Soundtrack to a Financial Advisor's Life – Barron’s Magazine’s Matt C. Klein discusses his book Trade Wars are Class Wars
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Barron’s Magazine’s Matt C. Klein discusses his book Trade Wars are Class Wars, the impact of modern shipping containers on world trade and his favorite restaurant in San Francisco
Trevor Chambers:
Hey everybody. It’s Trevor Chambers from Old Raleigh Financial Group here in lovely Raleigh, North Carolina. Today on Meet the Masters… Matthew, I’ve got to call you a smarty-pants. I read your bio and stuff. I did deep research as far as Google. This guy is cool. Matthew Klein is an economics commentator for Barron’s Magazine. His latest book is, Trade and Balances and How Global and Trade and Financial Systems Can Transmit Problems from One Society to Another. Did I get that right? Did I botch it? How did I do?
Matthew Klein:
Yeah, that’s fantastic.
Trevor Chambers:
Fabulous, man. Now where you are, my friend? Tell us where you are?
Matthew Klein:
I’m in San Francisco right now, sunny San Francisco.
Trevor Chambers:
How are things? I’ve got to mark the date. Today is May 20th, 2020. What’s the stage of the state there briefly?
Matthew Klein:
San Francisco is interesting because we had one of the first cases of coronavirus in the United States along with Seattle and we reacted very quickly to that. It seems like that worked pretty well. We’ve always had relatively few infections. I think the total death count in San Francisco itself is under 40 which obviously is a lot worse than zero but compared to a lot of other large cities, this is relatively good. Things seem to be, in many ways, I don’t want to say fully normal, but you see people out in the streets here. People go into stores that are open. Restaurants seem to be doing relatively brisk business in take out and delivery. I see plenty out when I go out on runs. Compared to some other places, I think we’ve been very fortunate.
Trevor Chambers:
Good. Yeah, I’ve got a good buddy there and he’s relaying the same information. All right. Are you ready, man? Are you ready?
Matthew Klein:
Yes.
Trevor Chambers:
Give me an amen. Give me an amen on this. No. I want to talk about a book that you put out called Trade Wars Are Class Wars. I want to get your thesis of this book, so let’s just get into it. Let me you a question here. Trades surpluses and deficits are mainly the result of domestic savings surpluses and deficits, which are themselves a result of domestic income inequality. Can you explain that a little bit?
Matthew Klein:
Yeah, sure. Basically the global economy as a whole all output is either consumed or used for investment so there’s no savings globally. It’s all either invested or consumed, there’s no extra. All income, similarly, is spent globally. For any individual entity or any subgroup that it is, income and spending don’t necessarily balance and you can get surpluses and deficits.
When we think about trade, it’s essentially saying that we’re drawing lines around, geographic lines for countries and saying, “Okay, all of the entities in that country; governments, business, households, collectively they’re all either spending more than they earn, in which case, they have a trade deficit, or they’re spending collectively less than they earn, and they have trade surplus.
What I mean by that domestic savings and balances lead to trade, in general, the balances between households, businesses and governments actually tend to be a lot larger than the national level. A lot of those internal ones cancel each other out to a large degree. When we talk about quality [inaudible 00:03:48] factor, the key thing to bear in mind is that different entities tend to save and spend in different ways. If you have changes in the distribution of income from entities that, for example, might spend most of what they earn or all of it to entities that do not, then you can have changes. People are overall spending and saving for that society.
To be concrete about this, people at the upper end of the income distribution generally have household saving rates of 40% to 50%. We’ve got data on this. It’s quite high. Then the higher up you go, it goes even higher. That makes intuitive sense because even if you have very expensive tastes, there’s only so much you can spend on goods and services, so the rest of the money you have, you’re probably going to accumulate assets, real estate, things like that.Whereas for most people, your material needs are not going to satisfied with income, so if you get more income, you’re going to spend it mostly.
Companies are interesting situations because companies, in theory, they can boost their CapEx or pay workers more and function equivalently in terms of doing things like spending and saving dynamic, but if they don’t, if they just retain earnings on the balance sheet, then that’s going to lead to trade surpluses because it’s depriving spending power of others.
Governments, it depends on their budgetary situation. Usually governments run budget deficits and that’s going to contribute overall to trade deficits, but again, you have to look at it in totality and how all those things add up.
It’s a situation that tying back into the concrete value of the book where two things; one, you see a lot of corporate profits, free cash loads rising and corporate investment rates going down. You have households, what looks like a transfer of income towards people in the upper portion of the distribution who generally save a lot more. That is going to create a bias towards trade surpluses in that society offset by other things.
Trevor Chambers:
Okay. I do want to talk to how you got to this point in your personal history. As I said, you have an interesting background. I think Yale was in there, in my deep research online, as I said. Do you want to expand on that thesis of the book a little bit more?
Matthew Klein:
Yeah. The big takeaway is that when we look at why countries are having trade conflicts with each other, it’s really important to understand that it’s not because of geopolitical conflicts or incompatible national interests or things like that. It’s not really right to talk about the US versus China. It’s really more appropriate to talk about things going on in each country that are creating economic imbalances that transmit across borders and then hurt people in other countries. It’s not that the Chinese government is doing things to harm American workers for the benefit of Chinese workers. It’s that the Chinese government is doing things to hurt Chinese workers and that a consequent of this is that American workers are also harmed. It’s really important to understand, those trade wars are class wars. It’s that we really would benefit from looking at this not in terms of national conflicts. We’re really looking at economic sectors and whose actual interests are being served by these changes.
Trevor Chambers:
Interesting, yeah. That right there is what interests me. You just stripped it back. This is an economic problem. You can pull away all the politics and everything. All right. It’s interesting. That leads me to this, how does Matthew Klein get into this business of trying to understand trade wars and their implications? Tell me about your history.
Matthew Klein:
Yeah. Basically if you want to go all the way back, I studies history in college-
Trevor Chambers:
I’d like to go back to elementary school, if you will please. Your favorite teacher in elementary school, shout out.
Matthew Klein:
I wouldn’t have gone that far, back all the way, but you brought it up.
