1. background – 40 years of disinflation
a. in 1990 Clinton let China into the world trade organization, making hundreds of millions of cheap workers available to the west. This promoted “the labor arbitrage” or “offshoring” – firing e.g. $40/hr auto workers in the U.S. and hiring $4/day workers in China. [i’m making up these numbers, but that was the basic idea.] So there was a lot of cheap labor as global trade grew enormously.
b. After Paul Volcker raised interest rates to 20% in 1980, the U.S. enjoyed 40 years of declining interest rates. Eventually the federal funds rate went to zero, and people got 2% mortgages. So there was a lot of cheap money. [the inflation of the 1970’s was driven by LBJ’s guns AND butter budgets combined with the baby boom generation entering their household formation period, enormously increasing demand for housing, furniture, and other goods. Also cost of living adjustments built into union labor contracts necessitated price increases by manufacturers, further turning the wheel of inflation.]
c. All those cheap laborers in the 3rd world produced a lot of cheap goods. Where would Walmart be without those? So there were a lot of cheap goods.
d. cheap labor + cheap capital + cheap goods were all deflationary, keeping down the general price level.
e. as U.S. manufacturing was hollowed out, the U.S. became increasingly a service based economy. Services cannot, in general, increase productivity as much as manufacturing can. [Think of Moore’s law: the transistors on an integrated circuit has doubled every 2 years.] Low productivity growth was a contributor to U.S. economic sluggishness.
2. the end of disinflation and emergence of inflation.
a. in 2015 China china published its “China 2025” plan: it stated that by the year 2025 China intended to be the world’s leader in artificial intelligence, quantum computing, biotech and so on. China had made great strides by stealing the West’s intellectual property – either by only allowing Western companies to operate in China if they agreed to share their tech, or by outright theft. The publication of “China 2025” was the starting gun for increasing friction and overt competition with the U.S. The decision to re-shore or “friend shore” manufacturing will promote a renaissance of manufacturing in North America [not just the U.S.] in particular, as well as Southeast Asia and some South American countries. “Just in time,” which is very efficient and lowers costs but is fragile, is being replaced by “just in case,” a more robust approach where increased inventories and the need for new manufacturing facilities raises costs.
b. the pandemic reinforced the tendencies above when the U.S. was confronted with e.g. the fact that all its personal protective equipment [masks, etc] were made in China and they were supplying themselves first. The pandemic also unleashed literally trillions of dollars of federal spending, funded by the federal reserve increasing it’s balance sheet from about $800 billion, iirc, to over $8 trillion. [I’m kind of guessing at these numbers, too, but they give you the idea.] The federal reserve buying all the bonds issued to fund the trillions in spending was, in fact, printing new money.
c. the pandemic money printing was different than the prior fed operations called “quantitative easing,” or “q.e.” With q.e. the fed bought bonds from bond holders, i.e. replacing bonds with cash which those investors put into other, riskier investments. That money did not enter the real economy but raised the price of financial instruments and increased inequality. Otoh, the money sent directly to individuals, the ppp loans, the moratoria on mortgage and rent payments, all put money in the hands of ordinary people, who spent a lot of it – they were not primarily investors, they were spenders. So people were locked down in their homes, with more money to spend. They bought more goods. However, supply was constrained as manufacturing had been locked down or restricted all around the world. Thus the price of goods was driven up. By the time everyone had built a new deck, painted the kitchen, gotten a new tv and so on, the lockdown ended. Demand for goods had been largely satisfied in time for demand for services such as restaurant meals and travel to explode. Thus the cost of services rose, too.
d. at the time of the pandemic the baby boomers were entering retirement, and the pandemic accelerated retirements by about 2.5 million workers. The demographics of a large generation retiring, while only a small generation – “generation z” – was entering the labor force caused a decrease in the supply of labor. Also the publicity attendant to a pandemic and its death toll created a YOLO attitude which promoted the avoidance of unattractive service jobs. This is contributing to an increasing cost of labor, and is the reason unemployment remains so low even in the face of tightening financial conditions.
