Turkey and the West Clash, Pleasing Russia and Iran

Ankara’s ties with the U.S. and other NATO allies are badly frayed

By Yaroslav Trofimov
Russian President Vladimir Putin, left, and Turkish President Recep Tayyip Erdogan at a September news conference.
Russian President Vladimir Putin, left, and Turkish President Recep Tayyip Erdogan at a September news conference. Photo: MIKHAIL METZEL/TASS/ZUMA PRESS 

ISTANBUL—Here’s one measure of where Turkey stands in today’s world.

Russian and Iranian citizens are free to enter the country without a visa. Americans, following the recent spat over the detention of a U.S. consulate employee, are essentially barred from traveling to their fellow North Atlantic Treaty Organization ally.

The unfolding breakup between Turkey and the U.S. goes far beyond that dispute. It is fueled by increasing frustration on both sides—and is encouraged by countries most interested in such a separation, especially Russia and Iran. Even in the Syrian war, Turkey now has found itself in a new convergence of aims with Moscow and Tehran—and opposing American goals.

“This is the worst it’s been since the independence of the Turkish republic,” in 1923, said Asli Aydintasbas, an Istanbul-based fellow at the European Council on Foreign Relations. “The institutional bond [with the U.S.] is really weakening and the distrust is spilling into business ties, into investment decisions, and even into the NATO framework.”

The freeze isn’t just between Washington and Ankara: Turkey’s relations with key European nations, most notably Germany, have frayed just as badly.

Turkey’s traditional alliance with the U.S. already came under strain during President Barack Obama’s administration. At the time, the U.S. chafed at Turkish President Recep Tayyip Erdogan’s systematic assault on democratic freedoms and civil rights. Turkey, meanwhile, viewed as an existential threat America’s support for Kurdish militias that combat Islamic State in northern Syria.

Following a failed military coup against Mr. Erdogan last year, many senior Turkish officials have also concluded that elements of the U.S. establishment were sympathetic to the plotters’ aims or even actively colluding with the putsch, a claim firmly denied by Washington.

Mr. Erdogan, however, entertained high hopes for a reset under President Donald Trump, who refused to criticize Turkey’s deteriorating human-rights record. These expectations seemed to be validated as recently as Sept. 21, when Mr. Trump proclaimed at a meeting in New York that Turkey and the U.S. are “as close as we have ever been” and Mr. Erdogan reciprocated by praising “my dear friend Donald.”

President Donald Trump shook hands with Turkish President Recep Tayyip Erdogan in New York in September.
President Donald Trump shook hands with Turkish President Recep Tayyip Erdogan in New York in September. Photo: SHEELAH CRAIGHEAD/PLANET PIX/ZUMA PRESS

Such optimism, however, belied the accumulating poison in the relationship. In Syria, instead of reversing course as Ankara had expected, the Trump administration essentially doubled down on the Obama policy of arming and backing the YPG Kurdish militia that Turkey considers a front for the Kurdistan Workers’ Party, or PKK, a group that seeks to carve out a Kurdish state in southeastern Turkey and that is considered terrorist by Washington and Ankara alike.

Ankara was also upset with the detention of Reza Zarrab, a Turkish-Iranian businessman with ties to Mr. Erdogan who has been charged in New York with violating sanctions against Iran, and with the continuing presence in Pennsylvania of Fethullah Gulen, the Islamist preacher whom Turkey wants extradited for allegedly masterminding last year’s coup attempt. Both men have denied wrongdoing.

American officials, meanwhile, were frustrated by the yearlong detention of Andrew Brunson, an American Christian pastor whom Turkish officials have accused of links to the coup. Mr. Brunson has denied the charges. The U.S. officials were particularly horrified by recent Turkish suggestions of swapping Mr. Brunson for Mr. Gulen or Mr. Zarrab.

All of this, combined with uproar over the allegedly violent behavior of Mr. Erdogan’s bodyguards during his visit to Washington in May, has cemented a growing perception inside the administration—and Congress—that attempts to mollify Turkey have become increasingly pointless.

