Inflation
+ Deflation = Chaos (not zero)
by Jim Willie CB
www.GoldenJackass.com
November 21, 2003
The entire concept and story of inflation is the Achilles Heel of the US central banking leaders, and the Hemlock for our economy. The Federal Reserve has attempted to control it for growth generation, to steer it for speculative exploit, to redefine it for confusion among the public, and to promote it actively in response to the persistent and widespread asset deflation and price pressures, the direct consequence of errant policy over decades. The US Economy is now being subjected to monetary expansion on a scale never seen before, against a supercycle secular price deflation backdrop. The current reckless Fed policy is fully blessed and urged by the USGovt, Congress, well-heeled speculators, and the financially illiterate public. In every single instance in modern history, active inflation generation has worked to destroy the subjected economy. The world’s largest economy is on its “debt death bed” from inflationary cancer, and our financial doctors are prescribing evermore inflation in treatment.
An effort will be made to clarify and shed light on this entire topic of inflation. Our Federal Reserve has done a thorough job in muddying the waters, disseminating disinformation, and creating a society of morons on the subject. In an earlier article (DOLLAR VICIOUS CIRCLE), a statement was made regarding this incredibly obfuscated topic wherein several inflation-related concepts are listed. Add to the list the two concepts reflation and stagflation, which are just as nettlesome. Each of several attendant terms will be covered, defined, explained, in an effort to lift the confusion.
“Our economic advisors and observers are befuddled by inflation, embarrassed by their inability to distinguish among inflation, deflation, disinflation, declining asset values, liquidity, credit, and money supply. They insist on thinking in aggregate terms, when we now see price deflation and price inflation simultaneously in separate sectors.”
INVESTMENTS TO PROFIT FROM INFLATION:
Listed are several stocks which cover gold, silver, copper, tin, zinc, oil, and gas. Each company is small in size, growing fast (or quick prospects), with strong management, and good properties. Two are large holdings for me personally.
Athlone
Minerals Ltd
$1.19 (ATH.V in Canada,
ALMLF for US equivalent)
Corporate website: http://www.athlone.com
Exploration and development of oil and gas in western Canada. Vice president of exploration David Smith was instrumental in discovering over 15 trillion cubic feet of gas and oil ($70 billion at today’s prices) equivalent with Shell Canada. The majority of Shell profits still come from Smith’s projects from the 1960’s.
Cardero
Resource Corp
$2.45 (CDU.V in Canada,
CUEAF for US equivalent)
Corporate website: http://www.cardero.com
Exploration of silver in Argentina, and copper/gold (IOCG) projects in Mexico, and Peru. Anglo American is their partner in Mexico.
International
Barytex Resources
Ltd $1.70 (IBX.V in Canada,
IBYXF for US equivalent)
Corporate website: http://www.barytex.com
Barytex can earn 75% of a tin/zinc project ($3.5 billion gross metal value) in Yunnan province, China. IBX Chairman Roman Shklanka sold Sutton Resources to ABX for $525 million, is also chairman of Canico (CNI-TSX) $15.50, with a market cap of over $400 million. IBX market cap is under $40 million.
Taseko
Mines Ltd
$1.02 (TKO.V in Canada,
TKOCF for US equivalent)
Corporate website: http://www.tasekomines.com
Taseko
plans on restarting Canada’s largest copper mine (Gibraltar) with a
capacity of 80 million pounds per year, and a 15-year supply. In place
is a $200 million infrastructure. An additional $20 million will revive
operations. Another project also in development, the Prosperity
gold-copper deposit. Gibraltar has 4.7 billion pounds of copper. Prosperity has 2.3 billion pounds of copper, and 6.7 million ounces of
gold.
FED-DRIVEN MONETARY EXPANSION HAS POOR TRACK RECORD:
Nowhere has the Federal Reserve, and Greenspasm in recent years, wrecked our national economy in a more spectacular fashion than with the uncontrolled application of monetary inflation. Numerous large-scale economic accidents were dealt with by liberal new liquidity treatment. Broad new applications of monetary carcinogens have been dispensed in recent months, in order to treat the financial cancer. The American public, after years of bankrupt and heretical education and training in the economics field, harbors the misguided support for current policy. Faith in the Federal Reserve is virtually unshaken, yet all evidence points to a total failure in its recent policies. Its mere existence is a repudiation of the free market system. The track record of the Fed is abysmal, to put it mildly. In the next two years, a clear picture will be visible for the Fed’s utter failure, when the bond bust occurs. It will be slow and painful, yet inevitable and regrettable. It will not resemble the fast and furious stock crash. Rather, it will be manifested as a slow leak. Paul McCulley of PIMCO recently proclaimed his forecast for 2004, a year with constant pressure on bonds and all assets associated with debt securities.
Unbridled monetary expansion and allowance of credit extension first spawned the 1930 Great Depression. Credit was extended mindlessly and uncontrollably, for the benefit of new communication systems, automobiles, and highly leveraged public participation in the stock market. As a nation, we take “creative destruction” to new heights. The next extreme monetary handiwork was evident following the challenge of OPEC quadrupled crude oil prices in the 1970 decade. A premeditated plan to inflate our economy, and thus neutralize increased energy prices, led to the worst inflationary period in our history. The scheme dealt crippling blows to the credit markets, in a horrendous bust. Saudis and other Arab nations were duped into recycling their enormous windfall petro-dollar surpluses into USTBonds, only to suffer steep losses.
