The gold price
The New Inflation - Thursday 2nd April 2009
Inflation never really went away, but now it's back regardless, and it's angry...
The US STOCK MARKET's begun inflating again, enjoying the occasional stellar gain but showing overall deflation for the first 3 months of the year, costing more than one-tenth, notes Eric Fry in the Rude Awakening.
Happily for recent investors, the stock market did more inflating than deflating during the last 30 days. So after all the inflating, deflating, gasping and hyperventilating, the S&P 500 Index wheezed to an 8.5% gain for March – the best one-month performance in seven years.
Emerging market stocks also inflated during March, as did bonds and almost every type of commodity except for gold. The precious metal deflated 2.5% last month.
How come? Inflation is not a monolithic or one-dimensional phenomenon. All around us, at all times, asset prices are in the process of both inflating and deflating. But most folks don't look at the world that way. Most folks only recognize inflation as the thing that that transforms a ten-cent ticket for the picture show into a $10 ticket for the cinema.
Inflation, as generally recognized, is the thing that causes the stuff we buy to go up in price. When the things we OWN go up in price, we call that a bull market, or in some cases, investment genius. But after stripping away all the flattering vernacular and marketing language that surround most bull markets, we find something that looks an awful lot like mere inflation.
An expanding money supply does not cause all assets to increase in price at the same time. An expanding money supply is usually a stream, not a flash flood – it flows along the path of least resistance. Sometimes, that path finds its way into a funnel of investor exuberance for a particular asset class. So as excess liquidity pours into the economy, investors will channel that liquidity into their asset of choice, like housing or stocks...at least for a while.
But over the long sweep of time, excess liquidity will manifest itself as the rising prices of goods and services – i.e., as the thing we call inflation.
During the Greenspan era at the Federal Reserve, a combination of delightful socio-economic accidents caused the excess liquidity he produced to find its way into the stock market first, then into the housing market. These asset bubbles masked the underlying inflationary trend that Greenspan nurtured. And the extent of this inflationary trend did not become clear until after both of these Fed-induced bubbles burst.
Though the prices of stocks and housing have collapsed, the thing we call inflation has not. In fact, it has accelerated. The nearby charts present a non-scientific picture of this phenomenon. In the first chart we see that over the last 12 years the consumer price index has increased 33%.
That's a few percentage points more than the S&P 500 index increased over the same timeframe.
A couple of observations for long-term investors seem appropriate:
To restate this same observation, if the CPI has managed to outperform the stock market during the relatively tame inflationary outcomes of the Greenspan era, imagine how the CPI might perform under the Zimbabwean policies of the current Federal Reserve...?
The second chart puts a little more meat on the bones of our inflation-phobia. During the last 20 years, home prices here in my beloved Los Angeles region have boomed and busted twice.
The latter boom nourished itself on the excesses of the easy-credit era, in the process convincing a generation of homeowners that rank speculation was actually "prudent investment."
Everyone understood that buying a home was a great investment, especially a Southern California home. But that was not entirely true.
During the last 20 years, most homebuyers would have been better off to take out a mortgage on a stack of Gold Bars, rather than on a stack of bricks and mortar.
The national bull market in housing was as much an inflationary phenomena as the bull market in stocks that preceded it...and the bull market in Gold Bullion that preceded the bull market in stocks.
But now that these enjoyable manifestations of inflation (i.e. rising prices for homes, stocks, baseball cards, vintage Coke bottles and all the other stuff that we own) have perished, what comes next?
The unenjoyable manifestations of inflation? That would be our guess.
As the Fed pumps newly minted dollars into the economy, these dollars are unlikely to find their way into the beleaguered stock market or housing market. Instead, they will find their way into the channels of classic inflation, causing the Consumer Price Index to rise.
Get ready for the new inflation.
The US STOCK MARKET's begun inflating again, enjoying the occasional stellar gain but showing overall deflation for the first 3 months of the year, costing more than one-tenth, notes Eric Fry in the Rude Awakening.
Happily for recent investors, the stock market did more inflating than deflating during the last 30 days. So after all the inflating, deflating, gasping and hyperventilating, the S&P 500 Index wheezed to an 8.5% gain for March – the best one-month performance in seven years.
Emerging market stocks also inflated during March, as did bonds and almost every type of commodity except for gold. The precious metal deflated 2.5% last month.
How come? Inflation is not a monolithic or one-dimensional phenomenon. All around us, at all times, asset prices are in the process of both inflating and deflating. But most folks don't look at the world that way. Most folks only recognize inflation as the thing that that transforms a ten-cent ticket for the picture show into a $10 ticket for the cinema.
Inflation, as generally recognized, is the thing that causes the stuff we buy to go up in price. When the things we OWN go up in price, we call that a bull market, or in some cases, investment genius. But after stripping away all the flattering vernacular and marketing language that surround most bull markets, we find something that looks an awful lot like mere inflation.
An expanding money supply does not cause all assets to increase in price at the same time. An expanding money supply is usually a stream, not a flash flood – it flows along the path of least resistance. Sometimes, that path finds its way into a funnel of investor exuberance for a particular asset class. So as excess liquidity pours into the economy, investors will channel that liquidity into their asset of choice, like housing or stocks...at least for a while.
But over the long sweep of time, excess liquidity will manifest itself as the rising prices of goods and services – i.e., as the thing we call inflation.
During the Greenspan era at the Federal Reserve, a combination of delightful socio-economic accidents caused the excess liquidity he produced to find its way into the stock market first, then into the housing market. These asset bubbles masked the underlying inflationary trend that Greenspan nurtured. And the extent of this inflationary trend did not become clear until after both of these Fed-induced bubbles burst.
Though the prices of stocks and housing have collapsed, the thing we call inflation has not. In fact, it has accelerated. The nearby charts present a non-scientific picture of this phenomenon. In the first chart we see that over the last 12 years the consumer price index has increased 33%.
That's a few percentage points more than the S&P 500 index increased over the same timeframe.
A couple of observations for long-term investors seem appropriate:
- The stock market has produced an after-inflation return of less than zero since 1996.
- The Consumer Price Index maintains an upward, inflationary bias, despite the plummeting values of stocks and real estate.
To restate this same observation, if the CPI has managed to outperform the stock market during the relatively tame inflationary outcomes of the Greenspan era, imagine how the CPI might perform under the Zimbabwean policies of the current Federal Reserve...?
The second chart puts a little more meat on the bones of our inflation-phobia. During the last 20 years, home prices here in my beloved Los Angeles region have boomed and busted twice.
The latter boom nourished itself on the excesses of the easy-credit era, in the process convincing a generation of homeowners that rank speculation was actually "prudent investment."
Everyone understood that buying a home was a great investment, especially a Southern California home. But that was not entirely true.
During the last 20 years, most homebuyers would have been better off to take out a mortgage on a stack of Gold Bars, rather than on a stack of bricks and mortar.
The national bull market in housing was as much an inflationary phenomena as the bull market in stocks that preceded it...and the bull market in Gold Bullion that preceded the bull market in stocks.
But now that these enjoyable manifestations of inflation (i.e. rising prices for homes, stocks, baseball cards, vintage Coke bottles and all the other stuff that we own) have perished, what comes next?
The unenjoyable manifestations of inflation? That would be our guess.
As the Fed pumps newly minted dollars into the economy, these dollars are unlikely to find their way into the beleaguered stock market or housing market. Instead, they will find their way into the channels of classic inflation, causing the Consumer Price Index to rise.
Get ready for the new inflation.
Eric J.Fry, 02 Apr '09
Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.
Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.
