How Much Stimulus Will Be Done by China, the EU and UK?

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.

Much weaker than expected trade data out of China on Friday indicates more economic stimulus will be forthcoming there soon.  Even bigger stimulus is expected from the ECB as it revs up the printing presses to bail out Spain and Italy (unless Germany stops it of course). According to a recent released report, the recessionary economy in the UK may need massive doses of quantitative easing to recover.

Exports in China rose by only 1% year over year in July and this was well below forecasts of an increase of 8.6%. Imports were up 4.7%. For a country that has an export-based economy like China does, this is a serious problem. Like the U.S., Europe and Japan, China engaged in a massive amount of stimulus during the Credit Crisis in 2008/2009, spending $586 billion or 14 percent of its GDP in addition to cutting interest rates and lowering banking reserves.  This led to a big expansion of local government debt, a major housing bubble that has yet to burst and consumer inflation. Apparently, there are unfortunate side effects when governments apply a lot of economic stimulus (notice you rarely read about them in the mainstream media).
This time around, China has already cut interest rates twice and reserve requirement ratios for banks three times since November. Its economy has slowed for the last six quarters and probably by much more than official figures indicate (China's economic numbers should be taken with a grain of salt).
China is still in spectacular shape though compared to Japan, which had a massive trade deficit in the first half of 2012. Japan has been economically troubled for 22 years and despite zero percent interest rates and an unending number of stimulus measures its economy remains in the doldrums. While all the stimulus hasn't solved Japan's economic problems, it has led to a debt to GDP ratio of over 200% (worse than Greece's).
One reason China's exports are doing so poorly is the weakening economy in Europe. On Thursday, the ECB cut its growth forecasts and is now predicting the eurozone economy will contract by 0.3% in 2012.  They are still hopeful of slight growth in 2013 however. Maybe they think it will come from all the money they plan on printing to bail out Spain and Italy. The Eurozone is basically tapped out from all the bailouts it has already done in Greece, Portugal, and Ireland (Cyprus and banks in Spain are now on the list as well). Greece needs a third bailout and is struggling to make it through the month until it receives its next welfare payment in September. The situation there is potentially explosive. The IMF has stated Ireland will need another bailout by next spring.
When ECB President Draghi said on July 9th that the central bank will take any measures within its mandate to save the euro, the inevitable conclusion was that he was willing to engage in massive money printing. The amount of money needed for the huge bailouts that Spain and Italy would require simply doesn't exist so it has to be created out of thin air. The Draghi proposal is for the ECB to buy bonds, but the ECB has already tried buying bonds under the SMP program.  The moment the buying stopped, interest rates shot right back up. This approach is costly and only effective in the very short term — a typical government program. It won't prevent the Eurozone's failure, it will merely delay it and make it worse when it happens.
The UK is not part of the Eurozone, but its economy is also contracting. Citigroup economists have stated that the UK will need to print an additional £500 billion and lower interest rates to 0.25% to prevent continued stagnation. Apparently, they don't think there are serious risks if this approach is taken. Neither did the Weimar Germans in the early 1920s, the Zimbabweans in the 2000s, the Chinese in the 1940s, the Brazilians for most of the 20th century, the Yugoslavians in the 1990s or the Hungarians in 1946. In fact, countries that create hyperinflation always claim the risks of money printing are minimal before it takes place. And there are usually a large number of top economists that support this view.  

There are serious structural problems in the major economies today. The usual Keynesian quick fixes that have been applied since World War II no longer seem to work, nor will they. These have led to a world drowning in debt and all debtors eventually reach their borrowing limit. When this happens with countries, they then try to print their way to prosperity. History makes it quite clear that this doesn't work either. 

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.

The Only Suprise for March Employment Was that it Wasn't Even Worse

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.

According to the BLS, the U.S. created only 120,000 non-farm jobs in March. The mainstream media cited this figure as a surprise because it was well below expectations. The real surprise was that the number wasn't even worse.

Winter month employment numbers came in at the 200,000 level and this was trumpeted as evidence that the economy was finally gaining steam. There were two problems will this line of reasoning. The first is that the U.S. needs to create approximately 150,000 jobs a month for the unemployment rate to stay even (this balances the loss of people retiring with new students and legal immigrants entering the job market).  In order to put any serious dent in the massive amount of unemployment that exists the monthly number of jobs being created needs to be well over 200,000. The second problem was the unusually warm weather during the winter that magnified the impact of the seasonal adjustments.

If seasonal adjustments boosted the numbers in January and February, then lower numbers should be expected in the normally warmer spring months. The weak March number seems to be bearing this out. It is interesting to note that the Retail Trade category lost 34,000 jobs in March. This does not support the idea that retail sales have actually been strong as has been claimed, but that the numbers have instead been artificially boosted by inflation. Retail employment is prone to large swings due to seasonal factors.

