Category: inflation

Be careful what you wish for

In August, 2002, nineteen months into Alan Greenspan’s experiment in easing credit to contain the fallout from a bursting tech bubble, a New York Times columnist and so-called economist weighed in with this bit of wishful thinking:

The basic point is that the recession of 2001 wasn’t a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Although the Maestro was optimistic, our economic guru had his doubts:

Despite the bad news, most commentators, like Mr. Greenspan, remain optimistic. Should you be reassured?

[W]ishful thinking aside, I just don’t understand the grounds for optimism. Who, exactly, is about to start spending a lot more? At this point it’s a lot easier to tell a story about how the recovery will stall than about how it will speed up. And while I like movies with happy endings as much as the next guy, a movie isn’t realistic unless the story line makes sense.

If you haven’t guessed, our opinion writer was Paul Krugman and he managed to get it wrong on two counts. First, the Greenspan medicine was successful in stimulating consumption and blowing a housing bubble for the ages. Second, Krugman’s recommended cure ended up being much worse than the disease.

Has Mr. Krugman (and Messrs. McCulley and Greenspan for that matter) faded into oblivion for his fatal advice? Not exactly. Last October, in the depths of a stock market collapse he failed to forecast, Paul Krugman received the Nobel Prize in Economics. (The award is given by Sweden’s central bank and by coincidence Krugman is a long-time supporter of fiat money.)

Krugman’s modus operandi is simple: during the bust always advocate “stimulus” in the form of government spending and cheap credit via the Fed. When the artificial boom arrives, take credit and assume it rests on a solid foundation. When the fake boom inevitably turns to bust, blame it on lax regulation and “greed.”

On March 20 of this year, Krugman cheered the Fed’s herculean attempts to inflate at any cost:

In effect, [the Fed’s] printing $1 trillion of money, and using those funds to buy bonds. Is this inflationary? We hope so! The whole reason for quantitative easing is that normal monetary expansion, printing money to buy short-term debt, has no traction thanks to near-zero rates. Gaining some traction — in effect, having some inflationary effect — is what the policy is all about.

Memo to all interventionists and inflationists: Be careful what you wish for.

Memo to fellow contrarians: When the bubble blowers and their apologists are still employed and appearing in the Mainstream Media, the secular bear market remains in its early stages.

The chess game continues…

Since we began maintaining this blog 14 months ago, we’ve focused on three themes:

  1. Government intervention is toxic.
  2. Intervention is driven by the schemers and dreamers. The schemers – political capitalists like the big banks and investment banks – leverage themselves to perpetual asset inflation. As their bet turns sour, friends in high places intervene on their behalf.
  3. This intervention, unlike the experience of the past 20 years, does not reflate the asset balloon. In fact, it is utterly doomed to failure. (Note: The Fed has expanded its balance sheet by $637 billion, or 74%, the past 12 months, yet residential real estate lost roughly $4 trillion in value and the stock market shed over $6 trillion.)

This Greek tragedy has unfolded in several phases.

  • Phase 1: An epic credit bubble begins to burst.
  • Phase 2: Speculators refuse to leave the casino, emboldened by government attempts to keep the party going. They simply move from the financial craps table to emerging market poker and commodity roulette.
  • Phase 3: Speculators go into full blown panic mode as they realize all the monetary tea in China can not save them. The overextended are taken out of the casino in bodybags while their facilitators counterfeit wager chips on a massive scale.

As we move well into Phase 3, what is the appropriate strategy for protecting wealth? On the one hand, every multi-billion dollar intervention is like sticking a needle into a voodoo doll of the economy. On the other hand, inflation hedges are on sale. For example:

  • The 30-year T-bond yields 3.97% and the Bullish Consensus is up to 69%. We remain short and shorting rallies.
  • Gold briefly dropped below $700/oz. today, more than 30% below highs set last March. We own and continue to buy physical gold held in the vault of the oldest private bank in Switzerland.
  • Gold stocks (as measured by the “XAU“) are 67% below their highs. We hold a significant stake (roughly 11%) and continue to buy on weakness.
  • Commodity-related stocks have been decimated with fertilizer stocks more than 70% off their June highs, the Natural Gas Index (XNG) 49% off its peak, and the Oil Index (XOI) 48% below its top. Even with crude oil cut in half to below $70/bbl, oil and gas stocks reflect significantly lower prices. We have built a significant position in ag/energy (roughly 9% in fertilizer, seeds, coal, oil and gas, uranium) while hedging somewhat with crude oil (1.7%) and grain shorts (1.5%). We are avoiding more economically-sensitive commodities and remain short copper (0.8%).

In order to hedge against our current economic swan dive trajectory, we remain short the credit sector, commercial real estate, and the broad market (though we’ve been covering on weakness).

Paired trade of the decade?

Long gold ($869.00/oz.), short the S&P 500 (1255.08). The gold/S&P ratio is currently 0.69 and going much, much higher (see above).

The catalyst? The federal government is planning to cut a check for $900 billion to bail out Fannie/Freddie and now purchase mortgage-backed securities at above-market prices. The final tab is going significantly higher, the lion’s share of which will be paid for with printed dollars. From these delusional levels, a 1930s-style collapse in real terms is all but guaranteed.

Addendum: As the graph shows, U.S. equities have been in a relentless bear market versus gold since their tech bubble highs of 1999-2000. In fact, a unit of the S&P 500 that purchased 5.23 ounces of gold 9 years ago buys just 1.45 ounces today. The S&P has lost 72% of its gold value during that time.

The next bubble?

