Buy enough government debt and interest rates go down. This prevents prices from falling and sends investors fleeing from low-yielding government bonds and into stocks.

According to Mr. Bernanke all this can be done — all this new money can be created — without the old money being cheapened. An inflated money supply cures all ills with no downside.

It seems to have worked. Stocks have soared, unemployment has dropped. Americans have started to spend again.

From the Associated Press:

“The move, which began in November, was unorthodox, but the logic was simple: Buying $600 billion in Treasurys would make borrowing cheaper and move investors out of low-yielding bonds into riskier investments like stocks. A rising stock market could then give Americans confidence in the economy and spur consumer spending, which leads to higher corporate profits.

“A lot has happened in the markets and the economy since then — most of it good.

“— The unemployment rate dropped to 9 percent in January, the most recent month for which data is available. It was 9.6 percent in August.

“— The Consumer Price Index rose 0.4 percent in January and 1.6 percent over the previous year. Prices rose 0.2 percent last August from the month before and just 1.1 percent over the previous year.

“— The Standard & Poor’s 500 stock index is up 27 percent since Aug. 26, the day before Bernanke’s speech, powered by stronger corporate profits and people moving their savings into stock funds.

“— Consumer spending has climbed seven months in a row. In the last quarter of 2010, it grew at the fastest pace in three years. Spending rose 0.2 percent in January, according to data released Monday.

“‘Measured in the fairest possible way, and by just about every measure, QE2 has succeeded so far,’ says Anthony Chan, chief economist at JPMorgan’s wealth management unit. QE2 is market slang for the Fed’s quantitative easing program.”

The Fed’s prescription has been “just enough” money creation — the kind that gives the economy a boost without all the horrible side effect of price inflation.

Associated Press reports:

“‘It’s been a success,’ says Bill Gross, who manages the world’s largest mutual fund at Pimco. Gross had skewered Bernanke’s attempt to boost the economy, comparing it to a Ponzi scheme. ‘It’s hard to dispute that since Jackson Hole the market is up around 25 percent.’

“But the Fed’s $600 billion program to buy Treasurys ends in June. And Gross and other investors are concerned the stock and bond markets will fall without the Fed’s $75 billion monthly injection. ‘At the end of June, the biggest bond buyer steps away,’ he says. ‘The markets could have a shock in store.’”

Bill Gross seems to have second-guessed his Ponzi scheme accusations. But maybe he shouldn’t be so quick to eat his words.

Inflation is a process. That’s where it gets the destructive power for which it’s renowned. The very poorest and those furthest away from the new money feel it the worst.

The creator of the new money gets the most benefit. He gets to spend it first. Those who receive it next are pretty well off too. But all that new money is going to keep working its way through the system.

So while stockholders offer prayers of thanks to the Fed, others down the line don’t feel so thankful.

Take those for whom a meager portion of rice and bread represent half a daily income. A small bump in the prices of these commodities means that they are suddenly a lot poorer…and a lot hungrier.

Since the dollar is still the world’s reserve currency — and since markets are now global — money creation in the U.S. doesn’t affect the U.S. adversely at first. Instead, the misery of inflation is exported. It’s distributed to poor people in other countries first.

So things may look fine in the U.S. for now, but someone is getting the downside of this money creation right in the kisser. That does seem awfully Ponzi scheme-ish. But not so fast says Mr. Bernanke…

Again from AP:

“The Fed chief blamed the recent jump in commodity prices on droughts and severe weather that have cut supplies at the same time China’s appetite has grown. Bernanke assured Senators he would quickly tighten lending before inflation posed a threat. He said the U.S. economy still needed the Fed’s support.”

These things certainly have had an effect on food prices. China’s appetite in particular has been key to the success of Chris Mayer’s newsletters’ portfolio…

…But there’s a whiff of pure inflation-driven price increases there too. You can tell because foods aren’t the only commodities that are getting more expensive as new money is being created.

If it were just food prices, then we could chalk all this up to a richer China and inclement weather. But the signs of inflation — and its expectation — are showing up everywhere. The world’s poorest feel it most, but the middle class in the world’s richest nation are starting to feel it too. Their dollars are buying a little less food, a little less gas, a little less medical care.

