Bull in the China Shop

By John Mauldin

The production of souls is more important than the production of tanks.... And therefore I raise my glass to you, writers, the engineers of the human soul.

Joseph Stalin, 1932

[Our purpose is] to ensure that literature and art fit well into the whole revolutionary machine as a component part, that they operate as powerful weapons for uniting and educating the people and for attacking and destroying the enemy, and that they help the people fight the enemy with one heart and one mind.

Mao Zedong, 1942

Art and literature is the engineering that molds the human soul; art and literary workers are the engineers of the human soul.

Xi Jinping, 2014

This week’s letter focuses on China’s economy. We’ll look at some numbers showing the challenges China faces, but they don’t explain something important. The way China will meet those challenges is going to be substantially different than we would see in the West. So I want to start with a little context.

When European Central Bank President Mario Draghi promised to solve the financial crisis with “whatever it takes,” central bank policy was his only tool. Xi Jinping has a vastly larger toolbox. It is hard for us in the Western world to understand that. Xi not only has every tool a top-down government can have, he has experts to wield them, all of whom are 100% aligned with his goals.

I used the “Bull in a China Shop” pun for this letter’s title to create an image in your mind. A bull tears up the proverbial china shop because it can’t comprehend the porcelain is expensive, easily broken, and hard to repair. It perceives the shelves as threats to its own freedom and so tries to escape, destroying them in the process. But that won’t unlock the door, so the bull stays stuck.

Similarly, many in the West misunderstand China and react counterproductively, breaking things and still not solving the problem.

The Stalin, Mao, and Xi quotes above have a common theme. “… engineers of the human soul.” Mao venerated Stalin, and Stalin’s books sold massively in China. Now Xi Jinping frequently quotes or alludes to Mao and Stalin. “Socialism with Chinese characteristics” has been the case since Deng Xiaoping.

I spent a few hours with Mark Yusko here in Puerto Rico this week. Mark is a good friend and every time I hear him talk about the opportunities he has found in China, it makes me want to get my checkbook and fly to Shanghai or Guangdong. The country has enormous investment opportunities, and an atmosphere where entrepreneurs can create almost anything they envision.

However, you must realize this comes with a level of government intrusion unfathomable to us in the West. In the US, we’re debating the data collected by corporations like Facebook and Google. Their Chinese equivalents are encouraged to collect such data and share it with the government. Moreover, in every interview that I have heard, the overwhelming majority of Chinese simply don’t care, at least not publicly.

These same Chinese companies will extend their practices along the One Belt, One Road initiative, and where do you think that data will end up? By the way, OBOR is a brilliant strategy from the Chinese point of view.

Source: Gavekal

Xi Jinping is intent on having China once again recognized as an equal global superpower and, at some point, even the leader. The Chinese leadership are all students of Chinese history. They know where they came from, and want to regain what they consider their proper place. They are playing a long game—decades long.

China is investing at least as much in artificial intelligence, robotics and Big Data as the West is, much of it controlled, directly or indirectly, by the Chinese military. So when US and European military planners get, let’s just say, nervous about China’s growing capabilities, it is not without reason.

China fully intends for the Yuan to be a global reserve currency. One requirement for that status is willingness to run trade deficits. It is no accident China’s large trade surpluses are beginning to dwindle. That is a feature, not a bug. It is by design.

As for intellectual property and patent rights, the Chinese are rapidly creating their own. China graduated 4.5 million, not counting software developers, mathematicians and other scientists. The vast majority of artificial intelligence patents filed last year were Chinese. Their interest in protecting that property is replacing the former practice of stealing the IP shirt off your back.

But China faces numerous challenges, too. Simon Hunt, who has been going to China for 25+ years and knows the country better than any non-Chinese person I’ve ever met, put it this way.

What should be clearly understood is that China’s economy is facing multiple changes in its structure. They include:

- Exporting companies relocating overseas because of rising domestic costs and American tactics (which won’t reduce the total imports, just the origination of those imports!)

- A shrinking labour force.

- A focus on high-tech

- The need to build infrastructure to accommodate the migration of another 150 million from the countryside to the urban community [in addition to the almost 300 million that have already moved in the last 40 years, in the largest single migration in human history]

- The need to focus development on the lower-tiered cities and rural villages

- Whilst continuing the process of deleveraging the economy.

I talk often about how big China is and how fast it is growing. Often I mention it is the world’s second-largest economy after the US. I may have to modify that practice soon.

Standard Chartered Bank said this month China will likely become the world’s biggest economy at some point in 2020, using nominal GDP and purchasing power parity. Gentle reader, 2020 is next year. This isn’t the far future.

Now, this won’t be the end of the world. It is simply math. GDP growth is a function of the number of workers and their productivity. China has more workers (as in four times more) who are getting more productive. At some point, their large numbers outweigh the higher productivity we have in the US and Europe. This is inevitable.

And that rise won’t happen without some hiccups. I noted last week in Something Wicked This Way Comes that the US and Chinese economies are co-dependent in ways we can’t change quickly. Problems in either country will hurt the other, and both currently have problems.
Demand Pulled Forward

The 2008 financial crisis and recession hit China hard, as it did everyone else. Not every country responded like China did, though. Most couldn’t do what China did because they lacked either the financial resources or the political ability. China had both, and so launched a stimulus program of mind-boggling proportions. Beijing compelled local governments and state-owned enterprises to take on massive debt for giant infrastructure projects, huge capacity expansions, and pretty much anything else they could imagine that would put people to work and bolster public confidence. Yes, they built ghost cities.

(Incidentally, the classic ghost city was in Mongolia, literally vacant for a time but now well on its way to being fully occupied or bought. Long game and deep pockets, indeed.)

Not coincidentally, China has doubled its debt relative to GDP since the beginning of the century, and the bulk of that was after 2009.

But it’s how they grew that debt I find amazing. We must remember that the Chinese economy is managed from the top down. The Chinese government is very aware of how its shadow banking system operates. Half of the total debt is from the nonfinancial (i.e., shadow banks) sector. And while Simon Hunt talks about deleveraging, when I talked with him what he really means is that the Chinese government is trying to move from Wild West shadow banking to more traditional bank financing. Central bankers sometimes accompany private bankers to meet loan-seeking businesses. Chinese characteristics, indeed.

