By John Maudlin
I have been in South America this week, speaking nine times in five days, interspersed with lots of meetings. The conversation kept coming back to the prospects for the dollar, but I was just as interested in talking with money managers and business people who had experienced the hyperinflation of Argentina and Brazil. How could such a thing happen? As it turned out, I was reading a rather remarkable book that addressed that question. There are those who believe that the United States is headed for hyperinflation because of our large and growing government fiscal deficit and massive future liabilities (as much as $56 trillion) for Medicare and Social Security.
This week, we will look at the Argentinian experience and ask ourselves whether “it” – hyperinflation – can happen here.
I will be quoting from Niall Ferguson’s recent book, The Ascent of Money. I cannot recommend this book too highly. In fact, I rank it up with my all-time favorite book on economic history, Against the Gods, by the late (and sorely missed) Peter Bernstein. There are very few books I read twice. There are too many books and not enough time. This book I will have to read at least three times, and soon, and I have a lot of underlines and mark-ups in it already.
If there were one book I could require every member of the Congress to read, it would be this one. As I read it, I am struck again and again by how fragile and yet resilient our economic systems are. Fragile in the sense that governmental policy mistakes, no matter how well-intentioned, can destroy the wealth of a nation, and resilient in that it doesn’t happen more often.
In his introduction Ferguson writes, “The first step towards understanding the complexities of the financial institutions and terminology is to find out where they came from. Only understand the origins of an institution or instrument and you will find its present day roles much easier to grasp.”
As is often said, those who do not understand history are doomed to repeat it. If you want to understand what is happening in the economy, what the consequences of our choices could be, then I strongly suggest you get The Ascent of Money. It is easy to read, engaging, full of moments where you are led to pull together different ideas into an “Aha!” Ferguson is a brilliant writer and historian, and we are lucky to have this book at a time when it is sorely needed. (order it at Amazon.com)
As I have been writing, the United States in particular, and the developed world in general, are faced with a series of very unpleasant, if not downright bad choices. The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when, or allowing the pain to build up to a climactic event. Today we look at what I think would be the worst choice of all.
At the beginning of the 20th century, Argentina was the seventh richest nation on earth. It’s very name means “silver.” “As rich as an Argentine” was a byword. Even after falling from the heights through a series of bad decisions, the country was still so wealthy that, in 1946 when new president Juan Peron first visited the central bank, he could remark that “There was so much gold you could barely walk through the corridors.”
Argentina had actually defaulted on its debt in the late 19th century, not once but twice! But still they managed to avoid destroying the currency and devastating the country. But in 1989, after years of massive budget deficits that were financed with borrowing from abroad and Argentinian citizens, the country was left with so much debt and no one was willing to lend it any more money, that the leaders felt compelled to resort to the printing press.
My Uruguayan friend and Latin American partner, Enrique Fynn, tells me of his experience of going to Buenos Aires and buying a pack of cigarettes one evening. He went into the store the next morning for another pack, and the price had doubled. He came back that evening and the price had doubled again (thankfully for his health, he has quit!). There were no prices on any items in the grocery stores. There was a man with a microphone who would announce the prices of various items, often increasing the price every few hours by 30% or more.
Workers would get their pay in cash and rush to the store to buy anything, as by the end of the week their pay would be worthless. Of course, shelves were empty. The US dollar was king, and could purchase things at amazing prices. I heard stories that were truly compelling. (It made me wish I had gone shopping in Buenos Aires at the time!)
Interestingly, the dollar is still the real medium of exchange. I was told by several people that if you want to buy a house for half a million dollars, you bring the physical cash to the closing. One person counts the money and the other checks the paperwork and title. Argentina has the second largest hoard of physical dollars in the world, only exceeded by Russia. Is it any wonder they are concerned with the value of the dollar?
Let’s look at some quotes from Ferguson (emphasis mine):
“The economic history of Argentina in the twentieth century is an object lesson that all the resources in the world can be set at nought by financial mismanagement… To understand Argentina’s economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon…
“To put it simply, there was no significant group with an interest in price stability…
“Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country’s political economy.”
