Hopes for a fade of the Covid-19 virus are rising. As vaccination rates increase and the Delta variant burns itself out, we may be able to see light in the tunnel. Markets are getting volatile as the steroids (zero interest rates and $120b of dollars added to the financial system monthly) of the Federal Reserve are being slowly reduced. The economic consequences of the pandemic would have been much worse without the financial doctoring that was administered by the Fed and its peers around the world.
Markets are now in an unnatural state. As the public healthcare crisis recedes, asset prices are at a very high level. In a different time and different crisis, unassisted economies would be depressed and primed for recovery. The 2021 markets are at high levels due in part to the “stimulus” that has been injected by governments and central banks globally. The hopeful endgame for the virus is now creating surging demand for fuel, goods, and services, while many workers are not rejoining the workforce. This is creating price spikes and shortages in raw materials, finished goods, and transit.
The science of economics would refer to this as a “supply shock”. Production, shipping and labor are not prepared for big upswings in demand as quickly as seems to be occurring. Historically, central banks would raise interest rates to avoid the risk of inflation or an overheating economy. Monetary authorities are hesitant as they do not want to injure the delicate patient.
“Three days at Camp David”, by Jeffrey E. Garten documents the profiles of the US government officials that participated in President Nixon’s decision in 1971 to “suspend” the fixed gold standard $35 per ounce. Nixon’s decision was not by choice as the notion of linking the US and global economy to how much gold is available has always been an anachronism of the past. Dollars had been produced at a much greater rate than the vaults of gold in the United States could cover.
This incredible moment in economic history occurred on August 15, 1971. A Sunday evening, Nixon announced that the United States was suspending the “Gold Window”, in what came to be known as the “Nixon shock.” The Atlantic Magazine remembered on the event’s 40th anniversary that “Nearly as controversial as the end of the gold standard was the president’s decision to announce it during Bonanza, one of the most popular shows at the time”.
The decision and the drama of a Sunday night surprise announcement is largely remembered for the moment in time that ended the link between US Dollars and gold. There was an additional menu of executive actions that were momentous for time but largely failed and forgotten. Nixon issued an Executive Order imposing a 90-day freeze on wages and prices. It is difficult to imagine a world where the President can decree that no prices can rise, and no raises can be given (if only for 90 days).
Excerpt from The Commanding Heights by Daniel Yergin and Joseph Stanislaw, 1997 ed., pp. 60-64
“Nixon won reelection in 1972. In the months that followed, inflation began to pick up again in response to a variety of forces — domestic wage-and-price pressures, a synchronized international economic boom, crop failures in the Soviet Union, and increases in the price of oil, even prior to the Arab oil embargo. Nixon, under increasing political pressure from the investigations of the Watergate break-in, reluctantly reimposed a freeze in June 1973. Government officials were now in the business of setting prices and wages. This time, however, it was apparent that the control system was not working. Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets. Nixon took some comfort from a side benefit that George Shultz, at the time head of the Office of Management and Budget, identified. “At least,” Shultz told the president, “we have now convinced everyone else of the rightness of our original position that wage-price controls are not the answer.” Most of the system was finally abolished in April 1974, 17 months after Nixon’s triumphant reelection victory over George McGovern — and four months before Nixon resigned as president.”
For students of economic history, the 1971 Sunday night speech is an inflection point for the lessons that history has to offer. Many casual observers may regard Nixon as disgraced, yet he was quite experienced and focused on big ideas deemed to be both necessary and beneficial to fundamental American principals. Also, it is less remembered that President Nixon was re-elected in 1972 with largest mandate in American history. Winning 49 out 50 states and nearly 61 percent of the popular vote.
With this popularity, in 1971 it is fascinating to observe some of the key events that led up to the dramatic shift in the underlying mechanics of the US dollar and the global monetary system.
June 13, 1971
The New York Times begins to publish secret internal documents referred to as the “Pentagon Papers,” an event which leads the White House to become increasingly fearful of further information dumps. Within a week, a special unit named the “Plumbers” is created to stop the “leaks”.
July 12, 1971
Emergency Employment Act
Nixon signs an Emergency Employment Act, earmarking $2.25 billion for the creation of public service jobs at state and local levels.
