Hello, listeners.

Welcome to another episode of the Jacob Shapiro podcast.

I am Jacob Shapiro.

Rob Laerty is joining me for our weekly chat.

I don't know if you can tell in the podcast or not.

I hope you can't tell, but we are both tired.

We have both had long weeks personally, professionally, everything going on in the world.

We've covered the Middle east.

We've covered China.

We've covered Russia, Ukraine.

I really also would encourage you if you missed some of our great episodes earlier this week.

The one with Ilo on Alberto Fujimori, one of my favorite episodes we've ever done.

Ilo was incredibly generous with his time and his perspective.

Cousin Marco speaks for himself.

That was a tour de force, and we had a lot of fun on that episode.

Looking forward to having him on more.

And actually, the Iran strategist episode that we did was also very interesting.

Not at all what I expected.

So with all that already on the podcast feed this week, Rob and I talk a little bit about the port strikes in the US.

As usual, some nerdy thoughts about labor and production and capital and protectionism, and closing with some thoughts on insurance.

The idea was to try and hit some of the things that have gone underneath the radar.

So if you're looking for what's on the front page, this is not the podcast to listen to.

Go back to the other four podcasts we published this week.

If you're looking for our unique brand of nerdy insights into the things that are on the fringes, but that will eventually be important, that's what we're doing in this episode.

Email me at Jacob Ognitive Investments if you want to talk about any of this.

As you can probably imagine, my phone and my schedule and my calendar have been blowing up this week, but I have room for more.

So please feel free to reach out if you need help.

Don't be scared away.

Take care of the people that you love.

Cheers and see you out there.

All right, listeners, it has been.

It has been quite a week just to start.

We're not really going to touch the Middle east that much in this podcast.

If you want.

You know, Marco and I did some stuff on the Middle east.

We had the iranian strategic analyst on Iran's position.

Hopefully I'm going to have an israeli military historian on here in the next couple of days.

So for your Middle east content, just go to the podcasts that are Middle east.

We know it's happening.

We know it's a big deal.

I promised rob a story about just how.

So we're recording Thursday, October 3.

Here's what my week has been like, both in geopolitical terms and in personal terms.

I was downtown.

I was in downtown New Orleans yesterday for a meeting, and I managed to find a parking spot on a little street off of Magazine street, which is one of the main drags where you didn't have to pay for parking.

And I was like, ooh, great.

This is great.

My day is looking so good.

I got this little spot.

So I'm halfway through this meeting, and somebody comes in from the street and says, there's a fire down the street.

Do any of you have cars parked down here?

And I was like, oh, God, let me go see if my car is parked out there.

Literally.

Literally.

Across from where I had parked on the same street is a fire that has engulfed a house, and it became a four alarm fire and spread to three or four different buildings next to it.

There was a fire engine in front of my cardinal and behind my car.

And I had to go pick up my daughter in about 30 minutes from that point.

So I got the person who I was meeting with to drive me to where my daughter was in daycare.

Then I called, like, different parents from the school, like, hey, I'm stuck here.

Do you have an extra car seat?

Cause I couldn't get uber to agree to pick me up without a car seat.

Eventually, my friend Jack shout out to jack was like, yes, I will come pick you up.

And he picked me up.

So I spent, like, 15 minutes at daycare sitting with the one year olds and my daughter on a little bench.

Meanwhile, you can see the smoke from the daycare.

It's, like, pluming in the air.

This thing burned for, like, 4 hours.

I came home, I smelled disgusting.

My shirt was terrible.

A couple hours later, I went back and got my car.

My car smells like.

Like a house fire.

But that's my day, and that's my.

That's my analogy for the week.

It has felt like that in geopolitics.

Four alarm fire, and you're.

You're stuck behind a fire truck.

That is a good analogy.

Literally.

Like, I couldn't have had worse luck.

So there's a grab bag of stuff that we wanted to update the listeners on today, Rob, and you said it well, a lot of it is going to boil down to, I don't know, what do you like, pitfalls of protectionism or the hidden costs of protectionism, but there's a lot of different things to attack.

I think the first thing I want to attack, though, is this.

Eastern port and Gulfport workers strike because this was something that I wasn't really, I didn't really know was sort of in the making.

And it seems like it's a pretty huge deal.

So what's happening is that the.

So the ILA, which is the International Longshoremen's association, so they're manning the ports on the Gulf coast and on the east coast.

They decided to strike their 45,000 port workers from Maine to Texas.

It is the first major stoppage since 1977 after talks for a six year contract with the United States Maritime alliance broke down.

I was doing a little bit of research on what happened in 1977, and it was interesting.

It actually does have some overtones with what's happening today.

Today, the port strikers, they're really worried about two things.

They want an increase in wages.

Not that surprising, by the way.

They, they want a 77% increase in wages versus, I believe, 50% is what they're being offered right now.

A really strident video from this guy, Harold Doggett.

Daggett, who's the chief negotiator, about how the longshoremen were out there killing themselves during COVID taking things off of ships while everybody else was sitting in their house.

That rings really untrue to me, especially as somebody who had a nurse who was going into the hospital and is not getting a 77% raise for saving people's lives, bro.

