Ben Bernanke's 'It's Not My Fault' Inflation Speech

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Americans shouldn’t expect to hear the truth about inflation from Fed Chief Ben Bernanke and he didn't disappoint in a speech he gave to the International Monetary Conference in Atlanta, Georgia on Monday. The money-printer-in-chief of the Federal Reserve denied that the Fed’s easy money policies are responsible for the inflation that is currently showing up in commodity prices. The public shouldn’t have expected anything else from the dissembling Fed Chair, nor should they believe anything he says.

Bernanke claims that rapidly rising commodity prices are the result of rising demand and not enough supply. While in isolation this is always the case in economics, it doesn’t explain why demand is rising in leaps and bounds and why this has occurred at the same time the Fed has been on a money printing binge. Bernanke did not make comparisons in his speech between demand and prices in 2008, when the Fed turned up the printing presses to max and conditions right now. Let’s look at a few of them:  U.S. gasoline prices went from approximately $1.60 a gallon to almost $4.00. Oil prices have tripled from a low around $33 a barrel. Copper prices almost tripled during the same period. Cotton prices have gone through the roof and took out a high established around 150 years ago. Silver prices went from a low of $8.88 to almost $50.  And that’s just the beginning.

Did global demand for oil, copper, and silver increase by three or more times in two and a half years?  It most certainly did not. If anything economic demand has only increased by a few percent at most. There is something that did increase by a lot more however – the Fed’s balance sheet, which grows when it prints money. That has gone through the roof just like commodity prices. Money printing of course increases demand for any number of items because it makes a lot more funds available in the financial system. For some reason, Bernanke didn’t quite connect the dots between the two in his speech.

The recognition that increasing the available money in the economy leads to rising prices has been known for 500 years and was first proposed by well-known astronomer Copernicus. The idea is based on grade-school arithmetic. If you have an economy of a certain size and a given amount of money and you increase that amount of money, then each unit of money is worth less. It’s not rocket science, and yet Fed officials with PhDs from top schools can’t seem to be able to grasp this simple concept. Or perhaps they don’t want to do so.

Bernanke’s speech also didn’t explain why the price of gold has doubled since its Credit Crisis low. While gold does have some industrial uses, its price is a good gage of inflation expectations on the part of the investing public. Bernanke claimed these were under control, so we don’t have to worry about inflation. Gold is telling a very different story – and gold is not known to lie.

Bernanke also fell back on the 'employment is high and there is slack in the economy, so inflation can’t happen' argument. Historical analysis indicates that hyperinflation takes place under just such conditions. The most recent example happened in Zimbabwe in the 2000s (perhaps Ben didn’t read the papers during those years). As the economy collapsed and unemployment headed toward close to 100%, prices skyrocketed. It wasn’t the first time something like this has happened, it’s the same story over and over and over again throughout history – yet Ben keeps telling us it can’t happen. Well, I guess if you don’t let little things like reality intrude in your worldview, it can’t.

As an author of a book which includes a lot of material on inflation history, I found no case in the past where the authorities admitted their guilt in causing inflation. In every instance, the government printed a lot money or cut the coinage (if it was before paper money existed). Without exception in modern times, speculators and foreign influences are blamed for inflation. For some reason the government money-printers behind the inflation that ruins their countries just never seem to admit that they’re at fault. Bernanke’s recent speech is just another example of history repeating itself.   

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Author, "Inflation Investing: A Guide for the 2010s"

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.

Why the U.S. Economy is Turning Down

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented amounts of money printing. This is the official blog of the the New York Investing meetup.

A number of economic reports have come in lower than expected recently and the talking heads on TV are perplexed as to why a sudden downturn is taking place. Listening to their commentary, you will hear all sorts of fanciful explanations except the most obvious one – the massive government deficit spending that has been the reason for the apparent economic recovery has been frozen because the U.S. national debt ceiling hasn’t been raised by Congress.

The debt ceiling is currently $14.3 trillion and this was reached in May. Debt was already getting close to this figure as early as February however and federal spending was decelerating long before May. Based on the 2011 fiscal year budget (which runs from October 1, 2010 to September 30, 2011), the U.S. was on track for a deficit as high as $1.65 trillion this year. This represents approximately 11% of U.S. GDP. This 11% is just the deficit part of federal government spending, not all of it. Subtract this from GDP, you would see GDP was only around $13 trillion – lower than before the Credit Crisis began.

