April 30, 2021
By Steve Blumenthal
“The question is, ‘Why do policies that have been shown to work so
badly still get used so regularly?’ I have long maintained that Keynesianism
is to Marxism and Socialism what diet cola is to the real sugary beverage.
Hence, it falls neatly into the popular, but not working category.”
– Charles Gave, Founding Partner and Chairman, GaveKal
Two summers ago, I landed in Bangor, Maine, rented a car, and drove an hour and a half north to Great Lake Stream to attend David Kotok’s annual Camp Kotok “Shadow Fed” fishing trip. Joining me for the ride was Jonathan Ward, author of China’s Vision of Victory and founder of Atlas Organization, a strategic advisor and government consultant on US-China competition. I had no idea that I knew so little about what’s going on in China. By the time we arrived, I marveled at how naïve I had been.
Jonathan presented his insights to all of us at Camp Kotok—a group that included investment managers, economists, and former Fed officials. We talked and debated and learned. His message: The threat from China is the “most important geopolitical challenge of our lifetime.”
China has been more brazen since that summer two years ago. Jonathan was in the press this week and I share a select few bullet points from his interview with Maria Bartiromo of Fox Business below. Idea here is to keep China and the rising geopolitical tensions on your radar.
Strategic Investment Conference May 5-18, 2021
Next week starts the 2021 Mauldin Strategic Investment Conference (SIC). It will be virtual again this year. I’ll be taking notes; hosting a session for accredited investors; and speaking on the final day, May 18. Mauldin Economics’ Ed D’Agostino will be interviewing me. We’ll be talking about how an investor might position herself for the period ahead, based on insights shared at the conference.
Presenters include Felix Zulauf, Byron Wien, Jeff Immelt, Lacy Hunt, John Hussman, Doug Kass, Richard Fisher, Karen Harris, Ian Bremmer, Gerald Jordan, Jr., Peter Boockvar, Ron Baron, Jim Bianco, David Bahnsen, Liz Ann Sonders, Grant Williams, Mark Yusko, Ivy Zelman, Louis-Vincent Gave, William White, and more. You can learn more about the conference and register for it here.
Interestingly, Louis-Vincent Gave was a China bull, but did an about-face at last year’s conference. I’m looking forward to the breadth and depth of information coming our way.
Charles Gave, Louis-Vincent’s father and founding partner and chairman at GaveKal, penned a piece this week titled, “Low Rates Are Socially Regressive.” It is an attack on Keynesian policies, and he draws a direct line between abnormally low interest rates and how they depress the “real” earnings of the working class. Put your geo-political goggles on and keep ’em in place… The stress induced by negative real interest rates is affecting people on a global scale. “Why do policies that have been shown to work so badly still get used so regularly?” The Fed has doubled, tripled and quadrupled down…. I think Charles is right… we should be asking that question. No one yet knows the right solution. There are domestic political pressures, geopolitical considerations and more… there is no perfect solution… I suspect sometime this decade, one will be forced upon us.
This week’s On My Radar:
- Jonathan Ward on China
- Low Rates are Socially Regressive by Charles Gave
- Trade Signals – Rate of Change in Inflation Sell Signal
- Personal Section – Puerto Rico and New York City
Jonathan Ward on China
You’ll find a link to the full interview by clicking on the picture below. Following are the main take-aways from the interview:
- Watch what’s happening in the South China Sea and worry about the potential invasion of Taiwan.
- The world pretty much understands that China’s claims over the entire South China Sea are bogus, concocted through the Communist Party’s reading of history.
- They have been trying to assert military control through island building over the last seven years, as well as massive military buildup.
- The good news is the EU is not getting involved; we are looking at the beginning of better transatlantic coordination and an improved understanding of the China issue—including China’s threat to Asia and the world at large.
- Ward advises a comprehensive approach to dealing with China:
- Economic engagement that transfers our industrial base to our primary adversary is probably one of the great mistakes of the past 100 years, and we are going to have to reverse that.
- We have to reduce our engagement to reduce China’s growth, which fuels China’s military and global communist ambitions.
