#28. Be your own “investor-economist”



Whilst economists are understandably loathe to admit it, their social science is in chaos.

All the old verities have gone up in smoke. Keynesians are at a loss to explain why brisk growth has not been restored despite the injection of truly staggering amounts of stimulus.

Liberal economists, meanwhile, are keeping their heads well below the parapet, since their ideology of minimal (for which often read “negligent”) regulation must carry a huge share of the blame for the biggest boom-bust in economic history.

Perhaps worst of all, those economists who claim to be most committed to the capitalist system often show a woeful ignorance of what capitalism actually is.

There can never have been a better time, then, for investors (in particular) to ask themselves this question – do I need economists, or can I do a better job of this myself?

The reality, you see, is that you really can do a far better job of the economy than economists can.

Official forecasting underlines this point. In round terms, the real (inflation-adjusted) output of the British economy is going to be roughly the same this year as it was in 2008. Had the forecasts of the independent Office for Budget Responsibility (OBR) been right, however, it would have been more than 7% larger. This is a huge difference.

The key point, though, is not just that even the best economists’ get their growth forecasts woefully wrong, but that they concentrate almost entirely on growth, to which they then append some supposedly growth-linked numbers such as unemployment.

Where investors do better

This almost exclusive concentration on growth is analogous to an investor who looks only at reported profits. Such an investor would not get very far, because his approach would be hopelessly narrow and naïve.

Rather, the astute investor is likely to look at equity investments very differently.

First, he looks behind the earnings statement to see if the reported number has been distorted by “extraordinary”, “special” or “non-recurring” items.

Second, he looks at cash flow as a better guide to performance than earnings, recognising that it’s cash, not earnings, which pays dividends, funds expansion and indicates whether performance is improving or weakening.

Third, he excludes movements in working capital (cash and equivalents, debtors and creditors) from his definition of cash from operations, which is not to say that he ignores these movements.

Fourth, he looks at the balance sheet, noting how cash flow, expenditures, debt and cash interact. Growth in earnings (or, for that matter, in cash flow) is all very well, but not if it is being “bought” using disproportionately large amounts of debt.

Fifth, he looks at industry prospects in the sector (or sectors) in which the company is involved. If the business is a conglomerate, of course, he balances his view of each of the activities in which the company is involved.

Next, he assesses both management quality and governance, since the quality of the hand on the tiller and the navigator on the bridge will do a lot to determine the course that is followed, and how competently the corporate ship weathers unexpected storms.

Lastly (for now, anyway) he looks at the creation of value for shareholders, since the bottom line has to be the return on investment earned for the owners of the business. Of course, the wise investor realises that companies also serve a broader constituency which includes stakeholders such as customers, employees, suppliers, the environment and the broader community, and recognises that a corporation which exploits or disregards any of these interest groups may be courting trouble.

The economy – the investor perspective

Getting away from the obsession with the simple “growth” metric, and adapting investor methods to the economy, can produce a much more nuanced and broader assessment of the economy.

Taking Britain as an example, what conclusions might “the investor-economist” arrive at?

Well, he would certainly look behind seemingly satisfactory growth figures to discern that, on an “underlying cash flow” basis, the picture is far from rosy. He would note that growth is being bought very expensively, in that additions to debt have long exceeded (and continue to exceed) increments to GDP.

He would further note that cash flow (and GDP) are being flattered by unsustainable movements in working capital, specifically a very severe current account deficit (which shows that 5.5% of GDP is being funded by the forbearance of overseas trading partners).

He would then notice that asset sales and borrowing are being used to bridge this gap, and would wonder quite how long this can go on, given that UK plc is very heavily indebted, and has already sold a big chunk of its industrial asset base.

Indeed, debts of almost 500% of GDP, plus “off balance sheet” contingent liabilities (including public sector pension commitments) would give our “investor-economist” very considerable food for thought.

Industry prospects, too, would worry him, since about 70% of the British “economic conglomerate” is invested in “ex-growth” sectors dependent either on private borrowing or on debt-funded public spending.

I’m not going to comment here on UK plc’s “management quality” but, where “governance” is concerned, I have no hesitation in observing that a more genuinely democratic system might be better than the over-centralised, under-responsive “Westminster model” where shareholder value is concerned.

