And now for something completely different: Hugh Hendry

If it's not Scottish, it's crap. And outspoken hedge fund manager Hugh Hendry is most certainly Scottish.

For years, we at the W.C. Varones blog have been advocating owning gold and equities, primarily because the federal government's debt and deficit situation is beyond the point of no return and far more likely to be resolved by money-printing than default.

Via ZeroHedge, Hugh Hendry gives us the other view: inflation is the consensus trade and it's wrong. We are going into debt deflation and the dollar will strengthen.

In the US, he says, capital has always been allocated where it could achieve the highest return [until Obama: Government Motors, AIG, Fannie/Freddie, Solyndra... -ed.]. In the 19th century, when America was the economic upstart on the block, it was also on the gold standard. Which is very important, according to Hendry, because it allotted entrepreneurs one – and only one – chance to succeed. It was not a time of bailouts and multiple bankruptcies!

China is different, he believes, because it is industrializing with a fiat currency. Thus they fall into the trap of misallocating capital – building bridges to nowhere, towers for nobody, and so on. China’s goal is similar to that of 1980’s Japan in his opinion – full employment, rather than maximizing return on capital. A critical, and even fatal, difference, in his mind.

You know the old drill – China and Asia produce, the US consumes. They cycle their greenbacks back over this way, finance our debt, we buy more of their stuff, and the beat goes on.

This model officially stopped with the launch of QE2, Hendry says, as the US officially started rejecting the globalization that had made the global economy hum (perhaps largely at the expense of US employment and manufacturing). With QE2, dollars were printed and exported – along with inflation – to Asia.


Because wage labor is approximately 70% of total business costs, he does not see meaningful inflation without wage inflation.

He’s also down on gold because it is not a contrarian investment today as it was 10 years ago (he had a nice year in 2003 buying gold and gold stocks when nobody wanted them).

The widespread belief among the greatest financial minds today that hyperinflation is inevitable greatly disturbs him.

In the Western world, he sees hyperinflation as a political choice – one that requires the will of the populous. (Forget Zimbabwe, he says – that might as well be Timbuktu. It’s not our culture.)

He sees society’s current mood as “dark” (Tea Party, Occupy Wall Street, and social unrest in Europe to name a few), and believes this makes bailouts and money printing very hard. The only environment that makes hyperinflation possible is “the mother of all depressions” he says.

All of which is possible, I suppose, but "hyperinflation" is a straw man. I'm not calling for hyperinflation, just inevitable eventual debasement of the dollar. This could take the form of 70's style stagflation, or Argentinian-style step devaluation, or slow and steady erosion of the dollar just like the Federal Reserve has done the last 100 years. The "political choice" is not hyperinflation, but inflation vs. depression. Even the Tea Party electoral tsunami and debt-ceiling posturing didn't make a dent in federal spending or the deficit. What makes Hendry think austerity will become politically popular now?

Two problems with Hugh's view:

1) If we do get his crash, how on earth does Ben Bernanke (or even a more sober successor) not print money in response? (Similarly, does he really think Europe will choose default and banking system collapse rather than printing?)

2) The U.S. Federal Government is currently running deficits of 9% - 10% of GDP, and in a depression scenario this would get even worse as revenues declined and social welfare costs increased. Running double-digit percent of GDP deficits is not consistent with a strong dollar or deflation.


Doo Doo Econ said...

I think his larger point is shared and is becoming consesus. The dollar is undervalued for all the reasons you mentioned, but that also gives us room for deflation as monetary policy.

What would happen if the Federal Reserve started to reduce the money supply? We have low monetary velocity due to tight credit, so this may not be as painful as additional inflation. We all know, despite the "excluding food and energy" charade, that inflation is near 13%.

This also gives us the opportunity to consider backing our currency again. Although, I have not heard it spoken aloud. This has been the dollars longest run as fiat. Maybe the run is over.

Wcv said...

Lots of people are calling for backing the currency again, most recently Steve Forbes.

I think a step devaluation followed by a return to the gold standard (at perhaps $5000 or $10,000 per ounce) would be a great way to devalue the debt, both household and federal, without creating a long-term inflation problem.

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