On the financial front, the inversion of the 2-10 year yield curve (which is approaching historical record) signifies tight financial conditions at a time when the federal funds rate should be approaching its terminal value between 5.25 and 5.50%. Bond issuance has decreased significantly and there have been few signs of worries regarding refinancing even when a good number of bonds would need to be refinanced starting in about 20 months from now. Home prices remain elevated despite high mortgage rates, home sales are rising slightly (mortgage applications are recovering slowly too), while internationally Chinese banks have raised their lending levels to over $725 billion in the month of January alone.
The concern with such positive news is that unless they are safeguarded, they could represent temporal successes that will not have a lasting impact. Aristotle described city-states and their long-lasting impact by discussing what gives birth to the city-state (the state comes into existence for the sake of life which advances the survival mode of existence). However, it is sustained and prospers when it pursues the good life. Communal life is far superior to individualized living, and thus the city-state becomes the epitome of good life. The basic principle of success for the city-states was shared prosperity. The latter’s proxy could be advancing incomes and standards of living for the average person/family. Therefore, in a bit unorthodox approach, rising wages should not exactly be perceived as causes of concern, red flags, and sources of inflation trouble.
The cities established by Alexander the Great didn’t pursue Aristotelian fences. The Romans did not adopt the concept of the city-state and when the barbarian invasions took place, civilization retreated within monastic walls. Charlemagne’s imperial city never achieved the success of the city-state of ancient Greece. However, the Italian medieval cities of Florence, Milan, and Pisa adopted the idea of a city-state within their communal lives of their commercial entities and enterprises. The liberty enjoyed by the merchant class created fortunes that spread the wealth around through rising wages. By the year 1300, Florence had become the epicenter of European banking, and its coin (the florin) became the first international currency. However, Florence became much more than a business center. The citizens dreamed and actualized the kind of glory not seen since the glory days of Athens. The city became a state where the citizens took pride in their civic achievements in art, architecture, politics, and paideia, all of which belong to all people.
Safeguarding economic successes via strong paideia fundamentals can sustain a good life in the long term. However, what do we do under the current circumstances for the economy at large, and how do we apply Aristotelian fences in safeguarding the economy and portfolios in the midst of inflation, interest rate, and geopolitical risks?
The graph presented earlier reflects three straightforward realities and two subliminal: First, as sentiment improves, economic activity could become brighter. Second, as deleveraging takes place, debt risks decline. Third, as equity allocations rise, investors’ optimism improves the market climate. The subliminal messages are twofold: First, sustained achievements (low unemployment, higher wage incomes, strong demand, reduced supply pressures, etc.) should not be considered enemies because they themselves can become engines of sustainable growth. Second, the market can live with the current trajectory. If our interpretation is correct, then overtightening financial conditions will backfire and could undermine sustainable growth. We could well be in an economic stage where we should accept a slightly higher inflation rate than 2%, which in turn does not lock down the fridge. The central banks missed the threat of inflation and were too late in starting rate increases, and when they started raising rates, they were too timid (raising them by just 25 bps). They had lost control of the money supply (monetary overhang), but now the latter is dropping at a very good pace, as shown below. That by itself implies for us that future inflation reports will be much better, especially if we become economic realists and accept the fact that structural changes around us point to an acceptable target inflation rate of 3%, which allows for both incomes and profits to grow while building up ammunition for central banks when the next recession arrives and providing some cushion for fixed income investors too. |
Market Plays in a Machiavellian Garden with Aristotelian Fences
Author : John E. Charalambakis
Date : February 21, 2023
One of the most intelligent studies on European history was written by Francois Guizot titled History of European Civilization. It’s a philosophical history as it elaborates on the causes and effects of particular events. Well-known authors such as John Stuart Mill, Alexis de Tocqueville, and even Karl Marx were inspired by Guizot’s work in their 19th-century writings. Guizot’s star fell out of favor due to Machiavellian manipulations in French politics. Few people talk about Guizot these days, and this is the result of building and realizing something wonderful (he became an admirable and inspiring European figure within the reality of Machiavellian forces) but failing to safeguard it with Aristotelian fences.
