Thursday, July 24, 2008

More Stagflationary Thoughts

2 million Americans get a raise today; Federal minimum wage rises 70 cents to $6.55 an hour

The new minimum is less than the inflation-adjusted 1997 level of $7.02, and far below the inflation-adjusted level of $10.06 from 40 years ago, according to a Labor Department inflation calculator.

The anti-stagflationists must be sighing in relief that this 12% boost in minimum wages isn't keeping up with inflation.

But he said he did not expect the change to have a major impact on the economy because recent increases in productivity, which enables companies to produce more with fewer workers, are keeping labor costs in check.

As I extrapolate to the logical conclusion, the productivity miracle of automation and outsourcing should see that there are no jobs someday. Based on the last six months of job reports, these must be truly miraculous times.

That makes it unlikely the minimum wage increase will trigger a "wage-price spiral," in which workers facing higher costs demand more pay, which in turn causes companies to raise prices higher, sending inflation coursing through the economy.

Wages can't seem to keep up with inflation any more now than they did in the 1970s. I refer you to the following chart. Inflation adjusted wages peaked in the early 1970s, well before much of the stagflation actually hit.

Historical Real Hourly Wages

Rather than focus on wages attempting (and failing) to keep up with inflation, I'd prefer to simply look at the vast amount of actual money sloshing around the world as we ship dollars overseas in exchange for goods. We do have a massive trade deficit.

Global Trade Imbalances

We might want to look where the jobs were/are actually being created. China has wage pressure. That's where we buy our finished goods. Right?

Inflation is Asia's problem, not the world's

"The increase in meat consumption by emerging markets as incomes rise is true but it is a 20- to 50-year phenomenon," says Cassard. "You can't use it to explain a three-month phenomenon."

I can't? In my opinion, the credit crisis was a 20- to 50-year phenomenon in the making. The bulk of the crisis hit one day in August of last year and we're still stuck with it.

Top 25 Quotes of the 2007 Credit Crisis

3. For the second time in seven years, the bursting of a major-asset bubble has inflicted great damage on world financial markets. In both cases--the equity bubble in 2000 and the credit bubble in 2007--central banks were asleep at the switch. The lack of monetary discipline has become a hallmark of unfettered globalization. Central banks have failed to provide a stable underpinning to world financial markets and to an increasingly asset-dependent global economy. - Stephen Roach, Morgan Stanley

I'm stagflationary for yet another day it seems. I just don't find the the wage-price spiral theory of inflation all that convincing. The massive amount of dollars already sloshing around in the global system and looking for some kind of "real return" home seems far more important to me. Some of it realized a few years ago that the return of capital was becoming more important than the return on capital. This can be seen in my own pantry. The canned goods are holding their value.

18 comments:

  1. Stag,

    http://www.prudentbear.com/index.php/GuestCommentaryHome

    This guy must read your blog.

    One thought. I still think that major losses are being hidden in the derivatives arena. Trillions of dollars of unregulated and highly complex financial instruments combined with wall street greed and record profits is a sure recipe for disaster. I fear it will be bigger than Elvis.

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  2. Another stagflation article.
    http://www.reuters.com/article/reutersEdge/idUSN1456888520080714?pageNumber=1&virtualBrandChannel=0

    This is one of the few that spells out negative real returns from stocks, bonds and cash during stagflation.

    I predict most investors won't ever consider the ugly fact of negative real returns. You know, most are above average investors. Way above average.

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  3. MAB,

    Thanks for the "must read" link(s). It truly was must read. I clearly agree with most of it.

    Given the failure of Paper Assets such as TIP’s to properly protect Investors from the true ravages of Inflation (due to CPI under-estimates in the Author’s view), Commodities have recently become the only viable safe-haven to protect against the risk of ever-higher Inflation.

    The bigger reason that TIPS cannot protect against the ravages of inflation would become evident if we seriously hyperinflate (as taxes on the inflation protection would drain the portfolio quickly). I'm "betting" that we don't go there, but the casino IS open for business. Here I am in TIPS anyway though, because I'm terrified of buying commodities these days. I generally believe that things that have quadrupled in price (or more) lose their "safe-haven" status at some point.

    Then there is your next link.

    "Even though I can't imagine our economy going to the same situation as in the 1970s, some form of stagflation may crop up," said Jonathan Lin, senior analyst with Louise Yamada Technical Research Advisors LLC in New York.

    I must have a very vivid imagination. For example, when I see "crop up" I immediately think of food prices. Go figure.

    Then there is your most amusing commentary (as usual).

    I predict most investors won't ever consider the ugly fact of negative real returns. You know, most are above average investors. Way above average.

    We've had negative real yields since at least 2004 (when I first turned bearish).

