I am afraid we will see an inflation tsunami hit our shores. The Fed seems to be on a wait-and-see approach: No matter what the horizon out at sea looks, they want to see the water level in the cities rise before they do anything. That seems to be the prevalent view of the ‘doves’, helicopter Ben being one of them. This crowd seems reluctant to believe inflation is a serious threat while there is so much slack in capacity and so many unemployed. But the inflation tsunami will come mainly from abroad with the dollar so weak as it is. The CEO of Wal-Mart U.S., Bill Simon, warned in a meeting with the USA Today last week that inflation is “going to be serious”. “We’re seeing cost increases starting to come through at a pretty rapid rate”, he said. Wal-Mart knows a thing or two about retail prices. In another example, LG told retailers in February that it will increase wholesale prices of its home appliances in the U.S. 8%-10%. And the price of WTI crude is $108 a barrel despite a weak economy. My feeling is that one of these days the core inflation read will be way above expectations, and that would certainly spook markets because it will become obvious that interest rates will have to move up sooner and faster than expectations. We may see a stock market correction, a commodities correction and a ‘bet against the dollar’ correction. But I would not shed my metals, Swiss Francs and Australian dollars. If interest rates move up, and up fast to contain inflation, borrowing costs for the federal government may go through the roof. And what really worries me more about inflation is not what is going on at the Fed, despite all the doves and Keynesians there, but rather what is going on at the U.S. Treasury. The spending situation there, as we speak, is out of control. Nobody really knows what could trigger a Greek crisis of global proportions, but we are now headed that way. The U.S. Congress right now cannot even agree to cut the 2010 budget (half way through) by 2%. So if the dollar rebounds I will use the opportunity to decrease my USD cash holdings.
A lot of people are bullish Brazil. I think emerging markets should be part of a portfolio allocation, but like anything else, don’t overdo it. First, there are good signs Brazil is in a housing bubble. We learned the signs in the U.S., so it is not hard to spot it: That horrible part of town becomes “up and coming”, unexpected people making zillions as real-estate brokers, people feel “they have to buy something” otherwise they are “missing the boat”, prices seem obscene to everyone but people buy anyway. All this is happening there. Secondly, don’t expect Brazil to grow like China. China is now a totalitarian capitalist country. It may be now more capitalist than a United States under Obama, and it is certainly more capitalist than Brazil. Red tape in Brazil is 100% Kafkaesque. It has endless labor rules. These rules led to the creation of a labor court and labor court cases can go on for a decade or more (my wife, a naturalized American from Brazil, is in one court case for eight years to recover two months of pay from a going concern that just did not to pay her). Employment taxes in Brazil are also notoriously high. One consequence of these rules and taxes is that ~50% of the labor force is informal. They without a doubt hinder growth.
Last but not least, Brazil in October will chose a new president. The likely winner is Dilma Rousseff, a lady supported by Lula, the current president. Ms. Rousseff has a long rap sheet. When the military took over to avoid a Marxist revolution in the 1960’s, she–no George Washington but a Marxist revolutionary–grabbed guns to rob banks, cars and $2.5 million from a safe. Her small group killed two policemen and set off bombs. She has no executive experience in office. God knows how her presidency will work out. Lula’s presidency wasn’t as bad as people thought. He kept policies from the previous president (a moderate), which helped Brazil. But he made no reform to improve business conditions further and there is much room for improvement. A lot of outsourcing could be going to Brazil instead of China and India. Brazil isn’t far from the U.S. and is in the same time zone.
The fabulous economic recovery that we saw in the first Reagan term was driven by a horizon that looked bright: Interest rates had nowhere to go but down (Volker had moved them way high to kill inflation), marginal tax rates were slashed and the federal government was in a de-regulatory mode. The public did not believe that the lower tax rates would necessarily mean higher tax rates later. In fact the federal government fiscal revenue went up, which was no surprise. The deficits formed during the Reagan years were a pittance compared to now and were driven by higher spending (especially on defense, which killed the Soviet Union). But they weren’t anything pathological. Now fast-forward to the current “recovery” where we may dip again into a recession. What is in our horizon? Interest rates have nowhere to go but up, pretty much all taxes will go up (some a lot!) and the federal government is in hyper-regulatory mode on a banana republic level (Obamacare, FinReg, EPA, etc). Moreover, there is a strong market sense that the higher taxes won’t do anything to lower the fiscal deficits. In fact there is a good chance they will make them worse because people will exercise (legal) tax-avoidance. Last but not least, the current children running the White House and Congress believe what the economy “needs” to move again is more government spending that is already driving our fiscal situation to the edge of an abyss. Therefore, forget about robust growth. Until government gets out of way to let our economy return to capitalist mode, you should realistically expect low growth, high unemployment and a lower standard of living.