So just a little personal.

Shut the frack up over there.

Anyway, hes a good chief negotiator because I dont even care about this.

And hes got me boiling a little bit.

So what was happening in 1977 was that containerization was absolutely transforming how ports worked and where you needed tens of thousands, if not hundreds of thousands of people to take things off of a boat and put them everywhere that they needed to go in the port and get them on their way.

Containerization meant that actual longshore workers, it was down to thousands of jobs, and things were going to keep going in that direction.

And that strike lasted for three months.

You got a pay raise for the longshoremen, and you also got guaranteed income for anyone who was employed before 1977.

So not for new workers who came afterwards, but guaranteed income through 1986.

That gets eliminated as part of a different contract.

There.

Not something I've really ever seen when looking at these things, although I'm nothing.

A hardcore expert on us labor industrial relations and things like that.

The reason I say that, there are overtones to today besides the geopolitical context.

Geopolitical context, Carter administration.

A lot of pessimism about the United States role in the world coming off the defeat in Vietnam, lack of trust in us government institutions because of Nixon and Watergate, you can sprinkle in some chaos in the Middle east, coming with the islamic revolution, you can sprinkle in little, little comparisons.

But not only do the longshoremen want 77% higher wages, they want their jobs to be protected from automation, which is kind of crazy, because you can imagine that taking containers off of ships is actually something that automation would be really good at.

If you can automate the crane to do these things, and if the containers are all the same shape and the same size, like that is the ideal sort of thing that machine learning and artificial intelligence could do the other thing.

And I haven't been able to do all the research on this, but I've been following some research from John Conrad on Exxon in some articles, and he has been talking about.

And I didn't know about this, Rob, this idea that every time a crane for the ILA.

So these workers who control the ports in the Gulf, on the east coast, the west coast, ironically, they had more radical positions.

So they get paid much more than their compatriots on the east coast, which might be why these guys are going on strike.

They're like, hey, the crazy has got higher wages now.

We're gonna be a little bit crazy anyway.

So for this union, every time a ship arrives in the United States, every time a crane moves a container, they get a massive fee off of it.

And the result of this is so that us shippers try as much as possible to limit the amount of times a crane touches a container.

So, in the United States, if you get to one of these ILA ports, the ship arrives, container, the crane gets the container, moves it to a truck, and a truck drives hundreds of miles to get it to its destination.

Compare this to Europe, where, okay, the ship arrives, crane takes the container, moves it to a terminal, another crane takes it, loads it onto a barge, the barge sails somewhere to maybe get to a smaller regional port.

Then it gets lifted up on a crane a third time onto a truck, and then it's a shorter drive to a warehouse.

And I couldn't believe this, because the whole geopolitical, geographic advantage of the United States, from everybody from George Friedman to Peter Zion to Hans Morgenthau to Stephen fracking Bannon, is that the US Mississippi river complex allows us to move things cheaply.

Largest inter navigable waterway in the entire world, all of it, for nothing.

Because we don't want to pay the crane guys for the fees that they take, which also, just, you know, the idea that we led on containerization and we're going to be behind on modernizing ports for the 21st century, there's a lot there, too.

So why don't I set you up there, Rob, and we can go into some of the other topics that we wanted to go into, but it does seem like it's going to be a big deal.

It does seem like the Biden administration has a choice.

It looks like they can maybe push the workers to go back for 80 days, I believe, via Taft Hartley.

There's also been progress in the negotiations over the course of this week.

But I will say more than 50% of all the goods imported into the US using container ships come in through east and Gulf Co.

Gulf coast ports.

Nearly 70% of containerized exports leave through them.

We're talking about, it's not going to, the impact is not going to be apparent.

But everything from perishable goods like bananas and blueberries and fish to toys and electronics ahead of Christmas season to automotive parts, all of these things are going to be massively affected.

Even if they get a deal tomorrow.

Like, there's already going to be weeks, if not months of disruption just based on the backlog that has built up.

And that's before we get to Red Sea shipping, before we get to anything happening in the Panama Canal, before we get to anything happening in the South China Sea.

I saw a picture this morning in Singapore of all the ships that have been stacked up because of the recent drama in the Middle east as well, and have been getting texts from some of our friends in the aerospace industry about how air freight is also suffering because of what's happening in the Middle east.

So anyway, I droned on a little bit there, but I'll let you take the wheel.

Well, there's a lot to go into there.

I guess there's a few different ways we could attack this.

One thing is to start just at the macro level, and the implications of this, as you pointed out, they are going to be significant.

I think what a lot of people don't realize is this is coming at a very important and specific time because now it's peak season for holiday shipping.

Usually peak season is like late August, early September, but that's, we're kind of in the tail end of when stuff is actually arriving in terms of building holiday inventory.

So basically, they're putting the squeeze on the supply chain at exactly the most crucial moment of when that supply chain is operating at the same time.

There had already been a sort of a squeeze in the supply chain, in part because there was a calendar shift this year that made the peak shipping season like a little bit shorter than normal.

And FedEx and UPS both announced, I think, about two months ago that they were going to squeeze surcharges on holiday shipping this year to try to protect their margins.

