Tag Archives: Inflation

The popping of the Chinese bubble?

With all the talk of inflation, China is experiencing a deflation problem. Marketwatch reports:

China is urging major supermarkets to boost vegetable sales and encouraging farmers to bypass middlemen and market produce directly, in a bid to curb a steep slide in prices that is hurting farmers’ incomes, the Ministry of Commerce said in a statement.

Twelve major supermarkets, including Wumart Stores Inc., have agreed to boost sales, the ministry said. The China Daily newspaper said Thursday Wal-Mart Stores Inc. and Carrefour SA are also involved in the effort.

The ministry has also set up a “work group” to maintain prices at a “reasonable” level.

Its statement Wednesday underscores the difficulties the government faces in controlling volatile prices. The impact of an official push last year to raise vegetable output appears to be unraveling now, amid overproduction and clogged distribution lines.

Vegetable prices have fallen 21% in a month and 5.9% from a week ago, the ministry said.

The sharpest declines were seen in green pepper, which fell 20.9% from a week ago, and cabbage, chili pepper and lettuce, which fell 12%, 8.9% and 8.1% respectively.

In contrast, grain, pork, beef, metals and rubber all continued to post small increases of between 0.2% and 1.7% from a week ago.

Last year, the Ministry of Agriculture pushed farmers to raise vegetable acreage by 7% and production by 7.5%, following almost three years of little to no growth in the sector.

The directive was part of wider efforts, including price caps on cooking oil and flour, to curb a surge in food prices.

Worldwide commodity inflation has been driven, in part, by demand from China. Are these price corrections the first sign that the Chinese bubble has popped and that inflation will turn to deflation as Chinese demand evaporates?

Boston Fed President invents new 1984-style system of economics.

Fed’s Rosengren: Higher gas prices may hurt growth:

Rising energy prices are a concern not that they will lead to higher inflation but that they will subtract from household income and thus weaken the economy, said Eric Rosengren, the president of the Boston Federal Reserve Bank on Friday. Rosengren said the lasting effect on energy prices on overall inflation “has been surprisingly small in recent years.” The surge in oil prices in mid-2008 were followed by significant declines in core inflation, he noted. Rosengren said the Fed’s innovative monetary policy has not been inflationary. “It has been more than two years since the Fed’s balance sheet expanded dramatically. Sine that time core inflation has fallen to something like 50 year lows, he said. Rosengren is not a voting FOMC member this year. He spoke to an event hosted by the Connecticut Mortgage Bankers Association.

Maybe Mr. Rosengren can explain to me how rising oil prices leads to falling household income? Spending money on oil is spending, obviously, not a change in income. I assume he meant that the rising prices eats up a larger portion of household income; in other words, non-discretionary spending rises. But there’s a term for this phenomenon of rising prices: INFLATION.

Trying to give the Fed President the benefit of the doubt, I thought maybe the article was misconstruing what he said. So I searched Google and found his actual words:

My primary concern about rising energy prices is not so much that they will lead to higher inflation, but that they will subtract from household income and thus weaken the economy.

Apparently, we live in a new economic reality. In the new economics, rising prices weaken the economy (by somehow hurting “household income” but I assume he meant income available for discretionary spending) but does not lead to inflation. Get that? I admit, this new economics is confusing so here it is in simple English: rising prices cause deflation or, at the least, disinflation.

We really are living in George Orwell’s 1984. “WAR IS PEACE, FREEDOM IS SLAVERY, and IGNORANCE IS STRENGTH.” And now, INFLATION IS DEFLATION.

Deflation bad for government, not so much for you and me.

According to Marketwatch, Federal Reserve Chairman Ben Bernanke warned against deflation:

He also said the risk of deflation, a steady decline in prices and wages, remained a threat.

He stressed to the Senate panel that deflation would increase debt burdens and lower living standards.

If prices and wages declined at the same rate, how would that hurt us? We’d make less, but our expenses would go down. Yes, it would hurt somebody in debt, but it would help the person holding that debt, i.e. savers.

Now, who would get hurt the most? Who owes the most money of anybody? THE UNITED STATES GOVERNMENT.

What the Federal Reserve fears is the real value of the government’s debt increasing, making it harder to pay back. Furthermore, in a deflationary environment, the Fed would lose its ability to keep rates low and inflate the money supply. How so? Currently, if inflation is about zero, the Fed can keep interest rates near zero as well. But if we have deflation of two percent, the Fed can’t really lower rates below zero, so the inflation adjusted interest rates would be two percent. In effect, the government will be paying a two percent interest rate, increasing its deficit and expanding the debt, and the Fed will lose control of interest rate policy.

