DONALD J. RISSMILLER: The US was the outlier over the past year, but now there's some evidence the US is joining that slowing. In terms of a US recession or a global recession, I don't think that's the right call.
DIANA CHOYLEVA: We are at the end of the beginning of what we call the great decoupling. And the world is set to split in two separate spheres of influence, American and Chinese. And I think investors need to think very carefully about this very different investment landscape.
VINCENT CATALANO: Hello. I'm Vincent Catalano, chief investment officer with Redmond Capital Partners. And this is "The Exchange." Today we're going to be exploring all matters economic with two really excellent guests that I am so delighted to have here today, Diana Choyleva and Don Rissmiller. Diana, if you would take a moment to please introduce yourself and your company, what you do. And then I'll ask Don to do the same thing. You first.
DIANA CHOYLEVA: I'm chief economist at Enodo Economics. And I've always said that if I wasn't an economist, I would have liked to be a detective. So for the past two decades, I've been analyzing China's economy, and I definitely can say that I felt like a detective doing that. So I've enjoyed my job tremendously. And we are just trying to get China right at Enodo Economics from a macroeconomic, geopolitical, political perspective, but with the view of giving actionable investment advice.
VINCENT CATALANO: That's fantastic. And obviously China is very critical to the world economy. And so viewers would be very interested in knowing your perspective in that regard. Enodo means "untangled." Is that what it means?
DIANA CHOYLEVA: Yes. In Latin it means "untangle." And the idea is that we are untangling complexity. The world is a complex place and we are trying to understand which are the key driving forces and what does that mean for financial markets.
VINCENT CATALANO: That's fantastic. Untangling detective.
Don. Don Rissmiller. You and your firm.
DONALD J. RISSMILLER: Yes. Thank you, Vinny. I'm Don Rissmiller. I'm the chief economist with Strategas Research here in New York City. So our clients are mainly institutional investors who come to us looking for advice on macroeconomics, on investment strategy, on policy research, market technicals. We do some survey work in asset allocation as well.
So in my role, looking at the economics here locally, you get to wake up every day, something interesting is happening. Sometimes it's fun, sometimes it's less fun, but it's never boring.
VINCENT CATALANO: Well, what we're going to do is we're going to explore the general economic environment. We're going to take a look at the role that central banks are playing, and then we're going to explore China to a fair degree. So let's first look at the general economic environment. And there is a Wall Street Journal quote that references the World Bank saying that global growth is cooling, it's slowing down from 2.9% to 2.6%. Give us, Don, your perspective in terms of the general economic environment right now globally. World Bank seems to be on point. A lot of other people are saying the same thing too.
DONALD J. RISSMILLER: Yeah. I think the idea of the slowdown in global growth makes some sense. I'm not trying to go surprise a lot of people here as we sit in the middle of 2019. So part of this was driven by China over the last several years that spilled over to places like Europe. Europe also had some idiosyncratic problems over the past year or so. You've had Brexit now to deal with for a while, you've had the yellow vest protests in France, you've had the budget in Italy, you've had some new auto regulation in Germany.
So those probably aren't systemic, related to each other all that much, but we've had a lot of idiosyncratic problems that have slowed down growth on top of the general global environment. And we go over to Japan and that's slowed as well. We also have the value added tax increase that's possibly coming later this year. That's another hiccup we'll have to deal with.
And if we come back to the US, the US has actually had a pretty decent year the past year. So the US was the outlier over the past year. But now there's some evidence the US is joining that slowing trajectory if you look at manufacturing, in particular. Manufacturing employment has started to level out. Purchasing managers indices are also looking more like Europe and others did last year. So that's what we see at the moment. Slowing is right.
VINCENT CATALANO: Still not a recession.
DONALD J. RISSMILLER: No. A recession is pretty far away, I would think here. Recessions are caused by policy errors of a significant magnitude, that could be the Fed fighting inflation, overdoing it. That could be some other exogenous events. So we've had some policy changes, but I don't think they rise to the level where we have to worry about recession here in the US at the moment. There are places in recession. Italy had a recession. In terms of a US recession or a global recession, I don't think that's the right call.
VINCENT CATALANO: And emerging markets?
DONALD J. RISSMILLER: So they're hanging in there given some of the volatility that we've seen. So, obviously, a source of growth, something that's closely related to China. So given that we have had slowing, given that we have had issues elsewhere, emerging markets are somewhat surprisingly hanging in there.
VINCENT CATALANO: China. Big part of the equation, global economy. Perspective on what's happening there economically?
DIANA CHOYLEVA: Absolutely. And, actually, if you get to China and the US right, you pretty much got 80%, 90% of global markets. And what I would like to start with is this very long term thesis that actually we are at the end of the beginning of what we call the great decoupling.
