Inflation: Enemy Number Two


All bubbles end in busts…and the perp walk.

Two hedge fund managers were arrested yesterday. It was claimed that the two Bear Stearns boys deceived customers.

Oh stop it! We’re going to break a rib laughing….

Deceived customers? What is a hedge fund anyway? It’s a way for Wall Street to take money from investors who can’t do math. There’s no deception required. In fact, the funds’ names – High Grade Structured Credit Strategies Fund and High Grade Structured Credit Strategies Enhanced Leverage Fund – told investors all they needed to know. They practically screamed out: ‘SAY GOODBYE TO YOUR MONEY…IF NOT NOW, LATER.’

So, imagine that you have money invested in the fund that advertises itself as offering “enhanced leverage” from “structured credit strategies.” Now, imagine that you read in the paper that houses are going down in price…and that subprime mortgages are going belly up. Couldn’t you put two and two together? Well…duh… but that’s just it, people who invest in hedge funds can’t do math. The managers didn’t have to deceive them. They just had to keep their mouths shut…which they did.

But this is the way bubbles end…in losses…in anger…and in jail. The losers always think someone else is to blame. It’s not long before they have a CEO, a speculator, or a fund manager mounting the scaffold.

Let’s leave that thought on the shelf and get on with our reckoning.

Oil lost $4 last Thursday. The Dow rose 34 points. The euro slipped a little. No biggie.

But look at this: “Inflation now enemy #1 for the Fed,” says the Wall Street Journal. This sort of thinking sent the price of gold up $10 yesterday; it’s now back over the $900 level. And one of the key fellows at Schroder Investment Management told a crowd in Hong Kong that he thought gold could go to $5,000 before this run of inflation is over.

$5,000? Who knows? But, the poor saps at the WSJ are missing the point. No central bank keeps rates 2.2% below the level of consumer price inflation if it is really fighting inflation. Enemy Numero Ono? What are they thinking? Why are all the Fed’s guns facing deflation, not inflation? Sure, there’s been some blabbing about turning around…about switching sides in the war between inflation and deflation. But so far, it’s just talk.

Talk is cheap. It’s action that is dear. And the action the Fed needs to take – raising rates – will be so potentially costly for the lame U.S. economy that Bernanke and Co. are afraid to do it. They’re hoping inflation will go away so they can continue the battle against the slump, without having to worry about their unprotected flanks. Most likely, they will make a gesture towards raising rates – perhaps a quarter of a point. But then, when the mob starts howling for his head, Ben Bernanke will drop them again.

Henry Paulson has been gurgling about a strong dollar. Yesterday, he gave voice to a contradictory notion – that the Chinese should let their currency rise (and the dollar fall).

The problem for the Chinese is that they have too many dollars, furnished courtesy of the Fed, while Americans have too few. In the United States, the average household barely has enough dollars to fill its gas tank and pay its bills. But the Middle Kingdom is flooded with them.

If you don’t watch out, you’re going to drown in them, said Paulson – or words to that effect. China’s economy continues floating higher and higher. But all these extra dollars are pushing up wages and prices as well as the economy.

And then, wouldn’t you know it, Chinese export prices go up too. And pretty soon, prices are up all over the world.

Which is why the WSJ thinks it’s the top problem for the Fed too. Of course, it is a problem. But with the official CPI at 4.2% it’s not enemy number one. Maybe it’s Enemy Number Two. Most likely, it will stay there for a while longer. We still haven’t seen a big drop in commercial property…or in consumer spending. Those are probably still ahead…and will give the Fed a reason to continue blasting away at a deflationary slump. Consumer prices will continue to rise, too. Eventually, they will become so high that inflation really does become Enemy Number One.

By that time, the price of gold could be $500 higher.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.


  1. I agree Talk is cheap, but that is all the fed has to offer the market – talk. In reality, that aren’t doing anything to fight inflation and the dollar will likely continue to decline.

  2. “the action the Fed needs to take – raising rates – will be so potentially costly for the lame U.S. economy that Bernanke and Co. are afraid to do it”

    There’s also that element of needing to save face (though I admit not much of a face remains for Ben & gang). As much as I loathe Ben for his demonstrated incompetencies, he deserves some sympathy for having inherited that one-wheeled tricycle of an economy. I look to his predecessors for answers. Not such feeling towards Paulson though, he’s a prick.

    “But with the official CPI at 4.2%”

    The ‘official’ inflation figure published by the RBA is so constrainted by assumptions that it lives in its own la la land. And CPI takes into account of a generalized basket of goods/services. What would core inflation be for essential goods alone like food, fuel and raw materials?

