TLT - Falling Inflation Dollar Dominance And PBOC Moves With Marc Chandler

2023-07-06 08:00:00 ET

Summary

• Marc Chandler and James Foord discuss international markets, economies and currencies.
• Has the Fed conquered inflation?
• China's economy and global liquidity.
• Marc's outlook on the US dollar.

Listen to the podcast below or on the go via Apple Podcasts or Spotify .

• 1:00 - What's coming from next Fed meeting?
• 4:50 - Has the Fed conquered inflation?
• 16:20 - China's economy and global liquidity
• 22:00 - Marc's outlook on the US dollar
• 28:50 - Is gold a viable alternative to USD?

Full episode originally published June 20, 2023 on The Pragmatic Investor .

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Transcript

James Foord: Today, I had the pleasure of speaking to Marc Chandler , the Chief Market Strategist at Bannockburn Global Forex. He is also a fellow SA contributor and today, we had a great conversation about the macro outlook for the U.S. economy, the outlook for Fed policy in the future, what this means for stocks, the U.S. dollar, the growing trend of de-dollarization, Marc’s thoughts on China, and why now is such a great time to invest in international stocks.

Alright, Marc. Welcome to the show. I thought a good place to start today would be reviewing one of your last articles on Seeking Alpha. I'm looking at here, Fed Day: Skip = Hawkish Pause, But Market Says Finito . However, if you look at the statistics for the next meeting, there seems to be a consensus about 50%, I believe, of the Fed actually raising.

So what are your thoughts on that? Do you think that’s what's coming then? A pause and then a raise?

Marc Chandler: Well, I'm not so sure. I mean, so what I've done is, I look at -- so we're looking at the Fed funds futures strip, and I'm looking at the January contract. And the reason I look at the January contract is because the December contract because of the year -- because of a couple of things.

One, you have to keep in mind that the contract settles not at the target rate, but at the effective average rate of the Fed funds. So, they're taking a weighted average of the cash transaction of Fed funds market. And so that's where it settles at. And since the Fed hiked rates in May, the average effective Fed funds rate has been 5.08%.

And when I look at where the market says, look at the January contract, the market right now, as we speak here, is at 5.12%. And so that tells me that it's only 4 basis points on top of the current rate. And so to me that's a very small chance of a hike being priced in.

But you could have – and some people have suggested a push back and they say, no, what I'm missing is the federal hike rates, in July, perhaps, and then cut them before the end of the year. So we're back where we are now. And I think while it's possible, I think it's highly improbable. The Federal Reserve would be raising rates and then cutting them. I think it presupposes some kind of shock. And of course, you know, and what we do, it's next to impossible to forecast the shock. I mean, the shock by definition is a surprise.

And so, while it's possible that the Fed will raise rates in July and then cut them before the end of the year, I think it's more likely that by the time we get to that July meeting, which takes place late in the month, we'll see CPI fall further.

Remember what happened last June, the CPI rose by 1.2%. This will drop out of the 12 months comparison, be replaced by something much lower, say 0.2, maybe even 0.3. That'll bring the rate down, the headline year-over-year rate down to something close to say 3.2% to 3.3%.

So in addition to the low inflation by the time the Fed meets again, at the end of July I think we're going to have some weaker economic data. I think the U.S. economy is peaking now, here in Q2, around 2% growth, give or take a little bit.

And that in the second half of the year, some of the tightening forces, whether it’s student loans having to be paid back for the first time in several years, whether it’s the tightening of fiscal policy as the price for the debt ceiling drama to end, whether it's just these continuation of some of these drags from – whether it’s from bank lending, tighter lending conditions, whether it's the contraction in money supply M2, whether it's the collapse and the leading economic indicators, will get next week again. And if you look at the six-month pace there, and we're at a pace that we've only seen during recession.

So, I'm looking at the economy almost be an inverse of last year. Remember what happened last year? Economy contracted the first half of the year, grew in the second half. Now, I'm suggesting they're going to grow here in the first half of the year, if probably the – if that cake is baked. But I'm looking at a weaker economy. So by the time the Fed meets in July, it is hard for me to see how they resume with falling inflation and weaker growth.

JF: Right. Yeah. Absolutely. It seems like a lot of what's driving the narrative today is of course that disinflation, right? So that inflation level coming down. At the same time, you're talking about the strength of the U.S. economy. So, would you say that maybe we're entering a period that the market would be quite favorable about, which is that lowering inflation together with the slightly weakening economic data probably pushing the Fed to cut.

