China | Emerging Markets | Equities | FX
This is an edited transcript of our podcast episode with Boris Vladimirov, managing director at Goldman Sachs and one of the top macro thinkers in the market. In this podcast we discuss parallels and differences to 1970s stagflation, the challenge of the current regime, why terms of trade matter, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
The views given in this podcast by Boris represent his personal opinions and not those of Goldman Sachs or any other organisation he is affiliated to.
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This is an edited transcript of our podcast episode with Boris Vladimirov, managing director at Goldman Sachs and one of the top macro thinkers in the market. In this podcast we discuss parallels and differences to 1970s stagflation, the challenge of the current regime, why terms of trade matter, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
The views given in this podcast by Boris represent his personal opinions and not those of Goldman Sachs or any other organisation he is affiliated to.
Introduction
Bilal Hafeez (00:01):
Welcome to Macro Hive conversations with Bilal Hafeez. We aim to bring you the best macro to help you successfully invest in financial markets. For our latest analysis, visit macrohive.com.
The world is seemingly looking good again, at least according to equity markets. They’re up on the week. Bond yields have gone sideways, even as U.S. inflation printed above 5%, and Bitcoin continues to march higher. Let’s see how long all of these trends last. I discussed many of these issues, including the UK situation and the Bank of England, on a Bloomberg interview, which you can see on the Macro Hive social media channels. We also, at Macro Hive, held a Bitcoin webinar where we ran through our new framework for analysing Bitcoin and crypto markets, which includes things like looking at ETF flows and hash rates. The hope is that this work will help demystify the crypto market for investors. You can watch the recording of the webinar on the Macro Hive website. You can get access to all of this content as a member of Macro Hive. This includes all of our research reports, webinars, transcripts of podcasts, and our member Slack room where the Macro Hive team and members discuss markets for all hours of the day. It’s refreshingly different from Twitter. And when you sign up to become a member, the first month is free, and then it’s only the cost of a few weekly cappuccinos. It’s well worth it, and many call Macro Hive the hidden gem for investors. So once again, sign up to become a member at macrohive.com.
An introduction to Boris
Bilal Hafeez (01:25):
Now onto this episode’s guest, Boris Vladimirov. Boris is a returning guest, and for good reason. I think he’s one of the top macro thinkers in the market. And right now I think is a great time to have him on to decipher what’s going on in the world. In terms of his background, currently, he’s a managing director at Goldman Sachs. Before Goldman’s, he was a Partner and Portfolio Manager at Rokos Capital Management, Fortress, and Brevan Howard. Boris started his career on the sell side, which included working at UBS and Dresdner. And in this interview, Boris will be giving his personal opinions and not those of Goldman Sachs or any of the organisations he’s affiliated to. Now, onto our conversation.
So welcome, Boris, it’s great to have you back on the podcast. You’re one of my favorite guests I’ve had on the podcast show. It almost feels like 100 shows that we’ve had so far, so welcome back.
Boris Vladimirov (02:15):
Pleasure to be back, and congratulations for the amazing job that you’ve done in such a short time.
What is reverse goldilocks?
Bilal Hafeez (02:20):
Great, no, I appreciate that. Now, clearly, there’s a lot of uncertainty in markets right now. We had this quiet summer period, and we’ve come out of summer with so many different crosscurrents. There’s energy crisis, there’s taper talk, central banks are trying to work out whether they should respond to high inflation or not, there’s a China story, and so there’s a lot of confusion. And you recently published some new work where you described something called the Reverse Goldilocks, and you’ve created this very good presentation, the Reverse Goldilocks Macro Regime, which I read through, and I thought it was excellent. And I think in many ways, you’ve been able to draw together lots of these crosscurrents into a framework which we can then use to hopefully invest successfully in markets. So I thought we could start with that, and maybe you could talk about what you mean by the Reverse Goldilocks, and then we can go from there.
Boris Vladimirov (03:09):
Sure, yes. I mean, obviously, coming up with a concept was a bit of a work in progress. Obviously, everybody has been talking about stagflation for a while, right? But somehow we thought that stagflation probably is not the best way to describe the current situation, because it’s very likely to be very different from the seventies, which is our key benchmark for stagflation, or the post-communism collapse where you had the big GDP drop with high inflation. That was also a stagflation, was a structural crisis. But this current period is different. And obviously, going back to 101 Macro and thinking about the four regimes in which any economy would be at any time, based on the direction, second derivative of growth and inflation, as well as the level, you have four options. And we know well the boom bust cycle. So it’s a strong growth, strong inflation, weak growth, weak inflation or deflation.
