Efficiency X Robustness

• Outsourcing, leverage, specialization and trade, low interest rates, these are the symbols of efficiency. A long period of efficiency over robustness appears to have come to a turning point, if a rather protracted one.
• Specialization and trade, globalization, led to increased efficiency and by implication disinflationary forces, for a long time. For several reasons, this dynamic is coming to an end. Re-shoring, friend-shoring, self-sufficiency, tariffs and embargoes, lead to lower efficiency and possibly more robustness.
• Leverage is capital efficiency but leads to precarious balance sheets less able to withstand shocks. Since the financial crisis in 2008, the financial system has pursued an agenda of reducing leverage in the banking system. Generally, leverage has been shifted from the private sector, i.e. banks, corporates and households, to the public sector, where insolvency is less well defined and the ability to absorb losses is greater.
• Low interest rates mean more propensity to experiment and fail, and a greater propensity to invest. Low interest rates aid and abet leverage in the quest for capital efficiency. Low interest rates lead to more fragile capital structures as it supports more leverage with higher debt service convexity. Higher interest rates present a higher hurdle for investment encouraging capital discipline and more robust capital structures and lower debt service convexity.

Focus X Diversification

• Index ETFs (exchange traded funds) provide low cost, diversified access to markets. Ironically, as more capital is funnelled into index ETFs, they reduce market diversification by directing more capital to stocks that are rising and less to stocks that are falling. As equity valuations are the inverse of cost of equity financing, this momentum loop acts as a tax on small companies and a subsidy to large ones.
• Robust systems require diversity (or entropy) for stability. Diversity means a large number of independent participants and resource allocation decision makers. Pooling vehicles, of which index ETFs are but one, reduce the number of independent participants and increase the size of the remaining ones. This can reduce the informational efficiency and robustness of a system or market.
• Norms and conventions can also cause pooling of behaviour. Value at Risk systems can lead to coincident de-risking and re-risking leading to heightened market volatility.
• AI adoption has been slow thus far but when adoption accelerates, will AI guide large numbers of humans into common behaviour and with what effects? Will it lower the entropy of social and commercial systems? 

Autocracy V Democracy

• Central planning is best when there is perfect information. In a subset with perfect information, central planning and hierarchical organization work best.
• Free markets are best when there is imperfect information. Subsets of perfect information and hierarchical organization transacting with one another under uncertainty result in the best outcomes.

• Autocracy suffer from informational inefficiency. Feedback is an important factor in effective policy. Autocratic regimes have poor feedback mechanisms making policy calibration difficult.
• Liberal democracies benefit from a safety valve. Failures are ascribed to individuals instead of their offices. This sustains the system while individuals who fail are replaced. In autocracies, failure tends to result in system change which can be disruptive.
• The USA is becoming less democratic as the organs of state are controlled by one party, and the party is heavily influenced by one individual. China is by construction a one party country and the concentration of power with one individual further affects the efficiency and efficacy of the state. India remains democratic especially as the current government has lost its simple majority in the lower house. European political dispersion remains alive and well despite a lurch to the political right.

The Longevity Imperative

• Lifespans are increasing.
• Healthspans and workspans are not keeping up.

Implications:

o Impact on personal finances.
 Will our personal savings and defined contribution pensions be sufficient for our extended lives beyond work and contingencies?
o Impact on public finances.
 What will happen to the solvency of public pensions and what will it mean for payouts and contributions?
 What is the impact on public healthcare in terms of costs and quality of care?
 What is the impact on tax revenues and on the ability to fund public services?
 What is the impact on interest rates, term premia, and the ability to raise and service public debt?
o Impact on the economy.
 What is the impact on savings rates and thereby on the ability to service public debt?
 What is the impact on the labour market?
 Will older workers displace younger ones causing greater youth unemployment? What are the social implications?
 What is the impact on the size and quality of the labour force?
• Other implications
o Will retirement ages have to rise? Almost surely.

