Yours truly has been following the news and much Internet/blog commentary lately with interest and calmness. On The Daily Capitalist website, we have seen Econophile opine about a stagflationary outcome, and Keith Weiner provide a futuristic view of some sort of hyperinflationary "crack-up boom", a term used by von Mises.
My view is more toward Econophile's but with some differences in the short term. Here's why. Mr. Weiner suggests that we watch, some years from now, for gold to trade at a higher price in the near-term months on the futures market than in the more distant months (i.e. "backwardation"), and that this will be a warning sign of what he calls a coming financial Armageddon. Without beating a theoretical horse that may or may not occur, I can think of a number of reasons why gold could go into sustained backwardation without leading to a breakdown of trust in the financial system. Reasons could include demonetization of gold, manipulation, mania, off-market contracts for gold delivery, and a general deflationary trend in prices of tangible goods, as well as the possibility of centrally-dictated negative interest rates.
In any case, perhaps a hyperinflationary depression is in our future, as Mr. Weiner posits. Shorter-term, I think we truly need to worry about a global industrial recession. My read of the commodity markets is consistent with that.
There is one very interesting topic in Econophile's linked post that I will address. That point relates to his statement that not all capital was consumed by the crash. I wonder. Certainly the physical structures of the United States were not damaged. There were no enemy bombs bursting in air, no giant toxic radioactive leaks, etc. But what if all banks, more or less, were bankrupt? Then, all the fiat claims and counterclaims tied into worthless bank deposits.
The way I am putting the Armageddon-lite events of the 2008 era together is as follows. The U. S. and Britain suffered a collective financial major myocardial infarction following Fannie and Freddie going into receivership in late summer 2008. This was followed by Lehman's collapse, Sunday evening panicky special broadcasts starring Hank Paulson and the like, President Bush admitting he was violating capitalist principles to save capitalism, and crony capitalism the likes of which America had not seen for many decades. The serial bailouts and intense subsequent money-printing just might be because the authorities took a look at the 40:1 leverage of the investment banks, the (perhaps) 100:1 leverage of the GSEs, and the unknown but high leverage of the other large financial institutions and realized that there was no equity left.
Therefore they just decided to create enough new dollars ("fiatscos") as were needed to begin the cycle anew. Of course, under a debt-based system of money creation, this could only be accomplished with ultra-low interest rates. Thus, "ZIRP". Thus, the Bank of England and "the Bernank" were charged with inventing any excuse to not see price inflation that the whole world sees, or to call it transitory. Thus, periodic endings of money printing, QE 1, QE1.5, QE 2.0, etc., in order to see if the economy was self-sustaining yet. Sort of like a cook taking a dish out of the oven to see if it needed more cooking. If no self-sustaining recovery, well, OK, let's cook it some more (i.e. print more money).
Thus, biflation, as the massive and leveraged capital that went into building too many homes, and too expensive homes, had perhaps destroyed all financial capital in the country, after accounting for debts to foreigners, and without selling the physical country and its mineral rights etc. to the foreigners.
Of course, this is just a theory, and I'm interested in comments. To me, it fits the facts as I see them, and it explains why hyperinflation has not happened and why we may be entering into a period of general disinflation and commodity price deflation as an industrial recession looms. The human, physical and intellectual capital exists, but when the accounting is/was done properly, perhaps the value of all those assets expressed in terms of the money stock that existed as of the summer of 2008 was zero.
If I am correct that the cyclical economy is on the rocks, stocks that will rise or at least hold steady will be few and far between over the next months. These may include utilities, McDonald's and retail discounters. Personally I have taken several short positions to offset my few longs, but mostly I am in cash with a reserve of gold. If I am correct, oil could easily hit $80/bbl on the downside this summer/fall and perhaps could go much lower. $60 has very strong support if $80 decisively fails. If we see $60/bbl, watch for gold to test $1000/ounce before, perhaps, doubling in short order to $2000+. If oil hits $80 and holds, then rebounds on an economic rebound plus QE 3.0 or its equivalent, then gold might hold above $1400 at its worst and then head to new highs by year-end.
Thus I am presenting a somewhat different potential scenario for the months ahead. Let's see what happens. As always, I am data-driven. Anybody who has a high degree of confidence in any sort of prediction and who lacks inside information is in my view overconfident.
Copyright (C) Long Lake LLC 2011