a. Energy is the master commodity. Energy is life. The global population can eat because of industrial agriculture powered by diesel fueled farming equipment, natural gas derived nitrogen fertilizers, diesel powered mining equipment to get phosphate and potassium fertilizers, and [mostly gasoline and diesel] powered transportation to process and distribute crops. But the production of energy is being artificially constrained by political fantasy.
b. electricity is a means of transmitting energy, not a primary energy source. I am a strong believer in the need to retard, stop, and reverse global warming, but I think we need every source of energy available. About 1 billion people live comfortable, first world lifestyles. The rest of the world’s population wants to have that lifestyle, too. Their per capita energy consumption is a small fraction of that in the developed world, but it is increasing and will continue to increase absent mass famine or plague. A motor bike or scooter uses a lot less gasoline than a car, but as those conveyances multiply the total consumption continues to grow. Furthermore all those people want to eat – see remarks on agriculture above. And once their incomes get to about annual $5000/per capita they increasingly desire meat, which is even more demanding to produce.
There are about 1.5 billion cars in the world. As of 2022 there were 26 million electric vehicles, or 1.7% of the global fleet. For all the talk about electric vehicles, there is not enough lithium, cobalt, nickel, etc in the world to produce such a fleet, and mining and refining and manufacturing with those minerals all require a large energy input, and the refining of those metals is very polluting. And no one knows how to recycle the batteries once they degrade. [One bev saves the emissions of 1 driver. Divide that battery by 4 to create plug-in hybrids which can drive 40 miles on battery alone. Most cars are driven less than 40 miles per day, but if we conservatively say there’s 80% emissions savings, multiply by 4 and you’ve saved the emissions of 3.2 vehicles. Divide the original battery by 20 and you can create prius-type vehicles with double baseline fuel efficiency, saving the emissions of 20 * 0.5=10 vehicles. Note: you still need gasoline and/or diesel.] If global civilization is supposed to be reconfigured so that we, as a species, do not want so many vehicles, it will take a long time. In the meantime vehicles will run on gasoline or diesel.
One could power an airplane with batteries, but the weight of those batteries would mean that the aircraft would have to land and recharge every 50 miles. Even if we could produce an all-electric auto fleet, and even if we could produce enough electricity to power those vehicles, we in the u.s. for example, do not have an adequate grid to deliver the power. Upgrading the grid to sufficiency would require tens of thousands of tons of copper to be mined, and high voltage transmission lines to be permitted over nimby objections. This whole scenario is implausible.
Improving fuel efficiency for all kinds of transport is a surer way to make significant reductions in carbon dioxide production. Similarly closing coal burning electricity plants [more of which are being built every year, e.g. 2 a week in china and I don’t know how many in india] and replacing them with dual-cycle natural gas would greatly reduce carbon emissions. Don’t let the best be the enemy of the good.
Battery backup of intermittent power sources like solar and wind: In aggregate, batteries required to back up New York City’s peak summertime electricity needs for 45 minutes would require 3,750 tons of lithium, 9,000 tons of nickel, 6,600 tons of manganese, 4,500 tons of cobalt, 30,000 tons of copper, and 82,500 tons of other materials. This is why we need nuclear baseload power.
c. Germany provides a good example of fantasy-based energy policy. They have already spent or budgeted 200 billion euros [about $220 billion] for their energy transition. They shut down their nuclear facilities and built a lot of solar and wind facilities. If you look at a map, you’ll notice the northern latitude of germany. If you look at weather records you’ll notice its cloudiness, and the variability of wind. Solar is a great idea in Arizona; in Germany, not so much. Because of the intermittency of its chosen energy sources, and its ideological opposition to nuclear energy, Germany has been burning a lot of lignite- brown coal, the dirtiest and most pollution-producing kind of coal. Thus, for all its investment in its fantasy of being pure green, Germany has not only the most expensive but also the dirtiest energy in Europe. Nuclear base power is a part of any realistic plan for reducing carbon emissions.
