Inflation Makes Economy Look Better; Stocks Soar on the News

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.


Despite a number of economic reports at the beginning of the month indicating continued problems, stocks rallied strongly on September 1st. The Nikkei was up over 1% and the major European markets were up between 1% and 2%. The U.S. markets were up over 2% in morning trade.

U.S. stock futures were up strongly in the pre-market and not even an incredibly weak ADP employment report indicating a loss of private sector jobs in August could derail the rally. In a rare moment of candor, even news service coverage found the rally odd. One article stated, "The sharp jump in U.S. stock futures is surprising given the domestic economic reports due out later in the morning. Often investors don't make big bets ... heading into key economic reports, particularly in recent weeks as data has consistently showed growth is slowing." And this was before the ADP report indicated that job losses in the U.S. are accelerating again after three challenging years and despite trillions of dollars of government stimulus spending.

What supposedly started the global stock rise was 'good' news on China's manufacturing index (PMI). The official government number was 51.7 in August versus 51.2 in July. While that may seem OK, albeit rather mediocre, the details indicate big trouble on the horizon. One component of the report was disproportionately responsible for the index not falling below 50 and indicating contraction. That component was the Input Price Index, which rose from 50.4 in July to 60.5 in August. Isn't that an inflation indicator? Doesn't that mean that input prices went up around 20% in only one month? Couldn't this possibly indicate that China is on the verge of experiencing major inflation and this is masking a big drop in manufacturing activity there? Then the U.S. PMI was released at 10:30AM and it unexpectedly rose.  Of all its components, the highest number was Prices, also an inflation indicator.

In the U.S., the market was also pleased that home prices were rising.  This news however was more laughable than ominous. According to Case-Shiller, U.S. houses prices in select cities were up 4.4% in the second quarter. The entire time period included the $8,000 home-buyer tax credit. According to other sources, an increase of $8,000 in the median average U.S. home price would be about 4.4%. So what happened was the government gave homebuyers $8,000 and they then spent an average of $8,000 more to buy the same home they would have without the tax credit. This obviously didn't make real estate any more affordable, all it did was create the illusion that this was the case. It wasn't just naive and gullible homebuyers that fell for this scam either. One prominent mainstream economist commented on the data, "Even with concerns about near term developments, we recognize that the housing market is in better shape than this time last year." Home sellers of course got an extra $8,000 courtesy of the U.S. taxpayer (if you check your bank account and notice $8,000 missing, this is where the money went).

So how is it possible that stocks are having a massive rally on the above news items?  The state of the economy is not the short-term reason stocks rally or sell off. Stocks rally on liquidity. And it is obvious that central banks are injecting huge amounts of liquidity into the global financial system at the moment. The liquidity free lunch doesn't last for a long time however. It has to be paid for periodically with withdrawals of liquidity to prevent a huge inflation spike. This causes lots of volatility with stocks experiencing big price rises followed by sharp drops. We saw a lot of this in the second half of 2008 when the market went up and down like a yo-yo on crack cocaine. While this resulted in an eventual market collapse two-years ago, this is not likely to deter the Fed from continuing to play the same dangerous game again until the November 2nd election. Investors should brace themselves for a rocky market during the next two months.


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.

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

Subprime Housing Leads to Subprime Financial Institutions

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 housing reports released in October 2007 which indicated the state of the market in September were even more dismal than those of the prior month. Nationally, foreclosures had doubled year over year and they had gone up as much as 500% to a 1000% in the worst hit bubble areas of the housing market. Existing Home Sales were down 23% nationally. Although also down substantially, New Home Sales were nevertheless reported as increasing (huh?).

The September 2007 New Home Sales report was a classic example of how the financial media frequently reports bad news as good and hopes people only read the headlines and not the fine print. The New Home Sales report originally indicated that there had been 795,000 houses sold in August. The report then indicated 770,000 houses sold in September. This drop of 25,000 was heralded by the media as a increase of 4.8%. This happened because the sales figures for August were revised downward to 735,000 (by almost 8%, an incredible error for a statistical report) and the September figure was above this number, so this indicated that sales were going up! The first thought of any rational person should of course have been, 'if the numbers for August were actually much lower, why shouldn't the ones for September be much lower as well?' Even a casual look inside the September report lent substantial support that this was indeed the case. Sales in the West, probably the worst hit housing area in the U.S., were supposedly up 38% - a completely absurd number and an indication that the September numbers were being overstated just as the August numbers had been.

Despite the complete devastation in housing sales., median house prices were reported up 2.5%. The statistical tricks that led to this impossible outcome were discussed previously in this blog in the posting, "Housing Market Collapses, but the Statistics Hold Up".

House sales were falling off a cliff because mortgage money was disappearing. By October 2007, 183 mortgage lenders had already closed their doors since the previous December. One that didn't was Countrywide, the largest mortgage lender in the United States and therefore presumably too big to fail. What kept Countrywide afloat was a $2 billion capital infusion in August from Bank of America. Barron's reported that there were rumors that this bailout had been secretly arranged by the U.S. federal government. If so, it would only be the first of many bailouts that the Feds would have to arrange to prop up failing American financial institutions. Shortly thereafter, one of the major British mortgage lenders, Northern Rock, experienced a run on the bank - the first in England since the 19th century. Northern Rock had been known for it 125% mortgages and when word got out that it needed an emergency loan from the Bank of England, depositors queued up for blocks desperate to get their money out. While the Bank of England directly provided capital to keep Northern Rock going, this approach would prove to be no more successful than the more circumspect American one. Both Countrywide and Northern Rock would barely survive into 2008.

