Anatomy of an Inflation

         The Federal Reserve announced a $15 billion per month taper and markets rallied.

          All markets rallied as noted in the databox above; stocks, bonds, and precious metals all moved higher.

          The Dow to Gold ratio remained in the neighborhood of 20.  I stand by the forecast of an ultimate ratio value of 1 or 2.

          In the “Headline Roundup” today, I discussed the anatomy of inflation.  Despite the fact that the Federal Reserve continues to describe the high level of inflation as transitory, it seems that it is here to stay.

          The taper announced by the Fed while leaving interest rates unchanged is, in my view, more symbolic than substantive.

          I expect that at the first sign of market distress, the Fed will reverse course and make the ‘adjustments’ they stated were possible in their taper announcement.

          Assuming I am correct, today’s discussion of the anatomy of inflation could especially relevant.  In the article, “Is the World About to Be Weimared?”, the author describes the progression of inflation or hyperinflation.  (Source: https://www.pgurus.com/is-the-world-about-to-be-weimared/#)

          The author also discusses the probable political outcome of such a hyper-inflationary event pointing to the Weimar, Germany hyperinflation and the rise of an authoritarian government.

          History points to this political outcome time after time.

          Extreme economic circumstances have the populace embracing extreme political solutions that often turn out to not be solutions at all.  That was the case in Weimar, Germany and we can all hope and pray that is not the solution presently should the current inflationary climate evolve into an environment that is hyperinflationary.

          To prevent such an outcome, it’s important to understand the inflationary cycle.  The author of the article referenced above published a chart that does a good job of explaining the cycle.

          As you’ll note from the chart, the first stage in what the author describes as the inflationary death-spiral is the development of the attitude that “deficits don’t matter”.

          This attitudinal change among the ruling class is almost necessary since government spending is out of control and balancing a budget would require significant pain and a huge amount of public sacrifice, both of which are politically unpopular.

          Here is a bit from the article (emphasis added):

“Given above is the typical scenario of how “well-meaning” governments end up causing depressions and high inflations.  Starting out in a benign commodity cycle where the monetary inflation does not directly translate into consumer price inflation, governments reach the absurd but very convenient conclusion that “deficits don’t matter”.  The Keynesian stimulus appears to work under these conditions and the governments get away scot-free from their monetary sins.  Albeit temporarily.”   

          In my view, this accurately describes the time frame from 2011 to 2019.  The Federal Reserve was creating currency and expanding the money supply, a.k.a monetary inflation, but the only apparent inflation was that of asset prices like stocks and real estate.

          More from the article (emphasis again added):

“When the payback time arrives, and it always does without exceptions, the monetary stimulus has the effect of pushing on the strings from a “growth” perspective.  The higher deficits translate into consumer price inflation while the growth seems to falter.  The currency weakens, there are greater trade deficits and the recessions and consumer price inflation both worsen.  Stagflation, Misery Index (unemployment + inflation) are some of the more commonly used phrases to describe these economic conditions and this is where the US, and perhaps the world at large is headed in the immediate future.”

          I would argue this is where we are presently.  The US just recorded the largest trade deficit in history due in large part to importing a lot more energy than just a year ago.  This from “United Press International”  (Source:  https://www.upi.com/Top_News/US/2021/11/04/trade-deficit-809-billion-imports-exports/2021636046685/):

The U.S. trade deficit reached an all-time high of $80.9 billion in September, sparked by consumer demand for computers, electric equipment, and industrial supplies, the Commerce Department said Thursday.

The Commerce Department said year-to-date, the goods and services deficit increased $158.7 billion, or 33.1%, from the same period in 2020. Exports increased by $274.1 billion or 17.4%. Imports increased by $432.8 billion or 21.1%.

            And, even using the highly manipulated Consumer Price Index measure of inflation, consumer price inflation is at levels not seen in years while economic growth is slowing.

