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.