The Breakdown - What If the Too-Strong Dollar Is a Solved Problem? Feat. Jon Turek

Episode Date: July 18, 2020

Today on the Brief: The latest information in the Twitter hack Thailand starts using its central bank digital currency Treasury Secretary Mnuchin calls on Congress for more funds  Our main conversation is with Jon Turek, author of “Cheap Convexity.”  In this conversation, he and NLW discuss: Why the dollar has gotten stronger thanks to a savings glut from Asia How a too-strong dollar hurts other markets more than the U.S. Why globalization died in 2011 and we just didn’t realize it  How the Fed fixed the global dollar plumbing  Why there are still questions of actual dollar shortages  The detente in U.S.-China financial relations  Find our guest online Website: Cheap Convexity  Twitter: @jturek18

The problem really, and I think this kind of gets overshadowed in the famous dollar bowl, dollar bear camp, is there fundamentally a shortage of dollars in the world? To me, you can easily make the argument that there's a shortage because we have all this, you know, dollar denominated debt over 13 trillion a bit. And you can easily make that there's a lot of dollars floating around because all of these countries have been buying dollars for so long. I think what matters more is not these, whether there's a short. or not, what kind of matters more is that we know the dollar is of fundamental use in the global

economy. The bigger point is there's something stuck and people can't get dollars who need them. Welcome back to the breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond. This episode is sponsored by bitstamp and crypto.com. The breakdown is produced and distributed by CoinDesk. And now, here's your host, NLW. Welcome back to The Breakdown. Happy Friday, everyone. It is Friday, July 17th.

And today, our main conversation is a super interesting exploration of the state of the dollar. This is obviously a recurring theme on The Breakdown, and today's guest, John Turrick, has a really interesting perspective that has evolved a lot this year. Earlier in the year, before the COVID-19 crisis, he wrote a piece about a new imperial circle, where effectively the dollar was the beneficiary of all of this excess savings from every other part of the world finding its way to U.S. markets, which created a really problematic impact, not just in the finances of other countries, but in the real economies as well, as the dollar's strength created a real problem for them, with the strength of the

dollar further suppressing real economic gains in those places. However, that started to shift quite a bit, and it's been a really interesting shift to see. So that'll be our main conversation. However, before that, let's get into the brief. First up on the brief today, I want to follow up on the Twitter hack, obviously the big topic from yesterday, but this is the type of story that we're going to continue to get new details, and I want to make sure to come back to it because I think it's that significant. So the few new details that I wanted to mention first is that it looks like the hack targeted 130 total accounts. We've gone over who they were mostly, but that was the ultimate number. Second, analysis from samurai wallet suggests that the hackers were involved

with the crypto ecosystem before this, having previously been on Bitmax and Coinbase. Now, that said, they also haven't laundered any of the 13 or so Bitcoin that were acquired yet, so people are watching that pretty closely. Finally, whatever the first day narrative was, and we talked about this a lot yesterday, people are starting to remember this as a Twitter hack much more than a Bitcoin hack, right? And this is particularly the case in the halls of Congress. Rob Wyden of Oregon said that he and Jack Dorsey had discussed end-to-end encryption on DMs as early as 2018, though obviously that hasn't happened yet. In addition to the letter from Josh Hawley that we mentioned yesterday, Representative James Cormer, Roger Wicker, and Frank Polone have all either sent letters to Dorsey

or release statements about this. Andrew Cuomo has directed the state of New York to conduct a full investigation into this issue. So this is one that I don't see going away for some time. I think that the significance of this is really, really profound and is more to do, obviously, than just a Bitcoin hack. And I'm going to get into this a little bit more on the weekly recap tomorrow. So if you haven't heard one of those before, the weekly recap is exactly what it sounds like. It's sometimes just one topic. It's sometimes a few topics just like a brief, but it looks across the entire week. Second up on the brief today, an interesting CBDC story. Thailand is already using a central bank digital currency for some transactions.

Thailand's assistant governor of their central bank, Vachira Aramdi, said that the bank was using a CBDC for transactions with some businesses and planning to expand. Thailand's CBDC is backed by currency reserves and the foreign currency reserves of Thailand have grown by more than $25 billion in the last 12 months. Why is this significant? I think that central bank digital currencies are the type of thing that's going to be a pretty not at all and then all at once phenomenon, right? Where it's just nothing but quiet kind of study groups and not a lot of action until boom, overnight, all of a sudden it is just the norm, and we can't even remember what it was like before them. We're certainly not in that accelerated, punctuated equilibrium type of moment yet, but it's something that I anticipate, and so I'm keeping a watch on. Last up on the brief today, the next wave of stimulus. So what's happening? As cases rise of the coronavirus in 39 or 40 states, jobless benefits are coming to a close, and PPP is starting to run out. Treasury Secretary Steve Mnuchin testified before Congress today, and there are a number of different interesting pieces of this. One of them was that he suggested that it might be worth thinking about turning loans of under $150K into grants, basically automatically forgiving those loans.

for the smallest businesses. He also talked about the need for or potential need for second round of this type of program, although he did mention that with any second round, there might need to be more of a revenue test to make sure that businesses actually are seeing impairment on the basis of the COVID-19 crisis. Why this matters is that a lot of the U.S.'s ability to stomach this crisis has come from these programs, both on an individual and on a business level. If they run out, it will absolutely be chaos. And, well, we'll see the type of frustration and demand for answers that we might otherwise have in the first place.

