- Speaker #0
Hello Vincent.
- Speaker #1
Hello Babak.
- Speaker #0
Very happy to have with you today our podcast from Think Macro, our podcast channel where we only discuss about our macro views. Today the topic is American exceptionalism in question. Now Could we start with a definition of what is American exceptionalism and what has been the historical milestone of that?
- Speaker #1
Yes, indeed, we are seeing, experiencing now, a major change of four decades of a model that has been developed more in the U.S. than anywhere else. U.S. exception, it's about these three decades of superior growth in the U.S. compared to... any other developed market. So how did the US achieve that? In the 80s, like in most developed countries, you just go for the liberal model. So you fight inflation, you cut taxes, you open up trade, and in that sense, you favor, you support private investment. That is the case in the US, but at this stage, there's no such thing. There's an exception. All countries did that. The exception comes in the next decade, in the 90s, when in the US, more than in any other country, you open up the country up to labor, immigration. You have cheap labor joining the economy. You also have educated labor attracted by the model. Students, engineers are coming and supporting. growth in the country. And you also open up markets, financial markets. You provide investors, households, people with a tool to invest, in that sense, support innovation and with all the positive implications on productivity, but also getting the reward of that, of their investment. And you start a positive loop. that ends up with some supportive wealth effect for the participants. And that's how in pushing that liberal model more than others, you have more productivity, more labor in the economy, and you end up with, in the end, more structural growth in the US.
- Speaker #0
Okay, so you have more consumption, more growth. But can you have excess in this model and speculative, for example, investment?
- Speaker #1
Yes. as for anything successful, as you might have expected there's speculation behind because a lot of people want to participate, seeing the performance of assets, particularly want to join the party. And that created, inflated a bubble in the late 90s and that bubble at some point bursts and you had to reboot the system. So the cost of this approach, of this... An ultimate liberal model that was developed in the US is that you need to refuel it regularly. In the early 2000 years, after the collapse of equity markets, you had to rebuild confidence. The model lies a lot on confidence of its consumers, of its investors. No problem at this stage. You can cut taxes. You can cut rates. Confidence comes back. You restart and you have another five, six, seven years of very strong growth. But then the next problem is that that refuel takes more and more. Every time you have a confidence shock, the drug you need to inject to fight the disease or the loss of confidence is bigger. You have less effect. You need to inject more. So at the next crisis in 08. It was a lot more systemic. It was not enough to cut rates, not enough to cut taxes. So you had to bail out banks and you had to go for new types of policies with QE. And lately, with COVID, third big confidence shock we had more recently, even more interventions with massive liquidity injections way beyond the standard orthodox. monetary tools and fiscal tools you would use in a normal world. So the bottom line is that you need more drug, more injections. to refuel the system, to reboot the confidence whenever it faces a shock. If you think of some measure of that in 2000, early 2000, debt to GDP increased only by a few percentage points. In 08, that was in excess of 20% over just two years. Covid, more than 20%, but just one year. You can get that notion of more cost, more injections. required to reboot the system.
- Speaker #0
So on one hand, you have to put those injections, fiscal, monetary policy, to maintain this confidence. On the other hand, the more you put those injections, the more you need those policies, but the less is the effect. But can you do that indefinitely?
- Speaker #1
Well, in theory, yes. The problem is that at some point, there's a a nasty poison that appears in the system. For three decades, we just had no inflation whatsoever. With the latest injections, inflation came back in 2022. And that's a double problem. It's a problem for the Fed with the monetary policy. Of course, you have a dual mandate for three decades. You could just intervene and cut rates at every confidence shock. focusing on growth, no need to take care of inflation. Now you have to cover the other side of the mandate as well, meaning that in practice, as a central banker, you just cannot act so forcefully immediately at the very first stage of the shock. You have to wait and make sure that inflation is under control before you really act. So what we can expect from the Fed from now on is probably a more cautious approach, which they have already voiced in their communication. But that's not the only problem. There's also a problem on the fiscal side. Inflation now, it's a recent issue, but now also blocks to a large extent any fiscal policy in the US.
- Speaker #0
Could you, because I understand that when the devil is out of the bottle. inflation. On the monetary side, I think it's straightforward. We can understand that the Fed is going to have less leeway, less options. But could you detail now what's the impact on the fiscal side?
