Balancing Conviction and Risk: Masters in Business with Maria Vassalou

Maria Vassalou · Pictet Group

US debt is serviceable only if technology and innovation keep fuelling growth; leadership underwrites repayment.

Vassalou argues that issuing large amounts of debt eventually raises doubts about repayment, which erodes creditworthiness and, via the Triffin dilemma, the reserve currency role. The US has avoided this because its innovation and technology machinery acts as collateral: it fuels growth and so guarantees the ability to service debt. That collateral is what is now under threat from China's rise in technology.

“But if you have a great machinery of producing innovation and technology that fuels economic growth, then that effectively will be your guarantee that you will be able to service your debt.”at 30:38

Maria Vassalou · Pictet Group

US debt is now well over 100% of GDP, and rising yields make debt servicing more onerous.

Maria says US debt was modest until the financial crisis, which was followed by the COVID episode that raised it again. Debt-to-GDP is now well over 100%, versus far less before. A greater part of the budget deficit now goes to servicing debt, which becomes more onerous as yields rise. Foreigners hold close to 28% of US debt, adding some refinancing risk, unlike Japan where about 90% of debt is internally held. She says the total obligations of governments, including pensions, matter more than external debt alone.

“And now it's well over a 100... So that's the main problem that we have.”at 1:04:13

Maria Vassalou · Pictet Group

If the US loses technology leadership, the dollar-based global financial arrangement crumbles.

The post-Cold War arrangement had the rest of the world run surpluses, ship them to the US, and receive dollars as the reference currency plus US Treasuries and US equity returns. It worked only while the US was the undisputed technology leader, because the US had to run deficits and issue debt to play that role. Vassalou says the moment the US loses that leadership, the whole global financial architecture and this arrangement crumble. She also says a lot will play out over the next five years, so how the US manages this period matters for the dollar's standing and for Treasuries.

“And the moment The US loses its leadership, the whole global financial architecture and this arrangement that we described crumples.”at 31:24

Maria Vassalou · Pictet Group

No obvious dollar alternative; China's yuan can't replace it given capital controls and deficits.

Maria argues there is no obvious alternative to the dollar. China would have to run deficits to make its currency a reserve, but it runs surpluses and maintains capital controls. Lifting those controls would let a lot of money leave. A reserve currency must be a big importer and a producer of safe assets: holders of dollars can invest in Treasuries and earn a yield, while holders of yuan have nowhere deep to invest. Weaponizing the dollar beyond a point is not a good strategy because countries have memories.

“There is no obvious alternative to the dollar, and it's not in China's interest...”at 1:06:23

Maria Vassalou · Pictet Group

US and Europe were naive to let manufacturing drain away; US share of global output fell from 45% to 19%.

Vassalou calls US and European long-term economic policy naive for letting their countries deindustrialize. She cites the US share of global manufacturing, about 45% after World War II, which has fallen to about 19%, and says Europe is now trying to reindustrialize. This shift increases economic vulnerability. The focus has moved from economic efficiency to economic resilience, so the mix of services and manufacturing has to be rebalanced, and current technologies can help.

“So I think if I remember correctly, after the Second World War, US manufacturing accounted for about 45% of global manufacturing, and now it's down to 19%.”at 37:38

Maria Vassalou · Pictet Group

US needs to reindustrialize in key industries to be self-sufficient and keep innovating.

Maria argues the US should not produce t-shirts and plastic toys but should be self-sufficient in certain key industries such as solar cells, pharmaceuticals and equipment, at least in a pinch. Producing goods also feeds innovation, since production builds knowledge and creates a pool of labor that can move across subsectors and cross-pollinate. She says China is benefiting from this Silicon Valley-style flywheel while the US is missing out.

“I think The US needs to some extent, reindustrialize, not produce t shirts and plastic toys, but be self sufficient in certain key industries.”at 1:09:17

Maria Vassalou · Pictet Group

A steep yield curve is a normal return after Fed support; the real problem is high debt rollover.

