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.

Debt Crisis -- Greece 2011 Compared to Argentina in 2001

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.

Headlines such as "Hopes for Greek debt progress lift world stocks" and "Wall St opens higher on European hopes" are in the financial news today. Before investors buy into the hype, they should realize that the powers-that-be always deny an obvious and inevitable default before it takes place. Greece in 2011 is on a very similar trajectory to Argentina in 2001 and is well past the point of no return for a default just as Argentina was back then.
There are many similarities between the current Greek debt crisis and the Argentina debt crisis in 2001. Greece is not using its own currency, but a transnational one, while Argentina pegged its currency to the U.S. dollar.  A connnection to a greater currency allows only limited policy responses and prevents the usual money printing that would have take place when debt becomes too high. This in turn causes a gradual rise in inflation up to the point of hyperinflation (Greece and Argentina have both experienced hyperinflation in the past). While skyrocketing interest rates in Greece are implying there is massive inflation, the official inflation rate is under 3%. Yields on one-year Greek governments reached approximately 100% on Tuesday, telling a very different story.  

While the Greeks are certainly underestimating their inflation rate (they have been caught lying and continually underreporting their debt figures and no numbers from the Greek Statistical Office can be trusted), it is relatively minor no matter what the actual number. Inflation is caused by a falling currency and hyperinflation by a collapsing currency. Since the euro is not dropping that much and Greece uses the euro, inflation is not showing up there. Argentina tying its currency to the dollar also created a very low inflation rate as long as the peg lasted.  There is no free lunch however (even though you may have repeatedly heard that there is from politicians). Profligate government spending eventually leads to major inflation. The inflation only showed up in Argentina after it decoupled its currency from the U.S. dollar and it will show up in Greece after it decouples from the euro. Instead of gradually building inflation, sudden major inflation will take place.
The Argentina crisis began when a new government was elected in December 1999 and had to deal with years of mismanagement from the previous administration. Greece elected a new government in October 2009 and shortly thereafter it revealed that it had a lot more debt and higher budget deficits than it had claimed. In both cases, sharp spending cuts were implemented and serious riots followed. By December  2000, Argentina had acquired bailout funding from the IMF. Markets rallied and press reports indicated everything was going be OK. Greece received its first bailout from the EU and the IMF in the spring of 2010 and markets rallied and press reports indicated that everything was going to be OK.  In both cases everything that followed wasn't going OK.
By the spring of 2001, events started spiraling downward in Argentina. In the spring of 2011, events started spiraling downward in Greece. In August 2001, Argentina received an increase in its standby loan agreement from the IMF. Greece received promises of a second bailout from the EU, but with some mandatory debt swaps as part of the deal. Argentina engaged in debt swaps in June of 2001. Interest payments on Argentina's debt eventually overwhelmed rescue attempts and on December 5, 2001, the IMF announced it would not disburse promised aid to Argentina. A collapse followed shortly thereafter. The EU is now questioning whether or not to continue to make disbursements to Greece. If the disbursements stop at any point, Greece will default shortly thereafter just as Argentina did.

No government is of course going to admit that it is going to default. If it did, no one would purchase its bonds and this would cause an immediate default.  It is not surprising that the Greek government is denying the obvious, EU leaders are grasping at straws to explain how a Greek default will be avoided, or that the mainstream media is trying to spin those straws into a golden fantasy of solvency. Argentina denied that it would default right up to the end as well, just like every other country (and major company) facing the same predicament has in the past. Despite the claims that, "this time is different", it never is.

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.

Quantitative Easing Means Foreigners Will Dump Treasuries

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.


Stocks and gold rallied strongly yesterday on the news that Japan is doing more quantitative easing and remarks from Fed Chair Ben Bernanke that more quantitative easing (also known as money printing) would be good for the U.S. economy. The major, and possibly disastrous, downside risks were not mentioned in mainstream media reports.

Quantitative easing has been tried many times before in Japan. It has failed to produce any lasting results, which is why it needs to be done again. The Fed has already engaged in quantitative easing during the Credit Crisis (frequently referred to as QE1) and is also doing it again because it didn't have any lasting results. Moreover, it isn't clear that any positive results took place at all because of QE1. The Fed claims it was a great success, but hasn't offered any proof to support its contention. There is certainly proof that it didn't work. Exhibit one is the much higher unemployment rate that we currently have. Just the need to do quantitative easing again is in and of itself proof that this was a failed policy.

