In what CNBC describes as the the “second most-anticipated CEO missive of the year, behind the annual Berkshire Hathaway letter penned by Warren Buffett,” JP Morgan CEO Jamie Dimon released his annual letter to JPM shareholders (coming in a modest 46 pages), where he touted the bank’s record earnings in 2017, shared his plans for expanding several key business lines and offered a stern warning about the risks of volatility and the Federal Reserve hiking more quickly than the market expects.
But most importantly, Dimon, in his infinite wisdom, explained his ideas about how to fix the US.
In an editorial published in the Wall Street Journal that effectively serves as an introduction to his letter, Dimon exhorts his peers across corporate America to “collaborate” for the good of the country.
As the economy is transformed, government and private companies must collaborate to add jobs, increase wages and help those left behind. We must overcome divisiveness and polarization, and work together on three policies that would help businesses and workers adapt to globalization and technological change.
He then went on to plug one of his favorite wonkish policy proposals…converting the earned income tax credit to a payroll credit. He says such a system would eliminate fraudulent claims and ensure that every eligible individual receives a credit that could potentially push them just above the poverty line (still not always the most comfortable place to be).
First, Congress should reform and expand the earned-income tax credit. The EITC rewards work and supplements the incomes of low-paid workers. A single mother with two children earning $9 an hour—approximately $20,000 a year at full time—could get a tax credit of more than $5,000. Last year the EITC lifted an estimated nine million Americans above the poverty line.
Yet it is far from perfect. Each year, about 21% of the people who are eligible for the EITC don’t file for it, likely because they don’t know about it. There also are many fraudulent claims. And the current rules make too few workers eligible. About 21 million Americans earn between $7.25 and $10.10 an hour. It’s hard to argue that this is a living wage, particularly for workers with families.
Converting the EITC into a payroll credit would deliver the benefit to more Americans in need. Automatically calculating the credit for everyone would help, too, while reducing fraud. Eligibility should be expanded to include more workers without children.
Moving on to the letter, Dimon indulged in some wishful thinking by cautioning investors that interest rates could rise much sooner than they expect. If inflation suddenly comes roaring back (say, if we see another ~3% wage-growth reading on Friday, even if it’s the result of a shrinking denominator), Dimon said the Federal Reserve might need to raise interest rates more quickly than many expect.
Since QE has never been done on this scale an we don’t completely know the myriad effects it has had on asset prices, confidence, capital expenditures and other factors, we cannot possibly know all of the effects of its reversal. We have to deal with the possibility that at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate – reacting to the markets, not guiding the markets. A simple scenario under which this could happen is if inflation and wages grow more than people expect. I believe that many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think.
Indeed, it’s entirely possible the 10-year could break above 4% in the near future as inflation returns to 2% and the Fed shrinks its balance sheet.
It would be a reasonable expectation that with normal growth and inflation approaching 2%, the 10-year bond could or should be trading at around 4%. And the short end should be trading at around 2½% (these would be fairly normal historical experiences). And this is still a little lower than the Fed is forecasting under these conditions. It is also a reasonable explanation (and one that many economists believe) that today’s rates of the 10-year bond trading below 3% are due to the large purchases of U.S. debt by the Federal Reserve (and others).
He also took time to tout the bank’s asset management business, which continues to dominate, while “plenty of opportunities” remain in investment banking and trading.
“In the high-net-worth business ($3 million to $10 million) and the Chase affluent business ($500,000 to $5 million), our market shares are only 1 percent and 4 percent, respectively. We have no doubt that we can grow by adding bankers and locations, particularly because we have some exciting new products coming soon. There is no reason we can’t more than double our share over the next 10 years.”
Dimon also highlighted the expansion of JPM’s retail banking business.
“We recently announced that we will start to expand the consumer branch business into cities like Boston, Philadelphia and Washington, D.C. Over the next five years, we hope to expand to another 15-20 new markets.”
While some have written off the return of volatility this year as a necessary – and even healthy – correction, Dimon warned that after a certain point it could impact the real economy.
“The biggest negative effect of volatile markets is that it can create market panic, which could start to slow the growth of the real economy.”
Dimon also cast a wary eye toward exchange-traded funds, which have seen their popularity multiply since the financial crisis. There are now many ETF products that are considerably more liquid than their underlying assets.
Far more money than before (about $9 trillion of assets, which represents about 30% of total mutual fund long-term assets) is managed passively in index funds or ETFs (both of which are very easy to get out of). Some of these funds provide far more liquidity to the customer than the underlying assets in the fund, and it is reasonable to worry about what would happen if these funds went into large liquidation.
But moving on from finance, a suspiciously large portion of Dimon’s letter is devoted to talk of “policy”, an imitation of Buffett’s own optimistic “hot takes” on the economy. The focus suggests Dimon’s leaving the door open to a political run after he leaves his CEO role in five years.
Notably, the report dedicated several dozen pages about how Dimon plans to “fix” America:
In the last several years, I have spent a good amount of time – in both these letters and elsewhere – talking about public policy. Some of the policies directly relate to JPMorgan Chase, while others are more indirect but have a large effect on the future of the United States of America, on the global economy and, therefore, on our company.With all of America’s exceptional strengths, it seems clear to me that something is holding us back. As we have already pointed out, our economic growth has been anemic. Our economy has grown approximately 20% in the last eight years, but this stands in contrast with prior average recoveries where growth would have been more than 40% over an eight-year period. The chart below on the left shows this.
Last year, I laid out in detail an extensive list of things I thought were holding us back, and it bears repeating here because, just as it took many years for these obstacles to develop, it is going to take sustained effort over many years to right the course. When you look at this list in totality, it is significant and fairly shocking. Most of these areas have become consistently worse over the last 10 to 20 years, and it is hard to argue that they did not meaningfully damage the country’s economic growth. It is also important to point out that I have never seen an economic model that accounts for the extremely damaging aspects of these items. (These items don’t include the trillions of dollars we have spent on war-related expenditures. And whether you were for or against these wars, they certainly did not add to American productivity.) This is not secular stagnation – this represents senseless and misguided policies.
While Dimon also touched on his plans for reforming the EITC (the focus of his WSJ editorial), he also dedicated sections of the letter to other ideas like “smart regulations” and “America’s growing fiscal deficit and fixing our entitlement programs.”
In it, he declares that the “real problem with our deficit” is the “uncontrolled growth of our entitlement programs.”
We cannot fix problems if we don’t acknowledge them. The extraordinary growth of Medicare, Medicaid and Social Security is jeopardizing our fiscal situation. We have to attack these issues. I am not going to spend a lot of time talking about Social Security. I think fixing it is within our grasp – for example, by changing the qualification age and means testing, among other things. When President Franklin Delano Roosevelt astutely put Social Security in place in 1935, American citizens would work and pay into Social Security until they were 65 years old. At that time, when someone retired at age 65, the average life span after retirement was 13 years. Today, the average person retires at age 62, and the average life span after retiring is just under 25 years.
Nestled in Dimon’s policy exegisis were a few jabs at President Trump and, presumably, his insistence on risking a trade war that has frustrated much of the US’s financial and corporate establishment.
“Critical thinking, analysis of facts and proper policy formation have become extremely difficult in a politicized and media-saturated environment. Often, politics misuses facts to justify a position.”
Read the whole letter below: