Is anyone else getting déjà vu?
In 1973, the U.S. economy had:
Record oil prices.
A stock market crash.
And jaw-dropping inflation.
Sound familiar? Yep, brush off your bellbottoms. The 70s are back.
And soon even Bernanke's shell games won't be able to hide the truth. After years of the Fed's loose money policy, inflation is biting back, hard.
The government could stop inflation in its tracks if it would make some hard decisions. But let's be honest. It probably won't.
When it does nothing, and inflation starts to gnaw at your wallet, there are proven ways to protect yourself.
And we'll show you how to keep inflation from destroying your earnings.
Core Inflation Lies – Consumer Prices Don't
Rising prices are hitting U.S. consumers a lot harder than the U.S. Federal Reserve – or the U.S. government – would have us believe. The government-issued consumer price index (CPI) is showing that "core inflation" – which includes prices for all items except food and energy – was up only 1% from last year.
By excluding food and energy prices, as volatile as they may be, the CPI fails to convey the pain that rising prices are inflicting on American households. Indeed, the true rate of inflation could be closer to 9% or much higher
The CPI is a joke. Every American knows that in reality it's far higher than the CPI tells us based on what they feel in their wallets every day. We've even heard kids talking about it. And with good reason. One of our editors noticed that Lego sets have gone from $22 to $33. That's a pretty steep jump, whether you're eight or forty-eight.
Our research suggests inflation is really running between 9% and 12%, which is more commensurate with what we experience at Cosco, Wal-Mart or your local grocery store.
Our view is that inflation is very real and it's already here – despite what those in Washington continue to believe … either because their data is so heavily manipulated or because of their own deliberate ignorance. Using history as our guide, we also believe it's going to get a lot worse before it gets better.
At Money Morning, we already have an inflation-fighting strategy in place. And you should, too. Click here to get our free research report: The Rich Trick Strategy that Beats Growth Stocks by 3000%.
What's Driving Inflation?
A few factors drive inflation, but the single-most-important contributor to high inflation right now is the trillions of dollars central bankers around the world have pumped into the financial system since the crisis began in late 2007. Never mind that the crisis was caused by too much money to begin with; the central bankers have embarked on a course that ultimately risks destroying the very wealth they are trying to preserve.
Granted, 99% of Americans won't see or believe that because the markets have rebounded significantly as part of the reflation process. But they will definitely feel it.
The only reason we've been able to stave off complete inflationary disaster so far is that we've exported it to places like China, India and Brazil as part of our monetary policy, in exchange for the cheap goods we've come to depend on. However, that's coming to an end as those economies grow and begin to struggle with inflationary pressures of their own.
Eventually, inflation will come full circle and when there is no place else for us to export it, there's going to be hell to pay.
Middle East Uncertainty
Inflation was already well under way before the powder keg in the Middle East exploded, so this is not as much a primary inflation driver as most people think. That's not to dismiss it, because there is a direct relationship between scarcity and higher prices especially at the consumer level.
The key is time – and by that we mean how fast prices climb and how long they stay at elevated levels.
Most companies are prepared to absorb short-term volatility. But longer-term, there is no doubt they'll pass along to consumers (you and me) the higher fuel and petroleum costs that are part of their manufacturing processes. Many, like airline and transportation companies, are already doing so. So are food suppliers and materials makers, for example.
We've noticed, for example, a dramatic price rise in what it takes to fly to Asia this spring. Breakfast costs 60% more now than it did three years ago. And many readers have probably noticed similar things in their own lives.
But, getting back to the Middle East … the risk there is that the unrest that's right now confined to a couple of countries spreads to the greater region … where we're talking about 60% of the world's oil supply being potentially at risk. We've diligently prepared our Money Morning and Money Map Report readers for this over the past 12 months and we've already profited significantly from our actions. But – and we can't say this strongly enough – the game is just getting started.
What the Future Holds
The end game for inflation isn't as clear-cut as many people would like to believe.
On one hand, the laws of money are immutable. We will have to pay the piper, but let's not forget we have virtually the entire G-20's banking apparatus playing against that possibility. They're obviously well intentioned. But it's all theory. They are complete economic morons when it comes to real money.
That's a strong statement; so here's an example. New York Federal Reserve President William Dudley recently told business leaders that inflation was not a big deal, especially food inflation. He noted that people forget that even as food prices are rising, other prices are falling and mentioned the new Apple Inc. (Nasdaq: AAPL) iPad 2 as an example … which elicited guffaws from much of his audience – and downright angered the rest who challenged him by asking how long it's been since he actually went shopping.
Dudley then went on to say that "while rising prices are giving some of you [audience members] headaches, they are not likely to lead to a sustained rise in inflation to levels inconsistent with our dual mandate."
These guys aren't even on the same planet as the rest of us.
By removing the freedom to fail and, instead, insisting on bailout after bailout, our leaders are propping up zombie financial institutions that will ultimately come back to bite us. History shows unequivocally that we cannot live on "free" money forever. And it's worth noting at the risk of sounding like a broken record that no nation in recorded history has ever bailed itself out by debasing its currency on anything other than a short period of time. That's never happened – and it's not likely to.
The Fed's Policy Could Destroy the "Recovery"
By keeping interest rates so low for so long, the Fed is not only risking inflation, but the catastrophic collision of entitlements – like Medicare and Medicaid – to the tens of trillions related to everything from mortgage debt to personal credit cards.
It's a financial deathtrap, for lack of a better term. What "Team Bernanke" is doing is locking down the short end of the yield curve while leaving longer-term risks to the markets in an effort to revive consumption, inventory build-out, and other short-term "stimulus" that will – at least according to theory, anyway – translate into sustainable growth.
