now, we have a low labor market mobility due to a lot of temporary factors. And once they’re gone, then we should expect employment to be almost running at full speed before New Years.

 

TN: Okay. Okay. Very interesting. Albert, take it away. Help me understand what you’re thinking.

 

AM: Well, I mean, I would agree with him in the old days. Right. But we are in a situation where these tapering assumptions are based on Fed rhetoric and the public comments that they’ve been making specifically addressing his unemployment, unemployment boost or surge.

 

You know, we still have COVID lockdown patchwork across the world happening at the moment. Australia, Japan, Taiwan, and most importantly, China, because no one’s looking right now in China, but China’s GDP looks like it’s not going to surpass two or 3% for the next four or five quarters. With that in mind, where the United States going to get inventory for the holiday season and have this boost in employment surge that we usually get on holiday season.

 

It’s just, to me, there’s so many negatives, so many variables with negative connotations towards it. I can’t see the Fed tapering and just absolutely obliterating the market right before mid term season coming up in 2022. It’s just for me, it’s just inconceivable for them to do such a thing like that.

 

TN: Okay. Understood. So, Andreas, what do you think? Let’s say it doesn’t happen in September. What is the Fed thinking through and what mechanisms do they have to use, say, instead of a taper? Are there other things they can do aside from taper that will basically bring about the same intended outcome?

 

ASL: Well, I want to first of all, address what Albert said on China. I perfectly agree with the view on China right now. China is slowing massively. But I actually find it very interesting that the Federal Reserve is now even more behind the curve when it comes to its reaction function compared to earlier cycles, given that they want to see realized progress in labor markets and not forecasted progress.

 

And we know that labor markets, they lack the actual economic development. So it’s almost a given in my view, that we have a surge in employment over the coming couple of quarters as a consequence of what happened during the first half of the year. So that’s one thing.

 

And the second thing is that what we see right now in China is another wave of restrictions that will lead to renewed supply chains disruptions across the globe. And again, we will have a wave of supply side inflation, which is the exact kind of inflation that we are faced with right now. And given how the Fed communicated just three months back, you have to be amazed by how scared they are of the supply side inflation, even though it’s not the kind of inflation that they like.

 

So I still think that they will react to this, even though it’s supply side driven. What they have in sort of the toolbox ahead of September is obviously that they could hint that the interest rate path further out could be hiked. But otherwise, I think the most obvious tool is to look at the purchases of mortgages. Since we currently have a situation where most US consumers, they are very worried or even scared of buying a house. Timing wise right now, as a consequence of the rapid rise we’ve seen in the house prices. And I guess that’s directly linked to what the Fed is done on mortgages.

 

TN: Yeah. I can tell you just from my observation here in Texas where we have a lot of people moving in. House prices have taken a pause for probably the last two or three months where things even two, three months ago wouldn’t stay on the market for, like, three days. We’ve started to see things on the market for longer.

 

And so, I’m seeing what you’re saying, Andreas, about the housing market. And the question is, can that stuff pick up again, and is it justified? Albert, what’s your response to Andreas statement?

 

AM: The best comparison that we have is the 2013 economy to today’s economy. No one can sit there and argue that today’s economy is stronger than 2013. And look what Tapering Tantrum did to 2013 market. It was an absolute debacle. Yellen was so put off by Bernanke’s Tapering that she refused to do it in 2015. And in 2017, when they even mentioned it again, the market took a leg down. So, with that, right? And especially with Andres mentioning the word inflation, which is an absolute bad word to talk about in DC, tapering would have to have the Fed admit wrongdoing on sticking inflation.

 

When have we ever seen the US Federal Reserve ever take blame for something that’s negative in the markets? They just simply don’t do that. In fact, what I think they’re going to end up doing is allowing a market correction late into the fall and then unleash another $3 trillion of QE with Yellen and Powell to support the markets. So which would be completely opposite of tapering.

 

TN: Yeah, that’s interesting. You have completely opposite views. And what’s your view on the possibility of QE? I mean, is it possible?

 

ASL: Well, I don’t think Albert and I disagree a whole lot on the structural view or outlook, since that QE is a permanent instrument and it’s needed to fund the debt load of the US Treasury. There is no doubt about it. The point being here that the Federal Reserve needs a positive excuse to start tapering. I agree with that as well. And that exact positive excuse will be another couple of very strong labor market reports.

