Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Halloway and I'm Joe. Wi isn't thal Joe?
Speaker 1: Doesn't it feel like, uh, supply chains are everywhere at
Speaker 1: the moment? You know what? Yeah, so we're recording this
Speaker 1: November one. I saw like three or four, maybe five
Speaker 1: supply chain related Halloween costumes like on Instagram this weekend. No,
Speaker 1: I don't think like kids themselves are excited about dressing
Speaker 1: up as something supply chain related, but it definitely seems
Speaker 1: like for a certain group of adults that was like
Speaker 1: a very like humorous, like you know, spooky thing this year. Yeah,
Speaker 1: I saw a pumpkin that had supply chains carved into it,
Speaker 1: which I thought was phenomenally spooky. But I mean, it
Speaker 1: is true that this is the issue that everyone is
Speaker 1: trying to wrap their heads around at the moment, And
Speaker 1: to be honest, I feel like it's not something that
Speaker 1: most economists have necessarily or most macro analysts have necessarily
Speaker 1: had to think about in detail before. Like obviously everyone
Speaker 1: talks about inflation, people think about what's driving that. Although
Speaker 1: I still maintain that we actually don't have a really
Speaker 1: good idea of how inflation works. But I don't think anyone,
Speaker 1: you know, in preparing to be a macro investor or
Speaker 1: a macro trader or a macro analyst. I don't think
Speaker 1: anyone ever sat down and thought, wow, I really need to,
Speaker 1: you know, start understanding how like dra age works at
Speaker 1: the ports. No, definitely, definitely not. And I mean I
Speaker 1: think that's spot on. And I think there's like two
Speaker 1: things that I've been thinking about. It's like, one is like,
Speaker 1: in normal times, whatever that means, like the supply chain
Speaker 1: is invisible to people, right, like maybe you see trucks,
Speaker 1: but besides that, it's like the product is on the shelf.
Speaker 1: So it's kind of like a bad sign that people
Speaker 1: are like talking and thinking about this because normally it's like,
Speaker 1: you know, you're just expected to just work and the
Speaker 1: stuff shows up, and most of it is still showing up.
Speaker 1: But the other thing is like I think, like you know,
Speaker 1: by and large, from an economist perspective, it's like this
Speaker 1: is like such incredibly like complex systems that it almost
Speaker 1: feels like, you know, you had that great piece on
Speaker 1: the blog about like sawdust and the price of milk,
Speaker 1: and there's all, you know, a little part here goes
Speaker 1: missing and that causes some other industry to miss a thing, etcetera.
Speaker 1: Like it does not feel like economics as we talk
Speaker 1: about it typically is particularly like equipped to like really
Speaker 1: like wrap your head around us at least, like you know,
Speaker 1: by and large, this is not like part of most
Speaker 1: economist tool kit totally. And of course the discussion about
Speaker 1: supply chains and how that feeds into prices and whether
Speaker 1: or not all of that is transitory. It's happening against
Speaker 1: this broader backdrop of just mass uncertainty about where we
Speaker 1: are in the economic cycle, what central banks are going
Speaker 1: to do. And of course you mentioned we're recording this
Speaker 1: on November one, and it is an absolute a massive
Speaker 1: week coming up from central banks. We have a meeting
Speaker 1: for the Bank of England and the Federal Reserve and
Speaker 1: they're going to have to figure out how they're dealing
Speaker 1: with these inflation pressures, whether or not they're going to
Speaker 1: push back against markets pricing in more hawkish moves. We
Speaker 1: just had some massive, massive moves in the bond market
Speaker 1: just last week with everyone sort of pricing in rate
Speaker 1: hikes much much faster than I think most central banks
Speaker 1: would want them to. So it's it just feels like
Speaker 1: this really complicated time from a macro perspective, incredibly complicated.
Speaker 1: One thing that's really striking right now is that the
Speaker 1: job market feels very disconnected from perceptions of the economy.
Speaker 1: The job market is booming in the sense that if
Speaker 1: there's tons of job openings, wages are going really fast.
Speaker 1: In the post grade financial crisis period, the job market
Speaker 1: was the economy. That was really the only thing that
Speaker 1: mattered was the pace of job creation. Now, you know,
Speaker 1: we have all these serve ways of consumers and they're like, yeah,
Speaker 1: the job market is great. We still think the economy stinks.
Speaker 1: That is a very new thing. The other thing, and
Speaker 1: I you know, this is what we'll get into, is
Speaker 1: from a central bank perspective. Right the economists sort of
Speaker 1: mantra is like, okay, still like it's transitory and that
Speaker 1: doesn't mean it's gonna go way right away. But by
Speaker 1: and large this is related to reopening kinks and people
Speaker 1: shifting consumption from services to goods and all that stuff,
Speaker 1: and all that's fine, but that doesn't I think like
Speaker 1: even in mainstream echo that is not to get out
Speaker 1: of jail free card for central bankers because they ascribed
Speaker 1: so much weight to expectations, and so because they're like, well, okay,
Speaker 1: maybe it's just related to uh, the inflation is related
Speaker 1: to supply chains and that will smooth out. But because
Speaker 1: they worry about changing inflation expectations as a driver of
Speaker 1: inflation itself, I think that explains why they're still getting
Speaker 1: like clearly like very anxious all around the world. Well totally.
Speaker 1: And I also think if you say that inflation pressures
Speaker 1: are transitory, than the converse has to be true as well, Like,
Speaker 1: you know, maybe at some point they disappear and we
Speaker 1: suddenly flip into deflation very very quickly. Yeah, okay, without
Speaker 1: further ado, I am very very pleased to we've been
Speaker 1: talking a while. I am very pleased to introduce our
Speaker 1: guest for this episode. He's one of my all time
Speaker 1: favorite analysts and also someone who has been doing this
Speaker 1: sort of granular detailed supply shortage work as a macro analyst.
Speaker 1: We're gonna be speaking with Matt King. He is strategist
Speaker 1: of City Group Global Markets. Matt, thanks so much for
Speaker 1: coming on the show. Again my pleasure. You're much too
Speaker 1: kind as usually in your introduction, so maybe just um,
Speaker 1: you know, Let's start with with what Joe and I
Speaker 1: were just discussing. How strange is it as a macro guy.
Speaker 1: You know, you've been covering the market's global economies for
Speaker 1: a long time, but I don't think until this year
Speaker 1: you've ever really had to dive in to you know,
Speaker 1: shipping rates and things like that. How much of a
Speaker 1: learning process has it been. So there's any number of
Speaker 1: things which are completely different. Likewise, we hadn't really had
Speaker 1: to worry about inflation except in a negative sense until now,
Speaker 1: and I've been deep in the disinflation recamp, and then
Speaker 1: suddenly you're you're recognizing this potential for a paradigm shift.
Speaker 1: So so yes, absolutely they are. I had never had
Speaker 1: to plot inventory curves for European gas storage, for example,
Speaker 1: never mind worry about effects cascading across from one segment
Speaker 1: to another. But what strikes me in all of this,
Speaker 1: so you're you're too complementary about the bottom up work
Speaker 1: I'm doing in a sense, and that I'm terribly interested
Speaker 1: in that. And yes, I'm having conversations with my shipping
Speaker 1: analysts and they're saying, oh, even as you strike deals
Speaker 1: now beneath the current spot price, it's nevertheless double or
Speaker 1: triple the rate that people have been paying over the
Speaker 1: last few years. But what strikes me generally is everyone
Speaker 1: has all these micro explanations for the distortions that we're seeing,
Speaker 1: where the blockages in Long Beach and the and the
Speaker 1: gas prices in Europe and the wind didn't blow enough
Speaker 1: and what have you. And for me, the striking thing,
Speaker 1: it's just the sort of systemic features that nobody's talking about,
Speaker 1: the way that economies have become steadily more specialized in
Speaker 1: ways that are highly efficient to make firms profitable when
Speaker 1: everything works, but are also vulnerable to exactly these sorts
Speaker 1: of breakages. And and again in this assumption that everything
Speaker 1: is transitory or sorts itself out and everything goes back
Speaker 1: to normal. I'm just terribly conscious. Again you were sort
Speaker 1: of hinting at it in in this discussion of how
Speaker 1: how systems behave you know, economics is full of examples
Speaker 1: of systems that are nice and well behaved, and you
Speaker 1: nudge them a bit, and then prices go up and
Speaker 1: demand goes down, and then they come back into equilibrium.