But you have the other two quadrants, which we know obviously about Goldilocks, because in terms of 2000 to 2007, and then immediately after Lehman for about five years, that was the dominant period in which EM did great, carry trades did great. That was the big emergence of the carry trade as a concept. Low volatility. And it was characterised by okay growth and weaker inflation. That was the so-called Goldilocks period.
And the reason underlying that regime basically was the boost to supply which came through very strong investment in China and the integration of China into the global economy, full and very profound and very efficient, with the transport networks and in the entire supply chains emerging. And at the same time, obviously technology plays a very important role for the supply curve, the emergence of shale, and US bringing a lot of cheap oil to the market. That allowed the supply curve to basically move towards the demand curve. And post-Lehman, the demand curve was practically soft because people hit de-lever. And banks also hit repair balance sheets, raised capital. So the two curves moved toward each other, and that was bringing price pressures down, allowing central banks to try to support demand and pump a lot of liquidity without any impact on inflation.
Bilal Hafeez (05:30):
So the key thing there, I guess, is that all the supply side issues we’ve had have been positive over this period of time, whether it was the integration of China, whether it was the shale gas. I mean, it was all moving in the right direction.
Boris Vladimirov (05:42):
Yes. Absolutely. And technology as well. Internet and so. In the current period, I think we are in a situation where those two curves have moved away from each other. And that’s why the Reverse Goldilocks, in a way. And on the supply side, we have experienced constraints not only due to COVID. I mean, COVID has played an important factor, particularly on the side of labour supply, and there’s a lot of work being done on the participation rate, on the fact that still, in surveys, people quote risk of infection as one of the reasons not to come back to work and so on. So that is one element. But I think it goes further and deeper. I think you get practically the start of that period from the point where the trade frictions between the US and China started to emerge. And the whole idea to practically re-shore and to create, practically, two supply chains or multiple supply chains in this context, would imply certain level of disruption at least until that transition is complete. That’s kind of one thing.
Bilal Hafeez (06:51):
And that was occurring before COVID, of course, and COVID kind of magnified it.
Boris Vladimirov (06:55):
100%. So we were already into that environment. But there is something even deeper. And I find it fascinating, actually, how relevant it is to the energy shock that we are seeing. I mean, that reminds me, basically in two words is, that we have not invested enough in the real world in the last 20, 30 years. And it reminds me of the joke about the hospital food, where the patients are complaining. One’s saying, “Oh, this hospital food is terrible. How do you eat it?” And the other says, “Yes, of course, and in such small quantities.”
So we have been investing not in clean energy for a while and it has been in small quantities. Just to give you an example, the IEA Investment Report shows, just in power gen, we’ve been investing $800 billion per year since 2010. In that period, global GDP and global money stock has doubled. So relative to output, and relative to money, we have halved our annual investment by 50%, even including the increasing investment in clean energy. And you can think of simplifications for real interest rates and the saving glut. I mean, obviously, if you do not invest, you’ll have more savings. But at some point, you are also going to get more inflation. That’s the idea. And the good thing about this type of macro-regime or part of a cycle, is that it is not that frequent. If you look at the last 25 years, and you define the four quadrants, the standard boom-busts are about 50/50 equally distributed as a distribution, one against the other, axis-wise. Goldilocks versus Reverse Goldilocks has been 80% Goldilocks, 20% Reverse Goldilocks. Very, very small. And the good thing about it, that it’s actually a difficult regime. And it’s good that we haven’t had it for so long, but it also means that it will be more confusing because, even from the point of view of econometrically estimated forward condition of probabilities of return for various assets, we cannot draw from the historical distribution because we have to go back to the seventies.
Parallels and differences to 1970s stagflation
Bilal Hafeez (09:02):
And you mentioned the seventies. So what’s the other differences between this sort of Reverse Goldilocks in the seventies?
