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Why We Can't Avoid Rampant Inflation

Economics / Inflation Aug 03, 2009 - 09:06 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleWilliam Patalon III writes: Has the massive Obama stimulus plan put us on a collision course with virulent inflation?

It sure looks that way.

Let me explain …

When the U.S. Commerce Department on Friday said the U.S. economy contracted at a 1% annual pace in the second quarter, the report was actually seen as good news: It was a slower decline than in each of the two prior quarters, and economists had expected a contraction of 1.5%.

"This is good news," Nariman Behravesh, an economist with IHS Global Insight Inc. (NYSE: IHS), told The San Francisco Chronicle.

But here’s the wild card: Although government spending did increase during the April-to-June quarter, only about 7.7% – $60.4 billion – of U.S. President Barack Obama’s stimulus package had actually made its way into the U.S. economy by June 30, the quarter’s official conclusion. Of that total, the largest component went to U.S. states to help defray the jump in Medicaid costs, reported.

Much of the $43 billion in stimulus tax relief – including the “Making Work Pay” tax credit for individual workers – also took effect during the second quarter, CNNMoney said.

At this point, it’s really difficult to “see how the effect of stimulus has been very large," Edward Lazear, an economics professor at Stanford's Graduate School of Business – who served as an advisor to former U.S. President George W. Bush – told CNN. "Very little has gone out." And that’s the problem.

In short, it looks like we’re already experiencing an economic rebound – without the Obama stimulus having really even kicked in … yet. In fact, the impatience over the continued U.S. malaise, the slowness of the economic turnaround and the fact that when growth does return we’re almost assured of a “jobless recovery” actually has some Washington legislators already pushing for a second stimulus.

That means the economy will be in rebound mode when nearly three-quarters of a trillion dollars in stimulus money starts to flow in. Dumping all that money into an already-growing economy won’t just serve as a simple tailwind that gives the economy a gentle push; it will be more like the head-snapping start followed by the thunderous charge down the quarter mile that we see from one of the supercharged Top Fuel Funny Cars driven by National Hot Rod Association (NHRA) star John Force. (From a standing start, Top Fuel Funny Cars cover a quarter mile in less than five seconds at speeds well in excess of 325 miles per hour).

And there’s only one outcome from that scenario – rampant inflation. In fact, U.S. consumers are probably headed for the worst bout of inflation since the 1980s. And that makes the so-called “exit strategy” of U.S. Federal Reserve Chairman Ben S. Bernanke all the more important.

To be sure, the Obama stimulus has given the economy a bit of a boost. So far:

  • The states have deployed what stimulus money they have received, which helped fuel the biggest surge in state and local spending since 2007.
  • Some early pieces of the stimulus – such as the $25 increase in unemployment benefits – have allowed consumers to spend more.
  • And one economist – Economic Policy Institute’s Josh Bivens – said Obama stimulus money may have boosted growth by as much as three percentage points during the second quarter.

But other economists say that – given the environment – the second-quarter GDP numbers were much too strong. After all, business spending dropped 8.9% and hours worked fell 7%. Somehow that doesn’t translate into a mere 1% drop in GDP. That latter figure will most certainly be revised downward in the future.

Unless or until that happens, look for the third quarter GDP statistics to give us a better picture of the U.S. economy’s health. Complaints that the promised stimulus money isn’t getting where it needs to be have Obama’s economic team working overtime to iron out the problems that keep cropping up.

Mark Thoma, an economics professor at the University of Oregon, told CNNMoney that “the third quarter will be a critical time period for assessing the stimulus package."

And for assessing the inflation threat – which Money Morning has repeatedly warned is a very real threat. Gold, commodities, and other hard assets will be key holdings. The same is true for dividend-paying stocks. And make sure to go global – the best growth prospects will continue to be overseas.

Market Matters

A report by the New York Attorney General’s Office claims the initial nine institutions that received Troubled Asset Relief Program (TARP) money paid out $33 billion in bonuses in 2008. Of particular note, Citigroup Inc. (NYSE: C) and Bank of America (NYSE: BAC) rewarded a combined 900 employees (combined) with bonuses of at least $1 million, despite having received $45 billion each in government aid (and that doesn’t count the $3.6 billion Merrill Lynch & Co. Inc. employees received). Imagine how much they would have made if the companies were actually doing well?

While President Obama continued his road trip across America to promote health care reform, a group of conservative Democrats (Blue Dogs) came up with their version of a bill, but offered no timetable for completion.

Meanwhile, regulators pushed forward with proposed rules aimed at reducing speculation in the marketplace and focused on so-called “naked” short selling and on lpacing strict limits on commodities contracts.

In corporate news, deals were the theme of the week. Microsoft Corp. (Nasdaq: MSFT) made amends with Yahoo! Inc. (Nasdaq: YHOO) and forged a 10-year partnership to cut into Google Inc.’s (Nasdaq: GOOG) share of the Internet search business. And International Business Machines Inc. (NYSE: IBM) is expanding its software empire with the purchase of SPSS Inc. (Nasdaq: SPSS) for $1.2 billion.