While the advantages of quantitative easing are dubious, the risks can be horrendous. The biggest danger is for a country with a massive debt held outside that country (this describes the United States, but not Japan) Printing money is inflationary. It devalues the currency of the country doing it. The trade-weighted dollar did indeed have a big sell off on the news. Inflation-sensitive gold hit another all-time high. Quantitative easing will encourage large foreign holders to sell U.S. debt and to not make purchases in the future, except for TIPS (treasury inflation protected securities). Even TIPS will ultimately be shunned because they reflect the understated official U.S. government inflation rate. Without this source of foreign capital, the U.S. cannot fund its budget deficit or its trade deficit. This would send the economy into a severe contraction. The only way to avoid that would be to print even more money...and then more money ....and then more money. Without the money printing, the U.S. economy would enter a severe depression. With money printing, the risk is hyperinflation.

The biggest foreign holders of U.S. treasuries are China, Japan, the UK, the Oil Exporters, Brazil, the Caribbean Banking Centers (off-shore money havens used to hide the parties involved in financial transactions), Hong Kong, Russia, Taiwan, Switzerland and Canada. Why would these countries continue holding U.S. government bonds if they know they are going to be paid back in devalued currency? Why will these countries want to buy more bonds in the future? According to TIC (Treasury International Capital) data, China held $939.9 billion in U.S. treasuries in July 2009. In July 2010, it held only $846.7 billion. It is also known that China has been selling long-dated paper and moving into the short end of the yield curve. Other countries would want to do the same in response to quantitative easing. This may be why yields on the two-year note keep hitting all-time lows.

The impact of the first round of U.S. quantitative easing shows up even more clearly in the amount of treasuries held by the Fed. At the end of the first quarter, the Fed held $5.259 trillion in U.S. government bonds - more than five times the amount of China, the largest foreign holder. The nightmare scenario of the U.S. having to print money to buy its own government bonds because it can no longer borrow enough money from foreign sources to fund its government operations has clearly already taken place. That the Fed is now doing more quantitative easing indicates a self reinforcing inflationary cycle is underway. Investors should act accordingly.

Disclosure: No positions.

Daryl Montgomery
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.

The Fed's Minimum Price Stability, Maximum Unemployment Policy

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 Fed says it's worried about deflation and high unemployment. So in order to tackle these two problems it's going to do more of the same things that lead to them.

In its post meeting statement yesterday, the FOMC said that inflation is 'somewhat below' levels consistent with its congressional mandate for stable prices.  Since the official inflation rate is positive, this indicates that under no circumstance should prices actually remain stable in the U.S. It also means that prices have to increase by more than the amount they are rising now. This of course leads to long-term dollar devaluation and indeed the dollar has lost 96% of its value since the Fed has been in business. They obviously can't wait to lop off the remaining 4%. Having a worthless currency is obviously a good thing as far as the Fed is concerned (you might disagree when you have to pay $5,000 for a loaf of bread). Inflation-sensitive gold hit its fifth record high in as many days on the news and was pushing $1300 an ounce this morning.

It order to tackle the non-existent deflation problem, the Fed intimated that more quantitative easing - also known as money printing - is on the way. There is no case in financial history when excess money printing hasn't eventually led to higher consumer inflation and it has frequently led to hyperinflation. The Fed has already done a lot of 'printing' and the ever increasing price of gold is showing the dollar losing value right in front of our eyes. However, the see no inflation, hear no inflation, and speak no inflation Fed ignores the gold market. Instead they are looking at ever dropping interest rates - the two-year treasury hit another record low after the meeting. Falling interest rates are being caused by all the new money they are manufacturing because bonds are being bought with some of it and this drives their price up and rates down. Using some form of inverted, twisted thinking, they view a market reaction caused by excess money printing as a sign of deflation.

