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.

Debt Crisis Back in Greece, U.S.Has Borrowing Problems Too

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 markets are telling us that the Greek debt crisis, which has supposedly been solved numerous times, is still with us and getting worse. Interest rates on Credit Default Swaps on Greek bonds hit a record 495 basis points on April 21st. While Greece is at the end stage of a sovereign debt problem, the U.S. is at the beginning. Some U.S. corporate bonds have recently had lower interest rates than equivalent treasuries indicating that the market believes those companies are in a better financial position than the U.S. government.

The problems that have arisen in Greece are those that occur when a government borrows too much money relative to its GDP. Eventually the interest payments on the debt become overwhelming and default becomes inevitable. Default can take place in two ways however. It can be a simple failure to make interest payments on bonds or it can result from a major inflation of a currency. With inflation borrowers get the nominal amount of money due them, but that money doesn't have the same purchasing power. Since Greece is part of a currency union and can't print its own money, it can only default by not paying off its bonds. The U.S. on the other hand, can print all the money it wants to so it can only default through inflation.

Up to now Greece has had no problem borrowing money. The problem is that the interest rate it has had to pay in the last several months is so high that it undoes the effect of budget cutting measures taken to get its fiscal house in order. The recent EU and IMF proposed 45 billion euro aid package makes funds available for Greece, but didn't do so in a manner that would lower Greece's interest payments. Unless Greece gets access to large amounts of credit at well below market rates, there is no possibility of it avoiding default. Even if it does, sovereign default in all likelihood will simply be delayed.

So what are the implications for the U.S.? The U.S. is not much more fiscally responsible than Greece is, but is does have the reserve currency of the world and a very big printing press. The U.S. can get away will a lot more than Greece does before an irreversible credit disaster begins. In the last few years, the national debt in the U.S. has been skyrocketing because of the Credit Crisis and the recession that followed. It was  estimated in the proposed 2010 federal budget that that the U.S. will owe slightly more than  $14 trillion by the end of the fiscal year. Debt service was listed as $164 billion.

Based on the budget figures, the U.S. is paying approximately a 1.2% interest rate on its national debt. Could interest rates get any lower than that? Not likely, especially considering that Federal Reserve has kept short term rates around zero. If interest rates return to a more normal, but still relatively low four or five percent, debt service would rise to around $600 billion, without any further increases in borrowing. U.S. federal debt is continually increasing by large amounts however. If 1970s interest rates return, debt service would eventually rise to around $2.4 trillion for the current debt, which is approximately the total estimated revenue for the federal government in 2010. Long before that happened, money printing would be a major source of revenue needed to run government operations on a day to day basis - and hyperinflation would become unavoidable.

The market has been sending hints lately that it is not happy with the U.S. fiscal situation. Interest rates on corporate bonds from Berkshire Hathaway (BRKB), Proctor and Gamble (PG), Johnson and Johnson (JNJ), Lowe's (L) and Abbot Laboratories (ABT) have been lower than equivalent U.S. treasuries at some point in the last few months. Corporate interest rates should never be lower than government rates, at least in theory, because corporations are supposed to be riskier than a government. The market is telling us that it sees things the other way around. Investors should consider this a long-term warning.

The euro (FXE) of course sold off on the latest developments in Greece, but did not make a new low. The market may therefore have already priced in the full impact, at least for the moment, of debt problems in the eurozone. There are more potential problems there in Portugal, Ireland, Spain and Italy however. Whether the market will continue to see those as more significant than the debt problems in the U.S. is still an unanswered question.

Disclosure: Not relevant.

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

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

Five Reasons That Gold is Going to Rise: A Response to Nouriel Roubini

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. Senate passed a $1.1 trillion spending bill this Sunday, December 13th. Five other appropriation bills for fiscal year 2010 were previously passed earlier this year and one more still remains, a $626 defense appropriation. The defense appropriation bill will contain a clause to raise the national debt ceiling. The national debt ceiling is currently $12.1 trillion and the U.S. is tapped out once again. As of now, it looks like congress will raise the debt ceiling by $1.8 trillion to $13.9 trillion. The last increase was only $0.8 trillion, but that would only last months at this point. Even with a $1.8 trillion increase, the U.S. congress will be fortunate if it doesn't have to raise the ceiling again before 2010 runs out.

The increase in the U.S. national debt is now so great that the monthly rise can be as high as the entire debt load in the 1960s (before the U.S. went off the gold standard). The U.S. is also by no means unique. The spending spree taking place is global and includes all major economies. In the midst of this spending and money printing orgy, there are a number of economists who claim it will not hurt the U.S. dollar and will be a negative for gold. In order to come to this conclusion, they have had to ignore a greater than 2000 year history that indicates otherwise. The Romans engaged in long-term debasement of their coinage and paid for it with out of control inflation. Since then, the use of paper money has made currency debasement much easier and quicker. Nowadays, central banks can create any amount of currency they want through a simple computer entry. What they can't create out of thin air is actual money.

History is littered with fiat currencies (currencies not backed by hard assets) that have failed. There is no fiat currency that has survived over time. There is also no case of currency creation that significantly exceeds economic growth that hasn't lead to inflation. This idea is by no means new. Copernicus the famous astronomer was one of the first to articulate it in the 1500s. It is based on simple arithmetic. If you double the amount of currency in circulation, but the economy doesn't change in size, goods and services will approximately double in price. This does not happen instantly however. There is a delay from when a government increases money supply and when consumer prices rise. In the 1970s, money supply in the U.S. increased by the largest amount in 1971, inflation peaked 9 years later, as did the price of gold. So don't expect to see the full impact of today's monetary policy actions until late in the next decade.

