Hello my friends. Today is June 20th and this is Markets Weekly. All right, so last week the big event of course was Cher Kevin's first presser. I covered that extensively on a podcast on forward guidance that's been uploaded to the channel. The second biggest event of course was a at least temporary resolution to the US Iran war that has sent oil prices absolutely plummeting. And despite that though, central banks across the world are still expected to continue on their mini hiking cycle. So, first let's talk about what's happening in the Middle East and why I think that it will be a durable piece. And secondly, let's talk about something a bit more thematic. That is the China shock 2.0 that is really changing the world and seems to be shaping European policy as well. Whereas Euroland is now also considering to erect their own tariff wall. All right, starting with the Iran war. So over the past few months, we've heard over and over again from the president that guys, war is going to end soon, war is going to end soon. Actually, I think since the first week of the war and President Trump has proved to be a master at managing the market. But over the 30some times he's declared an end to the war, it was just kind of fake. But last week and though he announced he had reached a memorandum of understanding with Iran and in the following days actually signed an agreement at Versailles of all places. So it seems like something really is different. Now at a high level the memorandum of understanding basically is the US giving Iran a lot of money to get out of the conflict. Now, if you've been following this channel, it was crystal clear to me as early as in March that this would be the outcome. Now, over the past few weeks, many people have been like, "Joseph, you don't understand geopolitics. You have knowledge gaps. Stay in your lane." But as it turns out, guys, I do geopolitics just fine. Now, why did the US enter in such an unfavorable deal? Well, the president is pretty candid. Let's listen to what he said at a G7 press conference in France. rather than possibly going into a depression. Rather than having your favorite president be Herbert Hoover, that was always the one I didn't want to be. I wouldn't have preferred Nixon. I wouldn't have preferred There were plenty I wouldn't prefer, but the one I always thought of, Herbert Hoover, and he caused it. He raised taxes too fast and he raised interest rates too fast all at the same time. and it caused the great depression. So I don't think I'll make mistakes like that. I lower >> So basically the president did not want to cause economic catastrophe. President Herbert Hoover was the US president that presided over the Great Depression. As we've been discussing over the past few weeks, the US has been heavily drawing down on its strategic petroleum reserves and strategic petroleum reserves were reaching a minimal operational level such that when you fill beneath it, you kind of can't draw on it anymore and oil prices could potentially shoot up. You even had many major US oil CEOs basically make the media rounds warning the White House and the public about this. And by many estimates that would have happened in just a few weeks. So the president basically ran out of time. He had to open up find some way to open up the street of Hormuz. Now even with the straight of Hermoose opened, it would take a few weeks for oil to leave the straight and reach its destination and it will take a few months for oil production facilities that had been idle in the Middle East to restart. So all this is a lagged process. Now, Professor Robert Pra of the University of Chicago is noting that we are at a window in time where Iran has its maximum leverage, right? Because oil stocks are low, it takes some time before opening up this trade uh to to for oil to get out. So, this is a time where, you know, they they uh Iran basically has the cards. Now, Trump basically sent has been trying to distance himself from this deal. It is obviously not looking good for the US. But I want to give credit credit to the president. Uh many US persons in the past have doubled or tripled down uh on unsuccessful military ventures for example in Vietnam and that just led to a bigger disaster. But the president did cut his losses and got out. He sent of course JD Vance to be the face of this deal and JD has been making the rounds strongly trying to sell this very difficult job. The president also joked that uh you know he JD will just be the fall guy if this deal doesn't work out. Let's listen to what the president said. >> If it works out great, you look like a genius for sending him. And if it doesn't work out, it's the vice president. >> I like that idea. Well, this way. If it works out, I'm going to take the credit. If it doesn't work out, I'm blaming JD. You better be careful, JD. He's going to turn his plane around and get the hell out of here. Yeah, I like that idea. I think it's a good idea.

