-- Posted Tuesday, 24 January 2006 | Digg This Article
Rick’s Picks
Tuesday, January 24,2005
For investors who’d rather be smart than lucky
Stocks rallied for all the wrong reasons yesterday, including an announcement from Ford that it will shut 14 plants and cut 34,000 North American jobs over the next six years. GM appeared to have benefited as well from investors’ loopy notions about the tonic effects of creative destruction. “Getting small” used to be the running gag of comedian Steve Martin, but now it evidently has become the driving force behind American industry, or at least what’s left of it.
Let’s hope Dearborn’s and Detroit's newfound zeal for shrinkage doesn’t take root in the malls, because if it does, things could get mighty bleak around the holiday season. Picture a Dollar Store or a Subway where Bergdorf’s used to be and you get the idea. You can’t blame the automakers for trying, though. Rather than, so to speak, putting a new Bergdorf’s in downtown Flint, they are finally getting serious about building cars that Americans might conceivably buy without huge discounts and incentives.
Selling the car instead of the deal is a tactic Detroit will have to relearn following years of profligate, low-interest giveaways. Can they deliver the goods? Perhaps. They might even get some help from their European competitors if Mercedes and BMW continue to push the envelope on horsepower. With gas prices lurching once again toward $3.00, it’s hard to believe all of the hubris emanating from Daimler Benz and BMW over their latest 500 hp stallions. Turns out, American automakers are not the only ones who have been bent on suicide. Meanwhile, it doesn’t take much imagination to morph China’s new $10,000 subcompact into a $30,000 cruiser will all the amenities of a Bentley.
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The Deflation Mailbag
We dip into the mailbag today for more insights and provocations concerning deflation. First up is Eric Andrews, who believes as I do that all roads lead to deflation. And by the way, he is unapologetically bullish on gold:
I’m not a subscriber, but like many of your readers I enjoy your straightforward take on deflation. I don’t see any conflict in the Inflation vs. Deflation debate. Austrian inflationists readily admit that inflations end in deflation, so the argument is more one of timing than outcome. [Richard] Russell's "Inflate or Die” dictum could as easily be "Inflate AND Die."
The inflationists simply believe that the government and banks will take extreme inflationary measures to prevent deflation. They must eventually lose, because the outcome is either hyperinflationary repudiation and depression, or direct collapse into depression. Either will cleanse debt and capacity for a fresh start. The inflationists are simply saying the powers that be have a few chess moves left, and we will see high inflation before the wheels come off the train. Unless the deflationary cross-defaults begin today, they will be right.
A Big ‘If’
This is an important difference, because if there is double-digit inflation for two or three years before reckoning day, you would be wiped out by holding cash and deflation-oriented assets. The markets trying to accommodate the fewest number again.
As for gold, you are correct that an impoverished U.S. and world would rather pay off debt and buy oil than make investments, especially in something as uncommon as metals.
China would lack US demand and would have social and economic troubles of their own, so they might not be able to buy jewelry or bars even if they want to. However, you’re missing the key demand for gold in troubled times: It’s one of the few assets that is not someone’s promise to pay, and is the actual goods, unlike a mine or plant that depends on the ability to sell product. Although trillions would be wiped out as paper promises evaporate, yet enough residue would look for safe harbor in gold-- as has always happened-- that it would nevertheless rise, especially as contractual vacillations or collapses seize up division of labor, global transport, and make well-armed nations geopolitically grumpy.
Gold Bubble
As Will Rodgers would say: “I’m more concerned about the return OF my money than the return ON my money.” In the meantime, if Bernanke chooses to fight deflation with “unconventional measures” as promised, then yes, gold could have a 1980-style bubble first.
I’m partial to Sinclair’s theory that being a major gold holder, the U.S. will use the corporate model found so successful over the last decades: declare bankruptcy, stiff the pensioners, repudiate the debt, and restructure the new stock of USA, Inc as “backed by gold” (still un-inventoried) while keeping the same management, assets, and management payouts while starting inflation tax-trick all over again with a clean slate, Argentina-style. It worked for that country without penalty, and as over 50% of U.S. debt is held by foreigners, I don’t see why they wouldn’t try it. The government is filled with businessmen who think this is the right way to behave. Planned repudiation is a cascading inflation, however. I don’t know if this is likely, it just shows that when you make the rules instead of living by them, there are always options.
