Taking Gold In The Inflation Olympics
"If you measure 'inflation' by looking at real money - gold - the current inflation rate is considerably higher. A year ago, an ounce of gold was still under $700. Today, it's $920 - a jump of nearly 20%."
We still don't know which way this thing is going - the battle between greed and fear, that is. Stocks held steady yesterday. Oil too. The commodity index remains almost right on the 500 mark. Gold is sticking about $920.
And yesterday, the Fed lowered its key lending rate another 50 basis points to 3%. At that level, it is substantially below the nation's inflation rate.
The official inflation rate was last clocked at a little over 4%. Then, the government helpfully takes out the things that matter most - food and fuel - and comes up with a "core" rate of inflation, which is much lower.
How much are consumer prices actually rising? Nobody really knows. Occasionally an economist or a newspaper will go out and buy things and then figure out how much they've gone up in price. Usually, they come up with "inflation" numbers closer to 10%. Naturally, results vary, depending on where you are and what you are buying.
If you measure "inflation" by looking at real money - gold - the current inflation rate is considerably higher. A year ago, an ounce of gold was still under $700. Today, it's $920 - a jump of nearly 20%.
However you measure inflation, the opportunity to borrow at 3% has got to be a plus for people who want to borrow. In effect, the money is free.
But wait a minute; Mr. Market doesn't usually give money away. What's the catch?
The catch is that speculators have to do something with the money. And while consumer prices are rising, asset prices are falling. So, if you take the money you have to find a place to invest it where your money will grow by at least 3%.
Stocks? Maybe not. Bonds - yields are so low…not much margin for error. Real property? Forget it. Borrowing capital in a declining economy rarely makes sense.
But for international speculators, abnormally low lending rates can be a gold mine. When Japan's economy went into a slump, the government responded with low rates and high government spending - just as the U.S. government is responding now. This created an opportunity in the "carry trade," where speculators were able to borrow yen (JPY) at low interest rates and then trade the money for dollars to reinvest in U.S. stocks. American stocks rose 13 times from '82 to '07, while the yen mostly went down. In other words, the Japanese policies didn't help warm up their own economy much…but they lit a fire under asset prices in much of the rest of the world.
That trade doesn't work anymore, because the yen is rising and U.S. stocks are falling. But maybe the opposite trade would work - borrow dollars and invest in Japanese shares? The dollar will go down, thanks to the feds' efforts to revive the U.S. economy…and Japanese shares are now nearly as cheap, relatively, as U.S. shares were in the early '80s. We're not proposing it…but stay tuned; maybe it will be our Trade of the Next Decade.
Another possibility, now, for speculators is the obvious one. One of the surest bull markets on the planet is in gold. The metal has been going up from $260 in the first year of George II's reign, to over $900 in his last year. And as the dollar continues its decent toward its true value - and indeed the true value of all paper currencies - our Trade of this Decade is one thing that will always be worth having.
No one knows the future, but it doesn't look like this bull market is going to stop very soon. Speculators can now borrow dollars at rates considerably below consumer price inflation…and then put them into gold, which is rising at 20% per year.
We only bring it up to highlight the tough spot in which our central bankers and politicians find themselves. They can make money cheaper and easier to get. They can pass a "stimulus" program at a cost of $146 billion. But what actually happens to the money? It ends up overseas. The feds can stimulate…but what they are really stimulating is Asian factories…the gold market…and global speculators - not the U.S. economy. Problems in the United States are too deep to be cured by a little more spending money. Besides, as we keep saying, the real problem in America is that people have borrowed and spent too much. Offering them more credit is not a solution; it's a temptation…like wearing a short skirt while counseling a sex addict…or turning your back on a kleptomaniac and then wondering what is missing.
Now, turning to the rebate package just passed by the House of Representatives, we haven't looked at the details…just the amount. At $146 billion it is almost exactly the same amount as Frederic Mishkin figures the U.S. economy lost last year in consumer spending because of the bear market in housing. Fed governor Mishkin says that families cut back spending by seven cents for every dollar their houses go down in price (with a lag, we presume). Last year, that comes out to about $150 billion of reduced spending. Assuming consumers spend their rebate checks, the economy comes out even.
But the drop in consumer spending caused by housing is just a small part of the deflation hitting the U.S. economy. Stocks are down 15% from their peak…and finance and housing industry leaders are reporting huge losses that could reach into the trillions before it is over.
What's more, the collapse in consumers' purchasing power comes not just from a fall in their house prices, but also from the fact that they aren't rising. At the peak of the bubble, homeowners were taking out as much as $250 billion per quarter in refinancing, home-equity lines, and other housing related credit. Now, that source is drying up.
The feds can try to replace that money, but they are not likely to succeed.
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Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.
Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics is available now by clicking here:
Mobs, Messiahs and Markets
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