Trevor Chambers:
I understand.
Matthew Klein:
I didn’t get interested or know about economics and math until I was leaving college. I was very fortunate to get a job at Bridgewater and Associates [crosstalk 00:08:29].
Trevor Chambers:
This is interesting. Brief about Bridgewater, for those who don’t know, and what did you do there?
Matthew Klein:
Yeah. They’re a hedge fund in Connecticut and they really focus on macroeconomic based investing.
Ray Dalio.
Matthew Klein:
Yeah, Ray Dalio is the founder of it. I didn’t know anything when I started there. They took the view, which I think was a relatively enlightened view, that whatever their accumulated knowledge was so much larger than anything could have learned in school for a new hire out of college. It doesn’t even matter what you studied in college because there’s no difference between having studied nothing and having studied something was, from their perspective, essentially zero, which worked out very well in my favor. Then they just divert you and teach you everything from scratch. That was really a fascinating learning experience.
I realized, “Hey, this market in finance and economic stuff is really interesting. It’s a fun elaborate series of puzzles with very real world implications.” I wanted to learn more about it and then eventually get into explaining it to people. One of the things that happened while I was there was I was introduced to the writings of Michael Pettis, who is my co-author on this book. He’s a fascinating guy. He has a very long background and had been in markets for a long time and went off. Now I think he’s mostly consulting. He’s a professor at Peking University’s business school of finance.
Trevor Chambers:
Peking? Peking?
Matthew Klein:
It’s called the Peking University in Beijing. That’s right.
Trevor Chambers:
Interesting. Okay.
Matthew Klein:
Yeah. He was at Columbia for a while before that. I think he moved to China, I think it was almost 20 years ago at this point that he’s been in China. He’s just a fascinating guy. I remember they passed along his newsletter when I was there and I started reading it and just learned a whole lot of things about … I really didn’t understand how economics and finance worked, but he would break it down into this very simple, true by definition equations about … When I say equations, I literally mean this plus this equals this, not anything too complicated. It’s really fundamental what the implications are and you could draw those out. Things like, “Okay. If globally all production is either consumed or invested, but individual companies consumption and invest in production domestic spending is not equal, then there has to be transfers on net of resources from one side to another and make those things balance out.
Trevor Chambers:
Right, exactly.
Matthew Klein:
That’s a really important point and people say, “Oh, we should all trade surpluses,” and I’m like, “No, you can’t.” Trade surpluses and trade deficits, or more broadly surpluses and deficits, you’re going to save and you’re going to borrow, but those things, they all balance out. There’s a thing called a symbiotic relationship, it’s called a parasitic relationship, whatever, but you can’t buy assets unless someone is selling them to you. The idea that no one should be borrowing or running debt anywhere is impossible essentially, or it means that no one is saving also. That’s [inaudible 00:11:57].
Trevor Chambers:
Right.
Matthew Klein:
Once you start wrapping your head around that’s, it’s really interesting what that could mean.
Trevor Chambers:
To repeat that, really the clarity of that is you’re either spending or you’re saving and if those, on either side of that transaction basically, get out of whack, we’ve got problems because then it then gets transmitted.
Matthew Klein:
That’s right.
Trevor Chambers:
That’s a fundamental, “Oh, okay.” So continue.
Matthew Klein:
Right, yeah.
Trevor Chambers:
Finish this thought and then I want to get into the history of trade wars. Go on.
Matthew Klein:
Right. One of the interesting points that Michael introduced to me over time is really again, you’re wrapping your head around it and it’s very counterintuitive, which is that because of this, what we’re talking about with spending and saving and stuff, the distribution of income in a society can have really significant macro implications. People talk about income inequality and they talk about a lot of things of what it could do. For either direction, you can talk about it as a system of incentives, you can talk about whether people think it’s fair.
You can talk about all sorts of things, but in a much more fundamental basic level, the fact that you can have a situation where concentrating income will lead to shifts between consumption and spending or not, redistributing from the other will lead to more consumption and less savings, that also has some interesting implications too, whether it’s good or bad, depending upon specific circumstances of society, that’s just a fascinating thought. Once you really internalize that in your head, it’s hard to get out of your head. I think it really affects all sorts of things about your thinking of it.
Well actually, normally you might reasonably say, “Redistribution is good for these reasons or bad for these reasons,” but at this much more basic level, this is what’s going to realistically going to occur if you do it. I think that’s just really fascinating. That plays a big part in terms of the thinking we have in the book and also in terms of the … We’re talking about the history of trade in the book and development because those things are really tied together. It’s really interesting.
Trevor Chambers:
Yeah. Talk to me about that because … Do you want to start before World War I? I think this is going to be from a US perspective obviously. Go ahead. What happened?
Matthew Klein:
Yeah. Starting with World War I is useful. One of the points that we make in the book is that in a lot of ways, the situation we have now and really have had for the past two or three decades is very similar in a lot of ways to what existed in the late 19th century and early 20th century. Yeah, I think it definitely makes sense to look back that far to look at it. Again, this isn’t something that necessarily be obvious unless you happened to have all this framework and interested in history.
Essentially, you have a world where you have a lot of manufacturing is being produced in Europe, really northwest Europe and the United States. Then there’s a whole network of colonial and quasi-colonial imperial relationships. What is going on in a lot of countries is that, and this isn’t true for all trade, but a lot of trade consists of trade sections, like the manufacturing powers mostly in northwest Europe and their colleagues on land, to a lesser extent between Europe and the United States, it’s mostly what trade is. Trade is a share of global economy was, in retrospect, relatively high. It would end up going down actually or much lower, basically after World War I really until you get into the ’70s and ’80s, it would be lower as a share of the global economy than it was in the late 19th century. That trade was very much within these big blocs.
You think about the British empire including India, Australia, Canada, a large portion of trade that Britain has was with them. I think it was half, something like that. You add in the United States, it’s also huge. From the perspective of the US, it was small because the US was not actually involved in international trade. The US was really focused on its own evolvement in wars.
