On Target 2021.10.09

On Target
2021.10.09

Martin Spring’s private newsletter
on global strategy

In this issue:

Mounting troubles
Aggressive affirmative action
Britain’s self-inflicted energy crisis
China’s property bust
Inflation winners
China’s dangerous research
Canada
Moonshots

Investors Face a World of Mounting Troubles

There are good reasons why investors should feel nervous about the immediate future. Although the world economy as a whole has recovered to where it was before the pandemic, many parts of it have been seriously damaged. Millions of small businesses have been wiped out. While some major sectors such as airlines and tourism struggle to survive, others such as automobiles, microchips and shipping are swamped by excessive demand.

A collapse in the quality of governance raises new risks for investors. Having abandoned commonsense dealing with the superflu, governments then abandoned all restraint about creating money. There has been a massive transfer of wealth to consumers whose additional spending-power is starting to swamp supply of goods and services. Our rulers are terrified at the prospect of a consequent avalanche of inflation.

Each of the major economies face specific crises that add to the troubling global issues…

► America seeks to agree the content and scale of another round of fiscal giveaways being deployed as weapons in the rising tide of identity politics.

► Europe is engulfed by an energy crisis.

► China awakens to the dangers of living with the consequences of Covid-19 and decades of speculation in its biggest industry.

The mainstream media are strangely silent on some of the issues that embarrass the elite they support. For example, there is an intensifying global campaign against “greenhouse gases.” But in Europe there’s such a shortage of the most important, carbon dioxide — a critical ingredient for processing in the food and other industries – that factories have been forced to close. The UK has even started to subsidize production of the gas! A government minister warns that the price of carbon dioxide could rise from £200 to £1,000 a tonne.

There are high prices to be paid to worship the god of climate change. Governments are obsessed with promoting unreliable and expensive renewables while discouraging investment in fossil fuels. That’s one reason why there are now such shortages of them that their prices have rocketed.

Europe is in the grips of an energy crisis because of a shortage of natural gas. Spot prices have trebled since the start of the year – in August alone they rose by 70 per cent — and have stoked prices of electricity to record levels.

The region has become increasingly dependent on natural gas to generate electricity as a substitute for coal, and as back-up for wind and solar supplies… which can’t be relied on.

But this year Russia, Europe’s biggest supplier. has been sending less gas for reasons that are fiercely debated. It’s suspected that it is seeking to force European Union regulators to give rapid approval for operation of the just-completed Nord Stream 2 pipeline linking Russia to Germany.

Demand for gas has strengthened because of economic recovery from the pandemic, inconveniently at a time when wind generation has collapsed. Normally Britain gets a quarter of its power from wind farms.

Ironically, given that the UK has said that all the country’s coal-fired power stations must close by 2024, Britain has asked the owners of the closed West Burton coal plant to restart. National electricity supplies are so short that two major fertilizer factories face shutdown.

It’s feared that Europe could face a major energy crisis if the coming winter turns out to be a severe one.

There are also major power shortages in China. Coal, the main fuel for its electricity generation, is now scarce, expensive, and stocks are down to just 18 days’ supply. Part of the reason is government policy to discourage mining and use of coal in a race to meet emission targets before the Winter Olympics in February.

Regions accounting for 70 per cent of GNP are now rationing power to industrial users and in some cases halting their operations altogether. Large areas face power cuts for several hours each day. Dozens of plants processing soybeans, feed and vegetable oil have been suspended. The steel, cement, aluminium and chemical sectors are under restrictive orders, facing staggered production in peak hours. In Guangdong airconditioners may not be set lower than 26 degrees.

The threat of rising inflation

Both in Europe and America there are labour shortages. Chris Gray of the UK’s Manpower recruitment agency says British companies are raising wages, paying for training, relaxing job requirements, in fact almost anything “to find the arms and legs to do the job.” In the US shortage of people to work in shops and warehouses is particularly acute. Walmart has boosted the minimum hourly rate at its Sam’s Club operations from $11 to $15.

As the world economy has rebounded from the impact of the pandemic, inflation has risen faster than many central bankers expected, driven by resurgent demand, the high energy prices, labour shortages and factory shutdowns caused by the spread of Covid variants. There are delays in deliveries of goods and of materials caused by severe shortages (containers for Pacific shipping, drivers for deliveries in the UK).

There is also the collateral damage to economic growth and households’ real incomes by the massive – and foolish – transition away from cheap and reliable fossil fuels. There will have to be enormous investment in the commodities used to make batteries and wind farms, and in the generating capacity to provide the electricity needed to substitute oil, coal and natural gas, which meet 83 per cent of the world’s primary energy demand.