The official unemployment rate fell to 8.2% from 8.3%. The obvious question is how can this happen if less than 150,000 jobs were created and that's the amount needed for things to remain in equilibrium? It can only occur if more people than expected leave the labor market. This happened again last month  as has been the case during the entire economic "recovery"(millions of people have left the U.S labor market since the Great Recession began). The mass exodus from the labor market creates a huge reservoir of unemployed waiting to reenter the market if conditions actually improve. This reentry could keep the unemployment rate from falling well into the decade.

People of course do not leave the labor market in droves when the economy is on an upswing. The continued shrinkage of the labor market indicates an economic downturn. Don't expect to hear that from either the U.S. government or the cheerleading mainstream media. Politicians don't get reelected by telling the public bad news.

A key question that usually goes unexamined in reporting about the jobs numbers is the high price the U.S. taxpayer and consumer will be paying in the future for the jobs being created today. The U.S. has run deficits of $1.3 trillion or more since 2009. Pumping all of that money into the economy will of course create jobs, but at what cost?  Unless there is a free lunch, that money will have to be paid back either through higher taxes or higher inflation. Both will lead to lower job creation in the coming years.

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.

John Paulson Says Double-Digit Inflation is Coming

 

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.   

As average U.S. gas prices head toward $4.00 a gallon, billionaire hedge fund operator John Paulson recently told a standing room only crowd at New York’s University Club that double-digit inflation is about to rear its ugly head. Paulson assumes that the Fed will continue to engage in its inflation-creating behavior.

John Paulson is famous for making a killing on shorting subprime bonds before their collapse. Most of Wall Street was bullish at the time and Fed Chair Ben Bernanke famously declared that he didn't see subprime mortgages causing any problem. The market completely fell apart weeks after Bernanke spoke.

The Paulson Bernanke dynamic is now back in play with predictions of inflation. Bernanke doesn't see it now and doesn't anticipate it. In an interview with ABC News done around the same time that Paulson gave his talk, Bernanke stated "We haven't quite yet got to the point where we can be completely confident that we're on a track to full recovery," and he continued that the central bank would take no options off the table to further stimulate the economy.  The interviewer didn't ask Bernanke the obvious question of whether or not the need for further Fed stimulus after four years indicates that the previous efforts have been a failure.

Paulson's presumption that the Fed will continue to feed inflation forces is completely supported by Bernanke's actions and statements. The Fed Chair further blamed rising oil and U.S. gasoline prices on geopolitical tensions. Prior to the mid-2000s though, geopolitical tensions only raised the price of oil to $40 a barrel. This time it's well over $100 a barrel. Money printing accounts for the price difference, but you'll never hear that from the Fed's money-printer-in-chief. And this is to expected. No government in inflation's 2000 year history has ever taken full responsibility for causing it.

Governments also have a history of finagling with the inflation numbers as well. This seems to be a universal practice once some form of indexation takes place (adjusting prices for inflation). The U.S. introduced indexation for social security and tax brackets in the 1970s. Starting it the 1980s, a number of statistical "improvements" were introduced in how the inflation rate was calculated. Interestingly, all of these "improvements" lowered the reported rate.

When it comes to inflation predictions, investors have a choice between John Paulson, who has made billions from his knowledge of how markets works, and Ben Bernanke, who has repeatedly shown he is oblivious to their dangers (remember how he let Lehman Brothers go under and this almost led to the complete collapse of the global financial system?). If you are betting on Bernanke, you are betting against history repeating itself. Money-printing has always led to massive inflation in the past. Apparently, John Paulson knows this.


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.

How Good are February Retail Sales Figures if You Consider 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.

Unadjusted for inflation, U.S. retail sales rose 1.1% in February. There may have been little or no gain if price increases are accurately taken into account.

Retail sales going up in the beginning months of the year should surprise no one because this is when companies typically raise prices. Anyone who goes to Starbucks is aware of this practice. It pervades a number of industries across the spectrum. Clothing prices are being hit particularly hard this year with jumps in prices estimated to be around 10% for the spring season (already underway in February). Mainstream media reports on February retail sales did glowingly mention that sales at clothing stores were higher while neglecting to report that higher prices were the reason.

This is not the only source of price increases in early 2012 however. Year over year, gasoline had the second  greatest percentage increase (10.3%) in the retail sales report. This can be considered a measure of energy inflation and not an indication that more product is being sold. A rough approximation of food inflation can be garnered from the Food and Beverages category. Year over year this increased by 3.7%, while the U.S. population is estimated to have grown only 0.7%. If inflation is the actual driver of higher retail sales, it would be reasonable to assume that the one area with chronically lower prices — electronics — would see a decline in sales. Year over year, sales in the Electronics and Appliance category did indeed fall by 1.4%.

