Post #4 - Leading Investment Managers' Views on Current Market Environment

Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains.  Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios.  The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term.  Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.

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Niall Ferguson, Harvard University
10th Annual Strategic Investment Conference
presented by Altegris Investments and John Mauldin

"What is it that ails us?   Has there been enough stimulus or is the current economic malaise a symptom of something else?

Adam Smith – brought forth the idea of the “stationary state” where economies transition from growth to stability. However, it is the rule of law that allows countries to grow.  Historically, what makes nations strong is the guarantee that justice will be done. This is what separated Europe from China during the 1800’s. Today, the west is now approaching the “stationary state.”  So, the central question of the “great degeneration” is whether our institutions, corporations and governments, are degenerating.   There are four symptoms of degeneration:

    Breakdown of the contract between generations.
    Excess regulation
    Rule of lawyers
    Decline of civil society

Generational Contract

Each generation has a responsibility to the next. Currently, we have violated the contract between our generation and the next. In order to restore the generational balance we could currently have to do one of two things:

    Immediately cut, and make permanent, all government outlays by 30%
    Immediately, and make permanent, increase in all federal taxes by 60%

The problem is that if these measures are not implemented immediately the percentages required to restore the generational balance rise each and every year.  While this is what is required to achieve generational balances – the individuals responsible for such decisions, however, are pursuing the opposite path – spend more and tax less.

Regulatory Excess

One of the major constraints to economic growth and the second pillar of the degeneration of our institutions is excessive regulation.  “Unlike my arch enemy Paul Krugman”….who believes that the financial crisis was not caused by deregulation – the reality that there was plenty of regulation over the financial institutions. (Enforcement of those regulations is another issue entirely) that ultimately were at the epicenter of the crisis.  The financial crisis was really a result of an increasingly complex financial system. However, in response to the financial crisis, the immediate course of action was to complicate the system further by adding layers of new regulation (Dodd-Frank, Consumer Protection, etc.).  However, the problem is that by making a complex system more complex – the outcome is not stability but rather instability. Instability leads to inevitably bad outcomes.

The Rule Of Law

Dodd-Frank demonstrates the primary problem with the rule of law. Statutes that cover thousands of pages are ineffective, cumbersome and impedes growth. The complexity of recent laws such as Dodd-Frank, Affordable Care and others, along with our current tax code, would have our founding fathers and those of the Gilded Age reeling from disbelief.  However, here is the real problem. The world is no longer under a rule of law - but rather a rule of lawyers. The U.S. has the highest cost of law of any other country in the world. The rule of law is supposed to be speedy, efficient and effective. However, the rule of law has been corrupted by the legal system for self-serving needs.

There are three key indicators of the health of the “rule of law.”

    Legal System and Property Rights
    Regulation
    Summary of Economic Freedom

Unfortunately, all of these measures have declined dramatically since the turn of this century. The outcome of this decline over the last 13 years is that it is more difficult than ever to do business in the U.S.   Compliance and regulatory costs are on the rise which reduces profitability.  The decline in the rule of law has led to daunting decline in the view of American Institutions. America was once the envy of the entire world - that is no longer the case.   Of the 22 measures of institutional quality, covering everything from property rights to bribery, the U.S. is not at the top of the list in ANY category. More disturbing is that today – the U.S. is soundly beaten by Hong Kong on every measure.

The Decline of Civil Society

Lastly, the decline of civil society is most disturbing. One way to look at this is by looking at the active membership is voluntary associations which has plummeted in recent years. Americans are no longer actively involved in civil society and now depend on the government to “solve problems". The problem with this, of course, is that the decline of the civil society also leads to a decline in economic output. Dependency on government to solve social issues has very little economic benefit. While the rest of the world is getting better in term of building better institutions – the U.S. is getting progressively worse.

Bright Spots

However, the good news is, as compared to others, is that the U.S. is ageing less rapidly. China, as an example, will be harshly impacted by an aging population in the next two decades.  For the U.S., despite have a completely flawed and non-existent energy policy, the country is undergoing and energy revolution that is just now becoming apparent. Natural gas is the new gold rush.

While a large portion of the U.S. will continue to languish due to regulatory and fiscal policy – there are four growth corridors:

    Great Plains
    Third Coast Region
    Intermountain Region
    Gulf Coast

However, the boom in these areas is not due to just the location of natural gas but rather pro-business regulatory and tax policies. If the current Administration was paying attention they would take the time to emulate the state governments that are growing versus declining. There is no question that institutions matter. It explains why the developed economies are struggling versus emerging markets.   The problem is that, despite mainstream media commentary and Keynesian economists, the decline of institutions cannot be saved by monetary policy.  In other words…Washington is killing economic prosperity.

    “The U.S. has the right to be stupid…and has been exercising that right for years.”

We have allowed our government to whittle away at the rule of law and replace a vibrant economic system with a European style welfare state. If you want to be stupid…keep doing what you are doing.

Q.A.

Worried about the U.S. – What of Japan?

The main lesson to be learned this year is the limit of monetary policy.   The story last year was that the Central Banks are the only game in town. The story this year, is that despite stimulus spending which is simply an anti-volatility policy, the economy will not achieve “escape velocity.”  I predict that the limits of monetary policy will be witnessed by the end of this year. We have a structural economic policy problem – not a monetary one.

Question by Paul McCulley:

    “The long run is a misleading guide to current affairs…in the long run we are all dead.”  Are we in a liquidity trap, are we at a zero bound of interest rates and stuck at 8% unemployment?

Keynes was a homosexual and had no intention of having children. We are NOT dead in the long run…our children are our progeny.   It is the economic ideals of Keynes that have gotten us into the problems of today.   Short term fixes, with a neglect of the long run, leads to the continuous cycles of booms and busts. Economies that pursue such short term solutions have always suffered not only decline, but destruction, in the long run.

Have Corporations Usurped Government?

    “It is corruption when corporations can buy regulation.   It is corruption when laws are sponsored by Wall Street.”  It is a sad state when the current level of corruption of the U.S. government is what was once only associated with third world countries ruled by dictators. The problem is that crony capitalism is a profound predicament in the U.S. and we now suffer from a third world disease.

What Is The Solution To Restore Growth?

The fiscal problems are a function of structural problems. Without addressing the structural problems that plague the economy from production to employment – stimulus will fail.   The reality is that the “punch bowl” won’t fix employment growth, economic growth or the rule of law. The party of the last 20 years is now over and the longer we fail to address the real issues the bigger the hangover will be in the future."


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Niall Ferguson is the Laurence A. Tisch Professor of History at Harvard University, a Senior Fellow of the Hoover Institution at Stanford University and a Senior Research Fellow at Jesus College at Oxford.   He is also the author of 14 books including the must read “The Ascent Of Money: A Financial History Of The World.”