In my research for this letter I came across several mentions that China is planning to move another 150 million rural citizens to urban areas, many into so-called second-tier cities. Only in China can a second-tier city have five million people. And people moving from the country into the city becomes far more productive in terms of GDP. And China is beginning to focus on upgrading the infrastructure and the rural cities as well.

As the entire world will come to realize in the middle of the next decade, the debt which financed that infrastructure does have a carrying cost. Even in a top-down economy. Yes, much of it is internal but our first concern is China’s enormous amount of dollar-denominated debt. Here’s Christopher Balding with the numbers:

According to official data, short-term debt accounted for 62 percent of the total [of almost $2 trillion in debt] as of September, meaning that $1.2 trillion will have to be rolled over this year. Just as worrying is the speed of increase: Total external debt has increased 14 percent in the past year and 35 percent since the beginning of 2017.

External debt is no longer a trivial slice of China’s foreign-exchange reserves, which stood at just over $3 trillion at the end of November, little changed from two years earlier. Short-term foreign debt increased to 39 percent of reserves in September, from 26 percent in March 2016.

The true picture may be more precarious. China’s external debt was estimated between $3 trillion and $3.5 trillion by Daiwa Capital Markets in an August report. In other words, total foreign liabilities could be understated by as much as $1.5 trillion after accounting for borrowing in financial centres such as Hong Kong, New York, and the Caribbean islands that isn’t included in the official tally.

So, China could owe non-Chinese lenders as much as $3.5 trillion, much of it in USD which are more expensive to acquire than they used to be. This is why a trade war is so threatening to China. Revenue from exports to the US helps pay that debt.

So that’s one problem, but the internal debt is not exactly benign. Yes, a state-dominated economy like China’s can deal with debt in its own currency. It has many ways to extend and pretend. But they have limits and don’t work forever. It has to be worked off.

Job Jitters

Leverage is fun. It lets you do things you otherwise couldn’t. Deleveraging is the opposite of fun because you must do things you would rather avoid. This is a particular problem for the Chinese government, which must keep a large population fed, housed, and otherwise content. Thus the drive to improve the conditions or move 150 million people from the poverty of rural China to the cities.

Beijing has many tricks up its sleeve but China’s labor market has its own Dynamic.

From my friends at Gavekal Dragonomics, written by Ernan Cui:

China’s job market is proving to be an early casualty of the US-China trade conflict. Layoffs in manufacturing accelerated over the second half of 2018 as US tariffs fell into place, and job losses have now matched the pace seen during the economic slowdown of 2015-6. But the situation is arguably worse this time, as the service-sector employers that previously absorbed many laid-off workers are now being squeezed by tighter regulations. Government officials are trying to adjust and soften policies to help employment, but the outlook for household income and consumer spending in China in 2019 is clearly worsening.

Consumer spending had already slowed in 2018, but most of the deterioration came from a decline in auto sales. [Which still total 27 million cars sold.] That was largely the result of the end of several years of favorable policies that had front-loaded vehicle purchases; spending on services and other consumer goods actually held up fairly well. But China looks to be headed for a more broad-based slowdown in consumer spending in at least the first half of 2019. The employment components of the PMI surveys, both for manufacturing and non-manufacturing sectors, started to deteriorate sharply in September. These are decent leading indicators of household income growth (see chart), so a further slowdown in income and consumption in the next couple of quarters is almost guaranteed.

Now, we should note that Chinese economic data is questionable in the best of circumstances. The last thing Beijing wants is to give the public rigorous data proving how hopeless its job-hunting is, or how unlikely its income is to grow. Fortunately, we have alternative sources like Gavekal, China Beige Book, and others with on-the-ground presence and access to non-government data.

Gavekal in their broad-based research found an amazing data point, too. The graph below shows an index of Chinese internet searches for the word “layoff.” Notice where it is now compared to 2008 and other recent economic slowdowns.

Now, this doesn’t mean Chinese employers are actually conducting layoffs.
It means people are looking for information on the topic, and I think it’s fair to call that a sign of worry. What is causing this concern? Do Chinese workers see something that bullish Western analysts are missing?

Credit Intensity

Economic weakness is relative. Like anything else, coming down from a level to which you are accustomed is hard, even if you land in a place that isn’t so bad in absolute terms.

Assuming (for discussion’s sake) the official numbers are right, China’s GDP growth has been around 4% at worst going all the way back to the 1980s, and usually much higher. The US has struggled to achieve anything near that. So a decline from the 6.9% growth seen in 2017 to, say, 6%, is a big deal to the Chinese. And that’s what the government apparently expects. Reuters reported on January 11 that in March the government will announce a 2019 growth target goal in the 6-6.5% range… and China always hits the target. Funny how that works.

Here in the US we would celebrate 4% growth. (I think by the end of 2019 we may be wishing for even 2% growth.) In China, they will hit the proverbial panic button at anything south of 6%. Look for the government to respond with even more debt and infrastructure spending to try and stimulate the economy and maintain growth in the 6% range.

The problem is, like a medicine to which the body adapts, debt is no longer having the same kind of effect. An IMF study last year measured China’s “credit intensity” over time.

Source: IMF

I’m sorry that picture is fuzzy—it’s that way in the original, too. Here is how they explain it.

However, over the last five years, domestic nominal credit to the nonfinancial sector has more than doubled, and the domestic nonfinancial sector credit-to-GDP ratio rose to about 235 percent of GDP as of end-2016. 2 During this period, the efficiency of credit expansion has increasingly deteriorated, pointing to growing resource misallocation. In 2007-08, about RMB 6½ trillion of new credit was needed to raise nominal GDP by about RMB 5 trillion per year. In 2015-16, it took more than RMB 20 trillion in new credit for the same nominal GDP growth.

So in less than a decade, the amount of debt needed to produce a given impact on GDP more than tripled. I’ve cited data from Lacy Hunt showing a similar trend in the US but it’s nowhere near that magnitude.

That tells us something important: In the next downturn, slowdown, or whatever you call it, Beijing may not be able to borrow its way out of the hole. Or if it does, the amounts could be astronomically high.

But absent debt stimulus, what else can they do? As noted, Xi Jinping has many tools. Some are more pleasant than others. I seriously doubt he has any way to restore growth to what everyone wants without massive adjustments (i.e., more debt). And it will be painful not just for Chinese, but Americans, too.

