Mirror, mirror on the wall, who is the wealthiest of them all?

When we talk about the European Union, we often lament that there are no fiscal transfers from the ‘rich countries of the North’ to the ‘poor countries of the South’, assuming that indeed this is so. But is this really so, and how have things changed since the inception of the EUR?

To measure wealth across countries, economists normally use GDP per capita. This is how some of the major EU countries rank according to this measure.

AT=Austria, BL=Belgium, FN=Finland, FR=France, GE=Germany, GR=Greece, IR=Ireland, IT=Italy, NL=Netherlands, PO=Portugal, SP=Spain

More or less, as expected, the bottom is taken by the four Mediterranean countries, while the north and core are at the top. However, GDP is a flow variable, measuring how much economic activity was created during a specific year. It tells us nothing about pre-existing wealth or, in fact, current debts.

A much better measure to use for that purpose, would be CSFB data for net wealth per adult. CSFB publishes two sets of data: mean and median net wealth per adult. Here is the data for the same set of countries as above.

The two data sets give a slightly different view. Looking at the mean net wealth, the bottom three countries in 2000, Finland, Greece and Portugal, are still the bottom three countries in 2019, though in slightly different order. The Netherlands was the wealthiest country in both 2000 and 2019. However, the top three in 2000 was also comprised by Italy and Belgium, while in 2019, they were replaced by France and Austria.

According to median net wealth, however, two things stand out. First, the Netherlands was top three in 2000 but last in 2019 (the data for the Netherlands does look strange; the median net wealth collapses after 2011; I wonder if it is a question of CSFB changing something in their model). Second, Italy was top in 2000 but right in the middle of the rankings in 2019.

The other striking takeaway is that whether we look at mean or median net wealth, Germany is not that rich at all: it is much closer to the bottom of both sets of data. What about the North vs South divide? Portugal and Greece do seem poor but Span and Italy are more often seen in the top half of the rankings than in the bottom.

Part of the confusion when it comes to classification between the ‘rich’ North and the ‘poor’ South comes from looking only at the asset side of household balance sheets. Using BIS data for household debt and World Bank population statistics we can also calculate household debt per capita for each of these countries. This is the ranking according to this measure (the lower debt per capita the better).

The Mediterranean countries are better off than the core and the north as they have much less household debt per capita. This might be almost counterintuitive: the more assets one has, the more liabilities, they might also have.

We can also cross check the CSFB data above by combining the GDP per capita and the household debt per capita data to arrive at an approximation of a net wealth per capita. As discussed, we have to bear in mind that GDP is a flow variable, while debt is a stock variable, so we are not comparing exactly apples to apples. Here is the ranking according to the difference between GDP and Debt per capita.

The Netherlands is bottom just like in the median net wealth data from CSFB. Portugal and Greece bring up the rear which is also consistent with previous findings. The top three are slightly different. Ireland is top here and was second in the median net wealth data from CSFB. But here Germany is third while it was more towards the bottom in the previous case.

And here is the ranking according to ratio of household debt to GDP to capita ratio.

The Netherlands is bottom again, with Portugal and Finland bringing up the rear, so, similar to the CSFB data. The top is a bit more mixed but Ireland still figures in both sets of data.

Bottom line is that there is a much less clear differentiation between the North and the South when it comes to net wealth per adult/capita than what we tend to assume.

How have some of the other major countries fared?

Mean wealth (top table below) in the US is almost twice as big as the average mean wealth of these European countries, but median US wealth (bottom table) is less than that respective average. Japan’s median wealth has barely risen from 2000 (at least compared to any of the other countries shown here) but it is almost twice as big as US’. The median Brit is richer than the average median European but only marginally so compared to the Spanish or Italian. Finally, despite its phenomenal growth since 2000, China is still twice less rich that Greece, which is the ‘poorest’ of the European countries above.

Will the US pull the plug on investing in China?


It has been going on now for a year, at least: after stopping Chinese companies on several occasions from buying specific US assets, the US administration has been also looking into banning outward US investments in Chinese assets.