Following the historically critical 1971 year, money creation was freed from all discipline. The primary wellspring has been the United States. Large trade deficits exploded on the scene for the first time. As new debt issuance and extensions paid for the VietNam War and fresh trade gaps, a great deal of money was exported abroad. The danger was unrecognized all through the 1980 decade. The risk stemmed from the fact that money in the form of fiat currency posed as legitimate money. Fractional banking practices functioned as awesome pump leverage on lending, powering the creation of dangerous geo-bubbles. See Thailand for a prime example, where entire cities were built and are still largely empty. The US exported bubbles, which resulted directly in the Asian Meltdown in 1997. Years earlier, Japan suffered its own calamity. They benefited from years of export surpluses. Factor in fractional bank lending, pet-pork projects, and speculation in stocks and real estate, and broken busted bubbles were the tragic outcome. The export from the United States of bubbles, and a strong Japanese assist, worked to produce the decimation of the Nikkei stocks, the Japanese real estate sector, and the collective Asian Meltdown. The Japanese banks tied their portfolios to absurd property values, only to realize years later a net negative valuation. Yet after decades of study, few point the finger to Federal Reserve monetary inflation, a world reserve USDollar currency lacking any gold-convertibility, and fractional banking methods. A sad commentary on economics can be written in historical perspective. Can anyone notice how the United States banking system is repeating Japan’s errors. Mortgage bankers and the Govt Sponsored Enterprises have enjoyed an orgy of mortgage lending. The result is a mountain of loans with the potential to go underwater.
Further critical errors were made. At the earliest years of irrational exuberance, Greenspasm changed his entire directive on monetary policy. Formerly, the Fed used to prudently guide the monetary base (MZM, M2, M3) to remain consistent with the GDP growth, being careful not to exceed that growth. In the mid 1990’s, he decided to allow greater monetary growth. In a horrible error of judgment, he decided to target the Consumer Price Index. As long as the CPI remained under control, the monetary base was permitted to expand. Poof, Greenspasm became a folk hero while inflation as measured by the CPI remained tame. Of course it remained tame, since the USDollar appreciated strongly, thus affording vast consumer imports to be subdued in price. However, the CPI ignores assets, services, taxes, tuition, and more. Greater money growth spawned the USDollar blowoff top, the stock bubble, and the unbridled bulge of debt. The outcome was an uncompetitive national economy, broken bubbles, and suffocating debt. Next is the delayed arrival of price inflation.
The Federal Reserve and USGovt have combined to coerce every aspect of the nation’s financial system into participation within the casino. Some are actively willing, but many are passively reluctant. Pension fund management has degraded into a speculative bingo match. Corporate debt administration has come to resemble a walk across a ship’s deck during a squall while lashed to moorings, often in a losing battle. Simple investment has not been simple for almost 20 years, as gains are fed by a fountain of sporadically flowing printed money. Or is it money at all, and perhaps counterfeit? Scandals, one after the other, rack the Wall Street casino parlors. Ethical experts proclaim that once money is debauched, as it is when no longer gold-convertible, morality slides down a slippery slope. That is precisely what we see: coercion into a casino, whose parlors are at times populated by criminals operating with puppet strings. Unfortunately, our govt and banking leaders are behind the curtains. Regulatory bodies seem often to act like mere lackey tools, as the SEC has amply demonstrated. The stock exchange ruling board seems to know all too well how to line their pockets and rig the game.
INFLATION
IN ASSETS NOT PROPERLY RECOGNIZED:
Unless the public sees price increases in consumer items, they do conclude that no inflation exists. Therein lies their failed learning. They do notice rising service costs, rising health costs, but somehow these remain in their eyes beyond the CPI rule of serenity. One can detect it in consumer prices, energy prices, stock prices, bond prices, real estate prices, art work prices, or elsewhere. When the public observes certain asset classes as rising strongly, it concludes a bull market is in progress. The late 1990 decade saw price inflation in stocks, corporate equity shares, as never seen before. A bust followed. But nowhere were there outcries that we suffered from ravages of inflation and its aftermath. Instead, the blame is placed on speculation without discipline, or a mania among investors, or a revolution in technology that went awry. The early 2000 decade now sees price inflation in all asset groups related to bonds: Treasurys, mortgage finance, and real estate. Once again, the public labels them as bull markets, and even applauds the restoration of household balance sheets. Beneficial effects of a purposeful inflationary policy almost without exception offer a temporary fleeting boon to investors.
The latest chapter in the Fed’s CRASH COURSE is their public relations campaign to convince the illiterate public that we have a deflation problem. In fact, we have the worst inflation problem in the modern era. Its symptoms are declining prices, realized after a long delay following rabid chronic overproduction and speculation. Recent inflationary practices have encouraged rampant new speculation. A similar outcome is to be expected down the road in time.
On
its face, the above statement seems contradictory, especially to those
who follow the inflation lectures by Mr Magoo of the ModernDay Fed. A
brief microcosm example might assist in elucidation, to clear up the
rampant obfuscation. The key is to separate cause from effect. The Fed
has spewed so much total nonsense and faulty principles into our
society, that we have been rendered helpless and clueless to the
financial crimes perpetrated upon our economic system. He now is avidly
entrenched in a premeditated reactive inflation policy, hoping to
inflate away the monstrous debts pervading our entire society and
economy. All he has accomplished has been to foster speculation and even
greater debts. The disaster bears only bitter fruit. Falling systemic
prices within the US Economy are due to years of credit abuse. Evermore
monetary inflation via further credit abuse will not remedy anything.
