Pod Insights Capital Allocators [REPLAY] Louis-Vincent Gave – Macro Consequences of Government Sanctions (Capital Allocators, EP.247) About this episode Louis-Vincent Gave is the Founding Partner and CEO of GaveKal, one of the world's leading independent providers of macro research, and GaveKal Capital, a manager of $2.7 billion in assets. Louis launched GaveKal alongside his father in 2000 and has become a go-to source for creative research on global economics and asset allocation, particularly in China. He recently penned CYA as a Guiding Principle, dissecting the consequences of Western government responses to Russia's invasion of Ukraine. He joined me to discuss the key takeaways.
Our conversation starts with Louis' background and founding of GaveKal, and turns to the potential second order impacts of freezing reserves, seizing oligarch assets, end of Swiss neutrality, energy prices, and military spending. We close discussing how the situation may affect China.
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3:32 Ted Seides? Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at capitalallocators.com.
3:59 Ted Seides? My guest on today's show is Louis Vincent Gav, the founding partner and CEO of Gavcal, one of the world's leading independent providers of macro research, and GaveKal Capital, a manager of $2.7 billion in assets. Louis launched GaveKal alongside his father in 2000 and has become a go-to source for creative research on global economics and asset allocation, particularly in China. He recently penned CYA as a Guiding Principle: Dissecting the Consequences of Western Government Responses to Russia's Invasion of Ukraine. He joined me to discuss the key takeaways. Our conversation starts with Louis' background and founding of GaveKal
4:42 Ted Seides? and turns to the potential second-order impacts of freezing reserves, seizing oligarch assets, end of Swiss neutrality, energy prices, and military spending. We close discussing how the situation may affect China. Please enjoy my conversation with Louis Vincent Gav.
5:03 Ted Seides? Louis, great to see you.
5:04 Speaker 02 Great to see you. Thanks for having me. How you been?
5:07 Ted Seides? I've been well, thanks. This is the first time I've had you on the show, so I thought maybe it would be helpful to give a little context before we dive in on the Ukraine situation. And why don't you just start with your background and what it is you do, how you got there?
5:20 Speaker 02 Well, first of all, yeah, thanks for having me. It's a pleasure to be here. I'm one of the founding partners of a company called GaveKal. We're based in Hong Kong and Beijing. I've spent really the better part of my past 25 years looking at China and at China's major impact on economies and on global financial markets. And GaveKal is, when people know us, they know us because we publish a lot of research. And sometimes they also know us because we actually do manage money. We manage institutional money, mostly in the Asian markets and specifically in the Chinese fixed income markets, which is where the bulk of our assets are deployed.
6:04 Speaker 02 So we're a somewhat unusual firm in that we do provide a lot of independent research and that's where about 2/3 of our staff works. And then we have another 3rd of our staff, completely separate, that manage these institutional accounts.
6:19 Ted Seides? And how about a little bit of an overview of you and how you got to that point of being one of the co-founders, I don't know, 20 something years ago now?
6:26 Speaker 02 I'm French originally. I grew up in France. I went to college in the US, went back to France. I was an officer in the French Army for a little bit in mountain infantry. Then I joined Paribas. And throughout this period, my father had created a big money management firm called Curseader Eaton. He was the CIO there. The firm was sold to Alliance Capital in the mid 90s. My father stayed there and he retired in the late 90s and he was, he kept writing things here and there, mostly for his friends he left at Alliance Capital. And I saw what he was doing, what he was writing. And I thought, oh, you know, this is, this is pretty interesting stuff. Maybe we can make a business out of it. Now, granted, this was the late 90s and in the late 90s, you can make a business out of anything.
7:10 Speaker 02 But that plus the combination of my mother telling me, you've got to get your father out of the house. He's driving me nuts. Having a retired husband is the worst of both worlds. It's more husband and less money. So put him back to work. And so he and I started a small research firm and we were joined pretty quickly by Anatole Kuletsky, who was a friend of ours and a famous financial journalist in the UK. And pretty quickly, everything, so this was all done out of London, but everything we're looking at was telling us that China was going to be a massive shift into the global financial and economic infrastructure. So I moved to Hong Kong. My father Charles moved to Hong Kong. We opened an office there.
7:50 Speaker 02 We teamed up with a fellow called Arthur Krober, based in Beijing, and he joined us as a partner. Yeah. And that's basically how, how things took off. So I spent roughly 20 years in Hong Kong. All my children were born there. It's a huge part of my life. A couple of years ago, just before COVID, mostly for school reasons, we decided, my wife and I, to move to British Columbia. And my idea was that I would sort of spend two weeks in British Columbia, two weeks in Hong Kong and go back and forth. But obviously COVID into being, and so I've spent the better part of the past two years in what is what I think one of the most beautiful spots in the world.
8:29 Ted Seides? So I have to ask, before we dive in, what was the dinner table conversation like with your father running an asset manager when you were a kid?
