Capital Flows and Asset Markets

I am a member of club in London that is somehow the best night out in London mid-week, while simultaneously the home of conservative thinking in the UK. I joined for the partying, but recently I have been frequenting this club to access their library of books on conservative thinking. Neo-conservative thinking has never really made sense to me. And as I thought it was not that important, and to be honest, largely discredited after the second Iraq war, something I could safely ignore. But reading Peter Thiel, I thought I should read more conservative writings to try and get an idea of where they are coming from. Intriguingly, it did not take long before the name Strauss popped up again. And even more intriguingly so did the name Hobsbawm. I knew I was on the right track.

Broadly speaking the ideas I took from a 2004 book (not pictured - but very similar version) edited by the “godfather” of neo-conservative, Irving Kristol, can be summarised as thus:

1 - America is a uniquely special nation. It's freedom makes it the natural leader of the world. Any nation that rejects the US as leader will have to define itself anti-US and anti-freedom.

2 - To defend this position as a world leader the US is completely justified in pre-emptively attacking or constraining rivals.

3 - Fiscal deficits do not matter. The US government should spend to create the society that is wishes to have. Spending on people that the government “likes” should be generous. The book specifically mentions pensioners are ideal recipients of welfare.

4 - Multinational organisations are there to limit US power and should be treated as hostile.

5 - Corporations are “good” for the lack of a better word and should be supported.

6 - Conservatism in Europe is weak as they lack the imperial ambition and belief of the US.

While President George W. Bush was seen as a neo-conservative (or at least surrounded by neo-conservative), President Trump is a much fuller expression of neo-conservative beliefs. Under President Bush, the US greatly underperformed the Chinese stock market (to be fair in 2000 - neither China or Russia was seen as a threat to the US), but from 2016 onwards in particular, US equities have massively outperformed Chinese equities.

Many macro and mean reversion style investors see the above chart, and want to buy China, sell the US. And given this how most investors made their names from 2000 to 2010, this is is understandable. But there are so many difference between 2000 and 2024, I am not sure traditional macro analysis works. One example is the US fiscal deficit. It was surplus in 2000, and deficit today.

I think the easiest way to understand the difference is neo-conservative policy is that it aims to reduce power of government as much as possible. The easiest way to do this is to reduce the revenue raising power, and the rise of big tech has meant that a large portion of wealth in the US is now untaxed. Share buyback transfers wealth in the most tax efficient way possible, and the ability to borrow against shares allows owner to avoid selling and realising capital gains tax. Back in 2000, companies and shareholders were much keener on selling shares, hence the fiscal surplus. This also explains why share count for the S&P continues to fall.

One thing about neo-conservative policy is that it is very good for equities (corporates) and bad for bonds. The relationship between SPX and treasuries reflects this strongly in recent years.

Interestingly, Japan is also showing a similar relationship, with equities and bonds going in opposite directions.

In practical terms, neo-conservatism is anti free trade as it strengthens rivals -Europe and China in this case. One thing that is clear to me about neo-conservative policy is that it is not really “pro-labour”. We have begun to see that with many US consumer facing stocks beginning to weaken as real wages fall. Japan is also seeing real wages fall despite low unemployment. Neo-conservatism is only pro-labour in so much as it is hostile to free trade. That is it does not want its corporates to use China. It is also clear in the use of policy to protect sectors like the tech industry from competition, while not demanding any tax from them - in stark contrast to FDR. Current US tax policy that allows US corporates to avoid taxation outside of the US would fit in with this view.

Neo-conservatism also suggests that active sabotage of other nations is also acceptable. For example, the destruction of the Nord Stream pipeline from Russia to Germany would benefit US natural gas exporters and harm both the Russian and European economies. There is of course no proof of US involvement- but it would be one of the few nations with the ability and motive to carry out such an operation.

So what are the risks to current neo-conservatism economic policy. There are numerous, but so far seemingly contained. It heightens risk of conflict in the rest of the world (by design). We now have war in Ukraine/Russia and Israel/Middle East. China has greatly increased pressure on Taiwan. This is in many way what neo-conservative policy wants - as it secures US pre-eminence. Even if China is aware that US is baiting them into aggression, politically it is difficult to resist, as American tariffs and other polices strengthen the voices of hawks in China. China now far more frequently violates Taiwan’s air defence identification zone (ADIZ).

