September 13, 2009
By Phil Davis
In the wake of the worst financial crisis in recent memory, is there an opportunity for unconventional schools of thought to force their way into the investing consciousness?
The investment industry is spotted with "cranks" – fund managers, brokers and advisers who distrust the whole structure of the economy and markets and believe that returns can only be made by exploiting the inherent flaws. (They are distinct from the large number of fund managers who adopt "contrarian" market views.)
Some of the "cranks" are given labels such as "perma bear" or "doctor doom" and include investors such as Marc Faber, the late Tony Dye and Nouriel Roubini. Others are simply ignored. Typically, they manage or advise modest amounts of assets and command a niche, but loyal, following. But in the US, in particular, there are some signs that the investment orthodoxy is starting to come under pressure from these outsiders following recent sharp losses in portfolios.
Peter Schiff, of Connecticut-based Euro Pacific Capital, an investment house credited with having predicted the meltdown of the housing and financial markets, is one of the voices bringing pressure to bear. Mr Schiff has become something of a celebrity in the US in recent months in the wake of a number of interviews he gave to CNBC and Fox News in 2006-7.
His view then that the US housing market was about to collapse was frequently met with on-air guffaws by other interviewees.
He was subsequently proved correct and when a compilation of the interviews was posted on YouTube this year it received more than 1.5m hits from an audience that revelled in the tables being turned on Mr Schiff’s tormentors.
Yet, despite the accuracy of his forecasts, Mr Schiff has received little acclaim in the mainstream media (YouTube excepted).
"No one ever admits they are wrong," he says. Worse, he was practically shunned afterwards. "I was invited on Fox and CNBC several times a week back then. Now it is once a month at most."
One reason is that his views continue to be unpalatable to those who yearn for a return to soaring house prices and stock markets. He believes US government and Federal Reserve actions since 2000 have set the US on a path to eventual economic ruin. The government, he says, will never be able to manage its debt, and will have to inflate its way out of the problem. "This will be disastrous for the dollar," says Mr Schiff. "I think in terms of per capita GDP, the US is eventually going to fall out of the top 20, behind even some of the poorer countries in Europe."
He advises his clients to avoid any dollar-denominated assets and to invest in overseas stocks and bonds, particularly in Asia and especially in companies that do not have significant exposure to the US. Commodities and precious metals are also recommended.
The economic shifts to come will, he argues, turn accepted theory on its head. He says the study of conventional macroeconomics in universities and business schools – which underlies nearly all financial services provision – will eventually be discarded. "Everyone going to business school learns macroeconomics," says Mr Schiff.
"They have no idea the whole thing is wrong and based on Keynesian policies that caused this crisis. Keynes stressed the role of government and central banks in markets and that is what has gone wrong," he adds, referring to the Federal Reserve’s setting of "artificially" low rates over a period of years, creating mal-investment.
He believes the Austrian School of economics – widely discredited by Keynesian economists such as Paul Krugman, a Nobel prize-winning economist who writes for the New York Times – will increasingly rise to prominence as it becomes clear that economies run by central banks and ultimately by politicians are prone to skewing incentives and monetary policy. The Austrian School argues for greater economic freedom, small government and the abolition of central banks.
Extreme though his views may seem, they are not unique. Similar views are championed in the US by Ron Paul, a congressman who ran against John McCain in last year’s Republican Party presidential nomination. Mr Paul, a political outsider, has garnered huge political and popular support for his bill to audit the Fed, which is viewed by its opponents as the prime mover in the crisis.
Mr Paul’s sudden emergence as a credible economics spokesman follows decades in the political wilderness and comes amid increased appetite in the US for an alternative to the economic orthodoxy represented by Mr Krugman. Evidence of this appetite can be seen in the success of books such as Meltdown, which adorned the New York Times bestseller list for 10 consecutive weeks earlier this year. In it, author Thomas Woods challenges financial norms and, like Mr Paul, places the blame for market failures squarely at the door of the Fed. Such open rebellion against the Fed’s policies would have been unthinkable during Alan Greenspan’s tenure.
So is this perhaps a sign of demand for new financial ideas? Mr Woods says there is a clear desire for change outside establishment circles, but establishment economic and investment ideas have, if anything, become more entrenched, he believes.
"We are asking all the wrong questions about what is happening to the economy today," says Mr Woods. "There is no moral or economic justification for our present monetary system and people might well ask whether our system of central bank-driven inconvertible paper might – perish the thought – be a source of financial instability instead of the greatest idea in the history of mankind."
Interestingly, Meltdown became a best-seller despite never being reviewed in the NYT itself. Could this signal that established organisations – within the media, politics and financial circles – have failed to keep up with a change in the mindset of the public, the end-investors? The success of Meltdown and the popularity of Ron Paul in the US and Vince Cable in the UK – both politicians who criticise the financial status quo – lend the idea credence.
But whether this shift in the public consciousness will translate into a genuine reappraisal of investment traditions is more doubtful. After all, it is axiomatic that fund managers, brokers and bankers who run with the herd are less likely to lose their jobs than mavericks. And institutional investors are unlikely to push them to change, as a recent report on investment firms by PwC, shows. The Day After Tomorrow: Asset Management, predicts a "flight to quality" as investors park their money with well-capitalised banks and fund managers. And, of course, these institutions are staffed with MBAs who were schooled in roughly similar economic and investment ideas.
Perhaps the cranks’ time has not quite arrived. Mr Schiff shrugs.
"Conventional wisdom is what it is," he says. "Most people are studying nonsense instead of the science of economics."