The Dividend Cafe - Economics and Investing

Episode Date: October 22, 2021

Today's Dividend Cafe dives into some of the great economic principles one has to learn if they are to ever learn anything about economics and finds a comparison with the great investing principle of all time.  I hope I will connect the dots well for you. DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to another episode of the Dividend Cafe. Those of you listening on podcast, watching on video, the video folks know that I'm obviously not in one of my normal studios. I'm actually in my hotel room in Dallas, Texas, and I'm going to be flying back to California here in just a couple hours. Flew to Dallas from New York the other day for a couple of different meetings and a board meeting and a big gala event for a nonprofit that I'm involved with. And now it's time to go back to California. I'll be out of our Newport Beach office all of next week. The topic for this week's Diven Cafe kind of changed a little midstream. I had some stuff I was going to do yet again on the subject of global debt, the impact of debt on growth in the economy, both the inflationary and deflationary ramifications, all of those stuff. I'm never going to run out of material on that subject. And I had some things I

wanted to kind of elaborate on with new data, new information, and we'll get to that. But this week, some of you know that I am teaching an economics elective course at the high school that I co-founded in Newport Beach, California, to upperclassmen. And this week in preparing my lecture, I was rereading an essay by the late and great Friedrich Hayek on the use of knowledge in the economy. And this is about a 17-page paper that I have read many, many, many, many, many, many times in my life, particularly in my young adult life. And I started thinking about a couple of things I've already lectured on this year, some of the things that are big themes in my new book coming out, and then particularly this essay, and how there's this sort of like under-arcing philosophical framework of economics that I believe in with every ounce of breath in my body, but I've kind of devoted my whole life to. I mean, these are things that are really at the core of who I am as a person and what I believe in. And it is so dramatically impacted the way I believe about managing money. And there are a lot of things that I think have evolved in my understanding about economics because of actually being engaged in real life

management of assets that has real world ramifications, the application side informs the theory just as, of course, you want the theory to inform the application. But I don't spend a lot of time talking about the theory in Dividend Cafe because most of our listeners or readers or viewers, depending on the medium, are interested in the investment takeaways. They're interested in the conclusion. They're interested, understandably, in the takeaways. How will this make me more money? Or how will this preserve some of my money? Or how will this optimize some aspect of either my accumulation, preservation, or transfer of wealth? And those three objectives in wealth management are all-encompassing, and they are also totally acceptable, totally satisfactory.

That's what people should be thinking about. And to the extent that people are clients of the Bonson Group, that's what they pay us for. They don't pay us. I'm well aware that people do not pay me for academic pontificating. But I don't believe that such thing exists in economics. My passions for pontificating, if you will, about economics are not armchair, they're not ivory tower, they're not faculty lounge, God forbid, they're not faculty lounge. They're not cocktail hour. They're not

any of these different kind of cliches that one may use primarily as a way of marginalizing the opinions of theoreticians, if you will, of marginalizing the theoretical. the theoretical. It's my view that there is a real practical significance and that this has practical significance specifically to investment outcome. So the paper I was talking about by Friedrich Hayek had to do with the knowledge problem. And it was essentially, for those who don't know, Hayek's treatment of the fact that knowledge in a society, let alone a large one, let alone a complicated one, is incredibly dispersed. And as I just got done lecturing to 20 high school students from this very video camera just moments ago, there's a lot of knowledge dispersed amongst 20 people in

a classroom. And there's a lot of knowledge dispersed amongst the few thousands of you that are watching this video, listening to this podcast. And there's obviously more so when you go up all the way to a whole county, a whole state, a whole region, a whole country, let alone a whole globe where you get to something in the range of 8 billion people. So whether it's 330 million Americans or 8 billion worldwide or 20 people in a classroom or something in between, a lot of knowledge is dispersed that impacts decisions people make economically. And high exposition was that central planners were limited in what they could do with that knowledge versus the risk takers. Now, I would add risk takers have a more optimal incentive structure. Risk takers will hurt

