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Investments Inc.

spacer October 2001

It is a struggle to evaluate the impact on investors of the September 11 cataclysm without sounding cold and callous. But we have a job to do, and we are doing our best to get on with it.

It is repeated endlessly that the world will never be the same. On one level, this is pure tautology — the world is not static, change is constant, and though repeating patterns emerge, history never repeats itself exactly.

Nevertheless, while commentators emphasize the scale and distinctiveness of this attack, it is a big stretch to suggest that this event in itself is changing the direction of business. Our view is that it is accelerating those factors that had already been turning the global economy southbound: the trillions of dollars that disappeared during the tech meltdown; the recent consumer buying binge that stocked larders to the rafters; and corporations that stupidly spent their hoards on ill-advised acquisitions and are now paying the piper with major write-downs.

After a decade of strong employment, a buoyant stock market, and tame inflation, it was seductive to believe that the so-called “Goldilocks Economy” — not too hot, not too cold — would last indefinitely. Then the tech bubble burst, and “cooler” heads insisted that a recession was unlikely because the overall economy was still strong. But it wasn’t. The accumulation of years of growth not only resulted in an accumulation of wealth, but also an overabundance of capacity as well as consumer and corporate debt. If it is now the epitome of patriotism to “spend, spend, spend,” as our leaders exhort, then we are coming off a period of unmatched national devotion.

On the government front, the outlook is also less rosy. While many of our elected bodies have trimmed debt, heading too far in this direction was politically unsavoury as lobby groups from a slew of factions screamed, “Spend the surplus here!” And government responded, weighing short-term electoral favours against longer-term exigencies. The moment is swiftly upon us where surpluses will turn to deficits, just when spending from the public kitty is required. Oops.

One other thing to keep in mind. Today’s frequent mantra among brokers and analysts is “defensive stocks.” Be a tad wary here. Many are strongly proposing that financial firms fit in this category. But with dropping asset values, corporations of every stripe in default, consumers parading to file for bankruptcy, and derivatives potentially running amok, write-downs in this sector loom large. When loan loss provisions prove inadequate, even the big boys will take their lumps. Don’t shed too many tears, though. While they moan and groan about their poverty and scream, "Merger, Monsieur Martin!" the odds of any of the Big Five falling off the proverbial cliff vary from slim to none.

As the recession winds blow, pockets of denial remain. The lowest interest rates in 39 years provide some solace. So too does the real estate market, which remains in high gear. However, cheap money will not wipe away yesterday’s excesses, and many of you remember how quickly the condo and housing markets turned in 1990. But if the business cycle cannot be repealed, it behooves us to at least try to put it into a broader economic and social context and understand it better.

In this issue, we present something a little different: a guest article by Steven B. Kurtz. Steve is a philosophy graduate of New York University and a member of the Canadian Association for the Club of Rome. He was an assistant director of Merrill Lynch International Bank during a 25-year career in financial derivatives.

After nine years of organic gardening in New Hampshire, he now does research and volunteer work in ecological economics and sustainable futures with several organizations. He has seen a few economic ebbs and flows in his time. As with any guest appearance, the views and ideas are the author’s, but we wouldn’t be presenting them if there weren’t some important points about the “big picture.”

GROWTH: Salvation, Addiction and Cessation
The human economy is a complex system. It is a subsystem of the ecosystem, in which our species lives, loves, competes, propagates and dies. Investing is usually seen as an activity by which individuals or groups attempt to grow their savings by buying shares of businesses, lending money to them (or to governments), and by buying real estate and other hard assets. What is rarely discussed is the totality of all human investments, the value added to current per capita quality of life and the resulting impacts on future options for all.

The concept of a “point of diminishing return” is applied to empires like the Roman and British, to civilizations such as the Mayan, to industries such as railroads and Internet marketing, and to individual companies. It may be that there is such a point for national and global physical economic growth. Is it possible that we have already reached it? Will we reach it this century? Or will it ever be reached?

Some preliminaries are in order. Originally, coinage, then bullion bars and “reserve notes” like the pound sterling were used as post-barter methods of exchange. Money is created by the developed world in the form of loans. There is nothing but “faith and credit” backing it. No gold, no silver, no basket of commodities. This is known as “fiat” currency. Investments around the world are made largely via this medium. Barter and “time credits” are tiny in comparison. There is also a fledgling e-currency that is gold bullion itself.