 

That’s exactly what they’ve been telling us. That they want to see between 800K and 1 million jobs created a month would be enough for them to launch a Tapering decision in September. Whether they will succeed with the entire tapering process is whole different question, but I’m looking for that decision in September. And then I guess Albert and I will agree a lot on the market takeaways if they take such a decision.

 

AM: Let me ask you a question Andreas. What would happen if the United States Congress refuses to deal with the debt ceiling and have no fiscal at that point? What would happen then?

 

ASL: Well, in such case, there is a whole lot of issues that you need to take care of as a Fed Reserve. So first of all, I’m not too scared of that scenario. I consider very low probability. I’m interested if you have another opinion.

 

AM: I personally don’t think it happens until at the very earliest November.

 

ASL: Yeah, but, I mean, obviously, every time there’s a debt ceiling deadline, we know that the true deadline is not the suspension deadline, its the deadline when the US Treasury is not able to run on fuels any longer, right? And that would be sometime during late October, there about I agree with you on that. So we basically have a window right now without a whole lot of issuance due to the debt ceiling being in place. And I actually think that’s a decent window for the Federal Reserve to utilize if they want to start tapering, since there is a smaller issuance for the private sector to swallow in such case.

 

TN: Interesting. Okay. What are you guys seeing on the corporate side? Are you seeing strength on the corporate side? I know we just had earnings season and they were very strong, but are you seeing a justifiably strong corporate position to start to taper?

 

AM: Right now, I really don’t. I mean, the University of Michigan Consumer Confidence had collapse. I think today, New York’s Manufacturer Index came in at 18.3, which was an astounding collapses in itself. You know, I personally deal with a couple of hedge funds, and they have been well behind the curve in returns right now.

 

I think the best ones are sub 10% for the year, so they’re gonna have to move back into cyclicals, and they’re gonna have to move back into small caps to make up the difference before the year end. Simply just even discussing that option, it makes tapering, you know, even less of a likely outcome just because it would ruin the market.

 

ASL: Obviously, if you go long small caps right now into a tapering scenario, you will end up losing. I agree with that. That would be kind of the worst. Yeah, exactly. But otherwise, I have to agree that the corporate sector is more doubtful, I would say, than the US Treasury in terms of a tapering decision. I’m much more scared of the corporate debt load than I am of the US Treasury debt load.

 

The State’s currency issue is they can always get rid of such a scenario. But the corporate sector is bigger trouble than the US Treasury into this scenario that I depict.

 

AM: Yeah. I completely agree with that one.

 

TN: Wow. We end on agreement. Guys. Thank you so much for this. Thanks so much for your time. I really look forward to it. Andreas, I look forward to having you back. Albert, of course, we look forward to having you back. Have a great week ahead, guys. Thank you very much.

 

And for all you guys watching. Thanks for taking the time. Please subscribe to our channel. And we’ll see you next time. Thanks very much.

Categories
QuickHit

The Death of Growth: Old & rich vs young & poor in 2030 & beyond (Part 2)

The world’s birth rate is changing. Clint Laurent from Global Demographics shares surprising discoveries that he believes will happen in the next 10 years and how this will shape the world?

 

This is the second part of this discussion. Go here for part one.

 

Clint started Global Demographics in 1996 and cover 117 countries throughout the world and China. They do that right down to county level of 2,248 counties. Clint believes that demographics are better than financial data from the point of view of forecasting  because they tend to be stable trends.

 

Global Demographics is able to come up with reliable forecasts at least 15 years out. After 15 years, reliability goes down and they are typically never more plus or minus 5% error in our long-term forecast. Their clients are mainly consumer goods companies, infrastructure backbones and things like that.

 

 

 

 

 

 

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This QuickHit episode was recorded on June 17, 2021.

 

The views and opinions expressed in this QuickHit Clint Demographics Part 2 QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

Show Notes

 

TN: So Indonesia, India, Brazil and so on, so capital formation, capital investment is the real weakness there and it seems to me that’s a function of largely education. Is that fair to say?

 

CL: That’s exactly what it is. I mean, they you know, as they get the education right and, you know, they’re working on it, most of these countries that have been quite responsible in that area. And as they get that right, so the investment comes in, so the consumer gets more affluent and becomes a virtuous circle.

