Investors Are Thinking: Inflation is Coming, But it Isn’t Here Yet


We love surprises! But only when we see them coming.

We’re always wondering: how will we be surprised? What will happen that we don’t expect?

It’s easy to make money…if there are no surprises. You just put your money in something that is going up and let it go.

But surprises sink ships, marriages, military campaigns and investment portfolios. Things happen that you’re not prepared for…

A friend told of what happened to a mutual friend:

“I guess it was the embarrassment that bothered him most. I don’t know. He was happily married…or he thought he was. They had three children. They must have been married 10 years. And then, she announced she was a lesbian…and moved in with a woman.

“I imagine he was devastated. He didn’t seem to have any idea. But just think how you’d feel. You’d think that you were so awful you’d turned her off on the whole male sex. She wanted nothing more to do with any of them…”

Yes, dear reader, you have to watch out for the surprises…

Stocks have been rising since March 9th. Yesterday, the Dow went up another 15 points… The Dow now looks toppy…like it will go down again soon. But the rally may have further to go – maybe all the way to 10,000, as we originally guessed.

And yesterday’s rain of news brought forth another green shoot. New houses are selling again – with sales up 11% in June. Maybe it’s time to buy a house. Better yet…buy a huge house with a huge, fixed-rate mortgage! Sometime between now and the next 30 years a fixed-rate mortgage is bound to lose its bite. What are the odds that inflation won’t rise in the next three decades?

Last week, in Vancouver, we left listeners confused.

“Should I buy gold or not?” was the question one posed.

It’s a good question… we’ll turn to it in a moment.

First, the background…

Everyone knows that stimulus leads to inflation. And everyone knows that this is the most daring use of stimulus ever attempted. Ergo, it seems likely that we will soon see the most inflation we’ve ever seen.

But it’s not that simple. The story is too easy to tell. It’s too obvious. Too logical. Too easy to explain and too easy to understand. Under these circumstances, inflation would be no surprise!

At least…that’s been our worry. That too many people understand the inflation threat and are positioning themselves to avoid it. Everybody can’t be right. As they say on Wall Street, when everyone is thinking the same thing no one is thinking.

But is it true? Is it true that people fear inflation and that they are taking investment positions to counteract it? Alas, we don’t know…but perhaps not. Neither the yield on Treasuries nor the price of gold signals a panic about inflation. Just the contrary; they seem to be telling us that investors are complacent…that they’re aware of the inflation threat. They may be even sure that inflation is coming. But they seem to think that they can take action later – after inflation actually shows up. Seems reasonable, doesn’t it?

The inflation rate is currently MINUS 1.4%. That is, we’re experiencing deflation, not inflation. Why try to protect yourself against something that is such a distant threat?

Our guess is that this is what most investors are thinking: that inflation is coming, but that it isn’t here yet. They’re watching…they’re holding their fire…but they won’t be surprised by it.

But what if they’re facing the wrong way? While they’re keeping an eye on inflation, what could be sneaking up behind them?

Ah…keep reading…

Practically everyone anticipates rising rates of inflation. The adjusted monetary base of the United States has more than doubled in the past year. Deficits are staggering. The price of oil – at $68 – is telling us that inflationary pressures haven’t gone away. Gold, too, at $953, seems to be whispering – not shouting – a warning: watch out…

So, what’s the prudent thing to do? Shouldn’t you keep an eye on inflation, like everyone else…and participate in the stock market rally at least until it shows up? If you failed to join the rally, you missed an opportunity for a gain of 20% to 40%. Though a correction in the rally is probably at hand, wouldn’t it make sense to buy stocks…hold them until the rally ends or until inflation appears…and then jump into gold?

Yes…that seems sensible.

But where’s the surprise? Here’s one possibility: a much deeper and more persistent depression/deflation than people expect. Ben Bernanke told Congress that he had sought to avoid “a second Great Depression.” Well…what if he failed?

Roger Lowenstein in The New York Times:

“The US economy is not only shedding jobs at a record rate; it is shedding more jobs than it is supposed to. It’s bad enough that the unemployment rate has doubled in only a year and a half and one out of six construction workers is out of work…

“The Federal Reserve now expects unemployment to surpass 10 percent (the postwar high was 10.8 percent in 1982). By almost every other measure, ours is already the worst job environment since the Great Depression…

“In terms of its impact on society, a dearth of hiring is far more troubling than an excess of layoffs. Job losses have to end sooner or later. Even if they persist (as, say, in the auto industry), the government can intervene. But the government cannot force firms to hire.”

