Inflection Point

Now approaching the year end, many countries or institutions are beginning to choose their word of the year. For Oxford Dictionary, it chose an Emoji for 2015. For Japan, the Prime Minister will choose the Kanji of the year. For the finance community, my vote definitely goes toward China.

South China Sea, RMB revaluation, AIIB and One Road One Belt aside, people ultimately just care about the economy. Policy makers, economists, investors, and businessmen all want China to continue its high growth, if not just stable growth. Some claim that China needs its high growth to maintain government legitimacy and avoid social unrest. some say China needs its high growth to keep the debt fueled economic churning and avoid a financial crisis. Some even cite neuro scientists who say people lack the ability to process large numbers. As a result, the pressure for high GDP growth is unwarranted since the additional GDP added through China’s 2014 7% GDP is equivalent to 15% GDP in 2010 terms.

However, just because making things bigger is hard to achieve or difficult to grasp, does that mean people stop trying? For the most part, I believe the answer is no. This explains why the world has so many policy makers, central bankers, economists, investment bankers, and businessmen finding what I call the inflection point.

These inflection point determines the point in which the input no longer contributes or no longer effectively contributes to the output. This is the point of diminishing marginal return. I believe at the end of the day, that is what every economic planning agent is trying to do.

Policy makers run models to find the optimal tax rate to maximize tax revenue. This optimal tax rate may be close to the the maximum tax the government can levy on its workers without disincentivizing them to stop working altogether. This rate bears huge implications and have great butterfly effects; it influences the subsequent welfare policies, public investments, technological progress, asset prices, and debt management. For instance, the amount of tax revenue influences how much a country can borrow. A country needs to borrow enough to keep the government running (if it cannot generate enough through taxes, which is the case for nearly all countries), but its debt burden also cannot be so large that it crushes its people’s economic sentiment.

Central bankers run models to conduct the optimal monetary policy to maximize growth or price stability. This optimal monetary policy, money printing or draining through the form of central bank asset purchases and sales. During times of inflation, it needs an interest rate high enough to squash inflation, but hopefully not so high that the economy crashes. During times of deflation, it needs an interest rate low enough that generates demand, but hopefully not so low that the system breaks down in the form of banking deposit outflows or bad loans.

Investment bankers run models to find the best debt structure to help a company find the cheapest money for whatever it wants to do. The optimal debt structure helps the company take advantage of whatever the tax codes and capital markets throw at the company, resulting in money that can contribute to greater growth, market share, revenue, or anything else.

I believe the same inflection point idea applies to people, too. People want the optimal debt structure, one where they can borrow to finance their education and home without feeling squashed and hopeless. People want the optimal tax rate so they can vote for the political candidates who share their aligned values without the fear of extortionary taxes.

As for to China, President Xi and Premier Li are looking to find the optimal interest rates, optimal tax rates, optimal industry mix, and optimal capitalist system to help China weather through its difficulties. Regardless of whether it will be able to achieve its goal, the GDP treadmill pressure may always be there. “Bigger, louder, and more teeth,” those word echoed in Jurassic World relate to our world. Countries want bigger GDPs, companies want bigger market shares, revenues, or both, investors want bigger EPS, and workers want more money.

My last point, considering how difficult and stressful it is to find the inflection point during our busy work days, it is now a good time to think about the optimal work life balance that gives you a full and happy life. Happy Thanksgiving and Happy Holidays!

Balloon Economies (Part 1)

What do you see here? Three work in progress paper mache projects? I see that too, but I also see something more. I see the balloon pasted paper mache as a metaphors that explain economic booms and busts and economic policies.

While I do not know why the artist (who uploaded this picture) wanted big paper mache domes, I do know why politicians want big economies. Big economies empower countries, bolster support, and provide better livelihoods. Especially on the last point, whether motivated by love, duty, power, or pride, politicians strive to improve their countrymen’s economic well-being. Some may say that the pie is big enough and society needs more re-distributive policies to address inequalities. However, given the high political cost and the economic inefficiencies, I believe politicians still see making the economic pie bigger as the simpler policy choice.

