We are going to depart from my usual training articles about commercial loans and how to underwrite them. None of us is going to be making a lot of commercial loans or selling a ton of commercial real estate if the U.S. loses this trade war with China. So, how is the trade war going? Below is this month's Investor Letter to our Private Clients (accredited investors).
INVESTOR LETTER
In my last Investor Letter, I made the point that if the U.S. must engage in a trade war with China, now is probably as good of a time as ever. Ideally there would be no trade war at all. There can be little dispute that free trade has been wonderful for the purchasing power of the U.S. consumer. To this day, I am still amazed at the low prices of goods whenever I go into Wal-Mart. Bicycles and baseball mitts cost just a fraction of what my loving father paid 55 years ago. I still remember the day when he bought me a brand-new Rawlings baseball mitt. I stayed up very late that night oiling my glove and making a pocket. Summer and a new baseball mitt. I was truly in little guy Heaven. I fell asleep with that glove still on my hand.
My dad paid over $25 for that wonderful, top-of-the-line baseball glove in 1962. Adjusted for inflation, that’s a whopping $208 in today’s dollars. I went online today and found a Rawlings baseball glove at Target for just $39.95. Folks, I do not want a trade war.
But if we are going to have a trade war, it might as well be now. According to the Austrian School of Economics, recessions and depressions occur when companies and consumers make malinvestments. A malinvestment is an investment that doesn’t generate enough income to service the debt taken on in order to buy it.
In 1928 and 1929, investors bought investment trusts on margin. In the years leading up to the S&L Crisis, syndicators intentionally bought apartment buildings with large negative cash flows for the tax benefits. When the Reagan tax change went into effect, commercial real estate crashed by 45%. In 1998, 1999, and 2000, the investing world poured tens of billions of dollars into dot-com stocks that did nothing but bleed money. Between 2004 and 2008, consumers and investors poured hundreds of billions of dollars into residential real estate. A depression and three severe recessions followed these horrific malinvestments.
This why I did dog flips when Bitcoin crashed so severely. Bitcoin crashed early, before tens of millions of Americans could lose another huge chunk of their life’s savings. What a blessing! In the euphoria following Trump’s election victory, U.S. stock prices started soaring 100 to 200 points per day. The last thing the U.S. needed was a stock market blow-off, where the smart money got out and U.S. consumers poured their life’s savings into a skyrocketing market, only to lose 40% of their investments when the top exploded. Fortunately, the stock market settled down when President Trump, though a series of tweets, picked this trade war.
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An old man was relaxing at his 100th birthday party when a reporter went up to him. "Sir, what is the secret of your long life?" The man considered this for a moment, then replied, "Every evening at 9 p.m. I have a glass of port. Good for the heart I've heard." The reporter then asked, "That's all?" The man smiled, "Well, canceling my voyage on Titanic sure didn't hurt."
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So, are we going to win? Don’t assume that China holds all of the cards. “The S&P 500 remains on track for a fourth consecutive month of gains…, while Chinese stocks have entered a bear market, with the CSI 300 Index down about 20 percent from its January peak, that’s occurred alongside softening growth and worries over rising corporate defaults.” In other words, through the early days of this trade war, our market is going up while theirs is going down. That being said, I’m glad I’m not a whiskey distiller in Kentucky. (The Chinese targeted whiskey.)
In order to soften the blow of our tariffs, the Chinese have been allowing the renminbi (the People’s money) to fall around 5% over the past few weeks, prompting President Trump to angrily tweet about their currency manipulation. While the Chinese could simply ignore Trump’s fierce rhetoric, they cannot ignore the risk of capital flight. After all, who wants to own renminbi when Trump is threatening tariffs on all Chinese imports?
About 10 years ago the Chinese suffered a similar flight of capital after a severe (40%-ish) stock market meltdown. The Chinese were forced to spend around one trillion dollars in foreign reserves propping up their currency. The Chinese “only” have around $3T in foreign reserves. “June saw $10.7 billion in cross-border outflows, Morgan Stanley estimates.”
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A woman visited a psychic of some local repute. In a dark and gloomy room, gazing at the Tarot cards laid out before her, the Tarot reader delivered the bad news: "There is no easy way to say this, so I'll just be blunt. Prepare yourself to be a widow. Your husband will die a violent death this year." Visibly shaken, the woman stared at the psychic's lined face, then at the single flickering candle, then down at her hands. She took a few deep breaths to compose herself. She simply had to know. She met the Tarot reader's gaze, steadied her voice, and asked, "Will I get away with it?"
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“A 2016 Urban Institute study found that 38 percent of American families in 1979 were middle class (defined as households earning between $50,000 and $100,000 annually, adjusted for inflation) vs. 32 percent in 2014. That sounds terrible. What happened to all those middle-class families?”
“The study divided households into five income groups: poor, lower middle class, middle class, upper middle class, and rich. Of those groups, the bottom three got smaller over the decades while the top two grew. The ranks of the poor shrank by 4.5 percentage points, the lower middle class by 6.8, the middle class also by 6.8 points. But the upper middle class got a lot bigger, expanding by 16.5 points, while the rich grew by 1.7 points. So, what happened to the middle class? It disappeared because it got richer. There has not been a middle-class meltdown. There’s been a melt-up!”