Economist Nouriel Roubini has just released an article on why the price of gold will fall. It should be kept in mind that Professor Roubini is an economist and not a professional investor. Unlike myself and a number of other bloggers, he does not publish when he buys and sells assets, but tends to make broad sweeping generalized comments. This approach is rarely helpful to investors who are trying to make money in the market and usually works to accomplish the opposite. Let's look at Roubini's five reasons gold will fall and deal with them point by point:

Point 1: The U.S. dollar carry trade will unravel.

Indeed this will happen eventually. I heard similar arguments made about the Japanese yen carry trade unraveling for about 15 years. It was finally replaced by the U.S. dollar carry trade. So if you are investing now based on how the world might look in the 2020s, pay attention to this point and just hope you don't go broke while waiting.

Point 2: Central banks will have to exit their quantitative easing strategies and jettison their effectively zero rate interest rate policies.

For governments to keep spending, they will have to continue to print money. National debts are now so huge that a significant increase in interest rates will cause the interest payments on the debt to skyrocket. Even assuming Credit Crisis bailouts and related economic damage no longer necessitate massive government budget deficits after a few more years, rising payments for government retirement and health programs will. There will be no respite. If unfunded liabilities for social security and medicaid are taking into account (which is required when using GAAP - generally accepted accounting principals), the U.S national debt is not $12 trillion, but somewhere between $60 trillion and $100 trillion. The official GDP is approximately $14 trillion.

As for interest rates, real interest rates are not zero, they are negative. Only highly massaged government statistics which understate the inflation rate make it look otherwise.

Point 3: Global risk aversion indicates that the U.S. dollar will rise and drive down the price of gold in dollar terms.

There are a number of problems with this assertion. First of all there are periods when both the U.S. dollar and gold rise, as happened at the end of the 1970s. Secondly, there is an implication that gold will be rising in non-dollar currencies (gold has been hitting new all-time highs in dollars, pounds, euros and Swiss francs lately). Thirdly, the statement essentially means that gold will not go straight up in price and the U.S. dollar will not go straight down, like every other major asset in history. So what else is new?

Point 4: The carry trade and the wall of liquidity from central banks is causing a global asset bubble and all bubbles eventually crash.

Indeed we are in the early stages of an asset bubble, with early being the operative word. People said the same things about stocks for years throughout the 1990s and eventually the bubble did peak. You of course make the most money by investing in bubbles. How can you tell when they are ending? This happens when there is a meteoric rise after many years of strong rallying. We know the history (or at least some of us do) of how the 1970s gold bubble ended. Gold went up 400% the last year. Silver rose almost a 1000%. Double digit annual price rises like we are currently witnessing are simply ordinary bull markets. While there may be a peak in gold prices in ten years, we are not anywhere near that point yet.

Point 5: The price of gold could be pushed up if there are expectations that central banks will monetize their countries' debts, but this increases investors risk aversion and will lead them to sell gold.

There is no way that most major economies can pay off their government debts. Monetizing them by creating inflation is the only alternative that will avoid default. One only needs to employ elementary school arithmetic to figure this out. The price of gold goes up with inflation. Yet Roubini contends the investor risk aversion will trump this factor. This could also be restated as theory will be more important than reality in the markets - the essence of all of Roubini's arguments in a nutshell. Investors and traders know better since they have to put real money on the line every day.

Roubini's current missive on gold prices is not a new view. Only a couple of months ago he made some highly negative comments on gold just as it started to rally 20%. He was wrong then, but being wrong in the economics profession has never damaged any one's career. Roubini is not unique in his views, but is one of a group of economic alchemists who repeatedly tell the public that government can create more and more of a currency and this is going to lead to an increase in the currencies value (also stated as deflation). In other words, actual money and value can be created out of thin air and by implication there is a free lunch. Considering the amount of inflation that history tells us is about to take place, there had better be a free lunch because few people will be able to pay for the real one.

Disclosure: Long gold, silver.

NEXT:

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

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

The Common Roots of Hyperinflation

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

Rating agency S&P lowered its outlook for Spanish government debt on December 9th. Fitch lowered its long-term debt rating for Greece to BBB+ from A- the day before. In the eurozone, there are concerns about Portugal also being in trouble, although Portugal's debt to GDP ratio is no worse than the United States and a case can be made that the U.S. is actually in much worse shape - the U.S. has a large money printing press however and Portugal does not. No country can compare to Japan however with its debt to GDP ratio currently over 200%. An examination of the CIA Factbook figures for 2008 estimated that only Zimbabwe had a worse debt to GDP ratio than Japan's. Zimbabwe also had the second largest hyperinflation in world history.

The roots of all hyperinflations are governments not being able to fund their operations. Government's first borrow money to do so and this can go on for years or even many decades (the more powerful the government, the longer it can live off of borrowed money). At some point, the credit either starts to run out or the expenditures get so high that the amount that can be borrowed is no longer enough. It is then that governments resort to printing money (not literally done in advanced economies where money is simply created by pressing the enter button on a computer) and this devalues the currency. The devaluation is the result of simple arithmetic. Currency increasing at a faster rate than the size of the economy means each unit of currency is worth less and it takes more money to buy any given good or service than it would have otherwise. The price rises that result are consumer inflation. Many economists do not use this obvious definition of inflation, which is one reason why their inflation predictions are frequently highly inaccurate. Central banks particularly don't like it because it would prevent them from engaging in politically popular, but potentially disastrous monetary policy.

