Since the downgrade of the US does not come as a surprise to adherents of the Austrian School of Economics let's discuss something else. Agcapita is Canada's only RRSP and TFSA eligible farmland fund and is part of a family of funds with over $100 million in assets under management. Agcapita believes farmland is a safe investment, that supply is shrinking and that unprecedented demand for "food, feed and fuel" will continue to move crop prices higher over the long-term. Agcapita created the Farmland Investment Partnership to allow investors to add professionally managed farmland to their portfolios.

1. Agcapita Update
August 2011

2. Agcapita Update
Since the downgrade of the US does not come as
a surprise to adherents of the Austrian School of
Economics and the unraveling of government finances
has been a cornerstone in my investment philosophy
for many years now, I don’t want to bore you with an
extended bout of hand wringing and soul searching
about Standard & Poor’s sudden revelation that the
US actually might be a deteriorating credit risk. Lets
step back and focus instead on the process in totality.
Sovereign borrowers have gone through a two-decade
period of having almost no restraint on their ability to run
deficits and borrow to fill the gap. That is now ending
and so going on the safe assumption that the political
class will not change it spots and that deficits will
continue - how can we expect the gap to be filled in the
future?
I’d like exercise an author’s holiday prerogative and
plagiarize briefly from my April 2010 letter. According to
Kenneth Rogoff’s research in the three years following
a financial crisis, on average, cumulative fiscal deficits
almost double. We seem to be well along this path in
the current crisis. Rogoff also shows that how these
deficits are financed is critical to the question of whether
inflation ensues, whether you have a Japanese or an
Argentinean style post-crisis experience. If the deficits
are funded from existing private sector savings (“belt-
tightening” as Rogoff describes it) they are typically not
inflationary - e.g. Japan. If they are monetized by the
central bank (the money is created) they are inflationary -
e.g. Argentina.
Today, in one corner, we have the wholesale liquidation
of mal-investments that have accumulated in virtually
every segment of the western economies from
residential and commercial real estate down to the
municipal bond markets. In the other corner, we have
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3. Agcapita Update (continued)
governments that continue to resist this cleansing A large government debt issue simply could not
process as it threatens the politically influential be marketed without a large increase in the money
financial sector. The result is that via bailouts and supply. Therefore the government creates not only
unprecedented fiscal deficits private sector credit the debt but also the money with which to buy it.
problems are being moved onto public sector In addition, large government deficit expenditure
balance sheets - balance sheets that are already in tends to accelerate the velocity of money because
precarious condition from past over-spending and the government spends its money more rapidly than
unfunded future liabilities. cautious private spenders do. This combination of
increased quantity and velocity of money, not the
By nationalizing private sector losses governments deficits, does the job, both for economic stimulation
around the globe have seriously compounded their and for monetary inflation.”
existing budget problems. According to research
by Société Générale EU and US net liabilities add Will we see inflation or deflation over the next
up to around $135 trillion. That’s roughly four times decade? I believe you can answer this question by
the capitalization of the world’s equity markets and considering the effect of the following factors:
forty times the cost of the 2008 financial crisis. Even – Government spending & deficits - increasing
after the farcical debt-ceiling crisis and “resolution”, – Regulation - increasing
the US plans to accumulate an additional $10 trillion – Taxes - increasing
in deficits over the next decade. These enormous – Money supply - increasing
numbers beg the question of how our governments
plan to fill their funding gaps. Unfortunately, all state activities however financed
require that capital be taken out of the hands of the
To quote Jens Parsson from his excellent book private sector, then deployed in typically loss-making
“Dying of Money”: “The government is free to incur (capital destroying) activities. The net result is that
any deficit and issue any amount of debt it may wish, growing government spending, deficits and printing
so long as it is willing to draw purchasing power are setting the stage for much greater problems in
away from other borrowers and to tolerate the rise in the future. Rather than allowing private sector savings
interest rates which will result. The debt will create no to replenish the pool of capital our governments are
inflation. Government deficits and government debt going further into debt.
thus are not inflationary if they stand alone, but they
never stand alone. The creation of government debt What western economies desperately need is more
is practically always accompanied by an increase capital. There is no way to create capital other than
of money. Competing against private borrowers for through savings and hard work - a message to which
a static supply of credit capital, a large government our governments are perennially reluctant to listen.
debt issue would drive interest rates upward, and Printing money seems alluringly easy at first, but it
high interest rates are anathema to a government. does not create capital, and worse, the inflation it
creates ultimately causes long lasting harm to the
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4. Agcapita Update (continued)
production structure of the economy. It follows that the politicians we find in government these days.
until the developed nations stop engaging in capital When did the current group come to believe that
destroying activities and our capital base recovers, compromise was a virtue? Almost everyone outside
sustained real growth is unlikely to take place. of the cocooned political capitals of the world
believes that if you are right then you should attempt
What we are now experiencing is the effects of a to prevail. Compare and contrast the political class
depleted and declining capital pool, combined with that elevates compromise to a virtue.
enormous expansion of the monetary base and
negative real interest rates. I believe that rather than Ultimately, the growing crisis of sovereign insolvency
pure inflation we will face stagflation in the developed isn’t even an ideological issue it is simply a
world as further state expansion into the economy will mathematical issue. No government can indefinitely
reduce real growth while accelerating fiscal deficits provide $1 of services with less than $1 of revenues
combined with money supply expansions will lead to - a fact that no amount of compromise will change.
inflation. Ignore this at your peril as eventually all spendthrifts
run out of palatable options.
Low growth + high inflation = stagflation.
Kind Regards
“Compromise - to make a dishonorable or shameful
concession.” Before I conclude this month I want Stephen Johnston
to engage in a small tangential observation about
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(including, without limitation, any commodities, securities or other financial
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other materials be considered as investment advice or as a recommendation
to enter into any transaction. Additional information is available by contacting
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