So first of all, what is your outlook on inflation? Do you think that the Fed has conquered inflation?

MC: Yes. So, inflation, I think it's a tough thing, partly because there's so many ways to slice and dice the data. What I have found most helpful is to look at what we’re doing at an annualized pace. So where are we at an annualized pace? And in fact, in the first five months of this year, the CPI has risen faster than it did in the second half of last year.

JF: Right.

MC: So, I think that's a concern. So, I guess if I had -- if you told me, like, you nominated me to be at the Federal Reserve for today's meeting. I'd probably be inclined to hike partly because I think that inflation -- I think that the way the Fed is thinking about it is, I think they recognize that they were behind the curve to take their foot off the gas by the QE and a little bit slow out of the box to raise interest rates. I think that the Fed thinks that inflation credentials have been scarred, or scratched, or deteriorated a little bit. And I think the economy has proven more resilient than the Fed has thought. And so I would be more inclined to raise rates, thinking that I'm done with today's fight.

But I don't -- I think that the Federal Reserve is still like wrestling with this. And so, I don't think inflation is conquered, but I do think that inflation in the second half of the year is going to be a bit tougher for this base effect because of inflation so low, below 3% in the second half of last year, I think that when we look at the base effect for the second half of this year, it's going to be harder comparison. And so I think the most of the decline in inflation might be behind us.

Getting it to come down from like 8%, to say what I think is going to be 3% or so, when we get this June print, that's one thing. But to get it to the 2% target is a bit different. And here's what I'm going to be watching with those dot plots from the Fed, is when you look at what they forecast in March, they still have inflation above their target next year.

But they have signaled by looking at their median forecast, they've signaled more than one cut next year. And so, I think when we talk about the market pricing in a cut, I don't think that this year is very likely, but I think a cut next year is very likely.

JF: Now when people think about the Fed cutting, that is usually an anticipation of weaker data or recession. This is something that has been talked a lot about. I think, as you said, we've had a bit of a surprise towards the beginning of this year with growth being a bit more robust. How do you feel about the timeline for that recession, soft versus hard landing? Where do you fall on that debate?

MC: Yeah. It's funny. I even thought that we would have a recession by now. I thought that, so the first two quarters of last year contracted, two quarters back to back. But it turned out to be a bit of a statistical fluke, having to do with the trade and inventory management. Economists typically don't admit they're wrong. At least not the economists I know.

What they typically do is, they just keep pushing out their forecasts. And so the recession from 2022, now it’s down likely second half of 2023, or into 2024. I think what's hard about forecasting a recession right now despite all these economic indicators pointing to weakness, despite the strength of the labor market, I'm concerned that next year, as you know, is a presidential election year.

JF: Right.

MC: And typically, that is not when the U.S. has a recession. That is to say that efforts are done to prevent that from happening. And so slow growth is one thing, a recession a different story. And I think that there's some favorable developments. I mean, besides the strength of the labor market, I think that the easing of supply chains. So far, the drop in oil prices, drop in commodity prices in general, I think that all generally like are helping to promote even if it's weak growth.

I think you raised an important point too. I think what’s like the outlook going to be? So, to me, what’s happened is, it's like the U.S. economy is a snake. And it ate a doe. And that is the shock that we've had. Whether it is the lockdowns related to COVID, whether it’s the uneven re-openings, Russia's invasion of Ukraine, the Chinese economy, all posing shocks, we got weather shocks as well with these Canadian fires, low water in the Panama Canal. So, as the U.S. economy, the snake absorbs these shocks, eating that baby doe it takes a while to like, work its way through the system.

And I suspect that on the other side of this, we're going to return to what we call the great moderation. Before the great financial crisis, we had a long period of slow growth, low inflation. And I think that that is, to me that the most likely scenario is return to slow growth, low inflation, low interest rates. Even though I know many people disagree with me.

They think that we've broken into this new higher inflation world, whether it's because of the end of globalization, whether it's because of various reasons they've come up with why we're going to be in this quasi-permanent higher inflation paradigm. And I think that – I think while it's possible, I still think that's more likely that we go back to the forces that were dominating before these shocks, that produces low growth, low interest rates, low inflation.

JF: Kind of comparable to that Japan kind of period of deflation, right? That Japanification of the U.S. economy, you might call it?

MC: Yeah. I mean I think people talk about that. The Japanification of the U.S. I think if there's any country that's experiencing the Japanification right now, probably China, in a sense that consumers seem to be more interested in reducing their debt.

