Category: Macro

Podcast notes – Brent Johnson on the Dollar Milkshake – Bitcoin Layer with Nik Bhatia

Brent Johnson – DLJ, then Credit Suisse, then wealth management
Started Santiago Capital – manage money for individuals
His website: SantiagoCapital.com

Coined the term Dollar Milkshake Theory
-framework for global sovereign debt currency crisis
-name comes a scene in There Will Be Blood
-US dollar and capital markets have advantages rest of world (ROW) doesn’t have
-US will drain ROW’s milkshake of dollars and capital

Dollar will become too strong for global system to function appropriately – lead to a crash, restructuring / new system (eg, new Plaza Accord)

Jim Grant: “return free risk” (when rates were zero)

US Treasuries outlook
-if rates drop, dollar will fall, Treasuries rise
-if rates continue higher, dollar will continue to strengthen
-if govt bonds are rejected globally, US Treasuries will be demanded more than other countries’ bonds

Milkshake Theory is a relative thesis – US assets / Treasuries / currency will outperform

Thinks there will be more QE eventually
In perfect scenario – whole world will return to QE, sovereign bonds globally will be rejected, all excess liquidity flows back to US, into stocks / real estate / USD assets, get a big melt-up
USD in this scenario will still rise – but underperform USD assets (eg, stocks)

Oil runs the world
-Oil mostly priced and traded in USD
-If oil rises 20% and USD rises 20% versus your currency, that’s 40% increase in energy costs!
-If crisis where every country for themselves, US more energy self sufficient than others
-Maybe Russia is stronger position
-Because of US energy self sufficiency, we’re exporting fewer USD to ROW to buy their oil, less supply of ex-US dollars

ROW still trades with each other but primarily denominated in USD
Huge amounts of USD credit between them – France-Singapore, Europe-Turkey, etc

Whole system is game of musical chairs
Chairs = base money (currency, bank reserves)
Credit = people walking around in the game
If more credit, new people enter the game, but same # of chairs
As US tightens monetary policy, not creating new money, taking chairs out of game, system becomes even more levered
Eurodollar market can’t add more chairs, only more people
Music could stop at any moment

Triffin’s Dilemma
A country currency that functions as global reserve currency – eventually situation where domestic needs conflict with int’l needs

Vicious loop
Other countries need to print more of their own money to buy USD / buy energy, and this causes further currency weakening vs USD
A few commodity producing country currencies have held up well – eg, Russian ruble, Brazilian real

Fed won’t stop while US equity is still rallying, unemployment low
Keep going until prices come down, wages come down, some jobs are lost
“Wouldn’t surprise me if it slows down” – dollar would then drop 10, 15%
Over next 2-3 years, dollar will continue to rise
Expects Powell continue to raise more than most expect

Europe already buying periphery bonds; UK with pension fund crisis
Japan doing YCC
Ex-US currencies down dramatically
Nothing ROW can do to make USD go lower that wouldn’t hurt themselves more

China’s gold-backed yuan – silly idea tbh
BRICS launching basket of currencies – not reality
If these things were done, would be even less USD in circulation – would worsen the short-term credit problem, Eurodollar market would lose a ton of assets

If the world moves to new system – process would be violent, may involve military conflict

US has weaponized dollar – doing it on purpose – Putin is doing same thing by requiring Russian energy buyers to pay in ruble

More free market price discovery in US Treasury market today than any other treasury market

Japan outlook
-can’t let rates rise – YCC will flood system with yen, and yen will lose value
-in 2013 and 2015, when yen weakened, led to Chinese yuan weakening
-because yuan and yen are competitive currencies, both exporting nations, yuan must devalue to maintain competition for exports
-think yen will go a lot lower – now around 147 – thinks yen will go to 200 or higher (!)
-will put enormous pressure on Chinese yuan – pull inflationary pressures into their economy to keep export markets strong
-yen could still rally 5-10% in bursts
-yen is big signal

Podcast notes – Russell Napier on Hidden Forces – “Central bankers…are largely impotent now”

Lawyer by training
Advises institutions on investment allocation
Chairman of listed company, wrote 2 books on financial history

