Chris Mayer

If Paul Revere were around, maybe he’d get on his horse and start yelling, “Inflation is coming! Inflation is coming!” I think it is coming. In fact, in many ways, it’s already here, just not yet widely recognized. The deflationists still hold sway in the bond market, where investors happily accept puny yields.

The deflationists argue that the dollar will buy more tomorrow than it does today. It is inflation’s opposite. When most people talk about inflation and deflation, this is what they mean. This definition would pain the old economists who were more careful in their use of language.

Be that as it may, deflation today is an argument facing death by a thousand cuts. Every day, evidence rolls showing that the dollar is buying less. Today’s Wall Street Journal points to the whale in the aquarium. One headline reads, “From Cereal to Helicopters, Commodity Costs Exert Pressure.”

The article goes on to point out what is painfully obvious to anyone who follows commodities and companies. The cost of nearly everything is going up. General Mills will boost the price of a quarter of its cereals to reflect rising prices for grains. Kraft is raising prices. Domino’s Pizza hasn’t said it will yet, but it did say the price of cheese is up 29% from a year ago. Profit margins are suffering in the meantime.

There is a long list of companies battling rising costs of the commodities. As the Journal notes: “Corn is up 44%, milk is up 6.5%, hot rolled coil steel is up 4%, copper is up 29% and oil is up 14% from a year ago… Across Corporate America, more companies are wrestling with when and how much to raise prices as raw materials costs climb.”

Still, the Journal’s article had no discernible effect on the optimistic bondholders. (Or should I write “bag holders”? For soon, they will be left holding the bag.) The bond market seemed bored and yields inched up just a touch today, such that the 10-year note recently paid a whopping 2.50%.

By the time the bond market says inflation is here, it will be too late – too late for bondholders. In the meantime, the prices of gold and silver are up too. All of these things point to the obvious: The dollar is buying less.

Why?

Let us the count the ways. There is the US government bleeding red ink and heavily in debt. Both factors portend bad things ahead. How will they square the circle? The easiest – and the most politically expedient – way is to print more money.

There is the jawboning going on between central banks of the world all trying to cheapen their currencies. The rationale is to stimulate exports. But don’t be fooled; the real effect of a cheapened currency is that your dollar will buy less. There are all kinds of fancy names for what the Fed is doing – “quantitative easing” comes to mind. But at bottom, they all mean the Fed will create more money.

I was at Grant’s Fall Conference in NYC recently. Jim Grant, the host and editor of the excellent newsletter Grant’s Interest Rate Observer, said: “Don’t you sometimes get the feeling that the economists are pulling our leg? A bartender would call it watering the whiskey.”

That is a good way to think about it. More dollar-printing simply dilutes the buying power of all dollars. And so we see today the beginnings, the mere sprouts, of a fully-fledged inflation. It can and will get much worse.

Don’t pay attention to that thing called the Consumer Price Index, or CPI. It is running at about 2%. It is an engineered figure and not to be trusted. Oskar Morgenstern, who along with John von Neumann contributed so much to game theory, once described it as a “mere index of doubtful validity,” as Grant relayed.

Nonetheless, on the basis of this suspect fluff, the Fed tells us inflation is under control. In fact, the Fed is complaining that the inflation rate may be too low. As Grant quipped, “That’s like the New York Police Department complaining about the lack of crimes.”

Bernanke would have us believe the Fed can calibrate inflation within tolerances of 100 basis points. But it way overestimates its powers. Once the inflation train gets going, it will be very hard to slow down. One day, the Fed will wish inflation were only 2%.

In the meantime, what to do?

I think we do what we have always done in my investment letter, Capital & Crisis: We try our best to invest intelligently. That includes investing in commodity companies that benefit from a higher inflation rate. Their selling prices will rise faster than their costs.

The price of commodities adjusts quickly to the falling dollar. Wages always lag that. Plus, there are fixed costs that adjust more slowly – such as leases, for example. So there will be a window for commodity companies to make some serious hay.

Investing intelligently also includes investing in good businesses at good prices, especially if they have the opportunity to grow much larger over time.

Chris Mayer
for The Daily Reckoning

You May Also Like:


Investing in the Middle of a Commodity Bull Market

Chuck Butler

Talk about counting flowers on the wall, playing solitaire till dawn with a deck of 51, and all those other things that fall under the category of being bored, and dull… That was the day in currencies yesterday…The euro (EUR) continued to have pressure applied from Greece, and the Canadian dollar/loonie (CAD) remained above parity […]

Chris Mayer

Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents

Recent Articles

The US Debt Crisis that Will Never Happen

Chris Mayer

One of the most heated political battles raging across the western world is debt versus austerity. In the U.S. this debate reached it's apex in 2011 when the U.S. credit rating was downgraded by Standard and Poor's. In today's essay, however, Chris Mayer throws the debate out the window, explaining why he thinks a U.S. debt crisis will never happen...


3 Tips to Finding Small Companies With Huge Potential

Matthew Milner

Believe it or not, more capital for a company doesn't necessarily mean better returns for investors. In fact, in a recent study that dug through data from more than 200 acquisitions going back to 2006, they found a "sweet spot" for the most likely acquisition targets. And it's lower than you think. Matthew Milner explains...


Disruptive Innovation Will Change How You View Obamacare

Greg Beato

The Affordable Care Act dumped 2,000 pages of regulations into the health care sector, stifling any innovation that could have brought about real cost savings. But even with these obstacles, there are still people looking for ways to do things better and at a lower cost. These new technologies could be the key to fixing health care in America...


Why Old-School Tech Stocks Are Beating Social Media

Greg Guenthner

While many of the newer social media stocks struggle for gains this year, old-school tech stocks have become some of the best trades on the market. With the rare exception (Facebook is doing well—shares are up 26% year-to-date) the social stocks are in the gutter. They got off to a fast start in January and Februray, but ran out of steam in the spring. Aside from a few feeble attempts, few have posted anything close to a noteworthy comeback. Twitter, LinkedIn, and Groupon are all down double-digits year-to-date. Groupon—the worst performer on this short list—is down 47%. On the other had, the biggest of the big tech stocks on the market are helping traders pile up even larger gains right now. Greg Guenthner explains…


Video
Creditism and the Threat of a New Depression

Richard Duncan

In the 1960s, total credit in the U.S. broke the one trillion dollar mark...and since then, it has expanded over 50 times. But now, as Richard Duncan explains, the explosion of credit that's made America prosperous, threatens to take the entire economy down. And that could mean the return of another depression...