“Ankara has few, if any, friends in Washington now,” said Steven Cook, a Turkey expert at the Council on Foreign Relations in Washington.

The detention of the U.S. consulate employee helped ignite the latest conflagration.

“The arrest has raised questions about whether the goal of some officials is to disrupt the longstanding cooperation between Turkey and the United States,” said the U.S. ambassador to Ankara, John Bass. The tit-for-tat visa issuance suspension means that only a small number of Americans with pre-existing Turkish visas can enter the country. U.S. citizens were until now able to get Turkish visas on arrival.

Ever since last year’s coup attempt, Turkish officials favorable to continuing cooperation with the West have been warning about the rise of the ultranationalist “Eurasianist” faction, particularly inside Turkey’s security and military establishment. This current, expounded by its main ideologue Dogu Perincek, a Turkish politician, seeks to reposition Turkey into a new “Eurasian” civilizational alliance with Russia, China and Iran—and to break off traditional bonds with West.

That breakoff intensified as Mr. Erdogan declared that the U.S. consulate in Istanbul was “infiltrated by spies,” and, in a fiery speech Thursday, warned the U.S. that if America doesn’t respect Turkey, “then we don’t need you.”

In a separate case this week, a Turkish court declared a Wall Street Journal reporter guilty of engaging in terrorist propaganda through one of her Journal articles. The Journal condemned the move and the reporter plans to appeal the decision.

“This was an unfounded criminal charge and wildly inappropriate conviction that wrongly singled out a balanced Wall Street Journal report,” said Wall Street Journal Editor in Chief Gerard Baker. “The sole purpose of the article was to provide objective and independent reporting on events in Turkey, and it succeeded.”

It is hard to see what avenues still exist for defusing the tensions between Washington and Ankara. The fates of Mr. Zarrab and Mr. Gulen are “judicial issues the U.S. government has no say in,” said James Jeffrey, a former American ambassador in Turkey. “President Erdogan’s advisers are misleading him if they think otherwise.”

Things are likely to get even worse in the foreseeable future, added Sinan Ulgen, head of the Edam think tank in Istanbul and a former Turkish diplomat. “There is no clear path to de-escalation,” he cautioned, “and therefore we will likely find ourselves on the path to escalation.”

The Global Stock Market’s Hidden Juice

Rising margin lending from Swiss and U.S. wealth managers can make a downturn far more painful

By Paul J. Davies

Loans secured against marketable securities

One common sign of trouble ahead is people borrowing heavily to buy equities.

Investors should be worried then that stocks are being supported by record amounts of margin debt, according to research released last week from the Bank for International Settlements, the Switzerland-based central bank for central banks.

These kinds of loans secured against stocks have often proved dangerous in a downturn because when share prices fall borrowers are forced to sell.

In the U.S., margin debt is more than three-times the level ahead of the 2008 crisis and is greater even than its peak in 2000 before the dot-com crash, according to the B.I.S.

However, lending volume alone isn’t a clear indicator of risk because equity values have increased, too. In the U.S. at least, lending as a share of market capitalization has been relatively steady for the past four years, most recently at 2.12%. But that level is much higher than the period before 2007 and above even the dotcom-era peak of 2.05%.

Swiss private banks, which have among the biggest and most international margin lending operations, have grown this business significantly. Credit Suisse has doubled its volume since 2006 to about $42 billion, while Julius Baer’s has grown by five-times to $24 billion, although it got a big boost from its takeover of Bank of America-Merrill Lynch’s international wealth business in 2013.

UBS with about $92 billion, has also seen strong growth, but an accounting change in 2012 makes it hard to say exactly how strong.

While overall growth appears to have slowed, that is partly due to a decline among Asian investors in 2015 and 2016, which is masking continued strength elsewhere.

Total in U.S. stocks trading accounts, a negative number means they are in debt (2000-2017)

The Chinese market crash in 2015 shattered investor confidence across Asia, according to bankers. But while Asian lending went backward, U.S. loans continued to grow, including at Morgan Stanley , Bank of America Merrill Lynch and UBS’s American wealth arm.

