As a follow up to our first piece on Monetary Regimes and Inflation, we thought we’d revisit an earlier post that outlined Niall Ferguson’s Five Steps to High Inflation. The Professor of History at Harvard University appears to agree with at least one of Bernholz’s conclusions. Professor Ferguson clarifies that, “Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon.”
And again, nearly a century before Ferguson reaches this conclusion, in 1919, the English economist John Maynard Keynes had theorized, in The Economic Consequences of the Peace that:
By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become ‘profiteers’, who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than of the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which from the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless . . .
We recently had the pleasure of listening to Ferguson present at the CFA Institute Annual Conference in Boston where we shared both investment ideas and lobster rolls with friends and colleagues from around the globe. My notes from Professor Ferguson’s presentation are outlined below, along with what looks like a similar presentation given to the Peterson Institute for International Economics in Washington DC.
Bottom Line: “It’s quite a short ride from here . . .
Niall Ferguson: Lessons & Legacies of the Financial Crisis
- Focus on Historical Understanding, not Mathematical Models
- Structural Deficit in Advanced Economies has been years in the making
- Financial History, in large measure, is a succession in sovereign debt crisis
- You’re fine . . . until you’re not fine
- When the market turns against you, and confidence evaporates, debt levels explode as interest costs spike higher
- Germans have a distinct memory of two hyperinflations
- PIGS R US
- UK and US in worse position than the PIGS on many fronts
- BIS projections are not encouraging
- Very little correlation between Debt/GDP ratios and bond spreads
- But, percent of revenues spent on interest payments is a highly correlated risk proxy
- Friedman said Inflation is always a monetary phenomenon.
- Sovereign Debt Crisis is always and everywhere a Political Phenomenon
- What Causes Crisis?
- Excessive Debt; Excessive Interest Payments
- Reliance on Foreign Capital
- Economic Weakness – declines in GDP, lower the denominator, increasing Debt/GDP
- Political Weakness – lack of leadership (see Europe)
- Irrational Exuberance – investors suffer from chronic amnesia; the history of sovereign debt crisis has a peculiar repetitive quality
- What are the Ways Out?
- Higher Growth
- Lower Interest Rates
- Fiscal Pain
- Default – including repudiation, standstill, moratorium, restructuring, rescheduling of interest or principal repayment, etc.
- Note the first three options are off the table, leaving the last three as the only feasible possibilities
- Rising Risk Premiums become a self-fulfilling process, so that leaves – Cut, Print or Default
- Cutters are few and far between – Britain, 1815-1914
- Printers – those states with monetary sovereignty and own-currency debt
- Defaulters – those states with limited monetary sovereignty and foreign-currency debt
- Risking real rates in a leveraged economy are a killer
- Crossover Moment
- Spending more on interest than defense
- Paying creditors more than soldiers
- Watch percent of voters receiving assistance
- Once over 50%, fiscal reform is impossible
- Europe is there; US is on its way
- Intelligent investors will shift from countries that are in this mess, to those who are not – Nordics? Canada?
- Gold is part of the answer; as are other commodities
- The End of the Strong Euro
- Costs of exit are too high for any one country to leave
- Can only stay in one piece if ECB prints
- No reason for Euro to even be at par in six to twelve months
- Greece will default; they’ll just call it something else (see above)
- No reason to postpone dealing with the problems; they will simply get worse
- We may be headed for a very different world where corporate balance sheets look much better than “AAA” rated sovereigns