Today I share a fantastic 20 min animation on how the economy works. It was created by Ray Dalio the Co-Founder and Chief Investment Officer of Bridgewater Associates who runs the world’s largest hedge fund. Aside from being ask to speak to the forum of world central bankers, his company is credited with having more research resources than the US Central Bank and has created the following Video for the benefit of the world. http://www.economicprinciples.org/.

It explains economic events that brought Hitler to power, the Great Depression, the Global Financial Crisis (GFC), why life is good in northern Europe, bad in southern Europe, and how the global economy will perform for the foreseeable future. It explains the importance of the most critical factors in the economy: Productivity, Spending, Money and Credit. Like gravity, economics applies to Communists, Capitalist, Fascists, and everything in between. The video is praised by the likes of Bill Gates and Paul Volker.

My take away from watching it was that global growth, due to excess capacity, lower productivity, and ageing populations, has been, and will be slow for the long term. So to avoid outright deflation, (a vicious spiral of deferred spending), and due to political gridlock, central banks have been left with the job of stimulating their economies by lowering interest rates and printing money, (Monetary Policy). There are two ways to stimulate growth;

1) Monetary policy, (reducing interest rates and outright printing money) and,

2) Fiscal policy (infrastructure spending through tax hikes or issuance of debt),

Expansionary monetary policy makes it easier to make money and or reduces the cost of debt, which is good for anyone with money/assets, (you & I), and highly indebted people and governments that risk being crippled by high-interest rates. When governments rely solely on monetary policy, as the US has for 8 years, they help the rich get richer by inflating the price of assets but do so at the risk of creating asset bubbles. The effectiveness of additional printing cycles diminishes with each iteration. Super rich people don’t spend all the money they gain from rising asset prices; buying a new fridge for a billionaire doesn’t get much of the wealth gained back into the economy. This might help explain why house prices, stock prices and bond prices are inflating so much.

So the key to fixing the economy going forward is trickier, and consequently, I expect to see future government policies based more on fiscal policy, (borrow, tax & spend). This requires a consensus at the federal Gov’t level. Fixing bridges, highways, building new water treatment plants, and giving tax breaks is a better way to redistribute the wealth, and key to keeping the money circulating in the economy at this point in the cycle. Get ready for a retirement in which the government takes more from the old/rich people and gives to the young/poor. I sense the days of Robin Hood will return. One person’s pay cheque is the source of another person’s income, (when this money is spent). We’ve seen this redistribution recently with the changes coming to the CPP; it is a necessary evil to repair a post-crisis economy.

So what’s likely to happen next?

Possible Negatives:

• Continued global government fiscal gridlock forcing the use of more monetary policy – continued asset price inflation interspersed with periods of volatility.
• The rise of protectionism – inefficient for economies, reducing the global living standard, insulating local firms from global competition, with the goal of saving local Jobs.
• The long-term dismantling of the Euro zone. Northern Europe’s constituents, like Germany, are against paying higher taxes in order to continue bailing out southern European countries’ indulgences,

Possible Positives:

• Governments overcome their impasses, and implement fiscal spending programs, slowing growing their way out of the fallout we’ve seen from the GFC, now 8 yrs and counting.
• China’s growth rate stabilizes and their economy successfully transition from an export driven economy to the world’s biggest service and consumer driven economy. (China has 300 cities with populations over a million, the US has 30, and Canada has 3)
• Long term; new technology improves our lifestyle at a constantly faster pace, (e.g., use of quantum physics to make the internet 100% secure from hackers, introduction of driver-less cars, battery/solar powered cars, falling cost of renewable resources). Here’s an article about the recent discovery of efficiently turning CO2 into ethanol, reducing global warming while increasing the supply of affordable energy. http://www.popularmechanics.com/science/green-tech/a23417/convert-co2-into-ethanol/
• Short term, global oil production caps are adhered to by OPEC and Russia, curtailing oil surpluses while global oil demand continues to rise at about 1% per year. This would underpin a rise in the price of oil, (good for Canada’s GDP).

Where is the opportunity?

• The economy is in the latter innings of the cycle highlighted by slowing growth and heightened volatility. There is opportunity from unexpected events like Brexit, which present buying opportunities for risk-sensitive fund managers. Unfortunately that particular event was short lived and didn’t depress asset prices low enough to foster a wholesale buying opportunity. It’s never been more important to be patient and invest carefully. To use a cliché: best to win by not losing.
• Strategies that incorporate downside protection at the expense of upside gains are vital in this environment; stock picking and patience will pay dividends for portfolio managers with depth of resources and scale. Global investing provides a larger investment opportunity set with potential for lower volatility and higher returns.
• The US elections will not overly impact the long-term market direction, as the check and balance system of the US places limits on presidential power; the USA is still one of the best markets in the world – in spite of which weirdo becomes President!
• From what I read, the US will increase their interest rates by ¼% per year, (very slowly) until they experience strong and sustained core inflation, (at or even above 2%), and the Bank of Canada might even lower our interest rate in the short term….So we could see the Canadian Dollar could fall to around 70 cents, and eventually climb to about $0.80, on the back of rising oil prices due to rising global demand. Here’s a good link to a recent story in the G&M about the state of global oil prices: http://www.theglobeandmail.com/globe-investor/funds-and-etfs/etfs/dont-let-the-opec-news-fool-you—tsx-oil-stocks-are-not-yet-buys/article32172213/
• Long-term: A greater percentage of retirees, (Baby Boomers), will warm up to the merits or necessities of selling their family home and renting, especially if house prices continue to sky rocket and if they still have a mortgage. The following is an article I’ve picked from a Globe and Mail article: https://www.massmutual.com/individuals/educational-articles/renting-in-retirement
• Interest rates will have a slower return to “normal” (5 years), and normal is now 2% lower than where it was 15 years ago. Neutral Interest rates will eventually be 3 % instead of 5%. Need a new mortgage? Ask me about a Manulife One Mortgage- the only mortgage that enables you to skip payments, not make any, or make huge payments, without penalties.

The two phrases, “may you living in interesting times”, and Mark Twain’s quote, “history doesn’t repeat itself, it rhymes”, best summarizes the current state of the financial world. As crazy as things are, I am forced to ask, when have they not been Crazy?

See the big picture, & don’t major in the minors,

Jay