Going Venezuela

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The views and opinions expressed in this article are those of the authors. CdR Capital Ltd is authorised and regulated by the Financial Conduct Authority. This article is for professional clients and eligible counterparties as defined by the FCA only.

Will some economies ever learn?

“Chavez is the best president Columbia has ever had” ~ Columbian home owner

Albert Einstein is said to have defined insanity as doing the same thing over and over again and expecting different results. In Wriston’s Law of Capital and Sleeper pins, reports I wrote in 2012 and 2014, I have defined the term ‘going Venezuela’ as “doing the wrong thing repeatedly and with great conviction.”¹

The two ideas are related. Both imply the absence of learning. The term is consistent with the Iron Law of Failure and Wriston’s Law of Capital, and is widely applicable to economies and societies that fail.

Two prominent textbook examples of long-term economic failure are Egypt and Argentina. At the beginning of the 19th century, both Egypt and Argentina were in an excellent position to excel. They were both larger than Germany at the time and multiples larger than South Korea, for example.

Today, the GDP per capita of both Egypt and Argentina is nearly four times lower than that of Germany and more than two times lower than that of South Korea. I believe neither has learned from their mistakes.

The fascination with Venezuela’s failure is not its magnitude, but the speed of the decay and the romanticised Che Guevara-manner by which the economic self-mutilation has been inflicted upon the oil-rich Dutch disease-suffering Latin republic.

The problem today is that the West is in a negative feedback loop with large parts of the industrialised world “going Venezuela” too.

The Iron Law of Failure

In the end, everything fails. Extinction is common in business, life and everything. In fact, 99.99% of all biological species that have ever existed are now extinct². On a somewhat shorter timescale, companies, governments, empires and political unions fail too. In 2006, Economist Paul Ormerod called this the Iron Law of Failure.

“The Iron Law of Failure appears to extend from the world of biology into human activities, into social and economic organisations. The precise mathematical relationship which describes the link between the frequency and size of the extinction of companies, for example, is virtually identical to that which describes the extinction of biological species in the fossil record. Only the timescales differ.”³

The Soviet Union and the European Union are good examples. Both started with good intentions and we all know with what the road to hell is paved. The former we call a failure because the failure has already taken place. The latter we call ‘political risk’ because the failure is apparent to many market observers but the process of failure is not yet complete.

As Margaret Thatcher put it in 2002, “Europe is the result of plans. It is, in fact, a classic utopian project, a monument to the vanity of intellectuals, a programme whose inevitable destiny is failure: only the scale of the final damage done is in doubt.”4 Mrs. Thatcher essentially quipped that the EU was ‘going Venezuela.’ The parallels to the Soviet Union are manifold.

Failure is not an ‘if’ question but a ‘how exactly’ and ‘when’ question. This means Brexit is just about one nail in the coffin. The pending constitutional referendum in Italy5 could be the next one. And whether or not a potential Frexit next year will be the historical equivalent of—by revolutionary standards—the orderly removal of the Berlin Wall in 1989, we do not know yet.

Brexit in June of this year and the pending handover of the political baton as well as the ‘biscuit’ (America’s nuclear briefcase) to an infantile and narcissistic egomaniac are confirmation that Vladimir Lenin was onto something when he said that “there are decades when nothing happens, and there are weeks when decades happen.”

Some commentators were quick to argue that—after an acceptance speech by the new leader of the free world that suggested he could be not entirely maniacal—everything will be just fine. One interpretation of history is to call those contemporaries appeasers. However, an optimist could argue that the new US leadership understands Wriston’s Law of Capital and might act accordingly.

