China’s Real Estate Poses Risk to the World
MAGGIE LAKE: Hey there, welcome to Real Vision Live. I'm Maggie Lake with Jeff Snider, Head of Global Research at Alhambra Investment, and we are going to try to break down some of these inflation figures that have come in that have really been shocking the markets. Hey there, Jeff, how are you? JEFF SNIDER: Good. How are you, Maggie? Good to see you. MAGGIE LAKE: Same here. I always like to start with a jam from one of your many legions of fans. And I saw a fantastic comment from one of your Twitter followers, who said Emil and Jeff are like Simon and Garfunkel at once, profound, poetic and melodic. Great comment from blacktip. Thank you for that, that made my day. So, I expect
you to be all three of those things today. JEFF SNIDER: Yeah, I'll try. That's a lot to live up to in a very short period of time. MAGGIE LAKE: It is. I like to set the expectations high. But speaking of high, we got to start with CPI. Because we've been going back and forth about
it. A lot of us know and understand where you come from on the inflation front. But this number was really surprising. So, what did you make of it? We have a six- handle now on inflation in the US. It's got all the inflation camp geared up. We are seeing a market reaction on the back of it. Did it change your thinking about anything? JEFF SNIDER: No. And I think the market reaction is good, too. But before we get to that, let's talk about the CPI itself. Yeah,
it was 6.2% year-over-year, but almost half of it, 47% of it was just energy, gasoline and energy services, as well as new and used car prices. That was it. Consumer prices are rising, and they really accelerated in October, but 6.2%, with a lot of that being because of energy and
automobiles, you're thinking more supply factors than actual anything else that are legitimately inflationary or consumer prices that are being driven by "money printing". It's still basically the same stuff as earlier in the year that just came back with a vengeance in October. MAGGIE LAKE: So, I understand the energy part, and a lot of people are saying that, but there is this feeling that you're starting to see housing, people are expecting wages to follow suit. Is all of this really going to be transitory? Isn't some of this stuff
a little stickier in nature and/or the longer it goes on, won't it still feed into that traditional inflationary spiral that people worry about? JEFF SNIDER: Well, the funny thing about the CPI is that most of what goes into it in terms of shelter is owners' equivalent rent, which you would expect to exhibit some tendencies from housing prices over the last year, which have gone crazy. So, those are starting to creep back in. But there's always a question about whether that's a real thing or not, if that's just a statistical quirk of the way the BLS puts together the CPI. So, yeah, there's definitely going to be some pressures from the housing sector. There's definitely still the supply factor is going to take place and they're going to linger on into next year. But as far as deciding what is inflation and
what is temporary, transitory, non-economic factors, like we've seen, that's really when we turn to the bond market. And even today, with this supposedly shocking CPI number that was much higher than expected. Yeah, the bond market long end is selling off a bit, but interest rates are still lower than they were earlier in the year. And more importantly
than that, the yield curve continues to flatten. So, even today, with the nominal yields rising, the 5, 10 Year spread is down to around 34 basis points, which is the flattest the curve has been since August of 2020. So, there's a message in that as well, where the market is saying, yes, we see the CPI are high. But we believe that this is both not only temporary, it's also not money printing, it's not inflation. It's other non-economic factors. MAGGIE LAKE: So, you have a chart that you sent through, the Treasury market inflation component. Explain it to us a little because when I look at this, it's really surprising to me, not the yield curve, if that's what we're looking at. Yeah, there you go. It's that gray area.
I think it's showing us that CPI is high, but the bond markets not following suit. What are they seeing that others aren't? Why do we have that disparity, because there are other times where it tracked a little bit more closely? JEFF SNIDER: They tracked very closely during the great inflation in the 1970s, even leading up to the great inflation. And there's always this debate, do bond yields accurately predict the CPI? And the answer is no. As you can see on the chart here, the bond market doesn't care about all CPIs, what it does is it sorts the various CPIs for us. In other words, if consumer prices are being elevated for non-economic or non- monetary factor, the bond market's going to shrug it off, because as Irving Fisher showed in the early part of the 20th century, long term bond yields are an aggregate of growth and inflation expectations. So, if consumer prices are going up, but not for monetary or economic reasons, the long-term bond yields are going to ignore that, because they're going to know those factors are transitory or temporary. And that's what we saw before 1955, bond yields never reacted to
spikes in CPI, because they were non- monetary, non-economic in nature. And since 2008, bond yields have done the same thing. We had consumer price spike in 2008 itself, another one in 2011. And then the one that's currently ongoing, which bond yields have simply shrugged off, because they're looking at these as supply factors, the temporary nature of Uncle Sam's helicopters earlier in this year, whatever you want to assign the consumer prices to. So, consumer prices are rising, but the bond market is telling us that it's not inflation. It's not
monetary. It's not money printing. They're not out of control banking and credit flows or things like that. It's simply these other things. In fact, it's entirely these other things. MAGGIE LAKE: Yeah. And we have a question already from CB talking about the flattening of the yield
curve today, saying it's fairly extreme. It seems to be forecasting lower growth, and a revision to lower inflation in the future. Do you agree? JEFF SNIDER: Yeah, that's really the question that we think everybody should be asking is when we get to the other side of this consumer price deviation, when it would finally get through the supply bottlenecks, whenever that happens, we finally start to see automobiles on dealers' lots again, and they don't push the CPIs up so much. What does the economy look like on the other side of this? And if you look, again, to the bond market, not just nominal treasury yields, but you got German yields, Japanese yields-- MAGGIE LAKE: We do have our bond, bond market yield, let's not jump ahead to the others yet. The yield curve. Landmine. I don't like it when I see that word. What does that mean? And are we on the precipice of another one? JEFF SNIDER: Well, that was the implication before today, when bond yields were falling ever since late October, they started to pick up steam. And
