hidden inflation

8/7/2019 Hidden Inflation

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Hidden Inflation: Why Prices Are Rising

Faster Than You Think

March 19, 2011By Money Morning Staff

Money Morning Staff Reports

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) forJanuary showed that core inflation which includes prices for all items except food andenergy was up only 1% from the same month the year before.

By excluding food and energy prices, as volatile as they may be, the CPI fails to convey the painthat rising prices are inflicting on American households. Indeed, some economists have claimedthat the true rate of inflation is closer to 8% or 9%.

To get a true picture of the current inflation situation and to understand its impact and potential

dangers (as well as several investment opportunities) Money Morning Executive EditorWilliam Patalon III sat down with Chief Investment Strategist Keith Fitz-Gerald for a question-and-answer session on the topic.

William Patalon (Q): Keith, we talk a lot about hidden inflation. Is inflation a problem

right now? If so, how bad is it? The CPI for January said 1%. Given what we see in the

marketplace, it sure looks like a case of hidden inflation. Whats the real rate of inflation

right now, and is it at its peak, or are prices going to continue to escalate? What do all the

statistics in this accompanying chart (see accompanying info-graphic) say to you?

Keith Fitz-Gerald: Short version? The CPI is a joke. Every American knows that in reality its

far higher than that based on what they feel in their wallets every day. Even my 8-year-old son,Kazuhiko, was asking me yesterday why the Lego set hes been saving for is now $33 instead ofthe $22 he initially spotted a few months ago.

My research suggests inflation is really running between 9% and 12%, which is morecommensurate with what we all feel in our wallets every day. As for whether or not inflation hasactually peaked, thats a tough call best left to those who deal in official numbers and believeme when I tell you that Im saying that with all the sarcasm I can muster.


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My view is that inflation is very real and its already here despite what those in Washingtoncontinue to believe either because their data is so heavily manipulated or because of their owndeliberate ignorance. Using history as my guide, I also believe its going to get a lot worse beforeit gets better.

Q: What are the big inflationary catalysts right now? And whats driving them?

Fitz-Gerald: I think there are a few, but the single-most-important contributory factor is thetrillions of dollars central bankers around the world have pumped into the financial system sincethe crisis began in late 2007. Never mind that the crisis was caused by too much money to beginwith; the central bankers have embarked on a course that ultimately risks destroying the verywealth they are trying to preserve.

Granted, 99% of Americans wont see or believe that because the markets have reboundedsignificantly as part of the reflation process. But they will definitely feel it.

The only reason weve been able to stave off complete inflationary disaster so far is that weveexported it to places like China, India and Brazil as part of our monetary policy, in exchange forthe cheap goods weve come to depend on. However, thats coming to an end as those economiesgrow 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,theres going to be hell to pay.

Q: How about the Middle East violence and uncertainty? How is that contributing to this?

Fitz-Gerald: Inflation was already well under way before the powder keg there exploded, so this

is not as much a primary inflation driver as most people think. Thats not to dismiss it, becausethere is a direct relationship between scarcity and higher prices especially at the consumer level.

The key is time and by that I mean time as in how fast prices climb and how long they stay atelevated levels.

Most companies are prepared to absorb short-term volatility. But longer-term, there is no doubttheyll pass along to consumers (you and me) the higher fuel and petroleum costs that are part oftheir manufacturing processes. Many, like airline and transportation companies, are alreadydoing so. So are food suppliers and materials makers, for example.

Ive noticed, for example, a dramatic price rise in what it takes for me to get home to Japan, oranywhere in the Pacific Rim this spring. My breakfast costs 60% more now than it did threeyears ago and my wife makes no bones about mentioning by just how much the cost of salmonhas risen at our local Costco (Nasdaq: COST). Many readers have probably noticed similarthings in their own lives.

But, getting back to the Middle East the risk there is that the unrest thats right now confinedto a couple of countries spreads to the greater region where were talking about 60% of the


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worlds oil supply being potentially at risk. Ive diligently prepared ourMoney Morning andMoney Map Report readers for this over the past 12 months and weve already profitedsignificantly from our actions. But and I cant say this strongly enough the game is justgetting started.

Q: Whats the end-game here? By that I mean, whats the potential fallout? Could it stallthe recovery? With unemployment still up in the 9% neighborhood, are we in danger of

experiencing a 1970s-style period of stagflation? If that occurs, whats the outcome you

see there?

Fitz-Gerald: I dont think the end game is as clear-cut as many people would like to believe.

On one hand, the laws of money are immutable, so we will have to pay the piper, but lets notforget we have virtually the entire G-20s banking apparatus playing against that possibility.Theyre obviously well-intentioned. But its all theory. T hey are complete economic moronswhen it comes to real money.

Thats a strong statement, so let me give you an example. New York Fed President WilliamDudley 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 andmentioned the new Apple Inc. (Nasdaq: AAPL) iPad 2 as an example which elicited guffawsfrom much of his audience and downright angered the rest who challenged him by asking howlong its 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 withour dual mandate.

Im not sure these guys are on the same planet as the rest of us.

By removing the freedom to fail and, instead, insisting on bailout after bailout, our leaders arepropping up zombie financial institutions that will ultimately come back to haunt us. Historyshows unequivocally that we cannot live on free money forever. And its worth noting at therisk of sounding like a broken record that no nation in recorded history has ever bailed itself outby debasing its currency on anything other than a short period of time. Thats never happened and its not likely to.

Q: It seems to me that the U.S. Federal Reserve, which contributed to this escalation in

prices with its QE policies, is now stuck between a rock and a hard place. The longer itmaintains current policies and keeps rates at historic lows, the worse price escalation will

get. But if it turns off the spigot, it risks shutting off the recovery, too. Is that how you see

it?

