Petrocapita Update

September 2010
Petrocapita Update

With hands firmly grasping the handle of the bucket…

Winston Churchill once said “that for a nation to tax itself into
prosperity is like a man standing in a bucket and trying to lift
himself up by the handle.“ It could be said with equal certainty
that printing and spending money as a path to prosperity falls
into the same category.

Unfortunately, it seems the only consistent skill governments

and central banks possess is the ability to debauch their
currencies. They have an unblemished track record in this
regard as evidenced by the uniform collapse in the purchasing
power of fiat money since modern central banking came into
widespread existence in the early part of the 20th century –
witness the greater than 95% decline in purchasing power
in both the US and Canada as an example of massive and
unrelenting central bank inflation.

Granted, pointing out the role of governments and central

banks in inflation is not a novel observation. Many have made
this connection before and much more elegantly including
Ludwig von Mises who said “Government is the only institution
that can take a valuable commodity like paper and make
it worthless by applying ink” and Voltaire, a man who lived
through a spectacular fiat money collapse, who said that
“paper money eventually returns to its intrinsic value -- zero.”

So you might reasonably ask what is the point of this note if

I’m going to state the obvious?

There is much talk about QE, stimulus, bond yields, risk

premiums, volatility, velocity of money, deflating asset prices
and so on and so on. My point today is that to focus on

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Petrocapita Update (continued)
what is happening in the immediate term is to
miss the forest for the trees. Only by taking a
step back is it possible to remember that the
developed world is still in the midst of a truly
massive and unprecedented experiment in which
the Keynesians are still in charge – printing and
dispensing money on a vast scale. Some say
that it will have no effect because the “velocity
of money has collapsed” while others predict
hyperinflation.
In the midst of all the seemingly contradictory
data and the clearly contradictory predictions I
prefer to fall back on a simple economic dictum
- if an item can be created for zero cost and is
created in increasing quantities its value will trend
to zero. Is money subject to different rules than
other economic goods?
That leads directly to my next question – will
the governments of the west continue to print
money? Morgan Stanley thinks yes. In a recently
published research piece proclaiming the US
“broke” and that no conceivable combination of
austerity and/or tax increases will fix the problem,
Morgan predicted that some form of default via
the printing press is sure to happen. Societe
Generale went a step further and conducted
a simple calculation of the approximate “net
worth” of various western governments. To
use SocGen’s circumspect language “the
fiscal challenges are unprecedented”. More
specifically SocGen concluded that Italy,
Germany, France, Portugal, United States,
United Kingdom, Spain, Ireland and Greece
all have large negative net worths – i.e. they
are bankrupt. Canada wasn’t mentioned, not
because the government’s finances aren’t in the
same dismal condition, but because SocGen
didn’t publish the numbers.
It is the unfolding bankruptcy of western
governments that will drive inflation as they
increasingly rely on the printing presses to
fund their deficits. Jordan Roy-Byrne reminds
us “Hyperinflation is a fiscal not a monetary
phenomenon. The reality is that hyperinflation is
first and foremost set in motion and driven by a
deteriorating fiscal situation. In fact, significant
economic weakness and deflation is a precursor
to hyperinflation. Too many analysts believe
that there has to be some economic demand
or some consumption to stimulate inflation or
hyperinflation. Printing money to try and stimulate
your economy or excessive credit growth is what
leads to inflation. Printing money because you
are broke and can’t service your debts is what
leads to hyperinflation.”
To follow the logic to it’s conclusion, if the
governments of the west are bankrupt isn’t a
printing press default plausible? Time will tell,
but I feel certain about this – the governments of
the world can’t print food and can’t print energy
but they can and will continue to print money.
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Petrocapita Update (continued)

Therefore I want to leave you with three simple

questions – in the next decade will:

– Fiat money be worth more or less

– Energy demand be higher or lower
– Food demand be higher or lower

If you believe as I do that fiat money will be

worth less while food and energy demand will
be significantly higher then perhaps you will
appreciate the logic of having long term, low
cost exposure to the things that the growing
economies of the world need (food and energy)
but located in politically stable parts of the world
like western Canada.

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