so, we see these periods and time in history when we get into these questions about a growth scares, the economy rolling over, what's it going to look like in the future? Usually, what happens is we get to this point in time where bond yields just simply drop. It surprises everybody, and people can understand, because usually these are during periods when people are convinced, it's going to be inflation, it's going to be growth. When we see these landmines, it's the bond market telling you that we've gone past the point of no return. And that the growth story, the inflation story, that's completely done and over with. Now, we haven't seen one yet this so far in 2021, but maybe that's something to look forward to. To get back to the earlier question,
the bond market has been inching closer and closer to thinking, when we get done with these transitory price pressures in the CPI, the real economy might not look very good at all. In fact, it might look pretty bad because when you look at real yields, for example, the TIPS market, we're talking about record low real yields in 10s and 30s and some of the longer-term issues, which is a really pretty underwhelming economic climate moving forward, not just next year, but beyond next year. MAGGIE LAKE: Yeah. Jeff, is it the higher consumer prices, even though they're transitory, it's so evident to people because it's hitting where everyone feels it. At the gas pump, at the food store. Everywhere you go,
you're feeling that. We know consumers are a huge part of this economy. Does growth slow because of the inflation? Or is that just compounding something that was already deteriorating the growth outlook? And Dean Ross is asking, is the economy growing or slowing? It's hard to tell. JEFF SNIDER: Yeah, I think that's what makes it even more painful is that the bond market is telling you the economy is slowing, at the same time, just basic living and trying to survive becomes that much more expensive. So, you have a bad situation that's made it even worse and more painful, more directly painful by what's happening in these non-economic consumer prices, which are just adding pressure and stresses to an already stressed-out situation. It's really just a matter of we went through a really deep recession in 2020, and for a while there, it was the lack of recovery was obscured by all of these other factors and now, we're starting to revert to the mean, whatever that mean reversion might be in the long run post 2020. Maybe it's not so good after all. MAGGIE LAKE: And the causation matters because if we were slowing any way and now, you have on top of that CPI causing more pain for the consumer, does that make the growth story look even worse? Could we see even more of a declining growth? JEFF SNIDER: Yeah, not only does it create the other side of transitory, because then the economy slows as consumers start to have to adjust to higher prices, which then constrains their own ability to do what the economy needs them to do. But then you have to ask, well,
do they actually pull back in their own reversion to the mean? Do consumers say, we're going to be more risk averse going forward having been burned so badly by this consumer price economy in 2021? So, it is a potentially a double negative here. We have the slowing economy at the same time, it really, really does impact the consumer. MAGGIE LAKE: Just because it's happening, clearly, not everyone agrees with your forecast. Because if you look across the headlines, it's-- JEFF SNIDER: Everybody says it's the-- everybody's this is all inflation. This is permanent. This is 1972 all over again. MAGGIE LAKE: Yes. And we've had people say that here on Real Vision as well. So, the debate's not just in mainstream media,
the debate is also among members of our audience and guests. What happens with monetary policy, because they're looking at, they have been holding off, separated the taper from interest rates, saying they have room, they've been arguing that it's also transitory, but Chris is asking, Powell out, rate hike in? What's your take on both of those, because if they see this inflation print, you know the pressure on the Fed to raise rates or increase the pace of taper and raise rates is going to exist? JEFF SNIDER: Yeah, well, not only does it exist, it's being priced into certain markets. That's really what's going on to the short end of the curve is that the market is saying that we believe that Jay Powell has fooled themselves into this inflation box, which he's painted himself into a corner. Not only do they have to taper, they're probably going to have to accelerate tapering over the coming months in order to clear this space, or to clear the calendar as they call it to get to the rate hikes. And that's really part of what's driving the flattening of the yield curve is that you have relatively higher short end rates that are diagnosing what the Federal Reserve might do. And then the long-term bond yields which are saying, they're doing it for all the wrong reasons. The economy is not accelerating. This isn't 1972. In fact, this is the opposite
of 1972. And that eventually will happen as though two things will collide at some point. In the not-too-distant future, what we'll see, like 2018 and 2019, where the Fed's hawkish stance will prove very quickly to have been the wrong stance, because the economy is not exactly the way that the Federal Reserve believes. And that the reason they're tapering and moving into rate hikes is the same reason that they allowed themselves to do it in 2018 and 2019, heading into 2019, which was following the unemployment rate version of the economy, rather than a wide variety of data, which shows the unemployment rate to be not the thing you want to depend upon. MAGGIE LAKE: Yeah, we're going to talk
about some of the implications of that, and some of the timing of those possibilities in a little bit, but I want to talk about other things that you're looking at to validate the forecasts that you have. So, if we're not looking at-- first of all, let's start with if we're not looking at inflation, what are we looking at? What cycle are we entering or are we in? JEFF SNIDER: Yeah, that's why I try to make the distinction here between inflation and not inflation, because inflation is a monetary phenomenon. And if you don't have the monetary problem, or you don't have the monetary excessiveness, then you don't really have inflation, you have something else. And that's really again, what we just said the bond market is telling you. This is not monetary, this is not real inflation. Yes, consumer prices are going up, but they're going up for other things.