Concerning the touted success of QE2, let me paraphrase a line from Harvey Keitel’s character Winston “The Wolf” Wolfe in “Pulp Fiction”:

Let’s not start shaking each other’s hands just yet, gentlemen.

Regards,
Gary Gibson
Managing Editor, Whiskey & Gunpowder

March 2, 2011

Was QE2 Money Creation with No Negative Consequences? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

For example, gold is trading at a record high, while silver has reached a 30-year high. Those new high prices are happening for a reason. The precious metals are sensitive to changes in inflation, both actual as well as future expectations.

Rising precious metal prices tell us that there is a lot of inflation in the pipeline, but they are not alone in giving us this message. More generally, look at the trend in commodity prices over the past few months in the following chart of the CRB Continuing Commodity Index, which is based on the price of 19 different commodities.

On June 4th the CRB Index closed at 450.24. Here we are just 3-1/2 months later, and the CRB Index closed Friday at 530.24, up 17.7%. That is a HUGE jump in prices in such a short period of time. To put this price rise into perspective, it is a 61.8% annual rate of “appreciation” — though we should call it by what it really is, namely, “price inflation.”

Commodity prices are not rising because of good economic activity, which remains in the doldrums with high unemployment throughout most of the world. Commodity prices are rising because too much money is being printed. But the Federal Reserve reports that M1, a narrow measure of the total quantity of dollars in circulation, rose only by a 9.1% annualized rate in the three months from May 2010 to August 2010, and M2 rose by even less. So why are commodity prices rising by an even faster rate than money growth? There are two reasons.

1) Because too much money has been printed for years, not just over the past three months, which can be illustrated by comparing M3 to the total US population. In 2000 there were $26,977 in circulation, as measured by M3, for every man, woman and child in the United States. That amount has ballooned to $46,538, a 7.1% annual rate of growth, which is more than 7-times the 0.9% annual rate of population growth during this period.

2) Demand for money is usually ignored, but it is an important part of the equation. Unfortunately, demand cannot be measured, so we again need to rely on observations of market prices to determine the prevailing trend in the demand for dollars at any moment.

So, for example, let’s look at the US Dollar Index, which measures the dollar’s rate of exchange against a basket of currencies. While commodities have been rising since June 4th, the Dollar Index has been falling. It is down 7.9% over this period, a 27.6% annualized rate of decline. Given that people are opting to hold other currencies in preference to the dollar, as evidenced by the dollar’s falling exchange rate, it is clear that the demand for the dollar is falling.

Thus, the dollar is being hit by both rising supply and falling demand. We know from Economics 101 that this condition results in falling prices, which when applied to money means declining purchasing power, or what today is usually called “inflation.” If monetary policy is not corrected and inflation is not reversed, in time hyperinflation will be the inevitable result.

I have been warning about hyperinflation since March 2, 2009 when I wrote that the dollar was on the cusp of hyperinflation. I noted that “the federal government has embarked on a course of runaway spending, and it is runaway government spending that causes runaway inflation”, which if left uncontrolled leads to hyperinflation. The trend has not changed for the better.

From February 28, 2009 to August 31, 2010, runaway federal government spending has resulted in a $2.57 trillion increase in the national debt. But over this period GDP increased by about $0.5 trillion, and the increase in economic activity is even less after adjusting for inflation. So clearly we need to ask ourselves, what have the bailouts and stimulus programs really accomplished?

The answer is very little in terms of economic activity, but there is an ominous consequence from this foolish binge by policymakers of soaring debt and reckless money creation. Given that these dollars are not being used to generate economic activity, they are now sloshing around the globe looking for a safe home. Tangible assets are one of the safest places to be to protect your wealth from a currency whose purchasing power is eroding.

The result is that the commodity markets are on fire. Prices are not rising because of a shortage of commodities, but rather, there is a surfeit of dollars. Too much currency has been created, relative to current economic activity.

Without an abrupt about-face to end the wrongheaded policies being followed by policymakers, there can be only one conclusion. The dollar is headed toward hyperinflation. The new record highs in gold and silver, an across-the-board rise in commodity prices and the renewed downtrend in the dollar’s rate of exchange are the “writing on the wall.”

