Guest Haymaker - Charles Gave

In The Ring - July 29th, 2022

June 25th MHM - Clarification and Developments

Prior to jumping into this week’s Haymaker, I wanted to clarify a point from our most recent Making Hay Monday (MHM). This pertains to Tesla’s spectacular stock performance since Elon Musk tweeted that he had funding secured for a leveraged buyout at $420 back in 2018.  We correctly noted that TSLA soared roughly 1000% from the time of that tweet (actually, even more at one point). With the stock currently at $860, that math superficially doesn’t compute; however, there was a five-for-one split in 2020. 

Regarding one of the key themes of that MHM, almost concurrent with its publication, Tesla, per CNN Business, “... disclosed in a quarterly regulatory filing Monday that it received a new subpoena from the SEC on June 13, related to ‘our governance processes around compliance with the SEC settlement.’".  These governance processes, or lack thereof, refer to Mr. Musk’s continuing tweets criticizing the SEC for coercing his agreement to settle the case involving the aforementioned “funding secured” tweet.  The SEC also revealed it is investigating Mr. Musk’s tweets regarding his attempt to acquire Twitter itself, a deal he is now trying to break.  In April, it had also contacted Tesla on the delayed filing he made with regard to his accumulation of a 9.2% stake in Twitter.  To say Mr. Musk is in the SEC’s crosshairs is merely stating the obvious

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To learn more about Evergreen Gavekal, where the Haymaker himself serves as Co-CIO, click below.

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“Government has no other end than the preservation of property. Tyranny is the exercise of power beyond right… there is only one thing which gathers people into seditious commotion, and that is oppression.”  -John Locke

Source: Wikimedia Commons

Most Haymaker subscribers are likely only vaguely aware, if at all, of the name John Locke.  Candidly, my knowledge of him most definitely qualified as vague… until I began researching his life and beliefs to write this introduction.

What precipitated my investigation was reading the note you will soon see from one of the men I most rely upon for rational thinking in this increasingly irrational world, Charles Gave.  As many of you know, Charles is the father of my partner and great friend Louis Gave. Together, along with Anatole Kaletsky, they founded one of the planet’s most prestigious financial and economic analysis organizations, the appropriately named Gavekal Research, whose clients include a plethora of the world’s biggest money managers. 

Now in his 70s, Charles still regularly produces some of the most thought-provoking essays that hit my inbox.  As I think you know by now, there aren’t many of the investment game’s best and brightest that I don’t follow.

It’s no exaggeration to say that John Locke had a powerful influence on the development of Western democracy.  His overarching philosophy of limited representative government, assurance of essential human rights, respect for private property and a steadfast adherence to the rule of law inspired America’s own founding fathers. 

This not to say he was perfect. Though his position on slavery did evolve into increasing opposition, at one time he received shares in a slaving trading company for legal services rendered.  He disposed of those, but these days any statues of him would probably be pulled down. (Though that doesn’t seem to be happening as much since the invasion of Ukraine; this must be a total coincidence.)

Charles’ article is actually a nice companion piece with this week’s Making Hay Monday, that railed against the ease with which Elon Musk has skirted around securities laws (see the above SEC note).  Per Charles’ second point, Mr. Musk clearly believes he is above the rule of law.  Charles and I share a conviction that if a nation’s citizens come to believe its legal system is rigged in favor of the rich and powerful, it is on its way to crony capitalism and, possibly, totalitarianism.  Neither “ism” bodes well for the nation, or the world… the latter of which already has too much of both.

The investment relevance, as he indicates, is the advisability of investors directing their funds toward countries that adhere closely to Lockean principles.  Presently, that’s a rapidly shrinking list, one from which America is increasingly at risk of self-eliminating.

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The End Of Our Lockean World* - Charles Gave

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John Locke advocated the rule of law and the separation of powers...

...as well as the separation of church and state

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I am disturbed by Louis’s recent papers outlining how Western governments have weaponized almost everything at their disposal, from public health to the global financial system (see The Age Of Weaponization and The Age Of Weaponization, Part Two). To explain my distress, I need to delve into how the writings of John Locke, a 17th century English philosopher, changed the world forever. At the risk of oversimplifying, I shall summarize several of Locke’s ideas:

1. Taxation. While the state might have a legal monopoly on violence, its power can be checked by “controlling the purse” and asking citizens to approve the state’s budget. It follows that governments cannot raise taxes without popular support.

2. Rule of law. No individuals—kings included—are above the law.

3. Separation of powers. In order to ensure points (1) and (2), a state’s executive branch must be subservient to its legislature, and an independent judiciary must exist to interpret the laws passed by the legislature.

