Is China More Capitalistic Than the US?
Ed D’Agostino // Partner & COO, Mauldin Economics
Louis Gave // Founding Partner & CEO, Gavekal
Ed D'Agostino:
Louis, always good to see you. Thanks for joining me again here at Global Macro Update. The
last time we talked, it's been a while, it was back in May and you …
Louis Gave:
Time flies.
Ed D'Agostino:
... were telling me... Time flies. It really does. It just gets worse and worse it seems. But at that
time, you were talking about an anomaly that you noticed in the global marketplace, in the
global trade that China was running, I believe you said, a 70 billion-dollar-a-month trade
surplus, and you wondered how long that could go on. You fast-forward to today, here we are
heading into the end of summer, and we're at what …
Louis Gave:
100.
Ed D'Agostino:
... $100 billion a month? What's going on?
Louis Gave:
It's a lot of money. I think if you take the biggest Japanese trade surplus in history and you take
the biggest German trade surplus in history, and I pick these two countries because they're
countries that historically have run very large surpluses. You take their two records, you put
them together, you still don't get to $70 billion, let alone a $100 billion.
Ed D'Agostino:
Wow.
Louis Gave:
So yes, China's trade surplus has accelerated a lot. Basically Chinese trade has been the one
silver lining in the Chinese growth story. Of course, we know about the disappointing real
estate, the youth unemployment, and the, frankly, somewhat disappointing consumption. But
exports have been undeniably the big bright light. And perhaps what a lot of your listeners
might not realize, what's particularly fascinating, is that today China's exports to other
emerging markets, to the broader developing world are now bigger than China's exports to the
developed market, basically to Western Europe and the United States or North America.
So yeah, China's trade is absolutely booming. The investments that China made 10 years ago in
things like the One Belt One Road, the Silk Road Fund, the Asian Infrastructure Investment
Bank, all the things that we laughed at and said, "Oh, you want to have trade with Kazakhstan?
Who cares? Sure, have it. It's all yours." The reality is, if you look at the BRICS countries, China
now does more trade with the BRICS countries than it does with the United States. So you've
seen a surge, an absolute surge in Chinese growth. But for me, the big question is this, as we
look at the $100 billion that China now sucks in every month, where is that money going? Now,
if you go back 15 years ago, we knew that if you were a widget manufacturer and you earn
dollars, you would turn to the Chinese Central Bank and say, "Here are the dollars that I've
earned, please give me some renminbi."
Then the central bank would take these dollars and buy US treasuries and recycle them to the
US. This clearly isn't happening anymore. All you have to do is look at the holdings of the
Chinese Central Bank of treasuries to see that it's clearly not happening. So what are all these
widget manufacturers, the guys on the other side of that trade, what are they doing with all this
money? Here, I think... Increasingly, the answer, I think they've kept it mostly in dollars, which
is why the
dollar's been strong, and I think they've been trying to buy US assets. You try to keep your
dollars in offshore booking centers like Hong Kong, like Cayman, like Bermuda, wherever. You
earn these dollars, you keep them in bank accounts there and from there, you buy whatever's
going up. And what's going up has been Microsoft, Apple, and so forth. The mag seven.
It seems to be, 15 years ago, the trade was, China ran trade surpluses. The money was recycled
into US treasuries. Today, China runs trade surpluses, and I think the money has largely been
recycled in mag seven. This is a hunch. It's a hard one to prove because a lot of that money's
offshore. But you have to think, okay, that's $100 billion a month. Where does it go? Which
inherently, by the way, means that the strong dollar trade and the mag seven trade are roughly
the same trade. Because if tomorrow, for whatever reason, let's say the Fed is cutting or US
growth disappoints or US politics turned even uglier than it already is, et cetera. For whatever
reason, the US dollar does start to roll over. Right now it does feel like it's rolling over. And
incidentally, as it rolls over mag seven stops to outperform. But as the US dollar starts to roll
over, which seems to be what is unfolding right now.
Then do these guys on the other side of that $100 billion start to say, "Hold on, I own enough
US assets already. I don't want to own anymore. I am earning all this money, maybe I recycle it
somewhere else"? Perhaps that's what's already happening. And perhaps what they're
recycling in now is gold. Gold is moving up every day. Gold is one of the few assets that's
making new all-time highs. Although that's not exactly true, because the Dow Jones is also
making new all-time highs. But if you look at assets around the world that are making new alltime highs, you've got the Dow, you've got gold, and you've got Chinese government bonds.
That's it. Those are the three asset classes that are making new all-time highs in US dollar terms
today. So if now the US dollar starts to weaken, the big question, which I think is a distinct
possibility as we start an easing cycle from the Fed. The big question is, where does that $100
billion start to get... Does it continue to get recycled at mag seven? Or does it start to go other
places?
Ed D'Agostino:
The bulk of the trade, this $100-billion-a-month trade surplus, is it happening primarily in
dollars?
Louis Gave:
Great question. No, and that's been a key change for China. China now has roughly about as
much trade that it settles in renminbi as it does in US dollars.
Ed D'Agostino:
Wow.
