NOV 15TH Dr Richebacher

BEST OF KURT RICHEBACHER
November 15, 2005
http://www.investmentrarities.com/archives.html#rp

INFLATION HAS MANY FACES
The narrow concept of inflation as a rise in consumer and producer prices made perfect sense until the late 1970s, as long as credit excesses used to go overwhelmingly into the purchases of goods and services. But ever since, it no longer makes sense, because credit excesses are dispersed over much wider areas, in particular asset markets and imports.
Judging simply by the atrocious credit and savings numbers, the U.S. economy has the most rampant credit inflation around the world. It shows lately in the huge trade deficit (lately at an annual rate close to $800 billion); it shows in grossly overvalued asset markets running into many trillions of dollars (mainly bonds, stocks and housing). But lately, it is also increasingly showing in the consumer and producer price indexes.
It is a regular comforting mantra in the Fed’s FOMC press releases that "Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated." Emphasis on "core" inflation serves to distract attention from the ugly realities in price inflation.
After all, U.S. inflation rates of consumer and producer prices are now at the top in the world, even despite the Fed’s gross understatement. As of September 2005, the PPI was up 6.7% year over year. A year earlier, in August 2004, the 12-month rise was 3.3%. As to the CPI, it showed a rise of 4.7% year over year in September, as against 2.5% a year earlier. Import prices are up 9.9%.
Annualizing the price increases over the last three months, the numbers become outright frightening. For the PPI, in September, it was 14.8%, for the CPI, 9.4% and for import prices, 20.5%.
Presenting these numbers, we have to repeat our familiar mantra that heavy hedonic pricing and quite a variety of other statistical ploys have substantially reduced the reported U.S. inflation rates. Conservative estimates put their downward effect on the consumer price index at 1–1.5 percentage points per year. Critical observers put them closer to 3 percentage points.
Yet even the officially reported, understated CPI rate of 4.7% has become uncomfortably high, considering that second-round effects of the surge in oil prices are possible, and even probable.
Until quite recently, the Fed prided itself on having learned from Japan’s experience that a bursting asset bubble should be treated with fast and massive monetary easing to moderate its aftermath. This assumes, first of all, that belated rate hikes are the main reason for the protracted dismal performance of Japan’s economy. It is hard to see how a mere delay in rate cuts can have such devastating long-term effects. In contrast, Japanese experts regard two quite different reasons as most important. They cite structural problems caused by the prior credit excesses and never-ending deflation of house prices.
Mr. Greenspan claims great success that with his policies he managed the U.S. economy’s mildest recession in the postwar period. Actually, he replaced the bursting equity bubble with a whole variety of other bubbles, of which the housing and the bond bubbles played the leading roles in fueling America’s greatest consumer borrowing-and-spending binge.
The trouble is that with these new bubbles, the U.S. economy and its financial system have accumulated ever-greater imbalances and excesses. And while the ensuing housing bubble saved the economy from deeper recession, it should be realized that a housing bubble is a far more dangerous specimen than an equity bubble. There can be no question that the economy today is in far worse shape today than in 2000–01.
It strikes us that the Fed’s increasingly hawkish talk lacks the slightest hawkish action. Rather, it keeps adding reserves to the banking system in order to prevent the federal funds rate from rising above the targeted 3.75%.
In other words, the Fed is accommodating increasing demand for reserves, due to continuous strong credit demand. In general, reserve policy outweighs interest rate policy in its effects on the economy and the markets. It explains why the credit rampage has so far not shown the slightest moderation. In terms of bank reserves, monetary accommodation remains in full force.
We keep wondering what the Fed has in mind with its new policy. First of all, let us make it clear that even a federal funds rate of 4.5% is anything but high compared with present inflation rates. But apparently, it is widely perceived as very high, possibly too high, and that tells us something about the U.S. economy’s truly perceived strength.