Thursday, July 12, 2012

Is Fredo an Ostrich or Am I Chicken Little?

A little while back, Fredo and I had a conversation about buying silver.  I gave my reasons for wanting to do so which included using it as a hedge against runaway inflation.  When I mentioned the Weimar Republic scenario, Fredo said he didn't think that would be able to happen here any time soon.  Doug Ross does a write-up of a Peter Schiff article from Investment News about the real fiscal cliff.

Schiff describes how the German people at that time didn't heed the warning signs and used brief periods of stability to rationalize leaving their wealth in the mark.  Are we doing this now?

What say you Fredo?  Is your head in the sand?  Or am I claiming the sky is falling?


Fredo said...

I don't think I expressed that it couldn't happen here, only that it wasn't likely, and silver may not be the best way to hedge against the risk of hyperinflation. Shorting treasuries would be a preferred method in my book.

That said, you've posed a very difficult question, so I'll answer it to the best of my limited ability.

The Weimar scenario is not so different from QE, except for the underlying size of the economies, and the scope of the money printing. But fundamentally, both scenarios involved creating money to fund unsustainable debts.

Of course, in the case of Germany, one could give them credit for effing their adversaries, paying off reparations with worthless currency. In the process they also managed to eff their entire population, so maybe not so much of a win.

In our case, we have the benefit that the Federal Reserve should be insulated from day to day political pressures. Unfortunately the governors seem more concerned with the growth component of their mandate than price stability. The dual mandate is the biggest threat to stability of the Dollar. And the insular nature of the Fed means a rogue Chairperson could wreak much havok before the elected officals could bring him or her to heel.

That said, Bernanke is not that rogue official. He's far more aggressive in QE than I would like , but not blind to the risks of inflation. There is a huge difference between inflation of 6%, 8%, or 10% per annum (which would be incredibly destructive), and the hyperinflation of 1,000% per annum that occurred in Germany. Current Fed policy risks the former, IMO, not the latter. It would be a very damaging outcome, but would not render dollar denominated assets useless.

I don't feel like my head is in the sand. There is a real possibility of '70's like inflation, which proved difficult to tame. This outcome would prove beneficial to the price of your silver. This outcome requires the Fed and U.S. politicians to follow the path of least resistance, and voters to continue to support progressive policies.

The other path involves austerity and tax reform, short term deflationary/recessionary pressure but much stronger long-term growth prospects. This requires U.S. voters and governmental officials to make intelligent, hard choices in the short term that will benefit us all later. These choices would benefit equities in the long term.

I'd put it 60/40 that we go down the first path, not the second.

The possibility of extreme hyperinflation would require a coordinated international effort to abandon the dollar, and a real alternative for assets that are currently dollar denominated. The implosion of the Euro leaves no real alternative on the table at this time.

Make no mistake, countries like China and Russia know the consequence of such a coordinated attack on our economic well being. The consequence is war, and Obama hasn't had enough time to make that outcome desirable. That outcome occurring in the next few years is a 1% likelihood, IMO. Get back to me in a few decades, and the playing surface may have changed.

Fredo said...

Another point I would make is that you are not, to my knowledge, acting like a chicken little. Owning hard assets is a reasonable approach given that a rise in inflation seems more likely than not.

If you quit your job, moved to a missle silo in Nebraska, plowed all of your assets into seeds, firearms, and silver, and hunkered down to await TEOTWAKI--that would be chicken little.

ManBeast said...

Wow! A well thought out response to me poking you with a stick. Nice work.

I'm not really all that concerned with hyper-inflation, but 70s levels of inflation are a 50/50 bet in our near future IMHO. If was that concerned, I would have converted my savings account to gold. Instead, I'm waiting for a good deal on this unique property in Nebraska.

Fredo said...

"Wow, Fredo had a thought out response..."

Indications that I need to keep my day job...


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Always sniffing for the truth

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