Friday, February 24, 2006

In the long run...the end game

In the long run we are all dead, said J.M. Keynes
No, Maynard, in the long run each of us is dead, replied his fellow Cambridge economist, Joan Robinson.

Inheritance in Public Policy: Change Without Choice in Britain
Richard Rose, Phillip L. Davies

There are times I think the main impetus driving modern society is evasion of long run effects- the ultimate Sisyphusian task. Increasing debt loads, obesity and family disintegration are just a few examples of behaviors which will have inevitably nasty effects in the long run. Perhaps though I shouldn't be surprised when truthiness is chosen word of the year. The currency markets are not immune to this habit of mind. With respect to the Iraq War, the writing is, in some respects, already on the wall. Yet, the US$ continues to hang in there.

Each time I recall Keynes view of the long run, I think to myself, you might be dead, Mr. Keynes, but we are still here. I wonder if later in life - he was 40 when he wrote A Tract on Monetary Reform, which contained that line - when his health was failing, he realized how silly it was. The long run comes to us all, individually and in certain respects, collectively. The period of bi-metallism ended, as did that of the Gold standard, the Bretton Woods Accords were broken and even the British Empire has receded.

My point being my belief that preparation for the future should include a clear view of the end game. This might manifest in a decision to treat one's children well as they will care for you when you are older, or financially in the choice of holding a portion of one's wealth in Gold, for all currencies collapse eventually.

Looking at Iraq, once the military option was chosen and initiated and long term bases began to be built, there seemed to me to be two options.

One, after a long, protracted, and importantly for our purposes, expensive war was fought, certain US corporations would gain control over Iraqi oil reserves. Bringing these reserves to market would require a not insubstantial amount of additional investment and military costs.

The second option,
after a long, protracted, and importantly for our purposes, expensive war was fought, the US would not gain control over Iraqi oil reserves, potentially leaving the region actively hostile to US interests.

Neither option would fix the hole in US external accounts although option one would be less onerous than option two.

on the FX markets, the US$ still holds its own despite a potential 2006 C/A deficit approaching US$1T or roughly 8% of GDP. We await congressional approval for a debt limit hike when the federal debt to GDP ratio is already 65%, a ratio that has doubled in the past few years. Meanwhile we seem to live in a financial world where corporations are reluctant to pass on higher input prices, which is cheered by Bernanke et. al. as a sign of flexibility, as if the US$'s loss of purchasing power is temporary.

In the long run, which will come eventually, the US$ will fall. It might be slow, as in the seventies. Or it might be quick, as in the Asian or Latam crises. Regardless, it will fall and fall far.

I received a few emails after my argument of a potential deflation scare in the offing to the effect that I sounded (metaphorically I imagine) like the average gold bug investment letter writer. I was a bit confused at that. I never wrote I was selling Gold, or any other of my inflation related investments.

Rather, I wrote I was mentally prepared to deal with potential portfolio losses and would be looking to add on any decline. My short term guess was based on a temporary halt in US federal debt monetization and a few other seasonal factors which, via Soros' reflexivity, and the black box crowd, might feed on themselves for a while.

More to the point, I wrote, if the pro inflation trades are not further unwound under the conditions noted, stronger forces would apparently be at work. Those stronger forces might include investors being forced by current events to begin to consider the end game in Iraq and its effect of the US$.

The long run comes for us all.