Revolutionary Future Ahead

By John Mauldin

Back in 1936, in Esquire magazine of all places, F. Scott Fitzgerald wrote something profound. “The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.”

As someone privileged to have met some of the world’s greatest thinkers, I know what first-rate intelligence looks like. I am not in their league, but I think I’m pretty good at holding opposing ideas. It’s why I’m often called the “muddle-through guy.” When I consider contradictory scenarios, I figure reality will be somewhere in between. That’s right more often than you might suspect.

So, let’s consider two seemingly conflicting ideas.

1.   Major economic pain is coming.

2.   We have a bright, prosperous economic future.

Can both of those be right? I think so.

I explained last week in The Good News Economy how the current recovery should continue for a couple more years. Beyond that lies the Great Reset, featuring the “major economic pain” part. But beyond that is something much better… a time unprecedented in human history, when life will improve in ways we can barely imagine right now.

We’ll have a better chance to get through the Great Reset with assets and sanity intact if we remember the good things waiting for us on the other side and take advantage of them as soon as possible. Today we’ll talk about some of the technology and biotechnology developments that I believe will drive economic growth in the next decade or two. Full disclosure: This is a very short version of my forthcoming book, The Age of Transformation.

Our various gadgets become so integral to daily life that we can forget what life was like without them. I’ve said this before, but it bears repeating: No one on Earth had a smartphone until 2007. That first iPhone, revolutionary at the time, was primitive compared to even today’s low-end models.

Now, can you imagine living without your iPhone or Galaxy or whatever you have? The answer for most of us is probably not. Some Luddites don’t like being online, and to each his own. I like my tech. But that just illustrates how fast the world can change. One invention, in one decade, radically altered both daily life and the global economy. Not without some downside, but I think mostly for the better.

Think about it from the other direction. In 2007, could you have imagined those little devices would have the staggering impact we now see as perfectly normal? Again, probably not. Many imagined the opposite: “Why do I want the internet in my pocket?” Guess what: Almost everyone who said that now has the internet in their pocket and would not dream of living without it. Certainly not if you are a Millennial.

In the next decade, we’ll see multiple inventions bring similar and, I believe, even greater changes. The details won’t be immediately obvious, but the changes will come. By 2030, they will be as ho-hum to us as smartphones are today.

It may not even take that long. The pace of technological change is accelerating, as is the speed at which new inventions propagate around the world. Intangible software and information can spread at lightspeed, while 3-D printing will let manufacturing capacity grow faster and more widely than we’ve ever seen before.

In sum, the kind of change, magnitude of change, and rate of change will all likely speed up considerably in the coming years. It will be a roller-coaster ride. Now let’s look at some of the twists and turns it will bring us.

Back in the late 1700s, maybe a dozen people understood the steam engine, mostly dilettantes doing it for fun. James Watt understood the business implications and eventually built a steam engine that could do the work of four horses pumping water out of a coal mine.

John Wilkinson—who developed a machine to make a true bore so cannons could shoot longer and further—decided to use steam engines to power his fires. He took the engine apart, saw that the “bore” of the engine was not true and redid it. Voilà, a 16-horsepower engine. Then dozens and eventually hundreds of engineers and tinkerers improved performance further.

Fast forward to today. Today we routinely throw hundreds of scientists and engineers at much simpler problems. But it is going to accelerate even more.

Google and Facebook are in a race to make wireless internet available to every part of the earth. Google will use what is known as high balloons and Facebook is working on solar drones. Google is already supposedly circumnavigated the globe at one meridian in the southern hemisphere. Both technologies are viable, it will simply be a matter of which is the less expensive and more workable.

In the not-too-distant future, and certainly by 2025, wireless voice and data networks will be available to every human on the earth.

By the middle of the next decade, Wi-Fi will be essentially free or at negligible cost. Seriously. That means three billion more people will be connected to the internet. If 0.0001 percent of those three billion people (or merely 30,000) create a major new technology or business idea, that will accelerate the pace of change and make life better for all of us. Give them access to the internet and artificial intelligence expert systems, and stand back and watch what happens as individual humans try to improve their own lives.

Demographic challenges lie behind many of our economic problems, and the #1 demographic challenge is aging. Specifically, too many of us aging at the same time and not doing it very well. The resulting health problems both cost money to treat and may remove us from the workforce when we could otherwise stay happily productive.

This is going to change for the better. I don’t mean simply longer lifespans, though I think that will happen, too. Adding more years is not necessarily a blessing if they simply extend your pain and make you a burden to others. Much better to have a long, healthy life, and then decline quickly when it naturally ends.

That is exactly where biotechnology is taking us. My friend Patrick Cox writes about this extensively. He believes, as do many top scientists we both know, that we are only a few years away from treatments that can not only slow the aging process to a crawl, but in some quite profound ways, actually reverse it. We already see it in animal studies. Elderly mice exposed to these new treatments regrow their hair, gain muscle mass, see and hear better, and even regain their sexual vigor. Maybe not the mythical fountain of youth, but at least a fountain of middle-age. And let me tell you from where I stand, about one month shy of 69, middle-age sounds really good right now.