July 15, 1971
Nixon plans to visit China
Nixon reveals a paradigm shift to the nation with the news that he plans to visit China within the next year, becoming the first president to do so. This visit helped to improve relations with China by ending 25 years of rivalry between the nations.
In his tax reduction proposals, he argued passionately for offsetting spending cuts. This type of fiscal responsibility has fallen off the map of conservative political thinking for decades. It is probably more likely for elected officials in DC to begin wearing bellbottom jeans before we see them paying for federal programs in a sustainable way.
This story of a difficult monetary policy dilemma is an illuminating history lesson. What we have seen in the last 12 years of activist central bank policies across the world has been the beginning of a new era. August 1971 is the 50th anniversary of the changes that allowed this current phase of monetary evolution to take place.
It has been discussed here repeatedly that monetary policy has been the most impactful element of the economics of the last decade. As we observe the theater of absurdity that is broadcast breathlessly from DC and the elected federal leadership, our unelected Federal Reserve board members quietly fund and maintain the mechanics of the global economy.
The last 12 years of Fed actions are a type of price control. The price of money is what the Fed has attempted to manipulate for the good of the economy, markets and workers. This is a complex endeavor and goes against the natural unpredictability and variance of markets. Covid was/is a wicked natural event that we attempt to buffer with vaccines and other pandemic tactics like masking and distancing. The economic consequences of the pandemic have been buffered by monetary tactics.
Nixon era price control experiments were overridden by market forces. Ultimately the efforts began in 2008 and expanded geometrically in 2020 will be shaped by supply and demand, not wish and good intention. This process will be filled with scares and volatility. Ultimately markets are likely to adjust to the vast additions to global money supplies. Buckle up, it is not going to be a smooth ride.
We are now witness to a Democratic Party that has a surplus of grand (or grandiose) ambition. This progressive movement is without the political capital that may be necessary to pass sweeping legislation. The idea that the federal government is the mechanism through which the problems of our time can be addressed is a movie that we have seen before.
The Biden Presidency initiative “Build Back Better” has a laundry list of current progressive aspirations. This initiative can be seen as the 2021 equivalent of the “Great Society” envisioned by President Lyndon Johnson. On May 22, 1964, LBJ gave a commencement speech to the graduating class at the University of Michigan. The moment is notable for it was the first substantial declaration of the federal initiative known as the “Great Society”.
The expansive and idealistic vision of President Johnson also included grand progressive initiatives. These items Include:
War On Poverty
Medicare and Medicaid
Head Start and Education Reform
Urban Renewal
Support for Arts and Humanities
Environmental Initiatives
These legislative goals were pursued over a three-year period. This was an era of immense political capital in the LBJ presidency along with Democratic Party majorities in the House and Senate. Johnson carried one of the highest polling approval ratings of the modern era and the Dems held 68 seats in the Senate (vs 32 for the GOP) and held congress 295 to 140.
The volume of LBJ presidential era legislation passed into law pursuant to the Great Society is astounding:
Civil Rights Act of 1964
Urban Mass Transportation Act
Economic Opportunity Act
Food Stamp Act
Higher Education Act
Immigration and Nationality Act
Voting Rights Act
Social Security Act (Medicare)
Note here that these initiatives we pursued via bipartisan negotiated methods along with fierce battles and infighting. These efforts produced a schism in the democratic party in what was previously referred to as “Dixiecrats” or the southern democratic block that fought vehemently against civil rights legislation.
We are now eight months into the Biden presidency. The approach unfolding is potentially as ambitious as Johnson’s, with crucial differences.
Biden’s approval rating is hovering around 47% while LBJ was polling at an astounding 70%+ range.
The Democratic party control of the House is slim; currently at 220 to 212 and the Senate is evenly split with control resting in the hands of VP Harris.
Biden’s political capital has been marred by footage of a sad Saigon redux in Kabul and the tenacity of the delta variant. One could also speculate that this presidency has an identity problem that will be addressed by campaign season tactics of “tax and spend Democrat” accusations.
As has been stated repeatedly, I do not compose ideological material, nor do I seek to provide cheerleading for any political party. Federal fiscal policy will have an impact on where markets will trade. Steady Federal leadership can reinforce the vitality of our economy. I was hopeful for a more constructive environment after four years of unconventional leadership on the right. It is difficult to be optimistic thus far with the leadership and messaging from the Biden team.
