Can Investors Stand the Heat?

08/15/2012 10:00 am EST

Focus: MARKETS

Jack Ablin

CIO & Executive Vice President, BMO Private Bank

Because inflation is the likely end result of any action the US takes to reduce its debt, investors need to find protection before policymakers turn up the heat, says Jack Ablin.

The debt millstone. How central banks and the financial markets are at odds at this point. I'm with Jack Ablin, who's going to explain this to us.

Thanks, Gregg. I think that now that we've run up so much debt, both on the private side and the public side, we have to look at history to figure out how we get out from under this mess.

Our best bet, and Plan A in terms of policymakers' minds, is what's commonly termed as financial repression. Essentially, let's run inflation higher than interest rates and then just pay back our debts with cheaper dollars.

If you look back in history, it's worked. After World War II, we ran up a debt to GDP of about 125%, and yet within ten years we were able to knock it back down to 55%, largely by running inflation between 10% and 20% and keeping interest rates at 5%. I guess from a pure big-picture policy perspective that makes sense.

All right, so there are some winners and losers. Well, who are the losers? The losers are going to be anyone who has lent us money, like the Chinese and some of our trading partners-but more notably, retirees. Anybody who is relying on the value of their portfolio to generate income to meet their spending could suffer and will likely suffer in an environment like that.

We've spent a lot of time researching and developing a plan to try to take care of our clients who in retirement are looking for income from their portfolios to make sure they stay ahead of inflation.

Now, do you see this as an inevitability? This sounds sort of like the Carter years, as well, where the real rate of inflation was a little bit lower, but yet huge inflation. When you subtracted out the interest rates, it wasn't so bad.

Yeah, the parallels are similar. I think that in my view, given the debt load and given the trajectory, unless we can wrap up natural growth in our economy so quickly to shrink this debt in real terms, the only other alternative would really be kind of a disinflation, deflation. Of course, with a debt-based society, that ends in default.

I think that given that Chairman Bernanke has studied the Depression and studied disinflation, my sense is they're going to err on the side of heating things up a little too hot, figuring they can always tamp them down later.

What are some of the advantages here? Who's advantaged in this scenario like this? Well, anybody who's borrowing who can lock in long term and then generate kind of more current income. Like a hotel or a rental apartment or even an equity investor. Long term, I think things are likely positioned well for any security or investment that has that purchasing power protection.

Related Reading:

Has Fed Action Helped or Hurt the US?

Are We on the Road to Hell?

Baby Boomers' Pensions Are Busted

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