Boris Vladimirov (09:08):
I think that there are definitely differences, and clearly, by far, the biggest difference is technology. And the second big difference is the level, the degree of unionisation. So both those would probably preclude the substantial surge of inflation to the point of the amount of money that we have created. So we need not be afraid for a very high inflation surge, but when we have inflation that is a percent above the targets of the major central banks, I wouldn’t say that this is unthinkable or impossible. And that’s one difference. The other, I think, is that you do not have the concentration of the economy in terms of having fewer sectors and smaller number of products.
Bilal Hafeez (09:54):
Okay, yeah. So the economy has gotten more diversified today compared to back then.
Boris Vladimirov (09:58):
Exactly. And usually the more diversified the economies, the less possible to propagate an inflation or impulse. Japan is probably the best example for that. It is the economy with the highest number of individual, single products.
Bilal Hafeez (10:11):
Oh, is that right? I didn’t know that.
Boris Vladimirov (10:13):
Yes. I mean, you just have to go to Japan to see the incredible choice you will have as a consumer. So in this context, the more products you have, the less pricing power the marginal company would have, or the marginal sector, or marginal product type. Because the moment the price goes up, the customer can never have the whole basket, so they will shift to something else. And, again, that kind of preserves a lid on high inflation, but there are underlying processes which can still bring us into a Reverse Goldilocks. And I don’t say that we are in a Reverse Goldilocks now. The markets are always forward-looking, so the markets start behaving as if we are, but based on that metric, on the four quadrants, we are still in inflationary boom.
Bilal Hafeez (10:57):
Okay, yeah. Because growth is still high.
Boris Vladimirov (10:59):
Growth is still… PMIs are well above 15. World PMI is 54. We are not in a too bad place yet.
The challenge of the current regime
Bilal Hafeez (11:06):
And just one thing on the monetary and credit side, how do you see that? Because, obviously, after the global financial crisis, we saw significant regulation and banks, even by themselves, were deleveraging. And so that broke the transmission from base money increase to credit growth. In the seventies, I don’t know the exact numbers there, but I imagine credit growth was a bit stronger back then. And there was less financialisation, you could say. How do you kind of see that whole transmission from QE or base money increase to credit growth?
Boris Vladimirov (11:34):
Definitely is constrained in the financial sector. And you can see that probably crystallising in the unwillingness of US banks to add to reserves and the rise of the RRP facility. If the banks are telling you that they do not want more reserves and do not want practically more QE, it means that they do not think that the asset reserve ratio would benefit them, in terms of making money out of it. Now what is different, I think, to the seventies, is the rise of shadow finance, and particularly the rise of crypto. And it is fascinating that, if you think as crypto as money stock, it is the fifth-largest money stock in the world after China, US, Europe, and Japan. Two-and-a-half trillion. And that is a money stock that is mostly deposits and has no lending on the others.
So, obviously, it is a slow process, but if this interacts with the finance industry and continues to develop and can create a transmission. And I’m not talking about internal leverage for speculation. That is happening already. And there have been a few burns there. But I’m talking about transmission to reactivity, either on the consumer or the investment side. That would definitely have impact on the multiplier in real terms. So it will move the aggregated demand curve to the right, and was trending the aggregate demand. And, obviously, this is probably still early days, but when we are thinking down into this decade into the business cycle, having de-levered consumer, partially de-levered corporates, or at least big corporates were big winners in this process, and that catalyst, you can envisage stronger credit transmission, stronger money transmission into the next 10 years as compared to the prelim. And there is another element to credit demand, totally different from that, and it is related to decarbonisation and to greening that insufficient and dirty energy-producing stock. The IMF is projecting we need to between six and 10 trillion investment for the next 10 years. So about six hundred billion to one trillion per year globally, that’s about one percentage point higher than demand, which isn’t small for the world altogether. And I would assume that a decent amount of that will involve some form of public involvement either through backed policy or actual projects.
Bilal Hafeez (13:57):
Okay, that makes sense. So basically, what you see there is sort of public-backed investment in the green sector that could underwrite credit in some form or another, depending on public-private partnerships or just some form like that. You’re seeing a lot of talk about that in Europe and Germany and so on. So that’s probably kind of the leader in this space.
What does it mean for the macro environment?
Bilal Hafeez (14:15):
Just so a couple of things to follow up what you were saying there. I mean, are you surprised by the unwillingness of US banks to lend to the real economy over the past 12 months? That they kind of just seem to be wanting to move all the cash away from themselves, or the reserves away from themselves, and just not want to sort of lend on.
