Inflation

They say that numbers don't lie. While this may be partly true, give these same numbers to politicians and crunch them through some econometric models and what pops out the other end could be nothing but a bunch of meaningless nonsense. But, correctly packaged and tastefully delivered, this nonsense could be enough to alter people's thought patterns.

This is a nutshell is what economist John Williams and his organization www.shaodowstats.com is all about.

Take for example the Consumer Price Index. After WW 2, CPI was devised to provide a measure of a fixed basket of goods so that contracts and wage increases with unionized auto workers could be hammered out. But in the late 1980's the Maestro – Alan Greenspan – suggested a "few changes" with the help from folks at the Council of Economic Indicators. He reckoned that if the price of steak went up, people would substitute hamburger instead. Hence by purchasing hamburger, one's cost of living would go down. The notion did not fly at the time, but during the Clinton administration, the idea of geometric weighting was introduced. So, if something went up in value, it was given a lower weighting based on the presumption that people would buy less of it. Thanks to this mathematical chicanery, Social Security payments today are quite a bit less than what they would have been if the constant basket of goods method had been maintained. Read more »

House insurance is something we all have to safeguard against disaster. Now, keep this theme in mind as I attempt to spin a tale of possible horror and mayhem.

Let's suppose there is a house and it sits on a potential earthquake zone. Inside the house lives a normal everyday family. There has never been an earthquake on this ground before, but experts warn that it could happen.

Now, let's suppose you approach an insurance company and you make moves to take out an insurance policy on the house. Remember, you do not live there. You just know it sits on a potential earthquake zone and that there could be an earthquake. If there is and if the house is destroyed, you would be able to collect on the insurance policy. True, it has cost you money to purchase this insurance, but you are quite certain that an earthquake will come and you will get to collect.

Now, let's say you mention what you have done to your buddies on the golf course. Being profit seekers, they too approach the insurance company and they too take out insurance policies on the same house that you did !! The insurance company collects even more fees and is quite happy to do so because there has never been an earthquake on the ground where the house sits and as far as the insurance company experts are concerned there never will be. Let's suppose your buddies tell a few friends about their strategy. These friends make their way to the insurance company and they too take out policies on this house. Cha-ching!! Cha-ching!! The insurance company has made a serious amount of money selling these policies. Read more »

After extending its gains for a 4th week in a row, the Treasury market pulled back as equities recovered from the abyss.

The trend of bonds and energy trading in lock-step remained intact as bonds now sold off as energy prices corrected sharply. There was a recovery in stocks – especially financials during the latter part of the week, so the reverse safe-haven flows pressed bonds lower. The sharp increase in headline inflation also added fuel to the sell-off. Real returns on Treasury bonds are now negative across the entire yield curve, as even 30 year bonds provide a -.35% return after adjusting for inflation. That is great news for spenders and the government (who gets to borrow massive amounts of money at ultra low rates) but not so good for savers.

The drumbeat of anti-inflationary rhetoric continues from various Fed officials. The Fed has never raised rates in a rapidly deteriorating employment environment like the one we are experiencing now. In spite of the fighting words, I don’t think the Fed is about to change tactics on that front, especially heading into a presidential election campaign. The shorter maturities of the yield curve remained well supported. I am standing by my forecast that the Fed is months if not years away from changing the Fed Funds rate and when they do, they will be more likely lowering - not raising rates as the consensus would have you believe at this point. Read more »

Watch interest rates around the world. We have come to the tipping point, the moment of reckoning where the savage beast inflation must be beaten into submission.

A meeting of finance types this past weekend in Kuala Lumpur, Malaysia concluded that the savage forces of inflation could derail the "Cinderalla-like" growth story that has charmed Asia for the past number of years. For example, inflation in Vietnam is running at a torrid 25%. Other Asian nations have now lifted subsidies on petrol, sending prices (and de facto, inflation) at the pump up 40% in some cases.

I can recall a speaker at a dinner event I attended back in 2005 making the bold statement that all would be well until such time as the Beijing Olympics were finished and then everything would come off the rails in Asia. Wow!! – he might just be right. As interest rates rise and bank lending tightens, the economy will slow notably in many of these Asian nations. And it is not just Asia. Look at what is happening in Iceland as it totters on the brink. Jean Claude Trichet in the Eurozone is now hinting strongly that maybe rates will start to ratchet higher. Even in Canada, finance officials are openly suggesting that the banking system should stop giving out mortgages amortized over 40 years and that there should be a ban on people borrowing their down-payment for a house purchase. Read more »

Currency traders – take note. This week the Bank of Canada was fully expected to cut its key interest rate another 25 bps. But….surprise, surprise. The Bank of Canada opted to leave rates unchanged so as to grapple with the inflation monster. This marks a major turning point in Canada. Central Bankers have been openly worrying about getting drawn into a US economic slowdown. But now all of a sudden the concern shifts to inflation. I say the global economy is at a critical turning point. Inflationary concerns will see rates move higher over the coming year in Canada and in other countries too.

For people like me who sell PUT Options on Currency Futures to earn extra money this week's policy shift is good news. A shift in stance on interest rate policy should underpin the Canadian Dollar. This week I was a seller of the Canadian Dollar July 95 cent Put Options. I brought in $160 per contract and I now have 3 weeks to go until expiry. Read more »

The gigantic experiment in globalization may be about to turn ugly in a classic Jekyl and Hyde type scenario.

In previous blogs I wrote about the fragility of the economy in Iceland. For the past several years, global financial players have been flooding the Icelandic banking system with capital in order to cash in on the higher interest rates being offered. In other words, the classic "carry trade" was at work. The bloated banking system started lending this capital to individuals who predictably went on a spending spree and to corporations who likewise went on an acquisition spree. I can think of 2 major firms right here in Canada that were acquired by firms from Iceland. I can recall thinking at the time – Iceland?, where are these companies getting the money to come to Canada to make acquisitions? But now, this money is seeping out of the system in response to the recent financial turmoil in the global banking sector. In an effort to stave off this outflow, interest rates in Iceland have risen to 15%. The backlash has resulted in the currency shriveling and the trade deficit ballooning. Read more »

The Wall Street Journal reporting on the current currency crisis in Vietnam seems very similar to what is going on here in the U.S.

"The government said this week the inflation rate in May was 25.2% on an annual basis, up from 21.4% in April and 14.1% in January. A slow government response was in large part to blame. When oil and food prices began to rise late last year, the State Bank of Vietnam, hoping to sustain growth, was slow to rein in inflationary pressure by raising rates or clamping down effectively on irresponsible lending. Efforts to control inflation proved ineffective -- such as a loosening of the currency's dollar peg, which backfired largely because of lending practices." Read more »