Why America is learning to love budget deficits

The trend towards looser fiscal policy could mark the biggest shift in economic thinking in a generation

Sam Fleming and Chris Giles in Washington

For a newly elected Democrat, it was an unusual way to make your mark. Ben McAdams, the Democratic representative from Utah, this month introduced an amendment that would make it unconstitutional in normal circumstances for the American government to fail to balance its books.

The proposal, which he says prompted a fierce backlash from within his own party, reflects a fear that both fellow Democrats and Republicans are giving up on any attempt to curb the budget deficit. “Politicians are like water — they will take the course of least resistance,” says the 44-year-old congressman, an ex-mayor of Salt Lake County. “In our case the course of least resistance is deficit spending.”

Fiscal conservatism may once have had deep roots within both the Republican and Democratic parties, but today it appears critically endangered. The Congressional Budget Office’s latest outlook suggests deficits are projected to average 4.4 per cent of gross domestic product in 2020-29, far above the average set over the past 50 years of 2.9 per cent of GDP. That will ensure public debt as a share of GDP rises steadily to eventually exceed records set immediately after the second world war.

US fiscal policy chart

Symbolically charged amendments such as the one sponsored by Mr McAdams and backed by the Blue Dog coalition of fiscally conservative Democrats have little or no chance of ever becoming law. Instead, they could end up being relics of a bygone era in thinking about the economy.

The trend towards looser fiscal policy led by the US marks potentially the greatest change in economic policymaking for a generation. Persistently low inflation is allowing central banks to keep interest rates down, easing the cost of servicing public debt. As a result, many economists now argue there is little pain and much to gain from further loosening budgetary shackles.

After four decades when central banks have been the dominant actors — first through their efforts to use monetary policy to vanquish inflation and then, over the past decade, to avert disaster following the financial crisis — it is fiscal policy and government spending that have the potential to become bigger driving forces in the economy.

US fiscal policy chart

While US politicians continue to publicly deplore deficits, many are in practice embracing them. On the right, President Donald Trump has led his party down a path to a US deficit blowout that will soon take annual budget shortfalls above $1tn. On the left, influential figures such as Alexandria Ocasio-Cortez, the leftwing representative from New York, have suggested that not all spending needs to be offset with extra taxes, as progressives propose major expansions of public health spending and environmentally-friendly investment. Bernie Sanders, one of the early frontrunners to become the Democratic presidential candidate, is advised by Stephanie Kelton, a prominent economist who argues deficits are harmless if twinned with low inflation.

Even in the sometimes lonely middle ground, economists are showing a willingness to embrace deficits. Lawrence Summers and Jason Furman, former advisers to Barack Obama, argued earlier this year that it is time Washington ends its debt obsession and recognises that there had been few if any fiscal crises in countries that borrow in their own currencies and print their own money.

British economist John Maynard Keynes advocated deficit spending during recessions, and when monetary policy has lost its power to stimulate spending © Getty

“The fiscal floodgates are wide open,” says Mark Zandi, chief economist at Moody’s Analytics. “Both the Republicans and the Democrats now have theories that allow them to ignore deficits and debt . . . The whole game has changed.”

Similar stories are playing out elsewhere. Japan has arguably not worried much about budgetary strictures for two decades. In Europe, politicians are beginning to question the old orthodoxy, which required the public finances to be sustainable and prudent while central banks sought to curb economic booms and busts. Germany is under particular pressure to relax its balanced budget policy — the so-called schwarze Null (“black zero”) — and boost its infrastructure.

To politicians, the allure of the new thinking on deficits is obvious if it helps justify popular tax cuts or public spending increases. In the past politicians were wary of the risks associated with lost budgetary credibility — including the threat of surging borrowing costs and higher inflation, or lower growth associated with hefty public debt mountains.

But now a series of developments has triggered a reassessment of fiscal policy, says Mohamed El-Erian, chief economic adviser to Allianz. These, he explains, include persistently low and, in some cases, negative interest rates; the absence of inflationary pressures despite low rates and central bank liquidity injections; a prolonged period of relatively low and insufficiently inclusive growth; and concern that the manner in which central banks conducted quantitative easing disproportionately benefited the rich.

“All this comes in the context of a growing realisation that central banks cannot be the only game in town when it comes to the policy challenge of generating high inclusive growth and genuine financial stability,” he adds.

The US serves as a vivid example of the changing political weather. Mr Trump spoke implausibly during the 2016 campaign about paying off America’s national debt in just eight years, and went on to appoint Mick Mulvaney, a hardline deficit hawk, to be his first White House budget director.

US fiscal policy chart

But the president then executed a stunning U-turn on the budget, ruling out reforms to the fundamental drivers of rising public spending — namely social security and pension-age medical expenditures. At the same time his administration embarked on a major tax-reduction programme, taking a leaf from supply-side folklore with claims that the cuts would pay for themselves via higher economic growth.

Trump administration policies are now set to push the US into the deepest protracted budget deficits on record outside wars and recessions — at a time when the US economy is near or at full employment.