Rising conflict globally drives more capital back to the US, which helps fund the US in a virtuous cycle. As a child of globalisation, neoconservative thinking does not come to me naturally. Generally I would take the view that war and conflict should be avoided. That being said, it looks to me like neo-conservative thinking is now embedded totally in the Republican party, and partially in the Democratic party (hostility to China). The Supreme Court also seems very neo-conservative in its view of corporates as “good” and government as “bad”. So neo-conservatism is here to stay for the foreseeable future - particularly after Biden’s horrible debate performance. For me, all the favourite macro, mean-reversion trades look to be a disaster. I see SPX/TLT continuing to do well (government spends to keep corporates doing well, and avoids raising taxes). I see GLD/TLT doing well as war tends to be good for gold and bad for bonds. I see Yen continuing to be weak, as it suits US policy to continue to put economic pressure on China. That is current markets are all being driven by neo-conservative policy. It ends when US policy ends - and politically the chances of that is fading into the distance.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

In my recent post, “Modern Marxist Theory” I argued that if Marx was resurrected today, he would predict an economic crisis from corporate and capitalists seeking to minimise and avoid tax, and hence hollowing out the financial capacity of the state. For me the obvious political response to this would be a enacting antitrust and tax reform, and restoring power to labour and unions. This was a left wing view of the world, so for balance I wondered where I could find a coherent right wing view of the world.

Coherent right wing thinking can be hard to come by. Many of the current day right wing thinkers are better considered as reactionaries rather than as coherent thinkers. After some thought, I wondered if the thinking of Peter Thiel would offer some insights. I did know that Peter Thiel was a major supporter of President Trump in 2016. Given his success across many different businesses I thought I should try and understand where he was coming. I spent the afternoon reading Peter Thiel, namely his essay, the Straussian Moment. My first thought was that this essay is almost deliberately opaque - constantly referencing other writers and philosophers, and written in a way that is hard to follow. But halfway through the essay, he reveals his reasons:

In essence, back in 2007, Thiel was trying to say that he disagreed with the way politics was working, but was so contrarian in his thinking, he needed to hide the meaning of his essay in plain sight. And the meaning, as I understand it, is that conflict is necessary. While the West will try and remain true to its ideals, of “live and let live”, there will remain foes who will relentlessly attack the West, using these exact liberal attitudes against the West. And the only way for the West to survive is to fight. Or to put it in other words, war is inevitable.

The conflict Thiel sees is between a Christian West and the rest of the world. In the western world, the continual battle between the church and capitalists in the 1600s onwards, eventually led to a détente, where “live and let live” became the fundamental governing tenet. The USA was established with the tenet, and has become the fully realised version of capitalism and individualism. However, in non-Western world, this idea has not taken hold. In simple terms, and in the words of President Reagan, in the US, the state works for the people, while in the rest of the world, the people work for the state . Hence the West, and the USA in particular, will be in constant conflict with other parts of the world until they come to their own internal accommodation of “live and let live”. The original premise of globalisation was that the whole world would come to govern and rule in the same manner as the west, and Thiel argues this is a pipe dream.

Ultimately this difference means that conflict is unavoidable, as much as a Western “live and let live” attitude wants to avoid this. If conflict is unavoidable, then policies that seek to avoid it are pointless and a waste of time. The old Freidman idea of countries that trade with each other do not go to war with each other as the cornerstone of globalisation has been disproved. From this point of view, you can understand the anti-globalisation movement, and general hostility of liberal policies. They are seen as strengthening the enemy, while weakening the US and the free West.

Born in 1974, and the end of the Vietnam War, and the last war that had conscription in Australia, I am a “peace baby”. Avoiding war seems like a good idea to me, which is why I thought Brexit which weakened the Eurozone, which was set up to end war in Europe, was a bad idea. I also thought President Trump and his hostile attitude to China was also a bad idea. But, one thing I have to admit, is that the logic of conflict and war is predictable. Once the US identified China as an enemy, then ultimately US actions will provoke a Chinese reaction, and hawkish members on both side will have been proven correct. Once this vicious cycle begins, its is very hard to stop. Given that left wing government in the West have adopted a hostile attitude to China as well, then this vicious cycle looks to have begun. War and conflict seem inevitable to me.

To Thiel’s credit, this note was published in 2007, when the US and China were still friends. As far as I can tell he has acted in accordance with the logic of his essay, and has done very well for himself. Straussian logic would imply that US policy has gone from favouring global order, to favouring global disorder. In financial terms US assets will do well, while the rest of the world would suffer. This is exactly what has happened - MSCI US has massively outperformed MSCI World.

This has also led the US to be richer that it has ever been. I see this as a policy that explicit favours US corporates over foreign corporates, as seen in tax policy, and industrial policy. US net worth to GDP is also surging to new high. Politically, to buy corporate compliance with the end of free trade, policies that enhance wealth have been embraced. US tax policy on overseas profits I find heavily favour US corporates over European and Asian corporates. Below is US net worth to GDP.

And the long term relationship of the S&P to US Treasuries has completely broken down. I see this as the US not really caring about foreign creditors anymore. In fact, it is easy for me to see a future where the US chooses not to pay interest or principal on treasuries held by the Chinese. Or to put it another way, Americans own equities, foreigners own treasuries.

