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Sage Capital Zrich AGBellerivestrasse 558034 Zrich

Tel +41 43 210 30 30Fax +41 43 210 30 [email protected]

On the nature of money, capital, scarcity, growth and

capital preservation. A wide-ranging discussion on investment

issues with the Austrian-school strategist of Sage Capital.

A conversation with Sean Corrigan

Mises meets Graham and Dodd

Q: Sean, during last weeks annual shareholders meeting of

Berkshire-Hathaway, Mr. Buffett suggested that sometime in the

next ten years he expects an economic disaster. Has someoneconverted him to agloom-and-doomer or what?

A: As we can infer from his expressed difficulty in finding

suitable investments these days, Mr. Buffett seems to realize

that wealth creation is becoming impaired by, not facilitated

by, the enormities of our present-day financial system. As one

who has made his money partly through a close reading of

balance sheets and income statements, he, of all men , must be well aware that

increasing indebtedness at an exponential rate, when the pace of material progress is

much less rapid and continuous, is a sure road to the poor house.

Q: Yes, but, you know, people have been forecasting disasters forever. There are a

number of people out there who make tidy profits preaching doom and gloom, but it

never happens. Life just goes on. Now Buffett pipes in with such melodrama. It makes

one stand up and take notice, no?

A: We should be careful of making the Sage of Omahaan investment geniusinto the

Oracle of Omaha the possessor of an economic crystal ball: he himself would

traditionally never have claimed any such a special insight. That said, when eminent

A conversation with Sean Corrigan Page 1


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investors such as Buffett, Sir John Templeton, Jim Rogers, and Pimcos Bill Gross, as

well as and sober and well-regarded market analysts such as Richard Russell, express

opinions ranging from caution to outright alarm at the state of play, we, too, should at

least consider what it is that they see that the central bankers and their mainstream

worshippers fail to recognize.

Q: Speaking of disasters let me ask you something. Virtually all Austrians view the

cup as being half-emptyI mean, constantly and forever bearish on the world. In the

meantime and somehow, the world keeps going. Lets be honest, can Austrians really

be good investment advisers?

A: A good point! After all, Mises himself once wondered whether, instead of being a

teacher, he was doomed to be merely a historian of decline, but he never yielded from

the task of pointing out the right path. Austrians are not pessimists, only realists. We

know that much of the present-day menu of policy choices are founded on erroneous

principles and thus do more harm than good, even when well-intended. However, we

also know that it is the lot of individuals, in the main, to make their own lives better by

materially enriching others and that it takes a very great deal of folly and vice to stemthe wellspring of entrepreneurialism which waters the fields of human endeavour.

Q: Fair enough. But again, what is it about the Austrian school that gives you any

marginal advantage in money management?

A: The Austrian school on its positive side teaches us to glory in the power of the

unhampered market to increase wealth and well-being even in the face of government

interference - and it extols the roll of the honest entrepreneur as the main agent of this

progress, praising his profits as a mark of his success in bringing about such

improvements. However, it also teaches us that the laws of scarcity are not to be

avoided by the simple printing of money; that mere technological know-how is not asufficient condition for our advance; that savings foregone present consumption

wisely parlayed into capital by placing them at the disposal of entrepreneurs is what

fuels the increase in our prosperity. The first helps us avoid unwanted pessimism: the

second instills in us a due measure of caution and helps immunize us against

investment maniasnot a bad philosophical starting point for money management,

surely!

Q: Yes, but you also seem to dismiss statistics and the whole lot of modern financial

analytics, no?

A: Yes, Austrian economics dismisses the supposed predictive ability of statistics andoffers valid criticisms of the worth of the common catch-all aggregates such as growth

and CPI, or productivity served up to us by the bureaucrats, while it teaches us to

beyond the immediate effects of any spontaneous change or imposed policy shift.

