Petrocapita February 2011 - Two Ways to be Fooled


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As Kierkegaard elegantly pointed out, "There are two ways to be fooled: One is to believe what isn't so; the other is to refuse to believe what is so." The problem of being fooled "by believing what isn't so" appears to be endemic in mainstream economic circles. Increasingly, we see the panic of central bankers and politicians in the thrall of the mistaken belief that the mere act of printing money can conjure wealth and sustainable growth into existence that this nostrum has stopped working. Petrocapita is an investment trust built around the premise that demand for energy will continue to move prices higher over the long-term. Petrocapita was created to allow investors to add professionally managed oil & gas assets directly to their portfolios.

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Petrocapita February 2011 - Two Ways to be Fooled

  1. 1. Petrocapita UpdateFebruary 2011
  2. 2. Petrocapita UpdateAs Kierkegaard elegantly pointed out, “There are two ways to befooled: One is to believe what isn’t so; the other is to refuse tobelieve what is so.”The problem of being fooled “by believing what isn’t so” appearsto be endemic in mainstream economic circles. Increasingly, wesee the panic of central bankers and politicians in the thrall of themistaken belief that the mere act of printing money can conjurewealth and sustainable growth into existence that this nostrumhas stopped working.In simple terms the powers that be in the west have been fooledby Keynesian dogma that:– nominal increases in GDP represent growth;– printing money increases nominal GDP; therefore– printing money must generate growth.Surely, this is to believe what isn’t so. A simple example ofthe fallacy this represents is Frederic Bastiat’s parable of the“broken window”. To paraphrase Bastiat, if all the windows inthe country were suddenly broken there might be an increasein nominal GDP as the reconstruction took place but we shouldnot be fooled into believing that this has made us wealthier.Keynesians would argue that business activity has beenstimulated, jobs were created and the economy benefited.In his own version of the “broken window” Keynes famouslyadvocated burying newly printed money and paying people todig it up as a way to stimulate the economy.With all due respect to Lord Keynes, this belief is in the processof being exposed as the mirage it has always been. The truemeasure of the wealth of an economy is the pool of productivecapital. Currency is merely the measuring stick. In our brokenwindow example, the pool has been maintained but withoutthe reconstruction it could have been increased - therefore the 1
  3. 3. Petrocapita Update (continued)net effect, taking into account both “the seen and overnight would we have more farmland, more oilthe unseen” in Bastiat’s words, is actually a loss of wells, more factories, more of anything other thanwealth. decimal places in our currency? The nominal price of all these things would likely increase but the size ofIf printing money does not create productive capital the capital pool has not changed. How do the moneythen how can you explain its perennial appeal printing programs currently underway differ from thisamongst the banking and political classes? in anything but magnitude?For politicians, printing money is desirable for two Unfortunately, the perverse consequences of printingreasons. Firstly, it acts as an unseen tax. One which money do not stop with the misappropriation offew voters understand and for which even fewer wealth from the inflatees to the inflators. A policyare likely to blame the political class, at least in the of artificially low interest rates serves to sustain orbeginning. Secondly, by reducing the value of the create additional mal-investments - investments thatcurrency, the measuring stick I mentioned above, cannot generate sufficient returns, and in many casespoliticians are able to fool many of the voters that over the last decade ANY returns, to justify theirtheir wealth has increased, but of course no such existence. The failure to liquidate mal-investmentsthing has happened. allows the economic problems they cause to multiply and the inevitable accounting to be that much moreFor members of the privileged banking class the devastating. Artificially low interest rates also fool theappeal of printing money is that they are best market into believing that capital is plentiful and thatpositioned to take advantage of the confusion consumption can continue at unsustainable levelsbetween the measurement of the pool of capital and with severe consequences for the real economy.the actual pool of capital itself. In simple terms, they The word consume means “to expend, to use up,can exchange the declining currency for productive