Enter the Recession

Most people believe that the way to respond to inflation is by tightening monetary policy – but that could turn out to be a very dangerous decision. The Mogambo Guru explains how the Feds are hurting economic growth…

Ben "Big Bonehead" Bernanke, the incoming new chairman of the Federal Reserve, is on record as being the champion of "inflation-targeting", which is the new code word for, "I’m going to kill you with inflation because I don’t care about any of you American pigs."

This ridiculous philosophy may not work like he figures, if we can believe Randy Buss, of Der Invest Informant, who quotes Professor Antony Mueller, an adjunct scholar of the Ludwig von Mises Institute, as saying, "The size of the debt level relative to the productive base at the peak of the boom will make monetary policy ineffective once the contraction phase takes hold." Well, perhaps that is why the Fed is so desperately trying to keep this contraction ("deflation") from taking hold in the first place, by creating inflation, which will kill us just as fast.

Max Fraad Wolff, at Mises.org, has had enough of listening to me run my loud mouth and not making any sense. He stands up to explain, "Standard fiscal and monetary policy work to attack inflation by pushing economic activity toward recession. Likewise, fiscal and monetary policy introduces inflationary pressure to fight recession." Well, I gotta admit that he is a lot more succinct in his explanation, but without the use of screaming, swearing, breaking furniture or even vowing blood oaths of revenge. As such, it seems to lack that sense of, umm, mortal despair and homicidal outrage that it really calls for.

Inflation: Stagflation Lurks

So, in my snippy little childish way, I say, "So?" Without missing a beat, Mr. Wolff, with a momentary flash of exasperation at my abysmal stupidity, explains, "Stagflationary dynamics occur when a growth recession – or worse – occurs alongside upward price pressure, inflation. Policy markers face unique challenges and enhanced prospects of failure in such an environment. Given the normally poor record of policy makers, this is scary. As price pressures persist alongside rising trade and federal spending imbalances into 2006, stagflation lurks. Keep your eyes out for data that suggests cooling growth and rising prices. When it rains it pours."

None of this is lost on Jim Puplava, which I can prove by directing your attention to his essay "The Two Bens." It can be found on his www.financialsense.com site. In it, he contrasts Ben Franklin and Ben Bernanke, which I am sure, has Mr. Franklin rolling over in his grave at the comparison. It is sort of like I hate it when my neighbors compare me to a diseased sewer rat, only not as cuddly. Some things never change, and you can gather that from his writing. He says, "From the birth of this nation to the present, the government would from time-to-time resort to debasement of the currency in time of war or in time of economic duress. We find it always ends with the same consequences: debasement of the currency and concomitant inflation. Despite the best efforts of government alchemists, the result is always the same in the end – inflation. The only limit to the quantity of money created is the destruction of its value."

To prove the accuracy of his words, Mr. Puplava writes, "Through September, the PPI was up 6.7% year-over-year, while the CPI was up by 4.7% over the same period. Even worse for Americans, who now import more of what they consume, import prices are up 9.9% over the last 12 months." This level of inflation should have the Federal Reserve jumping out of the windows in shame, or jumping out of the windows to escape the incessant screaming of The Mogambo about this inflation conflagration – that they caused – that is destroying our money.

And now, the new report of producer prices showed that prices jumped 0.7% in October, which is worse than anyone (except you and me) expected. The so-called "core" inflation (minus the pesky volatile items like food and energy) was, I guess, relatively tame for finished goods. But intermediate goods had prices that were up a smoldering 1.2%, and intermediate goods were smoking red hot, up a full 3% for the month.

And it is even worse than that in actuality, as he suggests when he says, "Today the true rate of inflation is running well over 7%," which one can see when calculating the consumer price index, "as it was originally constructed before the government began to tinker with the index." When one undertakes this exercise, we realize that the CPI, "closely relates to what most Americans experience daily in their lives." And I don’t know what you are experiencing in your life, but around here, the bills are showing at least that much inflation!

