THE SKEPTICAL INVESTOR
Issue No. 13. August 1998
posted 30.VIII.98
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Unlucky thirteen? I wonder. Perhaps this time it will be unlucky for me because I will get it all completely wrong.
But here goes anyway. In the April 1998 Issue [LINK]I asked the question of what to expect in the USA: Inflation, deflation ... or stable prices? I admitted approaching this crucially important matter for all investors with trepidation, and emphasized that I did not have any definate answer to offer, but here is what I concluded as my best guess:-
" The trend in the USA suggests a continuation of the current mild inflation or further disinflation. In the absence of a major economic shock (such as a stock market crash and/or a global recession) there is little chance of actual deflation: the money supply can always be pumped up to head that off. I see no reason in the short-term to expect the CPI and/or the PPI to begin to reveal any actual inflation."
and ...
"In my opinion the potential consequences of the events in Asia and the Stock Market Bubble are both of much greater concern than the possibility of a surge in inflation occuring first ... Both a global depression triggered in Asia and a market crash in the USA are potentially strongly deflationary events."
What I was trying to say was that there are powerful things going on in the US economy that based on recent (post-1945) historical experience ought to produce inflation. The most important is the surging money supply. But there are factors which have been delaying the emergence of the general increase in the level of prices which is what we mean by inflation. I explained what I think these factors are. So the question became one of timing - which will happen first, the emergence of inflation or a big overriding event [global depression and/or a Wall Street Crash] that will swamp the incipient inflation before it appears. No honest analyst could claim to know the answer to this for sure: it could only be a judgement call.
It remains a judgement call. But, I am now ready to make it. My call is for the global deflationary forces and collapsing US stockmarkets to arrive BEFORE there is any significant inflation in America. Don't forget though - this is Issue Number unlucky thirteen!
My reasoning follows:-
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Essentially, my case is this. There is still no sign of general price inflation in America. And the leading indicators still show almost no early warning signs (in fact, on balance, they signal deflation). So, even if there are inflationary forces working their way through the US economy, there is still time to spare. But on the other side of the issue, the global economic problems have accelerated, spread and are bearing down on the USA like an express train. Events are now moving very rapidly indeed and are directly affecting every major economy and region of the world outside the USA. At the same time the US economy is slowing and the stockmarket is looking shaky. I think it is now very likely that these forces will strike America soon.
The Global Economy
Let's look at this one first. There is a lot going on, but the conclusions can be stated in a few words. The reason that this Issue of The Skeptical Investor has taken longer than usual to write is the tremendous amount of research that I had to undertake. For several months I was able to concentrate my efforts on understanding events in Asia and North America, merely keeping a weather eye on other regions. But now I have to research and study unfolding events in Asia and Japan, Latin America, Eastern Europe (and Russia especially), the UK, the EC, Canada, the USA .... help!
The specifics and details of events in all these places can be read about elsewhere. I don't want to waste space and my, and your, time reiterating them here. My job is to try to interpret: to highlight "the big picture". And, as I said above, after all is said and done this will not take all that many words:-
There is no-one anywhere now making any plausible, credible case that the global economy is not heading into a deflationary spiral. There are of course still plenty of people who say it isn't, or it is extreme;y unlikely, or things like "Some time in the next six months, there will come a time when Asian stocks will be the best bargains in the world" (Michael Wilson, Investment International, August 1998). But when you look for the reasoning behind such optimism, there is nothing of substance there anymore.
Up until now, this has not been the case. Since the global economy began to unwind visibly last year, there have always been reasonably plausible cases that could be made that the problem could be contained: IMF bailouts, massive action by the Government of Japan to stimulate their economy, and so on. None of these things were silly or trivial. I said that they would not work, and they have not worked, but this outcome was never obvious or certain. It has never been easy to spot the flaws in what were mostly bonafide efforts by the international community to "do something."
Now though, I simply do not see any plans out there. There is no case for me to answer anymore. Mere optimism that the crisis will bottom out soon is all that is left. That and plaintive pleas for someone else to "do something, pretty please.":-
"The White House urged Russia to take swift action to salvage the rouble and its economy." (Reuters, August 26th). (Like what, exactly?)
