Don't Be Fooled - Inflation is Coming

Many people are using this latest weakness in the price of various resources (gold, silver, oil, and other commodities) to claim that the commodity boom is over. They’re wrong. Resource prices have been declining for a variety of reasons, but all of them appear to be temporary. These same people then point to the recent strength in the USD. I contend that the strength is temporary. How often in history does an economy that’s going into recession, with a policy of lowering interest rates, undergo massive increases in the value of its underlying currency? Only time will tell, but I’m willing to bet my money that this isn’t the last of the commodity boom. I’ll put my money where my mouth is and continue to buy undervalued resource companies at extremely attractive levels as I’m expecting inflation in the long-term. Short-term I do see strength in the USD, but not because it’s fundamentally strong. I could never see any long-term strength in any fiat currency due to inflation.

In regards to recent USD strength (and gold weakness), we’ve been witnessing the de-leveraging and unwinding of many hedge funds. Many of these hedge funds were invested in anything but the USD, and as such, when they are required to sell their assets, they are repatriating them into USD’s to give money back to investors and pay off debt. This buying of USD’s in mass is creating extreme strength when the dollar should be showing signs of weakness.

There also seems to be something fishy going on with the gold price on the Comex. Is it manipulation? Yes! On paper you can buy gold in abundance and relatively cheaply. In real life it is actually hard to find a gold/silver dealer that will sell you gold or silver for anywhere near the Comex spot price. The Fed doesn’t want gold to be too strong or they run the risk of losing people’s trust in the fiat currency, and trust is the only way a currency works. So could governments be manipulating the paper prices of gold? Of course, but we all know it isn’t the price or value of gold going up, but the debasement of fiat currencies, that they are attempting to mask by putting a lid on gold.

One of the primary reasons oil is headed lower right now seems to be driven by fear of a deep recession. This fear has merit. An economy financed completely on debt is not a stable or sustainable one. As U.S. consumers are finding out, you must actually pay back debts by cutting discretionary spending, and if you’ve gone too far, declare bankruptcy. With consumers tightening their purse strings, a recession was bound to happen. Now consumers aren’t all rushing to buy half million dollar homes at the same time and the economy is beginning to feel it. Even with a recession, oil is still being used at an alarming rate and drilling is actually down quite a bit! This might catch up with the oil price increasing during a recession! A large number of additional vehicles are being added to the world’s roads each year. Yes, the days of oil energy reliance are limited, but for now it’s still an essential resource.

Regardless of what you believe in politics, I don’t think any independent economist actually believes dramatically raising taxes on corporations will help the recession or the standard of living for those down the line. It probably won’t help the USD either. But for a variety of reasons, tax rates on corporations will undergo extreme changes upwards in the coming years. Combine that with the dramatic rise in minimum wages, and inflation is bound to happen even at a time when the economy may not be running on all cylinders. Outsourcing may continue to make the situation worse. These factors may only further impair the value of the USD.

The government shows no signs of cutting back on spending anytime soon. Massive deficits are forecast for years and years to come, with no signs of slowing or stopping! This is dangerous. An individual, corporation and country can only handle so much debt. If the country does intend to ever pay back these insanely high and still growing debts, there is only one way out; it’s called inflation. Inflation in the future will cause all of these debts to be much easier to pay down, but inflation doesn’t come without a price to the Middle Class.

There isn’t just fear of a recession, but also of deflation, which is affecting the price of commodities. The Fed has said they will do everything they can to avoid deflation, and they will, but at the cost of causing inflation. Flooding the system with capital will cause inflation, eventually.

Regardless of what people think, BRIC countries will slow down and they will feel the recession, but even with BRIC countries slowing, there are millions of additional people being added to the world economy and these people will increase the demand on the world’s resources. This will occur at the same time that fiat currencies are pumping money into the system. The result is an increase in a seemingly infinite resource (the ability to print unlimited amounts of money) to buy things that are finite (like resources).

Traditionally, when the resource sector booms, capital is supposed to flow into the system and many new mines are built. The supply eventually catches up with the demand and the prices fall back and level out. That isn’t happening this time. Resource prices have slipped before many mines were constructed, and now with the big credit crunch, many mines are being put on hold and many exploration companies are cutting back on drilling. This deficit of new mines and resource supplies will be felt, eventually. I’m preparing for a deep recession (not depression) and EXTREME inflation. Inflation will be a bigger issue than the recession. Inflation may well be the big story for the next century. There’s going to be a lot of people running around with an abundance of fake dollars (fiat currency) trying to buy up finite resources.

