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Interest Rates, Inflation, Debt and Dollar
I’ve been watching the Dow Industrial Index just barely clinging on to the 10,000 as trading progressed throughout the day. This doesn’t really surprise me after the action we saw yesterday. Stocks were crumbling badly with 25/30 stocks in the Dow losing ground and the index down roughly 160 points. The last two hours we saw the DJIA make a miraculous recovery of nearly 200 points for the close with 24/30 stocks in positive territory. Nice reversal, but it was difficult to find a market driven cause for the rebound. I read and heard three separate analysts claim stocks bounced higher because they were “technically oversold.” If you take a look at the two charts of the S&P 500 you can see what the analysts were referring to as the reason for the two-hour rally.
Debt and Interest Rates These are difficult financial times we live in! The short version is simply that interest rates need to go higher to arrest the dollar’s decline and slow inflation, but they can’t raise rates significantly because there are too many debts at all levels. It would be a crushing blow to an already fragile system that is purely based on debt creation. If you have not read “Illusions” by Jim Puplava yet, I strongly urge you to have a look as it explains much of the big picture. There are many noteworthy points in the article, but this is one that stands out in particular. “Wall Street believes the Fed will embark on a rate renormalization program that will take the fed funds rate from its current 1% to a more neutral rate of 3%. This is an illusion. In an economy that has $35 trillion in debt, of which $15 trillion has been added in the last six years, a tripling of the federal funds rate would become disastrous. The financial sector has doubled its debt from $5,532 billion in 1997 to $11,402 billion in 2003.” On Tuesday the Treasury sold $24 billion of three-year notes that went off fairly well with “indirect bidders” buying 45.6% of the debt. The indirect bidders are primarily foreign central banks with Japan and China making up the biggest portion. On Wednesday the Treasury sold $15 billion of five-year notes, but the indirect bidders only bought 34.6% of the debt. Today the government is auctioning another $15 billion of ten-year notes, but I haven’t seen the outcome yet. I suspect the demand will be weak since the higher than expected PPI report is causing the bond market to bleed red ink. The Fed has not raised the federal funds rate yet, but the bond market is demanding higher interest rates for the increasing rate of inflation. As a small side note, let’s put the $54 billion of government borrowing into perspective, especially for investors holding gold and silver stocks. The money the Treasury is borrowing this week would buy half of all the precious metals mining stocks in the world since the market capitalization of the entire sector is roughly $100 billion! The PM market is incredibly small and when people truly get scared of “paper” assets going up in flames, it will only take a small fraction of all stocks and bonds to send gold and silver through the roof! Eye on the Dollar Rally
When the Fed meets at the end of June they will either do nothing, or they will go higher by a measly 25 basis points. The difference between 1% and 1.25% couldn’t possibly do anything to stop the inflation freight train that is pounding down the track! The Fed obviously used some very careful language in their last statement by saying rates would go higher at a measured pace. If they see signs of an economic slowdown, they won’t move rates at all. The last time they embarked on campaign to increase rates they popped the NASDAQ bubble and many investors still feel the pain in their stock accounts. I believe the Fed will drag their feet and remain WAY behind the curve to higher rates. The Fed Backpedals on Inflation From the PPI report this morning a Bloomberg article reads, “Prices of crude goods, which are used at the earliest stage of production, rose 3% after rising 0.7% the previous month…Over the last 12 months, the cost of crude goods jumped 20.4%.” Based on the last month, the annualized rate of increase for crude goods is 36%! The Bloomberg article also said, “A report from the Institute for Supply Management last week showed that prices paid for raw materials rose to the highest since 1979 in April.” This week there were two Federal Reserve Governors out on the speaking trail in an effort to downplay the threat of inflation. Philadelphia Fed President Anthony Santomero said that Federal Reserve policy is unlikely to turn “restrictive” and inflation is “low and stable.” Then we had Chicago Fed President Michael Moskow say that the Fed has “yet to see the kinds of pressure on labor and capital resources that would foreshadow a worrisome increase in inflation.” In other parts of the world they see