Job losses result in fewer purchases…which result in fewer sales and earnings…and that leads to more job losses and falling prices. That’s what a depression is all about.

Currently, we look at that -1.4% inflation rate as a fluke…an aberration. And most people are sure the feds will stir up the inflation rate soon. But what if the feds are more incompetent than we realize? What if they can’t cause inflation? The Japanese couldn’t. And they never had deleveraging consumers to contend with. In other words, their households were never so deep in debt that they had to cut back spending in order to pay down debt. But they cut back anyway…and Japanese prices fell.

Nor did the Japanese have an entire world economy that was deleveraging. Instead, they were able to continue supplying goods to eager consumers in the United States…and making profits.

America’s economic situation is much more dangerous…and potentially much more deflationary. We could be entering a period of falling prices that will last for many years.

So, should you buy gold or not?

Ten years ago, we suggested a simple Trade of the Decade. Buy gold on dips; sell stocks on rallies.

This was not the best trade you could have done. There were huge run- ups in stocks and in oil, for example. Many investments would have paid off more. Google was probably the biggest hit of the period.

But the Trade of the Decade looked to us like the safest, surest thing you could do with your money at the turn of the century. Gold was at a record low; stocks were at a record high. What could have been easier?

And it turned out to be a decent trade.

The decade is not finished. So, we’ll stick with our trade a bit longer. Our guess is that we’ll see some additional profit when the stock market turns down again. But gold’s big day still may be a long way in the future.

So, if you are looking for quick profits, gold is probably not a good buy. It’s a monetary metal. It is fundamentally a protection against paper money and financial distress, not a real investment…or even a speculation.

Since we rate the risk of financial distress very high, we buy gold – as insurance. But we do not expect a major bull market in gold soon. Later, after deflation and depression have surprised investors and squeezed inflationary expectations out of them, we will buy gold as a speculation. Then, investors will be surprised by how fast inflation comes back.

Until tomorrow,

Bill Bonner
for 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.
Bill Bonner

Latest posts by Bill Bonner (see all)



  1. Inflation results from aggressive bargaining by unions for increased wages, a scarcity of resources required by consumer/industrial markets and manipulation of financial and commodity sectors. With millions of skilled workers laid off there can’t be much bargaining for wage increases so this can be taken out of the inflation equation.

    Metal and non-metal commodities are in surplus and potential oil offshore in Brazil and New Zealand should keep its price under $100/bl so here again no reason for prices to rise. Only weather affecting crop production could spur a significant price rise, but it’s unlikely that bad weather would hit all of the world’s growing areas simultaneously.

    While earnings of Chinese might inch up these may well be matched by increased, more efficient production so the price of consumer goods should continue to be a nonfactor in inflation.

    It’s not likely that anyone will beat down Chinese prices, additional oil whether offshore or from the tar sands will remain costly to produce and metal mining costs will not likely go down so the prospects of deflation occurring in these sectors are likewise remote. So the current “adjustment” in the economies of the world may well bring us to the steady state economy, particularly one in which the growth of government is curtailed; after all it’s government at all levels that primarily benefits (as well as contributes to) from inflation through the collection of increased taxes.

    Paul Tatarewicz
    July 29, 2009
  2. Paul:
    There are two common understandings of ‘inflation’.

    One is price inflation. The other is inflation of the money supply.

    I believe that the latter directly affects the former.

    From my understanding, the issue we have right now is that general asset* inflation was actually caused by so much credit in the system. Now we are in the process of asset price deflation.

    ‘If’ the Gov’s of the world decide to try and combat this deflation by expanding the money supply (as it contracts) this will cause inflation. Keynesians would probably argue that this is okay and that this inflation of the money supply is just filling the holes that the credit deflation left. Personally I don’t think they are so interchangeable.

    *The reason that assets inflate with credit availability is that you ‘usually’ use credit to buy assets (eg real estate, cars, TV’s) rather than groceries or daily items. That is why the CPI doesn’t really reflect that part.

    Thats my take on things anyway.

  3. who said that inflation has vanished?. maybe in the western credit bloated world. in india, salaries are up, hiring is okay, asset prices are still rising .housing prices havent stopped rising.

    the western worlds have just managed to export asset inflation. the carry trades are back on. instead of only japan, the whole wide western world is now a big japan. the receivers of the inflation are the BRICs

  4. Yes, buy gold a great idea (better still silver currently) because its in a secular bull market obvious to anybody glancing at a long term chart. This unlike most other markets and because of a clear difference in my opinion. Good old supply and demand and an unprecidented demand for sound currency in an era of almost universally unsound currencies.
    Despite manipulation of USDX (up)and gold prices(down) by bullion banks etc the gold price will glide effortlessly through $1000 in the not too distant future at which stage a huge degree of short covering and new long contracts will shoot the price up to a much higher level. A level which much closer represents the true demand for gold. China and others have already decided the fate of the US Dollar and their obvious intent for a gold backed future.