The fund in the spotlight is the Federal Government Thrift Savings Plan Fund (TSPF) – the largest defined contribution plan in the world with assets of about $558Bn. The assets are split in five core funds and one additional overlapping fund as following:

Of those above, it is the I Fund that is now in the spotlight. For the moment, it has no exposure to China as it is invested in MSCI ex US EAFE.

TSPF is an outlier amongst most large retirement plans that it still has no EM exposure. In June 2017, external consultants, Aon Hewitt, made a recommendation to the board to switch to MSCI ex US All Country which is a much broader index followed by all large retirement plans. One characteristic of this index is that it includes many EMs (and yes China). The board studied the proposal and made the decision to switch in November 2017 with a target for that sometime in 2019*.

As the US-China trade war was going in full swing, the threats of possible ramifications on US investments in China started coming in, and the I Fund never made that switch.

How big is this potential US investment?

The MSCI ex US All Country is still about 75% developed markets (DM). But China is about 11% weight (second largest now), which is rather big given the recent index inclusion (the weightings have increased progressively in the last two years). That means the I Fund would have between $6Bn exposure to Chinese equities.

Adding the L Fund exposure. The L Fund will have 9% in the I Fund (from 8% currently). Therefore, given the AUMs in each above, it will have between $1-2Bn Chinese equities exposure. So, total TSPF exposure will be max $8Bn. Note, however, the L Fund’s expected exposure going forward: projections are for a substantial reduction in the G Fund weights at the expense of all others. So, potentially the future Chinese exposure can grow substantially as also China’s weight in the MSCI ex US All Country index also grows.

What is that in the context of the big flow picture?

China is in the cross hairs of deglobalization which started before the Covid crisis, but now, that process is accelerating in direct proportion to the anger towards China amongst some of the major global players, especially the USA. In the USA, globalization coincided with financialization which promoted major capital inflows to offset the trade account outflows. Financialization is now on the wane in the USA (as per the regulations post 2008, and accelerated further post the Covid crisis), while on the rise in China (see flows below).

As the Chinese economy has been catching up to the US (and possibly the Covid crisis also accelerated this process as well), it is likely that we may see a reversal of some of these past flows, namely, a reduction in China’s current account surplus at the expense of net foreign inflows.


  • Last year passive index inflows in China A shares were $14Bn; total inflows were about $34Bn
  • Total foreign investment in Chinese A shares is about $284bn
  • Foreign equity inflows this year are still a positive $5Bn despite the Covid crisis: according to HSBC data, March recorded an outflow (largest ever) but all other months were inflows, with April inflow more or less cancelling the March outflow.

Fixed Income

  • Total foreign holdings are also around $283Bn, 70% of which are in GGBs.
  • Inflows into GGBs have been consistently positive since the index inclusion announcements last year and the year before.
  • According to Barclays, YTD net Inflows are at $17Bn (5x more than at same time last year) despite a net outflow in March (but that was only because of selling in NCDs).
  • Average monthly inflows in Chinese FI is about twice that in equities.

Domestic Flows

  • March registered the largest domestic outflow ($35Bn) of any month since the 2016 CNY crisis (largely due to southbound stock connect flow (mainland residents bought the largest amount of HK stocks on record).
  • According to HSBC, FX settlement data shows that, most likely, domestic corporates have actually been net sellers of foreign currency in Q1 this year. 


While Chinese exports are expected to decline going forward, in the short term, so are imports, especially after the collapse in oil prices. However, it is inevitable that if globalization does indeed start reversing, China’s current account will shrink and possibly go into a deficit. 


What happens to the overall flow dynamics then, really depends on whether foreigners continue to invest in Chinese assets (and expecting that domestic residents might look to diversify their portfolios abroad once the capital account is fully liberalized, if ever). A potential ban on US Federal Government investments in China might indeed be driven by short-term considerations and emotions following the Covid-19 pandemic developments, however, unless it is followed by also a ban encompassing all US private investment, it is unlikely to amount to anything positive for the US. Moreover, it could actually give the wrong signal to foreign investments in the US, that the administration is becoming not so ‘friendly’. That could spur an outflow of foreign money from US assets, something that I discussed at length here.

