What We’re Reading (Week Ending 07 January 2024) - 07 Jan 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 07 January 2024):
1. What the Solow Model can teach us about China – Noah Smith
The question of why economies grow, and why they stop growing, is perhaps the most important in all of economics. It’s also an incredibly difficult question, both because growth is such a complicated thing, and because it’s very hard to compare different countries’ experiences. The Solow model is an incredibly simple thing — so simple that a bright junior high school student can learn it. It has only a few variables and a few parameters. There’s no possible way that such a simple model can tell us most of what we need to know about how and why economies grow.
And yet the amazing thing about the Solow model is that it does tell us a few incredibly important things about growth…
…The Solow model assumes that economic output — also called “production” or “GDP” — comes from three things:
- Labor (human work effort)
- Physical capital (machines, buildings, vehicles, etc.)
- A mysterious quantity called “total factor productivity” (TFP), usually abbreviated as “A”, which some people associate with technology
The Solow model deals mostly with the question of how physical capital affects growth. Physical capital is everything you can build that helps you build other stuff or create economic value. It includes machine tools, factories, office buildings, delivery vans, highways, port infrastructure, trains, and so on. In my mind, the easiest type of physical capital to imagine is a machine tool — a sewing machine, or a drill press, or a lathe, or a nanolithography machine. So I’ll usually use machine tools as my examples of physical capital…
…Solow’s model makes three very reasonable assumptions about how physical capital works. It assumes:
- You can build more physical capital by saving and investing.
- Physical capital depreciates over time (at a constant rate).
- On its own, physical capital has diminishing returns.
The first of these assumptions is actually the most subtle. The basic intuition is that you can set aside a certain amount of your GDP every year to build physical capital — like a farmer choosing to reserve a certain percentage of the annual corn harvest as seed corn for planting next year’s crop. But most real types of physical capital don’t work like seed corn — a sewing machine can’t be used to create new sewing machines, etc. So what Solow is actually assuming is that we set aside a certain percent of our financial income and use it to pay people to build more capital. It basically assumes a market where sewing machines, and any kind of capital, can be constructed for a price.
The second and third assumptions are pretty straightforward. If you’ve ever owned a car or a house, you know that it needs regular maintenance, upkeep, and renovation over time. If you have an economy with a lot of capital, some portion of it wears out every year and has to be replaced. (In the Solow model, the portion that wears out every year is just some constant percentage — 5% or 7% or whatever.) Replacing or maintaining your old worn-out capital costs money.
Finally, on its own, capital has diminishing returns. That means if you hold the number of people constant, eventually building more machines and buildings and such won’t help you produce more. To see why, just imagine one person trying to operate 100 sewing machines at once. They definitely wouldn’t produce 100 times as much as one person operating one sewing machine!…
…So what does this tell us about how economies grow? It tells us one incredibly important thing. It tells us that because of depreciation and diminishing returns, a country simply can’t build its way to infinitely high standards of living. If you just keep trying to build more and more, at some point depreciation overwhelms you. and you just can’t build any more!
Let’s think about that in the context of China. Over the last four decades, China has built an absolutely incredible amount of physical capital — in absolute terms, the most any country has ever built in history. Think about the vast, sprawling factories filled with robots and machines, the forests of skyscrapers and apartment buildings, the rivers of highways and high speed rail, the fleets of cars and trucks and buses and ships and planes.
The Solow model gives a simple explanation for how China was able to build this much, this fast: It had a very high rate of savings and investment, far higher even than other Asian countries.
China dedicated everything it had to building massive amounts of physical capital, leaving relatively little of its economic output left over for its people’s consumption. As a result, it grew very very quickly.
But the Solow model says that this type of growth has a limit. Just as the model would predict, China started hitting diminishing returns. We started seeing “ghost cities” and massive overcapacity in all sorts of industrial sectors. China’s incremental capital-output ratio — the dollars of capital needed in order to generate an additional dollar of GDP — rose relentlessly from around 2007…
…And just as the Solow model foretold, China’s growth is slowing:
Slowing growth from physical capital accumulation is the Solow model’s first big insight. The second is that it’s actually possible for a country to save and invest so much of its income, and build so much physical capital, that it actually makes its citizens poorer.
