The Great Reflation

Source: Fleckensteincapital I'd like to talk about the prospects of paper versus assets. In the most recent issue of the "GloomDoomBoom Report," Marc Faber reprises Tony Boeckh's soon-to-be-released "The Great Reflation" -- whose title (in case it wasn't obvious to everyone) denotes the process that we are in now and what lies ahead. Though I haven't had a chance to pick up a copy yet (thus I can't vouch for it), based on what Marc shares, the book certainly seems like it will be useful to folks.

Investors Face a Risky New World To quote Boeckh directly: "The Great Reflation, if left unchecked, will run into a brick wall in the next few years, and another implosion and deep recession will occur. The result will be even bigger budget deficits and lower economic growth. Logic says that if the last crisis was caused by excessive money and credit inflation, even more of the same should cause an even bigger crisis. The ultimate end point to this trend is worrisome to say the least. The new investment world will be extremely challenging for investors. There will be opportunities in the Great Reflation to make a great deal of money and equal opportunities to lose a great deal of money on the downside of volatility.

"Investors, unfortunately, do not have the luxury of riding out this turbulent period by sitting in short-term deposits and money market funds. After taxes and inflation, capital will erode. To earn decent returns, investors have to take some risk; but in the new world of money, these risks are above the comfort level of most investors. Investors must come to grips with this risky new world.

"To do so, it is essential to acquire a framework for understanding the dynamics of how the Great Reflation will play out, what indicators to watch, and how to shift assets within a portfolio to minimize high-risk, low-return assets and maximize exposure to lower-risk, high-return assets. In a world of stability, buy-and-hold investment strategies can be very successful. In the financial world of the future, there will be an even bigger disaster than the past 10 years."

Printing Won't Dodge a Day of Reckoning I suggest folks read that passage a couple of times and save it. What he calls "the new world of no money" should be thought of as the new world of moneyprinting. In any case, this fits my scenario that we may be entering a period which looks a lot like the '70s, though perhaps on steroids, given the complete disregard in the minds of policymakers for the potential of inflation. And, as a consequence, the willingness to print enormous amounts of money.

Regarding what all of this means, Boeckh says: "Unstable money is both a cause of instability and a reflection of underlying decay. It is an integral part of the negative feedback loop. Historically, it is difficult to think of any empire in decline that didn't eventually succumb to monetary debauchery. That is never a direct policy objective. It happens because it seems like the least bad alternative facing the authorities when they have to make big decisions in difficult circumstances."

Well, that ought to sound pretty familiar. As for Marc's investment conclusions: "Under the Great Reflation, I suppose that investors will need to be positioned most of the time in assets such as equities, real estate, commodities, and precious metals. I have deliberately decided to distinguish between commodities and precious metals, because I believe that precious metals will increasingly be looked upon as an alternative to cash deposits and money market funds, whereas commodity prices will continue to be driven more by genuine demand and supply factors than by monetary factors."

"No Absolutes in the Investment Process" Marc goes on to note: "There are no absolutes in the investment process. There are times when equities perform better than gold, despite moneyprinting and rapid credit growth, which is something we've certainly seen in the last year." But in the end, "gold seems to be the only stable currency." The road ahead promises to be unusually tricky. However, those who understand the macro environment will at least have a fighting chance at making their money grow in real terms.
Turning to the stock market, the indices rose almost 1.5% by midday, for no good reason that I could see. (BBY won at beat-the-number, but that hardly explains the early action.) However, the afternoon saw those gains surrendered as the indices closed essentially flat for the session.
Away from stocks: The dollar was mixed. Oil and precious metals were more or less unchanged. Fixed income was a tiny bit lower initially but was hit hard in the wake of a poor 7-year auction. Once the Fed gets nervous about rising rates and decides to end its exit from QE, life in the financial markets will get very interesting. (Currently, as far as equity investors are concerned, the bond market seems to operate in another solar system.)
Index Close % Change
Dow 10841.21 +0.05
S&P 500 1165.73 -0.17
Nasdaq 2397.41 -0.06
Nasdaq 100 1949.15 -0.14
Russell 2000 679.1 -0.67
Sox Index 364.83 -0.15
Bank Index 52.43 +0.17
Dow Transports 4334.55 -0.63
Dow Utilities 375.21 -0.59
Nikkei 225 10828.85 +0.13
Gold - Front Month 1091.3 +0.13
Silver - Front Month 16.6 -0.25
Crude Oil 80.16 -0.56
Dollar Index 82.2 +0.26
Euro Spot 1.33 -0.29
Long Bond 20-year 115.03 -0.7
FOTM - Yen Spot 92.7 -0.43
3/25/2010 2:15:46 PM