Sunday, August 9, 2009

Andy Xie in the News Again

I search for him every week or so and he's made another appearance.

Before I show you the article I want to remind everyone that I've been a big fan of Andy Xie, I'm bearish on China, I tend to believe in double-dip theories, and I'm uncertain about inflation. That said...


Andy Xie: China Has Become A Giant Ponzi Scheme

Hahaha! Here's something to "whet" your appetite! ;)

However, monetary policy could start a short but powerful bull market for the dollar. In the early 1980s Paul Volker, the Fed Chairman then, increased interest rate to double digit rate to contain inflation. The dollar rallied very hard afterwards. Latin American crisis had a lot to do with that.

The current situation resembles then. Like in the 1970s the Fed is denying the inflation risk due to its loose monetary policy. The longer the Fed waits, the higher the inflation will peak. When inflation starts to accelerate, it would cause panic in financial markets. To calm the markets, the Fed has to tighten aggressively, probably excessively, which would lead to a massive dollar rally. This would be the worst possible situation: a strong dollar and a weak US economy. China’s asset markets and the economy would almost surely go into a hard landing.


What he is describing is the potential for more 1970s inflationary style activity followed by more Great Depression deflationary style activity, and that is something the global markets have almost completely ruled out. In other words, round two of what we've already experienced in recent years.

Based on those two paragraphs alone, I think you can see why I am a paper stagflationist long-term (in TIPS). I'm scared of hard assets but I'm also scared of inflation. I'm trying to ride that fuzzy middle ground in between the two. It served me rather well during the last inflationary/deflationary cycle overall and it did not require market timing. My goal is not to profit off of our demise, but simply to not be dragged down with it.

Please read it all. You'll be glad you did, even if you don't agree with it.

I also want to take you back to some of Andy Xie's previous predictions (especially as it relates to his well timed Chinese prediction on April 30, 2007).


The Thoughts of Andy Xie

I don't look to him so much for advice, as I do as a sanity check in a world gone mad.

19 comments:

  1. Mark,
    I have warmed up to the TIPS investment idea, due in no small part to your take on them. My only concern is inflation, as measured by the CPI on which TIPS are based, will be a really small print going forward. When I think about the rent component, that alone will be hugely deflationary and drag down the CPI. With stock markets in China and the US on fire, but real wages depressed, I fear the inflation that is to come will be targeted to items that do not raise CPI, and thus allow easy money policy. My 2 cents, but this should all get much clearer once October rolls around.

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  2. GYSC,

    I can certainly understand your fears regarding TIPS. I happen to think the government's methods are reasonably accurate as it pertains to my situation though. I track every expense to the penny and have been doing so since 1998. Inflation seemed underestimated on the way up and it now seems overestimated on the way down. Overall, it seems just about right to me.

    Let's take the rents you mention. I'm in the camp that believes that over the long-term, rents and housing prices are quite linked. That's one reason I felt there really was a housing bubble.

    If you are right about falling rents (and you could very well be right), then I would agree that it will be a huge deflationary drag on the CPI going forward. I would simply argue that it WOULD be a huge deflationary drag. Renters could afford to spend more money on other things. Rent is a big expense.

    Even though my house is paid off and I'm sitting in TIPS, I sighed in relief when deflation started to hit my own home. Property taxes were rising exponentially and were becoming a decent chunk of my annual expenses. At some point I would have been forced to sell and downsize (lower standard of living). That's reversed course, at least temporarily, and I welcome it. It is deflationary. It gives me more money to buy other things.

    Using old school CPI calculations, what we experienced WAS hugely deflationary but was not reflected in the new CPI much thanks to its reliance on rents. Of course, this worked in reverse on the way up. As housing prices exploded higher, the new CPI did not reflect it much. That brought the CPI conspiracy people out of the woodwork. They made good points, BUT the points only made sense if you thought there was no housing bubble. Otherwise, all you needed was patience.

    I've already ridden one TIPS cycle and it taught me one thing. TIPS often behave very counterintuitively and for exactly the reason you somewhat fear them. They can climb walls of worry and slide down slopes too. Further, investors do try to think ahead.

    I actually agree with you that at this point in time falling rents may hurt TIPS performance. However, the markets already know that. Much of it may have been priced in. TIPS seriously underperformed their non-inflationary counterparts. That trend appears to be reversing.