So you have higher surcharges from the two major shipping companies.

You have a calendar shift that is already squeezing more activity into a smaller space of time.

You have, obviously, this port strike that's just going to exacerbate things in a major way.

All of this leads to this notion that supply side inflation is not going away.

And that's really important because goods inflation, as we've talked about, has been deflationary, has been subtracting from the inflation numbers for really the last 14 months.

So if that should turn around and go in the other direction, that's a major headache for the Fed, for the Biden administration heading into the upcoming election.

But I think that's really important to think about.

And some of this sounds obscure, but if you get any reacceleration of inflation, even as growth is slowing, I think that could be a bombshell for investors expectations and markets, because we haven't experienced that before.

For the last, really, 40 years, inflation and growth have moved together because it's been about demand sopping up, whatever excess supply is.

So when growth increases, inflation increases, and vice versa.

What happens if you get a growth stagnation combined with inflation not only being persistently high, but moving in the wrong direction?

That's going to really freak people out.

So this is a really important issue.

That's one thing I would say.

The other thing I would say is I would expect more of this, because what you're seeing is a growing supply demand imbalance within labor markets that has cyclical elements to it.

Obviously, labor markets are loosening up now, but you saw similar things in the 1970s when you had sort of wage inflation.

You had a supply demand imbalance because we were running the economy too hot.

And despite the influx of baby boomers into the workforce over those years, we were running the economy so hot that they still had a lot of bargaining power.

And it's no coincidence that the last time you had a major strike like this amongst dock workers was 1977, because that was similar kind of background structurally in terms of thinking that they can put the squeeze on and they can, and that's not going to change anytime soon.

So you should expect to see more of this more frequently, which is also going to be inflationary and also speaks to the fact that you have sort of embedded interest groups that are willing to put the squeeze on other parts of society to get goodies for themselves.

And I told you I had a story this reminded me of from my dad, and my grandfather used to work in the Rheingold beer bottling plant in New York.

And I remember my dad told me this story that he heard from his father that there was one time where there were multiple days where a truck had come to the plant to drop off bottles or something.

Right.

And because there was a dispute between the teamsters and someone else over who was going to unload this truck, the truck was sitting there and two groups of guys were just standing around looking at these bottles for like four days, and no one would do anything.

And that was the story.

There was no, you know, eventually they found some way out of the impasse.

But that always, my father always was struck by that and told me that story about, like, it's just crazy how all these perfectly able bodied guys are sitting around literally looking at this box of bottles like, nope, this is my territory.

Nope, this is mine.

I say that story because there is no Rheingold beer bottling plant in New York anymore because it was too fucking expensive and it didn't work.

So let that be a moral for these sorts of organizations that squeeze other members of society for their own benefit.

In the end, that's not sustainable for too long.

Yeah.

And there's a much longer and deeper conversation, I guess, to be had here about the relationship between labor and production in the United States.

And I think it's a conversation that the United States government has not even really begun to think about even those terms, labor and production and marxist ideas like that.

Those are not concepts that are really in us political dialogue at this point, even though they're very valuable.

One thing I didn't say, by valuable, I mean from a sort of understanding point of view.

I'm not endorsing Marxism, to be clear, but one of the things that I forgot to say was one of the things that kicked off this labor unrest, which sort of gets to your story, is that at the port of mobile in Alabama, so far away from the New York beer guys, they installed a truck gate that did not require a unionized attendant to open the gate of.

So an automatic door, basically.

And the ILA is saying, this is the boogeyman.

There can be no more automatic gates installed.

There must be unionized attendance at all the gates to open the gates, because, you know, there's going to be all these safety concerns.

If we don't have these sorts of things, like, it seems to me like they're in a meaningful way fighting against progress.

I say that, though.

I mean, labor does have to protect itself because we saw during globalization, if you did not protect yourself as labor, you were going to get run over from a production standpoint because it was just going to go to China and you were going to lose your job.

So I'm not saying that that's all bad.

There's also, this is from the Capital Research center, which is a conservative think tank, so there is a conservative bent to it.

But they had an entire report on this, and they had two interesting other historical examples to keep in mind.

Number one was a railway strike in 1946, when Harry Truman literally compared the railway strike to Pearl harbor.

The first two lines of his speech, the crisis of Pearl harbor was the result of inaction by a foreign enemy.

The crisis tonight is caused by a group of men within our own country who placed their private interests above the welfare of the nation.

My God.

And also apparently a strike for air traffic controllers in the 1980s that cost them their jobs because Ronald Reagan wasn't going to have it.

And I think we're still paying for that.

I don't know if you saw that extremely scary article, I can't remember if it was the Wall Street Journal or New York Times, about how we basically have not nearly enough air traffic controllers, and there's been a bunch of near misses of, like, planes crashing into each other at airports and things like that.

So it's not like things are very harmonized.

Maybe that's a good way to segue into some of the other things that we wanted to talk about.

Rob, I know that you had, we wanted to follow up last week.

We were talking about the Biosecure act.

You had some more thoughts about, specifically batteries, but some of the other things that the United States is doing in terms of protectionism that I think fit into this idea.

