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Today, we’re going to complete our three part series re-evaluating the common arguments for inflation. If you missed the first parts of this series, you can review Part 1 here and Part 2 here.
Thus far we’ve shown that inflation has NOT yet gripped the market despite the public’s beliefs it has. Commodities remain nowhere near their 2008 highs (oil is currently entering a sharp correction) and that the dollar is actually higher than it was BEFORE Bear Stearns: both or which indicate inflation has yet to come home to roost.
So what’s the deal?
For starters, we need to address the most common misconception pertaining to the Fed:
that of “money printing.” The Federal Reserve doesn’t actually “create” money. It issues
debt and lends money out (like any bank), but it doesn’t just give money away.
Where does this money go?
Onto US banks’ balance sheets. And it only translates into inflation if the money flows
into the US monetary supply (the actual money in circulation, as opposed to the money
base which is a measure of money left in banks’ vaults and reserves).
And it isn’t.
US banks are not lending this money out. It is NOT entering the US money supply. Why?
Because the banking system is essentially insolvent, or would be if it marked the assets
on bank balance sheets anywhere near the price said assets would fetch on the market.
Banks have too many debts or liabilities and need to raise capital. They are doing this in
three ways:
- issuing more shares
- dumping liabilities on the Federal Reserve’s balance sheet
- hoarding the Feds’ low interest loans.
This analysis is often left out of most inflationists’ forecasts: the money the Fed is
lending out isn’t getting into the economy. Why? Because banks are hoarding it.
The below chart shows reserve balances with Federal Reserve banks. In simple terms,
this shows how much money is sitting on banks’ balance sheets in excess of what they’re
required to maintain. If you’re wondering where the $900 billion that the Fed has been
printing is ending up, look no further (BTW, the gray bars on the chart indicate
recessions).
This situation is not going to change any time soon. The easy money and loose credit
standards maintained by Alan Greenspan for 20+ years allowed banks, consumers, and
companies to take on a truly staggering amount of debt. All told, total private debt is
currently 350% of GDP or $49 trillion. To put this number into perspective, it’s far, FAR
greater than the percentage of credit debt relative to GDP that put the US into the Great
Depression.
Already insolvent, banks have absolutely no incentive to increase their lending. They
need to raise capital (hoard cash) and lower liabilities. So giving out money to consumers
or businesses (especially during a recession when earnings are falling due to the
slowdown in consumer spending and the rise in unemployment) is the LAST thing they
want to do. This is most obvious in the fact that credit card mailings are at their lowest
levels since 2000. Indeed, credit card mailings for the first three quarters of 2009 were
HALF of those mailed in the last three months of 2008.
Anyway, it’s not like consumers or businesses WANT to take on more debt. In fact,
they’re doing the same thing as the banks: trying to pay off debts and raise capital. For
consumers this has translated into two trends:
- Increasing savings
- Paying off debt
According to the Bureau of Economic Analysis, personal saving as a percentage of
disposable personal income was 5.7% in April, up from 4.5% percent in March.
Remember, this stood at 0% only four years ago.
Consumers are also cutting back on spending instead choosing to pay off debts in record
amounts. All told, Americans have paid off $40 BILLION in credit card debt since
February. Those who cannot pay off debts are simply choosing to default: credit card
defaults at Citigroup, Wells Fargo, and American Express are all at 10%, meaning it’s
very likely that $1 out of every $10 in credit card debt will NEVER be paid back.
There’s another reason banks aren’t lending, that being that lending standards have risen
dramatically. With unemployment rising, consumers still in debt up to their eyeballs
(despite paying some of it off), and household net worth plunging ($11 trillion lost in
2008 alone) the banks’ number of potential loan applicants has shrunken dramatically.
Thus we see the gaping hole in tradition inflationist claims that money printing = dollar
debasement and rampant inflation. The Fed is loaning out money as fast as it can… but
banks aren’t letting that cash get into circulation. And consumers don’t want more debt
anyway.
These are all facts, not opinions. And they go a long way towards explaining why the
dollar is actually stronger now than it was before Bear Stearns AND why commodities
are not soaring past their former highs.
Instead, what we are witnessing is a slow motion deleveraging and recapitalization of the
world financial system. Banks are trying to put off marking their assets to market so they
can continue to perpetuate the illusion that they are solvent while raising capital.
Consumers are paying off personal debts or defaulting (something the banks cannot
afford to do). Thus the trillions of dollars the Feds are pumping into the banks are not
entering circulation, thus inflation has not taken hold.
Bottomline: Inflation remains a very real future threat… but it is not here just yet. Setting up some inflation hedges now is not a bad thing, but you need to be prepared to hold for the long-term (at least upwards of a year). Gold is the ideal hedge since it performs well during both inflation AND deflation.
And historic trend dictate we may well see another spike in the precious metal in the next 3-4 months.
No investment ever goes straight up or straight down. During the last bull market in gold, the precious metal rose 2,329% from a low of $35 in 1970 to a high of $850 in 1980. However, during that time, there was a period of 18 months in which gold fell nearly 50% .
From mid-1971 to December 1974, gold rose 471%. It then fell 50%, from December ’74 to August ’76. After that, it began its next leg up, exploding 750% higher from August ’76 to January 1980.
Now, in its current bull market (2001 to March 2008), gold rose over 300% from $250 to a little over $1,000. And just like in the mid-70s, it began showing signs of weakness after its first big rally up to $1,014 in March ’08. At one point, it even fell to $700, a 30% retraction. Granted, it wasn’t a full 50% retraction like the one that occurred from 1974-76. But we are experiencing a financial crisis. And gold is the most common catastrophe insurance.
If we were to go by the historic pattern of the gold market in the ‘70s, gold should experience upwards resistance for 19 months after its first peak today. Gold’s recent peak was $1,014 in March ’08 (roughly 14 months before the writing of this report). If this bull market parallels the last one, then gold should renew its upward momentum in a very serious way starting in October 2009. And this next leg up should be a major one (the biggest gains came during the second rally in gold’s bull market in the ‘70s).
I’ve found a fantastic backdoor route to gold that allows you to buy the precious metal at a measly $188 an ounce. If Gold rallies above $1,000, investors who buy the Gold ETF will only pocket gains of 10+%. Meanwhile investors who buy this “backdoor” route could easily see their money double!
I’ve detailed this opportunity in full (what the investment is, who to buy it, etc.) in a FREE Special Report called How to Buy Gold at $188 an Ounce. You can download a copy, FREE OF CHARGE, at www.gainspainscapital.com
Good Investing!
Graham Summers
***
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