Regards,
James Turk
GoldMoney.com
for Whiskey & Gunpowder

September 22, 2010

They Are Printing Too Much Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Roubini’s four forces of Stag Deflation are: a slack in goods markets, a “recoupling” of the rest of the world with the U.S. recession, a slack in labor markets, and a sharp fall in commodity prices. These factors would, “reduce inflationary forces and lead to deflationary forces in the global economy,” he writes in an article in Forbes.

“Aggregate demand is now collapsing in the U.S. and advanced economies, and sharply decelerating in emerging markets,” he writes. “There is a huge excess capacity for the production of manufactured goods in the global economy, as the massive, and excessive, capital expenditure in China and Asia (Chinese real investment is now close to 50% of gross domestic product) has created an excess supply of goods that will remain unsold as global aggregate demand falls.”

You’ll have to bear with us a moment, dear reader, as we work out what this means. First, though, is Roubini right? Well, he’s certainly right that there’s a big fall in aggregate demand in the U.S. It’s obviously passing through to manufacturers and commodity producers (China and Australia). But won’t monetary and fiscal policy designed to combat deflation…you know…cause inflation?

Roubini takes that point head on. He says the liquidity measures taken on by the Fed to get credit flowing and recapitalise U.S. banks are not all inflationary. He says once liquidity is restored to the credit markets (banks begin lending, money market funds starts buying commercial paper again) the central bank can simply “mop up” excess liquidity before it seeps into the real economy to cause inflationary damage.

And what about the tendency of governments to fight debt deflation with inflation? Not a worry either, says Roubini. He says that most of the household debt in the U.S. is short-term variable rate debt that’s resistant to being “inflated away” by cranking up the printing presses. Is he right?

Well it all comes down to how much money the Fed and the Treasury are going to need before the recapitalisation of the American financial sector is over and how they plan to raise that money. The banks will probably need more capital than anyone’s expecting. And there are other landmines down the road.

In short, the Treasury and Fed will need more money. Roubini assumes the Fed can simply remove the lending backstops it’s provided once the market returns to normal. But what if it doesn’t and the Fed can’t? What happens next?

Governments get money three ways, taxing, borrowing, or printing it. You can rule out an increase in taxes large enough to fund the Fed’s needs. It won’t happen with an economy already contracting. Even if Obama raises taxes, it won’t be enough to meet the Fed’s immediate needs. That leaves borrowing and printing.

On September 17th, the U.S. Treasury announced a Supplementary Financing Program. It initiated the program at the request of the Federal Reserve. The Fed needed the Treasury to go out and sell more bonds so the Fed would have money to fund its various lending backstops. The Fed was nearly broke.

Since then, thanks largely to the huge flight to Treasuries sparked by deleveraging and the collapse of the dollar/yen carry trades, the Supplementary Financing Account set up by the Treasury has fed the Fed nearly $560 billion. Some of that may have gone to AIG. Some of it to Fannie and Freddie. Some may go to Chrysler, Ford, and GM. Who knows?

But the main point, from Roubini’s perspective, is that as long as the Fed can finance its lending with new borrowing from the Treasury, it’s not inflationary. The only thing that would make this armada of liquidity measures and loan guarantees and bailouts truly inflationary is if the Treasury couldn’t go out and sell new bonds to gullible foreign investors. As long as the Treasury can sell more bonds, the Fed can make more loans without sparking inflation.

But if we’re right and the bond bubble began bursting in late October, well then the Treasury’s line of credit with global savers is nearing an end. Global creditors will be reluctant to finance American deficits. In order to borrow, the Treasury is going to have pay much higher rates of interest to reflect the credit risk the U.S. government has become.

Trouble is, the U.S. can’t afford to borrow at higher interest rates right now. So that leaves the option Roubini thinks is least likely: printing money. The fancy term for it would be “monetizing the debt.”

That means the Fed would buy public debt issued by the U.S. Treasury with freshly printed money. And THAT, we reckon, is super inflationary. Any time you start rolling out new greenbacks to pay for new bonds which you give to corporations in exchange for their garbage securities, you’re going to damage the confidence people have in the currency (the U.S. dollar).

