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Special note to listeners, we're very keen to hear your questions and answer them. on the air. If you have burning questions about markets, finance, or the economy, send them to robert.armstrong at ft.com. Pushkin. Aidan, a couple of months ago we thought we had inflation beaten. Were we wrong? Very likely. That is depressing.
But today's show will not be depressing. We're going to talk about disinflation, demographics, and doge. The big three D's hanging over the American economy and American markets right now. I am Rob Armstrong, and this is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. We are coming to you from fabulous gold-plated...
air-conditioned, and extremely comfortable unhedged world headquarters in New York City. Joining me today is the brains behind the whole thing, Aidan Reiter, my partner in crime on the Unhedged Newsletter. Welcome, Aidan. Certainly not the brains, but I do type fast. No, you're the brains. So, Aiden, we have three important American things to talk about today. All three of them, as it happens, start with D. They're disinflation. Is it really happening? Demographics.
Is that going to sink American economic growth over the next 25 years and doge the new government department? I don't know if it's a department or what. It's certainly not a department, but it has the name of one. But it has. Doge, the Department of Governmental Efficiency, which is going to save the U.S. Treasury market. Sounds dope. Or so some people hope.
Let's start with disinflation, Aiden. Let's. I have before me a chart of CPI inflation, excluding the notoriously volatile food and energy categories. it seems like we've had about four months where cpi inflation depending on how you look at it is not going the direction that one would want it to go it's not shooting up
But man, it doesn't look great. What's going on here, Aiden? Yeah. So if you just look at core CPI, which, as you said, strips out volatile food and energy, it went up from 3.25 to 3.3. That's a small jump. But that's kind of the third month in a row that we are having not great directional changes in CPI. And the goal here is 2%, right? Yeah, the goal is 2%. However you cut it, it's 2%. Yeah, and that's core CPI. If you...
To include the food and the energy and remember that oil is really cheap right now, it still went up. So it went up from 2.4% in September to 2.6%. So either way you slice it, we're not really going the right direction. It has been a mantra. of the last two years in markets and economic circles to say the path of inflation downward to target is was always going to be unsteady
It was gonna weave and wend up and down a bit. This is actually a tiny bit worrisome, how long this has been going on now. Are there particular components? of inflation that are proving troublesome uh in september it was kind of all across the board This month, there were some funky readings we got from housing. Those might be two quirks in the data as opposed to some real change in shelter costs. That being said, we like to use one month, three month, and six month.
moving averages of annualized change. So just to tick through those, one month went down a little bit, which is good, but three months went up. And three months went up because the last three months have actually been above... what our goal had been, whereas we had a couple good months in the summer. So six months is down. I guess the optimist says we know housing inflation, which is the third of the basket.
is going to keep coming down. This is the old story where the way the government measures it, housing inflation is a very lagging indicator. But if we look at new leases, we do see that... disinflation has firmly taken hold. Am I getting this right? So the optimist says that will come through fully and that will bring us down another however many basis points. Yeah, and we had shelter coming down hugely from
August to September. But there's some other weird things in the housing market that it's kind of hard to understand right now. So for example, a lot of the home builders have a lot of supply, but they've essentially stopped building because there's not enough demand. So there's this fundamental...
thing not working in the market where prices which are supposed to come and meet demand are not coming to meet demand. And whether that's home builders waiting for inflation and mortgages to come down or something else. But either way- we can say that across the board there is some inflation going in food and other products that
look like they might be here to stay, especially if we keep on the same rate cutting trajectory we had thought we would be on. Yeah, only energy is really saving us. Energy, we should be very grateful that OPEC Plus can't get its stuff together.
