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Ray Dalio - John Mauldin Discussion, Part 5

July 5, 2019

“The belief that wealth subsists not in ideas, attitudes, moral codes, and mental disciplines but in identifiable and static things that can be seized and redistributed is the materialist superstition. It stultified the works of Marx and other prophets of violence and envy. It frustrates every socialist revolutionary who imagines that by seizing the so-called means of production he can capture the crucial capital of an economy. It is the undoing of nearly every conglomerateur who believes he can safely enter new industries by buying rather than by learning them. It confounds every bureaucrat who imagines he can buy the fruits of research and development.

The cost of capturing technology is mastery of the knowledge embodied in the underlying science. The means of entrepreneurs’ production are not land, labor, or capital but minds and hearts.”

“Whatever the inequality of incomes, it is dwarfed by the inequality of contributions to human advancement. As the science fiction writer Robert Heinlein wrote, ‘Throughout history, poverty is the normal condition of man. Advances that permit this norm to be exceeded—here and there, now and then—are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right-thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of society, the people slip back into abject poverty. This is known as bad luck.’

President Obama unconsciously confirmed Heinlein’s sardonic view of human nature in a campaign speech in Iowa: ‘We had reversed the recession, avoided depression, got the economy moving again, but over the last six months we’ve had a run of bad luck.’ All progress comes from the creative minority. Even government-financed research and development, outside the results-oriented military, is mostly wasted. Only the contributions of mind, will, and morality are enduring. The most important question for the future of America is how we treat our entrepreneurs. If our government continues to smear, harass, overtax, and oppressively regulate them, we will be dismayed by how swiftly the engines of American prosperity deteriorate. We will be amazed at how quickly American wealth flees to other countries.”

“Those most acutely threatened by the abuse of American entrepreneurs are the poor. If the rich are stultified by socialism and crony capitalism, the lower economic classes will suffer the most as the horizons of opportunity close. High tax rates and oppressive regulations do not keep anyone from being rich. They prevent poor people from becoming rich. High tax rates do not redistribute incomes or wealth; they redistribute taxpayers—out of productive investment into overseas tax havens and out of offices and factories into beach resorts and municipal bonds. But if the 1 percent and the 0.1 percent are respected and allowed to risk their wealth—and new rebels are allowed to rise up and challenge them—America will continue to be the land where the last regularly become the first by serving others.”

—George Gilder, Knowledge and Power: The Information Theory of Capitalism

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

—John Maynard Keynes, The General Theory of Employment, Interest and Money

“Nothing is more dangerous than a dogmatic worldview – nothing more constraining, more blinding to innovation, more destructive of openness to novelty.”

– Stephen Jay Gould, Dinosaur in a Haystack: Reflections in Natural History

I think Lord Keynes himself would appreciate the irony that he has become the defunct economist under whose influence the academic and bureaucratic classes now toil, slaves to what has become as much a religious belief system as an economic theory. Men and women who display appropriate skepticism on other topics indiscriminately funnel facts and data through a Keynesian filter without ever questioning the basic assumptions. Some go on to prescribe government policies that have profound effects upon the citizens of their nations.

And when those policies create the conditions that engender the income inequality they so righteously oppose, they often prescribe more of the same bad medicine. Like 18th-century physicians applying leeches to their patients, they take comfort that all right-minded people will concur with their recommended treatments.

This is part of an ongoing series of a discussion between Ray Dalio and myself. Today’s installment, adapted from a letter I wrote several years ago, addresses the philosophical problem he is trying to address: income and wealth inequality.

Last week I dealt with the equally significant problem of growing debt in the United States and the rest of the world. The Keynesian tools much of the economic establishment wants to use are exacerbating the problems. Ray would like to solve it with a blend of monetary and fiscal policy, what he calls Monetary Policy 3.

The Problem with Keynesianism

Let’s start with a classic definition of Keynesianism from Wikipedia, so that we can all be comfortable that I’m not coloring the definition with my own bias (and, yes, I admit I have a bias). (Emphasis mine.)

Keynesian economics (or Keynesianism) is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.

The theories forming the basis of Keynesian economics were first presented by the British economist John Maynard Keynes in his book The General Theory of Employment, Interest and Money, published in 1936 during the Great Depression. Keynes contrasted his approach to the aggregate supply-focused “classical” economics that preceded his book. The interpretations of Keynes that followed are contentious, and several schools of economic thought claim his legacy.

