Viktor Shvets on Why We Might Be Heading for a Deflationary Bust

for markets. But even without that, you were sort of at this inflection point where central banks were just beginning to respond to inflation risks, and there's this question of how much of an impact that's actually going to have on risk assets. Yeah, that's exactly right, and I think it's kind of been a confusing couple of leaks in terms of understanding both the plan from central banks and of course primarily we're talking about the FED and the

market response to them. Because we did have, uh, the start of a eight hiking cycle basis point, many more hikes expected, We've you know, the immediate market reaction which this rally, and so there's questions which was not necessarily expected, And the question as well, is this the market doesn't

think the Fed is going to go that hard? I didn't think the FED isn't gonna need to go that hard or is a market going to be surprised that the FED really is going to do what it says and maybe we're gonna get multiple fifty basic point hikes, lots of confusion the start of the raid high cycle.

Isn't that really created any certainty about what's next? No, And we actually had to have Jerome Pale, the FED chair, come back on and just emphasized that they were actually going to hike UM at a potentially significant rate, and then we saw the market reaction. But I mean, even beyond the US, there's been a lot of uncertainty and just looking at China at the moment, we've had, you know,

a big sell off in China tech stocks. Yet again at the same time that there was this expectation that they were going to be easing even more, and then we saw them crack down further on the tech space and then they seem to walk part of it back UM. So this is another open question mark over what exactly China's Central Bank is doing here. They seem to be you know, taking two steps forward and then one step back and trying to calibrate everything and it's I feel

like it's just confusing the market at the moment. Everything the real estate in China of core is a huge, huge deal energy so much. Yeah, Okay, Well, on that note, on the note of uncertainty, we are going to be bringing on one of our favorite guests. We're going to be speaking with Victor Schwetz about well everything really, what central banks are doing, the situation in Russia, what's going on in China. He's going to try to bring it all together. Victor Schutz is, of course, the head of

Global and Asia Pacific Strategy at McQuary Capital. So Victor, thank you so much for coming back on the show. Thank you for having me. I feel like one of the things that happens when we are in times of uncertainty is everyone starts reaching for a historic parallel and then they try to fit that on what's happening now.

And there's never a perfect one, but it does feel like the one that's emerged as consensus most recently is the idea of going back to the nineteen seventies era of high inflation, some sort of commodities shock that then feeds into the broader economy. Is that the right way of framing things. As you correctly said, no historical parallel is perfect. If you think of nineteen seventies, we today

live in a very different world. Labor market in the structure of labor market is massively different than what it used to be. Our financial leverage, addiction to a surprises is radically different to what it used to be. If you sink up technological innovation, we really live in the world where technologies everything. When people say tech, I basically say what do you mean by tech? Everything is tax these days, whereas ninety in seventies and sixties, we are

much more about inventiveness rather than innovation. We have a very different demographics, We have very different income and wealth. Inequalities were closer to nineteen ten nineteen twenties Gilded Age than we are to nineteen seventies. So there is no perfect parallels, UH that we preferred to look at. It is to say there were three big shocks to the system.

One was in early nineteen twenties, the other one was between nineteen forty five eight UH, and the third one is is that was clearly nineteen seventies, and what we're going through just another one of those cycles. Each one of those episodes have something to teach us, and so to me just looking at nineteen seventies sort of ignoring the lessons of some of the prior periods. For example, clearly there was a massive spike of inflation around nineteen

nineteen nineteen twenty one. That was the end of the Spanish flu or process of Spanish flu as well as the end of the Great War Great War, which is World War One. What you had then is a significant tightening of monitor and fiscal policy occurred, and one that occurred in nineteen twenty two. There was a massive deflation repost cp I was negative more than twenty before it finally stabilized in nineteen twenty three. If you think of nineteen forties again, that was the back end of World

War two. We had a significant inflationary spiked early on, but monetary policy remained incredibly loose that they didn't really tighten at all. Uh And what was happening through the back end of nineteen forties, inflation just worked this way out of the system and the only time it picked up again was the nineteen fifty one in the lead up to the Korean War. But then it stabilized for

almost two decades after that point. So the question is when you look at all of those periods, what they're telling us is that, you know, premature tightening is not necessarily a good, saying are waiting too long is not necessarily good, saying just using fiscal policy might or might not be the right thing. That every one of those episodes is different. And I think what you need to look at today and say and ask why are central banks tightening? Well, because there is inflation, Okay, why do

we have inflation? Why we did not have inflation in December two thousand nineteen before COVID, Why we were not running out of people in December two thousand nineteen, and why we're running out of people today? Well, the answer is it's not the month. The month globally is only slightly higher than it was prior to one set of COVID. I mean, there are some exceptions, uss further advanced on the countries and less, but globally it's not that much higher.

