How Today's "Deflation" Can Turn Into Tomorrow's Hyperinflation

 

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.

Since the 2008 Credit Crisis, deflation has been the primary worry of mainstream economists and monetary and fiscal policies that utilize various forms of “money printing” have been implemented throughout the world to try to stop it. Unfortunately, money printing combined with deflation can potentially lead to hyperinflation.

Hyperinflation is a little understood and little studied phenomenon. Even inflation itself is only partially understood and traditional university economic programs devote minimal attention to it (just ask someone with an economics degree what courses they took in inflation). Almost no one seems to have made the connection between deflation and hyperinflation, which are intimately related. Hyperinflation in fact could actually be defined as a self-feeding cycle of severe deflation combined with escalating money printing.

Historical analysis shows that hyperinflation is a creature of damaged and dysfunctional economies. It does not come from overheated economies that continue to grow out of control resulting in ever higher inflation rates.  This mythical view may have been created because government stimulus measures the employ money printing in its various guises to deal with   deflation can briefly make the economy fervent because of a declining currency. This creates high export demand since foreigners can buy the country’s goods cheaply and high internal demand because the population becomes desperate to get rid of any currency it holds. This phase does not last however and it takes place just prior to the final hyperinflationary spike. It was seen in Weimar Germany in 1922 because Germany had a developed manufacturing economy and most of the rest of the world wasn’t experiencing currency devaluation.

In many cases in the past, war preceded hyperinflation. This happened in Germany and Eastern Europe after World War I and in Eastern Europe and Japan and East Asia after World War II.  It also occurred in the United States after the Revolutionary War (arguably the first case of hyperinflation in history) and in the South at the end of the Civil War. Demand can collapse after a war and this will cause prices to drop (the U.S. had sharp deflation after World War I for instance). Governments, who were already printing money to support the war effort, then frequently print more to stimulate the economy.  If the economy isn’t brought back to real functionality however, a country’s currency loses its value and an ever-increasing amount of money has to be printed to create the same amount of stimulus.  

Even if there is no war, hyperinflation can exist just because an economy is dysfunctional. This would describe the cases of hyperinflation in South America, post-colonial Africa, and in Eastern Europe during the collapse of communism.  When an economy just can’t create enough demand on its own, the authorities stimulate demand by printing money. This leads to the same cycle of currency devaluation and ever-increasing money printing in an attempt to keep up with the loss of value taking place. In reality, the economy is continually shrinking, even though prices start heading toward the heavens.

While this has happened in a number of countries over time, mainstream economists continually make the claim that inflation can’t exist if there is slack in the economy. Hyperinflationary economies actually have maximum slack, with Zimbabwe in the 2000s being the extreme example. Unemployment reached 94% there, while the inflation rate was climbing to the sextillion percent level (a number so huge it might as well be infinity). Despite this real world example that took place right before their eyes, a number of economists had no trouble looking right into the TV camera and telling the public that inflation can’t exist if there is excess capacity in the economy. If they had been testifying in court, they would have been arrested for perjury.

Since hyperinflation has only occurred in certain countries at certain times, it is important to ask what it the key factor or factors that lead to it. The short answer would be: deflation created by demand destruction, followed by money printing that is taking place because the ability to borrow doesn’t exist or has been exhausted. Since developed countries have better credit and can borrow more, hyperinflation is less likely to occur in them than in more marginal economies – at least until their lending sources dry up.   

Deflation in and of itself does not lead to hyperinflation. It depends on what the root cause of the deflation is. There were deflations in the late 1800s and in the 1920s in the U.S. due to technological innovations and not demand destruction as commonly takes place after wars. Lack of demand was not the cause of falling prices, rising supply was. The exact opposite situation takes place after a destructive war or in an economy in a post-bubble era (as is the case currently in the U.S., the UK, Europe and Japan).  In the latter case, demand needs to be stimulated, in the former it doesn’t.