The problem is that US behaviour really leaves China with no option but go to war. Tariffs and financial restrictions have left China with over capacity that is leading to deflation. This is in stark contrast to the rest of the world.

Deteriorating economic conditions, and over capacity can be solved by going to war. It creates huge demand, and increases employment. It also has the benefit of rallying the public behind the government. I have always been sceptical of China going to war - culturally China has tended to assimilate rather than invade, but Theilian logic has convinced me that war is inevitable. What is a war trade? Long gold/short treasuries works for me. And it has already traded well.

US ally Japan has probably also moved policy from order to disorder. A weak Yen is good for Japan, but bad for the rest of Asia. A remilitarising Japan is probably good for Japan, and bad of the rest of Asia. Legacy Japanese weapon maker Mitsubishi Heavy (maker of the Zero fighter) has already reflected this new world order.

As I read Thiel I was reminded of an essay “Why American Hegemony Is Different From Britain’s Empire” by socialist historian Eric Hobsbawm, also published in 2007. In it he notes the Britain recognised the winds of change post World War II earlier than other empires, and adjusted course earlier. That is it granted independence to most of the Empire, rather than trying to fight to preserve it. Hobsbawm asks: “Will the US learn this lesson, or will it be tempted to maintain an eroding global position by relying on politico-military force, and in so doing promote not global order but disorder, not global peace but conflict, not the advance of civilisation but barbarism?” When right wing and left wing thinkers come to the same conclusion, then its hard to argue they are pushing an agenda, but making realistic conclusions based on solid analysis. War is an extremely pro-labour policy - almost unlimited demand for labour, and generally bad for financial assets. I thought food inflation would drive pro-labour policies. It looks like war instead. A golden era of peace and prosperity is coming to an end.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

This is a free preview of a paid episode. To hear more, visit www.russell-clark.com

I was first interested in Restaurant Brands International (QSR US) when a huge disconnect opened up between its listed subsidiaries and the parent company. The listed Brazilian operator of Burger King restaurants (Zampa) is down 90% over the last 5 years, while QSR is flat.

With Bill Ackman being a big owner of QSR US, and announcing a stake sale, I thought I would have another look. QSR gets most of its sales from Burger King, particularly in international sales, but even adding those numbers back, Tim Hortons, a Canadian coffee and bakery focused chain is the biggest profit contributor.

Reading between the lines, profitability is greater in North America than elsewhere for Burger King, something we have also seen at Domino’s Pizza. With Tim Hortons almost exclusively based in Canada and the USA, this leads it to be a much more profitable business.

This is a free preview of a paid episode. To hear more, visit www.russell-clark.com

I have been thinking about the portfolio a lot recently. One reason is that I have been calling for higher inflation for a long time, and put a range of “inflationary"“ trades on - various long commodity trades, as well as long banks, while putting a range of short short interest rates sensitive trades on. The idea was to diversify away from the core GLD/TLT trade - but rather than diversify, I was getting what fund managers call “di-worse-ify”. If I had to give a reason, it would be that China is pursing a deflationary policy, while the US is pursuing an inflationary policy. And in industrial commodity world, China policy dominates

Much of my analysis on bonds highlights that the traditional centre of politics has lost its appeal, and voters are craving change, which has led to rising vote shares for extreme left and right with parties, or the takeover by traditional parties by extremist elements. I have expressed a wish for a modern day FDR who could forge a new political consensus and centre. This may seem like wishful thinking, but many of the policy planks are in place, just waiting for a generational politician like FDR, Reagan or Thatcher to promote.

In essence there are two policy areas needed - one to raise wages, or to increase the share of GDP going to labour. And the second is pay for it - which involves taxation. I will write this from a UK perspective, but broadly speaking the ideas generalise.

Increasing Labour Share

* Abandon the WTO and free trade policies - tariffs to promotes wages and tax collection

This has largely occurred anyway, but to explicitly state that trade policy will be enacted to the benefits of workers, or domestic corporates that agree to rising wages would be a clear FDR-style policy. Currently tariffs are applied to “strategic competitors” like China. I believe that tariffs should also be applied to any nation that is undercutting wages (Japan and its weak yen policy) or undercutting taxes (Ireland and its corporate tax policy). This is necessary to incentivise good behaviour.

* Harmonise tax rates for Labour and Capital

Current tax system encourages income to be recognised as capital, distorting much of the system. Income sources should face a single tax rate.

* Tie immigration to house prices.

When house prices are high relative to income, immigration should be heavily curtailed, and when house prices are low, higher levels of immigration should be welcomed. High housing and rental costs reduce workers real wages.

* Central bank should target asset inflation

Central bank policy should more closely align with asset prices, aiming to keep house income ratios relatively low. In almost all cases, this would lead to a stronger currencies, and rising real wages.

