Savings Habits are Not Culturally Driven - CapEx is rising

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We had a fun, meandering conversation with Matt Klein from The Overshoot.  Love this guy. Smart as heck.

There is a lot of talk about China’s huge consumer potential and yes 1.6 billion gets the attention of S&P 500 companies. The challenge is very little of China’s GDP is controlled by the consumer because most is controlled by the state. In addition, China’s population is old - check out this podcast we did on China’s ageing population.  So what does huge ageing population with little extra money to spend have to say about the global demand trends and Chinese role in the world?  Throw in a $500 Billion gap in U.S. current accounts and a couple of stories about Mao acting crazy and boom – we got another episode of the Soundtrack to a Financial Advisor’s Life.

• Trade Wars are Class War’s

• Interest Rates Relation to Asset Prices and What it means to Household Income

• China’s Household Savings Rate is 30%. U.S. Household Savings Rate is 7%. Why?

• China’s Household Don’t Have A Safety Net and Have to Save not Spend

• The Consumer in China Has Very Little of China’s GDP and that Isn’t Changing Anytime Soon

• Interest Rates Relation to Asset Prices and What it means to Household Income

• What $500 Billion Gap in the U.S. Current Account Deficit Has to do with Companies Spending More on CapEx

• The Digital Yuan

• COVID Killed Consumer Spending in China? Not really. The Consumer never was spending in the first place.

• China is Getting Richer, but it is Still Really Poor

• Supply Chains – Good News, Rental Car Companies Have Rebuilt Their Fleets

• Mao killed a bunch of sparrows in China and 60 million people starved

• Mao told farmers in China to plant seeds a particular way and 60 million people starved

CHAMBERS:  Hey, everybody. This is Trevor Chambers from Olde Raleigh Financial, and unfortunately, I cannot say that it's sunny Raleigh, North Carolina. We're a little overcast, here. I don't know. Matt, how's things out in San Francisco? What do you got?  You got some sun there or what?

KLEIN:  Yeah, perfect blue skies, you know, 60 degrees.

CHAMBERS:  Nice.

KLEIN:   Can’t complain.

CHAMBERS:   All right, I'm going to throw you a curve ball. I got a bunch of questions to ask you, but I didn't bring this one up. This is not anything to do with your subject matter. But, where -- besides -- when you and your lovely wife want a cup of coffee in your neighborhood, is there any place that you guys go to get a nice cup of coffee that I might be able to shout out to in my blog, here?

KLEIN: Oh, Farley's.

CHAMBERS:   Nice.

KLEIN:  Definitely recommended that.

CHAMBERS:   Farley's. All right. I ask people like where do they go lunch, where they get their coffee? And that's right around -- that's in the hood?

KLEIN:  Yeah. It's a few blocks.

CHAMBERS:   Nice. So, they -- they know the -- they know the Klein family.

KLEIN:  Well, I don't know about that, but we know them.

CHAMBERS:   I got it.  They know your Amex card or whatever, right? Yeah, absolutely. So today folks, we're going to be not just talking about Farley's coffee shop and someplace in San Francisco, but we're going to be talking China and all the fun stuff that's going on with China. And we're going to be talking more specifically about trade imbalances that the United States and, really largely the world, has with China and kind of what are the ramifications on our society here in the United States, as well as China's society.  And I've got no better person than Mr. Matt Klein. How are you, Matt?

KLEIN: Doing great.  How are you?

CHAMBERS:  Awesome, man. So, Matt you're, you're an alumnus, you were on a year or so ago, and I really appreciate your time. You were quite a distinguished person. I've just looking at your -- tell me about The Overshoot.co.  Tell me a little bit about that because you did not have this, I'm sure this was germinating the last time we spoke. And I certainly can butcher your background a little bit, but maybe you can do a heck of a lot better job than that. Matt, who are you? And what's The Overshoot?

Trade Wars are Class War’s- Household Savings and Household Spending are not Culturally Driven Societal Factors

KLEIN:   Sure. So, The Overshoot is a subscription research service about the global economy, financial markets, and public policy. It's available, anyone can purchase an individual subscription.  Also, there's some institutional customers that buy in bulk and that also provides the option of, you know, one-on-one conversations with me. It's really in-depth analysis of the global economy, the US economy, Chinese economy, Europe and it's really just trying to take kind of in a very, you know, detailed, but also, you know, very sophisticated level, looking at what is going on in the world?  What can we see in the data? How should, you know, we understand what's happening? And it’s sort of falling onto the work I've done before when I was at -- I was at Barron's and The Financial Times, and also very much related -- if you liked the book that I wrote with Michael Pettis; Trade Wars Are Class Wars, which is what we -- I talked about last time I was on -- on the show with you. I think you'll like this and really, you know, we have some -- I'm very pleased. If you, you can go to the website and see some of the testimonials.

CHAMBERS:   Yep.

KLEIN:   There's some really very impressive readers and subscribers who are fans. So, you know, feel free to check it out and join them.

CHAMBERS:   Yeah, for sure. And we will, obviously include a link in the transcription of this. So, I'm excited for you, man. This is, and how's it going?  Is it going well?

KLEIN:   Yeah, it’s going pretty well. I mean, you know, obviously there's always room for further growth, but I mean, where I'm looking at right now in terms of the gross annualized revenue based on subscribers so far, I -- I'm very pleased and yeah, it's -- it's going nicely and, you know, signing up some more, you know, corporate customers and yeah, it's great. 

CHAMBERS:  Good for you, man.  I'm excited for you. You deserve it.  You work hard and it's great.

KLEIN:   Thank you.

CHAMBERS:   Yeah. I mean, I understand sticking your neck out and straight, you know, putting your own business up and doing -- it's challenging and it's --and the good days is great. And on the bad days, you know, and I don't know, it could be a little bit of a brown liquor or vodka. I got it. All right, my man, let's get right into this. So, this -- you know a lot about the status of child -- China's household savings rate and why that is so important. So, I want to kind of rehash what we talked about before, because I just want to get an update from you on what's going on with this.  And why is savings rates in China -- what effect does that have on us? And by the way, the first time you explained this to me, because I'm not that smart. I was like, what the hell is he -- I mean, this sounds interesting, but after I kind of like digested it, I was like, oh.  Interesting. So, anyway.

KLEIN: All right, so I'm gonna (sic) try it again.

CHAMBERS:   Try it again.

KLEIN:   I'll just break it down.

CHAMBERS:   It will take me a third time, man.

KLEIN:   Yeah. Maybe. I mean, it took me a long time to wrap my head around this too. It's not like I just, one day woke up and understood this.

CHAMBERS:   Yeah.

China’s Household Savings Rate is 30%. U.S. Household Savings Rate is 7%. Why?

KLEIN:    I guess the first thing to start with is saving is -- is not a thing itself, right? But the thing itself is you have income and then you spend your money and savings whatever's leftover.  So, people might try to target a particular savings rate, but at the end of the day, it's the saving is what they can't -- they can't control their savings. They can -- they can control how much they spend and to a little bit extent they control what they earn, but really, you know, the -- the adjustment mechanism is what they spend.  And so, when we talk about someone having a high savings rate, in practice, what it means is that whatever they make, they don't spend a lot of it relative to someone else. So, in China, the household savings rate, that's around, you know, 30% or so, which is definitely higher than in the US, which is around, you know, 7%, but it's not crazy high compared to some other societies in Asia or for that matter in parts of Europe.  The thing that is distinctive for China, when thinking about it as the macro economy is that the household sector is only one part of the broader economy. So, household saving a lot, you see that in places -- I mean, Italy households save actually a very large share of their income. But that's offset by other sectors of the economy that don't save as much, whether it's, you know, companies that are borrowing a lot of government -- and you see this in a lot of countries. It balances out in different ways. What's unusual in China is that the high household savings rate is matched by very high levels of corporate saving, in addition. And so that ends up and -- and government borrowing is relatively low in China. It's not, you know, zero, but it's -- it's relatively low. And so, the net effect there in -- in China is that the sort of national savings rate is extraordinarily high. The other way of looking at this, which is like, what is saving, right. It basically means that of all the stuff that's produced in China, all the goods and services and everything that businesses are putting out, relatively little of it is actually consumed by Chinese households and enjoyed as goods and services that people want. And so that leaves the question again, where does it all go? Well, a bunch of it's exported and then a bunch of it goes into, you know, building infrastructure projects or housing or things like that, you know, essentially industrial products that are not for consumers.  And the proportion of the Chinese economy that either is going to, you know, net exports or to, you know, the sort of heavy investment stuff is something on the order of like 50% of the Chinese economy.  It’s extraordinarily high. And again, this is not -- there is really no precedent for this outside of basically like, you know, Soviet Union in the 1930s. And that ends up, you know, because China is such a large economy, you have this very unusual composition of, you know, the mix between production consumption there.  It has a lot of effects that spill over to the rest of the world. In particular that, you know, people there aren't buying what other people -- other countries, other businesses are producing. And that creates a lot of challenges in terms of, you know, trade and balances and -- and weak consumer -- weak income growth abroad that then, you know, as we explain a lot more detail in the book, Trade Wars are Class Wars that, you know, has all sorts of problems. It might lead to, you know, higher debt, financial crises, lots of, you know, higher unemployment, lots of problems for the rest of the world. And it's also bad for people in China.  I should be clear because they're effectively living far below their means because of the low level of [00:09:00] consumption relative to income -- relative production I should say.

