An Inflation of Confusion

By: Chris Temple | Sun, Dec 20, 2009
Print Email

In my December issue, the cover story is entitled "The Blind Leading the Blind." In it, I use many examples to demonstrate that virtually nobody in positions of leadership in government, the economy or markets can quite figure out which end is up as they try to make policy, guide their followers, etc. Policymakers in particular have been playing a game of financial "Whack-a-Mole" as they frantically lurch from one doomed attempt to another to deal with the economy's troubles. I daresay that most of these folks couldn't find their own backside if they used both hands.

When it comes to financial pundits and advisors specifically, they seem no better able to assess things or -- in their case -- provide their clients and followers with any kind of a viable outlook and game plan based on it. Usually, they follow the presently dominant movements and theme(s) of the market. For much of 2009, that has consisted of playing the weak U.S. dollar against just about everything else. At some point, of course (a point I've believed for weeks now we are at) too many are following the same trade, urging those with prescience to get out of it, if not move to a contrary position.

For just a moment, I want to put in my own two cents on one of the themes that has driven not only the trade in gold over the last several months, but also that of such disparate assets as copper, oil and emerging market equities. And that is, the notion that the U.S. in particular, due to our monstrous and exponentially growing fiscal deficits, is about to endure a bout of rapidly-rising inflation, if not hyperinflation.

A couple days ago I watched as CNBC's Sue Herrera and Tyler Mathisen interviewed a prominent economist regarding his inflation outlook. He suggested that, with the exception of gold (which he clearly disdained), the Federal Reserve's ongoing low interest rate policy would lead to broad-based inflation in the year ahead.

Neither of the CNBC anchors thought to ask the question, "Why is it, then, that after two decades of rock-bottom interest rates Japan is still fighting DEFLATION!?"

This whole inflation-deflation debate is one I have weighed in on a few times; and, it's one I will be covering in even greater detail as the New Year commences. After all, I want to be able to provide the best and most profitable advice for my subscribers.

And getting this issue right will be a key to that.

It does not help that the very definitions themselves of inflation and deflation have changed over the years, and are so poorly understood by consumers and investors alike in any case. Others and I have often cited the infamous (and frankly, outrageous) public utterance way back in the early 1970's of Herbert Stein, then serving as President Nixon's chief economist. Asked about the misery being faced by Americans over the soaring costs for life's necessities, Stein had nothing to say about his boss' having taken the last step to break the U.S. dollar from any mooring in gold. Neither did he discuss the wildly inflationary Fed policy and devaluation of the dollar that followed. He shied from discussing the dismal failure (if not the idiocy in the first place) of the wage and price controls he urged on the president.

Instead, Stein blamed America's housewives. Paraphrasing, he opined that shoppers needed to be wiser and do most of their shopping when there are sales. Then, he said, "inflation" would not seem so bad.


As I stated above, I will over the next several weeks be spending a considerable amount of time in showing my subscribers the kind of "flations" that lie ahead. To some extent, I will need to walk our folks through a process of a re-definition of these terms, chiefly to take us back closer to the sources of these monetary phenomena. Only with an accurate understanding of this will we be able to craft a sensible investment approach.

For present purposes, I want to share with you folks the two chief mistakes that the pundits and investors alike are making in looking at the inflation vs. deflation issue.

FIRST, they fail to understand the fact that America (and, to varying extents, other countries) has already endured many years of hyperinflation. As I explained in my September, 2004 Special Report entitled Understanding the Game, almost everyone was looking in the wrong place, and missed this HUGE event.

The volume of "money" in circulation exploded over the last three decades; just as many predicted back in the late 1970's. But evidence of this did not show up in the expected places. Instead, that hyperinflation was evidenced in the valuations of (primarily) financial assets such as stocks and bonds during the 80's and 90's, and in real estate, securitized financial assets and derivatives in this decade.

It is critical to understand here, as I wrote in a recent commentary for my subscribers, that what we have witnessed over the last few years in particular is the inevitable reversal of this previous hyperinflation. It is a DEFLATION still much closer to its beginning than to its end. If one wants to have some decent clue as to what lies ahead for America, he or she needs only to go back and look at the grueling, on-again, off-again deflation (of everything but the level of public debt, that is) that has gone on in Japan since its bloated asset bubbles started losing air in 1989.

SECOND -- and somewhat of a corollary to the above -- is that, in order to properly divine the future of inflation/deflation, we need to look at all the sources of such monetary happenings. Most are not doing so. They focus exclusively on Time magazine's Person of the Year Ben Bernanke and his fleet of helicopters, and scream "inflation!"

Yet Helicopter Ben's private central bank is not the only source of inflation (and, thus, deflation.) As I explained back in my July, 2009 issue, one must also consider the impact on the inflation vs. deflation equation of what has in recent years been dubbed the shadow banking system. And it has over the last year or so been -- and will continue to be -- a major source of deflation.

The shadow banking system is a menagerie of banks (with their off-balance-sheet operations), hedge funds, private equity funds, structured investment vehicles (SIV's), derivatives alchemists and all the others who have effectively taken on banking functions in recent years. These players -- all monsters created and/or enabled by our modern-day monetary Dr. Frankenstein, Alan Greenspan -- have superseded the import to much of the economy of the official central bank itself. These entities have created trillions of dollars' worth of "wealth" via financial instruments of various (often dubious) kinds, which permeated our entire economy and banking system, fostering -- for a while anyway -- what looked like prosperity.

Much of this has only just begun to reverse itself.

I cannot yet make any kind of case for the sort of "hyperinflation" being predicted by some when -- for every $1 created out of thin air by the Fed--$100 is vaporized that had been previously "created" one way or another by the shadow banking system. As I wrote back in the July piece, "Sure, the Fed has pulled a few trillion dollars out of its hat and dropped it from Ben's fleet of helicopters in the hopes that it will arrest the economy's circling the drain. Yet what does this mean in the face of a $50 trillion plunge in asset prices worldwide since the start of the financial debacle last September?" (Emphasis in original.)

One could make an open-ended commitment to assets deemed beneficiaries of inflation (such as gold, oil, stocks, emerging market paper and the rest) if it could be determined that all (or almost all) of the unwinding, asset devaluations, debt implosions and the rest is over. I do not believe that it is over at all. Thus, we must always be on the lookout for these deflationary forces to reassert themselves, perhaps without warning. In such an environment, the just-mentioned asset classes that normally benefit from an inflationary or expansionary environment will suffer the same fate they did about a year ago: they'll get flattened.

It is my view that we will shortly see a return to such an environment, if we are not already going through the transition.



Chris Temple

Author: Chris Temple

Chris Temple, Editor
The National Investor

Copyright © 2004-2010 Chris Temple

All Images, XHTML Renderings, and Source Code Copyright ©