The problem with this is twofold. First, as long as the U.S. is in the driver's seat, Bernanke can get away with it. But we now have nations like China calling their own shots that are increasingly unwilling to submit to Washington's policy missives. Second, "stimulus" spending – as Washington has defined it – doesn't work.
If it did, our economy would be screaming along at 8%, or more. Instead we're like a 1970s Pinto limping along on three cylinders and risking an explosion if we get rear-ended.
In financial terms, the rest of the world is losing faith as reflected in the premiums they're now attaching to the debt they purchase. And that makes sense for the following four reasons:
- The Fed missed the recession crisis-in-formation, and even in late 2007 insisted that everything was hunky-dory. Our favorite was Bernanke who fabulously stated that the risks were "contained." And we can see how accurate a call that proved to be. So if you're tempted to put your faith in Team Bernanke, ask yourself this: Given this earlier miscue, why would we believe the Fed will be able to spot the turning point when everything is "fine" and back off the quantitative easing accordingly, which is one of the central bank's key arguments for taking the actions that it has taken?
- Our financial markets have gotten hooked on super-low interest rates in much the same way someone gets hooked on drugs. Just think about what happens when you take away the narcotics … history suggests we'll see the same "withdrawal" in the financial markets when cheap money gets taken away. From a political standpoint, this is a real time bomb: There will be untold pressures to make sure things are really recovering before the Fed raises interest rates. Of course, what this means in practical terms is that the Fed will keep rates too low for too long – and make too much money available – until it is "sure" we're on our way. Many market-watchers, analysts and traders – myself included – believe this will inflate another financial "bubble." Truth be told, we think the central bankers have already done that.
- An increase in interest rates will be the financial equivalent of a self-inflicted wound. It will dramatically increase our refinancing costs as borrowing costs go up. In very real terms, this will mean that banks have to potentially pay more on their deposits than they make from their investments as rates rise. Bear in mind that the Fed actually needs low rates to pay for all the debt it has pumped into the financial system. In that sense, rising rates will be like the adjustable mortgage from hell as the federal government struggles – and has to make tough choices – in an effort to service this debt.
- And finally, don't forget that the Fed has been buying trash as part of the bailout process – mortgage-backed securities, swaps, worthless bonds and other unconventional debt conjured up by investment banks – from Wall Street and from other parts of our economy. And while our central bankers may believe that they will be able to easily sell these assets "when the time comes," that clearly won't be the case. Think about it. Those assets will be worth less because a.) their value moves opposite interest rates, meaning any increase in rates will drive down their value, and b.) these assets were junk to start with. The banks that offloaded them to Uncle Sam are all too glad to be rid of them, and I can't think of any reason why they'd take them back.
Folks often refer to Hollywood as "La La Land." Those folks have never been to Washington.
Nine Steps to Real Recovery
The path here is very simple. But it won't be popular. And it won't be painless. We would tell the administration to:
- End the bailouts and stop printing money. You cannot suspend free-market forces and still have the economy function. If a company is going to fail, let it fail.
- Outlaw "non-deliverable" credit-default swaps to remove the speculative component from the debt market. By doing this, we will shift the focus of the economic recovery from Wall Street back to Main Street – where it belongs.
- Start to raise interest rates immediately – before the market does it for you. If you wait for that to happen, you'll not only lose control of your domestic destiny, you'll lose what little global respect this economy still commands.
- Partially tie our currency to oil and commodities – a move that's important because it will remove the uncertainty about what the U.S. dollar is actually "worth."
- Freeze the budget and allow private sector growth to compensate. Quit trying to "help" us and get out of the way.
- Simplify the tax code and flatten it out so that everyone contributes equally. The U.S. tax code is 8 million lines long … need I say more?
- Make it easier to start a business. Give people a reason to put their money to work and an environment that makes hiring people cost effective and not punitive.
- Address Social Security – privatize it if you have to – and Medicare while you're at it.
- And, finally, restructure the system in a way that encourages ownership and equity, instead of the current one that encourages people … and companies … to borrow money at seemingly ever-increasing levels. It's time to acknowledge reality.
We'd like to remind investors of an important point: Chaos is actually opportunity in disguise. Washington is creating chaos – but from that we'll see many wealth-building opportunities arise.
For investors, the key thing to do in the years to come is to make investment choices that can weather the storm, and profit from the opportunities that emerge. Here are some very sound choices for turbulent times:
- Altria Group Inc (NYSE: MO): Altria is a giant cigarette producer with a 6.23% yield that's a smart choice in rough markets. You may not like smoking any more than we do, but the firm's beta is a very low 0.47, which means the stock is slightly less than half as volatile as the broader markets. Operating margin is a healthy 39%.
- Ecopetrol SA (NYSE ADR: EC): Ecopetrol is a vertically integrated oil company that's based in Colombia. That makes it a play on Latin America's robust growth – with a nice 2.5% dividend, to boot. This stock has a beta of 1.01 – which means it's about as volatile as the overall markets. However, we're willing to overlook that volatility, since the company's five-year Price/Earnings/Growth Rate (PEG) ratio is 0.53 which suggests there is still good value at a fair price.
- iShares Barclays TIPS Bond Fund (AMEX: TIP): This exchange-traded fund (ETF) invests exclusively in Treasury Inflation Protected Securities (TIPS). When inflation really blooms, so, too, will its share price. The yield is still 2.4%, which is not much in the scheme of things but given its ability to help hedge off rising prices, we'll take it.
- Money Map Report: The Money Map Report just released an excellent free resource for inflation investment ideas. Click here for the research report: "How Some of America's Richest CEOs Live on $1 a Year".