Countries also don’t print money if they can borrow it. Less developed countries have limited and sometimes no borrowing ability and this means they turn to money printing early on and this makes them more prone to hyperinflation.  Since developed countries can borrow money, they do so for as long they possibly can. This has allowed Japan to get its debt to GDP ratio to an astounding 229%. The U.S. is already over 100% (based on official numbers, the ratio using more realistic numbers is much worse) and rising rapidly.  Despite its twenty years of economic malaise, Japan has managed to support demand by running huge and continuing budget deficits funded by the massive savings of its people (money printing has been relatively minor).  It is not likely any other developed country will be able to accomplish what Japan has done.  Japan also seems to have reached the end of the borrowing road and will have to start revving up the printing presses in the near future.

In contrast to the Japanese, Americans save little and haven’t been able to fund their budget deficits internally for decades —the U.S. relies on foreign sources for this money. When the Credit Crisis arose, foreign lending became inadequate and money printing began in earnest. The Federal Reserve increasing its balance sheet by over $2 trillion is only one example of this. While foreign lending might have continued to fund $400 billion dollar annual budget deficits, it was not adequate to support the $1.42 trillion, $1.29 trillion and$1.30 trillion deficits that occurred in 2009, 2010, and 2011. Trillion dollar deficits are going to with the U.S. for many years into the future and the only way they can be completely funded is by printing more and more money.  The EU isn’t in much better shape either and has been unable to fund its peripheral country debt by borrowing. Its current solution is to print money through massive credit expansion.

Claims that money printing won’t be harmful in the 2010s because inflationary policies were utilized during the 1930s Great Depression and they worked well back then are moreover completely misleading. The debt level of the U.S. government, businesses and consumers were minimal at that time compared to what exists today. Huge amounts of untapped borrowing capacity existed then, but this is no longer true. Consumer credit expanded so much in the intervening years that during one month of the Credit Crisis it dropped more than the entire amount outstanding at the end of World War II. An apt analogy might be one drink of alcohol won’t be harmful. If you haven’t had anything to drink yet it isn’t likely it will be. If you have already had twenty glasses, it might cause fatal alcohol poisoning. The global financial system now risks being poisoned by money printing.

The monetary authorities worry about deflation and attempts to handle it with money printing are nothing new. The current actions are disturbingly similar to what took place in Weimar Germany in the early 1920s. They handled their deflation problem with money printing as well. As prices rose, instead of facing reality, the economics establishment acted in concert to deny the obvious. Deflation was cited as the biggest danger to the economy until it became laughable. When inflation exploded, the usual scapegoats — foreigners, speculators and minorities — were blamed by the government. Unless human behavior has changed in the last 100 years, the same scenario is likely to play itself out again in the 2010s.


Disclosure: None

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

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

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.

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

 

Fed Will Leave Rates at Zero Until Inflation Shows Up

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.


The Federal Reserve left the fed funds rate in the zero to 0.25% range at its April meeting. This is the 16th month that the Fed has maintained rates at an all-time low. While the Fed was a bit more upbeat about the economy than it has been at recent meetings, it still pledged to keep rates near zero "for an extended period of time".

When it comes to the Fed and other government representatives, investors would be best off by paying attention to what they do and not to what they say. The Fed was certainly more upbeat in its statement from the April meeting than it was in previous meetings. It noted that "economic activity has continued to strengthen and that the labor market is beginning to improve","growth in household spending has picked up recently" and  "business spending on equipment and software has risen significantly". You would think happy days were here again and short-term rates will be 5% before you know it. Well maybe not, it turns out.

While strong economic growth leads to inflation, apparantly there is no risk of that (inflation that is) as far as the Fed is concerned. The Fed went on to say that "with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time". So the Fed seems to be talking out of both sides of its mouth. Either growth is not sustainable in the long-run and it thinks this will keep inflation subdued or the Fed has pumped so much money into the financial system that this is creating economic expansion (at least for the moment) and inflation will follow.

The first scenario was seen in Japan during the last two decades, especially after its two-year recession in the early 1990s. The economy was supposedly recovering nicely without inflation for a few years. Instead, it gradually fell into the abyss and a deflationary spiral. In the second case, uncontrollable inflation is possible - and this can take place with a great deal of resource slack. Rapidly declining and eventual collapse of resource utilization is the marker of hyperinflation. Fed chair Bernanke should tell Zimbabwe that it couldn't have possibly had the second highest inflation rate in world history, sextillion percent, because it had an unemployment rate of 94%. Weimar Germany, with a mere 100 trillion percent inflation rate, had unemployment that reached almost 25%.