from bad decisions they make, and they will benefit from good decisions. And therefore, I'm really interested in the decisions of risk takers. And that benefits other risk takers, because we can see what they're doing. And we know that what they're doing has consequences, that they reap the risks and rewards of their decisions. consequences, that they reap the risks and rewards of their decisions. And so it's informational and therefore actionable. Whereas with central planners, they don't necessarily have skin in the game. They're what we call disinterested third parties. They might be very knowledgeable about certain things. They might be very credentialed. They might just be only politically advantaged. They might just simply have good connections. But even if they're really

technocratically proficient, they don't have knowledge about everything. And Hayek's point was that the most optimal use of knowledge in an economy would come from decision makers on a decentralized basis, and that the method of communication that provides a lot of information to decision makers who are more likely to have time and place knowledge, local nuances of familiarity with available resources to solve a problem, to make decisions, to cut back on an expenditure, to add to an expenditure. The kind of management of the economy is most optimal with that local time and place knowledge that a central planner cannot have and the right incentives that a central planner cannot have and the right incentives

that a central planner cannot have. I would add as a never-ending moralizer and man of faith that I also don't believe a central planner can ever love someone. Their objective is never to actually have empathy and love for constituents the way that we may love our family or love our employees or love people that we have a relationship with, repeat customers at a restaurant. There's a more human dynamic with decentralized exchange versus centralized. But even apart from that, versus centralized. But even apart from that, the centralized planner simply cannot have the knowledge necessary to be a man or woman in the moment, responding in the moment, which is a metaphor Hayek had used. And that's where I think free markets are really powerful, is that you have incentives, you have risk and reward lined up the

right way, and then you have people making decisions. But they need this communication, and they can get a levered up access to knowledge in the economy with prices, with price discovery, what Hayek called the price mechanism. And so this is why I thought, well, some of this theoretical economic stuff is pretty important because I have believed since I began studying economics that it's a study of humans acting and that I do believe those humans who are acting were made in the image of God to be creative, to be productive, to be thoughtful. I think humans are rational. They are imperfect. They make mistakes. They could have moral failings. They could have

intellectual failings. They could have calculation failings. There's also failings that aren't really failings. And that is just taking a calculated risk and it doesn't work out. The idea that a calculated risk means you bat 1,000 is absurd. It wouldn't be a risk if you were going to bat 1,000. But it means that you measured the risk versus the reward and made a particular decision in the ebb and flow of the stewardship of your own affairs. What does this have to do with investment portfolios? I think that it is really probably

never old, never tired to reflect on the fact that this is all we are investing in. When we invest in equity markets, you're investing in the human action of entrepreneurs, of business owners, of an institution that is there to provide goods or services in an economy. There's a lot of complexity. There's a lot of speed with which these things happen. There's a lot of complexity. There's a lot of speed with which these things happen. But that there is a price mechanism that allows for a rapid adaptation to circumstances. So when all of a sudden there's price inflation coming in because of supply shortages, the actors are able to move quickly, to move prices higher, to order from an alternative source. There are decisions that can be made quicker on the ground level where there's more optics, where there's more awareness of other

resources, where there's more familiarity with nuance. And yes, philosophically, this is Hayek's point and certainly one I agree with, but the superiority of free enterprise versus central planning in the sense that I don't think central planners can have that knowledge, that adaptation, that speed, let alone the incentives and so forth and so on.

But that price mechanism is highly important. The ability to see what prices are doing as they convey signals of other information is highly important. And it affects investment outcomes. If people have less price discovery, make worse decisions, you can expect worse outcomes. Now, I made the comment a moment ago that this is what you should expect. This is what you're really investing in when you're investing in public equities. But see, I think it's what you're investing in. You're investing in human

action no matter what. You go, no, I'm just buying treasury bonds. Well, how do you think? Well, first of all, what are the treasury bonds? They are debt instruments that are to fund government. The government is spending that money on real things. And then the government plans to pay you back with taxes that come from the activity of real people. So even in the case of a treasury bond, the repayment of principal and the coupon that accompanies the debt instrument is encapsulated by human action, human activity. The idea of just buying a piece of real estate. I'm just buying an office building. I'm going to collect rent. I'm not a part of this. Well, you better hope that there are humans acting in their businesses from which they derive revenue to pay the rent in that office building. If you buy an apartment building, you better hope that

