EPISODE 244: Louis Gave, Founding Partner and CEO of Gavekal

My guest today on the Alpha Exchange is Louis Gav. He is the founding partner and CEO of Gavall, a global macro advisory firm that, uh, recently celebrated its 25th anniversary. So, first off, welcome back to the Alpha Exchange and, and congrats on that milestone, Louie.

I guess I should be happy I still have hair, even though it's all gray now. Thanks. Thanks a bunch for having you, Dean. It's a real pleasure.

Well, markets will give us gray hairs. That's, uh, that is for sure. And, uh, your firm has, uh, you know, spent a lot of time thinking about, uh, I would just call them complex, sometimes underappreciated lynchpins, lynchpin relationships in global market assets. And, uh, you've been doing a lot of thinking and writing on the, the USD yuan relationship. And, um, I think, um, you know, what I was just saying before we jumped on, China is just this under, I don't want to say underappreciated, but certainly underfollowed risk dynamic for US investors. You know, you go back to the period of FX weakness in China, 2014, '15, and there was a very direct and very widely followed relationship between CH and the VIX. You know, a risk-off in one was a risk-off in the other. That feedback mechanism doesn't get any attention these days. But, um, why don't you start by framing out, you know, maybe what investors are missing with respect to the developments in the Chinese economy, and then we can dive into this FX relationship, which you think is, is so critical.

First of all, thank you very much for the kind words and again, it's great to be here. Uh, secondly, I'm not sure you want to put a coin in that machine, but now that it's in, you're going to have to listen to me, I'm afraid. My starting point is that China, really for the past decade, has been a massive deflationary weight for the world. And I think everybody knows that, uh, you know, through the impact it's had on trade, etc. But I think people underappreciate how policies, deflationary policy settings were in China, and how the trade war amplified those deflationary settings. Specifically, I think when the US imposed a semiconductor embargo on China, when the US essentially weaponized the semiconductor supply chain against China, it sent Chinese policymakers into an absolute panic. They thought, if the US can block us from semiconductors today, tomorrow they can block us from chemical products or auto parts or, you know, you name it. And China told the banks, guys, normal loans to real estate, all the money has to go to industry because we need to de-Westernize our supply chains as quickly as possible, otherwise our economy is going to be too vulnerable. So while China was going through this exercise of capturing all of its savings and essentially redeploying it into industrial supply, this had a twin deflationary effect. And I think one of the charts that I have that, that I sent to you, shows the collapse in, in bank loans to real estate, uh, on the reds right there, and the shooting up in industry. You know, I think everybody who could pick up a copy of the Wall Street Journal knew about the collapse in real estate because, you know, you looked at it and people said, "Oh, I've seen this movie before. This looks like Japan in the 1990s, balance sheet recession, real estate prices down a third, construction companies going bust, commodity prices heading lower, consumer tightening its belt, wealth effect, etc." So, everybody saw that. I think the part they didn't see as much was the blue line, all the money going into industry, which showed that actually China was not Japan. That it was a very different cycle unfolding. That it was actually twice as deflationary because not only was Chinese demand curtailed, Chinese supply at the same time was going through the roof. And now we turn around and we find out that out of nowhere, China's the biggest car exporter in the world, the biggest tractor exporter, uh, the biggest solar panel, batteries, I mean, you name it. Essentially on anything linked to transportation that is not jet planes, anything linked to power, uh, generation, transmission, storage, anything linked to factory automation, robotics, anything linked to telecom data transmission. China has, it's not that it's caught up with the West, it's that it's actually leapfrogged the West. They're now producing better products at cheaper prices. You know, the idea that you and I might want to drive a Chinese car would have seemed laughable five years ago. Now you see the cars that BYD produces and you wish you could, you could buy them in the United States. So this transformation of the Chinese economy has been, you know, for me, it's the single biggest macro event. Now, as China was trying to de-Westernize its supply chain, one of the key tools in its toolbox was maintaining a stupidly undervalued exchange rate. You know, the renminbi today, when you look around the world and you think, what price is completely wrong? The most obvious completely wrong price is the price of the renminbi. It is so stupidly cheap. I tell everyone, you know, if you have time, go visit China to really appreciate how cheap it is. You can stay at Four Seasons, Intercontinental, Ritz Carlton hotels in Beijing and Shanghai for roughly a hundred US dollars a night. If you don't believe me, go to Expedia and, uh, and look it up. Uh, you can have some of the very best meals you, you've had in your life for a fifth of what my dinner, uh, here in New York cost me last night. Uh, you can have, you know, very nice cars for less than $10,000 US, so on and so forth. So the reality is that the renminbi is the most obvious wrong price. This was a deliberate policy choice, I firmly believe, for China because if you want to really bring up your industry, one of the best ways to do it is to maintain a very undervalued currency. Now, here's the fascinating thing and the important shift today, and I'm sorry this is a long preamble and answer to your question. This desire by the government to keep a very undervalued currency is now shifting. The renminbi has now gone up 44 out of the past 48 trading sessions. So this is very clearly the PBOC sending a signal to its importers, to its exporters. Guys, the renminbi is now moving up. Hedge accordingly. Now, China is doing this at a time when the world is already feeling very reflationary. At a time when, you know, the, the US, Europe, Japan are all running big budget deficits, where monetary policies are very easy, where the financial markets are telling you we're in a very reflationary environment. Metal prices going through the roof, financials outperforming, yield curves steepening. Wherever you care to look, you find the markets telling you we're in a reflationary environment. You find the policymakers telling you we're in a reflationary environment. And amidst all of this, China now comes in and essentially says, "Look, guys, I'm going to be reflating. I'm going to be revaluing the renminbi from here on out," which in itself is another sort of more fuel to the fire of, of the global reflation trades. And now as China starts to revalue, so does the Japanese yen. So does the Korean won. So, you know, year to date, there's been lots and lots of events. You've had Venezuela, you've had Greenland, you've had Iran, lots of things to capture investors' attention. But I think when we'll look back at the end of this year and think, actually, what really mattered this year, I think people will look back and say the fact that China changed its FX policy and started to revalue the renminbi, that was actually perhaps much more important than Venezuela, much more important than Greenland, much more important than all the stuff that, that keeps spilling ink in newspapers.

