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Deflation, Inflation or Stagflation - You Be the Judge!
- Auto Sales
- CDS
- Central Banks
- Commercial Real Estate
- CRE
- CRE
- Crude
- Crude Oil
- Double Dip
- Gold Bugs
- Gross Domestic Product
- Ireland
- John Maynard Keynes
- Maynard Keynes
- Monetary Policy
- Money Supply
- Real estate
- Reality
- Recession
- recovery
- Sovereign Risk
- Sovereign Risk
- Stagflation
- Switzerland
- Toyota
- United Kingdom
In continuing the rant on the possibility of the US entering a
stagflationary environment, as was hinted by Alcoa's quarterly report
(see "Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?"), I have decided to graphically illustrate the historically most successful inflation hedges. Click graphic below to enlarge.
For those "gold bugs" who have never ran the numbers, gold offers less
inflation protection than your house does. The same goes for WTI crude
and probably most other categories of oil.
The number one inflation hedge appears to be apartment buildings,
followed very closely by other classes of commercial real estate, with
MSCI emerging markets coming in a close second. I can assure you that
the supply/demand imbalance, credit environment, fundamental and macro
situations will prevent apartments (oversupply and softening rents from
condo conversion competition among other things, driving up cap rates)
and most CRE from taking off anytime soon. The short to medium term
direction for most of that stuff is down (see CRE 2010 Overview for the 42 page white paper). In addition, as anybody who has ever owned an apartment building can attest, in periods of rapid inflation, you actually lose money since costs and input prices actually rise faster than you can raise rents, causing negative cash flows.
So, if the traditional inflation hedges do not point to inflation, but
input costs are going up while real assets are deflating, what do we
have???
From " Economic contractions AND rising prices, dare Reggie utter the "I" word - Enter a global phenomenon", we get:
Stagflation is an economic situation in whichinflation and economic stagnation occur simultaneously and remain unchecked for a period of time.[1] The portmanteau "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament in 1965.[2][3][4] The concept is notable partly because,in postwar macroeconomic theory, inflation and recession were regarded as mutually exclusive, and also because stagflation has generally proven to be difficult and costly to eradicate once it gets started.
Economists offer two principal explanations for why stagflation occurs. First, stagflation
can result when an economy is slowed by an unfavorable supply shock,
such as an increase in the price of oil in an oil importing country,
which tends to raise prices at the same time that it slows the economy
by making production less profitable.[5][6][7]This
type of stagflation presents a policy dilemma because most actions to
assist with fighting inflation worsen economic stagnation and vice
versa. Second, both
stagnation and inflation can result from inappropriate macroeconomic
policies. For example, central banks can cause inflation by permitting
excessive growth of the money supply,[8] and the government can cause stagnation by excessive regulation of goods markets and labor markets;[9]
together, these factors can cause stagflation. Both types of
explanations are offered in analyses of the global stagflation of the
1970s: it began with a huge rise in oil prices, but then continued as
central banks used excessively stimulative monetary policy to
counteract the resulting recession, causing a runaway wage-price spiral.[10]John Maynard Keynes wrote in The Economic Consequences of the Peace that
governments printing money and using price controls were causing a
combination of inflation and economic stagnation in Europe after World
War I. Stagflation
was also a very serious macroeconomic problem in the 1970s. In contrast
to central bank responses to the oil price spike of the 1970s where
similar policies were pursued on both sides of the Atlantic, the 21st
century began with America going one way to fight recession and Europe
going the other way to fight inflation.
From the "The Butterfly is released!":
The
decline in consumer spending has compelled many companies to reduce
production. Toyota Motors Corporation reduced its auto sales forecast
for 2009 to 2.1% from 5.6%. The company projected auto sales to be 10.4
million vehicles in 2009, but rising gasoline oil prices are likely to
dent demand. Toyota expects sales to decrease 10% in North America, its
biggest market.The
cost of most inputs has risen sharply in the last one year. Although
prices have come down from record highs and are declining m-o-m, they
continue to remain high on a y-o-y basis. Prices of iron and steel,
which are essential components of manufacturing, increased 16.1% y-o-y
in August 2008. Prices of other commodities also rose globally, leading
to a sharp rise in input costs. Various indices in the UK are pointing
toward a trend of declining sales. The non-store retail & repair
index fell 3.2% m-o-m in July 2008. Falling sales are further
pressurizing the margins of industrial companies.
