Us vs. Them

By Dr. Ian Bremmer

 

Last week was James Comey week here in the United States. The former FBI director came out swinging, announcing that Donald Trump isn't morally fit to be president. Note to Comey: 1) We knew that. 2) We elected him anyway.

What does that say about the United States? That much of the electorate is morally unfit? If so, which part? The part that voted for Trump? The (larger) part that stayed home and didn't cast a ballot in the most important election in decades? The part that continued to vote for a bunch of establishment candidates who allowed the system to progress to the point where someone like Trump could actually be elected?

Don't get me going about the Electoral College. Trump and Hillary Clinton both campaigned given the rules in place; they would've campaigned differently with different rules. We know all about the Russians and Cambridge Analytica. Yes, the election could have gone differently. But let's be clear: Trump beat a huge Republican crowd... and Ted Cruz was a close second. Bernie Sanders could have easily been the Democratic nominee.

And all this on the back of Brexit. Soft authoritarian governments popping up and gaining momentum across Eastern Europe. Historic drubbings of establishment forces in the European Union's three most important remaining economies: Germany, France, and Italy. This isn't coincidence.

And so back to our note to Comey: 3) Isn’t there a bigger point here?

For 15 months now, Americans have been tearing themselves up saying how godawful this president is. Or how godawful the president's detractors are (and how godawful Hillary was/is/would’ve been). There's less middle ground than I've ever encountered in my country. And, as you know, this reality is not just limited to the United States.

The far more important question, and the one that nobody really wants to address is… How did we get to this point?

It's high time to answer that. Especially since blaming Trump is great political theater but won't resolve any of the underlying challenges. That's what my new book is about. And, as has become tradition over the past 20 years, I'd like to set out some of the big arguments in the EG update as the book launches.
 
“Us vs. Them: The Failure of Globalism”

Think of us vs. them as the bottom-up bookend to a G-Zero world [note: as noted above, this is his book of the same name]. The G-Zero is about the top-down unwinding of Pax Americana, a US-led global, political, economic, and security system. I've never been enthusiastic about the coming G-Zero. Who would be? (OK, Russia, rogue states, terrorists... but you get my point.) But it was structurally over-determined. The United States no longer wanted to play the role of global sheriff, multilateral architect of global trade, or cheerleader on liberal values. The transatlantic relationship was weakening; China was getting much (much) stronger and starting to develop its own economic and technological international architecture; Russia was trying to undermine the United States. In other words, you may not want the G-Zero, but the G-Zero wants you.

Us vs. Them is creative destruction from within our political systems. It’s the failure of globalism: the ideology that has underpinned the supremacy of the liberal democratic model for the last 75 years. I'm not happy that globalism is failing, that there's this big backlash against the sorts of policies that have produced free markets, open borders, and an idealized hope for global community. But that failure is seriously over-determined in a way that is unappreciated by both leaders and the markets. Once Trump is no longer president, the American population will not revert to support for the establishment. The "horrors" of Brexit have not undone the growth of populism across Europe (hence last week's warning, however late, from French president Emmanuel Macron that Europe is fighting a civil war against the forces of illiberalism. If it wasn't so impolitique, he'd surely mention the same of the United States). And indeed, those forces are set to spread across emerging markets as well.

There are four reasons, related but each distinct. Four pieces of a worldview articulated by globalists that have worked extremely well for “us”… but increasingly not for larger numbers of “them.” Economics and free trade; culture and open borders; security at home and abroad; and technology with automation and the information revolution. Together, they’re structural: In other words, the failure of globalism has a momentum behind it that’s unstoppable (at least for the time being). Let’s take each in turn.

1 - Economics. Of the four, this is the one that gets most of the attention and has been the most widely covered. Free trade provides the best possible global growth of any known economic system. It makes the transfer of goods and ideas as inexpensive as possible, bringing production globally to the places that are most efficient. That in turn makes goods cheaper and, overall, stimulates consumption.

Free trade also creates dislocations as people that used to have jobs in manufacturing and professional services lose them to countries where they can be performed more cheaply.

Absent structural government intervention, that’s led to greater income inequality across the developed world and, as labor rates increase in emerging markets, in important pockets of the developing world, too. In the United States, we've seen flat income and earning power for working and middle classes over the course of the past four decades. Infrastructure spending tracking with those inequalities has compounded the problem, with public school systems, policing and jurisprudence, health care and the opioid epidemic all becoming among the worst in any developed market for underprivileged people in the United States. All the while quality of life in America's first-tier cities has never been better.

There’s a similar trend in the United Kingdom and much of continental Europe (though not Germany), particularly given persistently high levels of youth unemployment. Support for free trade in the West has diminished accordingly, with demand for more subsidies and redistribution, promotion of “buy local” movements, and greater support for tariffs.

