China Has To Grow Up

China has become the world’s second largest economy based largely on the ability to churn out cheap consumer goods in vast numbers. It could do so because of a) very low wages, b) cheap land and c) nearly zero regulatory costs (i.e. pollution and labor safety regs).  Couple that with an artificially low foreign exchange peg, and it’s no wonder that  low and medium value-added industries moved there en masse.

However, China is now very keen to move up towards more sophisticated, tech heavy industries like autos, aerospace and high end electronics, heretofore the domain of Western companies and institutions that have created a huge pool of proprietary R&D and the mechanisms to transform it into high-end products.

The problem of safeguarding such Intellectual Property has been around since at least the early 1990s and has never been addressed properly.  As the US economy moves more and more towards a Fourth Stage (ie knowledge-based) leaving behind its manufacturing roots, IP is today’s fortune and must be protected.

China needs to realize that the US will no longer turn a blind eye to IP exploitation.  Furthermore, it needs to “grow up” and institute developed country norms:

• Its currency must float
• Its markets must open up
• Its government must impose western-level regulations on pollution and worker safety
• It needs to institute a comprehensive pension/social security system.

Trump’s opening salvo on possible import sanctions is a warning: join the globalization party as an equal on ALL terms, or suffer the consequences.

Trade War Over Steel? Gimme A Break...

So Trump throws up this firecracker about import duties on steel (25%) and aluminum (10%).  It’s a non-issue folks, despite hot air from Brussels about retaliation via Levi’s, Harleys and Jack Daniels. (Notice that the Chinese haven’t said a word - and rightly so).

Fact is, the US hardly imports any steel from the EU or China, as you can see from the graphic below.

Now, if Mr. Trump starts talking about consumer electronics, that would be an issue.  But in an economy completely dominated by the likes of Apple, Google, Microsoft and Amazon imposing duties on their products would be plain suicide and it won’t happen.

Greek GDP And PMI

Greek 4Q GDP rose 1.9% YOY, the fastest in 10 years. Similarly, manufacturing PMI rose to the highest level on record in February.

Steel Duties, Seriously?

Imposing import duties on steel and aluminum is akin to protecting the horse buggy business when Ford set up his car production line... completely useless and meaningless.

The US economy is long past it’s heavy, metal-basing industrial era.  Trump is just playing up to his lowest common denominator electoral base, that’s all.

For proof, just look at the makeup of the DowJones Industrial Average in 1980 (even 2000) and today.  Unlike the past, the US economy today is all about Google, Amazon, Apple, Microsoft and a couple pharma companies.

Move on...

Interest Rates And Savings

One single chart: Ten year Treasury yields and the personal saving rate (ie the percentage of income saved).

The correlation is interesting.

Yes, Virginia, There IS Volatility

What happened with US stocks?  Why did they tank so suddenly after months of steady gains?

No, there was no irrational exuberance, no massive leveraging, no pernicious balance sheet shenanigans at banks, no NINJA loans, no CDS/CMO/CDO (plain, squared or cubed) baloney. Valuations weren’t even that high, given forward P/Es around 18-16x.

There was, however, a sort of  “complacency bubble”, aka very, very low volatility. This in turn spawned a variety of listed and OTC trades that shorted volatility for profit.  It worked like a charm - until it didn’t.

The following chart makes things quite clear.  It’s the price of an ETF (exchange traded fund) that shorts VIX futures.  Yes, Virginia, there IS volatility!

In my opinion that’s all there was to it - the snap unwinding of short vol trades.

USA Margin Debt

Given the stock market plunge of the last few days, the following chart is interesting.  It is current to year-end 2017 (latest available), the data comes from FINRA.

Given that total market cap at the time was approx. $32 trillion, margin debt of $650 billion doesn't seem all that excessive.  In other words, selling due to system wide over-leveraging isn't the likely culprit of the sell-off.

Greek PMI Near Record

Manufacturing in Greece is staging a strong and rapid comeback.  The Purchasing Manager's Index for manufacturing is now at the highest level since 2007.  Increasing new orders is the biggest contributor to the rise, with new employee hiring also boosting the index.

The PMI is a diffusion index, with levels over 50 indicating expansion and under 50 indicating contraction. The light blue area is annual GDP change, left scale.

Manufacturing accounts for only 12-15% of Greek GDP, but the correlation between PMI and GDP is pretty solid.  Interestingly, the last time PMI was at current levels the Greek economy was growing over 5% per year.

USA Debt: Is It A Threat?

US federal government debt is now at 106% of GDP, the highest in decades.  It got there because it was forced to bail out the financial sector during the 2007-10 Great Meltdown, essentially having the Federal Reserve "print" money with its Quantitative Easing (a.k.a. Ben's helicopter).

 This debt load certainly looks formidable and perhaps threatening to the economy's health.  Is it so?  Well, yes.  And, no...

Yes, because a highly leveraged economy has, by definition, a lower capacity to overcome recessionary downturns without painful asset liquidations and capital losses, perhaps even social unrest.  Just ask the Germans and how scared they (still) are of the Weimar hyperinflation period which paved the way for Hitler.

And no, because it matters very much to WHOM the debt is owed.  Just ask the Japanese today, who owe their huge debt (250% of GDP) mostly to themselves (i.e. they are self-financed through a high saving rate).

 In the case of the US national debt, 25% is inter-government (mostly held by the Social Security Trust Fund), another 25% is held by American investors (e.g. pension funds, banks, individuals) and 12% by the Federal Reserve.  Thus, a total of 62% of the debt is owned directly by American holders. This leaves 32% owned by foreigners, but even there I expect that a chunk is owned by Americans through entities in tax havens such as the Virgin Islands, Channel Islands, Switzerland, etc.
 

 More important still, is how the government is managing its finances. It is doing quite well, as the following chart shows: government spending is back to 34% of GDP, very near a 50 year low.
 

 Bottom line - even though it may seem high, US debt is not a threat to the economy.

Disruption

Buffett, Bezos and Dimon announced they are going to massively disrupt US healthcare by designing and implementing an in-house system for their combined 1+ million employees on a not-for-profit basis, and potentially rolling it out to the rest of the country.

This is simply huge.

The US has arguably the world's most inefficient healthcare system, entangled in a mess of legal, insurance, pharmaceutical (need I mention Valeant?) and hospital concerns, all jockeying for legitimate and illegitimate profits.

The following chart says it all:  The US spends 17% of GDP on healthcare, far more than other countries. Even a 2% reduction means savings of almost $400 billion per year.

 If the trio manages to streamline the healthcare industry it will create a paradigm shift akin to Henry Ford's automobile assembly line.

There is another American "industry" that has also become very expensive when compared to the rest of the world: College education.  I don't think it will be long before some other leaders get involved there.