Governments are now working overtime in dispensing monetary and fiscal medicines intended to renew, restore and revive battered economies. In time the aid will quicken the economic heartbeat, although exactly when and to what degree is unknown. The patient has for years gorged on any number of goodies, ranging from the sweet treats of leverage and the candied delights of easy money to roller-coaster thrills of irrational investing.
The party, of course, is over, and the cleanup may go on for some time — probably longer than we expect. In a somewhat haphazard and increasingly desperate effort to ease the current and future pain, governments are dishing out unprecedented rounds of stimulus pills. For obvious reasons, everyone's watching each new step in what promises to be a long run of conventional and unconventional programs intent on propping up economies from east to west, north and south and everywhere in between.
But while the lion's share of attention is on the medicines, what might follow once the patient is no longer in imminent danger of cardiac arrest? In a speculative exercise of considering the possibilities, we offer the following thoughts for the post-crisis world order, which one day will arrive, amazing as it seems at the moment.
Yes, inflation. Strange as it sounds to talk about inflation at a time when deflation seems to be stalking the U.S. economy, it's never too early to think about the natural state of economic affairs. One day (don't ask us when), all this stimulus and its baggage will be yours. Pulling back on the sea of money washing ashore will eventually require the mother of all mopping-up campaigns. Assuming, of course, the Fed and central banks around the world have the stomach for the task.
Make no mistake: Pulling back will be tough, very tough. Imagine the scenario a year from now. Let's make a big assumption and say that the economy's showing signs of life and GDP manages to post a modest 1% rise in Q4 2009, with more of the same expected for 2010. Higher interest rates would certainly be warranted, relative to the near-zero levels of the moment. Perhaps much higher rates will be required. But will Bernanke and the boys be willing and able?
The political pressure to keep the stimulus going will probably be immense. Meanwhile, warnings of higher inflation at some point are likely to fall on deaf ears for an extended period. Higher inflation, after all, is just what the Fed wanted by lowering rates so low, and so arguments for containing the revival in prices will initially be dismissed.
Yes, the inflation beast will work his way back into the director's chair. He always does, and he has a thousand tricks up his sleeve. His task will be all the easier if the deflation mindset takes root, which looks increasingly possible.
Nonetheless, some corners of finance are worried about the longer-term risks. That includes the dollar sellers and the gold buyers. Yes, deflation is a risk, but in the long run history tells us that inflation always comes out on top eventually.
What's more, a sudden change in the weather is hardly beyond the pale. Recall that inflation worries were all the rage earlier this year. Yet that fear quickly gave way to deflation. Expecting smooth and gradual changes on the pricing front may be asking for too much in the 21st century.
Just as inflation worries have been banished in recent months, so too are the headline-grabbing predictions of $200 oil. These days, that's a forecast with one too many zeroes.
But let's be clear: The recession-inducing fears that are pushing oil lower these days will eventually abate. That doesn't mean oil will suddenly resume its skyward run at the first sign of economic stability. But marginal growth in oil demand isn't dead; it's merely hibernating.
China, India, and, yes, the United States will one day be in need of more oil. Yes, green technology will slow future demand for fossil fuels. But unless you're expecting miracles, the world economy will almost certainly be consuming more oil in 3 to 5 years compared with today. The crowd, however, will be focused on demand trends over the next year or two and thereby conclude that high oil prices are forever gone. Oil companies will be pressured into agreeing, resulting in a sharp decline in searching for and developing new oil fields. Those are the seeds that will push prices higher once more, perhaps to new all-time heights, although probably not for several years.
The Bubble of 2013?
No one knows where all the stimulus will wind up, but there are pretty good odds (and a fair amount of historical precedent) suggesting that exuberance will eventually reanimate itself with all its immoderate excess intact. Some say that Treasuries are now a bubble waiting to burst, courtesy of interest rates that can only go higher from here. Perhaps, although it's a safe bet that one day, perhaps sooner than we expect, bubble sightings will return.
Bubbles, writes John Kemp of Reuters, are no accident. "It is the direct consequence of the Fed's asymmetric response to shifts in asset prices." Much will depend on whether the reflation policy is, at the appropriate time, wound up and put in the closet. In theory, it's a no-brainer. In practice, there are complications.
Finally, we bring all this up mainly as a reminder that it's always difficult to maintain strategic perspective. Two years ago, when all the major asset classes were rising, few could imagine the current pain of the moment. Similarly, looking at where we're headed several years from now looks about as relevant as studying the moons of Saturn. But the future keeps coming, even if we're not looking. It's tempting to make all our investment decisions based on what happened yesterday, but we're all probably better off keeping our strategic-investing focus on what's likely to unfold several years from now. No easy task, to be sure. Par for the course if you're intent on winning the investment game.