David Rosenberg of Gluskin-Sheff is normally known as a deflationist, but in his latest note he passes along a freightening inflationary story under the title: “And you thought you were bearish.”
Here is one of the most insightful — if frightening — emails we have received in some time. We still maintain that portfolios should have a concentration in securities that spin off an income stream. But again, a “barbell” approach with hard assets such as commodities will act as an effective hedge if government policies produce inflation. Have a read of this zinger below:
“I don’t know if you remember but we worked together at Merrill. I
ran emerging markets from 1985 to 1996. I’ve always been a loyal
fan and kept up with your writings.
As you know, I used to specialize in what we called then toxic waste
countries. Reality has obviously taken a turn and what was toxic now
is golden and the prime is now toxic. Our best countries are being
run like banana republics and the famed moral hazard issues are
now at the individual level with the strategic mortgage defaults. Keep
in mind that in Mexico, it moved to wholesale credit card defaults at
the last stage of the correction.
It is interesting to note that back then (the 80s) without currency
zones but a fixed dollar, the order was devaluation, default,
restructuring and budget balance with exports beginning the process
of recovery. It was not until Summers’ bailout of Mexico that we
entered this ridiculous world of constant bailouts, raising the size of
them at every turn and lowering the bar to what constitutes risk.
Now, it’s worst than ever. The developed economies have huge fiscal
deficits with no state assets to sell. The balance sheets of the
developed nations are over leveraged. The deficits have taken a
permanence to them. In the case of Europe with no individual
devaluation alternative and their new massive debt load, the EU must
now make huge fiscal cuts to get credibility. This is very reminiscent
of the pre-depression year. If the EU follows through it will push a
weak world into a severe double dip and bring the question of
capacity to repay to the forefront anyways.
Monetization or printing may end up being the only end alternative. I
know, and agree with you, that to have inflation you need demand.
Where I disagree is that you can’t have inflation with such a
significant slack in the economy. For those of us that lived or worked
in the hyperinflationary South American zone of the seventies and
eighties, inflation comes when people lose faith in the currency and
see material goods as a store of value. Because commodities rise
and the goods can no longer be expected to be made at the same
cost structure, people assume that they will be worth more in the
future creating a self fulfilling upward spiraling effect. You can
anticipate that these state governments will introduce price controls
as well as potentially fixing exchange rates worsening the situation.
My biggest fear is that these politicians and advisors have little
experience in this area and are more concerned about controlling the
political short term without regard to the longer term implications. I
see this like an attempt at covering holes in a cracking dam with your
fingers while the cracks are spreading. Bonds in the thirties were not
a safe haven because they were restructured into 30 to 40 year
bonds at 1.0-2.0% interest. Ultimately spending habits must decline,
debt must be restructured, and growth must be promoted through
the private sector.
Political interests must be aligned with long term economic objectives
and I don’t see that any time soon. Obviously, I’m very negative right
now. What am I missing?”
Given that EVERYONE is a deflationist all of the sudden it’s good for you to consider alternative scenarios (and good on Rosenberg for publishing this).