AI Managers, US vs China Analysis, and AI Art w/ Byrne Hobart

Oh, I think it's really positive. Not so much like free trade in general has been very beneficial on net. There are certainly some costs, certainly some trade-offs, certainly some things that the US in particular could have done differently, but you know, overall just from a utilitarian kind of standpoint, the specialization is helpful and it seems to be the most effective way to get countries out of poverty, etc., etc. But the main reason to be more near-term optimistic about this is that for China in particular, participating in trade as a way of legitimizing the state is a relatively new part of their political mix. And I don't know that it's one that will last forever. So, I've always been kind of paying attention to whether it seems that the CCP views political repression or making people in China richer as better avenues to stay in power. And to the extent that they do view trade as the right thing to do, that's a whole lot better than the alternative both for people in China and for people elsewhere. So it's also just kind of funny. It is kind of funny that the chairman, you know, the ruler of the longest lasting I believe communist ruled state is this global champion of capitalism who's meeting with CEOs and telling them please continue doing more business especially business with other countries. They've come a long way since Mao. So I like that. It's just one of those funny things. It's like the fact that there is an institution called the Ho Chi Minh Stock Exchange. I think it's just hysterical. I think it is this total victory for the idea of capitalism that we have these communist insurgent war heroes and we memorialize them by naming a stock exchange after them. You know, eventually and I guess you know it is a testament to just the fact that trade works. It does not necessarily have to be completely free trade but just a system where countries can import some of the things they need. They manufacture things the rest of the world wants. Everyone is able to specialize a bit and ideally a system where countries do choose to retain some control over their futures. They do choose to keep some critical industries onshore even if there's a temporary economic case for moving them offshore. Like I think that's a better world than a world where what your country produces is what your country gets and where trade is rare and is mostly high value goods consumed by elites and like that system does exist in some parts of the world. There are some poorer countries like for a lot of developing countries when they're growing and they have export-led growth. One of the complaints they get from their trading partners is that these countries are intervening to keep their currency cheap because that keeps their goods competitively priced. And sometimes they do that very directly. Sometimes historically they've had fixed exchange rates. Sometimes you have places like Taiwan where they nominally don't. But there's been some interesting forensic accounting on the financial statements of the Taiwanese central bank and the financial statements of their big life insurers that indicates that implicitly they are buying dollar denominated assets in order to keep the Taiwan dollar cheap so that their exports remain competitive. So like that's the usual thing that you see. But there's this other pattern in countries that don't develop where they actually keep their currency artificially expensive. They keep it artificially highly valued. So it means they can't export very much, but it does mean that when they're purchasing luxury goods as imports, they actually have a lot of purchasing power. So it's the case for a lot of countries that are natural resource exporters where that's their main business and where the state is kind of either the state is controlled by natural resource interests or the state is kind of exists in part to extract some of the benefits of that. Like in a case like that, you know, it's very hard to have an exchange rate that makes oil a bad product to sell if you're a country with a lot of oil. So your economic policy at that point can be okay conditional on us having a lot of oil revenue, conditional on some of that oil revenue making its way towards people who are connected to the government, how much, you know, expensive property in London can they buy and how many nice cars can they get, things like that. So yeah, you do see both of those kinds of patterns show up in terms of how countries set up their exchange rate system.

I think it's best to bet on it being temporary. I think that tariffs as they're being rolled out now are just not going to be all that effective for achieving America's economic goals, but the costs are probably going to show up sooner than the benefits. And I don't know if that just means that we will just have tariffs for a while and prices will be a bit higher. The US I think would be less affected than a lot of other places but especially because in the event that you have global economic slowdown that's partly caused by slowing trade the US consumption actually becomes a more important stabilizing force for the rest of the world and so other countries may just have to produce things and sell them to Americans and we may just end up buying them like it's a kind of messy solution there but I like that is a case where it is a worse scenario than what you get without just blanket fairly high tariffs, but maybe a better scenario than some of the counterfactuals that you could dream up. But yeah, I do think that probably there's still some element of bluffing or some element of what will retroactively be seen as bluffing in the tariffs. But it is, as we've discussed before, it's really hard to talk about bluffing and the level of bluffing as this stable quantity because literally every time you speculate that tariffs are a bluff, you are making it slightly less effective a strategy to actually do the bluff you actually do threaten tariffs as a pure bluffing mechanism. And by the same token, if people do think that, okay, Donald Trump absolutely does not want to just put a 20% tariff on every single product coming into the United States, that would be crazy. And therefore we should assume that this goes away. Well, if you do that and Trump knows he's going to be in power for a while and he also has this vision and maybe the vision is not 20% tariff specifically but it is a bit more of a protectionist vision and a bit more of a vision where other countries are doing things they're forming more of their economic policy in light of things the US tells them to do. Maybe in that scenario he says okay we are doing tariffs because people have to not think that this is a bluff. They have to not think that they can make some tiny concession and the tariffs won't be a problem.

