Published on October 22, 2007.
Cash conservation becomes strategic, as the healthy disinflation era is challenged by rising food prices.
“We learn from history that we do not learn from history,” these famous words of George Bernard Shaw are a befitting reality for mankind. These people he talked about also dabble in stocks and commodities. And a majority of them are oblivious to these written words of fate. It’s the few who understand while the majority perishes owing to short-sightedness. The rush of greed has historically overshadowed sanity. Personal skill and the power of the state have always been overestimated. Great nations have failed along with revered geniuses in front of market cyclicality. And till the time humans last, our love for speculation and war, boom and busts, creation and destruction, celebration and vilification will continue. The great politician of yesteryears becomes the weakest one in the future. It is this cyclicality of mass psychology — cheerful today and depressed tomorrow — that pushes us to extreme behavior where we don’t know how to stop and hence the violent pause, which econohistory quotes as a crash.
The ideal time to study econohistory is when sanity matters most and greed busters are needed. We need them today. And nothing busts greed better than a pinch of econohistory. Spirituality can, of course, do it better than econohistory, but then the use of religion to bust greed seems a tall shot in the age of speculation.
We will stick to the econohistory, which exhibits very well how long the current boom will last. The subject relies a lot on cyclicality and makes some bold findings. It proves that every generation has its war. Every market has its crash, big and small. It also proves that economic cycles are driven by credit, which itself inflates and deflates cyclically. There is a shift from paper to hard assets and vice versa.
There are three stages linked with the credit cycle viz hyperinflation, disinflation, and finally deflation. Disinflation is a period of low inflation and low prices for food and essential goods. This leads to economic growth. While there is little literature available on the chronology of events, disinflation is the one preferred most by investors and market participants. Disinflation is generally perceived as beneficial. However, mass psychology extremes have been known to stretch the benefits to an extreme causing deflation. The most visible example of deflation is the 13-year slowdown of the Japanese economy. The deflation period is one of a decrease in the general price level over a period of time. Deflation is the opposite of inflation. During deflation the purchasing power of money increases. Many still consider deflation as a problem of the modern economy because the phenomenon can spiral into a depression.
Hyperinflation, on the other hand, refers to a period when inflation goes “out of control,” as cash or currency rapidly loses its value. A monthly inflation rate of 20 percent or more is hyperinflation time. Although there is a great deal of debate about the root causes of hyperinflation, it becomes visible when there is an unchecked increase in the money supply or drastic debasement of fiat currencies and is often associated with wars, economic depressions, and political or social upheavals.
The worst case of hyperinflation happened in erstwhile Yugoslavia where inflation doubled every 16 hours. Hyperinflation destroys real money. So the talk of hyperinflation in India or the US is a clear misinterpretation. There is a crisis of confidence in hyperinflation. China between 1939 and 1945 is a classic example of the government printing money to pay civil war costs. By the end, the currency was flown in over the Himalayas to be destroyed. The chaos often ends with a civil conflict. And there are a lot of zeros in the currency and they keep adding. A majority of countries around the world have experienced this phenomenon. In recent times, itʼs happening in Zimbabwe. There is a crisis of confidence under Mugabe and the country is in civil strife witnessing the biggest modern-day exodus.
So all our good times rest on how sustainable this current disinflation is, the good inflation. According to a research paper by Marc Hofstetter, Universidad de los Andes, very little is know about the sustainability of disinflations. The paper dispels misconceptions about disinflation and points to food as an essential sustainer of prosperous times. One cannot blame the low sustainability of disinflations during the seventies on rising oil prices as Yale professors Boschen and Weiss state that world food prices are a significant predictor of inflation in OECD nations. And food inflation plays a bigger role in undermining positive disinflation than oil prices. The significance of oil shocks turns out to be weak. The paper also comments on exchange rate regimes saying that an increase in exchange rate flexibility reduces the sustainability of disinflations.
Disinflations that bring inflation down to low rates of 5 percent or lower (like we have today) are more likely to succeed in keeping those gains in place. Rogoff (2003) and Razin (2004) add the idea that globalization played an important role in the recent worldwide disinflation. Since the early nineties, an increasing number of developed and developing countries have adopted inflation targeting regimes to conduct monetary policy, which is ineffective in determining the sustainability of disinflation. Politics also seemed to have little effect. The most interesting aspect was the linkage of whether US inflation had something to do with worldwide prosperity since the nineties. Boschen and Weiss found strong evidence that US inflation plays an important role in triggering inflation abroad and US monetary shocks have important consequences abroad ie a higher US inflation reduces the sustainability of disinflations abroad.
What all this means is that if food prices donʼt stop going up, the good times will come to an end. And there is nothing the central banker or the politician can do to sustain it. We see a lot of unsustainable greed at current levels. And highlighting the importance of cash before the crash cycle can never be overstated.
Disclosure: We are currently long Wheat, Grains and the Agro Commodity complex in our Ait Global Macro Fund.