8:36 Speaker 02 My father was an odd money manager in that he, I think he fell into it a little bit by accident. It was, to be honest, neither his temperament, nor definitely his family background. He came from a military family and pretty much aside from my dad, every male on his side of the family was in the military. So the dinner conversation actually didn't really focus on markets. It was always surrounding current events for sure, but it was very much heavy on history and, you know, fairly heavy on religion as well.
9:05 Ted Seides? Well, you just wrote this recent piece that relates to what's been happening in your perspectives, starting with the famous letter CYA. And I would love to just have you walk through some of your takes on the current situation and the parallels that you're drawing from it.
9:22 Speaker 02 Just in case people don't know, CYA stands for cover your ass. And I fear that this is increasingly how policy gets done in the Western world. At least that's the thesis of the piece that you mentioned. And I wrote a first CYA piece surrounding COVID. And at the time of COVID, what became pretty clear to me was that you obviously had a tough event unfold, you know, this start of this pandemic, and a clamor all of a sudden rises on social media, you know, something needs to be done. And so you get, I don't know if you've ever followed the British TV show, it's one of my favorites, called Yes, Prime Minister, where time and time again, the politician is in a situation where something must be done. This is something, so let's just do that. Regardless of whether
10:04 Speaker 02 it works or not, that's almost irrelevant. And I think we saw that in spades with COVID. It was a case of every week, something had to be done before the previous thing that had been decided had even been implemented, we were already moving on to new measures. So, you know, mask mandates and shutting down schools and full lockdowns and so on and so forth, regardless of whether it worked or not. And so with this framework, I think we're seeing exactly, of course, the same thing with the Ukraine situation. You have a horrible event that occurs, you know, the invasion of Ukraine by Russia. And the clamor is, of course, for for something to be done. And before we even have a chance to think, okay, what is this something that we should do to deal with this? We just implement a bunch of measures, one after the other.
10:48 Speaker 02 The the first measure is the freezing of Russia's central bank reserves. The second measure is the seizing of the oligarch's assets. The third measure is the seizing of Russians' bank accounts in Switzerland. The fourth is massive increases in military spending. And before we've even had a chance to stop and think, hold on, if we do this, what are the consequences of that? Already we're moving on to the next measure. And so this is the world we now live in, where policy doesn't get discussed in parliaments or in congress. Politicians don't run on campaign issues, etc. It's something bad happens, quick, let's have, let's have a policy and we'll figure out later what the consequences are.
11:32 Speaker 02 Now, when it comes to these measures that have just been taken, the confiscation of the oligarch's assets, the freezing of their bank accounts in Switzerland, the freezing of Russian central bank reserves, I think these are potentially enormous consequences to these actions. And people haven't really thought through them.
11:47 Ted Seides? Well, let's walk through them one by one, and maybe we'll just go in order. So freezing of Russians' reserves, we have seen as a really a new measure here in trying to control what's happening in the world through economics. Would love to get your take on the effectiveness and then the potential consequences, maybe the unintended consequences.
12:09 Speaker 02 Absolutely. Look, I think it's a massive shift. It's enormous. And here, let me start off by just acknowledging that we're, of course, all the fruits of our own experiences. And for me, one of the key events in in my career, partly because I had just started working in financial markets, was the Asian crisis. The speed at which Asian markets unraveled in front of of my very eyes in ninety seven, ninety eight, just as I'd started covering those markets. And it's called the Asian crisis, but it was really a broader emerging market crisis because Turkey also hit the wall, obviously Russia hit the wall. Brazil and Argentina ended up hitting the wall. And I think when you come out of the Asian crisis, most emerging market policymakers adopt an attitude of never must this happen again, never must my entire middle class be
12:53 Speaker 02 wiped out in the space of a few weeks. And to make sure that this never happens again, I must basically maintain an undervalued currency, maintain strong trade surpluses that I recycle into US Treasuries or German Booms and basically build myself a nice big safety cushion in foreign bonds. Now, as emerging markets do this for really 25 years, I think what happens on the other side in the Western world is in the Western world, we just get used to massive budget deficits being funded year in, year out without any question. And so you end up to where we've been in the recent years, where you have money supply
13:34 Speaker 02 growth growing at double digits and budget deficits that are 4, 5, 6, 8, 9% of GDP and no financial consequences for government. There's always somebody to fund these massive deficits, even as frankly, the attractiveness of Western bonds keeps on deteriorating. Today, you look at Germany, you look at France, you look at Britain, you look at Canada, you look at the US, all of these bonds now offer real yields of anywhere between minus 3 and minus 5. But the reason, of course, emerging markets keep on buying these bonds is not for any return on capital, but it's because of the perceived safety of capital.