The reality, though, is that this is an election year, and it's very hard for me to imagine this money spigot turning off, no matter what the long-term impact is, negative or otherwise. And so I expect fully to see a continuation of the types of normalization. of aggressive government intervention in the economy that we've seen before. The question really actually in my mind is not so much whether we're going to see more of this, but how normalized it becomes after the election. Regardless of who wins, is this just a momentum booster for things like UBI,

or is there a return to some semblance of normalcy with the government trying to claw itself out of the economy? It's kind of hard to imagine how that actually happens, to be honest. which ultimately actually provides a perfect segue to my conversation with John Turrick. John Turrick is a really interesting finance thinker. He is the author of the cheap convexity blog. He has been on Real Vision and other publications. And earlier this year, as I was mentioning, he wrote a great piece about a new imperial circle, the long U.S. asset short global growth feedback loop, which is a concept basically that he adapted from something that Soros was writing about a couple decades ago. He also wrote a lot.

wrote a piece, which I think is a lot of the thesis of this conversation of what if the dollar is a solved problem? In this conversation, we talk about what the problem of the dollar is, or specifically a too strong dollar is in the first place, and then how it might have been, quote unquote, solved in the context of the COVID-19 crisis response. In addition to that, we talk about the strange place of U.S.-China relations as it relates to, on the one hand, an increase in the aggressiveness of the rhetoric, but on the other hand, a something of an economic detente. I really enjoyed this conversation, and I hope you do as well. All right. I am here with John. Hey, thank you so much for hanging out today.

Thanks for having me. So, John, I've been reading your blog for a few months now, and I've been really, really enjoying it. And as I was just mentioning off air, I think one of the most persistent and recurring questions for the breakdown audience, certainly. and I think just anyone interested in global macro more broadly is the place of the U.S. dollar in the world. And so I want to eventually get to what your perception of where things are right now and what we're seeing going on in markets as it relates to the dollar. But first, I want to almost bring people up through some of the arguments and explorations

that you've been doing on your blog over the last few months. So first, let's start with this concept of the imperial circle, the long U.S. assets, that short global growth feedback loop. Could you explain what the idea is there? Sure. So, yeah, that was, I wrote that back in February. And I think what was kind of going on in the pre-COVID world was there was this interesting duality between the financial economy and the real economy and the intersecting variable

was the dollar. Because basically what seemed to have been happening is that the U.S. had this. relative growth outperformance, this relative yield advantage versus the developed world. And with a technology sector that was booming vis-a-vis kind of a global economy that was still much more cyclical dependent. So they were basically taking in capital flows from a lot of countries that have a high propensity to save. So Japan, Europe, Taiwan, Korea were kind of ended up flooding the US.

financial system with capital and that saw its way into investment grade credit, high yield bonds, CLOs, and U.S. equity data. And I think what kind of became interesting about this is that it turned into not exactly Soros' imperial circle, but a similar construct where that the inflows into U.S. assets would have a, it would lead to this relative outperformance of U.S. assets versus the rest of the world, which would be captured via the dollar. And the way the dollar impacts the global economy is in the disinflationary way. So as the dollar rises, then countries especially that are more export dependent,

which happens to be Europe, Japan, Korea, the places that were sending this capital to the U.S. actually hurt because their exports are 30 or 40 percent of GDP where the U.S. is only 14. So as the dollar was taking in all these flows, it was inflicting pain on the rest of the world. because the dollar is obviously the global reserve currency and most of global trade is invoiced in dollars. So the dollar kind of becomes like a tightening factor. And there's a couple channels that works like this. The BIS has done a lot of work,

how it works through the global credit channel as like the rate, the exchange rate of the dollar has a high correlation to trade financing rate. So basically supply chains are very dependent on financing because there's so many links to them in over different countries. And then there's as a Gidig open at the IMF now, then at Harvard said it is also an invoicing sense because all of these payments are settled in dollars. So it was kind of this, this negative feedback loop for the global economy, but a positive

feedback loop for the financial economy because U.S. asset, because because the dollar was repressing growth in a lot of these economies, capital kept getting exported because there was no productive use for it at home. And you kind of had this place where the dollar was saying, okay, like, yeah, the U.S. is the place to be. And then because the U.S. was the place to be the money would go into the dollar, the dollar doesn't have that much beta. But the U.S. economy doesn't have that much beta to trade as the rest of the world does. And it kind of furthered this, you know, this divergence. And these kind of forces ended up feeding on themselves. Super interesting. So, I mean, I think that one of the parts that makes this so interesting,

and the word you use or the phrase you used is a doom loop, right? It's this positive feedback loop where it basically is self-perpetuating, right? I mean, could you explain that mechanism just a little bit more? I guess I know that you kind of did. I just want to make sure that people really understand this because it's such an important concept. Sure. So as this money was kind of coming into the U.S., so the dollar was appreciating, and basically in the world right now, even though we've kind of been in this de-globalization age,

that most developed world economies are still getting 30 to 40% of GDP from trade. So if the dollar is a depressor on trade, more so for the rest of the world than it is for the U.S., then the thing that was causing the dollar to appreciate now has this almost second derivative effect by that the U.S. economic outperformance only grows because there, because the rest of the world is still dependent on trade. The U.S. trade is only 14% of GDP, not a big variable. So this, this, this, this divergence almost is self-filling. So the people who were sending money are now, are going to continue sending money.

They don't have so much productivity at home because there's the dollars repressing global trade. And then as they send more money to the U.S., the dollar only goes higher, which keeps feeding on this economic divergence until, and it kind of, it's, as you said, It's a doom loop. It really something has to stop it, which we'll get into it. Yeah, exactly, exactly. But before we get into that, so a couple points that I want to dig into deeper. So, well, actually, this is not so much a point to dig into deeper, but for folks who are familiar with Brent Johnson's Dollar milkshake theory, how does that relate? Yeah, so his, his, I've actually had the pleasure talking about it with Brendan. It's pretty similar. I would say it's his, theory is, is that I think, I don't want to speak for him totally, but is that the dollar will,

like the U.S. is the best place for capital to be in the world. So the dollar will get that appreciation on a relative sense and that the U.S. has really the only assets that the world wants. So it's kind of like this dollar and risk assets go higher together. And there's nothing really to stop because there's nowhere else to go. Yeah, and so as you were thinking about this, I mean, there's some parallels here, but the functional, I guess where does this imperial circle that you were observing diverge from that assessment or that thesis? Well, I think that I think part of mind, which I kind of found like, you know, very interesting to me is that it has this real economy effect because, you know, It's not just the financial side where the dollar appreciates because it's the best place to be. And the only place to be in terms of the asset side is in U.S. tech or whatever.