Rushing the Process

That being the case, now is not the best time for a trade war between the US and China. Yet we find ourselves in one. Let me again give my requisite disclaimer, since I always get letters saying, essentially, “China bad! Must do something!” Yes, China hasn’t played fairly in a number of ways. I get that. We have issues and problems that need resolution. Prior efforts haven’t worked. I get that, too. We have national security concerns about China, totally apart from our trade disputes. Granted on all counts.

It does not therefore follow that slapping tariffs on Chinese imports is the right answer. We have to fix these things, but without shooting our own feet. American and Chinese businesses have spent the last two decades integrating supply chains and developing markets with each other. Every one of us benefits from that integration every single day.

Could we reverse the integration and become less interdependent? Yes, of course. It’s happening already, simply due to technology that is letting production move closer to consumers. That’s a natural process that will continue. Rushing that process, while probably possible, would have a cost.

Last week I mentioned the US microchip companies that in some cases get half their sales from China. Some are one tariff away from being out of business. Gone, kaput. Stock zero, all employees jobless, all their small-business suppliers, bondholders, and bank lenders left to fight over the scraps in bankruptcy court.

This is one of my greatest short-term fears: that the Trump administration’s hardline tactics will push China into recession, which for them is less than 4% growth. The president himself seems to relish the prospect. He’s talked proudly of the way Chinese markets fell due to his policies. Maybe he thinks the threats will make Xi back down. I don’t think they will. We are pursuing a high-risk policy that will have massively negative consequences if it fails.

I titled this letter “Bull in the China Shop” because that is what we need to avoid. Running around breaking things may be satisfying in the moment, but the cleanup isn’t fun at all.

Next week I go to Tampa Bay for two days, then Baltimore for a few hours, then New York on Sunday, and then back to Palm Beach the following Tuesday. My schedule has changed so much in the last 24 hours it is really insane. I don’t even want to write about it, much less see that many airports and train stations. But it is what it is, and comes with the territory.

I had lunch this week with Harry Dent. He has been in Puerto Rico for several years, and bought property here 20 years ago. I always enjoy my times with Harry and now that we are almost neighbors, there will be more of them. I’m finding that I know many people in Puerto Rico and I’m meeting many more. And Shane loves it. What’s not to like?

My editors are going to have problems getting the word count down, so I think I will help them and just go ahead and hit the send button. You have a great week!

Your hoping we get the China issues resolved analyst,

John Mauldin
Chairman, Mauldin Economics

The Clinton-Obama era ends as US Democrats seek a radical new voice

The party owes a debt of gratitude to Donald Trump as it sweeps away a cautious mindset

Edward Luce

Listen carefully and you can hear the retreat of the Democratic establishment. Incrementalism served its purpose: it made Democrats electable again and safe for Wall Street. But it has had its day. The generation of Democrats that downplayed concerns about inequality and embraced global markets is being replaced by a far bolder political voice. No matter who takes the Democratic nomination in 2020, they will speak for a radicalised party in quest of the new New Deal.

They owe a debt of gratitude to Donald Trump. However much resurgent liberals detest America’s 45th president, they can thank him for sweeping away the mindset of systematic caution that has mesmerised Democratic leaders for a generation.

It began with Bill Clinton’s New Democrats in the late 1980s. It ended in 2016 when Hillary Clinton lost to Mr Trump. In between it spanned Al Gore, the losing 2000 nominee, John Kerry, who lost in 2004, and Barack Obama, whose eight-year legacy is now being destroyed by Mr Trump.

Mr Trump has served both as a call to arms and as an example of how establishments can be defeated. On the first, Mr Trump has demolished whatever case remained for the idea that Democrats must forever ready themselves for a promised land of bipartisan amity. In practice, many thought that stance had already been discredited by Newt Gingrich, the take-no-prisoners Republican Speaker of the House during the Clinton years. Others thought the wrecking ball the Tea Party took to Mr Obama’s fiscal plans had finally settled the argument.

No matter how much Democrats tacked to the centre, the rewards for this virtue never came. Republicans simply moved further to the right. Democratic presidents, such as Mr Clinton, created budget surpluses. Republicans, such as George W Bush, duly spent them on tax cuts. Inequality is far worse today than in 1992, even though Democrats held the White House for more than half that time. Median incomes, meanwhile, have barely shifted. The initial anger over the 2008 financial crash was captured by the Tea Party. It is nevertheless hard to believe the self-proclaimed socialist Bernie Sanders would have nearly defeated Mrs Clinton had she not developed such close financial ties to Wall Street.

But it was Mr Trump who changed the weather. He showed that you could bamboozle a hostile establishment and still win an election. Then he switched horses and pursued an aggressive Republican agenda. From tax cuts and deregulation to gun rights and anti-abortion judges, Mr Trump now has Republican lawmakers eating out of his hand. Those who still believed it would be possible to work across the aisle — and who pined for the days of Rockefeller Republicans — were robbed of any remaining force. Mr Trump has done a service for the American left.

Reality has also lent it a helping hand. Regardless of your ideology, today’s numbers paint a stark picture. Ten years into the US recovery, median household incomes are, in real terms, still much what they were they were in 1999. The top one per cent of households own more wealth than the bottom 90 per cent. America’s average life expectancy has started to decline.

Mr Trump has made inequality worse. But he is not its author. The numbers were almost as bleak at the end of Mr Obama’s two terms. So tinkering no longer holds much appeal.

Much of the focus is on who should be the Democratic nominee to challenge Mr Trump. That obviously matters. But the significant point is that the party’s centre of gravity has shifted. Whoever the challenger turns out to be, whether Joe Biden, the former vice-president, Elizabeth Warren, the economic populist, Beto O’Rourke, the sunny optimist, or Mr Sanders, their platform will have to reflect that shift. Stances such as “Medicare for all”, a “Green New Deal”, and public election financing will have to be part of the package. So too will higher taxes.

Attention has also been lavished on Alexandria Ocasio-Cortez, the 29-year-old Democratic socialist and youngest member of Congress. More notable is the respect her ideas, including a top tax rate of 70 per cent, commands among establishment Democrats. “The congresswoman is right,” Lawrence Summers, Mr Clinton’s former Treasury Secretary, said last week. Mr Summers personified the Washington consensus of the 1990s. Like Keynes, however, he says he changes his mind when the facts do. They no longer fit the arc-of-history Democrats used to narrate. “The false doctrines of the neoliberal priesthood are losing their hold,” writes Nick Hanauer, the entrepreneur who made his fortune with Amazon.

