Friday, July 31, 2009

The Business Cycle Continues

The last 12 months have seen unprecedented political, financial, and legal change in America and the world. Anyone who thinks they can make a 5-year expensive financial commitment today and go golfing is fooling themselves. Everything needs to be hedged and watched closely with a highly critical eye, with a strategy to get out and reverse course quickly.

The deleveraging angle so often touted as the required outcome from our recent past excesses is moot. There are two ways it can happen and the Fed has predictably chosen the unnatural path. The first way (the natural way) is credit contraction. Not just your favorite metric, but the entire scope across the globe. One thing the recent generation gets out of the new free-trade global economy is spreading of the costs of managed economies. No longer can one central bank destroy a nation through lousy policy as happened in the 90s. Now the consequences of lousy policies are dispersed globally.

The second way, the artificial way, is the course all industrial and developing nations are doing today: debasing the currency. This method works by keeping current-dollar credit values constant from artificial central-bank stimulated demand (see monetarism), but reducing the purchasing power of those dollars by dilution of the currency.

That's precisely why the U.S. economy is stabilizing, and that in turn stabilizes bonds across the spectrum. Oh yea, we will pay for it, but the piper isn't going to come calling in the next 12 months. He's lining up his resources to come charging in sometime in the next 3 or 4 years. The details of the intervention are different this time, but the pattern of replacing wealth destruction with new money (whether by fractional reserve credit expansion from absurdly low rates or direct injections of new reserves when rate intervention is insufficient) has been used over and over with the same outcome every time: economic boom followed by economic bust.

The boom is just starting. The really horrible bust that everyone is ranting about today won't hit us until about 3 or 4 years. You can see that pattern in any of your favorite long-term macro-economic charts.


  1. In short, you are claiming, it's impossible to own any asset unhedged, and that inflation, and a crash is a guaranteed event within 3 to 5 years?


    Bob Dobb.

  2. Close. Not impossible to own an asset unhedged, but the risks are significantly higher in this environment of massive market manipulation by central banks and governments. There are no guarantees, and I don't want to join the camp that claims everything is certain because of XYZ. What I'm saying is the most likely outcome is a boom-bust cycle like we've been having for generations, that monetarism is alive and well, and the consequences of global quantitative easing will be like the last round of global liquidity politics that create a bubble in some asset class that is most favored by the marketplace under whatever new guidelines the regulators decide to play with this time.

    What is most interesting is that the booms, bubbles, and busts of the past were never exactly like the one's that preceded them. That's why it's guesswork to try and proffer some guarantee of outcomes, this time or any time.

    The bottom line: Study monetarism (especially the Austrian economics theory of value and human psychology behind it) and watch for the signs of it in the next 3-5 years of global liquidity. Piles of money in the hands of people is a much more powerful force than selected examples of balance sheets and theories about debt servicing. Quantitative easing is the mechanism through which bankers change the measuring stick of past asset values. We have to learn how to analyze all over again with the new measuring stick.

    Thanks for your stimulating thoughts.