Mr. Hussman Gets It

Once in a while you sit up when an investment advisor speaks and pay attention.  That’s because unlike the pablum served up by most, you actually read something that is both factual and makes sense.

Today’s lesson in this quaint little oddity is from John Hussman.

Without question, one of the notions buoying Wall Street optimism here is the hope that the Fed will pull another rabbit out of its hat by initiating QE3. That’s a nice sentiment, but it does overlook one minor detail. QE2 didn’t work.

That, of course, depends on who you are.  It certainly “worked” for market speculators.  It “worked” for certain people in the political class who were about to see their careers go down the toilet after advocating for saving financial institutions through the promulgation of fraud in 2008 and 2009.  And it “worked” for Obama, who crowed about how it was “time to buy stocks” in 2009 as well – as that fraud was being promulgated.

But that “working” was fleeting, as all the “gains” from said manipulation disappeared in less than two market weeks, leaving one to wonder: What the hell was that?

But this is not worthy of a Ticker – I’ve spilled so much digital ink on this that the only point to be made is that despite screaming of the media about “inappropriate comments” one Rick Perry actually put the correct sentiment on the table yesterday:

Speaking just now in Iowa, Perry said, “If this guy prints more money between now and the election, I dunno what y’all would do to him in Iowa but we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in history is almost treasonous in my opinion.” Treason is a capital offense.


But then John comes up with this – the only correct use for credit in an economy – and defends it:

During the 1930’s, the Austrian economist Joseph Schumpeter captured the importance of productive investment nicely in his discussion of credit. The goal of lending activity is not the stimulation of demand per se, but rather the temporary relaxation of constraints in order to increase the stream of goods and services available to the economy:

“By credit, entrepreneurs are given access to the social stream of goods before they have acquired the normal claim to it. It temporarily substitutes, as it were, a fiction of this claim for the claim itself. Granting credit in this sense operates as an order on the economic system to accommodate itself to the purposes of the entrepreneur, as an order on the goods which he needs: it means entrusting him with productive forces. It is only thus that economic development could arise from mere circular flow in perfect equilibrium. And this function constitutes the keystone of the modern credit structure.


There are four uses of capital: Productive Investment, Speculative Investment, Consumption and Ponzi Investment.

Only one of them should ever be undertaken with debt – that is, leverage.  That’s the first on the list.


That’s simple, really: Only the first has a reasonably reliable set of odds in returning more economic output than both the principal and interest.

The latter two never can over the intermediate and longer term.  Consumption is nothing more than pulling forward tomorrow’s demand for goods and services into today through speculative means – the promise to produce tomorrow without proof that one can do so exactly as was lampooned by Wimpy in the Popeye cartoons while Ponzi Investment can only return a profit if one can find a bigger sucker upon which you can offload your purchase.

Note that trading – which I engage in – is the latter of these.  That is, my “investment” only has value to the extent that someone else will buy it from me (or sell it to me) at a price more favorable to my account than my original act.  On-market transactions are always of this character.  A speculative use of capital only occurs when one invests in an IPO (or secondary offering) in the capital markets (stock or bond) and the invested funds go directly to the person or firm being invested in – that is, you’re betting on their ability to productively use your capital (as opposed to using it yourself.)

Should credit ever be used for those last two purposes?  No.  But will it?  Yes, in any free society.  The problem is that the use of credit to consume or engage in Ponzi investments, in a free marketplace, is always expensive because it is inherently dangerous and everyone understands that there is a great risk that you will not pay and the lender will lose their money!

This is where the problem comes from with the so-called “backstops” and machinations of The Fed and other policymakers in preventing those losses from being realized.  Credit becomes inappropriately cheap and thus replaces production as a means of creating “advance” in output.

But that output advance is illusory.  It is in fact a public fraud, in that we “report” and then make economic decisions based on things that but for the backstop of speculators and consumers that would otherwise be forced to pay an extremely high price commensurate with their risk of failure would not happen.

Worse, these policies must eventually fail, because the ability to provide that backstop is not unlimited, and when, not if, that capacity is exhausted all of the combined and compounded damage that has been loaded into the economy as a consequence must come back off.

It is rare to see someone in the investing world speak to this truth.  Yet this is not, as some assert, about “economic theory” (e.g. Austrian, Monetarist, etc) – it is about cold, hard mathematical facts.

Indeed, it is exactly to those basic facts – so often overlooked and dismissed, and only rarely if ever mentioned by an investment house – that prompted me to write Leverage.

Investors would be wise to read Mr. Hussman’s missive, and contemplate both its message and implications.

Clearly, he “gets it.”

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