- We have to make sure the US military budget is sufficiently resourced to deal with both China and Russia.
Ultimately, the US is going to have to work with its allies to cut off Beijing from financing for Western technology; rebuild our industrial bases; rebuild the coordination between our countries; form an alliance-based trading system; and isolate Beijing from the wider global economy, which must be done over time.
During the interview, Jonathan was asked about a potential boycott of the coming Winter Olympics in China. He said, “The Olympics should be boycotted. Let’s face it, China’s carrying out a genocide right now and this is the first genocide that we’ve seen from an industrialized nation since Nazi Germany, and there’s really no reason for us to be giving any legitimacy to this regime at this point… Doing business with China, particularly anything that surrounds Xinjiang, is completely unacceptable. This should be a matter of a moral course. We do not accept further engagement with a genocidal regime when it comes to their military buildup, their human rights repression, and their strategic industries. We have the recognize the nature of the conflict we are in.”
Low Rates are Socially Regressive by Charles Gave
“There is no such thing as a free lunch.”
– Milton Friedman
Central bankers in most advanced economies still work on the assumption that maintaining abnormally low interest rates is a good thing for economic growth. From this springs the related idea that low rates must be favorable for the poorest in those societies. For reasons argued a decade ago, I consider such notions to be fallacies (see The High Cost Of Free Money).
- My argument then was that abnormally low policy rates must lead to falling productivity, accompanied by rising asset prices due to financial engineering that will increase if long rates also stay low.
- The result will be reduced investment in new capital, which makes the rich get richer, as they own the stock of old assets. Workers will get poorer as weak productivity growth militates against rises in real incomes.
- The reason is simply that low interest rates are a tax on savings that ultimately causes the savings rate to fall. This situation always leads to less capital spending, ensuring a shrunken capital base and with it lower productivity. Thus, relying on low rates to stimulate structural growth is about as smart as imposing rent control as a way to boost housing supply.
I first showed the chart below, which links the fate of US productivity growth and real rates, in 2011 and the ensuing decade has not detracted from the thesis. It should be noted that the same dynamic is seen in other economies.
It always amazes me when policymakers think that by manipulating market prices, they can help an economy achieve better returns. This is especially true in the case of interest rates, which are a pricing link between the present and the future, which is, by definition, unknowable.
In 2014 and 2015, I broadened my argument out to show how abnormally low interest rates depress the “real” earnings of the working class (see Poverty Matters For Capitalists and Poverty Still Matters For Capitalists).
- Not only do these policies lead to lower economic growth, their propensity to hit low end workers the hardest is unacceptable in political, social and moral terms, at least according to the late US philosopher John Rawls. A “just” society is one in which the poor see their standard of living rise consistently, he argued, and as a result they are comfortable with the rich also getting richer.
- But if they see the rich get richer while they get poorer, politics can become difficult.
In the US, I define abnormally low interest rates as the yield on three-month T-bills being negative in real terms. There are two direct ways that this makes the poor poorer.
- First, unlike the rich, the poor tend to keep whatever savings they can muster in cash. Hence, by depressing short rates, savers are deprived of legitimate income. The rich, of course, take steps to avoid the “euthanasia of the rentier”, and get out of interest-bearing instruments and into alternative reserves of value such as commodities and real estate.
- Second, since I spent my student days and early working life with limited means, I know from personal experience that the poor spend most of their money on food, energy and rent. Hence, as hot money drives up the price of commodities and energy, the price of staple items is pushed up, including rent.
To show this point, consider the chart below which compares the inflation rate for the average US citizen (the US consumer price index) to a narrower measure comprising food, energy and rent, split equally in one third proportions (I call it the Walmart index).
From the chart, it can be seen that each time the US has had negative real rates, the Walmart index rose far more than CPI, with the reverse happening when savings were normally remunerated. Next, consider the ratio between the two price indexes as shown in the two charts overleaf.
It can be seen in the left-hand chart that the Walmart CPI has consistently outpaced the US CPI since the early 2000s. That pattern was interrupted last spring by the big fall in oil prices, but the Walmart index now seems to be back on a track of rising faster than the US CPI. The right-hand chart above shows the average annual rate of change for both indexes over five years. On this basis, the rate of inflation faced by the US poor is 3.3% and rising, a level that is 50% more than that faced by the average US citizen.
