Integrating Assorted Convictions from the Inflation & Deflation ‘Camps’ – The ‘Scarcity of Capital’ Trade

The investment community at large has become strangely polarized into the ‘inflation camp’ and the ‘deflation camp’. The protagonists of these two – mutually antagonistic – groups are occasionally dogmatic in their convictions; a trait that we ought to avoid as contrarian investors. Seemingly, if you’re – say – long commodities, you’re assumed to have adopted the prejudices of the ‘inflation people’. Likewise, if you’re – say – long government bonds, you’re assumed to share the ideas of the deflationists.


Does it have to be like this? Does one have to choose to be an orthodox inflationist or an orthodox deflationist?


My opinion is that one doesn’t have to choose to belong to either group, and that one never had to choose. In fact – with the premise that large groups of similarly minded speculators never make serious money - I contend that it pays not to join a definite ‘camp’ in this debate. A passage from Humphrey B. Neill’s book, The Art of Contrary Thinking, comes to mind:


It is a simple matter to be dogmatic and definite when one is writing on a given economic subject or trend. A commentator can pick up a collection of comments from economists and analysts, jot down the composite conclusions expressed, and then write out a blunt “opinion”.


However, there is a serious drawback to being dogmatic in economic comments. Rather, there are two drawbacks to be considered:


  1. More often than not, a given economic trend may be unpredictable at the time of writing about it. Therefore, a definite or dogmatic statement is merely a guess expressed as if it were knowledge.
  2. Moreover, when definite statements become generalized they are likely to “defeat themselves.”


It is common to bemoan the confused state of affairs, when we’re trying to arrive at decisions. Quite often, however, we use the confusion as an excuse for not thinking.


I, contrarily, believe there is value in bewilderment.


Consider the opposite of uncertainty and confusion; namely, dogmatism. I dare to say that more important errors in decisions arise from dogmatic opinions than from what I shall call “confused considerations.”


For a fantastic example of a speculator who was flexible in thought and execution; see my article on Jacob Michael (he made a great proportion of his fortune by betting on a ‘scarcity of capital’ near the end of the hyperinflation of the Weimar Republic.)


The Bane of Our Existence: Wasted Capital


On an aggregated basis, the world has a finite amount of valuable stuff. This stuff has been accumulated by centuries of hard work, innovation, greatness and abstinence. The essence of our time is that an increasing proportion of the (developed) world’s capital is being controlled by (demonstrably) incompetent people. Such people draw upon existing wealth rather than create it. [Note: it is demonstrable by the prevalence of laws in favor of certain institutions, bailouts, etc.]


To be sure, I’m not explicitly saying that the economy as a whole is shrinking or whatnot. Rather, I’m saying that an increasingly large proportion of our precious capital is in the wrong hands. The creation and innovation elsewhere may entail net progress, I don’t know.


However, I can say something about a world where capital is continuously being burned, and people don’t realise it. If people opt for life and progress over death and decay, the future will eventually contain some kind of discovery that capital is considerably more scarce than previously thought.


Integrating the good parts of the Inflation & Deflation Sides:


The way I reconcile the great insights of the inflation/deflation debate is to note that – regardless of the particular manifestation – it is likely that the current policies of rewarding incompetence and punishing prudence will lead to a scarcity of capital.


If this is true, then – regardless of one’s particular investment bias towards inflation or deflation – one should exclusively own concrete forms of capital. In a world where it comes to be realized that – collectively – we’re not as rich as we thought, it should be clear that owning and keeping valuable wealth will be profitable (one would own something that everybody suddenly and desperately wants). Indeed, if the above is true, then one should avoid investments that are predicated on the status quo remaining in place. For the inflationists, this would include avoiding very conventional developed-market equities. Likewise, for the deflationists, this would include avoiding stuff that we call ‘cash’ that is really some kind of IOU; e.g. MMMFs , developed-market bank accounts (bar Swiss) and so on.




