Worried About the 'Stag' of 'Flation'

What else happened whilst we were gone?

More of the same is what it looks like.

The latest news tells us that the economy really is softening – as predicted. Unemployment is now up to 5%. Nothing to get too worried about, but heading in the wrong direction.

“Unemployment sounds warning on the economy,” says a New York Times headline.

It’s the “latest omen of recession,” adds the LA Times.

The New Year has been uncorked. We take a sniff. Pretty much what we expected…a slight odor of rot. Hey wait. There’s a faint smell of rice wine…yes…it’s Sushi Funk…the vintage produced in Japan between ’90 and ’07!

Hold on…we’ll explain.

In America, 2008 is beginning as a year of $100 oil…$850 gold…falling stock prices…5% unemployment…and a euro (EUR) is barely worth a dollar and a half.

The little countries of Malta and Cyprus chose to go with the euro. Investors all over the world, drug dealers, and central bankers seem to be making the same choice.

And did we mention? Stocks fell 256 points on the Dow on Friday. The index is now below 13,000.

What do we make of this?

First, we’d say that it appears that the economy is headed towards the dreaded synthesis of inflation and deflation known as ‘stagflation.’ Commodity prices are rising. Gold is rising. Oil has already risen. Up…up…up…and yet, the economy can barely get out of bed in the morning. Consumers are running out of money to spend. And financial assets – the kind of assets people like to see go up in price – are going down instead.

Second, we’d point out that this is not the first time the United States has suffered stagflation. The first time was in the ’70s. Inflation rose while the economy slumped. Realizing that looser monetary policies would merely cause more inflation, big Paul Volcker was called in. He raised reserve requirements…drove short-term lending rates to 20%…and stopped inflation.

That was then. This is now. Back then, the United States had much less debt that it does today. And now, it is not inflation that the feds fear – it is deflation. They’ve had the Japan example to watch for the last 18 years. The last thing they want to see is a Japan-style deflationary slump. America’s high debt, current account deficit, consumer credit economy couldn’t bear it. So they’re doing all they can to avoid it. When it comes to stagflation, they don’t mind the ‘flation’ part; it’s the stag that worries them.

And so, third, you can probably expect more efforts on the part of the feds to weaken the dollar…which will almost certainly have the effect of driving up oil, commodity, gold…and consumer prices. This is not the path followed by Volcker. Instead, it is the path followed by, are you ready for this, the Japanese!

Yes, dear reader, in our unrelenting efforts to keep you ahead of the news, we have pulled out a chicken…looked at its entrails…and what we see is a slimy mess. The one thing the feds fear most is a Japan-like slump. But it is the policies of the Bank of Japan and the Japanese Treasury that they are following…not the policies of the Volcker Fed in the late ’70s and early ’80s. Instead of crushing inflation, they are pumping it up. Instead of bringing on recession…they are trying to hold it off. Instead of protecting the dollar, they are trying to destroy it.

If they sow as the Japanese sowed, what harvest will they reap?

We don’t know, but we can barely wait to find out

*** Want to know what is coming in 2008? Before Christmas our old friend Christoph Amberger invited us to appear on TFN to be interviewed. He wanted to know what was ahead. Click here to view our insights.

*** “The boom in soybeans has changed Argentina,” said Francisco, the gaucho who manages our ranch. “I mean changed it physically. The good land used to be used for beef. That’s why Argentine beef is the best in the world. We didn’t even have feedlots. The cattle just fattened themselves up on grass. But then the price of soy – and other grains too – shot up so high farmers couldn’t ignore it. They sold the beef cattle, planted soy…and they got rich. That’s why you see so much money in Argentina today. And it’s why land prices are twice what they were a couple of years ago. And people are still buying. Because, even at $5,000 a hectare, land is still cheaper here than in other parts of the world. And when you figure in lower labor costs – and even lower fuel costs – we’re the world’s low-cost producer for a lot of things. Well, usually Brazil does better. But Argentine land is flat and rich. And farmers are coming from America, New Zealand, Australia and Europe. They’re buying it up. And at today’s grain prices…they can pay for the land in just three years.

“Of course, farm prices go down too. And then they’ll be sorry they didn’t stick to beef. The price of beef has doubled too. We’re getting nearly twice what we got two years ago.

“But it’s a whole lot easier to switch from beef to grains than it is to switch back. We say that ‘they plant soybeans in Buenos Aires’ – meaning that you can live in the city and operate a grain farm. You just make a couple of decisions per year. Some farmers never even see their land. They just call the foreman…or call the contractor…and tell them they want to plant.