Rich clients’ desire to borrow against stocks has been stoked by the low interest rates and rising stock markets. It is attractive for banks, too. Lending against shares is seen as less risky than mortgages because stocks can be sold more quickly than a house, so banks can hold less capital against margin loans. Also, if the borrowed money is invested with the bank, rather than spent on yachts or cars, that boosts assets under management.

Margin lending at the New York Sock Excahnge as a share of market capitalization (1992-2017)

The banks themselves all say that while lending looks high, their own approach is conservative and the general competition for clients is less aggressive than in the past. But neither the banks nor their investors have a full view of leverage across the system and the risk that may pose.

Equities have to fall 20% to 30% before margin loans are underwater. That protects the banks, but doesn’t stop a wave of selling to repay debt when a downturn comes. That could spell real pain for everyone else.

Time spent thinking about the next financial crisis is not wasted

Crises have increased in frequency, but do not flee risky assets

by John Authers

The generation that now includes key decision-makers in finance and investment has experienced several huge financial bubbles © iStock

We are all prisoners of our own experience. For me and the people of my generation who now tend to make the key decisions in finance and investment, our experience has included several huge financial bubbles and crises in the western world, and an unprecedented range of crises in the emerging world.

Does that mean that we spend too much time thinking about potential future crises?

The markets research team at Deutsche, led by Jim Reid, think not. This week they produced the latest edition of their annual long-term assets survey, and devoted almost all of it to “The Next Financial Crisis”.

It is an enormous and excellent piece of research, from which I will try to gloss the most interesting points. First, the era we live in does indeed have more financial crises than those that went before. This is true globally, demonstrated with a welter of statistics, and there is a clear point at which the crises began to accumulate — August 1971, when President Richard Nixon brought the Bretton Woods agreement to an end, ending the tie of the dollar, and ultimately most other currencies, to the price of gold.

Before this point, gold had in real terms lost an average of 1.5 per cent each year since 1900.

Since the end of Bretton Woods, it has averaged a return of 3.7 per cent. The equivalent figures for US equities are 6.4 and 6.2 per cent.

Meanwhile, the authors hold that the move to currencies backed by governmental fiat rather than the supply of gold being extracted from the ground has enabled a build-up of debt without parallel. Their global estimate for the total amount of stimulus in the decade since the crisis, which combines extra money printed plus widening of government budget deficits, is $34tn.

Leaving the straitjacket of the gold standard (and they do not advocate a return), has at least given governments the option to deal with a crisis by injecting new money, and they have taken it.

In a system that has grown prone to crises, and with unprecedented debt, that is enjoying its longest lull in two decades, the chances of a future crisis are overwhelming. I cannot dispute this argument.

But perhaps the most alarming part of Deutsche’s study is the sheer range of possible triggers for the next crisis that they mention. It could be driven by; an economic recession (which would find governments out of bullets and asset prices exposed); a central bank unwind, as attempts to retreat from extreme stimulus (which the Federal Reserve will start in a very gentle way next month) push up rates and trigger a collapse; deflation, which would bring more monetary stimulus and more negative rates, and finally force a banking collapse; stretched asset prices, in which obviously overpriced equities and bonds would at last begin to collapse under their own implausibility; or a lack of financial market liquidity, as trading has steadily evaporated particularly in corporate bonds, allowing relatively minor sales to magnify into a catastrophic fall.

If you want more specific trigger points, Mr Reid and his team mention Italy (a big and heavily indebted economy with a stricken banking system and an unpredictable election upcoming); China, which still has deep financial imbalances with the west, and where the rate of debt growth post-crisis appears unsustainable; Japan, which has been in a demographically driven slump for decades, but where the Bank of Japan’s huge balance sheet now adds a greater dimension of risk; and Brexit, which could endanger the financial and defence architecture of Europe. Then there is the risk of populism everywhere. Take your pick.

What conclusions should investors draw from this?

