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August 02, 2007

Negative Inflation: Courtesy of Coke Chocula
by The Mogambo Guru

"With the 'substitution effect' in play, we can then assume that the Fed will say that all consumers would try to escape higher prices in other foodstuffs by switching to breakfast cereals (which still cost the same in 'dollars per box'), which in turn would be substituted by cocaine (which went down in price), driving overall inflation in food to less than zero!"

I am nervously looking through the periscope of the Mogambo Bunker Of Ultimate Defensive Posture (MBOUDP), currently outfitted with the optional Awesome Offensive Capabilities Package (AOCP), and I am surveying the smoking carnage in the financial landscape bemusedly.

Investors who are still sitting on their stocks apparently have a Big Undying Belief (BUB) in the ability of the Fed, Wall Street and the Plunge Protection Team (that was created by an Executive Order issued by President Ronald Reagan to "manage" any stock market "surprise") to keep the markets from falling, or are very stupid, or are all playing with someone else's money, or are whacked out on drugs either prescription, over-the-counter or illegal (or all three at once), or something even more bizarre, like believing in the complete absence of counter-party risk in the hedge "insurance" provided by buying enormous amounts of mysterious derivatives at huge degrees of leverage.

And stockholders are screwed anyway, because even if everybody sells all their stocks, where in the hell do they put all that money? They have to put it into bonds, just because there is no other market so big that it can absorb so, so, so damned much money! And central banks of the world are making more money and credit all the time, too, to add to the pressure!

Thus the yield on all U.S. Treasury debt fell to less than 5% last week when the stock market sold off and all that money went into bonds. This "flight to the safety of U.S. bonds" is a Very Poor Move (VPM) because, thanks to Shadowstats.com, we know that consumer price inflation (as measured by the old-fashioned way of measuring the increase in consumer prices) is running at around 10% (or more!) right now!

So, by buying bonds, these yahoos are getting a nominal yield of less than half of the rate of inflation? Out of which they have to pay a lot of taxes, commissions, fees and expenses, so that they actually end up losing money at a rate that is nearly triple - TRIPLE! - the bond yield that they are buying? Hahahaha! What morons!

This is the modern way to "make money"? They think that they are making money by literally losing three times as much purchasing power as they are making? Hahahaha! This is the best that "investment professionals" can do? Hahahaha! We're freaking doomed! And your retirement account is in the hands of these guys? Hahaha! YOU'RE freaking doomed!

Okay, okay, I admit that is not really fair, as federal rules require that they remain fully invested, and that means that they can't sell even if they wanted to, which gets back to the absolute arrogance and stupidity of the people we elect to Congress (except Ron Paul) who made these laws, and the average American idiots who, even knowing this, keep putting their money into these investments! Hahahaha!

Well, as wrong as they are about that, they are even more wrong when they actually believe that owning precious metals is so old-fashioned and stupid, and how they are so smart to be making whole scads of money in a stock market that is still priced at an astonishing price-to-earnings (P/E) ratio of nearly 20!

A P/E of 20 means that you are spending twenty bucks to buy a share of stock in a company that makes one lousy dollar per year per share! In other words, the company itself will not earn enough to equal what you paid for it until after twenty long, long years of waiting and hoping. Then, twenty years from now, maybe you will finally see some profit from your investment. Wow! What optimism!

This is why this "P/E of 20" thing is around the point where all previous stock markets, both on this planet you call Earth and in all the other planets in the cosmos, both now and in all of history, eventually fell, corrected, or collapsed and ruined the hell out of everything.

In case you were wondering, the historical average P/E for a stock or stock market is around 12 to 14 or so, although it has gotten down to around 4 to 7 or so at big market bottoms and around 20 at the tops of bull markets.

In short, stocks ain't cheap, and the evidence is that there are Very, Very, Very Few (VVVF) instances in history where stocks went from expensive (like they are now), to even more expensive, to very expensive, to extremely expensive, to ridiculously expensive over the long term, thus explaining why there are no stories of legendary speculators who made plenty big wampum by "buying high and selling high". Perhaps this is why the market wisdom of "sell high" appears only after the admonition to "buy low", and not after "buy high".

