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.