04/12/2017 - WindRock Wealth On Cryptocurrencies

The first article in the series, Investment Themes Your Wealth Manager Isn’t Telling You About, provides great insight and perspective on cryptocurrencies such as bitcoin. This article may be especially relevant for investors who are still confused by the concept of and the opportunity provided by cryptocurrencies.

FRA acknowledges the potential for cryptocurrencies to mitigate risks associated with the continued war on cash by governments. Measures taken by governments to restrict and eventually eliminate the use of cash will only continue, especially if negative real interest rates persist or increase in magnitude.

In addition, cryptocurrencies present the opportunity to hold assets outside of the banking system. Doing so helps investors avoid the risks associated with bank bail-ins or other repressive measures “necessitated” by the banking crises inevitably generated by a fractional-reserve system.

Given bitcoin’s dramatic price increase over the last few years, its relative price stability, and the opportunities it presents, investors should learn more about cryptocurrencies.

Investment Themes Your Wealth Manager Isn’t Telling You About:

              Cryptocurrencies

Brett K. Rentmeester, CFA®, CAIA®, MBA

April 2017

                                                                                                                                                           

In 1994, most investors had heard of the Internet, but had no real idea of what it was or how it would impact their lives. An episode of the Today Show that year featured Katie Couric and Bryant Gumbel discussing the topic when Bryant Gumbel asked “What is the Internet anyway?”[1] By the time most investors truly figured that question out, fortunes had already been made and many other business models had been disrupted. The lesson: astute investors should take time to understand the technology that computer geeks are enthusiastic about. Today, that is bitcoin and other cryptocurrencies.

Like the Internet back then, most investors have heard of bitcoin, but few have a real grasp of the disruptive technology behind it – the blockchain. Blockchain technology has the potential to be as revolutionary and disruptive as the Internet itself.

What is bitcoin?

Bitcoin was the first cryptocurrency, a virtual money and payment system. It is based on a revolutionary technology referred to as the blockchain. Understanding bitcoin and other cryptocurrencies involves first understanding the blockchain itself, the genius behind all cryptocurrencies.

How does blockchain technology work?[2]

The blockchain is a digital accounting ledger. It is public, transparent, and includes the full history of all transactions on the system for all users to see and verify. Similar to a bank’s private banking records or ledger, the blockchain stores a registry of all user assets and transactions. This is done in a pseudo-anonymous way with users’ identification only specified by a numeric address typically held in a “wallet.”

The “blocks” contain bitcoin transactions. The most recent bitcoin transactions are recorded on these blocks which are verified with cryptography (an encryption system using advanced mathematics). Only a bitcoin owner’s cryptographic keys can alter that segment of the blockchain. This prevents double-counting of or multiple claims to bitcoins. The blockchain is thus a “chain” of these many “blocks” registering ownership in one comprehensive and transparent accounting ledger. Bitcoin owners have access to their respective transactions within the blockchain available to them anytime, anywhere in the world.

Further, this requires no middleman’s trust or approval. It is as if each individual becomes their own bank and controls their own money. This bank is open 24 hours a day, seven days a week, and it can be accessed globally and transacted quickly with minimal transaction fees. It is portable beyond national borders with a value that is set globally.

Contrast this to an investor with money in the bank. An investor’s money is also an electronic entry, but this time on a private accounting ledger controlled by the bank. This requires dealing with the bank to get access to their own money. Worse, due to fractional-reserve banking, money in the bank is actually largely lent out (depositors are creditors to the bank). Transaction costs may also be high or it may simply be impossible to do certain global transactions.

Who maintains the system?

It is a global peer-to-peer system, managed by its members and not reliant on any centralized governing body, corporation, or government to function. In this sense, it is a pure free-market model where members maintain the system in a way that supports their own economic interests. Essentially, the system is run by the majority of its most active participants referred to as “miners.” These miners are a global community of individuals who keep the blockchain updated by authenticating transactions. As a reward, they earn new bitcoins. In this regard, they are given the name “miners” in reference to gold miners who are rewarded for their mining efforts with new found gold.

Is bitcoin secure?

The ledger is replicated across the entire network of users such that no centralized institution or server controls the blockchain data. Since the data is replicated thousands of times over on computers globally, hacking would require massive computing power. In any such attempt, the offending computers will be identified as corrupted by the tens of thousands of uncorrupted copies of the blockchain.  For this reason, bitcoin and the blockchain are likely much more secure than most centralized systems we rely on today.

Although the blockchain has never been hacked, certain online accounts holding bitcoin have been hacked which created some negative publicity. However, it is critical to differentiate between the security of the blockchain itself and where a user chooses to store their bitcoin.  Related to the security of each transaction, the miners help audit and confirm the validity of every transaction on the blockchain many times over, such that hacking and fraud of the bitcoin are highly unlikely. Imagine a dozen accounting firms auditing every transaction of a business and only approving them if all accounting firms agree.

Why is the blockchain concept so revolutionary?

Blockchain’s disruptive potential is most heavily influenced by its key attribute – that it allows for a trustless system. It is a peer-to-peer system with no middleman. Users rely on the integrity of the blockchain itself and thus have no need to know the identities or reputations of a counterparty or place any trust in them. The integrity of the system itself is all that needs to be trusted. The mysterious founder of bitcoin, Satoshi Nakamoto, wrote: “we have proposed a system for electronic transactions without relying on trust.”[3]

What is the value of bitcoin?

The value of bitcoin or any cryptocurrency can be hard to grasp, although it has a price that is set globally and trades 24 hours a day. Thus, a global network of buyers and sellers act to set the price at every moment. At its core, bitcoin is a digital currency that can be used to transact, act as a store of value, or held as a speculative investment. Overstock.com was an early adopter to accept bitcoin, but bitcoin can now be used at over 100,000 merchants including household names like Starbucks, Walmart, Home Depot, Tesla and Subway.[4]

The value is contingent on supply and demand. For bitcoin, the supply is programmed to grow from approximately 16 million bitcoins today to 21 million bitcoins in the future.[5] It has a finite supply (unlike fiat currencies today), supporting its longer-term value. Demand drivers include the utility or benefit users get from using bitcoin. These include a trustless blockchain technology allowing individuals to become their own bank, an ability to transact or transfer value globally at any time to anyone at minimal costs, and the capability for micro-transactions (more on this below). With a market capitalization (or total value) of $18 billion, bitcoin is similar to the concept of owning a piece of other payment systems like PayPal ($52 billion market capitalization) or MasterCard ($120 billion market capitalization).

Micro-transactions today are totally uneconomical with financial institution fees, but bitcoin can be transacted in any fractional amount. For example, imagine someone needing to do a transaction in a poorer region of the world. Today, they could transfer 0.0012 bitcoin or approximately $1.44 (based on a bitcoin price of $1,200). Transferring dollars would be cost prohibitive with any normal level of financial fees. Applying this technology to regions of the world needing money in small denominations and lacking access to traditional banking could unleash the power of bitcoin as the money of the internet.

There has been some debate about whether cryptocurrencies like bitcoin represent money. Money is a medium of exchange and, as such, presupposes the ability to act as a store of value. Over two thousand years ago, Aristotle noted the primary qualities exhibited by money: portability, durability, homogeneity and divisibility. Bitcoin meets these criteria. Today, as most currencies are increasing their supply dramatically, bitcoin offers a unique alternative due to its finite supply.  Interestingly, the price of bitcoin surpassed the price of gold for the first time ever on March 3, 2017.

Why do investors own bitcoin or other cryptocurrencies?

Many owners of bitcoin are using it for transactions. However, some view it as a store of value or speculative investment. This former view is a hedge against the risks of a future global currency crisis as most governments today have debt levels which can only be repaid by massive monetary printing. Bitcoin may be a hedge against monetary instability or capital controls as it allows individuals to be their own bank and control their money outside of the fractional reserve banking system. For speculators, it is an opportunity to be part of a vibrant and mushrooming industry where the value of bitcoin may grow as more users enter its network.

What are the risks?

Technology is always evolving and its path is far from certain. In social media, early winners like Myspace gave way to Facebook, so the future of leading cryptocurrencies could change. Miners can also have disagreements leading to splitting a cryptocurrency in two separate coins, referred to as a “hard fork.” For example, there is currently a debate in the bitcoin community about block size as it relates to speed and cost of transactions. If a hard fork occurred, current bitcoin owners would get coins in each new currency that they could trade. Prices of any cryptocurrencies can be extremely volatile.

Also, cryptocurrencies pose a risk to governments as a store of value outside of the banking system. Since banks are reliant on depositors to keep a leveraged system afloat, governments could crack down on bitcoin or tax it excessively. Today, most governments have accepted bitcoin and, in the U.S., it is given favorable tax treatment under the capital gain tax laws.

What areas will be impacted by blockchain technology?

We see three branches emerging. First, money and banking as bitcoin and other cryptocurrencies gain acceptance as a store of value and payment system.

Second, titling and document retention. A group of open-architecture platforms, such as Ethereum, are creating smart contracts for many business applications to eliminate the need for a middleman due to the trustless nature of the blockchain. Ownership of their “coin” is somewhat akin to owning stock in their ultimate platform. This area is likely to disrupt many businesses as their platform allows developers to create business applications that act as smart contracts with a traceable system documenting all records, management, and transactions. This has the potential to disrupt any businesses that serve as a middleman to ensure trust amongst the transacting parties including title companies in real estate and even global stock exchanges.

Ultimately, we foresee many private and government applications built around the blockchain technology. Private uses of blockchain may be back office systems for banks and financial firms. We are even seeing disruptive social media sites like Steemit that reward key users and contributors with value in the social media network (akin to ownership) instead of these benefits only accruing to corporate owners (such as Facebook’s model). Securely storing and validating records (health, education, legal, etc.) and even authenticating voting remain likely possibilities.

This blockchain revolution is much bigger than bitcoin alone, but bitcoin remains the leader in payments and as an alternative store of value. While many of us may feel as lost about cryptocurrencies today as Bryant Gumbel was about the Internet, investors ignoring the potential of the blockchain may miss out on an equally lucrative opportunity.

                                                                                                                                                           

All content and matters discussed are for information purposes only. Opinions expressed are solely those of WindRock Wealth Management LLC and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists. WindRock Wealth Management may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. You may not modify this content for any other purposes without express written consent.

[1]       “What is the Internet, Anyway?” Today Show. 1994.  YouTube. 28 January 2015. https://www.youtube.com/watch?v=UlJku_CSyNg

[2]       The Financial Times Ltd.

[3]       Nakamoto, Satoshi. Bitcoin: A Peer-to-Peer Electronic Cash System. 24 May 2009 <http://bitcoin.org/bitcoin.pdf>.

[4]      SpendBitcoins. http://spendbitcoins.com/

[5]       Bitcoin: A Peer-to-Peer Electronic Cash System

 

WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high net worth individuals, family offices, foundations and retirement plans.

Brett K. Rentmeester, CFA®, CAIA®, MBA, is the President and Chief Investment Officer of WindRock Wealth Management. Mr. Rentmeester founded the company to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world. He can be reached at 312-650-9593 or brett.rentmeester@windrockwealth.com

Christopher P. Casey, CFA®, is a Managing Director with WindRock Wealth Management. Mr. Casey advises clients on their investment portfolios in today’s world of significant economic and financial intervention. He can be reached at 312-650-9602 or chris.casey@windrockwealth.com.


04/11/2017 - Introducing WindRock Wealth as New Contributors to FRA

FRA is introducing two new contributing authors to its blog, Brett Rentmeester and Christopher Casey from WindRock Wealth Management. Messrs. Rentmeester and Casey will be writing an article every few weeks in a series entitled: “Investment Themes Your Wealth Manager Isn’t Telling You About.” This series will cover investment themes typically shunned by mainstream wealth managers such as cryptocurrencies, cannabis, farmland, precious metals, private lending, uranium, rental residential real estate, and other ideas. FRA provides lead generation services to WindRock Wealth Management. Please mention “FRA” when contacting them.


04/14/2017 - The Roundtable Insight: 5 Top Money Managers Discuss Austrian School Investing – Now Published

LINK HERE to download the MP3 PODCAST

LINK HERE to download the Summary and Transcript in PDF

SUMMARY – also see FULL TRANSCRIPT BELOW

Today we have five panelists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Liechtenstein, Chris Casey from Chicago, Bill Laggner from Dallas, and Mark Whitmore from Seattle.

Chris is the Managing Director of WindRock Wealth Management. He combines a degree in Economics from the University of Illinois with a specialty in the Austrian school of Economics. He advises clients on their investment portfolios in today’s world of significant economics and financial intervention. He’s Also written a number of publications on a number of publications on websites including the Ludwig von Mises Institute, Zero Hedge, Family Business, Casey Research, and Laissez Faire Books. He is a board member of the Economics Development Council with the University of Illinois, a Policy Advisor for The Heartland Institute’s Center on Finance, Insurance, and Real Estate.

Bill is a Co-founder of Bearing Asset Management, he’s a partner with Kevin Duffy that manage the Bearing fund using an Austrian School of Economics lenses in terms of identifying boom-bust cycles, value in the marketplace, bubbles, and distortions created by both fiscal and monetary authorities. He’s a graduate at University of Florida, began his investment industry career in the late 1980s initially as a stockbroker, and then moved to the buy side at fidelity investments. He’s been featured also in Barrons, Reuters, and CFA magazine.

Russ Lamberti is the founder and chief strategist of ETM Macro Advisors. Which provides Macroeconomic intelligence and strategy services to asset managers, family offices, and high net worth individuals. He is the Co-Author of “When Money Destroys Nations”, a book about Zimbabwe’s hyper-inflation, and he’s a contributing author at the mises.org institute.

Mark Valek is a partner investment manager of incrementum, he’s a Chartered Alternative Investment Analyst (CAIA) and has studied business administration and finance at the Vienna University of Economics. From 1999 he worked at Raiffeisen Zentralbank (RZB) as an intern in the Equity Trading division and at the private banking unit of Merrill Lynch in Vienna and Frankfurt. In 2002, he joined Raiffeisen Capital Management and in 2014 he published a book on Austrian Investing. He’s one of the authors of “Austrian School for investors”.

Mark Whitmore is the Principal, Chief Executive Officer of Whitmore Capital. Mark has been managing personal portfolio assets, periodically publishing newsletters and blogs, and providing pro bono financial planning/investment consulting since leaving law in 2002. His specialties are currencies and international economic analysis. He obtained a B.A. in Political Studies from Gordon College, graduated Summa Cum Laude at the University of Washington he earned a Masters of International Studies (MAIS) at the Jackson School and a J.D. from the School of Law.