14:16 Speaker 02 It's again, the view that if there's a crisis, I need to have US Treasuries. Of course, Russia is now in a massive crisis. And what we've told Russia is that money that you thought was yours is no longer yours. Because that money is yours only if you behave in an appropriate way. If you start acting like a jerk, then we're going to confiscate your money. So we've just shifted the rules of the game. We've just shifted the rules of the game from this money is yours regardless to not only other returns on capital on this money absolutely horrendous and you're basically destroying capital over time with minus three to minus five percent real rates, but also if you
15:00 Speaker 02 don't do what you're told, then we're going to take your money away. And so, and I've had this discussion since the Ukraine invasion and this measure was announced with a lot of clients and the pushback is always, well, if you follow international law, then you don't have anything to worry about. But this is all well and good, of course, if you're France and if you're Germany and if you're Britain, you're going to trust the US to not, excuse my French, but just not screw you over. But what if you're China? What if you're Saudi Arabia? What if you're the Sultan of Brunei? You're going to worry about getting canceled from one day to the next. What if tomorrow China does invade Taiwan? Does that mean that it's one and a half trillion dollars of US treasuries go poof? What if tomorrow, if you're Saudi Arabia, what if tomorrow 20 Saudi citizens decide
15:45 Speaker 02 to once again hijack a US airliner and drive it into the Sears Tower or into the Empire State Building? Does that mean that Saudi's reserves get canceled? So all of a sudden, I think it's pretty clear that with this Russian invasion, a new sort of iron curtain has fallen on Europe. On the one side, you have Russia and Belarus. On the other, you have pretty much every Western democracy. And the Western democracies are telling the emerging markets like Brazil, like Saudi Arabia, like India, like China, telling them, come and join us on our side of the Berlin Wall and we'll guarantee you that your assets will be safe. But those countries all of a sudden are saying, I'm not so sure and maybe it doesn't make
16:29 Speaker 02 much sense for me to keep accumulating these assets. And so... If that's the case, then you enter into a new world where it's, hold on. Why do, if you're China, for example, and you're no longer sure, well, you're sure that you're getting a terrible return on assets and you're no longer sure about the safety of assets. Then you might think, well, why do I need to keep a cheap renminbi? Why do I need to keep running big trade surpluses with the US? To accumulate treasuries that could be confiscated from you? What's the point of this? Maybe I shouldn't even be trading with the US. Maybe I should be locking down Shanghai and Guangdong and letting the US get on with it and freeze the US out. And so I think we're moving potentially into a very, very different world.
17:13 Speaker 02 This reserve decision could be one of, I think it's the most important financial decision since the unpegging of the US dollar to gold in 1971.
17:24 Ted Seides? How would you track the potential for these countries significantly changing their reserve policies, say, based on that thesis?
17:33 Speaker 02 All right, on April 11th, I think is a historical day where Chinese bond yields have fallen below US bond yields. If you look at the 10-year notes, for the first time in modern history, since China has tried to open up its capital accounts to foreigners, since it's become possible for foreigners to buy Chinese bonds. This is the first time that Chinese bond yields are now below US bond yields. Let's think of that for a second. If I told you three or four years ago that Chinese bond yields would be below US bond yields, you'd have said, no way, this isn't going to happen. Too many structural uncertainties around China, too many uncertainties surrounding the rule of law, et cetera. So this is one potential answer to your question. How are you going to track this?
18:16 Speaker 02 Well, it's happening in front of our eyes. It's unleashing right now. Since we've decided to freeze Russian central bank reserves, US Treasury's German bonds have been in an absolute freefall. Two-year yields have just risen by 100 basis points. This is never in the space of less than a month. This has never happened before. The bond markets are, like the US Treasury, in the first quarter of this year, US Treasuries was the worst performing asset. Actually, German bonds were worse, but these were the two worst performing assets. It's happening. It's just striking us straight in the face.
18:51 Ted Seides? Yeah, I mean, how do you determine cause and effect, right? Some of that just could be the soaring inflation that we're seeing, in part because of what's happened in Russia. You have spiking oil prices and therefore you have increased inflation and you'd expect those bond yields to go up. So whereas in China, they're still transacting with Russian oil. So there are other cases for why that could happen, right?
19:11 Speaker 02 No doubt, but was inflation absent a month ago? A month ago, US bond yields were basically, what, 50, at the long end, 50, 60 basis points below where they are today. And you had plenty of inflation. Inflation was pretty bad a month ago. It was horrendous. Inflation has been horrible and accelerating for six months. You're right that, you know, the Russia war makes everything worse. It makes the energy crisis worse. It makes the supply chain dislocations worse. And it does make the inflation problem worse, no doubt about it. And you're also absolutely right that it probably makes it worse for the Western world than it does for China. And so it is hard to know what is cause and effect, et cetera. But to be honest, I don't really care what the cause and the effect is.
19:56 Speaker 02 I'm just looking at the trends. What I have is falling Chinese bond yields, rising US bond yields. We can debate all day which policy is implementing how, but the trend is there. The trend is your friend. And until you see a change in policies, why would you expect those trends to reverse? To me, that's what matters more because that's what you got to invest on.
20:15 Ted Seides? So when you speak of seizing assets, the oligarchs is a different, very different scenario than freezing reserves. And why don't you talk about your take on what the implications of that and why it's happening?
