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Decimal Digest
14 May 2012

The state of current political economy and its effect on relative asset values

The American economist, Abba Lerner once stated “Economics has gained the title of queen of the social sciences by choosing solved political problems as its domain.”

However, the current economic & political landscape seems like an exhibit of post-modern art – subject to many interpretations and capable of producing a rainbow of emotions – from exhilaration for the left-leaning thinkers to confusion & sorrow for the followers of Keynes. Right now, on the surface, nothing seems to be solvable, and future seems to be capable of engendering any of the possible outcomes –imaginable or unimaginable.

In the next few paragraphs, we will make an attempt to find a unified theme in the current confusing situation, which can potentially become a guiding beacon for investors.

In spite of following textbook Keynes for last two decades, Japan has not achieved anything - apart from accumulating sovereign debt 2x of GDP from negligible starting levels two decade ago.

The recent upheaval in Chongquing underscores willingness of Chinese ruling elite to weed out the left leaning elements, like Bo Xilai, from within them. Paradoxically, at the same time, the voters in Latin Europe are leaning towards leftist or even fascist politicians.

The above, and all other sundry trends, such as OWS movement in the USA, the half-based Arab Spring, the expected short-term reversion of India to Hindu rate of growth are all attributable to the excesses of post-Bretton Woods period.

These excesses started with increasing international trade imbalances, as a result of globalization. However, to counter the social effect of trade imbalances, many western economies resorted to the opium of a bigger welfare state. Nobody dares to point out that globalization and welfare state are ideologically incompatible. Also, to manage the increasing financing needs arising out of chronic trade and fiscal imbalances, many policy makers are forced to become writers of “post-facto put options” to the influential financiers. Again, nobody dares to point out that the provision of welfare state and provision of policy-based put options are ideologically incompatible.

At this stage, one needs to remember that we humans are a species in animal kingdom, and all our advanced facilities are a result of natural selection, namely infinite iterations of cycle of variation and selection. Any attempt to move away from principles of natural selection will ultimately lead to deterioration of the human race. Keynesian thinking attempts to reduce the variation by trying to reduce the amplitude of economic cycle. Leftist thinking attempts to reduce adverse effects of selection, either by providing so-called safety nets or by attempting to distribute wealth evenly.

The thoughts in the above paragraph are startling for many, leading to popular, even violent, backslash against such thinking. However, the alternative of soothing the pain, either of general public or of large financiers, through larger government will ultimately produce suboptimal results. Again, as people start seeing this sub-optimality, in the long-term, only pure form of competitive, transparent capitalism will be chosen. However, path to the same can be full of uncertainty and even violence.

This is the unified investment theme – theme of faith in success of transparent, competitive economic system; with a very uncertain path towards it. How to play this theme? Stay with economies with long-term skill-based competitiveness, stay with companies whose products will be demanded more during uncertain times, and maybe rethink about level of direct and indirect leverage in and surrounding your portfolio. Ultimately, Darwinism will become the true economic principle. Or should we say, Viva Angela?


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