Then you have the war, World War I, and then upends things a lot. On the one hand, you still have a situation where the UK, for example, is really adamant about maintaining the relationships it has with it’s imperial possessions, getting food and metal and stuff and also soldiers from its imperial possessions was really essential for keeping the British war effort alive. The other thing that was [inaudible 00:16:57] the US suddenly became a massive exporter of manufacturers to the on top powers, England and France. That really actually fundamentally upended the trade relations that had existed because until then, the US mostly was importing advanced machinery from other parts of the world, from Europe, England and France and exporting food. That really changed because so much production in western Europe had been transformed or rededicated towards the military or had just been destroyed outright that there wasn’t enough civilian production capacity available so they really had to rely on the US. Also they had to rely on Japan actually as another major power.
When the war ends, you have a long period of … A lot of countries have been just impoverished. They have very high deaths afterwards. The US is not really actually playing a very cooperative role in creating sustainable global system. Then you have the Great Depression, and then you have World War II. By the time you get to the end of that, the whole-
Trevor Chambers:
I’m sorry to interrupt. Sticking to the gold standard and all that’s all the confirmation is in there too. We don’t dig too deep in that, but that was not something that shouldn’t just be discounted.
Matthew Klein:
No, absolutely. That’s right. I don’t know how deep you want to get into this, but the short version is that before World War I, you had a system where basically all the major economies had their domestic financial systems tied to gold. It was all tied to gold. What that effectively meant was that if you wanted to … If you were in a situation where you were systematically borrowing from other countries to spend more than you earned, in other words you were going to trade in current Cap deficit, then you’re having gold flow out of your country.
Trevor Chambers:
Exactly.
Matthew Klein:
When gold flows out of you country, because gold is the anchor for your domestic market system, that tightens domestic financial conditions. That is eventually going to cause less spending in your own country. It is a self-correcting mechanism because sooner or later, you’re going to be cutting your imports and that will adjust so gold won’t flow back. At the same time, gold is flowing into countries. That’s going to have the opposite effect on the financial systems that are having trade surpluses. They’re going to have loosening financial conditions, people are going to spend more, they’re going to increase their [inaudible 00:19:40]. Again, that means that global imbalances as such couldn’t really get very large or persist for that long because there’s this natural balancing self-correcting mechanism where domestic financial conditions were tied to international payments.
But in World War I, for pretty good reason, governments essentially suspended … The US is the exception here, but they suspended the gold standard. What that mean essentially is they could print as much money as possible to pay for the war that led to high inflation obviously in a lot of places, but they still fight the war which was in the short term, you want to survive the war more than keep inflation under control.
Then after the war, it’s a question of how do you get back to the gold standard. It took a little while because people had different views of how quickly to do it and in what way to do it. The thing that was really harmful in the ’20s was the US and France, for so many reasons, but the net effect was they basically prevented … Gold was coming into the US and France, but the governments, the central banks there, prevented those gold flows with having the normal economic effect of easing financial conditions because essentially in France they were trying to maintain what they considered to be a federal balance of trade and they thought it would prevent … They needed to repay debts to the US or something like that, the US was thinking perhaps there was an inflation targeting regime. They didn’t want to have huge upward inflation.
Even if those goals might have seemed individually reasonable, the net effect was that it completely broke the functioning of the gold standard system because you essentially had all this gold going places and then it just disappeared. They sterilized it, is essentially what happened. You didn’t have a natural balancing effect that you should have had. Gold was going out which was cutting spending in the vested countries, but the places that were receiving the gold, surplus countries, weren’t increasing their spending as a consequence. That just led to all sorts of problems.
It’s essentially the reason why, in the 1920s, you had continued problems with debt service and all the negotiations of German reparations and not just German reparations, but the ability of the British and the French to repay each other and then also repay the United States for the loans taken out during World War I. All this became an extreme problem. The global economy is very fragile as a consequence and then it all came down to the Depression, but it really broke down before that with those choices.
Trevor Chambers:
Again, it just supports your thesis more because it’s the same. Maybe different players on the table and the table may be reshuffled a little bit, it’s still basically the same thing, it doesn’t really matter. These problems that were created may have been different sources but it’s in balances and it got transmitted. Yeah. [crosstalk 00:22:43].
Matthew Klein:
You can tie it into more recent events where you can countries that pay currencies, and whether or not paying your currencies is good or bad. That’s not as much an issue now as it was in the past, but in theory if you do that and your currency is close to appreciating, then the idea was that, “Oh, this wasn’t going to matter if you paid your currency. You get faster inflation.” That was the theory why currency and inflation shouldn’t affect trade. In practice, there are ways around this and you can sterilize. Essentially you have a repeat of what happened in the 1920’s which we saw in the 2000 with China in particular in the 2000s, but with other countries as well.
Trevor Chambers:
Hey, could you say that last five seconds again?
Matthew Klein:
Yeah. You saw this with countries, particularly in the early 2000s that paid their currencies-
Trevor Chambers:
Yeah, I got that.
Matthew Klein:
Of what inflation that in economic theory thought they would have and that therefore ended up having a similar effect on the trade balance as sterilization of gold inflows that the US and France did in the 1920s.
Trevor Chambers:
Yep, yeah. My grandfather had a saying, “The only difference between now and then is that the trees are taller and less light gets in.” Do you know what I mean? But fast forward to 1945, after the war. We got into the weeds, I love it, man. That’s fabulous. We get through the war and then what happens? That’s setting the stage for where we are today, it’s so interesting.
Matthew Klein:
Yeah. There were two basic things that happened after the war; one was this idea that we were going to have a different kind of international financial regime, so it wasn’t really based on gold. It was really based on the dollar. The dollar was tied to gold, but the expectation was people wouldn’t really convert their dollars to gold. Part of the way that that regime would be maintained is that there would be a lot of limits on cross border investment and financial flows. That would make it easier to maintain fixed exchange rates across countries. Countries had the flexibility to agree to adjust their exchange rates if there were imbalances in trade. The idea is that you’d have … I guess the word they would have used was discipline of the old gold standard without the rigidity of it. That was one decision.
