Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal, and unfortunately Tracy Alloway, my co host,
Speaker 1: is off this week. So I'm of course extremely sad
Speaker 1: about that, but I'm very excited about my guest today,
Speaker 1: and so it kind of makes up for Tracy being
Speaker 1: gone previously. He's a previous guest on an earlier Odd
Speaker 1: Lots episode. Today, I'm going to be speaking with screenavas
Speaker 1: two of a Dante. He is the director of research
Speaker 1: at the Jerome Levy Forecasting Center. Fascinating person to talk
Speaker 1: to about all kinds of things economics and markets and
Speaker 1: global macro. He's a fascinating voice on Twitter, knows so
Speaker 1: much about everything, and I just I'm very excited about
Speaker 1: having a wide ranging discussion about the economy, about the
Speaker 1: unique approach that he brings to analyzing it and applications
Speaker 1: of that to markets, and I'm just very much looking
Speaker 1: forward to talking to a screen of us. Thank you
Speaker 1: very much for joining us. Oh, thank you Joe for
Speaker 1: the very kind introduction. Yeah, no, I'm not being I'm
Speaker 1: not being sarcastic or facetious or anything like. One of
Speaker 1: my favorite people to talk to and to follow your work.
Speaker 1: Tell me just before we get started for people not
Speaker 1: familiar with the Jerome Levy Forecasting Center or your background,
Speaker 1: I mentioned that I think you do bring a sort
Speaker 1: of unique perspective to the analysis of markets and economics.
Speaker 1: But what is sort of the main base that you
Speaker 1: operate from Ideologically? Yeah, so, um, we are we use
Speaker 1: what's called the profits perspective, which basically is comes from
Speaker 1: the idea that for the capitalist economy, profits are central.
Speaker 1: They are what motivates businesses to hire and to invest.
Speaker 1: And so how do we look at how do we
Speaker 1: forecast where profits are in the aggregate, where they are
Speaker 1: going because they're central to the direction of the economy.
Speaker 1: Why is this unusual? Because I think if you were
Speaker 1: to say, oh, the capitalist system is all about where
Speaker 1: the profit is, I think a lot of people would
Speaker 1: hear that and say, well, yeah, of course that's capitalism,
Speaker 1: that makes total sense. So what is it that makes
Speaker 1: that a unique approach at all? But most of the
Speaker 1: time you're absolutely right. But most of the time, if
Speaker 1: you look at people forecasting the economy, they are looking
Speaker 1: at it from a real economy perspective where they're trying
Speaker 1: to forecast consumption plus investment, plus government spending plus net exports,
Speaker 1: and they're looking at aggregate output gap and things like that.
Speaker 1: You know, rarely a would see profits being in the
Speaker 1: aggregate sense. The people who are interested in profits and
Speaker 1: learnings are the macro strategy is and you know, the
Speaker 1: top down strategists and the bottom up people. Of course,
Speaker 1: we're putting up profits from company perspective and then adding
Speaker 1: it top but you rarely able to see people talking
Speaker 1: about forecasting earnings in the aggregate and what that means. Right,
Speaker 1: So you get company analysts and of course they're very
Speaker 1: focused on earnings and earnings for share and growth. And
Speaker 1: then you get macro strategists who, as you say, talk
Speaker 1: about interest rates in the output gap, the FED and
Speaker 1: trade and all this stuff. But what you don't get
Speaker 1: is people looking at it from a big picture perspective,
Speaker 1: looking at those overall profit flows. Is what you're saying,
Speaker 1: Absolutely got it. And tell me about your background. I mean,
Speaker 1: you have a PhD in economics. One one thing I
Speaker 1: find interesting about following your stuff is I feel like
Speaker 1: there's a lot of people who have that who have
Speaker 1: trouble bridging economics to markets. So you have theoreticians and
Speaker 1: you have people who talk about sorry economics and the abstract,
Speaker 1: but they tend not to be you often don't think
Speaker 1: of them as necessarily applying that to the study of markets,
Speaker 1: and they actually make trades and investments. Tell us about
Speaker 1: how you your background and how you bridge that. There's
Speaker 1: two practices. So before before I came to I came
Speaker 1: to do my PhD, I actually worked in banking in
Speaker 1: India and it was actually not a conventional bank. Back then,
Speaker 1: India had what is called Industrial Credit Bank, so it
Speaker 1: was more geared towards financing long term project loans. And
Speaker 1: it so happened I joined when India embarked on one
Speaker 1: of its major liberalization programs in that was the start
Speaker 1: of my career. So it was a huge deal. When
Speaker 1: I came in, there was an enormous turmoil and also
Speaker 1: enormous excitement. So you know, I could see from ground
Speaker 1: up in a way that that you know, banking, finance,
Speaker 1: you know, balance sheets, those things are are very, very
Speaker 1: central to how the economy operates. And it's very different
Speaker 1: from the theoretical models of economists. But you know, there
Speaker 1: is obviously something to learn from the theoretical models of
Speaker 1: economics as well, so I was able to bridge that gap.