The global economy, the global political order, financial markets are undergoing tectonic shifts in our view. And the world is set to split in two separate spheres of influence, American and Chinese. And I think investors need to think very carefully about these very different investment landscape that they face going forward.
And it was interesting you mentioned policy mistakes because we could have significant policy mistakes when it comes to political decision. The weaponization of the economy is not just any more at all in the hands of central bankers.
VINCENT CATALANO: Oh, I can't imagine what you're referring to.
DIANA CHOYLEVA: So, back to China-- I've covered China for 20 years and I would say that now I am the most skeptical I've ever been about their development model being able to pull it through what is a very different, both external environment for China, but also internal in terms of where Xi Jinping has taken the country.
VINCENT CATALANO: Well, does that refer to your November report of last year in which you stated globalization has gone too far? Is that an element of this as well? This tectonic shift of, to quote you, "the world economic and political order is undergoing a tectonic shift as the rules of engagement between existing superpower, the US, and the aspiring superpower, China, are being rewritten." Pretty dramatic.
DIANA CHOYLEVA: Absolutely. And let me actually bring it back quite a lot. I mean, China was accepted in WTO in 2001. And that really, together with technology, in my view, was the main fundamental shock and what shaped how the world economy developed. And you know that in 2006, the book called The Bill From the China Shop, arguing that we are likely to see a financial crisis. But the important bit was that it was because a bunch of countries around the world are saving too much, not because America's become profligate.
And the reasons why in China they were saving so excessively were entirely related to the command economy, most of them to the command aspect of their economy, not the market. What happened after the global financial crisis, in my view, is that Beijing actually genuinely concluded that their model is better and saw the financial crisis as the failure of Wall Street and capitalism. And of course, in the rest of the world, in the Western sphere of influence, the Americans were beating themselves up too much as we were at fault.
But the greedy bankers and the regulatory failures were at best playing a secondary role to the fundamental basically inability of the global economy to integrate that semi-command system with the free markets of the West. So having gotten the financial crisis right, I did get one thing very wrong. It was in the wake of the financial crisis. My view was that we will see protectionism and, of course, 10 years later we're seeing it, but that time horizon didn't help any of my clients. And with hindsight now, I realize that my mistake was the thing that this upending of the global order was possible purely on economic reasons.
We needed to see political change. And now my assessment is that we are seeing the critical amount of political change, and not just Trump, not just Brexit. Xi coming to power has changed dramatically the way China is moving. I mean, I trained on Japan, which was fantastic. I have to say in being able to then get China right. And one thing I learned was that when you start liberalizing, you can't stay still. You either have to move forward or you have to move backwards. And China under Xi is moving backwards in many respects.
VINCENT CATALANO: Don. Thoughts on any one of the things that Diana touched on?
DONALD J. RISSMILLER: Yes. So there was a professor, Graham Allison, who has talked about the Thucydides trap, which is when you have an incumbent power and a rising power and they often clash.
VINCENT CATALANO: Right.
DONALD J. RISSMILLER: And, historically-- and he's written about this quite a bit-- there is a physical conflict, especially when the countries share a border. So to some extent, this sounds to me a little anti-Thucydides, which is, instead of clashing in the traditional way, what we're going to see possibly is a pulling apart of global standards.
And I think the fact that the trade issue has morphed from just tariffs and some of the economic language into, OK, we're going to deal with Huawei, we're going to deal with whether that equipment can come into the US, We're going to deal with whether we send anything out to that company. This looks a little more to me like we're pulling apart standards. We're going to develop different operating systems, we are going to develop different tech standards, we're going to really separate into two spheres of influence.
And it's not clear to me America would mind going north-south. If you look at the recent issues of Mexico, there was some tension there but it got resolved pretty quickly. And so there is some move to get the new NAFTA, the USMCA through. We'll see. That could be a challenge, but I do see this pulling apart as a very real phenomenon.
VINCENT CATALANO: And to what extent do you see income inequality and the prevailing Western ideology of neoliberalism contributing to all of this? Do you have a sense of that?
DONALD J. RISSMILLER: So income inequality is clearly a big issue. An issue that's become much more important in the past decade. There was a book by Thomas Piketty called Capitalism in the 21st Century. And it's a very long book translated from French. Lots of statistics. Was an Amazon bestseller. So lots of people in the US bought this book.
VINCENT CATALANO: Sure. More than read the Mueller report.
DONALD J. RISSMILLER: More than might have read this book.
It's a very well done economics text, but it was not clearly a bestseller in the traditional sense. In fact, Amazon has a way of measuring the bookmark to see how far you get.
VINCENT CATALANO: Oh, really? OK.
DONALD J. RISSMILLER: And a lot people didn't get very far if I recall correctly. But I bring that up because people are clearly buying this book and not reading it. So what are they doing? What's going on the coffee table? I would guess it's the idea that there is something that's happening, it is impacting the global economy, it's impacting the US economy in ways that has not, for at least quite a while.
