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Inflation Breakout
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23 May 2001

Monetary policy of the pre-liberal era was either crude coin debasement, for the benefit of (the) financial administration (only rarely intended to cancel out outstanding debts), or still more crude paper money inflation. However, in addition to, sometimes even instead of, its fiscal goal, the driving motive behind paper money inflation very soon became the desire to favor the debtor at the expense of the creditor.

Ludwig von Mises; 1928

Smart chap that old fella'. In other words, the rare occasion will occur, on a changing mandate, where the aim of monetary policy IS intended to cancel out outstanding debts. This is an important point, for at this moment in history; US monetary policy is without a fiscal goal. The semi-annual congressional testimonies, which Greenspan still chooses to testify at, used to take place under the Humphrey-Hawkins legislation named after the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 called on in the seventies for reducing unemployment to four percent. This bill, for almost 30 years now, has been the fiscal goal to which the Fed has been accountable. But it expired in the middle of 1999 accompanied by Congressional views that the goal has been achieved.

So here we are, the world's largest debtors… searching for a new mandate to focus the Federal Reserve Board… but what if the mandate already exists and is searching to be accepted? The United States has become a net debtor sometime in the past decade. Sooner rather than later, the new goal of the Fed must be to cancel out outstanding debts. Ed Bugos.

Gold Stocks Dow Industrials
Too bad the Dow didn't have a gold producer in the average

Just as I was thinking about a fitting title for this week's report, last Wednesday, I began to wonder: Greenspan just finished lowering the State interest rate, five times, to nearly half of what it was only five months ago. Something spectacular has got to go off here. $50 oil, I thought! Sure enough, the charts look good. Anything is possible now. Something will give, where people least expect.

I began to wonder what questions the markets might debate this week, when I received what I think is a timely email from one of our readers:

As a long-suffering gold bug, I am thrilled to see gold perking up. Can you please tell me, either by responding to this email or by addressing it in your report, if this means we can be long gold for a number of years? Or is this a trading opportunity only? - Anonymous Subscriber

The second I read it I knew the answer. Of course, you know the answer too because we've been discussing it since the summer. In fact, the only reason that no one else knows it is because there is only one piece left to prove what everyone already sees happening around him or her. The very validation by the gold market itself, for what we all prefer to deflation anyhow: perpetually rising prices - the last bastion of profitability, under the current monetary order. The enormous monetary inflations we've had over the decade past have already been blowing holes in the price structure of the economy, giving price taking industries the decisive edge in attracting investment interest, a trend likely to continue. It is only utter irony that anyone sees these price distortions as deflationary.

But first, in order to understand how far gold prices might ultimately go, we need to understand what a free gold price is generally anticipated to prevent:

The Inflation Breakout!
Mises called it the crack-up boom. Still others like the term hyperinflation, or its more benevolent cousin, stagflation (a misnomer by the way). Your average Russian would call it something completely different, and he may be the closest. Of course, conventional economists (neo-Keynesian) like to call it an increase in the general price level due to an expansion in aggregate demand relative to the economy's capacity to produce, or thereabouts. But Keynesians, it has been shown on occasion, can't necessarily recognize a bubble while it is growing neither.

Note the consequence of the collision between delusion and reality, in the Nasdaq chart below. Now consider the historical reality that inflation will result in monetary confiscation as well as economic dislocation… against the delusion that a growing productive economy needs ever more liquidity if it is to grow.

Nasdaq Money Supply
NASDAQ Composite MZM Money Stock, U.S.

It often seems as though humans can only make essential paradigm shifts when a crisis confronts them. Until that day, however, they are usually content with the delusion of the day. It will not make a difference to the outcome, whether you anticipate it, or not. The conflict between reality and delusion is inevitable. But it does, however, make a difference to you.

National Delusions: to delude or not… that is the question
I think it is important to acknowledge that Lord Keynes' work tended to presume that people were capable of deluding themselves to committing unlimited resources for the production of green cheese, if they were determined enough to achieve impractical economic (fiscal) goals. One look, maybe two today, at this economy would confirm his presumption true.

Psychologists classify delusion as: an unshakable belief in something untrue. These irrational beliefs defy normal reasoning, and remain firm even when overwhelming proof is presented to dispute them. When an individual has deluded himself to the point that it affects his or her ability to cope with life, he or she will probably see a psychologist, who will provide all sorts of treatment. I am no psychologist, so it is only my observation that the capacity for self-delusion is not just apparent in every walk of human life, and especially in market life, but that we have also learnt how effective a tool it can be for managing so many daily tasks.

It is a choice, on some level, often between perpetuating a self-delusion and dealing with an unpleasant truth. Other times the desire to have something impossible to acquire is a good motivator. To a whopping extent, the remarkable technology bubble was a national, and perhaps, global delusion based on a vision of the very distant future. Of course, many people haven't accepted that yet, which is why the bear market ain't over.

If it is still too much to imagine that the modern world can, over and over, continue to fall for such schemes, consider that human history is absolutely littered with one bizarre example of national delusion, after another. We've studied accounts of many of them, and have found very few examples of individuals that were able to avoid participating in them. (See Charles MacKay's Extraordinary Popular Delusions and the Madness of Crowds)

The Bubble Masters (like Smith's invisible hand: you can't see them but if they don't exist, they might as well) know that, if nothing else, humans have throughout history shown that under certain economic conditions, they will pay dearly for the promise of safety, wealth, or admiration. We on the other hand often forget that the bubble heads exist in the first place because we want them to. Maybe it helps to forget about what we are really paying with - liberty. Why is it that the job of a man that makes potions at the traveling show, is as secure as that of a Doctor?

It was while Law's plan (John Law was the creator of the Mississippi bubble) was at its greatest height of popularity, while people were crowding in thousands to the Rue Quincampoix, and ruining themselves with frantic eagerness, that the South Sea directors
(in England) laid before Parliament their famous plan for paying off the national debt

- Charles Mackay

All through history, it is always the same: a group of very powerful people discovers the secret to human fallibility: the individual predilection for self-delusion. It is in this new world monetary order, one without an anchor, which the investor must at all costs work hard to arm himself with an ability to recognize unpleasant truth, if he is to win The Battle For Investment Survival (the title of Gerald Loeb's bestseller is coincidental).

This Week in the GIC:

  • We break out a new hypothetical asset allocation model
  • How will the Bank of Japan's decision to embrace Paul Krugman's quantitative easing model affect Dollar/Yen?
  • What stage of the inflation breakout are we at, and how far can it carry?
  • Aren't accelerating inflation rates going to obliterate the Dow's 29 times price earnings ratio?
  • Does Merrill Lynch aspire to do more business with the Fed?
  • Is the gold market breakout just a trading opportunity, or the beginning of a big bull market, in gold?
  • China's gold market ambitions, whatever they really are, hold a wild card that may throw a wrench into Japan's plan for an Asian currency alliance.

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Edmond J. Bugos

The GoldenBar Global Investment Climate is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you toconfirm the facts on your own before making important investment commitments.

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