“But when you run a cattle farm, you’ve got to see the cattle. Check on them. Touch them. Brand them. Vaccinate them. Take care of them when they’re sick. Make sure they get enough food and water. Especially up here, where there isn’t much food or much water.

“We’ve got another saying: ‘It’s the eye of the owner that makes cattle get fat.’ It’s true. You really have to work at it. And pay attention. And select your animals well. And when you want to switch from grains to cattle, it’s going to take you a few years to build up a herd. That’s why I think we’re going to see high grain prices for only a short time…but high cattle prices for much longer.”

Francisco is not an economist. His mind is clear of claptrap and mumbo jumbo. Plus out on the high plains, he has time to think.

But he probably has not thought about the difference between nominal prices and real ones. With so many people planting so much wheat and soybeans, we would expect prices to go down. But at the same time, the world’s central bankers are planting every possible acre in new money! It is very possible that the nominal price of grains could go up…while real prices (adjusted for inflation in other prices) could go down.

*** We haven’t told you much about our vacation.

Christmas Day was spent down in the ‘delta’ – an area of canals and rivers and dense vegetation about an hour from downtown Buenos Aires. There, our oldest son bought a charming cottage on the waterfront for $230,000. Of course, in the Delta, everything is waterfront…even places that are supposed to be landlocked. When the tide rises, it washes over bulwarks and dikes…fills swimming pools and basements…and splashes into backyard gardens.

“Yeah…it’s great down here…” he explained as he took us on a boat ride to visit the area. Besides, his house sits on an island; you can only get there by boat.

Everyone travels by boat. There are all manner of floating transportation – including wooden launches known as ‘collectivo’ – waterbuses.

Leaving the town of Tigre, we rode along…enjoying the sun…the waves…the boats, and the bronzed muscle-builders driving boats…and babes sitting at the back. Behind us a brown wake smashed into roots and mud, washing more earth into the already-silted river. Many houses were built on stilts. Many are rickety. Some have already fallen into the water. Some lots have disappeared completely – thanks to the action of so many boats and so many waves – leaving the houses standing over water, like fishing shacks.

“Elisa Marie” was the sign on one shack. “Fisherman’s Paradise” proclaimed another. “Mosquito Haven” said an honest one.

The Delta is an undiscovered treasure. Generations of Portenos (as Argentines call residents of Buenos Aires) have escaped the capital city by going out to the swamp…where they have built little houses…and some grand ones…for holiday retreats. They have let their imaginations lead them. One house looks like a Swiss chalet. Another looks like a place you might find in New Hampshire, a Victorian-era upright. Still another resembles a villa in Southern Italy. One is for fishing. Another is for sunbathing. In the other, owners swim off the pier.

Here too, rowing clubs have established themselves. There is the “Scandinavian Rowing Club,” for example, in Spanish, of course. But there is also the “Buenos Aires Rowing Club” (in English). And the Italian Rowing Club. We don’t know why people row by country of national origin…as far as we know, there is no “French Skiing Club” or no “Lithuanian Bowling Club”…but there you have it.

On Christmas Day, the Delta was alive with rowers, boaters, swimmers, sunbathers, picnickers, and backyard barbequers. There are no George Foreman grills down here…but everyone seems to love a cookout. Wherever we went, we could smell beef cooking over an open grill.

“Do you have a paddle on this boat,” we asked our son, as we set out.

By the time a man reaches 60, he wants to hold his pants up with a belt …and suspenders too. In his house, he puts on a deadbolt lock…and an alarm system, just in case. And when he takes a roadtrip, even if he hears voices from a satellite navigation system, he also takes a map; you never know.

“Yes, of course there is a paddle,” came the slightly annoyed response.

About a half hour into our trip, we were looking for the paddle. The engine had sputtered to a halt somewhere on one of the Delta’s hundreds of miles of bayous and canals.

But a young man hardly thinks of such things. For him, Plan A is always enough. Prices always go up. And everything always works out. Your author, on the other hand, remembers all the Plan A’s that didn’t quite work out. When a market goes up, he expects it to go down. When he gets in a taxi in Buenos Aires, he expects to be overcharged. And when he eats in an Asian restaurant, he is sure he’ll be sick. Instinctively, he looks for a Plan B. And even that isn’t enough. He wants Plan C, too. And a way to get home, just in case none of it pans out.

But it was all a nice adventure, down on the Delta. An hour of paddling…and we were home.