And as we just said, those other things are going to impact the economy in probably harmful ways rather than lead into an accelerating inflationary spiral. That's really what the bond market position is. That's why it's so helpful because it sorts out what's really behind consumer prices. And so, it's looking at the market- - MAGGIE LAKE: And when you say monetary, are you talking about too much money in the-- a lot of money in the system filling inflation? Is that what you're talking about when you're talking about monetary? JEFF SNIDER: Absolutely. That's what Milton Friedman said. Real inflation is always and everywhere a monetary phenomenon. So, if you don't have excessiveness in money, then you don't have actual inflation. So, again, you're going back to the earlier examples. 1950, 1951 is a perfect
example when the Fed forced its independence because it was afraid that the consumer price surge in 1950, 1951 was actually inflation when it wasn't. The bond market told them it wasn't. That was really the point that the bond market said this is not excessive money. This is not real inflation. It's just consumers going nuts trying to buy goods that they couldn't, that they knew they weren't going to be able to buy because of the Korean War, which was definitely a supply shock. And so, you have the Fed thinking, not about money because the Fed doesn't do money. So, the Fed is thinking that inflation is something like a combination of the Phillips Curve, whilst inflation expectation's embedded in an exploitable Phillips Curve or something like that.
They're looking at the economy from a non-monetary standpoint because they don't do money. The bond market does money and says this is not monetary inflation. This is not excessive money printing. In fact, it's the opposite. There's more deflationary potential in the monetary system than inflationary potential. I realize that most people are going to say, what are you talking about? The CPI is 6.2% and you're saying deflationary potential? Well,
that's what the markets are saying. MAGGIE LAKE: Right. And this speaks to the disconnect that you speak too often where you say that there's not all of this excess money floating around the system. But people think we're awash with liquidity. It's the era of cheap money. That's the perception. And that leads to this belief that there's just money awash everywhere because we're told that's why the stock market keeps going up, because there's all this excess liquidity. JEFF SNIDER: Yeah, and there's no excess liquidity. It's the interest rate fallacy, always go back to the interest rate fallacy. Low interest rates are a sign of tight money, not lose money. And this has been historically validated around
the world in all sorts of cases, the most famous of which is the 1930s in the United States. The Great Depression interest rates were low and went lower, not the other way around. The great inflation, as we just said, the bond market track to CPI, which meant interest rates rose during the 1970s inflation, not fell. So, if bonds yields are low,
that's a sign of tight money. But that's not the only sign of tight money. But it's the best sign of tight money, the most direct sign, where people trading in US Treasuries or German bunds are not investors like you and me, Maggie. It's these banks that do the money. The monetary system itself is telling you in a flattened, low real curve environment that the money's not there, and the money's not coming. So,
whatever's going on and consumer prices, it's not due to excessive money printing. And again, you can understand why people believe that because, as you just point out, all you've ever heard during this QE era, especially with the federal government's interventions earlier this year, that the world is awash in dollars. And then oh, by the way, along comes these 5% and 6% CPIs and you immediately connected to and think this is 1970s style inflation. And so, that's why it's so important to understand what these bond market signals are. The yield curve, Eurodollar Futures Curve, interest rate swaps, the People's Bank of China of all things, because they can tell you, they sort out for you. This is not monetary, this is not real inflation, it's something else entirely. MAGGIE LAKE: So, let's look at some of the global
signals and charts that you're looking at. And one of them is Japan business conditions. Why is that important? What is that telling us? And anytime we see Japan, I always think of Japan is like the ultimate deflationary story they can never get out of. And when we are in this period, where everyone's talking about rebounding from the pandemic, and a return to travel and normal and their high prices. Of course, you might think, oh, Japan's finally going to get out of this deflationary trap. What are we seeing in Japan? JEFF SNIDER: Yeah, unfortunately, Japan is like
a future glimpse of our own selves. Unfortunately, everything that we've done over the last 15 years, we've just copied from Japan. So, everything that didn't work in Japan isn't working here. And we're just basically following along. But in the short run, when you want to look at which way the global economy is turning, and it really is a global economic system, even if it doesn't behave exactly the same time in the exact same fashion, but by and large, in these large multiyear swings, there is a high degree of synchronization. So, if you look at Japan, and Germany and China, for example, they're pretty much good leading bellwethers about which way the global economy is leaning largely because those are the national economies that are exposed to global trade, which at the margins contributes a lot to which way the global economy is going to move either one way or the other. And what we've seen over the last six months or even longer in China, is that things are starting to look like maybe they're rolling over, like, we've seen the best days of this rebound from the 2020 lows.
That we're entering a period, call it a growth scare, call it rolling over, we don't really know what it means on the other side yet, the bond market is obviously taking a more pessimistic view. But it looks like we're in a period where the global economy is reaching an inflection stage. We've seen that in Japan, we've seen that in Germany, obviously, in China. And it's really like these leading bellwether economies are starting to send off some signals that, okay, now that we've seen the best days of the rebound, what does it look like after the rebound? MAGGIE LAKE: The fact that it's synchronous, it's all happening at the same time, it's got to be of concern. But you can always-- let's break down some of these. Japan, you could say they're a big exporter of energy. You could say that the rising price of energy is dampening on
their economic outlook, no? JEFF SNIDER: Sure, but if we were in a robust economic period where legitimate economic growth was accelerating, you would expect that economic participants that would demand energy from Japan or demand energy from anywhere would say, we're going to pay higher prices. This is not going to stifle our opportunity because we see tremendous opportunities ahead of time. And it's really where you get into an actual legitimate inflationary spiral. It's when economic participants say, we don't care if prices are up or input costs are up, we're going to pay them because the nominal opportunities are so good ahead of us for the prolonged future for a time in the future, we're not going to let rising prices slow us down.
