You can't help but know it when you see it...
INFLATIONARY POLITICKING is a little like pornography, writes Dan Denning for The Daily Reckoning Australia.
Because as US Supreme Court Justice Potter Stewart once said, confronted with the challenge of distinguishing pornography from free speech or art, "I know it when I see it."
One of the great criticisms of monetarist economists – those who believe the largest influence on the economy and trade is the boom-bust phases in money supply via new credit creation – is that they have a tough time proving when an increase in the money supply will actually be inflationary. They never know, in short, when or where the new money will show up in higher prices.
What good is a theory of credit creation if you don't know when or where it's going to end up as inflation? How do you use it to your advantage as an investor?
Well, easy money doesn't always end up in obvious places, or at least places people would notice it and consider it inflationary. When borrowed money goes to buy stocks, it's not inflation but "asset appreciation". When other borrowed money goes to buy new homes (or to buy securities whose value is derived from homes also bought with borrowed money) it's not inflation either – apparently – but "asset appreciation" once again.
But even if an expanding money supply doesn't show up right away as consumer inflation, it can still destroy wealth. That's what is happening now in the share market. Assets bought with borrowed money are falling. Credit is deflating, the necessary reverse of what was previously happening.
Meanwhile, investors know that the price tag for Hank Paulson's plan to recapitalize Wall Street and purge the credit system of bad assets will be massive. It could be US$700 billion. It could be a $1 trillion. It could be twice or three times that by the time it's all over.
The liability side of the United States government's balance sheet is growing. And what are US Treasury bonds but securitized tax receipts? (We'd say revenues, by the way, but revenues are something a business earns, while taxes are what the government takes.)
If people are having trouble paying their mortgage, and businesses run into a recession and have trouble turning a profit, you'll have rising liabilities and declining tax revenues. The government will make up the difference by printing new money. Gold finally heard the bell last week and rallied nearly $100 last week, close to 12%.
As for the Toxic Trust itself, that didn't work out at all. Investors had a full weekend to think about the details of the worldwide plan to save markets. And then they became terrified. They sold shares and bought commodities.
It shouldn't be that surprising. And perhaps it wasn't terror. Maybe it was just plain old common sense. You can't short stocks anymore in places stretching from Holland to London and New York. But you can buy commodities! At least for the moment. But with the global supply of dollars on the verge of a huge increase, investors declaring for crude oil should beware of yet more politicking.
The Reuters/Jeffries CRB commodity index just posted its biggest one-day gain since 1956, when iron ore exports were still capped in Australia because no one really knew how much ore there was in the Pilbara. This confirms our basic thesis that "stuff" is currently a much better bet than "paper". Liquid stuff – easy to buy and even easier to sell – has become the real star of the markets.
But with the October crude oil futures contract closing 16% higher on its last day – oil's biggest one-day move since crude futures began trading in the early 1980s – can a ban on speculation be far away now?
If you're a trader, this is the blessing of the times we live in. With immense volatility comes incredible opportunity. You just have to know what you're doing to spot these things.