Lastly, shareholder (and stakeholder) value looks less than robust, since income growth has now lagged living costs for an uncomfortably long time (anywhere from seven to twelve years, depending on how you measure it).

Do It Yourself

In this discussion, I argue that the ordinary person, using sound investment principles, can do a better job of the economy than economists can.

There can be no better way to conclude than by asking you to try this for yourself – and share your conclusions here!

#27. Energy costs – necessity, not folly

IF YOU’RE FAMILIAR WITH THE SURPLUS ENERGY INTERPRETATION OF THE ECONOMY, it won’t surprise you one bit that the global cost of energy has soared – it’s exactly what those of us who understand these things have been expecting and predicting.
According to the SEEDS model, the total trend cost of energy this year should be of the order of US$5 trillion, a number which includes operating and downstream expenses as well as through-cycle exploration and developments costs.

There is, though, a curious notion doing the rounds, which says that the energy companies’ vast capital investment is a mistake, because renewables will sweep in under the radar and turn this commitment into a capital sink. Indeed, the huge sums now being invested in oil, gas and coal have even been likened to sub-prime.

Frankly, this notion is one of the sillier ones that I’ve encountered for quite some time. It assumes that renewables can be scaled up to the point where the oil, gas and coal being developed now will be undercut by cheaper fuels. It also – inevitably – calls technology to the aid of an argument which simply doesn’t hold water.

Let’s deal with technology first. Energy supply, no less than the universe more generally, is governed by the laws of science, and particularly by the laws of thermodynamics. Technology can improve how things are done within the envelope dictated by the laws of physics, but it can not bend that envelope.

Technology can make a solar panel more efficient, but it cannot capture a square metre of solar exposure on a panel the size of a postage stamp. Technology can make wind turbines more efficient, but cannot reduce their height to three feet or reduce blade size to six inches. Likewise, battery efficiency continues to improve, but the scope for this improvement is limited by the laws of physics.


WE NEED TO BE PRETTY SCEPTICAL ABOUT THE ASSUMED SCALING UP RENEWABLES. Let me cite for you Chris Martenson’s analysis of how we might replace the quantity of oil – not gas or coal, mind, just oil – consumed in 2009.

Chris sets out our non-fossil alternatives to oil like this:
– Increasing the number of nuclear reactors in operation from 400 to more than 6,800
– Building 17 million new wind turbines
– Covering 13 million acres with solar PV panels
– Committing 16 billion acres, or 135% of the globe’s arable land, to biofuels.

Taking the latter as an example, Chris is talking about replacing the volume of oil with fuel crops. But about half of the energy produced by biofuels is consumed in planting, harvesting, processing and transport, so to give us the same quantity of net or “usable” fuel we would need to cover 270% of our arable land with biofuel crops.

And this, of course, is just to replace oil. Add in gas and coal as well and we’re talking 720% of all arable land, so we’d need seven planets for the energy industry and an eighth one for food. You’d need a pretty defective radar not to see the snags there.

I could perform similar mathematics to show how other renewables aren’t a substitute for fossil fuels either. Instead, let me make a couple of other points. First, oil (in particular) gives us high density, concentrated energy that can be used directly. Renewables don’t give you that, which is why using electricity (most of which is made from fossil fuels) to propel cars is a bit of a gimmick.

Second, consider the minerals used in building any of the alternatives to fossil fuels. Mining copper, for instance, involves shifting 500 tonnes of rock for each tonne of copper extracted. This is done using huge diesel-powered vehicles, to which there is no realistic alternative. Our steelworks, smelting plants and similar vital facilities are legacy assets, built in an era of cheap energy – and they will not last forever.


THE REALITY IS SIMPLER. Soaring capex is a direct consequence of an escalation in unit costs as easy-to-access, low-cost supplies of energy are displaced by ever more expensive alternatives. The idea that this expenditure will be left stranded by renewables is a pipe-dream.

The correct conclusion to draw is that an on-going process of “energy sprawl” – in which energy absorbs an ever greater percentage of global GDP – is happening before our eyes.