I think what's interesting is that this spillover of all this excess savings that wants to go somewhere and doesn't have so many productive places to go at home or is constrained because of local supply factors, what have you, is that because they were sending so much money to the U.S., they were actually almost, unintentionally, like, weakening their own economic model because when the dollar goes up, global trade falls, and they're so exposed to global trade. And that kind of, so it has a financial economy feedback loop, but it also has a real economy feedback loop, and they kind of coexist. And I thought that was kind of like maybe a different approach. Yeah, no, I think that that's, I'm really glad that you're so crisp about that because I think that that's a really fascinating element to this.

I want to maybe kind of dig into another piece of this that's come up in a couple parts of your analysis, which is this idea of a global savings glut. You wrote about this as well. And so first of all, I guess, could you explain that? And then secondly, as part of that piece, you wrote something where you said globalization died in 2011 and we just didn't realize it. So maybe first you could explain this idea of a global savings glut and then this sort of conceit or idea about globalization. Sure, sure. So the global savings glut, and they're definitely interconnected, so I'm glad you brought up by that. The global savings glut is basically a combination of two factors. Well, there's a lot of structural stuff. There's, you know, the world is older, the demographic reasons, et cetera. But I think since the financial crisis is a very interesting element of kind of why countries, especially in Asia, also in Europe, but it's become more pronounced. in Asia become massive exporters of savings is because there's been two things going on. There's one is that global growth since the financial crisis has been mediocre, to say the least.

And this kind of, when you don't have higher productivity and you have populations that already have a higher propensity to save, that kind of gets amplified. And then two is that there hasn't been really a place for them locally to put this money. So if you, Japan has been an amazing example of this where the life insurance sector assets are now 25 times the local investment grade bond market. So you, this massive mismatch basically. So on the one hand, if you're a Japanese life insurance, the Bank of Japan owns pretty much 50% of the, you know, the Japanese government bomb market. And then you have, and then you go to the, you go to the investment grade bond. market to buy assets. And there's just this massive size mismatch. And the reason that the

corporate sector isn't kind of expanding their balance sheets and issuing more debt is because productivity is very low and global growth is very low. So what happened is that like there was this humongous mismatch between and it happened in places like Korea and Taiwan and even in northern European countries is there's this massive mismatch between capital that needs to go places. and is way too big to go to only stay local, and it has to get exported. And where does it usually get exported? It usually gets exported to the U.S., who doesn't usually have a problem, you know, expanding the corporate sector balance sheets or the public sector balance sheets.

I mean, as we've seen, like, corporate sector debt as a percent of GDP is as as high as it's ever been. So that the U.S. kind of serves as a sink in that regard where, like, all this capital, which is too big to stay at home, kind of ends. up getting exported abroad. And I think the way that the China 2011 point, with the end of globalization fits in, is that the policy response since the financial crisis to economic weakness has been, especially for these, you know, we'll call them the savings countries, has been monetary focused. So we've had periods of economic weakness. And what is the response been? It's

always been, how do we cut rates further? How do we weaken the exchange rate? And the China thing, and I think the reason this has been the policy response has been the world pretty much since China's ascension to the WTO in the beginning of the early 2000s, the policy response is how do we make our trade more competitive for this, you know, this backstop of global aggravy at demand. Because in 2000, you know, for the beginning of the 2000s, it was like, okay, we can only grow so at home, but we have this massive market in China that's growing at a zillion percent, and that's really where the game is. And you would see this as, you know, Chinese imports as a percentage of global GDP

would climb and climb and climb. And then the financial crisis happened, and China played kind of, they didn't play lender of last resort, but they played growth of last resort with like a massive infrastructure push. But what happened in 2011 is it started to turn. And global exports as a percentage of GDP started to start. started to steadily and steadily decline pretty much for the next 10 years or next nine years. And because of that, these countries who are exporting 40 or 30 percent of GDP were, you know,

in this structural disinflationary trap because the thing they were exposed to is now shrinking, is Chinese growth kind of slowed. So what they did was the policy response, which kind of reinforced these disinflationary forces, was they said, okay, how do we weaken the exchange rate to kind of improve our terms of trade, which at the end of the day was mostly China dependent. Obviously, they also export a lot to the U.S. So the cycle was, is how do you, so this led to things like basically negative rates in places like Germany and Japan, when in Germany they were running a fiscal surplus.

So they had plenty of fiscal space, but they're like, no, the focus is on how does the ECB get the exchange rate? lower. And this basically led to things that kind of reinforced, in my opinion, the U.S. versus the rest of the world divide, which is because to me negative rates is just a tradeoff between your internal and external sector. It's trying to say it's like, we don't care about the bank lending channel for now because we want the exchange rate to weaken. And I think like these kind of forces were basically like this kept, you know, this kind of kept this divergence happening between the U.S. and the rest of the world in a growth sense because they were still chasing export demand that really wasn't coming back. You know, China's, you know, China's import machine and China's

industrial machine is not what is not growing at the same rate it was. And they weren't making the fiscal changes, which would have been, you know, more longer term, have more of a medium term effect on potential growth, et cetera. And they were more focused on the monetary side. So that's kind of how they interconnect in a longer way. Super interesting. One of the things I appreciate about your analysis is this sort of keeping in mind the sort of the financial markets as well as the real economy at the same time and understanding their interplay, right, not viewing them as sort of divorced even when they look divergent.

