Transcription
Hello, everyone, from the Rob Capital's team. I hope you're well. I'm here with my good buddy, the Fed guy himself, Joseph Wang. It's very appropriate today because we are just before the Fed rate decision. Drum roll, please, for the drama! So, Fed guy himself, welcome back to the show, buddy! What do you think is going to happen today?
Hey, George, thanks for having me! It's great to be back. In thinking about the Fed today, we have to remember that the Fed never wants to surprise the markets, so everything they do is going to be telegraphed in advance. They are definitely going to cut rates by 25 basis points today. But, you know, I think it's helpful to think about just the path that got us here. The Fed started cutting rates in September, beginning with a jumbo 50 basis point cut, and they were telegraphing that they would cut again in December based on the data they were looking at. It seemed like they got kind of panicky back in September. At that time, they had economic projections that were basically recessionary. They were thinking that the unemployment rate would surge to 4.4%, GDP growth would come down, inflation would come down, and so forth.
But what's surprising is that over the past couple of months, the data has been a lot better than they had forecasted. The unemployment rate has gone up, but not as much. GDP growth is still okay, but inflation is a little bit hotter. Even after all this, they still wanted to cut.
So, Joseph, let's take a look at all the economic data that you just mentioned. Let's assume it doesn't get revised, right? How are they justifying a 25 basis point cut when, I mean, producer prices surprised to the upside, didn't they? I know the headline went from 2.4% to 2.7%. And then what's their key metric that they look at? Is that the PCE?
Yeah, PCE. I think it's over 3%. So, how do they spin this?
When the Fed is looking at inflation, we get lots of inflation prints: we get CPI, we get PPI, like you mentioned, we get import prices, and we get PCE. Now, broadly speaking, these inflation metrics have been surprising to the upside. So, it's a very good question: why are they cutting even though inflation seems to be surprising on the upside? I think the key is to just listen to what Chair Powell has been saying. Now, at his press conference in November, he was basically asked that, and his view is that inflation, on a year-over-year basis, is pretty high. But when you look at inflation over the past few months—let's say on a three-month annualized basis or a six-month annualized basis—he's thinking that it's been coming down a lot. He also notes that a lot of the inflation in these indexes is shelter inflation. Right now, as we all know, shelter inflation is lagging because you only sign a lease once every 12 months or so. A lot of the inflation we see in shelter today is inflation that happened 12 months ago.
Now, he's looking at the leases that are signed more recently, and he's noticing that rent increases have been very low. So, he's really going out of his way to kind of push back against this inflation fear. Honestly, my sense is that he is thinking that inflation is all but mission accomplished, so he's not really worried about inflation anymore. What he is worried about, though, is the rise in the unemployment rate. The unemployment rate over the past year has been ticking higher. Now, historically, it's not that high—it's about 4.2%—but the trend is definitely higher. So, he's really concerned that maybe the unemployment rate is going to keep rising.
Another thing you have to keep in mind is that when the Fed is looking at the economy, it's not just about the direction of rates—are we going up or down—but also the level of rates. He's thinking, say, 4.5%, and he's thinking that's still pretty tight. So, he's worried that holding rates at a pretty elevated level while the unemployment rate is rising is concerning him. That's why he keeps wanting to cut rates, and I expect him to continue to do so throughout next year as well.
Do you think he's looking at other central banks? I mean, as Americans, we get hyper-focused on what the Fed's doing and what's happening here in the United States. Let's just say, you know, quote-unquote, sticky inflation, but then we completely ignore basically the global financial crisis that's happening right now as we speak in China. That's the only thing I can compare it to; I don't think that's using hyperbole. Then you look at what's happening in the Eurozone, you look at what's happening in Germany—I mean, that's really scary. They're actually shutting down Volkswagen plants and whatnot. You look at what's happening in the UK; I think they've had a couple of months of negative real GDP. We'll see what happens if that turns into two consecutive quarters. Then you've got all these other governments around the world that are quite literally collapsing because of the economic conditions there. I mean, let's look at Canada. You know, as Trump says, the 51st state. Their unemployment rate is almost at 7%, and it's gone from 5% to 7%. The Canadian Central Bank, I think they've dropped 50 basis points two in a row. The Swiss National Bank is dropping by 50, the ECB is dropping. I mean, does Fed Chair Jerome Powell look around the world and say, "Well, wait a minute here, this is likely a globally synchronized economy, and we're the outlier here"? What are the probabilities that we fall in line with the rest of the global economy, or do we continue this trend in a completely opposite direction?
