Integrating Assorted Convictions from the Inflation & Deflation ‘Camps’ – The ‘Scarcity of Capital’ Trade
The investment community at large has become strangely polarized into the ‘inflation camp’ and the ‘deflation camp’. The protagonists of these two – mutually antagonistic – groups are occasionally dogmatic in their convictions; a trait that we ought to avoid as contrarian investors. Seemingly, if you’re – say – long commodities, you’re assumed to have adopted the prejudices of the ‘inflation people’. Likewise, if you’re – say – long government bonds, you’re assumed to share the ideas of the deflationists.
Does it have to be like this? Does one have to choose to be an orthodox inflationist or an orthodox deflationist?
My opinion is that one doesn’t have to choose to belong to either group, and that one never had to choose. In fact – with the premise that large groups of similarly minded speculators never make serious money - I contend that it pays not to join a definite ‘camp’ in this debate. A passage from Humphrey B. Neill’s book, The Art of Contrary Thinking, comes to mind:
It is a simple matter to be dogmatic and definite when one is writing on a given economic subject or trend. A commentator can pick up a collection of comments from economists and analysts, jot down the composite conclusions expressed, and then write out a blunt “opinion”.
However, there is a serious drawback to being dogmatic in economic comments. Rather, there are two drawbacks to be considered:
- More often than not, a given economic trend may be unpredictable at the time of writing about it. Therefore, a definite or dogmatic statement is merely a guess expressed as if it were knowledge.
- Moreover, when definite statements become generalized they are likely to “defeat themselves.”
It is common to bemoan the confused state of affairs, when we’re trying to arrive at decisions. Quite often, however, we use the confusion as an excuse for not thinking.
I, contrarily, believe there is value in bewilderment.
Consider the opposite of uncertainty and confusion; namely, dogmatism. I dare to say that more important errors in decisions arise from dogmatic opinions than from what I shall call “confused considerations.”
For a fantastic example of a speculator who was flexible in thought and execution; see my article on Jacob Michael (he made a great proportion of his fortune by betting on a ‘scarcity of capital’ near the end of the hyperinflation of the Weimar Republic.)
The Bane of Our Existence: Wasted Capital
On an aggregated basis, the world has a finite amount of valuable stuff. This stuff has been accumulated by centuries of hard work, innovation, greatness and abstinence. The essence of our time is that an increasing proportion of the (developed) world’s capital is being controlled by (demonstrably) incompetent people. Such people draw upon existing wealth rather than create it. [Note: it is demonstrable by the prevalence of laws in favor of certain institutions, bailouts, etc.]
To be sure, I’m not explicitly saying that the economy as a whole is shrinking or whatnot. Rather, I’m saying that an increasingly large proportion of our precious capital is in the wrong hands. The creation and innovation elsewhere may entail net progress, I don’t know.
However, I can say something about a world where capital is continuously being burned, and people don’t realise it. If people opt for life and progress over death and decay, the future will eventually contain some kind of discovery that capital is considerably more scarce than previously thought.
Integrating the good parts of the Inflation & Deflation Sides:
The way I reconcile the great insights of the inflation/deflation debate is to note that – regardless of the particular manifestation – it is likely that the current policies of rewarding incompetence and punishing prudence will lead to a scarcity of capital.
If this is true, then – regardless of one’s particular investment bias towards inflation or deflation – one should exclusively own concrete forms of capital. In a world where it comes to be realized that – collectively – we’re not as rich as we thought, it should be clear that owning and keeping valuable wealth will be profitable (one would own something that everybody suddenly and desperately wants). Indeed, if the above is true, then one should avoid investments that are predicated on the status quo remaining in place. For the inflationists, this would include avoiding very conventional developed-market equities. Likewise, for the deflationists, this would include avoiding stuff that we call ‘cash’ that is really some kind of IOU; e.g. MMMFs , developed-market bank accounts (bar Swiss) and so on.
We should avoid thinking in the same way as large groups of people; regardless of the comfort of doing so. A neat way to reconcile the insights of both sides of the inflation/deflation debate is to note that they both describe manifestations of a scarcity of capital. Thus, regardless of our short-term bias towards inflation or deflation, we should seek to own concrete forms of capital and seek to avoid (and/or speculate against) assets that are predicated on a goldilocks economy.