Among other benefits, this makes us Austrians suspicious of the whole spectrum of

fancy financial engineering marketed to the public an approach which always sounds

impressive, with its scientific-sounding reliance on back-tested models and volatility-

based Value-at-Risk assessments to guide investment policy, but which is really no



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more than an abstruse way of saying Tomorrow will look much like Yesterday, when

all the evidence of history is that it never quite manages this feat!

Q: You have written a great deal over the past few years on the nature of capital in

view of theory and changes in our world. Make it simpler for us: what is money or

wealth and has this changed from what we used to think?

A: I will try. If you have a $10 bill in your pocket which you have earned honestly, you

have a token which says you added wealth to anothers life, but you have yet to decide

in what form to take your true reward. Now, if you buy a few gallons of gas with it,

you have converted the money into wealth- that is, into a good which is scarce and

which is valued by you and by others for its inherent qualities.

Q: Help me out here, why is gas scarce?

A: An economist might say it is scarce because it has a price, but I suspect that answer

would not satisfy you too much!

Q: Make it a little simpler.

A: I am only using gas as an example here, but the point is that the quality of scarcity

means that gas is not created costlessly and that it is not available without limit.

Scarcity here is a technical term which must not be confused with shortage. Free

markets ration scarce goods via the price mechanism: only Providence or that less

benign deity, the State, can ever create an actual shortage! Gas, then, may seem to be

readily available at the price at which it is offered today there is no shortage of it -

but that price must, in the long-run, reflect the extraordinary amount of effort, of capital

resource, of human sweat and intellectual input, needed to take it out of the depths of

the ocean, to refine it, ship it and arrange for you to be able to pump it into yourHummer in other words, it is scarce.

Q: Thank you. Please go on.

A: If you now use the gas to drive to the beach for a day out, or use it to light your

barbecue, you have consumed it once and for all and so you must see that while we

obviously acquire wealth in the first place in order to gratify our desires, consuming it

does just that it exhausts it, once and for all.

Q: Makes sense to me.

A: If, however, we use the gas in the course of picking up goods to stock in our corner

store, or in running a power lathe to make an ax handle, we are using up this material

in a productive fashion. Now, though we may have consumed the gas itself, we have

replaced it with another, potentially more valuable, form of wealth the wares in our

store-room, or the tool with which we will cut timber, to sell direct or with which to

build something, in turn. You must see that the initial decision to buy gas has now been

seen to have been nothing less than an investment and this has led to the formation of

capital whether circulating capital such as goods-in-process or inventory or fixed



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capital; plant and equipment. The gas itself has been used up just the same, but its

consumption has now beenproductive it has led to the creation of some other form of

wealth in its place not exhaustive as it was when we grilled our dinner with it.

Getting the balance wrong between these two uses lies at the root of much of our

economic woe and the inability to distinguish between them so that we parrot

nonsense like, the consumer is seven-tenths of the economy is the occasion for most

of the wrong-headed interference by central banks and governments who think that

consumption must always be stimulated, no matter how wastefully, or at whatever

cost to our financial status. To sum up this matter of the difference between money

and wealth; nowadays, sadly, too many people believe a bank balance represents

wealth - even if this balance was instantly conjured into being by the bank writing us

down for a loan. In the topsy-turvy world in which we live today, consumption of the

exhaustive kind - not production - is supposed to bring us prosperity and possessing a

credit line (i.e. the ability to go into debt and so to pre-empt tomorrows creation of

wealth) is seen as a mark of our riches!

Q: As one looks around, he sees what appears to be an incredible love affair withthings financialperhaps to the point of absurdity. As I can vaguely remember the

lives of my parents and grandparents, this was not the case in years past. What has

changed? And is this good or bad?