A FICTITIOUS EXAMPLE OF INFLATION GONE AWRY:
Let’s
assume that our govt leaders convinced the nation that their patriotism
dictated a conversion of flower pots and window sills into home gardens,
to ward off the evils of obesity and divert attention from the terrorism
threat. Suppose almost every single household in America took out a loan
for producing vegetables. All this after the US Dept of Agriculture and
the Health & Human Services, with the blessing of the Dept of
Homeland Security, commissioned a study that concluded the conquest of
obesity was within our grasp during this decade. The answer was
vegetables, from tomatoes and peas to carrots, corn, beans, and onions.
Loans for this purpose were easy to obtain, subsidized by liberal govt
grants. Flags waved across our land, with victory gardens in every
neighborhood city and town, even many apartment center rooftops and
office buildings. Small gardens yielded produce off vines like tomatoes
and peas, while larger potted beds yielded subterranean produce like
carrots and onions. When the dust cleared, debts were piled up, harvest
was reaped, and the marketplace shelves were stocked. Inventory levels
at supermarkets were augmented by local produce. Farm stands were
brimming with nature’s bounty. The majority of families traded produce
with their neighbors and enjoyed a measure of self-sufficiency. Most
families noted a 5-10% rise in their debt levels, to pay for all that
rich soil, seed, fertilizer, books, and capital equipment like big pots
and tools. However, demand dried up somewhat while supply overflowed.
The prices of almost every vegetable plummeted. This is an example of
how monetary expansion was misallocated to over-produce vegetables, only
to result in severely falling prices from excess supply made worse by
reduced demand. Now one must answer the basic question:
IS THIS AN EXAMPLE OF DEFLATION???
Of course not.
THE EXPORT OF US INFLATION:
On the world stage, the same principles were applied to the production of consumer goods (especially consumer electronics), to telecommunication equipment, and to many areas of technology. The source of the fuel was the Federal Reserve in the expansion of huge amounts of money, plus the unbridled growth in credit extension. The US Economy paid all its bills with printed and borrowed money. Our trade deficits were paid largely with debt, extended in the form of credit cards and on an increasing basis home equity loans. World production facilities outpaced final demand and continue to do so. Those facilities were financed by leveraged bank loans backed by stockpiles of trade surpluses deposited in commercial banks in Asia. Domestic plant has to a great extent been abandoned in favor of foreign, cheaper plant where labor is 10% to 25% of our pay scale. In the last decade, Asian exporters fell over each other to win our consumer markets, as they offered lower prices. They ramped up production and benefited from their own currencies trading at lower exchange rates. Their central banks reinforce the low-cost advantage with a continual currency debasement, which pushes down exchange rates.
On the domestic govt front, social programs and military adventures have been financed by even more debt issuance. Few regard federal deficit finance as yet more monetary inflation. What else can it be called? Our govt spends money (a lot of it) which is not offset by tax revenues and other income sources. So we pay the govt bills with credit, which expands our money supply and is technically identified as monetary expansion. Our federal deficits were paid largely with printed money, sold in the form of Treasury securities to both Americans and foreigners, principally Asians and Arabs.
And lastly, there are mortgages. The incredible dual system unregulated structured finance engines created mortgages for homeowners, backed by mortgage securities. It is estimated that in the year 2002, one quarter of the new aggregate money supply originated from Fanny Mae, Freddie Mac, and the Federal Home Loan agencies. This is a frightening development, especially since such agencies are not subject to regulation, their financial books are not fully disclosed, and their structures are highly leveraged. The credit is supplied by investors and banks themselves. An increasing proportion of the credit supply is funded by Asian govts, estimated at 20% of outstanding agency mortgage debt totals. They might feel a heavy vested interest, completing a loop. US homeowners rely on mortgages and equity lines of credit in order to finance household operations, thus permitting continued consumption and payment of mundane bills. Much of the consumption is of Asian imported products, such as electronic gear and automobiles. If the source of mortgage money is not freshly minted output from a printing press, it is from the Asian recycle. Asian muscle powers the mortgage and real estate pump machinery.
Our nation has “exported inflation” for over two decades. We have inflated the monetary aggregate in historically unprecedented fashion. We have paid for much of our entire economic growth with debt, at levels which have tripled in size since the late 1980 decade. Federal debt, mortgage debt, and consumer debt were all offset by increases in money supply and credit extensions. This is precisely what inflation is. Why doesn’t the public label all these growth sources as having inflationary origins? Because it saw bull markets in certain asset groups, with no onerous effects on consumer prices. If the disease does not show itself in consumer prices, then we conclude no price inflation. Even totally misguided economists make this mistake, from most of the major banks and brokerage houses. Hardly a day goes by without some inept economist speaking about the lack of any evidence of inflation. It is all around us. But if not today residing within the boundaries of bonds and related assets like in residential property, that inflation certainly has been exported to Asia. With a large trade gap, with a large federal deficit, with large credit supply emanating from Asia, one can directly conclude that our monetary inflation was exported to Asia.
Why our inept cadre of clueless economists cannot recognize inflation properly where it exists, is testimony to their bankrupt education, and empty continuing education units. Keynesian Monetarism is a cancerous disease, when it rests upon the human nature catalyst. Our economists begin with an assumption that our debt-based system and debt-based money is a strong foundation. It is not. The system is quicksand; the money has vaporous value, and is not even Constitutionally valid. Our economists are like alchemists with deep denial of our gross imbalances. In fact, an argument can be made that most economists are merely political apologists who comment on the economy. I am reminded of a joke. Just because an object lives in a garage does not make it a car. Neither does a person who comments on the economy necessarily qualify to be an economist.