But this is not about how we are the biggest bunch of buttheads in the universe for coupling the economy, the government, everybody's assets and everybody's retirement accounts with a manufactured inflation in the stock, bond, government and housing markets, because if those markets ever stop going up, everything else will stop going up, too, and this means that the Fed would be pressured to continue inflating the money supply forever, which means that inflation in consumer prices will continue forever, too, regardless of how insanely, criminally irresponsible it is for the Federal Reserve to do so, or how even MORE criminally irresponsible it is for the Congress (except for Ron Paul) to abet and oblige it to do so.

And neither is this about how all of this terrifying inflation requires that the money and credit needed by the new buyers will be created out of thin air by the banking system, and sure enough, Total Fed Credit has been going freaking bananas since 1997, and the stock, bond, real estate and government markets have been going freaking bananas since then, too, all thanks to the horrid Alan Greenspan, who will surely go to straight to hell when he dies because of all the misery, suffering and deaths that will happen as a direct result of him increasing Total Fed Credit continuously for all (pause for dramatic effect) those (pause) years, and thus increasing the money supply for all (pause) those (pause) years, and now we are going to have inflation in consumer prices for (insert a long, overly dramatic pause, during which you may take a drink, scratch something that itches, or smoke 'em if you got 'em) FREAKING YEARS TO COME!!!!

And new evidence of increases in consumer prices comes from Junior Mogambo Ranger (JMR) Chuck from Billings, who reports that the inflationary rise in the price of breakfast cereals is being disguised by re-sizing the boxes down to a smaller size, with the sneaky result that you pay the same amount of money for a box of cereal, but get less cereal, which is the alternative to making you pay more money to get the same amount of cereal.

JMR Chuck figures that this new packaging strategy "will result in approximately a 13% decrease in the amount of product in each box, in order to avoid a price increase (!). Can it just be coincidence that this is also the approximate increase in the money supply? And that it reflects the actual rate of price inflation? Um, no, stupid question, food price increases are not reflected in the CPI, so there is nothing to worry about. We are all FREAKING DOOMED TO EAT SMALLER BOWLS OF CEREAL!"

As an aside, The Economist magazine reports that (in England, anyway) "cocaine is cheaper now than it was a decade ago." A decade! Maybe the new way that the government/Fed calculates its hedonically-jiggered inflation statistics, "proving" that inflation is always going down or is even "benign", is actually correct in some things!

The lesson of this? When you can't afford food because of the rising cost of food, you can use the Fed's new "substitution effect", which is to substitute cocaine (which went down in price) for food (which went up in price) in your market basket, and thus inflation is reduced to less than zero for you! Hahaha! Who knew? Drugs as an anti-inflationary device! And probably lose a lot of weight, too!

Or maybe the government/Fed will just disguise the inflation in breakfast cereals by pricing breakfast cereals as "dollars per box" and not "cents per ounce"! Therefore, since the price per box did not go up because there is less cereal in each box, inflation in cereals would be zero!

And with the "substitution effect" in play, we can then assume that the Fed will say that all consumers would try to escape higher prices in other foodstuffs by switching to breakfast cereals (which still cost the same in "dollars per box"), which in turn would be substituted by cocaine (which went down in price), driving overall inflation in food to less than zero! Hahaha!

And the breakfast cereal company itself would have to be pretty stupid not to at least mention how they are selling more boxes of cereal (although neglecting to mention that they are actually selling less actual cereal since each box has less cereal in it), hopefully driving the stock, and the stock options of the executives, up! And taking the whole stock market up with it!

This inflation thing, not to mention the lying about it, makes me so crazy with anger that I was going to the window to throw open the sash and begin to again verbally assail my stupid neighbors for being such economic dimwits, and how they are going to pay dearly for their economic and financial follies, and for their political folly of consistently electing, "I Love Big Government Programs" morons and moronettes to the federal government (except Ron Paul), who immediately turned the government into a giant giveaway machine, and how that is EXACTLY what the Founding Fathers were trying to prevent when they took steps to make sure that the government did NOT have the power to create the money to spend and expand, and they did this by requiring that money be only of silver (and gold) for the sole reason that the government cannot just print the damned stuff.

