This ‘Inflationista’ Makes the Case for No Recession — Just Yet

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• Quarter after quarter, we’ve heard that a recession is looming. But we’re not seeing the economic indicators of a downturn. What are those factors, really?
• Louis-Vincent Gave makes the case that we shouldn’t expect a recession anytime soon.
• Why hasn’t inflation completely gone away — and what are the deflationary forces to look out for?

Amidst the buzzy narratives of an impending recession, a closer look at the underlying factors of global macronomics may suggest otherwise. Predicting economic downturns is a delicate art, and the current climate is no exception.  

Louis-Vincent Gave, Founding Partner and CEO of Gavekal Research, thinks we should keep calm and carry on. He makes the case that we shouldn’t expect a recession anytime soon.

“Well, first we have to clearly define what we mean by ‘recession,’” says Louis. “Because if we mean two negative quarters in a row, we actually had that in 2022 … but we had no meaningful increase in unemployment whatsoever.”

By that metric, a recession happened last year — and “it had zero impact on the markets,” he notes.

However, if by “recession,” we mean a period in which unemployment rises “meaningful, to the point where people cut back on their consumption,” leading to a “negative spiral” (in which more unemployment begets less consumption, which in turn begets further unemployment) — well, “right now, we’re definitely not seeing it again,” Louis says.

A self-described “inflationista,” Louis joined host Alan Dunne for a Global Macro episode of Top Traders Unplugged to talk about U.S. fiscal policy, the peaceful relationship between Iran and Saudi Arabia, “de-dollarization,” his take on AI, and more. Read on for highlights of Louis and Alan’s discussion about the advantages and disadvantages of inflation — and how weather patterns may be an underappreciated risk to inflation in the next few years. 

‘Inflationista’ rising

At the moment, employment numbers are strong and wages are still rising (“especially wages at the high end”), says Louis. The massive Inflation Reduction Act all but assures a big increase in infrastructure spending “right in time for the presidential election,” he adds. Some of the biggest states in the U.S. will soon ramp up spending as well.  

“So I look at all this and I think, Where is the increase in unemployment going to come from? … Ask anybody who’s trying to hire people: The labor market is super tight, especially at the low end. Wages are going up … so consumption stays strong.”

That reminds Alan of a piece Louis wrote recently about the “inflation-deflation debate.” 

“Initially I was a bit surprised to see you talking about this,” Alan tells Louis. “Because such a narrative has built up that inflation is coming down, and coming down steadily. … From your perspective, particularly if you see the economy as staying strong — fueled by fiscal expansion — where do you see inflation settling in the next couple of years?”

Louis says he will remain an “inflationista” publicly betting on high inflation, at least in part because he sees no fiscal consolidation. 

“I think if you’re serious about getting inflation under control, you’re not running budget deficits of 6%, 7%, 8% of GDP while you have full employment,” he adds. “You’re just not.”

Bullish on undervalued currencies

Louis points out that the financial milieu of the 1970s was the last example of a prodigious inflationary period. If we study emerging markets that have experienced inflation over the past 30 years, we find that inflation is a “volatile variable,” he says. “You go up to 10%, and you go back down to 3%, and then you go back to 6%, et cetera.”

Now, inflation is back to 4% or 4.5%, and that’s unequivocally good news. 

“We’re heading in the right direction and disinflation is back,” Louis says. “First, 4.5 is too high. Let’s put it out there. When I left the army, I was 75 kilos. I’m [currently] 95 kilos. Now, I’m still getting fatter every year. I’m just doing it at a slower pace, but I’m still not getting back to my optimal 75 kilos. So we still have inflation in the system. Let’s not kid ourselves.”

The disinflation “basically all came from [the] energy [sector],” he explains. 

But energy prices begin to “roll off” in the third quarter “because the year-on-year comparisons get much tougher,” Louis adds 

He’s not saying there aren’t other deflationary forces to consider, however.

Right now, some of those deflationary forces are “surprisingly weak” Asian currencies. Louis considers himself a “big bull” on Asian currencies, but he admits he has been “wrongfooted” by the weakness of the renminbi, the won and the yen this year.

These countries are the anchors of a region where “most of the stuff in the world is produced nowadays,” he notes. 

Louis thinks Asian currencies will likely continue to soften, so to speak. 

“I think your hope has to be that China continues to weaken and therefore, the renminbi continues to go down and Japan continues to do yield curve controls — so the yen continues to go down. But again, those two currencies are now seriously undervalued.”

It’s not impossible that something seriously undervalued declines even more over the long term, “but it’s just a tougher bet,” he adds.”

The ‘boom-bust cycle’

However, on the inflation side, Louis is fearful of several things that could happen in the near future.  

“I think we’re heading back to a summer of strikes in the U.S.,” he says. “And it all starts with the weather. By all accounts, it looks like we’re going to have a pretty strong El Niño this year, [which] means that the temperature goes up in a lot of places, not least of which in Central America.”

The Panama Canal is already “running dry,” he adds. The canal is above sea level and fed by a lake, so really big boats can’t pass through it. That gives power to the dockworkers on the West Coast. Next thing you know, those workers’ unions choose to go on strike. That could trigger a domino effect — possibly, the Teamsters could strike. The Teamsters union represents millions of truck drivers, including 34,000 UPS drivers.

Strikes like these, if they happen, will coincide with low inventories. Why? 

“Six months ago, everybody was telling us there was going to be a recession. So every procurement manager everywhere was like, I’m not going to stock up on inventories.”

Louis calls this phenomenon “the typical boom-bust cycle.” 

In the early days of the pandemic, low inventories and supply chain dislocations meant purchasers “triple-ordered” goods. Later, companies had to work through excess inventories and those buyers don’t want to make that mistake again. 

“Instead, they’re doing the mistake they did the previous time — where they under-ordered and now we’re back to strikes with low inventories. So I think we could easily head back to a summer of supply chain dislocations.”

But it’s a dry heat

There’s another geopolitical challenge on the horizon: fallout from unpredictable, ever-more-extreme weather.

Typically, El Niño leads to bad harvests — “a very dry Midwest and a very dry Asia,” says Louis. “Now, if it’s a one-year El Nino, that’s not that big a deal. So for this year, it might not be that much of a problem. Next year, it could become problematic.” 

“We still haven’t resolved Europe’s energy issues,” he says. “We got lucky this winter. I say ‘we’ because I’m French. We got lucky this winter because … [in Europe] the winter was fairly mild. Hopefully, we get lucky again this year, but that’s a coin toss.”

Just to make things interesting: deglobalization

The inflation/deflation debate includes another major factor: deglobalization.

“I think deglobalization is a polite word to hide what we really mean, which is de-sinicization. Because if you live in Shanghai, Beijing or Hong Kong, it definitely feels like your world is deglobalizing,” says Louis. “All of a sudden, there are fewer white people walking around the streets. All of a sudden, VC firms are shutting down their offices and it feels like China is being shunned. If you’re Chinese and you’re a graduate student hoping to do a Ph.D. in the U.S., things have gotten much harder.”

However, if you live in India, Dubai, Indonesia or Mexico, “it doesn’t feel like your world is deglobalizing at all,” he adds. “Your world is globalizing at an accelerated pace. People in Mexico are complaining of the number of expats. India all of a sudden is getting Apple factories. So deglobalization depends on where you stand.”

What if we never stand still? Stay tuned for more insights on our global macro-driven world.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.