Let's go back. So you wrote this piece in February. So clearly this was sort of like a large structural issue that you were looking at, focused on, concerned about going into COVID. When COVID started to hit and you started to see the economic response, what were your first thoughts? What did you start to watch right away? Yeah. So I think it was, to me, to be honest, pre-COVID, I think we were kind of kind of in that imperial circle part two, you know, doom loop sort of world where we would kind of continue to see these divergences between the real and financial economy, I think maybe what was interesting in the pre-COVID world that could have

at least served as like a near-term counter-trend move was that we were kind of in this post-trade war detente kind of situation, which could have led to, you know, pick up in industrial sentiment and maybe like improvement in Chinese growth that would have had, you know, maybe a more balancing effect, but I think that would have been broadly more near term. And I don't think it would have been enough to fundamentally change the dynamics, you know, of an outperforming U.S. stock market and an outperforming U.S. dollar. And then COVID came. And to be honest, like COVID was, at least in, especially in the financial plumbing sense for the dollar, could have been the end game. And what I mean by that is that it pretty much brought all of the factors that, you know, the dollar kind of

has in its back pocket, so to speak. It brought them all to play all at once, all in massive size. Because at least in the, you know, the dollar world outside of, you know, like traditional foreign exchange, more so in the, like how it's used in terms of either funding or raising capital or et cetera, is that we had on the one side, we had the EM corporate. sector, which more so than the sovereign sector, the sovereign sector has kind of gotten out of this funding in dollars. It's become much more, you know, much more local currency. Or as, you know, the old original sin has definitely changed. But the, but in the corporate sector, there's a lot of the M dollar denominated debt. And the reason being is that as supply chains have become more

elongated, they become much more credit intensive. And not only are they credited intensive within their, you know, their locality, it's that these kind of supply chains cross borders. So you can have a plant in, you know, in an EM country, then then have two other plants in two different EM countries. And they're all kind of, they're all inter- they're all interconnected because basically the way they get paid is the money comes down the line. So once the finished product is done, as in the money, they're basically all funding on the account receivable basis. They're not taking in cash flow because the money's basically downstream from when it's a final product. So until that happens, they're very credit reliant. And as we've seen,

and then you see like, you know, EM dollar denominated debt, you know, rising. It's actually a lot of it's from the corporate side and not from the sovereign side. And then on the, and then kind of coming back to, you know, to Asia is that Asian life insurance companies especially, it's kind of interesting. It was basically in 2008, we had the maturity transformation trade, which was European banks funding in dollars at the short end to buy U.S. residential mortgage-backed securities. Didn't end up being a great trade. But what basically kind of that form, it wasn't as risky because they were buying safer products, but that trade was basically happening in Asia where, you know, Japanese life insurance companies, Japanese. pension funds, Taiwanese life insurance companies, Korean life insurance companies, are funding in dollars at the short end to buy long duration U.S. credit assets. So as that, if they have a pinch,

basically there's this massive dislocation because they're the biggest users of this, what's called the FX swap market, which is basically where these dollars are provided in a technical sense. And so that froze. EM corporates are, our revenue goes to zero. So EM corporates have no way to deal with their, you know, dollar liabilities. And you end up kind of with this perfect storm. And to me, I was questioning, well, what if what the Fed's response is not enough? As in in 2008, Fed says, all right, everyone gets, well, not everyone, but a lot of people get, we'll get swap lines. And kind of all will be well. And all was well, but what was different last time is that the transmission mechanism was so much more fluid.

Because what happened in 2008 was the European banks were the ones who needed dollars. It was EM sovereigns who needed dollars. And it's basically how these, you know, the swap lines work is that the bank applies for the central bank. And the central bank gets from the Fed and basically downstream it to the banking sector. or if it's an EM sovereign, even easier because it just stays in the central bank. But this time around, it was going to, to me, and let's say why it maybe didn't end up being this way, is what the pinch really would have been is if the Fed does a massive swap line program, as they did with 16 different countries on it ranging from debt,

and eventually got to basically everyday operations. Well, what if the dollars don't get downstream properly because it's not European banks who need it now. It's the non-bank sector in Asia who needs these dollars. And that's a trickier thing because they have to then go. It's further steps down the ladders and they have to go to their local banking system. Banking system has to go to the bank of Japan. And it's not kind of as it's not as easy, quote unquote. And then on the EM side or on the, you know, the trade finance side, it's much harder because, one, you know, some of these countries are not going to be eligible for swap lines, even though a lot of the end countries ended up kind of getting access through that or having, you know, an IMF backstop or through a treasury repo program was that it's much harder for these corporates who are hurting to kind of reach their way up into the, you know, they're not in the banking system.

So it's harder for them to kind of get into the central bank purview and to kind of get those dollars. So to me, like the Fed had a real battle on their hands. And I was writing in March actually why I thought, well, let's say it doesn't work. And kind of how I ended up writing a couple weeks ago, like the what if the dollar is a solved problem is, is that all of these things that seemed insurmountable ended up being surmounted. So it kind of became to me like, okay, what if the Fed did figure it out? And if the Fed did figure it out, then that has, you know, massive consequences in a distribution sense because we no longer, you know, debate like, well, what if the dollar goes up another 30 percent and has like a massive deflationary effect on the global economy?

