As we wrap up the year and celebrate the festive season, we wanted to share some of our favorite moments from one of your favorite Wealthion interviews from 2024: Michael Howell with James Connor. Enjoy!
All the best for a happy, healthy, and prosperous New Year!
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Original interview aired Sep 18, 2024: https://youtu.be/H7q3kEZ2D-8
Andrew Brill 0:00
Happy Holidays from all of us here at wealthion. To all of you, I’m one of your hosts here at wealthion. Andrew brill, we took a look back at this year, and hope you enjoy these favorite guest moments from one of our best interviews of 2024 so why don’t
James Connor 0:18
we spend a few minutes talking about China? Because it is the second largest economy in the world, representing 20% of global GDP, and as you mentioned, there is a massive slowdown there. We really never know what’s really going on in China, but maybe you can give us some sense of how bad things are in China and how it’s impacting the rest of the world.
Michael Howell 0:38
Well, I think what you’ve got to do in terms of analyzing China is to sort of split out the secular, the trend from the cycle. And as I said, if you look at the cycle, the cycle has really been affected adversely by a tight monetary policy. And that tight monetary policy is really rested on the fact that China has had a goal, which is maintaining a firm, or at least stable Yuan against the US dollar. And that really goes back to their maybe longer term ambitions of trying to create a rival for the US currency, certainly within the Asian region, maybe even ultimately globally. And what they perceive is that they can actually extract a lot of soft power, if you like, by having a robust currency. So that’s been one of their geopolitical goals, if you like. And therefore, as the US dollar is strengthened over the course of the last two to three years, what you’ve seen is the Chinese really struggle to maintain the value of the yuan, and therefore they’ve had to tighten monetary policy. Now the reason that’s significant is that all economies were hit, as we know, two to three years ago by the COVID emergency, and the West came out of that, accomplished by a very easy fiscal and monetary policy, and in fact, so much so that we know we’ve got this short term legacy of inflation that policymakers are currently fighting. But China didn’t really have that luxury, and what China faced as it was trying to come out of COVID was this tight monetary policy that was put in place by the by the People’s Bank to try and maintain this firm Yuan against the US dollar. So they’ve never really had the opportunity of really a recovery from COVID. The economy has been in the doldrums for some time. That’s the cycle now. That cycle could be reversed as soon as they start to throw monetary policy or ease monetary policy back in onto the economy. The secular is a very different question. And I think what China is really seeing now is something that is called by economists the middle income trap. And that really means that you get up to a certain level of income per head, and you just find it very, very difficult to actually grow any more. The easy growth is there, and the more difficult growth where you’ve got to you’ve got to actually incentivize the consumer, you’ve got to get deeper productivity gains, you’ve got to invest in new technologies, etc, etc. It’s actually very hard to come by now. The problem that China has had, or still has, in fact, is that the consumer is not really enfranchised in China. So if you look at Western economies, clearly they’re driven to a very, very large extent by consumer spending. That is not the case in China. Consumer spending is important, but it’s not the same share of GDP that you see in Europe or the states, and that’s something that the Chinese ultimately will have to remedy. That means that their economic growth really depends on two features. One is more and more capital spending, or particularly infrastructure spending. And the problem here is that you can’t just keep building bridges or roads to nowhere. They’re very unproductive. They create a lot of debt. They saddle the economy with interest expense, and ultimately it’s a drag on economic growth. And the other dimension is export growth. Now, if you’ve got tariffs and trade protection isn’t emerging, it’s very difficult for China to actually maintain market share and actually grow its exports. So you can see the problems that China is facing, both secularly, cyclically and secularly, and those two problems are significant, and they’re basically causing China a lot of grief right now that have to be addressed. China is a big economy. This matters not just for China. It matters for the world, but we’re really searching for some sort of solution. And I think the ultimate, my ultimate answer, is that the current model of red capitalism, if you like, just doesn’t work.