Louis Gave:
That's a very profound shift. Of course, the huge catalyst to that shift. If you'd gone back three
years ago, the amount settled in renminbi was a tiny fraction of the amount settled in US
dollars. But three years ago, or two and a half years ago, we kicked Russia out of the dollar
system, and Russia therefore had no choice but to move to non-Western currencies. The more
obvious non-Western currency for Russia to trade in became the renminbi. So all of the natural
gas trade, all of the oil trade, all of the coal, the iron ore, anything that Russia could sell to
China. And there's a lot, because basically everything Russia produces China wants.
Then, all of a sudden, that shifted from being priced in US dollars to being priced in renminbi.
That was a huge boon for China. Having the ability to pay for your commodity needs in your
own currency is an absolute game-changer because you can always print your own currency. If
you've got somebody on the other side who's basically... You've got them over a barrel, they
don't have a choice but to accept your currency, that leaves you with tremendous power. The
reality, of course, is when we kicked Russia out of the Western trading system, the big winner
was China. We gave China a huge shot in the arm, which perhaps helps explain why all of the
cataclysmic bearish scenarios on China never materialized. You're not going to get to see a
Michael Lewis book on hedge fund managers who made a fortune shorting China. Because even
though the stock market went down, the stock market went down by two-thirds in five years,
and the real estate market went down by a third roughly over those five years.
The reality is that the Chinese economy has continued to hum along. Not at the growth rates of
the past, but the economy didn't implode. And this is something I often talk about with people.
I often say, "Look, imagine if in the US the stock market went down by two-thirds and real
estate went down by a third. What would movie sales look like? What would restaurant sales
look like? What would car sales look like?" The interesting thing is in China, all of these things
are hitting all-time highs. Now, I'm pretty sure if the stock market was down by two-thirds and
real estate down by a third, car sales in the US would not be hitting all-time highs. Neither
would restaurant sales. The economy would look like a big black hole. It would be a balance
sheet of epic proportions. Now granted, part of that is the fact that as an economy, the US
economy is massively financialized.
You have a stock market that... Today, if you take the US stock market, $55 trillion or so in
market cap. And if you take the private sector GDP... I always think that GDP is such a weird
measure, because if you increase your government debt, you increase your GDP, but it doesn't
.
mean you create growth. So if you take the US GDP, roughly $28 trillion, you take out the
roughly $10 trillion of government, it leaves you with an $18 trillion private sector GDP. Today,
in the US you have a stock market that's three times the private sector GDP. That's why when
the stock market goes up or down, it does have a big impact. It's the tail wagging the dog now.
The stock market is now so much bigger than the GDP that when the stock market goes down,
it impacts the GDP instead of the other way around.
Ed D'Agostino:
Interesting.
Louis Gave:
In China, the relationship was never like this. In China, only 10% of people own stocks. In the
US, 70% of people own stocks. So if tomorrow the US stock market goes down two-thirds, 70%
of people feel very poor. In China, the stock market goes down two-thirds, 90% of people don't
care. So it's a very, very different backdrop for how things work. But it does tell you, an
important thing is that when the economy becomes so over-financialized, as it is in the US,
having a two-thirds drop in stock market in the US, I think, as a policy choice isn't possible. It's
just not possible. So what we have in China, stock market goes down two-thirds, and every
foreign investor is jumping up and down saying, "Why doesn't the government do more?" And
the answer is, the government doesn't do more because only 10% of people own stocks, and it
doesn't really matter. Most companies don't fund themselves through equities, where the
equities settle doesn't have that much of an impact on growth. Completely different, of course,
than the US. Again, the US stock market goes down by two-thirds, it's a nuclear meltdown in
the economy.
Ed D'Agostino:
Okay. But what is driving China's economy, and where do the risks lie? Because if you are now
exporting $100 billion a month, that is your economy. It is an economy that is dependent on
exports.
Louis Gave:
Absolutely.
Ed D'Agostino:
In this multipolar world, I keep saying it, I am going to be proven a jerk, I think, in the end
maybe. There's this quest for resiliency, I think, among the US government and the Chinese .
government. And that resiliency means depending less on each other, at least for critical things,
like commodities.
Louis Gave:
I think there's a quest to depend less on each other between the US and China, no doubt about
it. But again, I'll come back to the fact that China now exports more to emerging markets than it
does to developed markets. When I started in this business, one of my very first clients told me,
"Look, Louis, in this business, you can choose to have a boss, or you can choose to have clients.
The good thing about having clients is you can have a lot of them. So if you lose one of them,
it's not the end of the world. Also, if you don't like one of them, you don't have to pay attention
to them. But if you don't like your boss, things get tough." Now, if you compare China's
situation today to China's situation in 2008. In 2008, most of China's trade was getting to the
US. So the US blows up, and then Chinese growth blows up, and they find out, okay, all of a
sudden you have 18 million workers that lose their jobs overnight.
And they have to do all this infrastructure spending and just funnel a lot of money into public
works projects to keep people employed. Because they thought they had a client, but in reality
they had a boss. Because when you only have one client, what you have is a boss. So in this
quest for resiliency, you want to move from one client, i.e. the United States, to thousand...