Now the question is like, what if global growth picks up and the dollar has this backdrop of, you know, the feds basically through the swap lines turned every government bond in the world into effectively dollars as those can be swapped for dollars. Well, what if it's the dollar can now maybe depreciate? I mean, we get into it more, but basically that transition has been like probably one of the more interesting things to me this year is basically how we went from, well, this could be, you know, the dollar end game that a lot of people have been talking about. It's kind of like how this denominated debt, the funding in dollars kind of all came to the forefront at once, all in a massive ball of it.

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So this is super interesting. And obviously, this is really, I mean, I had read the Imperial Circle piece and loved it. But the dollar is a solved problem concept. is it really, really captured my attention. And so I want to, I mean, you basically got into a key part of the argument already, but I want to expand it out because, you know, when I was reading it, I kind of pulled out three different elements, right? So first of all, when you say solved problem, I would love for you to just remind, you know,

what the problem was, which I think is why I wanted to start with this sort of imperial circle idea. But just let's remind everyone who's listening what the problem that is potentially being solved here is. Then second, you know, let's talk about the factors that have coincided to, potentially make it so. And you've gotten into the Fed, the Fed's piece of it, but also let's talk about your argument around how the response of Europe has changed thing and also China's role. Sure, yeah. So, I mean, the problem really, and I think this is kind of kind of gets overshadowed

in the, you know, the famous dollar bowl, dollar bear camp is, is there fundamentally a shortage of dollars in the world, right? I think this is kind of what breaks down the two polarized camps. And to me, like, you can easily make the argument that there is a shortage because we have all this, you know, dollar denominated debt over 13 trillion of it. And but then you can easily make that there's a lot of dollars floating around because all of these countries have been buying dollars, you know, for so long and through the, you know, their net international investment position actually happen to have a lot of dollars on hand. So, but my kind of thing is like, well, I think what matters more is not these, like, whether there's a shortage or not. What kind of matters more is that we know

the dollar is of fundamental use in the global economy, either through the asset side and invoicing for the real economy in everything. It's, you know, it's the global reserve currency. So it has massive, massive usage. And the bigger point is maybe not like, what? what's its backdrop, but like what is, what is when, when, what tightens the pipes of like where those dollars go and what kind of tightens the pipes and says like, okay, there's something stuck and people can't get dollars who need them. So basically what was happening in, you know, in, in the middle of March is that people who have dollar liabilities, we're not going to be able to roll them or get new ones because, you know, funding markets had, you know, collapsed.

And the people and the people who have a lot of dollar assets that funded them at the short, at like the three month part of the curve, we're also, we're trying to get dollars, couldn't get them. And basically this combination of people who wanted dollars and couldn't get them basically blew out things like the FX swap market, which is where a lot of these guys interact and get dollars. and that led to, you know, pretty substantial dollar appreciation as there was effectively a shortage. And I think kind of where, you know, where the Fed fits in and where, and then we'll get into how, you know, now the more, maybe the more secular things that are changing is the Fed basically fixed the pipes. So they didn't change, you know, whether there's a shortage or a surplus. They just said the pipes are going to work and anybody who needs dollars is going to be able to get them.

And I was skeptical at the beginning that they would be able to do that kind of on the intricacies we were talking about before. And how that downstream process has become a lot harder as, you know, the users are not, you know, banks or governments. It's the non-bank sector and corporates. So the Fed mostly via swap lines and very aggressive, you know, other credit facilities, has basically said the dollar, we understand the dollar is our problem. And we're going to get dollars to whoever needs that. And part of that is when you have these, you know, pretty substantial swap line operations, is you basically expand the supply of dollars

by saying like a Japanese government bond, a German Bund, those are now dollars, because if someone who needs dollars has them, they can just swap them at the Fed and get dollars. And so I think a lot of the debate really is, maybe there's a shortage, maybe the surplus. I'm not an expert,

but I think what happens is, was the, we were at a point where would the Fed, would the Fed be able to solve a pinch when the piping goes, you know, to shit? I don't know if we're a lot of curse, but if the piping goes to shit, so to speak, well, what does, you know, can the Fed fix it? And if the Fed can fix it, then these other things are kind of less relevant. They're obviously relevant in the structural sense.

They matter. But in terms of, you know, massive market dislocations, if the Fed can fix it, that's huge. So we had that happen. The Fed, you know, let's say fixed it. I can't, I don't know for sure if they did, but it seems as if they have. And, you know, we'll see how long they allow these swap line programs to continue into the future. And then the other part is, is now we had this kind of more structural backdrop for the dollar where Europe and China were basically not, you know, through, we're basically putting upward pressure on it by having these negative back.

And what I mean by that is Europe, because of this crisis, entered in, and obviously some domestic factors like the Christian Lagarde saying we're not there to tighten spreads, eventually they would be. But at the beginning is that Europe went into the crisis with fragmentation risk. And with fragmentation risk comes like, okay, Europe in a crisis actually has to answer the survival question. China went into this crisis, obviously, with slower growth, you know, increased tensions with Washington. And, well, it was at first the start of the crisis. And, well, what if China, you know, went the root of kind of weakening its exchange rate as a response to it and wanted the, you know, the export sector to bail them out?

So we kind of had these things like even as the technical side, you know, through. through the FX swap market and the technical need for dollars was happening. You know, the two biggest, basically the two biggest or two most important global economic centers outside of the U.S. We're having this bias to depreciate because what we had to factor in, what if China devalues or what if Europe breaks up? And those were risks. And now what's kind of happening is those like kind of right tail events for the dollar,

but things that could have led to massive appreciations are now changing, right? So Europe is even actually today and tomorrow at a summit where they're debating a recovery fund plan that would have part of it, a pretty substantial part of it, grants where the European Commission would raise money by itself and then transfer that and transfer money to, to the periphery and countries that have, you know, struggled more in relative sense through this crisis. And in terms of the U.S. and China, it's now it's not really, we're not in this tit for tat, you know, ramp up tensions. We weaken the exchange rate world. We're kind of in this. It's, you know, it doesn't feel like a detente because, you know, the rhetoric is so bad. But in terms of substantive trade action, it's kind of died down.