Keynesian economists often argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, in particular, monetary policy actions by the central bank and fiscal policy actions by the government, in order to stabilize output over the business cycle. Keynesian economics advocates a mixed economy—predominantly private sector, but with a role for government intervention during recessions.

(Before I launch into a critique of Keynesianism, let me point out that I find much to admire in the thinking of John Maynard Keynes. He was a great economist and taught us a great deal. Further, and this is important, my critique is simplistic. A proper examination of the problems with Keynesianism would require a lengthy paper or a book. We are just skimming along the surface and don’t have time for a deep dive.)

Central banks around the world and much of academia have been totally captured by Keynesian thinking. In the current avant-garde world of neo-Keynesianism, consumer demand—consumption—is everything. Federal Reserve policy is clearly driven by the desire to stimulate demand through lower interest rates and easy money.

And Keynesian economists (of all stripes) want fiscal policy (essentially, government budgets) to increase consumer demand. If the consumer can’t do it, the reasoning goes, then the government should step into the breach. This of course requires deficit spending and borrowed money (including from your local central bank).

Essentially, when a central bank lowers interest rates, it is encouraging banks to lend money to businesses and telling consumers to borrow money to spend. Economists like to see fiscal stimulus at the same time, as well. They point to the numerous recessions that have ended after fiscal stimulus and lower rates were applied. They see the ending of recessions as proof that Keynesian doctrine works.

This thinking has several problems. First, using leverage (borrowed money) to stimulate spending today must by definition reduce consumption in the future. Debt is future consumption denied or future consumption brought forward. Keynesian economists argue that bringing just enough future consumption into the present to stimulate positive growth outweighs the future drag on consumption, as long as there is still positive growth. Leverage just equalizes the ups and downs. This has a certain logic, of course, which is why it is such a widespread belief.

Keynes argued, however, that money borrowed to alleviate recession should be repaid when growth resumes. My reading of Keynes does not suggest he believed in the unending fiscal stimulus his disciples encourage today.

Secondly, as has been well documented by Ken Rogoff and Carmen Reinhart, there comes a point at which too much leverage becomes destructive. There is no exact way to know that point. It arrives when lenders, typically in the private sector, decide that borrowers (whether private or government) might have some difficulty repaying and begin asking for more interest to compensate for their risks. An overleveraged economy can’t afford the higher rates, and economic contraction ensues. Sometimes the contraction is severe, sometimes it can be absorbed. When accompanied by the popping of an economic bubble, it is particularly disastrous and can take a decade or longer to work itself out, as the developed world is finding out now.

Every major “economic miracle” since the end of World War II has been a result of leverage. Often this leverage has been accompanied by stimulative fiscal and monetary policies. Every single “miracle” has ended in tears, with the exception of the current recent runaway expansion in China, which is still in its early stages. (And this is why so many eyes in the investment world are laser-focused on China. Forget about a hard landing or a recession, a simple slowdown in China has profound effects on the rest of the world.)

I would argue (along, I think, with the “Austrian” economist Hayek and other economic schools) that recessions are not the result of insufficient consumption but rather insufficient income. Fiscal and monetary policy should aim to grow incomes over the entire range of the economy. That is best accomplished by making it easier for entrepreneurs and businesspeople to provide goods and services. When businesses increase production, they hire more workers and incomes go up.

Without income, there are no tax revenues to redistribute. Without income and production, nothing of any economic significance happens. Keynes was correct when he observed that recessions are periods of reduced consumption, but that is a result and not a cause.

Entrepreneurs must be willing to create a product or offer a service in the hope there will be sufficient demand for their work. There are no guarantees, and they risk economic peril with their ventures, whether we’re talking about the local bakery or hairdressing shop or Elon Musk trying to compete with the world’s largest automakers. If government or central bank policies hamper their efforts, the economy stagnates.

Many politicians and academics favor Keynesianism because it offers a theory by which government actions can become decisive in the economy. It lets governments and central banks meddle in the economy and feel justified. It allows 12 people sitting in a board room in Washington DC to feel they are in charge of setting the most important price in the world, the price of money (interest rates) of the US dollar and that they know more than the entrepreneurs and businesspeople who are actually in the market risking their own capital every day.

This is essentially the Platonic philosopher king conceit: the hubristic notion that a small group of wise elites is capable of directing the economic actions of a country, no matter how educated or successful the populace has been on its own. And never mind that the world has multiple clear examples of how central controls eventually slow growth and make things worse over time. It is only when free people are allowed to set their own prices of goods and services and, yes, even interest rates, that valid market-clearing prices can be determined. Trying to control them results in one group being favored over another.