The Fed statement also had two telling comments that provide significant insight in the Fed's thinking. These were, "financial market conditions remain supportive of economic growth" and "bank lending continues to contract". Taken together these indicate that the financial conditions that are supportive are the Fed's low interest rates and the high prices of stocks - the paper economy. While the paper economy is going great, as indeed it was before the Credit Crisis and during every other bubble in history, the real economy is struggling. It can't function well without adequate credit from banks. In other words, the Fed's positive view of the economy is based on economic make believe.

If the Fed really believed the economy was improving, it would be raising rates or at least getting ready to do so and not say it was maintaining its ZIRP (zero interest rate policy) for a long time. As I have documented in previous articles, there is usually a two to three year lag from the end of a recession until the Fed starts raising rates. If we assume optimistically that the recession ended in July 2009, that would take us until at least July 2011 before rates went up. Any rate rise before that date would indicate significant inflation risk and a rate rise after July 2012 would indicate a serious deflation problem.  In either case, the Fed's response will be too little, too late.

Disclosure: None Relevant

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Greek Debt Crisis: Why Not Try Dollarization?

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.


Like a thousand page novel that never gets to the climax, the Greek debt crisis is still dragging on. Terms have yet to be worked out for the aid package from the EU and IMF and the Germans seem hesitant about providing it. The market reacted by pushing yields on two-year Greek bonds above 13% today. Even with the proposed aid, Greece's debt problem will merely be put on hold until next year and not solved.

Greece is only 2% of the EU economy, yet its debt crisis has had outsized impact on global markets. Funds have flowed out of Europe into North America and Asia because of it. This has particularly benefited the U.S. and Canadian dollars and weakened the euro. Constant talk about the potential collapse of the euro currency union has accompanied these moves. This has happened not just because of Greece, but also because of looming problems in Portugal, Ireland, Spain and Italy.

There have been suggestions that Greece leave the euro currency union, at least temporarily, and start reusing the drachma. This would be more than disruptive to say the least. I have seen no one recommend the obvious solution of dollarization. This doesn't mean Greece would use U.S. dollars; it would still use the euro, but not as a member of  the currency union. Dollarization is the generic term for when one country uses another country's currency. Panama and Ecuador for instance use American dollars as their official currency, although neither is part of a currency union with the United States. In early 2009, Zimbabwe dealt with its hyperinflation problem by allowing foreign currencies to be used in the country. One of those currencies was the euro.

The EU should consider handling the problem with Greece by temporarily suspending it from the currency union with the understanding it would still be using the euro. Greece could rejoin when its debt problems were finally resolved. This of course might not be soon. At some point a country accumulates so much debt that default becomes inevitable. That point differs for every country. Greece looks like its already gotten to that state with its debt to GDP ratio over 100%. The debt to GDP ratio for Japan is going to be over 200% though this year and it is still functioning better than Greece. Japan has its own currency though and can therefore print any amount of extra money if need be. It has funded its spending internally by borrowing the massive savings of its people. That game is over however and the situation there could eventually turn ugly almost overnight as occurred in Greece.

While Greek bond interest rates and spreads are hitting new highs, the euro itself is trying to stabilize. A look at its chart shows that it has so far made a triple bottom in late March, early April and mid-April trading. Traders are obviously getting bored with selling the euro down and the currency will be due for a rebound soon. How long that lasts depends on how the EU handles its member countries ongoing debt problems. So far, it's been only an unending number of promises with no results out of Brussels.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Inflation Denial Won't Keep Prices Low

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.


Denial is one of the most destructive forms of behavior for investors. While the markets can operate on false scenarios for a significant period of time, reality always wins in the end. When it does, the situation can get quite ugly and all the profits gained from a belief in an unsupportable viewpoint can evaporate over night. At the moment, there is a lot of denial about inflation and investors should be paying attention to this.

The case for inflation is based on common sense and the laws of simple arithmetic. A country cannot create money at a faster rate than its economy is growing. If this occurs, the currency is devalued and it then takes more units of currency to purchase any given item (which is the same as saying prices go up).  There is a time lag between these two events however, sometimes many years, so people frequently don't connect them. Indeed, governments who engage in this behavior frequently go to great lengths to insure the public doesn't make the connection and realize that inflation is caused by government actions. Invariably throughout history, speculators and foreigners are blamed for rising prices. Think about whether or not you've heard any talk about speculators lately. There will be a lot more of that in the future.

