Hello and welcome to our video #MacroMemo. We have plenty to cover this week. We'll talk about chaos in Russia in the context of an attempted recent coup, or at least revolt. We'll talk about inflation and the extent to which it's been cooperating, but not everywhere. Central banks certainly come up for discussion and they are starting a new mini tightening cycle, it appears.

We’ll spend some time on China looking both at Chinese local government debt and also at Chinese youth unemployment, two problems in China right now. And we’ll finish with a little look at Canadian demographics. So that's the plan.

Russian chaos: Let's circle around to the top, we’ll begin with Russian chaos. At least as I record this over the prior weekend, just a few days ago, there was an attempted revolt and maybe even a coup in Russia.

Russia's Wagner mercenary group, headed by the leader Yevgeny Prigozhin, had been complaining of incompetence on the part of the official military for a while. They had also been complaining of insufficient supplies being furnished to them. And they claimed that the Russian military had attacked them. Wagner group is a mercenary unit that has been, in theory, helping Russia attack Ukraine.

The response of the Wagner group was to pivot and go from attacking Ukraine to attacking Russia. The group captured a Russian city, captured a major military base, took a portion of Russia, and was rapidly approaching Moscow, seemingly for a potential significant conflict with as many as 25,000 troops. A deal was abruptly struck with the help of the Belarus president and so the convoy turned around and there wasn't a coup. The revolt, I suppose, is over.

The whole thing is very strange, in the sense that Russian citizens appeared to be welcoming the Wagner move. Prigozhin, the leader of the group, would now seem to be in considerable personal danger for the indefinite future, having attempted to unseat the government or at least the military. His soldiers are angry and potentially at risk themselves, having been exposed.

You really do have to ask what the point was. The actual effort went about as well as could have been hoped, and yet the Wagner group will now essentially be disbanded, or worse. The whole thing really is a head scratcher at this point. Maybe we'll learn more with time, but in the meantime, we can say there are a few implications that come from that.

1. From a Russian political perspective, it does appear that President Putin is in a less stable, secure position than once imagined. He's been shown to not be all powerful. There may well be other challengers out there, but we should stop short of cheering the possibility of him being unseated. At this juncture, any change in government is unlikely to yield a West-leaning liberal that the West would embrace. More likely would be someone else with a military background. As an example, Prigozhin might have been better in a purely Ukraine context. He'd expressed some doubt about that war. But he would conceivably be worse for the world in other ways, given his militaristic background and so on. So politically, Putin is less stable, but its not clear there's a better outcome down the road.

2. From a Ukrainian perspective, certainly this is all very good, with the disbanding of the Wagner group. This has been the most effective fighting force against Ukraine. So that's quite helpful. Some of those soldiers will be absorbed into the Russian military, but presumably not deployed as effectively. Russia may also feel compelled to have more military support closer to home, in other words, protecting Moscow against future such events. So on a number of fronts, I would say the Russian effort is somewhat diminished in the Ukraine. Perhaps the Ukraine can make more advances as it continues its spring offensive.

3. From an economic perspective, there’s really not many implications at the end of the day. For a moment, oil and gas prices were going higher, they were theoretically in play. In the short run, you would imagine higher prices. Over the medium run, even if there had been a coup, it wouldn't be clear quite how those prices would settle. You could say the upside argument would be that any kind of disruption could reduce production, and result in lower supply and higher prices. Conversely, if any new regime exited the war in Ukraine as an example, we might see some sanctions lifted and maybe oil and gas prices could fall.

So energy volatility would have been a story had we seen a change, but in the end we didn't. Let's move on from geopolitics.

Inflation: Let's talk about inflation for a moment. Inflation, of course, has been very problematic. It is far from solved. But we did get some fairly nice cooperation in most countries in the month of May.

Just as an example, U.S. CPI in May fell from 4.9% year-over-year (YOY) down to 4.0%. So that's “just” double the target of 2%. In Canada, the inflation in that month went from 4.4% to 3.4%, so that's quite a move. In theory, the Bank of Canada wants 2%, but it has some tolerance for 1% to 3%. We’re getting fairly close to the upper end of that band now that they're at 3.4%.

We believe June inflation should be fairly cooperative. That's the next month's data so we don't have that yet. Real-time inflation measures are hinting in that direction, base effects are also helpful. We're going to lose a big honking month of price increases from last year (May 2022). As a result, we should see many countries’ inflation prints, including the U.S., fall from where it is right now at 4.0% down to potentially 3% to 3.4%, maybe even towards the lower end of that range.