          The next stage of the inflationary death spiral is described in the article (emphasis added):

Of course, the US Fed neither believes in the transitory nature of the CPI nor in the “strong economy” opinion that they voice in the public domain.  The only reason why the US Fed has not raised the interest rates is that they understand the inflationary death spiral that the US economy/dollar is about to enter.  Let’s say the Fed manages to hike the rates to a very nominal 1%.  That would still leave the real interest rates negative by a massive 4%.  But this 1% interest rate would deliver a devastating blow to both the housing and bond hyper-bubble markets that the US economy cannot possibly hope to recover from.

That would indeed set off a chain reaction of a recession forcing the government to step in with a big stimulus which would lead to even higher CPI.  In fact, this is exactly the same phenomenon that we have witnessed in many banana republics but perhaps for the first time, we will witness this happening to the world’s reserve currency in the years ahead. 

          In other words, once this cycle begins, it is self-feeding.

          The reality of currency creation is quite sobering when one compares the levels of currency creation by the Federal Reserve to that of Weimar, Germany.

          The chart above illustrates the amount of currency created by the Federal Reserve.  Notice in calendar year 2020, the expansion of the money supply went nearly vertical and has continued for about two years.

          The next chart below shows the level of currency creation in Weimar, Germany after World War I.  Notice the eerily similar chart patterns with the currency creation that led to hyperinflation and the destruction of the German Mark occurring largely over a two-year time frame.

          The Fed has arguably already created enough currency for a hyperinflationary outcome.

          The difference between the German Mark of Weimar, Germany, and the US Dollar of today is that the US Dollar is still used as a reserve currency. 

          It is my view that without that status, we would perhaps already be experiencing a hyperinflationary climate similar to that of Germany after World War I.

          As I noted last week, the only way to solve this problem is a balanced federal budget so currency creation is unnecessary.  Given the recent passing of a monster infrastructure spending package that adds to the level of deficit spending, we are moving in a fiscal direction that almost ensures the inflationary death spiral continues.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Money Printing, Inflation and Unintended Consequences

As I have been discussing for a very long time, the current economic policies being pursued will likely result in the realization of Thomas Jefferson’s warning to us more than 200 years ago.

If you are a new reader, Mr. Jefferson warned us that we should not allow private bankers to control the issue of our currency.  Should we do so, he cautioned, first by inflation then by deflation the banks and corporations that will grow up around us will deprive the people of all property until our children wake up homeless on the very continent our fathers conquered.

In the “New Retirement Rules” class that I taught beginning in 2011, I suggested that there were two potential economic outcomes depending on what the policy of the Federal Reserve was moving ahead.  We would have deflation, like we saw in the 1930’s during The Great Depression or we would have inflation followed by deflation as Mr. Jefferson suggested should the Fed elect to print money.

It is now clear that we are on the latter path and the one that Mr. Jefferson warned us about.

Signs of inflation are everywhere.

In last week’s issue of “Portfolio Watch”, I discussed the statements made by Warren Buffet at the Berkshire Hathaway meeting.  During his lengthy address, Mr. Buffet stated “We are seeing very substantial inflation.  We are raising prices.  People are raising prices to us and its being accepted.”

That statement (and reality) flies in the face of recent statements made by Federal Reserve Chair, Jerome Powell who insisted that inflation is “transitory”.  To think that the Fed has expanded the money supply by ridiculous amounts and we will have only short-lived or temporary inflation is ludicrous.

Bank of America this past week suggested something similar.  The bank stated that the US will experience a “transitory hyperinflation”.  (Source:  https://www.zerohedge.com/economics/and-now-rents-are-soaring-too)

To some extent, that statement is accurate.  History teaches us that hyperinflations are typically temporary and often last until faith in the currency is lost at which point a reset has to occur.

For many years, I have been suggesting a two-bucket approach to managing assets with one bucket invested to protect assets when the deflation part of the cycle hits and another to hedge from what is now inevitable inflation.

Just this past week, reliable news sources reported on the ever-increasing levels of inflation now hitting the economy as a result of the Fed’s money printing.  And now, with talk of another $4 trillion stimulus package heating up, more money creation to fund more spending is probably on the horizon.

