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e of Economics is as relevant as never before. e present work observes and describes the bubble economy of our days, analyzes the underlying of the central banks and makes aware of possi- ble investment philosophies.

It is also about historical recollection. e future is uncertain, unambigu- ous predictions cannot be provided. e Austrian School’s perception helps us to see long-term patterns and opportunities that today are often hidden.

I wish all readers an exciting journey of discovery, especially those who have to deal with the task of sustainable and value-based investments. For the authors and their important work I hope for the well-deserved success and the widest possible audience of a bestseller.

H.S.H. Prince Philipp von und zu Liechtenstein, Chairman LGT Group mises.at [email protected] © 2015 scholarium Translation: Heinz Blasnik Proofreading: Douglas Moser Typesetting: Gerald Kalb Cover design: Fanny Springer Original title: Österreichische Schule für Anleger

ISBN: 978-3-902639-33-2

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Preface ...... 9 Introduction ...... 12 1. e Austrian School ...... 17 Subjectivism ...... 23 Marginalism ...... 25 Individualism ...... 31 Realism ...... 37 2. e Illusion of Prosperity ...... 41 3. Forecasts and Prophecies ...... 59 4. e Monetary System ...... 77 What is Money? ...... 77 $e Paper Money Era ...... 96 $e Money Supply ...... 100 5. Monetary Tectonics ...... 107 In%ation ...... 107 De%ation ...... 111 Tectonic Pressure Build-Up ...... 113 6. Business Cycles ...... 131 Undistorted Production Structure ...... 131 Reorganization of the Production Structure ...... 134 Capital Structure ...... 138 Distorted Production Structure ...... 141 $e Cantillon E&ect ...... 153 $e Skyscraper Index ...... 156 7. Scenarios ...... 165 Hyperin%ation versus Hyperde%ation ...... 165 Stag%ation...... 173 Financial Repression and Compulsory Levies ...... 178 Special Drawing Rights as a Global Currency ...... 182 8. Austrian Investment Philosophy ...... 187 $e Morals of Saving ...... 188 Pro't and Interest ...... 194 $e Problem with Debt ...... 207 Hoarding ...... 212 Investing ...... 220 Consumption ...... 227 Endowment ...... 232 Speculation ...... 237 A Philosophical Portfolio ...... 240 9. Austrian Investment Practice ...... 245 $e Permanent Portfolio ...... 251 Precious Metals ...... 257 Stocks ...... 280 Analysis ...... 292 Bonds ...... 305 Mutual Funds ...... 318 Alternative Investments ...... 325 Conclusion ...... 347 Endnotes ...... 354 Authors ...... 364

Preface

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What would make of QE and ZIRP? Would Friedrich von Hayek be able to make sense of FOMC or ECB policy statements? What would these giants of the Austrian School and their cohorts think of funds, ETFs, mutual funds and the array of other assorted investment vehicles? Would precious metals 't into an Austrian template superimposed on the present day investment world? How will the spread of government into all aspects of the private sec- tor be ultimately resolved? $e answers, in some cases obvious and in other cases complex, require an understanding of Austrian economic thought which is all too absent in modern investment discourse or media commentary.

What passes for economic wisdom in the casino like 'nancial markets of the 21st century emanates from the conceptually %awed drumbeat of Keynesian analysis reconstituted into senseless quantitative aggre- gations of historical data extrapolated into future outcomes. $e prevalence of economic illiteracy evident in the constant eruptions of supposedly learned PhDs infects both public policy and investment thinking alike. $ese deeply rooted a(ictions distort valuations and investment %ows and suggest there is an inherent unsustainability for the complacent status quo.

Analysis grounded in Austrian thinking has been remarkably accurate in separating illusion from reality. It provides a sensible, highly acces- sible big picture of view of what exists and what is likely to happen as a result. $at is because it portrays economic activity and likely devel- opments as the product of individual behavior, a common sense and practical framework. It does not employ abstract groups or forces that are somehow quanti'ed and correlated by unintelligible formulas, a

9 Preface

methodology that succeeds only in explaining the arti'cial reality that it has created.

$e challenge for the modern reader is 'rst to become acquainted with the basic precepts of Austrian economics. $ese are well explained in the following pages. For many the exercise will seem like learning a new language, a testament to the corruption of thought and percep- tion that is evident in the mainstream 'nancial media and educational system. Whatever the struggle, the result will be clarity of thinking and a removal of confusion.