You're making a really good point in that the global economy is definitely not doing well. All those countries you cited are all heading into recession. This week, we have basically a fiscal crisis erupting in Brazil as well. Their currency is just imploding, their stock market is imploding. The U.S. plays a kind of special role in the world because the Fed is basically the world's global central bank, and the dollar is the world's global reserve currency. As you've talked about a lot on your channel, we have this euro-dollar system where what happens with the dollar impacts the financial conditions abroad as well. A lot of companies abroad borrow in dollars and invest in dollars. So, if you're a Mexican company, or a European company, or a Canadian company that has a lot of dollar debt because you need to borrow dollars to engage in global trade, as dollar interest rates are pretty tight and the dollar is strengthening, that's tightening financial conditions and creating a further headwind for the global economy.
Now, how this figures into the Fed's thinking, I think it's difficult to say. They're never going to say, "I have to cut rates because I'm worried about my friends outside of the country." That's a big no-no, and I think that would make an America First presidency very, very unhappy. But if you look at things historically, sometimes the Fed does conduct monetary policy with some view of what's happening abroad. We saw that, let's say, in the 1920s when they had swap lines. That definitely helps, but remember, not everyone has swap lines. Like you mentioned, things are not good in China, and they definitely don't have swap lines, although they may not need it since they have literally trillions and trillions of dollars in reserves.
I just pointed out the swap line just to illustrate the point that sometimes the Fed does actually consider what's happening in another country. Oh, exactly! Because if they don't take care of the dollar's funding outside of the country, that's going to impact their own U.S. financial conditions as well. I mean, imagine if they didn't have dollar swap lines in Europe. When the European banks really needed dollars back during the Great Financial Crisis, they would have just come to the U.S., bid up dollars, and made domestic interest rates much higher, which would have impacted the U.S. economy. Now, I'm not sure how much of it—so back to my example in the 1920s—it was well understood that at that time, the Fed kind of cut interest rates a bit because they were worried about what was happening in Europe, trying to bail them out. At that time, though, the U.S. was not as influential as it is today. Now, I'm thinking that it might play some consideration, especially forward-looking. Like you noted, if we have a global recession, the U.S. is probably not going to escape that as well, so that could be part of it.
Now, just listening to what the Fed officials were saying, I think what they're worried about is that there is a portion of people in the U.S. Now, in the U.S., if you go to the big cities, if you look at some of the numbers, it looks like it's a boomtown, right? Stocks are going to the moon, Bitcoin's going to the moon. But there is a big portion of Americans who are not doing well. When they hike rates, it really has an uneven impact on the economy. Now, say that you're a small or medium business, for example. A lot of times, your financing is from a bank, and bank loans are usually floating. So, for you, your interest rate expenses have been going up a lot. Or if you look at someone who's trying to buy their first home, mortgage rates are still around 6%. That's unaffordable for many Americans. If you're looking at housing starts, they've come down a lot over the past year. So, that is definitely going to feed in and impact home builders, construction jobs, and so forth.
Now, credit card delinquencies have ticked up a bit. They're not historically super high, but that does show that there's some portion of the public that's having trouble handling these higher interest rates. So, when they're making policy, I think they can't just look at the stock market or Bitcoin or stuff like that. They really have to think about the well-being of just the more middle-class average American. For them, I think interest rates are a bit high, and so they want to get interest rates down to make sure that the unemployment rate doesn't continue to go up.
Do you think 2% or 3% is the new 2%? What I'm implying there, Joseph, is—and I'm not saying this is my view or not—but it would make sense that if Jerome Powell and the Fed were worried about the debt, let's say debt to GDP, that they would prefer the economy to run a little "hot," as far as nominal GDP, just to try to get that debt to GDP down, hoping, you know, the government doesn't spend like the drunken sailor they are. Do you think that's going into their calculation?
I don't think so.
You think so?
Okay, I think so. I'll actually talk about this more broadly and then on the Fed more specifically. So, globally, in the Western world, there's definitely an unsustainable sovereign debt problem. Now, the house of cards really depends on the country. We see countries like France, where it's becoming more and more serious. France's deficit is around 7%, and they really haven't had a balanced budget for several decades. At the same time, we see French yields rising, and in some cases, a high-quality French corporation can actually borrow at lower interest rates than the French government.
