You are here: Home » Articles » Inflationary Head Fake

Inflationary Head Fake

by John Rubino on March 5, 2010

Today (Friday the 5th) has a meaningful feel. The news is good on U.S. employment and Greek finances, and the markets are in recovery mode: stocks are up, gold is rocking, and bonds are getting smacked. Inflationary days are here again, in other words. But — while uncontrolled currency creation will absolutely without a doubt get us there eventually — today’s action is probably a head fake. Consider:

The rising gas tax. Oil hit $82 today, which, while a long way from its credit bubble high, is still enough to take U.S. gasoline to nearly $3 a gallon in some markets. That’s effectively a tax increase on U.S. drivers.

Public sector mass layoffs. Job losses diminished last month, which is leading some to predict that unemployment has topped out. But today’s numbers don’t account for the massive cutbacks in state and local governments that are now in the pipeline. Mike Shedlock over at Mish’s Global Economic Trend Analysis has been covering the public sector story. And check out this speech by New Jersey’s governor Chris Christie, in which he lays it out in painful detail.

The short version of the story is that over the past couple of decades governors and mayors in badly-run states like California, New Jersey, New York and Illinois allowed public sector salaries and pensions run out of control, and now they’re broke. They’ll spend the coming year laying off workers and cutting pay and benefits, which will cause public employees to spend a lot less, which will produce more layoffs in private sector industries whose stuff the public sector workers would have bought.

More bad international news. Greece, to its credit, is braving some major protests to make legitimate cuts in public sector wages and benefits. Impressive under the circumstances. But the result will be slower growth and lower tax revenues going forward, so it’s not clear that it’s even possible to use austerity without devaluation to fix this kind of imbalance. And Greece, as pretty much everyone knows by now, is just the tip of the iceberg. The bigger PIIGS countries, along with Great Britain, are still to come, and their travails will be front page news for the rest of the year.

Spiking interest rates. While U.S. long-term Treasury bond yields were settling in at historic lows, two memes were spreading: 1) fiscal imbalances will force governments around the world to inflate, making bonds a bad bet, and 2) a recovery, when it comes, will enable monetary authorities to withdraw some excess liquidity and allow interest rates to rise to more normal levels. Whichever of these seems most reasonable, the resulting impulse is the same: to look for a sell/short point for Treasuries. Today, when the news is only mildly bullish (employment still went down, after all) bonds are being sold off hard.

So interest rates are poised to jump as soon as the world stops worrying about deflation. The move will likely be hard and fast, taking mortgage rates along for the ride. With the U.S. housing market barely hanging on despite huge subsidies for new home buyers, mortgage rates back in the 6.5% range will stop the housing recovery in its tracks — and push real estate-dependent states like California and New York further over the edge.

Add it all up and you get a system that’s vulnerable to bad news, with a lot of bad news coming. If any of the above — a spike in oil or interest rates, massive layoffs in California/New York/Illinois, a budget crisis in Britain or Spain — end up happening, then today will seem like one of those dreams from which you’re sorry to wake up.

Tagged as: Economy, Gold, interest rates

{ 18 comments… read them below or add one }

Bruce C. March 5, 2010 at 2:06 pm

John,

What do you mean that today (Friday the 5th) has a “meaningful” feel? It feels as upside down as ever to me. Things seem very precarious. There must be a lot of mis-information around, or ignorance, or both. How investors can continue to think that everything is working out and will be fine despite – well, everything that’s going on – is confounding to me. Maybe the market action today is the result of money blindly bailing out of Europe.

Bill Jones March 5, 2010 at 2:50 pm

But, But, But, we were told by the Maestro that we could borrow our way to prosperity.

John Rubino March 5, 2010 at 4:58 pm

Bruce,

By calling today “meaningful” I’m saying that the market seems to have gotten a very specific, positive message from the latest news, which is why everything moved in an inflationary direction. No meandering or ambiguity — as if this is the start of a major trend. You and I agree that the market is probably wrong.

Brad Thrasher March 5, 2010 at 8:37 pm

There can’t be any doubt that our present course will induce inflation of a scale thus far unseen. History teaches us that hyperinflation arrives in an instant. Zimbabwe, Argentina and the Weimar Republic are primary examples. Is today the beginning?

What strikes me as interesting, even significant about today is just how strong the faith in paper money remains. It seems incredible on its face that so many people representing so many buy/sell decisions remain steadfast in their belief that fiat currency remains the safe haven.

Time will tell. In the meantime, I will continue to buy gold and silver. Regardless of what happens to paper, I’m sure I’ll find someone with a chicken willing to sell me some eggs.

