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Dollar Bear: The Fed Can’t Fight Inflation

Posted June 26, 2008

“In announcing ‘no change’ in rates yesterday, the Fed pretends that its policy is perfectly calibrated to deal with the current economy. In reality however, the Fed is pinned down by a cross fire of inflation and recession.” — John Browne

by John Browne

Baltimore – (TFN): Cheerleaders will face reality, eventually.

When listening to the typical, television-based Wall Street cheerleaders working themselves up into a bull market frenzy, one is tempted to wonder if they ever bothered to compare the movie that’s rolling along in their heads to the one that’s occurring in the outside world. Perhaps for those living in a media bubble, the only reality that matters is the one reflected in the camera lens.

In the past nine months, we’ve seen increasing signs of economic contraction and falling corporate earnings in America. Although the financials, airlines, auto manufacturers, and retailers have grabbed the headlines, few American sectors are immune from the pain. Meanwhile, the cheerleaders and market pundits have advised that recession fears are overblown and that investors should buy ”unnecessarily” beaten down American stocks. Their advice is founded on some shallow mantras.

We’ve all heard the droning:

“If you exclude the sub-prime, or the financials, things look good.”

“If you strip out food and energy, inflation is not a problem.”

“You can never underestimate the resilience of the American consumer.”

“The earnings are way down, but the earnings are above Wall Street estimates!”

The cry that “stocks are cheap” has been repeated almost daily. But surely, the price of any item is only cheap when the outlook is for the price to rise, not just because it has eroded. Investors who heeded such advice to buy the financials have been crucified.

When faced with news of an unassailably bad character, we often see the pundits’ smile as they assure us that the depths confirm that recovery is nigh.

While the Dow Jones Industrials have slid nearly 17% since its October 2007 highs, they have consistently presented us with a series of occasions in which the “market bottom” has been proclaimed. Nevertheless, stocks have continued to slide. Don’t look now, but it appears that Toyota is replacing GM as America’s leading auto seller.

In an effort to reduce the public’s fear of inflation, cheerleaders have cited a reduced money supply. They make no mention of the way banks and derivatives have leveraged the money supply or the fact that the Fed no longer publishes M3 (the most widely recognized measure of money supply). While prices gallop out of control for tangible items in the real world, the cheerleaders point to the narrow yield spread shown by Treasury Inflation Protected Securities over classic U.S. Treasuries (TIPS Spread). They ignore the fact that the TIPS spread is a wholly manipulated creation of the “politically cooked” CPI inflation figures.

While the U.S. government has successfully hidden domestic inflation, the grossly debased U.S. dollar has exported inflation abroad to dollar surplus nations. Today, Europe is experiencing 3.5% inflation, China 6.7%, India 7.5% and Saudi Arabia more than 10%. Yet all of the cheerleaders proclaim that inflation fears are unfounded.

The latest Case-Schiller index shows a fall of 15.3% in U.S. house prices. The magnitude of the drop can be appreciated when it is applied to the $23 trillion total value of U.S. housing stock. Doing so reveals that $3.52 trillion in paper wealth has evaporated. This inconceivably vast figure dwarfs the $175 billion stimulus package in which the government and Wall Street cheerleaders have place so much hope.

In announcing “no change” in rates yesterday, the Fed pretends that its policy is perfectly calibrated to deal with the current economy. In reality however, the Fed is pinned down by a cross fire of inflation and recession. The Fed governors see their best move as keeping their heads down and hoping they emerge unscathed. Perhaps Alan Greenspan’s best move as Fed Chairman was getting out when he did.

The reality is that America is faced by stagflation, economic recession and financial inflation at the same time! Rank and file American investors are beginning to understand this. As a result, U.S. stock markets are looking decidedly nervous. The possibility exists for major falls in the months and years ahead. However, don’t look for anyone on television to tell you this. They’re too busy shaking their pom-poms.

More importantly, don’t wait for reality to set in. Subscribe to our free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp.

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Posted by John Browne · Filed Under US Stocks and Markets 

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