So it's not so much demand. What clearly happened is a demand shifted aestimily two goods against services. What we had is a massive disruption of supply chains. What we had as massive shocks to the system. But theoretically all of that prior to Russia's invasion of Ukraine started to normalize. If you think of most supply indicators and the value chain indicators that they really distressed. Maximum stress was about

September October one. After that it was all easy back. Um. And so if you think of why titan today, why do we have a problem today, Well, because we're disrupted. We disrupted labor market with disrupted supply chains, we disruptive products, We disrupted everything. And so the result is there as massive shortages suddenly emerging that do you just leave it

to work? It? So it's ways through the system. Because what we're seeing today already is that fiscal pulses massively negative global We're taking out amongst G five economies about three trillion dollars. Monetary pulse is becoming negative to we're taking out more and we will take an even more as we go forward. Uh. The result is that leading indicators are already weakening, reflation and cyclicality weakening. The system

is already adjusted, and as it continues to adjust. Why why do you want to necessarily quote twenty two time deflationary bust by tightening interface of already declining pressures. Now you could argue, of course, you could argue, of course, lets look Russia Ukraine upended all of this and we suddenly have another shot. Absolutely, but monetary policy is not the best tool to use when you have a supply chain problems or or a geopolitical problem. So it's interesting.

So I mean, god, I have like a million questions after that, and that was like a sort of fantastic overview, But I just wanna hone in on something very specific. I'm surprised is there for all of the talk about inflation in the wake or really with an ongoing pandemic, that I hadn't heard more about the inflation in the wake of the Spanish flu, because you think, well, if we're looking for historical analogies of pandemic and subsequent inflation, would be a pretty good place to start. And yet

you don't really hear many people go there. Can you just talk to us a little bit more about that inflationary boom? Then? But what was the catalyst for that inflation and how long did it last? And then of course you mentioned the tightening and turn into a bus, but give a little bit more color on what happened then, Yeah, sure, essentially that the think to remember in nineteen thirteen nineteen fourteen, the world was incredibly globalized UM. And in fact, globalization

of nineteen fourteen was thought again replicated until nineteen nine. Uh. And so there was a lot of books written back in nineteen of five, nineteen nine, nineteen basically saying there's a lot of job political pressures, but the war is inconceivable because we're so interconnected on a global basis. Plus our weaponryes are so dangerous and so deadly that you just can't have a war. And of course you did.

And so one of the things that happened in the wake of global war of World War one is that all the supply and value chains were disrupted, all the things we're seeing today. Through the war, there was a lot of distruction of physical capacity occurring, uh and so and so there were shortages in ability to supply goods UH was very pronounced towards the back end of World War One. The other thing you had, you had a

disruption of the labor market. Not as extensive. I mean, Spanish flu was much more deadly, uh, primarily because our medicine and science just progressed so much over the last you know, seventy eighty years. It was much more deadly, but in some ways it was a little bit less disruptive to the labor force because people just moved on

with it. Uh uh And but nevertheless, there was a disruption of Spanish flu occurring at the same time, and so there was a very significant spike in inflation rates because of a global disruption, because of destruction of capacity on the global basis, because of the Spanish flu uh. And So what happened is that the Federal Reserve of

New York massively raised the discount rates um. And as they raised discount rates and a fiscal policy were brought back into under control, in other deficits were reduced, you ended up with a significant past. Now, this episode was described by Milton Friedman and many others, and the view was that if perhaps Federal Reserve of New York acted earlier rather than waiting for inflation to persist, maybe they

wouldn't have had to tighten as much. So there was there is a debate clearly going on what you should have done. But the net outcome was more than twenty deflation uh in twenty two. But nineteen twenties three, it's stabilized, and in fact the climate was slightly inflationary and or slightly decent inflationary all the way to the crash of

nineteen um and so and so that's an example. This is the example of the government or the public instrumentalities either waiting too long to add and or acting too much and causing significant economic and a surprise destruction. Now in nineteen forties, on the other hands, remember the interest rates were fixed by then, and so there was no change in real interest rates, no change in the discount rate. Uh,

fiscal deficits have come down, but only gradually. The government was prepared to spend money to either construction or restructuring of the industries from wartime to peace time, and so the result was a very strong inflationary spike in night was basically out of the system by the time you get to around nineteen nine, and only spiked again at the onset of Korean law. But then after it basically stabilized.