Prescriptions and solutions:

• Lengthening healthspans
o Improve health through healthier lifestyle.
o Improve health through medications and therapies.
o Improve access to healthcare.
o Does work improve health? Answer this question.

• Lengthening workspans.
o Human resource regulations to address ageism.
o Retrain to remain economically relevant.
o Delay and defer retirement.

• Fiscal sustainability
o Raise GST.
o Impose land taxes.
o Consider wealth taxes. This can be complicated.
o Raise retirement ages to match lifespans. This is politically challenging but will have a significant impact.

• Economy
o Provide retraining and continuing education opportunities to match skills with abilities and needs.
o Use of technology such as AI and automation to extend the capabilities of human beings and not just replace them.
o The strategic balance of defined benefit and defined contribution pensions to provide for retirement and contingencies.
o Reform of defined benefit pensions schemes and social security. Back to solvency and adequacy.
o Reform of defined contribution pension schemes and regulation and development of personal financial industry.

• Others:

Areas for investment

• Healthy living.
o Preventative medicine.
o Fitness and activity.
o Diet and nutrition.
• Medicine.
o New medicines such as GLP1.
• Personal finance
o Savings and investment products aimed at longer lifespans.

27 Sep 2024. The PBOC cut the RRR and repo which will impact the MLF and mortgage rates. They will also offer a swap facility to brokers and mutual funds. Its managed to lift equity markets as sentiment improved. Will it materially impact the economy? I don’t think so. I don’t think people are in a mood to borrow to do anything. They might borrow to invest, hence the lines to brokers, but I don’t think anyone is going shopping anytime soon.

The government has managed to create a sense of despondency across the populace. They now need to repent and spend. I recommend that the government create a federal housing agency to buy up unsold housing, including uncompleted units, and complete them. This housing stock can be rented out at concessionary rates and will form a social safety net infrastructure, although I think they will probably be pretty empty for a while. There are a lot of buy to lets out there that will become the main inventory of this agency.

I recommend a 3 year term repo where developer loans and debt can be posted as collateral. This turns the PBOC into a giant pawnshop accepting dodgy heirlooms. Its ok. Banks will only be allotted this facility to fund new loans to property project companies, not the developers themselves, to complete the stock of uncompleted housing which the federal housing agency has agreed to purchase.

Its not a great solution but its better than offering cheap loans to people who don’t want them.

The Climate Crisis.

• The evidence of anthropogenic climate impact is incontrovertible and coincides with our increasing use of fossil fuels.
• A habitable environment is a public good (non-excludable and non-rivalrous) and therefore undersupplied by a free market.
• Given the complexity of the ecosystem, solutions likely will be equally complicated.
• Is a supply side solution (more renewable energy, better energy efficiency) sufficient? Will humans always exhaust resources regardless of supply? If so, what is needed for a long-term stable equilibrium?

What we can do:

• Invest in solutions to reduce carbon emissions, reduce fossil fuel and energy consumption and promote a balanced circular economy. Nuclear energy is a necessary long-term solution. Wind, PV and storage are mature technologies and immediately investable solutions.
• Advocate for and promote responsible consumer behaviour.
• Advocate and lobby for regulation to correct adverse selection in markets. Carbon taxes and quotas will play an important part in mitigation.

The Longevity Imperative.

• People are living longer but the proportion of life spent in good health is not keeping up, nor are employment opportunities.
• Some difficult questions:

  • If unaddressed, dependency ratios will rise, pensions solvency will suffer, and fiscal positions will weaken.
  • Do we have an adequate labour force? Will productivity be maintained or improved?
  • Do we have enough private resources for retirement? Will there be sufficient jobs?
  • Will older workers displace younger ones? What might the social implications be?
  • Can work be healthy and take some strain off healthcare?
  • Retirement ages will inevitably have to rise.

• Some hope:

  • Opportunities exist if we reform pensions, human resource policy, social and cultural norms.
  • Longer life spans, if in good health could mean accumulation of IP, continuity and higher productivity.
  • Older populations exhibit lower criminal activity, propensity for military conflict,
  • However, the transition will take time. What happens in the interim?

