The Exchanges

Q Louis, James, any additional thoughts to the framework that Marco just proposed?

A Look, we can talk all day about what's happening in the U.S. There's obviously a wider world. Yes, the end of U.S. exceptionalism has a lot mostly to do with the policy choices of the U.S., but also just the natural order of things. Trees don't grow to the sky. Valuations relative to the world were very stretched, et cetera. At the same time, we have to acknowledge that we're seeing very important policy shifts in both Europe and China. I spend a lot of time looking at China. I live in Hong Kong. We have an office in Beijing as well. The story of really the past six, seven years in China, first and foremost, where all the capital was being allocated to industry. The banks were told, don't lend to real estate anymore. Don't lend to the consumer. We have to build industrial resilience because the U.S. is trying to train our growth. It's not giving us access to tech, not giving us access to semiconductors. So we're going to have to build everything ourselves. This has now shifted massively in the past six to nine months. First reason is, industrially, China is much more confident and comfortable with where it stands relative to five, six years ago. At this stage, it basically dominates pretty much every single industrial supply chain. Number two, China's big fear over time became that the US would try to build an anti-China coalition. Now, funnily enough, having declared trade war…

AI assessment note: “we have to acknowledge that we're seeing very important policy shifts in both Europe and China.”

Q say, US or maybe European bonds, the first thing you think about is sovereign credit risk. As you talked about, the Fed's behavior might not be all that much different than what you've seen in some of the governments of the emerging markets historically. How do you think about assimilating the notion of sovereign credit risk into a shift potentially in owning developed market bonds to owning emerging market bonds?

A That's a great point. Whenever you look at EM bonds, you have the local currency bonds and the US dollar bonds, The interesting trend in emerging markets, if you go back 20 years ago, there really was no local currency bond market, very little. It was all U.S. dollar debt. You wanted to buy Indonesia, you bought an U.S. dollar, you wanted to buy Philippines, you wanted to buy Brazil, partly because their own currencies were trash. Who would want to own the Indonesian rupiah over the long term, or the Filipino peso over the long term? That makes no sense. I think this is the part that has really changed in the past 10 years, is you look at the local currency debt markets, In a lot of these places, they've gone tremendously, not only from the sovereign, but also on the corporate side. There's now a genuine local currency debt market for corporates in Latin America, and the same is true across Asia. China is now the world's second largest bond market, and it's all local currency stuff. The only country to ever go bust on its local currency bonds is Russia. In 98 or 99, they basically decided to stiff foreigners because that's how they are. You don't go bust on your local currencies. I mean, you can always print it. Now, of course, then the currency goes down, et cetera. But today the currency printing is really being done by the Western world, much more than emerging markets who h…

AI assessment note: “today the currency printing is really being done by the Western world, much more”

Q So you had the combination of those activities, and then through COVID, the issues with supply chains. It certainly feels like we're on a trend towards a deglobalized economy from what was for many decades, increasing globalization. How do you see the impact of that deglobalization playing out in the next couple of years?

A There's no doubt we are deglobalizing. The obvious impact is higher inflation. It's higher inflation, it's lower margins, higher structural interest rates, which makes for lower valuations. Going back to your underfunded U.S. pension plans, that's the worst of both worlds. On the one hand, your asset prices are lower, but the money you have to pay out keeps on accelerating, and this at the worst possible times when you're getting more and more old people all across the Western world. You could say, okay, but it's great on the other side, we're going to get more jobs back in the U.S., We're going to get more jobs back in Europe, et cetera. But it's not like labor markets aren't tight already. Labor markets are already pretty tight. So we're going to say, okay, let's reshore everything from China. The question becomes, well, how'd you do it? Where'd you find your workers? The big debate we have internally is, on the one hand, labor market is tight. On the other, the labor participation rate is not that great in the US. It's still lower than what it was pre-COVID. And here you get to other structural issues, which are particularly acute in the US. The whole lockdown thing made a couple of problems that are inherent to the US and to the US labor force worse, most notably obesity, which prevents a lot of people from holding the type of manufacturing jobs where you have to be sitting…

AI assessment note: “The obvious impact is higher inflation. It's higher inflation, it's lower margins”

Q As you look at this particular bear market at the beginning of the sell-off earlier this year, what's different or special about this one compared to others in the past?

