Founder & Chief Analyst, Blue Lake Capital Management LLP || IIM Ahmedabad, 2007 || NiSM Certified Research Analyst || Practising Elliottician
“An economy is not a complicated thing, it just has a lot of moving parts.”
– Ray Dalio
Discussions about the broad economy are prevalent in our day to day lives. We are bombarded on a daily basis with figures on TV about inflation, unemployment and the GDP. On our daily commutes, radio show guests make sure to remind us that the economy is in a ditch and that the world is about to end. And of course, we all have a friend that follows each and every little thing that the FM or the RBI Guv says or does and how that will affect the price of tomatoes or whether India can afford purchasing French Rafales and Russian S-400s.
That being said, Macroeconomics are not the exclusive domain of madmen and pessimists. The implications of decisions made in offices far removed from the hustle and bustle of our day-to-day preoccupations do, in fact, impact our wallets.
See, our human ecosystem can be viewed as a large-scale aquarium, and money, as the water that fish ingest and breathe in.
The qualities and quantities of the liquidity (water for fish, money for humans) present in the aquarium, in addition to its movements and concentrations, directly shape the fate of millions.
Some “good samaritans” (satirical), animated by their pursuit of the greater good (or by the desire for greater control) believe that they can influence the parameters of the aquarium and engineer optimal conditions for their resident fish.
And, diametrically opposed to the aforementioned, some “wild men” try to convince us to accept the savage nature of the economy. Their ideal version of a free market strangely mirroring an anarchist’s questionable visions.
Economic doctrines have been shaped across the centuries and economists, infatuated with their theories, have always sought some measure of influence over the course of things.
Unlike eerie scientists whose experiences are limited to the confines of their laboratories, economic doctrines tend to spill out into the broader world from the academic cauldron in which they were concocted. Their impact is often overlooked as the results of the policies and systems they effect may take years (even decades) to materialize.
Keynesians thought they could tame the business cycle, smoothen the convolutions of the economy and abolish market dysfunctions. As Arthur M. Okune has put it : “Recessions are now generally considered to be fundamentally preventable, like airplane crashes and unlike hurricanes.”
Whereas I understand the general sentiment that drives this mindset, I cannot help but balk at the scent of hubris surrounding it. Furthermore, thousands of years of economic history have all but disproved our dear economist’s ability to bring any sort of permanent “fix” to the dynamic nature of the financial beast.
But what is there to “fix” anyways?
Our modern economists seem oblivious to the second and third order consequences of their prerogatives. Interventions that cause more harm than good in the medical field are qualified as iatrogenic, and the economical sphere is not impervious to similar unnecessary meddling.
What are the goals of economists? To abolish unemployment, banish recessions and control inflation?
Lofty goals I would say, but what tools do they have at their discretion to achieve them.
Aside from advising economic policy, economists can do very little directly. The levers of macro-economic power lie in the hands of institutional actors such as governments and central banks. These levers are typically declined into two prongs:
- Monetary policy and,
- Fiscal policy
Monetary policy is the avenue of India’s central bank, RBI (Reserve Bank of India). The chief aim of RBI is to maintain price stability by regulating inflation. That goal is achieved through controlling the money supply, interest rates and the availability of credit. Decisions taken by the RBI trickle all the way down to consumers and businesses.
Fiscal policy on the other hand is the avenue of the government. Through fiscal policy India’s government can stimulate the economy, especially during a downturn. And the way it does so is mainly through taxation and spending. Government spending on infrastructure projects is an example.
As we can see, through these policies, governments and central banks exert influence over the broad economy. Increasing government spending during a downturn can in theory stimulate the economy by making work available to national businesses. On the other hand, a central bank can pull the brakes on an overheating economy that manifests symptoms of inflation by raising interest rates, thus restricting the availability of capital.
Proponents of interventionism would cite the examples above to justify the necessity to “guide” the economy.
In opposition to that, others warn that measures undertaken to artificially manipulate the economy do not take into account unexpected second-order consequences that may arise as a result of the meddling. They also highlight that these policies completely ignore the centremost pillar of a healthy economy, productivity.
As far as us investors and capital allocators are concerned, it is incumbent upon us to navigate the ebb and flow of the economy. Regardless of where you fall on the spectrum of economic doctrine, the end goals remain the same: first don’t lose money, and then only, make money.
Since we seldom have little influence over the policies drafted by high offices, we can nonetheless remain aware of the developments that occur at the macro level. Macroanalysis as such is critical for success and risk management.
Some businesses are particularly sensitive to changes in monetary policy. Let’s take for example real estate and particularly the mortgage industry. A lot of relatively “safe money” can be made from investing in collateralized loans. Furthermore, as an investment product, mortgages offer predictable cash flows. Yet the industry as a whole is highly sensitive to the interest rates set by the RBI. Any changes made, whether increases or decreases in rates, can impact the attractivity of credit. Changing rates can end up completely wiping up profits or boost revenues with equal likelihoods.
Furthermore, government spending may distort free-market economics and favor some companies to the detriment of others.
In light of these probable outcomes, prudent capital management is constantly monitoring macroeconomic circumstances. It is always sensitive to the current conditions within the “aquarium”. Proper understanding of the larger economic machine and where one stands within the ecosystem informs on the appropriate strategy to adopt.
Survival of the most “adaptable” is a truism of life and business.
“Economics is too important to leave to the economists” – Steve Keen