Speaker 1: The other for Twitter's thing is I went to Washoe
Speaker 1: Washington University, where Himan Minsky used to be there. By
Speaker 1: the time I went there, he had already left, and
Speaker 1: he had mentored Steve Fazzari, who happened to be one
Speaker 1: of my advisors and who I am still in touch with,
Speaker 1: and he's one of our advisors here at the Levy
Speaker 1: Forecasting Center. So I also got the Minsky perspective. And coincidentally,
Speaker 1: Minsky also was very involved in banking. He was a
Speaker 1: director of Mark Twain Bank for um twenty years. I think, so,
Speaker 1: you know, I think the understanding of finance and banking
Speaker 1: as being very central to the functioning of the economy
Speaker 1: is what helps me bridge the gap between financial markets
Speaker 1: and between the theoretical economics. Yeah, I love this idea
Speaker 1: that I think are people might have some concept of
Speaker 1: what a bank does, but I love this idea that
Speaker 1: as you put it, both in your own experience and
Speaker 1: in minsky is experience actually working for a bank and
Speaker 1: really seeing what a bank it does. It's incredibly helpful
Speaker 1: and something that a lot of people just don't appreciate. Yes, yes, absolutely,
Speaker 1: and and you know, many many people are are very
Speaker 1: proudly proud that they're ignorant about banking. Many economists they
Speaker 1: think that you don't need to understand any of that.
Speaker 1: All you need to understand is money and that's it.
Speaker 1: And I don't understand how they can understand money if
Speaker 1: they don't understand banking. Well, what is the main thing
Speaker 1: you learned when working at a bank that most economists
Speaker 1: don't get? So the critical thing about when you when
Speaker 1: you work in a bank, you realize that banks are
Speaker 1: driven by expectations of credit losses. And in that scheme,
Speaker 1: you know, the interst rate mechanism is not so important
Speaker 1: for the capital spending decisions of businesses. You know, when
Speaker 1: you actually go down to the trenches and you are
Speaker 1: looking at a project loan and you're trying to make
Speaker 1: various scenarios, you realize that the interest rate is swamped
Speaker 1: by all other factors. You know, the difference between scenarios
Speaker 1: is so huge that interstrates is a very very very tiny,
Speaker 1: um insignificant factor. More important, from the business perspective, they
Speaker 1: don't really care that much about the cost of capital.
Speaker 1: Their hurdle rates are so much higher than the cost
Speaker 1: of capital that most of the time the decisions are
Speaker 1: strategic and hardly based on the calculus. Okay, the interstrate
Speaker 1: is half a person lower, so I'm going to invest
Speaker 1: in this project. That's not how the world operates. I
Speaker 1: noticed this. Uh, you know, when you read through regional
Speaker 1: FED manufacturing reports or other surveys of business leaders, it's
Speaker 1: just incredible how rarely they bring up interest rate as
Speaker 1: an important aspect their business decision. So you read about
Speaker 1: all kinds of things, sometimes regulatory trade, commodity prices, other
Speaker 1: aspects of the global economy, and it seems to me
Speaker 1: that you know, we spend an incredible amount of time
Speaker 1: on the centrality of say the Federal Reserve, and are
Speaker 1: they going to hike four times or three times this
Speaker 1: year or how many times next year? And there just
Speaker 1: seems to be a remarkable lack of interest in that
Speaker 1: when you actually just read what business leaders are saying. Yes,
Speaker 1: And in fact, I think the Federal Reserve itself has
Speaker 1: a paper which is a survey of business uh hurdle rates,
Speaker 1: and over twenty years they've they've shown that hurdle rates
Speaker 1: have not changed much at all for capital spending decisions.
Speaker 1: But as you know if you've seen interstrates come down
Speaker 1: a lot in these twenty years, right, So yes, I
Speaker 1: mean it's not not at all relevant in the conventional
Speaker 1: way that it's modeled in economics. But of course monetary
Speaker 1: policy is very set and it operates more through balance
Speaker 1: sheets and through balance sheet effects. But it right. So
Speaker 1: we think of people think of the interest rate that
Speaker 1: the Fed controls is some sort of dial where they
Speaker 1: could turn it down or up to get the economy
Speaker 1: hotter or cooler. But it's really just one lever among many,
Speaker 1: and it's a minor one. And the idea that they
Speaker 1: have this much control is something you learn is overstated.
