Growth in a Finite World

These days I get a lot of queries on whether the stock market is overheated and is going to have a crash. I think people are expecting a crash since Sep-2020 but we have been investing regularly and never stopped. This strong journey has taken many by surprise as market is not seemed to be in any sort of negative mood. Every fall witnesses strong buying afterwards. I see reports about the linking of USD, Bonds, Oil, Gold, Interest rates/yield curve, FED policy, inflation etc. with the stock market and all try to conclude the coming crash (sometimes jump) of the market. In this crowd of variables; one can conclude anything and these days they are forecasting a crash. Many times, I ask these people what drives the base interest rate and there is no confident answer except some murmurs about inflation rate but I see them shouting on the top of their voice about yield curve and coming market crash.

But Stocks, Dollar, Oil, Gold, Bonds etc. don’t derive majority of their valuations from their inter-relationships. Most of the time and most of their valuation is impacted by their individual demand supply dynamics not the demand supply dynamics of other counterparts. Like, most of the valuation of the Bonds is impacted by its own demand supply dynamics rather than money from stock market entering bond market. Most of the money circulating in Bond market is meant for Bond market only and same is true for the stock market. Overlapping part is very less and shifting takes place mainly for short time. Like for example, the prices of Onions are settled based on its own supply demand dynamics. I call this price as Base price which is based on its own supply demand dynamics. Now suppose there is a big shortage of Tomatoes so people will shift some demand from tomatoes to onions and this will raise the price of onions over and above the base price. But the individual base price of the onion will still comprise the majority of the total price and for the purpose of long term decision making (like fresh cropping) the price impact due to tomatoes is not relevant and should not be considered.

Like for Interest rates, I always say that above everything, money is first a commodity...a commodity for enabling trade and exchange. Unlike other commodities like Onions money is not capable of satisfying any needs/desires directly by direct consumption as its primary function is to enable exchange. So in case I don’t need any commodity or service in exchange of my money I would keep the spare money with me. But other people needing money for the exchange of goods/services they don’t have create the demand for this spare money available within the economy and this demand of money as debt creates a price for the money in the form of interest rates. In case there is no demand for money as debt then we would in fact be required to pay some charges for keeping the money safe in banks etc. (regardless of whether inflation rate is high or low). So Interest rate is not the "cost of money" as is always said but a “price” which is a function of demand supply dynamics of money. So just like an onion, every asset has its own very individual base price upon which further layer (or layers) of price comes due to overlapping part (temporary shifting of money from one asset class to another).

So most important factor for interest rate is demand supply dynamics of money itself. Inflation is not the primary motivation behind interest rate. Inflation does impact the interest rate but it is not responsible for the establishment of base interest rate. Inflation can impact the portion of interest rate over and above the base rate. In my view, base rate is a function of opportunity cost of the money but base rate just takes the clue for the "Price" from the opportunity cost. Opportunity cost is not the reason for the emergence of the price (int rate) because price emerges due to its own demand supply dynamics. So Gold or real estate can play that role (opportunity cost). Somehow I feel that the corporate earnings and stock market returns are more relevant opportunity cost for interest rates for a fairly stable and strong economy. But inflation is not the opportunity cost of the money. There may be a situation where inflation is high but there may not be much demand for money from businesses or individuals as they mayn’t want to take risks for new investments etc. Hence even with higher inflation the rate of interest will still be low. Just consider the current issue of short supply of semiconductors which has raised the prices of cars worldwide (second hand cars also). So is it possible to reduce the resultant inflation by rising rate of interest? No, not at all. In fact, I think the solution is quite the opposite- Governments need to give low interest loans to corporates to build new capacities for semiconductor manufacturing. So in real life, economics principles are very different. 

Once one analyst told me that market would fall as interest rate was rising (money would shift from stocks to bonds). But I asked him why Interest rate was rising at first. Interest rate rise is not some isolated individual act of God like heavy rain which can cause floods and loss of crop. But the rise is a reaction to a number of events. Interest rate may rise- Due to rising demand for loans by corporates as they are investing big or due to risk of loan defaults by most of the corporates due to economy shuffle or earlier mis-allocation of credit (like happened in India in Infrastructure few years back). Stocks will fall in the later situation while in the former more money will come both to stock as well as Bond market. This more money will either come from other assets class or new money will be created by banks.

So every commodity or asset class has its own demand supply dynamics. Similarly, stock market also has its own demand supply dynamics and it is the earnings growth/future earnings growth (GDP growth) potential that drives the demand (base) for equities. And the issue is- how growth happens? And the bigger issue is that current GDP calculations are not more than a crude proxy for the real growth. Growth is much more comprehensive and multi-dimensional and much bigger phenomenon than summation of total income produced in a given period (GDP).

Here I remember one interesting book “The Limits to Growth” which was published in 1972 by a group of thinkers called “The club of Rome”. The book was an attempt to forecast the outcome of massive scale consumption of earth’s resources by humanity and the capacity of Earth to withstand such consumption as our Earth is a “Finite sphere” with a limited supply of resources like minerals. The club worked out a model based on five basic variables affecting the resources of Mother Earth industrialization, population, food, use of resources, and pollution. They modeled data up to 1970, and then developed a range of scenarios out to 2100, depending on whether humanity could took serious action on environmental and resource issues. If that didn’t happen, the model predicted “overshoot and collapse” – in the economy, environment and population – before 2070.

