E External Contributions

Money Printing, potentially higher Inflation and seeing the Wood from the Trees – Colm Fitzgerald

15 September, 2021
money printing - Forest

This is article was written by Colm Fitzgerald and was republished with consent. Colm Fitzgerald owns and manages his own forest in Ireland. He lectures in University College Dublin and was formerly Head of Quant Trading in Bank of Ireland Global Markets.



Times change, markets change, but some things don’t change so much. Today the dominant driver in markets is liquidity, primarily driven by the Quantitative Easing (QE) policies of central banks around the world. How does this work? A graphical explanation is outlined below, showing the interaction between money printing and asset price changes.

This policy has been successful at increasing economic growth. Asset owners have experienced significant wealth increases, albeit in proportion to their existing wealth, and this wealth effect drives economic growth. Those with wealth feel they have more to spend. Those without assets, in particular those without houses, have been aided by more employment opportunities, but also harmed as their aspirations to purchase a home have been damaged from rising house prices. They are, on average, no better off in terms of their aspirational living standards, or sometimes worse off. Their wages are effectively lower in terms of the lifestyles they can buy and a knock-on impact has been increasing inequality and the social tensions that arise from it. Since most of our populations fall into this category, it has acted to limit any price inflation arising from the money printing by central banks. Goods and services purchased by ordinary people, those that make up the consumer price inflation measures, have not seen additional demand pull inflation. Arguably, QE is mildly deflationary for consumer prices. Albeit the situation is helped by continuing productivity increases.

However, that has changed recently. QE increased significantly after the pandemic began and, combined with supply side issues in economies from the pandemic, it has seen consumer price inflation rising. Some say this is transitory, others that it might last longer. Printing money and keeping inflation down is key to keeping the punchbowl open and this worries some investors.

This is against a background of an enormous rise in crypto currencies, partly fueled by narratives about the global fiat money system being less trustworthy, and an increasingly large pool of wealth seeking to both protect itself and to grow itself. Popular investment narratives have also been driving investors into equities, e.g. TINA (there is no alternative) or stonks only go up.

The prudent investor risks not seeing the wood from the trees in this environment, especially with the increasing global concern about climate change.

Forestry investment is a potential solution, one that is getting arguably less attention than it deserves. Forestry returns are driven by biological growth of trees and changes in timber prices. A recent paper in the Journal of Alternative Investment, entitled “The Forestry Investment Total Return (FITR) Index” provides an analysis of historical timber prices that shows that timber prices have consistently outpaced general consumer inflation over the last 750 years (Fitzgerald, 2021). Salient aspects of this article are outlined below.

Forestry investors use a variety of valuation methodologies based on sample plot observations and statistical sampling techniques to estimate the volume of timber that will be harvested from a site in the future. ‘Growth and yield models’ are the most commonly used method, particularly in the US. They are a set of computer-based mathematical polynomial growth equations that are used in the forestry industry to dynamically estimate the growth of a forest under a variety of conditions. Based on assumed biological growth, determined from an assessment of the site, using the growth and yield models, optimization models are then used in conjunction with timber prices to create a discounted cash flow (DCF) model of future timber revenue. An example would be the Growfor model of Coford in Ireland. Older paper-based methodologies also exist for estimating the volumes of timber that will be harvested. An example would be the forestry management tables in the UK, now also available as a computer-based model. DCF forestry valuation models have been around for a long time. Perhaps the most famous is the Faustmann model published in 1849 – later republished in the Journal of Forest Economics in 1995 (Faustmann, 1995).

Prudent forestry investors typically only invest when the price paid results in a forestry discount rateabove their required minimum rate. In developed countries and established forestry investment markets, this forestry discount rate is typically 5% ‘real’ (assuming no change in current timber prices). The ultimate return achieve is the forestry discount rate used at purchase plus subsequent timber prices increases.

Two broadly different types of timber prices exist, one being the timber prices that forestry investors get from selling their harvested timber to sawmills, and the second being processed timber prices, usually referred to as lumber prices.

US lumber prices are available from 1798 to 1932 from Cornell University and from the Bureau of Labor Statistics from 1926 to date. These are graphically outlined below in Exhibit 1 and 2 below (from 1798 to 2018).

They show that US lumber prices have historically and consistently outpaced general inflation, by slightly greater than 1% per annum based on geometric averages, and that timber prices are positively skewed (more likely to spike higher and subsequently go lower than to spike down and subsequently go higher). The exhibits above do not include the recent spike in lumber prices this year.

Data is also available over long periods showing the relationship between US timber prices (aka stumpage prices) and US lumber prices, e.g. the graph below shows the relationship between 1910 and 1992 in Exhibit 3. The data show a consistent out-performance of US timber prices (stumpage prices) relative to US lumber prices (and data on harvesting costs shows this falling consistently over time). US timber prices have historically increased by approximately 1% more than lumber prices per annum.

Older data is available from England back to 1265 and shows a consistent picture.

Does money grow on trees? Of course not! The next article will discuss the practicalities and challenges involved in forestry investment.


References

Allen R (2001) The Great Divergence in European Wages and Prices from the Middle Ages to the First World War. Explorations in Economic History 38, 41 1-447

Clark G (2007) The Long March of History: Farm Wages, Population and Economic Growth, England 1209-1869. Economic History Review, 60(1) 97-136

Faustmann M (1995) Calculation of the Value which Forest Land and Immature Stands Possess for Forestry. Journal of Forest Economics

Fitzgerald, C. (2021) The Forestry Investment Total Return (FITR) Index, Journal of Alternative Investment https://jai.pm-research.com/content/23/4/131.abstract

Sohngen BL, Haynes RW (1994) The “Great” Price Spike of ’93: An Analysis of Lumber Price and Stumpage Prices in the Pacific Northwest. US Forest Service Research Paper PNW-RP-476

US Bureau of Labor Statistics – CPI and PPI data www.bls.org (components, WPU08, WPU081 and CUUR0000SA0)

Warren GF, Pearson FA (1932) Wholesale Prices for 213 years, 1720 to 1932 Part I. Cornell Agricultural Experiment Station

Williamson SH (2019) The Annual Consumer Price Index for the United States, 1774-Present. MeasuringWorth. http://www.measuringworth.com/uscpi/