A TPDEARR Article
Trans-Pacific Dynamic Equity Allocation Research Report
It’s all a part of the background; let that be the base of our approach to macroeconomic evolutions in this TPDEARR issue. And to stave off some further confusion, let’s agree that “the background” is noted as such for its ubiquity and omnipresence within a given environment, and not because it is somehow removed from interactivity with the immediate moment and local circumstances, which it is certainly not. Though we cannot physically touch a background feature like an interest rate (like the central bank-set Fed Funds Rate, which trickles down through the entire financial system) such a thing as a broadly-guiding interest rate still “touches” us by affecting the prices of the goods and services available to us, and it impacts the daily activity of all, even those who are blind to it.
The features of the macroeconomic background are very much influential in our microeconomic behaviors, and those features are, in and of themselves, increasingly tied into global and international dynamics, multivariate, and uncertain; no fully-encompassing conclusions about a domestic economy can be made, in this day and age, without incorporation of international economic relationships. By first looking at the force of relative purchasing power, we can then trace connections throughout the web of global trade flows to identify where economic players have outsized opportunities for success. As we shall see, though, it’s not just quantitative relationships that define the macroeconomic backdrop within which commercial activities unfold, but also non-numerical dynamics that emerge in the capitalist environment and constantly realign capital flows. Analysis of “the flock” helps us make sense of one of the fundamental shapes of the aggregate, and understand how to interpret the perpetuality of its emergence to guide our investment attention towards worthwhile focal points for the JUN.24 TPDEARR Squad.
Finally, we come face-to-face with (some of) the realities of integrating advanced technologies with the financial system, and the not-so-insignificant risks of trying to “convert” our current embedded infrastructure of monetary and fiscal institutions into something that would make the A.I. junkies and crypto-bros happy. As usual, we’ll try to keep the math1 jargon to a minimum as we breakdown the significance of these evolutions to the macroeconomic background. Promising targets for our JUN.24 Squad gain support as details about the inter-workings of the background conditions gain clarity.
Global Purchasing Power
The macroeconomic background is global, not just national. For our purposes, which really only include economies that are developed enough to host accessible public equity markets for investors to participate in, no nation or modern economy exists outside of the current highly-interconnected international system of commerce. All major supply chains stretch beyond national borders; populations are diversifying (and urbanizing, as we discuss in the JUN.24 Demographic Trends article); and integration with financial networks is world-spanning, and requires high standards of internationally-agreed-upon institutional sophistication and independence in order to reap all of its benefits2.
In virtually every trans-Pacific economy, what any given individual citizen is capable of purchasing, at any given time, with their own local money, is highly-interdependent on the macroeconomic tapestry of levers and pulleys that integrates financial behaviors from all of the other international economies connected to it. Whether or not you “buy local” and hone your purchases to direct your actual cash flows through purely internal and domestic sources and destinations, the very strength of your spending power is also contingent on foreign government policy choices, among other things. When we talk about “global purchasing power” we are pointing at the dynamic of “spending power” being globally influenced, and becoming increasingly (albeit, still partially) determinant on the successes and failures of other government administrations in their fiscal and monetary management; we are not simply pointing at the exchange rate for wealthy tourists, though that is also a significant factor, especially for less-wealthy nations with outsized hospitality sectors, generally speaking.
To illustrate how the nature of spending power for modern economies has been multilateral-ized, consider the two primary pole economies of the trans-Pacific sphere: the US and the PRC. Each of these nations has grown into its modern form in tandem with the other; both have been enormously complicit and supportive of the other’s rise. China spent decades making the infrastructure and manufacturing capacity to physically produce the stuff that the rest of the world, primarily the US, spent decades purchasing; the PRC, along with companies from other countries, used resources sourced from around the world to accomplish this inside of China; the flows of trade resulted in money from other places, primarily the US, pouring into China and fueling its own rise, further enabling it to expand its manufacturing and export capacities; a positive feedback loop of commercial growth, with neither major participant able to succeed to the same extent without the voracious appetite of the other (China: to make; US: to buy). We, they, we all did it together.
Now, we have an intertwined system of trade. Tariffs do not de-interlace or eradicate the fundamental understanding that brought economic participants together in the first place: someone providing something that someone else wanted at a price that they are willing to pay for it.
Now, our system of buy-and-sell is globally integrated; many economies are being primarily supported by outsized export industries and the ravenous purchasing appetites of players in relatively-wealthier nations. Thailand, Taiwan and Malaysia all have export industries that push out more than 60% of their respective annual values of GDP; Singapore and Viet Nam typically export >100% of GDP in value yearly. Major changes to the system can not be accomplished without extreme levels of economic distress, usually to the already-poorer party.
