The 1970s Never Ended

By John Mauldin 

Big economic storms are rare and usually end quickly, but they tend to have long-lasting effects. 

Today I want to talk about a storm 50 years ago that still affects us now. 

Important things happened in the 1970s.

I personally remember that decade well. 

I was in my 20s and they were formative years. 

I met people and learned things that led me where I am now. 

The funny part is its larger events, important as they were in hindsight, didn’t get nearly as much attention at the time. 

Those events did not even register to me as important. We didn’t have social media and 24-hour news networks. 

The “well-informed” people read local newspapers and watched Uncle Walter (Cronkite) in the evening. 

Business people and bankers read The Wall Street Journal

Political junkies read The New Republic or National Review. 

But none of us really knew everything as it happened, with the one exception of the Vietnam War. 

Selected portions of that were played out on our TVs in the evening and in papers. 

For that matter, most business and national news was also only consumed in light detail. 

Even back then, there was too much to portray in 30 minutes or a short column.

In any case, we are still dealing with the legacy of that time. 

But as I’ll show at the end, we may be starting to at least recognize some of the mistakes. 

That’s the first step to actually fixing them.

1971 Memories

A half-century later we are still enduring the effects of 1971, when Nixon “closed the gold window.” But to understand why, we have to consider the window’s origin.

Currency devaluations, leading to inflation, depression, and worse, were common before World War II. 

The 1944 Bretton Woods conference designed a new system which took effect in the 1950s. 

The US would hold most of the world’s gold, guaranteeing other nations could convert their gold reserves at a fixed $35 per ounce rate. 

Essentially, this tied other countries to the US dollar.

Bretton Woods “worked” for almost 20 years but with side effects, not unlike today’s euro problems. 

You can’t tie independent countries with their own fiscal policies to the same currency. It guarantees balance of payment problems.

Starting in the mid-1960s, various European countries began demanding payment for their dollars in gold. 

They wanted the US to balance its budget, which had gone wildly into deficit because of the Vietnam War. 

The US was literally using Air Force planes to ship gold from Fort Knox to New York and outbound. 

You can read many interesting stories like this one

We tend to think of crises as happening over very short periods. 

This one was building for years.

West Germany, faced with having to devalue the Deutsche Mark, instead abandoned the Bretton Woods system in May 1971. 

The dollar weakened considerably, concurrent with rising unemployment and inflation. 

Nixon appointed former Democratic Texas Governor John Connally as Treasury Secretary in early 1971. In an international meeting, Connally uttered the famous saying: “The dollar is our currency but your problem.”

As the situation worsened, Nixon called an emergency meeting at Camp David which included the Federal Reserve Chairman Arthur Burns and a young Paul Volcker. After much debate, Nixon listened to the ever-confident Connally. 

On August 15, 1971, President Nixon ended the Bretton Woods system and also imposed wage and price controls in the US. (CPI inflation was almost 6% at the time.) 

He added import tariffs, too. 

Basically, the opposite of what most economists would suggest. The dollar crashed even more and we had to invent the word “stagflation” to define the widespread misery. 

This was all later dubbed the “Nixon Shock

We can’t blame Nixon for everything, though. Other things were happening at the same time: social unrest amid the Vietnam War, the civil rights movement, more women entering the workforce, technological changes, and more. 

Much of it was good and necessary but still disruptive.

But whatever the causes, that period seems to have been a kind of economic fulcrum. I’m not the only one to notice it, either. A host of writers and websites have chronicled the seemingly sudden changes. 

For instance, try WTF Happened in 1971? 

You’ll see page after page of charts, each with a little red arrow pointing to 1971 as a turning point.

You can browse those later but for today I want to focus on income and job-related changes. I think they are the most relevant to today’s challenges, as we will see below. But first let’s quickly review some charts.

Hourly compensation grew roughly in line with productivity from 1948 until the early 1970s. From there, productivity rose far faster than income.

Source: WTF Happened in 1971?

Similarly, wages rose in line with GDP per capita before splitting in the 1970s.

Source: WTF Happened in 1971?

Income at the top of the pyramid, relative to the bottom 90%, began rising in the 1970s after a long post-Great Depression decline.

Source: WTF Happened in 1971?

This next chart again shows that the income gains were not as widely shared since 1971.

Source: WTF Happened in 1971?

If we really want to make it look bad, let’s look at just the top 1%. 

I should point out that this gets somewhat skewed by the increasing amounts made by a small number of entrepreneurs who created wildly profitable businesses. 

Nevertheless, the simple fact of the matter is we live in a relative world. Relative to the average worker, the top 1%, no matter how they ended up there, are incomprehensibly wealthier than the average person.

Source: WTF Happened in 1971?

One reason for that is the productivity we talked about earlier. It really shows up as the capital equipment and technology which is bought to reduce the cost of labor (robots, bank ATMs, computers, automated production lines, and many others). 