James Connor 4:28
So the consumer in the US economy represents approximately 70% of GDP. What would it be in China? No nearer 50% right? And it’s interesting, you brought that up because a couple of high end retailer retailers, lvhm and also Gucci, have both said their sales within China are down significantly. I think they it was around 50% so the consumer there is definitely feeling some pain. And I believe veil VHM also said their champagne sales were down 50% because people there have nothing to say. Celebrate
Michael Howell 5:00
absolutely right? Yeah, they can’t even drown their sores. So
James Connor 5:03
let me try to unpack what you said there. So first of all, the message that the Fed has been sending out for many months now is that they are hyper focused on inflation. They want to get inflation down from the high of 9% down to their target rate of 2% but you’re saying with this last speech that Powell made in Jackson Hole that he is now saying he’s still focused on inflation, but it sounds like they’re very concerned about what’s happening within the economy and the growth and the slowdown that we’re seeing in the economy. Do I have that right?
Michael Howell 5:34
You have that absolutely spot on. But also add another dimension, which is the fact that also financial stability is a key, key criteria, and that and that financial stability extends to the Treasury market on the ability of the government to fund itself. So we’ve got to look at these dimensions too. And so
James Connor 5:52
what were you saying the you think the Fed is concerned about what’s happening, even though they’re not saying in the
Michael Howell 5:58
economy, yeah, yeah. I think they are for sure.
James Connor 6:03
Are they more concerned about the inflation rate or about the economy slowing down?
Michael Howell 6:08
Oh, no, I think they’re more concerned by the economy slowing down. I think they that they’re not sure they’ve got a handle on it might be
James Connor 6:13
right, even though, yeah, okay, that’s good, because even though they don’t communicate that well, I think
Michael Howell 6:18
Powell’s last speech was sufficiently sort of nervous about the economy that it suggested there was some hint of panic.
James Connor 6:24
So do you think the Fed is sees a potential problem on the horizon, and that’s why they made these changes?
Michael Howell 6:34
I think they they see a I think they recognize there’s a problem in terms of funding in the medium term for the US public sector, absolutely, because there is a big problem. And you just got to look at what the Congressional Budget Office is projecting for the future debt GDP ratio in America. I mean, there’s, there’s an underlying secular, fast rising, secular trend in mandatory spending that somehow has to be funded. And the CBO are very explicit about this as being a major problem in the medium term. So there’s a lot of debt financing to do. And I think the Federal Reserve and the Treasury together, because of their activities, their joint activities, in what I was saying, if you like, actively duration, managing the calendar, they’re very concerned about this. So I think this is a background point, but it’s an important point regarding the economy. I think Jay Powell flagged growing concerns among the FOMC about the integrity of the economy. I don’t think the economy is in recession. I don’t think it’s near that near recession, but I think the Federal Reserve maybe is hinting here that it’s uncertain about the medium term, whether it has control over the economy, and what they clearly want is to put some support in, in my view, so this is perhaps a cushion or a safety net underneath the economy, and therefore cutting interest rates now. And read that as adding more liquidity, which is the key factor, is really what they’re up to. I mean, at the end of the day, the Federal Reserve, despite what it’s despite the markets focus on, you know, monthly CPI numbers, Federal Reserve is really looking at what the fixed income markets are saying in terms of longer term break even inflation, that that’s really the key. This is the whole, the whole sort of, if you like, framework that the Federal Reserve put in place for inflation fighting. And what that’s telling them is inflation is beaten. So
James Connor 8:21
you touched on debt, and the federal debt now stands at $35 trillion mind blowing number, and it’s growing by a trillion dollars every 100 days. Interest expense on that is a trillion dollars annually. So are you saying that the Fed is very concerned about potential interest rates when they go to refinance this debt, it’s going to be costing a whole lot more correct.