    Real estate is negative (or close to it).
    Cash is negative.
    Treasury bills are negative.
    Stocks are negative.

    Portable hard assets (assets than can be placed on ships to China) are positive. Toilet paper is even doing okay.

    How many years of stagflation does it take before people start to notice? I'm becoming a believer in your "won't ever consider" theory. I suspect that should everyone notice I'd finally be able to change my name. Unfortunately, Deflationary Mark might not win out over Hyperinflationary Mark. Based on your theory I might be able to keep my stagflationary name permanently though, much like frogs being boiled alive by slowly rising water temperatures. Sweet.

    But he does not expect the U.S. 10-year note yield to spike dramatically, unless foreign central banks stop buying Treasuries. Its yield should rise to about 4.50 percent next year. "If 10-year Treasuries move up 50 basis points that's not a disaster. It means you don't get any return (above inflation)," Loeys said.

    If yields rise to 4.5% next year I'm going to go out on the limb and argue that it could very well be in response to even higher inflation. If so, the "not a disaster" phrase might need some rethinking for those locking in the negative real rate long-term. What's worse? Full speed straight into the iceberg or slowly scraping a large gouge down the entire length of the ship? Either way she's sinking.

    Our ship seems to be slowly scraping by mode as we muddle past the iceberg. Since it didn't sink in the first few minutes the passengers are watching it play out from the "safety" of the deck chairs.

    When's that awful scraping sound going to end? I can barely hear the violins.

    Several hours later?

    Something's wrong with my chaise lounge. When I fell asleep it was flat but now it's reclining.

    Early the next morning?

    Why is the captain asking US to "bail out" the engine room? Clearly we cannot reward the risky behavior that got us into this situation in the first place. I say we just let them fail. Where are the lifeboats? What do you mean they sank once people filled them with their gold?

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  4. Here's a bonus link from April 2005.

    Analysts pour scorn on stagflation rumblings in the US
    http://www.smh.com.au/news/Business/Analysts-pour-scorn-on-stagflation-rumblings-in-the-US/2005/04/21/1114028488086.html

    But analysts were quick to quash talk of a return to stagflation. Macquarie Bank interest rate strategist Rory Robertson said yesterday that such talk was "silly".

    US unemployment and inflation remained "broadly where policy makers like them", he said, and all that could be witnessed so far was that the US economy had "hit an oil slick and slid into a soft patch in March".

    Oil prices have risen by 21 per cent in the past year, contributing to both slower growth and rising headline inflation in the US, Mr Robertson said.


    Silly is as silly does.

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  5. Stag,

    Here's a bonus link from April 2005.

    Hey, thanks for the bonus! Add to that the all the monetary and fiscal stimulus plans and I should be a bull again in no time.

    I'm just wondering if Bernanke is regreting his decision to slash interest rates. Since then, corporate borrowing costs are up, mortgage costs are up, commodities are way up yet housing and equity prices are way down. ALso, CPI is up and the dolar is down. Go figure. That's worse than a busted straight.

    Perhaps there's a little more to managing an economy than manipulating bank lending rates.

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  6. MAB,

    That's worse than a busted straight.

    Bernanke was dealt a bum hand.

    Well, there's a bum hand involved anyway. Let's just hope the other hand isn't someday holding a sign that reads...

    Will only work for food. Your [wheelbarrow full of] paper dollars are useless to me.

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  7. MAB,

    Perhaps there's a little more to managing an economy than manipulating bank lending rates.

    What if we made two spreadsheets though? We could call one spreadsheet Peter (the taxpayer). We could call the other spreadsheet Paul (the very same taxpayer). We move the good numbers from Peter over to Paul and the bad numbers from Paul over to Peter. We then give up on Peter entirely. He's toast. Paul's lookin' really good though!

    Hold on. I think I'm missing something. Didn't Paul eat at Peter's restaurants? How can toast eat toast? You are so right. This isn't easy.

    More blog name remorse today...

    Illusion of Intended Consequences

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  8. Stag,

    Bernanke was dealt a bum hand.

    I think you are right. In any event perhaps he should be more honest about our collective dilema. From what I can see, he's terrible at bluffing anyway. Like they said in the Movie Rounders - if a fish plays strong, he's bluffing.

    Besides having a "bum hand" I think Bernanke is playing against an invisible hand that isn't even there to ante up at times(see the Joseph Stiglitz section of the following link):

    http://en.wikipedia.org/wiki/Invisible_hand

    Now, if we were more like true free marketeers, I think that invisible hand would be more reliable. Remember the Titans, but don't forget the Troglodytes.

    http://en.wikipedia.org/wiki/Troglodyte_%28Dungeons_%26_Dragons%29

    Apparently, it's not only financial wizards that get rich.