Chris Wood of Jefferies says that labour shortages, combined with the energy price surge, is making an inflation scare seem inevitable. This should “be negative for high-multiple growth stocks, particularly in the American market,” where stocks trade on multiples of around three times sales.

How should you react to the evolving bad news? Ambrose Evans-Pritchard, financial editor of The Telegraph, says that “as a personal precaution I have liquidated most of my modest salaryman’s portfolio and intend to ride out the early autumn with 80 per cent in cash until risk and reward come back into plausible alignment.”

I think that’s an extremist point of view, but I certainly think that share markets are in a period of weakness that could take prices generally much lower. Eoin Treacy advises in FullerTreacyMoney that investors should rotate away from growth stocks into more of a value/emerging-market/commodities weighting.

Aggressive Affirmative Action: It’s ‘Poison’

American politics have increasingly become dominated by the concept of systematic racism. Blacks blame it on their inferior quality of life. The white elite, privileged to enjoy the highest quality of life on earth, are burdened with guilt. The white masses increasingly resent being accused of that guilt and being forced to pay for it.

Charles Murray, the well-known and highly controversial political scientist, has written a new book, Facing Reality: Two Truths About Race in America, arguing that systematic racism ignores facts that make America “more complicated” and “much less racist” than its radical critics describe.

The four main racial groups have different means and distributions of cognitive ability and different rates of violent crime. These drive the problems in policing, education and the workplace that are ascribed to racism.

The estimated IQs for Americans of European stock are 103, for Blacks 91, for Latinos 94 and for Asians 108. These ratios have consequences for society as a whole as they determine the proportions who rise to the heights of success and benefit most from its quality of life – and the proportions who are doing worst.

Detailed studies of 13 cities showed that Blacks were 21 times more likely than Whites to be arrested for murder. In New York police figures showed that 89 per cent of Black murder victims were killed by Blacks. There is strong evidence that arrest warrants are not biased against Blacks.

What about police brutality? “Police use of force… will always and then inevitably be higher in high-crime areas.” Those are overwhelmingly urban and Black or Latino. Videos show police mistreating people go viral and are seen by millions, but they don’t see video from police body cameras “showing the thousands of daily instances when police continue to be polite in the face of obscenities screamed at them, expose themselves to risk rather than overreact to a threat, or make extraordinary efforts to help someone who is injured or in danger.”

Murray says: “Outside big-city America, White America has become landslide-red Republican.” Much of the changing political landscape has had nothing to do with race relations but with alienation of middle-class and working-class Whites from coastal elites.

Tens of millions of them live in towns with few minority residents. Many millions are in big cities – but they live comfortably with Blacks and Latinos. They treat them with friendship and respect. They don’t behave as racists. And they don’t see themselves as beneficiaries of White privilege.

Whites have started adopting Blacks’ identity politics

Black opinion leaders representing 13 per cent of the population tell the Whites who are 60 per cent of the population that they are the cause of Blacks’ problems and better change… or else. “That’s guaranteed to produce backlash.” A growing number of Whites are disposed to adopt the same identity policies.

A big danger for society is that the political class has alienated most of the public. In 1958 73 per cent of Americans trusted the federal government to do right all or most of the time. Since then it’s plunged to the 15-20 per cent range. A government that is mistrusted by more than 80 per cent of its citizens has a “legitimacy problem.”

Working-class and middle-class Whites who now see themselves as second-class citizens are told by government officials, college administrators and corporate human resources managers to get in line behind minority applicants for admission to elite colleges, and for employment and promotion in attractive white-collar jobs. Well-to-do Whites can find ways to circumvent these problems, but working-class and middle-class Whites cannot. “Aggressive affirmative action is a poison leaking into the American experiment.

“It also has a side-effect that I have never seen heard or discussed in public… Aggressive affirmative action is practised most sweepingly for government jobs at all levels. At the city level it affects the selection and promotion of police, prosecutors, public defenders, correctional officers, personnel in the social welfare bureaucracies, healthcare workers on the public payroll and K-12 teachers in the public schools,”

The presence of incompetent or marginally competent people in those jobs is only occasionally important to the upper middle-class; many live in places where affirmative action is not an issue because so few of the minorities live in their communities. But for those who live in multiracial cities, incompetent police and prosecutors can be a problem. Incompetent teachers have driven many of them away from the public schools.

