Petrocapita May 2011 - Robbing Peter to Pay Paul


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“Everyone wants to live at the expense of the state. They forget that the state lives at the expense of everyone” - Frederic Bastiat.

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Petrocapita May 2011 - Robbing Peter to Pay Paul

  1. 1. Petrocapita UpdateMay 2011
  2. 2. Petrocapita Update“Everyone wants to live at the expense of the state. Theyforget that the state lives at the expense of everyone”- Frederic BastiatBy virtue of more than a decade of low and oftennegative real interest rates, rapid monetary growthand emerging market currency pegs, the economiesof the developed world have been skewed towardsconsumption rather than production. Unfortunately,consumption is the destruction of capital - by definitionit represents the diversion of resources from productivepurposes. Both the private and public sectors have beenindulging in this protracted debt fuelled consumptionspree. Savings rates have plunged and fiscal deficitshave expanded.To the increasing bafflement of the Keynesians, it hasbeen requiring a larger and larger amount of debt tocreate each additional unit of GDP - on the order of $4of incremental debt to less than $1 of incremental GDP.Why? Because on average, we are incurring debts thatdo not create offsetting cash generating assets. At somepoint this type of trend must result in default - whetheroutright or via the printing press.Surprisingly or perhaps not surprisingly, the governmentsand central banks of the developed world (let’s continueto call them non-profit maximizers or NPMs) seem intenton continuing this trend as they desperately force feedthe markets consumption-oriented programs in placeof stagnating private sector demand. An interesting factis that for the last decade in the US, private sector jobgrowth effectively has been absent and virtually all netjob growth has been in government or state dependentsectors. We are facing political as well as monetaryinflation. 1
  3. 3. Petrocapita Update (continued)There are many (invariably of the Keynesian stripe) stage for much greater problems in the future. Bywho observe that money must be lent into existence preventing private sector savings from replenishingand due to deleveraging in the private sector we face the pool of capital our governments are going furthera deflationary environment. Of course that ignores into debt to finance policies that at best can onlythat money can be simply spent into existence by serve to pull future consumption into the present -the state - a powerful inflationary mechanism when once again more consumption is not what the westthe state represents well over 30% of the western requires at this moment.economies and central banks have thrown off thelast few vestiges of restraint and are willing to directly So what of the seemingly relentless rally in the equitymonetize fiscal deficits. markets? Rather than indicating sound fundamentals a nascent recovery in the western economies, IIn our current world I would argue it’s a relatively believe we are simply witnessing the re-ignition oftrivial matter to bypass private sector borrowers bank intermediated speculative finance funded byaltogether and have government spending inject a wealth redistribution from savers to the financialnewly printed money into the economy. The presence sector. Of course the financial sector is a vocalof heavily leveraged and highly impaired asset classes proponent of this process for in the words of George- commercial and residential real estate and many Bernard Shaw “A government which robs Peter tobanks to name a few - don’t act as an offsetting pay Paul can always depend on the support of Paul”deflationary force as Keynesians would have usbelieve. Inflation is not an aggregate phenomenon. To reiterate, what western economies need is moreAfter being released into the economy by the state, capital. There is no way to create capital other thanthe newly created funds are simply avoiding past through savings and hard work - a message to which“bubble” sectors and flowing into new and less western governments are reluctant to listen. Printinglevered areas as is their wont. Banks may not be money seems alluringly easy at first, but it does notlending to homeowners but the state is spending create capital, and worse, the inflation it createsand this money is most certainly turning up in the ultimately causes long lasting harm to the productioneconomy - commodities are just the most recent structure of the economy. To ask a rhetoricalmanifestation of that process and will not be the last. question, what possible outcome does the Federal Reserve expect by increasing the base money supplyThe problem arises that all state spending requires (M0) of the world’s reserve currency 200% in 24that capital is first taken out of the hands of the months - a stronger currency, low food and energyprivate sector via taxes, borrowing or inflation, then prices, a robust economy?deployed in typically loss-making (capital destroying)activities. The net result is that while government I believe that until the developed nations stopspending may appear to increase nominal GDP, this engaging in capital destroying activities and ourspending and the attendant deficits are setting the capital base recovers, it will be difficult for sustained 2
  4. 4. Petrocapita Update (continued)real growth to take place. A depleted and declining wheat and $175/barrel oil. How does your portfoliocapital pool, combined with enormous expansion of and standard of living fare in such a world?the monetary base and negative real interest rates are – Are you holding a long duration portfolio of fixedcreating the ideal conditions for an extended period rate debt investments, particularly sovereignof stagflation in the west. With this backdrop in mind, credits?perhaps this is an appropriate time to engage in – Are you dependent on consumption growth in thesome “what if” analysis. west for investment returns? – Are commodities an input cost rather than a profitNPMs have allowed vast amounts mispriced risk to centre for you?accumulate in the financial system and are eagerto foster more in the form of higher nominal prices If the answer to these questions is yes imagine ifin real estate and equities. Even if we assume a real growth were to decelerate in the west whilesmall probability of the negative outcomes, given the commodity prices/inflation accelerated - stagflation.magnitude of the consequences, investors should Sooner rather than later you should take a mentaltake the time to properly consider these risks. walk through your portfolio - be objective and ask yourself what investments benefit and what suffer inFor instance, imagine a world with more than 10% the world I outlined above and to what degree?inflation, minimal real growth in the west, $12/bushel 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 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