Matt Howlett

Matt Howlett

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Ben Melkman - Macro Interview Notes (USD, Europe, COVID)

2020-07-03

Some notes from the Raoul Pal / Ben Melkman interview on Real Vision on July 3rd 2020:

  • COVID19: The short and long run effects are going to be different.
  • Employment: we're not going back to 4% unemployment. We've had a 12 year expansion. It always takes a shock to begin a recession. Even if there are no more shocks, unemployment will be sticky. The probability of more shocks is high.
  • Short term, there are deflationary forces.
  • Long term structural effects are very inflationary:
    1. Blend of monetary and fiscal policy together is something that hasn't been done over the last 10 years. We had loose monetary policy after the GFC, but this has been offset by fiscal austerity (governments paying down debts). With Trump, there was fiscal expansion, but this coincided with tighter monetary policy.
    2. Central banks are not going to be able to function as they have in the past as inflation targeting because in that case they're going to be in a position where they're going to be asking the government to write a $1T cheque every year (I don't quite get this, isn't the rate locked in?).
      • The Fed has 2 bad choices. 1. push congress to end fed independence (unclear what he was talking about here) 2. Fed sees the political problem and does anything to avoid raising interest rates. Tries to change definition of inflation etc. Eventually, lose control of inflation expectations. Dollar bearish.
      • Globalization has been deflationary (because systems are highly efficient). COVID is going to be a significant accelerant to the de-globalization trend.
    3. Private sector is going to have a net loss of aggregate demand. Higher unemployment. Higher savings. Loss of demand will be replaced by public sector demand. Government is going to step in with infrastructure etc. Public sector is not as efficient. Difference in efficiency is also clearly an inflationary effect.
  • Raoul: Gold works for inflation or deflation. If we get deflation, then central banks are going to print more and gold goes up. If we get inflation... then gold goes up. It's a crowded trade, but there's a big structural setup like bonds 30 years ago.
  • "The great paradox" of central banks: Need to do more QE to create inflation. But the bigger the balance sheet grows, the more that inflation is the only thing that undoes the system.
  • On a debt jubilee: How does this work? Blah blah ... possibly central banks lose independence, possibly have infinite duration 0 coupon bonds .. blah blah - there's no way to do it without a currency crisis.
  • Raoul: Has a gold vs equal weighted basket of fiat currencies position.
  • Ben: Norway is different. Have $2T in savings in foreign assets. When they want to do stimulus, they sell those... so Norwegian Krone should be a strong currency. Similar effect to Japan - when JPY depreciates, money brought back (by the private sector I think), pushing it higher.
  • If you have a cataclysmic view of JPY (Raol seems to, due to thinking there might be a debt jubilee) then go long NOK/YEN.
  • End game is an extremely bearish dollar event.
  • There is a coming deluse of liquidity from the treasury general account. It's hard to bet against that. This is the only account held outside the financial system. Any money taken out of that account into the economy is an injection of liquidity (and vice versa). They have a liquidity buffer that will act against any downside into the election (except via miscalculation, e.g. China tensions).
  • They'll extend the unemployment benefits. Seems very unlikely they'll scrap this before the election.
  • Fiscal stimulus works on a rate of change basis. For things to stay still, deficits need to stay as they are. Reducing them is massivley contractionary (but deal with this after an election year!).
  • Not necessarily bullish on US equities in the near term, but downside is somewhat protected. Extremely negative on the dollar. Accelerated move lower from here into the election. Views this as a higher quality trade than equities (too many cross currents to consider with equities). FX trade is clear as crystal.
  • Thinks of gold as a two factor model - inverse of dollar liquidity and real yields.
  • Bonds are a low quality trade here. At this point, capital gains are nearly topped out... essentially a short vol position. Upside to downside ratio is not good. Convexity is horrible. 2. Liquidity gives support, but on the other side of that, the asset trades at historically low risk premiums. 3. Massive supply. Aweful long term story. Fragile at best in the near term.
  • Raoul sees a solvency issue on the horizon. There's $12T of corporate borrowing in dollars. Dollar in the US is not fungible with dollars abroad. Swap lines don't reach the people who need it...
  • Every previous crisis has been dollar positive event because dollar liabilities have dominated. So the world had a lot more dollar debt than assets. Coming into COVID, this was not the case for the first time in history. There is a mis-match between who holds the assets though. Raoul doesn't see how it helps. Ben thinks it matters.
  • USD bearish points:
    1. The dollar no longer has a better yield.
    2. Relative growth differentials. US doesn't look so good any more. US doing bad with COVID.
    3. US equity "buy back" game doesn't look good anymore.
    4. World doesn't see the quality of US politics as good anymore. US have been weaponizing the dollar. Clear negative to large holders of dollars: China, Russia. De-dollarization is a thing.
  • What is a viable alternative to the dollar? People are only going to move to something else if there is an alternative. Europe: Getting its act together.
  • World has never been more overweight US equities, underweight European equities.
  • Thinks EUR could be north of $1.60 in 5 years.
  • More likely to be wrong on Europe optimism than US negativity.
  • US went from 40% of the global economy in the 70's to 25%. Dollar has gone to 79% of all trade transactions. World is too overweight dollars at a time when the US is weaponizing the dollar, being isolationist. Holders should be finding alternatives. There is a trend of diversifying away of dollars. On any relevant horizon, the dollar is in big trouble. Economics as well as political factors.