This Inflation Thing

Two adjacent news clippings – set in the Philippines – trigger a great booming laugh, audible for miles. Such a hearty laugh could only belong to one man…

Foreign Custody Holdings at the Fed – the place where foreign nationals holding foreign passports and speak with funny foreign accents come waltzing in with bulging suitcases full of money – is a very busy place, thanks to the trade deficit.

As they struggle into the lobby of the Federal Reserve, knees buckling under the enormous weight of all that cash, they look up at the menu of things for sale in America – it’s posted right there on the wall – and ask, "Where can we spend all this damn money?"

And because they can’t see anything they really like, they amass more big ol’ globs of Treasury and agency debt to add to the previous massive, huge globs of Treasury and agency debt they have been buying for years and years, and then they get back on an airplane and fly back to the foreign country they call home.

And then they get back, and their foreign wives meet them at the door of their foreign-looking little houses, and they ask, "Well, what did you buy with all that money?" and they say, "I bought some American Treasury and agency debt," and she starts screaming, "What? We are up to here with American Treasury and agency debt! We got Treasury and agency debt everywhere! In the cellar! In the attic! In the hall! In the guest room! In the kitchen! We even have stacks of American Treasury and agency debt in the bedroom, and I gotta sleep in there all night with it, inhaling the stench. And when I send you off to invest our money, you come back and tell me you bought MORE American Treasury and agency debt? What are you, some kind of moron?"

The Philippine Economy: Expanding Economies

Anyway, ignoring these unseemly domestic problems, foreigners bought another $9.3 billion for the week, which is higher than normal by quite some way, and stashed it at the Fed. This brings their total holdings at the Fed to (hit the "Total" button) $1.266 trillion, of which $320 billion of that was acquired in just the last 12 months.

Two adjacent Bloomberg news clips that the clever Doug Noland juxtaposed in his new Credit Bubble Bulletin essay on the Prudent Bear site, entitled "Speculative Finance and Liquidity Bulges," combine into a perfect illustration.

The first one, which sets up the joke, reports: "The Philippine economy expanded as much as 6% in the second quarter as manufacturing and services picked up, according to official estimates."

Well, to be fair, this is news to somebody? How could they NOT have an expanding economy? Everybody has an expanding economy! That is the whole freaking point of deficit spending and creating excess money and credit via the central banks! It expands economies! Nobody would ever suggest otherwise, and by "nobody" and "ever" I mean that there is not one instance of an idiot ever saying so, in the whole history of idiots, which is probably a long, long line of really dumb people all genetically related to me somehow, and I am as surprised as you are about that!

Of course, deficit spending will energize an economy, you fool! Tons and tons of instantaneous spending will always energize an economy! And with globalization, when one economy is energized, it tends to leak out into all the other economies after a few iterations of the system.

OK, now we know about the worldwide explosive expansion of credit, all of which stems initially from Alan Greenspan and his Federal Reserve, and how it is a tonic for economies. It is usually at this exact point where I throw in some verrrryyyyy disrespectful and insulting remarks about either A) monetary policy, B) fiscal policy or C) something entirely unrelated ("Oh, look!" she says. "A puppy with a pretty ribbon tied around its neck!" and I say "Yeah, just like the Federal Reserve has tied a rope around our necks, and pretty soon you are going to see how much fun it will be to have your legs slowly gnawed off by inflation in prices!")

But it always comes down, in the final analysis, to price. And price means money. And money means Federal Reserve. And Federal Reserve means Alan Greenspan. And Alan Greenspan means continuous Federal Reserve expansion of money and credit. And expansion of money and credit means expansion of the money supply into "surplus mode." And a money supply in "surplus mode" means all that money will eventually find a home in prices. And that means higher prices.

The Philippine Economy: Inflation in the Philippines

But anyway, we were talking about a pair of news items, before I got sidetracked, the second of which said: "Philippine inflation may average more than the government’s 5% limit this year, an official said at a press briefing in Manila."

Hahahahaha! People recoil in horror as the Mogambo literally falls to the ground and laughs heartily with that famous Mogambo Booming Laugh Until You Think He Is Going To Laugh Himself To Death Because He Is Laughing So Hard (MBLUYTHIGTLHTDBHILSH) – hahahahahahahahahaahahahaha – at the object lesson presented so adroitly by Mr. Noland, one that is so, so, so deliciously profound! It is this! This inflation thing! This is the reason why people don’t go around deficit spending and creating excess money and credit! Because it leads to inflation! It always does! And it always does because it has to! Because where else can all that extra money go?

And if you want to see how much fun price inflation is, just manage to stay alive a few more years, because it ought to get cooking pretty good right about then. You will be in the thick of it, where prices are rising month after month, year after year, and your after-tax income is NOT rising nearly as fast. And the newspapers will be full of heartbreaking stories about more and more misery affecting more and more people, and the television newscasts will show scenes of mobs of angry, desperate, starving, bankrupt people marching on state capitols and Congress, demanding free money!

Yes, people, this inflation thing.


The Mogambo Guru
for The Daily Reckoning
August 30, 2004

Those were the days!

