Inflation Wants to Eat Your Children

The Daily Reckoning PRESENTS: Increased money supply is a cancerous growth on the nearly perfect body of economics. Unfortunately, that body is fully exposed to the dangers of inflation. Let’s just hope the Mogambo can tell us how to fight this horrible monster. Read on…

INFLATION WANTS TO EAT YOUR CHILDREN

This week’s entry into the Most Pithy Investing Advice Contained In A Headline Or Title contest is “Profiting From Companies That Sell What China Wants” by Michael Dawson of TheTimeAndMoneyGroup.com. The title says it all!

There used to be a song that went “Whatever Lola wants, Lola gets”, which implied that this Lola chick was so enchanting that men gave her presents, which she greedily took, and kept demanding more, which I gave her, too, always more and more, until all my money was gone and I was forced to loot the employee retirement fund, steal money out of my wife’s purse and invent reasons why the kids wouldn’t be getting an allowance this week (“Sunspots made the money radioactive!”) so that I could give it all to her. Only her name wasn’t Lola, and in fact as I remember it, they went by various names, none of them Lola, but the point is that 1.) This title says it all, and 2.) The case is made when I point out that both Lola and China have two syllables.

And, I expect, they will both end up with all my, and our, money, and then it’s, “So long, sucker!” just like always.

If you are tired of my constant, irritating harangue to buy oil stocks, in one way or another, based solely on my Stupid Mogambo Say So (SMSS), then I proudly present John Loeffler, appearing with James J. Puplava on the Financial Sense Newshour, who buttresses the “Peak Oil” case by saying that, when looking at oil production, “If we look at the number of countries that have peaked versus remaining, so far 64 countries have peaked in oil production; 36 remain.”

I know what you are thinking: You are scratching your chin and thinking “Down by two-thirds? Hmmm! Maybe that Stupid Mogambo Idiot (SMI) is onto something significant here with his recommendation to buy oil!” And you would be right!

But if you went on to think to yourself, “Maybe that SMI is not as dumb as I thought!” then you would be, I am sorry to say, wrong.

I’m sure you’ve already heard that the Bureau of Labor Standards reported that the Consumer Price Index for all urban consumers, also known as the CPI-U, increased by 0.3% in January. Or perhaps you heard my loud scream of anguish and subsequent Hysterical Mogambo Violent Outburst (HMVO) at the report; in a lot of places it made the front page!

Either way, the latest report shows that, on an annual level, the January reading of that index, 202.4, was 2.1% higher than in January 2006.

Actually, nobody believes that inflation is really that low, and the government has already repeatedly admitted that they hedonically-adjust inflation statistics in a lot of different, although equally slimy, ways. This means that inflation is well over 3%, which is a number I choose because it is, historically, the point where smart people are panicking in the street; where shameful government and banking officials are being sacked, and there is turmoil everywhere – most of it being instigated by The Mogambo, who incessantly screams, “I am your king! Bring them to me and I shall deal with them harshly!”

But, oddly enough, everything is still calm, even though overall consumer prices rose 0.2% for the month. This mainly reflects that the prices of food, air travel and medical care went up a lot. And even core inflation (which excludes food and energy prices, so it is supposed to have a calming effect on our nerves) was up 0.3% for the month, which was NOT calming in the least.

And stepping away from sterile statistics, we get the same thing from Sprott Asset Management when they say, “In the real world, by all indications, the Malthusian shortages that began a few years ago with the most recent synchronized global economic expansion are continuing in earnest as we head into 2007. Nowhere is this more evident than in the rampant cost increases (a.k.a. inflation) that the companies we analyze are experiencing.”

George Ure, of the famous UrbanSurvival.com site, hears us talking about shortages, especially of the Malthusian kind, and reports that his web bots (which are looking for Internet references to “shortage” and “scarcity”) have, “for the first time since I started tracking, passed the 20-thousand hits level.” So, two guys have noticed shortages appearing! Shortages are up!

