hyperinflation

Hyperinflation is now here II: Food prices

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Bruce Walker writes today at the American Thinker that food prices are what is going to do in President Obama’s chances in the next election.  One of the signs of hyperinflation is spiraling out of control food prices, and Walker points out that the food commodities are up 27% over the last six months.  I don’t know about you, but a 54% annualized increase in food commodities looks a lot like hyperinflation to me.  I wrote a post in August 2010 that dealt with food prices, which I reproduce here:

August 3, 2010

What’s wrong with inflation? Do you have enough to eat?

Monty Pelerin has a excellent article on inflation this morning.  He maintains that the great temptation for government will be to try to solve the problem of debt and unfunded obligations by inflating it away, and that, since politicians are cowards, they will not make the tough decisions to avoid inflation.  He writes, however, about the consequences of inflation:  “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.”

I believe that the real danger of inflation may lie in the consequences it will  have on the food supply.  Never mind that food shortages have never been a problem in the living memory of most North Americans (unless they are over 75 or immigrated here from a war zone or something).  Today, obesity in developed countries is feared more than starvation.  So I made the following comment on Pelerin’s blog:

I am reading Adam Ferguson, When Money Dies (1975). He tells the story of Frau Eisenmenger, an Austrian who at the end of WWI had sufficient investments to live on and care for her family (31). She went into her bank in 1918 to withdraw some funds and her banker advised her to buy Swiss Francs, but it was illegal to hoard foreign currencies, and so she declined. Eventually, her savings became worthless. Her situation was greatly helped by her daughter working in the “American mission” paid in dollars, renting a room in her apartment to an American, and speculative investments in the Austrian stock market.

I fear that what will happen is similar to Europe in that period, when food was scarce and required a large percentage of income to procure. Eventually, the price of food will sky rocket and so more dollars will be created ex nihilo. Then the farmers will refuse to supply their food to people for worthless dollars and food stamps from the government, and they will have to stop producing–because their costs have to be covered too. Then, we will see shortages like never before. A farmer offered Frau Eisenmenger three month’s provision for her grand piano (33); and an acquaintance of hers sold her own piano for a sack of wheat flour.

Jeet kune do investing (III) vs. conventional investing

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I revealed offline to Mich at Beating the Index how much my portfolio (87%) is weighted towards oil and gas stocks, and only C.J.’s (my wife’s) defined contribution plan is in a balance fund.  He wrote:  “Your portfolio is high risk indeed! I imagined you would have some bonds and more utilities, you surprised me really …”  So I even managed to surprise another junior oil investor with my portfolio.

But let’s consider that conventional styles of investing are too rigid.  They present stereotypical strategies for conventional times.   If Bruce Lee had been a financial advisor, he would have advised his clients to adapt fluidly to the market–to anticipate the market’s moves and to respond in a way suited to each individual.  There are no recommended trades, for each investor is unique, with a unique set of risk tolerances, liquidity and investment goals.

I am an inflationista.  There is no doubt in my mind that Bernanke is creating money faster than the credit bubble is deflating; nor do I have any doubt anymore that the Bernanke Put is for real: no matter how fast credit deflates, Bernanke promises to pump it back up with fiat money.  Now the Bank of Canada wants to create inflation, albeit only 2%, but that they also want desperately  to keep the loonie on par with the greenback; and with these two strategies, governor Mark J. Carney will not be able to control run away inflation in Canada.  Indeed, one could argue that the Canadian housing market has already run away from him.   So now I have been investing for the last two years believing that hyperinflation is our opponent, and my jeet kune do moves must adequately anticipate and respond to that reality.

Consider these conventional strategies and how they cannot possibly succeed in time of hyperinflation:

(1) Get out of debt; (2) maintain a balance portfolio; (3) diversify your portfolio; (4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income; (5) Real estate is always a great investment.

(1) Get out of debt.

Debt is always very bad if it is high interest consumer debt (credit cards, lines of credit). But for many people their mortgage is their best protection against hyperinflation–the currency can lose value much faster than you pay off the debt or interest rates can go up.  Creditors lose in inflationary times, and so it stands to reason that debtors can win, provided that their debt is not spent on frivolous consumer goods.

(2) Maintain a balanced portfolio.

A balanced portfolio puts the emphasis on having stocks for growth and fixed income for safety.  But it is questionable whether stocks in general are a good hedge against inflation.   Warren Buffet wrote an article during the height of the last great inflationary period (1977, Fortune Magazine):  “How inflation swindles the equity investor“.  Fixed income investments are a disaster during hyperinflation, especially today, with the rate of return being so pathetic due to artificially low interest rates.

(3) Diversify your portfolio.

