The Great Debate

The widespread belief is that the Federal Reserve is currently increasing interest-rates to "control" inflation.  Puru Saxena tells us that this common misconception stems from the fact that most people don’t really understand the definition of inflation…

The entire investment community seems to be obsessed with the appointment of Ben "Helicopter" Bernanke as the new chairman of the Federal Reserve. "What will the new maestro do? Will he continue to raise interest-rates? Will he target inflation? How will the markets react?" Such questions have been popping up almost everywhere. I am going to address some of these issues but first, let me explain the key concepts of inflation and deflation.

The widespread belief is that the Federal Reserve is currently increasing interest-rates to "control" inflation. This misconception stems from the fact that most people don’t really understand inflation. The great majority thinks that inflation is an increase in the prices of goods and services, which is totally incorrect. In actual fact, inflation is defined as an increase in the quantity of money. A general increase in prices is merely a consequence of inflation. An over-supply of money (inflation) causes its value to drop and it takes more money to buy the same quantity of goods and services, causing prices to go up.

In addition to this, the consensus is that deflation is a fall in the prices of goods and services, which is also inaccurate. It is crucial to understand that deflation is in fact a decrease or contraction in the quantity of money. A general decline in prices is merely a consequence of deflation. A reduction in the supply of money (deflation) causes its value to rise and it takes less money to buy the same quantity of goods and services, resulting in lower price levels.

Misunderstanding Inflation: The Fed Has Failed

The fact that the public does not understand inflation or deflation allows the central banks to carry on with their money printing agenda. All the while, the public remains oblivious.

When the Federal Reserve was established in December 1913, its objective was to "control" inflation. Well, I hate to break this to you, but the Federal Reserve has failed in its task of "controlling" inflation. In fact, the U.S. dollar has lost 95% of its purchasing power through money printing (inflation) since the Federal Reserve came into power. In other words, the $1 your ancestors saved for you in 1913 is only worth five cents today! This is an outright confiscation of hard-earned savings.

Consumer prices only started to go up after the Federal Reserve came into power in 1913. It is interesting to note that money lost most of its purchasing power after gold was removed from the monetary system in 1971. Once the Americans made gold redundant, the central banks were allowed to print as much money as they wanted since money was no longer backed by a tangible. And print money they did! This reckless printing of money is the reason why things have become so unaffordable for most people.

The grim reality is that the modern day central banking IS inflation…and the quicker we get used to this idea, the better. The deflation scare is nothing more than a decoy, which the central banks use in order to continue with their money-printing (inflationary) program. Still not convinced? Then, consider the greatest fabrication, the Japanese "deflation" scare.

For years now, we have been told repeatedly that the root cause of Japan’s economic problems is deflation. We have been forced into thinking that deflation is the culprit. Allow me to share a secret – the central banks want you to believe that deflation is a total disaster so that they can freely print more money, thereby creating inflation. After all, who benefits from the monetization of the economy?

Despite all the brainwashing, close inspection reveals that Japan never really had any deflation! The truth is that throughout the past 15 years, Japan’s money supply has continued to grow (inflation). Japan has witnessed inflation, and not deflation, since 1980. Sure, Japanese asset prices have fallen since 1990, but the cause is not deflation, as advertised by the establishment. In fact, a sharp rise in interest-rates was the trigger, which caused the Japanese stock and property bubbles to burst.

Misunderstanding Inflation: The Surge in the Money Supply

These days, we are being told that the Federal Reserve is raising interest-rates to "control" inflation. If the Federal Reserve were really curbing inflation, why would the American money supply continue to surge despite recent interest-rate hikes? Despite all the noise about inflation, the Federal Reserve has added roughly $1 trillion to the system over the last year. So, on one hand, the Federal Reserve continues to inflate, and on the other hand, it is raising rates. "But why would they do that?" you may ask. You see, the U.S. economy is in a mess, and a true contraction in the money supply (deflation) would send the whole world into a severe recession. Under this scenario, millions of companies and individuals would go bust and the entire financial system may collapse. Therefore, you can rest assured that the Federal Reserve will continue to inflate for as long as possible. It is shocking to note that the broad-based money supply (M3) has increased from $ 6.5 trillion to $10 trillion in five years – representing a 54% increase! Yeah, Greenspan did a fine job "managing" inflation!

