China fights back
An unforeseen threat to escalating a trade war with China: the country owns over a trillion USD worth of Treasuries and could dump them on the open market. A couple of months ago, China hinted that it would stop purchasing Treasuries. With their record-low yields, Treasuries are becoming increasingly unattractive relative to other sovereign bonds and low-risk assets. Furthermore, there is speculation that inflation estimates in the U.S. are inaccurate, meaning the real rate of return of Treasuries might actually be negative.
These concerns have been elevated by suggestions that China is attempting to undermine the U.S. dollar’s status as the global reserve currency. Just last week, China announced it would pay for oil imports with Yuan instead of U.S. dollars, only a day after Yuan-denominated crude oil futures began trading. In this sense, China has a much more potent economic weapon to retaliate against the proposed tariffs. A modest increase in interest rates would prove disastrous for fiscal and monetary policy, particularly in light of the recent 1.3 trillion USD omnibus spending bill.
[Book Recommendation] Zero to One by Peter Thiel
A must-read for the entrepreneurially-minded. The book’s title is derived from the observation that:
it is much more difficult to create something new for the first time (0 to 1) than to scale (go from 1 to N).
Thiel offers some insightful commentary on the state of modern-day economies and common misconceptions for business owners.
With respect to monopolies, he notes:
“Non-monopolists exaggerate their distinction by defining their market as the intersection of various smaller markets […] Monopolists, by contrast, disguise their monopoly by framing their market as the union of several large markets.”
Successful companies have an incentive to portray themselves as competing on many fronts in order to avoid regulatory and public scrutiny. Microsoft makes operating systems and software, Apple makes hardware products, Google makes a search engine and Amazon is an online retail website. Yet the public still thinks these companies are embroiled in a fierce rivalry over small portions of their product portfolios. Unsuccessful companies, meanwhile, try to frame themselves as monopolies. By observing these different narratives, society has become biased towards believing competition (1 to N) is the driver of progress and not value-creating monopolies (0 to 1).
An extension: the Pareto principle
The consultants among us also know it as the 80/20 rule:
80% of the effects come from 20% of the causes
Vilfredo Pareto discovered this rule in 1896 by observing that 20% of the farmers in Italy owned about 80% of the land. This phenomenon has since been observed in other areas and is surprisingly consistent. During the course on Operations Management at Tepper School of Business, Dr Kekre covered some applications in the area of supply chain management. Here are some more examples:
- 80% of portfolio returns are attributable to 20% of assets
- 80% of sales come from 20% of products
- 80% of sales from the top 20% of products come from 4% of products (20% X 20%)
- 80% of environmental pollution is emitted by 20% of companies
- 80% of crime is committed by 20% of criminals
- 80% of all people are direct descendants of 20% of everyone who has ever existed
- 80% of light in the universe is emitted by 20% of stars
The numbers 80 and 20 are approximate. The more important takeaway is that: unequal outcomes are a state of nature. Here are a few ways in which we implicitly recognize this law:
- Historical narratives unfold from the perspective of a few individuals, not from the perspective of populations.
- People go to great lengths to research which restaurants, classes, schools, and physicians to patronize.
- Grades recognize differences in ability across individuals.
- Science, art and culture are advanced by a few luminaries; the rest are forgotten.
- Large incumbents are trusted to consistently produce staples of reliable products.
In the above examples, it is easy to accept the Pareto Principle at work. Its applicability to other outcomes is more controversial. Most Americans will take pause at whether it is fair that about 85% of the wealth is concentrated with 20% of the U.S. population (Norton and Ariely, 2011). In fact, the political rallying cry from the last election cycle was that free markets must be broken because such a wealth discrepancy exists.
The universality of the Pareto Principle seems to be called into question when measured against unequal economic outcomes. Whether the motivator is a widespread acceptance of the economic theory of perfect competition or simply political expediency, there needs to be more attention and explanation as to how, in this particular case, we are expected to go against a natural outcome. Furthermore, we should be careful to conflate such statistics with evidence of injustice.
Under the Pareto Principle, constraining the productive minority will lead to large incremental decreases in output. Ignoring this implication could lead to insufficient and inaccurate redistributive policies that may actually exacerbate the differences between the wealthy and poor. In the words of Charles Darwin:
“If the misery of the poor is caused not by the laws of our nature, but by our institutions, great is our sin”.
Do you think the Pareto Principle is a valid framework? Is it overly simplistic or are there more important considerations? Please contact us, we would love to hear your thoughts!
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