So that's a result basically telling you that we've made a decision back then that we're going to have inflationary spike and we're going to work its way out of the system rather than fight it. Whereas in nineteen twenties decision was made that fiscal policy needs to be brought under control and monitory policy was significantly tightened. Now, if you think of today's experience, what we actually have decided in twenty is that we are we would like to

have inflationary spike rather than deflationary bust. Remember when the onset of COVID started, banks were making huge provisions. And the reason that we're making provisions that we're expecting a deflationary bust. But it did not happen. And the reason, of course we know it didn't happen is because fiscal authorities and monitor resource is all step up and propped up demand. That's a cause for all the problems we're experiencing today. So in other words, we propped up the demand,

demop shifted the goods against services. Suddenly we have shortages, Suddenly we have inflationary spikes. And so the question now is it's all working its way out of the systems. Logistics is getting better. Certainly prior to Rush it was getting better. Supply times we're getting better. Should we just let it through because we already have economic activities slowing down. Most leading indicators are slowing down. Global money supply is

now only growing at three. Global credit is improving somewhat, but on the momentum it was negative for at least the last eight or nine months. And the global credit is only growing at about three. We're already taking out a lot of fiscal stimuli out of the system as well. Should we just let it run off and do very little to sort of to aggravate that situation? Russia Ukraine of course made a massive difference now. Uh and so.

But but as I said earlier on um sins like geopolitics or healthcare crisis, is uh, they are their fat tales. They can never be estimated, they can never be predicted. Uh. And and the monetary policy has said is not necessarily the best. Not necessarily it's not the best, though it's not it shouldn't be the tool that actually addresses either of those things. When you look at the yield curve

right now, it's clearly pricing in recession. But there is this big debate going on about how much informational value is actually embedded in the yield curve, given you know how much of the treasury market is locked up by the FED or in bank balance sheets and things like that nowadays. But clearly, just looking at the yield curve, you would think that the market sees some sort of

policy error on the horizon. You know, rates rise too much, uh, and eventually we end up hitting economic growth in order to bring down inflation. Yes, that's exactly what the yields coasts are telling you. And when people say, look, let's look at the short end or the long end, that's

that's that's incorrect. You should always look at the long end because that's where businesses the banks are expressing their views as to the trajectory of growth, as the trajectory of inflation rates, what the equity permeerates they should have in order to finance the balance sheds in order to carry on with their business. And what Clearly, whether you look at two by ten, whether you look at five by five, well, whatever you look at, there is this

incredible flattening occurring. In most cases, you only have twenty bibbs left. In some parts of the curve you already inverted. And so it's federal reserve and no central banks can leave you'l curve inverted for any length of time because basically, as you correctly said, what it basically the message it can baste to the marketplace is that credit conditions are

going to be too tight. Uh. And therefore interest rates ultimately will have to be at a much lower level, and that impedes economic activity as you as you go forward. So they can't just left it live it unattended, so to speak. And so the market is basically saying policy error is in the making. It will bring down massively economic growth rates. We might end up with recession, we might end up with a sequence of heart attacks potentially, but ultimately the inflation will get out of the system

through our substantially reducing the demank. That's what the market is saying. But on the other hand, as you correctly said, informational value of youl curve has significantly eroded. The webb seply compared is to say, you know, private sector, the musician in the in the orchestra pit, uh, and the central banks are conductors in the past that we're happy just to conduct, but now they could often jump in the pit and start playing instruments as well as conducting,

and so they do votes. Uh. And so whenever you have central banks starting to land to the main street, or buying collateral that they should never be buying, or breaching rules on state state financing, or having emergency reap A lines just because reaper market is the functioning properly, will just have a massive line out there to make

it work properly the way we think it should be working. Uh. And so whenever you have that, now the question is how much informational value do you have when the market is so distorted. And that's part of the reason why I think term premium just disappeared. Even today it's negative, you knows, which normally it should be more like a

hundred and fifty hundred and sixty bits. So as a result of term premium being so low, it's easy to invert, but it conveys less information to the marketplace as to what the real economy rather than financial economy, is doing. And the other thing I think it's important to highlight whenever you read I don't know all the all the all the important people, or you know Blanchard or Muhammadalarian or or Summers, they're all focusing on a real economy.

It's all about labor markets, it's all about capacity constraints. Very little is discussed about financial economy. It is regarded as somewhat the redistribution mechanism, it is not really a creative of anything. But we know that is not true. And a financial economy is at least five six times larger than the real economy and it has can really

crush real economy if it comes to it. So one thing with it is missing, And the discussion is asset prices and the impact of volatility of surprises will have on underlying economic activities. Said, we all talk about wages, we'll talk about wages per hour, we all talk about the capacity constraints ships trended in Los Angeles Harbor, but we're not talking about asset prices. And if we cause significant volatility of a surprises, what does it do to

gross what does it do inflation? And the answer it actually crushes acrosses both of them. So I wanna drill into this further. And I should note for listeners were recording this March twenty three, so who knows will happen in the next few days while people hear this, but before people hear this, But I doubt that this volatility will have gone down so much. The counter argument, I guess to what you're saying is that you know, there's so much real demand that's been put in the pocket