it differently. A New York Times article starts out by saying, “China took four more steps on Sunday and Monday to slow inflation, including setting limited price controls in provinces where the cost of living is rising fast.” Then from Reuters in London we hear, “The Bank of England has prepared the ground for faster rises in interest rates with a hawkish assessment of the outlook for inflation. From TheStreet.com we read, “While some CPI categories are well known for their volatility – particularly gasoline and food costs – steadier price indicators such as medicine, housing and education are also up sharply.” There is tons more evidence of the forthcoming inflation tsunami, but you get the picture. Oil closed in new high ground today at $41.00 per barrel and yesterday I read an article from Reuters titled, “OPEC Powerless to Stem Oil Price Surge.” They went on to say, “OPEC President Purnomo Yusgiantoro of Indonesia said on Wednesday the cartel is already pumping more than two million barrels daily in excess of official supply limits in a bid to cool world oil prices. The fact remains very simply that the U.S. has more global competition for the available supplies of crude oil as well as limited capacity at U.S. refineries to make gasoline. I doubt this problem will go away soon. Add terrorist threats to top it off, and prices could easily spiral much higher. Two of the primary reasons the Fed cites for a lack of concern toward inflation are low utilization rates for plant and equipment and softness in the labor market. In my mind that make paying for the inflation even harder. The inflation of the 1970’s was accompanied by wage increases, but today it’s difficult for workers to get raises and increased benefits with so many unemployed Americans waiting in line to take their jobs. The grocery workers strike on the West Coast was a prime example. My final quote to wrap it up on inflation comes from an article by Laurence Kotlikoff in the current issue of Fortune Magazine. “Hyperinflation is a real and present danger for the simple reason that the US government is effectively bankrupt. Its fiscal gap is $51 trillion, when measured as a present value. That’s 11.6 times official debt, 4.5 times GDP, and 1.2 times private net worth. Coming up with $51 trillion without a printing press would require, immediately and permanently, either hiking federal income taxes 78%, cutting Social Security and Medicare benefits 51%, or eliminating more than 100% of federal discretionary spending, which ain’t easy. And waiting only makes matters worse. This is America’s menu of pain. When investors around the world wake up to US insolvency, it will be extremely expensive for our government to borrow. The only option then will be printing huge sums of money – generating exactly the hyperinflation the bond market has decided to expect.” (This is why I make such a big deal about the government debt sales. They have to take precedent over all other market activities.) As I said, the above quote is right out of Fortune Magazine. The Fed is between the rock and the hard place. They have always erred on the side of inflation, and the Fed governor’s denial that we have a problem is proof in the pudding. Higher interest rates will burst all the asset bubbles and they know it. As Jim put it, it’s just an illusion. That’s why we’re invested in precious metals and that’s why we’re patient to see the inevitable outcome. This correction in mining stocks hasn’t been pleasant, but these brutal pullbacks are part of the volatility when true wealth competes with man made digital gains of paper instruments. Adam Smith’s invisible hand of market forces will have its final say. The bond market has been telling us so, even though the policy makers are in denial when preaching to the public. They know what’s going on, they just don’t want their power structures to be disturbed. It hasn’t been an easy ride, but so far it’s been well worth the short-term pain. I plan to stick with the fundamentals and stay the course! Have a Great Evening! Mike Hartman Charts courtesy of StockCharts.com
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There
was plenty of economic news for the markets to digest today. The
Commerce Department said retail sales fell by 0.5% in April which was
the first decline in seven months and the Labor Department reported
initial jobless claims increased to 331,000 from 318,000 reported last
week. The number is still considered relatively low when it comes in
below 350,000. The economic report that had the biggest impact on the
market today was the Labor Department’s release of the Producer Price
Index with an increase of 0.7% after economists were forecasting an
increase of only 0.3%. The surprise inflation number implies producer
prices are rising by an annualized rate of 8.4% and caused bonds to
fall, the dollar to rise, and stocks to flop around neutral for most of
the session.