Interestingly, the biggest increase in any retail sales category was in Building Materials and Garden Supplies. This was up 13.8% year over year. It is quite possible that the unusually warm winter weather pushed garden supplies purchases into February, instead of March (the numbers are seasonally adjusted and much higher garden supply sales in February would be magnified because of this). Prices for many building materials are rising sharply as well however. Lumber has been the one major exception, but even lumber prices rose this February.

Retail sales account for approximately 70% of the U.S. GDP, so how they behave gives a good indication of how the economy is performing.  Higher inflation is not an indication of a better economy though, it indicates just the opposite. The U.S. retail sales numbers are not adjusted for inflation, nor are the CPI numbers an adequate indication (they underestimate the actual inflation rate significantly). Analysis of the February report indicates that inflation is allowing the government to report better numbers. Investors need to keep this in mind. 


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.

Behind the Market Drop and Why it Could Get Much Worse

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.

After a sharp rise since last October, the market looks like it is set up for one of its usual spring downturns. Without continued liquidity injections from the major central banks, it won't be able to break through the wall of resistance it's currently facing, nor will there be much support to hold it up.

As has been the case for months, trouble in Greece is currently roiling international markets. The bond swap deal reached as part of the latest bailout settlement isn't going well. With a March 8th deadline looming, Bloomberg is reporting that private investors holding around 20% of Greek government debt have so far agreed to participate. The Greek government has set a threshold of 75% for the deal to go through. While the mainstream media has consistently cheer leaded the success of every bailout deal, the market has never been convinced. Yields on one-year Greek government bonds have been on a strong upward trajectory since last summer and were over 1000% today.

The eurozone debt crisis has resulted in a great deal of liquidity being poured into the market by the Europeans. The  ECB pumped approximately half a trillion euros via LTROs (long-term refinancing operations) last fall. The rise in global stock markets can be traced from this event. At the same time, the Bank of England was on its second round of quantitative easing and examination of the U.S. Federal Reserve balance sheet shows what looks like the beginning of QE3. The monetary base in the United States was also moving straight up the chart last fall and earlier this year. No matter where you looked, liquidity was flowing into the system. Since stock markets respond immediately to extra liquidity, a powerful global rise in markets took place.

The problem with liquidity-driven markets is that if the liquidity dries up, they can wither like a plant that has been denied water. The constant supply of liquidity always has to slow down because eventually the liquidity will flow into the mainstream economy and turn into ugly inflation. The big liquidity pump that started last fall seems to be falling to slow trickle lately and markets are quite vulnerable once this happens. A failure of the Greek bailout deal (and government bond yields indicate that the market expects this to happen), would cause a massive negative liquidity event that would be on the scale of the Lehman default in 2008. It might even be worse.

At the same time liquidity issues are impacting the market, stock prices are stuck at resistance and the technical indicators are deteriorating. The S&P 500 is at its high that it reached earlier in 2011. The Dow Industrials are also at last year's resistance. Only the Nasdaq has managed to break through because of a small number of stocks like Apple Computer (AAPL) -- which is clearly exhibiting bubble-like action.


Recent news indicates deteriorating economies outside the United States. The economy within the U.S. is only being held up by massive government spending with budget deficits of $1.3 trillion last years and projected to be $1.3 trillion again for 2012. This is all borrowed or newly printed money. How big would the U.S. GDP be without these continual massive injections of government pseudo-cash?  Inflation is also clearly showing up in the ISM Manufacturing and Non-Manufacturing (Services) reports. The Prices component is the highest one for both. Prices for services (80% of the U.S. economy) have been rising for 31 months in a row and are listed as accelerating in February.


Stocks usually have a selloff in March or April. This year they are especially vulnerable. There will almost certainly be some type of drop. How big remains to be seen. The possibility for major selling should be kept in mind by investors.

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.

Volcker Says U.S. Mired in Recession and Inflation is Coming

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 talk given to a small audience at the American Museum of Finance on Wednesday evening, former Federal Reserve Chair Paul Volcker stated that there was an ongoing recession in the U.S. and that we will be seeing inflation in the future because of the actions of the Fed and Treasury during the 2008 Credit Crisis.

While most of Volcker's talk centered on the current crisis in Europe, he frequently made connections to what was going on in the EU to what has taken place in the United States. His remarks about the U.S. being mired in an ongoing recession were in response to a question on whether an infrastructure bank would be a good idea. As part of his answer he stated, "We're not going to end the recession in the next month or the next year. It's going to take several years before the recession is over." The U.S. government claims that the last recession ended in June 2009and has repeatedly said that the U.S. has not fallen back into recession even though unemployment and consumer confidence have continually remained at recession levels.

When discussing the bailouts during the Credit Crisis,  Volcker remarked "people said that there will be inflation... that's true over time." Volcker was critical of pro-inflation policies. He said that "the problem with inflation is that it looks so enticing, but the historical record doesn't verify that it is." He continued, "We would be very foolish if we deliberately went out and created inflation." The Federal Reserve under Ben Bernanke has kept Fed Funds rates around zero percent for three years now, which means real interest rates have been negative. Negative interest rates are highly inflationary as is money printing. The Fed has expanded its balance sheet — one of the many ways it prints money — by over $2 trillion dollars since September 2008.

