Interest Rates, the US Economy, and Demographic Change — with Matthew Klein

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1:28Go! Go! Go!

1:37Welcome to the 256th episode of the Prop G Pod. In today's episode, we speak with Matt Klein, the founder of The Overshoot, a premium subscription service dedicated to tracking the global economy. We discussed with Matt the state of play regarding inflation and the financial markets, trends playing out across the global economy and his thoughts on economic and financial impact of demographic change. Oh, my God, that just sounded so highbrow. I'm not a primitive, heavy-browed, I don't know, arrested adolescent prof with erectile dysfunction who will be starched from the gene pool if people have their way.

2:14No, I interview people with subscription financial products that understand global markets. What's happening? What's happening? we witnessed a historic weekend. Yevgeny Prigozhin, the leader of the Wagner Group, essentially leading a mercenary army of somewhere between 25 ,000 and 50 ,000 people, turned direction, turned around and decided he was going to march on Moscow. And the most shocking part of all of this was that in Rostov-on-Don, he was welcomed, even cheered on. This has revealed Putin as being exceptionally weak and also that his grip on power was a lot looser than we had thought. It also brings to light how much nuclear weapons matter, that you can be a gas station posing as an economy, but if you have 10 ,000 nuclear warheads and a reputation for having your enemies fall out of windows, you carry a much bigger stick than you deserve.

3:08So what is being said around what happened here? A Russian state broadcaster wrote on her Telegram channel, The choice was between bad and monstrous, a series of decisions around bad decisions. Ukrainian President Zelensky said the bosses of Russia do not control anything, nothing at all. Complete chaos. Putin says he let the mutiny take place as far as it did to avoid bloodshed. President Biden says we had nothing to do with it. This was part of a struggle within the Russian system. They're keeping probably appropriately quiet. If there's a train wreck of your enemies, just stay out of the way.

3:41Our favorite geopolitical expert Ian Bremer writes, it undermines Putin's ability to govern, requiring greater state control of the population with the attendant surveillance and further mobilization required to enforce it. I just can't, I don't think anyone saw this coming. Supposedly our intelligence apparatus knew something was up or that Pradosian might be planning something. But this illegal invasion, although I would argue almost any invasion is illegal, this invasion has been a total disaster. It's hard to imagine a world leader that has fallen further faster than Putin over the last 14 months.

4:16First off, the invasion just didn't go very well and isn't going well. And two, his mercenary army, he doesn't appear to have control of it. And he had to call on someone he doesn't have a lot of respect for, Lukashenko, the Belarusian president, to step in and negotiate a resolution. And what will happen with this resolution? You've got to think that Pergosian's days are numbered. Without an army taking his command, I don't know how he doesn't end up in jail or dead. Or it strikes me that, hey, here's your new corner office and it has a big window and it's on the 11th floor. I can't imagine that this individual is going to be sleeping very well at night.

4:55It also just shows that Putin is a paper bear, if you will. that sitting on a lot of oil and putting in place a series of kind of mini criminal gangs that he controls through fear, no real ideology, no real prosperity other than the prosperity concentrated among a few elites, so to speak, in Russia. This was just a very weak foundation that is collapsing faster, appears to be collapsing fast. Also, real shout out to all the people on the far right and all the Putin apologists and sycophants who said that we should negotiate with Putin and that we had to face the reality of the war and the strength of the ferocious Russian army, they could not have been more wrong.

5:39And the U.S. administration, in conjunction with its allies overseas, and obviously on the front end, the heroic valor of the Ukrainian army has just has absolutely sent a signal to the world, including China, who probably had designs on invading Taiwan, that when the West binds together, our weapons, our strategies, our technology, our communications, our resilience, our ability to cooperate and bind together are unrivaled. The other winners here, I would argue, are India, who has been able to garner very cheap oil by playing the West off against Russia, and what looks like a GDP run that might rival, or at least have echoes of China's economic run over the last 20 years.

6:23But the nation that people aren't talking about as much that has grown its economy faster in the last year than any large economy, the kingdom of Saudi Arabia. And here's the reality. They sit on trillions of dollars, tens of trillions of dollars in oil reserves. They have pivoted from Islamism and terrorism. It used to be a Cold War with Iran and a hot war with Yemen. And MBS has pivoted to capitalism, which is the kind of the gangster economic construct and the way to exert influence. Well, how does that influence exerted? Everything from bringing the most famous soccer play in the world to the kingdom to hosting the World Cup.

