Daily Comment – 22nd January 2010: Inflationary Predator

Macro

Inflationary Predator

Well, well, well China’s growth and inflation actually accelerated more than forecast – and the forecasts were pretty robust. Now, China fears overheating and rampant inflation – what a difference a year makes, eh? But it is always the way: one wants what one cannot have and what one does not want one has in abundance.  In China they wish for disinflation and instead they have inflation looming. In the US the Federal Reserve and Treasury get on their knees every morning and pray for inflation, yet they are continuously pinned back by the immeasurable force of disinflation via the treacherous back-draft of a credit and consumer contraction which has never been seen before.

Westerners have become accustomed to inflation, it’s like the very air we breathe. The average City Boy was not alive during the stagflation of the 70’s or, at least, certainly not old enough to care. When the Fed does everything in its power to inflate the economy “back to health” we should stop to consider what the consequences may be. But we’re born into inflation, it courses through our veins the minute our parents fail to increase our pocket money in line with the ”candy price index” running riot in the school playground. Not only that, our central bankers are equipped to fight inflation, there is no limit on how high interest rates can go – but there is a limit on how low they can go. So it is deflation, on the other hand, which is the monster that lurks beneath as we apparently have no defense for it. So we’ve been programmed to err on the side of the devil we know: inflation.

But how well do we truly know this devil? We are children of a globalized, disinflationary, internet age – c’mon what do we really know about inflation!? Have we really taken the due time to consider the ramifications of an exploding Monetary Base which eventually manifests itself in rampant price-levels?

The truth of the matter is; runaway inflation, left to its own devices, is a form of financial terrorism exhibiting an incredibly destructive and asymmetric force on capital and society. Zimbabweans would not consider this an exaggerated statement. The relentless power of inflation is not lost on Beijing policy makers either, for whom the inflation-fueled Tiananmen Square massacres are still a fresh memory. The Chinese will not tolerate inflation, so when the numbers come out at double-digit growth and monetary policy tightens up and carefully worded language from officials changes tone – you’d better sit up and take notice.

Let’s take time to examine just how inflation (the thing we apparently crave in the West) would go about its work in a developed economy. Let’s open with Puru Saxena’s comment in the piece Inflation 101:

We want all our readers to understand that inflation is a disaster for society and it only benefits the elite. In fact, we will go even further by stating that inflation is a hidden tax, an insidious crime against the public. It is the easiest way for any government to confiscate the savings of the public and for generations, wealth has been transferred in this manner.

In our opinion, inflation is evil and the sole reason why human beings have become modern-day slaves. Remember, money is supposed to be a store of value, however due to reckless central bank-sponsored inflation, it can no longer fulfill this critical role. This is precisely the reason why human beings are never satisfied with what they have because nobody knows what their savings will buy them in ten or twenty years time. So, rather than enjoy their lives, the vast majority of people continue with their never ending pursuit of acquiring even more money! Unfortunately, nobody questions the inexplicable loss of the purchasing power of their savings, thus, central banks get away with financial murder.

It is our contention that inflation distorts the economy, it brings great harm to the public and it encourages speculation and mindless risk-taking. In fact, inflation acts as a poison for retired people since they are no longer able to earn more money in order to maintain their standard of living. So, thanks to inflation, most senior citizens are unable to enjoy the fruits of their labour.

The “Cons” of Inflation

• Inflation is a tax. I have to say, I couldn’t agree with Saxena more. When you are a government in debt, running huge deficits, you face a mis-match of income versus expenditure. If you don’t want your economy and political power to go down the toilet, this has to be matched somehow – either by taxing your people even more than they are already being taxed (not very popular and often counterproductive too) or by inflating those debts away. But, lest you thought we could get “something for nothing”, make no mistake: inflation is a tax. Not only is it a tax, it is a tax of the ugliest sort. That offiicals claim it happens for “economic reasons beyond control” is perhaps one of the biggest deceptions made by establishment to the public you will ever hear in your lifetime. There is a choice, but we all know, politicians tend to make the choices that increase the chances of them being re-elected.
• Inflation taxes the poor. Yes, that’s right. There is actually disproportionate taxation on the poor largely because the poor have little choice. The rich have options, most importantly they can choose to “invest in inflation” at an early stage when they see money supply spiking. The assets and investments (like property, commodity investments, shares) they hold often rise with inflation – so their net wealth effect can keep correlation with the rising cost of living. But the poor (and often the middle class) don’t have these options, consequently their net wealth is often negatively correlated with inflation. Also inflation is a “survival tax”, and this is where it gets really ugly. No matter how rich or poor you are, we all consume roughly the same amount of food, we all need to get around roughly the same amount. So, if the cost of feeding and transporting yourself goes from say $10k per year to $20k per year, the millionaire barely feels the pinch. It’s pittance compared to the $50k rise, say, in the value of his assets. But the guy who takes home $20k per year? Well he’s screwed isn’t he? Inflation has literally driven him to the point of desperation. It should not surprise us that inflation segregates society like nothing else. The two things that humans need most of all for survival are: food and energy – which is why I find it ironic that The Fed now chooses to effectively disregard all measures of inflation which include food and energy prices and now use only “core CPI” (or what I call inflation without all the inflationary bits) to gauge their “success”.
• Inflation is volatile. It’s not often mentioned, but, equally as destructive as the relentless expansion of money and the rising of prices, is the volatility or the uncertainty that this causes. It’s an incredibly disintegrative frictional cost on society. If you can imagine having to purchase materials while having no confidence in predicting the monetary pricing of them a year, a month or even a week later. This of course results in yet higher premiums for goods and services based on uncertainty. To add insult to injury, for the average worker, employers are always behind the curve on adjusting wages to inflation spikes.
• Inflation rewards failure, punishes prudence. This is especially true in a Western Society addicted to debt and hell bent on trying consume its way to prosperity. By inflating away people’s savings and retiree’s hard-earned pensions the prudent, the careful, the diligent are being compromised in order to subsidize the irresponsible indebted section of the economy. It’s ironic that there is so much media focus on The Big Bad Banks’ Bailouts and their inability (or ability to “pay back TARP money). Which in effect is a marvelous sideshow which helps distract us from a capital fraud that would make Madoff blush. That is that The Government is attempting to bail out an entire nation of indebtedness by using YOUR hard earned savings and it will manifest itself in the very thing you need to keep yourself alive – the cost of survival. This is no normal tax. You have absolutely no escape from the claws of this beast. Be taxed or die. Ironically, the “bonus fracas” the politicians and the media have got hold of, is something which I think should be (and perhaps is) welcomed by the banks as it detracts from the fact that they are, as a single group, perhaps the biggest benefactors of inflation. The banks, inflationary policies and the Federal Reserve have been around a long time and they’ve gotten good at making money out of it. As Saxena points out again in Inflation 101:

