Inflation: A Father-Daughter Reunion

The Daily Reckoning PRESENTS: Foreign holdings of U.S. debt recently went up $8.7 billion – and this is not good news. Our favorite masked economist will explain, below, if he can work through his latest bout of Mogambo Psychonomic Syndrome…

INFLATION: A FATHER-DAUGHTER REUNION

You probably know me for the real peach of a guy I really am. And in the few times per day when I am not, there is always a lot of anger about the mismanagement of the economy, replete with screaming and yelling, the sound of approaching sirens, and sometimes, a lot of spent bullet casings scattered on the ground. It merely adds up to the new psychiatric diagnosis, Mogambo Psychonomic Syndrome (MPS), as recently discovered by Dr. George Ure.

So, when Total Fed Credit went down by $7.18 billion, I really lost it, MPS-wise. I was running frantically around the living room, dressed in an adult-sized disposable diaper, desperately sucking on this ridiculous pink plastic pacifier that seems, suddenly, to have lost its power to soothe. I was snarling and mumbling something that sounds like: “Mmfmn ngnngg gagunm mumm, unh!”

My wife, barricaded behind the couch, was frantically leafing through the Market Laboratory section of Barron’s, hoping to find some good news to calm me down. I can barely hear her, as she is quietly muttering to herself, “No, I better not tell him that the gross national debt is at a new record, up $8 billion from last week! And if I tell him that consumer installment debt went up $11 billion in the month of June, he’ll really lose it!”

There was a little rustling of paper, and I heard her whistle softly to herself, “Wow! M2 money supply was down again!” By this time, I am clenching my fists, trying to control my mounting rage. Ripping that stupid little pacifier out of my mouth and throwing it to the ground, I bellowed, “What did you say?”

Nervously, quickly, she stammered, and then called out the first thing her eyes light upon in the newspaper. “Well,” she hesitantly says, “ummm, uh, well, foreign holdings of U.S. debt held at the Federal Reserve went up by $8.7 billion. So that’s good news, right?”

Initially, my heart was partially melted by the charming little hint of desperate, almost child-like, hopefulness in her voice. But it was, alas, to no avail. I patiently and politely explained, for what seems like the thousandth time in a row, “What? What are you talking about, you silly, stupid Earth woman? The enormity of it all is the ugly, ugly fact that foreigners now get a bigger chunk of America’s money and wealth!”

Obviously working myself into a hissy-fit, I was yelling, “And beyond the Mogambo Paranoia And Xenophobic Hostility (MPAXH) inherent in that basic fact, the worse news is that the money to finance all that this spending, new debt and new credit will be created, literally from thin air, by the stupid Federal Reserve! Do I have to tell you, again, about what horrors await those who allow banks to create excessive amounts of money at their whim? Do I?” Nobody said anything. There is nothing but total silence, as the universe itself bates its breath, awaiting my next move. Birds stop singing. Dogs stop barking. Babies stop crying.

Satisfied, I continued ominously, “And you think that giving a bigger portion of that money to support some rich guys and governments in Europe, Japan, China, or someplace, is some stupid good news or something?”

Still, there was not a sound! Instinctively, my hand slowly started inching toward the bazooka I keep in my shoulder holster, which I admit is not only very heavy and unwieldy, but stupid, too, although it is somehow very comforting in a “raw firepower” kind of way. My fingers were close around the cold steel of the trigger as I said, “Do you comprehend, even remotely, the staggering enormity of America being looted by the Federal Reserve, which is just a private bank owned by a shadowy, semi-anonymous group of people that includes a lot of foreigners, all for the obscenely profitable benefit of these selfsame mysterious foreign strangers? Do you?”

Suddenly, from behind the curio cabinet, my daughter sprang out, put her little fists on her hips, and with a booming voice said, “I, the one known as Daughter-Possessed-By-Demons, know!” I watched, dumbfounded, as she bellowed, “This means that we will soon be taxing ourselves more and imposing roaring inflation on ourselves (which is, actually, just another gigantic tax, in effect) by letting the Federal Reserve create the money to finance the government’s increasing deficit-spending, which is supposed to ‘offset’ the government’s increasing debt without resorting to the alternative of levying taxes. And this increased inflation in the money supply will be followed by horrific inflation in prices. Ain’t that right, Mighty Magnificent Mogambo Moron (MMMM)?”