And so I do think some of that came out of the global financial crisis, some of that came out of the response to the financial crisis. We have new tools that we did not have, something like QE. QE used to be called unconventional monetary policy. Lots of people do it now. It's not so unconventional anymore.
So maybe that had some role in contributing to this. I think there is a long line of research still developing on this. I'm not sure we can write the final chapter in how QE did.
VINCENT CATALANO: Right.
DONALD J. RISSMILLER: Yeah. That will depend on how we resolve some of these issues, like income inequality, like some of the other things that are coming up here.
VINCENT CATALANO: What you just mentioned ties in perfectly to the second area that I wanted to explore, which is central banks. OK. Over the last-- since 2008 or probably before that, central banks have been very generous with their money flows, capital flows that they have produced to first stem the great recession and then keep it going, so much so that recently fed Chairman Powell sounds very much like Mario Draghi, whatever it takes. Whatever it takes to keep it going.
And there's an element of this that I kind of want to touch on. But first, let's look at where the Fed is at with the level of interest rates being where they are, Fed's funds rates, OK? And historically, whenever you had a recession, you basically need 500 basis points, 5%, maybe 600 basis points to offset the recession.
Well, we're not-- we're like half that, less than half that. What happens-- so here's the obvious what-if question, what if a recession comes along sooner rather than later?
DONALD J. RISSMILLER: Yeah. So it's an important question because the toolbox is different than it's been in the past. So monetary policy probably can't do it alone or at least not in a traditional fashion, right? So you said they usually cut 500 basis points here, we have 250, let's go, let's be generous. And so you don't have enough.
You do have the balance sheet. Could go back to that exercise. You have other policies, though, that I think are going to become more important, especially in the political environment we're talking about. So there's monetary policy, there's fiscal policy, there's trade policy, there's regulatory policy. We can add immigration policy, but that's slow moving often.
So let's say of the things you could use, if monetary policy is going to be less effective, you'd have to look to either fiscal, trade, or regulatory. Well, I'm not holding my breath on trade, especially not after the last month here. So the problem is we're starting to run out of options. So, regulatory or fiscal, maybe some combination of that where we have to look to try to create some sort of cushion for that downturn.
Part of the problem, I would say, from the last recession was we relied on monetary policy alone. So Paul McCulley, who's up at Cornell now, has talked about the consequences of getting out of a liquidity trap using monetary policy alone. And--
VINCENT CATALANO: Only takes you so far.
DONALD J. RISSMILLER: It only takes you so far. And a liquidity trap means at some level you have too much debt or you're perceived to have too much debt. And so one way to get out of that is to make your asset number bigger. So your debt relative to your assets doesn't look as bad. Other ways to make your asset number bigger is to bid up asset prices.
VINCENT CATALANO: Which is what's happening.
DONALD J. RISSMILLER: Which is what's happening, except assets are owned by rich people by definition. And so there's a close connection between what's going on in the income inequality story. And now you're getting the unintended consequence, the political reaction to some of this as well. And it's global. It's not just US. This has been adopted by the ECB and the Bank of Japan. It's gone on many different levels.
So I guess we could say we had a success with monetary policy and that we got out of the 2008, 2009 liquidity trap. But there are still some follow-on consequences to that. And I'm not sure we've figured out all of them. We're still digesting them. We're still digesting how the next several elections are going to go. We're seeing how this plays out. It may take a while before we can write the final chapter on this.
VINCENT CATALANO: A big buyer of American treasuries is China. You hear talk from time to time that China might use that lever as a weapon against the United States in the middle of this trade war, this tectonic shift played out day to day. Any sense of China, Xi Jinping, and what they might do with their portfolio of American treasuries?
DIANA CHOYLEVA: That would be a measure to take as a last resort. Our view is absolutely every aspect of how the global economy and financial markets and the corporate sector works is getting or becoming weaponized. And investors should think in those terms, what could be done next and for what purpose, actually.
I started forecasting the year one only two quarters ahead because, ultimately, and not a year ahead or two years ahead, because ultimately, in this decoupling, the safety valve or the pressure valve that's most likely to be the first or further down the line, the one that equilibrate or start equilibrating the two separating spheres will be exchange rates.
But at this point in time, China is not prepared to let the currency depreciate significantly. If they were to open the capital account fully and allow capital outflows, then the currency's first response is definitely going down. And actually that would be a good thing for China and the economy, but they are not going in that direction. And if the market is not pulling the currency down, intervening actively to devalue, it's not what their long term strategy would be at this point in time.
But their economy wasn't so bad last year. And we're seeing a much worse Q1. It's likely to get worse from here. Our trend growth rate for China is 5%. Now, our real GDP growth estimates, which I've been doing for 13 years now, the average for the past three years is around about five. It's getting much harder for policymakers to deal with the next ratcheting down, structural ratcheting down of growth.
So I would say at this