Inflation has a Bigger Agenda

America’s triple-A credit rating may be in danger, says Standard and Poor’s.

If the country has to bail out Fannie Mae and Freddie Mac through a prolonged recession, it could cost the nation’s treasury as much as 10% of GDP.

We’re beginning to see the whole world financial situation as a U.S. problem. There is a lot going on…but the big story seems to be about America (and Britain, to the extent it shared the Anglo-Saxon economic model)…its money, its wealth and its place in the world.

The plot is simple enough. After an extremely successful run, the United States is struggling to maintain its edge. Its people are deeply in debt. Its currency is being sold off. Its labour…its capital markets…and its technological lead are all being challenged by faster, more youthful competitors.

Like any Greek tragedy, the hero is a victim of his own hubris. He thought he could steal the gods’ fire and get away with it.

Americans thought they could do things that have always been off-limits to mortals. They believed they could operate a financial system based entirely on paper money, for example. They believed they could spend money they hadn’t earned – and live off credit forever. They believed the myths of the Efficient Market Hypothesis and Benign Capitalism…the Black Scholes Option Pricing Model and the Great Moderation…that Deficits Don’t Matter and the War on Terror does.

And now…the whole society is being marked down – by inflation, deflation and a trillion-dollar, unwinnable war.

On the surface, it is merely another chapter in the world’s financial history. George Soros elaborates:

“The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years. However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.”

Those last 60 years were the 60 glorious years in which the United States was on top of the world. It’s the period roughly corresponding to Baby Boomers’ lives. Born after WWII…growing up in the ’60s…taking command in the ’80s…and now looking forward to retirement. Was there any better time to be alive? Was there any better place to be alive in than the United States of America? Its money was the world’s best. Its economy was the most dynamic and productive. And its people were the world’s richest. Full employment. Full stomachs. Free love and open bars…what more could you ask for?

Yesterday, the dollar hit another record low against oil. It now takes $111 to buy a barrel of oil…and, in Atlanta, $3.36 to buy a gallon of gasoline.

“That’s nothing,” said our driver in Manchester yesterday. “Here, the price of gas is nearly $10 a gallon. Of course, you don’t see any big American gas guzzlers either.”

Our driver showed us the instrument panel of his 2-year-old Skoda. It revealed an average fuel consumption of 56 mpg.

The car was comfortable and reasonably large. It didn’t seem to lack power.

“Here in England, we couldn’t afford to drive your cars,” he concluded.

Our guess is that Americans can’t afford to drive American cars either. The latest numbers show consumer spending rising – but only because consumers are forced to spend more on fuel. And experts believe that the summer of ’08 will be the first in which Americans actually drive less – forced off the road by high fuel prices.

Most people think of inflation as affecting prices they pay for bread and magazines. But inflation has a bigger agenda; it adjusts the wealth of whole societies.

The problem for Americans – and many others in the developed world – is that their wages are too high. They are used to earning a lot more money than their counterparts in, say, China or Vietnam. But why? Only because they have more capital and more skills, so they can produce more. But that situation is changing fast. Capital is piling up in China, Russia, Brazil and India – and elsewhere. As a result – wages in those places are soaring. Nestle just agreed to a 16% wage increase for its St. Petersburg, Russia, staff. In China, urban wages rose 18.7% in 2006. Ten percent annual increases in India are said to be the average.

In the United States, the last real, hourly wage increases came in the 1970s. Since then, adjusted for inflation, wages have been flat. But we Baby Boomers scarcely noticed. Because we were entering our peak earning years, our assets (stocks, then houses) were rising in value, and the expanding credit cycle left us with more money to spend.

But now, as Soros points out, that credit cycle has turned against us. The super boom is over. Our houses are going down. And the value of our labor and our stocks – which have held fairly steady – are being marked down by inflation. We are not becoming a Third World country…but we are becoming a poorer one…with a labor force that is less and less overpriced each year. Seems like a good time to retire. But forget the Winnebago – with gasoline at $3.36 a gallon, who can afford to cruise around on the wide-open spaces?

“Inflating is immoral in a sense because it steals,” Ron Paul said to us in an interview for I.O.U.S.A. “It steals value if you double the money supply and your prices go up twice as much…it’s an invisible hidden tax. But the real immorality here is that some people pay higher prices then others. So if you’re in the middle class, or especially low middle income, your prices might be going up fifteen percent a year. Somebody on Wall Street working leverage buyouts doesn’t have to worry about the rising cost of living. This to me is a immoral act, that is prohibited by the Constitution, and the outcome is always tragic.”