Currency devaluation’s effect on the markets and the importance of diversification

With commodities rallying across the board this year (most are up between 20% and 100%), copper is at an all-time high, palladium at a 10-year high, oil near its two-year highs, and the Treasuries falling, traders are obviously look for real assets.

The realest assets are commodities, but behind those are shares in companies that produce real goods and earn real profits. We tend to look at those profits in Dollar terms, but they really aren’t. A company making a 10% margin is making a 10% margin in the goods it sells, not in Dollars. In other words, a company could sell 90% of its goods to breakeven and hold the other 10% of the goods produced as profit instead of converting it into Dollars. Or that extra 10% could be converted into gold, silver, or whatever it wants, as long as it has a place to store the profits. Therefore, as long as a company continues to sell, the devaluation of currencies should affect it less than non-performing assets, such as Treasuries which will get hit by rising interest rates and inflation.

Actually, stocks tend to do well during periods of inflation, as long as the economy does well too. If a company’s costs rise, it simply passes along all or most of that to its customers. So if costs rise 10%, a company raises its selling price by the same amount to maintain its margin. As long as all countries experience the same inflation, there will little effect on the company. If we are seeing a worldwide currency devaluation, as I believe, stocks should rise as long as the economy holds up. Of course, commodities will likely do best, but stocks won’t be far behind. They’ll continue to earn a real rate of return of 4% to 7% or so. Bonds though will get double hit by rising interest rates and devaluation. Buying a bond yielding 4% today will yield a negative return if inflation exceeds that amount. And rising interest rates will reduce the Present Value of the bond too.

I would add a major caveat to all this: there is a chance of a major economic decline. With government’s deep in debt and many cutting back, the economy could suffer. Whether we see sub-par growth for the next generation or a double-dip recession remains to be seen. But if this economic decline occurs, stocks will get hit, of course. Commodities will also fall. Industrial commodities, such as copper and oil, may do even worse than stocks while precious metals will hold up better, but they too are likely to decline as they did during the 2008 market crash.

I’m not an economic adviser, but I always recommend diversification. Unless you have a lot of time to spend analyzing the market and become very good at it, chances are you won’t be able to “beat the market.” In fact, even the experts have a hard doing so and, statistically speaking, it has not been proven that anybody can beat the market (those that appear to do so may just be black swans). So own some stocks, some bonds, some commodities, and hold some cash. How much in each depends on your age and risk tolerance. You will not make a killing by diversifying, but in this political and economic environment, protecting your money is paramount. And with the future so uncertain, diversification is the only way to be sure your wealth won’t disappear in a market crash or rally, if governments go bankrupt or become solvent, or if the economy strengthens or weakens. No single investment will perform well in all the possible situations. Remember gold’s decline in 2008 or the larger decline from 1981 to 1998. Cash could be eaten up by inflation. Treasuries by rising interest rates. Stocks by an economic decline. But it is very unlikely that all four will decline together.

For example, learn more about Harry Browne’s Permanent Portfolio. I don’t necessarily recommend his portfolio as is. Much depends on your age and risk tolerance and ability to purchase these funds/instruments. But it certainly gives you a clearer picture of the importance of diversification.

Federal Reserve says: Damn the torpedoes, full speed ahead!

Fed vice chairman Janet Yellen acknowledges that the Fed’s low interest rate policy is creating a moral hazard and may cause companies to take too much risk but that the Fed will pursue this policy any way. AP reports:

Record-low interest rates may give companies an incentive to take excessive risks that could be bad for the economy, the Federal Reserve’s new vice chairwoman warned on Monday.

Janet Yellen has supported the Fed’s policy of ultra-low interest rates to bolster the economy and to help drive down unemployment. Her remarks, which don’t change that stance, may be aimed at tempering critics. They worry she’ll want to hold rates at record low levels for too long, which could inflate new bubbles in the prices of commodities, bonds or other assets.

Yellen, who was sworn in as the Fed’s second-highest official last week, made clear she is aware of the risks.

“It is conceivable that accomodative monetary policy could provide tinder for a buildup of leverage and excessive risk-taking,” Yellen said in remarks to economists meeting in Denver. It marked her first speech since becoming vice chairwoman.

Yellen has a long history with the Fed. Before taking her current job, she served as president of the Federal Reserve Bank of San Francisco since 2004. She also was a member of the Fed’s Board of Governors from 1994 to 1997, when Alan Greenspan was chairman.

As vice chairwoman, Yellen will help build support for policies staked out by Ben Bernanke, the current chairman.

The Fed at its November meeting is expected to take new steps to energize the economy. It’s likely to announce a new program to buy government bonds. Doing so would lower rates on mortgages, corporate loans and other debt. The Fed hopes that would get people and companies to buy more, which would strengthen the economy.

