Watch the Gauges!

Mogambo on Monday! The PPI is rising… oil, gas and energy costs are pushing multiyear highs… is something brewing? The Mogambo Guru takes a reading of the gauges, and shouts: INFLATION!!!

The most unsettling news of the past week, to me, is that Treasury Secretary John Snow has apparently requested a meeting with all 12 Fed governors. The Treasury Secretary and all of the Fed governors in the same room… at the same time. This cannot be good.

What will they discuss, one wonders…

Perhaps it has something to do with foreign central banks who gobbled up another $8 billion of U.S. debt last week and stashed it at the Fed. Are the chickens coming home to roost? Or maybe it has something to do with the fact that Fannie Mae has more than $900 billion of debt, more debt than either of the British or French governments. Perhaps estimates by the Bank for International Settlements – that global derivatives now total $208 trillion, roughly 700% of global GDP – have Snow on edge.

Or maybe the fact that the stock market is now so over valued, more than any other point in US history, is causing some concern. Or the meeting may have something to do with inflation. It is roaring like an unchecked bush fire – and that means US bonds, which are paying negative real interest rates, are now so overvalued that there is no way that anyone holding American debt can possibly SEE value, even standing on tiptoes and using the Hubble telescope.

Monetary Inflation: John Snow and the 12 Dwarves

Whatever the case… John Snow and the 12 dwarves from the Fed are going to meet. And something is going to be done. My prediction: whatever they do will be so horrible that future historians are going to have a field day with it. Trust me on this one.

The part that is so tragic is that everybody knows the end result of this kind of money-madness excess. Nobody even disputes it. Nobody even tries to hide the truth, because the history of the world is littered with the inescapable evidence. You will end up with, and you might want to write this down, because it will soon seem very important to you, high and ruinous price inflation caused by high and ruinous monetary inflation.

Robert Prechter still sees deflation on the cards, and points to the action in the money supply, which, when I look at the chart, is one of three possible scenarios: 1) slowing, 2) lacking in marked advance, or 3) stagnating, which are all de facto proof of monetary deflation. So, classically, we have less money chasing more goods, and prices should fall.

But not all prices will fall under deflation, just as some prices do not rise during inflation. I can easily see why houses, stocks, bonds, and collectibles, and other such things would go down in price – because demand will fall. And because they are being supported at these lofty prices by the rampant monetary goosing by the Fed, these prices would seemingly fall a long way if demand faltered.

Monetary Inflation: Food, Oil, and Everything Else

On the other hand, I can also see inflation on the cards. We are a nation that imports a lot of the stuff it consumes, and a falling dollar equates to the rising price of imports, ceteris paribus. I am thinking specifically of oil, which has gone up dramatically in price, oh and food as well, and since we are talking about it, just about everything else.

"The stagflationary 1970’s provide an important precedent in recent American financial history," opines Bill Fox, "particularly since I believe the decade ahead will echo the 1970’s, only worse."

"This type of inflation typically means an expansion of the money supply and bank credit ahead of gains from productivity and asset growth. More money and credit chasing fewer goods and services typically means higher prices over the long run." This is the kind of inflation that we have been subjected to by Greenspan and the Fed for as long as I can remember, and I ain’t no Spring chicken.

Inflation destroys consumer purchasing power. The creation of money and credit does not create prosperity, any more than a counterfeiting ring would. It’s a form of taxation on the consumer. "Stimulus spending typically creates the short-term illusion of prosperity at the long-term price of distorting the economy and debauching the currency."

Fox has also looked at the historical record and notes that "Price inflation may also remain initially muted because excess liquidity can first find its way into stock, real estate, or bond asset bubbles. It may experience a prolonged delay in running up commodity and consumer prices."

Well, take a look around! Sound familiar? This excess liquidity has already found its way into stock, real estate and bond prices. And now it’s finding its way into commodity prices, too, although the government wonks who are supposed to be looking at this kind of thing are all asleep, or lying, or both.

Monetary Inflation: Hyperinflation

"The magnitude of America’s trade deficits and indebtedness suggest that the US will eventually wind up with double-digit interest rates and hyperinflation." Check out that "hyper" in "hyperinflation." Scary stuff indeed.

"This is the kind of environment where gold often outshines all other asset classes," Fox concludes. "This is the overall underlying environment I believe we have been in since the Nasdaq top in March 2000, and it could last for many more years." So, and this is the important point, a guy who has been careful to look at the historical precedents figures that the bull market in gold could last for many more years…very interesting.