America’s left is turning into a factory of new ideas. Some of them, such as a universal basic income, may be questionable. Others, such as breaking up monopolies, are more promising. Either way, for the first time in decades, America’s intellectual energy is now on the left. Some liken the ferment to the “bold persistent experimentation” of Franklin Roosevelt, author of the 1930s New Deal. Doubters compare it with the false dawn of George McGovern, who lost in a 1972 landslide to Richard Nixon. Whichever view proves correct, the Clinton-Obama era is drawing to a close. A new one is just beginning.

Trump’s New Shutdown World

In 2013, Obama tried to maximize the difficulty. OMB is taking another tack.

By Kimberley A. Strassel

A girl outside the shuttered National Museum of African American History and Culture in Washington, D.C., Jan. 2.
A girl outside the shuttered National Museum of African American History and Culture in Washington, D.C., Jan. 2. Photo: andrew caballero-reynolds/Agence France-Presse/Getty Images

This weekend the federal shutdown becomes the longest in history—and yet, and yet, the sky has not fallen. Meet the team that has allowed the Trump White House to hold out for so long, and in the process forever altered future shutdown fights.

Across the street from the Oval Office, an only somewhat merry band of budget lawyers labor on one priority: making this event as painless as possible. That was the order from President Trump when the government closed, and the Office of Management and Budget was ready.

Acting White House Chief of Staff Mick Mulvaney had spent months as OMB director gearing up for a stoppage. Acting Director Russ Vought was all in. And OMB General Counsel Mark Paoletta and his small legal team (those not furloughed) has spent every day since putting out fires.

It’s the opposite of prior shutdown thinking. The Obama White House used a 16-day shutdown in 2013 to punish Republicans for withholding funds, and in the process penalized the nation. The administration immediately furloughed workers and cut pay for private contractors. It shuttered Head Start, suspended money for health care in the District of Columbia, and sealed national parks, including war memorials on the National Mall. Some agencies had carry-over funds that would have allowed them to continue operations; they refused to use it.

Some shutdown pain is unavoidable—and correctly so. Both the Constitution and the Antideficiency Act are clear that only Congress appropriates money, and no one should want the executive branch to flout clear legal requirements. Shutdowns are also wasteful and highlight Washington’s inability to function.

Yet since Mr. Trump “owns” this one, Republicans have an incentive to minimize the suffering. Congressional Republicans helped themselves by last year passing bills that kept most of the government open. As for the rest, it turns out the law provides some useful flexibility—when an administration cares to exercise it.

A series of OMB memos stretching back to 1981 had already established certain shutdown exceptions. Agencies can continue to function as necessary to protect safety and human life and property, as well as in aid of the president’s fulfilling constitutional duties. Those programs that operate under “indefinite” appropriations, including Social Security and Medicare, also continue. The current OMB team has employed some of these doctrines in ways past administrations haven’t but which nonetheless make obvious sense. The Food and Drug Administration, for instance, has on the grounds of safety continued to monitor adverse reactions to medical devices, conduct foreign drug-factory inspections, and watch for outbreaks of food contamination.

Lawyers have scoured other statutes for legal outs. It turns out that Congress’s latest spending bill, the continuing resolution that ended Dec. 21, contained a provision allowing the government to pay certain obligations that came due within 30 days. That’s allowed OMB to rush food-stamp payments for millions of Americans through February. It was the Interior Department’s own reading of prior statutes that allowed it to use entrance fees to keep national parks open.

Then there’s the past OMB legal finding that unfunded agencies can continue providing services that are “necessary” to funded ones or to mandatory services. An easy example: The Social Security Administration and Treasury Department, both technically shut down, must nonetheless process Social Security checks that operate under continuous appropriations.

That’s also why Americans will still get tax refunds. The OMB team dug through Treasury documents and found that long ago the Internal Revenue Service had determined refunds fall under permanent, indefinite appropriations. IRS workers are being recalled from furlough to process them.

Some critics claim these workarounds are “illegal,” but lawyers say the Trump team looks to be on sound footing—especially given these decisions have been approved by career OMB lawyers.

And also because the Trump team continues to nix proposals that fall too close to the legal line.

Yet there are no legal fixes for some truly painful effects—including Friday’s missed paycheck for 800,000 federal workers. And many patches were one-time wonders. There can be no additional payments for food stamps or for the Coast Guard. The pressure on Mr. Trump will only rise from here, and some Republicans are already nervous. Prepare for a lot more talk about national-emergency declarations.

But no matter the immediate outcome, the administration’s “painless as possible” approach has shifted the appropriations landscape. House Democrats will have to confront a new set of political calculations in budget negotiations during the Trump presidency. And future administrations will have a harder time justifying ugly shutdowns, in light of this example. Yet another way the Trump administration has changed Washington.

Apple and the Technology Cycle

The next society-changing innovation won’t be driven by the microchip.

By George Friedman

We all know that technological innovations have the power to influence geopolitics, but we tend to forget how quickly their returns diminish. The internal combustion engine revolutionized transportation and transformed society. Its birth in 1915 was accompanied by Henry Ford’s invention of another revolutionary technology, the assembly line, and a revolutionary business model, the auto dealership. These innovations transformed not just the United States but much of the world and drove human productivity for half a century.

By about 1965, the internal combustion engine, the automobile, the assembly line and the dealership model had matured. While still indispensable, they were no longer cutting-edge. Most important, they were not generating the vast increase in productivity or the transformation of culture that they once had. The basic architecture of the automobile was complete, from automatic transmissions to air conditioning. The rest was marketing. Neurotic, narcissistic and brilliant, Ford and his generation of revolutionary industry founders were replaced by a generation of managers tasked not with transforming the world but with managing the machine that had transformed it. Process replaced disruption.

The car became a commodity. Commodities do not produce the transformation on which American life is based. Over time, the U.S. auto industry had to deal with competing commodities produced by countries that thrive on them. German Volkswagens and Japanese Toyotas poured onto the U.S. market, while U.S. auto industry managers remained frozen in their processes, assuming their product was eternal. By the 1970s, Chrysler was crumbling. It is in this context that we consider Apple Inc., the tech giant that reported disappointing sales last quarter, causing its stock prices to drop.