Kevin Hassett, chairman of the president’s Council of Economic Advisers, insists the White House does care about the deficit, but that it was right to prioritise tax cuts that it expected to boost growth. “The growth part of the policies is working,” he says in an interview with the FT. “The White House agenda is getting ahead of the curve on spending.”

Stephanie Kelton, an adviser to Bernie Sanders’s 2016 and 2020 presidential campaigns, is a proponent of Modern Monetary Theory © Bloomberg

The Republicans’ relaxed approach to fiscal policy has helped spur a debate within the Democrats — who presided over a fleeting bout of budget surpluses in Bill Clinton’s presidency. As progressives gain influence within the party, some are backing massive and potentially deficit-expanding spending programmes addressing climate change and social policy priorities.

One example is the so-called Green New Deal investing in clean-energy jobs and infrastructure being pushed by Ms Ocasio-Cortez and Ed Markey, the junior Democratic senator from Massachusetts. Another is the “Medicare for all” public health proposals backed by many of the Democratic presidential candidates, including Mr Sanders.

Ro Khanna, a California congressman and leading progressive, insists that the party cannot afford to ignore deficits. But he argues austerity policies in the wake of the financial crisis were a mistake, and that the priority now is to shift away from tax cuts for the most wealthy towards investments in healthcare, education and infrastructure. Early this year he was part of an unsuccessful revolt by progressives against a package of rules in the House of Representatives that require new spending to be offset by savings elsewhere or extra revenue.

US fiscal policy chart

“The winning formula for the Democrats is they are going to have to endorse some of these relatively fiscally extreme positions to get nominated,” says one Democratic strategist, speaking of the 2020 presidential contenders. “The threats of debt and deficits have not panned out. We have been running deficits and debt for 30 years and where is the crowding out, the inflation and the soaring interest rates?”

One recent catalyst for the new thinking on easier fiscal policies, overturning seminal papers from the 1980s, which ushered in the pre-eminence of monetary policy and independent central banks, was the January presidential address at the American Economic Association by Olivier Blanchard, former IMF chief economist.

Mr Blanchard argued for fiscal policy to be given greater emphasis now that interest rates appear to be persistently low — and below the annual growth rate of nominal GDP. He turned around the famous argument of Thomas Piketty that inequality would rise because interest rates were higher than growth rates, which increased the power of capital. Instead, Prof Blanchard said the world was shifting toa more normal period where growth rates exceeded long-term, risk-free interest rates.

Backers of defecit-expanding spending programmes argue the priority now is to shift away from tax cuts for the wealthy to investments in healthcare, education and infrastructure © Getty

That meant countries can have higher debt because their ability to service it and eventually repay it becomes ever easier as their economies grow. “The issuance of debt without a later increase in taxes may well be feasible,” Prof Blanchard said.

An allied strand of academic thinking argues that with interest rates stuck at zero or close to zero, monetary policy is largely ineffective and fiscal policy will need to take up the reins of managing demand. Achieving this will be no mean feat in countries like the US, where political gridlock makes it tough to achieve nimble changes in budget policy.

Mario Draghi, president of the European Central Bank, issued a call for more help from governments at the recent IMF spring meetings in Washington. “It’s quite clear our current monetary policy is already very accommodative and can be made even more so if needed. But we reach a point where fiscal policy becomes more and more important,” he said.

As such, many economists complain that budgetary policies from institutions such as the European Commission are unduly harsh. Robin Brooks, chief economist of the Institute of International Finance, says it is “unsustainable” that a major economy like Italy is in quasi-permanent stagnation, adding that on the eurozone periphery there has been a “huge over-tightening [of fiscal policy]”. Italy’s populist new government has taken this argument to Brussels in its battle with the commission.

Bernie Sanders, an early frontrunner for Democratic presidential candidate, backs economists who argue deficits are harmless if twinned with low inflation © AFP

At the extreme end of the rethink is so-called Modern Monetary Theory, which argues that policymakers in countries that print their own currency can take on as much debt as is necessary to keep the economy purring away at full employment. These arguments, propounded by the likes of Prof Kelton, an adviser to Mr Sanders’s presidential 2016 and 2020 campaigns, go beyond standard Keynesian orthodoxy, which advocates deficit spending during recessions and when monetary policy has lost its power to stimulate spending.

Instead, MMT advocates say that in normal times governments do not need to counter every spending decision with either higher tax or an expenditure cut elsewhere. Inflation, if it becomes a menace, can be offset by higher taxes to counter excess government-created liquidity.

Prof Kelton complains that politicians in the US are accustomed to going to the Congressional Budget Office with spending proposals to see if it judges that their numbers balance up. “Now is not the time to wait around for permission slips to [take] action on climate change,” she tells the FT. “We are not going to tie our shoes and complain we can’t run.”

US fiscal policy chart

Those advocating budgetary prudence have by no means thrown in the towel. In a recent lecture to central bankers in Washington, Kenneth Rogoff of Harvard University questioned the assumption that interest rates and inflation would stay low for a long time, making public debt much less expensive and a MMT policy almost free to finance.

