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In our scrolling-headline world of impatience,
where every thought has to fit in an SMS message, one of the hardest things
to accomplish in debate is not to get people to listen to an opinion, per se,
but rather to get them to pause sufficiently before receiving it, so as to
check that the interpretation of the terms being employed by the expositor
are consistent with those of his audience.
Advertising execs, state propagandists, and
special pleaders of all sorts are only too adept at exploiting such
weaknesses. Their very art is to use the disjuncture between perceived and
intended meaning as a Trojan horse and so to infiltrate all manner of false
analogies, straw men, and logical non sequiturs behind the walls of their
listeners’ citadels of reason.
As a consequence of such — often
intentional — confusion, we can even be seduced into working backwards
from a received, phoney definition, allowing it to suppress and supplant our
own prior and more accurate understanding of a given word or phrase. As is
the malign intent, we find that once we have deceived ourselves in this
fashion, we have little hope of working forward again to unpick the tangles
of error contained in the many, fair-sounding arguments proffered by those
who would unduly influence our actions or sway our thinking.
In our professional life, perhaps the supreme
case of the difficulty caused by a regrettable semantic debasement is the way
in which the word ‘inflation’ has come to mean not an excessive
supply of money and credit — as it was classically and correctly taken
to be — but only the rise in a narrow index of particular prices, as
compiled (and subsequently heavily-doctored) by a given group of
statistics-sifting bureaucrats.
By relaxing our guard and not insisting that our
debating partner fully declare the precise boundaries of meaning implicit to
the term when he employs it, we give him room to construct an entirely bogus
view which implies that the absence of a frequent — though by no means
an inevitable — symptom of inflation (whether a rise in the CPI index
itself or in that of its emaciated ‘core’ version, ex-food and
energy costs) conclusively proves the absence of the disease itself.
Inflation proper — an unjustified and
initially unwanted increase in the availability of money and credit (which we
shall hereafter capitalize) — is dangerous not only because it leads to
inequitable transfers of wealth between actors, but because it leads to a
needless reduction in the overall stock of that wealth (both potential and
realized) by disrupting the economic decision making of both entrepreneurs
and their customers, thus greatly increasing the chances that today’s
seeming prosperity will be the ruin of tomorrow’s hoped-for provision. Inflation
proper is not even a zero-sum game of conman and conned (a violation of
property rights risibly known as ‘forced saving’ to the
mainstream economist), but is rather a fast-spreading pestilence which
blights even that portion of the harvest which the Inflators are carrying out
of the community silo as part of their ill-gotten booty.
Once we resolve to view the issue exclusively in
this light, not only does it strip away more veils of obfuscation than Salome
doffs during dance practice, it also allows us to make a consistent whole of
the opera buffa of easy money which so dominates the modern repertoire. Inflation,
then, is a monetary distemper, pure and simple. As such it tends to manifest
itself as a rise in asset prices, a narcosis of risk awareness, and an
increase in leverage. These, in turn, lead to the formation of misplaced,
overambitious business plans and overstretched budgets, while fostering
elevated levels of greed, chicanery, and the abuse of trust.
Thus, the entire hubris and nemesis which
characterize both the credit-driven business cycle and its distorted
reflection in that Hall of Mirrors which is high finance are the real
constituents of an Inflation. In fact, by the time that one is aware of the
rise in consumer prices — the ‘inflation’, lower case,
inverted commas — which often follows from this feverish and
disco-ordinated state of affairs, the street-corner card sharp is usually
about to tip his hand and reveal to his victim that he’s being fleeced.
Rats in the Cellar
Conversely, if we start with the central
bankers’ conceit that only a certain rate of climb in a clutch of
selected consumer prices constitutes ‘inflation’, we will
unfailingly find ourselves in all sorts of trouble, for some of the most
perilous of all economic conditions arise exactly when the range of end-goods
prices is quiescent in the face of significantly easier monetary conditions
(a combination which is typically dismissed, but which may, in fact, occur
for any of a variety of reasons).
The reason this state of affairs is so treacherous
is because we then tend to disregard the counterfactual possibility that such
prices, absent Inflation, would actually be falling outright: that they are
therefore being artificially propped up by a surfeit of the means of payment,
and that this hidden frustration of the free market is every bit as
unwholesome as the one which occurs when final goods prices are rising faster
and in a more widespread fashion than one otherwise supposes they would (the
only case which the mainstream will admit to as constituting
‘inflation’, in any form whatsoever).