When it comes to inflation, governments not only try to act like magicians and dazzle you with one hand while picking your pocket with the other, but they also engage in strong and persistent denial of its existence. Any number of fanciful, but easily debunked, arguments will be produced to show inflation doesn't and even can't exist. In Weimar Germany in the early 1920s, the economic establishment engaged in an across the board denial that inflation existed and there were even 'proofs' created to show that there was really deflation. Inflation eventually reached the hundred trillion percent level there.

So what is happening in the U.S. today? At the March 16th FOMC meeting, the Fed stated "With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.” The implication is of course inflation can't exist if there is substantial resource slack. By the rules of logic, if we can find a single example that contradicts this, we cannot rely on this statement. There are of course many, many such examples. The most recent and perhaps extreme is what just took place in Zimbabwe. The unemployment rate there reached 94% (yes that's unemployment) and the economy essentially experienced a total collapse. According to U.S. Fed, there should have been massive deflation in Zimbabwe, instead of the second worse case of hyperinflation in world history. How could this have happened? Zimbabwe printed a lot of money. The U.S. has also been engaged in significant excess money printing during the last two years.

The evidence of inflation is also not likely to show up first in U.S. government reports. The government has a vested interest in making sure that it doesn't. This is part of managing inflation expectations, which the Fed also mentioned in its statement. The last thing the government wants is for people to be aware of coming inflation and they will manipulate the official numbers and the news as much as necessary to keep this from happening. Investors who want to know what is really going on with inflation need to look elsewhere for the facts. The most recent ISM (Institute of Supply Management) reports indicated very strong inflation pressures in the system, particularly in the manufacturing sector. This story got buried in the media though and was covered up with glowing claims for economic recovery.

Investors should also watch the markets for what they are saying about inflation. There are three important indicators - interest rates, oil and gold. U.S. treasury interest rates have been bubbling up for awhile now. The market is having trouble absorbing the huge supply of bonds that the U.S. has to sell in order to fund the budget deficit. Long-term interest rates have broken a 30-year downtrend line and look like they will be heading higher for many years to come. Oil just broke above a nine-month trading range and is now heading higher as well. Nothing has more of an impact in leading to higher consumer inflation than does rising oil prices (which are set internationally and are out of the Fed's control). Gold has risen from a low just above $250 in 2001 to its recent high in December above 1200. It is in a seasonally weak period at the moment, but should be hitting new all-time highs in the fall.

Inflation provides an object lesson of how investors need to approach the markets. The media is filled with information on financial topics, and much of that information is misinformation. It is necessary to cut out or ignore the irrelevant to make good investing decisions. The best way to do this is think for yourself, believe your own experience, and watch what the markets are actually doing.

Disclosure: Long oil.

NEXT: An Analysis of Retail Sales Media Coverage

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Economists and Governments Pave the Way for Global Inflation

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.


In a just given speech at the London School of Economics, famed economist Joseph Stiglitz stated that the U.S. and UK should keep on spending and printing money to prop up their economies. Stiglitz apparently did not mention that recent hyperinflation basket case Zimbabwe followed this same approach. Meanwhile, plans for either an EU or German bailout of Greece continue to swirl about, taking the EU down the road of Moral Hazard and truly huge future bailouts for its member states. Government spending, bailouts, and money printing all go hand in hand.

The Stiglitz speech will be seen as a historically significant event. Stiglitz is not some minor, unknown economist, but is an insider's insider. Stiglitz is a winner of a Nobel Prize in Economics, former Chief Economist at the World Bank, former Chair of the Council of Economic Advisors, and has held economic professorships at a number of top universities. In his speech, he essentially stated that it is impossible for the US and UK to default on their debt because they have unlimited ability to print money. While this is certainly true, it is also simplistic, self-destructive, and immoral.

