Sunday, March 27, 2011

Can't Buy Food... Eat IPADs

Some three centuries ago the French state was in complete disarray, the government ran up huge deficits because of the wars with England and soon this transpired in the form of unabated inflation. It’s people unawares (like most common people are) and reeling under the severe bout of inflation went to their king and complained that they can’t eat bread as it has become too expensive before the king could speak his beautiful wife asked her pupil “To instead Eat Cake”, soon the obliviousness of the French royal family culminated to their demise in the then French Revolution.

History often repeats itself but the irony is that most of us can’t see it as we are it’s participants. It’s like if two trains are running on the same track in the opposite direction they are definitely going to crash into each other however the passengers inside the train would never get to know no matter how many times in the past they have seen it happening from outside. Something interesting happened about 2 weeks back. In one of the seminars the NY Fed President was asked about the Fed’s total obliviousness to inflation when instead the Food and energy inflation was the highest ever recorded since 1974!!!, to this the Great NY Fed President replied that overall inflation was still moderate (their freaking core inflation) and so while the Food inflation maybe high but there are something like “IPAD” that are getting cheaper!!! This statement by the NY Fed President (who is either like most economists completely oblivious to the real world or totally hand in gloves with his crony bankers) is a harbinger of the things to come (just to note that this month his totally manipulated core inflation was also the highest recorded in 2.5 years). While the queen of France could be excused for her comments these are supposedly learned men. If this trend continue the battle lines in Middle East and southern Europe would spread elsewhere, add the last night protests in London to the list. Let me point out that this trend is not just peculiar to Central Bankers in US but everywhere.

The response to the catastrophic disaster in Japan by its Central Bank was to the same predictable action of printing money. The Japanese Central Bank printed some 700 billion dollars!!! In just one week just so that it’s stock market does not crash. The result of this tsunami of money printing was that the Japanese stock market may have fallen overall by just about 6-7% in the last week but the price of rice which last time I checked was what was really needed by those people affected by quake rose by 12% (in a week) and to the best of my knowledge people can’t eat stocks, so great job BOJ.

What many people don’t understand is that the stock market going up is not always a good thing; it is the reason why it goes up and that is more important. During the last 2 years the markets across the world have gone up mainly because of one single reason (Money printing). To explain my point let me pick another lesson from history, that of the famous Weimar Republic. After the end of war in 1918, Germany had a huge task ahead… not only did it need to rebuild but also to pay the obnoxious price of war imposed upon it. Soon it found its hands full and resorted to the old money printing trick. The result on the asset price was as follows:

-          The nominal value of the stock market increased by 89 times in the 8 years following the war (looks good then read further)
-          The value of gold increased by 1600 times!!!
-          It soon took an entire wheelbarrow to buy 2 eggs
-          The people had to be paid their wages twice a day

More importantly with the large population living in tatters and only handful of bankers who were cognizant of this process were able to save their wealth by investing in hard assets thus created a serious communal rift in the society and thus paving the way for Hitler.

I am so glad that the BOJ saved the stock market and saved a few of their friends, while the majority of its people are going to soon feel the impact of higher rice and other commodity price for years. Just wonder why they couldn’t understand that because of the destruction in the quake that since the supply of goods has reduced so should the credit and yes assets have to deflate because of that. The realty is that the governments across the planet are so extended that they have no way but to generate inflation to get out of this mess. Unlike the private sector the government is not a profit generating entity but a welfare entity (supposedly) and so when it runs large deficits the only way it can repay is by increasing taxes… however the reason the taxes are so problematic with the masses is because it leads to transfer of wealth from one person to another and so the government devised another way out of it… debt, by selling its debt the government was able to create the mirage that it was not necessarily a transfer of wealth as my money taken from me would be ultimately returned back to me in the future. However how would the government return this money back, well there could have been just two possible ways either raise the taxes in the future or take more debt and run a ponzi scheme (this is what many developed countries tried for a while) and when this ponzi scheme is about to run its course then what should it do.. well then it came with that brilliant idea of currency. In my last article I explained how currency is nothing but the government liability of the shortest duration. The only difference between currency and other forms of government liability of the shortest duration. The only difference between currency and other forms of government debt is the fact that based upon the currency depends the overall private debt  generated by the fractional reserve system (check the previous article) so contrary to today’s logic in times of slowdown the currency supply should contract because the supply of goods have reduced. The irony is that currency which is essentially government liability and is controlled by just few non-elected representatives across the planet forms one side of almost each transaction and also the modern unit of accounting in economics and this a system that we describe as free markets!!! I wonder how different it is from a politburo of Soviet communists deciding the nations 5 year plan.

It’s very important the people understand that what they are earning every month by putting in their time and hardwork is essentially government debt that the Central Banks can print as much as they wish with the flick of a finger and distribute it to their crony bankers. Think about it this way that you have spend hours of your personal time and studied hard and passed the exam, at the time of the convocation the Director of the college announces that passing the exam was not necessary and everyone would get the degrees simply because his son failed in that exam.  So it’s important do away with the “cash” as soon as you have it and invest it in hard assets and especially not to deposit much of it in banks and thus not allowing them to play with under the fractional reserve system .

Often there is this propaganda that commodities don’t yield any cash flow and so are not good investments, while I agree to this hypothesis in normal times but these times are hardly normal… please not the key word in their argument “cash flow”…. While fixed income and equities would yield some cashflow 1 year down the road, however what good would be that cash if it’s value has significantly eroded because of the inflation generated by money printing. Don’t fall for these arguments, in an environment like this hard assets are the ones that would outperform because when the money is provided to a corporate he buys those hard assets first operates upon it in the second stage and sells it in the third stage so by the time he gets the “cash flow” to the shareholders in the third stage that money has significantly lost its purchasing power.

There are only 2 ways to deal with this situation, either do what people in Middle East and parts of Europe are doing or play the cards smartly that are dealt to you by the Central Banks and it’s pretty simple buy commodities (mainly bullion and agri) and hedge it by shorting equity (let me be clear even though equities would go up because of the money printing the pace at which the commodities would appreciate would far outweigh that of the equities. The hedge is important because we would have intermittent collapse of liquidity like the one we had in 2008 and this hedge would keep you in the game………

PS: With China increasing the prices of its rare earth metals soon Mr. Dudley (President of NY Fed) would find his IPADs also getting expensive not sure what would he eat for some food for thought.


Aarul Jain said...

Nice blog. Love your writing Jain sahab... :)

Aarul Jain said...

The last line is incomplete...
"The only difference between currency and other forms of go"

copy-paste error????

Stochastic Process said...

Thanks dost... Ya looks like I didn't paste the whole thing from my word doc.... Thanks for pointing out :), how are u dude and where are you these days....