Investing Themes for the Next Decade: 2010 to 2020

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.

Investors make the most consistent money by following bigger trends and going long in uptrends or shorting into downtrends. Longer term trends are not unidirectional however, but subject to either sharp or intermediate term reversals. At those points, it is best to get out of the market until the uptrend or downtrend resumes. Of course all trends eventually come to an end and it is important to recognize this when it happens and to close out your positions. Failing to protect profits is perhaps the biggest mistake that investors make. While it is not possible to predict the future with complete accuracy, it is possible to make some useful projections that can be used as a general investing guide for the next decade.

The way to see into the future is to look into the past. Human behavior hasn't changed in the last many thousands of years and this is what is mostly responsible for repeating market boom and bust cycles. History has shown that government leaders in particular are prone to making the same monetary and fiscal errors over and over again. People who run governments have a tendency toward megalomania and a belief that things that happened consistently in the past (assuming that they are even aware of them) because of certain financial policy actions won't happen again in the present. They are invariably wrong. Central bankers can and do evidence this behavior to an extreme. They have repeatedly claimed that they have the ability to control the economy. The Credit Crisis makes it very clear that they do not - otherwise it would not have happened. Real world events have not shaken their faith in their own omnipotence however. Their arrogance combined with denial indicates that workable solutions to the Credit Crisis are many years off and only likely to take place once extreme conditions have been reached.

Repeating cycles and the historically oft repeated government responses to them provide us with a lot of information about what can happen in the markets during the next ten years. Just like everything else, the cycles will behave as they have in the past because the fundamental driving forces behind them are the same as they always have been. Before the decade even begins, we can clearly see three major factors that will impact the market until at least 2012. These are: the lag between monetary stimulus and inflation, the steep yield curve, and price cycles in certain commodities. These predict that a peak in the inflation rate, long-term interest rates and commodities prices is probable between December 2012 and July 2013. This will not be the ultimate peak however. There will be at least one additional peak that follows this one and two extra peaks are even more likely.

The exact high for commodity prices and interest rates of course can't be stated yet. It can be said however that they will be much higher than the beginning of the decade and be at levels that would currently be considered extremely high by most investors. Sharp price acceleration is likely to be evidenced in the last several weeks to few months of the move with as much as 20% to 25% gains for commodities such as gold and oil possible during this end phase. While an inflation investing strategy centered around precious metals, energy, agricultural commodities and shorting long-term bonds will be highly profitable up to early 2013, investors will then need to sell these holdings to protect their profits. Either switching to cash or engaging in a deflationary investing strategy will then become the best option, at least for a while.

This first inflation peak will end because it will become politically untenable for governments to allow it to go on. Investors should expect the typical government responses from the past. These include price and wage controls, currency intervention and cross border currency controls, import/export controls, rationing, punitive taxation policy on certain investments, changes in investing rules and regulations and either indirect or direct government forced dissolution of certain investment vehicles. As has happened in the past, these policy initiatives will work quite well - in creating shortages, black markets, general disrespect for the law, and in preventing the economy from fixing itself. Inflation will remain controlled for approximately 18 months at most. At that point, there will either be a de facto or de jure dissolution of many of the policy initiatives because of lack of support among businesses and the public. By 2015, inflation will on the rise again and investors will need to switch back to precious metals, energy, agricultural commodities and shorting long-term bonds.

Some ultimate resolution to rising prices will likely take place toward the end of the decade between the 2017 and 2019 time frame. Prices for most commodities will reach levels that would be considered unimaginable in 2009. U.S. interest rates will be somewhere well into the double digits (if not higher) and the U.S. dollar will have lost most of its value. By that point, the world financial system will have to be restructured. The dollar will have to be given some backing to regain credibility. There will probably only exist a narrow window of time for inflation investors to sell their holdings so that they keep most of their spectacular profits. They must then switch their investing strategies to approaches that work in a disinflationary or deflationary environment. For an update on how to do this, check back in 2020.