*See the memo from that meeting here: https://www.frtib.gov/MeetingMinutes/2017/2017Nov.pdf

Beware of foreigners bearing gifts


There have been two dominant trends in the last four decades. The breakdown of the Bretton Woods Agreement in the early 1970s, the teachings of Milton Friedman, and the policies of Ronald Reagan, eventually ushered in the process of US financialization in the early 1980s. The burst of the Japan bubble in 1990, the Asian and EM financial crises of the mid-1990s, the dotcom bubble, and, finally, China’s entry into WTO in the early 2000s, brought in the era of globalization. This whole period has greatly benefited US, US financial assets and the US Dollar.

An unwind of these two trends of financialization and globalization is likely to have the opposite effect: causing US assets and the US dollar to underperform. From a pure flow perspective, going forward, foreigners are likely to invest less in the US, or may even start selling US assets outright. They are such a large player that their actions are bound to have a big effect on prices.  

Foreigners have played an increasingly bigger role in US financial markets. In terms of ownership of US financial assets, if they were an ‘entity’ on its own, they would be the second largest holder of US financial assets in the US, after US households.

Foreigners owned about 2% of all US financial assets between 1945 and the 1980s. That number doubled between 1980 and 1990 and then tripled between 1990 and 2019!

As of the end of 2019, there were a total of $271Tn US financial assets by market value. Non-financial entities owned the majority, $129Tn, followed by the financial sector, $108Tn, and foreigners $34Tn.

The financial crisis of 2008 ushered in a period of financial banking regulation (on the back of the US authorities’ bail-out), which has slowly started to dismantle some of the structures built in the previous period starting in the 1980s. The Covid-19 pandemic and the resulting government bailout of the whole US financial industry, this time, are likely to intensify this regulation and spread it more broadly across all financial entities. As a result of that, there have been already calls to rethink the concept of shareholders primacy which had been a bedrock of US capitalism since the 1980s.

In addition, the withdrawal of the UK from the EU in 2016, followed shortly by the start of a withdrawal of the US from global affairs with the election of Donald Trump, ushered in the beginning of the process of de-globalization. The US-China trade war gave a green light for many companies to start shifting global supply chains away from China. The Covid-19 pandemic intensified this process, but instead of seeking a new and more appropriate location, companies are now reconsidering whether it might make sense to onshore everything.

What we are seeing is the winding down of these two dominant trends of the last 40 years: financialization and globalization. The effects globally will be profound, but I believe US financial assets are the most at risk given that they benefited the most in the previous status quo.

De-financialization is likely to reduce shareholder pay-outs (both buybacks and dividends) which have been at the core of US equities returns over the years. The authorities are also likely to start looking into corporate tax havens as a source of government cash drain in light of ever-increasing deficits. As a result, and as I have written before, I expect US equities to have negative returns (as of end of 2019*) for the next 5 years at least.

De-globalization is likely to reduce the flow of US dollars globally. Foreigners will have fewer USD outright to invest in US assets. Those, which are in need to repay USD debt, may have to sell US assets to generate the USDs. Indeed, the USD may strengthen at first but as US assets start to under-perform, the selling by foreigners will gather speed causing both asset prices as well as the USD to weaken further.

For example, foreigners are the third largest player in US equities, owning more than $8Tn as of the end of 2019. See below table for some of the largest holders.

As a percentage of market value, foreigners’ holdings peaked in 2014, but they are still almost double the level of the early 1990s and more than triple the level of the early 1980s. Last year, foreigners sold the most equities ever. Incidentally, HHs which have been a consistent seller of equities in the past, but especially since 2008, bought the most ever. Pension Funds and Mutual Funds, though, continued selling.

Foreigners are the largest holder of US corporate bonds, owning almost $4Tn as of end of 2019, more than ¼ of the market.

As a percentage of market value, foreigners’ holdings peaked in 2017, but they are still more than double the level of the early 1990s and 8x the level of the early 1980s.