Austrian School of Economics Explained:

Mark Valek defines some basic points and differences of the Austrian School as: Economics about the behavior of individuals and human action, The Subjective value theory, under consumption of savings is necessary for sound investing and growth, capital structure being key to a sustainable economy, and price mechanic mechanism coordinates the centralized knowledge. Perhaps the most important distinction of Austrian Economics is its view towards the monetary system. Some of these points are inflation being defined as expansion of the money supply and finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory.

He points out that these are the typical differentiating points, but this is by no means a complete list, and you can discuss the differences between the Austrian School and traditional Keynesian theory.

Russell Lamberti thinks that one of the key differentiators from a practical analytical and investment perspective was that the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. He notes that at the microeconomics level, Keynesianism is very similar, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental break down there. He ends the thought by saying in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s why he thinks the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

Chris Casey discusses why Austrian Economics can provide new insight, saying that Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint to create a consistent and sound economic school and economic philosophy. And that’s what really makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

Mark Whitmore adds that specifically, the role of central banking is something that is really distinct from an Austrian perspective vs Keynesianism.  Specifically the asset price inflation that you’ve seen has largely been ignored by Keynesians in the last two bubbles.  Now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to there being really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates meaningfully. And I think that from an Austrian standpoint, this exacerbates this boom-bust cycle which we’ve seen which has been really compressed in terms of time lately versus what has historically been the case. Since the mid to late 90s the amplitude of bubbles to the upside has just been far greater. He highlights Henry Hazlitt’s two points as far as critiques of Keynesianism. The first one being that fundamental flaw in terms of interest, with Keynesians tending to service the visible minority at the cost of the invisible majority and again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, in its view, the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the accuracy of that. And second,the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

How it’s used in past, present and future Economies including how and why the 2007-2008 financial crisis happened:

Bill Laggner says what was interesting was that the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. He also points out that the distortions are epic, and that this won’t end well.

Mark Whitmore chimes in discussing Kurt Rickenbacker’s idea of “Ponzi finance” which is a powerful analytical insight that essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place.Credit can thus becomes increasingly untethered to any kind of historic connectors such as sound collateral. One increasingly witnessed these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic.


 

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

He notes that the curve and amplitude of the line showing the increase in central bank assets seen above is almost exactly the same as the line showing the increase in the S&P 500. He calls this the engine that’s driving what’s been taking place in terms of asset price inflation and ends by calling it highly unstable, and saying again that this will not end well.

Russell Lamberti emphasizes the importance in looking at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. He also discusses this unwritten law against recessions, saying this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. He ends by saying: we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again, I hope we get there soon.

Chris Casey adds that when discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what can not explain the 08 crisis, and that is mainstream economics. And it’s worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the great depression, and he basically said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. “They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call ‘the cluster of error’, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical than say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off.”

The Austrian School Investing, Investments/Asset Classes/Investment Strategies

Bill Laggner discusses how knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, he wrote an article with a colleague called “collateral damage”. And what he found fascinating about writing the article was the Bearing Credit bubble index created back in 2004 when it was pretty obvious that we were segueing into this new bubble. He says: I kept looking at the types of asset backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think  what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle, because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going.

Chris Casey discusses how it’s unclear if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. He goes on to say “They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up for most people the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s a very limited set. The people here on the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind.”

Mark Whitmore also tends to be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. What he think is incredibly valuable is how you explain the efficient market theory; this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups in asset prices that leads to catastrophic losses.

Russell Lamberti thinks it’s about creating a coherent perspective of macro-reality, saying how there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. He goes on to say “I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality to compare it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things: one is that an Austrian perspective gives you an understanding that you’re not in a free, unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be at the sense of you are defending your wealth against the plunderers”.

Mark Valek thinks knowing Austrian Economics provides you with a potentially huge edge. He points out that even though you can read about it online at mises.org or on other websites, many people don’t care enough or are not aware of it. He thinks another large edge is that Austrian Economists in general are able to understand alternative currencies much better. They are able to think about it outside of the money system just as we all think so much about the current system, that helps us for instance when bitcoin currency came up. So knowledge of Austrian Economics can provide a good investing edge sometimes in an indirect way as long as it’s utilized properly. He also discusses the potential weaknesses of using the Austrian system, saying that strictly speaking from an Austrian School, you don’t get any help regarding the timing of when we would expect to happen, however, you can still use other theories to help with that aspect.  The last potential risk he discusses is that Austrians have a dogmatic bias and tend to be very cautious in an investment space.

Ethical Issues:

Russell Lamberti points out that “We all have to make a decision about leverage. In a system where debt is created by fractional reserve banks, we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course when you participate in that system, there’s two ways you can look at that. You’re ether participating in the bank and leverage system as a defence mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage.” Bill Laggner agrees and adds “I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out”.

How Austrian Economics help you when looking at investments from a risk-return standpoint:

Chris Casey recalls what Mark Whitmore pointed out and added “hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value.”

Mark Whitmore adds “this notion of efficient market theory which attempts to just buy and hold the market no matter what, being completely price indifferent is clearly suboptimal. And that’s really key, as that Austrians, I think, have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action if you’re somebody who’s sort of a trend follower or you’re simply buying and holding, there’s a greater tendency among Austrian investors to appreciate value.”

Websites and other information on the panelists:

Russell Lamberti: www.etmmacro.com where you can sign up for a free newsletter called “The Macro Outsider”: http://etmmacro.com/the-macro-outsider/

Bill Laggner: http://www.bearingasset.com/ and a blog at http://www.bearingasset.com/blog

Chris Casey: https://windrockwealth.com/ includes podcasts, articles, blogs and more

Mark Whitmore: http://whitmorecapitalmanagement.com includes a quarterly newsletter

Mark Valek: http://www.incrementum.li/ and he has a book called Austrian School for Investors” available on amazon.

 

Abstract:

Austrian Economics takes into account the behavior of man, and has different views than traditional economic theories on monetary policy, and differs from Keynesian economics greatly on the macro level. It can also be used to identify when there is too much debt and when bubbles are in danger of bursting. Austrian Economics can be very useful for observing the overall behavior of the economy and can often help an investor make more informed decisions.

FULL TRANSCRIPT

FRA: Hi, Welcome to FRA’s Roundtable Insight. Today we have a special treat for our listeners, it’s a discussion on the principals of the Austrian School of Economics and how those principals can be used in investing. Today we have five panellists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Lichtenstein, Chris Casey from Chicago, Bill Laggner form Dallas, and Mark Whitmore from Seattle.

Welcome Gentlemen

So I thought we’d have a discussion initially about what exactly is the Austrian School of Economics and how does this school of economics differ from other schools such as the Keynesian School of economics. Mark Valek, would you like to begin?

Mark Valek: I’d love to, thanks for having me, very excited to discuss basically an economic school which is from Vienna, my hometown, unfortunately Vienna, in the University doesn’t really teach Austrian Economics anymore. However, I think the topic of the Austrian School is a big one, one can talk for hours on end on how it differs, we actually tried to make the Austrian School to list the 11 of 10 bullet points, we came up with an 11th one so we could describe the Austrian school in 11 bullet points. And this is by no means a complete observational but just some basic concepts we put together, we refer to them:

  • Economics is about behavior of individuals, it’s basically about human action
  • They can point human innovation and entrepreneurial action of a source of wealth creation
  • Private property is preconditioned for sensible resource allocation
  • Trading is mutually beneficial (The Subjective value theory. Theory of Value)
  • Another point would be under consumption of savings is necessary for sound investing and growth
  • Also, very important point I think which differentiates the Austrian school is its view towards capital structure. So capital structure is key to a sustainable economy. Thinking about Hayek‘s triangle for the guys who know what I’m talking about here.
  • And price mechanic mechanism coordinates the centralized knowledge.

So these were some basic, basic concepts and they are not only found in the Austrian School, perhaps what does differ more is the view towards the monetary system. And I just want to add 3 or 4 points regarding the Austrian view on the monetary system:

  • Inflation, for instance, is defined as expansion of money supply, something very central to Austrian Economists
  • Inflationary monetary systems chronically transfer wealth, I’m talking about the Cantillon effect, something I think the other schools really don’t talk about at length and it’s something very interesting for society also these days.
  • And finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory

So these are perhaps the more typically differentiating points, especially from the Austrians, but this list is by no means complete, just a few thoughts perhaps to put on a discussion.

FRA: And Russ you’re perspective on the Austrian School of Economics

Russell Lamberti: Yeah, well everything Mark said was valid, I would, you know at a high level I think that one of the key differentiators from a practical analytical and investment perspective was that, the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. In fact strictly speaking the Austrians wouldn’t differentiate between the two, whereas what you see in Keynesian and monetarist schools is that they have relatively sound microeconomic principals, although they do still differ with the Austrians in one or two key areas, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental breakdown there, Austrians are far more consistent there, I think part of the sense of that is also that the Austrians school derives its lineage from the classical schools of the 1700 and 1800s. And I think we must never forget that because a very key distinction in macroeconomics, a very key departure point between the different schools of thought is what’s known as Say’s law of markets. And you know Say’s law essentially is probably a poorly named concept because Jean-Baptiste Say was not necessarily the best articulator of Say’s law. But nonetheless, Say’s law essentially says that you know, properly allocated production, production that is sustainable is ultimately what finances the ability to demand. You know, and I think that in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s I think why the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

FRA: And Chris, your thoughts?

Chris Casey: Well the Austrian school certainly has a number of conclusions in Macroeconomic explanations that my colleagues have discussed, but if you boil it down and ask the true question as far as what makes Austrian Economics different I’m reminded of Ayn Randwhen she was describing, or criticizing I should say, other philosophiess and philosophers. And I remember her comment I forget which writing it was, it was something to the effect of: these philosophies have excluded man from their theories, and in so doing it’s no different than, let’s say, an astrophysicist that has no concept of gravity or a doctor that has no concept of germ theory. And the same could be said with other economic philosophies. Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint, create a consistent and sound economic school and economic philosophy. And that’s what really, I think, makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

FRA: And Bill, your perspective on the Austrian School?

Bill: Well, look I think everyone here has covered quite a bit of the main points, I would add that the world we’re living in today where we’re very far from any Austrian practices, you cannot have a healthy economy without savings, and by artificially setting the interest rate through central banking, you set in motion numerous distortions. And I think everyone at this table would agree that we’re living at a time where the distortions have never been greater. We have nothing resembling a natural rate anywhere around the world as far as I know. And so what’s happening is your setting in motion layers and layers of malinvestment and then every time there’s a crisis in the Keynesian way of looking at things, they come to the rescue and try and either bail something out through monetary or fiscal policy and/or socialize it directly or indirectly. And I would say we’re living in a time today where so much of the credit expansion that we’ve witnessed especially coming out of the great financial crisis in 2008-2009 is a function of either zero or negative interest rates and/or socializing some aspect of credit that’s entered the economy, and when you have that, clearly there’s no feedback loop. There’s no clear natural feedback loop you have a very distorted picture of things, and I think what makes today’s investing environment very challenging.

FRA: and Mark Whitmore, your thoughts on the Austrian school?

Mark Whitmore: Well, batting clean-up here is a little tough, because as Bill mentioned, I think that people have really nicely covered a lot of the main, sort of theoretical tenants of Austrian Economics, I guess I would add that specifically the role of central banking is something that I think is really distinct from an Austrian perspective vs Keynesianism, specifically the asset price inflation that you’ve seen has largely been ignored specifically in the last two bubbles, and now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to well there’s really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates. And I think that from an Austrian standpoint exacerbates this boom-bust cycle which we’ve seen really compressed in terms of time verses what has historically been the case since maybe the mid to late 90s and the amplitude of bubbles to the upside has just been far greater. And I guess I would just add Henry Hazlitt’s kind of 2 points as far as critiques of Keynesianism. The first  fundamental flaws being that it highlights in terms of interest, the visible minority at the cost of the invisible majority.And again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, you know, in its view the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the efficacy of that. And second of all, the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

FRA: Great, let’s move to a discussion on how the Austrian School of economics is helpful in understanding how and why the 2007-2008 financial crisis happened. And then sort of in parallel to that, what is the Austrian School saying today about the global economy, are there any trends or outcomes that could be identified using the Austrian school. Just general question opened to the floor. Anybody?

Bill Laggner: This is Bill, I would say that all of the Austrians I’m sure on this call saw the crisis building coming out of the reflation right after the tech bubble that burst. It was interesting, the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course I think it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. I think distortions are epic, I think we’re living in a fascinating time. It’s not going to end well, but I think along the way, there has been a continuation of decentralization, innovation, that’s the positive that I think we’re seeing today is as well, that’s just the natural order of the entrepreneurs and the ecosystem, they’re up.

Mark Whitmore: This is Mark chiming in here, I would say that in terms of leading up to the Global Financial Crisis I feel tremendously bad for Kurt Rickenbacker.  He was I think a really fine economist, informed by sort of the Austrian School perspective and he had done a great job identifying the perils of the tech bubble that I think Bill mentioned, a lot of us who are Austrians saw coming, and died right before the bursting of the second bubble.  And what he had talked about is this notion of “Ponzi finance” that I think is good analytical insight that Hayak also talks about which is essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place, and this credit can become increasingly untether any kind of historic connectors to things such as sound collateral and whatnot you saw increasingly these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic, there’s one slide that I drew up which essentially overlays the growth of S&P 500 with the growth of central bank assets in Japan, the Eurozone, and the United States.

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

The assets of these central banks have been expanded a little bit more jagged but the curve, the direction and amplitude of the line is almost exactly the same and so you see this again, unsustainable credit fueled engine that’s driving what’s been taking place in terms of asset price inflation.It’s just highly unstable, and again this will not end well.

Russell Lamberti: Hey it’s Russ, I just wanted to chime in on what Bill had mentioned, I think it’s really critical to look at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. There’s basically been since, I don’t know how long, maybe it was the Greenspan era that essentially ushered us in. But there’s essentially an unwritten law against recessions. And this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. But of course, as Bill rightly says, you have the countervailing forces of progress constantly working, the market is constantly trying to figure out how to make the best of its present reality and its present situations. This is why I think you have inherent paradoxes when you look at these big cycles, because there is so much to be bearish about, and yet there’s also a lot to be bullish about, and I guess that’s the essence and the nature of risk and opportunity. You know Mark Thornton once mentioned that Murry Rothbard used to say he was permanently bearish about the short term and permanently bullish about the long term. And I think that it’s an aphorism, but it kind of speaks to this notion that state intervention can really mess up markets and financial markets in the short term. But over time the power of the free market and of private enterprise is extremely pervasive and eventually seems to win out at the end of the day. Of course in the interim what that means is that because you have such disinflationary forces because of private enterprise and technology, it kind of emboldens the policymakers to run these bubbles longer and larger than they should be, so no question that the last two bubbles have been a symptom of these kind of policies, and I agree, we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again. I hope we get there soon.