As they say, the stupidest cartel in the history of the world. I mean, it's a fundamental game theoretic problem, right? You have the really rich one, Saudi Arabia, and you have all the poor ones like Iraq and Kazakhstan. Right now, oil prices are low for a lot of reasons. So, of course, the core ones are going to keep on...
going for oil because they need the money. But then once they do that, it keeps the price lower. And then, of course, Saudi Arabia is then annoyed. But in any case, I would say this puts Jay Powell and the Fed in an awkward little spot because... A new president has just been elected. I don't know if you caught that, Aiden. I think I heard something. Anyway, so they cut 50, right? And then at the last meeting, they did 25, right? So...
If they now look at these inflation numbers and say, maybe let's pause at the next meeting in December, they're going to look hopelessly partisan. Like, oh, Trump gets in and now we want to slow the economy. You know what I mean? To be fair, they cut right after the election. So Trump was already theoretically coming in. Yeah, yeah. But I don't know. It's going to be a prickly one for them. Absolutely. What does the market think they're going to do right now? The market is of two minds.
Right now, it's kind of half and half cuts bets on a 25 basis point cut in December versus no cut at all. That being said, Jay Powell just the other day said, quote, the economy is not sending any signals that we need to be in a hurry to lower rates, end quote. So he might not go for it. So we'll come back to that in another show before very long. You can be sure. Let's turn to demographics. I was really struck by a piece that came out earlier this week by Jim Reed's team at Deutsche Bank.
that kind of looked at the last 25 years of asset returns. This piece was called something like the long-term asset return study and then speculated a bit about the next 25 years and the really striking thing that came out of this report. was that a lot of America's outperformance in terms of GDP growth was because compared to other countries we had
a working age population that was growing relatively quickly, not super fast, but you know, a percent or something a year. And that really set us apart. And if you take out. the natural tailwind to growth that creates. the difference between us and a germany or a france or a japan although it's still there still there for sure i mean there's you know questions about tech adoption the internet age in america regulation regulation etc but but the real
growth rate difference once you back out the demographics is like 10 basis points a year, 20 basis points a year, 30 basis points a year. So the punchline to all this, of course, is that in the next 25 years, our working population. is not going to grow like it did in the last 25. Yes, which is absolutely true. However, we are still going to be growing. If, you know, migration levels stay at where they were, et cetera, whereas our...
closest competitors, quote unquote, in the developed countries, Japan, Germany, et cetera, are going to be shrinking much faster. Well, looking at this report from Deutsche Bank and Jim Reed has a lot of nice graphics of the expected. demographic trends in different countries, and it actually isn't Europe that looks the worst. Who looks the worst? China, Korea, Hong Kong, Taiwan.
These countries are going to be in serious demographic distress. And they've already entered into that. I mean, look at China's issues right now. So much of it comes down to questions of the working age population, youth unemployment, and the ability to actually marshal its workforce. If you wanted to make a scary story about the United States, despite its good relative demographic position, it has a bad absolute demographic position. The change is going the wrong direction.
We have very expensive assets in this country. So that's a bad place to start your next 20 years of asset returns is with extremely expensive assets. And we have a load of debt. And as Deutsche Bank points out, if you have a load of debt, the real returns on your bonds don't tend to be very good. So your American 60-40 portfolio. That returned in real term something over 4% over the last 25 years. I don't think, Aiden, I don't think you should plan on your next 25 years returning.
Yeah. You know, it's not that you're going to have any money to invest with probably no social security or at least not fully funded social security. My generation's not looking like it's going to be doing so well. You're going to have to save more money than my generation did to get the same or work longer.
Again, relative position of the United States compared to the rest of the world, good. Compared to itself since 2000 or 1999, these good times are unlikely. But something that I think is interesting that the Deutsche Bank... report pointed out, as well as you pointed out in our piece the other day, was that even the returns over the last 20 years have not been so good as they were as 20 years ago. Valuations were super high in 1999, 2000.