Foreigners are also the largest holders of USTs, owning almost $6.7Tn as of end of 2019, more than 40% of the overall market.

As a percentage of market value, foreigners’ holdings peaked in 2008, at 57%! At today’s level, they are still about double the levels of the early 1990s and early 1980s.

There is a big risk in all these markets if the trends of the last four decades start reversing. US authorities are very much aware of the large influence foreigners have in US markets. The Fed’s swap and repo lines are not extended abroad just for ‘charity’, but primarily to ‘protect’ US markets from forced foreign selling in case they cannot roll their USD funding.

The UST Treasury market seems to be the most at risk here given the mountain of supply coming this and next year (multiple times larger than the previous record supply in 2008 – but foreigners back then were on a buying spree). The risk is not that there won’t be buyers, eventually, of USTs as US private sector is running a surplus plus the Fed is buying by the boatload, but that the primary auctions may not run as smoothly.

It was for this reason, I believe, that the authorities exempted USTs from the SLR for large US banks at the beginning of April. If that were not done, PDs might have been totally overwhelmed at primary auctions given the increased supply size, the fact that the Fed can’t bid and if foreigners start take up less. It is not clear, still, even with the relaxed regulation, how the primary auctions will go this year. We have to wait and see.

*See ‘Stocks for the long-run: be prepared to wait’, at https://www.eri-c.com/news/380

**All data is from the Fed Flow of Funds data at https://www.federalreserve.gov/datadownload/Choose.aspx?rel=Z.1

Share buybacks and the economic cycle


This is my reading of an excellent paper by S&P Global, “Examining Share Repurchasing and the S&P Buyback Indices in the U.S. Market” by Liyu Zeng and Priscilla Luk, March 2020.

Over the past 20 years (up to end of 2019), the S&P 500 Buyback Index had outperformed the S&P 500 in 16 out of 20 years, or about 5.5% per year. YTD, it has underperformed, though, by about 14%! With that it, has managed to erase the last 10 years of outperformance! 

We had similar underperformance of the buyback index in the early stages of the last financial crisis, in 2007; while in 2009, the S&P 500 Buyback Index had a significant excess return. Make your own conclusions where we are in this cycle.

Reality is that “buybacks tend to follow the economic cycle with increased or decreased repurchase activities in up or down markets while dividend payouts are normally more stable over time, the S&P 500 Dividend Yield portfolio tends to outperform in down markets, while the S&P 500 Buyback Index may capture more upside momentum during bull markets.

Almost all of tech, financial sector and consumer discretionary companies engage in share buybacks. Less than 50% of utilities do (but they all pay dividends). As share buybacks tend to congregate in cyclical rather than defensive sectors, the buyback index tends to underperform during recessions (this year).

Since 1997, the total amount of buybacks has exceeded the cash dividends paid by U.S. firms. The proportion of dividend-paying companies decreased to 43% in 2018 from 78% in 1980, while the proportion of companies with share buybacks increased to 53% from 28%. 

Compare to other developed markets. Despite an increase of share repurchases in Europe and Asia, as a % of all companies, buybacks still stand at about half that in the US. On the other hand, fewer Canadian companies engaged in share buybacks during that period. 

For the S&P 500 Index, over the last 20 years, 2/3 of the total return has come from capital gains and only 1/3 from dividends. Before the mid-1980s, when buybacks became dominant, the opposite was true. Buybacks have been instrumental in driving equity returns since the mid-1980s.

What to expect from a potential 10-15 mbd OPEC++ cut



After yesterday President Trump tweeted about it, there is today continuous noise about a possible OPEC++ (global coalition of all crude oil producers) meeting next week with the expectations of substantial cut in production, anywhere between 10 to 15mbd. On one hand, if this materializes, it will be an unprecedented (not counting the 1970s oil embargos). On another, it will barely go to match the lost demand from the (almost) whole world going on economic standby for at least a month, maybe much longer on the back of COVID-19.