It all reduces the share of income going to labor while raising income for machine-owning capitalists.

Source: WTF Happened in 1971?

Let’s note a caveat to the above chart. 

Economists use the Gini coefficient to measure the statistical dispersion of income within a nation or any other group of people. 

A Gini coefficient of zero expresses perfect equality, where all values are the same (for example, where everyone has the same income). 

A Gini coefficient of one (or 100%) expresses maximal inequality among values, where one person makes all the money.

Quite often, the Gini coefficient as used by economists only measures income and does not include taxes and/or government transfers (like food stamps or tax credits). The chart below comes from a recent Wall Street Journal op-ed by former senator (and economist) Phil Gramm. 

It shows the Gini coefficient both with and without federal payments to lower income households (transfers) and taxes. Viewed this way, the Gini coefficient has been roughly stable since 1970.

Source: The Wall Street Journal

Let me state emphatically, this does not negate the real problem of income and wealth disparity. 

You can’t dismiss those realities. 

The income differences are real and the wealth disparity even worse. 

Those transfers simply maintain a semblance of balance, at great and rapidly growing cost.

Given that the technological revolution combined with increasing digitalization of the economy is going to make that income differential even more stark, we in the US are going to have some very difficult choices over this next decade.

Now, let’s get back to data from 1971. Income for the average Black American, relative to White Americans, rose in the 1950s and 1960s, then slowed considerably in the 1970s and after.

Source: WTF Happened in 1971?

Flat or slow wage growth is bad enough, but far worse when living costs are rising. 

That’s what has happened… and guess when it started.

Source: WTF Happened in 1971?

Owning your home is supposedly the key to financial success. 

But after the 1970s, home prices in major cities rose far faster than incomes did. 

This same phenomenon was happening all over the country.

Source: WTF Happened in 1971?

You can debate some of these numbers and their sources, but it’s clear the 1970s were a turning point in the average American’s financial condition. 

Wage growth stagnated while living costs kept rising. 

Not always and everywhere, but enough to form a long-term trend that is increasingly problematic.

It would be less problematic if either side of the equation were different. Income rising commensurate with inflation, or flat inflation along with flat income, would be a different ball game. 

But that’s not what happened.

I write often about inflation. 

This time I want to look at the other side of the ledger. 

Why haven’t wages grown like they once did?

IQ Tests

Most people derive their income from their employment. 

That’s why unemployment is a problem. It’s also why people want better, higher-paying jobs.

We say the path to a better job is to increase your skills. In an ideal economy, every worker would match with a job that fits their particular skills. Unfortunately, we have barriers. 

In the 1960s there were efforts to remove race as a job barrier. 

The 1964 Civil Rights Act banned pre-employment tests, which had sometimes been used to screen out minorities, unless they were directly relevant to the job.

Litigation followed to define exactly what that meant. Many companies had been in the habit of giving IQ tests to job applicants. 

In 1971 the Supreme Court ruled (Griggs v. Duke Power Co.) such tests were overly broad. The court also gave employers the burden of proving any pre-employment tests had legitimate business purposes.

This was difficult and risky, so employers found another screening method: demanding college degrees for many roles that hadn’t previously required them. 

It wasn’t what LBJ had in mind and actually had the opposite effect, but it was legal. Once again, well-intentioned social policies backfired.

Note this all happened about the same time Nixon closed the gold window. I suspect it also contributed to some of the sharp turns in those charts above.

When government makes hiring people more difficult, employers will find different ways to hire (often fewer) people. 

They may start by squeezing more productivity from the workers they already have. 

They will also automate more tasks, essentially expanding the labor supply with non-human labor. 

This puts downward pressure on wages.

But this particular method was even worse, because it told people the only way to advance their careers was to get a difficult, expensive, and time-consuming college degree. 

This further disadvantages poorer students, some of whom then go into debt to pay for degrees.

Do these degrees really deliver anything employers need? 

Sometimes, but we have established a system in which people think they need a degree, any degree, just to get a foot in the door. 

And they’re not wrong.

Those who are employers know how this works. Some highly skilled positions are hard to fill, but they tend to be those where all the applicants have degrees anyway. 

So education is kind of a non-factor there. 

At the other end are roles where you have too many applicants, and you need some impartial way to prioritize them. 

College degrees are handy in that case, even if not strictly required for the job.

I can personally say mea culpa

Back in the 1980s up until the mid-2000s, but especially after the development of online job websites, I would advertise for a job and get lots of applicants. 

I remember once getting 300 applications for an executive assistant role. A college degree wasn’t really necessary; talent and skill were. 

But we had to sort through 300 applications. The “easy” solution was to simply start with the college graduates.

That’s not unreasonable. Even if someone’s degree is far afield from what you do, the fact they have one gives you some useful information. 