Yeah.

So I want to talk about supply chains, and I do think it ties into this labor versus capital issue, because let's just return to that for a moment, because I think it's really important to have the background here, which is this is going to be a growing issue in general, and here's why.

Robotics has been a growth area for a long time, but for the most part, robotics, until today, this is still mostly true today, consists of industrial robots that operate in caged off areas and very carefully controlled conditions that are doing repetitive tasks.

And for the most part, where you can use those things, we are using them everywhere in the world, and especially in the US, because if you look us, manufacturing production has actually grown just fine since 2000.

I think 2000 is the watershed moment that you can really point to, because when China entered the WTO, what you saw was manufacturing employment in the US collapsed from about 20 million people to about 12 million people in seven or eight years.

And even today, I think the number is even lower than that.

Production in total did not collapse, in part because you moved higher up the value chain.

You used more automation, more capital, things that cannot be easily replicated and aren't subjecting you to a labor cost of labor imbalance.

So that's sort of where we've been.

And some of these things are sort of holdouts in terms of the dock workers.

Like they're in a very specific area.

But for the most part, unionized factory labor is not really a thing anymore.

This is going to become more of an issue because this is tying into AI and machine vision.

But robotics is about to get a whole lot better really quick.

And I don't think people are really prepared for this.

And not just in the traditional way that we're used to, which is closed off conditions, industrial robots, but robotics that can work in uncaged conditions near other humans.

I mean, everyone has seen this and they've seen little demonstrations like, this is a real thing.

And the reason why it's becoming a real thing is because the main bottlenecks to developing these kinds of robots are having the robot able to see what's around it and understand what's around it, which is a machine vision problem, which is an AI problem.

So to the extent that we're seeing amazing progress in AI, that's also contributing to the growth in machine vision.

And you mentioned your self driving taxi experience.

That sounds like science fiction, or it would have been seven or eight years ago.

Now it's real because the machine vision is at a point where you can make it work.

Well, robots are the same thing.

Robots taxis are robots that drive.

These are just robots that pick up stuff and move it around and put things over here from over here, and turn screws and do little manipulative tasks with robot hands.

And that's the other thing, is understanding not just what you're seeing, but understanding the physics models around different stuff.

So knowing that if you pick up a glass and you squeeze it with extraordinary force, it's going to shatter.

Like that sort of commonsensical, just monkey mind stuff that we take for granted is very difficult from an engineering standpoint.

But the progress we're making in that area is extraordinary just recently.

So this is going to be here very quick.

It's going to be very feasible to automate a lot of manual labor to the extent that it remains in the manufacturing sector or the sort of warehousing sector, transport, things like that.

This is coming and it's coming very fast.

So that's the background to the labor capital dispute because that's going to be an issue that's going to cause a lot of freight tempers because this is the next stage of what's going on.

With that said, you mentioned protectionism, and I think one of the themes as we're going through the knowledge platform this week and the news that we're combing through is the complications and interesting little nuances as protectionist policies get rolled out both in the US and in Europe, and how it's really nothing simple and there's a few preconditions that one has to have in place in order to make these things really work.

And you mentioned the batteries.

One of the things that was on the Bloomberg this morning was the United States is giving $2.8 billion to domestic battery makers to try to shield them from chinese competition.

And the funny thing about this was they originally announced these awards two years ago.

They've not released any funds yet.

Apparently one third of the companies that were originally slated to get rewards.

The industry has changed so much so quickly that they're no longer even, they're either bankrupts or they're not viable companies that you can give this money to.

So they've had to change all the awards as they've gone along.

So, you know, it's one specific example of one industry.

But I think it's very interesting both because $2.8 billion is like chump change in terms of what we're talking about.

It's taken several years to even distribute that amount, and you can see that it's so dynamic that it's basically not going to do anything because the industry is changing so fast and the companies that they're up against are so huge in comparison.

So I think that's one of the main themes around a lot of what we're going to talk about or what's in the news is you can have import substitution policies, you can have protectionist policies, but if you don't put in place the capacity to replace what you're import substituting, you're just paying more to import from abroad anyway.

And that's not where most of these nations are intending to go.

But I don't know if they have the wherewithal to distribute and really get engaged to the degree and scale required to go toe to toe with, you know, the chinese and korean battery behemoths, for example.

So you're sort of shooting yourself in the foot without any positive side effect in many cases.

Well, yeah, and countries like China are ahead here already because that's where a lot of the production is happening.

And then, to your point, also an economy and a political structure like China's is much better at deciding to allocate resources massively to something like this.

So while you were talking, I was just looking up, you know, cattle, which is the big.

The big chinese EV battery maker.

I mean, their revenue is like between 50 and $70 billion.

So a $2 billion investment.

I mean, it's literally nothing.

They're by themselves investing almost 2 billion in Bolivia to develop their lithium reserves.

Just by that figure, it doesn't work.

The European Union is also really straining with this.

They have those tariffs against chinese EV's that are being discussed.

Hungary came out this morning and said they were going to veto it.

I'm not sure exactly what direction that's going to go.