JF: Right.

MC: …and boosting consumption. And here in the United States, we still see – as I was teasing before about how in the U.S., it's really about OPM. You think about the success of credit cards versus debit cards. You think about this, you know, China has this social scoring. And in the U.S., what do people talk about? Credit scoring.

And I think that really illustrates the difference. So I think the U.S. is still caught up in I mean, you’ve seen this with the expanding consumer credit numbers. So I'm not sure that -- to me, the U.S. consumer is still alive, still well positioned, and that's really why we're not going to have a recession. Job growth, means income growth. Rising stock market means wealth income, wealth effect. All these things help underpin consumption.

JF: Yeah. It's very interesting. I was actually looking at some headlines the other day. I believe, it was credit card debts in the U.S. crossing that $1 trillion mark. So, we have the Fed pause coming up probably. On the other hand, I've also heard a lot of people talk about the idea of that liquidity being drawn out of the market due to the debt ceiling, right, because the debt ceiling was reached, the government is now going to refill that TGA, the Treasury General Account, kind of draining liquidity out. How do you see the outlook for stocks and equities in the light of those two events?

MC: Yeah, Just an amazing story. People talk about American exceptionalism. And I don't know any other country that could go through this debt, authorized spending and then not having congressional approval to pay for it. What a bizarre set of circumstances. And despite how bizarre it is, and despite Fitch putting the U.S. on credit watch for a possible downgrade of it, I think that we should expect this to happen again.

Partly I think that, yes, it's kind of bizarre thing, because in Europe, for example, or Japan, and the parliamentary system, this would seem to be almost impossible to happen. But the U.S. presidential system where the party in the executive branch, doesn’t necessarily have a majority or have control of the legislative branch to produce these kind of weird outcomes.

At the same time, I think both political parties have used the debt ceiling debate to try to exact concessions from the other party. And so neither party, I think really want to give it up even though it seems to me to be a dangerous game that the U.S. loses. I think it sort of mars our credibility on the world stage, when we have to get so close to this brinkmanship tactics. But you raised an important point and that is sort of what is going on with liquidity.

And we know that the Federal Reserve is engaged in quantitative tightening with letting the balance sheet shrink. Your point about the debt ceiling as the resolution, a flood of T-Bills hitting the market already. Now between last week and this week, I think something like $750 billion worth of bills and coupons have hit the market.

And the question really is, how are these paid for? If these are going to be paid out of bank's deposits, banks reserves, you get a tightening of liquidity conditions. But if it's going to be partly paid out of foreigners buying U.S. assets, then it's going to be paid partly by deposits coming back into the banks, that the squeeze on funding maybe a little bit less, especially if we see the reverse repo facility where a lot of money is parked.

So it's still not clear to me, but I think, to me the interesting development is that despite this, despite the rise in the U.S. two-year yield, the bill supply, which have all been fairly well received so far. Despite all this, the stock market now, the U.S. stocks are at 20% or so off their lows. The European stock market is near its highs for the year. The DAX is near their multiyear highs.

The Japanese stock market has also done incredibly well. I think this might be we might be at the highest since the early 90s or so. So broadly speaking, I think the idea is that whether the Fed goes July, whether ECB goes in July, or maybe later this year, whether the Bank of England still looks like it's got more wood to chop, yet the market suspects that the central banks are done or nearly done - - so they will be done, say, or just about done by the end of Q3.

And I think the market, this is where things - you think about, conceding of that swing toto market. It's that anticipatory mechanism like discounting future events, future probabilities and the market I think is looking past towards 25 basis points, even 50 basis points in the big scheme of things. And the market I think is looking past that. And I think that's why I think we’re seeing equities rallied so much in the face of rising interest rates, inflation, and the fact that central banks aren't quite done yet.

JF: Yeah. Absolutely. Like you said, the market is obviously forward-looking, it knows what is going to happen. And in that regard, I also wanted to talk about the recent news we got about China, basically, starting to ease conditions. I believe there was some news coming out from the PBOC saying they would be lowering the benchmark rates, and of course adding to that global liquidity. What are your thoughts on that?

MC: Yes. So you're right. I think the Chinese economy is recovering from the zero-COVID policies, they were locked out. They really disrupted the -- not only their economy, but because of their importance to the trading partner, it disrupted many other economies. So my sense is that the Chinese economy is well on track to reach its 5% target.