Since 1978, key question is what will happen to interest rates
Now largely an irrelevant question
Belief we live in market system, there’s relation between inflation and interest rates – but we’ve moved into a new system
Too much focus on central bankers – they’re largely impotent now

Old regime = China and others linked currencies to USD
Results = depressed inflation in US
Central banks (CBs) believed they were fighting deflation —> low interest rates
After GFC —> low rates was not enough, added QE – which kept rates low and added more to debt

Debt kept rising – then covid, which led to even more debt
US debt:GDP ratio to highest level ever

Fed Reserve did not create great growth in money supply – failed from 2009 to 2019 – but kept rates low
So low nominal GDP growth, high growth in debt
Then covid-19, caused another recession – debt:GDP spiked even more

Most people believe CB creates money but it’s incorrect
CB controls commercial banking system – like coachman and team of horses – the horses (the banks) pull the carriage
CB provided lots of liquidity, low rates – but banks didn’t expand balance sheets, so didn’t create money
But did create a lot of debt – in the bond markets, money markets, shadow banks, because rates were so low

There’s no beautiful deleveraging for US economy as a whole
Household sector is much better
But US govt, corporate sector, both debt:GDP are all time highs

Why can’t we just issue more debt?
2 recessions in last 12 years – both genuinely close to Great Depression
In recessions, cashflow declines, risk of mass defaults, turn into depressions because debt is so high
Bankers remember that after Great Depression —> World War, so very fearful of consequences

Very high debt:GDP after WW2 – governments decided to inflate those away
Socially it’s dangerous situation to be in

Demetri: Financial repression + inflation to reduce relative debt burden

It’s a political choice – no invisible hand to solve this problem
Some options:
1. Austerity = government borrowing less, repaying debt = scaling back social policies, welfare, not popular w/ voters
2. Default has tried before = crushing contraction in economy = domino effect of defaults, instability
3. Hyperinflation = technically 60% inflation a month = but roll of dice for consequences
4. Real growth = productivity and innovation growth, but very hard to do, can’t rely on this
5. Repression = most politically acceptable, more subtle tool

Volcker called this system the Hybrid system = some countries linked currencies, others float = our current system
Leads to unbalanced consequences – Volcker railed against it
Dollar at center of it, but driven primarily by other countries – primarily China – linking their currency to the dollar

What does financial repression look like?
Post WW2 1945 to 1979 – focused more on Europe
Similar system China has run
Aim to force savers to have money in fixed interest securities at level of interest below inflation
Slowly de-lever your economy
Before it was easier to do because inflation was low – now we need to regulate / force people and corporations to do it

Ex: Nixon’s price and wage controls

What drives inflation?
Supply side factors
40% increase in global money supply in last 2 years – root cause

Why did money creation work now when it failed in last 10-20 years?
Because of gov interference in commercial banking system – government guaranteed the loans, will underwrite the losses – so commercial banks start making loans, money starts getting created
Governments learning how politically powerful – push credit where they want it

Ex: UK gov’t – 600M sterling loan to Land Rover to make green vehicles – money creation to achieve a green policy

Govs justify it in the name of “emergencies”
-Cold War w/ China
-Climate emergency
-National security emergency
-Health emergency
-Inequality emergency
-Labor price emergency
Govs will use bankers to fund all of these – create lot of money – lots of inflation being created
Meet political goals, create higher inflation, financial repression

Finance = someone’s savings = governments will increasingly steer it to where they want it to go

US economy story for last 30 years: anyone who wants credit can get it – now that’s changing, state will play a role in prioritizing where it goes, historically they haven’t been good at it but need to do it anyway

Who won’t get this credit?
-PE, investment banking, commercial property, leveraged corporate finance, Krugman’s “realm of the rentier”
-credit will go to more productive industries
–

Lead to more capital controls in Western countries
Greece, Cypress, Iceland – struggled with high levels of debt
Solved thru capital controls, tons of external help
“Corralling savings into killing pens of fixed income securities”

More nationalization in Europe than America
EU tried to create single currency, failing so far

Governments will regulate biggest pools of $ first – securities, life insurance funds, corporate pension funds, mutual funds – will come for individual’s holdings last (eg, private gold holdings)

End of WW2 – 70% of UK stock market owned by individuals, now it’s ~10% – now it’s all run through institutions, easier for govs to direct / regulate

