The following is a transcript of a speech by Christopher Casey of WindRock Wealth Management to the Mises Institute’s 2016 Supporters Summit held on September 17th in Asheville, North Carolina.
In thinking about the title of this presentation, it occurred to me that some people may be uninterested. That is, attendees may feel they manage their own investments, and are therefore unthreatened by wealth managers ignorant of Austrian economics.
Fortunately, in the last several weeks, we have learned that a certain major bank has been kind enough to open multiple accounts for each and every person in this room.
So, it turns out you actually are at risk. We are living in a distinctive time period, which has introduced terms as unique as they are dangerous. Terms like negative interest rates, excess reserve balances, and quantitative easing.
I wish I could say we live in unparalleled times, and it is true that this economic situation is unique, but there are parallels in the magnitude of its gravity. Dates like 1928 and 2007 come to mind.
And no election will bring relief: we are faced with the choice between a man who frequently displays errors of judgement and a woman whose judgement is consistently in error.
I do not need to remind this audience of the worldwide economic situation that threatens the livelihoods of billions. But there is another danger lurking. One that threatens billions in savings. Actually, trillions. As Jeff Deist noted last night, the economics profession is broken. The same can be said for the wealth management industry. But while government officials, crony capitalists, and to a large degree, mainstream economists are motived by greed and power, the beliefs of wealth managers are driven by cowardice and ignorance. And this is evident from every phrase they utter.
The cowardice is evident from their 2009 chorus of “no one saw this coming” to their mantra of “you can’t time the market.”
The ignorance is apparent when they use phrases such as an “overheated economy.”
So, allow me to review some of the mistaken beliefs held by wealth managers, and how it impacts one’s portfolio.
First, price inflation. A word which used to be feared, but now is strangely welcomed by government officials.
Wealth managers speak of it even less than they understand it. They may have some vague understanding that it has something to do with the quantity of dollars which exist. They probably learned a phrase from a famous but flawed economist that:
“Inflation is always and everywhere a monetary phenomenon.”
But what does that really mean? It’s like saying ice and snow are always an everywhere a temperature phenomenon.
It doesn’t tell us much, because the statement’s truth is as selfWevident as it is incomplete.
Despite the massive increase in the money supply, wealth managers are unconcerned about inflation. They believe that, as long as wage and cost pressures are manageable, the economy will not “overheat.”
For the record, the ONLY thing on this earth less likely to become overheated than an economy . . . is someone trying to hide a serious illness while running for President.
If you ask a wealth manager what they mean by “overheating”, most cannot answer the question. Analogies are great to illustrate concepts, but this analogy has replaced the concept itself.
What they are trying to articulate is the classic theory of “demandWpull” inflation. It is the belief that until high employment levels and high factory utilization are achieved, prices will not rise.
Recessions and weak economic growth preclude inflation because aggregate demand, whatever that is, fails to increase substantially.
But apparently, no wealth manager lived through the 1970’s, because that’s exactly what we had.
They also do not fear inflation because commodity prices such as oil and agricultural products are low. In their paradigm, inflation occurs when costs rise and ultimately bubble up to consumer prices.
But if the price of oil or some other costWpush culprit rises, the buyers have less money to spend on other goods and services. Having less money to purchase something means less demand exists, and decreased demand reduces prices.
So, while some prices go up, it is at the expense of other prices which go down. Ultimately, no net effect to the overall price level.
We can see this with their false villain for the price inflation of the 1970’s: oil. The oil price increase in the 1970’s was certainly dramatic, but the price of oil has experienced equally pronounced changes in prices over the last decade or so as well.
Has the overall price level changed accordingly? Has the
U.S. economy experienced significant inflation and deflation as oil moved from $25 in April 2003 up to $133 in July 2008, down to $40 in December 2008, back up to $125 in March 2012, and down to less than $30 earlier this year?
Does anyone remember the price level gyrating like that over the last decade or so?
As if these misconceptions by wealth managers are not enough, they also do not believe we will have inflation as long as the “velocity” of money stays low.
I find this belief particularly odd. How can dollars independently create prices without the goods or services with which they transact?