Most recently though, concern – and here's we can only see from their action. It's hard to understand what's going on in their heads. So we can only look at actions. And what they did a couple weeks ago is they -- the PBOC convinced the large banks in China to cut the deposit rates.

Then earlier this week, the PBOC cut its 7 day repo rate and the market is looking for a cut in the medium, one-year benchmark rate, which will set up for a cut next week in the loan prime rates. So monetary easing, at least to some accommodation - we're talking about small move though.

We talk about the Fed raising interest rates, the other central banks, they were doing 75 basis points a clip last year. Some still doing 50 basis points a clip. In fact, many people expect the Bank of England after this recent strong employment data, strong wage data, strong inflation data, and possibly raise rates 50 basis points next week.

When the PBOC – when China moves, we're talking about 10 basis points. So it's hard to get too excited about it. I think it's more of a signaling device. And the thing too I think with China is, people have really avoided I think on valuation grounds, relative performance, people are not being big buyers of Chinese bonds or Chinese stocks this year.

And I think that's going to end. I think that money's going to come back into China. And not for political reasons, but just on valuation grounds. Here is a country, perhaps the large economies, the only one really providing new stimulus. And I think that if you told me that here's a bunch of countries, these are countries that are tightening monetary policy or fiscal policy, and here's one large country that's easing monetary policy, possibly going to ease some fiscal support as well, I’d say, maybe I want to buy that equity market.

But I do think that particularly with China, I think where my views differ from sort of the consensus on China is, I don't see the U.S. trade deficit with China, which isn't falling, and especially for low priced goods.

Now, I don't see the rise of China, meaning the U.S. is any poorer. I think it does impact U.S. trade balances though the kind of -- most has bypassed us. And I would think that, earlier in my career, some of the same arguments that people are using about China will apply to Japan.

And especially in the auto market. China has surpassed Japan this year to be the world's largest exporter of autos. And some of the same complaints, earlier in my career, there was a U.S. congressman from Missouri who ran for President, to the sledgehammer, the imported cars.

We, that is the U.S., but also to some extent, Europe, pressured Japan to let the currency appreciate. It ultimately solved the problem. Tomorrow and the day before the BOJ meeting, they're going to release their trade figures. And I don't think that Japan has reported a trade surplus in well more than a year.

So even though Japan – we thought, we in the U.S. thought that Japan's trade surplus was the reflection of the U.S. trade deficit and our problems would be solved if Japan would stop doing that. What Japan does now is they build cars, build products in the U.S., sell them in the U.S. They are trade surplus and got even with trade deficit, and yet the U.S. still has a trade deficit. But I suspect that the U.S. trade deficit with China will fall because of protectionism, tariffs, and whatnot. And instead, the U.S. trade deficit with countries like Vietnam and Malaysia will go up. This is…

JF: Right.

MC: …I think the U.S. -- out of all the U.S. policies, leaving aside, I mean, the foreign policies, now the U.S. trade policy seems to be the most, like inappropriate, the most bizarre. this whack a mole. Pick out a country that's running a trade surplus with the U.S., and get it to raise its currency or open up its markets and that didn’t make the U.S. trade balance go away.

JF: Right. Yeah. Definitely it makes a lot of sense. I find myself agreeing with the idea of perhaps China being an opportunity now. I wanted to talk a little bit about currencies as well because I know that's also one of your area of expertise.

Now, a few weeks ago, there was quite a popular interview going out as I don't know if you know Stanley Druckenmiller, the investor. There was an interview going out...

MC: I’ve heard of him.

JF: Yeah. So he was basically saying that he wasn't sure about anything. The only thing he was kind of sure about was kind of shorting the U.S. dollar or the idea that the U.S. dollar would go down now. We haven't quite seen that happen in the last few months at least. What are your thoughts on the U.S. dollar? What is your outlook there?

MC: Yeah. So I would draw a distinction between -- so the Druckenmiller idea that there's a trade to be made. There's money to be made by shorting the dollar. And then there seems to be another crowd of people who say that the dollar is lost, the dollar is in this -- that's going to be replaced by, whether it's China or a multiple currencies, like a multipolar world. In my career, which now goes back to -- I'm embarrassed to say, but back to the Plaza Agreement back in 1985, September of 1985, the dollar was very strong. The central bank's met at the Plaza Hotel which is now condominiums in New York and agreed to drive the dollar down.

And ever since then, I think people have been saying that the dollar was going to follow the historical path of other reserve currencies like Sterling, and lose its role in the world economy. And I think that was – it’s another one of these things that are possible, but still seems to me to be improbable. Partly, it seems that I've drawn distinction with the dollar between its use as a transactional vehicle.

