Patriotism is loving your country and fellow countrymen. Nationalism is hating your enemy more than you love your countrymen.
- Baroness Ros Altmann, Member of the House of Lords
Populism vis-à-vis misallocated capital
Ros Altmann is a long-standing friend of mine and an ardent supporter of a united Europe (like I am). I often think of Ros and the brave battle she is fighting in Westminster these days to keep Europe together.
Having said that, this month’s Absolute Return Letter is not about Brexit but about populism, although there is a powerful link between the two – more on that below. I will look at the costs associated with rising populism and I will argue that one of the biggest costs is plenty of misallocated capital.
Don’t get me wrong, though. Populism often leads to a lot more than rising amounts of misallocated capital, one of the worst being an increased risk of war but, after all, this is a financial newsletter. I am not going to speculate on whether the presence of Donald Trump, Nigel Farage or Boris Johnson (probably the next Prime Minister of the UK) could result in war. I will stick to the financial costs associated with rising populism.
Misallocated capital is a term I will bring up repeatedly in this month’s letter, so let’s define what it actually is. Economists use the term to describe capital that is deployed unproductively. One example: As society ages, more and more capital will be set aside to service the elderly, and that is, at least in economic terms, an unproductive use of capital, i.e. it is misallocated.
That is only the short answer, though. Here is the slightly longer, and more correct, one. Assume you make a portfolio investment or purchase a business or other asset, and that the return on that portfolio investment or business is below your cost of capital. If that is the case, the capital you deployed in the first place is said to have been misallocated. In order to adjust for the cyclical ups and downs, the capital was only misallocated if the return is below the cost of capital when assessed over a full economic cycle.
A quick word on Brexit
A quick word or two on Brexit before I begin. Here in the UK, it is virtually impossible to do anything these days without Brexit somehow entering the frame. Even at dinner parties with family and friends, if you start the meal by agreeing not to talk about Brexit, sooner or later, it enters the conversation anyway, and I have heard of entire families that have fallen out as a result of the mess in Westminster. Things are not easy in the UK at the moment!