Business Times

On reading piffle and the impact of reflation

One of the bores about writing a column is that everyone takes an interest in your views. A murmur about the desirability of underwater basket-weaving companies at a cocktail party, and the interest is noted; expatiate on the possibility of a bull-run in titanium or western hypocrisy, and someone, somewhere records it for posterity.

These are, in normal times, the warble flies of life; a lazy flick of the bovine tail keeps them on their wings, and life continues as before. Western hypocrisy and bullying of small irrelevant states (on the ascent since the departure of Osama) however is masking serious economic problems in the developed world.

The art of cross-examination in a court of law is essentially asking the right question (an art that is dying due to bad education policies and the general lack of deductive reasoning, another subject for another day). The same is true of assessing the economic outlook. Ahead of the credit crunch, one variable stood out above all others as salient: the inexorable rise in the total quantity of debt in the world. There was no need to call the inflexion point when greed would turn to fear – it was enough to know that one day this would happen, and at that time there would be an event, similar in and type to the eventual outcome of the credit crunch.

That was then, and today's decisive question is a different one – but still related to debt. It is this: can the debt built up over the last two decades be paid down? My answer is that it cannot. Two years ago that assertion was based on rather less than it is today. The tsunami of liquidity known as quantitative easing, which followed in the aftermath of the credit crunch, has achieved many things. It has stabilised the world economy, which is growing (in the US, anyway) at an above average 4% per annum.

Confidence has returned, and investment valuations have normalised. Everything is back to normal, it seems – except for one thing: the absolute level of debt. Quantification of debt is not easy, but there is a useful metric which divides a country’s debt by its GDP (of the economy).

For the US this sat at about 140% a generation or more ago, but rose from 220% in the later 1990s, through 300% in late 2005 to 373% at its peak three years ago. The latest published figure is 357% – effectively unchanged from its highest point. This is the world’s problem, and all the prestidigitation of the Federal Reserve has not alleviated it.

Debt can be extinguished either by repayment, which is not happening, or by default, which is the granite path to a depression. There is only one way in between: inflation, with interest rates kept well below that rate of inflation. This is what we are seeing in the UK, where there is already inflation, and what we will see in the US when it reappears there.

The policy of quantitative easing is massively inflationary but it is being superimposed on an economic world which has many elements of deflation. We saw how effective this combination was in the 1990s, when China’s cheap labour and cheap goods pouring into the West masked policies which were, even then, unequivocally inflationary. While the hot sun of inflation beats down, the land was protected by a deflationary mist. A similar dynamic is at work today.

The credit crunch provided massive and instantaneous deflation: the US easing has been burning off this mist. The Federal Reserve in the US sets a level of interest rates not only for domestic America, but, through the reserve currency status of the dollar, great swathes of the rest of the world as well, particularly emerging markets including Sri Lanka. Many of these don’t need quantitative easing at all – the mist has already been burnt away, and they manifest the classic signs of overheating in their respective economies. The consensus view in the market place is that while this will no doubt end in tears, it will first create a boom in asset prices (note the local share market and property prices in the South and East).

There will, so the thinking goes, be time enough to worry about the problems to follow. I think that investors will be disappointed. The Far East was on the wrong side of the disinflation trade in the 1990s – six years of boom, and a terrible bust under the baleful eye of the IMF in 1997 and 1998. They will have no desire to repeat so recent and painful a memory.

The investment outlook is difficult amidst inflation. Real assets offer the best defence and illiquidity premiums become attractive. Long term fixed deposits are pure poison. Commodities and farmland (especially in the Central Province) become invaluable in a world where structural shifts are occurring in the sector.

And to the 132 individuals seeking my opinion on the impact of a certain document (surprisingly and wastefully the single focus point of the entire country over the last two weeks) on investment outcomes; I’ve never heard nor read so elegantly expressed, so much piffle.

(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at

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