* Governments should mandate above inflation increases in the minimum wage for the next ten years

Give workers the comfort of knowing that any wage increases are not one off, but over a longer period. Businesses would be incentivised to train or automate, also boosting wages and productivity.

Paying For It

* Full commitment to the OECD Pillar 2 taxation policies.

The OECD has been working on a digital tax regime that collects tax from digital giants and then redistributes according to activity, Pillar 2 reform. A commitment by the US, with political pressure on hold outs like Ireland

* Require companies over a certain revenue threshold to operate as an independent subsidiary within the UK.

Many multinationals run two sets of accounts, one for tax purposes, and one for profit purposes. As a UK based subsidiary, transparency on actually profitability would increase. Royalty payments to offshore subsidiaries to be curtailed.

* Business taxation should be regressive

Larger businesses should pay higher tax than smaller business. Starbucks pays less tax in the UK than a locally run coffee chain. Tax policy should not be a competitive advantage. Companies found to use tax as a competitive policy should face administrative restrictions.

* Antitrust should move from consumer first to small business first

Does this M&A harm the interest of small business? Currently trustbusters look at whether prices to end consumers rise or not. With businesses like Google or Amazon, where consumers not paying higher prices, there is no antitrust issues. But for small businesses, avoiding using large tech companies is almost impossible, and pay higher rates because of it. Lina Khan head of the FTC made her name with this paper on Amazon. Moving more revenue from large firms to small firms will make tax collection more likely.

* Limit tax deductibility of interest payments

Interest payments encourage private equity and other owners to load up subsidiary companies to pay dividend, and erode the tax base. Perhaps when government debt to GDP is above 50%, interest can no longer be used as an expense.

* Increase funding to HMRC (IRS in the US).

Generally, tax collecting agencies have seen funding fall. The return on investment of hiring people at tax agencies has approached 1000 to 1.

* Ban the use of non-tax paying companies.

Companies that use tax minimisation and avoidance schemes such as Apple, should be banned from use at government organisations until they have normalised tax payments. In the case of no viable option existing, i.e. the entire industry use tax minimisation strategies, the case for UK funded competitors arise. That is, non-tax payment should be cause for a business to be banned from operating in the UK.

* Reform Council Tax

Currently very expensive homes in the UK (such as in Westminster council) charge a fixed amount for all homes of the value of £320,000. Reform of this system could leave homes up to £1,000,000 paying the same council tax, while adding huge revenue to the government, and encouraging the efficient allocation of property in the capital.

Broadly, speaking both the right wing and left wing of UK politics have inched towards these policies in some cases, but have not represented as a coherent strategy to boost the fortune of wage earners. In the hands of a skilled politician, this manifesto could be an election winner in my view.

While is offers many benefits to workers, it also offers some sizable benefits to UK business. Protection from undercutting via tax haven regimes. The potential of government subsidies to build businesses to replace tax avoiding companies. The aim would be to level the playing field between small business and multinationals. Some may argue it might tank asset markets - I would say it will merely restrain them as rising wages will have a tremendous boost to growth.

Most of these policies seem workable, but only with an overwhelming electoral mandate could they be implemented. That is, just as FDR did with his New Deal, it would need to be communicated to voters before implementation. As we have seen in Argentina, voters can back change, and even radical change when the end result is effectively communicated.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

This is a free preview of a paid episode. To hear more, visit www.russell-clark.com

My gut instinct for the last few years is that you want nothing to do with bonds. This has been correct. And just as the lead market for the bond bull market was Japan, it has been the lead market for the bond bear market. And Japanese 30 year yields continue to say bear market to me.

I see plenty of analysis of why now is a good time to buy bonds, and how interest rates are going to get cut etc. To be incredibly harsh - most of it reads like old men having a hard time accepting that the world has changed. As borderline old, I have some ideas I also struggle to let go , but the idea that inflation is going to act like it has for the past 30 years is an idea I can easily discard. For me personally, if JGBs are in a bear market, then that’s all I need to know that sovereign bonds everywhere are in trouble. We have already had the BOJ sell reserves to try and strengthen the Yen and now the Norinchukin being forced to sell foreign bonds due to capital losses. Governments are running the biggest deficits outside of war ever, and the biggest buyer is being forced to sell - what else do you need to know? But I know bond bulls, and slaves to backtesting models will find reasons to remain bullish. So lets talk about the French bond market - and why its another nail in the coffin of bond bulls.