Source: Government Website
The
price of crude oil, one of the major inputs for manufacturing
companies, increased at a rapid pace in 2007. Although the price has
cooled down (falling 44% from its all-time high) as of September 11,
2008, it continues to remain high (37.4%) on a y-o-y basis. The
increase in crude prices has pushed the cost of production higher.The
high cost of production can be passed by the manufacturer to the
retailer only in certain cases. Various companies are evaluating the
extent to which they can pass higher prices to end-customers. However,
industrial companies would be affected in both cases-higher prices
would weaken demand, while the increased cost of production would hurt
margins. In such a scenario, maintaining a fine balance between the two
is an extremely challenging task for industrial companies. Decline in
sales due to increased cost (input and borrowing) is exerting pressure on industrial companies.
The article above is about a year old, but still drives home valid
points. This material is a pre-cursor to the subscription material I
will be releasing to subscribers illustrating the concentrations of
sovereign risk around the globe. Remember, just because you transfer
private risk to the government doesn't mean it disappears. There are
pockets of risks in the usual suspects, but certain banks in certain
areas have actually acted like sponges, concentrating risks in places
where nobody really wants it. Now, back to the stagflation rant...
As you can see, UK inflation is
trending down, but you can rest assured that many input costs will
trend up, as in the diagram from the "butterfly". Spain, Ireland and
Switzerland suffer from outright deflation, but will probably not be
spared higher input costs as well.
Economic growth doesn't look very promising in any case. The EU is a dead-zone for the time being.
Very few in the EU can afford the result of higher input costs on the back of sagging GDP. The jobs just aren't there.
Does the CDS market see what I see?
So, what about the US and North America?
GDP is expected to increase, but relatively anemic compared to other
so-called recoveries. Some expect a double dip recession, I believe the
recovery is really just the masked effects of the government literally
purchasing GDP points, paying $1 for every 30 cents worth of recovery.
As you can see, as in the EU, we cannot afford price spikes in
anything. Higher input costs will simply lead to lower profitability,
for price in-elasticity is here. People couldn't afford to pay more if
they wanted to. Credit and income are way, way down. This means that
companies will have to eat higher input costs since they can't pass
them on. Translation: those sky high S&P earnings forecasts are
fantasy, at best. Even if fantasy were to transform to reality, the
stock market has already priced in la la land.
Inflation is expected to be tame. Stagflation is the threat.
I will walk through all of the world markets in the next week or so,
and culminate the study with the banks that I feel are most at risk
from the weakness in various sovereign states. The most "at risk" banks
will be for subscribers, but there are quite a few that I will share publicly.
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Reggie
You said: "Higher input costs will simply lead to lower profitability, for price in-elasticity is here. People couldn't afford to pay more if they wanted to. Credit and income are way, way down. This means that companies will have to eat higher input costs since they can't pass them on."
You forgot one side of that equation..at some point companies will adjust their production capacity to a smaller customer pool and actually increase prices to try to make up for less volume...I'm personally seeing this happening in the real world...price will not go down forever, something the deflationists do not understand very well.
This is what eventually bring things to a breaking point....government furiously printing and real productive capacity being reduced to adjust to real demand....when these 2 lines converge...watch out.
"companies will adjust their production capacity to a smaller customer pool and actually increase prices to try to make up for less volume"
Exactly! Just walk into a grocery store. It is plain as day.
The prices are rising on most items but the portion size is noticably smaller - from a can of tuna (reduced to 5oz. from 6 oz.), to potato chips, to dishwashing liquid.
It is a paradigm shift. A "Supersizing antithesis"!
This is price inflation.
Reggie,
Your points well taken - gold or other commodities are not a good hedge against the inflation. however, if you look at the performance of gold/silver in 1970 when the US experienced a stagflation, gold went from $35 to $850. We all know that was a bubble. However, a good investor/speculator knows how to take advantage of that bubble.
Gold is a good hedge against "Stagflation" and "Currency Bubble/Crisis" both of which we will see within 2~3 yrs.
Gold is far more of a hedge against govts unstable activity than against inflation. Look for this to continue.
inflation, deflation ... really, its the same dang thing. were talking semantics here. either the economy shuts down because no one has any money - or the economy shuts down because everything costs a lot more than people have to spend. functionally, you end up with the same result.
its too late to "get in position." and, trading your way through the crisis will not be possible.
word to the wise - a 7 step plan for financial success and survival
1. go back in time 5 years
2. buy physical gold and silver
3. build a low-operating-cost home that is as grid-independent as possible
4. stock up on food, stuff (like chinese imports), physical cash
5. pay off your debts and get square with the IRS
6. put any extra money in a Schwab trading account. Learn to short + trade options
7. find a young wife, repair to your home, grow a garden, start raising chickens ...