Well, let's first start, and I think this is just such a provocative framing of this, uh, topic, which is, you know, some version of the price is wrong. It's, uh, divorced from the fundamentals that folks like you would pay a lot of attention to. And, uh, you know, you're saying it's very difficult to explain. So the first thing is, I want to go back to some of your slides here and let you walk us through this one here, which is just what gets at the price being wrong, differentials and inflation rates, but a currency that doesn't adjust relative to that. Why don't you kind of walk through this chart and what it was supposed to mean for R&B?

Yeah. Um, look, actually, I think, uh, let's start with the, the previous chart, or maybe one or two before. The, the Chinese trade that, that one. The Chinese trade surplus today. China's trade surplus is a hundred billion a month. Now, I know, like, when we get to big numbers, it's hard to relate to exactly what that means, but this is, it's not even close. This is by far the biggest trade surplus any country has ever run in history. To put things in context, you know, at roughly 1.3 trillion a year, China's trade surplus is equal to Saudi GDP. So this is gargantuan. It also means that if you have a hundred billion US coming in every month, which you do, that means that if you want the exchange rate to not go up, you either have to ship out this money one way or the other very quickly, buy gold, buy oil, you know, just find ways to to reallocate this money, or that means you have to print 700 billion renminbi if you want to keep the roughly 7:1 ratio going, which I think is what, to some extent, China has been, uh, has been doing. Now, staying with this chart for just a second, you'll notice that in 2018, apologies, in 2018, China's trade surplus was roughly 20 billion a month. So this is when the trade war started in earnest. So, you know, the whole idea behind the trade war was to essentially, you know, create a moat around China, box China, and I think it's been an total failure. It's been a, you know, that was the one big bipartisan issue in the United States. The one thing that both left and right agreed on. I think if you told them in 2018, look, the trade surplus of China is now 20 billion, and by 2025, there'll be a hundred billion, and the world will be more dependent on China than it's ever been, including the US economy itself. Uh, then they probably would have said, maybe that's not a good idea to to go ahead and declare a trade war on China then. So if you judge a, a tree by its fruits, the trade war, at least so far, has been an abject failure. And it's been, I would say, you know, if I think if you call it a war, then seven or eight years later, we can say that the war has been lost. Uh, and I think this is what President Trump just did when he went to Busan, South Korea, and essentially he started to talk about a G2 world, and he started to say, essentially, look, we're going to refocus on the Americas because that's really what we care about. We're going to have a new Monroe doctrine, and we're going to focus on our own hemisphere and essentially forget about the rest. That is an acknowledgment of, we launched a trade war seven or eight years ago, and we lost it. So maybe I can move on to, to the next slide. And, you know, part of the reason I think the, the trade war was lost is on the one hand, China sacrificed immensely to to win this trade war. When the US said, we're going to take you down, uh, China said, okay, we have to de-Westernize our supply chain. We have to mobilize all our savings into this, uh, essentially moving up the industrial value chain. And that came at tremendous cost. Real estate prices went down a third, equity prices went down two-thirds. It was, it was a, it was a genuine sacrifice by China. And as I mentioned, it was a, a profoundly deflationary sacrifice by China. So if you look at the rates of inflation in China, with the, the red line on this chart here, essentially China, on official numbers, has had no inflation for five years. I actually think China's had active deflation. You know, property prices have gone down by a third. Electricity prices have gone down by a third. Healthcare prices have gone down by a third. So, if you're, you know, a guy living in Shanghai, it is now much cheaper to live, you know, your daily life than it was five years ago. The opposite, of course, is true in the United States because when the US declared its trade war on China, unlike China, it didn't say, you know what, let's de-sinify our supply chain. We need to make, we need to capture all of our savings and build our own shipping industry, build our own aluminum industry, build our own rare earth industry. We need to look at our, our own industrial supply chains and take China out of them. The US absolutely did not do that. Instead, the US declared a trade war on China and then basically went on a seven or eight year party. A seven or eight year party where it took all of its money, bid up asset prices, bid up real estate, bid up stocks, leveraged up its balance sheet, uh, but really at the end of the day, added fairly little productive capacity, little infrastructure investment, and now essentially, you know, put it, put all of its eggs in the AI basket. Said, you know, AI, we're going to put, we're going to put all of our investment money into this, and this will allow us to leapfrog China into the industry of the future. That was a big bet, and I would say that's a bet that doesn't look like it's won because China's actually kept up on AI. That was the big revelation last year of DeepSeek. That's the big revelation of Quanzhi. You know, when Henderson Horvitz, one of the biggest, silly, VCs in the world, comes out and says, 80% of the firms that come knocking on our door use Chinese LLMs because A, they're free. Second, they're open-sourced, unlike the US that are closed-sourced. When the boss of Airbnb, during his earnings call, comes out and says, you know what, we used to use ChatGPT, but now we use Quanzhi because we'd rather have an open-source system than a closed-source system. It tells you that the hope that the US had of leapfrogging China through AI, it's probably not going to work. Um, so what you've ended up with in the US is with all this monetary creation that really didn't go into productive investments, you end up with higher inflation. And this is the big divergence of the past five years is that on official numbers, China's inflation is flat. And I would say it's actually probably negative. The, the Chinese officials don't want to publish negative numbers. While in the US, over the past five years, if you trust the official data, and here again, I would say that it's probably underreported, if you trust the official data, the, the cost of living in the US has gone up by 25% over the past five years. And I, I think that course, you know, you, you talk to most people, they'll say definitely over the past, over the past five years, my healthcare costs have gone up at least 25%. My auto insurance costs have gone up at least 25%. My local taxes have gone up at least 25%, so on and so forth. So concretely, usually, you know, when you have a country with high inflation, a country with low inflation, exchange rates adjust for the difference. Exchange rates adjust for the difference because, you know, they're supposed to more or less track purchasing power. When it comes to the China-US, they abs, exchange rate, they absolutely have not. You've been hovering around seven for the past five years. And so, you know, today your seven renminbi buys a lot more in Shanghai than it did five years ago, while your one US dollar buys a lot less in New York than it did five years ago.