And to tell the truth, I like screaming at them because I love the looks on their stupid faces when I tell them how long and loud I am going to laugh at them, my voice dripping with contempt, and how much I will enjoy watching them suffer from the precipitous decline in their living standards that they will be forced to endure.

Well, I was halted in mid-stride towards the window when my thunder was suddenly available, with no work, from Bob Wood of Kaizen Managed Assets, who quotes Jens Parsson from his book, Dying of Money. He writes, "Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steeper money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices.

"This is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of traditional remedies."

The tragic summary is that in the beginning of a monetary inflation, "Everyone benefits and no one pays." Unfortunately, at the end, "Everyone pays and no one benefits. This is the full cycle of every inflation."

I bring this up not because I love bringing this up (although I do, and in fact I perseverate about inflation in some bizarre, mentally ill, one-track-mind focus all the time because it scares the living hell out of me), but because Total Fed Credit did NOT go up last week! In fact, it went down by another $3.7 billion! Yow! You can't have inflation without creating the money to make it happen!

In fact, TFC has actually been relatively constant at around $855 billion for the last nine months or so, the longest stretch of "stable" TFC in Fed history since 1997! (Before that, TFC didn't change all that much on an annual percentage basis).

I say that this is causing what is making the stock and housing markets go down; the lagged effect of the cessation of the constant, continual creation of excess money and credit needed to finance a bull market finally overwhelms mere momentum bullishness!

If so, there will be plenty more to come!

-- There was no MoGu last week, as I was in Vancouver, British Columbia, at the Agora Financial Investment Symposium, where I realized that since I was out of America, I could take off as much time as I wanted, go anywhere I pleased, do what I wanted, anytime I wanted, as you, your stupid American work ethic and your puny extradition laws mean nothing to me, The Mogambo In Canada (TMIC)! Hahaha! I laugh in scorn at your impotence!

The speech itself went well, in case you were wondering, after the awkwardness of the usual preliminary questions ("Who the hell are you?" and "How did you get past security?"), whereupon I just rushed to the stage and started yammering into the microphone while making menacing gestures to anyone who approached me, like Junior Mogambo Ranger (JMR) Chip W., who instinctively knew better than to tangle with a halfwit lunatic, and everyone else took their cue from him.

Anyway, there are (as surprising as it is) a group of pathetic people whose lives are so barren, so lifeless, so devoid of anything remotely interesting that they have sadly sunk to the desperate point that they actually asked to read the speech I gave at the symposium.

And since I am already revealed as a lazy, undependable halfwit who just takes off whenever he feels like it, I can nevertheless show both a little graciousness by granting the wishes of these wretches and a little Effortless Mogambo Productivity (EMP) in output by merely posting the text of the speech, as actually given by The Mogambo Guru, titled:

"We Know What We Know"

As I look out over the audience, I sense that the majority of you are wondering, "Who in the hell is this Mogambo Guru jerk and is he going to say anything helpful or even interesting?"

The short answer to your rude question is "no". I can only hope that your disappointment is attenuated by the fact that you have a very keen eye for people, and have already correctly deduced that I have no idea what in the hell I am talking about half the time, thus turning my whole presentation here today, titled "We Know What We Know", into both a big lie and a complete waste of your valuable, valuable time.

So while it is obvious that I do not seem to understand even the rudimentary basics of things like interpersonal social skills, or how a laundry hamper works, or how to ever think of anything but me, me, me, all the damned time, me, me, me, or (getting back to the theme here about crisis and opportunity in Asia) how those crafty Chinese bakers get those tiny little slips of paper inside those fortune cookies, I do know a little bit about money and how it works, especially in regards to the times when you don't have any money, and you need some money, and all the people you ask to borrow some money from only want to talk about when you are going to pay them back the money you already borrowed from them, and you tell them that is not the point, and then they say it IS the point, and you say no it isn't the point, and they say yes it is, and you say it isn't, and it goes on and on like that, back and forth, back and forth.

