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Nicholas Pardini
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Nicholas Pardini is the managing partner of the equity long/short hedge fund Nomadic Capital Partners. The fund specializes in commodities, emerging market consumer equities, and equities in the the global technology sector. His research and live trade updates are also found on his investment... More
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The Pardini Report
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The Definitive Guide to Emerging Market Currencies
  • Can Americans Afford an American Standard of Living? Part 2: How to Trade Trickle Up Poverty 2 comments
    Oct 13, 2011 11:02 PM | about stocks: POT, PM, VMW, GLD, PPLT
     With median wages only at $26,261 per year, and living expenses for a single person in a mid-tier metropolitan area at $26,743 the average American is financially underwater. The root of the weak economy in the Western world is the fact the majority of the population is priced out of their own countries and lack the disposable income to drive growth (or even money to pay the bills). This creates a downward spiral of cutbacks in spending which lead to job layoffs that fuel additional cutbacks in consumption and investment.

     What is the solution for this? As proven by the PIIGs, increasing the welfare state will not work and the current stagflation in the US and UK show that loosening monetary policy is not a legitimate solution either. Many commentators advocate fair trade policies. However, slapping tariffs on China will not do any good, as manufacturing will just move to nations with even lower wages. In the rare case where factories move back to the US, they will come back with robots instead of jobs anyway. My solution is to encourage wide scale deflation to bring living costs to a level where borrowing is not necessary for a "middle classstandard of living.

     There are a variety of ways to this. The first thing to is to stop printing money and let prices fall with develeraging. Pegging the dollar to a hard asset (silver, platinum gold; it does not matter as long as supply is relatively fixed and scarce) would be the best way to do this. Or simply do what Volcker did in the 1980's and let interest rates rise to market levels. Real interest rates will be positive again which will encourage savings growth and bring down commodity prices down as hard assets will no longer be needed to hedge inflation. These policies will severely hurt borrowers, but a economy based on irresponsible borrowing is unsustainable anyway and its better to clear out the defaults quickly to create a solid foundation for future growth.

     Another step is to eliminate government supports and subsidies that artificially increase the price of housing and other basic needs. This includes getting rid of Fannie and Freddie, repealing the community reinvestment act, subsidized FHA loans, and other government interventions that prop up home prices. Housing is still overvalued in relation to Americans' incomes and will continue to slowly decline over the next 5-10 years anyway. Removing these subsidies will accelerate the housing decline and make housing affordable to the point that the market will have support. Also with rent and mortgage payments declining, more disposable income will be available to the economy as a whole. Outside of housing, the government can reduce its interference in farming, healthcare, and education (by ending subsidies of student loans), which will cause the market to drive down costs to more reasonable levels.

      In addition both taxes and government spending (on federal and state levels) need to be severely cut as taxation is the biggest expense for the vast majority of American families. By cutting $1.50-$2 of spending for every $1 dollar in tax cuts, income available for private consumption and investment can be increased replacing unproductive government deficit spending. Cuts will need to be ubiquitous and entitlements will need serious reform, but areas the government can cut without harming the most citizens quality of life include ending foreign wars overseas, busting public unions, ending the subsidizing of the mortgage market, eliminating excessive federal bureaucracies, and eliminating welfare benefits for illegal immigrants. Focusing the cuts on these places will help minimize reductions in more critical aspects of the government such as infrastructure and education.

      The deflationary solution I propose to solve the unaffordability of a first world standard of living is harsh and may sink the economy even further into recession in the short run, but will provide a stable foundation for long term economic growth. Deflation encourages saving instead of borrowing increasing domestic capital investment so that small business and large corporations can grow.

     In reality, governments will not voluntarily enact deflationary policies because they have the most to lose. The probable
    alternative is that stagflation in the name of stimulus will continue and the government will fail to balance a budget and default through the debasement of their currencies. Those who call themselves "middle class" will need to just accept that they are part of the new global working poor. Depending on how well they tolerate their new normal will determine whether the Western world sees serious political and social unrest.

     The way to hedge is to buy hard assets or companies with pricing power in their respective industries. Companies I like that have strong pricing power include Potash Corp (POT) which has a de facto natural monopoly in the potash component of fertilizers, Philip Morris International (PM) in the inelastic tobacco markets overseas, and VMWare (VMW) which controls over 80% of the virtualization market. Another benefit of these three firms, is that they are resistant to recession (POT's growth driven by food needs, VMW driven by replacing workers via the cloud, and the addictive nature of smoking prevents significant downturns in earnings for PM).

     On the commodities front, I expect agricultural products and precious metals to perform well in the long run once fears about China subside. Declining demand may offset inflation in oil and industrial metals such as copper, but I do not think this will pass onto food products as population continues to grow faster than food supply in India, the Middle East, and Sub-Saharan Africa. Gold, silver, and platinum will rise as fears about collapses of the dollar and the Euro reenter the news cycle, and I expect them to rise until real interest rates turn positive.

      Overall, the right thing to fix the problem of the West outpricing itself is to make an effort to bring the price level back to affordability, but it is highly unlikely to happen. As an investor, protect yourself from a default via inflation by buying quality companies with pricing power and hard assets.



    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLD over the next 72 hours.
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  • This is not going to work due to the debt out there. You forget that a lot of people and companies as well as the government are deeply in debt and that kind of strategy would lead to massive defaults that would make the Great Depression look like a pleasant weekend.
    The problem that you are talking about is not solvable and the standard of living is likely to deteriorate further.
    14 Oct 2011, 03:22 PM Reply Like
  • Nicholas, I enjoyed reading the instablog. It offers another theory, namely deflation, to resolve our financial and political woes.

     

    Winningtrader's above comment also provides a very likely outcome if your solutions were 100% implemented - Great Depression II.

     

    I for one am more and more pessimistic everyday regarding our country's short to mid term fate given the greed, political logjam, and maldistribution of wealth and lack of opportunity for the poor, working and middle classes.

     

    My solutions are almost entirely opposite of yours so you can imagine how much we differ. I am more aligned with Paul Krugman's philosophy how we should get out of this mess.

     

    Thank you for supplying your ideas, however.
    26 Oct 2011, 03:07 PM Reply Like
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