*
its that simple
The S&P 500 did better than gold?? LOL uh what was the time frame and did you take into account the fact that the S&P only tracks winning companies (i.e. ones that aren't bankrupt).
Ill admit that gold hasn't done as well as some asset classes in the last 30 - 40 years but looking at 100 years it has done fairly well, or if you took the last 20 years it out performed the S&P easily. Also the housing market still has room to fall and if you factored in property taxes I very much doubt any kind of housing ownership would do better than gold. So basically I think your inflation hedge data is fatally skewed.
Personally I think your chart is a good example of what has been over bought and what has been under bought as the assets that have done better are also the assets with the most down side potential in the years to come (excluding JPM emerging debt fund of course).
P.S
Reggie, I do thank you for taking the time for you to write this. I didn't want to sound like a dick and ungrateful for the post.
I don't think you are a dick, but I do think you are missing the point of the article. This is not about which asset performed the best price-wise, it is about which asset has the highest correlation to the inflation index. If inflation went down, and gold went up - well, gold is not really tracking inflation, is it. It is most likely tracking some other basket of variables.
Notice, inflation dropped, and housing fell like a rock, as is CRE. What did gold do??? How about oil? If you want to be protected against inflation, you want a tight, consistent, reliable correlation.
Now, everybody and thier mother are jumping into the gold trade, it gets overheated and corrects. Suppose it does this as inflation heats up in 5 years. You may or may not have made money in your gold trade, but you damn sure weren't as protected againt inflation as those who stuck to thier real assets who had a much tighter historical correlation to inflation.
Just saying...
Wait, let me get this straight. So we havent had inflation these past 10 years or so? Could have fooled me. If you were to price houses in gold this past decade, the bubble was not, because gold was going up also. Gold is not in a bubble however, it is keeping pace with inflation, or the increase of the money supply.
A lot of things have doubled in price. Walk through your convenience store. 10 years ago, i was 16, and remember buying candy bars for 45-50 cents, now pushing a dollar. Gas, food, snowmobiles, ATVs.. How can you not see how things have gone up the past decade at an accelerating rate?
I remember being a big snowmobiler back in high school/college. when i got into it in high school you could buy a top end machine for half of what it costs now.
Everybody expects inflation.
Everybody is wrong 99% of the times.
Hence the outcome is deflation.
Many expect the sun to set in the west. Probably not
Many expect the sun to set in the west. Probably not
I experienced stagflation in 1970s - not a pretty situation at all.
Made me emigrate (from UK to NZ).
how does gold typically perform in a stagflation environment?
Very Good Reggie...Your piece sits well with us who are trying to reconcile both the inflationary and deflationary forces at hand. Stagflation is the ugly step-sister sitting in the corner and being ignored. Stagflation certainly has a bid and ask, and I expect the inflationary bids can only go so far for so long before pushing the deflationary ask floor lower. Hence, the stagflationary trend will be downward for most of this decade. This is a good argument for a stagflationary-depression, yes, this is the Great Stagflationary Depression.
Hi Reggie, welcome to the Austrian School.
One small note. Emergin markets do not do well during Stagflation. Think Rice queues spring 2008. Think 90% of money in pocket towards food and gasoline. Think tightening from Emerging Market Central Banks.
re: apt bldgs.... cost inflation causes negative cash flow.
If vacancy is 5% and expenses are 40% of collections, you need 100% increase in expenses to come anywhere near negative cashflow - anyone seen 100% increase in expenes on their CRE hodlings, including apts? ... Highly dependent on leverage.
Since you are goign to parse my words... I meant a negative trend, not necessarily negative net cash flow. I am sure most here get the gist of what I was saying. And yes, it is possible to get a 100% increase under the right circumstances, such as a lack of tolerance of tenants to carry certain expenses in very small buildings, ex. heat and hot water. It probably doesn't occur often, but it can occur.
Reggie, i dont spend time polishing my silver.Its good the way it is. On the other hand , i work in the building industry with the actual building.
Investors dont see what i see as a contractor. To keep it simple...
Property Management companies and tenants dont have the buildings health as their first priority. Only owners do and not all of them.
There have been huge losses in buildings over time due to degradation.
