–Hmm, so gold took a tumble from its lofty heights. And markets in the US didn’t look too much better. Europe was ok though.
–But what’s changed? Have people forgotten that the world is about to be flooded with the “full faith and credit of the US government”? (That’s the text printed on Federal Reserve Notes, which the US government has declared to be legal tender). Perhaps people would prefer J.F. Kennedy’s silver backed dollars, which were quickly taken out of circulation by the Federal Reserve after his assassination. With them, we’d be on a sound money footing, which makes sound investing a lot more likely.
–Maybe the “awwww” part of the “shock and awe policy” has set in, as discussed yesterday. QE1 didn’t work, why should 2 do any better? Not that it won’t do anything.
–But how does frying bigger fish today sound to you?
–Lets take on the decisive question. The mother of all queries. The game-changer of all known unknowns: inflation or deflation? Better known to your editor as the ‘flation wars’. That’s the big one, dear reader.
–Those with a shred of credibility post GFC are the ones who predicted it. But they are far from the monotonous bunch you’d expect. And the ‘flation wars’ are where they really come head to head.
–You see, anyone outside the mainstream could predict a crisis was around the corner. Simply by being different, that is. It’s an inherent contrarian characteristic. Some contrarians fancy themselves as a modern Galileo or Luther. Sometimes they turn out to be more like the people you see walking around in circles outside our office, muttering to themselves. The point is that being correct isn’t the same as being right. Seeing something coming doesn’t mean your understanding of why it’s coming is correct.
–So you have to dig down deeper to discover who has a more sound theory. Track records aren’t everything. But they do matter, so let’s narrow the ‘flation war field down to some of those left standing after 3 years of hullabaloo.
–Hold on. It’s probably best to frame the battlefield first. Sun Tzu would approve. We live in a highly leveraged world with an audacious academic in charge of the most important central bank and a community organiser in charge of the most important economy.
–Two of those three facts favour the inflationists. As Marc Faber often says, simply look into the eyes of Bernanke, Obama, Geithner and advisor Summers and you can conclude nothing but inflation to come.
–The deflationists, notably Robert Prechter, think a repeat of ’08 is in the cards before any inflation can really appear. That’s because the world’s leveraging troubles aren’t solved. And interest rates can only go up. So, even if inflationists are correct initially, the inevitable increase in nominal interest rates will trigger a crisis, which means deflation. To put it plainly, any inflation will trigger deflation anyway.
–A mental image might clarify things.
–Imagine a tug of war with Bernanke and the entire Obama administration on the inflation side, with the private sector (importantly including banks) on the deflation side. Yes, the banks are involuntarily on your side for this one. The question is which side will outweigh the other.
–Deflationists would contend that the private sector has jumped off a cliff without letting go of the tug of war rope and Bernanke and Obama will be dragged down with them. Inflationists would argue that Bernanke has tied a helicopter to his side of the rope and plans to lift everyone into the skies, cliff or no.
–It’s a power struggle. The problem is that half of it is a political one. And politics doesn’t conform to the usual laws of economic theory. That leaves analysts like us with a problem. Austrian Economics believes in an inherent logic to all actions. Not that the logic is often decipherable to the observer. Bernanke’s certainly isn’t. But even he acts based on incentives. The question is, what are they?
–To paraphrase a congressman during a recent hearing, “We do not question that you are working hard. We question who you are working for.” The obvious answer is that Ben Bernanke is working for Ben Bernanke. But what is the highest bid in that auction? The fulfilling reward of putting the economy back on a sound footing? Not likely.
–So what side do you take as an investor on the battlefield of the ‘flation wars? Precious metals and commodities generally signal inflation. But when things reach all time highs, it’s usually not the best time to join in. It seems like an amateur mistake to do so.
–So how about you just sit it out for a round and watch the carnage unfold – to the upside or downside. But where? Bonds aren’t risk free (don’t believe your economics teacher). The Aussie dollar isn’t too bad, but it seems like a small fish in a big, big pool and US investors will determine investment trends to come. They can’t stay in US dollars if inflation takes hold, so that isn’t safe either.
–The logical place to turn to if nothing seems appealing is liquidity. Keep your portfolio dynamic so you can move fast as things play out. Talking of fast, dynamic and responsive, did you see this yet?