All of this and nothing

All of this and nothing

By J.M. Hamilton (3-12-11)

The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.    

- Ernest Hemingway

In the song All of This and Nothing, Richard Butler’s lyrics take us on a journey describing a shattered romantic relationship and the wreckage left in its wake.  The song contains one of the most haunting saxophone intros known to rock and roll.   Per Mr. Butler of the Psychedelic Furs, the abandoned flat that hosted the relationship doesn’t contain much of anything, but assorted debris, painful memories, and “a picture of the queen.”   Inflation is a lot like a problematic relationship… perhaps a love story that comes to nearly the same ending throughout history, a very bad one. 

Inflation often serves to provide temporary economic relief, and provides a smokescreen to a nation’s real problems, which often require long term and economically painful solutions (call it a structural reconfiguration).   Politicians and central bankers often deploy inflation, as a means to an end: namely, achieving victory during the next election cycle.  The short term beneficiaries of inflation are the financial and political elite, who know better, but ride the wave – enriching themselves – while the general population, ultimately, suffers with the aftermath: unemployment, a stagnant economy, soaring costs for commodities and services, and a stumbling currency.  The economic sugar rush that is inflation can have the look and feel of a normal economic recovery – initially, while hiding festering problems that desperately need to be addressed, like global banking, run away government debt, and the lack of a national energy policy, driven by predatory oil monopolies.

Of course, inflation eventually catches up with everyone – even the elite: politicians fall, governments are overturned or change parties, corporations fail, and fortunes are eroded and spent.   Take a look at the following chart showing the S&P 500 results through the seventies, pretty stagnant stuff (for the babes in the woods out there, the '70's and early '80's were a period of rampant U.S. inflation):

According to the CIA fact book, the median age in this country is thirty-six.  This means nearly half of the U.S. population wasn’t around in the seventies and early eighties, or was getting ready to enter kindergarten.   The hypnotic – sleeper effect quality of QE2, present monetary policy, lulls the nation into a false calm, a sense that something is being done about the public’s problems, which gives our elected leaders an opportunity not to address the politically undesirable problems that lay before them: like cutting social security, Medicare, Medicaid, or reining in corporate welfare and tax breaks, and defense spending.

And the Chamber of Commerce was afraid of the “uncertainty” allegedly created by the Democratic Party’s feeble, half-hearted, and weak attempts to overturn three decades of financial deregulation, culminating Dodd-Frank (banking legislation that is so pathetically weak that Republicans aren’t threatening to overturn it).   Brothers, sisters, and business community… you haven’t seen anything until you have lived with double digit inflation.  Inflation is the father of economic uncertainty, as we are all about to discover or rediscover.  And it’s already here.

Fear and unemployment will drive the 2012 election.  No surprise.  And this creates a problem/ opportunity, which is Washington feels the need to do something, like enrich themselves and their friends, the oligarchs.  But with two wars going, record budget deficits/federal stimulus, and the Fed printing money like there’s no tomorrow, if the power elite are still struggling to get this relationship/economy off the ground or put a dent in unemployment – then we as a nation are in very big trouble.   Usually a war kick starts the economy.  Trillions in deficit spending… the “relationship” heats up and goes into overdrive.  Fed hits the switch on the printing presses and the economic honey moon begins.  

The problem created by Washington’s solution this time, as this blog has argued, is that all the government’s efforts are directed at propping up Wall Street banks, the Wall Street produced fallout in the housing sector, or ameliorating the effects of same, VERY LITTLE OF WHICH IS TRICKLING DOWN TO MAIN STREET – UNLESS YOU CATER TO THE RICH.  U.S. Republican and Democratic leadership replaces one bubble with another, via war-booms, deficit spending, or asset bubbles in housing, stocks or commodities – created out of thin air by the Fed.  And with the herd stumbling back into the stock market in record numbers, how long before the elite banks, and the government, takes their profits out of the stock market and run?

Our “capitalist society” is hooked on a very bad relationship with big government, with 40 percent or greater of GDP coming from government spending.  It is unsustainable, and as Mr. Herbert Stein, Richard Nixon’s Counsel of Economic Advisors chairman, so eloquently stated:  “If something cannot go on forever, it will stop.”  Can a global restructuring of debt be around the corner?  Watch the PIIGS in Europe closely, for the answer to that question.