The first point, I think, is that the sheer range of disaster scenarios shows that the experts at Deutsche simply do not know what will happen next. Several of their scenarios are mutually contradictory. They have shown that the status quo cannot be sustained indefinitely; they have not shown how long it will last or how it will end. They are not alone; there is a lack of historical precedent. We should all work on the assumption that we do not know what will happen next.

On that basis, it would be an unacceptable risk to get out of risky assets altogether. Putting all your money in cash, if you need your nest egg to grow, is in some ways as risky as putting it all in stocks. You could miss out on that one great spurt of growth in the stock market that would have enabled you to fund your pension, pay for your kids’ university education, or whatever.

And as the risks spread from Italy to China with many points in between, it would be wise to stay diversified.

Second, however, Deutsche have made clear that a crisis is coming, and therefore it is imperative to prepare for it. That might mean gold and precious metals — but they can be hard to trade in some circumstances and would do badly under deflation.

The wisest course is to carry rather more cash than you usually would. Cash itself could be endangered in some Armageddon scenarios. And if the equity rally continues a while longer, which it well might, it means reducing your gains — although you will still have gains.

But the point is that it gives you optionality. It is easy and costless to get out of it and move into something else in a hurry once the shape of the crisis begins to grow clear. Best to be prepared.

The Blockchain Is the Internet of Money

Silicon Valley visionary Balaji Srinivasan explains how bitcoin works and why he regards it as revolutionary.

By Tunku Varadarajan

Balaji Srinivasan’s distrust of authority began as early as first grade, when boys less cerebral than he was would beat him up at recess for reading a book. “Literally, like, ‘Oh, look at that nerd,’ and they’d go attack you.” That was in 1986, in Plainview, N.Y., an undistinguished Long Island hamlet where his parents, immigrants from South India, worked as physicians.

“Being the only brown kid among hundreds of people, lots of kids would gang up on you and call you ‘ Gandhi, ’ and you could say, ‘It’s not an insult,’ and run, but they’d just chase you.”

Mr. Srinivasan is now 37 and an eye-catching innovator in the world of digital currency. “I learned that the first guy who comes at me, I need to hit him—Bam!—with the book, and just act crazy so the other folks don’t jump on you.” Later, at the principal’s office, the assailants would have “crocodile tears” about how the little Indian boy had started the fight. “Their parents knew the principal,” Mr. Srinivasan recalls. “He’d say, ‘Balaji, why did you attack young Jimmy and Jamie?’ So, I learned early on that you’ve got to stand up for yourself, that the fix is in. . . . The state is against you.”

That experience informs his current work. Mr. Srinivasan has called the stateless digital currency bitcoin “the most important technology of the decade.” I ask him to explain why, and he says, in fact, that he’s amped up the description. “I’d update that today,” he tells me, “to say that the blockchain—which is not just bitcoin—is the most important invention since the internet.” My eyes widen, and he says: “Yep. I’m not sure if that’s consensus among Silicon Valley now, but it’s getting there.” The “blockchain,” he will explain, is like the internet of money—with similar decentralizing and liberating potential.

Mr. Srinivasan, who describes his school years as “completely wasted,” founded his current company, 21.co, in 2013 with $115 million in seed money from Silicon Valley’s leading venture capitalists. Plainview is now, mercifully, out of sight. “Life in the United States starts with a 13-year mandatory minimum K-12.” Mr. Srinivasan calls it the “school-ag archipelago,” an awkward pun on the Solzhenitsyn tome about Soviet prison camps. He has a 1-year-old son, whom he will not send to school. Instead he plans to band together with like-minded parents from the tech world and “crowd-fund a tutor.”

With his ill-fitting sweatshirt and sweetly inexpert haircut, Mr. Srinivasan doesn’t look much older than a schoolboy. One would be inclined to think of him as a typically arrogant tech-meister were he not so earnest and amiable. In 2006, immediately after earning a doctorate in electrical engineering at Stanford, he co-founded a genetic testing company, which was “conceived in a dorm room.” He was on President Trump’s shortlist to lead the Food and Drug Administration before ruling himself out for the job, and he has courted controversy by calling for Silicon Valley to “exit” from as much government control as possible. He has, in the past, invoked the notion of the “inverse Amish,” a society that “lives nearby, peacefully, in the future,” where “we can experiment with new technologies without causing undue disruption to others.”