There are probably configurations where that's true. I think the case where that has to be true is a case where the US has a lot of investment in manufacturing capacity that we could make, we don't make it because there's too much competition from foreign producers and therefore we just import the goods instead. So you could combine those. If you combine those two and suddenly a US-based manufacturer does actually have a viable business selling to Americans and maybe exporting globally, although that's going to be harder if there are retaliatory tariffs. So let's stick with okay US manufacturer does decide that they're going to build the factory because now they don't have to worry about competition from China or Germany or wherever else. So they do it and then that soaks up some surplus workers who would otherwise not be working and they do end up producing things and so on. Yeah, there's scenarios where that does work well. I think in a scenario like that, you're probably also betting on the spillover effects of if we do have more of the supply chain in the US, then US companies can iterate a little bit faster and maybe it does make sense to assemble some like there are some products where it makes sense to assemble them because more of the components are being built in the US and you can source them more quickly and you're operating under a consistent legal structure, etc. But I think in a case where that's the pitch, it's probably an even better pitch to actually choose which industries we want because there are some industries like it just doesn't make sense to pay American wages to make t-shirts. There's just not really a plausible world where we do that except a world where there's some very capital intensive way to automate almost all of it and we just for whatever reason want the t-shirt machinery all to be in the US and you know the one technician who's just looking at the machine and seeing that all the display lights are green and so the machine is working fine like yeah that is a job that we would get but that doesn't really move the needle on bringing manufacturing jobs back. It does move the needle on bringing some manufacturing capital back. But I think if you look at the space of industries where the US either could be competing more and isn't. So things like chips and a lot of the equipment that goes into chip fabs. I think that is a case where yeah the US actually is plausibly globally competitive in that space. We have been within living memory a major producer of those products. But if you have non-targeted tariffs then that doesn't really work very well. Chips are a weird case though because they do have very high incremental margins and so tariffs are just less of a consideration. It's the cases where the tariff actually exceeds the end profit margin that the supply chain expects to get. So which could be the case for some low margin products like in a case like that tariffs do have a really big impact. Everyone has to respond to them and they'll often respond to them just by raising prices because like a lot of the stuff, a lot of the imports especially from China and this is less the case every year but China does still have this huge manufacturing base and very low value added products that are just incredibly cheap and those are products where they're still just absurdly cheap even if there's a higher tariff like there's that famous chart of the century that AEI likes to put out which is just tracking cumulative inflation since 1990 in various categories. And the way they usually cast it, which is true, is that you see very high inflation in very regulated products. So, anything that touches real estate, education, healthcare, things like that, prices have been rising for a long time. Actually, a lot of those prices have leveled off since then. It's not as extreme as it used to be. And then if you look at things like toys and furnishings and electronics, then you see this rapid decline in prices. And that, you know, these are less regulated sectors, but these are also sectors where they're tradables. And that's the other thing the chart is showing is that if you have a very rich country, you should expect prices to go up disproportionately for non-tradable goods because if you're buying a haircut in America, like you can't outsource that haircut to a cheaper labor market. You can outsource the labor to someone whose labor is worth less than yours, and most of us do that, but you can't do the full outsourcing thing. Whereas, if it's, I don't know, a new action figure, like that's just going to get built in wherever the cheapest labor is. There isn't a lot of complexity to building things like that. And so, they just tend to go wherever they're cheapest. So, I think in categories like that, like there's just there isn't really a lot for anyone to do except raise their prices and accept that maybe on the margin there is a little bit less consumption in these categories. I did think about the chart of the century a while ago when I was considering what kind of allowance to give my kids and the allowance situation is just in constant flux. It is a lot like Trump's trade policy in a way and has a lot of the same political dynamics. We're always unsure about the extent to which we're making a really hasty decision or doing something as a negotiating ploy or making a deliberately bad choice entirely to preserve our ability to bluff in the future. But regardless, one of the things I thought about was the child consumption basket is very heavily weighted towards toys and electronics. And these are the things that have actually had the most deflation. So if anything, parents should actually be giving their kids like modern parents, parents my age, their kids actually have more purchasing power for a dollar than I did when I was a kid. So parental like the allowance should actually be much lower in nominal terms for modern kids than it was when I was a kid. But my kids really don't appreciate the nuances of this kind of macroeconomic argument for you know especially you know for that or for here's why the tooth fairy is not as generous as you may have heard from other sources. You know the sources could say what they want but the quarter under your pillow doesn't lie.

