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Macro Overload
Peter T. Treadway

Brexit, negative interest rates, a China slowdown of undetermined extent, a bizarre American Presidential election  – that’s more than a full plate of macro unknowns for investors to grapple with.  And we can add to that a longer term unknown called the “rise of the robots.”

Let’s start with Brexit. I have no idea whether this will pass or not. If the UK leaves the European Union (EU), short term this will be highly disruptive and the global stock markets will take a hit. Buying opportunity? Longer term yes but short term not so clear. Longer term things might not be so bad.

The predecessor of the EU, the European Economic Community (EEC), was founded in 1957. The EEC was a common trading market among former enemies that were recovering from the ruins of two major wars. The European nations (including the UK) had spent the better part of the eighteenth and nineteenth centuries building their empires and imposing their “superior civilizations” on grateful natives around the world. They spent the first half of the twentieth century killing one another and destroying their superior civilizations. The common market coming after the horrors and destruction of two World Wars was a good thing. The UK had tortuous relationship with the EEC and actually did not join until 1973.

In early 1990s, the EEC became the basis for the European Union (EU), which was established in 1993 following ratification of the Maastricht Treaty. The treaty called for a strengthened European parliament, the creation of a central European bank and common currency, and a common defense policy. The UK however kept its own currency and has never used the euro. The EU today is a supra-national entity which is overregulated by its Brussels bureaucrats of a protectionist and anti-free market bent. It is deeply resented by segments of the British population and by segments of the populations of a number of countries.

Longer term the UK may be better off out and other countries may follow. But the short term disruption pain could be considerable. The UK is tied to the EU by all kinds of treaties and agreements. Near term the UK’s leaving creates a mess.   If the EU throws up a protectionist wall to keep out British trade and finance, that could initiate a downward economic spiral in Europe. Will the Europeans and the British sit down and act like rational adults and negotiate an orderly UK exit? Maybe. They certainly didn’t act like rational adults in 1914 and 1939.

Monetary Madness –What We Worry?

Now let us turn to negative interest rates. Negative interest rates now prevail in a number of bond markets including those of Japan and Germany. The assumption is that these negative rates are the product of quantitative easing by central banks, notably the Bank of Japan and the European Central Bank. That’s probably right but the question needs to be asked what would rates be in the absence of quantitative easing. My guess would be that rates would still be pretty low as massive global debt burdens, growth-stunting overregulation not just in Washington and Brussels and “good” deflation coming from globalization and automation would act to drive down rates.

At any rate there seems to be near universal agreement that negative rates are failures in terms of stimulating real economic activity. If anything they are a recipe to destroy the banking and insurance industries which depend on positive spreads to survive. And they the road to poverty for senior citizens who used to live off of interest payments. In the private sector, when a product is deemed a commercial failure, it is generally withdrawn from the market. Not so with the public sector. If a program fails, do more of it.

The failure of QE to stimulate real economic activity has led to yet another related proposal for even more monetary insanity, i.e., helicopter money. As I understand it helicopter money involves a direct assumption of fiscal policy by central banks whereby by creating high powered money they would either finance government spending directly or checks directly to all citizens. The phrase, popularized by former Fed Chairman Ben Bernanke, is actually the product of a hypothetical musing by the patron saint of monetary theory, Milton Friedman. (Friedman died in 2006 before the 2008 and the ongoing crisis, thus leaving his leaderless disciples without guidance as to handle the crisis and at the same time preserving his impeccable image.)

As far as I’m concerned, QE and helicopter money could be renamed as Currency Destruction Projects. In my prior life when I was involved with Latin America, I became aware of a number of helicopter central bankers in past Latin American history who unleashed hyperinflation. Of course it could be argued that these hyperinflationary Latin American helicopter money printing exercises were undertaken in responses to overwhelming government demand for funding. The problem today supposedly lack of demand.  My answer: just give the helicopters a little time and, with entitlement-hungry aging populations especially in the West, the demand will materialize.

No wonder the price of gold and bitcoins has been rising of late – a phenomenon I never thought would happen in a time of strong deflationary pressures.

Can We Blame China for the Next Global Recession?

In his interesting new book The Rise and Fall of Nations, Morgan Stanley strategist Ruchir Sharma concludes there have been five worldwide recessions since 1970 and they all originated in the United States. But Sharma predicts the next global recession will be “made in China.” So if he is right we shouldn’t spend all our time worrying about Brexit and the EU falling apart. (And the epithet “Ugly American” can finally be retired and replaced by a suitable slur against the Chinese.)