So, in the non-economic case of consumer prices or producer prices, if they start to make an impact on production, for example, then that's, again, it's a nod toward the fact that this is not economic inflation, it's something else entirely. And if your margins are being squeezed by input cost, that's going to be deflationary over the intermediate longer-term future. MAGGIE LAKE: Yeah. And when you're talking about production, if you look at Europe, I don't know if we have the Europe industrial production, but Germany is the industrial powerhouse. It's so efficient, it usually is able to capture global growth. They're one of the strongest exporters in Europe. And that chart is looking terrible, especially Germany even worse than EU. JEFF SNIDER: Yeah. And why? What's going on in Germany? What's wrong with Germany? MAGGIE LAKE: Negative rates, I think still as well. JEFF SNIDER: Well, Germany, Japan,
and China, again, are three leading bellwethers that are sending us concerning signals that again, at the very least, the best days of the rebound are probably well behind us. And that leaves a lot of uncertainty about what comes next. It could just be that we slow down to more of a less frenzied American good story. It could be something even worse than
that. It could be something in between, but whatever it is, it's inflationary. MAGGIE LAKE: Yeah. David A has a question. M2 is rising at 12% to 13% year-over-year as it was in the 1970s. Doesn't that reflect monetary inflation? JEFF SNIDER: M2 rose precipitously in September and October 2008, too. M2 is an archaic number that doesn't match the actual situation in the global monetary system. It's strictly focused on
deposit-based monies. It doesn't take account of any of the wholesale money, the Eurodollar system, the global system is primary. It's entirely domestically focused. So, M2 is an outdated outmoded snapshot of a small piece of the overall monetary whole. And it has been sending unreliable signals for the last half century, even the Federal Reserve has been forced to talk about M2 at various points over the last 60 years, including the early 1990s, when they said, we're done with M2, because it doesn't seem to match the situation in the US economy, because M2 just went on its own way, velocity just fell through the floor, which they realized meant M2 was an unreliable signal. It's not representative of the entire monetary system, which is why I always prefer to use real time market prices, bonds, interest rate swaps, Eurodollar futures and things like that, that tell us in real time, because we can't really measure the global monetary system in any handy statistic. Why don't we let the system
tell us what it's doing without that information? MAGGIE LAKE: Right. We have some great questions, but I just want to come full circle with this global picture that you were painting, because I think China is so important. And again, when you're seeing the warning signs, if there are other circumstances, it's easy to dismiss them as particular to that economy. And I understand that-- JEFF SNIDER: That's what always happens, right, Maggie? Because you see weakness in China or Germany, you say, oh, that's just Germans got their own problems. What do we care? MAGGIE LAKE: And I think that's very true with China. We saw the fantastic problems surrounding Evergrande. We were all talking about it. We were
looking at whether it was systemic, and most people came to the conclusion that it wasn't, at least in the way we traditionally understand it because of the close nature of their financial system. But it is causing massive disruption and popping that real estate bubble with so many other implications for China. Do we need to-- I don't want to say look beyond that, but to what extent is that causing trouble within China? Is that getting exported around and weighing on growth? JEFF SNIDER: I'm not sure it's getting exported around. But I think you're right, it is definitely weighing on growth inside of China, because it's taking away what had been one of the primary sources for domestic economic growth, strength, whatever you want to call it. That's no longer going to be the case
going forward. And the Chinese government had been very clear about this, that going forward, they're not prioritizing growth in the same way that the world had become accustomed to before 2011 or so. So, the Chinese under Xi are very comfortable or at least outwardly comfortable with the fact that if the property situation changes materially going forward, then that's the way it is.