Comments

[pitaking:]

I actually agree with the scenario, deflation followed by hyper inflation but we are a ways away, 2010ish

2008 Oct 28 11:29 AM

[Mark Anthony:]

You need to be shocked that $2.29T US T-Bonds are being naked shorted. It's $2.29 Trillion, with a T. Read about it:

stockology.blogspot.co...

2008 Oct 28 12:54 PM

[CLH:]

Yes deflation and then hyperinflation after 40 years. Thats how long it took after the last deflation (1930s). But then gold will last forever but will you?

2008 Oct 28 01:16 PM

[MarvinMBA:]

So far were going to see people sleeping on the streets and begging for food with stores stocked and empty houses just rotting. During the 30's people broke into vacant houses and just moved in and the banks did nothing. Soup kitchens opened and fed the hungry. This could happen again sooner than anyone realizes.

Talking about inflation we just went thru a bout with energy and housing and financials before the bubbles burst. I'm not sure we are going to see a repeat of this type of inflation any time soon as we go thru a period of agonizing adjustment down a deep hole. We do not know what the next cycle will bring but you are right that the deficiets are not
going to be solved anytime soon. I doubt if they will ever be paid off now that we are going to try to spend our way out of this downdraft and make things worst. Probably the best place to be now and in the future
is to own a working farm as a inflation hedge.....MarvinMBA

2008 Oct 28 01:36 PM

[JBP:]

One independent analyst who does an excellent job tracking the growth of the money supply is John Williams. Many decades ago, money supply measures such as M2 and M3 were regularly reported. For some reason, the government stopped reporting M3, the broadest measure of the money supply, some years ago. Fortunately, the statistics and formulae needed to calculate M3 are easily available. Williams has taken up the slack and continues to calculate and publish M3.

The most fundamental monetary aggregate also calculated by Williams is called the adjusted monetary base, which measures very liquid forms of money such as bank notes and bank reserves. In his latest missive, Williams points out that the monetary base has recently exploded at a rate unprecedented in history -- up 38% year-over-year. Not even in the 1930s was so much money created so quickly. In fact, the only other time the monetary base grew anywhere near this quickly was during the build-up for World War II, when we needed a lot of cash to convert factories into making armaments.

Williams point is that all this cash is eventually going to work its way into the economy. The good news is that banks will have unprecedented amounts of money to lend, which will make them willing to lend more money at much lower rates. The Fed Funds rate will likely drop to 1% this week. Considering that banks can borrow money at the Fed Funds rate, deposit it at the Fed, and earn interest on those deposits, they will have access to virtually free money. So once the psychological impact of the current financial crisis wears off, we will be faced with an unprecedented rise in credit and monetary largess.

The next act in our economic drama could go one of two ways. One possibility is that all this new money will never find its way into the economy, because it will be overwhelmed by psychological factors, such as fear, which will make people stop borrowing and spending and plunge the world into a horrific depression accompanied by deflation.

However, I doubt that will happen. It's just not as likely as the alternative.
Instead, the most likely scenario is one of horrific inflation...

I expect a turnaround will occur in the near future in which the price of oil soars $2 for every $1 that it fell since last spring. Inflation may not hit record levels right away, but it will in time.

Prices of all commodities will soar. Gold especially...

2008 Oct 28 01:41 PM

[Kofi Bofah:]

Wages are the primary force behind inflation. Labor market is weak. Intuitively, inflation is a nonissue.

Has there been a time in history where rampant inflation has entered the equation with a weak labor market?

The 1970's. The rampant inflation came courtesy of an oil embargo, causing energy prices to spike.

The commodities boom is dead, and prices are on the downdraft. Unless Iran shuts down the Straights of Hormuz, I am doubtful that higher rates of inflation will materialize.

2008 Oct 28 02:33 PM

[Robert Nabloid:]

@JBP: I completely agree, and have written about the M3 index in the past. Part of the problem is that the U.S. isn't the only country injecting massive amounts of money into the world economy, so inflation has to pick up as the money does go somewhere. I did not know about John Williams, and am glad you mentioned his name!

@ K.Bofah: Minimum wages will be going up about 45% from $6.55 to about $9.50, very shortly. I understand that minimum wages are but a small portion of the entire 'wage' picture, but many input costs are still affected by this inflation. Even more input costs will be hit by a weak USD (it will get weak) and the increased cost of doing business in America that is sure to come.