Now, looking across the world, this is obviously unsustainable. If you have too much debt, what can you do as a government? Well, you actually have a number of tools. First off, because you're in a fiat system, you can always have the central bank buy it, right? You can simply print, and you can think of that as inflating the debt away. That's an obvious solution people have been using since the beginning of governments. Now, another way to do this is to raise taxes. If you have a spending problem, you can cut spending or raise taxes; that will make the deficit smaller. The third way you can do this is through growth. If you have a huge debt problem, maybe you can invent new technologies.
Excuse me, maybe you can invent new technologies and grow your way out. Now, when you're looking at Europe or Canada or the UK, Europe is in a predicament because a country like France, they aren't a monetary sovereign; they aren't a fiat system, but they're part of the European Union under the ECB, and they're just one player among many. They don't have a central bank that's just there to do whatever the government tells them to. If you look at taxes, well, you know, in Europe, it's pretty crazy. The marginal tax rates are around 50%, and you hit that top tax bracket maybe at €200,000. Sometimes it's around €100,000 if you're in some Euro countries, sometimes around €300,000 if you're in some Euro countries, but that's much lower than, say, the $600,000 maximum marginal tax rate that you hit in the U.S.
So, those guys are already taxed to the max, and they don't have any growth either, so they can't grow their way out. There's basically no technology in Europe. In the U.S., we had the 1990s tech boom with Microsoft, Amazon, and we have the AI revolution happening. In Europe, you know, it really is that bottle cap thing that sticks to the plastic bottle—that's their technology and innovation. They have a little bit, like ASML, but broadly speaking, they're not a very technologically advanced region. So, they can't grow. For them, I think sovereign debt is a very serious problem.
Now, just moving back to the U.S., listening to the Fed, in my understanding of how this institution works, I really don't think that they're adjusting monetary policy because they're worried about the interest rate expense. The interest expense is enormous; it's basically as much as defense spending. Now, it's on an upward trajectory, but when you go back to the U.S. case, when you're thinking about debt, you have a lot of tools to solve it. U.S. taxes compared to the rest of the Western world are pretty low. Now, it's higher than a lot of countries in Latin America, but compared to, let's say, Western Europe, our highest marginal federal tax rate is 37%, which hits at $600,000. If we were to have tax rates that are more comparable to other wealthy countries, the tax rate could go up a lot, and it could hit at lower levels.
So, we could definitely hike taxes to solve the fiscal issue. I hope we don't, but that lever is available. Now, we also have a lot of growth. The U.S. is a dynamic and technologically advanced country. We've got all this stuff coming online—AI, maybe robotics from Tesla and other companies like that. So, we could definitely grow our way out; that's still possible. And at the end of the day, if push comes to shove, we always have the Fed to bail everything out. So, at the moment, I don't think that the Fed is conducting monetary policy thinking about the fiscal situation.
Okay, maybe they will in other countries, but right now, I don't think we're there just yet.
Yeah, my view is that the U.S. debt is really not a problem, or else we would be seeing interest rates rise. I think people tend to forget that those who are worried about the long end of the curve blowing up—the 10-year treasury is still trading under fed funds. That is not an environment where the bond market is worried, or the bond vigilantes, let's say, are here. I discussed why I think that is in several of my videos. I think there's a—you know, the euro-dollar banks, I think they just pocket a spread, so they really don't care about the supply of treasuries, and they don't care about the CPI in the United States. But we'll save that for a separate video.
On the taxes, I think, now to be clear, I'm not saying government spending is good and that we get a free pass here or there—a free lunch. I think the problem isn't necessarily in the bond market or the treasury market; I think the problem is in the government spending distorting the economy and turning us into Europe, right? To where we don't have a dynamic economy because government spending, as a percent of GDP, let's just say is 50%, and the private sector is only accounting for 50%. Therefore, by definition, the economy is getting less and less efficient, which is impacting the standard of living of the poor and middle class. So, that's kind of how I look at the debt.
Now, look at the taxes. You know, what's interesting on that is it seems, just on the research I've done, that regardless of what our tax rate is in the United States, you always get about 18% of GDP as far as revenue. I don't see, you know, whether it was a 90% highest marginal rate in the 1970s—and I know there were a lot of loopholes back then—but it doesn't seem as though they've got that lever maybe as powerful as you'd think.
