Today, we’re picking up where we left off in our last conversation with Jerry in our series on a Christian Economic Worldview. And this time we’re talking about what he calls “Principled Reasoning.” But we might add the subtitle, “A Way Out of this Mess.”
We’ll start with a few key questions:
First, is there a way out of the confusion and the futility of boom and bust cycles?
And is there a way out of the confusion of a fragmented worldview that leaves out cause and effect and leaves us unable to understand the relationship between different parts of the economic process, wealth creation, and of course the investment decisions that we have to make?
Is there a way to properly value stocks and bonds and other investments relative to risk in a world where confusion reigns?
The answer is yes, there is a way out. We call that way out principle-centered reasoning.
PRINCIPLE-CENTERED REASONING
Where does this principle-centered reasoning come from?
It doesn’t come from the smartest person in the room because the smartest person in the room is who got us here. And the idea Is not to surrender to the idea that It's a random universe, fragmented and confused, in which there's no coherence or systematic understanding, but to acknowledge that there are certain foundational principles that have caused the United States and much of the Western world to perform well economically and given rise to some of the great economic and political minds of the modern world. And that if we go back to those foundational principles we can again make sense of the world. And that starts with the idea that God is in the center of reality.
As the creator of reality, he's created a rational universe because he's a rational God, our minds being made in his image are able to see clearly as well. Not perfectly clear.
We see through a glass darkly, Paul says. But just because you see through a glass darkly doesn't mean that you can't see at all. And so we bring man back together with God. We bring God back to his position, not relegated to some irrelevant otherworldly status, but engaged in his world.
HOW DO WE BRING MAN BACK TOGETHER WITH GOD, ECONOMICALLY SPEAKING?
We look at the demographics of man and woman and generations and we see that another principle is that people are economically productive by nature because they're created to be. They are creative like God, which means a new person who comes into the world, yes, that new boy or that new girl is a mouth, but they're also a mind and two hands. And when they're allowed to be free and be like their Heavenly Father and productive, they lead to economic growth, they lead to prosperity and they lead to abundance. So you pull man back into the picture in man's relationship with the earth and we see that we're actually designed to work on the earth.
We see that the God who made man and the God who made the earth is one God with one mind and we are compatible with one another. We run on the same software. That software is the divine mind. We are made in God's image and are able to think about the world in terms that make sense because the God who made our minds is also the God who made the world. And so abundance is possible and productivity gets placed back in the position of its centrality in the economic process that more people yielding more people yielding more productivity can cause the entire economic pie to grow.
HOW DOES THAT HAPPEN? WHAT MAKES THE ECONOMY GROW?
To bring economic growth back in, we bring investments back in, we bring consumption back into the picture and we get back to that trade-off where greater investment means greater economic growth and our production possibilities frontier begins to expand again.
And we see the relationship between those things and we see that that is the basis that this economic growth leading to greater investment is the basis of our capital markets.
That we have to save in order to invest and that we have to invest in order to grow. And so the capital markets move back into a position of coherence with the rest of the system. We're no longer left completely unable to measure the amount of risk. We're not left completely unable to say what is the proper level of risk.
We are taken out of a world of confusion. We're human, double-minded in nature, and therefore unstable and given to excessive optimism, excessively low-risk evaluation and then given to excessive pessimism, excessively high-risk evaluation. When we set things right, however, we're not trapped in that because we can see what the valuations should be. Given economic conditions and given the actions of the state, we put the state back into the system and see the relationship between policy, tax policy, spending policy, borrowing policy, and monetary policy and see how that affects the economy. See how that affects productivity, the economy, the availability of capital, and the proper valuation of assets.
So the first thing we have to do to get out of this mess is to see and think clearly— see the system as a system that fits together coherently with cause and effect.
WHAT COMES NEXT?
Let's zoom in and take a closer look at the investment markets. Now that we've used principle-centered reasoning to understand that a high-risk environment is an environment in which the principles are not being honored. Let's take a look at how different Investments perform in these different environments.
Remember, this is very important. The riskier the environment, the more yield you want to compensate you for that risk. So what are the various risk factors? There's one risk factor that we're likely all aware of. Which has to do with economic growth. Now, this is going to be a little bit more finance, maybe than you're used to, but if you follow along carefully, we think you’ll understand this.
Bonds pay a yield. It's a percentage of what you invest in the company or in the government. Say a hundred thousand dollars spent on a bond and they give you five thousand dollars a year. That's a five percent yield. Most people are not used to thinking of stocks that way, because usually stocks are either described in terms of their price or in terms of a PE ratio, which is the price of the stock compared to the earnings. In other words, the number of years you have to wait in order to get your money back. But if we just switch that around and make it earning/price, then stocks can be evaluated the same way as bonds.
Stocks in that way, like bonds, are promises to be paid something in the future and that's why stock yields tend to be higher than bond yields.
That seems easy enough to understand, so …
WHY ARE THINGS MORE COMPLICATED IN REAL LIFE?
Because other risk factors enter the picture, and an extremely important one is inflation.
Because every kind of paper that you can invest in involves a future cash flow expectation. You expect to get your money paid back to you plus a certain amount.
They're all an IOU of some form or another.
So, what's the risk? The risk is when you get the money back, it's not worth anything or it's worth a lot less than it is. Now that's inflation. Academic theories of portfolio management almost always leave that risk out, but that risk is pervasive in environments where the principles are not being honored.
Now, why doesn't that happen right away? It doesn't happen right away because there are a number of people who don't understand the principle. So they don't see the connection between these things. It doesn't happen right away because monetary policy tends to create confusion. Human nature tends to go from excessive optimism to despair and pessimism. A double-minded man is unstable in all his ways and without principles.
You and I and everybody else tend to misjudge the amount of risk because here we think we can do no wrong. I'm a day trader and it will always go up. And here we say, I'm never going to invest again; this market is so terrible. So using principle-centered reasoning, you identify the proper amount of growth risk and you identify the proper amount of inflation risk.
HOW DO WE DEFINE INFLATION RISK?
It’s whether the entire set of financial investments is not properly compensating you, for the level of inflation, and to the degree that the crowd of people driven by emotion and confusing government policies are pushing these yields higher or lower than the proper valuation.
To that degree, that creates opportunities to buy and sell. And of course, there's also investing off this curve entirely, which is the commodities market, which tends to do very well in times of inflation because you can print dollars, you can print Yen, you can print Euros. You can print any of the currencies that are out there in the world, but you can't print copper and you can't print oil and you can't print gold. So in environments like this, where risk yields, inflation risk yields are driving the entire stock market into risk territory, one of the ways to deal with that is commodity investing.
Jerry Bowyer is our resident economist here at Faith and Finance. He’s also the author of The Maker versus the Takers: What Jesus Really Said About Social Justice and Economics.
On today’s program, Rob also answers listener questions:
Remember, you can call in to ask your questions most days at (800) 525-7000. Faith & Finance is also available on the Moody Radio Network as well as American Family Radio. Visit our website at FaithFi.comwhere you can join the FaithFi Community, and give as we expand our outreach.
Remember, you can call in to ask your questions most days at (800) 525-7000. Faith & Finance is also available on the Moody Radio Network and American Family Radio. Visit our website at FaithFi.com where you can join the FaithFi Community and give as we expand our outreach.
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