Recommends people hold assets in own name instead of through intermediaries eg mutual funds

Govs will justify in name of emergency – climate, inequality – word “emergency” will keep appearing

Can characterize the saver, the rentier as evil – can see a shift to see saver as being demonized, or “capitalist”, greater political ability to force them to pay

Huge amount of path dependency – not difficult to forecast what will happen next

Capitalism created enormous imbalances, not enough political capital to stop it
Many thought it would reverse after 2009 (GFC), but there was one financial gasp — and now it’s over

Income inequality mean reverts ultimately – because of taxation, warfare – suggests a long cyclical thing for human societies

More wise macro words from William White: “Whether the future holds depression and deflation, or high and lasting inflation, or both in one order or another, remains to be determined.”

I’ve shared some of his work; here’s more from a recent AEI panel:

And here are his speaker notes, some excerpts below:

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during the “Great Moderation” the Fed and others attributed low and stable inflation to their own, wise policies of demand management. In reality, it reflected positive supply shocks (globalisation and demographics).

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While many are used to the word “stagflation’, implying that demand falls automatically when prices rise due to a supply shock (terms of trade losses in Advanced Market Economies in the 1970’s), it seems to me that many of these new shocks imply rising investment and demand going forward.

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If the Fed has to tighten much further, and then has to maintain that tightness, it seems to me to be very likely that something will come unstuck in the financial markets of AMEs. As well, the associated strength of the US dollar raises all sorts of problems for EMEs, especially those that have borrowed heavily in US dollars.

—

All by way of saying, there are many reasons to believe consumption will have to be reduced to help avoid enduring inflation and that both monetary and fiscal policy have a role to play. Evidently, none of this will be politically popular.

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“Interest is the price of time”

Good interview with author Edward Chancellor on the macro environment and interest rates. I just started reading his book “The Price of Time” which explores the history of interest rates. Interest rates are like water – we just assume it’s there and it works – but when it’s manipulated, it can poison the global economy, which is what we’re seeing now.

Source: https://themarket.ch/interview/edward-chancellor-central-banks-delayed-the-day-of-reckoning-ld.7051

Book: https://www.amazon.com/Price-Time-Real-Story-Interest/dp/0802160069

Some excerpts from the interview:

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Interest is the price of time. Time is valuable, or as Ben Franklin would say, time is money. And if you don’t place a proper price on time, then the world will turn upside down.

By aggressively pursuing an inflation target of 2% and constantly living in horror of even the mildest form of deflation, they not only gave us the ultra-low interest rates with their unintended consequences in terms of the Everything Bubble. They also facilitated a misallocation of capital of epic proportions, they created an over-financialization of the economy and a rise in indebtedness. Putting all this together, they created and abetted an environment of low productivity growth.

Going forward, we’ll have more inflation in the stop-go fashion that I described, we’ll have rising interest rates and a lot more volatility in financial markets

—

Chancellor also mentions Bill White who I’ve shared previously.

Russell Napier’s interesting macro views: “What does it tell you when central banks speak loudly? Perhaps that they’re not carrying a big stick anymore.”

Found him on Tyler Cowen’s blog, and now I’m reading his book on the 1995-1998 Asian Financial Crisis.

Here are more highlights from the article that Tyler references (emphasis mine):

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But now, when governments take control of private credit creation through the banking system by guaranteeing loans, central banks are pushed out of their role. There’s another way of looking at today’s loud, hawkish rhetoric by central banks: Teddy Roosevelt once said that, in terms of foreign policy, one should speak softly and carry a big stick. What does it tell you when central banks speak loudly? Perhaps that they’re not carrying a big stick anymore.

—

I’m not talking about a command economy or about Marxism, but about an economy where the government plays a significant role in the allocation of capital. The French would call this system «dirigiste». This is nothing new, as it was the system that prevailed from 1939 to 1979. We have just forgotten how it works, because most economists are trained in free market economics, not in history.

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I think we’ll see consumer price inflation settling into a range between 4 and 6%. Without the energy shock, we would probably be there now. Why 4 to 6%? Because it has to be a level that the government can get away with. Financial repression means stealing money from savers and old people slowly.