I only read the Communist Manifesto last year. I was trying to understand, how the Chinese planners think about economics, and I found it extremely illuminating. I had often heard people talking about Marx, without ever being interested enough to read it myself. All I knew was he was keen on collective ownership, which as everyone knows, doesn’t work. However, my favourite historian, Eric Hobsbawm, was socialist is his thinking and made the entirely valid point is that you cannot understand the 20th century without understanding Socialism. He also points out that many of things we take for granted, such as equal rights for all people regardless of gender, race or religion as well as anti-imperialism were all originally ideas originally championed by Socialism.

When I was very young, everything was about the Cold War and the Soviet Union. Every movie, (War Games, Red Dawn, Rocky 4, Rambo III etc) and every Olympics (1980 Western boycott of Moscow games, and USSR boycott of the 1984 LA Games) was an extension of the Cold War. Then suddenly in 1989, the Berlin Wall fell, and in a few short years Communism had disappeared. No one really studied Socialism or Marxism anymore, as its theories had been thoroughly discredited. My brother had also warned me off reading the Communist Manifesto with this warning, “Marx’s historical analysis is so perceptive, so you think his policy prescriptions must be right, but they were of course totally wrong.” In politics, as in finance, great historical analysis does not guarantee good future results.

Why did Socialism come to dominate the 20th century? Before the Great Depression, Marx argued that capitalism would destroy itself. His observation was that the pursuit of profits would drive capitalists to grow production, while looking to keep costs (and most importantly wages) as low as possible. Rising production, but falling demand from falling wages was unsustainable. At some point, this would lead to depression, as you would see prices fall across the board.

He also argued that greater and greater consolidation of capital, would yield higher and higher returns. This would lead to concentration of wealth in fewer and fewer hands. Politically, this could only continue as long as there was a bourgeoisie (I never really knew what this was, except as an insult. Apparently it means, someone that thinks they are wealthy and in control, but actually just doing the bidding of truly wealthy, a middle class apparatchik if you like). I was surprised to find that bourgeoisie is the source of the term “Boujee” - but makes sense. One important thing I took from the Communist Manifesto was that Marx assumes that at some point, the middle class (the bourgeoisie) also rise up against the capitalist class, particularly when they feel they are missing out on the gains.

Marx assumed the capitalist class was so powerful, only revolution could bring about change. Here Marx was very wrong. It is in fact possible for democratically elected governments to act against, or co-opt , the capitalist interests and enact pro-labour change. This is something that FDR did very successfully. FDR managed to get corporates to agree to raising prices and wages, in return for government protection from other producers threatening to undercut profits. In effect, FDR offered corporate America protection from competition in return for raising prices and wages. What FDR began was greatly expanded in the Post World War II period. With the threat of socialism everywhere, the US government also greatly increase spending on social services, and had aggressive taxation to reduce income inequality. Asset owners lost relatively speaking, while wage earners won handsomely. The leading industry of the time, the auto sector, was heavily unionised, and government owned business such as the US Postal Service offered a clear path to the middle class. These policies which were widely copied in the west, proved that socialism was not the only answer, and western liberalism could indeed prevail.

If Marx was alive today, what would he think of this world? Many of the policies that the west adopted to counteract the rise of Socialism have been rolled back. Effective tax rates faced by American billionaires are lower than wage earners, and with work arounds on inheritance tax, capital accumulation has probably accelerated. Capital concentration has definitely increased. Not only do we have a record share of the S&P 500 concentrated into relatively few companies, as a share of capex and R&D they are also dominating. Private equity control and coordinate a vast number of industries.

Marx observation was that capitalism’s constant search to lower costs would destroy wages and hence demand at some point. If I look at modern capitalism (ie 2024), my observation is that corporates go to extraordinary efforts to shield income from tax (another cost). Converting income stream to capital gains is the underlying organising principal of private equity, and much of large cap share buybacks. Hence, the risk to capitalism is not collapsing wages and a deflationary spiral, but the collapse in government credit worthiness driven by capitalism’s urge to minimise taxes. As Brad Setser recently posted, US corporates have been shifting an ever large amount of profits to tax havens.

The seven big countries represent over 3 billion people, and a USD 30 trillion GDP than the US. The seven tax havens have a combined population of less than 50 million, and a GDP of maybe USD 3 or 4 trillion.

Collapsing employment and wages of the 1930s, eventually gave way to the rise of socialism to counteract the political power of corporates. As governments are committed to full employment and rising wages (or more correctly austerity is a certain vote loser), and corporates are determined to maintain a system that shields income from tax, a political crisis seems inevitable. However, the problem is that there is a huge disincentive to cooperate from the winners of this system. The EU closed down the Apple tax avoidance scheme, only for Ireland to open up a new more legally robust system. Ireland has seen tax revenue surge. Corporate tax take has double in Ireland since 2019.

In non-tax haven nations, this is leading to the extraordinary situation that tax take is high, while government debt increases. The UK tax take is back at levels seen in 1970s.

