Reflexively responding to daily news is a low value function. But with all the debate around wages, inflation, and government support, here are some viewpoints that might prove interesting.
This is a complex and often emotive issue, so we’d love to hear your thoughts, criticisms, and comments.
“How All This Happened”
[10 minute read]
“If you don't know where you've come from, you don't know where you're going.”- Maya Angelou
In 2018, two wonderful things combined. The spectacular article curator, “The Browser,” awarded an article from tremendous finance writer Morgan Housel, one of its “Golden Giraffes” for best articles of the year. The article in question was “How All This Happened” (linked below).
Housel’s article is a snappy economic history of the U.S. economy since World War II. The primary conclusion is that the “Pax Americana” years from 1946 onward were actually a relatively anomalous period for the developed world. But because most of our parents and grandparents grew up and worked in a period of generally widespread prosperity and security, it’s a commonplace assumption that this is the base case. In most other places and times, flux has been the norm. In the 20th century alone, a citizen of Leipzig in Germany would have experienced 5 completely different regimes: the Kaiser, Weimar, Nazism, Communism, and Capitalism.
The creeping realization that this historical oasis might be the exception rather than the norm is behind a great deal of justified generational angst.
So what happened over the last 30 years? The relentless quest for efficiency, technology and globalization. On the latter, Matthew Klein and Michael Pettis’ compelling argument has basically been that capital inflows to the U.S. have driven down lending standards. Seemingly limitless demand for treasuries means lower borrowing costs. Consumers could take on more debt: credit cards, student loans, and mortgages. Capital outflows meant outsourcing to cheaper labor markets. The U.S. worker ended up secularly squeezed in the middle. Recall “The Elephant Curve” or “The Most Important Chart in the World” from a couple of weeks ago.
Source: Alvaredo, Chancel, Piketty, Saez, Zucman, 2018 World Inequality Report, World Inequality Lab
As capital freely dispersed all over the world, the U.S. and Western Europe stagnated, Emerging Markets rose into the middle class, and the top 1% exploded. Developed world wages came down to meet Emerging Markets on the way up.
Klein found that a staggering 96% of America’s net job growth since 1990 has come from sectors known to have low productivity. Construction, retail, bars, restaurants, and other low-paying services were responsible for 46% of total growth. Meanwhile, “Sectors where low productivity is merely suspected in the absence of competition and proper measurement techniques (healthcare, education, government, and finance) explain the remaining 50% of growth.” What’s common to all of those jobs? They can’t be outsourced.
The key distinction in today’s world is global/digital vs local/physical. Global digital flows deflated wages and technology costs, while some local physical costs exploded.
An incredible statistic is that, since 1990, about 88% of U.S. inflation boils down to 4 sectors of the U.S. economy: healthcare, higher education, real estate, and prescription drugs.
Looking at this stark chart of divergences in CPI from 1997 to 2017, Marc Andreesen’s explanation of the productivity paradox in the U.S. is increasingly compelling.
“Americans will continue paying more and more for sectors of the economy where tech hasn't had a big impact (healthcare, education, construction, and real estate), and we will pay less and less for things like media, retail, and financial services, where tech is impacting productivity.”
If it were built in 1957, an iPhone X would have cost $150 trillion and required 30x the world's entire power output. Digital goods and tech hardware on international supply chains have massively deflated. We can watch the entire world’s creative output on flat-screen TVs at a minimal cost that would have been literally unthinkable 30 years ago.
Meanwhile, the local/physical things a 1950s consumer would have considered life staples have inflated wildly. Adjusted for inflation, the median home price in 1940 would only have been $30,600 in year 2000 dollars. In 1950, college tuition was somewhere in the range of $6,000 in today’s dollars.
When the 100 year flood of COVID-19 materialized, it was precisely the most vulnerable local/physical growth sectors like retail and hospitality that were decimated.
So what’s next? This same logic dictates that you either need something like capital controls to create friction in those global flows, or to somehow get money directly to U.S. workers. And here we are at option B.