Let’s put this into context. We got a 25% decline in oil prices (from low 40s on WTI to low 30s) when Saudi Arabia and Russia (OPEC+) could not agree on a 1.5mbd cut a month ago, and Saudi instead announced they ‘might’ increase production by 1.5-2mbd (but as of yet they really haven’t). Arguably, if they had agreed on a cut, oil prices may have rallied a bit, maybe to mid or high 40s.

But then we got another 30% decline (from low 30s to low 20s) when the negative effect of COVID-19 on demand became more evident. In an alternative reality if OPEC+ deal had happened a month ago, prices could have then collapsed to the low to mid 30s (30% off mid to high 40s). Don’t forget that oil had already sold off about 30% YTD at the time of pre-OPEC+ no-deal weekend. These are the milestones to keep in mind when considering the scenarios ahead of a possible crude production cut in the next few days. 

So, this is the way I am looking at this:

  1. The likelihood of ‘everyone’ (not just Saudi and Russia, but OPEC++) really agreeing on a 10-15mbd cut is very close to nil;
  2. But the likelihood of a ‘fudge’ agreement is very high.

‘Everyone’ benefits from a ‘deal’, even the oil importers as crude has become the main sentiment indicator and that would help risk assets: OPEC++ could decide to announce a ‘deal’ simply to stabilize the market with the idea that no one is expected to really cut production (perhaps negative effects of COVID-19 eventually wear off and demands comes back0.

Reality is that, in a similar manner to Saudi Arabia not really ‘wanting’, or, arguably, even being unable to hike production by 2mbd (they have never really managed to sustain production above 12mbd), no one really intends to, or is willing to go the other way (cutting production may actually entail lost capacity for ever). So, in both cases, everybody is playing the waiting game and hopes to do nothing. But the trick is in delivering the right message.

But what could happen to crude prices if there is an announcement of a 10-15mbd cut?

One would expect that the low range point of a bounce would be the low-to-mid 30s on WTI (where prices would have been, had a cut happened between Russia and Saudi Arabia a month ago, and the demand lost we can project at the moment from COVID-19). We are just above 30 on WTI as of right now, on Friday close. But given the much larger cuts this time, the high point of the range could indeed be the low 40s where prices were before the Russia – Saudi deal fiasco.

What happens if there is not even a ‘fudge deal’ in the coming few days? We go back to the low 20s immediately and then we wait to see how much more demand is destroyed.

Dollar shortage vs. dollar funding stress

I think we should distinguish between dollar shortage and dollar funding stress. We have a lot of the latter and much less of the former compared to any previous crisis.

‘Dollar shortage’ is your classical EM currency crisis stemming from a balance sheet currency mismatch: borrow in dollars to fund a non-dollar asset. Cue Mexico’94, Asia’97, Russia’98, Brazil’99, Turkey’01, Argentina’01. There are fewer of them nowadays.

A ‘dollar funding stress’ stems from borrowing in dollars to fund a dollar asset – that’s the problem today (see for ex. Z. Pozsar’s latest). It feels like the old EM currency crises because a lot of dollar assets are owned by foreigners but it is very different at the same time as there are no balance sheet currency mismatches.

That distinction is important because the market is treating it as if it is a dollar shortage crisis while it is a classic ‘Mark-to-market (MTM)’ crisis. If the dollars were borrowed through the swap market, refinancing would widen the basis and move the currency. If the borrowing was in the loan/bond market, it would be a credit story, not a currency story.

There is also a break even price for dollar funding above which foreigners would choose to sell the dollar asset and repay the loan, rather than continue to finance it (probably they will have to top up if the MTM has moved too much from where they bought it). All this is a very different situation from a dollar shortage crisis whereby they would need to sell a local currency asset and actually convert proceeds into dollars.

The Fed is well aware of all this and has acted very swiftly to respond to the recent strengthening of the dollar by improving massively the terms of the five existing central bank swap lines and by adding today nine more to the frame. The extraordinary moves in some DM currencies, notably NOK and AUD, has also prompted the respective central banks to verbally intervene (Norges) or ‘not to rule out’ intervention (RBA).