Last time UK take rates were this high in the 1960s and 70s, debt to GDP was rapidly declining. Despite this high level of taxation, debt to GDP is not falling today.

The one nation that could probably change this dynamic is the US. US corporates are the overwhelming beneficiary of this tax avoidance. The principal reason (and greatly simplified) is that the US operates on a worldwide taxation system. If US corporates pay tax overseas, then it would receive a rebate from the US government. This encourages US politicians to turn a blind eye to US corporate tax practices in relation to overseas earnings. That is US tax policy, makes sense for US politicians and US corporates, but not for any one else. In contrast, inversions, where a US company relocated to the UK to reduce tax, was quickly stopped by the Obama administration.

The problem is that the current situation is so good for large corporates, and government finances are so parlous, and voters are so disenchanted, it’s hard to see what governments could offer to bring corporates to the table. The markets pretty much see it the same way, with corporate debt outperforming sovereign debt, reversing the trend seen since the 1980s. Credit markets prefer corporate debt to sovereign debt since 2020.

Coming back to Marx, he predicted crisis in the capitalist system when the middle classes, the bourgeoisie, started to realise that the system was not working for them either. Curiously, the market has been pointing out that middle class demand is collapsing, while very high end demand is robust. Hermes and Burberry use to have very similar performance, but from 2018 onwards, they may as well live in alternative universes. Similar breakdown has been seen in almost all luxury names - with middle classes, or lower upper class brands being destroyed, while ultra high net worth names holding up.

There is a large number of Americans who associate a soaring stock market with all that is good and great about America. For true patriots, and true believers in the American dream, a bear market would be better confirmation of the inherent goodness of the USA. A bear market would show that the checks and balances that the founders of America were so careful to add to the constitution to ensure power never became too concentrated were working as they should. A soaring Nasdaq is a sign of US failure, not success. US corporate power needs to be curbed. If it is not curbed, either a financial or currency crisis looms. This is what GLD/TLT tells you.

Crisis is coming, and while it won’t be exactly like the wave of socialism, seen post World War II, capitalism will still be the bad guy. Just at the failure of socialism turned former heroes to villains (Marx, Mao, Stalin were all lauded at one point), it is easy to see current heroes turning to villains (Warren Buffett freely admits to the tax system being broken, and has probably used it “better” than anyone else). A government debt crisis would be incredibly bad outcome. The question is whether we can find a FDR first, before a more unpalatable leader turns up. Perhaps its too late already.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

Back in January I wondered if semiconductors were the new oil. The price action this year probably says yes. Just as the Soviet Union tried to cripple the US in the 1970s through helping organise an oil embargo, the US is trying to cripple China through creating a semiconductor embargo. The US “war” with China was always about keeping China as a smaller economy than the US. From that perspective, it has been a resounding success. In dollar terms Chinese GDP has declined last few years.

The problem with embargoes, is that they heavily motivate those suffering from them to initiate policies to counteract and insulate them from a future embargo. In the US, the oil embargo led to reforms that reduced domestic demand, as well as encouraged increased supply from sources other than the Middle East. The end result of all these reforms was that we eventually saw the collapse of the oil price from near USD40 a barrel to USD15. With collapsing oil revenues, Soviet Union went into decline and eventual collapse. The unintended consequences of policy is often called blowback, and for the Soviet Union and OPEC, it was the eventually collapse of oil prices.

Banning high end semiconductor exports to China was meant to cripple development of high end industries in China. There is little evidence of this. China has become the world’s biggest exporter of electric cars. When I look at reviews of Chinese EVs on TikTok, they make Tesla look extremely second-rate.

EVs are not the main use for high end semiconductors - low end semis which China has pre-existing expertise in are probably sufficient. For AI and LLM, the very high end GPUs that NVIDIA sell are necessary. Even without access to high end semiconductors, there is evidence that China was able to approximate high end semiconductor performance through very aggressive use of low end semiconductors. Hence AI has ended up boosting the demand for all semiconductors. This would explain the phenomenal performance of Philadelphia Semiconductor Index. The embargo is creating demand across the entire semi spectrum.

A big driver in demand for semis has been AI and training large language models (LLM). It has been widely reported that a LLM price war has broken out in China. It is hard to understand how this is possible. It would be like seeing a price war among plastic producers in the US in 1974, just as their major inputs were soaring in price. After paying £14.50 for a Pimm’s at the cricket, I am shocked to see anything have a price cut - let alone the 90% prices cuts we have seen below. Some Chinese AI is now pricing at a 99.8% discount to OpenAI’s GTP-4. Whether this is a useful comparison is hard to tell, given the restrictions on access to Chinese internet (otherwise there is a huge arbitrage opportunity).