20:28 Speaker 02 I think the seizing of the oligarchs' assets is much, much worse. It's much, much worse because, you know, my starting point when I look at the world today, so the biggest comparative advantage the Western world has is the rule of law, is the fact that you can be brown, black, white, Chinese, Indian, doesn't matter. You can be Hindu, Muslim, Jewish, Christian. You can go in front of a court of law in New York, in London, in Paris, and you're going to get the same fair shake. I have some pictures of, you know, justice with her eyes covered, et cetera. This is the greatest strength. By far of the Western world. This is why rich people in emerging markets keep on investing in developed markets.
21:10 Speaker 02 And you know, this is why you buy, if you're a rich Chinese, this is why you buy Vancouver real estate. This is why if you're a rich Indian, you buy London real estate. This idea that you have an independent justice system and that my safety of capital is protected by this independent rule of law. It's a very powerful notion and it's what frankly capitalism is based on. And everybody is, gets to benefit from due process, et cetera. And what's just happened in the past six weeks, if we said absolutely, we believe in this fervently, except if you're Russian. And as soon as you make an exception, except if you're Russian. If I'm Chinese, if I'm Saudi, if I'm Bahraini, if I'm Qatari, I'm going to think, what do
21:54 Speaker 02 you mean, except if you're Russian? Does that mean, except if you're Chinese next? If I'm a rich Chinese guy and I own a bunch of real estate in Vancouver and London and wherever else, do I now worry that if tomorrow Xi Jinping decides to invade Taiwan, a decision on which I have no visibility, no control and no influence whatsoever? Does that mean that I lose all my stuff? Because that's what's just happened to the Russian oligarchs, right? Granted, nobody likes the Russian oligarchs. They made their money most, most of them by pillaging their country. At the first opportunity they got, they hid their money abroad. So they're not good patriots to Russia. They're not liked in Russia and they're not liked in the Western world because they flaunt that money around.
22:36 Speaker 02 But does the fact that they're not liked, does that give us the right to just take their stuff? The fact that Roman Abramovich all of a sudden can't run his football club. The fact that Michael Friedman all of a sudden has all of his assets seized for the crime of creating Russia's biggest private bank, even though he really has no relationship to Putin. This is a terrible precedent and it's a terrible precedent to set. And the message it sends to every rich person in emerging markets is your money is safe here as long as your leaders don't do things that we disapprove of. But the reality is, if you're a rich Chinese, the reason you put your money in Vancouver and is that you don't even trust your leaders in the first place, right? That's why you're, you're taking the money away.
23:21 Speaker 02 And so now you're being told, your money's not safe here. So it, to me, it's a potential massive shift because. The past 25 years has been very odd. We've lived in this world where, in essence, people in poor countries were subsidizing consumption in rich countries. You look at today, the world's big current account surpluses are in emerging markets. You know, it's in countries like China. And the big current account deficits are in places like France, like Britain, like the US. And those work, the way this balances out is because people in poor countries, whether the governments themselves or the rich people in those countries, were wanting to buy assets in the rich countries.
24:04 Speaker 02 But we have now just changed the equation on making these assets in rich countries attractive, which means that from now on, I think emerging markets, people will keep their money in emerging markets, which should make for much stronger currencies, domestic boot markets. But it also raises a very important question, which is that for the past 25 years, the US has been running massive current account deficits, year in, year out. There's now trillions of dollars floating outside the US that grease the wheel of global trade, that are people's working capital. And yes, that make up everybody's safety cushion. If you're a rich Indonesian and a rich guy from Nigeria or et cetera, you're going to have your safety cushion in US dollars. And if now all of a sudden you think, you know what?
24:49 Speaker 02 That safety cushion isn't as safe as I thought it was, and it's dependent on too many factors that I can't control, then I need to shift that cushion to something else, which means that you conceptually could have trillions of dollars that are currently floating outside of the US, coming back into the US at the worst possible time, right? Because you already have 8% inflation in the US. And if all this money that's now floating abroad comes back, your inflation rate is going to jump even further. US dollar goes down, everything you import from emerging markets go up, et cetera. And so, just as the Western world has basically, in essence, told, we'll change the rules on you without any debate, discussion, no parliamentary measures, nothing. It's just, you know what?
25:33 Speaker 02 We don't like you, you're Russian, you're rich, therefore you're punished. And by the way, you're punished whether you're in England, you're punished whether you're in France, you're punished whether you're in Switzerland. I mean, Switzerland, for crying out loud. This is the place that banked for the Nazis all throughout World War II and even thereafter. The Nazis that managed to make it to Argentina, to Brazil, they kept their Swiss bank accounts. And here, you know... Like if I was Michael Friedman, I'd be feeling a little pissed. Be like, what? You're taking my money and not Mengele's, not Adolf Heikman's. He gets to keep his account and I don't. And so all this to say that this is a dramatic shift with many consequences. The most obvious one for me is you're going to have to have the birth of new financial centers, which might be Hong Kong, might be Singapore, might be Dubai.
26:19 Speaker 02 But money will be starting to move away from Western world.
26:22 Ted Seides? Yeah, well, that's the key question, right? If you're feel your assets are less safe in dollars, you have to do something else. What do you think that something else is today?