of um. Uh sort of. I'm thinking back to, say, a conversation that we had with Jeff Curry about what's drives what drives commodity inflation, and the idea of purchasing power being put into lower income households is incredibly powerful. It results in more goods purchases, or results in more

commodity intensive demand and so forth. And so the argument that everyone should focus on the real economy is in part driven by the sort of fact that lots of people have lots of real buying power and their buying stuff and that's what's causing the jam at the ports and so forth. And Uh. The counter argument is that, well, yes, uh, rich people control a lot of the world's financial wealth, but not you know, really from a demand perspective, it's

not as significant. Talk us through a little bit more. Why you see in this environment, uh, financial asset volatility, which we've particularly seen in the bond market lately, how that feeds through to potential bust, potential recession, potential disinflation. Well, if you sink all and your specific we're thinking of the United States, because other other markets don't have quite

the same dynamics. But if you think of the United States, the top ten percent of households control roughly of that assets. Bottom households control absolute and own absolutely nothing on the net basis. UH. And so the whole idea is that the assets side of the balance ship is as our

top ten percent of the households they control assets. The liability side of the balance is a bottom fifty, right, and those bottom must be encouraged to consume and to borrow because if they don't, then the value of the top ten percent of the of the households will come down.

In other asset values will come down. But what we have seen through the COVID and what we have seen through every one of the episodes over the last twenty or thirty years, UH that the well screenation of the top ten just keeps on accelerating and keeps on accelerating, and that means the top ten percent getting more and more wealthy. That's your wealth inequality argument. And it's like, it's not just top ten percent. You have to remember

top one controls about that wealth. So it's even more than just top ten it's more like top one uh and and so as the result is that they're accumulating more and more and more assets. They're accumulating assets at a faster pace that they can consume or at a faster pace that they will get provide for the retirement, for example. And as it continue to create this extra access wells that needs to be deployed somewhere and wayas

doesn't get deployed. Well either get deployed in the Ferrari cars, you know, Hampton mentions, you know, Picasso painting and the rest of it. Maybe super jots and things like that, but mostly it gets distributed back to the bottom. To contin you need to encourage them to consume. Now because you're generating more and more wells, interest rates have to be lower and lawer, right, because you're generating more wells than you need, and you need to transfer that well

els to the bottom. And the bottom is already barely keeping up with commitments, which means the cost of money has to continue to fall if you were to encourage those bottom fift to continue to consume. And so the problem becomes if the bottom cannot consume, and or if you slow down the well's accumulation at the top of the pyramid, then the cost of money will go up right because you don't have as much access capital to relocate to the bottom. And as it goes up, consumption

at the bottom goes down even more. Uh And So the way I look at it, the role and function of Federal Reserve is to be an intermediary between the top one and the bottom six, or call the top ten percent and the bottom six to it, they're the conductor of the orchestra which they have to make sure that the two sides of the balance, all of the assets belong to the top one of ten percent, all of the liabilities belong to the bottom fifty or six, that those two are in unison, that those two are

in in in relative harmony. Uh And and that's not an easy task. Now, one way of getting rid of this system is to say, let's just get rid of monetary system as we know it. In other words, we live in the world which is highly financialized, highly leverage. We're all dependent on asset prices. Is a queue for our decisions whether to spend or the safe, whether to invest or to share buy backs, or what sort of see your compensation you're going to do whatever, let's break

that system and let's create a different system. Well, it's fair enough, but how do you break it without causing massive latility and massive collapses of esset prices in the meantime? Goues What what people will find if you create too much volatility? You know, for one case, are not going to be worse what you think they are. Pensions are not going to be worse what they think you are. Real estate prices won't be the same as what they're today.

So when people are discussing that we should junk this monetary system that we have built since nine eighties and replace it with another system, I I basically say, good luck. I agree we should. We should have done it twenty years ago, thirty years ago. Okay, good luck. How are you going to do it? How are you going to go from point eight to point B? Clearly the answer is fiscal policy. That's how you go from point eight to point B. But fiscal policy is much more inflationary,

uh than a monetary policy. Monetary policy is basically disinflation, but fiscal policy is inflationary because it takes the money from the cloud of finance and puts it down to the ground where real people live. Uh, and so as you create inflation, um, you're destabilizing your monetary system before you actually building a new system. So how do you make this transition? And so nobody in my viewer knows

how to do it. We all sort of understand that it has to change over time, but most of the thinking, most of the advice is still very very conventional, still treating financial markets as an afterthought, still treating as serprises as an afterthought. It's all redistribution. If one got well, said,