Could it be downhill from here on out – to the end of our lives?

*** Crude oil futures surged to their highest price ever today, hitting a new record of $113.93.

The rise in the price of crude was due to yet another rash of dollar weakness, prompting traders and investors to run to the safety of oil and other commodities, such as our favourite yellow metal.

Supply concerns also pushed the price up, as there were some minor pipeline disruptions.

There is a way we could circumvent these problems, our resident oil expert, Byron King tells us.

“There’s a new technology that can also be used to pump oil from old wells that were thought to be dry for decades. That alone could potentially add several hundred years to America’s oil supply.

“The truly awesome potential lies in this fact: The ‘Oil Vacuum’ could prove to be the only way to economically extract an oil reserve on U.S. soil that amounts to three Saudi Arabias.

“The U.S. Department of Energy says anyone who can pull this off ‘could contribute nearly 3 million barrels per day to reduce oil imports, improve energy security and fuel economic growth.'”

*** What’s up with food prices?

Agricultural commodities are notoriously cyclical. Prices rise; farmers plant more. The resulting bumper crop causes a bust in prices. Then, farmers reduce production, causing prices to rise again. Farm prices hit highs in ’74, ’77, ’80, ’86, ’94 and ’98. In the period following ’98, prices sank to what might have been all-time lows – adjusted for inflation. Now, they’re reaching up again. In terms of nominal prices, the CRB index of soft commodities is 150% above its 1993 low. Adjusted for inflation, farm products are up considerably less. And adjusted to the euro or gold…even less still.

What to make of it all?

Well, there are big cycles…and there little cycles. There are farm cycles…and there are monetary cycles. There are economic cycles and there are cycles of history.

Our guess is that right now we are witnessing a scene like on a street corner in Amsterdam – with several cycles coming together at once. There is a natural rebound of the farm cycle, in which farmers are offsetting low production with high production. We can expect prices to fall as a result.

But we also have a monetary cycle, in which the world’s reserve currency is being over-produced. This over-production will probably continue for a while – causing worldwide inflation in all globalized markets – notably foods, resources and gold.

And then, there is also a bigger trend in which billions of people who previously got by on meager, locally-produced diets are joining the international economy. They are moving to the cities (this year, the world’s urban population is said to be bigger than its rural population – for the first time in history), earning money, and buying their food with cash. Not only are they drawing on globalized food markets for their daily bread, they also want more food…and better food, such as meat rather than just grains. Meat requires more farm inputs…thus, putting pressure on the whole food chain. And there are limits on how much land and water is available to produce food. Some experts think we are near the limit now…or even beyond it.

At some point…in some places…the food chain snaps. Even today, billions of people spend 50% to 75% of their incomes on food. Double the price of rice or wheat – as has happened in the last two years – and millions of people are in serious trouble.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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4 Comments on "Inflation has a Bigger Agenda"

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Just one brief statement…..Australia went along with America’s liberal, diverse policies, over the past several decades, although I think reluctantly (don’t believe the people wanted it, but neither did the American citizens)…even so, now your country, as well as several other “democracies” are paying the price with higher costs of living, taxation, and uncontrolled immigration laws which allow thousands of people to enter from all over the globe…many of whom have no education or skills and therefore have to be taken care of by the government of their host country…’s a sad situation.

Unpopular Truth
No, the uncontrolled immigration (more applicable to the US than Australia) is only so that they can supply a cheap labor force to do the bad jobs that existing citizens do not wish to do. If they cut off immigration, then citizens will take up the jobs. Not because they want to, but because they need doing regardless. If you cant find someone cheaper to do it, you pay more. If you have to pay twice as much for your cleaners, burger flippers and factory workers, then everything you make costs more. This in turn drives inflation as the cost… Read more »
Diggin it!

The other problem with that current system is it creates a culture of laziness amongst the inhabiting culture, where those that should work will not and they become dependant on the system, from there a new generation is born that absorbs these principals of system living and lack nor require the motivation to be self dependant.

regarding the food chain in aus,we’ve had a decade and more in some areas, of less than optimal rain, wich means that actual grain harvests are down in levels are at all time lows.the drought has meant that stock numbers are down across most of the country, a lot of breeding stock were sold and slaughtered during the drought and most farmers are well down on numbers compared to a decade ago.prices for produce have been reasonably good in recent years at face value, but costs have soared especially in the last 2 years.managed investment schemes are buying some… Read more »
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