Some of Mr. Srinivasan’s views were distorted in news reports, with the now-defunct Gawker describing him as a “secessionist” (and, for good measure, as “bats— insane”). With evident distaste, he describes the Gawker story as “fake news, avant la lettre,” and notes: “Last I heard, they’d been sued into bankruptcy by profiting from revenge porn. Bitcoin is at $4,000, and Gawker is dead.”

Mr. Srinivasan’s present company enables people to be paid in digital currency for replying to emails. It cost me $20 to reach him, payable upon his response, which was almost instant. We met for lunch at his office earlier this week.

“Initially, and in the near future, 21.co is like a better version of LinkedIn InMail,” Mr. Srinivasan says. “Senders attach digital currency to messages to pay people they don’t know to reply.” That’s better than LinkedIn, he suggests, “because users are actually paid to reply, senders can mass-message people, and they can send complex surveys to people rather than just simple emails.” The ultimate goal is to facilitate paid work: “Anywhere there’s a phone, there’s a job. You just pick up a phone and whatever your skills, people will send you digital-currency-based jobs. You can click buttons and make money anywhere in the world.”

When I ask him to explain the “blockchain,” Mr. Srinivasan starts to roll with relish. “Short version? Bitcoin is a way to have programmable scarcity. The blockchain is the data structure that records the transfer of scarce objects.” I ask him to regard me as a dummy, and to give me the longer version.

We can understand bitcoin and blockchain in four steps, he says. “One, cash. When A gives a dollar bill to B, he’s transferring a physical object. B has it, and A no longer does. There’s implicit scarcity in the physical world.”

Step 2 supposes that we treat the serial numbers on those Federal Reserve bills as “a form of naive digital cash. Then A emails those numbers to B. Now B has a copy. But A still has a copy!” So if those serial numbers were treated as cash, A can “double-spend” the numbers by sending them to another party, C. This, Mr. Srinivasan says, is the fundamental issue with digital cash: “the double-spend problem. How do we introduce scarcity into the digital system?”

The way we resolved this problem before bitcoin, Mr. Srinivasan explains in his third step, “was through the use of centralized institutions called banks. Whenever you use PayPal or a similar technology to send money from A to B digitally, the bank is trusted to debit A and credit B.” This, he says, is how “scarcity” is introduced into a digital system; but it is “inelegant, from a computer-science perspective, to have a central, trusted node in any networking topology”—a word my dictionary defines, in this context, as being the way in which constituent parts are interrelated or arranged.

Mr. Srinivasan doesn’t care for this arrangement: “There are downsides to implicitly trusting banks, as the 2008 financial crisis showed.” So rather than require a bank to approve transactions, “Bitcoin figured out how to split this power across many different transaction approvers, called ‘miners.’ ” They “compete to approve transactions and integrate them into the so-called blockchain. Every time they integrate a new block of transactions into the blockchain, they receive a ‘block reward’ and are entitled to print digital currency.” The key point, he says, is that any computer could, in theory, approve transactions, and no single computer could block transactions.

Mr. Srinivasan concedes it’s “a big claim” to say the blockchain is the most consequential technology since the internet. “The internet is programmable information. The blockchain is programmable scarcity.” He elaborates: “All of these previously disparate things—from physical mail to television to music to movies to telephony—basically got turned into packets of information and got remixed by the internet. Plus things that we normally didn’t even think of as information—your Fitbit , your steps, your Facebook settings—became programmable.” It’s fair to say, he continues, “that the internet and all things downstream—search engines, social networks, ride sharing, and so on—have basically been the technological story of the last 25 years.”

