Transcription
Hello my friends. Today is September 27th and this is Markets Weekly.
Now, this past week, the equity markets were kind of boring. You know, not much going on, but I think there was some real action in some corners of the market. In particular, looking at silver absolutely surging, going parabolic, and we've talked about silver before. It is a very volatile metal. In the past, we've seen it squeeze higher to $50 in the 1980s when the Hunts brothers were trying to corner the market. And of course, in the post-uh GFC era, also had a huge surge to $50. It looks like we're going to try to hit that again. Again, before there was crypto, silver was basically the, um, I guess, the asset that received a ton of speculative flows and retail interest. So that was pretty interesting. Gold, of course, doing very well as well.
Now, what kind of caught my eye the past week, and actually the past couple weeks, is crypto doesn't seem to be trading very well. Now, some people think about crypto as, you know, levered NASDAQ. Some people think of it as digital gold, but, you know, it's it's kind of doing much worse than than gold and the NASDAQ, and not sure what's going on there, but it doesn't look good.
So, today, let's talk about three things because we do have some interesting developments this past week. First off, let's talk about this new, uh, I guess, line of thinking in the Fed where we have kind of a more coherent argument from the Trump appointees why the Fed should be cutting rates. And secondly, uh, something else that happened the past week was seemingly the Treasury is going to throw a lifeline to help save Argentina. Seems like it's going to be, uh, some extension of the Monroe Doctrine as as the president seems to be, uh, viewing the world in that way. And lastly, let's talk about some new developments in the ongoing AI bubble because I do believe it is a bubble.
Okay, starting with the Fed. So, this past week, we got the first speech from newly minted Governor Myin and also a couple speeches from Governor Bowman. Now, Myin and Bowman, along with Governor Waller, are Trump appointees, and they have been pretty vocal for lower rates in, uh, in the past few months. So, when you think about monetary policy, there's actually a lot of ways you can think about it. Again, you got the employment mandate, you got the inflation mandate, but you also have, uh, how restrictive the Fed is currently, and you also have, uh, basically how the Fed should approach the process of of looking at the economy. So, we have some interesting developments both from Myin and Bowman. And what they're trying to argue right now is a shift away from data dependence and towards more forward-looking, uh, views. Basically, a shift back to model dependency.
Now, if you recall a few years ago, the Fed usually is looking at the world with a forward-looking stance, right? They have models to think about, you know, I'm doing this monetary policy act with a lag. So, how is the economy going to be affected? So, that's kind of how the Fed used to operate. But in 2021 and 2022, based on that framework, the Fed was telling everyone, "Relax, inflation is transitory. We don't need to hike rates." That turned out to be a total disaster. So, from that point on, the Fed shifted to something, but they say data dependency. Basically, "I have no idea what the future is going to be like. So, I'm just going to look at the data as it comes in." But of course, if you're looking at the data that comes in, you are basically looking, uh, in the in the past. You're driving looking at the, um, rearview mirror.
Now, earlier this year, Chair Powell gave a speech and he said that we have a lot of things happening in the economy. President Trump is doing all sorts of changes with regulatory policy, uh, you know, fiscal policy, immigration policy, trade policy, and so forth. And I just don't know what's going to happen. So, I'm just going to stay and be data dependent in a sense, committing himself to being late. So, that was what he was thinking.
Now, what Governor Myin and Governor Bowman are saying is something different. They're like, and Governor Bowman actually says this directly, "You know, if we're too independent, we're going to be looking at the back rearview mirror. We're going to be too late. So, let's look forward to seeing how the world is going to evolve." And so, based on this, they're going to, they're looking at what's happening with the policy changes the president has and they're saying that, you know, maybe we should be cutting rates.
Now, first, from Governor Myin's perspective, he doesn't actually talk too much about, um, so far at least, about labor and inflation and so forth. His focus really is what's called, uh, R-star, the neutral rate. So, his argument that he's making is that, you know, the neutral rate is actually pretty low. And because it's pretty low, rates where they currently are are super, super restrictive. So, we got to get rates lower. That's why he voted for 350 basis point cuts this year. So, this is kind of an angle that you don't see that many Fed officials take because the neutral rate, basically the rate, uh, so in central bank speak, if interest rates are above the neutral rate, you're being restrictive, slowing the economy down. If interest rates are below the neutral rate, you're being accommodative. You know, people don't talk too much about the neutral rate because it's a notoriously vague, uh, thing that no one really knows, uh, where it is. And so, Chair Powell would say, would know it by its works. Again, just looking at the economy, don't want to have too much of a theoretical model.