Moreover, the part of the GDP generated by the deficit is being paid for with borrowed or printed money. Actually, it’s mostly printed money. The amount of quantitative easing planned by the Federal Reserve in the first half of the year is enough to cover 70% of the deficit.  The government issues bonds to pay for the deficit and then the Fed buys them with printed money. This is what has been making the economic numbers look better and is being described by the mainstream media as an economic recovery.

A monkey wrench was thrown into the works however when Congress refused to raise the debt ceiling. As a consequence, deficit spending has ground to a halt for a while (expect it to return soon) and this in turn slowed down the Fed’s effort to inject newly printed money into the economy. How dependent the health of the economy is on deficit spending supported by the Fed’s phony money operation has become apparent in recent economic reports.

The May non-farm payrolls indicated only a 54,000 increase in jobs for the month. Moreover, the previous two months were revised downward by 40,000 jobs. The manufacturing sector, which has been leading the recovery, actually lost 5,000 jobs. Close examination of the figures indicates there are well over two million less people in the labor force than last year at this time. If they had remained in the labor force, the current unemployment rate would be 10.6% rather than the reported 9.1%. It would be highly unusual for the labor force to shrink at all, let alone by over two million, if the economy was growing as it supposedly has been. People leaving the labor force make the unemployment numbers look better than they are though and government statisticians are well aware of this.

Regardless of how much recovery has taken place, it is clear that the goods producing sector of the economy is weakening. While the ISM Manufacturing report for May still indicated expansion, every component was lower than it was in the April reading. New Orders and the Backlog figure were barely positive.  The highest component, as has been the case for many months, was Prices Paid – a measure of inflation. It was down from a whopping 85.5 in April to a still very high 76.5 (above 50 indicates expansion). Much of the growth in manufacturing has occurred because the items coming off the assembly line cost more, not because of there are more of them. The Durable Goods reading from April, the most recent, was down 1.2%, confirming less demand for the output of U.S. factories.

Tying it all together are the Leading Economic Indicators (LEI), an indication of where the economy is heading. These were down 0.3 in April, indicating the economy is likely to continue to lose steam. LEI will probably stay weak until the deficit ceiling is raised and newly printed money can start flowing back into the U.S. economy at its formerly prodigious rate. If this doesn’t happen, Americans might discover that just like the proverbial emperor, the U.S. economy has no clothes.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Author, "Inflation Investing - A Guide for the 2010s", Volume 1
http://www.amazon.com/Inflation-Investing-Guide-2010s-ebook/dp/B0051GU06W/ref=sr_1_3?s=books&ie=UTF8&qid=1307366974&sr=1-3

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.

Will You Become an Inflation Victim? Take this Simple Quiz

The 'Helicopter Economics Investing Guide' is meant to help educate the public on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the offical blog of the New York Investing meetup.


Recently, San Francisco Fed President John Williams assured the public that there won’t be runaway inflation in the United States. His remarks follow a long litany of comments from  Federal Reserve officials that inflation is under control, inflation is low, and other variations of there simply is no inflation.  People who know inflation history, and this includes very few people alive today, are getting little comfort from these remarks. Central bank officials have repeatedly assured the public that there is no inflation in the past despite inflation obviously existing. One of the most vocal and sustained denials took place in Weimar, Germany in the 1920s. The central bank, the treasury department and top economists all agreed that inflation wasn’t a problem. It eventually reached 100 trillion percent.

Americans just have to open their eyes to see that inflation exists. Gasoline prices have risen from a $1.60 a gallon at the bottom of the Credit Crisis to almost $4.00 today. A number of food commodities, including sugar and coffee are having sustained price rises, and food prices in the supermarket are noticeably higher. I have a friend who records all of his family’s food purchases in Quicken and even though they are eating the same foods in the same quantity, the amount they are spending has gone up 10% in the last year.  Prices of clothing are also rising because commodity cotton prices broke a 150-year high recently. Copper, which has the widest of uses of all metals, has also hit an all-time high earlier this year.

Yet, the Fed tells the public not to worry as it continues one program of money printing after another. Even though this has always resulted in inflation in the past (the basic laws of arithmetic would have to be violated if it didn’t), they claim things are different this time. The continually fall back on the argument that there is a lot of slack in the economy and since U.S. unemployment is around 9%, wages can’t rise and this prevents inflation. Unfortunately, real world observations of past major inflations indicate how absurd this line of reasoning is. Unemployment in Weimar, Germany rose to 23% as their inflation rate reached the trillion percent level. Slack in the German economy was nothing however compared to Zimbabwe in the early 2000s. Unemployment there reached 94% and literally nobody in the entire country had a job. The inflation rate in Zimbabwe is estimated to have been at the sextillion percent level (a number so huge it might as well be infinity).