The other thing that was done was the creation of the general agreement on trade and tariffs or GAT. The Bretton Woods conference which was an Allied war conference in 1944, which is where they came up with this monetary system, they also came up with this idea for the international trade organization. This was supposed to involve all the countries of the world at the time. It would have been a formal body for adjudicating disputes and setting rules about what you could and couldn’t do and trying to promote free trade.
That ended up getting vetoed by the United States actually after the war. People didn’t want that. Yeah. It’s a additional footnote. Basically the argument was, and this is ironic in retrospect, the argument was that the US was afraid that the ITO would have had too much that would interfere in US domestic policy. That’s why the blocked it. Ironically if you look at the history of trade since then, a lot of the failures of the US to open up foreign markets to the degree that we would like generally comes from the fact that other countries have used domestic policy that don’t seem like they’re related to trade to block trade. In the sense the ITO … Who knows? But it could’ve potentially prevented a lot of those issues. This goes back at least as far as the 1970s and stuff in Japan and will they use regulations and government procurement decisions to favor domestic companies over foreign ones? Anyhow, people actually now complain about the WTO and China. That’s a major concern. We don’t have these kinds of ways of preventing trade really.
If you have the GAT, which is straightforward and focused on tariffs and quotas and reducing them. That worked. It started to reduce these really obvious formal barriers of trade, but there were still really big other barriers of trade. As I said, first of all there’s financial flaws that limited things to a degree, but also there were also technology and social barriers. One of the ones that really fun to learn about … There’s a great book called, The Box, by, I believe his name is Mark Levinson. We cite this in the book and talk about it. Essentially the ability to move things physically across the world was very slow. There were a lot of stupid things that prevented people from actually shipping things across oceans or elsewhere.
I’m not 100% sure, but I believe if I’m correct, actually because they’re shipping things in real inflation adjusted terms that were actually higher in the 1950s than it was in the 1870s. That was going to put a real damper on trade. You had trade of some finished goods that you really couldn’t get elsewhere. Americans wanted to import Scotch whiskey, you don’t really care about those things or the costs, and bulk commodities, because again, you need them. You really didn’t see a lot of trade in those things.
Then you have essentially, it’s really more a business innovation than a wants innovation because the technology is very simple. It’s just a big metal box. Container shipping comes along, not just container shipping on ships but the idea of having containers as intermodal transport that you can move a container from a truck to a train to a ship all pretty seamlessly in the same container. You pack it at one end, you unpack the other end. There’s no unpacking and repacking.
Trevor Chambers:
Wow.
Matthew Klein:
That’s a huge change because before the way it was … When I say before, even into the ’60s and ’70s, if you had a factory in Ohio and you wanted to ship something to France, you would have to pay people to pack it into a truck or train that would then take it to New York, probably because of the way the ports were in New York. You’d have to either get it moved from a train to a truck or that truck that whole way because the ports were basically in Brooklyn and Manhattan themselves. It was very hard to get to. Then you get unpacked from there and then put in a warehouse for a while and then repacked onto a ship, where they could find it.
Then it would go from the ship … This would be the fast part of the trip. The ship would sail from Brooklyn, probably Brooklyn, to maybe a harbor in France or something. Then it would get there and then you’d have to take it off the ship, everything would be unpacked and then put in a warehouse. Then we’ve got to repack somewhere, maybe onto a truck in France or taken to a train station. Then eventually it would get close to its destination, unpack again, put it onto another truck, repack before it gets where it’s going. It’s a fairly long trip.
You can look at the length of time that it took and almost the time in transit and the cost was not the Transatlantic part. It was everything that was on land. It was just incredibly slow. Of course, getting it on and off the ship, while the ship is in port, not just getting it to and from the ship but while the ship is there, getting it on and off like that. That was a huge innovation. That’s why I mentioned that global trade and the share of the global economy was lower into the 1970s than it was in the 1870s. Things like that are part of the reason, just because it was so expensive and because distances were so … If you were going to have more trade, it would have been further.
Eventually trade growth, relative to the global economy would take off around the 1970s and 1980s and it’s in large part because it becomes … One of the big reasons is it’s just a lot easier to ship things over long distances and move them, so that’s why you see this huge trend going up from them and into the 2010s.
Trevor Chambers:
Wow. Also, by the way, some of that cost was some wise guys taking some stuff off the back of the truck, if you know what I mean?
Matthew Klein:
Oh yeah, for sure. Yeah, this is again-
Trevor Chambers:
I don’t want to get in too deep into that, but yeah.
Matthew Klein:
On this book, The Box, I tried to put all the fun things in that book in our section on this, but one of the very earliest adopters of container shipping were Scotch whiskey producers for exactly the reason you said that it’s a lot easier to maintain and to keep a guy from stealing. They created a lock and contained it and you only opened it at the end.
Trevor Chambers:
Listen, I don’t care what economy or area you’re in, you’ve got to grease the wheel to get things done. No, no, no. That’s hilarious. Okay. That’s why, in part, flat screen TVs are so cheap is what you’re saying. That’s such a huge part of the history of this thing, so that’s very, very cool. That actually leads me perfectly into this, do you think that dampening inflation has affected and harmed our economy? In other words, particularly, do you think it’s harmed the lower classes? The working classes and the middle class? Do you have any thoughts on that?
Matthew Klein:
That’s a great question. It’s very hard to know the answers for sure. There’s the traditional argument that people make is that inflation hurts … One argument that you hear a lot is that inflation hurts the poor because the poor don’t own inflation hedge assets and the things they buy are the things that tend to rise and the prices rise more quickly in overall inflation, like food or gasoline. A higher share of their consumption is on those things. The fact that they don’t own things, they’re affected and the fact that food prices will rise more than TV prices or something. That means that the poor get hurt more than other people.
Matthew Klein:
On the other hand, as you said, there’s a pretty extensive, both theoretical and analytical literature on this and common sense which is that the way that we’ve fought inflation in the past has been brace unions or shoegazers pushing into our economy in a recession or whatever and inflation seems like it’s picking up, then yeah, that would also seem like that would hurt the poor and the middle class disproportionately because one thing that’s very common when you look at the data is that recessions always hurt people at the lower end more. Even if people at the upper end of income aren’t harmed by downturns, it’s almost always the case that people down lower are going to get hurt more severely in percentage terms.