The Credit Crisis has led to a lot of money printing (frequently referred to as quantitative easing) globally and this is taking place after decades of increased borrowing in most countries. While money printing will lead to inflation, it only leads to hyperinflation when it spirals out of control. The preconditions for this are that borrowing power has been maxed out (which is now the case for many countries, but was not true in the 1970s and this is why it was possible to tame inflation back then) and it no longer becomes politically possible to match government expenditures with revenues. In the modern era, this is always a problem during wars since no state is capable of raising enough money through taxes to pay for any major or prolonged military effort (the U.S. accounts for over 40% of global military expenditures by the way). Contemporary democracies also get caught between the need for large outlays for social expenditures and the resistance of rich individuals and corporations to paying the taxes necessary for funding them, so they compromise and give both sides what they want. This problem is by no means brand new. It is essentially what lead to the hyperinflation in Germany in the early 1920s.

Once the preconditions for hyperinflation exist, a major economic shock can then become the precipitating incident. Governments will always assume that the problem is temporary and the economy can be righted quickly through a little money printing. In deep economic shocks like that depression in the 1930s and the Japanese banking crisis in the 1990s, and the Credit Crisis today, this is not the case. The problem will take at least a decade and possibly multiple decades to solve. The possibility for long-term money printing then exists (the U.S. did not engage in this in the 1930s). Zero or close to zero interest rates will mask the damage that is being created. This is what has allowed Japan's government finances to spiral out of control (combined with a huge pool of personal savings of the Japanese people that it could tap into) and is now enabling the U.S. and UK to do the same. At some point though interest rates have to rise and when they do, interest payments on the national debt can equal or exceed the government's tax receipts. The game is up long before that occurs however with a hyperinflationary spiral becoming inevitable. For this reason, it is now no longer possible to solve a future inflationary problem by raising interest rates to high levels as was done in the U.S. at the end of the 1970s. This approach now would be disastrous.

The U.S national debt increased by a $1 trillion in 2008 and $1.9 trillion in 2009. The damaged economy and the after effects of the Credit Crisis are likely to keep the increase elevated for many more years. After that, increased outlays from Social Security and Medicare caused by the Baby Boomers retiring will kick in, so there will be no respite. At some point the whole scheme will fall apart. When interest rates rise well off the zero level, this will be the tipping point that means that an inflationary spiral has started.

Disclosure: Not applicable.

NEXT: Short Bonds When Retail Sales Improve

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


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

More Government Stimulus and More Debt

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.

Our Video Related to this Blog:

The future of U.S. fiscal policy can be seen in Japan today. The Japanese government announced on December 8th a new $81 billion stimulus package to prop up their sagging economy. This is only the latest of a long string of stimulus measures that have been enacted since the early 1990s. All of them worked for only a short time and then had to be followed up by new stimulus measures. The same day, President Obama was announcing a new job creating stimulus package for the U.S., even though the U.S. economy is supposedly already in recovery and the December jobs report indicated an improved employment picture. Investors should keep in mind that action speaks louder than words (and questionable statistics).

The latest Japanese stimulus package will be used to prop up regional economies, for public works projects (a perennial favorite of their failed stimulus packages for more than 15 years), for energy efficiency initiatives and loan guarantees for small businesses. In contrast, the Obama plan will focus on helping small businesses, energy efficiency initiatives, and public works projects involving transportation infrastructure. Looks like a copy of the Japanese approach to me. The idea is to pay for it with $200 billion of unused TARP funds. The only impediment to that is that the original bill specified that this money should be used for reducing the U.S. budget deficit. The Obama administration clearly has no intention of doing this and the implications for an already out of control budget deficit and spiraling U.S. national debt are clear.

The Japanese were once fiscally responsible, but that ended long ago with the failure of their banking system in the early 1990s. The picture in the U.S. for 2007 and 2008 is quite similar - in regard to the banking failures that is, not the fiscal responsibility. Despite an almost endless succession of stimulus plans, the economy has fallen into recession over and over again. This should be thought of as the modern Keynesian version of a depression. The cost of all the government programs has been tremendous. The ratio of public debt to GDP in Japan is estimated by the IMF (International Monetary Fund) to be 218% this year. This is the highest by far of the top economies. It is expected to rise to 246% by 2014. The Japanese budget deficit this year is expected to exceed tax revenue. They have only managed to get away with this by keeping interest rates close to zero for more than a decade. Time is running out for them however. They are already engaging in money printing to pay for government operations and this will eventually turn their long running deflation into a very serious inflation problem.

The U.S. which is at the earlier end of the 'banking crisis with never ending bailouts' curve currently has a public debt to GDP ratio that is supposedly only 83% (if you adjusted the official government GDP numbers to something more realistic, it would be 110% or more). The budget deficit in fiscal 2009 was $1.42 trillion - and that was considered good because it was less than expected. The national debt increased by $1.9 trillion however. Intergovernmental transfers and off-balance sheet items account for the discrepancy. The U.S. national debt is now over $12 trillion and rising rapidly. Keeping short-term interest rates close to zero allows this to continue since 44% of the debt is funded with bills of one-year duration or less. An examination of the 2010 U.S. federal budgets shows that 40% of the funding is expected to come from borrowing. Money printing would be included in the borrowing category.

There are worries in the Eurozone about Portugal because it expected to have a public debt to GDP ratio of 90% by 2011. The official U.S. numbers could be just as bad (the actual ones much worse). As the largest economy in the world and the issuer of the world's reserve currency, the U.S. has a lot more leeway in fiscal irresponsibility. The limits of that leeway will probably be revealed in the next few years in Japan.

Disclosure: Not relevant.

NEXT: Is the Gold Correction Over

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.

Bond Auction Puts Focus On Interest Rates

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.

Our Video Related to this Blog:

The U.S. is auctioning off $81 billion in government debt this week. This is just a small part of the never ending supply needed to fund trillion dollar budget deficits as far as the eye can see. The Fed officially stopped its quantitative easing program to buy treasuries on October 31st, so it will be interesting to see what happens to interest rates in the next two or three months. The most vulnerable part of the interest rate curve has always been the 30-year. Foreign central banks have moved their purchases to shorter dated paper and the Fed itself concentrated on buying in the 7 to 10 year range. If the Fed restarts its quantitative easing program (and this is a possibility) it will resume purchases of bonds with those maturities. The 30-year is orphaned without major supporters no matter what happens.