What we can do:

• Envisage the future under a few different scenarios. For each scenario, invest to provide solutions to the various issues.

  • We live longer, prepare for longevity and are able to extend health-spans and employment-spans to match. (What are the implications for healthcare costs, fiscal positions, dependency ratios, products and services (including financial services,) transition periods from current state. What are the implications for markets? We may require a consultant to advise.)
  • We do not prepare for longevity and spend more time in ill health and unemployment. (May require consultant to advise.)

• Vigilance on fiscal health is warranted. Ageing populations will place an increasing burden on sovereign balance sheets.
• Invest in solutions to private personal finance to pivot away from state pensions and savings.
• More public goods will be outsourced to the private sector. What are they and how can we profit from them?

The Fiscal Challenge.

• Government debt has been rising steadily over the last 4 decades
• Inflation had been benign over the last 4 decades until 2022. Inflation and higher interest rates could be a significant risk to debt service
• Many factors affect government debt

  • Economic and social models. Small or large government. Capitalist or dirigiste economies.
  • Geopolitics and conflict. Wars and paranoia cost money.
  • Demographics. Age, income and wealth distribution affects fiscal revenues and public spending.

What we can do:

• Although this will likely manifest over a longer time frame, FX and rates could get really unpredictable. Hedge what we can.

Once upon a time, there was a Thai philanthropist who funded a program in Africa which paid for the education of the poor. One of the beneficiaries of this funding program, a young physicist barely out of their teens, discovers a new physics, a new way of characterising, describing and understanding reality. From this new physics, they realise a way to achieve low cost, in more than monetary terms, energy, in the form of fusion, facilitated by coopting another fundamental force that surmounts the electrostatic resistance to fusion. The result is a power generator that is compact and cheap to fuel, and manage. Construction, though, is complicated and takes time.

The young scientist takes their invention to their benefactor, realising that what they’ve made is not so much an invention as a discovery and therefore a public resource. Together, they realise that there is significant political and expropriation risk. To mitigate this, they decide that the technology has to be housed in a company that is owned by a foundation whose governance will resist the forces of cynicism and self interest. Gravitas LLC.

Gravitas would be owned by the WC Foundation. The trustees of the foundation would be representatives from the world’s poorest nations. When a nation grew out of poverty, such representatives would have to resign and be replaced. The WC Foundation would provide governance and strategic direction to Gravitas while delegating the day to day management of the business to professional management.

Gravitas began to supply reactors to countries based first on their need and their relative poverty, with the rich developed world at the end of the queue. The complicated manufacturing process meant a considerable queue and significant waiting times. However, operational reactors were powerful enough that many clients of the first reactors were able to export power, at a price. Gravitas itself was run at modest profit margins to feed the foundation and its grant budgets, but never to enrich itself beyond modest return on equity thresholds.

Understandably, industrial espionage, lobbying and coercion, not to mention direct threats were rife. The reactor design, however, made re-engineering impossible. The reactor chamber was a vacuum with no moving parts and indeed nothing inside it. Whatever processes were at play when the reactor was operating disappeared when the reactor chamber was dismantled. Attempts to scan the reactor while at rest showed little while attempts to scan it in operation led to instantaneous reactor shutdown. Somehow, at a fundamental level, the reaction itself was shy, and evaded scrutiny.

It was important to the inventor of the reactor and the new science to distance themselves from the business and the technology for their own safety. Hence all commercial interests and intellectual property was transferred to the company and away from the inventor so that they no longer had any influence on the conduct of business of Gravitas. It was not enough that the technology might be obtained from the company but may be re-created by the inventor so the inventor lived the rest of their life in fear and under high security, a surely dreadful fate for a young and intelligent soul who had brought so much to a world that had been burning the furniture and indeed the walls and foundations of its house to fuel its energy needs.

AI, so topical in the mid 2020s, was aimed at trying to replicate this technology could only look on in wonder and return a verdict that “it’s a kind of magic.”