And probably because as we get into the election, there's less desire or less political will to push some of these more negative effects. So we had these two kind of pillars of what was like a steady, steady appreciation of the dollar was we had this technical side with the need for dollars. And then we had the fundamental side, which was, you know, the U.S. is the, you know, a cleaner shirt, so to speak. And those two things have been not, even if they're not been completely flipped on their head, they've, the delta change has been pretty humongous in my opinion. And where it's no longer like now the answer is, well, we know what Europe price, we know what Euro, US dollar pricing and fragmentation risk looks like. It looks like something like 108, 109, kind of in that spot effects rate. But what if it's now that they're going to embrace, you know, this is their Hamiltonian Monon and they're going to embrace, you know, further fiscal consolidation.

And that's, and we don't, we don't factor in fragmentation into the distribution anymore. And so like the combination of these things all happening at once. Again, it's really been a theme of all happening at once, which has been pretty amazing this year. kind of makes it seem like even if the dollar obviously can go higher, it's in terms of the bigger moves now, it seems to be biased lower. And I think what will be the ultimate arbiter of this is like this backdrop is constructive for maybe, you know, the dollar to depreciate. But I think what really fuels, you know, a dollar down move, such as when we saw in 2017 is not only like,

you know, the backdrop changing, but the, you know, the, you know, facts on the ground changing. So how do we kind of enter a world of more synchronized growth, you know, global fiscal expansion continuing past COVID? And I think that's really, you know, the bigger question now because we've seen a lot of promising signs on that as in going into the crisis, it was the, you know, the policy responses, how do I get the exchange rate we could? And now there's no reason to get the exchange rate weaker. There's no one, there's not much global trade in a pandemic. So, you know, know, is fiscal expansion is finally being embraced in places like Europe and Korea, etc.

And it's like, well, what if this kind of stays? And there are hints that it may stay. And if it stays, then we kind of have this dollar backdrop where the technical side, the feds providing dollars to anyone who needs it. Europe is no longer really at, you know, a breaking point. China is not, you know, in this steadily, you know, a steady rate. to devaluation and the world, you know, could be healing more in terms of, more in terms of, you know, more balanced growth as opposed to the last, you know, five years where it was very U.S.

centric. Then you kind of set up like a pretty interesting backdrop for the dollar going forward. So I want to expand this now to, we've kind of, we've come from where we were to where we are right now and how that big shift has happened to going into what might happen next. fully entering the realm of the speculative, obviously now. And you will not be held to account for anything that I ask from here and out. But I want to talk about maybe some of the implications of what comes next and maybe just two ways to pick up from the threads that you just had. The first, and you can order to answer them in either order, but the first has to do with

this kind of argument that there is a detente, at least from a kind of an economic perspective between the U.S. and China. And I'm interested in your take on that because obviously this week we've seen a radical downward spiral intentions in terms of other areas, right? The UK banning Huawei, basically on the back of pressure from the U.S. and U.S. sanctions. Donald Trump's signing the Hong Kong Autonomy Act, which basically is going to put sanctions on anyone who tries to threaten Hong Kong's autonomy. We'll see how toothful versus toothless, that is. And then on Monday, Mike Pompeo basically denying all China's claims to the China South Sea. So I'm interested in how that kind of squares as you try to make sense of because I don't actually disagree with your assessment

of where the trade piece has been. Do you think that that's, do you think that there's a chance that that's actually almost geopolitical showmanship so that the trade stuff can be happening in the background without threatening potential U.S. re-election issues? Yeah. I mean, I think, I think in general, that's probably the right approach because kind of what we've seen the last few weeks is we've definitely had a ratcheting up of rhetoric on both sides. And there was, you know, probably three weeks ago at this point, there was, you know, a Pompeo meeting with the foreign industry in China and Hawaii. And that was kind of like, it was the market at first was like, okay, this is going to be like, you know, nothing until the election. If we continue, it'll be after. And now it's like,

well, there's a lot going on. But what I think is very interesting is that the issues that are being talked about and the rhetoric that is being spoken is significant, but I'm not sure what the, you know, the direct, what's the direct financial spillover? So during the trade war, you know, 2018, 19, the financial spillover was the U.S. raises tariffs, China weakens the exchange rate. And that had massive global economic consequences as China's, you know, as we've spoken is, you know, the world's big, you know, is basically the world's biggest trading partner and a weaker exchange rate, is their, you know, their purchasing power effectively. So that part, you know, had a much more, you know, financial pass through.

And this is like when, you know, in the kind of the tech war part of the, you know, the Cold War, whatever it is, is, I think, very significant. And, you know, we're definitely seeing it in like, you know, Chinese tech stocks are, you know, have been flying and there's definitely a people are understanding what kind of the new frontier is and where to and who's going to benefit from it but i less see the kind of the the global macro you know price pass through in a more in a direct sense it's it's much more there's a lot of strategic things going on that i think will matter over time for asset prices but it's less you know directly impactful right now.

