Eric Fry

Let the boxing match begin!…In the near corner, we find deflation, with its furious fists of debt liquidation and credit contraction… And in the far corner, we’ve got Ben Bernanke’s printing press, with its menacing inflationary uppercut.

Inflation will win this contest eventually, but the match might go the full 12 rounds.

Deflation is no slouch. He packs a mean punch. Borrowers of all types – from single-family mortgage-holders to national governments – are defaulting on their loans…or moving rapidly in that direction. As the weakest of these borrowers fails, asset prices fall and confidence wanes, both of which produce additional defaults. Once this vicious cycle gains fury, all but the strongest – or least leveraged – borrowers endure.

If Greece defaults, for example, Ireland might follow…and so might Portugal and Spain, etc. If Greece defaults, a contagion becomes quite likely, as the folks who are kicking in their tax dollars to the European Central Bank and the IMF begin to realize that their bailouts are futile. Eventually, the taxpayers from relatively solvent nations resist pouring their capital down Greek, Irish or Portuguese rat holes. Eventually, the bailouts end and the defaults – politely known as “restructurings” – begin.

Aware of this grim prospect and fearful of deflationary forces in general, the Central Banks of America and Europe have been counterpunching with various combinations of money-printing, subsidized lending and debt-financed bailouts. In other words, all the classic inflationary responses, plus a few innovations like quantitative easing.

The match between deflation and inflation looks like a draw so far. The global economy is not slipping into a deflationary abyss. On the other hand, inflationary effects are popping up in numerous inconvenient places.

Based on official US data, the Consumer Price Index (CPI) is up 3.2% over the last 12 months, while the Producer Price Index (PPI) is up 6.8%. Both numbers are higher than in recent history, but neither one seems particularly terrifying…on the surface.

When you dig down into the numbers, however, you discover that these inflation rates are accelerating rapidly. During the first four months of this year, the CPI has jumped 9.7% annualized, while the PPI has soared at a 12.8% annualized pace.

Import prices are also rocketing higher – up 2.2% in April, after a 2.6% jump the previous month. Year-over-year, import prices are up a hefty 11.1%. But once again, the trend is accelerating. For the first four months of this year, import prices have increased at a 26.7% annualized rate!

Let’s put these facts and figures into a real-world context. Based on the lowest of these various inflation data, the CPI, the average US wage earner has made no progress whatsoever during the last four years…

US average per capita weekly earnings have increased about 12% since the beginning of 2006. But since the CPI has increased the same amount, that means inflation has wiped out all the growth of weekly earnings.

If, as we suspect, the forces of inflation continue to prevail in this contest, hard asset investments should perform well, at least relative to most other options. But this analysis is not new news to faithful Daily Reckoning readers. It’s probably not even new news to unfaithful Daily Reckoning readers. (You know who you are!)

We’ve been singing the praises of hard assets like gold and silver for many, many years. In fact, we’ve been talking up had assets for so long that our analysis would be growing tiresome by now…if not for the fact that it has been profitable.

Even so, your editor does not wish to grow tiresome to anyone – not to his kids, not to his girlfriend and certainly not to his Daily Reckoning readers. So he will add a nuance to his monotonous “buy hard assets” mantra.

Here goes: If inflation takes hold as we expect, the allocations in your portfolio that are not hard asset investments should, nevertheless, possess hard asset attributes. When allocating to specific stocks, for example, insist that those stocks possess two key attributes:

1) Significant exposure to non-dollar revenues.
2) Significant pricing power, even in an inflationary cycle.

A strong balance sheet and solid cash flow also help.

Eric Fry
for The Daily Reckoning

Eric Fry

Eric J. Fry, Agora Financial's Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling.  Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research, institutional research products dedicated to international investment opportunities and short selling. 

Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry  supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts.  His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.

  • gman

    “1) Significant exposure to non-dollar revenues.
    2) Significant pricing power, even in an inflationary cycle.”

    (checking google) so “pricing power” means people have to buy it no matter what. yep, that follows the general infestment principles of 1) find out what people need, 2) buy it before they do, and 3) make sure they can’t get it unless they pay you first. got it.

  • gman

    “And in the far corner, we’ve got Ben Bernanke’s printing press, with its menacing inflationary uppercut.”

    since the dollar is not mere fiat currency but DEBT currency, just how is printing benny bucks inflationary? the dollar is a debt pyramid scheme and the whole thing is coming apart. just where is the inflation going to come from?

  • BK

    Inflation comes from having to use more and more benny bucks to get the goods and services we need and want.

    Have you ever made a bid at an auction only to see someone else (say someone from China)outbid you? To have won the bid you would have had to bid a lot more than you may have wanted, or been able, to bid. That’s inflation.

    Whether it’s a fiat currency or a debt currency, the US dollar is dropping in purchasing power with each spin of Ben’s printing press. I just don’t think we can take much more help from Ben.

    We’ll likely get a lot of inflation on some things and a lot of deflation on others. It will be Jimmy Carter’s stagflation on steroids.

  • Time4Bed

    You are right, BK, and well stated.
    I would add, for the benefit of gman, that a debt is really only a debt if there is some intention of repayment. Otherwise it is nonsense.
    That is the mistake that the “Prechterites” and other deflationists make. Also, analyzing charts from when the country was constrained by a gold standard and applying that to today (Elliot wave) is a huge mistake.

  • g man

    ” You are right, BK, and well stated.
    I would add, for the benefit of gman, that a debt is really only a debt if there is some intention of repayment. Otherwise it is nonsense. ”

    bk does not understand the question. no matter how many dollars benny prints, all it means is we owe more. and if as you say there is no intention of repayment then as soon as that intentional default is taken into account by the people using dollars then the currency will outright collapse leaving us with no currency at all. default means the debt vanishes, meaning the dollar vanishes.

    an elegant weapon. not only is the debt dollar designed to fail, it is designed to take down everything associated with it as well.

  • Michael

    A good example of that strategy would be Coca Cola.

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