    That said, I'm a triple dip believer. Dip #1 was based on illusions of dotcom prosperity. Dip #2 was based on illusions of housing prosperity. In my opinion, dip #3 will be based on illusions of stimulus prosperity. I do expect more deflationary pain (although like Andy Xie, I think we'll be getting more inflationary pain sooner than most realize first, maybe).

    I'm in TIPS anyway. All I care about is long-term purchasing power. By investing in TIPS, I can somewhat be protected from inflation and deflation. In contrast, those who invested in oil are much, much braver than me. Enormous profits on the inflationary way up followed by staggering losses on the deflationary way down.

    I'd get no sleep investing that way, even if I could accurately predict it and therefore profit off of it! Part of me wants to short China. The other part of me calls that part an idiot though! It would probably double in price, ruin me financially, then crash 75% and prove me right in the end. Losing everything AND being right would certainly make me feel like an idiot! ;)

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  3. GYSC,

    I don't know nearly as much about TIPS as Stag Mark, but I did buy some fairly recently in a tax deferred account. A few of my thoughts:

    TIPS are indeed counter-intuitive. They are paradoxical in many ways. On the surface, TIPS seem to be designed as a longer term holding with protection against inflation. Yet, the thing that hurts the TIPS holder the most IS inflation, especially high inflation, due to taxes. Undoubtedly, TIPS holders would be hurt less by inflation than other longer duration fixed income holders, but "less bad" is not the same as good.

    IMO, TIPS are best in a tax defered account, especially a Roth. TIPS also seem like a good deal for foreign central banks as they pay no taxes. Another thing to consider is that TIPS can be negative cash flow - the inflation is added to principle but the taxes on said inflation are due yearly. That doesn't work for me.

    Stag Mark's financial situation is very unique. The CPI matches his lifestyle much more so than mine. Education, insurance/medical and transportation expenses seem to be a much bigger part of my budget than his. And those expenses have definitely increased faster than the ~ 2.5% the CPI has increased over the past decade.

    FWIW, I tend to agree with the inflation and growth forecasts shown in the TIPS markets - less than 2% inflation and less than 2% real growth. Bernanke won't allow deflation, but that is not the same as causing high inflation. For some reason most seem to feel the need to pick a side in the inflation or deflationdebat. Much like the Republican vs. Democrat war. I don't think it's an either/or world.

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  4. mab,

    Nice summary.

    You really nailed my unique situation. I put at most 3000 miles on my car each year. No education expenses (no kids). Often have subsidized health coverage through girlfriend's (domestic partner's) employers (once again, no kids). No major health conditions. No prescription drugs. Recreation is usually spent on deflating tech hardware and/or video games. Live in moderate climate which saves on heating/cooling. Don't travel. Never spend depreciating dollars in Europe. Abuse sale/discount grocery sales and adapt/substitute brands often. Low tax bracket (no job, low interest rates).

    Bizarro (opposite) Stagflationary Mark could easily find TIPS a horrible investment, especially outside an IRA. Unfortunately, THAT Mark is probably screwed. The markets won't give him better returns just because he needs them. Taking on more risk in order to get it might just make his situation worse, if the last decade is any indicator.

    As for the expectations of inflation in the TIPS markets, I think you may be right. That said, it says nothing of inflation volatily. Oil moving from $11 to $140+, down to $30+, and back to $70 is one rollercoaster ride I'd prefer to sit out! Talk about economic motion sickness!

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  5. mab,

    One more thought. Laddering TIPS removes at least some of that cash flow risk (as you can have at least some TIPS maturing each year to help cash flow). Heavy inflation and taxes could still see you slipping down the up escalator though. That said, in that environment many investors will be falling down the up elevator shaft (as has been the case for a solid decade even without the inflation tapeworm's full wrath).

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  6. Mark
    I seriously don't know what to think about TIPS yet but believe your synopsis of TP gets right to the bottom of the problem.
    It's a wonderful solution to the nasty situation of inflation and then deflation.
    I've even heard of TP being used for TIPS, especially in hurricane Katrina where TP was given as TIPS for boatrides and the such.
    (full disclosure, I currently own 96 rolls of high quality TP and in my own personal opinion would rate this commodity as a strong 'buy')

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  7. Mark and mab,
    Thanks for the very thorough posts on TIPS. I may be looking to park some cash and think this deserves a look.
    Mark,
    I know you have written on I-bonds before, what is the difference bewteen them and TIPS (wiki was not very clear)?
    Thanks and good to see you post!