“It is probably true — you can have much more debt — interest rates are low. But in MMT, the debt is all very, very short term, so [the debt] is cheap, but it’s risky,” he said. “It’s very cheap until it’s not.”

Professor Francesco Giavazzi of Bocconi University in Milan, Italy, argues that keeping a tight rein on budget deficits is necessary and does not harm economic performance if tax rates are kept low. “Austerity policies have been effective where implemented mostly by cutting expenditures,” he says, citing examples such as Ireland and the UK in 2010-14 and Denmark in the 1980s. Italy, he noted, had raised taxes and seen “its economy plummet”.

Larry Summers, former adviser to Barack Obama, argued earlier this year that it is time Washington ends its debt obsession © Getty

The more extreme versions of fiscal activism, including MMT, are being challenged by mainstream economists who question the idea that public debt can always be financed by printing money without triggering problems such as high inflation. Mr Summers has decried it as “voodoo economics” offering false promises of a free lunch — drawing a parallel with conservative supply-side theorists who he says argue tax cuts can pay for themselves. Jay Powell, the Federal Reserve chairman, has called the theory “just wrong”.

John Llewellyn, a former chief economist of the OECD, says MMT activists were “often near-messianic in tone, while somewhat vague in exposition”. He adds: “MMT is appropriate only in exceptional situations, where economies are far from full employment, deflationary pressures are in evidence, and interest rates are at the zero bound.”

Even US progressives are anxious to avoid being labelled as fiscally irresponsible, with Democrats focusing heavily on taxing the wealthy as a way of raising revenue and redressing inequality. Mr Sanders in a recent Fox News debate insisted that high public debt was a “legitimate concern” and insisted he would pay for his far-reaching plans to expand state medical coverage. “We pay for what we are proposing, unlike the president of the United States,” he said.

Yet few politicians are putting forward plausible plans to arrest the inexorable rise in debt. No matter who holds the White House, the world is set to watch a major fiscal experiment over the coming decade. This will establish whether the remorseless rise in America’s public debt is a largely benign phenomenon — or an economic and financial menace.

Free Exchange

Where growth is concerned, is population destiny?

New research suggests that, in the very long run, size is a great advantage

It stands to reason that countries with larger populations might enjoy long-run economic advantages. People are the raw material of economic growth, after all. The more there are, the greater the likelihood that one becomes a Gutenberg or a Watt. In a world without much international trade, populous countries offer the largest markets, and comparatively more opportunity to boost economic output through specialisation and trade. Projecting economic growth rates is fantastically hard even over very short time horizons; over centuries, it is as good as impossible. But there are worse strategies than betting on the places with the most people.

Klaus Desmet of Southern Methodist University, Dávid Krisztián Nagy of CREI, a research institute, and Esteban Rossi-Hansberg of Princeton University do just that. In a paper that last month won them the Robert Lucas prize, which recognises excellent research in political economy, they build a model that yokes economic performance to population size, within which they can run time forward by hundreds of years to watch the balance of economic power change. Long-run growth, they suggest, is driven by improvements in technology. And more populous countries should accumulate more innovation than smaller ones do because the return on developing a new technology is higher—there are more people to buy Edison’s light bulb and to enrich Edison, and therefore more incentive to invent the light bulb in the first place.

Leaning against this force, however, is migration. Right now, the richest places are not the most populous. Should it become relatively easy to migrate, people will move from countries that are populous but poor to others that are rich. As migration swells the population of rich places, their long-run dominance is assured because of the link between population size and innovation.

But if there is very little migration, then the populous but poor countries will out-innovate the small but rich ones, and make their way up the income league table. The process is not quick; the authors reckon that convergence takes about 400 years. In practice, rich places tend not to allow much migration from poor ones. That could change, but assuming that it does not, the model delivers a striking forecast: half a millennium from now, Asia and sub-Saharan Africa will have become great engines of productivity.

Stranger things have happened. A millennium ago real output per person was significantly higher in China than in Britain (see chart). To predict that a European backwater would lead the world into the most transformative economic epoch in history would have seemed like madness. Over very long time horizons the world’s poorest places can indeed become the world’s richest, even if it does not happen often.

Still, if Britain did not have the upper hand over China 1,000 years ago, it did soon after, at least in terms of real output per person. By 1400 incomes in Britain were meaningfully larger than in China (and higher still in the Netherlands and Italy), according to work by Stephen Broadberry of Oxford University, Hanhui Guan of Peking University and David Daokui Li of Tsinghua University.

By 1700 the diverging trajectories of China and north-west Europe were clear (though it was anything but obvious just how much further apart they would become). In other words, population over the past millennium has not been destiny. If China’s and India’s masses did not raise them to prosperity during the past 600 years, what reason is there to believe the future will be different?

More’s the pity

It is possible that population is destiny, other things equal, but other things are never equal. And so a plague here, or a fateful decision by a Chinese emperor there, can set a region down a path that wipes out the advantages of population. Perhaps those advantages must be harnessed by the right sorts of institutions, or an accommodating culture—which take far longer to develop or adopt than technologies do to emerge.