  5. I might be misunderstanding Pete (both you and/or the CPI makeup) but my take on things is that the CPI includes the cost of credit? – They call it “The Cost of Financial Services” or some such. And I think that explains (in large part at least) why the CPI is currently so low. Although core inflation in Oz is not low. But the RBA reckon it will be. That would be a nice change. But I’m not holding my breath. Smile!

  6. Ned S – having trouble sleeping? Then here is something about CPI that will send you to sleep. :)

  7. Ned S: I was referring to the cost of assets, not the cost of credit.

    Eg, does a 20% increase in house prices make it into the CPI? It’s not exactly ‘consumer’. And if so we’ve been affected by high inflation for a long time then.

    The CPI is a very distorted piece of work.

  8. Paul, union negotiations do not drive inflation.

    (just reviewed this when I finished, and I apologise for this posts size, and the rant nature, but, I hope it demonstrates accurately my considered opinion).

    It is margins on the movement of money that sets the rate of inflation above and beyond any expansion in the money supply.

    That a union is negotiating a 4% pay increase is only a symptom of a 3-4% official inflation rate (although as I argue later this is deliberately much underquoted).

    What has clearly driven inflation over the last 20 years has not been wage inflation. Who really considers themselves richer now than they were 20 years ago (exclude the lifecycle of being in the economy for 20 years and the advantages this brings). Compare a new job starter today with a new job starter of 20 years ago. Which had the greater capacity to spend his/her money on assets, the classic being a house?

    Even with the crash in housing around the World, housing affordability is still way in excess of earnings potential and many in our societys’ are financially excluded from home ownership, more so now, than they have ever been.

    All of these international securitised money transactions account for fees. Fees drive commerce. As sure as eggs is eggs when someone buys something from a supplier or retailer there is someone who is not directly involved in the transaction raking in a fee.

    1.5% of the vast majority of transactions is levvied as a fee via credit cards. No longer do retailers or suppliers burden this fee as it is now directly documented in transactions as a surcharge on the sale.

    The more inventive the banking system has become the more prolific and pervasive have fees become. The banks over the last 20 years have veritably gourged on them.

    This money leveraged from society has been deliberately leveraged back into society as an inflated loan book.

    Because governments and financial controllers realised they have little if no genuine control over the inflation cycle (primarily because they just love to spend beyond their means, look at George Bush snr and his attempt to get the U.S to balance its’ budget, raising taxes, and being voted out at the next election), they have massaged the statistical definition of inflation. CPI is a diversion for fiscal managers sake from real inflation.

    The single biggest asset any normal run of the mill Joe (wee hee!) will ever buy as a proportion of his/her earnings is their first house.
    If the value of this is not measured in official inflation, which then has no bearing on a nations wage structure you end up where we are, with the housing stock inflating anywhere upto 25% in a year, but wages restrained to 2%.

    So, we are where we are today because of the CPI lie, the over-spending of politicians desperate for re-election, and a banking system systematically designed to screw every fee possible (like a leech) from society.

    In the 80’s within manufacturing there was a process formulated to design efficiency into any system. This process was called ‘Business process re-engineering’. It’s primary principle was to remove all none value adding processes in a system to derive at the most efficient and cost affective method of either making something, or conducting a servicable unit of work.

    If getting $1 from A to B via so many intermediaries all taking a 1% cut leaves the original $1 deflated to 90c then you have an inefficient system that is designed to collapse. This is what we have today.

    An example of this is my pension with Legal and General in the U.K. Being a sole employee of my own company, I began a private pension in 1995. I emigrated to Australia in 2005, and 10 years worth of contributions were paid into it. These contributions rose annually with average earnings so more and more was paid into the fund each year.

    Since 2005 no more contributions have been made as I now have a fund here in Australia.

    The last quote (some 13 years of continued and fixed investment making some form of annual return) was still valued at less than the total contributions into the fund.

    Take all those fees and money dilutions and feed them back into the fund and there would have been a clear profit. This is the direct result of a banking and finance system that is clearly self serving.

