Transcripts
Erik: Joining me now is Forest for the Trees founder Luke Gromen. Luke, it's been since January that we had you on the program. Really great to get you back. I've been asking everyone about secular inflation. Now everybody can see that there is inflation. My question is, is this really transitory the way the government would like us to believe or are we seeing the beginning of a structural inflation that's going to last many years?
Luke: I think it's the beginning of a structural inflation that's going to last many years. I should probably say thanks for having me back on to start. But the reason I think it's structural lasting for many years is I think if you look at a lot of the key factors that have been disinflationary over the last 20 years, 30 years. A lot of them are going in reverse. So you know, whether you go back 10 years, we've seen a disinflationary impulse in oil and commodities, in no small part tied to US shale. US shale has been the biggest marginal producer of oil for the last 10 to 15 years. We are seeing that it is getting hard, if not impossible, to increase production at lower prices. And so we've been talking about peak cheap oil that is a structurally inflationary component to commodities.
I think if you look at another big one, globalization, globalization has been extremely disinflationary or deflationary for 20 plus years. Very clearly that is going in reverse and so if China and US trade was deflationary, or disinflationary, the breakdown of US and China trade relations, it strains credulity to think that that too, is deflationary. I think that's a very inflationary secular inflationary impulse. I think when you look at even things that are a little bit more counterintuitive, to me, I think they also point to a secular inflation. So for example, it's often pointed out that in the US demographics are deflationary that old people don't spend as much. I would question that a little bit, particularly at the consumer level. And the reason I say that is, if you look at US deferred compensation schemes, whether they be 401-Ks, or 403-B's, or IRAs. All of these programs effectively amounted to the sterilization of inflationary US deficits over the last 30-40 years. And in plain English, people could put away 10-15% of their income. And instead of having that income in pocket now, the reward was you got tax deferred status. So you put that money into assets, instead of putting that money in your pocket where you would have spent it and where it would have been CPI inflationary right away.
And so effectively, we were sterilizing inflation with these deferred compensation schemes for 30 or 40 years. Fast forward to today, you've got whatever it is 70 million baby boomers, there's an article in the journal last year, or earlier this year, noting that the estimate is that the boomers control roughly is $35 trillion in assets. And now they're all getting to an age where they have required minimum distributions that it's a technical topic, but for simplicity's sake, and just sort of, you know, good enough for government work, they have to spend about 3% of that money per year. And so again, if deferred compensation schemes were disinflationary, or sterilized inflation that would have been higher for the last 30 or 40 years, and instead, it resulted in asset price inflation, then again, the opposite this $35 trillion coming out secularly is also very inflationary. And so I think there's a number of factors and those are just three. There's probably some others I could come up with. I think they all point in the direction that there is a secular, we've seen a secular shift in the deflation, disinflation versus inflation impulse. So that's some thinking about it.
Erik: Joining me now is Cullen Roche, founder of Discipline Funds. Cullen, it's great to get you on the program. I know you've been on the Market Huddle before. I think this is your first MacroVoices appearance. I want to start with something that's actually been not so much in the financial press but the popular press. Now I know that you are an expert on monetary theory and currency systems. That's what you've studied. That's what you know about. Please help us understand why printing a trillion dollar coin out of Platinum somehow can be convoluted to be a solution to a country that lives beyond its means on borrowed money and doesn't pay back its debt. But seriously, let's try to understand the monetary theory of this because it's in the popular press and nobody's talking about why that would work or even if it would work.
Cullen: So the coin technically from a legal perspective, the Treasury would mint the coin and the Federal Reserve would be able to deposit that coin into the Treasury general account. The way to think of it really, it's like changing the credit limit on your credit card. So if you had a $20,000 monthly credit limit on your credit card, well, what happens with the debt ceiling is that basically Congress decides they're going to spend $21,000 this month, and then we get to the $20,000 limit and Congress is like, oh guys, look, we don't have the ability to actually do this thing that we want to do, because we have this self-imposed credit limit.
