It is difficult for an individual to hold, accumulate or acquire intellectual property directly. Storage capacity is one issue. At best an individual can hold or acquire the last mile of the intellectual property chain. The most practical way for an individual to own intellectual property is through ownership of a company or business. (Higher education and vocational training are examples of acquiring non exclusive access to existing technology and need separate treatment.)

The storage of intellectual property is one of the possible reasons that labour’s share of income has been declining almost monotonically. Perhaps the picture might look more balanced if we include under labour’s share, a portion of corporate’s share representing labour’s ‘IP holding company.’

One of the implications of this interpretation is that the distribution of intellectual property is somewhat dependent on individuals’ investments into companies or businesses. It follows that income distribution is also dependent on the extent of equity investments.

Incremental innovation and IP accumulation can therefore imply a steadily declining share of profits for labour. How far can labour’s share decline, and what could happen? In the extreme, what happens when labour’s share tends to zero? Are wages expected to tend to zero? What then is a fair distribution of intellectual property and how would it be allocated? A concrete example would be: if robots did all the work in the world, how much would humans get paid, and who would own the robots? If we assumed an arbitrary endowment of ownership at a snapshot in time, how would this evolve? It is reasonable to assume that ownership of such assets would compound much faster and lead to a greater inequality of wealth. Owners of equity are owners of intellectual property and will obtain a disproportionate and growing share of output and income. In the hypothetical limit, income is entirely derived from ownership of assets and labour obtains zero income and employment. Clearly, before this could happen, social and welfare issues would arise.

The disruption to the current trend of rising productivity, rising corporate profitability, the decline of labour’s share of income and production, appears only to be interruptible by non-economic, extra-commercial factors.

There is more to MV=PQ than meets the eye.

Central banks can expand M but this does not mean they can expand MV. V can always fall to compensate for the increase in M, as has happened for most of the period 2008 – 2014. The maintenance or expansion of V is dependent on a number of things. Necessary conditions include a functioning fractional reserve banking system with sufficient capital and appropriate reserve ratios to transmit the increases in V. Sufficient conditions include a health demand for credit which is dependent on business sentiment.

Assuming that it is possible to increase MV, the impact on PQ and its constituents remain complicated. While PQ is a scalar, P and Q are in fact vectors. Q is a list of all the possible stuff you can spend money on, and P is the corresponding vector of prices. A couple of things to note about Q are that it includes goods, services, and assets, indeed, anything you can allocate money to, and that while the scalar PQ must rise if MV does, its not clear a) which good, service or asset market is experiencing rising nominal output or b) for a given good, service or asset market experiencing rising nominal output whether price, real output or both are rising. In other words, even if MV and therefore PQ is rising, some markets may experience falling nominal output while others may experience rising nominal output and in markets with rising nominal output it could all be due to inflation or real growth or both, but you couldn’t control which. 

All things being equal, if nominal output in a particular market is not falling, and real output is falling or decelerating, then price must increase or accelerate. An example where this might be happening is the stock market, where companies are buying back stock. All things being equal, this will put upward pressure on stock prices. M&A is also another mechanism which may reduce the float.

The bond market is a bit more interesting. Prices are rising while output (issuance) is rising. That means that the bond (and loan) markets are responsible for diverting a large amount of liquidity away from other markets such as those for goods and services.

Asset inflation could divert liquidity away from current consumption resulting in lower inflation. Conversely, a recovery in inflation could signal a diversion of liquidity away from asset markets. There is a scenario under which inflation expectations driven by QE cause investors to divert capital away from savings in fixed income assets such as bank deposits and government bonds towards risky assets such as equities and high yield bonds in an attempt to hedge future inflation. Conventional wisdom seems to imply inflation encourages current consumption but the recovery in capital goods ahead of consumer goods seems to support some extend of substitution away from current consumption to future consumption albeit in assets that provide a positive linkage to inflation. If risky corporate assets are seen as claims on future production, there is an argument that they are inflation hedges. QE therefore causes inflation of these future claims at the expense of current inflation.

Fundamentals should not be ignored. However, fundamentals can be framed within the above concept as providing the relative attractiveness of each good or asset market in the allocation problem. The global allocation is still driven by the almost mechanical and physical allocation of liquidity.

At a more mundane level:

Monetary expansion can lead to asset price inflation.

For a given level of monetary expansion, assets and or goods and services can experience inflation. Excessive inflation in assets can explain lack of inflation in goods and services markets.

A withdrawal from expansionary monetary policy could cause deflation or slower inflation in assets or goods and services.

Under neutral monetary policy, goods and services inflation implies declining asset prices.