Speaker 1: I want you know, before we did this, while we
Speaker 1: were before we schedule this podcast, you had a really
Speaker 1: interesting thread on Twitter, and I would encourage everyone who's
Speaker 1: listening to follow you, and you talked about um things
Speaker 1: that we've learned in the post crisis era, that the
Speaker 1: that the post Kaynsians have gotten right. And of course
Speaker 1: Himan Minsky, who you mentioned, is associated with the post
Speaker 1: Kaynesian school of economics. What is post Kaynesianism people have
Speaker 1: been talking about it's more but if you have to
Speaker 1: sort of describe the school of economics, what is the
Speaker 1: central idea? Okay, so the post can scene is a
Speaker 1: really big tent and there are so many people disagree
Speaker 1: about what the basic fundamentals are. But from a purely
Speaker 1: practitioner's point of view, and there is relevant for financial markets.
Speaker 1: I think here is where I I distill it and
Speaker 1: I use it for myself. The way I organize my
Speaker 1: thoughts is the economy is it's a financial economy at
Speaker 1: the end of the day, and money, credit and balance
Speaker 1: sheets matter. You cannot treat it like a barter economy
Speaker 1: and then add on money and credit and money and
Speaker 1: credit are endogenous to the system. The second critical point,
Speaker 1: which I think all post can scenes agree is that
Speaker 1: demand matters, and demand matters not just in the short run.
Speaker 1: Most of the time the economy is operating in a
Speaker 1: slack so the demand constraint is a binding constraint. And
Speaker 1: the number three things, which I would say again is
Speaker 1: also critical that most post concents would agree, is that
Speaker 1: the investment and saving decisions are separated, and saving does not. Therefore,
Speaker 1: the act of saving does not automatically create investment. On
Speaker 1: the other hand, because money and credit are endigenous, investment
Speaker 1: creates its own saving, and because most of the time
Speaker 1: we are operating in a slack investment creates its own saving.
Speaker 1: And I think the last point, which is a more
Speaker 1: minsky in point, but I think most post concients would
Speaker 1: agree with, also is that there is a tendency towards
Speaker 1: instability and of the capitalist economy, and fiscal deficits and
Speaker 1: government debt are stabilizing mechanisms, whereas very rapid rise in
Speaker 1: private debt as a destabilizing right. So one we're calls
Speaker 1: during the two thousand and two thousand nine financial crisis.
Speaker 1: Obviously there is a school of thought that said the
Speaker 1: government just needs to get out of the way and
Speaker 1: market will find a clearing price at which the assets
Speaker 1: are truly valued. And then once we find this price
Speaker 1: and the economy can grow healthy from there. And Minsky
Speaker 1: and the other post Kansians would say that there is
Speaker 1: no natural stabilizing effect in the economy and that ultimately
Speaker 1: what is needed is large government deficits and as the
Speaker 1: government to play a substantial role in the economy, and
Speaker 1: that that ultimately would be the stabilizing force. The just
Speaker 1: going back to your experience in banking, I wanted to
Speaker 1: hit back on this point about how savings doesn't lead
Speaker 1: to investment, because I think most people probably have that.
Speaker 1: It's a wonderful life vision of what a bank is,
Speaker 1: where you put money in a bank and then the
Speaker 1: banker can look at all the money in the vault
Speaker 1: and say, okay, I have this much to lend out.
