I went to an excellent talk in the Library of Mistakes in Edinburgh this week, at which Edward Chancellor, the financial historian, discussed the great flaw in most financial thinking: the confusion of the cyclical with the linear.
It is, he said, almost never possible directly to extrapolate the past and the present into the future. That’s because we are constantly caught up in a series of cycles: there’s the trade cycle, the credit cycle, the real estate cycle, the valuation cycle, the capital cycle, and of course the fraud cycle, among others.
Nothing ever moves in anything like a straight line largely because stability creates its own instability (usually as a result of people borrowing too much). But every bubble, financial misconception or financial disaster — from the overpriced diving-bell stocks of the 1690s to the tech bubble and Britain’s finances under Gordon Brown — has been based on the assumption that things can and do move in a straight line.
So much for learning from the mistakes of the past. At the end of the talk, Russell Napier, the Keeper of the Library of Mistakes, reached into his bookshelves to bring out examples of bad linear thinking. My favourite (and there’s serious competition in the library) was written by one Howard J Ruff in 1979. It was called How to Prosper During the Coming Bad Years: A Crash Course in Personal and Financial Survival.
Mr Ruff felt that the world as he knew it was about to collapse and that, as it did, all conventional thinking about money, investing and life would become entirely obsolete. All the wealth he saw around him — the “roads jammed with motor cars . . . the casinos of Las Vegas and Atlantic City jammed with wall-to-wall gamblers” — would soon prove “an illusion”, one that would be “completely wiped out in the near future”.
With inflation at 12%, Mr Ruff reckoned that the buying power of his dollars would continue to drop at a rate “unprecedented in recent history”. The only way to survive the chaos of rising prices and rising interest rates was extreme portfolio management. For his readers with $50,000 he suggested spending $2,500 on food storage (he preferred dehydrated); $11,500 on pre-1964 silver coins (“three bags”); $10,600 on “concealed cash” or equivalent; $10,000 on speculative assets, by which he mostly meant gold shares; and the rest on diamonds, stamps, land and the like.
Ruff wasn’t considered remotely crazy in 1970s America. He published a well-read newsletter, he had a TV show (Ruffhouse) and his book was a bestseller (one reissued in 2008). But he went survival-crazy at the wrong point in the cycle. Inflation peaked in 1980, as did the speculative bubble in gold and silver prices, and that was that.
So to today. Most economists are convinced that there is absolutely no need to worry about inflation or about rising interest rates. Instead, we must worry about the opposite — deflation and falling interest rates.
This makes sense. Bad demographics (pensioners spend less) and our place in the deleveraging cycle (the deeply indebted spend less) combined with chronic global oversupply of almost everything suggest low growth and disinflation at least for some time to come. And the policy response (low rates and quantitative easing) seems unlikely to change any time soon. Instead, as it fails to work, it just gets more extreme.
Today, some $2trn of bonds globally trade on negative interest rates, and banks across Europe have started to charge depositors to look after their money. It’s hard to see this changing. Ask any economist or fund manager about the future, and he will shake his head sadly and say it’ll be a long, long time before rates rise.
That brings me back to cash — as in notes and coins. Very low interest rates are supposed to encourage people to spend and invest. But if they don’t want to spend and the banks are charging them to safeguard their money they might do something else instead: look after their own cash. So pension funds in Switzerland (where interest rates are -0.75%) are transferring money into vaults, and companies with proper safes are shovelling their spare cash into them too.
Should you do the same? Follow the logic of negative and falling interest rates (which will spread if we keep assuming that the solution to our woes is looser and looser monetary policy), add in a few of the super-bear worries about the fragility of the banking system, the fact that depositors can clearly now be made to take a hit when banks fail (deposit accounts can now be bailed in) along with general wealth confiscation and the answer is a firm yes. Deposits were once safe, liquid and profitable. Now they aren’t really any of those things.
So you should buy a safe (you can get one that will take £100,000 at thesafeshop.co.uk for just under £4,000) and fill it up. At worst, you’ll still have £100,000 in a few years. But at best you’ll have cash with a face value of £100,000 that’s worth rather more, thanks partly to deflation and partly to the fact that cash is scarce: when everyone clocks the problems in the super-low interest rate system, they’ll all want to get their cash out, there’ll be a series of bank runs and access to paper money will be restricted. Suddenly, actual cash will be worth significantly more than money held on deposit. Best have some.
I think there is a very strong chance of this happening. So I am hoarding some cash (I’m not telling you where) but I’ve also got Ruff on my mind. Ruff missed the great change in his cycle: Paul Volcker, the banker who killed inflation in the US, was appointed in 1979. I can’t see that change — or the political will for that change — in ours yet. But I’m watching for it.
What if circumstances combine to give us inflation and rising interest rates, or perhaps just the latter (as central bankers notice that negative rates create excess supply and deflation)? What if our 2015 somehow turns out to be Ruff’s 1979? Barring bank busts, anyone with their entire net worth buried in a safe in the garden is going to look pretty silly.
In 1979 it was almost impossible to imagine how inflation could be stopped. Right now it is almost impossible for most people to imagine how it can be started. But to not assume that it will is to forget Mr Chancellor’s lesson: the biggest mistakes are made by those who think linear in a cyclical world.
• This article was first published in the Financial Times