Obviously, humans are not mice and the research is ongoing. In fact, it is accelerating because the Japanese government (which not coincidentally faces major demographic headaches) is removing many of the bureaucratic hurdles that slow down progress. Some treatments could be available there as soon as two or three years from now.

If it works in Japan, other countries will follow quickly because it will be in their own financial self-interest. Taking care of an aging, unhealthy population is expensive. Think of all the time, money, and attention that goes to health care. In the US, it’s about 18% of GDP—the majority of which is spent on elderly people. If we can not only get them healthier but actually make them younger, some of that money can find better uses.

Then there is the astonishing progress being made against our most challenging medical foes: cancer, heart disease, diabetes, and assorted other killers. Big data and AI systems are quickly decoding the genetics behind some of them, leading to better detection and treatment. I truly believe we will have eliminated most cancers by 2030, or at least turned them into minor, easily treated conditions. Imagine the productivity boost from having all those patients stay alive and working. (Again, full disclosure: I’m invested in a company that is in phase 2 of a “silver bullet” cancer cure. If we are successful, and it is still if, the treatment will not require hospitalization and seems to have minimal side effects. I now think the biggest risk to my investment is not that our drug does not work, but that other drugs will be cheaper, better, and faster.) You can’t believe how much progress there is being made in this area.

As with HIV, cancer may soon become a chronic condition treated with a cocktail of drugs rather than just one therapy. There are so many possible scenarios, it’s almost impossible to describe what the path will look like over the next 10 to 15 years. But barring stupid governments, by 2030, cancer will be a nuisance and not a death sentence, and certainly not something that will take massive national expenditures.

At the end of last week’s letter, I mentioned the billionaires’ space race. Paul Allen, Jeff Bezos, Richard Branson, and Elon Musk all want to send satellites and/or people into orbit and eventually beyond. Unlike the 1960’s US-Soviet space race, this one has unashamedly commercial motives.

These men are so wealthy, in part because they can recognize opportunities and what it takes to seize them. Reaching space at a reasonable cost is the first step, so that’s the first order of business. They have different ideas on how to do it. Time will tell what works best… and competition between them will probably work better and faster than waiting for the government to do it.

The first goal is to put more satellites in orbit. We forget that our smartphone location features depend on the satellite-based Global Positioning System. And of course, satellites take the pictures you see on your phone’s mapping app. All that works well, but more satellites will make it even better.

My friend Peter Diamandis wrote an interesting blog post on this last month.

As of August 2017, there were nearly 1,800 operational satellites in orbit. Of these, 742 are communications satellites, 596 are used for Earth observation, and 108 are used for navigation.

We’re seeing a massive increase in the number of operational satellites as satellites become smaller and launch costs plummet.

Private companies all over the world are building out satellite technology. For example, China plans to place 60 commercial (i.e. private) high-resolution Jilin 1 imaging satellites in orbit by 2020.

Planet Labs is a disruptive company using milk-carton sized imaging satellites to help entire industries obtain game-changing data. Planet Labs showcases 175+ satellites in orbit, enabling them to image anywhere on the globe with up to 3.72-meter resolution.

Alternatively, Planet Labs offers a specialized, targeted satellite option called SkySats. Thirteen of these satellites can achieve up to 72-centimeter resolution. SkySats can also capture video, which can be used to extrapolate 3D models. These satellites are built on the same technology that Google deployed to capture crisp 3D image views for Google Maps.

Imagine Google Maps satellite imagery that is live, not months or years old. What could you do with that capability? Farmers, mapping software, construction, maintaining operational control of your logistics supply line, and a thousand other things we haven’t even thought about today. We’re going to find out, on top of many other benefits from easy, low-cost access to space.

Beyond that, a wealth of minerals are just waiting to be collected out there, both in asteroids and on the Moon. Bringing them to Earth in greater quantities than we have now could enable untold miracles.

Recently I heard someone say banks are now essentially technology companies. So much lending now happens in the capital markets and “shadow banks” that the legacy banks are mostly service providers. They process payments, hold assets in custody, and provide the financial system’s necessary plumbing. Old-style “banking” is on the way out.

That may be a stretch, but it is true that the financial services business is changing fast, due largely to technology. Stock trading commissions are one obvious example. Remember when it used to cost $50 to buy 100 shares of a stock? It wasn’t that long ago. Now the fee is pennies or even zero. That’s partly because brokers have found new ways to make revenue from order flow, and partly because their costs are mostly fixed. Once you have the systems in place, the incremental cost of processing one more trade is negligible. Competition does the rest and customers win.

More competition is coming. You know what Amazon has done to the retailing industry? Banks may be next. Here’s an amazing graphic from CB Insights.

Source: CB Insights

In short, Amazon has ways to deliver many of the services we presently get from banks. So where exactly is that line between technology and banking? It’s hard to say and getting harder.