From that perspective, yes. Also the other deep basic way of looking at this is we expect that inflation fighting is deputized to central banks. We expect that central banks have models that use the unemployment rate as a way of predicting how inflation is going to be. That creates a dynamic where they are always going to want to have a certain amount of unemployment to keep the economy from, what they would call, overheating. Obviously if you’re somebody who is at risk of becoming unemployed or spending time being unemployed… When you are unemployed, you wish you had a job, from your perspective, then yes. Trying to keep a lid on inflation is going to be bad for you.
How do you predict, again what’s the overall answer and then there’s the thing about surprise inflation is good for people who have debts and surprise dis-inflation is good for people with fixed income. That’s a little ambiguous, it if helps, because if you’re really poor you don’t have debt and there are quite rich people who do have debt, but people generally think of that as another indication that inflation, we all expect it to be 5% and then it goes down to 2%, and a lot of people who had taken out debt when it was expected to be 5% are going to get screwed.
How do you weigh all of that, I don’t know, but I think it’s definitely a reasonable question to think through that the way that inflation has been managed in the past … It’s not crazy to think that that has disproportionately harmed people in lower and middle class.
Trevor Chambers:
Yeah. It’s just a thought that I just wanted to explore a little bit. You were talking about the fed. How do you think the fed’s done, particularly from Greenspan? Any thoughts on that? We don’t have to go too deep into it, but how do you think the feds overall … You can talk about today if you’d like, and I’d certainly love to hear it, but the fed, as I overheard someone say, is the most political office in Washington. Do you have any thoughts on that?
Matthew Klein:
Well, I definitely think the idea of independent technocrats is not the right way to understand it as a institution because at a very basic level, every government agency, there’s always people who have a view of what their agencies roles and responsibilities are. There are formal oversight mechanisms and there are people who are trying to maintain their authority and ability to do what they want. There’s always a political element to it, not political in partisan philosophy, but you want to maintain the interests of your organization and your ability to make decisions and stuff.
I don’t know. I think, quite frankly, the way they’ve been behaving in the past few years has been pretty hard to fault them for, at least on this level. You can argue with their economic analysis or their things like that. That’s perfectly reasonable. I think, in many ways, we’ve seen really in the past couple of years a lot of revision to the ways they think about things, just in the past five or six years.
Mike and I were just talking before about how central banks used the unemployment rate as an in-quote for forecasting inflation and one thing that’s interesting is how much that model has been discredited by experience in the past decade or so. You’ve seen that really in the United States as people rethink their … Actually Chairman Powell, the current fed chairman, Chairman Powell has really been one of the people, I think, leading that rethink internally, also externally we’re talking about, but within the fed, I think he’s been someone who’s an early skeptic and seems to be quite willing to embrace this idea that 3.5% unemployment rate doesn’t mean much of anything one way or another in terms … Good things for people having jobs but not something to worry about in terms of inflation. I think they’ve been relatively quick to move when they think they’ve made mistakes.
One thing that’s interesting is some of our very recent history, at the end of 2017, there was a big package of mostly tax cuts and tax changes and also there was a big spending increase in the military and a few other things. I think initially the reaction both at the fed and also [inaudible 00:38:29] was this was going to be a big boost to the economy in that it would increase inflationary pressures at the market. The fed responding by raising interest rates relatively quickly, more than they’d anticipated earlier. I think by the back half of 2018, it was not, I don’t want to say clear, but it was increasingly likely that they overreacted, that enacting these fiscal measures wasn’t as big as they thought it was going to be, that markets were reacting in such a way that … I think bond yields basically peaked in 2018 and you saw a big flattening of the curve and things like that. There was an issue of stock prices freaking out at the end of 2018 everywhere.
Trevor Chambers:
Mm-hmm (affirmative), yeah, absolutely.
Matthew Klein:
To their credit, they reversed course relatively quickly. At the beginning of 2019, they said, “Oh, we’re not going to do that.” First they basically say they’re going to keep raising rates but essentially they’re not and I think that by the middle of that year, they started to lower rates in pretty quick succession. That’s the thing I don’t think they would have necessarily … It’s the kind of thing that happened in the ’90s actually but not something that’s happened in a while since then. I think that’s a positive evolution in being able to move quickly. Speaking of moving quickly, I think that what they’ve been doing in the past couple of months, not even whether it’s quick enough, there’s some technical things and setting up these new running facilities, but I think recognizing the scale of what is happening and trying to hit it with overwhelming force, or at least what I think is overwhelming force, those things that I think have been basically in the right place, even if there’s recent quibble about the execution.
Trevor Chambers:
Yeah. All right, let’s switch gears. Thank you for that. I love talking fed and interest rates and the impact of longterm interest rates and stuff. It’s just so interesting. Can you dissect this specific trade war that we’re in and what’s going on and then maybe talk about policy?
Matthew Klein:
Yeah.
Trevor Chambers:
No, go ahead. Sorry, I cede the floor.
Matthew Klein:
Yeah. Yeah, I think it’s interesting when you look at the trade … I assume when you said the trade war, the conflict with China?
Trevor Chambers:
Yeah, yes. That’s what I was going to say … Because there’s always trade wars, there’s a lot. We’re in a trade war, but let’s just talk. China obviously, that’s a hot topic. Go ahead.
Matthew Klein:
Yeah. As I said earlier, there had been a thing where the US was going after Europe and that seems to have stopped. That’s all right. What’s interesting is that there’s … I think there’s a reasonable perspective from which one could say, “Oh, actually there’s a trade war between China and the US for a very, very long time,” if you look at the data on trade and the data that’s actually occurred in the United States and the consequence of the trade relationship with China and therefore you can say that the recent policies, whether or not they’re particularly effective or whatever from the Trump administration, they represent more of a continuity with a pretty recent conflict than starting something.
Trevor Chambers:
Yeah.