- For those interested in the 12-month rate of change over the last year, the Walmart CPI is up 6.32% versus 3.31% for the US CPI.
One sign of the relative impoverishment of the poor can be seen in the number of hours that hourly-paid workers must toil in order to buy a house at the median market price. The chart below shows that the cost of this piece of the American dream has doubled since 1967 for hourly-paid workers, with most increases taking place in periods of negative real rates.
Lastly, consider the real income of the median US household when deflated by the US CPI and also that of the average hourly-paid worker when deflated by the Walmart index. It can be seen that in almost every “Keynesian” period of negative real interest rates, the real income of the poor fell in outright terms. On this basis, the standard of living for the lowest-paid has fallen since 1964, with all of the declines occurring in such Keynesian periods.
“The question is: why do policies that have been shown to work
so badly still get used so regularly?”
– Charles Gave
At the very least, Keynesian monetary policies can be seen to fail John Rawls’s test, as the result is the poor continually getting poorer. Alas, for the downtrodden in the US and Europe, things may get worse still as policy settings are presently more extreme than they have ever been in the past.
- I thus suspect that the Walmart index will continue to zoom upwards. But why are policies that have never worked still in use?
- To answer this question I will use a typology devised by the Italian economist Vilfredo Pareto. He said that an economic theory should be judged two ways: (i) does it work, and (ii) is it popular?
- As such, a theory can be one of the following: 1) Popular and not working: Marxism a few years ago in France, but not in the Soviet Union, where it was never popular. 2) Popular and working: Capitalism, in China now, or in the US a few decades ago. 3) Unpopular but working: Capitalism in France, as the French prefer to be wrong with Jean-Paul Sartre than right with Raymond Aron, whose most famous book asserted that Marxism was the opium of French intellectuals. France’s government spending is now at 61% of GDP and capitalism in the country is about to disappear. 4) Unpopular and not working but kept by a tyrannical political power: Cuba and Venezuela come to mind, and California may be next.
I have long maintained that Keynesianism is to Marxism and Socialism what diet cola is to the real sugary beverage. Hence, it falls neatly into the popular but not working category. As noted already, Keynesian policies have never really worked for the “little people”, but they have worked jolly well for those whom Joseph Schumpeter in the 1940s dubbed “false intellectuals”.
- These were folk made rich by an educational boom that had been funded by American capitalism, yet they ended up biting the hand that fed them. Most intellectuals have a “socialist” bias, as in socialist systems they are paid what they think they are worth, not their market price. Moreover, Keynesian theory grants “false intellectuals” political power that lets them stay rich enough to drink champagne and eat caviar, even if the poor get poorer.
- We are seeing this across the West, as the recipients of elite education try to destroy their own economic system. It is perhaps not surprising, as universities built by the Catholic church have for centuries attacked that very church. It follows that the system of universal education created by capitalism now aims to destroy both capitalism and democracy.
- Invest in Asia. Confucius did not approve of children killing first their mother (religion) and then their father (laws governing property). Confucian societies still believe in educating children to become responsible adults.
- Invest in Northern Europe and in Switzerland. Intellectuals in these generally small countries are thin on the ground, and they have never managed to capture political systems.
- Invest in countries that have the Queen of England on the money. I lived in the UK for 25 years and quickly realized that being an intellectual is not considered “proper” in good society (being a “character” is good).
Investing elsewhere could be dangerous, especially if the “educated yet idiots” (thanks Nassim Taleb for that one) are in the process of taking over political systems. As Ronald Reagan quipped: “The nine most terrifying words in the English language are ‘I’m from the government and I’m here to help’.” So as western governments spread their tentacles into every aspect of life, it feels that our systems face the kind of threat that Russia’s ancient regime did in 1917. Unfortunately for me, I live in one of the countries most at risk.