A It's like the misery in Tolstoy's families. Everybody's miserable, but in different ways. And that's the same for bear markets. They're all miserable, but in different ways. What is different this time? The most obvious and glaring difference is how this year you're losing more money on long bonds than you are on equities. This is a game changer. The past 30 or 40 years of market behavior has taught everyone that bonds and equities are negatively correlated, and clearly this is no longer the case. Let's say you're an average pension fund and you had a lot of your money in equities, a lot of your money on bonds. This year you're losing on both fronts. So actually the total capital losses this time around are bigger than they were in 2008. Cause in 2008, if you had a diversified portfolio, you took your licks on your equities, but your bonds came through. This is absolutely not the case this time. This time there's basically been nowhere to hide but energy. Energy is the one asset class that's up for the year. Unfortunately for pretty much every pension fund endowment, et cetera, out there, they all bought into the ESG stuff. And so they have none of that of the one asset class that could have saved them. And they still don't. That's the amazing thing. You would think that, okay, everything is going down. This is going up. So let's do more of what's going well, and let's do less …

AI assessment note: “The most obvious and glaring difference is how this year you're losing more money on long bonds”

Q So when you speak of seizing assets, the oligarchs is a different, very different scenario than freezing reserves. And why don't you talk about your take on what the implications of that and why it's happening?

A I think the seizing of the Aliyarx assets is much, much worse. It's much, much worse because, you know, my starting point when I look at the world today is that the biggest comparative advantage the Western world has is the rule of law, is the fact that you can be brown, black, white, Chinese, Indian, it doesn't matter. You can be Hindu, Muslim, Jewish, Christian. You can go in front of a court of law in New York, in London, in Paris, and you're going to get the same fair shake. Hence the pictures of, you know, justice with her eyes covered, et cetera. This is the greatest strength by far of the Western world. This is why rich people in emerging markets keep on investing in developed markets. And, you know, this is why you buy, if you're a rich Chinese, this is why you buy Vancouver real estate. This is why if you're a rich Indian, you buy London real estate. This idea that you have an independent justice system, And that my safety of capital is protected by this independent rule of law. It's a very powerful notion. And it's what, frankly, capitalism is based on. And everybody is, gets to benefit from due process, et cetera. And what's just happened in the past six weeks, if we said, absolutely, we believe in this fervently, except if you're Russian. And as soon as you make an exception, except if you're Russian, if I'm Chinese, if I'm Saudi, if I'm Bahraini, If I'm Qatari, I'm…

AI assessment note: “I think the seizing of the Aliyarx assets is much, much worse.”

Q I've been well, thanks. This is the first time I've had you on the show, so I thought maybe it'd be helpful to give a little context before we dive in on the Ukraine situation, and why don't you just start with your background and what it is you do, how you got there?

A Well, first of all, yeah, thanks for having me. It's a, it's a pleasure to be here. I'm one of the founding partners of a company called GAFCAL. We're based in Hong Kong and Beijing. I've spent really the better part of my past 25 years looking at China and China's sort of major impact on economies and on global financial markets. And GAFCAL is, when people know us, they know us because we publish a lot of research. And sometimes they also know us because we actually do manage money. We manage institutional money, mostly in the Asian markets and specifically in the Chinese Sphinx to income markets, which is where the bulk of our assets are deployed. So we're, we're a somewhat unusual firm in that we do provide a lot of independent research and that's where about two thirds of our staff works. And then we have another third of our staff completely separate that manage these institutional accounts.

AI assessment note: “I'm one of the founding partners of a company called GAFCAL.”

Q Yeah. Well, that's the key question, right? If you're feel your assets are less safe in dollars, you have to do something else. What do you think that something else is today?

A Well, so like I think the today, if you're a rich Russian tycoon, a rich Russian oligarch, you probably wish you had, I don't know, 3040, fifty million bucks in gold bars, and that you probably had 30, 40, fifty million bucks in bitcoins on a USB key somewhere. Because what we now know is, A, how quickly the rules can change, and how quickly things can unravel, and how everything can get seized in a heartbeat. And so if you're, I think, a super rich guy, you probably think, I need to have some assets that are off the grid, for lack of a better word. And there's only two of them, really. It's gold and it's bitcoin. So that if I need to leave, and I can leave somewhere, and I can leave with fifty million bucks in Bitcoin, and if that means I need to move to Dubai, or I need to move to China, or I need to move to wherever, I can do so. So that's, I would say, the first order consequence. All of a sudden, a bigger bid for, the second order consequence, if I'm a very rich guy, is I probably need to have many more bank accounts than I thought I did. Before I could think, okay, I'll have all my money in my bank account with UBS at Zurich, In Zurich, because nothing's going to happen there. But now I probably think I need an account in Zurich, I need an account in Singapore, I need an account in Dubai, I need an account in Hong Kong, I need an account in Panama, so that if tomorrow, ag…

AI assessment note: “And there's only two of them, really. It's gold and it's bitcoin.”