Apart from diminishing the purchasing power of savings, inflation also creates unfair advantages for the elite. When a new cycle of inflation (expansion of money-supply and credit) commences, usually the governments and banks have first access to this newly created money and they obtain this cash at a time when prices within the economy are still depressed. Therefore, these powerful entities are able to buy inexpensive goods by using this newly created money. Now, by the time this surplus money has permeated through the economy and reached the masses, prices have usually risen significantly by then. Accordingly, the public gets access to the additional money at a time when prices are much higher than the commencement of the inflationary cycle!

Put loosely, inflation enables the banks (remember who facilitated much of this crisis) to benefit disproportionally by the painful work-out scenario path that the Federal must (and always does) follow.

• Reported Inflation numbers are phony. As if to rub salt into the weeping wound that is our pathetic, miserable, ignorant little lives, not only has The Federal Reserve resorted to a fixation on “inflation without all the inflationary bits”, not only have we seen the disbandment of the reporting of real inflation such as money supply measures and the monetary base (Yes: why? You might ask), but the numbers we now see are just a convoluted, manipulated, manufactured mess of what they should be. They are to statistics what melamine-coated, deep-fried snickers bars are to healthy eating. The consequence, of course, is a set of sterile looking data which miraculously performs exactly to the tune The Fed and banking system wishes it to dance to. That is, to show low volatility at a benign absolute level consistently, allowing accomodative (inflationary) policy to exist and be justified – the Core PCE measure of inflation seems to do this job perfectly. You will know all the sordid details from my comments on 4th November and 5th November, where I refer to Chris Marthenson’s Fuzzy Numbers.

Inflation is a predator which stalks and seeks to destroy harmonious society.  If it was true for the Romans it’s certainly true for us – I’ve always said and it’s been true since civilization began:

“…taxation and inflationary policies together, for some reason, work a magically lethal cocktail mix on society… they seem to be both divisive and antagonistic in nature.”

Right now, we’ve managed to temporarily patch up some of the wounds of our global organism. But. as we stumble and crawl through the thick and perilous undergrowth that is the economic jungle before us, latent infections are taking hold as the bacteria multiplies under our skin. We fumble frantically, unbeknown to the whereabouts of the inflationary predator which we hear stalks the very woods we seek to exit and, should it catch the stench of our rotting flesh down wind, it will make short work of tearing our hapless body to pieces before we even know what’s hit us.

Macro Data to Watch:

• South Korean GDP
• Russian Inflation

Markets

Not a great day for the markets. The pundits on CNBC were calling for “another 100-point day” on the Dow to get things excited again. Well they got one. In fact, it was a 200-point day. That’s erased all the gains from this January. It’ll be interesting to see how Asia trades into the weekend. All seemed to be going swimmingly with banking profits out strong until Obama launched his tirade on the banks. As you will have read from above – much of this was smoke and mirrors and more distraction from the issue at heart but there was a hint of Volcker in there – did you detect it? Perhaps the old boy has a sympathetic ear afterall.

European Bonds got hoovered up as investors sought risk-free (ahem) assets. Graph of the day is the European 5 year swap rate. Yields hit the lows on the 5 year note dipping below 2.6%.

Source: Bloomberg

Global Stocks to Watch:

• Banks got slammed. Goldman reported a record profit but that did not prevent the banks getting wiped out. Some notable movers: JPM (-6.6%), BoA (-6.2%), Citi (-5.5%), RBS (-7%)
• Miners also got slammed. Anglo American (-6%), Rio Tinto (-5%)
• Good news! Ebay hit the cover off the ball and beat estimates. One of the few stocks which rallied yesterday – up 8.55%!
• Earnings:
  • Financials: HSBC, Fubon Financial
  • Consumer: Macdonalds
  • Manufacturing/Engineering: Larsen & Toubro, GE

Advertisement