Blockchain-based cryptocurrencies are slowly finding their place in the financial system, too. I’ve been a Bitcoin skeptic—and it may yet give way to some other currency—but this isn’t fool’s gold. The technology has real advantages that will change the industry.

When I see people like John Burbank and Mark Yusko essentially go “all-in” on blockchain investments, staking their careers and reputations and hundreds of millions of dollars on something so ephemeral to most of us, I sit up and take notice. Something is happening here.

Finally—and you wouldn’t know this from all the tariff talk—capital is flowing around the world like never before. Investors who once thought they should stick “close to home” have branched out internationally. They do this in part because technology makes it possible to monitor assets you own, even on the other side of the world. This is good because it means capital will flow more easily to the entrepreneurs with the best ideas, wherever they may be geographically. Ultimately, that’s good for everyone.

Cambridge and Oxford could have been Silicon Valley. They had the Turing machine, but the bureaucrats were so afraid Russia would steal it they literally tore it down. They drove the greatest mathematical mind of the time, Alan Turing, to suicide simply because he was homosexual.

Over in the United States, ENIAC was formally dedicated at the University of Pennsylvania on February 15, 1946, and was heralded as a "Giant Brain" by the press. It had a speed on the order of one thousand times faster than electro-mechanical machines; this computational power, coupled with general-purpose programmability, excited scientists and industrialists alike. (Wikipedia)

What did the US do? The University of Pennsylvania threw a conference and three dozen schools came. Shown every design detail, they all went back and created computer schools and courses at their universities. Truly open source development.

From a human perspective, it really doesn’t make any difference where an invention comes from, as long as it improves our lives. 35% of artificial intelligence research funding will come from China in the next three years. PricewaterhouseCoopers recently projected AI’s deployment will add $15.7 trillion to global GDP by 2030, with China taking home $7 trillion of that total, dwarfing North America’s $3.7 trillion share.

You think engineers and scientists in India are going to sit back? Or Thailand? No. Ricardo was right, different countries will specialize in their strengths. Yes, we would all like our home team to be the one that benefits the most, but the reality is the world is going to benefit, and we are all part of the world.

One day I will do a letter on China’s rising companies. Yes, many are state-sponsored, and we can grouse about it all we want, but then a lot of US research has been state-funded, too. That’s just what countries do. You think Airbus doesn’t get a lot of subsidies? But they make good planes. I like them. Just like I like Boeing planes. It makes no difference to me which plane I get on if it gets me there safely.

In India, you can get all the music you want streamed to your phone or device for literally pennies a month, not the $10 a month we pay to Spotify, which still seems incredibly low. I could go on with examples for pages, and probably will in my book.

But understand, all of these remarkable changes and improvements in our lives are going to happen even as we figure out how to deal with global debt. And those changes and improvements are going to be extraordinarily powerful investments if we get there at the right time and place.

None of this means we are entering Nirvana next week. We’re going to have another recession eventually. The Great Reset is still coming. I expect to be talking about recessions in the next century. But the Great Reset and recessions won’t be the end of the world. Good things will keep happening, and we’ll get to the other side.

In the Vietnam War, “light at the end of the tunnel” became kind of a joke because the war seemed endless. Finally it did end, and some bad years followed. But now Vietnam is at peace and its economy growing fast.

One of my favorite frontier market investors told me at Camp Kotok that Vietnam is his favorite opportunity right now. There really was light ahead in their long, dark tunnel. Getting to it just took time. We will get there, too.

I don’t have any trips or personal news to report this week. We’re in August, it’s hot and summer is winding down. I’m looking forward to cooler weather and even cooler new technology.  

Your really optimistic about the future analyst,

John Mauldin
Chairman, Mauldin Economics

The devastating cost of central banks’ caution

Timidity on monetary policy since 2008 has been as costly as the financial crisis

Martin Sandbu

Central bankers have fretted about being ready to 'normalise' monetary policy because they feared economies would overheat. Ten years on, we know how wrong this was © AP

An important group of economic actors have enjoyed undeserved impunity since the global financial crisis. I do not mean investment bankers, who will no doubt face revived opprobrium when the 10th anniversary of Lehman Brothers’ collapse is marked next month. I mean the central bankers, whose timidity since 2008 has been every bit as costly.

All the big central banks are now tightening or facing firmly in that direction. The US Federal Reserve is shrinking its balance sheet and steadily raising rates. The Bank of England just approved its second rate rise since the bottom. The European Central Bank, far behind the other two in the monetary policy cycle, has nonetheless announced an end to its asset purchase programme this year. Even the Bank of Japan is perceived by markets as at least considering a tilt towards tightening.

There is one fundamental truth about all these shifts: they have come much later than anyone — in particular central bankers themselves — thought they would. When central banks unleashed unprecedented monetary stimulus in late 2008, few expected that 10 years on, monetary policy would still be extremely loose by historical standards.