I bring this up not because I am an untrustworthy, vicious, deadbeat psychopath who gets into a lot of arguments, which is another whole story in itself, but because this is one of the things included in the category of We Know What We Know, which is that it all comes back, as everything always does, to The Money.

And I know this even though Nassim Nicholas Taleb, who wrote the book The Black Swan, says, "The gap between what you know and what you think you know is always dangerously wide", which is such a pleasant way of telling me that I am an idiot that I wish everyone would adopt such a similarly genteel manner.

And as a guy whose total knowledge base about Asia is pretty much limited to the fact that I eat a lot of Chinese food and can probably find China on a map no matter how drunk I get, this knowledge gap is obviously substantial. But I attempt to make up for my lack of education or smarts by concentrating on remembering a very few things that are universal.

Such as money. And not just The Money - oh, noooo! - but about the effects of creating too much money and too much credit, which are always very, very bad, because another of the things that we know is that all that excess new money and credit eventually drives up consumer prices, and continuing to expand the money supply drives prices so high that people are angry and very vocal - and then bad, bad things happen.

So while I am completely clueless about the "opportunities" alluded to in the theme of this symposium, namely "Crisis and Opportunity in the New Asian Era", I am frighteningly aware of the inflationary crises that will doubtlessly arise in this new Asian economy, and all the busts and booms that it will entail, as the stupid Asian authorities and economies are but another lame imitation of the stupid American authorities and economy, only smaller, in that they have committed the cardinal sins of accepting a fiat currency as money, and installed a corrupt banking system under a controlling central bank that is empowered to create massive amounts of money, credit and debt via unlimited fractional-reserve banking, the same as (I am very, very sorry to say) everywhere else.

Therefore, the cycle of booms and ruination of the economy by inflation in consumer prices is as guaranteed in China as it is everywhere else.

In fact, the Chinese already have a lot of the same stupid economic ideas that have come to predominate in America, like mercantilism, a willingness to believe a complete load of theoretical economic hooey, and a huge governmental apparatus thus made necessary to regulate and control everything by brute force.

Mercantilism, in case you forgot, is a belief in the necessity of state intervention in the regulation of foreign trade, imposing tariffs on imports and the encouragement of subsidized exports, all for the purpose of economic domination and eventually owning all the marbles of the world, which is not a bad deal if you are the one who ends up owning all the marbles. As Mel Brooks so famously said in his movie History of the World, Part One while playing a despotic, egomaniacal, and thoroughly lascivious, licentious French king just prior to the French Revolution, "It's good to be king!"

As regards tariffs, I think a quote from the book titled, On the Wealth of Nations, by P.J. O'Rourke has the perfect edge of vicious sarcasm when he writes that there are parallels between the plight of feudal serfs and that of people today, in that the universal, timeless constant is that "Unable to stop trade, the nobility instituted a protection racket", namely tariffs that were, in Adam Smith's own words in The Wealth of Nations, "levied upon the persons and goods of travelers."

Mr. O'Rourke never actually got to the point where he called governments and their nasty tariffs and levies a bunch of corrupt, thieving liars and filthy scumbags, although, if he had asked me, I would have been more than happy to say those exact words for him. Instead, he prefers to quote Adam Smith - a dead guy! - directly to prove my point that everything that the government does is about corruption, lying and personal aggrandizement by saying that even in the 18th century, "protection was seldom granted without a valuable consideration."

The classical, primary objection to all of this tariff stuff is that it benefits the domestic producers (who are always friends of the rulers and legislators who create these tariffs) at the ultimate expense of the domestic consumer, mostly in the form of higher consumer prices, as the costs of all those tariffs and fees and costs are passed along.

And you only have to read a little bit of history, or listen to me run my big fat mouth for just a few minutes, before you learn that it is inflation in prices that is the killer of economies and countries.