Volcker described the 2008 Credit Crisis as a "regulatory failure", but added "the Fed is only one regulator". He went on to state that "the Federal Reserve took a lot of extraordinary measures" to handle events back then and "the Fed and the Treasury did not necessarily follow the letter of the law" in attempting to control the damage to the financial system. Volcker further laid part of the blame for the Credit Crisis to proprietary trading by banks and said he was "not in favor of banks being speculative entities being supported by the U.S. government".

Paul Volcker was Chairman of the Federal Reserve from August 1979 to August 1987 and is widely credited with bringing down the high inflation of the 1970s by raising interest rates. More recently he headed the President's Economic Recovery Advisory Board, which he left in February.

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.

More Contradictions in Third Quarter GDP

 

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 Commerce Department reported today that third quarter GDP increased at a 2.5% annual rate. A supposedly much lower inflation rate created significant improvement over numbers from earlier in the year. There was also a surge in consumer and business spending reported, although other recent surveys contradict the claims in the GDP release.

Real personal consumption expenditures (consumer spending) increased by 2.4% compared to only 0.7% in the second quarter. Most of this was caused by a 4.1% increase in durable goods purchases. Nondurables were barely changed. Delayed auto and parts shipments from Japan because of disruption from the massive March earthquake can account for more sales being reported in the third quarter, but not likely to be repeated in the fourth. Despite claims of much higher consumer sales, businesses barely increased inventories in the third quarter — something they would do if they saw their sales climbing. Moreover, consumer confidence surveys indicate consumers were gloomy in the third quarter and readings have now fallen as low as they were around the bottom of the 2008/2009 Credit Crisis. Consumer confidence surveys are not controlled by the government and act as a check of the reliability on government statistics. 

While businesses didn't seem to notice any increase in customer spending, there was nevertheless a frenzy of equipment and software buying going on. This supposedly increased by 17.4% during the quarter. Apparently, I missed the all the news about major software upgrades and equipment innovations that took place this summer. Nonresidential structure spending was almost as buoyant increasing by 13.3%. Where this building boom is taking place isn't exactly clear. Coincidentally, the unemployment rate among U.S. construction workers is also 13.3% (See Household Data Table A-14 of the September Non-Farm Payrolls Report). As bad as this is, it is still a year over year improvement.

GDP figures are also boosted if the inflation rate is lower. It's a lot easier to report better inflation numbers — all it takes is some statistical adjustments — than it is to actually improve the economy. Inflation was supposedly 3.3% in the second quarter, but only 2.0% in the third quarter. Nominal GDP is reduced by the inflation rate to get the final figure. The change in inflation, whether or not it actually took place, added much of the improvement seen from the second to third quarter, not an increase in economic growth.

Mass media coverage about GPD was of course ebullient about what good shape the U.S. economy is in. Of course, we won't know the actual number for several more years. This report is only preliminary and there are two adjustments that will be made to it and then annual revisions every July. In the last several years, adjustments have been mostly down, sometimes by very significant amounts. Even then, that number is going to still be overstated because the U.S. consistently understates its inflation rate. To find an approximate level of the actual GDP, just subtract 3% from the reported number. This will give you a more accurate sense of what is going on in the economy. 

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.

October Consumer Confidence Well Into Recession Territory

 

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 October Consumer Confidence number fell to 39.8. It is once again approaching the all-time lows that occurred at the bottom of the Great Recession. The number has never reached the 90 level since 2009, which is the cutoff for a healthy economy. The continually poor levels of consumer confidence  bring into question whether the last recession ever really ended.

While U.S. consumers are gloomy about almost all aspects of the economy, they are most pessimistic about employment prospects. Only 3% of U.S. consumers think that jobs are plentiful. While it is true that this number could have been lower during the 1930s Depression when millions of ordinary Americans went hungry and were homeless, the lowest possible value is only zero. And the current reading could actually be zero since zero lies within the statistical margin of error for the survey. In contrast, those who say jobs are hard to get came in at 47% and that would definitely had been much higher during the 1930s.

The Present Situation Index — how consumers see the state of the economy currently — was a very dismal 26.3 in October. This number has remained at fairly low levels for four years now. What has caused the overall consumer confidence  number to rise has been expectations for a future improvement in the economy. The government and mainstream media has continually told U.S. consumers the economy is getting better and will continue to get better. So, consumers have told the survey takers that don't see things as being in good shape now, but they were hopeful about the future. Consumers are starting to lose hope however. The future expectations number fell from 55.1 in September to 48.7. Apparently, you can only fool the public for so long.