In a fully open free trading market, I would suggest the price war in China would have negative implications for Nvidia. And it might well end up that way - showing that AI needs a huge consolidation before it can be profitable. But what it does show is that Chinese policy of breaking cartels and fostering competition is producing exactly the results you would expect - lower prices. In the US, Meta, Google, OpenAI and Microsoft look determined to create a lock on high end Nvidia chips to starve out competition.

Increasingly the blowback for US policy to try and slowdown China, has been to spur an even more competitive Chinese tech industry, while creating a domestic tech cartel, with increasingly uncompetitive products : the iPhone continues to charge high prices for out of date tech for example, TikTok was destroying Meta and Google, while Microsoft remains Microsoft, Tesla looks pedestrian. Huawei has begun building an ecosystem completely independent of US tech. It would be no surprise if that system will produce substantially cheaper products.

Combine this with US sanctions on Russian oil that has created a parallel financial system that cuts the US dollar out, it’s hard to escape the observation that US is making every single long term mistake possible. I am reminded of Japan in 1991, vaulting ambition just as it was losing competitiveness. The US now has vaulting ambition just as it was getting exposed on every single front. One very striking similarity is sky high golf club memberships. In Japan in 1991, golf club memberships were traded for millions of dollars. In the US, unlike Japan, there is no shortage of land, but USD 500,000 for a golf club membership does exist.

Unlike Japan, I expect the US dollar to take the brunt of decline in US industry. Our currency, your problem as the US government used to say - Switzerland is already showing the strain, having to cut rates even though they are already far below US rates. In a pro labour world, I thought growth would be strong, and higher rates would be the big problem for the market, but markets would flatline - and this has been true (outside of tech). But the more I look at the US, the more I think I maybe I wrong. Maybe we are headed to the greatest short selling market of all time - collapsing share prices AND amazing carry proceeds. Fun times - for short sellers anyway.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

Since pushing the big red button, I have started talking to allocators, and financial professionals again. I have found it invigorating. I feel like I should apologise to the financial world. It is very easy to be prejudiced against finance people - “banker w****r” is almost the universal term. But after spending the last four years talking to parents worried about the 11 plus (high school entrance exams in the UK), karting parents, and football parents, engaging with financial professionals is a breath of fresh air. I suspect the problem with parents, is that everything seems like a zero sum game - your children are all competing for the same spot. There is also a level of delusion with parents and their kids that just does not exist in finance. Probably the best thing about finance, is that we can all make money together! Its not zero sum, so conversations are much more productive and interesting. As I tell people, you can’t spell fund manager with out “fun”.

Once you start talking to investors and allocators, you get a clearer view of their thinking and needs. Allocators have to manage lots of different risks - but there are two big interrelated ones: performance risk and career risk. Basically, allocators need to outperform to survive. Passive investing involves buying a low cost fund that matches the benchmark, of which Vanguard is the best known. Morningstar estimates that Passive AUM overtook Active AUM last year some time.

The bull story for passive is two prongs - one most active managers cannot beat the market, and two that the cumulative effect of fees make active funds born losers. When I first heard the arguments for passive funds, I thought the obvious flaw was that it assumes markets always go up. Passive investing in China shares or Russian shares has not been a winner!

For me, in markets dominated by share buybacks, passive investing makes a lot of sense. Share buybacks got a bad name in the 1929 Crash, as they were widely blamed for inflating asset prices, and we also saw share buyback in 2006/7 before the GFC, however they have broadly continued from 2011 onwards, with a brief hiatus during Covid.

For tax reasons, investors much prefer companies buyback shares that pay cash dividends. It does make me feel strange to see Nvidia buying back shares after its share price has risen so much, but that is inline with Apple and all the other big tech companies.

One feature of share buybacks is that it means investors are increasing their stake in the company, with no further investment on their part. Assuming nothing changes, which is always a good working assumption, then over time the value of their stake will increase. This has been a core part of Warren Buffett investing style. Share buybacks mean that the areas that are booming most, are most likely to have highest valuations (faster buybacks, implies a quicker increase in equity ownership). Apple, which at Warren Buffett’s urging, began aggressively buying back shares, and has seen it EV/Sales surge from 2 times to 8 times.

As an allocator, the share buyback pose a dilemma. Share prices are no longer priced by disinterested fund managers, but by very self interested CEOs. A booming business is never “priced in” anymore, as share buybacks imply its share price will keep rising in value. Of course the risk is that its business model is broken, it will collapse in value, but that was true when it was lowly priced as well. In a world where pricing has moved from third party to self interested, passive investing is the smart move. I think most forward thinking allocators know that something is amiss, but with timing uncertain, staying long via passive makes sense. It minimises career risk, if not investing risk.

What is the problem with share buybacks? Well ultimately it is concentrating cashflow into fewer and fewer winners. Buybacks benefit shareholders only, where as wage increases or paying tax benefits society and creates demand. That is buybacks have been seen at tops as they are ultimately self defeating. The US has avoided this fate this time by the government raising spending. So unlike in other booming periods of stock markets like 1929, 2000 or 2007, government finances are a mess.

