We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 07 January 2024:

1. What the Solow Model can teach us about China – Noah Smith

The question of why economies grow, and why they stop growing, is perhaps the most important in all of economics. It’s also an incredibly difficult question, both because growth is such a complicated thing, and because it’s very hard to compare different countries’ experiences. The Solow model is an incredibly simple thing — so simple that a bright junior high school student can learn it. It has only a few variables and a few parameters. There’s no possible way that such a simple model can tell us most of what we need to know about how and why economies grow.

And yet the amazing thing about the Solow model is that it does tell us a few incredibly important things about growth…

…The Solow model assumes that economic output — also called “production” or “GDP” — comes from three things:

1. Labor (human work effort)
2. Physical capital (machines, buildings, vehicles, etc.)
3. A mysterious quantity called “total factor productivity” (TFP), usually abbreviated as “A”, which some people associate with technology

The Solow model deals mostly with the question of how physical capital affects growth. Physical capital is everything you can build that helps you build other stuff or create economic value. It includes machine tools, factories, office buildings, delivery vans, highways, port infrastructure, trains, and so on. In my mind, the easiest type of physical capital to imagine is a machine tool — a sewing machine, or a drill press, or a lathe, or a nanolithography machine. So I’ll usually use machine tools as my examples of physical capital…

…Solow’s model makes three very reasonable assumptions about how physical capital works. It assumes:

1. You can build more physical capital by saving and investing.
2. Physical capital depreciates over time (at a constant rate).
3. On its own, physical capital has diminishing returns.

The first of these assumptions is actually the most subtle. The basic intuition is that you can set aside a certain amount of your GDP every year to build physical capital — like a farmer choosing to reserve a certain percentage of the annual corn harvest as seed corn for planting next year’s crop. But most real types of physical capital don’t work like seed corn — a sewing machine can’t be used to create new sewing machines, etc. So what Solow is actually assuming is that we set aside a certain percent of our financial income and use it to pay people to build more capital. It basically assumes a market where sewing machines, and any kind of capital, can be constructed for a price.

The second and third assumptions are pretty straightforward. If you’ve ever owned a car or a house, you know that it needs regular maintenance, upkeep, and renovation over time. If you have an economy with a lot of capital, some portion of it wears out every year and has to be replaced. (In the Solow model, the portion that wears out every year is just some constant percentage — 5% or 7% or whatever.) Replacing or maintaining your old worn-out capital costs money.

Finally, on its own, capital has diminishing returns. That means if you hold the number of people constant, eventually building more machines and buildings and such won’t help you produce more. To see why, just imagine one person trying to operate 100 sewing machines at once. They definitely wouldn’t produce 100 times as much as one person operating one sewing machine!…

…So what does this tell us about how economies grow? It tells us one incredibly important thing. It tells us that because of depreciation and diminishing returns, a country simply can’t build its way to infinitely high standards of living. If you just keep trying to build more and more, at some point depreciation overwhelms you. and you just can’t build any more!

Let’s think about that in the context of China. Over the last four decades, China has built an absolutely incredible amount of physical capital — in absolute terms, the most any country has ever built in history. Think about the vast, sprawling factories filled with robots and machines, the forests of skyscrapers and apartment buildings, the rivers of highways and high speed rail, the fleets of cars and trucks and buses and ships and planes.

The Solow model gives a simple explanation for how China was able to build this much, this fast: It had a very high rate of savings and investment, far higher even than other Asian countries.

China dedicated everything it had to building massive amounts of physical capital, leaving relatively little of its economic output left over for its people’s consumption. As a result, it grew very very quickly.

But the Solow model says that this type of growth has a limit. Just as the model would predict, China started hitting diminishing returns. We started seeing “ghost cities” and massive overcapacity in all sorts of industrial sectors. China’s incremental capital-output ratio — the dollars of capital needed in order to generate an additional dollar of GDP — rose relentlessly from around 2007…

…And just as the Solow model foretold, China’s growth is slowing:

Slowing growth from physical capital accumulation is the Solow model’s first big insight. The second is that it’s actually possible for a country to save and invest so much of its income, and build so much physical capital, that it actually makes its citizens poorer.

The reason is, again, depreciation. If you save and invest a huge fraction of your income — as China has done — you will build an enormous amount of physical capital. But the more you build, the more you have to pay to upkeep in the future. There’s a point called the “golden rule”, above which saving and investing more of your national income just forces your citizens to forego more and more consumption in order to stave off capital depreciation.

Does China save and invest more than Solow’s “golden rule” would suggest? It’s hard to tell. But if any country is above the healthy limit, it’s China. Note that in the Solow model, the optimal savings rate is lower if population growth is lower; China’s population is now shrinking, and its working-age population is falling rapidly. So the Solow model serves as a warning to China’s leaders that they should consider encouraging their people to consume more…

..Of course, there is a vast amount that the Solow model can’t tell us about economic growth. Most of those unanswered questions are contained in that innocuous little letter “A”; as one of Solow’s contemporaries put it, total factor productivity is a measure of our ignorance. One factor exacerbating China’s growth slowdown is that TFP growth has slowed relentlessly over the last three decades:

2. China’s Japanification – Robin Wigglesworth

The biggest question in global macroeconomics at the moment is whether China is on the cusp of a “balance sheet recession”. This sexy bit of economic jargon was first coined by Nomura’s Richard Koo to describe Japan’s lost decade(s), but is most commonly known as “Japanification”.

It can be described simply as a protracted period of deflation, economic sluggishness, property market declines and financial stress as households/companies/governments unsuccessfully try to deleverage after a debt binge…

…JPMorgan doesn’t explore cinematic history in its report but notes that there are a few eerie other similarities between China’s current predicament and Japan’s in the early 90s.

First is similarity in housing market development. As we have argued, China’s housing market correction since 2021 is not only cyclical (or policy-induced), it is also structural reflecting major changes in demand vs. supply in the housing market. This is similar to Japan’s housing market correction in the 1990s.

Second is similarity in financial imbalance, i.e. the pace of increase and level of debt problem. According to the BIS, China’s total non-financial credit/GDP ratio approached 297% of GDP by end-2022, similar to Japan in the 1990s. Also similarly, debt is mainly domestic and domestic saving rate is high in both countries.

The problem of population aging is also similar. The share of aged population (65 and above) was 12.7% in 1991 in Japan, similar to China in 2019 (12.6%).

On the external front, Japan’s large trade surplus vs. the US led to trade conflict, as exemplified in the Plaza Accord in 1985 (5-6 years before the start of Japan’s lost decade) and US-China tariff war that started in 2018. From a broader perspective, the rise of Japan (30 years ago) and China (right now) to challenge the status of the US as the largest economy in the world is quite similar, leading to the fight-back from the US that initially focuses on reducing the bilateral trade imbalance…

…Let’s look at what JPMorgan thinks are the “good” differences, before turning to the ugly. First of them (and JPMorgan reckons perhaps the most important difference) is a much lower urbanisation ratio in China.

China’s urbanization ratio was 65% in 2022, and if excluding migrant workers who live in urban areas but do not have the same privileges as urban citizens, the hukou ratio was only 47%. In Japan, urbanization ratio exceeded 77% in 1988. Lower urbanization ratio points at larger potential for productivity increase associated with labor migration from agricultural to non-agricultural sectors…

…Second, China has a much larger domestic market, a larger pool of STEM graduates and comprehensive manufacturing sectors. While China may be facing a more challenging external environment than Japan in the 1990s, there is also hope that China can achieve technology upgrade and commercialization in some areas…

…Third, perhaps somewhat debatably, we think China’s housing price overvaluation is less severe than Japan in the 1990s. This is in part due to prolonged administrative control on new home prices and in part due to solid income growth. Our estimates show that housing affordability has continued to be a big problem in tier-1 cities: it took 21.1 years of household income to buy a 90-sqm apartment in 2010, and 16.6 years of household income in 2022. By contrast, housing affordability is much better in tier-2 and tier-3 cities that account for the majority of China’s housing market. Using the same house price/income measure, the ratio fell from 13.4 in 2010 to 8.3 in 2022 in tier-2 cities, and from 10.2 in 2010 to 6.1 in 2022 in tier-3 cities.

Fourth, China’s capital account is not fully liberalized. This will reduce the risk of fire sale of domestic assets (mainly housing) to invest overseas…

…Lastly, the Chinese government has stronger control of both asset and liability sides of the debt problem. This could be a double-edge sword: it implies that the probability of a sudden-stop debt crisis is smaller in China, but the zombie parts of the economy will continue to stay and likely further expand, intensifying the moral hazard problem and weakening incentives for structural reforms. This may crowd out more productive activities in the economy and lead to faster-than-expected slowdown in economic growth…

…JPMorgan’s main concern is that China is actually ageing more rapidly than Japan was, which has led to predictions that it will ‘grow old before it grows rich(opens a new window)’ — a kind of demographics-caused middle-income trap.

In Japan’s case, the share of population aged 65 and above exceeded 10% in 1983, and exceeded 14% in 1994. The birth rate fell from 12.7 (per 1000 people) to 10.0 during that period. In China’s case, it took only 7 years (from 2014 to 2021) for the 65 plus population to increase from 10% to 14% of total population, and the birth rate has fallen faster from 13.8 (per 1000 people) to 7.5 during that period (and further down to 6.77 in 2022, similar to Japan in 2020 at 6.80). In addition, China’s total population started to decline in 2022, while Japan’s total population started to decline in 2008, nearly two decades after the start of the lost decade.

Second, China’s GDP per capita was around US$12,800 in 2022, much lower than Japan in 1991 at US$29,470. While lower GDP per capita may imply higher growth potential, it suggests that China is becoming old and high-indebted before it becomes rich…

…JPMorgan’s economists also point out that the global economic backdrop is worse for China than it was for Japan in the 1990s, and thinks the Chinese government has less scope for stimulative fiscal measures than is commonly assumed:…

…In recent years, technology decoupling from the US has replaced the tariff war to become the major challenge for China. Beyond the bilateral relationship with the US, the globalization process has slowed down notably after 2008 (when the share of global trade as % of global GDP peaked), in sharp contrast to the golden days of globalization in the 1990s. The Russia-Ukraine war in 2022 further accelerated global supply chain relocation, which weighs on China’s potential growth.

Moreover, the room of macro policy stimulus is more limited in China nowadays than Japan in early 1990s. On the fiscal side, government debt was 61.9% of GDP in Japan in 1991, the start of the housing bust. Government debt rose to 131% of GDP by 2000 in Japan. In China’s case, although central government debt was only 20% of GDP, if adding local government debt and LGFV debt, total public debt reached 95% of GDP by end-2022…

…JPMorgan warns that “the room for fiscal stimulus for China in the next 10 years is much smaller than Japan in the 1990s”. Nor do its economists think that China has any more scope to combat the economic miasma with monetary policy.

Similarly, on the monetary policy front, the BOJ’s policy rate was 8.1% in January 1991. The BOJ moved quickly after the housing bubble burst: by end-1993, the policy rate was cut to 2.4%; and in 1999, the BOJ became the first central bank to adopt zero interest rate policy. By comparison, China’s policy rate (7-day reverse repo rate) is already as low as 1.9%. The room for policy rate cuts for the PBOC, if deemed necessary, is much smaller than the BOJ in early 1990s…

…So why then does JPMorgan think that China isn’t about to suffer a Japan-style long-term balance sheet recession? It boils to the differences between “ordinary” economic downturns and Koo’s diagnosis of Japan’s pretty unique travails.

When asset prices fall, firms face binding borrowing constraints with balance sheet deteriorating, forced asset sales can further push asset prices lower and form a self-reinforcing downward spiral between asset prices and economic activities. In other words, asset price decline is critical in understanding the phenomenon of balance sheet recession.

Following this argument, balance sheet recession is not a reality yet in China. The Chinese government has adopted the strategy of protecting house prices but letting volumes correct dramatically. This is in sharp contrast to the Japan’s episode, when prices and volume fell simultaneously. As a consequence, the macro cost (sharp decline in volume activity and slower real estate investment) is larger in China, but the benefit is that financial risk associated with asset price decline has stayed under control.

Also Japan’s balance sheet recession manifested itself in a huge deleveraging by households and companies, but a massive increase in the government’s debt burden.

Corporate debt fell from the peak of 144.9 per cent of Japan’s GDP in 1993 to 99.4 per cent in 2004, and household fell from 71 per cent in 1999 to 60 per cent in 2007, even as government debt ballooned, pushing the overall burden for the economy as a whole higher.

In contrast, China’s debts have been building up across the board with hardly any interruptions since 2008, and this is likely to continue, according to JPMorgan…

…But the fact that Chinese debts have continued to rise and are likely to do so for the next few years — and that the property market hasn’t imploded yet — is not really an argument against China’s Japanification. Indeed, it might only indicate that a full-scale version just hasn’t started yet…

…But there are enough broad similarities to think that the overall disease — a protracted period of declining demographics, economic sluggishness, deleveraging and deflationary pressures that defies fitful government efforts to dispel the miasma — might end up being pretty similar.

3. 36 quick thoughts to end 2023 – Thomas Chua

#3 There’s zero benefit in dwelling on how luck shapes a person’s success. Instead, focus on controllable factors that can increase the probability of your success.

#4 As we progress in life, how we perceive wealth changes based on who we compare ourselves to. Define your ‘enough’ to avoid living your life solely pursuing wealth.

#5 If you don’t eat food that nourishes your body, sooner or later you’ll have to eat your medicine as food.

#6 Fast growth and quick wins are sexy in business and investing. Sustainable growth and compounding, however, are key to long-term outperformance…

#7 Just as food affects your body, the information you consume shapes your thoughts…

…#19 If you pursue any endeavors with half heartedness, your mind will become like a magnet for fear and doubts.  When you encounter difficulties, you’ll come up with various reasons to tell yourself why you shouldn’t do it.

#20 The fastest way to end your life is to retire and do nothing.

#21 The biggest wall separating high achievers from the rest is excuses.

#22 Knowledge isn’t power. It’s a potential power. Only when knowledge is applied, it becomes power…

…#24 For a list of book recommendations, check out the bibliography section of books written by your favorite authors.

#25 You seldom regret what you did. You often regret what you didn’t do.

#26 More is not always better when setting goals. Reduce, reduce, reduce.

#27 Advice from people who are older aren’t laws. They’re like clothes. If it doesn’t fit you, try others.

#28 It’s inevitable to avoid pain in life. But suffering is optional…

…#32 Ordinary returns over a long time period will give you an extraordinary result…

…#34 No book can substitute the experience of navigating a stock market downturn.  The best way to learn is to start.

#35 It’s not enough that you believe in investing for the long term. This idea must also be embraced by your spouse, family, and friends.

#36 Complexity gives you a false blanket of accuracy and control. It is usually the person who is able to explain things simply who knows what they are talking about.

4. The Nine Breakthroughs of the Year – Derek Thompson

1. CRISPR’s Triumph: A Possible Cure for Sickle-Cell Disease

In December, the FDA approved the world’s first medicine based on CRISPR technology. Developed by Vertex Pharmaceuticals, in Boston, and CRISPR Therapeutics, based in Switzerland, Casgevy is a new treatment for sickle-cell disease, a chronic blood disorder that affects about 100,000 people in the U.S., most of whom are Black.

Sickle-cell disease is caused by a genetic mutation that affects the production of hemoglobin, a protein that carries oxygen in red blood cells. Abnormal hemoglobin makes blood cells hard and shaped like a sickle. When these misshapen cells get clogged together, they block blood flow throughout the body, causing intense pain and, in some cases, deadly anemia.

The Casgevy treatment involves a complex, multipart procedure. Stem cells are collected from a patient’s bone marrow and sent to a lab. Scientists use CRISPR to knock out a gene that represses the production of “fetal hemoglobin,” which most people stop making after birth. (In 1948, scientists discovered that fetal hemoglobin doesn’t “sickle.”) The edited cells are returned to the body via infusion. After weeks or months, the body starts producing fetal hemoglobin, which reduces cell clumping and improves oxygen supply to tissues and organs.

Ideally, CRISPR will offer a one-and-done treatment. In one trial, 28 of 29 patients, who were followed for at least 18 months, were free of severe pain for at least a year. But we don’t have decades’ worth of data yet.

Casgevy is a triumph for CRISPR. But a miracle drug that’s too expensive for its intended population—or too complex to be administered where it is most needed—performs few miracles. More than 70 percent of the world’s sickle-cell patients live in sub-Saharan Africa. The sticker price for Casgevy is about $2 million, which is roughly 2,000 times larger than the GDP per capita of, say, Burkina Faso. The medical infrastructure necessary to go through with the full treatment doesn’t exist in most places. Casgevy is a wondrous invention, but as always, progress is implementation.

2. GLP-1s: A Diabetes and Weight-Loss Revolution

In the 1990s, a small team of scientists got to know the Gila monster, a thick lizard that can survive on less than one meal a month. When they studied its saliva, they found that it contained a hormone that, in experiments, lowered blood sugar and regulated appetite. A decade later, a synthetic version of this weird lizard spit became the first medicine of its kind approved to treat type 2 diabetes. The medicine was called a “glucagon-like peptide-1 receptor agonist.” Because that’s a mouthful, scientists mostly call these drugs “GLP-1s.”…

…3. GPT and Protein Transformers: What Can’t Large Language Models Do?…

…This spring, a team of researchers announced in Science that they had found a way to use transformer technology to predict protein sequences at the level of individual atoms. This accomplishment builds on AlphaFold, an AI system developed within Alphabet. As several scientists explained to me, the latest breakthrough suggests that we can use language models to quickly spin up the shapes of millions of proteins faster than ever. I’m most impressed by the larger promise: If transformer technology can map both languages and protein structures, it seems like an extraordinary tool for advancing knowledge.