But it’s not just cranky newsletter editors who’ve taken notice of the trend. Cranky financial journalists are on the case, too. "For the second straight month a forecasting outfit called Economic Cycle Research Institute said its inflation gauges have risen," John Crudele of the NY Post observes. "Federal Reserve Chairman Greenspan keeps close tabs on ECRI’s numbers – first because he trusts them and, second, because the organization was founded by one of Greenspan’s beloved former professors. And, I’m told, ECRI will start worrying about inflationary pressures – and convey that concern to the Fed – if there is a jump in this month’s numbers, which will be reported in early April."

So this ECRI bunch says its "inflation gauges" have, and let me check to make sure of the correct word, "risen." In other words, there has been a rise, which I derive from the root word "risen," that has been detected by some monitoring sensors equipped with readout functions, otherwise known as "gauges." And these aforementioned "gauges" have, thus, "risen."

Yet, and you gotta admire their patient courage, as they are waiting and worrying, and Alan Greenspan and the Fed are walking around unaware! They do not know of the gauges! The ECRI did not tell them, and are waiting instead ’til next month.’ The poor Fed! Rushing towards the waterfall on the log, and completely oblivious to any peril! But listen to the soundtrack, trumpets blaring and kettledrums pounding, it’s ominous!

Mr. Crudele goes on to say "The most worrisome thing is that the inflation is occurring even though the U.S. economy is showing only modest growth and very little job creation." This I interpret, as far as I can make out, to mean that if the prices of things go up, but there are fewer people with jobs who are thus able to BUY the things, then it is "worrisome?" You’re damn right it worrisome!

Crudele has also taken a look at the budget deficit. "If the government didn’t have its own accounting method and had to record costs like businesses do, the deficit would probably be more than $750 billion. For one year." And this ignores the gigantic wad of accumulated deficits from years gone by, which is, using Official Public Debt as a minimum, now over seven freaking trillion dollars (SFTD).

"These sort of numbers will be a big problem for the financial markets when they start paying attention," he says.

There are many intelligent people who are predicting a long, long and a painful, painful economic recovery, because it’s not just the house that is flooded. It is the whole damn neighborhood, stretching to the horizon in every direction, because it was the dam that burst.

"For many people," Mr. Prechter continues, "the single biggest financial shock and surprise over the next decade will be the revelation that the Fed has never really known what on earth it was doing. Make sure that you avoid the disillusion and financial devastation that will afflict those who harbor a misguided faith in the world’s central bankers and the idea that they can manage our money, our credit or our economy." Bravo!

"The ultimate consequences, will be more severe and more confounding that the consequences of the 1929-1932 crash."

Regards,

Mogambo Guru,
for The Daily Reckoning
March 22, 2004

P.S. While Mr. Prechter has been fairly bearish on gold, in Conquer the Crash, he also said that: "If gold were to move above $400 per ounce, I would probably be convinced that a major low had passed." Next time I see him, I will ask him if he is convinced that the "major low had passed." In the meantime, you can use the MoGu as a rough proxy, who says: "Gold will almost certainly never be cheaper in dollars than it is RFN."

Mogambo Sez: Things are seriously amiss, and getting more amisser by the hour. You should be scared. You should be buying gold, and silver, and commodities, because that is what the future will look like very soon.

Editor’s note: Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications. If you’re inclined to read more, you’ll find the whole Mogambo here:

Where’s The Value?

We’ll stick with our guess: the great rally is over.

On Friday, the Dow went down more than a hundred points. There was nothing in the news to cause buyers to lose courage. Americans are still ruining themselves. They borrow, they spend, they refinance.

From Vancouver comes news of a ‘frenzy’ of buying in the real estate market. Reports tell of 150 people lined up to buy into a new condo development. In a single day, most of the units were sold, bringing in $123 million to the developers.

The guardians of public financial virtue do not merely look the other way. They are right out in front of the mob, urging consumers and investors alike to err on the side of recklessness. They offer them good terms – the lowest lending rates in 45 years – and bad advice. Spend, spend, spend, they say, it only gets better.

"Until it gets worse," they should add. The ‘recovery’ is a fraud. While cheap credit vastly increases the public’s debt…and the price of all assets backed by debt…it does nothing to increase the number of jobs or the real incomes of people who have them. Unable to keep up with the payments, Americans are running out of time.

This is not a problem for Americans alone. The dollar is the reserve currency of the entire world, not just the U.S. And the Fed is — de facto — the bubble-maker for the whole planet. The Fed’s low rates have underwritten a huge boom in debt all over the globe. Assets backed by debt, especially real estate, bubbled-up all over again. House prices, as a percentage of personal incomes, are at the highest levels ever — in the U.S., Australia, Ireland, the Netherlands, Spain and Britain.