I mean, maybe sanctioning, you know, Chinese officials will change things. I don't know. But with tariffs, it was much more a, you know, there was this tit for tat element that had a financial market pass through. And this stuff outside of like who's the winner, who's the relative winner in the tech sector or in the chip sector, it's hard to see how like it connects a lot more pieces,

even though I do think in a longer-term time rise, and this is very significant. Yeah, I think it's a super interesting assessment. And I think it's always really important to whenever retrogratch it's up to look at the economic dimension sort of dispassionately, you know, and be able to separate out those two. I guess another question that I think relates to things that are happening now. So in some ways, you're kind of setting up this scenario where, there could be this sort of interesting, positive go forward. But then there's this X factor of, you know, 39 or 40 states in the U.S. seeing rising cases again,

states like California going back into partial shutdowns and quarantines. How do you think the actual health scenario on the ground potentially shapes some of these issues that we've been discussing? Yeah, I mean, I actually think the health situation will be a big factor. And I'm not sure if it's, you know, kind of if, you know, a second wave were to, you know, expand just beyond the U.S. and, you know, Brazil, India types, is it would be, you know, kind of the same price action we saw in March where risk assets are heavily offered. But I do think it is an interesting economic backdrop where Europe and Asia seem to, especially, especially on a relative sense, have the virus under control, and the U.S. doesn't. And over until probably the vaccine is like what kind of relative growth dynamic does that set up, where, you know, Europe is doing relatively well, Northern Asia is doing relatively well,

Australia, New Zealand are doing relatively well, does that set up, you know, a relative growth outperformance for those places? I'm not sure, but it's something I've definitely been thinking about. Of course, if it were to broaden out, then it probably becomes a major risk event. But it's very hard to be honest, I don't know. It's definitely a topic of struggle because on the one hand, yes, we are seeing rising cases. And, you know, the U.S. has on a relative basis done a very poor job in containing the virus. but are we going to see a really a global second wave where we have, you know, hospitals,

hospitalizations surging and hospitals overrun and excess death, et cetera, that I'm not sure. And I don't think probably that that's the right, I don't think that's the right bet, so to speak, is it if I think the more likely situation, probably, you know, the mean of a distribution here would probably that the U.S. continues to struggle with the virus. As we go on, treatments kind of get better, it moves into a younger cohort. And that basically, and there will be a lot of unfortunate and devastating outcomes, but it's not as out of control

as it kind of felt in March and April. And if, you know, Asia continues with, you know, strong mitigation measures in Europe, continues to be responsible, then we kind of have this world of, well, Europe and Asia more returning to normal faster than the U.S. And that kind of also feeds into, you know, kind of a more medium term dollar weakness case as opposed to a, you know, cases surge globally. And we have a major risk off event and the dollar surges. Yeah, I think it's a, well, one, obviously, just reinforcing this, obviously no one can know.

but I think that that makes a lot of sense. And I think that the part of what made March and April so terrifying is that it was happening everywhere at once, at least in the developed world, everywhere at once, right? And anytime there is sort of less pressure in the system, anytime it's even as devastating as it might be, where it's one kind of actor or a smaller set of actors versus everything. Transitioning, I guess, just because it's such a bit of such an interesting force this year. and we've kind of, you know, covered a lot of the key narratives of markets 2020. What has been your take or your observation on the sort of the stock market rally, you know, post-March lows?

And in particular, I'm interested in whether you have thoughts on the Robin Hood Rally, Wall Street Betts, Davy Day Trader piece of this. Is this a fly-by-night? Is it just another bubble? Is it just another mania? Or is it something that's a new structural force in the markets? Yeah, so, well, I, you know, I am a bit of a stooly, but the Davey-Dade trader thing is definitely throw me for a loop. I think more generally, I think the stock market question has been super interesting to me. I mean, we're basically, I mean, in NASDAF, we more than retrace the loads and S&Ps were, you know, four, three percent off the highs.

And I think one of the, I mean, it's somewhat tricky. in this global economic backdrop to justify that sort of price action. But I think in a policy sense, it's very interesting because what we've basically done, we've shown now that in a deflationary shock, that policy can play a role in basically, not totally offsetting it, obviously they can't, you know, global trade won't serve. They can't backstop that and they can't backstop. you know, people going to work, but they can backstop income and revenues, which is something that we never really, as in a negative event,

we were, the debate would be how long would it take kind of to build back up incomes, build back up revenues. And basically because of the policy response in the U.S., where we have, you know, the checks going out, unemployment, enhanced unemployment insurance, PPP, et cetera, we've kind of had this pretty effective, not necessarily perfect. I won't speak to that, but replacement of incomes

where the shock has been, I wouldn't say obviously not good, but much more manageable. And basically now if you're the market, you have to entertain this world where interest rates are going to be low for a long time. Central banks are active players in the asset market, bidding up assets,

and the fiscal policy, actors are basically saying have changed the game in terms of in terms of recessions. I mean, in a non-trivial way, they've said like if you were making, you know, $50,000 or less a year, you're going to be made whole. And that's a pretty fundamental policy change from the world where we were, you know, even 2008 recession, 2001 recession, et cetera, maybe closer to 2001. with the tax rebates, but not really on this scale where we said, you're at least for a large percentage of the people who lost their jobs, as in that's not going to have an income effect.

So we have all this slack in the economy through a very high unemployment rate, but in terms of purchasing power, it hasn't had a commensurate move. And I think that's a game changer in terms of pricing in recessionary risks in a market that already has zero interest rates and, you know, a tech sector that's flying. So I've been, it's definitely, I didn't, definitely didn't call it or have, and have still been surprised by the extent of these market moves. But in terms of a policy game changer, this kind of approach of making people and making companies whole for the time being has proved to be very effective. And the market going forward has to entertain the fact that like, as a lot of, as a

as long as, again, it's a deflationary recession, well, why wouldn't they do this again? Do you think in that context? Well, so again, two questions. First is, do you think that in that context, it increases the sort of the narrative versus fundamentals trade, right? Like, obviously narratives are always a part of markets. But in a world where you have this sort of backstop plus these new market entrance who are very comfortable leveraging narrative, which I think Dave Portnoy is a phenomenal example of. Do you have to play momentum and narrative even more?