The ownership of any of these forms of money brings the power to access goods and services to the relative extent that others value the medium of exchange. None of these media (metals included) can, in themselves, sustain life. They provide no nutrition, no fuel, no potable water. Nor do they provide shelter.

A characteristic of credit-based money creation is the requirement that more money be available in the future for repayment of the principle as well as the interest. If you doubt that money is created this way, consult the U.S. Federal Reserve or any other central bank’s Web site. Bankruptcies increase during economic slowdowns, due either to reductions or inadequate expansion of incomes to service the debt upon which the economy is based. Growth of the money supply is necessary to maintain economic expansion. It is a self-reinforcing system that adjusts to contractions via increased defaults.

What is my point? Well, the goods and services available for purchase and consumption are real economic wealth. And those items are either products of nature or are converted by humans from natural energy and materials. Even human ideas require caloric input. There is no inherent value in tokens or credits (money). In fact, inflation is the relative oversupply of money to the available supply of goods and services. Is that supply infinite? On a finite planet the answer is no.

As with individuals and species, natural selection — including luck of time and place — helps determine how the goods and services are divided. Cooperation and competition are behaviours which constitute the adaptive fitness of life forms, humans included. But what about nations, regions, industries and companies? It seems that they are not exempt from similar parameters. Complex planning and execution help determine winners and losers. Limits to growth need to be kept in mind to avoid overexpansion.

The economy is not a zero-sum game if there is room for growth without negative feedback that outweighs the benefits generated. An assumption of neoclassical economics is that human ingenuity will, if unfettered, always produce the best possible quality of life. History shows that unintended consequences can at times make apparent progress counterproductive. Overexpansion is a prime example of this; the “possible” can actually be diminished by the growth effort.

Economic growth is perceived by the bulk of humanity as the source of “salvation” from poverty, suffering, illiteracy, sickness and war. This is largely due to the relatively high quality of life in the First World (with the highest average incomes in dollar terms). With unquestioned belief in this credo, an addiction to growth at all costs has been fostered.

Governments in debt perceive population and economic growth as interdependent since, ceteris paribus, more tax revenues accrue from a larger GNP — difficult to achieve with a shrinking population. Businesses desire expanding markets to increase revenue and an oversupply of labour to inhibit wage inflation. The common good is an accidental byproduct of this addiction.

If the current meltdown in the equity markets of the developed world persists, or if recovery proves extremely difficult, perhaps notions of diminishing returns will be floated amongst the mantras for growth. Technology is often proffered as the supertool of this century. What can be missed is the increased dependence on non-human calories that it entails. The proliferation of always-on, 24/7, rechargeable, programmable, robotic, and all sorts of “smart” devices was a key cause of the blackouts in California last summer. Fossil fuels are finite, as is uranium. Other limits being tested are the waste storage and processing demands that economic growth engenders.

While waiting for “the system” to undergo positive change, one must still protect and try to “grow” one’s savings. Given the likelihood of increased stresses on water, energy, food and transportation systems, enterprises in the forefront of technology in these basics seem like prudent targets for investigation. Natural resource companies, long considered passe, may reawaken, with applied technology a key to profitability. Agribusiness is a necessity, but will face scrutiny regarding genetically modified organisms; scientific research in this sector must be beyond reproach, or risk lawsuits and worse. Medical technology and pharmaceutical companies will face a demographic boom of the elderly.

Those companies that succeed in design innovations and increased efficiency will do well. This is not revolutionary insight. What is news is that quality may overtake quantity in determining profitability.

It is also worth noting that precious metals, which were in decline during the boom years of the ‘90s and through most of 2000, have exhibited basing patterns during the past year. Massive increases in money supplies and the dramatic lowering of interest rates fostered by central banks may contribute to their reawakening. The uncertainties regarding U.S. retribution for the September 11 terrorist attacks are also potentially supportive for them. A steady state economy is in the cards at some point in our future. Just as materials will be recycled and renewable energy will become the norm, so will human population stabilize. A sphere contains finite surface area and volume.

Growth of tokens and credits can theoretically continue to infinity, but what they can obtain on earth is limited. The sooner this is realized, the sooner the average slice of the pie — currently 6.1 billion slices and increasing daily by 250,000 — will stop shrinking in size. Investment portfolios will be better protected as well, since systemic breakdowns should be less frequent during a steady state scenario.

An unintended consequence of recessions is a rest from competitive consumption. It is at these times that mindsets are most open to change, as challenges tend to lead to innovation. Perhaps the “growth at all costs” paradigm will soon be challenged, with stabilization the hallmark of a new era.

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