Courtesy of Stephen Johnston, Partner & CIO – Agcapita Farmland Investment Partners, a Calgary based, agriculture private equity firm.
Some Thoughts Macro, Value & Austrian
As Kierkegaard elegantly pointed out, “There are two ways to be fooled: One is to believe what isn’t so; the other is to refuse to believe what is so.”
The problem of being fooled “by believing what isn’t so” appears to be endemic in mainstream economic circles. Increasingly, we see the panic of central bankers and politicians in the thrall of the mistaken belief that the mere act of printing money can conjure wealth and sustainable growth into existence that this nostrum has stopped working.
In simple terms the powers that be in the west have been fooled by Keynesian dogma that:
– nominal increases in GDP represent growth;
– printing money increases nominal GDP; therefore
– printing money must generate growth.
Surely, this is to believe what isn’t so. A simple example of the fallacy this represents is Frederic Bastiat‘s parable of the “broken window“. To paraphrase Bastiat, if all the windows in the country were suddenly broken there might be an increase in nominal GDP as the reconstruction took place but we should not be fooled into believing that this has made us wealthier.
Keynesians would argue that business activity has been stimulated, jobs were created and the economy benefited. In his own version of the “broken window” Keynes famously advocated burying newly printed money and paying people to dig it up as a way to stimulate the economy.
With all due respect to Lord Keynes, this belief is in the process of being exposed as the mirage it has always been. The true measure of the wealth of an economy is the pool of productive capital. Currency is merely the measuring stick. In our broken window example, the pool has been maintained but without the reconstruction it could have been increased – therefore the net effect, taking into account both “the seen and the unseen” in Bastiat’s words, is actually a loss of wealth.
If printing money does not create productive capital then how can you explain its perennial appeal amongst the banking and political classes?
For politicians, printing money is desirable for two reasons. Firstly, it acts as an unseen tax. One which few voters understand and for which even fewer are likely to blame the political class, at least in the beginning. Secondly, by reducing the value of the currency, the measuring stick I mentioned above, politicians are able to fool many of the voters that their wealth has increased, but of course no such thing has happened.
For members of the privileged banking class the appeal of printing money is that they are best positioned to take advantage of the confusion between the measurement of the pool of capital and the actual pool of capital itself. In simple terms, they can exchange the declining currency for productive assets while artificially low interest rates finance these activities at minimal cost.
So in general while printing money creates no new wealth in the form of productive capital, a significant amount of wealth can be misappropriated silently by the banking and political classes. For the rest of us, the relentless expansion of the money supply offers no true benefits and the very real danger that it is our wealth that is misappropriated.
In the spirit of Bastiat, ask yourself if the central banks increased the global money supply 20-fold overnight would we have more farmland, more oil wells, more factories, more of anything other than decimal places in our currency? The nominal price of all these things would likely increase but the size of the capital pool has not changed. How do the money printing programs currently underway differ from this in anything but magnitude?
Unfortunately, the perverse consequences of printing money do not stop with the misappropriation of wealth from the inflatees to the inflators. A policy of artificially low interest rates serves to sustain or create additional mal-investments – investments that cannot generate sufficient returns, and in many cases over the last decade ANY returns, to justify their existence. The failure to liquidate mal-investments allows the economic problems they cause to multiply and the inevitable accounting to be that much more devastating. Artificially low interest rates also fool the market into believing that capital is plentiful and that consumption can continue at unsustainable levels with severe consequences for the real economy. The word consume means “to expend, to use up, to waste or squander”. Always remember that consumption represents the diversion of productive capital into non-productive uses – i.e. the destruction of capital. Savings, on the other hand, are the only source of capital to create productive assets.
I do not believe that the aggressive expansion of the money supply in the west will have a beneficial effect on the real economy – i.e. will not increase the pool of productive capital in any meaningful way. However, I do believe it will fuel inflation and speculative activities. Of course, more inflation and speculation are exactly the opposite of what western economies need. We cannot all make our livings selling condos, stocks and bonds to each other – someone has to produce something and production requires genuine capital.
But this Frankenstein, finance driven economy appears to be exactly what our governments and central bankers are trying to keep alive. The west has become a vast inflation-creating machine in order to support the impaired banking and housing sectors. According to data published by analyst Mike Hewitt, since the dot.com crash in 2001 and the onset of aggressive low interest policies, the global money (M0) supply has increased over 170%. Some, fooled by government inflation data ask – “but where is all the inflation?” Fortunately for us, the Renminbi peg and OPEC petro-dollar recycling have been escape routes for a large amount of western money/inflation creation and heavily massaged government inflation data has helped disguise the rest.
As fast as we have been creating money in the west, China and OPEC have been importing and storing it on their balance sheets in the form of developed world sovereign debt. Some observers even argue that China will indefinitely accumulate western debt in order to maintain its peg against our inherently weak currencies. I believe that this is wishful thinking and once again it is to be fooled into believing what isn’t so merely because something hasn’t happened to date. When the emerging economies are forced to take serious steps to check domestic inflation – which for example is already starting to happen in China – they will stop purchasing our debt and even start selling it, at which point decades of stored western inflation could be returned to us in a very short period of time indeed.
In general, my investment premise remains that sustained real growth is unlikely to take place in the developed world until we stop engaging in capital destroying activities. Worse, our depleted and declining capital pool, combined with an enormous expansion of the monetary base and expanding government is creating a high probability of an extended period of stagflation in the west.
This is not to say that I take a universally pessimistic view of possible future returns. I believe that exposure to inflation-hedging assets with strong macro fundamentals and underlying cash generating capability, ideally in sectors exposed to growth outside of developed markets, will continue to be a fruitful area to search for outperformance over the long-term. My personal preference remains agriculture and energy.