4. Fusion: The Dream Gets a Little Closer

Inside the sun, atoms crash and merge in a process that produces heat and light, making life on this planet possible. Scientists have tried to harness this magic, known as fusion, to produce our own infinite, renewable, and clean energy. The problem: For the longest time, nobody could make it work.

The past 13 months, however, have seen not one but two historic fusion achievements. Last December, 192 lasers at the Lawrence Livermore National Laboratory, in California, blasted a diamond encasing a small amount of frozen hydrogen and created—for less than 100 trillionths of a second—a reaction that produced about three megajoules of energy, or 1.5 times the energy from the lasers. In that moment, scientists said, they achieved the first lab-made fusion reaction to ever create more energy than it took to produce it. Seven months later, they did it again. In July, researchers at the same ignition facility nearly doubled the net amount of energy ever generated by a fusion reaction. Start-ups are racing to keep up with the science labs. The new fusion companies Commonwealth Fusion Systems and Helion are trying to scale this technology…

...5. Malaria and RSV Vaccines: Great News for Kids

Malaria, one of the world’s leading causes of childhood mortality, killed more than 600,000 people in 2022. But with each passing year, we seem to be edging closer to ridding the world of this terrible disease.

Fifteen months ago, the first malaria vaccine, developed by University of Oxford scientists, was found to have up to 80 percent efficacy at preventing infection. It has already been administered to millions of children. But demand still outstrips supply. That’s why it’s so important that in 2023, a second malaria vaccine called R21 was recommended by the World Health Organization, and it appears to be cheaper and easier to manufacture than the first one, and just as effective. The WHO says it expects the addition of R21 to result in sufficient vaccine supply for “all children living in areas where malaria is a public health risk.”…

…6. Killer AI: Artificial Intelligence at War…

…In the world’s most high-profile conflict, Israel has reportedly accelerated its bombing campaign against Gaza with the use of an AI target-creation platform called Habsora, or “the Gospel.” According to reporting in The Guardian and +972, an Israeli magazine, the Israel Defense Forces use Habsora to produce dozens of targeting recommendations every day based on amassed intelligence that can identify the private homes of individuals suspected of working with Hamas or Islamic Jihad. (The IDF has also independently acknowledged its use of AI to generate bombing targets.)…

…Meanwhile, the war in Ukraine is perhaps the first major conflict in world history to become a war of drone engineering. (One could also make the case that this designation should go to Azerbaijan’s drone-heavy military campaign in the Armenian territory of Nagorno-Karabakh.) Initially, Ukraine depended on a drone called the Bayraktar TB2, made in Turkey, to attack Russian tanks and trucks. Aerial footage of the drone attacks produced viral video-game-like images of exploded convoys…

…But Russia has responded by using jamming technology that is taking out 10,000 drones a month. Ukraine is now struggling to manufacture and buy enough drones to make up the difference, while Russia is using kamikaze drones to destroy Ukrainian infrastructure.

7. Fervo and Hydrogen: Making Use of a Hot Planet…

…Eleven years ago, engineers in Mali happened upon a deposit of hydrogen gas. When it was hooked up to a generator, it produced electricity for the local town and only water as exhaust. In 2023, enough governments and start-ups accelerated their search for natural hydrogen-gas deposits that Science magazine named hydrogen-gas exploration one of its breakthroughs of the year. (This is different from the “natural gas” you’ve already heard of, which is a fossil fuel.) One U.S.-government study estimated that the Earth could hold 1 trillion tons of hydrogen, enough to provide thousands of years of fuel and fertilizer.

8. Engineered Skin Bacteria: What If Face Paint Cured Cancer?…

…Some common skin bacteria can trigger our immune system to produce T cells, which seek and destroy diseases in the body. This spring, scientists announced that they had engineered an ordinary skin bacterium to carry bits of tumor material. When they rubbed this concoction on the head of mice in a lab, the animals produced T cells inside the body that sought out distant tumor cells and attacked them. So yeah, basically, face paint that fights cancer…

…The ability to deliver cancer therapies (or even vaccines) through the skin represents an amazing possibility, especially in a world where people are afraid of needles. It’s thrilling to think that the future of medicine, whether vaccines or cancer treatments, could be as low-fuss as a set of skin creams.

5. TIP595: Stock Market History & The AI Bubble w/ Jamie Catherwood – Clay Finck and Jamie Catherwood

[00:34:02] Clay Finck: And then this also brought to mind another solution that could be brought about and that’s to restructure the debt. Are there examples in history that you’ve looked at where debt restructurings have occurred?

[00:34:15] Jamie Catherwood: Yeah. So in the U.S, it’s not something that tends to get acknowledged but in the first few years of our nation, we restructured our debt.

[00:34:26] Jamie Catherwood: I mean, that’s what Hamilton was tasked with doing when he. Assumed office as the first secretary of the treasury. When he came into his role in 89, 1789, there was a dire financial state. At that point, I’ll take you back to US history class from high school but before we had the constitution, we had the Articles of Confederation, which were designed to severely curtail the central government authority because obviously Americans were very fearful after having fought a war with a British monarch that any type of new government in the U.S. would fall kind of victim to a similar. And so the articles of confederation essentially gave Congress no power.

[00:35:16] Jamie Catherwood: And so, for example, they did not have the authority to collect taxes, which is insane. And so that means that during those years, there was not a lot of revenue coming in. And so even after the constitution was passed and the government we have today was put into place, there was a real problem because there were.

[00:35:34] Jamie Catherwood: It was not a lot of revenue coming in, but there had been massive accumulation of debt incurred during the revolutionary war to fight the British. And I mean, we owed, I think, like 80 million, a lot of it to foreign governments and when Hamilton took office, he had to write to the French government asking.

[00:35:54] Jamie Catherwood: For a delay in payments because the U.S. was basically struggling to get on its feet. In fact, in the 1st year of his time in office, he had to write to Washington President Washington saying that, if we don’t get the exact amount, but a certain amount of money into the treasury’s coffers in the next month, then we’re not going to be able to pay congressmen their salaries. And there are going to be a lot of other departments and cabinet positions that won’t be able to receive their funds because. we’re just so on the whole and so what Hamilton’s novel kind of idea was, and it was politically very challenging and a difficult thread to needle was he had to essentially convince American debt holders to exchange their existing higher paying debt and U.S. bonds that they owned for a public loan. Package of new debt securities that he would issue, which would have a lower interest rate, but his premise to these investors was the only alternative for continuing to pay out these higher interest rates would be to introduce new taxes or, raise higher taxes, both of which we know would lead to probably armed rebellion, as you can see, in the case of the whiskey rebellion, when there’s a whiskey tax introduced.

[00:37:10] Jamie Catherwood: And so if you want to really avoid that, then the only way we can do so is if you accept the fact that instead of being paid 6% interest on these bonds, we’re going to give you 4% interest going forward. And that was obviously a tough sell, especially when the nation was very divided and people were still very wary of strong central government implementing new taxes or having too much control and, changing their commitments to pay out what they had promised originally at 6%. And so that was very difficult, but in a matter of, I think, 2 years or so, he had successfully converted something like 98 % of the outstanding debt into this package of new securities that were lower paying, lower interest bearing securities and it saved. Tens of millions for the government and so that was restructuring literally at the founding of our nation. That was very successful. And one of the ways that he also was able to retire a lot of the debt, just kind of as an interesting side note, is by allowing investors to purchase shares of the Bank of the United States, which was kind of like an early central bank esque institution in the U.S. And the bank IPO ed on July 4th, 1791, I believe very patriotic IPO date and he allowed investors that held U.S. government bonds to pay for shares of the Bank of the United States with these bonds. So it was kind of a win for the government because, it injected capital into this new bank, but also it reduced the amount of debt outstanding that they would have to pay interest on by allowing someone to use like three government bonds to purchase one share of the Bank of the United States stock and so interesting and often under referenced example of a restructuring in U.S. history, because when there’s talk of debt restructurings or defaults, et cetera, people tend to pull out the line that U.S. has never defaulted on its debt or something like that.

[00:39:14] Jamie Catherwood: The reality is that there have been these moments in U.S. history where we were in pretty dire times and some novel solutions were needed…

…[00:40:37] Clay Finck: But then another major factor I sort of think about in terms of market efficiency is the massive impact of passive flows on index funds. And you did a write up that referenced the telegraph looking all the way back and investors first getting access to this quick information. So talk to us about the efficiency of markets and how that’s changed over time.

[00:40:58] Jamie Catherwood: Yeah. So what prompted kind of my recent interest in this again was a quote from Cliff Asness in a recent financial times article, but he said something along the lines of people that think technology. It’s going to make asset pricing markets more efficient are the same ones who 20 years ago said that social media would make us all like each other more, which I think is just a fantastic way to put it because definitely social media does not make us like each other more and has increased the divisiveness in society.

[00:41:31] Jamie Catherwood: But also, I mean, it makes sense on its face throughout history that when you suddenly get these innovations and kind of communication and data. That markets have become more efficient because people have more information. And while that’s certainly true to a certain extent, there is. It’s definitely nowhere near kind of an elimination of mispricing and, inefficient markets, because I remember when the telegraph cable first took over the world and people could get information in India to London, for example, on something like 8 hours where it used to take much longer.

[00:42:07] Jamie Catherwood: Someone said that there would be no need for crises moving forward because now all the information would simply be known. And I just loved the kind of matter of factness with, I can’t remember his name is Arthur something, but he was a person of high authority and he just. I just put it so bluntly as if why would we have panics and crashes moving forward?

[00:42:28] Jamie Catherwood: Because now everybody will have access to information at the tips of their fingers, at least in their day, that was considered tips of their fingers. And so how could there be more panics and crashes? And obviously, if anything, the 19th century had more panics and crashes than any century and so there is this.

[00:42:46] Jamie Catherwood: Just the belief that technology will always make markets extremely efficient but throughout history, you see the introduction of these technologies and the opposite occurs where, ironically, you know, when the telegraph and the ticker were introduced there was a study done that showed how the states that as their ticker subscriptions increased.

[00:43:09] Jamie Catherwood: Within each state, people started gravitating towards companies listed in their state and so basically a home country bias but at the state level, if you can imagine it, and people started just hurting into the same kind of like top 10 stocks within their state and instead of. The ticker and telegraph broadening the speculation across a broader set of stocks, people just continue to concentrate into the same names.

[00:43:39] Jamie Catherwood: And you see this throughout history in the 1600s, when markets in London during the 1690s were kind of going through their first bubble is this IPO bubble and kind of the first technology mania you saw a list of securities in one of the kind of market write ups market commentaries that was published every two weeks by this guy, John Houghton, he had a list of 20 securities that he monitored the prices of and even though.

[00:44:08] Jamie Catherwood: There were a couple of hundred securities trading on the London exchange, the vast majority of all trading volume on the exchange was concentrated into the same list of securities that he provided prices for in his market commentary every two weeks, and so while that’s not necessarily technology by modern standards, it’s still just shows that even when investors are presented with A lot of different stocks to invest in, they tend to concentrate into the same ones that everybody else does.

[00:44:35] Jamie Catherwood: And so it’s just this interesting phenomenon throughout history that technology does not necessarily change our approach to investing and, cause us to expand our universe of stocks to select from. And I think during COVID, we saw that same phenomenon with the Robinhood tracker. I don’t know if you remember that, but it showed just the level of trading on Robinhood that was concentrated in the top 10 most popular stocks.

[00:45:01] Jamie Catherwood: And it was just crazy to see even in this modern age, when literally you have unparalleled access to information at the tips of your fingers. That’s still, we kind of just heard into these same names as everyone else, even though you could be looking at a really exciting micro-cap stock or something

[00:45:18] Jamie Catherwood: And I could be looking at mid-smith cap stock doing something exciting, the energy sector or something like that but instead people tend to just kind of hurt into the same us large cap stocks.

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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 31 December 2023:

1. How Not to Be Stupid About AI, With Yann LeCun – Steven Levy and Yann LeCun

Steven Levy: In a recent talk, you said, “Machine learning sucks.” Why would an AI pioneer like you say that?

Yann LeCun: Machine learning is great. But the idea that somehow we’re going to just scale up the techniques that we have and get to human-level AI? No. We’re missing something big to get machines to learn efficiently, like humans and animals do. We don’t know what it is yet.

I don’t want to bash those systems or say they’re useless—I spent my career working on them. But we have to dampen the excitement some people have that we’re just going to scale this up and pretty soon we’re gonna get human intelligence. Absolutely not…

…Why are so many prominent people in tech sounding the alarm on AI?

Some people are seeking attention, other people are naive about what’s really going on today. They don’t realize that AI actually mitigates dangers like hate speech, misinformation, propagandist attempts to corrupt the electoral system. At Meta we’ve had enormous progress using AI for things like that. Five years ago, of all the hate speech that Facebook removed from the platform, about 20 to 25 percent was taken down preemptively by AI systems before anybody saw it. Last year, it was 95 percent…

…The company you work for seems pretty hell bent on developing them and putting them into products.

There’s a long-term future in which absolutely all of our interactions with the digital world—and, to some extent, with each other—will be mediated by AI systems. We have to experiment with things that are not powerful enough to do this right now, but are on the way to that. Like chatbots that you can talk to on WhatsApp. Or that help you in your daily life and help you create stuff, whether it’s text or translation in real time, things like that. Or in the metaverse possibly…

…One company that disagrees with that is OpenAI, which you don’t seem to be a fan of.

When they started, they imagined creating a nonprofit to do AI research as a counterweight to bad guys like Google and Meta who were dominating the industry research. I said that’s just wrong. And in fact, I was proved correct. OpenAI is no longer open. Meta has always been open and still is. The second thing I said is that you’ll have a hard time developing substantial AI research unless you have a way to fund it. Eventually, they had to create a for-profit arm and get investment from Microsoft. So now they are basically your contract research house for Microsoft, though they have some independence. And then there was a third thing, which was their belief that AGI [artificial general intelligence] is just around the corner, and they were going to be the one developing it before anyone. They just won’t.

How do you view the drama at OpenAI, when Sam Altman was booted as CEO and then returned to report to a different board? Do you think it had an impact on the research community or the industry?

I think the research world doesn’t care too much about OpenAI anymore, because they’re not publishing and they’re not revealing what they’re doing. Some former colleagues and students of mine work at OpenAI; we felt bad for them because of the instabilities that took place there. Research really thrives on stability, and when you have dramatic events like this, it makes people hesitate. Also, the other aspect important for people in research is openness, and OpenAI really isn’t open anymore. So OpenAI has changed in the sense that they are not seen much as a contributor to the research community. That is in the hands of open platforms…

…But isn’t an open source AI really difficult to control—and to regulate?

No. For products where safety is really important, regulations already exist. Like if you’re going to use AI to design your new drug, there’s already regulation to make sure that this product is safe. I think that makes sense. The question that people are debating is whether it makes sense to regulate research and development of AI. And I don’t think it does.

Couldn’t someone take a sophisticated open source system that a big company releases, and use it to take over the world? With access to source codes and weights, terrorists or scammers can give AI systems destructive drives.

They would need access to 2,000 GPUs somewhere that nobody can detect, enough money to fund it, and enough talent to actually do the job.

Some countries have a lot of access to those kinds of resources.

Actually, not even China does, because there’s an embargo.

I think they could eventually figure out how to make their own AI chips.

That’s true. But it’d be some years behind the state of the art. It’s the history of the world: Whenever technology progresses, you can’t stop the bad guys from having access to it. Then it’s my good AI against your bad AI. The way to stay ahead is to progress faster. The way to progress faster is to open the research, so the larger community contributes to it.

How do you define AGI?

I don’t like the term AGI because there is no such thing as general intelligence. Intelligence is not a linear thing that you can measure. Different types of intelligent entities have different sets of skills.

Once we get computers to match human-level intelligence, they won’t stop there. With deep knowledge, machine-level mathematical abilities, and better algorithms, they’ll create superintelligence, right?

Yeah, there’s no question that machines will eventually be smarter than humans. We don’t know how long it’s going to take—it could be years, it could be centuries.

At that point, do we have to batten down the hatches?

No, no. We’ll all have AI assistants, and it will be like working with a staff of super smart people. They just won’t be people. Humans feel threatened by this, but I think we should feel excited. The thing that excites me the most is working with people who are smarter than me, because it amplifies your own abilities.

But if computers get superintelligent, why would they need us?

There is no reason to believe that just because AI systems are intelligent they will want to dominate us. People are mistaken when they imagine that AI systems will have the same motivations as humans. They just won’t. We’ll design them not to.

What if humans don’t build in those drives, and superintelligence systems wind up hurting humans by single-mindedly pursuing a goal? Like philosopher Nick Bostrom’s example of a system designed to make paper clips no matter what, and it takes over the world to make more of them.

You would be extremely stupid to build a system and not build any guardrails. That would be like building a car with a 1,000-horsepower engine and no brakes. Putting drives into AI systems is the only way to make them controllable and safe. I call this objective-driven AI. This is sort of a new architecture, and we don’t have any demonstration of it at the moment.

