Prepare for an inferno of inflation

InfernoOne of the more talked-about news items in recent weeks was the very public resignation from Goldman Sachs of Greg Smith, an executive director and head of the firm's United States equity derivatives business in Europe, the Middle East and Africa. In a letter to the New York Times he wrote:

"The interests of the client continue to be sidelined in the way [Goldman Sachs] operates and thinks about making money... It makes me ill how callously people talk about ripping their clients off... managing directors refer to their own clients as 'muppets'".
There was dissent in the ranks at BP , too, as chief executive Bob Dudley's £4.5 million pay package for 2011 did not go down well with many shareholders, one of whom told the Daily Telegraph:

"You should not be paying out these bonuses until shareholders actually benefit from the company's fortunes, otherwise you give an impression of boards' snouts in the trough at shareholders' expense."

The question of how businesses and financial institutions are managed has come under greater scrutiny since the start of the credit crunch. Former Dragons' Den investor James Caan suggests one solution:

"One of the questions we always ask is, if the global economy operated under Sharia-compliant finance, would we have had a credit crisis? I think the answer is no, actually."

John Bogle, founder of Vanguard, the world's biggest mutual-fund manager, also had something to say on declining standards in the industry:

"When I came into this field, the standard seemed to be 'there are some things that one simply doesn't do'. Today, the standard is 'if everyone else is doing it, I can do it, too'. When we replace moral absolutism with moral relativism, traditional ethical standards go by the board."

He had some words for British investors also:

"There's a lack of competition [in the UK Market]... People are taking a lot of time to wake up to the fact that the single most important factor in determining fund performance is expenses."

Peter Smith, head of investments policy at the Financial Services Authority, appears to be thinking along similar lines:

"In what is allegedly a competitive industry, the UK funds market, how is it that the average cost of funds has risen over the years rather than fallen? That's something we're going to be thinking about."

One bear, one bull
Regarding the markets, Neil Woodford, who recently explained why he dumped his shares in Tesco, was decidedly bearish:

"The current wave of optimism sweeping global stockmarkets assumes that the developed world will now emerge from the period of low economic growth it has faced since the banking crisis of 2008. Our view is that it will not, and that growth will continue to disappoint and, in the near term, will slow in 2012."

In the US, however, David Dreman was bullish:

"There are a number of good reasons for the rebound. First, we are slowly coming out of the worst depression since the 1930s. Despite the cries from 'gloom and doomers'... stocks are at their lowest values in over 20 years."

"Company balance sheets are strong, and earnings approaching record levels. A second important reason is inflation, which is coming. Smouldering inflationary fires will burst into an inferno once the unemployment rate falls below 7.5%, if not sooner. In this environment, good stocks, not Treasuries, are the place to be. Rising inflation-primed interest rates will send bond prices plummeting."

Wilbur Ross was similarly negative on US government bonds:

"I think the greatest bubble that is about to burst is the 10-year and longer Treasury, because the idea that inflation is gone forever and for all time, and therefore these artificially low rates can last, is silly."
Resource limitations
His comments echo recent statements from GMO's Jeremy Grantham, who was in London recently to give a talk on American attitudes to investing, resource limitations and global warming, which I had the pleasure of attending. To pick just three soundbites from a thought-provoking evening:

"What frighten me are the Americans who have developed a supreme contempt for science, and a wonderful ability to deny facts."

"You can have sustainability or you can have growth; you cannot have sustainable growth."

"I have become a Malthusian because of the facts and the logic of the math involved."

I'm sure he meant to say 'maths' rather than 'math' but after nearly 50 years in the United States, I'm sure he can be forgiven for that.

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