Inflation "The Obvious is Obviously Wrong"

Inflation

One can't help but feel a sense of dread about the consensus views on the risks of inflation. "With oil dropping there is no longer a risk of inflation" Really?

Is there any doubt that it's been record Low Interest rates that were at 45 year lows for almost two years that has allowed for the massive amounts of home mortgage refinancing and the creation of the largest real estate bubble in history?

That It was the unrealistically low interest rates, in conjunction with the Real Estate Boom that it caused brought on by the availability of easy credit to people that should never have had any credit extended to them, that has sustain this economy at a record rate of growth (3.8%) which is above the sustainable trend, for 17 straight quarters. The economy has not seen this rate of growth since the late 50's early 60"s and is much better than anything seen during the Clinton era.

The ten-year Treasuries are priced to yield less than 4.75 %. Anybody with a sense of history should know that the bond market's reputation for absolute safety is undeserved. After all, there are plenty of instances in history where bond investors were cheated by artificially low rates that eventually found their true levels.

The message today from the FED is that inflation is not a worry. The purchasing power of the dollar is secure, so that it is okay to tie your money up for thirty-years at less than 5%. Inflation worries are simply nowhere to be found in the nation's leading newspapers and have elusively slipped off-stage, and War, Terrorism, murdered and Mad men fro Iran and Venezuela are the new attention grabbers of the news. These days there are a host of other concerns likely to get top billing before inflationary worries. Among them, the Federal Governments' massive budget deficits, record high Trade Deficits or the spiraling cost of health care but most of all it's the bursting of the Real estate bubble, that I warned you about last year, that is now front and center along with falling oil price telling everyone that inflation is no longer a problem. It was just after GS predicted $100/bbl oil that I warned you all that the better bet was $50/bbl before $100/bbl. Economics always works.

How many times do I have to explain that INFALTION is a Monetary Phenomenon brought on by excessive money and credit creation by the FED: and has been going on for 20 years. Although the FED has recently slowed monetary expansion it has not stopped it as of yet.

There are a myriad of clues and warnings, beyond mere contrarian instincts, that rampant inflation will once again have its day. The new consensus of opinion in the bond market holds [that] heavy public borrowing, fast-paced monetization of the federal deficit, and high commodity prices and a 70's style guns and butter economy is all non-inflationary. That would be funny if it wasn't so dangerous. It's obvious that no FED official, politician or Wall st. talking head can ever give you a straight answer if it's negative for fear of losing their jobs. (only term limits could solve that problem) and as for the media is concerned, although they are very articulate they happen to be brain dead.

The DJ-AIB Commodities Futures Index in spite of recent 20% pullbacks is still up near record highs. Gold, oil, natural gas, foods and all other natural resources have been steadily on the increase for years. International turmoil may explain some of these increases, but the movements are more than broad enough for me to conclude that something more propels these commodities. Do commodity price increases only mistakenly represented "the latest manifestation of the rapid increases in the Worlds money supply? In the commodity pits, at least, there seems to be some clue that the purchasing power of the dollar may not be as secure as bondholders presume it to be. The fact that the $US is having trouble sustaining itself may be telling us something. What about China's revaluation of the Yuan, against not only the $US peg but now against a basket of currencies? {BE careful what you ask for you just may get it.

Beyond this, there is perhaps the most powerful reason of all; fiat currency has always shown its true value in the long run. Theory and history agree that its value only diminishes over time. Its primary weakness is what some Fed governors think is its greatest strength: The printing press analogy, which has been used not only by critics of fiat currency, but also by Federal Reserve Board Chairman, Ben Bernanke, who has stated that "the government can produce as many U.S. dollars as it wishes at essentially no cost." Yet another shot across the bow for those who still believe inflation is dead.

How much longer can the world stay fooled into believing that not only are companies absorbing all the increases in commodity prices and not passing their increased costs on to the consumer while still being able to continue to increase their profits at double digit rates? Does anyone believe that adding fuel charges does not constitute price increases.

The more I study and observe, the more I'm convinced that the entire world is sucking from the same bottle of inflation; inducing massive Government spending, Debt and overall Monetary and Credit expansion. Inflation and massive Credit has become the American way of life. It may hesitate but it never stops and the only reason that we have seemingly gotten away with it up until now is because the US$ is the worlds only reserve currency. But that too may be on the verge of change. Perhaps in our lifetime it has only crept, but there is always a possibility that it will soon start to gallop. It seems that in bubble America, people have forgotten that this horse still has legs and the barn door has been left wide open and unattended. Inflation is a process that forcefully re-distributes wealth from one group to another. You cannot hurt the rich without also devastating the poor. During periods of monetary inflation: Prices do not change uniformly; in this process, those that get the new dollars before their costs have risen gain at the expense of those whose costs rise first. Any analysis of inflation must proceed sequentially as it courses through the economic system. Moreover, it is this inflationary process that sets the cycle of boom and bust in motion. Prices are distorted and investments are inevitably made in unsustainable areas, leading ultimately to gross imbalances and finally to liquidation and/or busts. No one knows now just how much precious capital has been wasted on Takeovers, Real-Estate over building and capacity over expansion and like every mania before this one, will most assuredly have its comeuppance in the not too distant future.

For those who are comparing the coming bursting of the real estate bubble to the DotCom bubble, real estate is 10 times bigger and its bursting will have a much much worse effect on the economy.

Even though I don't have a crystal ball, I do know that there is one of only three possible outcomes that must come out of this record extended bout of money and credit expansion. Either Galloping Inflation, financial crises or both, either will bring about a massive financial collapse.

ELIMINATING POVERTY

If it was possible for the actions that the FED has and is currently pursuing to work, then why not solve the poverty problem at the same time. Let us just simply mail a yearly check for $25,000 to every family in America; "Bang" no more poverty, no more lack of demand No more unemployment, everybody could now afford the sky high home prices; While were at, why stop there? If printing money and creating credit out of thin air works, why not simply mail yearly checks to the rest of the poor throughout the world and eliminate world poverty once and for all. If we sent every Mexican family $25,000 to stay home, we would also solve our illegal immigration problem as well. It might even be cheaper than what we are currently planning to do. Who knows maybe my mother was wrong when she taught me "That you can't buy friends" May the world would them love us instead of hating us.

PLEASE NOTE:

This week and maybe next with most analysts being so short term bearish could be the best time for DJII to break out to those New All Time Highs that I have been looking for. BUT make sure that you all are not caught up by that final BULL HOOK that always precedes the final TOP.

I have split this week's missive in half. Next week we will examine previous American Depressions, especially The Great Depression of 1929 to 1947. Maybe by cutting through all the misconceptions we can learn something.

Aubie Baltin CFA, CTA, CFP, Phd. (retired)
Palm Beach Gardens, FL
[email protected]
561-840-9767

September 25, 2006

DISCLAIMER
The above is my personal opinion, and in no way be deemed investment advice to buy or sell anything. It is submitted purely for informational purposes, based upon my understanding of the markets.