So when Australia sells China iron ore, it'll be invoiced in U.S. dollars, priced in U.S. dollars. That could change. The dollar as a transactional vehicle, and then the dollar as a store of value. And I think the key to the dollar's long run sort of role in the world economy comes from its store of value. Naturally, it's use as a transactional vehicle.

And so to me -- and this is why I would look at the IMF's COFER, C-O-F-E-R, it's the most authoritative source of data about reserves, about the reserve allocation. And I know people look at it and say, the dollars role is declining. It matters, of course, where you begin it from.

Many people now are taking its peak which takes place around the time that there's conversion from -- to adoption of the single currency and the euro. And because of the mathematics of it, those deutschmarks, for example, they were at the Bank of France would no longer count as reserves. So all of a sudden, with the advent of the euro, the dollar share reserves jumped. I think there's an artificial number, something on the low 70%.

Today it’s probably a little bit below 60%. It's been fairly stable there. And so what's going to happen? I think that the dollar's role, I sort of think that the dollar, it would break into two blocks. It’s probably easier to conceive to the world if there’s two blocks. And within the dollar block, we'll have some junior partners like the euro, Aussie, or Canada, or Sterling, Swiss franc. These currencies will help - they are reserve currencies now. We already have a multipolar reserve currency system. The dollar just is the biggest share.

I think in the dollar block, those currencies will have a role to play. I think that there's another blocks forming, but it's not a block that is forming not because of the U.S. trade policies, its sanctions, dislike the U.S. fiscal policy. Rather than quitting the dollar zone, this other block was fired from it. And by that I mean, Russia, Iran, to some extent Venezuela, North Korea. And China, I think, is seizing the opportunity to internationalize the RMB.

But within that so you got the dollar block and so you got this RMB block. And within that RMB block, I don't think that the other currencies North Korea, Iran, Venezuela, and Russia, they really offer any of the, this sort of functionality of China. So, I think that while the dollar block will have these multiple currencies, like we already see with the euro and the Swiss franc or Canada, Aussie, the RMB block will really be dominated by just the sheer size of China and not having like junior partners. Within that in fact, you know, when Russia first invaded Ukraine, I thought that China was one of the big losers, of course besides Ukraine and the human tragedy there.

I thought China would be one of the big losers because NATO would be bigger. In fact, there's some talk of that this next NATO meeting not only will Japan attend, but NATO is opening an office in Japan. I thought that China would also be a loser from the Russian invasion because both Australia, South Korea, and Japan recognize the similarity between Taiwan and Ukraine. And so they are bolstering their own defense spending. So there's -- and so with China's gun in effect, one of the sort of Sun Tzu's principles is, don't allow your adversaries to come together.

The U.S. has done that allowing Russia and China to come together. But China's allowed South Korea and Japan to come together in a way that for obvious historical reasons, always see tense relationship. And so -- but I think that China has sort of taken the lemons and making lemonade with that. I think that they are able to dominate the partnership with Russia in a way that Beijing couldn’t have even dreamed about a few years ago.

And so I think that China recognizes the role for the RMB partly to help supplement the dollar's role. We see this in some emerging market countries too, for example, Pakistan, which is in serious financial straits has used its swap lines with China to raise the RMB to buy Russian oil.

Argentina, another distressed country, used its swap lines with China to take the RMB, and what did it do with the RMB? They bought Chinese goods. It’s almost like producer financed. So, I could see a role for China and partly sort of like, you know, that in the US, we have this Christmas cartoon, Rudolph The Red Nosed Reindeer, and there’s an island for broken toys, for unwanted toys. And I sort of think that is sort of like the RMB block. Again, these countries are not protesting the US. They've been kicked out. They've been sanctioned so they can't have access to the dollar market. China takes them together, and forms a little club.

JF: Absolutely. Yeah.

MC: I think it's a different story. But we could talk about the exchange rate, but different from the dollar's structural low in the world economy.

JF: Yeah. Absolutely. I think when people talk about that de-dollarization trend, they make some good points, but they forget perhaps the most important point which is, well, what is the alternative to the dollar. Right? What is the alternative? Now there is, in my mind, one possible alternative, which a lot of people talk about as well, an asset which actually has been increasing in value substantially making close to all-time highs in most currencies, not in dollars.