The hubris of such a sweeping legislative goal seems audacious to me. The thin layer of congressional control stands in stark contrast to the Democratic ambition of the 1960s during which the party held significant majorities. The goals of the Democrats are being pursued under the proviso of zero GOP votes, like recent legislation when power was vested in the GOP.
The most recent initiative from the GOP called “Tax Cuts and Jobs Act of 2017” cleared the house without any votes from Democrats. Polar legislation without negotiation or consensus creates volatility for investors and markets as laws shift with the political pendulum. It is a structural imperative that our two-party system works best through negotiation. The hope for centrist rationality currently seems naïve and uninformed.
We are subject to a push for undoing a tax code revamp that is only four years in effect. The Dems were excluded from the current tax rates and rules, thus the PR value in rolling back a tax cut “for the wealthy” is an obvious target for repeal. This game of ping-pong is driven by a lack of vision from either political party. To accomplish anything of lasting importance, you must convince your ideological opponents to participate. Short of consistent House and Senate majorities, legislative accomplishment would historically be done via negotiation somewhere near the center of the issues that we face as a society.
For markets and investors, the falling approval of Biden may foretell a reduction in the odds of a new tax code paradigm with a higher take for progressive goals. Whatever that actual rate of taxation, markets and investors will adjust. The unstable environment is a drag on investor confidence to see a push for structural change via tax policy by Democrats that will likely be redone as soon as the party in power changes.
It is not impossible to imagine a genuine political articulation of what the real challenges of our present circumstances. The current cloud is markets fearing the idea of the federal government raking in a greater portion of the wealth and income of the country. A significant percentage of the voting public is also hesitant to redistribute wealth by DC.
The laws of LBJ’s “Great Society” are available for revision and improvement while holding the obvious advantage in that they already exist. Medicare is perennially untouchable, yet it is a central plank of our crucial health care economy. Digging into the Medicare could have great benefit to seniors, Doctors, and medical workers. Yet there is no glory to be held in the technocratic improvement of old laws. Thus, each presidential regime just conjures up new ideas that pile on top of existing law in order to put their stamp on history. We can only wish for leaders that might come and improve the existing laws that we already have.
“According to Wittgenstein’s ruler: Unless you have confidence in the ruler’s reliability, if you use a ruler to measure a table you may also be using the table to measure the ruler. The less you trust the ruler’s reliability, the more information you are getting about the ruler and the less about the table.”
— Nassim Nicholas Taleb, “Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets” (2004)
Taleb is one of the most influential economic writers of the last 20 years. The impact of concepts like the one above can be applied to many areas of our lives. When we measure investment performance with instruments that are increasingly sophisticated, we can be misled by complexity and useless nuance. As always past performance is no indication of what will happen in our unknowable future.
The most common investment measurement is the simple notion of gains and losses. When the human brain observes gains, confidence and satisfaction is likely to rise. This confidence may appear without much deeper evaluation. Conversely, downward moves provoke concern and desire to “do something”. Downswings are often met with urgency and clouded with human instinct to flee.
“You cannot eat relative returns” is a portfolio management byword. The silly expression describes the difficulty in understanding that when the market is negative by a certain amount, say -15% and your account is only down -9%, you are experiencing positive “relative” performance. Yet our natural human instinct leads to concern regardless of the quality of a given strategy.
Measurement of crucial characteristics of investments can range from oversimplified binary thinking of winning and losing to sophisticated relative index and inflation adjusted measures. The ubiquity of digital information has created the Illusion of Knowledge for many investors. The volume of content being broadcast at minimal or no cost on the internet creates a risk of overestimation of expertise amongst the masses.
It is likely that the recent string of positive results will ultimately lead to a cycle of plateau or down markets. We must remember many examples of positive market moves that must pause, refresh and adjust. The new measure of what US Dollars and global currencies are worth will take time to be sorted. In the meantime, investors must remember the great potential of quality diversified portfolios. We must then remind ourselves to stay humble, patient and courageous. The temptation to “act” when down markets arrive can be overwhelming.
One thing that our current political class seem to agree on is that China represents a threat to Democracy. American Values, trade, and all manner of key characteristics of society are under siege according to the current narrative. It is impossible to determine exactly what the threat really is and how it will evolve.
