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Inflating Our Way Into Recession

Chart courtesy of Bill King, M. Ramsey Securities
>

For quite some time in these pages, we have been lamenting the mistaken belief amongst some on Wall Street that there was a free lunch to be had. Lowering interest rates, the Panglossians argued, would stimulate the economy, whose slowdown would prevent inflation.

If that argument strikes you as both circular and contradictory, welcome to the club. That obvious flaw was apparently lost on its authors, who required a 2 X 4 across the skull to show them the error of their ways.

That swing of the lumber took place yesterday -- even as demand supposedly weakened -- when Crude Oil passed $100 a barrel on a closing basis for the first time. OPEC nations are expected to reduce output when they meet next on March 5th.

But don't think its just Oil. The promiscuity of the US Federal Reserve has led to all manners of dollar-denominated commodity price surges:

-Gold soared $26
-Platinum exploded $91
-Iron-Ore Prices Up 65-71%
-Copper surged 20 handles
-Wheat prices surge to new high
-Soybeans traded at a record high.
-Fertilizer makers soared to record share prices

Then there's gasoline. A survey of prices shows the rising impact of inflation. Gasoline has rallied from $2.22 on Feb. 7 to a record $2.62 yesterday. This is an 18% increase in less than two weeks – and drive season buying is still way ahead of us. These increases have yet to work their way through to the consumer; the  economic impact of energy costs still lay off in the future.

One would imagine that expectations of ebbing inflation would be dashed by now. One would be wrong.

As we have seen time and again on the Street of Dreams, Wall Street pundits take months, if not years, to accept what is before their very eyes. Whatever you want to call it -- cheerleading or Cognitive dissonance -- it is a fact of life that the obvious takes much longer to be accepted than is logical. Hence, this simple numerical  inflation fact, reflected in global food prices, record energy and both industrial and precious metal inflation, will be ignored for as long as possible.

Maintaining this denial of reality is becoming increasingly difficult. Yesterday, Wal-Mart reported Q4 earnings,, and its becoming increasingly difficult to deny reality.  Net sales rose 8.3% to $106.3 billion, while earnings rose 4% to $4.1 billion, or $1.02 a share. The big increase in sales reflected a combination of new store openings and of course, gasoline and food price increases.

Sales at stores open at least a year were sluggish, up 1.6% rise over the year-ago period. Excluding fuel costs, sales rose 1.4%.  However, Wal-Mart (Costco also) do not break out food prices from their reports. Hence, Wal-Mart sales were likely much weaker than the headline number, reflecting inflation. We suspect that's why the company lowered its Q1 and FY ’08 forecasts.

So why this foolhardy approach? Why, as Bill King calls it, "Inflate or Die" ?  Several theories abound, led by Fed hubris  and/or incompetence.

I'm not sure I buy that. A more likely possibility is what John Cassidy describes in A Bankers' Bailout:

"The rescue operation brings to mind John Kenneth Galbraith's dictum that in the United States, the only respectable form of socialism is socialism for the rich."

 

Indeed.

~~~

Consumer Prices (CPI) is out today at 8:30am. Producer prices (PPI) are mysteriously MIA due on February 26. . .

>

Sources:

Weakening Demand? Oil Still Passes $100
By NEIL KING JR. and ANA CAMPOY
February 20, 2008; Page A3
http://online.wsj.com/article/SB120346863077378499.html

Opec worries drive oil price to $100 close
Andrew Clark in New York
The Guardian, Wednesday February 20 20
http://www.guardian.co.uk/business/2008/feb/20/oil.globaleconomy

With Iron-Ore Price Hikes Like This, Who Needs a Monopoly?
Heidi Moore 
Deal Journal, February 19, 2008, 12:13 pm
http://blogs.wsj.com/deals/2008/02/19/with-iron-ore-price-hikes-like-this-who-needs-a-monopoly/

Wary of economy, Wal-Mart cautions on '08
David Goldman
CNNMoney.com, February 19 2008: 10:43 AM EST
http://money.cnn.com/2008/02/19/news/companies/walmart_earnings/?postversion=2008021908

The Bankers' Bailout
John Cassidy   
Portfolio, March 2008    http://www.portfolio.com/views/columns/economics/2008/02/19/Massive-Bailout-Planned-for-Banks

Wednesday, February 20, 2008 | 07:37 AM | Permalink | Comments (67) | TrackBack (1)
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Comments

CPI will be massaged to.249999999999999999%

Rounded down to .2

Posted by: SM | Feb 20, 2008 8:02:55 AM

i have not seen gas at 2.22/gal in the last one year

~~~

BR: That's wholesale trading, not at the pump price

Posted by: techy | Feb 20, 2008 8:07:07 AM

"There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."

-- John Kenneth Galbraith

I think for these students (professors) of financial history that wield money-pricing power, an other problem is the severe political pressure they're under by the powerful... the powerful must have enough strands of evidence to declare the tax cuts for the rich a success.