The falling USDollar has initially led to a nascent gold bull market. Rising commodity prices have shown themselves almost universally. We have begun to see evidence of the round-trip return of 20-25 years of mammoth generated inflation to our nation’s economy. Bonds experienced a major revolt in July 2003. Without question, whether due to a growing renewed economy or due to rising systemic prices, interest rates will rise on long-term securities. The following Ten-yr Note Yield chart reveals a strong hint of a bullish Head & Shoulders pattern, with a strong upward trend bias in addition. A critical resistance level of 4.5% is apparent. A head impulse low rate of 3.1% and a neckline at 4.3% are evident. A target of 5.5% presents itself. The upward bias suggests even greater interest rate risk. Implications to bonds, stocks, and real estate are dire; gold should benefit from a discredited safe haven in Treasurys.
EXPORTED INFLATION MUST EVENTUALLY RETURN TO THE US:
The export of inflation on a magnificent scale over many years invites the question of when and how the world economy will deliver that inflationary aggregate of financial liquidity back to the United States Economy. It is not capital in the true sense. The world economy is a closed loop after all. Finished products come west. Debts head east. Credit supply returns west. While many blind economists actually regard credit recycle as a successful and healthy closure of the loop, the actual results are extremely detrimental. Import of credit supply to finance trade and govt operations has resulted in two intractable and lethal problems – colossal debt and lost manufacturing base. Hardly an optimal exchange. Instead, heavy debt burdens inhibit growth, hamper spending, render impossible capital investment, while jobs are either lost altogether or relegated to lower pay scales. But when does the inflation return to our shores here in America, the land of the indebted and easy financing?
In
1998 and 1999, the USGovt federal deficits were reduced. Of course,
these were not actual surpluses, since the Social Security Trust Fund
revenue deposits were systematically raided. Back up a few years. In
1996, Fed Chairman Greenspasm warned of “irrational exuberance” to
the public and the financial markets. He did not halt the supply of
credit, often labeled during those heady frothy years as “the punch
bowl.” Capital gains were
enormous from stock gains. As the new TBond issuance slacked off
immediately before the turn of the millennium, foreign recycled funds
had few alternative investment destinations within the USDollar
denomination arena. They settled on corporate bonds and stocks,
especially technology stocks. They bought hook line & sinker the
tech miracle. They also jumped on telecomm debt. Both asset groups died
a horrible death !!! Few
informed observers perceive to this day, that either outcome bust was a
derived event from the return flight of the monetary inflation produced
and promoted by the USGovt, the US consumers, and US homeowners.
CALIFORNIA’S INFLATIONARY WRECKAGE:
California’s
giant leaps in state revenues were also dominated by a huge upsurge in
capital gain taxes late in the 1990 decade. The national inflation
spigot is the veritable source of California’s fiscal problems, given
that the liberal moron machinery decided to anticipate such huge capital
gains would arrive on an annual basis. So they put in place a social
spending apparatus which bankrupted the system. Few regard the source
of California’s fiscal problems as being federal monetary inflation
though, right? We never
hear such thoughts or ideas. Fiscal irresponsibility on a massive scale
is only half the equation for the debacle.
UPCOMING IMPORTED INFLATION FROM ASIA, FINALLY:
One headline event has yet to occur. Consumer prices have yet to see substantive gains. This event is on the horizon, yet few notice. When the gargantuan bubble of US-originated monetary inflation, combined with monstrous Japanese monetary inflation, finds its way back into the US Economy, our consumer products will register increases in price. That day is nigh, since the Japanese Yen currency broke loose from its shackled range in early October. Its clear Head & Shoulders bull pattern points to a target for next year near parity. A chronic huge trade surplus with the United States, recently amplified by a hefty trade surplus with China, was too much for the Bank of Japan to overcome. Yet the BoJ continues to throw good money away after bad, to the tune of over $100 billion in the year 2003 alone. Just this week, a news item reported another $5-7 billion carelessly tossed into the FOREX for a temporary reprieve from the inevitable continued rise in the JYen. The rest of the Asian group of currencies will follow its lead, all in time. The end result will eventually be higher export product prices, which from our vantage point will be higher import product prices.
Notice the similarity to the previous Ten-yr Note yield chart over the last 18 months. If the breakout pattern is mimicked, expect a sharp upward move in interest rates within a couple of months. A lag of 4-5 months is apparent between the two charts. Fundamentals support the view from the magnitude of the Japanese trade surplus, and in rising price inflation threats within the US Economy. Since the Chinese Yuan is pegged to the USDollar, dual Japanese surpluses work in concert to prolong the JYen appreciation process for months on end. Its gains come much to the chagrin of Japanese leaders. They will be forced to adapt to an appropriately rising currency. What the US financial markets fail to factor is the uniform rise in all Asian currencies.
Asian imported inflation will arrive soon in quickly sequenced stages. The initial stage will see Asian exporters absorbing the currency exchange rate infringement upon profit margins. They are motivated by an avoidance of upsetting American consumer demand with higher prices. The secondary stage will see Asian distributors kicking each other’s shins in order to preserve and capture American consumer market share. The final stage will see wider agreement among Asian producers to swallow the bitter pill, to raise prices on American store shelves and car dealer showrooms, and to run the risk of reduced consumer demand. This expectation is precisely why the Nikkei stock index in Japan falters when their JYen currency heads higher.
