Strategies for Surviving Stagflation in the U.S. and Asia

Excerpts from Dr. Enzio von Pfeil's June 25, 2008, appearance on CNBC Asia:

1. Many believe that the Fed will keep rates on hold for now. What are your views? Do you think that Ben Bernanke has good reasons to stay neutral for now? Has the Fed been doing a good job?
   • I cannot imagine them hiking rates before the elections are over.
   • Besides, rate hikes only work where there is demand-pull inflation. But America's current stagflation - her fourth since the 70s - is of cost-push nature. Central banks can neither command more rainfall, nor can they tell OPEC to behave, nor can they tell Nigerian oil miners to stop striking.
   • I think that Bernanke is over-rated: the Fed operates as a group of very bright people, whom he leads. Besides, as I just suggested: what can Central Banks really do about cost-push inflation? It's only if this morphs into a wage-price spiral that they can step in. But I don't see this happening: unions are less powerful than they used to be, and people are clinging to their jobs for dear life, what with they huge mortgage debts and credit card loads. 
   • I think that he has done a good job, even if he does not have the marketing abilities of Dr. Greenspan.  Prof. Bernanke has inherited Greenspan's easy money mess, and that will take a long time to solve. Volcker was far more inflation-focused than Dr. Greenspan.
2. What's the primary worry for the U.S. economy? What's your growth outlook?
   • We have called stagflation since Spring of 2006.
   • The chief concern within this is, as suggested above, that Central Banks really can do very little about rising commodity prices.
   • Add to this the foolhardy people in Congress wanting an ever-lower dollar, and imported inflation rises on goods from Europe and from China.
3. What's your view on the U.S. dollar?
   • Superpower currencies always fall: the Empire runs out of money, and thus prints more of it. The result is that the supply of dollars rises, while demand for dollars falls (on account of competitor currencies like the Euro, the Australian or New Zealand dollar, etc), and down goes the price of the dollar.
   • On a six month view, you may see some short-term dollar strength, particularly against the Euro: if the Fed raises rates and the ECB does nothing, the dollar looks less unattractive vs. the Euro.
4. With uncertainty still very much in the picture, where should investors put their money?
   • I remain with my grammatically-incorrect statement that "cash are kings." Keep cash in:
     
     • Currencies like the Euro, Australian dollar and the yen, and
     • Commodity ETFs.
5. Are there any other trends that you'd like to highlight?
   • The lacking integrity of some Chief Global economists.
   • I put this on to my website some days ago. The basic thought is: how can people who are bright and are earning fortunes have been so blind to what has hit us economically?
   • Answer: the boys on the props desks told them to talk up the economy - so that the props boys could get rid of their "long" positions at a profit. Now that this exercise is largely over, expect this very same economist to start sagely emphasizing the "risks to recession/stagflation": their props boys have not told them to talk the economy down because the props boys have plenty of market shorts, so it is in their vital interest that markets fall.
   • Thus, greed is what caused the sub-prime meltdown. Also, greed is what has driven some - but NOT all! - Chief Global Economists/Strategists, particularly of American houses, to have been saying what they have.
6. What's the outlook for Asian markets?
   • Generally horrid.
   • America's stagflation is going to maul her corporate profits prospects.
   • European business sentiment is heading south, even north of the "PIGS" (Portugal, Italy, Greece and Spain).
   • So, the BRICs will be subdued,
   • and Japan will keep going nowhere.
7. Investment strategy for Q3 and Q4 - what sector/markets do you like and why?
   • The only markets that we have in our Economic Time Fund are Brazil, Russia and Taiwan.
   • It seems that with the political thaw that Taipei and Beijng have engineered, China will send plenty of tourist dollars Taiwan's way.
8. Inflation worries have markets expecting tighter monetary policies - what are you expecting for Asia and the impact on markets?
   • They are going to be caught between a rock and a hard place, these Central Banks.
   • Here in Asia, they may have explicit inflation control targets, but the political reality is like that in America: they also have to continue prodding growth. In China, Beijing has to create 10 million jobs a year!
   • Besides, fighting stagflation with traditional Central Bank tools is ineffectual. Given that prices are rising due to:
     • America's rising imported inflation courtesy of a weaker dollar (which Congress wants), and
     • rising commodity prices (which are due more to supply constraints than to excess demand),
     • I hardly think that Central Banks will find that "tightening" is all that effective.

Comments

[Dan Walker]

Bravo! I look forward to a follow-through, although I may disagree academically with your conclusion on the effects of 'tightening'. I believe it would shock the commodity markets into heel in the US rather quickly. The problem is in your (correct) conclusion that no one in office will attempt it prior to an election so it is a moot point.

[yank]

Dr. Von Pfeil's comments are correct. This is a "cost-push" inflation we are witnessing here in the US not a demand-pull. Therefore, a tightening cycle would merely exacerbate the current weakness. The other main issue is the yield curve. The Fed and Treasury have been working diligently over the last 6 months to "steepen" the curve (better for banks). Now that it has indeed steepened why in the world would they want to reverse course? Raising rates now would "flatten" the curve and in the process "flatten" the banks profitability (no pun intended). Election year or not, we have to face up to the fact that it generally takes 9-12 months for the full effects of a rate easing cycle to take hold. Raising rates today, in August, or even this year would be a prescription for economic disaster.