And so, China absent that real estate boost that had been the case for a very long period of time, looks then in a very different situation. But like much of the rest of the world, though, China has also these external global growth synchronized problems, too. So, a two for one there as well. They're not going to have the property sector come running to the rescue of a situation where, ever since late last year, the Chinese economy has been slowing down all year, not just over the last six months or so. MAGGIE LAKE: What is the balance sheet? We have a chart of the PBOC balance sheet. Walk us through what this means. Because I don't think
all of us look at the balance sheet all the time. And what does the blue represent versus the--? JEFF SNIDER: You really should. The People's Bank of China balance sheet is one of the best indicators of that money question that we just talked about. What's really going on in the Eurodollar system? Well, you can look at bonds, or you can look at the Chinese Central Bank balance sheet. As funny as that is to say, and to realize, what it really tells us is that look, the Chinese monetary system is highly dollarized. It's very much exposed to global dollar flows in the Eurodollar system, whether in or out. And so, we look at the Chinese balance sheet or
Chinese Central Bank balance sheet to tell us what must be going on in the monetary system by what shows up on the balance sheet or does not show up on the balance sheet. In the case of the latter, over the last few years, the People's Bank of China's balance sheet has been curiously devoid of dollar additions in foreign exchange. And over this year, the increase in foreign assets has been due entirely to what they call other foreign assets. We don't really know exactly what those are, but historically speaking, those have been tied to the People's Bank of China requiring the big banks in China. They're not private banks,
they're state-owned banks, but they sometimes act like private banks. It's the authorities requiring these big banks in China to post dollar deposits with the PBOC. So, essentially, borrowing or not quite confiscating, but taking the foreign reserves of these private bank or these state-owned banks, and putting them on their balance sheet for various reasons. And when you correlate these other foreign assets with various periods in the monetary system historically over the last 15 years, what you find is usually, when these other assets go up, when these dollar deposits are being demanded by the Central Bank, those are usually periods when you see dollar insufficiency, you see tight money in the Eurodollar system rather than the other way around. And that's consistent with, as I'm showing you on the chart here, the fact that the Chinese Yuan had been very strong in 2020 as the global economy rebounded, reflation took hold across most of the world. Then all sudden, in January of this year, it stopped. The yuan stops rising, and all of a sudden, we see among all the things,
we see the PBOC's other assets show up as well as the China and Belgium selling Treasury securities, which is consistent with a dollar problem, not dollars overflowing. MAGGIE LAKE: So, let's tackle some of these questions. So, we have a question from Mark B, we have a lot of questions around the bond market, a lot of questions around the growth outlook. Is there a relationship between falling real incomes due to rising prices
and constrained real income plus the impact of the fiscal cliff with demand? And if so, what is your forecast of the likely scale? JEFF SNIDER: That's hard to tell of the scale because so much is out of whack over the last year, because of so much artificial intervention from especially the federal government. It's really hard to say where is the equilibrium point, and especially in terms of private income, and then putting that in real terms where we're looking at. Will our real incomes going to be better next year because the consumer prices won't be as high, or it won't be accelerating as fast? It's really almost a crapshoot, which is just another way of saying the level of uncertainty about next year and beyond is probably at the highest it's been since say, maybe 2009 and 2010. Because it's really difficult
to tell at this point. Okay, we know things aren't going the way they should. The bond market is sending us all these pessimistic signals, but we really don't know that the exact scale of-- if we're reverting to the mean, what is that actual mean? What is the mean level of growth in the system, the long run mean going forward? MAGGIE LAKE: Yeah. Mark B also is asking the same thing if the bond market is forecasting a dramatic collapse in demand, when is your timing for this to manifest itself in retail sales? Again, hard to pin that down. You said something before about the confusion around the narrative that we keep hearing, that there's all this excess liquidity. And we've been told that excess liquidity is just fueling risk-on, maybe pushing people out the risk curve and pushing money into equities. If we don't
have excess liquidity, what is driving that stock market? Is it just excess speculation? Why do we see these enormous flows? Where is it coming from? JEFF SNIDER: Well, you and I know that it's not excess liquidity. But most of the people out there and I would have wagered the vast majority of people out there believe that it is. And if you believe that there's excess liquidity, and you buy stocks based on that belief, then stocks go up, regardless of whether there's excess liquidity or not, because everybody believes that there is, which is really the entire point of monetary policy, where monetary policy fails, or where it succeeds in the stock market, it fails in the real economy, because it doesn't work that way in the real economy.
You can't just have perceptions of money and liquidity in the real economy like you can in the financial economy. So, it's misperceptions of liquidity that drive asset prices higher, including real estate too to a certain extent. But that's why we have this gross disconnect. That's why everybody talks about inequality, right? Because the real economy has suffered, and it doesn't perform well, we see that in the participation problem. While at the same time, everybody says, well, the job market real isn't really good. The stock market's at record highs, and it goes up at seemingly 45-degree angle day after day after day. You look at any chart of the S&P 500 over the last couple years,
it should be completely unsettling. That's not natural for it to go up at a rate like that. MAGGIE LAKE: Oh, I have questions about that in just a minute. So, it's not excess liquidity, is the capital being diverted from other investments? JEFF SNIDER: That's part of it, especially from the corporate side of things. If you're a company, you're worried about liquidity risk, or you're worried about-- if you're looking at a long-term economy or economic climate that isn't robust, buy back your shares, instead of investing in some real economy project. And that's been a problem,
especially since 2008, 2009, where companies have contributed to this misallocation of capital, because they're chasing what seems to be endlessly good returns. Stocks always go up regardless of the economic climate, whereas real economic projects suffer because the economic climb can never really get going. So, that's again, you have this tremendous disconnect between the stock market view of things and reality, which contributes to all sorts of problems including the political question of inequality and things like that. MAGGIE LAKE: Are you worried about the action that we're seeing in the stock-- if we look to the bond market as an indicator for inflation and a signal about what's in store for growth, what is the stock market telling us right now? JEFF SNIDER: I don't think the stock market has any useful information at all. I think it's [?] at the casino, I think it's become a very apt term, it is essentially a casino divorce from economic fundamentals. And even earnings, which we tell ourselves is this fiction that anchors
stock prices to the real economy, most people price their equity positions based on forward earnings, which are essentially whatever you want them to be. You can look at them and say, share prices are high, therefore the market is saying forward earnings are going to be awesome for the long run future, when there's no actual evidence that's going to be the case. In fact, the history, especially the last dozen years has shown that's never going to be the case.