Economists, in their usual myopic manner, cannot recognize the threat to consumer prices. Heck, roughly 80% of our economy is retail consumption, and almost half of that engorgement of products stems from Asian mfg output. Imported Asian price inflation is now a giant blind spot by our crew of clueless economists. All we hear is shallow commentary about the advantages to be reaped by CocaCola, Gillette, General Electric, and other multi-national corporations. That is perhaps only one-tenth of the story. The other nine-tenths of the story pertains to Asian imports which dominate our retail landscape.
A
new threat lies on the horizon, with rising price implications. As our
trade imbalances with numerous nations widen into gaping gulfs, the
impact on job loss has led to heightened stress between our trading
partners. World Trade Organization decisions are now pending on steel
tariffs imposed by President Bushy two years ago. As national steel mfg
capacity is preserved, jobs are maintained, but steel prices have risen
domestically. Now the European Union and China are the subjects of trade
retaliation as per clothing and other products. The United States
requires almost $4 billion per day in capital, in order to finance the
federal deficit, trade gaps, and mortgage needs. We appear to desire a
battle of brassieres versus credit supply, incredibly. The US Military
aircraft carriers and smart bombs are no match for China’s imminent
reluctance to provide ready financing for our debt, a continuity of
their recycled trade surplus. Trade friction, barriers, sanctions, and
retaliation are in the process of repeating the errors of the Smoot
Hawley Act in 1930. Ill-advised protectionism is back on the radar. Politics
prevails over historical learning and prudent economic planning, sadly.
The
end result will be higher prices in affected industries, essentially an
indirect importation of inflation. US farmers should beware, since
grains and soybeans are the nation’s commodity export. Greenspasm
seems now to be at odds with President Bushy, who is clearly playing a
political card, seeking voter support from those who have lost jobs. The
vile winds of protectionism are blowing hard, and will blow harder
before November of 2004. This much is so predictable.
MAJOR FALLACIES PROMOTED WIDELY:
Today’s deception regarding “inflation versus deflation” is the most egregious and damaging you will ever be subjected to. The major fallacious messages are:
-
with deflationary pressures mounting, we need to increase the money supply infusions, to increase systemic liquidity, in order to generate some “beneficial” inflation
-
a measure of inflation will counteract and offset the recent deflation experienced, thus enabling the economic recovery to proceed
-
inflation manifestations within financial securities and key asset groups are deemed useful in supporting the economy and are labeled as “bull markets,” while effects within consumer products are deemed harmful and are labeled by the public in a clumsy fashion as “inflation”
These
are heretical notions. American economists, the worst in the modern era,
have actively chosen to turn their backs on three centuries of economic
study. They appear to be “making it up as they go along” only to
invite disaster at every turn. Since 1971, with the abrogation of the
Bretton Woods Accord, the USDollar was decoupled from gold, and all
discipline in monetary control disappeared. In the following three
decades, the booms & busts have become more severe and painful with
each successive cycle. We have truly lost our way, unable to recognize
what either money or wealth consists of anymore. We have redefined
inflation in such a way as to politically favor continued abuse. We have
indoctrinated the entire nation into sanitizing a debt-based system
built upon quicksand. Almost 80% of the US Economy is now devoted to
debt service, evidence of extreme suffocation. A two thousand year old
document, the most popular book on earth, advises building your house on
a strong foundation, made firm by a capstone. The US Economy has neither
the strong foundation of an asset-based banking system, nor a currency
founded upon a gold standard capstone. As a result, the entire
economy resembles a debt bubble. At the same time, much of our
societal behavior resembles the manifestation of addiction. The
combination is utterly lethal to our financial future.
THE FED TREATS BROKEN BUBBLE WITH MORE INFLATION:
Since 2001, the Federal Reserve has flooded the economy with liquidity. Excuse me, but I mean flooded the economy with cheap money attached to low interest rates. It has also monetized TBonds in the defense of the USDollar currency. By blocking future issuance of the 30-yr TBond, it encouraged concentration on the 10-yr TNote. Eventually, Greenspasm prevailed and long-term interest rates came down. Corporate debt costs declined, and mortgage costs declined, each a certain benefit. However, three new bubbles hit the scene, dangerous bubbles, extremely large bubbles. While they clearly support the economy, providing collateral for perpetuated consumer spending, the bubbles themselves are hardly permanent fixtures. Artificial manmade creations almost always invite a natural correction, in order to rectify excess. In July of 2003, we saw a worldwide bond revolt. Interest rates on long-dated bonds suffered sizeable losses in the USA, Europe, and Japan. Mortgage-backed bonds also suffered losses. But so far, residential real estate properties have yet to succumb to pressure. As night follows day, housing prices will yield to the pressure of either higher rates or inhibited power to service the debt itself.
The “beneficial” inflation fostered and nurtured by the Fed has produced new bubbles. Have they cured in any way the ills of our economy? Or have they created new threats of imminent further devastation, dislocation, and loss? Few seem to realize that with real estate, the size of the sector is much larger than the stock market. It is an order of magnitude larger than the overall stock market. Furthermore, if mortgage rates rise markedly, then their bond holders will lose value on their investments, AND the property owners will lose value on their investments. Two investor groups will feel the impact.