Speaker 1: And yet I can't help but feel exactly as you
Speaker 1: were saying, the economy is a complex system. Supply and
Speaker 1: demand are deeply into linked. We've made the systems more
Speaker 1: in elastic through this specialization process, and we've just given
Speaker 1: everything the most almighty whack. And there are plenty of
Speaker 1: systems in physics that don't behave sensibly once you give
Speaker 1: them an almighty whack, they go into a completely different
Speaker 1: form of behavior, and once they do so, they don't
Speaker 1: necessarily neatly settle down again. And so so I'm I'm
Speaker 1: just a bit conscious that everything we've got used to
Speaker 1: in this whole great moderation and just in time, supply
Speaker 1: chains and everything, there is some risk that we've now
Speaker 1: given everything such a big way that it doesn't simply
Speaker 1: settle down in the way in which the textbooks would suggest.
Speaker 1: I mean, this is what you said about the wind,
Speaker 1: and I was just thinking about this this morning because
Speaker 1: it was actually, you know, obviously with those I think
Speaker 1: it was about a month ago or a month a
Speaker 1: half ago in the UK, there were like three or
Speaker 1: four days where it didn't the wind didn't blow very much,
Speaker 1: and you know, there shouldn't be a big deal. But
Speaker 1: I think we were talking with Jeff Curry over Goldman
Speaker 1: actually made the point it's like, normally the wind not
Speaker 1: blowing for three or four days is just not a
Speaker 1: very big deal. It happens only when things are like
Speaker 1: so stretched, does the wind not blowing for three or
Speaker 1: four days. But because it's like insane like swing in
Speaker 1: the price of you know, natural gas or electricity. And
Speaker 1: then just this weekend of the US like that, it
Speaker 1: was like really windy and Dallas and that's caused this
Speaker 1: huge cascade of cancelations of flights from American Airlines, which
Speaker 1: is headquartered Dallas. And it feels like the thing that
Speaker 1: sort of is going on is, as you said, there's
Speaker 1: all these idiosyncratic events. So there's a drought in Brazil,
Speaker 1: there's no wind in the UK, etcetera. But that when
Speaker 1: the system is strategy, these little things could create rippling
Speaker 1: cast And I think one of the things that's interesting
Speaker 1: about that is you you might almost speculate in some
Speaker 1: of it, Yes, is is small and more open economies
Speaker 1: like the UK that have cut themselves off from Europe
Speaker 1: being vulnerable, But some of it is it is it
Speaker 1: a coincidence that actually some of these supply shortages are
Speaker 1: almost most intense in the most highly capitalist economies like
Speaker 1: the US, where actually, you've had an incentive over decades
Speaker 1: to make everything efficient, to whittle down your infantories to
Speaker 1: you know, to make a nice, lean product, which which
Speaker 1: which again when it works, gives you the super high
Speaker 1: profit margins. But the sorts of redundancy or over capacity
Speaker 1: which you might have built in as a cushion. That's
Speaker 1: exactly what we've taken out, whether it's from supply chains
Speaker 1: or even whether it's from health services and things. And
Speaker 1: suddenly you're seeing the potential vulnerabilities that result. So what
Speaker 1: does what do the supply chain issues actually mean for
Speaker 1: the economy from a very very broad perspective, because I mean,
Speaker 1: this is something Joe and I have been talking about
Speaker 1: this for a while, and I think even last year.
Speaker 1: I mean this was very very early on, but I
Speaker 1: remember writing something in like March because I'm in Hong
Speaker 1: Kong and I was seeing what was happening in China
Speaker 1: and talking about whether or not supply chain bottlenecks would
Speaker 1: end up being like short term good or bad for
Speaker 1: the economy in the sense that you know, you get
Speaker 1: this bullwhip effect. People start over ordering, inventories start building up,
Speaker 1: and then they realize, oh well, actually we've ordered too
Speaker 1: much and then they cut sales. So I don't know.
Speaker 1: It seems like you can argue it both ways. But
Speaker 1: how are you broadly thinking about this in terms of
Speaker 1: your economic models. I think it makes me mistrust the
Speaker 1: models that we built up over the last few years,
Speaker 1: even more than I mistrusted them anyway. I think it
Speaker 1: makes me worry about the return, at least temporarily to
Speaker 1: some form of boom bust cycle. And if I had
Speaker 1: to guess, I would say my suspicion or fear, but
Speaker 1: maybe I'm just being overly negative, is that the price
Speaker 1: increases are a bit stickier and more lasting than we
Speaker 1: would have liked, and then the central banks would like.
Speaker 1: And conversely, maybe the growth is a bit less robust
Speaker 1: than everyone likes to think at the moment. And as
Speaker 1: you say, it's this, it's this capacity to suddenly go
Speaker 1: back to de stocking restocking cycles that we've forgotten about it.
Speaker 1: I almost see it in my own behavior when I
Speaker 1: go to the supermarket. When everything is fully available, you
Speaker 1: buy only what you need, but the moment it starts
Speaker 1: getting a little bit low, you think, oh, maybe I
Speaker 1: better buy an extra one. And it's that potential to
Speaker 1: suddenly change the system's behavior, this in elastic linkage of
Speaker 1: supply and demand, or this this shift back to what
Speaker 1: our German economist are calling a stop start manufacturing cycle. Again.
Speaker 1: It's interesting because you start having these conversations around stagflation
Speaker 1: and everyone protests, well, that's absolutely rubbish. We can see
Speaker 1: the inflation side of it, but demand is really robust.
Speaker 1: And as we see these potential shifts again, I think
Speaker 1: that the the possibility that they end up rippling or
Speaker 1: cascading through the economy and are more lasting even though
Speaker 1: the existing the original problems get picked. That potential, again,
Speaker 1: I think is underappreciated in the nice linear models that
Speaker 1: everyone has got used to. You said something really interesting
Speaker 1: that had been on my mind as well, which is that, like,
Speaker 1: we see the supply chain shortages, and it seems like
Speaker 1: the inflation data worse in some of the more like
Speaker 1: hyper like leading efficient capitalist economies like the US. Inflation
Speaker 1: in the US is higher than it is in say, uh,
Speaker 1: the European Union, And I'm curious, like there is this debate.