If you are not convinced yet our fiscal situation is 100% out of control, that we don’t need to just shut down entire departments of the federal government, read this story. Our government leaders didn’t learn anything from the financial crisis. I am afraid things will only change when change is ruthlessly forced upon us. And obviously I am not talking about Obama’s Marxist “change”. I am talking about change to the basics of a limited federal government that minds mainly national defense and leaves almost all the rest to the states. It is true though that a big part of the blame falls on us. If we elect power hungry demagogues for president and Congress, we cannot expect any different. Like we’ve talked about before, own real assets, own fixed-rate mortgages. Don’t hold vast amounts of paper money or government debt, especially long-dated debt. Have also lots of savings in case you go without a job for three years. Buy only used cars. You will sleep better. It’s more important to feed your family than to drive the latest model.
There is a piece with the above title in the opinion section of the Wall Street Journal today by the owner of a business. He goes over a simple example of how less and less of what he pays an employee gets to her. Or in other words, if he were to keep an employee’s net pay flat, she would cost him more and more. This is thanks in part to the new hidden taxes from Obamacare. Given that he doesn’t forecast much growth, it makes no sense for him to hire more people that will cost him more while their output remains unchanged. The piece is fantastic because it gives you a clear picture of the destructive nature of hidden taxes. And the very sad thing is that as our federal constitution goes down the drain in terms of putting a brake on the federal government–the Commerce Clause now should be renamed the Unlimited Government Clause–, these sorts of destructive economic policies will be more common. Perhaps the greatest thing about our country was the idea that our constitution really puts the brakes on centralized economic policies. They are the worst thing for economic growth in any country because the government never gets it right. And central governments make nationwide mistakes, unlike on a state level, where you can have multiple policy experiments and people can vote with their feet. That is why the left hates state power. To implement their oppressive policies they cannot let you opt out by moving unless you move abroad and give up your citizenship. In an environment of unlimited federal powers, hidden taxes thrive. Politicians hungry for more government vote to tax “corporations” instead of voting for an unpopular marginal tax rate hike. Not that I am in favor of the latter, but politicians are just trying to push the tax hike under the rug by raising corporate taxes. Never mind that corporations are just an association of people. If you tax them more, you tax people more–be them investors, workers, suppliers, customers.
The piece on the journal also illustrates why this “jobless recovery” is actually no recovery. It’s just the new normal. Countries with large entitlements have morose growth and 7-9% unemployment as the norm. Obamacare is a new multi-trillion dollar entitlement. A lot of people–business owners, investors, tax payers–know that soon they will be hit hard with the bill from this entitlement fest, thus they are reacting even before they see the bill. Either they see the bill or the U.S. Treasury will implode. Either scenario doesn’t foster growth. If we don’t repeal it, get used to the new normal.
We hear a lot now about the fear of deflation. Let me tell you: Do not be worried about deflation. The Fed will not react to this fear until it sees evidence of it. The Fed in general does not react to the latest market fad. But if the Fed sees some evidence of deflation, I strongly believe that the Fed will act quickly. First because the Fed knows that the last thing that the housing market needs is overall deflation on top of it. Secondly because the Fed is also infested with Keynesians who love a stimulus of any sort—be it monetary or fiscal. Thirdly because Bernanke earned the nickname “Helicopter Ben” for reminding the markets in 2002 that deflation is easy to cure. The cure is called ‘printing press’. There is nothing easier to cure than deflation when you have fiat money. Why the Japanese did not want to cure their deflation is their problem, but we are not Japan. We may have a morose economy for a decade, but it won’t be due to deflation. It will be due to the socialist and mercantilist laws this Congress is approving and this president is signing. They will be a tremendous drag on the economy until the U.S. becomes a capitalist country again.
I think there is much more risk of inflation, and not because of monetary policy. What I really fear is the current insane fiscal policy of this administration and Congress. The president, the Speaker of the House, the Senate leader and the majority in Congress are socialists with zero knowledge of economics. This crew is creating new entitlements on top of the existing ones. And the existing ones are already tens of trillions of dollars in the red. Add to that all kinds of stimuli that go straight to the drain. Add to that Fannie and Freddi. To put it short, our fiscal situation is a calamity. Something has to give, and it may be quite ugly. Politicians have a natural tendency not to solve problems until they are pushed against a wall. We just saw that in Greece. It happens all the time where governments are irresponsible like this one. You would think a developed country like ours would have a Swiss fiscal policy. Well, we don’t. We have an Argentinean one. If or when a credit crisis hits the U.S. Treasury, the Fed will come to its rescue. And how can the Fed rescue the Treasury? Well, ‘printing press’ again. If this happens you can imagine that the dollar will be hit very hard. I hate to say ‘buy gold’ because now you see ads on TV for gold. It’s the biggest cliché by now. But be somehow prepared in case the dollar devalues 10%-30%. The least you can do is avoid the ownership of long-dated bonds. If you have a fixed rate mortgage, that’s great. Your nominal obligation would stay fixed while all prices inflate. Buy gold and silver at the dips. The press is now asking if the gold run is over, which means it is time to buy some.