Speaker 1: But as you point out, that's really not the mechanism
Speaker 1: at all. It's completely misleading in terms of the constraints
Speaker 1: on where investment comes from, the decisions, and whether a
Speaker 1: bank will make a lean in the first place. Right, So,
Speaker 1: if you think about it, I mean, if you look
Speaker 1: go to the principles of macro and the first thing
Speaker 1: that when they go to money and banking, they will
Speaker 1: teach you that, Okay, somebody comes and brings a hundred
Speaker 1: dollars and deposits in the bank, and through the deposit multiplier,
Speaker 1: now that gets into new loans vila and we have
Speaker 1: credit increasing. The question is where did the original hundred
Speaker 1: dollars come from? You know, they never asked that question,
Speaker 1: where did it come from? Is it? Did we? Who
Speaker 1: who give you the hundred dollars? We're talking about money here,
Speaker 1: It's not my act of saving did not create hundred dollars,
Speaker 1: you know. So that's a fundamental question in reality what
Speaker 1: actually happens, and which by now pretty much everybody agrees,
Speaker 1: and in fact the Bank of England has been on
Speaker 1: this drumbeat for a while now. Is that when banks,
Speaker 1: when you go to the bang, when a company goes
Speaker 1: to the bank for a loan, and the bank evaluates
Speaker 1: a loan and makes the credit, it does not go
Speaker 1: for looking for deposits, and then when the bank creates
Speaker 1: a credit, it automatically creates a deposit in the company's
Speaker 1: name for that amount of The company then uses that
Speaker 1: loan the deposit to make whatever it wants to purchase,
Speaker 1: the capital spending on other things, which then that money
Speaker 1: then goes to somebody else's bank account, which then becomes
Speaker 1: their deposit. So the money doesn't get extinguished that way.
Speaker 1: So so it's precisely the opposite rather than and you
Speaker 1: said this already, but just to restate that, rather than
Speaker 1: someone saving then creating the money available for a new loan,
Speaker 1: it's that the loan creates the money and then that
Speaker 1: becomes savings, either in the form of the company or
Speaker 1: more likely if they're going to make an investment in
Speaker 1: the income of whoever that company is spending that money on. Yes, absolutely,
Speaker 1: I want to get to in a moment how we
Speaker 1: can apply some of these ideas to the market in
Speaker 1: the economy right now. But before we do, one area
Speaker 1: I really impersonally curious on that I feel like I
Speaker 1: don't have a great understanding of is inflation. And I
Speaker 1: think one of the things that you said, and we've
Speaker 1: sort of touched on this in our discussion already, is
Speaker 1: you know, the central bank's ability to generate inflation. It's
Speaker 1: massively overstated. We just see it empirically in the post
Speaker 1: crisis era, all these banks completely unable to hit inflation
Speaker 1: targets despite desperate attempts and all kinds of innovations. What
Speaker 1: is this sort of what is the post Canzian view
Speaker 1: of where inflation comes from? Because it appears that the
Speaker 1: mainstream doesn't have many good answers right now, I'm not
Speaker 1: sure that post concients have necessarily a great answer. I
Speaker 1: think because there are many many different people having different
Speaker 1: views about inflation within the postcncient school, I think that's
Speaker 1: one of the places where I think there is I
Speaker 1: wouldn't say that there is a very strong answer that
Speaker 1: explains every single phenomenon accept narratives, you know, which can
Speaker 1: obviously be post talk. So I mean, in fact, my
Speaker 1: own view of inflation, I would say, is a very
Speaker 1: narrative one, and it is supposed to talk to some
Speaker 1: extent because I think it is a complex phenomenon. I
Speaker 1: think there is an economic aspect to it, but there's
Speaker 1: also a political aspect to it, and which is what
Speaker 1: makes it very difficult to analyze. You know, we can
Speaker 1: understand that, you know, if there is as a slack
Speaker 1: in an economy dwindles, eventually at some point, some inflationary
Speaker 1: pressure is build up. But the fact that we can
Speaker 1: already are hedging it by saying eventually at some point
Speaker 1: tells you that it is a very complex phenomenon in
Speaker 1: and of itself. On top of that, you do have
Speaker 1: institutional context, whether there are unions and what do we
Speaker 1: their bargaining power, what is a structure of the economy,
Speaker 1: structure of competition, so so many other things get into
Speaker 1: the mix that trying to mathematically try and forecast inflation
Speaker 1: is a very very tough job. Yeah. I like that
Speaker 1: UM mentioned that about slack because intuitively, I guess this
Speaker 1: idea Okay, you're running low on resources, whether it's labor
Speaker 1: or some other capital good, and that could drive up prices.
Speaker 1: But on the other hand, I always thought like that's
Speaker 1: what capitalism was for, which as well, if you're running
Speaker 1: low on trucks or running low on some resource, then
Speaker 1: you come up with some innovation to address that. So
Speaker 1: it's not totally intuitive to me the the mainstream story
Speaker 1: that lack of slack should be the major driver of inflation,
Speaker 1: because you know, we're always trying to solve our slack problem.