Speaker 1: It's like, a, is this just because the European Union
Speaker 1: is behind the US when it comes to reopening there
Speaker 1: are a few months lower with the vaccinations. B Is
Speaker 1: it because of the US like sent out that extra
Speaker 1: round of checks? Like is it a pure demand impulse
Speaker 1: or see? Is it as you say, the drumhead in
Speaker 1: the US is tuned tighter and maybe they're you know,
Speaker 1: the EU economies more vacation time, as everybody knows people
Speaker 1: have more time off, etcetera, aren't as hyper optimized to
Speaker 1: be like working efficient seven And nothing's even opened twenty
Speaker 1: four hours in the most Eropean cities. So I guess
Speaker 1: the exam puple that I was really thinking of is
Speaker 1: simply Japan, where inflation expectations have moved up much less
Speaker 1: than in other markets Euro versus the US. I'd say
Speaker 1: that this thing with running just in time economies or
Speaker 1: running everything lean, maybe that increases the vulnerabilities to suddenly
Speaker 1: supply chains failing. I don't know that that necessarily increases
Speaker 1: the price pressures, or at a minimum that that feels
Speaker 1: indirect to me. The obvious explanation there, I have to say,
Speaker 1: is simply that the Larry Summers explanation, as you said,
Speaker 1: it's it's just you know, you suddenly put in fifteent
Speaker 1: of GDP of fiscal stimulus to an economy which is
Speaker 1: already recovering really strongly, and you combine it with zero
Speaker 1: rates and massive amounts of que it's almost unsurprising. You know,
Speaker 1: there's all this uncertainty as to what the output gap
Speaker 1: really is, but it's just just unsurprising when at that
Speaker 1: point it starts to show up in in higher prices,
Speaker 1: and it's it's really that fiscal stimulus, which which has
Speaker 1: just been disproportionate in the US relative to the rest
Speaker 1: of the world. How come stocks don't seem to care
Speaker 1: about any of this? Yeah, I wonder this too, like
Speaker 1: really basic question. The basic questions are always the best
Speaker 1: and the and the hardest. Um So we have likewise
Speaker 1: been scratching our heads around this, and the obvious thing
Speaker 1: you can point to is the strength of earnings. But
Speaker 1: even and earnings have indeed been completely phenomenal. Even then, though,
Speaker 1: it's sort of interesting that you look at, say, changes
Speaker 1: in earnings expectations and they're still going up, but barely,
Speaker 1: and the rate at which they're going up has rightly
Speaker 1: been plummeting. And so while the guidance has not been
Speaker 1: quite as negative as it as it might have been
Speaker 1: if all of these problems were filtering through. With one
Speaker 1: or two single name exceptions, there still looks like there's
Speaker 1: a big mismatch between again those underlying fundamentals and these
Speaker 1: potential problems. And as you say that that the price
Speaker 1: action and to some extent likewise you can point to
Speaker 1: a narrowing of the stock market performance. But I think
Speaker 1: the big picture explanation, which increasingly i'm minded awards, is
Speaker 1: even as a number of people start saying, oh, we've
Speaker 1: priced in too many rate hikes, when you break down
Speaker 1: the rates market move into inflation expectations on the one
Speaker 1: hand and then real rates on the other, you come
Speaker 1: to this rather remarkable conclusion that actually, all, or even
Speaker 1: more than all in some cases, of the move up
Speaker 1: in nominal rates of the pricing in in rate hikes
Speaker 1: has been inflation expectations. And what that means is that
Speaker 1: real yields are basically still at the loads. They just
Speaker 1: begun moving up a little bit in Germany in the
Speaker 1: UK just the last day or two. But again, as well,
Speaker 1: as one client put it to me, that means that
Speaker 1: we're not actually pricing any tightening at all. It's almost
Speaker 1: as that we priced to stealth easing, and I think
Speaker 1: that goes a long way towards explaining why it is,
Speaker 1: especially in recent years where investors have sort of been
Speaker 1: trained almost, oh, don't look at the underlying fundamentals. They
Speaker 1: haven't got anything to do with the market price. It's
Speaker 1: only about the stimulus, is only about the real yield.
Speaker 1: And they're seeing real yields back at the lows, and
Speaker 1: they're saying, well, therefore there's there's there's nothing to worry about.
Speaker 1: And even as you get this aggressive yield curve flattening
Speaker 1: in particular again, it really feels to me as though
Speaker 1: there's just a mismatch between yield curves increasingly saying hang
Speaker 1: on a minute, we've got a policy era here. And
Speaker 1: then as you say that, the equity market saying, no,
Speaker 1: don't care. The long dated real yield has just gone down.
Speaker 1: Let me increase my estimate of the fair value of everything,
Speaker 1: because I'm discounting my dividends at a at a low rate.
Speaker 1: It is remarkable and I think is increasingly a source
Speaker 1: of vulnerability, and yet as of today it's mostly carrying on.
Speaker 1: So you mentioned real yields, and and this is something
Speaker 1: that we've been asking like a number of our guests
Speaker 1: about and it is true. If you look at real yields,
Speaker 1: so yields adjusted for inflation right now, they look incredibly low,
Speaker 1: particularly when you look at previous sort of periods right
Speaker 1: before or right as the FED was actually tightening monetary policy. So,
Speaker 1: for instance, if you compare them to what was going
Speaker 1: on when we had the Taper tantrum, there's just this huge,
Speaker 1: huge difference. And I guess my question is why is that,
Speaker 1: Like it seems like such an oddity in the market
Speaker 1: that as we expect central banks to start tightening, we
Speaker 1: have real yields that seemed to have barely budged. For me,
Speaker 1: there is a long term story here, and where we're
Speaker 1: going to probably get to is what level of real
Speaker 1: yields really counts for investors. But the long term story,
Speaker 1: the slightly scary story, is the last few cycles have
Speaker 1: not really gone according to plan. At no point, at
Speaker 1: least until now, have the central banks had to raise
Speaker 1: rates to choke off an inflation and overheating an economy.
Speaker 1: And what's triggered recessions has instead been accidental bursting of
Speaker 1: asset price bubbles. And the scary bit is that each
Speaker 1: time it's been a lower level of real yields, which
Speaker 1: has triggered that bursting of an asset price bubble. And
Speaker 1: it's almost as though it's taking a lower and lower
Speaker 1: level of real yields or a larger and larger degree
Speaker 1: of stimulus to keep investors holding on to fundamentally expensive assets.
Speaker 1: And my usual bad joke because that it's been years
Speaker 1: since I've visited any investor in any asset class who
Speaker 1: was buying things because the analyst told the portfolio manager
Speaker 1: it was cheap. It's always the PM telling the analysts will,
Speaker 1: we've just had another inflow, and we've got to put
Speaker 1: the money somewhere, and that The latest example here for
Speaker 1: me is twenty eighteen, which is still my favorite comparison
Speaker 1: with where we are now, where again growth had been
Speaker 1: strong and the West fiscal stimulus in the system, the
Speaker 1: ecty market was making new highs. The FED thought it
Speaker 1: had an appropriate level of bank reserves, an appropriate level
Speaker 1: of monetary policy, and appropriate level of real yields, and
Speaker 1: then all of a sudden, you've got this correction in
Speaker 1: markets out of the blue, and that threatened to seep
Speaker 1: into the economy and and persisted until the FED basically
Speaker 1: turned around a hundred and eighty degrees. And on the
Speaker 1: one hand, that level of real yields was two d
Speaker 1: basis points above where we are today, and it seems
Speaker 1: odd to think that we could again have outflows when
Speaker 1: real yields are so negative. And yet for me, the
Speaker 1: long term pattern suggests the actually and the wobbliness that
Speaker 1: was starting to get in some market behavior and to
Speaker 1: some extent and fun flows at the moment suggest we
Speaker 1: could be much closer to that point than people imagine.
Speaker 1: So I want to go back to something that you said,
Speaker 1: because I think it's worth diving into deeper. And uh,
Speaker 1: you know, you're pointing out that, Okay, we've had this
Speaker 1: big repricing of the short end of the yield curve globally,
Speaker 1: and that means, okay, the expectation is that, you know,
Speaker 1: central banks around the world, the major central banks, are
Speaker 1: going to be hiking sooner than people had expected two
Speaker 1: or three months ago, even maybe even one month ago.
