Inflation Insights From Chris Pavese and Dian Chu

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


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

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

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

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

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

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

Disclosure: None

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

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

Retail Sales Drop in May Shouldn't Be a Surprise

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. government released its Retails Sales report for May this morning. Analysts expected an increase, but sales dropped 1.2%. The markets were surprised that American consumers were spending less even though the unemployment rate is stuck around 10% and credit card debt has dropped for 19 months in a row.

The expectations for higher retail sales came from the massive amounts of federal government stimulus being pumped into the economy. There is a $1.6 trillion dollar budget deficit projected for fiscal year 2010 (the deficit for 2009 was $1.42 trillion) and this money is making all the economic numbers look much better than they would otherwise. The deficit alone is approximately 11% of the official U.S. GDP number (which is grossly overstated), but still represents less than half of all federal government spending.  Investors should ask themselves: Given all of this support, how weak is the U.S. consumer?

This is an important question because the U.S. has built an economy based on consumer spending, which reached 72% of GDP before the Credit Crisis. The consumer also became very over indebted in the 2000s and the saving's rate hovered around zero mid-decade.  To spend more, consumers need more income and credit (the amount available from savings is limited). A jobs recovery is needed to increase consumer income and even Washington admits that that is not happening in the foreseeable future. As for credit, the big banks are borrowing from the Federal Reserve at zero percent, but are not passing the savings on to the consumer. They are also decreasing credit card lines, not increasing them. Autos are one of the only areas where cheap credit has filtered down to the consumer level.

Auto sales have also directly benefited from government programs like Cash for Clunkers. There were no special government programs active in May and auto sales fell 1.7%. The drop in retail sales was essentially across the board though. Department stores were down 1.8% and general merchandise sales decreased 1.1%. Hardware stores were really hit hard with sales falling 9.3%. The only bright spot was a 3.3% drop in gasoline sales. This took place because gas prices dropped, not because less gas was purchased. The Retail Sales numbers are not adjusted for inflation.

For some time now, the message coming out of Washington has been one of economic recovery. This has been based on economic numbers pumped up by incredible levels of stimulus. The retail sales report today and the employment numbers in general show that stimulus is not working so well this time around. The basic idea for excess government spending is that it jumpstarts the economy just as an electric jolt jumpstarts a battery. If the battery is really dead however, no amount of electricity brings it back to life. The same is true for stimulus in a dead economy.

Disclosure: None

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

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

A New Theory of Sudden Hyperinflation

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


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

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

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

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

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

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

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

Disclosure: None

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

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

Bernanke Testimony Indicates Fed Still in Denial

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.


Fed Chair Ben Bernanke testified on Capitol Hill today and didn't disappoint. As usual, his lack of insight into the true state of the U.S. economy boggles the mind.

The key takeaway from Bernanke's remarks is that the U.S. economy is strong enough to withstand the fiscal tightening ahead. Bernanke then promptly undermined this claim by admitting that the housing market has "firmed only a little" since mid-2009 and that it will take a long time before 8.5 million jobs lost during the Credit Crisis will be restored. What Bernanke left out was that even though the federal government has spent trillions on bailouts and efforts to directly and indirectly prop up the U.S. housing market, it has managed to get only slightly better. As for the jobs lost, what will that number be after the 1.2 million temporary Census workers are let go in the next few months? A 10 million lost job figure is probably more realistic.

It is of course not surprising the U.S. economy has gotten better after the government has pumped trillions of dollars in extra spending into it and given banks credit at zero percent interest. What is surprising is how little improvement there has been given these extraordinary and unsustainable measures. There is little evidence of private sector hiring in the job market and moreover the weekly unemployment claims are stuck over the 400,000 number that indicates layoffs are taking place at a recessionary level. The U.S. economy is also dependent on consumer spending. This accounted for 72% of GDP before the Credit Crisis. Consumers not only have job problems, but they are also losing access to credit. While credit card debt is dropping rapidly, there was a minuscule increase of $1.0 billion increase in overall consumer credit in April. Loans held by the federal government increased by $1.7 billion.

