Recently, 1) the Fed wisely rolled back its plans to hike interest rates and to shrink its balance sheet and 2) Chinese negotiators made clear that they are willing to do a trade deal. These are good things that the markets reacted well to. At the same time, a) the wealth/opportunity gap is increasingly becoming manifest in b) increased populism of both the left and the right, which is leading to c) greater conflict both within and between countries and d) more extreme and worse decision making, which is especially risky when e) economic growth is weakening and f) central banks have limited capacity to ease, g) important elections are approaching, and h) the big geopolitical tensions arising from China emerging as a power that is challenging the US as the existing leading world power are intensifying. Over the next 2-3 years, this confluence of forces will come to a head and have big influences on markets, economies, societies, and world affairs (much as they did in the late 1930s).
Q4 hedge fund letters, conference, scoops etc
Greater Polarity and Upcoming Elections
One of my economic/political principles is: “If there is a big gap in the economic conditions of people who share a budget and there is an economic downturn, there is a high chance of bad conflict. If there isn’t a big gap (e.g., most people are poor or most people are rich), there is much less risk of a conflict. Disparity in wealth, especially when accompanied by disparity in values, leads to increasing conflict and, in the government, that manifests itself in the form of populism of the left and populism of the right. As a rule, populists of the right (who are usually capitalists) don’t know how to divide the pie well, while populists of the left (who are usually socialists) don’t know how to grow the pie. While one would hope that when such polarity exists leaders would reform the system both to divide the pie and make it grow better (which is doable and certainly the best path), unfortunately leaders who know how to bring people together behind policies that both grow and divide the pie well are both rare and unappreciated. So the problem of the gap in wealth and opportunity is unlikely to be resolved well and peacefully.”
In my study of populism from March 2017 (located on www.economicprinciples.org), it became clear to me that populism and populist leaders typically follow a pretty standard path of steadily increasing conflict both within and between countries; for that reason, conflict was the thing that I wanted to monitor most closely to help us see what is likely to transpire. That’s why my great research assistants and I created “conflict gauges,” which I will share with you at another time.
With this perspective in mind, it is important to keep in mind that the big questions of a) whether populists of the right (i.e., capitalists) or populists of the left (i.e., socialists) end up in control and b) whether or not their conflicts will adversely affect the operations of government, the economy, and international relations will largely be answered over the next 2-3 years because during that period the US, the UK, Italy, Spain, France, Germany, and the European Parliament either will or probably will have elections that will answer these questions.
In the US, the roster of Democratic candidates and their policies are now beginning to emerge. We can now begin to see that the wealth gap issue will probably be the biggest issue of the election, and we can begin to see where the emerging candidates are on the spectrum of populism of the left (socialism) and populism of the right (capitalism). For example, we have recently seen the proposal for a 70% top marginal tax rate on incomes over $10 million floated by the 29-year-old new Rep. Alexandria Ocasio-Cortez, who represents parts of the Bronx and Queens in New York City, and we can see that the majority of Americans polled are in favor of it. We have also recently seen the proposal for a wealth tax of 2% on assets over $50 million and 3% on fortunes over $1 billion come from Sen. Elizabeth Warren, who represents Massachusetts; we don’t yet have polling results for this proposal, but my guess is that it will receive a similar reception. While we haven’t yet seen markets react to such news, because it is way too early to handicap the odds of who will be in control and what they will do, we know this will become increasingly apparent and then will be determined over the next two years, and we know these things will have big implications for capital flows, market valuations, economic conditions, and domestic and international relations.
The same will be true in Europe, as the internal and external populist conflicts are intensifying at the same time as Europe is being economically held together by the thin thread of a central bank and a single currency, which is facing increased stress from some seemingly irreconcilable differences. More specifically, at the same time as wealth and ideological polarities within and between countries are intensifying due to the monetary union leaving some countries stuck in stagnation while others are getting richer, the ECB’s region-wide debt-buying program that held the currency together is becoming untenable because the mix of debt that the ECB has to buy in order to provide support for the euro is becoming of lower quality. That makes buying the debt increasingly objectionable to “Northern European” countries. This is happening at the same time as the Brexit precipice is approaching and important elections and political appointments will occur.
The US-China Geopolitical Conflict
While the US-China trade war appears to be negotiable, a geopolitical war over IP and how either to divide the world into agreed-upon spheres of influence (or to coexist in overlapping areas) is emerging with greater strength. This dispute is most immediately over where and how each country’s companies compete—especially the most important new technology companies (especially those in 5G, artificial intelligence chips, information/data management, and quantum computing). Rather than that being resolved soon, these economic and geopolitical disputes (e.g., over Taiwan’s reunification with mainland China) will be with us for decades to come. Still, it is hoped that enough can be agreed on so that a “trade deal” can be reached and the markets can celebrate at the end of the 90-day negotiating period. Time is on China’s side because they are growing and improving at a faster pace and because those in the US and Europe are their own worst enemies, so I would expect China to be relatively non-confrontational. If I had one wish for the Americans and Europeans, it would be for them to manage themselves well.
Article by Ray Dalio, LinkedIn