Then he unleashes the bombshell: "Deflationists and inflationists do agree on one thing: the U.S. is headed for another recession. Given the under-reporting of inflation, which overstates GDP, we may already be entering one. The only difference between the two camps is how it unfolds. As the U.S. enters into recession, tax revenues will decline and government spending will increase as a result of rising entitlements. Deficits will get bigger and the U.S. will have to borrow and monetize more of its debt. War, entitlements, and lack of fiscal restraint mean more debt, more borrowing and debt monetization. Eventually the dollar is going to collapse through the weight of the twin deficits. Inflation – not deflation – will be the result."

Inflation: Hurting Growth by Fomenting Inflation

John Hussman, PhD, of the Hussman Funds, has a slightly different take on all this. Oh, he agrees with everyone else that I am a big stupid idiot, but where he takes exception is, "It seems to be taken as an article of faith that the Fed determines inflation, but in fact inflation is not so much a monetary phenomenon as a fiscal one. It is essentially a reflection of unproductive government spending. Moreover, the belief that you should respond to inflation by tightening monetary policy is in some cases very dangerous. If you look closely at the data, you’ll find that economic growth and inflation over the same period actually have a negative correlation." So, as the Federal Reserve starts trying to foment more and more inflation, they are actually hurting growth? Hahahaha! I was right! We are freaking doomed!

So, what does one do? With the agility of a lithe jungle cat, I instantly leap to my Stinky Mogambo Feet (SMF) and exclaim, "Buy gold!" And if you think gold is a great investment and that you ought to be out buying some more gold right now instead of sitting there reading the stupid Mogambo Guru while saying hurtful things like, "This guy’s an idiot!" then Bud Conrad had an interesting article on the DailyReckoning.com site, entitled, "Measuring Gold’s Link to Inflation." He notes, "PPI and gold move together. You can also see that the trend is currently in place for both higher inflation and higher gold prices."

Although the PPI has been going up, he cautions, "Of course, forecasting PPI inflation is no easy matter. But the chart does tell us emphatically that when we see growing forces for inflation – rapid expansion in the money supply engineered by the Federal Reserve, artificially low interest rates, growing government deficits, unsustainable trade imbalances and currency competition – we should expect rising gold prices."

And since we are speaking of commodities, the "commodities expert" at the DailyReckoning.com site, Kevin Kerr, says, "So while bonds and once coveted shares sink, commodity prices continue to explode with growth. Many analysts predict they will continue to rise, because of growth in demand and dwindling supplies." And not only that, but all the inputs into growing or mining commodities (energy, tools, materials, wages, governmental fees, taxes, etc) are all rising, too! The Computer-Like Mind Of The Mogambo (CLMOTM) instantaneously concludes that (to use the precise economic terminology) there is no freaking way in hell that commodity prices cannot go up.


The Mogambo Guru
for The Daily Reckoning

November 21, 2005

Mogambo Sez: All lease rates on gold have suddenly turned up after bottoming, and so it must be time for gold to rise, according to the new Stupidest Mogambo Timing System Yet (SMTSY). Buy!

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, and a vocational exercise 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.

Oh what a tangled web we weave when first we practice to deceive.

One lie leads to another. Before you know it, you are so wrapped up in them you can’t find your way out.

We might be referring to any number of things in today’s news. But we will begin with the financial stories. Profits are up, we are told. And because profits are up, everything is hunky dory. Of course, stock prices are high – profits are rising! And why shouldn’t America borrow, it has so much more productive assets to borrow against. The trade deficit, housing bubble, consumer and federal debt – every blemish on America’s financial face is creamed over with profits. The result is such a beautiful glow; who can resist?

Just don’t look at her without makeup!

And don’t look carefully at the grease either. These are not the same profits your mother knew.

We have wondered whence cometh such "healthy" profits in an economy that is so obviously ailing. Richard Benson has helped enlighten us. Making money is easy, he points out, when the fed funds rate is low and the yield curve is steep. "Finance" operations become very profitable. All you have to do is borrow at low rates for the short term and lend at higher rates for a longer period. That’s why "finance" as a percentage of U.S. profits has soared.

It also helps when the low rates have caused a housing bubble.

"The housing bubble has created economic growth and job gains through the building of new homes, the hiring of mortgage bankers, and the issuance of 400,000 more real estate brokerage licenses (America now has over 1.2 million real estate agents who make over $60 billion in commissions a year)," he adds.