For years, central bankers have fretted about being ready to “normalise” monetary policy, a term whose main function has been to make a shift to monetary contraction in crisis-scarred economies sound responsible rather than risky. Their common concern has been that, without a timely contraction in monetary conditions, economies would overheat. The characteristics of growth beyond capacity — unsustainably high employment; inflation exceeding and potentially accelerating above target — would then be hard to rein in.

Ten years on, we know how wrong this was. Overheating is nowhere to be seen. In the US, the furthest ahead in the cycle, employers keep adding jobs without having to increase wages much. While unemployment has been at record lows for a long time, labour force participation remains below its historical peak even adjusting for demographic change. The growth spurt that followed Donald Trump’s huge tax cuts suggests that the economy can absorb a chunky aggregate demand stimulus.

In the eurozone, unemployment and underemployment have fallen but remain too high, showing the remaining slack. Estimates of their “sustainable” levels have dropped too, which means more slack than was thought. In the UK, wages are not picking up in response to high employment. The BoJ has not come close to jolting the Japanese economy out of deflationary expectations.

At best, central banks may be justified in thinking their economies are running out of slack soon. In the jargon, “output gaps” are now closing or already have. But to take this to mean all is well with monetary policy is to miss the much bigger lesson. If monetary policy is more or less appropriate now, then it has been catastrophically in error by being too tight for most of the past decade.

The error is this: if major economies are only now returning to full capacity, then central banks could safely have accelerated demand growth aggressively to close these output gaps much earlier. Once this mistake is acknowledged, the devastating cost comes into relief. For example, assume that the average output gap over the decade was 2 per cent of economic activity at full capacity. Halving this by boosting demand more and earlier would have saved 10 per cent of annual gross domestic product. That is enormous — and more than the immediate loss of GDP in the 2008-9 recession.

Still, this probably underestimates the damage. Many major economies remain some 15 per cent below the pre-crisis GDP trend. Either this reflects permanent damage to the supply side of the economy, or it is recoverable. If the former, some of the damage must have been caused by persistently weak demand, wearing down machinery and skills while discouraging new investment. If the latter, we are even further from full capacity than conventional measures suggest. Either way, central banks have done far too little.

What can banks say in their defence? Not that stabilising output was someone else’s job. This job was assigned to monetary policy as part of the pre-crisis understanding known as the Great Moderation. Nor can they say that inflation targeting lost traction on growth; they failed even to lift inflation to their own target. Central bankers fall back on the claim that they “ran out of ammunition”. This, too, is false. Some central banks stopped cutting rates before reaching zero; even those that did go into negative territory never pushed this policy to its limits. Asset-buying programmes all came with quantitative limits at the outset; those limits could have been higher.

Only the BoJ opted to target long-term rates directly, but did so late and timidly. Finally, no central bank tried the ultimate weapon in the monetary arsenal: issuing liabilities — cash — without acquiring assets in return, using its own equity, a policy instrument often dismissed as “helicopter money”.

Central bankers’ caution may have cost more in lost livelihoods than the recklessness of private bankers. Keep this firmly in mind during the Lehman anniversary.

We’ll Never Know How Bad the Federal Reserve Is

The central bank hides and then destroys documents.

By James Freeman

A security guard patrols the Federal Reserve building in Washington last month. Photo: leah millis/Reuters 

Sen. Rand Paul (R., Ky.) still hasn’t persuaded his colleagues to audit the Federal Reserve’s conduct of monetary policy. Perhaps lawmakers could simply agree that the Fed should stop destroying documents.

“Borrowed Time,” a history of Citigrouppublishing today and co-authored by your humble correspondent and Vern McKinley, finds that the bank was in many ways healthier and more stable during the century when it was independent than during the roughly 100 years it has been supported by the federal government. But the government has been working hard to prevent such stories from being told. 
Take the early 1990s, when Citi ran into trouble with bad bets on U.S. commercial real estate. To understand exactly what happened, it would be useful to go back and look at the Office of the Comptroller of the Currency’s examination reports from 1991 and 1992. Bank examiners normally put particularly juicy details about what they find in a confidential section that is not shared with the bank, and today this might represent a gold mine for financial historians. Such reports are available going back all the way to the 1860s, and the record lasts into the 1930s. But oddly these examination reports cannot be accessed for later periods due to the Federal Records Act of 1950.

For decades now, the government’s standard practice has been to warehouse individual examination reports for banks like Citi for 30 years while refusing to release them, citing exemptions under the Freedom of Information Act. After 30 years, the feds then destroy the reports. Based on this schedule, at some point during this year, the federal government will destroy the Citibank examination records from 1988. A few years down the line, the records from the early 1990s downturn will also cease to exist. Counter-intuitively, it is much easier for someone researching the history of a big bank to get their hands on an examination report from 1890 than from 1990. It is also certainly easier to repeat history if the lessons of the past are erased.

Fortunately some journalists have occasionally been able to counter the federal effort to destroy historical records in this area. One of the Comptroller of the Currency’s contemporary examination reports was obtained by the New York Times in 1992. The report chronicled the troubles of Citicorp Mortgage, which during 1989 was the nation’s largest mortgage lender. Its operations went south in the ensuing years and it had negative equity capital of $80 million at the end of 1991. Citicorp then pumped $172 million into its mortgage unit, most of which was consumed by additional losses.

