Benson's Economic
& Market Trends
 The Fed's Inflationary Cocktail
Richard Benson
May 7, 2004
Every measure
of economic growth and inflation shows the economy to be robust,
yet the Fed Funds rate remains an extraordinarily low 1%. The
Federal Reserve has been hoping that by keeping interest rates
artificially low for the past year, businesses would hire and
the economy would generate some "good inflation." And,
by getting the economy moving and creating improved corporate
profits and higher personal incomes, the economic recovery would
become self-sustaining so that our country's massive $34 Trillion
capital market debt burden could be serviced at a higher interest
rate. We wish the Fed good luck; they'll need it!
Debt service is in balance only because interest rates are artificially
pushed below the level of inflation. If only the Fed could "freeze
this point in time" until the election. This would please
the Bush Administration for sure!
Unfortunately, though, the Fed has already served up an extraordinary
inflationary cocktail guaranteed to inflict a horrible hangover!
Just take a moment to examine the latest inflation numbers for
commodities - many are up 50 to 100 percent! The reason that
world commodity prices are shooting up is because of the United
States' budget and trade deficits and the record growth of mortgage
credit, which has been supported by the unprecedented growth
of new money created by the central banks in Japan and China.
This Asian money growth and demand for commodities, is causing
inflationary "blow back" right back into the U.S. financial
markets.
Worse yet, the "managed CPI," in the first three months
of 2004, is rising at an annual rate of 5 percent, while the
price deflator for the GDP in the first quarter of 2004 was up
3.2%! (Both of these numbers are constructed to understate inflation).
In addition, the April ISM survey showed a pricing index of 88,
the highest level since 1979 when inflation was double-digit.
The supply executives in the ISM survey showed 77% reporting
higher prices and only 1% reporting lower prices.
At the May 3rd FOMC meeting, we again hear soothing statements
from Chairman Greenspan about "how inflation is not a worry,"
and how the Fed's response can be "measured" when it
comes to raising rates. Instead of looking at recent data that
clearly shows what is actually going on, Alan Greenspan is focusing
on a 12-month average for inflation that is slow to pick up on
the upward trend in inflation. Moreover, the Fed is sticking
to the logic of "underutilized resources" and "low
capacity utilization" to argue that inflation cannot possibly
happen with all this "slack in the economy." (This
is similar to a weather forecaster talking about a sunny forecast,
when he could look out the window and see the rain actually falling
on the ground!) Meanwhile, the Fed makes absolutely no mention
of money growth, which is pushing 10 percent.
Is there inflation now? Maybe you should ask the Fed Governors
when they leave their "statistically pure ivory towers"
to buy gas, milk, ice cream, beef or insurance; pay for college
tuition; take a taxi; go see a movie; or, simply engage in any
of the normal daily activities we all engage in to survive. If
they actually took a look at inflation, Congress would be bombarded
with requests for salary increases of at least 20%! How much
longer will the world financial markets believe this myth that
there is no inflation in our country? How much longer can this
inflation fairy tale of a Goldilocks economy continue?
By denying there is inflation and keeping short-term interest
rates suppressed and near 1% until after the election, a 4 to
5 percent annual rate of inflation "built into expectations"
is sure to occur. This Fed policy will only make inflation worse
and the economic bust in stocks, bonds, mortgages and housing
will stand out dramatically in the record books.
Moreover, as the bond market and "carry trade" start
to sense that holding short-term interest rates so far below
the level of inflation could be disastrous - they won't know
whether to laugh or cry - they will most likely try to liquidate
their mortgage and bond holdings. Only a few hedge funds and
investment banks will be lucky to get out in time.
Simple arithmetic shows that worldwide central bank holdings
of financial assets, particularly dollar assets, are growing
at around $700 billion a year. The major reason for this need
is the fact that the United States has no savings and is running
Treasury deficits of over $550 billion. Today, money growth is
rapid and hidden from view only because it is done by Foreign
central banks in their domestic currency.
At present, the world financial markets have not taken into account
the magnitude of inflation in our country. The big question for
this summer and fall is "what happens when financial markets
around the world add the specter of United States inflation running
at 3 to 4 percent above short-term interest rates? What happens
to inflationary expectations when the Fed starts buying massive
amounts of Treasury and Agency bonds to help prevent the collapse
of the carry trade and bail out banks, brokerage firms and hedge
funds? The Fed will always sacrifice a saver to save a hedge
fund.