The "don't believe what you see with your own eyes, but believe what the government tells you" efforts are still going strong however. Media reports cited better retail sales and a big stock market rally since early October as indications that the U.S. economic situation is improving. Retail sales may have indeed gone up since they are not adjusted for inflation and higher prices make them look better even if fewer units are being purchased. As for the wild behavior of the stock market, explosive rallies are common in bear markets and not in bull markets. They can also occur at any point because of liquidity injections into the financial system from central bankers in Europe, the UK, and the U.S. as would happen during a banking crisis like the one currently taking place in the EU. They don't last for long however.

No matter how you look at the consumer confidence, the numbers are ugly. They are not just indicating recession, they are shouting recession. Only 11% of Americans think that business conditions are good.  The Present Situations Index has dropped six months in a row. Some of the components are at rock bottom levels. Yet, the government and mainstream media keep reporting that the economy is on track for improved growth in the second half of 2011. How can such diametrically opposed views be reconciled? The simplest way to explain the discrepancy is that someone is lying. Any guesses as to who that might be?


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.

Economic Reports Indicate U.S.Economy Heading Down

 

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

Default notices on U.S. home mortgages rose 33% in July. Retail sales and food services rose only 0.0% -- adjusted for inflation they were negative. The CPI inflation measure for August came in at 0.4%, almost as high as it was in July.  Weekly jobless claims rose again this week, coming in at 428,000.  All are pointing to an economy in trouble.

The Great Recession began in the housing market after subprime loans started to default in large numbers in 2007. The U.S. economy will continue to have difficulties until all the excesses are ringed out of house prices. Government policy has instead been geared toward stabilizing the market with temporary fixes. The Federal Reserve instituted a number of programs to funnel money into the mortgage markets to protect the banks that had too much exposure to real estate loans and the Obama administration has created programs like HAMP (Home Affordable Mortgage Program) to lower the foreclosure rate. Banks themselves have avoided or delayed foreclosures as long as possible because they don't want the properties on their books. All the government's efforts have certainly slowed down the rate of foreclosures and that may ultimately be all that they accomplish. A 33% increase of foreclosure notices in July indicates a new wave of foreclosures is likely next year.

Meanwhile, U.S. retail sales are declining if you take inflation into account. Retail sales increased strongly with rising home prices in the first years of the 2000s, but after the housing market turned south they have yet to recover. They have been held up by trillion dollar plus annual federal budget deficits, Federal Reserve money printing, and government stimulus programs including the 'Cash for Clunkers' gift to the auto industry. Despite all of these efforts, retail sales and food services were up 0.0% in July (the same 0.0% for jobs created in August). The mainstream media reported 0.1%, but this is only the retail sales component of the report. The report is not adjusted for inflation, so even if retail sales rose 10% a year, but inflation was also 10%, there would be no actual growth (although that is not the story you would get from mainstream news sources).

Retail sales are crucial for the U.S. economy because they make up approximately 70% of GDP. If they don't grow in real terms (after being adjusted for inflation), it is difficult for the economy to grow. To get a quick read on how the retail sales numbers are being impacted by rising prices all that is necessary is to look at the gasoline sales subcomponent. There is no reason to think Americans are using a lot more gasoline from year to year, if anything less is being used. Yet, year over year gasoline sales are up 20.8%. This is caused by inflation. Retail sales and food services overall were up 7.2% year over year. Adjusted for a realistic inflation rate, this number would be somewhat negative. 

That is not to say that the government is reporting an inflation rate that high. The just released CPI for August was 0.4% or 4.8% on an annualized basis. It was 0.5% in July or 6.0% on an annualized basis. Alternative inflation measures from ShadowStats.com indicate actual U.S. inflation is several percentage points higher than the official numbers indicate. ShadowStats.com calculates its inflation numbers the same way the U.S. government did in the 1970s. Since there have been many changes in how U.S. inflation is determined since then, it is not meaningful to compare current numbers to the past ones since doing so is like comparing apples to oranges. The ShadowStats numbers indicate that inflation is much higher now or if you don’t accept that, then you are left with the absurd conclusion that high inflation didn’t exist in the 1970s (you will find that this is the case if you use current methods to recalculate the 1970s inflation numbers).

The other major drag on the U.S. economy -- lack of jobs -- also seems to be getting worse. Weekly claims rose again this week to 428,000. Over 400,000 is considered a recessionary level. With the exception of a few weeks, these have been continually over 400,000 for almost three years now, indicating an ongoing recession (despite all the claims to the contrary of a recovery). The trend is actually worse than it appears however. These numbers should strongly regress toward the mean (move back to the long-term average), but haven't as of yet. As a recession goes on and on eventually everyone that is going to be laid off eventually has been and that should cause this number to decline for statistical reasons even if the economy isn't improving. That it has managed to stay at such high levels for almost three years is truly amazing.

The overall picture provided by U.S. economic reports indicates a flat or declining economy with rising inflation. Little progress seems to have been made in the last three years. The new credit crisis arising in Europe is only going to make matters worse. The U.S. economy was merely weak before Lehman Brothers defaulted, but it fell off a cliff after that.