The Economist Big Mac Index is screaming in, in China.

It's a Big Mac Index. It's your hotel index. It's your cost of transport index. It's, you, you name it. The, the cost of living disparities are absolutely gargantuan. And I think, you know, it is, it is inflation that is now creating a lot of the political tensions in the US. Uh, and same in Europe, by the way. This is not just a US problem. Inflation is a massively, you, I don't think you need to be a Marxist to to believe that inflation is a massively socially destabilizing phenomenon. You know, I, the, you don't get people like Alexandria Ocasio-Cortez elected in New York unless you have a cost of living crisis.

You mentioned the, uh, trade deficit and the hundred billion US dollars basically coming in on a monthly basis. You alluded to it, but just would love for you to expand on how that capital is deployed. Um, you know, we, we are aware of the kind of de-dollarization theme. The, um, stockpile of US Treasuries that might have been a thing a decade ago is not a thing anymore. We read reports, uh, maybe from the World Gold Council on central banks accumulating gold as a substitute for reserves. Tell us a little bit more about how you see that capital that comes into China. Where, where is it going?

So, I, I don't think it's going directly into US Treasuries anymore. Now, first of all, we have to remember that a lot of the, you know, the trade surplus, it's not owned by the government. It's first owned by individuals, by entrepreneurs who run companies who sell widgets around the world, earn dollars. Now, the first thing that's happened, I think, is if you were a rich Chinese guy, imagine you're a rich Chinese guy and you know, you're selling widgets around the world, you're making money. In the past, you could bring it back. You brought the money home, and typically your default mode was to invest in real estate because real estate was going up. Because that's what people typically do in emerging markets because, you know, you can touch the real estate, you can feel it, it's there, you, you, you know it. So that was always the, the default mode. Of course, by the time the government starts to say, look, investing is, uh, real estate is not for investing, it's to live in, and we're going to bring the price down. And then they follow through on policies to do just that. All of a sudden, that's not such an attractive asset class. If, at the same time, for a number of reasons, equity prices are also getting crushed, then your default mode, what's becomes your default mode with the dollars that you've earned? Now, to the extent that you could, I think the first thing you did was you got those US dollars into a bank account in a place like Hong Kong or Singapore or some other offshore financial center. So if you look at US dollar bank deposits in Hong Kong, so, US dollar in cash sitting at the bank in Hong Kong, that's grown by almost $500 billion over the past couple of years, about two and a half years, $500 billion. Now, to put things in perspective, Hong Kong is roughly 8 million people. So, this is not Hong Kong people's money. You know, Hong Kong people didn't increase their US dollar saving by $500 billion. That's mostly Chinese money. Now, why would they put it in a bank account in Hong Kong? Well, again, you're a rich Chinese guy. If you put your money in Hong Kong, you're going to earn 5% a year on the interest that HSBC is going to pay you. And then the renminbi was going down 2 or 3% a year. So now you're making seven or 8% real. And remember, inflation is zero in China, right? So, and it's probably negative, actually. So 7 or 8% real when your domestic real estate market and equity markets are going down actually sounds pretty good with no volatility. I guess you're taking the risk of HSBC, but that's not a massive risk. So it's pretty, you know, pretty attractive proposition. So to some extent, that money was actually being recycled indirectly into US treasuries because HSBC ends up with the cash, doesn't know what to do with it because the demand for loans isn't there. Boom. I'll buy US treasuries or I'll put it into US money markets or whatever else. This is changing in front of our eyes right now. This is why the renminbi going up is so very important because now if I'm that same rich Chinese guy and I'm sitting on, let's say, a hundred million US in my Hong Kong bank account. Now all of a sudden the renminbi, instead of going down two or 3%, is now going up five or 6% a year. At the same time, I used to get 5% from HSBC, now the Fed is cutting rates. So, I'm gonna, I'm, I'm only getting sub-four, and pretty soon I'll be getting a three handle as the Fed continues to cut rates. So, what was a plus 8% trade is suddenly becoming a minus 2, minus 3% trade in renminbi. So, now I'm thinking, okay, I was happy with my plus 8. I'm not so happy with my minus 2, minus 3. What do I do with this money? And I think the obvious choice, so perhaps I buy gold. And so gold, gold, gold goes absolutely parabolic. Perhaps I buy high-yielding Chinese stocks. I buy some PetroChina giving me six and a half percent. Because PetroChina in Hong Kong dollar is giving me six and a half percent dividend yield. If, at the same time, the renminbi is going up 6% uh, a year against the US dollar, now all of a sudden I'm going to be making 12, 13 in Hong Kong dollars. You know, not, not such a bad proposition. So the change in FX is going to lead to a change to a lot of people changing their temperaments. Perhaps that's one of the drivers of metals going bananas as, as we speak. Perhaps it's one of the, the factors driving the steepening of the yield curves. I, I personally believe it is. You know, how this money, this trade surplus of China gets recycled is a super important, is undeniably a super important question.

When we go back, it's literally a decade. Uh, so 2016 is the early days of, you know, what I would consider, you're the expert, but kind of the peak of the China outflow story. The central bank is kind of more on the defending part of things. The VIX skew in CH is bananas. Uh, there's a lot of US hedge funds putting all kinds of structures in place to bet against the implosion, and regular everyday funds are very worried about the implications of a, you know, asymmetric move lower in the yuan, and doing all kinds of overlay hedges. I mean, I was a part of a bunch of these with clients. It was a very significant topic of conversation. The way you're framing it now is that the central bank is allowing the currency to to strengthen. It's sort of getting out of the way a little bit, I guess, is how I see you framing it. And a big part of how you've explained this conundrum of the weakness has been just capital outflows. That that's been a big part of it. I would love for you to just explain more around your, because what I've seen in your writing is a struggle to try to explain this conundrum. Why is this currency behaved the way it has given the inflation dynamics? And one of the areas that you point to as a potential explanation is just the kind of capital side of things. Explain to our listening audience a little bit more about your thinking there.

