Traumatized by Inflationary Gunfire

You might argue that the Mogambo was a little crazy to begin with; but one this is certain – inflation is massaging that craziness on a daily basis. Poor, poor Mogambo… Good thing he’s got his old friend tequila to help keep his mind right.

As usual, it is inflation in prices that makes me crazy, and it’s tequila that lets me do something fun with my natural insanity to take my mind off the horror of it, as it is inflation in prices that is the precursor to social upheaval and economic collapse, which is why I figure that the Second Amendment was invented in the first place, and if you don’t think so, then just manage to stay alive for the next couple of years to learn a real expensive lesson that you will never forget.

In the meantime, my dire prognostications continue apace, as the CRB index increased 1.4% for the week, which is a lot, and which is about a 15% increase year-to-date. The Goldman Sachs Commodities Index (GSCI) went up by a heart-stopping 3% last week, which means that this index is up a terrifying 42% y-t-d!

And speaking of inflation, the new Producer Price Index came out, and it looks like the price of finished goods, on a non-adjusted basis was up 6.1% year-over-year.

But for businesses, the prices they are paying keep going up, as the annual All-Items PPI inflation for October spiked to a 6.1% jump over this time last year. Food increased 7.1%, and Energy was up16.1%. Yikes!

For All-Items Intermediate Goods, prices were up 5.6%. Yikes yikes!!

For All-Items Finished Goods, prices were a blistering 25.7%. Yikes yikes yikes!!!

And even more ominous, The Economist magazine reports that "The Baltic Dry Index, which tracks the costs of shipping ‘dry’ goods such as iron ore, coal and grain around the world, dipped this week after hitting an all-time high on November 13th. But it is still up 154% from a year earlier." In fact, "The cost of shipping iron ore from Brazil to China is now more than the cost of digging up the ore itself."

The reason is the same old one, "As with so much to do with commodities, the extraordinary rise in freight rates is partly because of China’s appetite for raw materials."

And this means that the transportation pipeline is already too small to accommodate such a large movement of goods, as "A dearth of new ships, and flotillas waiting to berth in overcrowded ports (especially in Australia), are also driving rates higher", meaning that even if enough stuff could be grown or mined, very little of this surplus could be delivered, as the transportation system is maxed out already! Hahaha!

And that is why OPEC saying that they are going to pump more oil is a load of hooey. In fact, The Daily Reckoning’s Desidooru Saloon reports an online.wsj.com article that read, "Sadad I. Al-Husseini, an oil consultant and former executive at Aramco, Saudi Arabia’s national oil company, gave a particularly chilling assessment of the world’s oil outlook. The major oil-producing nations, he said, are inflating their oil reserves by as much as 300 billion barrels. These amount to hypothetical reserves that are ‘not delineated, not accessible and not available for production.’"

The worse news, for those expecting an open oil spigot to save our nasty economic butts, is that, "A lot of production in the Middle East is from mature reservoirs, and the giant fields of the Persian Gulf region are 41% depleted."

But we were not talking about how oil exporters are liars and cheats, but about inflation, and that inflation in prices is everywhere, and everywhere the official response is the same; "Paper that sucker over!", even in oil-exporting nations.

For example, according to the Financial Times, inflation in consumer prices in the United Arab Emirates is "rampant" at "around 10%", which has prompted the federation of seven emirates to think about "revaluing or de-linking the dirham from its long-standing US dollar peg in a bid to tame" the inflation.

There are many ways for a government to paper over this mess. In this case, the UAE plans to, I kid you not, "raise federal government salaries by 70%"! Hahaha! Too rich!

The article even says that there are many of us out here in the real world of economics who are scared out of our freaking minds about such irresponsible government behavior, and indeed there are other "economists" who said that this "could fuel inflation in the Gulf state", although there is no word on how many of these other "economists" are also scared enough to carry so much heavy firepower, so much so, in fact, that they are so burdened that they need a motorized wheelchair just to get around the office, and so much body armor and bullet-proof plating that you need an intern just to help you remove enough of that heavy stuff to take a crap, which you have to do a lot during the day because there is just so much economic bad news scaring the crap out of me, so you can see my problem.