2 - Culture. There's a populist backlash to open borders. The idea of free movement of people is as core to globalism as free trade. Immigrants should be able to move to where the jobs are. Rich countries should provide for the downtrodden, particularly those being persecuted, resettle those it can and help them develop better lives, integrating them into their new homes and making their countries all the culturally, intellectually, and economically richer for it.

But if the people that believe the country is rightfully “theirs” don’t think their political system is actually working for them, it gets harder to see them supporting access for others. That's even more true when those coming in show less willingness or capacity to assimilate into accepted cultural norms and mores. That reality led to the dramatic erosion of German Chancellor Angela Merkel’s support base after she accepted 1 million refugees from Syria. It's the driving force behind the (comparatively wealthy) support base for the League in Italy—whose principal campaign promise was to deport some 600,000 refugees if they came to government. It's the most coherent platform for right-wing movements across Eastern Europe. And a big piece of the support for President Trump in the United States.

On that latter point, detractors say that Trump is hardly “draining the swamp” when they look at his tax cuts materially benefitting the richest segments the most, or the regulatory rollback that benefits the private sector while removing protections for the poorest citizens. But on issues of identity politics, Trump connects with his base more effectively. No major political figure in the United States stands up for white males (and particularly white undereducated males) culturally the way that Trump does. Whether it's comments about Mexicans coming to rape and criminalize the country (and the wall needed to keep the undesirables out), Haitians bringing AIDS, Nigerians and others from "s***hole countries" who won’t want to return to their huts, or the black NFL players who are allowed to make millions and dare to kneel, disrespecting “our” national anthem. All of that shows Trump supporters as a unified "us" that haven't been forgotten, whose way of life is threatened by "them."

Interesting to note that when I recently posted a statistic (initially posted, with a favorable slant, by Fox News) that showed Syrian refugees went from 15,000 in the last year of the Obama administration to 3,000 last year, to 11 so far this year, about half of the Americans responding thought the number disgraceful; the other half thought it was appropriate (and many of them thought it was 11 too many). This issue is dramatically growing in importance across the developed world.

3 - Security. Globalism supports the need for the United States and its allies to project force around the world in order to help ensure international stability and security. There's strong opposition to those wars among populist movements in the West. That's most obvious in the United States, where decades of wars—in Vietnam, Iraq, and Afghanistan (now the longest war in American history)—were fought on the backs of millions of enlisted men and women and their families, hailing primarily from the working class. The wars ended in failure; those returning, all too often in pieces, were not considered heroes, and they lacked support from a dysfunctional Veterans Administration.

The political establishment's support for those wars (particularly Iraq, the clearest "war of choice") and their decision to maintain significant active deployments in other conflicts was deeply unpopular among those most affected by them. Trump's and Sanders's opposition to them played well against the comparatively hawkish Hillary Clinton. Since his election, Trump's pushback against Secretary of Defense Jim Mattis on expanding the Afghanistan troop presence (which Trump backed down on) and his promises to bring back 2,000 Americans in Syria "very, very soon" (let's see) play strongly with his base.

In Europe, Iraq was equally unpopular among coalition partners. And there's some of this opposition against French President Macron, who has expressed the most interest in expanding his country's defense engagements in North Africa and the Middle East (as well as in Germany, in resisting any change to the country's strong aversion to direct defense engagement with US-led or other military coalitions). The security issue has the most impact in response to domestic terrorism and crime, a challenge with great political resonance given growing numbers of comparatively unintegrated Muslim populations (refugees, first-generation immigrants, and citizens alike) and a growing Islamic terrorism threat. The immigration security threat in the United States exists as a perception promoted for political expedience but isn't borne out by facts (on either domestic terrorism or criminality of immigrants)—in part because of the comparatively small numbers; in part because the United States has historically integrated those populations more effectively than the Europeans, also allowing for better policing.

4 - Technology. This is the most recent of the developments supporting "Us Vs. Them," and by far the most transformational. It has two different components.

First, the polarization that the information and data revolution promote in the media and social media. With cable news and social media needing to maximize "engagement" (read: amount of time watching and providing data) to grow profitability, that requires segmenting of their audience/product into ever more narrow and tailored demographics to ensure that they are consuming what they "like." That in turn fosters political fragmentation, undermining civic nationalism.

And second, the automation and artificial intelligence revolution that is displacing jobs exponentially faster and more broadly than we've seen from globalization. That also leads to greater efficiency and profitability for those that can harness the technology and the data and goods flows that come from them. But it puts downward pressure on wages for those with skills that are being automated—and the prospects of retraining those people have remained theoretical for most.

