Marshalling the Armies of Inflation

Is Mr. Market schizophrenic? He’s acting like it. Just before 1pm on Friday, the All Ordinaries traded at 3,201. The market was bad and getting worse.

Then, shares rallied nearly 5.7% for the rest of the day. The All Ords closed up 54 points on the day. But from the intraday low to the close, it was more like 186 points. Now that’s what we call a bounce back!

Maybe Mr. Market had a few martinis for lunch and came back in a reckless mood. We know the feeling. Or maybe he just needed a stiff drink to give him the courage to say that scariest of words these days, “buy.”



Others too courage too. At much-maligned, forever-falling Oz Minerals (ASX:OZL), new CEO Andrew Michelmore told the market he was buying $30k worth of shares. Director Barry Cusack said he was in for $100k. The insider buying was enough to engineer a 25% turnaround on the day, with the stock closing up nearly 13%.

Whatever the cause was, we came in the control room at the Old Hat Factory this morning around 7am and found Swarm Trader Gabriel Andre already at work. It looks like the rally triggered a host of signals. But will it continue?

It’s been a tough market to trade. There’s no real momentum. No one really knows what’s going on. One day, you’re up three percent. The next, down four.

The Dow started its Friday bounce back work a little later than the ASX did. It didn’t begin its late-afternoon run until 1pm in New York. But when it finished, it had climbed 494 points above the open, for a daily gain of 6.54%.

The Dow Bounces Back


Who knows why these things happen? The story making the rounds in the papers is that traders “cheered” the news that Tim Geithner, President of the New York Fed, would be Barrack Obama’s new Treasury Secretary. He’d replace “Bazooka” Hank Paulson.

No word on Geithner is as good for Goldman as Paulson. But he has been one of the three big wheels behind the various bailout plans engineered by the Wall Street/Treasury Axis. He’s a known known, as Donald Rumsfeld might say. And since we’re going with the Roman metaphor, we’d say Geithner has been Caesar to Ben Bernanke’s Pompey and Paulson’s Crassus.

Of course the first Triumvirate coincided with the beginning of the end of the Roman Republic. It was never official. Just three men calling the shots from behind the scenes.

But it certainly marked the beginning of the Empire and dictatorship. Crassus was one of Rome’s richest men. He’d put down the slave rebellion led by Spartacus in 74 BC (still one of Kirk Douglass’ best performances, if you ask us). But he died fighting the Parthians at the edge of Empire at the Battle of Carrahae in 53 BC.

Pompey lasted longer. He gained fame in Rome after defeating pirates in the Mediterranean in 67 BC. He formed an alliance with Julius Caesar in 59 BC and cemented in by marrying Caesar’s daughter Julia.

But when Caesar famously crossed the Rubicon in 49 BC and brought his armies into Italy for Civil War, he put Pompey on the run. Caesar chased Pompey all over Italy for a bit, eventually defeating him in battle and driving him to Egypt, where he was promptly assassinated by his own friends and beheaded.

Tough place, ancient Rome.

But back to the modern world. There are no financial Rubicons left to cross that we can see. They’ve all been crossed already. And we believe they all lead to inflation in 2009. The New York Times Reports that Senator Charles Schumer wants the new stimulus plan to be around US$700 billion. That would match the TARP, providing some classical symmetry.

Gold must’ve noticed. It was up forty three bucks on Sunday. In the spot market, gold’s back over $800. By the way, Australian gold production fell by 8% in the third quarter, according to Bloomberg. Australia is the world’s third largest gold producer. But high production costs are biting.

In the bigger picture, gold traders and investors realise that the Great Fiscal Stimulation of 2009 is being prepared as we speak. President-elect Obama is conversing with his fiscal and monetary generals. He is marshalling his armies of inflation to go forth and multiply the money supply.

If gold investors are right (and we think they are), the upcoming war on deflation should unleash the epic inflation we’ve all (except for Bob Prechter and Marty Weiss) expected.

Obama and his Consuls Geithner, Summers, and Bernanke are preparing the public for operation GFS 2009. “We now risk falling into a deflationary spiral that could increase our massive debt even further,” the President-elect told Americans in a speech this weekend.

He’s right. The rising value of cash (in a deflation) makes debt harder to pay back (especially when you plan on adding so much more). That’s why all governments everywhere prefer the policy of soft, slow-motion inflation. Obama does not represent change here. Just more of the same borrowing and spending we’ve had for years.

Inflation gradually erodes the value of accumulated debts by allowing you to pay them off in an increasingly weaker currency. If you’re having trouble with that idea, think about this way. Say you borrowed $1,000 twenty years ago. Twenty years ago, $1,000 had more purchasing power than it does today. If you inflate steadily enough, it gets easier to pay back your accumulated debts. $1,000 ain’t what it used to be.

The United States also enjoys the luxury of paying off its debts in a currency it prints. So inflating the debt away is easier than, say, defaulting on it because you don’t have enough of the currency in which the debt is denominated. There is no reason to default, in fact, when you can print the currency in which your debts are owed.

This is why we increasingly think inflation is coming. Up until now, the best laid plans of Paulson and his team have been focused on recapitalising banks and keeping the financial system from imploding. Deflating financial assets have chewed up that new capital, and prevented it from becoming new lending in the economy.

But the next step is the reflation of household balance sheets. Wall Street got its bailout. Now it’s Main Street’s turn.

Already, Obama’s team has indicated it will let the Bush tax cuts expire naturally in 2011, rather than repealing them now. Expect an expanded foreclosure mitigation effort too. And eventually, a new government-backed refinancing plan will be floated to try and put a floor under U.S. house prices.

Yep. 2009 is shaping up to be quite the year if you love big spending government with big plans. Yet here in Australia, the government seems scared to follow Obama’s lead and go into deficit to “get things going.” The unemployment rate will have to go higher, or house prices will have to fall further, before the Australian public demands more rate cuts and deficit spending (rather than resisting the latter).

Here are a few problems to think about until tomorrow. First, if you’re a large owner of U.S. dollars and a major creditor to the U.S. government, and you see that the U.S. won’t default on its debt but instead, inflate it away, what do you? What policy levers can you pull to exert influence on your debtor?

Second, what happens to the world’s stock of available savings when governments start hoovering it all up to be used as fiscal stimulus? Does it crowd out private investment, leading to fewer new jobs, and a prolonged crisis? In other words, is the big government push to “fight the crisis” actually setting it up to be much longer and more painful than it otherwise might? More on this tomorrow…

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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2 Comments on "Marshalling the Armies of Inflation"

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Peter Carvapai
At the moment it seems that investment is dead, apart from financial firms too large to fall nobody else seems to be in position to access external funds and,therefore, government borrowings at this point in time may not cause any crowding out effect. The Federal Reserve Bank can also monetize government’s debt which will have no negative impact on the pool of available funds for private investment. The problem is, of course, that as soon as the economy is back to normal times government will have to raise taxes or cut public spending by an amount equal, in present value,… Read more »
Despite Australia having followed this creeping inflationary path since the 60’s and agreeing on the inflationary outlook I feel there is a problem with your thinking in this new world Dan. It is called the adjustable rate mortgage at the household level, and for the commercial banks the 5 year mortgage bond (mainly offshore sourced in a current account deficit country) and the accompanying CDS and exchange rate hedging contracts, and lastly the treasuries market that will finally come to price them rationally when surplus countries suspend political donations following the curtailing of trade and Keynesian desperations played out at… Read more »
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