Connecting the Dots
Taking Care of Business by Bachman Turner Overdrive was the #1 song, All In The Family with Archie Bunker was the top-rated TV show, Blazing Saddles was the top-grossing movie of the year, and the Oakland A's won the baseball World Series.
The cost of an home averaged $38,900, the median household income $11,197, a first-class stamp costs 8 cents, a dozen eggs cost 78 cents, and a gallon of regular gas was 53 cents.
I was a senior in high school with a full head of hair and a flat stomach.
I'm talking about 1974.
I know. I know. 1974 is a long, long, long time ago.
The reason that I am bringing up 1974 is that it has been that long since inflation has been as rampant as it is today.
At the time, inflation was running at a 13.9% clip, the Dow Jones slipped to 590, and Richard Nixon was our President.
When you think of Nixon, you probably think of Watergate and the Vietnam War. I do too, but I also think about his unusual strategy to fight inflation.
Nixon and 15 of his trusted advisors retreated to Camp David to device a battle plan to combat inflation. What they came up was a plan -- the New Economic Policy - that temporarily froze both wages and prices for 90-days. Nixon mistakenly thought that government policy could control free market forces.
"If this baby gets too strong we can strangle it in its cradle."
Wrong! The 90-day freeze turned into nearly 1,000 days of price controls: Phases One, Two, Three, and Four. Worse yet, these attempts to dampen inflation were a complete failure. Inflation surged from what seems like a very manageable 4% to over 13% in 1974.
Fast forward to October 18, 2005.
The Labor Department reported that inflation at the wholesale level -- the Producer Price Index or PPI -- jumped by 1.9% in September. That is the biggest single-month jump in the Producer Price Index in 31 years.
On an annualized basis, you're looking at over a 22% inflation rate. The last time wholesale inflation has been this rampant was -- you guessed it -- 1974.
I'm not suggesting that wage and price controls are around the corner, but it is clear that inflation has returned.
Don't listen to the don't-eat-don't-drive crowd
Of course, the don't-eat-don't-drive crowd on Wall Street keeps telling us to concentrate on the "core" inflation rate, which only increased by 0.3% in September.
I suppose the inflation picture looks very different behind the tinted windows of Manhattan and Washington D.C. limousines, but the rest of America is struggling with the surging energy prices.
But even the Jack-and-the-beanstalk crowd can't ignore the sharp increases in the price of energy.
After hitting a record high of $70.85 a barrel after Hurricane Katrina, Overall, energy prices increased by 7.1% in September, the biggest one-month increase in 15 years.
==> Gasoline increased by 12.7%
==> Natural gas increased by 9.0%
==> Heating oil increased by 4.8%
With winter around the corner, the double-whammy of high gasoline and high heating costs are about to crush millions of Americans budgets.
Energy isn't the only thing surging in prices. Food increased by 16.8% annualized rate in September and scarp steel prices surged by 22.8%.
We're not talking about an isolated, statistical fluke either. On October 14, we were told that the Consumer Price Index or CPI increased by 1.2% in September -- the biggest increase in 25 years.
Frankly, I believe that those numbers -- even as jumbo as they are -- dramatically understate the true rate of inflation.
I say that because the government number stooges somehow figured that shelter -- which accounts for nearly half of the inflation calculation --- showed that the cost of housing dropped by 2.5% in September. If not for that accounting hanky-panky, the inflation numbers would be out of this world.
How do you think the Alan Greenspan and his Federal Reserve buddies will react to this inflammatory inflation numbers?
I can tell you exactly how. Even though the Fed just raised interest rates for the 11th time last month, they have no choice but to keep raising interest rates in November and December. If they don't, they run the very, very real risk of allowing inflation to become deeply entrenched into our economy.
Don't be surprised in the least if the Fed abandons its 25-basis point baby step policy and start to aggressively raise interest rates.
"To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one." Philadelphia Fed Bank President Anthony Santomero.
"The inflation rate is near the upper end of the Fed's tolerance zone, and it shows little inclination to go in the other direction." Dallas Fed Bank President Richard Fisher
In the past, it was common for the Fed to jack interest rates by a half point, a full point, and even as much as two full points at a time!
I n the 1970's, the Fed kept raising interest rates until they topped out at 19.1% in January 1981. In total, the Fed raised short-term interest rates by 10 full percentage points.
Even though the Fed has raised interest rates 11 times, rates have only increased by only 2.75 points.
A lot of Americans will be losers from the surge in inflation and rise in interest rates.
Loser #1: Real estate investors and adjustable mortgage holders. The impact on mortgage rates is clear -- they are going higher. Last week, Freddie Mac reported that the rate on 30-year, fixed-rate home mortgages just topped that very important 6% barrier to 6.03%.
Worse yet, they are going even higher. Freddie Mac's chief economist, Frank Northaft, thinks mortgage rates are headed even higher.
"The specter of rising energy costs, will translate into higher long-term mortgage rates in the coming months...reach 6.4% by 2006."
Rising rates are bad news for the real estate market and potentially devastating news to the homebuyers that have opted for adjustable rate mortgages. Many of those homeowners are going to see dramatic increases in their mortgage payments.
Loser #2: Bondholders will become bag holders. Never a lender be will take on new meaning when bond and bond fund investors see the value of their investment shrink.
The yield on the 30-year Treasury bond has increased from 4.26% on August 31 to 4.71% today. That rise has already clobbered bond funds...but it will get even worse.
Loss since August 31
Rydex Government Bond
American Century 2025
Vanguard Long Term U.S.
T.Rowe Price Treasury Long
Loser #3: Corporate America and stock market investors. People forget how basic of a building block petroleum is in our modern world.
"The shortfall is largely attributable to the high cost of energy...these costs, which are approximately $10 million higher than third quarter 2004, are impacting almost every aspect of the company's operation from natural gas used at its manufacturing facilities to in-bound and out-bound transportation surcharges." Potlach
"This quarter, we are squeezed between a weaker upstream pricing environment and significantly higher energy and input costs. We continue to face challenges from escalating costs in energy and raw materials." Alcoa
"CONMED continues to experience significant rising raw material pricing on petroleum based plastics and increased distribution costs. This has caused the profit margin to decline on many of our products." CONMED
"The price of copper, one of our principal raw materials, has reached new heights during the current quarter and has put pressure on our operating margins." Belden CDT
The plastics machinery and processing industries, as well as most industrial manufacturers, are feeling the negative impact of higher energy and material prices." Milacron
"The entire soft-drink industry is dealing with the impact of rising PET costs." Cott
"Operational inefficiencies, rising fuel costs and pricing pressures are continuing to negatively impact gross margins." Diebold.
"Higher gasoline prices, which may now be impacting consumer habits." Jack In The Box.
Long-time readers may roll their eyes because they've heard my warnings many times, but the best time to buy insurance is before you need it. For most investors, the best insurance policy is a mountain of cold, hard cash.