Today’s press elaborates:

"Californians gamble on careers in real estate," begins an article from Reuters. One of 50 adults in the state is a licensed real estate agent, the report explains, with the agent population growing 13 times as fast as the growth in home sales. And small wonder. The typical house now sells for more than $500,000. An agent only has to sell a few houses every year in order to enjoy a modest income.

And if he is not selling his house, the Californian is dismembering it. In 2004 alone Americans "took out" $600 billion from their houses. Normally, when consumers earn extra money it comes from the businesses they work for. It is a cost to the business, reducing profits. But this new revenue comes to corporate America (when it is spent in America) without offsetting labor costs. U.S. businesses didn’t have to pay anyone a salary in order to increase consumer spending. Instead, the money came as though from heaven, and fell directly into profit margins.

Thus, like so many other things in modern America, corporate profits depend on people selling houses to one another at higher and higher prices, encouraged, aided and abetted by "emergency" low rates from the Fed.

What was the emergency?

Ah, we suspect that that was a little fib, too. But we won’t dwell on it. We merely note that when the "taking out" of equity comes to an end, so do the profits. Then, U.S. businesses will have to earn their money.

"As McMansions go, so goes job growth," says the New York Times.In the meantime, we pass along another small item from Barron’s. Inflation, as we all know, is as healthy as profits, and the economy in general. But here, too, by the time the Bureau of Labor Statistics has worked them over a few times, the numbers come out looking like prisoners in an Iraqi jail. Health insurance premiums have been rising at an annual rate of 10% for a number of years. But in the CPI figures, the medical component is up only 4.4% in the year ending in September. And while health care accounts for roughly 15% of GDP, it is given less than half that importance in the inflation index.

Similarly, a confession is beaten out of the housing numbers, another major component of the inflation measure. We all know the price of houses has been going up at a double-digit rate for the last five years or so. But instead of measuring what people actually pay to buy a house, the torturers at the U.S. Labor Department pretend that we rent our houses from ourselves. As more and more people have been lured into homeownership by low rates, the pool of renters has declined – actually softening rental rates.

There you have it, dear reader: Profits are up; inflation is down. Both are subject to change without notice.

More news from our currency counselor…


Chuck Butler, reporting from the EverBank trading desk in St. Louis:

"I know, these moves are like removing a bucket of sand from the beach, but at least they are in the right direction! The European markets have picked up the baton from Asia, and have continued marking the euro higher this morning."


Bill Bonner, back in London with more opinions…

*** Lies are no more static than fashions. They evolve to suit the circumstances. The Bush administration began the war with Iraq in order to get weapons of mass destruction out of circulation. When that plan washed up, it then decided to build a modern U.S.-style democracy on the banks of the Tigris and Euphrates. That project is still on the books, but it no longer seems to be enough to justify the expense in blood and treasure.

"It’s time to get out," say the critics. But wait, now the United States has to stay in Vietnam – oops, we mean Iraq – in order to prevent a bloodbath. "If the United States leaves," writes David Brooks, warmonger for the New York Times, "Iraq will descend into a full-scale civil war."

"I think that the Democrats who have undertaken this initiative [to pull out of the war] have made a mistake," said Rep. Duncan Hunter, the chairman of the House Armed Services Committee. "I think they’ve underestimated the toughness of the American people and the understanding that if we don’t change the world, the world is going to change us."

Spoken like a true world-improver. Guess Hunter hasn’t read his copy of Empire of Debt yet.

Much thanks to those who have contacted your state representative about reading the introduction to Empire of Debt – we promise to publish your experiences this week.

*** Gold hit an 18-year high last week. As the days go by, the precious metal becomes more and more precious. But the dollar has been rising, too.

"The seeming anomaly of both the dollar and gold on the rise suggest to us one or the other has got to give," writes Alan Abelson in Barron’s. "Our hunch is that it’ll be the dollar." Ours too.

*** We are amazed at how fast this year is going.

"Ground rush," said a friend. "Getting older is like jumping out of an airplane. At first, you seem to float in the air. Time goes by slowly. And then, all of a sudden, the ground rushes up at you."

The Daily Reckoning