Q There's a fair amount of what's happened over the last couple of years in the US, particularly with the central bank, the Fed, that feels like actions of emerging markets in the past. Money printing, currency issues, repatriation of capital. With your lens looking at all these different emerging market crises over the years, where do you see similarities and differences?

A There's no doubt. And what's been quite interesting with the COVID crisis was the view all across the Western world. It's the US, but it's also Europe and the UK and Australia and Canada, all across Western countries. We can print a bunch of money and we can spend a bunch of money and there won't be any long-term consequences. Obviously, emerging markets followed a very different path. You look at the monetary aggregates of Brazil or China or Indonesia, they didn't grow to the same extent as we saw in the Western world. So I think there was a fair amount of hubris in the Western world where it was like, The rules don't apply to us. There's macroeconomic rules for poor countries and macroeconomic rules for rich countries. Turns out it's the same macroeconomic rules for everyone. In emerging markets, they hadn't forgotten them. And in the Western world, we're in the process of relearning them. It's a painful and costly education. You're absolutely right. That's also key differences. If you look at the divergence in fiscal and monetary policies in the past five years between Western world and developing or emerging markets, it's never been this stark. And one of the charts in my presentation is long-term comparisons between Chinese bond yields versus U.S. bond yields. Now, Chinese bond yields have been between two 63 20 for the past five years. U.S. bond yields have been all over …

AI assessment note: “If you look at the divergence in fiscal and monetary policies in the past five years”

Q What do you see as people's resistance to adopting what you think is the right thing to do?

A The first thing, of course, is we're living in this age of weaponization, this feeling that going abroad is too risky. The geopolitical risk perspective has changed dramatically in the past few years, and even more so, of course, in the past six months with the Russian invasion. Depending on which part of the world you're in, Things may look too risky. So for example, trying to sell China to US institution or even a European institution today, forget it. It's not going to happen. You're wasting your time. But Latin America, then you could say, well, Latin America, everybody's electing leftists left and right. But today's leftists in America are not the leftists from a generation ago. Again, you learn from your father's mistakes. In Latin America, you talk to guys in Chile and in Colombia and in Mexico, they've learned from Chavez. They've learned from Argentina. They don't want to repeat that. What was it? Four or five years ago when AMLO came to power, everybody's like, oh, he's the next Chavez. It's going to be a disaster. But Mexico hasn't been that bad. He's definitely not being Chavez. So if you don't want to do it, there's always a reason to not do it. Emerging markets, there's always a reason. It doesn't smell right. The streets are dirty. It's too far from me. I can't drink the water. There's always a good reason not to do it. But by the time there's every reason to do …

AI assessment note: “we're living in this age of weaponization, this feeling that going abroad is too risky.”

Q the AI era, asset and wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. So as you look at that transition happening with leadership from emerging markets and equities and bonds, why do you think it's happening?

A Potentially lots of reasons. Right now, the core belief in the market is that you've got a big stinking pile of laundry, and the US is the cleanest dirty shirt, therefore I should be in the US. Right now, the view is Russia's obviously uninvestable, so we can leave that one aside. Europe is uninvestable because they might not have electricity this winter, so who wants to take that risk? China's uninvestable because they might invade Taiwan tomorrow, and I don't believe that for a second, by the way, but who wants to take that political risk? So perhaps the simplest explanation is once you cross out everybody for being uninvestable, you're not left with a lot. You're left with us, you're left with India, Indonesia, et cetera. And those are small markets. One possible explanation is as people leave China, as people leave Russia, as people leave Europe, it doesn't take a lot of money saying, okay, fine, I'll buy India and Indonesia to move those markets. That's one possibility. The other possibility why these markets are doing well, even in the face of a U.S. dollar wrecking ball, because usually as the U.S. dollar goes up, emerging markets struggle. Today, everyone sees the strength in the U.S. dollar as a sign of strength of the U.S. U.S. dollar is strong because it's the cleanest dirty shirt. U.S. is awesome and everything else is terrible. Now, personally speaking, through my …

AI assessment note: “One possible explanation is as people leave China, as people leave Russia”

Q So one last question, which is if we turn this lens to your wheelhouse of China, right? Very early on, there was this question, oh, what does this mean about China's potential to invade Taiwan? Where are your thoughts on the local scenario for you based on this?