Indeed, Albert Hahn once remarked that
“Inflation without ‘inflation’” — i.e., a
properly understood episode of monetary excess which does not immediately
translate into broadly dearer consumer goods — posed a much greater
threat to material well-being than the more usual case, precisely because the
damage was therefore being done so insidiously, like a ship whose timbers are
rotting below the waterline while we pride ourselves on the gleaming state of
the paintwork up on deck.
It does to remember that neither the Boom of the
late 1920s in the US, nor that in Japan in the 1980s would have caused
today’s central bankers much lack of sleep over what they insist upon
misperceiving as ‘inflation’, despite the undeniable evidence of
Inflation posed by the frenzied chase for assets — typically
channelled, then as now, into a very familiar mix of foreign bonds, real
estate, IPOs, M&A, and being pyramided by means of overlaid, successively-leveraged
holding operations in speculative stocks.
Again, with an ominous feeling of déja vu,
each of these episodes was accompanied by the complete abandonment of
prudence and thrift, follies which were justified by the thrilling delusion
that participants were all engaged in breaking the bounds of the possible and
in forging boldly ahead into a bright new tomorrow.
For our Inflation’s notable absence of
their ‘inflation’, we can thank not just the Boskin commission,
‘hedonics’, or the flawed concept of ‘Owner’s
Equivalent Rent’, but we can also express our gratitude to supply side
effects of a process of ‘globalization’ which was accelerated in
the wash-out of the previous Inflationary (but barely ‘inflationary’)
booms of the Asian Contagion and the Tech Mania and which was painlessly
financed by the ‘childish game of marbles’ some commentators have
dubbed ‘Bretton Woods II’.
The Wall Street Shuffle
Thus, for a good, long while, this latest
recovery was another which saw little upward movement in a broad range of
traded, end-goods prices. Indeed, as we have argued elsewhere, the Inflation
may even have contributed to the lack of ‘inflation’, for
Corporate Anglo-America could keep labour costs down by moving production
offshore while lending its income-deprived employee-customers back home the
wherewithal to buy its goods in place of paying cash for them.
Inflation as a stimulus mechanism moved from
being income-based to asset-based and dropped off central banks’ radar
screens as it did.
For it was primarily thanks to Inflation’s
direct role in triggering the ‘search for yield’ (and its
ancillary one in promoting prime brokerage to its apotheosis as the chief
divinity of modern-day bankers), that the GMACs and GEs of this world were
well able to securitize the resulting obligations at a lower rate of discount
than that being offered to their own customers.
Thus, ‘profits’ could be made and
balance sheets ostensibly enhanced, not by raising notional selling prices,
but simply by round-tripping what would otherwise have been a mundane and
unimpressive form of vendor finance through increasing levels of complex,
financially-engineered leverage. (One stops to wonder here how many of those
newly-enlightened corporate treasurers, virtuously eschewing all
others’ ABCP (Asset-Backed Commercial Paper) and flooding into zero
real-return T-bills in their place, realize they may be killing their own
golden goose, as they do).
In addition to this, Inflation also enabled the
riches of Croesus to be showered upon the Pooh Bahs of the boardroom via a
prodigious watering of share options granted into a steadily rising market. The
ensuing dilution could then be Miller-Modiglianied (after the two authors of
the typically sterile, Chicagoan-style, palpably unrealistic theory that it
is irrelevant whether a firm’s capital is in the form of debt or
equity) away and earnings per share duly bolstered with the lower denominator
delivered by means of vast equity buybacks ($1/2 trillion for non-financial
America alone, in the year to September), all funded at ever lower spreads
and rates.
Inflation thus kept eye-wateringly high executive
salaries from impacting the bottom line, either, completing yet another
virtuous-looking circle for the stock bulls. No marvel, then, that reported
profits seemed to make up a record share of GDP when Inflation was keeping a
lid on payrolls and salaries while simultaneously boosting dollar revenues:
no surprise that personal consumption rates have miraculously outpaced
reported compensation when Inflation was both boosting the prices of the
assets used as collateral (mainly stocks, options, and property) and
depressing the cost of borrowing against them in a benign double whammy for
their owners’ net worth calculations.
Meanwhile, a similar scheme was being run on a
pan-continental scale as the West’s main suppliers automatically
recycled their dollar (and sterling) receipts in a bid to prevent their own
currencies from appreciating along with their trade surpluses.
At first, the monies were parked in the bonds
issued by the debtor nations’ governments — contributing to a
‘conundrum’ of falling yields at the long end for those who
deliberately chose not to notice what was actually plain for all to see. Soon,
however, the same yield hunger infected the exporter-creditors, to the point
that they came to provide a ready market for the toxic credits being
concocted by the uniquely fertile financial minds of the West. From this
witches’ brew arose the poison of sub-prime as a means of underpinning
the robust securitization ‘profits’ being made in the West by
bankers and builders alike.