Speaker 1: But as you're saying, that doesn't necessarily imply that they're
Speaker 1: actually getting more hawkish, because if inflation next or if
Speaker 1: if you know, if inflation is expected to outpace those
Speaker 1: gains over the next one to five years, then you
Speaker 1: can have rate increases and yet actually the real yield
Speaker 1: doesn't necessarily uh, real yields can go up, you know,
Speaker 1: actually or they may need to tighten rates in order
Speaker 1: to prevent their being an effective easing. So I guess
Speaker 1: like the risk then for the market or the scenario
Speaker 1: then it feels like people aren't talking about and I
Speaker 1: don't know, you know, is the sort of the disorderly
Speaker 1: rate hike cycle where it's something a little bit more
Speaker 1: like the early eighties, where a bunch of central bankers say, oh,
Speaker 1: this is a serious problem. Rate high grade, high grade,
Speaker 1: high grade hike, intermediate grade hike, anything to stop inflation.
Speaker 1: That would be like the sort of like true like
Speaker 1: hawkers risk that could take down risk assets or where
Speaker 1: where do you wait? Bad scenario. I think it's not
Speaker 1: very likely. But I think it's not very likely because
Speaker 1: I see risk assets crumbling first, and hence we come
Speaker 1: back to this paradox that if they haven't crumbled, then
Speaker 1: you may go down that route. So again, Larry Summer
Speaker 1: has made an interesting comment at our City's Australian conference
Speaker 1: recently that he thinks the the U S economy could
Speaker 1: withstand policy rates going to five, sorry to three or
Speaker 1: three and a half percent before there was a correction
Speaker 1: in the economy. And if it were just about the economy,
Speaker 1: then I think I might sympathize with that view. But
Speaker 1: my suspicion is that actually we would go back to
Speaker 1: their being outflows from mutual funds and ETFs and people
Speaker 1: going back into catch long before that point, just as
Speaker 1: was the case in eighteen And I think maybe the
Speaker 1: underlying reason why it takes a lower and lower level
Speaker 1: of reals to prop everything up is because there's more
Speaker 1: and more debt in the system. And now, of course
Speaker 1: there's more debt still, and so again my suspicion is
Speaker 1: that that that we would reach that point earlier, and
Speaker 1: if markets were wobbling then actually which again Larry perfectly acknowledges,
Speaker 1: but then I think the risk of it filtering through
Speaker 1: into the economy more than might have been the case historically,
Speaker 1: that's actually quite elevated. And and and I think that's
Speaker 1: this thing that investors everywhere struggling with it. The bond
Speaker 1: market is, you know, the bond market flattening is telling
Speaker 1: you if you go down that route, it will be
Speaker 1: a mistake. It won't last very long, and the underlying
Speaker 1: disinflationary pressures from the overhand of are still there, and
Speaker 1: we're going to be stuck back in secularistagnation even more
Speaker 1: strongly than previously. And ultimately I think that's right. But
Speaker 1: the thing that's likely to make it right is a
Speaker 1: correction in equities and credit and housing, and so far
Speaker 1: there's no sign of that whatsoever. So I have a
Speaker 1: slightly strange question based on that. But what would happen
Speaker 1: if if central banks just did nothing? You know, if
Speaker 1: if they actually stuck to the transitory inflation argument and
Speaker 1: said they're just going to look through what the bond
Speaker 1: market is doing at the moment. Would that be like
Speaker 1: a big crisis of central banks um credibility, or maybe
Speaker 1: it wouldn't matter so much given that people are basically
Speaker 1: pricing in a policy error if they do start to tighten.
Speaker 1: I like to think in terms of what I call
Speaker 1: a credibility gap between inflation expectations on the one hand
Speaker 1: and real yields on the other. And when I look
Speaker 1: at that, basically we've already got the biggest gap between
Speaker 1: real yields and inflation that you've had since the nineteen seventies.
Speaker 1: And while I don't fully know, as I look at
Speaker 1: some of this aggressive behavior in bond markets in Australia
Speaker 1: and Canada and places that did almost seem dormant previously,
Speaker 1: and as I look at the still terribly low levels
Speaker 1: of term premium which exists across the board, I think
Speaker 1: you're quite close to the point where the central banks
Speaker 1: a damned if they do, and damned if they don't.
Speaker 1: If they don't respond at all, then I think quite
Speaker 1: rapidly you could see the bond market being destabilized at
Speaker 1: a minimum, let's say, in the five year portion, the
Speaker 1: longer and may may yet flatten more still, and and
Speaker 1: I think that's just that's just tough for the central
Speaker 1: banks to escape from. Frankly, now, now maybe I'm wrong,
Speaker 1: and that point is further away, but it's almost as
Speaker 1: though they packed themselves into a corner, because to begin with,
Speaker 1: they said, well, we don't need to worry about it
Speaker 1: inflation unless it turns into rises in inflation break evens
Speaker 1: and low and but sorry, in inflation expectations and low
Speaker 1: and behold, you've gotlonger dated inflation expectations in the US
Speaker 1: north of four percent on the new York fled survey,
Speaker 1: and likewise, they said, well, we won't need to worry
Speaker 1: about it unless it turns into you know, unless it
Speaker 1: moves away from just a few commodity prices and it
Speaker 1: turns into writers in wages and lo and behold, you've
Speaker 1: got average really earnings north of five And so again
Speaker 1: they've almost backed themselves into a corner. I'm not actually
Speaker 1: convinced that inflation expectations are quite as pivotal as the
Speaker 1: central banks think they are, but the markets are now
Speaker 1: liable to respond to that, and I think that's what's
Speaker 1: creating this environment that we're just starting to see where
Speaker 1: the market says, look, either you do the tightening and
Speaker 1: you have the abrupt turn around as the Bank of
Speaker 1: England is doing, or else I'm almost going to force
Speaker 1: you into it. Maybe not over the next two years,
Speaker 1: but definitely over the next five years. So you know,
Speaker 1: I'm thinking about this in the context of how we
Speaker 1: started the discussion, which is the economy as the incredibly
Speaker 1: complex system that we've given a huge too. And I
Speaker 1: think people could debate what the lack was. It was
Speaker 1: obviously the pandemic itself, and then the fiscal policy response
Speaker 1: and the public health policy response, which involved lockdowns in
Speaker 1: many places, numerous numerous jolts out of equilibrium. Do rate
Speaker 1: hikes like work? I mean, it's in in this sort
Speaker 1: of environment in other words, like okay, like maybe there's
Speaker 1: some sort of like traditional economic conception of overheating were
Speaker 1: demand is picking up a little bit, and then the
Speaker 1: high grades and then calls off loan growth nekels demand
Speaker 1: and everything gets back to normal. But do rate hikes
Speaker 1: do anything or accomplish anything in an environment in which
Speaker 1: we're not seeing normal, in which we're seeing as pendulum
Speaker 1: swing around like crazy. Even after the event, people will
Speaker 1: argue about it. Yeah, of course I think and and
Speaker 1: I think that for me, the paradox is it is
Speaker 1: a bit like bringing up children or something. You almost
Speaker 1: need to be stricter today in order to create longer
Speaker 1: term stability. And versely, if you are laxed today, then
Speaker 1: the bad behavior will carry on. And maybe that was
Speaker 1: I used in my presentation, this example of the double
Speaker 1: pendulum where once it starts, it's going a bit banan
Speaker 1: is it doesn't settle down by itself as the oscillations
Speaker 1: get smaller. It remains very erratic until you really crimp
Speaker 1: down demand until you really almost stopped the system through
Speaker 1: a recession or through rape rises, and only then can
Speaker 1: you does the thing start but start behaving. So on
Speaker 1: the one hand, yes, there is exactly a perfectly valid
Speaker 1: criticism that, look, if I raise interest rates, it's not gonna,
Speaker 1: you know, improve the availability of truck drivers necessarily, and
Speaker 1: so it seems a terrible shame to crimp down demand
Speaker 1: as a means of bringing the two back into into
Speaker 1: line with one another. But equally Irving King put it
Speaker 1: nicely on another city cool. He said, the role of
Speaker 1: a central bank is to is to keep supply and
Speaker 1: demand in line with one another. When the virus first hit,
Speaker 1: it became clear we were going to have a massive
Speaker 1: shot to demand, and so you needed all the support in.