Posted by: VennData | Feb 20, 2008 8:09:03 AM

Man, Rick Santelli just burned down Steve Leisman's house...

Posted by: Chief Tomahawk | Feb 20, 2008 8:20:06 AM

Thank you for reference to Cassidy article. Eye-opening.

Posted by: Tom Durff | Feb 20, 2008 8:20:28 AM

The PPI is due on Feb 26. The entire year's release schedule is available from a link in the dead center of the bls website.

Why is this a mystery?

~~~

BR: Doh! Fixed above

Posted by: easy | Feb 20, 2008 8:21:57 AM

I love the bearish sentiment... Look at the lack of volume. "They" can't push this market down. We are going up. JMHO (and many others as well).

Posted by: Contra-Trader | Feb 20, 2008 8:28:46 AM

Feb 20, Bloomberg:

The Fed ``will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke told Congress last week.

``To date, inflation expectations appear to have remained reasonably well-anchored,'' he said.

You could almost say they were contained... (con-tainted?!)

Posted by: Michael M | Feb 20, 2008 8:30:17 AM

As credit/debt is vaporized much faster than it's being originated, we won't be worrying about inflation as the 800 pound Gorilla in the months to come, but it does serve the purpose of misdirection when it's needed.

Inflation in things we need, and deflation in everything we formally wanted. Anyone have a recipe for soup using a big screen TV as the stock for the soup?

Posted by: SPECTRE of Deflation | Feb 20, 2008 8:38:33 AM

Inflation ? What inflation?!

I trust the run up in commodity prices far more than those CPI/PPI/core deflator numbers.

Posted by: Dave | Feb 20, 2008 8:38:57 AM

"Whatever you want to call it -- cheerleading or Cognitive dissonance --"

It's none of the above. The clowns doing this stuff are professional liars and their reason for existence on Wall Street is to keep the public hoodwinked. They know exactly what's going on. We have an inflation problem and they know it.

Posted by: Tom F. | Feb 20, 2008 8:41:06 AM

When I look at these headlines, inflation is the least of our problems:

Wed Feb 20 2008
Banks quietly borrow $50 billion from Fed (news.yahoo.com)
Signs Point To Banking Crisis Getting Much Worse (247wallst.com)
U.K.'s Northern Rock Move Highlights Risk to Taxpayers (online.wsj.com)
America's economy risks the mother of all meltdowns (news.yahoo.com)
Wall Street Faces Fury Over Subprimes (biz.yahoo.com)
Mortgage Lenders Toast Wall Street with Kool Aid (seekingalpha.com)
Turning a Costly Blind Eye to Mortgage Speculators (seekingalpha.com)
Median LA listing prices down $110K from peak (latimesblogs.latimes.com)
Preventing foreclosures: Why bother? (latimesblogs.latimes.com)
The REAL American Dream: It's NOT Owning A House! (erica.biz)
Forclosure Map Of Vegas (foreclosurepulse.com)
Loans go bad as English housing bubble pops (latimes.com)
Inflating Away Debt (minyanville.com)
Vallejo On Brink Of Bankruptcy (nbc11.com)
Midwage jobs vanish in Silicon Valley (sfgate.com)
Obama says Clinton's housing plan helps rich (reuters.com)
Housing: Is it Going to Get Worse Before it Gets Better? (seekingalpha.com)
Homeless Woman Approved for $470,000 Mortgage (efinancedirectory.com)
Invalid Property Value (patrick.net)

Posted by: SPECTRE of Deflation | Feb 20, 2008 8:43:04 AM

So, this is new news?

How does any serious market/economic historian think that we got out from under our massive WWII debt and the Marshall plan? Print money...

How did we pay for the Great Society and a massive war effort? Print money...

When Bernake blinked last August, the smartest man I know had two investment ideas. Precious metals and Ag...

It's in the Constitution. Freedom of the press. Bring your own paper, print money...

Posted by: Ross | Feb 20, 2008 8:47:51 AM

The 69% increase in iron ore price translates into a 13-18% increase in rolled steel products (sheet, plate, structurals).

Chian projects a 11% increase in steel imports and a 27% decrease in steel exports. As the world's largest steel producer, what effect do you think that will have on the price of steel? Driving the prices of rolled steel products up by another 20% would be my guess.

Lloyds shipping news yesterday has a story on how the build price for a very large tanker was $90M in 2004 and is now $150M. A 66% increase in 3 or 4 years. No inflation, nosiree...

This is of more than casual interest to me, as I run a steel fabrication company.

How would you bid the price for a project of 2 year duration with no escalator clause offered?

Posted by: Neal | Feb 20, 2008 8:49:57 AM

CPI 0.4
Ex-inflationary items: 0.3

Contained my @ss

Posted by: shoeless | Feb 20, 2008 9:10:58 AM

Barry, Thanks for this blogsite.

I am 51 and I have never seen such a mess financially, socially, geopolitically (domestic and international) swinging wildly from one issue to the another.

Maybe we should just reverse our thinking completely. Maybe we should only discuss those things that are going well and accept by default that everything else not discussed is totally @#cked-up! It's sad to see all of this happening. I am not referring to just the CPI, economy, subprime or gas prices. I feel like the US and its citizens are losing control of their destiny. We are losing our ability to contain problems and issues that are detrimental to our well-being.