So inflation is cooperating somewhat, not all the way back to normal, though, and we'll talk about that in a moment. One country where it is fitfully cooperating, maybe even not cooperating, at least in May, is the UK. The UK has these extra challenges in the context of Brexit also being an inflationary force, and in the context of being on an island and reliant on imports to a heavy degree, with significant supply chain problems in recent years.

The inflation problem has just been all the greater in the UK. UK inflation in May was 8.7%. That's a lot higher than in the U.S. and Canada and a number of other markets. It was actually unchanged from April, didn't stage any improvement and quite worryingly, British wage growth is accelerating. It's actually actively accelerating and they're running at about 8% YOY, which is quite fast.

This is a country in which wage-price spiral risk is greater. In most countries, wage growth is settling down somewhat. It's robust but declining. In the UK, it's aggressively fast and still actually increasing. So the Bank of England responded with a big 50-basis-point rate hike. They’d been delivering 25-basis-point rate hikes for a while.

Monetary policy: That brings us quite naturally to central banks and monetary policy. Central banks have come a very long way. Over the last 18 months they've gone from roughly 0% rates in the developed world to roughly 5% rates. So that is quite a lot, and we've seen quantitative tightening as well.

I would describe the last couple of weeks as the institution of a new mini-tightening cycle. We've got the Reserve Bank of Australia with a surprise rate hike. Bank of Canada delivered – it wasn't a surprise, but it was after three months/decisions that were unchanged – a 25-basis-point rate hike, and signaled another one was likely coming.

Bank of England has just raised rates by 50-basis-points in one go. The market there is pricing that the policy rate goes from 5% where it is now, all the way to 6% in the not-too-distant future. The thinking is there could be a fair chunk of more work there.

Even in the U.S., the Fed was unchanged but signaled that two more rate hikes are the default expectation. This would take the U.S. policy rate up into the high 5%s.

So a number of central banks are doing more. I would say that is because, as much as inflation is coming down, it's still not where they'd like it to be. I think there's a bit of trepidation that economies are too strong and maybe housing is reviving a bit too much as well.

A few things can be taken from this. One is, of course, just higher interest rates, higher bond yields and so on. But central banks are proving they aren't going to simply accept 3% to 4% inflation as the new normal. They will fight for something more closely approximating their 2% targets.

As we've said before, we think that service inflation, which really is the problematic place right now, is going to be hard to control unless you get unemployment rates higher. It's very influenced by wages and unprecedented to get unemployment rates higher without getting a recession.

So theoretically, central banks need to induce a recession. They won't say that, I'm sure they're hoping to avoid that. But history would suggest if you need to weaken the labor market, you do need a recession at some point in time.

You can go so far as to say that if the most rate-sensitive sector of the economy, which is housing, is reviving in a number of countries – as it is right now – then you can argue that rates aren't nearly high enough. You'd expect that sector, at a minimum, to be softening significantly. I think that's motivating central banks to go further.

I hope they don't have to go to too much further. But nevertheless, clearly it's not quite enough when Canadian and U.S. and German and Australian and a number of housing markets have been reviving.

Again, central banks do have a little bit more work to do, that is a change. Previously it appeared they could be done in the realm of 5% and now a number of them are going to have to breach that threshold.

Okay, let's shift from central banks.

China: Let's talk about China in two contexts. These are problems we need to better understand.

1. Chinese local government debt. There's a lot of Chinese local government debt. The estimates are a little hazy and blurry, and there are all sorts of off-balance sheet transactions and things like that. But I would say it's reasonable to think that there could be $10 trillion USD of local government debt in China.

   Some claims go as high as $15 trillion USD. That's a lot of money. But for context, the U.S. Treasury market has about $24 trillion worth of U.S. federal government bonds. So it's not as big as that, but the U.S. is the biggest single debt market in the world. China is a big debt market as well.

   The reason it exists is that there's a structural mismatch. Local governments are expected to spend a lot of money on all the various services that people get in China. They really don't have the revenue tools to pay for that. So they earn some money by selling land, and that has not been a viable prospect recently given the housing bust in China.

   They do the rest by accumulating debt. So they've accumulated 10 to $15 trillion of debt. Two-thirds of local governments are estimated to be at risk of breaching the 120% debt-to-income threshold that the national government sets as sort of an unofficial limit. One-third of local governments in China are already struggling to make their interest rate payments.

   So this is a real problem. It's not China's first debt problem, China has once a decade encountered a debt problem. Generally, it handles them well, it has a standard playbook of extending maturities and lowering interest rates, etc. These are basically technical defaults, but officially you're still paying back the principal and so you can turn a bit of a blind eye. They are having policy banks and national asset managers get involved. In China, there's such a blurry line between many financial institutions and the government that it's a little unclear just who is paying for what. The bottom line is there is some coordinated response that exists right now.