Speaker 1: I guess you could say that is absolutely correct. I mean,
Speaker 1: your your point is very correct, and you know, see
Speaker 1: that's that's where this inflation story becomes very complex. Is
Speaker 1: that for a business to start deciding, Okay, this slack um,
Speaker 1: this tight labor market is permanent and therefore I need
Speaker 1: to address it by automation or trying to labor saving devices,
Speaker 1: they need to be convinced that there is a rather
Speaker 1: permanent state of affairs, right so, and then they need
Speaker 1: to so so to be convinced, you need to have
Speaker 1: a situation of tight labor markets for a for a
Speaker 1: while before businesses decided to do that, especially if the
Speaker 1: memory of having slack labor markets is is very strong,
Speaker 1: which is what we have right now in the US,
Speaker 1: right because the memory of slack labor markets over the
Speaker 1: last ten years is so persistent that even when there
Speaker 1: is tight labor markets, businesses are will not really believe
Speaker 1: that there is a permanent state of affairs, and they
Speaker 1: will try to resist pages. They will also not try
Speaker 1: to You often hear businesses saying that there are not
Speaker 1: qualified workers. Of course you're not going to be able
Speaker 1: to get workers plug and play that you had the
Speaker 1: opportunity and unemployment was eight percent, right, I mean, you
Speaker 1: need to find workers who you need to train. But
Speaker 1: the reluctance to train, which is an investment, is a
Speaker 1: mindset that comes from the adaptive expectations of the last
Speaker 1: ten years that I don't want to spend money on
Speaker 1: training because you didn't you didn't have to do that
Speaker 1: until now. I almost wonder if there's an analogy to banking.
Speaker 1: It's like where where does the dollar come from? It
Speaker 1: comes from investment, Where does a trained worker come from?
Speaker 1: It's kind of similar. You might have you get, you
Speaker 1: make the hiring first, and then the trained worker becomes
Speaker 1: a second. Finally, I want to you know, one of
Speaker 1: the debates that and it's become this massive political debate
Speaker 1: and people don't know how to address it. Inequality. I'm
Speaker 1: curious what what is your view or what is the
Speaker 1: post Kynesian view on what the origins of wealth inequality
Speaker 1: in the economy are. Well, wealth inequality has been there
Speaker 1: for a long time. Let's focus on income inequality, which
Speaker 1: is an easier thing to deal with. I think most
Speaker 1: of the time, if you look at the economy, I mean,
Speaker 1: growth and inequality are actually fairly very well correlated, I mean,
Speaker 1: inversely correlated. When you have strong growth, inequality tends to decline.
Speaker 1: And most of the time that's because strong growth trends
Speaker 1: to drain the slack and does give workers some bargaining power,
Speaker 1: you know, I mean you have seen some pages increasing,
Speaker 1: you know, in the economy, and and it does give
Speaker 1: workers some bargaining power. And that is that's especially the
Speaker 1: workers who are most vulnerable, you know, the most marginally
Speaker 1: attached type of workers. They are the ones who start
Speaker 1: getting good raises relative to everybody else when you have
Speaker 1: a strong economy. And if you go back to you know,
Speaker 1: the golden period of capitalism according to post gain science,
Speaker 1: which is not necessarily a pot everybody agrees on. From
Speaker 1: seven to seventy three, the lower end of the the
Speaker 1: economy actually got relatively high wage gains relative to the
Speaker 1: opper end, especially the top twenty and so there was
Speaker 1: what the economy is called the Great Compression, the biggest
Speaker 1: decline inequality. But it was also a period of very
Speaker 1: robust growth, I mean, the strongest twenty five years in
Speaker 1: the entire history of developed markets. So I think growth
Speaker 1: solves a lot of plems. I think that focus on inequality.
Speaker 1: I'm not trying to dismiss inequality as an phenomenon that
Speaker 1: shouldn't be addressed directly or indirectly, but I think if
Speaker 1: we focus more on how can we get growth going,
Speaker 1: I think a lot of the problems around inequality will
Speaker 1: tend to meltivate. It doesn't mean it will completely go away, um,
Speaker 1: and there may be other direct mechanisms we which we
Speaker 1: may or may not want to address, and that depends
Speaker 1: on one's political persuasion. But I think from a purely
Speaker 1: objective analysis, if you're concerned about inequality, try to address
Speaker 1: growth and a lot of the problems will go away. Well,
Speaker 1: let's apply some of these ideas and So we've talked
Speaker 1: about some basic concepts, this idea that the market or
Speaker 1: the economy is not naturally self correcting, that interest rates
Speaker 1: are pretty overrated as a major determinant of the economy
Speaker 1: or business decisions, that the correct approach to see the
Speaker 1: world is through the profits perspective, and so on. So
Speaker 1: apply that now when you're thinking about markets these days,
Speaker 1: what do you see as the interesting phenomenon or opportunities
Speaker 1: based on this lens? Okay, so let's look at the
Speaker 1: profits perspective as applied to the U. S. Economy, uh,
Speaker 1: and then we'll look at the other other economies. So
Speaker 1: here we were coming into two eighteen and we've got
Speaker 1: a massive physical stimulus. It's not just the tax cut,
Speaker 1: but also the sequesters removal of the sequester spending caps,
Speaker 1: which is going to add about hundred fifty dollars in
Speaker 1: spending UM. So the profits perspective tells you that the
Speaker 1: flow of funds that go on to profits deficits is
Speaker 1: one of them right now. Obviously there are adjusting mechanisms.