Oh, how we danced on Saturday night…and laughed…and sang…

…Yes, we sang Johnny Cash and Hank Williams songs to an audience of potted Frenchmen, Belgians, Poles, Romanians, Germans…and no one cared that the end of the world was coming…

They whirled around the dance floor…raised their glasses and lowered their eyes…and all were gay. Monique, with her low-cut gown…the woman must be over 65, but she looked as though she were at a debutante ball. Anne-Marie, too…she must be collecting Social Security…but when the band started up, she danced like a teenager. And Jean- Maurice…the poor man had such a bad leg last week he couldn’t get out of bed. But there he was – like a 20-year- old – waltzing around the room with the grace of a swan.

The party went on ’til 4 a.m…and even then, a small group remained on the veranda…singing, talking, smoking…

"I understand you wrote a very gloomy book about the economy," began a conversation with an attractive woman. She had reddish-blond hair and a bright look. Even in her gown, she was not so much elegant as fun loving, in an almost earthy way. Her hands were rough. Like so many of France’s "little aristocracy," she must be doing the hard work herself. And her body, though not young, was taut…as if she were a gymnast. She probably works in the kitchen in the morning…and in the garden in the afternoon. Whatever she is doing…it seems to work.

We noticed these things while explaining to her why the world economy – led by American consumer spending – was coming to an end. We have said these things so often we can do so while thinking of other things far more interesting. But since we cannot tell you what we were thinking – this is, after all, a family publication – we will tell you what we were saying:

"The Asians have outsmarted us," we began. "No…not outsmarted. It is not an intellectual matter…it is not the brain at work, but the heart and the soul. The Asians can’t see into the future anymore than we can. But as George Washington once put it, "We can’t guarantee success, but we can deserve it.’" The Asians deserve success; we deserve failure. They’ve done the right things; we have done the wrong ones.

"What the Asians did right was to save their money and work hard. We Americans have squandered our money and only pretended to work hard. The net national savings rate in America used to be almost 10%… that’s net of depreciation. You need net savings in order to build new factories and new means of production…in order to make new profits…pay higher salaries…and so forth…so that people become wealthier."

Savings net of depreciation did not seem to trigger any emotional reaction in our listener. She did not put out her hand, blink and say…"Oh…you…" She did not toss her hair back or even smile, except in a wan way that seemed to say: "you pathetic schmuck…you think I care about net savings after deprecation?"

But we were too far advanced in our rap to back off now. We had crossed a Rubicon…we had to continue. More below…following the news from Baltimore:


Tom Dyson, under the gray and rainy skies of Baltimore…

– If the average domestic price of an unleaded gallon of gasoline at $1.88 is starting to hurt, dear reader, spare a thought for the poor people of Asia. They might be amassing all the dollars; they might soon get all the jobs. But they can’t buy enough oil to fuel their factories – not at any price, it seems.

– Beijing’s senior economist reckons China will have to pay an extra $8.8 billion to maintain crude oil imports at 2003 levels. But trouble is China’s demand for the black stuff has increased by 20% since then. It’s doubled over the last 20 years. In February, China overtook Japan to stand second only to the United States in terms of its thirst for oil.

– Still, second place to America puts China a long way behind. The average Chinese consumer uses only 10-15% of the energy an average American guzzles, according to a BBC report. There’s a lot of catching up to do. Governments across Asia are worried…

– In Bangkok, starting last week, department stores must close at 8 p.m.; petrol stations will close at midnight; billboards will no longer be lit after 10 p.m. The Thai government reckons this should save the economy 3 billion baht, around $72 million.

– Over in India, the Bombay government has cut customs and excise duties on gasoline and diesel duties from 20% to 15%. In the Philippines, meantime, rising oil prices helped create a $142-million trade deficit in June. The same month last year saw a surplus of $132 million. Worse still, analysts say exports could fall if demand from China and the United States starts to fall…which it already has, according to figures just out from Taiwan.

– The Taiwan Republic of China – or the 23rd province of the People’s Republic, as Beijing would like it to become – saw industrial output rise by 8.4% in July, compared with 15.7% growth in June. The wonks in Taipei attributed the slowdown to cooling U.S. and Chinese demand. The U.S. Fed, naturally, disagrees.

– Last week, Fed governor Ben Bernanke told PBS viewers that while "There’s going to be a little bit of a slowdown effect [due to the high oil price]…I think it won’t derail what looks like a self-sustaining expansion at this point." Dallas Fed President Robert McTeer – he of the SUVs – repeated the claim for CNBC. Growth "is self-sustaining, and it’s not terribly fragile," he said…which is a curious phrase to use when you think there’s nothing to worry about.

– What does all this mean for investors? With oil up 50% in dollar terms in just one year, you might expect energy stocks to be reaching all-time highs. But as Elizabeth Wine writes in the FT, "The decoupling is clear from the numbers: Crude oil has soared 45% this year, while [U.S.] energy stocks have gained 12%."

– The reason? Energy stocks "are not overly loved by institutional investors," says Ms. Wine. Fewer than 44% of U.S. mutual funds are overweight in energy stocks, according to Merrill Lynch. Even some professional oil traders are wary of oil stocks. One oil trader at Bear Stearns says that "Oil could go down 15-20% in a day, and these stocks will get crushed." He believes oil is so high thanks solely to speculative trading…which could unwind very quickly.