the other one got poorer. How you have a transfer wells, it's it's not treated as part of the system itself and a critical part of the system, given that it is five six times larger then the underlying economies are. So that's that's that's the answer. In the short term, You're absolutely right, you put more people into into poorer people's hand. They consume it. That's why you have increased

in demand. That's absolutely correct. But they forget the other side of the bell where belong those sets belong in the top one percent of the households. Um I wondered if we could shift focused slightly and maybe talk about what's been going on in China. Because there have been a lot of headlines coming out of that specific market, but they've also been overshadowed a little bit by events

in Europe. So we've seen a big route in China equities, tech stocks, and real estate stocks, and then it seemed like the authorities came out and seemed to suggest, Okay, maybe we went a little bit too far, maybe we're going to start rolling back some of these various crackdowns that have really hit those two industries. I believe you were fairly bullish on Chinese equities. UM, certainly for and

maybe going into two. But just talk to us about how you're thinking about that market at the moment and whether or not the Central Bank seems to be um correcting its path. Yeah, you're absolutely right going into twenty two. UM. I was bullish on Chinese equities for a couple of reasons. First of all, remember China is the only major economy on the other side of the title everybody is starting.

China is the only one which is completely contracyclical. Uh, China already was contracyclical over the last eighteen months when everybody was flushing but was money. China actually was contracted and for the next twelve eighteen months. It looks like China again will be contracyclical and being on the other side of tightening trade has a great deal of value

for investors. Not only gives you more inflation growth in China, but it also assumes at least that a reman be probably don't balance ought to be weaker as China liquefies and the rest of the world titans. Uh. The other argument that I had was all to do with political, geopolitical and regular repressures. That whether it's Olympic Games, whether it's a party events, all the way through November twenty two, that China will try to don't play some of those challenges,

whether it's political or regulatory. In other words, it's not going to be of primary importance. Now, don't get me wrong, China will not change its political system, it's political views, or its regulatory views. One uh, there will be no change. It's irreversible trend. But at least for a period of six or twelve months, I felt that the degree of

pressure that China will be under will diminish. And the third reason, of course was China was a horrible performer through one and earlier part of twenty two, and I was assuming that at least some of that can be can be reclaimed. So if you think of it right now, it's been a wrong call because China and the performed so far, Asia, Japan as well as as well as a bergeant market universe by an the eight or nine percent, that's say, they got to perform by last year. So

clearly it was the wrong call. Uh. And there are a couple of reasons for that. Reasonable one is what you've alluded to. Uh. The Chinese policymakers are really calibrating this idea that they're going to do the same thing is what they've done the last three times is well and truly debt. They don't want to add another ten or fifteen trillion dollars of debt, although they don't mind a little bit more leveraging. They don't want infrastructure investment

to be galloping again. They don't want another massive bubble in real estate, and so they are trying to calibrate, trying to give you enough stimulus in order to achieve reduced gross expectations without complicating longer term picture. And so the result is you actually have less differentiation. I guess between tightening and easing countries. And so this argument that you on the other side of the trade so far has been as strong as I thought it might be.

The second area, of course, is politics, your politics, and and the and the regulatory drive. UM. To me, China has no choice but to support Russia, UH, and and and and and the reason for that is very simple. It's nothing to do with the economics, it's nothing to do with markets, and it's everything to do with the fact that Russia, China, some other places like Iran, Central Asia, they look at the world in a similar way. In other words, their view is the status dominant debut is

its interests of society and community trump interests of individuals. UH. They have their own view what international rules should be, whether it's rules or for the trade, including how you treat state or enterprises. UM. Absolute sovereignty sort of harping back to eighteenth century and part of the nineteenth century where there was absolute sovereignty. Nation is entitled to do

whatever they want within their own borders. So whether it's internet and valcanization of internet, whether it's a rule of the state, whether it's a rule of state, US as private sector a boss Russia China believe that private sector is subordinate to the state and should be largely doing what the states sink they should be doing. China clearly is not Russia. It gives a lot more freedom to private sector. It's much more universal. So it's not the same,

but the basic concepts are the same. And so what we're seeing is this massive illiberal Eurasian bloc forming led by China, what I called Sinus sphere. But within that will be nassault smaller you know, Russian Empire ing the

empire Central Asia and many other parts. And to me, the objective of redefining global rules ready mining global behavior to be much more in line with the way countries like China think about the world is far more important than any particularly given trade relationship or a slight diminution of our GDP numbers. So the Russian invasion of Ukraine UH did not come at the good time for for China,

and I'm sure China would rather not have that. But at the end of the day, at the end of the day, China has to be on on on on. They can't be completely neutral in this because as I said, they do look at world very similar way. The way places like Russia around look look at the world, and the same applies to regulatory issues because it goes down to the concept of a separation of state enterprises and

state itself versus private enterprises. What we have seen since two thousand and twelve is increasing fusion between the two. Prior to two thousand and twelve, you actually have separation, and in many ways state enterprises were encouraged to behave more like private enterprises. Since two thousand and twelve there was a very strong link towards a few fusion of the two. So the space separating state and non state private public has been diminishing for more than more than

a decade. And so when people say, hey, we're finishing with a regulatory aspect, no we're not. Uh. You can ease back a little bit tactically, but the basic strategic thrust of lack of separation between the two is something that is going to stay with us. UM And I was surprised a little bit that actually continued as aggressively as it did over the last over the last six months, UM.

