Wednesday, August 16, 2006


I still think we will have a military conflict with Iran before the November elections. I am almost 100% certain we'll have one before Mr. Bush leaves office, but I'm about 95% certain it'll come before the elections.

I am certain we're in the leading edges of a depression. That is, a period of two or more quarters of flat or declining GDP. This is before the effects of the first prediction are worked in. The leading cause of the depression is the increasing cost of necessities - energy and food especially - and will have strongest supplementation from the unemployment resulting from the housing bubble deflating (at best plateauing, at worst blowing up).

This depression will be characterized by a 'mild stagflation'. That is, the increasing prices of necessities will provide inflationary pressure, but flat wages and unemployment will mean the money supply doesn't grow to match. The effect will be deflationary in principle. That is, given x amount of money in the pocket of which proportion y goes to necessities and z goes to everything else (aka luxuries), as y goes up z shares a smaller pool of money. The response of sellers of z will be enhancing their products so the money comes to THEM. The easiest - and most frequent - enhancement will be reductions in price. Second most frequent will be 'toss-ins' - things added to the item purchased. These can range from intangibles (longer or more comprehensive warranties) to supplemental goods (50 pounds of laundry detergent with that new washing machine, or a dozen CDs with the new music system) to pure system enhancements (extra content or 'more' or 'bigger' or...).

During this period of time the 'winners' will be those who can maintain cash in excess of necessities and who can effectively negotiate/haggle when buying luxuries. The optimal side of the financial duology is the lender - what you lend comes back with more and at the same time the original loan has more purchasing power. The confusion to this is the rising cost of necessities. Eventually such a situation has to break. There are three general avenues. First, the necessities reverse price trend to follow the luxuries, and we enter truly deflationary period. Second, money is injected into the mix which allows/encourages more spending on luxuries - reversing their trend and pushing us into a pure inflationary period. Third, things happen to make necessities unnecessary (or at least less important), which both moves them to luxury status and frees more money for other luxuries. This last results in, well, it can go either way depending on the details.

But remember the first prediction -- War by November. War because of the Bush Ego (as I mentioned before), supported by numerous reports that the administration informed Israel that if it followed a plan to push into Syria during the recent hostilities it'd be supported. (That's pretty much confined to papers from Israel, though Reuters had the note in a couple of articles as well.) The recent Hezbollah suppression incident was supposed to lead to a region-wide war - Israel/US vs Syria/Iran, both with lesser supporting characters. But I digress, I was speaking of the effect of this on the economy.

On the one hand, it will push a necessity - energy (in the form of oil and natural gas) up toward catastrophic levels. This will be due to both fears of and actual shortages worldwide. On the other hand... on the other hand there will be a big buyer of a lot of goods - the US government. Yes, it's been buying a lot already, but this would be another significant increase. And that's where it'll inject more money into the pool for inflationary pressures. Yes, we'll still have consumer deflationary effects in a lot of places -- whereever the money from Big Customer Sam needs more than a couple of steps to get to the employee. (One problem with trickle down - if it worked - is that it's so delayed in delivery.) But this time the cost of most goods goes up because of the inflationary pressures of not only necessities but increased money supply.

This one's going to be rough. If you can borrow and get through till the money trickles into your pocketbook, do it. It's lenders that get bit by inflation. Also, if you can get attached to the government teat for direct money flow - but don't make it your sole source as I'll point out shortly. Another thing is to traffic in necessities. Note that you need to be careful here as some apparent necessities are or will be starting at costs too high to get a decent margin (if any - housing/rents). Finally, you can convert your money to hard and divestable goods that tend to track with inflation -- gold and silver being the classics, though there are other options as well.

I said don't weld yourself to the government teat. That's because of the after-effects of this engagement. I think - though I'm getting into much weaker levels of value - that the preceding inflationary period will approach hyperinflation rates. The inevitable consequence of hyperinflation is recovery - deflation if everything is perfect, and collapse being much more likely. Currency replacement - New Dollars - is a common solution. Even the essentially never-experienced disinflation to 'normal' levels will feel catastrophic. And during this time the government will be not only a lousy customer but will reverse the pumps - those industries most attached will be the ones that get to support the money contraction most strongly.

If you've lent money, try to anticipate. In just about every case calling in or selling the loans is a best option. After the downturn is fully recognized, well, nobody will want it. If you're sucking on the government teat, reduce the flow. Necessities - if you're in that business - are still a good business, though you should beware of the fact that things don't move evenly. It's a given that SOME luxuries will do extremely well in reaction - the problem being guessing the luxury. Hard goods are, well, it depends. If it's a collapse, keep them. If it's 'only' deflation, you might consider converting to a trustworthy currency - which may be the dollar or may be something else.

- 3 to six months of 'mild stagflation'. Lend if possible, but keep it short-term.
- six months to two years of heavy inflation. Borrow with care against overstretching. Provide necessities. Hold hard stuff. Try to get close to the money stream from the government.
- A period of correction, unknown duration, intensity from disinflation (0%) to collapse, probably deflation. Close the loans, cut the ties to the money stream, continue to provide necessities. The hard stuff just flat depends on the intensity.

Hopefully I'm wrong. Hopefully I'm overstating the whole thing, and I'm misreading the march to war.

But I'm in short-term CDs and I'm buying silver right now - the latter is trying to buy low for expected increases.


Anonymous sublemon said...

War with Iran would certainly make USO at under $68 a good buy. Iran closing the Strait of Hormuz would block the exit of something like 14% of the middle east oil export.


8/16/2006 12:59 PM  
Anonymous sublemon said...

Appologies, its 90%. I just don't know where I came up with where 14%.

8/16/2006 1:02 PM  
Blogger Kirk said...

dunno where you got 14% either. shrug. Anyway...

For what it's worth, I don't think "shutting down the straits" will be completely successful. Depending on a lot of factors I expect a 25 to 60% cut in oil transiting that body of water. Since 24% of the world's oil comes through there (90% of 27%), that's a 6 to 14.5 (approximate) cut in total oil production. Add in the ~2% of total oil that comes out of Iran via Bandar Abbas and it's nominally 10 to 15% of global oil production. Which doesn't sound like much until you recall that approximately 75% of total oil production is used in-country. So that's a cut of "import oil" by ~50%. Plan gasoline (at the pump) and heat and other expenses accordingly.

For what it's worth, I'm hesitant of placing funds in USO for this. Basically it's due to recognized ignorance. In the event of such a crisis, can the US seize the stockpile Victoria Bay has in storage as assets held for the ETF's basis? I have a rule never to put money into known black holes, and this qualifies.

8/17/2006 9:29 PM  

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