Here is the link to the pdf version of Charles Gave’s piece. These views are GaveKal’s and not to be viewed as CMG’s views, nor is this information a recommendation to buy or sell any security. GaveKal provides their research to clients. You can request a trial subscription here.
I subscribe to Mauldin Economics’ “Over My Shoulder” publication. It’s inexpensive and excellent. John Mauldin and Patrick Watson share research they feel is meaningful. You can learn more about a subscription here. Hat tip to Patrick for the excellent piece and for allowing me to share it with you today.
Trade Signals – Rate of Change in Inflation Sell Signal
April 28, 2021
S&P 500 Index — 4,183
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
For informational purposes only. Not a recommendation to buy or sell any security.
Notable this week:
“Nothing to see here, just keep moving.”
Leslie Nielsen, The Naked Gun: From the Files of Police Squad! (1988)
I think I have overstayed my welcome with the Naked Gun quote. It just fits in sometimes… maybe more times lately. I promise to put it to bed for a while.
We are at a critical turning point for the equity markets where the risk to the downside is greater than the reward to the upside. Let’s take a quick look at Margin Debt and the rate of change in inflation.
The first chart looks at Margin Debt as a Percentage of GDP. I’ve notated 2000 and 2007 peaks and also show an arrow to 3-31-2021. Investors are aggressively doubling down on their stock bets. More buyers than sellers and prices rise. We know from the weekly Supply/Demand chart (further below) that buying volume is greater than selling volume. What Margin Debt to GDP charts show is how much margin debt exists. The buying tied to margin debt is behind us. How much more can be margined? Really not sure; therefore, while not a good timing signal, margin debt is an effective measurement of the degree of risk. Think of it as a warning signal.
Next, let’s take a look at the rate of change in inflation, as it recently flashed a Sell signal. Here is how the signal works: When the year-to-year change (2.6% as of 3-31-21) moves above its six-month smoothed moving average trend line, a sell signal occurs. As you can see, rising inflation is generally not good for stocks (data upper left-hand section of chart). This process has a 70% “profitable trades” record dating back to 1965. It performed especially well in the inflationary period in the 1970’s. Did not do so well in avoiding the 2000-2002 tech crash. It did very well in 2008-2009. The most recent signal is the first since 2017.
I hear you saying, “Steve, it’s different this time since the latest reading compares inflation vs. a year ago and that is when COVID-19 began.” Yes – true. My answer is, “I’m not so sure.” If we are at the beginning of an inflationary cycle, better to be forewarned. You can see the signals marked by “S” and I’ve circled in red the most recent sell signal. That’s the message here. We’ll need to keep watch. Lights on!
Lastly, I was asked if I have a favorite shorter-term signal for equities. I do and I share it with you in this next chart. This is for short-term traders and not for long-term investors. It may be useful in hedging. I’ve also added it to the weekly dashboard below. Here is the chart (it’s in a Sell signal – red arrow bottom right). Learn more about MACD here.
The Trade Signals – Dashboard of Indicators follows next. Click here to see the Dashboard and Charts with Explanations from this week’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note – Puerto Rico and New York City
Tomorrow morning, I fly to Puerto Rico to meet with my business partners John Mauldin and Kevin Malone. Puerto Rico is an Opportunity Zone. Opportunity Zones are economic development tools that allow people to invest in distressed areas in the United States. Their purpose is to spur economic growth and job creation in low-income communities while providing tax benefits to investors.
We are meeting to discuss various investment opportunities. One in particular piques our interest. We are all fully vaccinated, which feels great.
I then fly from Puerto Rico to NYC next Tuesday for meetings and will celebrate a special friend’s birthday on Wednesday evening. We’ll be watching his favorite hockey team, the New York Rangers, face off against the Washington Capitals. He’s arranged a club suite for his family and friends.
The Rangers and Capitals are tied for first place in the East Division, sitting seven points ahead of the Philadelphia Flyers. I’ll be pulling for the Rangers, as my Flyers were mathematically eliminated a few days ago. Ugh! Next year.
Excited for the week ahead. And I’m getting really excited for the Strategic Investment Conference next week. Much to learn.
Hope your week was productive and you have something fun planned…
Best to you and your family,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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