Now, most major nations have to manage their own currency values in very close consideration of even the most minute of fluctuations in the US dollar forex profiles, among others. Not doing so results in financial stress from exposure to events in the global monetary regime, which is dominated by the US dollar, that were not anticipated or planned for. In short, it costs less to plan to coordinate with the USD—a self-reinforcing monetary regime if there ever were one.
Now, citizenries all over the world, after having been exposed to the lower price points made possible by globalizing supply chains to source the cheapest inputs and labor available, are familiar with standards of living that, quite frankly, they can’t afford, especially if provided without the cost advantages of non-local production. Demand pressures for higher quality of life measures, introduced and made possible by the past 3 decades of the PRC’s “world factory” activity, proliferate through virtually all market economy voting constituencies. China sold cheap stuff to everyone. Companies and central/local governments do not have access to the same mix of resources domestically as they can find internationally, so the cost for producing locally will almost always be higher, and more prohibitive to the consumer, if it’s even possible at all. The act of “going local” erodes purchasing power, both domestically, and for foreign residents of foreign lands whose economies are highly susceptible to richer nations’ citizens opening up their wallets to global purchases, and will necessarily shift domestic capital flows. When nobody buys the stuff for sale, it comes off the shelf, and becomes thereafter unavailable.
Now, we have a commercial system that is broadly supported by funding from a financial infrastructure that enables and allows monies to be exchanged and moved throughout capital markets in dozens of countries, providing the real-time capital flows that enact the world economy. US companies are bolstered by equity injections from foreign individuals and governments, and vice versa, all around the world. The ability to channel and utilize highly-pluralized cash flows from around the world is what provides the capital liquidity that enables commerce itself in today’s modern economy. The combination of the highly variable amounts and values of each of these currencies obviously impacts the overall value of the flows: there is no such thing as “one money” with “one value”.
Stuck with the globalized system that we’ve got, the strength of our money’s value (what it’s capable of buying) is powered by global macroeconomic evolutions, even for those of us who have never left the town we were born in. And in fact, it is those who are most oblivious to the machinations of their financial environment who are the most susceptible to being taken advantage of, especially by innocuous activity such as default circumstances and “boilerplate” agreements. Moreover, it is quite specifically the absence of financial literacy and individually-directed forethought that we come to in our next topic, and so let’s follow the flock into the void!
The Thrust of the Flock
Look at the horde.
See all those people, and their machines? See all those savers, spenders, investors and “investors”? See all that capitalist activity perpetuated by individuals with their computing toys and their wide variety of intellectual capacities? Remember, all together, they are the aggregate, the behavior of which is more closely aligned with that of a superorganism: a collective, not an individual. As such, one of the most significant actions of the aggregate is to flock, and it is this act of flocking that we cannot stress the importance of enough.
As individuals, thinking individually, the average person poses no threat to the financial system that supports her. But people are not only thinking individually; they are subject to social environments and collective influence. And despite the loud calls of anthropocentrism, the human animal is, in many ways, no different than any other animal that flocks. The human animal regularly participates in superorganism-ic behaviors of flocking—humans are routinely influenced to match their behaviors to closely resemble those of the people around them. Just like birds, and ants, and molecular particles, people participate in the emergent game of alignment/non-alignment that operates through superorganisms at all scales, especially in considering the idea of threshold activation. People will tend to more closely align with the behavior of their more-immediate peers, and this pattern formation emerges and occurs everywhere, at all times, simultaneously. Booms, busts, bubbles, fads, flops and fashion are just some of the many examples of human flocking. As you may well surmise, there are also financial ramifications of this phenomenon.
When J.P. (FED Chair Jay Powell) has to deliver carefully-worded public announcements about Federal Reserve policy action or inaction, he is doing so because he understands that jolting the expectations of the human herd may very likely cause them to flock their financial behaviors in a way that poses threats to the financial system as a whole; all central bankers around the world face this dilemma. Humans can’t be trusted to behave rationally, no matter how much we’d prefer they did3. That doesn’t mean “The system is broken! We have to change everything!” (There is no “new system” to switch over to, and there is no Hard Reset button.) But it does mean that J.P. and other central bankers have to be very careful with their wording, and it does mean that smart money investors who actually account for real behavioral dynamics, such as flocking and its effects on commercial and capital flows, will be the first ones moving into profitable positions, before the flock gets there.