Fitz-Gerald: I see it that way, too. By keeping rates so low for so long, the Fed is not onlyrisking inflation, but the catastrophic collision of entitlements like Medicare and Medicaid tothe tens of trillions related to everything from mortgage debt to personal credit cards.


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I think its a financial deathtrap, for lack of a better term. What Team Bernanke is doing islocking down the short end of the yield curve while leaving longer-term risks to the markets inan 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 drivers seat, Bernanke canget away with it. But we now have nations like China calling their own shots [that are]increasingly unwilling to submit to Washingtons policy missives. Second, stimulus spending as Washington has defined it doesnt work.

If it did, our economy would be screaming along at 8%, or more. Instead were like a 1970sPinto 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 theyre nowattaching to the debt they purchase. And that makes sense for the following four reasons:

1.

The Fed missed this crisis-in-formation, and even in late 2007 insisted that everythingwas hunky-dory. My favorite was Bernanke who fabulously stated that the risks werecontained. And we can see how accurate a call that proved to be. So if youre temptedto put your faith in Team Bernanke, ask yourself this: Given this earlier miscue, whywould we believe the Fed will be able to spot the turning point when everything is fineand back off the quantitative easing accordingly, which is one of the central banks keyarguments for taking the actions that it has taken?

2. Our financial markets have gotten hooked on super-low interest rates in much the sameway someone gets hooked on drugs. Just think about what happens when you take awaythe narcotics history suggests well see the same withdrawal in the financial marketswhen 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 Fedraises interest rates. Of course, what this means in practical terms is that the Fed will keeprates too low for too long and make too much money available until it is sure wereon our way. Many market-watchers, analysts and traders myself included believe thiswill inflate another financial bubble. Truth be told, I think the central bankers havealready done that.

3. An increase in interest rates will be the financial equivalent of a self-inflicted wound. Itwill dramatically increase our refinancing costs as borrowing costs go up. In very realterms, this will mean that banks have to potentially pay more on their deposits than theymake from their investments as rates rise. Bear in mind that the Fed actually needs lowrates to pay for all the debt it has pumped into the financial system. In that sense, risingrates 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.

4. And finally, dont forget that t he Fed has been buying trash as part of the bailout process mortgage-backed securities, swaps, worthless bonds and other unconventional debtconjured up by investment banks from Wall Street and from other parts of oureconomy. And while our central bankers may believe that they will be able to easily sellthese assets when the time comes, that clearly wont be the case. Think about it. Thoseassets will be worth less because a.) their value moves opposite interest rates, meaning


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any increase in rates will drive down their value, and b.) these assets were junk to startwith. The banks that offloaded it to Uncle Sam are all too glad to be rid of it and I cantthink of any reason why theyd take it back.

Folks often refer to Hollywood as La La Land. I submit t hose folks have never been to

Washington.

Q: Ive asked you this type of question before, and you always seem to have a great

response. So Im going to pose it again. If President Barack Obama and U.S. Federal

Reserve Chairman Ben Bernanke hired you to help the U.S. government arrest this rise in

costs, what advice would you provide? What strategy would you employ?

Fitz-Gerald: I think the path here is very simple. But it wont be popular. And it wont bepainless. I would tell the administration to:

1. End the bailouts and stop printing money. You cannot suspend free-market forces andstill have the economy function. If a company is going to fail, let it fail.2. Outlaw non-deliverable credit-default swaps to remove the speculative componentfrom the debt market. By doing this, we will shift the focus of the economic recoveryfrom Wall Street back to Main Street where it belongs.

3. Start to raise interest rates immediately before the market does it for you. If you waitfor that to happen, youll not only lose control of your domestic destiny, youll lose whatlittle global respect this economy still commands.

4. Partially tie our currency to oil and commodities a move thats important because it willremove the uncertainty about what the U.S. dollar is actually worth.

5. Freeze the budget and allow private sector growth to compensate. Quit trying to help usand get out of the way.

6.

Simplify the tax code and flatten it out so that everyone contributes equally. The U.S. taxcode is 8 million lines long need I say more?7. 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.8. Address Social Security privatize it if you have to and Medicare while youre at it.9. 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 moneyat seemingly ever-increasing levels. Its time to acknowledge reality.

Q: Lastly, given what you see for the markets, could you give investors a couple of ideas as

to how they should invest both to protect themselves and, even better, to profit?

Fitz-Gerald: You bet. In my talks around the world, I like to remind investors of an importantpoint its kind of a mantra of mine: Chaos is actually opportunity in disguise. Washington iscreating chaos but from that well see many wealth-building opportunities arise.

For investors, the key thing to do in the years to come is to make investment choices that canweather the storm, and profit from the opportunities that emerge. Here are some very soundchoices for turbulent times:


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y Altria Group Inc (NYSE: MO), recent price: $24.43: Altria is a giant cigaretteproducer with a 6.23% yield thats a smart choice in rough markets. You may not likesmoking any more than I do, but t he firms beta is a very low 0.47, which means thestock is slightly less than half as volatile as the broader markets. Operating margin is ahealthy 39%.

y Ecopetrol SA (NYSE ADR: EC), recent price: $39.70: Ecopetrol is a verticallyintegrated oil company thats based in Colombia. That makes it a play on LatinAmericas robust growth with a nice 2.5% dividend, to boot. This stock has a beta of1.01 which means its about as volatile as the overall markets. However, Im willing tooverlook that volatility, since the companys five-year Price/Earnings/Growth Rate(PEG) ratio is 0.53 which suggests there is still good value at a fair price.

y iShares Barclays TIPS Bond Fund (AMEX: TIP), recent price: $110.09: Thisexchange-traded fund (ETF) invests exclusively in Treasury Inflation Protected Securities(TIPS). W hen 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 risingprices, Ill take it.


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