Look at the chart below. Using realistic assumptions, It suggests that the annual US government fiscal deficit will approach $2 trillion in 2019. How can we come up with what looks to be about $15 trillion over the next ten years? The Argentinian answer was to print the money
In the US, the short answer is that unless the US consumers become a massive saving machine, to the tune of 8% or more of GDP and rising each year, and willingly put their savings into US government debt, it’s not going to happen. So sometime in the coming years, interest rates are likely to start to rise in order to compensate bond investors for what they perceive as risk. That will bring us to some very difficult and painful choices.
As I wrote a few weeks ago, this scenario could be averted IF the Obama administration produced a credible plan to lower the deficit over time and stuck to it. But today’s thought process is about what happens if they don’t.
Ferguson pointed out in the quotes above that hyperinflation is always and everywhere a political decision. Governments have to choose to print money. In theory and in practice, what would happen if the Fed decided to accommodate a politicized US government that wanted to spend money on favorite projects and support groups, maybe even deserving programs like health care or defense or pensions or Social Security? Money they could not borrow?
Then Peter Schiff and like-minded thinkers would be right. Once you start down that path, it is hard to stop short of the brink. Brazil got to 100% inflation per month and has really lowered that level over time, but it is not easy.
In such a scenario, you want to own hard assets. Gold. Foreign currencies. Stocks. Almost anything other than the currency that is being printed.
I was asked at almost every speech about that scenario. In Latin America, hyperinflation is not a theoretical issue; it has been reality. More than one person commented on that no one in US economics schools studies hyperinflation. It is required material in Latin America. For many Latin Americans, the dollar has been their safe haven. And now they are worried, with good reason.
For the record, I do not think the US will experience hyperinflation as long as the Fed maintains its independence. Read the speeches from various Fed governors and regional presidents. These are strong personalities, and they understand that going down that path ends in massive tears. Bernanke warned just a few weeks ago that the government needs to get serious about the fiscal deficit. Watch the rhetoric from the Fed heat up after his reconfirmation and the confirmation of two new governors in the first quarter.
The Fed has committed to buy a fixed amount of government debt in its quantitative easing program. That commitment will be finished by the end of the first quarter (if I remember correctly). Then comes the tricky part.
I have been writing for a long time that the main force in the economy right now is deflation. The Fed will fight deflation tooth and nail. But they don’t have to buy government debt to fight deflation. They can buy mortgage securities, credit card securities, commercial paper, etc. That will have the effect of easing without encouraging the government to run massive deficits. And such debts are naturally self-liquidating, while government debt is not, at least not in the same way.
I believe the Fed will maintain its independence. Not to do so is to court economic disaster of the first order. These are bright and serious men and women. They get it.
The risk is that something changes to compromise their independence. And sadly, there is some risk. Let me quote my fishing buddy friend David Kotok:
“It’s now official. The proposed legislation to reform America’s financial service supervision includes granting the Secretary of the Treasury a veto over Section 13(3) emergency action by the Federal Reserve Board of Governors. If this becomes law, it will be a sad day for the independence of America’s central bank.
“The Secretary of the Treasury, a very senior cabinet position, is appointed by the President and meets with the President in the Oval Office weekly. The governors of the Federal Reserve Board are also appointed by the President. Both cabinet officers and Federal Reserve governors are confirmed by the US Senate. There are supposed to be seven governors; politics has purposefully limited this to five throughout the three-year financial crisis period.
“The Federal Reserve governors are supposed to serve staggered 14-year terms with all seven seats filled. Instead, we have been governed by the present five-member, politically configured board.
“The original seven-governor construction was designed to insulate them from political pressure, for very good reasons. Decades of monetary history throughout the world have disclosed what happens when political influence on a central bank intensifies. The Weimar Republic and Zimbabwe are evidence of the worst inflationary effects of politics. The Great Depression in the US and the nearly two-decade deflationary recession in Japan demonstrate that monetary policy is not only inflation-prone. When central banks are under political influence you can get fire or you can get ice.
“In Japan, the central bank contends with two members of the cabinet sitting in on its deliberations. There is no way to know how much of the last 15 years of deflation and recession is attributable to the inside political pressures placed on the governors of the Bank of Japan. But there is evidence to suggest political influence, especially when you observe how little the Bank of Japan has engaged in asset expansion during this crisis.”
This is the nose of the camel under the tent. Starting down this road is very worrisome indeed. I find it appalling that Tim Geithner and Larry Summers went along with this. This is a very clear attempt by the political class to put political pressure on the Fed. I hope the Fed responds with vigor. I can tell you that the officials of whom I am aware will not take kindly to pressure. And that might be an understatement.