[CLH]

Raising rates would continue to strengthen the dollar and lower commodity prices. Its the right thing to do and would stop inflation before it gets going. (few can even define inflation so they wouldnt know it even if we had it). High oil prices are not inflation. Push -pull and stagflation are BS words.

Little off the above article makes any sense.

[TinyTim]

if the Fed raises rates and the ECB does nothing, the dollar looks less unattractive vs. the Euro.


WTF???

[David Lentz]

If you want to rein in the US commodity markets (which are clearly out of control, with speculators running the asylum), merely raise the margin reserve requirements. That's the sort of tightening that would help things.

No reason why commodities margin requirements should be in the 5%-10% range, while equities are at 50% -- well, there IS a reason, to enrich the speculators in the futures markets.

The responsible authorities (stop laughing!) could raise the futures margin reserve requirements overnight, and all the pressure in the commodities markets would immediately subside.

If there truly is more demand than supply, then prices would not be altered much. But the amount of money percolating in the commodities markets would subside to that necessary to perform trades pretty quickly -- taking about as long as they were given to raise the reserve levels required.

[TinyTim]

So Sorry. Double negatives always screw me up.

That was: less UNattractive

[iThinkBig]

Times are going to be bad. Yes, we know. That a black swan event because of lack of leadership in Washington couple with beyond greed, lets call it malfeasance from Chief CB Economists is now a probability. I am preparing for such an for the first time in my life and I will strongly say that I am not prone to market hysteria, I generally consider firesales a great opportunity to create wealth. Part of my planning is on the physical side to avoid the mob in a short-time period of dollar/financial collapse. In some ways this is better for our nation to start-over with the right perspectives. But I do not relish the difficulties such a massive correction will bring.

[sw05052002]

Only for investors in US-$:
theoptimizedportfolio.... results into
a highly leveraged purchase of short-term bonds in Chinese currency.

[yank]

clh:
If you don't understand the difference between cost-push and demand-pull inflation maybe you need to go back to school and take Econ 101. The bottom line is that unless wage growth explodes (has remained fairly flat) inflation will be limited to commodities. Again, we will NOT see any chance of a rate hike this year and traders better get used to that. We are facing record bankruptcies in the housing sector, rising loan delinquencies, and stagnant wage prices. All of this makes it virtually impossible for the Fed to raise rates this year. We are on the verge of a precipice and a rate hike would push us over the edge. Be careful what you wish for.

Newby

[semar]

wrote about staglation this week in one of my articles. I'll add an excerpt here:

[...]Some voices have started to indicate that the next thing to come is stagflation, inflation linked with no growth. All all the cycles that a country goes into, stagflation is the worst, and the answer is very simple: to fight inflation properly high interest rates are needed, but high interest rates kill growth in the economy, that is the point of it. To fight a slowdown, monetary policy can be used to cut the interest rates, but then inflation will increase at a very fast pace. So basically, the Central Bank is between the hammer and the anvil, not being able to move easily in any direction.

Inflation expectations are very high on both sides of the Atlantic and at the same time the whole world is sharing this view. The other common thing shared on both sides of the pond is a visible slowdown.

We could very easy say, and this may surprise many, that at this time the Euro-area, UK, Japan and US are all in a stagflation period or very close to going into one. If future inflation and growth estimates come true, stagflation will be here. Morgan Stanley reveal charts showing each major economy, and in what cycles is currently in. Guess what, all of the major economies are heading to stagflation and the only improvements from a 70s like period are the developments in the monetary policy arena and the financial markets, to keep us far enough away from a prolonged period like that. At least Japan seems to be making a big step forward from deflation to inflation. Good job BoJ, you only needed 18 years for that to happen.[...]

The full article can can be read here Stagflation is next

[Kunst]

Inflation is when prices and wages both go up.

When only prices go up, it is called getting poorer. Get used to it.

[tuckfinitee]

Kunst the Bureau of Statistics solved this problem 20 years ago. Instead of eating hamburger you switch to dog food. Instead of shopping at Walmart you scavenge dumpsters. If you lose your job you go into business for yourself. That will require a capital expenditure for a hoe and seeds.

[Kunst]

Isn't that clever of them? If I go live in a cardboard box under a bridge, my housing cost has gone to zero. Eat roots, berries, and insects -- maybe trap a few mice -- and my food costs are zero too. Since I walk everywhere I go, transportation costs ditto. Why didn't we think of these solutions before?

[wcrxlpeditorialcollective]

If it is stagflation, it is for consumers only.

Asset values have been collapsing at financial institutions.

The response for the banks is to try to attract additional capital at deflationary values.

Insurance companies too, but with a twist.

Portfolio asset values have suffered which limits premium writings.

Policy limits are lowering gradually, which is also deflationary.