Yeah, absolutely. So I think there were different waves of capital outflows from China. And I say this as someone, you know, we, we're based in Hong Kong, we have an office in Beijing, I spend a lot of time there. Uh, we ourselves, uh, manage a lot of Chinese fixed income money. And our biggest outflows by far were not, was not the 2016, 2015, 2016 FX volatility. The, the biggest outflows all came at the time of Russia's invasion of Ukraine. We had, in our fund, we had more than $2 billion walk out the door in the few weeks that followed Russia's invasion of of Ukraine. And why did so much money walk out? Because if you were a German insurance company, a Swedish pension fund, a US endowment, if you had any money in Russia whatsoever, all of a sudden that money got locked down, right? You, you couldn't access it anymore. You were frozen. And so I think everybody looked at their portfolio and thought, okay, we didn't see that one coming. What if the same thing happened to my China holdings? Now, people had a lot more money invested in China for a lot of obvious reasons than they did in Russia. And so it, I think it became a sort of cover your ass where it, you sold China even though it was super cheap, even though it was about to come out of its COVID lockdowns, even though the economy was about to bounce back. You sold China in '22 and '23 partly because, you know, it had had a very disappointing five years, partly because you had massive policy uncertainty, but most of all because you were so afraid of having your capital locked in. This was the, the heyday of, "China is uninvestable," and "you got to get out," etc., etc. And so at, during basically '22, '23, the capital outflows from foreigners out of China were absolutely enormous. Whether it was the real estate funds, the private equity funds, everybody sold their stake. Sequoia itself, for, you know, the biggest VC firm in China, spun out their, their China VC funds. They didn't want to be seen to to be having a China business anymore. They, uh, they spun it out and the local partners took it over. So it was, it, it China became this very toxic thing that people didn't want to have in their portfolios. And during this period, the central bank, as all this capital was flowing out, in spite of trade surpluses, the central bank had to fight to keep the exchange rate from falling. Because remember, the trade surpluses are not owned by the central bank itself, it's owned by entrepreneurs. And over the same period, entrepreneurs in China were also afraid. You, China was still very much in, into lockdown, which, you know, anybody with two brain cells could could tell that this was a, a massive, massive policy failure. I mean, lockdowns were policy failures everywhere, but for China to keep them going this long was was particularly suicidal. So the capital, both domestic and foreign, was was flowing out, and the central bank had to step in to prevent money for the renminbi from falling. Now, why did it prevent the renminbi from falling? I think deep down, the, the central bank, when it comes to the exchange rates, is a firm believer of maintaining low volatility. And by the way, that, that's why people were freaked out in 2015, 2016, because all of a sudden, in a pair that where the volatility was always very, very low, the volatility spiked, not that much in the whole scheme of things relative to a lot of FX, but it was still more than people had expected, and that's why everybody freaked out. So having said all this, I think when it comes to China FX, the first thing you have to acknowledge is A, the trend. Is it going up or is it going down? Today, the renminbi is going up. Second, you have to acknowledge that whatever moves you have will be modest. The PBOC, one of the big sayings in China that Deng Xiaoping used to love quoting is, "We'll feel the stones as we cross the river." It's a good image of how things get done in China. We'll do, we do things very small, tentative. When you know, running across the river, you go slow and steady, and this is especially true in their management of their FX policy. But today, what matters, the trend has gone from going down to now going up. So this is a super important shift. It might not be that important for you sitting in New York. It is super important for any Chinese entrepreneur, any Chinese investor, because now all of a sudden the bias will be towards keeping money at home. So that's the first thing. The pace of it will remain modest. But in a world with low interest rates, if all of a sudden you have a currency that you know is going to go up six, seven, eight percent a year and do so for the next three, four years, that's a huge tailwind for fixed income returns. It's a huge tailwind for fixed income returns. It also means that inflation in that country will remain modest. And with inflation remaining modest in that country, policy settings can remain pretty loose. It can, the, the central bank, the, the fiscal authorities can continue to step on the gas, which is exactly what's happening. So you have all the setups for what we call in our, in our firm, a triple merit scenario: a period of interest rates that stay low or even fall, a currency that rises, and this setup allows asset prices to re-rate and consumption to to accelerate. And so the big picture from an investable standpoint, you've talked a little bit about high dividend paying stocks in China. It's a bullish equities call. Is there a nuance to that in terms of how you implement that? You know, what, what are the broad implications?

