Moonwalking the Monetary Tightrope, Inflation or Deflation

A few weeks ago the Weekend Markets and Money was about walking a monetary tightrope. A tumble into inflation on the one side and a drop into deflation on the other. But we’re getting both – inflation in stock markets and living costs, and deflation in the economy.

Stagflation alert!

Stagflation is the worst possible combination of economic conditions. You get rising prices and economic stagnation at the same time. In economics, you’ve got stagflation when GDP grows less than inflation. On that basis, the US, Europe, emerging economies and the world as a whole are all in stagflation: rising prices with no growth.

Severe stagflation happened as recently as the 70s. Economists thought it was impossible. The effects on investors are hard to wrap your head around. On the one hand, inflation pushes up share prices. On the other hand, the businesses those shares represent are actually doing poorly in the real economy. So what’s the solution? Where do you invest?

Economist Andy Xie, who reckons our ‘stagflation alert’ is a bit late, has an answer:

‘Multinational companies remain the biggest beneficiaries of the current global environment. The macro instabilities give them opportunities to arbitrage the frequent fluctuations in demand and production costs across the globe. The negative real interest rate has boosted their profits significantly, too.’

This sounds a lot like Dan Denning’s theory of Fortress Stocks. These are companies so big and powerful they behave like a fortress on the one hand, but like a dynamic profit making enterprise on the other.

If you’re going to invest, you want to invest in a bastion of strength with some return baked in. That used to be provided by government bonds. But these days, defaults and low returns are baked in instead.

Investor Marc Faber often points out that the German company Siemens survived world wars and all kinds of economic crises intact. Even if you didn’t make money by holding the shares, at least you had something after each crisis. Holders of German government bonds got wiped out over and over again in all sorts of different ways, including inflation and default.

But Fortress Stocks aren’t the only option. Andy Xie goes on to point out another strategy might work. Xie writes that, ‘Speculative capital also profits from the mismatch between economic challenges and policy responses.

This is the world Murray Dawes  lives in. Rather than trying to figure out the world based on some kind of theory, you simply take the trading opportunities when they come. You can find them in any market, in both directions.

If you’re market neutral (neither a bull nor a bear) who cares what the politicians, central bankers and bankers are up to? In reality, traders are people too. And most people do care. But the success of your trades shouldn’t rely on whether you’re right about how the world works.

Traders are one group that can benefit from a market headed in two directions at the same time. Another group of people that benefit from a stagflationary world are the ones who opt out of the monetary and financial system as much as they can. Well, they don’t necessarily benefit from stagflation, but they are less at risk.

Investing in things in your immediate environment is a great way to distance yourself from the monetary mayhem. Are there ways you can invest your money that will cut your power bills, save on groceries, get a better bang for your buck, or escape Australia’s ridiculous cost of living? Rather than looking to financial markets, look around you for investment opportunities.

In other words, do the opposite of this new pop group in Japan:

 “We base our costumes on the price of the Nikkei average of the day. For example, when the index falls below 10,000 points, we go on stage with really long skirts,” Mori explained.

‘The higher stocks rise, the shorter their dresses get. With the Nikkei index ending above 13,000, the four went without skirts altogether on the day of their interview with The Japan Times, instead wearing only lacy shorts.

Well, that explains the rally in Japanese…stocks. The new national obsession with inflation and economics even involves the new ‘Branomics’ bra which inflates volume by 2%.

If you’d like to let the financial world determine your day to day life…good luck. Unless it’s for entertainment value, of course. If you think the world of high finance is boring, check out these quotes from the Financial Times blog Alphaville on recent events. The first one is about central bankers making conflicting announcements, causing havoc in currency markets:

‘The euro dropped on Draghi’s pronouncement, recovered on Nowotny’s suggestion that “markets have over-interpreted the discussion yesterday’ and sagged a bit when he said he hadn’t said what we thought he said about Draghi not having said what we thought he said… or something.’

But, as far as entertainment goes, nothing can top the cause of chaotic goings on in the Italian bond market (emphasis is ours):

‘Since the authorities were convinced that high fail rates were the result of operational glitches – people not picking up phones, or overlooking faxes – rather than any sinister settlement-avoidance strategies,  they moved to give market participants more time to settle trades. A total of 10 extra days was in fact the recommendation.’

Faxes? Not picking up phones? This is the Italian sovereign bond market for heaven’s sake – the third biggest in the world. And people are ignoring faxes and not picking up phones?!

Watching bumbling politicians, lazy bankers and loony central bankers is more fun than listening to skimpily dressed Japanese pop singers.

But part of your financial life needs to be serious. Given that financial markets can’t be taken too seriously while money printers, Italians and Keynesians are in charge, where do you look for powerful investment ideas? Our suggestion is taking a long hard look at yourself. How could you invest in yourself and your surroundings in ways that will make and save you money?

Last week we asked readers for help naming this new ‘Money Trend’ (a way of investing). The response was overwhelming. Unfortunately, we can’t show you the best suggestion…for language reasons. Yes, you know who you are Ronnie.

The publishable and more positive name we’ve decided to go with involves being able to stand on your own two feet. But before we can reveal the trend, we need some more specific ideas under our belt. Look out for more on this Money Trend soon.

In the meantime, how will the stagflation end? Well, in the 70s, Federal Reserve Chairman Paul Volcker realised low interest rates were hindering, not helping, the economic recovery. Inflation had to be dealt with before stagflation would end. Everyone else at the time believed in increasing growth first.

Volcker had to raise interest rates to 20% before inflation halted. At first it worsened economic conditions. But then inflation stopped and the stability allowed the economy to grow again. People went from burning effigies of him to calling him the greatest central banker of his time.

Unfortunately for us, interest rates at 20% are impossible. The governments of the world can’t afford that kind of interest bill, let alone homeowners. This time, we won’t be able to walk back down the monetary tightrope to safety. We’ll be taking a tumble.


Nickolai Hubble.
Markets and Money Weekend Edition

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About the author: having escaped from academia, Nick decided to drop his tights (the required attire of a trapeze artist) and join Port Phillip Publishing. Instead of telling everyone about the Markets and Money, he now spends his time writing for the weekend edition.

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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