Obama’s Inflation

America is heading towards the path of inflation and under Obama’s economic plan it may very well be one of the worst inflationary periods ever experienced.

The cornerstone of Obama’s economic plan rests on the following, from a CNN story:

On Monday, President-elect Barack Obama said the measures would be “creating and saving 2.5 million jobs – jobs rebuilding our crumbling roads and bridges, modernizing our schools, and creating the clean energy infrastructure of the twenty-first century.”

In order to understand why this is far more dangerous than meets the eye, one needs only to look at the root cause of inflation. Despite what you may know or not know about inflation, the primary cause is the increase in monetary supply, or simply put – money. When money is created out of thin air and not matched by a corresponding output (GDP), the value of this money drops. There is only force that can create money, it is our government and it is doing so at a very rapid rate and more will follow. Observe chart:

Virtually none of what is proposed will actually increase production; a road, a bridge, even a modern school will not increase our country’s output. Instead it will provide jobs under the employment of the government. However, the government needs money to pay for these jobs and it will be forced to create this money by printing or purchasing bonds – much like we have been doing currently in order to bail out failed companies.

This will be Obama’s inflation and will become his responsibility. While America can be convinced that increasing money is justifiable for the sake of Homeland Security or that withdrawing from Iraq is too dangerous – how can we justify that we must install computers into schools or create unprofitable green energy sources? There simply is no justification for this type of money increase in this kind of economy.

At first blush, everything would appear to be quite rosy. People will be happily employed, new infrastructure will be appearing and everyone will be dancing in the streets. But guess who will be implicitly paying for all this? Answer – anyone holding money (you), because the value of your money will drop. As additional currency enters the market place your buying power will diminish. It will be an implicit tax on all citizens, but unfortunately it gets worse.

In conjunction with Obama’s tax cut for the middle class, there will be a substantial increase in money – because once again these tax cuts must be paid for somehow, but virtually no appreciable increase in production/output.

Inflation will begin to erode our savings, reduce our purchasing power and weaken our currency. While the US has experienced double digit inflation before, during the 1970s for example, out of control inflation has power to destroy countries. A well known example is the Weimar Republic in Germany during the 1930s. Money became so inflated, German citizens were burning German marks to keep warm because the paper was worth more than the actual money!

Yet while no government wants hyper-inflation, the general approach toward moderate inflation is a bit more receptive. Reason being is that the government can continue frivolous spending at the expense of it’s citizens. Wages will generally increase to compensate for the increase in prices, but salaries now move up the tax bracket scale. Why would the government object to that, right? Furthermore and probably even more important, it is a convenient way to reduce the national debt. As our dollar drops in value, holders of our debt will get less back from the United States – while we sheepishly ‘pay back’ our obligations. Possibly the trickiest aspect to recognize and most important for you, is that the inflation lag can be quite long. The effects of newly printed money entering the economy can take anywhere from 4-12 months to materialize. So while we are in a deflationary period now the landscape can change dramatically and very quickly.

What should be done instead?

First of all, this obsession with employment is unhealthy and nothing more than a gimmick to create an illusion of improvement. FDR did the same thing during the New Deal by employing thousands of Americans on public works projects. Yet not surprisingly unemployment and people on relief were just as high in 1939 as they were in 1932 (if not more). Japan tried to spend their way out of their real estate crisis with massive construction projects and remnants of failed projects still line the roadsides.

Creating jobs out of thin air and paying for them with money the government does not have, is dangerous.

Instead jobs must be created in sectors that will boost the nation’s GDP. The best way to achieve this result would be stimulate employers. Cutting the corporate tax and decreasing government regulation could be a tremendous boost to both employment and total output. Anything from deregulating the FDA to the ICC would be a welcomed change.

Second of all, Bush has been rightfully criticized for his spending habits, yet Obama is headed down the same path. Spending must be drastically cut. The tax cut to 95% of Americans should be buried, Obama became president based on that promise, but now it’s time to disappoint people. Those hundreds of billions should instead go towards paying back our national debt.
Low-income families might experience a tingling sensation after receiving a $1,000 check, but it will be of little use to them when gas goes back to $4 a gallon and crude oil back to $100/barrel. With inflation, this will most likely happen, because oil is traded in dollars.