What we are witnessing on the economic front nowadays is supply-chain improvements including shipping costs, some retreat in oil prices, a continuous demonstration by US firms to domesticate and increase production, no sign of a widespread credit crunch, layoffs not affecting the unemployment rate, and few signs of any kind of landing for the US economy (at least for now as it is probably sustained by infrastructure spending which may turn out to be a super cycle in the next few years). So, from that perspective, the continuous strength of the US economy (and to some extent even of the EU economy) – whether we want to call it resilient or antifragile – reminds us of Guizot’s successes. This type of strength could partially be reflected in the following graph, which we will discuss once we provide some additional background information.
The concern with such positive news is that unless they are safeguarded, they could represent temporal successes that will not have a lasting impact. Aristotle described city-states and their long-lasting impact by discussing what gives birth to the city-state (the state comes into existence for the sake of life which advances the survival mode of existence). However, it is sustained and prospers when it pursues the good life. Communal life is far superior to individualized living, and thus the city-state becomes the epitome of good life. The basic principle of success for the city-states was shared prosperity. The latter’s proxy could be advancing incomes and standards of living for the average person/family. Therefore, in a bit unorthodox approach, rising wages should not exactly be perceived as causes of concern, red flags, and sources of inflation trouble.
The cities established by Alexander the Great didn’t pursue Aristotelian fences. The Romans did not adopt the concept of the city-state and when the barbarian invasions took place, civilization retreated within monastic walls. Charlemagne’s imperial city never achieved the success of the city-state of ancient Greece. However, the Italian medieval cities of Florence, Milan, and Pisa adopted the idea of a city-state within their communal lives of their commercial entities and enterprises. The liberty enjoyed by the merchant class created fortunes that spread the wealth around through rising wages. By the year 1300, Florence had become the epicenter of European banking, and its coin (the florin) became the first international currency. However, Florence became much more than a business center. The citizens dreamed and actualized the kind of glory not seen since the glory days of Athens. The city became a state where the citizens took pride in their civic achievements in art, architecture, politics, and paideia, all of which belong to all people.
Safeguarding economic successes via strong paideia fundamentals can sustain a good life in the long term. However, what do we do under the current circumstances for the economy at large, and how do we apply Aristotelian fences in safeguarding the economy and portfolios in the midst of inflation, interest rate, and geopolitical risks?
The graph presented earlier reflects three straightforward realities and two subliminal: First, as sentiment improves, economic activity could become brighter. Second, as deleveraging takes place, debt risks decline. Third, as equity allocations rise, investors’ optimism improves the market climate. The subliminal messages are twofold: First, sustained achievements (low unemployment, higher wage incomes, strong demand, reduced supply pressures, etc.) should not be considered enemies because they themselves can become engines of sustainable growth. Second, the market can live with the current trajectory. If our interpretation is correct, then overtightening financial conditions will backfire and could undermine sustainable growth. We could well be in an economic stage where we should accept a slightly higher inflation rate than 2%, which in turn does not lock down the fridge. The central banks missed the threat of inflation and were too late in starting rate increases, and when they started raising rates, they were too timid (raising them by just 25 bps). They had lost control of the money supply (monetary overhang), but now the latter is dropping at a very good pace, as shown below. That by itself implies for us that future inflation reports will be much better, especially if we become economic realists and accept the fact that structural changes around us point to an acceptable target inflation rate of 3%, which allows for both incomes and profits to grow while building up ammunition for central banks when the next recession arrives and providing some cushion for fixed income investors too.
During the Guizot years, the Industrial Revolution that changed the world was taking shape, the energy transition from wood to coal was energizing the economy, Impressionism was making its mark on the arts and the intellectual understanding of reality, and by the time of his death Victorien Sardou started drafting “La Tosca”. A few years later Giacomo Puccini made the work into the famous opera which may reflect in the best way possible the spirit and work of Realism by which Guizot, entrepreneurs, scientists, and Impressionist artists touched and changed our world.