  9. Joe, while I agree with much that you say you cannot discount productivity as a factor in the inflation cycle. In the Whitlam 70’s in AU the public sector got pay rises that swamped productivity gains. We were also affected (and I don’t use the word in a political or critcal sense) by equal pay for women and other gains in working conditions as a result of union campaigns.
    Now I might sound like Chairman Keating but the brigand that he is at the same time took the low road of current account debt fueled multipliers to GDP, financialisation, more extreme market rigging banker-investment positions than the US post Glass-Steagal cancellation, and the greed servicing ticket clipping asset price inflating tomfoolery that you mention.

  10. Pete – The sort of case I’ve seen made for including the actual prices of housing in the CPI goes along the expected lines that if it is getting high that would add to the CPI and trigger an interest rate increase by the central bank to take the heat out of the housing market. But the problem remains that interest rates are a “blunt tool”.

    An alternative is to specifically set different interest rates for different sectors of the economy. (George Soros did a writeup on that too. If I remember correctly, I think the US Fed may have had that ability at one time and Soros was advocating bringing it back into play?)

    In many ways it is what we have in effect in Oz now I guess, with very different interest rates being set for consumer credit cards and business borrowing and residential RE finance. But those rates are set by the banks bearing in mind whatever it is that affects them – Including the single rate set by the RBA.

    I’m not at all sure if central banks will ask the pollies for that level of control in the future. But when the world is talking about the desirability of reining in energy market speculation, the possibility would certainly seem to exist.

  11. Ross, productivity measurement, like inflation has now been fudged into a meaningless value.
    IMO labor productivity should be measured in units output per hour.
    Instead it is measured in dollars which means it’s subject to inflation, and other factors.
    I suspect that most of the so-called productivity gains in Western economies over the last 10 years have really consitituted paying people less real wages for an hour of work rather than producing more in an hour.

    Inflation is also affected by directors and shareholders paying themselves excessively in the short term when they should have been looking ahead to tougher times. They neglected to pay down debt and strengthen their companies for the tough times.
    This excess money brought forward from the future drove up prices and hence inflation, assisted by the lending multiplier.

  12. Richo, I basically agree with you re the measure of productivity but in extreme circumstances like the 70’s or right through until Volcker it could be counted in inflated dollars or most any other widget. The McEwen inspired hang on to the protectionist era for a couple of decades past the reform due date got a boost from Fabius Maximus Whitlam public sector spending and wage largess and that left productivity in the hole in anyone’s measure. And then Keating and his wallies that still hang around the economics profession saved us ….

    And banking productivity gains have languished despite the internet banking revolution in the past decade which is one of those amazing things that you allude to.

  13. USDX poised to drop off a cliff this coming week (now 78.31). There’s some potential for inflation. S’pose it may bounce again but it seems to be running outa bounce.

  14. Hi Greg, biker Pete, and ca and the crew.
    Love reading your stuff keep the DR in perspective
    Just on interest rates in oz.
    ReadinG BetweeN ThE LineS.
    There is no real reason for interest to go up by more than say 4.5% in the next 2 years(oz).
    The banks can get there cheap credit from RBA (print money)
    So they don’t need to raise interest rates to get borrowers in to balance the books (as Dan mention)
    So only other reason to raise rates (OZ) is to slow the economy down to par with rest of the world as did in 2007, so they could stimulate it as the G 20 told OZ in 2008.

    I picket 4.5% as that was the height of the USA rates around maybe 04 or 2006 then they went down.
    So I think the next round for OZ rates say 2011 to 12 will be the next to fall in house price as Steve keen says (or interest rates will fall (1 to 2%) to keep us going)
    It is true we are behind the USA by 5 to 10 years for better or worse?

    If the (w)hole world needs credit to survive then when does it end, it does not.
    If this is not a bear market rally because a bull market runs more than 1 to 3 years
    Then things will drop cycle 2010 to 2012
    It is not sustain able
    What will the G 20 say lets all take one zero off all the currencies around the world so we can keep the dollar value at bay.

    It is only a matter of time can some one pick it for OZ (house correction)
    The age of borrowing time life expectancy 30 years for a loan.
    Life expectancy for a worker to pay a loan off 30 to 40 years, what 50 years.
    Do the maths and tell me.

    I can see the stock market going off on stimulus in oz maybe for a year or 2.
    But it is after that
    Something got to give
    Make your money in 1 to 2 years.

    When the matrix change yes I will change my forecasts
    That’s how it works.
    DR in oz were to optimistic so I gave me my own fix.
    Remember this is just crap I wrote
    Make your own mind up as it is made by some one else.

