Richard Duncan is the Chief Economist at Blackhorse Asset Management in Singapore. He is the author of numerous books including, The New Depression: The Breakdown of the Paper Money Economy, and The Dollar Crisis: Causes, Consequences, Cures, an international bestseller that predicted the current global economic disaster with extraordinary accuracy. Since beginning his career as an equities analyst in Hong Kong in 1986, Richard has served as global head of investment strategy at ABN AMRO Asset Management in London, worked as a financial sector specialist for the World Bank in Washington D.C., and headed equity research departments for James Capel Securities and Salomon Brothers in Bangkok. He also worked as a consultant for the IMF in Thailand during the Asia Crisis.

Richard has appeared frequently on CNBC, CNN, BBC and Bloomberg Television, as well as on BBC World Service Radio. He has published articles in The Financial Times, The Far East Economic Review, FinanceAsia and CFO Asia. He is also a well-known speaker whose audiences have included The World Economic Forum’s East Asia Economic Summit in Singapore, The EuroFinance Conference in Copenhagen, The Chief Financial Officers’ Roundtable in Shanghai, and The World Knowledge Forum in Seoul. He runs a blog called https://www.richardduncaneconomics.com/ where he has a video newsletter service called Macro Watch, which is available to our listeners at a 50% discount using the code word: authority

I coined the term ‘Creditism’ to describe an economic system driven by credit creation and consumption, in contrast to Capitalism, which was driven by investment and savings. Creditism replaced Capitalism when money ceased to be backed by gold nearly five decades ago. But Creditism requires Credit growth to survive. The evidence presented in this video suggests that Creditism is in crisis globally because Credit is no longer increasing fast enough to drive global growth, even with record low interest rates. It is not possible to understand the global economic crisis without taking account of the exhaustion of Creditism.”
– Richard Duncan

Current Creditism trends:

Once we stopped backing money with gold in 1968, the nature of our economic system changed very profoundly. Credit growth became the driver of economic growth. When we were still on a gold standard, there were constraints as to how much credit could be created, but after we stopped backing money with gold, all those constraints were removed and credit absolutely exploded. Total credit or total debt in the United States first went through one trillion dollars in 1964, and now it’s 66 trillion.

So it’s expanded 66 times in just over 50 years. This extraordinary explosion of credit in the US has completely transformed the global economy. It ushered in the age of globalization, it allowed countries like China to be revolutionized from a very poor, developing country, to the second largest economy in the world. What I’ve seen is even adjusted for inflation, every time credit has risen by less than 2% in the US going back to 1950, the US goes into a recession. And the recession doesn’t end until we get another big surge of credit expansion. So it’s crucial to be able to forecast credit growth if you want to be able to understand what’s going to happen in terms of economic growth. And it’s been very weak since 2008; we’ve now hit the point now where the private sector, the households, are so heavily in debt that they just can’t continue taking on new or additional debt to make credit expand enough to drive the economy.

So this is the real point: once credit started to contract in 2008, the global economy began to spiral into a new great depression. And it was only the expansion of government debt that prevented that from occurring. US government debt has more or less doubled since 2008, it is roughly $19 trillion now. It was the expansion of government debt that kept total credit expanding, and that prevented the world from collapsing into a depression.

The key as to what is going to happen next to the US economy and the global economy is interest rates. Interest rates are crucial to the future of Creditism as I call it. Going back to 1980, interest rates in the United States have gone down very steadily.

The 10-Year US Government Bond Yield in the early 80s was as high as 15% and now it’s gone down to around 2.2% today. And as the interest rate fell, this made borrowing more affordable, so the Americans were able to afford more debt. They became increasingly indebted, and we can see this by looking at the ratio of total debt to GDP in the United States. Now when I talk about total debt or total credit, I mean all the debt in the country. The government debt, the household sector debt, the corporate debt, financial sector debt, all debt. In 1980, it was only around 150% total debt to GDP, now it’s about 350%. So as credit expanded, the credit growth drove the economic growth in the United States. And as the US economy expanded, US imports from other countries grew, and that drove the global economy.

As interest rates have fallen, Asset prices have gone up. The stock market, property market, bond prices, they’ve all gone higher as interest rates have gone lower. The best measure of total wealth in the United States is household sector net worth.

Household net worth is now $90 trillion, it’s gone up by 60% since the post-crisis low in 2009. The reason this wealth has expanded is that the government and the fed took very aggressive action to reflate the global economy after 2008. The fed and the central banks around the world had interest rates to near 0% and reflated the global economy.