Nevertheless, Bernanke is confident that "gains in final demand will sustain the recovery in economic activity" even though "support to economic growth from fiscal policy is likely to diminish in the coming year". Bernanke went on to state the federal budget deficit is was estimated to decrease by $500 billion in fiscal year 2011. It was not clear where in the private sector the 'final demand' would be coming from to make up the reduced spending from the federal government. It certainly doesn't look like it will be coming from the over leveraged American consumer. As for the reduction in the budget deficit, prior to the last year of the Bush administration, the record budget deficit in total was less than $500 billion. A reduction by that amount now indicates the federal government will be spending $1.1 trillion more than it is taking in during 2011. That is still an enormous amount of deficit spending and hardly indicates an economy that can function on its own without constant ongoing government stimulus.

What led to the tragedy of the Great Depression in the 1930s were major missteps from the Federal Reserve and the federal government. The Fed put the interests of the banking community over those of the American public and this is what turned a bad recession into a bad depression. This was combined with an ongoing campaign of denial of the problem on Washington's part. Herbert Hoover gave a press conference in June 1930 announcing the Depression was over (it was only just beginning). The similarities to all the talk coming out of Washington today about economic recovery should give investors pause.

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.

Market Sells Off Even Though Bernanke Is Bullish

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.


Fed Chair Ben Bernanke stated last night that he is 'hopeful' the U.S. economy will not fall into a double dip recession. After a tremendous drubbing on Friday, stocks somehow managed to sell down to even lower levels yesterday. They are down again this morning following Bernanke's comments - a fitting response to his forecasting acumen.

Few people in the United States seem to be as oblivious to the condition of the American economy as is the guy who is in charge of the Federal Reserve. Bernanke notoriously stated that subprime borrowing wouldn't cause any problems only weeks before it blew up into the biggest financial crisis the world has ever seen. Following this, the Fed released a number of statements in the spring of 2008 about how it was hopeful that its policies would prevent the U.S. economy from falling into a recession. Unfortunately, the economy had already fallen into recession months before, but the Fed was blissfully unaware of this even though it has more access to economic data than anyone else. The buffoonish Bernanke has been beating the drum of economic recovery for a long time now, even though analysis of U.S. statistics indicates the private sector is still struggling. The only recovery that seems to have taken place is in increased government spending.

At the moment, the markets don't seem to share Bernanke's rosy view of the future. The Dow dropped 115 points (1.2%) yesterday and most of the selling took place around the close, as is typical in bear markets. The Dow's ending price of 9816 was well below the key 10,000 level. The S&P 500 fell 14 points (1.4%) and closed at a new low for 2010, as did the Dow. Selling was even more pronounced in the tech heavy Nasdaq and the small cap Russell 2000. The Nasdaq lost 45 points (2.0%) and the Russell 15 points (2.4%). As of today, the Dow and S&P 500 have spent 13 trading days below their simple 200-day moving averages, a bearish pattern. Selling was also widespread with market breadth close to three to one negative on the NYSE.

The only areas of the market that did well yesterday were utilities, gold/ gold miners, and treasuries - safe havens. Financials were hit hard with Goldman Sachs (GS) falling 2.5% and Bank of America (BAC) losing 3.4%. U.S. bank failures have reached 81 so far this year and look like they are going to handily exceed 2009's very high figure. Credit card debt has fallen for 19 months in a row and May's employment report indicated private sector hiring has disappeared. Once the 1.2 million temporary Census workers are dismissed, the U.S. unemployment rate should go above 10%. These are not signs of economic recovery and yet the Fed chair keeps spouting one cheerleading remark after another about how recovery is taking place. Herbert Hoover did the same thing in the early 1930s as the Great Depression was developing. Consequently, he is now treated as a historical laughingstock. History may take the same view of Ben Bernanke. 

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.

Markets Trading Like They Did During Credit Crisis

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 are selling off globally. Commodities are down, but gold is holding up the best. Money is pouring into the perceived safe havens, the U.S. dollar and treasuries. Is it the late fall of 2008 or late spring of 2010?

Without further information, you can't answer that question. There is a global financial crisis occurring now because of the problems with the euro. There was a global financial crisis in 2008 because of the collapse of the prices of derivatives related to subprime mortgages. The problems with subprime debt had begun the year before and started impacting stocks in July 2007. Stocks were already in an advanced bear market sell off by the fall of 2008. The current euro crisis is only a few months old and U.S. stocks are only in a correction so far (loss of over 10% versus loss of over 20% for a bear market).

