In an attempt to curb out of control inflation, Richard Nixon thought it would be a helluva good idea to freeze prices! He might as well have tried to command the ocean to retreat during an incoming tide for all the good it did him.
Price controls are one of those ideas that sound good but are actually the worse thing a country can implement to curb inflation.
Let me explain:
Commodity prices can start declining when expensive commodities get replaced with cheaper materials. For example, in the '70s, as metals prices soared, we saw plastic begin to displace metal in automobile production.
As commodities increase in price, commodity companies drastically increase production. At some point the commodity price gets so high that it eventually kills demand. That lack of demand, matched with oversupply, results in sustained periods of commodity price declines.
Remember that high commodity prices actually spur innovation. Without high oil prices, we may never have seriously looked at alternative renewable fuels. Without the oil spikes of the '70s, we never would have developed the diamond tipped drill that revolutionized deep water drilling. When oil was at $20 a barrel nothing could compete with it, but at $100 it’s a different ball game.
When you have price controls, the commodity bull market cycle is prolonged due to two linked factors. The first is that commodity producers manufacture less of the commodity because they are not being adequately compensated. In addition, consumer demand continues to rise since prices are being held artificially low.
As a result, horrible shortages in essential commodities develop. From this, two markets emerge: the “official” market and the “black” market. The black market prices end up being far higher than if the government had not intervened.
The only viable ways for a government to shorten the up swing portion of the commodity cycle is to do everything in its power to foster overproduction or aggressively fund the large scale commercialization of cheaper alternatives. While these options seem counterintuitive to most policy makers and they are definitely not popular with the voters, they work.
China is further compounding its errors by subsidizing the price of oil to their citizens. This is a grievous mistake that will result in huge price shocks to the average Chinese citizen when China abandons its oil subsidies due to high prices. Over the short to intermediate term, I’d avoid too much direct international exposure and start to look at the US market.
The values here in America are beginning to become quite compelling. Yes, sentiment is an absolute mess right now, but for longer term players there are some bargains to be had. I haven’t seen sentiment quite this grim since 1998 and 1991. A quick perusal of the banks, brokers and retailers would certainly suggest that a recession of some magnitude has already been priced into these stocks.
Of course, this being the market, most will be too afraid too commit funds down here as was the case in ’98 and ’91. Paradoxically, it’s at times like these that risk is lowest. That doesn’t mean that we can’t see more volatility, we surely will. But, if you believe that the sun will shine again for the US economy, then it’s time to start taking a hard look at the US banks, brokers and retailers.
Chief Investment Officer
ETF Master Trader