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  8. watchtower,

    I doubt TP could be considered a sell. I'm hoping hindsight will show it was neutral. Just ruling out sell makes it worth the money to me.

    Here's another thought about TIPS. If I'm wrong to like them short-term, then I should do even better long-term. Long-term is really all that matters to me.

    Ways I could be wrong, but actually do better...

    1. Real yields rise big time. TIPS would lose short-term, but the higher yields going forward would do more than cancel those losses long-term.

    2. Deflation persists. That actually does better for TIPS purchasing power than inflation though (due to lower taxes). Inflation never helps TIPS investors (unless bragging rights could be resold, lol).

    Being right would actually stink.

    1. Lower real yields would increase the value of the TIPS I already own, but as they mature where could I safely reinvest the proceeds?

    2. Although I would be thankful to own TIPS heading into heavy inflation, I'd simply be ruined slower than most.

    I own TIPS yet can actually root for higher real yields and tame inflation. Both hurt their nominal value though. VERY weird!

    In fact, one of my fears is that TIPS do so well that they become a horrible investment and I'm forced to take on more risk at some point in the future just to keep up with inflation.

    Best outcome... return of the dotcom bubble that lasts the rest of my life. Nobody wants to invest in TIPS (or oil!). Real yields climb and stay obscenely high. I lose big time in the short-term. Long-term the remaing nest egg grows exponentially thanks to the higher yields. Doubt I get even remotely that lucky though.

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  9. The TP really is a great idea.
    Along that line of thinking I probably have an abnormal amount of those Bic disposable razors, soap, cans of tuna, etc.

    Mark
    I'm just curious as to what your top video games are at this time?
    I bought my daughter an Xbox 360 for Christmas and made the mistake of purchasing a game called 'Fallout 3' for myself.
    Thought I'd entertain myself during the bleak days of January, but find myself still wondering around the 'Capital Wastelands' to this day.

    I'm trying to grow up but I'm having a hard time of it : )

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  10. GYSC,

    I-Bonds WERE awesome. Had real yields nearly as high as TIPS. Current rate is a miserable 0.1% over inflation though. Not good (especially after taxes). Hopefully rate will climb later this year. Fixed rates are determined in May and November, and it applies to all I-Bonds purchased during the period (and applies until you cash them out).

    1. They grow tax deferred up to 30 years, yet you can cash them out early if you want. Must hold one year (and then they are VERY liquid). After 1 year, 3 month interest penalty. After 5 years, no penalty.

    2. Growth rate is based on initial fixed rate + CPI and is reset every 6 months.

    3. Fantastic deflation protection. Growth rate cannot drop below 0%. Nominal value can never decline. Good as cash during deflation.

    4. Fantastic interest rate risk protection. Don't like your rate? Cash them out. No loss. Like your rate? Don't cash them out.

    5. All growth compounds. The only payment you'll ever receive is when you cash out the I-Bond. That's also the year you'll pay the tax on its gains. Plan accordingly.

    6. Can buy them at many banks. No fee. Fill out simple form. Pay. They are mailed to you. That's the paper form of I-Bonds.

    7. Can buy through Treasury Direct. That's the electronic form of I-Bonds. They will not be mailed to you.

    8. Can only buy $5,000 of each (paper and electronic) each calendar year. That's down from $30,000 each a few years ago. Government seems to have realized some investors were using I-Bonds as nest egg protection strategy. *whistling* *trying to look innocent* ;)

    If you want to buy them this year, at least wait until November. 0.1% is awful. I'm not hopeful that November's reset will be much better, but it certainly can't be much worse!

    Key differences...

    I-Bonds have much more favorable tax situation.
    I-Bonds have much more favorable deflation protection.
    I-Bonds offer complete interest rate risk protection.
    I-Bonds are much more liquid (after one year). Government is the buyer and won't haggle. ;)
    TIPS have much better real rates (currently).

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  11. watchtower,

    Nearly 100 cans of tuna in the pantry! Hahaha! Um, seriously.