Speaker 1: If the government spends more around a bigger deficit, the
Speaker 1: other sectors might be contracting that to some extent. You know,
Speaker 1: the perfect Ricardian equivalences. If the government runs a deficit,
Speaker 1: the private sector completely saves it. In real world, that
Speaker 1: never happens. So what you see instead is a big
Speaker 1: rise in profits. That's why we've been beating the drama
Speaker 1: on saying that profits are going to be really strong
Speaker 1: in the U. S economy, and you know they were.
Speaker 1: Not only was the first quarter strong, which people expected
Speaker 1: because we got the tax cart, but the second quarter,
Speaker 1: which has taken a lot of people by surprise, has
Speaker 1: been even stronger. And that's because the sequest of spending
Speaker 1: caps were removed, and they it took time for the
Speaker 1: spending to build up. So that's one direct application and
Speaker 1: the other one, which when we look at emerging markets,
Speaker 1: which we identified is one of the issues of the
Speaker 1: emerging markets a structural issue, is that if you think
Speaker 1: about what drove the emerging market boom of the two
Speaker 1: thousands and what happened to them since then, is they
Speaker 1: had their current accounts, were balances were expanding, improving because
Speaker 1: they were growing their exports share in the developed markets
Speaker 1: thanks to outsourcing and things like that. Um and because
Speaker 1: they were running such high exports, they were also investing
Speaker 1: in the capacity to cater to those exports. So if
Speaker 1: you think about both investments, so the current account balances
Speaker 1: is a direct increase in profits the investment. If you
Speaker 1: think about what an investment is, investment for the company
Speaker 1: that is making the investment is a balance sheet transaction,
Speaker 1: whereas for the company that is selling the capital good
Speaker 1: its revenue and profits. So the investment is generally leads
Speaker 1: to higher aggregate profits. So they were having the best
Speaker 1: of both worlds. Since the crisis, developed market growth obviously
Speaker 1: has been structurally weaker, and the imaging markets have also
Speaker 1: saturated their export potential in the developed markets, So since
Speaker 1: then they have had to move more towards the domestic
Speaker 1: demand led growth, which means that they have to now
Speaker 1: create profits domestically in some sense. Right, So an investment
Speaker 1: that is geared towards domestic demand, now think about what's
Speaker 1: happening when you are trying to create domestic final demand.
Speaker 1: You have to then create the credit in your own economy. Now,
Speaker 1: many of them do not have a financial sector that
Speaker 1: is sophisticated enough to deliver credit in the responsible way
Speaker 1: over long periods of time. And initially they were very
Speaker 1: successful from two thousand ten to two thousand thirteen in fact,
Speaker 1: but the effects were already starting to show by two
Speaker 1: thousand thirteen. And you know, one perfect example is India,
Speaker 1: but Brazil is also another one. And India is still
Speaker 1: dealing with the excess and bad lending that was done
Speaker 1: during those years. And once that model was was exposed,
Speaker 1: what they have now been floundering with is to figure
Speaker 1: out how to grow. And they have not been able
Speaker 1: to grow, So they're back to the old iron constraint,
Speaker 1: which is that they can grow only fast as their
Speaker 1: exports grow, which is basically another post incient insight. It's
Speaker 1: called third World's law. Basically, it says that the b
Speaker 1: OP constraint your your you can't grow much faster than
Speaker 1: your exports because if you do, then your imports start
Speaker 1: growing and your current account starts to worsen, and then
Speaker 1: you come unto some kind of currency pressure and capital flight.