- Speaker #1
Yeah, it's a bit more subtle there because there's no direct impact. The problem is markets, how investors react. The problem with inflation is when you are... at these current levels, 2 to 3%, you know, you're in a dangerous area. It can easily slip and you can lose control. Now, considering the deficit you have in the US, particularly on the fiscal side, the government deficit in the US now, whenever they want to go at these levels for more fiscal stimulus, now the market says no. That is the big difference. Back two, three years ago, when you had these fiscal injections with the Biden administration, the market accepted them because rates had been taken up. Inflation was perceived as being about to be controlled. No problem. You have a direct economic impact. Today, the market disagrees with this and considers, investors consider, that we are on the verge of losing control on inflation and potentially on... debt refinancing in the US. So whenever you stimulate the economy with a loser policy, the yield curve steepens with investors saying, I need more of a premium to lend you money over the medium to long term. So what you gain on the one side with stimulation, you easily lose on the other with higher long term rates, which, of course, impact the consumer. and potentially impact the equity market we know is important for US households as well.
- Speaker #0
Yeah, it's clear that it impacts everyone from investors to the consumer, for example, on his mortgage. But if we come back on this, not loss of confidence, but this less confidence, so you want to be paid more. you have in front what the government has put in place, reduction of the deficit and also the big beautiful Bill Act. Don't you think that those measures could mitigate the expenses of the government and the deficit?
- Speaker #1
The big, beautiful bill is definitely at stake here. Whatever is decided there, it may be challenged by investors and the market. So there's what the new administration would like to do. The big difference with the previous instances is that they've got a lot less leeway and investors are ready to accept a lot less from them because we've reached the limit of the deficits in the US and debt on GDP sustainability. So they're going to bump immediately into what investors are ready to accept. That's the big change. That's where inflation completely changes the game, not just for the Fed, also for the government today. Foreign investors that are big holders of U.S. treasuries, they're just not ready anymore to accept a low, even a negative term premium we had for some time. They need to be paid more. And we also could question the behavior of equity markets in such contexts. Of course, equity markets are not too happy. when financing costs increase. So long-term rents also matter for equities, long-term investment, and potentially the return US households get on their savings.
- Speaker #0
Okay, so if we zoom out two seconds, we understand that the fact that we are at a stage where we need much more fiscal and monetary to have an effect. on one hand, and on the other hand, that now we have a game changer in the equation, which is the inflation. This is what puts all this US exceptionalism in question. But how is that on the market? We can see the resilience of the equity market, for example, in the US. We don't talk about markets here during our... our podcast.
- Speaker #1
We are really focused. They are important because they play a role, particularly in the US, of course, but yeah.
- Speaker #0
Yeah, so we can see this resilience of the market despite the sticky inflation for years now.
- Speaker #1
Yes, indeed. At this stage, the US economy is just in a fragile situation. You can keep that going for some time. Yes, the Fed is more handcuffed now than it was was in the past. Yes, this is also the case for the government. But as long as it goes, you can continue. As long as confidence is there, you can keep it going. Now, the problem is you are now in a much more fragile situation with the loss of leeway for the Fed, or at least is it delayed? You have to wait and make sure inflation is under control. It's a lot more constrained on the fiscal side. You could also argue there's a lot less buffer in terms of excess savings in the US. A lot of savings have been spent lately. This confidence is really there. So Americans, unlike many other countries, most other countries, spent all the savings accumulated over the COVID period a lot more than others. So there's not much of a buffer there. Equity markets have. very limited potential from here. They're really expensive. I'm not saying that they can't continue to go up. But of course, the pace, the speed at which they appreciate is a lot more limited by their valuation. So you've got starting conditions, starting conditions that are more exposed to a shock. It goes, but it's more unstable. And there you have the new administration saying, I want to change the whole model. That's what the new administration has announced. They would like to rebalance the world trade. And that alone is a major shock. So you're shocking something that is already quite exposed, quite fragile. This is where we can call it the end of the U.S. exception. There's a notion of willingness there to just rebalance it.
- Speaker #0
But somehow... the fact that the US administration wants to change global trade could make us think that the analysis of the situation is right. Because your view and the view of H2O Asset Management is that, okay, we're not going to have an America great again or an American economy great again for years. But here, the fact that you want to shock trades is probably maybe a good way. to bring the economy maybe back again.