Going back to 1950, the ratio of wealth to income has averaged about 525%. During the property bubble, this ratio went up to about 650%, and of course, the property bubble blew up, and the ratio went back down to its normal level of about 525%. But now this ratio has once again expanded and is now at its back at its all-time peak level at 650% once again. And this is telling us that asset prices are very high, and the stock market is very expensive, property prices are expensive. And that means interest rates now begin to move higher, then asset prices are very likely to fall. So we’re seeing a situation now where interest rates are the key, because if interest rates move higher then credit is going to contract.  That’s going to throw the economy into a severe recession, and on top of that asset prices would have a very significant correction or crash, that would cause a negative wealth effect, and that would also cause a US economy and the global economy to go back into severe recession, or worse.

The US budget deficit

When the government borrows money it tends to push up interest rates. For instance, if the government doesn’t borrow anything then there’s less demand for money and interest rates will be lower. But if the government were suddenly to borrow $3 trillion, then that would suck up all the money available in the economy and that would push interest rates to very high levels. So when the government borrows more, it tends to push up interest rates. This is assuming all else is unchanged, but over the last many decades, something very important has changed. Once the Bretton Woods system broke down in 1971, the United States discovered they could run very large trade deficits with the rest of the world. This is important because it means the US will have very large capital inflows. When the US has a large trade deficit, it will have an equally large amount of capital inflows coming into the country to finance that trade deficit. The larger the capital inflows are, the easier it is to finance the government’s budget deficit at low interest rates.

In 2006 we had about $800 billion in capital inflow, and that was enough to finance the entire government budget deficit that year a few times over. So these inflows are very important financing the budget deficit at low interest rates. If Trump is successful in his promises to cut taxes and increase government spending, then it’s going to make their budget deficit considerably larger.

The Capital Inflows are the mirror image of the Current Account deficit.  When the Current Account Deficit grows larger, the Capital Inflows also grow larger, making it easier to finance the budget deficit. But, when the Current Account Deficit shrinks, Capital Inflows also shrink, making it more difficult to finance the budget deficit at low interest rates.

President Trump’s plans to force US companies to bring their factories back to the US, to renegotiate trade deals and/or to impose trade tariffs on China and Mexico would all cause the US Current Account deficit to shrink. A smaller Current Account deficit would cause the capital inflows into the United States to shrink, too.  Less capital inflows would mean less demand for US government bonds. That would push up interest rates and pop the asset price bubble. So, we must keep a close eye on the US Current Account Deficit because it will determine the size of the capital inflows.

What Could Cause Inflation to Rise?

Inflation has fallen since the early 1980s because increasing trade with low wage countries has pushed down US wages and the price of consumer goods. Now, however, if the US imports less from low wage countries, the price of manufactured goods will rise, US wages will rise, and inflation will rise. Forcing companies to bring their factories back to the United States or imposing trade tariffs on imported goods would cause inflation to increase. Increased government spending could also cause inflation to pick up.

The Undesirable Consequences of Eliminating the Trade Deficit

If the US reduces its imports, the global economy will shrink. If the US eliminates its $1 billion a day trade deficit with China, China’s economy could collapse into a depression that would severely impact all of China’s trading partners, and potentially lead to social instability within China and to military conflict between China, its neighbors, and the US. Additionally, if the US Current Account deficit returns to balance, the global economy will suffer from insufficient Dollar liquidity, which could cause economic stagnation or worse. A reduction of imports from low wage countries would cause US inflation to rise, which would push up US interest rates. The elimination of the Current Account deficit would cause a sharp reduction in capital inflows into the US, which would also cause US interest rates to rise. Higher interest rates would cause credit to contract and a sharp fall in US asset prices, which could cause the economy to go into recession. It could also cause a wave of credit defaults in the US and around the world, potentially leading to a new systemic financial sector crisis.

Moving Forward

The US could stimulate the economy “the old fashion way” by increasing military spending and starting a war, or they could invest in 21^st century industries and technologies. We could invest a trillion dollars over the next 10 years in developing renewable, green, solar energy. And if we did that, we could then re-structure the entire US economy, and induce a new technological revolution that would be so profitable, that we would pay off these investments many times over. We could grow out of this crisis, rather than collapsing into a new great depression.

