As long as there has been capitalism, there has been banking. As long as there has been banking, there has been debt. As long as there has been debt, there has been pressure to inflate or debase money. This book will look at the modern debate between borrowers and lenders.
During the Roman Empire, the government created inflation by reducing the silver content in coins. This increased the money supply in the ancient economy in order to inflate away government debt. The problem of debt and government spending has clearly persisted throughout history, but the tools developed to deal with these problems have been substantially refined. These new tools, like the modern system of central banks and quantitative easing, are more powerful than the tools of the past, and while they have helped the U.S. deal with a global financial crisis and other financial bubbles, it is my belief that they will also significantly alter the investment environment over the next 20 years.
America’s periodic love affair with populism, when mixed with monetary policy, has a potent effect on the economy. This book examines how the populist movement of the late 1890s relates to today’s populism and how this trend could alter the financial environment into the future. Past debt bubbles have often been answered with increased inflation, and with no gold standard in place, central banks have the ability to rapidly increase the money supply through the purchase of financial assets outright. These powers will likely be used to inflate away the extraordinary amount of consumer, corporate, and government debt that has been accumulated during previous decades. The country can either slowly and painfully try to reduce debt, or we will reduce the debt through inflation. I believe the country will opt for inflation.
As I put the finishing touches on this book in February 2019, a new Congress has been seated, many Democrats have announced their in- intention to run for President in 2020, and fiscal policy lines in the sand have been drawn. In this environment, I am struck by how quickly the topic of Modern Monetary Theory (MMT) has entered the political arena, particularly amidst the current Democratic candidates. MMT is a theory that promotes a new role for central banks in debt creation and allows increased deficit spending of governments. In the past, Keynesian policy was limited by a “crowding out effect.” In other words, when governments borrowed too much money, interest rates rose throughout the rest of the economy because the government was using too much capital. Now, with the Federal Reserve allowed to purchase ever more government debt, there are theoretically few limitations on debt creation because there is no “crowding out effect.”
MMT proponents argue that during the 2008 financial crisis, governments were able to fulfill emergency monetary demands through the use of quantitative easing, without creating inflation, or simply put, by printing money and monetizing debt without much of an inflationary cost.
The effects of government deficits have been debated for decades, and to be clear, increased deficit spending has been instrumental in helping to manage the past several recessions. The purpose of this book is not to preach against deficit spending. Rather, it is to consider the history of the modern financial system and the investment implications going forward, given the debt and viable policy responses to it.
Although new to Congress, Representative Alexandria Ocasio- Cortez has captured the political spotlight in ways that are framing the new monetary debate. Recently she announced her sponsorship of a Green New Deal bill, which would transform the electricity, housing, and transportation sectors over the next 10 years. At the time of writing, 60 House Democrats and nine Senate Democrats have announced support for the bill. Five Democratic Presidential candidates have also thrown their support behind the bill: Bernie Sanders, Kamala Harris, Elizabeth Warren, Cory Booker, and Kirsten Gillibrand.
What interests me is not so much the bill’s policy, but how politicians want to pay for it. The net effect of MMT is a renewed belief that deficits don’t matter with our modern financial system. Central banks are now free to purchase government debt through what is called quantitative easing. This solution worked well during the last financial crisis and was not as inflationary as feared, so it is a very tempting avenue for politicians who want to introduce expensive new programs. This new genie is “out of the bottle” and if history is any guide, it is here to stay.
In recent months, other politicians have also put forward aggressive new plans that would greatly increase deficits. Senator Bernie Sanders has proposed increased government spending for health care. There are serious discussions about income redistribution through raising taxes on the wealthiest citizens to help alleviate growing income disparity.
I do not want to give the impression that Democrats alone believe in deficit spending. The current environment is a result of both parties’ inability to develop policies aimed at long-term financial goals. Early in his first term, President Trump, with the backing of a Republican Congress, passed legislation that greatly increased the federal deficit.
I have genuinely enjoyed researching and writing this book. After taking the past few years to think about equity markets and economies, writing this book has allowed me sort through several ideas. In 1990, I was lucky enough to secure a job as a portfolio manager in what turned out to be one of the fastest-growing and top-performing mutual fund families of the 1990s. In 1991, I became one of two founders of AIM Funds’ (now known as Invesco) International Investment department. During the next decade, international investments in our department grew to approximately 14 billion dollars, and we garnered one of the top-performing track records of the time. In 1998, I was the lead manager on the top-performing European Equity Fund, as well as the number-one Canadian Equity Fund. I left the mutual fund business right before its peak in 1999 and piloted my own hedge fund until 2012.
I learned that successful investing involves a balancing of ideas. Outcomes are not deterministic, but they are not completely through chance either. There are often many potential ways that the economy could move forward, but the forward moves are also bounded by some constraints. In this way, investments are more organic. That is, an economy is more accurately studied as a historical process of change and development, rather than a series of supply and demand curves that just do not capture all of the variables active in the economy at a given time.
My hope is that this book helps readers apply history’s lessons to make successful investment decisions in the current environment. Equity and bond markets have strongly outperformed since 1981, but now many of the economic forces that propelled this outperformance are reversing. As these new policy options enter the American political debate, they will become increasingly inflationary. History shows us that higher inflation is what happens to countries with high levels of debt. New attitudes toward deficits, even those not as extreme as MMT, will eventually raise inflation and interest rates. This will tend to shift the economy into a cyclical period similar to the 1970s, an environment in which real assets strongly outperform financial assets.