DR: Higher Inflation is on the Way
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The Daily Reckoning U.S. Edition Home . Archives . Unsubscribe The Daily Reckoning | Monday, February 28, 2011
- A meddler's mentality: Blaming rising prices on...rising prices,
- More on "that ruckus" going on in the Middle East,
- Plus, Bill Bonner's thoughts on freedom and frappacinos...
Chaos Across The Middle East...Skyrocketing Commodities...Food Riots...
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History in the Making Why Volatility in the Middle East is the Only Near-Certainty
Reporting from Laguna Beach, California...
"Buckle your seatbelts. You're watching history in the making," a journalist cautioned yesterday.
Was this particular journalist referring to:
1) The Wisconsin "Tea Party Revolt;"Although the journalist's quote could apply to any of the items cited above, the topic in question was not the long-standing hostility between Sheen and Lorre, but rather the long-standing hostility between the oppressed peoples of the Middle East and their oppressors.
2) Ben Bernanke's history-making foray into dollar debasement;
3) The suspension of filming Two and a Half Men, due to Charlie Sheen's very public dispute with producer, Chuck Lorre;
4) The bizarre rift between child superstar, Miley Cyrus and her dependant father, Billy Ray Cyrus;
5) That ruckus going on in the Middle East;
The revolutions sweeping across the Middle East are not merely one-off attempts to overthrow unresponsive autocrats or crazed tyrants, CNN journalist, Fareed Zakaria, asserts, these revolutions are a reaction to 1,000 years of subjugation by foreign powers and their hand-picked, domestic lieutenants.
"[F]or the first time in 1,000 years, Arabs are taking control of their own affairs," Zakaria explains. "Since the 11th century, Arab lands have been conquered and controlled by foreigners... In fact, most of the Arab world was ruled by the Ottoman Empire for centuries. Then came the Europeans, who carved up the region after World War I - creating most of the states we know today... [These states were] all creations of the colonial powers."
"Throughout this 1,000 years of foreign domination," Zakaria continues, "the Arabs always had local rulers. But these sheiks and kings and generals were appointed or supported by the outside imperial powers. Most of the Middle East monarchies, for example, were created out of 'whole cloth' by the British.
"These local rulers were more skilled at negotiating up to the imperial rulers, than they were at negotiating down to their own people. They ruled their own people, not by negotiation, but by force and bribery... That game is in trouble..."
Finally, says Zakaria, the winds of change are blowing across North Africa and regions to the East. As these winds gather intensity, socio- economic conditions in the region will shift as unpredictably as sand dunes in the Sahara.
Volatility is probably the only near-certainty.
"The Middle East is witnessing a revolt against the Old Order everywhere," Zakaria concludes. "Where it will lead, where it will fail, where it will succeed, all of this is totally unclear. But this is a big, system-wide and historic shift. So buckle your seatbelts. You're watching history in the making."
If volatility is the likeliest course of the Mid-East revolutions, what would be the likeliest course of the oil price?
Volatility, with a bias to the upside, would be our guess.
And if the oil price is likely to spike higher, what would be the likeliest course of the global financial markets?
Volatility, with a downward bias, would be our guess.
As we remarked in Friday's edition of The Daily Reckoning, "We are not so certain that the contagious revolutionary virus spreading throughout the region is bullish for anything other than the oil price...and Anderson Cooper."
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The Daily Reckoning Presents Higher Inflation is on the Way
Reported inflation is headed higher - much higher.
The stakes have seldom been higher. With the unemployment rate still above 9%, and federal debt at record levels, this latest error by the monetary authorities is likely to be the most costly since the Great Inflation of the 1970s. Monetary instability will slow employment growth and further erode confidence in government at the same time that higher interest rates will add billions of dollars to the interest cost on the national debt. Yet, failure to act in a timely basis will lead to an even greater crisis.
