Posts tagged ‘hyperinflation’
Inflation and the Debt Default Paradox
With the federal government anchored down with over $14 trillion in debt and trillion dollar deficits as far as the eye can see, somehow people are shocked that Standard & Poor’s downgraded its outlook on U.S. government debt to “Negative” from “Stable.” This is about as surprising as learning that Fat Albert is overweight or that Charlie Sheen has a substance abuse problem.
Let’s use an example. Suppose I received a pay demotion and then I went on an irresponsible around-the-world spending rampage while racking up over $1,000,000.00 in credit card debt. Should I be surprised if my 850 FICO score would be reviewed for a possible downgrade, or if credit card lenders became slightly concerned about the possibility of collecting my debt? I guess I wouldn’t be flabbergasted by their anxiety.
Debt Default Paradox?
With the recent S&P rating adjustment, pundits over the airwaves (see CNBC video) make the case that the U.S. cannot default on its debt, because the U.S. is a sovereign nation that can indefinitely issue bonds in its own currency (i.e., print money likes it’s going out of style). There is some basis to this argument if you consider the last major developed country to default was the U.S. government in 1933 when it went off the gold standard.
On the other hand, non-sovereign nations issuing foreign currencies do not have the luxury of whipping out the printing presses to save the day. The Latin America debt defaults in the 1980s and Asian Financial crisis in the late 1990s are examples of foreign countries over-extending themselves with U.S. dollar-denominated debt, which subsequently led to collapsing currencies. The irresponsible fiscal policies eventually destroyed the debtors’ ability to issue bonds and ultimately repay their obligations (i.e., default).
Regardless of a country’s strength of currency or central bank, if reckless fiscal policies are instituted, governments will eventually be left to pick their own poison…default or hyperinflation. One can think of these options as a favorite dental procedure – a root canal or wisdom teeth pulled. Whether debtors get paid 50 cents on the dollar in the event of a default, or debtors receive 100 cents in hyper-inflated dollars (worth 50% less), the resulting pain feels the same – purchasing power has been dramatically reduced in either case (default or hyperinflation).
Of course, Ben Bernanke and the Federal Reserve Bank would like investors to believe a Goldilocks scenario is possible, which is the creation of enough liquidity to stimulate the economy while maintaining low interest rates and low inflation. At the end of the day, the inflation picture boils down to simple supply and demand for money. Fervent critics of the Fed and Bernanke would have you believe the money supply is exploding, and hyperinflation is just around the corner. It’s difficult to quarrel with the printing press arguments, given the size and scale of QE1 & QE2 (Quantitative Easing), but the fact of the matter is that money supply growth has not exploded because all the liquidity created and supplied into the banking system has been sitting idle in bank vaults – financial institutions simply are not lending. Eventually this phenomenon will change as the economy continues to recover; banks adequately build their capital ratios; the housing market sustainably recovers; and confidence regarding borrower creditworthiness improves.
Scott Grannis at the California Beach Pundit makes the point that money supply as measured by M2 has shown a steady 6% increase since 1995, with no serious side-effects from QE1/QE2 yet:
- Source: Calafia Beach Pundit
In fact, Grannis states that money supply growth (+6%) has actually grown less than nominal GDP over the period (+6.7%). Money supply growth relative to GDP growth (money demand) in the end is what really matters. Take for instance an economy producing 10 widgets for $10 dollars, would have a CPI (Consumer Price Index) of $1 per widget and a money supply of $10. If the widget GDP increased by 10% to 11 widgets (10 widgets X 1.1) and the Federal Reserve increased money supply by 10% to $11, then the CPI index would remain constant at $1 per widget ($11/11 widgets). This is obviously grossly oversimplified, but it makes my point.
Gold Bugs Banking on Inflation or Collapse
Gold prices have been on a tear over the last 10 years and current fiscal and monetary policies have “gold bugs” frothing at the mouth. These irresponsible policies will no doubt have an impact on gold demand and gold prices, but many gold investors fail to acknowledge a gold supply response. Take for example Freeport-McMoRan Copper & Gold Inc. (FCX), which just reported stellar quarterly sales and earnings growth today (up 31% and 57%, respectively). FCX more than doubled their capital expenditures to more than $500 million in the quarter, and they are planning to double their exploration spending in fiscal 2011. Is Freeport alone in their supply expansion plans? No, and like any commodity with exploding prices, eventually higher prices get greedy capitalists to create enough supply to put a lid on price appreciation. For prior bubbles you can reference the recent housing collapse or older burstings such as the Tulip Mania of the 1600s. One of the richest billionaires on the planet, Warren Buffett, also has a few thoughts on the prospects of gold.