d. “ESG” stands for Environmental consequences, Social effects, and Governance, and has been adopted as a policy goal by many financial institutions including banks, insurance companies, endowments and investment firms. Of course, for political reasons esg is interpreted in a rigid and extreme fashion. As financial institutions refuse to invest in fossil fuel exploration or production, refuse to loan to the relevant companies, and refuse to insure their equipment, exploration and production has been increasingly constrained. When gasoline was over $5/gal Pres. Biden had the ceo’s of the big oil compnies in to tell them to produce more. At the same time the administration’s stated policy was that their businesses were to cease to exist within 10 years. Given that major projects cost billions of dollars and may not show a net profit for a decade or more, no company was going to invest in major projects. Instead they would charge what the market would bear, and pay dividends and buy back shares to reward their owner/investors. The very limited amount of “capex” [capital expenditures] means limited supplies in the face of ever-growing global demand. Thus
energy prices will inevitably rise.
4. money vs purchasing power
a. as inflation proceeds, the value of hard assets – the price of goods, not dollars which are paper claims on goods – will rise. Thus I have allocated 20% to commodities, mostly energy but some agricultural products, fertilizer companies, and so on. I have also allocated an additional 5% to nuclear in particular, mostly uranium itself but some uranium mines.
b. given my belief in “sticky” inflation I have put 25% of my assets in an 8 year TIPS ladder. TIPS are Treasury Inflation Protected bonds – they reset their principle value every 6 months based on the cpi. They are not great inflation protection, since the cpi is a heavily manipulated index, but they give some inflation protection. [a bond ladder means holding bonds which mature in each of several future years.]
c. the dollars you have are claims on future goods and services. i.e. their value is based on the goods and services that you might purchase with them one day. The gov’t is currently running a budget deficit of 5-7% of gdp. i.e. the gov’t is spending an extra 5-7% of gdp with funds it doesn’t have. It must borrow those funds. However, foreign central banks ceased buying u.s. debt some time ago. u.s. banks and money market funds were mandated to increase their holdings of gov’t debt, and are already stuffed. The federal reserve has been net selling its holdings of gov’t debt in an attempt to shrink its balance sheet. Who will buy the debt? Investors will buy a lot because the rise in interest rates means they can get paid a “riskless” return- riskless except for inflation. Also the gov’t is spending that money into the economy, increasing the demand for goods and labor. Also, urrent interest rates are high enough that interest payments by the federal gov’t are inflationary in themselves.
5. financial repression
The “solution” for such a situation is “financial repression.” The model for our inflation is not the 1970’s, it is the 1940’s and early ‘50’s. At that time the gov’t had an enormous debt because of WWII, a debt comparable in size [relative to gdp] to our current debt. What they did was hold interest rates artificially below the rate of inflation. Because the growth of GDP includes its nominal not just real growth, nominal GDP grew faster than the debt and the debt, relative to GDP, shrunk to a more manageable size.
Financial repression will mean that regulated pools of capital will be mandated to buy gov’t bonds. Banks and insurance companies are already stuffed with gov’t paper for regulatory reasons. I expect IRA’s and 401K’s to be mandated to purchase some percentage of treasury bonds, or perhaps some new annuity-like treasury paper, all “for our own good” of course. Another part of financial repression is capital controls – not allowing money to leave the domestic economy. I currently have a maximum planned allocation of up to 20% in gold and silver, including miners, depending on future information and conditions.
a. I have 20% allocated to Eastham Capital private partnerships, originally introduced to itulip readers by ej. They have created really good returns. Their core model is to buy class “c” multi-family properties in “b” neighborhoods. They fix them up, install better management, raise rents to market levels for the upgraded apartments or townhouses, and then either sell them if they can get a good enough price, or operate them for rental cash flows otherwise.
b. I have a cash position [treasury bills or money market funds], with the expectation that sooner or later we will have a recession and market sell-off. At that time I plan to add further to the commodities and to the precious metals.
c. by sometime in the early 2030’s most baby boomers will have died and the largest living cohort will be the millennials. It is my hope that our current political divisions will be healed, and our industrial renaissance will be in full bloom. At some point before then it will be appropriate to re-orient investments around the re-shaped economy, the industrial renaissance of north america . I don’t think I will be around to implement that shift.