I think you know my view of renewables. Some (like solar power) can provide a critical contribution to the energy picture. Others, typified by biofuels, are a disaster. Still others lie in between these polar extremes.

The explanation for the vast sums being invested by energy companies is simpler, and harsher, than the subprime parallel. Subprime was a purely financial form of idiocy, as are other cases of over-pricing homes – capital is diverted into an unproductive “sink” instead of being invested constructively. Energy costs are a completely different issue, governed by the laws of thermodynamics.


THERE ARE INDEED INVESTMENT LESSONS TO BE DRAWN from the escalating cost of energy, but these lessons do not involve wastage of capital by the energy giants.

Continued high energy prices should be very positive for solar operators, but commentators should focus just as much on the squeezing out of non-energy activities as an ever greater proportion of economic capacity is invested in essentials such as food, water, minerals and, of course, fuel.

#26. Moving the deck-chairs

UNLESS SUCH THINGS HOLD A FASCINATION FOR YOU, the details of David Cameron’s cabinet reshuffle will be of little or no interest. What matters much more is the logic (if such it can be called) behind what is almost certainly the last big shake-up before next May’s general election.

There are two big ideas behind this move – and both typify the kind of thinking that, over decades, has moved Britain ever closer to an economic disaster. One of these mistakes is a preference for campaigning over governing. The other is the apparent desire to have more women in the cabinet.

Taking the latter point first, I find it astonishing that senior appointments continue to be made seemingly on the basis of gender rather than ability.

The only criterion for appointment to high office should be suitability for the task. If David Cameron is more concerned with what his cabinet looks like than how good it is at its job, he must be every bit as addicted as his inept predecessors to putting spin before substance.

Moving Michael Gove from education (where he seems to have done an excellent job) has been done, apparently, to give him a more prominent role in campaigning.

That’s it, then – the government moves an excellent minister because the Tory party’s immediate electoral prospects are more important than sorting out education.

THIS MOVING OF THE DECK-CHAIRS REINFORCES BRITAIN’S SIMILARITY TO TITANIC, though, even there, Ismay and Smith did not reassign officers’ responsibilities whilst water was pouring into the hold (or, in point of fact, actually move any furniture). The economic outlook is such that Britain simply cannot afford to select its leaders on the basis of anything other than ability. As for putting party politics before considerations of substance, any comment from me would surely be superfluous.

Let me spell out what the real issues are.

First, Britain depends on borrowing to create “growth”, and the increment to GDP this year seems sure to be, as usual, a lot smaller than the additional debt taken on to finance it.

An economic policy which involves borrowing money, channelling it into consumer spending and then describing the outcome as “growth” is an imbecility that has been with us for far too long. It has made us by far the most indebted major economy, with formal debt at close to 500% of GDP even without the inclusion of vast informal quasi-debts, such as public sector pension commitments, PFI and the off-balance-sheet debts of state-owned enterprises.

Britain’s current account deficit, meanwhile, reveals that we are rapidly running out of time. Though we’ve been in the red on trade for three decades, the big change revealed by this broader number is that our previous big surplus on net investment income has gone up in smoke. Profits and interest remitted out of Britain now exceed the amounts coming in, a situation that can only get worse as more assets are sold to foreign buyers, and more overseas debt is taken on.

A recent analysis suggested that, even on the most optimistic assessment of our net asset position, we can only support a current account imbalance of 4% of GDP for a maximum of five years. Given that the deficit is actually well over 5%, we may have less than four years in which to sort this out.

The energy outlook should reinforce a sense of urgency, since North Sea output continues its sharp decline whilst we are years away from commissioning replacements for our ageing nuclear capacity. I’ve long believed that the lights could go out in the winter of 2014-15, and it won’t be long before we find out if I’m right.

ULTIMATELY, THE NEED FOR REFORM goes far beyond the need to shore up our energy supplies, reduce our imports and, more generally, find a growth model that does not depend on borrowing-to-spend.

Britain needs new ways of doing business, and time is short. Shuffling ministers who, for the most part, are unknown to the voters can play no part in this process unless it concentrates abilities where they are needed most.

Titanic, of course, had too few lifeboats. Britain, as things stand, has none at all.