The reason is, again, depreciation. If you save and invest a huge fraction of your income — as China has done — you will build an enormous amount of physical capital. But the more you build, the more you have to pay to upkeep in the future. There’s a point called the “golden rule”, above which saving and investing more of your national income just forces your citizens to forego more and more consumption in order to stave off capital depreciation.
Does China save and invest more than Solow’s “golden rule” would suggest? It’s hard to tell. But if any country is above the healthy limit, it’s China. Note that in the Solow model, the optimal savings rate is lower if population growth is lower; China’s population is now shrinking, and its working-age population is falling rapidly. So the Solow model serves as a warning to China’s leaders that they should consider encouraging their people to consume more…
..Of course, there is a vast amount that the Solow model can’t tell us about economic growth. Most of those unanswered questions are contained in that innocuous little letter “A”; as one of Solow’s contemporaries put it, total factor productivity is a measure of our ignorance. One factor exacerbating China’s growth slowdown is that TFP growth has slowed relentlessly over the last three decades:
2. China’s Japanification – Robin Wigglesworth
The biggest question in global macroeconomics at the moment is whether China is on the cusp of a “balance sheet recession”. This sexy bit of economic jargon was first coined by Nomura’s Richard Koo to describe Japan’s lost decade(s), but is most commonly known as “Japanification”.
It can be described simply as a protracted period of deflation, economic sluggishness, property market declines and financial stress as households/companies/governments unsuccessfully try to deleverage after a debt binge…
…JPMorgan doesn’t explore cinematic history in its report but notes that there are a few eerie other similarities between China’s current predicament and Japan’s in the early 90s.
First is similarity in housing market development. As we have argued, China’s housing market correction since 2021 is not only cyclical (or policy-induced), it is also structural reflecting major changes in demand vs. supply in the housing market. This is similar to Japan’s housing market correction in the 1990s.
Second is similarity in financial imbalance, i.e. the pace of increase and level of debt problem. According to the BIS, China’s total non-financial credit/GDP ratio approached 297% of GDP by end-2022, similar to Japan in the 1990s. Also similarly, debt is mainly domestic and domestic saving rate is high in both countries.
The problem of population aging is also similar. The share of aged population (65 and above) was 12.7% in 1991 in Japan, similar to China in 2019 (12.6%).
On the external front, Japan’s large trade surplus vs. the US led to trade conflict, as exemplified in the Plaza Accord in 1985 (5-6 years before the start of Japan’s lost decade) and US-China tariff war that started in 2018. From a broader perspective, the rise of Japan (30 years ago) and China (right now) to challenge the status of the US as the largest economy in the world is quite similar, leading to the fight-back from the US that initially focuses on reducing the bilateral trade imbalance…
…Let’s look at what JPMorgan thinks are the “good” differences, before turning to the ugly. First of them (and JPMorgan reckons perhaps the most important difference) is a much lower urbanisation ratio in China.
China’s urbanization ratio was 65% in 2022, and if excluding migrant workers who live in urban areas but do not have the same privileges as urban citizens, the hukou ratio was only 47%. In Japan, urbanization ratio exceeded 77% in 1988. Lower urbanization ratio points at larger potential for productivity increase associated with labor migration from agricultural to non-agricultural sectors…
…Second, China has a much larger domestic market, a larger pool of STEM graduates and comprehensive manufacturing sectors. While China may be facing a more challenging external environment than Japan in the 1990s, there is also hope that China can achieve technology upgrade and commercialization in some areas…
…Third, perhaps somewhat debatably, we think China’s housing price overvaluation is less severe than Japan in the 1990s. This is in part due to prolonged administrative control on new home prices and in part due to solid income growth. Our estimates show that housing affordability has continued to be a big problem in tier-1 cities: it took 21.1 years of household income to buy a 90-sqm apartment in 2010, and 16.6 years of household income in 2022. By contrast, housing affordability is much better in tier-2 and tier-3 cities that account for the majority of China’s housing market. Using the same house price/income measure, the ratio fell from 13.4 in 2010 to 8.3 in 2022 in tier-2 cities, and from 10.2 in 2010 to 6.1 in 2022 in tier-3 cities.