And without the least bit of irony, the very next sentence was, unbelievably, that "A cabinet meeting yesterday raised the 2008 budget by 47%." Yow!

In other sites around the region, Saudi Arabia, according to the Financial Times, "Inflation, which crept up to 4.9 per cent in September after averaging 2.2 per cent last year, is raising anxiety among the authorities." What I think is really worrying authorities is that "Food prices have increased 18.8 per cent", which makes you wonder how in the hell the overall inflation stayed at 4.9 percent?

King Abdullah, proving that being a king doesn’t take a lot of smarts about money, especially if you have a lot of oil to pump that is making you lots and lots of money without lifting a finger, is apparently unaware of the basics of economics, which says that all this excessive flood of money inflating the money supply will cause inflation in prices, which is exactly what is happening. Being a stupid king, and thus at a loss, he "felt compelled to summon officials last month [to] explain the phenomenon."

I don’t know what they did or said, but I assume that they did some uniquely Arab thing, like looking into the eye of some camels and eating figs or something, I dunno, since the idea of actual economics doesn’t seem to appeal to them.

Well, to be fair, the fact is that the supply of oil can’t apparently be increased, and in fact it is going down as part of the Peak Oil phenomenon, and with demand rising, oil exporters are going to be making scads of money, tons of money, mountains of money for their oil, no matter how little they pump.

And speaking of oil, in Martin Wolf’s column in the Financial Times, he quotes the International Energy Agency as reporting the astonishing factoid that "The increase in China’s energy demand between 2002 and 2005 was equivalent to Japan’s current annual energy use." Yow! This is just the increase!

Suddenly, I feel compelled to remind you to buy gold and silver, as much as you can, and take physical possession of them, and put them somewhere safe and sound, someplace where you can get a good shot at anyone who even goes near to that locked closet, and when you demonstrate your resolve with a couple of warning shots to one of the kids who "accidentally" wandered over to the closet while chasing a stupid rubber ball that had rolled in there, leave the bullet holes in the wall as a reminder to the others. Trust me; it’s worked like a charm around here!

But we were not talking about me or my Mogambo Closet Of Bullion (MCOB), or even how some snotty "mental health professionals" think that the stupid kids are now "scarred for life" because of a little gunfire, some random screaming and vague death threats for trespassing in the Mogambo Forbidden Zone (MFZ). Instead, we were talking about inflation and oil, and combining both of them brings us to the further news that in other "Gulf countries", inflation is running at double-digit rates! Ten percent and more! Much more! My God! This is horrific news!

But explaining to stupid social workers the relative degree of the two situations, namely a traumatized bunch of stupid kids or a traumatized stupid economy, is a waste of time, as they just "don’t get it."

I’ll bet you do, though. And if you don’t, you soon will.

Until next time,

The Mogambo Guru
for The Daily Reckoning
December 3, 2007

"I’d wait for him to get home. Then, I’d listen for the car in the garage…and stand by the door until he came out."

Elizabeth’s grandmother was explaining what it was like during the Great Depression. Her husband, a stockbroker, had lost almost all his clients…and maybe all his money. Some men couldn’t take it. They sat in their cars with the motor running until the stock market disappeared forever.

It is hard for us to imagine what it was like. Hardly anyone alive today remembers. Instead, what we remember is a long period in which nothing went wrong. Credit default swaps – insurance against non-payment – grew like mushrooms, up nine times in the last three years…to more than $45 trillion.

And why shouldn’t they grow? It cost almost nothing to insure against default…because nothing ever defaulted. Even if you wanted to default – whether on a commercial loan or a mortgage – it was hard to do; there was always someone waiting to lend you more money.