Is part one of the question? Then part two is, I guess, to kind of hints it where the Fed is headed. I know you did a thread on Lail Braynard's speech yesterday or the day before. And I'd love to see what was interesting to you about that. Sure. Yeah, so the David Day Trader phenomenon, to be honest, and maybe I'll be a little disappointing. I think it's a little bit overrated.

I mean, I think in terms of, you know, specific securities can retail have like an outside effect on price for sure. We definitely saw that in, you know, some of the bankrupt companies like Hertz. And you've probably seen it in some of the, you know, more cyclical companies like, you know, casinos and airlines and what have you. But I don't think there's been, you know, a massive retail chase in, you know, in Korea or in Germany or in France. And those equity markets are also, you know, 30% off the lows. So I think that there is pockets of where, listen, there's a lot of liquidity in the system.

People got money and didn't have that many places to spend it. They either, their retail activity was constrained via just the only place you could spend money is Amazon if you're locked in your house. And you, if you were as Davey Daytray was, if you were sports better, there wasn't sports to bet on. So it kind of was, you know, a lot of people got, you know, especially from the checks at a minimum, even if they kept managed to fortune enough to keep their jobs. There was just, there's just a lot of liquidity in the system where, you know, it makes sense that it gets that retail, that retail participation expanded. I'm just not sure it had, you know, the board large cap effects that, you know, people are talking about.

about. I know it's a compelling narrative, but I'm not convinced by it. I'm not ruling it out as a very important variable in the global macro sense, but I think it's probably a little overstated. And then getting to the Fed going forward, I mean, I think the interesting thing for the Fed is what they learned from 2018 was that they're never going to let financial market excess kind of get in the way from them, like, continuing to make labor market gains, inflationary gains. And I think what Brainerd was hinting at on, when was it, on Tuesday in her speech, was kind of this transition from, okay, we stabilized the economy, we stabilized the financial market.

Now, how do we become a source of accommodation going forward? And I think what, you know, the Fed will be very very. very keenly focused on is kind of letting a recovery play out over time. So you kind of get to this 2019 point, which they seemed very comfortable at, where because rates were pretty low, I mean, they were cut already three times. And, you know, they soften financial conditions. And you kind of let the labor market feed on itself. And then you kind of get better, you know, societal outcomes when you have much lower,

or lower unemployment rates, especially in the backdrop of Phillips curve, the tradeoff between unemployment and inflation that's very flat where there's not much of a pass through. So they're going to be very keenly focused on making sure the recovery is durable and they're not going to do anything that gets in the way of that. So even if the market's where it is or goes to 3,500 or 4,000 or, the recession is much shorter than we originally assumed, it's still going to be. be very hard to see this Federal Reserve kind of saying, wait a second, let's slow down because they're very much chasing these kind of very, very low unemployment rates that we had previously, and they're going to do what they can to do that. And basically, the way this will

manifest itself is that the Fed will do a lot of things that don't allow yields, either at the, especially at the short end, obviously, but even at the long end to suggest that, you know, things things could change, and they're just going to push it and say, we're not coming. We're not hiking. We're staying the course. We're not pulling back support. We're staying the course in the hopes of that they can accelerate a recovery and a recovery that's durable.

So I think that's a pretty interesting force going forward. Well, John, this has been a really, really fascinating conversation. And I guess by way of just kind of wrapping up, I'd love to know what you are watching. You know, you've kind of shared a lot of what surprised you and what has shifted about this year. But going forward, what are the things, whether it's assets or different parts of the market, but like what are you watching right now and think is going to have some big ability to tell us what to expect next? Yeah. So I think I think the biggest thing for me now is what is kind of the at a global level.

what is the fiscal impulse post-COVID? As in, did we say that fiscal policy is just a stabilizer? Is it just a thing that says, okay, we've had a shock, how do we fill it? Or does it make the transition, as Brander and the Fed are going to make, and say we're also an accelerating? We're going to drive growth outcomes. We're going to drive higher nominal GDP. And I think that transition is really going to be what,

justifies or not kind of where the market sits right now, you know, with SMPs at 3200. So I think, you know, good ways of tracking that is definitely the commodity space, risk currencies like Aussie Kiwi, Korea, a lot of the EEM names. And I think that's really the big question going forward. There's a lot of evidence to suggest that it could happen. but as we know with a lot of these fiscal bodies that, you know, deficits are not their cup of tea. So it's possible that once the COVID threat is kind of passed and, you know, there's a vaccine, whether it's earlier mid-20201, do they decide to pull back support and let, you know, kind of the economy

go on its own? And I think if they let the economy go on its own, you're going to have worse, worse outcomes. and maybe then you really start to really question what multiples are doing here. Thank you so much, John, for spending this time with us. It's really, really interesting stuff. And I want to make sure people can follow you if they want to hear more of these great insights. So where do you live on the internet? Oh, sure.

Thank you. So I'm at at J. Turrick 18 on Twitter. And I write a blogger macro trading note called cheap convexity. Awesome. All right, John, thanks again for hanging out. Thanks so much. Have a good one. One of the things that I really value about John's thinking is that it is dynamic and flexible and responsive to new information. I like that he had this thesis going into the beginning of the COVID crisis about how the dollar might react that was changed that he's able to come out of on the other side and ask new types of questions.

I think it's really important because we are on fundamentally new ground and in fundamentally uncharted waters. Even to the extent the dollar is a solved problem to use his terminology, the question quickly becomes solved for how long and in what ways and with what externalities, with what other negative impacts that we might not realize yet. As those potential externalities and implications come to light, we're going to have to update our mental models and think through how we address new problems that arise. For now, though, I appreciate you hanging out and listening to this conversation, and I hope that wherever you are, you're heading into a great weekend. So until tomorrow, be safe and take care of each other. Peace.