Gold can only be degraded by comparing it to colored bits of paper.
Gold's value is only what the people who may buy it percieve it to be. When you get hungry, you can't eat it. When you get cold, it can't keep you warm. When it snows, it makes a poor shelter. When pockets get thin, it yields very little income.
Mayhaps there is a reason why income properties have served as better inflation hedges. Keep in mind that this is not my opinion, but historical fact. Hence, it is relatively useless to argue with it, that is unless you plan on changing history.
Reggie
If and when the fiat currency system collapse people still need to trade, life goes on...and historically what is the system nations revert to when the fiat madness run its course?? You guessed right, gold...
So the argument that you cannot eat gold, gold doesn't keep you warm, etc.. frankly, it's silly.
Let's speculate that tomorrow all gold contracts "want" to go physical.....I wonder what that would do to the price of gold....
However I agree with you that gold is not the only game in town ad inflation hedge...real physical assets are too (agricolture, commodities, shelter, etc...stuff people need)
Historically (medieval), the soldiers had to be paid in gold. Even in Zimbabwe it was the soldiers who were paid first, and paid the most.
So call it a way to pay for insurance in the future.
Maybe you can pay your 'protection' fee in gold. Of course on its own it is no good, but it really shines as part of a basket of assets including lead, long-lasting foods, grains, real estate, and cheap booze
Gold has other advantages as everyone knows. It's largely out of the reach of the authorities and their shenanigans, and bypasses paper money. It's portable and liquid. The same can't be said of apt. buildings.
Hey, I'm just reportin' the facts. Many believe gold to be relatively efficient inflation hedge. Recent history doesn't support that assertion.
Actually, if more market participants paid better attention to the numbers and the facts, this great recession cum depression would have lasted for a year or two, versus what will probably be a few years to a decade or more since asset values would have fully deflated and we would probably be on our way back up from an organic perspective - you know, from natural market demand and bids from real investors, not the government and computers with a 90 nanosecond investment horizon.
Then again, what the hell do I know.
history . A running man was stopped by police. Possible suspect.
History revised "running man was part of 26m marathon.
Gold and silver have a long, long history. All truh the ages we have raped your women, pillaged your miserable villages and burned your houses.
But we always took and kept your gold. LOL
How much truth is there in this article?
http://afteramerica.wordpress.com/2010/01/08/operation-stillpoint-to-des...
I give it ZERO credence.
You have to be deaf,dumb, and blind, to not see what Administration is DEAD set on taking us down.
And, doing a damned good job thus far.
A cursory look at HIS background,his CZAR's, and economic policies, tell you all you need to know.
If anything, this is END GAME Scenario in progress...............not being Stopped.
"inflation" and "deflation" are really the same thing. you're arguing semantics.
you end up with less purchasing power, lower asset values, a contracting economy, and more fundamentally conservative people.
avoid any asset that requires a lawyer to explain why it is valuable ...
Don't mean to be pendantic but neither Switzerland nor the UK are in the Eurozone ........
I had to condense the charts. Was in a hurry.
The obvious outcome is deflation, IF you ignore the Fed/Market feedback loop...
Reggie,
Good post. Some advice: clean up your posts using HTML when editing. I noticed funny things appearing when copying and pasting from Blogger onto Wordpress.
As for the great inflation debate, readers can refer to my post on predictions 2010. Listen to what Ed Hyman of ISI says about China exporting inflation. Funny, in the 1990s, China was exporting disinflation. If it caves or stumbles, I predict another wave of goods disinflation. As for the Fed, they are betting that asset inflation can translate into real economic inflation. Dangerous bet indeed. I have my doubts on this.
Great post Reggie, I love the first figure, a classic!
One thing that is worth clearing, in the mind of many inflation=higher interest rates, and most times this is the case, but there are times where higher interest rates simply is a reflection of risk (credit or asset risks), and this may not necessarily appear as inflation since the transmission mechanism to the consumer is broken.
In short, consumers can't cope with higher costs, so inflation is unlikely to show up anytime soon, at the same time interest rates will create a squeeze (even if they stay moderate!).
Crucial question -
What is the time window of the first
inflation hedge return chart?
Here's the source of the charts: Reggie Middleton's Take on Investing for Inflation, pt. 1
Scroll down towards the bottom of the post.
Amen. Higher rates here reflect credit default risk;
not inflation. Record collapse in business and
consumer credit continues. Big4 short gold and
silver while lemmings leap...
http://www.jubileeprosperity.com/