The recent Standard & Poor’s outlook downgrade on U.S. government debt has caught a lot of press headlines. Fears about a technical default may be overblown, but if fiscal constraint cannot be agreed upon in Congress, the alternative path to hyperinflation will feel just as painful.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in FCX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Flying to the Moon via Hyperinflation
With Ben Bernanke and his fellow Fed friends about to crank up the printing presses to overdrive, QE2 (quantitative easing part II) is top of mind among investors. QE2 talks of purchasing Treasuries and mortgage backed securities to pump more dollars into the financial system has been cited by many observers as a key factor in the upward progression in the equity markets over the last couple months. But is too much of a good thing in the short-run, detrimental in the long run due to inflationary pressures?
Not necessarily, if you consider the path of stocks in the hyperinflationary Israeli market of the 1970s and 1980s. Dylan Grice from Societe Generale notes that Israeli inflation averaged 84% from 1972 – 1987. During that period, Israeli equity markets managed to increase by a factor of 6,500 times according to Grice. So while inflation skyrocketed to the moon, so did stock prices. Will QE2 ignite dormant core inflation, which is hovering around 1%? If a declining U.S. dollar and rising commodity prices are the canary in the coalmine, then maybe piling into bonds like the majority of Americans is not the best idea?
Source: Business Insider - Clusterstock
Grice may be worried about inflation in the U.S., but Japan is at the forefront on his radar. Supporting that view, he has a modest 63,00,000.00 target on the Nikkei index by 2025 (the index sits at 9,160 today). That’s right…63 million. A near 7,000-fold increase may sound insane, but with exploding debt levels and deficits, coupled with declining demographics from an aging population, perhaps hyperinflation is not out of the question?
If push comes to shove, the Japanese government may print enough money to monetize debt the marketplace cannot absorb. Crazier things have happened in world history – during 1923 in the Weimar Republic of Germany hyperinflation led to a 4,200,000,000,000 German Mark to $1 U.S. dollar exchange rate. More recently we experienced a 79,600,000,000% inflation rate in Zimbabwe and the government actually issued a $100 trillion note. These astronomical inflation rates make our domestic inflationary worries seem like kids-play, but eventually the simple laws of economics will take over, if we do not get our fiscal house in order.
Double digit inflation in the U.S. during the stagflation era of the 1970s crimped Price-Earnings (P/E) ratios to single-digit levels, but this is not surprising with a Federal Funds rate that hit 20% in 1980 – 1981. Today the Fed Funds rate is at 0%, so I don’t think single-digit P/Es will be upon us anytime soon.
The great thing about money is it goes where it is treated best over the long run. In the short-run, money will slosh around and chase performance based on speculative animal spirits, but over time what Adam Smith called the “invisible hand” directs capital to appropriate investments. It was just a few months ago that pundits were talking about double-dip and deflation scenarios (see Double-Dip Guesses), and now on the brink of QE2, the pendulum has swung back to inflation fears. Printing excess amounts of money may provide temporarily fuel to help lift the economy off the ground, but if irresponsible fiscal decisions continue, then the economic rocket scheduled for the moon may come crashing back down with the economy. Do yourself a favor and pack a parachute filled with an adequate amount of equities – they will help protect you if your bond portfolio comes crashing down on higher rates and inflation.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Emperor Schiff Has No Clothes
In the Hans Christian Andersen fairy tale The Emperor’s New Clothes, the emperor unwittingly hires two swindlers whom he pays to create a special make-believe suit, which the cons claim appears invisible to stupid people. When the emperor cannot visibly see his clothes, he sheepishly avoids confronting the swindlers to escape appearing stupid. Not until a little boy, who is watching the royal precession, points out the “emperor has no clothes” does the emperor finally realize he has been had.
