Invest in Strength Amid Weakness
Required reading: a word from my favorite deflationists — bond investors that have beaten all others handily, at Hoisington Investment Management. They agree with my view that most of the actions taken by our government are useless or even counterproductive. They cite Kindleberger, Schumpeter, MInsky and Kondratieff. I would add in the Austrians. High levels of debt and debt complexity lead to large recessions/depressions eventually.
High levels of debt and debt complexity rob an economic system of flexibility. So long as the debt is increasing, there can be one tremendous boom. But when the asset cash flows can no longer carry the debt, the system goes into reverse, with falling asset values. During that time, monetary policy is useless, and fiscal policy is useless, until the debt levels are reconciled.
We are in the midst of a great experiment. Are the Neoclassical heirs of Keynes right? Can you prevent a depression via loose monetary and fiscal policy? Since loose monetary policy led to this crisis, why should looser policy solve it?
Also, fiscal policy has been loose for seven years — should extremely loose fiscal policy solve the problems? And what of those who lend us money? Should they be happy with dilution of their claims on the US economy? What if they stop lending, which is in their long-term interests to do, but not in their short-term interests?
As for the Federal Reserve, with all of their cleverness regarding credit easing versus quantitative easing, the problem sill remains. The central bank attempting to fix a lending market becomes a new offeror of credit, at rates the private market won’t touch. As the central bank brings the rates down, grateful borrowers borrow, but private lenders would hang back, unless they became convinced that there was nothing to fear in the absence of central bank lending. That’s pretty tough to achieve.
I don’t like quantitative or credit easing. If we are going to be Keynesians here, let’s let the money supply expand, creating real inflation, and raise the nominal prices of homes that are currently underwater. Rather than trying to be too clever, and trying to solve all problems without inflation, let’s have inflation. I don’t think the problems can be solved without a rise in the price level, which will also make foreign countries adjust their policies to match US actions.
I don’t find the Federal Reserve exit strategies credible. As we have learned before, introducing subsidies is easy, removing them is hard, and it doesn’t matter if the subsidies are monetary or fiscal.
My view is that we will go through continued deflation until the pain is too hard, and then we will experience inflation in a big way. Thus I continue to advocate TIPS, and short corporate debt. Away from that, I encourage caution — focus on companies that can survive the worst.
January 18th, 200910:54 am at
Why would you think Keynesian inflation would find its way to housing prices rather than other necessities of life such as food and energy.
Inflation is a far worse choice for the lower half of the income hierarchy and deflation is a worse choice for the higher half.
In either case, giving money to the banks is worse than both as it just selects directly who gets the benefit (all from the higher half).
January 19th, 200911:26 am at
I think you are dead right. We are in the Lake Woebegone economy, where all children are above average and there are no failures. So if relative asset prices need to be adjusted, but no prices are allowed to go down to their appropriate level, then what outcome is possible except inflation? Then prices can adjust via the mechanism of differential increases while no one takes a loss in nominal terms.
Bernanke and Summers must know this, so the question is, how much inflation? And are they thinking that they can micromanage the level, then stop it?
From an investment standpoint, it looks binary. Either the problems are not as bad as I fear, and the steps taken can right the boat, or we will get serious inflation. But I am skeptical of TIPs — if inflation gets serious, the government will find a way to weasel out, as it did with the gold clauses in the 1930s.
January 29th, 200912:25 am at
David, you recommend Hoisington’s analysis, then you dismiss it by advocating the OPPOSITE of their recommendations of long-dated U.S. Treasury bonds.
To disprove Hoisington, I think you must explain:
1. Velocity of money is way down. A key driver of velocity, financial innovation, has been revealed as risky or a sham for more than half the instruments created in the past 20 years.
2. Debt bubbles take a long time to correct. They cite 1872-1892, 1928-1948, and Japan 1990-present. Why will this current one be different? Why buy short corporates and TIPS if deflation will be a multi-year phenomenon?
January 29th, 20091:05 am at
I can’t disprove Hoisington, their logic is fine, so long as the Fed does not move to inflate the currency in a major way.
We can point at other episodes of history where desperate governments did use inflation to get out of a crisis (admittedly creating another).
America has generally been the most debtor-friendly nation on earth, which is one of the reasons we have had high rates of inflation during some wars (Revolutionary, Civil, others?), and occasionally during peacetime (bimetallism, the 1960s-80s).
The biggest down cards in this game are: what will the government/Fed do when it runs out of options? What if we get a real war, with real calls on resources?
Our government is trying to do too much with too little, and we have not faced down the entitlements crisis yet.
I think for Hoisington to be right, and they very well might be, we would have to enter an era of much higher taxes with shared sacrifices on the part of Americans, and somehow in the midst of it, there is still enough demand to drive industry.
We can have deflation in real terms, while facing increased inflation. That’s what I think we are going to get, simply because our Government/Fed will run out of options.
And no, that’s not proof. I’m just one guy. I have long appreciated Hoisington, their view challenges me. As it is, I am talking with some of their staff regarding ideas in the equity premium, where we are in agreement, but for different reasons.
Does that help?