    As for Hedge Duds, they’ve been pruning investment capital for yonks. It’s always going to be a spectacular hazard when the derivatives market (essentially just a bunch of contracts) is numerous folds the size of the underlying assets market they represent. It’s nuts – and now that the primary focus is on inflation, one should be very wary of several new and upcoming innovations including those dubious “inflation hedges” and swap-based arrangements. It seems to me that sheep’s clothing is no longer adequate disguise for the wolf – if I were institutions, I would probably ditch the word ‘hedge’ for something less conspicuous like ‘Tip Top Inflation Pruning Swear to God Fund’.

  3. The FED is letting the dollar be destroyed. It’s part of “the script”.

    Gold will be reintegrated (as money) by the market, bottom-up, but this time around , it will not be based on a fixed peg !!! The peg had to go. Gold was NEVER a problem, only the logistics of past gold systems presented a problem. A fixed peg could never reflect supply-demand fundamentals between currency supply and gold supply. The need for more currency under a fixed peg system such as Bretton Woods meant needing more gold. Doesn’t work.

    Now , however, gold can be related to currency in real time. Digital currency backed by 100% gold weight , where accounting by weight is “shipped” from account to account makes for a debt free transaction. Liquidity with no debt ….. global …… seamless ! The ability to “slice off” a tiny piece of gold is where the measurement using currency has its place ….. any currency. Gold is then recentralized as it should be. Balance.

    Think. If this is a bottom-up market evolution, it needs market participation and a massive move toward gold, even if it’s just as an investment at this time. Is that monetary transition best served in an inflationary or deflationary environment ?

    We’re getting near the end of the last act. Won’t those commodity based ETF’s make wonderful personal monetary reserves … time?

  4. Bill,

    You should not believe a word the US Gov’t says. Inflation is up 60% just this year, for groceries, & is expected to go up another 20% THIS MONTH ALONE. We could even be on the verge of “hyperinflation,” who knows? It is ridiculous what Bernake claims the CPI is. And inflation is not anywhere close to 3.5%!

    Out here in the trenches, I’ve seen moms standing in line in the grocery store putting babyfood back, when they can’t pay the bill. I’ve paid for their groceries on a few occasions. There are people who have stopped driving their cars altogether, since they must make a choice between food & gas. ($4/gal, going to $5, 6 & now I’m hearing $7.)

    Not to mention employment. The true number is somewhere around 12-15%. About 1 out of every 8 people I know is unemployed.(None of the realtors or mortgage brokers will show up on the unemployment rosters, since they were “independent contractors….but the existing offices all have skeleton crews,) & vacating agents are mostly unemployed, & can’t find jobs. The peripheral businesses are falling off like flies, too – furniture companies are losing people (no sales,) & many are closing their doors. Every business that depends upon real estate is in decline.

    The #1 problem IS the falling dollar. We need less gov’t & a leader who understands economics, or has the sense to put someone who does into a position of responsibility, & bring in someone to regulate the irresponsible credit & mortgage industries, too.

    The #2 problem is that America needs to GET BACK TO WORK. With all the OUTSOURCING going on, no wonder America is unemployed/ underemployed! Can we get those jobs back? NO! Because why pay an American $15/hr when someone in India will do the work for $1.50/hr? So we must take the ball & run with it ourselves. Where is the ingenuity we once had, many years ago? We need a new invention to replace the car, and to RE-THINK the way it RUNS. This is what we should be working toward.

    America is a great country where people of all walks of life can achieve their DREAMS. We have always been pioneers in the world. We came up with the railroad, then autmobiles. We came up with the space program & the shuttle. We lead the world in films, multi-media, & much more. We are all interdependent. When America sneezes, the rest of the world gets a cold. So it will be in everyone’s best interest to begin thinking globally, & start working together. America needs to re-invent itself to be a player in this new global marketplace.

    Becki Weaver
    June 26, 2008
  5. Dear Dan,

    The availability of gold as a liquid tradable commodity would, to an extent, reinforce its capacity as a proxy standard for currency exchange. However, the effect of open market speculation and trade noise would greatly diminish its effectiveness as the universal benchmark. Thus, the only way for a stable system of exchange using gold as the fundamental base currency would be to nationalize, or rather internationalize, the operation of this commodity. Gold would have to taken out of private ownership and restored into the hands of the global citizenry. Furthermore, this process of reconciliation and subsequent management of the standard requires unprecedented international cooperation just to ensure that adjustments to gold and/or currency volumes are pro-rationed to maintain ratio equilibria. Proportional commensuration is crucial to prevent mal-distribution and have people throwing fits when they discover their wealth diluted in this world of a universal currency. Before this happens, I suggest try getting Iran and Israel to sit side by side for 5 minutes without gouging eyeballs.

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  7. It’s like being hog tied, and gagged..
    Gov. needs to loosen up..drop the income tax and allow America to redefine itself..We are in need of our hard earned pay!

    Seem’s like the crooks are the only ones able to get ahead in this day and age.


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