(Yes, I am aware of the problems of the Fed being able to decide whom to bail out and why. It is not a perfect world. But better the Fed than Congress.)
All that being said, if the Fed starts to increase its buying of government debt above its initial commitment, then my “optimistic” scenario of a very rough economic patch, which I have been outlining the past few months, is far too rose-colored. I do not think it will happen, but I can guarantee you, I and a lot of other people will be watching.
Just to remind ourselves of flippe-floppe-flye’s analysis and position in this stock.
Here are the hard facts, without opinionated rabble:
■EQIX is increasing the amount of cabinets in Europe by 1,700, thanks to strong demand. As of now, 75% of the 1,700 are pre-sold. Oh, the lack of demand is just so startling.
■96% of revenues are recurring, usually 2-3 year contracts. In other words, businesses are not in a rush to fulfill their bandwidth needs elsewhere.
■Current capacity is 81%, near historical highs.
■And, finally, the company has guided revenue estimates up from $863 million to $879 for ‘09 and from $1,023 to $1,055 for 2010.
In other words, despite what Cramer is saying on his teevee show, the future looks bright at Equinix, Inc. (EQIX: 92.29 -1.98%) , much to the chagrin of the very vocal 20%+ short position. Hmm, I wonder is Cramer knows anyone short Equinix, Inc. (EQIX: 92.29 -1.98%) from the $50’s?
NOTE: I will increase my position, once the stock hits the high $80’s.
Fly Buy: EQIX
I bought 1,000 Equinix, Inc. (EQIX: 92.29 -1.98%) @ $97.60.
The capitalization structure of this common stock has seriously deteriorated over the past five years. Debt has increased from 11% of the capitalization to 44%. While this ratio is not yet at a critical point, the way in which it has deteriorated, as we shall see later, is a major concern.
As of today, the common stock has no net earnings. Therefore all consideration towards an intrinsic value fall precipitously close to $0.00. I have a valuation of $1.35/share [which is generous] reflecting speculative potential.
The debt is expanding as interest is being capitalized. Without earnings, it is difficult to meet interest payments. This must be said is extremely lucky for the common stock, as without this covenant, essentially the common would be worthless.
Costs are also being capitalized in an effort to boost other profitability ratio’s. Discretionary cashflows being diverted include: Accts Payable @ $2.4, CapEx @ $35.0, and SG&A @ $4.0.
Current Liabilities are growing faster than Current Assets, 54%/46% respectively. While the Current Ratio is acceptable at 2.55 having improved from 1.86, this is an illusion and should essentially be ignored.
CapEx expenditures have been reduced. This common stock essentially tried to buy growth. This strategy is never good. Growth is most robust when it is organically driven.
Depreciation is a really murky area. Depreciation accounts for on a five year average of 76% of Cashflow from Operations, which essentially shows the very low profitability of their business. Currently, this has become only 48% of their Cashflow.
Why is this still a problem?
Plant, Property and Equipment, which constitutes their business, will be an important component in driving their business forward. They depreciate at only 9%/annum, giving a 10 year lifespan to capital equipment. In the area of high technology, is this realistic? I’m not sure, not being conversant in this area, however, I’d say that a 5 year depreciation schedule as far as capital equipment in this sector would make me far more confident – that would however eliminate all current earnings.
While on the subject of earnings, just what is the quality of these earnings? Not very high. Cash from Finance, accounts for 40% of the Revenues. This is simply not sustainable in the longer term, and explains why various items are being capitalized, this is a common stock on the brink of implosion.
In addition, Accts Receivables are also financing customers. Not in a major way [yet] but definitely not a trend that you would want to see continuing.
Speculation most likely accounts for the current shareprice of this common stock. There has been a rally of the rubbish from the March lows, I suspect that this is one of them.
In summary, flippe-floppe-flye and the fabled ppt have been hoodwinked yet again. No surprises here.
Markets love narrative, to assign causation. Today, yesterday, pick any day, you’ll be told why stocks went up or down. Today the story was apparently consumer spending –
Stocks headed lower after the Labor Department said personal spending fell 0.5 percent in September. The drop was in line with forecasts, but it was the largest slide in nine months and followed a 1.3 percent jump in August fueled by the government’s popular Cash for Clunkers car rebate program.