You know they are willing to sit in a classroom, turn in assignments, take tests, and otherwise go through a defined process to reach a goal. These are helpful.

The problem is those skills aren’t unique to college graduates. Many others may have them, but haven’t had the opportunity to prove it. 

Employers would have a larger talent pool if they had other ways to sort it, beyond the presence or absence of a college degree.

Ironically, requiring college education for jobs that don’t really need it aggravates the income disparity you might think it would fix. It becomes a kind of self-fulfilling prophecy. 

Employers require degrees for higher paying jobs, so of course the higher paying jobs go to people with degrees.

The Jobs Problem Is Really a Data Problem

College degrees have become a proxy for the IQ tests that were made illegal 50 years ago. 

They aren’t a particularly good proxy, but large employers lack better options.

This is an economic problem for everyone. People contribute more to growth when they are deployed efficiently in jobs that fit their particular talents and goals. Businesses filled with workers who are just there for a paycheck tend not to produce much, and may even be a net drain on the economy.

Data from the National Federation of Independent Business and other groups consistently shows that finding skilled workers is a top problem for employers. 

There are lots of jobs but matching them with people who can do them is a real issue. 

It’s a big problem, especially for small businesses where the entrepreneur is trying to produce a product, increase sales, and a dozen other things all at once.

What we need are ways to

  • Define the specific skills needed for each job role, and
  • Identify people who have those skills, and
  • Match them with each other.

Moreover, the matching process has to be more efficient than sorting through resumes, and objective enough to not discriminate in illegal ways.

All that is possible without college degrees. 

Many professional organizations offer certification programs, specific to certain job categories, which interested people can achieve far more easily and less expensively than a college degree. Some people acquire specialty skills in military service. 

These offer the kind of objective, third-party certification employers need to see. They just need to see it.

In other words, some of our economy’s jobs problem is really a data problem. We have many jobs available. 

We also have many workers available, who already have the skills employers want, or could acquire them fairly soon.

Yet many employers are still hiring more by pedigree than skill. In so doing, they may reduce their own odds of success. 

One recent study mentioned in The New York Times found that 74% of new US jobs require a four-year college degree, which only one-third of American workers possess. 

That’s a recipe for frustration for both employers who can’t find workers and workers who can’t find jobs. 

Let’s quote from that article:

For the past four decades, incomes rose for those with college degrees and fell for those without one. But a body of recent and new research suggests that the trend need not inevitably continue.

As many as 30 million American workers without four-year college degrees have the skills to realistically move into new jobs that pay on average 70 percent more than their current ones. That estimate comes from a collaboration of academic, nonprofit, and corporate researchers who mined data on occupations and skills.

The findings point to the potential of upward mobility for millions of Americans, who might be able to climb from low-wage jobs to middle-income occupations or higher.

But the research also shows the challenge that the workers face: They currently experience less income mobility than those holding a college degree, which is routinely regarded as a measure of skills. That widely shared assumption, the researchers say, is deeply flawed.

“We need to rethink who is skilled, and how skills are measured and evaluated,” said Peter Q. Blair, a labor economist at Harvard, who was a member of the research team.

That doesn’t mean no one should go to college. 

The experience has value. 

That said, it often doesn’t have the kind of value we are trying to squeeze out of it. Organizations like Opportunity@Work and Rework America Business Network are trying to promote alternative approaches. Solving this problem will pay giant economic dividends. 

I highly recommend reading the data at these links especially if you are looking to try to find skilled labor for your business. 

There is also an excellent NBER working paper

All of these will help you think outside the box in your hiring practices.

Imagine if millions of unemployed and underemployed people could have sustainable jobs that match their abilities. 

It would go a long way toward solving the fiscal problems I discussed last week. 

We would need less safety net spending and we would have more and higher-earning taxpayers. Businesses would run better and the economy grow faster. 

We could begin, at least, to reverse those 1970s trend changes.

Of course, we want to maintain the progress we made in the last 50 years, too. Not everything has gone wrong. 

Quite a bit has gone right, as I’ll discuss in next week’s letter.

Closer to Traveling, Inflation, and College Degrees

Theoretically, next week I get my second vaccine shot at the local Walgreens. 

The first one was a nonevent for me. 

Hopefully the second will be as well. 

I am looking forward to beginning to travel after the end of the Strategic Investment Conference (May 5–15). 

This is simply going to be the best conference we’ve ever done. 

You really should register Click here to do it now.

The website I mentioned above also had this quaint list of prices from 1971.

Just glancing through it brought back lots of memories.

My family lived in Bridgeport, Texas, on the edge of West Texas where there were no ports or bridges. 

There was a man-made lake. I remember going to the local grocery store with my mother where she would buy what was on sale. 

I remember there would always be a few low-cost items to draw people into the store. 