Their main point was Earth being Finite has limited capacity to provide resources for the huge growing population. Hence our quest for unlimited growth by over-production and over-consumption of resources will eventually lead to a crash. But we never grow only by over-consumption and it is the emergence of new innovative technologies which bring more growth. As we can see much of our growth in the last century was mainly related to “Invention of New and Substitute technologies” like the invention of Aircrafts and transportation technology which made possible the exchange of goods/services across the globe, telephone and then Mobile phones, Computers and then softwares. Their model was not well accepted as Population, capital and pollution all grew exponentially in all their models, but technologies for expanding resources and controlling pollution were permitted to grow very marginally.

But I feel their model has one very valid hidden (implied) statement- that unless we create and discover newer, innovative, clean and efficient technologies we can’t afford to grow by consuming the finite resources of the earth as one day they will be obsolete. And good thing about technology is that they have INFINITE possibilities and potentials. Technology does not create linear growth opportunities but even a small innovation can bring massive growth and revolutionize the existence of entire humanity. Here, I remember one such small innovation-Elevator. It was a very small technological breakthrough but just imagine the world without it. Real estate sector’s massive growth has been possible only because of elevators so as of mining sector. Elevators have made it possible to construct massive vertical buildings resulting in the most efficient use of available land. Just imagine the cost of land and houses in the absence of elevators as we could have only made 3-4 storey buildings not 50 storey now.

So technology is transformative beyond imagination. Technological innovations can create new products/services classes, can result in more efficient use of existing resources, and can create new resources. Another massive but less talk about transformative impact is on the even distribution of income and resources. This distribution pattern of production and wealth is the biggest limitation of our current GDP calculation measures as they don’t (can’t) take into account the decline in the “value” of marginal production when it flows only to a few people (unequal distribution of income). Right now, we are at that stage of our evolution that only technology can create next leg of growth and save the humanity from pollution and destruction. I find it funny to see words like “sustainable growth” because unsustainable growth is not growth but short term exploitation of resources and we count this short term exploitation of resources as production (extracting coal is production but the resultant destruction of forests and water resources is not “deducted” from the value of production) is the biggest mistake ever committed by humanity (of course after Religion). I call this like having a “Profit & loss account without a Balance sheet”.

And right now, we are witnessing a period of major technical innovations which will result in the next long leg of growth and luckily it appears that this time the growth will also extend and save the humanity and this earth also. This growth is going to be led by clean technologies in the form of solar, wind and Hydrogen power. These are going to transform the current energy dynamics across the globe and will also solve the existential threat in the form of pollution. These clean technologies will result in the even distribution of resources (energy) because wind and solar are evenly distributed among nations as compared to oil which is concentrated only to a few countries which has made many countries poor as they are dependent upon costly imports for their energy needs. But this clean energy is more democratic and this will change the distribution of wealth also. Just imagine the scale of income generation in India if our energy needs are satisfied in house from wind/solar/hydrogen rather than costly imports. It also means that India can’t afford to lag behind in this race of clean technologies and we need to up the ante for developing these in house.

After clean technologies, there is a massive growth in communication technologies in the form of 4G/5G and space tech and these new age communication tech is going to create the next industrial revolution. 5G is going to reduce the latency to just 2 milliseconds which means that networks will almost be latency free and information will be exchanged between devices in real time. New age communication technologies will result in the growth of IOT, factory automation, autonomous vehicles, augmented reality, remote healthcare etc. New age communication technologies, automation and AI are also going to bring next revolution in agriculture which is hampered by the negative impacts of 3^rd agriculture revolution in the form of chemical fertilizers. Then we have genetic engineering revolution which is developing higher yielding and disease-resistant crops. Similarly Genomics and Genetic engineering is going to transform our healthcare.

So we are now at a very critical juncture in the journey of humanity and earth and our actions are going to be critical. Good thing is- Humanity is looking good for most of the part…people are surprisingly more aware and conscious about everything which is negative and inflicting damage. World has taken a good start in the form of huge growth in clean technologies and this is going to be the norm for the coming decade. So we are going to witness a period of growth which has the capability to bring comprehensive prosperity across the globe and it appears that market is aware of this high growth phase and this is why we are seeing continuous rise in the stock market and looks like it is not going to witness any major correction.

India in particular has done some major policy reforms which are going to result in high growth in manufacturing in India which was the major pain point for India. Agriculture as of now is not capable of transforming India into another leg of high growth as it is hampered by political, technological, economics (small size) and supply chain issues. But this Void is also an opportunity and recent start of policy reforms is a good step. India’s focus on policy support in the form of PLI schemes and Make in India for local manufacturing of electronics goods, medical devices and chemicals is going to result in high growth in GDP even at the same consumption levels because the money will be spent in india not on imports. This will also create demand for new investments and incremental job growth. The focus on growing Ethanol production is also going to create the same impact of high growth in GDP even at the same consumption levels also raising the income levels of farmers which is the long targeted objective of the Government but which has taken a quite a bit of time (of course due to politics).

So the time is to be optimistic about the growth potential and India is also in a very sweet spot. Clean energy technologies and new age communications technologies are going to lead the next leg of growth.

( Reach me at oscillationss@yahoo.in)