- hyperinflation is “a statistical inevitability”
- “It’s going to happen for sure”
- We face “a dire scenario”
- CPI is “a bogus number”
- The current system is “unsustainable”
- “There’s no way out”
We’re supposed to be headed off a cliff any day now. But some version of this pitch has been on offer from a variety of sources since at least 2005 despite reams of contrary data. Why is that?
The specific iteration of this story that I’m referring to (and quoting) is the work of the commodities trader Victor (“Trader Vic“) Sperandeo. To this point, even though Sperandeo concedes that he has been giving the same presentation “for years,” the data remains uncooperative. Inflation of any sort — much less hyperinflation — seems at least a significant ways off. No less an authority than Jeff Gundlach argues that interest rates aren’t going up anytime soon.
Low inflation is both a domestic and a global phenomenon (see below). Yesterday, the European Central Bank even cut its principal interest rate. A day earlier, the Federal Reserve voted to maintain an accommodative monetary policy and noted that inflation has been running below its expectations. The consumer price index has been trending downward since last fall (see below).
Using any of the standard indexes (e.g., CPIAUCSL; PCEPI; PCEPILFE), long-term inflation has been flat since around 1995 at essentially 2%. Those who claim the statistics have been manipulated make an interesting argument (generally discredited), but they have lost credibility because they have been claiming that hyperinflation is just around the corner since at least 2005, sounding like Soviet bureaucrats who always saw prosperity as finally being in store next year. In fact, many experts believe that the CPI overstates the true rate of inflation because of a statistical flaw in its measurement. This is the rationale for changing the way Social Security benefits and tax brackets are indexed for inflation to what is called “chain weighting.” Moreover, some even argue that inflation is too low.
Long-term interest rates have refused to spike higher despite the predictions of so many. Indeed, they fell to historic lows in 2012 and are currently less than 2 percent. As Laura D’Andrea Tyson emphasizes, “[t]he experience of the last four years demonstrates that there is no simple predictable relationship between the government deficit and long-term interest rates.” Even so, she does not project anything like hyperinflation.
As Bruce Bartlett argues, market expectations of inflation are actually falling. Comparing yields on inflation-linked securities with those on non-indexed bonds tells us what markets are expecting in terms of inflation, and they aren’t expecting much (see below).
Many people believe that the price of gold is a very accurate indicator of inflationary expectations. Sperandeo himself is typically in this camp (“there is no opportunity loss owning it. Gold wins in this environment and will go beyond $2000/oz. at a minimum, unless things change on a political level.”). However, gold is signaling declining inflation. The price of gold is down 13 percent since the first of the year (to less than 75 percent of Sperandeo’s alleged “minimum”) and many observers think it has much further to fall to be consistent with the moderate inflation since the big run-up between 2009 and 2012. One of the Fed’s leading inflation “hawks,” James Bullard of the Federal Reserve Bank of St. Louis, has even warned that inflation in running so far below the Fed’s target rate that it may require further Fed action. Falling federal spending due to various budget deals and the ongoing sequester is decidedly disinflationary as well.
In perhaps the biggest news, the budget deficit has fallen by half from 10 percent of the gross domestic product in 2009 to 5 percent this year and will fall by half again in 2015, according to the latest Congressional Budget Office projections. In fact, the Treasury expects to run a $35 billion surplus in the second quarter of this year. Arguably, the deficit is actually falling too fast.
Perhaps most embarrassing of all, Sperandeo’s personal commodities “index”, which is ”designed to capture both rising and falling price trends by taking long and short positions on a monthly basis on 24 futures markets across the commodity, fixed income and foreign exchange asset classes” and which utilizes a “volatility control overlay” has been consistently crushed since its inception (see below). Returns are negative over 1 (-5.6 percent annualized), 3 (-15.0 percent annualized) and 5-year (-12.3 percent annualized) periods (the “index” was created on March 29,2012; earlier data reflects what would have been returned has the “index” existed). As a supposed hedge against what has been deemed a sure thing since 2005, it’s hard to imagine a worse result. Historical backtesting suggests that the “index” shouldn’t be expected to provide more than half the expected returns of stocks — that’s okay for a hedge during particularly tough times or in small positions but quite dangerous when played in size and over extended periods.
Guys like Sperandeo are easy to mock, of course, because they have been so consistently wrong for so many years (despite earlier successes). And while his favored scenario may someday come to pass, in the investment world, early is wrong. And many years early is way wrong. Even so, he could eventually be right if he holds on long enough (indeed, as I write this, silver may be primed for a bump) — even a stopped clock is right twice a day. But that doesn’t mitigate the magnitude of the error.
It’s pretty easy to see what has gone so terribly wrong for Trader Vic.
Sperandeo has taken the big risk of investing based upon his political and ideological commitments. Vic is a libertarian-leaning guy who was certain that Obama couldn’t win reelection. His view of the President is that he is “at best, a socialist who wants to keep his power, and at worst a Marxist who would love to see the OWS [Occupy Wall Street] protests turn into a revolution to kill capitalism.” Moreover, Sperandeo thinks Obama is seeking “class warfare.” Finally, “Obama is a monster problem to the economy, but more so a threat to the freedom of the successful individual.” Rigidity is kryptonite to a trader and since political ideology tends to be very rigid indeed, trading based upon it is very dangerous business. Whatever your political leanings, as Barry Ritholtz explains, politics and investing make terrible bedfellows.
Sperandeo also makes the error of jumping onto a plausible general scenario but pushing it to extreme (and unlikely) heights. Sadly, extremism seems to be necessary to get heard today and nuance is somehow a bad thing. SInce the public responds to extreme certainty, and since there seem to be no consequences to being wrong (Harry Dent – who once predicted that the Dow would reach 40,000 and last year called for a crash to 3,000; the Dow passed 15,000 for the first time this week — is still writing books after all), extreme certainty is what is provided.
Perhaps the most straightforward explanation for Sperandeo’s position is that it is in his economic interest to hold it (no matter how the data ultimately develops). The presentation linked above is used to sell an indexed annuity with returns linked to Sperandeo’s “index.” The product is dreadful, of course, but it is being gobbled up like hotcakes. A big reason it sells so well is fear-mongering as promoted by Sperandeo. It’s hard to imagine a clearer case of confirmation bias and motivated reasoning. As Upton Sinclair famously expressed it, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”
Trader Vic is clearly and obviously wrong (even if hyperinflation were ultimately to show up). His key argument is that the inevitable “tipping point” making hyperinflation inevitable is when a country’s deficit reaches 20 percent of GDP. SInce the budget deficit has fallen by half from 10 percent of the gross domestic product in 2009 to 5 percent this year and will fall by half again in 2015, according to the latest Congressional Budget Office projections, and since Treasury expects to run a $35 billion surplus in the second quarter of this year, I’m not talking politics and I’m not talking about opinion when I state unequivocally that “Trader Vic” has made an enormous and egregious error.
Just don’t expect him to recant anytime soon. And if you’re acting today on Sperandeo’s ”inevitable” hyperinflation, don’t say you weren’t warned (and look-out for the consequences).