The New Fed Paradigm

Inflation is not dead, the BLS admits…which, in Mogambo-ese, means it must be wildly flourishing beyond control. So why then does the Fed maintain its ’emergency rate’ of 1%?

"For at least some investors," writes James Gipson of the Clipper Fund, "the relevant lesson of history seems to be that repeating the major mistake of the recent past is a really great idea."

To paraphrase in Mogambo-ese: "For the morons in the government and the Federal Reserve, the relevant lesson seems to be ignoring the One Great Lesson Of History." Namely, creating excess money and credit is a recipe that does NOT result in a delicious chocolate cake, but rather results in something else that is chocolate brown, alright, but much stinkier and spread all over everything in the economy after it hits the proverbial fan.

And the worst part is, this latter chocolate-colored substance is starting to appear where it’s least wanted. Especially in prices, which are zooming skywards for everyone but, apparently, Sir Alan and his merry men at the Fed.

Hyperinflation: "Fed Officials Should Get Out and Shop"

"Fed Officials Should Get Out and Shop," says Caroline Baum in the title of her article on Bloomberg. "In the rarified atmosphere at 20th and C Streets, better known as the Federal Reserve Board, there is no inflation. In the parallel universe in which most of us live, prices are going up."

Ms. Baum is doubtlessly referring to the Bureau of Labor Statistics, whose latest fraudulent report revealed a 0.5 percent increase in the CPI, and a 0.4 percent increase in the core index, which excludes food and energy.

But "The price hikes are pervasive and led by the service sector, which is not energy dependent," says Bill Dunkelberg, who is the chief economist of the National Federation of Independent Business in Washington. So price rises resulting from the rise in oil are not causing this price inflation, he says.

Mr. Dunkelberg has also taken a look at recent prices action in finance, insurance and real estate, and found that nobody cut prices, while 43 percent of the companies raised them. Similar results came from the March NFIB survey, which noticed "the most aggressive price behavior seen since early in 2000," with 19 percent of all firms who have not had their phone service cut off and were hightailing it out of town one step ahead of the collection agencies, and who bothered to answer the phone, reported an increase in average selling prices.

So where does the Greenspan Fed get the idiotic idea that there is some deflationary crisis brewing? Where in the hell are the damn prices that are falling that are requiring interest rates to sit at their lowest level in half a century? Nobody can see them except this Greenspan twit and his little playmates at the Fed.

Hyperinflation: The Hyperinflation Greenspan Won’t See

And this is very dangerous, because before you know it, the inflation that this Greenspan character doesn’t see could turn into the hyperinflation he doesn’t see. What happens in a hyperinflation is that people start buying things, anything, everything, desperately getting rid of their money, spending all their cash to stock up on these things that are going to cost more in the future because their money is going to be worth less in the future. And then prices rise like they were rocket-propelled in response to this heightened demand. The result is that everybody who has any money that they were not able to spend is gradually bankrupted.

And sure enough, Census Bureau statisticians report that "Some farmers have been pre-paying for their annual supply of fertilizer, getting a discount up front and immunizing themselves against price increases down the line. Some fertilizers are up 25 percent in price in the past year."

Then all this panicky buying makes prices go up even more, as a result of the old supply-demand dynamic, thus reinforcing the hyperinflationary price rises. Which causes more panicked buying. Which causes prices to rise even more. Which causes more panicked buying. Which causes, well, you probably get the idea.

But you wonder where the AARP is in all of this, as the Social Security benefits that its members receive every month are not going up nearly as fast as the rise in prices. The main reason for this decline in purchasing power of retirees is that the Cost of Living Allowance (COLA), with which monthly Social Security benefits are adjusted to for inflation, IS the fraudulent Consumer Price Index! So the government has engineered a fraud for the express purpose of robbing a lot of old people. Or as Richard Benson said in the title of one of his recent articles, "Using the Consumer Price Index to Rob Americans Blind."

Hyperinflation: Trade Gap Narrows — Minimally

In a similar vein and in a separate report, Bloomberg reports that in the "U.S. Economy: Consumer Prices Rise, Trade Gap Narrows." And sure enough the Commerce Department said that the trade deficit narrowed to $42.1 billion from a record $42.5 billion. Whoopee. A measly $400 million dollar change, or, in percentage terms, 1%, which is probably statistically insignificant, according to court-appointed psychiatrists who posit that 1% is the chance that I will ever say anything that is not laughably stupid.

"So far this year," Bloomberg tells us, "consumer prices are rising at a 5.1 percent annual rate." Perhaps this has something to do with the fact that "the dollar has lost 11 percent of its value in the last two years against a basket of currencies from the biggest trading partners."

Against all of this surging inflation, which you will remember is what the Mogambo confidently predicted as the lone voice squeaking in the wilderness like some brain-damaged rodent, pitted against the mindless cacophony of the multitudes of the other clueless jerks who bill themselves as "economists" and who, almost to a man, all took time out from filling in their Daffy Duck coloring books to opine that there was no inflation, and that inflation was dead, and how we will all spend the rest of our lives living in a world with no inflation, and how the Fed printing up all that money and creating all that credit had no connection to inflation, and blah blah blah. Jackasses.

