Investing is about staying on the receiving end of money flows

Investing is all about money. As money buys time and time is money, it is about understanding the time value of money and staying on the receiving end of money flows.

But what is money? The Ascent of Money by Niall Ferguson is a great book for those who want to learn more about money and the history of money. Money, in its different forms, be it sea shells, precious metals or signed paper bank notes, is a promise: its value based on trust.

If I accept to receive as payment a seashell against the mammoth I just killed, it is because I trust that when I need to buy a mammoth myself, the same shell will be accepted and be seen as worth it. In that sense, money is a form of credit. Money is both a means of exchange and a store of value. 

In a fiat currency (paper/digital money) system (the current system), the currency in which the investor operates is what is determining his or her purchasing power and the time value of money that will ultimately determine the value of his or her savings and investment priorities.

The value of cash in a high inflationary economy tends to depreciate as fast as inflation. In an inflationary system a dollar today is worth more than a dollar tomorrow. In a deflationary environment, the opposite is true, although the social pressures imposed on the population may raise questions on social trust and or the inclination of central banks to debase the currency to restore inflation.

One of the basic rules of economics is that when too much money chases the same goods or assets, the price of these goods or assets rise.

In a simple economy that does not grow, where the income and the needs of the population don’t change, increasing the monetary base will either increase the pot of savings (more money than can be spent is put aside) or the quantity of money chasing goods (or services). The former would drive the value of financial assets, the latter price levels of real assets, goods and services.

If money makes the world go round, the real economy and financial markets are indeed the two sides of the world’s balance sheet.  Financial markets represent the funding side of the economy and the economy how money is spent.

Money flows from financial assets to the real economy and vice versa. This permanent state of flux will determine all price regimes. The role of credit and credit cycles so brilliantly explained by Ray Dalio’s 30 minutes Youtube video “How the Economic Machine works” would add another dimension to the equation: transmission mechanisms, psychology and the credit cycle.

Most people struggle to understand why the stock market starts rising in the middle of recessions and starts falling when the economy is firing on all cylinders. Yet, this simply reflects money flowing from one side of the balance sheet to the other.

The role of an investor is to position his or her portfolio on the receiving end of these money flows and grow its share of the money pie, by anticipating the ebb and flow of money and alternatively purchasing and selling real or financial assets accordingly.

An entire global macro strategy can be defined along those lines and across the four asset classes: starting with FX, Bonds/Credit, Equities and finally Commodities. Something we shall cover in later posts.