Friday, February 13, 2009

Deepening Global Recession Means More Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The economic news out this morning corroborates a deepening global recession. GDP in the eurozone fell 1.5% during Q4 2008. This is the third drop in the row and the steepest. Predictions are that Japan's Q4 GDP will fall somewhere around a 10% annual rate. Media coveraged emphasized how the U.S. economy was doing better than those overseas, rather than questioning the absurdity of the U.S. GDP figures. Dire warnings of DEFLATION were mixed in with the reporting.

While it is true that declining economic growth leads to falling demand (an economic argument that discusses only demand and not supply is meaningless) and the current declines are rivaling the Great Depression in the 1930s, this doesn't mean there will be deflation this time around. During the Depression, the U.S. monetary authorities contracted the money supply in the beginning, which is a major reason the Depression lasted so long and became so steep. Currently, the monetary authorities are inflating the money supply at a rate worthy of Weimar Germany in the early 1920's or Brazil in its inflationary heyday. Simple common sense indicates the outcome will be different now than it was in the 1930s.

The truth will be found in the markets. While they can be manipulated in the short term, in the long term they have to move to accurate price levels (unless the government bans trading, which has indeed happened many times in the past). Even though constant efforts are made to suppress the price of inflation-indicator gold, it is nevertheless still rising and could easily hit a new all time high sometime within the next several weeks. It reached 950.00 in futures trading yesterday, just a smidge below the 1000 level. Silver has also been rallying strongly in the last two months. Oil is trying to find a bottom at current levels and expect it to put in a good rally once it does.

Anyone who reads this blog knows the alledged deflation that is taking place is accounted for almost completely by falling oil prices. While the manipulations in the gold market are well documented, oil is probably even more manipulated but in different ways. Right now Light Sweet Crude is in extreme contango (prices for futures months are much higher than the current price). While the current oil contract was trading at $34.45 this morning, April was trading at $42.14 and June was trading at $47.62. Also the price of Brent (an inferior grade of oil) is way above Light Sweet Crude, with Brent trading at $45.90. This is the reverse of the usual price relationship and is somewhat analogous to table wine costing more than a good champagne. Light Sweet Crude may have put in a double bottom yesterday (only time will tell), falling to $33.98, close to the low of $33.16 reached last December 19th. Press coverage on oil seems to have changed this morning, with some talk about how supply is going to be reduced at current prices and how this can support prices even though demand is falling (did someone recently give the reporters a basic lesson in economics?).

Ignore all the talk about deflation coming from the press and well-known deflationists like Noriel Roubini (who is predicting a big decline in consumer prices). Yes, global economies are sinking, but monetary and fiscal stimulation (both of which are inflationary) are being applied at historically high levels. It's only a matter of time before they work their (black) magic. Just remember though that it takes many years before the full impact of inflation shows up.


Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:

Vassilis Bakopoulos said...

Re:Oil: interesting day today. Oil price is up 10%, but OIL ETN is down 2%. Wonder why...