Letter from Westport...by Still Press
...investment thoughts and the podcast Things I Didn't Learn in School.
Greetings — A few months ago, I began sharing these letters and alerting you to podcasts via social media. Using Substack is easier. Today, I am sharing two items. First, below are investment thoughts recently published in the South China Morning Post. Second, part 2 of my podcast conversation with Chinese legal scholar Gao Xiqing. This podcast is also available on Apple, Spotify and my website paulpodolsky.com. Enjoy!
Visualizing a Coming Shift in Economic Policy
Investing is looking over the horizon and imaging what might be next. The very best investors are about 60% right. I am wondering how policy makers will respond to the schism between city and countryside. The response will vary by region; in the US regulating mis-information and some form of wealth re-distributing seem likely.
The split evident in the US Presidential electoral map is mimicked in many countries. Elite in New York and Beijing have more in common with each other than people out in their respective country sides. This schism is fed by powerful emotion. In a recent poll, 77% of Trump voters believe Trump won.
Compared to these internal rifts, international conflict almost seems like a distraction. Take the US and China. The US exports $100 billion to China. Given the US is a $20 trillion economy, doubling the 0.5% of GDP going to China would have virtually no impact on US growth.
The schism within countries coincides with a miraculous period of global economic disruption. Ideas considered sci-fi when I grew up, like being able to see people when you talk to them on the phone, are now considered banal. Fleets of driverless trucks or goods delivering drones seem within reach. These inventions both create and destroy jobs and destroy, fomenting at once wealth and insecurity.
Not surprisingly, those getting rich are more sanguine about these shifts than the people seeing their livelihood threatened. Changes in thinking in turn disrupt existing social institutions. Nothing new here. Four hundred years ago, the Catholic Church censured Galileo for suggesting the earth revolved around the sun. Amid change, how much of the old do we keep? The Catholic Church is still here and a source of inspiration for a billion plus people.
If you work in sectors like tech, medicine, entertainment or finance that are at the forefront of today’s shift you get paid to embrace change and adopt a set of social norms. Work teams are endlessly combined and re-combined, like Legos. Sharp edged views on religion, race, politics or sexual preference hamper productivity and are stamped out. Politicians can then use religion, racism and jingoism to stir up support among those left out. This dynamic is exacerbated by an explosion of information services customized to both addict and confirm entrenched perspective.
In response, a China-type regime needs to incent enough capitalism to create more wealth while simultaneously re-distributing this wealth, all while prohibiting the free flow of information. It seems like a delicate balancing act. Too much pressure and inventiveness slows, too little and the system quivers. Scientists asking for Google present a real conundrum.
A US-type regime needs to bring the balkanized information process to heel and re-distribute wealth while protecting rule of law, also a delicate balance. Of the two policies, re-regulating the information is easier to accomplish. A Federal Trade Commission anti-trust lawsuit against Facebook is the latest step. Re-distributing wealth, on the other hand, is complicated to engineer.
Minimum Basic Income, raised in the US Presidential campaign, would cost more than US spending on defense and healthcare and dis-incentivizes work. Not good, nor realistic. Monetization seems both more likely and stealthy. This is already underway in Japan, where debt as a percentage of GDP is among the highest in the world yet interest rates are zero. The Ministry of Finance issues debt and the BOJ buys it. When the debt matures, the BOJ repays the principle back to the Ministry of Finance and government debt is extinguished via printing.
If the US and others with very low interest rates pursue this policy aggressively enough it will create inflation, which will redistribute wealth from lenders to borrowers, quietly easing some social strain. Boosting inflation has now moved from a fringe idea to one endorsed by major central banks. Yet creating inflation isn’t guaranteed. Today’s profitable industries do not require much capital, which is one reason why US interest real interest rates are at the lowest level ever.
US potential GDP, the rate the economy can theoretically run without inflation, is around 1% to 2%. To create inflation the economy would need to grow faster than that, which means fiscal stimulus would need to increase by about $400 billion a year for a few years when the economy is already growing at potential! Given that discretionary spending in the $4.8 trillion US budget is only around $700 billion, this is a lot of on-going stimulus and would reflect a real shift in policy.
Look for tell tail signs of policy change in market pricing. Facebook stock underperforming would be significant. If the fall in the dollar (and consequent rise in the renmimbi) already underway is followed by a rise in US bond yields that forces the Fed to intervene and buy long bonds, this would also be significant. Given these risks, I’m adjusting my asset allocation, which I can share upon request.
Please share your asset allocation.