At the risk of being too political for this publication, in which I try to focus on economic and investing issues, there are actually politicians (in both parties) who are calling the proposed $4 trillion stimulus package an ‘investment’ not an expense.

That is pure rhetoric and not based in fact.  In order to make an investment, you need to have money to make the investment.

As we all know, the government has no money, and the current levels of debt and unfunded liabilities simply cannot be funded by any kind of tax increases.  As I’ve discussed in the past, 100% of household wealth in the US could be confiscated via a 100% wealth tax and the financial house of the US would still not be in order.

The reality is this.  Current policies being pursued by the Fed will result in a tax on savers and investors. 

Not in the form of a physical tax, but rather an inflation tax that sees the purchasing power of investments and savings diminish.

As I’ve been noting here each week, it seems that the inflation part of the cycle is now upon us.  What we’ve been discussing as theory for the past several years is now transforming into an ugly reality.

Rents are increasing significantly.  This will adversely affect the lower income workers who typically rent and don’t own their home.

This from “Zero Hedge” (Source:   https://www.zerohedge.com/economics/and-now-rents-are-soaring-too):

On Thursday, American Homes 4 Rent, which owns 54,000 houses, increased rents 11% on vacant properties in April, the company reported in a statement:

.           .. Continued to experience record demand with a Same-Home portfolio Average Occupied Days Percentage of 97.3% in the first quarter of 2021, while achieving 10.0% rental rate growth on new leases, which accelerated further in April to an Average Occupied Days Percentage in the high 97% range while achieving over 11% rental rate growth on new leases.

Invitation Homes, the largest landlord in the industry, also boosted rents by similar amount, an executive said on a recent conference call. Or, as Bloomberg puts it, record occupancy rates are emboldening single-family landlords to hike rents aggressively, testing the limits of booming demand for suburban rentals.

While soaring housing costs had put homeownership out of reach for most Americans, rents had been relatively tame for much of 2020. But in recent months, rents have also soared as vaccines fuel optimism about a rebound from the pandemic, and a reversal in the city-to-suburbs exodus.  The increases, as Bloomberg so eloquently puts it, “may add to concerns about inflation pressures.” Mmmk.

“Companies are trying to figure out how hard they can push before they start losing people,” said Jeffrey Langbaum, an analyst at Bloomberg Intelligence. “And they seem to be of the opinion they can push as far as they want.”

The article states that “Bloomberg” eloquently stated that increasing rents ‘may add to concerns about inflation pressures’.  I’d suggest it’s evidence of inflation.

There are many other examples of ‘inflation pressures’.  One of these examples, food, also disproportionately affects lower income households.  Michael Snyder commented this past week (Source:  http://theeconomiccollapseblog.com/what-will-you-do-when-inflation-forces-u-s-households-to-spend-40-percent-of-their-incomes-on-food/)

Did you know that the price of corn has risen 142 percent in the last 12 months?  Of course corn is used in hundreds of different products we buy at the grocery store, and so everyone is going to feel the pain of this price increase.  But it isn’t just the price of corn that is going crazy.  We are seeing food prices shoot up dramatically all across the industry, and experts are warning that this is just the very beginning.  So if you think that food prices are bad now, just wait, because they are going to get a whole lot worse.

Typically, Americans spend approximately 10 percent of their disposable personal incomes on food.  The following comes directly from the USDA website

In 2019, Americans spent an average of 9.5 percent of their disposable personal incomes on food—divided between food at home (4.9 percent) and food away from home (4.6 percent). Between 1960 and 1998, the average share of disposable personal income spent on total food by Americans, on average, fell from 17.0 to 10.1 percent, driven by a declining share of income spent on food at home.

Needless to say, the poorest Americans spend more of their incomes on food than the richest Americans.

According to the USDA, the poorest households spent an average of 36 percent of their disposable personal incomes on food in 2019…

Needless to say, the final numbers for 2020 will be quite a bit higher, and many believe that eventually the percentage of disposable personal income that the average U.S. household spends on food will reach 40 percent.

