Inflationary Head Fake

By: John Rubino | Fri, Mar 5, 2010
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Today (Friday the 5th) has a meaningful feel. The news is good on U.S. employment and Greek finances, and the markets are in recovery mode: stocks are up, gold is rocking, and bonds are getting smacked. Inflationary days are here again, in other words. But -- while uncontrolled currency creation will absolutely without a doubt get us there eventually -- today's action is probably a head fake. Consider:

The rising gas tax. Oil hit $82 today, which, while a long way from its credit bubble high, is still enough to take U.S. gasoline to nearly $3 a gallon in some markets. That's effectively a tax increase on U.S. drivers.

Public sector bloodbath. Job losses diminished last month, which is leading some to predict that unemployment has topped out. But today's numbers don't account for the massive cutbacks in state and local governments that are now in the pipeline. Mike Shedlock over at Mish's Global Economic Trend Analysis has been covering the public sector story. And check out this speech by New Jersey's promising governor Chris Christie, in which he lays it out in painful detail.

The short version of the story is that over the past couple of decades governors and mayors in badly-run states like California, New Jersey, New York and Illinois allowed public sector salaries and pensions run out of control, and now they're broke. They'll spend the coming year laying off workers and cutting pay and benefits, which will cause public employees to spend a lot less, which will produce more layoffs in private sector industries whose stuff the public sector workers would have bought.

More bad international news. Greece, to its credit, is braving some major protests to make legitimate cuts in public sector wages and benefits. Impressive under the circumstances. But the result will be slower growth and lower tax revenues going forward, so it's not clear that it's even possible to use austerity without devaluation to fix this kind of imbalance. And Greece, as pretty much everyone knows by now, is just the tip of the iceberg. The bigger PIIGS countries, along with Great Britain, are still to come, and their travails will be front page news for the rest of the year.

Spiking interest rates. While U.S. long-term Treasury bond yields were settling in at historic lows, two memes were spreading: 1) fiscal imbalances will force governments around the world to inflate, making bonds a bad bet, and 2) a recovery, when it comes, will enable monetary authorities to withdraw some excess liquidity and allow interest rates to rise to more normal levels. Whichever of these seems most reasonable, the resulting impulse is the same: to look for a sell/short point for Treasuries. Today, when the news is only mildly bullish (employment still went down, after all) bonds are being sold off hard.

So interest rates are poised to jump as soon as the world stops worrying about deflation. The move will likely be hard and fast, taking mortgage rates along for the ride. With the U.S. housing market barely hanging on despite huge subsidies for new home buyers, mortgage rates back in the 6.5% range will stop the housing recovery in its tracks -- and push real estate-dependent states like California and New York further over the edge.

Add it all up and you get a system that's vulnerable to bad news, with a lot of bad news coming. If any of the above -- a spike in oil or interest rates, massive layoffs in California/New York/Illinois, a budget crisis in Britain or Spain -- end up happening, then today will seem like one of those dreams from which you're sorry to wake up.



John Rubino

Author: John Rubino

John Rubino

John Rubino

John Rubino edits and has authored or co-authored five books, including The Money Bubble: What To Do Before It Pops, Clean Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar and How to Profit From It, and How to Profit from the Coming Real Estate Bust. After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He now writes for CFA Magazine.

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