China’s Household Don’t Have A Safety Net and Have to Save not Spend 

CHAMBERS:  What role does the environment or the, you know, the -- what role does the Chinese environment play in that? I mean I did, I don't know if you and I talked about this before, but after we spoke, I remember reading or something that, you know, one of the things that the average Chinese person has to kind of reconsider is that their environment isn't very great and they very well could be sick as they grow older.  So, they have to save a little bit more, keeping that in mind. Do you have any thoughts on that?

KLEIN:   Yeah, I think that's actually something we mentioned the book. This is a point that Michael Pettis has made; my coauthor on the book in the -- in the past. And part of the reason why the household savings rate in China is high, you know, a lot of people talk about cultural or whatever, and like, maybe that's part of it. But the simple reason is because there isn't much of a government welfare state, social security system to protect people. And so, they have to save. If you don't save, you're going to, you know, starve and, you know, if anything bad happens to you, you'll have no money.  You retire, you stop working, you have no money. So, there have been improvements over the years in terms of, you know, things like expanding access to healthcare coverage and so forth, but it's still a very, very bare bones, kind of welfare state compared to what you'd have in many other societies.  And so, one of the ways that people try to provision for this is basically saving themselves, you know, save as much as they can to cover their own costs. One of the other things that happens, there’s a lot of -- so, in addition to the savings rate, being high, the thing that I think is actually more important and this relates to the corporate savings side I was mentioning is that the share of income that goes to households is very low.  So, household savings rate is high, but that's not really why consumption in China is as low as it is. The reason consumption is as low as it is because households just aren't making that much money in the first place. If household income share were higher, even with a high savings rate or a relatively high savings rate, they'd spend more but so much -- they don't have a lot of income. And one of the ways that income is transferred is through the mechanism you're talking about. And this is a kind of thing where it doesn't show up in like, you know, a tax or spending government budget. But it is a real thing, which is that you're effectively privileging companies and the owners of companies.  Those might not be Chinese people by the way, but they're owners of companies operating in China through environmental regulations that then end up harming consumers in China by making them sick. That's one thing you can do. Another thing that happened a lot in the past, it's less of an issue now, but like it had been a big issue in the nineties and the two thousand was the government essentially seizing land that people had been living on. Giving them very low in compensation, then essentially gifting it to, you know, companies that were coming in and bringing in investment. You have things like preferential access to electricity and other utilities, which again, those particular things aren't necessarily as much of an issue now, but they -- they are part of a, you know, overall piece of mechanisms that transfer income and consuming power from, you know, ordinary people in China to companies. And that ends up having all sorts of knock-on effects. Again, it's bad for people in China and it also is bad, you know, for people in the rest of the world, because if someone is in China and they're, you know, an ordinary person who they'd like to have more things and have a nicer life they are -- they feel compelled to save money and not spend.  And by not spending, they end up depriving people and the rest of the world, of income. And, you know, the people who would sell things to people in China, aren't able to, because the Chinese consumers are, you know, held back. And so that, you know, it's -- everyone is worse off, or almost everyone's worse off, as a consequence of this.

CHAMBERS:  Yeah. The other thing, I don't know if you have some comments on this, but I think that you guys also said in the book that a lot of -- a lot of money gets chewed up by local governments. So again, that's just more GDP not getting into the hands of the consumer. So basically, what you're saying is, they're just getting taxed to hell, basically.  I mean that’s –

The Consumer in China Has Very Little of China’s GDP

KLEIN:  Yeah, effectively. I mean, the question of like what's a tax versus what's -- yeah. I mean, right. It's not a tax that shows up on a tax statement. Like officially tax rates in China are actually pretty low. In fact, they don't really have much of an income tax. They don't have property taxes. So, in fact there's like a controversy now about the possibility of introducing a property tax. Probably is not going to happen because a lot of people -- that's a -- that's a story we can get into separately. But -- but the -- the issue is that like the sort of overall social economic system is -- is structured in a way to transfer income and spending power away from ordinary people. And you know, where it goes, you know, people talk about like different things. State owned enterprises or, you know, companies like -- I think that's actually kind of a waste of time, like talking about like the private sector versus State owned enterprise.  Like everything in China, there's a -- there's a great book that came out. I think it was like 2009 called, The Party by Richard McGregor. And he talked about this, I think really convincing other people, made some of this point, which is that the way the communist party operates in China. And it has a very sort of old-school Leninist approach, which is that you don't want to have any kind of alternative centers of power, whatever they are. That's why the Chinese government's been, you know, so, you know, adamant about prosecuting, or persecuting, you know, religions because they don't like -- they didn’t at that time, an alternative source legitimacy. And it's also why, you know, economically they, you know, the -- the idea of like a private company, isn't really a thing. Like you always have communist party, you know, representatives in there, the government regulators will -- will push people to do things. So, whether or not it's officially a state-owned enterprise or not, it's kind of the same system that applies to everyone. And so again, and this also applies like the local government point you're making as well, like the local governments own most of the state-owned enterprises --

CHAMBERS:   Right.

KLEIN:   -- and the local government officials will also through various means have their own, you know, hooks into, you know, extensively private companies.  So, you know, the distinctions there in terms of, you know, who -- who exactly has been -- and it's all, I mean, in the book, we generally use sort of the catch all phrase, elites, because, you know, who these people are, you know, it -- it kind of -- you don't want to get too caught up in semantics and distinctions when, you know, it’s sort of a broader point here about how the society is structured and it was structured this way, I think very deliberately, you know, in terms of the political priorities of the party.

CHAMBERS:  Wow.  So, essentially Americans don't save because we -- we can just buy cheap stuff, and so we do, and we're just a very active consumer.

 KLEIN: Well, I'm not sure I’d quite put it that way.

CHAMBERS:   Okay.

KLEIN:   I mean, there's an element of that, but I think a lot of it is, you know, it's a function of, right -- it's a function of incomes and it’s a function of -- of consuming.  And so, one of the points we make in the book, if you talk about, you know, the pre financial crisis period.  You know, the 2000’s in particular, which is when everyone, you know, it was easiest kind of to point to this stuff. Consumer spending did not grow particularly rapidly in the United States. In fact, if anything, it was a little slower than sort of the long-term pre 2000 trend. The thing that was unique and distinct about that period is that income growth was really weak. And that's really what happened. And you can see that in, you know, manufacturing production basically flatlined, and, you know, a lot of people lost jobs and it was business investment kind of cratered after the -- the tech bust and never really recovered until after the financial crisis.  And so those are the kinds of things, and then, so basically what could -- there are two options that could have happened given that backdrop. Either consumer spending would have sort of fallen with that. We would have had sort of a global depression. You know, the post 2000 world would have been a lot like the post 2008 world. Or what did happen, which is that consumers basically maintained the spending that they would have had more or less, even though incomes and employment were a lot worse.  And they did that by borrowing. And that borrowing was accommodated by the global financial system partly, you know, and, you know, there's a whole lot of mechanisms that are involved. A lot of other, you know, we -- we wrote about it. Other people have written about like, what exactly happened. How that worked, what the linkages were, but essentially that's -- that's how everything played out.  And so, it's not so much that American consumers just didn't feel like they needed to save. It's more that they wanted to maintain sort of a certain standard of consumption and the only way they could do that, given the weakness of income growth, was by borrowing. I would also note that it's not really true anymore.  It really stopped being that way after the financial crisis and basically ever since then. I mean, the savings rate in the US -- household savings rate has been much higher. Not, you know, 30 percent like in China, but definitely, you know, higher than it had been really until the 1990s. So, or rather I should say, the 1990s and 2000s, it was low and now it's back, sort of, to where it was before then.  So, in that sense, we sort of had a bit of a normalization there. Not -- coincidentally you've also had a lot slower growth in consumer spending after the financial crisis. It was not like there was an income boom. But, you know, that -- that, I think sort of gives you a sense -- it's not like -- I don't think that sort of cultural explanations -- I'm sure there's some role there, but I think it's very easy to overstate it.  I mean, Michael Pettis, likes to talk about how, you know, you go back and read what people are writing about, you know, China and Japan and stuff, you know, say before World War II or whatever, they say, oh, you know, Confucianism makes people indigent and lazy and they don't save anything. And then people look later on, Confucian values means that they're hardworking and thrifty.  And it's like, okay, well they can't both be -- like, the answer is probably neither. Right? Essentially it has nothing to do with these things. And people just respond to all sorts of other, you know, stimuli. But yeah, I -- I think it's very easy to overweight cultural explanations for stuff when these kinds of things -- when they're usually other, I mean, I'm not saying culture has no role, but I think it's, you know, we should be very careful before, you know, assuming that’s --

CHAMBERS:   Yeah.