When it arrives, the Federal Reserve and its defenders will call it "cost-push" inflation and blame it on economic growth, the weather, Arab sheiks, China, and perhaps greedy companies and labor unions.
The actual cause of the looming crisis is the same as the cause of the Great Inflation of the 1970's: a too easy monetary policy that has devalued the dollar by 40% against gold during the past two years.
I choose gold as the reference point for the dollar's value because it has the remarkable characteristic of maintaining its buying power in terms of other goods and services over long periods of time. As a consequence, the dollar price of gold is the best, though imprecise, real-time measure of the price level. Other, more traditional measures, such as the consumer price index (CPI) are merely lagging indicators of inflation or deflation that has occurred already.
I also choose gold because I remember what happened after President Richard Nixon in August 1971 severed the link between the dollar and gold. At the time, those who warned that the rising price of gold was signaling higher inflation ahead were widely dismissed as "gold bugs." The conventional wisdom then, as now, is that economic slack would protect the U.S. economy from inflation regardless of what happened to the value of the dollar in terms of gold.
But it didn't work out that way.
At first, the conventional wisdom seemed to hold. The rate of inflation as represented by the CPI slowed in 1972 to 3.2% from 4.3% in part because of wage and price controls, and then rose 5.6% in 1973. But, in 1974, the CPI jumped 12.2% in the face of rising unemployment. Shocked and dismayed, the purveyors of conventional wisdom made the circular argument that the unexpected rise in the overall price level was caused by the rise in commodity prices, especially the tripling of the price of oil. In other words, they blamed rising prices on ... rising prices!
But, those who followed the price of gold were not shocked. For example, the sudden tripling in the price of oil between 1971 and 1974 roughly matched the tripling in the price of gold over the same time period. In other words, the rise in the price of oil was simply the mirror image of the preceding devaluation of the dollar against gold.
In the last two years, the price of gold has increased around 75% - roughly half the increase of 1972 and 1973. Last week's inflation reports indicate that this devaluation of the dollar will hit the CPI in the year ahead just as it did in 1974.
The price of crude materials in the Producer Price Index (PPI) increased by 3.3% in January alone and now stands 21% above where it was just six months ago. Moreover, during the three months ending January, the rate of advance in the producer price indices for intermediate products, and finished goods have all accelerated into double digit annual rates of advance.
This upward adjustment of prices to the cheaper dollar is beginning to flow through to the consumer. For the past 3 months, the seasonally adjusted annualized rate of advance in the CPI is up to 3.9%, with food and energy prices - the items that have the greatest short-term impact on a family's budget - accelerating to 3.1% and 27% over the same 3 months. Given the relative magnitudes of the dollar's devaluation against gold, it is reasonable to expect consumer prices to be rising at a 5% plus annualized rate in the months ahead.
Fed Chairman Ben Bernanke's assurance during last December's interview on 60 Minutes that he was "100% certain" the Fed could control an outbreak of inflation above 2% was hubris. These data show that inflation has already broken out, and that there is little the Fed can do to stop the price indices from reflecting the dollar's devaluation of the past two years. And, his statement last Friday in Paris at a meeting of the finance leaders of the Group of 20 that "resurgent demand in the emerging markets has contributed significantly to the sharp run-up in global commodity prices" ignores the central role of the dollar's devaluation on rising global inflation.
Moreover, Bernanke's promise to respond to higher inflation by raising the Fed Funds rate carries with it significant additional risks. Slowing the economy reduces the supply of goods and services relative to the supply of money, which itself can be inflationary. In addition, higher short-term interest rates increase the opportunity cost of holding currency and checking accounts, and therefore will lead to an increase in the turnover or velocity of money. That too will add upward pressure to prices.
The experience of the 1970s illustrates the danger. The Fed raised the Fed Funds rate from a low of 3.3% in February 1972 to more than 10% in July 1973. But consumer price inflation continued to accelerate for the next year.