I was stunned! She’s exactly right! I naturally suspect a trick of some kind. So, cautiously, I test her by leaning forward, looking her right in the eye, and ask in an open-manner, “And…?” She immediately answered, “To support rich foreigners who can’t even speak English without some thick, stupid accent, who drive foreign cars, who marry other foreigners, and who actually live in foreign countries, too! And then, while they are living it up, having a wonderful time spending our American money and eating weird, exotic foods like, oh, I dunno, filet of marmot earlobes or something, we Americans will suffer from crippling inflation in prices as the dollar is devalued to accommodate them in their gluttony!”

For some reason, the shock of hearing my own kid saying this, and all this talk about devaluing the dollar, made me suddenly recall the essay entitled “Vox Populi, Vox Suckers” by Gary North of LewRockwell.com. In the piece, he writes, “The history of the demise of the dollar is the history of the replacement of a gold coin standard with the Federal Reserve System. The decline began in 1914.” I remember thinking to myself, “Huh? Why am I remembering this, and why right now?” Then, I see the wisdom of it when I further remembered that he went on to write, “But it has come in waves of depreciation. We are on the cusp of the dollar’s next great decline.”

I am kind of freaking out here about what the kid and Dr. North are saying about this coming decline in the dollar, and so I was overpowered when she, again correctly, said, “And don’t even get me started on Robert ‘Elliott Wave’ Prechter and that whole Socionomics thing, Pops, where society mirrors the economy, which both break down into a post-Apocalyptic nightmare when the buying power of the currency is destroyed!” Suddenly, the room was silent. I looked at her. She looked at me. Then she said, softly, “We’re freaking doomed!”

Incredulous at these words, I looked at her with wide-eyed in wonder, and asked, “Did you say, ‘We’re freaking doomed’?” She said, “Yes!” Delighted beyond words, I excitedly cried out, “Daughter!” She excitedly said, “Father!” Spontaneously, we rush together, and fall into an embrace of joy, elated at our reunion!

Overwhelmed at the tenderness of this unexpected “father-daughter reunion moment,” I spontaneously blurted out, “I love you! Loan me $20!” Immediately, out of the blue, she said, “I love you! Loan me $50!” The actual evidence for what happened next is sketchy, but everyone agrees that I called her a greedy, hateful little snot, some bad words were spoken, and for some reason she abruptly stormed out, shouting, “I hate you! I hate you! I hate you!” None of this is surprised me, as that is how most conversations usually progress around here, usually ending with the old lady starting up with me about my “attitude.”

Until next week,

The Mogambo Guru
for The Daily Reckoning
August 21, 2006

Editor’s Note: 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.

“Project Sunrise,” they call it.

Yes, we begin today’s reckoning where we think we might all end up – in Zimbabwe.

The wretched country is suffering the highest inflation rates in the world – over 1,000%. But don’t worry, the government and central bank that caused the inflation have now decided to do something about it. Lucky Zimbabweans.

Project Sunrise is billed as part of a fresh government drive to stop inflation and black market trading. As of today, you can no longer use your old Zimbabwean dollar bills. You have to use the new bills, with three fewer zeros.

Billboards advertised the facts as though it would save consumers money. “More bang for your buck,” is one slogan. And, an advertisement shows a loaf of bread with the caption: “Was $85,000, now only $85.” You can imagine the glee with which the typical housewife anticipated the changeover.

But the program got off to a rocky start. This weekend, there were reports of chaos…scuffles. People tried to spend their old money on anything and everything they could get their hands on, which wasn’t necessarily much. Inflation and price controls have made many consumer items vanish already. But people were desperate to get rid of the old currency before today, because the government had limited the amount that could be traded for new currency to no more than $400 U.S. per transaction, per week.