Money printing erodes the value of a currency and governments that engage in it are acting dishonestly since it is essentially legalized counterfeiting. Yes, they will give their lenders back the same nominal amount of money as was originally given to them, but lenders won't be able to buy as much with it as they could have previously. Lenders usually catch on to this scam pretty quickly and demand increasingly higher interest rates to compensate for the loss in value of the government bonds they are buying. Needing to pay more interest, the government then prints more money. An inflationary spiral results and the government can't stop the printing because doing so risks an economic collapse.

Stiglitz's approach is hardly original. This is the strategy that every country in history has followed that has experienced hyperinflation. Zimbabwe is only the most recent example; there are dozens of others in the last hundred years, with Greece being one of them. In all cases, the only thing that stopped the inflation was when the money printing stopped. This was most blatantly demonstrated in Zaire in 1997 when the government couldn't pay the outside printer of its currency. It received no new paper money and its hyperinflation ended abruptly. The Weimar Republic in 1920s Germany managed to stop its money printing by creating a new currency (a common solution) and backing it with hard assets. Top German economists during the Weimar Republic backed the government's money printing plans, just as Stiglitz is doing today for the U.S and the UK. 

While the U.S. and UK are well along on their money printing agendas, the EU has lagged behind. The impending bailout of Greece will help them catch up. Greece, in and of itself, is not that big. It is only 2% of the euro zone economy. The implications of a bailout for the future are enormous however. There are a number of other countries in the euro zone that will need their own bailouts. While Ireland, Portugal and Spain are on the list, the most serious problem by far is Italy. Italy is perhaps one year behind Greece in the deterioration of its financial condition. Its economy is approximately the same size as the UK's. How is it possible to bail out an economy that large?  How much money would have to be printed to accomplish this? It would take quite a lot obviously and the euro would be damaged considerably.

We are living in times when almost every government is engaging in policies that will devalue their paper currencies. Hard assets unquestionably become more valuable under such circumstances. How much the U.S. dollar, the British pound, the euro and the yen devalue in relationship to each other remains to be seen. The Japanese have the worst debt to GDP ratio of any major economy in the world and are approaching levels last seen in Zimbabwe. The UK and the US have been the biggest money printers so far, but the euro zone might catch up and surpass them. The best approach for investors would be to avoid keeping any significant amount of liquid assets in any of these currencies.

Disclosure: No positions.

NEXT: World Economic Leaders Need IQ Bailout

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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 Inflation Is and Will Be a Problem

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.

In December 2008, I predicted at the New York Investing meetup that inflation would reappear in the U.S. by the end of this year. The just released PPI report for November had wholesale prices up 1.8% (a 21.6% rate annualized). Year over year PPI was up 2.4%, the first positive reading in a number of months. The CPI report for November had prices up 0.4%. Year over year was up 1.8%. I made last year's prediction that inflation would be turning just about now based on another prediction that oil prices would be much higher today than they were in late 2008. Both government reports cited higher energy prices as the main driver of the uptick in inflation.

As would be expected, many mainstream economists (who as group significantly underestimated the PPI number) and Fed Chair Bernanke quickly told the public not to worry. They argue that this has to be just a temporary blip because inflation can't have a sustained rise unless the economy is expanding strongly. They point out that the most recent U.S. capacity utilization rate is 71.3% and claim that inflation can only become a problem if this number is over 80%. The capacity utilization argument might have some validity if the U.S. was a self-sustained economy that didn't engage in trade (something I refer to as a non real-world condition). The U.S. not only engages in trade though, but imports much more than it exports. The country has run a trade deficit with the rest of the world continually since the 1970s. One thing that we import a lot of is oil. Like almost all commodities (natural gas is the exception), the price of oil is set globally. The U.S. capacity utilization rate has only an indirect and minor impact on oil and other commodity prices. The error that many mainstream economists have made in their thinking is that the U.S. inflation rate is controlled by conditions that exist solely within the U.S. In actuality, markets outside the U.S. are the key determinant of the how much inflation American consumers experience.

The capacity utilization argument can also be debunked through historical analysis. Not only have there been cases of major inflation in countries with low capacity utilization, but this condition invariably accompanies hyperinflation. The most extreme example of this took place in the last few years in Zimbabwe. The unemployment rate there rose to 94%. With almost the entire nation not working, presumably capacity utilization was as low as it possibly could get under any circumstance. According to many mainstream economists and the U.S. Fed, Zimbabwe couldn't possibly have had inflation. Instead, it had sextillion percent inflation, the second highest rate ever recorded.