Fourth, China’s capital account is not fully liberalized. This will reduce the risk of fire sale of domestic assets (mainly housing) to invest overseas…
…Lastly, the Chinese government has stronger control of both asset and liability sides of the debt problem. This could be a double-edge sword: it implies that the probability of a sudden-stop debt crisis is smaller in China, but the zombie parts of the economy will continue to stay and likely further expand, intensifying the moral hazard problem and weakening incentives for structural reforms. This may crowd out more productive activities in the economy and lead to faster-than-expected slowdown in economic growth…
…JPMorgan’s main concern is that China is actually ageing more rapidly than Japan was, which has led to predictions that it will ‘grow old before it grows rich(opens a new window)’ — a kind of demographics-caused middle-income trap.
In Japan’s case, the share of population aged 65 and above exceeded 10% in 1983, and exceeded 14% in 1994. The birth rate fell from 12.7 (per 1000 people) to 10.0 during that period. In China’s case, it took only 7 years (from 2014 to 2021) for the 65 plus population to increase from 10% to 14% of total population, and the birth rate has fallen faster from 13.8 (per 1000 people) to 7.5 during that period (and further down to 6.77 in 2022, similar to Japan in 2020 at 6.80). In addition, China’s total population started to decline in 2022, while Japan’s total population started to decline in 2008, nearly two decades after the start of the lost decade.
Second, China’s GDP per capita was around US$12,800 in 2022, much lower than Japan in 1991 at US$29,470. While lower GDP per capita may imply higher growth potential, it suggests that China is becoming old and high-indebted before it becomes rich…
…JPMorgan’s economists also point out that the global economic backdrop is worse for China than it was for Japan in the 1990s, and thinks the Chinese government has less scope for stimulative fiscal measures than is commonly assumed:…
…In recent years, technology decoupling from the US has replaced the tariff war to become the major challenge for China. Beyond the bilateral relationship with the US, the globalization process has slowed down notably after 2008 (when the share of global trade as % of global GDP peaked), in sharp contrast to the golden days of globalization in the 1990s. The Russia-Ukraine war in 2022 further accelerated global supply chain relocation, which weighs on China’s potential growth.
Moreover, the room of macro policy stimulus is more limited in China nowadays than Japan in early 1990s. On the fiscal side, government debt was 61.9% of GDP in Japan in 1991, the start of the housing bust. Government debt rose to 131% of GDP by 2000 in Japan. In China’s case, although central government debt was only 20% of GDP, if adding local government debt and LGFV debt, total public debt reached 95% of GDP by end-2022…
…JPMorgan warns that “the room for fiscal stimulus for China in the next 10 years is much smaller than Japan in the 1990s”. Nor do its economists think that China has any more scope to combat the economic miasma with monetary policy.
Similarly, on the monetary policy front, the BOJ’s policy rate was 8.1% in January 1991. The BOJ moved quickly after the housing bubble burst: by end-1993, the policy rate was cut to 2.4%; and in 1999, the BOJ became the first central bank to adopt zero interest rate policy. By comparison, China’s policy rate (7-day reverse repo rate) is already as low as 1.9%. The room for policy rate cuts for the PBOC, if deemed necessary, is much smaller than the BOJ in early 1990s…
…So why then does JPMorgan think that China isn’t about to suffer a Japan-style long-term balance sheet recession? It boils to the differences between “ordinary” economic downturns and Koo’s diagnosis of Japan’s pretty unique travails.
When asset prices fall, firms face binding borrowing constraints with balance sheet deteriorating, forced asset sales can further push asset prices lower and form a self-reinforcing downward spiral between asset prices and economic activities. In other words, asset price decline is critical in understanding the phenomenon of balance sheet recession.
Following this argument, balance sheet recession is not a reality yet in China. The Chinese government has adopted the strategy of protecting house prices but letting volumes correct dramatically. This is in sharp contrast to the Japan’s episode, when prices and volume fell simultaneously. As a consequence, the macro cost (sharp decline in volume activity and slower real estate investment) is larger in China, but the benefit is that financial risk associated with asset price decline has stayed under control.
Also Japan’s balance sheet recession manifested itself in a huge deleveraging by households and companies, but a massive increase in the government’s debt burden.
Corporate debt fell from the peak of 144.9 per cent of Japan’s GDP in 1993 to 99.4 per cent in 2004, and household fell from 71 per cent in 1999 to 60 per cent in 2007, even as government debt ballooned, pushing the overall burden for the economy as a whole higher.