Chris: This is Chris, I’ll just add that in discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what does not explain the 08 crisis, and that is mainstream economics. Whether it’s so-called Chicago or Keynesian schools. And it’s probably worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the Great Depression, and he basically said “We’re never going to have a significant recession again.” I believe he said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call “the cluster of error”, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical then say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off. The response by the government and central banks should be to not re-inflate the money supply, do not create bailouts, not have deficits which only will spur consumer spending at the expense of savings. So if that’s the antidote for recessions, the governments since the 08 crisis has done the exact opposite and it’s simply set up the economy for far, far greater downturn then what we even experienced (in 2008), with the possibility of significant inflation. So the 08 crisis gives great lessons and basically proves out the Austrian theory, the business cycle. And it really demonstrates errors and issues with other explanations from other economic schools of thought.

FRA: and Mark Valek, any thoughts on applying the Austrian school to the financial crisis and where we’re potentially heading today and the Global economy?

Mark Valek: Definitely some thoughts, very short though because again, a lot has been said already. Where are we going in the Global Economy? Providing you have the Austrian perspective as we all obviously have, you actually know that there are significantly high (inaudible) to the capital structure, and this is not a sustainable state. But there lies the problem for investing obviously, the timing question, but sooner or later this state of capital structure will not last, it’s absolutely not sustainable. Just on a side note, as an asset manager, I encounter sustainability so many times a year, it’s kind of a hyperinflated world, everybody wants to invest sustainably and what bugs me that is nobody things about if our, for instance, monetary system is sustainable, and I would argue against it. So this is to me, really a very superficial discussion here. However, I think if this cleansing process starts the next time, we will probably will not see the big fear we saw the last time, which was basically the fear of deflation of debt deflation if you want to call it, like debt. I think the authorities have proven that they just will not let this happen so market participants probably are not going to have fear that will be too little money going around or being printed, but perhaps we’ll start to fear that this is going to be an overdose the next time, and I think as soon as this psychology changes, you have (Inaudible) things like price inflation look much more realistic in such an environment if you ask me.

FRA: Great insight, and so given this view of applying the Austrian school to the economics environment, if we can consider that as far as the investment environment, does it make sense to look at the principals of the Austrian school in investing, I mean, we see some of the principals, of being stores of value, indirect exchange method, meaning exchanging fiat currency for investments that are real assets that provide cash flows, investments with little or no debt, high free discounted cash flows as well. Little or no leverage, also scarcity in innovative industries, and then perhaps cryptocurrencies that are outside of the banking system but are still regulated within the financial system. So does it make sense to apply those principals in investing, and what are those principals? Also, are there any empirical studies or analysis that taking this approach can provide an edge or an enhanced investment management performance? This question is for the floor.

Bill Laggner: This is Bill, I could say I think knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, I wrote an article with a colleague called “collateral damage”. And what was fascinating about writing the article was we had created the Bearing Credit bubble index back in 2004 when it was pretty obvious that we were segueing into this new bubble, and I kept looking at the types of asset-backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage-backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going. So ultimately I think you know gold, we own a lot of gold, we’ve owned gold since 2002, I mean gold will continue to act well, and may become one of the best performing asset classes over the next several years until we ether get some kind of boom or something close to it. So that’s how it’s helped us and how we employ it in day to day portfolio management.

Chris Casey: This is Chris, I’ll say that I’m not sure if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up, for most people, the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s very limited set. The people here in the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind. So there are very limited data points out there.

Mark Whitmore: This is Mark, I would sort of follow up on Chris’s comments. I tend to also be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. And I think that’s a harder thing to make a case for. What I think is incredibly valuable, is how do you explain reality and in essence, the kind of the largest school out there in terms of money management is the efficient market theory, this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups that leads to catastrophic losses. And if investors can simply, instead of, and I remember reading one of the most tortured treatments by Burton Malkiel who wrote the seminal Random Walk Down Wall Street which is sort of like the bible of efficient market theory, and soon after the edition following the 1987 stock market crash where the Dow went down 20% in a day, he attempted to try to explain how this was a rational response to changing monetary conditions, and the market was kind of correctly pricing things all the way along. And you find these things which, I think Chris mentioned earlier simply that Keynesians and the people who look at kind of classical economics and efficient market theory, they can’t explain reality. But the power, the strength of Austrian Economics you can see bubbles when they’re coming. And like Bill, I’ve leaned into the defensive positive in the last few years, so in the short run you might seem to be looking like a fool, but if you can help your investors avoid and maybe even profit from bubbles as they unwind, you’re going to be far better off than the vast majority of investors out there that are just being caught up and are losing 50% of their portfolio in multiple stretches.

Russell: Hey guys, its Russell here, Mark you’ve just made some really great points. And I think I would echo a lot of what you said. I think it’s about creating a coherent perspective of macro-reality, you know there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets, because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality and comparing it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things one is that an Austrian perspective gives you an understanding that you’re not in a free unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be the sense that you are defending your wealth against the plunderers. The second component is that business opportunities can be false, and that’s something that’s embodied in the essence of boom-bust cycles, subsidization, and the principals of Say’s Law, you know expecting consumer markets to boom when in fact you’ve got misallocated productive capital, those consumer markets are not going to perform how you expect. And the flip side of that of course is that you get overestimated business risk, because some people are avoiding sectors that look unattractive when in fact they are fundamentally attractive, particularly if they can exploit state failure. And then finally Hayek spoke about the pretense of knowledge in his famous Nobel acceptance speech, and you know one of the things that none of us, whether you’re an Austrian or not, none of us have the entirety of knowledge that we need to make very precise and accurate calls about the investment world. And that’s one of the reasons why, and it’s spoken about in the book “Austrian School for Investors” but you know you’ve got to start off by exploiting opportunities as an investor that are close to you. That you’re capable of having knowledge about, and that’s why before you invest in public companies and in funds, you probably have to invest in yourself, in your own entrepreneurship or in private equity opportunities that are very close to you and where you have some special knowledge. Because you don’t have any more knowledge then the central planners do either. So I think those are some really key objectives. I think there’s some ethical issues as well but I don’t want to go into that right now, but I do think that when we talk about Austrian Economics being free of value judgment, that’s very much in the theoretical analytical sense. But once you’ve derived conclusions from that, value judgments definitely come to the fore, and I think there’s a strong ethical component that can be informed across a range of asset classes and how you invest and how you go about investing. I’m going to not go into that right now, we can maybe circle back to that a bit later.

FRA: Then Mark Valek, as Russ refers to your co-authored book on the Austrian School for investors, can you provide some insight from that book on these principals?

Mark Valek: Yeah thanks. Just a small supplement here, we thought about this topic very hard and we thought, where potential opportunities lie in Austrian investing and where do potential risks lie in such a discipline. Just a few words on opportunities we’ve heard I think already in that direction. The fact that it’s not read among investors. I think that’s potentially a huge edge, it’s a huge edge in a marketplace where it’s not really a secret, it’s out there, you just have to read it on the internet, go on mises.org or wherever, but most of the people just don’t care or know about this so it’s not read. Second edge knowledge about Austrian business cycle theory we also talked about, but I just want to point out the third edge which we identified and I think Austrians in general are able to understand alternative currencies much better they are able to think about it outside of the money system just as we all think so much about the current system that helps us for instance when bitcoin currency came up, I was not even as a tech guy but just from an Austrian view I was able to pretty fast wrap my head around the basic concepts. And I knew if this thing monetizes then it’s huge financial gain and if it doesn’t well until it does it’s speculation on a potential alternative money, but now I think it’s more clear to the rich investor too, but such thing I think come with an Austrian mindset. On the other hand just also to talk about the risks perhaps for one moment with Austrian investing, generally, and I’m sure all of us know about this potential risk, is a bearish bias is associated to the Austrians. I think that’s because Austrian investors are sensitive to these flaws in the capital structure we already talked about. And they always kind of think perhaps this boom will be bust sooner than later and so on, and we know the problems I think associated with that. Another problem I also touched already is the Austrian School statistic it does not make timing calls. So this is a predictive problem obviously, especially in finance. I think one can circumvent this problem with the help of other techniques from the quantitative side take the analysis, whatever. But strictly speaking from an Austrian School, you don’t get any help regarding the timing problem. Just to mention the last potential risk, Austrians do tend to be very convinced, it’s like what we call potentially a dogmatic bias, and dogmatism is probably a thing where one should be cautious in an investment space. So there are other opportunities, but there’s also risks and one should be aware of these risks and find some ways to manage these risks as an Austrian investor.

FRA: If we could do one more round on bringing it all together and providing some examples of investments or asset classes or perhaps investment strategies that exemplify using the principals of the Austrian School in investing or the outcomes as Chris mentions, of the Austrian School. Let’s do a round based on that to close out. No specific companies or securities, but just generically speaking. Anybody?

Russell: It’s Russell here, maybe I can come in and say one or two things about some of the ethics around investing. I mean, we all have to make decisions about leverage. In the system where debt is created by fractional reserve banks we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course, when you participate in that system, there’s two ways you can look at that. You’re either participating in the bank leverage system as a defense mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage. I think from an Austrian perspective, you would typically favor equity over debt and you would favor non-bank debt over bank debt. The other big ethical question, of course, is to talk about government bonds – financing the state. The state is essentially a mechanism of wealth destruction, you know do you really want to be financing plunder, but in another sense, by funding the state, you’re again, aiding and abetting a fairly large degree of wealth destruction. And ultimately getting your coupon payments in part by being taxed more and your friends and family being taxed more. So one’s got to think about that, some of these issues. And then, we know that Ludwig von Mises was one of the greatest advocates for peace, and anti-war, and you have to think about what firms are doing in terms of financing and funding and equipping governments to fight unjust wars. These are obviously very tricky and murky. And I’m not trying to make any kind of high-brow ethical statements here, I just think that these are the kind of things that have to be considered and Austrians do think a lot about these things. So I just wanted to kind of lay that out there, because ethics and feeling personally good about your investments, not just intellectually, but emotionally as well, I think is an important part of an investment strategy.

Bill: This is Bill, I’d like to just touch on something Russell mentioned, great points by the way, the state has grown immensely around the world subsequent to 2009. And I don’t want to get to far into the metrics we all know what played out in certain parts of the world, I think one of the beauties of the internet and the search for the truth and leading us to the election in the United States for example last year in WikiLeaks, the internet is essentially exposing a lot of the fiction that we’ve all grown up around over the last number of decades. And with that comes almost an awaking, a move to higher consciousness. So people are, I see it every day, I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out. Cryptocurrencies, I’ve spent a lot of time looking at the economic actors within this interesting ecosystem and you think about not being a participant in the plunder if you look at just the banking system and all of the friction within the banking system, let alone the leverage, you’re looking at a couple trillion dollars a year just in general friction that’s being stripped out of the ecosystem. So the movement towards the internet of value as opposed to what we witnessed the last couple of decades, the internet of information knowledge I think is another fascinating innovation playing out. So I think more and more people per Russell’s point, don’t want to participate in the plunder and are actually spending time and capital creating these new economic fabrics and I think it’s quite exciting to witness.

Chris: This is Chris, if we take out the ethical considerations that a couple of my colleagues just mentioned, the question is how Austrian Economics help you when looking at investments from a risk-return standpoint. And I think Mark mentioned this earlier, hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. So maybe in America you want to consider the cannabis space. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value. I’ll also say that I think Austrian Economics lends itself naturally to contrarian investing which I think is a great way to make money. It’s pretty obvious that there’s not a lot of people out there managing money that believe in Austrian Economics. So we hold a key, we understand something that few people embrace or have any kind of knowledge of. And I think that really is a key factor in contrarian investing which really just means you’re looking for extreme market value questions on the high or low side, and identifying the catalysts that will bring that prices back to its historical mean or median. And I think the explanation and conclusions of Austrian Economics do that quite well.

Data Courtesy of the St. Louis Federal Reserve

Mark Whitmore: This is Mark Whitmore, I keep forgetting we have two Mark’s on the line here, and Chris you absolutely interpreted what I was trying to say correctly, and kind of to follow up a little bit, I think one of the things that the other Mark pointed out is the issue of timing, and whereas the two prevailing investing paradigms out there seem to be this notion of efficient market theory which attempts to just buy and hold the market no matter what, completely price indifferent. And that’s really key, is that Austrians I think have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action, if you’re somebody who’s sort of a trend follower, or you’re simply buying and holding, there’s a greater tendency among Austrians to appreciate value. And this point dovetails with the other point as far as since we don’t pretend to know the precise timing of when bubbles kind of unwind or when the busts will finally reach a bottom, the idea is that we can actually be in the right quartile of activity, in other words I never try to catch the very top of a bubble, I don’t try to ride things to the very end, and similarly I don’t mind catching falling knifes. Because as investors if you’re looking at this current contemporary global macroeconomic backdrop from the 10-12 year perspective, I find it with the typical disclosure here that I’m not able to see with a perfect crystal ball or anything but it’s hard to believe that traditional assets, that global equities, will be thriving in this environment just from the simple perspective of how overstretched they are from any reasonable measure of valuation.  And similarly, the global bond market which has been the classic offset to unwinding stocks in the past, is also so stretched.Because just like bond prices are inversely related to interest rates, you have interest rates around the world, I mean you have negative interest rates in Sweden, in Japan, in Switzerland, and back last July you have negative interest rates over a swath of different developed markets so there’s simply not a lot of room basically for bond appreciation. I think it’s a very careless time for equity and bond investors from a longer term perspective whereas those of us who are Austrian have a bend for the idea of real money, sound money, and one of the things that looks pretty attractive in a Ponzi finance global macroeconomic backdrop would be precious metals I would say. And I particularly play in the currency space and one of the thing that’s attractive there is the idea that in eras where you have reckless central banking there’s huge distinction between reckless central bankers and those who are engaged in reckless central banking with abadon and as a result I think that there becomes some real value disparities from a currency standpoint as well. But I mean I think that’s how I at least use Economic principals from the Austrian school to inform overall investing decisions in the marketplace.

FRA: And finally, the other Mark?

Mark Valek: Yeah, I think that most points have been touched seriously. Yeah I just don’t want to drag it out unnecessarily, but I think there were very interesting comments in all kind of directions, really enjoying this discussion, I don’t know if we have anything else on the plate?

FRA: Nope, that’s it. Just wanted to close out with regard to giving everybody a chance to identify how our listeners can learn more about your work, if you have a website or perhaps a newsletter?

