A Macro View: Hyperinflationistas Unite for the Revolution!
Tue, Nov 30, 7:15 PM ET, by Ron Rutherford, Sabrient.com
Investors are constantly bombarded by triviality and meaningless data. Thus it is hard to make sense of all the noise, and then to know how to interpret the data to make good investment decisions. Take for example, this article from MarketWatch titled Weekly jobless claims fall 34,000 to 407,000. Should long-term investors (like RSY readers) be that concerned whether the report said 407,000 or even 441,000? What should the reaction to reports such as this be? Considering that this is just one weeks data set and is subject to changes, then it seems trends are more important than a single point in time. Even given the fact that weekly jobless claims are less than 450,000 in four out of the last 5 weeks and the four-week average is 436,000 (which is a two year low) is still too high to reduce overall unemployment rates.
So what did investors think of this new data? It seems that some took this as a clue that “employment-related companies” could benefit from this decreased level of unemployment claims. Jeffry Bartash noted that MWW, RHI and KFRC gained 7.9%, 3.3%, and 2.7% respectively. It seems to be nearly the opposite by logic for recruiters, as the less number of newly laid-off employees there are, the less need there is for employment assistance services.
There are of course important trends that investors should keep close track of. One of them is inflation or the more scarier side called deflation. This is one reason that A Macro View looks so closely at the price indexes of the ISM reports. I can not deny that there is always a possibility of rising inflation levels, but the trend in inflation is downward. The US, being an open liberal economy with a diverse resource base and broad capital base that includes high levels of human capital, should prevent rapid changes in price stability at least over the short term. While there is a possibility of price changes in a limited basket of products, the US attributes listed above should minimize any vicious cycles of inflation.
Inflationistas and Hyperinflationistas should take their own advice.
There has been much, and I mean way too much, written about QE2 (Quantitative Easing). Many good economists from both conservative and liberal points of view have expressed their views on this topic, so I find no reason to belabor that. (Even Mish felt frustrated when Debating the Flat Earth Society about Hyperinflation.) The question I raise here is what do the Inflationistas and Hyperinflationistas advise us to do and what is their investment strategy? I distinguish between the two for ones that may see some level of inflation rising but not sure to the degree and are more than likely to see any levels of inflation above zero as bad, which are called the Inflationistas. The second group (Hyperinflationistas) only predict that the US will end up as either Zimbabwe or Weimar Republic and see no other alternative scenarios.
One group that is always ready to declare hyperinflation is Kitco. Strangely, every article I have read ends with advice to buy gold, no matter what the state of the economy has been over the last 10 years. For example, Chris Mack wants to Quantify What QE2 Means for Future Inflation and Gold and Silver Prices. His conclusion about inflation is:
QE2 Projected to See Inflation Rise by 10-20%!
A dollar on November 1st is now worth 92 cents if measured in treasuries or 91 cents if measured with the money supply. It can be seen that inflation as measured by the growth in money supply is projected to increase by 10 to 20 percent on an annualized basis.
He also implies that inflation could be as high as 100% if we assume it goes to currency solely. So what advice do Hyperinflationists give, aside from buying gold and silver (Gold or Apple?) or whatever they are hawking? Although not very elaborate in explanation, trevorlewthor tells us How to Get Ready for Hyperinflation.
The first bit of advice about buying a new house now for first time buyers is certainly good advice, as this will avoid uncertainty about monthly housing costs. Refinancing is simply a cost-benefit analysis and is good advice no matter the level of inflation in the future. If hyperinflationistas actually believed that inflation levels will skyrocket based on QE2 or the stimulus packages or simply the dropping in the value of the dollar, then of course buying tangible assets is the best course of action now. And taking on more debt now is a way to leverage across time to maximize returns. The simplest way to determine what to invest in is to use net present value (NPV) on each set of assets to determine under which scenarios one would achieve positive returns. The sooner that hyperinflation takes hold, then the more number of asset classes will increase above a positive NPV. Take for example this graph (File:GermanyHyperChart.jpg) :
Once inflation starts on a vicious cycle, it spins higher and higher. Thus to take advantage of it, an investor should try to get into higher levels of debt when rates are still low.