So, we can’t get rid of the flock, as flocking is an emergent property of self-propelled organisms, and we can’t discount the impact of flocking, for to deny its significance would precipitate likely-market-collapsing events. We thus find ourselves with a system of two classes of participation: the individual motivations of people, funds, companies and governments and the contracts and influences that precipitate them; and the contingent motivations of all the same players, but which is subject to (essentially) social/external influence in real-time, and cannot be adequately predicted or foretold. Despite the absence of any logical reasoning that might precipitate anticipatory advantage, people can still be expected to mimic their peers’ behavior.
As you might suspect, no statistical equation fully encapsulates the unpredictability of flocking. And because some markets, such as stock/equity and housing markets, are more exposed to flocking than others, more-assured investment realities are frequently perceived in other markets, such as bond/fixed-income and interest rate derivatives4, and financial players who are more concerned with their cash flows being uninterrupted flock to these other markets, so no capital haven is actually unexposed to the influence of the flock.
Investors’ shifting of perspective according to background macroeconomic features is a hallmark of flocking. As conditions change, major capital flows will alter to find what is most-profitable and what is most consistent/predictable, and flocking will contribute to that determination. For a recent example from the Federal Reserve, consider how stimulus funds released to counterpunch the COVID-driven recession in 2020-21 were “sopped up” in markets all around the world by an increase of corporate bond issuance, reaching record highs in many economies. In the face of adversity, investors flocked to these new, more-secure capital vehicles, not unlike the way crypto-bros flock to (highly volatile) meme stocks , which still transpires despite the absence of fundamental economic rationale. Such a thing is no different than gambling; only the lucky will come out ahead.
Be wary of the flock, but fear it not. Groupthink suffocates individual autonomy, but also lends a hand in keeping provisioners of financial products honest, as the threat of a mass flight-to-quality always looms large. Some of you investors will struggle out there on your own, making your own decisions, and you’ll be tempted to coordinate with the flock for what feels like safety in numbers. You have the freedom to choose that path, but we would never endorse such a thing here in the TPDEARR. Please, think for yourself, for your own good.
No, You Can’t Play, Because We’ll Lose Control
And now we come to the headline show on the macroeconomic marquee: A.I.-integration. The combination of machine learning and machine “decision-making” is, quite literally, beyond our human comprehension. It is specifically this supra-human capacity as to why we turn to it, and it is this very capacity which holds the new spectrum of macroeconomic risks that we must manage. Already heavily engaged in “automated” trading, financial players around the world now face the question of whether or not to incorporate “A.I.” decision-making into the process, but find themselves between the rock of losing ground to early adopters, and the hard place of opting to include a “black box” of processing power that spits out answers that no human can fully appreciate the complexity of, even if they do feign partial comprehension.
Janet Yellen, the brilliant and level-headed US Secretary of the Treasury, recently warned about how insufficient and faulty datasets might introduce and perpetuate new biases in financial decision-making. Because the technology (and logic processing) underlying such decision-making is extremely advanced and opaque—in all likelihood, far more sophisticated than any person could ever understand (much less a congress!)—it would be essentially impossible to prevent, detect or repair system anomalies. Yellen agrees that lots of potential benefits exist, no doubt, but rash adoption would be dangerous, and the backlog of A.I. companies seeking approval for new fintech applications is growing rapidly.
US SEC Chair Gary Gensler regularly echoes the same sentiment and its multiplying dangers to financial stability. In recent remarks to the Yale Law School, he lays out how 8,316 domestic financial institutions are clamoring to participate in A.I. and crypto trends, and how an ongoing consolidation of the major players (like that seen in cloud services, search engines and online retail platforms) would likely be replicated in generative A.I., and the monocultures and network interconnectedness of such consolidation introduces systemic vulnerabilities. Even if/when regulation is updated to include many of the new technologies, Gensler believes it will still be insufficient to properly monitor and regulate the markets. When everyone is getting the same signals, from the same database source(s), herding/flocking, fraud and manipulation are just a few of the most pernicious risks.