 

TN: OK, well, what timescale are we talking about for that consumption to come in a really notable way, for example, to take the place of, say, the under 40 Chinese consumption or the under 40, say, Western Europe or American consumption?

 

CL: Well, that’s the bad news. I mean, when you take India at least 15 years to get there. Because the education is only just coming right. And again to pick on India. India’s urbanization, 10 years ago, it was 30% of the population. Today, it’s 33% of the population.

 

TN: OK. So it’s not happening nearly fast enough.

 

CL: No. When you’re an uneducated girl in a village, why would you go to a slum somewhere of a big city? Your lifestyle would be actually worse, not better. And so they hadn’t been able to get that China effect of moving people from the low productivity agriculture into high productivity urban type of work.

 

TN: Yeah, but I think a lot of the, particularly the Westerners who are watching this would say, yeah, but I’ve been to Gurgaon and I’ve, you know, I’ve been to that kind of tech hubs in India. And I see, you know, a lot of women coming up in those hubs or have come up in those hubs over the last 10 or 20 years. But is not just such a small percentage that it matters, but it’s not making a huge difference?

 

CL: Exactly. It’s a small percentage. I mean, remember India is just behind China in terms of total population now. And by 2045, there’s 1.5 billion people. Because they’ve got the birthrate right under control as well. It’s dropping. But again, they’ve got an inertia of more women of childbearing age coming through. So total births keep going up. So they’ve got this problem of just too many people looking for jobs, which keeps the wage rates down. And that. And that’s what’s frustrating the education system, too, is they have to keep growing the number of school places to stand still, let alone expand. But they’re getting that right. So I don’t want to sound negative about that. All these countries are doing quite nicely on that, some positive.

 

And so but one important point to make is the demographic dividend hasn’t been collected. There’s was a lot of talk about India having a demographic dividend because there are always young people entering working age. But the trouble is they weren’t well enough educated, so they didn’t find jobs. In 2010, the propensity of a working age person to be in work was 58%. It’s now 50%. In other words, they couldn’t find the jobs for these people, so the dividend never paid off.

 

TN: OK, so jobs lead to consumption, of course.

 

CL: That’s right.

 

TN: But I guess. So it’s going to take these countries 10 to 15 years or more to get the quality of jobs that are needed.

 

CL: Yeah.

 

TN: So, you know, that growth that we’ve lazily relied on, say, China for the last 10 or 20 or 20 to 30 years, is there a gap between now and 10 to 15 years from now in terms of the rate of growth for, say, consumer goods and say, economic kind of new market entry, that sort of thing?

 

CL: Yeah, well, this is the crisis that’s coming. Because if we take, again, the kind of what I call the family stage countries, India, Brazil, etc, they actually need around about 250 million extra jobs in the next 25 years to get, to maintain their existing level of employment. Not lift it. Just maintain it. And that gives them a reasonable level of income. Not great, but hopefully with education situation, the earnings go up.

 

But let me put another layer on the cake, so to speak. This is fourth group of countries, which I call young and poor. I call them young because the median age of all of the countries in this group is 20 and some of them have a median age of 14. Mali and Niger, they both have a median age of 14.

 

That means half the population in those countries is under the age of 14 today. Yeah, and their birth rates are high. The average birth rate, an unweighted across these countries is 130 per thousand women. Most countries are at 40 elsewhere in the world. And the number of women of childbearing age, of course, are going up dramatically because of that as well. So even though the birthrate is starting to come down, it goes up dramatically. And it has a seismic effect.

 

First of all, is roughly a billion people in this part of the world at the moment. In 25 years time, there’s two billion of these people. In other words, in twenty five years, they add a billion people to their populations. And if I can just go on and to take Nigeria, for example, at the moment, has 45 million school age children, irrespective whether they are going to school, most of them are not. 45 million. It’s 90 million in 25 years time. Just to stand still on education, they have to double their education budget. And so, little own issues need improving.

 

TN: OK, so governments take, need tax revenue to grow their budgets. So will there will there be the incomes to allow them to grow those budgets just to keep up with where they are? And further, will they be able to accelerate the job growth to make sure they have those incomes, to keep their education, to improve their education like, say, India or Indonesia is doing well?