Speaker 1: How do you analyze the potential impact of a trade
Speaker 1: war from the profit's perspective? Okay, so most of the
Speaker 1: time people are looking at trade as Okay, exports are
Speaker 1: exposit of GDP, how much will exports fall and broad
Speaker 1: impact can it have on the economy? And most of
Speaker 1: the time, the analysis will be it will be very minor,
Speaker 1: or you know, half a percentage point, which is not
Speaker 1: insignificant but not recessionary. But also tied to those exports
Speaker 1: are the financial structures and more important, the investment right
Speaker 1: that is tied to the exports. This may not be
Speaker 1: huge for the US, but it's certainly huge for countries
Speaker 1: like Mexico, Korea, China, India, countries that are have much
Speaker 1: more open trade. The US is a relatively closed economy
Speaker 1: in that sense, not because we have tremendous trade barriers,
Speaker 1: but because our domestic economy is huge. And so in
Speaker 1: those places, if you look at look at all the
Speaker 1: investment that is behind those export industries, now all those
Speaker 1: investments look shaky, and all the financial structures behind those investments,
Speaker 1: whether it is equity or debt, now look also started
Speaker 1: looking shaky. Right, So then people will now be reluctant
Speaker 1: to make further investments in in export capacity, for sure,
Speaker 1: but they also will be not so sure that the
Speaker 1: demand will be there for the domestic investment because all
Speaker 1: the people employed in the export industry, their incomes are
Speaker 1: insecure now. And number two, you don't know what the
Speaker 1: final trade arrangement is going to be until then there's
Speaker 1: going to be uncertainty about where should I locate my
Speaker 1: supply chain, what is going to be that tariff structure,
Speaker 1: you know, So those things are going to constrain investment.
Speaker 1: So the decline in investment is a much bigger deal,
Speaker 1: which we cannot really We can try to have some
Speaker 1: bounds on how much can investment can get affected, but
Speaker 1: ultimately it depends on animal spirits and there is also
Speaker 1: feedback loop. You know, the more worst investment does, the
Speaker 1: worst economy does. And so the key insight here is
Speaker 1: that everybody knows that if trade barriers go up, that
Speaker 1: you could look at a country like Mexico and it's
Speaker 1: like this is not going to be good for them,
Speaker 1: But that if we're just looking at the share of
Speaker 1: exports as a percentage of GDP or so forth, we're
Speaker 1: missing a big aspect, which is all of the income
Speaker 1: that they would get from people building factories in Mexico
Speaker 1: with the idea of exports, and then the sort of
Speaker 1: all the knock on effects from that lack of income
Speaker 1: and the job instability and so forth. Absolutely, now what
Speaker 1: is you know right now? Obviously this year probably for
Speaker 1: a few different reasons. We've seen selling in emerging markets
Speaker 1: pretty ugly year for AM again going back to this
Speaker 1: idea that there's no natural stability mechanism in the economy.
Speaker 1: They're not just going to bounce back for the shake
Speaker 1: of bouncing back. Are there any flows in place or
Speaker 1: any countervailing um countervailing forces in place that will mitigate
Speaker 1: that at some point? Well, you know, I mean, I
Speaker 1: think they're not. I mean, except in places where there
Speaker 1: is real risk of political instability. I think they will
Speaker 1: eventually find some some bottom. I mean, the emerging markets.
Speaker 1: One of the things that they have. The board itself
Speaker 1: was coined in the eighties, you know, And the reason
Speaker 1: why it was coined is people saw some glimmer of
Speaker 1: hope even amidst all those Latin American crisis and everything,
Speaker 1: and and some of those are actually true in the
Speaker 1: sense that I've seen it in my lifetime. Lifetimes with
Speaker 1: India is that there has been an emergence. Part of
Speaker 1: the reason is you have shed the socialist practices and
Speaker 1: generally the workforce has become educated. You know, there are
Speaker 1: a lot of good things that have happened in the
Speaker 1: long run, So there is there is obviously a place
Speaker 1: where they will settle, and I don't know where that is,
Speaker 1: but I do think that to make the next transition
Speaker 1: to a higher growth again there they need to be
Speaker 1: able to find a way to have a domestic financial
Speaker 1: system that is sophisticated enough to be able to deliver
Speaker 1: credit domestically. And that's a harder challenge than doing some
Speaker 1: cyclical rebalancing, you know. That's that's the problem. I mean,
Speaker 1: the previous challenge they addressed as soon as after the
Speaker 1: Asian crisis. They figured out, look, we can't depend on I,
Speaker 1: m F and all these two to give us reserves
Speaker 1: when we need them. We need to have a huge buffer,
Speaker 1: and they went about building the buffers, and every emerging
Speaker 1: market economy today has pretty much large buffers, so they
Speaker 1: don't have the conventional currency crisis. So they solve that problem.
