DEFLATION & INFLATION COEXISTING SIMULTANEOUSLY
Jim Puplava's brilliant perfect storm scenario unfolds
Wednesday September 11, 2002 Market WrapUp (Puplava)
Inflation + Deflation = The Perfect Financial Storm
Among the topics discussed in the financial markets these days, deflation is at the top of the list. With the exception of real estate, asset prices are deflating. In manufacturing it is not hard to find goods that are priced to sell. It is taking everything from rebates, zero-percent loans and numerous other sales incentives to get merchandise out the door. Companies don’t have any pricing power due to a buyers market in everything but real estate. On the surface it looks like the arguments for deflation are holding true. However, deflation is only half the story, and contrary to the deflationists, we are also seeing the simultaneous occurrence of inflation. It has long been my contention that we will see both. Just as in the Perfect Storm in 1991 where a cold front collided with a heat-induced hurricane to join forces and become the Perfect Storm, that is what we are now seeing unfold in the financial markets.
We now have asset depreciation, collapsing corporate debt and falling prices for most manufactured goods (deflation). However, we also have rising prices in commodities. Looking at today’s commodity charts, I see rising prices in energy, cocoa, cotton, corn, soybeans, wheat, cattle, coffee and sugar. Since hitting its nadir at 183.52 last October the CRB Index (Commodity Research Bureau Futures Index which measures 17 commodities), has begun a relentless climb, taking it back to levels not seen since January 2001. Rising raw material prices is one more factor that is hurting company profits. Their costs are rising; while the prices of goods they sell are falling.
Unlike manufacturing where there is a surfeit of goods and capacity, commodities have been in a multi-decade bear market. As a result of falling prices over the last two decades, fields have gone fallow, mines have shut down, access to energy has been denied, forests and land are put off limits, and the companies and individuals that produced them have gone out of business. The commodities industry has contracted, leaving only the big and strong as the survivors. Meanwhile, population growth continues around the globe, especially in China, India, and Latin America. Each day new consumers of commodities are born around the world and there is no sign outside of a nuclear holocaust that population growth will contract or remain neutral.
Bank Credit Inflation & Unchecked Spending
Furthermore, there remains the issue of bank credit inflation. At the moment there appears no sign of the credit bubble deflating. Asset values are destroyed with each new bond or loan default, but there is plenty of new money to take its place. The U.S. is still creating credit and borrowing money at an annual rate of $2 trillion a year. The era of limited government is also over with government intervention in every aspect of our economy now a reality. It doesn’t matter whether it is fiscal or monetary policy, regulation or intervention; we are seeing healthy signs of each occur in every aspect of our economy. Fiscal policy is running at full throttle with the U.S. heading back to $200 billion in annual deficits. That figure may be conservative given the ambitious plans of Congress and the Bush Administration to spend money on war and social policy. The government keeps spending money on everything from welfare to warfare, with ample evidence this is just a down payment with even larger spending programs on the way. Monetary policy is also running at full steam with the help of the Fed and financial intermediaries, lending money and securitizing credit faster than a baby can go through diapers. Congress is busy hatching new regulatory schemes and wealth transfer programs; while individual states are raising taxes, which raises the cost of everything you buy. Businesses merely transfer the cost of the tax to the consumer.
With regard to intervention, it is everywhere. It is visible in the financial markets when stocks plunge and then rise like a Phoenix from the ashes with little or no explanation. It is visible in the precious metals market where there is a battle going on between self-interested bankers and a growing worldwide demand for bullion. Intervention is visible in the currency markets where various governments intervene to prop up the price of one currency over another. Invention is visible in various industries where price supports have been put in place through tariffs or through enormous subsidies. Everywhere you look, you will see the hand of government and this is just the beginning. More intervention is on the way as the economy and markets weaken. A Fed's Beige Book report out today showed the economy continues to weaken with sluggish manufacturing (excess capacity-deflation) and with few signs of a pickup in employment. It appears from the looks of things that more layoffs will be coming during the next quarter as companies fight to keep costs under control and conserve cash.
Forget all of the talk about deflation as the only outcome for the economy and financial markets. With the government going into hyperactive mode, an upcoming war, and growing populations and demand for raw materials, you will also see inflation. It is important to understand that inflation is pure monetary phenomenon. It is reflected in depreciating currency values. The dollar has fallen steadily since Spring and will continue to do so as foreign money exits U.S. financial markets. There is another phenomenon that is worth observing which is the simultaneous rise of gold against all major currencies around the globe. This is due to currency depreciation as well as fear.
Today's Markets
We started the day with a momentary relief rally that later faltered. Momentum is gathering for a strike against Iraq that is sure to inflame the Arab world that still denies that Arabs committed the crimes of September 11th. War creates another major uncertainty that the markets abhor. War is never predictable - especially a war fought against terrorism. There will be other battles during this war with many of the skirmishes fought on U.S. soil. This won’t be a war that is viewed from a distance and fought on foreign ground. September 11th has changed that perception. The U.S. will become the number one target for any retaliatory response to an invasion of Iraq. The upcoming war, and all of the uncertainties it entails, is keeping the markets focused on geopolitical events. It’s reflected in investor anxiety, the price of gold, and the price of oil which remains above $30 a barrel.
These anxieties are reflected in gyrating stock prices. Today was another example. The Dow gave up a 1.4% gain to end the session on a losing streak. It was no different for the S&P 500 and the NASDAQ with both indexes giving back earlier gains to end up in the minus column. Overall, it was an emotional day with stock prices heading up in relief, and then heading down as the reality of a weakening economy and lower profits set in on investors. Financial stocks led today’s decline as some investors sense they are vulnerable to economic weakness as delinquencies and bankruptcies rise. This situation could get worse as employment conditions weaken in the months ahead. The Fed has given notice that there are more signs of economic weakness. The markets will be alert as to what the Fed intends to do when Mr. Greenspan addresses the House Budget Committee. Hopefully, we will get something of significance other than the utter nonsense that came out of Jackson Hole last month.
Tomorrow should be another volatile day for the markets as Bush and Greenspan both deliver speeches -- one on the economy and the other on war. The President is expected to make his case for war when he speaks at the UN. Mr. Greenspan, on the other hand, will have to explain bubbles and troubles in the economy and financial markets. His speech should be confusing and opaque as usual, which will leave room for multiple interpretations depending on ones disposition. It will be another day of confusion that should be reflected in gyrating stock prices outside another day of intervention.
Outside memorial services celebrated across the country, it was otherwise known as a slow news day. Volume levels were low as expected with the markets opening up late due to media coverage of events in New York and Pennsylvania.
Overseas Markets
European stocks rose as some investors, relieved that the anniversary of the Sept. 11 terrorist attacks was passing without more strikes, focused on the prospects for profit growth at companies such as Nokia Oyj and Bouygues SA. The Dow Jones Stoxx 50 Index added 2.1% to 2722.45 points. It has gained 4.8% since Monday's close, the biggest two-day rise in a month. All eight major European markets were up during today’s trading.
Japanese stocks rose for a third day, led by exporters such as Sony Corp., after a plunge in the yen against the dollar in New York trading, prompting some investors to raise expectations for companies' overseas sales. The Nikkei 225 Stock Average climbed 1% to 9400.08, completing a 3% rise in three days.
Treasury Markets
In the bond market, treasury prices contracted in early action, sending key yields back above 4%, as stocks were expected to gain during an emotional day for financial markets and the country. The benchmark 10-year Treasury note declined 18/32 to yield 4.06%, and the 30-year bond shed 25/32 to yield 4.89%.
© Copyright Jim Puplava, September 10, 2002 |
