By Kirk Spano
The fiscal-cliff deal — the tax half of the deal anyway — is now past us, and the reflation trade continues along. However, what we now see, which the very scary Paul Farrell pointed out this week, is a number of very strong headwinds developing for 2013 and 2014. Farrell is primarily looking for the Black Swan, which is the in vogue thing to do since 2008, but there are much more evident storms coming to eventually find shelter from.
Not among the headwinds is the trillion new dollars coming out of the Fed this year. The Fed has committed to buying back debt of about $85 billion a month for the duration of the year and will almost certainly continue to do so at some level into at least 2014. That flow of money is strong and is largely responsible for tempering the effects of the demographic depression which has flattened aggregate demand.
Consider that right now the Mississippi River is low on water due to drought and environmental factors. Now imagine that there was a giant faucet at the north end of the mighty river that could be turned on to raise the water level. The Fed is that faucet for the American economy. The Fed is a pump that is connected to the world's biggest money aquifer — the reserve currency.
The Fed pump is not inexhaustible, however. At some point, if the pump runs too long, bad things can happen. The pump could break. Many talk about that possibility. It is unlikely that the Fed pump would break anytime soon, though, as that would mean that somehow, suddenly, the dollar was not the world's reserve currency. That is extremely unlikely to happen this decade or even the next. There are no real alternatives to the dollar.
What is more likely to happen, is that the pump overheats and needs a rest. An overheated pump is recognizable by the monetary inflation that it causes. We have been told that those controlling the pump, at the moment Ben Bernanke, will know when to slow or quit pumping.
I mostly believe whoever is in charge of pump control will know when to back off. What I am not confident in is that most Americans will appreciate the need to slow the money flow down a bit. We certainly did not appreciate that from 2002 to 2007. Would it be different next time?
We have a very fickle populace that will ask for more government action to fix what they see, in the short-term, as what ails them, even if what ails them is really the result of an inoculation. The likely response will be pressure on politicians to spend more money when the Fed prints less.
If the politicians succumb, which they are apt to do, we are in trouble, and our opportunity to use our resources as a bridge to a better and more sustainable future is shot. In fact, if the federal government does not stop overspending soon, the American dream really will turn into Farrellian nightmare.
It is important for people to recognize that as the size of government grows, eventually, the use of money by government starts to crowd out private spending, particularly job-creating entrepreneurship. I know this because a professor told me so a long time ago. I also know this because I am seeing it happen among many small businesses right now.
As we heard during election season, small business is the backbone of job growth in America. When government uses a large percentage of the nation's capital — anything in excess of a low 20s percentage, small business is stifled. That is very stagflationary and can lead to an non-virtuous downward economic spiral.
Already the headwind of inflation is coming from the ground up. This inflation is clearly compressing margins at many companies that produce consumer-finished goods. Because those companies have already wrung out the easiest efficiencies for maintaining margins, they have little left to do to maintain profit margins, which will ultimately impact their share prices.
There are two inflationary forces at work. The first, we have essentially covered, is monetary inflation. The second is scarcity-driven inflation (quibble with me about definitions if you must).
Many inputs are becoming more scarce, and prices have been drifting up for a decade now. That trend is not going to stop. Due to under investment in new supplies of materials, recycling and alternatives, scarcity-driven inflationary pressure really is in my mind the darkest of potential black swans. The Pentagon agrees, as a recent report cited scarcity for necessities as a very likely potential cause of future wars (the not-too-distant future).
So, while I discussed throughout 2012 (and have recently devoted a newsletter to the subject), that in the intermediate term, investing in and using our resources prudently should act as a bridge to a better more sustainable future, I am not so convinced about the short-term being smooth. The government- and central-bank-supported rebound off the bottom has now happened and further growth will need to be more organic.
I do not see strong organic growth on the horizon. We have recessions in Europe and Japan. China and India are growing, but not as much as a few years ago. U.S. residential real estate markets promise to be flat for years, as inventory slowly bleeds into the market from people who wish they would have or could have sold years ago. Health-care expenditures globally, not just in America, continue to utilize more household resources. The list of challenges really does go on and on at present.
It will take time for things to shake out. That is neither good nor bad. It just is.
As investors and citizens, we need to pay very close attention to whether governments find an efficient balance in these next few years. Too much manipulation of the natural timeline and interference with the clearing of broken markets will ultimately lead to very bad unintended consequences. Too much of a move in any ideological direction leads to a lower standard of living for most.
This all leads to a general forecast that economic growth will continue to be slow, inflation will drift higher, margins will compress for consumer companies and a case of near-but-not-quite stagflation could become a worse problem if small-business creation does not accelerate.
Investors have a few tools to overcome this environment, make nominal gains, keep up with inflation and maybe even generate new wealth. Click in Friday, when I talk about what to sell on rallies (like now) and what to invest in for the big shift that is developing.
Kirk Spano is the owner of Bluemound Asset Management, LLC and publisher of the American Resource Boom Letter. Opinions subject to change at any time without notice.