On 7-17-21 the Economist wrote:
“Now Joe Biden is converting Trumpian bombast into a doctrine that pits America against China, a struggle between rival political systems which, he says, can have only one winner. Between them, Mr Trump and Mr. Biden have engineered the most dramatic break in American foreign policy in the five decades since Richard Nixon went to China.”
It seems that we may be witness to an unfortunate era of “China Baiting” like the post McCarthy era of “Redbaiting”. Looking weak on communism drove the political environment in unfortunate ways that contributed to the American tragedy in Vietnam. The political price for being seen as “weak on China” is a mortal danger to presidents and all politicians.
Niall Ferguson recently wrote: “Let’s begin by recalling how many experts believed the Soviets would overtake America. In successive editions, the economist Paul Samuelson’s hugely influential economics textbook carried a chart projecting that the gross national product of the Soviet Union would exceed that of the U.S. at some point between 1984 and 1997. The 1967 edition suggested that the great overtaking could happen as early as 1977. By the 1980 edition, the time frame had been moved forward to 2002-2012. The graph was quietly dropped after that.”
The results of China’s seventh census, conducted last year and released on May 11th, 2021 seem to indicate that CCP has begun a decline in its population. In the 5-13-21 issue, The Economist states, “the census shone a light on the demographic trends reshaping China. For a start, the country is ageing rapidly. The number of people aged 60 and older hit 264m last year, up by more than 80m over the past decade, as China added roughly a Germany’s-worth of old folk.”
The consequences of decades of the “One Child Policy” have led to this outcome since this population control policy was officially implemented in the late 1970s. It is likely that the global economy will be impacted as the low-cost manufacturing juggernaut of the last twenty years begins to weaken of old age and a shrinking labor pool.
The potential effects of this are inflationary for the globe. The low-cost factories of China are facing the challenge of an ageing population and the inefficiencies of central planning. This era may hold out great opportunities for other countries and regions to pick up the mantle of efficient manufacturing. There are many challenges to a true renaissance in American manufacturing, yet the Chinese economic juggernaut may be another threat that took care of itself.
The “command capitalism” model in China is likely to reveal great flaws as the incredible growth and economic accomplishment of the last 20 years shows its flaws. It may yield to the current shift in increased government control and a Politburo that seems increasingly eager to decide what is best for individual Chinese citizens.
Look no further than the vaccine efficacy data of Chinese pharmaceutical companies. The recent headline, China Vaccine Diplomacy Wavers as Nations Seek Western Shots delineates how when offered the choice, people seek American pharma. The comparison between Chinese and American Capitalism has many great differences. As volatile and unseemly as democracy can be, it is better than the alternatives. The greatness may come from the fact that markets ultimately decide, not central planning committees. It is exceptional because of our fight for a better future. That is why we’re believers in capitalism and the opportunities that it creates for investors.
The US Labor Force Participation Rate is currently around 62% down from 66% in 2005. 13 million workers that may have been productively adding to society are not economically engaged. These statistics are quite complex, leaping to conclusions can create flawed theories. The participation rate in 1950 was ~59% so it may be that the number has recently declined closer to the long-term equilibrium level. The times of 70 years ago have a skew for less females in the working population so throw out that number!
The US workforce has been dramatically impacted by Covid-19 as fear of infection has driven workers out with some entering early retirement. A vibrant workforce is crucial to growing standards of living. The epidemic of support for workers is not something that leaders of the past would have found inspirational.
FDR in his annual address to Congress in 1935 said:
… continued dependence upon relief induces a spiritual and moral disintegration fundamentally destructive to the national fiber. To dole out relief in this way is to administer a narcotic, a subtle destroyer of the human spirit. It is inimical to the dictates of sound policy. It is in violation of the traditions of America. Work must be found for able-bodied but destitute workers. The Federal Government must and shall quit this business of relief.
As the era of Covid-19 federal intervention and assistance recedes, markets and investors are left to wonder how the American Economy will respond. As difficult as it may be to remain optimistic, we can turn to the 2021 annual Berkshire Hathaway letter from Warren Buffet that was released on 2/27/2021; “Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of the American Tailwind … and the compounding wonders [from the power of retained earnings], will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions.”
Hear! Hear!
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The opinions and forecasts expressed are those of the author and should not be used for anything other than discussion purposes. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee future results.