4. The right of property. For citizens to be truly independent of the state, they must have an absolute right to what Locke calls “property,” which he defines as one’s self and the fruits of one’s labor. Citizens are free to sell the proceeds of their work, which should be paid for at market price. A key function of government is therefore to protect the “life, liberty and property” of its citizens.

5. Tolerance. As Locke outlined in his 1689 Letter Concerning Toleration, the system outlined in points (1) to (4) can only function if religion is entirely separate from the political process. The state must limit itself to the domain of law, and may prosecute its citizens only if they are in contravention of existing laws. This means no law can be retroactive. Questions of morality and sin must be excluded from the state’s mandate, as they fall under the purview of religion. This separation allows for freedom of religion, and by extension the implicit freedom of speech, leading to the marketplace of ideas that fuels innovation. As this requires the buy-in of every citizen, Locke rejected the idea of “tolerating intolerance” and encouraged the prohibition of any religion that demands its adherents impose their faith on others or that sins be punished as crimes. Any such religion would undermine the separation between church and state.

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Locke’s ideas paved the way for Western prosperity

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Over time, these ideas became integrated into the bedrock of British culture, leading to a series of innovations that slowly but surely paved the way for the Industrial Revolution. This revolution brought about the end of a finite Malthusian world and marked the beginning of the continued economic growth that persists to this day.

Locke’s ideas would also frame the founding principles of the United States, to the point that the three inalienable rights that the US Declaration of Independence asserts are available to all—life, liberty and the pursuit of happiness—are echoes of the Lockean trinity of life, liberty and property. The Western world could just as easily be called the Lockean world.

At this point you might be wondering: “What does an Englishman who wrote in the 1690s have to do with today’s financial markets?” My answer is: a lot more than you might think. If Locke’s ideas paved the way for Western prosperity and innovation, then the dismantling of this Lockean framework could lead to an Ursus magnus bear market of enormous scale. My goal in this paper is to show that we are witnessing nothing less than a pernicious attempt to tear down Locke’s ideals from within.

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Institutions that once upheld Lockean ideals are seeking to do away with them

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First of all, I should point out that the various modern ideologies that over the last 100 years or so sought to attack Locke’s tenets—communism, fascism and theocracy, to name three—have all failed to dislodge Locke as a guiding light of Western civilization. I hope today’s attacks will also end in failure. There is a key difference, however. Many of the competing ideologies that attacked Locke in the past were promoted by nation-states from outside the Lockean world—the USSR, fascist Italy or the 18th and 19th century papacies, for example. In contrast, the latest attack comes not from without, but from within. Institutions that once upheld Lockean ideals are today seeking to dismantle them. To paraphrase the French thinker Paul Valéry: civilizations are not murdered; they commit suicide.

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Western states have printed money to circumvent checks on their purses

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Know your enemy

To defeat your enemies, you must first understand them. To this end, I shall detail the latest attacks in terms of the five Lockean ideas summarized earlier.

Taxation. The state should be financed by taxes voted on either directly (via direct democracy) or indirectly (via representative democracy) by citizens. This acts as a check on government spending and ensures that the state does not impose rates of taxation higher than citizens can bear. Unfortunately, two tools at the state’s disposal have rendered this check obsolete.

1. Fiat currencies. The transition to fiat currencies in 1971-73 allowed the state to finance itself via central bank money-printing without the consent of the citizenry.

2. Bond issues. If the state issues a 30-year bond, it is effectively raising taxes on a generation as yet unborn, and therefore unable to vote. In a truly Lockean system, budget deficits would be unconstitutional and government bonds would be illegal outside existential crises such as wars. But over the last 20 years in the West, deficits have ballooned to the point that more money-printing appears inevitable.

Rule of law and separation of powers. All are equal before the law. These fundamental tenets have been widely admired by citizens of non-Lockean societies and are one of the West’s chief comparative advantages (see Hernando de Soto’s The Mystery Of Capital: Why Capitalism Triumphs In The West And Fails Elsewhere).

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Supranational organizations have undermined perceptions of accountability

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Equally important is that citizens have faith in the rule of law to which they are bound—a faith that is currently under attack on several fronts.

1. Supranational organizations. The advent of supranational organizations such as the European Union has fed popular perceptions that leaders have become less accountable to their electorates. The impression is that elites have created their own system, which exerts a growing amount of regulatory control over national economies. This includes the perceived ability to inflict collective punishment on foreign nationals. The extent to which this is accurate is beside the point; the perception alone has helped fuel populist movements across the West.