2. China’s debt isn’t the problem – Michael Pettis

IMF in its latest Global Debt Monitor highlighted how China’s overall debt-to-GDP ratio has increased fourfold since the 1980s. It has been particularly rapid over the past decade. Over half of the increase in the entire global economy’s debt-to-GDP ratio since 2008 is solely due to an “unparalleled” rise in China, according to the IMF.

That $47.5tn total debt pile has grown further in 2023, which might mean that China has now finally overtaken the US in debt-to-GDP terms…

…However, the surge in Chinese debt is not itself the problem but rather a symptom of the problem. The real problem is the cumulative but unrecognised losses associated with the misallocation of investment over the past decade into excess property, infrastructure and, increasingly, manufacturing.

This distinction is necessary because much of the discussion on resolving the debt has so far focused on preventing or minimising disruptions in the banking system and on the liability side of balance sheets.

These matter — the way in which liabilities are resolved will drive the distribution of losses to various sectors of the economy — but it’s important to understand that the problems don’t emerge from the liability side of China’s balance sheets. They emerge from the asset side…

…In proper accounting, investment losses are treated as expenses, which result in a reduction of earnings and net capital. If, however, the entity responsible for the investment misallocation is able to avoid recognising the loss by carrying the investment on its balance sheets at cost, it has incorrectly capitalised the losses, ie converted what should have been an expense into a fictitious asset.

The result is that the entity will report higher earnings than it should, along with a higher total value of assets. But this fictitious asset by definition is unable to generate returns, and so it cannot be used to service the debt that funded it. In an economy in which most activity occurs under hard-budget constraints, this is a self-correcting problem. Entities that systematically misallocate investment are forced into bankruptcy, during which the value of assets is written down and the losses recognised and assigned.

But, as the Hungarian economist János Kornai explained many years ago, this process can go on for a very long time if it occurs in sectors of the economy that operate under soft-budget constraints, for example state-owned enterprises, local governments, and highly subsidised manufacturers.

In these cases, state-sponsored access to credit allows non-productive investment to be sustained. And as economic activity shifts to these sectors, the result can be many years of unrecognised investment losses during which both earnings and the recorded value of assets substantially exceed their real values. Because the debt that funds this fictitious investment cannot be serviced by the investment, the longer it goes on, the more debt there is.

But once these soft-budget entities are no longer able — or willing — to roll over and expand the debt, they will then be forced to recognise that the asset side of the balance sheet simply doesn’t generate enough value to service the liability side. Put another way, they will be forced to recognise that the real value of the assets on their balance sheets are less than their recorded value.

That is the real, huge and intractable problem China faces…

…The third and most important impact is what finance specialists call “financial distress” costs. In order to protect themselves from being forced directly or indirectly to absorb part of the losses, a wide range of economic actors — workers, middle-class savers, the wealthy, businesses, exporters, banks, and even local governments — will change their behaviour in ways that undermine growth.

Financial distress costs rise with the uncertainty associated with the allocation of losses, and what makes them so severe is that they are often self-reinforcing. As we’ve seen with the correction in China’s property sector, financial distress costs are almost always much higher than anyone expected.

The point is that resolving China’s debt problem is not just about resolving the liability side of the balance sheet. What matters more to the overall economy is that asset-side losses are distributed quickly and in ways that minimise financial distress costs. That is why restructuring liabilities must be about more than protecting the financial system. It must be designed to minimise additional losses.

3. The pharma industry from Paul Janssen to today: why drugs got harder to develop and what we can do about it – Alex Telford

The biopharmaceutical industry expends huge sums shepherding drug candidates through the development gauntlet and satisfying regulatory requirements. In 2022, the industry spent around $200 billion on R&D, more than four times the US National Institute of Health’s (NIH) budget of $48 billion. Pharmaceuticals is the third most R&D intensive sector in the OECD countries.

The bulk of that spending goes towards clinical trials and associated manufacturing costs; roughly 50% of total large pharma R&D spend is apportioned to phase I, II, and III trials compared to 15% for preclinical work. While early phases may cull more candidate compounds in aggregate, the cost of failure is highest during clinical development: a late-stage flop in a phase III trial hurts far more than an unsuccessful preclinical mouse study. By the time a drug gets into phase III, the work required to bring it to that point may have consumed half a decade, or longer, and tens if not hundreds of millions of dollars.

Clinical trials are expensive because they are complex, bureaucratic, and reliant on highly skilled labour. Trials now cost as much as $100,000 per patient to run, and sometimes up to $300,000 or even $500,000 per patient for resource-intensive designs, trials using expensive standard of care medicines as controls or as part of a combination, or in conditions with hard-to-find patients (e.g., rare diseases). When these costs are added on top of other research and development expenditures, like manufacturing, a typical phase I program with 20-80 trial participants can be expected to burn around $30m. Phase III programs, involving hundreds of patients, often require outlays of hundreds of millions of dollars. Clinical trials in conditions where large trials with tens of thousands of patients are standard, such as cardiovascular disease or diabetes, can cost as much as $1 billion.

Because executing late stage clinical trials and manufacturing enough of the drug to cover them is so expensive, companies prefer to manage risk by conducting studies sequentially, even though many steps could in principle be done in parallel.

A major reason that COVID-19 vaccine development was so fast was not because shortcuts were taken, but that the funding from operation warp speed and advance purchase agreements allowed companies to parallelize much of the process, scale up manufacturing early, and jump quickly into phase IIIs because they were insulated from the financial risk of failure. Early trial phases were combined in multiphase designs, Pfizer commandeered existing manufacturing infrastructure and repurposed it for COVID-19 vaccine production, and employees and regulators worked around the clock. The FDA and other regulators took reviewers off of non-COVID-19 drugs and redeployed them to review the COVID-19 vaccines; there were essentially no delays in safety reviews that you would otherwise see in other clinical trials. The little delays that crop up in development were powered through with extra manpower and resources: at one point during Operation Warp Speed the military recovered a vital piece of equipment needed to manufacture Moderna’s vaccine from a stalled train, and put it on an aeroplane so it could arrive in time. While the vaccines were approved under expedited emergency use regulatory pathways, they were nevertheless rigorously tested. Allocating such extensive resources for every new drug, as was done during the pandemic, is unsustainable and comes with substantial opportunity cost.

In business-as-usual times, the industry’s expenditure on drug R&D nets us about 40 new US FDA drug approvals a year — and a similar number (though not always exactly the same drugs) approved by the equivalent agencies in other regions, as well as some new indications for existing drugs.

All that money spent by the industry on R&D appeared to go a lot further in the past10. Despite continued growth in biopharmaceutical R&D expenditure, we have not seen a proportionate growth in output. Industry R&D efficiency — crudely measured as the number of FDA approved drugs per billion dollars of real R&D spend — has (until recently) been on a long-term declining trajectory11. This trend has been sardonically named “Eroom’s law” – an inversion of Moore’s law. Accounting for the cost of failures and inflation, the industry now spends about $2.5 billion per approved drug, compared to $40 million (in today’s dollars) when Janssen was starting out in 1953…

…Even though we’re spending more money than ever before, historical statistics on drug candidate failure rates suggest that we haven’t really gotten much better at developing drugs that succeed where it counts — in clinical trials. The real bottleneck is not finding drug candidates that bind and modulate targets of interest, it’s finding ones that actually benefit patients. Almost paradoxically, despite huge improvements in the technologies of drug discovery, the rate of new drug launches has hardly shifted in 50 years. High-throughput screening, new model systems, machine learning, and other fancy modern techniques have done little to change the statistic that 9 in 10 drug candidates that start clinical trials will fail to secure approval.

What’s behind this ‘Red Queen’ effect, where we seem to be expending more and more resources to keep running at roughly the same speed?

For one, as we’ve seen across scientific fields, new ideas are getting harder to find. There are more academic researchers than ever — 80,000 in the 1930’s vs. 1.5 million today in the USA — yet we have not seen a proportionate growth in the rate of meaningful discoveries. This may be because ideas are getting inherently more difficult to find, or it may be that the institutions and processes of science have become less effective: bogged down in bureaucracy, sclerotic, chasing the wrong metrics, and thereby limiting the impact of individual researchers.

The biopharmaceutical business is built on top of basic discoveries, and so it is not immune from this general trend afflicting all of science. Without the discovery of methods to stabilise coronavirus spike proteins and enhance immunogenicity prior to the pandemic, it’s unlikely that we would have had effective vaccines for COVID-19 as fast as we did. Imatinib, a breakthrough targeted therapy for a rare blood cancer, was predicated on the discovery of the mutant protein produced by the “Philadelphia chromosome” rearrangement. In support of the ‘low hanging fruit’ argument is data showing changes in the landscape of drug targets over time: compared to past decades, drugs in development are now much more frequently going after targets that would have historically been viewed as intractable. Modern protein targets are more likely to be disordered, with shallow or non-existing pockets for small molecules to bind, or otherwise difficult to interact with.

The more important reason for the decline in R&D efficiency, however, is that it is not enough for drugs to simply be novel and safe, they must also improve meaningfully over the available standard of care, which may include a large armamentarium of effective and cheap older drugs.

This is the so-called ‘better than Beatles’ problem. Imagine if in order to release new music it needed to be adjudicated as better than ‘Hey Jude’, or ‘Here comes the sun’ in a controlled experiment. New experimental music might have a hard time getting past the panel, and wouldn’t have the chance to refine its sound in future iterations. The situation for new drugs is somewhat analogous…

…Yet, even though there are major forces pushing against drug developers, there is a sense that the industry is still underperforming, and that it could do more. One reason for optimism can be seen in the recent flattening of the slope of Eroom’s law following decades of declining productivity. It remains to be seen whether the recent uptick is a sustained turnaround or not. The pessimistic view is that it is illusory, a result of how drugmakers have side-stepped fundamental productivity issues by focusing on developing drugs for niche subpopulations with few or no options where regulators are willing to accept less evidence, it’s easier to improve on the standard of care, and payers have less power to push back on higher prices: rare disease and oncology in particular. It’s no coincidence that investment has flowed into areas where regulatory restrictions have been relaxed and accelerated approvals are commonplace: 27% of FDA drug approvals in 2022 were for oncology, the largest therapeutic area category, and 57% were for rare/orphan diseases.

There is however, a more charitable and optimistic take for the flattening and possible reversal of Eroom’s law. The first possibility is that advances in basic science are finally being widely adopted in the drug development process and bearing fruit. Historically, it takes upwards of 20 years for new drug targets to lead to new medicines. Consider that the sequencing of the human genome was completed in 2003; genomics research has by now improved our understanding of many relatively simple monogenic genetic disease, and has identified new targets for more common conditions through genome-wide association studies (GWAS) that look for associations between gene variants and disease phenotypes in large populations. The PCSK9 inhibitors alirocumab and evolucumab, as an archetypal example, were developed after screening for genetic mutations in families with elevated cholesterol levels identified the PCSK9 gene as a key driver of cholesterol regulation. Drug programs with genetic support are more likely to succeed, and we may have only recently truly started to benefit from our improved understanding of human genetics.

4. Peter Lynch 1994 National Press Club Lecture (transcript here)- Monroe Carmen and Peter Lynch

Peter Lynch: And if you can’t explain – I’m serious – you can’t explain to a 10 year old in two minutes or less why you own a stock, you shouldn’t own it. And that’s true, I think, about 80% of people that own stocks.

And this is the kind of stock people like to own. This is the kind of company people adore owning. This is a relatively simple company. They make a very narrow, easy to understand product. They make a 1 MB SRAM CMOS bipolar risk floating point data, I/O array processor with an optimising compiler, a 16-dual port memory, a double diffused metal oxide semiconductor monolithic logic chip with a plasma matrix vacuum fluorescent display. It has a 16 bit dual memory. It has a Unix operating system, four whetstone megaflop polysilicone emitter, a high bandwidth – that’s very important – six gigahertz metalization communication protocol, an asynchronous backward compatibility, peripheral bus architecture, four wave interweave memory, a token ring and change backplane. And it does in 15 nanoseconds of capability. Now, if you own a piece of crap like that, you will never make money. Never. Somebody will come along with more wetstones or less wetstones or a big omega flop or a small omega flop. You won’t have the foggiest idea what’s happened. And people buy this junk all the time.

I made money in Dunkin Donuts. I can understand it. When there was recessions, I didn’t have to worry about what was happening. I could go there and people were still there. I didn’t have to worry about low price Korean imports. I can understand it. And you laugh. I made 10 or 15 times my money in Dunkin’Donuts. Those are the kind of stocks I can understand. If you don’t understand, it doesn’t work…

…Peter Lynch: I’m trying to convince people there is a method. There are reasons for stocks that go up. Coca Cola, this is very magic. It’s a very magic number. Easy to remember. Coca Cola is earning 30 times per share what they did 32 years ago. The stock has gone up 30 fold. Bethlehem Steel is earning less than they did 30 years ago. The stock is half its price of 30 years ago. Stocks are not lottery tickets. There’s a company behind every stock. The company does well. The stock does well. It’s not that complicated…

…Peter Lynch: Considering there’s not that many billionaires on the planet, I had logic – so I had syllogism and studied these when I was at Boston College – there can’t be that many people who can predict interest rates because there’d be lots of billionaires and no one can predict the economy.

A lot of people in this room were around in 1981 and 82 when we had a 20% prime rate with double digit inflation, double digit digit unemployment. I don’t remember anybody telling me in 1981 about it. I didn’t read – I study all this stuff. I don’t remember anybody telling we’re going to have the worst recession since the Depression. So what I’m trying to tell you, it’d be very useful to know what the stock market is going to do. It’d be terrific to know that the Dow Jones average year from now would be X, that we’re going to have a full scale recession or interest rate is going to be 12%. That’s useful stuff. You never know it though. You just don’t get to learn it. So I’ve always said if you spend 14 minutes a year in economics, you’ve wasted 12 minutes. And I really believe that.

Now, I have to be fair. I’m talking about economics in the broad scale, predicting the downturn for next year or the upturn, or M1 and M2, 3B, and all these all these M’s. I’m talking about economics, to me, is you talk about scrap prices. When I own auto stocks, I want to know what’s happening to used car prices. When used car prices are going up, it’s a very good indicator. When I own hotel stocks, I want to know hotel occupancies. When I own chemical stocks, I want to know what’s happening to price of ethylene. These are facts. If aluminium inventories go down five straight months, that’s relevant. I can deal with that. Home affordability, I want to know about, when I own Fannie Mae or I own a housing stock, these are facts. There are economic facts and there’s economic predictions. And economic predictions are a total waste.

And interest rates. Alan Greenspan is a very honest guy. He would tell you that he can’t predict interest rates. He could tell you what short rates are going to do in the next six months. Try and stick him on what the long term rate will be three years from now. He’ll say, “I don’t have any idea.” So how are you, the investor, supposed to predict interest rates if the Head of the Federal Reserve can’t do it? So I think that’s – But you should study history, and history is the important thing you learn from.

What you learn from history is the market goes down. It goes down a lot. The math is simple. There’s been 93 years, a century. This is easy to do. The market’s had 50 declines of 10% or more. So 50 declines in 93 years, about once every two years the market falls 10%. We call that a correction. That means – that’s a euphemism for losing a lot of money rapidly, but we call it a correction. So 50 declines in 93 years, about once every two years the market falls 10%. Of those 50 declines, 15 have been 25% or more. That’s known as a bear market. We’ve had 15 declines in 93 years. So every six years the market’s going to have a 25% decline. That’s all you need to know…

…Peter Lynch: So you only need a few stocks in your lifetime. They’re in your industry. I think of people – if you’d worked in the auto industry, let’s say you’re an auto dealer the last 10 years. You would have seen Chrysler come up with the minivan. If you’re a Buick dealer, a Toyota dealer, Honda dealer, you would have seen the Chrysler dealership packed with people. You could have made 10 times your money on Chrysler. A year after the minivan came out, Ford introduces the Taurus Sable, the most successful line of cars in the last 20 years. Ford went up sevenfold on the Taurus Sable. So if you’re a car dealer, you only need to buy a few stocks every decade…

…Peter Lynch: And then I want to conclude with, there’s always something to worry about. If you own stocks, there’s always something to worry about. You can’t get away from it. What happens in the 50s, people were worried about the only reason we got out of the depression was World War II. We got another recession in the early 50s. We said, “We’re going to go right back into a depression.” People worried about a Depression in the 50s and were worried about nuclear war. Back then, the little warheads they had then, they couldn’t blow up McLean, West Virginia, or McLean, Virginia, or Charlestown. Now, all these countries that end in ‘stan – there’s nine of these ‘stan countries that have come out of Russia. They all have enough warheads to blow the world up, and no one worries about.

When I was a kid, people were building fallout shelters and we used to have this civil defense drill. Remember this one in high school? You get under your desk. I never thought even then that was a particularly good thing to do. They’d blow us and some people put a hat would, all get under our desk. But in the ‘50s, people wouldn’t buy stocks. Except for the ‘80s, the ‘50s was the best decade in the century of the stock market, and people wouldn’t buy stocks in the ‘50s because they’re worried about nuclear war and they’re worried about depression. Remember when oil went from $4 to $40 and it was going to go to $100 and we’re going to have a depression. Remember that one? Well, about three years later, the same experts, now higher paid, oil is now at $10. They said it was going to go to $4 and we’re going to have a depression…

…Monroe Carmen: Are you concerned about the volatility in the financial markets today? Do you think something needs to be done to reduce it?