I am not sure that this strategy works in conventional times, supposing that such times ever exist.  Diversification is not the same as not putting all your eggs in one basket.  My portfolio includes debt, real estate, oil and gas, and gold mining companies.  But it doesn’t include anything in aviation because my C.J.’s business is in aviation maintenance.  So you won’t see me investing in Bombardier, Boeing, Air Canada or West Jet, because if one company goes down, it can have a domino effect on the entire industry.  That’s not putting all your eggs in one basket.  But those who advocate diversification suggest that the investor either own an index fund or diversified mutual fund, or a roughly equal number of stocks in each of the major sectors of the economy.  I am pretty sure this will only lead to pretty mediocre results.  I’ve noticed over the years that most investor billionaires are barely diversified, but have made their money in highly concentrated moves:  for example, Warren Buffet is mainly an insurance guy.  John Paulsen shorted sub-prime mortgages then bought gold.  Sometimes it is better to get to know one or two industries really well, and stick to what you know.

(4) Subtract your age from 100 and this is the percentage of stocks vs. fixed income.

This bit of conventional wisdom has cost people a lot of money.  The last two years has provided pathetic yield on fixed income and meanwhile we’ve been in a great bull market.  Hyperinflation is going to wipe out whatever seniors have left and they’ll be saying a final “good bye” to their wealth.  The reason why this strategy is wrong is it has an imaginary understanding of what is a high risk investment.  Stocks are considered high risk and fixed income, low risk.  But in hyperinflation, there is nothing more certain to destroy a portfolio than fixed income investments.

(5) Real estate is always a great investment.

The sub-prime mortgage crisis has done much to destroy this myth.  For me, real estate has been a wash in the last two years.  The rental house we bought is up $70,000; but the commercial building in Texas which I bought with my brother has zero equity, is not breaking even, and $70,000 of my initial investment is basically a write-off.  But many people think that real estate will maintain its value in a time of hyperinflation. Gonzalo Lira trounces that myth in an article demonstrating that during hyperinflation the high interest rates and the unwillingness of creditors to lend out a rapidly devalued currency, destroys real estate prices.

Meanwhile, as of this moment, my concentrated jeet kune do portfolio is 86% above book.  Commodities go up during hyperinflation; so my stocks are nearly all in Canadian commodity companies (oil and gas, gold, and sugar).

Jeet kune do investing II: Toyota RAV4

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I consider a car a consumable not an investment.  Yet as an investor who strives to have “no style” –like Bruce Lee’s Jeet Kune Do, a style which is no style–today I signed a deal to buy a second RAV4 in two years.  This is not a necessity.  We do have the flimsy excuse that my assistant’s car has given up the ghost and he can now purchase my 2001 Pontiac Montana which probably has at least three years of life to go.  I could have driven it for a lot longer.  But here is why I’ve decided to buy the RAV4 now instead of waiting:

The price was identical to last year’s purchase, though the financing was a little different.  Toyota was under a lot of pressure last year because of all the negative publicity and Congressional scrutiny.  I chalked up this political harassment to Toyota’s main competitor being the US government itself, seeing as Obama had just bought two car companies, GM and Chrysler with taxpayers’ money.  So I felt that the bad publicity and the political harassment was unfair, and that Toyota was like a value stock, and besides, C.J. (my wife) needed a car.  You buy a value stock when you know the fundamentals are sound, but the market has abandoned it.  Toyota, which had become the number one car manufacturer in the world, had never offered 0 % financing until last year, when we bought C.J.’s RAV4 with 48 months 0 %; and this year’s RAV4 I’m getting at for 36 months 0 %.

Once I drive that car off the lot next week, Toyota Credit will have floated us over CDN $70,000 at 0 % (my RAV4 and the remaining debt on C.J.’s).  Why is that a jeet kune do move?  Because in times of inflation or hyperinflation, debt is the best hedge.  I am anticipating that cars are going to go up in price in the next few months because of commodity inflation, and 0 % financing will be an historic anomaly because credit will become increasingly expensive–to be honest I was surprised that anyone would still offer 0% today.  I expect the US dollar to experience hyperinflation in the near future.  The Canadian loonie will likewise experience high inflation, though not hyperinflation, as the Bank of Canada seeks desperately and unsuccessfully to keep the loonie at par with the greenback.  My gut feeling is that inflation will pay for all of the depreciation on both of these vehicles, and three years hence we will have become the clear winners, for we will have paid Toyota back in devalued currency.   If not, well, we will have paid no interest on the loans, so no big deal.