2. Legitimacy. Locke stipulated that the state should act for the good of the nation as a whole—not just to benefit the powerful. In his time, justice was meted out in the name of a sovereign; later, it was in the name of the people. If legislation is perceived to no longer be in the name and interests of the citizenry, then citizens will increasingly view the law as illegitimate.

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Negative interest rates limit how investors can express their time preferences

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Interfering with market pricing suppresses enterprise

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Property rights. The fruits of my labor are mine to do with as I please. This cornerstone of Lockean philosophy has clearly begun to crumble, with governments chipping away at this fundamental right in two ways.

1. Interest rates. Let me start with the state’s attempts to control my property through the time value of money, also known as interest rates. Even during Locke’s time, there was debate in England about whether interest rates should be determined by the market or kept artificially low to encourage investments (proving that bad ideas have a long history). Locke maintained that rates should be set by the market, as artificially low rates would be unjust for society’s savers. He defended the idea that savings were necessary, and argued that the way to lower interest rates was to grow a current account surplus, so increasing the money supply via gold inflows, which would lead to lower rates. In the last few years, however, our central banks have attempted to nationalize time by setting interest rates at zero or negative, so limiting how citizens can express their time preferences in the management of their assets. We will pay for this crime for years to come.

2. Valuations. Property rights can only be observed if the owner understands the value of his or her property. Yet the state has muddied the waters. Subsidies, currency debasement, nationalization and price controls all prevent citizens from understanding the value of what they own. How can you properly value your assets when prices and exchange rates are controlled and interest rates are at zero? This has a chilling effect on enterprise. Why should you risk your assets when you lack the proper context to make an informed decision? The effect harms economic growth, leads to the misallocation of capital and further calcifies social strata, as the poor are denied a vital path out of poverty.

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Judging individuals by their membership of a group leads to collective punishments

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Tolerance. My final point is on the necessity of tolerance—a vanishingly rare commodity in modern times. Tolerance relies on three principles, all of which are under attack:

1. Freedom of speech. The Voltairean principle of “I wholly disapprove of what you say but will defend to the death your right to say it,” has been replaced with “because I think you are a bad person, I have the right to prevent you from speaking.”

2. Freedom of dissent. An individual has a right to oppose the majority. Being in the majority may make for a more comfortable life, but it does not mean the majority opinion is correct. The chilling effect of Western outrage culture has eroded this freedom.

3. Freedom of individuality. Individuals should not be prejudged according to the groups they may belong to. Doing so inevitably leads to collective punishment, as individuals are declared guilty by association even if they are in no way responsible for the actions of other individuals with a group or of its leaders. Western polarization and tribalism have eroded this freedom to the point that group affiliations and identity politics often prevent meaningful discourse on an individual level. I cannot overstate how a return to collective punishment would destroy our societies far more completely than any war.

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The destruction of Lockean ideals will lead to fragile, totalitarian societies

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Conclusion

A society in which I cannot invest according to my individual preferences or the marginal return on invested capital, but must follow the whims of politicians; a society in which there are two legal systems, one for the elite and one for the rest; a society in which I might be discriminated against because of factors beyond my control—such a society meets the criteria laid out for a totalitarian society by the philosophers Hannah Arendt and Raymond Aron. In such societies, the only companies that will prosper are those that pursue crony capitalism—companies in which I refuse to invest.

In these societies, the poor get poorer while the rich get richer. The rich will get richer simply because they have access to more and more debt, denominated in an ever-falling currency, which they can use to accumulate real assets (a process known as the Cantillon effect). These societies are ultimately fragile: the average return on invested capital will decline structurally, as the market will be unable to engage in the creative destruction needed to revolutionize economic structures from within. One day, the rich will simply no longer be able to service debt on assets sporting an ever-falling ROIC.

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Invest where capitalism still rules, even if governance is not democratic

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In such societies, the poor will inevitably suffer, and will demand solutions to their suffering. In response, their rulers will start trotting out scapegoats. I am convinced that free-minded or religious people will be the first target, as they always have been. We are well on what the Austrian economist Friedrich Hayek called “the road to serfdom.”

As far as my capital is concerned, I know that price-to-earnings ratios in these societies will eventually drop to zero. Therefore, I would rather invest my capital in societies where capitalism is firmly in place, even if their governance is not yet democratic, than in societies where the elites are moving away from capitalism, knowing full well that their societies will become less democratic as a result.

*Originally published July 19th, 2022 (Substack post updated)

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