"I wanted to buy an apartment in Paris," said our host this weekend — a Frenchman living in Normandy — "but have you seen the prices? It’s crazy. I’ll wait until they come down…I’m not going to get into this madness. I don’t know when it will happen. But these prices have to come down sometime. People can’t afford to pay them."

The Economist looks ahead. It thinks it sees the next big trend in real estate. Even a slight upward bias in interest rates could do for the average house what Al Qaeda does to Baghdad hotels. Expect a 20% drop in prices, says the Economist. It would be the "first global property bust in history," says its source.

It might also be the biggest financial bust in history. Property is a bigger business than stocks. More people own property. There’s more debt leaning directly on the wobbly walls of real estate. And more people are in danger of getting crushed when the earth shakes and the bricks and mortar come falling down.

While there are about $30 trillion worth of stocks in the world, the property market is estimated at about $50 trillion. Much of it is heavily mortgaged. And in the UK, for example, rental income often doesn’t even cover mortgage payments, let alone upkeep and other costs.

In the expansion phase of the debt cycle, debt increased… and everything you could buy with debt was bid up. In the contraction phase, which we think is just beginning, debt will be paid down, downgraded, withheld, discounted, written off, blown up, cancelled, renegotiated and worked out. What it bought — notably real estate — will go down.

Stay tuned…

Meanwhile, here’s Addison with more news:

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Addison Wiggin casting an eye over the financial news…

– If you ignored Monday and Friday, last week would have been a pretty good one for Mr. Market. Unfortunately, a man’s character is measured by the sum of his works… not just the good ones.

– On Monday and Friday the Dow, Nasdaq and S&P were down approximately 250, 70, and 30 points, respectively. Throw in the mid-week rally and the Dow still lost 53 points for the week to close at 10,186. The Nasdaq lost 44 points for the week to close at 1,940. The S&P fell 11 by session’s end Friday… it closed at 1,109. [As we write, we notice what began on Friday is continuing this morning. The Dow has opened 150 points down… the Nasdaq is off by 35 in early trading. Hmmmnnn…]

– Ever the performer in tenebrous markets, gold rocketed $14 to $412. It’s now at $417! The barbaric relic now just a short spike shy of a multi-year high. Silver, too, is threatening the $8 mark! Mining stocks, as you might expect, enjoyed a fantastic week, many scoring 5% gains. The sector is highly volatile, making the ennuie in the major averages seem almost… well… even more booriing!

– "Buy the rumor, sell the news" say the old-time traders. The rumor is that Japan is considering stopping this irksome practice of printing yen to buy dollars. Buying the rumor, currency traders pushed the yen up 4 to 106 against the dollar for the week. The yen is now threatening to break important resistance levels last seen in January. What, one wonders, will the traders do when they hear the news?

– Well, you might think they’d sell. But despite the nation’s staggering twin deficits – the Fed’s spent a whopping $96 billion more in February than they took in tax receipts, and American’s consumed $43.1 billion more than they produced – the dollar lost a mere cent against the euro last week, falling to $1.23. In the meantime, net foreign investment in the US for January, it was reported last week, totaled $92 billion… more than twice the amount needed to finance the trade deficit.

– And, despite a large sell off at week’s end, Treasury markets finished Friday’s session flat. The 10-year yields 3.75%; just below the halfway point of the 12-month low of 3.10% and the 12-month high of 4.60%. "Sooner or later," writes Stephen LaTulippe, sounding an awful lot like a Daily Reckoning junkie, "foreigners are going to look at the Federal balance sheet and realize that they shouldn’t loan us any more money."

– Of course, your curmudgeonly editors at the Daily Reckoning continue to think ‘sooner’…But Alan Greenspan, Treasury Secretary John Snow, Mr. Miroguchi, central bankers, a host of bond vigilantes, and the lumps…keep managing to push off the inevitable until ‘later’. Our simple advice, don’t bet on it forever.

– But at least there’s some cause for celebration: The PPI is in! After two months of delay, the Department of (be)Labored Statistics finally released their January Producer Price Index numbers. But, as Dave Lewis of Chaos-onomics remarked, with a slight 0.6% rise "one wonders what all the fuss was about." Unless, of course, with their swanky new computers it actually takes longer to cook the books than it did before.