So when I look at China for me, so look, I've, I've been a raging bull on, on, on Chinese for 10, 12 years. I wrote book after book saying you have to invest in Chinese fixed income. Chinese fixed income. If you're going to own bonds everywhere, they, they have to be in China. I, I sort of changed my stripes as China reopened. To be honest, I changed it about a year too early. As China reopened, I thought, okay, it's probably time to move away from, from bonds, start to move towards towards equities, and everything that's happened the past essentially two and a half years reinforces my equity bullishness now. And, and people often quote, you know, myself back at me because I used to go on podcasts and and sort of poo-poo Chinese equities and say that, you know, "When China enters a room, profits walk out" is a quote that, uh, that, uh, is often thrown back in my face. And the reality, uh, I think is that when you look at China buying equities, over the very long term, buying equity indices has not worked for a number of reasons that I can go into if you want. But within the equity indices, for me, there's essentially three important pockets that are very interesting. The first pocket that was always there is you do have a handful of businesses that do actually have moats. Few relative to what you have in the US because China is a much more competitive environment, but you do have some businesses that have moats, either for regulatory reasons, for example, the life insurance guys, the Macau guys, or simply because of scale. Uh, so you take a company like Tencent, it's almost impossible to spend 24 hours in China today without giving money to Tencent. You, you have to have, uh, WeChat Pay on your phone. And just like it's hard to spend 24 hours in the US without giving money to Visa or Mastercard or American Express, the same thing is true for essentially for Tencent in China. So you have the, your first basket is businesses that have big moats. And I would put Tencent in that, that one. I would actually put Alibaba as well. There, there's a few of them. I'd throw Meituan in there. So there's that basket. The second basket when you look at China, and this is a new basket, is that as all this money has poured into industry, as China's moved up the value chain in industry, you now have in China, actually industrial world leaders, companies that are now absolute world-class. And, you know, some of them people know, you know, BYD and autos is an obvious example, CATL and batteries is a third. Without going to the very, very top market caps, you do have some smaller ones that are world-class. I'll give you a simple example company. It's, full disclosure, it's one of my biggest holdings, company called Hesai. They're, they're a lidar company. To equip a car with lidar five years ago would cost $50,000 US. So this is why Elon Musk said, "Forget lidar. It's not going to work. The future of autonomous driving is cameras." Hesai comes along and brings the cost down from $50,000 a lidar to $200 US a lidar, cost down 99.5%. To the point where now lidars are no longer a play on autonomous driving. In China today, increasingly, if you don't have a lidar on your car, you're not going to get it insured. So, we'll move to a world where lidars will be like airbags. The insurers or the, the car, um, regulators will force you to have a lidar in your car because when you have a lidar, the odds of a fatal accident absolutely collapse. So, and you look at a company like today, at the very pinnacle of lidar manufacturing at $200, nobody will be able to compete, and they are profitable at $200. So they will own most of that market. And, you know, you, you can find examples like this across different supply chains in a way that these types of companies before only used to exist in Germany or in Japan or in Switzerland or in the United States. And now you do find those in, in China. So, I'd say there's a second interesting basket of, of genuine industrial leaders that are completely missed by most of the Western investors because nobody's visited China in the past five years and nobody's exposed to to these guys. Then you have your third basket today, the one that's ripping the most, which is all your commodity producers that today trade at massive discounts because, remember, China was uninvestable up until two minutes ago. So, you know, your PetroChinas, your China Aluminums, your Baosteels, your Fuyao Glass, like, you name it. A lot of commodity-related GL guys that have been crushed because you had the real estate bust, because China was uninvestable. And all of these guys actually have tend to have very, very high dividend yields. And so today, I think this basket is actually ripping for a couple reasons. Obviously, because commodity prices are moving higher. Secondly, because as all of a sudden holding cash in US dollars is no longer attractive for Chinese savers. And remember, Chinese savers, there's a lot of them, and they now control a lot of money because holding US dollar cash was such a great trade for them for so long, and now no longer is. They turn around, they look for dividend yield. PetroChina at six and a half, and the old price is now moving up. Why not? Oh, CGN Mining, the biggest mining company in China, high dividend yield, metal prices are going up. Why not? So, the flows are definitely going there for now.