But then, Roubini has been right about an awful lot lately. It’s possible the Fed will not be forced to monetize the debt. It’s possible that a global contraction is truly deflationary. We don’t really know. But we’re not nearly as sanguine as Roubini that you can expand the monetary base as quickly as the Fed has and be confident it can all be mopped up later without causing inflation. Try getting motor oil out of an engine and back into the bottle.

Regards,

Dan Denning
November 05, 2008

Falling Commodities and Inflation in the Wings was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Many of us out there who have been involved in commodities trading and analysis have been warning, watching and waiting for the last two-three decades. So it comes as little shock to us that we are in this “crisis” now.

The Long Emergency

One of my favorite writers and lecturers is James Howard Kunstler. The Long Emergency is the title of one of Kunstler’s books, as well as one of his catchphrases, and, boy, is it dead on.

This commodities frenzy, and the related dash by nations to snatch up and secure all sorts of resources, has been a long time coming. It certainly didn’t happen overnight. I can safely say that for the vast majority of my career, commodities have been the poor redheaded stepchildren of the investment world. Two decades ago, when I walked onto the trading floor of the New York Cotton Exchange at the old World Trade Center, the climate was very different from today’s.

Back then, most “mainstream” investment houses looked at the commodity markets as a subculture. Commodities were, basically, another branch of Las Vegas, just without the free buffets, dancing girls and booze. Actually, maybe some of that stuff was available on a daily basis, but it was a lot different then.

I compare it to how Times Square was back in the 1970s and early ‘80s. If you ever visited the Big Apple back then, you know that Times Square was the worst of all things. It was a seedy, grimy, crime center filled with many colorful characters. Let’s just say Times Square was not a place tourists went, unless, of course, they were sex tourists.

Beneath it all, though, was an unpolished gem. The same is true with the resources market.

Respect Is Earned

Fast-forward to today.

Imagine you’re Rip Van Winkle and you go to sleep on 42nd Street back in, say, 1975 (let’s call you “Rip Van Wino”). You wake up in 2008 and see all the porno houses gone, bars shut down, strip clubs a distant memory…and then, suddenly, you are escorted to a homeless shelter because of New York policies on street people near 42nd Street… Welcome to the new world.

In some ways, this is true of the commodity markets, too. When I got involved with commodities in 1988, the exchanges were the low men on the totem pole. The members held all the exchanges privately, and none were traded on the stock exchange. It was a secretive world, and the only way to get a job on the floor was to know somebody. I got my job because my best friend’s brothers owned seats on the floor and gave me a job as a clerk.

Everyone on the trading floor was either related to or knew someone in the biz; it was a very incestuous market. The basic reason was that there was so much money to be made in the market nobody wanted outsiders coming in. It was a shortsighted approach, but it was the rule of law down there. The problem was that the markets stayed small and took only a small percentage of the global investment pie.

As the early 1990s set in, commodities, basically, fell and/or stayed stagnant for much of the decade, except for during the occasional war, such as we had in 1990 and 1991 (oil went wild when Saddam Hussein invaded Kuwait).

The general public focused on stocks and still pooh-poohed commodities. Nobody talked about corn or soybeans at any cocktail parties I went to in 1991. Now it’s different. I must get 15 calls a week inviting me to speak about corn and soybeans at events or on TV. It’s been a paradigm shift from 1989 to 2009.

Bubblicious

The most common question I have gotten on a weekly basis for the last 18 months is “When will the bubble pop?”

My answer is pretty standard: “There is no bubble!”

I am not usually invited back to those cocktail parties, as it scares the guests. The truth is we are not in a bubble. We are in an upward correction propelled by years of denial, stupidity, underinvestment and neglect. The blame falls squarely on several parties.

Wall Street is guilty for not embracing the commodity markets earlier. Wall Street should have allowed commodity prices to reflect the true nature of pent-up demand by making those markets available to its clients. Instead, Wall Street discounted commodities as some form of gambling.

The commodities exchanges and traders are also to blame for not making their markets more transparent, and for also projecting an image of secrecy and mystery.

And I could tell you stories about the underinvestment in basic production over the past couple of decades. Really, what were people thinking? That prices were low, and would stay low forever? Did it ever occur to anyone that all those babies born in the 1970s and 1980s might some day grow up and want food, energy and manufactured goods?