*

Put these four factors together and you get what's been happening across the West.
 
Remove Trump and you still have plenty of Trumpism. Conclude a challenging Brexit and Jeremy Corbyn still looks reasonably likely (and perhaps even more likely) to be the next British prime minister. And that torturous Brexit process has done nothing to reduce the challenges on the continent: Italy's most strident anti-establishment election result since World War II; Germany's, too. Hungary's Viktor Orban just won a two-thirds constitutional majority in Hungary that none of the polls expected (in part because, as in so many of these cases, many citizens voting populist don't want to admit who they're voting for to pollsters).

And so, no, the French election wasn't a tipping point back towards globalism—Macron may be a poster child for a stronger Europe and a more globalized French economy, but it's worth remembering that he almost didn't make the second round because of the gains of the far-right National Front and the far-left Communists. And now that he has won, his prospects for leading a stronger Europe given Brexit, a weak Merkel coalition in Germany, and perhaps a soon-to-be League five-star movement government in Italy are stillborn. Macron has had more success in reforms at home, but despite his extraordinary win, those policies have hardly been extremely popular, and he's been sinking in the polls accordingly.

The primary exception is Japan where, despite all the troubles being faced by Prime Minister Shinzo Abe right now (not helped by a Mar-a-Lago summit last week where Trump gave him less public face than I had expected), the country remains essentially a stable single-party democracy. There’s been no hit to Japan's civic nationalism over the past decades and popular support for institutions, established political parties, business interests, and the media remain as high as they have been. For some obvious reasons… go through the four drivers I've mentioned and you see: on the economy, the population is shrinking so flat growth amounts to highest per capita gains in the OECD; on culture, Japan allows virtually no immigrants into the country and has one of the most homogeneous communitarian populations in the world; on security, Japan has an extremely limited armed forces with constitutional prohibitions against taking part in military engagements. Only the filter bubble piece of technology is a problem in Japan, limited by the nature of the population and the less individualistic nature of society, while automation is a net plus given the country’s shrinking population.

Emerging markets, on the other hand, are set to see "us vs. them" grow. Reactions to the economics of globalization are more muted in the developing world because most of the countries have populations that have benefited. The cultural issues depend on the countries; we’re seeing much more of that in India and the Middle East now; less in Latin America (despite all the refugees, since unlike in Europe and the United States, they’re seen as the same people). Security concerns are also growing given refugee trends (particularly in sub-Saharan Africa, the Middle East, and South/Southeast Asia). But the technology piece is by far the biggest driver… with social media rapidly creating more extremism in political affiliations in democracies across the developing world (and we'll see this play out in coming months in elections in both Brazil and Mexico), and automation set to undermine political stability in places where political institutions are far less resilient and the social safety net protecting citizens is much less strong.

China is the fascinating counterexample. Where the technology trends are every bit as important—but the nature of the state capitalist and authoritarian political system means Chinese technology trends have very different implications. In China, a majority of the population is on social media... but the government ensures that an ultimately politically-driven process helps move citizens towards consensus and builds up rather than erodes civic nationalism. Chinese manufacturing and services are among the world's sectors most set to be automated—but control over employment (and especially inefficient employment) is ultimately in the hands of government, which prioritizes social stability over economic gain. Which means that China may well be better set to avoid populism than any other major economy in the world... but with a completely separate political and economic model. That’s challenging news for liberal democracy.

What's Next

For the West, the good news is that it's not urgent. That's also the bad news.

The strength and durability of political institutions in advanced industrial democracies, coupled with the comparative wealth of working and middle classes (and, accordingly, their overall limited appetite for political and social activism) means there's no near-term crisis facing national governments that choose not to address these four growing challenges. The permanently unemployed and underemployed in the West aren't facing starvation; there's little danger of Tunisia-style popular uprisings.

Add to that present levels of economic growth, which are the best since the 2008 financial crisis. The IMF last week added to the good news, upgrading global growth projections to 3.9% for the remainder of the year and 2019 to boot. Which means there's more room for short-term spending to keep existing discontent to a simmer—like the massive deficit spending of the Trump tax bill, which certainly provides near-term relief to working classes (and a bunch of one-year bonuses, too). We're likely to see the same in Italy if a populist government is put together. Which isn't about to drive the European Union into crisis.

But if the "us vs. them" trends are this strong now, when the global economy is doing so well... what happens during the next recession? Exactly.

For those with the weakest governments, some states will collapse. That's a huge concern for those populations, but it's also most likely in countries that have the least economic capacity, and accordingly, global markets will be mostly insulated from their troubles.