Another thing that I'd be concerned with there, as far as that lever, is it seems like the tax revenue is more a function of asset prices, right? Like, as the S&P goes, so goes the tax revenue. And as the housing market goes, so goes the tax revenue. So, even if you increase that marginal rate, I don't know if that really moves the needle. But I'm with you on the growth. I think that with Doge, people get really hyper-focused on reducing government employees and increasing efficiencies. I think that's great. And then they say, "Well, it's going to bring down the deficit." I think that would be great as well. But I think the bigger component there, the more important part of Doge, is reducing the regulations. I said even if you don't fire the employees, just tell them to go to the golf course. Just, you know, the EPA—just tell them to go play golf for the next two years. Just don't do anything. Just don't get in the way. And that in and of itself would be a big win, which takes us to that growth, which I think is the most realistic component of those three things that you talked about. Any thoughts on that?
Yeah, I think the dynamism you mentioned is really important. That goes hand in hand with less regulation. I mean, there's that really good photo of the Eurocrat there, you know, trying to regulate AI and everything like that, even though they don't even have AI in Europe. That's ridiculous! There are so many regulations there that you can't get anything done, and I think that is a big reason why there's just so little growth in Europe.
Now, a good comparison that just happened in the past few years between Europe and the U.S. is if you look at the overall statistics. U.S. productivity and U.S. GDP growth have really just gone on and on after the pandemic, whereas in Europe, it's really stagnated. A lot of people think that part of the reason for this is that dynamism you mentioned and that regulation.
So, let's think about it this way. In the U.S., we did really, really different things during the pandemic than they did in Europe. In the U.S., the pandemic comes, and what happens? Everyone gets fired. Everyone gets fired, stays at home, has some stimulus checks, maybe trades some Dogecoin or something like that. But what—that sounds cruel to many people in Europe and so forth. You know, how could you fire people? That's so sad! But what happened was those people, you know, it's not like they died or anything. They went and they found new jobs. They found jobs they wanted to work at, jobs that were better matched to their skill set. So, you had this great reshuffling. Everyone gets fired, goes and finds new jobs in a hotter labor market. They're finding jobs that are better suited to them, and so productivity and money went up.
And productivity went through the roof in the U.S., and that's a big reason why our GDP growth has recovered so quickly. Now, in Europe, they did the exact opposite. The pandemic's here, and they say, "All right, guys, we don't want to fire anyone. That's very sad, so we'll just give you stimulus checks, keep your jobs, you know, job guarantee, everything is frozen. You just do your thing." And so Europe didn't have that great reshuffling. They just kind of stood in place, got some stimulus checks and subsidies to get through the difficult situation, and then just went back to normal. Because they didn't have that big reshuffling, their productivity just kind of stagnated. They didn't see the big boom in productivity that we got here in the U.S.
So, that dynamism and being able to, you know, just go and try new things and find things that are more suited to you—that's a huge benefit that we have in the U.S. that is becoming less and less common throughout the world.
So, this kind of dovetails on Trumponomics. How do you think—let's assume that Trump actually follows through on these tariffs. How do you think that impacts Fed policy in 2025?
Man, I think the Fed is in a tough spot. Trump has said so many things that kind of have cross currents. For example, let's say we have big tax cuts. Well, that's bullish, right? You got to keep rates a little bit higher than you otherwise would. But then, on the other hand, let's say you have a big trade war. We saw that happen in 2018 and 2019, and that was not good for the economy. So, what do you do? If you're looking at unemployment, let's say that Trump really has a giant deportation program—millions and millions of people go back to their own country. Okay, that tightens the labor market up. But then, let's say you have Elon Musk, and he fires a lot of government employees. Well, that loosens the labor market. So, you have all these conflicting things. From the Fed's perspective, it's going to make it difficult to actually do policy ahead of time.
What Jerome Powell has been saying when he's been asked about this is that we won't act ahead of time; we're just going to wait and see what happens and then react to it. I'm not sure there's a better way of doing this because you have so many big ideas, and you don't really know which will actually happen.