No, this is not a bubble. It’s a coming of age, a big, hard reality check that has been decades in the making. I have seen more activity by Wall Street in the resource markets in the last three years than in the previous 17. And I do not expect that it will ever go back to the way it was. I also don’t expect to see 42nd Street filled with porno and hookers again, either.

Change is often hard to accept. $140 oil, $1,000 gold, $8 corn…this is all the new reality. None of these new price trends are a figment of some rogue speculator’s imagination or the products of evil activity. This is a wake-up call that our growing world is hungry for the limited resources it still has.

The most important thing to remember is that markets, even parabolic bull markets, always correct. Those corrections can be painful if one is overextended or married to one side of the market — in this case, the bull market.

So ride the wave of change, of course. Be flexible, buy on the corrections, sell for profits on the overdone rallies and vice versa. Go short when clear tops have been made (although I grant it can be hard to determine the exact top).

There is no trail of breadcrumbs to follow on Wall Street, but that’s why you have me to help guide you. As long as grains don’t go up too much more, I should be able to supply you with a good trail to follow for many years to come, whether commodities are in rally mode or consolidation.

Yours for resource profits,
Kevin Kerr
July 16, 2008

P.S.: So if you agree that high prices are here to stay, that means there is definitely money to be made in commodities markets. But how exactly do you begin? It’s definitely a tough world out there, and the guys that have been in forever will try to keep the new guys out. That’s why I’m offering you a guest pass into this market that will help you earn more than enough money to help you keep pace with these rising prices.

Commodities Market was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

After all, gold offers a refuge against bad times ahead. Like all good insurance, it’s best bought before trouble arrives — not during or after.

And just how much worse can the news get from here?

1. The Dow’s on track to close out its worst June since the Great Depression, down almost 10 percent for the month.
2. GM’s stock is trading at a 54-year low, taking it right back to when CEO Charles Wilson declared “what was good for the country was good for General Motors and vice versa.”
3. U.S. Dollars — the bedrock of world forex reserves — now buy one-third less against the rest of the world’s money compared with 2002.
4. The price of crude oil has risen more than five times over since U.S. and U.K. troops liberated the oil fields of Iraq in 2003.

5. Libya is threatening to cut its oil production in protest at U.S. anti-terrorism laws; Tehran just pulled $75bn worth of investments from Europe to avoid sanctions against Iran’s nuclear program.
6. Global inflation has risen from three percent last June to more than 5.2 percent per year today; analysts at Barclays Capital believe U.S. inflation will hit 5.5 percent by August.
7. Real estate prices have turned sharply lower in the U.S. (down 15 percent year-on-year), Ireland (down 13 percent) and the U.K. (down 3.6 percent) as well as in Spain, Australia, South Africa and the emerging economies of east-central Europe. Price in Riga, Latvia dumped 38 percent in the year to May.
8. Western consumer confidence has sunk to multi-year lows; emerging-market consumers face the worst rates of inflation in more than two decades, rising 25 percent year-on-year in Vietnam and more than 13 percent in India; surging fuel and food prices have sparked protests and riots in Asia and now unionized strikes across Europe.
9. Investment and lending banks are being forced to take back “securitized” debt onto their balance sheets, destroying their capital adequacy ratios and halting new lending as pension & insurance funds try to flee risk. In the U.K. alone, new lending fell 95 percent in May after allowing for such “de-securitization.”

Watch out below! It’s every man for himself — women and children included! Or so the financial pundits now claim.

Makes you wonder where they’ve been during the bull market in gold starting in 2001. But with inflation surging and new credit shrinking, “we’re in a nasty environment,” said Tim Bond, head equity strategist at Barclays bank in London, this week.

Above all, “there is an inflation shock underway,” he said in Barclays’ latest Global Outlook. “This is going to be very negative for financial assets. [So] we are going into tortoise mood and are retreating into our shell.

“Investors will do well if they can preserve their wealth.” And investors who choose to buy gold are usually looking to achieve just that.

Indestructible, un-inflatable, and instantly priced in the world’s only true globalized market, gold bullion stands apart from all of those boom-time investments. Stocks, bonds, securitized debt, real estate…you can keep ‘em when the end of the world strikes.