There's no thousands of countries, but to hundreds of clients. China has accomplished this quite
nicely over the past 10 years. So when you look at China's massive trade surplus, which is,
again, the silver lining today to China's growth, then you find out that it's actually with a bunch
of different countries. So it's far less dependent on any one relationship than it was in the past.
Now, to your point, what does Chinese growth depend on?
Ten years ago, people were saying, "Oh, China's growth, it all depends on real estate. And if
they lose that, then the economy is going to implode, and it's going to be terrible, et cetera."
And back then, Chinese growth was all dependent on real estate, and they did lose that. It was
a policy choice. They said, "You know what? This growth is imbalanced. It's creating social
tensions. Young people can't house themselves. It's creating all these political problems, riots in
Hong Kong. We don't want those kinds of issues to come into Beijing and Shanghai, so we're
going to crack down on real estate." And they did. They cracked down really hard. A lot of
property developers went bust. There was a lot of force selling of a lot of inventory, and it's still
going on today. And yet the economy didn't implode because over the same period, what China
did was register tremendous productivity gains in manufacturing.
Here, I really think that people who haven't visited China in the past five years have missed this
story. Now, very few people have visited China in the past five years because, first, you had the
COVID
August 30, 2024
Global Macro Update is a free weekly interview hosted by Mauldin Economics Publisher &
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lockdown starting in 2020. Then after that, China supports Russia once Russia invades Ukraine.
And everybody decides, China's not investable. I'm not going to waste my time going there. Plus
the stock market stinks. They're going through a massive balance sheet recession. Property
developers are all going bust. Why am I going to bother going there? China's dead. The story's
over. Meanwhile, over that period, what do we find out? We find out that China comes from
nowhere to be the biggest car exporter in the world. Literally nowhere. Five years ago, China
was not exporting cars, and now China... You may remember the charts I showed at the
Mauldin conference in May, but China's now the biggest car exporter in the world, the biggest
solar panel exporter.
It's exporting turbines; it's exporting earth-moving equipment, tractors, building roads, building
high speed railways, all across basically all these emerging markets. And I think, to be honest,
that's the part that people have missed is the productivity gains that have occurred in China's
manufacturing are simply mind-blowing. And I think one of the reasons they've missed it is,
inherently one of our core beliefs in the Western world is, yeah, what China can copy. They can
churn up pale imitations at a cheap price. The Chinese business model is, we invent in the West,
then they'll copy it, and they'll do a somewhat shoddy job of it. They'll do a product that's like
85% is good for 70% of the price. Because for 25 years that was the case. That's what
happened. And I think what people are missing right now is how China's leapfrogging us in a lot
of things. I'll give you a simple example. A couple months ago, BYD came out with their latest
sedan. Think a car basically same size as a Toyota Corolla, the BYD Dolphin. The hybrid goes
2,000 kilometers on one tank of gas. You can drive from Vancouver…
Ed D'Agostino:
Wow.
Louis Gave:
... to LA without refueling it, from London to Rome without refueling.
Ed D'Agostino:
Wow.
Louis Gave:
This is revolutionary stuff. It raises the question of, do I even want to buy an electric car? Most
people drive 10,000 kilometers a year. That means you fill up your car five times in a year. It's
like, "Maybe I don't even bother buying an electric car if I only need to fill up five times." And
that car, by the way, retails for 14,000 US dollars in China. They're not exporting it yet because
the demand in
August 30, 2024
Global Macro Update is a free weekly interview hosted by Mauldin Economics Publisher &
COO, Ed D’Agostino. You can learn more and get a free subscription by visiting this page.
China is so high for it. What's the point of exporting when we can't even produce them fast
enough for our domestic market? But this is the kind of thing that is unfolding right now. So
yes, China, I think, has evolved from being an economy that was all about real estate five, 10
years ago, up to about five years ago, to an economy right now that is all about exports.
But it doesn't mean that five years from now China will still always be about exports. By then it
might've evolved again. It might be all about consumption. It might be all about real estate
again, although I doubt it. We will see. But I think what we have to do is keep an open mind and
accept that this isn't an economy that is evolving very, very rapidly in part because of the
incentive structures that are put in place. The reality in China is, five years ago you had 20, 30
automakers, and since then a bunch of them have gone bust, which is... So if you're an
entrepreneur in China, you've got to run fast or you die, which is something that I think we've
forgotten about in the West. Let me ask you this, what was the last big Western bankruptcy?
Here we are, we're the hallmarks of capitalism …
Ed D'Agostino:
That's a good question.
Louis Gave:
... we're as capitalist as we get. I can name you 10 Chinese bankruptcies over the past three,
four years of automakers, of solar panel manufacturers, of real estate developers, et cetera.
Here we are in the Western world, whether in France, in the UK, in the US, and we pat
ourselves on the back about how capitalist we are, about we're red-blooded capitalist, et
cetera. When was the last big bankruptcy?
Ed D'Agostino:
Wow. That is a phenomenal point.