NEW INFLATION CANNOT NEUTRALIZE CURRENT PRICE DEFLATION:
A widely believed notion is that a new crop of inflation will counteract and offset the recent deflation experienced. In the process, the economic recovery can proceed. There seems to be no end to shallow economist thought patterns. In the last decade we heard that growth causes price inflation, that a strengthening USDollar bolsters the economy, that continued consumption sustains jobs, that trade deficits are a sign of more advantageous opportunity inside the US, that huge federal deficits do not matter. These notions are lunatic, yet they persist. More stupidity is evident, illustrated within the difficult inflation topic.
Base and acids mix to produce simple water in the world of chemistry, a harmless result. In the world of financial liquidity, heavier money flows can offset inadequate flows so as to neutralize the effect. However, when it comes to forces and pressures, the typical result is violent storm. The economy and financial markets can often be compared to weather patterns. As high pressure (monetary inflation) collides with low pressure (price deflation), a more likely result is lightning, damaging winds, heavy rain, perhaps even hail stones. To expect inflation to neutralize deflation is simply absurd. As with weather activity, the result will make for a nasty mix, a sure mess, and considerable ongoing damage. Nature offers up broken tree limbs, downed electrical power lines, and crop damage from hail. The economy and financial markets will be no different.
In order for the underlying price deflationary trend to slow down and be rendered less powerful, the real need is to reduce supply of finished products (not to encourage continued consumption), to facilitate the bankruptcy of overextended debtors (not to aid their continued elongated lifespan), to stem the flow of more credit (not to foster even greater debt), and to bring about a lower cost basis structure for diverse sectors within the economy (not to stimulate and perpetuate the current dislocations). Actively promoted monetary inflation accomplishes none of these. To the contrary, the long-term consequence is to worsen the oversupply, over-indebtedness, and high cost structures. Hence, even more sources of the same fundamental ills which led to price deflation are created. Debt continues to suffocate its victims.
The
immediate and near-term benefits are sought after, and given too much
focus, at the expense of further aggravation of the same systemic
problems witnessed on a long-term basis. Benefits seen quickly are an
improvement to spendable money from home equity loans, from stock &
bond market gain extractions, from simple credit card extensions. But
what do these avenues gain us?
A real estate housing bubble, a financial market bubble, and
more household debt. Is that progress? NO. Where is the neutralization of excess supply, over-extended
debt burdens, existing high-cost structures, and the flow of dangerous
credit? NOWHERE. In fact,
we have only created a worse problem and further postponed the required
corrections to cull the excess.
NIGHTMARE WITH PRODUCTION COSTS:
The unintended consequences are what bite hard. New bubbles are actually celebrated as new asset bull markets with stocks, bonds, and housing. Instead of regarding them as more evidence of unhealthy manifestations of inflation, they are viewed as signs of “renewed good times” and the source of new capital for spending. Stock market margin balances for the NASD recently exceeded lofty peaks seen in March of 2000. Even hapless Greenspasm crows of improved household balance sheets, when in reality higher debt levels are offset by higher home equity values that could be reversed when these bubbles dissipate somewhat in the future. Did the stock market dissipate in 2000 and 2001? Did the bond market dissipate in 1994 and 1995? Did the real estate market dissipate from 1988 to 1992? YES, YES, YES. Like night following day, a rise in asset prices from artificial sources almost always sees a downturn.
Most commodities are priced in USDollar denomination. Industrial metals like zinc, aluminum, copper, silver, and platinum are now rising in price. Energy supplies like crude oil, heating oil, gasoline, and natural gas are now rising in price. Food groups like corn, wheat, soybean, and beef are now rising in price. So are clothing supplies like cotton rising in price. Last summer I repeated my prediction for rising production costs. Last month, I stated my expectation for a breakout in the important CRB index of commodities above the 250 level. It happened last week finally, confirming a new threat to businesses and consumers alike. The Producer Price Index just registered a 0.8% monthly rise, which failed to awaken sleepy investors in either the stock or bond market. That is almost 10% annual rate. The lack of CPI follow-through indicates upcoming pressure on profit margins. Brain-dead economists declare the commodity price surges indicate a successful Fed policy to “reflate” the economy. Stock, bond, and property appreciation may place money in speculator pockets, even less rabid investor accounts. The MAJOR RUB is that producers, already wracked by poor pricing power, now must absorb even higher material costs, and higher shipping costs. HOW IS THIS BENEFICIAL?
Worse still, producers must now deal with a new problem which originates from currency markets and Japanese Yen appreciation versus our crippled USDollar. In time, producers will be facing an array of higher Asian component supply costs, and consumers will be facing higher Asian finished product prices. Japan’s currency is the only major Asian currency trading actively in large volume in the FOREX. Any Asian exporter has one vehicle with which to hedge their operations from currency exposure, the Japanese Yen. In future months, Asian imported components will see price rises, further aggravating producer profit margins. Asian imports can be treated much as a commodity like metals, energies, food, and fibers. With a declining USDollar, the costs of all these items rise. Their common denominator lies in their foreign origins, thus their exposure to price effects from a falling US currency.
Why do commodity prices stand at such risk with respect to a weakening USDollar? Because they are typically produced in foreign lands. Crude oil pumped out of Middle East or Russian or South American or African land will cost more when converted into dollars. Derived from crude oil, both heating oil and gasoline will thus cost more. A copper mine in the Andean Belt of South America will send its final product to warehouses, at a rising price when converted. Soybean farmers must incur greater fuel costs, higher fertilizer costs, and hence their bounty will cost more. Add Chinese strong demand, and prices rise a quantum leap greater. We in the USA are the consumers, and rely heavily on foreign production sources. As the USDollar falters further, all commodities (including Asian components and finished products) will rise in price.