So, stock prices are essentially divorced from economic fundamentals, which means you're left with trying to define essentially what everybody else thinks about the economic fundamentals or what the Federal Reserve is doing. You're buying stocks based on those perceptions. MAGGIE LAKE: And so, if the stock market tells us nothing, what is the bond market telling you right now? JEFF SNIDER: It says the bond market is telling you that growth and inflation are not happening and moreover, there's great concerns about what actual growth can be any long run potential level. As bad as the 2010s had been in the post crisis era, is it possible that we may be seeing an even lower growth paradigm in the 2020? That's really where the bond market is right now. It's not saying that 2022 is going to be a disaster, there's going to be a collapse, and there's going to be a recession, or even a great recession number two. What we're just trying to parse out is,
once we get past these consumer prices and the damage they're causing to the consumer, the business climate, China, Germany, the global economic situation, what is the long run potential of 2020s, and the bond market is pricing long end potential that is somehow less than it was in the 2010s if you could believe something like that. MAGGIE LAKE: Yeah. Which begs the question from someone yesterday, could bond yields go negative? They still are in some ways. JEFF SNIDER: Absolutely, yeah. Can Treasury yields go negative? And the answer is yes, absolutely. That can be the case. If we do go into a period where the transition between lackluster to unsatisfying 2010s growth to 2020s, which is really bad, or potentially even worse than we're thinking right now, you might see negative yields along the Treasury curve. And I actually think that's a high probability going forward. At some point, we'll probably see
negative yields on the some of the notes, not just bills, but some of the notes as well. MAGGIE LAKE: Have you been surprised at how long this has gone on? Because you always have the people say, well, you see this but if you were sitting in bonds this year, you could be right and lose your shirt or right and be on the wrong side of a trade that even if it's irrational. How do you wrap your head around that? Or how do you stay with your narrative even in the face of the gains that we've seen in equities? JEFF SNIDER: You make yourself irrational too.
As long as you understand what you're doing here, you're not buying stocks, because you believe the economy is improving. You're buying stocks because you believe everybody else believes the economy is improving, that can prove to be an entirely fruitful thing. And there's other places to go as well. Commodities, commodities, even though the economic climate's uncertain and there's questions surrounding demand, there are still tailwinds in terms of supply problems in many commodities out there. You just got to be careful that you find the right ones, because as demand becomes more of a problem like you see in something like iron or steel prices, you could lose your shirt in that too. So,
as long as you understand what it is you're doing, and what the economic climate or the macro background really is, it doesn't mean you have to sit in bonds or sit in cash forever and ever, it just means that you understand the risks that you're taking if you're going to buy stocks, for example, or crypto or something like that. If you really want to be irrational and go out into some of those things, just understand what you're doing, what you're doing is making sure that you're not the greater fool because you realize that in things like stocks, they're pricing essentially a bunch of fantasies. MAGGIE LAKE: And that matter for two things, I would think it matters for your timeframe, your duration, and it matters on how you hedge yourself. JEFF SNIDER: You always got to be hedged. Because as easy as we try to make it sound as sometimes, there are times when it does go against you very quickly, and maybe you don't see it. So, you do have to be careful and not be entirely exposed to the irrationality. You have to understand that irrational behavior
will behave irrationally in both directions. MAGGIE LAKE: So, we have a question from Raphael. In your view, what would make the risk averse behavior of dealers change to provide the elasticity back to the system? Would the acceleration of the 10 Year Treasury be a reliable signpost? JEFF SNIDER: Acceleration in terms of rising nominal yields? I think that's one of them. There's quite a few but just in terms of very simple indications, what we would like to see something like we saw earlier than the year. In January and February and part of March, not only did nominal yields at the long end rise, the yield curve also steepened. That was a very positive signal that the market was saying things look marginally better, dealers were willing to take on a little bit more risk because of the vaccines and end of the pandemic. Maybe the government stimulus might possibly
work this time, low probability, but you never know. So, what we would expect to see is that trend would have continued beyond stopping at about 1.75 on the 10 Year Treasury. And if it does pick up again next year, or even late this year, we see nominal yields rise and the curve steepen, that would be a generally positive and less pessimistic signal that not only is maybe the economic cloud parting, but also in terms of the monetary system itself. That's a signal that maybe the money dealers and the monetary situation is somewhat loosening itself, which would contribute to rising growth potential. MAGGIE LAKE: We have a question from CB. Don't we need the excess reserves in the banking system to get into the real economy to experience true monetary inflation? JEFF SNIDER: That's the thing, they can't. It's bank reserves are stuck where they are.
They're simply an interbank token. And this goes to why most people are confused about the monetary situation because quite understandably, nobody stops and thinks, what is a bank reserve? What is it the Federal Reserve does? And so, when the level of bank reserves go up, it sounds like the Fed has printed a bunch of money but all they've really done is print some limited use interbank tokens. And to actually get money moving and become inflation and growth and acceleration, you would need the banking system to either take account of what's going on with the Federal Reserve, which they won't, but do something it afterwards. So, if the Fed is going to swap an asset in quantitative easing,
where they buy a bond from a commercial bank and give them reserves offsetting it, there's another part of that story, which is the commercial bank then goes into the marketplace and either buys a risky acid or does more likely or more, what we're really want to see is we want them to lend. That's really the purpose of quantitative easing. It's not to create bank reserves, but it's to remove safe assets from commercial banking systems so that they go out do risky things.