These happy assets promise to pay you income. They also rise in value as the economy grows. Whereas gold, in sharp contrast, just sits there — neither smiling nor frowning, and never paying an income. Its value comes from, well, from its gold-ness alone.

And as the spike above $1,000 an ounce showed in mid-March — just as Bear Stearns collapsed — you need the end of the world to make buying gold worthwhile.

Right?

Well, perhaps not.

Because the value put upon gold should also be expected to benefit from sub-zero real rates of interest. War and terror be damned! The only sure push that gold prices need is low interest rates colliding with rising inflation.

And right now the world’s got that in spades.

“Figure 8,” notes Michael Lewis of Deutsche Bank in a recent paper for the London Bullion Market Association (LBMA), “illustrates the strong performance in gold returns as US real interest rates decline. We find that when real interest rates in the U.S. move below -3 percent, gold returns have tended to be significant.”

Listen up at the back! Because the Federal Reserve’s key interest rates stands at just 2.0 percent, scarcely half the rate of U.S. consumer-price inflation. And with a real return paid to cash of minus 200-basis points, you really should doubt the Fed’s true intent toward the value of money from here.

Even with the Euro trading above $1.57 on the foreign exchange markets, however — and even with the European Central Bank (ECB) promising to raise interest rates to defeat inflation next week — the Eurozone’s 320 million consumers are also suffering a 12-year record rate of wealth destruction. Here in the United Kingdom, after inflation and tax since the middle of 2003, the real returns paid to cash savings have stuck right on zero since mid-2003.

The fast-growing economy of India, meanwhile, offers negative real interest rates of 3 percent and worse. Taiwan’s real interest rates sit slap bang on zero after a rate-hike this week. And Chinese cash savers are way under water with inflation running at seven percent.

Any wonder “the number of credit cards in circulation jumped 93 percent in the year ending March 31 to 104.7 million,” as the Asia Times quotes the People’s Bank of China this week? Central banks everywhere want you to spend money, not save it, forcing the issue by destroying the value of money itself.

So any wonder that the world bid for gold — a tangible asset that can’t be inflated and can’t be destroyed — just keeps rising higher? “The purpose of money is to be a store of value,” said Dr. Marc Faber — the infamous fund manager behind the Gloom, Boom & Doom letter — to CNBC today.

(He kept laughing for some reason. No doubt he’s long gold…)

“When interest rates are negative, it destroys the wealth of honest depositors who have their money in the bank and don’t want to speculate,” Faber went on. “Now what people should do, basically, is to invest in gold. Because when it comes to action, the Fed shows no concern about inflation…

“The policies pursued by Mr. Bernanke have damaged the American public enormously by pushing commodity prices — specifically food and oil prices — much higher. And so real incomes are going down and discretionary spending is being hurt very badly.”

Gold represents wealth, in a word. Just remember that it won’t actually grow wealth, because it’s not a productive asset. Whatever else you might want from a metal, wealth preservation is the gold buyer’s best hope.

And that might prove all investors can ask if the news on inflation and rates, stocks, bonds and jobs, doesn’t start getting better.

Regards,
Adrian Ash
BullionVault
June 30, 2008

Gold Price Dip was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

He did that to get your attention.

Fed chairs rarely ever say that word, for reasons that Greenspan learned on his first days in office back in 1987 — the same reasons that CEOs rarely comment on their stock’s valuation.

Bernanke’s original remarks came before Friday’s unemployment report rained on Wall Street.

But just in case anyone thought the weak report might have softened his stance over the weekend, on Monday, he repeated his determination to tackle increases in long-term inflation expectations, and to fix the dollar. The rhetoric helped boost the currency and splashed cold water on gold’s recovery.

I say “helped” because the Saudis did most of the work by announcing an output hike (500,000 bpd).

Let me tell you right out of the gate that, as a rule, the Fed talks tougher than it is capable of acting, especially with a new administration around the corner. Bernanke has nothing more in mind than taking away the interest rate stimulus, as Greenspan did after 2004 — gradually and marginally…if that!

What’s more, the consensus doesn’t expect any action near term. Even more crucially, ultimately, his resolve rests on the correctness of his premise that the risks to economic growth have abated.

The Fed is not ideologically equipped to tackle the duality of rising unemployment and rising prices. Do you really think it is going to hike rates while stocks are reeling?

