Where is Inflation?
Note: This commentary was originally posted to Metal Augmentor on June 15, 2009 at 10:27PM EDT.
Last October, I wrote a commentary called Monetary Base Rocket. In it, I argued that the liquidity and bailout programs of the Federal Reserve under the leadership of “Helicopter” Ben Bernanke were the equivalent of a monetary drop from a proverbial helicopter, but with an important caveat:
The Fed has added as much to the monetary base in 6 weeks as it has added in any prior 10 year period going back to the early 1980s. Indeed, the rate of increase appears to be about $100 billion every two weeks and yet the logjam in the credit markets still has not been cleared.
So, is this the fabled helicopter drop? Yessirreee! There is, however, a slight matter that deserves some mention. The money dropped from the helicopter has not reached the ground yet. In other words, most of this money is still being held by the banks in the form of Reserve Balances. Put another way, it has not yet started to work its way down through the fractional-reserve lending process to the credit-strapped private sector.
The reason these funds are being held and not loaned out by the banks is simple. The Fed is actually paying banks to hold the funds in reserves. Indeed, the Fed has just today increasing the rate it is paying by 40 basis points. Some of you may know that the Fed was originally going to start paying banks for excess Reserve Balances starting in 2011 but the recent emergency bailout legislation moved that date up so that Reserve Balances would start to earn interest immediately. The Fed’s intent is to try to keep the massive increases in Reserve Balances close to the heart so that these funds serve mainly to shore up the banks’ balance sheets but don’t create a tsunami of “unnecessary liquidity” in the money supply. Remember what I said earlier about jumping out of a burning building. In helicopter lingo, the $300 billion has been dropped but it is fluttering in midair due to an updraft created by the rotor.
I suspect, however, that the Fed will have to dispense with its “gradualism” before too long and fly the helicopter to open airspace in order to avoid a crash. Even if the Fed has no intention of moving clear, the longer the money stays out there fluttering in midair, the more difficult it will be to keep it aloft. Moreover, once the dropped money has cleared the updraft from the helicopter’s rotor, it can no longer be reclaimed by the Fed without consequences, especially while the global economy remains on an unsure footing. Thus I suspect most of the dropped money will eventually flutter to the ground.
What I think we should watch for in particular is an increase in M1, which includes circulating currency (Federal Reserve Notes) and demand deposits. The latest data only goes up to October 13, but that data actually shows weekly average M1 shrinking by as much as $100 billion since the end of September. If and when we see M1 reverse sharply upwards, we could start to suspect that the first batches of the monetary drop are starting to reach the ground and that a “hyperinflationary event” will not be very far behind. How long could this take? I give it 6 to 18 months although others say it could be literally weeks from now. Jim Sinclair claims something big will happen in 13 to 88 days, which is the timeframe between the U.S. elections and the inauguration of the next President.
The caveat was that the helicopter actually has to fly clear of the money fluttering in the sky so that it can start falling to the ground. Much has taken place since I wrote the above piece and several related ones but the simple fact is that the helicopter has not flown clear. The money drop continues to be kept aloft primarily because banks are unwilling to lend their borrowed Reserve Balances as there are no qualified borrowers who need loans. Also, there is a stigma attached to these borrowed Reserve Balances. Lending them out means they won’t be paid back anytime soon, which is a reason of itself not to lend them out. Indeed, some of the money drop has even been sucked back up. For example, the largest bailout program, named Term Auction Credit, has seen outstanding balances drop from $493 billion in early March to $337 billion last week. On a related front, a number of banks have announced they will be paying back their TARP money as well.
Be that as it may, the most important development since my “helicopter” commentaries has been that the Fed has essentially abandoned the liquidity and bailout programs targeting banks in favor of a more “traditional” policy move involving open market purchases of mortgage-backed securities and U.S. Treasury paper. At the same time, I’ve also mentioned recently in the Dollar & Bond Bottom? entry that the Fed was targeting the portion of the Treasury yield curve that is the most supportive to banks. In the last several weeks, the Federal Reserve has continued to make most of its Treasury purchases toward the middle of the yield curve which arguably has the best chance of keeping the entire curve suppressed while assisting the banks’ borrow-short-and-lend-long policy.