Michael Howell 8:44
I mean, that that’s got to be a worry. Because, you know, you can now see, I mean, just by the math of this, is that if interest rates go up, debt service costs go up, which means more debt. And what you’re doing is you’re piling debt on top of debt. And this is not a, this is not a great situation to be in. So if you look at the debt GDP ratio of the US as projected by the Congressional Budget Office, it looks like an exponential curve upwards. I mean this. These are not healthy situations. We’ve got too much debt. You know, this is the problem. But the reality is, is that one of the things that people have got to recognize is the debt goes hand in hand with liquidity, and we’re in a situation now where financial markets have moved very clearly away from being new capital raising mechanisms into being basically debt refinancing mechanisms, and that’s a very important, subtle but very important difference. Now what that basically means is that liquidity is needed to roll over debt. And you know, the reality, which people forget, is that, you know, if I issue a five year bond today, that may be great for five years, but in five years time, I’ve got to refinance that bond. And to refinance You need balance sheet capacity, which is really liquidity in the markets. So you definitely have to have with rising debt levels, rising liquidity levels. Now, the reality is that that liquidity spills out. For the last decade or two decades, most of that over spill of liquidity has gone into other financial assets. In the last two years, it was so significant that it spilled over into the high street, and so you’ve got consumer price inflation as well. But what we’re looking at is debt, which is growing at something like two to three percentage points faster than US GDP, which basically means that you’re looking at something like, what, 8% per annum growth in debt, which means you’re getting 8% growth in liquidity, and that is the sort of benchmark or hurdle you’ve got to think about in terms of your asset market returns, because liquidity drives those asset market returns, and so you need assets that will keep pace with monetary inflation. Gold has shown us for centuries that’s what it does. It may lead lag a bit, but generally the trend is there? High quality equities seem to do that. That’s what experience shows. Fixed income markets do not do that. Prime residential real estate does that. And for the last five years, Bitcoin has done that. Michael,
James Connor 11:14
you have said in the past that all financial disasters are brought on by an inability to refinance debt. Do you see that happening in the coming months? And I guess also what I’m asking here, do you see a potential black swan on the horizon, and that is an inability to refinance debt?
Michael Howell 11:34
Well, I think the sort of glib answer is yes, but I don’t know when, because the fact is that what you’ve seen historically, and you go back through history, and you go back, particularly in the last two decades, what you find is that every financial crisis has largely been a refinancing crisis. Think of 2008 think of the Asian financial crisis in 97 you know. Think of what happened in the US repo markets in 2019 all these, all these are instances where refinancing becomes a problem. I mean, you know, arguably, even Silicon Valley Bank was a refinancing crisis. And what it what it comes down to is, if we’ve got so much debt, we’re sitting on so much debt, that debt is a burden, that’s a cost, that debt has to be refinanced. And if that mountain of debt just keeps growing. The refinancing challenges obviously grow with it, and what you need is more and more liquidity to keep pace. Now, liquidity, as we’ve argued, is cyclical, and therefore if you get at a time when you need a lot of refinancing capacity, liquidity turning down, then you’ve got a problem. And in that environment, you either get debt defaults. People tend to fire sale assets so they can refinance in other areas, etc, and that’s where the tensions emerge. So it may be a good comment, but yes, we will get that, because at the end of the day, liquidity is cyclical and it’s very you know, we can’t depend on monetary authorities to manage things perfectly. So I think it’s going to come. Is it going to come in the next 12 months? I think that’s very unlikely. Because I think the if you look at the other debt wall, the debt wall is probably about 18 months to two years away. That’s when a lot of debt has to be refinanced in the world economy, or the US economy in particular. And I think we’ve got a window now where there’s not that much, so it should be manageable. And one of argued, liquidity is picking up, therefore there should be few problems. I think the question really comes is, when you get an inflection in that global liquidity cycle, which, if you go back to the first chart I showed, our reckoning is that comes sometime towards the end of 2025 and that might be because inflation begins to pick up again. It may be because the world read economy starts to get more traction and financial markets suffer. Could even be because the Federal Reserve thinks it’s made a mistake and wants to push rates up again. Thanks
Andrew Brill 13:58
again for watching these favorite moments of 2024 and we hope we can continue to provide you with information that will help you invest wisely and be financially resilient. Wishing all of you a healthy, happy, safe and prosperous 2025.
