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  • Writer's picture Kester Eddy

"Can someone go to the SPA to cover some crazy story?" A crazy story? I volunteered, of course.

Malinvestment? In case you don't know what it means, here's a good chance to find out.

Photo: Les Nemethy, CEO of Europhoenix, a Budapest-based financial advisory One morning in the summer of 1992, I was in the dingy offices of the old Budapest Week newspaper and the phone rang. Rick Bruner, the editor, picked it up, and listened for a while. "Can someone go to the SPA to cover some crazy story?" he shouted across the room.

A crazy story? I volunteered, of course. I think Rick handed over the phone, and I talked to the agitated lady at the end of the line who was on about some unique Hungarian porcelain that the entire world seemed to know about, except me. Whatever, she insisted this would be the scandal of the decade, one which no journalist between Zurich and Moscow could afford to miss. And I could have it, on plate. The SPA - the State Privatisation Agency - was based in the former Hungalu building on Pozsonyi utca in XIII. Today the building houses the National Asset Management Company (kind of ironic, since it manages what its forebear failed to privatise :)) I went over to find the lady on the ground floor even more agitated, breathing fire and brimstone about "the communists" wanting to sell "unique Hungarian heritage" at "bargain basement" prices either to themselves or foreigners, I couldn't quite work out which as it seemed to change with each telling. In truth, it was all too much to absorb in one go, but as I was the sole blessed journalist to be onto this, I was going to get the best chance of all. I imagined the letter announcing my Pullitzer was already being drafted. A few minutes later, and lo! One of "the communists" not only appeared, but politely invited us into a side room to discuss the matter. I think he was in a suit - treacherous devils, these modern commies, trying to lull us westerners into thinking they were like good, free-wheeling capitalists - and he spoke very good English, if with a North American accent. As the meeting went on, the lady worked herself into a frenzy, while the besuited commie kept surprisingly calm and cool, methodically explaining how the privatisation of any company would be an open and transparent process. I confess that, even if he were a commie, I quite liked the fellow. As for the lady, I was beginning to think there was perhaps a good reason why I was the only journalist to take her up this 'scandal of the decade'. I tried to remain neutral and dispassionate, and understand the whole caboodle, but I left the SPA thinking I must have been onto the best non-story ever. Still, in journalism, as in life, one just never knows what transpires. And would you believe it, the next day the darned clever commie phones me up to ask me what I thought about it all, and could he help if I was writing a story. Frankly, I totally forget if I ever did - though I think not. This was, however, the beginning of my knowing Les Nemethy, the most ethically-minded, free-market believing "commie" you're ever likely to meet. Les was, at the time, head of the transaction unit at the SPA, a job he held for a little over 12 months.

As he told me in an interview in 2018, it felt like a year "sitting on top of a volcano". Fast forward to a week or two back, and I was on the Budapest metro, reading a copy of the Budapest Business Journal which I'd picked up at random. It turned out to be from last October. Les now has a regular column in the BBJ which is invariably a decent read, and rarely time dependent, so I naturally sought out his words of economic wisdom in this 8-month old paper. It was one I had somehow missed, entitled Malinvestment in our Strange New Economic Environment.

It was one of his best, so much so I wrote to him saying it should be translated into Hungarian, with three million copies printed onto A4 paper and posted into each Hungarian household.

But since I can't do that myself, I asked Les if I could republish it here, just to spread the word to a modest English speaking audience.

Economics not your thing? Don't be put off. This one is spelled out in a straight and simple way, so even a politician could understand it.

Hopefully, a few sitting in in the Castle, or even on their yachts in the Adriatic, might even read it.

Have a good weekend.

Guest Post By Les Nemethy, CEO, Euro-Phoenix Financial Advisors Ltd

Interest rates are near zero in most of the developed world, sometimes negative, despite which new investment and velocity of money are falling; Governments continue to try to stimulate them. In many countries Governments are subsidizing loans (e.g. Hungary) and in others, guaranteeing bank loans (e.g. Italy). All this leads to malinvestment—investment that is not efficient (e.g. propping up zombie companies, or projects). This article discusses some of the perverse effects of malinvestment, and what actors in the economy might do to diminish malinvestment. Just as the north star served ancient navigators as a compass, so too interest rates serve modern decision makers as a compass for making investment decisions. Prices are essential signals in a market economy. The interest rate is perhaps the single most important price or signal in every market economy. If a government distorts prices through monetary inflation or artificially low interest rates, a distortion in resource allocation is likely to occur: malinvestment1. When I ran a telecom company, our board approved only those investments which generated a certain minimum return on investment (which of course was determined by our cost of capital at the time). So if interest rates and therefore cost of capital are lower, less productive investments would be undertaken. When this happens on a macro scale, this cannot have any other effect than reduce standards of living and well-being. A loan is a way of bringing forward an expenditure from the future to the present, and the lower the return, the more it will be at the cost of future generations. Investments undertaken at near-zero interest rates rob future generations to create an ephemeral present stimulus. Unless you assume that there is no intention of paying back loans in the future—just rolling them over, possibly even adding to them—which creates a different set of problems, discussed below. Government stimulation of the economy with negative interest rates becomes counterproductive. Rather than accept negative interest rates (e.g. paying the bank to hold your money rather than vice versa), individuals may well prefer to hoard cash under the proverbial mattress (corporations opting perhaps to keep cash in the safe). This cannot serve towards any other purpose than further reducing velocity of money, effectively sterilizing savings, depriving the financial sector of its role transforming savings into investments. While cheap interest is like a drug that stimulates the economy when interest rates are headed downward, when the direction of interest rates, particularly real interest rates begins to increase, many projects and companies that were formerly viable at lower interests lose their ability to service debt and collapse. This explains the addictive nature of low interest rates—it is a hard habit to kick without creating diminished output, unemployment, etc. So what can we do to escape this cycle? First and most importantly: Governments should wean the economy of artificially low interest rates. Over the past few years, the Fed had made feeble attempts to do this in the US, until Covid hit, which triggered another massive round of lower interest rates and monetary easing. As Ludwig von Mises, eminent economist from the Austrian school wrote: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as the final and total collapse of the currency itself.”2 In other words, if we continue issuing massive debt and printing money ad infinitum, at some point people may lose confidence in the currency, resulting in a collapse of the currency. Bankers should pull the plug on zombie companies and investments, or even better, force their restructuring, even if this results in short-term pain for long-term gain. Furthermore, rather than devoting large amounts to safe investments like government bonds, banks should take on intelligent risk, backing good entrepreneurs with quality projects. Entrepreneurs should use their business acumen to generate high rates of return—both for their own good, and for the good of society. There are still quite a few start-ups and technology investments that promise considerable returns. Individuals, who ultimately save for retirement, will need to put aside a higher percentage of earnings, not only because interest rates are lower—but when equities trade at record price/earnings multiples, equities, too, are statistically more likely to appreciate less over the medium to long-term. In short, malinvestment over the years means we have collectively dug a hole that is getting deeper. At some point, post-Covid, we must begin exiting the hole. To use the analogy of forest fires, the more debris and undergrowth exists in the forest, the more substantial the conflagration will be when it comes. We need to begin cleaning out the debris.

1 2Human Action, Ludwig von Mises, Chapter XX, section 8 This piece can be viewed on Les' Europhoenix website here Or on the bbj website here: I would post the link to the story I did on Les in 2018, but the new BBJ website just doesn't yield any trace of it.

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