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.

Manufacturing Goes Flat Throughout the World

 

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.

Purchasing manager surveys in a number of countries indicate that the manufacturing sector of the global economy has stalled. Recent readings in Europe, North America, and Asia are either slightly above or slightly below 50, the dividing point between expansion and contraction.

The U.S. ISM survey released on September 1st came in at 50.6, down 0.3 from July. While the number was still clinging to positive territory after 25 months, key components such as New Orders, Production, and Backlog of Orders were in contraction mode. Backlog of Orders was the lowest at 46.0. The highest component, as has been the case throughout the expansion, was Prices -- a measure of inflation.  While this reached an astronomical 82.0 just six months ago in February, it was a relatively tame 55.5 in August.  Not only is the manufacturing index not adjusted for inflation, but higher inflation makes it look better and this has been the case during the entire expansion.  

While manufacturing was still just barely expanding in the U.S., it was slightly contracting in Europe. The August Purchasing Managers Index for the 17-nation eurozone came in at 49.0, down from 50.4 in July.  Germany, the Netherlands and Austria had readings still above the neutral 50 level, while France, Greece, Ireland, Italy, and Spain were just below. The UK, not part of the eurozone, also had a PMI reading of 49.0 in August. This was down from 49.4 in July and was at a 26-month low.

China was either in expansion or in contraction depending on which survey you believe. The official survey produced by the Chinese government had a reading of 50.9, while an independent survey less subject to bias came in at 49.9. In both cases, the numbers are around the no growth level.

If only one region of the world had weakened manufacturing activity, it might not be meaningful. However, when it exists on three continents in major production centers, it is impossible to ignore. There has been an approximate two-year period of expansion fed by various stimulus measures, massive budget deficits, quantitative easing, and rock-bottom interest rates. While the low interest rates are still with us, the stimulus measures have waned and there are now minimal attempts to reign in deficit spending from its outsized levels. Even though there is still a lot of government support for the economy, this still doesn't seem to be enough for manufacturing to grow. 


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

Should Stocks be Rallying on Hopes of QE3?

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 have rallied significantly since August 10th on the hopes that the Federal Reserve will engage in a third round of quantitative easing (QE) -- a form of money printing. While QE1 and QE2 were successful in juicing stock prices, this is not what the Fed is supposed to be doing.

The Fed's current mandate was established by the U.S. Congress in 1977 in the Federal Reserve Reform Act. This legislation requires the Fed to establish a monetary policy that "promotes maximum employment, stable prices and moderate long-term interest rates". Manipulating stock prices is not supposed to be on the Fed's agenda. Quantitative Easing was unknown in 1977 and was therefore not specifically addressed by Congress.

If anything,the Fed has significantly overshot in its goal to keep long-term rates moderate. The Fed Funds rate has been kept at around zero percent since December 2008. The Fed has stated it will maintain this rate until 2013. The interest rate on the 10-year treasury fell below 2.00% at one point this August -- a record low. Two-year rates fell below 0.20%, also record lows and well below the bottom rate during the Credit Crisis. Low interest rates indicate an economy in recession and not deflation as is commonly claimed in the mainstream press. Maintaining interest rates at a low level for too long is inflationary however.

The Fed announced its first quantitative easing program in November 2008 (according to an analysis of its balance sheet, it was begun somewhat earlier). The second round ended this June. How has the employment situation changed during the two rounds of QE?  When QE1 started in November 2008, the official U.S. unemployment rate was 6.8%. When it ended in June 2011, it was 9.2%. The high was 10.1% in October 2009. The post-World War II average has been 5.7% and unemployment has fallen to the 3% range when the economy is strong. With respect to employment, quantitative easing seems to have been a failure.

So what about price stability, the Fed's other mandate? While the inflationary effects of quantitative easing are most evident in commodity prices, the typical American consumer has seen them in gasoline, food and clothing prices. The average price of gasoline was as low as $1.60 a gallon when the Fed started QE1 and it almost reached $4.00 a gallon during QE2. A number of commodities, including cotton and copper, hit all-time record-high prices during QE2. Gold, the ultimate measure of inflation,rose to one new price high after another. Silver went from under $10 an ounce to over $48 an ounce. Quantitative easing obviously hasn't led to price stability. In fact, it has resulted in much higher prices and is therefore counterproductive to the Fed's goal of limiting inflation.

There is no question that quantitative easing has helped the stock market and resulted in higher stock prices. This is not exactly a secret however and all Wall Street traders are well aware of it. They will therefore push stock prices higher if they think more quantitative easing is on the way and much of any rally that results will occur before it even takes place. Quantitative easing is also no panacea for stock prices. It doesn't insulate the market from external shocks. While it doesn't make crashes more likely, it will make them worse when they occur. A default on Greek, Spanish or Italian debt and any number of other crises will have greater impact than they would have ordinarily because the market has been pumped up to artificially high levels. The market has also become dependent on quantitative easing and has not been able to rally since late 2008 without it. Almost as soon as it stops, the market drops and those drops will become more serious after each succeeding round.