As far as the current situation is concerned,  I believe the Federal Reserve is raising interest-rates to prevent an outright collapse of the U.S. dollar. A weak currency needs to offer a high yield (interest) in order to attract capital. Indonesia, Russia, Brazil and Venezuela come to mind. Today, the United States is the world’s largest debtor nation, and its current account deficit stands at $730 billion or 6.3% of GDP! Students of economic history know that no other country or its currency has ever managed to get away with such economic murder. It must be obvious to both Greenspan and Bernanke that the U.S. dollar is skating on very thin ice. In an attempt to rescue the situation, interest-rates in the United States are being pulled up to increase the demand for dollars.

In my view, interest-rates in the United States will rise much higher than most people expect at this time. If history is any guide, Mr. Bernanke will continue to inflate the money supply whilst increasing interest-rates over the coming months. Already, he has talked about dropping dollar bills from helicopters. Well, at least the guy is honest!


Puru Saxena
for The Daily Reckoning

November 22, 2005

P.S. "At some point, America’s debts will probably be incinerated by inflation," write Bill Bonner and Addison Wiggin in their new book, Empire of Debt. "When the howls from consumers and voters grow loud enough, the Feds will panic. In desperation, Ben "Printing Press" Bernanke will point toward Argentina. ‘There…that is our only way out."

Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication. An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC World, Bloomberg TV & Radio, NDTV, RTHK Radio 3 and writes for several newspapers and financial journals.

Markets rise – first for the right reasons, and then for the wrong ones.

We’re thinking of gold. The precious metal becomes even more precious every day. Yesterday, it nudged up against $490 (Dec. contracts.) This leaves us feeling a little left behind. Our buying target is still at $450. The price fell as low as $459 a few weeks ago. We were tempted. We wondered whether to stick with our discipline – buying below our target figures – or whether to merely buy whenever we have the money. A few years from now gold at any price under $500 is likely to look like a great bargain – even the chance of a lifetime.

Gold is rising for the right reasons. Gold is insurance against financial breakdown, inflation, and mendacity. As the lies mount up, the price of gold rises. Lies cause people to believe things that aren’t true, which leads them to do preposterous and suicidal things.

While energy, housing, and health care rise at record rates, for example, people believe that "inflation" is not a problem. Statisticians at U.S. Labor Department "black sites" have twisted and hammered the numbers so much they’re ready to perjure themselves: "Do you see any inflation? We don’t see any inflation."

More evidence of mistreatment came in yesterday’s news:

According to the U.S. Labor Department, hotel prices were down 2.5% in September from a year earlier. But don’t expect to find lower prices the next time you check into the Holiday Inn. Industry executives say prices are actually rising – sharply.

Patrick Jackman, a U.S. Labor Department statistician, explained that the government’s number boys had put hotel rates on the rack, put pliers to them, and pulled out hotel rates for business travel, which have been going up. The price of a standard room at the Waldorf-Astoria hotel in New York is up 20% over last year.

Looking around, we see hardly a single number, fact, news item, or presidential press conference that doesn’t need footnotes, retraction or medical attention. All have been stretched, crunched, twisted or bent into such grotesque shapes that even their own mothers wouldn’t recognize them.

Americans do not spend too much; there is merely a "savings glut" overseas that we help absorb. Nor is there a housing bubble anywhere in the United States; everybody knows houses go up forever. Nor does the administration sanction torture of alleged terrorists; it just uses "unique" methods. No kidding, we read it in today’s paper. The CIA defines torture in the same spirit that the U.S. Labor Department defines inflation: "uniquely." They both get the answers they want.

We sigh. We are reminded of a more innocent, more honest age: when gold stood behind the dollar, when children said please and thank you, and soldiers treated their adversaries with respect.

"Farewell to Alfred…final survivor of the Christmas truce." Britain’s last known survivor of the informal truce between British and German troops in 1914 died yesterday at the age of 109. Only eight WWI-era soldiers are still alive. Alfred Anderson was the last one who took part in the Christmas Truce. The Scotsman recalled that on Christmas morning the shooting stopped. Soldiers in the trenches on both sides spontaneously began shouting Merry Christmas and singing carols. Soon, they had crawled out of the trenches and met in no-man’s land. They traded tobacco and sweets. A soccer match was even organized. Some stood for group photographs.

But then the orders came down from the high commands. By afternoon they were at work again – trying to exterminate each other.

It was an important era. Scarcely a year before the Christmas Truce, the Federal Reserve System was set in motion. Three years after, America took the lead role in the Anglo-Saxon empire. Since then, the high command in Washington has steadily gained power. It has troops all over the globe. Its money is accepted by merchants in souks in Morocco, as well as brothels in Thailand. Its fashions – from Harley Davidson motorcycles to Che Guevara T-shirts – rule the world.

