The answer is 1260 to 1320. Now this may seem like some snippet of arcane knowledge, of little relevance to the current world. But I think that there’s more to it than meets the eye.
Over the weekend I continued reading ‘Psychology of intelligence analysis’ by Richard Heuer. And the more I read of it, the more I think that it might be the best book on analysis ever written. So much so that if I ever take on a head of research post in the future, it’s the one book I’d buy for all my analysts to read. As it is I’ve got a research department of one, and I made myself read it before coming up with any more theories.
Heuer’s central idea is that we do analysis all wrong. We’re inclined to build a mental model, a hypothesis, about current events. But we’re very slow to recognise if another hypothesis is better. And things we look at to confirm our view, well, they might support a very different view of the world as well.
Heuer’s prescription is to do something very unnatural – to hold all competing hypotheses in your head, keep an open mind, and then use your observation, analysis and argument to render some less likely, and others, one if you’re lucky, dominant.
Heuer also distinguishes between good analysts – who have a detailed knowledge of similar circumstances – globally and historically – to draw from, and policy makers, who have much less, but who perhaps benefit from a less tenacious hold of their recent best theory.
Heur’s bête noir seems to be historical comparison. It’s poor analysis, he reckons, because it fails to point out the difference between periods – just the similarities. And a major problem with policymakers, he feels, is that they draw upon too little knowledge – they use the last incident to inform their judgements. They keep fighting the last war.
And this is where a lot of analysis of the current situation falls down, in my book. We’re not going through a repeat of the deflationary bust of the late 1920s or the late 1990s. Why? Because returns on capital are miles ahead of the cost of capital in the BRICs, and in several, but not all, of the Western world non-financial sectors. That means that growth is self reinforcing – as it creates profit, investment, and more profit. Back in 2000 the story was totally different. Just about every major region in the world was facing a cost of capital above its returns – so growth became self-defeating, feeding in, as it did, to lower profits and lower investment.
Over the weekend I continued reading ‘Psychology of intelligence analysis’ by Richard Heuer. And the more I read of it, the more I think that it might be the best book on analysis ever written. So much so that if I ever take on a head of research post in the future, it’s the one book I’d buy for all my analysts to read. As it is I’ve got a research department of one, and I made myself read it before coming up with any more theories.
Heuer’s central idea is that we do analysis all wrong. We’re inclined to build a mental model, a hypothesis, about current events. But we’re very slow to recognise if another hypothesis is better. And things we look at to confirm our view, well, they might support a very different view of the world as well.
Heuer’s prescription is to do something very unnatural – to hold all competing hypotheses in your head, keep an open mind, and then use your observation, analysis and argument to render some less likely, and others, one if you’re lucky, dominant.
Heuer also distinguishes between good analysts – who have a detailed knowledge of similar circumstances – globally and historically – to draw from, and policy makers, who have much less, but who perhaps benefit from a less tenacious hold of their recent best theory.
Heur’s bête noir seems to be historical comparison. It’s poor analysis, he reckons, because it fails to point out the difference between periods – just the similarities. And a major problem with policymakers, he feels, is that they draw upon too little knowledge – they use the last incident to inform their judgements. They keep fighting the last war.
And this is where a lot of analysis of the current situation falls down, in my book. We’re not going through a repeat of the deflationary bust of the late 1920s or the late 1990s. Why? Because returns on capital are miles ahead of the cost of capital in the BRICs, and in several, but not all, of the Western world non-financial sectors. That means that growth is self reinforcing – as it creates profit, investment, and more profit. Back in 2000 the story was totally different. Just about every major region in the world was facing a cost of capital above its returns – so growth became self-defeating, feeding in, as it did, to lower profits and lower investment.
And it’s not the 1970s either. The chart below shows what happened from 1967-1976. Everything, including wages, went up.
That’s not what we’re seeing today. TV prices are down 18% YoY in the US, computers and broadband access are similarly falling in price. This is no money induced frenzy of escalating inflation expectations like 1967-1976. Something else is happening entirely.I got the two historical charts out of a storming book by David Hackett Fischer called ‘The Great Wave’. And he offers an interesting explanation for the events of 1260-1320. It was all caused by a massive population boom (itself caused by rising real wages in the previous couple of generations), and only amplified by easy money. The rising population pressed against resource constraints. The fuel in chart one is firewood, and the rising population helped exacerbate deforestation. At the same time, more workers meant downward pressure on real wages, and on ‘value added’ goods with a large labour component.
I think population is the missing element in much global macro analysis today. Probably the paramount economic event in the modern era was the tearing down of the Berlin Wall in 1989. It was that event, combined with Tiananmen Square, itself fallout from an inflationary spiral, that induced the Chinese authorities to embrace profit seeking, and a greater interaction with the capitalist world. It also pushed India into substantial reforms.
In one fell swoop, that should have doubled the world’s capitalist workforce. The problem was, to start with, they couldn’t compete. And if you can’t compete in a capitalist world, you don’t exist.
The dearth of Western standard capital stock, and the high cost of capital available at the time, meant that however cheap the workforces, they could neither produce goods economically enough, nor good enough, to sell abroad. My Dad reckoned that there was only one factory in all of East Germany, a glass optics business, which could sell anything overseas at all once the wall came down. Everything else was expensive rubbish.
Russia and the Baltic states fell immediately into a deflationary spiral, followed by Latin America and to an extent China in 1994/5, then by the rest of Asia in 1997/8. All the while, the US boomed.
Only in 2003 did the BRICs see their returns rise above the cost of capital (Chart 2). At which point, you could say, the workforce in the world – the competitive workforce - doubled.
It is difficult to explain the enormity of that point. But it is critical in understanding what will happen next.
Because, if the competitive labour force doubles overnight, as it did in 2003, it likewise halves the capital to labour ratio. And that should double the returns on capital until…..there is enough capital around to bring the ratio back into line. But that is a static analysis – because if labour keep rising – due to population growth, while returns on labour rise due to productivity gains – then the returns on capital will keep rising further – until investment accelerates sufficiently to drive them down again. And that capital is not just private capital, invested in plant and machinery, it is infrastructure capital in particular, and intellectual capital as well.
Now of course, the credit crunch is a big issue, and it stemmed from a period in the 90s and early 2000s when rates stayed low, because the global factors of production; labour as well as capital, were underutilised. Now that utilisation rates are high, and the bloom is off the structured credit rose, we’ll have a sustained underperfomance of all things leveraged.
But is this as big an issue as the doubling of the world’s workforce, and the need to more than double the world’s stock of private and infrastructural capital. This is the Billion dollar judgement call. And my call is simple – the doubling of the world’s capitalist population and the massive increase in the returns on capital employed, that is the bigger issue.
That’s why I think the BRIC’s demand for infrastructure and resources will generate continued strong returns for investors, and why I think it will simultaneously crowd out consumers and financials in the West.
To that end, I’ve raised my exposure to global infrastructure stocks with purchases of Alstom (Alo FP), Parker Drilling (PKD US), Technip (TEC FP) and Veolia (Veo FP).
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