KLEIN:   -- that's what's behind it.

CHAMBERS:  Yeah, well thank God for guys like you and Pettis that kind of break these things out for us. So, by the way, how did you -- how did you end up just getting into this area that you're in and like knowing so much?  I mean, what drew you to this subject matter that you -- that you, you know, I mean, not everybody -- I mean, this is -- it's just such -- so interesting.  How did you end up -- like did you stumble into it or just your studies kind of brought you here or --

KLEIN:  Oh yeah, definitely stumbling. I mean it really, I guess, started with like, you know, if we go back, I hadn't, you know, when I was in college, I didn't really know what I wanted to do when I grew up as it were.  And I was fortunate that I ended up managing to get an internship and then a job offer at a macro hedge fund. And they -- they had the very broad-minded view that I wouldn't know anything. I couldn't have learned anything in college that was useful to them anyway. So therefore, it didn't matter that I hadn't learned anything in college that was useful to them.

CHAMBERS:   Right.

KLEIN:   And they taught me a bunch and I got very interested. This was right around just before and during the financial crisis. So that -- that was definitely time to get, you know, realize how interesting and invaluable understanding this stuff is. And while I was there, I mean, I -- I ended up learning and reading about the work of Michael Pettis actually, and following that stuff.  And -- and, you know, and kept being, you know, seeing how -- what happened with the financial crisis and, you know, the -- the fallout and the reactions to it and how, you know, having this sort of global framework and, you know, balance of payments thinking, is very helpful for understanding it, even for stuff that doesn't seem like it's, you know, trade specific. 

CHAMBERS:   Right.

KLEIN:   And so that really got interesting to me and I just spent a lot of time. I mean, it's -- the good news is that even if it's, you know, not intuitive, there's a lot of material out there that's really good and that's free, in fact.  I mean, like it's -- it's dry, but like the International Monetary Fund publishes a manual for how to understand the balance of payments.  So, you know --

CHAMBERS:   Yeah.

KLEIN:   -- I mean -- you’d read it.

CHAMBERS:   Yeah.

KLEIN:   It’s -- I mean, I wouldn't, you know, necessarily recommend it to someone who's not interested, but I mean, I think quite frankly, our book does a more engaging job of explaining --

CHAMBERS:   Oh, yeah.

KLEIN:   -- these concepts in a shorter time. But, like it's there for you if you want. I mean, that's like, I definitely, you know, went back and looked at it when we were writing some passages there just to make sure, you know, to say like, you know, be precise with the terminology and everything.  And I mean, it's -- it's all laid out and then these -- these frameworks. And so, there's a lot of, and there's, you know, other, I said like Michael's work and the books before, and, you know, and this book, I think, you know, you can pick it up over time. And as I said, it's a really powerful tool for understanding, you know, what's going on and thinking through, and, you know, putting data into context.  Which is a lot of what I do now with the Overshoot is, you know. We, you know, some -- some numbers will come out and you say like, okay, well, what does it actually mean?  How does it fit into things; you know? Stepping back and remembering that everything that happens in the global economy is connected and it all fits together. And so, you can't look at any individual piece of it in isolation. You have to think about how everything, you know, what the ramifications are and how everything flows through with everything else.  And, you know, a lot of people don't do that because they don't, you know, it's not necessarily intuitive and you know, but it's --

CHAMBERS:   Right.

KLEIN:   -- I think very useful. So, I try to do in the day job.

CHAMBERS:  Let me tell you, that point of view is very important when you're -- when you're investing somebodies -- for somebody who's on a 30-year timeline and actually be considered, at least for our clients largely.  You know, we always found most of our clients have -- are fortunate to have pretty high net worth. [00:22:00] And a lot of times this money is their grandchildren's money. So, you have to think, okay, really just you have to think broadly, like, wow, I've got a good guidance for this because, you know, I've been a good steward of my money.  I've instilled good stewardship of my money to my children. And so, I can only extrapolate that to actually, this is my grandchildren's money, you know what I mean? Very few clients are going to call and say, I need a half million dollars, send it over because I'm blindfolded in the middle of like Venezuela being, you know, I -- I got -- I got captured. Nobody calls up and says, I need a half million dollars. You know what I mean? So that's, I mean, it just doesn't happen. Meaning like this money is invested for the long term. So that's why I love talking to you guys, to people like you, because I think it sets a stage for people's retirement. It’s like, okay, you know, what's going on and what can we expect? Now that being said, just to hone back here, can you talk to me about the role inequality plays in maintaining like a low inflation, low price regime that we're in and maybe coming out of.  And then I want to talk about supply chains.

KLEIN:  Sure. So, I mean, the thing that I think is really interesting from the framework of, you know, the sort of systematic balance of payments framework and income distribution stuff, is that it can be presented in a very dry way.  What we tried to do with Trade Wars or Class Wars is to show that actually these have really important consequences.  They are -- there are real-world consequences that actually matter to a lot of people, and in fact, it can be very provocatively.  I picked a title that is provocative to highlight this.

CHAMBERS:   Yep.

KLEIN:   And the reason I say this is because the distribution of income -- changes the distribution of income.  You can call it inequality and call it income concentration, whatever.  They've all sorts of macro-economic ramifications. And we talk about a bunch of them in the book. I think the sort of most simple, basic point is that people at the very top of the income distribution, they are not going to spend as much on, you know, consumer goods and services as a share of their income, as other people.  And so, if more income and more spending power goes to those people at the very top, relative to everyone else, you're going to have a shift in how much, you know, it's going to have all sorts of interesting consequences. One consequence could be just lower consumer spending overall. But realistically, that wouldn't be the case.  That can't be, right? That's an example. Yeah. That's like the first order implication, but it can't be because then how are the people at the top making money, right? You have, the only way you make money is if someone else is spending money.  So if they have more money at the top, they're spending, you know, you have lower -- in theory of lower consumer spending, but what's -- somethings making up the difference.  You have to have more borrowing from people lower down, more borrowing from the rest of the world. That's a big argument that we make in the book. Is that the reason why income and inequality in parts of Europe and in China and so forth, didn't have the kinds of consequences one might've expected in those countries is because they were able to offload the costs or some of the costs to [00:25:00] other countries like the United States. In terms of inflation and consumer spending, I think that's sort of a piece of it. And so, I would phrase it this way, which is, you know, what -- why does inflation happen in sort of the macro level?

CHAMBERS:   Yeah.

KLEIN:   And the -- I think correct, but sort of difficult to quantify is there's -- there's more nominal spending power, however we define what that is, relative to the real value of goods and services that people want to buy.  And, you know, that's tricky to actually turn into like an investment strategy because like what -- what is the real value of stuff (inaudible)?

CHAMBERS:   Yeah.

KLEIN:   What is that capacity? What does nominal spending power actually mean?  Because it's not -- it's not the money supply. Right. It's any so, whatever that is. So yeah, it's tricky.  I mean, I think it's right when I say it that way. I mean, --

CHAMBERS:   Yeah.

KLEIN:   -- I'm not sure how useful it is, but -- but so you think about what this means in the context of, you know, the income distribution. If you have, you know, more, you know, income going to people at the very top, less income going to people lower down, that in principle means, you know, unless there's some offsetting, you know, credit expansion, which there, you know, at some level there kind of has to be, but you know, there has to be somewhere, then, you know, that means less consumer spending, less pressure to buy stuff.  And that would therefore put down prices. Now again, though, like it wouldn't actually have less consumer spending because then people at the top wouldn’t be making more money. So, there's usually, there may be the government's borrowing more, you know, maybe you have a government budget deficit that then has welfare spending to make up the difference.  Right? I mean, that's effectively what happens in much of the world or you have consumers borrowing against, you know, houses or whatever to make up the difference. Right. I mean, that's generally how these things happen. And historically it’ll sort of offset this.  But those aren't -- that's not a sustainable arrangement.  So that in of itself makes me think that inequality, you know, globally, it wouldn't necessarily have an impact on inflation either way -- like it's the growth, it's how much growth flows through inflation, right? Like you could have either the -- the nominal income -- nominal spending power wouldn't necessarily change the way, because you might have less income, but you have more credit, for example.

CHAMBERS:   Right.

