Inflation Goes Global

Already, much of the world is scratching and grousing as if it had lice. Consumer inflation is rising at 8.5% in the Middle Kingdom…while the costs of its own inputs soar. But whence all this inflation? Bill Bonner gives you his assessment…

“Cost of living spirals,” begins The Times of London. “Families face 40% rise in energy bills.”

“Inflation outstrips salary rises for first time, and it’ll get worse,” adds the Daily Mail. “While wage increases are running at 3.2%, the Consumer Prices Index has gone up by 3.3% – its highest rise since 1992.”

As if struck by a new strain of social disease, the English are starting to itch and moan. The papers have made a fuss and the doctor has been called in. In the interest of full disclosure, we have no sympathy for either the patient or the doctor. Both delighted in it when they were contracting the malady; that is, they frolicked gaily when prices for their houses and their shares were going up. Nor was any grumble heard from the City (London’s equivalent of Wall Street) when juiced-up bonuses were handed out. But now that prices for beer and petrol swell like beestings, they’re reaching for quack ointments and mountebank remedies.

Naturally, the witch doctors have their potions: Tax the greedy oil companies, stop “excessive speculation,” control prices, nationalize the mortgage industry, raise interest rates…no, lower interest rates!

All of this might have been foreseen by Antonio Rosmini, a 19th century catholic priest. He wrote that humans were not necessarily “angels, confirmed in grace.” Instead, they were “fallible.” And then, he must have had central bankers in mind when he noted that government “is composed of people, who since they are men, are prone to error.”

There are many different kinds of errors. But among central bankers, one is practically universal – they tend to over-do it. There are many things of which more is not necessarily better. Desserts and mistresses, for example. One or two is plenty. But it is inflation we are writing about. The first bit of it hits an economy like a shot of whiskey on an empty stomach. Then, more drinks keep the party atmosphere going for a while. It is not long before you reach the point of where things get out of hand. Pretty soon, you’re doing things you’ll regret.

But let us look at the doctor’s report:

Inflation was not his fault, was the gist of Mervyn King’s letter to the chancellor. Instead, it was the result of “development in the global balance of demand and supply of food and energy”. Then, get used to it, he seemed to say: Inflation “is likely to remain markedly above the target until well into 2009.” Musing on how the inflation rate might be brought down to the 2% target, he went on: “The path of bank rate that will be necessary to meet the 2 percent target is uncertain.”

‘Or impossible,’ he might have added. Britain already has the highest interest rates among the G7 nations….and the lowest inflation rate. In the United States, for example, inflation is running nearly a full percent hotter. And it looks as though prices will all go higher almost everywhere. In America, imports are rising at more than 15% per year, the fastest increase since 1982. In Britain, producers’ input prices are up 27.9% over a year ago. It won’t be long before these wholesale germs turn into a retail epidemic.

Already, much of the world is scratching and grousing as if it had lice. Consumer inflation is rising at 8.5% in the Middle Kingdom…while the costs of its own inputs soar. In Russia, consumer prices are going up 10.5%. In Vietnam, at 25%. And in Zimbabwe? Who’s counting?

Whence all this inflation? You have Mervyn King’s explanation. We will give you our own.

Last week came word that the Gulf States were piling up $1.5 billion net per day in oil revenues. In China, not an oil exporter, the rate of growth of foreign currency reserves has slowed down recently, but the country still nets about $1 billion per day. Overseas central banks accumulate Everests of these dollars, and lend many of them back to the United States – by buying U.S. Treasury bonds. To give you an idea of how fast this mountain of money is growing, foreign central bank holdings of U.S. treasury bonds, held in custody at the Fed, are increasing at a 37% annual rate.

But to buy these dollars, foreign central banks must increase their own currencies to pay for them. And so the global inflation contagion continues to function much as it did for the last five years – except that the flow of funds has shifted away from the finished product exporters in Asia in favor of the exporters of food and energy in the Gulf, Brazil and Russia. The world’s leading central bank is still over-doing it. Result: higher prices.

That is how it works. But for why it works that way, we turn from sinners to a saint. Yes, that same Antonio Rosmini. In 2007, a decree from the Vatican confirmed that he had indeed performed a miracle. Then, in November, he was beatified by Pope Benedict 16th.

Rosmini was a catholic priest, but also an economist. He was our kind of economist, not one who wanted to put his clumsy paws on the knobs and levers of the delicate machinery of capitalism…but one who stood back, admiring it…and trying to figure out how it worked. Back in the middle of the 19th century, free market economics (what we would call ‘libertarianism’ or Austrian school economics) was regarded by the catholic church as only one short step removed from Satanism. Rosmini’s career and his life were cut short when he was put on trial by the Vatican in 1854. He died the following year. Thirty three years later, 40 of his “propositions” were condemned by the Holy Church. But by rehabilitating Rosmini, the Vatican is at least headed in the right direction.

Now, it is the profane authorities who err. Just as he said they would.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

June 20, 2008 — London, England

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

All bubbles end in busts…and the perp walk.

Two hedge fund managers were arrested yesterday. It was claimed that the two Bear Stearns boys deceived customers.

Oh stop it! We’re going to break a rib laughing….

Deceived customers? What is a hedge fund anyway? It’s a way for Wall Street to take money from investors who can’t do math. There’s no deception required. In fact, the funds’ names – High Grade Structured Credit Strategies Fund and High Grade Structured Credit Strategies Enhanced Leverage Fund – told investors all they needed to know. They practically screamed out: ‘SAY GOODBYE TO YOUR MONEY…IF NOT NOW, LATER.’