The Fed first lowered its Funds rate to zero in 2008. With help from the U.S. treasury, they have engaged in an expansionary money creating policy since then as well. Unemployment is now much higher than when they started these moves and is stuck around the 10% range if you believe the official numbers (if not, it's much higher). After the worst recession since the 1930s, the economy is stuck in neutral, if you believe the official numbers (if not, we have already entered another recession). So the Fed's solution is to ratchet up the same policies that have failed over and over again and they claim somehow they will work now. It is far more likely the Fed's actions will nstead lead to minimum price stability and maximum unemployment.

Disclosure: No positions.

Daryl Montgomery
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.

Liquidity Trap: The Global Collapse of Government Bond Yields

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.


Government bond yields are dropping throughout the world. The U.S. 2-year, the German 5-year, 10-year and 30-year, and the French 10-year have all hit record lows recently. The Japanese 10-year is back below 1.0% and has fallen as low as 0.90%. The UK 10-year yield has been dropping for months and is only 17 basis points above its Credit Crisis low.

Record or close to record low yields on government bonds indicates enormous buying demand. Bonds hitting record low yields are by definition hitting record high prices. Moreover bond prices are going up when supply has undergone a tremendous expansion to pay for all the economic stimulus programs governments are running. So demand for government bonds has to be increasing faster than the rapidly growing supply if yields are falling. The obvious question is: Who is buying all of these bonds?

If yields were dropping in just one country instead of in almost everywhere, increased demand might be partially explained by countries with big foreign reserves like China buying more government debt. China has been a major purchaser of U.S. treasuries for a long time, but last month it sold about 3% of its holdings. Yet yields on long-term treasuries continued to drop, when they should have gone up. In the U.S., there has been enough buying to not only make up for the loss from China, but to purchase an even larger amount of bonds. There is only one possible source for funding for this demand for government paper in the U.S. and elsewhere on the planet and that is the national central banks and treasury departments.

Essentially, the central banks are 'printing' huge amounts of new money. This money goes into the financial system and gets recycled into purchasing government bonds and also stuck in the banking system as reserves. Most of the newly created money does not go into the real economy. It does allow governments to spend much more money than they could have ordinarily however, but most of this 'stimulus' actually goes for maintaining the status quo (with the objective of preventing further collapse) rather than for anything that would create growth in the future. So the economy stagnates, but holds up as long as the money printing ruse can be maintained. This is a liquidity trap and much of the global economy has already fallen into it based on the interest rate behavior of government bonds.

A liquidity trap is an ugly situation to say the least.  Either a country continues to spend its wealth to support its lifestyle until all of it is dissipated and complete impoverishment occurs or it finds a way to get some of the liquidity into the real economy. The problem is that only small measured amounts of liquidity can be allowed to flow into the economy in any given time period, but this is not the likely scenario. If the central bankers were capable of making this happen, they would have already done it. More likely is that the floodgates will be open and too much liquidity goes into the real economy too quickly. Hyperinflation will then occur and prices could start to skyrocket almost overnight. Japan has faced this situation for the last twenty years, now it looks like all the developed economies are going to be facing it.


Disclosure: No positions.

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 Insights From Chris Pavese and Dian Chu

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 inflation versus deflation debate is the hottest economic topic of our era. While real world events will eventually resolve the argument, for the moment readers might want to take a look at some just released articles on the topic by Christopher Pavese and Dian L. Chu.

In essence, where someone lies on the inflation/deflation debate depends on what data they look at, how long their view of history is, their reliance on basic principals versus economic models, and how much they rely on practical market signs versus abstract theory. We could also add to this how much someone believes the economics numbers published by the world's governments and whether or not they have a vested interest in promoting an establishment viewpoint. Economists who work for a government or large financial institution are paid to generally see no evil, hear no evil and speak no evil. Independent advisors, newsletter writers, and bloggers on the other hand need to strive to be accurate or they lose their clients or audience. There is no government bailout waiting in the wings for them if they screw up. Although it is not 100% the case, the inflation argument tends to be put forward by the independents and the deflation argument by establishment interests.