In contrast, China’s debts have been building up across the board with hardly any interruptions since 2008, and this is likely to continue, according to JPMorgan…
…But the fact that Chinese debts have continued to rise and are likely to do so for the next few years — and that the property market hasn’t imploded yet — is not really an argument against China’s Japanification. Indeed, it might only indicate that a full-scale version just hasn’t started yet…
…But there are enough broad similarities to think that the overall disease — a protracted period of declining demographics, economic sluggishness, deleveraging and deflationary pressures that defies fitful government efforts to dispel the miasma — might end up being pretty similar.
3. 36 quick thoughts to end 2023 – Thomas Chua
#3 There’s zero benefit in dwelling on how luck shapes a person’s success. Instead, focus on controllable factors that can increase the probability of your success.
#4 As we progress in life, how we perceive wealth changes based on who we compare ourselves to. Define your ‘enough’ to avoid living your life solely pursuing wealth.
#5 If you don’t eat food that nourishes your body, sooner or later you’ll have to eat your medicine as food.
#6 Fast growth and quick wins are sexy in business and investing. Sustainable growth and compounding, however, are key to long-term outperformance…
#7 Just as food affects your body, the information you consume shapes your thoughts…
…#19 If you pursue any endeavors with half heartedness, your mind will become like a magnet for fear and doubts. When you encounter difficulties, you’ll come up with various reasons to tell yourself why you shouldn’t do it.
#20 The fastest way to end your life is to retire and do nothing.
#21 The biggest wall separating high achievers from the rest is excuses.
#22 Knowledge isn’t power. It’s a potential power. Only when knowledge is applied, it becomes power…
…#24 For a list of book recommendations, check out the bibliography section of books written by your favorite authors.
#25 You seldom regret what you did. You often regret what you didn’t do.
#26 More is not always better when setting goals. Reduce, reduce, reduce.
#27 Advice from people who are older aren’t laws. They’re like clothes. If it doesn’t fit you, try others.
#28 It’s inevitable to avoid pain in life. But suffering is optional…
…#32 Ordinary returns over a long time period will give you an extraordinary result…
…#34 No book can substitute the experience of navigating a stock market downturn. The best way to learn is to start.
#35 It’s not enough that you believe in investing for the long term. This idea must also be embraced by your spouse, family, and friends.
#36 Complexity gives you a false blanket of accuracy and control. It is usually the person who is able to explain things simply who knows what they are talking about.
4. The Nine Breakthroughs of the Year – Derek Thompson
1. CRISPR’s Triumph: A Possible Cure for Sickle-Cell Disease
In December, the FDA approved the world’s first medicine based on CRISPR technology. Developed by Vertex Pharmaceuticals, in Boston, and CRISPR Therapeutics, based in Switzerland, Casgevy is a new treatment for sickle-cell disease, a chronic blood disorder that affects about 100,000 people in the U.S., most of whom are Black.
Sickle-cell disease is caused by a genetic mutation that affects the production of hemoglobin, a protein that carries oxygen in red blood cells. Abnormal hemoglobin makes blood cells hard and shaped like a sickle. When these misshapen cells get clogged together, they block blood flow throughout the body, causing intense pain and, in some cases, deadly anemia.
The Casgevy treatment involves a complex, multipart procedure. Stem cells are collected from a patient’s bone marrow and sent to a lab. Scientists use CRISPR to knock out a gene that represses the production of “fetal hemoglobin,” which most people stop making after birth. (In 1948, scientists discovered that fetal hemoglobin doesn’t “sickle.”) The edited cells are returned to the body via infusion. After weeks or months, the body starts producing fetal hemoglobin, which reduces cell clumping and improves oxygen supply to tissues and organs.
Ideally, CRISPR will offer a one-and-done treatment. In one trial, 28 of 29 patients, who were followed for at least 18 months, were free of severe pain for at least a year. But we don’t have decades’ worth of data yet.
Casgevy is a triumph for CRISPR. But a miracle drug that’s too expensive for its intended population—or too complex to be administered where it is most needed—performs few miracles. More than 70 percent of the world’s sickle-cell patients live in sub-Saharan Africa. The sticker price for Casgevy is about $2 million, which is roughly 2,000 times larger than the GDP per capita of, say, Burkina Faso. The medical infrastructure necessary to go through with the full treatment doesn’t exist in most places. Casgevy is a wondrous invention, but as always, progress is implementation.