But then at the same time, you also had that thing about electrolyzers that you were talking about where the EU is trying to stop using chinese electrolysis equipment for hydrogen production, even though that's where a lot of these things are made.

So it just.

Yeah, it doesn't really make sense to me, and it doesn't make sense that you can go from.

And I mean, this is something that we've talked about quite a bit on the podcast.

It's not something we're going to stop talking about anytime soon.

But if this is the game that countries like the United States and the European Union are going to play with China, I don't exactly know how they win.

China has lots of weaknesses, and we talked about them in depth last week, but this is not one of them.

Yeah, there was a very good financial Times piece this week that I put on the knowledge platform that I assume no one is going to read, but I think is probably the most important thing that no one is talking about.

And it was about the latest estimates of chinese FDI, specifically in renewable energy.

And really, the takeaway was twofold.

The first was the amounts are enormous and growing in extraordinary leaps and bounds.

And secondly, that the shifts between the west, meaning the EU and the US, away from the west and toward sort of, especially in Asia, but eurasian countries, southeast asian countries, has been extremely rapid.

So you're seeing chinese companies building out their own supply chains into these other nations, both to supply rich world markets, but also to service demand in those markets.

So we've been talking internally a little bit about Pakistan and their amazing hunger for solar panels as they go through a sort of death spiral on their electric grid.

China is the one who's stepping in and supplying this equipment and this is a major opportunity for them.

It's an opportunity that the us and european countries are mostly missing because they're not focused on exports and servicing these markets and they're not putting in place the tools to compete with the chinese producers because they have an enormous advantage, they have subsidized capital, they have all sorts of structural advantages that have been put in place.

We talk about this all the time.

Chinas great problem is the imbalance between households and business, production and consumption.

The chinese system is geared toward production and investment and its not geared towards consumption.

And that has obviously negative ramifications which we talk about all the time.

But one of the positive ones is you can really kick ass when you want to go build these industries out, go abroad.

I mean if you look at this electrolyzer story, it was absolutely shocking because electrolyzers are not a big business.

This is a tiny business.

This is like barely a pimple on the butt of the battery business or the solar panel business.

So it's not like, oh, these chinese producers have just gotten this huge scale advantage and it's all over.

Electrolyzers are not economic anywhere.

Hydrogen is super nascent just for the background there.

But if you read the story, the chinese electrolyzer equipment is one third the cost of the european competitors.

And some of these european projects are actually foregoing EU funds entirely because they want the chinese equipment because it's so much cheaper and it's good.

That is extraordinary.

I don't think we've ever seen that.

There's no historical parallel for that.

Even if you were to look at the US and look at the US's current account surplus during the 1920s, which I think is the only historical analogy to today that makes any sort of sense, the US was not nearly as embedded in terms of having these national champions that were just untouchable and providing manufactured goods in a way that was just untouchable.

They were exporting a ton of capital, but it was primarily because Europe was destroyed and they were shipping bonds to Germany to build municipal swimming pools and rebuild the industry after sort of the, the Ruhr valley was kind of blown to bits.

So I don't know what to say.

History provides almost no guide to this, but this extraordinary.

The scale and the degree of what's happening.

And the US and Europe don't seem to have any really cogent solutions for this other than allowing the trends to continue.

Yeah.

I'm also struck by how all of this ends up boiling down to energy and where weaknesses become strengths and strengths become weaknesses.

Because the United States, as a result of the 2008 fracking revolution, and because it has become this massive oil and natural gas superpower, it doesn't need to invest in much in these renewable forms of energy.

You can, for ideological purposes, you can if you think it's going to save the environment, but there's not a demonstrated need.

The same was true for Europe up until Russia invaded Ukraine.

The problem for Europe is now they have the need, but now they have this Frankenstein political structure that is not designed for everyone to agree.

And Hungary can raise its hand and say, we don't want that, or a France can raise its hand.

We're getting this right now with the Mercur EU free trade agreement, which basically everyone in the EU except France wants, and France doesn't want it, they say, because of deforestation in Brazil.

It's really because they're rightfully afraid of what brazilian agricultural exports are going to do to France's agricultural industry.

Us farmers who are listening to this are living the story, literally, right now.

All of which is just to say the EU's political structures are not strong enough to say, okay, we do have an energy imperative issue, let's pivot to that so that we can become energy secure and give the types of incentives we need to produce these things inside of Europe.

The ironic thing about China, and this was true, this is where the China Japan comparison, sort of the early 20th century Japan comparison, I think, carries a lot of water, because China doesn't have enough food to feed itself.

It doesn't have enough energy to power itself at the rate that it's growing with current technology that's available to it, and it doesn't have any oil or natural gas resources.

And it's sort of come up on the limit of what it can do with fossil fuels, because the environment had gotten so bad that it was literally killing people and that the population was literally turning against them, to the point where Xi Jinping.

I remember this very vividly.

I think I was still at GPF.

I think it was 2017, 2018.

He declared war.

Not against the United States, not against Japan.

He declared war against the environment and against cleaning up the environment so that people could breathe a little bit easier.