Marc Faber is widely recognized as an expert in Asia, commodities, and international markets, as is Jimi Rogers. These men offered an interview to Financial Sense Online back in early September, during which I took copious notes. I located my transcription notes on a Silicon Investor posted message at that time, for timeless keeping. Their comments and observations make for an eye-popping read. They cover the incredibly uncontrolled Fed policy, inflation, trade, recent Asian (in particular China) trends, currencies, bonds, debts, and commodities. If their comments are not found to be thought provoking, alarming, and disturbing, then the reader is simply not registering a literate pulse. See NOTES on their lengthy interview.
Very recently, even Warren Buffet has announced his massive investment in foreign currencies. He is well aware of the risk to the USDollar, as well as myriad harmful consequences. The greatest beneficiary in my opinion will be gold, from currency debasement, world reserve USDollar weakness, miner hedge buybacks, and the fledgling international movement toward alternatives to the USDollar. Since the last Fed Fund rate cut in November 2002, our monetary system has been operating with negative real interest rates. Several market watchers are aware of the connection between negative real rates and a rising gold price. Investors continue to pursue bonds in this unfavorable intermediate-term inflationary environment. When price inflation arrives, when Asian credit funding abates, gold will be the primary beneficiary. A few years from now, like in 2008 to 2010, the secular price deflationary powerful trend will exert itself once more, as it did in 2000.
SHRINKING
PROFIT MARGINS, REDUCED HOUSEHOLD BUDGETS:
To suggest that higher material costs and higher energy supply costs represent a successful reflation of the economy is lunatic quackery at best, and pure unadulterated bullshit at worst. Rising production costs make for an ongoing threat, never a benefit to a business. They are no more a benefit than rising health care costs or increasing labor costs or higher tax rates. With no relief from oversupply, or debt burdens, or Chinese competition, pricing pressures will remain as a relentless ongoing nettlesome hindrance. The end result is shrinking corporate profit margins. Increased borrowing costs are coming real soon, as interest rates rise. Thus, more pressure on profit margins. All this systemic intentional monetary inflation results in pressure on profit margins, not restoration of profitability.
On the household front, the central benefits are new employment income from working in mortgage finance, or as a real estate broker, or in import shipping, or in debt consolidation services, or in legal bankruptcy counsel, or in stock brokerage, but not yet investment banking. These are surely limited benefits, in all likelihood fleeting benefits, except for debt and legal counsel. The backlash of inflationary fallout is huge, countering such minimal benefits.
Rising commodity prices hit households hard, with heating costs, electricity costs, gasoline costs, food costs, and more. Many families report anecdotally that their winter heating bills have doubled since the year 2000. The insane new trend toward sports utility vehicles only exacerbates the higher fuel costs for commuters and travelers. Fully 45% of new vehicles purchased domestically are SUV’s, which I label as urban Sherman tanks. They serve as evidence of American consumer gluttony, operating at 10-15 miles per gallon. My little sporty sedan operates at 27-30 mpg. The end result is that households will have less discretionary spending funds, less to spend, less to save. Heck, who are we kidding? American savings is negative $400 billion annually. That figure will go even deeper negative.
The Fed’s reflation policy will result in shrinking corporate profit margins, and reduced household spending budgets. The anticipated resuscitation of income for both entities will simply not be present. As Faber and Rogers warn, a planned national inflation policy is in almost every way a disaster for a nation, its economy, and its financial markets. Initial benefits will be illusory and fleeting, and inevitably lead to even more pain and loss. We will soon stand daily in the midst of coexisting price inflation and price deflation, one the direct result, the other the indirect result, of monetary inflation. What a mighty storm comes this way!!! GOLD is the ultimate safe haven, especially as the USTBond sanctuary is assaulted by diminished demand (as price inflation returns) and by diminished supply (as Asia loses willingness to recycle). Other commodity-based investments will also prosper.
GLOSSARY OF INFLATION TERMINOLOGY:
Inflation is defined as an increase in the money supply, called by some the monetary base or monetary aggregate. Some definitions refer to an increase in money supply relative to industrial output or relative to another asset base. The money supply can expand from naked printing of money for a certain purpose, called govt monetization, or from issuance of debt. In the case of debt, many sources can serve as the originator, such as the federal govt, state govt, municipal govt, private corporations, public utilities, or mortgages. The debt could be associated with other collateralized assets such as cars or equipment or art objects, or business plant. It can even be unsecured from credit cards, or student loans, or just a person’s name. As more money accompanies demand for supplied products or assets, prices rise. Inflation is the expansion of the total supply of money above and beyond the available supply of what money buys. It inevitably leads to systemic price increases (called price inflation) when the money supply outpaces what the economy offers for a price.
In recent years, a perversion in the definition has invaded the lexicon. In a confusing aberration of terminology, a widely held notion has taken inflation to mean a rise in prices. The effect has now taken over dominance within the definition, thus obscuring the root cause. However, simple shortage could cause a rise in prices, as could overwhelming demand. As a result, confusion reigns. The public accepts monetary expansion as a politically acceptable force, even a necessary agent for govt operations. At the same time people have lost sight of the accelerated expansion’s unavoidable consequence, namely price inflation. In time, price deflation ensues, but only after the entire system suffers from a glut over many years.