"Prime Minister Jean Chretien" (of Canada) "reiterated that its not his job to rescue the plunging" Canadian dollar. "Its his job" he said, referring to Gordon Thiessen, the governor of the Bank of Canada. (quotations from Reuters, August 25th).(unbelievable, but this really is what he said!).
Michael Camdessus of the International Monetary Fund has been having emergency meetings with the Russians. So what? Does anyone expect that the IMF can stop what is happening now?
As an observation, I think that it was, as expected, Japan that was the key. Once it became obvious that their new Prime Minister could not (or would not*) stop that nation's slide into a deflationary Depression, then many realised that there may be no more lines of defence, anywhere.
It may not be apparent to readers, but believe me, I am constantly looking for evidence of a bottoming out of the crisis. I do not wish for a global Depression! And I would be delighted to be able to start bottom-fishing for stocks in the Far East and elsewhere again. But I see no such evidence. If I do I will report it here in The Skeptical Investor with great delight.
(* It doesn't really matter anymore. But as I have opined several times in The Skeptical Investor, I believe that Japan has no options left - with the Nikkei now below 14,000 virtually the entire Japanese banking system is insolvent).
Inflation ahead?
Turning then to the other side of the question - is there evidence of impending inflation in the USA?
The direct measures - the CPI and the PPI - still do not reveal any. And taken together the Leading Indicators [LINK] (except for money supply) have become sharply more deflationary since I wrote my earlier assessment in April this year. Look at the yields on US Treasuries. And at the CRB Index - at 197 it is at a two decade low. And at the price of gold.
In April, I was still worried about the US money supply. It is still surging, and it is still something that I am keeping a very wary eye on. But, on balance, I no longer believe that it will trigger an inflationary cycle in the US. Under "normal" economic conditions it certainly would. But once you enter a true deflation the destruction of credit (which is what the deflation is all about) simply wipes it out. This is what has been happening in Japan. In other words a surging money supply within a context where all other indicators are pointing to deflation is not necessarily at odds with them.
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So what is in store for the USA?
In my opinion, the most likely outcome is a nasty slump, possibly rivalling that of the 1930s. Sometime this year now, I expect the stockmarket to crash, as it did in 1929, and then to wind down in a long grinding bear market for some years.
Following such a Crash, I expect to hear many analysts compare it with 1987 and call for a recovery after a few months. Many, many investors will agree and buy in at what they think is the bottom expecting to make huge profits. But this is not 1987 - if this time we are indeed in a global contraction then the economy will NOT recover after the Crash. It will continue to wind down. In which case those investors buying in at the "bottom" will find only a Suckers' Rally.
How bad could it get? It might be worse than your worst nightmare. In 1929 the US government finances were quite sound. Today they are not. In 1929 the average US corporation had a clean balance sheet and sound finances. Today typical financial statements hide more than they reveal. America is in no state to weather a major economic crisis.
The worst case scenario is a total collapse of the worldwide currency system. I merely mention this in order to point out that those few "goldbugs" and other lonely voices predicting total collapse are NOT lunatics - though sometimes they are called that. I think they are wrong, and things will not get that far out of hand, but what they see is merely highly improbable, not crazy and impossible.
I am positioning myself for a deflationary slump, not for a total collapse. As a cautious, patient investor I consider the best strategy to be to preserve ones liquid wealth with the expectation that in due course it will be possible to buy up sound, productive assets at bargain-basement prices. That is not a get-rich-quick strategy, but it is the way that many fortunes have been made in the past:-
"Quiet contemplation is the best speed." (Chinese proverb)
I am NOT planning to buy up gold, head for the hills, bury it under a rock, and wait for financial armageddon. If, in the unlikely event that things are going to get that bad, I expect that there will be warning signs and that I will be alert enough to see them. After all, there have been plenty of warning signs for more than a year of the current global financial and economic problems: the signs are always there but have to be looked for. There will be time ...
Time for you and time for me,
And time yet for a hundred indecisions,
And for a hundred visions and revisions,
Before the taking of a toast and tea.
(T. S. Eliot, 1917)
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