Three pounds of hamburger for a dollar (although I can assure you the fat content wasn’t the 80 to 90% we get today). 

Mother would add oatmeal to make it “stretch.” Three dozen eggs for a dollar. 

Milk was under one dollar a gallon. 

On annual summer vacations to Aberdeen, Mississippi (near Tupelo) we bought gas for $0.17 a gallon in East Texas. 

Tuition, room, and board for Rice University was about $3,000 a year. 

I was lucky enough to have a full tuition ride and loans for the room and board at 3%.

I will readily admit that while Rice was a fabulous experience, I don’t use my degree today (let alone my Master of Divinity from Southwestern Baptist Theological Seminary). 

Tammi Cole, my executive assistant/financial officer/scheduler/boss, has a chemistry degree. 

She was a bench chemist for a while before she started her own business that had nothing to do with chemistry before she moved to Texas. 

My daughter introduced us when I was looking for help. 

I can guarantee you that whatever she does for me doesn’t require chemistry knowledge. (Enormous amounts of patience, yes.) 

My wife Shane has her own technical degrees, and she needs even more patience. 

I am not sure how you put sainthood on a job and/or marriage skill qualification.

And with that, I will hit the send button. 

You have a great week

Your watching those inflation numbers analyst,

John Mauldin
Co-Founder, Mauldin Economics

After the protests

China is not just shackling Hong Kong, it is remaking it

And it does not think global finance will object

For most of its modern history, Hong Kong had no time for nostalgia. 

Little remains of the Victorian mansions or art-deco towers that once flanked its harbour. 

The city was built by unsentimental people in a hurry: traders and shippers and British opium peddlers turned merchant-grandees; imperial officials as tough as the granite of Victoria Peak; wave upon wave of Chinese migrants. 

20th-century elites replaced domed and colonnaded landmarks with towers of concrete, glass and steel, destroying their heritage in the name of progress and profit. 

Only in recent years did the pace of destruction slow, as growing civic pride saw a few old sites preserved.

Today’s ruling elite is bent on further demolition. 

Its mainland Chinese envoys and Hong Kong officials who look to Beijing for their orders have earmarked a breathtaking list of Hong Kong institutions for dismantling and replacement.

It starts with democratic elections. China’s autocrats were appalled when, after months of demonstrations in 2019 against a proposed new extradition law, pro-democracy politicians won a landslide victory in elections for Hong Kong’s district councils that November. 

The result gave Beijing reason to fear a similar drubbing in elections to the somewhat more powerful Legislative Council (Legco), set for September 2020. 

Those elections were duly postponed, with pro-democracy politicians barred from standing and accused of subversion for saying they would oppose the government.

On March 11th, far to the north in a smoggy Beijing, delegates to the National People’s Congress, China’s pliant legislature, approved sweeping changes to Hong Kong’s election laws by a margin of 2,895 votes (there was one abstention). 

Branded “Patriots administering Hong Kong”, the amendments will effectively bar avowed opponents of the Hong Kong government or critics of China’s Communist Party from seeking election to anything.

Candidates for elected office are not the only ones to whom such conditions will apply. China and its local allies are demanding all public officials should pass stricter patriotism tests. 

Over time that will leave less room for the proudly independent judges, some of them foreigners, who currently make Hong Kong’s courts some of the most trusted in Asia. 

The rule of law in Hong Kong will be remodelled.

A national-security law imposed last June in response to the protests of 2019 is limiting liberties such as the freedom of speech, a free press and the right to peaceful protest. 

Almost 50 democratic activists were recently charged under the law for holding a primary election before running for seats in Legco. 

Others have been arrested for holding up banned slogans or for calling for sanctions against China.

In February officials unveiled a new patriotic curriculum to teach children “a sense of belonging to the country” and “affection for the Chinese people”, a response to the pride schools in the city have taken in teaching Hong Kong children to think critically. 

Children as young as six will be asked to memorise offences criminalised by the national-security law, including subversion, secession, terrorism and collusion with foreign powers. 

Chinese officials and their local allies are convinced that years of liberal education have poisoned Hong Kong’s young minds, leaving them easy prey for foreign troublemakers.

The totemic pledge that Chinese sovereignty over Hong Kong would be guided by the principle of “one country, two systems” lies in ruins. 

The formula, coined in the 1980s by Deng Xiaoping, China’s paramount leader, spoke to Hong Kong’s unique value as a gateway to a vastly richer and more advanced Western world from which China could learn, a value which justified exceptionalism. 

Guaranteeing that Hong Kong’s capitalist way of life would continue for at least 50 years after the Union Flag was lowered was a way to keep that gateway open without seeing capital and know-how rush out through it.

The China ruled by Xi Jinping today still sees benefits in preserving Hong Kong as an international financial centre. 