Politically share buybacks are a disaster. How can you ask voters to accept austerity when the rich get richer? You cannot. So allocators face a problem. Politically markets are unsustainable - but maybe lasts 10 more years? It hard to find parallels to the current situation, perhaps the British empire in the 1910s, as it found that its former ally Japan, was beginning to become a trade competitor, which forced it to move from a free trader to a supporter of tariffs. Maybe this cycle ends tomorrow no one really knows - but passive solves this problem - and everyone will fail together so mitigates career risk, if not investment risk. Obviously, the risk here is the sovereign debt market. 2022 saw markets move to favour gold over treasuries, and 2022 was a weak year for assets, but obviously markets have continued on their merry way since then.

I assumed the change in GLD/TLT marked the beginning of the end, as it suggests markets wants governments to get serious about their fiscal situation. But all time highs in markets still suggest passive over active. In a politically world, passive is probably the correct option for most allocators, even as the political world continues to tears itself apart. Safety in numbers is real.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe

I was state school educated in Australia, so I missed out on an education in “classics”. But whenever I hear a good turn of phrase, I bring it into my vocabulary. “Hubris before nemesis” is one such phrase - basically meaning arrogance precedes a fall. I have seen many investors suffer from it, and I have also suffered from it myself.

As it happens I was in the Midlands this weekend - Peaky Blinder country for my American readers - and had a fascinating chat with an engineer in the car industry. The first part was that demand was falling of a cliff. Higher interest rates, and the withdrawal of government subsidies was crushing the auto market. Tesla’s share prices has lagged the market for a few years now.

The second part of the conversation was how difficult it was to recruit and retain engineers. Every manufacturer was understaffed, and trained engineers had the whip hand, especially young engineers as companies had to deal with a wave of retirements by older engineers. UK unemployment rates remain very low, and below levels seen in 2007 for example, but beginning to turn higher.

Slowing auto market, unemployment ticking up and Bank Of England cutting rates. This sounds like conditions for deflation, and buying long dated bonds. If that is your line of thinking, then you are in luck! 30 year gilt yields remain at close to the highest levels since 1997, and at levels around when Liz Truss apparently broke the gilt market. What a bargain!

Politically, buying UK gilts is problematic. The easiest way to show this is with housebuilding. Post World War II, politics was pro-labour, and getting people in to homes was a priority. There was a huge boom in government and private sector building of houses. Inflation was high, interest rates were high, and house prices were low. Buying in the 1970s or 80s as supply was falling, was the key to riches, particularly as interest rates were also falling.

Labour is targeting 1.5 million homes over its 5 year term, or 300,000 homes a year, so inline with house building in the 1960s. A cynical, hubristic fund manager would likely say, every political party for the last 20 years has promised more homes and failed. And that would indeed be a fair point. But simplifying the political maths, we can just look at the changing voting power of baby boomers. Baby boomers are defined as people born from 1946 to 1964. In the UK, that gives us a group 14.4mn people. In 1979, when Thatcher was elected, they were 26% of the population. They are now 21% of the population, and falling in numbers everyday. In other words, their relevance as a voting block is now in decline. Politically, it was impossible to ignore their wishes from 1980s onwards. From 2024, the baby boomers need to scrap with everyone else. This analysis understates boomer influence, as they tended to vote more than younger people. Rishi Sunak choosing July 4th as the date of the General Election is a transparent attempt to reduce student turn out, as they are often registered where they go to university, and will likely be at home July 4. Voter ID rules etc are also part of this pro-boomer voting policies.

Assuming the polls are correct, and Labour achieves a generational win at the general election, we can expect pro-boomer policies to be reversed. I suspect Labour will hit its house building targets, as it will see it as a policy to win the next election on. I also expect council tax to be reformed and charge on current value, to encourage baby boomers to downsize and free up homes for families. Falling house prices in real terms is likely. Another aspect of pro-labour policies that should return is that a strong exchange rates is encouraged, as it boosts workers incomes. Remember when central banks raised interest rates to keep exchange rates strong? That policy should return I think. Post World War II, UK interest rates rose to over 15%. I think a similar type of shift is likely.

What are bond bulls looking at? Almost all bond bulls are looking at money supply, which is negative year on year, and has historically coincided with bond buying opportunities (since 1980).

The problem with this analysis is that from 1980s onwards, voters wanted smaller government, and higher asset prices. Governments were “encouraging” deflation. This is no longer true. Governments are encouraging inflation, and central banks need to act as a brake. Bonds are nemesis - they are the asset that will suffer in this new world.

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit www.russell-clark.com/subscribe