Well the coin basically takes that extra $1,000. It deposits it into the account and then all of a sudden, we magically found this money that literally the printing presses already have. And so to me, it's one of these, like legal sort of, you know, loopholes that exists and doesn't really solve anything that is the you know, the root cause of the problem that exists. The root cause of the problem is that the government decides to spend way too much before we actually get to that credit limit. So it's not irrational to have a credit limit, it's irrational to put in a credit limit, and then say, you know, we should only spend $20,000 this month, but we're going to pass a bunch of legislation that requires $21,000 of spending. It makes no sense the way we go about this. And so this should all be done in a more proactive way. If we want to be more, you know, fiscally prudent about the way we go through all of this, that should be done at the congressional level, before they actually appropriate all of this spending that necessarily needs to be funded either through debt issuance, or a coin after the fact.
Erik: Joining me now is best selling author and advisor to many financial institutions, Russell Napier. Russell, it is great to get you back on the show, I know you've got a new book out, which I'm really excited to read. It's called ''The Asian Financial Crisis from 1995 through 1998: The Birth of the Age of Debt''. And I'm waiting, actually, for the audio book to come out in a couple of weeks so that I can listen, which is my preferred format, rather than read, but it's available to order right now.
I want to talk first, you know, we've been talking to every guest about this inflation-deflation debate. You were one of the first people to really tell us, hey, it's time to just have a secular shift in thinking because we've got a secular shift toward inflation and you've been a very outspoken deflationists for many years. I've really been looking forward to asking you this. Does the situation in China change your tune because that's turning some people back to deflationists?
Russell: Sure. So the answer in any intermediate timeframe and long term timeframe is no. But, let me discuss the situation in general, because it is currently somewhat deflationary and to get worse before it gets better. The question is why? And the answer is because they have a managed exchange rate, which for many years actually has been keeping monetary policy too tight. If you look at the People's Bank of China balance sheet, it's one of the few that hasn't grown. In fact, it's not much bigger than it was in 2017. Which when you think what has happened in Japan, the European Union, America, the United Kingdom, is quite remarkable. Not many people look at that and say, well, that's a choice of people at the Bank of China. That isn't a choice. It's forced upon them, because they have a managed exchange rate, which controls the size of the PBOC balance sheet. Now there are mitigating factors like capital controls, but that is the bottom line. Broad money growth in China just about over 8% is one of the lowest levels ever recorded. These are the classic situations in which you'd expect to get to some sort of credit crisis and that's what we've got.
Now, obviously, property has been overbuilt in China for many years. Already in the book that the Thai property market was clearly overbuilding in 1993. But we didn't get a catalyst to reveal that until 1997. Well now we have the catalysts for China. And that is that monetary policy is too tight. So here's the bottom line, does China accept this tight monetary policy that has been forced upon it by targeting the exchange rate on the basis that you target one monetary variable at a time or do they do something about it? So here's my call, this is a property crisis. It looks like a property crisis but ultimately, it's an exchange rate crisis. Everybody knows what you do when you have a decline in property prices or a credit crisis associated with risk in the property market. That is the main form of collateral across the financial system and the banking system and the non-banking system. And here's what we do, you cut interest rates and you print money. That's what you do. And there's no reason to think that just because Xi Jinping is unelected that he would follow a different path. So the question obviously isn't timing which we can go back and discuss.
So my view is that we don't go far down the path of in the property market, lower Chinese growth, something that looks like a credit crisis, until Xi has to move to what everybody does in a situation like this. Now, just one more minute on that. It does mean a lower exchange rate. If Xi cuts interest rates and increases the supply of money. It will give you a deflation shock. To the markets, we'll see that as deflationary. But it is actually very inflationary, and is inflationary for three key reasons. Number one, tariffs. There will be tariffs again. So this is not 1994 China everybody, this is a economy. The world will have to cope with the consequences of China pouring cheap products, and all returns into the world. Number two, it's only happening because China is printing a lot of money and it takes a while to get to consumer goods and consumer price inflation but it does get there.