A: All things in moderation is as sound a precept in finance as it is in dietary science. I

sometimes point to the contrast between todays Casino economy with a pawn shop

outside every saloon and our Fathers Machine Shop economy with a savings bank

at the corner of every block. Having an enhanced ability to lend or to borrow and

having more liquid and transparent markets through which to raise and in which to

place funds is obviously a benefit, but when there is no connection between the amount

of credit extended and the volume of savings voluntarily made beforehand, and whenfinance becomes both a speculative end in itself, as well as a means by which to confuse

those to whom greedy executives and self-enriching directors have a duty of trust, then

matters have clearly gone too far.

Q: You once described General Motors as a giant finance house with a garage in back.

But, if the idea is to make a profit, and if industry is making a profit, does it matter

how? I mean, isnt profitability the sine qua non of capitalism? If companies can deliver

these by financial means and if individuals want to speculate in index funds and so

long as the activity is profitable for both, what difference does it make?

A: Buffett himself had words to say on this score, a year or two back, when he askedhow it was that people, who had simply borrowed money to dabble in the market and

had then sat back while their actions and those of all their neighbors, who were out

doing the same thing, drove ALL stock prices higher, could come to believe that they

had miraculously all become wealthier. After all, nobody here had actually DONE

anything. No-one had hoed a row of beans, or cut out the pattern for a dress. No-one

had invented a better beer can, or had shipped some mineral from where it was

relatively cheap to where it was more urgently wanted and thus, more highly priced.



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In fact, the main reason that stock prices had risen was because they were among the

prime beneficiaries of the ongoing monetary inflation which was taking place, so all

that was happening was that much the same amount of genuine wealth was being

measured by a yardstick onto which the Fed and its peers, via the agency of the banks

and brokers, were cramming more and smaller inches. This way, people came to

believe they had a few extra of these new yards of cloth, but, in fact, they had no more

material than before with which to cover their nakedness indeed, since they now

owed more money than ever before much of the cloth they did have was effectively

pledged to someone else instead.

Q: Now, arent you just dismissing the business of finance in general?

A: Look, finance is supposed to be a facilitator of wealth creation: it should never

become an end in itself, for, then, all we end up doing is to indulge in the same illusion

as that of a gambler on a hot streak who boasts of his riches while eagerly ploughing his

winnings back into the same game of craps. Sooner, or later, hes going to shoot snake

eyes and, sooner or later, in a business, or under an investment policy, based on

nothing more than the effects of financial manipulation, all but the lucky few and theeven more uncommon number of instinctive traders, will also wake up to the true

import of the adage that while assets may go down, as well as up, in price, liabilities

always have 100 cents in every dollar.

Q: If a man was dropped from Mars and his job was to read the financial press, hed

undoubtedly be amazed at the divergence of opinion that exists among those who

profess or imply expertise. Frankly, hed be confused by the conflicting voices. Why is

this and how can a person with genuine interest separate the wheat from the chaff, so

to speak?

A: Remember that, by and large, if you wouldnt run your own household, or manageyour own family firm in the way the experts suppose they can direct that mythical

beast known as the Economy, thenyou are probably right and they are probably

wrong, no matter which Wall Street firm, government department or academic faculty

they hail from! Be suspicious of people who say more government involvement is

better and that cheaper and more available money is the answer to all ills.

As to the first, consider what the very different consequences were of the Russians

following Marx and the Americans initially following Jefferson. As to the second, ask

yourself whether we could possibly all be better off if we all, simultaneously, took out a

pen and added another nought to the end of the denomination of each dollar bill in our

pockets. Finally, bear Henry Hazlitts famous One Lesson in mind: namely that the artof economics consists in looking not merely at the immediate, but at the longer, effects

of any policy; it consists in tracing the consequences not merely for one group, but for

ALL groups.

Q. What do you mean?

A: Well, you never win at chess simply by working out your next move. Unfortunately,

those who prognosticate on the economy are not grandmasters, who can look ahead ten



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Q: Surely something impossible in real life...