When an institution like Citi has problems as it did during the early 1990s, a regulator would normally catalog all the bank’s weaknesses in a written agreement in which the bank promises to sin no more. Citibank was placed under just such a memorandum of understanding. But you can’t read it.

In response to a FOIA request, the Comptroller’s office claimed that “after a thorough search,” staff were “unable to locate the document.” The regulator also said that “memorandums of understanding are not disclosed to the public.” Margaret McCloskey Shanks, Deputy Secretary of the Federal Reserve Board, responded by letter to a FOIA request with the potentially good news that Fed staff had found 13 pages of information responsive to the request.

“I have determined, however, that this information constitutes confidential supervisory information regarding a financial institution,” added Ms. Shanks. The Fed official claimed that the material was therefore “exempt from disclosure.”

It will not be immediately clear to most taxpayers why such information needs to be kept confidential for more than 25 years.

How about a century? Citi’s troubles in the years following the creation of the Federal Reserve in 1913 are especially intriguing. That’s because, for nearly 80 years prior to the creation of a federal backstop, the bank had been rock-solid. Yet by an amazing coincidence the creation of a new government safety net was immediately followed by an era of reckless investment overseas. In early 1917 the institution we now call Citi opened a Russian branch, just months before Soviet communists seized power. It turned out that protecting shareholders of a big U.S. bank was not high on Lenin’s agenda.  
Back in the U.S., regulators started to recognize problems in 1919, and the bank became a heavy consumer of government assistance. In 1920 its borrowing from the Federal Reserve Bank of New York surged, according to an examination report. But good luck getting the details on this emergency lending. The New York Fed says it is unable to locate any such records. They were probably destroyed a long time ago.

How will Americans ever fix problems in a federal bureaucracy if we’re never allowed to see them?

Thoughts On Friday's Dollar Coup

by: The Heisenberg

- On Friday, a double whammy from the PBoC and Jerome Powell sent the dollar tumbling, much to the delight of those hoping the greenback would take a breather.

- This helps to shore up delicate sentiment in emerging markets where outflows have picked up amid concerns about an increasingly challenging external environment.

- Here's a quick recap of global dollar liquidity dynamics, a visual trip through Friday's action and a quick note on September.

On Wednesday, I suggested that if you're long risk assets of any kind, you're implicitly short the dollar (UUP).
That's not exactly some kind of revelation. That is, it's no secret that the proximate cause of the emerging market (hereafter "EM") unwind is hawkishness from the Fed and the concurrent USD-positive widening in the policy divergence between the U.S. and the rest of the world.
When you think about idiosyncratic flareups in Turkey and Argentina (to name two), you should view them through the lens of vulnerability to a rollback of post-crisis accommodation by developed market (hereafter "DM") central banks. The Fed is the furthest along on the normalization path and U.S. fiscal policy is prompting the FOMC to lean more hawkish than they otherwise might.

Additionally, the increased Treasury supply necessitated by the tax cuts and spending bill helped catalyze an acute dollar funding squeeze in Q1 and at least two EM central bankers (the RBI's Urjit Patel and Bank Indonesia's Perry Warjiyo) have cautioned Jerome Powell to be mindful of these dynamics when thinking about the future course of Fed policy and the pace of balance sheet unwind.

Some developing economies are more vulnerable than others, and there of course are idiosyncratic factors at play (e.g., Turkish President Recep Tayyip Erdogan's recalcitrant attitude on rate hikes).