Peter Lynch: I love volatility. I remember when in 1972, the market went down dramatically and Taco Bell went from $14 to $1. They had no debt, they never had a restaurant close. And I started buying at $7, but I kept onto it and it went to $1. And it was the largest position in Magellan in 1978 when it was bought out for $42 by PepsiCola. And I think it would have gone to $400 if they didn’t buy it out. I think volatility is terrific.

I think these collars are very important. I don’t think the market going up 80 points one day and down 80 the next is a good thing for the public. I think that’s not a very good thing, but I think all these collars and all these other things to keep the volatility down each day is important. But the market’s going to go up and down. Human nature hasn’t changed a lot in 25,000 years and some event will come out of left field and the market will go down. Or the market will go up. So volatility will occur. Markets will continue to have these ups and downs. I think that’s a great opportunity if people can understand what they own. If they don’t understand what they own, they can own mutual funds. Try and figure out mutual funds they own and keep adding to it.

Basically, corporate profits have grown about 8% a year historically. So corporate profits double about every nine years. The stock market ought to double about every nine years. So I think the next market is about 3,800 today, 3,700. I’m pretty convinced the next 3,800 points will be up, it won’t be down. The next 500 points, the next 600 points, I don’t know which way they’re going. So the market ought to double in the next eight or nine years, it ought to double again in the eight or nine years after that because profits will go up 8% a year and stocks will follow. That’s all there is to it…

…Peter Lynch: October has always been a special month. I remember in 1987 I was very convinced that the market was not in trouble and I didn’t worry about things. And Carol and I had planned this great golf vacation to Ireland. And we’re going to visit one course and stay in a little house and visit another. Go all along the west coast of Ireland and play golf. And we left on a Thursday night and the market went down 55 points that day, which was not too good. And the next day we got to Ireland. Because of the time difference, we’d completed our day and I got back to hotel and I called and the market had gone down 112 on Friday. I said to Carolyn, “I think if the market goes down on Monday, we’re going to have to go back.” We stayed there for the weekend and on Monday the market went down 508 points and my fund went from, I think, $12 billion to $8 billion and that gets your attention. In two working days. I said, by the end of this week, I’d have no funds.

Now, there wasn’t a lot I could do. I mean, here I was on Monday, because the market didn’t open by 12:00 – it was in Ireland, it was still 07:00 in New York. So we did spend that day and we played around golf in the morning. Then we went somewhere and sort of watched the market deteriorate. And I did come back. There wasn’t nothing I could do. I mean, just nothing I could do about it. But I think my shareholders, they called up and they said, “What’s Lynch doing?” They said, “Well, he’s on the 6th hole and he’s even par up to now, but he’s in a trap. This could be a triple bogey here. This could be a big inning.” And I don’t think that’s exactly what they want to hear. So I could do something about this damn thing. So I came back home and suffered with everybody else…

…Peter Lynch: I had this biggest position in my fund one time was Hanes, which owned Leggs and was a huge stock. And it was bought eventually by Consolidated Foods and it was the best division of Consolidated Foods. But it’s my biggest position. Made a monopoly on this Leggs. And Leggs is a really big hit. And I knew somebody would come along with a new product, and it was – Kaiser Roth introduced No Nonsense. I was worried that this thing was better and I couldn’t quite figure out what was going on. So I went to the supermarket and I bought 62 pairs of No Nonsense. Different colors, different shapes, different – they must have wondered what kind of house I had when I was going back. But I brought it in. I brought to the office and I passed that to anybody, male or female, anybody who wanted these things, just take them home and tell me how it is. And they came back in about three weeks and they said, it’s not as good. And that’s what research is. That’s all it was. And I held onto Hanes and the stock was a huge stock. So that’s what it’s about.

5. From Penny-Farthings to Pounds: The Great British Bicycle Bubble of 1896 – Nicholas Vardy

The bicycle’s humble beginnings can be traced back to the “dandy horse” – a pedal-less bike patented in Germany in 1818. Over the next half-century, inventors tweaked the design. In the 1860s, a French enthusiast added pedals and a rotary crank to the dandy horse, creating a rudimentary version of the modern bicycle.

However, the later penny-farthing design, with its oversized front wheel, proved hazardous and cumbersome. It wasn’t until the 1890s that the innovations of chain-driven transmission captured the British public’s imagination. It was also when John Boyd Dunlop invented the pneumatic tire in 1887, making it easy to ride bicycles on hard roads.

Overnight, the bicycle became a technological marvel and a revolutionary new mode of transportation.

What accounted for the bicycle’s remarkable early success?

First, the bicycle liberated the British public from the constraints of railway schedules. The bicycle became synonymous with the freedom to travel when you want, where you want.

Second, the bicycle was cheaper to buy and maintain than horses. It also provided a much-needed solution to the horse manure-laden streets of London.

Third, even women could ride bicycles. That alone doubled the size of its potential market. By 1895, the bicycle came to represent feminine independence.

The bicycle had a large effect on Britain’s infrastructure.

Much like their counterparts did for railroads 60 years before, cycling organizations began to lobby for a network of good roads to connect cities and rural communities. The first roads were built for commuters and travelers on cycles, not in cars.

With every successful new road, the pool of consumers and their need for a bicycle grew. Predictions of hypergrowth abounded. Companies were keen to meet the seemingly endless demand…

…The venture capitalists of their day in the United States and Britain quickly pounced. They bought up Bicycle companies. They bolstered balance sheets with vast amounts of intangible goodwill and patents. This financial sleight of hand allowed them to leverage companies up to invest in increased production.

As a result, the 1890s saw a tremendous boom in bicycle shares in the Birmingham stock exchange, not dissimilar to today’s EV boom.

In 1896, there were roughly 20 British bicycle companies. But demand was quickly outpacing supply. Enter Ernest Terah Hooley, a property dealer from Birmingham, who saw an opportunity. He bought a company called Pneumatic Tyre for a staggering 3 million pounds, a hefty premium given its modest profits.

Thanks to Hooley’s sales prowess, shares in the newly renamed Dunlop Pneumatic Tyre Company skyrocketed by 1,138% in the spring of 1896. Other British bicycle companies followed suit, with their share prices tripling. Speculators made fortunes overnight, and more and more people flocked to get in on future growth.

In 1896 alone, 363 cycle, tube, or tire firms were listed on the London Stock Exchange, with another 238 added in the first half of 1897. The British press hailed the bicycle as a revolutionary technology. The Financial Times even dedicated a daily page to the share prices of bicycle companies…

…Then, the narrative began gradually to shift.

Cycles were made not just in Birmingham but also in the United States.

Suddenly, advances in manufacturing meant new bicycles flooded the market.

Investors learned that expansion in the market did not necessarily translate into the same profit growth.

Competition soon drove prices down. Profit margins fell…

…The bicycle companies had become overleveraged. Vast orders anticipated that failed to come through. You only need to buy a new bicycle every five or ten years. The market became saturated. Sales growth entered a slow-motion collapse. Intense competition led to oversupply and plummeting prices.

Meanwhile, technology had advanced. Other competitors emerged. The automobile was even more of a game-changer than the bicycle. The fortunes associated with the bicycles’ promise of hypergrowth dissipated rapidly.

Only with the benefit of hindsight did it become clear that bicycles were a bubble…

…By December 1897, an index of bicycle-related stocks had plummeted by 40%. In 1898, bicycle stocks traded at an average of 71% below their peaks. More than 80% of the companies participating in the 1890s British bicycle boom went bust.

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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

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Here are the articles for the week ending 24 December 2023:

1. Google DeepMind used a large language model to solve an unsolved math problem – Will Douglas Heaven

Google DeepMind has used a large language model to crack a famous unsolved problem in pure mathematics. In a paper published in Nature today, the researchers say it is the first time a large language model has been used to discover a solution to a long-standing scientific puzzle—producing verifiable and valuable new information that did not previously exist. “It’s not in the training data—it wasn’t even known,” says coauthor Pushmeet Kohli, vice president of research at Google DeepMind…

…Google DeepMind’s new tool, called FunSearch, could change that. It shows that they can indeed make discoveries—if they are coaxed just so, and if you throw out the majority of what they come up with.

FunSearch (so called because it searches for mathematical functions, not because it’s fun) continues a streak of discoveries in fundamental math and computer science that DeepMind has made using AI. First AlphaTensor found a way to speed up a calculation at the heart of many different kinds of code, beating a 50-year record. Then AlphaDev found ways to make key algorithms used trillions of times a day run faster.

Yet those tools did not use large language models. Built on top of DeepMind’s game-playing AI AlphaZero, both solved math problems by treating them as if they were puzzles in Go or chess. The trouble is that they are stuck in their lanes, says Bernardino Romera-Paredes, a researcher at the company who worked on both AlphaTensor and FunSearch: “AlphaTensor is great at matrix multiplication, but basically nothing else.”

FunSearch takes a different tack. It combines a large language model called Codey, a version of Google’s PaLM 2 that is fine-tuned on computer code, with other systems that reject incorrect or nonsensical answers and plug good ones back in.

“To be very honest with you, we have hypotheses, but we don’t know exactly why this works,” says Alhussein Fawzi, a research scientist at Google DeepMind. “In the beginning of the project, we didn’t know whether this would work at all.”

The researchers started by sketching out the problem they wanted to solve in Python, a popular programming language. But they left out the lines in the program that would specify how to solve it. That is where FunSearch comes in. It gets Codey to fill in the blanks—in effect, to suggest code that will solve the problem.

A second algorithm then checks and scores what Codey comes up with. The best suggestions—even if not yet correct—are saved and given back to Codey, which tries to complete the program again. “Many will be nonsensical, some will be sensible, and a few will be truly inspired,” says Kohli. “You take those truly inspired ones and you say, ‘Okay, take these ones and repeat.’”

2. How Energy Traders Left A Country In The Cold – Stephen Stapczynski and Faseeh Mangi

Within a few weeks, Alleyne’s colleagues identified a candidate: Gunvor’s deal with Pakistan, which depends heavily on LNG but is a far smaller customer than major importers such as China and Japan. After some internal debate, the traders ran the idea of scrapping it past the firm’s legal team and decided to proceed. When the Russian army invaded Ukraine on Feb. 24, 2022, gas prices soared more than 150% in 11 days. Around the same time, according to people familiar with the events, Gunvor stopped responding to communications from the Pakistani government. Then it terminated Pakistan’s deal, saying the country had underpaid for one of its LNG shipments. (Pakistan disputes this.)

Under the terms of the contract, Gunvor was supposed to supply Pakistan with five tankers’ worth of LNG over the next several months. Instead, ship-tracking data show, Gunvor sent the cargoes to countries including the UK and Italy, where buyers paid the “spot,” or market, price. If the gas had been delivered to Pakistan as originally planned, the value of the sales would have been about $200 million, according to calculations by Businessweek. By the same arithmetic, Gunvor’s traders unloaded it for more than $600 million. Some would receive seven-figure bonuses for the year, the highest of their careers.

Gunvor’s decision to redirect its supplies—and other canceled gas deliveries by Eni SpA, a state-controlled Italian energy group—helped prompt an energy crisis in Pakistan that continues today. The nation of 240 million people, which has a per capita gross domestic product of just over $1,500, uses natural gas to heat homes, power industry and even run cars and buses. When it ran short, factories were forced to shut or dramatically cut their output, throwing workers into poverty; so were fertilizer plants, threatening food production. As it scrambled to procure replacement LNG, Pakistan paid record spot-market prices, draining its modest foreign currency reserves and pushing it to the brink of default. Now its government is trying to implement economic reforms after receiving a bailout from the International Monetary Fund before elections scheduled in early 2024…

…There’s no suggestion that Gunvor or Eni acted illegally. Both appear to have operated within the bounds of their contracts—albeit in a way that’s all but unique in an industry where suppliers have traditionally done whatever they can to meet customers’ need for gas. Moreover, Pakistan’s woes are the result of much more than a fuel shortage. Successive governments—some installed through military coups—have mismanaged its economy for decades. Notably, politicians have long subsidized power and gas rates, providing little incentive for energy efficiency and forcing the government to pick up the difference between the true cost and what consumers pay.

The situation nonetheless provides a stark example of how traders in the cutthroat world of commodities can profit at the expense of some of the world’s least developed nations. When they agreed to long-term gas deals, Pakistani officials thought they were protecting their economy and citizens from the vagaries of commodity markets. Instead they learned just how quickly, and brutally, those markets could turn against them…

…For countries that can’t meet their energy needs domestically, LNG provides major benefits. Until it was commercialized in the 1960s, the most common way to ship large quantities of gas was through pipelines, which have obvious disadvantages for places that are isolated, far from reserves or both. By contrast, a tanker full of LNG can be sent to any port with a so-called regasification terminal, where the fuel is heated up into usable form. To ensure reliable supplies, governments and utilities try to make long-term LNG deals to guarantee deliveries at a relatively stable price, rather than take their chances on the spot market. Even a single shipment that arrives late—or, worse, not at all—can have a significant impact on local energy supply.

Pakistan’s entry into the LNG market was engineered by former Minister of Petroleum and Natural Resources Shahid Khaqan Abbasi, who’d worked in the Saudi energy industry before shifting to politics. (He later served as prime minister.) In 2016, Abbasi made a $15 billion, government-to-government deal for LNG imports from Qatar. The shipments made up for dwindling production from domestic gas fields and eased conditions for Pakistani companies almost overnight. GDP grew more than 5% in 2016, the biggest rise in more than a decade, in part because of stronger output from large manufacturers.

Abbasi wanted to do more, and he opened two additional requests for LNG contracts: one for a five-year supply deal, the other for as long as 15 years. Roughly two dozen companies expressed interest, including Gunvor and Eni. Some had concerns about dealing with such a poor country. According to a person who participated in the tenders, gas traders applied an unusually high degree of scrutiny to the proposed contracts, seeking terms that ensured Pakistan would pay in full and on time. Pakistani officials, who were focused on securing the best possible price, didn’t insist on strict penalties for failing to deliver gas; at the time, cancellations were rare. (The Gunvor spokesperson says the company was “required to sign up to terms stipulated” by Pakistan, without amendment. The Eni spokesperson says that the relevant agreements “were not the results of a bilateral negotiation,” and that Pakistan set out their contents.)…

…In December 2020, Pakistani officials received a curious email from Eni. The Italian company said it would deliver only part of its LNG shipment for the following month, explaining that an unnamed supplier had failed to make its own delivery. Eni’s head of LNG portfolio, Ilaria Azzimonti, apologized and said her team would try to send replacement gas later…

…Under the terms of Eni’s contract, it didn’t have to provide details about the supplier default. But even after telling Pakistan it lacked sufficient gas to meet its commitments, according to a person with direct knowledge of the transaction, Eni sold an LNG shipment elsewhere at the spot price of roughly $100 million.

Although it was just part of the expected cargo, representing less than 10% of the country’s monthly supply from long-term contracts, losing the Eni gas put Pakistan in a difficult position. Cold weather was coming, increasing the need for fuel, and domestic production had declined significantly, the result of years of underinvestment. The government tried to find a spot-market shipment to make up the shortfall, but it deemed all the options too expensive. It had no choice but to temporarily curtail supplies to some households and factories.

There are occasional cancellations in the LNG business, often when problems at an export terminal affect supplies, and at first the undersize Eni delivery looked like a one-off. Regular shipments resumed in February 2021, coinciding with a collapse in spot prices. But later that year, with the recovery from the Covid‑19 pandemic driving energy demand, more of the gas expected by Pakistan failed to arrive. In August, Eni blamed reduced output at an Egyptian LNG plant for a missed shipment…

…Then, in November 2021, both companies canceled their deliveries, documents reviewed by Businessweek show. Gunvor cited a “force majeure,” a legal term for an unavoidable event that makes it impossible to fulfill a contract. Specifically it blamed an outage at a plant in Equatorial Guinea, a tiny, hydrocarbon-rich Central African dictatorship. (Although Gunvor didn’t offer details, there had been technical problems at a facility at the country’s Alba gas field that September.)

That justification from Gunvor, as well as the earlier statement by Eni about production in Egypt, took advantage of another part of Pakistan’s contracts. Unlike other LNG deals, which stipulate where a supplier will obtain the gas it’s selling, the Pakistani agreements said shipments could come from anywhere within Gunvor’s and Eni’s global portfolios. Pakistani officials have said they believed this would insulate them from disruptions, by allowing the companies to provide any gas they could source.

In their communications with Pakistan, people with knowledge of the discussions say, Gunvor and Eni turned that logic on its head, arguing that because no source was specified, a disruption anywhere gave them the right to cancel delivery. Problems in Equatorial Guinea therefore qualified as a force majeure, even though Gunvor rarely shipped gas from the plant to Pakistan. Over the next several months, Gunvor declared force majeure on two additional shipments and only partially delivered one more. At the same time, it was continuing to sell large quantities of gas to wealthier countries at spot prices, according to traders who participated in the deals…

…The events of early 2022 provided Alleyne and her team with an opportunity for a once-in-a-lifetime payday. At the average price of LNG from 2010 through 2020, a single tanker cargo could be sold on the spot market for about $30 million. Suddenly the potential number was north of $150 million. Alleyne and her colleagues, people with knowledge of the matter say, were under significant pressure from Gunvor’s billionaire chief executive officer and controlling shareholder, Torbjörn Törnqvist, to find ways to capitalize. (Gunvor denies this.)