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.

July Consumer Spending - Reports of Its Health Greatly Exaggerated

 

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 U.S. stock market reacted jubilantly to July's consumer spending numbers. Apparently, it didn't see the bad news the BLS report contained. Some of this was understandable since the AP (Associated Press) article -- carried by hundreds of news outlets -- seems to have reported more favorable numbers than the ones the government released.

The important take-away from the report was that disposable personal income adjusted for inflation (or more accurately adjusted to reflect some of the inflation that actually exists) was down 0.1%. So if there was any increase in consumer spending, it was taking place on money being borrowed by already tapped out consumers. U.S. consumer debt, including mortgages, is already more than the $15 trillion GDP. Federal government debt is approaching that amount.

Both the BLS and AP reported that consumer spending increased by 0.8% in June. This number is unadjusted for the official inflation rate. The rise was concentrated in the durable goods component of the report. The BLS reported this as being up 2.0% and AP had it up 1.9%. Apparently, U.S. consumers ran out and bought more automobiles and automobile parts in July. According to the government, they then spent less on non-durable goods (items that last less than a year). According to AP, they spent more.

The BLS report had non-durable goods spending down 0.3% in July. AP reported it up 0.7%. Both reports had spending on services being up, the government by 0.5% and AP by 0.7%.  The story reported by AP was far more favorable that the one told by the U.S. government, which was in turn much more favorable than would be the case if some realistic inflation rate was used. The discrepancy for the non-durable and services numbers in the two versions is probably a consequence of AP using numbers not adjusted for inflation. These numbers will always make things look as favorable as possible. This is not news; it's public relations that favors Wall Street and makes the government look like it's doing a better job with the economy than is actually the case. Traditionally, this would be referred to as propaganda.

While the spending on durable goods was concentrated in transportation, increases for services took place because Americans were using more electricity to run their air conditioners during the record hot weather in July. This does not indicate the economy is getting better, nor that it is even flat. It indicates that it was hot in July. Yet, the AP couldn't wait to quote economists that claimed the consumer income and spending numbers that it reported indicated a U.S. economy with rosy prospects. Perhaps they should try including comments on the actual numbers next time.

The BLS report can be found at: http://www.bea.gov/newsreleases/national/pi/2011/pi0711.htm

One of the hundreds of places the AP report can be found is:
http://finance.yahoo.com/news/Consumers-spending-rebounds-apf-1701587266.html?x=0&sec=topStories&pos=4&asset=&ccode=

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.

Today's Stock Market Action Looks A Lot Like August 1998

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.

Something is seriously bothering the stock market and the news that's out there isn't enough to justify what is going on. Such was the case in August 1998 as well. What caused the sudden bear market to appear out of nowhere in 1998 became fully evident only after the fact. The same could be the case in August 2011.

Perhaps the flash crash in October 1997 was a warning of things to come, just as the flash crash in May 2010 may have been a prelude to today's stock market drop. In the second half of July of 1998, stocks began to nosedive suddenly, just as they did in 2011. Some stabilization took place in the market toward the middle of August in 1998 and then a new deeper plunge began. Today, the Dow Jones industrials were suddenly down over 500 points this morning on what could only be considered minor bad news.

There were actually two problems causing the market debacle in 1998. Everyone knew about one of them - the Russian debt default and devaluation of the rubble, which took place on August 17th (less than half of the eventual market decline took place before this date).  Only Wall Street insiders knew about the second one - problems at Long-Term Capital Management (LTCM) - that almost brought down the financial system. 

Trouble in Russia was evident as early as October 1997 and it resulted from the fallout from the Asian financial crisis, which in turn started as a currency crisis in Thailand in July of that year. Today, Europe is undergoing a crisis with the euro that began in Greece in 2010. By August 1998, the Russian central bank had spent a great deal of its dollar reserves defending the ruble and decided to give up. The default had a number of ripple effects, but the most important one on LTCM wouldn't be known by the public until late September, only days before the market finally hit bottom.

After the Russian debt default, stocks plunged until the beginning of September. The market was close to its ultimate low at that point, but only because of the subsequent successful rescue of LTCM.  Stocks then rallied for approximately three weeks. A bailout of LTCM was arranged by the Federal Reserve on September 23rd. The market then sold off until early October hitting a new low and then the decline  was over.

In the rally that followed the stock market experienced huge gains led by a bubble in tech stocks. This was a consequence of the Fed lowering interest rates and pumping too much money into the financial system. The Fed had a lot of leeway to do both in 1998 and still there were serious negative results between 2000 and 2002 when the tech bubble collapsed. Inflation wasn't a concern back then because commodity prices had been declining for almost two decades and were around their lows. It should be assumed that a failure to have successfully rescued LTCM would have caused a much bigger drop in stocks (as happened when the Fed didn't bail out Lehman Brothers in September 2008).