If you are wearing your Expensive Junior Mogambo Ranger Watch (EJMRW), the on-board Supply/Demand Ratio Alert is beeping right now. If it is not, it is probably broken, and there is nothing you can do, because while the certificate of authenticity is certainly valid, the lifetime guarantee (like the guarantees on all Mogambo Inter-Stellar Enterprises (MISE) products and services) is not worth the paper it is printed on.

Hopefully, you will be consoled to learn that the value you received is not in the watch itself (for which you obviously overpaid) but in the lesson you just learned.

But as an astute Junior Mogambo Ranger (JMR), “you don’t need no stinking watch.” This, of course, may explain why sales are down (and why repeat sales are zero), and has already conjured up a mental image of the graph of the supply/demand dynamic, which has been adjusted to reflect the change in the supply curve to reflect these reported shortages, and says, “Eek! Higher prices are coming!”

Mr. Sprott sends a nervous glance over at me to see how I am taking this news about inflation. My breath is shallow and rapid, but I am not actually screaming in fear or even twitching visibly. Thus emboldened, he goes on to say, “The largest companies in the world in the mining and energy industries are all stating, with nary an exception, that the cost estimates they made a few years back for some of their biggest projects are now grossly understated.”

Reader George P read these same remarks from Sprott, and he thought that this line was most remarkable; “We’ve heard estimates by knowledgeable sources that global money supply grew 18% last year – so shocking as to be almost unbelievable.”

And if you are the least bit conversant with the bountiful plethora of examples in the historical record of what happens from such cancerous growth in a money supply, then your heart is undoubtedly beating like a trip-hammer, although you are unsure exactly why.

If you are more educated than most, and are completely familiar with what happens, then you are naturally thinking that although you have an Uzi in each hand, a Bowie knife between your teeth, are sitting on your weight in gold and silver, wearing a tinfoil hat and some cool shades, you still feel exposed and defenseless! And you need more of each!

The Mogambo reassuringly says, “That’s right! It’s that damned terrifying!”

Until next week,

The Mogambo Guru
for The Daily Reckoning
March 5, 2007

**** Mogambo sez: I’m not an expert on distress signals, but flares shooting into the air all around the world must mean SOMETHING! And if it means what I think it means, then soon, more than ever, you will appreciate the immense value of gold and silver. And so will all other sentient beings between heaven and earth, as the meteoric rise in their market prices will attest, oh so dramatically. And those who have them will be – especially relative to everyone’s poverty – wealthy.

Now, all you gotta do is decide if you want to have a lot of the wealth for yourself, or whether you just want to envy those who do. It’s your choice right now!

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.

Watch out; the yen is rising.

Here’s our theory: Hundreds of billions of dollars are caught up in the ‘carry trade.’ Speculators borrow yen at preposterously low interest rates. They trade the money for other currencies – notably those of English-speaking countries – in order to place the money in higher-yielding investments. They then pocket the difference and think they are geniuses.

The game works beautifully. Nothing goes wrong. That is, until something goes wrong. Then, the speculators get spooked and begin to look for the narrow door that leads out of the trading room. In the best of cases, they exit in an orderly fashion, selling their high-yielding investments and buying back yen so they can repay their loans. Dollars, pounds, and New Zealand dollars go down. Yen and Swiss francs (another low-interest rate currency borrowed for the carry trade) go up.

You will know when the game is over, dear reader, when you see the yen and Swiss franc rising.

Recently, both seem to be moving up. The British pound, on the other hand, took a step down. So far, the movements are so orderly they haven’t even been noticed. But watch out…if something goes really wrong, speculators will make a mad dash for the door and many will be crushed.

Last week’s mini-crash in China scared a few speculators. U.S. stocks, for example, got hammered down below where they began the year. The stocks and bonds of the money shufflers – Goldman, Morgan Stanley, Merrill Lynch – seem to have topped out. The swap market tells us that their own traders regard their bonds as though they were junk.