Disclosure: Long precious metals, agricultural commodities, short long-term bonds.

Next: Energy Investing Guide for 2010

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.

How Media Manipulates Investors to do the Wrong Thing

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:

As anyone who reads this blog knows that we have watching oil closely for quite awhile now and recommended buying DXO on the evening of February 17th. Oil double bottomed the next day. Did all the media investing pundits tell you to start buying at that point like the New York Investing meetup did? No, not at all. All of these geniuses missed it. So what happens when Wall Street misses the bottom, as it invariably does? Suddenly negative articles permeate the media about how dangerous it is to invest in that stock or asset... how its likely to go even lower yet... how you better get out in case you thought you timed it right. And while you're selling or staying on the sidelines the big money is picking up bargain goods behind the scenes. I have seen this ploy over and over and over again. You should be aware of it and make sure that you don't let yourself be shaken out of a profitable investment.

What is going on in the oil market right now is a quintessential example of how the media allows itself to be used by big money sources to misreport to the average investor what is really going on. There has been an unending drum beat in coverage of the oil markets about how demand is going down (while exaggerated, this is in and of itself a true statement), but with little or no mention of the supply side of the equation. We pointed out yesterday that a drop of 1.4 million a barrels a day globally is projected and sometimes in the same article you can find out that OPEC has cut 4.2 million barrels a day of production. Kindergarten economics tells you when supply drops much more than demand, price goes up. Not only is this simple analysis missing in media articles about the oil markets, the headline usually screams something about demand dropping for oil and how negative this is. I have seen this mindless idiocy echoed on comments on numerous investing sites. Many investors became irate when oil started going up and insisted manipulation was going on in the market because how could price go up when demand is going down? The average investor is indeed quite gullible (and knows nothing about economics).

Even when the mainstream media reports oil supply, it does so in a misleading way. The big supply news is always U.S. oil reserves in Cushing, Oklahoma (as if on one outside the United States uses any oil). Oil sold off sharply yesterday after a 'big' increase in supply was announced. 'Oil glut' and 'awash in oil' were phrases investors heard from the media. Oh really? Let's analyze just how big this 'oil glut' is (figures thanks to Bob Pascazio). U.S. oil inventories rose 700,000 barrels. Sounds like a lot if you don't know that there are 351.3 million barrels in storage. The increase in oil reserves was less than a 0.002%. The U.S. uses 833,000 barrels of oil an hour. So the 700,000 increase represents less than one hour more supply of oil. We have only a little over 17 days of usage in total storage. Even a minor disruption in supply and we would be out of oil before you knew it. Some glut!

This blog is being published late today because I wanted to see if suddenly oil went up today after all the negative press yesterday. DXO was mostly flat during the morning, but then started zooming in the afternoon. How surprising! Maybe all of those articles that appeared in the press yesterday saying OPEC isn't going to cut aren't true after all. The media not given investors the real story? Now I wonder who could benefit from that?

NEXT: Market Will Reward Real Value Going Forward

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.

PPI and CPI - Don't Get Excited Just Yet

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:

Yesterday the PPI (producer price index) indicated that wholesale prices dropped 2.8% in October, the biggest one-month decline in the 60 years that this data series has been in existence. Today the CPI (consumer price index) report had consumer prices falling 1.0% last month, the biggest monthly drop in its 61 year history. One item alone, energy prices, made a disproportionate contribution to falling prices. Oil has dropped over 60% from its high in July and gasoline prices in the U.S. are down around 50% from their top the same month, having dropped an unprecedented 60 days in a row (with sharp decreases just before the election). This entire drop is still not fully reflected in PPI and CPI and is likely not yet over either, so expect further drops in both in the next couple of months.

