China beats poverty, U.S. supply chains buckle

Plus bitcoin stumbles, Dems surrender, GameStop surges

Mar 01, 2021

Welcome to another edition of Contention! This week we have six and a half minutes of overheated dissident business news. We cover:

Rates rising, stocks falling, ‘experts’ missing the point
China beats poverty, pivots to rural inequality
Rapid Round: Bitcoin’s uneven week, bailing on the minimum wage, meme stocks roar back… briefly

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Rates rising, stocks falling, ‘experts’ missing the point

U.S. equity markets declined across the board last week, with the Dow losing 1.8%, the S&P 500 2.5% and the tech-heavy Nasdaq dropping 4.9%, its worst performance since October.

Driving the declines: interest rates surging in response to supply chain chaos and cost-driven inflation. The dominant narrative has missed these facts, as observers stay locked into excuses rooted in bad politics.

Rates on the 10-year Treasury bond -- a benchmark for interest rates across the economy -- have been rising since the start of the year, but Thursday brought a “flash crash” in the market. Yields move in the opposite direction from bond prices, and Thursday’s sell-off meant the fastest one-day rise in 10-year yields since the pandemic panic last March.

Stock prices are supposed to reflect future earnings, and interest rates discount those expectations -- they anticipate inflation, eroding the value of money over time. Rising rates mean falling valuations, and stocks tumbled along with bonds: the Nasdaq 100 megacaps lost 4% on Thursday alone.

Weak government bond auctions precipitated Thursday’s rout. The U.S. Treasury had its worst auction for 7-year notes since at least 2009 that morning, days after a “tepid” 5-year sale and struggles auctioning off 30-year and 20-year notes earlier in February.

Why the weak demand? Bond buyers worry that rising inflation could wipe out the value of their investments.

The most common explanation for these fears: “overheating” in the economy. Personal income soared 10% in January as stimulus payments arrived and enhanced unemployment payments returned. Retail spending followed, rising 5.3% -- a huge beat on a forecast of 1.2%.

But related price increases were well in-line with previous expectations; they should be priced into interest rates already. This same “overheating” hypothesis led to persistent inflation fears throughout the roaring 1990s, but inflation barely budged over the period. There is little evidence that the U.S. economy actually works this way.

Instead, inflation is being driven by rising commodity and input prices, themselves the victim of a “bullwhip effect” -- rising demand meeting scaled back supply chains, creating at least two critical bottlenecks:

Basic materials: lumber prices have gone up 4x in a year, steel prices are at a 13-year high, and copper has nearly doubled. Unanticipated demand has increased delivery times by 300-800%.
Shipping: unexpected demand for shipborne containers means doubled delivery times and 3-4x higher cargo costs. A 2016 analysis found that a 15% shipping cost rise led to a 0.10% increase in inflation.

Decades of margin shaving through “just-in-time” logistics and outsourcing -- both domestic and international -- mean that the delays are now cascading through the economy. Manufacturer costs were at a 10-year high in January, with pass-through prices rising at the fastest rate on record.

These are the prices sending bond market inflation predictions soaring. But why are the world’s smartest investors instead blaming something that doesn’t actually exist? Because they operate from a worldview that says demand is primary in driving the economy -- if prices are going up, it’s because aggregate demand has “overheated” them.

This worldview has important political implications: the economy is a reflection of everybody’s desires, so if you don’t like it, it’s your fault. It also justifies austerity to keep working families from raising the market’s temperature.

The truth is that production is primary in the economy. It looks the way it does because large investors and executives have directed capital in certain specific directions, and by prioritizing cost-savings over supply resiliency they have created a system that can’t meet demand at the prices everyone expected. That’s raising rates and sapping asset values, with unpredictable consequences to come.

China beats poverty, pivots to rural inequality

The Communist Party of China held an official conference in Beijing Thursday declaring “total victory” over absolute poverty in the world’s most populous country. A multi-decade effort kicked into overdrive eight years ago, the campaign lifted 99 million rural people living in 832 counties and more than 128,000 villages above government poverty thresholds.

The celebration coincided with the 100-year anniversary of the party’s founding, and honored nearly 2,000 individuals and 1,500 collective units for their role in the effort. It also commemorated 1,800 party activists who died from accidents, disasters, and disease during the push.

Poverty has been endemic in China for centuries. Major famines in 1876, 1927, 1929, 1939, and 1942 each killed millions of people. As late as the 1970s, 30% of the country’s population was undernourished -- the average six-year-old in 2015 was two inches taller than one born 40 years earlier.

The anti-poverty campaign used a variety of quantitative definitions for poverty over its history, but also used a qualitative standard called the “Two Assurances and Three Guarantees” -- assuring adequate food and clothing and guaranteeing access to education, basic medical services, and safe housing. The party removed the final nine counties on its impoverished areas list in November, with average annual net incomes (including subsistence food production) reaching three times the national quantitative threshold.

How did China do it? The party began by charging its chiefs at all levels with specific goals while the government invested 1.6 trillion yuan ($256 billion) into the effort. A total of three million party members organized into 255,000 teams executed a “targeted poverty reduction” strategy, going household-to-household to identify poor families and determine their needs. A nation-wide database tracked their conditions and helped identify common causes and possible solutions for different communities. Third-party inspection teams verified each local party’s outcomes.