And so so to me, when I look at China, UH, people want an investors want to have a bit of ray of sunshine and any any any idea or any concept that somehow rush in Ukraine might be winding down in some form, any view that perhaps regulatory precious will get a little bit less, perhaps you're going to get a little bit more stimulatory action. As we progressed through the balance of the year. Still should be enough which

I need is equity still off performed EMOJIU marks. But as I said in an earlier part of the year, that coal was wrong because basic ingredients that I was hoping I'm going to play through that didn't quite get that. I wanna expand further on this idea as you put

in a sort of Eurasian illiberal coalition or block. And one of the things that's been striking, of course with Russia is beyond just the formal sanctions, the degree to which US companies are inner European companies as well as will have just sort of abandoned Russia, abandoned operations, in many cases severed ties with the local unit of the business. And I'm curious that you know what is if these blocks harden, these relationships hardened, what does that mean for

the US China economic relationship? And could there be a slower version of that same process in play by which you know, if there is this separation, if there is two internets, if there is this sort of dramatically different regulatory environment, there will we see this sort of some sort of break with the companies that have trade and links in both countries. Yes, you will. I I prefer to call it a slow moving train wreck. Uh So Russia was an immediate implosion, a very very fast implosion.

China is not Russia. China is critical to every supply and value chain. China as wasn't temper cent of the global economy, it's not less a two percent of global economy. So the things that could be done to Russia can never be done to China because the blowback to the Western economies and the Western societies will be just enormous.

But what you're going to get, I believe as we continue forward, as the blocks hottened, sort of the anglist here, the U twenty seven, the signus feel Liberal duration block. As it haddens, you will find more and more separation. It usually starts with the software areas and more high

tech areas. So for example, transfer knowledge, transfer technology, educational institution ability to acquire skills, uh, it progresses onto some more humanitarian pockets um, and then it progresses onto sanctions against certain individuals, it progresses to inability to access capital um and so so to me, that's an inevitable progression.

Access to capital will be a privilege, not a free market opportunity the way it has been over the last three to four decades, but then gradual level creeping up into other relationships as well as we progress foward. Again, I want to highlight that China is not Russia uh and and this disconnect or ability to quarantine the country of the size and important of China is just not on nobody will ever contemplated, but gradually, bit by bit over a long period of time, that's going to be

the answer. And so the question that becomes from an asset perspective or investor perspective, is China investable? Is a portfolio manageable? Because if we continue on this pass, which looks likely we will, then from international investors opportunity to invest in China and Chinese equities will become more constrained. Now, that doesn't preclude private equity participating in various ventures. It

doesn't preclude companies investing into some plants, for example. But whether your private equity, whether you are company, or whether your portfolio manager, you'll be second guessing yourself. You'll be saying, should I do this? Well, I wake up on Monday morning and finding financial times and done something I shouldn't have done. Uh. And and whenever people start the second guests themselves, so to speak, they are slower. Uh, they will be a little bit less committed. And I think

that's what you're going to see. You're gonna see a little bit less commitment, slower responses, more desired to look again and double check yourself whether you, in fact are doing the right thing. And it does wouldn't just apply to portfolio managers. It will apply to their trustees. It will apply to management teams that are running uh those funds. Uh. And so I think you're absolutely right. That's that's what

the final trajector would look like. Doesn't mean that there is no capital in China or China will be stopped of capital. That's not the case. China has no shortage of capital. China needs expertise, um and knowledge rather than capital. So it doesn't mean necessarily disaster for China or a uration block or sinus sphere block, whatever you call it,

it doesn't mean that at all. It's just it will be functioning by different rules, it will have different systems, it will have different rule of the state and private sectors. It will just be different. But it doesn't mean necessarily a disaster. So, given all this uncertainty that you've laid out, what are you actually recommending people buy at the moment? Because I feel like we often have these macro conversations and you know, it's like, here's a risk, here's another risk.

Bonds clearly aren't good bet if rates are going to go up significantly. But on the other hand, you probably don't want to own stocks if you think that rates are going to go up and then lead to some sort of recession. It feels very very hard to advise people on what exactly to buy in the current environment.

