Inflation is when the supply of money expands faster than the growth of goods and services in the economy. When there are too many dollars chasing too few goods and services, prices rise.
So, the rising price of beer, milk, eggs and gasoline is the result of inflation. But that part of the equation doesn’t usually happen right away. And that’s what makes it so dangerous. It is a huge mistake to believe there is no inflation, just because prices aren’t rising.
The inflation has already happened. And it continues. Take a look at the chart below. It represents the U.S. Monetary Base – currency in circulation, plus bank reserves held at the Fed.
Hmm. Looks like inflation to me.
So, by definition, massive inflation has already arrived. The question is: when will the wave of monetary inflation show up in the prices we pay?
“It already has,” says IDE natural resources analyst, Rusty McDougal. “Take a look at the stock market. And look at how the financial companies have soared. That’s where the new money shows up first. It’s only a matter of time before consumer prices start to rise.”
“But what about the other side of the argument?” I asked him. “There are some experts who believe deflation is more of a threat than inflation.”
I pointed out some of the deflationary forces at work. People are saving more and spending less. We’re losing 400,000 jobs a month. Companies have cut their spending. And to top it off, the banks are hording cash and borrowers are reluctant to borrow. Even if the Fed stuffs the banks with cash, the money stagnates if the banks don’t lend it out.
But at some point, the “velocity” of money will increase. Prices will too. And Rusty points out that the banks don’t even have to lend money for the devastating effects of inflation to hit.
“Right now, the Federal Reserve is buying Treasury bonds to finance the deficit. And they are trying to do it undercover, so the public is unaware. The goofs running US economic policy are sacrificing the dollar to keep selling Treasury debts. But something has to give. Mark my words. This will lead to a crisis.”
What the Federal Reserve is doing is monetizing the debt. We are buying our own debt with our own funny money. And the Fed’s balance sheet proves the case. Compared to this time last year, the value of Treasury securities held by the Federal Reserve has increased 187%.
In the short run, this can mop up an oversupply of Treasury debt. In the long run, it’s about as effective as trying to create wealth by writing checks back and forth to your spouse.
Rusty contends that the debts owed by the U.S. government are too astronomical to ever be repaid. This debt must therefore be devalued through inflation. Not an easy trick when billions of foreign eyes are watching.
A trillion here, a trillion there… what’s it really mean?
In the 1960s, during a debate over government spending, Illinois Senator Everett Dirksen famously said, “A billion here, a billion there -- pretty soon, you're talking real money.”
Today, billions and trillions are thrown around so much it’s hard to picture what this amount of money really means any more. Well, picture this…
A trillion seconds is 30,000 years ago. And if you laid a trillion dollar bills end-to-end, it would stretch to the moon and back… 400 TIMES.
Think about that the next time you hear that the U.S. government will spend $1.58 trillion more this year than we bring in.
I’ll take two of whatever he’s having…
Most experienced investors are scratching their heads over the market’s rally from the March lows. What has it been built upon?
CNBC has an answer. They recently interviewed the chief investment strategist for a capital management company. This is a “real rally” he told viewers.
“I think one of the biggest things driving Wall Street right now is the March low, and the only reason we got down there is that we had created the nationalized banks scare.”
“I think we’re really early in this recovery which also tells me we’re really early in the stock market recovery,” he added.
This is the sort of “expert advice” that makes for great comedy on CNBC. The market drop wasn’t caused by fears that the government was going to take control of the banking system. The market started dropping in November 2007.
It was caused by the collapse of the housing market, hundreds of thousands of jobs lost every month, and the global economy teetering on collapse.
And here’s what has fueled the rally:
* “Not as bad as expected” earnings announcements
* Crappy bank stocks
* Investors desperate to rebuild their retirement account
We are not “early” in the stock market recovery. The Dow is up 46% since the March lows. If we recover any faster, it will be an “I” shaped recovery, not a “V” or “W” shaped.
This recovery is built on shaky ground, nothing I would consider a solid base for an extended growth period in the markets. Now is a time to be fearful. It is a time to be protective of your profits.
Speaking of shaky ground… On Monday and Tuesday this week, almost 40% of the share volume on the NYSE was comprised of Citigroup, Bank of America, Fannie Mae, and Freddie Mac.
These are not exactly pillars of financial strength. Fannie and Freddie are bankrupt for all intents. And Citi is still hovering around $5 a share, with shaky prospects. And as we mentioned on Tuesday, the overall volume has been declining for several months. That these four companies make up such a large percentage of the volume is concerning.
So why are they trading so heavily?
One reason is that their low share prices attract uneducated investors. Investors have seen the rise from the March lows and want to get in on the action. And because so many shares of these companies were shorted during the meltdown, investors are now scrambling to cover positions.
When these four companies are the last ones pushing the market higher, it’s time to consider taking some profits to safety.
The latest “this doesn’t sound right” number coming out of China is their estimate for inflation.
The official estimate is that price inflation will be 2% for 2009. Andrew Gordon, our value expert who follows China closely, almost jumped out of his chair reading the report.
“Numbers coming out of China have always been a guessing game,” he said. “But this is outrageous. Prices have fallen six out of the past seven months there. The only way for China to have 2% inflation this year is if they averaged 6-8% inflation from now until December. And that’s impossible”
It would be one thing if the markets took the “official” numbers coming out of China and discounted them like Andrew does. But the markets here pay attention to them. Too much attention.
When China’s Purchasing Manager’s Index (PMI) rose for two months in a row this past March, Wall Street took it as another sign that global growth was bouncing back. It was no coincidence that the U.S. market began to rally about the same time.
Andy suspects a Chinese government bureaucrat concluded you can’t have near 8% growth and price deflation at the same time. So one had to go. Naturally, it was deflation.
Spinning the data is an art form in China. The next time the market here rallies on positive news from over there, be careful.
You can make money betting on China though…
It didn’t take long for the iPhone to become the most popular cell phone in the U.S. A large touch screen, thousands of applications, and the “cool” factor have all driven sales.
So imagine the demand when the iPhone is introduced to China , a market where there are 687 million cell phone users. That’s three times larger than the U.S. market.
Talk about a growth opportunity!
And if the sheer number of potential subscribers isn’t enough to excite you, Apple has another advantage: the Chinese view the iPhone as a status symbol. And according to the Wall Street Journal, they also love phones with touch screens and Internet access, two things the iPhone does very well.
Gurus are falling over themselves to recommend Apple. But this news has already been priced in. To play the iPhone craze, you need to dig a level deeper. Our options expert Ted Peroulakis did just that.
He’s found a relatively unknown company that doesn’t just supply parts for the iPhone, but also sells parts for the Blackberry and other smart phones.
You don’t need to know anything about technology to know that “smart” phones are the future. And the company Ted has identified is perfectly positioned to ride this tidal wave to huge profits.
Good Investing,
Bob Irish
Investment Director
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