The Inflation Narrative, Richer Wiser Happier, Ethereum

May 20 2021

“Very few things move in a straight line. There’s progress and then there’s deterioration. Things go well for a while and then poorly. Progress may be swift and then slow down. Deterioration may creep up gradually and then turn climactic. But the underlying principle is that things will wax and wane, grow and decline. The same is true for economies, markets and companies: they rise and fall. The basic reason for the cyclicality in our world is the involvement of humans…. People are emotional and inconsistent, not steady and clinical.”

- Howard Marks

"Everything is vague to a degree you do not realise till you have tried to make it precise, and everything precise is so remote from everything that we normally think, that you cannot for a moment suppose that is what we really mean when we say what we think.”

- Bertrand Russell

“If things are too easy, life is a whole lot less interesting.”

-Marian Wright Edelman (American activist)

A. A Few Things Worth Checking Out

1. One of my favourite authors Cal Newport (author of Deep Work amongst other books) was on the Daily Stoic podcast to discuss Knowledge Work and Effective Communication.

They discuss: A World Without Email: Reimagining Work in an Age of Communication Overload, Cal’s latest book on how knowledge workers can improve their efficiency and gain autonomy, why effective communication is so important…..

2. 50 Very Short Rules for a Good Life From the Stoics - by Ryan Holiday.

3. Stanley Druckenmiller gave a keynote a week ago at USC. The first 20 minutes expands on the ideas he discussed in his op-ed in the WSJ on May 10th titled “The Fed is Playing With Fire” where he expressed concern that the Fed was remaining accommodative for too long and risking an asset bubble.

B. The Inflation Narrative

The investment narrative between May 2020 to May 2021 has gone from fears of massive defaults and deflation to run-away inflation is around the corner. Finance is full of these narratives, and narratives should be taken seriously because they drive behaviour and hence asset prices.

While I respect the narrative, I am trying to look six months ahead to see where we are headed and how structural inflation really is.

Most of Wall Street is pumping the inflation narrative.

I am a little sceptical and while my opinion doesn’t matter at all, here’s where I come out: In terms of inflation data, we have to remember the base effect. Last year inflation and GDP collapsed, so high GDP and inflation prints matter much else while we are catching up on lost production. I take the short term data with a huge grain of salt. We also have supply chains issues as we re-start the global economy, this will lead to short-term price spikes but isn’t structural or persistent. Then there are rising commodity prices, but will they really get passed on to the consumer. They didn’t in the past.

The most interesting report I’ve read on the inflation debate is by the independent research house Alpine Macro.

Here’s the bottom line from them (I’ve shortened to make it easier for you):

Most people’s mental framework goes back only as far as their own memories and experience and creates a subconscious bias. The 1960-80 period was structurally totally different from today’s. Very few investors, economists, journalists and policy makers today were working then. Some salient differences between then and now are worth noting. 

(1) The U.S. was essentially a closed economy in the 1970s. Imports were about 3.5% of GDP. They are now almost four times larger relative to GDP. Imports are a big safety valve; when shortages arise and prices rise, imports increase to take the steam off. That doesn’t happen easily in a closed economy. In addition, there has been a relative abundance of excess savings in the rest of the world. This means that the U.S. can easily import much cheaper foreign savings to make up any shortfall in domestic savings, should the economy run too hot. 

(2) Manufacturing then was almost a quarter of the economy; it is 10% now. The world currently is well into the “Fourth Industrial Revolution”, dominated by both technology producers and users, and a perfect storm of technological innovation is occurring and will accelerate in the years ahead. The rapid digitization of the world economy, robotic technology, AI and 5G communication are inherently deflationary which goes a long way towards explaining why the Fed has not been able to get inflation up to its target for more than a decade.

(3) Unionized workers then were 25% of the labor force, now they are about 10%. Labor unions introduce wage rigidity, while reducing labor productivity. In the 1970s and 1980s, wage rigidity was a key reason causing wage-price spiral. Most workers in the U.S. today not only have to compete for jobs among themselves, but also, directly or indirectly, have to compete with workers in low-wage countries as a result of globalization. It is very hard for the average wage rate to sustainably exceed labor productivity. 

The burning question today is whether another major inflationary surge could happen again? My take is that it is possible but very unlikely. Slack in the economy is still substantial, estimated at roughly 2.3% of GDP, in contrast to significant excess demand for much of the 1960s and 1970s. 

Some would argue that the Fed’s monetization during the two oil shocks in the 1970s greatly exacerbated the inflation outbreak and the Fed is monetizing fiscal deficits today.

