Energy, Inflation and the U.S. Dollar

by: Michael Fitzsimmons

With global headline inflation at 7% PIMCO's Bill Gross asks the question: does it make sense that US inflation should be 3-4% less than the rest of the world as reported by the US government? See here.

I would throw in the minor inconvenient fact that the US imports 60% of its oil and the cost of that oil has doubled in the past 12 months. So, of course we all agree that the US government is fudging the inflation numbers. Why? Here's the two main reasons:

  1. Social security checks, veterans benefits, and inflation indexed securities all get adjusted upwards with rising inflation. Since the US government is in debt up to its eyeballs, it simply cannot afford the higher expenditures while fighting two wars and simultaneously giving tax breaks to the uber-wealthy
  2. The Fed needs to have a rationale for cutting interest rates in the face of rising inflation. After all, fighting inflation is (supposedly) one of two mandates. Additionally, Bernanke cannot imitate Paul Volker and raise rates to fight inflation, because, unlike Volker's's age, the US consumer is plagued with debt: credit card debt, upside down in their house and car mortgages, and the very low savings rate. To pull a Volker now would be to risk a severe economic recession or very likely a depression.

My conclusion: Despite what Bernanke and Paulson have been pontificating about the last few days, Fed policy will continue to promote negative real interest rates and thus, a lower US dollar. I am sure this was the rationale behind Axel Merk's Merk Hard Currency Fund [MERKX] which is up over 6% YTD. On the other hand, there are people like Steve Forbes who contend all we need to do is shore up the dollar and oil prices will come down. As usual, Forbe's has things back-asswards. It is the rising cost of oil (due to worldwide supply/demand fundamentals) that is causing, in a vicious circle, the US dollar to decline. Does Forbes really believe the rest of the world is not aware of the $650 billion US dollars that leave the US every year to pay for our oil addiction? Please. Did anyone look at the faces of the sheiks in the crowd yesterday while Paulson was speaking? The only question I have is when are the Middle Eastern countries going to get off their US dollar currency pegs? Seriously, they are having to cut their interest rates every time the US does even though inflation is running, in some cases, between 10-20%. They must be very irritated...

We know that jawboning a strong dollar policy (wink-wink) doesn't work. We know the US government will continue fudge inflation data. Barry Ritholtz says the US government's reports inflation data as "inflation excluding inflation".

So, is there no hope for the US dollar? Actually, there is one prudent thing to do. It is also the key to future economic prosperity and addressing global warming: a comprehensive, well-crafted, long term US energy policy. Since the President, Congress, and the media cannot seem to come up with an energy policy, here is one courtesy of the author (free of charge, which is saying something since I don't have a job).

Notable updates since my last energy policy published on Seeking Alpha are:

  1. 60 mph max speed limit
  2. 4 day work week

I have no doubt that the US will eventually adopt such an energy policy. However, it may yet be sometime before the idiots in Washington wake up, and it will probably be after the US dollar drops another 25% and oil goes over $200 a barrel. But, let's be optimists and assume an energy policy like the one above does get adopted. From an investor point of view, what are the good plays? I have often written about the straight energy plays. This time, let's look at the alternative energy plays. I'll give brief descriptions, and let the reader do his or her's own in depth research:

  • General Electric (NYSE:GE): wind energy, China infrastructure, compressor and turbines for electrical generation and LNG market. Yielding 4%
  • Sasol (NYSE:SSL): South African based CTL and GTL technology leader
  • Air Products and Chemicals (NYSE:APD): chemical supplier of hydrogen and equipment supplier for chemical processes, oil, power generation, and heat exchangers for LNG terminals.
  • Chicago Bridge and Iron (NYSE:CBI): Netherlands based engineering and construction company heavy in the energy business. Consructure experts in building refineries and LNG terminals.

Disclosures: The author owns none of the above at present. However, he is actively shopping around and could well own one or more of these stocks by the time these words are read.