Conventional Wisdom

I'm a big believer in anti-conventional wisdom thinking and right now it isn't looking good, not good at all.

First, I want to go back in time.

April 22, 2008
What You Would Expect to See in a Developing Country

After 30 years trying to defy economic gravity, the US is well on the way to becoming the world's largest banana republic.

I obviously believed it was possible, or I wouldn't have quoted it. So let's see how we are doing.

March 29th, 2009
The United States As A Banana Republic

The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.

Let's back up a paragraph or two.

Above all, there is arrogance. Arrogance not only on a personal level, but on a systemic level…that this system is the “cause” of our prosperity, and that the world “needs” our dollars.

If you've been reading this blog then you surely know that I agree. Oh crap.

March 22, 2009
TIPS give guarantees, but they require patience

To fight against the risk that inflation will erode the value of your money, advisers typically suggest people put a substantial portion of their savings in stocks.

But Bodie challenges that thinking.

"Conventional wisdom is wrong," he said. Stocks were the only way to try to keep ahead of inflation in the past, but since the government started selling TIPS in 1997, the safe bonds help fight inflation risks.

We can't prove that conventional wisdom is currently wrong, but we can prove that it was wrong in the year 2000. The I-Bonds I bought in April, 2000 paid 3.4% over inflation. As of March, 2009 they have compounded a 74% gain and continue to earn interest tax-deferred for up to 21 more years. Meanwhile, the Nasdaq was 3,860 in April of 2000. It is now 1,545. That's a 60% loss.

In summary, that's $1.74 for each dollar invested in I-Bonds vs. just 40 cents in Nasdaq stock. Safe did more than just win. It slaughtered risk (by a factor of four). Here's the scary part. There wasn't even all that much inflation. Just imagine what would happen if inflation did actually pick up. Picture what would happen to the stock market with inflation at 15%, interest rates at 15%, and "safe" TIPS earning 17% (2% over inflation). I doubt very much it would be pretty, any more than it was in the 1970s.

For example, how would restaurant stocks perform in such a scary environment? Who would eat out? It sure won't be me. I'll be too busy resupplying the "Apocalypse Pantry".

Let's assume for the moment that our government won't allow 1970s level inflation to happen again. It is suggested that 15% inflation would ruin this economy and is therefore simply not an option. I am certainly willing to entertain this theory, mainly because I agree with the reasoning. Whether or not the government can stop it from happening is still open for debate.

I tend to think of this differently than most it seems. In the past, inflation was an option. I'm now told that inflation can't be an option. That tells me that we now have fewer options. Having fewer options is always bad. We've literally painted ourselves into a corner. We need inflation to bail us out, yet we can't use it? And that's a good thing?

I would point to our current situation and what got us here. Inflation was rising. Inflation was not an option. Interest rates were therefore held up until something broke, and sure enough something did break. That thing was everything. The entire global economy broke.

As an extrapolator, I would argue that inflation will rise again someday but if inflation isn't going to be an option, then something will break again, and again, and again. That environment is even worse for stocks. Further, if that new cycle continues then at some point the economy will be so weak that it will be impossible to actually stop inflation. We'll be stuck with stagflation. We'll need to raise interest rates to stop inflation but we'll also need to lower interest rates to create jobs. That's when I would argue that the metamorphosis into a true banana republic will be complete.

That's why I am a long-term stagflationist. It might not happen on this cycle, or the next cycle, but at some point I do think we'll get there if we keep trying to use debt and printing presses to solve all of our structural problems.

January 5, 2009
Conventional Wisdom

Conventional wisdom holds that the way out of the “recession” is to spend our way out of it. A trillion dollar stimulus package is being touted by the pundits as the right way to "shock the economy" (I suppose the economy is just in a coma, and merely needs awakening) into growth again.

Damn that conventional widsom.