All of the above leads to the observation that I would like to make today which is that we are NOT seeing a growing rate of monetary inflation at this point. The Fed and Treasury bailout and liquidity programs are swimming against a strong deflationary tide created by business failures, tight credit and consumer entrenchment. Until this logjam breaks, and it will at some point in the future, the threat of hyperinflation will be relatively mild. In my earlier post I estimated that it could take 6 to 18 months for a “hyperinflationary event” to take place. Arguably such an “event” did take place when the Federal Reserve announced its massive open market securities purchase program but clearly that will not have an immediate impact.
Based on the current situation, I think it would be appropriate to change the “6 to 18 months” guess to “12 to 24 months”. And I still expect that the M1 money supply would serve as a leading indicator of such an event. Alas, we find in the latest Fed statistics that M1 money supply has increased at an annual pace of just 1.6 percent for the 13 weeks ended June 1, 2009 on a seasonally adjusted basis compared to March 2, 2009. Indeed, M1 money supply has essentially been frozen since last December after climbing rather strongly during the height of the banking panic. It’s as if deflationary forces are even stronger now despite the “green shoots” mentality than they were a few months ago when everybody was peeing in their pants about the global economy being at the edge of an abyss. In any case, no growth in M1, no monetary inflation regardless of what else happens.
Yet that has not stopped some people from making some spectacular (as in spectacularly wrong) statements about inflation. When facts get in the way, why not make something up? Let’s take the recent words by “one-handed economist” Howard S. Katz in the commentary Liar, Liar:
According to the June 1, 2009 Federal Reserve release H-6 (table 3), demand deposits plus other checkable deposits are equal to $740 billion. But according to the memo this reported figure is only half of the real deposits. Thus the true number for bank deposits is $1480 billion. Adding back the missing $740 billion gives us a money supply of $2.34 trillion (1.6 + .74).
Calculating from end May 2008 to end May 2009, the U.S. money supply has grown from $1.37 trillion to $2.34 trillion. This is an increase of 70%.
To put this figure into context, the previous high one-year growth in U.S. money supply was 16.9% in 1986. The money supply figures for the late ‘70s, which gave us a 13.3% rise in the Consumer Price Index, were in the range of 8%-9% per year.
Here is what this means for the price of gold.
My previous calculation for the price of gold was $3500/oz. And this was calculated as follows: We are now in an economic phenomenon I call the commodity pendulum. This means that, when the Fed creates money, it has an immediate (1-2 year) effect on consumer goods but a long term (10-20 year) effect on commodities. The commodity pendulum started in 1963 with the Kennedy tax cut and printing of money. Over the next 8 years, commodities did not go up and thus became undervalued in real terms. By 1971, commodities were very undervalued, and began a 9 year rise from 100 to 337 on the CRB index. This was the first upswing of the commodity pendulum, and during this time the rising commodity prices passed through into consumer prices. Thus for this period (1971-80) the Consumer Price Index rose faster than the money supply. Then came the second downswing in the pendulum (1980-1999), in which commodities got even more undervalued than in 1971. This was why Reagan and Bush, Sr. were able to print so much money with only a small effect on consumer prices. The decline in commodities was undercutting the rise in consumer prices and making it smaller. Now we are in the second upswing in the commodity pendulum. It started in 1999/2001 and I estimate that it will run for about 20 years.
Unfortunately for this gold price prediction, Mr. Katz is incorrect to assume that swept deposit balances are time deposits and therefore not counted in “the U.S. money supply”. He states:
This process of reclassifying bank demand deposits as time deposits is the fraudulent part of the new procedure.
Some demand deposits are in fact swept to savings deposits (a component of M2 which is part of “the U.S. money supply”) and they have been swept for a long time, not just the past year. By excluding the swept amount from the $1.37 billion balance of M1 in May 2008, Mr. Katz makes it appear as if there has been a great amount of monetary inflation during the past 12 months. There has not. Moreover, if the deposit sweeps themselves were concealing monetary inflation in M1, it would still show up in M2. The growth of M2 over the past 12 months, however, has been 9 percent on a seasonally-adjusted basis. That’s high but by no means hyperinflationary.
So, we remain on hyperinflation watch, forced to guess like everybody else (if and) when the initial “event” will take place. Given the widespread and severe nature of the economic crisis, any guess (including our own) is going to be a shot in the dark. And while such a guess might be an acceptable basis for speculation, it should not be used for determining the timing of a whole-portfolio investment allocation. By that we mean a “fully-loaded buy-and-hold” strategy involving gold and/or silver is way too defensive, presumptive and will not be as profitable as Mr. Katz and many others would have you believe.