6:59Well, that was Qatar. It's regional, but you're going to see, I believe the kingdom is going to get the World Cup in probably 2030. Their creeping takeover of the U.S. sport, specifically Libs takeover of the PGA. They are now exerting their power in the tennis world or their influence, you're going to see a massive, a massive migration of human capital to Riyadh. When I was in Riyadh a couple months ago, I was struck by how many people, talented people from Asia and Europe had moved to Dubai and were now moving to Riyadh. Because a decent strategy for economic security is to find the biggest pile of money and stand as close as you can to it.

7:39And the biggest pile of money in the world right now is in Riyadh. We are spending about$550 billion on our infrastructure act here in the U.S. We're over there in the U.S. I'm in London today. And when I was in Riyadh, some officials took me through seven projects that are above a trillion dollars each. I mean, they're building a city, Neom, which in comparison, they want Dubai to feel like a small, cute village. I mean, they have unbelievable ambitions because here's the bottom line. They have about 30 or 40 years to pivot. Why? The good news is they sit on the Pacific Ocean of oil. The bad news is it's going to run out at some point.

8:21So they have three, four, five decades to pivot to a non-fossil fuel based economy, education, tourism. They're trying to get big into the gaming industry, entertainment, services, and they are saying, all right, this is the good news. We have an unlimited supply of capital, but the bad news is we have to get out of our existing business. And this notion that we're going to wave our finger at them and lecture them, okay, a vocal minority will do that. And then 98 % of the rest of the world is going to decide to work with them. I think we should restore relations or we should absolutely give a big bear hug to India and also normalize relations.

9:00And we do. We don't like to say this, but we have actually military bases in the kingdom. But encourage more commerce between the two nations, because these two nations are going to play an increasingly important role. And China fucked up here. They bet on the wrong cowboy, specifically a cowboy that runs around on a horse with his shirt off. But quite frankly, underneath that facade of masculinity is a guy who's remarkably flaccid and losing power. This is a wonderful moment for the West. We are standing with our brothers and sisters in ukraine Our economy is still relevant who the hell is doing better than the u.s.

9:34right now geopolitically This really has kind of a reasserted U.s. Hegemony and that is we are still the leader. We are still the free leader We are on the side of the righteous. We fuck up all the time But the arc of america bends toward justice. This is a wonderful moment for us. No one could have seen this coming We had our own insurrection, but I would argue it was mostly a few thousand crazies who are whipped up by Fox and a corrupt criminal president, but you don't see Northrop Grumman or the Navy marching towards Washington, D.C., threatening to overthrow the government with weapons, for God's sakes.

10:10I mean, this got very scary very fast or very strange very fast. But again, to sum it up, go USA. This is a wonderful moment for the West. We should feel proud of ourselves. In America, we love to raise a generation of young people who don't like America, But guess what? Guess what? This matters. And this was handled really well by the U.S. and her allies. This is a great moment for us. We make the best weapons. We have the best intelligence. We back the right horses. And we aren't afraid of a murderous autocrat just because a bunch of people on the right are libertarians, so-called libertarians, think we should negotiate and be an apologist.

10:46No Neville Chamberlain's in this administration.

10:52We'll be right back for our conversation with Matt Klein.

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12:39Welcome back. Here's our conversation with Matt Klein, the founder of The Overshoot and co-author of Trade Wars Are Class Wars. Matt, where does this podcast find you? I'm in San Francisco. Nice. So unprecedented velocity and rate increases over the last five, six quarters. Give us your thoughts on the state of the markets and sort of unintended consequences and second order effects of these rate hikes. so the the context here is that basically since about 2008 2009 you've had interest rates being very very low and you have a whole you know half generation or so of of people consumers and businesses and investors being used to this low rate environment and there are a lot of reasons why interest rates were low and that made sense at that time but people built up a whole set of expectations about what was normal what they should be you know what was sort of the range of possible outcomes.

13:35And then very quickly, you have a very sharp disruption to those expectations and interest rates move. In the grand scheme of things, you look at a long-term chart of interest rates, you think five percentage points, maybe not that much. But zooming in on the past 15 years or whatever, if you're used to the short-term interest rates, the cash or whatever being essentially zero, and even at the longer-term interest rates, maybe not going above three, it's sort of the upper end. And then suddenly everything is above five. That is going to have a really big impact on a lot of people. This isn't the first time that's happened, by the way.

14:07You can go back to the 1960s. You have a similar dynamic of a lot of businesses. For a very long time, interest rates just didn't go very high. Then as inflation started to build in the 1960s, before oil shocks or anything like that, that put upward pressure on interest rates. It put pressure on banks that had made all these loans, 6%, and they took deposits at 3%. You can read reports in the time and how much trouble they were getting into. And so that adjustment is going to be challenging. I mean, the good news is that, as was the case then and as is the case now, I mean, a lot of other parts of the economy are doing relatively well.

