Dear Richard,
richard5za wrote:
> You would flee the dollar into what is called "inflation hedges"
> as we did in the 70's with pounds and rands etc to protect the
> value of our money. That was a period of little economic growth
> and quite high inflation, which came to be called stagflation. ...
> Let me recount a real life story of myself. I am not blowing my
> trumpet; I was very well advised by some caring and knowledgeable
> people. I am not an American so some of this story may be
> culturally a bit different to your experience. I finished all my
> studies in 1968 and secured employment with a successful British
> multinational group. In 1971 the "big boss" said to me "Boy, do
> you own a house?" ...
Thanks for recounting your story, which is very interesting.
I'm having trouble dealing with this hypothetical scenario of 10%
inflation because it's so impossible today that it's hard to know how
to describe that world. It's like trying to describe a world in which
the earth's gravity were suddenly cut in half. Everything would have
to be different.
Since you and I are the old guys here, let me try to recount a story
of my own from the 1970s, and try to show why your 1970s inflation
hedging strategy wouldn't work today.
When I was working for Digital Equipment Corp. (may it rest in peace)
in the 1970s, there was a girl who has an entry level job as a
computer operator. After she'd been there a couple of years, she left
DEC and went to Data General (RIP) with a good salary increase. After
a few months, she left DG and went to Wang (RIP), with a good salary
increase. After a few more months, she left Wang and came back to
DEC. The net effect is that in the space of a year she had changed
jobs three times and almost doubled her salary at DEC.
There were lots of stories of that kind in the 1970s. It was well
known that anyone with good skills and willing to work hard could
change jobs and get a good salary increase.
You talk about stagflation in the 1970s, but I don't agree with that
characterization. There was plenty of inflation, and it's true that
the stock market fell during the 1970s (which I believe is why people
use the word 'stagnation'), but the economy was extremely vibrant in
the 1970s. Everyone knew that people who had bought IBM or DEC or
Xerox stocks had made out like bandits (to use a phrase I heard at the
time) -- not because speculators had created a stock market bubble,
but because these companies had scored some real technological
achievements.
In the 1970s, almost every company was still "young". Almost every
business had gone bankrupt in the 1930s, and the ones that didn't had
to totally restructure. By the 1970s, all of these businesses were at
their peak of robustness and productivity. New products and
technologies were coming out all the time. Skilled workers were in
high demand, and even unskilled workers had no trouble getting a job.
There were plenty of job openings, and not enough workers to fill
them. As a result, salaries increased -- based on merit, not based on
social skills -- resulting in inflation.
The other thing about the 1970s is that everyone was worried about
a new stock market crash. You could walk into a bookstore and find
several books on "How to survive the next Great Depression." Your
boss was actually quite prescient, since he correctly worried about
inflation rather than a crash.
Now today, all of those indicators are flipped on their heads. Each
job opening gets hundreds of applicants. If you change jobs, then
you have to take a salary cut. Jobs in the last decade have fled
overseas, seeking low salaries rather than high skills.
Today's businesses are no longer "young." This is something I haven't
written about lately, but I used to call it the "crusty old
bureaucracy" effect, using a phrase that I'd seen in a description of
some company. Lots of employees do little or nothing but sit around.
Salaries are increased based on longevity only, with little
relationship to skills. There's little innovation going on, with
something like the iPad providing a rare exception. Today we have
REAL stagnation.
In the 1970s, people worried about a new Great Depression, because
that's what they remembered from the 1930s. Today, people are worried
about a new Great Inflation, because that's what they remember from
the 1970s. A new Depression couldn't have occurred in the 1970s
because the wrong generational constellation was in place, and a new
Great Inflation can't occur today for the same reason.
Everything is in a bubble. Stocks have had historically high valuations
since 1995. Real estate has been in a bubble internationally since
1995, and has only partially recovered. Gold's trend value is about
$500/oz, but now it's in a bubble at three times its trend value.
So now returning to the hypothetical scenario of 10% inflation, where
you put money into other assets, you're talking about assets that are
already in a bubble, and by the time that 10% inflation is reached (as
if that's possible), the bubble would be much bigger. With huge
amounts of liquidity flowing into gold, for example, the price would
go from 3 times trend to 10 times trend.
And this is where you run into the logical contradiction. You said
investors would flee from dollars, I asked flee to where?, and you
mentioned these inflation hedges. But they're already in a bubble,
the bubble would be growing even larger, investors would realize that
these hedges are way overpriced, and many would stay in the "safe"
dollar rather than risk a bursting bubble.
Of course you can always invest in real estate or gold, knowing that
its price will eventually go up. But you could have invested in
stocks in 1929, and you would have made money by the mid-1950s.
So now, to close the circle, the businesses with a "crusty old
bureaucries" are going to be destroyed or forced to restructure, like
similar businesses in the 1930s. With layoffs increasing and salaries
decreasing, there's no chance of anything close to 10% inflation.
Investors will not flee the dollar.
richard5za wrote:
> In the past at generational crisis points of economic ruin
> deflation seems to have accompanied the crisis e.g. deflation
> during 1930's Great Depression. Is that coincidental? Or is it a
> necesaary condition? Just thinking, you can have a devastating
> economic crisis on hyperinflation. I'll give it more thought.
The only way that I can imagine dollar hyperinflation would be
in a disaster of almost unimaginable proportions. It would mean
Higgenbotham's scenario of destruction of electronic records,
to undo the value of being the reserve currency, and then it
would require the US losing the war with enough destruction that,
out of desperation, whatever government is left would inflate
the currency by ACTUALLY printing money.
Other than that, no, you can't have a generational financial crisis
that leads to inflation. A generational crisis, at its core, is based
on widespread abuse of credit, creating a huge bubble. When the
bubble bursts, there must be deflation. It can't happen any other
way, as far as I know.
John