As a result, no different from the artist who used the balloon to prop up the paper mache dome, politicians also look for ways to build the economy as big and as quickly as possible. In the picture’s case, the third largest balloon allows the economy to have the biggest GDP and its people the highest GDP per capita. In this scenario, people’s material wealth increases, the government fulfills its promises, and everyone is happy. Here, politicians and entrepreneurs are lionized as geniuses and saviors.

However, the paper mache dome and the economy dome comparison now ends here. While the artist has complete control over when to lift the solidified dome off the balloon or even burst the balloon intentionally to remove the dome, the government does not. The government did not know whether the San Francisco economy is able to wean itself off the dependence on the Tech bubble. The government did not know whether the US economy could hold up if the housing bubble burst. In the end, the ordinary folks who the government sought to help in the beginning are hurt the most. Seemingly overnight, 401Ks are reduced, home equity are halved, and entire departments are laid off. The US economy went through this bubble bursting in 2008. Seven years later, the economy is now finally starting to pick up.

Quick Lesson from LKY's Passing

With the passing of Lee Kuan Yew, the world has been extra critical in debating his legacy. No one disputes Singapore’s economic progress achieved under his 31 years of PM rule. However, many also see him as a ruthless autocrat who cracked down on free speech and political opposition senselessly. Lee Kuan Yew is well aware of these criticisms. He believes there is no freedom without order and people value economic freedom more than political freedom.

Seeing himself as Singapore’s father who knows what people need best, he says “you take a poll of any people. What is it they want? The right to write an editorial as you like? They want homes, medicine, jobs, schools.” As a result, he has made his utmost effort in building Singapore’s prosperity, not democracy.

Now, I am not here to debate whether Lee Kuan Yew is right. I am here to talk about cultural understanding. For the most part, Westerners are more critical of the political repression while Easterners are more forgiving of such human costs. Having grown up in the East and West, I understand the historical vestiges, the government agendas, and the family upbringing that contribute to this different interpretation of Lee. However, for most of the world, people grow up with one dominant value system. As a result, cultural misunderstandings are bound to happen right? I disagree.

The pace of globalization post the fall of the Iron Curtain has caught the world by surprise. It seemed like just yesterday when people still used point cards to dial internationally. (I vividly remember my parents dialing a million digits just to have a ten minute conversation with family abroad.) Now, internet, smartphones, apps have bridged all gaps, except cultural ones. Now on to the final frontier, how do we overcome cultural differences? I believe replacing heuristics with common sense is all we need.

When one uses heuristics, judgement shortcuts, to approach another culture, one is bound to pigeonhole the said culture to either end of the extreme. Cultures are never inherently exotic or common; it all depends on the frame of reference. Just because another culture’s food seems exotic does not make the said culture’s values alien. Just because another culture’s life style is western does not make the said culture’s beliefs western. Heuristics that simplify a culture’s complexity down to a simple transitive equation are inadequate for today’s society. The walls have come down, but the neighborhoods are still divided. Cultural sensitivity issues, most analogous to the left over barb wires from the torn down walls, scare people away. However, there is nothing to be afraid of. Common sense over heuristics is all one needs to understand other cultures. Like most things in the world, the truth is always somewhere in the middle so book that flight, sign up for that exchange program, follow that blog, and explore all that the world has to offer.

Borders to Conflicts and Inequality

One way or another, they sit huddled together quietly, usually with some sort of blanket draped over their backs. They are fatigued, but alert. Wherever they are, whether on a boat or a truck, they are all trying to immigrate to a new land. From the Indonesians going to Australia, the Libyans going to Italy, the Mexicans going to the US, or the Rohingyas going to wherever that accepts them, these migrants leave everyone and risk everything for a chance to get out and get in. Most have grown insensitive to these news, barely raising their eyebrows as they come across these headlines. At the same time, there are also many who share statuses, wear T-shirts, attend rallies, host meeting, and everything else they can do to bring light to the issue. Lastly, there the policy makers who talk about it and… just talk about.