On the earnings front, energy companies highlighted the week’s reports and the results were not pretty (though were expected). On a positive note, Motorola Inc. (NYSE: MOT) surprised analysts by reporting an unexpected profit, while offering a promising outlook, and Deutsche Bank AG (NYSE: DB) continued the favorable trend among (previously depressed) financials by posting strong earnings on solid investment banking operations.

Investors digested the mixed earnings news and chose to focus more on the positives. Despite a temporary setback in China (5% index decline before encouraging comments by its central bank), the Dow Jones Industrial Average moved higher late in the week after General Electric Co. (NYSE: GE) was upgraded to a “Buy” by a major analyst, a sign of an improving climate. The Nasdaq Composite Index even flirted with 2,000 for the first time since October 2008, and the Standard & Poor’s 500 Index edged closer to 1,000, a level not seen since last November.

The Dow ended July with its best monthly performance since October 2002. Japanese stocks moved to their highest levels in about 10 months and European equities soared to nine-month highs. Bond investors breathed sighs of relief as a record $115 billion Treasury auctions came to a close and foreign bankers emerged as buyers on the final day.

Market/ Index Year Close (2008) Qtr Close (06/30/09) Previous Week (07/24/09) Current Week (07/31/09) YTD Change
Dow Jones Industrial 8,776.39 8,447.00 9,093.24 9,171.61 +4.50%
NASDAQ 1,577.03 1,835.04 1,965.96 1,978.50 +25.46%
S&P 500 903.25 919.32 979.26 987.48 +9.33%
Russell 2000 499.45 508.28 548.46 556.71 +11.46%
Global Dow 1526.21 1,629.31 1,747.64 1,773.69 +16.22%
Fed Funds 0.25% 0.25% 0.25% 0.25% 0 bps
10 yr Treasury (Yield) 2.24% 3.52% 3.67% 3.50% +126 bps

Economically Speaking

Has Fed Chairman Bernanke suddenly become Mr. Optimist these days? Early in the week, he proclaimed that the financial debacle ultimately would produce favorable results as “not only will we will be back on track, but the economy will be stronger than it had been before this started.” He also urged Congress to move forward with a regulatory reform package to ensure that such dire times will not be repeated.

The Fed’s Beige Book showed that the economy remained weak, though signs of stabilization and improvements in manufacturing, housing, and even labor are occurring across several regions of the country. Some districts reported enhanced corporate hiring, particularly within the healthcare and technology sectors.

The afore-mentioned second-quarter GDP report was better than expected, giving yet another indication that the recession is drawing closer to an end.

Still, it’s a much deeper recession than most realized: For the first time since records have been kept (1947), economic activity has declined for four consecutive quarters. New homes sales skyrocketed in June by 11%, the fourth increase in the last six months, and home prices even climbed on a month-over-month basis for the first time since July 2006 according to the S&P Case-Shiller index.

Durable good orders fell in June, though once the volatile transportation category was removed from the statistic, orders actually increased. Consumer confidence fell in June, as ongoing pressures on the labor markets brought continued concerns and many Americans are refraining from major purchases (now and for the foreseeable future).

On the other hand, jobless claims rose in the most recent week, though analysts pointed to discrepancies from the auto industry. Looking at the four-week moving average as a better gauge, claims for unemployment benefits actually fell to the lowest level since January and continuous claims unexpectedly declined, as well. Weekly Economic Calendar

Date Release Comments
July 27 New Home Sales (06/09) Highest level of sales since November 2008
July 28 Consumer Confidence (07/09) 2nd consecutive monthly decline
July 29 Durable Goods Orders (06/09) Decline due to cutbacks in volatile aircraft orders
Fed’s Beige Book Weak economy, though signs of stabilization
July 30 Initial Jobless Claims (07/25) 4 week average, best since January
July 31 GDP (2nd Qtr) Contracted, but at a slower than expected pace
The Week Ahead
August 3 Construction Spending (06/09)
ISM – Manu (07/09)
August 4 Personal Income/Spending (06/09)
August 5 Factory Orders (06/09)
ISM – Services (07/09)
August 6 Initial Jobless Claims (08/01)
August 7 Unemployment Rate (07/09)
Non-farm Payroll (07/09)
Consumer Credit (06/09)

[Editor's Note: If it's inflation you're worried about - and commodities you want to invest in - there's no better place to look than the Global Resource Alert trading service, which ferrets out companies poised to profit from the so-called "Secular Bull Market" in commodities.

If you're new to the commodities-investing arena, and are uncertain about the landscape - or even if you're an "old hand" at natural-resource stocks, but want some insights into the new profit plays and new players - consider hiring a guide: Money Morning Contributing Editor Peter Krauth, a recognized expert in metals, mining and energy stocks, who is also the editor of the Global Resource Alert. A former portfolio advisor, Krauth continues to work out of resource-rich Canada, which keeps him close to most of the companies he researches.

Don’t get caught up in the uncertainty caused by the competing and contradictory analyst forecasts. In such an environment, Krauth says that commodities are among the most-profitable and least-risky investments available, and notes that this may well be the most powerful bull market for commodities we'll see in our lifetimes. He makes a strong case. To read more about his strategies, and the sector plays he likes the most, please click here. ]

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