Louis Gave:
Are we capitalist if nobody ever goes bust? How does that work? How does capitalism work
without bankruptcy? It's like Christianity without hell. The concept doesn't work.
Ed D'Agostino:
What do you say, Louis, what do you say to the argument from both the Europeans and the
North Americans that the Chinese subsidize their car industry to such an extent that they're
now able to deliver these cheaper goods? Substantially cheaper than we could possibly
produce, so it has to be subsidized.
Louis Gave:
Yes, there's big subsidies in China, but I don't think people understand how they work.
Now
first, of course, let's not pretend Tesla didn't live off subsidies for the first 10 years of its
existence.
Ed D'Agostino:
Huge subsidy. And that's my point is, when I looked at the reviews of a lot of the new Chinese
cars that are coming out, both electric and hybrid, they're awesome. It's not like it's a cheap
version, a cheap imitation of... They're phenomenal vehicles.
Louis Gave:
In the US, the way the subsidies work or in Europe is, we subsidize a business so that you end
up, at the end of the day, with a Tesla that costs $70,000 so that Elon Musk can be a
quadrillion-billionaire or whatever the number is. He can be massively wealthy.
So in China, the way the subsidies work is somewhat different. And the way capitalism works is very different.
The way it works is, you have somebody at the top, like a Xi Jinping who says, "Guys, electric
vehicle is the future. We need to do electric vehicles." And that's all he says.
Then what
happens is, every provincial governor, every mayor of a big town, every party secretary of a
province who wants to get ahead thinks, "Okay, Xi Jinping will like me if I managed to generate
in my region, city, province, a national champion on electric cars."
So what happens then is that because of capital controls, because of the financial repression in
China, basically most of China's savings, which are massive, are in the banking system.
Then
what happens is, every provincial bank is told, "Hey, you need to lend money to ABC car
company or to XYZ car company or to BYD car company." So all the car companies, then you
have like 30 or 40 car companies in China who are, all of a sudden, all cash rich. They got access
to credit because the government said, "This is the sector we want to be in."
And then the
Hunger Games start. Literally. You have 40 guys, and they're going to just throw money at being
the best knowing that only two or three of them will survive. It is just a Hunger Game.
You
could say, "Well, all this is basically subsidized by unfairly-priced credit from the banks."
Because out of those 40, 38 will go bad, and so the banks will take the hit. That's how the
Chinese subsidies work.
But it's unlike Xi Jinping is sitting in his office looking at different car
designs and saying, "Yeah, this car design is good. We'll subsidize this one. And this car design is
bad, so can this one." That's not the way it works. It's, everybody gets funded, and then it's the
Hunger Games.
And at the end of it all, what you end up with is, you don't end up with Elon
Musk who's made $100 or $200 billion and produces $70,000 cars. You end up with a BYD that
produces sub
August 30, 2024 $10,000 cars and a Chinese population that can, all of a sudden, afford cars and a Chinese car
market that's now the biggest car market in the world by a factor of two.
Ed D'Agostino:
Interesting. So the Chinese economy and government structure, in some ways, are more
beneficial to a middle class…
Louis Gave:
Well, they definitely...
Ed D'Agostino:
... than the country that invented the middle class.
Louis Gave:
I think they definitely favor competition more. In the US, do you... In which sector would you
say you have the most competition today in the US? Competition that it continues to drive
down prices to the point where companies go bankrupt. You definitely don't see that in
healthcare. One of the biggest sectors in the economy. I would argue…
Ed D'Agostino:
Trading and ETFs.
Louis Gave:
Yeah, you see it in finance. No, but you're right. You do see it in finance. You do see it in
finance, partly because the barriers to entry in finance are pretty low. You and I tomorrow
could go out and set up a hedge fund at a fairly low price, or we could... The barriers to entry in
finance are pretty low. So you're right, it still does happen in finance. And by the way, that's
probably the one sector in China where it does not happen. Because of regulation, because of
financial repression. Because the Chinese system, the way it's built, is basically dependent on
this ability to capture the savings and create a bunch of Hunger Games episodes for various
industries.
But you look at the US, your agricultural sector is dominated by three guys. You go
sector after sector, there is no competition.
Ed D'Agostino:
It's definitely been the last... Ever since the great financial crisis, '08, '09, it's been bigger is
better.
Louis Gave:
It's been bigger is better. And I think the big lesson of '08, '09 was we're not going to let
anybody go bankrupt ever again.
We let Lehman go bankrupt, and that turned out to be a
disaster. So, God forbid, nobody goes bankrupt now.
If that means keeping the cost of capital at
zero to make sure people don't go bankrupt, we'll do that. If that means giving subsidies, we'll
do that. If that means blowing out budget deficits and sending checks to everybody in the mail,
we'll do that. But absolutely, God forbid, that anybody go bankrupt, because that would just be
un-capitalist, it would be un-American if anybody went bust.
Ed D'Agostino:
Anyone lost their job.
Louis Gave:
That'd be, damn right, un-American.