Russell Lamberti: Yeah my website, ETM macro advisors website is www.etmmacro.com and I am starting a new newsletter called the macro outsider, and you can sign up for it for free on www.etmmacro.com and you’ll get a free essay called “The real currency war” which is subtitled “monopoly money vs real money” and essentially there I just go into a lot of what we’ve spoken about today in terms of chronic malinvestment, the weakness of fiat currency reserve systems, and then ultimately where I think the real currency war is, which is in centralized vs. decentralized money, and I talk a little bit about cryptocurrencies there as well, so that’s www.etmmacro.com you can sign up for that free newsletter.

Bill Laggner: This is Bill, so Kevin Duffy and I, we manage a couple of funds, long short-biased, I should say long short strategy macro oriented funds, bearing asset, like ball bearing .com, http://www.bearingasset.com/ and then we also write a blog http://www.bearingasset.com/blog and then Kevin and I are on twitter as well, we post some comments from time to time.

Chris Casey: This is Chris Casey with WindRock Wealth Management, we manage money for high net worth individuals. I would encourage anyone that wants to check us out just to visit our website https://windrockwealth.com/ We have our contact information there, we have all of our content, meaning podcasts, articles, blogs etc. That’s been posted since we started the firm and the people can feel free to read more about our philosophy on various issues.

Mark Whitmore: Great, and this is Mark Whitmore in Seattle, I have a website at http://whitmorecapitalmanagement.com there’s a research and article section which has, I do a quarterly newsletter and would be happy to put anyone interested on the mailing list for that, and basically we have a strategic currency fund that is again, informed largely by Austrian Economic principles that I operate. I also will make a plug here for one of my co-panellists, Mark Valek, who has his book “Austrian School for Investors” is essentially that he co-authored is one of the only kind of resources out there that’s an outstanding resource and really well researched and thought out, so I want to complement the fine work you’ve done on that.

FRA: Great, and now Mark Valek

Mark Valek: Thanks so much, thank you if you’re interested the book is on amazon I guess, Austrian School for Investors” our homepage is http://www.incrementum.li/ we’ve got lots of good stuff which is relevant up there, first of June our annual “In gold we Trust” report is going to be published as well. You’ll find that on the homepage as well.

Summary and Transcript by Jacob Dougherty jdougherty@Ryerson.ca


04/11/2017 - The Roundtable Insight: 5 Top Money Managers Discuss Austrian School Investing – Now Published

LINK HERE to download the MP3 PODCAST

SUMMARY – also see FULL TRANSCRIPT BELOW

Today we have five panelists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Liechtenstein, Chris Casey from Chicago, Bill Laggner from Dallas, and Mark Whitmore from Seattle.

Chris is the Managing Director of WindRock Wealth Management. He combines a degree in Economics from the University of Illinois with a specialty in the Austrian school of Economics. He advises clients on their investment portfolios in today’s world of significant economics and financial intervention. He’s Also written a number of publications on a number of publications on websites including the Ludwig von Mises Institute, Zero Hedge, Family Business, Casey Research, and Laissez Faire Books. He is a board member of the Economics Development Council with the University of Illinois, a Policy Advisor for The Heartland Institute’s Center on Finance, Insurance, and Real Estate.

Bill is a Co-founder of Bearing Asset Management, he’s a partner with Kevin Duffy that manage the Bearing fund using an Austrian School of Economics lenses in terms of identifying boom-bust cycles, value in the marketplace, bubbles, and distortions created by both fiscal and monetary authorities. He’s a graduate at University of Florida, began his investment industry career in the late 1980s initially as a stockbroker, and then moved to the buy side at fidelity investments. He’s been featured also in Barrons, Reuters, and CFA magazine.

Russ Lamberti is the founder and chief strategist of ETM Macro Advisors. Which provides Macroeconomic intelligence and strategy services to asset managers, family offices, and high net worth individuals. He is the Co-Author of “When Money Destroys Nations”, a book about Zimbabwe’s hyper-inflation, and he’s a contributing author at the mises.org institute.

Mark Valek is a partner investment manager of incrementum, he’s a Chartered Alternative Investment Analyst (CAIA) and has studied business administration and finance at the Vienna University of Economics. From 1999 he worked at Raiffeisen Zentralbank (RZB) as an intern in the Equity Trading division and at the private banking unit of Merrill Lynch in Vienna and Frankfurt. In 2002, he joined Raiffeisen Capital Management and in 2014 he published a book on Austrian Investing. He’s one of the authors of “Austrian School for investors”.

Mark Whitmore is the Principal, Chief Executive Officer of Whitmore Capital. Mark has been managing personal portfolio assets, periodically publishing newsletters and blogs, and providing pro bono financial planning/investment consulting since leaving law in 2002. His specialties are currencies and international economic analysis. He obtained a B.A. in Political Studies from Gordon College, graduated Summa Cum Laude at the University of Washington he earned a Masters of International Studies (MAIS) at the Jackson School and a J.D. from the School of Law.

Austrian School of Economics Explained:

Mark Valek defines some basic points and differences of the Austrian School as: Economics about the behavior of individuals and human action, The Subjective value theory, under consumption of savings is necessary for sound investing and growth, capital structure being key to a sustainable economy, and price mechanic mechanism coordinates the centralized knowledge. Perhaps the most important distinction of Austrian Economics is its view towards the monetary system. Some of these points are inflation being defined as expansion of the money supply and finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory.

He points out that these are the typical differentiating points, but this is by no means a complete list, and you can discuss the differences between the Austrian School and traditional Keynesian theory.

Russell Lamberti thinks that one of the key differentiators from a practical analytical and investment perspective was that the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. He notes that at the microeconomics level, Keynesianism is very similar, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental break down there. He ends the thought by saying in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s why he thinks the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

Chris Casey discusses why Austrian Economics can provide new insight, saying that Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint to create a consistent and sound economic school and economic philosophy. And that’s what really makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

Mark Whitmore adds that specifically, the role of central banking is something that is really distinct from an Austrian perspective vs Keynesianism.  Specifically the asset price inflation that you’ve seen has largely been ignored by Keynesians in the last two bubbles.  Now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to there being really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates meaningfully. And I think that from an Austrian standpoint, this exacerbates this boom-bust cycle which we’ve seen which has been really compressed in terms of time lately versus what has historically been the case. Since the mid to late 90s the amplitude of bubbles to the upside has just been far greater. He highlights Henry Hazlitt’s two points as far as critiques of Keynesianism. The first one being that fundamental flaw in terms of interest, with Keynesians tending to service the visible minority at the cost of the invisible majority and again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, in its view, the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the accuracy of that. And second,the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

How it’s used in past, present and future Economies including how and why the 2007-2008 financial crisis happened:

Bill Laggner says what was interesting was that the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. He also points out that the distortions are epic, and that this won’t end well.

Mark Whitmore chimes in discussing Kurt Rickenbacker’s idea of “Ponzi finance” which is a powerful analytical insight that essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place.Credit can thus becomes increasingly untethered to any kind of historic connectors such as sound collateral. One increasingly witnessed these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic.


 

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

He notes that the curve and amplitude of the line showing the increase in central bank assets seen above is almost exactly the same as the line showing the increase in the S&P 500. He calls this the engine that’s driving what’s been taking place in terms of asset price inflation and ends by calling it highly unstable, and saying again that this will not end well.

Russell Lamberti emphasizes the importance in looking at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. He also discusses this unwritten law against recessions, saying this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. He ends by saying: we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again, I hope we get there soon.

Chris Casey adds that when discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what can not explain the 08 crisis, and that is mainstream economics. And it’s worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the great depression, and he basically said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. “They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call ‘the cluster of error’, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical than say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off.”

The Austrian School Investing, Investments/Asset Classes/Investment Strategies

Bill Laggner discusses how knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, he wrote an article with a colleague called “collateral damage”. And what he found fascinating about writing the article was the Bearing Credit bubble index created back in 2004 when it was pretty obvious that we were segueing into this new bubble. He says: I kept looking at the types of asset backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think  what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle, because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going.

Chris Casey discusses how it’s unclear if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. He goes on to say “They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up for most people the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s a very limited set. The people here on the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind.”

Mark Whitmore also tends to be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. What he think is incredibly valuable is how you explain the efficient market theory; this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups in asset prices that leads to catastrophic losses.

Russell Lamberti thinks it’s about creating a coherent perspective of macro-reality, saying how there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. He goes on to say “I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality to compare it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things: one is that an Austrian perspective gives you an understanding that you’re not in a free, unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be at the sense of you are defending your wealth against the plunderers”.

Mark Valek thinks knowing Austrian Economics provides you with a potentially huge edge. He points out that even though you can read about it online at mises.org or on other websites, many people don’t care enough or are not aware of it. He thinks another large edge is that Austrian Economists in general are able to understand alternative currencies much better. They are able to think about it outside of the money system just as we all think so much about the current system, that helps us for instance when bitcoin currency came up. So knowledge of Austrian Economics can provide a good investing edge sometimes in an indirect way as long as it’s utilized properly. He also discusses the potential weaknesses of using the Austrian system, saying that strictly speaking from an Austrian School, you don’t get any help regarding the timing of when we would expect to happen, however, you can still use other theories to help with that aspect.  The last potential risk he discusses is that Austrians have a dogmatic bias and tend to be very cautious in an investment space.

Ethical Issues:

Russell Lamberti points out that “We all have to make a decision about leverage. In a system where debt is created by fractional reserve banks, we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course when you participate in that system, there’s two ways you can look at that. You’re ether participating in the bank and leverage system as a defence mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage.” Bill Laggner agrees and adds “I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out”.

How Austrian Economics help you when looking at investments from a risk-return standpoint:

Chris Casey recalls what Mark Whitmore pointed out and added “hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value.”

Mark Whitmore adds “this notion of efficient market theory which attempts to just buy and hold the market no matter what, being completely price indifferent is clearly suboptimal. And that’s really key, as that Austrians, I think, have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action if you’re somebody who’s sort of a trend follower or you’re simply buying and holding, there’s a greater tendency among Austrian investors to appreciate value.”

Websites and other information on the panelists:

Russell Lamberti: www.etmmacro.com where you can sign up for a free newsletter called “The Macro Outsider”: http://etmmacro.com/the-macro-outsider/

Bill Laggner: http://www.bearingasset.com/ and a blog at http://www.bearingasset.com/blog

Chris Casey: https://windrockwealth.com/ includes podcasts, articles, blogs and more

Mark Whitmore: http://whitmorecapitalmanagement.com includes a quarterly newsletter

Mark Valek: http://www.incrementum.li/ and he has a book called Austrian School for Investors” available on amazon.

 

Abstract:

Austrian Economics takes into account the behavior of man, and has different views than traditional economic theories on monetary policy, and differs from Keynesian economics greatly on the macro level. It can also be used to identify when there is too much debt and when bubbles are in danger of bursting. Austrian Economics can be very useful for observing the overall behavior of the economy and can often help an investor make more informed decisions.

FULL TRANSCRIPT

FRA: Hi, Welcome to FRA’s Roundtable Insight. Today we have a special treat for our listeners, it’s a discussion on the principals of the Austrian School of Economics and how those principals can be used in investing. Today we have five panellists from around the world, Russ Lamberti from Cape Town, South Africa, Mark Valek from Lichtenstein, Chris Casey from Chicago, Bill Laggner form Dallas, and Mark Whitmore from Seattle.

Welcome Gentlemen

So I thought we’d have a discussion initially about what exactly is the Austrian School of Economics and how does this school of economics differ from other schools such as the Keynesian School of economics. Mark Valek, would you like to begin?

Mark Valek: I’d love to, thanks for having me, very excited to discuss basically an economic school which is from Vienna, my hometown, unfortunately Vienna, in the University doesn’t really teach Austrian Economics anymore. However, I think the topic of the Austrian School is a big one, one can talk for hours on end on how it differs, we actually tried to make the Austrian School to list the 11 of 10 bullet points, we came up with an 11th one so we could describe the Austrian school in 11 bullet points. And this is by no means a complete observational but just some basic concepts we put together, we refer to them:

  • Economics is about behavior of individuals, it’s basically about human action
  • They can point human innovation and entrepreneurial action of a source of wealth creation
  • Private property is preconditioned for sensible resource allocation
  • Trading is mutually beneficial (The Subjective value theory. Theory of Value)
  • Another point would be under consumption of savings is necessary for sound investing and growth
  • Also, very important point I think which differentiates the Austrian school is its view towards capital structure. So capital structure is key to a sustainable economy. Thinking about Hayek‘s triangle for the guys who know what I’m talking about here.
  • And price mechanic mechanism coordinates the centralized knowledge.

So these were some basic, basic concepts and they are not only found in the Austrian School, perhaps what does differ more is the view towards the monetary system. And I just want to add 3 or 4 points regarding the Austrian view on the monetary system:

  • Inflation, for instance, is defined as expansion of money supply, something very central to Austrian Economists
  • Inflationary monetary systems chronically transfer wealth, I’m talking about the Cantillon effect, something I think the other schools really don’t talk about at length and it’s something very interesting for society also these days.
  • And finally expanding money and credit supply causes a boom and bust cycle in the business cycle theory

So these are perhaps the more typically differentiating points, especially from the Austrians, but this list is by no means complete, just a few thoughts perhaps to put on a discussion.

FRA: And Russ you’re perspective on the Austrian School of Economics

Russell Lamberti: Yeah, well everything Mark said was valid, I would, you know at a high level I think that one of the key differentiators from a practical analytical and investment perspective was that, the Austrian school draws a very straight and consistent line between microeconomics and macroeconomics. In fact strictly speaking the Austrians wouldn’t differentiate between the two, whereas what you see in Keynesian and monetarist schools is that they have relatively sound microeconomic principals, although they do still differ with the Austrians in one or two key areas, but when they aggregate it up to the macro, a whole different theoretical framework is used and there’s essentially no consistency between neo-classical and Keynesian micro and macroeconomics so there’s a fundamental breakdown there, Austrians are far more consistent there, I think part of the sense of that is also that the Austrians school derives its lineage from the classical schools of the 1700 and 1800s. And I think we must never forget that because a very key distinction in macroeconomics, a very key departure point between the different schools of thought is what’s known as Say’s law of markets. And you know Say’s law essentially is probably a poorly named concept because Jean-Baptiste Say was not necessarily the best articulator of Say’s law. But nonetheless, Say’s law essentially says that you know, properly allocated production, production that is sustainable is ultimately what finances the ability to demand. You know, and I think that in today’s Macro world it’s only really the Austrians who are talking about the unsustainability of certain demand trends because of misallocated capital and misallocated productive resources and that’s I think why the Austrian Business Cycle is such a key distinguishing feature of the Austrian school.

