“Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge."
- Alan Greenspan, June 25, 2009
"The US economy may witness double-digit inflation in a few years unless the central bank tightens up its monetary policy… Unless we roll in this whole degree of expansion, we will be in trouble… I am not talking 3-5 per cent inflation, I am talking double-digit inflation in the US.”
- Alan Greenspan, September 9, 2009
Man, the Dow hit 10,000! Happy days are here again! Right?
Do you know what I loathe about the word "recovery?" It can mean whatever you want it to. It's sort of like using the word love. You might say you love sushi, or you love beef jerky, or you love Michael Jackson. Or whatever. But that's a whole lot different, for instance, than saying you love your child. We can agree on that, right? Children are way more important than beef jerky. And Michael Jackson.
I can't say I'm Alan Greenspan's biggest fan anymore. He did, after all, betray his roots not so many months ago, when he essentially proclaimed free markets to be flawed. Those of us who have studied his career -- and especially its beginnings -- know better, of course; poor old Alan was just reacting to a political environment that needed someone to whom it could point its ugly, bureaucratic finger. Who better than Alan? Somebody had to take the blame, right? You can't just have a financial meltdown without getting mad at somebody. My only beef with the poor man is that he actually agreed to do it.
But then again, Alan Greenspan has been swimming in the Washington political sea for a very long time, so we really shouldn't be all that surprised, should we? And, after all, he did play the let's-create-the-illusion-of-wealth-by-making-money-cheap game. No, he took the appointments, scratched his ticket, and came up a loser. Unfortunately, he took the entire U.S. housing market -- and subsequently the global economy -- down in the process. Thanks Alan.
No matter where you stand on the Greenspan issue, you still have to respect the man; he was, for better or for worse (I say worse), the architect of the longest protracted bull market of the 20th century -- and beyond. So when I read the quotes above, I can't merely dismiss them just because I think Alan is a sell-out, a turncoat, and a political lackey. And, of course -- as most of you know -- I happen to agree with Alan Greenspan on the particular point of coming inflation. Well, sort of. I actually think inflation is going to be a lot worse than "double-digit." Here's my favorite part of his observation:
"...unless the central bank tightens up its monetary policy... Unless we roll in this whole degree of expansion, we will be in trouble..."
To me, that says it all. There are literally trillions of components to the U.S. economy. How in the hell is the Fed going to know the precise moment it needs to reverse policy? I mean, who's going to argue against the fact that the success of its predictive power has been -- at its very best -- questionable. If Bernanke and his pride of dullards don't call this one right, we are all screwed. And in my mind, that means only one thing.
We are all screwed.
Dollars, Equities, Housing and All the Rest of It
A lot of people sit in front of televisions all day, staring at Erin Burnett and Maria Bartiromo (and the people they talk to), believing that, because the stock market is moving up so rapidly, we are in the middle of an economic recovery. And that's just silly. One might argue we are in the middle of a stock market recovery -- and based on simple, raw percentages, that position might carry some weight. But then you think about the the first time the Dow hit 10,000 -- about a decade ago -- and you look at the relative prices of gold (about $250 per ounce in 1999, as opposed to almost $1100 an ounce today) and something starts to become clear: this so-called "stock market recovery" may not be all that recuperative after all. I mean, gold is the ultimate and most efficient harbinger of inflation -- is it not? And what is gold telling us -- in a loud, clear voice?
And what about oil? Since its recent bottom eight months ago, it has more than doubled in price. I've been trying to tell you that oil, gold, and agriculture are going to be the biggest winners when the dollar starts its slide. Did you listen? Well... some of you did. But, my goodness, there were certainly a lot of people telling me I was a fool, an idiot, and a traitor. I'm sure they're all still out there, as eager as ever to show me the errors of my ways. Unfortunately most of my dissenters and critics believe there are only three phases to this economic fiasco, and they wrongly believe we've completed both -- that the recession is over. But that's just more nonsense. Here's what the common wisdom is saying:
PHASE TWO: Global quantitative easing -- meaning unprecedented rate-cuts, coupled with unprecedented currency-printing, borrowing, and spending.
PHASE THREE: Stock market recovery.
And suddenly everything is fine, right?
No! Everything is not fine. A quick look at the prices of oil, gold, and agriculture tell a much different story -- they have been rising significantly. And perhaps the most powerful signal of all is the increase in long-term Treasury yields over the last nine months -- despite the Fed's repeated announcements that it intends to keep rates low by buying the long end of the yield curve! The evidence continues to mount -- we're not anywhere near the end of the pain. No, there is a fourth phase to this economic storm: foreign creditors begin to abandon U.S. Treasuries, driving yields higher. Unprecedented printing causes massive inflationary pressure, driving the prices of all asset-classes higher, as major world currencies fail. Most people become euphoric, proclaiming an "economic recovery." Others buy gold, oil, and agriculture and hunker down for the worst.
The most interesting part of all this to me is watching the business news channels, who focus 90% of their energy on equities. I know it's natural; audiences comprehend a share of Google (GOOG) a whole lot better than they do a barrel of oil. But the stock market is in trouble -- even as it continues to rise. And that seems to be the most difficult concept for anyone to grasp! Mark my words: in real terms, equities are going to underperform gold, oil, and agriculture for a long time, and this necessarily means stocks will underperform inflationary price increases. It's just math.
