The stock market is a forward discounting mechanism.

How much forward?

It seems quite a lot judging by this chart above.

At 28.6% return YTD, the S&P Index is on course to one of its best years on record. Going back to 1927, only 10 years have seen more than 30% returns. It will also wrap up a spectacular decade for the index: with still a few days left in 2019, it can still beat 2013, the best year of this past decade, which finished just shy of 30%, at 29.6%.

While US corporate profits have remained flat since 2012, the S&P Index has doubled. That’s a lot of discounting. But that pales in comparisons to Apple’s share price which has doubled from the lows this year, while its revenue is down during that period (latest numbers for Apple are only as of Q3, so things may change with Q4 numbers released).

To be fair, the spectacular performance of US stocks this last decade may be just catching up with the previous decade (2000-2009) during which S&P 500 Index declined while US corporate profits increased 2.5x. So, starting point matters.

Therefore, it is best to look at the long term-chart, at the beginning of the post, going back to 1947.  S&P Index and US corporate profits moved hand in hand until the early 1980s when US financialization kicked in (shareholders primacy and the share buybacks era). There had been, of course, some going back and forth between the two even before 1980 but at the beginning of the 1980s they were ‘on top of each other’.

The volatility between the two sharply increased thereafter. Stocks raced higher and while corporate profits also grew, the growth rate of the S&P index outperformed. Then in the mid-1990s, corporate profits stopped growing but the S&P index continued to race higher. The dotcom crisis and the 2008 financial crisis served as a reset but it still took until 2012 for US corporate profits to ‘catch up’ to US stocks.

The time post 2012 seems very similar to the 1995-2000 period whereby corporate profits did not grow but US stocks rose nevertheless. Only this time, at the end of 2019, the disconnect between the two seems to be the most extreme ever.

The stock market is a forward discounting mechanism indeed, but judging from history a reset is more likely to ‘justify’ that discounting. One problem though: no one can claim to know when that will happen.

!! ⚠️ CAUTION! MAY CAUSE EXTREME BOREDOM ⚠️!!

YOU’VE BEEN WARNED

OK. *breathes in*

Let’s do this.

We only spent around 4 weeks in China, but by then, I had noticed some recurrent behaviour traits:

– Ill manners: rudness was pervasive. It was present mostly at train stations: I was shocked to see grown-ups fighting like children, pushing past each other to get on the carriage and to grab a seat, even before others had gotten off. So, most of the time, we ended up standing in the carriage. I watched other passengers to see if this bothered them, but they turned a blind eye whenever this happened. It must be cultural norm, I then thought.

Similarly, in the Forbidden City, Beijing, which was incredibly busy, people were always shoving past each other to take a picture. I almost dropped my phone on several occasions, which would have been a disaster, since I had just repaired it (in Xi’an😄).

– Littering: The Chinese government seems to buy into some basic environmental policy by providing lots of bins and cleaners everywhere, even on the station and running trains! Unfortunately, the citizens don’t seem to share the same environmental concerns and regularly disregard any common rules on disposing of garbage or personal fluids.

We witnessed many examples of this. A particularly amusing one, for me, was on the tube where a young boy eating a chocolate bar subtly dropped the wrapper under the seats and pushed it away with his leg. Apart us pointing and chuckling no one else seemed bothered.

Unfortunately it wasn’t just big city behavior. While descending down the Yellow Mountains a man, ignoring the bin situated right by his feet, threw a bottle deep down the cliff, left to decompose for eternity. In the same countryside experience, people were smoking in non-smoking areas (while, in smoking areas, even though there were plenty of people, no-one was smoking!).

Generally speaking it was also hard not to witness constant relieving of personal fluids. People seemed unfussy about opening their zipper and urinate whenever nature called. Also, my mum had warned me of the cultural habit of spitting and I’ve been wary since then. Once, at a cafe, after seeing a man outside the window spitting all over the ground I made sure I kept track of where it went so that, when we left, I avoided the spitwads. After that little episode, I noticed that every now and then, somebody would lean over and dispose of their saliva.

To be honest, by the time we ended up in Beijing I grew quite disgusted with the amount of people spitting and littering. It really hit me at the Beijing stadium where Coke cans and tissues were strewn across the grass.

– Aseptic nature: It looks like the Chinese government also feels responsible for taming nature to fit neatly into an health and safety proof entertainment.

This was evident in the Yellow Mountains again. All throughout the walk, we were accompanied by built-in stairs and handrails which seemed completely at odds with the idea of mountaineering. In addition, a service of a chair manually carried was offered. I mean, it would make sense if there was a real necessity but I witnessed a young child carried on the chair, while playing on his phone (and people complain that the new generation are too lazy! Maybe that’s due to the naive parents who turn their head away when their children sit on the couch, watching TV or play video games all day long) .

In the Gobi Desert we encountered a similiar approach. Planks of wood and handrail were built across some of the dunes! We, of course, took the longer and fun way up, old school, climbing up the sand, barefooted.