Ed D'Agostino:
We could keep going on this, but I want to make sure that I get with you on commodities
because that's a big area that, I think, a lot of people are going to be interested in. We've been
talking about different areas of market distortion, and I think that what China's doing versus
what the US is doing and Russia's doing are all having big distortions on commodity markets.
Can you talk a little bit about that? Is China strategically hoarding certain commodities to set
the price? What's happening with things like copper and oil?
Louis Gave:
First, let me say, I think when we spoke in May at the Mauldin conference, I was quite
optimistic on commodities. Partly because I was decently optimistic on China, partly because I
was very optimistic on global growth and especially optimistic on the broader emerging market
growth. Right now I've got a lot of egg on my face, because since mid-May all the cyclicals in the
world have gotten smoked. Commodities, first and foremost. You mentioned copper, but it's
true of uranium, it's true of energy, it's true of energy stocks, basically anything that wasn't
gold. Even silver has been disappointing since mid-May, and forget platinum and palladium.
Anything that wasn't gold since mid-May, and if it's commodities, pretty much anything. I'm
sure you can say, "Okay, orange juice is up, et cetera." But whatever. Everything since mid-May
and anything that really has anything to do with the economic cycle has indeed been
disappointing. Yeah, it does. Frankly, this against a geopolitical backdrop that's, I think, more
harrowing by the day.
Ed D'Agostino:
Exactly.
Louis Gave:
Between the Middle East situation, between Ukrainian troops moving into Russia basically
raising the level of temperature. Any one of these things you would've thought could, frankly,
at least put a bit on oil.
Ed D'Agostino:
Exactly. I would not think oil would be below $75, and I would think US producers would be a
lot higher than they are right now.
Louis Gave:
Yeah. All that's been super, super disappointing. So, why is that? You could say, "Okay, well,
Chinese growth has been disappointing," but Chinese growth has been disappointing for a
while. Hasn't gotten that much worse. I don't really think so. It's basically been on a subdued
trend for a while. So then we get to your question, is China using build-up stocks to manipulate
prices? We do know that during the COVID years when China was doing nothing, because it was
locked down, China kept importing tons of oil, tons of copper, tons of iron ore. Very clearly it
built up inventories then. For years and years, China was a price-taker because it didn't have
much choice. But now, I think, it has built enough strategic reserves in a lot of things that if
prices run up too much, they just back off. And if prices dip enough, then they come back into
the market and buy it back. So that gives you... Perhaps it's what's been happening in oil. You
look at the past 18 months, oil has sort of been range trading.
So it means that, I think, if you're investing in the commodities, in the physical commodities
themselves, that's super frustrating. You're going nowhere. You're burning premium. But
logically, this should be a pretty decent environment for commodity producers. A lot of oil
companies will tell you, "Hey, if oil prices stay between $75 and $85, we are making tons of
cash flows. We're like cash flow generating machines. We can dish out dividends; we can buy
back our stocks." So if you're along the WTI contract or the brand contract, you're very
frustrated. Logically if you think oil stays between $75, $85; $75 China buys, $85 China stops
buying; I don't see why that's bearish oil stocks. I think it's super bullish oil stocks because in
that kind of environment, nobody's adding capacity, really. And these guys, again, are typically
generating pretty hefty cash flows at those prices. Or most of them are.
Ed D'Agostino:
Agreed. Companies like Devon Energy, it's one of my favorites, and yet this price just doesn't
reflect it.
Louis Gave:
No.
Ed D'Agostino:
Great dividend, great operation, well-run company.
Louis Gave:
So you say, "Okay, these guys are…”
Ed D'Agostino:
[inaudible 00:31:41].
Louis Gave:
Yeah, these guys are... Right now, energy is towards a lower trading band, and a lot of the
energy stocks have derated. You buy them here, oil prices get back to 90 bucks, you sell them
again, and you just have to keep doing that. Or you just say, "You know what? I don't care. Over
the next five years, I know I'm going to make lots of money on dividends. I know I'm going to
make lots of money on share buyback, so just I'll buy those and go to the beach." And I think
that also works.
Ed D'Agostino:
Okay. Let's talk about some other areas of the world.
Louis Gave:
Sure.
Ed D'Agostino:
There's so much going on. It's fascinating from a macro perspective, but it's also... The level of
complexity just seems to be near all-time highs. You mentioned, before we started rolling, that
there's a lot happening in France, especially lately. Tell me a little bit about that [inaudible
00:32:39].
Louis Gave:
Well, first we had a great Olympics. We had a great Olympics.
Ed D'Agostino:
You did.
Louis Gave:
It was super-fun. No terrorist incidents as a lot of people feared. And frankly, the level of
security that was deployed was super impressive. So on that front, that's good news. The bad
news is really more on the political front where we have a country that's now divided between,
more or less, three equal poles, between the center, the far left, and the right, the populist
right. And three blocs that hate each other, where reaching compromises seems to be
impossible. So here we are, we... Right now, we have the old government that has absolutely
no legitimacy because they just lost the election and no ability to put in a new government that
would get a majority of parliament. Now, the reason this matters is that the European Union
told France that by the end of this year, they needed to shave 25 billion euros off of their
current budget. And right now, we don't have any political leaders proposing, "Okay, let's cut
defense, or let's cut education, or let's cut pensions," or whatever.