Next: What Banks and Enron Had Common

Daryl Montgomery
Organizer, New York Investing meetup

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

All The Glitters Isn't Gold, It's Also Silver

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.

Commodities are priced in U.S. dollars. When the Fed began its rate cutting campaign in earnest on September 18, 2007, it became inevitable that the U.S. dollar would fall. While the value of the dollar goes up and down all the time, this time the drop would have serious consequences. The trade-weighted dollar was hoovering just above all time lows in August and would fall through multi-decade support by the end of September to reach levels never before seen. Since the dollar was hitting all time lows and commodities were priced in dollars, everything else being equal, it was reasonable to assume many commodities would subsequently be hitting all time highs. This is exactly what happened to commodities that were consumer necessities or that were currency substitutes.

The biggest price rises took place in food commodities. Wheat had already started rallying in mid-2007. Once it became clear that the Fed was beginning a new easing policy in mid August, the price of wheat on the charts started to move straight up. By the end of September its price would almost be double what it had been only three months before. Major rallies in soybeans, corn, and rice also occurred taking them to multi-decade or all time highs as well. These rallies in turn showed up in rising global food prices, up 20% for 2007 and 75% since the lows of 2000. While U.S. consumers were paying more at the supermarket just like consumers elsewhere, the Federal Reserve continued it long term policy of generally ignoring rising food (and energy) prices because they were 'volatile'. While food prices can indeed be volatile, a report by Bloomberg News found there had not been a year over year drop in food prices in the United States for at least 40 years.

Like food, energy prices were also not a part of core inflation, so the Fed tried its best to ignore them as well. U.S. consumers unfortunately did not have this option. By the end of September, oil had broken through it's all time high set in mid-2006 and headed toward a $100 a barrel, which it reached around the turn of the year. While this was a new nominal high, it was approximately only the 1980 high adjusted for (official) inflation. Interestingly, the price of gasoline at the pump did not break its 2005 post-Katrina high, when oil was only $70 a barrel, until March of 2008.

Finally, the money-substitute commodities, gold and silver, also had significant rallies. Gold broke its April 2006 high before the end of September, while silver lagged by several weeks. Gold would break its January 1980 nominal closing spot-price high in November and the all-time intraday high of $875 an ounce somewhat thereafter. Gold would reach 1000 in March 2008. Unlike oil, gold was not even near its (official) inflation-adjusted high of approximately $2200 an ounce. While percentage wise, Silver had an even bigger rally than gold, reaching $21 an ounce in March of 2008. This was not even near its approximately $50 nominal price high in January 1980, not to mention its over $130 inflation adjusted high.

For more on this topic, please see notes for the talks, "Thinking Outside the Bucks - Inflationary Investing" and "How to Profit from the Falling Dollar" at: http://invesing.meetup.com/21/files
and our video, "Commodity Investing - How to Profit From the Falling Dollar" at:
http://www.youtube.com/watch?v=IG5zApWcOk0.

Next: Australian and Canadian - the Only Dollars Worth Holding

Daryl Montgomery
Organizer, New York Investing meetup

Please see our web site for more about our group: http://investing.meetup.com/21.

Housing Market Collapses, but the Statistics Hold Up

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 August housing sales figures released in September 2007 indicated that housing sales had fallen off a cliff in most of the areas of the U.S. that had been at the center of irresponsible mortgage lending. Los Angeles county California lead the way with a 50% decline in houses sales from the previous year. Orlando, Florida and Phoenix, Arizona were not far behind with a 40% drop. House sales in Las Vegas, Nevada were 37% lower than a year before. The collapse in the U.S. housing market would be led by these four housing bubble states: Arizona, California, Florida and Nevada plus two others: Michigan and Ohio, which were suffering economic hardship from declines in U.S. manufacturing.

One of the most fundamental tenants of economics is that price is determined by supply and demand. When demand drops or supply rises, prices should fall. When demand drops a lot, prices usually fall a lot. While there were anecdotal reports of housing prices falling 50% or more at bank auctions in various parts of the country, the overall statistics indicated only modest drops in housing prices in most communities, and even small increases in others. How was this possible, assuming there was no fraudulent manipulation of the numbers (something that should always be considered when two and two doesn't add up to four)? As with many of the U.S. government reports, statistical sleight of hand by the number crunchers was at work .

When housing prices were being compared year over year, there were in reality two different markets being measured. In other words, the comparison was being made between apples and oranges and was therefore effectively meaningless. When housing sales fall dramatically, they don't fall evenly across the economic spectrum. People who buy more expensive homes are more likely to be able to get a mortgage and the high-end of the housing market holds up. People at the lower end get shut out and sales for cheaper homes fall much more than those of expensive homes. The most recent housing market statistics will have a lot more high-priced homes in them proportionately than the previous years statistics and this skews the average and median prices up. It is in fact easy to come up with examples where every house price in a market falls by a significant amount and yet the average and median house price goes up! This was exactly what was happening in the summer and fall of 2007. While the plummeting housing sales numbers were accurate, the officially reported prices in no way reflected actual pricing trends in the market.

Next: Bubble, Bubble, Toil and Trouble

Daryl Montgomery,
Organizer, New York Investing meetup

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