- Speaker #1
Yeah, the diagnostic is not bad. Indeed, you have a model that is good. It's a strong one, but it leads to overconsumption. With more confidence, you get more return on your asset, which means more confidence, more consumption, and that loops and you end up with an overconsuming economy. In the US today, you're talking almost 85% of the economy is driven by consumption, and this is enormous. You're more like in the 70-75 in Europe, in Japan, and a bit more than 50 in China, for instance. So it's an over-consuming economy. So, yeah, it does make sense to try and rebalance that now that you know that you've sort of exhausted the current model and you're losing the safety nets that enabled you to reboot it every time there was a shock. So that makes complete sense to do that now. The issue is it's an enormous task. There's a lot to do there. You need first to accept to slow down in the U.S. You need to accept to consume less, meaning less growth, because that's the number one engine of growth in the U.S. Possibly you would like other countries to consume more, and that would really help this rebalancing. why not being helped by a weaker currency that would definitely help in the process? But you can see that it's not just a task for a few weeks or months. There you're talking of a major change.
- Speaker #0
And if you were Trump, would you impose those tariffs so that because American consumer is the biggest and the greatest consumer, in the world to get your growth from this angle.
- Speaker #1
There's a lot of pros and cons on the approach there of the new administration. I'm not going to enter a debate on that point. But what we can say is that regardless of where we end up with tariffs now, I mean, they've already shaken. the economy enough to slow it down substantially. As we said, you're starting from a fragile point, which had not been the case in the previous even 30 years. It's the first time really you have starting conditions in the economy today that are exposed to a shock. And with just what was already, this is already in the cake, and we're saying the 10% across the board that are going to stay. We could call them the ideological part of tariffs in the US. Whatever the result of negotiations, you're going to end up with at least these 10% and a few more on some sectors that are targeted by the US administration. That means, in any case, a major increase of tariffs. That means, in any case, a big tax on the US consumer or on corporates. It could be adjusted by both. you talking something in the vicinity of half a trillion dollars there could be a bit less, a bit more, depending on where we land. But that's big. That's probably in the region of one and a half percent of GDP. And that's going to happen now as a tax on the consumer. So you will have a substantial impact on the economy. You could add to this the immigration that has been also... taken down a lot lately after two years of strong immigration as a catch-up of Covid. That was very supportive for growth. Now it's come to a halt and you have an economy that is receiving a lot less labour from neighbouring countries. That's drag on growth. We could mention government cuts with the Doge. program of of eden musk uh same thing That's a drag on growth, at least locally, even if now they spend more and they can maybe reverse that and backpedal a bit on that side. That's also a cost. And we should never forget, as well, uncertainty, a big part. And we said at the beginning, the whole purpose, the whole starting point of that model was about creating a context, some visibility. You could see far away, no inflation, good, strong, solid financial markets. You can invest. for years, you can take risk supporting innovation, productivity, and so on, and getting the reward of that. Uncertainty kills that, maybe just for some time. Hopefully, it won't last. But that alone has a major impact, particularly on the American model, where certainty, stability matters a lot. So at the end of the day, you will have a U.S. economy that slows down substantially in the second half of this year. It's already in the cake and we're going to see it in the hard data very soon.
- Speaker #0
I think everybody agrees on this or no one will disagree with the fact that we have more uncertainty. There is this quote from Lenin that says, sometimes nothing happens during decades and sometimes you have decades that happen during weeks. We all feel that those six first months of the year, we had decades happening. The picture you're painting is pretty dark for the US economy and probably de facto on the market. But what can the administration do in this environment to mitigate this economy, which is going to have difficulties to continue to perform at the level it had performed?
- Speaker #1
Yeah, I wouldn't say dark. I mean, you know, the US is still a... big and strong economy and has got many ways to absorb the shock. But he's going to slow down for sure. Now, what can the US administration do? I'd say not much because of what we said. I mean, the tools are just today not really available because of inflation. Plus, they've decidedly, they've decided to move towards that rebalancing. of the model itself so that they've chosen that route. So whatever the communication around it, they've sort of accepted that rebalancing with all the slowdown that comes with it. So in that sense there's not much really they can do and there's probably not much they are really willing to do. In any case there's not much the market will accept. as long as it comes from more spending, which is now impossible, will not be accepted by investors in the US.
- Speaker #0
What about the currency? When you have the global reserve currency, isn't that one of those features that can help you to go out of such situation?