That would mean that many poor households would end up spending well over 50 percent of their personal disposable incomes just on food.

As benevolent and perhaps even as well-intentioned as stimulus to help those who have been harmed financially over the past year sounds, the fact that money has to be created out of thin air to fund stimulus payments ultimately ends up hurting those that were supposed to be helped.

Stagflation is here.  The economy is contracting, and prices are rising.  If you have not yet seriously investigated how the two-bucket approach to managing assets might help you navigate what lies ahead, I would urge you to do so. 

And I would do so soon.

If you know of someone who could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Artificial Markets and Where We Go From Here

In my view, we are entering a time of significant financial transition.  Most financial markets are now artificial.  As I’ve discussed, the CARES Act changed the financial rules to allow for even more money creation.  Prior to the CARES Act becoming law, the Federal Reserve, the central bank of the United States, could only purchase US Government bonds and US Government backed mortgage securities.

The CARES Act changed the rules allowing the Federal Reserve to loan money to the US Treasury to use to purchase corporate debt securities through the use of a SPV or special purpose vehicle.

Within a week of that rule change, the Fed also announced it would begin the direct purchase of junk bonds despite the fact that the central bank has no legal authority to do so. 

Monetary policy change is as extreme as the policies themselves.

Despite the Fed’s venture into purchasing junk bonds, it seems that there will still be a record number of defaults on lower quality corporate debt issues.  This from “Market Watch” (Source:  https://www.marketwatch.com/story/feds-foray-into-buying-junk-rated-corporate-debt-wont-stop-wave-of-defaults-that-could-reach-21-analysts-warn-2020-04-17) (emphasis added):

Even with the Federal Reserve aiming a $750 billion fire hose at U.S. corporate debt markets to offset carnage from the pandemic, defaults at speculative-grade companies already are starting to climb as business buckle under their debts.

Frontier Communications Corp,  LSC Communications Inc.  and hospital operator Quorum Health Corp. in April defaulted on a combined $14.3 billion of speculative-grade (or junk-rated) bonds, a sharp uptick from the $4 billion seen earlier in the year, according to B. of A. Global analysts.

They called the Fed’s announcement last week to start buying riskier assets “bold, surprising, and reflecting its commitment to respond forcefully to signs of dysfunction in the key corners of U.S. debt funding markets,” in a client note Friday, but also cautioned that defaults among junk-rated U.S. companies will likely reach 21% over the next two years.

The Fed will be directly buying junk bonds.  Yet, despite their aggressive purchases, Bank of America analysts forecast that 21% of junk bonds will default.  That gives you an indication of how dismal the financial health of many smaller and already distressed companies really is.

“Forbes” reported that JC Penny elected to skip a $12 million interest payment that was due on April 15.  (Source:  https://www.forbes.com/sites/walterloeb/2020/04/17/pandemic-bankruptcies-threatens-jcpenney-neiman-marcus-and-many-others/#59e688354b10).  “Business Insider” reported that the company was considering bankruptcy (Source:  https://www.businessinsider.com/experts-say-several-retailers-to-consider-bankruptcy-amid-coronavirus-2020-4).

It is an accepted fact at this point that even if the constraints put in place to attempt to contain COVID 19 are soon lifted, the second quarter of this year, economically speaking, will be the ugliest in US history.  “Market Watch” reported (Source:  https://www.marketwatch.com/story/morgan-stanley-forecasts-38-drop-in-second-quarter-us-gdp-2020-04-03) that Morgan Stanley recently lowered second quarter economic expectations on what was an already dismal forecast (emphasis added):

Morgan Stanley has lowered its U.S. economic forecasts, as social distancing measures and closures of nonessential businesses have spread to an increasing number of states. The bank lowered its first-quarter GDP forecast to -3.4% from -2.4% and its second-quarter GDP forecast to -38% from -30%. 