Boris Vladimirov (14:31):
First, I wouldn’t say that US banks have not lent to the US economy. And here, obviously, I’m not speaking as a Goldman Sachs employee. This whole discussion is private views and my personal opinions, not those of Goldman Sachs. But you have to differentiate on the numbers. Even if C&I loans have not gone up, securities owned, kept by US banks, are up 18% year-on-year. So the lending has gone through the securitised channel. And there has been some transmission.
Bilal Hafeez (14:56):
But is that mainly to treasuries? Is that mainly to the government?
Boris Vladimirov (14:59):
Non-government securities. So I’m talking about corporate securities. So it is a different form of transmission. On top of that in this early part of the cycle, following such a large fiscal transfer to the private sector, the private sector has enough cash because of the fiscal injection. So operational cash balances are okay, and actually the credit demand, paradoxically, so early in the cycle, is not there. A credit demand will come later, after the commodity price shock, and with a higher price level, when companies start building up more and more inventories and the whole private side of the economy starts roaring, so to say. And I have no doubt that over the next three, four years, this will be the direction of travel of the US economy, even though everybody’s a bit more concerned about next year.
Bilal Hafeez (15:47):
No, absolutely. So that makes sense. So actually credit growth side, in terms of lending to the private sector, is telling us more about the household balance sheet which has been so strong because of fiscal transfers, rather than a supply issue per se.
Kind of a related point, I suppose, and this is something I’ve often been thinking about when I speak to investors as well, is, can we classify the downturn that we saw last year during the peak COVID, where economies collapsed around the world, is that a proper recession, and so we’re at the beginning of a new expansion? Or are we in the same expansion as the post-GFC period, and that was kind of like a mini-correction of sorts, and so we’re late cycle right now. Because last year wasn’t really a proper recession in many ways, if you just looked at household income, credit, all of these sorts of things.
Boris Vladimirov (16:32):
That’s a great question, because it touches on the definition of recession. And by NPR terms, actually, to quote, you have to probably avoid the concept of recession, and then you can make the argument of a late cycle. Now where I do not agree with the late cycle definition is… I mean, first on the recession concept, the depth of shock was so intense, and the magnitude, that irrespective of whether we call it a recession or not, this is one of the biggest shocks that we have seen with the biggest follow-up rebound that we have seen, and the biggest fiscal response post-war. But highest public debt levels.
So it has created macro-volatility in the system. That will probably be double the average recession, macro-volatility that’s been generated. So from the point of view of asset prices and investment, that macro-volatility might be a little more relevant of whether we would label two consecutive quarters of negative growth, and so on. So what definitely it is not, is not stagnation. So the whole concept of secular stagnation now is part of a previous period. So we are definitely moving away from that. Now, in terms of whether we are late cycle, I think one of the characteristics of late cycle is a highly indebted private sector or any sector that needs to de-lever. Now if you look at the balance sheet increases, the biggest balance sheet increase post-COVID is the public debt balance sheet. The public debt balance sheet, however, apart from situations in emerging markets where it becomes unsustainable, is not a great cyclical driver per se. Because in the real world of the big macro blocks, the public debt is the safe asset still.
So that’s why I tend to believe, and people are saying, that commodity price increases… This is late cycle phenomenon. There is an element to that in a way that in the late cycle, you have a build up in financial balance sheet that triggers excess demand, that triggers that energy price back. And that energy price back can shortcut the market plus one and trigger de-leveraging. Now the thing is that the current energy shock isn’t likely to trigger a de-leveraging snowball apart from maybe in sectors in China. And then we can talk about China, maybe.
What gives central banks credibility?
Bilal Hafeez (18:53):
We should definitely talk about China, but actually, you mentioned that public debt problems don’t apply to many DM markets but does to some EM markets. And I just wanted to pick you up on that point, which is, why is it an issue for some EMs? Is it the fact that they don’t have the right institutions or credible institutions? Is it the fact that there’s a currency issue? Is it that they have foreign holders of their debt? I mean, what it is it about EM that prevents them from running large public debt to GDP ratios.