The idea of velocity derives from an equation popularized in the early part of the 20th century by the economist Irving Fisher to explain the price level. But it originally derived from, of all people, Copernicus. However, while he was correct about that Sun thing, he was wrong about this.
The flaw is that velocity is not a proxy for the demand for money. If anything, maybe we can say it represents volume. And the volume of transactions has no bearing on prices. Strange that wealth managers do not apply their velocity theory to the stock market: they talk about weak or high volume, but no one says weak or high volume causes stock indices to move up or down.
Austrian economic theory proposes that money, like any other good, has a price set by supply and demand. So, any theory of a price level – which is another way of saying a theory of the value of money – which ignores demand is flawed.
If wealth managers really think low monetary velocity is keeping a lid on inflation, they will be surprised when inflation eventually skyrockets despite low velocity.
So not only do wealth managers fail to prepare portfolios for any possible inflation, but the concept of inflation is so alien to them, they neglect to convey its effects when determining investment returns.
Wealth managers are equally unable to explain recessions.
All of us are familiar with the basic outline of Austrian business cycle theory: artificial increases in the money supply lowers interest rates below their natural levels which induces economic actors to make malinvestments which are ultimately revealed in a recession.
A few wealth managers may subscribe to a Chicago school or Keynesian business cycle theory, but many believe recessions are natural outgrowths of the free market and are, in fact, unexplainable.
They cannot explain the widespread and severely erroneous judgment of businesses in forecasting the future as revealed in the “bust”.
They cannot explain why it is a cycle, and why this cycle first appeared in the 19th century.
They cannot explain why capital goods industries are more sensitive to booms and busts relative to consumer goods industries.
They cannot explain why significant money supply expansion precedes every single recession. But the wealth management industry’s ignorance about the causation of business cycles is surpassed by their misunderstanding of recession remedies.
As Austrians, we know one directive should be followed by policy makers in a recession: do not interfere with the economy’s adjustment process.
Do not prevent the liquidation of assets or companies with bailouts. Do not stimulate consumption and discourage savings through deficits and other means. And above all, do not inflate the money supply again which will only bring another recession in the future.
Because wealth managers do not have an adequate theory of what causes recessions, they applaud the standard recipe used to deal with economic downturns: big bailouts, huge deficits, and massive monetary expansion.
It is to the point now where they buy stocks and bonds solely in reaction to Federal Reserve action. Or better stated, inaction.
It is to the point now where the interpretation of Federal Reserve policy is as delicate and important a science as that of the Kremlinologists from days past.
Who is standing next to whom at the May Day parade has been replaced by which words have been added or deleted from the minutes of meetings.
Not only do the stock and bond markets move solely in relation to the Federal Reserve, but the Federal Reserve acts only in relation to the stock market. It’s like they’ve formed some sort of binary black hole system.
A key reason why wealth managers applaud dovish Federal Reserve comments and actions, and a key reason why the Federal Reserve acts as such, is the mistaken believe in the “wealth effect”.
They believe that by increasing wealth through rising stock and housing prices, the populace will increase their consumer spending which will spur economic growth.
Regardless as to whether or not increased wealth will actually spur increased consumer spending, the most important component of the wealth effect is the assumption that increased consumer spending stimulates economic growth.
It is a pure Keynesian concept and it is critical to the wealth effect’s validity. If increased consumer spending fails to stimulate the economy, the theory of the wealth effect fails. Wealth effect turns, in effect, into wealth defect.
Does increased consumer spending improve the economy? On one side of the argument, we have the aggregate individual conclusions of hundreds of millions of economic actors, each acting in their own best interest. These individuals and businesses are attempting to reduce consumer spending and increase savings.
Dissenting from their views is Board of Governors of the Federal Reserve. Each member appears to believe in the paradox of thrift – the belief that increased savings, while beneficial for any particular economic actor, have negative effects for the economy as a whole.
The paradox of thrift can essentially be described as this: decreased consumer spending lowers aggregate demand which reduces employment levels which negatively affects consumption which in turn lowers aggregate demand. The paradox predicts an economic death spiral from diminished demand.