The real action may come today, tomorrow…or a year from now. But when it comes, you will be better off holding yen and Swiss francs than dollars or pounds. Sterling looks particularly risky to us – since so much of the hot money of the money shuffling trade has found its way to London.

In the meantime, we note another curious thing…gold is getting clobbered too. How could that be? Remember, there’s no magic to the yellow metal. It goes up and down like everything else. Gold is money; it represents purchasing power. The excess liquidity pumped into the world economy by the central banks, the carry traders, and the financial industry represents a kind of inflation of purchasing power, too.

And when inflation increases, so does the price of gold – typically overshooting. A collapse of the liquidity bubble, on the other hand, represents a decrease in purchasing power…a deflation. Gold will not necessarily go up when that happens; it could go down. People will need cash to pay their debts. Cash, for Americans, means dollars.

We don’t buy gold because we think it is going up (though we do think it is going up). We buy it because we see the financial world as much riskier than most people think. Inflation…deflation…we expect some kind of ‘flation’ as a result of all the debt and credit pushed onto the world over the last 15 years.

Remember, a correction should be equal and opposite to the deception that preceded it. This new ‘liquidity’ – trillions of dollars worth – pretends to be real money. It is not. It has no resources…no real savings behind it. Since it is not real…when the correction comes, it will disappear – along with many of the ‘assets’ and much of the “wealth” that people today think they have. The good thing about gold is that it will still be there.

More news:

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

“The yen continues to strengthen, approaching the next big resistance level of 114.60. If we see it trade through this level, the next stop is a test of the 110 level.”

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

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And more views:

*** “Mortgage Crisis Spirals, and Casualties Mount”, says the New York Times.

“Now an escalating crisis in the market, which seemed to reach a new crescendo late last week, is threatening a wide band of people. Foremost are the poor and minority homeowners who used easy credit to buy houses that are turning out to be too expensive for them now that mortgage rates are going up, but the pain is also being felt widely throughout the business world.

“Large companies that bought subprime lenders during the boom, like H&R Block and HSBC, are now scrambling to sell them or scale back their exposure. Many investors are also likely to suffer: Wall Street firms made billions in fees, commissions and trading revenue from packaging and selling subprime mortgages to them as bonds.”

And now the feds are on the case. New Century – a large California-based subprime lender – is being investigated by securities regulators and federal prosecutors. The G-men saw what happened to Eliot Spitzer’s career when he took on a few high-profile corruption cases. The next thing you knew, the man was on Oprah and living in the governor’s mansion. They’re not going to miss this chance.

Besides, who’s going to stand up for the subprime lenders? The three founders of New Century sold shares in 2004, 2005 and 2006 – realizing more than $40 million in profits, according to the Times. Even as late as November of 2006, they were unloading the shares – more than $20 million between August and November alone. They got millions more in dividends, salaries, bonuses and perks. We don’t know how much they started with, but recently they were down to just 7% ownership of the firm.

They were getting when the getting was good. At the end of 2004, New Century stock sold for $66. In 2006, you’d still have had to pay more than $40 per share. But if investors liked the stock last year they should be delighted now. Last week, $40 would have bought them nearly four times as many shares.

The best way to make money in the dotcom boom was, of course, not by buying dotcom shares…but by selling them to the public. Likewise, the best way to make money in the housing boom was not by buying a house…or even by buying the shares of a mortgage lender. You would have done much better to start a subprime lending business yourself and sell the shares to the public. The secret was to get out fast…before the market crashed…and before the feds came after you.

(There is something about being a member of the public…a card-carrying member of the lumpen masses…a good citizen…a voter…that seems to doom a man to a life of failure. We are working on some thoughts…)

*** We wondered last week about the money supply figures for China. Surely, the supply of cash and credit in that go-go country must be going through the roof.