Some people have mentioned to me that a new Plaza Accord is needed. I am not so sure. In my opinion, it would be counterproductive. From a behavioral point of view, a weak dollar is not necessarily beneficial for US assets given that a big chunk of them is owned by foreigners. Just like a worsening of the dollar funding terms may push these people to sell, so could an attempt to substantially weaken the dollar. We shouldn’t forget a small but very much overlooked fact of the 1987 stock market crash: on the weekend before Black Monday, the US Treasury Secretary threatened to devalue the dollar.

Bottom line is that a dollar funding crisis should have a much smaller effect on weakening the local currency than a dollar shortage crisis. The market does not need a dollar devaluation, rather a stable dollar. Policy makers should make sure foreign dollar funding does not blow up. And finally, market pundits should be careful exaggerating the dollar shortage issue.

Fed’s crisis response may endanger the dollar



The response from the two most powerful central banks could not have been more different. ECB is innovative, using fine tuning and precision in tiered rates and targeted lending; Fed is still throwing the kitchen sink at the market by flooding the banking system with liquidity.

ECB is also going more direct partially because the banking system there is in shatters, but also because it makes sense regardless. Plus, the ECB is already taking credit risk by buying corporate bonds. Surely, the next step is literally direct credit lending and massively expanding the ECB counterparty list.

Fed is still stuck in the old model of credit transmission, entirely relying on the banking system. That model died in 2008, in fact, even before that, in the early 2000s, as the first Basel rules came into effect and the shadow banking system flourished.

Post 2008 it became much more common for financial institutions, like PE etc. to get in the credit loan business. Needless to say, this carries a big risk given that they don’t have access to Fed’s balance sheet like the banks.

The US banking system is now flooded with liquidity. If the new repo auctions are fully subscribed, this will double banks’ reserve balances and will bring them to the peak post the 2008 crisis. But do banks need that liquidity?  It does not seem so: the first $500Bn repo auction yesterday had just $78Bn of demand. But that liquidity from the Fed is there on demand, plus the central banks swaps lines are open, and as of March 12, none has been drawn. And finally, the foreign reverse repos pool balance at the Fed has not shown any unusual activity (no drawdowns). All this is indicating that USD liquidity is at the moment sufficient, if not superfluous, so, it should have a negative effect on USD, given long USD has been a popular position post 2008.

All this liquidity, however, may still do nothing to stocks, as seen by their performance into the close yesterday, because balance sheet constraints prevent banks from channelling that liquidity further into the US economy where it is surely needed. From one hand, the Fed is really pushing on a string when it comes to domestic dollar liquidity, but, on the other, it is providing more than plenty abroad. 

Risky assets are still a sell on any bounce, and the USD is probably a sell as well, as the Fed will be forced to keep cutting but it is now running a risk of foreign money exiting long established overweight positions in US assets. 

Keep Calm and Stay at Home


China went through three main changes to stem the spread of the Coronavirus:

  • Quarantine
  • Lockdown
  • Rationing

In the ‘West’, we’ve added ‘Self-quarantine’ first, in some countries. Others are in the delusional phase of ‘Delay’, because, apparently, they are worried that ‘people will get bored and break out of self-isolation if it last too long’. In fairness, there is a logical reason to delay because as China and Italy will find out, the economic costs of going through those stages above are enormous. That reason is that scientists could be able to find vaccine in time. That is a very dangerous bet for the infections grow exponentially, and if a vaccine does not come soon enough, the health care system of the country will be overwhelmed (and no, the coming warm weather in the Northern Hemisphere is unlikely to slow down the infections, like in the normal flu, because this is not the normal flu, and infections have shown to grow also in hot weather like Singapore or Iran). Then, not only the economic costs but also the societal costs will be unspeakable.

Finally, one other country’s leader still thinks this virus could be ‘fake’…

WHO went on a fact-finding mission to China and released a report on February 28. The report is unequivocal:

“China’s bold approach to contain the rapid spread of this new respiratory pathogen has changed the course of a rapidly escalating and deadly epidemic.”