Before inflation really gets out of control, take the  following quiz to find out how well-informed you are about inflation investments and how your portfolio will be affected by it.

QUIZ

ANSWER TRUE OR FALSE

1. Safe investments like money market accounts, CDs and government bonds are just as good during high inflation as other times.
2. TIPS (Treasury Inflation Protected Securities) will at the very least maintain my capital during inflation.
3. Buy and hold in the stock market is an effective wealth building strategy during high inflation.
4. The higher the inflation rate, the better residential real estate is as an inflation hedge.
5. The U.S. dollar is the strongest currency in the world and will remain so during a period of high inflation.
6. If I have 5% of my portfolio in gold, my assets are protected from high inflation.
7. Of all possible inflation hedges, gold will provide the biggest return during high inflation.
8. When inflation is taking off, commodity prices will rise at the same rate as inflation.
9. When a government imposes wage and price controls, you can assume the inflation rate will come down and stay down.  
10.  Speculators are the cause of high prices during inflation.

WHICH INVESTMENT WOULD YOU RATHER OWN DURING HIGH INFLATION?

11. The U.S. dollar or the Australian dollar
12. A U.S. treasury bond or a collectible Pez dispenser.
13. A house in the Chicago suburbs or a 100-acre farm in Iowa
14. A 5-year CD or a copper mining stock
15.  Utility stocks or commodity oil
16. Municipal bonds or Thai grade B rice
17. TIPS or a set of silverware
18. Long positions in U.S. treasuries or short positions in U.S. treasuries
19. A money market account or a gold ETF (exchange traded fund)
20. British stocks or an antique map of England

HOW TO GRADE YOUR QUIZ

The answers to questions 1 through 10 are all false. The correct answers for questions 11 through 20 are the second choice. If you scored between 0 and 5, don’t be critical the next time you see a homeless person looking for food in a public garbage can. If you scored between 6 and 10, you will probably remain in your home, but won’t be able to heat it that much and your cupboards won’t be well stocked. If you scored between 11 and 15, you will get through a period of high inflation relatively unscathed. If you scored between 16 and 20, go to a neighborhood of high-priced homes (assuming you don’t already live in one), find someone who scored under 5 on the quiz and tell him that you will be living in his house in the future.

Explanations for questions 1 through 10: People who own liquid investment, such as money market accounts, CDs and bonds will lose money during inflation. In the worst cases, they will lose everything. TIPS are not an effective protection because their returns are based on official inflation rates and the U.S. government has been underreporting inflation since 1983. Stock prices tend to go sideways during inflationary periods and can be highly volatile. Residential real estate is a very poor investment during inflation because it can become extremely cash flow negative because of rising taxes and maintenance costs. The U.S. dollar has not been the strongest currency in decades and it went down against every major currency between 2000 and 2010. It is good to hold gold during high inflation, but 5% isn’t enough. Gold does not produce the highest inflationary returns, silver and many other investments can outperform it. It does produce the most reliable returns however. Commodity prices actually rise much faster than the overall inflation rate (examples were cited in the beginning of the article). Wage and price controls almost always fail. The only work if government money printing is permanently halted at the same time that they are imposed. Speculators don’t cause high prices, but along with foreigners, they are universally blamed for inflation. Central bank money printing is the cause of high prices.

Explanations for questions 11 through 20:  In general, tangible investments are preferred to liquid investments during inflation, so if the choice is between a money market account, CD, or bond versus a commodity or commodity related stock, the commodity is the best investment. Antiques and collectibles are also better investments that liquid investments. Of all the public currencies in the world, the Australian dollar most closely tracks price changes in gold, so it is the top choice during inflation. Farmland is the best real estate investment during inflation. Interest rates go up during inflation, so the way to make money in bonds is to short them, not own them.

Disclosure: Author does not own any specific investments cited in this article, but does hold some U.S dollars.

Daryl Montgomery
Author: Inflation Investing – A Guide for the 2010s
http://www.amazon.com/Inflation-Investing-Guide-2010s-ebook/dp/B0051GU06W/ref=sr_1_4?s=books&ie=UTF8&qid=1306940501&sr=1-4

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