Poor and politically isolated, Pakistan was an easy target. Gunvor traders were also conscious of an incident that had occurred in 2020, when the pandemic caused gas prices to crash globally. At the time, Pakistan had threatened to pull out of its LNG contract, since it was cheaper to pay the cancellation penalty and source gas on the spot market. Now it was the traders who had the advantage…

…Decision-makers in Pakistan’s energy industry say they’ve learned a painful lesson about international commodity markets. “As a supplier, if you have the option to sell it to Germany over Pakistan, 99 times out of a hundred you sell it to Germany,” Maniar, the Sui Southern Gas executive, says in an interview at the company’s offices in Karachi. To conserve electricity, the hallways of the building are dark. “You cannot stop people from making money.”

3. Xi Jinping repeats imperial China’s mistakes – The Economist

The rigours of imperial China’s civil-service examination system—the keju, used to select scholar-officials for over 1,300 years—are described in a new book by Yasheng Huang called “The Rise and Fall of the east: How Exams, Autocracy, Stability, and Technology Brought China Success, and Why They Might Lead to Its Decline”. Arguing that the exams stifled innovation in ancient times, Professor Huang sees lessons for Xi Jinping’s China.

The keju became more doctrinaire over time. First instituted in 587, the exams progressively shed such subjects as mathematics and astronomy. Soon, they only tested candidates’ mastery of dense Confucian texts filled with injunctions to revere fathers, officials and monarchs. The curriculum narrowed again in the 14th century, requiring candidates to memorise ultra-conservative commentaries on Confucian classics. The commentaries advocated unquestioning obedience towards rulers. A final refinement was added during the Ming dynasty: answers had to follow a rigidly scripted format, the “eight-legged essay”, described as “the greatest destroyer of human talent” by Ch’ien Mu, a historian…

…But a dataset of 11,706 Ming-era keju candidates shows that exam-takers who reached the third and final stage of the keju got there in middle age, on average. Millions sat the exams and never passed. This focus on bureaucratic glory crowded out other paths to social mobility. It was handy for autocrats, as test preparation left scholars “no time for rebellious ideas or deeds”, the book argues. The keju’s Confucian values promoted conformity of thought and disdain for commerce. Over time, the exams smothered the scientific curiosity that saw ancient China develop many technologies before the West, including the compass, gunpowder, movable-type printing and paper, known in China as the country’s “four great inventions”.

The keju was scrapped in 1905, but its legacy lives on today, in civil-service tests and in the fearsome gaokao, the college-entrance examination which rewards relentless toil. In the book’s telling, the curse of the keju spirit was broken once in China’s history, when Communist Party leaders embraced market-based reforms after the disasters of Maoism and central planning (and revived the gaokao, abandoned during the Cultural Revolution). During that reform era, lasting for 40 years after 1978, the book credits the party with successfully balancing stability, economic growth and technological progress. As in imperial times, a strong state overshadowed a weak society. But the reform-era party also praised private entrepreneurs and allowed policy experiments by regional governments. To harness the world’s dynamism, officials sought out foreign capital and international academic exchanges.

Then, in 2018, Mr Xi abolished the only term limits that constrained him as leader. His China is increasingly autocratic, statist and inward-looking. Private businesses endure more meddling by party cadres, and youth unemployment is high. In a flight to safety, almost 2.6m people applied to sit civil-service exams this year, chasing 37,100 posts. Too often, in public institutions that once boasted of being meritocratic, “merit” means fealty to one man. Officials and university students must devote ever more hours to studying Xi Jinping Thought and other dogma.

4. The Revenge Of The Ottoman Empire – Louis-Vincent Gave

In recent years, we have seen:

1. The Western world attempt to trigger a collapse in the Russian economy by blocking access to the US dollar, euro, British pound and Swiss franc. Unsurprisingly, Russia immediately shifted to selling its commodities for renminbi, Indian rupees, Brazilian real or Thai baht, and trade between Russia and the world’s major emerging markets went parabolic…

…2.The United States encourage domestic producers to repatriate production from China which is a non-democratic Communist country. Or, alternatively, to move production to countries that happen to not be non-democratic and nominally communist—for example, Vietnam.

The end result? China’s trade surplus has essentially tripled over the past few years…

…China’s trade surplus did not triple due to North American or European consumers deciding to buy three times as many plastic toys for their kids. Necessity is the mother of invention, as the saying goes, and the surge in China’s surplus is linked to it opening up new markets for its products. Back in 2017, the value of Chinese exports to Asean economies amounted to 60% of China’s exports to the US. Today, China’s exports to Southeast Asia stand at roughly 120% of China’s exports to the US.

China did this by moving up the value chain and exporting decent quality, aggressively-priced capital goods and other higher value-added products. The most visible example of this is how China came from nowhere five years ago to become the world’s largest car exporter. These cars are typically not sold in the US or Europe, but have been snapped up by drivers in Southeast Asia, the Middle East and Latin America. Just as importantly, while the cars have captured the general public’s imagination (hard not to notice Chinese cars when every shopping mall, or airport, one enters in an emerging economy now has very attractive Chinese cars on display), one can draw parallel stories for power plants, earth-moving equipment, tractors, telecom switches, turbines, and machine tools—basically, all the capital goods that are heavily in demand across India, Indonesia, Brazil and Saudi Arabia…

…How could China withstand both a frontal attack from the US (a country that controls the pipes of global financial flows to an even greater degree than the Ottoman Empire controlled the Eastern Mediterranean), and a real estate slowdown? The answer, as with Columbus and Vasco da Gama, is that necessity is the mother of all discoveries and inventions. Trade will tend to flow, either where it is the most profitable; or alternatively, if walls and barriers are put up, then trade will flow around these walls and find new destinations.

All of which brings us back to the Gavekal foundational concepts of Ricardian growth and Schumpeterian growth.

From its infancy as a firm, Gavekal has identified economic development as deriving from one of two sources:

• Ricardian growth that stems from falling trade barriers, new roads, and improvements to modes of transport and communication. Such developments pave the way for a more efficient use of existing resources, whether land, labor or capital.
• Schumpeterian growth, when new inventions trigger sharp productivity improvements…

…In fact, in recent years, global trade has continued to grind higher, thanks mostly to a sudden acceleration of trade within emerging economies…

…hardly a month goes by without the announcement of some new road, railway, canal or free trade deal linking the economies of the Istanbul-to-Jakarta axis described in the above reports (draw a line from Istanbul to Jakarta and one finds a population of roughly 3.5bn people—excluding China—that is growing by 1% a year, and with some of the highest income growth in the world).

Construction of new roads, railways and canals are appearing all across emerging economies because countries across the “Global South” can now:

• Purchase commodities in their local currencies, from Russia.
• Purchase capital goods from China, either in their local currency (if they have good relations with China), or, alternatively, in renminbi.

The combination of these two factors is a game changer for emerging economies like Indonesia, India and Brazil, which can now break free from the tyranny of the US dollar funding constraint. This explains why, for the first time in living memory, we have just seen a significant Federal Reserve monetary tightening cycle without a single emerging market going bust. On the contrary, in recent years the US dollar returns offered by most emerging market bonds have trounced those of US treasuries, along with German bunds or Japanese government bonds.

Indeed, for the first time ever, the yield on investment-grade sovereign emerging market debt is now lower in aggregate than that on US treasuries…

…If an economy contains two cities, it requires one link (say a railway line) to connect them. If an economy contains three cities, it needs three links to connect each city with the other two. If an economy contains four cities, the number of required connections rises to six.

For any number of cities, N, the number of links needed to connect each city to the others, is stated by the formula N*(N-1)/2. As more cities/countries join the system, the number of links therefore rises at an accelerating rate. For example, from the early 2000s, global economic activity was massively boosted, not just by connecting China to the rest of the world, but also by connecting Chinese cities to each other, with all the associated construction of rail, air, road, telecommunications and power links this involved.

And what occurred in China is now occurring across the broader Eurasian continent. Obviously not at the same pace (no country will ever be able to match China in mobilizing land, labor capital and natural resources towards the delivery of infrastructure) but it is happening nonetheless. Take India as an example. Over the past few years, India has opened 70 new airports and currently has plans to start the construction of another 70. And as more cities start talking directly with each other, this should mean more growth, more productivity and lower prices. Such dynamics bring me back to another staple of Gavekal analytics, namely, the acceleration phenomenon.

The concept of “acceleration” was developed by Albert Aftalion, a French economist active in the inter-war years. It is most useful in abrupt adjustments but is not easily explained mathematically, which may explain why it has not secured the following it deserves. Here goes the CliffsNotes version:

• Most socioeconomic variables are distributed according to the “normal” law, the famous Gaussian bell-shaped curve.
• This is especially true of incomes: in a “normal” country, where a large share of people have an income close to the average, a few people have very low incomes and few very high incomes. At both ends of the curve (the tails), one finds a very small population in percentage terms.
• As incomes grow over a period of a few years, the right side of the tail will grow much faster (the acceleration phenomenon) than the growth of income. This is where it gets complicated since our minds are accustomed to thinking in linear patterns, yet the number of people earning a certain amount actually grows exponentially.

This matters because when it comes to the purchase of certain goods and services, history points to the existence of key income “thresholds’’. For example, if the average income in a country is below US$1,000, nobody owns a television; when incomes move above US$1,000, almost everybody buys one. For smartphones, the level seems to be around US$2,500. For the automobile industry, the critical level seems to be US$10,000 a year. For university education, the level is US$15,000 and above. For financial products like life insurance, brokerage accounts and mutual funds, the level seems to be US$30,000…

…Now let us further imagine a few things, namely that:

• Just as incomes grow, the prices of goods delivered to consumers—whether cars, or smartphones, or personal computers—actually go down
• As incomes grow, interest rates charged to consumers actually go down (“on ne prête qu’aux riches” and all that)

Then all of a sudden, one could face a double-, or triple-charged acceleration phenomenon.

Unsurprisingly, as cars replaced bicycles on the streets of Beijing, Shanghai and Chengdu, China’s energy demand also accelerated, as shown in the chart below. Could similar events now unfold across Southeast Asia, India and the broader Middle East? Given the growth in incomes, the fact that China is now offering high-quality sub-US$10,000 cars, and the funding for such purchases, is this not the path of least resistance?

The fall of Constantinople did not trigger “the end of globalization”. Instead, it unleashed a sharp move higher in global trade. Could the same thing happen as a result of the sanctions against Russia and the US’s attempts to take China out of global supply chains? Actually, this is precisely what seems to be unfolding. Both of these events mean that the likes of Indonesia, Brazil, Saudi Arabia and India can now use their own currencies to pay for the commodities they need to power their growth and the machine tools they need to industrialize. At the very least, they no longer need US dollars. Last year, for the first time, China made more loans to EM economies in renminbi than in US dollars.

And this is before the recent announcement of Saudi Arabia signing a RMB50bn swap line equivalent with the People’s Bank of China and the possible sale by China of nuclear power plants to the kingdom.

Today, the notion that the world is deglobalizing would seem laughable to anyone living in Dubai, Singapore, São Paulo or Mumbai. Rather, the world is going through a new wave of globalization, which is different from its predecessors.

5. Car wars – Noah Smith

Over the past two years, China has gone from an also-ran in the auto industry to the world’s biggest car exporter. EVs are a huge chunk of those exports, and most of China’s EV sales go to Europe.

Some forecasts say that by 2025, about 15% of EVs bought in Europe will be made in China — some by Western automakers like Tesla and Volkswagen, some by Chinese companies like BYD.

It’s very easy to understand why this is happening. China massively subsidizes the production of electric vehicles, and Europe massively subsidizes the consumption of electric vehicles. When that happens, any Econ 101 model can easily predict the outcome — China will produce a lot of EVs that are sold in Europe…

…But China’s EV export surge is more recent, so let’s go over some of the reasons it’s happening.

First, here’s a good Bloomberg article about the EV subsidy regime in China. China pays manufacturers a subsidy worth more than $1400 per EV they produce, provides EV companies with cheap land and financing, and heavily subsidizes R&D in the sector. Both China and Europe pay people to buy EVs, and their governments buy EVs directly. But China subsidizes local production a lot more than Europe.

That’s one reason for China’s export dominance, but not the only one. Another is that China controls nearly the entire supply chain for EV batteries, except for the initial mining.

An electric vehicle is a much simpler machine than an internal combustion car — it’s basically just a battery with wheels. The battery in an EV represents about 40% of the car’s purchase price. Making EVs in large numbers is a lot easier when the supplier is right nextdoor; batteries are 33% more expensive in Europe than in China.

Batteries are also about a quarter of an EV’s weight. The fact that they’re all made in China cuts down on the amount of shipping cost you can save by locating car factories close to consumers.

Yet another reason is macroeconomic. As everyone knows, China is in the middle of a big economic slowdown, which has cut local demand for new EVs despite all the consumption subsidies. Europe’s economy is in the dumps as well, but China basically planned to produce enough EVs for a much faster-growing Chinese economy than the one they ended up with. So Chinese EV producers are stuck with massive inventory that they can’t sell domestically. So they’re slashing prices and dumping the inventory on Europe.

And finally, let’s not discount the ingenuity and innovation of Chinese auto and battery engineers and entrepreneurs. The industry shift toward EVs gave upstart carmakers a once-in-a-century opportunity to do an end run around the entrenched dominance of the old-line companies that knew internal combustion engineering backwards and forwards. European startups could have challenged Volkswagen and Renault and Mercedes-Benz. They did not. Instead it was Chinese companies like BYD and SAIC, along with one American company, Tesla, who seized the day…

…Losing the car industry could thus push Europe further along the path to deindustrialization. Cheap Chinese EVs are a boon to European consumers, and they help speed the green transition and reduce carbon emissions. But the competition also threatens to put a bunch of European workers out of a job — 7% of the region’s workforce work in the automotive sector. Traditionally, Europe has been much more concerned than the U.S. about protecting its industries from foreign competition; the EV spat with China will be a test of whether this is still the case, or whether Europe has embraced more of a “neoliberal” approach to trade.

But there could also be a national security angle here too…

…A domestic auto industry gives Europe much more ability to repurpose production lines and ramp up defense production when needed. If the auto industry flees to China, Europe will be that much more vulnerable to Russia. In fact, this is one reason the auto industry is so globally distributed today; during and after World War 2, lots of countries decided they needed car industries in order to maintain strong militaries.

So if Europe does decide to protect its car industry, what might it do?…

…tariffs don’t do much to help European carmakers become more competitive in the export markets they used to dominate. The fact is that Chinese-made EVs are mostly just better than European-made ones right now, and tariffs aren’t going to change that.

In order to address these issues, Europe would need more than tariffs. It would need an equivalent of the U.S.’ Inflation Reduction Act — a major program of production subsidies, not just for EVs themselves but for the batteries and the mineral processing facilities necessary to make them. Europe would also need to simplify and slash some of the overgrowth of regulation that it has piled up around the auto industry over the last few years. And it would need to subsidize R&D in the EV sector more heavily.

And another important step would be something Europe has shied away from doing in recent times: encouraging startups. It’s no coincidence that Tesla, a startup automaker, was able to run rings around the stodgy old giants of GM and Ford, with their deep reliance on legacy markets and legacy technology. Europe has no Tesla; if it really wants to compete with China, it needs at least one.

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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

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But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 10 December 2023:

1. Charlie Munger – A Conversation with Charlie Munger & John Collison – Charlie Munger & John Collison

John: [00:15:25] So my question is, how do you think about the quality of the business when overarching tech changes are really going to shake it up?

Charlie: [00:15:32] You’ve got to recognize the tech changes do cause some new businesses to flourish and other businesses that looked impregnable to fail. And that’s one of the realities you have to understand.

John: [00:15:44] So you secretly are a tech investor because your reasoning about the effects of tech on Costco or on…

Charlie: [00:15:51] Yes, it’s just that — take, for instance, pharmaceuticals. The American pharmaceutical industry is better than any other pharmaceutical industry in the whole world. And number two is not remotely even close. So we have one of the great achievements in the whole history of the world in science and technology and so forth. At the same time, there’s a fair amount of sleaze in the way pharmaceuticals are distributed. Everybody rooks the government…

John: [00:16:16] The PBMs, yes.

Charlie: [00:16:17] Yes. And that’s just the system. By and large, we haven’t invested in pharmaceuticals because we’ve got no edge. I don’t know enough about biology and medicine and chemistry to have any edge in guessing which new pharmaceutical attempt is likely to succeed and other people who know those things, not that they have perfect knowledge, but it’s way better than mine. Why in the hell would I play against other people in a game where they’re much better at it than I am when I’m playing for something desperately important to me like a way of feeding my family. So of course, we didn’t go near it.

I would argue that they’re — in practical life, you want to succeed, you got to do two things. You got to have a certain amount of confidence. And you have to know what you know and what you don’t know. You have to know the edge of your competency. And if you know the edge of your competency, you’re a much safer thinker and a much safer investor than you are if you don’t know it. And I constantly meet people, better to have an IQ of 160 and think it’s 150 than an IQ of 160 and think it’s 200. That guy is going to kill you because he doesn’t know the edge of his own competence and he thinks he knows everything.