- Speaker #1
Yeah, we may say whether they like it or not, the US economy is going to slow down. Okay. On the currency, it is something the new administration has been more vocal about. They would be quite happy with a weaker currency. They've said it in a number of occasions. And that makes sense. Now, it should happen. It should continue to happen. We've seen that year to date. We had a bit of a weakness of the US dollar. It should continue for a number of reasons. First, because at some point, as soon as inflation is... deemed under control, the Fed should start cutting rates to accompany this slowdown in a lot less proactive way than in the past. But yet that's rate cuts in the making. And on the other side, investors also there are themselves questioning the superiority of the U.S. economy. And for them, investors hold a lot of US assets, not just local investors, foreign investors. The world is exposed to US assets, equities, bonds, and the dollar with it. And these investors today are asking the question, should I reallocate? And that's a legitimate question because of all we just said. It's reached its limits. You can expect... probably less return on your equity investment in the US in the future, more challenge. on your bond investment because of debt refinancing questions. And in turn, you can expect at some point a Fed that comes on the loser side progressively and takes the dollar down. You already have some foreign investors that are hedging more their exposure of us assets today so the process has already started it's not just uh speculation having taken long dollar position off the table. There's more to it already in the market. So you would expect, yeah, we definitely expect the dollar to weaken over just not the coming quarters, probably even the coming years.
- Speaker #0
But it won't be enough.
- Speaker #1
No, I mean, that's not enough. You need to reform a lot. I mean, and you need, again, first to... As we said, there's three big conditions for that. It's a long, long process. The share of consumptions in the U.S. needs to come down. A weaker dollar will help. And the rest of the world should consume more.
- Speaker #0
But, you know, the old quote says, when the U.S. sneezes, the rest of the world catches a cold. What's going to be the impact with the... with the rest of the world. How would other economies, Europe, Asia, would react if the American consumer, the number one consumer in the world, consumes less?
- Speaker #1
Unlike previous instances, we would expect the rest of the world to absorb the shock. Because essentially, the starting conditions are different. We said in the US, not much savings left. Not much potential of wealth effect on equities that saved the year last year. Equities, not much leeway on the fiscal side, on the monetary side. All these factors, these sources of support are alive and well in many places elsewhere. If you take Europe, for instance, you have fiscal leeway. You've seen Germany today is launching. an important program of spending. It's not the case of the whole region, but as a whole, the region has got some leeway. The US hasn't. On the monetary side, the ECB can definitely cut rates easier. There's no such thing as demand inflation you could lose control of. So the ECB is in a much easier position to continue to cut rates. You've got another source of support here. asked for savings, ULOP. like many other regions, has not tapped much in its post-COVID savings. So the US is a bit of an exception there. So you've got three big dimensions already where other countries, Europe, are in a much better position. We could even add financial markets. I mean, most other countries are a lot less exposed to financial markets, so a lot less sensitive for good and bad. to the performance of equities. When it's strong like last year, it boosts US growth relative to anybody else. But when it turns volatile, as is the case this year, it has a bigger impact on US households than on any other household worldwide.
- Speaker #0
So Europe could benefit from this situation. And what about China?
- Speaker #1
I wouldn't say benefit. At least weather the shock. You have the safety nets, missing safety nets in the US. You have them in Europe. And to a large extent, the same can be said of China. Yes. And even more, China has got today the potential to reshape its growth towards more consumption. China is in this phase. big, long transition phase over the last 12 years. It had to digest the housing bubble. It had to digest an overinvestment in its economy, stabilize its financial markets. There was a lot to do in China, but we're now reaching that point where you have now the preconditions for a reshuffle of its growth model towards more consumption and less dependence on exports and investment.
- Speaker #0
But it's something we're hearing for years. China consuming, being more... consumers than exporters. What has changed now? What is the catalyst that makes H2O believe that it's now that it's going to happen?
