For the nine months ended September 30, our average account gained +18.6%.
It is not quite ninety days since we wrote to you saying, “Inflation is no longer incipient, it is here.” We have spent the intervening three months wondering whether anyone still balances a checkbook, or does the dawning of the age of home planner software mean no one actually knows where their money goes anymore?
If you live on the small island off the coast of America we write from, it is possible you have not been directly touched by 45% year over year increase in oil prices; if you are in regular contact with a gas pump or an oil burner, however, the change ought to be immediately apparent. The rapidly rising price of the world’s most important commodity has quite definitely escaped the attention of the popular press, where “Death of Inflation” is now a headline writer’s staple. Oil has an endless capacity to do a monetary standard damage, as anyone alive in the 1970’s can attest.
It is odd that the country can be suffering from a great many higher prices and not know it, but odder still is the devil-may-care attitude of the investment community. Inflation is lethal to financial assets, particularly with a tax code as punitive as ours. To add to the mystery, the stock market itself is reflecting rather graphically the changed circumstances from the deflationary beginning of this decade, as your accounts are indeed testimony to, since we are outperforming major share indices handily with our inflation-hedged theme, while simultaneously, and characteristically, carrying much larger cash balances than the average manager. Yet the people in the stock market seem not to know what the market itself knows, as the most popular and speculated items remain high-multiple mutual funds, that stand to be savaged should the current considerable inflationary impetus well and truly take hold.
The wealthy believe overwhelmingly that inflation poses no threat to them because the government has been so remarkably convincing on the point. Secretary Rubin garners laudatory press, and Federal Reserve Chairman Alan Greenspan is regularly chosen as the most admired man in the country in poll after poll.
They have formed a two man chorus claiming that the existing consumer price index vastly overstates current inflation and should be sharply “overhauled” by which they mean, of course, de-sensitized to rising prices. This is an artful way to cut entitlement spending, particularly Social Security and Medicare programs, without directly touching those third rails of American political life. It spells political death to limit the rate of increase in these programs, but cutting their cost-of-living adjustments back is considered a mere detail of statesmanship. It is in fact one and the same thing, but the lack of public outrage at the patent dishonesty of the latter method is mute testimony to the power of the notion that inflation is a thing of the past.
Soon the government will add weight to the conflict of interest burden it already bears by issuing inflation indexed bonds. These instruments, said to be expected to replace as much as half of the government’s debt in a few year’s time, grow more expensive to the government as inflation worsens, and less as it wanes. The issuer is also the arbiter of value; would you trust yourself with that sort of power? In the next deficit crisis, there will be no pressure to cut corners by trimming the announced inflation levels just a bit? None?
By a process that is subtle but sure, the government’s efforts to suppress the extent of the current monetary excess, and the market’s willingness to be beguiled on the issue of current inflation, are wonderful opportunities for us. The longer they succeed in blinding Wall Street to the outcome of an excessively easy monetary policy, the greater the head of steam hard assets build up. Jim Rogers, the noted financial commentator and hedge fund manager, has eloquently noted that the last great bout of inflation took years to build, and that the greatest fortunes were made long in advance of the last and most spectacular spurts in the popular price indices.
Our greatest advantage, from here to the end of the century, may well be that the authorities have tied their own hands. The Federal Reserve has countenanced, and indeed oftentimes encouraged, the over the top boom in mutual funds. Common stock mutual funds seem certain to take in this year a sum 30% greater than the entire oil industry revenues. Already Chairman Greenspan uses the expression “runs on mutual funds” in Congressional testimony when referring to nothing more noteworthy than the July slowdown in fund inflows. We put low odds on the prospect of Mr. Greenspan taking vigorous action to rein in a party he has had such a prominent role hosting.
We do not want to leave you with the notion that renewed inflation will be just peaches and cream for all of us, and no consequences in the long run. Here is how John Maynard Keynes characterized the process at the beginning of this century.
“By a continuing process of inflation, Governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
The early days of the process are plenty of good fun, however, and we hope you are as pleased with the results as we are.
Sincerely yours,
Edwin A. Levy
Michael J. Harkins