But the commercial banking system and going all the way back 20 years in Japan, has been adamant that that's not happening. So, the level of bank reserves is immaterial to the inflationary circumstance, because if commercial banks wanted to engage in risky lending, they would do so regardless of the systemic level of bank reserves. It's all about the commercial banking system. MAGGIE LAKE: And isn't that their
job to lend? Why is that not happening? JEFF SNIDER: Their job is to intermediate, which is essentially to look at the economic climate and say this project's worth funding, this project's not worth funding, what is the risk of doing both of those things? And the problem is the commercial banking system hasn't been doing intermediating in the same way it didn't intermediate very well before the crisis when it just gave credit and money to anybody. So, the banking only swung all the way the other direction. MAGGIE LAKE: Why are they not doing that still? JEFF SNIDER: Part of it is this risk aversion based upon liquidity risk, the idea that the monetary system markets are prone to breaking down which can catch banks in a perilous situation where, for example, if the repo market freezes up, you're out of business. So, you can't engage in expansionary activities when you're worried about the short-term liability side of your balance sheet, you just can't. And that's something the Federal Reserve has never addressed, bank reserves don't fix. Instead, it's all about balance sheet mechanics, and banks are rightfully saying we can't intermediate, because we're so worried we have to hold only safe and liquid assets. Otherwise,
we can get our butts hung out in the sling in a very short period of time, as we see continuously through the years. MAGGIE LAKE: Right, or fail or outright fail, which was unthinkable before we saw what happened with Bear Stearns. JEFF SNIDER: Maggie, exactly. Bear Stearns was the lesson, that was the thing. The Feds thought that was a tremendous success. They thought, well, we shepherded Bear Stearns into the waiting arms
of Bank of America, when the most of the rest of Wall Street said, holy crap, we can actually fail here. If we get wiped out, our jobs are gone. Everything that we built up just disappears. MAGGIE LAKE: Which was unthinkable before that. JEFF SNIDER: Before that, it was, oh, the Fed will just fix everything. And then it was, oh, wait a minute. There is such a downside risk here that it could be the worst case.
MAGGIE LAKE: I think it's almost impossible to underscore that. I remember getting phone calls that-- by the way, fun fact, that was the day that I-- the next day was my first day back from maternity leave. [?] and a newborn and that was my first day back, the day that Bear Stearns declared bankruptcy. But it was the disbelief that this was happening, and it lasted, and then the dominoes that fell with Lehman. It was almost impossible for people to wrap their head around. JEFF SNIDER: Go back to the bond market. I go back to the bond market all the time, because it sends you these signals. Before Bear Stearns ever failed between the onrush of the
crisis in the summer of 2007 and March of 2008, there were three of what I call those landmines, three of them. Three signals that the bond market was sending people to say, number one, subprime wasn't contained. And number two, this wasn't really about subprime mortgages. So, the bond market had told people, if you paid attention to it, the monetary system was telling you things were going the wrong way, not the right way. And by the time Bear Stearns actually ended up nearly failing, it was like, yeah, that makes a lot of sense. MAGGIE LAKE: And so, when I hear all of these things, it keeps leading back to, I just finished having a conversation, an hour-long conversation about the future of finance involving all of these new technologies, blockchain, crypto, defi, and you can understand why people think that when you hear about these intrinsic problems with the existing system, that a new system has to develop to replace that. It's in its infancy, but is that going to
be what has to happen to break us out of this? JEFF SNIDER: Well, I think yeah, absolutely. The current system and its malfunctioning, constant malfunctioning has opened the door for other solutions. They just need to prove themselves, which is a long and involved process. But once they proved themselves, the opportunity is right in front of everybody to essentially create a competing currency system or two, maybe even three from scratch because again, the current system has malfunctioned for all this long period of time creating not just all these economic and financial problems, but social and political problems, confusion, all these other things. So, there's tremendous opportunity. I do believe that digital currencies, decentralized finance and those types of trends and innovations, they're disruptive technologies that will prove to be very fruitful in the future. It's just
that future isn't today, it isn't tomorrow. MAGGIE LAKE: It's not for you today, right? JEFF SNIDER: No, it's going to be a long time. MAGGIE LAKE: It's funny, from your perspective, and to hear how necessary you believe changes and that this is a solution to hear you not in the space, though? JEFF SNIDER: Well, I think that's because there's this disconnect between the prices of various cryptocurrencies and what's actually happening underlying in the technology. There's tremendous value in the technology and the technology, if we break it down into monetary roles, there was three functions of money. There's medium of exchange, store of value and unit of account. And most people are trying to pile into Bitcoin, for example, because they believe they need to store of value to protect themselves from the Federal Reserve printing too much money destroying the dollar and inflation going through the roof.