Wriston’s Law of Capital

Wriston’s Law of Capital is named after Walter Bigelow Wriston (1919-2005), a banker and former chairman and CEO of Citicorp. The term Wriston’s Law of Capital was coined by Forbes magazine’s Rich Karlgaard from an article on his blog Digital Rules in 2006:

“Capital will always go where it’s welcome and stay where it’s well treated… Capital is not just money. It’s also talent and ideas. They, too, will go where they’re welcome and stay where they are well treated.” 6

Wriston’s Law of Capital is called many different things, including ‘common sense’ among practitioners with an aversion to over-intellectualise the simple and obvious. The reason for mentioning it here is that this law, like the Iron Law of Failure, is ubiquitously true and can explain the movement of capital—where capital is broadly defined—very well.

This law explains what went wrong in Stalin’s Russia, Mao’s China, Perón‘s Argentina and Chavez’s Venezuela. The Columbian home owner7 quoted at the start sums up Wriston’s Law of Capital best because Columbia became a magnet for capital.

Putting it another way, no American ever risked his life to get to Cuba. The flow of capital is always towards freedom and opportunity and away from repressive and kleptocratic regimes. Always.

Over the past couple of decades many industrialised economies have accumulated vast amounts of debt. This debt has not been put to good use. In an epochal misinterpretation of Keynes, the debt was used, not to invest in the future, but to build and expand the welfare state.

This means the debt was used for consumption rather than investment. We know this by measuring the gain in productivity of the marginal unit of debt. The marginal gain has been falling continuously and productivity has decreased because of the widespread misallocation of capital.

The current financial repression (ultra-low or negative interest rates, quantitative easing in all its forms, potential helicopter money and limitation to the use of cash) are desperate attempts to uphold the welfare-socialist dream via governmental re-allocation of capital.

All of this means that the West “went Venezuela”, and now Stein’s Law applies.

Stein’s Law

Herbert Stein (1916-1999), Chairman of the Council of Economic Advisers under Presidents Richard Nixon and Gerald Ford, was the formulator of Stein’s Law, which he expressed as “If something cannot go on forever, it will stop”.

By this Stein meant that if a trend (balance of payments deficits in his example) cannot go on forever, there is no need for action or a programme to make it stop, much less to make it stop immediately; it will stop of its own accord.

The practical relevance of this is that an economy, or a political union, based on a romanticised perception of peace and harmony, can only disregard Wriston’s Law of Capital and be “going Venezuela” for so long. Stein’s Law gives us the conviction that, in the end, the Iron Law of Failure does indeed apply.

A very optimistic assessment of Brexit and the Trump victory is that there is indeed wisdom in crowds, as it is sometimes claimed, and the trend of socialisation is reversed.

It is well known that when one is in a hole, one ought to stop digging. This means that changing the variables, institutions and political establishment, which caused the fall into the hole in the first place, is a good starting point for reform.

This would mean changing the socio-economic structure in a way that capital is not ousted but embraced; to allow that capital can move towards opportunity and not towards governmental dependence; towards freedom, and not more repression.

This would result in the reformer’s productivity—the ultimate source of prosperity—to improve.

 

Alexander Ineichen is the founder of Ineichen Research and Management (IR&M), an independent Zug-based research firm focusing on investment themes related to absolute returns and risk management.

¹ See: Wriston’s Law of Capital (10.7.2012) and Sleeper pins (11.4.2014), IR&M Risk Management Research

² See: Kunin, W.E, Gaston, Kevin The Biology of Rarity: Causes and consequences of rare—common differences (31.12.1996), Springer Science & Business Media

³ See: Thatcher, Margaret Statecraft—Strategies for a changing world (2002), Harper Collins

4 Why is Italy’s constitutional referendum important? (27.9.2016), The Economist

5 See: Ormerod, Paul Why Most Things Fail – Evolution, Extinction and Economics (2006), Faber and Faber

6 See: Predicting the Future: Part II (13.2.2006) Rich Karlgaard, Forbes

7 See: Trouble in Venezuela brings benefits to its neighbour (8.5.2012), The Financial Times

 

 

 

 

The views and opinions expressed in this article are those of the authors. CdR Capital Ltd is authorised and regulated by the Financial Conduct Authority. This article is for professional clients and eligible counterparties as defined by the FCA only.