Conclusions

The proposals outlined thus far by President Trump suggest that:

1. The budget deficit would grow larger (due to tax cuts and increase government spending);
2. The current account deficit would shrink (due to renegotiating trade deals, bringing US factory jobs back to the US and possibly trade tariffs);
3. And inflation would pick up (due to increased government spending, higher US wages, pressure on China to push up the RMB and, possibly, tariffs).

More about Macro Watch

Macro Watch is a video newsletter published by Richard Duncan. Every two weeks a new video is uploaded describing something important going on in the global economy, and how that’s likely to impact asset prices. Macro Watch monitors and forecasts credit growth and liquidity to measure and anticipate economic growth. You can subscribe to Macro Watch at https://www.richardduncaneconomics.com/ where you can save 50% with the discount code: authority

LINK HERE to download the MP3 Podcast

Summary by Jacob Dougherty jdougherty@Ryerson.ca

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“Many, perhaps most, current city and state workers simply aren’t going to get anything like the pension
benefits they have been led to expect” .. Fred Sheehan: ‘We are promised… is the haphazard refrain often encountered when the reduction of pension claims is mentioned. Promised or not, one distinguishing feature of non-federal government spending commitments stands out: only the United States has a printing press. States cannot print money. They can earn returns on their pensions’ invested assets, they can sell city hall, lay off the public works department, and tax, but an underfunded pension plan can only pay claims with dollars that exist.’ .. This list of options is actually too generous. Sell city hall? That presumes someone will buy it. Lay off the public works department? Not good for property values. Raise taxes? Right, on all the people in those houses without sewage service .. Repeat Sheehan’s last line and burn it into your brain: ‘An underfunded pension plan can only pay claims with dollars that exist.’ No one gets anything if the money isn’t there, and in a disturbing number of places it isn’t.

We know that pension plans typically have only 40–50% of their assets in equities, something like 40% in bonds, and the rest in real estate and alternative asset classes. How do you get 8% from that mix? Keeping 40% in bonds at 3% (if you’re lucky) means everything else has to make 15%. Marc Faber, who is even better at scaring people than I am, points out something that should be obvious but apparently is not: Pension plan funding ratios have been declining even as financial markets have posted impressive gains: ‘I find the deteriorating funding levels of pension funds remarkable because post-March 2009 (S&P 500 at 666) stocks around the world rebounded strongly and many markets (including the US stock market) made new highs. Furthermore, government bonds were rallying strongly after 2006 as interest rates continued to decline sharply.’

Like state and local pension obligations, US federal government pension obligations are also basically unfunded. They are expected to come from future tax revenues. Those obligations are the bulk of the over $100 trillion in unfunded liabilities that show up in the estimates of how much the United States is really in debt. That money is going to have to come from somewhere. But just as the United States will never default on its actual debt, I truly don’t believe we will default on US government pension obligations.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

LINK HERE to the article and source of images

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“We believe that the ECB is presently using monetary policy in effect to conduct fiscal, as well as monetary policy. Elected politicians should be up in arms; that they are not would imply either that they do not understand this or that they simply accept it. This may provide an interesting pointer as to the future of the EU itself .. Private-asset QE purchases by the ECB is a big deal, because the selection and execution of these asset purchases benefits some elements of the private sector at the expense of others .. The absence of any objection from the vast majority of eurozone governments implies acceptance of this usurpation of power by the ECB. Perhaps this portends a pathway to federalization among those countries (unlikely to include Germany) who have chosen happily to acquiesce.”

by Gordon Kerr, John Butler, with Enrico Colombatto, 16 April 2017

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Mohamed El-Erian, chief economic adviser at Allianz SE and a Bloomberg View columnist, discusses global economic risks with Tom Keene and Francine Lacqua at the IMF and World Bank meetings. (Source: Bloomberg)

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Former Fed Alan Greenspan discusses U.S. entitlements growing 9% a year and that no one wants to attack that. On Stagnation he says we have a slow growth economy where you end up with inflation and slow growth just like the 70s.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman,” wrote Louis Brandeis in 1914. Today, the Freedom of Information Act and internet make it possible to post online all spending at the federal, state, and local levels. This kind of radical transparency can transform U.S. politics.