Boris Vladimirov (19:22):
This is the standard EM DM 101 kind of differentiation. And it is all about the saving rate and the trust of international currency and international safe assets. And it’s not so much… I mean, often people say, it’s foreign speculation that causes those crises. The real essence of a typical EM confidence crisis or debt crisis is that at some point, the country, the national savers, they decide that they don’t want to keep their savings in the national asset, and they start heading for the door. That’s what happened, basically, in Germany after the first World War. It’s not the typical emerging market phenomenon. It’s the phenomenon of confidence loss. And the ultimate epitome of example of the other side is Japan, where practically after decades of public stimulus and high private saving, private assets and public debt have been going together. But because the home bias and the confidence in the system is so strong, Japan is the most monetised or over-monetised economy with the highest public debt level which remains completely sustainable because the social contract works in that context.
EM, of course, now is differentiating. And there are countries where you have reasonably high domestic saving and also, partially because of capital controls, the money remains there and it’s not going to head to the door anytime soon. And maybe China is an important part of that group because of its size. You have other countries like Brazil where the rising in public debt to GDP has been more concerning for domestic investors, and that has led to capital outflows. So I think that is kind of the differentiating factor. The biggest paradox in that kind of typology is Russia, where you practically have a sovereign that has zero net debt. There are only four countries in the world that have no public debt. And at the same time, the domestic investors, they have almost insatiable demand for dollar assets or for foreign assets.
Views on China
Bilal Hafeez (21:29):
Now, you talk about China and, obviously, there’s a lot of folks in China at the moment, the real estate sector, Evergrande and so on, and there’s also some energy issues, factories shutting down. I mean, how do you contextualise this? Are you worried about China, or not?
Boris Vladimirov (21:43):
You know, it is very interesting. I think China is obviously a huge economy and very diverse structure among the provinces as well. And I think, generally, when we try to make a rational judgment about what’s going on in China, we have to be really careful how we build our knowledge first. Because what is happening is clearly the domestic new sources they’ll be uniformly positive, most of the time, and at the same time, what’s happening on the external information sources, you would have an increasing bias towards negativity. First, because negativity sells better. I mean, this is 101 Media Business. But also because, obviously, there are some problems happening, and we have clear situation with the private property developers. And I think that I prefer to actually rely on the numbers which are hard numbers. And I definitely look at the PBOC balance sheet and what’s going on there. And when I look at that, and we’ve been saying that for the last several years, is that PBOC is doing quantitative tightening, which is a risky policy. It helps to stabilise the currency or to make it stronger, but it’s at the cost of increasing the credit risk in the system. Why? Because when you have an economy that’s going up 10% nominal per year, and you reduce the money base by 17% over three years, you’re going to massively increase the acquired velocity in the system and through the money market channel that will start squeezing the most levered borrowers.
Now when we think about China, I think, it’s very relevant to think in terms of the big guidelines which, the government has given us policy directives because clearly, an important characteristic of the Chinese economy system is that this plan, it is based on direction of policy targets that need to be fulfilled over certain period of time. And these targets go from very broad kind of lines until they structure and crystallise into directives for sectors. So the big three that we need to know is that they want to reduce income inequality, that’s number one. Number two is, they want cleaner environment. And number three is, they want to reduce financial leverage. So in this context, the difficult situation which some of the property developers have gotten into, is because of one and three. And that means that given that these policies are part of the big directive, it is less likely that there will be immediate relief on that. Now where I hope that there will be a relief, and there will be change, is in the policy of quantitative tightening from the central bank. And if the central bank pulls back a bit on that, and I don’t say that they should start doing a large QE and flood the whole system with huge unnecessary amounts of liquidity, but just to bring back at least, and give back these 17% in the money base over the course of the next six to 12 months, actual relief or will prevent that process of deleveraging from going from property developers to other segments which will have a bigger impact on employment and output. Which would be unwelcome, obviously, given that they have employment as a target.