It is it is, and that's one of the problems was not having a normal distribution of events people are functioning, and corporate finance and investment theory functioning on the normal distribution. In other words, you can anticipate, you can predict certain outcomes, you can estimate what the impact that those outcomes will be, and so it is no longer normal distribution. UH. Those events cannot be predicted. Those events cannot be estimated. UH,

and enhance As a portfolio manager, You're lost. Whatever bet you're making, it's just a bet. It's a gamble. It's not really an investable proposition. Now you might take a view that commodities is a way to go forward, absolutely fine, but more likely than not that actually over the longer term might turn out to be wrong unless you're in the right commodities. People will say, should I go into

high asset, low return invested capital type company as well? Yes, maybe, but it depends what's going to happen, depends what is the role of the state going to be, What is the roll of fiscal policies are going to be the same applies to the bond market. The same way as we're worried about inflation, the same inflation could collapse very quickly as we go into twenty twenties three. Remember inflation is a delta, uh and others. All the prices have

to be higher in UH. You know March April twenties three compared to March April two to give you a positive read on inflation. UH. And it is quite possible that the markets are right that by twenty twenty four you're going to have at least three or four interest rate cuts occurring rather than tightening of monetary policy. It is also possible that fiscal policy will go back into

becoming a player after contracting for eighteen months. So all of this could change very quickly, and therefore ten year bonds could end up back at one one and a half percent easily rather than just marching onto two and a half three percent. Uh So, to me, in all the sea of confusion, and we haven't even talked about whether it's a healthcare emergency, so whether it's pandemics, or whether it's your political events, we haven't even talked about that.

So in that sort of sea of confusion, to me, just identifying what are the right circular drivers, What is changing, what isn't changing, Well, financialization is not changing. Remember, but the only reason US has an opportunity to raise money or race cost of capital is because the policy rates today in the US are below neutral rates. Neutral rates in US are roughly around zero in real terms that

means about two percent and nominal terms. But if you think of Eurozone, in Japan, their policy rates are in line, if not even higher that their neutral rates, so they can't really tighten. Uh, And so US has an opportunity to tighten. But as they tighten and get closer to our start or a neutral rate, what's going to happen. Molatility of enterprise increase. So financialization is unstoppable because as soon as molatility of enterprises goes up, central banks have

to back off. And this idea that we need to generate more money and more liquidity than underlying economy is required cannot be reversed. So that's a given. The other thing is given is technology will continue progressing. Right now, we have shortages here and there, but at the end of the day, technology will continu your reducing marginal pricing power of both capital marginal pricing power products corporates as well as as well as labor. That should be that

should be given. And the third thing that should be given is that geopolitical, social and political pressures will continue boiling over. It might get much tougher actually as we go over the next over the next five to ten years. So none of that stuff is actually changing. So if it is not changing, what do you want to buy? Well, you want to buy commodities that are actually replacing today's world and building the new world. That's your copper, your nickel,

your aluminum, you're lythium, your rearse, your semiconductors. What else do you want to do well? Capital goods companies that actually will be rebuilding where I was destroyed, plus building the new the new era. What else do you want to do well? The new startups that will be operating new world, whether it's alternative transportation platforms, energy platforms, whether it's a fusion of infat tact and by attack all of that staff. Plus in addition to that, some software

and select digital companies. You want to have, not all of them, but you want to have some of that. You want to look at any company in any sector that has not just pricing power, but ability to do things differently, whether their products are marketing, the way they use technology and therefore their productivity growth rates are faster so to meet the in the in the sea of confusion, the only thing is certain is that go with a

circular strengths and go with the productivity drivers. In other words, those guys who consistently deliver access our productivity, circular strength, productivity drivers. To me, that's an easiest way to sort of conceptualize it in the short term. However, Yeah, you're absolutely right energy. If you take out energy, global markets would not have performed. Uh. And if you were an energy you're up to against any index. If you have a mix of energy and financials, you would have been

up at least ten. If you are somebody like Cassi would have ARC, which is completely on the opposite side, you would have been down twenty five gains the indexes. So somewhere in between those extreme outcomes to me is the sort of the essence of resilient portfolio. Do you really want to pluck more on energy at the current prices or do you really want to completely double down and triple up so to speak, on on on extreme

startups or profitable tech companies. Uh. The answer to me, both of those answers are wrong because both of them will lead to very high crystallized flatility. And somewhere between

those outcomes I think lies sort of resilient performance. I just want to go back real quickly just to this idea of as you put it, prior to the invasion of your craned are already indicators of normalization and it's really not clear how much aggressive easing is needed, especially in light of the massive amount of fiscal that's being taken out of the system. What is the worry? And you know we talked about the deflationary bust after the inflation of the Spanish flu. How do you see a

potential policy mistake playing out right now? Well, the the only number sort of to look at Israeli financial conditions. Different countries call it different the names. Some call it stress conditions, some call it some other names, but essentially all of them are the same, all of them taken

to count. Variety of spreads are like high yield spreads and a variety of volatilities in various markets in order to define how how easy or tight financial conditions on what you have seen so far in the last sort of six weeks seven weeks is a fairly dramatic tightening occurring in Eurozone as well as in Egic market. But in the U s. Typing star far has been less pronounced. And the reason for that is that, as I said, the our star in the US is above the policy rids.