But as Jack Kerouac put it to Ken Kesey: Nothing lasts. The empire that was built on industrial profits persists on post-industrial credit. The habits and principles of many generations – upon which the Anglo-Saxon empire depends – have given way to conceits and lies.

Gold grants no interviews and holds no press conferences. It is mute. It neither panics nor dissembles. It is a universal antidote to lies. The more lies there are, the more valuable it becomes.

More about gold, after a word from The Rude Awakening…


Joel Bowman, reporting from the sweaty pit of the New YorkBoard of Trade…

"Fierce men are eyeballing each other from their perches on all sides of the cauldron. Their neck and temple veins are bulging and beads of sweat build on their forehead and around their noses. The weak have been pushed to the back and the level of noise and activity in the pit intensifies. The time is 11:57 – three minutes before the close of sugar trading at the New York Board of Trade."


Bill Bonner, back in London with more views…

*** "People shouldn’t be surprised to see gold trade in the four digits," said John Hathaway of the Toqueville Gold Fund. Let’s see…four digits…that is more than $1,000!

We wouldn’t be surprised, but we would be disappointed. Gold is now cheap and almost hidden. People are buying it for the right reason: because it is cheap. It also provides an insurance against human error, complacency, and shock. We see signs, though, that gold is coming out of the closet. The price is approaching $500, and the financial press is beginning to notice. "Four-Digit Gold," is Barron’s headline.

But Hathaway sees the world’s financial cup not half empty, but filling up.

"There is not a lot of [gold] around. If you took one-tenth of one percent of global financial assets and stuck them in gold, you would wind up with a couple of years of mine supply. It is a trade you can’t do. But it still gets back to the question as towhy people get more interest in gold, and it’s not all based on bearishness. India is getting more prosperous, and Indians like gold. China is getting more prosperous and the Chinese like gold. More disposable income in Asia definitely helps gold."

When gold goes over $500, it is sure to get attention. Then, the second stage of the bull market will begin – the stage when ordinary investors and institutional money managers put some of their money into gold. These are people who probably don’t read The Daily Reckoning and don’t necessarily share our view of the world economy. But they will notice that the price of gold has doubled in the last six years. They won’t understand why the price is rising, but they won’t want to miss it. As prudent investors, they will place a small part of their funds in the yellow metal – just in case.

This mainstream buying, along with the fundamentals of course, will drive up the price of gold further. Eventually, speculators will begin to buy it for the wrong reasons. They will expect it to soar. At first, they will be right. In the short run, markets are like democracies: voters get what they want. In the long run, they get more or less what they deserve. When the price of gold goes over $1,000, the bull market will be in its bubble phase. The price may go far higher – depending on what else is going on in the economy and the markets. But this will be a time to be careful…when we stop adding to our positions and begin to reduce them.

But that is still a long way off. Right now, we are wondering whether to move our buying target up to $475. If we’re right about what is coming, whether we bought at $450 or $485 is not going to make much difference. Still, we don’t like to abandon our system. A man who believes in nothing is ready to believe anything; a man who has no self-discipline will be disciplined by others; and a man who…well, we can’t think of an appropriate dictum. But there must be one. Use your own judgment, dear reader.

*** Jules misses Paris. He has begun his college career in America. He finds himself a bit out of place. After spending his high-school years in French schools, he says he often thinks he is more French than American – at least, that is how he feels now that he is surrounded by his countrymen.

One of the risks of living overseas is that your children have a harder time figuring out who they are and where they ‘fit.’ Sometimes, they end up feeling as though they don’t fit in anywhere.

"For me, it’s a big advantage," says Maria, in her second year of theatre school in London. "I will be able to work on stage in Paris…or London…or the United States. Besides, I guess in my line of work, none of us really wants to ‘fit in.’ Instead, we all want to stand out."

*** The subject came up again on Saturday. Henry attends the French school here in London. Apparently, it is such a good school that colleges from all over the world come to recruit. On Saturday, Henry went to a "fair" at the school.

"There were representatives from all over. Of course, the big French schools – such as HEC and Sciences Po – were there. But there were also people from Yale and Duke, Oxford and Cambridge, and lots of others. Big companies were there, too. The head of American Express had a booth. He was sitting there…nobody was talking to him."

"Henry, where do you think you might want to go to college?" asked his father.

"I dunno."

"Then go to the French schools…they’re cheaper."

The Daily Reckoning