Thursday, March 1, 2012

Tradewinds - David Iben’s January 2012 Commentary: Devo



It has been a strange evolutionary course from the early 1970’s Whip Inflation Now (WIN) campaign of President Ford and then Chairman or the Council of Economic Advisors, Alan Greenspan, to the current era where the very same Greenspan (who now claims to have always viewed the program as “unbelievably stupid”) and Ben Bernanke are well underway with what amounts to the “PIN" program: Print Inflation Now. While some may argue that recent Commentaries have over-emphasized this topic, I will suggest the opposite: it is impossible to over-emphasize the topic of money, especially in this age of Bernanke. So here we go again…..


But maybe it’s different this time and governments can be trusted (couldn’t even type that with a straight face). Let’s start our investigation of this thesis with a look back at the evolution of the attitude toward debt over time.

“I, however, place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared.”

“We must not let our rulers load us with perpetual debt.”

-Thomas Jefferson

“The consequences arising from the continual accumulation of public debts in other countries ought to admonish us to be careful to prevent their growth in our own.”

“There are two ways to conquer and enslave a country. One is by the sword. The other is by debt.”

-John Adams

“There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures”

-Warren G. Harding

“It is critically important that Congress act as soon as possible to raise the debt limit so that the full faith and credit of the United States is not called into question.”

-Timothy Geithner

So our government has gone from one instilled with a deep fear of debt to one that actually believes that the way to maintain credit worthiness is to take on more debt! Unbelievable!

Or maybe we can grow our way out of the mess? That would be nice, but consider QB Partner’s argument that the principal due on bonds outstanding is more than 25 times the cash available to pay them, and it is clear that a default of some type must happen. It is likely to take place in the form of eventual payment being made, but with currency of greatly diminished value. This repayment will not be of much consolation to the recipients.


Warren Buffett wrote an interesting article back in the late '70s suggesting that stocks are really quite bond-like, since over time the ROE (return-on-equity) gravitates to 12%, effectively making for a fixed return. This is an interesting concept worth paying attention to. Stocks could disappoint badly, especially given current lofty expectations. Equity-holders, of course, have the same problem of getting paid in a devalued currency. This is in addition to the age-old problem of uncertainty regarding any future receipts. On the surface, bonds are preferable, just as we’ve always been taught. Yet, it is also important to be cognizant of the differences between stocks and bonds that tip the scales in favor of stocks.

Stocks offer more than just the right to collect a payment of currency in the future. They offer ownership: ownership of land, buildings, trademarks, patents, goodwill, know-how, and future value creation. While the ROE may not rise with inflation, the E (shareholders’ equity) upon which the returns are generated should, in nominal terms, increase with inflation. The assets of the business can increase in nominal value and/or the nominal value of the services that a business provides can also increase. Therefore, investors are well-advised to forget about CAPM (Capital Asset Pricing Model) and momentum and risk-free rates and quarterly earnings estimates and relative performance and all the other ways in which they can “major in the minors,” and focus instead on owning businesses that can sustainably create value over the long term. We believe this should be done in a diversified portfolio of companies, across borders, in different currencies, and in many industries.