Purchasing Power

Today’s bizarre confluence of negative real interest rates, money printing, eurozone sovereign default, aberrant asset prices, high unemployment, political polarization, growing distrust… none of it was supposed to happen. It is the unintended consequence of past crisis-fighting campaigns, like a troupe of comedy firemen leaving behind them a bigger fire than the one they came to extinguish. What will be the unintended consequences of today’s firefighting? We shudder to think.

It is painfully self-evident that our financial system doesn't just enable theft, it is theft by nature and design. If you doubt this, please follow along...

There are certain potential catastrophes that can be so threatening we must take steps to insure ourselves even though the probability of one actually occurring is slim. It’s like keeping a small fire extinguisher under your kitchen sink and hoping you never have to use it. We cannot put our life savings and our family at risk by trivializing dangers potentially on the horizon. While CNBC may want to pooh-pooh the probability of something similar happening in our country, we all know that creating massive amounts of currency out of thin air always results in the currency collapsing, or at the very least being revalued in a way that most of us will suffer from. A prudent investor (particularly one on either side of the cusp of retirement) would do well to take out some insurance. That is generally done by investing in metal, farm land, and other forms of hard assets.

The heart of any con is winning the trust of the mark, and the heart of counterfeiting is persuading the mark that a facsimile of value is real. What happens when trust in the counterfeiters is lost? What happens when the assets presented as zero-risk lose value? What happens when "the Fed has our back" doesn't stop the stock market from careening off the cliff of a global credit crisis, which is another term for a crisis of faith that the system is as stable and resilient as it is presented? Trust is a fragile creature. It is a most ephemeral yet powerful force. Once lost, it can never be fully regained; it can only be earned back, one step at a time. We are fast approaching the moment when the value of the counterfeit trust, the counterfeit assets and the counterfeit promises are revealed as fakes.

Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed world’s currencies will have to bear the brunt of the “adjustment”. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new “basket” currency is likely to replace the dollar as the world’s reserve currency. The “Inflationary Deflation” paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold.

If we analyze inflation by these two metrics (purchasing power - which declines as real income stagnates and prices rise - and by exposure to real costs), we find the middle class is increasingly exposed to skyrocketing real-world prices. Pundits in the top 5% have the luxury of pontificating on the accuracy of the CPI while those protected by government subsidies and coverage have the luxury of wondering what all the fuss is about. Only those 100% exposed to the real costs experience the full fury of actual inflation.

Last week Federal Reserve Chairman Ben Bernanke delivered what may well be his last Congressional testimony before leaving the Federal Reserve in 2014. Unfortunately, his farewell performance was full of contradictory comments about the state of the economy and the effects of Fed policies on the market. One thing Bernanke inadvertently made clear was that the needs of Wall Street trump Main street, the economy, and sound money.

Financial asset investors may continue to benefit in the short term while stocks and bonds remain well bid, but production and labor in over-levered economies should continue to wither. When we take it to its logical conclusion, central banks cannot withdraw debt support (on a net basis) and so our baseless currencies seem highly likely to fail to provide sustainable purchasing power. (This happens as producers demand more currency units for their labor and resources, not when consumers drive prices higher by competing with each other for finite supplies of labor and resources.) Continued inflation of all global currency stocks is likely. This implies to us that fundamental expectations of the inevitability of price inflation across borders and in all currencies must change, from unlikely to highly likely. Since very few investors expect rising inflation anytime soon, the return skew is overwhelmingly positive in its favor.

So, when it boils down to it what does it take to become a 1-percenter in the US? You know, one of the elite, the people with power.

Bernanke's prepared remarks, which said nothing the market did not already know, have already been disseminated, and now it is time for the House Financial Services Committee to open their mouths and confirm to everyone they have no idea they are now irrelevant (everyone already knew they have zero understanding of monetary policy and that in fact, Bernanke is begging Congress to raise spending so he has more QE purchasing power as all Ben does to the Hill is monetize their deficit) and the sole person who calls the shots is an unelected Princeton historian, with his finger on the print button. So, without further ado, here is Ben Bernanke at the "Delivering Beta" conference, live from room 2128 in the Rayburn House Office Building.

That Marx's prescription for a socialist/Communist alternative to capitalism failed does not necessarily negate his critique of capitalism. Marx spent hundreds of pages analyzing capital and capitalism and relatively few sketching out a pie-in-the-sky alternative that was not grounded in historical examples or working models. So it is no surprise that his prescriptive work is an occasionally risible historical curiosity while his critique stands as a systemic analysis. Marx got a number of things right, one of which appears to be playing out on a global scale.

If Bernanke is looking for inflation under every rock and cranny, he may have just found it in today's PPI, if only in its energy components. While the headline June number was expected to jump sequentially by 0.5%, the same as May, the final print came at 0.8%, or 2.5% on a Y/Y basis - the highest since March 2012 - driven entirely by Energy good prices, which soared by 2.9% sequentially, the most since February's 3.2%. Foods PPI jumped by a more manageable 0.2%, although no matter how, it is inevitable that producers will now pass both of these to consumers whose purchasing power, especially at the gas pump, is about to be severely tested especially with fuel prices now once again rising at the fastest pace in months.

If the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse.  For if you must rescue everything, then ultimately you will be able to rescue nothing.

          -  Seth Klarman, Baupost

After the angst that he created when he last spoke, and today's shenanigans after the Minutes, we can only imagine how his presentation at the NBER's Boston conference will impact the markets. We would be surprised if anything new came from Bernanke's presentation on "The Last 100 Years of The Federal Reserve" but the following Q&A (as we noted here) will be trial-balloon after trial-balloon we suspect as he prepares for next week's Humphrey-Hawkins.

As the EU agrees to fund another bailout deal to help Greece rise from the ashes, providing them with another $8.7 billion in financial aid, the question that begs an answer is: will this have any effect on the austerity that is being imposed on the country. Throwing good money after bad?