26:33 Speaker 02 Well, so like I think the today, if you're a rich Russian tycoon, a rich Russian oligarch, you probably wish you had, I don't know, 30, 40, 50 million bucks in gold bars and that you probably had 30, 40, 50 million bucks in Bitcoins on a USB key somewhere. Because what we now know is A, how quickly the rules can change and how quickly things can unravel and how everything can get seized in a heartbeat. And so if you're, I think, a super rich guy, you probably think I need to have some assets that are off the grid, for lack of a better word. And there's only two of them really. It's gold and it's Bitcoin. So that if I need to leave and I can leave somewhere and I can leave with 50 million bucks in Bitcoin and if that means I need to move to Dubai or I need to move to China
27:17 Speaker 02 or I need to move to wherever, I can do so. So that's, I would say, the first order consequence. All of a sudden, a bigger bid for... The second order consequence, if I'm a very rich guy, is I probably need to have many more bank accounts than I thought I did. Before I could think, okay, I'll have all my money in my bank account with UBS at Zurich, in Zurich, because nothing's going to happen there. But now I probably think I need an account in Zurich, I need an account in Singapore, I need an account in Dubai, I need an account in Hong Kong, I need an account in Panama. So that if tomorrow, again, I'm a rich Chinese guy, China invades Taiwan, maybe UAE condemns me, but Panama doesn't. Who knows how things unravel? So that's the second order consequence. But the third order consequence is...
28:02 Speaker 02 Is all the repercussions from that. So here Switzerland for me is the best example. Switzerland has been for the past 10 years, one of the biggest buyers of the 50th large cap, large cap growth, growth, large cap stocks in the world. It basically sits on the bid day in, day out. Why? Because every day it tries to keep the Swiss franc down. And the reason it keeps the Swiss franc down is the Swiss franc is perceived as a strong currency. So you look at Switzerland, they've in essence managed to build themselves a sovereign wealth fund, massive sovereign wealth fund. The Swiss National Bank is a massive sovereign wealth fund without having to sell anything. Idea, Norwegians Bank, they had to sell oil, they had to sell gas, they got money and they recycled it into
28:44 Speaker 02 assets. All Switzerland sold was the credibility of its currency. And because people wanted that, it's not one of the top 10 shoulders in Apple, one of the top 10 shoulders in Microsoft, et cetera. But this may no longer be the case. People may no longer think, okay, Switzerland is the ultimate safe assets, therefore I need to have my Swiss francs, et cetera. Instead of buying Swiss francs, people may now be selling it. And so the days of the Swiss francs sitting on the bid of every large cap tech stocks may be behind us. And so lots of consequences. The reality is when you start changing the rules of the game, you never know quite how things happen. You change the rules and people adapt, then the game goes on.
29:26 Ted Seides? You touched earlier on the rise in energy prices. And I'm kind of curious your thoughts on what happens from here.
29:34 Speaker 02 My starting point is before the Ukraine war started, before Ukraine invasion started, we were already entering into an energy crisis. And you saw this very clearly this past summer when China had to shut down steel mills, shut down naval shipyards, ban Bitcoin, all of which because it was too energy intensive and China didn't have enough energy. So we've been in an unfolding, a slow moving energy crisis, which was the result of a number of factors. But the number one factor, of course, was that so much capital was destroyed in the US shale oil patch. For me, the biggest macro development of the past decade is actually the US shale revolution. The US moving from 5 million barrels per day to 13 million barrels
30:14 Speaker 02 per day in less than a decade, broadly adding a Saudi Arabia, meant that you witness a massive collapse in inflation in the US because the price of energy in the US, as gas went from 10 bucks to 250, inflation went down in the US. US trade balance improved dramatically, which led to a stronger dollar. Stronger dollar, weak inflation allowed the Fed to stay easier much longer than anybody expected. And so you had a decade of, in essence, a Fed being super easy against a backdrop of a strong dollar and therefore a massive outperformance of US assets. The US shale revolution, however, it was a miracle for US policymakers. It was a miracle for US consumers. It was a miracle for US manufacturers.
30:55 Speaker 02 It was an absolute disaster and nightmare for investors in US energy. More than 300 billion of complete capital destruction occurred in the US shale oil patch. And so the appetite to keep going just isn't there, wasn't there. Even with Orlid a hundred bucks or wherever it is today, you're still not seeing a pickup in US capital spending in energy. So the US day of adding massively into the energy balance are behind us. While you had the US shale patch, you saw no increase in energy capital spending in the Middle East. And finally, Europe followed a complete boneheaded energy policies that were basically reliant on two things. The hope and prayer that alternatives would turn out to be much more productive than what
31:40 Speaker 02 they knew they were. So that was sort of magical thinking there. And on the other, the belief that, well, if alternative energy ends up falling short, which it is falling short, we'll have Russia to step in and make the adjustment. And here I want to be very frank, I think if Europe hadn't followed such a boneheaded energy policy, perhaps Russia wouldn't have invaded Ukraine. The fact that Europe puts itself so dependent on Russia gave Russia perhaps some hubris and some view that we can go ahead and do this because nobody will dare, in a world that is short energy, nobody will dare to punish us. And so that's the situation we're in now. We were entering into an energy crisis because of the wrong decisions made in terms of energy policy.