While capacity utilization is a red herring when analyzing inflation, currency policy is not.Commodity prices are affected by the strength of the U.S. dollar since all commodities are priced in dollars. A weaker dollar means higher commodity prices and higher inflation in the U.S. This is merely a specific example of a declining currency being the actual correct definition of inflation. Central bank easy money policy with excessive government borrowing backed up by money-printing is what causes a currency to decline.

Many economists refuse to accept that the declining value of a currency is the root cause of inflation though. When not using the capacity utilization argument, inflation-denying economists and other Fed apologists resort to defining inflation as a rise in credit and deflation as a drop in credit. Like capacity utilization, this viewpoint doesn't stand up to real world analysis either. For this to be true, there would have to be ever increasing amounts of credit in real terms in hyperinflationary environments. Not only does this not happen, but credit availability tends to implode during hyperinflation - the exact opposite of what would be predicted. The one thing that all hyperinflations do have in common though is excess money-printing.

Inflation is not a new phenomenon. There have been hundreds of inflationary episodes over time. The one thing they all have in common is that there is too much money (currency actually) for the size of the economy. Central banks in most major economies are currently engaging in excess money creation with abandon. At the same time, they are telling the public not to worry because things will be different this time. They also said that last time and the time before by the way.

Disclosure: Long gold.

NEXT: U.S. Plays Shell Game with Bailout Money

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.

The Common Roots of Hyperinflation

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.

Rating agency S&P lowered its outlook for Spanish government debt on December 9th. Fitch lowered its long-term debt rating for Greece to BBB+ from A- the day before. In the eurozone, there are concerns about Portugal also being in trouble, although Portugal's debt to GDP ratio is no worse than the United States and a case can be made that the U.S. is actually in much worse shape - the U.S. has a large money printing press however and Portugal does not. No country can compare to Japan however with its debt to GDP ratio currently over 200%. An examination of the CIA Factbook figures for 2008 estimated that only Zimbabwe had a worse debt to GDP ratio than Japan's. Zimbabwe also had the second largest hyperinflation in world history.

The roots of all hyperinflations are governments not being able to fund their operations. Government's first borrow money to do so and this can go on for years or even many decades (the more powerful the government, the longer it can live off of borrowed money). At some point, the credit either starts to run out or the expenditures get so high that the amount that can be borrowed is no longer enough. It is then that governments resort to printing money (not literally done in advanced economies where money is simply created by pressing the enter button on a computer) and this devalues the currency. The devaluation is the result of simple arithmetic. Currency increasing at a faster rate than the size of the economy means each unit of currency is worth less and it takes more money to buy any given good or service than it would have otherwise. The price rises that result are consumer inflation. Many economists do not use this obvious definition of inflation, which is one reason why their inflation predictions are frequently highly inaccurate. Central banks particularly don't like it because it would prevent them from engaging in politically popular, but potentially disastrous monetary policy.

The Credit Crisis has led to a lot of money printing (frequently referred to as quantitative easing) globally and this is taking place after decades of increased borrowing in most countries. While money printing will lead to inflation, it only leads to hyperinflation when it spirals out of control. The preconditions for this are that borrowing power has been maxed out (which is now the case for many countries, but was not true in the 1970s and this is why it was possible to tame inflation back then) and it no longer becomes politically possible to match government expenditures with revenues. In the modern era, this is always a problem during wars since no state is capable of raising enough money through taxes to pay for any major or prolonged military effort (the U.S. accounts for over 40% of global military expenditures by the way). Contemporary democracies also get caught between the need for large outlays for social expenditures and the resistance of rich individuals and corporations to paying the taxes necessary for funding them, so they compromise and give both sides what they want. This problem is by no means brand new. It is essentially what lead to the hyperinflation in Germany in the early 1920s.