This weeks auction includes $25 billion in 10-years on Tuesday and $16 billion on Thursday. Bonds prices are rallying today (and interest rates going down) even though supply is increasing. This defies free-market behavior and should make it clear that the bond market is regularly highly manipulated in the short term. The Fed notched the usual manipulation up much higher this year however. Figures from the second quarter indicated the Fed bought 48% of newly issued government debt ... and it did so with newly printed money. While the mainstream media has constantly reported that demand for U.S. bonds has remained strong this year, it almost always fails to mention that it is because the Fed is making a substantial percentage of the purchases.

Rising interest rates will be one of the last legs of the inflation trade to kick in because the government has a lot of control over them. The U.S. 30-year interest rate has been in a 27 year downtrend with a yield peak of just over 15% in September 1981 and a bottom last December at just over 2.5%. A rise in interest rates to around 4.8% will break a downtrend line from 1987 (when Alan Greenspan became Fed chair and easy money became the norm for U.S. monetary policy). When 30-year rates can break this level and stay above it, a multi-year rise in interest rates will begin.

In the short term the daily interest rate charts are bullish for the 30-year ($tyx or ^tyx). The 50-day moving average has been trading above the 200-day since last May. Both the 50-day and 200-day are moving up. After the rally from last December to this June when the 30-year rate doubled, the yield fell back to and bounced off the 200-day moving average. So far, this looks like it was the end of the retracement and the perfect buy point. The short-term uptrend is still in place and will remain so as long as the 200-day moving average keeps going up. When it occurs, a decisive break of the 4.8% yield could lead rates up to 6.0%. There are two leveraged ETFs that traders and investors can use to go long 30-year interest rates (the same as shorting the bonds), TBT and TMV. TBT represents a 2X short of 20 to 30-year treasuries and TMV a 3X short of 30-years. Both of these can be highly volatile.

Disclosure: Currently long TBT and TMV.

NEXT: Gold Rumbles as Dollar Crumbles

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 Longer Term U.S. Interest Rate Picture

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.

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There is a debate going on in Wall Street about whether or not interest rates will be rising sharply in the next year or two. As usual the mainstream media is obscuring the most important facts that the individual investor needs to make an accurate determination. Articles frequently wave the deflation straw man argument and cite 'robust demand' for U.S. bonds. They usually don't mention that the robust demand is coming from the U.S. Fed and has only been made possible through massive printing of new money. The picture is quite different once these significant extra pieces of information are added to the puzzle.

According to a report from Barclay's, the U.S. has sold $1.517 trillion in debt securities prior to September of this year compared to $585 billion up to the same point in 2008. Barclay's estimated that only $50 billion a month of new supply was purchased in the market, which would be $400 billion in total up to the end of August. That would leave over $500 billion in new debt having been purchased directly by the Fed or approximately 56% - yes most of the new U.S. government debt issued in 2009 is being purchased by the Federal Reserve... and a lot more debt issuance is coming. Barclay's estimates that total U.S. government debt issuance will be $2.1 trillion this year versus $0.892 trillion in 2008. Estimates for 2010 are even higher at $2.5 trillion.

The Fed is supposed to stop its purchases of treasuries by the end of October. Only $300 billion has officially been set aside for this program and they have spent most of that budget. If they do indeed do this, U.S. interest rates will skyrocket overnight. So, don't hold your breath. Somehow this program will be extended perhaps under another guise if not directly. The Fed announced at its last meeting that it was extending its program to purchase agency debt (mostly Fannie Mae and Freddie Mac) to the end of the first quarter in 2010 (it was originally slated to terminate at the end of this year).

While figures are published about who holds U.S. debt and how much each party holds, these are updated at different points in time and how recent or accurate they are is open to question. The biggest holder of U.S. debt by far is the U.S. Fed. As of the end of March of this year, the Fed owned almost $4.9 trillion worth of federal debt (you can think of this number as an approximation of the amount of excess money that has been printed over time). The total U.S. National Debt is currently $11.8 trillion. State and Local governments are the 5th largest holders with a total of about $520 billion of U.S. government paper (can you see a need for them to be bailed out?). The fastest growing category this year has been the 7th biggest one, "Other Investors". Between just April and August of this year, holdings in this category went up over 50%. This includes GSEs (like Fannie Mae and Freddie Mac) and broker-dealers, who sell the bonds. This category is a great place for 'indirect' Fed purchases to take place and to remain hidden. There are also researchers who claim the Fed has been hiding purchases through off-shore money havens, such as the Caribbean Islands and Luxembourg, which are the 10th and 15th biggest holders respectively of U.S. debt.

As long as the Federal Reserve continues to purchase a huge percentage of U.S. government debt, interest rates can remain low. While supply of debt has increased tremendously, the Fed has increased demand for the debt by an even greater amount by printing a lot of new money and this holds price up and interest rates down. Excess money printing leads to inflation .. and there are no exceptions to this ever. Creating artificially low interest rates also feeds inflation. Inflation eventually leads to higher interest rates. The key determinate of when this is going to take place now is the amount of money printing that the Fed is engaging in. When this goes down (proportionately), interest rates will go up.

NEXT: Unwinding the Fantasy Trade

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.

Oil Up; Retail, Economy and Deficit Down

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.

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Oil had a huge rally yesterday, going up more than 4% on a bullish storage report. It is still over $72 this morning. The oil/natural gas ratio is over 20 and is at the same high that it was in 1990 when it last peaked. There is about a 20 year cycle to this ratio and it should be falling for the next 10 years or so. We shall see. In the shorter term the natural gas storage report is out at 10:30 this morning (New York time). Natural gas can be bought either with the ETF UNG (which is being harassed by the regulatory authorities) or with the ETN GAZ. Natural gas futures are in extreme contango.