32:25 Speaker 02 We've, in essence, emboldened Russia to do what it's done and it's Murphy's Law. It's like now we've made a bad situation much, much worse. And so I think, you know, this energy crisis is unfolding and the biggest victim of all will of course be Europe. Because if you look at block by block, the US, energy-wise... Sure, the consumer doesn't like it when energy prices goes up. But in the past, when energy prices went up in the US, it meant that money was leaving the US consumer's pocket to go to Venezuela, to go to Nigeria, to go to Russia, to go to Saudi Arabia, and that would mean at the time a US recession. This time around for the US, energy prices going up means money leaving New York to go to Texas. It means money leaving Michigan to go to Oklahoma.
33:08 Speaker 02 As a whole, for the US, it doesn't matter too much. Now granted, it's going to create some imbalances with the US. I wouldn't want to belong any munis in an energy importing state, any municipal bonds in an energy importing state, because the economic devastation there is going to be pretty severe. But meanwhile, Texas is going to boom. Colorado is going to boom. Oklahoma, Louisiana, it's going to be phenomenal. In China, they're dealing with the energy crisis in a different way. Last summer, China decided to reopen its coal mines. China had spent the past 10 years seeing a consolidation in coal production. It kept falling. It had gone from 50 million ton in 2000 to 350 million ton in 2011, and then it had fallen back down to 300 million tons. We're now back at 400 million tons.
33:52 Speaker 02 So China has basically said, look, in a world that's entering an energy crisis, I'm going to pick being polluted over being cold. I'm not even going to bother going to COP26. I'm not going to pretend that I'm going to follow these rules. I'm basically in a world where the energy prices is going up. I'm going to go down the quality and increase the pollution. That's China's policy response. And then China just gets gifted Russia on a silver platter, because now all of a sudden, China can buy the Russian energy, not only at a discount, but it can buy it in its own currency. So for China, it basically means that energy becomes free. If you buy your energy in your own currency, it's a huge comparative advantage. So China should actually be fine out of all of this. The real loser in all of this is Europe.
34:36 Speaker 02 I mean, Europe is the one that now has to pay a lot more for its energy and pay for it in US dollars and doesn't have even the right infrastructure. You say, oh, it's okay, the US will ship natural gas to Europe. Qatar will ship natural gas here. We don't have the infrastructure. We don't have the boats. We don't have the ports. We don't have the terminals to bring in the gas. It's, Europe is... In pretty dire straits. And so Europe will be, as today, we're in an inflationary boom. Global growth is pretty decent and inflation is still very strong. The breaking point, the weak link in the system is Europe. So you have to monitor Europe because that will be the part that will hit the skids. As the energy price goes up, Europe will go bust. The only question is at what price?
35:17 Ted Seides? So you talked earlier about this increase in military spending as well. Yeah, we are seeing military activity we have not in decades. So just again, would love your thoughts on what this means and the implications of this quick action.
35:31 Speaker 02 Yeah, well, again, I think it's the CYA thing. It's like, oh, something bad happens, something needs to be done. Increasing military spending is something, so let's do that. But you know, what have we announced? We've announced, well, look at Germany being the prime example of this. So here's a country with whatever it is, I think it's seven and a half percent inflation right now, and significant budget deficits. And inflation is never popular anywhere, but in Germany, as your listeners know, it comes denoted with some very heavy historical context. The German population is definitely not keen on inflation. And as you're dealing with this inflation crisis, you also have an immigration crisis, not one, but two immigration crises looming, right?
36:15 Speaker 02 The first one, of course, is the immigration from Ukraine, which is understandable. Millions of Ukrainians are showing up in Europe and it's our duty, of course, to help all these refugees. And you know that most likely soon enough, you're going to get a refugee crisis coming in from North Africa and the Middle East, if only because of soaring food prices and soaring energy prices and the extremely likely political instability that high food prices and high energy prices tend to unleash. Last time, if you go back to the last time food and energy prices went through the roof in 2011, you basically had the whole of Southern Europe that went bust. Greece went bust, Italy and Spain almost went bust. And of course, you had the whole Arab Spring that unleashed a wave of immigrants into Europe.
36:58 Speaker 02 So same causes, we should probably expect same consequences. If you're a European policymaker today, you should be bracing yourself for these events and figuring out, okay, how do I tackle these problems? Is buying a bunch of warplanes from Lockheed Martin and buying a bunch of missiles from Raytheon? Really the best approach to this? To me, it strikes me as smart as France building the Maginot Line in the 1930s. And I say this for a few reasons. The first is, we've seen with this Ukraine conflict, but also with the Armenia Azerbaijan conflict, or frankly, with the Yemen Saudi Arabia conflict, that warfare is changing. Technologically, it's not what it used to be. You can now buy these planes that Lockheed sells.