Partly, Warren and I, we pretty much know what we know and what we don’t know, what we’re good at, what we’re not good at. And one of the things we’re not good at is guessing which new pharmaceuticals. So we don’t even look at it. After all, it’s a big universe out there and if we have to leave a certain kind of investment behind because we lack the capacity to deal with it as well as some other people. That’s all right. We don’t need an infinite number of opportunities…

…John: [00:21:36] So what examples do you prefer of businesses driving capital efficiency without squeezing small suppliers?

Charlie: [00:21:43] Well, Costco is one.

John: [00:21:44] By turning the inventory quickly?

Charlie: [00:21:46] Yes and doing that because they have fewer stocking units and they’re way more efficient.

John: [00:21:51] You’re on the board, right?

Charlie: [00:21:53] Yes. I am somewhat the older member. But Costco, it’s an amazing culture. The whole damn culture of the place is so subtle and it just marches from triumph to triumph. It was smart to have a small number of stocking units flowing through with enormous speed. It was right to have a membership system.

There are three things that Costco didn’t want. Didn’t want people who stole merchandise. They didn’t want the people who used bad checks, and it didn’t want people cluttering up his goddamn parking lot without spending a hell of a lot of money in stores. So a membership system, where they accept only a certain kind of a member, all of a sudden now they’ve got nothing but people who buy a lot per trip.

Costco has always had the lowest shrink rate in the world. Tricks the inside too. So the net theft rate at Costco was always below 2/10 of 1%. That’s unheard of.

John: [00:22:46] I hadn’t thought of the parking lot efficiency with the membership system.

Charlie: [00:22:49] You can’t go to Costco just to buy bottle of iodine, just drop in. You got to be a member and then you got to pay enough, so to an ordinary person, they’re not going to pay an extra $100 to buy a bottle of iodine or something. We keep the peach pickers, the little buyers out.

Sol Price used to say “A business should be careful in the business it deliberately does without”. Of course, that’s straight out of a Munger book. You figure out what you want to avoid. And they want to avoid theft losses, embezzlements, bad checks and cluttering up the parking lot without buying much. And their system caused all those effects at once.

John: [00:23:27] It’s like your first speech in the book, start with the business you don’t want, work backwards.

Charlie: [00:23:30] I know, but it’s so simple.

John: [00:23:32] Any others? Of businesses driving capital efficiency without squeezing suppliers.

Charlie: [00:23:35] There are lots of others. Practically all of the aerospace businesses have learned to make very high returns on capital.

John: [00:23:42] How do they do it?

Charlie: [00:23:43] They specialize in being good at something and handling the government well as a paying customer.

John: [00:23:49] Did you ever look at TransDigm?

Charlie: [00:23:51] Sure. I don’t like that way of making money.

John: [00:23:54] Because the price increases.

Charlie: [00:23:56] It’s too brutal. They figure out something that has a little monopoly due to the defense department regulations, and they raise the price 10 times. And they’re famous for it. I regard that as immoral…

…John: [00:24:25] One of the things you raised in the book is this question of when you have a small number of players in the industry, say, two or three players in the industry, it is not always easy to predict who will earn good profits and who will not. And so the airlines lost money since the Wright brothers versus the cereal manufacturers, very durably profitable. If you’re looking at the business today and you know that the industry will consist of two or three players, how can you predict will those players make money?

Charlie: [00:24:50] I don’t think it’s possible to be 100% accurate in making these predictions. But certainly, we’re looking backward, the people who had branded profits like coffee and oatmeal and so forth, made very high profits and airlines basically made no profits at all for their shareholders.

John: [00:25:09] But the airlines were branded goods.

Charlie: [00:25:11] But everybody had big capital equipment if they didn’t use it, they obviously were losing a lot of money. So that everybody was almost forced into a very destructive competition by the logic of the individual situations. There are a lot of businesses that are very hard to make money in permanently.

If you want to go into the business like restaurants, most people fail, small percentage of restaurants even last long enough to make a living to the people who own them. Too competitive. That’s why they fail. Just like there are too many deer on an island and no predators, pretty soon there are too many deer. So all the deer suffer because there are too many of them.

John: [00:25:49] But again, to go back to this question, if I want to understand, will the business be like an airline or like a cereal company. Is this then the ongoing capital expenditure that’s required where airlines fundamentally, they have lots of CapEx on an ongoing basis, it’s like the original Berkshire textile mills?

Charlie: [00:26:02] The airlines are like a guy who builds a big hotel and it’s just sitting there and he makes some incremental profit from filling it. And if it’s got up and staff, that’s better than just letting it sit there vacant. It almost forces irrational intense competition. The same thing does not happen within cereals.

John: [00:26:19] BNSF was one of the biggest acquisitions you guys did. And my sense from the outside is that it’s maybe even been more successful than you would have expected. Is that accurate? Or did you expect it to be this successful?

Charlie: [00:26:31] The railroads were a lousy investment. There were a few people when they were first created that basically stole all the money by milking the government, bribing legislators and doing all kinds of terrible stuff. But by and large, most railroads are lousy investors, like the airlines for a long time. And finally, it got down after years of fighting unions and consolidations, so you get down to a few big systems.

Now there are just two big transcontinental systems, and we’ve got one of them. Of course, that’s a less competitive market than it was — than it existed earlier when there were 100 different railroads. But early railroads when they were terribly competitive, they were terrible places to invest money.

John: [00:27:12] But again, airlines, bad business, not a good investment.

Charlie: [00:27:16] Early railroads, bad business.

John: [00:27:19] Early railroads, yes. Railroads today still require a lot of ongoing CapEx.

Charlie: [00:27:23] Yes, but they’re so dominant. Once you have a railroad that can put shipping containers on that stack too high on tracks. It’s one of the most efficient ways of transferring assets all over the country. It’s way more efficient than trucking. So that they have a system that just accidentally happened. Nobody anticipated you’d be able to double the capacity of the railroad just by shoving containers one on top of the other. So they got very efficient finally. And now they’re so efficient. They’re more efficient than anything else. And of course, they do well…

…John: [00:32:38] You have been famous for criticizing gold earlier on and now cryptocurrency.

Charlie: [00:32:46] I like to gold a lot better than I like cryptocurrency.

John: [00:32:49] You’ve criticized both.

Charlie: [00:32:51] Before there was cryptocurrency, I never bought gold. So I didn’t like gold. But I don’t hate gold as an investment as much as I hate cryptocurrency. I think cryptocurrency ought to have been driven out as illegal.

John: [00:33:03] At the risk of maybe getting ejected from the premises, if I can try to defend cryptocurrency, isn’t the perspective you have where — I think you would say, invest in a productive business. Isn’t that a reasonably U.S.-centric perspective, where absolutely, we have a great currency here. We have a great respect for property rights here. If you’re in Turkey and their property rights aren’t as strong, the currency is inflating 80% a year as it has this year, then the ability to move your wealth…

Charlie: [00:33:34] Well, if I lived in Turkey, I might do something odd. Buy my gold if I were in Turkey, but I would never buy cryptocurrency.

John: [00:33:39] Even in Turkey?

Charlie: [00:33:40] No. I don’t think that buying a percentage of nothing is a good investment, even though it’s hard to create more nothing.

John: [00:33:47] But isn’t gold functionally an investment in the percentage of nothing?

Charlie: [00:33:50] It is similar, except it’s been established so long as a…

John: [00:33:57] An agreed upon store of wealth…

Charlie: [00:33:58] With the history we have and with the need for a currency and a currency that is backed by something and gold is hard enough to mine and so forth. Gold is a perfectly reasonable thing to use as a currency. And the evolution of use of gold as a currency was a very good thing for civilization. I don’t have the feeling that gold is evil. Gold helps civilization develop. But I think cryptocurrency is scumball activity. And I think by and large, the people who promoted it are scumballs or delusionary. And I don’t know which is worse, being a scumball or a delusionary. But I think they’re both pretty bad.

John: [00:34:31] Some people can manage to be both. There’s plenty of scams in crypto. That’s absolutely not up for debate. But are we talking about questions of degree here between gold and cryptocurrency, where they are societally agreed upon stores of value, which trade above…

Charlie: [00:34:46] Let’s put it this way. If we didn’t have gold, we might have invented something like cryptocurrency as a substitute. But once we have gold and fiat currencies that are now long established, we don’t need to add in cryptocurrency.

John: [00:34:59] But isn’t cryptocurrency handier? If you can work with it in just software, you don’t need to actually go get some physical gold, trade it, melt it down. It’s much harder to seize cryptocurrency than it is to seize gold in an autocratic regime.

Charlie: [00:35:10] You don’t have to bother with any physical inventories or anything has any intrinsic value. You can create system very efficiently dealing in it. I don’t want to officially deal in nothing and craziness. I want to make it illegal. All nations have had anti-counterfeiting laws. And I think the anti-counterfeiting laws ought to have been used to totally bar cryptocurrency.

John: [00:35:33] But nothing’s being counterfeit here.

Charlie: [00:35:34] Well, if I am a nation and I have a currency, I don’t want a new currency established.

John: [00:35:38] But it’s not really a new currency. It’s a new store of wealth.

Charlie: [00:35:42] You can call it a store of wealth, I call it a store of delusion. I don’t think it’s good to participate in delusion even when it gets quite common. A second medium of exchange widely used. It’s ideal for drug dealers, dope dealers, scam artists of various kinds. Every kind of criminal you can imagine. Very good in extortion, kidnapping.

Why would we want a wonderful crime facilitating new medium of exchange? Why wouldn’t we just say this is like counterfeiting? You’re coming into the government’s business and you’re trying to create a fiat currency and you can’t do that. It’s a feel they don’t…

John: [00:36:18] All right. Well, I will agree to disagree on crypto. But…

Charlie: [00:36:20] You don’t have to agree. I can handle it if you like crypto. I don’t like it, but I can handle it.

John: [00:36:25] We’re staring into a recession, potential stagflation. What advice do you have for people thinking about how to work their way through the…

Charlie: [00:36:35] I have one standard set of advice for all difficulties, suck it in and cope. That’s all any human being can do, suck it in and cope. Partly, you have to be shrewd. That’s one way of coping is to be as shrewd as you can possibly be. But that’s my recipe. And I must say it’s worked pretty well for me. It will work very well for any other person who uses my methods…

…John: [00:37:59] How do you feel about American society over the coming decades?

Charlie: [00:38:03] Old men have always tended to think that new generation is going to hell. The old Romans, o tempora, o mores. That goes back to the earliest civilizations we had. The old guys were saying when I get out of the world, it’s going to hell. And it really wasn’t going to hell net by and large. But I do not like the way politics has morphed in my lifetime in the United States. I don’t like democracy. The way it actually morphed into existence with these primaries and the dominance of two parties where only the most extreme members of each party have a lot of pulling power and therefore, they control the nominees and so forth.

I think our way of getting nominees is deeply flawed now. It may have worked pretty well up until now. It worked better when we had those old, crooked bosses in the cities then it’s working now with the primaries. I wish those old, crooked bosses would come back and replace the present primaries. Wanted to control the patronage so they actually nominated some pretty good people like Teddy Roosevelt. And these modern primary systems, the worst people often win…

…John: [00:39:10] How do you feel about declining birth rates?

Charlie: [00:39:11] It creates a different kind of a world. Well, I don’t see that mankind would be at all smarter if everybody had six children. I think that just jams up population way too much starting with 7 billion for the whole world. So I think it’s good that the population is growing more slowly. But do I think it is good for people to be quite self-centered below 35 and then get married compared to marrying at 21 or 22 and having a lot of children?

No, I think the people who married at 21 or 22 and grew up fast because they had to because they have those young children. In a sense, I think they were a luckier generation than the people who came along with all these different options and who delay marriage into late age and have one or two children, I’m not at all sure it’s good for the people who are having these new options, but it is good for the population…

…John: [00:43:15] Where do you think the world is getting worse?

Charlie: [00:43:17] I think we have a political game problem that’s probably as bad as we’ve ever had. We have some crazy dictators on the verge of creating a nuclear war. We’ve got lots to worry about. The world has never been a perfectly safe place and it isn’t now.

John: [00:43:32] Kind of a societal version of your avoiding mistakes framework from Poor Charlie’s Almanack, where societies need to avoid the major mistakes just like individuals do, avoiding nuclear war.

Charlie: [00:43:42] We’re lucky to have done it so far. But if enough crazy people have enough hydrogen bombs, there will eventually be enough hatred, we’ll have an atomic war of some kind someday. You can almost count on it. So you can say that our generation, it was quite unlikely, but I think it’s getting more likely and not less…

…John: [00:46:15] And what’s an example of where you are more multidisciplinary than the architects in some of the buildings you’ve designed?

Charlie: [00:46:19] If you take the building, the graduate residence at the University of Michigan. They had a magnificent site with a parking lot. They had no other site. They’d used up all the land in the dormitory. They have a second campus, but on their main campus, they’d used up all the sites. And there is one little parking lot left. And I realized that if they used their power of eminent domain and doubled the size of that parking lot, they’d get it with a big square building on the site tha would hold a lot of graduate students.

But there was no way to do that without creating a window shortage in some of the bedrooms. And I also knew that it didn’t matter that there was a window shortage in the bedrooms because I went around Ann Arbour and saw the private builders in Anna Arbour now have already created  apartment rooms with no windows and relying on artificial light. And I walked side-by-side exactly identical bedroom, one with a real window and one with just a blank wall. And the one with just a bank wall renting for 10% less.

So it wasn’t much of a problem. I looked for the evidence and then once I realized that, I could do all kinds of wonderful things in that building once I got over this prejudice that it was absolutely required under any and all circumstances that every bedroom have a window. So it’s just an example of just the most elementary common sense. I looked at the evidence at Ann Arbor. I understood geometry well enough to know. And then too, I was well aware that every ship has exactly the same problem. Every ship has a window shortage automatically. Every cruise ship. Yeah, and they pay $20,000 a week to be on the ship and so forth.

And if they don’t want a little light, they walk out of the ship and go into one of the common rooms. And of course, that’s what I arranged they do in the dorm. So I was following correct precedents from marine architecture. But show me an architect that’s learned anything from marine architect. I think you could go into any school of architect in the country and you won’t find anybody studying marine architecture. They think it has nothing to do with it. It has a lot to do with what they’re doing. If you don’t look, you won’t find.

John: [00:48:27] I feel like another example of understanding the customer is giving the students in the dorms single rooms where most people design…

Charlie: [00:48:32] Oh, well, that — talking about insanity. Now, I have sent a lot of children through a lot of graduate education. And I’ve never had a child that liked being in a room with one or two other unrelated people sleeping in the same room…

…John: [00:49:19] Why did this shared delusion persist for so long?

Charlie: [00:49:22] What happened was that the fire codes, they worry that the fireman would need a ladder to go and look through the window and crawl in through the window and haul somebody who had passed out from smoke. So they required that every sleeping space have a window. So the fireman could crawl up on a ladder. There were two things wrong with that.

One, it never happened. Nobody could find a case were a fireman — they would crawl up by ladder and look through and they had found somebody lying in bed passed out of smoke. And two, of course, a modern building with automatic sprinklers, that’s why there was going to be zero.

And that’s why the fire codes changed. And when the fire codes changed because — but the people are used to doing it in a certain way. Of course, they keep doing it the same way they’ve always done. Isn’t it the Mayo Clinic is one of the best places on earth in terms of an admirable culture. They kept doing hip replacements by a procedure that the doctors knew how to do because the new one that was better for the patient was very hard for the doctor to learn. And so they just kept doing it the old way. Architects are no different. They do what they’re used to.

John: [00:50:32] Again, for say, someone who’s 25 or 30, is the lesson that there are a lot of $20 bills lying on the sidewalks? There’s a lot of inefficiency in the world to be rectified that people should not assume the world works efficiently?

Charlie: [00:50:45] Well, of course, there’s always a lot of things that can be improved, always a lot of people who are getting ahead by doing something new. And that’s one of the pleasures of modern civilization. And imagine a postal clerk in the United States can go to Hawaii on a 2-week vacation on a superjet and have a nice time. A postal worker could do that in the world that you’re up in.

You can learn a whole new profession just punching buttons on the Internet and so forth, so the possibilities of self-education is fairly enormous. So all kinds of things have been greatly improved. Of course, that causes new opportunities for some people, and it causes absolute economic destruction from certain people who get obsoleted.

Imagine the Kodak company, which hired all the PhD chemists, totally dominated the chemistry of film and so forth and had the most reliable trademarks in the whole world. Go through Africa when I was young, there are 2 things you always saw: a Coca-Cola and Kodak. That was the brands all over Africa, the poorest villages. And of course, Kodak went totally broke because somebody invented a new way of taking photographs and developing photographs. And it just obsoleted their whole damn business, and Kodak wiped out its common shareholders. That happens all the time, that kind of thing. And you can’t blame the management for it and say, “Well, didn’t Kodak invent its own destruction?” That’s hard to do.

I mean for human nature, you’ve got a business as big as Kodak, everybody’s lived over for years. They’re like the surgeons who didn’t want to learn a new trick that was lot harder to learn when they were old. People don’t welcome having to learn something new. It’s really hard to learn. Everybody would rather get ahead using what he already knows…

…John: [00:53:18] You spend a lot of time in the book talking about businesses that are win-win for both sides and the importance of this for their long term.

