Beware the false choices of mainstream narratives

We’re at a point in the market that’s difficult to read. The S&P 500 was flat all week, with intraday false breakouts on the upside and the downside. I closed out my short-dated SPY puts Friday morning for a loss a bit under 10%, which is not bad considering they went from 3 weeks to 2 weeks in duration while I held them. Many sectors have been on a parabolic rise for quite some time, and it’s difficult to tell if this is just a pause before more explosive upside, or a top which could lead to a reduction in our extreme levels of margin debt leading to a cascade of forced selling. I’m going to wait for a better signal before I make short-term downside bets again, which will probably be in the 2nd half of May.

I still haven’t found reason to change my positioning focused on a deflationary long bet with TLT combined with a bet that money will eventually rotate back to the gold and silver miners which haven’t really participated as nearly everything else so far has rallied.

I spent this weekend with family and I’ve seen a lot of political tweets, which got me thinking about the strong narratives giving us false choices. Even worse is that passive news sources totally leave out international news, space exploration, new technologies, and anything else just to hyper-focus on divisive social narratives. Consider how blatantly manipulative many of the mainstream narratives are:

• Capitalism vs Communism
  • We constantly see this debate as if our only choices were a “Capitalism” of government favored monopolies and oligopolies versus a “Communism” of direct government control over everything. Don’t fall for this debate – the real issue is about individual choice that everyone wants, which we are losing as power and money are continually concentrated by both political parties. In the end it doesn’t matter if you are being micro-managed by a corporate monopoly or a government panel – this trend toward centralized decision making is bad for all of us.
• Endless Race-baiting
  • The way that major news networks continually push stories about racial violence by police, while constantly asking what side you support, is extremely manipulative. What good does any of it do if we fail to offer a path toward real living-wage jobs?

Inflation vs Deflation

The most important fight in the investing world right now is inflation vs deflation. Unfortunately, it also becomes extremely political. How can you say that inflation is low when the costs of living are soaring, particularly in real estate and rents? The simple answer is that you need to define much more specifically what you’re trying to predict. Are interest rates going up or down and should they? Why are prices in real estate and many base commodities soaring right now? Is it purely monetary – too much money in the system – or is it something else? Are these forces permanent or temporary? The political and economic ramifications of these things are enormous.

I’ll try to illustrate the bulk of my thinking here in bullet points. Let’s start with inflationary vs deflationary forces.

• Inflationary forces
  • Increases in borrowing, putting more money into the economy.
  • Deficit spending, which is simply an increase in borrowing by the government.
  • Supply constraints which can be caused by shutdowns in factories or mines as well as by bottlenecks in shipping due to covid constraints
  • Growth in private incomes which allow individuals to spend more.
  • Inflation concerns which cause people and businesses to increase a stockpile of goods.
• Deflationary forces
  • Taxes, which pull money out of the real economy.
  • Debt payments and interest payments also pull money out of the real economy.
  • Reduction in private incomes which prevent individuals from spending.
  • Uncertainty of incomes which increases the need for saving.

Most of the inflation versus deflation debate concerns whether the enormous increase in the federal reserve balance sheet is flooding money into the economy. The inflation side tends to think it does or it will, while the deflation side argues that all created money is offset by debt, and that all the central bank is doing is forcing the banks to hold more government reserves on their balance sheets which pay out a near-zero interest rate.

Back to the political situation (unfortunately), comes the fallacy of focusing solely on government debt. People are wired to think that way because of our own personal budgets, but it simply doesn’t work in the overall economy. As a family, you assume that your labor can provide a fixed amount of money which can pay down debt or purchase goods. When you look at the overall system, you can’t ignore the fluctuations of demand for labor in general as jobs are created and destroyed. If you just cut spending then it cuts the demand for labor which causes higher unemployment and other associated problems that often trigger required spending with reduced tax revenue and you end up in a bigger debt hole than before. This is what the Eurozone has been living through for the past decade.

The economy is built of people who actively work to produce goods and services. We can encourage this production to increase or decrease. More production can be used for a variety of things from typical service jobs, to mining or construction, to infrastructure building or environmental cleanup. Less production simply means that the economy uses less labor and more people are left to scramble for other methods of public or private support in order to survive.

We are stuck with yet another false choice politically with one side saying we should just pay people to stay home and the other side saying that we should cut spending and let them fend for themselves. Meanwhile homelessness has been soaring for decades while the labor force participation rate has been declining, and this has only made the debt problems worse.

My prescription is simply that we need to address these problems head on, rather than throwing money into asset bubbles and expecting that to solve all our problems. There are many ways to do this, and my favorite is bringing back the Civilian Service Corps and allow anyone to sign up. Just like a military branch, they would have uniforms and barracks and mess halls, and they could assign you to whatever work they needed done. Unlike a military branch, anyone could sign up and the government would have to strive to make them useful.

The most common question is always “how do we pay for it?”. That is entirely the wrong question because it assumes a balanced budget is possible when it isn’t, and it assumes that ignoring the problem is a viable solution when that clearly isn’t either. In the end, debt levels aren’t what matters – it’s all about cash flows. Inflation is a problem when cash flows exceed productive capacity, which can happen in the short term (solved by expanding production or temporary money supply running out), or in the long term (caused by steadily increasing money supply or permanent reductions to production). This is where the “Economic Pie” analogy comes in. We increase this pie by encouraging and increase in production, even if we have to stretch to find uses for the labor. When it comes down to it, we’re better off having a burger-flipper earning a living wage rather than a homeless person fighting for handouts.

I have to close out here as more family events are calling. As a final note, I encourage everyone to keep an open mind and try to figure out where people are coming from rather than trying to convince them of anything. Also, make sure that at least some of your news comes from proactive sources (internet searches, youtube searches, online articles, etc) rather than passive sources (TV or radio programs). Finally, always remember that no amount of online interaction can replace our need for physical human contact and interaction. I’ll be back to markets again next week, I promise.

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