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Posted 11/17/2003
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All roads lead to inflation
Note to the Fed: Rather than perch on your crow's nest looking out for deflation, cut the juice from your money-printing machine to stave off incipient inflation.
By Bill Fleckenstein
Now that the hoopla surrounding the Nov. 7 employment number has subsided, I'd like to take advantage of this quiet time to put the results into perspective.
First off, let me take a step back. For my entire career, I always have believed that monetary stimulus "works." Throughout the Greenspan reign, I have believed that the Fed would print as much money as was required to try to make things better. Consistent with those two points, I always have believed that in a social democracy with a fiat currency, all roads lead to inflation. But since the bursting of the biggest bubble in the history of the world, I have been dubious about the ability of stimulus to work its magic in any sustainable way, because of the excess capacity and the misallocation of capital produced by the mania.
As we all know, the combination of a) monetary/fiscal stimulus, and b) the housing market's ability to stage a mini-mania in the post-bubble period conspired to give us a better quarter in the third quarter than I had expected. Now it seems that the job situation might not have been as bleak as it previously appeared (even though corporate America still is laying people off), because of all the stimulus. The economy has gone through a burst of strength. Expectations now place it on the path toward a self-sustaining recovery.
Nevertheless, I do not share those expectations, nor do I accept the innards of the employment number as gospel. Though space does not permit me to reprise the skepticism of some wise commentators who sliced and diced the employment data, I'd like to pass along the following from the UPI news service, published last Tuesday:
"The next real job boom will occur in 2008, according to the international outplacement firm Challenger, Gray & Christmas. The 2008 job boom will likely come either in health care, such as biotechnology or genetics, or in international business. The job creation during this economic cycle, however, will not take place in the United States, but in China, India and the Philippines, the beneficiaries of our outsourcing, Challenger, Gray & Christmas said."
Greenspan grills double-edged swordfish
In the not-too-distant future, we will find out if the stimulus-engendered economic strength fizzles, as is my expectation. However, what if it doesn't fizzle right away? Then what? Well, folks who've been counting on economic strength to save the day are going to learn that all is not rosy, even if we head down that path.
I have given the possible outcome of that scenario short shrift because I felt that the idea of more strength for a few quarters was less likely. It could happen, however. The path woven by the stock market, the bond market, the currency markets, the metals markets and certain industries would be different than if we just fizzled. However, in terms of the stock market, the ultimate outcome would be the same: lower prices. In the short run, stock prices obviously can go where they want, but, at some point, they will return to a tighter relationship with the underlying businesses.
As to what a stronger economy might portend, financier George Soros has said that he expects the recovery to abort. Why? Because we'll wind up with higher rates at a time when we are very dependent on massive stimulus and extremely low rates. Perversely, an improved economy could trigger an ugly outcome sooner, as higher rates could really wreak havoc in the housing market and all the debt outstanding.
That will slow the economy, and then we'll lapse into recession. We saw a variation of this stop-go economic action in the 1970s -- and wound up dealing with a whole lot of inflation.
We should admit our mistakes
The bottom line is, we are in a box because we had a mania. Post-mania, the best possible behavior would have been to admit our mistakes, let the markets clear, clean up the dead wood, hunker down for a while, and create the foundation for a long-lived recovery. The path chosen by the Fed, the government and, apparently, most people was to pretend the mania didn't happen, and try to power past it, still believing in the tooth fairy. This has caused only further misallocations of capital and other problems that will have to be sorted out prospectively. The idea that a short and sweet recession could close the book on our epic bubble is strictly a fairy tale.
Investing takes a backseat to insanity
Meanwhile, bubblelike behavior has been giving a good account of itself on Wall Street. Consider what transpired after Cisco Systems (CSCO, news, msgs) released its third-quarter results after the market closed on Nov. 5.
Almost immediately after folks learned that Cisco had won at "beat the number," the stock was up 5%. Some $10 billion -- or two quarters' worth of revenue, to put that into perspective -- were added to Cisco's market cap as fans cheered the veneer covering less than earth-moving results.
I could cite hundreds of additional examples of ludicrous prices, but you get the point. That is what passes for investment rigor in this bubblelike environment. As we learned in the late 1998-early 2000 period, just because something is ludicrous doesn't mean it can't get even wilder.
Craziness is not a sufficient catalyst to end the party. Speculative fervor has survived all the crookedness on the part of Wall Street, corporate America, the mutual funds, and the asleep-at-the-switch-ness on the part of top brass at the NYSE and SEC. But as we learned in the last go-round, this will end painfully for most people. The only questions we face are: When will we pay, in what way, and who will feel the burden most?
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money. He held no positions in the securities mentioned in this article.
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