- Speaker #1
It's a lot less timed than the US side, because in the US we know that that's the willingness of the new administration and they're doing what it takes to reshape the model. In China, it's a lot smoother, but yet we are about there. Take the housing bubble. It's now well deflated. The supply of housing, of real estate is now smoothly lending on structural demand you have there. So that's a bubble that is over. That means for Chinese households that they can tap into their precautionary savings that they had in the past to cover that risk, that there's no need for them to keep these savings against the potential. problem on real estate. Bear in mind that in China, unlike the US, savings are big. Chinese people have spent in excess of 40% every year of their revenues, which is not abnormal in an emerging market. You have a lot of precautions to take. There's a lot of things that are just not available and you are in a riskier situation. So you can understand that. But now that... That still makes it of a lot of big pent-up demand in China, with a lot of accumulated savings in the economy that are now ready to be spent. Now, do you need to keep that rate of savings when there's no more housing bubble? Probably not. You can take that number down. Do you need to keep that amount of saving when social security, education are improving? They are improving. pretty fast in China. And now you don't need that much precaution against the risk of not finding a high level job or health risks. That also is supportive for more consumption in China in the coming years. We're talking years here. But it's about now, that transition is about over in China. And this too. Two more elements that tell us we are at that moment, plus or minus, you know, a couple of quarters in China. The first one is that the population now, it's aging and that's an issue for potential growth in China. And definitely potential growth in China is coming down. But it's also this workforce is now retiring. And that's, you know, the dependency ratio, if you look at China, is now about to rise or has started to rise again. And that's more spending. And when you retire, you spend more and you save less. So that's another source of reshuffling and more consumption. And last, markets. We should never forget the importance of the tools to deploy investment. That's what the Americans did in the 1890s better than anybody else. They developed financial markets. They made them more liquid, more stable, more attractive than any other market. That attracts investments. The Chinese have done the same. They've spent 12 years to build a deep and liquid yield curve that is now used actually all across the region, even by neighboring countries, to... at the expense of equities, where they've been regulating more to secure a number of assets, making more credit worthy. All these reforms in China that took years are now in place and make it for a much more stable financial market. And what are they doing now? Now they're favoring investments. Now they are pushing people to invest in equities and on the other side, have programs that favor innovation. in technology, in a number of sectors they consider as strategic, with all the incentives to make it rewarding for the investor. Higher dividend payment, pension fund incentives, that sort of thing that basically make it for more capital market access and more reward you get as an investor when you participate in that innovation effort you have in China. That's a very positive loop that will participate as well in that transition toward more consumption. And if you think... of numbers, wealth, and the performance of assets, has a big contribution on U.S. household spending, a lot more than in any other countries. In China, unsurprisingly, it's very small. Chinese authorities are really working on means to increase that and favor that.
- Speaker #0
So you have many planets that are aligned today. On top of that, or... or maybe one of the reasons that those planets are aligned, there's a strong political will to have this shift from exporters to consumers.
- Speaker #1
Yes, indeed, definitely. And that means you can weather the storm, any shock coming from the US, depending on the results of the current negotiations. But there's more to it. Really, regardless of the results of that, China is definitely a bad... to move towards a more consumption driven model. Doesn't mean more growth. It's definitely coming to more like developed market standards, but it's a different shape of growth, growth, different model.
- Speaker #0
We will conclude in a few minutes, but just what you said here, for you, China, is it one country that has a specificity? in this environment to grow? Can we talk about Chinese exceptionalism? Or is it one country among others that could benefit or be less harmed by this US exceptionalism, which is in question today, and that can benefit from that, such as maybe India and Europe? You mentioned a few.
- Speaker #1
There's definitely some Chinese specificities. Of course, but there's a common part that a lot of countries share. Fiscal leeway, the US doesn't have, many other countries have. Monetary leeway, because it's hard to find another country outside of the US that really risks losing control on inflation. So there's a lot more. leeway there for central banks and savings people in most countries worldwide have accumulated a lot of savings they haven't spent yet so that makes it for really three solid starting conditions that should enable most most of the rest of the world say absorb a shock from the u.s and with the right reforms, with the right incentives, why not? Outgrow the US, as we described, is possible for China in the coming years. And why not in Europe, if the right decisions are made?
- Speaker #0
You have over 30 years of experience. You've seen many different macro environments, macro shifts. How would you rank? the shift we're living now in terms of magnitude and in terms of impacts and in terms of length for it to materialize and to have an impact on the market.
- Speaker #1
We had many different environments in markets and in the economy over the last 30 years. Big, small shocks, some systemic, some more exogenous. Yeah, we had a lot of things. Now this One is more about the transition. So that makes it very different. You're talking about something gradual. As we said, it is going to take a while to rebalance. If we ever manage to move toward that rebalancing of world trade, that remains to be seen. But it's a strong force, really strong force, that will drive economies and markets for not just the coming quarters, probably in the next years, if not.
- Speaker #0
So the impacts on asset allocation, portfolio positioning can be, will be very important. I think we're going to close here today.
- Speaker #2
Thank you. And if you want to have more information about how we translate those macro views into positions and into portfolios, please contact... the sales team of H2O Asset Management. You can find their contact details. per region or per country on our website www.h2o-am.com