  15. Rick, it’s all anybody’s guess. My kids have a totally different perspective to mine… and they’re both doing really well in their mid-twenties. Flexibility and maximising income streams is the way I’ve chosen to go, in a very chaotic world. Are we ten years behind the US? I don’t know about that… . It’s in Australia’s favour that our systems appear to be far less complex… and need less maintenance and repair. US infrastructure maintenance represents a future nightmare… .

    Biker Pete, Halifax NS
    August 2, 2009
  16. Rick I have trouble working out what will happen next week let alone months or years ahead but my guess at the moment is that inflation will creep up in Oz because of such things as increased government charges and the ETS. (since energy prices are going to increase) Also remember our banks need to borrow money from overseas (as do many companies) so the RBA rates do not reflect the true cost of borrowing in many cases. With so many governments racking up so much debt this would tend to push up rates simply because the people lending the money can ask for a higher return and get it.

    The real wild card with inflation is oil. If demand for oil picks up again we could see oil prices run back up near $100 a barrel and that would certainly give inflation a push up.

  17. Rick e At the moment I’m worse than Greg. I can’t even work out what is happening today – particularly given some apparent insider trading on 2 stocks that I hold. I’m also trying to articulate (or rather say plainly) why the investment approach of a particular super fund will continue to lose money.

    My gut feel has always been that the green shoots will continue to grow until such time as interest rates rise and / or the USD tanks. The hypotethical 4.5% interest rate increase you mooted would put most of OZ underwater – perhaps after other segments of the Asian market recover (this could be the event to drive the rates up).

    I’ve invested in selected energy stocks knowing well that it will be a roller coaster ride but in the hope that milestone production & discovery events will prevail over all else. I see gold as stable for the time being but who knows? The market isn’t recognising fundumental relative risk/ reward shifts and everything continues to be mispriced as a result(as I see it).


    Coffee Addict
    August 3, 2009
  18. Biker – Bear in mind that there is truth in the underlying implication of both cliches “hard to put old heads on young shoulders” and “old generals fight old wars” I think. But you and yours seem to be doing way better than most in striking a balance there.

    Regarding the rest; I’ve gotten real cynical about all this stuff (or should that be realistic?) but regardless, the thought occurred to me a while back that the masters of the universe would probably be happy to see Dow at about 10,000 before announcing a bunch of bad news re regulatory changes that potentially drives it back down to 8,000. (I notice Bill Bonner recently mentioned Dow 10,000 being his toppish punt as well – But more based on a belief in the operation of free markets perhaps? Which I no longer have.) There are two guaranteed givens for the future: 1) Higher taxes in the West and 2) America continuing to exert influence regarding international energy markets. And one strong likelihood: Increasing regulation of the financial industries. Plus a sure knowledge: If the wallys running the world can possibly cause inflation without thinking they’ll destroy it, they will.

  19. You’re not wrong, Ned. Take that raft of cash our eldest put into indexed funds… . I’d have counselled him a.) not to do it; b.) to cash it in back at 3800. My wife counselled me to STFU! I think you and Greg have summed it up fairly well between you: * higher interest rates; * higher taxes; * higher inflation. Looking at rents abroad, I suspect that the long-term trend will be up and up. My guess is that property may stay flat for a year or so more. Greg is correct that some energy stocks are worth watching. It’s amusing to see how different the Canadian attitude to energy is (so far). The US is burning the stuff up at a rate which is utterly staggering… while a few kilometres across the border, Canadians conserve it conscientiously. Dozens of examples, but here’s a quickie: Our NY hotel needed 800W of lighting above the bathroom mirror… a row of eight 100W bulbs! Our Halifax hotel has one simple low-energy bulb drawing 15W. Equally effective and at my age, I don’t need 800W to reflect my image! Previous travels in the US (’78, ’87, ’95) were an eye-opener, but we thought some things might have changed in the interim… sadly, the US is _still_ asleep at the wheel.

    Biker Pete, Halifax NS
    August 3, 2009
  20. Richo wrote:
    “Ross, productivity measurement, like inflation has now been fudged into a meaningless value. IMO labor productivity should be measured in units output per hour. Instead it is measured in dollars which means it’s subject to inflation, and other factors. I suspect that most of the so-called productivity gains in Western economies over the last 10 years have really consitituted paying people less real wages for an hour of work rather than producing more in an hour.”

    Agreed. A classic case explained by Bastiat as people first confusing produce with cash, and then cash with “money”, after which they draw totally incorrect conclusions about reality.

    Gernot Hassenpflug
    December 15, 2009

Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to