And now for something completely different: Hugh Hendry
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.