We nominate the debt of the U.S. government. The case against the long bond is clear:

  1. The U.S. government is taking on massive (possibly measured in the trillions of dollars) liabilities with the bailout of Wall Street, the banking system, and the GSEs for their role in helping foment a housing/consumption/credit/speculative bubble for the ages. (This in addition to the ticking time bombs of Medicare, Social Security, and the more recent prescription drug promise.)
  2. The U.S. government is broke. The U.S. taxpayer is crying “uncle” as the U.S. consumer is tapped out. This spells D-E-F-A-U-L-T, unless…
  3. … Fed chairman Bernanke fires up the printing press, in which case the hapless bondholder gets destroyed.
  4. Under this dire scenario – a lose-lose for Uncle Sam’s creditors – the 30-year Treasury bond is yielding all of 4.11%, its lowest level since the 1960s.

We’ll defer to our good friend, Tony Deden, who adroitly manages the Edelweiss Fund from his perch in Zurich:

I ask you, would you lend money to the world’s greatest debtor for a period of ten years at 3.7% – nearly 2% below the official (and understated) rate of price inflation? I would not. No sensible person would think of it. Yet this is the price of the U.S. government’s ten-year bonds. It earns our award of the mispriced asset of the new century. ~ Monthly Review, September 3, 2008

Of course, let’s not forget the 10-year Japanese government bond yielding all of 1.5%.

The difference between gold and commodities

We are having a hard time understanding the recent hand-wringing over gold. Since July 11 its price is down just 14.8% in dollar terms (currently $818.60/oz. on the Dec. futures contract), this after a 3.7-fold rise over a 7 ½ year bull market. During the past 2 months gold has also lost 9.3% of its purchasing power vs. the S&P 500 and 4.6% against the euro. However, gold now buys 3.8% more copper, 9.0% more corn, 32.3% more crude oil, 44.0% more silver, and 58.6% more platinum.

We were actually expecting a correction in gold and were underweight 2 months ago. Since that time the case for gold has clearly improved with the lower price and better fundamentals (i.e., massive bailouts moving us closer to the day of running the printing presses flat out). We now have our gold/gold stock weighting back up to about 19%, and expect to take this higher.

Commodities are a different animal, its inflation-hedge credentials questionable heading into a global recession/depression. That said, we actually did some nibbling in the food/fuel area yesterday on the weak open (in part because there has been a bit of capitulation by some commodity bulls like Ken Heebner). Over the long haul, we’d prefer to own the businesses instead of the actual commodities. Michael Aronstein stated the rationale against owning physical commodities very well a few weeks ago:

“The whole cycle that began around the turn of this century ended. Human ingenuity creates productivity, and the real price of almost everything that’s extracted or manufactured goes down over time. That’s the nature of human progress.”

This is not to say commodity-related businesses can not do well in a declining price environment; witness Dell Computer in the 1990s. They just don’t prosper in a weak economy. As for industrial commodities, we’ll relegate these to the penalty box at least until the global malaise is constant front page news.

Tony Deden on money

When you destroy the money, you destroy the glue that holds society together. — Anthony Deden

Core inflation: the emporer’s new clothes

  • From 1958-1999 headline inflation exceeded core inflation 38% of the time.
  • Since 1999 headline beat core 76% of the time.

There are lies, damn lies, and government-doctored statistics.

Bernanke’s printing press drives gold stocks to all-time highs


U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Since Ben Bernanke gave his fateful deflation prevention speech on November 21, 2002, the Greenspan/Bernanke Fed has succeeded beyond its wildest dreams. The value of the dollar has dropped 26%, commodities – as measured by the CRB Index – have risen 44%, and gold has vaulted 130%. Corn is +52%, silver +200%, and crude oil +205%. Meanwhile, the official measure of inflation, the CPI, is only up 14.9% (+3.0% per annum).

Let’s review their combined track record:
  1. Preventing deflation: Commodity prices for American consumers have risen 8.1% per year, for foreigners just 1.4%/year.
  2. Keeping inflation expectations contained: Official inflation is only up 3.0%/year, even less after subtracting volatile food and energy prices. The 10-year TIPS spread shows fixed income investors expect CPI reported inflation over the next 10 years of just 2.31%, up from 1.64% in November, 2002.
  3. Keeping asset inflation stoked: The investor class is happy, with the S&P 500 up 64%, or 11.2% per year.
  4. Lining the pockets of their banking constituents: The total return for bank stocks is roughly 10% per year, while the total return of brokerage stocks is about +23%/year. The Bernanke Fed in particularly has done everything in its power to rescue Wall Street and the commercial banks from their ill-conceived investments.
Great job, guys. But before you accept your Central Banker of the Century awards, you might want to pay closer attention to 27-year highs in gold prices and inflation creeping into every nook and cranny except where you most need it – in real estate prices. Right now, inflation expectations are contained. (For example, the Rydex Precious Metals Fund has experienced a steady stream of outflows the past 4 years, despite the recent breakout in gold stocks. See graph below.) But what happens as investors begin to wake up, as they inevitably will? You are in a box. Lower short-term rates and you unleash inflation expectations, driving up long-term rates and ultimately short-term rates. Do nothing – your best course of action – and you let your banking cronies suffer the consequences of their recklessness, ineptitude, and fraudulent behavior of the past 7 years.

We wish you well.

Forbes: luxury goods inflation rate at 6%

What inflation? The annual Forbes 400 richest Americans issue is out and the cost of living extremely well is on a tear:

Over the past year the cost of our basket of luxury goods climbed 6%, more than double the rate of inflation.

My comment: What asset inflation giveth, luxury goods inflation taketh away. …Well, not quite.

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