The burden of the sub-standard government services produced by aggressive affirmative action is borne overwhelmingly by America’s poorest and most vulnerable populations.

Murray’s solution: “Eliminate all forms of government-sponsored preferential treatment by race.”

That doesn’t look realistic. But without it America seems to be heading into worse and increasingly nasty identity politics.

Britain’s Self-inflicted Energy Crisis

By Matt Ridley

Matt Ridley is a British journalist and author who writes on science, environment and economics. He is a peer who sits in the House of Lords.

One could call Britain’s current energy crisis a perfect storm. Wind farms stand idle for days on end, a fire interrupts a vital cable from France, a combination of post-Covid economic recovery and Russia tightening supply means the natural gas price has shot through the roof. And so the market price of both home heating and electricity is rocketing.

The root of the crisis lies in the monomaniacal way in which this government and its recent predecessors have pursued decarbonization at the expense of other priorities including reliability and affordability of energy.

It is almost tragi-comic that this crisis is happening while prime minister Boris Johnson has been in New York, futilely trying to persuade an incredulous world to join us in committing eco self-harm by adopting a rigid policy of net zero carbon emissions by 2050. That’s a target that is almost certainly not achievable without deeply hurting the British economy and the lives of ordinary people, and which will only make the slightest difference to the climate anyway, given that the UK produces a meagre 1 per cent of global emissions.

Yet this crisis is a mere harbinger of the candle-lit future that awaits us if we do not change course.

It comes upon us when we have barely started ripping out gas boilers to make way for the expensive and inefficient heat pumps the government is telling Brits to buy. Or building the costly new power stations that will be needed to charge electric cars.

When David Cameron’s energy bill was being discussed in Parliament in 2013, everybody already knew that renewables were unreliable; that wind power fully works less than one-third of the time; and that solar power is unavailable at night (of course) and less efficient on cloudy winter days.

Yet whenever we troublemakers raised this issue, we were told not to worry – it would resolve itself, they said, either because wind is usually blowing somewhere, or through the development of electricity storage in giant battery farms.

This was plain wrong. The task of balancing the grid and maintaining electrical frequency has grown dangerously the more reliant on wind power we have become – as demonstrated by the widespread power cuts of August 2019. The cost of grid management has soared to nearly £2 billion a year in the last two decades.

The grid needs vast extra investment to transfer wind power from northern Scotland to southern England. One of the cables built at huge expense to do just that has failed multiple times and Scottish wind farms are frequently paid extra to switch off because there’s not enough capacity in the cables.

As for batteries, it would take billions of pounds to build ones that could keep the lights on for a few hours, let alone a week.

So the only way to make renewables reliable is to back them up, expensively, with some other power source, responding to fluctuations in demand and supply.

Nuclear is no good at that: its operations are slow to start and stop. So, ironically, renewables have only hastened the decline of nuclear power, their even lower-carbon rival (remember it takes 150 tonnes of coal to make a wind turbine). And in any case, an inflexible approach to regulation has caused the cost of new nuclear to balloon – despite its being perhaps the most obvious solution to our long-term energy needs.

Coal – the cheapest option and the only energy source with low-cost storage in the shape of a big heap of the stuff – was ruled out as too carbon-rich, even though countries such as China are currently building scores of new coal-fired plants.

Unlike those countries, the UK government has rushed to close its remaining coal power stations – and banned the opening of a opencast coalmine at Highthorn on the Northumberland coast last year. Ministers decided they would rather throw hundreds of Northern workers out of a job, turn down hundreds of millions of pounds of investment, and rely instead – for the five million tonnes of coal per year gap that we still need for industry – on energy imports from those famously reliable partners, Russia and Venezuela.

Natural gas makes more sense than burning wood

To add insult to injury, the government has been handing out hefty subsidies to a coal-fired power station in Yorkshire, Drax, to burn wood instead of coal, imported from American forests, even though burning wood generates more emissions than coal per unit of electricity generated.

That leaves gas with the task of keeping the lights on. Gas turbines are fairly flexible to switch on and off as wind varies; they’re relatively cheap, highly efficient, and much lower in emissions than wood, coal or oil.

Until 2009 the conventional wisdom was that gas was going to run out soon. Then came the shale gas revolution, pioneered in Texas. Britain – whose North Sea gas was running out – watched on in snobbish disdain as America became the world’s largest gas producer, with their gas prices one-quarter of ours, resulting in a gold-rush of industry and collapsing emissions as a result of a vast, home-grown supply of reliable, low-carbon energy.