The Silver cave at Yuangshan, an impressive work of nature on its own right, had also been subject to the beautification process. Man-made lights were set up to make the cave seem so much more dazzling, but it felt unnatural and artificial, because it removed the sense of nature’s accomplishment and replaced it with what human civilization has made.

I reminiscented of the days where we would hike in the countryside in Britain. The most civilised works would be the gates to keep out the aggressive cows.

I personally found it hard to enjoy the works of nature when works of humanity were clearly present, begging for attention.

– Friendliness (or lack of): Overall, in China, people’s attitude towards foreigners seemed either extremely unfriendly and unhelpful oral as extremely friendly and generous. We were lucky enough to encounter some of the latter. Random people offered us their help and some taxi drivers did try their best to understand us and get us to our destination (even though they often struggled to understand the Western name of the place we wanted to go to).

China may get plenty of tourists, but we still attracted many curious locals. Once, in Dunghuan, we stopped by a restaurant owned by a family with two boys. The children, who were studying late in the night, were particularly curious and we developed a bond and had a great conversation. They even taught us how to hold chopsticks properly, which was a relief, because since then it wasn’t such a struggle to eat food.

It also became obvious to me that the Chinese have a little pet peeve about loose laces. Every now and then, my shoelaces would undo themselves and a random stranger on the street would pat me on the shoulder and gesture to my shoe. Once a man even went as far as lifting up one leg while walking to point at his own shoe (since he probably couldn’t speak English) and gesturing to me. Another time, I was playing with my sister and this woman shouted across the entire room, frantically pointing at my undone shoelaces. And no, I’m not exaggerating.

– Cuteness: Another thing that perplexed me was how the society was eager to educate children through cartoons. For instance, short clips of safety were presented on the TVs in the trains. I can see why it makes sense though, because these children are going to be the next generation – among the cluster of kids, included a future president, teacher, soldier, doctor. These were going to be people who could possibly change the course of history and the Chinese society is determined to bring the best out of them.

Moving on to Dunghuan, I spotted a cute dog on the streets. Many were present throughout our journey on the Silk Road and they were all homeless. So, I was wary about stroking it, but it was still a cute animal. We had carried on walking and then I realised the dog was following us. At some point, we were inside a shop buying breakfast and the dog was waiting outside for us. Here’s a picture to show just how adorable it was.

The dog followed us the whole way. Unfortunately that day we were leaving to go to Zhangye so it broke my heart to see the dog scampering after the car we drove away in.

I wonder if it will ever think about me.

– Spices (and crawlies): If there’s one thing that was common in China, it was spices. The pungent substances were everywhere. Almost every dish we ate had spices. Plenty of shops in the market were selling spices. What would be a lot of spice to us would be very little spice for the Chinese. In addition, in Beijing, I spotted some live baby scorpions on a stick sold as food, which totally freaked me out. Even now (writing this in Myanmar) I shudder at the mere thought of these tiny animals squirming and wiggling.

To conclude: while China does offer excellent sights and polite locals, littering, smoking and spitting is present almost everywhere and you are bound to be shoved by people, adamant to get on the train. It was an experience like no other and I wonder if I will see things differently when (and if) I return to London.

And that’s China for you, folks.

*curtains close*
*applause*

Low productivity is the least of our problems. Why would we want to produce more output, when there is no one able to consume it, is beyond me. If we take care of our stagnating aggregate incomes and put more real purchasing power in the consumers’ wallets, productivity will take care of itself. However, it is a fact that the 200-year old Industrial Revolution-time model of income generation and distribution has broken down due to the spread of globalization and the rise of sophisticated technology which displaces even cognitive and non-routine human jobs. The problem is that we keep wanting to fix it instead of coming up with a new model which fits better our economic realities.

• Low wages are not a result of low productivity. It is the other way around.
• If full employment comes at the cost of lower wages, purchasing power may not rise and aggregate demand may not rise->output stagnates.
• Stagnating numerator (output) and a rising denominator (employment)-> decreasing productivity.
• Work dynamics have changed dramatically. The 200-yr old distribution model of Work=Job=Income is broken.
• Machines are cheaper, more efficient and smarter than humans in increasingly more industry sectors.
• The rate of growth of human cognitive skills (education and training) is unlikely to keep pace with the rate of growth of machine learning.
• IBM Watson reads 1m books per second (now probably even more): 100k of human evolution is now ‘equal’ to 7 minutes of machine learning.
• New ‘job’ creation in the digital era will happen but is unlikely to keep pace with the destruction of old jobs.
• We will always want to work but do we need a job? If we create AGI but insist on people having a job for survival, we would have totally failed.