Anyway, against all of this surging inflation, the Labor Department has been working double shifts to massage every bit of inflation from every price rise so that they could issue one of their laughable reports on the Consumer Price Index, so that they could show that inflation was non-existent. But even those corrupt wonks have now been overwhelmed by the sheer deadweight tonnage of evidence that inflation is NOT dead, but that it is rising by, at least, 5.1% a year. So you can take it to the bank that if those corrupt weenies are now backed into a corner enough to admit THAT, then the REAL inflation in America is undoubtedly much, much worse.

Of course, there are the inevitable opinions that the Fed will now be forced to raise interest rates to combat this surging inflation. I say, hahahaha! Says who? Who’s going to make them? You? Hahaha! The Fed can sit on 1% rates forever if they want to, as far as they are concerned. And they probably will, as they have shown absolutely zero intention of doing what they are supposed to be doing all this time, which is to keep inflation from destroying the USA and to keep the idiot banks from financing ruinous bubbles, and I have serious doubts, make that VERY serious doubts, that they are going to start now.

In fact, Dan Denning of Strategic Investment says that the Fed CAN’T raise rates, "…until the final piece of the inflation puzzle is in place: rising consumer incomes. Until that happens, rising prices will simply make consumers cut back on spending. Throw in rising interest rates and energy prices and you have two more factors which lead to slower consumer spending and economic growth. Bottom line: the economy can’t grow until the consumer can spend more. And the consumer can’t spend more when prices and interest rates are rising."

Seems about right to me. So where does that leave us? Mr. Denning says, "Here’s a prediction for you – the Fed will become so concerned with the market pricing in rising rates (and pushing mortgage rates up) that it will cut rates by 25 basis points at its May 4th or June 30th meeting."

So the old aphorism about how the Fed is supposed to take away the punch bowl after the party really gets started is now proved false. The new Fed paradigm is something more bizarre: the Fed is pouring pure grain alcohol down the throats of partygoers who are passed out drunk on the floor.


The Mogambo Guru
for The Daily Reckoning
April 26, 2004

— Mogambo Sez: I get the feeling that things are building to a head, sort of like a great big pimple. And, again like a great big pimple, when it bursts it ain’t a-gonna be a pretty thing.

Editor’s note: Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications. If you’re inclined to read more, you’ll find the whole Mogambo here:

Two scoops and a sprinkle of inflation

We wait. We wait.

We’re waiting for something to happen.

Stocks are, generally, too expensive. The dividend yield on most stocks is less than 2%. Investors are merely gambling that the stocks will go up. And yet, they are already near the top of their historical price range.

Real estate, generally, is too expensive also. Where can you get a decent return, after costs, on real estate? There are probably some areas, but most buyers are not investing for yield…they’re speculating on higher prices, and leveraging themselves heavily with mortgages, as it if were a sure bet.

Bonds? Our guess is that bonds may surprise investors by not collapsing. Now that Greenspan has officially denied deflation, it seems a near-certainty. Deflation would mean lower, not higher, yields…and, obviously, higher bond prices.

But so what? We do not invest on our hunches. Bonds could go down as well as up. And whatever gain is left in bonds is small potatoes compared to the immense losses investors will suffer when inflation finally returns.

So we count our gold coins and wait. Cash – in dollars, euros, yen…or gold – is what you end up with when you’re waiting for something to happen.

Meanwhile, something very interesting is happening at the meeting of the G7 get-together. Gary Duncan reports in today’s Times of London that both French and German government officials are annoyed at Jean-Claude Trichet, president of the European Central Bank.

Remarkably, Mr. Trichet seems to be taking his responsibility to protect Europe’s money seriously. German and French politicians would like a cut in interest rates to give their economies a little boost. But Mr. Trichet reminds them that his job is not to help them get re-elected; instead, he’s supposed to control inflation. Economic growth in Euroland is already as high as can be expected, he points out. Besides, "Inflation in eurozone to breach ceiling," says a Financial Times headline. This is no time to cut rates, says Trichet.

How the huns and frogs must envy their American counterparts. While the rigid Monsieur Trichet seems unwilling to bend even a finger to help inflate the European economy, America’s own central banker, Mr. Alan ‘Bubbles’ Greenspan, is pure jello in comparison. His masters in the White house seem able to pour him into any shape they want – no matter how unnatural or perverse.

Federal deficits, bubbles in the stock and real estate markets, consumer debt, adjustable rate mortgages – Mr. Greenspan has never met a mold so awkward or uncomfortable that he couldn’t get into it when the occasion called for it.

His "emergency" 1% lending rate will have to crack sometime. We wait for it to happen…and save our cash for the moment; we might need it.

While we’re waiting, here’s more news from Eric, our man-on-the-scene in Manhattan:


Eric Fry, writing from Wall Street…

– On three consecutive mornings last week, your New York editor ambled into the glistening new Time Warner building at Columbus Circle to be the guest host on CNNfn’s "Market Call." And on three consecutive mornings last week, a procession of Wall Street pundits also appeared on the show to gush about "surprisingly strong" earnings reports and "surprisingly robust" economic growth.

