|
Last week when I wrote, "Extraordinary Measures Today, a Financial Funeral Tomorrow," I
didn't literally think that the funeral would actually occur 'tomorrow'. Someone
started the financial Armageddon clock when the ratings agencies downgraded
AIG this evening and the Fed told AIG that they were on their own to raise
capital. It was reported on CNBC that they have until Wednesday to secure $75
billion or risk being forced to declare bankruptcy--setting off the most
nightmarish of scenarios.
Is this
how it ends? I have a hard time believing the US government isn't holding
some kind of a trump card (possibly a figurative 'gun to the head' of
Goldman, JP Morgan, others to 'pony up'). Otherwise, all of the Herculean,
extraordinary measures they have made up until now would be a waste of time
(all of those weekends they could have been watching football like the rest
of us). They will almost undoubtedly pull something out before permitting the
entire world to descend into credit chaos. I think they have enough juice
left to avert the financial catastrophe once again. But the smell of fear is
nonetheless becoming more and more palpable. Many in the goldilocks crowd
appear to be entering a state of shock. It is actually healthy to move out of
denial and into panic. It means you at least have chance to survive.
But you
have to react appropriately. Once you get your bearings and correctly
position yourself, you can move from panic to equanimity. As I wrote in my
last article, deflationary-type investments have been the
winners since mid-July. They have certainly outperformed the Goldilocks gang
this decade, but have lagged those who have been positioned for inflation,
benefitting from a much weaker US dollar. Many of the inflation investors
have seen their portfolios grow several-fold since 2002.
But many
of the gains enjoyed by those who were "long inflation" quickly
evaporated over the last few months, placing many of them on par with the
performance of those who were "long deflation." Deflation means
portfolio death for those who are betting on inflation. Today, a Bloomberg
article titled, "Asia to 'Monitor' U.S. Banking Crisis; Assess Impact,"
quotes Tony Tan, deputy chairman of Government of Singapore Investment Corp.,
who said, "The world may face 'Japan-like' economic stagnation as
turmoil in financial markets weighs on growth and challenges the ability of
policy makers to manage the crisis. If house-price declines are significantly
greater than expected, larger financial institutions could become insolvent,
the credit crunch would be more severe and economic growth could weaken
considerably. A vicious deflationary cycle with falling house prices, failing
financial institutions and weaker growth could then ensue." This
captures the deflationist view of the negative feedback loop that now seems
inevitable.
"Team
Obama" and "Team McCain" may have something to say about this
outcome, however. Obama is already promising free money to people who pay no
income tax! Billions of dollars! These checks are going to the people who
have no concept of savings and who will definitely spend it. Once he figures
out that the real consumption comes from people who earn more than
$250,000/year, he will be giving this cohort rebates too. McCain will do the
same. Do you think they are going to sit by and watch deflation doom their
economy? They may fail, but they are at least going to try. And when they do,
the inflation trade will be back on. The Fed will be forced to monetize the
debt in this scenario as the US Government is forced to issue more bonds to
compensate an exploding budget deficit. Dollars could become worthless. Or
they could fail and deflation will win out.
We may
remain in the grips of deflation through the remainder of the year. If
problem of the financial markets bleed into the real economy as I expect, you
can expect to see trillions of dollars mailed out to consumers in an effort
to stave off Keynesian concerns over deflationary thrift as a new
administration takes charge. McCain and Obama are both Keynesians at heart.
Stimulus packages coming from Obama and Democrat Congress could be unlike
anything this country has ever seen. They could call it "The Great New
Deal Society." Descendant of FDR and LBJ could show up on the White
House lawn as the bills are signed into law.
You
should expect for the markets to oscillate between inflation and deflation
until the final reckoning occurs and be prepared to reposition accordingly. Those
who are positioned one-way will likely see their portfolio shredded a little
more each time the sword-sharpened pendulum perilously swings from one
extreme to the other. Determining which 'flation prevails ("who
wins") might depend on which team "has the ball last." There
is one possible "buy-and-hold" strategy designed to hold up in both
scenarios. I discuss it in my commentary.
Kurt Kasun
www.greenfaucet.com
A contributing writer to GreenFaucet.com, Kurt Kasun writes a
high-end investment timing service, GlobalMacro, which is focused on
identifying opportunities that produce returns in excess of market with reasonable
risk. He is strategically located in Washington, D.C., a key to maintaining
contacts and relationships which help Kurt understand global policy and
economic factors as they emerge. His investment approach has always been
macro in nature largely due to his undergraduate studies at the U.S. Military Academy at West Point (B. S. National Security, Public Affairs, 1989) and his
graduate studies at George Mason University (M.A. International Commerce and
Policy, 2006).
| 
