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Posted 6/21/2004
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Talk is cheap; the Fed's inaction won't be
Despite promises from Greenspan & Co. to stay vigilant, the inflation genie is already out of the bottle. We'll pay for it when the dollar drops and stocks decline.
By Bill Fleckenstein
Last Tuesday, the same day as the release of the May Consumer Price Index, Easy Al Greenspan made his pitch to the Senate Banking Committee to remain Fed chairman until January 2006.
These subjects go well together, given Al's track record for incessant crowing about tame inflation.
CPI minus the petrol and pie
The CPI turned out to be 0.6% higher, as opposed to expectations of 0.5% higher. But don't worry. For those of you who don't eat, don't drive and don't use energy period, inflation was only up 0.2%.
I would expect that any and all inflation indexes are going to be examined, re-examined and re-re-examined, now that the Fed has said it's paying attention to inflation. I can't get over the number of speeches that have come pouring forth from different Fed heads. There seem to be several a day now, all with the promise to be vigilant about the inflation genie they've already let out of the bottle.
On the op-ed page of Tuesday's Wall Street Journal, for example, Chicago Fed head Michael Moskow said, "Of course, we must continue to be vigilant in monitoring developments that pose a risk to this accomplishment." His definition of the Feds accomplishment: "Over the past 25 years, inflation has come down from double-digit rates to a pace consistent with effective price stability."
Not to put a crimp in his back-patting, but that occurred for two reasons:
First: Former Fed Chairman Paul Volcker broke the back of inflation by focusing on the amount of money in the system, letting the price of money (i.e., interest rates) go wherever it wanted to. Easy Al Greenspan and his current crop of money printers focus primarily on the price of money, spewing out as much as needed. Even when they supposedly tighten, all they do is raise the cost of money. They never restrict the supply of money.
Second: Three unique factors, all outside the Fed's control, came together to bring inflation down:- The North American Free Trade Agreement.
- A period of increased productivity spawned by a series of special factors, not least of which was revved-up technological innovation.
- The first post-Cold War economic boom, which allowed us to arbitrage lots of cheap labor.
Fed flunks paternity test for prosperity
The bottom line is that this Fed had nothing to do with the lowering of the rate of inflation. Of course, this serial bubble-blowing Fed has done an incredible marketing job on various world markets, convincing participants that it will be vigilant in not letting inflation get the upper hand -- which already has happened, as the Fed has provided negative real interest rates for at least the last year.
Meanwhile, let's contrast the Fed with the European Central Bank. According to a Bloomberg story last Wednesday, the ECB is considering "changing its method of forecasting inflation because oil price futures are understating (my emphasis) the pace of price increases." To help with its inflation forecast, the ECB uses oil futures, but now it's concerned that this measure hasn't done an adequate job of forecasting inflation.
That's what a central bank ought to do, monitor inflation and purchasing power and pursue policies to ensure the currency it stewards doesn't turn into confetti. Im not saying the ECB is perfect, but there's no comparison between what a real central bank does, or what Paul Volcker might have done, and Greenspan cheerleading speculation and risk-taking beyond any reasonable measure (i.e., Al Greenspan's championing of derivatives) and focusing on the so-called core rate of inflation stripped of offensive price increases.
It's worth noting that Volcker, in an interview last Tuesday on Bubblevision, said there was never a very serious threat of deflation. "Not in this country," as he was quoted by a reader of my daily column who brought the interview to my attention. He also heard Volcker say that we'd better get after inflation before it's too late.
Obviously, the views of Volcker, who is one of my financial heroes, are similar to those I have espoused about the likelihood of deflation and the looming problems of inflation. Gee, I wonder how he knew what to think before I was born!
The Fed: tough or trapped?
As for the man who could never fill so much as the toe box of Volcker's shoes, Easy Al gave himself a gold star Tuesday morning when he told the Senate Banking Committee, "The performance of the U.S. economy has been most impressive in recent years, in the face of staggering shocks that in years past would almost surely have been destabilizing."
What's ironic about that is: The financial shocks have been 100% the result of his reckless policies.
But his prepared remarks were nothing relative to the mind-boggling utterances that followed in the Q&A. First, a reprise of the headlines that passed on Bloomberg news service over the course of this spectacle:- The "U.S. economy is 'growing in a solid fashion.'" (So why is the Fed funds rate still at 1%?)
- Inflation is "not likely to be a serious concern."
- His reiteration that "changes in monetary policy are very likely to be measured."
My summation of that little troika? Acting tough is not in the Fed's repertoire. Talking tough is in its vocabulary, but, as we all know, talk is cheap.
Easy Al went on to opine, Bloomberg writes, that "high oil prices are not hurting the economy yet," and "evidence shows growth starting to boost wages." However, he then said, "Wage growth is not rising fast enough to boost inflation." Similarly, trade imbalances should "gradually adjust."
He also debunked the myth that consumer debt was a problem, saying we face no "serious" consumer debt problem, and, furthermore, the U.S. is "nowhere near" a consumer debt problem. (Earth to Al: Last Tuesday, MBNA, the country's largest credit-card provider, lowered estimates because of an increase of bankruptcy filings in March and an increase in delinquencies.)
Al: large and in charge
After all that don't-worry-be-happy talk, he served up what to me is the pice de rsistance: "Hedge funds help make markets more flexible," and that he saw "no purpose" in regulating hedge funds. He also found the time to take a swipe at China and its yuan manipulations, while allowing that China was "successfully" slowing growth.
In other words, everything is okay because the Fed chairman has seen fit to create this perfect world for us. Whatever mistakes he may have made have all been taken care of. Just as he has his whole career, he sees no problems anywhere (other than the one time in 1996 when he talked for 10 seconds about irrational exuberance. Of course, by the time things really got out of hand, he had exchanged his concern for pom-poms and a megaphone).
Paging Dr. Baby Steps
Therefore, because he sees no problems, you can be sure that Dr. Baby Steps is not going to do anything to rock the boat in the asset markets. Folks seem to be content that housing prices are going up and stock prices are not going down. (In fact, as my friend Lance Lewis of Lewis Capital noted, Investors Intelligence reports bullishness at 55%, a level not seen since the March peak -- even though we have a lower high than in April in nearly every major index.) That said, the Fed chairman has already done enough damage, and the imbalances will expose him once and for all as the irresponsible bubble-blower that he is.
For now, though, we happen to be in an interlude where folks can't see the damage coming from the Fed's prior actions. It reminds me a little of the period from the fall of 1998 to early 2000, when I was ranting and raving about what a clueless, dangerous man he was. Folks asked, how can you say that? Look how wonderful things are.
Well, we found out where that was headed. Now we're in another interlude period, compliments of all the stimuli. When this period ends, folks will once again see how costly he has been to their net worth.
Beneficiaries of bozo central banking
As I was saying in my daily column last week, the next big trade is the Fed losing its credibility. Whether you want to express that view by being short stocks, or by being long metals or foreign currencies, it doesn't really matter. Though the risk/rewards are different, as well as the timing of when these ideas will work, it's all one trade.
If Al goes wild and cranks up rates, the economy would tank. Given all the debt we have, so would the dollar. The financial system would be a mess, and the price of metals would go higher. If he decides to stay behind the curve, at some point inflation will grow until it can't be hidden any longer, causing the dollar to go down and metals to go up.
In going over this issue countless times in my mind, I keep coming back to the same place: The dollar is a short sale. Precious metals are going to be winners over time. Stocks are on borrowed time. I wish I knew the timing of all this, but I don't. Nevertheless, I am still looking for clues to try to capture this inflection point as well as I can.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, he did not own or control any of the equities mentioned in this column. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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