"Real Interest Rates" (defined as the difference between
actual inflation and the nominal Fed Funds rate) are dropping
like a stone and are headed for a minus 3 percent! They are designed
to shift the burden of taxation away from debtors and on to savers
and anyone else not savvy enough to know that holding financial
assets, denominated in dollars, is a mistake. Even if the Fed
raises the Fed Funds rate to 1.5 percent before the election,
the real rate of interest will drop this year compared to 2003.
With a negative rate of interest, it will still pay for speculators
to borrow and run from the dollar!
Inflation, without sufficient Fed tightening, will set the stage
for a horrible "dollar crash." For instance, when Latin,
Asian, African and Middle Eastern countries run monetary and
fiscal policies like those that the United States Treasury and
Federal Reserve are running, investors will "dump that country's
currency" fast before any currency controls are put in place!
In addition, speculators will borrow as much of the inflating
currency as they can and then dump even more before it really
"goes down the drain."
The present trend towards a stronger dollar - because the markets
fear a Fed firming - is nothing more than a big "short covering
rally." When this dollar rally is over, it will be time
for a "dollar rout" as the crowd switches back in the
other direction and the "one way bet against the dollar"
is back with a vengeance!
The United States has earned the right to have the dollar as
the World's reserve currency. In the past, America has benefited
from our country's stable fiscal and monetary policies and leadership
in foreign affairs. However, if America starts running 5% inflation
and only raises interest rates to 1.5% by the November election,
and continues to insist on running expensive foreign wars of
"choice" while making enemies of foreign "friends,"
what is going to happen to our foreign friends who are holding
40% of all United States government debt? When private and foreign
central bank investors discover they are being asked to accept
interest rates that guarantee that if they hold dollar assets
their value will be taxed away by inflation, will they feel conned?
It's likely that corporations and most individuals and money
managers, wise enough to do so, will "dump the dollar."
(Indeed, Warren Buffet has announced at his firm's annual meeting
that he has moved even more of Berkshire Hathaway's $32 billion
of cash out of the dollar.) To take up the slack in dollar buying,
foreign central banks will be asked to come to the rescue and
buy "even more bad dollars" to prevent their currencies
from rising too much. Will all central banks sign up to lose
their citizens' wealth?
European central banks are already gearing up to sell more gold,
which can only mean they take the inflation threat seriously.
(Selling gold to make the "dollar look strong" is what
the United States Treasury did during the credit inflation of
the Clinton Administration). The Asian central banks may say
"enough is enough" and start to diversify their foreign
exchange holdings. Indeed, the diversification of foreign exchange
holdings is now China's stated policy. This is not good for the
dollar, particularly as China's sentiment spills over to the
rest of Asia. The Middle East setting the "shadow price
of oil in Euros" or wanting to hold non-dollar assets for
safety is also not good for the dollar. Who's left to fund our
deficits? Look's like we're stuck with our own Federal Reserve
and their printing press!
While the Fed can hold back a rise in long-term interest rates
temporarily by running the printing press to buy long- term bonds,
the longer the Fed waits to raise interest rates, the higher
inflation will become. By this summer, Alan Greenspan's credibility
could be inflating away.
Inflation is nothing more than a tax on all financial assets,
namely cash, notes, stocks and bonds. If you hold a financial
asset, you get to pay the inflation tax. Smart investors will
be selling their financial assets and investing in "real"
things, such as commodities (including gold and silver). A flight
from the dollar is virtually guaranteed. Later this year, the
dollar is likely to be a sell and gold a buy. While a falling
dollar has been kind to gold, "rising inflation is what
makes gold really glitter."
The Fed should be careful about what it wishes for..by trying
to keep the party going by stimulating inflation and keeping
interest rates too low for too long to get nominal GDP up - in
order to service the debt burden - the Fed may get a crashing
dollar, soaring inflation and a gold price that central bank
gold selling can't tarnish! Get ready to say hello to more money
growth and inflation for a very long time.
Richard Benson
President
Specialty
Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: rbenson@sfgroup.org
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321gold Inc
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