And that is, of course, gold. And the idea has also been floating around that maybe Russia and China could issue a gold-backed currency. Now would that be a viable substitute replacement? Would that allow these kind of misfits to perhaps challenge the reign of the U.S. dollar?

MC: Yeah. So gold is one of these incredible things. Right? It's got such a long history of being used as a store of value. I'm not so sure it's practical. Partly, I'm not sure that China and Russia have sufficient amounts of gold to back their currency, a substantial part of the currency even in gold. You know, so it is true that in recent months, like maybe for the last 6 or 7 months or so, China has been buying gold.

Of course, it means other central banks are selling gold like Turkey, for example, or Venezuela. But just focusing on, like, China. And Russia probably has been -- having to sell some gold too. So China absorbing buying gold, Singapore has been buying gold as well. And when I look at the dollar value of the gold, it’s a very small part. Remember China has over of $3 trillion of reserves.

And I want to say that the gold holdings, I haven't done these numbers for the last couple of months, but I want to say the gold holdings is something maybe $170 billion, maybe even $200 billion of gold. $3 trillion in reserves, $200 billion being generous with the gold holdings. So I don't think that -- I think that the people who really talk about gold as a -- rekindling gold’s role as a key to global finance, don't appreciate the kind of price appreciation that'll be needed to make sure there's enough gold backing.

And by that, I mean, like gold, like you mentioned, near record highs, we're hovering just below $2,000 an ounce. I think gold has to get to, like, $20,000 an ounce before it can really rival the amount of financial securities out there that go with the dollar.

Here's what strikes me. And this is one of the things that I've fascinated with the foreign exchange market. Average daily turnover, and this is done by a survey from the Bank for International Settlements. So you can find it online, bis.org . They do this survey every 3 years. The last survey showed that the average daily turnover in the foreign exchange market $7.5 trillion - $7.5 trillion a day. Now global trade in a year is only about $30 trillion.

The world economy, everything the world produces, the goods and the services the world produces in a year, roughly $100 trillion. So this – we’re talking today on a Wednesday. That already means that by the end of business today, we would have seen about almost $30 trillion of foreign exchange this week. And so what’s happened I think that a reason why the U.S. went off the gold standard in 1971, even though the U.S. still has more gold than any country in the world. And the reason is that gold was too much of a straitjacket.

What we've done is, I worked at this bank earlier in my career that David Bowie approached and he said, listen, I sell millions of dollars of CDs and DVDs every year. Can't I get my money upfront? And so there are David Bowie asset backed bonds, municipalities in the U.S., also in Europe have tried how to lower the interest rates, so taxpayers don't have to pay so much. And one way to do that is to secure a bond, guarantee the bond with a certain income stream, like parking meter income, or toll income.

These are only possible because after Bretton Woods collapsed, after the dollar no longer linked to gold, it allowed for an explosion of a sort of financial superstructure. And that financial superstructure is so large, we talk about -- there's different ways to talk about it. Sometimes, people talk about thinking about how much debt there is. There's too much debt. And the challenge though, of course, is you look at a US bond. And you say, well that's the government's debt.

But I look at the U.S. bond on my household balance sheet, and it's an asset. And so that -- so it's really like who has it, who invented the issuer or the buyer. But it seems to me that there's been this explosion of financial assets, partly debt, partly assets, it’s sort of the opposite sides of the same coin. And gold was too small for a market at current prices to really take that -- to take any significant part of that burden away.

So I think that the idea of gold coming back as a -- whether China, Russia, or the BRICS Bank backed currency in gold, I really don't think that it's really going to be practical. And even now, people are talking about a BRICS currency. And it just seems so weird to me, partly because, look how -- look what's happening with the euro. People thought that the euro, the Europe, the euro zone, was not like an optimal currency zone. And surely, the BRICS are not an optimal currency zone.

And even the countries in the BRICS sort of plays down rivalry within them. For example, India and China have killed each other, they have border disputes with each other. There's no way that India wants to help promote the internationalization of the RMB. And to have them under the same currency seems highly unlikely to me. And I think about how long it took Europe to have a common currency.

I think about how long it took the U.S. When the U.S. was founded, we didn't have a common currency. We didn't get a common currency. That's what the Federal Reserve Act in the early 20th century did. It gave us the dollar as the national currency. Before that, the different states would have banknotes, state banknotes, and the third-world crisis of the 19th century was U.S. real notes, U.S. states. And so, yeah, I just think that this -- the idea of – two things really, one is that, ever since the beginning of my career, people have started an alternative to the dollar.