Deflation is the opposite of inflation, defined as a decrease in the money supply, the monetary aggregate. Some definitions refer to a decrease in money supply relative to output or an asset base. The money supply can contract from outright debt default, or the repayment of debt, as in paying down corporate debt, car loans, credit card balances, or student loans. As less money accompanies demand for supplied products or assets, prices decline. Deflation is the reduction of the total supply of money below the available supply of what money buys. It inevitably leads to price deflation when the money supply cannot keep pace with what the economy offers for a price.
Disinflation is defined as a gradual slowdown in the pace of price inflation. This is a recent term in usage to describe a beneficial subsidence in the rate of annual price increases. In simple terms, it is a trend of declining price inflation. During such times, bond yields decline as the risk premium can be shed from value erosion. As yields decline, bond principal grows and a bond rally is born. This occurred in the 1990 decade, as long-term interest rates dropped from 8% in 1995 to 4% today. Bond investors profited heavily during this period.
Another perspective can be offered, whereby disinflation is the aftermath following a feverish period of time during monetary expansion, i.e. inflation. After years of inflation’s effects, such as over-production of finished products, over-speculation of assets (e.g. stocks, bonds, real estate, beanie babies), or excessive service provision (e.g. wireless telephone, cable television), widespread liquidations can occur in the face of competition, withdrawal, and debt default. Prices subsequently come down. If this occurs on a widespread systemic basis, we call it disinflation.
Reflation is defined as an intentional resuscitation of the economy by means of an official inflationary policy in the classic sense. In past business cycles, expansions and recessions repeated a pattern of frequent ebb and flow. When contractions within the economy took root, and stimulus from government actions had run their course, fiscal measures became ineffective. Actions typically took the form of tax changes or corporate collaboration or construction projects. The new stimulus identified by lower interest rates or fresh infusions of printed money (unassociated with debt issuance) is called monetary stimulus. When the Federal Reserve undertakes a program of planned attempts to revive the economy with encouraged expansion of the money supply via a controlled explosion of new debt and expansion of business investment, we have reflation. It represents an attempt to reinflate the economy, to kickstart the inflation process once more.
Stagflation is a truly aberrant condition for the economy. The United States has witnessed one period of time in recent decades when such a condition persisted for several years. It is characterized by a combination of economic stagnation or recession, together with price inflation. The term comes from a melding of stagnation and inflation. The condition is pure corrosion to an economy and financial markets. Stocks suffer from poor earnings, as demand falters and profit margins diminish. Bonds suffer from rising interest rates, which must compensate the erosion over time in asset values. Real estate values decline, from both rising mortgage rates and poor demand, as jobs hardly flourish.
When stagflation last occurred, following the OPEC pre-emptive crude oil price quadrupling in 1973, up to about 1980, the pressure valve was gold. The London Gold Pool had just been rendered toothless. Gold was permitted to run wild for the first time since FDR. Sponsored inflation provided extremely favorable conditions for gold to run uninhibited. An ounce of the precious metal grew in price from $35 to $880. We will in all likelihood not experience a secular inflationary period. However, the Fed will get what they want. They are engaging in reckless astonishingly powerful monetary inflation. An intermediate episode of sponsored inflation is certainly in our midst, which will be nourished until it arrives. It should last for a span of two to three years, maybe more. Gold should once again flourish, as bonds suffer serious upcoming damage. It is my contention that gold will far surpass $1000 per ounce in this bull market in precious metals.
Liquidity is defined as the flow of funds, the movement of money, from available sources. Its presence ensures the absence of systemic lockup and seizure from lack of money, which would result in either rapidly falling asset prices and rising interest rates, or both. The source of the money is not relevant to the effects. Monetary stimulus is the usual source of liquidity. Fiscal stimulus can also put more money in the hands of taxpayers. As such, liquidity has become a euphemism for monetary inflation. When the stock market has heavy inflows, we say it benefits from added liquidity. When the bond markets see free flowing inflows, we say it benefits from added liquidity. When the Federal Reserve enters the Treasury market in open market operations, we say the banking system benefits from added liquidity. When the govt quietly supplies money into plunge protection actions, we say the financial markets benefit from added liquidity. Oftentimes, money is created from the printing press or new debt issuance, which has direct inflationary implications. For political reasons, leaders prefer to use the word liquidity rather than other terms which might expose blatant inflationary strokes.
Secular is defined as a long-term phenomenon in wide development, often lasting one to two decades or more. It describes a lasting trend with powerful forces from numerous contributing sources, not easily dislodged. Intervention forces might bring about changes for a brief period, such as 12-24 months, or 2-5 years, but the defined long-term trend will exert its greater forces. For instance, a world economy response to 30 years of monetary inflation, leveraged lending, expansion of Asian production capacity, and extreme speculation has led to magnificent and historic debt collapse and asset price deflation. This secular price deflation trend will be with us for years to come. The Federal Reserve monetary stimulus and USGovt fiscal stimulus will offer temporary reprieve. An intermediate cycle of price inflation will visit upon us, only to be chased back by the more powerful secular price deflation trend. In the interim, stagflation is the most likely event.
© 2003 Jim Willie CB. All rights reserved.
Jim
Willie CB is a statistical analyst in marketing research and retail
forecasting. He holds a Ph.D. in Statistics. His career has stretched
over 22 years. He aspires to one day join the financial editor world,
unencumbered by the limitations of economic credentials. Visit his free
website to find articles from topflight authors at
www.GoldenJackass.com
. Any stock cited requires due diligence for personal investment. No
guarantees are given. No compensation has been by any company for
opinions offered.