Core inflation (inflation minus food and energy) painted a very different picture from the headline numbers however. PPI core rose 0.4% on the month. CPI core fell only 0.1%. There is also no year over year deflation either. Prices for finished producer goods have risen 5.2% in the last year and consumer prices are up 3.7%. At least these are the official numbers. The New York Investing meetup has demonstrated several times in its meetings how consumer price inflation is significantly understated by the U.S. government. Falling prices based on drops in commodity prices also have their limitations. While there is no maximum to commodity prices, there is a minimum which is determined by the cost of production. As this is approached, less efficient wells and mines are closed down. New projects are postponed. Supply falls so that profitable prices are maintained.

How does this compare to the deflation that took place in the early 1930s during the Great Depression? Estimates are that U.S. consumer prices fell approximately 3% in 1930, 9% in 1931 and 11% in 1932 (the bottom year). Production output was also falling by similar amounts during this period. Similar drops in prices and production took place in a number of countries. The one common denominator among these countries was a fixed-exchange rate gold standard and not the inherently inflationary fiat currency standards that now prevails throughout the world. Big increases in money supply, which are inflationary, are not sustainable under a gold standard, but can now take place in seconds by hitting the enter key on a computer keyboard. While the U.S. monetary authorities actually supported deflation by constricting the money supply at the beginning of the Depression, today they are doing everything possible to expand the money supply and create inflation.

Nevertheless, there are a large number of people who maintain that deflation is taking hold in the U.S and will only get worse over time. The crux of their argument is usually that bank credit is in collapse and the amount of bank credit available determines inflation or deflation (not rising or falling consumer prices, which is everyone else's definition) . They also frequently claim that inflation is led by rising wages and can't take hold otherwise. This was indeed true in the U.S during the 1970s, but apparently unbeknownst to these people, history began before that decade. Large inflations have existed since at least the Roman Empire and have taken many forms. As for Wiemar Germany, the one case of hyperinflation so far in an advanced industrial economy, there doesn't seem to have been any major increase in bank credit, which would be required in the deflationists world view. The government simply spent money it didn't have and had to keep printing more and more currency to keep up. For something like this to happen in the here and now, the U.S would have to be running larger and larger budget deficits and the national debt would have to be skyrocketing. Or in other words, exactly what is taking place.

NEXT: Market Must Hold In Here

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.

When the Lender of Last Resort Becomes the Only Resort

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:

In the current credit crisis, central banks and governments in the U.S. and Europe are making the transition from supporting the financial system to becoming the financial system. There seems to be no ruined financial company that governments won't bail out (at least if its large enough or if the impact of its failure would have some significance), nor any limit to the amount of money that central banks will lend. The complete dependency relationship on governments that now exists among financial institutions is the ultimate outcome of Moral Hazard - banks have repeatedly been bailed out in the past, so they take on greater and greater risks until a total systemic failure takes place requiring a government takeover.

The latest bank bailouts include UBS last week and ING this weekend. After UBS declared a surprise profit, the Swiss government announced it would be injecting up to $60 billion into the bank and would get a 9% stake in return (apparently the Swiss government doesn't even believe their accounting figures). The UBS bailout was predicted long ago by the New York Investing meetup. The Dutch government today announced it would be giving ING Groep NV $13.4 billion in exchange for non-voting preferred stock, but would nevertheless be getting two seats on the board. Yesterday, the Korean government announced a blanket $100 billion backing for its bank's foreign currency debts.

As for cash injections into the financial system, these hit a record last week in the U.S. with banks and dealers direct borrowing from the Fed reaching $438 billion per day. This was up from the $420 billion per day the week before. The only Fed program that had less lending last week was the one that allows banks to purchase asset backed securities ($123 billion versus $139 billion the previous week). The U.S. Treasury sold $499 billion in T-bills for the Fed's Supplementary Finance Account to support all of this lending. Meanwhile, the Bank of England started implementing a new framework to provide emergency funds to banks. The new facility cuts the penalty for banks borrowing funds directly from it overnight. Why go elsewhere under those conditions? Ditto in the U.S. where funds from the Fed are plentiful and cheaper than can be gotten elsewhere.