T-Dog March 6, 2010 at 3:54 am

“There can’t be any doubt that our present course will induce inflation of a scale thus far unseen.” Yes but when?? Tomorrow….20 years from now?? Will silver go for the ride or will it first get killed with industrial metals as we slump before an epic inflation?? If inflation is going to be a real problem you are saying the housing market will turn around soon???? No??? So you expect mass inflation without housing participating?? That would be a first no??? (Does it annoy you when I write “no??” because it annoys me too)

I’m not trying to bust chops here, I’m curious.

doctor jd rubino March 6, 2010 at 4:10 am

john, you are 100% correct. people are starting to listen to you but not enough of them. perhaps a “black swan event” is needed to convince people.
people are starting to see that the fed’s usual techniques of easy money is not working anymore. the fed is still the most powerful bank in the world and until they end QE you cannot trust these markets. today could just be another intervention by the fed to buy stock futures and to manipulate peoples confidence. i would stay away and continue to buy physical gold and silver.

Bruce C. March 6, 2010 at 5:20 am

T-Dog,

The question of “when” is the most interesting to me. From what I read and hear, most people do still hold pretty conventional beliefs (“king dollar”, all the bad news is sensational and affects only the margin, things will improve – they always do, etc.) so things may plod along for longer than we might think possible. On the other hand, the big financial downturns recently (2001, 2008) seemed sudden and surprising to most, so – hell – we could say $4 gas by Wednesday.

Inflation can take many forms. If interest rates rise then money itself costs more, so even if a house price is “low” if the buyer will pay a lot for it even if he has cash, since he forfeits “risk-free” interest earned. I still say labor costs will decrease because of global population (greater supply) and lower living standards in most parts of the world. The cost of goods, materials, commodities, however, will rise due to supply constraints and high demand – not because of economic growth but because so much of the world has become more westernized and modern and will want to consume the same things. Also, taxes have the same effect as monetary inflation because they increase the costs of things. Obvious stuff to you perhaps, but I like writing about this stuff to clarify my ideas.

Brad Thrasher March 6, 2010 at 6:56 am

Hey T-Dog,

Forgetting the coma makes me nuts, no?

Whomever is either lucky or smart enough to time this market could become the wealthiest person in the world from a relatively modest stake.

Money is flowing into real estate in China where the banks have continued to lend to anything with a pulse. Although very recently the central planners have begun to put the brakes on.

We haven’t seen real estate respond to inflation here in teh USA yet for a couple-3 reasons;

1. While our own central planners at the Fed have more than doubled the money supply, the new money is held by the banks and not directed out into the general economy. All this new money is circulating in a tight little circle among the Fed, the banks and the Treasury.

2. The gubment is lying to us about inflation. The gubment inflation number is 2-3%. More reliable and straight forward estimates, such as John Williams at SGS put inflation at over 9%. More people believe the government and act accordingly.

3. We are witnessing the FUBAR of all time. It’s way past time to set aside
all of our preconceived notions and pay attention to what is happening, rather than what should be happening.

4. Oh and the short answer to why real estate isn’t responding to inflation is that paper money isn’t chasing real estate. All evidence indicates that real estate has yet to hit bottom, no?

Jason C. March 6, 2010 at 7:17 am

It’s seems possible to me that we have another leg down in all markets ahead of us. Lending is not going to get any better with all the alt-a and option-arm resets this year and next not to mention increasing defaults in commercial real estate. During this time I would not expect inflation to be an issue. We have asset deflation and a little inflation in life-sustaining necessities (food, water, energy), the worst of both worlds. Before this failed reflation effort is over we could see the stock market retrace even higher and oil hitting $100 going into 2011. We do have the the bottoming of the 120-year Kress cycle and Kondratieff long-wave cycle to contend with centering around the ominous 2012-2014 period, which indicates a strong deflationary wave and the world-wide recognition of great depression 2. Stronger government resolution to debase currencies would surely follow such a scenario.

paper is poverty March 6, 2010 at 8:28 am

I can’t quite believe the VIX is at lows last seen in May 2008. If that’s not a screaming contrarian indicator, I don’t know what is. And when stocks crash again, that will take down consumer confidence, make the pension situation even worse, etc.

Brad Thrasher March 6, 2010 at 8:31 am

Hey Jason C.,

For the first time in our 25 consecutive year marriage, we are checking the mailers for food prices. This is different for us because we had always just bought what we wanted. Vine tomatoes hit $3.49 lb. here in Southern California and that’s the day I pulled out the coupons.

As for oil, the price seems dependent on whether we choose to reward the Russians and punish the Chinese or vice versa.

All the Best,
Thrash

Jason C. March 6, 2010 at 11:12 am

Brad,

Yes, it’s certainly an indication of the middle-class march toward reduced living standards. I’ve heard some food suppliers are reducing their package sizes in order to keep the image of stable prices (same as inflation). Costco seems popular these days. I’ve almost eliminated eating out and when I do, I find a coupon first. My wife has become an Ebay expert, finding bargains that undercut retailers such as Home Depot and most clothing outlets.

Retailers are being squeezed at the margins. For the first time I can remember our average sale per prescription drug has fallen steadily for the past 2 years from $50 to $40 while, during the same period, I’ve seen acquisition costs for brand and generics drugs rise. We’re selling more generics cheaper than ever before and our average gross profit per prescription is where it was 10 years ago.

I’m sympathetic to John Williams’ more accurate statistics on inflation and unemployment. Even that CPI doesn’t seem like a great measure of inflation because I think it includes residential rents rather than actual homeownership costs/prices. If home prices were thrown into the mix, I think we would see higher inflation during the 2002-2006 property ladder boom and, subsequently, lower inflation or even deflation during the 2007 – present housing market crash. It’s obvious to anyone other than our mainstream media commentators that government stated inflation and unemployment figures are increasingly rosier than reality would dictate.

Bruce C. March 6, 2010 at 1:39 pm

Does anyone know anything about a personal finance advisor/manager named Ric Edelman (sp?) ? I’ve caught a few minutes of his radio show over the last few months and he’s a real optimist. He is constantly trying to get people to believe in the markets and stay the course on their investment plan. Today he explained the concept of “confirmation bias” and warned against falling prey to it. Basically, that means allowing your political and economic beliefs to sway your investment decisions by dismissing what data doesn’t fit your beliefs and focusing on only those that do. One basic claim/belief of his is that Washington policy ultimately has nothing to do with businesses’ ability to make money and profit. He points out that monthly unemployment has dropped 95% since last year (36,000 versus 700,000), business profits continue to rise, CEO outlooks are positive, GDP projections are in the 3% range, Greece turned out to be no big deal, there is no evidence of inflation in the near-term, etc. etc. – and all of this despite bailouts, QE, stimulus, possible HC reform, possible Cap & Trade, possibly higher taxes, etc. He predicts the DOW will end the year around 11,700 and urges his listeners to not fall for the fears that these things might bring, because they won’t.

Brad Thrasher March 7, 2010 at 11:23 am

More inflation. Yesterday while doing some shopping, we realized we hadn’t pulled anything out for dinner. She loves KFC so I suggested it. We pull up and I see her #2 dinner (breast & wing – 2 sides) is now $7.49.

Instead, we went across the street for Chinese. Instead of spending 20 bucks, I spent less than 12 and there’s still enough left over for a decent snack or lunch.

I suppose KFC will be going out of biz pretty soon.

John Rubino March 8, 2010 at 10:06 am

Bruce,

That’s a pretty standard view among mainstream financial planners and stockbrokers. For them the past 70 or so years constitutes the “normal” world, and in that time the market has always come back. So buy good stocks and bonds and let them ride.

Their mistake (and it’s the same mistake most economists seem to be making) is that they’re looking at only one side of the ledger. Since the Depression we’ve been inflating history’s greatest credit bubble, which has allowed corporate earnings and home prices to rise artificially and kept government bond yields low. But each new market recovery has come with a higher level of debt, and now we owe so much that the whole show is about to end.

The guys preaching traditional buy and hold (especially those recommending long-term bonds) will spend the next few years fielding calls from pissed off clients, and then they’ll be fired. Poetic justice for sure, but still, you have to feel for their families…

Bruce C. March 8, 2010 at 8:10 pm

John,

Thanks. Sometimes the more I study the more confused I become, especially when I run across studies that warn against acting on what you believe to be true.

Bruce C. March 8, 2010 at 8:12 pm

John,

Thanks. Sometimes the more I study the more confused I become, especially when I run across studies that warn against acting on what I believe to be true.

kenny March 12, 2010 at 6:25 pm

Face it folks we’ve had our day in the sun, the party is fizzling out…….start practicing now what we’ll be facing in the near future, while at the same time thank God for right now because that is all we really have any way……….savor the moment because these will soon be call the good old days……peace.

Leave a Comment

 
[Most Recent Quotes from www.kitco.com] [Most Recent USD from www.kitco.com] [Most Recent Quotes from www.kitco.com]