A Few Things....
August 14 2019
1. I’ve been thinking about Debt, MMT (modern monetary theory) and the future of markets recently.
Lending and borrowing grew dramatically after the scientific revolution because humans started to believe in progress. This was fuel to the development of capitalism, which, as originally defined by Adam Smith nearly 250 years ago, broadly depends on two driving forces: productive reinvestment of capital and a growing population.
You could say that lending depends on a brighter future where debts can be paid – a future built on progress. In other words, it depends on a growing pie, or something beyond a zero-sum game. Alternatively, the 99% would say it leads to forced growth & activity because the debt demands to be paid…..
Quoting from David Graeber’s: Debt, The First 5,000 Years:
That giant debt machine that has, for the last five centuries, reduced increasing proportions of the world’s population to the moral equivalent of conquistadors would appear to be coming up against its social and ecological limits……It seems to me that we are long overdue for some kind of Biblical-style Jubilee: one that would affect both international debt and consumer debt…
With $14 trillion worth of negative yielding debt, it’s worth exploring the relationship between interest rates and hope for the future.
Technology, power laws, and inequality are perhaps shifting pie filling, so to speak, from ‘the many’ to ‘the few’ instead of growing the overall pie. If that’s the case, then it represents a much less hopeful future: a pie that won’t be getting bigger.
Moreover, the slower-growing pie combined with lower birth-rate trends would imply a future of less demand and therefore less inflation. A future of lower inflation, combined with technology-driven deflation, and a shift toward an economy that is driven more by information than commodities and hard assets is a prescription for low rates.
That sounds like one plausible explanation of the global situation today. Therefore are low rates a direct reflection of less hope for growing the pie and the way that pie filling will be distributed ?
What's more pessimistic than negative interest rates on $14 trillion of debt ?
I'll give you a dollar today and I only want 99 cents back in the future. It's a rather bleak explanation; however, it would suggest, rather speculatively, that redistribution in the form of higher wages, lower consumer debt burdens, and even direct government subsidies would create more hope, more inflation, and higher rates along with a stronger global economy.
2. The two biggest paradigms or trends of the last fifty years have been Globalization and Disinflation. The world became hyper-connected, cost of production fell, and assets levered to falling interest rates outperformed.
Everything we know and think about investing is from this world.
The thing with trends is that they persist far longer than reason or logic would dictate and but they will finally reverse when they can’t be pushed any further. I think we are fast approaching that event horizon.
Highly recommend this deep dive by Ray Dalio on Paradigm Shifts.
What’s important to remember about Ray Dalio is that his firm, Bridgewater Associates pioneered risk parity strategies that recommend (among other things) maintaining a levered exposure to fixed income.
Let me share three critical sections that have helped me think about Paradigm Shifts.
Think of it this way: one person’s debts are another’s assets. Monetary policy shifts back and forth between a) helping debtors at the expense of creditors (by keeping real interest rates down, which creates bad returns for creditors and good relief for debtors) and b) helping creditors at the expense of debtors (by keeping real interest rates up, which creates good returns for creditors and painful costs for debtors). By looking at who has what assets and liabilities, asking yourself who the central bank needs to help most, and figuring out what they are most likely to do given the tools they have at their disposal, you can get at the most likely monetary policy shifts, which are the main drivers of paradigm shifts.
To me, it seems obvious that they have to help the debtors relative to the creditors. At the same time, it appears to me that the forces of easing behind this paradigm (i.e., interest rate cuts and quantitative easing) will have diminishing effects. For these reasons, I believe that monetizations of debt and currency depreciations will eventually pick up, which will reduce the value of money and real returns for creditors and test how far creditors will let central banks go in providing negative real returns before moving into other assets.
He then goes on to say:
So, the big question worth pondering at this time is which investments will perform well in a reflationary environment accompanied by large liabilities coming due and with significant internal conflict between capitalists and socialists, as well as external conflicts. It is also a good time to ask what will be the next-best currency or store hold of wealth to have when most reserve currency central bankers want to devalue their currencies in a fiat currency system.
Most people now believe the best “risky investments” will continue to be equity and equity-like investments, such as leveraged private equity, leveraged real estate, and venture capital, and this is especially true when central banks are reflating. As a result, the world is leveraged long, holding assets that have low real and nominal expected returns that are also providing historically low returns relative to cash returns (because of the enormous amount of money that has been pumped into the hands of investors by central banks and because of other economic forces that are making companies flush with cash). I think these are unlikely to be good real returning investments and that those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets, meaning that if they just wanted to have a better balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio. I will soon send out an explanation of why I believe that gold is an effective portfolio diversifier.
We are all “long” long-duration assets that do well in a disinflation cycle of falling interest rates and globalization - Credit, Private Equity, Venture, Global tech companies at a time when the cycle might be turning towards inflationary assets in a G-Zero world.
Happy to discuss where I’ve been looking across Gold, Silver, Uranium, Shipping…..
If you’ve got another 8-minutes to spare then check out this video from commodity fund Gorozen. Their head PM lays out his fundamental bull case and why he thinks the yellow metal is going to $2,500 this time around. I’m a fan of their work and find them to be some of the better commodity researchers out there over many cycles and years.
Quotes I’m thinking about:
“The majority is always wrong. The minority is rarely right.”
— Henrik Ibsen
“If everybody is thinking alike, then no one is thinking.”
— Benjamin Franklin