So in that context, if we get soon, I would say sometime in October, stats from the central bank… And there, I’m not really thinking about interest rate cuts, but I’m thinking more about the quantitative policies. And they would be safe because you would be so tight if you are close to running an account deficit or trade deficit. But given the amount of export revenues that they have accumulated over the past one year, the risk is not that dollar China is going to go higher, the risk is that there is a trillion dollar of deposits and at some point, if you get that short liquidity, corporates will have to start selling them, and the currency can strengthen. So it’s a different situation from the typical EM risk situation. And another number which I think is very relevant, energy consumption… Power shortage in China is not just because of co-production, reduction, because what you have is, you have 13% growth in rail transport. Half of rail transport is coal. 22% increase in services energy demand. This is not an economy that’s on the brink of recession. That’s January to August. These are recent numbers. So clearly property is important, and it’s an important part. But property, I think you have to think a bit as part of the asset management of the Chinese household. He is a saving instrument that creates real world investment. But because the Chinese will not continue to save less, or they will probably move some of their savings into the equity markets. So the current difficult situation on the property side might lead into, surprisingly, into an equity market rally next year. And if you look at the past five property busts, after two of them, there was a very big rally in equities.
How will policymakers respond?
Bilal Hafeez (26:38):
Just, on the point about quantitative tightening. I mean, despite the concept of quantitative tightening, we’ve still seen relatively growth in credit over this period, no? Over the past three, four years. The debt to GDP. However you slice and dice the credit numbers, it’s been quite strong over that period of time. So how do you square that circle?
Boris Vladimirov (26:56):
Yes. Okay, first, you do have China still well below 100% on loan deposit ratio. So they have relatively large deposit base. But what I mean is that in the system, the money market, we are coming back to Lombard Street. The money market is the high velocity part of the core that would redistribute between the haves and have-nots, in terms of meeting the requirements to balance the books. And it’s like an inverse pyramid. If you let the top end of the pyramid expand at a fast pace, but you keep core unchanged or smaller, you will, by definition, increase the velocity in the intermediate sectors. So a key indication of such situation would be stress in the money market and money market rates starting to kind of push higher. That’s kind of one of the indications. And that has not been the case yet, apart from short periods. There was, actually, some pressure up in the weeks before, and PBOC reacted immediately, adding 450 billion of liquidity just before the Golden Week. But it could develop if that type of credit stress broadens beyond external developers. That’s my point. So I think, if I would be a policy maker, I would think about the contingent risks, rather than the immediate state of the system. Because these decisions are all forward-looking. And speaking about policy maker, maybe we can talk briefly about what’s the optimal policy in Reverse Goldilocks.
Bilal Hafeez (28:25):
Yeah, I was going to ask you that. So what is it?
Boris Vladimirov (28:27):
It is very interesting, I think. I mean, this is pure speculation, of course. I don’t think there is a textbook written on that, but if you think about it during the Goldilocks period, obviously optimal policy was maximum support from monetary. And probably would have been more support from fiscal, but we didn’t get it. So that was the kind of main argument of the secular stagnation theme.
Boris Vladimirov (28:49):
So in Reverse Goldilocks, clearly, you would need better coordination between monetary and fiscal. And from investor point of view, it will need more attention on monetary and on fiscal, but in a different way. So it is, obviously, fairly difficult to predict, understand the fiscal impact, because it is complex. There are political uncertainties as we follow daily what’s going on with the debt ceiling and with the Social Infrastructure package. So in that context, I think… Let’s speak briefly first about monetary.
I think that one key differentiation from Goldilocks is that hawkish monetary policy is not necessarily bad for risk. And let me explain that, because it sounds very counter-intuitive. But in Reverse Goldilocks, you have two scares. You have the inflation scare, and you have the growth scare. And the market, the investors, they linger between the two. They would go from one to the other. It can be in one region or another region. So this year, for example, is the year of the US inflation scare and the China growth scare. So, as a policy maker, you have to be sensitive to where the scare is. That’s kind of the key thing. And then, basically if you do address the inflation scare, you address it one way. You take a more hawkish stance. And this is what the Fed did. What you do is, that’s not bad necessarily for risk, because what you do is, you basically clip the inflation fear part of the distribution. You stabilise that. You’re moving to clip it. You’re reducing uncertainty about your policy. That’s already a positive. And then, also you’re opening your space to move towards easing, because you have created the hawkish move. That piece, kind of, your condition of course, you have to be very sensitive. If the pendulum swings to growth risks, that you do not stay on clipping inflation risks for too long.
Bilal Hafeez (30:44):
And in that context, does it matter whether you focus on QE or tapering versus policy rate hikes? I mean, is there a distinction between the two, or is it, broadly, the same directions, hawkish in either case so it doesn’t matter?