We should avoid thinking in the same way as large groups of people; regardless of the comfort of doing so. A neat way to reconcile the insights of both sides of the inflation/deflation debate is to note that they both describe manifestations of a scarcity of capital. Thus, regardless of our short-term bias towards inflation or deflation, we should seek to own concrete forms of capital and seek to avoid (and/or speculate against) assets that are predicated on a goldilocks economy.


See here for our collection of rare historical economic data.

Posted Mar 24, 2011
  • http://concreteformsofcapital=? Floyd

    Silver? Unless we are heading hi-inflation, isn’t it suspect [bubble]?
    Gold? Some argue that it became really expensive vs. housing (and may be bubbly, too).
    Housing? (lots of concerns and actual issues here)
    Commodities? They sure seem overpriced nowadays…


    • Aftab Singh


      With regards to silver & gold; perhaps, I don’t know. My personal investment bias is to try and execute against consensually minded people that base their decisions on false premises. So applying that here, I guess we know that one doesn’t have to think contrarily to buy silver now; people are comfortably long, so I’m not even dreaming about entering here. However, that being said, I bought my silver and gold a long time ago and I’m not selling (probably even if it halves).. You can own gold and silver in a really concrete way (physical) that means that you’ve definitely ‘got capital’… I like that aspect. And even if we do have a deflationary collapse, severe monetary debauchery might follow and one could miss entry points into gold and silver… at least this way I sleep at night..

      With regards to housing, yeah I agree; in particular I’m worried about the effects of QE2; the composition of the Fed’s balance sheet is changing away from MBSs and towards conventional government bonds. The institutions that are deeply entwined with housing may once again find themselves insolvent (as the burden of their dollar liabilities overpowers their assets). I talk about this in my Fed Balance sheet updates.

      Again, I kind-of agree. I wouldn’t buy commodities now really, I’d look for better entry points that come along with the gut-wrenching turns that typically occur in these markets. I wouldn’t short physical commodities now either (with futures); that would violate my above contention about the ‘scarcity of capital’ (I may do that in the future with really overbought levels though). If I were to play the ‘overpriced’ nature of commodity prices today (if that’s true), I would speculate against equities that are predicated on those commodity prices staying high (e.g. commodity-related companies that are brazenly unhedged etc.).

      What about you, are you convinced enough to bet against some of these things? I admit that there could be enormous potential for a vicious cascading of trades, it’s just not in my personal objectives.

  • Kyle

    “Likewise, for the deflationists, this would include avoiding stuff that we call ‘cash’ that is really some kind of IOU; e.g. MMMFs , developed-market bank accounts (bar Swiss) and so on.”

    In a deflationary environment, why would one want to avoid cash? Is the reasoning simply because the status quo of the deflationist is to hold USD cash, and therefore avoid holding cash?

    Thanks, new reader, so I may be behind on what otherwise might be communicated clearly through other blog postings.

    • Aftab Singh

      Hi Kyle,

      Apologies, perhaps I was somewhat unclear in my post, your questions are always welcome.

      What I mean is that you don’t want to own claims on cash whose credibility could come into question. I still think that the essence of a deflationary period is that cash becomes – suddenly and drastically – very scarce. That is, the ‘money supply’ plunges in a short period of time. Personally, I take that as meaning that you don’t want to own a portion of the money supply that goes up in smoke: rather, you want to own the surviving portion of the money supply. That is, you want own concrete forms of cash, and not (conventional) IOU claims on cash. Practically, I take that as meaning bank deposits at exclusively solid institutions, physical cash stored somewhere, or some other robust form of ‘cash’. ‘Inextinguishable cash’ – so to speak.

      If the institutions that owe you physical dollar notes are dependent on the current structure of prices; those claims could seriously come into question: at that time, if you’ve got solid capital – you’re king. (Like Jacob Michael of the Weimar Republic).

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