But now…things have changed:

"Suddenly the mood has darkened," reports the London Times. "Just when bankers and investors were hoping the worst was over, a second devastating wave of writedowns from major banks has rocked confidence. In recent weeks, Citi announced it would write down a further $6.4 billion in losses related to the sub-prime mortgage crisis. Merrill has also revealed more losses, while HSBC last week said it would take $45 billion back onto its balance sheet by rescuing two structured-investment vehicles. Last month Barclays wrote off $1.3 billion.

"More pain looks inevitable. Analysts expect Citi to be hit with a further $15 billion of writedowns. Investors will be nervously scrutinising a Royal Bank of Scotland trading statement this Thursday when the bank is expected to reveal sub-prime-related losses of more than £1 billion. Goldman Sachs analysts have estimated that the total sub-prime-linked losses could reach a whopping $500 billion – far higher than Federal Reserve chairman Ben Bernanke’s initial estimate of $50 billion, later revised to $150 billion.

"To add to the gloom there are mounting fears that the problems could engulf other types of American debt – credit cards, car finance and unsecured loans.

"’What has happened is that the risk has been spread so far and wide that no-one really knows where the pain is being taken. The financial bombs just keep going off,’ said one senior investment banker."

Last week, none of our milestones were hit.

Gold didn’t rise above $850. The euro (EUR) didn’t go above $1.50. Oil didn’t hit $100.

Well, there’s always next week!

You will recall, dear reader, that we are watching a titanic traffic accident. The unstoppable force of inflation is running smack dab into the immoveable object of falling prices.

We don’t yet know how it is going to turn out…but we’re sure of one thing: sparks will fly when these two collide.

Last week, the European Central Bank announced that it "fears inflation more than a slowdown," according to the Financial Times. But most of the news points to an increasing danger from falling prices, not rising ones.

Commodities were down on Friday. Gold fell $13. It could go as low as $700 in this correction. Buy the dips, dear reader. Take advantage of a correction in the yellow metal – and it could turn out to be a golden Christmas for you.

"Foreclosures are piling up," says the Associated Press. And now comes this shocker from the Commerce Department: the median house price in the United States fell 13% over the 12 months ending in October. The median house now sells for $217,800. Hmmm….that’s about $2.6 trillion in disappeared value from the national balance sheet.

But we have a long way to go. Wives are not listening to their husband’s automobiles; not yet.

*** As anticipated, here comes the Bush Administration with a plan to make the subprime situation worse.

It’s called the ‘teaser freezer’ program and it could be announced as early as today. What’s the idea? Well, it’s quite simple – just pass a law! Actually, we’re exaggerating. The discussion so far, as we understand it, is to ask for voluntary cooperation from the mortgage lenders. They are supposed to let the teaser rates ride…for people who can’t afford an increase.

"Deal in the Works to Freeze Rates on Subprime Loans," says the Washington Post. Of course, if such a deal made sense, lenders and borrowers could work it out on their own. And if it were possible to eliminate the problem – or even ease it – by government decree, it would be a very different world than the one we live in. When people owe money and can’t pay it back, someone is going to take a loss. You can diddle with the details all you want…all you’re going to do is to shift the loss from someone who deserves it onto someone else.

The great innovation of the recent credit boom was to create a stick that was long in the middle and short on both ends. On one end, the borrowers are now losing their houses. On the other, the investors are losing their money. The financial intermediaries – notably Goldman Sachs (NYSE:GS) – are sitting pretty. They made their money by putting the two dumbbells together. And now, the Bush Administration is taking the time-honored tradition of pushing more of the losses away from the borrowers…and towards the other end of the stick, that is, towards the lenders. Why? Hey…where have you been, dear reader? We live in a democracy. One man, one vote. How many subprime borrowers are there? How many subprime investors are there? You do the math. And expect more meddling as the crisis continues.

*** Among the many investors in subprime debt were state and local governments. Now, the press reports that Florida schools are "flat broke" as a consequence. And they’re not the only ones. We’re read about a couple French banks that have taken huge hits. And in last week’s news was a report from north of the Arctic Circle, where towns in Norway had – you guessed it – invested in subprime debt. Citibank sold them the toxic stuff. Now, the poor Norwegians are not going to be able to retire in the style to which they had hoped to become accustomed.