The microchip, a core technology that has been at least as transformative as the combustion engine, is commercially about 50 years old. (I held a Hewlett-Packard microchip-driven calculator in my hand in 1972.) The surge in American productivity driven by the microchip ended in the last decade. The products that flowed from microchip technology – the computer and the cellphone among them – remain indispensable to society, but they have already transformed our lives.

In the early years of the auto industry, when new models rolled out of Detroit, everyone was transfixed. Now, a model year means almost nothing. When cellphones first emerged and when Apple created devices that received email, took photographs and provided navigation, in addition to taking calls, consumers greeted each new generation with genuine, almost hysterical anticipation. Yet the microchip, the cellphone and the smartphone also have become commodities. Countries that excel in commodity production have taken over. Most of Apple’s products are manufactured in those places.

It’s been a while since Apple or any of its peers has introduced a cellphone feature that has revolutionized the way we live. Jobs, Gates and Grove – the original tech disruptors – are gone or have moved on. Computing and cellphones are no edgier today than an Oldsmobile was in 1965. The technology is simply part of our lives; the launch of Apple’s $1,000 cellphone met with the same tepid response that greeted the Edsel in 1958. The Edsel was just a car. New iPhones are just phones, and these days nobody lines up at the Apple Store to buy them.

The endless, merciless search for the next big thing that will change everything is what drives the United States. When it’s found, it does just that. But America is easily bored and takes miracles as commonplace. It has no pity for the old, and the old cannot grasp that their time has passed. This is what is happening to the U.S. computer industry, like the auto industry before it. The latter saw itself as the center of American culture and was shocked when the culture moved on. It couldn’t adjust. Apple is now feeling that same pressure and can’t imagine that it will soon be as uninteresting as a minivan. Today, we hear the computer industry emitting the first sounds of the appeals the auto industry made in the 1970s: The Federal government must do something, since without our industry, America is not America. The microchip economy will demand that Federal policy focus on their needs. It might work for a while, but the need even to ask is the first sign of commoditization.

This progression – disruption, maturity, decline – has played out in industries from railroads to electricity. Once revolutionary, each became a commodity, no longer the source of a tenfold return on investment. The U.S. rapidly absorbs core technologies, and they become quotidian.

There is an interesting quirk to this cycle. We can sense that something new is coming, but we all assume it will be more of the same. The first half of the 20th century centered on transportation – cars, planes and rockets. In the 1960s, visions for the future included rockets flying between cities and to the moon, cars that were also boats or planes, personal helicopters, or personal jetpacks reminiscent of “The Jetsons.” Imagination is constrained by the moment. The most radical thought we have is often that the future will be like the present, only more so. It never is.

Silicon Valley and its observers are convinced that artificial intelligence will sustain microchip-driven industry. But the one thing we don’t understand is intelligence, and creating an analog to something we don’t understand is a dubious venture. That humans will create enormously more powerful computers is almost certain. Like intercity rockets, though, this endeavor raises the question of cost. How much will it cost to save hours of airplane flight? What is the cost of replacing a human’s mind with a simulation? I could be wrong – AI may live up to all the promises. If that’s the case, it will revolutionize not only how we live but the very rhythm of technology.

When a radical breakthrough reaches maturity, we await its next act – but there usually isn’t one. I remember holding that HP calculator without the slightest idea of how it would transform the way we live. I looked to the transportation industry to whisk me to Paris for a night and back home for finals. I wish it had.

Apple is living out an old story in American society, but it’s only at the beginning. We will expect more disruption from the company and its industry. There’s much money yet to be made. But the next extraordinary moment will not come from the tech industry. The managers must maintain stability. The next wave will surprise us, and we will not recognize its importance until years after it emerges.

The United States constantly reinvents its past and longs for the future. That is the foundation of its power. It has no mercy on what is passing away and worships that which is coming to be. American nostalgia has many shapes; for me, it is the BlackBerry. Its successor, the iPhone, won the battle (if not my heart). The iPhone now begins its slow transformation from totem to automatic transmission. It will be something that was once exciting, something that still exists but that no one really cares about.

This Really Is the Next Revolution in TV Technology

MicroLED is better looking, more efficient and more versatile than any previous display tech. Now all Samsung, Sony, LG and others have to do is figure out how to manufacture it affordably

By David Pierce


LAS VEGAS—One of the most exciting things I’ve seen at this year’s CES tech show was a man putting a TV together. It looked more like he was hanging photos. He’d grab square tiles off a pile, attach them to the wall, then screw a small plate up top. A moment later, the surface would spring to life. He’d attach another, and it would extend the picture. He built a TV one tile at a time, and it looked awesome.

This particular set was a prototype of a new Samsung modular TV project. At CES, the company displayed screens as small as a magazine cover and as large as 219 inches—which it called, aptly enough, The Wall. Samsung’s goal is to let customers choose the exact size and shape of their own TV, assembled like Lego bricks.


You won’t be able to buy The Wall for a while—and even then it’ll likely only be affordable to people who already own several yachts—but in the meantime, Samsung intends to sell a 75-inch 4K TV based on the same technology. It’s called MicroLED, and it’s worth knowing about now, because it’s the biggest change coming to screens in a long time.

Painting the Picture

For years, LCD (aka liquid crystal display) has been the dominant TV tech. But LCD has a downside: Its pixels basically sit in a sheet of glass, and can’t be seen well unless there’s a big light—or many little lights—shining through it. Without the light, your TV would look more like an Amazon Kindle. Backlighting, though, means dark colors can only be so dark.

More recently, a technology called OLED (aka organic light emitting diode) has hit the high end of the market. Rather than light needing to hit every pixel, or big clusters of pixels, the pixels can light up individually. That’s good for power consumption and great for picture quality: Any pixel that’s supposed to be black just stays off, which means deeper colors and better contrast. But OLED relies on organic compounds (hence the name), which degrade over time and can cause screen problems.

MicroLED is, at least in theory, the best of all worlds. A MicroLED screen is made up of massive numbers of the teeny tiny versions of the LEDs you already know and love. Each is self-powered so it can have similar image quality to OLED, but MicroLED’s inorganic material won’t degrade over time or cause screen burn-in. MicroLED is smaller, thinner and brighter, too, so its displays can be even flatter and less power-hungry.

