Descend the Austrian rabbit hole
Tim Price Mar 12, 2012
“Physician, heal thyself.” If you fancy a laugh, ask investment professionals what they’re doing with their own money. I first learnt this lesson when I went back to visit some former colleagues in a bond dealing room. The City tends to force people to specialise: you may start as a generalist bond salesman, but you will end up as a specialist in Brazilian corporate debt, or as a trader in three- to four-year German Bundesobligationen. (This is even more boring than it sounds.)
These former colleagues were credit specialists in whom I had absolute faith. But when it came to their stockmarket portfolios, their choices were frankly grotesque. The firm itself went on to specialise in being bailed out by the American government.
But if we’re talking investment ironies, perhaps the greatest of our time is that the most successful investor of the 20th century appears not to understand money. When Warren Buffett tipped opprobrium over the gold market last month, at a time when central-bank money-printing is off the charts, he earned the justified astonishment of Austrian school investors the world over. Banking archetype JP Morgan understood. “Gold is money,” he once said in testimony to the US Congress. “Everything else is credit.”
Morgan’s testimony dates back to 1912. The US Federal Reserve was established the following year. Of all the institutions that have contributed to the destruction of the concept of sound money, the Fed surely comes closest to the top. Since the Fed’s inception, the US dollar has lost around 98% of its purchasing power. If ‘store of value’ is a fundamental characteristic of money, paper currency is some way away from being good money.
Management consultant Andreas Acavalos has expressed the problem nicely. “The problem of economic calculation under a fiat monetary regime,” he says, “is fundamentally insoluble. It cannot be solved for exactly the same reason that you cannot solve the problem of ‘measuring’ a length of cloth with an elastic tape measure. The only ‘solution’ is to throw away the elastic and use a yardstick that cannot be stretched at will.”
The elastic tape measure, of course, is any paper currency – the US dollar, sterling, the beleaguered euro. So the gold sceptics have the situation entirely the wrong way around. A behavioural economist would say that they are suffering from a massive framing bias.
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The question they should be asking is not what gold ought to be worth in dollars, but what the value of the dollar can possibly be when it has no backing other than a subjective faith in the American political system. What is any currency worth if a few extra billion or trillion (the numbers by now are largely meaningless) can be conjured into being at negligible cost by desperate central banks hoping to keep a fundamentally flawed banking system afloat?
Coming to terms with the flaws inherent in what we call ‘money’ leads to some strange effects. My colleague Killian Connolly has described discovering and then appreciating the logic of the Austrian economic school – which stresses the importance of sound money – as like falling down the rabbit hole. Once you have experienced it, there is no going back to business (or investing) as usual.
One of the most impressive fund managers I know describes the mandate of his fund as “focusing on the preservation of wealth against the erosion of the purchasing power of money”. He has also chosen to descend down the Austrian rabbit hole – and like the Red Queen in Lewis Carroll’s Through The Looking Glass, and like any investor today trying to protect their capital from the fraudulent manipulations of governments and central banks, he finds himself having to run twice as fast just to stay still.
Lest you think this is the embittered tirade of a singular misanthrope, take a look at what David Stockman, the former White House budget director, said last week in an interview with the Associated Press: “Here’s the heart of the matter. The Fed is a patsy. It is a pathetic dependent of the big Wall Street banks, traders and hedge funds. Everything [it does] is designed to keep this rickety structure from unwinding.”
When asked if we face a financial crisis like the collapse of Lehman Brothers, Stockman’s response: “Oh, far worse... When the real margin call in the great beyond arrives, the carnage will be unimaginable. Capital preservation is what your first, second and third priority ought to be in a system that is so jerry-built, so fragile, so exposed to major breakdown... We have to eat our broccoli for a good period of time.”
Living down a rabbit hole and having to second guess every aspect of what passes for our monetary system admittedly isn’t a bundle of laughs. But it has to beat the alternative. The good news is that the rabbit hole is getting slowly more populous by the day.
• Tim Price is director of investment at PFP Wealth Management. He also writes
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