Parenting classes should include, you know, some basic macro to better deploy accordingly. Well, like part of what you want when you're arguing with kids, you just want the ability to deploy overwhelming argumentative force. I first read about this in the context of it was a book about Enron that was talking about Enron's COO Jeff Skilling who was kind of the architect of a lot of what Enron did including a lot of the good stuff but also a lot of the bad stuff and he came from McKinsey and someone was describing him as this prototypical McKinsey consultant where if he doesn't know the answer he's just going to recite in perfect complete paragraphs endless statistics about every little data point that implicitly supports his argument and he's hoping that if he talks fast enough, you won't be able to trace this back and say, 'Wait, those numbers, those are accurate and it's really impressive that you knew them to that many significant figures, but they don't actually have any connection to what you're telling me we should do.' Anyway, I thought of that as like actually a decent strategy for arguing with the kids is just if it sounds like you just know a whole lot more about this process and that you will just bore them to death if they want to argue about it, then sometimes they give up. That might work with adults, too. I feel like I've seen it happen.

So I would say demographics probably very slightly underrated just it is very easy to underrate how much the demographic situation in a country affects what the optimal balance sheet is for the country as a whole has channeled through households and the government to a lesser extent companies but companies don't seem to change their balance sheet policy all that much in response to demographic factors but your basic the basic way to think about it is that young people do lots of consumption when they save. They should be putting a lot of money into equities. They do end up putting a lot of money into real estate because that one step of household formation and having kids and things is often owning a house. Not required and the cultural norm for that might actually weaken over time. But it is kind of a default. But housing is this really interesting asset class where houses tend to last for a very long time and you need them when people want to have houses. And so you can't it's not really economically optimal for people to save up enough money to just buy as much house as they want. What you'd have is a lot of people living with their parents until they're like 45 and then they finally buy a house and it's perhaps a smaller house that they really want to live in. It is a better system to have people save up enough to borrow a lot of money to buy a house. And taking the other side of that borrowing, you have older savers who should not be putting most of their money into equities. They should be putting a lot of money into fixed income and because they're going to be alive for a long but uncertain period of time they tend to it tends to be best for them to have very long duration income sources. So you have this older generation that wants to buy duration and then you have this younger generation that because they're buying an asset that lasts for a very long time, they want to sell duration by borrowing for say 30 years. And so you can intermediate between those two and it works really really well if those two sides are really balanced. And then if you have a surplus of young people as in the baby boom, it often pushes interest rates up when they get old enough to actually start buying houses. That was, you know, the big headline component of 1970s inflation was the oil crisis and then all the ripple effects from the US having to rearrange a lot of industrial supply chains not to rely on oil for power. But then and also to be more careful about using oil for transportation, but then you also had a lot of baby boomer household formation. And then you also this rise in divorce which has this really interesting effect in wealthy countries where if you have two households they just have a large consumer durables purchasing footprint. So every time a couple gets divorced and they each want to maintain a kind of similar standard of living now you have two households that each need a dishwasher and a dryer and an air conditioner and all these kitchen gadgets and of course they need a car. So it does end up driving a lot of one-off spending on consumer durables and those can be very inflation sensitive because the manufacturers of those durables, they can recognize that sometimes demand is really high, sometimes demand is really low. And if you're running a manufacturing business that is selling some asset that has fairly cyclical demand, you pretty much you should be thinking to yourself that if you are never at the point where you would be selling more, but you just can't find the labor and you just can't run your factory for that long. Like if you never run to that point, you are overproducing on average. And what you want is sometimes your factory is underproducing. Sometimes you're even losing money. But then during boom times, you have some pricing power and you can produce flat out