We are living in interesting times.  While the professional economists are trying to figure out what happened we have all become economists of sorts just to try and understand the events that greet us every day.

With huge deficits many would expect inflation as another weak willed government resorts to the printing press to solve its problems.  In response we are saturated with ads to buy gold, the default inflation hedge.  Yet I well remember the inevitability of inflation in the 1970’s as gold passed $800 an ounce; only to hit the Reagan/ Volcker wall.  Inflation fell as did the price of gold.  In inflation adjusted dollars gold has yet to recover over 25 years later.

Retired economist Scott Grannis, in his excellent blog, Calafia Beach Pundit, explains how we can be looking at record low bond yields and interest rates while the deficit hits and record levels and  inflation remains tame.  It is a subject that has puzzled me. Read A bond bubble?

Excerpts:

So perhaps there is, in addition to weak growth expectations, an inordinate fear of the future: a fear of big tax hikes, and of a prolonged economic malaise caused by an overbearing state that absorbs the fruits of and smothers the private sector. Japan comes to mind, with its massive deficits, a debt/GDP ratio that has been well into triple digits for years, and sluggish growth. Perhaps it’s the case that as debt approaches and exceeds 90% of GDP the economy simply loses much of its forward momentum, a thesis supported by the findings of a recent research paper by Rogoff and Reinhart. There’s even some support for this thesis in our own history—muddled of course, by WWII—when federal debt surged to 120% in the early 1940s, even as 10-yr yields traded at 2% or so.

If the market is scrambling to buy bonds yielding 2.5% or less, it only makes sense if market participants hold little or no hope for a better alternative in the foreseeable future on a risk-adjusted basis.

It also makes sense that today’s almost-zero yields on cash, extremely low yields on risk-free bonds, and massive debt sales become in a sense a self-fulfilling prophecy. Low yields represent very low hopes and aspirations on the part of the private sector, while the bonds being sold and the money absorbed from the private sector by our federal deficit are being used to fund a level of spending and wealth redistribution such as we have never seen before.

We’re not witnessing a bond bubble in the making, we’re living in a statist nightmare.

During the 1970’s the sudden and enormous wealth of the Arab World as a result of the oil cartel OPEC, made everyone think they would rule the world. Raising oil prices as a result of the US aid to Israel during the 1973 Yom Kippur War (disproving the myth that we only fight for oil), the oil shieks were reported on lavish shopping sprees at Harrods’s in Great Britain handing out 100 dollar bills as tips.

In the 1980’s the Japanese were in the ascent. They bought the Pebble Beach Golf Club, and management consultants tried to copy the Japanese miracle as Japanese cars spelled disaster to the Detroit auto industry.

In the 1990’s the Japanese bubble burst and they have yet to recover.  We refer to their lame policies to reignite their economy as the lost decade. The 1990’s was the American decade. The dot.com boom, the internet industry, billion dollar hotels in Las Vegas, stunning victory in Desert Storm, and a budget surplus showcased American economic strength.

The first decade of the millennia was the Chinese decade. They discovered capitalism, hosted the Olympics, began to develop a middle class, and began an industrial growth that fueled a boom in commodity prices. But the Chinese economic growth was fed from the top down, not from the bottom up the way an enduring capitalist economy develops. While we saw our banks crash as a result of revaluing inflated assets, such market adjustments are prevented in China and their banking system in more vulnerable than their government allows to show.

Who will dominate the new decade?  India.

India’s capitalism is more bottom up.  British rule has left in place institutions of property rights and law that are essential to developing capitalism.  Like China, India has cultural shackles to grow out of, but they may be more ready for capitalistic growth than the northern neighbor.

My best performing stock of 2009 was Tata Motors, the GM of India (the old non government owned GM); up over 230%. (Suntrust was the second best.)

We are entering India’s decade.