Since 2011, American Transparency, a nonprofit, has built and operated OpenTheBooks.com, the largest private repository of U.S. public-sector spending. The ultimate goal: post “every dime, online, in real time.” To date, OpenTheBooks.com has captured 3.5 billion government-spending records, including nearly all disclosed federal government spending since 2000; 48 of 50 state checkbooks; and expenditures in 60,000 localities across America.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“It has long been understood that when the government borrows excessively, it pushes up interest rates and crowds out the private sector .. the government’s demand for money will exceed the supply of money from capital inflows and Quantitative Easing. The resulting drain of liquidity is likely to put upward pressure on US interest rates and downward pressure on US asset prices .. Crowding out is back. Liquidity is already negative. Any policy that would make it even more negative could cause a very significant correction in the stock market and the property market, where prices are already very stretched. A combination of policies that produced a much larger liquidity drain would almost certainly cause asset prices to CRASH.”

HEADS UP – we just interviewed Richard and the interview podcast will be posted up shortly ..

The Return Of Crowding Out Threatens Your Wealth

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“Tax-exempt municipal bonds play an important role in our building of infrastructure – we see the results every day in roads and bridges, airports, mass transit systems and affordable housing, hospitals and universities. Tax exemption results in lower interest expense for issuers, thus reducing property or other taxes and fees for residents .. Some lobbyists have suggested that everything is on the table, including taxation of municipal bonds .. The fear that municipal bond interest will be taxed has been one factor contributing to the muni–Treasury ratio’s being higher than average. Additionally, Treasury bonds may have lower yields than usual due to their attractiveness in a world of low-to-negative interest rates. They may also be benefiting from a flight to quality .. We do not think municipal bonds will lose their tax-exempt status .. If certain deductions are not allowed at the personal and corporate levels, municipal bonds will be one of the few tax breaks that remain. However, it is clear that the exemption is in play and that there are folks fighting hard for its continuation.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“The government will ban speculators from ‘assignment flipping’ in the pre-construction housing market. The move is targeted at investors who put deposits on multiple units at pre-construction prices — typically in condominiums, but sometimes in new subdivisions — then sell the title for profit before the building is complete, a process known as assignment .. Anyone who buys real estate in Ontario will have to reveal their citizenship and place of residence .. What this really means is that as two of China’s favorite targets of capital outflows shut their doors to more Chinese ‘investment’, the local oligarchs will simply have to find a new willing recipient. We expect that cities along the US West Coast – not to mention Warren Buffett, who as we reported earlier this week is now selling US houses to Chinese buyers – will be more than delighted to greet China’s trillions in capital outflows with open arms.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“One of the greatest monetary experiments in financial history has been the global central bank buying of government debt. This has been touted as a form of ‘money printing’ that was supposed to produce hyperinflation. That never materialized as predicted by the perpetual pessimists. Nevertheless, the total amount of Quantitative Easing (QE) adding up the balance sheets of the Fed, the ECB and BOJ is now around $13.5 trillion dollars, which by itself is a sum greater than that of China’s economy or the entire Eurozone ..  The withdrawal of the Federal Reserve (Fed), the European Central Bank (ECB) and the Japanese central bank from the QE programs will lead to an increase in yields on the bond markets sending the financing costs for the states higher. This is predicated upon the notion that people will continue to buy government debt. Governments have increased their spending sharply because interest rates were effectively zero and the central banks were buyers. Now comes the moment of truth .. Here comes the problem. The governments continue to borrow. With the central banks no longer buyers, then interest rates can rise faster than anyone expects because they will have to entice fresh buyers. If that fails to materialize, then we come to the Sovereign Debt Default crisis .. The negative effects of the balance sheet shortening of several central banks will mutually reinforce each other in 2018 and help to bring the financial crisis to a head for 2018-2020 .. The shrinking of the balance sheets represents the continued deflationary trend from a real economic expansion trend. The government will be competing for cash in an ever growing tighter economy. This will serve to demonstrate the unintentional impact of this entire unorthodox monetary policy experiment .. The inflation will be asset inflation – not demand inflation. So hold on – this is going to be the craziest ride in monetary history of human kind.”

The End of Quantitative Easing – Perhaps Now It Will Be Inflationary?