and there's just no end to how many cars and appliances people will buy. So that all of that is to set the stage for saying that when you have the opposite phenomenon. When you have an aging society, what you have is a lot of people who are looking for long-duration assets and simply can't find them. So that tends to push interest rates down. And when interest rates are down, that means that assets that have some stream of cash flows over a very long period tend to go up in value. And if you think of a house as a financial asset where it basically pays this continuous dividend in the form of your sometimes we call it owner's implicit rent or sometimes you can just think of it as the value the equivalent rental value of that house. Like that's a very long duration stream of cash flows. So its value also goes up. So you can end up in this pretty uncomfortable situation where those assets are being bid up. They're out of reach of a lot of people and it's mostly or entirely driven by demand from older savers. And just anytime you have a case like that, you have an economy that's actually kind of hard to manage. We have one example of a country that was able to get through an aging crisis in arguably pretty decent shape which is Japan where they started aging a lot earlier than many western countries and the US is still a fairly young country and is not aging as fast as many economic peers. But Japan did have a quasi like a sort of drawn out banking crisis that could have been a real crisis and that probably would have been better for them. But instead this very long period of economic stagnation in terms of total output. But if you break down the numbers and just look at real GDP per working hour, Japan and the US were actually pretty much even. There were just a lot fewer working hours both from older people retiring and then from younger people taking a while to start fully participating in the workforce. And in an environment like that, you can see this weird thing where rates are low, but now one of the things that drives housing prices is just there aren't really opportunities that push people to live in particular expensive places. And then Japan is also uniquely weird and it is not a good guidebook for any other country because Japan has this very unique property market where houses tend to depreciate a lot faster than they do in the rest of the world and they tend to just get torn down at the end of their useful life and then rebuilt. So Japan actually turns over its housing stock really really rapidly compared to the rest of the world. So Japan is this one place where housing is not this long duration. It's not nearly as much of a long-duration asset that has corresponding long-duration liabilities associated with it when people buy it. So there is not really we just don't have in modern history that I know of, we don't really have an example of a country that went through shrinking population under modern technological constraints and with a fairly modern economic system. It's just very unclear exactly how we would manage that. My guess is if I were a Chinese policy maker and I were trying to figure this out, I would be offering very large down payment subsidies to new families buying first homes and I would be trying to run a larger budget deficit to basically soak up some of this demand for excess savings. I'd probably be shutting down some banks, recapitalizing them, and just getting trying to get things to the point where if you're looking at a given bank, you assume that the bank is solvent. But this is a case where you can I think it's easy to overrate the extent to which China is actually at a risk of a real financial crisis because going back to that repression point, they don't really need to have bank runs. Like they do not need to allow people to actually line up in front of a bank and ask for their money back. And they don't need to allow a lot of other normal market behaviors that happen when you have financially dubious financial intermediaries where people stop giving them short-term wholesale funding, etc. Like China can just tell banks to keep one another alive when those banks would otherwise naturally fail and they can have a more orderly wind down at different parts of the financial sector. So they also have some room to just restructure some of the local government obligations because a lot of those are not on the balance sheet but they are pretty real obligations. And that seems like a case where China as a country issues a lot less long-term government debt than many other places of comparable size or you know they issue a lot less long-term debt than you'd expect given the size of their economy and given how interconnected it is with the rest of the world in trade terms. And one pretty good excuse to do that would be recapitalizing some of these local government financing vehicles that are just insolvent will be paying back their money and that are thus making some of the lenders to them also potentially effectively insolvent. So I do

I suspect that they will get through okay, but I think it's totally reasonable to expect something akin to the Japanese lost decade, just with Chinese characteristics.