FRA: And Chris, your thoughts?

Chris Casey: Well the Austrian school certainly has a number of conclusions in Macroeconomic explanations that my colleagues have discussed, but if you boil it down and ask the true question as far as what makes Austrian Economics different I’m reminded of Ayn Randwhen she was describing, or criticizing I should say, other philosophiess and philosophers. And I remember her comment I forget which writing it was, it was something to the effect of: these philosophies have excluded man from their theories, and in so doing it’s no different than, let’s say, an astrophysicist that has no concept of gravity or a doctor that has no concept of germ theory. And the same could be said with other economic philosophies. Austrian Economics is the only one that really puts man at the center of the discussion. It boils economics down to man in the context of nature as it relates to scarcity for his needs and wants. And in so doing they then use a number of first principles that build on from the deductive reasoning standpoint, create a consistent and sound economic school and economic philosophy. And that’s what really, I think, makes the difference from the other economic schools out there. It’s not just the conclusions, it’s how we arrive at those conclusions.

FRA: And Bill, your perspective on the Austrian School?

Bill: Well, look I think everyone here has covered quite a bit of the main points, I would add that the world we’re living in today where we’re very far from any Austrian practices, you cannot have a healthy economy without savings, and by artificially setting the interest rate through central banking, you set in motion numerous distortions. And I think everyone at this table would agree that we’re living at a time where the distortions have never been greater. We have nothing resembling a natural rate anywhere around the world as far as I know. And so what’s happening is your setting in motion layers and layers of malinvestment and then every time there’s a crisis in the Keynesian way of looking at things, they come to the rescue and try and either bail something out through monetary or fiscal policy and/or socialize it directly or indirectly. And I would say we’re living in a time today where so much of the credit expansion that we’ve witnessed especially coming out of the great financial crisis in 2008-2009 is a function of either zero or negative interest rates and/or socializing some aspect of credit that’s entered the economy, and when you have that, clearly there’s no feedback loop. There’s no clear natural feedback loop you have a very distorted picture of things, and I think what makes today’s investing environment very challenging.

FRA: and Mark Whitmore, your thoughts on the Austrian school?

Mark Whitmore: Well, batting clean-up here is a little tough, because as Bill mentioned, I think that people have really nicely covered a lot of the main, sort of theoretical tenants of Austrian Economics, I guess I would add that specifically the role of central banking is something that I think is really distinct from an Austrian perspective vs Keynesianism, specifically the asset price inflation that you’ve seen has largely been ignored specifically in the last two bubbles, and now we’re into a third bubble I would argue as well. And essentially the Fed and the Keynesians will continue to point to well there’s really no headline inflation pressure and hence there’s really no reason to begin to normalize or adjust or move up interest rates. And I think that from an Austrian standpoint exacerbates this boom-bust cycle which we’ve seen really compressed in terms of time verses what has historically been the case since maybe the mid to late 90s and the amplitude of bubbles to the upside has just been far greater. And I guess I would just add Henry Hazlitt’s kind of 2 points as far as critiques of Keynesianism. The first  fundamental flaws being that it highlights in terms of interest, the visible minority at the cost of the invisible majority.And again it gets to this whole issue of government being the problem solver, the one that can allocate assets essentially, you know, in its view the most effectively from a Keynesian perspective in a counter-cyclical effective way, where the Austrians are much more skeptical of the efficacy of that. And second of all, the propensity under Keynesian Economics to over-consume in the present generation at a cost of creating massive debt or future debt for future generations to essentially somehow deal with, we’re sort of seeing that today in all developed parts of the world.

FRA: Great, let’s move to a discussion on how the Austrian School of economics is helpful in understanding how and why the 2007-2008 financial crisis happened. And then sort of in parallel to that, what is the Austrian School saying today about the global economy, are there any trends or outcomes that could be identified using the Austrian school. Just general question opened to the floor. Anybody?

Bill Laggner: This is Bill, I would say that all of the Austrians I’m sure on this call saw the crisis building coming out of the reflation right after the tech bubble that burst. It was interesting, the internet created this initial innovation wave decentralization wave, and of course due to excess credit creation, money creation, you had a bubble and then a subsequent bust. And then instead of letting the system purge and heal, the central banks led by the U.S. came and lowered interest rates and you segued from a technology bubble to a private sector credit bubble. And of course I think it went longer then everyone on this call thought it would, and it eventually hit a wall and again tried to cleanse and it’s interesting central banks let certain groups fail and then when things started to get out of hand, they stepped in and bailed out a number of politically connected contingents and then laid the foundation for this third bubble, and this third bubble’s gone on longer I ever imagined or my business partner imagined that it could. I think distortions are epic, I think we’re living in a fascinating time. It’s not going to end well, but I think along the way, there has been a continuation of decentralization, innovation, that’s the positive that I think we’re seeing today is as well, that’s just the natural order of the entrepreneurs and the ecosystem, they’re up.

Mark Whitmore: This is Mark chiming in here, I would say that in terms of leading up to the Global Financial Crisis I feel tremendously bad for Kurt Rickenbacker.  He was I think a really fine economist, informed by sort of the Austrian School perspective and he had done a great job identifying the perils of the tech bubble that I think Bill mentioned, a lot of us who are Austrians saw coming, and died right before the bursting of the second bubble.  And what he had talked about is this notion of “Ponzi finance” that I think is good analytical insight that Hayak also talks about which is essentially the boom-bust cycle is endogenous to the particular type of finance credit system you have in place, and this credit can become increasingly untether any kind of historic connectors to things such as sound collateral and whatnot you saw increasingly these signs of the economy going off the rails in the upward direction in a trajectory that was simply unsustainable. So indeed that bubble went longer than most of us expected, and this one is truly epic, there’s one slide that I drew up which essentially overlays the growth of S&P 500 with the growth of central bank assets in Japan, the Eurozone, and the United States.

* Includes the US, ECB, BOJ and PBoC.

Sources: Yardeni Research, Inc. (www.yardeni.com); Haver Analytics

The assets of these central banks have been expanded a little bit more jagged but the curve, the direction and amplitude of the line is almost exactly the same and so you see this again, unsustainable credit fueled engine that’s driving what’s been taking place in terms of asset price inflation.It’s just highly unstable, and again this will not end well.

Russell Lamberti: Hey it’s Russ, I just wanted to chime in on what Bill had mentioned, I think it’s really critical to look at this as three very big bubbles in a row, but also to think about the compounding effects of repeated malinvestment that has been essentially dis-allowed from correcting and from reallocating promptly. There’s basically been since, I don’t know how long, maybe it was the Greenspan era that essentially ushered us in. But there’s essentially an unwritten law against recessions. And this is not just a problem in America, this is a problem everywhere in the world. Politicians don’t like recessions. As they push back through repeated cycles we have chronic malinvestment, chronic poorly allocated capital. And this creates a hostile working lifetime of living in an essentially very strange unreal financial and capital structure. But of course, as Bill rightly says, you have the countervailing forces of progress constantly working, the market is constantly trying to figure out how to make the best of its present reality and its present situations. This is why I think you have inherent paradoxes when you look at these big cycles, because there is so much to be bearish about, and yet there’s also a lot to be bullish about, and I guess that’s the essence and the nature of risk and opportunity. You know Mark Thornton once mentioned that Murry Rothbard used to say he was permanently bearish about the short term and permanently bullish about the long term. And I think that it’s an aphorism, but it kind of speaks to this notion that state intervention can really mess up markets and financial markets in the short term. But over time the power of the free market and of private enterprise is extremely pervasive and eventually seems to win out at the end of the day. Of course in the interim what that means is that because you have such disinflationary forces because of private enterprise and technology, it kind of emboldens the policymakers to run these bubbles longer and larger than they should be, so no question that the last two bubbles have been a symptom of these kind of policies, and I agree, we’re in a third very excessive state of distortion and the best case scenario that we can hope for is a sharp, painful clear out of chronic malinvestment. That is the fastest path to genuine economic progress again. I hope we get there soon.

Chris: This is Chris, I’ll just add that in discussing how Austrian Economics explains the 08 crisis gives us some guidance to future bubbles in economic recessions, it’s worth recounting what does not explain the 08 crisis, and that is mainstream economics. Whether it’s so-called Chicago or Keynesian schools. And it’s probably worth remembering that in 2002 at Milton Friedman’s 90th birthday party that Ben Bernanke stood up and literally apologized for the Great Depression, and he basically said “We’re never going to have a significant recession again.” I believe he said something to the effect of “we won’t do it again” and so that tells you central bankers pretty much around the world do not understand the causes of recessions at its most fundamental level. They can’t explain why it occurs, they can’t explain why it’s a cycle, they can’t explain what Austrians call “the cluster of error”, why all these businesses have made horrendous investment decisions. They can’t explain why every recession is proceeded by monetary inflation, they can’t explain why certain industries are far more cyclical then say consumables. So it’s just something that cannot be explained, the Austrians do, and for the listeners who may not be all that knowledgeable on the Austrian School, in short, whenever you inflate the money supply, you are decreasing interest rates which distorts the whole structure of production, it forces economic actors to make investments they would not have otherwise done, that they would have otherwise deemed unprofitable, and it creates this malinvestment in the system, as my colleagues here today mentioned, we’ve already seen this play out twice in the last 20 years. And the response, if that’s the causation of a recession, the response should be hands off. The response by the government and central banks should be to not re-inflate the money supply, do not create bailouts, not have deficits which only will spur consumer spending at the expense of savings. So if that’s the antidote for recessions, the governments since the 08 crisis has done the exact opposite and it’s simply set up the economy for far, far greater downturn then what we even experienced (in 2008), with the possibility of significant inflation. So the 08 crisis gives great lessons and basically proves out the Austrian theory, the business cycle. And it really demonstrates errors and issues with other explanations from other economic schools of thought.

FRA: and Mark Valek, any thoughts on applying the Austrian school to the financial crisis and where we’re potentially heading today and the Global economy?

Mark Valek: Definitely some thoughts, very short though because again, a lot has been said already. Where are we going in the Global Economy? Providing you have the Austrian perspective as we all obviously have, you actually know that there are significantly high (inaudible) to the capital structure, and this is not a sustainable state. But there lies the problem for investing obviously, the timing question, but sooner or later this state of capital structure will not last, it’s absolutely not sustainable. Just on a side note, as an asset manager, I encounter sustainability so many times a year, it’s kind of a hyperinflated world, everybody wants to invest sustainably and what bugs me that is nobody things about if our, for instance, monetary system is sustainable, and I would argue against it. So this is to me, really a very superficial discussion here. However, I think if this cleansing process starts the next time, we will probably will not see the big fear we saw the last time, which was basically the fear of deflation of debt deflation if you want to call it, like debt. I think the authorities have proven that they just will not let this happen so market participants probably are not going to have fear that will be too little money going around or being printed, but perhaps we’ll start to fear that this is going to be an overdose the next time, and I think as soon as this psychology changes, you have (Inaudible) things like price inflation look much more realistic in such an environment if you ask me.

FRA: Great insight, and so given this view of applying the Austrian school to the economics environment, if we can consider that as far as the investment environment, does it make sense to look at the principals of the Austrian school in investing, I mean, we see some of the principals, of being stores of value, indirect exchange method, meaning exchanging fiat currency for investments that are real assets that provide cash flows, investments with little or no debt, high free discounted cash flows as well. Little or no leverage, also scarcity in innovative industries, and then perhaps cryptocurrencies that are outside of the banking system but are still regulated within the financial system. So does it make sense to apply those principals in investing, and what are those principals? Also, are there any empirical studies or analysis that taking this approach can provide an edge or an enhanced investment management performance? This question is for the floor.

Bill Laggner: This is Bill, I could say I think knowing the Austrian business cycle theory is helpful in fact, during the second bubble, the credit bubble, I wrote an article with a colleague called “collateral damage”. And what was fascinating about writing the article was we had created the Bearing Credit bubble index back in 2004 when it was pretty obvious that we were segueing into this new bubble, and I kept looking at the types of asset-backed securities are being created mainly, and mortgage arena, and then the derivatives wrapped around it, and then attended a few conferences. But I started focusing on the collateral because it’s a confidence game, right, I mean people have confidence when these troubles start, they grow and what was interesting was in 2005 the home-builders had started declining severely and writing down land values ext. but subsequent to that you had maybe 12-18 months of watching paint dry. I mean the other related industries kind of kept chugging along. And it wasn’t until early 07 where the secondary market for certain types of mortgage-backed securities just locked up. And that was the beginning of the end. So to me, when I look at excess credit creation through the socialization of credit by the central bank and or other government agencies like Fanny and Freddie in the U.S. I was looking at collateral that was kind of a helpful sign that we were near some kind of inflection point. I think what makes this cycle so much more difficult, and look full disclosure I mean we’ve had a net equity short bias for the last several years, and it’s been pretty painful. I think this cycle because they’re all playing the same game, they’re all in together. Is there any limit to what the central bank balance sheets can go to? I mean, how many bonds can the central bank give Japan or the ECB or the Fed purchase, and I think it’s pretty clear that since all the chips are in the middle of the table, they’re going to continue to buy bonds, and try and hold certain parts of the yield curve suppressed to keep the game going. So ultimately I think you know gold, we own a lot of gold, we’ve owned gold since 2002, I mean gold will continue to act well, and may become one of the best performing asset classes over the next several years until we ether get some kind of boom or something close to it. So that’s how it’s helped us and how we employ it in day to day portfolio management.

Chris Casey: This is Chris, I’ll say that I’m not sure if Austrian Economic principles are necessarily applicable to investing, but Austrian Economic conclusions certainly are. They certainly are as they relate to the macroeconomic phenomena of recessions and inflation. Because these are the two forces that create the greatest risk factors regarding ones investment portfolios. The recessions are going to pop any bubbles that are out there pushing the equity markets, and inflation will destroy the bond markets. And when you’re looking at equities or bonds, these obviously make up, for most people, the vast majority of their investment portfolio or at least the core of the investment portfolio. So if you’re able to use Austrian economics to navigate these two risk factors, I think it presents a tremendous advantage for investing. As far as whether or not there’s been empirical evidence demonstrating this, not to my knowledge, I think it would be difficult to construct such a study for a couple reasons. One being the time period that we’re looking at. Austrian economics hasn’t been utilized in this form for very long. And secondly would be the sheer number of people using Austrian Economics in this fashion. It’s very limited set. The people here in the call know that they represent a good portion of that universe, may be the universe, of people managing money with Austrian Economic concepts in mind. So there are very limited data points out there.