In the West and in many emerging markets, we'll see more walls. Virtual and physical, dividing countries from each other and also internally. Trump has repeatedly said that if you want to see if walls work, just look at Israel. It's absolutely true: Take a plane to Tel Aviv and you'll see what "extreme vetting" looks like. They have a "ceiling" (the Iron Dome) stopping Hezbollah missiles from coming in, border walls keeping Palestinians out, and are completing a "basement" with underground walls and sensors to end tunneling from Gaza. Add extraordinary human intelligence and cyber surveillance and you have a country that's completely kept out "them," while "us" not only enjoys the best run, least corrupt, and among the most open democracies in the Middle East, but even among advanced industrial democracies. Sustainable walls mean Israel doesn’t need a two-state solution, or even to spend much time thinking about the dramatic discrepancies in education, healthcare, or economic opportunity for the Palestinians just across the border. That's "them."

In the near future, and especially following the next recession, we're set to see much more wall-building, allowing growing levels of structural inequality to maintain politically stability for those on the right side of the walls.

I recognize that's not a very rosy picture. The good news?

The good news is that even when central governments aren't prepared to address (or even don't yet understand) the nature of the problem... other actors do.

In the United States, I see that happening in a series of cities where universities and corporations are engaging in partnerships to bring better training and jobs to the working classes otherwise left out of urban growth. San Francisco recently announced that all citizens will have access to free community college—something that will make that city both more attractive and, if it works, will likely convince other cities they should do the same or they'll be less competitive.

There are experiments with universal basic income in some towns in Ontario and across Scandinavia. Singapore is putting in place some unprecedented support for universal digital education, not just in the schools but over the lifetime of its citizens. There are new efforts to develop a more flexible gig economy for citizens in Denmark, where it becomes easier for companies to hire and fire individual workers, but they also pay high tax rates that go toward improving the social safety net for those that are underemployed. There are a series of start-up companies allowing for more efficient (Uber-ization/Airbnb-ization) distribution of skills across a wide variety of skill sets and jobs that could allow more people access to meaningful employment. I could point to many more examples (and do in the book).

It's too early to know which of these grassroots experiments are likely to succeed and, among them, which could become suitably scalable to really make a difference. Certainly, as we see more "us vs. them," these efforts will multiply and I'd be willing to bet that, like the mostly local level and uncoordinated responses to climate change, some will end up being embraced by major governments and changing the way we think about what citizens can come to expect from their leaders.

Changing the Model?

But before I close, there's a bigger question that I at least want to throw out there. And that's the nature of this coming "revolution" in technology and what it means for society.

The world has come to describe the coming transformation in society as a "fourth industrial revolution," which means it's an even bigger, faster version of the first three industrial revolutions. We'll have even more efficiency, even more growth, and even more jobs. Sure, it's going to be challenging to make sure that those displaced get the skills to participate, and maybe there's a "lost generation" that we need to support who otherwise can't make it... but ultimately, there's a glorious future doing more of what we've been doing.

I'd urge caution.

After all, we've just heard Facebook CEO Mark Zuckerberg say he had no idea that society would be so divided by his company's technology. I don't think he was lying. I think he presumed it would be fine because that was consistent with the company and technology he was developing (he was "talking his book," if you will). He hadn't spent any time thinking about why it might be otherwise.

So, when technologists developing artificial intelligence tell us we'll have even more jobs, or CEOs buy into the fourth industrial revolution as bringing even faster growth and more consumption, let’s first recognize that the assumption supports the continued success of their existing models... so, they certainly want it to be true. But there’s no reason to believe that necessarily makes it so. After all, we don’t have many historic case studies for transformational industrial revolutions—there have been three. Of them, this one is far more disruptive: radically faster and more all-encompassing of society. And it’s not like species haven't been displaced before—the first industrial revolution displaced the horse population, which were no longer relevant for capital generation, bringing their numbers to 10% of what they had been within decades.

What if we face not a fourth industrial revolution, but a post-industrial revolution?

What if the AI revolution means that most of what billions of human beings do as productive work no longer is critical to drive the economy? What if labor and capital become disentangled? At the very least, it's worth considering as a medium-term possibility.

The reason that's important is because the human history of treating those that are dispensable isn't attractive. We claim animals don't feel pain or don't have consciousness (both of which we now know scientifically isn't true) because that's the necessary precondition for cognitive dissonance that allows the present-day treatment of the world's livestock populations.

There's plenty of history of humans treating other humans with equivalent inhumanity. Overall, that’s improved dramatically over past generations... but a big part of that is because human labor has become ever more critical to capital generation. If that's no longer the case, but the primary model of human worth remains driven by economic contribution to society... the potential for dehumanization returning to society on levels we thought we'd consigned to the dustbin of history could well reappear. That's the danger of "us vs. them" as it continues.