If only one government was engaging in increased lending, a case could be made that it could borrow the money from other more financially sound countries. However, in the current crisis, all the developed countries are increasing available funds substantially. They do so by selling bonds. But if everyone is selling more bonds, who's left to buy them? Only an increase in the supply of the world's major currencies can make this possible, which means they are all being devalued in this crisis. By how much, only time will tell.

NEXT: The Fed Should Be Careful What It Wishes For

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 Inflation Versus Deflation Argument - Part 5

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.

If the deflationists aren't really discussing consumer price inflation, what is it that they are really talking about? To figure this out, it is helpful to seperately analyze the two components of the deflationist argument, bank credit and money supply, since they operate in very different ways and combining them obfuscates the picture.

Since people don't take out a bank loan to buy a quart of milk or a tank of gas, but they do borrow to buy a house and financial instruments, there is a direct relationship between bank credit and asset prices. The effects of increases or decreases in bank credit are likely to show up relatively quickly in prices for real estate, bonds, and stocks. Only much lately are they likely to impact consumer prices and even then they will represent only one of many components (currency exchange rates being potentially far more important).

This proposed direct relationships between credit and asset prices and currency and consumer prices seems to be well supported by real world observations. In the late 1920s U.S. there was a massive increase in credit and strong bull markets in housing, stocks, and bonds, yet consumer prices were dropping. Even though the U.S. currency didn't float at the time, capital was flowing into the New York from around the world and if the value of the dollar had been market driven, it's exchange rate would have been rising. A similar picture exists for Japan in the 1980s, although there was an even more massive asset bubble and the Yen was experiencing a far more significant rise that the U.S. dollar would have had in the 1920s.

In contrast, the U.S. in the 2000s was a period of declining currency values, the dollar peaked in 2002 and lost more than a third of its value by 2008. Bank credit expansion during this period led to massive bubbles in real estate and related debt instruments, with the S&P testing its 2000 bubble high in late 2007. When bank credit began its severe retraction, prices for real estate, non-government bonds, and stocks had significant drops. Consumer prices on the other hand accelerated higher. One major reason was the rising price in commodities. Since commodities are priced in dollars, they will go up if the U.S. dollar goes down.

The other component of the deflationist argument, money supply, has an obvious lagged effect on consumer prices. Changes can show up many years later. An examination of a money supply chart from the 1970s illustrates this quite clearly. M3 growth peaked in 1971, yet U.S. consumer price inflation didn't have an intermediate term peak until 1974 and the final high wasn't reached until 1980. The large rise in M3 in 2008 isn't likely to have its full impact on consumer inflation until some time in the 2010s.

Since deflation inevitably follows serious inflation, the deflationists at some point will be correct that there will be deflation in the United States. Worrying about deflation now though is like closing your windows and turning up your heat in May because you are worried about a cold winter coming.

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:http://investing.meetup.com/21/Files

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

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 4

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.

While it is true that the U.S. experienced consumer price deflation in the 1930s and Japan did so in the 1990s and both experienced sharp drops in bank credit, there are few if any other similarities to the current situation in the United States in 2008. The situation in the 1930s U.S. and 1990s Japan is also a bit more nuanced that the deflationists would have you believe. In the late 1920s, the U.S. did see a big rise in money supply and credit, just as occurred in the U.S. in the early 2000s. According to the deflationists, this should have resulted in rising U.S. consumer prices at some point. It did not. Prices actually fell between 1926 and 1929. A similar thing happened in Japan in 1986. While consumer price deflation did appear in Japan after its banking system literally fell apart, it didn't show up consistently until 1999, nine years after the Japanese asset bubble began to burst. Based on these observations, the relationship between consumer prices and money supply and credit seem to be rather tenuous at best.

The deflations in the 1930s U.S. and 1990s Japan did have an important element in common that does not exist today - dropping commodity prices. As early as the spring of 1929, farm commodities in the U.S. experienced a sharp drop. All commodities declined in the crash month of October and then they crashed themselves in the spring of 1930 . While commodity prices didn't crash in the 1990s, they were weak throughout the decade. Oil reached its price low of just over $10 a barrel in 1998. Ten years later it would be almost 15 times higher. Not only were commodities not declining in the 2000s, but they were experiencing major price increases resulting in significant inflation in the U.S. and most of the world. The commodity picture in the 2000s was just the opposite of the early 1930s U.S. and 1990s Japan.