Christopher Pavese in his article "Why Most Western Economies Are Veering Toward Hyperinflation" relies on the work of Peter Bernholz and his seminal book, “Monetary Regimes and Inflation”.  Bernholz analyzed 2000 years of inflation history and concluded that countries with deficits in excess of 40% of expenditures risk hyperinflation. The number is currently 42% for the U.S. Those who look at inflation from a broad historical lens invariably conclude a huge inflation outbreak is on the horizon. The deflationists on the other hand tend to only look at the theories used to explain how inflation developed in the U.S. during the 1970s.  This is too narrow a time frame and geographic scope from which to create any broad conclusions. Furthermore, many of the common explanations for 1970s inflation are fanciful and were developed to mask the U.S. government's role in its development.

Dian L. Chu takes a more observational and short-term approach in her article "Deflation? Try A Tale Of Two Inflations". She describes current conditions as biflation, a state where some prices can go up substantially while other don't change or even go down. Ms. Chu specifically cites that U.S. core PPI for crude materials (excluding food and energy), shot up 60% year-over-year in April. She thinks that the biggest risk of inflation is in energy products and chemical feedstocks. In her longer-term outlook (after 2012), she maintains hyperinflation is a bigger risk in China and India, while stagflation is a bigger risk in the U.S. and Europe. While Chris Pavese is more negative on the U.S. inflation outlook, he doesn't foresee a big inflation outbreak in the immediate future either.

Chu does mention in passing the possibility of sudden hyperinflation. This idea was proposed recently by newsletter writer Harry Schultz, but without any details of how it could occur. I myself independently developed the explanation of why this is a possibility and how current conditions in the U.S. are appropriate for a major reversal from very low inflation to very high inflation in a short period of time.  This doesn't mean that this is imminent however.

Regardless of the time frame of inflation, stagflation and 1970s levels of inflation no longer represent a stable state for the U.S. economy. We can have very low inflation or very high inflation for a long time. The middle can take place, but it can't last. Our national debt is now so high, that 1970s interest rates would mean that all of our tax receipts would be needed to make interest payments and there would be no money left to run the government. Long before we got to that level, we would be creating so much new 'money' that it would devalue the dollar and this would necessitate printing even more to make up for the loss in value. A self-feeding cycle would begin and this would make some extremely high level of inflation inevitable. We may   already be at the early stages of just such a cycle.

Disclosure: None

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.

A New Theory of Sudden 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.


While everyone acknowledges that governments are printing and printing excess amounts of new money, more market observers are currently worried about deflation rather than inflation. There is a smaller group concerned about hyperinflation, but the theoretical underpinnings have been missing up to now that would justify how this could be possible. There is an explanation though and this indicates that hyperinflation can not only take place, but that is can happen suddenly.

There have been a number of impediments in how economists look at hyperinflation that have prevented original thought (and sometimes any thought at all) in this area.  Here are the necessary ideas:

1. Inflation is a currency losing its value (an idea most mainstream economist can't seem to grasp).
2. Severe deflation is a precursor to hyperinflation. They are not inconsistent events as is generally thought, but deflation sets the stage for hyperinflation.
3. Disinflation/deflation and inflation need not by symmetrical. For instance, if there is 30 years of disinflation, this doesn't have to be balanced by 30 years of inflation. The same amount of inflation could take place in only months or even weeks, let alone 30 years.
4. Inflation doesn't have to be a continuous phenomenon. The chart can have gaps in it with prices going up significantly overnight. Furthermore this can start from a low point where almost no inflation exists.

The origins of hyperinflation are with excess 'money' printing by a government. It is not possible to produce an ever-larger amount of currency and have each unit of that currency maintain its value. If it were, real money could be created out of thin air and everyone in the world could become infinitely rich overnight. This would also violate the basic laws of arithmetic. So excess money printing always devalues a currency and because of this less and less can bought with each unit of that currency.

This becomes a potentially dangerous problem when severe deflation takes place because of a shock to the financial system (the Credit Crisis for instance). To make up for the loss in value of assets (deflation), the government prints a huge amount of money. The printing causes devaluation of the currency and requires more printing to try to make up for the additional loss of value. A self-feeding money printing cycle then develops.