Charlie: [00:53:24] How can anything be more important? It isn’t just that it works better in terms of creating plenty for all. It’s better morality. Of course, both sides want both sides to win, that’s more moral than trying to take advantage of other people when it’s so obviously the right way to live and it’s the right way to do business…

…John: [00:55:56] So you wouldn’t invest in drugs, tobacco or the Grateful Dead?

Charlie: [00:55:59] No, that’s correct. I would not. When I sell you a tennis racket for $100, one side gets the tennis racket they’d rather have than a hundred dollars they’re partying. The other guy, he likes what he’s getting, too. It’s win-win.

That’s the beauty of capitalism. It makes win-win transactions very easy and almost automatic. That’s such a hugely important idea. And people like Bernie Sanders and Elizabeth Warren, both of whom I regard as quite talented in some ways, but they just don’t get it.

John: [00:56:27] But I think you mean that as a backhanded compliment.

Charlie: [00:56:29] It’s both a compliment and a criticism.

John: [00:56:32] Is the fundamental thing they don’t grasp that a lot of the win-win businesses are net positive and win-win for both sides and they…

Charlie: [00:56:40] It’s automatic in a capitalist transaction, unless one side is making a big mistake. And most people are pretty good at not making mistakes over and over again with their own money.

John: [00:56:49] It’s not fully automatic, right? We can…

Charlie: [00:56:51] No, it’s not. But a lot of good happens automatically.

John: [00:56:54] Do you worry about the rise of this faction of the political spectrum who don’t really believe in capitalism?

Charlie: [00:57:00] Of course, look at the misery that’s happened to the Russian people. They didn’t like their old system with a bunch of serfs serving a bunch of landlords and so forth, corruption and so forth, so they went to something worse.

They were rebelling against something that was awful, so they substituted something that turned out to be actually worse. It’s hard to create a new form of government worse than Russian serfdom, but Russia has managed to do it. And not only that. They’re proud of having done it. You should never be proud of your defects.

John: [00:57:30] What are Berkshire’s defects?

Charlie: [00:57:31] We haven’t eliminated all mistakes of judgment or even all mistakes of morality. So nobody gets anywhere near perfect ever in human affairs. It’s not exactly a defect. A lot of what worked for us in the early days, we can’t do anymore because the world is more competitive.

The low-hanging fruit has all been picked, and we can’t get fruit out of barren branches where the fruit has gone away. And so we have to go to something else. And of course, that’s harder. A lot of people have that problem, and they go to the new systems in new ways.

John: [00:58:01] I’ve always liked the quote capitalism is how we take care of people we don’t know.

Charlie: [00:58:05] It’s certainly remarkable how it works. I like a social safety net, but I’m different from other people. If I were running the government, the modern civilization, I would be quite liberal at rewarding everything that can’t be faked, like being blind or not blind or something. I’d just give a very blind person a lifetime pension, which goes up with inflation.

If life is tough enough for you, we can afford to do it, and you and your handlers can figure out how you use the money. So I would be very liberal. I would give anybody any education right through college, courtesy of the government, but it would be meritocratic. You have to be able to do the work or you don’t qualify for the benefit.

So I wouldn’t let people pretend to be learning things in some half-assed institution and send the bills to the government. But places like Caltech or MIT, anybody could get in and do the work, if I was the government I’d pay for it all the way through college and graduate school, which they do in places like New Zealand and Australia and so on.

Again, everything in medicine, that is almost automatic, I would pay for that, too. But would I pay for Freudian analysis? No. Stuff that can be gamed and it was crazy, I would not pay for. And I wouldn’t allow the people to get rewards for low back pain, even though they have real low back pain. And it’s easily faked. I wouldn’t pay. It just causes too much cheating and the cheating gets to the eventual and so forth.

I would just say we can’t do that. It’s not that we don’t sympathize with your low back pain and your poor life adjustment? But we can’t give lifetime pay just because you say, “My lower back hurts.” or, “my life adjustment is imperfect.” That’s the way I would organize the government. Nobody thinks the way I do. I feel lonely. I would be quite generous, but I will be quite tough on people with low back pain or psychological problems…

…John: [01:12:23] If Patrick and I came and put you on Stripe, what would you want to understand about the business? What would your concerns be?

Charlie: [01:12:30] That’s an interesting question, considering how much Berkshire Hathaway has made out of other payment systems, including American Express. We recognize the power of having a dominant position in payments in a way that’s very efficient. And of course, anything in modern payments that enables all this Internet stuff is very useful. So you’ve come into a field and made a contribution and made yourself very useful.

I’m for all these payment systems that get better and better. So I think you’ve made your money honorably and you’ve made a lot of it, and good for you. I admire what you people have done. Why wouldn’t I? I regard everything that you’re doing as a little bit threatening to American Express, but American Express actually has a position where it’s like Hermes or something, and so it won’t necessarily be ruined by Stripe.

John: [01:13:22] In evaluating a business like Stripe, what questions would you want to answer for yourself?

Charlie: [01:13:26] Is it likely to remain forever as a money generator? And that’s a more complicated subject. It’s hard to know how the world is going to evolve. If Kodak could suddenly be obsoleted away, maybe it’s not utterly unthinkable if Stripe could.

The company that dominates software for architects, terribly prosperous company, but some other companies come up in that field a lot and it no longer dominates as much as it did. So not everything in software always wins. So I do not have the feeling — the venture capitals tend to think everything in software is always going to win. I don’t believe that for a minute…

…John: [01:14:48] Why has NetJets done so well?

Charlie: [01:14:50] It’s better in its niche than anybody else. In NetJets, the whole culture, safety is first, customer service is second. And after that, we’ll start worrying about the capitalists who own NetJets. And of course, there’s enough fanaticism of that kind of a culture. We create a hell of a product for the person who can afford anything. And ours is better than anybody else in the country, and it’s now big. It’s a big business. And we have yet to kill our first passenger. All these many years, we’ve never killed a passenger…

…John: [01:15:33] I can feature the magazine ads. NetJets- “No one has died yet”.

You’re very bullish on China. Why?

Charlie: [01:15:41] Well, first reason is that their economy was growing faster than ours. That isn’t necessarily true as we consider this exact minute, but for a long time, that economy grew a lot faster than ours. Number two, we could get way better and stronger companies at a much lower price in China than we could get in the United States. Now on the other side, we had to take the political risk of buying into a peculiar system of government that’s not different from ours.

As long as we were getting enough bargains, I was willing to run the — as with part of our assets is we would never invest all of our money in China, for Gods’ sake. But we were certainly willing to invest part of it. That’s perfectly logical. And of course, we were investing through Li Lu, he was a very exceptional money manager. And we put all those 4 things together, the ones, of course, that made sense…

…John: [01:17:19] How does the current geopolitical hawkishness change your view on investing in China, if at all?

Charlie: [01:17:24] Obviously, I’m more uncomfortable now than I was. The guy who changed the whole system and said, “I don’t care if the cat is black or white as long as it catches mice.”, he wanted the goddamn economy of China to work like Singapore’s. Of course we love that guy. And the new guy isn’t quite as much like that guy as we would consider ideal. We think the political risk in China should be run, and I think we should go out of our way to have a lot of friendly relations with big atomic powers.

Both China and the United States ought to get along with one another as a matter of wholly duty because they’re 2 big atomic powers. And the way you get along best is we should carefully work out a bunch of win-win transactions between us and China and actually work to make them work even better. That is the right policy in the United States.

We should not be trying to discipline China by telling them like a nattering nanny how China ought to behave and say, “We know better. We’re a democracy and you’re not.” We have a lot to be ashamed of in our own form of government. We shouldn’t be going around lecturing everybody else. And we should organize win-win transactions with China. Anything else is madness.

And for a long time, we had that. You can argue that China came to modernity primarily in win-win transactions with the United States because we’re so open to their imports. That’s what enabled them to get ahead so fast. And I’m proud of that, and I’m glad we helped them. And I want to do more of it. I don’t want this hostility on both sides.

John: [01:18:53] Tom Wolfe wrote a short story about Bob Noyce. I’m a huge Tom Wolfe fan of his books, but he has a great short story about Bob Noyce. And you can read the short story as it’s really about Grinnell, Iowa and the effect of Midwestern culture in Silicon Valley.

Charlie: [01:19:11] It’s a huge success, of course. And the success is interesting, but I would argue that the failure of Intel was just as interesting a story. Intel was on the ground floor of modern chip making. Absolutely ground zero. They were at the absolute best place. And they just grew and grew and so forth. And they eventually lost all their leadership completely, and they’re just a little pissant company compared to the big guys now.

John: [01:19:40] Why did that happen?

Charlie: [01:19:41] Firstly, some of that’s inevitable. In competitions, somebody are going to lose. It’s — partly it demonstrates the inevitable even if you’re successful, so a little guy that really scrambles, be sure that there’s some accidents, but partly, they were so interested in always reporting more earnings. They didn’t go to the leap enough, just stay on top.

If you’re serving along the edge of a new development like that, you have to just absolutely be going flat out all the time, and you have to be leading all the time. Berkshire, we don’t have to invent new things, particularly, compared to most places. They’re in the business of inventing new things, and you have to be totally fanatic.

And the truth of the matter is that the people in China were way more fanatic than Intel. In China, you had one old guy that controlled the place and he was a fanatic, and Intel had an army of bureaucrats, and they were interested in their executive rewards and the way the price earnings ratios and the approval of Wall Street. A whole lot of other things. And they were powerful. Now they look good for a while just by using their power to make the earnings go up.

But they should have been using their power to make sure their goddamn chips stayed way ahead of everybody else. And they had to be a totally reliable supplier, which they weren’t. They disappointed a lot of customers, and you can’t disappoint customers if you wanted to have a Mayo system of trust. That’s the interesting part of that, not the Noyce story. The story of the failure of Intel was the great story there…

…John: [01:31:17] Is the secret of Berkshire’s culture just the anti-bureaucracy bend? Could you sum it up…

Charlie: [01:31:22] Berkshire is pretty extreme in culture. We are deeply aware of how bureaucracies tend to create their own internal dynamics so that everybody protects everybody else and nobody changes anything, ruffles any feathers. And the net result is that a lot of bureaucracies make some very stupid decisions and we try and avoid that.

But the way we’ve done it, mostly, is by not having anybody around. They can’t be bureaucratic if they’re not there. There is nobody in the head office. So we avoided the bureaucracy. We just don’t want other people to do it. Nobody else is as extreme as we are in that. It’s a huge advantage to us.

And another thing is, we like very trustworthy people. I’d rather have a brief telephone with somebody I trust than I would a 40-page contract prepared by the finest law firm in the world with somebody I don’t trust. And so we like to deal with trustworthy people and to be able to count on their oral promises.

If you look to go into a Mayo operating room is what I call a seamless web of deserved trust. The surgeons trusting the anesthesiologist, the anesthesiologists trusting the surgeon, the nurses are trusting — everybody trusts everybody else. There’s no bureaucracy at all. They don’t have time for bureaucracy.

It’s in patients’ interest to get it over as soon as possible. And so that seamless web of deserved trust can do these very complicated procedures. We like a business system that operates as much as possible like a Mayo operating room, and that requires having very good people who are experienced enough with one another to trust one another.

John: [01:32:55] And that trust is internally between the Berkshire folks or between the Berkshire folks and the managers?

Charlie: [01:33:00] Both. We want the internal and all the Berkshire people to trust one another internally, and we also want the customers to trust us. We’re all for trust. Trust is one of the greatest economic forces on earth.

2. Charlie Munger’s Life Was About Way More Than Money – Jason Zweig

It’s 1931, and a boy and girl, both about seven years old, are playing on a swing set on N. 41st St. in Omaha. A stray dog appears and, without warning, charges. The children try to fight the dog off. Somehow, the boy is unscathed, but the dog bites the girl.

She contracts rabies and, not long after, dies. The boy lives.

His name? Charles Thomas Munger.

Charlie Munger, the brilliant investing billionaire who died on Tuesday in a California hospital 34 days before his 100th birthday, told me that story when I interviewed him last month. I’d asked the vice chairman of Warren Buffett’s Berkshire Hathaway BRK.B -0.75%decrease; red down pointing triangle: What do you think of people who attribute their success solely to their own brilliance and hard work?

“I think that’s nonsense,” Munger snapped, then told his story, which I can’t recall him ever publicly recounting. “That damn dog wasn’t 3 inches from me,” he said. “All my life I’ve wondered: Why did it bite her instead of me? It was sheer luck that I lived and she died.”

He added: “The records of people and companies that are outliers are always a mix of a reasonable amount of intelligence, hard work and a lot of luck.”

I had the extraordinary good luck to get to know Charlie Munger in the past two decades. If you think his life was only about piling up money, think again. Few people have ever been wealthier, in all the senses of the word, than Munger was.

Those who know only a little about him think Munger was a paragon of how to pick stocks—which he was. But those who knew him well consider him a moral exemplar—someone who showed how to think clearly, deal fairly and live fully. He took nothing for granted.

More than almost anyone I’ve ever known, Munger also possessed what philosophers call epistemic humility: a profound sense of how little anyone can know and how important it is to open and change your mind…

…“Part of the reason I’ve been a little more successful than most people is I’m good at destroying my own best-loved ideas,” Munger told the Journal in 2019. “I knew early in life that that would be a useful knack and I’ve honed it all these years, so I’m pleased when I can destroy an idea that I’ve worked very hard on over a long period of time. And most people aren’t.”…

…Munger deliberately kept himself surrounded by people he liked. “Many of the richest people have holes inside of them that they’re always trying to fill,” Munger’s friend Peter Kaufman said last month. “But Charlie knows you can’t fill those holes with money. That’s why he spends so much time with friends and family.”…

…One lesson: the importance of what Munger called “a seamless web of deserved trust” in which a company deals fairly with employees, customers, competitors and other constituencies.

“If you’re structurally adversarial to those adjacent to you in the ecosystem, maybe you prosper for five years,” said Collison, “but not for 75 years!”…

…“You know how a lot of old people say, ‘At my age I don’t even buy green bananas’?” regular guest John Hawkins, co-founder of private-equity firm Generation Partners, said recently. “Well, Charlie is buying green bananas by the truckload. He’s making investments for the next 10, 20, 30 years. He has his foot on the gas and is not taking it off.”…

…He mocked the marketing of short-term investment performance by telling a story about a man who walks into a fishing-tackle store and sees a bunch of gaudy, iridescent lures. “My God, they’re purple and green!” he says to the owner. “Do fish really take these lures?” The store owner answers, “Mister, I don’t sell to fish.”…

…Then I asked what he might want for an epitaph of no more than 10 words.

His reply was immediate and full of epistemic humility: “I tried to be useful.”

Not “I was useful.” That would be for other people to judge. But “I tried.” That much he knew.

3. What Will It Take for China’s GDP to Grow at 4–5 Percent Over the Next Decade? – Michael Pettis

There are two different groups of economists in China that believe that with the right—albeit very different—set of economic policies, China’s economy will be able to grow sustainably by 4–5 percent for many more years. One group argues that China must maintain the investment-driven and manufacturing-intensive strategy it has followed during the past three to four decades. The other group argues instead that China can maintain high growth rates only if it sharply reduces the investment share of GDP and replaces it with a greater reliance on consumption, something which Beijing has been trying to do for over a decade…

…Can China maintain high GDP growth rates driven by high investment? Some simple arithmetic is useful here. Globally, according to the World Bank, investment represents on average 25 percent of each country’s GDP and has remained within a tight range of between 23 percent and 27 percent during this century…

…China, however, is a huge outlier. It currently invests 42–44 percent of its GDP. What’s more… for the past two decades China’s investment share of GDP has never been below 40 percent; it reached as high as 47 percent in 2010 and 2011. In the previous two decades, the investment share of GDP was lower, but it still exceeded 35 percent on average, leaving China during the past four decades with the highest investment share of GDP, and the fastest growth rate in investment, in history.

The obvious implication is that while China accounts for a disproportionately small share of global consumption, it accounts for a disproportionately large share of global investment… According to the World Bank, China’s $18 trillion economy accounts for just under 18 percent of global GDP, making it the world’s second-largest economy after the United States, which accounts for about 25 percent. But China comprises only 13 percent of global consumption and an astonishing 32 percent of global investment…

…if China maintained its high investment share of GDP—in other words, if investment continued to grow as fast as GDP—and GDP grew at rates of 4–5 percent for the next decade, China’s share of global GDP would rise by less than 3 percentage points, to 21 percent, while its share of global investment would rise by more than 5 percentage points, to 38 percent. Its share of global consumption, however, would rise by well under 2 percentage points, to less than 15 percent.

Can China really account for 38 percent of global investment while its economy comprises just 21 percent of global GDP and 15 percent of global consumption? Every $1 of investment has required approximately $3 of consumption globally to sustain it during this century. In China, however, $1 of investment is balanced by only $1.30 of consumption. If the global relationship between consumption and investment held over the next decade, an increase in the Chinese share of global investment from 32 percent today to 38 percent in a decade would require that the rest of the world disinvest to accommodate China’s domestic imbalances.

To give a sense of just how extreme this requirement is, it would mean that to prevent a global overproduction crisis (which would hit China especially hard), the rest of the world would have to agree to reduce the investment share of its GDP by roughly 1 full percentage point, to 19 percent of GDP, well under half of the Chinese level. Needless to say, this is very unlikely, especially with the United States, the EU, and India putting into place policies aimed at boosting domestic investment.

