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Sunday, February 24, 2008


Musings on the Stagflation Blues

Recent economic reports leave little doubt that we are in a period when we will experience a downturn in economic performance and an upturn in inflation simultaneously. This is an anomaly that Keynesian's have difficulty explaining, but is no problem for supply - siders, who believe fervently that inflation is strictly a monetary phenomenon unrelated to either employment or real economic growth. Since we have had an overly accommodative Fed, which has monetized huge federal deficits for extended periods since 2001 (due to Y2K, 9/11, disinflation, and the mortgage crisis), it is no surprise to supply - siders to see ballooning commodity prices in spite of a retracting economy. The one journalist/economist I find to be reliably accurate, Steve Forbes, predicts much higher long term interest rates soon, despite the Fed's efforts to keep short term rates low.

So that begs three questions: What should the Fed and the new administration do about all this, what will they do, and what should investors do?

Federal policy should be aimed at strengthening the dollar. The collapse of every empire's golden age has begun with the debasement of its currency. Instead of targeting a Federal Funds rate based on its reading of the economic tea leaves, the Fed should determine a target for the price of gold (a stable commodity) or as an alternative, a basket of commodities. With gold well over $900, the Fed could choose from several alternatives to accommodate political realities. It could select a lower target, realizing it has built inflation into the current scenario, such as $800 or more draconian, $600. Alternatively, it could select the current price, accepting as a sunk cost the inflation that implies, but drawing the line there. Any of these solutions will tip the economy into recession for sure, but that may already be in the cards. My choice would be to target $800 and allow for a target inflation allowance of 1-2% per year. So if we choose 1.5% as acceptable annual inflation, we would increase the target gold price for 2009 to $812, etc.

The Fed would modulate open market actions to keep gold's price near or at that target. This would provide our major economic players and investors with transparency, predictability and stability. It is a much better way than what we now have, with the Fed's successes and failures much more dependent on the skills and luck of the Chairmen and the Board. Best of all, the Fed could avoid its tendency to overshoot in either direction.

The Federal Government must get a hold on spending. For Mr. Obama to campaign on the ability to afford all of his programs if we get out of Iraq is turning policy priorities on their collective head. The Federal Government's first priority is national defense, and entitlements have taken up the rest of tax revenue and then some. It is past time we get rid of all the waste. Earmarks are an easy target, but all they actually do is reserve the allocation of funds already authorized. The problem is the size of the bureaucracy. Consider all the folks in all the Departments that are out of control of the administration, the swollen staffs of Congressmen that both cause and allow a flood of expensive legislation each year. This is why we have tremendous, intractable deficits at all levels of government. Simply put, we do not get our money's worth and increasing taxes won't change that equation. And, as has been written here previously, we have to get entitlements under control too.

Unfortunately, in an Obama or Clinton administration, the emphasis will be on increasing the cost of government, not reducing it. As for a McCain administration, it will certainly be more frugal, but we are likely to have a gridlock situation with a Democratic Congress, that will allow the current tax rates to expire and continue to pressure the administration with outrageous spending bills. The question is, could we expect President McCain to be tougher with Congress than Bush 43 has been? This was the worst part of GWB's performance.

So how does an investor play this? I think you have to assume that whatever happens to the Presidency, the GOP can not recapture Congress in 2008. So you have to assume the tax cuts expire in 2010. That means taking your capital gains in this year or next, stuffing dividend paying stocks in your IRA's instead of your taxable accounts, and selling bonds before interest rates start shooting up. Treasuries are not a bad place to hide out if you are in a high tax state, but really, equities are the only way to keep up with inflation in the long run. However, commodities, especially gold, should be good unless the Fed follows the above prescription, which I doubt it will. Cash will be a hopeless investment until the Fed and the Treasury seriously attend to dollar weakness. Not many good choices, I'm afraid.

Will the Islanders make the playoffs? They have come off their horrible slump with a pretty good hot streak, but really does anyone care? Hockey has big problems, as they assess more rule changes. Getting rid of the red line and reducing goaltender freedom behind the net did not help scoring as much as hockey's leaders hoped, so now they are looking at the size of goaltender equipment. This has some promise. The fact is, I haven't seen anyone score on a slapper from the blue line in about 20 years, and that is the real problem with hockey. Today, almost every goal results from a scramble in the crease, which means you don't really see it except on replay. This means that a game that was always more entertaining in person than on TV is now not entertaining anywhere.

In the glory days of the league, when it was a 6 team operation in the 60's, the sight of a Bobby Hull or Frank Mahovilich or Boom Boom Geoffrion or even Andy Bathgate skating the puck over the blue line and winding up for a slapper struck fear into the heart of an (often) unmasked goaltender, and thrilled the crowd. Today, it's a waste of time, since the average goaltender is much bigger, and with his equipment, covers the bulk of the net. He simply has to hold still and keep his balance and whatever else he does, don't open the 5 - hole. So instead, every team plays the same way - they dump the puck in, slowly, and chase, hoping that a forecheck will cause the puck to luckily come loose toward the crease where, if another player has created enough chaos, they can bat the puck in. Since every team plays the same way, the teams have no real personalities anymore - in effect the NHL has become...the NBA on ice.

In the old days, there were the Bruising Bruins, the Bad Guy Blackhawks and the Clutch and Grabbing Maple Leafs. Then you had the finesse teams, the flying Habs of Montreal with their three man rush, the non-checking but very skillful Rangers, and of course, the Red Wings led by the incomparable Gordie Howe. Hockey was not just great sport, it was a morality play like professional wrestling and like tournament poker is now. Today, very few of the sports fans I know can sit through a game on TV or ever go to the rink.

Personally, I would prefer watching Danny (Kid Poker) Negreanu take on Mike (The Mouth) Matasow, any day.

For OTBN, I opened a 1996 La Dieux Dunjon from Chateauneuf Du Pape. Fortunately, the cork came out perfectly intact and the wine was dry and delicious. I had it after dinner, since Barbara isn't really interested in OTBN and prefers white wine anyway. Nevertheless, the wine worked perfectly following a nice meal of barbecued ribs. As per the promoters' instructions, I left some for later this week and sure look forward to finishing it.

On 2/19, I bought 300 shares of Books a Million (BAMM) at 9.42. This stock has been a sensational trading vehicle for me. Despite the popularity of the internet, the demise of book publishing and selling has been grossly exaggerated. On 2/20, I bought 100 shares of Lowes (LOW) at 22.92, again for the IRA account. Hard to believe but this is now a value stock. People may not be buying so many houses, but that just means they will do more work in the ones they already own. When they do, LOW will again be in fat city. This company runs circles around its nearest competitor, Home Despot.

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