Casino Capitalism

I came across this Hedeye interview featuring David Stockman, which was a gem. It hits the nail on the head on a plethora of issues that mire not only the financial markets, but the American politics and the coming social unrest. While each of those topics themselves are complicated and will need deep dives to read and understand, an overview should pique the interest of investors on the said topics. This 30 minute video will be time well spent and I invite you watch it and delve on the topics and rethink on what it means to your personal finances and investments.

Short Bio: David Stockman is a former businessman and U.S. politician who served as a Republican U.S. Representative from the state of Michigan (1977–1981) and as the Director of the Office of Management and Budget (1981–1985) under President Ronald Reagan. After leaving government, Stockman joined Wall Street investment bank Salomon Bros. He later became one of the original partners at New York-based private equity firm, The Blackstone Group. Stockman left Blackstone in 1999 to start his own private equity fund based in Greenwich, Connecticut.

 

Broken Fed

Thanks to the Fed not raising interest rates this week, we can keep this party going for a few more weeks/months. We keep hearing in some small corners of the media that the Fed’s model is broken. But what does that really mean? I came across this video recently and thought it was a gem and addresses this point. Its a long video, and for the most part, its a very dry subject and theoretical (I skipped most of it myself). But one section from Dr. Jason Cummins, who is an ex-Fed member, really stood out and was very refreshing to hear. He turns it into more of a rant, but makes some very good points of how the Fed is working with a broken model and needs to be addressed. I invite you to watch this video (about 25 minutes long) that we can all understand and relate to .

Bio: Jason Cummins joined Brevan Howard in 2004 and is the Head of Research and Chief US Economist. Jason is also a member of the US Treasury Borrowing Advisory Committee, a government appointed panel of external experts that has served the country for almost half a century. Formerly, Jason was a Senior Economist at the Federal Reserve Board, where he ran the Macro Forecasting team. Jason began his career in 1995 as an Assistant Professor of Economics at New York University and also taught at Harvard University. Jason earned a Ph.D. in Economics from Columbia University and graduated with high honours from Swarthmore College.

 

Is Inflation Just Around the Corner?

Inflation is a tricky beast to control. The central bankers around the world do not want it rampaging and destroying the masses in its path. They want to rein it in and control it without killing it. Ever since the financial crisis of 2008-2009, the US Fed has slashed the interest rates and has been on a bond buying spree. The central bankers of the developed economies have followed suit with slashing their interest rates, whilst keeping an eye on the inflation rate. Cutting the interest rate was supposed to be a temporary measure to spur the economies and inflation for now, remains dormant. On the contrary, the International Monetary Fund (IMF) recently warned of deflationary risks. Deflation would be the biggest nightmare for the economies – something that occurred during the Great Depression of 1930s, a repeat of which Ben Bernanke wanted to avoid by any measure while he was the Fed chair.

The Fed decided to cut the interest rates for an extended period of time (at the risk of rising inflation, even though it hasn’t happened so far) and the bond buying route, which has resulted in additional trillions of dollars of deficit to the US national debt. The insurmountable debt may seem daunting, but there are some tweaks that are at their disposal. Recently, the the government has changed the way inflation is calculated – which leaves out essential parts such as food and energy costs; and the government has also changed the way the GDP is calculated to make the economy look better than it really is.

How does the central bank and the government dig itself out of these problems? Normally, governments have three tools to fix their books: (a) Taxation – which is an unpopular option and raising taxes could result in political suicide, (b) Borrowing – by issuing bonds and (c) Devaluation of currency – which results in inflation.

The debt can be more manageable by devaluing currency, the US$, since all the debt is issued in local currency. This is great for the debt issuer, i.e. the US, and hurts the debt holders. But how can they spur it on and inflate their way out of this problem? One way to spice up the economy and the spending is to raise the wages, more importantly the floor – the minimum wage. As wages rise, more money in the economic system should results in inflation. If wages are rising, fixed amount of debt can be paid off more easily using cheaper dollars. Normally, its the other way round – where wages rise due to inflation. But we could be witnessing the government trying to approach the problem the other way round. The media is abuzz (see the Google Trends chart below) with wage increase talk over the last few months across N. America.

In the US, a number of states including Kentucky, Connecticut, NY, NJ, California have started debating about increasing the minimum wage, if not already started passing the bills. Some of the states have proposed raising the minimum to $10.10 per hour. In Canada, Ontario recently announced raising its minimum wage to $11.00 per hour. Quebec has followed that with increasing its minimum wage to $10.35 per hour. More money in everyone’s pocket should result in more spending to spur the economy and we could finally start seeing some of the inflation that the central bankers want to see.
As an investor, you want to strategically position yourself to, not only protect yourself but take advantage of these shifts. There are many ways to protect your portfolio against inflation such as – inflation-indexed bonds, owning commodities, real estate etc. A more detailed account of this can be found on my earlier post – How to Fight Inflation.
Are your investments positioned to protect you from inflation? My full list of holdings can be found here
Acknowledgement: A special thanks to Bryan from Fast Weekly for reviewing and providing feedback for this article before publishing.