No. It just assumes that won’t be happening at the same time that prices are generally still rising.

But what is most important to understand is the factor that stirred the hawkish rejoinder.

For it is obvious that the Fed is reacting to market sentiments. And those sentiments are what I want to bring to your attention.

Is This the Crackup?

Back in March, oil prices were just breaking through $100, and the Fed hinted that it was probably finished cutting interest rates. Investors started looking for a big commodity and oil price correction.

It wasn’t to be.

Oil continued charging higher, egged on by bullish calls from America’s biggest investment dealers.

It is now backing off a high of about $139 in the nearest futures contract. That’s up 40 percent in three months, 100 percent in 12 months and nearly 200 percent in fewer than two years. It’s up more than 1,000 percent over the past 10 years. The moves in crude have been nothing short of spectacular.

On May 21, when the front month was breaking through $130, I got a call from a friend of mine — an oil analyst who runs his own investment service out of New Jersey. Like me, he’s been bullish since the turn of the millennium, but neither of us expected anything like this. Is this the crackup, he asked?

That’s the first time someone asked me if this was it…you know, “it.”

The crackup is a stage of the inflationary boom that occurs late in the cycle — when the market gets the idea that money grows on trees…and it finally abandons the idea that “prices will one day drop.”

Fear marks this final stage — in particular, of the erosion in monetary values.

It is born of a revelation, according to its author: “Finally, the masses wake up” to the fact that “inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crackup boom appears.”

However, it is the final stage of the boom. It is relatively short. It could last days, weeks, maybe even months, but the author (Mises) did not have much more in mind than that.

It is literally the death of that particular money.

Importantly, Ludwig von Mises concludes, “If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds.”

The laws of supply and demand determine money’s value, as with anything else. And if the supply of something is unlimited, it’s not usually worth much. So the Fed likes to downplay the fact that it can or will print money “beyond all bounds.”

I doubt we are seeing the crackup.

But we are seeing some of the things that characterize the onset of the late stages of a long-in-the-tooth inflationary cycle — in which prices rise because people expect them to rise, and the demand for money drops as confidence in the economy and the world’s common medium of exchange erodes.

As Market Focus Shifts to Money Relation…

Bernanke senses that the market is making a dangerous transition.

If I could point to one catalyst, it would be that the commodity markets are making moves that make the situation difficult to explain in terms of regular supply-and-demand fundamentals. That is, people are finally asking questions like how could the total demand for oil have doubled in just 12 months?

As Dr. Benn Steil, an economist at the Council on Foreign Relations, on May 20 stated:

“If you want to explain this terrifying apparent shortage of food that we now have in the world, I don’t think you could possibly explain it based upon enormous growth in the world’s appetite for food over the past three quarters. It just can’t be done.”

Indeed, although it was completely unrelated to this speech, the question of crack-up came the day after Steil’s speech to the Committee on Homeland Security, in which he pinned the commodity bull market almost entirely on fiat money inflation, and drew attention to gold’s relative stability as money:

“Whereas the prices of oil and wheat measured in dollars have soared over the course of this decade, they have, on the other hand, been remarkably stable when measured in terms of gold — gold having been the foundation of the world’s monetary system until 1971. It is, therefore, reasonable to conclude not that we are  experiencing a commodities bubble, but, rather, the end of what might usefully be termed a ‘currency bubble.’”

George Soros’ subsequent comments last week regarding doubts about the dollar’s reserve status were like a beacon to the Fed. Undoubtedly, they provoked Bernanke’s rebuttal. For they reflect sentiments the Fed would rather discourage, as they are difficult to “control.”

For the past eight years, the big money has explained the commodity bull market in terms of events like Sept. 11, growth in Asia and other developing frontiers, previous underinvestment or the finiteness of commodities. The Fed has succeeded in discouraging the market from pointing its invisible finger at it.

But the commodity bull market is about to take on a whole new form…

Regards,
Ed Bugos
June 18, 2008

P.S.: With gold still readying itself for another historic run, there has never been a better time to begin investing in the miners that bring this gold to market. Readers of my Gold & Options Trader service have already heard the word on a new miner that has a new take on the process of mining itself.

Inflation and Commodity Prices was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.