There is no academic consensus regarding what determines economic fortunes over long time horizons, important though the question is. Alternatively, one might argue that conditions have changed in ways that amplify the power of population. A billion brains seem a more economically potent force in an era of mass education, in contrast to the mass illiteracy that prevailed in the past.

But crucially, Asia’s recent rise has not been the result of a spurt of indigenous innovation given its impetus by the size of its population. Rather, it has happened as part of a wave of globalisation, which aided the transfer of technological know-how.

Openness to exchanges of goods and ideas, or indeed to immigration, is not an immutable parameter, but subject to change based on human preferences. Mr Desmet and his co-authors reckon that eliminating all barriers to migration would raise global welfare threefold—an extraordinary figure that reflects yawning differences in output per person between countries, and the unrealised human potential they represent.

As intriguing as it is to consider the directions in which macro variables such as population or GDP are likely to nudge the world in coming centuries, it is human decisions that will determine which places and people are given the opportunity to become rich. National populations matter to the extent that borders do. It is a depressing notion, but a plausible one, that in half a millennium’s time they will matter still.


Economies and stockmarkets do not always match up well

That makes it hard for investors to diversify into emerging markets

EVERYBODY KNOWS Monty Python’s “cheese shop” sketch—everybody who is over 50 and a comedy nerd, that is. The shopkeeper, played by Michael Palin, asks a customer, played by John Cleese, what cheese he would like. Do you have Red Leicester? Sold out. Caerphilly? On order. Cheddar? Not much call for it. Each increasingly testy request for a different cheese (43 of them) is cheerfully met with a “no”, “sorry” or feeble excuse. Pressed to back up his claim to the best cheese shop around, the shopkeeper replies: “Well, it’s so clean, sir!”

This leads us, as smoothly as a Python segue, to a frequent complaint about the main stock index for investors in emerging markets. The opportunity is as clear as a sign saying “Cheese Shop”. Most of the growth in the world’s GDP over the next five years will be in developing countries, says the IMF. You might like to buy a basket of stocks from a broad range of countries that taps into this growth. But the benchmark MSCI emerging-market index does not really offer that.

It is light on exposure to the fastest-growing bits of the world economy, notably in Africa. Instead it has a heavy tilt towards economies in the Asian supply chain to rich-world consumers. In short, it looks to some investors like a cheese shop that is so clean because it is uncontaminated by cheese. Yet the trouble lies not with the index compilers, but with the nature of public markets.

The matter turns on the different ways in which economies and markets are classified. With countries, it mostly comes down to income level: if GDP per person is above a certain threshold, an economy counts as developed. The criteria for financial-market development are different.

Here, what matters is how easy it is for foreign investors to move large sums into and out of local stocks. That in turn depends on two things. The first is the stockmarket’s liquidity: the bigger the market, the better equipped it is to handle big purchases or sales of stock on any given day. The second is openness. A market with lots of biggish listed stocks, which trade frequently, might still fail to qualify for developed-market status because it has limits on foreign ownership or other barriers to cross-border trading.

Take South Korea, for instance. Decades of sustained growth turned it into a rich country, with GDP per person of $31,000 at current exchange rates. Yet its currency can be bought and sold only in Korea, and only during local market hours. It cannot be traded offshore. That may seem like a minor matter. But index funds that move vast sums to and fro quickly like to do their currency trades in one go. Developed stockmarkets are defined by the absence of such frictions, says Sebastien Lieblich, of MSCI. Though Taiwan is richer than Portugal, and Korea’s GDP is bigger, they are both classified by MSCI as emerging markets. Together they account for a quarter of the index. Add in the 33% weight for Chinese stocks and its constituents lean heavily towards “Factory Asia”.

A stock index measures what is investable. If you are seeking exposure to broad-based economic development, you need to be creative. That means looking at smaller, less liquid stocks outside the index, or perhaps the shares of rich-world firms that earn the bulk of their revenue in developing countries. The alternative is to drop down a level in terms of liquidity and openness to “frontier markets”, which include fast-growing economies in Asia, such as Bangladesh and Vietnam, but also in Africa. This is a much smaller universe of stocks. The market capitalisation of MSCI’s frontier-market index is around $120bn, compared with around $5trn for its emerging-market index. And it is also dominated by a few countries. Stocks listed in Kuwait, Vietnam and Argentina account for more than half of it.

Economies and stockmarkets do not match up well, even in rich countries. America accounts for 55% of MSCI’s world index but a much smaller share of the world economy. The size of its equity market relative to GDP is at one extreme (along with Britain and Switzerland), notes Victor Haghani of Elm Partners, with Germany and Italy at the other. The best reason for investing across borders is not to plug into faster GDP growth (for which you may overpay), but for diversification. By owning a broad range of stocks, investors leave themselves less exposed to specific company, industry or country risks. The best thing about indices of big, liquid stocks is that buying and selling them is cheaper. For the only thing that grates more than Parmesan is high-cost investing.

Fragmented Europe risks paralysis

Parties built around the structure of last century are losing their relevance

Gideon Rachman

Those of us who waste time watching YouTube videos are familiar with a classic from the American racetrack, in which two horses called respectively “My wife knows everything” and “The wife doesn’t know” battle it out.