Boris Vladimirov (30:56):
Great question. And I would say, by all means, rate hikes have more significant implication. And there is a very interesting loop process there, which I hope we’re not going to see. But that is the loop of the debt sustainability. Because you have to think about the inflation and growth risks as these two doors in the action movies, like Indiana Jones, that may start moving close to each other. As policy maker, you do not want them to move too close to you, because if they close, then it becomes impossible to stabilise, to do anything with monetary policy. In that situation, any easing destabilises or increases the risk premium on public debt because you are in a kind of proper stagflation scare and debt sustainability scare. Because any addressing of growth increases your inflation risk and destabilises, and any keeping of inflation rates deteriorates your growth expectation.
So at the moment, we are definitely not there. And I see a very small probability that we enter in such situation. We are not there in terms of public debt to GDP levels and so on. I speak about developed world. But these types of developments have happened in the past in emerging markets. And the only solution there is a default and resetting the system. This is Argentina, or earlier, thousands numbers of EMs. So of course, in the EM, people say this can never happen. But I say after COVID, the probability… Obviously, previously probability has been 1%, now it’s probably 5% over the next 20 years. So it’s non-zero. It’s non-negligible. And as a policy maker, you have to be very sensitive on the two sides of the risks and be more active in addressing those. That’s on the monetary. On the fiscal, I think, is also very relevant and very important. Almost as important as the monetary. Because you have practically three choices, I think. Tighten fiscal, and to regain fiscal space, and stabilise the debt to GDP level at the cost of increasing the growth fears. Now, the fiscal must also be sensitive, whether you are into the inflation scare or the growth scare. Because if you tighten the fiscal when you’re in the growth scare, you’ll be accelerating that effect.
The second thing is, and I think it’s very important to filter all new information in terms of macro decisions to these supply-demand curves. Are you moving the demand curve with your fiscal decision, or are you trying to move the supply curve? This is probably the most important. So, for example, in that context, I’ll come back to QE. So the absolutely optimal policy would be to maintain QE and fund energy infrastructure investment. Why’s that? Because you will not be crowding out the private sector. The private sector will be able to also invest more, which will give you more supply. That, by definition, should be reducing the inflation fears and reducing the growth fears at the same time. So my optimal policy… Actually, ECB, and Europe in particular, is pretty close to that type of framework, with the green investment initiative, the recovery fund initiative, and the idea that after PEPP is reduced, there should be probably a bump-up in the running QE. So that’s kind of how I think the interaction is. Obviously, if you do fiscal for subsidies, given the energy shock, you will be anchoring the inflation side at the higher level.
Why terms of trade matter
Bilal Hafeez (34:27):
Yeah, I understand. So that’s quite a compelling case for the fiscal side. Now, in terms of the implications on the macro side, I mean what does this all mean in terms of growth, prices, and so on?
Boris Vladimirov (34:38):
I generally think that we will see slower growth over the next 12 months, but I do not think we are going to see a double dip recession. I think that China will stabilise and will start improving into next year. European growth will moderate. And US growth will moderate with a fiscal cliff. But I would say, I don’t think that the relative price shock at the moment is of the level that is going to completely destroy demand. Also because the private savings significant coming out from the COVID shock. And the sovereign is less sensitive to the energy price shock. And in this context, I think the most important relevant macro factor for investors to think about is terms of trade or input-output prices or in good old words, who is benefiting and who is losing from this relative price volatility? So that’s kind of the thinking.
In terms of trade, it’s very interesting, because it allows almost on a daily basis to classify and see all that’s going on. So it gives you a high-frequency update of where the countries are heading to, or companies. And you have to, of course, contextualise that on the base of the saving rate of the country or the cash levels of a corporate, depending on what you’re looking at. So the shock absorber potential. So you have in one, countries that have high savings rate and positive terms of trade shock. Those countries, they can be in their own Goldilocks environment within the Reverse Goldilocks of the world. Why? Because they can let their currencies depreciate somewhat. They’ll have lower inflation. And they can invest more, import more technology, and grow faster than they would in a normal situation.
Bilal Hafeez (36:16):
And what are some examples of those countries?