2. GLP-1s: A Diabetes and Weight-Loss Revolution
In the 1990s, a small team of scientists got to know the Gila monster, a thick lizard that can survive on less than one meal a month. When they studied its saliva, they found that it contained a hormone that, in experiments, lowered blood sugar and regulated appetite. A decade later, a synthetic version of this weird lizard spit became the first medicine of its kind approved to treat type 2 diabetes. The medicine was called a “glucagon-like peptide-1 receptor agonist.” Because that’s a mouthful, scientists mostly call these drugs “GLP-1s.”…
…3. GPT and Protein Transformers: What Can’t Large Language Models Do?…
…This spring, a team of researchers announced in Science that they had found a way to use transformer technology to predict protein sequences at the level of individual atoms. This accomplishment builds on AlphaFold, an AI system developed within Alphabet. As several scientists explained to me, the latest breakthrough suggests that we can use language models to quickly spin up the shapes of millions of proteins faster than ever. I’m most impressed by the larger promise: If transformer technology can map both languages and protein structures, it seems like an extraordinary tool for advancing knowledge.
4. Fusion: The Dream Gets a Little Closer
Inside the sun, atoms crash and merge in a process that produces heat and light, making life on this planet possible. Scientists have tried to harness this magic, known as fusion, to produce our own infinite, renewable, and clean energy. The problem: For the longest time, nobody could make it work.
The past 13 months, however, have seen not one but two historic fusion achievements. Last December, 192 lasers at the Lawrence Livermore National Laboratory, in California, blasted a diamond encasing a small amount of frozen hydrogen and created—for less than 100 trillionths of a second—a reaction that produced about three megajoules of energy, or 1.5 times the energy from the lasers. In that moment, scientists said, they achieved the first lab-made fusion reaction to ever create more energy than it took to produce it. Seven months later, they did it again. In July, researchers at the same ignition facility nearly doubled the net amount of energy ever generated by a fusion reaction. Start-ups are racing to keep up with the science labs. The new fusion companies Commonwealth Fusion Systems and Helion are trying to scale this technology…
...5. Malaria and RSV Vaccines: Great News for Kids
Malaria, one of the world’s leading causes of childhood mortality, killed more than 600,000 people in 2022. But with each passing year, we seem to be edging closer to ridding the world of this terrible disease.
Fifteen months ago, the first malaria vaccine, developed by University of Oxford scientists, was found to have up to 80 percent efficacy at preventing infection. It has already been administered to millions of children. But demand still outstrips supply. That’s why it’s so important that in 2023, a second malaria vaccine called R21 was recommended by the World Health Organization, and it appears to be cheaper and easier to manufacture than the first one, and just as effective. The WHO says it expects the addition of R21 to result in sufficient vaccine supply for “all children living in areas where malaria is a public health risk.”…
…6. Killer AI: Artificial Intelligence at War…
…In the world’s most high-profile conflict, Israel has reportedly accelerated its bombing campaign against Gaza with the use of an AI target-creation platform called Habsora, or “the Gospel.” According to reporting in The Guardian and +972, an Israeli magazine, the Israel Defense Forces use Habsora to produce dozens of targeting recommendations every day based on amassed intelligence that can identify the private homes of individuals suspected of working with Hamas or Islamic Jihad. (The IDF has also independently acknowledged its use of AI to generate bombing targets.)…
…Meanwhile, the war in Ukraine is perhaps the first major conflict in world history to become a war of drone engineering. (One could also make the case that this designation should go to Azerbaijan’s drone-heavy military campaign in the Armenian territory of Nagorno-Karabakh.) Initially, Ukraine depended on a drone called the Bayraktar TB2, made in Turkey, to attack Russian tanks and trucks. Aerial footage of the drone attacks produced viral video-game-like images of exploded convoys…
…But Russia has responded by using jamming technology that is taking out 10,000 drones a month. Ukraine is now struggling to manufacture and buy enough drones to make up the difference, while Russia is using kamikaze drones to destroy Ukrainian infrastructure.
7. Fervo and Hydrogen: Making Use of a Hot Planet…
…Eleven years ago, engineers in Mali happened upon a deposit of hydrogen gas. When it was hooked up to a generator, it produced electricity for the local town and only water as exhaust. In 2023, enough governments and start-ups accelerated their search for natural hydrogen-gas deposits that Science magazine named hydrogen-gas exploration one of its breakthroughs of the year. (This is different from the “natural gas” you’ve already heard of, which is a fossil fuel.) One U.S.-government study estimated that the Earth could hold 1 trillion tons of hydrogen, enough to provide thousands of years of fuel and fertilizer.