In today's world, savers and entrepreneurs are left to eat the crumbs that fall from the plates of the well-connected crony capitalists and live off the income from repressed interest rates. The irony of using “cheap money” to drive consumer demand is that retirees and savers get less money to spend, and that clearly drives their consumption down.

Why is the consumption produced by ballooning debt better than the consumption produced by hard work and savings? This is trickle-down monetary policy, which ironically favors the very large banks and institutions. If you ask Keynesian central bankers if they want to be seen as helping the rich and connected, they will stand back and forcefully tell you “NO!” But that is what happens when you start down the road of financial repression. Someone benefits. So far it has not been Main Street. As George Gilder said,

Those most acutely threatened by the abuse of American entrepreneurs are the poor. If the rich are stultified by socialism and crony capitalism, the lower economic classes will suffer the most as the horizons of opportunity close. High tax rates and oppressive regulations do not keep anyone from being rich. They prevent poor people from becoming rich. High tax rates do not redistribute incomes or wealth; they redistribute taxpayers—out of productive investment into overseas tax havens and out of offices and factories into beach resorts and municipal bonds.

Without Savings, Nothing Happens

Those who were forced to endure Economics 101 may remember that Savings = Investment. In any real-world economic system, you must have savings in order to have investment in order for the economy to grow. Generally, savings are actually leveraged to produce more investments (and thus eventual production and consumption) than if the “profit recipients” had simply spent the money themselves. This will become critically important next week.

This idea that consumption is better than savings is the heart of the Keynesian conceit. Yes, I know, I’ve written many a time about Keynes’s Paradox of Thrift: “It is a good thing for individuals to save, but if everybody saves then there is less consumption.” That seems true on the surface and makes a great sound bite, but it has an inherent flaw. It assumes that savings don’t become investments that increase productivity, which in turn leads to the production of more goods and services, which ultimately creates income, which then creates more demand.

Without savings, nothing happens. Nothing. There has to be capital of some kind from somewhere in order for economic activity to happen. Productivity growth is ultimately a product of savings, and it is productivity growth that will generate an increase in income for the country as a whole. There are consequences to the fact that savings are close to an all-time low.

And when those limited savings go to purchase government bonds, it takes money away from more productive and income-producing endeavors.

A static economy does not raise overall income or wealth. Only an economy that is growing as a result of a healthy level of savings and investment can produce the results Keynesian economists want: increased incomes for everyone.

Your typical Keynesian economist isn’t willing to wait for savings to become investment. They and the politicians they serve want results today. And the only way to get results today is to get people to spend today, while the process of saving and investing takes time.

Neo-Keynesian economists are ultimately teenage children who want the pleasure of consuming today rather than thinking about the future. And I won’t even go into the burden we are placing on future generations by borrowing money to goose our current economy and expecting them to pay that money back. We are building toward a future intergenerational war that is going to be very intense once our children learn how we misspent their future. But that’s yet another letter.

Maine and Montana

Early August sees me in New York for a few days before the annual economic fishing event, Camp Kotok. Then maybe another day in New York before I meet Shane in Montana and spend a few days with my close friend Darrell Cain on Flathead Lake.

After a long day spent in airports, I arrived at my home in Puerto Rico (Shane is in California) in the early evening with the full intent of writing and finishing a much different letter than the one above. Then I realized I did not have the key to the house. Shane and I had talked about dealing with such a contingency, but we never actually did it. That will shortly change. And while the key did materialize some six hours later, the new time constraints forced me to go back to previous material to address what is a serious obstacle to resolving the problems Ray and I see.

Next week, we will look at policies that not only increase savings and investment, but will restart economic growth and put us back on track to more equitable distribution of the economic pie.

And with that I will hit the send button and wish you a great week!

Your hoping to find a balance analyst,

John Mauldin

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james100@rogers.com

July 30, 4:21 p.m.

Ah if only humans acted logically all the time.  Unfortunately they don’t.

Interesting letter and I would only point out that the guy screaming for a rate cut is Trump who is a showman and anything but an economic Keynsian.

I read your collaborator on EndGame book the Myth of Capitalism.  I would love to see you deal with his contention that the oligopolistic economy of the United States is stultifying it’s economy.  These companies are in my view the real bureaucracies not the government people who are end run and bullied by the consultants in to doing what the heads of such companies want

Jim Lovett

Brian McMorris 46364174

July 8, 9:53 a.m.