China’s geography -- fertile coastal plains in the east, desert and mountains in the west -- has created long-standing divides in economic development, which the poverty campaign took into account. Well-off counties, cities, and provinces in the east partnered with low-income areas in the west, exchanging resources and personnel.

Business at all levels, including state-owned enterprises, played key roles in the campaign. Last week’s ceremony recognized Alibaba -- recently in hot water over founder Jack Ma’s criticism of Beijing’s financial risk reduction strategies -- for its role in developing web platforms to help rural people sell their agricultural products, totaling more than $155 billion in sales. Private and state-owned industries have extended broadband internet to 98% of the country’s previously poor villages since 2012.

Despite the celebrations, China’s leadership emphasized that the accomplishment is “not a finish line, but a starting point,” acknowledging that income levels for those just out of poverty are still low. The government has now replaced the nation’s poverty alleviation office with a new National Rural Revitalization Bureau tasked with what the party says is now the main contradiction in Chinese society: “unbalanced and inadequate development” holding back “the ever-growing needs for a better life.”

The victory has global implications as well. At the international poverty line set for middle-income countries, China accounts for 100% of the world’s poverty reduction since 1990. The country outlined a new foreign aid strategy earlier this year, reaffirming its focus on “south-south” development aid as opposed to the donor-client relationships modeled by Western economies.

These “North” governments appear set to let sour grapes keep them from exploring China’s experience. Poverty reduction is not a priority for them, so they are pursuing a different strategy: undermining China before their populations learn from its example. Time will tell who is better able to execute and accomplish their goals.

Rapid Round

Bitcoin drops, Bitfinex busted

Bitcoin retreated last week from a record high, tumbling more than 21% to $45,353 dollars at press time, its worst weekly performance in a year. The benchmark cryptocurrency is still up 432% from March 2020.

Rising U.S. Treasury bond yields are hammering the speculative vehicle alongside actual capital assets. Also weighing on the coin: crypto exchange Bitfinex reached a $18.5 million settlement with New York’s Attorney General over allegations that the company lied about its reserves and covered up losses. As we reported in January, Bitfinex is controlled by the same investors in charge of Tether, a $36 billion “stablecoin” supposedly backed 1:1 by U.S. dollars. The AG’s ruling could mean trouble for bitcoin if it confirms suspicions about unbacked Tether propping up the cryptocurrency.

Meanwhile, rival exchange Coinbase is heading toward a public stock listing, and megabank JPMorgan Chase floated the idea of advising investors to use bitcoin to diversify their portfolios. Billionaire hedge fund icon Peter Singer, on the other hand, told his investors in an annual letter that he is eager to tell bitcoin holders “I told you so” when the bottom eventually falls out.

Dems bail on minimum wage

Democrats abandoned a pledge to boost the federal minimum wage to $15/hour after Senate Parliamentarian Elizabeth MacDonough ruled a hike can’t be passed by a simple majority as part of a major COVID relief package. That would have more than doubled the current minimum wage of $7.25/hour by 2025, lifting pay for around 40 million people.

Alleged reasons for not doing it: rising payroll costs would force businesses to close and push people out of work. That’s not so, says Morgan Stanley, as around 900,000 people would lift up from poverty with an “outsized positive impact on the income of minority communities,” according to the bank’s economists, “where nearly 31% of Blacks and 26% of Hispanics would see an increase in labor income.”

Prices for goods and services would likely rise, with the cost borne by higher-income consumers who’d barely notice the difference -- as seen in Hungary after its minimum wage hike. More pay also reduces turnover, allowing companies struggling to meet demand to increase sales.

Many states have already boosted minimum wages well above the federal minimum, and wholesaler/retailer Costco with its 250,000 workers announced last week that its starting pay would rise to $16/hour, with average wages around $24. Walmart, by comparison, sets a $11/hour minimum with average pay at nearly $15/hour. Congress last raised the federal minimum in 2009.

GameStop rises again

Shares of GameStop surged again last week, tripling before tumbling back to earth on Friday. Prices had previously settled in the $40-50 range after a speculator-fueled short squeeze in January drove prices up more than 700%. Other “meme” stocks such as Express and AMC also experienced spikes as speculators piled in.

Like before, the cause once again appears to be a combination of increasing volatility in markets and the collective power of Reddit’s r/WallStreetBets forum. The horde of retail traders saw an opportunity on Wednesday when news dropped that the video game retailer pushed out its chief financial officer, Jim Bell. The former CFO reportedly clashed with board member and activist investor Ryan Cohen, who founded the pet-food retailer Chewy.com, and joined the GameStop board in January.

Unlike January’s big squeeze, GameStop’s short interest now only sits at around 25% outstanding, making an exact repeat unlikely. What is similar is that retail traders have jumped on news of boardroom reshuffling, using sheer volume to pump up the price before an inevitable bust that leaves a “greater fool” holding the bag.

Disclaimer

Our only investment advice: When you dip, we dip.

CONTENTION