Speaker 1: But then equally came rapidly clear that there's also been
Speaker 1: a shock to supply. Now, if anything, you just don't
Speaker 1: have that need for super easy monetary policy, and if
Speaker 1: you carry on with it, it's quite likely that you
Speaker 1: do get overheating and the erratic behavior continues. And so
Speaker 1: so for me, maybe it maybe maybe I mean that
Speaker 1: the at a minimum, even if they were right and
Speaker 1: some of the immediate inflationary pressures have slowed down. For me,
Speaker 1: there's a funny parallel with with with almost with climate change. Here,
Speaker 1: what's the paradigm we've been in for an extended period.
Speaker 1: It's one where even if there hasn't been CPI inflation,
Speaker 1: there's been asset price inflation, and there's been these boom
Speaker 1: bust cycles in asset prices, and central banks have looked
Speaker 1: back and said, but we fell short on the CPI target.
Speaker 1: We should have had easier monetary policy, and now they're
Speaker 1: trying the easier monetary policy. I and many people in
Speaker 1: the markets look back at the boom bust cycles, at
Speaker 1: the asset price bubbles, at more and more debt in
Speaker 1: the system, and say, with hindsight, you should have had
Speaker 1: tighter policy at a minium when the bubbles were forming.
Speaker 1: And I think the trip and likewise you were to
Speaker 1: reason twenty, but you should have tapered way earlier. And
Speaker 1: the trick to doing it is to make it conditional,
Speaker 1: to take the holistic view that includes asset prices a
Speaker 1: little bit more, or looks at broader credit dynamics and
Speaker 1: says here, I will tighten rate today, but if it
Speaker 1: starts going horribly wrong because there's a big bust in
Speaker 1: that in the housing market and equity markets, then I
Speaker 1: will be and then I will be easier in future.
Speaker 1: And on the one hand, a number of central banks
Speaker 1: are moving in that direction, the e c B whe
Speaker 1: it's we're going to maintain favorable financing conditions, or the
Speaker 1: b o J with your curve control, or the r
Speaker 1: b Z with having to include house prices alongside their
Speaker 1: CPI target. But on the other hand, for the for
Speaker 1: the big one, for the FED, that's still is almost anathema,
Speaker 1: and they're inclined to function differently and say, no, we
Speaker 1: need to pre commit to a certain course of action.
Speaker 1: And for me, that's the paradox. You may need to
Speaker 1: almost commit to being more volatile with your policies in
Speaker 1: order to get market stability, and conversely, by committing to
Speaker 1: easy money for longer, you've pushed the system into an
Speaker 1: unstable state. You touched on this earlier, but I would
Speaker 1: just love to drill down a little bit more. But
Speaker 1: you know, when it comes to the inflationary pressures that
Speaker 1: we're seeing, now, what's your sense of the breakdown between
Speaker 1: demand versus supply issues? So you know, we've all been
Speaker 1: talking about the supply chain shortages, transportation gridlock. But on
Speaker 1: the other hand, we have had massive fiscal stimulus that's
Speaker 1: injected trillions of dollars into the economy, put money into
Speaker 1: people's pockets. And I was just looking at a chart today,
Speaker 1: I think it was from Barclays, but it basically showed
Speaker 1: that incomes in the US, even if you strip out
Speaker 1: government transfers, so you know, unemployment stimulus payments and things
Speaker 1: like that, even if you strip those out, they've still
Speaker 1: been going up quite a lot. So people are wealthier
Speaker 1: than they were before. So I don't know, it just
Speaker 1: feels like it's sort of it's difficult to get a
Speaker 1: good handle on what's demand versus supply at the moment.
Speaker 1: That may be true for the US in particular. The
Speaker 1: US is the only place where people's incomes really went
Speaker 1: up massively. And yet of course we have the inflation
Speaker 1: pressures showing up elsewhere as well, And so I think
Speaker 1: in the immediate analysis you have to say, well, it's
Speaker 1: about supply shortages, about bottlenecks, it's about you know, the
Speaker 1: lack of wind in Europe and gas prices. And yet
Speaker 1: the conclusion that people therefore draw is it would make
Speaker 1: no sense to to tighten policy in order to deal
Speaker 1: with it. And again it's sort of this presumption it
Speaker 1: will settle down by itself. And I'm no expert on
Speaker 1: the on the nineteen seventies, but again it seems to
Speaker 1: me ironic that there too, you start from what was
Speaker 1: largely about supply constraints, supply shortages and segments like oil.
Speaker 1: But again you saw that actually that became much more entrenched,
Speaker 1: the inflation that results became much more entrenched than you
Speaker 1: would have thought, and almost the only way ultimately to
Speaker 1: bring the system back into line was through the aggressive
Speaker 1: rate rises to make everything settled down. And so I
Speaker 1: think that that, for me, again is the paradox. Even
Speaker 1: if the problem is the supply side, it may be
Speaker 1: that you need to tighten policy and reduce demand in
Speaker 1: order to get the good behavior just in time behavior
Speaker 1: to the smooth behavior that we got used to revert
Speaker 1: to it. And that's the puzzle. Everyone is busy scratching
Speaker 1: their head looking at these micro supply chain shocks, saying
Speaker 1: I don't understand, why can't it just go back to
Speaker 1: how it was previously? And I think the system is
Speaker 1: a bit more complex than that. So just to be clear, though,
Speaker 1: you think it might take inducing a recession or some
Speaker 1: sort of like meaningful slamming the brakes of demand to
Speaker 1: get back to some sort of what we might call
Speaker 1: equilibrium or balance or normal behavior. Yeah, and either that
Speaker 1: happens by itself because the market valuations are overly elevated,
Speaker 1: it happens earlier than you would have thought, or if
Speaker 1: it's not happening, and the equity market is making new
Speaker 1: highs and the housing market is becoming even more ridiculously
Speaker 1: expensive than it is at the moment. Again, I suspect
Speaker 1: you may need to move in that in that direction.
Speaker 1: So I'm conscious that we haven't you know, we're having
Speaker 1: this big global macro discussion and we haven't actually talked
Speaker 1: about China just yet. And you know, I'm based over
Speaker 1: in Hong Kong and we're watching UM the Chinese p
Speaker 1: M I numbers come in over the weekend, which showed,
Speaker 1: you know, a pretty stark slow down. And again, like
Speaker 1: you start to think back to parallels of UM I
Speaker 1: guess early when we sort of had weakness in China
Speaker 1: spread to global markets. How are you thinking about that
Speaker 1: at the moment? Is there a likelihood that the slowdown
Speaker 1: in China, China's refusal to actually um stimulate or easy
Speaker 1: the economy at this point in time, that starts feeding
Speaker 1: into global markets and the economy. The funny thing is
Speaker 1: that the China slow down, while I think it's hugely significant,
Speaker 1: and e M investors seem to think it's hugely significant. Again,
Speaker 1: DM investors have mostly shrugged it off. And as you
Speaker 1: even the numbers over the weekend are a perfect illustration
Speaker 1: of this. The market just hasn't seemed to care today,
Speaker 1: and so that the slowdown needs to become much more entrenched.