So you see how it works? What goes around comes around. A fellow buys a home he can’t afford. Wall Street sells the debt to a pension fund. The guy defaults on his mortgage. He loses his house…and his pension! The Wall Street financier, in the meantime, puts a new wing on his palace in Greenwich.

*** But don’t worry. Another rate cut is coming – in less than two weeks. Let’s see how this works again…people get into trouble because they’ve borrowed too much money. Then, the feds come to the rescue – by offering to lend them more at lower rates!

But what’s this? The banks aren’t cooperating. While the feds lower…the banks raise. They ask for higher rates to protect themselves from the growing losses.

Part of the problem is that there is so much credit around…of such dubious quality…that the banks (and investors generally) don’t know what to make of it. Double-A mortgage-backed credits are now trading at half their prices three months ago. It may be true that investors are overreacting. But after such a long period of not reacting at all…what would you expect?

"Lower rates usually boost stock prices. But there’s another side to this story. There’s a side few financial forums care to consistently report," Free Market Investor’s Christopher Hancock tells us.

"Lower rates mean more money. More M3 means more inflation. Most haven’t noticed the effect yet, because Chinese imports have delayed the hangover. But the days of importing Chinese deflation are coming to an end, as well.

"Every imaginable rescue mission for the overly indebted American consumer, not to mention the overly indebted American government, leads to increasing quantities of dollars and credit, which can only mean one thing:

"Dollar-holders beware."

And isn’t is possible that the Fed, like the Bank of Japan before it, is now in the unenviable position of no longer pulling on the string of credit…but pushing on it? Isn’t it possible, that the market no longer welcomes cheaper credit, but fears it? And isn’t it possible, as we guessed last week, that the Fed is no longer driving the price of credit – by lowering rates – but following along behind what the market is already doing? U.S. Treasuries are dear; yields are low. The 10-year note is already below the yield of the Fed Funds rate. People are happy to lend to the government, because they know they will get their money back. But woe to the borrower without the U.S. government behind him.

Will a lower Fed rate encourage the mortgage lender to finance another house in the Detroit area? Will it encourage a builder to put up more condos in Miami or Las Vegas? Will it entice the marginal homebuyer to enter into another ARM contract?

Maybe not. That’s the trouble with the immoveable object of deflation. It can be stubborn. Sometimes, it won’t budge.

*** Poor Henry. The 17-year-old has to write his college essay. He’s applying to various American universities…and to Cambridge in the United Kingdom. But he’s also going to one of the toughest schools in France…where he is doing math that bears no resemblance to anything tackled by the Class of ’66 at Southern High in Anne Arundel County, Maryland.

The problem for Henry is that he has to try to keep up with his work in school…while also figuring out where to go to college and getting together his applications.

"Sorry, Henry, I have no idea what any of this stuff means," we had to tell him…after trying to figure out one of his math problems. "But maybe I can help with your essay."

"Well, I’m supposed to write something that tells a bit about who I am…about something that influenced me…or a book that made a big impression on me. I was thinking of writing about To Kill a Mockingbird."

"Don’t do that," was our advice. "They must get thousands of kids writing about To Kill a Mockingbird. And what are you going to say that hasn’t already been said a thousand times? Instead, I would choose something that is specific to you. Original. Don’t try to talk about big themes…don’t try to sound smart…or wrestle with global warming or ethical issues. Just tell a story. Write with your eyes and your ears. Tell it as it happened. Tell what you heard. What you saw. What happened. Let them see who you are…by seeing the world that you see…through your eyes. Don’t try to explain who you are or what you think. Don’t come to a conclusion; let the reader do that. Don’t use big words…and no Latinate words; stick to Anglo-Saxon words."

"Hmmm….then maybe I should tell about that time I helped Damien. That was an experience. We were working with power tools in the rain. It was shocking. Heh heh. And Damien practically cut his finger off."

Until tomorrow,

Bill Bonner
The Daily Reckoning