So, imagine that you have money invested in the fund that advertises itself as offering “enhanced leverage” from “structured credit strategies.” Now, imagine that you read in the paper that houses are going down in price…and that subprime mortgages are going belly up. Couldn’t you put two and two together? Well…duh… but that’s just it, people who invest in hedge funds can’t do math. The managers didn’t have to deceive them. They just had to keep their mouths shut…which they did.

But this is the way bubbles end…in losses…in anger…and in jail. The losers always think someone else is to blame. It’s not long before they have a CEO, a speculator, or a fund manager mounting the scaffold.

Let’s leave that thought on the shelf and get on with our reckoning.

Oil lost $4 yesterday. The Dow rose 34 points. The euro slipped a little. No biggie.

But look at this: “Inflation now enemy #1 for the Fed,” says the Wall Street Journal. This sort of thinking sent the price of gold up $10 yesterday; it’s now back over the $900 level. And one of the key fellows at Schroder Investment Management told a crowd in Hong Kong that he thought gold could go to $5,000 before this run of inflation is over.

$5,000? Who knows? But, the poor saps at the WSJ are missing the point. No central bank keeps rates 2.2% below the level of consumer price inflation if it is really fighting inflation. Enemy Numero Ono? What are they thinking? Why are all the Fed’s guns facing deflation, not inflation? Sure, there’s been some blabbing about turning around…about switching sides in the war between inflation and deflation. But so far, it’s just talk.

Talk is cheap. It’s action that is dear. And the action the Fed needs to take – raising rates – will be so potentially costly for the lame U.S. economy that Bernanke and Co. are afraid to do it. They’re hoping inflation will go away so they can continue the battle against the slump, without having to worry about their unprotected flanks. Most likely, they will make a gesture towards raising rates – perhaps a quarter of a point. But then, when the mob starts howling for his head, Ben Bernanke will drop them again.

Henry Paulson has been gurgling about a strong dollar. Yesterday, he gave voice to a contradictory notion – that the Chinese should let their currency rise (and the dollar fall).

The problem for the Chinese is that they have too many dollars, furnished courtesy of the Fed, while Americans have too few. In the United States, the average household barely has enough dollars to fill its gas tank and pay its bills. But the Middle Kingdom is flooded with them.

If you don’t watch out, you’re going to drown in them, said Paulson – or words to that effect. China’s economy continues floating higher and higher. But all these extra dollars are pushing up wages and prices as well as the economy.

And then, wouldn’t you know it, Chinese export prices go up too. And pretty soon, prices are up all over the world.

Which is why the WSJ thinks it’s the top problem for the Fed too. Of course, it is a problem. But with the official CPI at 4.2% it’s not enemy number one. Maybe it’s Enemy Number Two. Most likely, it will stay there for a while longer. We still haven’t seen a big drop in commercial property…or in consumer spending. Those are probably still ahead…and will give the Fed a reason to continue blasting away at a deflationary slump. Consumer prices will continue to rise, too. Eventually, they will become so high that inflation really does become Enemy Number One.

By that time, the price of gold could be $500 higher.

*** An empire is, fundamentally, in the business of providing protection. People in America applauded when the Soviet Union collapsed and China took the capitalist road…but it practically put them out of business. There was nothing to provide protection against.

The sensible thing for the United States to do, following the fall of its one and only major enemy, would have been to cut the defense budget down to a nub…and invest the money in infrastructure and capital improvements, so Americans would be able to compete on better terms with the rising economies of their former enemies. It was obvious that with billions of people entering the modern economy for the first time, the world was beginning a new, more competitive phase of development…and that without huge capital investment, labor rates for marginally skilled workers were doomed to fall.

But what kind of world would it be if people always behaved sensibly? Instead, it was party time in the U.S. of A. Americans went on a binge of spending, borrowing and soft-headed thinking. Colleges switched from teaching engineering to letting students emote on subjects such as gender and racial equality. The leading profit makers switched from manufacturing to finance…from making things to lending money…from Detroit to Wall Street. New regulations imposed higher operating costs…and more lawyers and more delays. And lobbyists got billions in special favors.

No lobbyists were as successful at squeezing the public tube as those who work for the defense industry. People come to believe what they must believe when they must believe it. The United States is an imperial power with one major leading industry: defense. But with no enemies capable of inflicting real damage to the country, the defense industry had to invent one: terrorism…and the people had to believe it.

Readers typically want to argue this point. “What about 9/11?” they ask.

Of course, terrorists always pose a danger to individuals. And if they are daring and determined enough, they pose a danger to many individuals. But they pose no real danger to the state…and none to the Pentagon. You could put all the world’s terrorists together in a single army…they would still stand no chance whatsoever of defeating the United States of America.

Normally, it is the police who are charged with protecting citizens. The fuzz fight crime and criminals…even gangs of criminals. Terrorists in the U.S.A., as near as we can tell, are practically non-existent. They don’t seem capable of breaking into a parking meter, let alone challenging the U.S. Army. There must be 10,000 paid cops for every one of them. Why bring the Pentagon onto the case?

As mentioned in these reckonings, the feds are adding to the official national debt at the rate of $1.5 billion per day. Still, neither Democrats nor Republicans dared challenge the Pentagon’s latest $600 billion spendfest. No one wants to audit the Pentagon. No one wants to oppose it. The Pentagon is in a bubble of its own.

The average man is no genius. And half the population is even dumber. He responds to popular issues by instinct. He’s not going to spend his leisure time thinking about how the military industry complex works. Instead, he’s going to get behind the man in the crisp uniform. He’ll support America’s leading industry – until it ruins him.

Yes, dear reader…every empire is a kind of bubble in power…an extraordinary, temporary thing. And like every bubble, empires end in bankruptcy…disgrace…and the perp walk.

The Daily Reckoning