A Mouthful of Price Inflation

The Daily Reckoning PRESENTS: There are certain topics regarding today’s markets that are constantly talked about by investors and analysts alike. Among them are China, the usefulness of commodities, and dollar strength. However, there is only one who can discuss them while eating a double-grande burrito supreme. Read on…

A MOUTHFUL OF PRICE INFLATION

The AdenForecast.com takes a look at China and is impressed at “the ongoing, extraordinary growth in China. China is not slowing down. The economy grew at an 11.1% pace in the first quarter, its trade surplus about doubled and its foreign exchange reserves surged to a record $1.2 trillion.”

Since I have heard this “bullish China story” a lot in the last few years, and am actually watching it happen in front of my very eyes, it was old news, and I immediately got bored and was idly daydreaming about what I would do with reserves of $1.2 trillion and, you know, what kind of car I would buy.

So I was only half listening and half mentally taking a new red Ferrari screaming around a sweeping turn, delighting a crowd of hot babes with my fabulous controlled 4-wheel slide. Abruptly, I was snapped out of my reverie and back to reality when they said, “China is the biggest consumer of copper, nickel, lead, zinc, tin and aluminum.” I jumped to rapt attention! That squirty little Chinese economy, with a GDP that is about a tenth of the USA, is the biggest consumer of these industrial metals? Wow!

I was trying unsuccessfully to digest both that surprising news and a foot-long chilidog with greasy fries (“Make it a combo!”) I had for lunch when they followed that up with “Copper imports alone were up 123% in the first quarter compared to a year ago.” Doubling? More than doubling in a year?!?

If you are like most people, you immediately noticed the odd mixture of punctuation in that last sentence, namely two question marks and one exclamation point. For those of you who do not have a Mogambo Dictionary And Punctuation Code (MDAPC) or are just too damned lazy to get up and look it up, it means, “To indicate surprise and alarm, as in the phrase ‘What in the freaking hell is going on here?'”

There was an alternate definition of, “Indicating the state of not trusting your eyes, ears, tongue, nose, or nipples because the facts as stated are so unbelievable, and you finally decide that people are lying to you, which they probably are, because they are all a bunch of lying scumbags who are out to get you.”

Well, the Aden Forecast (like everybody else) has a long history of ignoring The Mogambo, and true to form, they go on, “And as long as China’s growth stays on track, we’ll continue to see ongoing rises in commodity prices in the years ahead.”

Well, if you see the Aden sisters, tell them that The Mogambo says that China’s growth rate don’t really mean squat around here, because the prices of imported commodities will become very cheap (and inflation in commodities will fall) to the Chinese when the yuan rises in buying power, and commodities will become very expensive to us as our dollar falls in buying power.

As usual, nobody is impressed with my clever economic analysis, and thus miss the point across about the horror of a falling dollar. Just in time, and as a living example of a falling currency causing higher-priced imports, I proudly present Jack Crooks, the Currency Director of The Sovereign Society, who writes, “Kuwait cried ‘uncle’ and officially dropped its peg to the U.S. dollar. That means their currency, the dinar, is no longer solely controlled by the U.S. dollar’s performance.”

If you are like me, you were instantly quizzical at the connection between Kuwait, a tiny little country that nobody can even find on a map, for crying out loud, and the American dollar. So you looked up after taking a big ol’ bite from a delicious double-grande burrito supremo and, too impatient to chew and swallow the food in your mouth before saying anything, blurted out “A wa en uh how aa aa nee?” meaning, of course, “What in the hell does that mean?” memorably punctuated by pieces of burrito ingredients flying out of my mouth and getting all over the floor and everything, making a big mess. I act like I am going to clean it up, but I don’t, and I just kind of smear things around a little bit with my foot.

Pretending not to notice my appalling lack of couth or the chunks of salsa stuck in my mustache and down the front of my shirt, he politely explains, “They dropped the U.S. dollar peg because they couldn’t afford to anchor their currency to the falling dollar anymore. It was costing them too much. Kuwait’s cost of imports soared, as the dinar was being dragged lower by the sinking greenback, thus triggering a big surge in domestic inflation.”

“Eh uh e!” I cry with another mouthful of burrito, meaning “There it is!” That’s the problem! Inflation in consumer prices! Kuwait is taking drastic action in response to the terrifying inflation in consumer prices, and the terrifying growing grumpiness of the populace, caused by having a falling currency because it is pegged to a falling currency!

And the US dollar is destined to fall even more now that President Bush is going to sign another “supplemental spending” bill of another $100 billion or so, give or take a few jillion dollars, which is supposed to be enough to last only until (get this!) September! Talk about your Keynesian stimulus spending! Wow!