So many people are concerned that you know this deal might not be stable because part of the pillars of the deal is a ceasefire in Lebanon and that's where we have to remember that there are three people at this table and Israel is the party that has been bombing Lebanon and you know they don't want to be bound by this agreement. Now also remember that there are upcoming elections in Israel towards the end of this year and Prime Minister Netanyahu really wants to be able to run on a successful war and and this would not help him. So as we're recording today uh it seems like there's headlines saying that the straight of Hamus is again closed because uh Israel continue to bomb Lebanon. But now this is this is what makes it very difficult for the ceasefire to hold and many people are understandably skeptical. There's actually a report in the Washington Post citing US intelligence saying that the Israelis will try to undermine the ceasefire. But I also note though that it seems like the US is pressing their leverage to try to control Israel. And so that determination that I see coming from US politicians is what makes me think that this is actually something that will hold uh at least for a few months. So you have the president report suggesting making calls to the political revi rivals of prime minister Netanyahu. The threat being of course is that if BB does not behave, Trump will endorse one of his political rivals and that is is not good for BB. But more importantly though, you have Vice President JD Vance making some very strong public comments on the US-Israeli relationship. So in his public comments and this is something that if you don't follow US politics you may not realize it is something that is truly revolutionary coming from a Republican politician basically saying that you know if you look out throughout the world the US is basically your only friend. the Israel has really isolated itself with his actions in Gaza and also JD Vance is very openly saying that you know most of the defense in Israel is provided uh by the US. So without the US you really can't defend itself. So that is a significant leverage point that it seems like the US is exercising. And so that tells me that yeah, this is this is a ceasefire that is probably going to hold and honestly it seems like maybe the Iran war is going to mark the twilight of the influence of the Israeli lobby in the US. So this is some some big changes that I think is is going to ripple through US Middle Eastern policy uh for decades to come. If you look at Iran as a country, they have 90 million people, highly educated, smart people. They have an industrial base. They can actually make a million cars a year, right? That is very different from say Saudi Arabia or Qatar, uh which are really just giant gas stations. So, um and of course, Iran controls Hermuz. So, they have a geopolitical power and a formal military. There is kind of it's not in the US's interest to push them into the Chinese sphere of influence. It's not don't have to be best friends but you know Iran is the natural hedgemon of the Gulf and it would be good to have at least you know not terrible relationships with them. there's really no uh doesn't benefit the US doesn't benefit the global economy for that and eventually maybe Iran would have a market be a market for US goods in the memorandum of understanding one of the stipulations is that the money released to Iran be spent on US goods so you know that that is maybe a beginning a very very small beginning

now the market is also buying into this peace agreement as well if you look at spot oil prices they've absolutely plummeted. So you can see spot Brent all the way down. This is not futures. This is oil that's traded today. So this is a large large disinflationary wave that is sweeping through the global economy. Now notwithstanding that though if you look at markets they are still pricing in an ongoing mini rate hiking cycle. You had the ECB hike not too long ago. You had the Bank of Japan hike last week. The market expects them to continue to hike. Market expects the Fed to continue to hike. And the market also expects other other banks like the Bank of Korea uh to also actually hike a few times. Korea may be special because as you can see the Colby speed literally doubled this year. So they have some financial stability concerns over there as well. So you're kind of in an interesting kind of predicament where the market began the price in rate hikes because oil prices surged and now that oil prices are coming down the market is actually not really taking away those hikes. I think that might be some tension that might be resolved perhaps in the coming months as the market becomes more comfortable that this is an in a durable ceasefire uh at least for the midterms. I'd say obviously uh oil prices are very important to the US voter but we'll see. It seems like this is a very positive development not just for the US but for the Middle East and the global economy.

All right, the second thing that I want to talk about is the China shock 2.0. So, first let's review a little bit. So, if you look at this chart, you can see what the China shock 1.0 and 2.0 are. Basically, a few decades ago, as China entered the WTO, you had literally a few hundred million people basically join the global economy. And those people specialized in manufacturing, right? So a lot of times it was just you know kind of cheap stuff like shoes like clothing and stuff like that. And as China entered in the global economy there has a tremendous increase of goods into the global economy and you can see that in the rise of Chinese exports. Now that goes a long way to explaining why for a period of time for for a few decades actually there was low inflation throughout the developed world. That low inflation was largely due to deflation in goods. They were importing lowcost goods from China that was keeping inflation low and not some like magical monetary policy stuff. Man, that that's so stupid. So you have a flood of real goods coming into the economy that pushes prices down to goods deflation and so that benefited the global economy significantly, right? That increased the living standards of everyone in the world as they had or access to lowercost goods. Now, at that time, people would widely consider Chinese-made goods to be cheap. Not just in price, but in quality as well. It was perceived to be stuff that was just not good quality. And indeed, a lot of the stuff was, you know, like cheap plastic toys and so forth. But over the past few decades, uh, China has really changed a lot and really advanced a lot in its technology. If you look at what China exports today, it's, you know, not so much plastic training kits and and textiles. A lot of that stuff has gone to places like Vietnam, but it is high-tech goods like iPhones, like battery technology, like solar panels, like electric cars. So, they've moved up significantly in the value chain. Whereas now, not only do they have worldclass manufacturing, many people call them uh no lights out manufacturing facilities because it's so automated that there are no lights on because there are no people in there. but also the quality of the goods has risen a lot. If you have a computer, many of the components will be made in China. So that's what people think of as the China shock 2.0. Now a large part of this boost in manufacturing is due to public policy. So as many of you know in China there is a huge property bust that really impacted Chinese growth. So the government began to devote resources into building out even an even more competitive manufacturing export sector. And uh the success of that can be seen in the surge in Chinese electric cars. And if you look at reviews on Google, you'll see that reviews of BYD electric cars, although you can't see them in the US, they are uh you can see them in other countries. And the car reviewers universally tell you that it is a very good highquality car. Now, if you look at this chart again with the China Shock 1.0 and 2.0, you notice that in the China Shock 1.0, zero Chinese exports increased but their imports increased as well. So in the US and Euroland and so forth they were receiving a lot of lowercost Chinese goods and that was bankrupting a lot of industries in their countries but at the same time it was a boost to some of their export oriented industries such that the you know it it wasn't it was a more politically complicated problem. It was helping some industries and hurting others. So some people were happy that the Chinese opened up their markets so that they could sell, you know, let's say Mercedes Mercedes or Louis Vuitton backs into China. So it wasn't an unambiguously good or a bad thing. But as you move to China shock 2.0, you can see that as Chinese exports have continued to surge, their imports really haven't grown. And that is in part because the economy in China isn't doing that well. So what's been happening in China shock 2.0 Zero is that you have the Chinese moving up the value chain and threatening a wider range of industries in the west and you have fewer western companies benefiting by being able to export into China and that is causing more political difficulties in the US.