Matthew Klein:
In the sense that you see that trade with China really since the late 1990s and especially since the early 2000s has coincided with and seems to have caused the loss of several million US manufacturing jobs directly plus other reduced incomes for a lot of the other people in those towns and cities and communities. That led to a whole lot of other social problems. I think also you can draw a pretty clear link between that and the inflation of the housing debt bubble in the 2000s, which we go in that in some length in the book.
You could look at that and go, “Oh, it’s a trade war.” I don’t think though, and this is where it gets tricky like trade wars or class wars, it’s not as this benefited regular people in China. It’s not like there was some massive transfer from the US to China and regular Chinese people think it’s great. I’m sur there are people in China that think that’s what happened but what really happened is basically the Chinese government has, over time, had a lot of policies in place that systematically transfer wealth and income from Chinese workers and retirees to businesses and various other elites. Elite can mean a lot of things in China. It could be part of the provincial standing committee or the head of the state owned or other things, but basically that kind of cohort.
They’ve done very well and other people have done much less well so. Overall growth in China has been extremely rapid so it’s easy for people there who are outside of service are hard to miss, but it coincides with a big shift in the distribution of income. People who are at the very top upper echelon have seen their share of income and spending go way, way down. If you’re an average man in the street, if your overall income is growing at 6% to 8% a year, you don’t really care, but if it should have been growing at 10% or 12% a year, that’s at a loss to you. For a lot of people, it’s actually quite extreme and there are a lot of specific policies we talk about in the book that the Chinese government has that the net effect is that if you look at the data that China’s national growth puts out, the share of corporate value ad, and it goes to different segments, this is standard statistics that basically every government puts out, if it’s a non-bank business sector, about 40% of the value add goes to workers.
Now, for perspective, that’s extraordinarily low, 40%. For perspective in the US and in western Europe, Japan, Canada and places like that, it’s 60% to 70%. You have this huge imbalance between what is normal in China and what’s normal in most other countries. So people thought that China was undercutting the US because of low wages. It’s not so much that wages were low, it’s that they were low relative to what they should have been in terms of Chinese productivity and their profit margins therefore are unusually high. That’s why there were so many companies that moved production to China because if your profitability is really high, that’s standard CFO thing to do.
The net effect of that was your had a transfer from people who would have spent, basically, everything they have in goods and services, which creates jobs elsewhere in the world and locally, to basically you’re not because if it goes into higher profit margins, some of that’s going to get spent somewhere or another, but a lot of it’s not, not in the same way, or it’s going to go on the accumulation of financial assets. It will be spent on something. It’s spent on share repurchases or housing or something. It’s not going to get spent on goods and services that provide people with jobs.
That is the underlying reason where this was this wealth. There’s nothing wrong with having trade with low wage countries, there’s nothing wrong with having more imports coming into your country. The problem is if you’re having a trading relationship where one side of that relationship is you’re sending them money and they’re just not spending it on anything ….but they’re just not spending it on anything. Essentially, again, like we were saying, it’s a 1920s situation where the gold flows are coming in and then they just disappeared. That’s just very bad for global economy. It’s also bad for people who live there. Chinese people could have had much higher living standards if this had been a different situation than they actually did. They were very much formed by this.
Trevor Chambers:
Essentially, the government, the Chinese companies, whoever, the elites, were getting way too much of the pie and the common guy was not able to save and that created a ripple effect that’s transmitted over here.
Matthew Klein:
Absolutely.
Trevor Chambers:
Then also obviously we outsourced, we gutted the manufacturing and then that explains the whole cycle.
Matthew Klein:
Right. I should also add that this is done with the collaboration and cooperation or whatever, of business elites and to a certain extent politicians that would be business elites in the US and Europe at the same time. The fact that there was so much relocation and production was something that was enthusiastically embraced. People were like, “Oh it’s great that their labor costs are so low because unions are illegal,” and there’s all these other things. It was pretty much hand in hand. They were among the beneficiaries. The people who benefited weren’t the elites in China. They were certainly among the beneficiaries, but also elites in the US and in Europe. Yeah, that’s why we say trade war, it’s class war. It’s a better way to think about it. If you look at the data in a simplistic perspective, it’s like, “Oh well, China had a trade deficit, the US had a trade deficit, the US lost jobs and these things, US had debt rise. US and China are going after each other.” But a more complete holistic view of what was actually happening within each country gives you a very different perspective on the same numbers.
Trevor Chambers:
Then of course, savings rates, we’re not able to save that much here. Therefore we’re not able to invest. Can you talk a little bit about that because there’s a savings imbalance.
Matthew Klein:
Yeah. Not to get too deep in the weeds here, but there’s this idea that the US savings rate at the national level is extremely low.
Trevor Chambers:
Yeah.
Matthew Klein:
There’s a big question that a lot of people … That information doesn’t tell you what’s actually causing that. It’s useful to break down exactly what the savings rate is. Essentially you have the total economic output that’s produced and then there’s however much you consumed domestically. Then whatever is the difference is savings. If you just take that saving and you divide it by the amount you produce, that’s the saving rate, the national saving rate. If it was individual, your income and then you spend it on goods and services and whatever is left over is savings. That’s your savings, but at the national level, it’s what I just said.
The question is, is a low savings rate the function that consumption is too high or is that production is too low? It could be either one. The savings rate is just the ratio of two numbers. It doesn’t tell you which one is driving it.
A lot of people look at this and they say, “Oh well, it must be because consumption is too high because consumption, that’s something you can control. That’s the variable. If the savings rate is too low, you should just consume less.” That’s a real problem because if you consume less, that in economic system, not that we have but in any economic system, production is a function of consumption. Businesses respond to what customers want or don’t want. If you just have everyone consume less, then businesses are not going to be able to sell the things they produce. They’re going to produce less, they’re going to go out of business or they’re just going to come back or something.
That’s almost how you’re going to change the saving rate. That’s what essentially happens if you apply this to the macro level. Everyone is trying to save more at the same time by consuming less. The savings rate is probably not going to change because they will consume less but they’ll also produce less and have lower incomes so the net effect is nothing. That’s obviously not great for anybody. Everyone is worse off and the saving rate is the same. That’s a pretty general outcome.
