28 THE BiG DROP
Both outcomes are very dangerous for you as an investor.
The economy is poised on the knife edge of destructive deflation
and runaway inflation. Prices could quickly and unexpectedly
fall one way or the other.
This doesn’t mean you should throw up your hands and
say “I don’t know.” Plenty of analysts will tell you why you
should fear inflation. And prominent policymakers such as
Christine Lagarde of the IMF and Mario Draghi of the ECB
have warned of deflation. Yet analysis has to be more than
a matter of guesswork or stating a bias. The correct analysis
is that both deflation and inflation are possible. Anyone who
warns just of inflation or deflation is missing half the puzzle.
If you knew deflation was coming, you’d have an easy time
constructing a profitable portfolio. You would have some cash
and invest primarily in bonds. The value of cash goes up during
deflation as prices decline, and bonds rally as interest rates de-
cline. You might want to own some raw land in that case also.
During a deflationary period, the nominal value of the land
might go down, but the costs to develop the land go down
faster. The key would be to develop it cheaply in time for the
next up cycle.
If, on the other hand, you knew inflation was coming, it
would also be easy to construct a robust portfolio. All you
would need to do is buy commodities like gold and oil, and
stocks of companies with hard assets in sectors such as trans-
portation, energy, natural resources and agriculture. You could
also purchase fine art, which has excellent wealth preservation
properties in an inflationary environment.
What should you do when the outcome is on the knife edge
and could tip either way toward deflation or inflation?
The answer is prepare for both, watch carefully and stay
nimble. Your initial portfolio should have gold, fine art, raw
land, cash, bonds, select stocks and some alternatives in
strategies like global macro hedge funds and venture capital.