Mark Whitmore: This is Mark, I would sort of follow up on Chris’s comments. I tend to also be somewhat skeptical as far as can you look at Austrian Economics as instrumental tools for specific kinds of investment analysis or recommendation. And I think that’s a harder thing to make a case for. What I think is incredibly valuable, is how do you explain reality and in essence, the kind of the largest school out there in terms of money management is the efficient market theory, this idea that whatever the price of the given asset is at any time, it’s the “right price”. Because all the information is being priced in so trying to outguess the market is kind of a fool’s errand. And I think that one of the most basic, the most essential insight of Austrian Economics is this idea of subjectivism, and that prices are wholly derived by human beings, and one of the other schools of economic thinking that I think dovetails nicely with the Austrian school is Economic behaviorism, this idea that individuals are driven by greed and fear, and as a result, and this feeds very much into the boom bust cycle of the Austrian framework, that you get these ridiculous, unexplainable run-ups that leads to catastrophic losses. And if investors can simply, instead of, and I remember reading one of the most tortured treatments by Burton Malkiel who wrote the seminal Random Walk Down Wall Street which is sort of like the bible of efficient market theory, and soon after the edition following the 1987 stock market crash where the Dow went down 20% in a day, he attempted to try to explain how this was a rational response to changing monetary conditions, and the market was kind of correctly pricing things all the way along. And you find these things which, I think Chris mentioned earlier simply that Keynesians and the people who look at kind of classical economics and efficient market theory, they can’t explain reality. But the power, the strength of Austrian Economics you can see bubbles when they’re coming. And like Bill, I’ve leaned into the defensive positive in the last few years, so in the short run you might seem to be looking like a fool, but if you can help your investors avoid and maybe even profit from bubbles as they unwind, you’re going to be far better off than the vast majority of investors out there that are just being caught up and are losing 50% of their portfolio in multiple stretches.

Russell: Hey guys, its Russell here, Mark you’ve just made some really great points. And I think I would echo a lot of what you said. I think it’s about creating a coherent perspective of macro-reality, you know there’s so many investment firms, you go on their websites and they talk about how they like to find miss-priced assets, because they believe that the market doesn’t always effectively price assets. But they’ve never really got a coherent reason why. I think the nature of clusters of error of boom and bust cycles, of the business cycle creates a very coherent reason why you get big distortions and big mispricing. And what I try to do for my clients is I say to them that ultimately using Austrian principals is essentially about creating a coherent perspective of reality, and also using that coherent perspective of reality and comparing it to the market narratives that emerge. Donald Trump gets elected, and there’s a narrative there that emerges, a reflationary narrative. A narrative might be that he’s going to deregulate and the market finds an excuse to run even higher. And you’ve got to kind of test all these market narratives against really sound perspectives of reality. In addition to that I’d say a few things one is that an Austrian perspective gives you an understanding that you’re not in a free unfettered market, you’re in a market where the state plays an incredibly dominant role and is essentially trying to plunder private resources. And so a huge element of investment strategy from an Austrian perspective has to be the sense that you are defending your wealth against the plunderers. The second component is that business opportunities can be false, and that’s something that’s embodied in the essence of boom-bust cycles, subsidization, and the principals of Say’s Law, you know expecting consumer markets to boom when in fact you’ve got misallocated productive capital, those consumer markets are not going to perform how you expect. And the flip side of that of course is that you get overestimated business risk, because some people are avoiding sectors that look unattractive when in fact they are fundamentally attractive, particularly if they can exploit state failure. And then finally Hayek spoke about the pretense of knowledge in his famous Nobel acceptance speech, and you know one of the things that none of us, whether you’re an Austrian or not, none of us have the entirety of knowledge that we need to make very precise and accurate calls about the investment world. And that’s one of the reasons why, and it’s spoken about in the book “Austrian School for Investors” but you know you’ve got to start off by exploiting opportunities as an investor that are close to you. That you’re capable of having knowledge about, and that’s why before you invest in public companies and in funds, you probably have to invest in yourself, in your own entrepreneurship or in private equity opportunities that are very close to you and where you have some special knowledge. Because you don’t have any more knowledge then the central planners do either. So I think those are some really key objectives. I think there’s some ethical issues as well but I don’t want to go into that right now, but I do think that when we talk about Austrian Economics being free of value judgment, that’s very much in the theoretical analytical sense. But once you’ve derived conclusions from that, value judgments definitely come to the fore, and I think there’s a strong ethical component that can be informed across a range of asset classes and how you invest and how you go about investing. I’m going to not go into that right now, we can maybe circle back to that a bit later.

FRA: Then Mark Valek, as Russ refers to your co-authored book on the Austrian School for investors, can you provide some insight from that book on these principals?

Mark Valek: Yeah thanks. Just a small supplement here, we thought about this topic very hard and we thought, where potential opportunities lie in Austrian investing and where do potential risks lie in such a discipline. Just a few words on opportunities we’ve heard I think already in that direction. The fact that it’s not read among investors. I think that’s potentially a huge edge, it’s a huge edge in a marketplace where it’s not really a secret, it’s out there, you just have to read it on the internet, go on mises.org or wherever, but most of the people just don’t care or know about this so it’s not read. Second edge knowledge about Austrian business cycle theory we also talked about, but I just want to point out the third edge which we identified and I think Austrians in general are able to understand alternative currencies much better they are able to think about it outside of the money system just as we all think so much about the current system that helps us for instance when bitcoin currency came up, I was not even as a tech guy but just from an Austrian view I was able to pretty fast wrap my head around the basic concepts. And I knew if this thing monetizes then it’s huge financial gain and if it doesn’t well until it does it’s speculation on a potential alternative money, but now I think it’s more clear to the rich investor too, but such thing I think come with an Austrian mindset. On the other hand just also to talk about the risks perhaps for one moment with Austrian investing, generally, and I’m sure all of us know about this potential risk, is a bearish bias is associated to the Austrians. I think that’s because Austrian investors are sensitive to these flaws in the capital structure we already talked about. And they always kind of think perhaps this boom will be bust sooner than later and so on, and we know the problems I think associated with that. Another problem I also touched already is the Austrian School statistic it does not make timing calls. So this is a predictive problem obviously, especially in finance. I think one can circumvent this problem with the help of other techniques from the quantitative side take the analysis, whatever. But strictly speaking from an Austrian School, you don’t get any help regarding the timing problem. Just to mention the last potential risk, Austrians do tend to be very convinced, it’s like what we call potentially a dogmatic bias, and dogmatism is probably a thing where one should be cautious in an investment space. So there are other opportunities, but there’s also risks and one should be aware of these risks and find some ways to manage these risks as an Austrian investor.

FRA: If we could do one more round on bringing it all together and providing some examples of investments or asset classes or perhaps investment strategies that exemplify using the principals of the Austrian School in investing or the outcomes as Chris mentions, of the Austrian School. Let’s do a round based on that to close out. No specific companies or securities, but just generically speaking. Anybody?

Russell: It’s Russell here, maybe I can come in and say one or two things about some of the ethics around investing. I mean, we all have to make decisions about leverage. In the system where debt is created by fractional reserve banks we understand that the core of business cycle problems arises from creating debt liabilities without prior saving – this is a systemic problem. And of course, when you participate in that system, there’s two ways you can look at that. You’re either participating in the bank leverage system as a defense mechanism against that system, but you can also argue that you’re aiding in advancing that system, so I think every investor has to answer some pretty tough questions about leverage and about the kind of leverage. I think from an Austrian perspective, you would typically favor equity over debt and you would favor non-bank debt over bank debt. The other big ethical question, of course, is to talk about government bonds – financing the state. The state is essentially a mechanism of wealth destruction, you know do you really want to be financing plunder, but in another sense, by funding the state, you’re again, aiding and abetting a fairly large degree of wealth destruction. And ultimately getting your coupon payments in part by being taxed more and your friends and family being taxed more. So one’s got to think about that, some of these issues. And then, we know that Ludwig von Mises was one of the greatest advocates for peace, and anti-war, and you have to think about what firms are doing in terms of financing and funding and equipping governments to fight unjust wars. These are obviously very tricky and murky. And I’m not trying to make any kind of high-brow ethical statements here, I just think that these are the kind of things that have to be considered and Austrians do think a lot about these things. So I just wanted to kind of lay that out there, because ethics and feeling personally good about your investments, not just intellectually, but emotionally as well, I think is an important part of an investment strategy.

Bill: This is Bill, I’d like to just touch on something Russell mentioned, great points by the way, the state has grown immensely around the world subsequent to 2009. And I don’t want to get to far into the metrics we all know what played out in certain parts of the world, I think one of the beauties of the internet and the search for the truth and leading us to the election in the United States for example last year in WikiLeaks, the internet is essentially exposing a lot of the fiction that we’ve all grown up around over the last number of decades. And with that comes almost an awaking, a move to higher consciousness. So people are, I see it every day, I think people are leaving tax-free bonds or government bonds and doing other things with their capital, getting involved with private local businesses. I don’t want to get too far off track but I think that is something clearly playing out. Cryptocurrencies, I’ve spent a lot of time looking at the economic actors within this interesting ecosystem and you think about not being a participant in the plunder if you look at just the banking system and all of the friction within the banking system, let alone the leverage, you’re looking at a couple trillion dollars a year just in general friction that’s being stripped out of the ecosystem. So the movement towards the internet of value as opposed to what we witnessed the last couple of decades, the internet of information knowledge I think is another fascinating innovation playing out. So I think more and more people per Russell’s point, don’t want to participate in the plunder and are actually spending time and capital creating these new economic fabrics and I think it’s quite exciting to witness.

Chris: This is Chris, if we take out the ethical considerations that a couple of my colleagues just mentioned, the question is how Austrian Economics help you when looking at investments from a risk-return standpoint. And I think Mark mentioned this earlier, hopefully I’m not misinterpreting him, but I believe Mark made a point that Austrian Economics doesn’t help us analyze any particular investment vehicle or perhaps even investment asset class, and by that I mean just because one company has more or less debt then another company doesn’t make it more or less Austrian. Or just because a company operates in such and such industry doesn’t make it more or less Austrian. Austrian Economics helps us because of the explanations as to inflation and recession. It helps us protect portfolios it helps us minimize risk. It also helps us profit from macroeconomic developments when they occur. Primarily meaning any kind of pops in bubbles or bond markets, whether stock or bond markets. So there you want to look for investments that will do well in that context, or that will weather the storm so to speak and do well regardless as to what happens. So you want to consider industries that potentially have high growth that will not be negatively impacted or at least will not shrink or be reduced in size through the effects of inflation of recession. So maybe in America you want to consider the cannabis space. Maybe you want to look at investments that historically have done well when you have inflation, meaning you want to consider gold, you want to consider farmland, things like that. So, I think Austrian Economics again helps us from an investment portfolio standpoint, minimize risk, and really seize onto some great opportunities as these things transpire. But as far as analysing any particular asset or asset class, I don’t think they lend that much value. I’ll also say that I think Austrian Economics lends itself naturally to contrarian investing which I think is a great way to make money. It’s pretty obvious that there’s not a lot of people out there managing money that believe in Austrian Economics. So we hold a key, we understand something that few people embrace or have any kind of knowledge of. And I think that really is a key factor in contrarian investing which really just means you’re looking for extreme market value questions on the high or low side, and identifying the catalysts that will bring that prices back to its historical mean or median. And I think the explanation and conclusions of Austrian Economics do that quite well.

Data Courtesy of the St. Louis Federal Reserve

Mark Whitmore: This is Mark Whitmore, I keep forgetting we have two Mark’s on the line here, and Chris you absolutely interpreted what I was trying to say correctly, and kind of to follow up a little bit, I think one of the things that the other Mark pointed out is the issue of timing, and whereas the two prevailing investing paradigms out there seem to be this notion of efficient market theory which attempts to just buy and hold the market no matter what, completely price indifferent. And that’s really key, is that Austrians I think have a sense of value in the marketplace naturally. And it doesn’t come from any unique insight of the Austrian School, other than the fact of the combination of the subjectivism coupled with the inherent boom-bust cycle makes those of us who use Austrian Economics very sensitive to issues of price and value. I think a cynic is often defined as someone who knows the price of everything and the value of nothing and I feel like Austrians are exactly the opposite.  Whereas other investors are chasing price action, if you’re somebody who’s sort of a trend follower, or you’re simply buying and holding, there’s a greater tendency among Austrians to appreciate value. And this point dovetails with the other point as far as since we don’t pretend to know the precise timing of when bubbles kind of unwind or when the busts will finally reach a bottom, the idea is that we can actually be in the right quartile of activity, in other words I never try to catch the very top of a bubble, I don’t try to ride things to the very end, and similarly I don’t mind catching falling knifes. Because as investors if you’re looking at this current contemporary global macroeconomic backdrop from the 10-12 year perspective, I find it with the typical disclosure here that I’m not able to see with a perfect crystal ball or anything but it’s hard to believe that traditional assets, that global equities, will be thriving in this environment just from the simple perspective of how overstretched they are from any reasonable measure of valuation.  And similarly, the global bond market which has been the classic offset to unwinding stocks in the past, is also so stretched.Because just like bond prices are inversely related to interest rates, you have interest rates around the world, I mean you have negative interest rates in Sweden, in Japan, in Switzerland, and back last July you have negative interest rates over a swath of different developed markets so there’s simply not a lot of room basically for bond appreciation. I think it’s a very careless time for equity and bond investors from a longer term perspective whereas those of us who are Austrian have a bend for the idea of real money, sound money, and one of the things that looks pretty attractive in a Ponzi finance global macroeconomic backdrop would be precious metals I would say. And I particularly play in the currency space and one of the thing that’s attractive there is the idea that in eras where you have reckless central banking there’s huge distinction between reckless central bankers and those who are engaged in reckless central banking with abadon and as a result I think that there becomes some real value disparities from a currency standpoint as well. But I mean I think that’s how I at least use Economic principals from the Austrian school to inform overall investing decisions in the marketplace.

FRA: And finally, the other Mark?

Mark Valek: Yeah, I think that most points have been touched seriously. Yeah I just don’t want to drag it out unnecessarily, but I think there were very interesting comments in all kind of directions, really enjoying this discussion, I don’t know if we have anything else on the plate?

FRA: Nope, that’s it. Just wanted to close out with regard to giving everybody a chance to identify how our listeners can learn more about your work, if you have a website or perhaps a newsletter?