In the US in particular, I think when people look at that, you look at exactly has happened with consumption and production over time, I think it’s pretty clear that the low saving rate is a function of the fact, not that consumption is too low but too high … Not that consumption is too high but that production is too low.
Trevor Chambers:
Yeah.
Matthew Klein:
In the US, you have a situation and it’s really obviously looking at the manufacturing sector, but it’s true in other sectors as well, where there’s a lot of spare capacity and there has been over quite a few years, and in fact, it’s been rising over time. You look at that and you look at the trends of consumption and you say, “Okay well, the period that everyone thought the US savings rate just collapsed in the 2000s, that was clearly a problem with excess consumption.” But if you actually look at what consumption was in that period, in other words, the average household spending per person, and the inflation of interest, you look at that and you look at that relative to this longterm trend, it doesn’t stand out at all, that period. If anything, it’s actually slower consumption growth between 2000 and 2006 than you did in 1947 to 1998 longterm average, which is pretty stable.
That would suggest there wasn’t really a consumption boom. Some would argue that maybe should have been lower. I don’t know, it’s interesting but why? We hardly had inflation or anything. It’s not really clear why that would be the case. If that’s the reality of consumption having been not particularly remarkable, then the decline of the savings rate must have come from insufficient production and that’s consistent with the fact that you had this massive trade deficit that showed up.
Again, a trade deficit can be a function of either domestic spending has gone up a lot relative to domestic production so you are employing more in order to make up the difference, or it can come from the fact that domestic spending is changing, it stayed the same but your domestic production has fallen for some reason and your imports are essentially either replacing the lost domestic production or alternatively, or caused the loss of domestic product because they displaced it. That again, seems to be what happened in the United States.
It’s nothing in other countries, at least to the same degree. If you look at, for example, Spain is a very different story and we talk about that in the book. In the US, that seems to be what happened. When people talk about the low US saving rates because they’re consuming too much, that’s not really right. Some of the deeper questions are why did this low savings rate happen? Essentially the savings were … There are various ways to describe it, but as I said, essentially production was too low because other people in the world weren’t spending as much as they should have. Then foreign imports essentially crowded out domestic production and then the apparent response to that was a decline in the US savings rate, but it wasn’t because consumption boomed.
Trevor Chambers:
All right. That leads me to the, what are we going to do? What are we going to do? How are we going to balance this out? Policy. What do you think we should do? Do you have any thoughts on this?
Matthew Klein:
That’s the big question. What we talk about at the end of the book is we provide a series of suggestions for different countries because the most face forward ideal solution is that we maintain the basic open international system because there are a lot of good things that come from it even though there can be bad things, but there’s a lot of good that can come from it. Really what you want to do is you want to fix the actual problem. The actual problems aren’t that we have more or less free trade. Our actual problem is that there are a lot of places in the world where people are living below their means where, for various reasons of decisions of political and business elites, you have under-spending and you have as a consequence lots of excess production that has to get done somewhere. That’s the real problem. For example, and obviously now the coronavirus is a whole other added wrinkle of what’s going on now-
Trevor Chambers:
Let me just stop you there. You’re saying over-production in China is one of the major problems right now and also they don’t have enough domestic production because they don’t have their own-
Matthew Klein:
It’s not over-production, it’s more that production is … I don’t think that over-production is the problem because we still have a world where there are lots of material needs.
Trevor Chambers:
Got it.
Matthew Klein:
I think it’s more the perspective that there’s under-consumption in a lot of places.
Trevor Chambers:
Okay.
Matthew Klein:
Again, the coronavirus now is making this confusing to the people who would have wanted to consume things and can’t. Forgetting that for a moment because this problem is going to be with us … It was with us before and it will be with us afterwards, I fear … That would be the goal. Give more money to regular people in China, if you give more money to people in Germany and other parts of Europe … We spend a lot of time talking about Europe in the book. That would have a really positively impact on the rest of the world, including the United States.
Trevor Chambers:
What kind of impact?
Matthew Klein:
Sorry, what?
Trevor Chambers:
What kind of impact? I didn’t catch that.
Matthew Klein:
A very positive impact. It would be good for them fundamentally. If you are a person who lives in China or Germany or elsewhere, this is contributing to the global glut of things, that would fundamentally be good for you because your living standard is going to rise, so you’re consuming more, but it’s also going to be good for everyone else. It’s the reverse of how problems are transmitted across the world. This would the situation of benefits being transmitted across the world. They have a rise in living standard and that’s good for them, but then that also flows to higher living standards for everybody else. That would be a really good thing. That would be the ideal solution.
Good things that we can do domestically as well in the United States to improve our situation, we talk about those, a few specific ideas, but fundamentally, the most important thing would be the places where there is significant under-consumption. We should fix that.
Trevor Chambers:
Okay. Is that coming out of … Who’s paying for that? Is that tax policy?
Matthew Klein:
Yeah, it could be. It depends on the country. As I say, we go into specifics for China and Germany and Europe in particular because that’s where we’re focused on, but this is everywhere. In China for example, probably the number one thing you can do is, there’s something called the household registration system. It was designed under Mao to keep workers tied … Not workers, people, tied to the village they grew up in and they were born in. Part of it was to maintain an agricultural labor force, part of it was preventing mass limits of people that could threaten the stability of the regime.
Anyhow, they realized over time that people can move internally in China for work and you have seen hundreds of millions of China move from the countryside to the cities to work, but it’s still the case that if you do that, you considered a migrant. You’re an internal quasi-legal person, you don’t really have legal rights in the place that you’ve moved to. You don’t get access to government benefits-
Trevor Chambers:
If I moved to Pennsylvania and I have a whole set of other rights is basically what you’re telling me?
Matthew Klein:
Yeah, you basically don’t have rights.
Trevor Chambers:
Wow.