Now, there is a good—I mean, there is a path forward where things could turn out really well. Just thinking about the trade wars, you could get a situation where it's not projected; it's just a brief negotiation, and everything improves. We saw that happen the past month, right? President Trump says he's going to put tariffs on Mexico or Canada if they don't get their borders under control, and basically immediately, the president of Mexico is doing something. Governor Trudeau up there in Canada is also doing something. They basically caved very quickly, and everything was able to—I'm sorry to go off topic here, but boy, the power Trump has is really apparent when you look at what's happening in Canada right now. I mean, all he did was suggest a 25% tariff, and the whole country is freaking out! Like, Trudeau's done. Their finance minister—what's the girl's name?
Chrystia Freeland.
Yeah, Freeland. I mean, she's like having a panic attack. You know, she's writing a letter to Justin Trudeau, I think basically saying that he needs to resign and that his policies are crazy and that, you know, the house is on fire because if Trump enacts this 25% tariff, then they're going to have these huge economic problems, and we have to prepare for this. The government isn't ready to handle it. Basically, just by Trump going out there and floating the idea of the 25% tariff, he's almost single-handedly taken down Justin Trudeau. That is some serious power!
And I guess the point there is maybe some people are right that Trump might not actually enact these tariffs; he's just using them as a negotiating tool.
Well, absolutely! And it's been working wonderfully so far. Now, like we discussed earlier, there's basically a global recession outside of the country. The U.S. is doing really well; other countries, not so much. And as you noted, the unemployment rate in Canada has been surging, so their government is in a very weak position. Trump has much better cards, and so they have to cave.
Now, zooming out and looking across the world to China, which is really where the big trade battle will occur, you know, they're not doing so hot over there as well. So, that does strengthen Trump's hand. So, we could have a faster-than-expected resolution there as well. Although I will note, you know, President Xi is a real leader. You know, he's not like some former drama teacher.
So, he's probably going to—what I've been reading recently is that they've been doing more stimulus there. They've been talking about depreciating the RMB, so they're bracing for impact there. They're probably not going to roll over that quickly. But we'll see. A lot of things can happen.
I did some research the other day, and I'd like to get your take on it. A lot of people think if China or other countries responded with tariffs of their own, or even if they go into an economic downturn, that there's no way that will impact the United States because everyone knows that we have these massive trade deficits and we're a net importer by far. But I think that's missing the point because if you actually look at how much we do export, it is substantial. I believe it's upwards of $600 billion per month that we are actually exporting. So, if we have a global slowdown, or if China or these other countries respond with tariffs of their own, that could significantly decrease our exports to where it could actually impact domestic GDP.
So, you're right. If you look at the gross volumes, exports are very large; imports are very large—larger, yes. So, listen, a lot of people are going to be impacted. We're going to be impacted less, but we're still going to be impacted.
Now, when you're thinking about this, you know, trade wars, I think there are two points that people often miss. One is that a lot of the trade deficit is actually from American companies. Now, let me explain. We have a few hundred billion trade deficit with China, right? Because China is sending a lot of goods to the U.S., more than they're buying from the U.S. But if you look at the details, a lot of those goods are actually American goods.
Now, think about Apple. They are manufacturing in China and sending it from China to the U.S. Now, that shows up as a trade surplus for China because, right, China is sending a lot of goods to the U.S. But at the end of the day, that impact goes to American companies producing in China. So, that's going to impact American stock prices and the profit margins of American companies. That huge deficit, that huge trade surplus from China, doesn't just all go to Chinese people or Chinese companies. A lot of that is American companies producing in China.
So, it's a little bit misleading to just say that China is robbing the U.S. A lot of it is actually U.S. companies who have set up shop in America to avoid higher American labor costs and then shipping those goods back to America. So, the losers of a trade war are going to be the Chinese workers, the Chinese government, but it's going to be these big multinational American companies as well.
That's one thing. But when you look at what happened during the first trade war, there's a lot of data we have since then. The bigger losers were actually these retailer companies that imported stuff that was more expensive to them, but they weren't able to pass the prices to consumers. So, it really did hit the corporate sector a bit more than I think we thought back then. The consumers were not as impacted.
Yeah, I do think there's strong potential for the consumer to be impacted in the United States. I'm just using Colombia as an example. So, down here in Colombia, where I live, they have massive tariffs or import taxes on cars, as an example. So, if you go to buy a Toyota 4Runner, let's say a 2022 Toyota 4Runner, you're going to pay, let's just say, $50,000 in the United States. That same exact identical car here in Colombia, you're going to pay $90,000. I mean, sometimes it's double. You know, you might even pay $100,000 for it. So, that's an example. You know, Toyota is not absorbing that cost. Unfortunately, the Colombian consumer is having to absorb that cost.
