Sunday, May 18, 2008

Money supply growth: Unprecedented


...And inflation is certain to follow.

A strong recommendation: check out the free weekly analysis at Zeal.com and reflect on what the history, the trends and the combinations of current factors imply.

For me, there are a few conclusions:
  • Inflation is coming, at levels higher than the past 25 - 30 years. It will feel like 1979 all over again.
  • In addition to the inflationary pressures, we remain in a bull market for commodities. Between monetary inflation and supply-demand forces, commodity prices will continue to grow
  • Debt is now not a bad thing, but interest costs to service that debt will leap upwards. Variable rate mortgages feel good now; there will be benefits from locking in the low interest rates later this year.
  • Bonds are going to be investment road kill
Markets exist, and work, because people draw opposite conclusions from the same data. The opposite opinions to mine come from the following ideas:
  • Credit markets are collapsing, and this shrinks the supply of money as lenders foreclose and people are forced to live within their means. This is DEflationary not INflationary.
  • Central bankers are growing the money supply in a desperate attempt to offset the impact of collapsing credit markets, but credit is such a leveraged creature that bankers can not print money faster than credit failures destroy it.
  • In a deflationary environment prices fall, and consumers are reluctant to spend money today because things will be cheaper tomorrow. This reinforces the deflationary spiral.
  • Debt is crippling in a deflationary environment because the borrower has to repay with increasingly valuable dollars.
I weigh the two arguments and come down on the side of inflation, not deflation, for somewhat cynical reasons.
  • Governments and businesses represent centralized power and influence. Their interests are aligned towards inflation, and voters are easily persuaded to allow the gradual debasement of their currency to avoid short term pain.
  • Prices can drop in market sectors such as housing, while rising in sectors like commodities, without either change being labeled as deflation or inflation. Supply/Demand changes are not monetary changes.
  • Deflation, in my view, would have to be triggered by a global pattern of shrinking monetary factors. Countries who have had a credit bubble and who have post-modern demographics (low birth rates) are vulnerable, as Japan was in the 1990s. Examples are Britain and Italy. Countries who have not had a credit bubble, and who have natural population growth, are in the majority.
My picks? Gold and silver stocks now, and oil stocks that pay dividends this fall, after the oil price corrects from its current overbought levels.

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