Monthly Archives: June 2017

Size of Government vs. Growth

Charles Gave recently published a post showing a simple but important fact:  economic growth is inversely proportional to the size of the government.  This is shown in developed economies over varying conditions.  Published on John Mauldin’s website:

In the US, a similarly straight forward picture emerges, with the big increase in government spending that took place after 2009 being the main cause of the subsequent decline in the US’s structural growth rate.

By way of contrast, consider the reverse case of Canada, which in the mid-1990s slashed government spending to good effect. In two years Canadian government spending was cut from 31% of GDP to about 25%. The ensuing 18 months saw predictable howls of protest from economists that a depression must follow. In fact, not only was a recession avoided but Canada’s structural growth rate quickly picked up and in the next two decades a record uninterrupted economic expansion was achieved.

As an aside, I would ask readers to cite one case in the post-1971 fiat money era when a big rise in government spending did not lead to a structural slowdown. Alternatively, if they could cite an episode when cuts to public spending resulted in the growth rate falling. I am always willing to learn and change my mind!

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Vertical Farming

This is really cool, and great news in a lot of ways.  From impactalpha.com:

Bowery Farming raises $20 million for vertical farm expansion. Indoor farming is still small but investors think it’s poised for growth with rising global food need and the environmental strain of traditional agriculture. Bowery Farming, based in Kearny, N.J., calls itself a tech venture focused on the future of food and claims its approach grows 100 times more produce than a similarly-sized outdoor farm. It has raised $27.5 million to date for its approach to growing greens indoors. The process uses LED lighting, robotics and specially-developed software. The latest funding round was backed by Google’s venture fund, GV; General Catalyst; and GGV Capital—a venture capital firm focused on the U.S. and China. Vertical farming “is no longer just a pie-in-the-sky theory,” says GGV’s Hans Tung. “It has the chance to scale in the next five years.” Earlier this month, AeroFarms, another New Jersey indoor farming operation, raised $34 million from Emirati investors interested in bringing the technology to the desert-covered Gulf region.

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More about ETF liquidity and the underlying assets’ liquidity

Sorry for the ridiculous title.  Not clickbait.

Noah, from Noahpinion, posted at Bloomberg, which was reposted at wealthmanagement.com:

It’s Smart to Worry About the Risks ETFs Pose

Remember how mortgage-backed securities turned out?
Now *that’s* a clickbait title.
The article is actually a lot more interesting than the title implies.

My own biggest worry about ETFs revolves around liquidity.

There is no single unified definition of liquidity. In general it means the ease with which you can trade an asset, but that depends on conditions in the market — mortgage-backed securities were plenty liquid before the crisis struck, but became incredibly illiquid once people started doubting the quality of their ingredients.

ETFs look very liquid, because as the name implies, you can trade them on exchanges. Take a thousand hard-to-trade bonds and pile them into an ETF, and you suddenly have one bond fund that the lowliest retail investor can buy and sell at will.

But what happens in a crisis? Suppose some bonds turn out to be a lot lower-quality than most investors believed. Without ETFs, those bonds would plunge in price, but other bonds would be fine. But now imagine that both the bad bonds and the good bonds are all bundled into ETFs. Now, when the bad bonds are discovered to be bad, investors who ignored the composition of their funds will suddenly wake up to the fact that they might contain toxic assets. Liquidity in the ETF market might suddenly dry up, as everyone tries to figure out which ETFs have lots of junk and which ones don’t.

With assets like stocks, this isn’t so much of a danger — when stocks go bust, everyone can see which ones are bad. But when the ingredients in an ETF are complex, highly heterogeneous assets, as is the case with many bonds and derivatives, one ETF might be fine while another is worthless, and yet investors may ignore the differences until it’s too late.

Another possibility, pointed out to me by a friend in asset management, is that some of the individual securities in an ETF might start to have their own liquidity problems. If banks or other big broker-dealers suddenly become unwilling to facilitate the trading of certain kinds of bonds, ETFs that include large amounts of those particular bonds might suddenly plunge in price. Investors now buying up ETF shares might not realize that danger, thus leading to general overpricing.

So the more bespoke and exotic markets ETFs expand into, the greater the worry that they could be involved in a 2008-style liquidity crunch. That could pose risks for key financial institutions that hold ETFs, and it could also spell danger for individual investors’ retirement savings.

A few people are already worrying about this possibility, which is good. The more we worry about financial innovations in advance, the less chance we’ll need a crisis to teach us the limits of those innovations.

This is sort of the flip side of my earlier post regarding bond mutual funds vs. ETFs.  My assumption is that traders will quickly price in the illiquidity of the underlying assets.  His assumption is that they will not, or may not.  I think if you are investing in funds of illiquid assets, though, you are still better off in an ETF than a mutual fund if you are a buy and hold investor.  This article gives you even more reason to hold a mutual fund if you plan to sell into a downturn.

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