What’s more, to the extent that the surge in China’s debt burden is driven by its extraordinarily high investment share of GDP, it would require China’s debt-to-GDP ratio to rise from just under 300 percent today to at least 450–500 percent in a decade. Given the huge difficulties the Chinese economy is already facing at current debt levels, and the difficulties Beijing has had in its attempts to reduce the debt burden, it is hard to imagine that the economy could tolerate such a substantial increase in debt…

…Globally, according to World Bank data, manufacturing represents 16 percent of GDP and has ranged from 13 percent to 17 percent during this century.

China, once again, is an extreme outlier, with manufacturing representing 28 percent of the country’s GDP. This share had declined from 32 percent in the decade before 2020, but it has risen in the past two years. This recent increase is not surprising. As a consequence of the contraction since 2021 in China’s long-lasting property bubble, there has been a major, policy-driven shift in investment from the property sector to the manufacturing sector, even though the evidence suggests that investment in Chinese manufacturing has been constrained by weak demand—not by scarce capital—so that even more investment in the manufacturing sector implies a further growth in excess capacity (that is, growth in domestic capacity that exceeds growth in domestic demand)…

…While China accounts for 18 percent of global GDP and only 13 percent of global consumption, it currently accounts for an extraordinary 31 percent of global manufacturing. If China maintained annual GDP growth rates of 4–5 percent while also maintaining the role of manufacturing in its economy, its share of global GDP would rise by less than 3 percentage points in a decade, to 21 percent, even as its share of global manufacturing would rise by more than 5 percentage points, to 36 percent…

…To accommodate this and prevent a global overproduction crisis, the rest of the world would have to allow its manufacturing share of GDP to drop between 0.5 and 1.0 percentage points. It would also have to allow a surge in China’s trade surplus—currently equal to nearly 1 percent of the GDP of the rest of the world—as a 5–8-percentage-point increase in China’s share of global manufacturing would be backed by a 2-percentage-point increase in China’s share of global consumption.

Again, this is very unlikely, especially with the United States, the EU, and India enacting policies aimed at protecting and boosting domestic manufacturing. In fact, given China’s determination to increase its reliance on manufacturing to drive growth, I expect global trade relationships to deteriorate sharply in the next few years as the world’s major economies battle over their respective manufacturing sectors…

…The net result would be persistent downward pressure on global demand as major economies competed by subsidizing production at the expense of consumption. This would only worsen global trade relationships because, in the end, only economies that were willing to protect their manufacturing sectors, or maximize the subsidies they delivered to domestic manufacturers, would be able to prevent their manufacturing sectors from contracting as a share of total GDP…

…If they set off a global trade conflict involving the United States, the EU, India, and Japan, the results would be especially painful for countries such as China that rely on large trade surpluses to balance weak domestic demand with an overreliance on manufacturing to drive growth.

That’s because without sustained trade surpluses, there are only two ways a country can balance excess supply with weak domestic demand. One way involves a painful and potentially disruptive collapse in production, as occurred most famously in the United States in the early 1930s, when it had to try to resolve its huge trade surplus in a contracting world economy exacerbated by beggar-thy-neighbor trade and currency policies. The other way is to boost domestic demand as quickly as possible…

…To put it another way, if China wanted to maintain GDP growth rates of 4–5 percent, Beijing would have to engineer policies that caused consumption to grow by at least 6–7 percent a year, with investment growing at roughly 1 percent annually.[3] Any lower consumption growth rate would mean that China could not rebalance its economy in a decade and still maintain current GDP growth rates.

If China pulled this off, at the end of the ten-year period its GDP would comprise 21 percent of global GDP (up from 18 percent in 2022). Its economy would be far more balanced, with investment comprising 29 percent of global investment (down from 31 percent in 2022) and consumption comprising 18 percent of global consumption (up from 13 percent in 2022). In that case, as its share of global GDP would rise by nearly 3 percentage points, its share of global investment would decline by 2 percentage points and its share of global consumption would rise by 5 percentage points.

With consumption growing at roughly 4 percent a year before the pandemic (and much less since), is 6–7 percent growth in consumption possible? No country in history at this stage of the development model has been able to prevent consumption from dropping, let alone cause it to surge, but that doesn’t mean it’s impossible.

But it won’t be easy. With investment growth slowing, which means fewer jobs building bridges, train stations, and apartment complexes, the only way to accelerate consumption growth sustainably is to get household income growth to accelerate through transfers—either directly (such as through wages and other income) or indirectly (such as through a stronger social safety net).

The problem with transfers is that they must be paid for, and there are only three sectors that, in theory, can meaningfully pay for them. One sector that can pay is the rich, who consume a much lower share of their income than ordinary households…

…A second sector that can be forced to pay is the business sector. For example, businesses can pay for these transfers in the form of rising wages, higher taxes, a strengthening currency, or higher borrowing costs (if these are matched by higher deposit rates for household savers). The problem is that with China’s manufacturing competitiveness based primarily on the very low share of income Chinese workers retain relative to their productivity, this would seriously undermine Chinese manufacturing.

The only other sector that can pay is government. There are in fact two levels of government in China: Beijing and local governments. Given the structure of payments and social transfers in China, along with Beijing’s explicit refusal to absorb the various debt and adjustment costs, it is very unlikely that Beijing will be willing to take on the full costs of transfers, which would require mainly central government borrowing.

That leaves local governments as the sector most likely to absorb the costs. By my calculations, if Beijing forced local governments to transfer roughly 1.5 percent of GDP every year to households, it would be possible to drive the growth in both household income and household consumption to around 7 percent annually. This is not as hard as it might at first seem. In spite of terrible cash flow pressures in recent years, local governments may own assets worth as much as 20–30 percent of China’s GDP.

But transferring such a large share of local governments’ assets won’t be easy. Such substantial transfers would be politically contentious and require a transformation of a wide range of elite business, financial, and political institutions at the local and regional level…

…The arithmetic, however, is quite straightforward: unless the rest of the world is willing to reverse its strategic economic priorities to accommodate Chinese growth ambitions, global constraints imply that China cannot continue growing its share of global GDP without sharply reducing the growth rate of investment and manufacturing. 

4. The CRISPR Era Is Here – Sarah Zhang

Four years ago, she joined a groundbreaking clinical trial that would change her life. She became the first sickle-cell patient to be treated with the gene-editing technology CRISPR—and one of the first humans to be treated with CRISPR, period. CRISPR at that point had been hugely hyped, but had largely been used only to tinker with cells in a lab. When Gray got her experimental infusion, scientists did not know whether it would cure her disease or go terribly awry inside her. The therapy worked—better than anyone dared to hope. With her gene-edited cells, Gray now lives virtually symptom-free. Twenty-nine of 30 eligible patients in the trial went from multiple pain crises every year to zero in 12 months following treatment.

The results are so astounding that this therapy, from Vertex Pharmaceuticals and CRISPR Therapeutics, became the first CRISPR medicine ever approved, with U.K. regulators giving the green light earlier this month; the FDA appears prepared to follow suit in the next two weeks. No one yet knows the long-term effects of the therapy, but today Gray is healthy enough to work full-time and take care of her four children…

…The approval is a landmark for CRISPR gene editing, which was just an idea in an academic paper a little more than a decade ago—albeit one already expected to cure incurable diseases and change the world. But how, specifically? Not long after publishing her seminal research, Jennifer Doudna, who won the Nobel Prize in Chemistry with Emmanuelle Charpentier for their pioneering CRISPR work, met with a doctor on a trip to Boston. CRISPR could cure sickle-cell disease, he told her. On his computer, he scrolled through DNA sequences of cells from a sickle-cell patient that his lab had already edited with CRISPR. “That, for me, personally, was one of those watershed moments,” Doudna told me. “Okay, this is going to happen.” And now, it has happened. Gray and patients like her are living proof of gene-editing power. Sickle-cell disease is the first disease—and unlikely the last—to be transformed by CRISPR.

All of sickle-cell disease’s debilitating and ultimately deadly effects originate from a single genetic typo. A small misspelling in Gray’s DNA—an A that erroneously became a T—caused the oxygen-binding hemoglobin protein in her blood to clump together. This in turn made her red blood cells rigid, sticky, and characteristically sickle shaped, prone to obstructing blood vessels. Where oxygen cannot reach, tissue begins to die…

…The basic technology is a pair of genetic scissors that makes fairly precise cuts to DNA. CRISPR is not currently capable of fixing the A-to-T typo responsible for sickle cell, but it can be programmed to disable the switch suppressing fetal hemoglobin, turning it back on. Snip snip snip in billions of blood cells, and the result is blood that behaves like typical blood.

Sickle cell was a “very obvious” target for CRISPR from the start, says Haydar Frangoul, a hematologist at the Sarah Cannon Research Institute in Nashville, who treated Gray in the trial. Scientists already knew the genetic edits necessary to reverse the disease. Sickle cell also has the advantage of affecting blood cells, which can be selectively removed from the body and gene-edited in the controlled environment of a lab. Patients, meanwhile, receive chemotherapy to kill the blood-producing cells in their bone marrow before the CRISPR-edited ones are infused back into their body, where they slowly take root and replicate over many months.

It is a long, grueling process, akin to a bone-marrow transplant with one’s own edited cells. A bone-marrow transplant from a donor is the one way doctors can currently cure sickle-cell disease, but it comes with the challenge of finding a matched donor and the risks of an immune complication called graft-versus-host disease. Using CRISPR to edit a patient’s own cells eliminates both obstacles. (A second gene-based therapy, using a more traditional engineered-virus technique to insert a modified adult hemoglobin gene into DNA semi-randomly, is also expected to receive FDA approval  for sickle-cell disease soon. It seems to be equally effective at preventing pain crises so far, but development of the CRISPR therapy took much less time.)

In another way, though, sickle-cell disease is an unexpected front-runner in the race to commercialize CRISPR. Despite being one of the most common genetic diseases in the world, it has long been overlooked because of whom it affects: Globally, the overwhelming majority of sickle-cell patients live in sub-Saharan Africa. In the U.S., about 90 percent are of African descent, a group that faces discrimination in health care. When Gray, who is Black, needed powerful painkillers, she would be dismissed as an addict seeking drugs rather than a patient in crisis—a common story among sickle-cell patients…

…Doctors aren’t willing to call it an outright “cure” yet. The long-term durability and safety of gene editing are still unknown, and although the therapy virtually eliminated pain crises, Hsu says that organ damage can accumulate even without acute pain. Does gene editing prevent all that organ damage too? Vertex, the company that makes the therapy, plans to monitor patients for 15 years.

Still, the short-term impact on patients’ lives is profound. “We wouldn’t have dreamed about this even five, 10 years ago,” says Martin Steinberg, a hematologist at Boston University who also sits on the steering committee for Vertex. He thought it might ameliorate the pain crises, but to eliminate them almost entirely? It looks pretty damn close to a cure…

…The field is already looking at techniques that can edit cells right inside the body, a milestone recently achieved in the liver during a CRISPR trial to lower cholesterol. Scientists are also developing versions of CRISPR that are more sophisticated than a pair of genetic scissors—for example, ones that can paste sequences of DNA or edit a single letter at a time. Doctors could one day correct the underlying mutation that causes sickle-cell disease directly…

…We have opened the book on CRISPR gene editing, Frangoul told me, but this is not the final chapter. We may still be writing the very first.

5. Introducing Gemini: our largest and most capable AI model – Sundar Pichai and Demis Hassabis

I believe the transition we are seeing right now with AI will be the most profound in our lifetimes, far bigger than the shift to mobile or to the web before it. AI has the potential to create opportunities — from the everyday to the extraordinary — for people everywhere. It will bring new waves of innovation and economic progress and drive knowledge, learning, creativity and productivity on a scale we haven’t seen before…

…Millions of people are now using generative AI across our products to do things they couldn’t even a year ago, from finding answers to more complex questions to using new tools to collaborate and create. At the same time, developers are using our models and infrastructure to build new generative AI applications, and startups and enterprises around the world are growing with our AI tools…

…We’re approaching this work boldly and responsibly. That means being ambitious in our research and pursuing the capabilities that will bring enormous benefits to people and society, while building in safeguards and working collaboratively with governments and experts to address risks as AI becomes more capable…

…Now, we’re taking the next step on our journey with Gemini, our most capable and general model yet, with state-of-the-art performance across many leading benchmarks. Our first version, Gemini 1.0, is optimized for different sizes: Ultra, Pro and Nano. These are the first models of the Gemini era and the first realization of the vision we had when we formed Google DeepMind earlier this year…

…We’ve been rigorously testing our Gemini models and evaluating their performance on a wide variety of tasks. From natural image, audio and video understanding to mathematical reasoning, Gemini Ultra’s performance exceeds current state-of-the-art results on 30 of the 32 widely-used academic benchmarks used in large language model (LLM) research and development.

With a score of 90.0%, Gemini Ultra is the first model to outperform human experts on MMLU (massive multitask language understanding), which uses a combination of 57 subjects such as math, physics, history, law, medicine and ethics for testing both world knowledge and problem-solving abilities.

Our new benchmark approach to MMLU enables Gemini to use its reasoning capabilities to think more carefully before answering difficult questions, leading to significant improvements over just using its first impression.

Gemini Ultra also achieves a state-of-the-art score of 59.4% on the new MMMU benchmark, which consists of multimodal tasks spanning different domains requiring deliberate reasoning…

…Until now, the standard approach to creating multimodal models involved training separate components for different modalities and then stitching them together to roughly mimic some of this functionality. These models can sometimes be good at performing certain tasks, like describing images, but struggle with more conceptual and complex reasoning…

…Gemini 1.0 was trained to recognize and understand text, images, audio and more at the same time, so it better understands nuanced information and can answer questions relating to complicated topics. This makes it especially good at explaining reasoning in complex subjects like math and physics.

We designed Gemini to be natively multimodal, pre-trained from the start on different modalities. Then we fine-tuned it with additional multimodal data to further refine its effectiveness. This helps Gemini seamlessly understand and reason about all kinds of inputs from the ground up, far better than existing multimodal models — and its capabilities are state of the art in nearly every domain…

…Gemini Ultra excels in several coding benchmarks, including HumanEval, an important industry-standard for evaluating performance on coding tasks, and Natural2Code, our internal held-out dataset, which uses author-generated sources instead of web-based information.

Gemini can also be used as the engine for more advanced coding systems…

…Using a specialized version of Gemini, we created a more advanced code generation system, AlphaCode 2, which excels at solving competitive programming problems that go beyond coding to involve complex math and theoretical computer science.

When evaluated on the same platform as the original AlphaCode, AlphaCode 2 shows massive improvements, solving nearly twice as many problems, and we estimate that it performs better than 85% of competition participants — up from nearly 50% for AlphaCode. When programmers collaborate with AlphaCode 2 by defining certain properties for the code samples to follow, it performs even better…

…We trained Gemini 1.0 at scale on our AI-optimized infrastructure using Google’s in-house designed Tensor Processing Units (TPUs) v4 and v5e. And we designed it to be our most reliable and scalable model to train, and our most efficient to serve.

On TPUs, Gemini runs significantly faster than earlier, smaller and less-capable models. These custom-designed AI accelerators have been at the heart of Google’s AI-powered products that serve billions of users like Search, YouTube, Gmail, Google Maps, Google Play and Android. They’ve also enabled companies around the world to train large-scale AI models cost-efficiently.

Today, we’re announcing the most powerful, efficient and scalable TPU system to date, Cloud TPU v5p, designed for training cutting-edge AI models. This next generation TPU will accelerate Gemini’s development and help developers and enterprise customers train large-scale generative AI models faster, allowing new products and capabilities to reach customers sooner…

…Gemini has the most comprehensive safety evaluations of any Google AI model to date, including for bias and toxicity. We’ve conducted novel research into potential risk areas like cyber-offense, persuasion and autonomy, and have applied Google Research’s best-in-class adversarial testing techniques to help identify critical safety issues in advance of Gemini’s deployment.

To identify blindspots in our internal evaluation approach, we’re working with a diverse group of external experts and partners to stress-test our models across a range of issues.

To diagnose content safety issues during Gemini’s training phases and ensure its output follows our policies, we’re using benchmarks such as Real Toxicity Prompts, a set of 100,000 prompts with varying degrees of toxicity pulled from the web, developed by experts at the Allen Institute for AI. Further details on this work are coming soon.

To limit harm, we built dedicated safety classifiers to identify, label and sort out content involving violence or negative stereotypes, for example. Combined with robust filters, this layered approach is designed to make Gemini safer and more inclusive for everyone. Additionally, we’re continuing to address known challenges for models such as factuality, grounding, attribution and corroboration…

…Starting today, Bard will use a fine-tuned version of Gemini Pro for more advanced reasoning, planning, understanding and more. This is the biggest upgrade to Bard since it launched. It will be available in English in more than 170 countries and territories, and we plan to expand to different modalities and support new languages and locations in the near future.

We’re also bringing Gemini to Pixel. Pixel 8 Pro is the first smartphone engineered to run Gemini Nano, which is powering new features like Summarize in the Recorder app and rolling out in Smart Reply in Gboard, starting with WhatsApp — with more messaging apps coming next year.

In the coming months, Gemini will be available in more of our products and services like Search, Ads, Chrome and Duet AI.

We’re already starting to experiment with Gemini in Search, where it’s making our Search Generative Experience (SGE) faster for users, with a 40% reduction in latency in English in the U.S., alongside improvements in quality.

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