Thursday, June 18, 2009
The musings of Van R. Hoisington and Lacy Hunt at Hoisington Investment Management have been crossing my computer screen for years now, thanks largely to John Mauldin's weekly emails. They've always made for interesting reading and, today, CNN/Money files this report on their views regarding the raging inflation-deflation debate.
During a recent speech, money manager Van Hoisington, president of Hoisington Investment Management, asked his audience of sophisticated investors to raise a hand if they thought inflation was going to be a problem sooner or later.It's important to remember that they are a largely a fixed-income investment management company so, to some extent, they are talking their book, a book that happens to have done quite well in recent years.
Everyone raised a hand -- except Hoisington.
This "inflationist view of the world," which he outlines in his firm's recent quarterly review and outlook, stems from Milton Friedman's observation that "inflation is always and everywhere a monetary phenomenon." Hoisington goes on to say that "the Fed has expanded the money supply dramatically, and since inflation is too much money chasing too few goods," people think inflation is inevitable. But he thinks they're wrong.
Nonetheless, it is somewhat tiring to hear the same comparisons to the 1930s era when, as noted here on many occasions in the past, just about everything is different than it was 75 years ago, most importantly, the money itself.
Second in change only to the nature of the money are two other important factors - emerging economies around the world and the finite nature of natural resources, all of which set the stage for a commodity driven surge in inflation, sometime down the road.
But, there's where the disagreement between inflationists and Mr. Hoisington lie.
For starters, Hoisington believes the economy will continue to be weak for years. And with unemployment at such high levels, companies won't be raising wages, and consumers won't be increasing their spending. That means demand for commodities and other goods will be muted, so there will be no upward pressure on prices. Overall, he sees the economy being no bigger in 2012 than it is today.This is a very U.S.-centric view of the world that will soon be put to the test. Personal debt is virtually unheard of in much of the rest of the world, a point that shouldn't be ignored.
Even if inflation and interest rates were to rise in this recession or the beginning of a recovery, the economy would quickly stall. "With unemployment widespread, wages would seriously lag inflation," he writes. "Thus, real household income would decline and truncate any potential gain in consumer spending."
What about all the money the government is pumping into the system? That's not by itself inflationary, he says, pointing to the work of economist Irving Fisher (who died in 1947).
Fisher believed that gross domestic product is equal to money times its turnover, or velocity, which is basically, the speed with which people spend it. In the last two quarters, money supply has grown at 14% but velocity has declined by about 17%, so nominal (non inflation-adjusted) GDP fell 4.5%.
One reason velocity is down, according to Hoisington, is that people would rather repay debt than go out and buy a lot of new stuff. He points again to Fisher, who wrote in a 1933 article "The Debt-Deflation Theory of Great Depressions" that excessive debt controls all, or nearly all, other economic variables.
Hoisington sees this today. "People are more interested in trying to get out of debt than increasing it, which means the economy cannot grow," he says. "If there's no increase in demand, there can be no increase in prices."