Boris Vladimirov (36:18):
I mean, these would be your energy exporters that run current account surpluses. This will be your Middle East, your Russia, Kazakhstan, Indonesia, Malaysia, in Asia. These are Colombia… It is not running a current account surplus, but it definitely is a big beneficiary of that. And you do have, of course, countries that traditionally have lower savings rate. And in terms of shock, the effects there will be still positive, but they’ll be trickier. It will not be as straightforward. The political risk will be more important. This is your Brazil. So if we get the direction of travel in politics that kind of brings back investor confidence, actually Brazil can experience a very positive period. And then you have countries that partially have… basically are losers in that environment. They are big energy importers. They will have to maintain higher real rates in order to keep the… especially if they have low savings rate and run current account deficits.
Bilal Hafeez (37:15):
Which then is obviously more challenging for the policy makers in those countries, because they have to face the trade-offs there.
Boris Vladimirov (37:20):
They’ll be facing the trade-offs, and it will be more risky if they decide to start easing policy, for example. Especially if US is stabilising inflation. You have to then contextualise yourself on what US is doing as an EM policy maker. And that is going to be more challenging. Of course, now, most of the emerging markets, actually, are normalising and tightening, and they will probably be able to stabilise inflation more successfully and faster. So as a whole, probably, the inflation differential between EM and DM is going to be the narrowest that it has been for a while, which is not necessarily bad for emerging market asset classes at all.
Bilal Hafeez (37:58):
Yeah. And what are some examples of the countries that are facing negative terms of trade shock and have poor savings?
Boris Vladimirov (38:04):
I mean, look, actually, luckily in EM, all North Asians who have negative terms of trade shock, they actually do have relatively high savings. And they have high beta to global trade, which has been doing very well. So they’re not immediately impacted. This is your India, your Korea, China. They rank. In this time zone, clearly Turkey stands out as risky. And of course, they’re benefiting from some improvement with tourism now that they have done very well with their vaccination rate. And that improvement on the service side, tourism in particular, is going to bide us some time. The strength in Europe is biding us some time. But if Europe starts slowing down, and with energy prices where they are, over the next 6 to 12 months, it will become more challenging to cover a widening trade deficit.
How will equities, bonds, and FX perform
Bilal Hafeez (38:49):
And if we just round things off, what are the broad implications for global real rates and the dollar?
Boris Vladimirov (38:55):
Yes, I think, obviously, this is the million-dollar question. For the dollar, it’s not that straightforward because I think we are… Swinging between these fears, from inflation to growth, creates very choppy two, three months kind of moves in the dollar. And I think that will continue. So if we swing now to growth, the dollar will probably weaken, most likely will weaken. And I think for investors, it will be more interesting to think more in terms of the terms of trade axis across trade currencies. So in this context, funding an EM, for example, might be more interesting. Because also term premium might have to rise, given all the investment that we might need to do in energy and infrastructure and so on. So that’s kind of another theme.
Boris Vladimirov (39:38):
Also, long-term volatility will probably have to increase if the macro-volatility of growth and inflation is higher in this cycle. And then correlations, especially if we enter into a Reverse Goldilocks regime, correlations between assets will be very different from the standard. So that’s another theme. And then we see it already this year, where actually being long treasuries has not been a good risk-off hedge. And that’s why people tend to overweigh buying dollars as risk-off hedge. But as all hedges, that’s also not without its risks.
Bilal Hafeez (40:09):
Yeah, no that’s really good. There’s some really good takeaways from our conversation. I mean, one important one is that we need to use different framework from the environment we’re in today, so the Reverse Goldilocks framework rather than the stagnation framework or the Golden Era 1990s framework. And then the other one is, the importance of understanding in terms of trade shocks, which I guess we haven’t really thought about that much, beyond smaller currencies when we’ve had big rise in oil prices. But this becomes a lot more central now. So it’s really useful framework. And it’s great insights that you provided.
Boris Vladimirov (40:39):
It’s a pleasure. It’s been a pleasure to be able to discuss and debate. And of course, future, any feedback, thoughts would be greatly appreciated from your side as always.
Bilal Hafeez (40:48):
Yeah, absolutely. Yeah. And if listeners have any feedback, viewers have any feedback, then sort of pass it on to me, then I’ll pass it back to you, Boris, and we can kind of keep this conversation going.
Boris Vladimirov (40:57):
Yeah. Because it’s an evolving environment, right? I hope we do not enter into that regime properly.
Bilal Hafeez (41:02):
Correct, yeah. So thank you! Thank you very much. Great, thanks.
Bilal Hafeez (41:05):
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