Russell Lamberti: Yeah my website, ETM macro advisors website is www.etmmacro.com and I am starting a new newsletter called the macro outsider, and you can sign up for it for free on www.etmmacro.com and you’ll get a free essay called “The real currency war” which is subtitled “monopoly money vs real money” and essentially there I just go into a lot of what we’ve spoken about today in terms of chronic malinvestment, the weakness of fiat currency reserve systems, and then ultimately where I think the real currency war is, which is in centralized vs. decentralized money, and I talk a little bit about cryptocurrencies there as well, so that’s www.etmmacro.com you can sign up for that free newsletter.

Bill Laggner: This is Bill, so Kevin Duffy and I, we manage a couple of funds, long short-biased, I should say long short strategy macro oriented funds, bearing asset, like ball bearing .com, http://www.bearingasset.com/ and then we also write a blog http://www.bearingasset.com/blog and then Kevin and I are on twitter as well, we post some comments from time to time.

Chris Casey: This is Chris Casey with WindRock Wealth Management, we manage money for high net worth individuals. I would encourage anyone that wants to check us out just to visit our website https://windrockwealth.com/ We have our contact information there, we have all of our content, meaning podcasts, articles, blogs etc. That’s been posted since we started the firm and the people can feel free to read more about our philosophy on various issues.

Mark Whitmore: Great, and this is Mark Whitmore in Seattle, I have a website at http://whitmorecapitalmanagement.com there’s a research and article section which has, I do a quarterly newsletter and would be happy to put anyone interested on the mailing list for that, and basically we have a strategic currency fund that is again, informed largely by Austrian Economic principles that I operate. I also will make a plug here for one of my co-panellists, Mark Valek, who has his book “Austrian School for Investors” is essentially that he co-authored is one of the only kind of resources out there that’s an outstanding resource and really well researched and thought out, so I want to complement the fine work you’ve done on that.

FRA: Great, and now Mark Valek

Mark Valek: Thanks so much, thank you if you’re interested the book is on amazon I guess, Austrian School for Investors” our homepage is http://www.incrementum.li/ we’ve got lots of good stuff which is relevant up there, first of June our annual “In gold we Trust” report is going to be published as well. You’ll find that on the homepage as well.

Summary and Transcript by Jacob Dougherty jdougherty@Ryerson.ca


03/22/2017 - The Roundtable Insight: Chris Casey on The Austrian School of Economics and Why It May Be Time To Change Our Perspectives

Chris Casey is a trusted advisor to many business owners and companies alike on their pool of investments within their portfolios. With a specialty in the Austrian School of Economics, the far less popular thread of the study especially here in North America, Chris combines a unique viewpoint on traditional economic themes with an expertise on the Austrian way of thinking.

As name would suggest, the Austrian School of Economics did in fact originate in Vienna, Austria. It was powered by what was called the “marginalist” revolution in the 1870’s, which aimed attention at diminishing marginal utility-that an individual’s given choice is made on the margin. With that said, the Austrian school is a body of thought that puts emphasis on the value products as being determined by its utility to the consumer. This is balanced with Keynesian economics which focuses on the importance of dissecting the nature of various aggregate economic variables such as output, employment, interest rates, and inflation.

The Western world is largely exposed to only the Keynesian study of economics, possibly causing narrow perceptions of the principles themselves. With the emphasis of both schools of thought centered around two very different principles, a basic understanding of both is essential to better understand the world around us and how it functions.

 

FRA:     Hi, welcome to FRA’s roundtable insight. Today we have Chris Casey. He combines a degree in economics From the University of Illinois with a specialty in the Austrian School of Economics. He advises clients on their investment portfolios in today’s world of significant economic and financial intervention. He has also written a number of publications on websites including the Ludwig Von Mises Institute, Casey Research, and Laissez-faire Books. He’s a board member of the Economics Development Counsel with the University of Illinois, a policy advisor for Heartland Institute Centre and Finance, Insurance and Real-Estate. Welcome, Chris.

Chris Casey:     Thanks for having me on today.

FRA:     Great! Today we wanted to discuss an approach to investing that uses the principles of the Austrian School of Economics. Chris takes that approach with his clients, and we just wanted to explore in detail how he does that, and how it gives an edge to investing. Chris?

Chris:     Sure. Well, anyone’s portfolio has exposure to two very significant and primary forces; and that is the business cycle, and that recessions could pop any kind of financial bubbles out there whether it’s the stock or bond markets, as well as inflation, although that’s not talked about in today’s circles as often as it should be, it’s certainly a significant threat to anyone’s portfolio as anyone who lived through the 70’s certainly witnessed.

The Austrian school has unique explanations for both of those economic phenomena as well as interest rates. Having a unique economic perspective, truly understanding the way the world works, and being able to interpret the repercussions of various economic actors within the economy whether it’s the federal reserve, other central banks, or the treasury issuing bonds etc. is really key to structuring one’s portfolio to protect yourself from these significant threats that are out there.

FRA:     How do you apply this process…is it sort of like a flow chart-based approach? Do you look for certain characteristics, or do you look at the macro view first from that economics perspective? How do you actually approach that?

Chris:     Well, we’re always trying to interpret what the true effects or repercussions of, for instance, Federal Reserve actions would be on the economy. For instance, while some people may believe that raising rates will stifle inflation, we realize that that’s one of but several tools that federal reserve uses to inject money into the economy, and therefore doesn’t have much significance nor does it happen right away relative to other tools at their disposal. It’s really an interpretation of the actions that are out there and it lends itself well to Contrarian Investing because it’s a great way to truly make money in any market. So in Contrarian Investing, you’re looking at any kind of price levels that are extreme highs or extreme lows and just as importantly, you have to look at a catalyst to bring those extreme price levels to their median or mean average over time. And if you have a catalyst that is out there that’s a true interpretation of how the economy works and you understand it but everyone else believes in something different even though you’re looking at the same data, I think that’s a significant advantage in structuring your portfolios.

FRA:     That’s right the Austrian view places a strong emphasis on how the “interventionary”-type policies are distorting the price of risk, the price of money, interest rates, so that wouldn’t make sense. Do you do this on a daily basis; do you monitor central bank policies, fiscal stimulus policies, government regulations…how do you monitor what’s happening and the potential distortionary effects in the investment environment?

Chris:     Sure, well, we’re looking at same data as everyone else is, it’s not like we have some special insights or we’re necessarily looking at different data, it’s really the interpretation of the data. Let me give you a couple of examples. A lot of people, a lot of mainstream wealth management firms, a lot of media within the finance industry take a lot of stock with what the Federal Reserve believes and does and says, which astounds me because they are the absolute worst predictors of future events of any prognosticator out there. Think about it like this, it’s one thing if you’re wrong about predicting the future, but the Federal Reserve is even wrong about predicting their own actions. I mean, how many people can you say that, or economic actors can you say that, are simply wrong in predicting what they will do in the future. Yet time and time again, they are. If you look at the Federal Reserve, you could look at previous pronouncements, you have Ben Bernanke in January of 2008 saying they don’t see any kind of recession, and famously he did the same with the housing bubble. I don’t know why anyone believes these people on anything that they believe will happen to the economy. It’s not because they have obviously more access to data than we do, it’s simply an interpretation of what’s going on. They simply have an unsound and fundamentally flawed understanding as to what causes recessions. They cannot explain a business cycle. If you cannot explain the root causes as to why something happens, then predicting when something will happen is no different than reading tea leaves. The whole point is that it’s a different interpretation, it’s a different lens on the same data that’s out there.

FRA:     Can you provide some specific examples of investment asset classes and how they are tied into an Austrian school of economics view?

Chris:     Well the one everyone always talks about is of course precious metals, and that’s because they understand the true nature of money and what money represents, what it does not represent, and therefore they understand the dangers of a Fiat currency in today’s world and its ability to create inflation. Let me just reiterate what a Fiat currency is because a lot of people just assume it means paper money, it doesn’t. Fiat means by force. It’s government required use of money, legal tender laws, and the ability to print money that’s unbacked by any kind of commodity. So we’ve obviously had that in full blown mode since 1971, and because of that we’ve experienced significant inflation in the 1970’s. The Federal Reserve has printed a huge amount of money since the 2008 recession, so people think, well why haven’t we had inflation since then? There’s a couple forces at play, it’s not a simple matter of the stock of money goes up and prices go up automatically. There are some deflationary forces to the extent that loans are called in or loans are repaid, there’s time elements, there’s a lag. It’s very possible that the demand for money has gone up, and that’s a key element to the price level equation…what is the demand for money? In times of uncertainty and in times of extreme low growth when people are afraid, the demand for money, I’m sure, goes up, so that’s been keeping a damper on inflation as well.

10 year performance mar17 image

Data Courtesy of Federal Reserve Bank of St. Louis

FRA:     What types of investments would provide yield and preservation of purchasing power?

Chris:     In addition to, obviously precious metals, I think you want to look for any kind of investment or economic activity where you are getting paid in more stable and increasingly valuable foreign currency, but you have your costs in dollars. Let me give you a couple of examples that exist in the real world: in Russia over the last couple of years the Ruble has fallen tremendously relative to the US dollar, but if you look at their commodity producers, if you look at an oil company there, they’re getting paid in international markets in dollars. Meanwhile their costs are lower relative to their revenue. Another example would be in Brazil, we have the same thing happening with producers, their costs have fallen dramatically and yet they’re getting paid on the international market in dollars. And so people should look at that and think about what will happen next in the US, how could they position themselves to benefit from any kind of US inflation. US farmlands are a good example. Much like Brazil, the same thing could happen here, we saw that in the 1970’s when the price level essentially doubled over a ten year period, farmland prices went up about threefold, so they more than kept pace with inflation because the more farmers started exporting, as dollars became cheaper for foreigners to buy, their real sales went up in real terms, their land value went up in real terms. So that’s another way to play inflation, not just a knee-jerk reaction to precious metals but actually looking at other areas where you could benefit between the discrepancies in currencies.

decline vs US dollar image

Data Courtesy of Federal Reserve Bank of St. Louis

trade weighted US dollar image

Data Courtesy of Federal Reserve Bank of St. Louis

 

FRA:     What about other investments in agriculture, does that make sense as well in agricultural commodities or companies focused in that sector?

Chris:     If farmers are doing better, if they’re wealthier, if their underlying land values are better, I’m sure that there’s a lot of by-products that they will do very well. We haven’t looked at any in particular, but there are certainly a ton of products that would do quite well on that scenario

FRA:     Given the Austrian School of Economics places a big emphasis on debt, in a negative sense, would it make sense to look at investments where there are business with little or no debt, little or no leverage?

Chris:     I wouldn’t say that the Austrians necessarily view debt per se, negatively, they certainly view the non-repayment of debt negatively because that affects everyone in the economy, and they are strong believers in property rights and contractual obligations. But they do view government debt extremely negatively, for a number of reasons: morally, constitutionally, and just economically. They would advocate a balanced budget and much lower debt levels to the extent where there is no debt overall which we haven’t seen since the time of (pres.) Andrew Jackson.

FRA:     Yeah, exactly. Would it be possible for the government to consider some type of migration plan from a Keynesian based to an Austrian based management of the debt? Is that possible or could that be proposed, perhaps, as an evolutionary?

Chris:     Well I don’t think anyone in government actually subscribes to the Austrian school of economics, which is unfortunate, but out of the thousands of economists, very few of them would even be aware of the school, let alone understand or believe in any of its principles. I just don’t see anyone within the government, in any significant way, migrating economic policies towards an Austrian viewpoint.

FRA:     Do you know of any studies or empirical analysis with regard to using the principles of the Austrian School of economics for investing? Are there any past performance studies that indicate taking this approach has advantages and can provide an edge to investing?

Chris:     I’m not aware of any, and frankly it would be very difficult to conduct those, but more importantly I’m not sure exactly what those results would show meaning I’m not sure how beneficial someone simply believing in Austrian economics would have an advantage over others. I mean, we use it, we believe it is an advantage but just knowing about it doesn’t necessarily do anything, you have to really act on it. It’s not foolproof either. The Austrian Economics will help you identify bubbles and the catalysts to pop those bubbles. It will tell you about the direction and magnitude of markets, perhaps, but it won’t tell you anything about the timing, or at least that’s the trickiest part. In my mind, timing is far less significant when you have those other attributes nailed down because otherwise you’re “picking up nickels in front of a steamroller”. So, I’m not aware of any studies that would be interesting down the road, it’s also a pretty small data set of people who actually believe in this and act on it.

FRA:     Given the level of government intervention of central bank policies that intervene in the economy and in the investment environment on a long term basis, how does one address the challenge of timing, as you just mentioned? Is it a matter of waiting a certain period of time or are there tipping points where the distortions have just become too large and there will be a reversion to the meaning of Contrarian type-based approach? How do you actually look at the timing challenge?

Chris:     I do believe that direction and magnitude are more important. Let me give you an example: 2008 was a horrendous time. You had businesses thinking about where they have their cash, whether or not it’s even safe in a bank, that’s how fearful they were. The unemployment rate literally shot up in 7/8 months to 10% from maybe a high 4(%) in early 2008. You cannot understate the severity of that recession. Now from that, the government and Federal Reserve and treasury did exactly what they should not have done. They should have let these liquidations happen, they should have let the recession run its course but instead they did everything wrong. They printed a lot of money, they ran huge deficits, and all they did was cause dramatic and increased distortions within the economy. So make no mistake, what happened in 2008 was devastating, could be dwarfed by what comes down the pike based on what’s happened, because the distortions are even greater. The longer this has gone on, the greater the distortions are allowed to run their course and the more severe will be the contraction; the beneficial time period where we restore the structure of production to how it should be. So, timing to me just isn’t as important as magnitude and direction.

FRA:     I see, yeah. Given what’s happening in the economy and what’s happening with central bank policies, not only with the central bank of the US, the Federal Reserve, but other central banks around the world, as well as government policies on fiscal stimulus, the potential for increased infrastructure. Given that, and from an Austrian school perspective, where do you see the asset classes preferable to be in over the next 6-12 months, 1-2 year period?

Chris:     Well perhaps more importantly, is to what you should be in, is to what you should NOT be in. I think everyone should start looking at Cryptocurrencies in some form, emerging markets are very tempting based on not only the disparity in values between currencies but based on the disparity in relative values between their markets. Farmland, as I mentioned, I think is attractive. There are certain one-off sectors that have nothing to do with the economy which should do well regardless as to what happens. So for instance, uranium, or cannabis for that matter. But more importantly than these areas that one may want to consider, are areas that you should avoid; certainly anything within the equity markets that’s highly overvalued based on historical norms, I think, people should think about not having it in their portfolio. Certainly any kind of debt instruments are potentially at risk with rising interest rates, so you may want to lighten up on those. So in general, those are some themes to embrace or consider as well as what to avoid.

FRA:    Great, and how can our listeners learn more about your work and your services?