The second point of the article seems to contradict higher levels of debt. But while the first point was in regard to fixed rates of interest, the second point is mostly in regard to variable rates that will adjust (although with some lag) upward as inflation and inflation expectations increase dramatically. So yes, it is good advice to lower these debts that are variable in interest just as moving out of rental to a house will reduce uncertainty about outflows of money. In addition consumers should not necessarily take on more debt, but planned consumption might be better to do now instead of later when costs have risen dramatically. If the consumer is already planning to make major purchases, like a new car or kitchen appliances, then purchasing them now and possibly using the low interest rates as mentioned above is sound advice.
The third bit of advice is good no matter what the future holds. Since high levels of inflation and especially hyperinflation alter the structural components of the economy, it is best to think about which sectors of the economy are more likely to grow and which are to shrink. For example, even though tangible assets grow in value including buildings and land, long-term investments are no longer feasible. If a project takes more than a short time, the costs for continuing the project become astronomical, even if cost of capital was low and/or fixed (interest rates). Costs for raw materials and of course labor costs increase dramatically during the final stages of any project. One area that does well under hyperinflation historically is the entertainment business. The growth of German cinema during the 1920’s certainly leads one to believe that hyperinflation does not stymie this sector, and in fact helps promote it. Although the “blockbusters” may disappear, the number of films produced increased dramatically under hyperinflation. Labor costs are relatively low and time to get film projects to the projector can be fairly short.
Point four goes along with buying tangible assets now. Of course stocks do offer more liquidity and thus more savings should be devoted to this liquid asset under hyperinflation. Since cash or cash equivalents become nearly worthless, then lowering cash balances is a good move. Margin accounts again would be variable in rates but a second mortgage on a house may result in positive NPV of the investments in stocks. One way to increase assets now is to follow point five and put more in retirement vehicles now. Pre-tax dollars help to lower taxes now and provide income in retirement when hyperinflation has gone away (hopefully).
Our Economy Desperately Needs More Hyperinflationistas.
Looking through the advice given above, I see many similarities in what is needed to get the US economy out of this recession. Technically we are out of the recession but clearly unemployment rates near 10% are too high to consider an economy that is functioning well. The benefits to the economy of this advice to individuals is done through several different avenues. First, by increasing levels of tangible assets in portfolios helps create a base on the prices and prevents nominal asset price declines. Most definitely this is something needed with respect to the housing markets. This changes expectations of prices in the future to a more stable outlook versus deflationary expectations.
Secondly, the advice will lead to increased “absorption” into the economy through both increased production and consumption. This process is through increased spending on education, increasing production at current jobs or taking on additional jobs, front loading spending now instead of the future, and even increasing household production. Increased levels of savings do not directly raise absorption but this does not lead to stuffing money in a mattress but increasing levels of investment which raises absorption.
Thirdly, the fact of settling some debts and taking on others increases the absorption and number of transactions in an economy, and thus increases the velocity of money.
Should Krugman et al. Worry About the Inflationistas (or Hyperinflationistas)?
From the above analysis, it appears that if enough individuals in our economy take the advice of hyperinflationistas, then our economic troubles will vanish or be greatly reduced at least. Dean Baker tells us Why printing money makes sense and how “right now, even a counterfeiter issuing dud dollars would be better for the economy than our deficit-fixated policymakers”. Baker, like most Keynesians, talks in terms of aggregate demand. I used the term absorption to more precisely express not only consumer demand but also aggregate spending that includes planned and unplanned investments for businesses, and of course government demand.
His idea is that if a short-term counterfeiter could produce a lot of money (cash) now and distribute it throughout the economy, then aggregate demand would increase until the time it is no longer needed. One problem with this idea is that it would alter the demand structure of the economy when implemented and then it would make a reversal of that demand structure to the correct one. This is based on the assumption that “free money” would alter people’s spending patterns from normal patterns, and more than likely result in a huge increase in luxury goods consumed in the short term. Baker describes how the counterfeiting stimulus would work in the following passage.
In the current situation, it would provide an enormous boost to GDP and create millions of jobs. After all, everyone thinks the money is real. It is no different whether the counterfeiter and his underlings spend $2tn of counterfeit money or if firms suddenly start investing their hoards of cash or households begin to spend again as though the housing bubble had never collapsed.
Essentially whether a counterfeiter or the hyperinflationistas advice works, will depend on whether it changes peoples expectations and thus behavior in the markets. It does not appear that the fiscal stimulus packages have worked because it never changed expectations and monetary policy instruments have run against the zero interest rates bound which have not changed overall inflation expectations.