How can we determine if a generative A.I. program is engaging in intentional and strategic deception of its user base? What sort of new, unpredictable harms will be introduced? How can we manage oversight and regulation when algorithms are learning and changing their operations on the fly and independently? Who (or…what?) is liable for harms resulting from non-human trading activity? How can large-scale, highly liquid, highly leveraged financial flows by managed and overseen on decentralized crypto networks? What’s the mode of recourse in the event of theft, loss or “permanent” destruction of digital monies? Even from an internal, in-house information standpoint, not even counting outside counterparties, what sort of discussions and information constitute materiality? When it comes to unknown and unknowable risks, what must be disclosed to shareholders regarding discussions of ultra-advanced technologies and algorithmic iteration? The currently unanswered questions are myriad, and there are no simple legislative answers for any of them. Yes, the “train has left the station”, and it doesn’t appear that we can stop technological progress, but we also certainly cannot just overlay epoch-shifting software onto our current system, especially when we can’t predict or plan for the ensuing results. Digital financial commodities, enticing and important as they are, are still growing in their legitimacy; volatility therein will surely continue for the foreseeable future.
So what’s the bottom line here? The system of interconnected institutions that currently manages and administrates the global economy, already exposed as it is to an endless variety of catastrophic vulnerabilities, is not convinced that fully implementing these new technologies is in our best interest, right now. We don’t even understand the new uncertainties we are facing. If we “put the ‘bot in charge,” we will not be able to predict or anticipate the “decisions” it will make, and we will lose control; it’s just a matter of time.
A.I. and crypto are “cool” new technologies, but they can’t come to the party, because the powers that be will lose control and the system will collapse. Macroeconomics is a tightrope walk with disaster always looming in the wings. If regulators can’t read and understand the mechanisms of activity, no sustained prosperity can last—humans have done this dance before. Some of you may feel this sort of upheaval is desirable, but you haven’t properly considered the truth that there is no alternative system that’s developed and ready to manage the global economy. Remember, all major economies are globalized; any one of them collapsing poses serious systemwide catastrophic risk. Oversight is not optional; bad actors can’t be willed out of existence. One day, hopefully, A.I. and blockchain will contribute to healthy global commerce, but today is not that day.
Additional Notes
While still premature to infer that generative A.I. and machine learning will soon form the regulatory basis of financial market decision making, we can still appreciate the enormity of its influence on private sector activity, such as in [JUN.24 Squad Asset #1]. Automation and roboticization will continue to penetrate and percolate throughout the manufacturing and production sectors and upend virtually everything, replacing and displacing humans while dramatically reshaping and upgrading productive machinery. Machine learning and generative A.I. will play an increasing role in these efforts, largely led by B2B relationships that underlie advanced capacity installation without the kind of blowback that comes from hesitancy and uncertainty in B2C interfaces… until the public’s comfort level rises to an acceptable range for any given application. Concerns about user “privacy” don’t ring so loud in manufacturing endeavors where the “users” are employees of the company that’s utilizing the machines in the first place. There is plenty of room for profitable growth of A.I. companies “behind the scenes”, without threatening macroeconomic stability, while the public gets their collective feet wet from commercial exposure in incremental ways.
- We treat mathematics as a meditation on real activity. Math measures and analyzes phenomena numerically, which is useful, for sure, but it’s also incomplete as a full representation of the subject. Math helps see “between the lines” of other disciplines, which likewise lend themselves to see between the lines of math.
For the mathematically more-inclined: we at tkscm, limited continually find that traditional economics relies on statistical and quantitative methodologies that don’t properly account for the very-fat-tailed distribution dynamics that play out in the real world. Systems of “statistical reasoning” that should very likely be abandoned entirely continue to underlie fundamental economic policies and behaviors. From various vantage points, and with an infinite variety of goals, math can be “used” by crafty participants to paint virtually any numerical perspective, so we encourage readers to be skeptical and to understand the nature of mathematics as one of many possible analytical tools, rather than a quantitatively-definitive provider of answers.
For the less-inclined: the vast majority of math is adding and subtracting. Don’t let those nerds intimidate you! You can understand all core concepts logically, with no advanced math training.
↩︎ - Only the richest of nations can achieve the full wealth of benefit-reaping available, it would seem.
↩︎ - For the uninitiated, the blossoming field of Behavioral Economics is attempting to bridge the gap to a more comprehensive understanding and incorporation of the irrational human animal into economic “rationality”, though much still remains to be accomplished. We strongly recommend Andrew Lo’s Adaptive Markets for readers to lay the groundwork of integrating natural evolutionary principles, such as adaptation, natural selection and competition, into financial understanding.
↩︎ - For a little study in scale, consider that the market capitalization value of the entire US stock market, by far the largest in the world, is a little more than USD$50Trillion. For comparison, the Bank of International Settlements calculates that the total global value of interest rate derivatives is ~USD$530Trillion, over half of a quadrillion dollars, ten times larger than the entire US stock market, and about 5 times larger than the entire global equity market.
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tkscm, limited 