Speaker 1: And yes, want to speak to investors, and number of
Speaker 1: them do seem to think that there's going to be
Speaker 1: a more aggressive easing earlier than than we do. And
Speaker 1: and we look instead at China's willingness to tolerate slow
Speaker 1: down and draw parish conclusions. But again, it's it's puzzling
Speaker 1: how the market hasn't responded. And maybe this comes into
Speaker 1: a whole sort of broader set of questions around around
Speaker 1: how markets have really been behaving and what the underlying
Speaker 1: drivers have been. So a convention analysis would be, oh,
Speaker 1: the China slowdown might be significant for some commodities or
Speaker 1: might be significant for Germany exporting two in Switzerland ex
Speaker 1: support supporting to China, but it's not a big deal
Speaker 1: for the US with its more insular economy, and may
Speaker 1: we can have the same conversation around rate hikes and
Speaker 1: tightening of policy. A conventional approach would be to say,
Speaker 1: but oh, normally markets do well during during the first
Speaker 1: few rate hikes in the cycle. Surely there's nothing to
Speaker 1: worry about. And for me instead, there's a whole broader
Speaker 1: story which has become ever more intense over the last decade,
Speaker 1: almost where all my favorite fundamental relationships are broken down
Speaker 1: as companies have leveled up and spreads of tightened in
Speaker 1: and there's been lots of uncertainty, but there's been no volatility,
Speaker 1: and where the underlying drivers of everything, as far as
Speaker 1: I can see in market terms, have revolved around the
Speaker 1: wall of money, the reach f yield, the global liquidity patterns.
Speaker 1: There are a number of terms for it, but it
Speaker 1: really boils down to for me, there's quite literal process
Speaker 1: of money creation, and it's in this context where China
Speaker 1: has historically, over the last decadels have been terribly important,
Speaker 1: not only in the immediate commodity markets and some real
Speaker 1: estate markets where you might have imagined, but even more
Speaker 1: broad oddly than that, I remember people were struggling with
Speaker 1: the same thing, and they said, how come the the
Speaker 1: China slowdown and the depreciation of a remimbi is suddenly
Speaker 1: causing yoursel off in the SMP when the US doesn't
Speaker 1: export that much to China. And one of the responses
Speaker 1: I gave at the time is China maybe the stock
Speaker 1: of dobal global debt, but it's six of the flow
Speaker 1: of private borrowing, and often it's been eight of the
Speaker 1: of the impulse of the change in the flow. And
Speaker 1: I think this this for me a lot of what's
Speaker 1: happening to markets. More broadly. We all tend to assume
Speaker 1: that markets have this nice balance and it's between the
Speaker 1: buyers and the sellers, and everyone has their own independent
Speaker 1: estimate affair value, and if a few buyers and sellers
Speaker 1: drop out, it doesn't really matter. But for me, markets
Speaker 1: in recent years have been driven much more by the
Speaker 1: the massive off market price insensitive buying that has come
Speaker 1: as a result of money creation, most obviously from que
Speaker 1: through central banks, but also through China on a great
Speaker 1: many occasions. And I think what are just beginning to
Speaker 1: realize at the moment is that that que is not
Speaker 1: going to be there. The goldilocks environment is going to
Speaker 1: be there. The central plants can't provide support. And similarly,
Speaker 1: the flow of credit from China rippling out and setting
Speaker 1: prices in global commodities, if they're really committed to financial
Speaker 1: stability as they now seem to and rebalancing the economy
Speaker 1: away from the real estate market, that's not going to
Speaker 1: be there. And what we've seen on previous occasions like
Speaker 1: eighteen where we did this on a smaller scale, is
Speaker 1: that you don't get an instant correction down in market prices,
Speaker 1: but there's a sort of void beneath the market price
Speaker 1: as you discover that the that the inflows aren't there anymore.
Speaker 1: And once you suddenly have somebody who really needs to sell,
Speaker 1: that's when you're prone to this sudden sort of gapping.
Speaker 1: And so that is my interpretation here, But hey, maybe
Speaker 1: I'm completely wrong, and there's just another more traditional view
Speaker 1: that says, no, China doesn't matter anymore, there's too much
Speaker 1: stimulus elsewhere, and so we don't need them. So this
Speaker 1: is like a perfect and you mentioned, you know, the
Speaker 1: big risk aurset reaction to the R and B. And
Speaker 1: you know, this gets to the puzzle that we've sort
Speaker 1: of been uh that we started with it, which is
Speaker 1: why with all of these sort of things steering at
Speaker 1: us in the face the supply chain issues that don't
Speaker 1: seem to be smoothing out, the hawkish pivot from central
Speaker 1: banks and the market expectations thereof which we see reflected
Speaker 1: in short term rates elevated inflation, why you know why
Speaker 1: it hasn't hit risk assets and your view seems to
Speaker 1: be that it's coming that it's simple. You know, maybe
Speaker 1: central banks will have to induce a recession, maybe the
Speaker 1: market is going to do it for it, and so forth. So,
Speaker 1: setting aside what happens over the next like week or
Speaker 1: the next month in markets, what is and what is
Speaker 1: an investor to do? Like does how? Does the how
Speaker 1: should the If the Goldilocks era of like the post
Speaker 1: GFC or the Great Moderation which was arguably longer, is
Speaker 1: officially coming to an end, then in theory I would
Speaker 1: imagine portfolio strategy should change too. So what is they're
Speaker 1: translate to in terms of like rethinking portfolios? So if
Speaker 1: you really think that Goldilocks is over, that the inflation
Speaker 1: is permanent and that the central banks will allow it
Speaker 1: to run. And then obviously you start digging out your
Speaker 1: very long term historical returns and you look back to
Speaker 1: the nineteen seventies and so on, and you look at
Speaker 1: what would be an inflation hedge, and people sometimes say
Speaker 1: equities on the numbers, I look at that's not very persuasive.
Speaker 1: You really come back to commodities, especially obviously, and to
Speaker 1: real estate as being your inflation hedges. If though you
Speaker 1: think that you're in this almost temporary environment where the
Speaker 1: inflation pressures are there, but actually markets everywhere have been
Speaker 1: made fundamentally expensive by all of the stimulus in a way,
Speaker 1: that means that you could be close to some form
Speaker 1: of tipping point, especially if real yields start going up.
Speaker 1: Then in a sense, it's more complicated. Maybe it's more temporary,
Speaker 1: but it's more complicated. And that's the framework that I've
Speaker 1: tended to use. I like to talk in terms of
Speaker 1: the real yield cycle, where when central branks come to
Speaker 1: the rescue and real yields go down, she's supposed to
Speaker 1: pilee and even though the fundamentals look bad, and then
Speaker 1: there's a second phase where growth begins to return and
Speaker 1: investor in inflation break evens move up, and the market
Speaker 1: rally shifts away from investment grade to high yield and
Speaker 1: away from growth equities and towards more cyclical equities. But
Speaker 1: if you if we're now getting back to this point
Speaker 1: where fundamentals are supposed to be taking over, but really
Speaker 1: you'll start moving up. Multiple times we've seen in that environment.