The blockchain is the next phase, Mr. Srinivasan says with some zest. “With the blockchain, everything that was scarce now becomes programmable. That means cash, commodities, currencies, stocks, bonds—everything in finance is going to be transformed, and aspects of finance baked into everything else.” By way of example, Mr. Srinivasan suggests that there could be “a spot market for the cost of storing one megabyte on 1,000 remote computers.” He then offers a slogan for the new age: “If you deal with information, you need the internet. If you deal with money, you need to deal with blockchains.” Pretty much everyone, he adds, deals with information and money.

The blockchain, Mr. Srinivasan continues, “is a religion that works.” Here’s why: “If you take 10,000 people and put them in a circle and they close their eyes hard and say, ‘Let this plane fly,’ it’s not going to fly. But if they close their eyes hard and say, ‘Let this thing have value,’ and they all value it, they’ve suddenly got a price for it.” They will exchange things of economic value among themselves, and the external world can interact with them. “In the same way that once you’ve got enough people, you’ve got a nation, you’ve also got a currency. So, belief is actually something you can now materialize into currency.”

I steer our conversation, here, toward China, where the government has cracked down hard on digital currencies, banning citizens from exchanging them online. Is this the first major blockchain crisis? Mr. Srinivasan ponders the question before noting that “the Chinese government is actually run by engineers. Hu Jintao was an engineer, as is Xi Jinping. One of the things they do in China is that they actually give seats in government to folks who are successful in technology.”

He tells me—“not necessarily in an admiring way”—that there are “probably not many people in the U.S. government who could explain to you exactly what a ‘firewall’ is, but that’s a fundamental instrument of policy in China.” Chinese politicians, he says, are more conversant with the long-term implications of information technology than their American counterparts.

But what does China’s crackdown on bitcoin mean? Mr. Srinivasan believes that Beijing is doing something similar to what it did when it deployed the so-called Great Firewall in the early 2000s. “It wanted the internet, but it wanted a controlled internet.” It now has a vigorous and competitive Internet economy, with Alibaba, Tencent and Baidu, “but it also takes measures that Western societies would not, in terms of explicit internet censorship.”

If the Chinese government wants the benefits of the blockchain “without the decentralization of bitcoin,” Mr. Srinivasan says, “we might see a ‘Great Blockchain of China’—perhaps a ‘Chinacoin’ issued by the People’s Bank of China.” It may seem too early for “something of that magnitude” to happen, Mr. Srinivasan says, “but sometimes the future happens more quickly than we expect.” An interesting question, he adds, “is whether this ‘Chinacoin’ would just be directly pegged to the renminbi, as seems most likely, or whether it would be freely floating like bitcoin.”

A more plausible short-term alternative, in Mr. Srinivasan’s view, may be that “the Chinese government asserts its jurisdiction over the Chinese miners who provide most of the world-wide mining capacity of bitcoin and Ethereum,” the latter an open-source blockchain-based platform. Mr. Srinivasan imagines a “cat-and-mouse game would likely ensue, after which the Chinese government would gain control of a fork of bitcoin and Ethereum chains, but the rest of the world would fork to different versions of those chains.” The Chinese government could even attempt a hostile takeover of bitcoin.

Mr. Srinivasan is confident, however, that the protocols that sustain a decentralized, global digital currency will weather a crisis of this sort. “This is the kind of test these protocols were built for. If they survive, which I think they will, then we’ve proven something amazing.” We’ll have proven, he says with a smile, “that there’s now a new kind of digital asset which even a very technically competent and motivated government cannot seize.”

Mr. Varadarajan is a fellow in journalism at Stanford University’s Hoover Institution.

Up and Down Wall Street

Dow 1,000,000

Warren Buffett predicts that the benchmark will hit that number by 2117. That’s a modest goal, but one that could be difficult to reach.     

By Randall W. Forsyth 

Jemal Countess/Getty Images for Time Inc.
“It’s tough to make predictions, especially about the future,” Yogi Berra supposedly said, as he channeled Niels Bohr, the atomic scientist.