Immigration policy is a hot topic. It stirs up xenophobia. The fear of the undesirable economic, community, and identity impact is enough to turn an otherwise kind individual nasty. Simply put, there is no shortage of why dislike newcomers. However, I believe the popular opinion against immigration actually fails to understand the whole issue. A closed door immigration policy leads to conflicts and economic inequality.

First, the closed door policy strengthen dictatorships and their regimes. For instance, before fences, the immigration centers, and the passports, people were able to migrate more freely. As self-interested humans as they are now and forever will be, they go to places that gives them the best opportunity. Under this system, people flee oppressive regimes more freely for fairer rules. This mobility punishes the bad kings and rewards the good kings since the size of the population determines the kingdom’s military and economic strength. A large population allows a large military, a large tax base, and a large pool of productive workers. As a result, there is a natural accountability system in place to promote progress. However, this current system breaks the natural order. For instance, because developed countries set strict limits on immigration, the policy is not able to accommodate all those who wish to come to enter. Therefore, they are forced to stay and empower the bad kings’ military and economic strength. This translates to a false legitimacy for the bad king, lending him credit and enabling him to conduct the further oppressive policies. So what does this mean for those in the developed countries and how does this hurt them? The closed policy fosters these bad kings, allowing the so called Axis of evil countries to continue their ways. In the end, at least in the case of the US, this leads to military conflict, death, hatred, and terrorism. The xenophobia and closed door policy contributes to the death of young soldiers, terrorist attack victims, and countless tragedies. One may have been able to minimize change by rejecting immigrants, but one has also contributed to a more violent, unstable, unsafe, and tragic world for everyone.

Second, the closed door policy contributes to greater inequality. It is true that the family and environment one is born in plays a great role in determining one’s economic well-being. However, except for the extremely impoverished and wealthy tails of the normally distributed population, most probably lie somewhere in the middle, only differing by the type of house they live in and the type of vacation they go on. As a result, for this group of general population to become richer, they need to work to accumulate their wealth. Yet, it is always easier said than done. High paying jobs are competitive and wage growth is slow. There are many theories behind wage growth, such as the labor productivity gains, the technological improvements, and a country’s monetary policy, but I would just like to focus on one, the supply and demand of the labor. I believe now that developed economies have most of their basic needs met, such as food, housing, clothing, and transportation, the equilibrium supply and demand price has little room to grow. The peak in demand leaves little room for wage pressure; the political pressure to keep employment high leaves little space for supply cuts. These forces combine to cap a lid on wage growth. It is true that new demand can be created, but niche demands only has enough room to benefit a selected few and structural demands take time to form. Therefore, the only logical answer to this wage growth cap is markets with new demands. When one looks around, one will realize there are many such markets. These emerging markets have insatiable demand for modern goods and services, which can translate to high equilibrium supply and demand prices. While it is debatable whether these emerging markets can afford all the modern good and services they need or want, the demand is irrefutable. As a result, anyone who can supply this demand will make a fortune right?

Wrong. Only a selected few will be able to supply this demand. Since those with a deep enough pocket to negotiate with foreign governments and those with a long enough investment horizon to wait for emerging market consumers to pay are able to supply the demand, common folks will lose out again. They may observe the demand, but will not be able to supply the demand and drive up their supply and demand equilibrium wage. As a result, large corporations will again be able to keep a wage ceiling on such jobs due to the large labor supply. They will again either work for in a low wage growth job or fight to death for the competitive, high paying job. In the end, those fortunate enough to be born in the extremely wealth tail of the population will win out again. However, it does not have to be like this. In a more freer border environment, the entry barrier to these emerging markets may be lower and an eager entrepreneur may have a fighting chance against the big corporation. Furthermore, a freer border environment may have a strengthened accountability system mentioned before and the emerging market and developed country gap may be smaller.

Obviously, there are many other things to consider when it comes to immigration. A country’s fiscal budget has to be conserved, a community’s tolerance for foreigners is limited, and most of all, politicians’ political lives are fragile. In the end, whether developed countries’ closed door immigration policies to those in need lead to military conflicts and domestic inequality, politicians will just continue to talk about and… just talk about it.