14:44So there are going to be losses. I mean, clearly we've seen some banks having those issues, but at the same time, job growth is still pretty robust. Wage growth is still reasonably healthy. There hasn't been a huge reliance on borrowing to fund consumer spending in the past few years compared to previous expansions. It really has been coming much more out of either income growth or money that had been saved during the pandemic. And stocks have been, you know, compared to the peak at the end of 2021, kind of flat, right? But flat is a lot better than, you know, down substantially. I mean, so I think in that sense, there is a sort of recognition that there's these big countervailing forces here.

15:20There's some big losses for some individual sectors. But so far, it seems that things are sort of, you know, muddling through, even if, you know, you know, a few particular banks have gotten overextended and getting blown up. So it feels as if we were a month away from recession for the last 18 months. And yet, as we sit here, unemployment at historic lows, the real estate market has been shockingly strong. The markets, as you've pointed out, seem somewhat resilient. Is this the recession that never happened? Or do you still think we're looking at a recession sometime later in the year, 2024? What is your, recognizing no one has a crystal ball here, where would you put your money right now?

16:05Yeah, I mean, that's a great question. I mean, if you look back to right before the Federal Reserve began raising interest rates, the expectation that they had, the expectation that was priced in the markets is that they would maybe raise interest rates by, you know, two percentage points over the course of 2022. And they ended up doing almost five percentage points. And, you know, one might have thought if you'd known at the beginning of 2022, what they actually ended up doing relative to what people thought was, you know, reasonable expectation, you think, wow, that's going to really tank the economy.

16:32And yet that's not what happened, as you said. So, you know, I think this gets back to the question of Normally, the way that channel is supposed to work is that if you make borrowing more expensive and you make it more attractive for people to just hold cash in a bank account as opposed to buying things that create jobs and income, that's going to slow the economy down and that's going to have all these attendant effects. And yet, that doesn't seem to really have had the impact, even with the housing market, which is the most obviously sensitive interest rates. And your mortgage rates going from below 3 % to almost 7%.

17:05And that did have a notable impact on house prices in some areas are down. Housing activity in terms of new construction has come down substantially. And yet, it seems like we've already found the floor. You look at the data from May, the most recent month that we have, and it already seems as if, you know, home sales and home construction are picking up again. And it suggests to me, I mean, you know, again, there was this sort of big, painful one-time reset, but people have managed to sort of get through it because underlying wage growth is still strong. There wasn't that much, I guess there wasn't that much, you know, reliance on borrowing.

17:38You know, if you compare this to say like 2005, 6, 7, 8, there you had a situation where so much of consumer spending was dependent on people borrowing against rising home values. And so as soon as that was no longer possible, you had this downward cascade very quickly. That wasn't really the case this time around. You had this big cash injection from the federal government as a consequence of, you know, responding to the pandemic and trying to make sure that we didn't have a financial crisis because we all had to stay home in the first months of, you know, 2020. And then people saved money from that.

18:13The economy recovered. You had, you know, more cash injections to really turbocharge recovery. And then at that point, you had a pretty healthy situation where, you know, the economy isn't fully normalized, but it mostly gotten back to normal. And then people have the extra cash that's available. And that's that seems to have really been, you know, a helpful cushion. I mean, you could argue from, you know, the Federal Reserve's perspective, it's unhelpful because it means they have to push harder to get the results that they want. But, you know, to your point, I mean, to the extent that you might think that, oh, we're going to have a, you know, economic downturn, it seems like this has really been preventing that and all the things, the channels you might be worrying about for a downturn, you know, I mean, obviously, you know, things could happen, you know, the Fed might decide they want to, you know, keep squeezing, but their ultimate priority is to get inflation back in a line.

18:55And if they think inflation is going to come back in a line without the economy going into a downturn, they're not going to, they have no interest in overdoing it. You know, that's where it gets really kind of a tricky question is, you know, can that happen? So we had what I think will be described as this pretty serious geopolitical shock, even if it ends up, I mean, I remember this past weekend, it's just like, I just don't think anyone was prepared for what happened or went down in Russia. Have you thought through what kind of the direct impact or the second order effects on the markets might be?