But the entire EM complex benefited from the hunt for yield catalyzed by a decade of DM accommodation that pushed investors out the risk curve and down the quality ladder. Now, the tide is going out on that, which means the entire space is exposed to a greater of lesser degree.
(Source: BofAML)
Note how I mentioned BI's Perry Warjiyo above. Indonesia has hiked rates four times since May in an effort to shield the rupiah from the storm. As of July, foreign bond ownership in Indonesia was nearly 38% of outstanding.
(Source: Nomura)
In case it isn't clear enough, the problem with that in an environment where the global hunt for yield is reversing on the back of Fed tightening is that it sets up a potential exodus, with serious consequences for countries that rely on external funding. On Tuesday, Indonesia's Finance Ministry said it's aiming to reduce the amount of sovereign debt owned by offshore accounts by nearly half, to 20% from the 38% shown above. That's an effort to make the country less vulnerable to episodes like what's going on right now.
The risks grow when acute flareups (e.g., Turkey) prompt investors to indiscriminately abandon EM assets if for no other reason than to fund redemptions. Here's something I posted on Twitter Friday morning that speaks to this:
Consider that with the following excerpt from a note penned by Nomura's Charlie McElligott:
Just as QE pushed investors into riskier EM assets, DM monetary policy normalization stands to have the opposite effect, refocussing investor attention from EM yields to EM risks. A VaR shock, as experienced in previous instances of specific EM stress, is possible. Like the Russia-led VaR [shock in 2014], the contagion effect is driven by the need of real money investors to sell their holdings (even those with strong local fundamental stories) in other markets to fund redemptions, as indicated by discussions with EM real money investors, as well as by the strong historical relationship between global EM and specific EEMEA/LatAm/Asia dedicated funds’ net flow data.
I'm feeling a bit deadpan on Friday, so let me just preempt any potential pushback from readers by saying that exactly none of the above is debatable. These simply are the dynamics at play and while you can quibble with the potential scope and severity of an unwind, you cannot argue that what's happening right now isn't happening or that it's not down to Fed tightening and the surging dollar colliding with the vulnerabilities engendered by nine years of accommodation in DM markets.
Nedbank’s Neel Heyenke and Mehul Daya have been two of the most vocal analysts this year when it comes to cautioning against the prospect of a dollar liquidity shortage leading to a further unwind across markets, and especially in EM. For their part, they believe deglobalization will exacerbate the situation. Their research has been getting more and more attention of late. For instance, it was featured in a Financial Times post on Thursday. I've been highlighting it over on my site all year long. Here's some interesting commentary from a special report Nedbank released earlier this month on this subject (more here):
Should global growth become less synchronized the US deficit will shrink. This will provide less USD into the global financial system resulting in a shortage of dollars. Tighter monetary policy from the Fed, a higher Fed funds rate and shrinking of the Fed’s balance sheet, will further slow down USD creation.
One way to protect yourself if you're an EM central banker is to hike rates, but the self-defeating nature of that in an environment where global growth seems to have peaked and trade frictions threaten to dent the prospects further, should be obvious. You can hike to protect the currency and guard against capital flight, but that risks undercutting domestic economic conditions and also has the potential to drive local stock prices lower. Worse, it actually contributes to the same tightening of global financial conditions that caused the problem in the first place. Here's a helpful excerpt on that from a note out last week by BofAML's Barnaby Martin:
The orthodox response to EM currency stress is central bank rate hikes. But this will serve to exacerbate the Fed-inspired liquidity drain already at work across markets. Note that year-to-date, the number of central bank rate hikes across the globe has shot up, and the pace is now almost on par with the pre-Lehman peak. And with less liquidity comes less “crowding” by markets into risky assets. Thus, investors should prepare for an ongoing period of high performance dispersion and idiosyncratic risk, in our view.
And it's not just Fed tightening or tentative normalization from other DM central banks (e.g., the ECB winding down its asset purchase program) that's at play when it comes to the liquidity tide receding. Credit creation in China is a key piece of the macro puzzle and as Citi’s Matt King recently noted, a slowdown there “is being reflected not only in directly affected variables like Chinese fixed asset investment but also in the rise in global volatility.”
Here's a look at Bloomberg's China credit impulse index (it's basically just new credit as a percentage of GDP):
(Source: Bloomberg)
If you lose the China credit impulse at the same time that DM central banks turn off the liquidity spigot, it's trouble.
For all of the reasons above, the dollar rally needed to abate. I went over that extensively on Wednesday in the post linked here at the outset. Donald Trump's criticism of the Fed (as published by Reuters on Monday) was thus a welcome development for global risk sentiment.
The question, though, was whether Jerome Powell would effectively negate that by saying something overly hawkish on Friday in his closely-watched speech in Jackson Hole.
Well, at around 7:00 AM ET (so, three hours prior to Powell's speech), the PBoC announced that it would be bringing back the counter-cyclical adjustment factor (hereafter "CCAF") in the yuan (CYB) fix. Regular readers are familiar with this. If you need a refresher course on the CCAF, you can find the history of it here, but suffice to say it's yet another tool the PBoC has at its disposal when it comes to ensuring the currency doesn't careen too far one way or another (i.e., weaker or stronger).
The reintroduction of the CCAF (which basically just means the central bank called banks that contribute to the daily fixing and informed them to start using it again) is the fourth measure taken this month aimed at ensuring the yuan doesn't hit the psychologically important 7-handle. The other three measures were: the reinstatement of forwards rules on August 3, the chiding of onshore banks for selling RMB on August 7, and a move to squeeze offshore liquidity on August 16. Here's an annotated chart of the onshore yuan going back to the 2015 devaluation:
(Source: Heisenberg)
Fast forward three hours from the PBoC news and Powell struck a reasonably dovish tone in Wyoming. Specifically, these were the key soundbites from his Jackson Hole speech:
While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating.
That's as dovish as you're going to get from Powell, given the current economic backdrop.
While I'm not one to posit conspiracy theories, it certainly is convenient that Powell avoided being hawkish and the PBoC brought back the CCAF in the same morning. It's even more convenient that this comes during a week that found Donald Trump expressing more concerns about the strength of the dollar and also featured a low-level meeting in Washington between U.S. and Chinese trade representatives.