Speaker 1: Maybe temporarily bank equities do a bit better, but basically
Speaker 1: it's really difficult. And you know, even things like gold
Speaker 1: might ultimately be a defense, but they tend to do
Speaker 1: poorly if real yields are are going up in the
Speaker 1: near term, And almost what you end up doing is
Speaker 1: going back into cash in a great many cases and
Speaker 1: awaiting a re entry point, either to government wants because
Speaker 1: and and investment grade credit because inflation is under control
Speaker 1: and the auchi flating his character carrying on. Or conversely,
Speaker 1: if when the central branks are going back to easing,
Speaker 1: then you compile into into risk assets all over again.
Speaker 1: And I wanted at a client event recently, we did
Speaker 1: an interesting survey where we asked, if there is a
Speaker 1: correction in markets, will you be buying the whole way
Speaker 1: through because you've been preparing for this. Will you be
Speaker 1: buying only when we get back towards fair value you
Speaker 1: call it five or ten percent, maybe ten ten or
Speaker 1: more percent down in the in the equity market, or
Speaker 1: will you only go back to buying once the central
Speaker 1: banks are back to easing again. And the rather dismaying
Speaker 1: response from a majority was a little bit like, we're
Speaker 1: going to wait until the central banks go back to easing.
Speaker 1: And if that's the case, the trouble is again with
Speaker 1: the inflation pressures in the system. We're miles away from
Speaker 1: that point where they where the Fed put kicks back
Speaker 1: in again. And so just temporarily, basically, I end up
Speaker 1: holding much more cash than you would do otherwise. And
Speaker 1: maybe you can combine it with put spreads or bar bells,
Speaker 1: with some commodities or some risk assets, or even some
Speaker 1: of my strateg just the same things like Asian high yield,
Speaker 1: where at least you escape the systemic pressure where everything
Speaker 1: has become correlated with real reals, everything has become correlated
Speaker 1: with central bank policy. At least I get something idiosyncratic
Speaker 1: in my portfolio. Again, that's the idea, but basically when
Speaker 1: we've created this environment where everything depends on monetary policy
Speaker 1: more than it depends on fundamentals, Those periods where monetary
Speaker 1: policy at least temporarily is withdrawn take it really really difficult.
Speaker 1: M So this is one of the things that stands
Speaker 1: out in this conversation and also from your work. It's
Speaker 1: the sort of like being trapped in a endless cycle
Speaker 1: idea where we have this feedback loop of easy monetary
Speaker 1: policy that inflates risk assets, that then leads to some
Speaker 1: sort of like destabilization in the market, and then the
Speaker 1: central banks come back in and ease further and we
Speaker 1: start the cycle all over again. Is there any and
Speaker 1: I'm conscious that you've been writing about this for a
Speaker 1: long time, but is there any off ramp that that
Speaker 1: you see? You know, are we ever going to get
Speaker 1: away from this psyche gore of financialization? I certainly hope so,
Speaker 1: And in a sense we touched on it already. For
Speaker 1: for me, what this boils down to is basically a
Speaker 1: series of cycles in which you buy the bubble and
Speaker 1: you sell the bath. Also, when the central mats come
Speaker 1: to the rescue and we punt the system full of debt,
Speaker 1: it may look terrible from a long term sustainability perspective,
Speaker 1: but you close your eyes and buy it. And conversely,
Speaker 1: whenever they try and do the right thing again, it's
Speaker 1: almost like dealing with climate change that would make things
Speaker 1: more stable in the long term. Actually, in the new
Speaker 1: term you get nervous about a correction in markets, and
Speaker 1: so for me, these long term questions boiled down to
Speaker 1: can we achieve some form of long smooth deleveraging, And
Speaker 1: clearly the hope is, oh, now with fiscal stimulus, productivity
Speaker 1: will go up and everything will be fine. Personally, I
Speaker 1: don't believe that at all. For me, actually, the right
Speaker 1: thing to do is to almost aim for some form
Speaker 1: of long smooth deleveraging, some form of that for years.
Speaker 1: The best I can imagine is a benign Japanification but
Speaker 1: coupled with deleveraging and ironic, and people say, oh, that's
Speaker 1: just a story to that that that never works. I
Speaker 1: think actually the Eurozone periphery has done way better than
Speaker 1: people give it credit for. They haven't needed more and
Speaker 1: more and more austerity. You just adopt a less credit
Speaker 1: intensive growth model, which is very difficult at the beginning
Speaker 1: and gives you a negative impulse at the beginning, but
Speaker 1: then you can achieve a steady deleveraging. And I hope
Speaker 1: that we may yet get to this. For me, the
Speaker 1: policies that would create it are the ones where the
Speaker 1: central banks actors are backstop when things are going wrong,
Speaker 1: but then are much more circumspect than they have been
Speaker 1: about about inflating bubbles. And that that, for me, is
Speaker 1: that the sort of key judgment here. It's it's how
Speaker 1: if there is another correction of markets, how do they respond?
Speaker 1: Is it providing much more temporary sort of support or conversely,
Speaker 1: do they say no, we just need more stimulus, still
Speaker 1: back by even larger amounts of QUEI, even as we
Speaker 1: see this spilling over into things like inflation. And so
Speaker 1: that that's been the trade off for a long time,
Speaker 1: the unfortunately selling to the general public the idea of
Speaker 1: the long smooth deleveraging. It's sort of like vote for me.
Speaker 1: I'll give you ten years of stagnation, but it will
Speaker 1: be better for your children. And then that's a difficult cell.
Speaker 1: And yet the easiest solutions are steadily increasing the likelihood
Speaker 1: of runaway inflation, increasing the likelihood of kind of military
Speaker 1: debasement in a sense we've had that debasement already, not
Speaker 1: with respect to goods prices up till now, but relative
Speaker 1: to asset prices and people's ability to afford a pension
Speaker 1: or afford a house. And the more debt you put in,
Speaker 1: the more polarized systems become, the more unequal everything becomes.
Speaker 1: The greater is the likelihood of those really negative tale scenarios.
Speaker 1: You must hear this debate a lot, and we have
Speaker 1: a lot of guests, part because of my own personal
Speaker 1: predilections and interests that come at this from the MMT
Speaker 1: perspective that as government debt is fundamentally different than private
Speaker 1: sector debt, and that if you look at say right
Speaker 1: now in the US, for example, household balance sheets are
Speaker 1: in extremely good shape, and part of that is due
Speaker 1: to asset prices, part of it is due to generally speaking,
Speaker 1: households not having taken on a lot of debt in
Speaker 1: the post GFC period, and that we did have this
Speaker 1: big private sector deleveraging. And well, it's true that government
Speaker 1: debt treasury issuance has shot through the moon. The debts
Speaker 1: fundamentally different, that governments don't have credit risk in the
Speaker 1: same way that households and firms do, and that therefore
Speaker 1: the US is already currently in a implicitly or explicitly
Speaker 1: much less leveraged position. The economy does not bear the
Speaker 1: same level of private sector debt risk than it may have.