The slide marked an about-face for the market, which rallied strongly on Thursday after the government reported that the economy grew faster than expected in the summer. Much of the 3.5 percent jump in gross domestic product was tied to government spending programs, however.
The poor report on personal spending cast further doubt on the economy’s recovery, which many economists fear has been driven largely by the government stimulus. Without a rebound in consumer spending, which makes up a major part of the U.S. economy, investors worry the recovery won’t last.
With Friday being the last day of the month and the end of the fiscal year for many mutual funds, the market’s gyrations could be exaggerated, analysts said. Fund managers looking to minimize taxes for shareholders often sell some of their investments as the fiscal year comes to a close.
So apart from the odd fluctuation, does the trend in economic data support the premise put forward?
Consumer sales have stabilised. While they certainly might not be that exciting going forward, that’s only part of the story.
Inventory is falling as manufacturing has bitten the dust as capital goods were liquidated in the rush to liquidity or capital goods in the form of money. Less inventory in the face of stabilising demand creates the supply/demand imbalance that creates higher prices. Higer prices increase earnings…all analysts bullish wet-dream.
Manufacturing capacity is liquidated. Transferrable capital goods have been moved closer to final consumer demand, moved to money, or liquidated. Thus the ability to adjust supply to demand has been lost. This in the face of expansionary fiscal policy creates an inflationary environment.
If the Federal Reserve remains accomodative within the Bond markets, which to date it is, although as posted earlier, speculation is rife, then the stockmarket, as the unhampered market trades higher.
From Morgan Stanley
Excess reserves on the Fed’s balance sheet will soon cross the US$1 trillion mark. Our US economics team expects the combination of more QE asset purchases, smaller further decreases in passive QE and the wind-down of the Supplemental Financing Program (SFP) of the Treasury to drive excess reserves in the US to US$1.2 trillion by January 2010 (see US Economics: Fedspeak: Roadmap for the Exit, October 26, 2009). And balance sheets and reserves in other countries are at elevated levels too. Confronted with such massive amounts, even the normally straightforward task of draining excess reserves is no longer a simple task for central banks.
From Morgan Stanley
October 21, 2009
The Global Monetary Analyst
We have flagged inflation as a major long-term risk going forward. Beyond structural reasons, we think that central banks are likely to err on the side of caution when it comes to withdrawing the unprecedented conventional and unconventional monetary stimulus. Yet there is another source of inflation risk – the possibility that central banks might want to engineer ‘controlled’ inflation to reduce the public debt burden
From Morgan Stanley
January 28, 2009
The Global Monetary Analyst
Could Hyperinflation Happen
One stark lesson from the ongoing financial and
economic crisis is that so-called black swans –
large-impact, hard-to-predict and seemingly rare
events – can occur more frequently than generally
believed. With policymakers around the world
throwing massive conventional and unconventional
monetary and fiscal stimuli at their economies, we
think that it is worth exploring the black swan event
of very high inflation or even hyperinflation. While
such an outcome is clearly not our main case, the
risk of hyperinflation cannot be dismissed very easily any longer, in our view. We discuss the historical
evidence, the conditions that can lead to very high or
hyperinflation, and whether and how it might happen
David Pett, Financial Post
Published: Friday, October 30, 2009
Financial markets can expect to feast on record low interest rates for a little while longer.
While the U.S. economy exited its worst post-war recession with stronger-than-expected growth in the third quarter, analysts say the U.S. Federal Reserve is unlikely to upset the fragile recovery with any talk of rate rises at its meeting next week, which is the market’s next obsession.
In order to maintain credibility, Mr. Strazzullo said the central bank will use language in crafting next week’s statement that continues to stress the need for an exit strategy and also alludes to their vigilance as “inflation fighters.” But tough talk aside, he doesn’t think the central bank is anywhere close to raising rates.
“The risks are too great. If you raise rates and snuff out what is still a fragile recovery, what are the policy options? Are you going to cut taxes — we have massive deficits at every level of government. Is there an appetite for more stimulus — you can see with the healthcare debate, people are already concerned with deficits we are running up already. If they are wrong and move too early, there are no more rabbits to pull out.”