Operating outside the mainland’s strict capital controls, Hong Kong issues its own hard currency, the Hong Kong dollar, that is freely convertible against the American dollar, and offers Chinese firms access to some of the deepest pools of capital on Earth. 

But Hong Kong’s access to Western know-how, as opposed to money, holds less interest for party chiefs.

Changing the guard

Mr Xi and others repeatedly declare that “the East is rising and the West is in decline.” 

Successive crises, from the financial crash of 2008 to the covid-19 pandemic, have left Chinese leaders increasingly confident that their model of techno-authoritarian state capitalism is superior to the partisan squabbling, short-termism and selfish individualism they see in the democratic West. 

When officials talk of preserving “one country, two systems” they are talking of different Chinese systems, not paying tribute to a discarded Western one. 

China’s rulers are not impressed when Western governments suggest that losing the hearts and minds of 7.5m Hong Kongers is a calamity. Throughout 2019, officials in Beijing growled that they served the interests of 1.4bn Chinese.

They are especially scornful of protests from America, Britain and other Western powers that the changes being imposed on Hong Kong are a betrayal of undertakings to preserve Hong Kong’s way of life that it agreed to before the 1997 handover. 

Chinese officials and state-backed scholars call the pre-handover Sino-British Declaration a “historical document” and accuse Western critics of colonial nostalgia. 

To focus on China’s breaking of old promises, though, is to risk missing the sheer scale of its ambitions for Hong Kong's future.

Talk to Chinese officials and state-backed scholars, as well as to pro-government politicians in Hong Kong, and they will insist that neutralising the opposition is a necessary step towards a greater goal: repairing flaws that render Hong Kong’s political and economic systems structurally unsound through a wholesale remodelling of its institutions and society. 

What is more, they are sure that Hong Kong’s role as an international financial centre will generate such profits that Western financial institutions will rush to invest, rendering the grumbling of foreign governments irrelevant.

They may well be right. 

Many foreign executives reject the notion that political repression is pushing global investors away. 

On the contrary, a surge of global capital seeking to reach Chinese markets has drawn more investment to Hong Kong over the past year. 

Cambridge Associates, a large investment group, said on March 8th that it would open an office in the city. 

The race to enter China has forced some managers to “turn money away”, says a managing partner at a global law firm.

Today’s Hong Kong stock exchange is utterly changed from that of the turn of the century. 

Then local companies dominated. 

Now the top traded companies are Chinese giants such as Tencent, Alibaba, Meituan and Xiaomi. 

There are now more than 2,000 mainland mutual funds that can invest in Hong Kong, a number which increased 268% in 2020. A wave of mainland cash has followed. 

Chinese investors brought net inflows of HK$672bn into the Hong Kong market last year through an investment channel called “stock connect”, 170% up on the year before. 

The inflows have made the city’s old corporate stars irrelevant. 

“Fuck them,” says an executive at a Chinese-state-backed investment manager. 

“They are a drag on the index.”

The hkex posted a 23% increase in profits for last year, boosted by a number of Chinese initial public offerings. 

But the fat fees associated with such successes flow mostly to Chinese groups; the financial sector’s success is divorced from the rest of the city’s economy. 

Many local companies have struggled through the past two years of protests and pandemic. 

Swire, a 205-year-old, British-headquartered conglomerate which was a pillar of Hong Kong’s old economy, said on March 11th that underlying profits for its property unit fell by 47% in 2020. 

One investment manager who was born in Hong Kong and works for a local firm says the boom in Chinese business has made him and many around him rich. 

Yet he sees few opportunities for the city’s youth outside of working for Chinese financial-services groups.

Some of the mainland-born, Western-educated bankers in the upper echelons of Hong Kong banks actively welcome the national-security law. 

During the protests of 2019 they feared being attacked by locals in the streets for speaking Mandarin, rather than the local tongue, Cantonese. 

Many are relieved to see order restored to the streets, even with an iron fist. Tougher policing does not affect Westerners, says a mainland financier. 

His foreign clients in Hong Kong laugh about the anxious memos they receive from bosses at home, asking about political developments. 

“It doesn’t really affect their life, right? They’re not going on the street to try to demonstrate against the government.”

Class against class

Despite the success of the financial sector Beijing longs to diversify Hong Kong’s economy, says the mainland financier. 

There are two reasons. One is an ideological distaste for high finance among party bosses who see the proper role of banks as supporting the real economy by lending to businesses that make and sell tangible products. 

Maintaining Hong Kong as an international financial centre is perhaps at best “a necessary evil” for Mr Xi and his close associates, says the financier—a pragmatic way to allow Chinese firms to raise foreign funds while the mainland maintains capital and currency controls.

The other reason is real concern about Hong Kong’s income inequality, which is among the most extreme in the developed world, and the cruelly high costs of housing in the territory. 