So, let's just go back to the uninvestable term. And, um, you're alluding to it a little bit with Trump's recent meeting and this reference to quote G2. Give us a sense as to, you know, whether it's, I don't know if you call it a permission structure, or the way in which, you know, Trump and company have essentially moved on, if that is correct, the degree, you know, to which capital outside China, which was a big thing and ceased to be. How do you see that kind of reawakening process materializing? And what part of the Trump philosophy on its relationship with China is at play there?

So, look, I think the Rand Corporation put it best. They actually published a paper on this back in November. For, for your listeners who don't know, the Rand Corporation is essentially the outsourced think tank of the US Department of Defense. I think the Pentagon pays the Rand Corporation around 200 million bucks a year. So, it's, it's the outsourced think tank of the Pentagon. And they came up with a great, a great paper back in November. They had it on their website for two or three weeks and then they pulled it. But essentially the paper said, "Look, we, we've been treating China as an adversary, and that's probably been a mistake. We should look at them as as a competitor." And, and the reason for that is that de-sinifying our supply chains is actually going to be too expensive. We, we literally cannot afford this because if we want to build our own, uh, rare earth supply chain, that's going to be a trillion dollars. If we would need to build, you know, if we need to go back to having 30 aluminum smelters in, in the United States up from today six, which is what we'd really need to do, that's probably another 5, 600 billion. If we need to have our own shipping industry, that's probably another trillion dollars. So this, this would be all well and good, but you're starting off from a position where the US is already 120% debt to GDP, where in the mid-five years into an economic boom, the US budget deficit is 6.5% of of GDP while unemployment is only 4%. Where in the past, you know, 6.5% of GDP budget deficit was at the bottom of the cycle, not at the top. So it's, it's all a question of where do you want to allocate resources. And again, China went through this exercise for the past seven, seven to 10 years where they said, okay, we're going to de-Westernize our supply chain, and they did so at great cost. Debt to GDP in China moved from 30% of GDP up to 100%. You moved real estate prices. I mentioned it, but real estate prices went down a third. Equity prices went down two-thirds as China mobilized all of its resources and put all that capital in endeavors that had low returns on capital, that had great cyclicality. If the US wants to go down the same path, it would completely blow up its stock market, completely blow up its real estate market. And frankly, what politician wants to run on that platform? So you could, you have to question, you know, what is, what is more existential for the United States going forward? Is China truly an existential threat, or is the NASDAQ going down two-thirds more of an existential threat? And is real estate going down one-third? Because if, if real estate goes down one-third and you end up with riots in the streets, what's the point of, you know, for, for obviously elected officials, but for the good of the United States in general? And so I think very wisely, President Trump, you know, looking at the choices, decided, actually, maybe China isn't that much of a threat, and we should stop treating them as one. And hence the, the talk of G2. Hence the fact that as Treasury Secretary Yellen highlighted, the US and China, uh, presidents, she and Trump are scheduled to meet four times over the next 14 months, which, you know, you've never seen. The Chinese and US presidents meet four times over such a short period of of time. And Yellen was very clear during the CNBC interview that Trump wants these meetings to go well. Now, she also wants these meetings to go well because he has a problem of domestic confidence. He wants to get his economy doing better. One of the easiest ways for things to for him to do better is to have a better relationship with the United States. So I, I firmly, I hope, I believe that, you know, reason is seeing the light of day, that essentially moving towards a massive clash with China is a suicidal policy for all involved. And it's, same, same is true for China moving forward, for a clash towards the United States is is also economically suicidal. That finding areas of compromise, finding areas of of growth is will be much better for, for everyone involved. I think this is the way that Trump essentially has shifted. This now allows China not only to revalue the renminbi but to focus more on domestic consumption, to embrace things like the anti-involution campaign, which essentially says, okay, let's stop adding overcapacity on top of overcapacity. All of that is bullish. All of that is very reflationary for the world. One of the downsides that we have to consider is that all of that does mean much higher commodity prices. Now, of course, it's not downside if you're long commodities, and it's not downside if you're a producer of commodities. For the consumer, it's not too much of a problem as long as energy prices don't go up. If the only commodities going up are copper and nickel and tin and gold and silver, doesn't really matter. You know, how much copper do you use every day? Fairly little. So, it, it's like water off a dog's back. If energy prices start to move up, then we move into a more challenging environment. And I do worry that that might be what's unfolding right now.