The stock market is trying to maintain its rally, which is supposedly dependent on the coming economic recovery. Sears Holdings, which released its Q2 earnings this morning, is going to be a drag on the rally today. The company lost 17 cents last quarter. Analysts expected a gain of 35 cents. Revenue fell 10.3% and was also below expectations. The company's credit rating, which was already in junk territory, was lowered further today by Moody's. Although the financial picture of this major retailer is nothing short of disastrous, the stock has risen 80% this year as of yesterday. At least it is down this morning. This company typifies the market rally - a huge rise in the midst of really bad fundamentals. Who would buy under such circumstances and why?

Weekly job claims also rose this morning to 576,000. This is still deep in recession territory. The rule of thumb for years has been weekly claims at or above 400,000 indicates the U.S. economy is in recession. A healthy economy has weekly claims around 300,000. The market had a good rally a couple of weeks ago when claims fell to 550,000. The "better numbers" were heralded in the press and claimed to be an indication of the waning recession. The press should have waited until claims fall and stay below 400,000 before publishing that story (but that would be responsible reporting, so of course that didn't happen). The press also never mentions that a large percentage of the U.S. workforce isn't eligible to collect unemployment, so when these people become unemployed they don't show up in the weekly claims figures.

The "good news" out this morning is that the Obama administration is predicting the federal budget deficit will be only $1.58 trillion this year. This is still almost 4 times bigger than the previous record budget deficit. Some contingency bailout funds for the big banks won't have to be spent (at least by September 30th of this year). Before you trust any numbers from the White House, consider that their argument for the current stimulus package was it would keep the unemployment rate at 8% or lower. Without it they claimed that unemployment could rise as high as 9%! So the stimulus package was passed early this year and so far unemployment has gotten as high as 9.5% - and that is with a lot of manipulation of the numbers to make them look better. You should assume that all the other numbers coming from the administration are just as reliable.

NEXT: Natural Gas Deconstructed

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 Simple Arithmetic of Hyperinflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. 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.

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The U.S. government inflation figures were out last week. According to official statistics, about as reliable as a pronouncement from Pinocchio, CPI fell 1.3% year over year. This was the biggest drop in 59 years. Core CPI was up 1.8% year over year, so no drop there. Core doesn't include energy and food prices, so the fall in oil prices from last year doesn't fully show up in it. The PPI figures had an even bigger annual drop. Mainstream news articles were filled with remarks about how great it is that the Federal Reserve has lowered interest rates to zero and flooded the economy with money to save us from deflation. I have no doubt that they will be very successful in this endeavor.

While there are still a lot of deflationists out there, I think even they could all agree that if a government has so much debt that its tax receipts could only cover interest payments on that debt, massive inflation would necessarily follow. This would happen because the government would need to constantly print a lot of new money to cover its regular expenses. Few outside sources would be willing to lend to that government. While this is an obvious worst case scenario, the inevitably of hyperinflation takes place somewhat before this situation is reached. Finding that exact inflection point depends on a lot of complicated mathematics involving a large number of factors and is subject to significant interpretation. For that reason, it is not possible to say that the U.S. has already reached it.

Examining the national budget figures for 2009, there is now $3.9 trillion in projected spending. Government receipts (mostly taxes) look like they will come in at $2.1 trillion. Only 53% of expenditures are covered. It is the decreasing coverage of government expenditures by tax receipts that led to the hyperinflation in Weimar Germany. The government had to print more and more money to keep itself running. Five years before their hyperinflation peaked, only 69% of the national budget was covered by taxes (yes, 16% more than is currently the case in the U.S.). Falling below 50% coverage seemed to have been the point of no return for the Weimar government.

What about interest payments on the national debt? In 2008, they were only $412 billion. This was during a time of multi-decade low interest rates that were close to zero for short term bills. Interest rates can't go any lower, but have a lot of room to go up. Everything else being equal, if we went back to the interest rates at the end of the 1970s, interest payments on the current debt would use up all tax receipts. Everything else will not be equal however. Every year the national debt is going to increase substantially and the interest rate needed to use up all tax receipts becomes lower and lower with time. Tax receipts need to rise enough to compensate for that. However, this would indicate a rapidly growing economy, that could easily raise interest rates more than enough to overwhelm the benefits of more taxes.

How can the U.S. government deal with this situation other than cutting the budget drastically (don't hold your breath for that one)? Since it is increasing the supply of government debt rapidly, it needs to increase demand even faster for its bonds. But foreign lenders are backing off. So the only solution is to print even more money, so it can buy even more of its own debt. Now that's going to help keep inflation under control!

NEXT: Stock Market Turns Ugly

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.

Dollar Weakens; S&P's British Outlook, TED Back From Dead

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.

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Minutes for the Federal Reserves April 28-29th meeting were released yesterday and they revealed that the Fed thought that more purchases of long-term debt might be necessary to spur the economy into recovery (and uncontrolled inflation... but they left that part out). More quantitative easing would require the 'printing' of additional currency and debase the dollar even further. Not surprisingly the dollar fell on the news and hit a 7-month low of 80.002 (if it breaks key support of 79, watch out below). While the condition of the U.S. government's finances are in worse shape than Britain's, S&P revised Britain's credit rating outlook to negative this morning. While the pound fell for a short time, it is way above its lows against the dollar. Even though the central banks are flooding the world with more fiat money, the TED spread, a measure of stability in the global financial system, has returned to normal levels - this is a necessary, but not sufficient condition for recovery.