The Fed has a lot less ability to maneuver in August 2011. Fed funds rates have been at zero since December 2008. The Fed has already expanded its balance sheet by approximately $2 trillion since the Credit Crisis began. Commodities are closer to their all-time highs now, not their lows. Another bailout like the one in 1998 (which was minor compared to what occurred during the Credit Crisis) could send inflation assets into a bubble. Gold is already trading over $1800 today and seems to be leading the way.  

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.

U.S Credit Rating Downgrade - A Humpty Dumpty Moment

 

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.

As everyone knows by now, S&P downgraded the U.S. sovereign debt rating from AAA to AA+ on Friday. While the extent of the downgrade is minor, the implications are major. As the recent debt ceiling negotiations revealed, the U.S. cannot run its day-to-day operations without borrowing money. It lives on credit (as do most countries in the world today) and anything that impacts its ability to borrow money has serious consequences.

It takes a lot for a credit rating agency to lower the credit rating of a top corporation or country. This is usually only done long after the actual credit worthiness has experienced a significant decline.  The last major Friday afternoon credit downgrade from the credit rating agencies was when they lowered Bear Stearns rating on March 14, 2008. The company didn't open its doors again the following Monday.  The rating agencies were also tardy with lowering the credit ratings of accounting fraud poster child Enron, although they all did finally lower its rating to junk status four days before it declared bankruptcy. Perhaps the best analogy to the current U.S. situation though is the AAA ratings given to a number of securitized bonds that held subprime mortgages. These turned out not to be worthy of a top credit rating after all.

The farcical nature of how the credit agencies determine the rating of U.S. government debt was made clear during the debt ceiling negotiations. Numerous articles in the press reported that failure to come to an agreement, which would allow the U.S. to continue to spend money it didn't have because it could borrow more, would be viewed as fiscally irresponsible! A more rational response would have been, it's quite obvious that the U.S. can't function without borrowing an increasing amount of money and it is therefore insolvent. Under such circumstances its credit rating should be at the junk level - a BB or less - not an AA+. Eventually, this might happen, but as was the case with Enron, this would mean the U.S. would likely be going under a few days later.

The difference between the AA+ credit rating and the BB or lower one is caused by the fantasy factor. The AA+ rating is based on the glorious financial past of the U.S. and ignores the current downward trajectory it is on. Before the debt ceiling problems temporarily curtailed spending for a while, the U.S. was on course for as much as a $1.65 trillion budget deficit. This represents 11% of the current GDP number of $15 trillion (there are many reasons to think GDP is substantially overstated). It is true, that the U.S. is not borrowing money to pay for most of this deficit however - it's printing it. Quantitative Easing 2, a form of money printing, conducted by the Fed covered 70% of the deficit in the first half of the year. A country doing this certainly does not deserve an AAA credit rating, nor does it deserve an AA+ credit rating unless you can make a case that a company engaged in the business of counterfeiting money also deserves a close to top credit rating.

The Obama administration complained that S&P overestimated future U.S. deficits by $2 trillion. What this means is that S&P refused to accept the pie-in-the sky budgets numbers that the government generates. If you look at these, you will see that they assume GDP growth of over 5% a year, each and every year, until 2016. One year of GDP growth over 5% would be good and continual annual GDP growth of over 5% for the U.S. economy just isn't possible. The budget scenario also assumes very low inflation, which would certainly not be the case if the high growth it assumes takes place.  A combined deficit of $20 trillion in the next decade instead of the administration's $7.7 trillion would be more plausible. S&P assuming $2 more is still ridiculously low.

The immediate impact of the U.S. credit downgrade will be to cap the credit rating of companies at AA+. The government of the country has to have the highest credit rating in that country because in theory it has no default risk. Economists say that governments can use their ability to tax to pay off their debts. Although as finances deteriorate it is much more likely governments will print money to pay off their debts. No fiscally solvent government ever engages in excess money printing however. The U.S. Fed had increased its balance sheet (a measure of money printing) by $2 trillion since 2007. It doesn't appear that the credit agencies are taking this into account.

The longer-term implications for the lowered credit rating are far more serious.  More downgrades are likely. Interest rates will go up. Money will leave the United States. The U.S. dollar will lose its reserve currency status and this will lower its value substantially. Higher interest rates and a falling currency will both be inflationary. 

The financial world operates very much on image and reputation. Once that's shattered, it can take years to repair it, if it can be done at all.  When Bear Stearns was downgraded in March 2008, the damage to its ability to operate in the financial markets was terminal. The company imploded like an overinflated balloon that had a pin stuck in it. Fortunately, this is not likely to happen to the U.S. - at least not yet.

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.

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