Now, notice that foreigners are so conceited that they do not even care about our stupid deficit spending problem or how any of this is going to affect me personally, but only about their own stupid problems, which Mr. Crooks proves by quoting Sheikh Salem Abdul-Aziz al-Sabah as saying, “The massive decline in the dollar’s exchange rate against main currencies…has contributed to the increase in local inflation rates and this step is part of the central bank’s efforts to curb inflationary pressure.”

In short, “Kuwait, along with the other oil exporters, is earning huge U.S. dollar surpluses from the crude it ships to oil-thirsty America. So Kuwait must issue a huge amount of dinars to maintain its currency peg. This is why Kuwait’s domestic money supply growth is running at a whopping 19% a year. That’s rocket fuel for inflation. It’s no wonder why the Sheikh is concerned.”

And you can bet that a lot of other people who have a currency pegged to the dollar are also concerned, and they are looking at Kuwait and wondering if there is lesson in there for them, too.

And there is. An ugly one. For us. Ugh.

Until next week,

The Mogambo Guru
for The Daily Reckoning
June 4, 2007

Mogambo sez: Let yourself indulge in a wild, giggling buying spree of gold, silver and oil! The government is doing everything it can to disguise, denigrate and deny the inflation that is raging all around us, and part of that effort is working behind the scenes with “interested others” to keep these three things down in price because it looks so bad otherwise.

And the older you get, the more you savor the sweet victory of making a lot of money on the stupidity of government (now including the Federal Reserve) and stupidity of the overwhelming majority of the laughably incompetent or cowardly PhDs infesting the nation’s major universities, especially Princeton, none of whom ever see anything wrong with Fed policy. Hahaha! How delicious a revenge!

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.

Who’s the most important economist on earth?

The answer to that question used to be simple – Alan Greenspan. God created heaven and earth. But Greenspan created the Great Bubbles – first in stocks…then in housing…and now in art, watches, private aircraft, yachts, commercial properties, emerging markets, hedge funds, derivatives, private equity…and much, much more.

But now Greenspan is out making speeches…and Ben Bernanke has to tend the bubbles, sweating what to do to keep them from blowing up.

So, who’s the most powerful economist now?

We don’t know his name. We don’t even know if he IS an economist. But whoever runs Chinese financial policy – perhaps the head of the People’s Bank of China – is the man to watch. China is the world’s fastest-growing economy. It has the biggest pile of dollars in the world – more than one trillion of them. It also has the world’s most go-go stock market.

Friday, the Chinese stock market fell again. The People’s Bank had been warning The People that they were getting a little carried away. It has gotten so feverish in the Middle Kingdom that postings on tips and rumors on online chatrooms are driving millions of retail investors. The central bank tried various measures to cool them down. But nothing seemed to work – until last week. Then, after they bank imposed a couple of more restrictions on stock trading, all of a sudden, The People caught a chill. The CSI 300 Index hit an all time high on May 29 – at a level 200% above where it was 10 months ago. Since then, it’s gone down 15%.

Looking back four score years, we wonder at the similarities. Then, the United States was the world’s most dynamic economy. And then it was the United States that had the biggest pile of money; it had half of the entire world’s central bank gold. And then, it was the United States that was eager to boost up the currency of the world’s aging imperial power, Britain, by providing additional dollar liquidity. And then it was this liquidity, which U.S. central banker Ben Strong had called “a little coup de whiskey,” that had sent the U.S. stock market soaring. And then the U.S. central bank tried to put the brakes on…and the whole system swerved out of control…ending in the Crash of ’29 and the Great Depression.

Now, we are absolutely sure – after spending Sunday afternoon in meditation on this subject – that whoever is the most important economist in the world is a smart guy. He’s not going to do anything stupid. After all, he didn’t get to where he is by being dumb. True – Ben Strong was not exactly an idiot, either. And the fellow running British financial policy back in the ’20s was none other than Winston Churchill.

But we are all so much smarter now than our grandfathers were. The poor old coots thought the way to wealth was by working hard and saving your money. Today, we know that only saps would try to get rich that way. Now, we know better. Now we know the way to get wealthy is to buy something. A Chinese stock, for example. Or a painting by Francis Bacon. Or, almost anything. The thing in question inevitably goes up in price – 100%…200%…300%…and we’ve made some money.

Not to be too greedy about it, but the smart way to wealth is to leverage the purchase. Don’t put your whole wad down to buy the thing. Put down only, say, 10%. Borrow the rest of the money. So, when your Chinese stock triples, you don’t make 200% on your money…you make 2,900%. Now you’re talking!