The new effort is expected to be smaller than the $1.7 trillion launched during the recession. Under that program, the Fed bought mostly mortgage securities and debt, although it did buy some government bonds, too.

The Fed has held its key interest rate at a record low near zero since December 2008. Because it can’t lower that rate any more, it has turned to other unconventional ways to pump up the economy.

By now, we all know that low interest rates created the housing bubble. And before that, the tech bubble. Almost all bubbles are created by the Fed lowering interest below the market rate and encouraging companies and individuals to take on excess risk. They are at it again.

So where is/will be the next bubble? Treasuries? Gold and silver? Equities? All of the above?

Second Fed official opposes Quantitative Easing.

In a follow-up to my previous blog post Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work, another Fed official announced his opposition to the planned trillion Dollar quantitative easing:

Dallas Fed President Richard Fisher, who will get a vote on the policy setting Federal Open Market Committee next year, on Friday made his case against a new round of bond purchases, saying it is not clear the benefits of further quantitative easing outweigh the costs. Fisher, according to a copy of prepared remarks he’s due to deliver in Vancouver, made the case that removing or reducing the tax and regulatory uncertainties is the best way to promote business spending and have firms “release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity, rendering moot the argument for QE2,” he said. “I consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet.”


Doesn’t this seem to the motto of our current government? Purchase mortgages, expand the Fed’s balance sheet, and print more money even if there is no evidence that this helps the economy. Enact a trillion Dollar stimulus bill, pass a TARP bill, extend unemployment benefits to two-years and drop the requirement to look for work, and raise taxes on the rich even though logic and history prove that this things also do nothing for the economy.

Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work.

The Fed is currently planning a one trillion dollar quantitative easing program. As Jonathon Trugman of the NY Post reports:

The Fed will likely undertake a very large quantitative easing program sooner rather than later, if the economic data doesn’t get markedly better in the very near future.

This QE2 will need to be far more aggressive than most expect, for there is not going to be a QE3. It is essentially the last chance the Fed has. It will want to eradicate any doubt about its ability to work; it is, in essence, the nuclear option.

The measure could be as much as $750 billion to $1.5 trillion. And expect far more aggressive purchases than in QE1.

Mortgage-backed securities, the root cause of the economic collapse, will be the cornerstone of the purchases, thereby allowing a possible 10 percent to 15 percent increase in home prices, which would do wonders for the flat-lined economy.

Credit card-backed paper will be on the tab as well as some auto loans to keep the administration happy.

Sadly, with credit still unavailable to the “middle class” due primarily to poor fiscal policy and economic leadership, the Fed will have to dramatically increase the money supply in order to spur spending. It will work, but it’s going to be complicated.

So Mr. Trugman believes this quantitative easing will work, but that it has to be huge to spur spending. He fails to ask the simple question: will such an aggressive program be worth the benefit?

But others are arguing that the quantitative easing will have no effect at all. Marketwatch reports:

A new round of Federal Reserve purchases of bonds would have little impact on markets or the economy, Minneapolis Fed President Narayana Kocherlakota said in a speech on Wednesday.

Speaking in London, Kocherlakota on Wednesday outlined several reasons why buying government bonds wouldn’t make a major impact. For one, banks already have nearly $1 trillion in excess reserves. “QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones,” he said, according to a copy of the text he was due to deliver.

As to the first round of quantitative easing by the Fed, Kocherlakota cited an academic study showing that the $1.5 trillion purchase of agency debt, agency mortgage-backed securities and Treasuries by the Fed between Jan. 2009 and March 2010 reduced the term premium on 10-year Treasurys relative to 2-year Treasurys by about 40 to 80 basis points, which in turn led to a slightly smaller fall in the term premia of corporate bonds.

Kocherlakota estimates a new round of QE would have a more muted effect, because financial markets are functioning much better than they were in early 2009. “As a result, the relevant spreads are lower, and I suspect that it will be somewhat more challenging for the Fed to impact them,” he said.

So Trugman says this aggressive quantitative easing will work, but Kocherlakota says it won’t. In reality, who knows? The real problem is that there is so little discussion of the risks and costs involed. Marketwatch explains the risk in one sentence:

Kocherlakota also said that the impact of quantitative easing is to shift the interest rate risk on bonds from investors to taxpayers.

So the real impact of this quantitative easing will be to socialize risk. The Fed risks creating further moral hazard. The Fed risks producing interest rates that are too low, which will create more bubbles. The Fed is going to create distortions in the market system. But despite these risks, there is no guarantee of success.

I applaud Minneapolis Fed President Narayana Kocherlakota’s efforts to restore reason and common sense to our ineffective and inefficient monetary policy.