What’s the difference? In my view, the comparison is not entirely correct: Back in the 1970s, the U.S. economy was running above potential, so the Fed eased into a booming economy with no spare capacity. Since 2020, however, the Fed has been easing aggressively on a collapsing economy with unemployment shooting up to 15%. Even today, the U.S. still has 8 million people out of a job. Of course, if the Fed continues this policy long after the economy has fully recovered, that would be inflationary, but it is too early to make that judgment at the moment. 

How about fiscal stimulus? A lot of the fiscal thrust with current policy is in the form of transfer payments and has nothing like the demand impact of government expenditure in goods and services via investment. In addition, these transfer payments will reverse in good part in the year ahead. President Biden's infrastructure proposals will get scaled back as will the tax hike proposals. It is hard to believe that the Fed would remain aggressively expansionary once inflation is moving back to where they are aiming. 

With the dramatic reduction in the U.S. economy's oil intensity, there cannot be a major oil shock like the 1970s. If anything, the oil price is likely to reinforce deflationary pressures as the decarbonization of the economy proceeds and technology continues to reduce the cost of green alternatives. The mania in anything green means that access to capital is seemingly unlimited and this has to increase the supply of energy alternatives. 

C. Richer Wiser Happier

Just finished William Green’s great new book: Richer, Wiser, Happier.

William interviewed and then distilled the wisdom of some of the greatest investors into a book I will be re-reading. It’s as much about living the good life as it is about investing better.

Here are the big ideas I picked up:

  1. Studying investing is not only about learning how to make money, but learning how to think and make decisions. Learning how to think by probability will do you more good than any book on investing.

    A dispassionate analysis of the facts and probabilities is one of the best mental habits you could build. They key lies in understanding how to optimise the odds for success.

  2. Mohnish Pabrai: Clone the best ideas and habits of the giants. People have a bug in their DNA where they feel shameful stealing the best ideas of others. Don’t think like that.

    Clone the best ideas but be open to personalising it to your personality and context.

  3. Nick Sleep and Qais Zakaria: They used what they call destination analysis, aiming to understand where a company is, where it can go in 10 years, and what would help it get there or veer it off course.

    This type of inversion or reverse engineering is wildly helpful in all areas of life. Where do you want to be at the end of your life and what can you do today to help you get there?

    Focus on the things with the longest shelf life, not the ephemeral. Must look long term and have the capacity to suffer. This is another principle that applies far beyond investing. Sacrifice today so that you can have more tomorrow.

  4. Charlie Munger: Inversion is a really powerful thinking habit. Before trying to help, first ask how you might harm. Must have great clarity on what not to do. Collect stupidities and learn vicariously through the mistakes of others.

    Be aware of your emotions and physical state before making a decision. A question as simple as “are you hungry or tired?” Can help your decision making.

    Expect your portfolio to hit 50% drawdowns at some point. The point is to be ready and to be able to act rationally on the hard times. You have to instil good habits before you need them.

    Build up wealth to be independent, to live the life you want without having to compromise or answer to others.

This podcast with him is really good.

D. The Crypto Section….

I realised that I was probably too far down the crypto rabbit hole, so I have broken it out into it’s own section for now.

1. Launched in 2015, Ethereum is an open-source, blockchain-based platform with a native cryptocurrency, Ether. Today, ETH stands as the second most valuable cryptocurrency to Bitcoin, and Ethereum is the preferred platform for blockchain projects.

Patrick O’Shaughnessy had Justin Drake on the Business Breakdowns podcast to help me break down Ethereum. Justin is a researcher at the Ethereum Foundation. They cover what differentiates Ethereum from Bitcoin, the increasing number of projects being built on the Ethereum platform, and what a shift from proof of concept to proof of stake means for Ethereum. 

2. Ethereum isn't just a crypto currency. It's a software platform with users, revenue, and applications. If you cover businesses like AWS, MSFT, SNOW, or TWLO you should cover Ethereum ($ETH). To get started, check out its Q1 'earnings' results.

3. Why ETH will win store of value:

4. Demetri Kofinas at Hidden Forces spoke with Nikhil Shamapant, the author of a recently published report that sets an ambitious, 18-month price target on Ethereum of $150,000 per ETH—more than 30x the current level—transforming Ethereum into “ultrasound money” and thus, the preferred savings vehicle in crypto.

Here’s the link to his full report:

5. Just another correction or the end?

These numbers are just staggering to me!