A few days ago I watched a presentation by Marc Faber, the notorious Dr. Doom, that was being circulated online and stirring up controversy as usual. Whether the forecasts contained in this presentation – as summarized below – will in the end prove correct, and the relative extent and timing of such correctness, is guesswork really, and Dr. Faber acknowledges as much. But the analytics behind his conclusions, the thought process, are in any case fascinating, educating, and makes the video well worth watching.
Cutting to the chase – although, again, the value of the experience lies principally in the part that precedes the summation – a case is established for an economic environment in which high inflation and low interest rates coexist: an unusual but not impossible scenario. In such an environment, Dr. Faber argues, currency is devalued while income-generating securities, (debt of various types), do not generate sufficient income to keep pace with inflation. It is Dr. Faber’s contention that in such a world the risk-reward dynamic of financial assets is turned on its conventional head, so that, in order of least attractive to most, we begin with cash, proceed to debt, followed by equities, and finally the volatile commodities. Conversely, it follows that in a deflationary environment – which other prominent economists, such as David Rosenberg, have warned about with equal dexterity – the order of attractiveness begins with the least desirable commodities and follows the reverse path past equities, debt, and towards cash.
As we consider this discussion, it may be worth giving thought to repercussions from the two alternative scenarios upon corporate finance and, by extension, corporate strategies and even the direction of whole sectors. If it is the case that availability of capital, and the nature of the capital that is made available, is as likely to influence strategic direction and growth opportunity as to be influenced by such things in turn, then maybe a scenario in which equities are seen as a superior asset class, for example, would favor corporate strategies that are more equity-intensive than others – that is to say, by virtue of equity capital being in greater supply than debt capital. Such a scenario could favor the more volatile but higher-growth business models, while the opposite case would favor debt-friendly cash flowing counterparts.
Such an analysis about the relative value of cash and debt in an inflationary or deflationary environment is not necessarily new, but this takes on particular significance in an economy that is fueled by liquidity and financing access, as already alluded. As an example, of which there could be many, the relative availability of debt or equity funds in capital markets could serve to determine the direction of sub-segments within technology, media, and telecom – which have been in a perpetual state of transition, and in which certain business models lend themselves to equity finance while others more so to debt.And in a most ironic twist, in an unlikely sequence of causality, it could be that the particular mode of economic shakeup envisioned by “Dr. Doom” will prove to be a net-positive outcome for venture capital, and by extension a lift for bright-eyed entrepreneurship.
Disclosure: No positions.