The other ugliness of this tariffs and duties crap is what the government then does with the money it collects in tariffs; it spends the money by increasing in size, creating more permanent programs and spending more money, making the government bigger and more costly on top of the higher prices people already have to pay for imported goods! A double whammy!

But even that ugly mercantilist corruption pales in comparison to the unrestrained use of fiat currencies, like the American dollar, and like the Chinese yuan, and like all of the world's currencies these days, and especially when leveraged with outrageous degrees of fractional reserve banking, which will always, always, always be used to create too much money and credit because it is just too, too irresistible.

Like being hungry and getting offered tacos four for a buck! How can you say no? It's too irresistible!

And the problem is always that all of this borrowing shows up as inflation in the money supply, which is the actual definition of inflation, and which is already increasing at about 14% in China. And monetary inflation must always lead to inflation in the consumer prices of some things, then to inflation in the prices of a lot of things, and then to inflation in the prices of most things, and then to inflation in the prices of all things, and prices always increase faster than wages.

And all you have to do to see how THAT is working out is to stand up, go over to the window and shout out, "Hey! Hey! Hey, you! Yeah, you! How do you like your financial situation, now that inflation in prices is eating you alive? Ya like that? Huh? Do ya? Do you like paying higher and higher prices for everything, you stupid moron?"

And to show you what a darling I am, I will save you the trouble of actually conducting such an experiment, and just tell you that experience has consistently shown that people don't like it very much at all, and there are usually a lot of people shouting hateful things like, "Shut up, Mogambo! Shut the hell up, you raving lunatic, or I'm calling the cops again!" and using a lot of bad words, and then one thing leads to another, and pretty soon you realize that your neighbors are a bunch of low-life morons and idiots who have no freaking idea what in the hell they are doing.

And then they get all huffy with their noses all bent out of joint when you politely and thoughtfully take a lot of your time to patiently educate them to the fact that they are a bunch of retarded, conceited, butthead wankers, and that this inflation in the money supply is the asinine and stupid poison that is killing the United States of America, is killing all other countries in the developed world, and will be killing Asia and China!

And then the whole thing gets weirder and weirder until it ends with everybody yelling and the police running around, hollering into their megaphones and demanding that you come out with your hands up, like these idiot storm trooper Gestapo goons think that hassling me is going to stop the inflation in consumer prices or something! See what I mean about morons being everywhere? Jeez!

And in Asia, as everywhere else, politicians and banks, as with most all politicians and most all banks, including the Chinese governments and Chinese banks of today, are greedy, slimy, corrupt, conceited, lying, thieving, ignorant, stupid, vicious, venal vampires who are always willing to accept and defend outrageous expansions of the money supply, and the unholy expansion of the system of governments, because it is so pleasant for them and their nasty little friends.

And too much is never enough! Hell today, in 2007, most governments are now so large that they spend at least a third of GDP, and consume half of all incomes! In America, the system of governments directly employs one out of seven workers and directly supports half of all Americans!

Which, as horrific as it sounds and as horrific as it is, I assume is mere chickenfeed when compared to the impact of government in China, which has been at this societal control thing for a long, long time and all that government apparatus is still there in one way or another!

From a theoretical and historical perspective, to even propose such a colossal stupidity for an economic system is beyond preposterous, and is out in the range known as Theatre of the Absurd, which is seldom actually funny although it sounds like it should be, but which will be the only funny thing you are going to see on the mournful way to the next step of Kafkaesque fascism and the repressive police state that will be needed to contain rioting citizens when the inflation in prices and the collapse in the economy destroys them utterly.

And yet, as ludicrous as it sounds, thanks to a fiat dollar, an irresponsible Federal Reserve and a complicit Congress, here we are! And as ludicrous as THAT sounds, it is the same story in China, only coming from a very low level.

This is insane! Insane, I tells ya!

And what does this have to do with "Rim of Fire: Crisis & Opportunity in the New Asian Era"? It means that there may be many, many opportunities for profitable investment in the New Asian Era, but being kind of stupid and lazy in that regard, I would, of course, not have any idea what in the hell any of these opportunities could possibly be.