Maria argues that rates were held artificially low by financial repression, with the Fed buying Treasuries across the curve to push investors out the risk curve. As the Fed steps back, it is normal for the yield curve to become upward sloping. She does not find the steepness particularly worrisome. The real issue is the high debt that must be rolled over, and the rising cost of servicing it as yields go up.

“I don't personally find the steepness of the curve particularly worrisome in terms of how steep it is. The problem is that, of course, we have a high debt that needs to be rolled over.”at 1:03:01

Barry Ritholtz · Ritholtz Wealth Management

Current long yields are just the long-run average, not a crisis, versus zero-rate periods.

Ritholtz relays bond managers' view that rates are reverting to the long-term average rather than being high. He notes a 10-year yield around 5% and mortgage rates of 6.5 to 7% are the average of the past fifty years. He says the current rates feel like a crisis only relative to zero-rate conditions, and he agrees with that view.

“a five percent ten yield and a six and a half or 7% mortgage rates, that's the average for the past fifty years. It's not a crisis.”at 1:03:50

Maria Vassalou · Pictet Group

The small-cap and value premium is a default-risk effect that grows when default probability rises.

In a paper with a PhD student, Vassalou built a default-probability measure based on Merton's model. Small caps load heavily on this default measure. Default risk varies with the business cycle, so when default risk is low the small-cap effect is diluted, and it becomes more pronounced as default probability rises. Using this measure, she says the team could explain away the small-cap effects, which suggests a risk-based explanation rather than an anomaly. This is academic research rather than a current market call.

“And what we would show is that the small caps will always load highly on this default measure. But as the default probability in the markets will vary over time with the business cycle, when default risk was low in the economy, the effect will be diluted”at 25:08

Maria Vassalou · Pictet Group

China has strategically gathered key resources and processing control, giving it leverage in technology production.

Alongside a long-term industrial policy that forced knowledge transfer and joint ventures with local firms, China has been strategic about accumulating key resources worldwide. It either controls them directly or indirectly, or controls their processing. These inputs matter for industrial production, innovation and new technologies. Vassalou says that because China controls so many of these factors, it controls much of the process needed to be a producer of these technologies, and this underlies many geopolitical developments.

“And the other thing that happened was China was very strategic in accumulating key resources around the world that either it controlled directly or indirectly or controlled the processing of these resources.”at 34:57

Maria Vassalou · Pictet Group

China trails the US in innovation and production despite patent counts; the rivalry will persist.

Vassalou says China is not yet at the US level in innovation and production. Patent counts may suggest otherwise, but she calls that misleading. China's control of many inputs needed to produce these technologies is what makes it a serious challenger. She adds that the US–China competition will not go away when the administration changes, because US leadership in technology is existential for the financial system and not an ego-driven pursuit.

“So now we are in a situation where China is not at the same level as The US in terms of innovation production, even though the patterns, the number of patterns may give a different idea, I would say this is misleading.”at 35:26

Maria Vassalou · Pictet Group

AI productivity gains will spread beyond tech firms into old-economy sectors.

Maria argues that much of the productivity gain from new technologies will come from using them in other products, not only from tech firms. She says some older economy sectors can benefit greatly from this technology and become very attractive investment opportunities. She frames this as a set of investment points along the technology's development and application path.

“A lot of the productivity gains will be in the use of these technologies in other products. And I think some of the more old economy sectors... can greatly benefit from this technology.”at 40:31

Maria Vassalou · Pictet Group

Europe's productivity has been very low; Germany's has been effectively zero for decades.

Maria argues Europe's productivity has been low across parts of the world. Germany, the manufacturing heart of Europe, has seen effectively zero productivity gains over the past couple of decades, with no gain even in total factor productivity. She links this to flat real wages and rising income inequality. She says Europe must invest in productivity gains, improving efficiency without changing its culture.

“Even if you look at Germany for instance, which is the manufacturing heart of Europe, productivity has been effectively zero.”at 41:59

Maria Vassalou · Pictet Group

Germany's nuclear exit was a mistake; nuclear should stay in Europe's diversified energy mix.