You go back to, I want to say it's August or September of 2024, and China first articulated some of their desire to reflate, at least, you know, kind of asset prices. There was a big lurch higher in indices like the FXI. David Tice was very vocal and very early.

And very courageous because he was doing this at a time when China's evil, Chinese Communist Party is trying to take over the world, etc. So for Tice to go on TV on CNBC and say, "I'm going long China," I thought was very courageous in the political mood of the time. Sorry, I interrupted you.

Yeah. No. And, and very, um, you know, sort of counter-trend in terms of what people were saying and doing. As 2025 evolved, was there indications that folks took his word and said, "Okay, I think this is time to do this"? Or you didn't really see much of that?

No, we've seen no flows. Look at the shares outstanding on the FXI, as an example. So shares outstanding on KWEB, the, the tech index, China tech index that has Tencent and and Alibaba and Meituan and, you know, all the, the guys, that's picked up a little bit, but still, it's, you, you look at the flows into KWEB, the flows into FXI, just as an indicator, these are the big China ETFs traded in New York, as an indicator of, of flows, it absolutely, absolutely has not happened. So it's a super important point that you highlight because in 2024, China massively outperformed every market after, you know, many years of of underperformance. Huge outperformance in '24. Most people looked at it and said, "Yeah, whatever. Short-term rally. Sure. It was beaten up, so it rallies." Whatever. 25, again, big outperformance. This time, you also get massive Korea outperformance and also Latin America outperformance for different reasons, different drivers, we can discuss if you want. But now all of a sudden, you have a bunch of different decent-sized emerging markets, i.e., Brazil, Korea, China, that are all going up. So in my conversations with various pension funds and insurance companies and, and whatnot, I think there is some starting to be some discomfort about the fact that everyone sold China in '22, '23, and China is now up 100% since then. So, it's hard to go back to the board and say, you know what, I was wrong to sell China at the bottom. It's not gone up 100%. So, I think we need to put China back into the portfolios. It's a hard conversation to have because you look like an idiot. And you're also worried that China has this history of rallying 100% and then going down 50%. So, it's like, great, I'm going to go back in and it's going to blow up in my face. So the way people are getting around that, I think, in '26 and '27, and this will be a key theme of markets, is to turn around and say, let's go overweight emerging markets. Now, the flows haven't happened. The discussions are happening as we speak. And going overweight emerging markets essentially means you're buying China back without having to say, "I'm buying China back," because, because half of the index is, is China. And you can say, "Oh, look, Korea's doing great, and Latin America is doing great. We should go overweight." And now the US dollar is going down. We should go overweight to emerging markets. And those discussions are just starting. The story of '26, the story of '27 will be the story of the EM flows coming back in. And then the question will be, as those flows come back in, who will be the marginal seller? Who, who is, as the Western money comes back into emerging markets, who will be the seller? Historically, if you look at emerging market cycles, for a few years, there are no sellers, and the market rips. And then after a couple of years, two, three, four years of of large outperformance, the corporates themselves start issuing paper like crazy. The corporates start to say, "Oh, you guys like this paper? Here's a bunch more." So you start to see big IPOs, big rights issues. We are not yet there. By the way, that's one of the reasons, one of my bigger holdings is Hong Kong Exchange, uh, the, the, the Hong Kong stock market itself, because I think we're still very much in the foothills of a, uh, emerging market bull market. And when, what, when you, when the flows come in, the IPOs will come in, the the rights.

issues will come in. The same by the way you could buy the BVESPA and you can buy the the Brazilian exchange itself. You can buy the Singapore exchange. You know, if you if you're a big believer that China is uninvestable, therefore you don't want to buy the Hong Kong exchange, there are other exchanges to buy. We are still in the foothills of this EM bull market. The flows haven't even begun.

Well, here's where I wanted to spend the last 10 minutes. So, so our conversation has about your thinking on this, you know, incredibly important relationship, this global FX relationship that's got so much consequence for other residual assets, US versus China, the FX. We have a history in markets of getting prices wrong, sometimes spectacularly so. You know, the price of mortgage credit in the US in 2006, the price of sovereign CDS in Europe in 2010 and '11, right? Uh, or the Fed funds rate in 2022, right? So sometimes when the market realizes it gets it wrong, price disruptions can occur, and there can be a lot of volatility as we try to find the new home. That can be very disruptive. I think as you're describing mispricing, it doesn't necessarily have to be that disruptive.