KLEIN:   And so, I think what makes it tricky to kind of figure out the answer, I think what might be sort of the clue to the answer is if -- if the income that people have, you know, it -- it lowers the -- they can still spend as much, you know, in theory. Because if there's credit or whatever, but if that -- but if employers aren't necessarily paying that as a cost in the -- in the goods that they're produce -- services they are selling, then that might lead to lower prices potentially that otherwise would be the case.  And then, you know, people are kind of making it up for it and then like it shows up some other way in like taxes or something, I don't know. But that's, to be honest, I'm not entirely sure how it would play out. I mean, we can think of examples of societies that have, you know, relatively more egalitarian, less egalitarian and then how their -- what their inflation tracker has been.  It's not really clear to me, there's a pattern either way. So, I would be sort of wary of -- of making that point. I mean, the thing that I think is clear is what it shows up in interest rates. And this is a piece I wrote about, we mentioned this in the book and I wrote about it more extensively back -- back in August, actually for the Overshoot and, you know, because interest rates, you know, there's an inflation component. But there's also the real rate component. And, you know, the real rate, you know, who knows what -- there's all sorts of things can affect that. But I mean, a very simple level. If you have a big group of people that want to buy financial assets and other people who, you know, maybe they’ll be issuing -- maybe they're borrowing it or, but they don't, you know, it's not, it's not like they're going out and saying, I really want to borrow.  It's more like, well, I just want to keep from spending a certain amount or whatever. That's going to be potentially lead to some kind of mismatch and lead to a drop in interest rates. I think that, you know, like I explained in more detail, but essentially like, it makes sense that you would have interest rates keep going down in a world where income concentration is going up because, you know, you could think there are a lot of ways of thinking about, but one simple way is like, if central banks are trying to maintain, you know, the -- the main way of, you know, sort of keeping employment full or whatever. And you know, they would want it -- they'd have to keep [00:29:00] lowering interest rates to sort of offset the impact of -- of, you know, generating the credit and the borrowing that would be necessary to offset the concentration of income at the top.  You know, the only way to do that as you lower rates. And so, you have that sort of, that's -- which is what we saw, basically or have seen. So, you know how that, again, how it translates to inflation, I think is -- is, you know, not obvious to me, but I think it translates into interest rates pretty clearly.

Interest Rates Relation to Asset Prices and What it means to Household Income

CHAMBERS: Yeah.  Interest rates have certainly been long for, I mean, low for a historical basis for a long time. And to your point, if -- if you're in a low interest rate regime, if you have assets; real estate, financial, okay, your home, you're doing, you know, you're doing well. Right?

KLEIN:   Right.

CHAMBERS:  You're doing well. If you don't, which is by the way, a majority of us, it's not so -- it in the long run, yeah, you can borrow a little more whenever you can.  But I don't think that's so good. And -- and I -- and I think it's stressing, you know, inequality and Phil's point was, you know, it's kind of a populous cause. And -- and so he, you know, some people think that this is -- this is gonna (sic) create, you know, it's creating political problems and it's adding to this polarity and in the -- in our country. I don't know, you know, if that's true or not, but it seems as though, like I said, by the way, if you have assets you're doing well because interest rates are low.  If not, I think it's kinda (sic) throwing gas on them.

KLEIN:  I guess I’d put a little slightly different languages. If you had assets, when interest rates were high, now that interest rates are low, you've done very well.

CHAMBERS:   Yes.

KLEIN:   But if you -- as you get assets now, you're not. So, it's -- it's more -- it's, you know, it's a timing thing. Like, you know, the perspective returns are lower now, which actually, so it's bad if you're going to, I mean, that's sort of why interest -- that's sort of the mechanism then how it's supposed to be, right.  If -- if people are -- if you know, it's a signal that there is too much desire to be acute buying financial assets, and so the returns on those assets keep going -- the forward, looking returns, keep going down. Doesn't seem to be having the impact that, you know, the theory is supposed to have of people buying fewer stuff -- fewer assets and more stuff.  But that's, I mean, that's how it's supposed to work.  And that's why, you know, central banks try to accommodate this process. But that's -- that's -- I do think that you would expect that if you had kind of a more egalitarian shift in the distribution of income that interest rates might go back up. I mean, the flip side of that is that you'd also have, you know, how it would flow through demand for your borrowing is tricky.  I mean, people who are borrowing; governments that are borrowing, would have less need to do so, because there’d be more income.  But on the other hand, there's also less, you know, spare income to invest, you know, to use, to buy these financial assets. So, you know, how that nets out is, is tricky. But I guess I would -- I would suspect that in that kind of world you'd have interest rates going up and, you know, with growth expectations going up as well.  But you know, we haven't seen that. I think it's kind of telling that, you know, that hasn't -- hasn't, that has not happened yet. I think there was a brief moment, you know, sort of spring of 2021 and people thought that might happen. But not really since then. That kind of faded.

What $500 Billion Gap in the U.S. Current Account Deficit Has to do with Companies Spending More on CapEx

CHAMBERS:  Well, I am seeing more and more articles on corporate CapEx spending.

KLEIN:   Yep.

CHAMBERS:   So maybe that'll help the cause.

KLEIN:  Yeah.  For sure.

CHAMBERS:  All right.  I probably should have asked you this prior to getting into that, but I'm going back, here. You just wrote an article for The Financial Times. Tell us about that.

KLEIN:  Yeah. So, you know, this is all again, looking at sort of the holistic, systematic view of the world.  Everything has to add up. One thing that I was looking at, which is something, a lot of people don't look at, because it's kind of obscure, but the current account deficit in the United States, you know, there's sort of the standard way of measuring this, which is you look at the balance of payments data and then say, okay, well what's the trade deficit.  What's the difference between, you know, what Americans are earning on their foreign assets versus what foreigners are earning on their US assets? You know, what are remittance flows. You add that up, and you say, okay, well it looks like Americans overall are spending about 800 billion dollars or more per year than, you know, we're earning.  That's what the current current account deficit says, balance payments. There's another way of looking at this, that in principle, should give you the exact same number, and this is okay. The national current account deficit should be the sum of the current account balances of the major sectors of the US economy.  So, the government, businesses, and households. So, okay well, we know what household income is.  We know what household spending is. Okay. So, we can get -- we can figure out like the savings and investments that we know what households spend on, you know, housing and, you know, remodeling, and things like that. We know what the government budget balance is, both for the federal government and for state and local governments.  We know how much of that is, you know, current consumption versus how much was investment spending, taxes and all that. That's pretty straightforward. We know what businesses make extensively. We know what profits are. We have a reasonably good sense of what profits are. We know what businesses spend on cap ex.  If you add those things up, you should get the same  number, $800 billion difference.  But it turns out that if you do this, you do not get that number. You get 300 hundred billion. So, there's a $500 billion dollar gap. Now the government knows about it.  This is not a secret. I mean, they publish it. And in fact, there's a line item in the -- in the national income and product accounts and they call it the statistical discrepancy; which is the gap between these two numbers.  That gap also shows up if you compare gross domestic income with gross domestic product.  It's the same exact discrepancy. Income is basically, okay, well we know how much people are paid. We're going to add that up. That should be equivalent to the value of everything that's produced. And that's based, you know, so GDP is, you know, right, it's consumer spending and government spending and -- and the trade balance and -- and corporate investment. Income is things like wage income, profits, you know, small business income, stuff like that. Those numbers should add up, but they don't. I mean, they're close, but they're not -- there’s statistical discrepancy. So, the statistical discrepancy between GDP and GDI is the same as between these two measures of current account deficit.  And it's large. As I said, 500 billion dollars in 2021 is about two and a half percent of GDP, which is the biggest that it’s been in that -- in that direction ever. I mean, the data go back to, I guess, 1960, I think, and that's as far, you know, is a very large difference. So, the question is why? And if you look at all the components, the government basically varies the statistical discrepancy or not varies, attributes -- attributes the statistical discrepancy to the business sector.  So, it's basically some combination of corporate profits after dividends, which is what they call corporate saving. And Cap ex and specifically either cap ex before after depreciation. You know, if you -- if you take depreciation out of cap ex and you add to, you know, then you, you know, the -- if you're -- if you include, never mind. We'll skip that part.  So basically, so then the question is, okay, so which of these things is wrong, right? Is it that profits are too high? Is it that investment is too low?  Or are we going to assume, I think less reasonably that the current account balance is -- the balance of payments data are wrong by a lot. I think the balance payments data are not wrong. This is why the fiscal discrepancy, they generally assume, you know, the other side of the things that's -- that's -- that's different.  But like, I guess it's possible, but that would be kind of weird, right? If the balance of payments data were off by that much, the current account balance worth 300 hundred something billion as opposed to 800 hundred billion. It's a huge difference. The trade data, there's no way that would be, I mean, you'd have to have some, it's not like people are dramatically overstating imports.  So, they're either a ton of hidden exports, which is extremely unlikely. It's possible, there's some foreign investment income that's being missed, but again, you talking the percentage difference to kind of reconcile would be enormous. So, I find that very unlikely. And then the governments have a very good track record of getting this right.  So, it's probably not that. The government agency that is in charge of putting these numbers together, the bureau of economic analysis, they --

