Having looked at the bleakest monetary situation imaginable in my previous post on Venezuela, I should probably point out that this is a special type of destructive monetary scenario. It’s highly unlikely to occur globally, and probably won’t start locally, at least, not until you start to see the helicopter cash drops outside your living room window. Deflation is much more likely in the near-term as is evidenced in the Austrian School article I linked from 2009 on the Marginal Productivity of Debt and it was also evidenced in my post on the global M2 monetary aggregate. Commodities are the canary in the coal mine here. Regardless, a few specific countries might become debtor pariahs to the creditors and get Venezuela’d.
This naturally begs the question, how do we hedge against deflation?
Well, you might have already guessed that cash, or currency is the way to hedge deflation. I would point out though, it isn’t as simple as it sounds. There are multiple risk factors present. In this kind of crisis it becomes a question of “what is sound money?”
Firstly, what currency? Well, I’m banking in the near-term, as are a lot of other investors upon the US Dollar (see the DXY chart). This makes me deeply uneasy though. I prefer to be contrarian, and lots of people are already deep into this trade.
Precious metals, or even diamonds might be a store of value against rising taxes. Clearing debt is always advised, but of course, the trick is to clear the debt before you are crowded out by the paradox of thrift.
Once again, in the short-run, cryptocurrency should probably feature. I’ll post more on Bitcoin and cryptocurrencies in general at a later date.
I would absolutely NOT recommend property. It is a five lane highway going in, and a goat trail coming out. In deflation liquid assets which hold their value reign supreme. Property is not a liquid asset. This is a definite bull trap, I’ve spent long periods of time trying to think of just one positive scenario I can fit to property and I couldn’t come up with one. (Well, maybe just one.) But again, probably keep the subject of another post.
Dividend paying stocks, with minimal leverage and good cash flows might also feature.
In addition to hoarding stores of wealth, a deflationary trend will make it extremely difficult for many people to maintain an income and if their income is assured, it might see declines. All on account of thinning liquidity everywhere.
This is pretty obvious now from the increasing lay-offs in the commodity space, including Schlumberger’s layoffs of which an additional 10,000 were announced just recently. It will transmit through the other segments of the economy as we go. When it comes to how to invest during deflation, we should probably take cues from the Japanese.