Going Postal on Inflation

The Daily Reckoning PRESENTS: Well dear reader, it appears we are backed into a corner. Once again inflation is the bully in the schoolyard, and we are the little guy who doesn’t want to give up our lunch money. Our only hope is that the mighty Mogambo makes it in time to stop him – or at least offer some amusing insights onto why this bully is so ridiculous. Read on…

GOING POSTAL ON INFLATION

An unseen hand slips a piece of paper under my door, and then I hear footsteps hurrying off. Curious, I walk over and pick up the paper, and see that it is a Bloomberg.com news item about the Labor Department reporting, “Prices paid to factories, farmers and other producers rose 0.7 percent after a 1.0 percent gain in March.” No wonder they hurried away, as I feel those old feelings welling up inside me, wanting to lash out in anger, and all I need is a target!

Even worse, as Bloomberg writes, “Today’s report showed food prices rose 0.4 percent in April, after the previous month’s 1.4 percent increase.”

Beads of sweat broke out on my forehead as I realized that more of the same is on the way, as “Costs of intermediate goods, those used in earlier stages of production, rose 0.9 percent last month, after rising 1 percent the prior month.”

Inflation is everywhere! I can’t even afford to write my stupid Congresspersons (“Dear Morons, You let the Federal Reserve destroy our money by creating so much of it!”) as first-class postage is going from 39 cents to 41 cents, which is an increase of 5.1%. In case you were wondering, other classes of mail will have newly altered rates, too, and the average rate is going up 7.6%.

This comes on top of (if you remember) the increase in postal rates that took effect in January of 2006, with first-class postage going from 37 cents to 39 cents, a 5.4% increase.

An interesting note to the ugly news was that there is a new restriction on the Post Office, as future rate increases in postage cannot exceed inflation, as determined by the Consumer Price Index! Hahaha! That’ll teach them!

The Post Office is quoted as saying that this would be “extremely challenging” to them, as “Significant portions of our costs – such as fuel and employee retirement and health benefits – routinely exceed the consumer price index.”

Hahaha! You, too? Hahaha! Relax, letter-carriers of America; your own government says that you are wrong, and that prices are not going up! You’re all just a big bunch of stupid poopie-heads about inflation, just like The Mogambo! Hahaha!

If you want to measure inflation, then perhaps the Post Office should read, “Dow Jones Plus 13000 – No Big Deal”, an essay at gold-eagle.com by independent analyst Mark J. Lundeen. In it he wrestles with the problems of measuring inflation, and writes, “as an investor I must come up with a rate of inflation that is real world and easily determined, or risk losing purchasing power, over time, due to inflation’s erosion on the dollar.”

Looking at alternatives, he compares the rise in various costs, expenses and indexes to the rise in the Dow Jones Industrial Average since 2000, and concludes that the annual increase of his property tax can be accurately used “as the yearly inflation benchmark to determine if I am making an inflation proof return on my capital.”

Even better, “the calculation is very easy as we only have to do it once a year and our county officials will make sure we have all the information we need”! How handy! Thanks, Mark!

And how much did his property tax increase from 2000 to 2007? About 6.7 times as much as the Dow increased!

Now that the housing market is in obvious distress, perhaps you would be interested in knowing exactly who is going to eat those mortgages going bust. In his book Financial Armageddon, Michael Panzner reveals that the Bank for International Settlements (BIS) figures, “more than half of all U.S. residential mortgages were incorporated into mortgage-backed securities in 2006.”

A mortgage-backed security, in case you were wondering, is when a bank bundles up a lot of mortgages altogether into a unit, slices and dices the bunch into various pieces, or “tranches” which vary according to what the piece yields, pays or promises, and the pieces are then sold to various buyers, who buy them for various reasons.

The very, very interesting part is that “the yield of each tranche would vary, with the overall average working out to less than what the underlying mortgagees were paying.” Hahahaha! So, as stupid as the banks were to make these risky-but-low-yield loans, the average of the “investors” who bought the mortgage-backed securities from them is even more stupid, as he got, on average, a still-risky-but-even-lower-yielding “investment”! Hahaha!

And, even worse, the last tranche was the “equity tranche”, which apparently doesn’t get any payments at all, but that “Anything left over after making good on loan losses would go to the equity tranche holders!” Hahaha!

A voice calls out from the back of the audience, asking “Hey! Stupid Mogambo Jerk (SMJ)! If all the pieces and tranches of the mortgage-backed security add up to less than the whole thing, where did the money go? Did you steal it, you Filthy, Stinking Crook (FSC)?”

I was, of course, livid at the insult. I could plainly see my rude and insulting adversary smirking at me from the back of the room, and I quickly realized that striding back there, grabbing that little snot by his geeky little neck and repeatedly slapping his nasty little face was the only Appropriate Mogambo Response (AMR).

So I say to Mr. Panzner, “Take over for me, will ya?” and I start striding downstage to get my hands on my little nemesis. But I was stopped mid-stride when Mr. Panzner provided my alibi when he explained that the difference went not to the slimy Mogambo, but “to cover the fees of those involved in the securitization and later sale to investors, as well as any legal and administrative costs.”

Until next week,

The Mogambo Guru
for The Daily Reckoning
May 21, 2007

**** Mogambo sez: I am astonished that gold and silver are not leaping in price to heady new highs, and grateful that they are not. So should you be, as it allows you to get rid of some more overvalued dollars by exchanging them for gold and silver while they are still cheap. One day it will not be so!