Speaker 1: But now they have to make the next big leap,
Speaker 1: which is to have a financial system that is capable
Speaker 1: of delivering credit in a in a responsible way. Not
Speaker 1: that we have covered ourselves in glory, but remember we
Speaker 1: had the biggest financial crisism since the depression, and ten
Speaker 1: years down the road, we are the strongest economy in
Speaker 1: the world. Now, how much of that you mentioned India
Speaker 1: and other countries in which you just sort of see
Speaker 1: an improvement in education and better policies. When you think
Speaker 1: about the maturation of an emerging market financial system, how
Speaker 1: linked are those two things in terms of this sort
Speaker 1: of basic human development being necessary for the emergence of
Speaker 1: a stable and sound and expanding, strong financial system. But
Speaker 1: that's a very good question. I actually never thought of
Speaker 1: it that way, but that's an excellent question. I do
Speaker 1: think that ultimately, if you to have a sophisticated financial system,
Speaker 1: you have to have a large domestic investor pace that
Speaker 1: is invested mostly in financial assets. So if you look
Speaker 1: at the US, most people's saving. A lot of people
Speaker 1: may not have any saving, but most people saving is
Speaker 1: in the form of financial assets. Aside from their home
Speaker 1: right aside from real estate. Most of it is in
Speaker 1: the form of UM. Therefore, oh one K plans or
Speaker 1: c d s and you know, UM their mutual funds
Speaker 1: or whatever it is. Right, So you have a very
Speaker 1: large domestic investor base and domestic financial base for financial
Speaker 1: instruments UM. Most emerging markets, that's not the case because
Speaker 1: it's cash economy and most people their investments are either
Speaker 1: in the real estate or they are in gold in
Speaker 1: India like for instance. You know, those kind of things.
Speaker 1: And even the real estate in the developed markets is
Speaker 1: actually financialized because if you look at the amount of
Speaker 1: credit behind the real estate and the mortgage markets, that's
Speaker 1: not the case in the developed markets. Most people are
Speaker 1: on real estate outright, so there's not a sophisticated financial
Speaker 1: market behind the real estate. So once you create a
Speaker 1: large domestic financial base, you automatically then create demand for
Speaker 1: the domestic sovereign debt, which then becomes the safe acet
Speaker 1: in that currency. That's what allows then the government to
Speaker 1: do counter cyclical fiscal policy, you know, the all the
Speaker 1: m empty stuff, which doesn't work in most emerging markets
Speaker 1: because the government debt is not considered as a safe
Speaker 1: acet because there's not a big domestic financial base. There's
Speaker 1: no manufacturing it overnight. It just sort of needs to
Speaker 1: build up organically over time. Yes. Absolutely. Before we wrap up,
Speaker 1: I want to go back to the US real quickly.
Speaker 1: You mentioned that, contrary to the expectations of many, Q
Speaker 1: two earnings have been phenomenal. Once again, Q one wasn't
Speaker 1: just a one off. Do you expect further sustained strong earnings,
Speaker 1: strong profits in the US going forward. I think through
Speaker 1: the end of the year probably, I mean, I don't
Speaker 1: want to look too far out. Profits look fairly solid.
Speaker 1: I mean I don't think that would have maintained the
Speaker 1: second quarter piece. You know what your basis, but they
Speaker 1: are still going to be very strong, all right, Screens.
Speaker 1: I really enjoy talking to you. I learned a lot there,
Speaker 1: and there's just I really like the your ability to
Speaker 1: sort of take these big theoretical ideas and make them
Speaker 1: incredibly concrete, and there aren't many people who can do
Speaker 1: that and also actually apply them to market. So appreciate
Speaker 1: you coming on. Thank you so much. Well, here's again
Speaker 1: where I would typically banter with Tracy and ask her
Speaker 1: what she liked about the conversation, but I would just
Speaker 1: say that I liked the whole thing, and uh, that's
Speaker 1: about it. So this has been another episode of the
Speaker 1: Odd Lots podcast. I'm Joe Wisenthal. You can follow me
Speaker 1: on Twitter at the Stalwart. You can follow Tracy on
Speaker 1: Twitter at Tracy Alloway and definitely follows Srinavas on Twitter.
Speaker 1: He's I honestly think he's one of the best people
Speaker 1: on there. And also one of the most underfollowed given
Speaker 1: all the pearls of insight that he regularly has every day.
Speaker 1: Follow him at T three T E A s R I,
Speaker 1: and follow our producer on Twitter tofur Foreheads at foreheads
Speaker 1: t as well as the Bloomberg head of podcast, Francesco Levy.
Speaker 1: She's on Twitter at Francesca Today. Thanks for listening.