Fortunately, Agora Publishing, and the guests they have invited to speak to you, all say that they do, and I will leave that to them.

And since I, the all-seeing Mogambo, cannot wax eloquent and prescient about opportunities in the New Asian Era, then three questions should spring instantly to your mind:

1. What in the hell am I talking about?

2. What does it have to do with the Chinese economy, and the people who invest in China? and

3. How can people make some money on this thing?

Well, for one thing, when the inevitable decline starts when prices get so high that consumers can no longer afford their previous standard of living and people start selling assets to get the money to pay their bills, the central banks will want to lower interest rates in a panic until they reach a point where people and businesses are compelled to borrow, bereft of any semblance of self-control in the presence of this fabulous, screaming, once-in-a-lifetime bargain of being offered money at less than the rate of inflation, and theoretically everyone (including the government itself) will borrow, borrow, borrow more and more money, to buy more and more and more things, reversing any and all declines in asset prices!

I tilt my head backward and laugh the hollow laugh of the damned, "Hahaha!"

And if the weird symbolism of a bizarre man laughing bizarrely at a bizarre economic situation is not enough, that frightful laugh also means that the Chinese are going to learn a lot of very ugly lessons in modern real-world economics, just as all groups of idiots have learned a lot of very ugly lessons about wallowing in the abomination of a fiat currency and/or massive expansions of bank reserves to support a huge, expansive, controlling government, and which is exactly the lesson that the United States is learning, again, right now.

And fortunately for an idiot like me, there are but few constants in all of economic history to learn. And it is all made easier that the big constant, the one really big constant in the whole universe is that a fiat currency that is expanded by massive excesses of money and credit is the essence of the cooties of inflation.

And if you are not a doctor and don't have much experience with treating cooties, suffice it to say that eventually everything the cooties of inflation touches is destroyed.

Another timeless lesson is "except for the people who had gold."

And so with expansionary governments, all being financed by fiat currencies and insane levels of fractional-reserve banking in a corrupt environment that is already expanding the American money supply by 13% a year and the Chinese money supply by 14%, the "opportunity" is the same "opportunity" that I see all around me right now.

And that is to buy gold; it is so historically cheap, and the world is so bizarre and divorced from any semblance of economic normalcy, that I calculate that the odds stand at eight zillion to zero that such a condition has never lasted, and the result has always been that people who owned gold made out like freaking bandits.

And in the hearts of grubby, greedy speculator trash like me, the words "made out like freaking bandits" ring sweet and clear. And I hope to you, too, so that you are moved to run out and load up on gold, and then one day in the future when gold is selling at astronomical amounts of money, and there is chaos all around you, you will say to yourself "Wow! I'm rich as hell, and everyone else is not! That Mogambo idiot was right about gold! Too bad he was such a creepy and hateful little man!"

Yes, it really is too, too bad. But ending up rich as the result of performing absolutely no work, except for reading a little history, has a way of making it bearable.

And for those whose tastes run more to Schadenfreude, even better will be that all others will have done so poorly because they did not buy gold, and now you can buy and sell them and their miserable little lives anytime you want, or even financially crush them like the insignificant little worms that they are, and you can laugh at them, and make fun of them, and tell them to get off your lawn and throw empty beer cans at them when they don't move fast enough to suit you, just like they have done to you all those years.

And won't that be nice?

(End of speech).

I know: Ugh.

Mogambo sez: The money is desperately running back and forth between stocks, bonds, real estate and currencies, in and out, up and down, around and around.

And as these markets must all trend down from these severely overpriced levels, the majority of people will continually lose more and more money, and they will only find true enlightenment when they consider gold, especially when the majority get to the party late, and then only after seeing all the gigantic money being made by people who already got into gold, silver and oil.

Then it truly gets interesting. And lots and lots of fun if you are one of the ones who already owns gold, silver and oil!

P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Richard Daughty, the angriest guy in economics
The Mogambo Guru

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications.

Copyright © 2005-2008 Richard Daughty

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