Extreme Monetary Policy
CantillonObserver: Since the financial crisis broke in 2008, central banks have subsequently embarked upon repeated programmes of unprecedented quantitative easing, coupled with “financial repression”. All of this, ostensibly, to stimulate economic growth. Ronnie, what is your assessment of the success of these policies (Fed Reserve, ECB, BoJ, BoE,PBoC) ? Do you believe that these Central Banks can ‘unwind’ their massively inflated balance sheets without causing great risks and volatility in financial markets ?
Short answer: No
Longer answer: My countryman Friedrich August von Hayek once said that “If a policy is pursued over a long period which postpones and delays necessary movements, the result must be that what ought to have been a gradual process of change becomes in the end a problem of the necessity of mass transfers within a short period”. This basically says it all.
It is very sad that nowadays, the main factor influencing financial markets seems to be the anticipation of central bank actions. Market participants are conditioned to monetary stimuli like Pavlov’s dog! Historical market patterns have been radically altered over the recent years. Since 2009 the Fed has reacted to every economic slowdown by introducing fresh easing measures. As a result, we can observe the following paradoxical situation now: disappointing macroeconomic data lead to price increases in stocks, as a continuation of QE is priced in. Better than expected macroeconomic data on the other hand lead most of the time to price declines, as a reduction of future QE is anticipated.
Based on my observations in the last few years, I expect that financial repression in all its ugly facets is going to gain more and more in importance over the coming years. I regard this as a terrible long term strategy, as it will only achieve redistribution and a delay, but no solution to the problem. We already see that the whole “stimulus bubble” does not produce significant effects anymore, as we are experiencing declining marginal utility of additional debt.
CantillonObserver: Would you agree that the main, unspoken, reasons for central bank money printing are to fund government budget deficits and also keep afloat insolvent banks by buying up their loss-making mortgage securities and sovereign bonds ?
Yes, but as students of Austrian Economics we try to analyse the root of our current problems. I am firmly convinced that the origin of today’s debt/financial/systemic/political crisis can be traced back to the events of August 15, 1971, when Richard Nixon ended the Bretton Woods agreement with the words “Your dollar will be worth just as much tomorrow as it is today. The effect of this action is to stabilize the dollar” Since then the purchasing power of the dollar in terms of gold has declined from 0.75 grams per dollar to currently 23 milligrams.
We explained this interplay between inflation and deflation in our last Chartbook “Monetary Tectonics”: As Austrians we know that the natural market adjustment process of the current crisis would be highly deflationary. As the financial sector in most parts of the world reversed its preceding credit expansion, overall credit supply is reduced significantly. The reason for this lies within the fractional reserve banking system, as the largest part of money in circulation is created by credit within the commercial banking sector. The much smaller portion is created by central banks.
In a highly leveraged world like today, price deflation is – from a political viewpoint – a horror scenario that has to be averted whatever it takes, due to the following reasons:
- Deleveraging leads to consumer price deflation and asset price deflation. Tax revenue declines significantly. Asset price inflation is taxed, asset price deflation cannot be.
- Falling prices result in real appreciation of nominal denominated debt. Increasing amounts of debt can therefore no longer be serviced.
- Debt liquidation and price deflation have fatal consequences for large parts of the banking system, in an over-indebted world.
- Central banks also have the mandate to guarantee ‘financial market stability’ so they have to make sure “It” doesn’t happen here and keep inflating
Therefore this (credit) deflation, respectively deleveraging, is currently compensated by very expansionary central bank policies. In my opinion, this is an extremely delicate balancing act that will ultimately fail.
Future of Fiat Money
CantillonObserver: Ronnie the prime theorist of Austrian economics, Ludwig von Mises, applied the term “fiat money” to paper money that is irredeemable in commodity money and “backed” only by a government monopoly on currency issuance. He consistently attacked fiat money for being subject to the whims and manipulation of politics and politicians. If von Mises were alive today, what do you think he would be saying and doing about the policies of the central banks ?
I think Mises would be very, very concerned. As he famously said “Continued inflation inevitably leads to catastrophe”. Another one of my favourite quotes is: “Inflation and credit expansion, the preferred methods of present day government openhandedness, do not add anything to the amount of resources available. They make some people more prosperous, but only to the extent that they make others poorer.”… This is what we are seeing at the moment and I am absolutely certain that it will end in tears.
CantillonObserver: At Incrementum you are very fortunate to have on your Board of Management the well known author of “Currency Wars”, Mr. Jim Rickards. He has recently written another book in which he takes his arguments to the next stage. He says that the current world monetary system of fiat monies is in the process of breaking down. It will be terminal and require introduction of a newly-designed global monetary system. What are your thoughts on his views ? Especially the possibility that such a new system might bring back some role for gold ? Also, is the US dollar doomed as a reserve currency ?
We are really delighted to have Jim Rickards on our advisory board. He’s a very smart, modest and likeable gentlemen and I really enjoy discussing investment ideas with him. Moreover, I am really looking forward to reading his new book “The death of money”.
I am absolutely certain, that the renaissance of gold in classical finance will continue. Last year, OMFIF, a global think tank for central banks and sovereign wealth funds, in a report argued in favour of a remonetisation of gold. In their view, gold should once again play a central role in the international currency system. It’s a really fascinating piece and shows strikingly that fundamental changes to the currency system are already being discussed at the highest levels.
There are many other interesting developments going on. In a study commissioned by the European parliament, author Ansgar Belke came to the conclusion that gold-backed bonds would be far more transparent, attractive for investors than government purchasing programs. According to Belke, gold-backed bonds would alleviate the sovereign debt crisis at least in the short term, as it should lower financing costs and restore the damaged confidence.
