1. The Myth Of Gold as Inflation Hedge: Is another bubble being created? « Wars & Rumor February 22, 2010 @ 5:52 pm

    […] Black Swans, Bell Curves and Stagflation […]

  2. Raju March 30, 2010 @ 2:29 am

    The post included some complex topics. But you try to make readers clear about those complex topics.

Black Swans, Bell Curves and Stagflation

Economics, Finance Comments (2)

This is not the promised article about the stupidity of black swans. This is an article about how we tend to focus our attention on the odd, rather than the mundane. I guess some talking head mentioned stagflation, because the previous article on the subject received unusual attention. People are hitting the site searching for a “stagflation hedge”. In my cozy ivory tower (I am done trading for the year, and there is no point in ruining a nice winter vacation with long- term worries), I can imagine that there’s quite a bit of fear and looting going on in Wall Street.

Let me remind my readers of what I said October 3: “News will fly, both bad and great, talking heads will talk about recession and inflation, and some times, they will talk about them on the same line to mention stagflation (stagflation will be mentioned only by those at the forefront of thefinancial analysis).” I think we are finally there. Wall Street operators will put a lot of pressure on the markets to sway the small guy. If you can’t afford losing a fortune and you are short, they will take you out before the big payoff. If you can’t afford losing a fortune and you are long, they will take you out before the big payoff.

What do I think? We are at the bottom of the recession, or close.

In any event, the next year will be harsh. The only escape for the Fed is to keep injecting money into the system. They are able to do it because China needs to keep growing in order not to collapse. China will keep buying our debt to finance our purchases in order to keep growing, betting to build an internal market before it is too late. As the Fed injects more and more money into the economy, the balance between the deflationary force of China and the inflationary force of the American lazy-faire economy will break and a real crisis will develop. But I wouldn’t think this will happen until gold hits somewhere around 1,400.

I started hearing rumors of foreign investment clubs buying condos on the cheap in Miami (and I mean, entire buildings, and with a 50% discount). It is a long-term strategy that makes a lot of sense if you are a foreigner and you think that the dollar will eventually recoup against other currencies.

I would expect oil rich countries to start hedging the falling value of the dollar with the purchase of American companies (like the recent incursion of Abu Dhabi) and prime real estate (most probably commercial real estate in big cities). I am wondering how and when China will start buying real American assets. They need to do it, but so far there has been a lot of resistance.

Oh yes! I was writing about stagflation! Well, it is a rare occurrence. It is possible, yes, as is everything else in our wide universe. The question is not if it is possible, but how probable it is. The likelihood of stagflation as we saw during the 1970s is academically slim. Which means, you will be able to prove with numbers that we are, or were for a time in stagflation, but the effect will not be in any way similar to that of the 1970s. And this is where the bell curves and the black swans come to play.

And now, the warning coming from Wall Street, I become suspicious of the fear of stagflation. In other words, I find it prudent to buy life insurance, but I find it suspicious when somebody threatens my life and offers me a policy.

Everything is possible, but some things have more probability of happening than others. The distribution of probabilities follows a bell curve, with the more probable events in the center of the curve.


The things that happen with more frequency are those in the shadow of the green line around the 0. Everything else you see happening in the chart is possible, just not as probable as the rest of our boring lives.

So, let me impress you with a formula: The probability of a period of stagflation is well down there by the sides of the curve, next to dating a smart and deep super model who really understands your inner needs.

The black swans are like the understanding super models who find our neurosis attractive, if we ever see one, we will be talking about it for the rest of our lives.

Happy holidays!

PS: Right after finishing this post I found an interesting piece of news regarding China and the purchase of American companies: Morgan Stanley Gets $5B Investment From China

Franklin @ December 19, 2007

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