Not so for David Meade, a so-called Christian numerologist who has been predicting that the apocalypse will arrive on Sept. 23, which, if correct, would mean you’re probably not reading this. He based this prediction on prophesies he gleaned from the New Testament, but like any good forecaster, he revised it late last week. “The world is not ending, but the world as we know it is ending,” he said to the Washington Post.

Either way, Meade evidently skipped over the admonition in Matthew’s Gospel, that “you do not know the day or the hour.”

At the other extreme, Berkshire Hathaway’s Warren Buffett offered a far happier forecast last week: The Dow Jones Industrial Average will reach 1,000,000 in a century. Yes, 1,000,000, with six zeros, a seemingly incomprehensible feat, relative to Friday’s close of 22,349.59.

Yet the Sage of Omaha actually was proving Einstein’s purported observation that “compound interest is the eighth wonder of the world.” To reach 1,000,000, the Dow would have to increase at a compound annual rate of just 3.87% for the next century. That moved longtime Barron’s Roundtable sage Mario Gabelli to quip in a tweet, “Has Buffett turned bearish?” In actuality, over the past 100 years, the Dow’s compound annual growth was 5.5%, boosting the index from 95 at the end of 1916 to 20,069 this past January.

That doesn’t take into account the effect of inflation, however. With inflation averaging 3.1%, the Dow’s real compounded annual growth rate was 2.3%, according to the R Street Institute, a free-market think tank.

Inflation over that span meant that at the end of 2016, it took $2,116 to buy what $100 did in 1916, based on Bureau of Labor Statistics data. (As a frame of reference, 1916 was two years after the Federal Reserve began operations.)

Although Buffett’s prediction represents a relatively modest goal for 2117, given the magical math of compounding, the mention of such big, round numbers for the Dow echoes hubristic forecasts that tend to appear around market tops. The most notorious was the book Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market, published in 1999, just before the dot-com bubble burst.

The Dow was supposed to hit that vaunted 36,000 level by 2004. Moreover, the authors asserted, equities were no riskier than riskless government securities, and therefore shouldn’t have any risk premium (that is, the required return over the risk-free interest rate), even though Treasury securities, unlike stocks, come with a money-back guarantee, at maturity, at any rate. Well, we know how that turned out. From a peak of 11,722.98 in January 2000, the Dow plunged to 7286.27 by October 2002, and wouldn’t top the previous high until October 2006.

Buffett’s mathematically modest expectation of a 3.87% compounded annual rate of return is more defensible. Assuming no expansion of the price/earnings ratio—now approximately 18 times expected earnings on the Standard & Poor’s 500 index—stocks should track the increase in corporate profits. That, in turn, should parallel the growth in the U.S. economy.

Assuming 2% inflation, the Fed’s as-yet-unattained target, that means roughly 2% real growth is needed to produce 4% nominal growth. Real growth consists of labor-force increases multiplied by gains in productivity. On the former, the fertility rate in the U.S. has slid below the replacement rate (2.1 children per woman over her lifetime), which limits the size of the labor force without immigration. As for productivity, it remains sluggish, growing at just 0.6% annually since 2011.

Economist Robert Gordon has been a prominent dissenter in projecting the prosperous past of the U.S. into the future. He foresees productivity growth of 1.3%, well below the 2% achieved from 1891 to 2007. In his much-discussed 2012 paper, he concluded that the information-technology revolution of the internet and mobile phones hasn’t brought gains similar to those of the “second industrial revolution” (electricity, the internal-combustion engine, running water and indoor plumbing, communications, entertainment, petroleum and chemicals), which generated robust 20th century economic growth.

In a 2014 follow-up, Gordon added that the U.S. economy faces four headwinds: demographics (baby boomers retiring, plus lower labor-force participation by people of working age); plateauing of educational attainment; growing income inequality; and increasing debt, which will force higher taxes or reduced transfer payments in the future.

In terms of demographics and debt, Japan offers an example. The Nikkei 225 peaked at the end of 1989 at just shy of 39,000, almost twice Friday’s close of 20,296.45. In the 1980s, many predicted that Japan would rule the global economy, just as many expect of China. On the latter score, S&P lowered its rating on China’s sovereign debt last week to single-A-plus from double-A-minus, owing to too-rapid credit growth.