 

CL: Well, this is the crisis that’s coming because the answer simply is no. And it’s no for the simple reason that up until now, this is really what I was saying we were at a cusp. Up until now, the growth in consumption by the older affluent or the older countries generally, which includes China, has been such that it’s kept relatively full employment throughout the world.

 

There’s been enough jobs for those who are looking for jobs. And that doesn’t sound a bit. But even the young, poor countries have been trotting along at about 55% of working age people employed, which seems to work out quite well. But suddenly that whole relationship changes. As I said, the countries that account for, well, the old affluent account for 63% of global consumption. The other old add another 14% say up to 77% or 80%, chuck in a bit of India, 80%, which is also flattening out. So the countries account for 80% of the money that’s spent by households now flatten out in growth in their demand.

 

Layer on top of that, there’s a continuous increase in productivity per worker. The amount of number of workers needed to meet the new additional demand over the next 25 years is 300 million. And as I told you earlier, this 740 million people that are going to be looking for an extra job.

 

It’s going to be roughly 400 million people, mainly in the poor countries, are in a little bit in need, family stage countries, who are at working age, would like to have a job, but can’t get a job. That’s 400 million.

 

TN: That’s astounding. OK, so that’s as big as, say, the EU, right?

 

CL: Yeah, well, bigger.

 

TN: So if everyone in the EU didn’t have a job but they wanted a job. Man, woman and child couldn’t get a job.

 

CL: That’s right.

 

TN: So that’s terrible. So what do you think those people will do? What do you think some of the effects will be of this? First of all, where is this, kind of generally, geographically? Is this the kind of Bangladesh, Nigeria, kind of those types of countries?

 

CL: It’s based of the African continent and what we call South India, but not including India or Sri Lanka, which will be in Tibet, out there.

 

TN: So Bangladesh, Pakistan, Central Asia generally.

 

CL: And there’s a few small countries, obviously, in South America or Central America that are falling into this category as well. So it’s reasonably concentrated geographically. And it’s a real worry. And I think of myself. If I was turning, well, let’s say 20 and I cannot get a job. I’m scrambling for food. I’m scrambling for water, in some places in the world. What do I do? I’ve got nothing to lose. And that’s what something dramatic, I would rot and just die miserable, which is terrible.

 

So I think the world has a fairly major migration problem coming. These people are going to walk north. I would. So I don’t blame them. But it’s a desperate situation. So much so that in my own mind, it’s all very well to donate money to buy mosquito nets and things like that. I actually think would be better to donate money for a TV and an Internet connection so we could educate the kids. Because we could deliver education quite cheaply using modern technology. And if you could educate them, then they could do more productive things and then and so on and so on. You get the part of that. But there’s no easy solution to this one.

 

These people are largely alive today, will be alive in the next 10 years. And the consumption trends, well, they’re there too. The people with the money are getting older and saving. So the drawbridges are coming up. So this is.

 

TN: So migration. The migration issues we’ve seen over the last, say, 5 to 10 years sounds to me that they only intensify over the next, say, 15 to 20 years.

 

CL: Oh, incredibly so.

 

TN: And Europe is really the focal point. Yes. The US has some issues and maybe India, China have some issues. But it really seems to me that Europe is the major focal point there.

 

CL: But it’s the easy one to get to.

 

TN: Sure. Yeah.

 

CL: But there’s some other dimensions of migration, too, which is starting to come under stress. And I mean, for example, let’s take the U.K. It has one nurse for every 440 people in the population. So if you get sick, your access to a nurse is pretty good. But the UK hires nurses who have been trained and educated in the Philippines where there’s one nurse for every 4000 people in the population. Is that morally correct? Should affluent countries take skilled workers, from developing countries?

 

TN: But can you blame that worker for wanting to go to UK?

 

CL: Not at all. If I was the nurse, I’d be on the plane. I mean, basically, you’ve got the individual motivation and you’ve got the moral issue, and you’ve got the need. And then even if you take a country like Greece, which everyone says, oh, that’s nice and comfortable.

 

Greece’s population has dropped by one million people in the last 10 years. And that one million that are gone are skilled workers who got on a train and went north to Germany because under the EU, they can move.