Spending money on ineffective programs like the civilian national force, massive construction projects and battling global poverty are all examples of programs that should be abandoned. All these programs result in monetary supply increase and have no benefit to our production capabilities. Only in booming economic times should these types of programs be considered and even then – sparingly.

If Obama continues down the path of attempting to spend his way out of this recession using money we do not have, we will face an inflation of staggering proportions. As an educated consumer, you can protect yourself by sheltering your money in traditional inflation safe havens; real estate, physical gold, shorting the dollar (UDN) or shorting bonds. I recommend the ETF – TLT (ultra long) and TBT (ultra short – thanks to one of the readers for providing this).

Be patient though as this will take a long time to play out, but once it does – you can not only protect yourself, but benefit from a potentially devastating scenario.

Treasury bubble?

The market has bounced strongly and did not visit Dow 7,000 – yet. This may still be a head fake, but it appears for now that the sector rotation is positive. Oil and other commodities will continue their spiral as global recession worries deepen, but another interesting development is underway. This one is rather troublesome too.

This is the chart of the 10 year yield. http://stockcharts.com/h-sc/ui?c=$TNX,uu[h,a]daclyyay[pb50!b200!f][vc60][iue12,26,9!lc20]

You can play around with it and change the time frame. Suffice it to say that the yield is now flirting with historic lows. Why does that matter to you?

Well, first of all, the 10 year note is what the 30-year fixed mortgage rates look at. The lower this yield, the lower the rate. Now could be the best time to lock in a new 30-year fixed rate on your house. Or is it?

It appears that the US economy has gone from bubble to bubble and typically, like a cop investigating the mafia, you just need to follow the money.

So first we went through a massive credit bubble where people were getting loans just for breathing. This lead to all sorts of issues including the housing crisis, but has spread to school loans, credit cards, car loans and the like. Commercial paper is completely in the toilet.
Then money went into the stock market, the Dow especially bubbled over and finally collapsed shaving off about 45% in value.

At the same time, the commodities were raging, particularly oil. Hitting 147 bucks per barrel was not only a death knell for the economy, but a speculation train badly derailed. Remember, when oil/gold lead – a recession is absolutely on it’s way.

After that bubble popped, there should have been some kind of recovery period. However there is a rumbling in the treasury market with bonds reaching historic highs. This is where the money is going? What is frightening is that the bond market is an indicator.

When bonds fall, they are afraid of inflation. Naturally, right? Inflation implies that the power of the dollar is weakening and not only is your purchasing power diminished, but so if your capital. Capital is the difference between the poor and the wealthy. Those that can accumulate capital and wealth, enter a welcomed circle of money making money. High inflation destroys that wealth creation and is often the #1 problem that the Fed faces. During Jimmy Carter inflation was in double digits and the economy was devastated. After Reagan left it was in low single digits, but I digress.

So with bonds rallying as they are now, they are suggesting that there is no sense of inflation. NONE. In fact, they are telling us, that it’s quite the opposite. As bonds rise and yields fall, the implied statement is this; We the bond market, are suggesting that in the next 30 years you will not do any better than 3.5% gain on your money. That is a very depressing notion.

Money is essentially flooding the last good market out of fear, panic, whatever. The bailout that is being foisted upon us by the government is playing a role I am sure and the cheap money (due to low interest rates) is promoting this kind of behavior.

This bubble is not sustainable and if it bursts just like other bubbles, we are going to be looking at a world of hurt. With a falling bond market, the signal will be immediately reversed and panic will grip our economy. At some point, our government will start printing money to pay off our loans and if the bond market bursts, we might be looking at hyper inflation. I frankly do not see any other way around this, the printing presses will start working around the clocks. Either that or our great country declares bankruptcy. One or the other. But before we reach a crisis of epic proportions, back to the mortgage question.

Why would I refinance now if all the money is flooding the bond market. 30 year fixed rates are now at 5.5% or so, but where will they be in a week? month? No, I am going to wait.

Here is a great article that explains the macro of it all.