A So I've never been a big believer in China invading Taiwan. And nothing that's really happened in the past six weeks has changed my mind on this. Perhaps even the opposite. This Ukraine invasion has shown that invading a country is not easy. And we've known that. I think we saw it with Iraq. We saw it with Afghanistan. We saw it with the Saudis and Yemen. How often does the invader get to win? Invading is tough business. And so I was never a big believer. And, and by the way, invading over the sea is extremely hard. Extremely hard. And so I was never a big believer in China invading Taiwan in the first place. And I would say that the sanctions that Russia has been hit by, the struggle that their army has had, if anything, it really highlights to Xi Jinping that the risks are really pretty big. It'd be a hell of a dice to roll to go ahead with this. So in that respect, I could say that this is going to sound callous, but If you want to look for a silver lining to this horrible Ukraine situation, perhaps this is it. If ever Xi Jinping had thought of invading Taiwan, he'll now think twice and three times and four times. And not only that, but the people around him, because China, you know, China's a dictatorship as well, but it is a dictatorship of the Politburo of more than one man. Now granted, Xi Jinping has accumulated more power than his predecessors, but they're still a Poli…

AI assessment note: “I've never been a big believer in China invading Taiwan.”

Q How would you track the potential for these countries significantly changing their reserve policies, say, based on that thesis?

A All right. On April 11th, I think is a historical day where Chinese bond yields have fallen below U.S. bond yields. If you look at the 10 year notes, for the first time in modern history since China Has tried to open up its capital accounts to foreigners since it's become possible for foreigners to buy Chinese bonds. This is the first time that Chinese bond yields are now below US bond yields. Let's think of that for a second. If I told you three or four years ago that Chinese bond yields would be below US bond yields. You'd have said, no way. This isn't going to happen. Too many structural uncertainties around China, too many uncertainties surrounding the rule of law, etc. So this is one potential answer to your question. How are you going to track this? Well, it's happening in front of our eyes. It's unleashing right now. Since we've decided to freeze Russian central bank reserves, U.S. Treasuries, German bonds have been in an absolute freefall. Two year yields. I've just raised by a hundred basis points. This is never in the space of less than a month. This has never happened before. The bond markets are like the US treasury in the first quarter of this year, US treasuries was the worst performing assets. Actually, German boons were worse, but these were the two worst performing assets. It's happening. It's, it's just striking us straight in the face.

AI assessment note: “How are you going to track this? Well, it's happening in front of our eyes.”

Q But if you look at a global asset allocation today and say it's roughly market cap weighted, there's public market exposures, there's private market exposures, fixed income exposures, How would you suggest someone think about the implications of those shifts over different periods of time? And that could mean a year from now, it could mean three or five years or longer. Louis, do you want to tackle that one?

A The obvious argument we've already made, people are too overweight the US and they're too overweight the US dollar. That's your first trend. And then you get to the question indeed of, okay, that all sounds great. What do we buy? For me, there's the few things happening today that are Pretty visible. The first, when I look at the U.S. foreign policy, it seems pretty clear that the U.S. is essentially retranching on its own borders. It's taken the lessons from the failed Ukraine war, and it's come to the conclusion, look, we actually can't protect power that far. Our weapons that we thought were terrific are not as strong as we thought they were. When we look at the actions of the Trump administration, it's pretty clear that they're essentially trying to retrench onto the Americas. J.D. Vance's speech to Munich was he was coming in to break up with Europe. Now, usually when you break up with someone, you have the decency to say, it's not you, it's me. J.D. Vance came out and said, it's you. You suck. And so I'm walking out of this relationship. At the same time, essentially what the U.S. is saying is not only are we tranching on the fortress of America, or maybe we could call it Fort Monroe, at the same time, what we're doing is we're going to kick everybody out of the Americas. Argentina, you can't do deals with China anymore. Panama, we got to get the ports back. Venezuela, ge…

AI assessment note: “What do we buy? For me, there's the few things happening today that are Pretty visible.”