Editor’s Note: This year, the Mighty Mogambo is actually going to bravely exit his Big Mogambo Bunker (BMB) in order to speak at the Agora Financial Investment Symposium in Vancouver, British Columbia. Don’t miss this opportunity to hear his rants live, on why “We are all Freaking Doomed!”

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

Daily Reckoning sufferers will get a little break today. We’re rushing to a meeting…not much time to write.

We barely had enough time to read the news…and make our head swim.

First, the big news is that China is investing $3 billion in the giant buy-out firm, Blackstone. Remember how we wondered what China would do with all those dollars it has accumulated? It has enough to buy, say, the entire state of Illinois, if it wanted. But now we know…and it confirms two suspicions we have held for many months: the world financial system has gone mad…and the Chinese are simpletons.

In China, people line up to open brokerage accounts. Stocks soar. And when people want to exchange real money for paper (stocks, bonds, hedge fund accounts…) there are plenty of people ready to operate printing presses. So, we read in today’s Financial Times that there is a “Surge in Emerging Market IPOs.”

And now the Chinese government is taking its own money and investing it in the Blackstone magic…which consists of buying companies, putting them deeply in debt, cutting them up, charging huge fees, and selling them to the public – or at least to the other players in the market.

Of course, Blackstone couldn’t do this unless there were plenty of people with plenty of money to throw around on this sort of stuff. We have not only more evidence of that in today’s news…we also have an explanation.

For the evidence, we have a report from last week’s art sales – that hit new records of absurdity. Can you imagine paying $70 million for one of Andy Warhol’s slick inventions? Well, someone did. And others spent millions more on other works of art. How did they know they were valuable works of art…and not just silly pieces of pop trash? Ah…ah…ah…how did they know these objects had VALUE…and not merely prices? Ah…ah…ah…

As we said, our head is swimming…and we feel as though we might have to lie down.

But let us return to China’s purchase of a $3.3 billion share of Blackstone, which the papers tell us is a ‘historic event’…and the source of all this restless, reckless cash. Without all this money, Blackstone would have to settle down…all these wheelers and dealers would have to cool their heels…all these art buyers would have to restrain themselves…and all these emerging market companies would have to actually make money before they could sell IPO paper to the public. And now cometh the UN’s OECD with a pronunciamiento on where this money is coming from: from China and Japan’s lax money policies, sayeth the august institution.

Of course, that is what we’ve been saying for many months. But, at least we had the good grace to give credit where credit was due, by remembering that China and Japan are largely reacting to excesses pushed upon them by the United States of America. But since we are in a hurry this morning, we will leave that subject, and merely report that the OECD says China and Japan are responsible for the buy-out fervor. They allow institutional borrowers to get their hands on so much money, at such low interest rates, that Blackstone and the others are able to do all the deals they want.

In other words, when China finally comes to its senses – and stops goosing up its money supply at such a hell-bent speed – the buyout business will become a lot less interesting…and its shares in Blackstone should fall back to what they are actually worth.

You can join us in Vancouver in July for the Agora Financial Investment Symposium to discuss the ins and outs of investing in the Far East. This year’s theme is “Rim of Fire: Crisis and Opportunity in the New Asian Era” and we’ll have all of your favorite DR editors…and a few very special guests.

But in the meantime, everyone has something to celebrate. The dead artists are happy – they meant to put one over on polite society. Now they have done it. China is happy too. Now the communists are full-fledged members of the Inner Circle…the crème de la crème of 21st century capitalism. And of course Blackstone is delighted. Having the Chinese government as a partner opens up a whole new world of corrupt, insider deal making.

Oh…and we’re happy too. Of course we are. Who would have thought that watching the financial markets could have been so entertaining?

More news:

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Addison Wiggin, reporting from Charm City…

“Over the weekend, the Canadian dollar rose to $.92 – a 30 year high against the dollar.

“Back at the turn of the century, when the euro was trading at $.83 we laughed at the prospect of euro-dollar parity. Who would have thunk… just a few short years later… we’d be on the verge of loonie-buck parity? With gold, the dollar, commodities, real estate all going haywire…you’d expect Sid Vicious to be returning from the grave with a new hit album.

“What’s next? The return of Paul Volcker? More on this theme tomorrow…”

For more insights into today’s markets, see The 5 Min. Forecast

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And another last-minute thought…

*** USA TODAY tells us that another historic event happened last week. For the first time in more than a quarter of a century, Americans are cutting back on their driving.

We don’t know the cause of this big trend reversal. The pundits are blaming high gas prices. Apparently, prices at the pumps are also hitting records – up to $3.18 per gallon on average.

If drivers really are cutting back because of the price of gasoline, it suggests that the consumer is weakening. A poll of consumer confidence says that the poor consumer’s spirits have fallen to an 8-month low. And the housing problem seems in no hurry to go away. “Gloom settles over housing market,” announces a weekend headline.

It appears that the world is in the grip of two major and contradictory trends. At the top, money has never been easier to get…nor have rich people ever been more eager to get rid of it. Money changes hands so fast…and in such volume…the markets and bankers are having trouble keeping up with it. Institutional investors have so much money they don’t know what to do with it.

Meanwhile, down in the Lower Depths…the poor lumpen can’t even afford to drive to the store to rent a movie. They’re not earning any more money…while their costs continue to rise. Every year, we get a notice that a college has raised its tuition. Our insurance and health care costs seem to go up annually. Every time we fill up our tank…or eat in a restaurant…we get a nasty shock. True, the cost of fuel and food is higher in Europe than in America, but the trends go in the same direction. Thanks to our Dear Readers we have enough income to keep up with these expenses; but we wonder how most people are able to do it. Maybe this latest news on U.S. driving habits tells us something…that they can’t.

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