The current stock market sell off is worldwide as it was in 2008. It goes without saying the stocks in the eurozone are suffering, but technical damage can be found in major markets everywhere. The Dow Jones has broken key support at 10,000 twice already. The Nikkei gave up its significant 10,000 level a while ago, closing at 9521 last night. The Hang Seng has fallen below important support at 20,000, dropping to 19,378. In the UK, the FTSE is barely holding above 5,000 today.

The trade-weighted dollar (DXY) was as high as 88.71 in New York this morning (June 7th). This is higher than its peak in November 2008, but not as high as the top in March 2009. There was a major sell off in the middle, with the euro (FXE) having a sharp rally. Something similar is likely to happen early this summer. The dollar is very overbought and the euro is very oversold. The euro has traded as low as 1.1878 today. It may pop back up to the 120 support level and if not, there is stronger support around 115. The dollar is already hitting major resistance, so the set up for a short-term reversal looks like it is taking place.

As would be expected, U.S. treasuries have rallied strongly during the euro crisis. It is highly unlikely that they will get to the extremely low levels they did in 2008. As treasuries rally, interest rates go down of course. Interest rates on the 10-year fell to around 2.00% in December 2008. They were at 3.18% this morning. There is strong chart support at and just above the 3.00% level. So not much more of a treasury rally, interest rate sell off should be expected for now.

Currently gold has recaptured its safe haven status. It was selling off with the euro between last December and this February. Then it started rallying with the U.S. dollar, although it usually trades opposite to the dollar. Gold sold down in the fall of 2008. Central bank leasing was responsible for this. The big banks and large hedge funds leased gold at a small price and then sold it on the market to raise desperately needed cash. This is not happening at the moment to a significant enough degree that it can offset buying elsewhere. Ironically, a sharp relief rally in the euro could be short-term bearish for gold. Despite the selling in the fall of 2008, gold still closed the year up along with the U.S. dollar and U.S. treasuries. Almost every other asset closed down. It's still too early to tell if 2010 will end the same 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.

First of the Month Indicator Gives Bear Market Signal

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.


It was a horrendous day in the markets on Friday June 4th. Trouble began when the euro broke support and selling then spread from Europe to North America. A disappointing U.S. jobs report added to the downward pressure and stocks sank. The small cap Russell 2000 had a mini-crash. The first four trading days of the month were down for the second month in a row, indicating we have established a bear market trading pattern.

Problems began in Europe with rumors of a possible default of a major French bank. Another European country, Hungary, indicated its finances were in trouble. The euro (FXE) fell below the key 1.20 level and traded as low as 1.1919 taken out the 1.1920 low in March 2006. Adding to the woes in Europe was the May employment report that came in well below expectations. Almost all the jobs added were from Census hiring and those jobs will disappear almost as quickly as they appeared. U.S. markets gapped down on the open.

Selling in U.S. stocks was almost continuous throughout the day. By the close, the Dow was down 323 points or 3.2%. The S&P 500 dropped 38 points or 3.4%. Nasdaq was worse still, losing 84 points of 3.6%. The Russell 2000 though gave up 33 points or 5.0%. The rule of thumb is a 5.0% drop in one day is a mini-crash. The Dow closed at 9932, which is the second recent close below the key 10,000 level. This one took place on Friday, so it appears as a loss of technical strength on the weakly charts, a more serious problem than if it had occurred just on the daily charts as was previously the case.

Even worse was that all four major indices were down for the first four trading days of the month. This is a typical bear market pattern. It does occasionally happen in bull market rallies though, so to be significant there needs to be two months in a row with a loss in the first four trading days. May also saw just such a loss, so the two down months in a row have now taken place. A bear market doesn't mean the market isn't going to go up again. Bear markets are known for their sharp and sudden short covering rallies. Traditionally, it means that traders should switch to shorting the rallies instead of buying the dips. Adept short-term traders can of course play the market both ways.

Classic market watchers will not consider stocks to be in a bear market until they've lost 20% of their value. Investors of course should never accept that type of loss. By the time that confirmation takes place; a lot of money is already gone from your brokerage account. So far, the Dow is down 11.5%, the S&P 500 12.5%, the Nasdaq 12.3% and the Russell 2000 15.0% from their respective peaks. Market observers agree that this is a correction because all the indices are down more than 10%.  Informing investors of how much they've lost after the fact is not particularly helpful. The idea is to avoid these events before they take place. If you check, you will see I published a number of articles warning of the sell off before it started.

Disclosure: No positions

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

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