Deflation

Today I received in my e-mail missives from:

  • Hoisington Investment Management
  • Michael Pettis
  • and John Mauldin

I have come to value each of their opinions.  Hoisington has been one of the leading deflationists for the last 20 years, racking up a 10%+ return annually in T-bonds.  I don’t know of anyone that can beat that in bonds. Their commentary is not posted on their website yet, but they did say:

Based upon the historical record of effects of excessive and low quality indebtedness, along with the academic research, the 30-year Treasury bond, with a recent yield of less than 3%, still holds value for patient long-term investors. Even when this bond drops to a 2% yield, it may still have value in relation to other assets. If high indebtedness is indeed the main determinant of future economic growth and further government “stimulus” is counterproductive, then a prolonged state of debt induced coma may so limit returns on other riskier assets that a 30-year Treasury bond with a 2% yield would be a highly desirable asset to hold.

Michael Pettis is a leading observer of China and other emerging economies.  You can read half of his commentary here.  The rest comes if you get on his e-mail list.

China’s GDP growth is slowing, and a rebalancing is necessary so that domestic consumption can fuel the Chinese economy.  That may be happening now but will likely require that Chinese GDP growth slows further.  A quotation near the end of the piece, not on the blog:

Since these two processes, commodity de-stocking and flight capital, work in opposite ways to affect the trade account, it is hard to tell whether China’s real trade surplus is lower or higher than the reported surplus. But once de-stocking stops, we should remember that the trade numbers probably conceal capital outflows.

How does all this affect the world? In the short term rebalancing may increase the amount of global demand absorbed by China, but over the longer term it should reduce it. Rebalancing will inevitably result in falling prices for hard commodities, and so will hurt countries like Australia and Brazil that have gotten fat on Chinese overinvestment. Rising Chinese consumption demand over the long term and lower commodity prices, however, are positive for global growth overall, and especially for net commodity importers. Slower growth in China, it turns out, is not necessarily bad for the world. The key is the evolution of the trade surplus.

I am less convinced that the rebalancing is taking place, because of the command & control mindset of many Chinese leaders; it is hard to exit the “growth via forced investment” mindset.

John Mauldin is well-known to many. I have known of him since the ’80s.  He is a flexible reasoner who thinks we will get significant deflation, before we get significant inflation.  I tend to agree, but that leaves us watching for a change in bank-lending to see when the scenario shifts.  Here is his most recent missive.  Comparing alchemy and central banking is fitting, I think, with central bankers toying with the asset side of the balance sheet, since liability policy has hit the zero bound.  Sorcerer’s apprentices, I think; they do not know what they are doing.

There you go.  We live in deflation world for now until the time for inflation is ripe, where banks compete for loans.   One thing is for sure, when things shift, they will shift dramatically.  I don’t believe that the central banks of our world have more forecasting power than the rest of us.  I think they have less, because they always have to defend their prior bad decisions.  Those with nothing to defend can look at the future, and estimate with less bias.  Remember that some of those who called the housing bubble were business economists who did not buy into the idea that debt is neutral.  Debt is not neutral; wherever there too much of it, failures occur.  The big expansion of debt is with governments now; what happens if they have a lack of willingness to pay for political reasons?  Inflation or repression are more likely, but higher taxes or government defaults are not impossible if the politics lead to a stalemate, where no one is willing to compromise.

ByDavid Merkel CFA of alephblog