– Oh really? "We don’t believe in oil at $49," said Jim Rintoul of to your editor over the weekend. "We didn’t believe in it at $48 either," he continued. "A pullback is overdue. But the long-term uptrend is solid and intact. The froth in the press about a sudden sharp pullback…it ignores the facts – soaring Asian demand, maxed-out global capacity, fears over the approach of ‘peak oil.’"

– Last week, NYMEX WTI for October slipped $4.68, nearly 10%, to $43.18…did news that Russian President Putin had called the White House to assure the United States that he will keep the spigots open – even if he does close Yukos – cause the sell-off? Or was it something more technical?

– Over in New York, stock market investors took Vladimir at his word. The Dow rallied another 95 points from last week’s tiptoe turnaround. It closed Friday at 10,195 – a six-week high. The S&P also limped ahead, adding 9 points, to 1,108, for a 0.8% gain on the week. And the Nasdaq pushed 24 points higher, closing at 1,862, a four-week high.

– Away from the noise of the markets, however, the fact remains – OPEC production is running at 95% of capacity. Deutsche Bank reckons oil demand in 2004 has increased at twice the rate it did in the previous 20 years. So while the price of oil might slip in the short term, it’s only headed higher, we think, as 2004 heads into winter.


Bill Bonner, back at the party…

We bought this place in the Poitou region of France nearly 10 years ago. On Saturday, we feted the end of summer with a big party, inviting everyone we knew…along with an international group of associates who had come for a business conference.

Tout Paris was there…

Well, tout Poitou, at least.

"It’s amazing how many friends you’ve made in the area," said a visiting American. "I had heard the French were hard to get to know – especially in the countryside."

"Yes, the French are reserved. But they’ve been very nice to us," we replied, "in the way that people are nice to a blind man or a mental defective. They knew we were helpless and clueless…"

"Currently, net national savings in the United States is only about one-half of 1%," continued our explanation of the coming end of the world. "Which means, we do not have the savings needed to build new factories – assuming we wanted to – or to live beyond our means. So we have to borrow from the rest of the world. That’s why our current account deficit has reached over 5% of GDP – about $600 billion per year."

The current account deficit had no more effect than net savings. The blond woman’s eyes wandered; she was looking for a path to beat a retreat. She wanted to dance…to play…to throw her head back in idle, silly laughter. A dull economist can no more entertain a lively woman than a stand-up comic can make a dead accountant smile.

"We have to take up the world’s savings – about 80% of all the savings of everyone on the planet, just to keep spending money at the same pace. And for a long time, we wondered why the foreigners would send their money to America. The United States controls the dollar…in which their loans are calibrated. And everyone knows the Fed will inflate the dollar over time – did you know that it’s lost 95% of its value since the Fed was set up in 1913? – so it must be a sucker’s bet to take a big position in dollar- denominated paper. It was pretty obvious what could happen: The dollar would crash, and all those foreign holders of U.S. paper would wish they had never heard of dollars. It would turn out to be like lending money to Argentina in the 1980s…or to Germany in the early ’20s…or Russia before WWI.

"But look what is happening. Long-term yields are still going down…or at least staying steady. Bonds are going up. And commodities – it is hard to believe, but they are going down. And the dollar? It’s actually going up.

"We referred to what we called the ‘GUDD’ world of the last couple of years – gold up, dollar down. But that world seems to be stalled. Or even reversed. We don’t know yet.

"But it looks as though the Asians could come out of this in good shape, after all. They’ve done the right thing…at least as far as saving and capital investment are concerned. If the world continues to go into this long, slow, soft decline that we predicted in our book…well, all that paper they’ve accumulated in dollars will be worth more, not less. And they’ll be able to cash it in against real assets in the United States.

"You know, we keep telling readers that it will a supremely elegant development if Americans should sell Manhattan to Asians for trinkets – computer games, flat-screen TVs and other geegaws – after buying it from Indians for $26 worth of trinkets 350 years ago."

We presumed that "long term bond yields" had stirred about as much interest as "net savings" and "current account deficits." We expected her to tell us she had to go to the powder room. But she surprised us…

"It’s not the economic situation that worries me; it is the political situation. The whole world has a kind of fin de siecle air to it. In France, we cannot continue living as we have. Everyone knows it, but no one does anything about it. No politician will dare say anything.

"Young people get paid not to work. If you are unemployed, you can live better than if you have a job. So you can’t find anyone to do anything. All the old artisans are dying off or retiring. You have to do everything yourself. And the government keeps making more and more promises to everyone – especially to government employees. Who’s going to pay for all of this stuff?

"And then, what you are telling me makes me think the situation in America is not much different. People expect something that they cannot ever have – to live better than they can really afford. How can that continue…?

"And there is all this talk of a war against terror. From time to time, people seem to like war. I guess it diverts them from other things…

"But I’m not going to worry about it…"

"Yes, what would be the point…? Shall we dance?

"Yes, let’s…"

The Daily Reckoning