8. Engineered Skin Bacteria: What If Face Paint Cured Cancer?…
…Some common skin bacteria can trigger our immune system to produce T cells, which seek and destroy diseases in the body. This spring, scientists announced that they had engineered an ordinary skin bacterium to carry bits of tumor material. When they rubbed this concoction on the head of mice in a lab, the animals produced T cells inside the body that sought out distant tumor cells and attacked them. So yeah, basically, face paint that fights cancer…
…The ability to deliver cancer therapies (or even vaccines) through the skin represents an amazing possibility, especially in a world where people are afraid of needles. It’s thrilling to think that the future of medicine, whether vaccines or cancer treatments, could be as low-fuss as a set of skin creams.
5. TIP595: Stock Market History & The AI Bubble w/ Jamie Catherwood – Clay Finck and Jamie Catherwood
[00:34:02] Clay Finck: And then this also brought to mind another solution that could be brought about and that’s to restructure the debt. Are there examples in history that you’ve looked at where debt restructurings have occurred?
[00:34:15] Jamie Catherwood: Yeah. So in the U.S, it’s not something that tends to get acknowledged but in the first few years of our nation, we restructured our debt.
[00:34:26] Jamie Catherwood: I mean, that’s what Hamilton was tasked with doing when he. Assumed office as the first secretary of the treasury. When he came into his role in 89, 1789, there was a dire financial state. At that point, I’ll take you back to US history class from high school but before we had the constitution, we had the Articles of Confederation, which were designed to severely curtail the central government authority because obviously Americans were very fearful after having fought a war with a British monarch that any type of new government in the U.S. would fall kind of victim to a similar. And so the articles of confederation essentially gave Congress no power.
[00:35:16] Jamie Catherwood: And so, for example, they did not have the authority to collect taxes, which is insane. And so that means that during those years, there was not a lot of revenue coming in. And so even after the constitution was passed and the government we have today was put into place, there was a real problem because there were.
[00:35:34] Jamie Catherwood: It was not a lot of revenue coming in, but there had been massive accumulation of debt incurred during the revolutionary war to fight the British. And I mean, we owed, I think, like 80 million, a lot of it to foreign governments and when Hamilton took office, he had to write to the French government asking.
[00:35:54] Jamie Catherwood: For a delay in payments because the U.S. was basically struggling to get on its feet. In fact, in the 1st year of his time in office, he had to write to Washington President Washington saying that, if we don’t get the exact amount, but a certain amount of money into the treasury’s coffers in the next month, then we’re not going to be able to pay congressmen their salaries. And there are going to be a lot of other departments and cabinet positions that won’t be able to receive their funds because. we’re just so on the whole and so what Hamilton’s novel kind of idea was, and it was politically very challenging and a difficult thread to needle was he had to essentially convince American debt holders to exchange their existing higher paying debt and U.S. bonds that they owned for a public loan. Package of new debt securities that he would issue, which would have a lower interest rate, but his premise to these investors was the only alternative for continuing to pay out these higher interest rates would be to introduce new taxes or, raise higher taxes, both of which we know would lead to probably armed rebellion, as you can see, in the case of the whiskey rebellion, when there’s a whiskey tax introduced.
[00:37:10] Jamie Catherwood: And so if you want to really avoid that, then the only way we can do so is if you accept the fact that instead of being paid 6% interest on these bonds, we’re going to give you 4% interest going forward. And that was obviously a tough sell, especially when the nation was very divided and people were still very wary of strong central government implementing new taxes or having too much control and, changing their commitments to pay out what they had promised originally at 6%. And so that was very difficult, but in a matter of, I think, 2 years or so, he had successfully converted something like 98 % of the outstanding debt into this package of new securities that were lower paying, lower interest bearing securities and it saved. Tens of millions for the government and so that was restructuring literally at the founding of our nation. That was very successful. And one of the ways that he also was able to retire a lot of the debt, just kind of as an interesting side note, is by allowing investors to purchase shares of the Bank of the United States, which was kind of like an early central bank esque institution in the U.S. And the bank IPO ed on July 4th, 1791, I believe very patriotic IPO date and he allowed investors that held U.S. government bonds to pay for shares of the Bank of the United States with these bonds. So it was kind of a win for the government because, it injected capital into this new bank, but also it reduced the amount of debt outstanding that they would have to pay interest on by allowing someone to use like three government bonds to purchase one share of the Bank of the United States stock and so interesting and often under referenced example of a restructuring in U.S. history, because when there’s talk of debt restructurings or defaults, et cetera, people tend to pull out the line that U.S. has never defaulted on its debt or something like that.