The early interpretations of the European elections reminded me of that video — except in this case the two horses are called “This changes everything” and “This changes nothing”.

Those who argue that “this changes nothing” have some powerful points. Collectively, pro-EU parties will continue to dominate the European Parliament. Anti-EU parties now account for about a quarter of the seats in the parliament, up from about 20 per cent. But some of the stars of the nationalist right had disappointing nights — including the Alternative for Germany, the Danish People’s party and the Forum for Democracy in the Netherlands.

However, those who think that “this changes everything” also have evidence to point to. Eurosceptic (or Eurohostile) parties emerged as the largest in four of the six most populous EU countries: France, Italy, Britain and Poland.

One reason for this clash of interpretations is an over-focus on just one question: what does this mean for the battle between the pro-EU forces and anti-EU insurgents? But if you ask a different question — what is happening to the parties that have dominated European politics? — then a clearer trend emerges. The traditional centre-left and centre-right are in decline. They are losing ground not just to populist nationalists, but also to parties that appeal to an urbanised middle-class, such as the greens and liberals.

In France, the centre-right and centre-left (the Republicans and the Socialists) scored less than 15 per cent of the vote, while the far-right, the liberals and the greens scooped up almost 60 per cent. In Italy, the centre-left and centre-right won about 31 per cent of the vote; populist parties scored 58 per cent. In Britain, the Conservatives and Labour won just 23.2 per cent of the vote between them. This trend against the traditional mainstream parties extended even into stable, sensible Germany, where the centre-right Christian Democrats and centre-left Social Democrats fell well below 50 per cent of the vote combined. The greens came in second with just over 20 per cent, with the far-right claiming another 11 per cent.

It seems that political parties built around the class and economic structures of the 19th and 20th centuries are losing their relevance. European voters are increasingly motivated by new issues — such as climate change, identity and migration.

The consequence is likely to be a period of political uncertainty and flux that will make it harder for the EU to act. The fact that the centre-right, socialists, liberals and greens are all broadly pro-EU cannot disguise their very different views on key areas such as climate change and eurozone reform. One big issue to look out for is the political future of Angela Merkel, the German chancellor. Another dismal result for the SPD may persuade them to pull out of the governing coalition, so collapsing the government. Ms Merkel will also be under pressure from within her own CDU. The party’s weak electoral performance may empower Annegret Kramp-Karrenbauer, the chancellor’s heir apparent, to push for Ms Merkel to go sooner rather than later. Meanwhile, some in the CDU will argue for a move sharply to the right on issues such as the euro and energy policy.

If Ms Merkel is forced out early, the EU will have lost its dominant political figure. But even if she stays in office for another two years, the fragmentation of European politics, reflected in the European Council and the parliament, may hinder the EU reaching decisions on crucial matters, including the euro, migration, Brexit and policy on China.

An early test will come with the discussion over the new leaders for the European Commission, the European Central Bank and the European Council. In theory, this should be wrapped up quite quickly, with the first serious discussion taking place this week. But the confused picture emerging from the elections may lead to a protracted process that glues up the institutions.

Some issues cannot be deferred forever. By October, Britain and the EU will once again have to consider whether to extend the Brexit process, or to accept a “no deal” Brexit. The odds of “no deal” have surely risen after the polls.

French president Emmanuel Macron’s ambitious plans for eurozone reform look even less likely to make progress, given his own relatively weak performance and the current political confusion in Germany. However, events in the markets — in particular, renewed pressure on the euro — could force the EU’s hand.

The big question underlying all this is whether the EU is gradually disintegrating, or gradually progressing towards a closer union that can defend Europe’s interests. That matters increasingly in a world that would otherwise be dominated by two potentially hostile superpowers — the US and China, with Russia also playing a malevolent role.

The beginnings of a global trade war ensure that this is not an abstract question for the EU. On the contrary, European unity will be tested repeatedly by world events in the coming months and years. Political paralysis and fragmentation is a luxury the EU may not be able to afford.

Time Travel to the End of the World

By Joel Bowman

The only reason for time is so that everything doesn't happen at once.

~ Albert Einstein

We write to you today from the past, Dear Reader… and the future, too. Our former and future home city – Buenos Aires – is both a reflection of days gone, and harbinger of things to come.

Neither good, nor bad, it stands as a monument to sentiments ongoing… at once romantic, nostalgic, chaotic and terrific.

Strolling around the city… along her wide-open boulevards and cobbled stone streets… through her lush parks and leafy plazas… around her café corners and restaurant-lined alleys… we don’t see a futuristic megatropolis.

The “Paris of the South” is not a Shanghai or a Dubai. In some parts, it’s barely even a Mumbai.

There are some modern buildings, down in trendy Puerto Madero… but it’s as bland and uniform there as in any other “big smoke” capital around the world. In all the years we’ve been journeying here, we’ve probably visited the area twice.

The real charm, as you might expect, is to be found in this city’s older barrios. Recoleta… San Telmo… Palermo. There, stepping into the street is like stepping into a Borges poem or a Cortázar novel.