That's of course led to the uh US China trade war with tariffs and so forth but it seems to be impacting Europe as well. Now, uh, in particular, when we look at a country like Germany, we'll notice that Germany, German growth hasn't been all that great over the past few years. Now, there's a lot of reasons for that. Part of it, of course, you have the Ukraine war that's driven up energy costs. You have a trade war with the US, but when you look at the performance of Germany compared to other European countries, it's still not that good. And that has to do with the business model that Germany had as an exporting powerhouse. So we all know Germany for example makes really good cars, very fancy cars that they export throughout the world. But in addition to that though they also do all sorts of other stuff. They are a world leader in machinery, machine tools and so forth and they would export that throughout the world. Their business model is kind of like China's to be an exporting superpower. Um but when you when when according to this paper a very good paper by Brad Ceser and uh Sander so you can see that a big reason according to their analysis why German growth hasn't been good over the past few years is because German exports have been declining in their contribution to growth. So the very core German economic export model is not working as well as it should. So what seems to be happening now is that as Chinese have moved up the value chain they are threatening uh the German business model. Now looking at this chart of German equipment uh exporting you can see that they used to equipment export equipment all throughout the world but you know that has gone way downhill that is Chinese competition stepping up. Now a good example of this of course is just looking at the Chinese car industry. You can see that over the past few years the number of Chinese cars being exported has absolutely surged whereas say car exports for Germany have basically plateaued. So you're in a situation where as a country your business model is basically uh being overtaken by China and you also of course Euroland doesn't have stuff like AI which has been causing the US market US economy to having this big buildout and so forth. So as a as a country, as a region, they have big problems. And one of the things that they're considering actually is to be do something similar uh basically to erect a tariff wall to try to make their own goods a bit more competitive relative to imports. Now, one reason that this would make sense is that there's a lot of Chinese policy that is supporting the export boom in China such that the playing field is not completely level. know standard things would go from like you know government subsidized loans and and so forth and uh all sorts of stuff in China to try to boost their exporting industry which is a major creator of growth and jobs but also from a financial perspective you they also are I guess managing their currency. So in theory in theory if you had a country like China who keeps selling a lot of stuff and earning a lot of euros earning a lot of dollars uh trade surplus to the tune of $1 trillion a year you would expect their currency to gradually strengthen right so you you're a Chinese manufacturer you are um earning euros and then you sell those euros for uh R&B R&B appreciates and that would naturally make your products more expensive to foreign markets and so maybe equilibiberate uh the market a bit but the Chinese government is of course managing the currency such that the Chinese currency is structurally undervalued and and some people estimate maybe 20 to 30% undervalued of course they have a trillion dollar surplus their currency should be much stronger than it is today and that could be part of the reason why that the market is unable to equilibriate Chinese continue to have a great surplus and if you have government policy kind of making it making market forces difficult to uh to work. Then the response of course is to also have a similar government policy. In the US that was tariffs and it looks like possibly in Europe that may be tariffs as well. So that's something that is continuing to to play out and we could have again another move towards a world that is a bit less globalized where there is more of an emphasis on um just just national sovereignty. Now I'll also note though a big reason why that our living standards have improved over the past few decades is because we have access to all these cheap cheaper lower cost imports right high quality stuff that's lower cost. So it hasn't been a bad thing to your living standards although it has been to let's say some industries and also of course uh your uh I guess national security because you're dependent upon other people for imports. Now recall that once upon a time Britain was the world's uh ind manufacturing superpower with the industrial revolution and all that and of course Britain uh became a proper superpower and ruled the world and once upon a time the US was a manufacturing superpower supporting of course turning out guns and butter winning wars and of course ultimately became the world superpower as well. So, you know, the wealth of a country, it's the country's ability to produce goods and services. It's not like how high your stock market is. That's just numbers in a computer screen, right? Wealth is real goods and services. So, being able to be a manufacturing superpower is what lets you to produce missiles like a thousand a day in China to project force and to raise the living standards of your people. And that actually is something that I think that the US has forgot. All right. So that's all prepared for today. Thanks so much for tuning in and um talk to you all next week.