Petrocapita January 2012 Briefing - Trees, Meet the Forest


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

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Petrocapita January 2012 Briefing - Trees, Meet the Forest

  1. 1. Petrocapita UpdateJanuary 2012
  2. 2. Petrocapita UpdateAre we witnessing the end of a mercantilist, Keynesian financialsystem? Gustave Flaubert said “The future is the worst thingabout the present.” Gustave would have made a wonderfulcentral banker. Who can read this and not feel that it is an aptdescription of the global financial situation? Despite all the highlevel assurances that matters are improving who can’t help feelthat more bad news lurks in the future. The political and financialclasses are attempting to create a state of suspended animationbased on a dread of what the future surely holds for their deficit& leverage heavy operating models. They seem to genuinelybelieve that the problems can be indefinitely postponed by furthermercantilist, Keynesian debauchery in the form of even greaterdeficits and deeper currency devaluations. If only all life’s problemscould 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 tradeto try to create a positive balance of payments most often viacurrency devaluation. As for Keynesianism, at this stage in thefinancial crisis I doubt the concept of government deficit spendingneeds much introduction.The tide has been going out for a few years now and we arebeginning to see who has been swimming naked - this hackneyedphrase is a simpler way of saying that we are finally discoveringwhat themes, managers, and sectors were actually just providingdebt fueled beta while advertising alpha. The finance, insurance& real estate economy ( “FIRE”) particularly real estate and mostof what passes for investing by the financial industry come tomind immediately. In fact, a large part of the financial sector hasbeen engaged in a business model that I have heard described as“picking up dimes in front of a moving steamroller. Leverage allowsyou to pick up lots of dimes but eventually the steamroller flattensyou with ugly results for your investors.”Instead of relying on privatized gain and socialized losses as amodus operandi, I would encourage the FIRE economy to returnto more fundamental models - seek out value, try to invest with a 1
  3. 3. Petrocapita 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 continuedcentral bank misbehavior. And therein lies the issue. Our commitments are entering a high growth phase in the face ofPerhaps the reason for the foreboding in the west deteriorating demographics. The magnitude ofis that we are experiencing the simultaneous our impending entitlement costs are barely on thedenouement of three powerful trends - central radar. Layer on an absence of political support forbank inflation/currency debasement activities, state a reduction in government spending and can somesponsored mercantilism and demographic driven form of printing press default be far behind? Itsinsolvency. certainly difficult to see how any combination of tax increases, economic growth or marginal adjustmentsAs states strive to create or maintain current account to entitlements is going to close western fundingsurpluses there is what amounts to a race to the gaps. The era of exponentially growing governmentbottom in the currency markets. Unfortunately it is a borne by a linear productive economy is in thetruism 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 isalready at high levels for most developed nations, yet If this is the case, and it looks increasingly likely, theninterest rates are at historic lows. As state finances the unvarnished truth is that we are living beyondenter distress, they are forced to finance themselves our means and dishonestly passing the cost ontoat shorter durations creating roll-over risk. The future generations. On that note I will leave you withcombination of interest servicing issues and duration the words of Herbert Hoover who prophetically saidcompression leaves them heavily exposed to even “Blessed are the young for they shall inherit themodest increases in interest rates. When rates rise, national debt”.state revenues will be rapidly consumed by just the 2
  4. 4. DISCLAIMER: The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Petrocapita Income Trust (“PETROCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither PETROCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to PETROCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting PETROCAPITA or its relevant affiliate directly.#205, 120 Country Hills Landing NW Tel: +1.403.218.6506 www.petrocapita.comCalgary, AB T3K 5P3 Fax: +1.403.648.2776Canada