Once the preconditions for hyperinflation exist, a major economic shock can then become the precipitating incident. Governments will always assume that the problem is temporary and the economy can be righted quickly through a little money printing. In deep economic shocks like that depression in the 1930s and the Japanese banking crisis in the 1990s, and the Credit Crisis today, this is not the case. The problem will take at least a decade and possibly multiple decades to solve. The possibility for long-term money printing then exists (the U.S. did not engage in this in the 1930s). Zero or close to zero interest rates will mask the damage that is being created. This is what has allowed Japan's government finances to spiral out of control (combined with a huge pool of personal savings of the Japanese people that it could tap into) and is now enabling the U.S. and UK to do the same. At some point though interest rates have to rise and when they do, interest payments on the national debt can equal or exceed the government's tax receipts. The game is up long before that occurs however with a hyperinflationary spiral becoming inevitable. For this reason, it is now no longer possible to solve a future inflationary problem by raising interest rates to high levels as was done in the U.S. at the end of the 1970s. This approach now would be disastrous.

The U.S national debt increased by a $1 trillion in 2008 and $1.9 trillion in 2009. The damaged economy and the after effects of the Credit Crisis are likely to keep the increase elevated for many more years. After that, increased outlays from Social Security and Medicare caused by the Baby Boomers retiring will kick in, so there will be no respite. At some point the whole scheme will fall apart. When interest rates rise well off the zero level, this will be the tipping point that means that an inflationary spiral has started.

Disclosure: Not applicable.

NEXT: Short Bonds When Retail Sales Improve

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


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.

Today's Economic Lunacy

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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If ever there was ever any doubt that lunatics are running the economic asylum, we received more than enough confirmation of it today. Fed chairman Ben Bernanke expressed confidence that the current recession (actually depression) could end in 2009. It has been revealed that much of the AIG bailout money went to pay other banks and brokers who were also receiving bailout money and for executive bonuses. OPEC caved into pressure from the West not to cut oil production because it would hurt the world economy, as if this could somehow undo all the damage the Central Bankers were doing.

Fed Chair Ben Bernanke made his remarks about the recession on 60 Minutes (they should have resurrected the 1960's classic show, 'The Twilight Zone', for his commentary). While media headlines this morning blared that Bernanke said the recession would be ending in 2009, he actually added the important caveat that this would only happen if the banking system is stabilized. A realistic assessment of the chances of that happening can not be found in most press coverage. Bernanke further stated (try not to laugh) the largest U.S. banks are solvent and "they are not going to fail". The large U.S. banks are of course insolvent, although it is true that they are not going to fail because the government will pump an infinite amount of money into them if necessary to prevent this from happening. U.S. taxpayers should not worry about this however. Bernanke assured us last night that the bailout aid is not coming directly from tax funds and is "more akin to printing money than it is borrowing." Isn't that the approach the Weimar Germany and Zimbabwe took?

Government money printing is bad enough as is, but the news out of AIG over the weekend shows just how much of this is going to waste (hey, don't worry, they can always print more... and they will). Of the $170 billion that AIG received in government bailout funds, $105 billion went to pay other banks, including many foreign banks. Many of the U.S. banks were already receiving other government bailout money as is. As for the foreign banks, why is the U.S. bailing them out? Adding insult to injury, AIG is also using its bailout money to also pay executive bonuses. It claims that it is legally obligated to do so. Personally, I would like to see those contracts that state government money must be used to pay these bonuses. I think this problem could easily be solved if the people running AIG spent some time with Bernie Madoff in his new home.

Since the ordinary rules of basic economics are being ignored everywhere else, why should they apply to oil production. At its meeting on Sunday, OPEC did not cut production quotas again, but instead said it would aim to enforce the already existing cuts. In the last several months OPEC has announced a 4.2 billion reduction in quotas and it is estimated there has been 80% compliance. They are now trying to get the extra 20% or 800,000 barrels a day. Oil production is being cut elsewhere as well, including the U.S., and this is happening because it simply isn't profitable to produce oil under $40 a barrel in many places. And no amount of wishing, hoping and jawboning is going to make this happen. The rules of economics always win in the end. Someone should tell Ben Bernanke.

The New York Investing meetup is having its second class in Technical Analysis on Tuesday. If you are in the New York area, you should be attending (space is limited and by invitation only to members of the group, if you didn't get an invitation email me through the website).

NEXT: When Bad News is Good News and Vice-a-Versa

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.