We prefer a strategy consisting of a core position of physical gold and silver bullion held in your own secure possession and perhaps a few mining equities that are buy-and-hold with the remainder of the portfolio being traded on the basis of market fundamentals and technicals. An allocation to core physical gold and silver bullion of at least 10% is warranted in the current environment. The portion allocated to mining equities and trading positions will vary on risk tolerance, age to retirement, income and other factors that each individual should carefully weigh, with the assistance of a professional if needed.
Tom. You say : ‘Based on the current situation, I think it would be appropriate to change the “6 to 18 months” guess to “12 to 24 months”‘
Is that 12 to 24 months starting from october 08 or starting from today ?
From October 2008, but keep in mind that virtually every prediction of a future financial event has suffered from being too early, not too late.
I wonder how reliable money supply figures are anymore. How do we define money? isn’t credit money today. Home equity was used as money when one could get a heloc and go to the atm to spend it anytime or use it to buy an suv. Same with credit cards. Many people have muitple credit cards and to them the amount of credit available is money, no?
On the other side what about all of us who are saving in PM that for sure is money too but doesn’t show up in any of the Ms does it?
what about all the treasuries? 11 trillion or so outstanding, are they considered money in any of the Ms? When China or whoever cashes them to buy up oil and other assets then they are money right?
waht about money people think they have but don’t like Madoffs 50 billion?
Some of the money aggregates are used to buy goods and services and some to buy assets depending on who holds them, so how do you know where that money will enter the economy and what prices it will affect.
I would agree that changes in the various figures give us an idea of which way money supply may be heading but to use those figures to predict specific % changes in inflation can be and I think has been very misleading at least since A.G. let everything run wild.
I think the inflation question is wholly dependent on whether the dollar continues it’s role or get’s trashed and we have a currency crisis, that event will spark inflation perhaps a hyper one and radically change the whole lifestyle and financial landscape of dollar holders/earners.
Dear Sir
Has Mr Katz replied to your analysis?
Thank you
Jennifer Heaven
The central bank in Sweden has cut its deposit rate to -0.25% (I’m assuming this is the rate paid on settlement accounts with the central bank).
Does this mean Swedish banks will now buy gold instead? from the sounds of things they don’t seem to be keen on lending.
INFLATION IS COMING:
There is a DIFFERENCE between the DEFLATION of the 1930’s DEPRESSION and the INFLATION coming our way in the SECOND GREAT DEPRESSION. In 1930’s EROEI (Energy Returned on Energy Invested) was 100-1, in 1970 it was 30-1, today its about 10-1. The world was AWASH in HIGH EROEI in the early 1900’s. Today the CANADIAN TAR SANDS is losing money when OIL is below $80-90 a BARREL.
Back in the day all it took was for some SLOB to SHOVE a PIPE in the ground and OIL JUST GUSHED OUT. Today, you need HIGH TECH EQUIPMENT to pump the oil. A $BILLION DOLLAR OFF SHORE RIG called “THUNDERHORSE” comes to mind. When THUNDERHORSE hits its peak production it will only be producing 250,000 barrels a day, but these OFF SHORE FIELDS deplete rapidly in just a few years….not like the great OIL FIELDS from OKLAHOMA, TEXAS and CALIFORNIA that lasted for decades or half a century.
When the price of oil DEFLATES to a certain level, then we have SUPPLY DESTRUCTION. This translates to our whole MODERN ECONOMY as it is now based on FOSSIL FUELS and not MANUAL LABOR as it was in the early 1930’s.
A local LARGE DAIRY in my area lost $600,000 the first quarter of 2009. They have about 3,500 cows and produce about 170,000 lbs of milk a day. They are getting about $10 a 100 pounds. Another HUGE DAIRY in Colorado has ten times the number of cows 35,000 and produces about 1.5-1.6 million pounds of milk a day. It is in debt now over $60 million. Looks like BANKRUPTCY is just around the corner.
People don’t realize that AMERICANS have put their money not in their FOOD SOURCES, but worthless SUBURBAN SPRAWL as in BROKERS, INSURANCE AGENTS, STAR BUCKS, RETAIL GARBAGE, STRIP MALLS and etc. We should have been paying the FOOD PRODUCERS much better. There is a DISASTER waiting to happen in the FARM, RANCH, and DAIRY INDUSTRY. The small farms are gone with only LARGE CORPORATE ENTITIES that remain. These are going to VAPORIZE as the EROEI drops even lower to 8-1 or 5-1. Americans will soon be paying much higer prices for FOOD, unless they want to STARVE TO DEATH.