[00:39:14] Jamie Catherwood: The reality is that there have been these moments in U.S. history where we were in pretty dire times and some novel solutions were needed…
…[00:40:37] Clay Finck: But then another major factor I sort of think about in terms of market efficiency is the massive impact of passive flows on index funds. And you did a write up that referenced the telegraph looking all the way back and investors first getting access to this quick information. So talk to us about the efficiency of markets and how that’s changed over time.
[00:40:58] Jamie Catherwood: Yeah. So what prompted kind of my recent interest in this again was a quote from Cliff Asness in a recent financial times article, but he said something along the lines of people that think technology. It’s going to make asset pricing markets more efficient are the same ones who 20 years ago said that social media would make us all like each other more, which I think is just a fantastic way to put it because definitely social media does not make us like each other more and has increased the divisiveness in society.
[00:41:31] Jamie Catherwood: But also, I mean, it makes sense on its face throughout history that when you suddenly get these innovations and kind of communication and data. That markets have become more efficient because people have more information. And while that’s certainly true to a certain extent, there is. It’s definitely nowhere near kind of an elimination of mispricing and, inefficient markets, because I remember when the telegraph cable first took over the world and people could get information in India to London, for example, on something like 8 hours where it used to take much longer.
[00:42:07] Jamie Catherwood: Someone said that there would be no need for crises moving forward because now all the information would simply be known. And I just loved the kind of matter of factness with, I can’t remember his name is Arthur something, but he was a person of high authority and he just. I just put it so bluntly as if why would we have panics and crashes moving forward?
[00:42:28] Jamie Catherwood: Because now everybody will have access to information at the tips of their fingers, at least in their day, that was considered tips of their fingers. And so how could there be more panics and crashes? And obviously, if anything, the 19th century had more panics and crashes than any century and so there is this.
[00:42:46] Jamie Catherwood: Just the belief that technology will always make markets extremely efficient but throughout history, you see the introduction of these technologies and the opposite occurs where, ironically, you know, when the telegraph and the ticker were introduced there was a study done that showed how the states that as their ticker subscriptions increased.
[00:43:09] Jamie Catherwood: Within each state, people started gravitating towards companies listed in their state and so basically a home country bias but at the state level, if you can imagine it, and people started just hurting into the same kind of like top 10 stocks within their state and instead of. The ticker and telegraph broadening the speculation across a broader set of stocks, people just continue to concentrate into the same names.
[00:43:39] Jamie Catherwood: And you see this throughout history in the 1600s, when markets in London during the 1690s were kind of going through their first bubble is this IPO bubble and kind of the first technology mania you saw a list of securities in one of the kind of market write ups market commentaries that was published every two weeks by this guy, John Houghton, he had a list of 20 securities that he monitored the prices of and even though.
[00:44:08] Jamie Catherwood: There were a couple of hundred securities trading on the London exchange, the vast majority of all trading volume on the exchange was concentrated into the same list of securities that he provided prices for in his market commentary every two weeks, and so while that’s not necessarily technology by modern standards, it’s still just shows that even when investors are presented with A lot of different stocks to invest in, they tend to concentrate into the same ones that everybody else does.
[00:44:35] Jamie Catherwood: And so it’s just this interesting phenomenon throughout history that technology does not necessarily change our approach to investing and, cause us to expand our universe of stocks to select from. And I think during COVID, we saw that same phenomenon with the Robinhood tracker. I don’t know if you remember that, but it showed just the level of trading on Robinhood that was concentrated in the top 10 most popular stocks.
[00:45:01] Jamie Catherwood: And it was just crazy to see even in this modern age, when literally you have unparalleled access to information at the tips of your fingers. That’s still, we kind of just heard into these same names as everyone else, even though you could be looking at a really exciting micro-cap stock or something
[00:45:18] Jamie Catherwood: And I could be looking at mid-smith cap stock doing something exciting, the energy sector or something like that but instead people tend to just kind of hurt into the same us large cap stocks.
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