Richard Gooding:  This idea (from the Left) that in a tight production market that executives will give themselves a raise or buy some equipment rather than hire more or give workers a raise is not logical, therefore, not true.  Labor is subject to the same law of Supply and Demand that products adhere to.  When Supply is tight and Demand increases, then Price must increase.  It is undeniable over centuries of economic proof.  In this case, the Price is of labor.  Labor will be paid more until Labor can be increased (more hired).  If quality executives are in short supply, then yes, this law also applies to upper management. 

@Richard Gooding:  It is the Law of Economic Substitution that dictates if more automated equipment (robots) are purchased.  But from someone in the automation industry, I can say with certainty that labor is often cheaper than equipment, especially at the margin.  Automated equipment is today much harder to train, is less nimble and adaptable that human labor.  That gap is narrowed every year with the advent of AI and better electronics.  But the gap is still considerable and will be for decades.  Labor is not threatened in the short term and humans are adaptable, so will find new ways to make economic contributions as machines do the simpler tasks of manufacturing.

irvrube@gmail.com

July 7, 7:18 p.m.

Mr Mauldin

I have waited till I had a relaxing weekend to read up on Mr Dalio’s 2-part essay and your responses. Being neither an economist nor a seasoned investor, I have learned much from this task and wish I was in academia so that I could digest it among my academic peers, from both sides of the aisle.

As you so wisely admitted, you have your biases re Keynesism and your critique demonstrates them clearly. I feel you failed, however, to undercut Mr Dalio’s argument that our leaders need to review the problem facing capitalism as an existential one even as you agreed that it is. Thus, I await your solutions in future posts. For now, though, I’d like to share my main complaint with this, Part 5, acknowledging my own biases toward restrained Keynesism: that is, government should spend when the economy is in deep do-do, and pay back debt when it recovers. (Note, neither party has been willing to undertake this and, furthermore, both, but especially the GOP, have merely proposed even greater spending and lesser taxation to stifle any chance that surpluses could be directed toward debt repayment.)

When you write, ” That is best accomplished by making it easier for entrepreneurs and businesspeople to provide goods and services. When businesses increase production, they hire more workers and incomes go up,” I feel you are abiding by pre-1980 economic principles.

For one thing, the US is no longer producing many goods compared to those heady post-WW2 days, and the services we’re creating are not achieving or receiving compensation to enable the middle let alone the working classes to thrive. Furthermore, as technologies and global systems advance, entrepreneurs and businesses do not really hire more people, at least not in America, to provide those goods and services at wages worthy of applaud. In fact, jobs that are created, especially for services, are low-paying; and those for manufacture and distribution of goods are no longer sufficient to allow savings let alone move up the socioeconomic ladder. For a company as large as many of our high-tech, information-based companies like Facebook, Amazon, Apple, Google, and even auto manufacture, the relative numbers of employees compared to mega-corporations of yesteryear are slim. And they are also relatively elite so far as educational requirements are concerned.

My recommendation for you and Mr Dalio is to consider that times have changed, populations have increased, and our economic structure is based primarily on credit-backed consumption vs spending restraint. Whether driven by capitalism, cronyism, greed or government deregulation, so long as we face the debt numbers you tout and the large percentage of our population that is undereducated, from broken families and neighborhoods and cities, solutions that do not factor in top-down decision-making that is painful to all spectrums of society will never help. That, in my pessimistic world view, cannot be met by the levers of capital’s smartest investors and managers. Only, as you sardonically say, a Platonic cabal of thinking and feeling leaders with a statesman-like view of the country’s needs can the painful solutions even get a hearing. Thanks.

stefanpreston@me.com

July 7, 4:13 p.m.

If the marginal cost of goods is zero then Keynesian thinking really falls over.  The excess money in the economy cant really go anywhere other than into real assets.  And isn’t it true that large components of our economy are behaving this way?  For example GDP numbers and reported growth is actually depressed by technology gains (eg: digital distribution of goods).  I am surprised that more is not said about this in the Mauldin analysis.

Ty Thompson

July 6, 8:12 p.m.

This is why there’s such a decline in new businesses, low rates are a defacto cap on profits. If you do find a profitable niche, you’ll be promptly approached to sell or you’ll be replicated by someone with good or better credit access. When there’s primarily downside risk, why bother?

Richard DesJardins

July 6, 6:29 p.m.

Who is going to invest in something like BTX or AGE if they don’t think they can get enough to cover both RISK of the venture and some kind of RETURN on the investment?  TODAY WE ARE GETTING ZERO FOR THE RISK, and we hope there is come kind of return on the capital.  We are not getting paid for our savings efforts. Why invest in anything?

amalagoli@gmail.com

July 6, 3:52 p.m.