And look, I'm not the only one suggesting that this was likely some semblance of coordinated.
Here's a screengrab from a feature Bloomberg article out Friday:
At one point, the Bloomberg dollar index was down some 0.6%.
(Source: Bloomberg)
That largely negated Thursday's gains and putting the greenback on track for its largest weekly decline since the week ended July 6.
(Source: Bloomberg)
You're reminded that positioning in the dollar is extremely stretched. By that, I mean net long to the tune of $24.3 billion overall, the most since January 2017. That position is ripe for an unwind, as is the record spec short in the 10Y Treasury. As a reminder, the net non-commercial short in the 10Y increased to a record 698,194 contracts in the week through last Tuesday.
(Source: Bloomberg)
A dovish Powell has the potential to squeeze that short - just ask Jeff Gundlach, who said as much on Twitter last Friday. Sure enough, yields snapped lower on the Fed chair's speech, as Treasurys pared early losses. As of this writing, 10Y yields are down ~4bps on the week.
(Source: Bloomberg)
Again, this is welcome news for EM and for risk more generally. EM equities (NYSEARCA:EEM) are up nicely on the week and extended gains Friday amid the slump in the dollar.
(Source: Bloomberg)
Meanwhile, commodities erased Thursday's losses and then some, extending gains as soon as Powell's comments hit the tape.
(Source: Bloomberg)
You get the idea. Do remember that a recovery in global risk sentiment will likely be key to preserving the rally in U.S. stocks (SPY) going forward.
So far in 2018, Wall Street has managed to shake off losses incurred around the globe thanks in no small part to the effects of late-cycle stimulus (e.g., record earnings and the buyback bonanza). If those effects fade (and you don't have to be a bear or a pessimist to know that they will), then U.S. shares will no longer be inoculated from the global risk-off environment. That's why it's key that the dollar doesn't resume its ascent in the month ahead.
You'll want to watch the latest CFTC data out this evening for signs that this week's action caused an unwind in either the dollar long or the spec short in the long-end of the curve. If those positions weren't shaken out by Tuesday, it would speak to just how convinced market participants are about the durability of the dollar rally, as the data will capture Monday's comments from Trump about Fed policy.

Meanwhile, for those of you who might be inclined to bet on a resumption of the trades that have been working for U.S. equity funds (i.e., long momentum/growth and short value), the above-mentioned Charlie McElligott thinks the stage is set for a "monster" momentum rally in September. That's a call based on seasonality:
(Source: Nomura)
But be careful, because that prediction came with a caveat which serves as the perfect way to end this post.
After September, McElligott thinks things might get dicey again. His reasoning: a resumption of the tightening in financial conditions catalyzed by ongoing QT and the possibility that the slowdown in the Chinese credit impulse bleeds over into growth proxies.
With that, I'll leave you with a quote from Charlie's Friday missive:

My call to get long U.S. Equities “1Y Momentum” into September is going bonkers in the best of fashions—the Nomura Momentum Factor is now +3.1% in two sessions. 
Finally to reiterate, I DO then believe that following this Equities burst into September that we will see reinvigorated October cross-asset volatility. The macro-catalyst being the “QT escalation” theme I’ve been speaking to leading to potential interest rate volatility / tantrums. I too expect high-potential for position asymmetry to tip-over, as both systematic- and fundamental- investors accumulate leverage and large position size via lower realized volatility into the risk rally.

Yuan Weakness Isn’t Just About Trump

The real story on China’s currency has much bigger implications for investors

By Nathaniel Taplin

   China no longer sells much more to the world than it buys. Photo: -/Agence France-Presse/Getty Images 

China, President Trump’s favorite trade target, produces too much and consumes too little. Right?

Not exactly. China no longer sells much more to the world than it buys these days, a key factor—alongside slowing growth and Mr. Trump’s ratcheting trade threats—behind the yuan’s 8% slide against the dollar since late April.

China’s narrowing trade surplus could enhance U.S. trade leverage, and eventually force wide-ranging changes in Chinese industrial policy. But nearer-term, it could make it harder for China’s central bank to keep the yuan, currently at 6.8 to the dollar, from breaching the totemic level of 7.

China’s current-account surplus last quarter was just $5.8 billion, well down from a quarterly average closer to $70 billion back in 2014 and 2015. The main reason: Net services imports have nearly tripled since late 2013, hitting $74 billion last quarter. It’s no great mystery why. Consumption accounted for nearly 80% of China’s growth last quarter, compared with less than 50% five years ago.

This underlying change in China’s trade position has some important implications. To prevent the yuan’s decline from becoming permanent, Chinese policy makers need to encourage more inward investment to offset rising consumption of foreign wares. They also need to keep Chinese capital at home. Otherwise, the central bank will have to spend more of its foreign-currency reserves to prop up the yuan.

Though there isn’t much sign of big capital outflow yet—China’s reserves barely budged last month—the central bank isn’t taking any chances. Last week it reinstituted reserve requirements for yuan forwards to make speculating against the currency more expensive.