Now, what Myin is saying though is that if you look at the policy changes that Trump has done, it's very clear the neutral rate is coming down. And he makes a few, I think, pretty good points. One, of course, is immigration. Now, one of the reasons why we've had high inflation over the past few years is that we've had tremendous, tremendous population growth, right? So, you know, under Biden, there has been tremendous amounts of illegal immigration. No one knows how many millions of people came in, but public sources say maybe two or three million people more than we did usually. Now, a lot of people coming in at millions at a time, obviously, we're not building houses as easily, as quickly, right? So, that puts upward pressure on shelter inflation. And this is something people see all throughout the world. In Canada, in the UK, in Australia, they have tremendous amounts of immigration. And rents just keep going higher and higher, uh, because they don't really build a lot of housing. Again, everyone has all these regulations that limit that. And yet, you have people who need to live somewhere. And that pushed up rent a lot. But now that that's over, and maybe we have some deportations, shelter inflation would come down, right? So, maybe that means that we don't have to be as restrictive as it used to be.
And Myin also makes a couple other interesting points. So, if you have deregulation, and again, everyone can agree that President Trump is reducing regulations, that essentially decreases the cost of businesses. And so, if you decrease the cost of businesses, you know, maybe you have a higher productive capacity, increasing supply. Again, that puts downward pressure on the neutral rate. And the last thing that he suggests is that because we're collecting tariffs, maybe the deficit will be better lower in the future. And we have a lower deficit, government is not competing as much for resources. Is maybe that means we can have a lower neutral rate as well? So, he makes these R-star arguments.
Now, again, these are pretty vague, and I, I don't know if anyone takes them literally. He does have a table decomposing it. Uh, but I think it is useful to look at these big policy changes that Trump is doing. Again, these are huge changes, and try to at least think about how they could affect the economy rather than just being data dependent because, you know, you are driving in the rearview mirror.
Now, Governor Bowman this past week also made similar arguments for low interest rates, and she sounded a little bit panicky. Actually, she doesn't talk about the neutral rate at all. She's not a PhD economist, and to be clear, neutral rate stuff is is not super useful in real life, but she seems to pay a lot of attention to the labor market, and she's sounding the alarm. The labor market really does seem to be cracking, and she really wants to get ahead of it. But in addition to that, again, if you follow Bowman for the past few years, you'll know that she is actually by nature a very hawkish person. Uh, she's turned on rates, uh, but when it comes to the other stuff, still quite hawkish. So, she also wants to, you know, sell mortgage-backed securities, maybe shrink the Fed's balance sheet, maybe reduce some of these emergency facilities like this, like the standing repo facility and so forth. So, her views are basically things that would lead to a curve steepening, lower front-end rates, and higher longer rates. So, again, these are interesting developments, mostly from my perspective, uh, to focus on being more, uh, forward-looking. And I'm not sure if anyone else is going to come along to that perspective, but it does make sense when you're having so many big policy changes.
All right. Uh, the second thing that I want to talk about is, of course, uh, the Treasury's lifeline to Argentina. So, President Milei in Argentina has really done revolutionary work, and Argentina has been a country that's mismanaged for some time. If you go back a hundred years, Argentina was one of the wealthiest countries in the entire world. There's a saying that, you know, you can be as wealthy as an Argentinian. Uh, however, things have not been going well. They have huge inflation, and economic growth has not been doing well. So, Milei really did something heroic. He massively, massively slashed government spending. Argentina actually has a fiscal surplus now. And that seems to have brought inflation down. At least for Argentinian standards, it's much, much lower than before. And a lot of people were feeling a bit more positive on this turn in Argentina. However, uh, recently, Milei's party seemed to have not done very well in a local election, and that suggests that maybe appetite for reform in Argentina is waning.
Now, if, uh, the Milei revolution is just something that's going to end very quickly, then investors are thinking that maybe they'll go back to huge deficit spending, and maybe things, uh, will go back to the way it was. And so, they got to pull money out, and so you had a huge run on the currency, and of course, the bond yields began to spike. Obviously, doing lots of austerity is unpopular. So, this is a totally, I think, predictable thing that would happen. Um, however, thankfully, uh, President Milei has built a pretty good relationship in Washington. I mean, if you watch TV, you'll see him over the past few months, you know, every now and then popping up into events that are, you know, supportive of, uh, the Republican party. You know, we saw him hang out with Elon a bit. So, and, you know, it's actually a really, really long flight from Argentina to the US. So, he's definitely been cultivating this relationship, and today it seems to pay off.
Now, uh, Argentina had already borrowed about $20 billion from the IMF. Uh, they probably have trouble repaying that and trying to support their currency and all that. It's been spending their foreign reserves. Over the past week, Secretary Besson also suggested that, you know, the United States is going to step in and give Argentina maybe a swap line, some kind of currency swap, and maybe even outright buy Argentinian, uh, dollar bonds.