Maria argues energy needs a portfolio approach with a diversified pool of sources, not a single path. She has nothing against green energy but says nuclear should be part of the mix, and that Germany's exit from nuclear was a mistake. She points to France's nuclear-heavy system as evidence of the benefits. She also says fossil fuels will stay in the mix for the foreseeable future, and that alternative cheap energy sources matter given recent Strait of Hormuz disruption.

“And it was a mistake that Germany got out of nuclear power. We see the benefits of nuclear power in France, for instance.”at 43:45

Maria Vassalou · Pictet Group

Europe matters less strategically to the US now that China has become the main competitor.

Maria argues that Europe is not as strategic to US interests as it used to be. In the past the main adversary was Russia or the USSR, but the competition has now moved to China, which has degraded Europe's role in that respect. She adds that Europe, as an affluent region, does not need the military subsidy it has received since World War Two.

“Europe is not as strategic as it used to be... Now the competition has moved to China. So the role of Europe in that respect has been degraded.”at 45:21

Maria Vassalou · Pictet Group

European militaries can't work together independently without a new integrated framework beyond NATO.

Maria says Europe is less strategic to the US because China has replaced Russia as the main competitor. She argues the US push for higher European defense spending is a wake-up call that could make Europe more self-sufficient and a stronger ally. Yet apart from France, European militaries are linked to NATO's central command, which the US controls. Europe can produce drones and other equipment, but its countries cannot coordinate as they stand without a new framework to integrate their militaries.

“they can't really work together as different countries as they stand now unless they build a new framework to integrate their military.”at 48:27

Maria Vassalou · Pictet Group

Developed vs emerging labels are becoming obsolete; resource-rich emerging markets gain importance.

Maria argues the key question is not where countries are now but what drives growth going forward: productivity, access to commodities and energy, and demographics. The mix is changing, and developed status is not permanent. Technology is not necessarily produced in today's developed markets, and China is a technology leader. Bottlenecks in minerals, commodities and energy mean emerging markets that control such resources can become much more important.

“So some of the emerging markets that have control over such resources can become much more important going forward.”at 56:35

Maria Vassalou · Pictet Group

US is the only developed economy to grow 2% real for decades, which shrinks its debt ratio.

Maria argues the US has never paid off its debt, even after World War Two, and instead grew at high rates that reduced its debt-to-GDP ratio. She says the US has been the only developed economy to grow at about 2% real for several decades, which she calls spectacular. Growth is what offsets debt, geopolitics and deficits, so strong growth matters more than the debt level alone.

“US has been the only developed economy that [has] grown at 2% real growth rate for the past several decades.”at 59:40

Maria Vassalou · Pictet Group

COVID-era fiscal and monetary stimulus was excessive and caused the inflationary episode.

Maria argues the second debt increase, during COVID, was a misguided increase in debt. She says there was far too much fiscal accommodation in the economy, together with a lot of monetary accommodation, which eventually led to the inflationary episode. She supports this with the Fed cutting rates to zero and starting QE while the fiscal surge was under way, so inflation was no surprise. Barry Ritholtz adds that the CARES Acts and the infrastructure bill were the largest fiscal stimulus as a share of GDP since World War Two.

“that was a bit of a misguided increase of debt. I think there was way too much accommodation, fiscal accommodation thrown in the economy together with a lot of monetary accommodation that eventually led to this inflationary episode.”at 1:00:22

Maria Vassalou · Pictet Group

Technology eliminates some jobs but pushes workers to use creativity and intellect at a higher level.

Maria's view is that current technologies eliminate certain jobs, but this pushes people toward more creative and intellectual work. She argues the pace of change is much faster now, so workers must constantly reeducate. They need to be proficient with the technologies and their implications for their careers, and invest in their full skill set, not only in the technology itself.

“my view is in general technology in a sense eliminates certain jobs, but that also pushes people to use their creativity and intellect at a higher level.”at 1:14:41