It's not like the American story has been flawless to begin with. Yeah. So we've had an incredible run in like the teens. But the thing that brings the returns down over the last quarter century is that we started from such. precipitously high valuations, an experience we might repeat again now with the price to earnings ratio of the S&P at 24 or whatever it is now. So it's something to think about now. What's interesting about this to me is there's only one
one solution to these problems. If you don't have a growing population, if you have a lot of debt and you have expensive assets to begin with, There is only one thing that can save you, which is the productivity fairy who has to flutter her magical wings and land on the US economy and mean that workers.
Produce more per hour of work. So despite the demographic changes, you can produce more, which allows you to manage the debt load and allows asset prices to rise so that, you know, so they can live up to. the valuation that they have. Yeah, or produce things of higher value. But given that we already have high valuations, that seems that it's not going to be part of the equation. You know, but I mean, we've made a fair amount of fun of AI hype on this show.
But the robots kind of need to show up over the next 20 years because that's productivity. Automation, making each hour of work we put in produce more output is what we need. So. We say to the robots, hurry up, robots. Whether they're made by Elon Musk or someone else, we want you to show up quickly, guys. And speaking of Elon Musk... Let's talk about his new job. How many companies he's running now and now in the government initiative? Yes. His latest job is running the department.
of government efficiency. Which is named after his favorite cryptocurrency, Patojcoin. And we should note that it's not just him. It's Vivek Ramaswamy. Yes. a pharmaceutical mogul who ran for president. And I would be remiss if I did not say that it is highly inefficient to have two heads of initiative. If you're really going to name it the Department of Government Efficiency. I know. And there's an unavoidable irony in starting a new department.
in order to make government smaller, but we shouldn't make fun. It's not a department. We have, and it's not a department, we have... an unsustainable debt trajectory in this country this i don't think you and i agree and i don't think there's any argument the deficit trajectory is bad and we are headed for larger and larger deaths. And eventually that is going to awaken the bond vigilantes.
And, you know, we're on a sustainable path here. So something's got to be done. Yeah. I mean, I think there is an argument that America's special and America's debt doesn't matter. And I think there are people from both parties that want to believe that. Yes. But, you know, I think there is a... Speaking of fairies, we...
We want to believe. We want to believe. But there's a market consensus at least, or at least have we seen in other economies, that too much debt is bad if your growth can't deliver. Yeah. So Musk, who's been known to exaggerate, is talking about $2 trillion.
Yeah. Out of a six, am I getting this right? Six trillion dollar U.S. federal budget? 2023 it was 6.1. Okay, great. And it was a little bigger this past year. Let's just quickly run listeners through what's in that six trillion. What are the big chunks there? Yeah, well, let's start with things he's probably not going to touch.
Perfect. So there's Social Security. That's about $1.3 trillion. Medicare, that's health insurance for the elderly. Trump has already said that he won't touch them. Medicare is what on top? That's about $800 billion. So together, that's a little over $2 trillion. $2 trillion. Third of the budget. There's this other bucket that's like government pensions and deposit insurance, 500 billion. They can't touch it.
So now we're at 2.5 trillion. You can't touch. 2.5, 2.6 trillion. Yeah. There's net interest on the US's debt. Can't touch that. Definitely can't touch that. That's about 700 billion. Okay. So now we're at half the budget, roughly speaking, right? We're over three now? Am I doing the math correctly? We're over three now. Okay. And then there is the defense budget. So theoretically, Trump is isolationist, but at least in the first term, there wasn't that many cuts in the defense budget. Yeah.
So that's a little under a trillion. That's 800 billion. So now what's our total of stuff we've talked about that is hard to touch? Total stuff we've talked about that's hard to touch is about 4.2 trillion. That leaves 2 trillion in the budget. So if I'm doing my math correctly, Musk has promised to cut everything else completely. Everything. To zero. The State Department.