And it has. Money supply (M1) in China is increasing at a 20% rate…it has been going up an incredible 14% rate for the last five years…

*** And here, old friend Marc Faber tells us what he thought of last week’s shudder in the financial markets:

“Markets obviously peak out when everything looks best and bottom out when things look horrible… In this sense we have the goldilocks outlook and things look fantastic. This is precisely the climate in which stocks can make a longer term high and start to decline.

“At every market peak…you have excess liquidity. At the present time a very significant part of what people call excess liquidity comes actually from the American current account deficit. That 800 billion dollars flows around the world and boosts economic activity…

“Credit standards are now tightening. That leaves the consumer in the United States vulnerable…and consumption in the [United States] will hardly grow this year, which means the trade deficit in the [United States] will not expand therefore international liquidity, while still plentiful, will not grow at an accelerating rate…therefore markets may come off quite a bit more than the typical portfolio managers now expect…

“We can easily have a correction of 10-15% on the S&P…followed by a summer rebound, but I doubt that we will make new highs as the economy deteriorates towards the end of the year that will get another big sell-off in equity markets around the world…

“The gold bull market will end when there will be lines of people in front of gold shops buying gold because they want to move out of cash…when they really become afraid that paper money loses all its value.”

*** Our return from paradise to Paris was not easy. From the soft sand and tropical splendor of our beach shack in Nicaragua, we tumbled onto the hard concrete of Paris and into the dust of our apartment on Avenue Mozart. Elizabeth is having the entire apartment redone. So when we got back we found not a square inch of the place clean enough to put our bags down. Instead, there was a happy crew of Portuguese wreckers making a mess of the place…along with another team of Polish women pretending to clean it up. It was almost too much for your author’s mental stability. But he pulled himself together after a good night of sleep and saw the humor in the situation.

Now, we’re already planning our next trip – to Argentina! We wrote to the farm managers to warn them that we were coming. We got back a message telling us – wouldn’t you know it – that during the first year we own a farm, the whole region is suffering its worst drought in history! The cattle are starving from lack of grass, and they’ll have to be sold or moved to lower pastures.

*** Speaking of Argentina, Capital & Crisis’ Chris Mayer sends us this note from Cafayate, Argentina, which sits in a valley surrounded by rugged red-speckled mountains…

“Argentina is one of the places where the American dollar still goes a long way. We had a dinner party of eight last night. We drank wine and ate appetizers and steak. The bill was almost laughably low, about US$70. Later, we had six beers and coffee for a total of $7.

“Real estate is also cheap. That’s why Americans and Europeans have been among the most active buyers of property in Argentina. They are real estate bubble refugees, you might say. They cashed out of their expensive and inflated properties in the U.S. and Europe, and then they came down here and live like kings. It’s a cash market, and you don’t have the speculation you have in hot U.S. markets, for example.

“Over the last week, we also spent some time at an Argentine ranch in Salta. There are some 60,000 acres here at this ranch. It has livestock and grows alfalfa, tobacco and corn. This place, too, was owned by a group of overseas investors who have plans to carve off lots and develop the property, while maintaining it as a working ranch.

“Besides the potential for development, the agricultural lands out here should grow increasingly valuable. As I’ve written about before, there are several factors creating a boom in the agricultural markets. There is the push for more biofuels, which results in increased consumption of the basic feedstocks used to produce alternative fuels – such as corn, sugar, palm oil and more. There is increased prosperity in China, India and other emerging markets. This leads to greater demands for meat in particular, which also fuels the boom in demand for grains (crucial in feeding livestock).”

More reports from Argentina to come…

[Ed. Note: Chris Mayer is just one of the many speakers we have lined up for our annual Agora Financial Wealth Symposium in Vancouver, British Columbia, taking place at the Fairmont Hotel, July 24-27, 2007. This year’s topic? Rim of Fire: Crisis & Opportunity in the New Asian Era. This event is sure to sell out, so secure your ticket by calling Agora Travel at 800-926-6575.]