Hussman on Bailouts of Poor Stewards of Capital

This fairly well sums up my view:

[W]hen our policy makers insist on defending reckless lenders with public resources, we have to recognize that this is not free money. When the government issues a paper liability for real value, that real value gets directed to the recipient at the expense of countless other activities. Even seemingly costless interventions can be redistributions of wealth. For example, the strategy of dropping short-term interest rates to nearly zero as a way of increasing the interest spread earned by banks has the direct effect of impoverishing savers, very often elderly people who rely on lower risk investments for capital preservation. With regard to Fannie Mae and Freddie Mac, either the Treasury securities issued in order to cover their losses will crowd out other private investment, or the eventual inflationary effects of printing money to do so will act as an implicit tax on people with fixed incomes. As a side note, we don’t hold any Fannie or Freddie liabilities in the Strategic Total Return Fund. I am still unconvinced that the Treasury’s unlimited 3-year backstop was authorized or even contemplated by the 2008 HERA legislation, which is what the Treasury used as justification.

A dollar spent by the government is always a dollar taken from somebody and diverted from some other activity. The only question is whether the dollar spent is more productive, or satisfies a more desperate human need, than the alternative activity would. If not, the spending is hostile to economic growth and public welfare. There is no free lunch. At best, what people call "stimulus" can only occur if the dollars spent by government are more productive than they would have been if they were allocated privately. I cannot imagine how allocating public funds to the same reckless stewards of capital that made the bad loans in the first place can possibly be a productive use of capital.

All of this would be fairly moot if it we were simply talking about 2008 and 2009. However, my impression is that as the effects of last year’s surge of deficit spending taper off, we will begin to observe a more accurate and generally flat reflection of underlying economic activity.

For the US, it is this understanding – that stimulus has merely been used to maintain a malinvested status quo ante  – that is causing people to turn to austerity in disgust. Team Obama is still talking about stimulus as if there is popular support for such measures. There would be if Hussman’s take on the bailouts weren’t correct.

The Obama Administration has effectively demonstrated that special interests are too entrenched to trust the government to apply effective stimulus. They gifted the financial services industry billions and are still bailing them out via Fannie and Freddie. Afterwards, they went on the Healthcare boondoggle which is rightfully seen as a giveaway to the healthcare insurance companies resulting from secret closed door agreements with the Obama Administration.

They have discredited stimulus as a policy tool. And even deficit spending via tax cuts is now seen as irresponsible because of their efforts. Americans are willing to go with fiscal austerity if only to stop this predatory transfer of wealth.

What does that mean for investing? Hussman thinks that "we have modestly eased from strenuous overvaluation to still clear overvaluation." But that doesn’t mean he is buying the dips. Instead, he is gradually expanding his exposure to precious metals, keeping his treasury duration down to 3-4 years while hedging toward longer term inflation via TIPS.  As I have been saying, first the deflation then the inflation.

Much more here.


Extraordinarily Large Band-Aids – John Hussman

  1. Aram says

    I am not sure if I agree with you that the stimulus has only served as a “predatory transfer of wealth.”

    Take a look at the site for my state — New York — and you see it goes to the exact spots you would expect; transportation, education, energy, housing etc…

    It’s important to note that I am talking about the ARRA ( and not any of the dead-of-night bailouts of AIG et al which should not be considered stimulus IMO.

  2. Curious says

    Edward, could you explain or point to an explanation of exactly how deflation turns into inflation? The reason I ask is that I’ve seen this assertion countless times, but have never seen a detailed, step-by-step sequence to connect the two, not even anyone a theoretical attempt from, say a textbook.

    1. Edward Harrison says

      Consumer Price Inflation comes when sectors of the economy are working near full capacity such that the demand for goods and services outstrip supply. Right now – and for the foreseeable future, supply of capital and labour far outstrip demand. So there is no increase in inflation. Eventually, this will not be the case. In China, the first signs of wage inflation due to the Lewis Turning Point are now being reported:

      After the deflation, these forces will again gather strength and companies with pricing power will be able to pass on the increase in input costs (labor, commodities, etc) onto consumers.

      At that point in time debt levels will probably still be high and so central banks will be loath to withdraw liquidity. Governments will be loath to increase taxes to try and stave off demand. Inflation will rise.

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