As we were meditating on all this, a dark thought crossed our mind. How did we get so much more intelligent than our fathers and grandfathers? How come they didn’t invent the things that make our civilization so comfortable and so productive – automobiles…internal combustion engines…telecommunications…airplanes…painless dentistry…globalization…electricity…air-conditioning…central banking…nuclear weapons…skyscrapers…TV…crispy duck…barrel-cured whiskey…the semi-colon…cotton underpants…or penicillin?

Oh…they did invent those things?

Okay, well, maybe they invented all the basic ingredients of modern life… Still, they didn’t invent YouTube! So you see, they must have been morons.

Then, another dark thought came upon us. If we’re all so much smarter…who is doing the SELLING? You get my meaning, dear reader? If the smart people are all getting rich by buying things…from whom are they buying them? Don’t the sellers know what is going on?

We read in the paper that another huge hedge fund is biting the dust. The report had far too much detail for us, but what we were able to get out of it was that UBS put up a few billion dollars and set up a group called Dillon Read, with 250 employees, to do the trading. Then, this hedge fund company charged clients 3% of capital, plus 35% of performance. Typically, hedge funds charge “2 and 20” for their services. But these elevated fees helped the company pass out average annual bonuses of more than $1 million per employee.

The fund is now being closed down…after a bad month of trading left the group with millions in losses. When you have a group of 250 people trading…you will have losses. Sometimes, substantial losses. Even the alpha hedge fund – Goldman’s Alpha fund – lost money in the first quarter of this year, down 3.4%.

But what must investors think? They must believe that these new money shufflers are smarter than their grandfathers. Back in the days of our grandfathers, a person managing other peoples’ money could expect to earn a decent salary, and maybe even a small incentive bonus. But we’re all so much smarter now. We know how to manage money so much better…and how to charge clients for it. The financial world is now full of smart people in hedge funds…mutual funds…managed accounts…private equity. Every pool of money – including China’s Yangtze of cash – has to be managed. And every manager is now a genius, who buys and sells and earns a fortune.

But who is on the other side of these trades? Who are the idiots they are trading against?

More news:

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Addison Wiggin, reporting from Baltimore…

“Over the weekend, Russian President Vladimir Putin canceled his country’s contract with BP.  According to the Kremlin, BP has not been producing a “satisfactory amount” of gas.  Fair enough.

“But, we’re suspicious. Russia has the largest natural gas reserves on earth and is the world’s second largest oil exporter. Senor Chavez’ forays into nationalization in Venezuela may have Putin longing for the days of yore in his Mother Russia. Will he take the next step? It would be a bold one…”

For the rest of this story, and for more insights into today’s markets, see The 5 Min. Forecast

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And more thoughts…

*** The Dow is at a new record high. But as much as the Dow has gone up, earnings have gone up more. So many commentators believe American stocks are a bargain and surely, some are.

But what could lie ahead?

Analysts have been focused on the hydraulics of the system. So much new liquidity is coming into the markets, they say, prices have to go up. What can an investor do but buy investments?

The Wall Street Journal reports that even the Fed thinks the economy will keep expanding, but is not sure that inflation is under control. That could mean rate cuts aren’t in store. But then again, they’ve said that before…and cut.

We are not capable of predicting price movements. We’ve proven that point to our satisfaction on a number of occasions. All we can do is to marvel at the spectacle of it…and try to guess what will happen next.

In fact, you can get all of our best guesses…predictions…analysis for life! With the Agora Financial Reserve, you can get a lifetime subscription to all of our trading services and newsletters at one low price…but you have to act fast. We only open the doors to the Reserve twice a year – and this is the last time you’ll be able to get in at this price.

Our guess is that the system will bubble along for a while longer. For the present, there is a lot of cash around. And people, generally, have never been more confident. Last week brought news, for example, that the risk premium on junk bonds has fallen to its lowest level ever. Now, investors are so confident that they will buy junk bonds, rather then treasuries, and ask only 2.42% more in annual interest.

But we remind readers; we do not invest our money on this kind of guesswork. When we invest, we want decent odds that we’ll end up with enough of a gain to offset the risk. But since, so many markets are so high, and there are so many geniuses taking so many chances with so much money, we judge the odds at less than even.

No, dear reader, in our opinion this is not the time to take big risks in the public markets. So, we buy gold…keep our Crash Alert flag flying over company headquarters…and hold onto our hats.

*** In April, a record 4.1 million houses were for sale in the United States. A headline told us that Americans were cutting back their driving for the first time in history. Another headline, today, tells us that they are turning away from SUVs.

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