Fire and Ice

The Fed has but two weapons in its arsenal... both deadly for American investors

(Source: Getty Images)

Bill Bonner, reckoning today from Poitou, France...

“Although inflation has moved down from its peak—a welcome development—it remains too high. We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

~ Jerome Powell in Jackson Hole

First, a news flash from Argentina. Bloomberg:

Argentina Central Bank Sees Monthly Inflation Going Over 10%

Argentina’s Central Bank expects monthly inflation in August to have accelerated to almost double the pace of July after the government devalued the peso, two officials said in another sign the economy is quickly deteriorating.

The August data, to be released by the country’s statistics agency on September 14, would dwarf the 6.3 percent monthly inflation that Argentina posted in July, confirming the significant impact on prices from an 18 percent peso devaluation announced by the government earlier in August.

That’s 10% per month. Not annually. And, as we’ll discover below, 10% inflation costs a lot more than 10%.

The “Dame Dos” Years

Carlos Menem had a winning smile, a warm personality and some of the most impressive sideburns we’ve ever seen. It’s now hard to imagine, but in the 1990s, when he was president, Argentina had nearly zero debt and zero inflation.  

There was a simple reason for this sudden and unexpected bout of solvency. Inflation has worked its magic. The country had recently been through a hellfire of hyper-inflation that reduced its peso debts to cinders…and caused Menem to introduce a “peg,” one peso to the dollar…neither more nor less.

The economy boomed. And in a few years, creditors had forgotten what harm they had so recently suffered, and the gauchos were able to borrow again – and stiff their creditors, again, about 10 years later.

And now, 2023, out of credit again, they have turned back to the printing presses.

Our daughter, Maria, is now living down there. She and her husband are taking care of our farms, trying to do business in a country where the financial ground shifts under your feet…with small tremors and catastrophic quakes as daily occurrences. 

How can you invest in such an economy? How can you plan for the future? You have no idea what anything will cost…tomorrow. As for sales, ‘down the road,’ forget about it. Even the road may give way.

As an aside…Maria reports that the grape harvest from last year was a disaster. A late frost killed half the crop.  

That’s the trouble with high altitude vineyards; you get an extraordinary flavor…but you pay for it. Early frost…late frost…hail…drought – the extreme weather creates extremely-rich grapes. But not many of them. This year we only have enough grapes for, maybe, a few hundred cases.  

(Readers who want to be sure to get some of our Tacana Malbec should reserve now…before it is all gone: https://bonnerprivatewines.com/tacana-offer-bpr/)

Meanwhile…

The $50 trillion Debt Overhang

Inflation is always and everywhere a political phenomenon. In the US as well as Argentina, it is a policy decision. Governments either go with it…or refrain from it. But once they begin inflating, it is a hard habit to break. It’s ‘inflate or die.’  They must keep inflating in order to prevent bankruptcies and defaults. Or, they stop the music and end the party right away.

Either way, the final result is much the same…sooner or later hearts are broken and dreams wrecked. The Fed’s ultra-low interest rates enticed people to borrow. One man borrowed to start a business. Another borrowed to gamble on stocks. One borrowed for a house. Others borrow for vacations and big screen TVs.  

All have their hopes, dreams, aspirations and fiddles. And all of them are now embedded in $95 trillion of debt. But keeping interest rates too low for too long, the Fed falsified the real costs. And now, as interest rates rise, it becomes harder and harder to keep those dreams alive. Eventually, many must fail.

Right now, based on the historical relationship between output (GDP) and debt, Americans owe about $50 trillion too much. That extra debt is a threat and a burden. It can ruin debtors and creditors alike, taking resources from the present to pay for hamburgers already eaten…investments already gone bad…and vacation sunburn that has already disappeared. With more and more time and money directed towards the past, less is available for the future; growth slows.