Peter Schiff, former stockbroker and President of Euro Pacific Capital, has been proudly parading along the business media network on route to his senatorial candidacy, taking credit for accurately predicting the timing of the economic financial collapse. Endless amounts of praise have swarmed the airwaves and cyberspace through countless interviews and YouTube clips.
Maybe the same lessons learned from aforementioned fairy tale can be applied to Mr. Schiff? Perhaps he too wears no clothes?!
Let’s take a look at Mr. Schiff’s track record. Certainly Mr. Schiff was correctly bearish on the housing market, albeit about five years too early. I thought “timing is everything?” Apparently not for the media masses judging Peter Schiff’s track record. Let’s take a look at the chief tea-leaf reader in 2002 when he was calling for NASDAQ to reach 500 and the Dow Jones Industrials to reach 2000.
As you can see documented in the video, the Dow didn’t ever come remotely close to collapsing from 10,000 to 2,000 and the NASDAQ didn’t plummet from 1,700 to anywhere near 500. The significant percentage of the Fortune 500 he predicted to file bankruptcy never materialized either. Rather the market proceeded to march upwards on a five year bull market run that led to a doubling in the S&P 500 index from the bottom in 2002. Like a broken clock, if you stubbornly stick to one position, chances are you will eventually become right (at least twice per day).
I am not the only person to question the accuracy of Mr. Schiff’s persistently bearish and often inaccurate calls.
For one, Mike Shedlock of Mish’s Global Economic Trend Analysis gave an incredibly detailed review of Schiff’s track record in an article titled, “Peter Schiff was Wrong.” To get a little flavor of the piece, here is an excerpt:
12 Ways Schiff Was Wrong in 2008
- Wrong about hyperinflation
- Wrong about the dollar
- Wrong about commodities except for gold
- Wrong about foreign currencies except for the Yen
- Wrong about foreign equities
- Wrong in timing
- Wrong in risk management
- Wrong in buy and hold thesis
- Wrong on decoupling
- Wrong on China
- Wrong on US treasuries
- Wrong on interest rates, both foreign and domestic
Todd Sullivan from Seeking Alpha wrote an equally scathing, although shorter, look at Mr. Schiff’s track record.
More recently the ever-bearish Schiff continues to call for a collapse in the U.S. dollar and economy but refuses to short (bet against) the U.S. market because a hyper-inflationary period may ensue, driving U.S. index prices higher. Wait a second; is he saying that buying U.S. equities would be a good hedge against rising inflation? All this talking in circles is getting me dizzy. As for his position on gold, just last year he said gold would hit $2,000 per ounce by 2009 – well if it rises 100%+ in the next few months, then Mr. Schiff will be right on target.
Peter Schiff certainly lacks no confidence in making bold predictions despite his spotty record. Whether you think Peter Schiff is an overly bearish buffoon filled with hot air, or you think he is the greatest market prognosticator since sliced bread, it never hurts to wipe your eyes to make sure the media king du jour is wearing clothes?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
U.S. the Next Zimbabwe? Faber Thinks So…
Imagine paying $2 for a tube of toothpaste today and then $4,600,000 for that same tube one year from now – well that’s what happened in Zimbabwe. Zimbabwe is the first country in the 21st century to hyperinflate. In February 2007, Zimbabwe’s inflation rate topped 50% per month and according to Bloomberg, the latest official figures on Zimbabwe’s inflation rate registered 231 million percent in July 2008.
“I am 100 percent sure that the U.S. will go into hyperinflation,” Marc Faber, a.k.a. “Dr Doom”, creator of the Gloom Boom & Doom Report said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”
Dr. Gloom - Marc Faber
Click Here For Video (Bloomberg)
Faber goes on to say the U.S. economy will enter “hyperinflation” approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Faber said. Prices may increase at rates “close to” Zimbabwe’s gains, Faber said in an interview in Hong Kong. Zimbabwe’s inflation rate reached 231 million percent in July, the last annual rate published by the statistics office.
I’m not sure if the United States should be included in the same camp as Zimbabwe? Haven’t check recently, but do they have a comparable financial system producing the likes of Microsoft, Genentech, Starbucks, and Pfizer? I think not. Our economic situation is no box of chocolates, as our deficits expand and national debt balloons, but our problems are well documented. More appropriately, I would say we are the tallest midget (or “little people” to be politically correct) and some growth hormone is on the way.
Investing Caffeine 