    ReplyDelete
  9. MAB,

    From your "hand" link...

    It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest.

    Butcher? Brewer? Baker? Can't Bernanke the Banker lend us our dinner or at the very least drop it out of a helicopter?

    http://video.yahoo.com/watch/1499909/5115198

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  10. Stag,

    Can't Bernanke the Banker lend us our dinner or at the very least drop it out of a helicopter?

    Lending the dinner will not work. We've borrowed too much already. That leaves the helicopter as the only workable option. Plus, free lunches are an easy sell these days.

    In case you missed it, that Troglodyte link had a re-direct to "Wizards of the Coast." I stumbled on that completely by accident while searching for a kidney cloaking device. Anyhow, it made me realize that you have a lot of first hand experience with paper assets. So let me bounce this idea off you.

    I think I have a way to stop the train wreck in the financials. It's becoming clear to everyone that book value is the real issue. Hence the solution is we simply take the banks' assets and place them in more valuable books. Something really nice with broad appeal. I'm thinking new leather bound books with embroidered edges. We could even add some sequins to dispell all doubt if our budget permits.

    I'm also thinking we unveil the new books with a fancy slogan. People love slogans. "Whip inflation now" has already been used so I'm proposing "mission accomplished."

    The fancy new books are made over seas so time is really of the essence here. We need to issue a purchase order asap before our dollar falls further. The last thing we need is another negative feedback loop.

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  11. MAB,

    Something really nice with broad appeal. I'm thinking new leather bound books with embroidered edges. We could even add some sequins to dispell all doubt if our budget permits.

    I'm reminded of the amount of money spent on the fancy brochures with clear plastic protector sheets that was presented to me in hopes I'd buy an inflation protected bond fund with ~1.7% annual fees (about 1/3rd of the expected total return).

    The fancy new books are made over seas so time is really of the essence here. We need to issue a purchase order asap before our dollar falls further. The last thing we need is another negative feedback loop.

    I think I see where you are going with this. Let me know if I am wrong.

    The pages of the new books would use US dollars as the paper. It doesn't get any more ASAP than that since many of the dollars are already overseas. It also avoids the negative feedback loop. Central bankers are looking for a cash sponge to tame inflation now that the dotcom bust is over and the housing bust seems fully underway. Therefore, the bigger the book the better. I propose...

    Economic War and Lack of Peace

    This book uses 5,000 recycled paper dollars and is therefore eco-friendly. It is made from a special paper especially suited to the holding up in any environment. It is therefore suitable for burying in your backyard and is guaranteed to rise in value if a serious deflationary event occurs (even as central bankers drop more paper money from helicopters).

    In order to keep inflation under control it could be heavily subsidized by the government.

    * I expect the price point to be $19.95. How can anyone make money selling the book that cheap when it costs $5,000 to create? Simple. Volume!

    * I expect an entire industry to spring up based on the success of the book. Expect TV commercials proclaiming that "There's never been a better time to own the book."

    * The buying and selling of the book would ideally require book selling professionals and the creation of a National Association of Bookateers. This would provide jobs to displaced housing professionals.

    * Should the economy continue to deteriorate and people find the $19.95 price point too high, a government agency named F'in Man could be created to help people get into the book of their dreams. Here's yet another TV commercial slogan. "Who helps you buy the book? The US Government is the F'in Man!"

    * Pawn shops would be required by law to pay $100 per book pawned (still a bargain considering it took $5,000 to create). Those down on their luck could therefore make money buying the books for $19.95 and pawning them for $100. The public would be encouraged to only do what they need to get by though. Any abuse of the system would not be tolerated (there wouldn't be a system in place to stop it though). As a side note, taxpayers should not worry that any pawn shops forced out of business by this new rule would be bailed out. None are currently too big to fail.

    Simple solution. What's not to like? Your plan sounds fantastic. Once implemented, I'm switching my name to Anarchy Mark!

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  12. MAB,

    One more thought.

    I'm also thinking we unveil the new books with a fancy slogan. People love slogans. "Whip inflation now" has already been used so I'm proposing "mission accomplished."

    As seen in recent food prices, how about a slogan that simply describes where we are.

    Miracle Whip Inflation Now!

    The nice part about it is that we can all continue to do nothing about it. It is not a proactive button. It certainly appeals to me. I can be somewhat lazy.

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  13. Yet another thought.

    http://www.marketwatch.com/news/story/kraft-reports-strong-second-quarter/story.aspx?guid=%7B98B4F7C4-1A93-428B-B5BB-EAAC9674E75C%7D&dist=hppr

    Organic net revenues grew 4.5 percent as price increases in several categories more than offset lower volume and unfavorable product mix. Double digit revenue growth from the relaunch of Kraft pourable salad dressings and continued momentum of Kraft macaroni and cheese, as well as strong growth in Jell-O dry packaged desserts, was partially offset by pricing-related volume weakness in spoonable dressings such as Kraft mayonnaise and Miracle Whip. Operating income excluding items increased 5.2 percent as pricing and overhead savings more than offset higher input costs.