The changing trade picture should increase Mr. Trump’s leverage over China. To keep exports to the U.S. from collapsing, Beijing may now be more willing to offer trade concessions. It may also be more willing to make investing in the country easier—particularly since China’s latest domestic growth stimulus has yet to kick it.

To make up for lower earnings from trade in the long run, keeping both domestic and foreign capital happy will be critical. That means boosting returns at home, a goal at odds with an industrial policy of shoring up inefficient state-owned giants at the expense of private companies. Real state enterprise reform may eventually become a necessity, not a choice.

Such policy shifts take time, however. The near-term risk is that as China keeps pushing domestic interest rates lower, large dollops of cash will start to find their way around the country’s strict capital controls. At that point, even the yuan’s recent sharp fall may start to look like a gentle decline.

Cold and Flu Viruses Reveal Clue to Anti-Aging and Age Reversal Therapies

Dear Reader,

My biologist son recently brought a cold virus back from Tokyo. Therefore, it was probably inevitable that I’m now recovering from a minor respiratory tract infection (RTI). On the upside, it gave me time to think about what virus-borne diseases are teaching us about curing aging.

I’ve written a lot about rapamycin and will again in the future. The accidental discovery of this molecule, produced by bacteria in the soil of Easter Island to combat fungi, is one of the most important milestones in scientific history. Someday, monuments will be built celebrating the enormous impact of the rapamycin molecule on humanity’s health and longevity.

Source: Getty Images

Rapamycin’s anti-fungal properties were largely forgotten when it was discovered that the drug suppressed immune system function in organ transplant recipients better than existing treatments. The drug was first approved under the name Rapamune for that purpose.

While transplant recipients have obviously benefited from rapamycin, the molecule has had a far greater impact on the science of aging.
Initially, researchers were concerned that organ transplant patients taking rapamycin might be susceptible to otherwise minor wounds and infections. The term “immune suppression” always made me think of the movie Bubble Boy, based on the true story of David Vetter. Born without an immune system, he lived his short life in a sterile environment because any pathogen could have killed him.
However, rapamycin didn’t turn off people’s immune systems. Instead, doctors wary of infection observed unexpected and positive effects in older patients. My cousin-in-law, for example, was prescribed a Japanese version of rapamycin following a kidney transplant, and his graying hair began to regrow in its original color.
During this period, scientists began to view the immune system as a two-edged sword. Inflammation, the mechanism used by the immune system to fight pathogens, could also cause harm, especially in older people. Gerontologist Claudio Franceschi coined the term “inflammaging” to describe chronic, low-level overactivation of the immune system.
This was a new way of looking at immunosenescence, the recognized decline of the immune system’s function in the aged. One example of immunosenescence is that older people often fail to develop immunity when given vaccines.
Many scientists assumed older people’s immune systems were failing because they were “weak,” but that term is misleading.
A better way to think of immunosenescence is that older immune systems have hair triggers and are constantly responding to minor threats and false alarms.

Overextended and exhausted by constant activation, they’re less able to deal with real problems such as infections or cancers.
Dr. Joan Mannick—who now works as chief medical officer for resTORbio, but back then worked for pharma giant Novartis—suggested that turning down the dial on the immune system via a version of rapamycin (RAD001) might be the answer.

In a 2014 paper in Science Translational Medicine, she showed that “RAD001 enhanced the response to the influenza vaccine by about 20% at doses that were relatively well tolerated.” Additionally, she and her collaborators found improvements in T cell function.

Even the Elderly Can Benefit from Rapamycin
Source: pixabay

The benefits from calming overactive immune systems are easily observable in animal trials. Mice given low doses of rapamycin experience health and lifespan increases of about 20%. The most exciting aspect of this discovery is that older animals given rapamycin get almost the same effects.
It appears that rapamycin provides two benefits, even in elderly people. First, it reduces inflammation, which is a source of constant cellular damage. Second, it allows the immune system to repair real problems. That’s why we see gray hair restored to its original color and wrinkles fade.
By the way, I heard that the rapamycin experiment on older mice was accidental—like so many other aspects of this story. Researchers had intended to dose their lab subjects at middle age but encountered some sort of bureaucratic delay. Because mice only live a few years, the animals were already old in human terms when the experiment was able to proceed. The researchers expected little but were amazed to see the mice visibly rejuvenate.
The theory that overactive immune systems contribute to inflammaging was further confirmed by resTORbio, which licensed the Novartis rapamycin IP. The company recently released phase 2b trial data on its rapalogs, which showed reduced incidence and severity of respiratory tract infections in high-risk elderly patients.  
The reason: there is little to no evidence that Tamiflu is effective in treating the flu, despite $18 billion in annual sales. The resTORbio data, on the other hand, indicates that rapamycin and the rapalogs—if dosed correctly—are a much better solution to RTIs, including influenzas.
However, the bigger picture is that the knowledge gained from rapamycin and the rapalogs has already led to new discoveries. Behind the scenes, other scientists are focused on strategies that will make the 20% increases in healthspan delivered by rapamycin trivial.