KLEIN:  So, the statistical discrepancy, the government agency that compiles all these numbers, the Bureau of Economic Analysis, they attribute it all to the business sector. Which means that it's either that their estimate of profits after taxes and dividends is too high, or that their estimate of corporate investment is too low. Now in general, what they -- they're sort of house view and they've written papers on this, is that they think that the issue is often with profits. That they -- that profits are sometimes being overestimated. You know, capital gains are being counted as income when it shouldn't be. Things like that, which maybe is true, although bear in mind that if we look at the size of the statistical discrepancy,

 which is about 500 billion dollars in 2021, and we look at the size of profits after tax and dividends, which they say is a little over a trillion dollars, that would imply their estimate of profits, you know, is off by like half, which seems, you know, they effectively doubled it from what it should be, which I think is probably not right.  And I also think it's, you know, worth noting that if you look at their estimate of profits with dividends, which is not for the balance payments, but, you know, relevant for this, it's basically gone up the same as, you know, what S&P earnings have. So, it seems like it's, you know, what their reporting is pretty consistent.  Or what they're measuring is pretty consistent with what companies are reporting. So, I think that's probably right. It might be off by a little bit, but not enough to nearly explain the statistical discrepancy that we -- that we see in the data. And so that leaves business investment. And, you know, for it to be off by 500 billion dollars would not be, I mean, that's like basically, you know, ten, fifteen percent, which is, you know, meaningful. But it's a lot smaller than, you know, what -- the kind of areas that would have to be -- we have to think would be going on if the balance of payments data are wrong, or if the data on profits are wrong. And I also think that there, you know, another reason we can -- we think that the -- I think that the capital investment data might be understated. And there's a precedent for this. In fact, there are a lot of precedents for it where the government, over time adjust their methodology to incorporate kinds of business spending that they didn't have before and the GDP data. And that generally end up closing some of the gap that in the past has shown up between, you know, gross domestic product and gross domestic income. So, for example, you can, I mean, I have a sort of a little list of this in -- in -- in the FT column here, but like in 1986 they decide, you know, up until 1986, they basically assumed that the prices of computers had, you know, no -- there was -- there was no price change at all.  Which, if you think about the improvement in computer quality, even if there was no price change in, you know, the dollar value of charge would really understate, you know, what companies were getting. And so, then in 1986, they published some, you know, document explaining, well, we, you know, consulted with IBM. We did some of our own tests and we concluded that instead of being 0 percent a year from 1972 to 1986, that it’s actually negative fourteen percent. That was, you know, the prices were falling that much. And that obviously has a really big impact because computers aren't, you know, that much of business spending in that point in time. But it's enough that overall business spending suddenly ended up growing a lot more as a consequence of that methodological change. In 1999, they decide that business spending on software should be counted as investment.  It wasn't before. It was originally just counted as an expense. Like it's equivalent to like, you know, you pay your electric bill which is not, I think, you know, clearly, they realized that was not right. So, they changed that 1999. That had to change. In 2013, they made a change saying, well, actually, you know, business spending on R&D should be counted as investment spending. And so like, there are all these other, you know, in 2018, they changed how they do depreciation and like that all these things kind of cumulatively end up meaning that more and more investment -- more and more spending is being measured as being investment.  You know, whether or not the government captures it in its measure of CapEx like it's still, I mean, it's happening, right? It's either happening or it's not happening. But the question is, are they -- are they measuring it? So, I think that would be very consistent with -- with the data. And also, one point that I make as well, and I think is important here, is that the high level of investment also helps explain why corporate profits have gone up as much as they have. Because if you have a situation where the trade deficit is as big as it is in rising, your situation where household saving was falling, but just sort of, you know, stop falling. And the government budget deficit is -- is contracting pretty quickly. How is it that corporate profits are rising so much and like the basic explanation that makes sense, is like, because the business are investing. If businesses, you know, the great thing about investment is, you know, the company that invests, they get an asset on the balance sheet. They depreciate it over time. But they basically get an asset so that doesn't cost them anything. And the company that sold them the thing, they get revenue immediately. So that's -- that's essentially where corporate profits come from at the very basic level is like investment is what is where corporate profits come from?  And so, I think it's -- I'm not saying like this is definitively what's happened, but it is definitely an explanation that fits and helps explain what is otherwise a very weird puzzle that’s showing up in the data. So that's, you know, that's what I wrote about.  You know, I wrote about it, you know, I started looking at this actually back in January for a piece I did for the Overshoot.  And then, you know, I got a chance to write about the specific angle for -- for the FT. But I think -- I think this could potentially be an interesting theme for, you know, I mean, you were talking about how, you know, companies are investing more and I think that they are and that, but it hasn't yet shown up in -- in sort of the macro-economic data.  And I think, you know, maybe it will.  Maybe it already -- maybe -- maybe it already has happened and we haven't seen it.  You know, it just hasn’t been out, yet.

CHAMBERS:  Right.  Well, the other thing is, is a big difference, you know, over the past, my lifetime and your lifetime is and Bill and I talked about this, there's a lot of more intangible assets on balance sheets of fortune 500 than there were prior to the Silicon chip.

KLEIN:   Right.

CHAMBERS:   I mean --

KLEIN:  And that's what's hard to count.

CHAMBERS:  Yeah. So, there's a counting --

KLEIN:  Yeah. Right?

CHAMBERS:   I get it.

KLEIN:   So, like basically the government can count construction spending very easily. They can count, you know, if you order like a finished capital good, like you order a truck or a plane or a computer, like you can count that. The thing that's tricky and where -- and this is like, there's some academic research suggesting that this is what, including by people of the FED that suggest this is what's being missed right now is like, if a company buys a bunch of spare computer parts and builds their own server, that's investment. But it's not counted that way because the assumption is that the parts, you know, if you're only buy like a random part you're just going to, you know, put it in something and sell it. So that's a cost of goods, sold. It's not CapEx. But that would be wrong in this case. Another example would be like, you know, so like you buy those parts for example, or like your, you know, how are, you know, people when they purchase, you know, cloud computing services, is that, how is that being captured?  So, there's -- there's, that's like another example. So, these are the kinds of things and then the intangibles. I mean, we’ve seen how they've, you know, software and then research and development stuff? And so, yeah, I think that if there is missing investment, it's probably these kinds of things, not, you know, trucks or planes or, you know, machine tools or whatever.  But I think that it's definitely possible. That's where some of this is showing up and that would explain a lot of the, you know, why they've had trouble capturing it.

CHAMBERS:  Is that good or bad for the economy by not capturing it, do you think?

KLEIN:  Well, I don't think it makes it, you know, for the economy, I mean, the economy is just, you know, it is what it is.  I mean, it's more like, are we -- are we getting a good picture of it from the official government data? So, I mean, as a -- as a consumer and interpreter of the data, I think it's, you know, it's bad for me personally. Or maybe it's good for me, if I can kind of, you know, come up with these arguments like this, that get people interested, but --

CHAMBERS:   Oh yeah, no you generate revenue from that argument.  I like it.

KLEIN:  But yeah, no, in general, I think more information is better.  So ideally a more comprehensive, you know, measure, but I'm sure they'll figure it out eventually. I mean, they're very good at doing what they do and they always eventually, you know, they'll -- they'll be revisions or -- or maybe the statistical discrepancy will be close some other way. I don't know, but I mean, we'll see how that plays out.

The Digital Yuan

CHAMBERS:  Well, either way what it shows is that the economy is constantly evolving and more so, and it's just speeding up, especially with this little thing called Silicon chips. It's just, right. So, even more reason why you need a wealth advisor to keep your act straight here, people. All right. I'm going to go back to, oh, hey, I sent this to you prior, like a couple of weeks ago. Matt and I had a little -- we were scheduled and then had some things happen.  You know, that’s how life goes.  And so, I don’t know if you remember this, but do you remember, do you know a woman named Rebecca Patterson? She's at -- she's at your former, the -- the hedge fund that you used to intern for, there, at Bridgewater.  And she, Ms. -- Bridgewater, that's where you were at, right? Yeah. And she said, this goes back to China and I know I’m bouncing around a little bit, but I just want to know if you have any comment on this, but so China's doing the digital Yuan and she said that there's rumors, they might experiment -- and so they're rolling that out. And so, I don't know if you have any comments on that, but they're rolling that out and they've got a bunch of digital wallets in consumers' hands, and she said there could be a test. This relates back to spending, the consumer spending. There could be a test where people will get money put into their digital yuan wallet, that they have to spend in a certain way, or it goes away.  So, you've got 90 days to spend it. And I was -- I immediately thought it because I was just like, oh, does Matt know about this? I mean, this is kind of interesting because so, basically going back and so the -- the -- the Chinese consumers aren't spending enough for all the reasons we said, and what an interesting concept of getting them to spend more.  I don't know if it's it, you know, apparently this test hasn't happened and again, I'm hitting you with this little bit of a curve ball, but they're really embracing -- they really kind of gotten out there on that -- in this digital currency earlier than us. And I just wonder, you know, that's kind of an interesting concept.

KLEIN:  Yeah. So, a couple of things. One is that the idea of giving people money that expires if you don't spend it, is actually a very old idea.