An advantage of MicroLED is that it can be built into tiles that fit seamlessly together, making a TV as large or small as needed. Photo: Emily Prapuolenis/The Wall Street Journal 

“MicroLEDs are the most interesting and exciting new display technology since the launch of OLED display products beginning in 2010,” said Ray Soneira, chief executive of DisplayMate, a display-technology research company.

Make It So

Samsung may have had the largest MicroLED display at CES—and may be hitting the market soonest with the first living-room-targeted set—but many other companies are working with the technology. TV giants LG and Sonyhave shown off MicroLED displays of their own. In 2014, Apple acquired a company called LuxVue that was also working on MicroLED displays.

Traditional TV sizes go away with this technology, which can be shaped into vertical, elongated or even square sets. Photo: Emily Prapuolenis/The Wall Street Journal 

In some ways, the tech may be even better for smaller screens like phones or smartwatches, or future devices like VR headsets and AR glasses. Your phone’s display accounts for a huge amount of its battery drain. Who wouldn’t want a screen that uses less power, looks better and can change its shape and size?

Your MicroLED TV is a long way off. “A very high proportion of displays using MicroLEDs will not happen in the next few years,” said Jamie Fox, an analyst with research firm IHS Markit . “It is still quite early in the progress of this technology.” As much as anything, it’s a manufacturing challenge: Your Samsung Wall would require careful placement of millions of tiny sub-pixels, each smaller than a human hair. That’s expensive, difficult and slow, three words nobody likes coming off the factory line.

For those for whom cost is no object, Samsung has The Wall, a monstrous, modular MicroLED TV that has grown in size. Last year, it was 146 inches, and now it’s 219 inches. Photo: Samsung 

Still, MicroLED is the display technology to watch in the coming years. When MicroLED manufacturing ramps up, and costs go down, the idea of dotting every surface with pixels won’t sound crazy. William Shakespeare famously wrote, “All the world’s a stage.” More likely, someday not too far off, all the world will be a screen.

Monetary Disorder 2019

Doug Nolan

The S&P500 advanced 6.5% in 2019’s first 13 trading sessions. The DJ Transports are up 9.2% y-t-d. The broader market has outperformed. The small cap Russell 2000 sports a 9.9% gain after 13 sessions, with the S&P400 Midcap Index rising 9.3%. The Nasdaq Composite has gained 7.9% y-t-d (Nasdaq100 up 7.2%). The average stock (Value Line Arithmetic) has risen 9.7% to start the year. The Goldman Sachs Most Short index has jumped 13.6%.

Some of the sector gains have been nothing short of spectacular. This week’s 7.7% surge pushed y-t-d gains for the Bank (BKX) index to 13.7%. The Broker/Dealers (XBD) were up 5.3% this week – and 11.0% so far this year. The Nasdaq Bank index has a 2019 gain of 11.3% (up 4.9% this week). The Philadelphia Oil Services index surged 22.3% in 13 sessions. Biotechs (BTK) have jumped 16.1%.

Taking a deeper dive into y-t-d S&P500 sector performance, Energy leads the pack up 11.2%. Financials have gained 9.0%, Industrials 8.9%, Consumer Discretionary 8.4%, and Communications Services 7.9%. Last year’s leaders are badly lagging. The Utilities have gained only 0.4%, followed by Consumer Staples up 3.2% and Health Care gaining 4.2%.

Canadian stocks have gained 6.9% (“Best Start to Year Since 1980”). Mexico’s IPC Index has risen 6.3%. Major equities indices are up 6.1% in Germany, 7.6% in Italy, 6.2% in Spain, 3.6% in the UK and 3.1% in France. European Bank stocks have gained 5.3% (Italy’s banks up 5.1%). Brazil’s Ibovespa index has gained 9.3% and Argentina’s Merval 15.9%. Russian stocks are up 4.9%, lagging the 7.9% gain in Turkey. The Shanghai Composite has recovered 4.1%. Hong Kong’s Hang Seng index has rallied 4.8%, with the Hang Seng Financial Index up 5.1% to start the year. With WTI crude surging 19% y-t-d, the Goldman Sachs Commodities Index is up a quick 10.4% to begin 2019.

After trading as high as 3.25% on November 6th, 10-year Treasury yields ended 2018 at 2.69%. Yields traded quickly sank to as low of 2.54% on January 3rd and have since rallied to 2.79% - up 10 bps y-t-d. German bund yields traded to 0.57% in early-October before reversing course and ending the year at 0.24%. After trading as low as 15 bps on January 3rd, bund yields closed this week at 26 bps (up 2bps y-t-d). Japan’s JGB yields ended the week at about one basis point, up from the negative 5.4 bps on January 3rd. No “all clear” here.

I titled last year’s “Issues 2018” piece “Market Structure.” A decade of central bank policy-induced market Bubbles fostered momentous market distortions and structural maladjustment. At the top of the list is the historic shift into “passive” ETF “investing.” With the ETF complex approaching $5.0 Trillion – and another $3.0 TN plus in the hedge fund universe – financial history has never seen such a gargantuan pool of trend-following and performance-chasing finance. Add to this the global proliferation of listed and over-the-counter derivatives strategies (especially options) and trading, and we’re talking about a world of unprecedented financial speculation. It’s an aberrant Market Structure, and we’re witnessing repercussions.

After powerful speculative flows and early-2018 blow-off excess, we saw the emerging markets (EM) then succumb to abrupt market reversals, destabilizing outflows, illiquidity and Crisis Dynamics. We witnessed how fragility at the “Periphery” propelled inflows to the “Core,” pushing U.S. securities markets into a destabilizing speculative melt-up (in the face of a rapidly deteriorating fundamental backdrop). This speculative Bubble burst in Q4.

The Powell Fed chose not to come to the market’s defense at the December 19th FOMC meeting. I viewed this as confirmation that Chairman Powell appreciated how previous hurried Fed measures to backstop the markets had bolstered speculation, distorted market functioning and fueled Bubbles. By January 4th, however, the pressure of market illiquidity had become too much to bear.

The Fed, once again, intervened and reversed the markets. Those believing in the indominable power of the “Fed put” were further emboldened. The resulting short squeeze and reversal of hedges surely played a commanding role in fueling the advance. And in a financial world dominated by trend-following and performance-chasing finance, market rallies can take on a wild life of their own. There is tremendous pressure on investment managers, the speculator community, advisors and investors not to miss out on rallies. All the makings for a wretchedly protracted bear market.

