China’s Real Estate Poses Risk to the World

China’s Real Estate Poses Risk to the World

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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,   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 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

2022-01-23 07:16

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