On our podcast (Part I is gratis) we got into more Wizard of Oz debating about whether the Fed would act to counter inflation or wind down QE2. Not sure if anybody picked up my points clearly, but here it is in writing. My response: It's too late for the Fed and any action, short of a Volcker-like stratagem (zero possibility), will be spitting into the wind. Speculators and shadow banks are all in on crack-up boom trades, including oil. Ultimately, these positions will be liquidated, but the question is when. Even if the Fed let QEs finish up in June, I believe the riskloves will pile drive into these inflation trades, especially energy, as the risk is too tempting for them because they love gambling with other people’s money, especially the taxpayers. This is irresistible with free money provided by Oz. The Fed is unlikely to crack this inflation, but an inflationary bust will. Inflation, like cancer, will end up killing its host. I see all this playing out over the next two or three months.
The key marker will be when almost all participants realize an economic downturn is at hand. The Fed will then counteract any economic weakness by promising even more damaging toxins (QE3 or QE 3 lite) for the inflation cancer-ridden patient. They will soon get plenty of opportunities for this. It’s the diametric opposite of what is required, the equivalent of medieval bleeding. This will metastasize the tumor even further.
Lee asked me if this was a Weimer hyper inflation situation, and I said all that is required to completely deep freeze the US and developing economies, including China, will be 12-15% inflation. Higher inflation than that would be more icing on the cake. Note: I define inflation as the actual prices (versus some academic) businesses and people pay for goods and essential services. This is effect, when those prices go up, that’s inflation. Period.
I would say we are half way to hell right now, with the rest already solidly baked in [Blowback from the Input Goods Meltup] and following through every day. In turn, it will come on just as fast as the parabolic MIT billion prices survey chart clearly illustrates. The wild card for worse than teens inflation will be an even larger oil spike.
Chart: MIT billion price survey, now shows 6.5% three month inflation annualized and rising
The end result will look like this: The economic deep freeze will get a renewed acceleration by more or remaining QE moves. If the Fed bluffs inflation with talk (the Pinocchio Theory), the acceleration will quicken and speculators and riskloves may build up an even bigger Inflation-Bust scenario. Then everything will suddenly hit a trigger breaking point via the mechanism of a massive economic shutdown. The follow-on liquidation of all fictitious assets and commodities will be rapid and deep.
In the second stage, the Too-Big-Too-Fail banking system will then be brought down by all the elements: economic inflationary dislocation; the emptying of consumer pocketbooks; and commodity and emerging market shadow bank activity losses on top of the unresolved, non-dormant cancer from the housing bubble. The hit on stocks will be on the order of 50 to 60%, and similar amounts on commodities. Play the blow-off phase of these assets bubbles at your peril.
After hours, one of the global growth darling stocks Finisar bombed due to a weak outlook centered around (drum roll please) China slowness and “inventory adjustment.” I think we’re well aware of what this is about. I strongly suspect the lemming crowd is going to get a steady dose. In their after hours report, Texas Instruments suggests there is too much optimism around the industrial demand market. Incredibly, these reports have had no effect on the machine-driven overnight equity futures.
The following chart gauges the damage of an oil spike. Since 2009, this is closing in on $200 billion in higher cost so far. According to Trim Tabs, government has increased (borrowed) transfer payments by $514 billion.
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