Buffett suggested that it is foolish ever to bet against America. He, along with most Barron’s readers, has been lucky to live through a golden age for the U.S. economy. Perhaps the future will be like the past. Maybe it will be better, maybe it won’t.

Attainment of a 4% nominal growth rate for the U.S. economy, implied by his Dow 1,000,000 prediction, may seem like a modest goal, but we’re falling short of it currently.

Godot has finally arrived. The Federal Open Market Committee last week announced that the long-anticipated shrinkage of the central bank’s $4.5 trillion balance sheet will begin in October.

To review the mechanics of monetary policy, when the central bank purchases securities, it pays for them with money created out of thin air, which then goes into the private economy.
Conversely, when the central bank sells or redeems those securities, the real cash it receives is withdrawn from the economy. So, as the Fed allows its Treasuries and agency mortgage-backed securities to mature, Uncle Sam and his niece, Fannie Mae, and nephew, Freddie Mac, will have to replace those funds in private markets. Some of the $2.2 trillion of excess reserves sloshing around the banking system will probably be taken up in the process, which will still leave a surfeit for some time.

This, however, fails to capture the reality of a world in which money crosses borders freely in search of the highest returns. The Fed isn’t the dominant player around the globe by a long shot, notes Mark Grant, chief strategist of Hilltop Securities. Citing data from Yardeni Research, Grant points out that the People’s Bank of China has the Fed beat with $5.2 trillion in assets, followed by the European Central Bank with $5.1 trillion and the Bank of Japan with $4.7 trillion. The money created by the Fed is no different than that from the Swiss National Bank, the ECB, or the BOJ, Grant observes. And that foreign money heads to American shores for higher returns than its home markets’ sub-1%, or even negative, yields.

Similarly, JPMorgan economist Nikolaos Panigirtzoglou writes, the shrinkage of the Fed’s balance sheet will be offset by the central banks of the other G4 countries. JPMorgan estimates that the Fed will shrink its balance sheet by about a third, to $3 trillion, by 2021. But that will be mitigated by estimated ECB monthly purchases of 40 billion euros ($47.8 billion) of bonds in the first half of 2018, €20 billion in the second half, and no more after that. The BOJ is also projected to buy 60 trillion yen ($535.77 billion) a year.

“The Fed’s cutback is about $300 billion a year, while the other central banks are pumping in $300 billion a month,” as Hilltop’s Grant points out. “The money will go somewhere and, given that American yields are so much higher than those in Japan or Europe, a lot of it will find its way here.”

Jesse Fogarty, who manages U.S. investment-grade corporate debt for Insight Investment, a unit of BNY Mellon Investment Management, remarks that there has been a persistently strong bid for U.S. corporate bonds from global buyers—especially since the ECB began buying European corporates.

Fed Chair Janet Yellen insists that running down the central bank’s balance sheet from its crisis levels should be as uneventful as watching paint dry. While its counterparts abroad continue to expand their assets, the impact of the Fed’s shrinkage should be limited. Yellen also says that the Fed’s main policy tool will remain the federal-funds rate, which the FOMC indicated is on course for another quarter-point hike in December, from the current 1% to 1.25% target range.

In addition, the FOMC has penciled in three more hikes for 2018, based on its so-called dot plots. Less certain is who will be making those calls next year, given that Yellen’s term as chair will be up. In addition, until the Senate confirms Randal Quarles’ nomination, there will be four other vacancies on the seven-member Board of Governors after Vice Chairman Stanley Fischer retires next month.

Perhaps the most important fact to emerge from last week’s FOMC meeting is that the panel further lowered its estimate of the long-term “neutral” federal-funds rate by a quarter-point, to 2.75%. Put together with the dampening effect from foreign central banks on the Fed’s balance-sheet reduction, that points to bond yields remaining lower for longer, which is consistent with a low-growth U.S. economy.