To avoid another extended period of high inflation and interest rates, the Fed and the Obama Administration need to acknowledge that the current, paper dollar system is deeply flawed and prone to error and instability. The alternative is a rules-based system in which the Fed begins to use quantitative tightening and easing to steady the value of the dollar as represented by the price of gold. A monetary system in which the dollar is as good as gold - for all of its imperfections - would quickly deliver price stability, low and stable interest rates, and increased financial security to the American people.
for The Daily Reckoning
Joel's Note: Mr. Kadlec is a member of the Economic Advisory Board of the American Principles Project, an author and founder of the Community of Liberty.
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"What's your view on the revolutions in North Africa," asked a Dear Reader.
Generally, we avoid having views on things we know nothing about. Which is almost everything. As to what is going on, we have no idea better idea than the State Department or the CIA. Maybe the revolutions are driven tribal rivalries. More likely, increases in food prices - caused by Ben Bernanke - are to blame. And who knows? Maybe people really do crave liberty, democracy and Starbucks' frappacinos.
But man is a restless beast. Often, he is content with the way things are. And then, a stone gets in his shoe...and he begins to limp and complain.
Each has his own private itch. One man has a fat wife and wants a skinny one. One has a slender wife and longs for one with more meat. One wishes he could bring his deceased wife back to life. Another has a lively wife and wishes she were dead.
Ask any of them and he will give the acceptable public line: it's "freedom" he is after, or so he'll tell the news media. But what kind of freedom? Most often it is the freedom to boss others around. He will want to vote, but only so he can tell other people how they should educate their children, which gods they should worship, and how much money they should send his way.
The only sure thing is that no government survives forever. Francis Fukayama thought he saw the "end of history," when democracy got a toehold in Russia. Dictators need to be toppled, often in bloody revolutions. But democratic governments come and go, without making history.
But democracy has a sell-by date too. Its fatal flaw was identified hundreds of years ago. When the majority realizes it can vote itself money from the minority -or from the next generation - the system is doomed. Elected governments change, but the system just goes deeper and deeper into debt -until it can go no further.
What happens then?
We don't know. But we're all going to find out.
In the meantime...
Stocks fell on Monday of last week...and continued falling until Friday. On Friday, the action reversed, with the Dow up 61 points and gold off $6.
What to make of it?
It's too early to say. By week's end it didn't look like the big break in the market that we've been expecting. But who knows? This is a new week. Anything can happen.
But, no matter what happens, it's best to expect what SHOULD happen. And the way we see it, stocks and bonds should go down. The time for making money in stocks and bonds is over, in other words. This the time for getting out, hunkering down, and waiting until the crisis blows over.
There are just too many things wrong with the market...the economy...and the political situation...
..and oh yes...the people trying to deal with these problems are a bunch of...what's the technical word? Oh yes, clowns.
What's wrong with the market? Well... Bonds have been going up for nearly 30 years. Yields have fallen from near 20% for 10-year Treasury notes in the early '80s to 3.42% on Friday. Very nice, if you've been holding bonds. And it might lead you to think you can hold them forever. Thirty years is a long time.
Unfortunately, nothing lasts forever...and certainly not a bull market in bonds. Instead, trends in the bond market tend to last about a generation. Yields generally fell from the '20s until the Eisenhower administration. Then, they rose until Paul Volcker finally got control of inflation in the early '80s. Next, they fell for the next three decades.
Are they still falling? No one knows. But it looks to us as though they've found a bottom. And even if they haven't, you're probably better off thinking they have. Because the bottom can't be too far off...and there could be Hell to pay afterwards.
Meanwhile, over in the stock market, stocks are expensive - close to the record highs of '29, '66, and '99. In fact, nominal prices are about where they were in the late '90s, after doubling over the last 2 years. If the bulls are right, these high prices are just the beginning.