This attempt to stop the so-called
‘price-specie’ mechanism from performing its proper regulatory
function retarded the ‘inflation’ which should have resulted in
from higher import prices. Notably, the Fed, the very institution which could
have done much to halt the build up of the ensuing ‘imbalances’
any time it chose, fatuously called the phenomenon a ‘saving
glut’ instead, implying that its own, sustainedly lax policies played
no role in the alarming widening of America’s trade gap.
It all came down to semantics, again, for the use
of this harmless seeming phrase meant that rather than admitting the US
(among others) had become a serial overspender and that, conversely, its
partners were aiding and abetting Occidental excesses by succumbing to the
age-old fallacy of mercantilism, America’s strip malls were only
buzzing and its Stakhanovite builders heroically throwing up a metropolis of
McMansions in the selfless quest to provide needy Asians with a secure outlet
for their otherwise homeless retirement savings.
We wish them well of the fruits of this Reverse
Marshall Plan for we suspect the harvest is likely to be a bitter one for all
concerned!
Ring-a-ring-a-roses
Domestically, too, the Inflation among the
urbanisers has been largely predicated upon this influx of foreign currency. Initially,
it helped suppress ‘inflation’ there (as recognised by the
macromancers) by holding down, or even — in the case of the dominant
state-owned lenders and borrowers in China — effectively eliminating,
the cost of access to the tidal surge of financial capital sloshing around
inside a closed network of piping. Along the way, it unleashed an investment
boom, the likes of which the world had never before seen in peacetime.
Incidentally, such is the maths of GDP accounting
that this orgy of investment is also likely to be flattering the true degree
of profitability at the macro level while, at the micro level, we should ask
whether anyone worries about fully covering costs when capital accounting is
largely absent; when much factory land is grabbed from its existing owners
without paying them any compensation; when dividend distributions are a
rarity; and when loans never need to be repaid?
The problem faced by those importing their
Inflation in this manner becomes one of what to do with all the extra product
which results from the crash programme of industrialisation and urbanisation?
They send it abroad, of course, often with the aid of a little export subsidy
built into the taxation system — throwing their goods into the sea, as
Bastiat might remark. Input prices (oil, steel, copper) may rise worldwide as
this goes on and on in ever-mounting volumes, but we shouldn’t quibble,
for final goods prices are the only ones that matter for
‘inflation’, remember, and these are being held down along the
way.
Thus, the urbanisers face something of a margin
squeeze when they come to swap their paper dollars for the natural resources
required in their products’ fabrication, This has lead to the kind of
barely-concealed accounting loss which Asia’s price-capped petrol
refiners and cooking oil suppliers are most visibly suffering today. But,
don’t fret that this represents a gross misuse of capital — the
fruits of Inflation can be readily used to cover this gap, if only at the
expense of a burgeoning central government budget deficit.
Moving on to the next link in the chain, the
recipients of such an embarrassment of resource dollars – especially those
among the energy-rich — mainly run greenback-linked currencies and so
have imported their own Inflation, too, (leading to a series of construction,
real estate, and equity bubbles in their generally underdeveloped home
markets). Despite the widespread use of subsidies on politically sensitive
goods to deaden the impact of all this new money, their thrumming container
ports have also been discharging a significant consignment of CB-variant
‘inflation’, along with the asset booms.
Additionally, since the Gulf States, in
particular, are incapable of fully absorbing the torrents of petrodollars
flooding their system, they participate in a $600-700 billion a year vendor
finance scheme of their own with their customers, the major oil and gas
burners — a policy which, in turn, helps reduce the ability of higher
fuel prices to ration demand effectively, even in those parts of the world
where relatively free pricing of the product still exists.
At this juncture, however, with Western credit
markets in disarray and with the dollar at hazard of wearing out the
well-tried patience of its main sponsors, we have to worry whether the
unimaginable non-linearities which comprise this system are about to rip
apart at the seams.
If so, what we are arguing implies that our
apparently effortless Golden Age of corporate profitability may very well be
coming to a juddering end and, further, that many of those already-booked
‘profits’ will prove to have been utterly insubstantial in sober
retrospect. If that happens, the Bull’s oft-repeated mantra that
— at a forward multiple of 15-16 — the market is
‘cheap’ enough to support present prices, might ring very hollow,
indeed.
Sean Corrigan
Sean Corrigan is Chief
Investment Strategist at Diapason Commodities Management (Lausanne and
London)
Copyright © 2007 -
Copyright © Diapason Commodities Management - Sean Corrigan
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