37:42 Speaker 02 They go from anywhere from 120 million bucks to 300 million bucks with, and it takes a couple million bucks to train the pilots. And then they get taken out by drones produced by Turkey that cost 750,000 bucks, just like the tanks do. One of the big lessons out of Ukraine is that the struggle that Russia's had to control the skies, even though it has 20 times as many planes as Ukraine, because Ukraine is loaded with drones. Warfare is changing in front of our very eyes. These super expensive planes, do they still make sense in an era of 750,000 dollar drones? I'm not sure. So today, European reaction to this, which is in essence, let's buy a bunch of US-made weapons, is gonna make domestic inflation worse, in that it deteriorates further the
38:25 Speaker 02 current account balances, which then leads to weaker currency, which leads to greater inflation, etc. It's poor public spending in that you're gonna get no return on that money. And it's frankly, I think, poor military spending. So it's, again, it's, something bad happens, let's completely change in less than 48 hours how we decide to spend our budgets. Let's decide, oh, let's, oh, quick, let's do something. Okay, let's order 35 planes from the US, that's something. But it's like, have we talked to the generals about this? Have we done a proper review? No, all this is decided in 24 hours. And by the way, people in emerging markets notice this. One of the strengths of the Western world, beyond the rule of law, was the view that
39:10 Speaker 02 the guys who make policies in the US, in Europe, etc., are smart. I think if you're a policymaker in Nigeria, if you're a policymaker in Thailand, you would look to the guys at the US Treasuries, or the guys at the French Defense Department, and think, these are the guys, they're top in their field. These guys, they're like, they're the business. You know, these guys are the sharpest guys in the room.
39:35 Ted Seides? Louis, there's a lot of reason to be pessimistic in everything you've said. And I'm wondering, as you look out, where do you see windows of opportunity?
39:45 Speaker 02 I'm actually a cheerful and hopeful guy. I don't mean to depress your listeners, but the reality is we nonetheless have to acknowledge that the investment environment is changing in front of our very eyes, that we live in a world with greater uncertainty and making a lot of money at a time of tightening monetary policies, which is where we are, rising energy prices, which is where we are, and most likely tightening fiscal policy, which is where we'll be heading, at least in the US following the midterm elections. That's a tough backdrop. You know, how often have you made lots of money on markets with tight fiscal, tight monetary and rising energy prices? It's a tough backdrop to make money. It doesn't mean it's impossible. Now, my starting point, when I look at markets, is that there's three ways to make money in financial markets.
40:30 Speaker 02 You can make money running some kind of carry trade. You can make money running some kind of momentum trade. And you can make money running some kind of return to the mean trade. Now, the reality is the past decade has been the era of the momentum investor and to some extent, the era of the carry trade guys, because you could always count on the central banks having your back and collapsing interest rates and printing money, et cetera. What I would like to suggest to you is that the era of the momentum investor and the era of the carry trade investor are now done. We've entered the period of the return to the mean investor. And what we're seeing in the markets for the past six months is that all the undervalued assets are thriving, whether your energy, whether your materials, whether you're Latin
41:15 Speaker 02 America, whether your commodity currencies, whether you're a lot of the emerging market currencies, this is what's going up. This is the new trend and this is what you have to play. This trend is very, very far from over, partly because a lot of what is a return to the mean trade, a lot of investors can't touch today. I just came back from Europe and I saw a number of our clients and I was telling them, look, you got to own energy and you got to own metals and you got... Most of the clients I talked to say, "We can't." Like because of ESG constraints, because of this, because of that, we just can't. And so... That means there's tremendous opportunities for the rest of us. Like, nobody owns this stuff yet. So we're in an energy crisis. Everybody knows that we're in an energy crisis.
42:00 Speaker 02 Everybody can see it. And yet, nobody's overweight energy, or very few people are. I think that's great. Where are the opportunities today? Well, look at it this way. For 25 years, emerging markets have had to maintain undervalued currencies to always accumulate US Treasuries, to always accumulate US dollars. If this is potentially, and I'm not saying it is, but I think there's a good chance it could be over, then the opportunity set in emerging market bonds, in emerging market currencies, and even in emerging market equities is simply enormous. I look at emerging markets today, both in relative terms when it comes to valuation,
42:41 Speaker 02 but also just on fundamental terms when I look at the shift, the structural shifts that are undergoing in the world. The Western world basically doing everything it can to undermine the very strength of its system by undermining its rule of law, by undermining the sanctity of property rights. That leaves me super bullish on emerging markets. I want to own a lot of emerging market debt today.
43:04 Ted Seides? So one last question, which is if we turn this lens to your wheelhouse of China, right? Very early on, there was this question, oh, what does this mean about China's potential to invade Taiwan? Where are your thoughts on the local scenario for you based on this?
43:20 Speaker 02 So I've never been a big believer in China invading Taiwan. And nothing that's really happened in the past six weeks has changed my mind on this. Perhaps even the opposite. This Ukraine invasion has shown that invading a country is not easy. And we've known that. I think we saw it with Iraq, we saw it with Afghanistan, we saw it with the Saudis in Yemen. How often does the invader get to win? Invading is tough business. And so I was never a big believer in. And by the way, invading over the sea is extremely hard, extremely hard. And so I was never a big believer in China invading Taiwan in the first place. And I would say that the sanctions that Russia's being Hit by the struggle that their army has had.