2008 Oct 28 03:32 PM

[JBP:]

Bofah,

One word on commodities, Asia. They were basically non-existent in the 70's and we hadn't reached peak oil at that time. World population keeps growing while commodities are being squeezed whether it's from limited sources or the high production costs to run mines. Food, cotton, etc. included. Yet, I'm glad people believe the way yo do because you have to have losers to have winners. I just think my case along with others is much more compelling than yours. This world is not coming to an end... Good luck.

2008 Oct 28 09:08 PM

[zanardm:]

As has been mentioned, the ultimate bubble - the Treasuries and the dollar, backed by the full faith and DEBT of the U.S. government.

2008 Oct 29 12:19 AM

[Flubadub:]

The concensus sounds like a gaggle of Libertarians espousing personal economic philosophy as the gospel then extrapolating that gospel to predict future scenarios.
It is no secret that the US is a country driven by debt. It now takes approximately $3.25 of total debt in the US to generate $1 of GDP, a significant increase from 1952, when it took just $1.30 in debt to generate $1 of GDP. However, in 1952, government debt—federal, state and local— was $244 billion and accounted for 55.1% of the $443.6 billion in total debt outstanding in the US. Today, government debt stands at $7.2 trillion but accounts for just 15.7% of the $45 trillion in total debt. Household debt today has a much larger impact on economic growth than government debt— at $13.6 trillion, it is almost twice as much as government debt, while in 1952 it was just one-third of government debt.
Todays infusion of money into the economy by the Fed. is nothing more then the assumption of private debt by the U.S. govt. It is not unpresidented. The capital infusion will simply place the debt ratios back where they were in the 1950's. This is not the stuff of gloom and doom. What it is is a total reputiation of laissez-faire capitalism. It should be. Laissez-faire capitalism has failed.

Pablo

2008 Oct 29 04:22 AM

[flow5:]

JBP: "The most fundamental monetary aggregate also calculated by Williams is called the adjusted monetary base, which measures very liquid forms of money such as bank notes and bank reserves"

Absolutely wrong. An increase in currency is deflationary unless offset by open market operations of the buying type. The only base for an expansion of total bank credit, and the money supply, is the volume of legal reserves supplied to the member banks by the Fed, in excess of the volume necessary to offset currency outflows from the banking system. The adjusted member bank legal reserve figure is that base.

M3: It is a succulent irony that professional economists, (those who confuse the supply of money with the supply of loan-funds), thus conclude that increases in the old monetary figure “L”, (or M2, or M3), are inflationary.

The conclusion is tantamount to saying, “don’t save money” as savings (which we don’t have enough of) adds to “L” (or M2, M3), and therefore has an inflationary bias, when in fact, savings (a large portion of “L” (or M2, M3) is evidence of money that has already been saved/spent/invested. Savings-investment accounts have been lumped into the Keynesian inspired concept of the money supply (as are MMF funds, etc).

The money supply is unknown & unknowable.
----------------------...

The trade deficits are inexorably forcing the dollar down in terms of its foreign exchange value—and no consortium of central bankers, treasury secretaries, et al. can stop the process.

Consumers are being subsidized by approximately by the current account deficit . For the people of limited foresight, which apparently includes a substantial majority, debt expansion can be very exhilarating. One’s standard of living can take a quantum leap forward.

We have temporarily concealed the underlying factors that will shortly push down the future standard of living of most people in the U.S.

The “foreign trade deficit” & the “domestic federal deficit” have an insidious, if not an incestuous, relationship. An increase in the demand for loan-funds is reflected in higher interest rates than there would otherwise be. Higher interest rates are significantly responsible for an “over-valued” dollar which is in turn the principal contributor to our burgeoning trade deficits.

The rising cost and diminishing volume of imports will contribute to an increase in inflation, and the expectation of further inflation will also push up interest rates. This spells stagflation.

The U.S. needs to sell higher quaility, and lower cost, goods & services. As it is highly probable that the U.S. will never have a coordinated response to the increased world-wide competition for overall products and services, and that it's manufacturing problems will continue to grow.

That implies that this countries' exchange rate will continue to move irregularly downward, along with the vast majority of American's standard of living and we will live in increasing world wide isolation, and retreat towards totalitarianism.

The FED cannot achieve stability in our exchange rate with other countries by resorting to any type of financial gimmickry (read Currency Swaps). Central bankers are powerless to alter long-term factors that determine the supply of, and the demand for, any particular country’s currency. The chronic and accelerating deficit in our balance of trade is one such factor.