@SRSrocco
These are good points but I note that you cannot even GIVE sulfuric acid away these days despite trading for almost $400/tonne last year. Sulfuric acid is key in the manufacture of phosphate fertilizers and ethanol. I think the sulfuric acid market will be a good “stealth” indicator for inflationary and food price pressures.
[Shameless plug warning]: By the way, we have revealed to Metal Augmentor subscribers an interesting gold exploration company with potentially a very positive exposure to sulfuric acid prices. One of the interesting things about this company, which I haven’t even mentioned over at Metal Augmentor, is that the sulfuric acid exposure might serve as a hedge against rising energy prices, which is always a big concern with mining since it constitutes a major cost. We feel sulfuric acid and oil prices will have a price linkage going forward and therefore this gold explorer could end up having a mega-valuable gold project on its hands.
Gold is money. Everything else, including paper gold, is currency, commodity or speculation subject to manipulation.
@SRSrocco
Also to be remembered is the fact that something like 30-40%
of Americans still lived on farms during the 30’s. If they had no
outstanding debt against their farms, they had far less need for
money as they were essentially self sustaining as far as essentials
were concerned. That is not so today. The vast majority of
the populations of developed countries must buy their food, clothing
and shelter and are absolutely dependent on a functioning money system.
There is a far greater array of goods and services availiable now
than there was in the thirties. In addition, there has been an
expotential increase in the proportion of the world’s population
that has left subsistence farming and has joined the world
of money and commerce. India and China are the most obvious
examples. This vast expansion of populations who use money and
the increase in world trade may be what accounts for the delay
in inflationary price increases. There is simply far more commerce
than 80 years ago. Consequently each new Dollar, Euro, Yen etc.
has less impact on prices.
Is a Comex default nigh? Adrian Douglas penned this last week.
“In a few days I will report some information that this default could come at any time because the Comex is not what it seems. Stay tuned.”
AD has been following Comex inventory data for some time now so it will be interesting to read the conclusions he comes to.
Yesterday we saw quite interesting chart movements probably lead by the Yen/$ exchange rate without any causal news. What is going on here? Are the markets playing with the idea of an Israel attack on Iran? E.g. a try to get rid of shorts positions in currencies and gold before this happens by forcing the longs to cover.
Any other ideas?
@Joe M.: There has been a good amount of influx and outflow of COMEX Ag the last weeks but not at an level which will cause a short squeeze or a default (yet) - at least as I can perceive.
SRS,
I gotta tell ya, I am comin around to your thinking. The near future does not look for the average person on the street. You may not agree, but one possible scenario was for nominal rates to stay low while nominal assets, wages and prices fell, so that real rates rise a little. Before all the Monetarists and Austrians jump on my case I subscribe to the money AND credit school as being drivers of monetary inflation or deflation. So far so good! It is now looking like nominal rates may eventually rise while nominal assets, wages and prices fall. This will tear a new a%#hole for holders of debt. When the “effective” money supply is expanding everything is hunky dory, when it contracts old paradigms no longer hold. I am nearly out of debt and will then turn my efforts toward independance from the current system.
During the last depression one of my parents grew up in the country on a small property aprox 150k from a capital city. My other parent grew up on a larger farm further out. They had small gardens and animals for sustinance. They were independant from any conventional economic system and in fact provided food to passers by that were looking for work. They also traded excess produce in town for other goods. They did just fine and lived a hard but stress free simple life.
Earlier this year I spoke of delayed and canceled construction projects in the early planning stages in Western Australia. I was flat out on longer term large scale projects that had commenced mid 2008 while the new work was drying up. I had one project placed on hold that got canned formally this week. There is now a half built office building in Osborne Park Western Australia with no immediate future. I pre-empted this trend and migrated to small scale projects and have remained at full capacity all year. With the so called “green shoot economic recovery” there are now larger scale projects coming back out for tender and everybody is busy again. However I am looking for a larger contraction that will make last years events look like a cartoon. Last year I was vulnerable, this year I am not.