$e Austrian analytical framework is not a prescription for short term investment success or even a pathway to building a fortune. $ere is no such magic here. However, it does provide a foundation for sanity in the midst of mass delusion. It is grounded in ethical behavior, com- mon sense, and sober re%ection. $e Austrian investment approach eschews leverage, promotions, and fads. It is likely to steer one away from disastrous investment outcomes through a balanced approach to wealth preservation. In short, the Austrian methodology is based on reality, not fancy, and its application in daily practice will provide an investor with favorable odds to achieve 'nancial well-being.

$is book is the result of extensive research. It is a compilation of wisdom from many sources 'ltered by Austrian economic thought. It is a highly relevant contribution to a complex world that cannot be understood in simplistic terms. It covers a broad range of topics rang- ing from macro to micro economics, from history to current events, from theoretical to practical, and from general to anecdotal.

$e 'nancial markets of today are dominated by hyper active high frequency trading guided by trend following quantitative algorithms. Original thought is replaced by arti'cial intelligence. Market prices are manipulated and gamed by institutional and political interests. Valuations are in%ated by the zero interest rate policies of all central banks for whom it is dogma to drive up the prices of paper assets to

10 Preface

in%uence the behavior of individuals and corporations to achieve their announced goals of full employment, moderate in%ation, and 'nancial market stability. Financial wealth has become an illusion that has little resemblance to real wealth. Financial wealth is dependent on the func- tionality of a matrix that must be navigated according to its unique rules that are often at odds with common sense. For those who fear that the functionality of this matrix is unsustainable, $e Austrian School for Investors o&ers a path to the kind of critical thinking that will provide sustainability for its practitioners long after the demise of the arti'ce of paper wealth.

John Hathaway, Senior Portfolio Manager of Tocqueville Gold Fund

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Introduction

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Confusion and uncertainty with regard to investing have rarely been as pronounced as they are today. On the one hand, we are living in an era in which wealth can seemingly grow to incredible heights. On the other hand, there are always rumors of crisis – a dark premonition that security prices could collapse at any moment, and the savings of a lifetime could be decimated overnight. Although o)cial data show only moderate in%ation, in some cases even de%ation, many people feel that their currency is continually losing value. Most of them suspect that they should give a bit more thought to preserving the value of their savings, but are faced with contradictory advice. Trust in “experts” is declining, whether they are economists, bankers or politicians. If someone dispenses investment advice, he wants to make money from it – just as everyone seems eager to make money from retail investors.

It is di)cult for investors to do the right thing, but incredibly easy to make a mistake. $e current economic environment seems like a game with marked cards, with the odds of winning systematically stacked against the multitude of small players. One gets the impression that it is all a giant rip-o&.

$is book does not introduce a new investment fad, it is not an adver- tisement for a new investment product and not an ideological program. It aims to make knowledge that is highly useful in dealing with the questions of our time but has been unjustly forgotten, available to the average investor. It is based on the research of an economic school of thought that has only in recent years slowly been rediscovered by the broader public, because it was once again proved to be prophetic. In the history of ideas, this tradition is known as the “Austrian School” or the “Viennese School of Economics”. Engaging with the Austrian

12 Introduction

scholars of yesteryear is tantamount to being inoculated against all sorts of illusions. $e Austrian school makes clear why the so-called “ortho- dox” perspective on the economy, savings and investment borders on irresponsibility. While the Austrian School de'nitely o&ers a kind of therapy, it is not a ready-made miracle cure, but rather a thorough program in disillusionment helping to activate one’s own mind.

Why should investors of today study an old and possibly outdated theory of economics? Is that not tantamount to a waste of time, or even misleading? Does it provide a crystal ball, or a secret recipe for higher returns? Indeed, there is some evidence for both and the evi- dence is astonishing and seemingly paradoxical. $is is because the Austrian School, like no other school of economic thought, categor- ically rules out that theoretical forecasts can be made based on past data. Most adherents of the Austrian School regard the models of mod- ern economics that claim to represent expert forecasts as the work of quacks, unless the models simply serve as illustrations or mental tools. Moreover, most theoreticians are not good investors, something that also applies, and sometimes to an even greater extent (if for a good reason), to representatives of the Austrian School. Nevertheless – and this may actually be quite surprising – several of the greatest forecasters of their time were adherents of the Austrian School. $eir foresight often proved downright spine-chilling.