One of the most interesting and rewarding investment opportunities currently available trades on the reform of the banking sector. We live in a world where, unfortunately, pragmatism has for too long trumped ideology. This lack of a guiding philosophy had led banks to myopia and to overreach themselves resulting in over-levered balance sheets and inappropriate operating practices, culminating in the financial crisis of 6 years ago. Regulators are still trying to reform the banking system and this has produced a host of investment opportunities. 

What is the raison d’être of a bank; why does it exist and what is its place in the economy? A bank exists to borrow money from those who have more than they can currently spend or invest and to lend it to those who have less than they can currently spend or invest. A bank is therefore no more than an intermediary. From this function, pragmatism and the profit motive led banks to turning their credit expertise to bond arranging and underwriting and ultimately to trading and hedging. From bonds, this same capability was extended to equities, commodities, foreign exchange and pretty much anything for which a market could be created. The liquidity provided by banks trading serves a useful purpose in price discovery and risk transfer. However, as is often the case, when competency trails behind the state of the art, or complacency or hubris develops, banks can and have overreached themselves leading to credit crises. Glass-Steagall in 1933 and more recently Dodd Frank are legislation enacted to manage this tendency for efficiency to dominate stability and governance, especially when clever minds are at work.

One of the primary sources of instability is not just the commingling of principal and agency activities in a bank but rather the liquidity mismatch between its assets and liabilities. This mismatch arises because banks borrow short term from depositors and each other, and lend longer term to businesses and homeowners. Normalized interest rate term structures mean that banks earn a higher interest rate lending long and pay a lower cost of funds borrowing short. This is efficient but inherently unstable. So far, no rules, limits or regulatory device have been able to mitigate the force of fear during a bank run. One way by which the financial industry has sought to address this liquidity mismatch, is the so-called Shadow Banking system. This is a parallel funding system where it is hoped that the liquidity or maturity between assets and liabilities can be matched. More cynically, they are a means of circumventing regulatory capital requirements. Generally, Shadow Banks are thought of as any non-bank institution conducting a banking business. Structured Investment Vehicles, Collateralized Debt Obligations, Collateralized Loan Obligations, Private Debt or Private Equity funds, indeed even mutual funds, can be considered part of the Shadow Banking system.

In the run up to 2008, banks who witnessed demand outstrip capital saw Shadow Banking as an outlet, but as with trading and hedging before, competency and circumspection trailed the state of the art and avarice, and before long the Shadow Bank’s collapsed, and collapsed onto the banks themselves. Regulators were quick, though late, to step in to regulate the financial system and in such a way as to limit banks to focus on their core reason for being, that is to borrow and to lend safely. This regulation, unlike the singular Banking Act of 1933 is a raft of international sanctions. As such they will be more difficult to dismantle than Glass-Steagall which was repealed by Graham-Leach-Bliley in 1999. Basel 3, Solvency 2, Dodd Frank and the Volcker Rule are some of the fragmented rules that banks will have to navigate in future.

Herein lies the investment opportunity. New leverage and capital rules will discourage banks from certain types of lending, from many types of trading, and encourage banks to restructure their balance sheets through asset sales, new methods of funding and accounting acrobatics.

Where banks are retreating from lending, returns can be earned for replacing them. Examples of this are private debt funds that lend directly to small and medium sized enterprises, to fund infrastructure or to real estate development and do so flexibly to the benefit of both borrower and lender. Many of these funds work with banks, to reduce the leverage of the bank’s funding, enabling them to lend efficiently while complying with the new regulations. Investors in such funds can reap a liquidity premium in addition to the credit spread.  Returns to secured lending can be as high as the mid teens.

Where banks are no longer trading, the public traded capital structures of companies have become improperly priced leading to arbitrage opportunities. Capital structures used to be policed by bank trading desks as they trade across equities, preferred shares, bonds and loans. Mutual funds tend to segregate trading of such securities so that the pricing of one segment relative to another is not arbitraged away. Only a small group of hedge funds did this. They are now growing as banks shutter their trading desks and traders have to find a new home. Capital structure and credit arbitrage hedge funds generate very attractive risk adjusted returns.

Banks own capital structures are inefficient. The financial crisis led to bank bailouts and rescues that necessitated emergency capital structures. As the crisis has waned and new regulation is implemented these capital structures are no longer efficient. Some capital securities will be reclassified as debt. Some apparently dangerous securities such as CoCos (contingent convertibles) are being deleveraged making them safer than the market thinks. Some of the most lucrative trades will be in the trading of bank securities across their capital structures. Some mutual funds and hedge funds are active in these securities.

