After a night of heavy drinking in the pub…and pious reflection in our hotel room…we woke up worried. What if our friend Hugh Hendry is right? Heck…what if WE’RE right?
The most critical question an investor faces today is whether he wants to smash up on the rocks of deflation…or run aground on the hard place of inflation. Posed the question – inflation or deflation? – we have always answered ‘yes.’ We will have both. But it is gradually occurring to us that we will have both more abundantly than we realized. As Hugh reminded us: we know of no case where quantitative easing has actually worked. It seems to work only where it is applied to excess – where the results are catastrophic hyperinflation.
The feds are more incompetent than even we suspected. They are trying to cause mild inflation – say, 4%…maybe 6%…even 8%. But they aren’t doing a very good job of it. Their efforts are too hesitant…they’re too worried about what the anti-inflation hawks will say…and about what the bond vigilantes will do. “What if the Chinese dump their Treasuries?” Yikes, that is too awful to contemplate. “Better go easy on that quantitative easing.”
The Chinese…unhampered by bond vigilantes [they are the bond vigilantes] or good sense…are increasing their own money supply three times faster than the United States.
Our Feds are trapped between the same rock and the same hard place as the rest of us. Either they run into the rocks of hyperinflation…or into the hard place of deflation. Just like Japan’s central bankers and finance ministers. They COULD cause inflation…but the price of it is too high. So, they take baby steps…boosting the money supply too little to offset the natural deflation of a major correction.
Of course, this is what makes us fear hyperinflation too. There doesn’t seem to be any safe channel between Sylla and Charybdis. If they are going to cause inflation…they have to really inflate the money supply. Not by 9% a year…but maybe by 900%. We don’t know what it will take; neither do they. All we know is that what they are doing now is not working. Prices are falling, not rising. Bond prices are rising – indicating that the vigilantes don’t think inflation is a problem. And the foreigners – notably, the Chinese – are still ADDING to their supplies of US Treasury debt.
So, dear reader, what should you do? Inflation could take much longer to arrive than most people think. A dull, sinking, dreary economy – like the weather in Ireland today – could be with us for years. The dollar could go up…gold could go down…for many moons.
Are you prepared to wait it out? We will leave you to think about that….
We’re still troubled by Hugh’s comments. The inflation narrative is “too easy to articulate,” he says. Too many people see it coming.
“The market clearly is not worried about inflation right now,” says colleague Chris Mayer. “That is the only way to explain 10-year Treasury yields of 3.30% as of last Friday. The deflationist view is the one that prevails. This view, which makes some compelling and elegant arguments, maintains that the credit losses far surpass the monetary and fiscal stimulus. All those trillions in destroyed debt, plus the yanking of credit from consumers and businesses, overwhelm new money creation.”
Many years ago, we looked at the danger of a “Japan-like slump.” We were early. We’re facing the sushi now. Falling prices. Big output gap. Rising unemployment. On again, off again deflation.
When we considered the risk a few years ago, we came to the conclusion that the United States couldn’t afford to wait it out the way the Japanese have. We have too many people who owe too much money to too many wobbly creditors.
But now we’re in it. The feds are propping up the wobbly creditors just like they did in Japan. The banks have gotten trillions in loans and guarantees.
The feds have been trying to prop up households too. They recently approved 125% mortgage refinancing by Fannie and Freddie. In other words, they now officially condone…and finance…underwater homeowners. If your house is only worth $200,000…and you owe $250,000…the feds will refinance your mortgage in full. No need to sell and take the loss. No need to let the banks
foreclose. No need to face reality. Now…you can just stay underwater – indefinitely.
The feds are preparing to keep the whole economy on life support – with oxygen provided by quantitative easing. Eventually, of course, they’ll run out of gas. But that could be far in the future…
Government deficits are getting worse and worse. Tax receipts are falling. The US deficit for June came to $94 billion…a new record. And the budget deficit has topped $1 trillion for the first time ever. This is also exactly what the Japanese did. They ran the biggest deficits in history. And still the yen went up!
As we keep saying…inflation is no sure thing, at least not in the short-run. But Chris Mayer believes that “the problem with the deflation arguments long term, it seems to me, is that you are betting against a government’s ability to destroy its own currency. Governments are seldom good at anything, but one thing they are undeniably good at is destroying their own currencies. The dollar has lost 95% or so of its value since 1913. That’s a pretty darn good job. Other countries have been even more thorough.”
It takes a determined and suicidal central bank to pull off hyperinflation. Like the Central Bank of Zimbabwe, for example.
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