“When sorrows come, they come not single spies, but battalions…” – Hamlet
Yesterday brought more sorrows. Stocks fell – with the Dow down 227 points. Oil rose to $132. The dollar fell to $1.57 per euro. And gold hit $928.
But what’s this? Bonds – strangely – fell too. This could be a very important, like the dog that didn’t bark. Usually, when stocks fall bonds go up. Investors anticipate lower yields as the economy cools and fewer borrowers compete for funds. But now, the bond market seems to be worried about something else…and we think we know what it is.
We have long mistrusted numbers. And we especially distrust numbers coming from the Labor Department, public officials of any sort, or Wall Street, or the media, or Congress, or the family.
“I saved a lot of money by buying this jacket,” a daughter reported yesterday. “It was on sale. Don’t you like it?”
“Well…yes…but how much would you have saved if you never bought it at all?”
“Daddy…don’t be silly…I needed a summer jacket….”
Maybe we are being silly today…but we see money slipping through our hands. And so does everyone else!
Prices are going up for nearly everything – milk, bread, gasoline, liquor…all the essentials.
In the United States, reports Martin Hutchinson, the official inflation numbers are the worst in 17 years…but the raw numbers even more alarming. Of course, the raw numbers are never even mentioned. They are like a forgotten aunt, consigned years ago to a nursing home; nobody comes to call…nobody even asks about her.
In March, the raw data showed consumer prices rising at a 10% annual rate. But by the time the Labor Department’s goons got finished with it, they reported a CPI going up at an annual rate of only 3.6%. ‘Seasonal adjustments,’ they called it. Then, in April, when the raw data came in at a 7.2% annual inflation rate, they seasonally adjusted it down to only 2.4%. They didn’t seem to notice that the season had changed!
Hutchinson: “Both adjusted’ figures were greeted by the stock market with a sharp upward move. In the ten years to 2007, no seasonal adjustment has ever exceeded 0.3%, plus or minus; the probabilities that the March and April seasonal adjustments were randomly arrived at by the same method as those of the last decade were thus 0.18% and 2.3% respectively (so the probability of two such anomalies in successive months was 0.0041%, about 1 in 25,000.) If the raw March and April figures are adjusted by the average March and April seasonal adjustments of the last decade, consumer price inflation in those two months averaged 7.4% per annum.”
You can fool some of the people all the time, said Abraham Lincoln. He didn’t know any modern economists or professional fund managers. But he must have anticipated them. They’re pricing stocks and bonds as if inflation were still under control – on the Labor Department’s say so.
Who knows? Maybe they’ll turn out to be right. Stranger things have happened. But here at Markets and Money …we reckon prices are rising more than most people think…that’s there’s more inflation to come…and that the bond market is catching on. That’s why bond prices went down yesterday; investors are worried about inflation. At long last – perhaps – the bond vigilantes are awaking from their long, deep slumber.
Readers will remember the bond vigilantes – perhaps only by reputation. Back in the ’70s inflation rates rose. Bond buyers took a terrible beating. Then, they strapped on their guns. Henceforth, it was said, the feds couldn’t get away with causing inflation; because the bond market wouldn’t let them. As soon as bond investors saw inflation coming, they would act like vigilantes – selling off their bonds and forcing up yields. Higher yields cooled off the economy…and reduced inflation.
By way of full disclosure, this is not the first time we thought the bond vigilantes were saddling up and riding off to stop the Fed from destroying the dollar. At least twice in the past 5 years we thought so…only to find that they were just on their way to a saloon to join the party!
Back to the first point – that the numbers lie: A couple of English newspapers had the same suspicion – that official numbers were bent and distorted, always to the downside, of course. So, they sent their reporters out into the real world to buy things.
“The results are ‘alarming,’ says one tabloid…“the most savage increase in living costs for a generation.” What did the papers actually find? The Daily Express came up with an increase in consumer prices over the last 12 months of 11.5%. The Daily Mail ’s tally came in at 15%.
That’s getting to be serious inflation. And we suspect there’s more coming. And less, too.