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“What you see isn’t always what you get, and it is likely a mistake to extrapolate today’s market performance into the future .. Admittedly, the charts, momentum, and fund flows are all very positive (US equity exchange-traded funds took in a huge $22 billion of net inflows last month) .. But some aspects of the technical picture have become muddled—the share of NYSE stocks trading above their 200-day moving average is at the highest level in nearly four years (a sign of overextension) .. As previously discussed in Outside the Box, sentiment is wildly bullish, and while it has been such for weeks now, we have hit some pretty extreme levels .. As per Bob Farrell’s Rule #9, in reference to the herd mentality: When all the experts and forecasts agree—something else is going to happen .. Just because it hasn’t happened yet, doesn’t mean it is not going to .. And of course, that then leads to Rule #4, which also has to do with excessive manic behavior .. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways .. They do not correct by going sideways! .. And lurking in the background is the Federal Reserve, which is poised to raise rates sooner rather than later .. Monetary policy is profoundly more important to the markets and the economy than is the case with fiscal policy, though all the Fed is doing now is removing accommodation .. The time to get interested is when no one else is. You can’t buy what is popular and do well .. Long ago, Ben Graham taught me that “price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down .. Be fearful when others are greedy, and be greedy only when others are fearful.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“The US president has criticized Germany’s enormous current account surplus and claimed it is the result of German currency manipulation .. There are two reasons for the undervaluation of the euro today. One has to do with the ECB’s quantitative-easing program, which over three years will have flooded the euro zone economy with €2.3 trillion of freshly-printed money through bond purchases. Part of that money flows abroad and leads to a devaluation of the euro. One has to admit this is indirect currency manipulation. However, we should also remember that this program, as well as the ECB’s other expansive measures, were decided by a majority on the ECB’s governing council over fierce opposition from Germany’s Bundesbank .. President Trump should look more to Wall Street than to Germany when he complains about the high exchange rate of the dollar,
The other reason for the undervaluation of the euro is to be found in the United States itself. By pushing the dollar as the world’s reserve currency, the US financial industry was able to offer global investors a potpourri of attractive financial products. This drove up the dollar exchange rate to a level that undermined the competitiveness of US exports. That is why President Trump should look more to Wall Street than to Germany when he complains about the high exchange rate of the dollar, which has cost America so many manufacturing jobs. And he should also bear in mind that the attractive financial products, which came from his country and damaged the US export industry, occasionally seemed more like fool’s gold than serious investment products .. With their Community Reinvestment Act, Mr. Trump’s predecessors Jimmy Carter and Bill Clinton made brokers help the country’s poor buy homes with generous loans, although it was clear they would not be able to repay the loans. The brokers sold their credit claims to banks, which repackaged them in opaque asset-backed securities and sold them all over the world. The game was up with the 2008 financial crisis .. As a result, in the year 2010, the German government had to inject €280 billion into its banking system to finance two ‘bad banks’ that had taken on these problematic financial products from America. So, in this sense, a considerable number of the Porsches, Mercedes and BMWs delivered to America have not actually been paid for. That is what the new American president should bear in mind before starting a trade war, or spreading unjustified accusations via Twitter against other countries.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“What we’re really discussing is a mismatch between the amount of money pouring into commercial real estate and the actual return on that investment”

We have a large supply of commercial real estate out there but the supply is still increasing, they’re continuing to build and have overbuilt in many areas. Meanwhile, the demand side is low and is still moving downwards. There have been very high vacancy rates in the U.S. specifically in the office and retail sectors.

There is also generational trends in play, there is less demand for office and retail space because millennials are causing the office space standard to rise and retail is more often done online at websites such as amazon. At the same time, there are valuations that are sky-high, even higher than the financial crisis. This could boil over as soon as 2018, but the central banks should have enough tricks up their sleeves to save the system one more time, but they’re running out of rope to do that a third time.

From the podcast:

Charles: The commercial property price index has now exceeded the previous bubble top in the 2007-2008 period by about 25%. So we’ve got a bubble that exceeds the previous high, and that should alert us to the potential for some downside here.
And if we look at commercial real estate loans at banks, then we see the chart is almost just an exact overlay of the price action. In other words, we’ve got more loans by about 25%, basically $2 trillion of U.S. commercial real estate loans. What makes that sobering is if we look at the retail square footage per capita.

We find that the United States has multiples, and so does Canada actually, has multiples of what other countries, advanced post-industrial companies like France and Italy. They have 2 or 3 of square foot per person and the U.S. has almost 25 and Canada has almost 15. So it looks like we’ve got a situation where there’s a lot of leverage debt on an overbuilt sector.

FRA: And you mention also that they’re still building and a lot of places have been overbuilt?

Charles: Yeah, I dug up a chart called Retail Space under Construction, and this was a year ago first quarter 2016, but there are millions of square feet of shopping centers, malls, and specialty centers still under construction.

Now if these are all in extremely hot markets like Toronto, or Vancouver, Silicon Valley, Brooklyn, then of course there’s going to be a demand for this kind of space, but these white-hot markets are fairly limited and so there’s a suspicion that there’s a lot of space being added to an already extended inventory.