Looking at what has taken place since the pandemic, government has clearly tackled incomes and childcare costs directly. One of the key insights over the last 18 months was from Scottish strategist Russell Napier. Essentially he argues that politicians, not central bankers, now have control of the “magic money tree.” Caesar does not relinquish power easily.
The common response to the concept that low-end jobs will see wage inflation is that they will be increasingly automated and digitized. But “Moravec’s paradox” has shown that it’s much, much harder to automate a “local physical” construction worker than an accountant. As Pedro Domingos puts it in The Master Algorithm:
“One of the lessons that we’ve learned in AI painfully and that everybody should be aware of is that we used to think 30 years ago that the easiest jobs to automate were going to be the blue collar ones. We thought that the white collar jobs, which require education, were going to be hard to automate. That has it exactly backwards. The hardest jobs to automate are things like construction work because they require dexterity, moving around, not stumbling, seeing things that we take completely for granted. These are tasks that took hundreds of millions of years to evolve.”
That brings to mind an appropriate, but probably apocryphal, anecdote: in the 1950s, Henry Ford and Walter Reuther, the head of the UAW, were touring a new engine plant in Cleveland. Ford gestured to a fleet of machines and said, “Walter, how are you going to get these robots to pay union dues?” The union boss famously replied: “Henry, how are you going to get them to buy your cars?”
While all other bottleneck inflation seems transitory, the biggest question to consider is: do politicians risk giving up the unprecedented power they have now been granted to put money directly in voters’ hands? Do we end up with Universal Basic Income by any other name? As Stifel’s own Barry Bannister puts it: “Washington’s strategy appears to be back-door Universal Basic Income via front-door MMT to raise private wages.”
Three critical things to be watching from here are: efforts to secularly deflate or disrupt the key local/physical costs (hard!), capital controls (hard!), or direct government intervention in wage growth (hard!).
The key variable is essentially an interventional sliding scale by government. On one end, you had completely free movement of capital that deflated wages for the middle and lower classes. On the other end, you have Universal Basic Income. In the middle might be a state or federal initiative to drive productive local investments, enhanced by the ongoing frictions in global supply chains. Averaging across industries, McKinsey now estimates that companies can now expect supply chain disruptions lasting a month or longer to occur every 3.7 years, and the most severe events will take a significant financial toll. Companies can now anticipate losing 42% of a single year’s earnings on average over a decade.
Counter to the prevailing consensus, Lacy Hunt of Hoisington Investment Management recently outlined the case for decelerating inflation. His principal concern is that, while government debt works transitorily, real per capita GDP, which is a measure of the standard of living, continues to lose momentum as the debt levels move higher. He sees cyclical, structural, and monetary considerations trumping transitory effects as the year progresses.
Obviously a lot of this is naturally backward-looking in nature: reshoring and a U.S. manufacturing renaissance appears to be gathering pace. New technologies like blockchain seem to be rapidly decentralizing wealth. The number of U.S job openings are currently the highest on record.
But certainly to see where we’re going, it’s useful to see from where we came.
- Read. How All This Happened by Morgan Housel (36 minute read)
- Why read. As described above, a classic read from one of finance’s “GOATs,” and one of The Browser’s best reads of 2018. I suggest this reading to anyone wanting to get a firmer handle on what our recent economic past looked like and how it shaped our present.
- Read: Central Banks have become irrelevant- Interview with Russell Napier in TheMarket.ch (24 minute read)
- Why read: One of the better “macro” pieces I’ve read in the last 18 months. Napier’s insight on some developed governments moving to politically determined government guaranteed debt is fascinating.
- “Governments create broad money through the banking system. By exercising control over the commercial banking system, they can get money into the parts of the economy where central banks can’t get into. Banks are now under the control of the government. Politicians give credit guarantees, so of course the banks will freely give credit. They are now handing out the loans they did not give in the past ten years. This is the start.”
- “Remember, a credit guarantee is not fiscal spending, it’s not on the balance sheet of the state, as it’s only a contingent liability. So if you are an elected politician, you have found a cheap way of funding an economic recovery and then green projects. Politically, this is incredibly powerful.”
Have a great weekend!
Director of Communications and Content
The Knall/Cohen/Pence Group
Past performance is not indicative of future results.