Joseph Shelton has his own ideas about diversification:
I assume that the inflation vs. deflation debate is really about how to protect oneself from a very bad potential situation. If deflation is the order of the day, then cash is king. If inflation is the table we are sitting at, then investing in precious metals seems wise. Diversification presently implies stocks, bonds and cash (mostly the electronic kind.) But is this really diversification ?
Electronic Money
The present system has one common theme: It’s all electronic -- and therein lies the danger! There is very little actual printing of greenbacks. As much as 70 percent of all hundred dollar bills are outside of the United States. When we talk about cash, are we referring to electronic markers in an account, or the actual federal notes in hand ? The fed is not printing too many greenbacks. The real money-growth is credit in electronic form. This system is leveraged to the hilt and will be the financial weapon of mass destruction. If credit is destroyed, then deflation will rule and fed notes in hand will be hard to come by. And going one step further in thought, coins will be the currency of choice because federal notes might be changed in a real panic. But coins are Treasury-issued instead of fed-issued and are therefore much safer.
What, then, is real diversification? How about a third of your investments in cash (coins preferred, in-hand) in case of deflation; a third in precious metals (not in electronic form) for inflation; and, a third in stocks, bonds, and e-cash in our present credit system. Think about it: Our houses, retirement savings, stocks, bonds, IRAs, 401ks and Social Security are all a part of this leveraged credit system that is teetering.
And here’s Sidharth Jhaveri, grinding his axe:
I am not a student of economics, just an amateur technical analyst and share & bullion trader, but I find your bearish bias on the stocks a little perplexing. Why is it that you are always talking of the impending crash when there are no signs of it in the bigger picture? A look at the weekly, monthly and quarterly charts of the above seem pretty straightforward: We’ve been in bull territory since December 2003 and there is no convincing sign of a major reversal. The daily charts are a little bearish -- but that would construe a buying opportunity on a bad/crash day.
Incidentally, I was a subscriber of yours earlier but let the subscription lapse since my main interest is daily trading in gold/silver/crude futures. I have downloaded your pivot theory but still haven't found the time/inclination to study and implement same. Surely, my loss! I would resume subscribing if you initiate more active bullion/crude analysis. (If pivots work in reliably in crude, I would eat out of your hands!)
My response:
You should check out my archive, Sid. I don’t emphasize coverage of crude, but I doubt you can name any forecaster who has nailed the trends and major swing points in crude more accurately than I have over the last two years.
A fat pitch from Tony Rodrigues. What say you, readers?
I absolutely buy the notion that the dollar goes up in a (asset) deflation environment. I think the one we are entering will see all asset classes depreciate: stocks, bonds and tangibles (real estate and commodities). We know there is a proliferation of debt globally and the largest debtors are Americans. The reason the dollar goes up is because bonds go down (long interest rates that the Fed cannot control go up). It will be a dash for cash or a liquidity crisis caused by an implosion of the global debt bubble. The Fed will find that the more it tries to monetize, the more the bond yields rise as fear takes hold of investors. So they will do nothing and their credibility will be utterly damaged. So I cannot see why you and Jas Jain seem to believe that government bonds will rise in value. Your thoughts?
Ian Rayner brings precision to a debate often mired in vagueness:
One of the difficulties we are confronted with in the inflation/deflation debate is the correct use of terms like inflation, money, credit, etc. The dollar prices of goods change for many different reasons, but I think there are three reasons that are germane to this discussion: increased money supply, speculative bubbles and supply/demand relationships. In the real world, their effects are overlaid and hard to separate.
