Tuesday, February 7, 2017

Emerging Inflationary Scenario

Out in the distance 
I could hear some people laughing
I felt my heart beat back
A weekend's worth of sadness
--Til Tuesday

These pages have frequently considered the 'great debate' as to whether the next time down will be initiated by an extreme inflationary or deflationary event. Although I originally found the deflationary argument intuitive, I have been warming to the inflation side. Currently, I am entertaining a previously unconsidered scenario that lends further weight to the inflation case.

The scenario is predicated on a new wave of economic optimism brought on by the election of Donald Trump. Trump is promising a business friendly environment by rolling back regs, investing in infrastructure, and favoring US job creation and production from a policy perspective. Whether some of those initiatives actually are ultimately business friendly is beside the point. The issue is whether people think they are. If they collectively do, then their herd-like reflexes may lead to investing more and biding up prices at a time when leverage is extreme and financial securities are priced at all time highs.

It is easy to envision another leg higher in stocks, perhaps even a moonshot, and another hefty layer of debt added to an already over-leveraged system. Prices of goods and services are also likely to shoot higher.

For this scenario to play out, however, interest rates need to stay low. If rates move higher as they have already started to do, then the chances of this scenario decline as it depends on debt creation.

The wild card may be the wild man Trump himself. Trump has publicly criticized the Fed and its role in blowing financial bubbles in the past. But that was before Trump took over the Big Chair. Now that he's seated, Trump may find it preferable to keep interest rates suppressed lest his Make America Great Again agenda shrivels.

Past behavior suggests that Trump will hammer away against a non-compliant central bank institution until he gets his way. If Janet Yellen and/or other Fed governors do not accommodate, then Trump will seek to swap them for people who will.

Subsequently, if a Trump-picked Fed re-initiates bond buying (a.k.a. Quantitative Easing) in a big way, then Big Inflation via this scenario is almost a lock.

While I can't be generally long stocks in any significant way at current prices, there is no way I want to be short them in lieu of this scenario. Gold and silver, on the other hand, beckon.

positions in gold and silver

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