Serious illiquidity issues were unfolding a small number of trading sessions ago, as equities and fixed-income outflows – along with derivatives-related and speculative selling – began to overwhelm the marketplace. Fed assurances reversed trading dynamics. De-risking/deleveraging has, for now, given way to “risk on.” A powerful confluence of short covering and risk embracement (and leveraging) has acutely speculative markets once again perceiving liquidity abundance and unwavering central bank support. Dangerous.

At least at this point, I’m not anticipating a crisis of confidence in an individual institution (i.e. Lehman in October 2008) will dominate Crisis Dynamics. Rather, I see a more general unfolding crisis of confidence in market function and policymaking. A decade of reckless monetary expansion and near-zero rate policies unleashed Intractable Monetary Disorder. Among the myriad consequences are deep structural impairment to financial systems - certainly including global securities and derivatives markets. The world is in the midst of acute financial instability with little possibility of resolution (outside of crisis).

These policy-induced bouts of “risk on” bolster confidence in both the markets and real economies. Importantly, they also feed dysfunctional Market Dynamics. Upside market volatility exacerbates market instability, fueling pernicious speculation, manic-depressive flows, and destabilizing derivative-related trading dynamics. With fundamental deterioration accelerating both globally and domestically, I would argue a speculative run higher in securities prices exacerbates systemic risks – while ensuring a more problematic future dislocation.

The global Bubble has begun to deflate. Chinese data continue to confirm a serious unfolding downturn. Not dissimilar to Washington policymakers, Beijing appears increasingly anxious. In theory, there would be advantages to letting air out of Bubbles gradually. But the bigger the Bubble – and the greater associated risks – the greater the impetus for policymakers to indefinitely postpone the day of reckoning. The upshot is only worsening Monetary Disorder. With still rising quantities of Credit of rapidly deteriorating quality, systemic risk continues to rise exponentially in China (and the world).

January 14 – Reuters (Kevin Yao): “China… signaled more stimulus measures in the near term as a tariff war with the United States took a heavy toll on its trade sector and raised the risk of a sharper economic slowdown. The world’s second-largest economy will aim to achieve ‘a good start’ in the first quarter, the National Development and Reform Commission (NDRC) said… Central bank and finance ministry officials gave similar assurances. Surprising contractions in China’s December trade and factory activity have stirred speculation over whether Beijing needs to switch to more forceful stimulus measures…”

January 15 – Reuters: “Chinese banks extended 1.08 trillion yuan ($159.95bn) in net new yuan loans in December, far more than analysts had expected but down from the previous month. Analysts polled by Reuters had predicted new yuan loans of 800 billion yuan last month, down from 1.25 trillion yuan in November…”

January 15 – Bloomberg: “China’s credit growth exceeded expectations in December, with the second acceleration in a row indicating the government and central bank’s efforts to spur lending are having an effect. Aggregate financing was 1.59 trillion ($235 billion) in December, the People’s Bank of China said on Tuesday. That compares with an estimated 1.3 trillion yuan in a Bloomberg survey.”

January 15 – South China Morning Post (Amanda Lee): “China’s banks extended a record 16.17 trillion yuan (US$2.4 trillion) in net new loans last year…, as policymakers pushed lenders to fund cash-strapped firms to prop up the slowing economy. The new figure, well above the previous record of 13.53 trillion yuan in 2017, is an indication that the bank has been moderately aggressive in using monetary policy to stimulate the economy, which slowed sharply as a result of the trade war with the US. Outstanding yuan loans were up 13.5% at the end of 2018 from a year earlier… In addition, debt issued by private enterprises increased by 70% year-on-year from November to December last year, indicating that the central bank’s efforts to support the private sector are working.”

There’s a strong consensus view that Beijing has things under control. Reality: China in 2019 faces a ticking Credit time bomb. Bank loans were up 13.5% over the past year and were 28% higher over two years, a precarious late-cycle inflation of Bank Credit. Ominously paralleling late-cycle U.S. mortgage finance Bubble excess, China’s Consumer Loans expanded 18.2% over the past year, 44% in two years, 77% in three years and 141% in five years. China’s industrial sector has slowed, while inflated consumer spending is indicating initial signs of an overdue pullback. Calamitous woes commence with the bursting of China’s historic housing/apartment Bubble.

Typically – and as experienced in the U.S. with problems erupting in subprime - nervous lenders and a tightening of mortgage Credit mark an inflection point followed by self-reinforcing downturns in housing prices, transactions and mortgage Credit. Yet there is nothing remotely typical when it comes to China’s Bubble. Instead of caution, lenders have looked to residential lending as a preferred (versus business) means of achieving government-dictated lending targets. Failing to learn from the dreadful U.S. experience, Beijing has used an inflating housing Bubble to compensate for structural economic shortcomings (i.e. manufacturing over-capacity). This is precariously prolonging “Terminal Phase” excess.

The Institute for International Finance is out with updated global debt data. In the public interest, they should make this data and their report available to the general public.

January 16 – Financial Times (Jonathan Wheatley): “Emerging-market companies have gorged on debt. Slower global growth and higher funding costs will make servicing that debt harder, just as the amount coming due this year reaches a record high. The result? Less investment for growth and yet more borrowing. These are some of the concerns raised by the Institute of International Finance… as it published its quarterly Global Debt Monitor… The world is ‘pushing at the boundaries of comfortably sustainable debt,’ says Sonja Gibbs, managing director at the IIF. ‘Higher debt levels [in emerging markets] really divert resources from more productive areas. This increasingly worries us.’ The IIF’s data show total global debt — owed by households, governments, non-financial corporates and the financial sector — at $244tn, or 318% of gross domestic product at the end of September, down from a peak of 320% two years earlier. In some areas, though, borrowing is rising. Of particular concern is the non-financial corporate sector in emerging markets (EMs), where debts are equal to 93.6% of GDP. That is more than among the same group in developed markets, at 91.1% of GDP.”

