The causes of economic events, as opposed to the often more head-line grabbing symptoms, are frequently overlooked by the mainstream financial media. So while recent public opinion has seen virtually a consensus of hostility towards the symptom of financial sector malfeasance, as yet there does not seem to be a coherent understanding about the cause of the financial crisis. The Occupy Wallstreet movement is an almost perfect example of this symptom/cause confusion.
I am glad that the brazenly kleptocratic behavior of politically favored financial institutions is receiving the criticism it deserves, but it is important not to let the prime culprits in the ongoing debacle slip away in the confusion.
At its core, the financial crisis results from the belief amongst the political class and their Keynesian apologists in tenured academia that exponential government can be supported by a linear productive economy.
What we are currently witnessing is the inevitable collision between the exponential government economy (debt/fiat driven) and its proxies in the Finance, Insurance & Real Estate sectors ("FIRE") and the linear, underlying capital/production-based economy. In the simplest terms the financial crisis is the direct result of:
- Capital destruction caused by growth in the size of government;
- Risk subsidies for the FIRE sectors; and
- Artificially low/negative real interest rates that have skewed western economies to consumption.
All this has taken place at the expense of the productive /capital based economy in the west. Remember - you cannot print capital; the real economy ultimately makes the rules.
The political class is all too happy to divert attention away from its pivotal role in the financial crisis. They are now falling over themselves to co-opt the legitimate anger at what can only be described as the wholesale looting of our economies by politically protected financial institutions. But we must never forget what came first. It was the actions of the political class with relentlessly expansionary fiscal and monetary policy in the form of ultra-low interest rates that provided the risk subsidy to the financial sector activities. A subsidy that certain participants from the financial sector exploited with ruthless diligence.
But stop and honestly ask if what has transpired would have taken place if the central banks had not slashed interest rates to historic lows following the 2001 dot-com crash (which provided the low cost fuel for an explosion in the financial sector's speculative activities) and central governments had not created mortgage markets consisting almost entirely of subsidized loan financing (which in the US in the form of Freddie and Fannie Mae provided the low cost fuel for an explosion in retail investors' speculative real estate activities). Absent these two government created drivers you would have had no financial crisis.
Given their culpability in providing both implicit and current explicit back-stops to this massive mal-investment in real estate and financial speculation, it is unseemly in the highest degree for the same politicians to be attempting to absolve themselves of any responsibility and make sure that if anyone is held accountable it is not them. We must never forget that it is the state created interest rate subsidies and financial guarantees that directly or indirectly created debts that do not have offsetting productive (cash producing) assets to service them. Debts with no offsetting assets is the dictionary definition of a crisis.
And so what of the future? Well first of all, I believe it is wishful thinking that volatility will subside to historic norms anytime soon. Volatility will persist as it results from the collision of two titanic and competing forces in the global economy - the liquidation of years of low interest rate fueled mal-investments versus continuing inflationary fiscal and monetary policy.
Sadly then, the financial crisis will not end until real interest rates are positive and back to historic norms, decades of mal-investments are liquidated and governments are spending within their means. Because of this I believe the key investment drivers to understand over next decade are very different from those that were in place in the last decade. For the foreseeable future I believe we will continue to see:
- Deteriorating finances of the public sector;
- Monetary authorities willing to fill the gap by printing money;
- Low real growth rates in the west; and
- High real growth rates in the emerging economies.
And so my investment beliefs remain:
- Underweight investments that rely on real growth in western markets to generate returns
- Overweight investments:
- that are directly exposed to emerging economy growth in politically stable parts of the world;
- that eliminate or reduce counter-party risk - e.g. farmland versus wheat futures;
- that hedge inflation; and
- whose products have inelastic demand curves.