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Philip Fischer was prescient about depressions


scorpioncapital
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Check out this quote from Common Stocks and Uncommon Profits:

 

"As already explained, our laws, and more importantly our accepted beliefs of what should be done in a depression, make one of two courses seem inevitable. Either business will remain good, in which event outstanding stocks will continue to out-perform bonds, or a significant recession will occur. If this happens, bonds should temporarily out-perform the best stocks, but a train of major deficit-producing actions will then be triggered that will cause another major decline in the true purchasing power of bond-type investments. It is almost certain that a depression will produce further major inflation; the extreme difficulty of determining when in such a disturbing period bonds should be sold makes me believe that securities of this type are, in our complex economy, primarily suited either to banks, insurance companies, and other institutions that have dollar obligations to offset against them, or to individuals with short-term objectives. They do not provide for sufficient gain to the long-term investor to offset this probability of further depreciation in purchasing power."

 

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It is almost certain that a depression will produce further major inflation

 

 

 

Japan's experience with persistent deflation seems to offer contrary evidence. There is a fine article from the JapanReview.net titled "Can the Bank of Japan Create Inflation?" If you look at the author's "top 5" post-hoc explanations for the absence of inflation, any of them can be applied to America today.

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Phil Fisher's comments are based on the American system and what has become politically acceptable and not after the dark days of the Great Depression (which not a lot has changed in that regard).  Japan's employee/employer culture is completely different.  5 years into their crisis, the unemployment rate was only at 3%.  10 years into it --- unemployment peaked at 5%.  Compare that to the U.S. situation where unemployment will perhaps hit 10% or more in very short order. 

 

The labour/corporate culture in Japan meant that as a loyal employee you agreed to take a cut in wages now and then to keep yourself and fellow workers employed.  While this might exist to a certain degree in the American system it is not nearly to the massive long-lived scale as it is in Japan.  If your employer is to keep cutting back your wages in America you eventually seek a new employer or move on to a new line of work or maybe self-employment, etc --- that is not the way it is in Japan.  In Japan you are loyal to your employer until retirement and that tradition is passed down to your children (as it has been for generations).  But it is again a mutual system and in tough times as they were -- the Japanese employer was also obliged to cut back on margins. 

 

Think about it --- employees taking pay cuts + employers purposely lowering margins = deflation.  It might be a good system when it comes to employment security -- but when it comes to creativity in growing an economy not so good compared to the American one. 

 

Furthermore, it took about 12 years for Japan to lower interest rates from about 8% to near zero.  Compare that to the swift action of the Fed.  Two completely different situations.   

 

UCP / DD

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That is a fair point about differing unemployment rates; that, and similar misallocation of capital, distinguishes Japan from the U.S. Or, I should say, similar types of misallocation of capital. Rather than pushing money to less productive workers, the U.S. will bolster inflated home prices via tax credits, deferral of GSE foreclosures, and various purchase plans for real-estate linked assets. Efforts to reflate real estate seem to be an attempt to maintain a 70% consumer economy. And Japan did lower the discount rate by about a percent a year from '90-'95, until it sat below 1% thereafter. After '95, real GDP increased by more than 1% despite the IMF crisis and the stock bubble. Meanwhile, avg. household disposable income fell by about 3.6% and expenses by 3.9% from '95 to '01. Households also saved less, down from 12% in '95 to a little over 7% in '03. So why did the Japanese watch their savings and incomes shrink without aggressively seeking yields higher than the paltry prevailing interest rates? Discouraged investors?

 

Japan and the U.S. may be apples and oranges. But it's also possible that tremendous real estate deflation will smooth differences. Of course, I hope that the stimulus works and that the worst case scenario is a high interest rate environment to contain future inflation. I still want to prepare for an economy that goes flat for a while. 

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Print and deliver $1 million cash to each and every family in America -- and I can assure you the system will inflate (no doubt big time!!).  Of course this is an overblown/exaggerated example -- but if inflation is preferable to deflation it should be obvious that the only thing standing in the way is political will.  And that political will works a lot quicker in America than it does in most other parts of the world (here in Canada there is arguably a lot of envy over the American system).

 

Finding the right balance at the current moment is the trick.  If it is too much the system will certainly inflate.  If it's not enough then deflation may become a problem in the short term but one can be assured that more (stimulus) will come.  Prior to the crisis in Japan --- unemployment was typically close to zero percent.  Had it reached 5% very quickly (rather than taking a decade) --- there would no doubt been a lot swifter action and deflation would have not been a long term issue.  The culture may be changing a bit in Japan now --- but that was the way it worked back then. 

 

As for the current stimulus and interest rate action in the States --- finding the right balance is obviously key.  To some it seems that they are overdoing it and inflation is going to be huge going forward.  Others like yourself worry that it will take forever to work through this and deflation is going to be a persisting problem.  Perhaps the right balance is being struck?  In the end --- I don't see the stimulus being such that will enable people to pay off their houses (and other debt obligations) in any dramtic fashion.  If that's the case then mortgage rates won't be rising much any time soon (perhaps for the next decade or two).  Higher rates simply are not affordable without pushing the system back into recession. 

 

So could it be possible that mid and long term bonds trade in the current range of 2-4% (or lower) for the next several years?  If so -- that would seem to bode well for common stocks which are currently yielding much higher.  If it bodes well for common stocks as a whole --- it would seem to be the most opportune time in quite a while to seek out of favour bargain situations of good quality. 

 

One other point is that a lot of emphasis has been on the financial and housing crisis being the sole cause of this global recession.  But what about high oil (and other commodity) prices?  High oil prices have been the prelude to many recessions in the past.  An increase in oil price (first Gulf War) also helped push things into the brink for Japan -- but the rise was not nearly as dramtic as it was in the current situation.  I think the role that high energy and commodity prices played in helping ignite the current situation has been under-estimated to a great degree.

 

UCP / DD   

 

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