The import/export and deficit picture has no similarity to the contemporary U.S. either. In the late 1920s, the U.S. had a massive trade surplus and was the biggest creditor nation in the world. Its boom had been built on exports as was the case for Japan in the later twentieth century. Drops in exports damaged both economies. On the other hand, the U.S. in the 2000s was the biggest debtor nation in the world having both a massive trade deficit and government debt, which required heavy borrowing and had inflationary implications. Japan in the 1980s was similar to the U.S. in the 1920s and both were very dissimilar to the U.S. in the 2000s.

Currency also plays a different role in all three scenarios. The U.S. was on the gold standard until 1933 and even after that the currency didn't float. The Japanese yen traded relatively flat during the 1990s. In neither case, did currency have a significant deflationary or inflationary effect, in contrast to the U.S. in 2008 where currency played an inflationary role. The U.S. dollar dropped to all time lows in late 2007 because of the Federal Reserves easy money policy. Since the U.S. imported much more than it exported, this raised import prices and had a bigger inflationary impact than it would have had otherwise.

NEXT: The Inflation Versus the Deflation Argument - Part 5

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

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

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 3

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.

For a theory to be valid, it must produce results consistent with reality. Neither the deflationist arguments in Wiemar Germany in the 1920s, nor those made in 2008 in the United States could meet this most basic of all criteria. The contemporary U.S. deflationists are claiming that an era of lower prices is upon us even though consumer prices are continuing to rise and the rise seems to be accelerating. Both groups of deflationists redefined inflation to be something else, or in other words, they changed reality to match their theory instead of the other way around. In neither case was any relationship demonstrated by them between their definition of inflation and changes in consumer prices.

The deflationists claim that inflation is an increase in money supply plus bank credit. While everyone could agree that bank credit in the United States was falling in 2008, the same could not be said for money supply. Their are many definitions of money supply and M3, a broad category that would include the Federal Reserves newly created money pumping operations such as the TAF, TSLF and PDCF was expanding rapidly. Since the deflationist argument would fall apart using their own criteria if M3 figures were used, they chose to look at much narrower definitions of money supply such as M2 to try to support their theory. Even then, M2 was experiencing robust growth of over 6% until the second quarter of 2008, when it slowed to around 1%. This was hardly the dire collapse that the deflationists claimed to be happening.

Logically, the deflationist definition is inherently defective because it considers inflation to be a local rather than a global phenomenon. In an era with worldwide commodity trading, prices are set globally for key components of consumer inflation such as energy and food products, not based on what's happening in a single country. Under such circumstances, currency fluctuations then determine the different rates of inflation between countries.

The deflationists argument is also too limited in that it considers money supply and credit, but not assets. In a rich developed country, people can spend their wealth (liquid and tangible assets) as well and they will if they need to do so to buy necessities. This is exactly what happened in Wiemar Germany, where the middle and even upper classes sold their family's prized possessions in order to eat.

The U.S. deflationists also try to bolster their case with comparisons to what is happening in the United States now and what happened in the deflationary periods of the 1930s U.S and the 1990s Japan. Only the most superficial comparison shows any similarities between the U.S. in 2008 and these earlier time periods. Under closer examination the deflationist comparisons completely fall apart.

NEXT: The Inflation Versus Deflation Argument - Part 4

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

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

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 2

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.

Inflation can only get out of control if the monetary authorities act irresponsibly by failing to stop rising prices and respond with denial and duplicity instead. In general, the worse the denial the greater the final inflation rate. In no case was this more clearly demonstrated than during the German hyperinflation when prices rose a 100 trillion percent between 1914 and 1923. Toward the end, consumer prices more than doubled every two days.