19:30Well, what happened this weekend is really an interesting question, because I'm not even sure we know exactly what happened and, you know, whether it's even over in that sense. So I think, you know, zooming out a little bit, what's interesting is that as the war has progressed, and, you know, obviously it's been extremely disruptive to people who live in Ukraine and a lot of Ukraine's neighbors, but, you know, things, you know, the sort of that initial shock, people have managed to adapt in various ways um you know the you know the energy markets got rerouted food you know there was also helpful that you know there was a very good harvest in places like argentina and australia and the southern hemisphere wheat producing countries but in general there was a degree of which after that initial shock thing you know sort of passed the worst you know that surprise happened once you once you have the surprise that's what that's what matters for markets the surprise but once you once it's happened you know the surprise is over i mean still obviously very destructive it's terrible for the people who live in ukraine Obviously, you'd want the war to end soon.

20:25But that, you know, and the impact on markets seems to sort of stabilize there. And one of the things that was sort of always a possibility once the war started is what would the impact be on Russia internally? I mean, the specifics of what happened this weekend might have been very surprising and unanticipated. But I mean, the idea that you start a war that ends up being relatively unpopular domestically and because it doesn't end the way you expect it to, you have to conscript a lot of people, you have a huge wave of emigration, it doesn't seem to be going the way you want it to. The idea that that creates some kind of instability at home, that in and of itself is not inherently surprising.

21:03It's just a question of how it plays out and then who ends up winning, what kind of conflicts are, what the next person would be like. I mean, that kind of possibility presents itself. You see this, I mean, it certainly wouldn't be the first time in Russian history that you're fighting someone else and then it goes badly and then there's a revolution at home. So obviously what happened this weekend didn't play out the way it did in, say, 1905 or 1917. But, you know, that possibility sort of created itself as soon as the war started. And so, you know, looking ahead, the question is, well, is it more likely that something like this will be successful in the future?

21:36And if so, like, who would be the kind of person to take over and what would that mean? I mean, that's where it gets. I don't know if we've learned anything new in that sense. And that's really what, you know, what the impact for markets is. Like, that risk was always there once the war started. And so that's sort of my initial perspective. But again, we don't even know exactly what happens. So at war, if it's over. So that makes it challenging. So we think of it, switching gears, we think a lot about sort of population implosion or depopulation or more specifically how ideally we should create more opportunities for young people such that they can afford, should they choose to, to have children.

22:08You've actually spent a decent amount of time focused on how demographic change affects societies, politics, markets. Can you say more about what is playing out in the U.S.? Sure. So getting some sort of little historical perspective here is that after, you know, basically after World War II, you have a big increase in populations and particularly populations of young people, the baby boom, you know, in the U.S., in Europe, and in much of the world in Asia. and that process more or less peaked around the 1970s in terms of the the child boom and the share of younger people uh and the total population and since then we've had basically a shift is that cohort ages the population of you know what we conventionally think of as working age people you know sort of 20s to 60s depending upon you know where you draw the exact cutoff um peaked uh as a share of the total in a lot of places sometime around, you know, either the 90s or 2000s or 2010s, I don't know where exactly you're looking.

23:11And if we use sort of standard population forecasts from places like the United Nations, which, you know, if you figure who's already alive, you can do a pretty good sense of what, you know, who's going to be alive in the future, more or less, you know, based on, you know, trends and life expectancy. And you say, okay, well, it looks as if the share of people who are going to be in, we think of this prime working age or is going to be falling as a share of the population, a lot of places, the share of people who are over the age of 65 or over the age of 70 is going to be rising a lot a lot of places the share of people who are under the age of 15 is going to be has been falling is probably going to continue to fall pretty substantially in a lot of places and then the question is what does that what does that mean um you know for society and and for markets and everything else and you know the first thing to say is that there's a lot of variation depending on where you're looking so the more extreme cases are places like china certain parts of europe where you're actually going to see outright population decline and particularly outright population decline for people of sort of what do you think was the working age so if we take the u.n forecasts seriously the number of people in china age you know 20 to 65 20 to 70 is going to fall by something around half uh but between now and the end of the century it's already been falling and is going to fall that which is we've not seen something like this before uh you look at a place like the u.s actually it's relatively more benign i mean part of this is sensitive to forecasts about immigration and things like that but you know in principle in the u.s you're going to see a situation where the total population will rise on net a lot that's going to be elderly, but you're still going to, the absolute number of people in sort of the 20s to 60s cohort is going to be rising small, you know, flat to rising.

24:45Either way, though, you're going to have some distributional challenges because in every society, you have a situation where there's some people who are producing more than they consume. So essentially people who are working, and then you have people who consume more than they produce, which are, you know, children, elderly, the disabled, things like that. And so, you know, that's fine. That's what living in a society is. But obviously, if you have a big change in the balance between, you know, one group versus the other group, that's going to create some challenges in terms of, well, how are you going to distribute the cost of the lower living standards?