This article is authored by MOI Global instructor James Davolos, vice president and portfolio manager at Horizon Kinetics, based in New York.
James is an instructor at Best Ideas 2023.
Financial markets thrive on predictability, as greater certainty about the future permits greater risk tolerance, which promotes economic growth, ergo growth in wealth. The past decade, if not decades, of modern central economic planning have sought to reduce economic uncertainty, largely by intervening in free markets by providing liquidity support through monetary (interest rate) and fiscal (spending) measures.
The requisite magnitude of financial support to stimulate the economy has grown in excess of nominal economic growth and financial leverage within the system, creating reliance on a rapidly increasing amount of stimulus. This cycle of ever greater financial stimulus may have recently culminated (temporarily), after U.S. money supply grew approximately 45% between January of 2020 and April 2022. This translates into approximately 31% of the total U.S. Dollars in existence having been “created” within the past 26 months.
It should come as no surprise that an unintended consequence of decades of policy aimed at supporting asset and economic growth is inflation. “Inflation” first came in the form of financial asset inflation (i.e. stocks, bonds and private assets), followed by consumer and producer goods (e.g. CPI, PPI), and now, seemingly, everything.
The U.S. Federal Reserve is no longer denying that inflation is extremely unlikely to abate on its own, and it has begun raising interest rates aggressively in order to combat rising price levels. Tighter money can only combat inflation by reducing demand, as interest costs consume more of businesses’, individuals’ and governments’ cash flows.
Contractions in demand are often associated with economic contraction, i.e. recession. Fear of economic/demand contraction is driving irrational price action in financial markets, as investors underestimate structural trends and rely on heuristic analysis of past cycles. It may shock many people to learn that commodity prices and broader consumer prices can, in fact, rise during a recession.
To quote Zolten Pozsar of Credit Suisse, “You can print money, but not oil to heat or wheat to eat.” This quote summarizes the dilemma that central banks face, as decades of underinvestment in indispensable raw materials are coinciding with growing demand, specifically from emerging (non-OECD) markets.
Further, there is a growing risk that aggressive central bank policy aimed at reducing inflation via curbing demand will achieve its goal in reducing growth, but without impacting structural inflation, thus resulting in stagflation.
This leaves the global economy in a very uncertain position, where restrictive bank policies are in direct conflict with slowing global growth. We do not have any unique insight into what will catalyze this dynamic to shift, or how or when it might occur, but we do believe we have an informed opinion about what the ultimate economic and investment implications are. In short, the current paradigm of investing, which has reigned for decades is shifting – and at warp speed due to the policy mismatch.
This change will be uncomfortable, and many individuals and institutions will surely reduce exposure due to the uncertainty, which will pressure asset prices. However, this short-term orientation fails to recognize the difference between cyclical and structural inflation, hence missing investment opportunities in secular inflation beneficiaries.
The past 40 years can be characterized as an era of abundance, driven primarily by globalization, technological innovation, and declining interest rates. These supporting trends simply cannot be sustained, and most are either stalling or outright reversing. This will result in a markedly different investment environment for the next decade as compared to the past – yet most investment “models” rely on historical performance and correlations based on 10, 20 or 30 years of data, which is no longer a valid analog.
Specifically, we believe that the changes in these trends, in conjunction with underinvestment in raw materials, will result in a new era not of abundance, but of scarcity. In short, the new era will place a primacy on existing high quality, hard assets – which stands in stark contrast to the prevailing primacy on intangibles and cheap investment capital.
 M2 Money Supply
 Cash Flow: Cash Flow is the increase or decrease in the amount of money a business, institution, or individual has.
 OECD: Organization for Economic Co-operation and Development