Are we witnessing the end of a mercantilist, Keynesian financial system? Gustave Flaubert said “The future is the worst thing about the present.”

1. Agcapita Update
January 2012

2. Agcapita Update
Are we witnessing the end of a mercantilist, Keynesian financial
system? Gustave Flaubert said “The future is the worst thing
about the present.” Gustave would have made a wonderful
central banker. Who can read this and not feel that it is an apt
description of the global financial situation? Despite all the high
level assurances that matters are improving who can’t help feel
that more bad news lurks in the future. The political and financial
classes are attempting to create a state of suspended animation
based on a dread of what the future surely holds for their deficit
& leverage heavy operating models. They seem to genuinely
believe that the problems can be indefinitely postponed by further
mercantilist, Keynesian debauchery in the form of even greater
deficits and deeper currency devaluations. If only all life’s problems
could be managed this way.
For those of you unfamiliar with the term - in its current application,
mercantilism is a policy of government intervention in foreign trade
to try to create a positive balance of payments most often via
currency devaluation. As for Keynesianism, at this stage in the
financial crisis I doubt the concept of government deficit spending
needs much introduction.
The tide has been going out for a few years now and we are
beginning to see who has been swimming naked - this hackneyed
phrase is a simpler way of saying that we are finally discovering
what themes, managers, and sectors were actually just providing
debt fueled beta while advertising alpha. The finance, insurance
& real estate economy ( “FIRE”) particularly real estate and most
of what passes for investing by the financial industry come to
mind immediately. In fact, a large part of the financial sector has
been engaged in a business model that I have heard described as
“picking up dimes in front of a moving steamroller. Leverage allows
you to pick up lots of dimes but eventually the steamroller flattens
you with ugly results for your investors.”
Instead of relying on privatized gain and socialized losses as a
modus operandi, I would encourage the FIRE economy to return
to more fundamental models - seek out value, try to invest with a
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3. Agcapita Update (continued)
linkage to sectors/markets with demonstrable growth interest on servicing their debt, let alone funding day-
prospects, and if possible incorporate some low to-day commitments.
cost inflation hedging as insurance against continued
central bank misbehavior. And therein lies the issue. Our commitments
are entering a high growth phase in the face of
Perhaps the reason for the foreboding in the west deteriorating demographics. The magnitude of
is that we are experiencing the simultaneous our impending entitlement costs are barely on the
denouement of three powerful trends - central radar. Layer on an absence of political support for
bank inflation/currency debasement activities, state a reduction in government spending and can some
sponsored mercantilism and demographic driven form of printing press default be far behind? Its
insolvency. certainly difficult to see how any combination of tax
increases, economic growth or marginal adjustments
As states strive to create or maintain current account to entitlements is going to close western funding
surpluses there is what amounts to a race to the gaps. The era of exponentially growing government
bottom in the currency markets. Unfortunately it is a borne by a linear productive economy is in the
truism that few people win in a currency war - other last gasps - the question is then how does it end?
than holders of real assets. Current indications are with a default by the printing
press to fund ballooning fiscal deficits.
State debt service as a percent of tax revenues is
already at high levels for most developed nations, yet If this is the case, and it looks increasingly likely, then
interest rates are at historic lows. As state finances the unvarnished truth is that we are living beyond
enter distress, they are forced to finance themselves our means and dishonestly passing the cost onto
at shorter durations creating roll-over risk. The future generations. On that note I will leave you with
combination of interest servicing issues and duration the words of Herbert Hoover who prophetically said
compression leaves them heavily exposed to even “Blessed are the young for they shall inherit the
modest increases in interest rates. When rates rise, national debt”.
state revenues will be rapidly consumed by just the
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