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Essays on Growth, Liquidity & Inflation - I



Introduction


Is there a beginning to the story of growth, inflation, and liquidity? Why was there a need to create or acquire more than basic needs? When I was 14, I learned to arbitrage for a profit by buying video games cheaply and selling them at a higher price to my classmates. Most of the profits went towards acquiring new inventory or fulfilling recreational needs. However, this entire scheme was exposed by teachers who found it to be unjust, serving as a classic example of marketplace regulation.


I received training as an investment analyst, where I developed the ability to identify businesses that can generate higher savings from their capital. In my role, I aimed to generate higher returns on savings for both institutional and retail clients compared to our peers. Our focus was on identifying undervalued businesses that not only demonstrated proficiency in generating excess capital but were also undervalued by other investors.


When we found companies that exceeded expectations in terms of savings (earnings), it not only changed people's perception of the business but also led them to be willing to pay a higher price for it. As a result, we were able to profit from either one or both of these phenomena, ultimately generating substantial profits for our clients.


I also observed that certain businesses were able to generate higher returns during specific market conditions but lost their ability to generate higher profits during other periods. For example, banks earned higher profits when the economy was performing well and there were increasing inflation expectations, leading to higher interest rates. Asset managers performed well when the markets were in a risk-on mode, while financial exchanges performed better when the markets were in a risk-off mode. By identifying solid quality and growth businesses and strategically positioning investments based on the probability of the next market regime, I was able to generate substantial profits for our clients. The real experiment was conducted between 2020 and 2023, where all the major regimes played one after the other in a systematic fashion. My interest in regimes and macro-level movements increased substantially.



A Framework for Understanding the Global Macro


My interest in macroeconomics has allowed me to apply the principles of growth, cost (inflation), and savings to evaluate the rise and fall of nations. When growth surpasses inflation, liquidity is created, which can then be directed towards further savings and so on.



Some of the savings can be set aside as reserves to meet future liquidity needs. These empires had previously accumulated reserves or power, which allowed them to have flexibility in enhancing liquidity. Here is an example of government-generated liquidity in the last two decades.



Reserves are accumulated when the earned liquidity exceeds the liquidity generated by the government. Central banks are responsible for both accumulating and spending reserves to achieve their objectives.





Total liquidity can be defined as the sum of created liquidity and government-generated liquidity.



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