Perpetual Motion Theory of Inflation

by: Michael Shedlock

Let's take a look at a point counterpoint discussion of inflation. The October 8 2007 issues of Newsweek provides the point: There's No Inflation (If You Ignore Facts).

In the first eight months of 2007, the consumer price index—the main gauge of inflation—rose at a 3.7 percent annual rate. That's more than 50 percent higher than the mild 2.3 percent core rate. The prices of energy and food are soaring, at 12.7 percent and 5.6 percent annual rates, respectively, and have been doing so for years. As a result, the CPI—including food and energy—has risen 12.6 percent since July 2003, for a compound rate of about 3 percent.

Signs of inflation are evident throughout the economy. When investors fear a rising inflationary tide, they latch onto the driftwood of gold. The day Bernanke cut rates, the price of the precious metal soared to heights not seen since 1980, when inflation ran at nearly 12 percent!

China's government is trying to deal with its inflation in predictably Orwellian fashion. "Beijing has instructed local provincial and urban statistical bureaus in a subtle form of denial—they are not to use the word 'inflation' to describe what is happening," notes Keidel. It's easy to mock Beijing's clumsy bureaucrats. But by focusing on core inflation, the Federal Reserve—along with the legions of investors who reacted ecstatically to the interest-rate cut—is practicing its own subtle form of denial.
Meme of the Moment: CounterpointProfessor Kevin Depew provides the counterpoint in Point #2 of today's Five Things - Meme of the Moment: Inflation.
Inflation - the meme of the moment. It's even made the pages of Newsweek, the magazine where investment themes go to die, which is not a critique of Newsweek because popular news magazines, by definition, purpose and mission only cover news stories at moments of maximum saturation.
  • We write mostly about deflation here and sometimes about stagflation, which is the transition from cyclical inflation to deflation, but mostly about deflation.
  • Most of the emails we receive read like this:
    - "C'mon man, take your head out of the sand and look around! Inflation is everywhere."
    - "Where do your kids go to college? Because tuition for my kids is going through the roof."
    - "Do you get free gas or something?"
    - "Wake up! The government is purposefully disguising inflation through their bogus numbers."
  • We're sympathetic to these views because, believe it or not, because we too have found ourselves paying more for things such as education, healthcare, energy and food.
  • But the hysteria over inflation is beginning to tautologize itself.
  • The argument is basically becoming this: Inflation is being ignored by the Fed and is making inflation worse, which threatens to make inflation even worse as inflation gets worse.
  • To be clear, the cyclical inflation we have been experiencing does not itself sow the seeds for... still more inflation.
  • In a weird, geeky way, we kinda wish it did because then we would be on the verge of discovering something akin to perpetual motion.
  • Instead, this cyclical inflation is simply sowing the seeds of deflation.
  • How does that work?
  • Well, take a look at housing - a macro event that we like to remind is a symptom, not a cause - in today's Number Three... Too Broke to Sell...

The Emails Kevin received are certainly tame compared to the comments on some of my blogs and the Emails I receive. But Like Kevin, I do not believe there is a magic perpetual motion machine. If financial perpetual motion worked in practice, Zimbabwe would be the richest nation on the globe. All we can say is that for now, the Fed has managed to fan the fires of speculation once again.

And speculation is all that's left. It was mammoth speculation that drove up the prices of homes to absurd heights in the summer of 2005. Time Magazine's cover at the time was "Why We Are Gaga Over Real Estate".Speculation is now driving up the price of stocks. Some know it and are playing the Greater Fool's Game, but most believe in perpetual motion.Today Citigroup Says Profit Dropped 60% on Credit Losses.

Citigroup Inc., the biggest U.S. bank, said third-quarter profit fell 60 percent after $5.9 billion of credit and trading losses on loans and mortgage-backed securities.

Earnings may drop to the lowest since the second quarter of 2004 because Citigroup will write down loans for leveraged buyouts by $1.4 billion before taxes, the New York-based company said in a statement today. It lost $1.3 billion on subprime assets and about $600 million in fixed-income trading, while higher loan-loss reserves contributed to $2.6 billion in credit costs in the consumer-banking business.

Citigroup shares rose as much as 1.9 percent after Chief Executive Officer Charles Prince said earnings will return to "normal" in the fourth quarter.

It's highly likely that Citigroup threw everything but the kitchen sink into third quarter writeoffs. That means earnings may indeed return to "normal" in the 4th quarter. But it's not really bank earnings that everyone should be watching. Please see Bank Balance Sheets and Earnings for what's really important.

Fourth quarter earnings will come soon enough.In the meantime, the market shrugged off a horrid quarter at Citigroup as if it was a onetime affair. Oddly enough, the focus is on rate cuts as being the economic savior when rates cuts created the credit bubble in the first place. Belief in the Fed's perpetual motion machine to smooth things out is obviously running strong.