And number three, it kickstarts a huge capital investment boom into the rest of the world as we tried to replace all the stuff we're not buying from China. So that may sound like a complicated roadmap, because it is complicated by the fact that it's difficult to be right on the timing. So there may be one more deflation shock. It doesn't make me want to move away from my call for inflation, nor particularly change the portfolio because I think it'll be very, very quickly. But people will begin to realize that this time, unlike 1994, there's movement on the Chinese exchange that is actually not deflationary, but ultimately is inflationary. And finally, it really does trigger the cold war. It's really a case of forcing everyone to take a side. Do you devalue with China or do you not devalue with China because of the great pressure from the developed world not to do that. So a little hiccup in the road. But that doesn't make me change my portfolio because basically I don't think I'm smart enough or quick enough maybe to know how to play that and getting back in when we have this final wrinkle on the deflationary shock.
Erik: Joining me now is Jeroen Blockland, who is founder and head of research for True Insights, a new investment research platform focused on multi-asset investors around the globe. Jeroen has produced a fantastic slide deck to accompany today's interview. Registered users will find the download link in your research roundup email. Now if you don't have a research roundup email, that means you're not registered yet at macrovoices.com. Just go to our homepage, look for the button that says looking for the downloads at macrovoices.com.
Jeroen as we dive into this, I'm really excited to get you in the program. Being in Rotterdam, you've got obviously a European perspective. Our Federal Reserve has been telling us over on this side of the pond that hey, don't worry, this inflation stuff is just transitory, it's not going to last. What's your take on inflation? Where's it headed? What does it mean?
Jeroen: Yes, well, thank you for having me. And to get right into the topic of inflation, which is, of course on everybody's minds. So basically, you have these two angles to look at it. First, you look at these, mainly the three big components that add to inflation in recent months. The usef cars, airfare, and hotel rates, and you see that they have peaked. So the year-on-year change on these items is still very large. But for example, used cars, they fell in price one and a half percent in August. So from that angle, I think most central bankers are pretty convinced that the inflation being transitory is still alive as well. And also, if you look at page nine of the slide deck, if you look at the flexible versus sticky CPI, and this is calculated by the Atlanta Fed. You see there in the chart that the core sticky CPI is actually not much higher than the long term average. And also, if you look at it from 2015 onwards, it's actually in the middle of what it has been. So if you argue that this is only about flexible prices, and again, used cars prices, airfares, and hotel rates are in that category, of course, then you can say inflation is transitory and also you see in this chart that even the flexible component is coming down a bit.
So from that standpoint, you could argue it is transitory. And I think also you should take into account that over the last 10 years me included, we have thought of higher inflation many times, but it never came. And this is because mainly there are some big deflationary forces at work, globalization, technology, and so on. So the odds are also against you and I think the base case of the Fed are more favorite. Having said that, there are a couple of indicators that point to continuously or longer than expected, higher inflation rates and perhaps not 5% or 6%. But maybe a longer time in above 3%, or even 4%. A couple of these things I want to mention is first, if you look at inflation indicators, so the ice and prices paid index, it's close to 80. That is down from 90, but it's still historically high. If you look at the latest Empire State survey, the prices received component is at a record high. And it has a very strong relationship with, among others the core PCE, one of the favorite inflation integrator of the Fed.
And two other things I would like to highlight. First is owners equivalent rent and you can see that on page eight of the slide deck, you see there's a clear relationship, obviously between owners equivalent rent and house prices. Well, we've got another data point on house prices just today. So house prices are up almost 20% and this is what the green line shows. And you can also see that owners equivalent rent, they take about 18 months to catch up with these housing price appreciation. And that means that from now, and let's say 12 months, it is very achievable, that this owners equivalent rent component of the CPI basket will rise to above 4%. Now it has a weight of 25%. So you can do the math. So this will be a upward pressure on inflation for at least another 12 months unless the US housing market collapses. And that is not the case, I think we are close to the peak, but it won't collapse immediately. So this is also a thing to take into account.