Asset sales are another means of deleveraging bank balance sheets to comply with new capital rules. These assets need a new home and, at the right price, even apparently poor assets can make good investments. Distressed asset funds are on the prowl for such assets.

Lending to banks in creative ways can also be lucrative. Some private debt funds do this. By providing capital relief on assets that remain on the borrowing bank’s balance sheet, these lenders release capital allowing the bank to continue to lend. For this service they exact a high yield on their capital. Some very specialized funds invest in this area. There is even one such fund based in Singapore.

The strategies arising from bank regulation are diverse and offer rewards to risks other than market risks and therefore are a useful diversifier in any investment portfolio. The issue with these strategies is that they are often either illiquid and thus require term capital or they are complex and require special analysis. The shame is that these opportunities will likely not be made available to retail investor but will remain the preserve of institutional investors.

If we stop thinking about QE as an expansionary policy but rather as a treasury refinancing operation and debt monetization, the behavior of the Fed becomes clearer. For one, the Fed surely understands that without reducing the banking system’s reserve requirements, the money multiplier and the velocity of money cannot accelerate and thus asset purchases have very little impact on real or nominal output. Indeed by increasing capital requirements, the Fed is effectively neutralizing any expansionary effects of QE. A side effect of refinancing the treasury is an expanded balance sheet which risks runaway inflation should the velocity of money pick up. Any sign of improved fiscal position must encourage a corresponding reduction in asset purchases.

The impact on pricing of the term structure due to the Fed going forward should be regarded as at best neutral.

Current economic wisdom is that geographical labour mobility is an almost unqualified positive and an inalienable right. This should not go unquestioned.

Labour mobility is responsible for improved employment, lower costs, greater efficiency and is associated with an overall increase in welfare. Other considerations should include factors such as overcrowding in cities, hollowing out of secondary cities, towns and villages, infrastructure requirements, distribution and allocation of resources, and the equitable distribution of wealth.

One metric of welfare should be population density. There is an optimal density in the welfare function below which the incumbent population regards an increase in population a good thing and beyond which it regards it as a bad thing. A local population deserves certain rights to control the population density in their area. The problem lies in determining the appropriate level and nature of the controls.

Different groups within a local population have different objectives regarding population. Business owners and employers seek the import of skilled or cheap labour. Owners of land seek demand for labour storage. Governments may see immigration as a means for maintaining demographic characteristics and as a source of tax revenue. Employees may regard immigration as competition for jobs and resources, as demand for goods, services and housing drive inflation. The representation of various groups in government will drive immigration policy.

Sprawl has infrastructure costs related transport and communications. Some of these costs are public and some private, but the public cost is significant. Countries are collections of local populations. National policy can affect the cost of doing business in a country creating divergences between countries. Most countries are evidently operating productivity accretive immigration policies, subject to the tolerance of the majority of the incumbent population who prefer less immigration. This is indicative of the representation of the various groups in most governments. Priority is unlikely to be given to policies where the costs are not associated with commercial gain in the most direct, immediate and evident ways. That the factor of population density in the welfare function is often subordinated to more commercial interests or is omitted altogether, it is not surprising that current policies encourage concentration of population, in particular productive labour in urban centres, while less productive groups are left in suburban towns and villages. If valid, this will be evidenced by larger cities getting larger and more dense while smaller cities shrink and get less dense in a ‘winner’ take all dynamic.

The concentration if population in cities leads to potentially major disparities in real estate prices as well as rapidly inflating prices. As overcrowding sets in, proximity to resources and infrastructure also command significant premia. Foliage, water, aesthetically pleasing surroundings and locally lower population density are goods that can command significant premia. River side and park side housing show evidence of this.

As a scarce resource, real estate can become a source of rising cost for both residents and businesses in a city. Costs should rise as long as people continue to move in to cities, pushing up prices until they reach the limits of affordability. Availability and cost of credit can increase demand by spreading the cost of ownership over time and easing affordability at least in the short term. Excessive credit can create real estate bubbles if credit underwriting is too lax and or loses sight of rationality. Principal agent issues in mortgage markets where mortgage loans are sold or securitized and sold by originating banks can exacerbate the problem. Artificially low interest rates also add to the problem, enabling unsustainable real estate prices. Such interest rate policies may or may not be integral to housing policy.

This analysis is incomplete and some of the hypotheses untested. It is built on expectations and understanding of human behaviour, an approach that has worked elsewhere, such as in economics and financial markets. The above should therefore be regarded as interesting speculation rather than an academic study or survey.