Inflate OR Die? Or Inflate AND Die?
Jay TaylorRichard Russell likes to say that policy makers are faced with a choice to either inflate the currency or watch the economy die a horrible deflationary death. I have often suggested that no matter how much inflating the Fed does, there really is no choice. The economy will eventually die BECAUSE the money supply is being inflated. I say that with certainty, because one of two kinds of "deaths" will occur. It will be either "death" via hyperinflation or "death" by a deflationary implosion.
I admit to having sat on the fence between these two scenarios unlike most of my friends in the hard money camp who are either on one side of the fence or the other. Shedlock and Gordon, for example, are on the deflationary side. James Turk, John Williams, and most other gold bugs are on the inflation side.
Of course my lack of ability to have a firm view on which way our pathological monetary system tips was the reason I set up my IDW back in January 2005. And for now, at least, it has turned mildly inflationary. (See discussion below.) Actually we believe this move higher is a natural bounce that coincides with Dr. Robert McHugh's (B) wave higher before the dreaded (C) wave down-starting a "cataclysmic nation changing event to correct the bull market that started in 1718."
The chart on your left shows a plunging M-3 as calculated by inflationist John Williams, for whom I have a huge amount of respect. Note how M-3 is plunging, despite a hockey stick-like surge in money pumped into the system by the Federal Reserve Bank. The St. Louis Fed monetary base, which is a part of our Global U.S. Dollar Liquidity measure (GUSDL), is surging at nearly 40%. Our GUSDL, which adds U.S. dollars lodged with foreign central banks, is growing at slightly over 40%. The point is that as money is being pumped into the banking system in an effort to inflate, it simply isn't working, at least not so far.
The problem is, unless there is a massive transfer of money to the masses directly from the federal government, pumping money into the system only fuels the kind of speculative boom we have been seeing in stocks, bonds, and commodities of late. Banks are not lending to any great extent, because they are having a hard time finding creditworthy borrowers or they are afraid those who may appear creditworthy now may not be so in the near future as the economy continues to worsen.
This was the same kind of problem policymakers had in the 1930s. "You can lead a horse to water but you can't make him drink." It's like "pushing on a string," to use another analogy of the 1930s. And the big question in my mind is this. On what basis are the talking heads on CNBC painting an optimistic picture at this point in time?
We have the worst consumer credit situation in our history. Credit card lines are being taken away because consumers are unable to pay. I heard a story from a fund manager last week about young professional people who had been using their credit cards to pay their property taxes. Now many of them are finding that their credit lines are not being renewed when their cards expire. Thus, they are now defaulting on their property taxes and will soon lose their homes.
Yes, I know this is only anecdotal evidence, but with the vast majority of Americans having no savings and living hand to mouth, and with 600,000+ job losses every month when 100,000+ new jobs are required just to stand even in terms of economic growth, why should we think there won't be massive new defaults yet to come?
But here is the real kicker. Corporate profits have fallen over into the abyss of a great Grand Canyon. Check out the following two charts, which really illustrate the horrible mess we are in. Note that the inflation-adjusted earnings of the S&P 500 are down more than 90% and more than during the Great Depression. Yet at this point in time, only about a third of the bad loans have been written off. As more bad loans are written off, profits are likely to plunge still further and, perhaps even on a massive national scale, display huge losses in the aggregate.
The chart above on your left shows the current S&P 500 PE ratio at record highs. How in God's name do Wall Street analysts in good faith tout stocks, given these pictures? Guess they will do what they have to do to keep their jobs, eh?
How about China? Won't demand from China pull the world out of this recession/depression? I have my doubts, in part because China remains very much a command economy. In Friday's Wall Street Journal, a story appeared about how Chinese banks are now starting to realize significant losses on loans they were forced to make by their government. Sounds like Barney Frank suggesting we make laws to force U.S. banks to lend to unprofitable consumers and companies, doesn't it?
Also another growing concern and sign of deflation is the massive money creation by all central banks in an effort to cheapen their currencies so as to gain some competitive trade advantage. Also there is a rising tide of trade barriers being passed around the globe, just as happened during the 1930s.
The carnage is simply awful, which is why from a fundamental point of view, despite our IDW's bounce, we have no trouble believing Dr. McHugh's (C) wave scenario. Above all other financial concerns, we want to be ready for that event when/if it comes. That is one reason I pour over Dr. McHugh's work every day.
June 5, 2009
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
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