The chickens are coming home to roost in a thousand different areas simulataneously. Our time of putting things off until tomorrow is over. Everything is evolving faster and faster and faster. That is a bad situation if you are going in the wrong direction. We in total are out of control. We just don't realize it yet. I guess that lack of realization at the inflection point is the only thing that hasn't changed over the years. God Bless America!!

Posted by: BG | Feb 20, 2008 9:13:46 AM

Neal,
It's a cost plus contract world again. If one of your competitors under bid you on fixed price, let him have it. He'll be toast in a few years and you will have one less vendor in the market.

In 1974, Westinghouse and Combustion Engineering were technically bankrupt because they had fixed price contracts to build power plants. Long lead times and faulty accounting crushed their margins.

Tell your accountant to be sure you are using LIFO inventory accounting and accelerated depreciation or you will be paying taxes on inventory gains and replacement costs on your fixed assets.

Posted by: Ross | Feb 20, 2008 9:14:10 AM

Maybe we should only discuss those things that are going well

don't you think it would get awfully boring talking about the same two things all the time BG? OK, I stand corrected, the same thing all the time

Hey Barry, don't worry. When the inflation enters the labor pool IT ENDS! That is their promise. The circle will not be full

Posted by: DavidB | Feb 20, 2008 9:25:43 AM

"the only respectable form of socialism is socialism for the rich."

History shows that it is so, until the middle class get its head handed to them by severe recession; and this one promises to be a nasty one.

Since socialism is state-induced, replacing those who head the State can shift the socialism toward other classes. Just look at what happened in the years following the Great Depression. BTW, things do not need to get that bad for a deep seated and enduring shift in attitudes (leaning "left" vs. "right") take place in American psyche.

I do not think voters are ready to forgive anything by now. Too much abuse has taken place in the last 25 years and even the dangerously dim-witted cluster of Joe 6-packs and Jane Cartoons is getting the distinct feeling that something is definitely wrong in Uncle Sam's turf.

For once, election season promises to be quite interesting.

Posted by: Francois | Feb 20, 2008 9:29:59 AM

Ross,

You're hysterical. Inflation is nowhere near bad enough to switch to LIFO if your company has decent inventory control and quick turns. If you're turns are slow enough to require inflation accounting for your inventory, then you have bigger problems to worry about. LIFO reserve accounting (you probably don't know what that is) is not something to do for fun.

For tax purposes, MACRS is accelerated until straight line becomes beneficial, Then it automatically switches over. Most, but not all, depreciable assets, use accelerated depreciation for tax purposes. Real estate requires SL, I believe. This is all built into the tables. Tax law is pretty rigid with respect to applicable depreciation. Unless he can take a $179 deduction, the IRS removes discretion from depreciation.

For books, do what you please since tax accounting controls the cash for most small businesses.

Please define the term 'replacement cost on fixed assets'. It sounds slick but appears to mean gobbledygook.

Posted by: cinefoz | Feb 20, 2008 9:42:40 AM

Thanks, Ross, the cost plus contract may make its way back into use when the buyer realizes that the smart estimator is over-estimating price increases in order to make sure that they'll be in business next year.

It seems to me that this is the point when inflation spirals out-of-control--the point where a business cannot reliably predict costs in the next year or two within a reasonble (and survivable) margin of error.

Posted by: Neal | Feb 20, 2008 9:47:34 AM

You guys will love this.

From the government economic indicators page:

Due to budgetary constraints, the Economic Indicators service (http://www.economicindicators.gov) will be discontinued effective March 1, 2008.

Draw your own conclusions. How much do you want to bet the next TAF report doesn't get reported to the public?

Posted by: Burnt burrito | Feb 20, 2008 9:52:01 AM

cinefoz:
You think BR doesn't know what LIFO reserve accounting is? He is a financial analyst(When you boil it down). I'd take his word over yours any day. And just curious, at what point would inflationn get bad enough? Weimar Republic type inflation?

Posted by: Joe Klein's conscience | Feb 20, 2008 9:59:24 AM

Neal,

Might it be worth looking for a hedge, and build the hedge cost into your bids? Even if there isn't a perfect hedge for your material costs, maybe a close enough for government work proxy hedge?

Posted by: Estragon | Feb 20, 2008 10:03:32 AM

Joe Klein's conscience said ...

You think BR doesn't know what LIFO reserve accounting is? ...

reply:

Just for grins, What Say Ye?

Posted by: cinefoz | Feb 20, 2008 10:06:53 AM

December 2008

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