The need for the U.S. to print more money well into the future could easily be determined by anyone with knowledge of elementary arithmetic. Nevertheless, the market is constantly surprised such a thing will be necessary. Bonds and the dollar should sell off on this news, but stocks and oil are getting hit today as well. Oil, which has to be purchased in U.S. dollars, should automatically go up if the dollar falls or if there is news about increasing inflation. NYMEX crude closed at $62.04 yesterday and is still above its breakout point of 60. Gold was flat this morning and silver down slightly. They should be zooming.

Although S&P changed Britain's credit outlook to negative, this is not as bad as being on credit watch. S&P reaffirmed Britain's triple A credit (they also rated a large number of subprime mortgage bonds triple A, so take that into account when considering the accuracy of this rating). S&P is worried that Britain's government debt will rise to 100% of GDP by 2013. If the U.S. doesn't beat Britain to this milestone, we will indeed be lucky. If there was an accurate measure of both out national debt (it's understated) and our GDP (it's overstated), we might indeed already be there. Perhaps S&P will be making an announcement on this matter soon?

The TED spread was mentioned frequently in this blog last fall. When the financial system is in stress it zooms upwards. Its long term average is around 50 basis points. It went over 450 last October, substantially exceeding its peak during the 1987 market meltdown. It was 48 this morning. This indicates that the global banking system has returned to normal interbank operations. This was an important goal of central bank policy that they have been successful in accomplishing it. Now that stabilizing the banking system has been achieved, the possibility of economic recovery exists.

NEXT: A Golden Opportunity with a Silver Lining

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.

Budget Deficit Screams Inflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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The Obama administration released revised estimates for the 2009 budget deficit (the difference between the yearly income and spending of the federal government) today and it now looks like it will come in at $1.75 trillion. The original estimate for the 2009 deficit made by the Bush administration in February 2008 was $407 billion. Yes, the current estimate is now more than four times the original one... and we're not done yet. For a perspective of just how huge this number is, the largest U.S. budget deficit so far according to official figures was in 2004 and it was $413 billion. The current estimate represents over 12% of GDP (the overstated official number), approximately equal to the percentage in the World War II year 1942. As bad as a$1.75 trillion budget deficit is you can assume it is a gross underestimate of the actual number.

How the original 2009 budget deficit figure was obtained is not immediately clear. The Congressional Budget office estimated a deficit of $219 billion, which did not include the $168 billion stimulus plan passed early in the year. Adding those two numbers together, you would get $387 billion. Spending for the Iraq war was also not included in the number. If you use the current absurdly low estimate of only $170 billion that would bring the figure to $557 billion, not $407 billion (much Iraq war spending seems to somehow be kept magically out the budget). I frequently run into arithmetic problems such as these when looking at government reports. Nothing adds up correctly and the final number looks much better than what you should be getting from the component parts.

There were a few voices that were questioning the deficit numbers back in early 2008. Bill Gross from Pimpco warned that the budget deficit could rise to 5% of GDP and be as high as 600, 700, or even 800 billion dollars. We at the New York Investing meetup predicted that the first trillion dollar deficit would take place during the Bush administration. While this was considered an outrageous claim at that time, it was actually too low. As with much of the Credit Crisis, things have turned out to be even worse than the most dire outlook.

No one really knows what the actual budget deficit or national debt (the accumulated debt over time) is. Many items don't appear in either and this is not limited to Iraq war spending. Toward the end of last year, it was estimated that $8.5 trillion has been spent on trying to deal with the Credit Crisis. Most of that money is not included in the budget deficit or national debt. Future obligations for social security and medicare/medicaid are also ignored. Accounting for those could raise the national debt to the $50/$60 trillion level, if not more.

Where is the money coming from to pay for all of this spending? The major source is through 'printing'. While you can not print more and more of your currency and not have it devalue (the correct definition of inflation), this doesn't stop top economists such as Paul Krugman and Noriel Roubini from constantly opining in the media about the dangers of deflation. Just in case the 'experts' are misguided on this one, you might want to pick up some gold and silver during their current pull back. Oil, another inflation hedge, is also a great buy at the moment.

NEXT: Citi Dives, GDP Plunges - Both Off the Cliff

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.

State of the Nation - Denial

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.

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President Obama gave his State of the Nation speech last night and Governor Jindal of Louisiana gave the Republican's rebuttal. Neither indicated any realistic grasp of the extent of the economic/financial crisis that the U.S. is facing or proposed any innovative solutions. Generally, more of the same things that have failed in past were proposed. As per usual, the talks were long on rhetoric and platitudes that almost everyone can agree on and short on details for implementation. Not only doesn't there seem to be a realistic plan for fixing the financial system, there doesn't seem to be any plan at all.

The three cornerstones of Obama's agenda are improved education, health care, and alternative energy - the same items he emphasized during his campaign. Improved education as an agenda item is nothing new and has been emphasized by most recent presidents - the quality of American education has continually deteriorated during those administrations. As for health care, the government is going to extend it to more people, but costs have to come down (how exactly Obama plans on accomplishing these contradictory goals remained unstated). Increasing the use of alternative energy is indeed a good idea, but it will be a long time before this significantly impacts U.S. energy usage (it was not mentioned if the economically absurd corn ethanol program created during the Bush administration will be closed down).

There were a number of allusions to the financial crisis peppered throughout the speech. Obama did say that when large banks failed to function, they would be set right so they could lend again Apparently closing them down isn't an option, but failure will be rewarded instead (it should be remembered that Obama lobbied Democrats in congress to support TARP and without his efforts TARP might not have passed). Obama also stated that the auto industry was not going to disappear in the country that invented the car. At first, I wondered why he was trying to meddle in the internal affairs of Germany, but then realized he meant the U.S. and was planning on bailing out GM, Chrysler and Ford. There will be more aid for the unemployed and struggling homeowners as well. Obama praised congress for its swift passage of his close to $1 trillion economic stimulus package.