But is Sharma right? Or is he right enough, i.e., add European to Chinese problems that will be scary enough.

Unfortunately, predicting the Chinese economy is a perilous undertaking. I have repeatedly argued that forecasts of an imminent collapse of the Communist dynasty are wrong and foolish. Chinese dynasties last a long time. The Communist “Dynasty” was only founded in 1949.  The prior Qing Dynasty lasted from 1644-1911 and the one before that, the Ming Dynasty, lasted from 1368-1644. The Chinese people have had to go through horrific total disruptions of their society in the 150 years or so prior to the advent of Deng Xiaoping in late 1970s. They don’t want more disorders. They want more Chanel bags, a car, a smartphone, travel experiences and their one child to attend a fine US university.

I have argued that gauging the state of the Chinese economy is much more difficult than performing the same exercise for Western economies. China functions in a language most Western analysts cannot read or understand and its statistics in many cases are outright fabrications. Although there are some great new private sector firms like Alibaba or Tencent, the Chinese economy is basically state run and in recent years has directed an excessive amount of now debt financed capital into commodities, real estate and capital destroying state owned corporations.  The country’s hard working population has functioned for thousands of years under a Confucian ethic of obedience which has been reinforced by the Communist Party’s need to perpetuate the one party state and to suppress the flow of information. A perfect system for building roads and toilets –which India can’t seem to do–but a handicap in building a knowledge society. (Which is why, I would guess, Alphabet is a superior company compared to Baidu. But that’s another story.)

I think we can safely assume that the Chinese economy going forward will grow far more slowly than it supposedly did in the past. But will the next global recession really be made in China? I’m not sure about that—it may be too pessimistic an assessment. I do worry that Sharma is half right.

The Bizarre American Presidential Election

I’m not going to spend a lot of time talking about the Presidential election except to say it is of investment significance and something to worry about. With Hilary we get more of the same – more taxes, more regulations, more anti-business rhetoric and a major attack on the biotech and health care industries. With the Donald we get ?  Take him at his word and he will destroy world trade and perform a major necessary reform of the American government. In baseball batting .500 is a superhuman achievement. But not in economics.

The Robots Are Coming! The Robots Are Coming!

A disparate group of influential people, including Bond Wizard Bill Gross and noted conservative intellectual Charles Murray, have been calling for some form of something called Universal Basic Income whereby each citizen would receive a type of cash stipend from the government. Depending on how it’s structured, this plan would compensate the many individuals who presumably would have lost his or her job to a robot. (And compensate maybe everybody else as well.) Actually this fits in quite nicely with the helicopter money proposal, the only caveat there being the Fed, rather than the taxpayer, supplies the stipend from its arsenal of fiat created money.

Nobody has paid much attention to the observation of the above mentioned Ruchir Sharma, who in his book argues that the robots are coming just in time. It seems that working age populations in most countries are either slowing or, as in the case of Japan, Russia and China, exhibiting actual negative growth. Demographic forecasts, which tend to be fairly accurate at least in the short to medium term, show that this trend is likely to worsen. Pick up a copy of the South China Morning Post and you will find article after article talking about robots needed to replace China’s diminishing working age population.

The most famous example is Taiwan headquartered Foxconn. Foxconn employs hundreds of thousands of workers and has 12 factories in China. It is the major assembler of iPhones. The company has come under severe criticism for the working conditions in its factories and there have been a number of suicides in these facilities. The company has announced would install one million robots and replace thirty percent of its workforce by 2020. Naturally Foxconn is being criticized in some quarters for this. You can’t win. But the fact is that China’s working age population has started to decline and the fresh supply of cheap labor from the countryside is drying up.  This story is hardly unique to Foxconn. The robots are arriving just in time. China, it seems, loves robots.

I think it’s quite foolish at this stage to be advocating massive attacks on the public purse in order to compensate people for jobs supposedly lost to robotics. In the past the market provided new industries and new jobs for those replaced by new industrial techniques. We don’t know how this is going play out right now. But inviting politicians to send people money for not working is to – pardon the crudity—invite the public purse to be raped. A modified version of Universal Basic Income was recently voted down by 77 percent of Swiss voters. The thrifty Swiss just didn’t like the idea of paying people for not working.

I continue to believe investors should be looking for companies that are deep into artificial intelligence and related areas like the cloud. In fact that should be their core underlying business.