AgcapitaFebruary 6, 2012Briefing

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NEXT TIME PERHAPS WE SHOULD LET THE MARKET SET INTEREST RATES

I thought perhaps I would indulge in a little gallows humor at the “sudden” discovery of the insolvency of western nations - after all it’s a theme on which my partners and I have been focused for some time and there is only so long one can remain on high alert about the future without trying to have some fun at its expense. It has been quipped that history might not repeat but it certainly rhymes. Who can read the following quote from Andrew White recounting the hyperinflation of the French assignat in the eighteenth century and not see some striking similarity to current events? “The first result of this issue was apparently all that the most sanguine could desire: the treasury was at once greatly relieved; a portion of the public debt was paid; creditors were encouraged; credit revived; ordinary expenses were met, and, a considerable part of this paper money having thus been passed from the government into the hands of the people, trade increased and all difficulties seem to vanish. The anxieties of Necker, the prophecies of Maury and Cazales seemed proven utterly futile. And, indeed, it is quite possible that, if the national authorities had stopped with this issue, few of the financial evils which afterwards arose would have been severely felt; the four hundred millions of paper money then issued would have simply discharged the function of a similar amount of specie. But soon there came another result: times grew less easy; by the end of September, within five months after the issue of four hundred millions in assignats, the government had spent them and was again in distress. The old remedy immediately and naturally recurred to the minds of men. Throughout the country began a cry for another issue of paper; thoughtful men then began to recall what their fathers had told them about the seductive path of paper-money issues in John Law’s time, and to remember the prophecies that they themselves had heard in the debate on the first issue of assignats less than six months before...”

Agcapita Briefing

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Agcapita Briefing (continued)

Obviously, Mr White’s quote is unlikely to be anyone’s idea of humor but permit me to add the laugh track so to speak. For those of you unfamiliar with the assignat or for that matter Europe’s track record with fiat inflations, France and Germany alone have had 4 noteworthy and complete fiat currency failures (and counting?): 1) France 1716: John Law introduced paper money

to France in the form of livres. Louis XV required that all taxes be paid in livres. Ostensibly, the currency was backed by coinage. However, the new paper currency was rapidly inflated until nobody wished to hold worthless paper and demanded the coinage. After making it illegal to export any gold or silver, and the failed attempts by the locals to exchange their paper currency for something of actual value, the currency collapsed.

2) France 1791: In the latter part of the 18th century, the French government tried fiat currency again - called “assignats”. By 1795, inflation of assignats was running at approximately 13,000% per annum.

3) France 1930s: In the 1930s, the French government took over the Bank of France and introduced the paper “franc”. It took only 12 years for them to inflate their currency until it lost 99% of its value.

4) Germany: Post-World War I Weimar Germany is one of the most well known episodes of hyperinflation in history. The Treaty of Versailles imposed heavy reparations on Germany. The German government took the expedient of printing the money to make the repayments. Inflation was so high that it was cost effective to burn marks to heat your home. Here is a brief timeline of the Mark/U.S. dollar exchange rate at 2 year intervals: April 1919: 12 marks, November

1921: 263 marks, December 1923: 4.2 trillion marks.

And yet they keep on trying. Full marks for determination. Though given the asymmetrical distribution of the benefits and the costs perhaps there is something more sinister than meets the eye in their dogged Keynesian devotion to nominal GDP growth. Cui bono anyone? In any event, their perseverance has finally borne fruit as European politicians can now proudly claim to have discovered the holy grail of economics in the form of a perpetual motion machine whereby bankrupt nations bail out other bankrupt nations and so on. Why didn’t someone think of this sooner? Sadly you and I don’t live in the nominal GDP world inhabited by politicians, central bankers and celebrity Keynesian economists. We live in the much more demanding real GDP world - you know the one with cash-flow, assets, liabilities, products, customers and all those other bothersome details. But you say, surely we must expand the money supply to lower interest rates, to stimulate demand, to save the economy. Perhaps it’s a case of “financial crisis attenuation sickness” but I feel compelled to rely on the wisdom of others to make my points this week. Let’s reflect on the thoughts of Jean-Baptiste Say on consumption: “The encouragement of mere consumption is no benefit to commerce because the difficulty lies in supplying the means, not in stimulating the desire for consumption; and production alone furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.”

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Agcapita Briefing (continued)

How comic and also convenient that the political class and their Keynesian court advisors have been obsessed with the wrong part of the economy for almost 40 years. Unlimited, deficit driven consumption is only possible, granted sometimes for an intoxicatingly long period of time, via the illusion of wealth created by an ever-expanding fiat currency. It does not, however, create long lasting prosperity as ultimately becomes apparent. Just how bad are our problems? Difficult to quantify in the limited space available here, so permit me to fall back on another quote, this time from the venerable Ludvig von Mises. Though 60 years old it seems almost purpose written for today. “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” For once I hope Mises is wrong. Regardless, let’s not tell the Germans shall we, as Greece is still hoping to collect a $150 billion donation or are we still calling them loans? As much fun as it is to mock hapless politicians and central bankers I do want to talk about something important if still somewhat removed from this stage of the financial crisis - the conclusion. More specifically what form the conclusion is going to take. The issue

comes down to how complex systems correct where risk and failure have been allowed to accumulate almost indefinitely through bail-outs? Do they go through a gradual purging of mistakes? Or do they collapse? These are not trivial questions as they bear directly on how we as investors conduct ourselves over the next decade. I tend to err on the side of the sudden discontinuous events model but we shall see. In supposedly free market economies why is the cost of one of the most important commodities set by government agencies - the commodity being interest rates on money and the agencies being central banks? Can that give anyone comfort given government track records in administering even simple tasks let alone controlling the yardstick by which all economic activity is measured? I do not mean to make an ideological observation here, just a mathematical one. The track records of the so-called right and left are equally uninspiring in their respective areas of focus. I digressed. Unless market forces are allowed to re-assert themselves in the interest rate markets, our governments and their proxies in the banking sector will continue to lurch from one crisis to another, each progressively larger and more unexpected (at least by the Keynesian powers that be). More alarmingly is that the solution will continue to be massive bail-outs in the form of the purloined savings of millions of innocent and long-suffering taxpayers. Savings that the same taxpayers need desperately to fund their dwindling prospects of retirement.

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