Disdeflation revisited
Recent cross currents on debt, financial crisis, policy responses, and money / inflation / deflation:
- A short UniCredit piece on the inflation-disinflation-deflation debate that (1) overlooks “disdeflation” and (2) finds little likelihood of either inflation or deflation
- An interview with Felix Zulauf in which he predicts eventual debt monetization that will cause a global currency crisis (TOH Ed Harrison)
- A David Rosenberg interview in which he argues that gold could eventually reach $3,000
- Emerging controversy over the ‘natural’ or ‘non-accelerating inflation rate of unemployment’ (NAIRU)
The UniCredit piece does a nice job parsing current and expected data, arguing that short term disinflation will be followed by (very) mildly accelerating core inflation in 2011. While we view that as a possibility, we still believe that prevailing global policy hawkishness — against a historically fragile background in terms of debt, deleveraging, stagnant incomes, and demographic ‘internals’ (.pdf) — means that deflation continues to be a serious threat, at least until the end of this decade.
On that point, we are in some agreement with Felix Zulauf. Where we disagree with him — and his interviewer — and many analysts and pundits — is that central bank monetization of debt is always and everywhere inherently inflationary (listen to his interviewer’s breathing patterns when Zulauf outlines that scenario). In what we think of as ‘normal’ conditions, it certainly tends to be. But in deflationary conditions, it may simply modulate those conditions to some extent (“disdeflation“). Where we do agree with Zulauf — and it’s disconcerting to us — is that said monetization won’t occur until powerful deflationary conditions have taken hold and financial crises have unfolded, at which time confidence in fiat currencies will be severely shaken. Thus his advice to own things like gold and farmland. We don’t place a high probability on this, but it is possible, and we think that a general currency crisis is most likely to happen if policymakers carry out monetization measures in a panicky and haphazard manner with poor communication.
We’ll stick our necks out though, and predict that political processes are likely to push policymakers towards some less deflationary outcome, and thus avoid the worst case laid out by Zulauf. In some of those outcomes, it is not at all unreasonable to expect fiat currencies to strengthen against other assets (including stocks, gold, and farms…), much as the Japanese Yen has done since around 1990. But if policymakers err — or fiddle — too much in rectifying a multi-decade process of over-leveraging, then Zulauf could prove right, and that would not be a pretty outcome. And if his prediction that global currency reforms would follow such a crisis proves false — and recent events in the eurozone provide little comfort — then even global military conflict could enter the realm of possibilities.
On a side note, Zulauf mentions Switzerland as a low sovereign debt nation whose currency might prove attractive, but don’t be so sure. Some economists see severe trouble ahead for Swiss banks due to unfolding depressions in eastern European economies (TOH Ed Harrison). If enough of those loans go bad — and given continental banks’ love affair with high leverage, “enough” isn’t many — then the Swiss public sector may have to take large amounts of private sector debt and other financial assets onto its ledgers. This should sound familiar to anyone who’s lived in the U.S., the U.K., or Europe since 2008.
David Rosenberg sounds some important cautionary notes on the economy and stock markets, and then predicts that gold will top out somewhere around $3,000. We’ve argued against this call recently, but admit to having some misgivings. If Zulauf is right, and deflation is en route, then it is entirely irrational to chase gold — unless you believe, like most of the world does, that something like “disdeflation” does not exist. We’re well aware that history is replete with episodes of fairly persistent irrational asset pricing — gold might thus have a ways to go. And if central bankers and other policymakers lose their heads in the fashion that Zulauf fears, then higher gold prices might turn out to be rational in hindsight. Thus, we continue to watch gold prices closely. Some of our clients continue to hold shares of GLL, but if gold prices take out their November 2009 highs, we will close them out and look for a better entry point.
Finally, Nobel economist Ned Phelps and a couple of Wall Street analysts are arguing that the natural or non-inflationary rate of unemployment in the U.S. may be higher, which would mean that the Federal Reserve has less of a margin of safety to avoid fostering inflation via low interest rates. However, given the hawkish stance and signals of fiscal policymakers the world over (and montary policymakers in a handful of countries), it’s highly unlikely that U.S. unemployment will converge to its ‘natural’ level any time soon, even at a high current NAIRU estimate of 7.5%.
IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Some clients of the firm hold long positions in ProShares UltraShort Gold (GLL).
URLs:
http://www.fxstreet.com/fundamental/analysis-reports/friday-notes/2010-05-28.html
http://kingworldnews.com/kingworldnews/Broadcast/Entries/2010/5/28_Felix_Zulauf.html
http://www.creditwritedowns.com/2009/02/switzerland-threatened-with-bankruptcy.html
http://seekingalpha.com/article/207629-no-rosie-outlook-more-downside-for-stocks-3-000-gold-ahead
http://symmetrycapital.net/index.php/blog/2010/05/holiday-reading-viewing-and-reflections/
News and Views | art June 1, 2010