CHAMBERS:   Okay.

KLEIN:    I think it at least goes back to the great depression, if not earlier, but the concept of, you know, back then, of course it was just like paper money with a special stamp on it or whatever.

CHAMBERS:   Right.

KLEIN:   But I mean, that was -- that was -- and it made sense in that way of like, okay, you can think back about the conversation of interest rates, right? Like the point of interest rates is to, you know, either, you know, if interest rates are high and that's what the -- if that's what's good for the economy, then it’s because you -- you don't want a situation where people are spending a lot right now, for whatever reason you want to restrain demand and change that balance between production and consumption. Interest rates are low, it's the opposite, right. People aren't spending enough. And so how do you get interest rates way below zero is, you have money that expires, right? That's effectively an extremely negative interest rate is essentially the way to think about that.  And, you know, it never really took off, I think for a lot of reasons. I mean, I think usually the way it played out in the -- in that period was, you know, maybe some local town council to create some special money you could only use in that town. But I think in the Chinese case, if we're looking at that in this, like, would that work, the question that I would have is that, I mean, in general, the reason why consumption is low in China is because incomes are low.

CHAMBERS:   Right.

KLEIN:  It's not because consumers are like weirdly thrifty. It's not like there's some kind of mental illness, you have to break people of. That's not -- that's not the situation.  So, if you are just going to -- habits that people have money that goes away. I mean, if you're giving them more money and then as a condition of giving them more money, you know, the money that you give them has to get spent, that might have an impact. If it’s enough.

CHAMBERS:   Yeah and that’s -- that was what I think she was implying.

KLEIN:  Right. But I guess it's the question of how much, you know, I mean, you could also just give them more money and not have it expire and it would still have this -- I mean, because the fundamental issue is that there isn't enough, you know, household -- ordinary households, aren't earning enough.  Like that's the -- the main problem.

CHAMBERS:   Yeah.

COVID Killed Consumer Spending in China? Not really. The Consumer never was spending in the first place.

KLEIN:  You could also just have a social safety net that's better. Right? I mean, one thing that's really striking, if you look at the pandemic, what happened in China, when the pandemic first hit and the economy, you know, they -- they shut down a lot of things. You did not have an increase in the unemployment rate, or the registered unemployment rate. And the reason you didn't have an increase in the registered unemployment rate is because most people in China are not eligible for unemployment.  And so, the people who lost their -- including predominantly the people who lost their jobs.  The people who lost their jobs, because it wasn't as if unemployment didn't go up.  Unemployment went up tremendously. You had tens of millions of people lose their jobs, but they didn't have any unemployment insurance. So, what do they do?  They went -- they were -- these were internal migrants who came from the countryside to the city. They were not eligible for those benefits in the city because they didn't have the right household registration. So, they went home. They went home to become subsistence farmers, tens of millions of people. I think many of those people have since gone back, you know, as the economy is recovered or what have you, but I mean, that's -- that was what happened.  And, you know, that's obviously very different from what happened in the U S, what happened in Europe, what happened in Japan, what happened in many other countries, including countries that are not rich, right? I mean, China is much poorer than those countries. But even in many poor countries, they had a, you know, more of a system for maintaining consumption of people who lost their jobs.  So that just reflects a very different kind of system, different set of priorities.  And people -- and people, you know, people know that, right. That's why they -- they know that, that's how it works, that it's not, you know, they don't have that kind of safety net. So, you know, if you fix that, then people wouldn't feel the need to save as much on their own.  And in fact, not only would they not feel the need, but you know, they'd just be better off and you'd have all sorts of -- there'd be a lot of improvements. The fact that consumer spending in China fell much more than it did -

CHAMBERS:   Oh, yeah.

KLEIN:   -- I mean, not only much more. In the US, consumer spending did not fall in the aggregate in 2020.

CHAMBERS:   Right.

KLEIN:   I mean, consumer spending on services fell a lot, but that was compensated for the fact that, you know, so people, you know, essentially the government response worked in the sense that people had enough money to keep spending stuff. They just switched what they bought.  In China, they did not get more money. So, they just -- they cut their spending very dramatically. And so, it's really striking, and people talked about like, oh, China's economy handled COVID so much better. It did not really. Not from the perspective like the average person. Like the average person was much -- did not have an improved, you know, response.

CHAMBERS:   Yeah.

KLEIN:   They were poorer, and they got less stuff. Which is the opposite of what happened in the US.

CHAMBERS:  And what you just said was -- and in fact, left the city, went back to mom and dad who were in the country, right, and -- and went back to that, probably not great life, for at least --

KLEIN:   No.

CHAMBERS:  -- a little while.

KLEIN:   No, yeah.  Exactly.

China is Getting Richer, but it is Still Really Poor

CHAMBERS:  Yeah.  You know, people that don't appreciate -- I heard an interview with a woman, a Chinese born woman who's here. She was on a Bloomberg's Odd Lot podcast, which, you know, those guys are awesome.

KLEIN:   Yeah.

CHAMBERS:  Anyway, she was talking -- she was saying that in 30 years, so she's about 30, so when she was born, okay, her town that her parents grew up in, basically didn't have paved roads, 30 years ago.  They didn't have anything. And now she's in New York. Grandma is in this rural setting out in China and they FaceTime each other, in 30 years. I mean, that -- that's like, people -- so people don't appreciate how --

KLEIN:  That’s definitely true. Although I would push back a little bit in so far as rural China is still extremely poor.  There's a book that came out. It's a -- it's a book I wish -- I wish it had come out earlier because I would've loved to cited it in our book. But it came after our book. It's called Invisible China and it's all about the, you know, extent of rural poverty in China. Even now it is extremely, extremely underdeveloped.

CHAMBERS:   Yeah.

KLEIN:   In fact, like it's actually striking how, you know, even compared to other poor countries. So, China's overall average GDP per capita is about same as Mexico.  But if you look at things like access to education, literacy rates, public health for a lot of people, it's actually much worse. So, you have, I mean, a lot of the international stats, people compare like Chinese schools or whatever. They're looking at like a few really good schools in Shanghai, which is one of the richest cities and it's not really comparable. It's like, okay, yes, if you compare, you know, Stuyvesant to like --

CHAMBERS:   Yeah, exactly.

KLEIN:   -- obviously like America’s would look great too, but it's like, it's not really representative of the country as a whole.  So, like that's a big issue. There's like all these sorts of preventable diseases that kids are getting -- like they can't -- they don't get glasses. I mean, like, you know, sort of like ringworm infection, I mean, it's like really, really bad stuff. And it -- it's, you know, we talk about in our book, like, there's a tradeoff between, oh, this focus on investment and exports versus consumer spending.  Like it can be abstract, like what that means, but in practice, a lot of it is like, yeah, you build all these housing complexes that people don't want. They're buying them literally because it's like the only way to save money in China is to buy a house. They -- it's like essentially, it's an asset class, not anything else. When people -- so that's why most people own a house own more than one.  It's not like they need to live in it. Right. So, you're building all this and at the same time you have like hundreds of millions of people in the countryside living in extremely, extremely low levels of standard of living. And, you know, that's clearly, you know, is bad for them and you know, as -- as we make in the book, it's bad for -- it's bad for a lot of other people too.  It's bad for everyone. So that, I think is just, you know -- that’s why everything needs to be appreciated.

CHAMBERS:  Yeah.  And I don't mean to cut you out, but let me put a finer point on that for going back to investing.  Going back just really I think sums it up. If these people in China don't get more cut of the pie to spend, that's less stuff that the United States can sell to them.

KLEIN:   Right.

CHAMBERS:   You said that earlier and that -- because of the, you know what -- you know, Matt what the biggest -- what's -- what's the scarcest thing in a global economy? Demand. Got to have it.

KLEIN:  That -- that -- is what we said at the, yeah. I mean --

CHAMBERS:   Gotta (sic) have it.

KLEIN:   Yeah.

CHAMBERS:   I know. I stole it from you guys. I'm not that smart. I just --

KLEIN:   A customer.  Everyone wants customers.

CHAMBERS:  Yeah. You gotta (sic) have demand. And so, if these -- these guys, and same could be said for probably Africa and other markets, you know, they -- they've got to get on board and I -- I -- God forbid, I don't know what that's going to do to the environment, but. Yeah. I mean, it's -- it's a problem because we need demand in the United States.  They need it. We need it.  Everybody needs it. So, it's important that 1.6 billion people get their act together. You know, the other thing is the thing about China is like people -- people, you know, the headline is that they're going to take over the world or whatever, at least they're moving towards being a regional power.  They are a power. I'm not saying they're not, but my God, trying to run 1.6 billion people, that's a problem right there. How do you do that? How do you do that? So, I don’t know. They got a lot of challenges.

Supply Chains – Good News, Rental Car Companies Have Rebuilt Their Fleets

CHAMBERS:  Alright. I've taken up so much of your time and I just want to ask you just one or two other questions here.  Any thoughts on the supply chain, my man?

