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!