Where Now Inflation?

RichardSchwartz — Fri, 12 Sep 2008 13:39:00 GMT

THE FIRST INFLATION SURGE IN 25 YEARS IS OVER. So, what now?

First, let me give credit when credit is due. Federal Reserve Chairman Ben Bernanke and the Fed finally got one right. They’ve been promising us moderating inflation for a year or more and now with -30% lower crude oil prices and a big general commodity collapse we’re finally we’re seeing it happen. Or, at least, starting to (most things economic happen with a lag). And with the US dollar now surging, that’s going to reverse/diminish rising, problematic imported inflation as well. So now the deflationists out there, those who say deflation is our real problem facing us for some time – Gary Shilling, Robert Prechter, Ron Insana to name just three -- can really have their time in the sun.

Still, there remains some debate whether problematic rising inflation is going quiescent. Mac Courtenay of Seeking Alpha, I guess a boutique research firm, offers up seven reasons why inflation isn’t going away:

1. Inflation is already firmly entrenched. Schwartz View: I agree. I’ve been observing the Fed’s incessant jawboning that inflation expectations remain low is wrong and we all know that the government’s inflation data is terrible skewed to the downside from what inflation really is.

2. Inflation is already here. Schwartz View: The Producer Price Index (PPI) is up +9.8% over last year, and that’s only what the government grudgingly admits to.

3. Inflation is now moving its way through the “food chain” showing up in consumer prices as well. After some hope that because of global competition (globalization) producers would eat the higher inflation. Schwartz View: This rippling through is evidenced by the Consumer Price Index (CPI) rising too, again up the fastest in 17 years.

4. Average weekly earnings fell in July the largest since 1990. Schwartz View: I’d guess Mr. Courtenay’s point is that when earnings drop, we can’t buy as much. ???

5. More and more Federal Reserve governors are talking about raising interest rates next, not lowering them. Especially if we see energy prices stabilize above $100 and bounce. Schwartz View: Of course, these Fed officials, meeting again next Tuesday, can change their views.

6. Global (food?) consumption patterns are heading higher. Schwartz View: I don’t know if author Courtenay is talking about food, metals or just what. But I agree with him on food. As people get a little money, one of the first things they spend it on is more and better food. Thus global food consumption patterns should keep heading higher even if the global economy recesses.

7. The markets will take charge. If the Fed doesn’t raise rates, the marketplace will raise them. Schwartz View: Not sure about this reason he positing for inflation staying problematic. Right now the markets, the long US Treasury market, is still forecasting a slowdown by yields going lower and lower, which to me means more disinflation ahead, not rising inflation.

Schwartz View: He goes on to say part of oil’s recent comeuppance, coming down, is forced hedge fund liquidation because of Congressional pressure (I agree). And that it’s a great time to buy TIPs (Treasury Inflation Protected Securities) and the easiest way is to buy the symbol TIP. And to buy commodities on this correction, recommending also symbols DBC (a basket of commodities) and GDX (gold). Myself, while I believe this commodity pullback is indeed a correction, I think it’s too early to buy them back.

Schwartz BIG PICTURE Inflation View. My belief, garnered from studying stock market history and looking at thousands of charts over the last 20+ years, is that when any new trend begins, many times it begin with a surge in the new direction, then a pullback or at least a pause, sort of to regroup, consolidate gains, make believers out of disbelievers, open the eyes of others who are slow to see and just basically kill enough time to see if the new trend has legs. Then after this pullback correction, which more often than not can be large and long lasting, runs its course, the new trend reasserts itself.

Basically that’s where I see us today with rising inflation, in a pause to refresh. I’ve theorized over the last year than oil and other commodities would stay stronger, longer than most thought this year. I’d say that proved correct with oil going up all the way to about $147 and related sectors like natural gas, energy services, solar, wind and other alternative clean green leading the stock market for the whole first half of 2008. Similar to what happened during the first year of the last severe Papa Bear stock market back in 1973-1874 (oil stayed high the first year). But now, with commodities reversing downward and in major correction, it’s obvious change has occurred, that a pause to refresh is underway. And we can expect this new trend to last longer and correct deeper than many would think I’d venture. Sure, first because commodities are inherently extremely volatile, much more so than stocks and bonds. But also because of the emerging new, macroeconomic backdrop. We seem to be in line for a major, global economic slowdown which will throw a big detour on the road to a new long term trend to rising global inflation. If the global economy really goes blah for the next few years, commodities will take a longer than expected breather. Schwartz View: Still I’m in agreement with former Federal Reserve Chairman Alan Greenspan who predicted in his 2007 book The Age of Turbulence that we live in an inflationary world and that the disinflation trend dominating all during his tenure as Fed chief is coming to an end. And I’m in agreement also with famed, global investor Jim Rogers who says commodities normally correct 50% or more and that’s what we’re seeing now, a correction not the end, to this so far about 9-year commodity bull market.

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Where Now Inflation?