Eminent financiers, economists, politicians and Wiemar government officials all denied that inflation even existed in Germany, at least right up to the time of its final hyper phase and some of them continued with their denials even in the midst of those explosive price increases. Minister of Finance, Helfferich, assured the public that there was no inflation in Germany because the 'value' of currency in circulation was covered by a greater amount of gold reserves than it had been before prices began rising. Eminent professors, Elser and Wolf, echoed his argument. President of the Reichsbank, Havenstein, categorically denied that the German central bank was creating inflation and was convinced he was following a restrictive monetary policy. The Statistical Bureau of the German Government concluded in a study that there was a shortage of currency in Germany, but a great deal of inflation abroad!

How did these government officials and eminent economic authorities justify their continued assertions that there was no inflation despite rapidly rising consumer prices? They used one of the oldest tricks in the book, simply redefining inflation to be something else. By saying X really isn't X, but X is really Y and Y has certain attributes so X must have those attributes, you could of course prove almost anything. And the Wiemar German experts did just that by defining inflation as an in increase in the real value of currency in circulation (instead of the nominal value, which would essentially be the current definition of money supply) plus credit . While the total face value of currency in Germany was increasing dramatically, the total actual value was declining and this was interpreted as 'proof' that deflation was taking place. The accurate interpretation would have been extreme consumer price increases can take place when real money supply and credit are decreasing.

If instead of defining inflation as a function of real money supply and credit, Wiemar economists had defined it as the change in the value of a nations currency, they would have arrived at the correct conclusions about consumer price inflation. The exchange rate of the German mark essentially went to zero as price increases in Germany approached infinity. Since that time, globalization has only made the importance of currency as the key determinant of inflation even more important.

While the mistakes of the Wiemar German officials and financial experts seem laughable today, almost the exact same arguments about inflation began circulating in the U.S. in 2008. If such absurdities only surface prior to a massive outbreak of inflation, serious trouble was obviously ahead for the U.S. financial system.

NEXT: The Inflation Versus Deflation Argument - Part 3

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

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

For more about us, please see our web site: http://investing.meetup.com/21

The Inflation Versus Deflation Argument - Part 1

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.

One of the Federal Reserves two major purposes is to provide price stability for the American economy, a goal they chose to abandon in September 2007. While the Fed's interest rate policies after that time were highly inflationary, Fed officials excused their actions by denying that inflation was a problem, making rosy predictions that it would subside, and by assuring the public that they were capable of handling it and taking care of it in case it became a problem. None of this was true of course and the Fed's position increasingly lost credibility as gasoline and food prices skyrocketed in the U.S.

The Fed's biggest cover for its actions was the official inflation figures produced by the U.S. government statistical agency, the BLS (Bureau of Labor Statistics). The method of calculating the CPI (Consumer Price Index) was modified several times during the 1980s and the 1990s, with each modification producing a lower reported inflation number. Essentially these modifications involved reducing the importance in the CPI calculations of anything that was experiencing significant prices rises, thereby automatically lowering the final reported inflation numbers. It was hard for significant inflation to show up in the official government figures given this approach. By May of 2008, year over year CPI was only 4.2% in the U.S. despite rapidly rising energy and food prices during that period.

Recalculating CPI using the 1970s methodology indicated U.S. inflation was more likely around 12% (for more info: http://www.shadowstats.com/), almost as bad as it had been at its height in 1980. It became increasingly hard to convince the public otherwise, when the average U.S.consumer saw regular price increases at the gas pump and in the supermarket. Nevertheless, U.S. media continued to dutifully report the unrealistic official inflation figures as if they were true, helping the Federal Reserve perpetuate the fantasy on which it based its irresponsible monetary policy.