We, meanwhile, decided to kowtow to organizations like Friends of the Earth, with its misleading claims about the extraction of shale gas. Nobody was more delighted than Vladimir Putin, who poured scorn on shale gas in interviews, and poured money into Western environmentalists’ campaigns against it to maintain Europe’s dependence on imported Russian gas.

By 2019 shale gas exploration in Britain was effectively dead, despite one of the biggest discoveries of gas-rich rocks yet found: the Bowland shale, a mile beneath Lancashire and Yorkshire.

Just imagine if we had stood up to the eco-bullies over shale gas. Northern England would now be as brimming with home-grown gas as are parts of Pennsylvania and Texas. We would have lower energy prices than Europe, not higher, a rush of manufacturing jobs in areas such as Teesside and Cheshire, rocketing wealth, healthy export earnings, no reliance on Russian whims (they control the reliability of supply and the price we pay for imported electricity, as we are experiencing right now) – and no fear of the lights going out.

Russia is delighted by Britain’s energy policies

In lieu of that, we could at least invest in gas-storage facilities, to cushion against the Moscow threat and any potential disruptions to supply. But no, we chose to close the biggest of them, Rough, off East Yorkshire, in 2017, and run down our gas storage to just under 2 per cent of annual demand, far lower than Germany, Italy, France and the Netherlands.

Why? Presumably because the only forms of energy that ministers and civil servants respect are wind and solar.

British consumers’ bills are loaded with ‘green levies’ that in part go to reward the crony capitalists who operate wind farms to the tune of around £10 billion a year and rising.

Because energy is a bigger part of the household budget of poorer people than richer people, this is a regressive tax. Because of the price cap on domestic bills, these levies hit industrial users even harder than domestic, and thus put up the prices of products in shops and deter investment in jobs too.

In the past, coal gave Britain an affordable supply of electricity that was also reliable so long as the miners’ union allowed it to be. The market mechanisms introduced by Nigel Lawson in the 1980s gave us greater efficiency, the dash for gas, cheaper electricity, a highly reliable supply and falling emissions.

The central planning of the 2010s has instead given us among the most expensive energy on the planet, futile price caps, bankrupt energy suppliers, import dependence, rising worries about the reliability of supply and – because of the fading influence of nuclear power – not much prospect of further falls in emissions.

So, it’s time to tear up the failed policies of today. What would I do? Take a leaf out of Canada’s book and reform the regulation of nuclear power so that it favours newer, cheaper and even safer designs built in modular form on production lines rather than the huge behemoths built like Egyptian pyramids by Chinese investors.

Look to America’s example and restart the shale gas industry fast. Call the bluff of the inefficient wind and solar industries by ceasing to subsidize them.

Energy is not just another product: it’s what makes civilisation possible.

China’s Property Crisis

Attention is understandably focused on what’s going to happen to China’s Evergrande, the world’s biggest real-estate developer, which is struggling to meet its commitments on $309 billion of debts. Its evolving crisis is part of a much bigger one enveloping the country’s property and construction industry, which accounts for 29 per cent of GDP and four-fifths of personal wealth. Sales of land for property developments are the source of 40 per cent of local government revenues. But by August land sales were down 64 per cent on last year’s.

It’s a crisis that has been brought about deliberately by government policy. Last year President Xi Jing-Ping decided to address serious imbalances in the economy, in particular the unhealthy focus on property speculation. He introduced a policy of “three red lines” putting the squeeze on property developers – a cap of 70 per cent on ratio of liabilities to assets, a 100 per cent cap on net debt to equity, and enough cash to cover short-term debt.

Companies that failed the tests lost access to banks’ credit, short-circuiting the traditional system of funding through pre-selling properties long before they were bought. The crisis gathered momentum and now seems to have come to a head. Sales of residential developments have evaporated.

For many years investors have been confident that the government would never let important companies go bust. That’s no longer true. But Evergrande is a key test. It’s so big, so important, it embraces millions of families.

It’s almost certainly not going to be allowed to collapse, but we can expect it to undergo radical remodelling, with creditors – particularly foreign ones – seeing many billions of their assets wiped out.

The squeeze has already gone far beyond Evergrande, engulfing other major developers such as Vanke, Country Garden, Sunac and Kaisa. Pain… a lot of it… is exactly what Xi wants to see, to punish speculation and divert resources into the high-technology industries such as microchips, electric cars, robots and weaponry.

Families who pre-bought homes are likely largely to be protected by the government in the name of “social stability,” but Chinese investors who sank money in dubious “wealth management” products will suffer haircuts. Bondholders on the $220 billion offshore dollar market can kiss goodbye to most of their capital. As can most shareholders. Evergrande’s market capitalization has plunged from $41 billion a year ago to less than $4 billion.

