Inflation 1; Economy 0
America’s recent economic “recovery” is just a dismal version of “Mother May I.” Almost every “one step forward” will succumb to “two steps backward.”
To switch metaphors, the so-called recovery is not the fruit of sustainable underlying demand; it is merely the weed of rising inflation expectations. Let me explain…
Much of the recent improvement in economic statistics can be chalked up to inflationary expectations. Business operators believe that future prices for many goods and services will be higher next month than they are today. As a result, many companies – and some households – are asking themselves: “Why don’t we buy the supplies we’ll need in the future today?” Those with savings and capital can afford to do so.
This buying activity, which is driven by expectations of higher prices in the future, results in a transfer of future economic activity into the present. It’s the type of activity that Keynesian central bankers like Ben Bernanke want to encourage. But the transfer of future economic activity into the present carries with it the same problems we saw during the housing and credit bubbles: when the “borrowed-against” future finally arrives, we see a collapse in demand for the pre-bought items.
An example of this phenomenon was the spike and crash in the construction of new homes in the US. During the peak years, several years’ worth of future demand was pulled into the present.
Bernanke’s goal of inducing a benign rise in expectations for future inflation will backfire. Pushing consumers and businesses to “buy now” with the expectation of higher prices in the future is hardly different from subsidizing the reckless growth in debt-driven economic activity in 2004-07. As a result of Bernanke’s quantitative easing experiments, we’ll see sugar rushes in economic activity, followed by hangovers. The result will be stagflation.
While some industries and companies enjoy pricing power, most do not. Those without pricing power will see weaker profit margins as higher raw material prices flow through the chain of production.
I continue to be amazed by the market’s complacency in the face of obvious deterioration in the economic picture. There’s no denying the recessionary impact of gasoline spiking to $4-plus per gallon – and staying there for some time. The International Energy Agency estimated this week that the turmoil in Libya has shut in between 850,000-one million barrels of oil per day. Governments and investors around the world are more interested in securing their oil and food imports than they are in holding US dollars paying negative real interest rates.
Central banks and governments remain blind to the inflationary consequences of their policies. Based on his public comments, Ben Bernanke seems to view rising energy and food prices as a deflationary shock to the US economy – which would, in his mind, necessitate even more money printing. He sees no connection between the expansion of the Fed’s balance sheet and rising prices for necessities. He blames the weather and growth in emerging markets. How convenient!
One would hope that Bernanke understands the dilemmas that faced one Rudolf von Havenstein, president of the German central bank during its hyperinflation of 1921-23. In a research piece posted on Zero Hedge, SocGen strategist Dylan Grice offers an interesting perspective of von Havenstein’s experience. Here is a snippet:
[Let’s] not ignore the parallels [between Weimar Germany and today’s monetary environment]: as is the case for today’s central bankers, Von Havenstein was faced with horrible fiscal problems; as is the case for today’s central bankers, the distinction between fiscal and monetary policy had blurred; as is the case for today’s central bankers, the political difficulty of deflating was daunting; and as is the case for today’s QE-enthralled central bankers, apparently respectable economic theory reassured him that he was doing the right thing.
Grice’s piece is over a year old, published at a time when the consensus view was expecting a “self-sustaining recovery” and an “exit strategy” from QE1. Instead, after a few short months of economic deterioration in mid-2010, Bernanke came out blazing with his QE2 guns. So the question must be asked: how are endless QE programs not considered an effort to monetize the US federal deficit? Everyone has their own answer, but it’s hard to imagine that more investors won’t start worrying about a dramatic collapse in confidence in the US dollar.
The proposed budget cuts from the Obama administration and Congress are jokes. They are woefully inadequate. And polls this week revealed that even many self-identified Tea Party members have no desire to cut Social Security and Medicare benefits. The weaker the political will to enact painful budget reforms, the faster the federal debt will grow. The faster the debt grows, the more the Fed will be pressured to monetize, which boosts the money supply. The further the money supply grows, the more urgency investors around the globe will feel to buy gold, silver, and other hard assets.
Demand for gold should keep growing in the coming months, as Bernanke and other central bankers willfully ignore the inflationary consequences of their actions. It’s hard to imagine a reversal of this trend until we see much more political support in Congress for handcuffing the Fed or changing its so-called “mandate.” As Rep. Ron Paul noted in his questioning of Bernanke recently, the Fed’s quantitative easing enables reckless federal spending like an accommodating bartender enables an alcoholic.
Investors looking to protect their portfolios from the ravages of deficit spending and money printing will look to buy gold.