January 16 – Washington Post (Robert J. Samuelson): “Government debt has tripled from $20 trillion in 2000 to $65 trillion in 2018, rising as a share of GDP from 55% to 87%. Household debt has increased over the same years, from $17 trillion to $46 trillion (from 44% to 60% of GDP). Finally, nonfinancial corporate debt rose from $24 trillion to $73 trillion (71% of GDP to 92%)… According to the data from the IIF, emerging-market borrowers face $2 trillion of maturing debt in 2019, with about a quarter of those loans made in dollars (most of the rest are in local currency). To avoid default, borrowers must somehow raise those dollars, either from a new loan or from other sources.”

January 16 – Barron’s (Reshma Kapadia): “A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020. Most of the redemptions in 2019 will be outside of the financial sector, mainly from large corporate borrowers in China, Turkey, and South Africa. The question will be if they can refinance the debt…”

Considering the unprecedented global debt backdrop, it’s difficult for me to believe last year’s corrections went far in resolving deep structural issues throughout the emerging markets - and for the global economy more generally. “A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020…” “…Borrowers face $2 trillion of maturing debt in 2019, with about a quarter of those loans made in dollars.”

Positive headlines from Washington and Beijing engender optimism that a U.S./China trade deal is coming together. One can assume President Trump yearns for those morning Tweets lauding record stock prices. President Xi certainly has ample motivation for a deal to goose Chinese markets and the increasingly vulnerable Chinese economy.

A deal would be expected to boost U.S., Chinese and global equities. It will be curious to see how long Treasuries can observe rallying risk markets before turning nervous. So far, Treasuries, bunds and JGBs have been curiously tolerant. If the risk markets rally gains momentum, I would expect flows to be drawn out of the safe havens. A jump in global yields – perhaps accompanied by a resurgent dollar – could prove challenging for the fragile emerging markets.

Pondering the massive pool of unstable global speculative finance, I ponder how both EM and global corporate Credit will trade in the event of a more sustained recovery in global equities and sovereign yields. Bear market rallies feed optimism and perceptions of abundant liquidity. But I believe the global liquidity backdrop has fundamentally deteriorated. This predicament, however, is completely concealed during rallies – only to reemerge when the buyers’ panic runs its course and selling resumes. It would not be surprising to see liquidity issues resurface in EM currencies and debt markets. In general, the more intense the counter-trend rallies the greater the vulnerability to sharp market reversals and a return of illiquidity.

Fed officials have fallen in line with the Chairman’s cautious language. But I would not totally dismiss “data dependent.” With labor markets unusually tight, a scenario of a trade deal, speculative markets and economic resilience could possibly see the Fed contemplating a shift back to “normalization.” Market pundits were quick to highlight “hawkish” Kansas City Fed President Esther George’s newfound dovishness. Comments from “dovish” Chicago Fed President Charles Evans were as notable: “I wouldn’t be surprised if at the end of the year we have a funds rate that’s a little bit higher than where we are now. That would be associated with a better economy and inflation moving up.” It’s going to be a fascinating year.

Chart Of The Day... Or Century?

by: Mark J. Perry


- During the most recent 21-year period from January 1998 to December 2018, the CPI for All Items increased by exactly 56.0% and the chart displays the relative price increases over that time period for 14 selected consumer goods and services, and for average hourly earnings (wages).

- Various observations that have been made about the huge divergence in price patterns over the last several decades include:

- The greater (lower) the degree of government involvement in the provision of a good or service, the greater (lower) the price increases (decreases) over time.

- Prices for manufactured goods have experienced large price declines over time relative to overall inflation, wages, and prices for services.

- The greater the degree of international competition for tradeable goods, the greater the decline in prices over time.
As I wrote last summer on CD, I've probably created and posted more than 3,000 graphics on CD, Twitter, and Facebook including charts/graphs, tables, figures, maps and Venn diagrams over the last 12 years. Of all of those graphics, I don't think any single one has ever gotten more attention, links, re-Tweets, re-posts, and mentions than the one above (and previous versions), which has been referred to as "the Chart of the Century." Here are some examples of those mentions from last year for the version of the chart with price data through December 2017.
A multi-colored graphic that's made the rounds at the Federal Reserve hints at what Chairman Jerome Powell could face if President Donald Trump succeeds in throwing globalization into reverse: Higher prices for many goods and potentially faster inflation. 
Plugged as possibly the chart of the century by economist and originator Mark Perry, it shows that prices of goods subject to foreign competition - think toys and television sets - have tumbled over the past two decades as trade barriers have come down around the world. Prices of so-called non-tradeables - hospital stays and college tuition, to name two - have surged.
A chart that has been making the rounds at the Fed from economist Mark Perry shows how falling prices for trade-sensitive things like TV sets and toys have helped offset rising costs for things like medical services, housing and education.
Based on today's BLS report for CPI price data through December, I've updated the chart above with price changes through 2018. During the most recent 21-year period from January 1998 to December 2018, the CPI for All Items increased by exactly 56.0% and the chart displays the relative price increases over that time period for 14 selected consumer goods and services, and for average hourly earnings (wages). Seven of those goods and services have increased more than average inflation, led by hospital services (+211%), college tuition (+183.8%), and college textbooks (+183.6%). Average wages have also increased more than average inflation since January 1998, by 80.2%, indicating an increase in real wages over the last several decades.
The other seven price series have declined since January 1998, led by TVs (-97%), toys (-74%), software (-68%) and cell phone service (-53%). The CPI series for new cars, household furnishings (furniture, appliances, window coverings, lamps, dishes, etc.) and clothing have remained relatively flat for the last 21 years while average prices have increased by 56% and wages increased 80.2%.
Various observations that have been made about the huge divergence in price patterns over the last several decades include:

a. The greater (lower) the degree of government involvement in the provision of a good or service, the greater (lower) the price increases (decreases) over time, e.g., hospital and medical costs, college tuition, childcare with both large degrees of government funding/regulation and large price increases vs. software, electronics, toys, cars and clothing with both relatively less government funding/regulation and falling prices. As somebody on Twitter commented:
Blue lines = prices subject to free market forces. Red lines = prices subject to regulatory capture by government. Food and drink is debatable either way.  
Conclusion: remind me why socialism is so great again.
b. Prices for manufactured goods (cars, clothing, appliances, furniture, electronic goods, toys) have experienced large price declines over time relative to overall inflation, wages, and prices for services (education, medical care, and childcare).
c. The greater the degree of international competition for tradeable goods, the greater the decline in prices over time, e.g., toys, clothing, TVs, appliances, furniture, footwear, etc.