Something needs to be cut.
But more importantly, we need to propose, we being France, I say we because I'm French. We
need to propose in September a budget to the European Union. Now, that budget is... Right
now, we don't even have a government to propose the budget, but whatever we propose, it's
most likely going to be rejected because we didn't even do the 25 billion euros savings for 2024
that we were supposed to. So you look at this, and we're going to come to a standoff between
France who doesn't have a government and a European Union that, I think, is getting more and
more frustrated with France's inability to deliver the kind of rigorous budgets that everybody
else in Europe is doing. You look at Italy, you look at Spain, you look at Portugal, all these
countries, they tighten their belt, and France just refuses to do so.
Now, I get it with France, we're bigger, we're better, we're stronger and more handsome. So
maybe we get away with it. But I fear it might not be. I fear that this time we're coming in...
Then you get to the second problem is even if the EU says, "Okay, fine, whatever. You guys
want to keep spending, just go for it." So the problem is, who's going to buy all this debt? And
here, this is a genuine problem for France in that France is basically in the same situation
Greece was back in 2011, where now more than a third of the debt is owned by foreigners.
Domestics always buy their domestic debt, like local banks buy their debt and local insurance
companies buy their debt because regulations. That's just what you do. But once you become
dependent on
August 30, 2024
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the funding of foreigners, you risk that at some point the foreigners come in and say, "Hold on,
do I want to own French debt?"
"Where's their government? What if there's riots in the streets in the fall because of postcuts?" Riots in the streets, by the way, when all the policemen... Every French policeman was in
Paris for the Olympics. Usually you get time off in the summer, they're all going to get time off
in the fall. Fall is usually when there's riots. We're going to have riots without the policemen.
So, I think there's this risk emanating around France that perhaps the market is being a little too
comfortable with, partly because it's like, "Oh, we've seen this before with Italy, with Portugal,
with Greece. And at the end of the day, things always work out and ECB steps in, et cetera." But
the numbers keep getting bigger and bigger and bigger, and the French numbers are pretty
darn big.
Ed D'Agostino:
Yeah. And France is not Portugal or Greece when it comes to size of the economy.
Louis Gave:
No. That's right.
Ed D'Agostino:
Well, we as Americans, I'm American, we are doing everything we can to help the French
economy by way of Boeing.
Louis Gave:
It's actually interesting because this summer, if you look through the tourism numbers, Spain,
Italy, Greece, they had monster summers. France, not so much. I think everybody stayed away
out of the fear of Olympics. The Olympics tourism-wise were a dud. The events were great, the
organization was very good, et cetera. But in terms of revenue, it was a disaster. Paris was a
ghost town. This was the year you wanted to visit Paris. You had the museums to yourself. It
was an awesome summer to be in Paris. It was truly terrific. But not if you were running a
restaurant in Paris or a hotel, then it was a bit of a disaster.
So to your point, the number of American tourists you see everywhere today is mind-blowing,
which is another indication for me that the US dollar is overvalued. When you walk around
some small village in Spain in the middle of nowhere, and there's a bunch of Americans, you're
like, "Wow, okay." They're so far off the beaten path it's a testimony to the strong dollar and to
how weak all the other currencies are. By the way, I was looking at the tourism numbers into
the US, and they were very weak this past summer. Foreigners didn't come to the US. The US .
has just gotten too expensive. The US is now a very, very expensive place to visit. The rest of
the world is very cheap.
Ed D'Agostino:
Speaking of weak currencies, let's take a stop in Japan.
Louis Gave:
Sure. Well, it's not that weak anymore.
Ed D'Agostino:
Right. So that's the story. It has been getting stronger, but do you think that that trend
continues?
Louis Gave:
Yeah. Look, you mentioned that the Chinese trade surplus is one of the big anomalies in the
world. I think in our talk back in May, I mentioned that for me, one of the biggest anomalies in
the world was the yen at 160. The yen at 160, it was just simply ridiculous. You could get a topnotch meal in Tokyo for less than 25 bucks a head, when in New York for that amount of
money, you don't even get a slice of pizza anymore. So no, Tokyo, Japan, at 160 was a bargain.
Now granted, at 143 or wherever we are today, it's not the bargain it was two months ago, but
it's still a bargain. 143 is actually still cheap on the yen. I would imagine that what we're going
to continue seeing as an improvement in the US... Sorry, in the Japanese trade balances,
because at 143, a lot of Japanese companies remain extremely, extremely competitive.
Ed D'Agostino:
Do you think that that continues? Because there was a time in this country where we thought
that Japan was going to take the country over, trophy real estate was being bought, and
Japanese cars were taking over. And then…
Louis Gave:
Do you remember the movie Rising Sun?
Ed D'Agostino:
... the Japanese stock market collapsed. Yeah.