Which means for all the efforts to improve the social safety net, provide training, and help those who have been left behind by globalism, we may also need to start spending some time rethinking the basic capitalist model. Not because it's obsolete, but because if we haven't and it turns out we're wrong about this fourth industrial revolution, you’re not going to like the EG update I’m going to write. 


China’s Elitist Collaborators

Juan Pablo Cardenal

 Chinese President Xi Jinping and Argentina's President Mauricio Macri


HONG KONG – At the beginning of this century, when China launched its “going out” policy – focused on using foreign-exchange reserves to support overseas expansion and acquisitions by Chinese companies – few expected the country quickly to emerge as a leading economic player in Latin America. Yet that is exactly what has happened. The question is whether this is good for Latin America.

In less than 15 years, China has gone from playing a rather marginal economic role in Latin America to being among the top investors and trading partners for most countries in the region, as well as its foremost lender and infrastructure builder. With its economic plans in Latin America cruising along smoothly – a trend that seems unlikely to change anytime soon – China has now set its sights on another goal: expanding its political influence in the region and beyond.

Of course, China’s status as an economic heavyweight already affords it a significant degree of political clout. But the Chinese state and its ruling Communist Party of China (CPC) are also pursuing a more direct, coordinated, and far-reaching strategy to expand its soft power.

That strategy – more “sharp” than “soft” in practice – focuses largely on promoting personal and institutional engagement, cooperation, and exchanges with Latin American elites in four main areas: media, culture, academia, and politics. For example, China produces free media content to be shared locally, provides scholarships to Latin American students and professionals to be “trained” in China, creates partnerships with local universities and think tanks, and opens and operates Confucius Institutes, among other initiatives.

But the single most powerful tool China employs is people-to-people exchange, whereby China seeks to build strong personal relationships with influential individuals from a variety of fields.

To that end, Chinese leaders bring Latin American political figures, academics, journalists, high-ranking government officials, ex-diplomats, and others to China to participate in weeks-long trainings, academic events, or ad hoc exchange programs, and meet their Chinese counterparts.

This “elite capture” is not insignificant. According to President Xi Jinping, China will train 10,000 prominent Latin Americans by 2020. Moreover, the CPC has committed itself to inviting 15,000 members of foreign political parties to China for exchanges in the next five years – initiatives in which many Latin American political representatives are already engaged.

The primary goal of these efforts is to ensure that prominent figures, including current and future leaders of Latin America – typically handpicked by the Chinese leadership – are on China’s side. To put it bluntly, China’s authoritarian regime is subtly and gradually buying Latin America’s elites.

And the plan is working. The luxurious five-star hotels, over-the-top hospitality, and carefully crafted narrative and agendas make a powerful, even hypnotic, impression on China’s foreign guests. Many of them return home believing that China is a fundamentally benign actor, and thus that they have nothing to fear from its engagement in their countries. Many go so far as to become cheerleaders for China.

Their praise for China – expressed through published work, public remarks, or private comments – often, and understandably, focuses on the country’s perceived economic success.

They speak with admiration about the economy’s transition from Maoism to “red capitalism,” its resilience in the face of the 2008 global financial crisis, and its emergence as perhaps the main winner of globalization. And they celebrate China as a valuable source of investments, loans, and market opportunities.

China’s experience proves, according to many of the regime’s newfound friends, that development without democracy is possible. That assessment is almost never qualified by recognition of the potential dangers of becoming too dependent on China, much less any reference to its authoritarian political system or poor human-rights record.

These enthusiasts probably would not want a China-style regime in their own countries. Yet, by accepting and even propagating the CPC-endorsed narrative and abjuring any critical analysis, they are contributing to a worryingly inaccurate image of China across Latin America. With little knowledge about China, many in the region are getting their information from their local elites – the very people whom China’s leaders are trying to attract.

The public, in Latin America and elsewhere, deserves to hear the whole story. They should learn about China’s asymmetric relationships with many of its trading partners, and the stark terms of Chinese loans, which have left many borrowers mired in a debt trap. They should also know the truth about labor conditions at China’s overseas projects, not to mention their environmental and social impact. And they should know about intensifying domestic repression in the age of Xi.

There is no doubt that Chinese engagement has brought major opportunities to Latin America.

But the risks cannot and should not be ignored. The journalists, academics, politicians, and other influential people whom China is courting have a responsibility to avoid being swept up in the charm offensive, and to provide a clear-eyed assessment of the potential pitfalls of engagement. Otherwise, Latin America may soon find itself paying a high price for its blurred visión.


