Economic Recovery?

The economy as I see it is in a strange no man’s land. I suppose some would label it a recovery, but I’m hesitant to call it that. Unemployment is still uncomfortably high and the problems in housing are still with us. Certain sectors are doing well, others not so well. The economic situation in America is complex, and it takes some thinking to figure things out.

Effect of Inflation

Inflation is an interesting phenomenon that is generally misunderstood. Unlike most deflationists, I think debt is inflationary. Since we got off the gold standard, we haven’t had a sustained deflationary period even though our debt has been on a steady upward climb. Deflationists just have it wrong, but I’m sure they’ll focus on real estate and real estate alone to support their thesis. I don’t even know if it’s worth my time to tear down their arguments since it’s so obvious we’re in an inflationary trend. How long do we have to wait for a stock market crash before deflationists admit they are wrong? 

Anyway, the CPI experienced its biggest year-over-year gain since October 2008, rising at a 3.2% rate. The early stages of inflation following a recession always give off the impression of a rebounding economy. The only problem in this cycle is that we have so many retirees relying on fixed incomes. The real discretionary consuming power of retirees is taking a big hit, especially with interest rates so low. Younger generations in the U.S. will have to support the economy, but I’m not so sure they can handle it just yet. Young professionals are saddled with student debt that they cannot repay. This is one of those structural problems we can’t grow our way out of. The only way out is some kind of legislation to relieve students of their debts. After that, hopefully we will rethink the higher education system model. But understand that this is a crisis we cannot avoid.

Effect of Foreigners

There are some positives for our economy though. I’ve mentioned previously how I believe foreign investors are going to support real estate in America due to favorable exchange rates. Interestingly enough, I came across this WSJ article that supports my thesis. For now, America still has the reputation of being a country favorable to investing. Beliefs of this kind, however flawed, don’t change overnight.

It’s hard to appreciate how far the dollar has fallen if you haven’t stepped foot outside America. If it’s been a decade since you traveled abroad, trust me, you’ll feel a lot poorer. On the other hand, foreigners feel a lot richer. A 40% decline in U.S. real estate appears to be closer to a 60% decline to many foreigners. How many people realize the Canadian dollar is past parity with the U.S. dollar? Asset prices in America will rise, but the average American won’t benefit.

 The best way to play this is to just get into tangible assets. Bonds are going to crater, and I am probably weeks away from finally going short. Pension funds are overweight bonds, and this should create an interesting situation when bonds collapse. There is an eerie complacency in bonds that I can’t explain. It’s hard for me to imagine the smart money doing anything but going short government bonds. We’ll see how it plays out, but I’m fairly certain that cracks will appear soon.  

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