The man whose administration opened with a budget busting piece of legislation emphasized how he was going to get the deficit under control by the end of his first term (I have to admit I was laughing uncontrollably during that part of the speech). How is he going to do this? First, it is obvious he plans on ending the war in Iraq. While this is an incredibly expensive waste of money, Obama himself admitted that many of the costs of the war aren't even listed in the budget (the Federal government's off balance sheet items would be the envy of an Enron accountant). There is also a task force being formed to get rid of waste and fraud. If this works (and you be skeptical until you see proof), this could indeed cut the budget deficit significantly. Subsidies for big agribusiness are going to be cut and tax breaks for companies that send jobs overseas (what exactly these tax breaks are has never been clear to me). But one of the most important components in Obama's plan to reduce the deficit is the increase in taxes that is going to take place when the Bush tax cuts expire in 2010. He didn't mention that in his speech. He also didn't mention that only a very small percent of the estimated $8.5 trillion in bailout money as of the end of last year is included in the budget deficit or national debt. So don't hold your breath for increased transparency that is being promised in this arena.

Governor Jindal for his part admitted that the Republicans were irresponsible when they were in power and had reneged on their long standing promises to the American people and their core value of fiscal conservatism. It of course would be hard to deny this. It took over 200 years to create a national debt of $5 trillion. President Bush, with the help of a Republican controlled congress for much of his administration, managed to approximately double that debt to $10 trillion in just eight years (at least those are the official figures, tripling it to $15 trillion is more realistic). This occurred even though there were budget surpluses for the last few years of the Clinton administration and projections that the national debt could be reduced to zero by 2010. Like a husband caught cheating, Governor Jindal assured the American public that the Republicans have learned their lesson and aren't going to do that again.

The essence of the speeches last night can be summed up as follows: When the Democrats are in control, they spend like drunken sailors on shore leave. When the Republicans are in control, they spend like drunken sailors on shore leave. No one in Washington has any new ideas or approaches for dealing with the financial crisis. The problems will be dealt with by spending more money. The economy is likely to revive because of all of this spending, but you can assume that this will eventually catch up with the dollar and its value will fall precipitously. The economy after all, always looks good during the beginning stages of hyperinflation.

NEXT: Budget Deficit Screams Inflation

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.

Bailout Cost: $8.5 Trillion so far ... and Counting

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.

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One analysis has calculated that so far the bailout efforts of the U.S. government are up to $8.5 trillion. This is almost as much as the U.S. National Debt was when the bailout efforts began. So basically in a year the U.S. government has managed to double a debt level than took well over 200 years to accumulate. Don't expect to see all of these bailout costs included in the official National Debt figures however since the U.S. government engages in more off-balance sheet accounting than Enron ever dreamed of.

While these figures would seem alarming to even a casual observer, many mainstream economists don't find them troubling. Recent Nobel winner Paul Krugman claims the U.S. National Debt could be twice GDP (which would be around $28 trillion if you believe the official overstated GDP figures). How this could be a sustainable debt load for the U.S is hard to fathom, especially since we have a huge stream of social security and medicaid payments coming due in the next couple of decades because of retiring Baby Boomers (there is no money in either of these trust funds by the way, all the funds are used to support current government spending the moment they are received). Economists are also not worrying because over 50% of the bailout costs so far have been structured in the form of a loan. Much of those loans are backed by the truly worthless assets though - apparently the hope that sub-prime borrowers (this time companies) will by some magic pay back their loans still lives on and on in the fantasy land of modern economic belief. While up to now over 95% of bailout costs have been in the form of corporate welfare, expect this to change starting next year with a shift toward more support for individuals.

Although the inflation implications of U.S. government bailout profligacy should be ratcheting government bond yields to record levels, this has not happened yet. A flight to safety among desperate investors had kept U.S. bond yields unusually low (corporate bond yields are at a record spread to treasuries however). The drop in yields combined with the plunge in U.S. stocks has actually caused S&P 500 yields to be greater than 10-year U.S. Treasuries for the first time since 1958. Before that date this relationship was the norm. Don't assume that norm is returning however as some pundits are claiming. Stock yields are being kept artificially high by the bailout programs, which have allowed some companies to fund their dividends with U.S. taxpayer money. Stock dividends are going to come down and U.S. bond yields will eventually go up when they adjust to the inflationary realities of government spending.

Meanwhile, the bailout programs are not nearly at an end yet. As we have said in the New York Investing meetup since the credit crisis began, there is no such thing as one bailout for an insolvent financial firm. No firm has been better than Citigroup in proving this point. After five private bailouts earlier in the year, Citi got $25 billion from TARP and only weeks later had to have a much bigger government cash infusion to stay afloat. The auto makers are in Washington hat in hand at the moment with a low entry level bailout request - expect those costs to keep going up next year as well. And of course, their are more bailouts waiting in the wings.

NEXT: Economic Predictions for 2009

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.

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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.

The House Caves in, but it's the Market that Collapses

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 Videos Related to this Blog:
http://www.youtube.com/watch?v=h2f4XUpVINs
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On Friday, the House of Representatives took up the Wall Street bailout bill in a second time do-over and passed it by a comfortable margin of 263 to 171 (the party breakdown was 172 Democrats and 91 Republican yes votes). What made the difference wasn't that any of the horrendous provisions that looted the U.S. treasury on behalf of Wall Street were removed, but more costly measures, at least $110 more billion, were added! These pork runneth over items were for programs that had particular appeal in a number of districts where Congressman had previously voted no. The penny for your district, a dollar for Wall Street game worked like a charm. So did the lobbying efforts of those who benefited from the bill. One representative who switched his vote, said he never talked to so many bank presidents in his life (calls coming into the capital from just regular people were up to 100 to 1 against the bill). The U.S. congress proved once again that like every other regime in history that had created hyperinflation, it deems restraints on government spending to be unnecessary. Both presidential candidates showed their 'lemming to the sea' leadership abilities by not only supporting this legislation, but by helping to round up votes in their respective parties. It was reported that Obama alone helped switch 22 votes.