            Later in the article, it was reported that Morgan Stanley expected 2020 GDP to drop more than at any time since 1946.

            Meanwhile, over the past 4 weeks, stocks have rallied off their lows.

            The stock rally in my view is reminiscent of past stock rallies – the Fed announces more radical monetary policies due to deteriorating economic conditions and stocks rally.  Financial markets, as noted above, really are artificial at this point with markets reacting to more easy money the same way as an addict reacts to another hit.

            Short-term the effect is positive, but long term it will be harmful.  And, the longer the artificial market stimulus is applied, the worse the ultimate crash will be.

            Back in 2011, when my book “Economic Consequences” was written and then again in 2015 when my “New Retirement Rules” book was published, I predicted a Dow to Gold ratio of 2, or more likely 1.

            I still stand by that forecast.  Now; however, it seems like there is a more obvious path forward to that eventual outcome.

            Jim Rogers, billionaire investor, co-founder of the Quantum Fund with George Soros and past guest on my radio program has the same perspective.  This from a recent interview with “Business Insider” when Rogers was asked if the current crash was going to be the big one. (Source:  https://www.businessinsider.com/coronavirus-market-outlook-forecast-legendary-investor-jim-rogers-federal-reserve-2020-4) (emphasis added):

In 2008 we had a very serious problem because of too much debt. Since then, the debt has skyrocketed everywhere, so it seems to me self-evident. The next one has to be worse than 2008. People seem to be surprised.

Anyway, so yes, this is probably it. I’m sure that the rally is going to be nice. It already is a nice rally. You know, governments all over the world are spending huge amounts of money, printing huge amounts of money. There is an election in November, so the rally will probably be nice, but it’s not over, Sara, it’s not over.”

            When Rogers was asked how low stocks could go, this was his response (emphasis added):

I can tell you in history, bear markets go down 50, 60, 70% this is just history. This is not an opinion and many stocks go down 80, 90%. Some disappear. That’s just the way bear markets work.

            It’s important to remember that markets rarely go straight up or straight down over the long term.  That’s true of every market including stocks.

My opinion remains that we are likely going to see some initial deflation and then, assuming no change on monetary policy, probably significant inflation.

            Egon vonGreyerz, founder of Matterhorn Capital Management, states that inflation or hyperinflation has to be the ultimate consequence to the greatest financial bubble in history.  He forecasts that massive inflation, like coronavirus, will quickly move from one country to the next with very few being spared (Source:  https://goldswitzerland.com/the-greatest-financial-crisis-hyperinflation/).  This will be as a direct result of money printing by central banks which creates artificial markets.  This excerpt from a piece recently written by Mr. vonGreyerz explains (emphasis added):

Ever since the last interest cycle peaked in 1981, there has been a 39-year downtrend in US and global rates from almost 20% to 0%. Since in a free market interest rates are a function of the demand for credit, this long downtrend points to a severe recession in the US and the rest of the world. The simple rules of supply and demand tell us that when the price of money is zero, nobody wants it. But instead debt has grown exponentially without putting any upside pressure on rates. The reason is simple. Central and commercial banks have created limitless amounts of credit out of thin air. In a fractional banking system banks can lend the same money 10 to 50 times. And central banks can just print infinite amounts.

Global debt in 1981 was $14 trillion. One would have assumed that with interest rates crashing there would not have been a major demand for debt. High demand would have led to high interest rates. But if we look at global debt in 2020 it is a staggering $265 trillion. So, debt has gone up 19X in the last 39 years and cost of debt has gone from 20% to 0% – Hmmm!

            You don’t have to be an economist to understand that today’s markets are completely artificial.  As Mr. vonGreyerz points out, when interest rates fall, it indicates no demand to borrow money.  Yet, despite this, debt has ballooned to levels that are totally unsustainable. 

            That simple fact proves my argument that all financial markets are now artificial.

            That’s also why I have long advocated the two-bucket approach to managing money.  One bucket consisting of assets that are safe and stable to provide income needs and another bucket containing assets that will function as an inflation hedge.