And it makes sense. Nobody likes -- whoever is on the top of the hill nobody likes and everybody looks to an alternative. But I'd say that despite that, I'd say that we still haven't found one. To your point, it’s just not clearly, a compelling alternative. We probably use, I'm sure we use the same type of keyboard, QWERTY. And I've told that there are better ergonomically designed keyboards out there. Someone will have a better currency, but it can't just be a little bit better. For me to learn a new keyboard, it has to be like vastly better. It can't just be equal. Because of the experience I already had to learn. And I think a lot of people are like that.

I can give you another example too. Many years ago, people thought it'd be great to have a common language for the whole world called Esperanto. And I know there's still some people who follow Esperanto, some documents in Esperanto, but it's not an official language. It's hard to -- and I kind of think that's what would happen if a group of countries come together with no common central bank, no common fiscal policy. We see what that means in Europe. They have that in BRICS. I think this is more fantasy and more reflection of this desire for an alternative than a real concrete alternative in itself.

JF: Yeah. Absolutely. And like you said, I think there's just too much of a cost associated to abandoning the dollar that it’s just a price that a lot of people don't want to pay. Now I can sort of intuit what your answer to this is going to be, but since we have touched on gold and currencies, and this is something that I write about quite often, any thoughts on Bitcoin?

MC: Bitcoin. Yes. What an amazing thing though. On one hand, I'd say, it's an amazing story that sort of captures, sort of, say, early 21st century finance developments, technology developments. So it’s like kudos for crypto for employing the latest technologies and for really telling, for showing the credit card companies have competition, banks have competition.

On the other hand, it's sort of, in some ways, it might be a bit of the moral majority. A political movement in the U.S., there was neither a majority nor a necessarily moral. Crypto is a coin, or crypto like Bitcoin, these are called coins, but because they call themselves coins, not because they really have the function of money.

And I think there’s a – so one I don't think that's really money. You know, even though the price goes up, I have turns out, I have a comic book when Clark Kent, not Superman, but Clark Kent proposes to Lois Lane. That comic book is worth a bit of money these days. I think I might have paid a couple bucks for them on the streets in New York. It might be worth, say, $20, $25 now. I've got a stack of them. I cannot pay my landlord in them. I cannot pay my taxes with them. Are they really money, even though they've increased in value?

I think the same thing with crypto. If I try to offer my grocer, my landlord, my lawyer, my accountant, crypto, they wouldn't know what to do with it. I don't see corporations - these days, Bannockburn who employs me, thankfully, is a -- they help small, medium sized businesses and asset managers, family offices, manage the foreign exchange market. And what they're trying to do is manage their risk. If they all of a suddenly take on crypto, they're taking on more risk. They're not managing their old risk like sending out an invoice when they buy it. Hedging when they send out an invoice or locking in a price for the euro when they buy a German machine tool.

So I don't think that there's really much of a space for crypto among corporate treasurers. And I think that there's like a contradiction at the very heart of it. Many people I know who, many of my friends who have invested in crypto, they tell me that fiat currencies, are they’re fiat. They're not backed by gold or silver. Central banks are printing them like it grows on trees. They say they're going to lose value.

And so there's a law in economics, Gresham's law, which basically says, bad money chases out the good. And so here's what happens next, you have your choice, you have your crypto wallet, you've got some bitcoins in there, and you've got dollars. And so time to buy something. And maybe you find someone who will take either one from you. Because you think as a holder of crypto that this fiat money is going to lose value over time, you're likely to spend that and hold on to your crypto.

And that’s what happen – that’s what we find. In some of the studies I've seen, crypto holders, and you look at the IP addresses, your ISP addresses, you see that there hasn't been so much of a turnover. And while there are traders of crypto, a lot of people buy and hold. You now that HOLDER. And I think that what happens then because the dollars are spent, the crypto is held on to. I think that that means that the crypto can't get that critical mass, that networking effect that makes it widely acceptable.

And so I think that because of the mentality, thinking that fiat is bad, and it only goes down over time and crypto is good, it's going to go up over time, it means you're going to be selling or using the wasting asset to make your transactions, and thereby giving the dollar its networking effect, but not giving crypto its networking effect.

JF: That's very interesting, kind of like a catch 22 situation for Bitcoin.

MC: Yes. I think that it's an incredible idea. And I've - I think that other places, we've -- I mean, to really explore, like, what blockchain does, for example, stepping from crypto, trying to use their technology. But I think that crypto is an incredible asset in the sense that people can buy and sell it, but it's intrinsic value like the use value I think is very limited.