 

TN: What percentage of the population is that? One?

 

CL: About 10%.

 

TN: 10% of the population?

 

CL: Well, you know, it’s a big drop. And again, you don’t blame the skilled plumber or electrician or whatever because he or she can earn 2 to 3 times as much going to Germany or getting across to Britain, which they could do perfectly legally. And then in 5 years time, the wife is with them, the kids are going to school, that kids speak German now, they never go back.

 

TN: So does this change, does this, you know, let’s say the education deficit issues and the jobs deficit issues in Africa, does it change immigration policy in Europe, for example, in the way Australia has the checklist of skills and those sorts of things to to migrate?

 

Does Europe come more to that type of migration policy to where they incentivize people, let’s say, in parts of Africa before coming, meaning get educated, you know, these sorts of things. And you can definitely come in. I mean, it certainly sounds like something that would be really helpful for places like Greece.

 

CL: Yeah, but not too helpful for places like Nigeria.

 

TN: Right.

 

CL: They’re losing the skilled worker. And the ability to lift the Nigerian economy is going to be a function of having skilled people. And if Greece takes them, that’s actually not that great. Right. So, yeah, you sort of resolve the great problem, but you don’t resolve the core problem, which is the change so to speak. Yeah. So it’s interesting because Greece, with its drop in population, its household values are dropping because the number of households is going down. And that’s the core asset of many households. So it’s trying to create some economic problems as well because the asset they could borrow against is going down in value, not going up in value. But that’s not just Greece. It’s Italy, Spain. It’s Romania, it’s Poland. And that being, you know, some of the talents are being sucked out. And that’s not good.

 

TN: So in sum, let me try to sum this up, because this has been a great conversation and it’s really opened up a lot of things I haven’t really thought about before. So so global consumption generally for, let’s say, the next 10 years or so is relatively stable.

 

We won’t see the rapid expansion that we saw in places like China over the last 10 or 20 years. So let’s say the pull on commodities right now, the inflation we’re seeing, the, you know, this sort of thing, that stuff really tamps down pretty quickly and really stabilizes for maybe a decade or so.

 

CL: Exactly.

 

TN: Once that stabilizes, then we see real disparities as these kind of young, poor countries explode in population. But the wealthy countries are pretty stable and continue to be pretty rich. Right. So we kind of have a status quo for the next decade or so. But then after that, there’s a real danger that emerges from global disparity.

 

CL: That’s right. You start to have a major, what I’d call a population crisis.

 

TN: Wow. OK. It’s a little bit dire. But this is great. Before we go, can you talk about, I know you have a couple of books coming out. Can you tell us what they’re about? I know they’re a little bit from coming to press, but I think it would be really helpful for people to understand what you’re writing about.

 

CL: Right. Well, one of the two books is basically called 2045: The Growing Demographic Crisis. And it’s pretty much along the lines that I’ve just discussed, the difference is, all the data is there. And you’ve got the data, if you like, at the segment level, which also go to by country level. And you can see how the numbers play out. It’s not something that we’re making these numbers up. They’re actually there. They’re pretty solid. And the core source, of course, is the World Bank and the United Nations that you can’t really argue with that. And it’s all old numbers behind what I’ve just discussed.

 

And the second book coming out is called China: 2040. Similar sort of theme. And what I have done that is China is going through a lot of changes that I’ve explained and China will continue to be important economically and politically for the next 10 years at least, if not longer. We know that.

 

So it’s actually quite important that people have a better understanding of what China is like demographically. And it’s not one country, it’s at least thirty one countries. The differences in consumption within that, it’s quite diversified.

 

This book is, if you like, the primer for someone that’s either doing business, thinking of doing business, investing in, whatever, into China. If you haven’t read it and you don’t know China, then you’d be dealing somewhat riskilly. If you read this, it’ll help you focus where the opportunities potentially are. Thanks for the opportunity to mention.

 

TN: Of course. Thank you so much for your time. You’ve been very generous and I think we’ve taken it a lot. I think of it to watch this two or three times before I kind of fully take it in. So I really appreciate it.

 

Further watching, please. We’d really appreciate if you’d like the video. We’d love it if you’d subscribe to our YouTube channel. And we’ll see you next time. Thank. Thanks very much.

 

CL: Thank you.