All of which is to say it's an interesting dutch disease experiment, because one of the reasons I think that China is at the forefront of EV's and at solar panels and at batteries and electrolyzers, I mean, it's, you know, they're at the forefront of a lot of things from production perspective, but they have to be, because if theyre not, theyre absolutely screwed.

Whereas until 2022, that wasnt true for Europe, its not ever going to be true for the United States, or at least not in the next ten to 15 years.

And you can see how in other parts of the economy, this really does damage China.

But in this particular thing, which the narrative pendulum has shifted here, everybody wants renewables, everybody wants the things that China is producing here for both energy security reasons and for ideological reasons.

And like they're the game in town, nobody else is going to be able to compete with them at scale.

In many ways, it's the same treadmill to hell idea that we talked about in relation to the property market in China.

This notion that you need to keep doubling down on this strategy.

And you have a, you know, you have a, what's the thing that's on the playgrounds?

Them having a total brain fart that goes back and forth and one kid gets a seesaw, an imbalanced seesaw that you keep having to push down on one end so that it doesn't fall over.

That's kind of an analogy for where the chinese economy is, I guess a positive view, because this is all well and good, but I think you need to identify well what is going to make this change.

And we talk about this all the time.

Does Xi Jinping have the wherewithal?

Does he have the power to shift these levers in such a dramatic way?

Ive expressed doubt about that.

I think the onus is on the changers to show that thats actually going to happen, because theres no evidence of that really happening.

Instead, theyre kind of pushing the imbalanced seesaw in a different direction, the treadmill to hell, if you want to use a more negative analogy.

So if it does continue, then what happens?

I think the positive view is that China's dependence on foreign markets, because if it's going to be pushing on the supply side even more, that dependence is going to grow.

And you get the Norman angel positive view, which is it makes it that much less likely that there'll be large scale conflict between these major economic regions.

You might, you know, maybe that's maybe that's panglossian, but it certainly pushes in that direction at the margin.

It's definitely panglossian.

There's going to be no conflict until there is going to be conflict or until the us version of the port worker comes out and says, no, no, no, we're going to keep what we want for ourselves.

And they traipse across a red line that they don't realize that is a red line for China, which is a great example of, again, and we've talked about this a lot too, and it's one of the through themes for what we're talking about now, us foreign policy and us industrial or economic policy not being on the same page.

Us foreign policy was not, was to find a negotiated settlement with Japan.

Us economic policy, like embargoes on oil to Japan and all the things that went into that made that completely impossible.

And even up until the week before Pearl harbor, the Roosevelt government is thinking, we've got one more chance here, maybe we can push it through, even though Japan had already decided no.

Like they've told us what we need to know, like we have to make our move in either direction.

There's one other part of this that I wanted to talk about, and then we can do a little around the world thing if you want, Rob.

But if listeners want to.

I did a little micro geopolitics on the flooding in western North Carolina.

We'll put a link to the notes here.

But one thing that I didn't say in that piece, which I thought was particularly, which hits on some themes we've talked about here before and was particularly shocking to me, was how few people in western North Carolina have flood insurance.

The data here is absolutely insane.

So Buncombe county, which is where Asheville is located, 137,123 housing units.

This is from distilled earth, by the way, an excellent substac.

941 of those units.

So less than 0.7% have flood insurance.

In Rutherford county, which is a home of chimney Rock, a lot of the worst videos on social media have been in Chimney Rock.

32,967 housing units.

90 of them have flood insurance.

90.

I don't know what this does to western North Carolina in the future.

I mean, are people ever going to live back there?

I was talking to a friend of mine who was like, ah, FEMA is just going to come in.

The US will bail them out somehow.

I don't know.

Those are absolutely shocking figures.

And one of the things that distilled earth talks about is that North Carolina is not an outlier here.

So inland counties in South Carolina, Georgia, Florida, all these places, very, very few people have flood insurance.

And flood insurance is more expensive now than it ever was before because one of the things that capped flood insurance went off the books a couple of years ago.

So I obviously pay for flood insurance because I'm in New Orleans.

It would be very foolish not to, even though my house has never flooded in its history, built in 1853, we've never flooded here.

I probably just tempted the gods right there after my fire day yesterday.

But first of all, listeners, you should have flood insurance if you don't have flood insurance inside the United States.

Oh, yeah.

And there was one other thing I wanted to say about that, and this is something that Elo and I talked about the last time we were together in Wisconsin.

Listeners, if you have not listened to the podcast with Elo about Alberto Fujimori, here's the plug for it.

It was a really great episode.

But I was telling Elo when I saw him in March in Madison about how flood insurance had gone up and how I was pissed about it.

He laughed at me and he was like, what is this american thing?

You have insurance, like in Peru?

We're not insuring, like, this is not a concept that exists outside of the United States.

I don't even know what exactly you're complaining about, which is also something in the american mentality, whether it's crop insurance or flood insurance or all the different insurances we have to try and manage risk.

The cost for those are going up.

It's not even clear that they can get paid out, and people aren't even using them.

So I don't know what point I'm circling around there, Rob, but this is a theme that we've talked about before, and I wanted to let you talk about it as well.

