Economic Report for September 2009: Infamous Anniversary, Inflation, and Irrational Exuberance

Patricius Maximus here. After a longer-than-expected 40+ day absence, I finally have the time and information for a new edition of my economic report (which has so far failed to garner a single comment (oh well...)). Over the past month I've had my own technological debacle (see Franklin County for more information), and I have been trying to figure out recent events in the economy and markets.

I now have answers and predictions for both after much contemplation and research.

Firstly, a rundown of the events in the market and economy these past 50 days:

- Gold enters into a bull run, passing 1000 USD per ounce for the first time since March 2008, and rapidly closing in on a record high. It is now at around 1020.
- The US Dollar, as measured against other major fiat currencies, takes a bearish turn, going from 78 to 76 in one month (a drop of close to 3 percent)
- The stock market continues a rabid run-up, with the Dow at 9800, closing in on 10 000, and the S&P 500 over 1050.
- Oil remains stable, holding at around 70 USD per barrel.
- Treasury bonds remain relatively stable, but continuing a sustained drop in rates after peaking in early Summer.
- Unemployment improves somewhat, despite a chilling U3 number of 9.7 percent (I measure U5, U6, and U6+not in labor force but want job now - the last two numbers are improving (see prior reports for more info))
- Retail sales show an unexpected improvement (or so it would seem)
- Inflation picks up as measured by the CPI.

And a few other points, which is not exactly economic news:

- HR 3200 gets a good roasting (as John Boehner accurately predicted¹) at town hall meetings in August. Town Hallers are called racist and astroturfed, but actual facts prove otherwise. Most are genuinely liberal-minded people² who want their rights to be respected by their government, and for that I commend them.
- Relating to the above point, a "Tea Party" protest organized by various right-wing groups is held in Washington on September 12, to protest totalitarian government policies. The tea party crowd is more right-wing than the town hallers, but still, most are genuine liberal-minded people, despite the manifestations of extremists carrying around signs saying Obama is a Musilim (which has led to wild accusations from some Democrats). Crowd estimates range from 50 000 to 1 700 000. My personal rough guess would be 1/4 to 1/5 of the inauguration crowd, which would yield a figure of 200-500 000, which I think plausable.
- Ben Bernanke says that the recession is over. I am skeptical about this statement because Bernanke has a conflict of interest -- he may say that to make himself and his policies look good in order to be reappointed. In addition, he may be trying to talk up the markets and consumers to spend and invest more in order to mask his failures. Regardless, the recession may be over, but something exponentially worse may be just beginning.

And other miscellaneous market news:

- Rumors of a big bank failure chill some traders, but do not faze many, either because they don't believe it, or they believe the government will bail them out using TARP (which speaking of that, Washington has no political will to bail out anyone)
- Other rumors circulate about the FHA, the agency which currently owns Freddie and Fannie. The rumors state that FHA will go bankrupt in the next month because of crushing toxic debt inherited from the two GSEs.
- The annoying TD Ameritrade commercial showing their pitchman in front of a then-year-to-date chart of the Dow will turn one year old this month, still running on TV networks.


And I'll start off the commentary with this chart of the Dow over the past year, for the first time showing the post-Lehman era at the beginning of it:



I'll keep it simple and concise this time. I see a disturbing trend which has emerged in the markets this year. It has these factors:

- Stock market continuing a rabid runup with no supporting facts
- Doubling of the money supply
- Gold continuing to rise
- Commodities in general shooting up
- Weaker dollar
- Higher inflation

It is my belief that these are not disparite facts being cobbled together -- taken together, they tell a story and reveal what is happening. What does a doubling of the money supply, rising commodities and stocks, a weaker dollar, and high inflation tell me? They tell me of an inflationary scenario which is playing out at this moment.

An increase in the money supply is inflation. Commodities certainly rise with inflation. Stocks rise with inflation. The dollar falls on inflation. Prices rise with inflation.

All of these factors in an inflationary scenario are here, and can be marked with a big check mark.

The only thing that doesn't really fit in my opinion is the rise in consumer spending. Ordinarily, when prices rise, consumers cut back. But I can discount this fact for now in my scenario considering that consumers have to replace products every so often (nothing lasts forever) and spending has been weak since October 2008. It can continue to be discounted if this is a 1-3 month dead cat bounce, but cannot if it is a sustained trend.

Also, let us assume for a moment that Bernanke's call that the recession is over is correct. Let us also assume that he said it a few months after it actually ended (big assumptions). Then we would be in the early stages of a recovery, and the inflated money stuffed in the bank's vaults would start trickling out in the form of loans.

If all of this is true, then the little amount of introduction of the new money into the system caused all of these market moves and inflation pickup. Imagine what would happen when all of it is out of the vaults and into circulation. I am not saying it is happening now, but it will inevitably happen at some point in the future. Let us assume that the current lending represents about a hundredth of the total of the new money (which is a reasonable approximation IMO).

If all of these points play out, which they may or may not, then the current market moves are only a small fraction of what is to come. What is to come would be double or triple digit inflation, gold at least at 5000 per ounce, oil at triple digits again, and a much higher stock market³. In other words, a hyperinflationary scenario, which I believe is likely to happen given current Fed attitudes and policies. We saw what Greenspan's inflationary policies did to the economy. Imagine what that would do to the economy multiplied by a hundred times or more, which is Bernanke.

Lastly, if the rumors of the FHA bankruptcy come true, which they very well might, then the market will go into a Lehman-type crash pattern of the same sort it did in 2008. Also consider if the large bank failure rumors come true, a crash would happen there also. And I don't believe it would be bailed out, because of a simple lack of political will. I have elaborated before on why no bailouts would be the best choice in the long-term.

Below are charts of the US Dollar Index over the past year:



And gold recently:



¹ I do not lend any prophetic powers to John Boehner. He said it "would be a very hot August for Democrats in Congress". He was right, but only because he helped orchestrate the hot August.
² I use liberal in the generic sense, to refer to poltiical philosophies which consider personal liberty to be paramount, and have it at the center of the philosophy. This encompasses libertarians, most self-identified liberals, a few socialists, and some conservatives.
3 I say stock returns will go up because of this example from the Zimbabwe Stock Exchange, showing that shares go up with high inflation: