Warming Up the Helicopters: The Next Re-Inflation On the Way?
By Tony Allison, September 17, 2007
“High inflation countries almost always have high money growth and low inflation countries have relatively low money growth.” Federal Reserve Chairman Ben Bernanke
To cut or not to cut, that is the question. With apologies to Will Shakespeare, the chances of the Federal Reserve standing pat on September 18th are slim to none, and slim just jumped on the last bus out of town. Perhaps it’s just a question of beating a dead horse, or tilting against the mainstream tide of denial, but with a global financial system built on massive debt and easy liquidity, the Fed must re-liquefy the system, and it will. One day the liquidity tide may ebb, but no one can accurately predict when, so for now the party will rage on into the night, keeping all boats afloat.
Actions speak louder than words
While central bankers around the world speak gravely of the dangers of inflation and pledge to protect their citizens against its scourge, their actions speak differently. The money supplies of the world’s largest nations are growing rapidly. According to M3 and M2 statistics, Russia leads the pack with 51% growth this year in its money supply, followed by India 22%, China 20%, Brazil 16%, UK and Australia 14%, Europe 13% and the US 12%. Relatively speaking, the US is showing remarkable restraint, although that may soon change. Can you see a general trend forming here? Do you believe GDP growth is keeping up with these money supply figures?
As the supply of money and credit increases around the world, the value of each unit of currency depreciates. It takes more and more money (as purchasing power declines) to buy the same number of goods and services as the money supply expands beyond each nation’s growth rate. That’s why tangible asset prices have been trending higher for years; too much money chasing a limited supply of assets. It’s always going to be easier, and much cheaper, to print money than to locate and extract oil, natural gas, base metals, and precious metals. And much cheaper to print money than to grow wheat, soybeans, produce milk, etc., etc.
Pressure on the Fed to act
As the nation enters a critical presidential election cycle, the odds of the Fed cutting rates grow even higher. The drumbeat of pressure on the Fed to “do something” about the housing debacle is growing daily. The irony of course is the Fed’s flooding the markets with easy money starting in 2001 helped create the massive bubble in real estate. The response to every crisis is yet more liquidity to “solve the problem.”
Inflation politically acceptable
Politically, every government in the world would rather opt for inflation, even modest hyper-inflation, over a devastating deflation. (Although a period of deflation might be best for the general population, if market forces were allowed to work. Politically, it would never fly.) For debt-based economies such as ours, inflation is far more politically acceptable. The dollar will buy less over time, but it will be a surreptitious decline (like slowly raising the water temperature in a tub until one is cooked). Asset prices will rise, the stock market will hit new highs, and the banks will prosper. The crisis will be averted. But the purchasing power of the middle class and the retired will suffer greatly. Without realizing why, American’s quality of life will deteriorate. Henry David Thoreau’s famous line that “most men live lives of quiet desperation” will gain resonance in a hyper-inflationary outcome.
Chairman Bernanke has stated repeatedly that he will do whatever it takes to forestall a deflationary depression for the economy. With or without the black helicopters, the Fed will cut rates and inject liquidity into the economy as it feels necessary. The Fed will jawbone all day long about the dangers of inflation and its vigilance to stand firm and hold the line. But the Fed’s actions will speak to its true intentions.
Recessions politically unacceptable
Former Fed Chairman Alan Greenspan was on “60 Minutes” last night and claimed he “didn’t get it until very late” regarding his awareness of the reckless lending practices and resultant real estate debacle, until late 2005 or early 2006. If the leader of the world’s leading central bank didn’t see this disaster coming years earlier, we have reason for concern.
Looking back at his reign as Fed Chairman, it seems he has tried his best to abolish the business cycle through persistent liquidity injections. Recessions prior to Mr. Greenspan’s term, while painful, have healed and cleansed the economy as part of the normal business cycle. As the Fed faced financial challenges in 1987, 1991, 1994, 1998, 1999, 2000 and 2001, the response was always to flood the economy with money and credit. Each liquidity “bailout” just encouraged the next bubble, and extended the imbalances. We appear to have reached the point where it is politically impossible to allow a significant recession to cleanse and rebalance the economy. Perhaps the extreme levels of government and individual debt have made this necessary. This is also reason for concern.
Look for the Fed to receive assistance from European and Japanese central banks by way of purchasing Treasury Bonds to help prop up the dollar after September 18th. An imploding US dollar will not benefit any of the major players, so a coordinated global re-inflation may be required. The one potential winner, longer term, is likely to be gold. For the near term, gold may be sold by foreign central banks to protect the dollar by driving down the gold price.
Prepare for the next bubble
The next re-inflation cycle will likely lead to the next bubble, and that bubble points in the direction of natural resources. With the major nations scrambling for commodities of all types (oil, natural gas, iron ore, copper, zinc, uranium, nickel, lead, silver, etc.), the race to secure future supply sources will be on. China, India and Europe will be competing with the US for limited natural resources with nearly unlimited currency to pay for them. Just as in any spirited auction process, the bidding may become frenzied and irrational as China and India flex their growing muscles through Sovereign Wealth Funds. China in particular desperately needs commodities of all varieties to keep its industrial revolution on track, and its enormous and expectant population productive and stable. And as prices rise, China can afford the sticker shock with its trillion-dollar trade surplus.
The western world will be right in the middle of the fray as well, looking for investment opportunities in the fastest growing areas of the world, and urgently seeking to secure future energy needs in a world with flat-to-down supply growth and rapidly growing demand.
The next global re-inflation will provide the greatest rewards to those investors who get in early to those areas of great promise and who exhibit patience as the flood of global liquidity discovers that sector of the global economy. I believe the gains we’ve experienced in natural resources this decade are the beginning of a longer, and even stronger trend.
Stocks fell moderately Monday as Wall Street awaits the Federal Reserve's impending decision on interest rates.
The Dow Jones Industrial Average fell 39.10 to close at 13403.42. The S&P 500 Index closed down 7.60 to close at 1476.65. The Nasdaq also closed modestly lower, ending at 2581.66, down 20.52.
Northern Rock PLC, Britain's fifth-largest mortgage lender, saw its stock plunge and customers withdraw billions of dollars after it issued a profit warning Friday and drew on emergency funds from the Bank of England. That gave U.S. investors an added impetus to pare their stock holdings, particularly in the financial sector.
Gold for December delivery climbed as high as $728.30 an ounce on New York Mercantile Exchange. It finished up $6.00. Crude oil futures climbed to another record level above $80 a barrel, finishing at $80.57, up 1.47 for the day. Oil prices overcame earlier weakness as traders worried about near term global supply issues and a bet that a Federal Reserve cut in interest rates will help lift energy demand.
Wishing you a good evening,
© 2007 Tony Allsion