    As for video games, like Civilization and Rock Band 2 on Playstation 3. MANY hours, too many. Absolutely loved Valkyria! Great game! Currently playing Rogue Galaxy on Playstation 2. It's fun too.

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  12. Mark,
    thanks! I think I-bonds may be the way to go for me personally. You are a bad influence!

    Watchtower and Mark,
    I am like the worst gamer in history. I bought this really advanced F-18 flight simulator game a while back (I always dreamed of being a fighter pilot, but Im too short at 5'9). I spent like $80 on the game and about another $200 on a control joystick to match the software. I never got the jet off the ground!!!!!!!! The simulator was so real I could not make any sense of it!
    I know, pretty sad!

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  13. GYSC,

    Just keep in mind that the current 0.1% rate on I-Bonds truly is awful.

    After 30 years that's roughly a 3.0% real gain. After you pay the taxes on the total nominal gain (30 years of compounded inflation), you could easily have a 20% real loss overall though. That's assuming you can fully trust the CPI too. Even I am not THAT trusting, especially long-term.

    My lowest accepted rate has been 0.7% so far (earlier this year). I figure that at best I'll simply break even on that one. Fortunately, I've already bought this year and can wait until November of 2010 to buy again. Hopefully the rate will improve. I'd have to be VERY bearish to buy 0.1% I-Bonds virtually guaranteed to lose money long-term. That said, a 20% real loss over the span of 30 years could be a lesser evil. Of course, if it does end up being a lesser evil then gold and silver would skyrocket.

    The real rate on long-term TIPS is MUCH higher. They should therefore do much better IF we don't hyperinflate.

    If only we knew what the price of toilet paper will be in 30 years. It sure would make current investment decisions easier.

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  14. GYSC,

    I've done I-Bond vs. TIPS charts in the past that let you see which is currently better long-term based on current interest rates, your inflation assumptions, and your tax rate assumptions.

    I'll update the charts and repost them in the coming days. It will also show the hidden risks in TIPS (namely that VERY high inflation and taxes can inflict much pain).

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  15. Actually, my old charts are still mostly valid. Here's a link from May.

    http://illusionofprosperity.blogspot.com/2009/05/i-bond-rates-tank-again.html

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  16. (Reuters) - Large U.S. food companies said the country could "virtually run out of sugar" unless the Obama administration eased import curbs, the Wall Street Journal said.

    In a letter to Agriculture Secretary Thomas Vilsack, the companies -- including Kraft Foods Inc (KFT.N), General Mills Inc (GIS.N), Hershey Co (HSY.N) and Mars Inc -- said there could be a severe shortage of sugar used in chocolate bars, breakfast cereal, cookies, chewing gum and thousands of other products, the paper said.

    The companies warned they would hike consumer prices and lay off workers if the agriculture department did not allow them to import more tariff-free sugar, the paper said.

    http://tinyurl.com/poxsgx

    Sweets fot the sweets

    Kevin

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  17. Kevin,

    "The companies warned they would hike consumer prices and lay off workers..."

    Inflation recovery meets jobless non-recovery.

    I think I'll keep my Stagflationary name yet another year.

    "Sweets fot the sweets"

    My sugar hoard is sure looking sweet! Sigh.

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  18. Mark,

    "My sugar hoard is sure looking sweet! Sigh."

    So is the one controlled by the sugar cartel here in the US, they were out today saying that there wasn't any reason to import sugar.
    Funny how that works.

    Kevin

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  19. Kevin,

    The CPI came in at 0.0% in July on a seasonally adjusted basis. Go figure.

    This isn't exactly the 1970s thank goodness!

    Still earning a real yield in TIPS, and will be paying next to nothing in taxes on the illusionary inflationary gains, at least this year in theory. Can't really complain.

    Heard on the TV yesterday that one of the faster growing segments is home canning equipment. Needless to say, I'm still VERY bearish on our long-term economy!

    The switch to home canning could easily be a permanent mindset change (much like my hoarding of basic needs has become permanent).

    What I think stock market bulls don't understand is that without exponential long-term revenue growth, exponential long-term income growth is 100% impossible. Cost cutting can't do it alone. So other than inflation, where is future long-term revenue growth going to come from? Especially if the world someday does run out of cheap energy and/or food!

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