– "Is $2.50 gas on the way?" wonders the N.Y. Post. "Worries mount about soaring gasoline prices," adds MSNBC. The Economist chimes in on cue: "Light crude is hovering around a 13-year high…"

– "Global demand for oil shows no sign of weakening," writes our friend Martin Spring, "yet oil reserves in the US are at their lowest levels since 1975, while in the advanced nations as a whole they are only enough to meet 28 days’ use… The most significant demand has been from China. Last year China accounted for more than a third of the global increase in demand and overtook Japan to become the world’s second biggest importer (after the US). Supply disruptions in major producers such as Venezuela, Nigeria and Iraq have prevented a build-up of stocks from their low levels."

"For the last 30 years," claim the authors of ‘Oil Factor’, a gloomy new book about energy on the planet, "the price of oil has been the single most important determinant of the economy and the stock market." They also claim, reports the Economist, that the oil price will soar above $100 a barrel ‘by the end of the decade, and possibly sooner.’ Such a spike, they say, would drag the global economy into a severe recession."

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Bill Bonner back in Paris…

*** "I’d rather buy property in Costa Rica than stocks in France," said the Marquise. She and her husband, the Marquis, run a Bed and Breakfast in Normandy, in a restored 17th century chateau. They had tried to buy a small hotel in Costa Rica, but were outbid by foolish Americans who paid too much and later regretted it. "At least, when the price goes down we can still go there and enjoy it."

*** The Marquis sat next to Elizabeth at a lavish dinner party, held in a grand chateau. Your editor is struck, on occasion, with a bad case of chateau envy. On Saturday night, the syndrome hit hard. For he found himself in such a marvelous house, he might have shoved his own humble pile into its grand salon alone… and had room left over for a riding stable.

Your editor is an amateur of libraries. He loves to curl up in front of a warm fire…on a leather couch…with a glass of whiskey at his side and a copy of, say, "Ceasar’s Gaullic Wars" in his hands. What a marvelous way to fall asleep! When we saw the magnificent bibliotheque, his eyelids grew heavy. Along the walls were exquisite leather-bound volumes…ancient books…beautiful, rich, wonderful tomes. Histories, philosophies, natural studies…on chestnut shelves installed by fine craftsmen during the Second Empire. The shelves went all the way to the ceiling — about 6 meters high…accessed by a hidden staircase that led to the mezzanine.

In the center of the wall, facing the doorway, was an elaborately-carved wooden fireplace…with a crackling fire. And there before the fire, on a sumptuous green leather couch – long enough to hold your editor and two of his friends, was the heir apparent…the little blond-haired grandson of the chatelain. Just a baby…barely able to tottle, little Ascagne — for that was his name — has big shoes to fill. Ascagne, or ‘Ascanius’ in English, was the son of Aeneus. He was said to be a founder of Rome…Julius Ceasar claimed him as an ancestor!

*** "The trouble with American business," the Marquis opined to Elizabeth, "is that it is so selfish. Managers are only interested in how they can make more money for themselves. They don’t care about anybody or anything else."

Elizabeth reported this conversation the next day. It is the sort of opinion one hears often in Europe. American business is ruthless, cutthroat…only interested in profits. Elizabeth protested. She tried to explain that ‘selfishness’ is the driving force of capitalism…and that the lust for profits forces business to pursue goals that actually benefit the consumer more than the businessmen. The baker does not get up at 4am to warm his ovens just for the love of his countrymen…or so that they might have full stomachs when they go off to work. No, he does it for his own reasons – which end up putting bread on everyone’s table, including his own.

But the Frenchman was right. There is something a bit decadent, shortsighted and corrupt about modern American capitalism. The trouble is, we think, that there are not enough real capitalists. Business still serves the interests of consumers. But it rewards corporate managers too well; they take advantage of today’s naïve little capitalists. Buffett wouldn’t stand for it. Yet, the little shareholders have no power and no clue.

They pay their company managers as if they were rock stars…when anyone with any real business experience knows that most of what they do is either irrelevant, unproductive or harmful. The corporate chieftain’s job could be outsourced to an Indian as easily as any other, but who’s going to suggest it? Top executives sit on each other’s boards…they award each other pay packages that would make a maharajah blush…and often know little or nothing of the business they’re supposed to be in. They cannot invest the company’s money for long-term projects. They don’t really have any ideas for the long-term. And they know that the lumpeninvestors wouldn’t much appreciate it if they did. So, they merely try to maximize current profits — and put as much into their own pockets as possible.

*** Yesterday was the 100th anniversary of W.R. Grace’s death. Now, there was a capitalist. He ran away from school in Queenstown, Ireland, at the age of 14 and worked his way to New York on a sailing vessel. After a stink in Peru, he clerked in a trading company and gradually built the business that became W.R. Grace…made a fortune…and became mayor of New York.
Your editor bought shares in W.R. Grace about 3 years ago — just weeks before the company declared bankruptcy.