We can help terminate these deficits by (1) the U.S. government drastically reducing its overseas military expenditures – or by transferring most of the cost of maintaining bases and personnel to foreign governments; (2) revitalizing a large segment of U.S. industry so that it will be able to compete in foreign markets; (3) sharply reducing our dependence on foreign energy sources; and, (4) increasing the attractiveness of foreign long-term investment in the U.S.

2008 Oct 29 01:23 PM

[JBP:]

Flow5-

What investment is good for stagflation as you predict?

2008 Oct 29 04:56 PM

[Robert Nabloid:]

@ flow5: Thank you for the comments. I agree, it would be hard for the U.S. to continue the way it is without losing some economic ground to foreign competition. Standard of living may not decrease, due to new technologies, but from an economic standpoint - the economic standard of living is bound to decrease for Americans - I believe it will be largely hidden in inflation, but it won't be completely hidden as Americans will now be less optimistic to take on further debt (and debt was another way of hiding our problems in the past). www.nabloid.com/the-co.../

The Fed is unable to do much due to circumstances largely beyond their control, but they do seem to make things worse in some situations. I'm not a big fan of the Fed for many reasons but I can't blame everything on them (much as I've tried in the past).

I couldn't agree more with you. We have hid our problems with the expansion of personal debt. When the expansion of debts stops or starts to decline, we will finally witness the consequences to our problems - I believe this is happening now...
.
"The rising cost and diminishing volume of imports will contribute to an increase in inflation, and the expectation of further inflation will also push up interest rates. This spells stagflation."
-Yup, I've seen it coming for a while. That's why I paid off my debts. I see high interest rates ahead... along with inflation. !!!Pay off your debts and invest in resources and things that do well during inflationary periods!!

I also believe (rightly or wrongly) that "free competition" from foreign countries with massive currency differentials and no regulated minimum wages is a huge problem. We can't compete with wage slaves in foreign countries. This is especially true for countries that have been granted free access to American markets but do not offer American companies free access to theirs. Completely "free trade" should only be implemented with countries that protect their workers with minimum wages and some standards.

Also, currency arbitrage is being used against us and our currency is bound to see some dramatic changes. Some of the countries are manipulating their currency to stay much lower than ours so they will continue to have the currency arbitrage in their favour. We grant some of these countries "free access" to our country, while due to the currency arbitrage, we don't have fair access to theirs.

Then there are sovereign wealth funds that are the property of governments that have billions (in some case, trillions) to go around and buy up our most competitive businesses, simply because they don't want to compete with them or they would rather control them and earn money off them. Either way, this isn't exactly the way we meant capitalism to be. Capitalism will do well - but a fair and level playing field is necessary.

"We can help terminate these deficits by (1) the U.S. government drastically reducing its overseas military expenditures – or by transferring most of the cost of maintaining bases and personnel to foreign governments; (2) revitalizing a large segment of U.S. industry so that it will be able to compete in foreign markets; (3) sharply reducing our dependence on foreign energy sources; and, (4) increasing the attractiveness of foreign long-term investment in the U.S. "

I couldn't agree more. We must stop spending beyond our means. The industries need to be revitalized, but how is the biggest question. I think we need to allow free trade, but only when it is reciprocated BOTH ways. If a certain country doesn't allow us to export freely to them, we should not allow them to export to us freely. It might sound protectionist, but we need to make a fair and level playing ground so we have a chance at competing, and don't forget about foreign currency manipulation. Same thing applies for foreign investments... We should have the same opportunity to own and invest in another country's economy that they have in ours. If they don't reciprocate, then there needs to be some consequences.

2008 Oct 29 07:49 PM

[Lin:]

Flow5 , + Robert N ,
You are both correct . The chickens are comming home to roost ! No , The US wage earner cannot compete with the " wage slaves " in asia et al , who average about 18 cents an hour ! It is for this reason That the standard of living for the us masses will decrease massively . It's called Depression , Glad I have little debt as well !

