Das 2023: Crippling Capital
Marxism usually doesn’t fit neatly into capitalistic thinking, yet most economists will have a view on the seminal piece Das Kapital.
Capital, it may seem to the modern view is a simple, objective, lifeless concept that reflects one simple thing: money.
Marx had a different view entirely and asked questions we almost look at as silly, e.g., who should own capital? Today, the question seems like an obfuscation of a simple question, who has the money?
But more important to our current views and more importantly, to our money, is that later thinkers gave us a framework to think about the importance of capital on innovation and consumer behavior, and that’s where all this thinking comes to a head in 2023, with one driving factor: inflation.
Recent Developments: 2023, the year of the Seesaw
Most capital allocators today are moving too slow in response to rising rates… and it’s not our fault, really. Inflation isn’t something most operators and investors today have had to dealt with. If you’re under 60, you weren’t there for the 1979–1982 stagflation-era. And unless you were born in Yugoslavia or Argentina, you likely don’t have any real intuition around inflation. And that’s the problem!
In early 2021, when we began feeling the first inklings of inflation, we put out a slide showing how drastic inflation has been over the 1900’s and compared it to the last 30 years where it’s been drastically low.
So if we don’t know how to interpret inflation, how can we make effective capital allocation decisions?
Intuition and emotion drive the majority of our investment decisions. Most of us save into our 401K’s because we feel that’s good financial hygiene. We do tax planning because it feels like we’re getting a better deal than cutting a bigger check to Treasury. We splurge on luxury goods because it brings us status. And it doesn’t matter how smart you are: even the shrewdest negotiators are trying to get to a feeling of fair, or they’re trying to get the feeling of a win.
The point in short: you don’t know how to feel about this inflation thing yet, you just haven’t had enough time with it yet.
However, the fed does.
When asked the role of the Federal Reserve, William McChesney Martin, the fed’s longest standing chairman who served under four presidents put it succinctly as a Yale man “to take away the punch bowl just as the party gets going,” that is, to raise interest rates when the economy gets too hot.
And why does the party-pooping Fed do this? Because if the economy gets too hot, then it bursts. And fortunately or unfortunately, many of us who worked during the Great Recession of 2008–2009, know what that feels like.
This is the seesaw, the Fed must be aggressive to curtail inflation while trying not to derail the economy completely. It’s a soft landing we’re after, not a crash (that’s what we’re trying to avoid in the first place).
But how bad is inflation itself? Bad, just ask your parents and grandparents who paid 15–20% mortgage rates. Better yet, look at what it’s done to the banking sector a-la SVB.
Impact on Capital Allocation
While many factors affect capital allocators’ decision making, the biggest and most clearest back drop, is the opportunity cost of risk-free yield.
This is concept 1 and can be driven home by asking yourself how you feel about return and risk.
Between (a) getting a guaranteed return of 4.67% on your money, or (b) get an expected 5–15% return on one of the following:
- Short-term rental real estate (5–12% cash on cash return)
- S&P 500 ETF (8–9% historically between 2010 and 2020)
- Venture debt (5–15% depending on the fund)
What do you pick? For those math wonks out there, you’re trying to risk-adjust the investments to pick which has the best return after you consider the probability that the investment fails and give you something on the low end or ZILCH!
The right answer is actually asking the right question, how am I feeling about the risk? It’s not about the actual risk, we don’t know, it’s about our perception of it that affects how we deploy that capital.
And the reality is as noted earlier, how we feel about risk under uncertain conditions leads to inaction, we move or don’t move based on how we feel and right now, we’re not feeling good.
But you know what does look good? This 4.67% yield on one year treasuries (mmmm… yummy yeild).
Especially when you consider where it has been for the last 20 years.
Risk may have to wait. And that means there’s less cash in a rising-cost environment for swinging for the fences.
So returning the original question, what is capital? In today’s economy it is more a vital resource to steward by the consumer, investor, and operator, not so much a means to economic activity that is owned by a particular class.
Bunt single baseball has returned, and along with it a different approach to allocating capital in our portfolios, businesses, and every-day lives.