Even though huge money creation has occurred because of the Credit Crisis, we still haven't seen significant inflation yet. Indeed, the American government claims the U.S. inflation rate has fallen close to zero. How is this possible? The answer can be found in the banking system. The feds have pumped huge amounts of money into it (U.S. bank reserves have increased approximately 100 times or 10,000% since the Credit Crisis began) and banks have received this money at close to a zero percent interest rate.  Yet, if you look at commercial and consumer bank lending, you will see that they have been declining. So where did all this money go?  It was used to buy treasuries and this is what is allowing the federal government to fund its massive deficits. For all intensive purposes, this is a massive Ponzi scheme being run by the U.S. government.

Ponzi schemes though don't follow the same rules as normal businesses or economic statistics. They build to a crescendo over time and then suddenly collapse to zero instantly. The analogy for inflation will be the opposite however. Inflation will go to zero and then suddenly jump up to some very high level. In theory, zero interest rates should produce infinite inflation (hyperinflation), but nothing mandates that this has to be a gradual, long-term process. If you think about it, the Credit Crisis seems to have come out of nowhere. It didn't of course; there was a slow, long-term build up behind the scenes that just exploded suddenly. Inflation is likely to follow that same path of development. Global governments eventually got control of the Credit Crisis collapse by throwing trillions of dollars at the problem. That solution however won't work for dealing with inflation.

Disclosure: None

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.

Inflation News Sends Gold Soaring

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.

Our Video Related to this Blog:

The ISM Services Index was released this morning and it came in at 48.4, which indicates only a slight contraction. While the mainstream media put the usual bullish spin on the news, it was actually nothing short of disastrous. One component was overwhelmingly responsible for the improvement from last month - Prices Paid. Prices Paid is a measure of inflation. It came in at an eye popping 63.1 in August versus 41.3 in July. The biggest increase in the Manufacturing Index yesterday was also Prices Paid (new orders was a very close second though, there were no close second in today's Service report). In the manufacturing report, prices paid was 65.0 in August versus 55.0 in July. None of the ISM reports are adjusted for inflation, just like most of the government's economic reports. In both cases, higher inflation as opposed to better economic activity can make the numbers look better. Financial media usually fails to mention this.

Spot gold reached $987 this morning. It is approaching once again the key $1000 breakout level. Spot silver almost reached $15.80, just below important resistance at $16. Gold has traded just over $1000 twice. The first time was in March 2008 and the second time in February 2009. This key level was reached at the end of gold's bullish seasonal period which ranges from August to February. This time the $1000 level will be reached at the beginning of the strong seasonal period. Expect silver to follow gold up. Once it breaks above $16, it will head toward $21.

While you would think that the U.S. dollar would nosedive on this news, it was down only slightly from yesterday's close of 78.38. After dipping just below the 78.33 breakdown level, it started rallying and is now up. This illogical trading of the dollar has been common since the Credit Crisis began. Why would traders rush to buy it, when the currency is constantly being debased by the central bank? They wouldn't, at least not voluntarily. Nations, including the United States, have a long history of trying to maintain the value of their weakening currencies by manipulating the market. The manipulation always fails in the end however.

Fed chair Ben Bernanke has said over and over again that there can't be inflation because there is spare capacity and slack in economic production. While he may be an expert in the U.S Depression, he apparently never studied hyperinflation where just such a scenario is common.
Bernanke has also been repeatedly wrong in everything he has said and done. For those who would like a video review of Bernanke's appalling record, click on the link below:
http://www.youtube.com/watch?v=HQ79Pt2GNJo

NEXT: No Recovery in Jobs

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.

So Much for No 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.

Our Video Related to this Blog:

The monthly PPI and CPI came out yesterday. Even the government's highly manipulated figures indicate that inflation has suddenly resurfaced (you can assume that inflation is actually a lot worse, see http://www.shadowstats.com/ for a more accurate set of numbers). But don't worry, the mainstream media assures us that "inflation is not expected to be a problem any time soon given a severe recession which is keeping a lid on wage pressures". Of course, they also said the same thing last month before inflation zoomed this month. They will probably also still be saying the same thing when you are paying $50 for a loaf of bread.

The PPI yesterday was the real shocker, rising 1.8% month over month (expectations were for it be up by 0.9%). While the media blamed this on a rise in energy prices, the core rate, which excludes food and energy prices, was up a substantial 0.5%. Media reports assured us that this was nothing to worry about though because PPI was down 4.6% year over year. The core PPI however was UP 3.3% year over year. This huge discrepancy indicates that the PPI went down because of falling energy prices. According to the media, a drop in inflation caused by falling energy prices is important, but a rise in inflation because of energy prices increasing is irrelevant. Those of you who are capable of basic logical thought may not think this makes any sense.

