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Enterprising Voices
Investors face inflation ... or deflation “Many signs seem negative for stable prices: … the propensity of major groups in our society to utilize their electoral muscle to shift, rather than solve, economic problems; the demonstrated unwillingness to tackle even the most vital problems if they can be postponed; and a political system that rewards legislators with re-election if their actions appear to produce short-term benefits even though their ultimate imprint will be to compound long-term pain. Most of those in political office, quite understandably, are firmly against inflation but firmly in favor of policies producing it. When very human politicians choose between the next election and the next generation, it’s clear what usually happens.” — Warren Buffett, 1977
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ver the past few months, the chorus of pundits claiming deflation is our biggest concern incredibly seems to have matched the din of inflation extremists calling for gold to reach $5,000 per ounce. In the same week, I read an article pointing to the “End of America” — when we will see Zimbabwe-like hyperinflation — while famed economist Paul Krugman published a New York Times warning that we are on the verge of the next Great Depression. In the last few weeks, our European brethren called for sweeping fiscal spending cuts to bring their budget deficits in line with their GDPs while the U.S. administration — namely our treasury secretary — arrived at the G-20 summit calling for increased stimulus. Who is right? Let’s consider some key data. First, the historic stimulus program launched 16 months ago still has some legs. As of midJune, the data reported at Recovery.gov indicates that $372 billion of the $787 billion stimulus (47 percent) still
Jonathon FITE | remains to be spent. That’s a lot. Next, let’s look at China. To ward off criticism at the G-20 meeting in late June, China indicated that it would adopt “greater currency flexibility.” If the Chinese yuan appreciates against the U.S. dollar, over time that will prove inflationary for the U.S., which is the largest consumer of Chinese goods. Depegging the currency may also lead China to hoard fewer Treasuries and turn its attention to the euro instead. This attempt to help stabilize exchange rates between China and its European customers would increase pressure on long-term U.S. interest rates.
But recent reports of the consumer price index (CPI) indicate that inflation is currently low. Why should we be concerned? Because inflation statistics are manipulated. Jim Rogers, the renowned investor whose Quantum Fund launched in 1970 gained 4,200 percent in the following 10 years, had some interesting comments about the CPI in a recent interview: “Have you looked at it? [The government has] changed their accounting several times in the past few decades. When housing was 20 percent to 25 percent of the CPI and housing was going up, they didn’t count it, saying rents weren’t going up, and then when home prices started going down, they counted it. It’s the same with many things. … When the price of gasoline goes up, they say it’s not really going up
because it’s better gasoline, better quality; therefore, you’re getting more for your money.” If the U.S. Bureau of Labor Statistics used the CPI definition of the 1970s, it would show a 9 percent annual rate of inflation right now. Wow. Given the government’s inflation-pegged obligations (social security, inflation-protection treasuries, pensions, etc.), it is clear that there are plenty of incentives to keep the reported numbers low. As I consider investments for my own hedge fund, it is clear I must heed Buffett’s warning. While some may claim deflation is the real threat, our elected officials, the treasury secretary and the Federal Reserve have stated — and their actions demonstrate — that they will do whatever it takes to prevent the
ravages of a deflationary spiral. While avoiding another depression is good, the consequences of these actions will be inflationary. So, what is an investor to do? In my readings, I found three data points particularly relevant. The first was a summary of Germany’s hyperinflation of the 1920s. The second was a study of the inflationary explosion in the U.S. during the 1970s. The final data point came from Mexico’s peso devaluation of the 1980s. In all three cases, interest rates skyrocketed, the currency collapsed, and both bonds and cash were rendered all but worthless. But investments in the stock market, while volatile, kept up with inflation. The retirees, family trusts and working professionals who have invested in my hedge fund expect me to do more than just keep up with inflation. To outpace inflation, I must deploy FITE | CONTINUED ON PAGE 17
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