Inflation stands for the ultimate debasement of the dollar, and the defilement of the American dream!  And the unintended consequences of QE2 are stacking up like so many couples headed for divorce court.  While the Fed maybe trying to kick start the economy with a boom in manufacturing, to replace the boom it had previously helped create in housing, with easy money policies designed to make dollar denominated U.S. manufacturing goods more affordable overseas, this love interest may be short lived; this is because emerging and foreign markets are already raising interest rates to stave off QE2 induced capital inflows and inflation.  Interest rate hikes in developing nations will have a contractionary effect upon their economies, and slow down demand for U.S. manufactured goods.  So America manufacturing will be faced with less global demand at a time when demand here at home is very limited, because we are still suffering the ravages of the last crisis created by the Fed and Wall Street banks.  Meanwhile, the inflationary effects of QE2 may very well be felt in this country for years to come (And can we see QE3 around the corner to bailout state, county and municipal government?  Yes we can.).

One positive unintended consequence from QE2 is the democratic revolution throughout the Arab world.   It appears that these folks have been under the boot heel of European and U.S. sponsored thugs for decades and they are not going to take it anymore.  Rather than rejoice at the possible freedom of the enslaved and impoverished, the big fear here at home is that rising oil prices may stall a nascent economic recovery, and U.S. political aspirations for re-election.   What our elected leaders and business community may fail to realize is that monarchies and military dictatorships are both highly unstable, and that Arab democracies will be just as hungry to sell BRICS, Europe and the U.S oil, if not more so, as the cutthroats who presently run the Arab world.   And if, per chance, during this time of governmental transition throughout the Persian Gulf, oil prices should spike, than the U.S. should look upon it as an opportunity to, finally, reduce our dependence upon foreign energy, and start hooking up U.S. transportation and power facilities to natural gas and alternative energy.  But I digress.

In 1979 my father, a smart man on many financial matters, explained certificates of deposit to me, and said that he could tie my meager amount of savings into a C.D. that would earn roughly 14%.  I was young and distracted by other things, like skirts and hotties, but even with my short attention span fourteen percent seemed like a good deal.  The problem was that by late 1979, early 1980, my “real rate of return,” that is my return adjusted for inflation, at an interest rate of 14%, was probably negative or minus five to six percent.  And that’s inflation.  No matter how fast your earnings and wages may climb the cost of goods and services, once those inflationary expectations are set, often rise faster.  It is very destabilizing.

That is until a Gandhi – like figure comes along at the Fed, an economic marriage counselor if you will, and says enough is enough, we are going to strangle inflation, even if the short term economic pain or cure is almost as great as the inflationary illness, itself.  Unfortunately, there are not many Paul Volckers in the world, and we have certainly not seen his like at the Fed, since his departure.  Had Paul Volcker not saved us from inflation, the U.S. might have continued to plod along with stagflation, indefinitely, or worse, really gone off course, “Weimar style.”

At the end of the day:  When you weaken a country, as both our political parties have done for years, with excessive and unsupported government spending, weak business regulation, unfunded foreign adventures, and loose monetary policies, you set a country up for problems and possible failure.   Those in the know, the elite and the politicians, can sometime plan ahead and via currency arbitrage, protect their interests and assets (all at the expense of the nation).  Shucks, politicians and the elite may even profit from the demise of a countries currency and economy, through the purchase of credit default swaps (C.D.S.) and derivative contracts; that is as long as the counter-party to that financial instrument has the assets to pay off, in the event of collapse or default. 

You see, one really is gambling when Americans purchase C.D.S. betting against the dollar and the U.S., because if such a bet comes to fruition, in all probability there would be no U.S. government in any semblance of financial shape to bailout the counter-parties.

As happened in Iceland, it has been written that many of the government officials who were responsible for the collapse of that nation’s banking system, currency and economy, took out hedging positions against their own country.   So there’s a flag right there.  But with derivatives contracts not open to public purview on open exchanges, how is the U.S. public to know that we won’t be left, like a jilted lover, with anything other than “a picture of the queen?”

P.S.
There are some who may still argue that there is no inflation, but if we study the history of the consumer price index (CPI), we know that the government took out unimportant items, such as food, commodities, and fuel a long time ago.  Apparently, price spikes that affect the vox populi are inconvenient economic and political truths.   As for interest rate inflation, as Mr. William Gross so well noted on the PIMCO web-site this month,the Fed dominates, that is to say, purchases 70% of Treasury debt issuance; effectively crowding out the bond vigilantes, who would, undoubtedly, demand higher yields and insist upon Federal budgetary and monetary policy reform. 

In response to the Fed’s monetization of the national debt, both Messrs. Hemingway’s and Stein’s comments immediately come to mind.

Copyright JM Hamilton Publishing 2014