Matthew Klein:
Also, you had to do things like pay into Pennsylvania’s social security system because it would run at the state level as opposed to the national level, but you wouldn’t get anything. You wouldn’t have access to the healthcare, the schooling or anything that’s there. They just make you go back to your village if you wanted that. And there’s always the risk that you get internally deported, so you’re kicked back from Pennsylvania to North Carolina or wherever it is that you were coming from.
We actually saw this, I guess it was 2018, where the two biggest and richest cities, Beijing and Shanghai, they put in population caps because they didn’t want any more people coming in. They didn’t want anymore immigrants coming in, immigrants in this case being other people from other parts of China. They were rounding up migrant workers and deporting on the grounds that the slums that they lived in were unsanitary or things like that. That can always happen to you because, as I said, you don’t really have a lot of rights. You’re paying way more for government benefits than you’re actually getting. Fixing that system would be a huge improvement in China.
Obviously there’s no equivalent to that in the US or Europe so we wouldn’t need to do that, but in China, they could it. It’s something that leadership in the Communist party has talked about for a long time about fixing it, but it hasn’t happened yet.
Trevor Chambers:
Maybe one other thing, maybe shut the wet markets down too so we don’t have maybe this problem. That would be helpful.
Matthew Klein:
Yeah.
Trevor Chambers:
I didn’t want to kill your thought there. Do you want to finish that thought up there?
Matthew Klein:
Oh yeah. There are other things in China. We can talk about. Actually, it may seem obvious, but environmental protection rules and regulations is actually a really good example of something that would help people in China and also fix trade imbalance because essentially if you don’t pollution regulation, what you’re effectively doing is you’re effectively imposing a tax on people who live in a place that’s getting polluted and then using the money to raise that tax to inflate the profits of companies that are polluters. A, why would you do that, and B, it’s a classic case of what we talk about is it’s something that would boost the income of people who would spend it and boost the income of companies that generally speaking, or as profits, they’re going to retain those earnings or distribute them in ways that don’t necessarily boost spending on goods and services.
Having better pollution regulation would effectively increase incomes and living standards for regular people in China and it would also lower the healthcare costs which is also a big issue now. The people who would pay for that would be polluting companies. That would be an example of, it’s not necessarily obviously anything to do with international trade policy but it really would have an impact.
Trevor Chambers:
Yeah. Interesting. Well, I’ve got to tell you, this has been really cool and interesting to explore these topics with you. I’m going to just wrap up with two big questions, all right?
Matthew Klein:
Sure.
Trevor Chambers:
What are you podcasting or watching on Netflix or whatever? What are you reading? Give me a shout out to a couple of things that are going on there.
Matthew Klein:
Yeah. Let’s see. In terms of serious things to read, there’s a new book, I actually bought it about John Mather Kane that just came out by Zack Barter. I haven’t gotten very far in it yet, but so far, I’ve been enjoying that quite a bit.
Trevor Chambers:
Economic nerds unite around that book. That’s awesome, yes. Cool.
Matthew Klein:
Exactly. Yeah, yeah. …things that I want to be watching.
Trevor Chambers:
The other thing I wanted to ask you is can you shout out to one or two places that you’ve been getting to go in town in sunny San Francisco? Is it sunny today? Is it sunny today? What’s going on out there?
Matthew Klein:
It’s very sunny today.
Trevor Chambers:
Oh man, nice.
Matthew Klein:
Yeah. Let’s see. Well, actually yesterday we got some delivery from Tartine, which is a San Francisco institution and then had some … Yesterday was the day the book officially launched so we thought we’d treat ourselves to some seafood.
Trevor Chambers:
What’s the name of that restaurant again?
Matthew Klein:
Tartine.
Trevor Chambers:
Tartine, okay, yeah, yeah. Okay, cool. Awesome. Everybody look that up. Okay, go ahead.
Matthew Klein:
Yeah. Let’s see. There’s a great Napolese place that we ordered from recently called the … Actually we’d been there in person before we got some dinner from them not too long ago called the Dancing Yak which I’d also recommend.
Trevor Chambers:
The Dancing Yak. Oh, I like that. I like that a lot. All right, cool.
Matthew Klein:
Yeah.
Trevor Chambers:
Of course, we’ve got to shout out to Asloff. Those guys did a much more professional podcast last time. This is more like a really smart guy running into a train wreck, do you know what I mean? But that’s okay. Listen, do you know what I want to do? Let’s have another call because I would love to explore … You talked about China. I don’t want you to give away the whole frigging book by any means, but there’s so many nuances. What I got from you in this conversation is this stuff is way more nuanced. You can think about what it is politically through your lens, but this stuff is way more nuanced than we’d care to admit, this stuff that you study and write about and this subject.
Matthew Klein:
Yeah. I think that’s right. Definitely a lot of the conversation in the public is much more who’s good and who’s bad or country versus country, yeah. There is a much different way of looking at it that is precise and is much more enlightening I think to really understand what’s really going on.
Trevor Chambers:
Yeah. Hey, do you think we’re going to start making more stuff here?
Matthew Klein:
Ah, it’s possible. I think the destiny of the US to not produce things is very strange to me. The US still does make a lot of things in terms of manufacturing, less in some ways than it used to, but there’s still a lot. There’s no fundamental reason why that couldn’t be the case.
Trevor Chambers:
Wouldn’t that be helpful?
Matthew Klein:
Yeah, it could be. Again, to expect that, a lot of things … It’s that some things are being made in this country because there’s just a global weakness in demand that is filtered through to lower demand for US made products. I think that’s definitely … That’s reversible and should be fixed.
Trevor Chambers:
Yeah, yeah. Well listen my man, this is deep stuff. This is deep, as I said, smarty-pants stuff and I appreciate it. Thank you so much in taking the time in talking to us here. I want you to be safe out there. When you go out, do you have to wear a mask and all that stuff or what’s up?
Matthew Klein:
Yeah. We wear our mask every time we leave the house.
Trevor Chambers:
It seems like you guys have done a nice job out there handling this. That’s cool. Listen Matt, thank you so much for the time. All right, man, let’s stay in touch. I appreciate it. Have a great day, all right.
Matthew Klein:
Yeah, you too. Take care.
Trevor Chambers:
Later. Bye-bye.