And then also, too, you get it with goods. So, you have fewer goods available to you because a lot of those people that were exporting to Colombia now, it doesn't really justify it because demand goes down so much that they just stop exporting, period. And now, all of a sudden, when you go to the grocery store, instead of having five or ten choices for mustard, you've got one, and it's inedible. So, I'm not predicting that for the United States, but I want to tell Americans, because they're so really unfamiliar with tariffs, that that is a possibility.
Well, absolutely! It will depend on the product. I think one of the more famous products that people who don't like tariffs like to cite are washing machines. There are also a lot of studies during the first trade wars that washing machine prices went up a lot because a lot of them were made in China, and the importers passed on the cost. So, for that particular good, it did hit the consumer.
But looking across the whole universe of consumer goods, it will depend.
Joseph, how do you look at broad-based inflationary pressures if we have tariffs or the price of oil going up to, let's say, $100 or $120, while at the same time the banks aren't lending?
So, what I always do is I look at bank credit or loans and leases or something like that, or just M2, and use that as a proxy for bank lending. As you know, M2 is actually down over the last two years. Now, it has trended slightly up more recently, but still, if you look at the pre-COVID trend, it's way, way, way below—basically flat. So, I always try to think, how can you get sustained broad-based consumer inflation if you don't have that money supply growth? Because I get it that the prices at Walmart are going to go higher, but that's just going to take a higher percentage of the average American's paycheck, and therefore they have a lower percentage to allocate to other things.
So, it's almost like you get this inflation over here, but this deflationary pressure over here as far as the actual demand. Unless we have the 1970s, where the banks are playing ball and you do have that straight-up trajectory or that uninterrupted trajectory of money supply growth that is funding the additional expenditures and therefore the additional wages. How do you look at that through the lens of Friedman?
Well, through the lens of Milton Friedman, I would have a broader definition of what money is. I think it's a lot more than M2. Treasuries are money, right? If you have a million dollars in treasuries, it's not part of M2, but there's no credit risk. It's very liquid; you can easily convert that into something that is spendable.
But, you know, you can be—especially if you're a hedge fund, you have access to the repo market and so forth. But if you kind of redefine that to not just look at M2 but a broader category of money, like safe assets, well, your fiscal deficit—that's 7% of GDP. You're printing $2 trillion in treasuries a year; that's a lot! You go and, let's say, George, I don't give you cash, but let me just write you a hundred million dollars in treasuries and give it to you. You can spend that, right? Even though it's not part of M2, your purchasing power increases. And so, we're doing that at an industrial scale.
So, maybe a better way to look at that is the aggregate balance sheet. So, although M2 isn't increasing, the aggregate balance sheet is because you're adding those treasuries to your net worth.
Yeah, yeah, yeah. So, the aggregate balance sheet maybe is a better monetary predictor or input to that analysis of the probability of sustained consumer price inflation or broad-based inflation.
Yeah, that makes sense. And I would also note that assets have different degrees of "money-ness." M2 obviously has a high degree of "money-ness." Treasuries are a little bit less, but you go beyond that. You look at things like Bitcoin or Tesla stock or something like that. It's not quite money because it's so volatile, but those prices have gone up a lot, and that's creating a lot of wealth for some of these people to spend.
Actually, I came across a really interesting study about crypto users and spending. They somehow got their hands on this giant data set that actually has the bank account-level data of millions and millions of Americans. What they found was that oftentimes when crypto prices go up, these guys will sell their crypto, and a few weeks later, you will see that they have higher mortgage payments. So, they're basically converting their crypto wealth into housing, and so you have that increase in housing prices, which increases inflation.
Right! So, you have all this kind of big wealth effect. So, if you look at it on a balance sheet basis, you'll capture more of that.
What do you think about—let's go back to consumer price inflation being sticky. So, once the CPI goes from 2.4% to 2.7%, although it's historically rather low, you get everyone now talking about hyperinflation and, you know, interest rates going to 20% and the 1970s and all that stuff. Where I say, okay, I get the argument there; it makes sense. But then I go back to the last cycle we had, which is eerily similar, right? You talked about the Fed cutting by 50 basis points in 2024, but the Fed also cut by 50 basis points in 2007 on the exact same date and from the exact same level. Right? Fed funds was at 5.25%, and it was September 18th, 2007. They cut by 50, and then, as you know, they cut two more times going into the end of the year—the exact same thing that they're doing in 2024.