There are also stories about two different strains of the virus, apparently stemming from the desire to explain higher number of infections/deaths in some countries and lower in others. I don’t know. To me this is simply a function of testing more people and proper reporting. It also makes sense to run with that story in countries which have chosen to be in the ‘Delay’ stage. Occam’s razor: even if there were two strains, I don’t see how they can be country-specific.

“Everywhere you went, anyone you spoke to, there was a sense of responsibility and collective action, and there’s war footing to get things done”

~Bruce Aylward, the epidemiologist who led the WHO mission to China 

There is no doubt that even in the best cases in the ‘West’, the ones which added ‘Self-quarantine’, it will take longer to get through this also because of culture, different societal structure and more liberal thinking. For example, the talk in Italy is that if things don’t start improving in a couple of weeks the country might have to go to the next stage, ‘Rationing’ (only one person per household can leave the house to replenish supplies).

After decades of general peace, no major natural disasters in the ‘West’, and used to thinking only in financial terms, we cannot comprehend what is happening to us and are unable to quickly make the right decision how to proceed forward. For almost everybody, understandably, limiting our movement is at minimum uncomfortable and for a lot of people, unacceptable. To go through rationing is unimaginable (even though for some of us, who grew up behind the Iron Curtain, this was a feature of daily life). But seriously, it’s not like we have been asked to go to war, like our grandparents; we are just told to sit on the couch at home and play video games!

It can’t be that bad, can it?

Oil: OPEC’s Russian Roulette



I did not expect the ‘no deal’ from OPEC+ largely because of the urgency of the immediate demand destruction from the Coronavirus.

In hindsight, Russia’s reaction was quite rational. What about the Saudis?While they are still the lowest cost producer, the precariousness of the political situation there (see developments this weekend) makes me believe that they have a lot more to lose from the current status quo. Russia may be at a disadvantage when it comes to cost, but after years of sanctions, it is more prepared to withstand lower prices for longer.

As a result, I see Saudis’ attempt to lower prices on their products as a ‘bluff’, which, if called, they will have to fold. On the long run, lowering prices can only be counterproductive for them. First of all, it will affect their fiscal balance. Second, it will reinforce Russia’s (supposed) game plan (to push US shale out of the game) and hurt US, a Saudi ally. Therefore, this is at best an attempt to gain marginal market share; it would be extremely imprudent to begin a price war.

While indeed Trump has been very vocal on the benefit of low oil prices to US consumers, the sands started shifting in 2019 as the US became a net exporter of petroleum towards the end of the year: all of a sudden, Trump started extolling US energy independence. Would the US president be eager to keep a campaign promise to end US reliance on foreign energy? If so, he would now need to balance low oil prices with the risk of the US shale oil industry going bust. Therefore, I would not be surprised if the Saudis get a call from the White House should oil prices continue to plunge and that threatens the viability of US energy production.

I think the short-term market reaction this week will be brutal, but this is very different from 2014-2016 when we had similar producers’ dynamics and oil hit $30. First, inventory build-up back then was +230mbd, today it is -1.5mbd. Second, shale was in the upswing then, while now it is on the backfoot: oil-well declines are much bigger, costs are higher, and capital is scarcer. 

I was bullish WTI at $45 last weekend partially because I expected the markets to bounce on sentiment, which they did, but more importantly, because the price reflected a demand-supply imbalance discounting a sharp drop in demand from the Coronavirus effect – there was, I thought, a decent cushion. Moreover, it is my view that either China will use the oil price drop to simply buy more oil, or that economic activity in China, being the marginal swing buyer of oil, will slowly come back – or rather much faster than in the West thanks to the actions the authorities there took to contain the outbreak.

Oil eventually hit $30 in 2016 but did not stay there long. It is much more difficult to model today the demand destruction from the Coronavirus but also there should be some marginal energy demand coming from the digital medium as all these people staying/working from home get online (ICT energy use is now more than half travel energy use, and it is growing very fast). Supply side is always easier to model, and it shows that compared to 2014, inventories are much lower, shale is largely out, and specs are short.

