Musings 25 6-25-11
You are receiving this email because you are a subscriber/major contributor to www.oftwominds.com.
For those who are new to the Musings: they are basically a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books.
Simulflation, and A "Nothing Fancy" Investment Strategy
Correspondent Paul E. recently asked a question which is on many minds these days, and with good reasons:
My nightly reading includes The Automatic Earth, Of 2 Minds, Financial Sense, and Chris Martenson. I like to get different views without the political spin. We clearly have TAE in the deflation camp and Puplava / Martenson in the inflation camp. I know I've asked before (and you have answered), but where do you stand on this issue today?
A very smart reader, David Gobel, sent me an essay in which he coined the word simulflation, a condition where we have both inflationary and deflationary forces. Many smart analysts such as Ty Andros see us having “inflation in everything we need and deflation in everything else.” Many other smart analysts like Eric Janzen of iTulip see deflation followed by hyperinflation.
In other words, what is often presented as "either/or" is more Boolean: it can also be "and" or "nand" (not and).
The general assumption in this debate is that one force will dominate the other at some point. My basic view is that these forces are more like yin and yang--two forces which together make up a single system.
Where I differ from other observers is that the previous models they present as guides to the future--the Great Depression, the 1970s stagflation, and so on--are not models for our present era, for a number of reasons which are familiar toregular readers.
In a nutshell, the forces of deleveraging and renunciation of debt and speculation that began to work their "creative destruction" of financialization in 2008 were summarily frozen and rolled back by unprecedented interventions and manipulations by central banks and central governments. The past 3 years were a gamble by the Status Quo that "extend and pretend" would allow leveraging and financialization to recover their dominant role in the global economy.
That gamble has failed, and all the destruction of bad debt and leverage that was put off in 2008 has only been delayed. Now the destruction and cleansing will be much more volatile and less controllable.
This is the key dynamic I see: not deflation or inflation but instability and unpredictability. As these forces break away from the control of central banks, then policy will swing wildly to and fro as financial authorities attempt to tame what cannot be tamed.
Beneath the surface of central bank "easing" and stimulus, assets and credit are being destroyed faster than the central banks can print money. There is a growing political awareness that printing money has failed as a policy, and so further stimulus and “easing” will be constrained. This was the “read between the lines” message in Bernanke’s sober press conference: he admitted that the Fed has no idea of what to do to re-install financialization and leverage and that future Fed actions will be constrained by political resistance.
In other words, if markets lose $11 trillion as in 2008, then the Fed printing another $600 billion in QE3 is essentially a drop in the bucket.
I have concluded the inflation-deflation debate doesn’t capture the fundamental dynamics of this era—that debate is a construct of the Depression. I am now thinking that the key dynamic is the creative destruction of all centralization, be it central banking or central government, by the forces of decentralization, which are being powered by the Web. Centralized institutions from the Fed to Big Education are losing credibility, and the Web is enabling parallel systems which bypass these centralized powers: for example, peer-to-peer lending.
I see a “black hole”/event horizon occurring around the “Fourth Turning” crisis years circa 2021, and who knows what financial “wealth” will emerge on the other side of that. As a result, I am thinking social capital will be the real wealth, along with income streams from enterprises providing essentials.
The main features of the next decade will be volatility, instability and unpredictability. If this is correct, then we could have periods of deflation and inflation which are met with major policy responses intended to stabilize a rapidly devolving situation. There may not be a “trend” that lasts for an entire decade. This scenario seems highly likely to me, as the centralized authorities are “fighting the last war,” i.e. the Great Depression, and so they are clueless on how to keep the “eternally expanding” credit-consumption machine going. As we know, it cannot continue. Credit will be wiped off the books, and thus assets will be wiped off the books, and the economy will have to shrink by 20% or more until output equals consumption plus savings.
As a result of misunderstanding the deeper dynamics, the conventional consensus will be proven wrong on every count, in my view. For 80 years central government has been expected to do more of everything. Now it will be doing less, and what it does attempt in terms of monetary and fiscal policy will fail to achieve the desired results. This is not just the failure of a specific policy, it is the failure of conventional economics.
The conventional investment view is that emerging markets will be good places to make money as they’re growing faster than the US. I see political instability as taking down or nationalizing most of the emerging markets. Betting on stability overseas is a very risky bet IMO. Assets will be seized or nationalized on a grand scale.
The general consensus in the blogosphere is that gold is on a trajectory to $3,000 and then $5,000. That assumes high inflation is the path we’re on. There are good technical reasons to see gold going to $5,000/oz, and my view is, maybe, but not just yet.
http://www.marketoracle.co.uk/Article28891.html
My gut feeling is the market isn’t going to reward that consensus, and that gold and oil will both plummet hard in another December-2008 type event as global credit markets are destabilized. If policy makers choose hyperinflation, then gold could easily top $5,000 or even $10,000 an ounce at some point. Given the uncertainty, holding some gold as a hedge is a wise precaution. But I wouldn’t “bet the farm” on gold or anything else tripling in the next few years.