   I don't think we should think of this as a financial crisis in the making. I don't think that's the story at all. I think it really is, instead, one in which there are potentially up to a few trillion dollars of losses to be absorbed. And those losses no doubt will be spread out across various banks and insurers and asset managers. The Chinese government will likely transfer more funds as well to the local governments.

   There is already a transfer system that works. But at the end of the day, this is money being sent towards bad credit as opposed to productive directions. It's fair to think that maybe Chinese credit and the flow of that credit over the next few years could be somewhat impeded as they're dealing with this big expense and they're not able to nurture new industries and so on to the extent they might like. And that's not ideal.

2. Chinese youth unemployment. Twenty-one percent is the youth unemployment rate in China. That is double the pre-pandemic level, that is four times the national level, which is 5%. It was never this high even during the COVID-19 lockdown, which is sort of strange, to the extent that a lot of high-touch service jobs went away, you would have thought young people would have been most adversely affected at that time.

   So it's a strange one.

   I should say it's not unusual for youth unemployment rates to be higher. Spain has a 28% youth unemployment rate, Italy has 20%. That's a little bit of cherry picking, those are the worst ones. But even the U.S. and Canada have a youth unemployment rate that's about double the overall unemployment rate. So it's normal to be higher, but not normal to be four times higher, so China does have a problem here. China doesn't have the sort of two-tier labor market that explains the Spanish and Italian Mediterranean country problem.

   We think some part of the China story is there's a double cohort. A lot of people went for more schooling during the pandemic, and so they're all coming out at once. That's been proving difficult to absorb.

   We think some is a sector mismatch. A lot of young people come out trained for education and the tech sector and China really cracked down on those two sectors in recent years. Some people think there are just too many educated young people coming out of China. I balk a little bit at that, usually more educated people is a wonderful thing. Even if they're underemployed, you still find a place for them. And so I'm not convinced that's quite the right answer. But that's one theory.

   The explanations aren't fully satisfying. It's a little bit mysterious why it's this high. We have some answers, but not all the answers. I would maybe abstract away and say it's certainly not good for the economy.

   It's also not good for political stability in China, in theory, at least. You have a young population failing to find its place in society. That can create unrest, so it's something to be tackled.

   The Chinese president recently expressed remarks that didn't show a whole lot of sympathy. He talked about returning to the rice paddies and things like that, which certainly isn't the aspiration for a recent university graduate.

   So this is an issue for China. It speaks to some real problems beneath the surface.

Canadian demographics: Let me finish just briefly with Canadian demographics. I'll start by saying Canada has roughly the same aging population, declining fertility rate, as a lot of other countries. So there is a demographic challenge in essence.

However, Canadian immigration is pretty remarkable right now. Canada has long been an immigrant-oriented country, but the federal government has been targeting ever more people. Five hundred thousand per year is the new target. That actually was well exceeded over the last year.

Through March, over the prior year, Canada actually attracted 1.05 million more people, more than a million. That's practically double the prior record. Some of that is catch up from the pandemic, some of this is temporary students. Temporary workers don't count towards that 500,000 target, but it's a million more people versus a year ago.

Canada, just in the last week or two, actually surpassed 40 million people in total for the first time. So this is some pretty fast population growth to a pretty significant number. This is remarkable stuff, and it seems set to continue.

It brings with it negative aspects from a housing affordability perspective, maybe also from a quality-of-life perspective. It brings positive aspects in terms of broad GDP growth. So positives and negatives, some are certainly attractive to the government in the sense that it helps the fiscal picture.

I can say that the growth is almost entirely immigration. In fact, we project that Canadian domestic population growth, ex-immigration, will trend down towards about zero over the next five years, so it will be entirely growth through immigration before too long.

Just to put into context, if you map Canada's population growth out through 2050, it’s no surprise that it's expected to outgrow the likes of Japan, Russia, China. They’re shrinking already. Maybe slightly surprising that Canada is set to outgrow the UK and U.S., those are traditionally peer nations. Amazingly, Canada is set to see population growth also outpace Brazil, Mexico, India. These are traditionally fast-growing countries, particularly India.

So it's worth understanding, not that population growth is necessarily set to be ultra-fast in coming decades, there is some slowing as the population ages and fertility rates are an issue. But the bottom line is with immigration, Canada is set to outpace a lot of countries, which does help a lot when it comes to that raw GDP horsepower.

Okay, that's it for me. Thank you so much for your time. Hopefully you found this interesting and please consider tuning in again next time.