The Milkman Indicator

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Our family has a milkman. Yes, a milkman, just like in the old days.

He comes every Friday and drops off a crate full of cold bottles of milk, along with tubs of yogurt and butter, cheeses and sometimes meats. You place your orders online, and the milkman brings it your doorstep, fresh from a local family-owned farm not far from where I live.

I mention this because I got an interesting e-mail from the farm over the weekend, which I think sums up what we face in today’s economy. The problem we face is particularly insidious because lots of people don’t really understand what causes it, which allows it go on.

But before getting to abstractions, let’s look at the e-mail I got from my milkman.

“We would like to take the time to tell you,” it begins, “that due to some large price increases we are facing on materials we use to bottle milk…we must raise the price of our glass bottled products.”

The e-mail then goes on to show, in some detail, exactly what price increases the farm sees. The milkman is a model of good disclosure and transparency. Many of our banks and corporations should use this e-mail as a model for communicating with the public.

The sources of the pain include a 4% increase in the cost of glass bottles and a 6% increase in the cost of plastic caps. The farm has also seen a 14% increase in shipping costs in just the last six months due to the rising price of fuel. There is more: a 2% increase in materials such as latex gloves and hairnets, a 5% increase in lab supplies for milk testing and an 8% increase in the chemicals used to clean the plant and equipment.

“I hope that you can all see that we have seen a huge increase in total,” The e-mail continues. “This is why at this point it has become a must to increase the price of our bottled products 7%. This is always an agonizing decision for us, but sometimes can’t be avoided.”

We might call this the Milkman Indicator. I can tell you that this is happening across the economy right now. I follow a lot of companies, and rising raw material costs are at the top of the list of concerns facing anybody who makes anything.

Naturally, as investors, the idea would be to play those who benefit from such rising raw material costs and fade those who cannot pass on these costs to their customers. So for example, the rising cost of glass bottles makes me think of Owen-Illinois. This is the world’s largest glass container company. I recommended it in my investment letter, Capital & Crisis in December. Part of the thesis there is that price increases in 2011 would help raise margins and profits. So far, the stock hasn’t gained much ground, but the core idea behind owning it is still very much in play.

This has actually been something of a mini-theme in Capital & Crisis, where I have recommended several specialty producers of materials that are rising in price. Another idea is to own the producers of the commodities rising in price, like many of the energy and mining stocks I have recommended.

This phenomenon of rising raw material costs brings us around to causes. Why is this happening?

The short answer is that our Federal Reserve is printing a lot of money. It’s funny how I can explain this to my 12-year-old using monopoly money – and he gets it – yet it seems economists with Ph.D.s and fancy titles in think tanks and government agencies don’t get it all.

When you create a lot of money, that money loses some value. It buys less than it did before. That’s what we’re seeing, in essence.

The main barometer for monetary creation is the Fed’s balance sheet. When it expands, so too does the amount of money sloshing around. All that money sloshing around has to go somewhere. People buy stocks, commodities and gold. There are many, many ways to show this, and I’ve seen many different kinds of charts that all show the same thing. But I grabbed the one below from today’s Wall Street Journal to show you:

So “QE2” is the fancy name given to a very base and simple act: money printing. And you can see that as the Fed’s balance sheet has swelled, so too have stocks and gold surfed the wave of cash. The dollar has also weakened (buying less), and rates on mortgages have gone up.

This is just the beginning. We know how past bouts of money printing ended. Badly.

[If you want to read up on the hazards, no book details it better than Adam Fergusson’s When Money Dies. Take 20% off when you buy a copy from Laissez Faire Books right here.]

Look again at that table above that shows mortgage rates. Those rates are in the 4-5% range. In the 1980s, it was rare to see new home mortgage rates below 10%. In 1982, the average interest rate on a new home mortgage was 15.12%.

These cycles often take a generation to play out from peak to trough and to peak again. Mortgage rates of 10% didn’t just happen in one year. It was a slow buildup over a good two decades. The average mortgage rate in the 1970s was 8.8%, compared to 11.79% in the 1980s. In the 1960s, mortgage rates were in the 5%s.

Look at gold. It didn’t jump to $1,500 in a year. It’s been in a 10- year bull market.

So to wrap up here, I think we’re looking at a long period when prices rise and the cost of money rises. I doubt the Fed’s resolve to take back the cash it put in, until it gets really bad. Then another Paul Volcker will arrive on the scene to break the inflation and a deep recession will ensue, like a nasty hangover.

Until then, I think the Fed will keep the bar open and let the good times roll. This means gold up, dollar down, interest rates up and commodities up. And the prices the milkman charges will go up as well.

Regards,

Chris Mayer
For Daily Reckoning Australia

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
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3 Comments on "The Milkman Indicator"

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Here I was thinking the milkman indicator was when you see an increase in pregnancy but a decline in reported sexual activity between husband and wife.

gutfeeling
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Unpopular Truth, PMSL

gutfeeling
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:-)

wpDiscuz
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