Our Perspective.
“THE EXPERIENCE WHICH WE HAVE HAD OVER THE LAST FEW HUNDRED YEARS FURNISHES ALMOST CONCLUSIVE EVIDENCE THAT ALL THE GREAT INFLATIONS WHICH WE HAVE WITNESSED HAVE BEEN CAUSED BY A DELIBERATE POLICY ON THE PART OF GOVERNMENTS.” ~ Friedrich Hayek on inflation in his work “Money, Capital And Credit”.
Rather than asking the usual question, we thought we would this month introduce a concept that we define as the Fiscal Age: a period where fiscal dominance will replace the era of central bank control.
Following a decade of monetary experimentation, policy makers and central bankers are unlikely to return to the world of negative or zero interest rates policy (NIRP / ZIRP) any time soon. However, the era we entered during the pandemic carries significant implications for investors and society as a whole. It is specifically the misaligned incentives and resulting policies that poses the greatest risks, perhaps most notably to the income dependant majority.
For years, central banks held the reins, manipulating interest rates in an attempt to manage inflation and labour market dynamics. The effectiveness of interest rate policy, and central banks generally, to manage the prices of goods and services, not least to impact economic growth, are justifiably being questioned. If anything, we might say the law of ‘diminishing-effectiveness’ is evident. This, coupled with the growing misalignment between economic reality and political incentives, creates a perilous investment environment.
Economists whose economic philosophies are based on the Austrian School of Economics – which have nothing really to do with Austria – have long warned of the pitfalls of fiat money and excessive money printing. Von Mises, Hayek and others argued that such practices devalue the purchasing power of money and exacerbate the business cycle. In a world already grappling with asset bubbles and unsustainable debt levels, these warnings should resonate more than ever. The risk is that misaligned policy makers desperate for short-term growth, and government officials with populist policies in search for voter support, might further exacerbate existing trends, leading to a reacceleration in inflation and the erosion of purchasing power.
Another economic giant, Joseph Schumpeter, who coined the term and theory of creative destruction, also warned against government overreach. He argued that innovation disrupts existing industries, creating opportunities while causing temporary economic dislocation. While central banks may attempt to smooth these cycles, Schumpeter believed that creative destruction is vital for long-term growth. In a ZIRP and NIRP monetary regime, creative destruction falls by the wayside, providing a lifeline to zombie companies, in turn allowing inefficiencies to persist. In the fiscal age this characteristic will likely persist. Policymakers might be tempted to prop up failing industries, hindering this crucial process and stifling economic dynamism.
But why this misalignment? In a democratic governance regime, politicians facing sluggish growth and social pressures will prioritise short-term political gains over long-term economic health. Their objectives are to the get re-elected. They will do what they have to. It is human nature. This could lead to excessive spending, further inflating the debt burden, and rampant money printing to service it. The consequences of such misalignment are dire.
Ultimately fiat currencies will face the spectre of hyperinflation as governments resort to the printing press to finance their ambitions and fund burgeoning liabilities. This erodes the purchasing power of savings and might spark a flight from cash and a desperate search for alternative stores of value. Imagine a scenario where society lose trust in the value of our money – the Pound Sterling, the Euro or the US Dollar…supposedly stores of value – the very foundation of our financial system.
Investment strategies will need to adapt to this new reality. A new playbook is required. Commodities and real assets might offer some refuge, but government intervention, trade barriers and price controls could distort these markets. Active management and security selection will be paramount. Companies demonstrating strong fundamentals and pricing power positioned to weather the storm will no doubt benefit. Whilst industries reliant on cheap credit or government handouts could be vulnerable. The bond market is particularly exposed as investors are not protected against inflation, nor rewarded for the interest rate and credit risk they are taking. Gold on the other hand, will play the role it has for the last 5000 years: a hedge against political misalignment, social unrest and, if nothing else, a hedge against fiat devaluation.
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