JF: Right. Now to wrap up, we were talking before we started about some ideas within the currency space, some possible trading ideas. What are your thoughts? What would you recommend to viewers? Any ideas there?

MC: Yes. Sure. So a couple of big picture things for you. So the first is to appreciate that the dollar has risen in value, basically since the end of the financial crisis, the great financial crisis, say call it 2000, Crisis 08/09, say since 2010 or so. And I think that big dollar rally is over.

And what this means is if you have a basket of international stocks, the currency component could be a third of your total return. If you have a basket of international bond, the currency volatility could be two-thirds of your return. So, I think that the dollar is super cycle, the dollar’s rally since the end of the great financial crisis,. I think that ended last September and October.

The Sterling made, I was on Bloomberg radio and people were talking about how last September the UK was an emerging market country and they had Sterling going down below the euro. And I thought that was just a gross exaggeration to me. This is a reflection of extreme market sentiment. And so as we talk here today, I look at -- so currencies -- as crypto friends tell me, have no intrinsic value because they're not backed by gold or silver. So what economists have done, if they created a model we use it -- we call it purchasing power parity.

And you can see in The Economist magazine, they sometimes use a Big Mac or a Starbucks cappuccino. The idea is that a basket of internationally traded goods should trade for this -- should sell for the same price when you make the currency adjustment. To the extent they don't, shows you a currency misalignment.

But The Organization for Economic Cooperation and Development, like the 26 large rich countries, western countries, Japan, Australia, these large countries, their currencies typically don't move more than plus or minus 20% from fair value.

The euro is about 50% undervalued. The Japanese yen is about 45% undervalued, Sterling's about 20% undervalued. So one of the things that tells me is that after being long U.S. stocks for quite a while, that I'm interested in buying international stocks, stocks that have international exposure because the dollar is so expensive compared to the euro and yen. And what that mean - and Sterling, what that means is that the dollar investors can get a lot more bang for their buck, whether they're buying companies, whether they're buying earnings stream, whether they're hiring labor, so much cheaper outside the U.S. right now.

So one suggestion, as far as I kind of take advantage of this currency insight, what does this mean for individual investors, retail investors, look to diversify into European and Japanese stocks.

Second thing is I think that one of the memes to the themes in the market lately has been the strengthening of Latin American currencies. And I think that the Mexican peso still has room to go. The peso is trading already at roughly seven year highs. We're trading around 17.20 or so. And I think we could go down to about 16.50 or so. And again, the story here is not that people like – and that is to say global investors, don't like necessarily AMLO's investment policies and the investment climate.

What they do like is that the central bank and the Supreme Court in Mexico have institutional strength and independence. Right now, the overnight interest rate in Mexico is 11.25%. There’s a huge carry to be picked up. The stock market also is among the better performers of emerging markets done much better than say the MSCI Emerging Markets.

And I think that there's room for capital appreciation if you buy bonds with long end of the curve to bond appreciation, partly because Mexico like Brazil, maybe Colombia, Chile can cut rates before the end of the year. This time around, Latin American countries were very early, and aggressive in raising interest rates. And they'll be rewarded by that by being able to cut them well before the Federal Reserve.

So for currencies – so for broadly speaking investment purposes, the dollar is strong can buy foreign assets cheaper, especially Europe and Japan. For individual currencies, I like the Mexican peso. And the Colombian pesos should have wrestled for the top dog this year. Colombia's got this slight advantage now. So, I still like Latin American currencies.

Broadly speaking, like I say, I think the dollar - the U.S. dollar peaked last year. And I would look for the euro, which is trading today around 1.08, maybe 1.085. I think we've looked to 1.12 this year, 1.20 next year. I look for dollar, yen to peak. I think the dollar peaked last year above a 150 to the dollar and I think we could be trading closer to 120 in a year's time. Today, we're trading close to 140.

JF: Well, I must say, Marc, I find myself agreeing with what you're saying. I've been beating the drum about these kind of ideas for the last few weeks and months, international stocks. I've been myself purchasing some international bonds. Also stocks in Brazil, for example, I think a good economy. So overall, I find myself agreeing with what you're saying a lot.

Thank you so much for coming on. It's been great. I look forward to following you on Twitter and all your stuff on Seeking Alpha as well. Thanks again for coming on, and hope we can do this again sometime.

MC: Sure. Good luck to everybody.

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Falling Inflation, Dollar Dominance And PBOC Moves With Marc Chandler