But what could drive them higher? The consumer economy runs on two important pistons of prosperity. Employment gives consumers more money to spend. And rising housing prices increases their net worth. Neither of those pistons is firing now. There are half a million fewer people with jobs now than there were 2 years ago. And house prices are still going down.
How is it is possible for a genuine prosperity to develop under these conditions?
But wait...it gets worse. The fed are still adding debt to the system - even while the private sector desperately needs to off-load it. Not only that, they are making the entire system dependent on negative interest-rate financing. The Fed lends below the level of consumer price inflation. Businesses, consumers, banks and speculators soon NEED cheap money just to keep going. Most of all, government needs it. You can easily see how this works. Zero interest rate financing allows the US government to run a deficit of $1.5 trillion this year. But the feds only have revenue of $2.2 trillion. So, they're spending roughly 60 cents more for every dollar they take in. And soon the official interest-bearing debt will be at $15 trillion - nearly 7 times revenues...
Now, imagine that the feds had to pay interest at just 5%. Let's see, 5% of $15 trillion is what...$750 billion...or about a third of all tax revenues.
Do you see the problem? Low interest rates permit the feds to borrow. They run up huge debts...and then they have so much debt that they can't afford to raise rates. They are stuck. They have to keep borrowing until it's too late to stop...until we're all busted.
And more thoughts...
We went out to the country this past weekend.
"What's happened around here?" we asked our gardener.
Damien knows everyone in the area and everything that happens. We counted on him for a quick update.
"Oh...nothing. Nothing ever happens here. Everything is exactly the same...
"You know how dull it is out here in the country. Nothing ever happens...
"Of course, Marie Jeanne...you know her? She and Jacques were always arguing. But they seemed to get along somehow. Jacques is a fun-loving guy. Marie Jeanne is a bit harder to live with. Very intense. She wore the pants in that family.
"Well, they finally called it quits. After about 30 years of marriage. I wasn't particularly surprised, because they never got along that well.
"And I figured that Jacques had had enough. But when I saw Marie Jeanne she explained that she and Bernard Toffler have been seeing each other for the last two years. Apparently, Jacques knew all about it. Bernard would stay with her at her house while Jacques was in Paris. Then, when Jacques came home for the weekend, Bernard would go back to his house.
"I asked her what it was like, living with two men. Her husband and her lover at the same time. She said it was 'very complicated.' I don't doubt it.
"Personally, I've never been married and now, at my age [Damien is 48] I don't think I ever will. But I don't see how you can get along with one person...let alone with two at the same time.
"But I guess that was the problem. She couldn't get along with Jacques. So he's out of the picture.
"Now, poor Bernard has to put up with Marie Jeanne. She's a handful.
"Oh...and what else? I guess you know that Annette had a stroke and Rafael had his bone marrow transplant?
"Annette was driving home from town. She drove off the road twice. To the right side each time. She got home and called the doctor. They sent an ambulance for her. But then when she got to the hospital she seemed fine so they sent her home. Fortunately, she called her friend Alexandra...you know, she's a doctor...and she told her to get right back to the hospital. She was having a stroke.
"Now, the right side of her body isn't working right. She can't raise her right arm...and she speaks out of the left side of her mouth. It's a shame. Because she was so pretty. Well, I guess she still is pretty. I haven't seen her. But it's not easy for a woman of her age to recover from that. She's at least 70.
"Old people are always having trouble. That's just the way it works. It's Rafael that makes me feel bad. He's only 19. And he seemed to be doing so well. The last time I saw him, he looked good. And I heard that his leukemia had been cured...or it was under control.
"Then he had a relapse when he was traveling and he had to come home. They put him in the hospital. They've been giving him radiation...and chemotherapy...and they keep him in a tent, because he has no immune system. It took a long time to find a donor for a bone marrow transplant. It has to be a perfect match. And now you have to hope and pray it works. Because if it doesn't work, well...I don't think there is anything else they can do.
"I feel sorry for the whole family..."
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