Charles: We can see that the residential vacancy rate has plummeted from the 2010 post financial crisis peak. And it’s essentially near zero, around 3% or 4%. But the retail and office vacancy rates are still hovering around 9% or 10% which is way above where they were in 2007 and 2008. So this vast expansion of credit and some of that money is pouring into retail and office commercial real estate, but the demand really isn’t there. And we know that because of these high vacancy rates.

FRA: You also add a chart on commercial real estate credit derivatives which gives an indication of the risk inherent in commercial real estate, is this indicative of rising risk in that sector?

Charles: Right, this chart is credit derivatives and it’s a fairly high-risk series, its BBB not AAA, so this is the kind of credit derivatives that are sensitive to risk and interest rates. And there was a very steep decline, a spike down about a year ago, the first quarter of 2016 in these commercial real estate credit derivatives which showed that there was a heightened sense of “we better get out now” and limit our exposure to the credit derivatives on the commercial real estate sector. And it’s recovered, but it’s recovered to a lower high then it was. It was quite stable all the way through 2015. So this is telling us that the financial people that are exposed to the commercial real estate sector are starting to hedge their bets and starting to pull the trigger to minimize their exposure, which means they see a heightened risk.

Charles: This chart shows how much space employers now provide to each of their employees. And that number is plummeting from 2010 as businesses have to get more efficient, they need less office space. And if you combine that with flex work and working at home and teleconferencing its hard not to conclude that we as an economy are going to need less office space. And in the retail sector, the number of stores closing is at an all-time high, it’s far exceeded the 2008 financial crisis peak.

So what we’re seeing is a huge fleeing and closure of the retail sector, and a lot of subletting going on in the office space sector, so there are corporations and retail business which are shedding space because that space is no longer generating sales and profits.

If you would like to learn more about Charles Hugh Smith’s work, you can visit his website at http://www.oftwominds.com/ where you can look at his archives and read free samples of his books.

Summary written by Jake Dougherty<jdougherty@ryerson.ca>

LINK HERE to download the podcast in MP3 format

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

A must read to under how and why financial repression is happening .. 

“By using sub-zero interest rates to cut excessive debt, central banks are transferring wealth from savers to borrowers .. Sovereign debt can only be reduced through strong growth, inflation, a debt default or, in the case of foreign borrowings, currency devaluation .. Apart from growth, all the other strategies involve some amount of transfer of value from savers, either by way of a reduction in the nominal value returned or decreased purchasing power .. Negative rates point to the fact that the global economic system cannot generate sufficient income to service, let alone repay, current debt levels.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

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 11^th 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

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“In a detailed report by the IMF, their economists argue that the current trend is an offspring of the financial crisis. Slowing business investment/trade and an ongoing level of low to negative interest rates have resulted in a misallocation of capital to low risk projects and a slowdown in small business creation. Longer term secular demographic factors such as an aging population also play a significant part since older consumers consume less of almost everything except health care.

Equity markets are priced for too much hope, high yield bond markets for too much growth, and all asset prices elevated to artificial levels that only a model driven, historically biased investor would believe could lead to returns resembling the past six years, or the decades predating Lehman. High rates of growth, and the productivity that drives it, are likely distant memories from a bygone era.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

Mish Shedlock: “The rate hikes various Fed presidents think will happen are pure Fantasyland material. Huge equity and junk bond bubbles are in play. The Shiller 10-Year PE is 29.2. The only higher numbers were 1929 and the dot-com bubble in 2000. The bursting of these bubbles will be anything but an inflationary event. Those looking for a steeper yield curve, might get it, but not the way they expect. When recession does hit or the stock market collapses, the Fed will be cutting rates, not raising them.”

LINK HERE to the article

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

“In sum, we see a global expansion gathering strength and being liberally financed by politicians, politically influenced bankers and academics with little feel for reality. It is these academics who are now floating the idea of raising the inflation target to 4% from 2% on the pretext that it will be easier to achieve negative real rates without having to breach the zero-interestrate bound — the next time they are called on to save the world!

There is good reason to believe, then, that we are still early, that the bull is proceeding as it always has, confounding the great majority of experts, defying the well-armed but uncritical skeptics and taking its sweet time. So what is needed is patience (don’t switch lanes — you will always regret it), blindness and deafness (to experts’ concern about valuations, presumed political gridlock, Brexit, etc.) and discrimination (persist with active managers, for their time has come).”

LINK HERE to the latest Friedberg Quarterly Report

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.

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.

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.