How Confident Are You in a Hyperinflationary Future?   (February 11, 2011)

Our actions reflect the strength of our convictions and confidence in specific outcomes.

My longtime friend G.F.B. recently asked me: "If you really expect the dollar and the financial system to collapse, why not max out your credit cards and live large, knowing you'll never have to pay the money back?"

This banter of old friends is also a fair and insightful question, for it ties our actions in the real world (behavior) to our stated beliefs and convictions. Indeed, if someone is absolutely confident that the dollar will go to zero, i.e. hyperinflation, then it makes compelling sense to immediately run up $50,000 in credit card debt and buy tangible goods or unique experiences, knowing you will be able to pay it off with the wages from a month, week or even a day in the future.

Similarly, if the financial system collapses, then who's going to come after a measely $50,000 in unsecured credit card debt?

G.F.B. then questioned my criticism of a friend planning a lavish European vacation this summer with her two teens, despite the household having little savings for the kids' college expenses.

If hyperinflation is the guaranteed future, then why save for college, or anything else?

G.F.B. further posited that if someone is convinced precious metals will outshine all other assets in hyperinflation, then wouldn't they sell their house now along with any other assets, and transfer that wealth into gold and silver?

Undoubtedly a few people have sold their homes and bought gold with the proceeds; others never bought a house at all, preferring to invest their capital in tangibles and precious metals.

But the vast majority of people are not selling their homes or running up as much debt as they can now and either living large or sinking the fiat-money proceeds into gold. In effect, they aren't acting in accordance with the view that a hyperinflationary financial collapse is just around the corner, even if they express concurrence with the view that the dollar is doomed as a holder of value.

Our confidence in specific outcomes is reflected by our actions in the real world.

Many people with some net worth seem to be distributing those assets over several classes, taking prudent steps to diversify their wealth out of stocks and into assets which offer some protection against future meltdowns.

Others are pursuing a financial strategy which implicitly reflects a belief in a deflationary future: thay are paying down debt and accumulating a cash position in anticipation of tangible goods being cheaper in the future.

My old quant boss Stew Pillette often said that in broad economic matters (as opposed to financial fads and investment trends), the public was a better indictor of the future than professional Wall Street seers.

Thus we can interpret the exodus out of U.S. stock mutal funds as a reflection of a general loss of faith in Wall Street as a provider of trustworthy value. The argument can be made that stocks will outperform in hyperinflation, as they are proxy ownership of real assets. If this is the future, then those predicting "Dow 40,000!" will be off by a few zeroes. Why not Dow 400,000 or Dow 4,000,000?

The fact that $100 billion has been extracted from U.S. stock mutual funds (and yes, a paltry few billion may be seeping back in, marking the top of this "recovery rally") suggests that ordinary investors aren't buying the Dow 40,000 scenario--their confidence in stocks as a bulwark against hyperinflation is evidently low.

Human behavior is not a simple vector influenced by a variable or two; it is far more complex than standard economic models. We can easily imagine a number of causes for a disconnect between a person's stated belief in a certain financial outcome and their inaction/hesitancy in the present.

Some are too occupied by getting the Pampers and groceries in the elevator and the kids back from the babysitter to devote time to asset allocation. Many others have few assets to allocate, and still others find more value in a family home, ranch or flat in a good school district than a vault or safe of precious metals, even if they reckon the metals will likely outshine the home on a purely investment basis.

This reflects the utility value of homes and productive assets in comparison to precious metals. A house is also a hedge against inflation (property taxes can go to the moon, but a fixed-rate mortgage will not), but just as importantly, it has utility value as shelter, potential rental, etc.

The same can be said of solar panels, high-mileage, high-volume vehicles that will likely have ample spare parts available for a long time, productive land, oil wells, lumber mills, etc.

As I have stated here before, I am unpersuaded by the hyperinflation arguments for the simple reason that I cannot figure out how the Financial Elites (Cartel-Capital) could profit from such a mass erasure of dollar-based financial wealth.

In small countries with a few trillion dollars of wealth, the Elites could conceivably transfer their wealth out of the country, let the political class destroy the country's currency (via hyperinflation or massive devaluation), and then move their cash back into the country to scoop up the now-cheap real assets.

But U.S. Financial Elites have to conserve roughly $45 trillion wealth in the U.S., and they have already diversified into the global economy. There is no asset class where they can "park" $45 trillion while the U.S. dollar goes to zero.

At $1,300 an ounce, all the world's gold is worth about $7 trillion. So the U.S. Financial Elites could buy all the world's gold at $2,600 an ounce and still have $30 trillion in dollar-denominated assets left to protect.

The better trade, as I have often suggested, is to strengthen the dollar to increase their purchasing power, drive up interest rates while keeping their cash in short-term bonds, and then buy long-term bonds when rates spike to the moon.

That way, as rates slowly decline, they have locked-in high yields for decades, and the Central State (Federal government) does the hard part by collecting higher taxes off the citizenry to pay the high bond yields to the Elites.

And to top it off, the Elites can package their ownership of high-yield long-term Treasuries as being "patriotic." Gold, in comparison, pays no yield; it is a store of value which appreciates or depreciates. It has advantages but also disadvantages, and there are prudent arguments to hold a variety of assets, shifting them to take advantage of relative overvaluation and undervaluation.

The reason I'm not maxxing out my credit cards and blowing the cash on high living is I expect dollar-denominated cash to gain in purchasing power. Maybe hyperinflation will rise up after that deflation, as many predict--it's certainly plausible.

But I have little faith in long-term prognostications, mine or anyone else's. History has shown the future is full of surprises. If it was easy to divine what will happen in the next six months, much less the next six years, we'd all be millionaires.

The public enthusiasm for gold and silver (as reflected by TV adverts proclaiming "get the best price for your gold" and various pundits pounding the table to "buy gold") suggests that they don't buy the official "inflation will be low for years to come" stance. But their refusal to crowd into the stock rally suggests they don't buy into the idea that stocks are a good inflation hedge, either. Clearly, the public has lost faith in the stock market, and it's hedging its bets on the future in other ways: gold, silver, emerging markets, TIPs, farmland, commodities, and yes, even cash.

If the public truly believed high inflation was inevitably just around the corner, it wouldn't be paying down credit cards, it would be maxxing them out, knowing they could pay them down later with much cheaper dollars.

Maybe people would max out credit cards if they could, but credit has been tightened; that is a distinct possibility. But it's also possible that the public prefers to hedge its bets rather than gamble on the impending dominance of one outcome. Maybe gold is perceived as a long-term hedge, but cash is still valued for short-term hedging or as a safety net. The reasons behind investment choices are as complex as each household and individual making the choices.

Perhaps balancing one's faith in a particular outcome with an appreciation for unforeseen contingencies is a wise path in such uncertain times.

Note: I was out of town all last week and have yet to catch up on correspondence. Your patience and forebearance are much appreciated.

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