While the Federal government altered inflation calculations to produce the desired numbers in order to fool the general public about current inflation, lying about future inflation could not be done so easily. The augurs of where inflation was going, the money supply, are generally only looked at by the financially sophisticated. To solve this problem, the Federal Reserve simply stopped publishing the broad M3 money supply figures, the most telling number series of all, in 2006. Since many people realize that when a government hides information, its almost always information that would be particularly damaging if known, attempts to reconstruct M3 by private parties began immediately. By the spring of 2008, the reconstructed figures indicated that M3 was growing at approximately 20% (MZM, zero money, or cash and its equivalents was growing at an over 30% rate). The money supply figures indicated that U.S. consumer inflation was likely to peak at a minimum of 20% to 30% sometime around 2011. Depending on future readings, much higher inflation levels were possible.

The U.S. government's long-term misinformation campaign about inflation rates and its secrecy concerning money supply figures apparently didn't provide enough cover for the Federal Reserve. One group of apologists for the Fed (and the Fed had a legion of apologists who were feeding off the easy money gravy train that it was providing them at the expense of the American public) began publishing arguments about the risks of deflation in the U.S and how this justified an even easier money policy. Claiming that deflation actually existed in a period when inflation was getting out of control was by no means a new idea. It was in fact a prelude to some of the worse inflationary episodes in history.

NEXT: The Inflation Versus Deflation Argument - Part 2

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:
http://investing.meetup.com/21/Files

Daryl Montgomery,
Organizer, New York Investing meetup

For more about us, please see our web site: http://investing.meetup.com/21

Central Bankers Gone Wild

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.

The New York Investing meetup has made a companion video to this blog entry. To see it, please go to: http://www.youtube.com/watch?v=y9kzKAzn2Ig

In the hundred years before the Federal Reserve existed, aggregate inflation in the United States was approximately zero. This does not mean that there was never any inflation, inflation did indeed exist, but that the periods of inflation were offset by periods of deflation so that over a long period of time there were essentially no changes in prices. A new era for inflation began when the Fed was created in 1913. Except for the Great Depression in the 1930s, deflation essentially disappeared from the United States economy and there were only periods of lower or higher inflation. This continuing inflation resulted in a 1923% inflation (based on understated official figures) for the first 95 years of the Fed's existence. Conversely, it could be said that the U.S. dollar had lost 95% of its value during this time. And the remaining 5% seemed to be endangered as well.

The beginning of 2008 saw what was probably the biggest injection of liquidity into the U.S. monetary system by the Fed in history. There were two massive rate cuts separated by only 8 days. First there was a 75 basis point cut in the Funds Rate on January 22nd and this was followed by a 50 basis point cut on January 30th. The previous time the Fed had cut rates by 75 basis points was when the Funds rate was at 20%. The January cut took place from a 4.25% level and was the first inter-meeting cut since the 9/11 crisis. Only two months later the Fed would again cut the Funds rate by another 75 basis point, this time from the 3.00% level. Based on the starting levels, the cuts in the Funds Rate was enormous and took place in a very brief span of time.

The cut in the Funds Rate was by no means all the liquidity that the Fed was pumping into the system. The TAF (Term Auction Facility) auctions were raised from $20 billion to $30 billion each by January and would reach $50 billion for each auction in March. Two additional auction facilities were added to the TAF by March - the TSLF and the PDCF. The TSLF (Term Security Lending Facility) was set up to swap $200 billion of treasuries for illiquid securities being held by the banks. The PDCF (Primary Dealer Credit Facility) opened the Fed's credit operations to the 20 firms that bought treasuries directly from it. The Fed had only lent money to commercial banks during its entire history and the PDCF represented a big extension from its traditional scope of operations.

The impact of the Fed's liquidity boosts caused the money supply to explode. MZM (money with zero maturity and therefore available for immediate use) grew by an over 37% annual rate in the first quarter of 2008. This would have been OK if the economy was expanding by around 37% as well, but the economy was contracting instead. The difference between money supply and economic growth was more than enough to create a massive future inflation problem and possibly even hyperinflation. How much inflation would actually take place was something only time would tell.

NEXT: The Fed's Manipulation of the Stock Market

Daryl Montgomery

Organizer, New York Investing meetup

For more about us, please go to our web site: http://investing.meetup.com/21