I dont know. These three words dont
inspire a lot of confidence in the messenger and probably will
not get me invited onto CNBC, but that is exactly what I think
about the topic I am about to discuss.
I received a few e-mails from people who had a problem with
a phrase in one of my
blog posts this fall. In that article I examined various
risks that other investors and I are concerned about. The
phrase was the prospect of higher, maybe even much
higher, interest rates. These readers were convinced that
higher interest rates and inflation are not a risk because we
are not going to have them for a long, long time, that we are
heading into deflation. These readers basically told me that I
should worry about the things that will come next, not things
that may or may not happen years and years down the road.
I am pretty sure that if that phrase had addressed the risk
of deflation and lower interest rates ahead, Id have
gotten as many e-mails arguing that I was wrong that
well soon have inflation and skyrocketing interest rates,
and deflation is not going to happen.
I dont know whether we are going to have inflation or
deflation in the near future. More important, Id be very
careful about trusting my money to anyone holding very strong
convictions on this topic and positioning my portfolio on the
basis of them.
Any poker player knows that the worst thing that can happen
is to have the second-best hand. If you have a weak hand, you
are going to play defensively or fold (unless you are bluffing)
and likely wont lose much. But if youre pretty
confident in your hand, you may bet aggressively (god forbid
you go all-in) after all, you could easily have the
winning cards. Four of a kind is a great poker hand unless your
opponent has a straight flush.
Generally, the more confident you are in an investment, the
larger portion of your portfolio will be placed in that
position. Therefore superconvinced inflationists will load up
on gold, and superconvinced deflationists will be swimming in
long-term bonds. If their predictions are right, theyll
make a boatload of money. If theyre wrong, however, they
will have the second-best-hand problem and lose a lot of
The complexity of the global economy has been increased by
monetary and fiscal government interventions everywhere. There
is no historical example to which you can point and say,
That is what happened in the past, and this time looks
just like that. When was the last time every major global
economy was this overlevered and overstimulated? I think never.
(Okay almost never, but you have to go back to World War II.)
What is going to happen when the Fed unwinds its $4 trillion
balance sheet? I dont know.
Also the transmission mechanism of problems in our new
global economy is so much more dynamic now than it was even a
decade ago. Just think about the importance of China to the
global economy today versus 2004. That year U.S. imports from
China stood at $196 billion. Just in the first eight months of
2014, they were $293 billion. China was single-handedly
responsible for the appreciation of hard commodities (oil, iron
ore, steel) over the past decade as it gobbled up the bulk of
I dont want to sink to the level of the one-armed
economist but conversation about inflation and deflation
is just that, an on one hand . . . but on the other
Just like in poker, second-best hands may be tolerable if,
when you went all-in, you did not leverage your house, empty
your kids college fund or pawn your mother-in-laws
cat. Even if you lost your money, you will live to play another
hand maybe just not today.
In the I dont know world, second-best
hands when you bet on inflation or deflation are acceptable on
an individual position level (you can survive them) but are
extremely dangerous, maybe fatal, on an overall portfolio
Investing in the current environment requires a lot of
humility and an acceptance of the fact that we know very little
of what the future holds. Id want the person who manages
my money to have some discomfort with his or her economic
crystal ball and to construct my portfolio for the I
dont know world.
As a writer, you know you are in trouble when you have to
quote both Albert Einstein and Mahatma Gandhi in the same
paragraph, but when I ask readers to do something as difficult
as I am in this column, I need all the help I can get.
It is unwise to be too sure of ones own
wisdom, Gandhi said. It is healthy to be reminded
that the strongest might weaken and the wisest might err.
Einstein took the idea a step further: A true genius
admits that he/she knows nothing. Smarter and humbler
people than me were willing to say, I dont
know, and it is okay for us mortals to say it too. Repeat
after me . . .