Well, I think you're circling around an important point, which is insurance is something that societies adopt when they're wealthy, because insurance is basically using the wealth of the country as a cushion to spread out costs in a way that's more manageable.

And we talked about this in relation to Brazil and the floods in Porto Alegre and the fact that most of those people will not have insurance because Brazil is not a rich country.

And as Ilo pointed out in Peru, insurance is something that's a very foreign concept.

But that is because those are poor places.

Those aren't deliberate or good choices per se, because if you look at underdeveloped countries, one of the major problems, especially when you're really at low on the income scale places in certain areas of sub saharan Africa, for instance.

One of the major problems is that no one has any protection when things go bad.

Someone gets sick, breadwinner in the family gets ill, someone dies, your home gets burned down, gets flooded.

Those are catastrophic outcomes for people in those societies because they don't have the wealth to buy insurance.

And that's one of the great things about developed countries.

So I think one of the themes here is that insurance requires wealth, and it's a drawdown of that wealth in a more steady manner rather than all at once in great spikes.

Because if you don't have savings, which most Americans don't, and you don't have insurance, you're screwed.

You don't have the wealth to build your, to repair your house or to recover from something like this, you have to depend on some kind of handout or you're just done.

You have to move somewhere else and find some way to recover.

Right.

This is really important, I think, for two reasons.

First, because when volatility is low in all sorts of ways, then the economy can run in such a way without a lot of quote unquote insurance in all sorts of forms, because the economy doesn't have to be as anti fragile if you want to say it that way.

And that gives you the illusion of being wealthier than you are, because you're not drawing down on your wealth to protect against a rainy day, literally.

So you look richer, your margins look higher.

If you think of this in terms of supply chains, if you don't have excess capacity, if you haven't built in protection, then you look like you're operating super efficiently, you look like your margins are just great, but really you have a hidden cost, the depreciation.

If you were to think in accounting terms, let's get really nerdy here, and if you were an accountant and you had to take into account like, okay, we know there's going to be the hundred year flood every hundred years, or in whatever area the Houthis blowing shit up in the Red Sea, every ten years, whatever the tail event is, then you would take the magnitude of that and depreciate it over the life of that ten years or 100 years.

And that's a real cost.

You only have to pay the cash every ten years, but the real expense is carried year by year by year by year.

So you look really smart and really profitable.

If you don't pay that expense and you don't recognize it, you don't have insurance, you don't keep extra semiconductor capacity, you don't keep extra shipping capacity.

You don't build out alternative routes in case something goes wrong.

But then when the flood does come, then you're screwed.

And you recognize all the costs all at once.

And that's what we're doing in North Carolina.

That's what people are doing against their will in Porto Alegre because they can't afford it.

And God forbid if there were an earthquake in Peru, those people would be screwed as well.

But the broader theme is very similar, whether you're talking about developed world or the undeveloped world, just this notion of we're not as wealthy as we think we are, because so many of these costs are hidden.

And when volatility increases, when floods go up, which they are, when the climate changes in ways that are difficult to predict, that's when these costs manifest themselves.

And you realize like, oh God, I have no rainy day fund.

Yeah, well, that actually brings up a question, because I think you're right.

And the flip side of that is that markets reward the companies that have high margins and that are super efficient and that have been moving in that direction.

Markets would probably like, I would guess, the equity price for a company that has backup, that has excess capacity on hand, and whose margins aren't as good because they maintain operations in a secondary location or warehouses in a secondary location in case something happens in their primary location.

Probably the market, at least until now, is not only not going to reward them, probably going to punish them for having that sort of excess capacity.

Are you positing that that might change, that investors might be looking for the companies that do have those sorts of backups that they don't have right now?

Or is this sort of one of the bugs of the capitalist system, which is the system is pushing us to be as efficient as possible, to push on the string as much as possible, and the global environment has become less favorable to that.

But ultimately, that's still what the incentive is for companies to do.

The incentive is not to pay the cash every ten years or every hundred years.

It is to ride it as long as you possibly can, make as much money as you possibly can, and hopefully survive the one in ten year or 100 year event.

And if you can't, okay, generated value in the short term, it's definitely a.

Bug in the capitalist system.

I mean, that's one of the major problems.

And you see this every day.

This isn't just theory.

Like you can look at individual companies all day long and see individual instances of companies that just, they don't really give a shit about.

The long term management is incentivized to increase the stock price over a two year time horizon.

And whatever they need to do to do that, they will do it.

It brings up one of the interesting.

You know, I was doing some research on the side, looking at family owned companies and how their decision making is different, and I think there's some interesting work being done there.

It's hard to have counterfactuals, because if you look at places where there's a lot of family owned companies, they tend to be geographically very concentrated in India and Europe and places like that.

But it is a different set of incentives in many ways.

So, yeah, it's definitely a bug.

The answer is, I think capitalism can adjust for it.

It'll never go away entirely.

But right now, we're especially complacent, and that's going to be adjusted over the next four or five years.

That's almost guaranteed.

Because if you look at the balance sheets of american companies in particular, there are virtually no more aaa or rated balance sheets anymore.

And I think one of the few exceptions is Berkshire Hathaway.

And I think that's the exception that really proves the rule.

