Saturday, December 06, 2008

Here we go...

The more asset values spiral down the less onerous inflation looks in retrospect. More than a few farmers smile inwardly when reminiscing about the 70's, for example.  I have been wondering how the massive increase in money supply could NOT spark significant inflation, since even the strongest budget hawk (one of whom will be in position to do so) would be, I think, deeply reluctant to start restraining inflation too early.

Therefore, I am becoming even more convinced the other side of this seemingly bottomless crevasse will be characterized by strong inflation for a few years at least.  I am not alone, as this formerly unthinkable idea gets better looking with each shot of unemployment increases.
It is time for the world's major central banks to acknowledge that a sudden burst of moderate inflation would be extremely helpful in unwinding today's epic debt morass.
Yes, inflation is an unfair way of effectively writing down all non-indexed debts in the economy. Price inflation forces creditors to accept repayment in debased currency. Yes, in principle, there should be a way to fix the ills of the financial system without resorting to inflation. Unfortunately, the closer one examines the alternatives, including capital injections for banks and direct help for home mortgage holders, the clearer it becomes that inflation would be a help, not a hindrance.
Modern finance has succeeded in creating a default dynamic of such stupefying complexity that it defies standard approaches to debt workouts. Securitisation, structured finance and other innovations have so interwoven the financial system's various players that it is essentially impossible to restructure one financial institution at a time. System-wide solutions are needed.
Moderate inflation in the short run – say, 6% for two years – would not clear the books. But it would significantly ameliorate the problems, making other steps less costly and more effective.
True, once the inflation genie is let out of the bottle, it could take several years to put it back in. No one wants to relive the anti-inflation fights of the 1980s and 1990s. But right now, the global economy is teetering on the precipice of disaster. We already have a full-blown global recession. Unless governments get ahead of the problem, we risk a severe worldwide downturn unlike anything we have seen since the 1930s. [More]
 The truly tricky bit from my point of view, is how long it takes to get from here to there, assuming I'm close to right.  My experience leads me to suggest 18-24 months based on personal anecdotes from previous bubbles.  About the time I say, "How much longer can this insanity go on?" that amount of time proves me wrong, and suckers me into surrendering with the admission I don't know squat.  This happened with the tech bubble (I bought a tech fund in March 2000, after finally admitting  dotcoms could go up forever). I had been expecting a selloff then for over 2 years.  Ditto for the housing boom, and derivatives market.

So based on three questionable data points, I think mid-2010 to early 2011 could see the start of brisk general inflation.  And I don't think the time spent with asset values flat (the bottom) will be noticeable.  Once housing prices show an increase, for example, they won't look back.

I reach this conclusion the recovery will be v-shaped simply because we've never lobbed trillions of dollars at a recession like were are doing with this one.  And we have never had the need to devalue public debt more than we will have 2011.

The fact investors and savers are shunning even profitable alternative investments for money is a clear indicator to central banks to continue to print money, and stimulate consumption.  And many think that is exactly what they will do.
The fear of deflation gives governments this freedom because investors and savers want to keep all their money in cash or government- guaranteed bonds. As a result, governments can borrow without limit, secure that they will always find willing buyers for their bonds. Investors will buy these bonds not because they trust governments or approve of their borrowing and spending, but because all other assets - shares, properties or commodities - seem too risky, and their money must go somewhere.
Similarly, governments have little to fear from currency markets. Investors may believe that the British and US governments are profligate in their borrowing and spending, but will sell the pound or dollar only if they can find a government with a better fiscal record - and in a deflationary global environment, none seems to offer a better bet.
And even if investors get nervous about future inflation and reluctant to tie up savings in bonds for ten years, governments can still go on spending and borrowing. All they have to do is instruct central banks to print money. If taken to excess, such resort to the printing press would stoke fears of Zimbabwean- style inflation. But if consumers delay purchases while investors favour paper money over inflation-protected asssets, it implies that, whatever they may say about fearing inflation, their behaviour reveals the opposite concern. If they are not spending or investing in real assets it is probably because they believe that prices will fall. Under these circumstances, central banks can safely print money and are right to do so.
As Sir Samuel Brittan, the doyen of British economic commentators, noted a few weeks ago, in today's deflationary environment Treasury ministers have a simple answer to the perennial question: “Where will the money come from?” The answer, according to Sir Samuel, is simple: “From the Bank of England's printing works in Debden.”
But what happens when savers do regain enough confidence to start investing in real assets? Then the reallocation of capital from “risk-free” paper guaranteed by government to genuinely productive, but risky, economic assets will mean that the dangers of a prolonged depression are on the wane. [More]

Should the central banks take government borrowing rates to zero (as widely expected around the globe) it is a guessing game before investors begin to fear less about preservation of capital and more about income.  Meanwhile, the government doesn't have to pay any deficit-increasing interest - something that had not occurred to me until just now.

Of course, that makes another reason inflation could get a big head start.  Until tax revenues edge up from increased activity, raising interest rates - which also raises the rate the governments pays - would compound already huge fiscal deficits.  I think we'll find ways to accommodate a brief, but torrid affair with inflation.


Anonymous said...

So what could this expected inflation do to midwest farmland values in 2 or 3 years? Or even 10 years?

John Phipps said...


I have no answer or guess right now. I'm not sure how much land prices will deflate, since being relatively illiquid, most parcels will be pulled off the market at the first sign of weakness.

If prices don't decline substantially in 2009/10, they will accelerate faster than any commodity recovery, IMHO.

The reason is the proven track record at that point. If farmland hold firm during this recession, I think everyone will want some in her portfolio.

Anonymous said...

Just an observation...Farmland prices here (western Ohio) have shot up this fall. We're not selling, but were just offered $6,000 an acre--neighboring land sold for $3,000 two years ago, we paid $2,400 five years ago for some of ours and $870 an acre 20 years ago. I think people pulling $ out of stocks want to put it somewhere solid.

Suddenly I feel a lot better about my debt to asset ratio.

Anonymous said...

Farmland , like stocks or companies eventually react or over react too markets-profits..myself I am looking at either land that would return reasonable rent or stocks with long history of good buyers here are the 65+ crowd who seems pretty well heeled as last 3 farms sold locally (50,300,1200 acres) went to this group..we will lose another bunch of farmers this winter..problem I see presently is neither livestock or cash crop guys can sell much to-day and make money......Peter Schiff had it right on you tube--regards-kevin