The Great Inflationary Melt-Up… Coming to an Economy Near You

Money, money, everywhere, and not a stock to buy.

Nerves are frayed in America. Ever seen a central banker quail in fear? Just watch CNBC this month. We reckon there will be plenty of furrowed brows and damp foreheads.

You see, it is now dawning on market pundits that we’re on the verge of a huge inflationary melt-up, and that is not a good thing. And we mean melt-up in the hot, nuclear sort of way.

“Fed may reduce rates three times this year, amid housing woes,” reports Bloomberg. “Big four to ride liquidity wave,” reads another headline in the Sydney Morning Herald.

As if there weren’t enough cash and credit driving stock and house prices up all over the globe, Bloomberg reports that the U.S. futures markets are now predicting the Fed will cut rates this year to try and avert the blooming crisis in the U.S. housing market. Note to Fed: you do not control long-term interest rates, and thus mortgage rates.

Second note to Fed: you can lower rates all you want, but mortgage lenders (the ones that are left and healthy) are already raising lending standards. The liquidity in the mortgage market is already drying up. Fewer credit- worthy buyers are entering, but plenty of new homes and condos are just now coming on the market. Short version: big increase in inventories, big decrease in buyers. Result? Falling prices, central bank easing, and some kind of repeat of the 1970s, where inflation whipped through the global economy like a scourge of locusts, eating purchasing power day by day.

If you are expecting an instantaneous global meltdown as credit dries up in America, well, you might get it. But odds are the subprime meltdown will be painful and long, punctuated by big one day swings in the share markets (followed by barrels of ink telling you not to panic and buy the dips. Why? 2005 and 2006 were even bigger years for subprime mortgage originations in the States than 2004. Those loans won’t adjust to their higher rate for another 12-24 months…meaning the very last people to the house price party won’t begin to feel the sting of higher rates and falling prices until later this year and early next.

Still, it might be better to panic now, as we advised a few weeks ago. But panic into what? As we said last week, the problem in most markets right now is too much money, not too little. Too much money makes valuing an asset hard to do. And even when you find something you like, you may be asked to pay too much for it.

What we really need now is a theory of investment relativity. Governments love inflation. America’s government and its central bank will need to worship the inflation gods in the near future. Inflation lightens the burden of heavy debt loads by making possible to pay back loans (or bonds) in paper currency of increasingly less value. You simply print more of the stuff ( U.S.dollars.)

This is what the Fed has said it plans to do. And if it does so, spurred by the rising scream of voting American homeowners, then you’ll see rising stock and home prices. The real question is what will go up the most in dollar terms: gold or the Dow?

It will be a great inflationary melt up. And if history is any guide, owning assets that are hard to produce is the best way to preserve the purchasing power of your savings and cash. That means precious metals over ordinary financial shares, or shares of precious metals companies, over, say, financial stocks.

We would not recommend, for example, that you buy shares in newly-floated “alternative asset” management firms, aka Pirate Equity firms going public. “BLACKSTONE Group is closing in on an initial public offering that would enable the US private equity group to raise billions of dollars, massively enrich its top executives and thrust the booming buyout industry further into the public spotlight” reports a wire service story.

The only people who will get rich from private equity going public are the underwriters who arrange the IPO and the pirate insiders. Everyone else is a sucker, and will probably get screwed.

On the other hand, while creating new shares or private equity funds seems to be remarkably easy these days, finding uranium is still difficult. In today’s world, any commodity whose supply cannot be increased by a meeting of men in suits and ties is worth a second look. Uranium, gold, grains, biofuels and a few other commodities fall in that category.

Uranium is probably headed to US$100 quite shortly, stunning us into regret here at the Old Hat Factory. We’d hoped for a larger correction to buy into. But we may have to wait a few decades for lower prices. “In a case of perfect timing, Perth’s Paladin Resources on Friday officially opened the world’s newest uranium mine, Langer Heinrich in Namibia. Paladin stands to be the biggest Australian beneficiary of the higher uranium price, which has spiked as a supply shortage has coincided with a huge jump in demand,” reports today’s Australian.

Pretty simple formula isn’t it? Find assets short in supply but growing in demand. This rules out most stocks and bonds, both of which are in ample supply, are already being chased by billions of dollars, and are getting increasingly harder to value.

How about local housing? A reader wrote in asking what we thought of the local market. We are not expert on the local market. But here’s an uninformed opinion: the high end will be fine because the rich are getting richer and can pay with cash. The middle and lower end is where the damage will be done. You don’t make homes more affordable by making credit more available. That increases homeownership, but also inflates home prices so much that new buyers must become indentured servants just to get into the market.

Yet that’s precisely where we find ourselves in late March 2007. Debt has become the only way to paper wealth. It’s a pretty horrible trade, if you ask us. That’s why we find ourselves trading down this weekend, looking to downsize our life-style (and monthly rental payment) in anticipation of tougher times ahead. We are wary of cash because inflation eats purchasing power the way a sumo wrestler eats sushi. But we’d rather be in cash than stocks and bonds. The liquidity crunch is coming…and it will be followed by the great inflation…it’s time to fireproof your portfolio.

Dan Denning
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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