KLEIN:  I got a lot. I mean, one of the things I've been covering a lot at The Overshoot has been inflation. What's been driving inflation and there are obviously a lot of different stories here about that. And I think the thing that I think is really striking is it's not the only reason, but many of the --much of the excess inflation and if you look at just like, why hasn't the price level grown more than, you know, sort of it had been before the pandemic, at that pace?  Much of that excess is attributable to a relatively small group of categories that we can all tell a very clear story about how supply has been constrained as a response to the pandemic.  The most obvious one is cars, motor vehicles. But also, like oil and some other -- some other categories like meat and all these things are really interesting because there's obviously a lot of other stuff happening as well. And I -- I'm not going to say that it's also a function of the fact that people have more money to spend and what have you, but it's really striking, I think. You know, people need to put this in perspective. The reason why car prices, not just new cars and used cars, but also like car rental and stuff are so much higher now than they were before the pandemic is because the number of cars and trucks that were made, just collapsed. In the early months of the pandemic motor, and then manufacturers never tried to make up the difference.  So even before you had the situation with the chip shortage emerging at the end of 2020, even before then, the number of US light motor vehicle assemblies, so the federal reserve tracks this every month. You know, how many cars and trucks and by different category are made -- finished in this country. You know, between February 2020 and December 2020, there was a shortfall relative to, you know, the prior trend about 2 million vehicles.  Since December, 2020, so then once the chip shortage started getting -- kicking in, that shortfall has grown to 3.7 million vehicles. So, it's not surprising given that --

CHAMBERS:   And that's just the US?  That's just US?

KLEIN:    That's just the US.  That’s right.  That just -- motor vehicles assembled in the US, right. Obviously like there are imports and stuff as well. Right? So, this is -- it's not surprising that -- that you have a lot of pressure on, you know, car prices, one way or another.  And initially it was kind of masked in the [01:05:00] US in the first months of pandemic, because there were fewer new cars being built, but you had car rental companies basically selling tons of stuff into the market. And so, for the consumer's perspective, it wasn't as much of a big deal. The reason everything started becoming very inflationary is because that turned around very rapidly where the rental car companies, A, they needed to raise the prices because they didn't have enough cars and B, that they started to buy as many cars as possible. I think the good news is that, and we're going to see this, I think when the earnings for Hertz and Avis Budget come out, but they've basically rebuilt their fleets, the rental car company.  So, they're three big -- basically all the rental cars in the US come from three companies, Enterprise, which is privately held. So, we don't have high-frequency data on their fleet size. And then Hertz and then Avis Budget. And they all -- all the brands like underneath, basically are owned by those three. And so, if you look at Hertz and Avis Budget, which represent a big chunk of the total together with all their brands, their fleets fell a huge amount between, you know, first quarter of 2020, and first quarter 2021. They’ve since rebounded mostly.  As I said we’re going to get in the next couple weeks, I think we’re going to find out what they had by the end of 21. And they'll be basically back, I think, to where, you know, they were, which is -- which should reduce a lot of the pressure on things like used car prices and rental car. I mean, rental car prices have already come down from the peak of what they were over the summer. Used car prices that had been going up still, but I mean, hopefully that'll put some downward pressures and, you know, I mean the real trick is like, will then we see more production come up as, as the chip shortages is reconciled? But, you know, who knows.  But that's been like a lot of, you know, that is partly due to the fact that the chips that the car makers need are not the high-end chips.  They're not profitable. They're not the kinds that chip makers like to make because they're not profitable, not like, you know, Apple and Ones or whatever.

CHAMBERS:   Yeah.

KLEIN:   And they cancel all their orders, you know, in early 2020. And by the time they realized that that was a mistake, like they got lost in line and so like, you know, the toaster makers, whoever got in front of me. They're like, that's essentially the problem.  And so, it's just amazing. Like, these are very specific stories we can tell about supply being constrained and like, it actually explains an enormous amount of where, like inflation's come from the United States. Oil is another huge story where, you know, total oil production, crude oil production is still substantially lower than it was before the pandemic. Like ten percent or so. Demand is -- is not.  So, like, that -- that creates a problem. Right. And a lot of it is like, okay, you had it in the beginning of pandemic, like shale producers basically either went bankrupt or had to shut down or whatever, because the negative, you know, WTI or whatever --

CHAMBERS:   Right.

KLEIN:   -- claiming this a catastrophe for them. And then they've, you know, they've come back sort of, but they're not willing to produce the same extent.  I mean, if you look at the, sort of the track record before the pandemic, where prices are right now, they'd be pumping like crazy. But they're not because, you know, they have new set of investors and creditors who don't want, you know, to have this rebound, but that's a new thing, right? That's a new thing. That's in part, a function of -- essentially supply constraint imposed by the pandemic.  Again, that's a huge explanation for the why inflation has been high. You know, a smaller, but I think also relevant one is like meat, right? I mean, I remember writing about this back in the spring of 2020, you had meat packing plants are like probably one of the highest risk places to be working and if you have a respiratory pandemic.  And so, a lot of people got sick. A lot of people died. A lot of plants either shut down because they just couldn't get workers or they had to -- or, you know, they -- they -- they created a lot of new safety mechanisms to try to, you know, make it less risky, but that reduced the rate at which they could process meat.  So, what that meant is that the ranchers and the farmers and stuff who grow the hogs and the cattle, they couldn't sell as much. And again, this is also partly a function of the fact that like the restaurant sector got hammered. And so like, you know, certain cuts of meat, but that's just like another, it's they got -- they were getting hit from two sides.  And so, what'd, they do, they called their herds. Which is exactly what you'd expect. Right. So then like we get to 2021, 2022 now, right? Like people are now -- things are better, but like, oh, it turns out the cattle herd is, you know, several percent smaller than it was. And the hog herd is several percent smaller than it was.  And like, if demand is not smaller, but the herds smaller, like you have to figure out the way to balance that. And so higher prices. I mean, that's like, so this is like, I think these are the kinds of stories that, I mean, hopefully, I mean, I like to think that these are temporary phenomenon. Like there's no reason why this is a permanent condition.  You know, you can -- you can raise, you know, once you -- the breeding cycle, especially for hogs is pretty short. So, if you -- if you want to have more, you can have more.  You know, for cars, again, like in theory, there is like spare capacity. Like once they have chips and in fact production has not really picked up, but I mean, there -- there's -- there's scope for doing that.  Also demand for cars is somewhat come down, although it’s -- that's partly, I think dealers telling people just not to buy anything. But like, these are the kinds of things that will hopefully, you know, lead to reversal. I mean, there's other forces going on in inflation that I think are not -- that are much slower moving and not going to reverse, but like the really big spike we had, you know, seven and a half percent year over year.  Right?

CHAMBERS:   Yeah.

KLEIN:   Most of that is due to this kind of stuff.

CHAMBERS:   Right.

KLEIN:   Or it's like, look at year over year, as opposed to sort of, I prefer to look at the cumulative change since like February 2020, but like, you know, if you're looking at year over year, a lot of it's just like stuff went down, it went back up, like clothing prices, right?  Like nobody needed to buy any clothes because they were staying at home and then like they do. So, the price of apparel went like this as the V-shape -- as a V-shape recovery; hotels, and you know, things like that. So, you know how that all adds up to inflation going forward is going to be interesting, but I think a lot of the stuff we saw is really driven by the sort of weird supply constraint issues and will, hopefully be resolved.

CHAMBERS:   Yeah.

KLEIN:   I don’t know when but that’s --

Mao killed a bunch of sparrows and 60 Million people starved

CHAMBERS:   Yeah. I, you know, the -- you probably know more about this than me, but you know, lumber was insane. That, you know, obviously people were home. Low interest rates. Let's redo the back room. Let's move, if you can't find something, right. And then we had to re -- we gotta (sic) redo that, whatever. And then you get Canada with forest fires and some bug that kills off a huge bunch of things.  So now they're all jammed up and it's again, it’s one of these, you know, but I -- I'm, you know, a lot of people are -- again, the consumer sees the year-over-year number, the headline number, and sorry about that. And we're just live and crazy here and -- and they think, oh my God, the world's shit, you know, the world's coming to an end, but I don't think it is. I think things will get straightened out.  There will be -- I will say though that the labor number, that's going to be the interesting numbers to work out. So that's a whole another -- all right. One more thing. This is kind of a -- going back to China. Going back to China. This story, I just want to see if you just have any comments. So, Mao way back in fifties or sixties and wherever this was, Mao’s running China, right? And he -- his -- his like -- his people around him, say, hey stupid sparrows, birds, they're going around eating up our wheat and they're eating up our crops, I mean, we -- Mao what -- what are you going to do about that? So, Mao says, let me -- army guy, come in here. Tell me what to do with all these sparrows that are eating up crops.  And --and, you know, hurting people's livelihood, eating the food that we're trying to, you know, what are we going to do? Well, I'll tell you what. Why don't we go out and kill all the sparrows? We'll get the people out on the -- on the countryside but we'll kill all the sparrows. How's that sound? And they -- and they go and do it.  The problem is the sparrow -- the sparrows were eating the locusts. Well, no more sparrows, now locus rise up and eat all the wheat. And you studied China for a long time. And to me, that's sort of like -- it's sort of like a combination of like, you know, one person running the show for 1.6 billion people. I don't know how they do it.  And not that, again, not that we haven’t in Western society made major mistakes in policy.  Believe me, we have.  You got any comments on this story?

