Tag Archives: war

War, Peace, Inflation, and Software

Is inflation dead?

Source: Morguefile

Growing up in the ‘70s, inflation was a fact of life. Sometimes we would see prices rise four or five percent in a single month. Persistent, high inflation was a problem, economically. The purchasing power of our savings was depleting at a rapid rate. Federal regulations kept interest rates low; banks couldn’t pay more than 4.25%, even while inflation was running at 10% per year. Gerald Ford declared a war on inflation.

Annual change in CPI. Source: St. Louis Federal Reserve

But those days seem as remote to us today as buggy whips and livery stables did to folks back then. What happened? The most important change happened in the early ‘80s, with monetary policy. The Fed reduced the growth of the aggregate money supply, and since the velocity of money in the economy was fairly steady, slowing money’s growth also slowed the rate of price increases.

But since 1990 – well after Paul Volker’s monetarism was implemented – inflation has fallen even more: from about 5% then to only 2% now. The most current measures indicate that it might run at only 1.5% going forward. And low inflation is a fact of life everywhere, not just in the United States. To answer this, we need to go a little further back.

Source: Ed Yardeni

The answer may have to do with war and peace. Dr. Ed Yardeni has written that during times of war, labor is in short supply, markets don’t work, commodities get requisitioned, and the Government prints money to finance the war effort. It’s inevitable that for prices to rise, often dramatically. During peace-time, the opposite happens: markets expand and trade flourishes, competition comes back, and prices fall. War is inflationary, peace is deflationary. Note that in the past this happened whether or not we had a gold standard. Congress determines the basis of all weights, measures, and standards, including our monetary base.

In 1989 the Cold War ended with the fall of the Berlin wall. The last 28 years has seen the greatest expansion of markets, trade, and capitalism that the world has ever known. The influx of supply has been met with an influx of demand as well, as billions of producers and consumers have entered the global marketplace. In addition, the nature of demand is changing: In the past, we needed raw commodities; as economies developed we needed finished goods. Increasingly, we need knowledge: knowledge about our work, our environment, our finances, even our own bodies. Increasingly, this knowledge is provided by software, readily available via computers we carry in our pockets. That’s why software is eating the world. And the marginal cost of software is virtually zero.

Software costs money to develop, but once it’s in place, it costs almost nothing to replicate. That’s one reason software companies that provide free products have done so well: Google provides free search, Facebook provides free networking, Amazon provides free streaming, storage, and shipping, if you’re a Prime member. Of course, nothing is truly free. These companies make money on your browsing and buying behavior. But the marginal cost of providing software is practically nothing, and they’re passing those savings on to consumers.

This is why inflation is dead. Peace killed it. And software.

Douglas R. Tengdin, CFA

Rumors of War

What happens when an irresistible force meets an immovable object?

Map: US Army. Source: Wikipedia

That’s an old philosophical question. The answer, of course, is that no force is really irresistible and no object is truly immovable. But when they seem that way, spectacular conflict can be the result.

That was the case during the 5th century BC in Greece. Sparta had been the dominant power in Greece. They had a militant, military culture built around their army. Athens was a rising power. It had a commercial culture and a powerful navy. What made war between the two city-states inevitable, according to the ancient Greek historian Thucydides, was the growth of Athenian power and the fear which this caused in Sparta. The immovable object was Sparta. The irresistible force was Athens. The Peloponnesian War was the result.

The Thucydides Trap is a conundrum that’s been studied by the historian Graham Allison. He found 16 instances of a dominant nation threatened by the rise of a growing power. Twelve of those sixteen cases ended in war – the most destructive of which was the rising industrial power of Germany challenging the British Empire in the early 20th century. That did not end well.

Today, the rising power is China. The dominant nation is the US. After the Cold War, the US was left as the world’s sole remaining superpower. Western political and economic institutions became so dominant that Francis Fukuyama declared that liberal democratic capitalism was the “end of history” – that there was no comparable, coherent system.

But the rise China threatens this Pax Americana. They have a fast-growing economy, a rising middle class, and the desire to be taken seriously on the global stage. They are now the world’s largest producer of ships, steel, aluminum, autos, cell phones, and computers. Baidu rivals Google as the world’s largest search engine. Alibaba rivals Amazon as the world’s largest online marketplace. Conflicts at sea, in space, in cyber-space, and in trade are all possible, and need careful, cautious management.

War doesn’t always happen when a rising power displaces an established power. The UK took the long view in the 1890s when President Cleveland accused the Salisbury government of establishing a new colony in Venezuela, violating our Monroe Doctrine. Britain backed down, and agreed to go to arbitration rather than war. Our special relationship with England has been the result.

Public Domain. Source: Wikipedia

War isn’t inevitable, but war has happened 12 out of 16 time with the “Thucydides Trap.” If we do business as usual with the Chinese, we may end up with history as usual. Let’s hope not.

Douglas R. Tengdin, CFA

Crimean Crimes?

Why do we care about the Crimea?

Like many people, I grew up with a vague sense that the Crimea was an obscure piece of land somewhere in eastern Europe, and that is was most famous for being the occasion for the “Charge of the Light Brigade” that Tennyson immortalized in his poem. The point of the poem, as I recall, was that hundreds of lives were wasted in a dramatic military action because “someone had blundered.”

Now it looks like a repeat is taking form. The Ukrainians ousted their President, who was sympathetic to the Kremlin, and the ethnic Russians in the Crimea rebelled against the new Ukrainian government. Russia wants to secure its naval base in the Crimean port-city of Sevastopol. Russia is staging military exercises on Ukraine’s border, and there is talk that the US and other countries may apply some kind of economic sanctions to Russia.

Global markets have been roiled, first down, then up, then mixed. Russian markets have traded down dramatically. I feel vaguely unpatriotic for thinking about investing in Russian stocks like Lukoil or Gazprom because they’re so cheap—price-earnings ratios less than half that of the rest of the world.

The first Crimean War began in 1853 and was the result of slow-motion blundering by inept statesmen and their leaders’ search for prestige and strategic advantage. It didn’t have much impact on the US—we were preoccupied with our own inept blundering in the run-up to the Civil War. It resulted in over half a million casualties. The only bright spot was that it forced Russia to sell Alaska to the US to help pay off its war debt.

Most Americans are skeptical of a new conflict in an obscure location fought for vague, strategic goals Twain famously quipped, “History doesn’t repeat itself, but it does rhyme.” Let’s hope it doesn’t rhyme this time.

Douglas R. Tengdin, CFA

Chief Investment Officer