Dear Mr. Mauldin,

I very much enjoy your response to Ray Dalio’s new old ideas about what amounts to another government bailout of a failing economic system, under the guise of the new popular Modern Monetary Theory. I personally find that MMT has some interesting ideas worth considering, but unfortunately it is now being mis-used to justify yet another Keynesian bailout.

Having said that, I would like to suggest another perspective worth considering. I fully agree with your criticism of the whole keynesian/government intervention framework. However, one needs to understand the real reason of why such ideas come to be. In my analysis, the real problem is not socialism vs capitalism, but crony capitalism vs true capitalism. I do not think that current attraction towards a more redistributive system is driven by desire for socialism, but for a more fair form of capitalism.

The unhappiness with the 1% stems from the perception that our capitalism system is corrupt and biased towards few rich individuals/corporation that can buy government policy with their financial and political influence. If you really want to find a problem with the current system, look no further than Citizens United, which has given large corporations the ability to steer government regulation to their favor. Let’s remember that much government regulation exists not to thwart entrepreneurs per se, but to preserve the status quo of large incumbents. This is one of the reasons why, for example, we have a healthcare system that is resisting cost reducing innovation and is extracting enormous rents from unfair monopolistic advantages.

I think it is time to have a honest discussion about the failures of the current capitalist system and about how to bring it back to a level where true competition and entrepreneurship matter. Let’s talk about removing government regulations, but not the regulations that prevent companies from polluting, instead the regulations that allow big companies to squeeze entrepreneurial competition.

lawrence stirtz

July 6, 1:20 p.m.

is what you describe just two power groups of different positions and therefore opinions duking it out?

Ed Matluck

July 6, 12:42 p.m.

John you are confusing Keynesian economics with classical economics.  the classical economists had a system which was self regulating and always in equilibrium or on its way toward it.  Keynes saw that either this didn’t happen or it took to long for society to endure the wait.  He also didn’t think that the cause of the great depression was insufficient consumption but came up with the idea that in the face of the consumers’ inability to spend government could step in.  This was new and innovative at the time.

Note, our problem today is not insufficient demand!!!  It is low interest rates.  Keynes never said government could micromanage the economy.  Some of his disciples have suggested that but there is little evidence it can be done.

Also inflation is not the reverse problem of insufficient demand.  Businesses will raise prices to preserve margins in the face of falling demand.  We are starting to see that now.  Look at the US auto sector.

Our main problem today is that we have no theory of by the the interaction of a democratic government with a market economy.  They are not independent and there seems to be no way to systematically keep the deficit, created by the politicians, in check with the economy or assign responsibility for it.  The only adjustment mechanism seems to be a crisis.

I would also note that in the modern world the link between investment and growth is changing.  How would you measure the investment that Zuckerberg put into Facebook compared with the entire industry that resulted.  Or the development or Unix which would show up in GDP as a year or 2 of wages and salaries at Bell Labs. yet led to massive productivity and growth.

Note that productivity can increase without conventionally defined investment.  If a person learns to eat healthy their productivity can easily double.  Practicing a job skill raises productivity and may or may not involve the sacrifice of some output.
So the concept of macro economics needs to be refined and what we think of as conventional ideas need to be reexamined.  You are doing a great job of stimulating this process.

Thank You

Ed Matluck

Richard Gooding

July 6, 11:41 a.m.

‘’When businesses increase production, they hire more workers and incomes go up.’’

What happens when business doesn’t hire new workers or give them raises. Instead buying equipment and automating their jobs. Or, giving the money to shareholders, or buying back their stock, or increasing executive salaries, or donating to PAC’s that give them unfair market power to keep out entrepreneurs. If entrepreneurs shared more of the wealth with the workers that created that wealth, we wouldn’t be where we are today. Instead that wealth has been used to undermine the worker’s power. Instead of owning four $5M homes why not pay your employees enough so the can own one home? I’ve heard some entrepreneurs refer to it as “f__k you money”.

The issue isn’t one way or the other. The issue is the balance between the benefits that go to workers and the benefits that go to owners/entrepreneurs. Would you propose that we do away with ALL taxes? Let business decide what it wants to contribute to the common good. Get government out of protecting its citizens or making America truly great.

One other issue. If you are for free markets, how much of the government debt is tied to bailing out businesses that made bad decisions or subsidies to industries that need to die. It’s okay to spend tax money on these but not education or health care.

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