Imagine architecture from the ‘20s (the good), politics from the ‘50s (the bad) and haircuts from the ‘80s (the ugly). Here at the end of the world, the past holds something for everyone.

Alas, as far as abstract concepts can express a preference, time has not exactly been on Argentina’s side. 
At the turn of the 20th century, this country was among the top ten most prosperous nations on earth. Only Switzerland, Britain, Belgium and a handful of former English colonies – including the United States – were more favorably positioned, economically.

In 1913, Argentina’s bustling, cosmopolitan capital had one of the highest telephone penetration rates in the world. Her per capita income at the time was 50% higher than in Italy, almost twice that of Japan and five times greater than her northern neighbor, Brazil.

Argentina’s industry, manned by competent, entrepreneurial individuals, churned out quality textiles and barcos frigoríficos (refrigerated ships) carried her prized beef, first introduced in 1536 by the Spanish Conquistadors, from the fertile plains of las pampas to the farthest reaches of the known world.

But as the century wore on, protectionist policies at home and increased competition from the post-WWII, export-led economies abroad colluded to undermine Argentina’s international edge.

From 1900 through to the beginning of the new millennium, Argentina’s real GDP per person grew at a rate of barely 1.8% per year. Brazil outpaced her handily, growing at a 2.4% annualized rate. And Japan, starting with a real GDP per person of roughly $1,500 (2019 equivalent dollars) at the turn of the twentieth century, grew an average of 2.8% per year.

Today, Japan’s real GDP per person (at USD$40,000) is almost quadruple that of Argentina’s (USD$10,400).

Currency debasement, war, civil unrest, military rule and the usual circus of politicians, equally corrupt and inept, all conspired to stultify Argentina’s vast potential.

In many ways, if you wish to see a version of America’s (and Canada’s, Europe’s, Australia’s, etc.) future, it helps to take a walk with the ghost of Argentina’s past.

Of course, the idea of traveling back in time by heading abroad is not a new one.

In his 1928 collection, Skeptical Essays, the eccentric English polymath, Bertrand Russell, observed as much. It’s worth quoting him at length here, as his insights are at once timeless… and a product of their own time.  
Everybody knows Wells's Time Machine, which enabled its possessor to travel backwards or forwards in time, and see for himself what the past was like and what the future will be. But people do not always realize that a great deal of the advantages of Wells's device can be secured by traveling about the world at the present day.

A European who goes to New York and Chicago sees the future, the future to which Europe is likely to come if it escapes economic disaster. On the other hand, when he goes to Asia he sees the past. In India, I am told, he can see the Middle Ages; in China he can see the eighteenth century.

If George Washington were to return to earth, the country which he created would puzzle him dreadfully. He would feel a little less strange in England, still less strange in France; but he would not feel really at home until he reached China. There, for the first time in his ghostly wanderings, he would find men who still believe in ‘life, liberty, and the pursuit of happiness’, and who conceive these things more or less as Americans of the War of Independence conceived them. And I think it would not be long before he became President of the Chinese Republic.


Obviously, the world has changed plenty since Mr. Russell penned those words back in the roaring 1920s.

For starters, many of the skyscrapers of New York and Chicago today stand in the shadows of those in Guangzhou and Shenzhen. In fact, seven of the world’s tallest ten buildings are to be found in the Far East (five on the Chinese mainland; one each in Taipei and South Korea).

Over in the Middle East, the world’s tallest building, The Burj Khalifa in Dubai, is as tall as the Empire State Building and the Willis (formerly Sears) Tower… stacked on top of one another!

The Abraj Al-Bait Tower in Mecca, Saudi Arabia (3rd) and One World Trade Center, New York (6th) round out the top ten. The U.S. does not feature in the next 10 rankings.

As for politics and culture…

We’d pay good (gold) money to hear Mr. Washington’s thoughts on the state of the modern day pre-election circus. And why stop there? Who wouldn’t toss a quarter sovereign into the hat to see the rest of the Founding Fathers up on the debate stage?

What choice words might Mr. Jefferson offer to the “freshperson congressperson” from New York, rep. Alexandria Ocasio-Cortez? What advice would thrifty Mr. Franklin pay budget-busting Mr. Trump? And how about Messrs. Paine, Adams and Hamilton? Might they have a thing or two to say to the bench-warming B-Team of Beto, Bernie, Biden and Buttigieg?

More to the point, what might these “ghostly figures” think of the hulking leviathan over which today’s droopy candidates hope to take charge? And what of those quaint notions of “life, liberty and the pursuit of happiness”?

Our suspicion is that the Founders would soon be looking for Wells's Time Machine… hoping to hitch a ride to another place and another time.

Stay tuned for more tales from the end of the world…

Technically Speaking: Running On Empty

by: Lance Robert

- After four months on advances in the market, investors have once again been lured back into the belief that markets are a "one-way trip higher."

- Currently, momentum and growth stocks are substantially outperforming value-oriented stocks.

- But investors are paying an excruciatingly high premium for that performance.

- Historically, when markets have previously been this overbought combined with negative divergences in momentum, short-term outcomes have been less than optimal.