Officials in Beijing deny all blame for an unhappy Hong Kong and are impatient with Westerners who cast Hong Kong’s discontent as a clash between a freedom-loving public and despotic rulers: Marx has taught them that all politics is rooted in economic forces. 

Their favoured scapegoats are foreign saboteurs and a small number of Hong Kong-Chinese oligarchs who have dominated the city’s property and retail sectors for generations.

Western critics focus on the blow that the new election law lands on pro-democracy parties. 

Chinese observers are equally interested in its changes to the Election Committee, which will give Beijing-appointed members the power to dilute the influence of the property tycoons. 

“It’s shameful for an economy as rich as Hong Kong to have that many people living without basic human dignity in terms of housing conditions. 

And that sentiment is shared extensively in Beijing, in the leadership,” says the mainland financier.

He predicts a campaign to build large amounts of public rented housing. This could be facilitated by forcing local tycoons to release some of the territory’s copious undeveloped land, a resource they are accused of hoarding so as to increase the value of their property holdings by creating scarcity. 

Beyond that assault on Hong Kong’s old-school business bosses, a wider campaign is brewing to craft a new “capitalism with Hong Kong characteristics”. 

The ultimate target is the city’s whole laissez-faire, low-tax economic model, which some officials in Beijing grumble has been elevated to an almost religious creed by local oligarchs, foreign business leaders and civil servants.

National leaders do not hide their exasperation with the low calibre of many who enter Hong Kong politics today. 

At the same time as the election law changes were being passed in Beijing, the central authorities sent what was widely seen as a warning along these lines in the form of a Hong Kong newspaper op-ed by Tian Feilong, a Beijing-based law professor and member of a government-backed think-tank, the Chinese Association of Hong Kong and Macau Studies. 

Mr Tian wrote that national leaders do not want to see rubber-stamp loyalists running the city.

In an interview in Beijing, Mr Tian expands on that thought. 

The central government wants to set patriotism as a “baseline”, so that Hong Kong politicians can stop dwelling on questions about who is a patriot or not and begin to compete on the basis of their policies. 

Patriots should love their country, says Mr Tian, but only need to respect the Communist Party. 

The professor insists that moderate democrats, “once they have adjusted” to the new rules, are welcome to seek election to “supervise and criticise” the government as a form of loyal opposition.

It is less clear where calls for loyalty leave judges from Britain, Australia and Canada whose part-time service on Hong Kong’s Court of Final Appeals is an indispensable source of international business confidence. 

Some pro-government lawyers describe a legal system in which commercial cases and political cases will be handled on different tracks, with more deference from judges in political cases. Mr Tian says that foreign judges will not be pushed out. 

But he concedes that the principle of “patriots governing Hong Kong” will create more cases that are not suitable for foreign judges and expose them to discomforting political pressure. 

“The rules on that”, he says delicately, “may need further clarification.”

As for the hundreds of thousands who joined the protest movement, Mr Tian trusts that education reforms will produce a new generation of youngsters who understand China and love it. 

He has blunter advice for those too old for school and stubbornly wedded to liberal values. “I think they will experience a painful psychological transition, in other words, they will have to re-educate themselves.”

All the sad mercenaries

Even among some who support the government, this is a moment of painful introspection. 

A member of Legco elected by one of the “functional constituencies” that represent a specific business sector expresses shame at his role as a reliable vote for the government. 

“I’m a mercenary for the rich,” he says. Other loyalists are more bullish about managed democracy, seeing a moment to bring technocrats into public office. 

Maria Tam Wai-Chu, a senior member of the National People’s Congress from Hong Kong, points to the global technology giants which have transformed Shenzhen, the gleaming megapolis that lies just across the border from Hong Kong, and laments that: “We are so backwards here in Hong Kong.” 

She would like to see technology experts or business executives appointed or elected to Legco, to help the city confront the 21st century.

She scoffs at foreigners who worry that those new legislators must be patriots. 

British mps swear allegiance to their monarch, she notes.

Regina Ip, a law-and-order conservative and pro-establishment member of Legco, talks of Hong Kong becoming an “epistocracy”, the technical term for a society governed by experts and the highly educated. 

At the same time, she admits, the anger and discontent seen during the protests in 2019 “has gone underground, it has not gone away”. 

She calls for patriotic education but also social-welfare policies to generate housing and jobs for the young. 

“We must have more redistribution,” she says.

A palpable sense of sadness hangs over the territory. 

Politics has divided workplaces, friends and families. 

If winning over a majority of Hong Kongers proves slow work, leaders in Beijing may be tempted to play social engineer and craft a more biddable Hong Kong, whether by blurring its borders with the mainland or shipping in new people. 

More than 1m mainlanders have moved into Hong Kong since 1997. 

Loyalist politicians in Hong Kong urge young people to try studying and working in the booming mainland next-door, or join the Chinese army.