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  14. Stag,

    Miracle Whip Inflation Now!

    Now we're really getting somewhere. "Miracle Whip Inflation Now!" is the perfect condiment for a free lunch.

    I'll take some more of that in a big way!

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  15. Stag,

    Here's a gaggle of charts that might interest you:

    http://www.financialsense.com/economy/charts/price/main.html

    I guess the bullish take from all these charts is that things aren't as bad as they could be. That's not comforting though as it clearly underscores that things can get worse (and likely will imo).

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  16. MAB,

    I guess the bullish take from all these charts is that things aren't as bad as they could be.

    There was more rice at Costco today and no more signs telling us to limit our purchases. It offered a glimmer of hope. (There was still no white basmati rice though.)

    The rice must flow. He who controls the rice, controls the universe!

    Behold the wonder of the Baron Harkonnen Economy.

    That's not comforting though as it clearly underscores that things can get worse (and likely will imo).

    Yeah, it would probably be better for us in the long-term if we were experiencing a House Atreides Economy instead. It seems the the lips acquire stains and the stains become a warning. I see that every time someone comes on the TV to proclaim that their financial company is well-capitalized.

    Merrill Lynch: Don’t forget the salt
    http://blogs.reuters.com/reuters-dealzone/2008/07/29/merrill-lynch-dont-forget-the-salt/

    Analysts are applauding Merrill Lynch’s attempt to cut its losses and raise more capital, but investors may be forgiven if they take the company’s remarks with several large grains of sodium chloride. CEO John Thain repeatedly insisted that Merrill was well-capitalized over the last eight months, yet the bank still had to go back for another $8.5 billion.

    Most things taste better with salt, and rice is no exception.

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  17. Stag,

    That Merrill deal is a sign of desperation. Looks like perverse vendor financing with leverage to me. Seriously, it's like funding your own reverse mortgage.

    In a way, that's the Chinese model. Finance U.S. stupidity so that you can sell to excess. As the following chart shows, those kind of growth for the sake of growth vendor financing shenanagins didn't work out to well for Lucent and a bunch of other tech/internet gadget vendors.

    http://finance.yahoo.com/echarts?s=ALU#chart1:symbol=alu;range=my;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

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  18. MAB,

    In a way, that's the Chinese model. Finance U.S. stupidity so that you can sell to excess. As the following chart shows, those kind of growth for the sake of growth vendor financing shenanagins didn't work out...

    I resemble that remark!

    Although I did not invest in the dotcom stocks directly, I did have a tiny investment (compared to the other stocks in my portfolio) in Nortel. The thinking was that I'd merely be helping to supply the shovels during the gold rush.

    I bought at $11. I saw it go to $100. I wanted to sell as early as $50 but I was under extreme tax pressure thanks to the investment in Wizards of the Coast paying off. I opted to hold instead.

    I did get my wish in the end. Tax considerations REALLY worked out in my favor. Nortel dropped to $1 and I was able to squeeze some serious capital losses out of it (the tax write-off was worth more to me than the actual value of the stock at that time). It seemed the "shovel" industry dried up once the gold did, lol.

    Lesson learned though. It taught me that there is more than just cause and effect. There is cause leading to effect leading to even more causes and effects, and so on. Never underestimate the power of a positive feedback loop followed by a negative feedback loop.

    These days I look at our entire economy as positive feedback loop followed by a negative one. I cringe every time the winds of change blow. The "house" of cards can't handle the (di)stress.

    I have no proof that I should be a bear and that things won't somehow miraculously work themselves out. Surely the turnaround in our economy once the 1970s was over would have surprised me back then.

    That being said, I have far less proof I should be a bull. In order for me to risk my nest egg, that's where the burden of proof must lie.

    Speaking of lie...

    Fraud said soaring and set to worsen
    http://uk.reuters.com/article/UKNews1/idUKL845141320080728

    The most bizarre case to come to court in the first half of the year involved someone who allegedly conned an investor into believing that he was acting on behalf of the Barclay brothers to sell the Ritz hotel in London for 250 million pounds -- less than a reported market price of about 600 million. The investor paid a deposit of 1 million, quickly spent by the fraudster.

    "The ingenuity and audacity of fraudsters often simply catches people off their guard," Patel said in the report. "That is why companies and individuals need to be fully alert to what is, in these challenging economic conditions, an ever-present and growing threat."


    *cringe*

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