to waste or squander”. Always remember thatassets while artificially low interest rates finance these consumption represents the diversion of productiveactivities at minimal cost. capital into non-productive uses - i.e. the destruction of capital. Savings, on the other hand, are the onlySo in general while printing money creates no new source of capital to create productive assets.wealth in the form of productive capital, a significantamount of wealth can be misappropriated silently by I do not believe that the aggressive expansion of thethe banking and political classes. For the rest of us, money supply in the west will have a beneficial effectthe relentless expansion of the money supply offers on the real economy - i.e. will not increase the pool ofno true benefits and the very real danger that it is our productive capital in any meaningful way. However,wealth that is misappropriated. I do believe it will fuel inflation and speculative activities. Of course, more inflation and speculationIn the spirit of Bastiat, ask yourself if the central are exactly the opposite of what western economiesbanks increased the global money supply 20-fold need. We cannot all make our livings selling condos, 2
  4. 4. Petrocapita Update (continued)stocks and bonds to each other - someone has to In general, my investment premise remains thatproduce something and production requires genuine sustained real growth is unlikely to take place in thecapital. developed world until we stop engaging in capital destroying activities. Worse, our depleted andBut this Frankenstein, finance driven economy declining capital pool, combined with an enormousappears to be exactly what our governments and expansion of the monetary base and expandingcentral bankers are trying to keep alive. The west has government is creating a high probability of anbecome a vast inflation-creating machine in order to extended period of stagflation in the the impaired banking and housing sectors.According to data published by analyst Mike Hewitt, This is not to say that I take a universally pessimisticsince the crash in 2001 and the onset of view of possible future returns. I believe thataggressive low interest policies, the global money exposure to inflation-hedging assets with strong(M0) supply has increased over 170%. Some, fooled macro fundamentals and underlying cash generatingby government inflation data ask - “but where is all capability, ideally in sectors exposed to growththe inflation?” Fortunately for us, the Renminbi peg outside of developed markets, will continue to beand OPEC petro-dollar recycling have been escape a fruitful area to search for outperformance overroutes for a large amount of western money/inflation the long-term. My personal preference remainscreation and heavily massaged government inflation agriculture and has helped disguise the rest. Kind RegardsAs fast as we have been creating money in the west,China and OPEC have been importing and storing Stephen Johnston - CIOit on their balance sheets in the form of developedworld sovereign debt. Some observers even argue Petrocapita Income Trust & Agcapita Farmlandthat China will indefinitely accumulate western debt in Investment Partnershiporder to maintain its peg against our inherently weakcurrencies. I believe that this is wishful thinking andonce again it is to be fooled into believing what isn’t Stephen graduated from London Business Schoolso merely because something hasn’t happened to and is the founder of one of Canada’s largestdate. When the emerging economies are forced to farmland investment funds, Agcapita, and Petrocapitatake serious steps to check domestic inflation - which Income Trust. Petrocapita is an energy investmentfor example is already starting to happen in China trust built around the core premise that the world is in- they will stop purchasing our debt and even start a bull market in commodities driven by inflation andselling it, at which point decades of stored western a step-change increase in demand and, accordingly,inflation could be returned to us in a very short period that investments with direct or indirect exposureof time indeed. to commodities in a politically stable environment 3
  5. 5. Petrocapita Update (continued)such as Canada will provide above average returns.Petrocapita holds a portfolio of low risk, producingenergy assets.Stephen has over 15 years experience as a fundmanger – working for organizations such as theEuropean Bank for Reconstruction and Development,Societe Generale and Baring Brothers.Stephen has appeared on Business News Networkand CBC News and been quoted in such mediaoutlets as Fortune, the Financial Times and TheGlobe and Mail. 4
  6. 6. 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.#400, 2424 4th Street SW Tel: +1.403.218.6506 www.petrocapita.comCalgary, Alberta T2S 2T4 Fax: +1.403.648.2776Canada