A: Exactly. Take the case instead of an isolated community in which there is just one

bakers shop. If the honest and hard-working baker can produce enough bread to feed

his customers, year in and year out: if the proceeds of his sales are always enough to

buy in his flour and coal and to repair, replace, and occasionally to upgrade, his ovens

and his shop premises; if he can also compensate his staff; if, all that having been seen

to, he can rely upon having enough left over to feed himself and his family, the baker

has clearly secured his livelihood in the face of all foreseeable events. Now it should be

obvious that there has been no hint of growth here, yet certainly, we might wish to

have a share in the bakers business to likewise enjoy such relative security though we

would be very careful indeed to make sure we judged the price we paid to be

commensurate with the prospective income.

Q: Sounds like a great business.

A: Yes, but now enter a stock promoter, a Wharton MBA, and a Harvard Law Schoolgraduate and the next thing you know, there would be no-one who would think it

foolish that the baker should borrow money to buy two ovens, in place of his single

one. Soon, no-one would be left to suggest that he should not be seeking to merge his

business with the miller, or the butcher - or even with the man who paints his store.

Nor would anyone would desist from trying to persuade him that he would gain more

sales through extending credit to his customers, especially if the loans could be

repackaged and booked elsewhere so none might suspect he was impairing his own

creditworthiness as he did. Before long, there would be a rush to enter into an auction

to try to bid the shop away from him, almost irrespective of the price paid indeed, the

auction would be characterized by ever more urgent bids, the higher the price had

already risen! Growth and increased shareholder value would now be the buzzwords and there would be a brief glow of self-congratulation among the bakers

stockholders, large and small, while our trio of financial interlopers would be growing

fat on fees and commissions.

Q: So, whats wrong with that?

A: To start with, nothing suggests that the bakery would henceforth turn out any extra

loaves, or that, if it did, that these would command greater aggregate revenues in the

marketplace than before. Sadly, then, the fetish for growth would have left a great

many of its cult-followers to endure either lessened returns, or outright losses and, if

things were to go really awry, the upshot might even be that the baker, who haddevoted more time and money to making his share price, rather than his breakfast rolls,

rise, might be forced out of business in the inevitable collapse, so that the people of the

village might not only be monetarily the poorer, but more hungry, too.

Q: Surely there is a kind of growth that you do like, no?

A: Indeed, growth is clearly something to be welcomed, but it should be the growth of a

sturdy oak, deeply-rooted on a fertile and well-watered hillside: a tree, whose rings



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might thicken a little more in good years than in poor, but which will continue to

spread a little wider and to climb a little higher throughout all the long ages,

impervious to all but the most savage tempest. But what we must never do is to listen

to the blandishments of the seed catalogue salesman and to overlook the staid old oak

for the newly-planted and exotic saplings stippling the field below, whose expected

rapid gain in height will be only the result of extensive irrigation, the liberal application

of fertilizer, and a constant dousing in pesticides. This crop often grown precisely

because it is new, or because it is the subject of a passing dietary fad, but which is

inherently sickly and prey to all the vicissitudes of the season - may seem to grow

faster initially, but, it is one whose harvest of fruit is far too uncertain in both quantity

and value (as fickle tastes inevitably change) to be the focus of a wise programme of

investment.

Q: Is there a main thrust to this thinking?

A: Well, as the Austrians are often at pains to point out, by and large the only way to

preserve capital in the long run is to identify honest, hard-working and far-sighted

entrepreneurs in whom to invest men who can peer that little bit more acutely into thefog of Tomorrow and who can take ones own wealth often acquired through ones

own prior entrepreneurialism first to nurture it, then to multiply it by best and most

profitably serving the identified needs of their customers. So, we can only ultimately

preserve our own capital by making it contribute in some way to the improvement of

the general commonwealth. Not a bad objective to which to adhere, Id say!

Q: So, are you really mixing a bit of Ludwig von Mises with a dash of Graham and

Dodd here?

A: That seems a neat way to sum it all up.

11 May 2004

[email protected]

www.sagecapital.com