Now, this is an interesting thing because it seems like the swap agreement is not going to come from the Fed, but it's going to come from the Treasury. The Treasury itself has what you can think of as a rainy day fund called the ESFR, Exchange Stabilization Fund, something like that. Um, it's something that actually they accumulated in the past, beginning when, uh, during the gold standard to try to manage the currency, but more recently in the past decades, it was actually used to try to weaken the dollar, so sell dollars and buy foreign currency, uh, when the dollar was too strong. So, that the ESFR has basically been, ESFR has basically been, you know, kind of dormant for for some time, but at the moment, when you, when I look at it, it has about $20 billion in Treasury. So, $20 billion that could be used to to at the Treasury's discretion to try to do whatever they want with it. And it looks like they're going to use that to kind of shore up the Argentinian, uh, peso.
Now, technically speaking, I, I'm guessing that they could have forced the Fed to do something like that as well. The Fed has independence when it comes to interest rate policy, so monetary policy. Um, but it doesn't have independence when it comes to regulatory policy. And when you have these international diplomatic things like this, when there's that geopolitical strategic thing, uh, I'm guessing they probably could have maybe had the Fed give them a line. Although, of course, it would be a huge departure, uh, for Fed to Fed, uh, behavior. But at the moment, they're structuring this just, uh, using money that they have full control over and to give to Argentina. I think so, broadly speaking, this seems to further, uh, President Trump's view of what happens in the Americas is strictly within the United States's geostrategic region, and they're trying to shore up more support.
Now, Argentina actually also has a swap line with China as well. That that has made President Trump unhappy, and they don't want to have other countries come in and try to, you know, buy influence by, you know, being there as a last resort. China obviously has tremendous amounts of resources they could lend to Argentina. So, it seems like the United States is trying to move in, shore up an ally, and, uh, you know, cement their influence in this western hemisphere. And you can also see President Trump acting similarly when it comes to Brazil, being very mean to, uh, President Lula, who was very mean to President Bolsonaro, who was the president's friend, and also sending ships over to Venezuela, kind of hanging out and, you know, it's kind of bombing, uh, ships that, uh, seem to have drugs in them. So, it, it seems like this is kind of a broader, broader geostrategic push to cement power within, uh, the Americas. So, it's kind of an interesting development.
Okay. The last thing that I want to talk about is, of course, the ongoing AI bubble. Now, we've talked about how, uh, you know, basically all these companies are spending hundreds of billions of dollars to build out AI infrastructure, and that means building plants, spending a lot of money on chips, and so forth. And at the end of the day, these AI so far isn't really profitable. There's studies suggesting that companies are trying to use them, trying to make a return, but just not being very successful at it. And OpenAI, the star of the world, has been doing interesting things. Working with Broadcom to develop new chips, promising Oracle that they will buy tens of billions of dollars worth of computing capacity. Then, in all the stock market has loved all this stuff, but ultimately the question was, where is OpenAI going to get all this money? Right now, they make revenues of about $13 billion a year, and that's not enough to cover their costs. So, they lose money. For the Mag 7 hyperscalers like Microsoft, like Facebook, they've been financing their expansion through their cash flows. They're still very successful companies making a lot of money, but they've been plowing that money into these GPUs that have, you know, high depreciation rates and don't seem to be at the moment, at least, being very profitable. Actually, there's a story in the Wall Street Journal the past week where they suggest that the gap, the revenue gap to pay back all these AI investments is in the several hundred billion category, and there's really no indication that's going to be met.
So, now we figured out the past week with Nvidia's $100 billion investment into OpenAI, where the money is going to come from. So, this idea, this basically round-tripping thing is something we also saw during the dot-com boom. During the dot-com boom, you had all these big fiber companies laying down fiber networks throughout the world thinking that the internet would change the world. And so, you got to lay down fiber, and eventually, you're going to have a return on all these investments. Um, but what they realized was that, you know, laying down all this fiber, the demand actually wasn't there, and so they weren't really making money. So, what they ended up doing was actually, uh, buying each other's capacity. So, one fiber company would buy capacity from another, and in exchange, they would sell their own capacity to the other company. So, at the end of the day, there was no cash exchange, but then they would report in their earnings that they had tremendous amounts of revenue, even though it was basically fictional, right? They were trying to, one company is buying stuff from another company who, and also, uh, selling their own products to the other company. And this kind of reminds me of that because at the end of the day, Nvidia is giving $100 billion, an equity investment of $100 billion into OpenAI, and OpenAI is then in turn buying chips from Nvidia. So, it seems, you know, kind of, uh, somewhat shady, but the market did love it. And things like this can go on much longer than anyone expects. So, again, when you're in a bubble, things go on, can go double or triple, but one day, and you never know when, it could also come crashing down. So, continue to think that it is a, you know, it's an interesting time, and also, I think, also a risky time.
All right, so that's all prepared. Thanks so much for tuning in. Talk to you guys next week.