Sound Money

I recently read Austrian School for Investors by Rahim Tagizadegan, Ronald Stoferle, Mark Valek and Heinz Blasnik

I thoroughly enjoyed this practical application of Austrian Economics. It is written in such a way that a novice in this field could navigate his/her way through. That being said, the Austrian’s School’s departure from Monetarist and Keynesian economics is often shocking for a novice and I wouldn’t recommend this book unless the person in question is willing to challenge the economic status quo espoused in mainstream media and universities. The quality of the explanations and the relevance of the examples sparked a myriad of research ideas, investment strategies and bought to life many ground breaking economic concepts which lay dormant in my mind.

The authors clearly explain a number of the central tenants of the Austrian School including, history, philosophy, the monetary system, business cycles and constantly provide relevant real world examples. As with most texts in this school of thought, the commentary is more philosophical than a standard financial book but the writers display an extensive knowledge of the financial market specifics and the interaction between theory and the markets, which is often a missing link in Austrian texts. The portfolio implications are also very practical and implementable with many asset allocation ideas. I’ve outlined a few of the ideas that arisen on account of the book below. This doesn’t suggest that these were the central focus on the text. They are just the areas that resonated with me.

Monetary Tectonics: Opposing forces between inflation and deflation

This is an incredibly useful lens through which to view inflation. Often investors get caught up with moderate level of CPI inflation, which ignores all of the meaty inflationary dynamics taking place below the surface. It is critical for investors to understand the different definitions of inflation, ranging from a misleading simplistic view of consumer prices, to asset price inflation to actual monetary inflation. Myopic focus on CPI as the only version of inflation doesn’t allow analyst to truly understand monetary forces. The best example is the post Global Financial Crisis (GFC) monetary inflation that resulted in asset price inflation (equities and bonds) but not in consumer prices, which lead many mainstream analysts to believe that no inflation had taken place. I.E. Myopic focus on CPI disguised noteworthy asset price inflation and led mainstream analysts to believe that more monetary inflation was required.  The charts below show various versions of US inflation over the past 15 years (3-year % change in the various indices).

The authors provide a particularly good explanation of these factors and how the misunderstanding of the concept of inflation has led to a distortion of the perceived role of central banks. I love these quotes from the text: “As a result the central bank is magically transformed from the engine of inflation into an inflation fighter – the arsonist becomes an inflation fighter.”

In reference to repeated monetary reflation attempts by major central banks: ” just as an organism can die from regular overeating alternating with hunger, the real economy is damaged by this unsustainable monetary bulimia.”

The Structure of Production is deteriorating on account of credit expansion

The explanation of the Hayekian triangle and the structure of production was fantastic. Not only is the relationship between the monetary expansion cycle and inflation misunderstood but there are serious negative consequences of monetary expansion.  The illusion of savings, generated by monetary expansion, actually leads to capital consumption and therefore a deterioration of the production potential, reducing longer-term output. This resonates in the current world where the monetary domination of economic policy since the 1990’s has actually led to diminishing levels of aggregate productivity and output. In reference to using debt to consume in the present, Roland Baader says, “What we have eaten in advance in recent decades in the paper credit binge, we will starve for in the coming decades.”

This concept makes so much sense! Debt is merely a process of consuming the future in the present. Eventually we reach the future and we find that the capital has been consumed, leading to reduced economic potential.

Cantillon Effect: Credit expansion is driving inequality

Following on from this topic, an area that really hit home was the impact of credit expansion cycles on income inequality. As a South African, income inequality is a topic which has always interested me but it has become an increasingly important topic globally. The rise of left and right wing politicians in the developed world highlights that voters are disenfranchised. While the focal point of the discontent can vary widely I believe that the central cause of this social tension is a lack of economic and social mobility and that the deteriorating structure of production due to the monetary system is at the root. The Austrian School provides the clearest explanation of this relationship. It is an area of thought that needs to be bought to the forefront of economic debate going forward (Hernando de Soto writes a lot of this topic so I’ll have to get hold of a few of this books).

Summarizing the idea, Richard Cantillon (1680-1734) recognized that money is not neutral. Newly created money benefits those receive it first and disadvantages those that receive it last. By the time the credit expansion trickles down to the poor in the form of wages prices have usually adjusted and as a result real wealth is eroded. Modern day economies are reliant on credit expansion as the driver of economic growth rather than the more sustainable drivers like capital accumulation, investment and productivity. As a result the economic structure inherently benefits those with the first access to credit expansion at the expense of those with delayed access. Improving access to credit will not solve this problem because there are inherently certain sections of the population that will always have first access at the expensive of others.

Even in developed countries where poorer people have access to banks and credit, they will still experience the impact of the credit expansion after the traditional first receivers.

The idea that “access to credit” is the panacea for the poor in developing countries is dangerous. While access to credit, in my opinion, is not a bad thing, it is not the solution to inequality and might actually exacerbate it, if combined with monetary inflation, because there will always be others who get their hands on the wealth first. Moreover the first receivers often make better use of the new money due to their already existing capital stock, while later receivers usually have minimal capital to leverage.