Catching the intellectual elite being irrational can lead to blockbuster investment opportunities.
In The Fatal Flaw, we showed how omitting important variables from an analysis incorrectly attributes the effects of the variables left out of the analysis to the variables kept in. The intellectual elite use this technique to lead the consensus down the path of irrationality, including we believe in its assessment of the costs and sacrifices required to reduce the world’s carbon footprint. The intellectual elite leave many variables out of the analysis. We are positioned to benefit as the future unfolds, reality emerges, and the irrationality is exposed.
The intellectual elite likewise lead the consensus down the path of irrationality by failing to account for the non-coincidence of cause and effect. Like leaving variables out of the analysis, ignoring the non-coincidence of cause and effect leads to irrational conclusions and blockbuster investment opportunities.
The important element with an analysis involving cause and effect is time. Rarely does a cause and its associated effect occur at the exact same instant in time. While the effect can never precede the cause, it can and frequently does follow the cause with a considerable lag. Retroactively analyzing cause and effect while ignoring the lag leads to misleading and inaccurate conclusions.
Consider, for example, a cyclical industry with cycle troughs occurring two years after cycle peaks. The root cause of the cyclical nature of the industry operates with a two-year lag. That is, the root cause of the industry’s peak activity precedes the peak activity (the effect) by two years and the root cause of the industry’s trough activity precedes the trough activity by two years. Analyzing industry data without accounting for the lag would give the false impression that the causes of the cycle peaks were actually the causes of the cycle troughs and the causes of the cycle troughs were actually the causes of the cycle peaks. The analysis would “prove” beyond a doubt that the causes and associated effects were exactly the opposite as the underlying truth.
Failing to account for a lag between cause and effect can also incorrectly characterize effects as causes. Consider a cause with multiple delayed effects. A study that analyzed only the effects without accounting for the lag between the cause and its multiple effects would likely miss the true cause entirely because it could have occurred years in advance of the effects. Because as humans we are wired to search for causes, the analysis that ignored the lag and missed the preceding cause could easily mistakenly characterize one of the effects as the root cause.
We believe the intellectual elite routinely use this sleight-of-hand to account for inflation.
The root cause for inflation is clearly the creation of money, which devalues the monetary unit and leads to broad price increases across the economy, but only after a significant lag. Analyzing an inflationary period while ignoring the lag could and typically does lead to the erroneous characterization of one of the many effects of monetary devaluation as its root cause.
The U.S. jacked up the money supply in the 1960s to pay for increased spending associated with the Vietnam War and to fund the plethora of new social programs created by President Lyndon Johnson. Inflation predictably followed in the 1970s, but only after a considerable lag. The intellectual elite, in a mostly successful attempt to deflect blame and conceal the true cause of the inflation (money creation) repeatedly cited escalating oil prices as the root cause of the 1970s inflation. Oil prices escalated, of course, because the value of the dollar was falling not because the value of a barrel of oil was increasing. Escalating oil prices were one of the many effects of the 1970s inflation, not its root cause.
The deception of ignoring the lag ironically created blockbuster investment opportunities for the savvy investor in the early 1970s. Inflation was baked into the cake as we entered the 1970s, yet the traditional inflation hedges were selling at all-time lows. No one cared. The price of gold increased 14x during the 1970s, a compounded annual growth rate of 30%. All that was needed to capitalize on that opportunity was to ignore the intellectual elite and appreciate the lag between cause and effect. The time to invest was during the lag.
The intellectual elite today is likewise ignoring the lag between money creation and its many effects. It attributes the cause of today’s inflation to practically anything correlated in time with the broad escalation in prices we see today: supply chain issues, the war in Ukraine, you name it. By ignoring the lag between money creation and its associated effects, the intellectual elite not only deflects blame and conceals the true underlying cause of today’s inflation, but also glosses over and minimalizes the severity of the inflationary problems we face. The creation of money since the global financial crisis of 2008 is orders of magnitude larger than the money created in the 1960s, the inflationary pressures stemming from the more recent surge in the money supply will likely be more intense as well.
Inflation, in short, is already baked into the cake. As investors, all we need to do to capitalize on the opportunity is to ignore the intellectual elite and appreciate the lag.