2008 Oct 30 02:00 AM

[winslow:]

For the last 50-70 years, money has flowed to the United States. As the world fiscal cycle proceeds, the flow will be toward other countries. This will give olther regimes the power to control world events (even though it may only be psychologically for some). While we had been good stewards during most of this period, this started to change over the last 10 years. The Bush ideology was that we could export by force our perceived values. Now that we have demonstrated that "free-enterprise capitalism does not work 100% as had been believed, other countries will feel free to experiment with their own philosphies. What this means long-term, is that the US will not be the decider of world events. The sooner we understand this, the sooner we can begin the process of making this country stronger internally. What has been very interesting over the last 10-15 years is that as China has expanded at a tremendous(almost inconceivable) rate and has grown more powerful on an economic basis, they have not exerted their power. If they can contain this newly-developed power, China will become what the US had once been...with perhaps a more efficient government and economic model. As a world leader, China might be able to bring all countries together. However, if China uses the power to control and demand (much of what the US has done), the world will develop into possible annihilation.

2008 Oct 30 11:31 AM

[Dividends A...:]

We're seeing asset deflation, not rampant deflation in all prices. People thought the Chinese were eating iron ore, potash and nickel for breakfast on a daily basis. The growth & demand there is real, but prices have to be more realistic.
Commodity bulls look at the rise in operating expenses as the reason for continue strong commodity prices but when you have everyone gunning for production & exploration that is not sustainable someone has to pay for all that. Emerging markets need those raw materials, but they're not going to pay astronomical prices for the stuff just because that is what it "costs" to produce. Supply & demand....just wait until that actually is reflected in commodity prices and not because the USD has risen dramatically. The commodity BOOM is bust and while the world still needs it we're not likely to see prices anywhere near where they were for a long-time. There's now too much supply and we know that demand will moderate.
Its simple economics of a rational perspective.

2008 Oct 30 11:34 AM

[Robert Nabloid:]

@ Dividends Anon:

I disagree. We may see short-term mild asset deflation (due to the stock declines), but long-term inflation is coming for the entire economy. It always has. I'm not dooms day preaching, as inflation has always been with us and we even expect yearly wage increases to help negate the inflation occurs (not that the government stated rate of inflation is accurate, or that our yearly wage increases keep up with the real rate of inflation). A coca cola cost my grandpa a nickel. It costs me over $2. Inflation is a result of our monetary policy and having a fiat currency. Do some research on fiat currencies. Inflation will occur, don't act as it won't.

As you said, "Commodity bulls look at the rise in operating expenses." Inflationary pressure.

"Emerging markets need those raw materials, but they're not going to pay astronomical prices for the stuff just because that is what it "costs" to produce."
- Wow. If emerging markets need those raw materials, they will HAVE to pay what it costs to produce them or no one will produce them. Yes, we have too many speculators that are also causing massive price fluctuations in many commodities, and they often go too far too fast. That said, if an emerging market won't pay what it costs to produce a resource, they won't get it. Resource companies would go out of business if they don't pay what it costs to produce... and resource companies going out of business would cause a decrease in supply.

2008 Oct 30 05:36 PM

[derryl:]

Robert Nabloid,
I agree re commodity prices. They boomed because rapid increases in demand created a tight supply market and nobody wanted to be the one left with no supply of critical inputs to their operations.

Like oil: if you can't get feedstock you shut down your refinery. In a tight supply market you'll pay a significant price premium to ensure you can stay in business. Especially if there is no substitute for the product you're making, like gasoline, and your buyers have to fill up their cars and trucks to go to work no matter how high gas prices go.

"Normally" the high prices induce new supplies to come onstream and loosen up the supply market which creates supplier competition for sales rather than buyer competition for supplies. Prices come down. This time it was the financial troubles that slowed demand and reduced prices (far below what is required to motivate new supply being built, so supply tightness will reemerge with a vengeance once the current shakeout clears and economies start growing again), rather than new supply bringing down the price.

Remember the 1980s when Western banks were pipelining Arab petrobillions into Third World resource plays? Once all that new supply came onstream commodity prices collapsed and all those Third World countries defaulted, bringing about some close calls and some closures of the banks who had funneled the investment money.

Regardless whether or not "speculators" tie up supplies to extort higher prices, commodity prices are pretty much always the consequence of the tightness or looseness of supply markets. That's the principle OPEC operates by, reducing supply to shore up prices, and loosening supply to calm prices down when overly high oil prices threaten global recession and resultant demand destruction.

Exploration and production costs are systemically higher now because most of the easy resources have already been produced. Now we're into the harder and more expensive zones, and it doesn't matter if it's a Chinese miner or an American one, they both have to put the same higher amount of effort into extracting the resource. So resource costs are structurally higher and if nobody will pay the higher price the resources won't get produced, as you observed.

2008 Oct 30 10:20 PM

[Shannon Melton:]

experienceiseverything...

Jan 15 09:08 AM