August 30, 2024
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Louis Gave:
The movie with Sean Connery. So will the yen continue to rise? I think it will. I think it will. To be
honest, I think we've started a downturn on the US dollar, but just because of shrinking interest
rate differentials. The Bank of Japan was extremely, extremely slow to raise rates, but they've
now started raising rates very slowly. They've had to because inflation is now a politically
sensitive issue in Japan. You have to remember that Japan is a much older society than the
United States, than pretty much any country out there. And while inflation is fine for young
people, because typically wages follow inflation, and you can work harder and make money, et
cetera, inflation is a killer for pensioners. It's devastating. Now, Japan is an old country, so
politically... Inflation just cost the prime minister his job. Japan has been…
Ed D'Agostino:
The irony, after so long, of them trying to create inflation.
Louis Gave:
Well, here's the funny... I think a lot of Japanese pensioners, they kept voting the LDP back in,
et cetera, because fundamentally they were fine with deflation. Again, if you're on a pension,
deflation is happy days. It's awesome.
Ed D'Agostino:
Great point.
Louis Gave:
Inflation is politically sensitive in Japan. It just cost the prime minister his job. I think you will
see higher interest rates in Japan. Meanwhile in the United States, we've now started... At
Jackson Hole, Powell, for all intents and purposes, signaled that he's cutting in September. So
just because of the interest rate differential, yeah, I think the yen's heading higher from here.
Ed D'Agostino:
We've covered a lot of ground, and I don't want to take too much of your time, Louis, but
you're the definition of a global investor in my mind. So what do you like? We don't have to get
into specifics, but just in general, where are you thinking that there are opportunities right
now?
Louis Gave:
First, thanks for having me and the kind words, and it's always good to catch up. My friend
Kevin Weir likes
August 30, 2024
Global Macro Update is a free weekly interview hosted by Mauldin Economics Publisher &
COO, Ed D’Agostino. You can learn more and get a free subscription by visiting this page.
to talk about the... He writes a newsletter called the Macro Tourist. It's a great read. He likes to
talk about series of rolling bubbles. We seem to go from bubble to bubble over the past.
Because we've injected so much liquidity into the system that we had a big fixed income
bubble, then we had a crypto bubble, then the meme stock bubble, then a mag seven bubble,
and then an artificial intelligence bubble. I've been scratching my head thinking, "Oh, what's the
next big bubble?" Now, if you'd asked me back in May, I was all gung ho on commodities.
And to be honest, I still am. I still think that we've under-invested in the extraction of a lot of
the commodities that we will need. And I still think that what people underestimate is how
quickly China is helping countries like Vietnam, like Mexico, like Indonesia, or others, pick any
one of them or Bangladesh, helping these countries industrialize on the cheap and on credit. It's
giving these guys canals and satellites and telecom systems and machine tools. And as they do,
you get raises in disposable income as countries industrialize and people want to buy
motorbikes and they buy cars. We're not talking about 100 million people here, but we're
talking about 2, 3 billion people who in the coming years are going to start buying refrigerators,
buying microwaves, buying cars, buying motorbikes. We've written a lot of pieces about the
upcoming boom across the Indian Ocean, the upcoming boom across Southeast Asia, across
parts of Africa.
I still think that people underestimate that the drain on commodities that all this will represent,
the demand for oil, for copper, for iron ore, for everything. So I do remain a bull on
commodities. But it was a whole lot easier to be a bull on commodities in May when all the
prices were going your way than it is today where I feel like I've got a ton of egg on my face and
where I feel like... I look at my own portfolio, and I feel like everything's been on fire for the
past three months, and it's been pretty brutal. So when things are not going your way, you
always have to say, "Okay, what am I missing?" Being an investor is a little bit being
schizophrenic. You go one way, and then you have to say, "Okay, this is what I believe. Now,
let's forget all this, and what am I missing?"
Ed D'Agostino:
You have to be able to change your mind.
Louis Gave:
Yeah. So you're like, "Okay, what am I missing? Is there a US recession coming? Am I wrong
about growth in emerging markets?" I really don't think I'm wrong about growth in emerging
markets because I do travel around a lot in emerging markets. I spend a lot of my time on the
road, and I go to Latin America, I go to Africa. I travel a lot across Southeast Asia.
I'm heading
back, in fact, into Africa in six weeks. I'm back in Southeast Asia next week. And everywhere I.
go, I see it. It's blindingly obvious to me. It's more cars, and it's Chinese tractors. So you see it
everywhere. I don't think I'm wrong on this. So then it's like, "Okay, am I wrong on a US
recession about to unfold?" Because if there isn't a recession about to unfold, I think
commodities come right back pretty quickly.
Ed D'Agostino:
Okay. For what it's worth, I agree with you.
Louis Gave:
Well, good. Thank you. It's painful. It's been a painful three months.
Ed D'Agostino:
My money is where my mouth is. It has been a painful three months. But at the same time, if
you're looking to put money to work, it's a better time than it was three months ago.
Louis Gave:
That's right. Absolutely.
Ed D'Agostino:
Louis, one random question for you.
Louis Gave:
Sure.
Ed D'Agostino:
[inaudible 00:47:05].