Rather, I see the firestorm that was extinguished in 2008 reigniting globally. Dan Norcici makes the technical case for this: Continuous Commodity Index signaling Deflationary Forces are in the Ascendancy (via U. Doran) http://traderdannorcini.blogspot.com/2011/06/continuous-commodity-index-signaling.html
The consensus view is that the Fed can and will keep interest rates low indefinitely. I doubt that, for the basic reason that credit and assets are about to be destroyed in amounts far beyond the Fed’s ability to print and push free money into the banks and the stock market.
The consensus view is that the US dollar is doomed, the euro is solid, and the yen is a “value play.” Once again I think the consensus will be proven completely wrong, and the US dollar will appreciate far beyond what most observers think possible. The basic reason for my view is that the USD remains the reserve currency, and once the euro is understood to be doomed in its current configuration, and Germany’s export-based economy implodes in the next global recession, then the euro will fall to parity (1 to 1) with the USD and perhaps even lower. That suggests the USD could gain 40% from here.
Politically, despite all its fundamental problems, America’s difficulties are fairly transparent. Demographically and in terms of resources such as natural gas, water and soil, America remains wealthy enough to make huge policy mistakes and survive those political crises. That makes the USD a “safe haven” as Japan’s unfavorable demographics and debt overhang will finally catch up with them, and the eurozone crumbles into instability and uncertainty.
If I’m right about the consensus being completely wrong on virtually everything, then the irony is that everyone who didn’t get fancy, i.e. just saved cash and held it in USD, will be well-placed to take advantage of much higher interest rates and bargains in real estate and all other “hard assets.” As debts are written off, a tremendous amount of financial wealth will be dissolved, and owners will have to sell whatever they have to raise cash to pay down debt. Additionally, assets taken as collateral will be sold into a market with few cash buyers.
These are my private views, and I have learned the hard way that expressing skepticism about the hyperinflation story and gold’s meteoric rise to $5,000/oz in the next few years is a surefire way to draw the hyperventilating wrath of hyperinflationists, not to mention the quasi-religious fanaticism of the anti-USD crowd who are convinced the dollar is going to zero, and soon. I suffer enough abuse as it is, and I don't need any more. So this will remain safely in the Musings.
Every market is made up of people on one side of a trade or the other. Everyone who is confident that the USD is going to zero soon and that gold will skyrocket from $1,500/oz to $5,000/oz and beyond in the next few years has made their bet. The other side of those trades is definitely the contrarian bet.
The beauty of my perspective is that it doesn’t require any fancy analysis or investment strategies: the most basic strategy, saving as a much cash as you can and keeping it liquid in USD may prove to be the “winning” strategy, while everyone who bought into the China story, the emerging market story, the USD to zero story, the commodities to the moon story, etc., will see their capital decline in terms of purchasing power.
There will very likely be some financial and political crises erupt in the US in the 2012-2015 timeframe. I have long been on record as seeing the bottom in real estate around 2014, just on the basis of bubble symmetry. I get furious emails from gold bugs informing me that gold “will never touch $1,200/oz again.” I have no interest in “debating” such people; they can make their bets however they wish to. I am increasingly skeptical of any ideology or “faith” in terms of confidently predicting the future; the only thing I am confident in is rising systemic instability and unpredictability.
Technically, I see no reason gold couldn’t retrace to $1,000/oz, and the fact that so many deny that as a possibility only increases the likelihood of such a retrace, IMO, as the market rarely rewards the consensus or those who expect things to move in straight lines.
This is a long response, and it boils down to: nobody knows the future, especially in an increasingly unstable era, and the more that centralized powers try to control markets, the more unstable and unpredictable things will become. In my view, the consensus views on everything from interest rates to gold are uncompelling. My own investing strategy is very simple: save cash and hold it in USD, and USD instruments such as the ETF UUP.
If I’m wrong, the downside still looks less risky than betting with the consensus. I am well aware I could be wrong, and choosing a course of action in unstable times boils down to risk management and independent analysis grounded in human history and human nature.
I don't see how the Status Quo can put off the forces which briefly surfaced in late 2008 for much longer. Rather than look to 1938 or 1978 for models, we can look at what happened in 2008 for a much more accurate model: gold and oil crashed, along with stocks in every market.
This is the basis of my view that there is really only one trade in the entire world right now: everything correlated on one side (gold, stocks, bonds, commodities, derivatives, etc,.) and the US dollar on the other side. In the Second Act of the 2008 play, I will take the USD.
From Left Field
via Richard Metzger and Dangerous Minds
Thanks for reading--
charles