When the Federal Reserve injects money into the economy by monetizing assets at a greater rate than is necessary to facilitate economic growth, we experience inflation; each dollar purchases less. Looking at the Federal Reserve's balance sheet (i.e. the assets that back the dollar, primarily government bonds and gold), one can see that it grows faster than the economy. From 2000 to 2004 it grew at a compounded 7.8%. To me, this is the number that gives us a handle on inflation. It is annoyingly high, in excess of what is needed and constitutes a pernicious tax on savings, but it certainly is not hyperinflation.
Bubble Not Inflation
During a speculative bubble, prices of a particular class of assets rise. Bubbles are fueled by asset-based lending, and therefore tend to be self-reinforcing. They are more a function of social mood than anything the Fed does - there were plenty of bubbles before the Fed existed, during times when money was 100% gold-backed and during times of high interest rates; clearly a bubble is not inflation. When a bubble collapses, the debt used to inflate it does not. This is what people, including myself, have referred to as the "deflationary depression" scenario. But that is actually incorrect; a more accurate term would be "credit contraction and/or demand destruction" - I resolve not to refer to this as deflation.
When supply/demand relationships change, so do prices of goods. China’s and India's demand for industrial commodities is growing at a time when their supply is constrained through underinvestment. Naturally, the prices of the those commodities increase. This is not inflation; it reflects an increasing preference for these goods over others.
Key Concern: How Will Fed React?
All of the above effects are taking place at the same time. Furthermore, they are inter-related (for instance, a construction bubble increases demand for commodities). The burning issue in the debate is "How will the Fed react to a credit contraction?" I imagine they will try to inflate, but I believe they will be unable to prevent the economic contraction - there is simply too much debt. It is inconceivable to me that they would hyper-inflate because that will be the end of the dollar whose stability and protection is the very reason for the Fed to exist, it is their primary mission: no dollar, no Fed.
I believe we will experience a significant credit contraction, possibly a depression, which will be the end-game of 25 years of declining interest rates and ballooning debt. Prices will decline, particularly in housing, stocks and bonds. For commodities I think the future depends upon Japan, China, etc. and how they deploy their dollar reserves in the context of declining demand from the U.S. consumer. I believe the Fed will attempt to expand the money supply (inflate) but will never get anywhere close to hyperinflating, and we may even find the Fed's balance sheet contracting as they attempt to mop up the excess dollars (deflation). It's happened before.
A Postcript
Postscript: Your reader Rene seems to think that if a borrower repudiates a loan, no money is destroyed, it is somehow marooned out in the economy. I hope he is not the shareholder of a sub prime lender. In addition, he claims that securitizing loans doubles the amount of money created by simply making a loan. But how? Finally, the idea that repatriating dollars currently held as U.S. Treasurys will flood the market with dollars is odd - don't the holders have to sell them to someone else thereby absorbing the same amount of dollars? I am trying to figure out what happens to the dollars currently frozen as cash reserves. (I can't believe they are just stuffed under the Chinese mattress; surely they would be in short-term paper).
Creating credit money is like creating a matter-antimatter pair, the antimatter (loan note) may get transformed but ultimately it will destroy an equal amount of matter (money), whether it is from the original borrower or from someone else. It's like a law of nature (and, incidentally, what double-entry book-keeping is predicated on). Someone might ask "what about the S&L crisis - none of that was ever paid back so doesn't the money still exist?" The answer is yes, the money still exists because the loans taken out by the government to finance the bailout still exist.
In answer to John's question about what happens to a currency in a hyperinflation - you don't get to trade in your old money for new at some fixed ratio. Your old is simply worth nothing because it is no longer accepted anywhere as legal tender. Your savings are worth nothing. You have to start from scratch, selling hard assets (house, car, gold) to raise cash. During Russia's 1990 - 1994 hyperinflation the life expectancy of Russians dropped from 62 to 58 for men and 74 to 71 for women ("Godfather of the Kremlin" Paul Klebnikov), it is estimated that 3m of a population of 100m Russians simply starved or froze to death. Simply horrifying.
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Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers’ initials will be used unless express written permission has been granted to the contrary. All Contents © 2006, Rick Ackerman. All Rights Reserved. www.rickackerman.com
-- Posted Tuesday, 24 January 2006 | Digg This Article