Juan Pablo Cardenal is a researcher at The Center for the Opening and Development of Latin America (CADAL).

 Gold And Silver: Sell In May And Go Away? Not Exactly


It’s easy to dismiss seasonality in the price of a tradable asset. After all, if supply and demand fluctuate regularly you’d think the resulting arbitrage would attract enough traders to smooth out prices.

But that’s apparently not the case with gold and silver. Here’s an analysis from Casey Research on the subject with a couple of highly revealing charts.
Gold Is Seasonal: When Is the Best Month to Buy?
Many investors, especially those new to precious metals, don’t know that gold is seasonal. For a variety of reasons, notably including the wedding season in India, the price of gold fluctuates in fairly consistent ways over the course of the year. 
This pattern is borne out by decades of data, and hence has obvious implications for gold investors. 
Can you guess which is the best month for buying gold? 
When I first entertained this question, I guessed June, thinking it would be a summer month when the price would be at its weakest. Finding I was wrong, I immediately guessed July. Wrong again, I was sure it would be August. Nope. 
Cutting to the chase, here are gold’s average monthly gain and loss figures, based on almost 40 years of data:  
gold average return by month
 
Since 1975—the first year gold ownership in the US was made legal again—March has been, on average, the worst-performing month for gold. 

This, of course, makes March the best month for buying gold. 
Here’s what buying in March has meant to past investors. We measured how well gold performed by December in each period if you bought during the weak month of March. 
gold if purchased in March
What does this pattern means for us here at the end of April? Most likely a couple of boring months are in store, in which both upside potential and downside risk are modest. This in turn means that decisions (to stack, take profits, or add to mining share portfolios) can be considered instead of rushed, with good-until-canceled orders being allowed to sit until, in the summer doldrums, some bored trader comes along to make you a good deal.

COTs remain bad for gold, good for silver

 Meanwhile the structure of the gold futures market got a little less screamingly bad, with both speculators and commercials moving back in the direction of balance. They’re still a long way from what would normally be thought of as a bullish posture, however. Speculators are too long and commercials are extremely short, which traditionally precedes a drop in price. Maybe “sell in May and go away” will turn out to apply for gold this time.

Gold COT April 27 2018

Silver speculators closed out a lot of shorts last week, but are still closer to net short than is usual. That’s bullish, just less so than in the past couple of weeks.

Silver COT April 27 2018


In other words, nothing huge to report, just as you’d expect as precious metals enter their slow season.


Prepare for the Last Bull Market of Our Lifetimes

By E.B. Tucker, editor, Strategic Investor


Right now, we’re seeing a set of indicators we’ve never seen before. If someone told me about them 20 years ago, I would have struggled to picture them.

In short, we’re on the cusp of a tremendous bull market.

It’s nothing like what we saw in the 1960s or 1980s. Those bull markets rode on the back of economic growth. In both cases, you would have made more acceptable returns by simply buying the Dow Jones Industrial Average.

The coming bull market looks entirely different. Most people will miss it because they’re used to making “easy money.”

You see, investors dumped $692 billion into passive funds like the Vanguard 500 Index Fund last year. They blindly invested in stocks, and that worked quite well. Now, the average person believes buying the overall market index is his path to steady riches. He’s dead wrong.

Here’s why…

The U.S. stock market is worth $29 trillion today. Twenty years ago, it was worth $12.9 trillion.

That’s an increase of 124%.

U.S. GDP looks similar. Twenty years ago, it was $8.9 trillion. Today, it’s $19.8 trillion—a 122% increase.

And yet, there are half as many publicly listed companies in the U.S. today than there were 20 years ago. You can see what I mean below:



You can see that the number of public companies used to grow in step with the economy. Americans would start businesses, build them up, and take them public when they needed access to more capital.

Public companies also became the lifeblood of the wealth-building process for most investors. And for good reason. You see, there’s a gap between what people earn and what they need to retire. Capital gains from investments usually help close the gap.

But it’s tough to get out and source private investment deals if you sit behind a desk all day. Even if you do, digging into the details takes time. You also need to make sure you avoid crooks and cheats. I know about these headaches because I’ve been involved in many private investments.

Buying stocks is much easier. This is because public companies are required by law to publish detailed financials and operating information. Anyone can look at this.

The problem is that the number of publicly traded companies in the U.S. is falling at an alarming rate.

The good news is that we know why it’s happening. More importantly, we see a way to profit from it.

Pigs Get Slaughtered

Consider this: In 1975, 109 companies produced 50% of earnings. In 2015, just 30 companies accounted for half of all the earnings from all U.S.-listed companies.