A news story in the Financial Times tells us something very interesting. “The gap between input prices and what can be passed on to consumers is at its widest for 20 years.” For example, a 4-pint bottle of milk has gone up 16.5% in the United Kingdom. The price of milk from the farm has soared nearly three times as much – 45.8%. Or take bread. Wheat is up 56.9% over the last year. But a loaf of bread has only gone up only 8.5%. Crude oil is 62% more expensive today than it was a year ago. But a can of oil…or petroleum products generally, at the retail level…are up only 25.4%.
What does this mean? Probably two things. Maybe more. First, input prices have jumped so fast retail prices have not been able to keep up. It may also mean that retailers don’t think the raw output prices are permanent…or that they, the retailers, can afford to pass them along without losing customers. It may also mean that commodity or wholesale prices have gone up too far, too fast.
One thing is certain, the gap can’t last. The retailers can’t buy oil 62% higher and sell it only 25% higher – not for long. Either the price of crude comes down…or the price of retail petroleum products goes up.
Which will it be? Inflation or deflation? More inflation at the retail, consumer level…or a collapse of commodity/wholesale prices?
Our guess, as usual, is that it will be both.
*** There are two types of consumer price inflation. There is wage-push inflation…and cost-pull inflation. Or, is it the other way around? Doesn’t matter. The most familiar type of inflation comes when an economy heats up…companies need more labor…so workers demand more money. Employers meet the new wage demands…and then raise prices to maintain profit margins. Result: consumer price inflation.
The less familiar type of inflation happens when retail prices are pulled up by higher input costs. This is a very different kind of inflation because it provides consumers with no way to pay the higher prices. So far, we’ve seen very little increase in wages. As prices go up, consumers must cut back. This has the obvious effect of reducing demand…and reducing price pressure. Just as wholesale prices work their way down to consumer prices, so does consumer resistance work its way back up to producers. Effect? De horses go down and den dey come back. Doo dah. Doo dah. Producers cut back on production in the face of lower demand. Result: prices fall.
But here we introduce three wrinkles – each one the size of the Rocky Mountains.
First, have you heard that word: “decoupling?” We were afraid to use it; we thought it described the end of a porno movie. But now we discover that it really refers to the parting of the ways…between the mature economies of the United States and Europe…and the growing economies of the rest of the world. It was presumed for a very long time that “if the U.S. sneezes, the rest of the world catches a cold.” Well, now we’re not so sure. The rest of the world seems to have developed immunity to America’s germs. We don’t know; but maybe a consumer slowdown in America would not keep the Chinese, Indians and Russians from buying. Result: the normal corrective feedback loop would be twisted and broken. Prices would still go up, even though the U.S. economy was in a slump. This would put Americans in a terrible position – where they were earning less money but their costs of living were still going up.
Second, global prices are denominated in dollars. And the custodians of dollars – the feds – are determined to keep Americans spending money, even if they don’t have any. ‘Rebate’ checks… mortgage bailouts…lower rates…lower lending standards – the feds are going all-out, trying to keep the money flowing. Our guess a year ago was that this flood of liquidity would buoy up oil, gold and commodities. It certainly has done that. But will it continue?
This brings us to our third crease. Many commodities seem to us to be near bubble territory. Oil, for example, is an important commodity. But it’s just a commodity. It has users. It has producers. Barring a war, the relationship between supply and demand doesn’t change overnight. How is it possible, then, that the price should double in less than two years…or that it could go up another $25 before the end of the year (as much as the entire oil price 5 years ago), as T. Boone Pickens predicts? How could it go to $200, as Goldman predicts?
The answer is simple – the price is rising on speculation, not supply and demand. Oil may already be in a bubble.
Five years ago, there was only $13 billion invested in oil market indices. Now, there’s $260 billion, according to an article in the FT . In the futures market, oil is usually sold short – as oil companies hedge future production. In 1990, only 13% of open interest was long. Today, 58% is long.
Besides, markets work. When prices go up it draws forth new supply. In yesterday’s news, for example, we found that oil companies are spending four times as much on exploration and drilling as they did eight years ago.
Of course, there are reasons to think oil may go higher – a lot higher. But markets are markets…and bubbles are bubbles. And there’s one thing you can count on – bubbles always pop.
Markets and Money