Though emigration is a constant topic of conversation, an offer of a new fast track to residence in Britain was taken up by just 7,000 Hong Kongers between July 2020 and January of this year. 

“I think the elites won’t leave because they live well and make so much money. 

If other people choose to leave, it won’t be difficult for Beijing to find new middle-class professionals to replace them,” says Mrs Ip. 

“China does not lack people.”

The democratic world has every right to be shocked by the demolition of “One country, two systems” and to respond. 

America has not lost interest in Hong Kong, which is seen in Washington, dc, as a proof of China’s intolerance for dissent. 

Last October it imposed banking and other sanctions on the chief executive and nine other mainland and Hong Kong officials accused of undermining the territory’s autonomy, in breach of long-standing Chinese commitments. 

The territory’s chief executive is now paid in cash, her home filling up with bank notes. On March 16th Joe Biden’s administration imposed bank sanctions on 24 more officials. 

But the most dramatic steps, involving changes to American policies that treat the Hong Kong dollar as a fully convertible currency, have not been taken, not least because the resulting pain would be felt worldwide.

Western governments are not going to deter the demolition. 

The old Hong Kong is gone. 

Judge Mr Xi’s China by what it builds in its place.

How to overcome the uncertainties of the Fed and market psychology

Investors should focus more on individual securities than market-wide trends 

Mohamed El-Erian

It is hard to make confident predictions on current ‘top-down’ factors driving markets as they are not determined by fundamentals, history or market maths © AP

A healthy pause that refreshes or a warning sign of a much more consequential dip down the road? 

This is the question on investors’ minds as markets recover from an early-year dip in which portfolios lost money on both stocks and government bonds that are usually seen as “risk-free”.

The answer is unusually complex, involving uncertainties over the “top down” view of central bank policy and market psychology. 

Fortunately, there is greater clarity on “bottom-up” factors that drive the selection of individual investments.

In a volatile start for 2021, the previously high-flying Nasdaq lost more than 10 per cent between February 12 and March 8 before bouncing back sharply. 

In the process, it underperformed the Dow Jones Industrial Average by an eye-popping 12 percentage points. The prices of government bonds — which move in the opposite direction to those of stocks — also fell, adding to investors’ woes.

For many, these moves were due to changing US economic prospects. 

These were highlighted by stronger-than-expected data for jobs, personal income and manufacturing activity — all before the economy feels the impact of a $1.9tn fiscal package involving fast cash disbursements to Americans. 

No wonder the OECD revised up its 2021 growth projection to 6.5 per cent, an unusual intra-year increase of 3.3 percentage points.

Inflation projections are also going higher. 

It is increasingly likely that US growth in prices will exceed both the current consensus of market expectations and the Federal Reserve’s central target as the supply of goods and services struggles to keep up with soaring private and public demand. 

Indeed, there is already evidence of supply bottlenecks.

Yet this economic improvement does not in itself shed much light on the recent market volatility. 

If anything, high and durable growth is needed to validate elevated asset prices. 

The underlying driver of this year’s uncomfortable market action is concern that the beneficial effects of such an economic regime change would break the dominant factor that has ruled markets for a while — ample and predictable liquidity.

One of two things would need to materialise for this concern to become reality. 

First, that the Fed starts walking back from its extremely stimulative policies. 

Yet, while not impossible, top Fed officials are yet to show any inclination to contemplate this, let alone embark on it. 

This is not because they are blind to the improving economy and massive fiscal stimulus. It is because they are worried that a tightening of financial conditions would destabilise markets and undermine the recovery.

Second, that due to changing market conditions, even if the Fed were to maintain its current policy approach, the impact on markets goes from being beneficial to problematic. On several occasions this year, guidance that monetary policy will remain extremely loose has tended to push yields on longer-term government bonds higher rather than lower.

Influential voices in markets worry that the combination of such ultra-loose fiscal and monetary policies will unanchor inflationary expectations. They argue this could force an unwinding of market positions for which the Fed has no good policy response.

Fortunately for markets as a whole, such worries have been tempered for now by stabilising inflows into bond markets from abroad because US rates are more attractive than the debt of many major markets and because investors are seeking to match future liabilities with predictable interest income.

Still, it is hard to make confident predictions on current top-down factors driving markets as they are not determined by fundamentals, history or market maths. One needs to predict the mindset of Fed officials who currently seem stuck in an “active inertia” mode — that is, recognising that conditions are changing yet continuing on the same path. 

Additionally, the psychology of markets is changing due to technology and the greater involvement of retail investors.

Despite this, I believe it is still possible for investors to build higher confidence in their portfolios using careful bottom-up selection on individual securities. 

These securities should be screened for robustness in four areas: strength of balance sheets, positioning in the faster growing parts of the global landscape, a presence in sectors that are not vulnerable to lasting Covid-19 disruptions and solid management teams.