Yeah. So there's the non-defense things. So there's highways, State Department, the agencies, the deep state, quote unquote. Yeah, yeah. But a lot of those are programs that people rely on and or expect. So highways, roads. They talk about cutting the Department of Education. Department of Education doesn't have that big of a staff. They're just really sending out checks to school districts. Yes.
if your kid has special needs and doesn't get the money they want, they might face some backlash. So that's what they want to cut there. And then there's the rest of it is, again, also kind of... Check sender outers are Medicaid and other income security programs. Right. Medicaid is health insurance for the poor. We're talking about helping the poor here. Yeah. And income security programs like.
child and other tax credits, which have been in and out of the law. There's unemployment benefits. There's the food stamp programs. So if they want to cut out $2 trillion, you're going to have to be cutting things that people really want and things that a lot of people really rely on. I mean, it would be something if they got a quarter that much.
If they took 500 billion or 200 billion out of the US budget. But it's not that easy. A lot of these things are already enshrined in law. So they'd have to go through Congress. Yes. You know, part of the reason we have high spending in almost every economy is.
Congress wants to please their constituents. So if you're not going to get every congressman to start slashing the budget. Suppose he gets all the Republicans, right? Yeah. He does enough. But a few Republican defectors. Yeah. You know, you have. He can't get it done. Very slim majority, if even in the house. And the Senate has a sizable majority, but still, you need the House and the Senate to pass anything. They're going to use some novel legal strategies to get around this.
But it's unclear what they can actually do. The other way to think about this is from personnel, though. Right? Like the federal civilian employee workforce. So that's not contractors. That's not military. It's about 2.2 million people. It's like a bit over $300 billion to pay every year. Yeah. robots, you're still not anywhere near his goal. Yeah, exactly. You can literally disappear all the federal employees and replace them with free robots and...
You're not talking about the numbers they're talking about. And we should note that a lot of people have tried to do these things in the past. And there's been so many government efficiency initiatives. Panels. Yeah, panels and other names. Usually they're part of the government. This one is not, which is its own interesting legal question. So the takeaway from this is, if you are an investor in U.S. treasuries...
And you are worried that treasury yields are going to rise, meaning that the treasury prices themselves are going to fall. And you are hoping that Doge will prevent that by making the government more efficient. You are probably smoking dope, as my mother would say. Is that the right takeaway, Aiden? I mean, there are things that will change this administration for sure. As far as...
stopping adding to the deficit and cutting $2 trillion out of the budget, I would not put any money on that. Yeah, I wouldn't put, I don't think they're getting a 500 billion. No. Never mind. All right, on that thought, we will be right back with Long and Short. If bonds are back today, why wait for tomorrow? At PGM, our fixed income strategies help investors uncover hidden value and unlock opportunities.
Whether you're looking to enhance your income or diversify your portfolio, our broad range of strategies bring together local expertise and deep credit research to help you achieve your long-term goals. Our investments shape tomorrow, today. Welcome back, listeners. This is Long and Short, the part of the show where we go long stuff we like and short stuff we don't like. Aidan, are you long or short something? I am long the Turkish economy.
Turkey had unconventional. That's bold. It's bold. Turkey had unconventional monetary policy for a long time. They switched about a year ago to more conventional monetary policy. By unconventional, we mean insane. Insane. Yeah. They wouldn't raise rates even though inflation was like 80%. Anyway.
It seems to be working. The lira is doing pretty well. That might be from carry trading, but still inflation is starting to come down, although it's definitely not beat. So I think things are on the right path. They still have some hurdles, but Turkey's looking good. I am long-ish another D, which is Disney.
Disney has had a hard time with the transition to streaming. We've talked about it on the show before. They reported a good quarter last week and I think they are finally figuring out how to be Disney in a world. that is about streaming video. And the characters are great. The brands are great. They just have to get this distribution thing figured out. And I have the feeling they're starting to get there. So I am slightly tentatively long.
On that animated note, we will be back in your feed on Thursday. And don't forget, send me your questions about markets and finance. Unhedged is produced by Jake Harper and edited by Bryant Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the unhedged newsletter for free, a 30-day free trial.
is available to everyone else. Just go to ft.com slash unhedged offer. I'm Rob Armstrong. Thanks for listening.