The CPI report had consumer prices up 0.7% last month. The core rate was up 0.2%. As with the PPI, the media said it's nothing to worry about because its all because of energy prices going up. However, the price of food, clothing and medical care all went up as well. While the price of almost every necessity went up, some luxury items like airline travel went down in price and this helped moderate the reported inflation rate. CPI was down 1.4% year over year, while the core was up 1.7%. Once again falling energy prices accounted for the drop.

What is causing inflation is that the U.S. government is printing a huge amount of additional currency. Since commodities are priced in dollars, in the long term it is going to take a lot more dollars to buy a given amount of oil, food or any other commodity. Prices have to go up. And it doesn't matter if there is a recession, or excess capacity in the system. This was the case in the U.S. in 1974 and prices zoomed. It has also been the case in every incident of hyperinflation throughout history.

NEXT: CIT DOA; Liquidity Injections Rally Market?

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.

Government Price Controls in the Making

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.

Our Video Related to this Blog:

British Prime Minster Gordon Brown and French President Nicolas Sarkozy had a article in the Wall Street Journal yesterday entitled, " Oil Prices Need Government Supervision". In this article they recommend that "the Expert Group of the International Energy Forum take the lead in establishing a common long-term view on what price range would be consistent with the fundamentals." They claim at many points in the article that producers and consumers benefit from price stability and the hand of government is needed to assure this. Obviously, their knowledge of history doesn't extend beyond yesterday's lunch.

The Brown/Sarkozy idea was tried on a mass scale in post-war communist Eastern Europe. The government kept prices very stable. That consumers benefited from the chronic shortages that resulted is doubtful. Industrial production was highly inefficient and ultimately fell apart. Some of the worst hyperinflations in history followed in the 1990s. Yes, there is certainly a lot of evidence from the real world that 'government supervision' of markets works well. Brown and Sarkozy hope to bring these benefits to YOU. Note to Brown and Sarkozy: There is already a mechanism for finding the correct long term price for any item - it's called the free market. Just because you don't like that price, doesn't mean it's the wrong price.

Unlike price controls, which is what Brown and Sarkozy are recommending even though they didn't use the term in their article and which NEVER work, there are solutions to the problems they have with the price of oil. Businesses and consumers are paying too high a price in their countries? Well they can cut the extremely high taxes that their governments place on fuel. The price of oil is going up too much. Well, stop letting it be priced in U.S. dollars or tell the U.S to stop running $2 trillion budget deficits and engaging in money printing through quantitative easing. Mr. Brown should follow this advice himself, since Britain is in possibly worse financial shape than the U.S. Don't expect any of these solutions that would actually solve the problem to be implemented though. That would require some real leadership. It is much easier to blame speculators for prices rises and this is the tack the governments have always taken throughout history.

Why should anyone listen to Brown or Sakozy as is? Do either of them have any record of economic success? I don't recall reading about any French 'economic miracle' in the last few years. As for Brown, he was the one that sold half of Britain's gold for $260 an ounce in 1999 and then bought a big chunk of U.S. dollars with the proceeds. The dollars lost a lot of their value subsequently while gold prices were rising to a $1000. The man is obviously an economic 'genius'. Britain also had a worse subprime housing crisis than the U.S. Banks there gave 125% mortgages to people who couldn't pay them back. When someone has done stupid things over and over and over again, it is generally a good idea not to follow their advice.

Nevertheless, you can safely assume that price controls will eventually be implemented because governments that create inflation are governments that try to take the easy way out. You can also safely assume that they will cause shortages. You can also safely assume that prices will subsequently rise much higher than anything previously imagined. You can also safely assume that if Western countries clamp down on free market trading, it will simply move elsewhere (to Dubai, the Far East or possibly any number of offshore money havens). Governments never learn and Brown and Sakozy's article yesterday is just more evidence that things are not going to be any different this time than they have been hundreds of times before in the past.

NEXT: Energy, Commodities and the U.S. Dollar

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.