Regarding the US dollar, global confidence for it as reserve currency has definitely started to wane. Without a return to sound financial and monetary policy the US dollar sooner or later will be questioned sooner or later.
Therefore I believe that gold should continue to be an integral part of every investment portfolio, as it is the only liquid investment asset that neither involves a liability nor a creditor relationship. It is the only international means of payment independent of governments, and has survived every war and national bankruptcy. I truly believe that it’s monetary importance, which has established and manifested itself in the course of the past several centuries, is in the process of being rediscovered.
OMFIF is the Official Monetary and Financial Institutions Forum
Part III of this interview will be published soon. Part I is published below
Interview Part I
We are delighted to welcome our first Guest Interviewee at theCantillonObserver.com, Ronnie Stoeferle. Ronnie has a professional background in research (gold, silver, energy) and banking.
Last June, he became a founding partner of Incrementum AG., a wealth management firm domiciled in Leichtenstein. The company has a unique and innovative investment framework anchored in a deep understanding of Austrian economics. All the Incrementum partners and managers are “Austrian” economists/asset managers. The fund that they are currently launching will invest in different asset classes based upon their careful monitoring of inflationary and deflationary tendencies in the global economy; tendencies aggravated by the extreme monetary policies of the worlds’ central banks.
CantillonObserver: Ronnie welcome and thanks for agreeing to come and talk to us. These must be exciting times. You have a start up firm, Incrementum AG, to nurture and grow. Can you tell us about the challenges and opportunities you see as an entrepreneur in the wealth management industry in these difficult times ?
Well, when I quitted my job at Erste Group a colleague told me “starting up a financial services company these days is like opening an ice cream parlour in November”. I agreed but said that spring will come every year and that you just have to offer exceptionally delicious ice cream and will create demand (referring to Say’s Law)…
However, you have to be extremely confident (or crazy) to start up a company in the financial services industry these days. The whole industry is highly regulated and the administrative barriers are plenty. On the other hand this also restricts competition and creates plenty of opportunities.
But to put it in a nutshell, after more than one year, I am very excited that Incrementum AG is doing so well.
CantillonObserver: Very interesting. Can you tell us a bit more about you and your partners approach and what differentiates you from mainstream asset managers?
Ronnie Stoeferle: Sure. Incrementum is an owner-managed asset manager & wealth manager based in the Principality of Liechtenstein. At the moment, we are 7 partners from Switzerland, Austria and Germany. Our partners practice what they preach – all our partners are invested in the funds they manage. This creates alignment of interest between our investors and us.
All of us sincerely believe, that the traditional way of thinking about financial markets and asset management is no longer beneficial for investors.
On our webpage we state “Ex scientia pecuniae libertas – Out of knowledge of money comes freedom.’” What we want to express thereby is, that we evaluate all our investments not only in perspective of the global economy but especially in the context of the current state of the global monetary regime. This produces what we consider a truly holistic view of the state of financial markets.
As we know, over the longest periods of human history precious metals were used as money. Since over 40 years we are once again experiencing an exception to this rule. Nowadays money derives its value solely from government regulation or by law (‘fiat money’). Beginning in 2007, the current global financial system has entered an increasingly unstable stage, which from our point of view exhibits extreme risks and on the other hand exceptional opportunities for financial wealth.
CantillonObserver: Ronni you are actually from Austria but also a keen follower of the Austrian School. Can you tell me a bit more about your view on Austrian Investing?
Ronnie Stoeferle: Definitely. At Incrementum, we believe that only the Austrian School of Economics is able to provide us with the appropriate intellectual foundation in this world of monetary and political excess and insanity. Austrian thinking offers exceptional understanding and superior interpretation of the interdependencies between money supply and price inflation. This knowledge is valuable especially nowadays, as central bank policies massively distort and influence financial markets.
We all know that followers of the Austrian School have been extremely successful at anticipating major economic events like the Great Depression, the stagflationary environment of the 1970s, the Dotcom Bubble and the Housing Bubble. However, timing has often been too early as many Austrians often tend to be very pessimistic and dogmatic. Therefore we are trying to combine Austrian macro views with technical (sentiment, market structure) and quantitative timing-models as well as pre-defined market triggers.
CantillonObserver: Your investment management strategy is built upon your understanding of Austrian economics. What was your own personal journey of discovery into Austrian economics ? What got you started and why are you today a committed supporter of Austrian economic theories ?
I started writing about gold in 2006. My annual “In Gold We Trust” reports over the years became bigger and hopefully better. The Wall Street Journal once refered to it as the gold standard of gold research, which is obviously a flattering term for a gold report. However, at the beginning of my research work on gold, I only analysed the supply demand situation. As I am an avid reader, I started to read everything I could get my hands on about gold. Then somebody once mentioned “The Austrians” and quoted Ludwig von Mises: “If it were possible to calculate the future state of the market, the future would not be uncertain. There would be neither entrepreneurial loss nor profit. What people expect from the economists is beyond the power of any mortal man.” (from Human Action). This quote made me think a lot and it completely changed my view about my profession as an analyst.
CantillonObserver: I have heard that you are very active in promoting Austrian ideas and “spreading the word”. What are you doing to educate your fellowmen about the Austrian tradition?
Ronnie Stoeferle: I really enjoy writing and holding presentations about my views on the markets and our monetary system. My partner Mark Valek as well as Rahim Taghizadegan – the founder of the Institute for value-based economics – and I will be publishing a book on Austrian Investing in June. Moreover we are holding seminars about Austrian Investing and we are trying to educate students and pupils about Austrian ideas. If Incrementum will continue to prosper, we would love to finance a foundation to fund a professorship for Austrian Economics here in Vienna.
In the second part of the interview, we will be discussing monetary policy, the future of fiat money and an Austrian Investment Strategy at the end of a Longwave