44:03 Speaker 02 If anything, it really highlights to Xi Jinping that the risks are really pretty big. It'd be a hell of a dice to roll to go ahead with this. So in that respect, I could say that this is going to sound callous, but if you want to look for a silver lining to this horrible Ukraine situation, perhaps this is it. If ever Xi Jinping had thought of invading Taiwan, he'll now think twice and three times and four times. And not only that, but the people around him, because China, you know, China's a dictatorship as well, but it is a dictatorship of the Politburo more than one man. Now granted, Xi Jinping has accumulated more power than his predecessors, but they're still a Politburo. So even if Xi Jinping said tomorrow, let's do this, probably the Politburo would grow a backbone and say, let's not.
44:47 Speaker 02 If you want to look for a silver lining to this horrible Ukraine mess, for me, that's it.
44:52 Ted Seides? All right, Louis, I don't want to let you go without asking a couple of fun closing questions. So what's your favorite hobby or activity outside of work and family?
45:00 Speaker 02 Well, I'm very involved in rugby. My dad and I own a professional team in France called the Biarritz Olympique. I still play myself, actually, and I used to coach, I'd ref. So I'm very involved in that. And it's been a big part of my life. Where I come from in the south of France, rugby is a very, very big part of the culture, of the cultural makeup, of the, I would say, the identity of the place. And I guess you can take the boy out of southwest of France, but you can't take the southwest of France out of the boy.
45:29 Ted Seides? What's your biggest investment pet peeve?
45:31 Speaker 02 My biggest investment pet peeve probably is, and it's not a pet peeve, but it's a frustration I've had over 15 years, is people applying things that work in a country and looking at China and saying, because it happened this way in the US, it will happen this way in China. And sort of not taking into account all, frankly, all the differences of the local system. This has been for me the most obvious. I've spent way too many hours of my lifetime. Explaining over the past fifteen years that the Chinese banking system wasn't about to implode, that the Chinese real estate bubble wasn't going to lead to the bankruptcy of every Chinese bank, and wasn't going to lead to a massive devaluation of the renminbi.
46:14 Speaker 02 I think part of the problem, this view of China being about to implode, really came to the fore in the wake of the US crisis. So many investors saw, okay, US had a real estate bubble, real estate bubble imploded, and the US banks went bust. And so then they can't come to China and say, oh, China has a real estate bubble, ergo, it's going to burst, ergo, the Chinese banking system is going to burst and everything's going to collapse. And the reality is, you're comparing, it's not that you're comparing apples and oranges, you're comparing apples to tennis balls. They're not, it's not even the same fruit, it's not the same system, it's not, and so all the rules that you think you know, you can't apply.
46:50 Ted Seides? Which two people have had the biggest impact on your professional life?
46:54 Speaker 02 Like, I know this is going to sound corny, but it's hard enough for me not to mention my dad. He and I have been in business together, and he's taught me a lot, a lot of what I know. And frankly, I would say the other one is my other business partner, Anatol Kuletsky. The three of us have now been together for more than twenty years, which, you know, for a partnership is, that's longer than most people's marriages. I don't think over these twenty years, we've ever had a single fight. And what is amazing is we have completely different worldviews, and completely different political opinions. And you would look at any market situation, and we seldom have the same feeling about it. And to me, this is what has made our strength as a firm, to be honest, is our tremendous disparity
47:36 Speaker 02 of beliefs, of thoughts. And these two guys have definitely had the greatest influence on me.
47:41 Ted Seides? What teaching from your parents, or touched on your dad, has most stayed with you?
47:46 Speaker 02 To always walk a mile in somebody else's shoes. Before you get in a fight with anybody, walk a mile in their shoes. Like this, when you fight, you're a mile away and you have their shoes. And it's, so no, always try to see things from the other person's eyes.
48:00 Ted Seides? All right, Louis, last one. What life lesson have you learned that you wish you knew a lot earlier in life?
48:04 Speaker 02 Get up earlier and work harder. The harder I work, the luckier I tend to be. I look at big parts of my youth as perhaps being somewhat misspent. I could have done better, but I learnt it in time.
48:17 Ted Seides? Louis, thanks so much for sharing the views and taking the time.
48:20 Speaker 02 Absolutely, my pleasure. Great to see you.
48:22 Ted Seides? Thanks for listening to the show. If you like what you heard, hop on our website at capitalallocators.com where you can access past shows, join our mailing list, and sign up for premium content. Have a good one and see you next time.
Previous [REPLAY] Marko Papic – Geopolitical Alpha at Clocktower Group (Capital Allocators, EP.161) Next Geopolitical Uncertainty – James Aitken, Louis-Vincent Gave, and Marko Papic (EP.440) Page updated November 3, 2026 · transcript and summary are machine-generated