In terms of practical application, Austrian theory has also left its mark. Two of today’s most famous investors are testament to this: Warren Bu&et’s father was strongly in%uenced by the Austrian School and passed important insights to his son. ’ longtime partner and most important analyst Jim Rogers is also an Austrian School adherent. Benjamin Graham, Bu&et’s teacher and mentor, developed a methodology that shows astonishing parallels to the Austrian School’s ideas, although Graham actually was not aware of it. Lastly, the Austrian School originated when its founder , who worked as an economic journalist, came to realize by observing activity on the stock exchange in great detail that was unable to explain the real world.

13 Introduction

High returns can never be obtained – at least in the long term – with- out exposure to commensurately high risk. $e only long-term path to high returns consists of sustainable capital accumulation through entrepreneurship. $e theories of capital and entrepreneurship are the greatest strengths of the Austrian approach. However, this approach cannot be employed without 'rst embarking on the di)cult road to disillusionment. $e Austrian School is utterly useless for “system dorks” – i.e., those who blindly follow majority opinion and are constrained by the exigencies of the present. $is is also the reason why the school is not more widely known; its insights are generally considered uncomfortable.

To begin with, the practice of Austrian investing requires theory: theoría was the term used by the ancient Greeks for what they considered the highest form of practice, namely critical re%ection. It is no coincidence that the terms “crisis” and “criticism” have the same etymological root. Times of crisis as a rule exert a positive e&ect on the ability to re%ect. $e Austrian School was established and has matured amidst the most severe crises of the 19 th and 20 th centuries. Austrian economists were the world’s leading crisis experts: they had a close-up view of stock market bubbles, recessions and severe depressions, hyper-in%ation epi- sodes, economic and political decline, dramatic geopolitical upheaval and two world wars.

Times during which the monetary system was impaired were always times when monetary theory made great strides, as

remarked. * In times of crisis, the enduring value of the Austrian School comes to the fore. It is no great feat to make money during a boom – it practically self-multiplies. Good investors di&erentiate themselves from bad ones in times of crisis. $e most famous recent example of an investor who succeeds in times of crisis is probably Nassim Taleb, who is clearly in%uenced by the Austrian School. His long-term partner

and even more successful investor + Mark Spitznagel, has written a book

on “Austrian” investing as well. , A book that, although penned by a practitioner, is far more theoretical and philosophical in its approach to the topic than this book.

14 Introduction

$e necessary process of re%ection demands nothing less than a rad- ical rejection of conventional investor perspectives. Anyone who has decided to read this book in the hope of being able to jump on a new trend or to be provided with a few tips and tricks to make a fast buck is going to be disappointed. Although the typical speculator will cer- tainly not be left entirely empty-handed, this book will pull the rug out from under today’s dominant illusions and that may prove pain- ful. $is book came into being at the academy scholarium in Vienna (scholarium.at), where the authors met. Rahim Taghizadegan is one of the last representatives of the Austrian School of Economics in Vienna and is an interdisciplinary theoretician; Ronald P. Stöferle and Mark J. Valek are two professional investors who have founded an invest- ment fund in Liechtenstein, which incorporates the insights of the Austrian School in its investment strategy. $is combination of theory and practice led to many fruitful debates at the scholarium, followed by joint courses and 'nally this book. A number of people from the scienti'c sta& at the institute have lent a helping hand in its creation, Raphael Schaad, Johannes Leitner and Andreas M. Kramer in partic-

ular - Michael Schmidt assisted us with the topic of value investing, and Harald Steinbichler on the treatment of the ‘distressed bonds’ asset class. We want to express our sincere thanks to all of them.

$is book is to date the most comprehensive attempt at a critical examination of today’s investment universe from the perspective of the Austrian School and deriving conclusions for investors from it. To this

end + we frequently move back and forth between theory and current practice. $e di)culty of connecting these two worlds will become clear to the reader as the book progresses: the relationship between taking the time for slow and deliberate re%ection and the pressure and urgency that characterize investing in 'nancial markets under distorted and volatile circumstances.

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