Most people, you know, we look back on the GFC and we think about it in terms of deflation, especially asset deflation, and at the very least, disinflation when it comes to the overall economy. But when you actually look at the month-to-month data, you see that when they started cutting by 50 basis points, the CPI was right around 3.5%. If you fast forward to August or June or July of 2008, it went up to 5.6%. So, I think about that. That's a huge increase in CPI.
So, if you try to take yourself and think about what the narrative would have been back then while the Fed was doing these dramatic interest rate cuts, it would probably be very similar to what we're hearing today: you know, the Fed's cutting too much; you know, going into the end of 2008, they're going to have to increase interest rates; inflation is obviously not just sticky, but it's increasing tremendously; this should be the Fed's number one concern.
In fact, when I go back and look at archives of the Wall Street Journal around the time those CPI prints came out, this is exactly what you were seeing on the front page of the Wall Street Journal, you know, CNBC back then. This is August of 2008, when two months later, Fed funds was at zero, they were doing QE, and within a year, we were at deflation.
So, my point is not to say that we're going to have a repeat of 2008, but it is to say that just because the narrative right now is for sticky inflation, it doesn't necessarily mean that's the way it plays out.
Oh, absolutely! You know, predictions are hard, especially about the future. So, I guess my question would be, in looking at past cycles where they've cut by 50—so that would be the GFC—how do you compare this cycle to that cycle? Do you think there are similarities there that we should factor into our analysis? And then do you think that there are differences that we should factor into that same analysis?
So, I think the way that I look at the world is that the relationships between variables are always changing, right? We see this all the time looking at markets. Sometimes good data is good for the stock market; sometimes good data is bad for the stock market because it means a more hawkish Fed. So, the system is dynamic; it's always changing. So, it's always about judgment and context about what the world would look like going forward.
Now, in 2008, we had an over-levered banking system. Today, the banking system is actually really boring. You know, it's super highly regulated—probably overregulated, almost kind of like a utility. And instead, all the power is not in the financial industry, but it's in the tech industry now. So, you've got all these structural changes in how the world works.
Now, just looking at the context right now, I think a couple of things stand out to me. One is that the U.S. is doing well, and the rest of the world is not doing as well. That makes it very difficult, I think, for you to have a huge upward inflation cycle because everything outside of the country is somewhat depressed.
The second thing that stands out to me is that I think the next downturn in the stock market is not going to be some kind of blow-up from the banking system. What stands out to me is that looking at the data, you have this huge, huge over-allocation of foreign investors into the U.S. equity market. It's really remarkable looking at the data over the past, say, 10 years. Now, foreign exposure to U.S. equities has basically doubled in just a few years. Part of that is because the U.S. is doing better than other countries; part of that is because we have an AI revolution here. You don't really have that elsewhere. And part of that is because the dollar continues to strengthen.
If you are a foreign investor from Europe or from Colombia or from Japan and you're owning, let's say, the U.S. Max 7, you're making money because the Max 7 is going up, but you're also making money because the dollar is appreciating. You're getting a double play. It's been really, really good.
So, you have this tremendous amount of concentration of capital in the U.S. Now, I think that's super vulnerable because at this time, stock prices are already very high, and the dollar is very strong. If you have a reversal of the dollar—say, let's say U.S. data comes in worse than expected, the Fed begins to cut rates, and the dollar goes down—you can easily see a big reversal of those huge capital flows. If you're a foreign investor, you're losing money on your currency side. You don't want to lose anymore, so you sell your stocks, sell your dollars, and take your money and go home. You know, that could be a catalyst for a pretty big decline in the U.S. stock market.
That's kind of what I'm thinking as a base case for next year. So, I think that's the difference this time compared to the prior context. Again, it's always different, so it's always about looking at the context and making a judgment. And that's what I'm seeing right now.
Thank you, Joseph. It seems like George has—
Hey, Josh, how's it going?
It seems like George is gone. So, where can people find you? And then we'll end.
Okay, well, thanks so much for having me! If you're interested in learning more about what I have to say, I have a YouTube channel called Joseph Wang, and every week I post debriefs on what happened in the markets. Of course, you can follow me on Twitter; I'm @fedguy12.
Great! What's your website?
Fedguy.com.
All right, great! Thank you, Joseph.
Bye!