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Agcapita August 2011


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Since the downgrade of the US does not come as a surprise to adherents of the Austrian School of Economics let's discuss something else. Agcapita is Canada's only RRSP and TFSA eligible farmland fund and is part of a family of funds with over $100 million in assets under management. Agcapita believes farmland is a safe investment, that supply is shrinking and that unprecedented demand for "food, feed and fuel" will continue to move crop prices higher over the long-term. Agcapita created the Farmland Investment Partnership to allow investors to add professionally managed farmland to their portfolios.

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Agcapita August 2011

  1. 1. Agcapita UpdateAugust 2011
  2. 2. Agcapita UpdateSince the downgrade of the US does not come asa surprise to adherents of the Austrian School ofEconomics and the unraveling of government financeshas been a cornerstone in my investment philosophyfor many years now, I don’t want to bore you with anextended bout of hand wringing and soul searchingabout Standard & Poor’s sudden revelation that theUS actually might be a deteriorating credit risk. Letsstep back and focus instead on the process in totality.Sovereign borrowers have gone through a two-decadeperiod of having almost no restraint on their ability to rundeficits and borrow to fill the gap. That is now endingand so going on the safe assumption that the politicalclass will not change it spots and that deficits willcontinue - how can we expect the gap to be filled in thefuture?I’d like exercise an author’s holiday prerogative andplagiarize briefly from my April 2010 letter. According toKenneth Rogoff’s research in the three years followinga financial crisis, on average, cumulative fiscal deficitsalmost double. We seem to be well along this path inthe current crisis. Rogoff also shows that how thesedeficits are financed is critical to the question of whetherinflation ensues, whether you have a Japanese or anArgentinean style post-crisis experience. If the deficitsare funded from existing private sector savings (“belt-tightening” as Rogoff describes it) they are typically notinflationary - e.g. Japan. If they are monetized by thecentral bank (the money is created) they are inflationary -e.g. Argentina.Today, in one corner, we have the wholesale liquidationof mal-investments that have accumulated in virtuallyevery segment of the western economies fromresidential and commercial real estate down to themunicipal bond markets. In the other corner, we have 1
  3. 3. Agcapita Update (continued)governments that continue to resist this cleansing A large government debt issue simply could notprocess as it threatens the politically influential be marketed without a large increase in the moneyfinancial sector. The result is that via bailouts and supply. Therefore the government creates not onlyunprecedented fiscal deficits private sector credit the debt but also the money with which to buy it.problems are being moved onto public sector In addition, large government deficit expenditurebalance sheets - balance sheets that are already in tends to accelerate the velocity of money becauseprecarious condition from past over-spending and the government spends its money more rapidly thanunfunded future liabilities. cautious private spenders do. This combination of increased quantity and velocity of money, not theBy nationalizing private sector losses governments deficits, does the job, both for economic stimulationaround the globe have seriously compounded their and for monetary inflation.”existing budget problems. According to researchby Société Générale EU and US net liabilities add Will we see inflation or deflation over the nextup to around $135 trillion. That’s roughly four times decade? I believe you can answer this question bythe capitalization of the world’s equity markets and considering the effect of the following factors:forty times the cost of the 2008 financial crisis. Even – Government spending & deficits - increasingafter the farcical debt-ceiling crisis and “resolution”, – Regulation - increasingthe US plans to accumulate an additional $10 trillion – Taxes - increasingin deficits over the next decade. These enormous – Money supply - increasingnumbers beg the question of how our governmentsplan to fill their funding gaps. Unfortunately, all state activities however financed require that capital be taken out of the hands of theTo quote Jens Parsson from his excellent book private sector, then deployed in typically loss-making“Dying of Money”: “The government is free to incur (capital destroying) activities. The net result is thatany deficit and issue any amount of debt it may wish, growing government spending, deficits and printingso long as it is willing to draw purchasing power are setting the stage for much greater problems inaway from other borrowers and to tolerate the rise in the future. Rather than allowing private sector savingsinterest rates which will result. The debt will create no to replenish the pool of capital our governments areinflation. Government deficits and government debt going further into debt.thus are not inflationary if they stand alone, but theynever stand alone. The creation of government debt What western economies desperately need is moreis practically always accompanied by an increase capital. There is no way to create capital other thanof money. Competing against private borrowers for through savings and hard work - a message to whicha static supply of credit capital, a large government our governments are perennially reluctant to listen.debt issue would drive interest rates upward, and Printing money seems alluringly easy at first, but ithigh interest rates are anathema to a government. does not create capital, and worse, the inflation it creates ultimately causes long lasting harm to the 2
  4. 4. Agcapita Update (continued)production structure of the economy. It follows that the politicians we find in government these days.until the developed nations stop engaging in capital When did the current group come to believe thatdestroying activities and our capital base recovers, compromise was a virtue? Almost everyone outsidesustained real growth is unlikely to take place. of the cocooned political capitals of the world believes that if you are right then you should attemptWhat we are now experiencing is the effects of a to prevail. Compare and contrast the political classdepleted and declining capital pool, combined with that elevates compromise to a virtue.enormous expansion of the monetary base andnegative real interest rates. I believe that rather than Ultimately, the growing crisis of sovereign insolvencypure inflation we will face stagflation in the developed isn’t even an ideological issue it is simply aworld as further state expansion into the economy will mathematical issue. No government can indefinitelyreduce real growth while accelerating fiscal deficits provide $1 of services with less than $1 of revenuescombined with money supply expansions will lead to - a fact that no amount of compromise will change.inflation. Ignore this at your peril as eventually all spendthrifts run out of palatable options.Low growth + high inflation = stagflation. Kind Regards“Compromise - to make a dishonorable or shamefulconcession.” Before I conclude this month I want Stephen Johnstonto engage in a small tangential observation about 3
  5. 5. 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 Agcapita Partners LP (“AGCAPITA”) 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 AGCAPITA 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 AGCAPITA 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 AGCAPITA or its relevant affiliate directly.#205, 120 Country Hills Landing NW Tel: +1.403.608.1256 www.agcapita.comCalgary, AB T3K 5P3 Fax: +1.403.648.2776Canada