As I have said for most of this year I pulled back to core positions back in Feb looking for a nominal decline in price. My intitial expectation was for nominal metal prices to fall while the counter trend equity market was to rally. This was obviously wrong as current events have proved. It now appears that nominal metal prices may suffer in a looming liquidity crunch that is about to unfold. I am still looking to reload speculative positions in a few months at lower prices as I expect metal to bottom very early in this looming contraction. The core is non negotiable and nominal price is irelevant since it carries zero counterparty risk.
It looks like the housing market is getting a little bounce here near Saint Louis. On my road, two forclosed homes sold recently albeit at 1997 prices. One was a “short sale” and the other was sold at auction.
Looking at the employment situation around the area, its hard to imagine where any new jobs might come from. A few years back, Ford permanently closed their Hazlewood plant and now the Fenton Chrysler plant is done.
GM has a plant in Wentzville that is starting to fizzle too. Things have been going downhill here for 15 years as far as large employers are concerned. The TWA debacle and Boeing buying out McDonnell Douglas are a couple more biggies. The housing boom was the only bright spot really.
Prices still aren’t falling across the board, so I’m not buying into the classic deflation idea yet, but I think its obvious, hard times are right around the corner. I have doubled my bullion holdings over the last few months…I agree Lone Ranger, zero counterparty risk on the core is priceless.
Well don’t get to carried away with buying bullion at these prices. We maybe headed much low shorterm becuase of the masive paper short position. I’m very bullish on silver, however I am not stupid to the fact the crooks will drive this thing much lower. http://www.contrarianprofits.com/articles/and-then-theres-thisthursday-july-9-2009/18937
Last year when spot dipped below $10, 1 to 100 OZ bullion still cost around $14…if you could find it. I think we’ll get a repeat of high premiums and limited availability if spot gets lower than $11.75 or so.
For what its worth, scanning completed sales on ebay yesterday shows prices still hovering around $15 for generic silver. Go figure.
Today could be the bottom. If we get positive price action on Monday/Tuesday I think we will be off to the races for a rare Summer rally. If not, I think it will happen the following week.
Either way, I strongly believe we WILL get a strong summer rally, blow past 1,000 and never look back.
Not that I’m aware of, and I’m not holding my breath.
Well glad to see someone at treasury is thinking…
http://www.theonion.com/content/video/us_to_trade_gold_reserves_for
Comex paper to physical silver is leverage 100:1. Didn’t the banks get into trouble at 30:1 leverage. I wonder what 100:1 leverage would cahttp://www.goldnewswire.net/significant-silver-withdrawals-from-comexuse.
Medvedev shows off New World Currency at G8:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aeFVNYQpByU4
@Relic
Interesting that Bloomberg did not mention that the coin is made out of gold.
http://www.futureworldcurrency.com/Documents.asp?DocumentAreaID=47&DocumentID=204
JULY 8 COT REPORT LIQUIDATES 5,000 COMMERICAL SHORT POSITIONS
Even though the COMMERCIALS liquidated some 5,000 short contracts, there still seems to be more selling to take place.
On APRIL 17, when silver hit a low of $11.82 an ounce the COT REPORT showed the COMMERICALS with a low of only 59,541 SHORT POSITIONS or 63% of open interest. By the time SILVER hit its high of $16.23 on JUNE 3rd, the COT REPORT showed the COMMERCIALS had 73,464 SHORT POSITIONS or 69%. That means from the low to high price of silver the COMMERICALS had added about 14,000 SHORT CONTRACTS. This is what brings down the price of silver. The NON COMMERICAL SHORTS are insignificant and are not really worth mentioning.
As of now, we have sold off about 6,000 of those COMMERCIAL SHORT CONTRACTS. And it looks as if we have another 5-7,000 SHORT CONTRACTS to be sold off before this bottoms. Again, we have to remember, this report was taken on WEDNESDAY……so I have to imagine more COMMERCIAL SHORT CONTRACTS were liquidated.
According to Adrian Douglas, we now have fractional reserve Gold via the ETF’s. Read his smoking gun here.
http://www.gata.org/node/7586
Tom any thoughts on why JPM has taken delivery on over 10 million ounces of silver on the comex this month? There must be something to read into that. What’s your take?
thanks
Here’s a peice which provides a insightful look into the recent negative lease rates which you have been following no doubt on Kitco,etc.
Prof. Fekete is also mentioned in the article regarding the Backwardation which occured last DEC.
http://ftalphaville.ft.com/blog/2009/07/15/61861/getting-to-the-bottom-of-negative-gold-leasing-rates/