Because why can Berkshire Hathaway have a aaa balance sheet?

Because people trust Warren Buffet to hold all this dry powder, because they think, oh, well, this guy's.

He's a genius.

Like, you're buying the optionality of Buffett.

You're happy for Berkshire to have tens of billions of dollars of cash and to be overcapitalized, in your view, because it's Buffett.

But if it were anyone else, the investors would be saying, well, why aren't you levering the balance sheet?

You're overcapitalized.

Why are you running with this extra capital?

And that's what you're seeing in almost every other company, because the average balance sheet rating, the average credit rating has deteriorated significantly in the last two, three decades.

And if you look, every company now is hovering right at that BBB to BBB rating because that's the lowest rating you can get and still be not junk rated because you don't want to be junk because that imposes a significantly higher cost of capital on your business.

But everyone is sort of gamed.

Not only are they not AAA, but they're all right on the knife's edge of that junk rating.

And if you look even within that, the EBITDA numbers that are used to judge these things are total bullshit.

And the quality of earnings has gotten significantly worse in that 20 year period.

So the actual cash flow, that's your EBITDA is supposed to be your cash flow.

That's like a mirage.

And most of these companies have cash flow that's significantly worse than their so called reported EBITDA numbers because they're gaming it.

And that's the situation we've gotten ourselves in, because they've been incentivized.

It's like someone who has the incentive to get in their Ferrari and drive 200 miles an hour to win the race, because as long as you haven't crashed, why would you do anything different?

Right.

But the problem is, inevitably, that's going to run into a credit.

Credit, I don't want to say crisis, because it's not really a crisis, but it's going to be a default crisis like we saw in the late 1980s during the savings alone period.

And then it resets itself and people will start putting value again on having buffers, which currently they do not.

So that's sort of where we are.

I think you want to be very wary of any businesses of owning corporate bonds in general right now for that reason, because the whole underlying structure is very weak.

But these things move in cycles, and we're getting to the point where we're going to be entering the nasty part of the cycle, most likely.

Yeah.

While you were talking, I was googling which us large equities have AAA credit ratings.

So this is old.

This is a year old.

So maybe this has changed since last October.

But as of October 2023, there were two companies in the S and P that had AAA rating.

Do you know, you want to take a guess at which two companies we're talking about?

Oh, yeah.

I don't know.

I couldn't tell you who the other one.

Number one, is not surprising.

Microsoft, which is the same sort of buffet principle, I guess.

They've just made so much money that they literally, like.

They can't.

They can't.

They're talking about restarting three Mile island now.

So maybe they're putting some of that capital to use.

The other one is Johnson and Johnson, which I would not have quite expected there.

And I don't know if that's before or after the spin out of.

I forget what the spin out was of the tile and all the other stuff that they did.

What the name of it was.

Kenview.

Yeah, Kenvue.

Anyway, not investment advice, but there are your two aaa guys left.

Whereas in 1980, more than 60 public companies had a aaa credit rating, to your point.

And just to put that into context, Microsoft is not like.

That doesn't count.

They're a software company.

The only reason they even have debt is because they borrowed to buy back their stock, artificially engineered the balance sheet with some debt, just because the cost of debt was so low.

So that's not a company that would ever need to carry any leverage and should always have net cash.

Right?

So if you were to compare now to 1980, there were no, virtually no software companies in 1980 in the S and P five.

Those were companies with physical assets that needed to be financed with a lot of debt.

That's the difference.

Like 1980, you just had 15 years of chaos and shrinking margins and inflation and volatility spiking to the moon.

Yeah, of course there's going to be a lot of companies that put a lot of premium on having buffers.

That's a real illustrative difference.

Anything else we want to tell the listeners, Rob, or should we give them a break?

They've gotten a lot of content this week.

Oh, oh, the last thing I wanted to say, and I wanted to ask you about this, in relation to the credit rating thing.

I don't know if you saw that Brazil's credit score is getting raised by Moody's to the highest junk grade, so they're right on the cusp of being investable.

I wondered if you had anything to say about that in the context of talking about credit ratings and things like that.

Because on some level, I don't trust any of these things because it's all a racket.

But we like Brazil, so let's applaud the racket when the racket does what we want it to.

Well, credit ratings are useless because they're always backward looking.

Let's just say that.

Don't ever rely on credit ratings to make any kind of decision, because they're always way behind the curve when things change.

But I think it does show that the brazilian economy is going from strength to strength.

One thing I found very striking was Brazil is having elections right now for the.

At the mayoral level.

So local elections and city elections.

And the major talking point is not the economy, it's crime, which is interesting because crime has actually gone down significantly on most measures over the last seven or eight years.

So I put this on the thing and I said, hey, this is actually a really good sign for the economy, because the economy must be really darn good if everyone who's trying to come in as an insurgent and get elected, all they can do is point to the typical brazilian bugbears of, you know, getting robbed in the street and murders and, you know, law and order and stuff like that, which is always has always been the case in Brazil.

Like that's always a public fixation, but things are pretty good there.

All right, well, on that rosy note, we will talk to the listeners probably sooner rather than later based on how things are going.

Cheers, y'all.

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