In the new currency regime, there will even be one-cent notes we are told. Students at the local university calculate that it will be cheaper to heat your house burning bundles of the new notes than using coal or wood.

We turn to the “Dark Continent” not to laugh, but to weep. For there are we bound…

Empires are expensive. Bread and circuses at home…foreign wars. Eventually, the bills grow so large they can’t be paid. After the Roman Empire peaked out in the second century, its emperors repeatedly staged financial schemes like Project Zimbabwe. Until then, their monetary system had been based on gold and silver coins, which acted as a restraint on inflation – the mints could turn out only a limited supply of coins. But then, Emperor Aurelian decreed that his coins were two and a half times as valuable as their actual worth, effectively jacking up the money supply by 250% overnight!

With more than $70 trillion in the hole and most of that money owed – in the form of Social Security and Medicare benefits – to voters at home (and the rest to nervous foreigners), the American government might want to consider Aurelian as a model. For, as in Rome or Harare, the financial authorities can get away with almost anything. And now, the temptation to inflate has grown just too great…irresistible, in fact.

But is it that simple? If it were, wouldn’t it be easy for you to know what to do, dear reader? Just take out the biggest mortgage over the longest period possible…and wait for inflation to reduce it to nothing. We remember how we envied people with old 6% mortgages in the 1970s. When inflation rates headed over 10% in the late ’70s, they practically got their houses for free. Could the same thing happen again?

Corporate America seems to be thinking along those lines. A Wall Street Journal piece tells us that businesses are taking on more and more debt. Money is cheap, they reckon. Get it while you can.

Bonds are going up. The yield on the 10-year T-note is only 4.83%. Mortgage rates, too, have gone down over the last four weeks.

Declining lending rates are not usually a sign of inflation, but deflation, which is why the strategy of taking on more debt now may be premature. Yes, in the long run, inflation may lighten your debt load and make you feel like a financial genius. But in the short run, the load could grow a lot heavier…making you feel like the village idiot.

Orange juice is at a 16-year high, but most commodities seem to be trending downwards – along with bond yields. Housing prices, too, are beginning to soften. Gradually, people are coming to realize that they don’t have as much money as they thought.

What’s worse, people with ARMs are getting their financial legs knocked out from under them. As much as a half trillion worth of adjustable rate mortgages are to be reset in the coming year, says the Los Angeles Times. Many of these were Neg Am contracts, meaning that the principal amount is larger now than it was when the mortgage was taken out. The L.A. Times report:

“In order to head off potential problems, the largest mortgage originator in the United States, Countrywide Home Loans, has begun sending out letters to thousands of borrowers who have been making only the minimum payments on the company’s popular PayOption adjustable-rate mortgages.

“The letters explain that ‘this is an early message to alert you that, based on your current payment trends and potential future interest rate changes, the monthly payment you will be required to pay may increase significantly.’

“A model letter provided to me by Countrywide includes this hypothetical example of what could be ahead for a California homeowner currently making only minimum payments monthly on a $402,000 loan.

“The current full interest rate on the loan is 7.6%, but the borrower has been paying only $1,348.47 monthly, far less than what’s needed to fully amortize the mortgage over its 30-year term.

“If the loan reset at today’s rates, the letter explains, the full payment required would be $2,887.50 – more than double what the homeowner has been paying. Future reset rates could be even steeper, making the payment crunch much worse.”

Yes, dear reader, inflation could eventually wipe out much of the real value of those loans, but in the meantime, there are mortgage payments to be made. And many people will not be able to make them. They will walk away…or go belly up. Mortgages will be worked out, re-negotiated, stretched out or foreclosed. House prices will fall. At the margin, people will stop spending so much money and push the economy into a slump. Jobs will be lost and overtime curtailed. Payments on debt will be even harder to make. Debtors will default and go bust.

In short, there will be a dark night of reckoning before the “Sunrise Project” comes to America. Borrowers are likely to deeply regret their mortgages, before they wish they had bigger one.