• In a free-floating fiat currency regime, sovereign bonds are the same as sovereign cash. They do not represent a promise to pay. Rather they are an accounting concept used to measure economic activity over time.
• There is no bubble in sovereign bonds and the concept of valuation here is meaningless. Bonds are different from any other asset class because they have a terminal value and a maturity structure. They are simple math. No need to put bells and whistles there.
• If the risk of default of a sovereign bond is 0%, then the only other risk is inflation. If also inflation is 0%? We happily hold risk-free currency in our pockets. Sovereign bonds are just like a savings account with the government instead of a private bank. How much do you get for a 1-year CD with your local bank at the moment? Why should 1-year T-bills yield 100bps more given that it is also better credit?
• There is no natural rate of interest. Economics is a social science and there are many different equilibria.
• However, over the very long run, interest rates have fallen from 25% in Babylonian times to almost 0% now in a consistent fashion through the ages. This is a result of the inevitable advances of innovation and the subsequent creation of extra surplus capital accumulation. There is no mean reversion in interest rates.
• The only time interest rates have deviated from this long-term decline is when there has been a disruption on the supply side which had resulted in the subsequent destruction of capital. Wars and natural disasters or trade barriers and embargoes could be the cause of this. 
• Negative interest rates are just one state of equilibrium. It may seem that they are central-bank imposed, however, the central bank only follows the market forces in their attempt to manage the debt burden.
• Every single attempt by the central banks in the developed world to raise interest rates post the 1980s has been unnecessary as the economy has had plenty of surplus capital and labor on the back of years of peaceful technological advancement and no negative supply shocks. It has also backfired and led to recessions because of the increasing debt burdens.
• Recessions are a balancing act. However, if economic balances are not resolved each following recession becomes more severe than the preceding one.
• As the economy moves away from manufacturing, which requires heavy upfront investment, to services which require much less investment, and now to digital technologies which require even less investment, interest rates substantially lose their power to affect economic activity.
• If it were not for externally-driven rising healthcare and education costs, US would have fallen in a deflation already in the mid-1990s.
• If it was not for the decline in the labor participation rate after the 2008 financial crisis, the US unemployment rate would have been much higher. In addition, the jobs created in the last 8 years are predominantly in the service sector, low-wage, and in many cases, without benefits.
• Yet interest rates affect the balance sheet of the financial sector. However, the effect is asymmetric. Lower rates push asset prices higher and make debts easier to service, but they do not cause an economic boom. Higher rates, on the other hand, cause asset prices to fall, but do nothing to liabilities which stay unchanged. This creates financial imbalances which eventually also cause economic imbalances.
• Therefore, central bank interest rate policy may be effective in managing the financial economy but it can become a lose-lose game in servicing the real economy.
• As a result, on one hand, there is an increasing demand for the medium of exchange from income-poor and debt-laden private citizens and for the unit of safety from savings-rich creditors. And, on the other hand, there is inadequate supply of both from the public sector.
• This is not a recent phenomenon. We had a similar environment in the early 2000s. The market responded by creating fake-safe private assets (repackaged mortgage CDOs and the likes) which allowed the income-poor to buy real estate while it also provided a seemingly safe-haven for the savings-rich.
• That did not work out well eventually.
• The rise of cryptocurrencies in the last few years is just the more modern equivalent of these fake-safe assets. They are a result of the advances in technology but they also are a response to this broken monetary transmission mechanism which eventually led to the current inefficient income generation model.   
• Cryptocurrencies simply fill in the void left by the central bank in its refusal to extend its balance sheet to the public at large. There is no other way for the public to receive the medium of exchange other than direct from the central bank at no cost: the private debt super-cycle in the developed world reached its peak in 2008, while the Work=Job=Income model broke down already in the 1990s.  
• In the past, we used to call this kind of money creation by the central bank/government direct, “helicopter money”. It has a lot of negative connotations because of recent historical examples of autocratic rulers printing more money than the economy needed (and often for their own personal use). However, there are plenty of examples in earlier history when “helicopter money” actually worked in restoring and stabilizing economic growth.
• Examples of that are the Roman Republic and the Song Dynasty in China when there was a solid institutional infrastructure guaranteeing social accountability.
• The modern equivalent of “helicopter money” is central bank digital cash (CBDC – or some version of that). Given the rapid spread of cryptocurrencies, CBDC is inevitable. I wonder, though, whether CBDC would only be introduced after the next financial crisis forces the authorities’ hand.
• In the present environment of large capital and labor surpluses, CBDC is unlikely to cause a runaway inflation unless it really is misused. The existence of solid institutional infrastructure in the developed world, however, makes that less likely.
• However, there are still technical hurdles to the wider use of CBDC. Even with good intentions and with impeccable system of checks and balances, the world is too complex for human central planning.
• What is the right amount of CBDC to inject in the economy? For how long? Does everyone get the same amount? Etc.  
• Luckily, harnessing the enormous amount of data we have created using advanced machine learning and with the help of the blockchain to organize and store it, policy makers can draw conclusions about economic activity in real-time and thus supply the medium of exchange on demand.
• Technological advances causing bigger and bigger capital and labor surpluses, the move from services to the digital economy causing lower and lower demand for investments, the introduction of CBDC making interest rate policy obsolete, what happens to our savings? What use is it to us? Can we live without financial assets?
• This is not a trick question. Developed world governments have been buying up their own debt back and corporates have been buying back their own shares. Maybe that is a trend reflecting the new economic reality as described above…