And finally, and that's on page seven, there's also a thing called the medium price rise and this is just the middle of the whole range of the whole U.S. CPI basket and you take the middle price increase and in August that was 0.34%. And you can see by the arrow, that was the biggest increase monthly increase we had since February 2007. You can also see that the month before that July 0.3% was also relatively high. So the median price level, I think something that central bankers would also look at is increasing at a faster pace than we have seen for a long time. And I think if you add these things together, and the fact that we are seeing supply chain disruptions getting worse and not less, or they're actually getting worse well, not perhaps 5 or 6%. But that we see, clearly above average inflation for let's say, the next 60 to 12 months, I think that is that is, the odds of that are not low. And that is why we have a somewhat more nuanced stance on this whole inflation is transitory narrative.
Erik: Joining me now is Juliette Declercq, founder of JDI Research. Juliette has prepared a slide deck for us for today's interview. Listeners will find the download link in your research roundup email. If you don't have a research roundup email, just go to our homepage macrovoices.com. Look for the red button that says looking for the downloads. Juliette markets have been directionless and a little bit difficult for the past few months. Now you specialize in splitting out underlying trends from noises. So how about if we start with your macro diagnostics since we last spoke?
Juliette: So let me think about them. When we last spoke, I think it was in March when we were nearing a macro inflection point. And you've got a great timing in reminding me on your show Erik because I think we're nearing another inflection point, which normally should mean good trading opportunities. So let's start with what really happened since we last spoke. If you check chart 1 and 2 of the chart deck that I've produced for your listeners. You will see that the reflation trade which started on the COVID vaccine in early November 2020, and which consensus strongly believed was going to be the main theme in 2021. As now fully unwound, and unsurprisingly cyclical stocks and real yields were the main casualties. It's also interesting to note that the peak in real yields and cyclical outperformance also coincided with a global demand peak, as shown by the peak in the global PMI survey.
So what really happened? I think the answer is that investors grew too comfortable as normally happens in earlier but this year was like a particularly was different because of like the massive leverage that was available in market. So I think investors grew too comfortable in big size with the narrative of the grand recovery trade and the view that cyclicals would basically sail into the sunset. When consensus is overwhelming, it doesn't take much to disrupt trends. And inevitably, three things ruin the party. One, higher production costs and persistent supply bottlenecks curtailing company's growth potential. Two, the secondary effect of higher prices suppressing consumption. And three, obviously the rise of the Delta varient this summer, depressing animal spirits just as most of the developed world we're starting to see light at the end of the COVID tunnel.
So um, let me start here with the global supply chain crunch. Instead of seeing an easing in 2021, we actually experience a worsening far beyond the ones in 2020. We can blame a front loading of Christmas orders and delta and use port closures in Asia. I was speaking just last week to a luxury perfume maker in France, and they would have had the absolute best year ever in 2021. If it wasn't for the fact that they can't deliver on orders. It's not the glass bottles that are made in France or Italy. But what they're missing is basically the plastic tops that are made in China. The issue is, is that the explosion of globalization in the past two decades. Goods production depends on intricately intertwined global supply chains. I'm not teaching you anything here, a missing link and delay prediction tremendously. And persistent semiconductor shortages is another prime example.
Meanwhile, global manufacturers face bidding wars for space on vessels pushing Fred rates to records as you can see on chart 3. So even if you did manage to get your orders shipped, cost pressures remain acute and we are yet to see a peak there. There is really no secret. You get price inflation when the money supply - which tends to lead global demand - rises much faster than the supply of products and services. And as shown on chart 4, the Global Bottlenecks index has now peaked, but it remains extreme historically. So the question going forward is whether prediction will eventually catch up to strong demand as the supply crunch eases, or whether inflation will eventually kill reflation in the stagflation scenario that we have been pricing since May.
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