When Endo Pharmaceuticals (ENDP) acquired two experimental testosterone products earlier this year, CEO David P. Holveck predicted that safety issues might delay approval by the U.S. Food & Drug Administration. Synthetic versions of the quintessential male hormone are prescribed to thousands of patients in the U.S. to treat fatigue, sagging libido, and other signs of testosterone deficiency. But when they’re applied as topical gels, they have an unpleasant propensity to rub off on other people—moving, say, from a father to a child and temporarily causing symptoms of puberty, increased aggression, and other annoyances. In addition, the FDA is concerned about the growing use of testosterone by anti-aging clinics seeking to restore youthfulness to baby boomers, and by the abuse of such drugs in sports.
Holveck was right to be worried. On Oct. 19 the FDA said it would not approve Endo’s Fortesta, a topical testosterone gel, until the company performs additional safety trials. Only seven weeks earlier, regulators delayed Endo’s other product in this class, an injectable version—also over safety issues.
It’s no surprise the FDA is being so vigilant. Sales of testosterone products already on the market have rocketed 25% in the 12 months ending in June, to just under $1 billion. The recession has knocked the wind out of other “lifestyle drugs”—medicines to treat conditions that aren’t life-threatening. Even Pfizer’s (PFE) blockbuster Viagra fell 8% in the most recent quarter, year over year.
But not testosterone. Boomer lust for the hormone is now spurring a land grab by companies that make it. On Sept. 28 drug giant Abbott Laboratories (ABT) paid $6.6 billion to acquire Solvay Pharmaceuticals, which makes the leading testosterone product, AndroGel. Auxilium Pharmaceuticals (AUXL) is also angling for market share, and Endo’s Holveck thinks there’s plenty of room for growth. “The driving element is demographics,” he says. Analyst Annabel Samimy, who covers Endo and Auxilium for Thomas Weisel Partners, expects continued double-digit growth for such products, figuring that only 10% of patients who have low testosterone are currently treated.
New entrants in this market, however, will be dealing with a regulatory backlash that began last May. The FDA, having received more than 20 reports of testosterone in commercial products rubbing off on children, required that dreaded “black box” warnings be added to the labels for AndroGel and Auxilium’s rival product, Testim. The companies put boldfaced warnings on all their packaging and marketing material, and they had to produce new package inserts instructing patients to wash their hands thoroughly after applying the gels.
The FDA won’t say what requirements it will impose on testosterone products that are still under review. But Holveck says the agency wants Endo to do a “washing” study on Fortesta. Patients in the trial will have to clean their hands after applying the gel and then be tested to see if residues remain. The requirement will delay approval until sometime in 2010, Holveck predicts.
Testosterone is one of the fastest-growing therapies prescribed by the $80 billion-a-year anti-aging industry, which has embraced it as the cure du jour for andropause, more commonly known as male menopause. Conservative doctors question the existence of such a malady, and testosterone makers shy from discussing it because they’re not allowed to promote the drug “off-label”—for uses not endorsed by the FDA. Still, off-label prescriptions are likely to account for much of the market’s rapid growth. That fact isn’t lost on the FDA: During a press conference to announce the black boxes, an agency spokeswoman said she was alarmed that 25,000 testosterone prescriptions per year are written off-label for women, who use it to boost their libidos.
The market is so hot that, far from fretting about a regulatory crackdown, testosterone makers are focusing on keeping generic competition at bay. Earlier this year, Auxilium filed a petition with the FDA arguing that the agency shouldn’t let a generic version of Testim onto the market without requiring its manufacturer to do washing studies to prove the generic—which has slightly different ingredients—poses no more risk of testosterone transfer than the original. The FDA agreed, freeing Auxilium to concentrate on battling Solvay, which has more than 80% market share, according to researcher IMS Health (RX). In effect, Auxilium turned the agency’s growing safety concerns into a strategic coup: It won’t face low-cost competitors anytime soon.
Auxilium CEO Armando Anido admits he doesn’t have the capital to invest in heavy advertising, as Solvay has done with AndroGel. But he thinks all those Viagra ads urging men to talk to their doctors about erectile dysfunction may be helping him—by fanning interest in products the FDA still views with concern. “Instead of the little blue pill,” Anido says, “those men may end up on testosterone replacement.”
Here’s some British beef, 5 time Mr Olympia.