Best of 2013: Economics after the End of the World
Remember a year ago when — according to some interpretations of the ancient Mayan calendar — the world was supposed to end? Guess what? It didn’t. And a whole lot happened in between.
We have come to the end of 2013, but instead of looking outside, it’s time to look inside. To reflect. To assess. And, where necessary, adjust our thinking. That is, grow. You’re a year older, but are you wiser? Are you closer to truth? Or somehow farther away, perhaps lost in a sea of details? Remember, what happened this year was not just a random series of events to commit to memory. It was a complex sequence of cause and effect, even when — in the immortal words of Frédéric Bastiat — the effects are unseen. Investing operates at the nexus of finance, sociology, economics, history, technology, and the political economy, and we need to understand how the jigsaw puzzle fits together. Ultimately, whether in your career or in your personal life, it all comes down to one thing: Have you grown? It’s time to find out.
Top Story. One of the most fascinating stories of 2013 was, undoubtedly, the rise of the virtual currency Bitcoin. While it still has many hurdles to overcome to gain acceptance as a form of payment — including acceptance by governments — it has gained substantial traction with more and more retailers accepting Bitcoins as a form of payment. For my perspective on the opportunities and challenges facing Bitcoin, read “Bitcoin: New Gold or Fool’s Gold?” What is most interesting about the Bitcoin phenomenon is that its success is a direct reflection of the distrust in government currencies spawned by today’s monetary policy.
Top Market Shift. The beginning of 2013 was marked by currency wars, in which countries raced to debase their currencies. Interest rates were low and falling. And capital was flowing into the emerging markets. However, the talk of the Fed taper abruptly reversed the status quo. Rates began rising, capital fled emerging markets, and currencies, such as the Indian rupee and the Malaysian ringgit, began falling sharply. In the wake of the taper talk — meaning a possible reduction in US monetary stimulus from an $85 billion per month run rate — countries had to raise rates, or in some cases increase capital controls, to compete for capital. These changes made me wonder whether we had gone back in time. In “Turmoil in Emerging Markets: Is it 1997 All Over Again?,” I compared the sequence of events in the Asian Contagion of 1997 to the taper events of 2013. Of course, with the Fed announcing its intent to taper in 2014, it appears that we could see a meaningful change in the status quo in the coming year.
Top Issue. Since the onset of the financial crisis in 2008, many have cited rising income inequality as a risk to political stability. While that may be true, the anger over the issue seems wildly misplaced in my view. While the United States, for example, was born of a free market system, the country has over the years adopted many policies that depart from the free market. New laws and regulations have continued to alter and obstruct the way markets would otherwise work, had they been free to find their own equilibrium. And 2013 saw the impact of many new laws and regulations, as well as the manifestation of various changes in policy initiated years before. A steady path of incremental change makes the aggregate change hard to perceive. Nevertheless, a journey of a thousand miles on foot or by plane is still a thousand miles. In 2013, for example, we saw the ongoing and massive stimulus by the Federal Reserve, which artificially lowered both short- and long-term rates and flooded the world with liquidity — much of which has ended up in markets driving up asset prices, rewarding the wealthy who invest in markets. At the same time, low rates and massive money printing effectively reduce the value of pension benefits, life insurance benefits, and the like — all of which have the greatest impact on the lower and middle classes, exacerbating income inequality. Moreover, the massive money printing brought about by QE3 also supports price growth in hard assets, and that increases commodity prices more than other prices, resulting in an outsized impact on lower-income people who must pay more for gasoline, household energy costs, food, and other basic essentials.
Also in 2013, the US implemented the Patient Protection and Affordable Care Act, which will drive up health costs for average consumers, as tax payers are forced to pay for the uninsured and large government bureaucracy. Although the new law is designed to provide coverage to the many Americans without a safety net, this increase in costs impacts younger and healthier families that tend to be lower and middle income as well. What all these policies have in common is that they disproportionately increase costs on lower-income families as a direct result of departing from free markets. So, the pressures on lower- and middle-income families are growing as a direct result of these government interventions. In addition, as a result of the recent implementation of the Dodd–Frank Wall Street Reform and Consumer Protection Act and a dramatic host of regulatory changes at the SEC, EPA, and the FDA among others, America keeps shifting further and further to the left, which is to say further and further away from free-market equilibria. To quote James Grant, “I think we should try capitalism. It’s a wonderful alternative to what we currently have.”
Perspective. Undoubtedly, the best thought piece I stumbled across this year is Bridgewater Associates’s paper, “How the Economic Machine Works.” As I am leading a project to build a historical financial crisis database, I was pleasantly surprised to find a whole section devoted to German hyperinflation, starting on page 115. While most investors are vaguely aware that there was a hyperinflation in Germany in the early 1920s, very few people understand it. Because I have researched the issue, I know firsthand how difficult it is to stitch together reliable data from this time period. Ray Dalio does a masterful job of piecing together these events — and more importantly, drawing the lines between cause and effect.
As I pondered how the world got itself into such a big economic mess of late, I began tracing the sequence of events that led us to today. To understand the large and persistent trade deficits that certain countries produce year in and year out, one must go all the way back to the departure of the United States from the Bretton Woods system by the Nixon administration in 1973. Shockingly, he engineered the departure primarily, if not solely, to help his reelection chances in 1974, not for what might be good for the country, let alone the world. During 2013, transcripts of the infamous Nixon tapes were publicly released, revealing for the first time the inner workings of the Nixon administration during this pivotal moment in history. In “President Nixon: The Man Who Sold the World Fiat Money,” I detail the changes made and the corresponding impact they have had on the world economy ever since.
Most Underreported Story. The Fukushima nuclear disaster is by far the most underreported story of the year. The nuclear reaction is ongoing, and the site continues to leak radioactive waste. And it is by no means under control. TEPCO is producing 400 tons of radioactive, contaminated water each day. Where will this water go? Can they ever store enough? Can they ever sanitize the water? Are they telling us the truth? Do we know the extent of the radiation? What happens if Japan gets hit with another Tsunami? How much will it impact Japanese trade? Will the ongoing disaster affect Japan’s ability to export? Will it leach into the broader water supply in Tokyo?
As the year draws to a close, unfortunately, we still have more questions than answers. In a recent news release from BBC, we learned that current radiation leaks are so toxic that they can kill an exposed human being in just four hours. The blogosphere is rife with stories of a massive coverup. Given the incentives in downplaying the bad news, I suspect we don’t know the full extent of the problem. Fukushima could also compound Japan’s economic problems, too, by offsetting the BOJ’s intentions to create growth in exports (with a weaker yen), making the situation precarious indeed. Monitor closely.
Summary of the Lessons from 2013. The interest in (and success of) Bitcoin is mostly fueled by distrust in the current monetary system — and some speculation no doubt. The market shift after the taper talk this year indicates that the US still drives global monetary policy, although Fed actions will likely weaken the grip of the dollar in the long run. Perhaps the most important lesson of the year is that central banks wield enormous power in directing whole markets and even economies. How they avoid public blame for their massive failures remains a mystery, but my appreciation for their involvement and responsibility has grown dramatically. No human system is perfect. But it’s high time we start recognizing the trade-offs that departures from free market policies can create.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.