We should not underestimate that lack of liquidity/margin calls work both ways depending on positioning (as per gold sell-off a week ago) That means one needs to watch the newswires and trade rather than invest. That’s what I am doing.

Toto, I’ve a feeling we’re not in Kansas anymore


This worked out quite well. Too well given the G7 “strong and coordinated response”. Let’s not kid ourselves, unless they can build a hospital in six days, this is going to be highly inadequate.

As if rates going negative was not enough of a wake-up call that what we are dealing with is something else, something which no one alive has experienced: a build-up of private debt and inequality of extraordinary proportions which completely clogs the monetary transmission as well as the income generation mechanism. And no, classical fiscal policy is not going to be a solution either – as if years of Japan trying and failing was not obvious enough either.

But the most pathetic thing is that we are now going to fight a pandemic virus with the same tools which have so far totally failed to revive our economies. If the latter was indeed a failure, this virus episode is going to be a fiasco. If no growth could be ‘forgiven’, ‘dead bodies’ borders on criminal.

Here is why. The narrative that we are soon going to reach a peak in infections in the West following a similar pattern in China is based on the wrong interpretation of the data, and if we do not change our attitude, the virus will overwhelm us. China managed to contain the infectious spread precisely and exclusively because of the hyper-restrictive measures that were applied there. Not because of the (warm) weather, and not because of any intrinsic features of the virus itself, and not because it provided any extraordinary liquidity (it did not), and not because it cut rates (it actually did, but only by 10bps). In short, the R0 in China was dragged down by force. Only Italy in the West is actually taking such draconian measures to fight the virus.

Any comparisons to any other known viruses, present or past, is futile. We simply don’t know. What if we loosen the measures (watch out China here) and the R0 jumps back up? Until we have a vaccine or at least we get the number of infected people below some kind of threshold, anything is possible. So, don’t be fooled by the complacency of the 0.00whatever number of ‘deaths to infected’. It does not matter because the number you need to be worried about is the hospital beds per population: look at those numbers in US/UK (around 3 per 1,000 people), and compare to Japan/Korea (around 12 per 1,000 people). What happens if the infection rate speeds up and the hospitalization rate jumps up? Our health system will collapse.

UK released its Coronavirus action plan today. It’s a grim reading. Widespread transmission, which is highly likely, could take two or three months to peak. Up to one fifth of the workforce could be off work at the same time. These are not just numbers pulled out of a hat but based on actual math because scientist can monitor these things just as they can monitor the weather (and they have become quite good at the latter). And here, again, China is ahead of us because it already has at its disposal a vast reservoir of all kinds of public data, available for immediate analysis and to people in power who can make decisions and act fast, vert fast. Compare to the situation in the West where data is mostly scattered and in private companies’ hands. US seems to be the most vulnerable country in the West, not just because of its questionable leadership in general and Trump’s chaotic response to the virus so far, but also because of its public health system set-up, limiting testing and treating of patients.

Which really brings me to the issue at hand when it comes to the reaction in the markets.

The Coronavirus only reinforces what is primarily shaping to be a US equity crisis, at its worst, because of the forces (high valuation, passive, ETF, short vol., etc.) which were in place even before. This is unlikely to morph into a credit crisis because of policy support. 

Therefore, if you have to place your bet on a short, it would be equities over credit. My point is not that credit will be immune but that if the crisis evolves further, it will be more like dotcom than GFC. Credit and equity crises follow each other: dotcom was preceded by S&L and followed by GFC.

And from an economics standpoint, the corona virus is, equally, only reinforcing the de-globalization trend which, one could say, started with the decision to brexit in 2016. The two decades of globalization, beginning with China’s WTO acceptance in 2001, were beneficial to the USD especially against EM, and US equities overall. Ironically, globalization has not been that kind to commodity prices partially because of the strong dollar post 2008, but also because of the strong disinflationary trend which has persisted throughout.

So, if all this is about to reverse and the Coronavirus was just the feather that finally broke globalization’s back, then it stands to reason to bet on the next cycle being the opposite of what we had so far: weaker USD, higher inflation, higher commodities, US equities underperformance.

That’s my playbook.