Chris:     More importantly than that, is what we believe in and how we apply Austrian economics. We have a lot of content on our website. I would just encourage people to check out our website which is WindRockWealth.com, and certainly our contact information is on there as well.

FRA:     Excellent! We will be posting this podcast as well as a number of charts and graphs that Chris will be providing on the website. We will also do a write-up abstract-transcript of this interview for anyone who wants to read that, including the charts and graphs. Thank you very much, Chris.

Chris:     Thank you.

windrock image

Abstract written by:  Tatiana Paskovataia <tatiana-p28@hotmail.com>

 

LINK HERE to download the MP3 Podcast

 


04/01/2016 - Chris Casey: “COST-PUSH INFLATION IS ANOTHER KEYNESIAN CONCEPT THE FED BELIEVES IN – They’re Wrong!”

FRA Co-founder Gordon T. Long is joined by Christopher P. Casey in discussing the decrease in oil price and its potential effect on the global economy.

Mr. Casey is the Managing Director of WindRock Wealth Management, a registered investment advisor and wealth management firm that subscribes to the Austrian school of economics. Mr. Casey is a frequent speaker before a number of organizations and conferences, including USA Watchdog, GoldMoney, Freedom Fest, and various bar associations and radio shows, including weekly financial and economic commentary on The Edge of Liberty (WNJC 1360, Philadelphia).  His writings have appeared in a variety of publications and websites including The Ludwig von Mises Institute, Zero Hedge, Family Business, Casey Research, and Laissez Faire Books.  He is a board member of the Economics Development Council with the University of Illinois, a Policy Advisor for The Heartland Institute’s Center on Finance, Insurance, and Real Estate, and a Chartered Financial Analyst charterholder (CFA®)

COST PUSH INFLATION

oil1Cost push inflation is a Keynesian concept that was developed to explain inflation during inflation; if any important commodity’s price rises, all other prices of goods and services rise. As we pay more, the standard of living would go down and inflation would creep in. But this actually puts downward pressure on other goods and services, so in the end the price level itself is largely unchanged.

“The price level is a function of the demand and supply of money itself, not of any individual commodity.”

It used to be that minor shifts in the oil price had profound impact on the economy, but that isn’t the case right now. Oil went from about $25 in 2003 to $140 in 2008, back down to $30 in late 2008, and $140 a couple of years ago. But have we ever seen a price level that rose or decreased according to the oil prices over the last fifteen years? The answer is no. The issue is that the Federal Reserve does believe in cost-push inflation, and they do think that deflation could be caused by lower oil prices.

“The great danger here is that they, in their mistaken belief that low oil prices could put a cap on any inflationary moves they do, as far as printing money, is that they could overshoot and end up causing more inflation than they intend.”

oil2EFFECT OF LOWER OIL PRICES

“Lower oil prices are good for the economy, but not for the reasons people cite on mainstream media.”

There’s a possibility that this could spike interest rates, or mitigate a downfall in interest rates.

STATE OF THE OIL MARKETS

 

Lower energy prices used to be considered good for the economy, since people have more money to spend. But that’s going toward servicing debt; it’s not actually consumption, it’s going toward debt payments. There are also some real dangers that aren’t being discussed by mainstream media.

Oil production has increased about 85% since 2008, but what isn’t mentioned is how oil imports have decreased. It’s down from approximately 12% of total imports to 5% today, not just in Dollar terms but overall volume.

Toil4he price has dropped 60% in the last five years. Oil producing nations are making less Dollars from the US customer. This is a problem because there are limited options for what they can do with those Dollars, so the US’ major trading partners and oil producing countries hold a massive amount of US treasuries. If they reduce their purchase of US treasuries, that could increase interest rates.

“Interest rates would have fallen further, but for the selling or lack of demand from these oil producing countries.”

SAUDIA ARABIA PEG

The Riyadh is pegged to the US Dollar at 3.75 Riyadh to the US Dollar, but their economy is under strain and their deficit is staggering. In any fixed exchange rate, the only way to keep it is through manipulation of the currency market by active buying and selling of Riyadh and US Dollars, but that is only making them go bankrupt faster. This could ultimately affect US interest rates as well.

OIL SUPPLY & DEMAND

oil3With multiple countries putting out as many barrels of oil a day as possible, there’s pressure to keep the oil supply up and maybe keeping oil prices down. But if the world economy falls off significantly, there will be a decrease in demand and then cut backs and lots of capital not invested. Then if demand rises there won’t be much capacity, which makes the market volatile. The banks are holding out in the hopes of a rebound, because they have so much debt outstanding to the oil industry. Eventually this will either create incredible inflation or a banking crisis.

“The banks cannot put up with this kind of strain . . . it’s kind of like being a patient and your doctor, who would be the central bank, is subjecting you to stimulants and depressants whether its quantitative easing or negative interest rates.”

FEDERAL RESERVE’S MISCONCEPTIONS

Regarding the nature of growth, history shows that the key is a high level of savings and decreasing government intervention. Another is the idea of deflation being bad; for example, the US experienced experienced two 30-40 year periods where the price level fell by half, but it was also the greatest period of growth in US history. The Federal Reserve also has misconceptions about inflation’s impact on unemployment, and interest rates, which could cause a banking crisis.

ADVICE FOR INVESTORS

If people believe that the oil market will create a banking crisis in the future, then they need to look at assets outside of the banking system. Gold and silver should absolutely be considered as part of their portfolio since it’s much safer than a number of currencies, as it has alternative value. Farmland is also an excellent inflation hedge and pays a dividend, unlike precious metals.

“A lower oil price, although all things being equal is good, there are some real dangers: there is the danger it could increase interest rates, there is the danger it could increase inflation levels… and there is the danger it could induce a banking system crisis.”

Abstract by: Annie Zhou: a2zhou@ryerson.ca

Video Editing by: Min Jung Kim <minjung.kim@ryerson.ca


01/27/2016 - Investing Techniques In Financial Repression: Profiting When Stock Markets Fall

WindRock Logo-FINAL

With increasing signs of a global recession, stock markets throughout the world have experienced one of the worst annual starts in history.

Many investors fear 2016 will bring another stock market downturn similar to 2000 and 2008. While investors can protect themselves by selling equities or even shorting the stock market, both of these approaches involve potential problems. An options strategy offers a third alternative with the potential for sizeable profits.

WindRock interviews Ed Walczak, Senior Portfolio Manager of the Catalyst Hedged Futures Fund, about the use of an S&P 500 options strategy.

LINK HERE to the podcast

LINK HERE for more information on WindRock


12/03/2015 - Brett Rentmeester Outlines: APPROACHES TO SOLVING YIELD CHASING & HIGH VALUATION RISKS

FRA Co-Founder Gordon T. Long interviews Brett Rentmeester on Austrian economics and the importance of having an entrepreneurial mindset in investment.  Brent Rentmeester is the president of Windrock Wealth Management and has been in the wealth asset management for over 18years. Mr Rentmeester believes the uniqueness of Windrock is its focus on the macroeconomic picture, Austrian economics and what it all means for investment implications as well as an entrepreneurial mindset on how to find investment opportunities.

The Austrian school to him is the “acknowledgement of the influence that central banks have on the business cycle and interest rate and therefore the opportunities left for investment”.

He mentions that the traditional stock, bond portfolio is under a lot of challenge going forward because there is no real and safe income anywhere today. As a result people are becoming speculators and risk takers even when they don’t want to.

Brett believes having an entrepreneur mindset when investing, is the key to addressing the dilemma of income and the future of investment. Secure private lending is lending money to borrowers that is backed by real tangible assets or an income stream. According to him, what makes this a unique category is that it addresses the pockets of lending that is being neglected by the big banks as a result of  the financial banking distress that took place in 2008.

On examples of secure private lending, Brett highlights 3 different categories with his examples. He explains that in auctioned rental properties, the government organizations Fannie Mae and Freddie Mac by law are restricted from buying mortgages on such properties until after 2 years, this results in a niche market for private lenders. “In energy markets more states are moving towards a deregulated market. What this means is that a consumer can buy energy from a variety of energy companies. Now this system is facilitated by third party brokers who go door to door offering this energy from various energy companies. Now because the brokers want the commissions up front and the energy companies can’t provide it, we see people coming in to pay the brokers a discounted fee upfront and then agree to collect the 3year contract provided by the energy companies.

Trade financing

“Global trade happens between different parties but often times it’s financed by big banks, trade receivables. So one party needs to buy goods and a supplier supplies them but someone’s got to finance that transaction and it’s often the third party bank”.

Due to new regulations, banks are required to reserve more capital in such situations, as a result an opportunity is created for private money to finance the transaction between the customer and supplier.

“Rather than taking on more risk you don’t have to today, you just have to be more creative”

– Gordon. T. Long.

Brett echoes this sentiment saying:

“So much of the industry and investors think in a very narrow box of stocks, bonds and maybe hedge funds but there’s a lot of things outside of that, that if you open your mind to the opportunities, are quite interesting to research”.

Abstract written by Chukwuma Uwaga – chuwaga@gmail.com


10/30/2015 - Chris Casey: The Austrian Case for Inflation

Special Guest: Chris Casey – Managing Director, WindRock Wealth Management

 

FRA Co-Founder, Gordon T. Long interviewed Chris Casey of Windrock Wealth Management on the concept of inflation and other applications of Austrian economics to investment theory.  Mr. Casey, an Austrian economist, is a frequent speaker and writer on macroeconomic topics and their related investment implications.

WHAT IS AUSTRIAN ECONOMICS AND WHY DOES IT MATTER?

The Austrian school offers the “most realistic interpretation” of society and economics according to Mr. Casey.  Gordon agrees in noting that “mathematical models are only as good as their assumptions.”  While equations and models may be useful as a construct to frame concepts, any social science cannot be scientifically tested due to the inability to control the countless variables at work.  As such, Mr. Casey prefers the Austrian approach which “looks at basic self-evident axioms as it relates to mankind in nature and then uses deductive reasoning to describe how the real world works.”  According to Mr. Casey, the unique Austrian explanations of inflation and the business cycle (recessions) have direct applications to practical investment ideas.

THE AUSTRIAN EXPLANATION OF RECESSIONS

Most mainstream economists believe recessions are inherent to capitalism since their repeated cycles largely began during the industrial revolution.  The Austrian school recognizes a different causation occurring at the same time: fiat money with or without central banking.  By artificially increasing the money supply through fiat money, interest rate levels are temporarily lowered.  This incents businesses and individuals to make investment decisions they would not otherwise have made: in short, malinvestments.  Recessions to liquidate the inevitably follow monetary mischief.

THE AUSTRIAN EXPLANATION OF INFLATION

The Keynesian school of economics has two theories of inflation which fail to comport with reality and are theoretically faulty.  Their “demand-pull” explanation requires full employment and full capacity in an economy, but Mr. Casey demonstrates that fails to account for a doubling of prices during the 1970’s during economic weakness.

The “cost-push” theory is equally wrong.  By blaming a particular price increase in a commodity such as oil for all price increases, it would have predicted pronounced inflation and deflation over the last 15 years as the oil price gyrated wildly.  In addition, it is theoretically faulty as more money spent on oil means less money is spent on other goods and services – which lowers their prices and renders the overall price level largely unaffected.

“Prices are merely a function of the supply and demand for money” states Mr. Casey.  More supply means dollars are worth less while higher demand lowers prices as people seek to increase cash balances by selling goods and services through lower prices.

WHEN WILL WE EXPERIENCE INFLATION?

Mr. Casey believes that “once we have another downturn, the Fed . . . will step right in.  Once we have that . . . we’ll really start to see the inflation take off.”

What will the Federal Reserve’s next move be?  They have other options besides another round of quantitative easing.  Mr. Casey notes they may stop paying interest on excess reserves held by commercial banks at the Federal Reserve, and they may also lower the reserve requirement which could have a pronounced and immediate impact on increasing the supply of money.

WHAT SHOULD INVESTORS DO?

“Timing is everything, so utilize investments which pay well now, but in an inflation will be a home run.”

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08/31/2015 - Chris Casey Talks Financial Repression & the Myth of Money Velocity

Special Guest: Chris Casey – Managing Director, WindRock Wealth Management

 

CHRIS CASEY DISCUSSES TYPES OF FINANCIAL REPRESSION, THE MYTH OF MONETARY VELOCITY, AND WHAT IT MEANS FOR INVESTORS.

FRA Co-Founder Gordon T. Long interviewed Chris Casey of Windrock Wealth Management on the monetary policy aspects of financial repression.  Mr. Casey, an Austrian economist, is a frequent speaker and writer on macroeconomic topics and their related investment implications.

TYPES OF FINANCIAL REPRESSION

“Financial repression can best be described as government intervention in the financial markets which causes distortions not only within financial markets, but throughout the economy.”

According to Mr. Casey, financial repression can take direct and indirect forms.  The most damaging form of indirect financial repression is the expansion of the money supply decreases interest rates.  The artificially lowered interest rate structure causes widespread malinvestment within an economy.

All of this would perhaps be tolerable if monetary policy actually stimulated the economy, but Mr. Casey states that even Federal Reserve economists have recognized the ineffectiveness of the multiple quantitative easing programs.

THE MYTH OF MONETARY VELOCITY

Mainstream economists believe inflation is currently mitigated by today’s historically low monetary velocity (“the number of times one dollar is spent to buy goods and services per unit of time”), so the money supply can be expanded without the damaging effects of inflation.  Chris Casey takes issue with this as well as the very concept of velocity.

“Velocity has no impact whatsoever, in fact it is a meaningless statistic.”

Worse, the theoretical construct from which the concept of velocity derives, the Fisher Equation of Exchange, is equally faulty.  This equation attempts to explain the price level within an economy, but while it includes the supply of money, it ignores the demand for money which renders it useless.   A useless theory in the wrong hands can create disastrous policy:

“The real danger is that by looking at velocity, by being focused on velocity, mainstream economists have been focusing on a false measure which creates false decisions which is going to have a very real impact on investors.”

WHAT SHOULD INVESTORS DO?

Where may the faulty policy decisions lead the U.S. economy?  Chris Casey believes that “the endgame eventually will be a massive inflationary recession.”  Gordon T. Long then asked Mr. Casey:

“What could you suggest to our listeners that they should be doing or thinking about to protect themselves in this environment?”

After recommending investors consider becoming fairly liquid, Chris Casey addressed how to profit from the coming economic environment:

“Build a portfolio of hard assets.  You want to look at anything from precious metals to certain types of real estate such as rental residential real estate to farmland.  You potentially want to look at foreign currencies to diversify from the U.S. dollar despite the dollar’s strength over the last year.”