– "It’s a party!" one commentator declared.

– "If it’s a party," your editor replied, "the bond market is the designated driver…soberly looking on while the stock market revels. The 10-year Treasury note will be the key security to watch for the balance of 2004," your editor continued. "The bond market’s trend will determine the stock market’s trend."

– The Nasdaq partied all week, gaining 2.7% to 2,050, while the Dow added only 20 points to 10,472. But both the Dow and the Nasdaq nosed back into the black for the year to date. The U.S. dollar also whooped it up last week, jumping more than 1% to $1.184 per euro. But the dollar’s delight was gold’s grief, as the monetary metal slumped $5.90 to $395.70.

– All week long, favorable economic reports flew across the newswires like champagne corks. Technology companies from Motorola to Microsoft dazzled investors with strong first-quarter earnings, as did homebuilders, cable companies and numerous other enterprises.

– Capital goods companies also delighted investors with their quarterly reports. Apparently the economy has become so strong that companies are once again buying the kinds of things that rust in the rain – Caterpillar, Ingersoll-Rand and Parker Hannifin all reported stellar results. Friday’s stunning durable goods report – up 3.4 percent in March – suggests that capital spending is proceeding at a blistering pace.

– So far this earnings season, nearly 90% of the S&P 500 companies to report earnings have met or exceeded the consensus earnings expectations, according to Thomson First Call. Earnings results are averaging a hefty 26% growth from the 2003 period.

– But lest we get carried away by the glad tidings, we should bear in mind that interest rates are rising even faster than the collective glee over economic strength. Last week, the 10-year benchmark Treasury note fell for the fifth straight week, as its yield jumped from 4.34% to 4.46%. And as we noted last week, "Neither Wall Street nor Main Street is well prepared for rising interest rates. The shares of banks, mortgage lenders, brokerage firms and other interest-rate sensitive stocks make up more than 25% of the S&P 500. So if the financial stocks struggle, so would the entire S&P 500."

– The stock market’s many "closet financials" might also struggle in a rising rate environment. Caterpillar, General Motors and Ford all leaned very heavily upon their in-house finance operations to produce their surprisingly strong earnings. Continuing what has almost become a tradition in Dearborn MI, GM’s finance operations contributed more to the company’s bottom line than its auto operations. Tellingly, however, the profit from it sizeable mortgage operations dropped more than 30%. If rates continue rising, GM’s non-auto profits will continue sliding.

– Which brings us back to the bond market. Alan Greenspan promises that interest rates will rise "at some point." We believe him. Indeed, "some point" seems to have arrived already. The 10-year Treasury note yield has jumped from 3.77% to 4.46% in less than two months.

– Alan Greenspan hopes and believes that gradually rising rates will slow the economy GRADUALLY – down to a "sustainable" rate of growth. Unfortunately, Greenspan wields even less power over effect than he does over cause, rumors of the chairman’s omnipotence notwithstanding. Perhaps rising rates will brake the economy – and the stock market – as gradually as hoped. On the other hand, rising rates may brake the economy as abruptly as a stick through the front spokes of bicycle.

– Already, mortgage demand is toppling end-over-end. The Mortgage Bankers’ Association’s index of applications dropped 22.1% in the week ended April 9 – the fourth straight decline – while the index of applications to refinance mortgages plunged 30.7%. Both declines were the biggest in nearly nine months.

– Maybe the stock market will "learn" to cope with rising interest rates, like a dog that learns to walk with three legs…But don’t expect it to set any speed records.


Bill Bonner, back in London…

*** Durable orders surprised economists on Friday – rising 5 times as much as expected. Bonds fell in reaction. Investors took the new orders as evidence of an economy heating up. Higher interest rates, they believe, will follow.

*** But here is the problem, dear reader. The average consumer has leveraged himself to the margin at rates that Greenspan set at artificially low levels. They have become like a curious breed of over-domesticated animal that can no longer survive in the wild. Rising rates will strike them like a particularly cold winter.

*** "Tax defaults soar as homeowners struggle," reports the NY Post.

*** "Grasshoppers Threaten Nebraska Crops," adds the Associated Press.

*** Venice was an agreeable place to spend a week. The city is full of renaissance art…voluptuous churches…and elegant old buildings with the plaster falling off. When we arrived, we were a little surprised and worried to find that our apartment was not located in the heart of the city, but on the island of Guidecca, across a wide canal from the piazza de San Marco. But it was only a few minutes ride by water taxi from the main part of Venice and the water proved a blessing. The city has a museum-like quality to it, with tourists – including our own family – wandering through as though it were the Louvre. As in a museum, the restaurants were over-priced and not very good. And, as in a crowded museum, you find yourself bumping into other tourists every time you turn around. Giudecca was a relief; Italians lived there.

*** On this day, in 1889, just 6 days after the birth of Adolf Hitler, one of the world’s great philosophers was born – Ludwig Wittgenstein. More about Wittgenstein later in the week.

The Daily Reckoning