Inflating Our Way into Recession

by: Barry Ritholtz

For quite some time in these pages, we have been lamenting the mistaken belief amongst some on Wall Street that there was a free lunch to be had. Lowering interest rates, the Panglossians argued, would stimulate the economy, whose slowdown would prevent inflation.

[click to enlarge]

Chart courtesy of Bill King, M. Ramsey Securities

If that argument strikes you as both circular and contradictory, welcome to the club. That obvious flaw was apparently lost on its authors, who required a 2 X 4 across the skull to show them the error of their ways.

That swing of the lumber took place Tuesday -- even as demand supposedly weakened -- when Crude Oil passed $100 a barrel on a closing basis for the first time. OPEC nations are expected to reduce output when they meet next on March 5th.

But don't think its just oil. The promiscuity of the US Federal Reserve has led to all manners of dollar-denominated commodity price surges:

-Gold soared $26
-Platinum exploded $91
-Iron-ore prices up 65-71%
-Copper surged 20 handles
-Wheat prices surge to new high
-Soybeans traded at a record high
-Fertilizer makers soared to record share prices

Then there's gasoline. A survey of prices shows the rising impact of inflation. Gasoline has rallied from $2.22 on Feb. 7 to a record $2.62 Tuesday. This is an 18% increase in less than two weeks – and drive season buying is still way ahead of us. These increases have yet to work their way through to the consumer; the economic impact of energy costs still lay off in the future.

One would imagine that expectations of ebbing inflation would be dashed by now. One would be wrong.

As we have seen time and again on the Street of Dreams, Wall Street pundits take months, if not years, to accept what is before their very eyes. Whatever you want to call it -- cheerleading or cognitive dissonance -- it is a fact of life that the obvious takes much longer to be accepted than is logical. Hence, this simple numerical inflation fact, reflected in global food prices, record energy and both industrial and precious metal inflation, will be ignored for as long as possible.

Maintaining this denial of reality is becoming increasingly difficult. Tuesday, Wal-Mart (NYSE:WMT) reported Q4 earnings, and it's becoming increasingly difficult to deny reality. Net sales rose 8.3% to $106.3 billion, while earnings rose 4% to $4.1 billion, or $1.02 a share. The big increase in sales reflected a combination of new store openings and of course, gasoline and food price increases.

Sales at stores open at least a year were sluggish, up 1.6% rise over the year-ago period. Excluding fuel costs, sales rose 1.4%. However, Wal-Mart (Costco (NASDAQ:COST) also) do not break out food prices from their reports. Hence, Wal-Mart sales were likely much weaker than the headline number, reflecting inflation. We suspect that's why the company lowered its Q1 and FY ’08 forecasts.

So why this foolhardy approach? Why, as Bill King calls it, "Inflate or Die"? Several theories abound, led by Fed hubris and/or incompetence.

I'm not sure I buy that. A more likely possibility is what John Cassidy describes in A Bankers' Bailout:

"The rescue operation brings to mind John Kenneth Galbraith's dictum that in the United States, the only respectable form of socialism is socialism for the rich."



Consumer Prices [CPI] out Wednesday at 8:30am. Producer prices [PPI] is mysteriously MIA...


Weakening Demand? Oil Still Passes $100
February 20, 2008; Page A3

Opec worries drive oil price to $100 close
Andrew Clark in New York
The Guardian, Wednesday February 20 20

With Iron-Ore Price Hikes Like This, Who Needs a Monopoly?
Heidi Moore
Deal Journal, February 19, 2008, 12:13 pm

Wary of economy, Wal-Mart cautions on '08
David Goldman, February 19 2008: 10:43 AM EST

The Bankers' Bailout
John Cassidy
Portfolio, March 2008