That means the earning power of public companies is concentrated in a shrinking number of firms. As a result, investors have fewer choices today than at any other time—maybe ever.

But why? Well, the Federal Reserve has had a lot to do with it. You see, the Fed’s been running an ultra-low interest rate experiment over the past 20 years.

This has made borrowing money easy, even for people who don’t need the money. After all, it’s not too hard to pay interest on a 0% loan. Now, you and I can’t borrow money that cheaply…

But the most connected borrowers can.

As a result, the private equity industry has been one of the biggest beneficiaries of this money experiment.

In case you’re not familiar with the private equity industry, here’s how it works... High-net-worth investors pledge cash to a specific fund. Once the fund raises its target amount of money—say $200 million—it closes to additional investment. It also closes the door for investors to pull money out.

The fund’s managers then take the $200 million in cash and borrow an additional amount. This can turn $200 million into $1 billion of buying power. Keep in mind, the managers receive 2% of the $200 million invested each year. That gives them $4 million to pay their salaries and expenses while they invest the funds.

I’ve seen this play out firsthand.

Just after college, I worked as a sales rep for a manufacturing firm. We produced mattresses in 26 factories across the U.S. The owners sold the company for $800 million to a private equity firm. Within months of taking over, I learned that the private equity firm took out a massive loan against the business.

Here’s what’s interesting. They didn’t use that money to invest in new factories or equipment.

Instead, they paid a huge dividend—equal to almost the entire purchase price—to themselves.

This meant that the business merely had to generate enough income to service the massive loan.

If it could do that, its private equity firm owners had a risk-free investment.

It gets better. These firms also capture 20% of any profit they generate when they sell assets. In this case, if they resold the firm a few years later for $1 billion, they’d collect another $40 million in incentive fees.

This type of investing went mainstream in the 1980s. And it only grew from there. Today, it’s officially out of control. It’s a large part of why there are so few public companies remaining today… and this wave of consolidation is just getting started.

Just look at the chart below. It shows how much cash private equity firms are sitting on today.



You can see that private equity firms are sitting on a staggering $1.7 trillion in cash. That’s equal to 9% of the entire U.S. economy’s annual output… just sitting in cash.

In the coming years, these private equity firms will use this cash hoard to take businesses private, load them up with debt, pay themselves rich dividends, and then leave the companies for dead… just like they recently did with Toys "R" Us.

The good news is that you can turn this market phenomenon into huge profits by buying takeover targets or highly successful serial acquirers.


China warns Chile against blocking $5bn SQM lithium deal

Move to halt sale of stake in miner to Tianqi could ‘leave negative influences’

Henry Sanderson in Santiago
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SQM lithium mine on the Atacama salt flat: if Tianqi were able to buy the 32 per cent stake, it would have a dominant influence on global supplies of lithium © Reuters



The Chinese government has criticised a move by regulators in Chile to try to block the sale of a $5bn stake in the country’s largest lithium producer to a Chinese company, saying it could harm bilateral relations.

The comments could ease the way for China’s Tianqi Lithium to buy 32 per cent of Chile’s SQM, the world’s second-largest producer of the metal, a key material in batteries, which has been put up for a sale by a Canadian company called Nutrien.

Xu Bu, China’s ambassador to Chile, told local newspaper La Tercera that the opposition to the stake sale could “leave negative influences on the development of economic and commercial relations between both countries”.

The comments add pressure to the new administration of President Sebastián Piñera, who has vowed to attract more foreign investment to Chile. China is the largest buyer of copper from the country, but has invested less in Chile compared with other South American countries such as Brazil.

In January, China said it wanted to extend President Xi Jinping’s Belt and Road infrastructure and investment plan to Latin America.

If Tianqi were able to buy the 32 per cent stake in SQM, it would have a dominant influence on global supplies of lithium, just as carmakers are pouring billions of dollars into ramping up production of electric cars.

Shenzhen-listed Tianqi is already one of the largest suppliers of the battery raw material, through its ownership of the Talison Lithium mine in Western Australia.

SQM is the lowest cost producer of lithium in the world, due to its use of the fierce sunlight in the Atacama Desert to extract the metal from brine. SQM could supply over half of the world’s demand for lithium by 2025, according to analysts at Scotiabank.

On March 9, the last day of former President Michelle Bachelet’s administration, Eduardo Bitran, executive vice-president of Chile’s national development agency, filed a petition with Chile’s antitrust regulator, urging it to block Tianqi’s bid.

Mr Bitran argued that a sale of the 32 per cent stake to Tianqi would give China too much power over the global lithium market.

“Interlocking of . . . companies that represent a significant participation of a given market is a considered a risk to competition according with the law, [and] therefore has to be investigated,” Mr Bitran said in an email to the Financial Times.