- It is where we close the week that matters. A break that is reversed by the end of the week doesn't register as a valid signal.
Running On Empty
"Running On Empty" was an iconic song about life on the road as a traveling musician. The 1977 live recording, which became a 1978 hit for Jackson Browne, is considered one of true representatives of Heartland Rock and a concert favorite.
When Jackson Browne was interviewed about the song by Rolling Stone Magazine, at the time he was recording the album "The Pretender" he said:
I was always driving around with no gas in the car. I just never bothered to fill up the tank because - how far was it anyway? Just a few blocks.
"Running on, running on empty
Running on, running blind
Running on, running into the sun
But I'm running behind"
Those lyrics are not so far and apart from where we are in the markets today.
As we discussed this past weekend, everyone is in the car driving along with no worries about how much "gas is in the tank."
"Yes, since investors did sell the December lows, they are now buying the February-March highs. But to Doug's point, investors are still heavily weighted towards equity."
More importantly, they are getting long at a time where volatility has once again become extremely low, which has historically led to negative outcomes.
"Lastly, market 'complacency' is back to levels which have denoted short-term corrections in the market previously with near record levels of short-volatility positioning."
After four months on advances in the market, investors have once again been lured back into the belief that markets are a "one-way trip higher."
As noted by the Wall Street Journal on Monday:
"Sentiment is incredibly bullish. So many people are chasing performance now." - Nancy Davis, CIO at Quadratic Capital Management.
She is right. Currently, momentum and growth stocks are substantially outperforming value-oriented stocks.
But investors are paying an excruciatingly high premium for that performance. Michael Lebowitz recently ran the analysis for our RIA PRO subscribers.
Growth Stocks vs. Value Stocks
  • Price/Sales: 8x more
  • Price/Book: 16x more
  • Price/Cash Flow: 7x more
  • Dividend Yield: 5% less yield
More importantly, our "Greed/Fear Gauge," which is based on allocation exposure, is back to historically high levels.
Investors are current extremely optimistic that even with the fuel gauge warning light glaring red, passing the "last chance" gas station won't be a problem.
Maybe, they are right.
However, historically, and as shown in the chart below, when markets have previously been this overbought combined with negative divergences in momentum, short-term outcomes have been less than optimal.
Let me clear, this does not mean the markets are about to "crash."
It simply suggests that after an incessant run higher, asset prices are likely going to correct, which will provide a better "risk/reward" entry point for investors.
But it doesn't rule out a much deeper correction either. As I noted on Friday:
"The overbought condition (top panel) is now back to where was the last time we were registering 'all-time highs.' Currently, that signal has flattened out to the point where it is dangerously close to crossing lower. Any additional weakness this week will likely trigger a sell signal."
Importantly, it is where we close the week that matters. A break that is reversed by the end of the week doesn't register as a valid signal.

I will update this chart this coming weekend and discuss the next set of actions as necessary.
Running On Hope
When you are "running on empty," it requires a lot of "hope" you can make it to the next gas, or charging, station before the engine quits running.
The same is true with the markets. The current advance is not built on improving economic or fundamental data. It is built simply on "hope."
  • Hope the economy will improve in the second half of the year.
  • Hope that earnings will improve in the second half of the year.
  • Hope that oil prices will trade higher even as supply remains elevated.
  • Hope the Fed will not raise interest rates this year.
  • Hope that global Central Banks will "keep on keepin' on."
  • Hope that the US dollar doesn't rise.
  • Hope that China will keep stimulating.
  • Hope that a "trade deal" will be concluded soon.
  • Hope that high yield credit markets remain stable
I am sure I forgot a few things, but you get the point.
"There's a whole lotta' hope goin' on round here."
However, with valuations expensive, markets overbought, volatility low, and sentiment pushing back into more extreme territory, there are a lot of things which can go wrong. While stocks above their 200-DMA have surged from their recent nadir, the negative divergence, light trading volume, and narrowness of the rally leaves a lot to be wished for.
The overriding message is that fundamentals are not driving the current rally.
Prices are are dictating policy.
The sharp decline in prices in 2018 set the Fed against the White House.
You can deny it. You can rail against it. You can call it a conspiracy. But in the "other" famous words of Bill Clinton: "What is... is."
The markets are currently betting the economy will begin to accelerate later this year. The "hope" that Central Bank actions will spark inflationary pressures and economic growth is a tall order to fill, considering it hasn't worked anywhere previously. If Central Banks are indeed able to keep asset prices inflated long enough for the fundamentals to catch up with the "fantasy," it will be a first in recorded human history.

My logic suggests that sooner rather than later somebody will yell "fire" in a very crowded theater.
When that will be is anyone's guess.
In other words, this is probably a "trap." But as I wrote previously:
"Over the next several weeks, or even months, the markets can certainly extend the current deviations from long-term mean even further. But that is the nature of every bull market peak, and bubble, throughout history as the seeming impervious advance lures the last of the stock market 'holdouts' back into the markets."
Unfortunately, for most investors, they are likely stuck at the very back of the theater.
With sentiment currently at very high levels, combined with low volatility and excess margin debt, all the ingredients necessary for a sharp market reversion are currently present.
Just to clear, I am not calling for the "end of the known universe." I am simply suggesting that remaining fully invested in the financial markets without a thorough understanding of your "risk exposure" will likely not have the desired end result you have been promised.
As I stated often, my job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered "bearish" to point out the potential "risks" that could lead to rapid capital destruction, I am unabashedly a "bear."
But I have been through three previous bear markets and lived to tell about them.
However, just to be very clear, I am still in "theater;" I am just moving much closer to the "exit." 