Louis Gave:
Don't ask me who's going to win the US presidential election.
Ed D'Agostino:
No, I wouldn't even dream of that.
Louis Gave:
Good.
Ed D'Agostino:
And even if we knew, I'm not sure that it's predictable what would happen to the markets.
Louis Gave:
A very fair point.
Ed D'Agostino:
Jared Dillion has been saying that he thinks private equity is in a bubble. He's not necessarily
saying that it's going to trigger a market correction or a crisis. But he's saying that when we do
get a correction, if there is any financial system stress at all, that private equity and the leverage
of private equity will greatly exacerbate it. I'm curious if you have any concerns about private
equity in general.
Louis Gave:
First, haven't you heard, bankruptcies are not allowed. So why are we worrying about this?
Bankruptcies are no longer allowed in the United States. Jokes aside, it's funny because I
actually just finished writing a piece, it's with my editors now, it's not been published yet. But
on this very theme of the over-financialization of the United States,
I mentioned how US equity
market is now three times US GDP, which is close to all-time highs. The all-time high was in
2021. The US economy has to grow pretty fast to carry this burden on its back. But here's a big
difference. Sorry, not 2021. It was the highest in 1999.
Here's a big difference from 1999 is if you look back in 1999, if you look at private assets, so
private equity, venture capital, real estate funds, infrastructure funds. Your typical lockup being
five to 10 years. If you look at all these private assets, back in 1999, it was 4% of US GDP. Today
it's gone from basically a three or $400 billion industry to now a $15 trillion industry. So $15
trillion.
Again, private sector GDP in the US is $18 trillion. Private equity is $15 trillion. Now,
private equity, and I'm using private equity loosely. Again, adding real estate, adding VC, et
cetera. The promise is that it will grow by 15% a year. That's typically what they pitch. Because
historically, a lot of them have delivered this.
So it's like, "Okay, our aim... We don't promise because we can't promise, nobody knows the
future, et cetera.
But give us your money and our aim is we'll make 15% a year." Now, here's
the question I would have is, how can you genuinely... I can see how you can make 15% on
$300 billion. Can you make 15% on $15 trillion when the US private sector economy is $18
trillion?
Can you make $15 trillion when the US economy... Can you make 15%, sorry, when the
US economy is roughly growing by, let's say, 5% nominal? You look at it, it's roughly two and a
half percent .
inflation, let's call it that, plus two and a half percent GDP growth. So 5% nominal when the cost
of debt for guys is typically 6%.
Now, part of the 15% came from the fact that the cost of debt
was zero.
Ed D'Agostino:
Absolutely.
Louis Gave:
You leverage things up and you get to 15%. Here's the reality is, you start at $15 trillion on an
economy that's $18 trillion, and you grow that by 15%. By 2026, it'll be bigger than US GDP.
Does that sound? Or do the maths no longer add up?
Ed D'Agostino:
What happens when you just can't make the numbers balance anymore?
Louis Gave:
Well, you don't return 15. What happens is pretty simple is, you turn to all your sponsors, the
big pension funds, and you tell them, "Oh, guys, sorry, we're not returning 15. We're going to
return two, we're going to return three, we're going to return four."
Now, you could say that's
not cataclysmic, whatever. Instead of returning 15, they got so big they go back to returning,
more or less, what GDP returns.
So they return four or 5%. That doesn't create a crisis, per se.
But what it does actually is, it creates a funding hole in all the institutions that were assuming
15% returns and don't get them.
So the way this gets resolved is all of the pension funds end up being underfunded and have to
raise taxes.
So you get higher taxes in California and higher taxes in Illinois, and then you get
more people leaving those states for other states because they don't like the taxes. You
amplify, I think, the problems in the states that already have problems.
If you're Jared and you
think this is going to be happening in the coming years, perhaps the way you structure that
trade is you buy CDS on California debt and you buy CDS on City of Chicago debt.
Ed D'Agostino:
Interesting.
Louis Gave:
Because those guys' budgets... If the private equity funds that they've invested in don't return
the 15%, those guys' budgets are going to get blown out.
Ed D'Agostino:
Oh, wow. That's a great point. I'm looking for the private equity equivalent of the Silicon Valley
Bank. I'm looking for the Private Equity Valley Bank.
Louis Gave:
Well, you have some…
Ed D'Agostino:
Easier to short.
Louis Gave:
Well, you have some private equity guys who are listed. Of course all the big guys are almost
listed now.
Ed D'Agostino:
Oh, absolutely.
Louis Gave:
But again, it might not be a disaster. Maybe instead of returning 15, they'll return five, and it
doesn't mean they blow up. It's just the guys who are banking on the 15, that's where the
problem will be.
Ed D'Agostino:
I won't include this part in the interview, I was just generally curious…
Louis Gave:
Oh, you can. You can if you want.
Ed D'Agostino:
... what you thought.
Louis Gave:
You can include it. I don't care.
Ed D'Agostino:
We'll see how it looks.
Louis Gave:
Sure.
Ed D'Agostino:
Louis, always fascinating speaking with you. Really appreciate the time.