But here's where I wanted to kind of juxtapose that, which is Japan. You know, that's really been in the news recently. The 10s and 30s and 40s, small markets in JGBs, but just gigantic, gigantic moves. And if you believe Bloomberg's reporting, it was something like $280 million of notional trading, I think in 30s and 40s, that created this illiquidity cascade that caused global yields to rise sharply, took down the US stock market for a day or so. And so I'd love to hear your thinking on Japan as it tries to normalize, you know, its curve relationships. Obviously, if its FX is getting a lot of play, frame out what you see in Japan and whether you think that there are asymmetric risks as we try to get towards a new equilibrium there.

I love the examples that that you use to show how markets all of a sudden can gap and and readjust very, very violently. Whether the the euro CDS trade of 2011, 2012, the mortgage trade of of 2008. The reason I think you had those massive, massive moves in those markets is that participants typically in fixed income markets are not there for losses. I mean, the point you're in in the fixed income markets is is because you want steady, predictable, calm returns. And every now and then you you realize that whatever bond I have isn't going to deliver on that promise. And I think when you buy an equity, you come in wide-eyed, wide open. You know that what you buy might go bust. You know, you you're accepting a certain level of volatility when you you come into equities. Now, sometimes the volatility does get uncomfortable and and that forces you to readjust portfolios, etc. it. But you most equity investors are willing and able to stomach much higher volatility levels than fixed income investors.

And so that brings us to to Japan today, where indeed the volatility on the long end of the Japanese curve has been, I think if you're a fixed income investor, deeply unsettling and uncomfortable. This is now, you know, I mentioned earlier, the the one wrong price in the world was the renminbi. I would say that the other wrong price, it's less wrong now, but the other wrong price was of course the JGB yields. You had three, three and a half percent inflation in Japan for the past few years and long-term yields at one and a half percent. You know, this this doesn't make sense. So, what you've seen in Japan is a bond market that has adjusted. I think you've seen two things. A bond market that has adjusted to an underlying economic fundamental of a Japan that is no longer in a deflationary bust. Number one. And then a bond market that is essentially trying to force the hand of a BOJ that has done all of it all it could to prevent to not to raise interest rates. You know, as inflation accelerated in the US, inflation accelerated in Europe, the ECB, the Fed, they weren't really willing to do it. They kind of did it kicking and screaming. But as the long end sold off, they they followed. Yeah. They raised interest rates as long followed. In Japan, they never did. In Japan, the long end sold off and the BOJ stayed sitting on its hands.

It's a very interesting question. Why did the BOJ do nothing in the face of rising inflation? I think you have two possible answers. The first answer is, well, they're still traumatized about their 25-year deflationary bust and didn't want to shoot the gun too early, etc. Okay. I actually think it's something else. I actually think that in Japan, policy is essentially driven by the big Keiretsus, the massive groups, the Mitsubishi's, the Hitachi's, the Toyota's. These guys have their network, have their their fingers all over policy. And these guys actually, of all any Western groups, have the longest history into China. And I hate to bring this back to China again, but I really think that's the key player. They have a long history into China. And so when you remember that very first chart I showed you with all the money going into industry during that period in Europe and the US, everybody was going around, Wall Street Journal, FT saying, "Ah, China, it's imploding. Forget about it. Who cares?" And nobody was paying attention to what was happening in China. The Japanese were paying attention. The Japanese were very much paying attention because they have deeper networks into China than anybody else. And the Toyota's of this world were turning around to the BOJ and saying, "Bring the yen down. Bring the yen down now because if the yen stays at 110 to the US dollar, we're not going to survive." BYD. Fanuc was saying the same thing. Mitsubishi was saying the same thing. Hitachi was saying the same thing. So whatever the reason was, and I think it was this, it was we need to drive the yen down if we're going to survive China's industrial onslaught. Let's not forget that Japan is fundamentally a very industrial nation itself. If we're going to survive the Chinese industrial onslaught, we can only do so with a massively undervalued yen.

The reason this matters is that if you now have the shift of policy in China where the renminbi can go up, that means that the BOJ can now turn to the Toyota's and the Mitsubishi's of this world and say, "Okay, fine, the renminbi is going up. We can now let the yen go up. I can start raising interest rates again. I can start raising interest rates in earnest. I can start dealing with my domestic inflation problem." And of course, this fuels into a bond market that was already selling off. So the reality today is we are moving into a world where Asian currencies are going to be moving up, where bond yields in Japan that had been selling off at some point will find their level with the renminbi with the yen going up. And that point may not be too far. So, I personally wouldn't go out and short JGBs here. And as essentially Asian currencies go up, this will have an impact on bond markets all over the world because Asians will bring savings home and will be less likely to buy German bunds, less likely to buy Indonesian rupiah debt, less likely to buy US Treasuries.

Well, Louie, you've given us a ton to think about. I love the way you tie together these trade flows across countries, the the FX relationships, the bond market relationships. It was uh excellent uh to catch up and thanks so much for sharing your insights.

Absolutely. My pleasure. Thanks so much for having me.