As our Argentine friends have shown us, you can borrow for a long time, but not forever. Eventually, the debt can’t be supported. It must go away. That can happen by fire (inflation) or ice (deflation). From the standpoint of the central bank, it’s either ‘inflate or die.’  

But while both will eliminate the excess debt, they are far from equal.  

Tango and Hard Drugs

If the party ends suddenly, as Paul Volcker ended the US inflation of the ‘70s, many people will be annoyed. They’ll grumble as they fumble for their car keys.  Many are already in no condition to drive. They’ve borrowed too much, speculated too recklessly and spent too lavishly. They’ll have to call an Uber. Some will take their chances and end up in a ditch…or in jail.

No, it won’t be fun. But at least most will make it home safely…and be able to get to work on time the next day; the real economy will be relatively unharmed.  

But if the Fed chooses, it could put on a little tango music…and even bring out the hard drugs. This would keep things going for a while longer…people would go further into debt. They would make even more reckless investments. They would be able to spend more. And the eventual reckoning would be more severe…simply because there would be more bad debt to reckon with.

But there’s more to it. Just look at the economies that have tried to inflate their way out of debt – Zimbabwe, Venezuela, Argentina; inflation has not just wiped out debt…it has wrecked their economies too. Long term investment goes down. Businesses are not started. Those that exist already struggle to stay alive. Households cut back on spending…the ‘rich’ put their money in Miami…or squander it on high living before it gets inflated away.  

In other words, inflation does not just reduce asset prices…bringing the rich down a notch. Like a bad drinking habit, it makes it hard to earn a living. People get poorer. Their lives become shabby and sordid.

Argentines used to swagger down the boulevards of Paris, proud to be richer than the French. Now, they scurry down dark alleyways of Buenos Aires, looking in the trash for discarded, half-eaten sandwiches.

More to come. Who pays for inflation? Who pays for deflation? Rich people north of Richmond? Or poor people south of Portland?     

Regards,

Bill Bonner

Joel’s Note: As alluded to above, the “dame dos” years of Argentina in the 1990s refers to the time the gauchos were on top of the (bottom of the) world. Our friends in Buenos Aires explained…

“We would go to Brazil and, whatever was offered… dinner, tickets to a show, hotels, caipirinhas, boat rides… our answer would be the same: Dame dos! (gimme two!)

“Our Brazilian brothers and sisters hated it, of course, because we were rich. But then, they were beating us at football [soccer]. Now, we have Messi…and no money. The World Cup is here in Argentina… but we are broke. And the Brazilians come to our cities, eat at our parrillas, stay at our hotels and they say to us, ‘me dê dois, me dê dois’”.

Fortunes can turn quickly. Both for individuals…as well as for entire economies.

Here in Georgia, where your editor-at-large is presently enjoying his last couple of days in the nation’s splendid capital, the country’s GDP is growing at a 10% annual clip. The math is surprising. At this rate, the economy DOUBLES in size every 7.3 years.

And you see it. Everywhere we look, there’s construction. New hotels… office buildings… restaurants and upscale housing developments. It’s also exceedingly easy to set up a business here as well as to open a bank account. We spoke with a junior conservative politician last week who told us her country aims to be a friend to all neighbors, the preferred place of business in the region.

Of course, there are cycles to these things… from the early years of go-go growth and optimism, to the late, degenerate stages of rot and decay.

Right now, “The West,” (loosely defined as the US, UK, and NATO powers) are taking on debt and making Faustian pacts with the monetary gods. The BRICS nations, by contrast, are bringing new countries into the fold, adding letters to their nifty acronym at a pace that would the LGBTQIA2S+ coalition blush.

What does this say about where we (and they) are in our respective cycles? And what does it mean for our overall investment strategy?

BPR members are invited to tune into a special Private Briefing this Sunday, when we spend an hour speaking with energy and resource expert, Harvard trained geologist, retired senior US Navy officer and all-round man of letters, Mr. Byron King. We hope you can join us. If you’re not already a member, correct that cosmic oversight here…