the tenants have jobs, have income. See, human activity, human enterprise is driving all forms of a return on capital. It's inescapable. It's extreme when people think of a savings account or treasury bond, but it's still true there. And then it becomes a little easier when you say, I'm investing in my friend Bill's new business startup. Well, there you just say, I'm investing in Bill's action of his business. But it's no less true when you go down the food chain of a brick and mortar investment to a treasury bond. It's all encapsulated in the same thing. And so to the extent that I find much of the equity space to deliver a better risk-reward

paradigm around human activity, and then to the extent that I believe within that, that the dividend paying companies are representing the most satisfactory means of monetizing the investor and de-risking the investor over time, I believe that it fits within our investment framework and provides a more optimal way of finding that solution. But it's inescapable no matter what you're investing in human activity. And it's inescapable human activity is informed by knowledge. I think that where there's less central planning, there can be more knowledge, better decision making.

And then where there's more price discovery, there can be more information to guide a more optimal outcome and therefore deliver better results for wealth creation, but also for investor results. We live in an era where price discovery is under assault. And that price discovery being under assault might be for good intentions. It may be even, and I make this point in dividendcafe.com today, it may be that sometimes the price discovery that is being altered, that if it weren't being altered, it still may be kind of close to what is happening. it still may be kind of close to what is happening. My point when we talk about the Fed, and this is the price discovery alteration I'm getting into, is they can have good motives or bad motives. They can make good decisions or bad ones. There's a lot of different reasons. One can think they're doing it to help monetize the government's debt and spending. One can believe they're doing it to help create full employment. One can think they're doing it to help monetize the government's debt and spending. One can believe they're doing it to help create full employment. One can think they're doing it to stabilize

financial markets. It could be all of the above, none of the above. But at the end of the day, what is indisputable is that interest, an interest rate, is a price of money. It's the price for time separated from your money. And by command controlling that price and holding it down and other mechanisms of also impacting the price of money, like quantitative easing and other instruments in the toolbox of a central bank, what you get is limited price discovery. You get an altered price mechanism. And I make the point that I think a lot of critics of the Fed have been wrong in that they've said, oh, well, the interest rate's here.

And if they got out of the way, it would go here. have been wrong, and that they've said, oh, well, the interest rate's here. And if they got out of the way, it would go here. And then in reality, there are plenty of times I'm willing to admit in the course of history that the delta between the kind of controlled rate and the natural rate has proven to not be that much, that maybe even if they didn't have their thumb on the scale, that things wouldn't be that different for a period of time. But the problem is you can't even know that because the thumb is on the scale. So it alters your ability to think about what is naturally happening in the economy. And why does the interest rate matter? It affects your cost of capital. It affects expected rates of return.

It affects the leverage you put on a project. It, you know, there's very few price signals more relevant than the cost of money. And I believe that our goals out of, and our beliefs about human action, about the knowledge problem, about all these basic economic ideas, that there's a lot of complexity and challenge that exists right now in the life of an investor. And so what I want to be able to do is explain that connection between investor desired outcomes and what the challenges of the day are. And it's not just the Fed that is altering price discovery. Anything that creates more rigidity in prices limits the signal benefit. The more inflexible prices are, the less able we are to get information from them that can guide optimal decision-making in a free economy. can guide optimal decision-making in a free economy. So my belief is that next week's talk needs to focus on what the investment implications of this are in private markets, in public markets,

in debt, in equity, and how we're viewing these things. Because the last thing I want someone who gets paid to manage money for a living to do is to not think about this, to not care about it, to not understand it. I think it's malpractice. And yet understanding it theoretically still has to lead to the burden of application. And that's, of course, what we're here to do. So I guess I've gone on long enough for this week, but I look forward to coming back to you next week. Big week ahead for us at the Bonson Group. We're so excited to be able to present to you the Dividend Cafe every week. Please do read dividendcafe.com. Subscribe if you haven't already. Subscribe on YouTube or on the podcast player of your choice. And we appreciate your continued listening to,

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