So you still stimilitary, you still have the capacity to come to come up. The question is half far can you come? How close can you come to our star? Can you go above our star and actually become contraction? To me, the answer is you can't go above that. But as you go closing closer, volatility of esset prices increases. Now, remember theoretically our star is zero in real, which is say two nominal, So there is a room for fifty BIPs,

maybe another twenty five, maybe a little bit more. But as you go up and get closer and closer to our star, volatility of enterprises will six potentially significantly increased. When that happens, it flows straight through into financial conditions indexes. And that's a cute four central banks to pull back, they have no true is spot to pull back very quickly. Uh and and so I I, as you know, I I I tended to believe that twenty two will be

the year of removal of fiscal and monetary supports. Twenty twenty four will be the years of putting it back off, uh and and so and so I still maintain that that's probably will be the right answer, and the que will be financial condition indexes. If you want to look at specific areas, of course, you can look at the high yiel spreads. You can look at the plumbing of the banking system. There are specific indicators you can look at it, but all of that is kind of conceptualized

into financial condition indoors. Now you can also argue that we talked about the yield curve, the more it inverts, the more federal reserve. We need to consider operation twist, or in other words, some degree of yield curve control. That's something that might be part of the discussion and debate as we go towards the end of twenty two. All right, well, Victor, we're gonna have to leave it there, but thank you so much for coming back on the show.

Thank you. I'd really appreciate it. So, Joe, it's always great hearing from Victor, and he has this uncanny knack of bringing everything together under one sort of giant macro umbrella. But I thought what he was saying about the parallel to the post Spanish flu era was really interesting. And also to get back to this idea of, you know, we can have an inflationary spike, but that can easily tip over into deflation. This idea of it's not necessarily that prices are just going up and up and up

right now. It's actually that they're really volatile and it's hard to measure. And what that means is that it's really difficult to get a handle on real demand versus sort of fake stockpiling. To Matt, yes, absolutely, and you know something that he touched on, and I've been writing a little bit about this, and you know, even Powell

talked about it in his two recent appearances. Whatever you say about the two word transitory, transitory, some of the current inflation is still likely the result of it, even

though no one uses that word. And there's been major disruptions, and uh, there's the shift in consumption from services to goods and all these sort of unusual things, and the trillions of dollars that spent which is not going to be spent in two there is physical tightening and so I do you know, no one talks about the user of the word transitory, but that is still an element.

And if it's significant, and if we were going to see some sort of normalization naturally, plus you add in an aggressive hiking cycle, then you get to the scenario Victor laid out where by three they're talking about eating again totally. I mean, this is the other thing that

emerged from the pandemic. We didn't really get a proper recession after the pandemic because we had all the stimulus, and then we sort of got shunted into a recovery that was really supercharged again thanks to that physical stimulus. And now it feels like we're sort of getting the response.

I know some people say it was too slow coming, but it actually feels like it could come very quickly, with pal talking about fifty basis point increases and so it feels like we could get a whole another cycle happening very very fast. Yeah, you know, it's interesting. I had this thought about like this sort of I guess it's like the the fun house mirror version of the downturn and how fast this I'm trying to turn it out?

And you know what day I felt like that specifically is that day, remember like the price of nickel went completely to shut down the nickel trading, And the day it reminded me of, weirdly was the day that oil

went negative. Even though it's the exact opposite move it one is this huge spike, but both are these days that sort of like broke the market, except in opposite directions, and so to some extent it did feel like I don't know, like, yes, I think what you're what you're saying is we'll put like we're just getting this really extremely torqued version of what we experienced throughout hopefully thanks you know that. Hence that, hence the dream of a

soft landing or just te normal. Yeah, the torque does a good word. Isn't it all? Right? Um? Shall we leave it there? Let's leave it there? Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't Thal? You can follow me on Twitter at the Stalwarts. Big thanks to our producers Magnus

Henrickson and Colin Tipton. Followed the Bloomberg head of podcast Francesco Levy at Francesco Today and check out all of the podcasts at Bloomberg onto the handle add Podcasts. Thanks for listening.