Until tomorrow,

Bill Bonner
The Daily Reckoning
Buenos Aires, Argentina
Monday, January 7, 2008

The Daily Reckoning PRESENTS: That the economy is facing a collapse is something that The Mogambo would not disagree with. But to make a compelling argument for a deflationary collapse throws a giant wrench in the Mogambo’s inflationary belief system. Don’t be surprised if he attacks without mercy like a cornered rat. Read on…

by The Mogambo Guru

There is a line of argument which says that because money will be literally disappearing as loans default and new loans are not taken out, inflation in the money supply will fall, which means that prices will fall, and thus this proves that we are going to suffer a deflationary collapse instead of an inflationary collapse, where prices go up and up.

You gotta admit; it seems to be a compelling argument; the money supply will fall as loans go bad, which means consumer prices will fall. And with loans going bad, nobody is going to either make a loan or take one, and so the money supply will not grow.

This presents a real difficulty for me, as it means that when people demand that I defend my thesis that we will, instead, see an inflationary collapse, I can’t. The fall in the money supply seems so compelling!

So I nervously hem and haw, desperately looking for some plausible reason, and I can’t think of one, and pretty soon I am resorting to personal attacks against the person questioning me (“Did your stupid kids dream up that question, or is that your own stupid question?) and all-in-all I get to feeling like a cornered rat, which usually leads to the Attack Without Mercy (AWM), which is, actually a “surprise attack” even if the enemy knows right where you are, is looking at you, and is actually laying in ambush for you! I get this little-known tactical nugget from General Armstrong Custer himself in the movie “Little Big Man”, where he said, in this very “they know we’re here!” circumstance, “Nothing is more surprising than the attack without mercy!”

So imagine my great relief to have an ally in Peter Schiff of Euro Pacific Capital, who writes, “Many mistakenly believe that when the U.S. economy falls into recession, reduced domestic demand will lead to falling consumer prices. However, what is often overlooked is the fact that as the dollar loses value, the rising relative values of foreign currencies will increase consumer demand abroad. As fewer foreign-made products are imported and more domestic-made products are exported, the result will be far fewer products available for Americans to consume. So even if the domestic money supply were to contract, the supply of goods for sale would contract even faster. Shrinking supply will be a major factor in pushing consumer prices higher in America.”

Hey! I love it when math works in my favor for a change, instead of the bank showing me the math of where I had screwed up my checking account, and the math about how I owe them money for overdrafts and bounced checks. Now it would be the other way around, for a welcome and long overdue change! Now I would get right in THEIR stupid little faces and demand that THEY come up with some cash, you deadbeat losers, and right now, or I’m calling the cops! Oooh! I tingle at the anticipation!

I was enjoying this little tingle and almost missed the whole point, which is that, “The big problem politically is that hyper-inflation may superficially appear to be the lesser evil. If asset prices are allowed to collapse, ownership of those assets will pass to our creditors. If instead we repay our debts with debased currency, we retain ownership of our assets and shift the losses to our creditors.”

That’s the way it shapes up, and the deciding factor is, so he says, “Since American debtors can vote in U.S. elections and foreign creditors can not, the choice seems obvious. Of course there are some American creditors as well, but since they comprise such a small percentage of the electorate, my guess is that their losses will be seen as acceptable collateral damage.”

Exactly so! That is the depth to which the American government has sunk; the “good of the majority” is paramount over the desires of the minority, which is proved when something like the bottom half of taxpayers ranked by income pay no income tax at all, while the top 1% pays more than half of all income taxes, and the fact that almost half of the people in the USA receive money directly, or indirectly, from the federal government each and every month! Hahaha! What a system! The “Good of the Majority” run amok! Ugh.

Until next time,

The Mogambo Guru
for The Daily Reckoning

Mogambo sez: With all the losses, the Dow Jones Industrial Average index is now sporting a price-to-earnings ratio of 47. You have probably concluded by the way my face is ashen and my breath comes in ragged gasps that something is wrong, because this means that the price of the Dow would have to fall to half to bring the P/E ratio back to 23, which is also unnaturally high, and due to fall some more!

And bonds? Hahaha! Bonds are so highly priced that they are literally yielding less than the rate of inflation as it is!

But this is all not just wrong, it is more than wrong; it is insane! Hahaha! Insane! Insane, I tells ya!

And that is why I cling to gold and silver with such force, measured in sheer firepower, which is the only sane thing left to do in a world gone mad! And that is not just me talking like I am such a smart guy who has figured out something new and exciting, but the sum total of all of the world’s history, which proves over and over and over again that everyone always turns to gold at the end. Always. The smart ones first.

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.

The Daily Reckoning