More news from our currency counselor…

————–

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

“The University of Michigan survey on consumer sentiment fell to 78.7, which is much lower than the market forecasted 83.6. It is also well down from July’s final 84.7 print. So, maybe, just maybe, somebody is paying attention!”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

————–

And more thoughts from Bill Bonner summering in France…

*** Iran has reported – again – that they will not, under any circumstances, stop enriching uranium. We’re surprised that we’re even still asking them.

“This latest news and ongoing obstinate behavior from Iran, and then in the next month or two a test of nuclear weapons in North Korea, plus at least one hurricane in the Gulf, could spell much higher oil and metals prices,” predicts our commodities expert, Kevin Kerr.

“The oil price rise could mean a rally in sugar and corn, which are both vastly oversold in my opinion,” continued Kevin. “When the funds pour back into these markets they will do so with a vengeance and the markets could go up just as fast or faster than they came down. It’s all just one headline away. All of this came up when I was at Princeton Friday with a group of speakers, and it created quite a lively debate indeed.”

*** We spent the weekend working on our gypsy wagon while part of the family was off on a jaunt around France. We had no guests and scarcely left home. It was the first peaceful weekend all summer.

Examining our tools, we expected to find that they were all made in Asia. Not at all. The Bosch drills were made in Germany and Switzerland. The circular saw, too. We have another drill, Black and Decker, which seems to have been made in England. Black and Decker is a Maryland company; at least, we thought it was, with a headquarters near Baltimore.

We were surprised to find that our Ryobi router was made in Pickens, South Carolina…or so it appears from the nameplate. The pine siding, meanwhile, came from Scandinavia, but at least the oak was cut locally.

Maybe we are just old-fashioned, but when we think of spending money, we can’t help but think of things made of wood, steal, plastic or other tangible materials. We might have bought a gypsy wagon, for example. Instead, we bought the tools and materials to build it.

We might want to buy a painting, a new automobile, or some windows to replace those that are falling apart. Or, perhaps, a piece of sculpture to put in the garden. Certainly, more fruit trees and flowering bushes to fill out the garden.

What was in the back of our mind was the item from Friday’s Daily Reckoning…about how house prices were going down in areas that were losing manufacturing industries. Of course, that’s just what you’d expect. As incomes go down, so should the prices – in real terms – of the houses people live in. And since, speaking very broadly, lower- and middle-income labor rates are going down because of Asian competition, you’d expect housing to go down, too. And in Detroit, or in Pittsburgh, where such jobs are dying, housing is indeed cheap.

Many economists tell us that it is a new world. “Making things” is old economy. The new economy is in “Services.”

What we can’t understand is what these services are…and why anyone would want them. We are told, for example, that financial services are the growth industry of the 21st century. Young people graduate from college and want to go into finance, because that is where the money is. Manufacturing? Yecch. Let the Asians do that.

But never in our entire lives have we felt the slightest need for financial services. Granted, a person may need financial services, but where does he get the money for the financial industry to manage?

*** “Dad, you should watch this,” said Jules.

“Oh, what are you watching?” asked grandmother, who is spending the summer with us. The poor dear is getting frail, but always cheerful and alert.

“It’s a dumb movie, Grandma. I don’t think you’d like it. In fact, I don’t think you should watch it,” replied Jules.

Saturday night, with nothing better to do, we sat down to watch a movie. Jules is a movie fanatic. So much so that he has dropped out of his classics program at St. John’s College to take up film at another university in Boston.

“You have to see this movie to understand my generation,” he continued.

It was called “Jay and Silent Bob Strike Back.” We watched it, appalled. It was puerile. Sophomoric. Vulgar. Disgusting. And, amusing at various points. There is very little in the way of plot. Two low-life New Jersey comics make for Hollywood to have their book made into a movie. A long genetic sequence of F-words, D-works, S-works and every other kind of word you hope your children never say or hear pervade the film. We doubt that our mother has ever heard these words spoken in her entire life.

We presume the language was used ironically; we’re not sure. Nor do we have any idea what it means to the under-25 set. But we fear for the future.