But the authorities can be expected to instruct state banks to keep lending developers enough to stay afloat.

A crisis deliberately created by government may prove nastier than its initiators intended, but they have the resources to manage it and achieve the reforms they envisaged.

However, the glory days for property are over. The workforce is shrinking by three million a year, marriages have fallen by a third in seven years, household formation has slowed, and rural migration has all but ended. Buyers will be progressively scarcer.

Tailpieces

Winners: Inflation favours real assets. Investment management company BlackRock reports that globally the total returns of privately-held property and infrastructure assets have beaten those of main equity and bond indices whenever annual inflation has exceeded 2½ per cent.

However The Economist warns that several factors have made performance difficult to predict. Think of retail space and office blocks under threat from e-commerce and remote work; airports and power plants exposed to decarbonization; farmland vulnerable to climate change.

Another problem is that real assets are hard to access: they are typically private. Only the most sophisticated investors have the resources and patience to find gems on their own. The rest may gain exposure in public markets through real estate investment trusts, infrastructure stocks or exchange-traded funds. But these tend to be closely correlated with equities, defeating the point of investing in them to achieve diversity.

To protect capital, investors must seek assets that don’t just tread water but gain value more quickly during inflationary bursts than other holdings depreciate. There is not a lot of consensus over which ones fit the bill: gold, commodities, inflation-linked bonds, derivatives – each has champions and detractors.

Internet service: It’s so poor in Germany that delivery by horseback is faster.

A photographer in Schmallenberg-Oberkirchen proved it by experiment. He sent a 4.5 gigabyte data file via the Internet to a printer 10 kilometres away, but simultaneously had a friend on horseback deliver a DVD with the images. The horse arrived first.

MishTalk reports that Germany, which is way behind with digitalization, has a history of underestimating the implications of several important technologies, such as the electric car and the mobile phone. Most households are connected to the Internet through copper cables. Only 1.4 million use fibre optic cables compared to 5 million in the UK.

Covid: Agencies allied to Big Pharma such as the CDC and the World Health Organization go to extremes to discourage use of two long-established drugs that are so safe that they’re available over-the-counter in most countries – Ivermectin and Hydroxychloroquin. But fortunately the campaign to keep people ignorant of them is crumbling. In Japan the Tokyo Medical Association has authorized doctors to use Ivermectin to combat Covid-19. In India it’s been used widely to stop the disease in its tracks. In Europe the ministry of health in Slovakia has now registered the drug as an approved prophylaxis and treatment for Covid-19.

Hydrogen: There’s much publicity about its potential as an alternative to oil or batteries, but it’s misleading. Nearly all hydrogen is fossil fuel. Half comes from methane, which comes from natural gas; nearly all the rest comes from gasification of coal and oil. Only 4 per cent of world production is produced by electrolysis of water. That can be called green hydrogen, but only if the electricity used to manufacture it is itself generated by renewables.

For the moment the version that is “green” costs several times as much as hydrogen sourced from natural gas, oil or coal.

Sport: They’re calling it “the Emma Raducanu effect” – the impact made by the British teenager with her surprise emergence to top-ranking tennis in winning the US Open championship. Wimbledon’s All England club has sold 1,250 debentures for No.1 Court at its annual Grand Slam tournament for £46,000 apiece. They guarantee the best seats for five years at Wimbledon’s second most prestigious court. Debentures for its most prestigious, the Centre Court, sold for £80,000 in 2019.

Labour: For the third month in a row pay for low-skilled workers in the US has risen more than for the high-skilled. That’s never happened before in the past quarter-century. However, it’s almost certainly a temporary phenomenon. The long-term trend in advanced economies has been to shift jobs to the Third World and replace low-skilled workers with robots.

Migration: Arrests of illegals at the US’s southern border are now running at more than 200,000 a month and are on track to set a new yearly record. Apprehensions jumped after President Joe Biden took office and dramatically changed the immigration enforcement system, altering or outright stopping key tenets of the former administration’s policies.

Energy prices: They’re going up sharply everywhere, not only in Europe and not only in natural gas. The Brent price of crude oil by mid-September was up by 46 per cent, in China coal is up 61 per cent, uranium has risen by 60 per cent since mid-August.

Inflation: The OECD forecasts that the average rate for the world’s 20 leading economies will hit 4½ per cent in the current quarter, driven by supply-side shortages and higher wages.