Speaker 1: You know, prior to the Great Financial Crisis or several
Speaker 1: years ago. I don't buy any of it, or rather
Speaker 1: I've b very very little figured. It is certainly true
Speaker 1: that governments are able to pull more levers and cope
Speaker 1: with debt in ways that corporates or households cannot. However,
Speaker 1: debt is this almost magical thing which, on the one hand,
Speaker 1: is just money that the system os to itself, and
Speaker 1: the process of adding more of these obligations to the
Speaker 1: system is almost always positive for growth or positive for
Speaker 1: asset prices, provided that it remains credible, provided that people
Speaker 1: believe that they're going to get paid back. It's sort
Speaker 1: of like having a pension. When you think that the
Speaker 1: government is going to pay you a pension in future,
Speaker 1: you go out and you spend more money today. The
Speaker 1: moment that you get to the point where you start
Speaker 1: to call into question whether or not the government is
Speaker 1: actually going to be able to afford the healthcare that
Speaker 1: it's promised you then you're you're spending today gets called
Speaker 1: into question. And while the limits around this for governments
Speaker 1: are greater than they are for private sector actors, when
Speaker 1: you do the long term historical analysis, Ray Dalio has
Speaker 1: done some some wonderful work on this, and you look
Speaker 1: back across centuries, unfortunately, all the signs that the system
Speaker 1: could be close to a tipping point. Maybe it's a
Speaker 1: bit better now because interest rates are lower, but basically
Speaker 1: we've passed them already in terms of aggregate debt levels
Speaker 1: across the public and private sector together, in terms of
Speaker 1: political polarization, in terms of inequality, and frankly, all of
Speaker 1: that is extremely alarming. So so to me, yes, it's
Speaker 1: all just an accounting construct, but actually it's such a
Speaker 1: powerful accounting construct that even that that the governments and
Speaker 1: central banks are not actually as fundamentally different as we imagine.
Speaker 1: The clue is in the titling our debt or credit
Speaker 1: is about credibility. It's about whether those promises will get repaid.
Speaker 1: And as you make more and more promises, so at
Speaker 1: some point those get called into question, and and and
Speaker 1: maybe on on this what's further alarming is even though
Speaker 1: in general we don't seem particularly close to that point,
Speaker 1: and even emerging markets that are stretching things. In many
Speaker 1: cases today we've had currency weakness, we haven't had runs
Speaker 1: on currencies today. I also think, unfortunately, it's a bit
Speaker 1: like bank runs in the nineteen thirties or in the
Speaker 1: nineteenth century. The thing that causes a run on my
Speaker 1: bank or my government or my currency isn't necessarily anything
Speaker 1: I've done today. It's the fact that there was a
Speaker 1: run on the currency down the road, of run on
Speaker 1: the bank down the road, and suddenly investors get nervous.
Speaker 1: And so if we started to see this in emerging
Speaker 1: markets or in some of the smaller economies, then actually
Speaker 1: it could quite rapidly spread through to the to the
Speaker 1: stronger economies. And that, as I look at the price
Speaker 1: action in some of the front end of rates markets today,
Speaker 1: could be a very very early precursor. But you you
Speaker 1: begin to see that potential contagion effect coming through. All right, Well, Matt,
Speaker 1: it was lovely having you on. As always really appreciate
Speaker 1: you coming on the show. My pleasure. That was fantastic, Matt,
Speaker 1: So Joe, I always loved talking to Matt and I
Speaker 1: do think he's a really good foil for some of
Speaker 1: the other guests that we've had on the show recently.
Speaker 1: And I have to say, like, unfortunately our listeners couldn't
Speaker 1: see this, but as we were talking Matt, we were
Speaker 1: doing this over zoom and Matt was bringing up like
Speaker 1: he basically had a presentation for every single one of
Speaker 1: his points and would pull up stuff from like three
Speaker 1: years ago and flip through it as he was speaking.
Speaker 1: And this times like this, I kind of wish we
Speaker 1: were doing this as a like a digital video show
Speaker 1: or TV or something like that. But that was really good.
Speaker 1: That was great, And he had like a chart for
Speaker 1: like every question and he immediately knew where it was.
Speaker 1: It was like, why isn't blah blah blah, and you
Speaker 1: immediately it's like being here's a chart that I put
Speaker 1: into report. No. I agreed, it was good, And you know,
Speaker 1: I do think that, like, there are many issues that
Speaker 1: he identified from my perspective that are clearly of concern.
Speaker 1: And I would say one is just this sort of
Speaker 1: general assumption that we will come out of this sort
Speaker 1: of like goldilocks. Yeah, OK, we're gonna get We're gonna
Speaker 1: hike we're gonna have a couple of hikes in two,
Speaker 1: maybe we get a hike in three, then we get
Speaker 1: the rate cut cycle, and then risk guess let's go up.
Speaker 1: So let's just fast forward to the end of the videotape.
Speaker 1: But we know it's going to be fine because we've
Speaker 1: done seen this a million times therefore whatever, you know,
Speaker 1: it's all fine. It does kind of feel like investors
Speaker 1: are in the mode. Always saw this movie before we
Speaker 1: saw the tape, re tangent, but ended up not being
Speaker 1: a big deal. So why selling stocks? And I do
Speaker 1: think like we don't really know. I mean, like, maybe
Speaker 1: it won't be that smooth this time right. I was
Speaker 1: also thinking about that, like that is the key difference
Speaker 1: this time around is we've had, you know, over a
Speaker 1: decade now of deflation or very low inflation, and so
Speaker 1: investors got used to that cycle because the FED could
Speaker 1: just continuously drop interest rates and nothing really happened to prices.
Speaker 1: But the big difference in one seems to be that
Speaker 1: we do actually have a of inflation, and so the
Speaker 1: idea that they're just going to immediately like revert back
Speaker 1: into easing after a big market blow up, I don't
Speaker 1: think that's necessarily a given, and I don't think investors
Speaker 1: are really thinking about that at the moment. No, And
Speaker 1: I definitely like don't think investors are thinking about like, look,
Speaker 1: it's pretty stark, as he laid it out, and it's
Speaker 1: kind of vulcar ish that maybe there's so much sort
Speaker 1: of chaos, pendulums to hinge, pendulum swinging in unpredictable ways,
Speaker 1: that the only way to to slow that down, or
Speaker 1: that central banks decide, Okay, we have to induce a
Speaker 1: recession because right now things are too unstable. I don't
Speaker 1: think is on many people's radars. I think, yeah, the
Speaker 1: expectation is we're going to get rate hikes next year,
Speaker 1: but as he pointed out, it's not even clear that
Speaker 1: the market believes rate hikes will be uh monetary tightening,
Speaker 1: because if inflation is expected to outpace the rate hikes still,
Speaker 1: then you can have will uh you know, real yield
Speaker 1: to go up, and you're not actually um, you're just
Speaker 1: sort of like, you know, keeping things neutral. Yeah, it's
Speaker 1: always a bit scary when people start talking about you know,
Speaker 1: basically like resetting the financial system or the economy. No,
Speaker 1: you know, just just to play push back on one
Speaker 1: thought I had though, is like after crises, there is
Speaker 1: that temptations like everything is different this time now, And
Speaker 1: we certainly had that in twenty not, but that one
Speaker 1: was kind of different. It's like, oh, we need to
Speaker 1: retrain everyone because they're just aren't the jobs that there
Speaker 1: used to be, and everyone needs to become a coder
Speaker 1: in order to get back to full employment. It turns
Speaker 1: out we just needed to have more robust growth and
Speaker 1: nothing had fundamentally changed from the pre grade financial crisis
Speaker 1: to the post grade financial crisis economy. So like, I
Speaker 1: also think that people should just remember that every time
Speaker 1: there's a big event, there is that temptation to say
Speaker 1: something big has changed and not. It's not always a
Speaker 1: case it's different this time. You might be the same
Speaker 1: this time. But yeah, I just it's just just my pushback.
Speaker 1: All right, shall we leave it there? Let's leave it there. Okay.
Speaker 1: This has been another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway and I'm Joe Why Isn't All? You can
Speaker 1: follow me on Twitter at the Stalwart. Follow our producer
Speaker 1: Laura Carlson. She's at Laura M. Carlson followed the Bloomberg
Speaker 1: head of podcast francesco Leedy at Francesca Today and check
Speaker 1: out all of our podcasts on Twitter under the handle
Speaker 1: at podcasts. Thanks for listening.