Well, that's not really the case. And I don't think that's what's really driving the impetus behind the technological and the innovation in the digital space, which is more of the monetary form of medium of exchange. We think about what Ethereum is attempting to do, it's become more of a legitimate currency system that has less to do with store of value than it is a useful way of undertaking commercial transactions, which is what money is supposed to be. So, for me, the current prices in cryptocurrencies may not reflect the current potential of digital currencies, and there may be a huge imbalance there. And there may come a time when that isn't the case, or maybe cryptocurrency prices, current prices of some of these cryptocurrencies adjust lower, where it makes more sense to then invest in some of these really good technologies, even though they're still in their formative stages. MAGGIE LAKE: Do you think that's inevitable? Do you think they have to correct lower to more adequately mirror where the development process is? JEFF SNIDER: Yeah, and I think there's the parable, or the analogy to the dot-com bubble is an apt one, because again, dot-com was a very disruptive technology. Everybody saw the potential in it, but it was very difficult to decide,
what are the winners here? In fact, at the time, it looked like everybody was a winner, when that wasn't really the case. I was just talking to somebody yesterday about pets.com, which had been one of the ones that we laughed about in the immediate aftermath of the dot-com. But it was just 20 years ahead of the curve. What happened to pets.com? They went out of business. The stock went to zero. It's very difficult to stand on the leading edge of a disruptive wave and say, these are the ones that are going to win, because you really have no idea. So,
to answer your question, I think there does need to be another maybe one or two adjustment periods where we see the prices of some of these cryptos go to zero, because they're just not worth the time of day. And there's others that we don't really know ahead of time, but there's others that are maybe going to be a real part of our economic and financial landscape at some point in the future. MAGGIE LAKE: Back to our current future, but it involves what's happening in cryptocurrency, too, I think. I had two conversations last week here on Real Vision, where two separate people talked to me about being really concerned about the amount of leverage in the system. Now, it's a happy community. And I'm not saying that
they don't hear each other, and then out again, talk to someone else unrelated who also said it's crazy. I've never seen it like this. That makes me worried. Are you concerned about the amount of leverage in the system? JEFF SNIDER: Well, there's two parts to that. Leverage, a lot of it, when you talk about it in the aggregate level is about how much debt is there compared to economic growth? So, if economic growth is really weak and bad, then it almost doesn't matter how much more leveraged there is. Any amount of additional leverage is bad, because it doesn't fit the situation. And that's where we are with the current discussion is trying to figure out where that long run potential in economic opportunity growth could be.
And if it's somewhat worse than we thought, then anybody who took on debt over the last years believing in Jay Powell's fantasies and inflation or whatever else, they're in that much of a worse situation, because now they've taken on unproductive debt that's going to be a burden upon the upon their growing concerns as economic growth reveals itself to be much weaker. And so, how widespread is that? Well, it's maybe not as widespread as some people may be thinking. Because the debt curves, the amount of debt in the United States and around the rest of the world, that changed back in 2007 to 2008. So, yes, we're adding more debt. We're adding more debt at a much lower rate but the other side that is we're adding more debt at a much lower rate at the same time the global economy is much, much weaker, too. So, the ratio of leverage to economic growth maybe is more of a potential problem than it is the absolute or nominal level of leverage itself. I think that's really what the main concern should be is that without legitimate economic growth, debt becomes that much more of a burden. MAGGIE LAKE: What about leverage in a
financial market? I think that we see huge moves in these stocks. And I think there's concern that some newer participants in the market may be playing the speculation using margin, using vehicles in the option market that they've never really experienced operating in that market in really turbulent downward moving markets. JEFF SNIDER: Well, every generation believes it solves every problems. We had day traders in the dot- com bubble. And people today think, well, we figured it out, we're not going to end up like they did. And I think you're right, Maggie, that there's a lot of-- especially over the last couple years, when you see the S&P 500, or any stock index for that matter, just go up at a 45-degree angle in a very low volatile, very narrow range always up until the right. There's this sense that it's invulnerable. And then when you think that it's invulnerable,
you act as if it's invulnerable when reality shows at some point, there is vulnerabilities in that way of doing things, and it has the potential to become self-perpetuating. But I think the bigger problem is why these indices continue to go up into the right, every chart is the same. And it's almost a straight line, because a lot of it is based on passive investing, where everybody just buys the same things, regardless of any fundamental properties. We just buy index funds,
because everybody buys index funds. And the more everybody buys index funds, the more those indexes go up, which just entices everybody else to buy the same index funds. And that's really, I think the larger problem here is that again, there's no real fundamental anchor to stock prices, they just go up because they go up. MAGGIE LAKE: Yeah. We have a question from
Raphael, if we can't depend on private monetary elasticity anymore, and public monetary elasticity only has marginal effects, are economic growth prospects doomed until there's a rupture in the current monetary system? JEFF SNIDER: It depends on what you mean by doom. Doom is a spectrum, it's a pretty wide spectrum. Usually, when you get into those kinds of conversations, a lot of people think you're talking about, oh, the system's going to crash tomorrow. And that's really not what we're talking about. And this is where it's sorted as it is, this is where the Japan example comes into it. Because this can go on for a very, very long time. As frightening, as awful as that sounds, that is actually a possibility. And we're already--
it's 2021, heading into 2022, we're talking about a monetary breakdown that happened in August 9th of 2007. So, we're nearing 13 and a half years of the same situation and thinking, and every time we think, oh, it can't go any further and then another year. So, doom is-- MAGGIE LAKE: It's perhaps when you don't address the real underlying problems, right? JEFF SNIDER: Yeah, we're stuck in a rut. And nobody knows how to get out of it,
because everybody thinks we're full of liquidity. And that's not a problem. And so, nobody's looking at the monetary system. Everybody thinks the Fed's got it. And the Fed's done too much. Haven't you seen the CPI? MAGGIE LAKE: Yeah. Which is certainly the case. So, Jeff, in this environment, I want to circle back to what you were talking about before, like, listen, you just don't have to sit in bonds. Given the outlook that you have right now, and the timing is uncertain, but you see deflation as a threat, you see the economy slowing, it's just a matter of how much. What is the best investment strategy in this environment? What do you want to own? JEFF SNIDER: You want to be rational.
Going back to what we just said, we're understanding that we're in a period of higher rationality, and that we should transition to more rational, you want to become more defensive. Now the problem becoming more defensive and that can mean various things to various people, as you want to pay more attent
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