But history suggests the opposite: it is higher savings rates which lead to economic prosperity. Examine any economic success story such modern China, 19th century America, or postWWorld War II Japan and South Korea: did their economic rise derive from unbridled consumption, or strict frugality?
The answer is selfWevident: it is the savings from the curtailment of consumption, combined with minimal government involvement in economic affairs, which generates economic growth.
So why do so many wealth managers and economists falsely believe in the paradox of thrift, and thus the wealth effect? It is because of their mistaken understanding of the nature of savings. They believe savings leak out of the economic system and are never spent.
But savings are indeed spent. Not directly by consumers on electronics and espressos, but indirectly by businesses via banks on more efficient machinery and capital expansions. Increased savings may (initially) negatively affect retail shops, but it benefits producers which create the goods demanded from the increased pool of savings. On the whole, the economy is more efficient and prosperous. So, to what investment advice do these economic fallacies lead? What errors are being inflicted upon one’s portfolio?
Without fear of either inflation or recessions, wealth managers have no understanding of interest rates, and thus see no danger in bonds.
It is somewhat understandable. Given the recent history of massive intervention in the bond markets by central banks, few remember that interest rates are ultimately a product of the free market.
At a fundamental level, interest rates reflect the time preferences of various actors within the economy. Add in assessments of credit risk as well as expectations of future price levels, and a structure of interest rates over various time frames is revealed.
All markets can be suppressed, distorted, or manipulated, but only for a limited time. The bond market is no different; whether through a sober assessment of credit worthiness by investors or via rising price inflation, the market will compel higher interest rates.
For this reason, the U.S. government has suppressed interest rates for years: it simply cannot afford for them to rise. It will continue to do so by remaining reliant (and increasingly so) upon the printing press to purchase bonds to lower rates. But this strategy will only work for so long.
In Human Action, Mises wrote:
Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract.
If the Federal Reserve continues with proliferate production runs of the printing presses, expect Mises to be prophetic: bondholders will be “repaid”, but with a currency which hardly meets the “terms of the contract.”
Wealth management’s enthusiasm for stocks and bonds is matched only by their hostility to such inflationary recession protections as precious metals, private lending, and certain types of real estate such as farmland and rental residential properties.
The hostility to gold can be seen by its widespread exclusion from recommend investment allocations. It can be seen by the fact that the value of all of the gold in the world ever mined is dwarfed by the national debt of the U.S. It can be seen by the fact the entire gold mining industry is easily dwarfed in value by a number of individual U.S. stocks.
The fact advisors ignore such major asset classes as farmland is a great example of the problems with the wealth management industry. For even if they heeded the dangers of inflation and recessions, they could not consider farmland within their portfolios.
The reason is that there are very few public farmland vehicles – Real Estate Investment Trusts – or REITs, in the
U.S. Accordingly, there are no investment benchmarks for farmland to be considered by wealth advisors (because the sample size is too small).
Therefore, wealth advisory firms will not consider an investment in farmland. Mind you, it’s not because the investment opportunity doesn’t exist, rather it is because wealth managers cannot be viewed as performing out of sync with commonly used real estate investment benchmarks. To do otherwise will entail risking their careers.
This is the real problem in the wealth advisory industry – advisors are worried about losing clients, not with losing clients’ money. Wealth advisors are happy tracking what everyone else is doing – because in so doing, they believe they are preventing their clients from switching to another firm. This “career risk” syndrome forces wealth advisors into shortWterm outlooks and a herdWlike mentality.
Wealth managers really manage money, not wealth. Wealth is beyond that of money and includes such things as health, judgement, and knowledge – basically everything that helps bring about our happiness.
But money is a critical component. It grants optionality and the means to make choices.
Mises understood this and embodied it in the concept of acting man – the motivation to increase one’s level of satisfaction.
The best way to maximize your satisfaction Wyour wealthW is to make sure your portfolio is guided by Austrian economic theory.
Christopher P. Casey 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 312O650O9602 or chris.casey@windrockwealth.com.
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