While such a portfolio would not be immune from liquidity-related volatility, it would provide investors greater protection should this year’s uncomfortable moments turn out to be a harbinger of something nastier down the road.

Archegos blow-up poses hard questions for Wall Street

Biggest hedge fund collapse since LTCM raises concerns over level of exposure enabled by big banks

Robin Wigglesworth

Bill Hwang, pictured in 2012, runs Archegos, a remarkably opaque investment group © Emile Wamsteker/Bloomberg

It is still unclear exactly where Archegos Capital fits into the annals of spectacular hedge fund blow-ups. 

But the early signs are that it will probably prove the biggest since Long-Term Capital Management’s collapse in 1998.

The saga erupted into the open last Friday, when Goldman Sachs and Morgan Stanley broke cover and started dumping multibillion-dollar positions in US and Chinese stocks. 

They did it on behalf of an unnamed investment fund that had failed a “margin call” — essentially a demand to put up more collateral against its trades or face a forced liquidation. 

That sparked an epic whodunnit across markets, with Archegos — an obscure, remarkably opaque investment group run by Bill Hwang, a former Tiger Management hedge fund manager with a chequered past, quickly identified as the primary party involved. 

By Monday, Credit Suisse and Nomura were admitting that they would probably lose billions of dollars in the fallout. 

At this early stage, there are still far more questions than answers. 

Here are some of the more pressing ones.

First and foremost: What on earth were some of the world’s biggest investment banks thinking when they enabled an opaque family office whose founder had a history of regulatory issues to rack up multibillion dollars worth of leverage? 

Hwang paid $44m in fines to settle US illegal trading charges in 2012, and in 2014 he was banned from trading in Hong Kong.

True, Archegos’ status as a family office means that it was exempt from a lot of the standard regulatory disclosures demanded of hedge funds. 

But banks’ prime brokerage desks — which service hedge funds with research, trade structuring and leverage — appear to have failed basic “know your customer” processes. 

Each bank may have felt comfortable with their exposure to Archegos, assuming they could always ditch its positions to cover themselves. 

But they failed to appreciate that if everyone has to dump tens of billions of dollars worth of equities, the collateral they may have embedded in their contracts is going to be wholly inadequate.

In LTCM’s infamous blow-up in 1998, the fund adeptly took advantage of Wall Street’s hunger for fees to play banks up against each other and get access to hefty leverage from each of them — with each often unaware of their rivals’ true exposure. 

But at least LTCM was at the time the biggest hedge fund in the world, founded by storied Salomon Brothers traders and advised by Nobel laureates. 

Aside from the under-appreciated and obscured size of Archegos — and the fat fees they probably paid to prime brokers — the fund and Hwang were essentially non-entities on Wall Street. 

Which leads us to another question: What is Archegos Capital exactly? 

The size and leverage of its positions would be extreme even for one of the more aggressive members of the hedge fund industry, let alone a family office. 

In truth, it seems more like a Reddit day trader got access to a Goldman Sachs credit card and went bananas. 

Prime brokers have estimated that it managed about $10bn of capital before this debacle erupted, which is a lot for the family office of someone who was hardly a titan of the hedge fund industry. 

Historically, family offices have not had to register with the Securities and Exchange Commission because of an exemption for firms with 15 clients or fewer. 

The Dodd-Frank Act that tightened regulations in the wake of the 2008 financial crisis removed this exemption to shed more light on the hedge fund industry. 

However, the SEC has let family offices decide for themselves whether they should be registered and file regular reports. 

Given its size, does Archegos manage money from people other than Hwang, and if so should it have been required to make more disclosures to the SEC?

A search for Archegos on the SEC’s “Edgar” reporting system yields pretty much nothing — itself eye-catching. 

Its use of financial derivatives known as swaps to build positions might have allowed it to circumvent reporting requirements on big stakes. 

So far there have been about $20bn of stock sales from investment banks, but analysts say more could be in the pipeline. 

How much more though? 

Estimates vary wildly. And are there any other funds that are also being forcibly liquidated, with Archegos merely the first to be identified?

Finally, but most importantly: Can the Archegos collapse trigger a wider financial conflagration, as LTCM did two decades ago? 

Luckily, the answer is probably no — with some caveats. 

LTCM was far bigger, more woven into the fabric of several systemically important markets and its collapse could have taken down several major banks had the authorities not orchestrated a bailout and co-ordinated its dismemberment. 

The Archegos losses will be humiliating to many banks, and in some cases ruin their financial year, but they are much better capitalised since 2008. 

That said, there is a danger that a debacle of this magnitude encourages the entire investment banking industry to scale back how much leverage they offer their hedge fund clients. 

If so, then the forced liquidation of an isolated, gung-ho investment group could become a snowball that triggers a broader hedge fund deleveraging. 

For now, markets are taking the debacle in their stride, but that could still change.