Chile’s National Economic Prosecutor’s Office has until August to decide whether to pursue the case. Tianqi officials met with the office on March 29 to discuss the issue, according to Chilean records.

In the interview, China’s ambassador said Mr Bitran’s remarks had turned “this totally commercial action into a political issue”.

The Chinese embassy in Santiago did not respond to a request for comment. Canada’s Nutrien has until April 2019 to sell the 32 per cent stake as a condition of the merger last year between PotashCorp and Agrium, which created the company.

The stake sale has raised fears that a new shareholder could seek control of SQM. This month SQM’s other largest shareholder, Julio Ponce Lerou, requisitioned a shareholders meeting to change the company’s bylaws to prevent any new buyer from using the stake to take control.

Mr Ponce, the former son-in-law of Chile’s dictator Augusto Pinochet, has held a controlling stake in SQM through an agreement with Japan’s Kowa, which owns 2 per cent of SQM. But in January, Mr Ponce was forced to give that up as part of a deal to allow SQM to expand its production of lithium.

 No (Wall Street) Bank Left Behind! 


Times have been hard for Wall Street banks lately, what with record amounts of cash pouring in and causing all kinds of bookkeeping headaches. So — big-hearted people that we are — Americans stepped up and helped by lowering the banks’ taxes. From Today’s Wall Street Journal:

The Four Biggest U.S. Banks Made $2.3 Billion From Tax Law—in One Quarter 
Big banks just cashed in the first installment of benefits corporate America will reap from the new federal tax law. 
The haul: more than $2.3 billion. 
That is how much the combined earnings of the four major national banks— JPMorgan Chase, Wells Fargo. Citigroup, and Bank of America, — increased in the first quarter because of the lower corporate rates under the tax-overhaul law enacted in December, according to an analysis of the banks’ results by The Wall Street Journal. 
That amount is only a modest-size chunk of the banks’ total first-quarter earnings—less than 10% of their combined net income applicable to common shareholders. But it comprises a major chunk of their year-over-year earnings growth. 
Without the tax savings resulting from the new lower corporate tax rate, Wells Fargo’s earnings would have declined from a year ago instead of increasing, and much of the year-over-year growth at Citigroup and Bank of America would be gone. At JPMorgan, losing the tax bump would have cut its earnings growth to 28% from 35%. 
The $2.3 billion boost isn’t the entire story. For one thing, other provisions of the tax law prompted some of the same banks and many other companies to take big charges against their earnings in the fourth quarter. From that perspective, the first-quarter boosts merely help even things out. 
The Journal’s analysis calculated what each bank’s results for the latest first quarter would have been if the effective tax rate from last year’s first quarter was still in effect. 
Each bank’s tax rate has declined dramatically since then. Wells Fargo, for instance, had an 18.8% effective tax rate in the latest first quarter, down from 27.5% in the year-ago quarter. Applying a 27.5% effective tax rate to the latest quarter’s pretax income would have shaved about $636 million off earnings, cutting Wells Fargo’s diluted earnings per share to 99 cents from the actual $1.12. (Wells’ first-quarter 2017 earnings were $1.03 per diluted share.) 

Citigroup, which had a 23.7% effective tax rate this quarter, would have seen about $452 million cut off its first-quarter earnings if its year-ago 31.1% effective tax rate had been in effect. That would have eliminated most of its roughly $530 million in net-income growth from a year ago. 

  
The tax overhaul added about $798 million to Bank of America’s net-income growth. At JPMorgan, it added about $470 million to its earnings.  
While all four banks disclosed the figures for their current and year-ago pretax income, excluding the effect of taxes altogether, Bank of America highlighted them in the headline of its press release, noting that its pretax income had risen 15%, even as its diluted EPS rose 38%. 
Mr. Gomatam notes not all companies will see the kind of tax-rate reductions the big banks did, and some tax savings could go to a company’s customers or employees rather than profits. Investors “need to see that all of the tax savings are falling to the bottom line.” 
Investors may have looked through the numbers and realized that much of the banks’ earnings growth came from a tax cut, not from operations. In the two trading days since the first big U.S. banks announced earnings Friday morning, Wells Fargo shares fell 3.6%, JPMorgan’s slipped 2.8% and Citigroup’s lost 2.9%.

As the Wall Street Journal points out, we taxpayers were generous, but not overly so: “That amount is only a modest-size chunk of the banks’ total first-quarter earnings—less than 10% of their combined net income applicable to common shareholders.”

Still, it’s the thought that counts. And you can bet that many who read this will definitely be thinking about Wall Street’s banks as we contemplate our own just-completed taxes.