This article is authored by MOI Global instructor Roshan Padamadan, chairman of Luminance Capital.
Roshan is an instructor at European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.
It is October 2022, and it has been a year full of macro events – the Russian invasion of Ukraine; rising and persistent inflation; sharp interest rates hikes in the US; massive devaluation in the currencies of Japan, Eurozone, and the UK; as well as high commodity prices, while at the same time, expectations of a recession in the US are widespread.
I wish to approach the macro situation in an unconventional way: Let’s explain it to a Martian.
We are usually so caught up in the micro that we miss the macro wave(s).
Let’s consider the key ingredients of the last two decades:
- Bursting of the US housing bubble (2006-2007)
- Subsequent bailout (2008-2009)
- Covid pandemic (2019-2020)
- Stimulus packages (2020+)
These crises were large, but the impact was contained by massive stimulus packages, involving major increases in the Fed balance sheet.
Dear Mr. Martian,
We use untethered currencies on earth, i.e., no currency is pegged to a fixed measure of value. At one time we used gold, and we measured the strength of a country in part based on its gold reserves. We went off the gold standard in 1971, but still keep track of the size of a country’s gold reserves.
Time dilation. Things can be moved back and forth in time. The impact was contained, yes, but the impact was just spread out. Here are the questions we need to understand:
- Who paid for the 2008 bailout?
- Who paid for the 2020 stimulus packages?
Most people on earth will say the government. But the government is a framework, there is no real person, with a big fat purse and a big heart. It is an artificial “company”, with a balance sheet and P&L and cash flow, just like any company. True, it has some special powers such as it can enact laws, and raise or reduce taxes, etc.
I have found it useful to think of the government as a passthrough mechanism, doing swaps all the time between groups of people, both present and future groups, acting as a giant exchange. It can and often does pass through things to the next generation, who do not yet have voting power.
Mr. Martin, please understand: While the government moves value from one set of people to another, the direction of money flow is determined by the political structure, the current ethos and the overall culture of the nation. An extreme form is where all wealth moves to the top (a dictatorship or an absolute monarch). No major economy on earth is run that way now. Some move money from the masses to the rich. Some move money from the rich to the masses. Most do both at the same time, albeit in unequal amounts.
For the 2008 bailout, the answer is that the savers paid for the bailout. They received and continue to receive sub-par returns on their savings dollars. The extra margin was used to recapitalize the banks – and the US government made back its money when bank share rose (as it got paid in warrants). (Ah, yes, Mr. Martian, they became an investor in the sector they rescued).
Mr. Martian, the governments can do time dilation – they can move things from the present to the future. A trillion dollar bailout can be arranged in a day or a week, with a view to recover it over the next ten years or so.
Unlimited credit is one way where time dilation comes in. People who play Monopoly (a board game popular on our planet) in a friendly way realize that the game never ends if you give unlimited credit to your broke friend. The game goes on ad infinitum until someone cuts the credit line, and someone exits the game having run out of money.
Mr. Martian, our government can do “unlimited” (not so, I will explain shortly) credit, and thus can move things from the present to the future. This is how the massive pain of 2020 lockdowns was averted – we gave people money. But the (small) businesses which did not see footfalls and still kept their shops open for weeks and months in the hope of a quick recovery, still suffered massive losses on their business (and personal) balance sheets. Hordes of shops closed down and I see empty stores in so many malls across Singapore, New York, St. Louis – in 2022.
This is a delayed recession. Airlines may be running full, but their balance sheets are debt-laden, and they are in worse shape than before. Current business boom cannot substitute for two years of lost revenue and massive losses. Covid-19 should have caused an immediate and massive recession – our governments moved it out by a few years.
Our governments are still limited in that they have limited resources – all rescues must be paid by someone, and our savers are already only getting only ~0.1% for their assets, still paying for the last housing crisis bailout, so there is no one else to take money from, for a continuous bailout. Therefore the government’s unlimited credit potential is a fallacy – it is indeed limited.
What happens next, you ask?
Next, we will tax the masses. We will raise GST or equivalent, asking consumers to pay. Even Singapore is raising its GST from 7% to 8%, come 1 Jan 2023. That’s a 14%+ increase. (Singapore is one of the few countries that run a government surplus. Most countries on earth spend more than they earn).
New taxes will be introduced across countries.
Who will it hit? All.
Who will pay more? The people with assets. Naturally.
Mr. Martian, why does Europe buy its energy from a country it is sanctioning, you ask?
This one I have not figured out yet. And this is one reason why the war may end sooner rather than later. A Russian retaliation by cutting off gas supplies to Europe in winter will be devastating. Germany, Italy, Netherlands, even Switzerland import most of their power from Russia. Gas pipelines are interconnected, so even if you are not connected to Russia, when Russia cuts off gas, all of Western Europe suffers. The Eiffel Tower now shuts off its lights an hour early, but this is a drop in the ocean compared to what France and rest of Europe will have to endure if the war stretches to the winter. I see zero appetite for such sacrifices.
What if it doesn’t end, you ask?
Well, this will be the last time I write a macro view.
Still, what would I do, you ask?
Mr. Martian, in a true world war, you only true capital will be your human capital (what you know). And your social capital (who you know). Who can you count on when you have nothing at all? Can you make friends quickly in a new country(planet)? Do you have friends all over the world? Are you resourceful and can start from zero in a new place? These will matter most.
Most of your material possessions you cannot take with you if you are displaced. Your bank assets may be frozen or inaccessible from a foreign county. You can take a few pieces of gold, or sneak jewels sown into your clothes. Rolex watches and cigarettes may become informal currency in a refugee camp. But there are limitations to such plans. You may still be robbed if you are the only one who thought of some smart way to take gold with you. You may be robbed if you are disliked. Ultimately, it is the human capital and social capital which will matter.
Where would I go, you ask?
Mr. Martian, if WWIII really breaks out, I would head far away, to New Zealand, if the borders remain open. If it weren’t for 75% of its gas coming from Russia, I would have gone to Denmark. It was the only country where the Danes united and saved the Jews in WWII. I am not a Jew, but I like the spirit. An entire country working as one, to save its Jewish population from Hitler’s purges, shipping them away to Sweden. It is a gripping story for another day.
I exaggerate, you say, with talks of migration and refugee camps, etc.?
Mr. Martian, people are moving away from their homes in Russia to avoid a compulsory military draft. 100,000 people have moved in just two weeks, according to estimates. We must keep following all the micro dots, to make sure we do not miss the macro wave.
I will end with an investment angle.
Mr. Martian, the reason the US dollar is so strong is simple: it is the economy with the most dynamism. Printing more money does not create true value – it is only created by productivity gains, driven by innovation. Technology stands for a better way of doing things – in any sector. Tech is not limited to Technology names. It can be applied to a copper smelter, a printing press, a miner, and not just to a company figuring out a better way to show you more relevant ads.
By and large, US has the best tech – across sectors. The labor force is nimble, agile and highly organized and productive. I have personally worked with Japanese, Indian, German, British and American companies. I can vouch for the immense productivity at the American ones.
So, you see, I put the strength of the dollar on the dynamism of the American economy. True, it has its challenges, but it is the most likely to address them, adjusting and innovating.
Thanks for the chat, Mr. Martian. I hope you got some insights.
We are seeing the effects of a delayed recession, caused by time dilation. We must accept the pain of higher interest rates- it is the cold water needed to cool down the economy. Our governments do not have unlimited firepower of any sort.
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