KLEIN:  So, I guess a couple of things.  One is that I mean, just for a little more context here, that -- that episode was part of The Great Leap Forward. And so, it was part of a broader campaign that Mao had to rapidly modernize the entire country. You know, at that point in time, and in fact, until quite recently, China was predominantly a poor agricultural society. It was not an urbanized society. I mean, Mao -- Mao’s whole thing, in fact, if you were going to distinguish whether, you know, Mao's version of communism versus say what the Russians were doing was that it wasn't based on the industrial proletariat, it was based on the peasants.

CHAMBERS:   Right.

KLEIN:   Which made sense, because of course it was predominantly a peasant country. There wasn't an industrial, which in fact, incidentally is the reason why the Soviets initially did not support the Chinese communists because they thought they were, you know, getting in the way of the historical order and they supported the nationalists because they thought they were necessary to, you know, first modernize the country before the industrial. Anyhow --

CHAMBERS:   Yeah. (Inaudible.)

Mao told farmers in China to plant seeds a particular way and 60 million people starved

KLEIN:   That was several -- yeah, that's the past. Right? So, we're now in like 1958 and so this is the -- one of the five-year plan they come up with and they -- they basically, okay. How are they going to modernize the country as quickly as possible?  They know that in principle it's by becoming less agricultural and more industrial. So, the question is, how do you do that when your country is very agricultural to begin with? Now, the way it's generally been done in -- in every other society that’s done this is you increase agricultural productivity.  So, you have fewer -- you have less need for people and less need for, you know, since you have machines, working on farms and producing food. And so those people can be doing other things. That's what happened in, you know, the original industrial revolution in England and -- and all sorts of other places. So, okay, that's a reasonable starting point. And then the question is, okay, how do you -- how do you -- how -- what kinds of things can -- could China do in 1958? So, it's not clear what they actually could have done, but what they did do is they basically came up with a whole suite of things, including this idea of getting rid of pests and sparrows were considered a pest, in order to increase agricultural productivity.  The other big thing that they wanted to do, and this is -- there was a great book about this. It's a very depressing book. I would definitely not recommend trying to read too much of it in any one sitting because it's a real, incredible downer. It's very -- it's definitely worth reading. It's the kind of thing people should know more about, but.  It's called Tombstone by a Yang Jisheng. And it's -- it's a history of -- of the -- the great leap forward and the famine that resulted from this. But one of the -- one of the things that was done in the -- in the beginning was in addition to the sparrows and the other pests that they were going after, was this idea that if you -- some -- I don't know where they got this idea from exactly.  But if somehow, they -- they -- they became convinced that if you change the way that you put seeds together, like the spacing of them or something, that you can dramatically increase output. Somehow Mao got this -- this idea in his head. And when he said that everyone else was like, well, it has to be true. So, we basically, no one really wanted to push back against this.  And so, it then became very -- so whenever it was asked -- so it was a very strange thing. So, like he said that he thought it would be true or something. And so, then when they asked for evidence of it, people like kind of created these wildly over optimistic estimates of what the impact would be. And so, he was like, okay, everyone’s telling me this is -- this, this is good.  So, it must actually be good. Of course, he's also, you know, the implicit thing is like, if you -- if you disagree with him, then you know, something very bad happens to you. So, but anyhow, so this happens. And so, then the assumption -- then along -- then the government is like, well, if we are able to increase agricultural productivity as much as, you know, these studies say that we are, these studies are done by people who've, you know, trying to show how much they agree with you.  Then we can move all these people out of farming and into industry and infrastructure investment. And so, they do that. So, you have all these people who had been working on farms. They're moved into like these big products. That's when you build like the Three Gorges Dam and stuff like that. So, this is around this period, all sorts of big, heavy construction projects.  And -- and trying to move them into manufacturing.  The idea is like, oh, you also probably don't need to have as much farm equipment. So, they said there's metal in like your -- your hose and your rakes and stuff. You can bring that down, melt it down, we'll use it for something else. It turns out of course, that agricultural productivity had not increased by the amount, you know, from the seed spacing mechanism.  And also, there's the issues you mentioned with the sparrows and stuff. And so then what ends up happening is that agriculture output falls pretty significantly because they don't have farmers to harvest. They don't have farmers to plant. They don't have the implements that they used to have. And there's a massive famine and something like 60 million people die.

CHAMBERS:   Yep.

KLEIN:   Which, you know, an enormous percentage of, you know, shared population relative, you know, I mean, this is one of the worst famines in history. And for it to occur in peace time was essentially unprecedented. So that is really sort of the broader context for this, this episode. And it's yeah, I mean, it's -- it's -- it's a testament to the challenge or the problems of having, you know, one man rule and -- and a system that doesn't provide feedback to -- I mean, it's definitely not unique to China. It's -- it's an extreme case, but other societies certainly had kind of these collective madness as well.

CHAMBERS:   It’s 60 million people.

KLEIN:   Sixty.

CHAMBERS:   Yeah.

KLEIN:  Sixty million people, yeah. 

 CHAMBERS:  Sixty million people. I mean like -- yeah. It's -- it’s -- it's just unfathomable. I mean, you know, to think, but anyway.  Yeah.

KLEIN:  It's pretty horrific, but I would definitely recommend the book if you want -- for anyone that wants to learn more.

CHAMBERS:   Yeah. I wrote it down. I wrote it down. If it's on audible. See, I'm not, again, I'm not that bright. So, I don't really read. I just, if it's on audible I’m in.  If it's not, you know what I mean? I -- I don't know. I -- it doesn't exist to me apparently. I don't know, but I will look it up. That sounds -- I love books like that. You kidding me?  I think -- I think I got through it all and, you know, and I think I got through it all, man. I think I covered it all. Well, Matt, it is such a pleasure to have you.  You know, you guys, this guy he -- he's just -- check out his site. If you're in the business like me or not, check out the Overshoot.  It could be of good value, a great value to you.  And I just appreciate your time and your -- your knowledge is on this -- in the spaces that you cover is just super deep. And -- and I just love talking to people about this stuff. And I also love how -- how you tie it into how we should look at the world and how we should invest or at least think about these things when we invest, because everything is so intertwined.  Well, man, is there anything else? Any closing, any parting words?

KLEIN:   Yeah, I mean, I -- first of all, thank you for having me.  I appreciate it. You know, please, everyone who is listening, check out, if you have not already, Trade Wars are Class Wars and you know, check out the Overshoot.  I think, you know, hopefully you will find it valuable.

CHAMBERS:  And for -- what was the name of the article in -- the in the Financial Times?

KLEIN:  What was the name of the article?  That's a great question. It is -- the headline online, I don't know about in print but online, it's Are the US GDP Data Missing a Capital Spending Boom. It's in the market’s insight section.

CHAMBERS:  Yes.  Okay, cool. All right. So, look for that. What an interesting topic that is.  That's very, yeah, I hope there's a big spending boom. I really do. I think it's happening. You know, because that would help the cause for sure. All right, my man. Well keep trucking. I know that you got a two year old there, you gotta (sic) get to and I appreciate it and let's -- let's roll this back maybe in a year or so like that. But let's stay in touch and I do appreciate it.  So, for everybody, this has been the Soundtrack to a Financial Advisor's Life. We call it the Soundtrack and today some -- some Google keywords were China, the Sparrow incident in China, and there's a couple of keywords that I'll get to later, but thanks Matt. I really, really appreciate it and have a wonderful day in San Francisco.

KLEIN:   Thank you.  You too.

CHAMBERS:   All right, bud.  I'll talk to you soon. Thanks man.

(INTERVIEW CONCLUDED.)

Trevor Chambers

Trevor joined Olde Raleigh Financial Services in January of 2015 and his primary role is new business development and marketing.  Prior to joining the firm, Trevor spent 12 years working at his family’s restaurant, Raleigh’s Bella Monica Cucina & Vino. “Exceptional service, no matter the industry, is paramount and we attract clients who value and take comfort in being taken care of.”  

Matthew Klein

Klein has over a decade of experience studying the intersection of economics, public policy, and financial markets. He has written for the Economist, Bloomberg, the Financial Times, and Barron’s, where he was the Economics Commentator. He now runs The Overshoot, a premium subscription research service dedicated to tracking the global economy.  At the beginning of his career, Klein worked in global macro investment research at Bridgewater Associates. Following this, he was a Research Associate in international economic and financial history at the Council on Foreign Relations.