Finally, when hyperinflation hits the world and believe me, I think it is already well under way, people will be desperate to get their hands on real goods, for their currency will be increasingly worthless–and the bottom may fall out of the real estate market too.  As for cars, they are a real good.  Consider this anecdote from the colorful South American hyperinflationista, Gonzalo Lira:

A true story: In ’73, at the height of the Allende-created hyperinflation, an uncle of mine, who was then a college student, was offered an apartment in exchange for his car. That’s right—an apartment. He owned a crappy little Fiat 147—a POS if ever there was such a thing—but cars in Chile in the middle of that hyperinflation were so scarce, and considered so valuable, that he was offered an apartment in exchange. To this day, my uncle still tells the story—with deep regret, because he didn’t follow through on the offer: “That Fiat was in the junkyard by ’78, but that apartment still stands! And today it’s worth nearly a half a million dollars!” Actually, I think it’s worth a bit more than that.

In the style that is no style, the jeet kune do investor must be able to anticipate the future.  The best way to do that is to study the past.

A note of caution:  this is not a recommendation to the esteemed readers of this blog to go out and buy a car.  It relates to our personal circumstances and investment style–or no style (see Jeet kune do investing I).

Canada’s currency manipulation: the inmates are in charge of the loonie bin (update 2)

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UPDATE 2:  I asked Denis, my economist friend, how much of the US treasuries is owned by the Canadian government and how much would be owned by the private sector, and he suggest consulting the Bank of Canada balance sheet.  It is clear that the total assets on the balance sheet are 60.8 billion, which means that there is no way that the government of Canada could have lent $134 billion to the US, and that most of the ownership of these US securities must be in the Canadian private sector and can be explained by covered interest arbitrage.  Nevertheless, the reason why this arbitrage happens is because the Bank of Canada has kept the interest rates at low levels and is therefore to blame if the loonie is inflating like crazy.  Denis provided me with the following chart of interest rates:

UPDATE:  Thanks to the comment by blogger 101 Centavos, I finally asked my local Canadian economist if he could tell me what the number $134 billion means.  He says it is not the Canadian government alone that holds this debt, but all Canadian holders both sovereign and private.  I am going to try to reach him by telephone for clarification.  Meanwhile, in the words of the ever opinionated Emily Latella of Saturday Night fame, “Never mind”.

[Please note: the updates above are intended to substantially correct  what follows, which is the original post]

I am thinking about writing a blog for the American Thinker about the announcement that China would spend another 5.4 billion in the Canadian resource sector, this time to buy 5.4 billion of Encana’s natural gas holdings.  My view is that China’s purchases of Canadian resources is more about diversifying themselves out of US treasuries.  But  I found a table updated in November 2010, which shows that the Chinese have actually increased their US treasuries by $265.3 billion since November of 2009 (the chart only goes back that far).  Meanwhile, one stat jumped off the page.  In that same period, Canada has increased its holdings of US debt by $84 billion! I am shocked.

Canadians greatly fear the death of the manufacturing sector.  So now they will tolerate this.  But I am dismayed and shocked that our government is manipulating the Canadian dollar so that it will not rise against the US.  The immorality and the bad management of this situation is beyond words.

A couple years ago, I thought that given the bad fiscal policy of the US government would lead to the loonie soaring against the US dollar.  But now I see that rather than allow that to happen, the Canadian government is subsidizing the American lifestyle and the American bubble.  So that finally explains to me why the loonie remains at par and why price inflation is slow to happen in the US–why price inflation is happening in Canada the same as elsewhere in the world.

Why I think QE will create inflation and why it is qualitatively different than credit expansion

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Meredith Whitney has come down hard on the municipal bonds and she is getting a lot of heat from others, including David Rosenberg.  But even if she is wrong, bonds of all sorts are bad investments because the US dollar is going to hell in a hand basket.  But what about shrinking credit which causes deflation?  I am no economist but here is why I think QE causes inflation while credit expansion is less inflationary:

Inflation is caused by too much money supply chasing too few goods.  Money supply can be created through credit expansion or through QE.  Credit expansion results in the creation of goods and services such as building of houses and manufactured goods, for every time a business borrows, its creates more real wealth in the form of its products.  Every time a home owner buys a house with a mortgage, the demand for new housing goes up and it results in larger supply of homes, i.e., more goods.  Thus, though credit expansion can obviously create bubbles, it also results in the increase of goods and services.

QE, quantitative easing, or the monetization of debt results in a disproportionate demand for goods and service without the creation thereof.  This is because the US federal debt is being monetized, and the US government in turn gives the money to government workers, pensioners, social security, welfare, food stamps, etc.  I.e. to people who increase demand without increasing the quantity of goods and services.  This increased demand, too many dollars chasing to few goods, devalues the dollar.

And this is why I think that QE leads to inflation and why it is much worse than credit expansion.