Don't get me wrong; I love Google and a dozen or so other companies just as much as the next guy. At my core, I'm a value investor. I just don't happen to think there is any value to be found in this economy. The American consumer -- who drove the vast majority of the economy up until two years ago -- is dead. How are companies going to make money? Sure, stock prices will fly higher as the dollar falls, but what does that mean? Just because the dollar is failing does not mean American corporations are necessarily becoming more productive. Can net income outpace inflationary dollar-destruction? The answer is, of course, no.
Let's return to Google. I think the company is going to be around for a long time, and I believe it's a great business model with a lot of room for growth. And when Google beats its numbers and the CEO says he's excited about the future, well I get just as warm inside as the next guy. For about twenty seconds.
Just because stocks are moving up -- and even reporting some good numbers -- does not mean this is an economic recovery. And don't forget that, for the last year or so, I've been predicting not only a rise in the stock market, but a meteoric rise. I think the Dow is going to 20,000 and beyond, and I think it's going to happen a lot sooner than anyone believes. I also have no doubt it will blow through that mark with all the euphoric and histrionic drama of every other media-driven bull market explosion in the last thirty years. Of course the stock market is going to go higher -- in dollar terms -- because the dollar is falling apart! Housing is going to do the same thing: if the government keeps rates artificially low and offers tantalizing tax-incentives for investing in real estate, of course prices will go higher! Why wouldn't they? And thus the next (bigger) bubble begins.
In fact all asset classes are going to go higher as the dollar disintegrates! That's the way inflationary pressure works! But again: just because asset-classes are moving inversely to the phony currency in which they are denominated (by definition) does not mean we are in the middle of an economic recovery! According to BusinessDictionary.com an economic recovery is the "...phase in an economic cycle where employment and output begin to rise to their normal levels after a recession or slump." Yes, I know. Economists everywhere are saying the recession is over. Yes, CEOs everywhere are starting to become optimistic. But isn't this the same gaggle of pundits, academics, experts, and general know-it-alls that were prepared to deliver us the so-called "Goldilocks Soft Landing" three years ago? Yes. Smart group of folks, that.
On October 2, 2009, The United States Bureau of Labor Labor Statistics gave us the happy news: U.S. unemployment now sits at 9.8%. More specifically, it said this:
"Since the start of the recession in December 2007, the number of unemployed persons has increased by 7.6 million to 15.1 million, and the unemployment rate has doubled to 9.8 percent."
Does that sound like an economic recovery to you?
Our foreign creditors -- like Japan, China, and Saudi Arabia -- are now talking about ditching the U.S. dollar in favor of another reserve currency. Do you really believe they're going to continue to lend to the United States at absurdly low rates, in perpetuity? Our government has committed itself to spending $13 trillion dollars on this economy. Where is that money going to come from? You can read any number of my articles over the last year to get the answer to that question. But I assure you, printing dollars in current quantities is the death knell of our beloved currency. And I equally assure you our creditors are neither naive nor stupid, and they are not going to simply keep dumping money into a debtor economy whose currency is in jeopardy, whose savings rate is almost zero, and whose consumer has run out of leverage. Why do you think the Chinese -- for instance -- have bought U.S. Treasuries for so long? Because they knew the American consumer would return the capital to the Chinese economy many times over! But the American consumer is out of fuel. So what now...?
I've been talking for months about the $13 trillion mistake, as well as its historical implications. The evidence only continues to mount: on Friday, October 16, The U.S. reported that the federal deficit just hit an all time high of $1.42 trillion. My favorite part is the annual percentage increase in government spending, up 18.2% -- the biggest jump since 1975.
So here's the deal. Just as every asset-class in the universe collapsed starting in 2007, the massive implementation of quantitative easing that ensued is going to ensure equally massive inflationary pressure on most -- if not all -- of the world's currencies. So your job, as an investor, is not to try to figure out which asset-classes are going to increase in value, because they all are -- relative to the currencies in which they are denominated.
No, your job is to figure out which assets are going to outpace inflationary price increases. I've already given you one clue: this stock market surge you're seeing? It's an illusion. While equity prices will undoubtedly go higher, productivity and earnings are not going to outpace inflationary price increases -- simply because consumers are not going to have the power to fuel corporate profits as they once did. Sure, you'll get a good return from the stock market -- in nominal terms -- in coming years. And maybe that's enough to get you excited. I watch CNBC enough to know that there are a lot of people who believe this rally is authentic. But in real terms, it's unsustainable and unrealistic, because the dollar is falling, and its decline is accelerating. It won't be long before the smartest investors recognize stocks are not going to outpace inflationary price increases. And thus begins Phase Four.
So what asset-classes will outpace inflation? Do I have to say it again? Precious metals, energy, and agriculture. These assets are no longer mere hedges against inflation. Not only will they continue to elicit demand from investors seeking return, but many of them have industrial value, as well -- increasing the likelihood of increased demand and superior returns. And there's one more thing I have to add, which is probably going to cause me all sorts of grief from my more conservative readers, but I'm going to say it anyway: I'm not a huge fan of leverage -- for obvious reasons, considering the mess we're in. Nonetheless, if you can get into any superior-performing assets using leverage at a low fixed-rate of interest, you're rate of return is going to be exponentially higher.
Phase Four. The train is starting to pick up speed. If you weren't listening to me over the last ten months, I hope you will now...
Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.