Nations, Wars and Liberal Democracy

By George Friedman


Having considered the origins of the United States, Australia and Hungary over the past month, it is time to return to the underlying issue of the origin of nations and other communities and the relationship of the individual to community.
In looking at these three examples, we can see that nations originate in the movement of people from one place to another. In the case of the United States and Australia, it was the movement of individuals from different origins to a place and the emergence of a national identity from fragments of other nations that led to the formation of a nation. For Hungary, it was the mass movement of a coherent and self-aware people to the place in which they finally settled that led to the establishment of a nation, even though the Magyar people existed long before the Hungarian nation was created.

All nations, at some point in their history, displace, reshape or destroy another group of people. In this process, which can take years or even centuries, nations form and reform. America is a nation built of people with European and African origins that displaced a large number of other nations. Those nations were collectively called Indians but were actually distinct peoples with unique languages and cultural memories, who also continually displaced each other prior to the arrival of Europeans.

Even in the Bible, we can see a history of displacement of nations, the creation of new nations, and the subsuming of individuals in that matrix. According to the Old Testament, a nation emerges from family. Abraham and Sarah gave rise to a distinct people that victimized and was victimized by others. The nation emerges from core biological relationships and searches for a place to settle. This process is seen as so vital to human existence that God’s relationship to humanity is mediated through the transformation of the family into a nation.

The family and nation are, therefore, intimately linked. Just as the family defines who a child is, so too it defines the nation, and the nation in turn defines the family. When Europeans came to the United States, they came as families or formed families once there, and the emergent power of the national culture was a crucible that shaped these families. There are exceptions, however. African slaves brought to the United States were denied the right to form autonomous families and, therefore, were prevented from developing an organic relationship to the nation, something that resonates centuries later.

In the family, we gain our language and culture, our friends and enemies. But it is in the larger community – the nation – that these things are defined. There are three layers in human existence: the individual, who is born of family and lives within the matrix of family and nation; the family, which creates the individual and transmits the general culture to its members; and the nation, which shapes the culture and confronts other nations to protect the family, sometimes by sacrificing individuals. And all of this occurs in the place in which the nation was created, and that place determines a great deal of the nation’s culture and its enemies.

This model poses a problem for liberal democracy – the doctrine on which the United States was founded. America has two founding principles. The first, and the most important, is the right to life, liberty and the pursuit of happiness. In elevating this principle to the cornerstone of American society, the United States turned the pursuit of happiness into the central moral project of liberal democracy. In other ideologies, sacrifice and duty to others is at the center. In liberal democracy, it is the individual that is at the heart of the nation.
The second principle is the right to national self-determination. Based on this principle, foreign interference in the right of other nations to govern themselves is viewed as immoral. But the history of humanity is full of such interference – the American Revolution itself was necessary because of the British desire to block the American nation from evolving. Thus, national self-determination is not a moral principle that has been respected or adhered to throughout history.

But this is an old story. The deeper question in liberal democracy is how the right to pursue happiness can be reconciled with an individual’s obligation to the nation. Adam Smith tried to solve the problem by arguing that the individual pursuit of wealth helps nations develop. But that pertains only to economic life. The nation emerges from the bonding together of individuals, and that process creates obligations between them. Those obligations are most extreme when a nation is at war – at such times, life, liberty and the pursuit of happiness can be curtailed in the most radical way imaginable.

That creates a moral problem for me. I believe deeply in the American project and in the right to pursue happiness. I also believe deeply in the obligation of citizens to perform their duties as citizens, even to the point of going to war. Since war is endemic to nations, there seems to be a contradiction between the two understandings of citizenship.

There’s a fundamental tension between the individual, the family and the nation. Every human being wishes to be happy. But the nation may demand an individual to sacrifice their happiness, just as a family may require parents to sacrifice their happiness. The desire for happiness would seem to make the family tenuous and the nation almost impossible to create. Yet it is there. It is an objective reality that defines human history. So either liberal democracy’s moral hierarchy is invalid, or the fundamental motivation of human beings must to be seen as more complex than liberal democracy might claim.

This is an important question for my work. The foundation of geopolitics is that place shapes the community, the community shapes the family, and the family shapes the individual. In other words, the individual is a product of powerful forces and is free only in a limited sense. Liberal democracy sees the individual as the fundamental unit of humanity and the driver of history. Both views can’t be true. Therefore, we must make one of three conclusions: liberal democracy is wrong (which would be a tragedy for me), geopolitics does not grasp reality (which I think it does), or the two can be reconciled on some subtler level.

That’s where I want to go. Let’s see if I can get there.