Monday, October 12, 2009

Andy Xie: For Economic Stimuli, a Revolving Exit Door

Andy Xie: For Economic Stimuli, a Revolving Exit Door

My central point is that the global economy is cruising toward mild stagflation with a 2 percent growth rate and 4 percent inflation rate. This scenario is the best that the central banks can hope to achieve; it combines an acceptable combination of financial stability, growth and inflation. But this equilibrium is balanced on a pinhead. It requires central banks to constantly manage expectations. The world could easily fall into hyperinflation or deflation if one major central bank makes a significant mistake.

I believe with 100% conviction that this is indeed the best scenario that central banks can hope to achieve.

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before -- money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

1. We can officially declare national bankruptcy. This would take a VERY brave set of politicians. I am 100% convinced we don't have many left. Can you imagine one of the politicians actually standing up in front of all of us and saying that we spent all of OUR money bailing out the banking system but there isn't anything left for the rest of us? We're now going bankrupt? Oh yeah, I can sure picture that. NOT!

2. We can allow inflation to silently erode our debts. This does not take any VERY brave politicians. It can happen behind closed doors using a monetary printing press that can print them "at essentially no cost". In fact, it has already happened.

Long-term, my money is firmly on #2. That's the you-know-what that will be hitting the fan in my opinion.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

Gold and oil prices continue to confirm the long-term theory. Both are far more expensive than when I turned bearish in 2004. I rode some of that action from 2004 to 2006, but now sit entirely in inflation protected TIPS and I-Bonds. I think at least some stagflation will arrive at some point and it may linger for MANY years, perhaps even the rest of my life.

We've ridden a long-term deflationary wave by outsourcing our manufacturing to the rest of the world (China in particular). I believe that wave is coming to an end for the most part. "Made in USA" is now pretty much a relic. There just isn't that much manufacturing left to outsource.

How much do I believe in the long-term stagflation theory? Let me simply share an example. I bought a new Swing-A-Way can opener (great product!) at about the same time I turned bearish in 2004. It was "Made in USA" at the time. Although it continues to work fine I know that it is only a matter of time before rust and/or a dull blade eventually takes their toll. As part of my "hoard future needs now" mindset I therefore opted to buy another and tuck it away. When I saw that it was now "Made in China" I actually decided to buy two.

I could be wrong, but I just don't see products made in China getting all that much cheaper over the long-term (especially if oil keeps rising in price). We keep sending them paper money and they keep sending us real goods. If that isn't sustainable long-term (which I strongly suspect it isn't), then it would stand to reason that prices are going to go up long-term.

5 comments:

getyourselfconnected said...

Mark,
Just finished Chris Steiner's work "$20 per gallon" and while I would dispute his rosy "we will all live in harmony in small cities" thesis (because it works that way now??) a huge point I took away was that Iclandic fisherman catch cod, freeze them, send them across the globe to China for processing, and then the fillets are sold in iclandic stores!?

Cheap oil makes the world go round. It has to end.

I am of the opinion that if oil runs out on a Tuesday, on Thursday a new power source will be unveiled to solve all our needs, and the clear scope of how we were ripped off will be clear.

Stagflationary Mark said...

GYSC,

"I am of the opinion that if oil runs out on a Tuesday, on Thursday a new power source will be unveiled to solve all our needs, and the clear scope of how we were ripped off will be clear."

Patience. Assuming your conspiracy theory is correct (which I am not saying it is), I'd say that if oil runs out in 2010, then in 2015 a new power source would be unveiled.

This will give Wall Street a full five years to get everyone on the wrong side of the trade. Two days though? You sure are an optimist!

Did the dotcom bubble take just two days to form? No.

Did the housing bubble take just two days to form? No.

Did the Chinese bubble take just two days to form? No.

Five years. That's my thinking. Hahaha!

AllanF said...

Since you mentioned gold in this post, I've been wanting to share a thought I had on gold. What bothers me about gold is that for the last year or so and the last six months in particular it has been highly correlated with equities.

A lot of goldbugs hate equities and think they are over-valued. Fair enough, in fact I agree. But what does that say for gold if it's been tracking equities so closely? None of them seem bothered by that. It makes me nervous as heck.

Any thoughts, anyone?

Stagflationary Mark said...

AllanF,

I will simply share what I've said many times in the past.

The toilet paper price to gold price ratio is tremendously out of whack in my opinion.

Either toilet paper is a screaming bargain and/or gold is way too expensive. If there was a way, similar to a hedge fund, that I could short physical gold and be long physical toilet paper then I would seriously consider doing it. That doesn't mean I think gold is necessarily going down in price though.

"In metals and oil there’s been a terrific price move. It’s like most trends: At the beginning, it’s driven by fundamentals, then speculation takes over. As the old saying goes, what the wise man does in the beginning, fools do in the end. With any asset class that has a big move, first the fundamentals attract speculation, then the speculation becomes dominant." - Warren Buffett, May 8, 2006

Gold has priced in a decent amount of future inflation in my opinion. Some, much, or most of that is surely based on fundamentals. How much? Who knows! On the other hand, using an inverse relationship, I think at least some, much, or most of it is now speculation too though, as is clearly seen on late night gold informercials and the massive popularity of the GLD ETF that owns gold. The average trading volume over the last three months is a massive 11.5 million shares. At roughly $100, that's over a billion dollars per day in trading. I just want no part of that. In sharp contrast, that fund didn't even exist when I invested in gold in 2004. Gold was off the radar screen.

http://finance.yahoo.com/q?s=gld&=

Further, the Mint I bought gold from in 2004 actually tried to talk me out of it. When I sold in 2006, the Mint was already changing its tune. The people were telling me the exact same things I was telling them in 2004 as a reason to continue to own it. It was so unreal. I could still remember what they said in 2004 though. They see people all the time who want to buy metals at the top (when others do) then sell back to them at the bottom. It isn't fun for the customer and therefore it isn't fun for the Mint either.

At the time I bought in 2004, gold was at the top of the trading range. I think they thought I was one of those customers who would be unhappy in the end. In hindsight, it seems so easy to have made the money on gold that I did. At the time, I was sweating bullets though. I knew I was taking a large risk. These days, I'm not so sure people see ANY risk though. Gold only goes up. Right?

Stagflationary Mark said...

AllanF,

One more thought.

"But what does that say for gold if it's been tracking equities so closely?"

If you look at gold you will see that the only time it's had a major price setback since starting its bull run is when the deflationary spiral began in late 2008. In other words, so much for the theory that gold does best during price deflation. That's also when the stock market got most beaten up too.