The passage of this bailout bill represents the third key policy blunder of the financial and monetary authorities in handling the credit crisis. The first was the rate lowering campaign by the Fed that started in August 2007, which flooded the financial system with a tsunami of liquidity. The second was the Bear Stearns bailout, which established a policy that would inevitably lead to bailouts for almost any failing financial institution. Now with this Wall Street rescue bill , the bailouts have gone from individual companies to the entire financial industry. Just as Bear Stearns was not the only bank/broker bailout, nor will this bill be the only industry bailout for the financials (Warren Buffet promptly stated that this bailout isn't big enough to work). The fourth key decision that will lead us down the road toward hyperinflation will be to expand the bailouts outside the financial system. The auto industry has already received its second government loan, expect more to come. This new phase for bailouts though will not be limited just to industry. The Federal government will also have to turn on its money spigot to save state and local governments from going under. Governor Schwarzenegger has already requested $7 billion in assistance for California.

In a little more than two months, the national debt ceiling has been raised $1.5 trillion because of the Fannie Mae and Freddie Mac bailouts (add another $5.3 trillion for their government takeover) and the Wall Street rescue legislation. A national debt of a little over $9 trillion will soon be exceeding $16 trillion, around $2 trillion more than the official overstated GDP figures. It looks like the U.S. government intends on borrowing from foreign governments to pay for this (both the Fannie Mae/Freddie Mac and Wall Street bailouts are sending a lot of money overseas). However, it is more realistic to think the printing presses will have to be scheduled for 24/7 operation.

The stock market spoke very clearly in its reaction to the the bailout bill. It started tanking immediately. The Nasdaq, S&P 500 and the small cap Russell 2000 all closed at new lows for the year - below the crash bottom on Monday. Only the Dow held above this level. Key support around 2000 was broken on the Nasdaq on Monday and this break was confirmed on Friday. The next major support level for Nasdaq is around 1800 and for the S&P around 1000. Expect a visit to these levels some time in the future. Although I suspect the government will try to interrupt this journey - perhaps instead of banning just short-selling, they'll try to ban all selling of stocks.

NEXT: Today's Global Stock Market Meltdown

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.

Probable Future Outlook for the United States

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.

Guest Blogger: Trevor Gauntlett from 'Running the Gauntlett'

What concerns me most is looking at the highly probable future outlook for the U.S. …

The government is taking over Freddie and Fannie, which will help out new, but not existing home buyers. By assuming responsibility for their debt, the gov’t is using inflation adjusted tax dollars to keep these companies operating . However, a $500 billion dollar short fall is projected this year in the budget and the U.S. national debt is already at about 9.7 trillion and growing ever so rapidly. If we tack on unfunded liabilities, we are talking anywhere from 50-70 trillion in obligations. Effectively the government is insolvent. Now what happens when government revenues begin to decline due to the slowing economy, baby boomers start to take money out of social security and access Medicare when they retire, and the continuation of the Iraq war / Afghan war / maybe Iran war?

I’m failing to see the light at the end of the tunnel.

During the housing boom, U.S. consumers purchased houses because money was cheap. Everyone felt rich so they purchased more consumables for immediate gratification. These weren't investments with productive value that would add to the economy in the future and they experienced immediate depreciation. Once U.S. consumers could no longer get money out of their homes through refinancings and HELOCs (home equity lines of credit), we started using our credit cards. Look at who is producing and who is consuming… we in the USA are primarily guilty of the latter and it is all funded through the rest of the world’s savings. At some point other countries are going to refuse to continue supporting the U.S. spending binge - this might already be taking place.

As for housing it will have to come back down to reasonable values. If we encounter a period of hyperinflation then housing could be a good asset to hold onto (although this was not the case during the hyperinflation in Wiemar Germany in the early 1920s). On the other hand, if we have a depression I could argue the opposite.

People are already losing their HELOCs because banks are worried that consumers won’t be able to afford them. Legal or not this is happening. I also heard from a Real Estate agent in Seattle that banks are asking for 25% down on new mortgages. In an earnings call in late January 2008, Bank of America executives said credit card delinquencies in California, Florida, Arizona, and Nevada—states with high foreclosure rates—increased five times as fast as in other states, suggesting that consumers struggling with their mortgage debt are also finding their credit card bills hard to pay. “We’re focused on getting paid for the risk we take,” said Joe Price, chief financial officer. - US News and World report 2/28/2008.

What happens if the United States dollar loses its status as the reserve currency? Then everyone with dollars will flood the market to get rid of them. The dollar is a commodity just like gold and silver, but unlike gold and silver any amount of it can easily be created. It has no intrinsic value and is a exchangeable commodity and legal tender because of government fiat (hence paper money is fiat money or fiat currency). If people want dollars, the price rises and as people desire them less, the price falls. Loss of reserve currency status would mean the demand for U.S. dollars would fall significantly. Why would anyone want dollars when you look at the future for the US economy except because of necessity or political reasons?

The GSE bailout will help to prolong the issues that the financial industry is facing. The United States government will do everything in its power to support the system through money creation and taxation, giving individuals and institutions more time to pull their money out of the dollar. An immediate collapse would make that very difficult and costly.

I’m getting the sense that things could get a whole lot worse than any of us imagine.

NEXT: The Banks and Brokers Most Likely to Fail - The Big Players

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