We've been warning about this for months and months. Since the financial meltdown in the fall of 2008, we knew this risk was inevitable, and we told you so.
Sure enough... it's here. The chart below shows the current year-to-date price change in a range of basic commodities. Outside of energy, just about every commodity in the world is up by around 20% – or a lot more. Why do you think that is? It's not because demand is growing rapidly – our economy is barely growing at all. And it's not because there's a sudden shortage of every commonly traded commodity. It's because our monetary authorities are desperate to stimulate, and they're printing almost unlimited quantities of new money. They're playing a dangerous game...
Here's another way to see the same forces in motion. It's a chart of the CRB index – the most widely followed index of commodity prices on Wall Street. Since the Fed began its quantative easing program in March 2009, the CRB index has gone from around 200 to around 300. That's a 50% increase. The key thing to remember is the amount of corn, wheat, soybeans, etc. represented by each unit of the index has never increased one iota. You immediately see a 50% increase in the price of the CRB actually represents a corresponding decrease in the purchasing power of the U.S. dollar.
You might recall a number of analysts (a few even work here) claimed the Fed couldn't manufacture inflation in the face of a banking-sector crisis. They claimed inflation wouldn't materialize unless the banks were ready to lend a lot more money (unless the velocity of money increased). I knew they were dead wrong.
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Why? Because the total credit in our economy has continued to expand despite the massive banking sector losses. How? The U.S. government has expanded its balance sheet even faster than the banks have contracted theirs. And that's bound to continue, thanks to the unlimited bailout of Fannie and Freddie and the ongoing federal deficits that equal more than 10% of annual GDP.
Now... let's ask a different question: Has this inflation helped "save" the country? Well, the S&P 500 has gone from around 700 to around 1,200. That's a big move – more than 70%. But adjusted for inflation, the index has only gone up about 10% a year. That's not much, considering we were starting from a depressed level (700). What about unemployment? Has the debasement of the U.S. dollar led to a big surge in economic activity or hiring? Absolutely not.
So what has it accomplished? Fans of the government would claim the Fed's actions saved us from a depression, that things would be a lot worse right now if it hadn't stepped in. Maybe that's true – there's no way to know what might have happened. But what these folks never mention are the costs of the Fed's actions...
We know the massive inflation hasn't jump-started our economy. We know it hasn't led to more employment. And we know it came at a massive price. We have a $14 trillion economy. Put a reasonable multiple on it – say 10 times earnings. That represents the "market cap" of the U.S. dollar's economy. It's worth roughly $140 trillion. Would you trade half of this value – $70 trillion – for the impact of what the Fed has done so far? No way. But that's the impact of devaluing your currency.
To improve our economy in a real and lasting way, we have to become more competitive with the rest of the world. Make no mistake, there's no other path to prosperity. You can't "protect" your way to wealth with tariffs and taxes. Nor should we have to govern ourselves like a banana republic merely to survive.
We have enormous advantages in technology, infrastructure, capital markets, and, until recently, the rule of law. We have one big disadvantage: labor costs. To maximize our advantages and overcome our big disadvantage, we need to cut the costs of government and lower the costs of capital formation (which can easily overcome high labor costs). To do this, we must drastically cut the size of our government. The federal government alone equals more than 40% of our gross domestic product. That is obviously unsustainable in a world where our competitors are only paying 12%-15% of GDP for government. And most importantly, we must eliminate taxes on corporations and capital.
Discussions about who should pay what or whether or not we need tax cuts are moot. Like it or not, America's economy cannot return to its position of prominence when we have the highest taxes in the developed world on corporations and capital. Especially when you understand our biggest competitive disadvantage is labor costs.
These facts are so clear and so obvious, a sixth grader can understand them.... And yet... I'd wager not a single U.S. congressman truly understands why our economy can't seem to get back on its feet.
There's one other very important issue to understand when it comes to inflation: income inequality. High rates of inflation benefit the wealthy at the expense of the poor. And high rates of inflation can destroy the wage-earning middle class. Inflation dramatically increases asset prices relative to real wages. This immediately makes the rich (who own most of the assets) vastly better off. It makes the poor much poorer. And it devalues middle-class incomes year by year.
Since we left the gold standard in 1971, real wages (after inflation) have declined. Income inequality has soared. All of these things are caused by inflation. If the Democratic party ever figures out the root cause of income inequality in America is our paper money, we have a chance at getting back to real money. Somebody buy the Democrats a literate economist.
What should you do? The main thing is for you to understand what's happening. You should expect your wages to buy less. You should expect investment bubbles to form (like in the so-called rare earth companies). You should expect stock market and interest rate volatility. You should expect the currency markets to be volatile. You should expect inflation hedges – like gold and silver – to do well.
This is a terrible time to be a saver or a long-term investor. Volatility and the loss of purchasing power associated with inflation makes it difficult to hold onto anything and earn much of a real yield. On the other hand, this is a fantastic time to be a speculator – perhaps the greatest period in history. My advice is to put most of your wealth into things that are concrete, tangible, and under your control. Buy gold. Buy silver. Buy a farm (or part of one). Buy high-quality bonds with short durations. Then, take part of your wealth – maybe 20%-50%, depending on your age, your skill level, and your risk tolerance – and follow our advice.
Matt Badiali's newsletter, the S&A Resource Report, is making a killing in resource exploration stocks. This will likely continue. And he's not the only one of my guys who knows how to make a killing in a speculative environment. With real inflation running at 15%-30% per year, we're going to do well in almost all of our newsletters – as our existing readers will tell you we've been doing.
The point is, you've got to make 20%-30% a year on your portfolio just to keep up with inflation. Sorry, but that's the reality. And you can't do that in T-bonds.
New highs: DirecTV (DTV), Penn Virginia Resource Partners (PVR), Altria (MO).
It seems we've struck a chord with the estate tax issue. But there's no need for debate. We know we're right... send your e-mails to feedback@stansberryresearch.com.
"Thanks for the link. This was the clearest explanation of the factors driving inflation that I've encountered. It provides a context for what will be happening that will keep us, the small investors, less susceptible to hype and bafflegab. As the coming drama unfolds we can see what fits where and, hopefully, act accordingly." Paid-up subscriber D.H.
"When he makes you money, he is a genius. When he wants you to pay your fair share of taxes, he is a hypocrite." – Paid-up subscriber Chris McKenna
Porter comment: The idea that the rich aren't paying their "fair" share of taxes is preposterous. The top 1% of all taxpayers earn roughly 11% of all the income. They pay more than 22% of all the taxes. Nothing about that is fair, especially not considering one of the founding principle ideas of "America" was everyone should be equal before the law.
No one would join a club where drinks for some members were $1.11, while other members had to pay $2.22. Likewise, no one would agree to pay taxes on this basis, unless they were compelled to do so by the awesome powers of The State. But don't fool yourself into thinking that coercing people to pay grossly unfair taxes doesn't come at a cost. The higher the marginal rate of tax, the more inefficient and uncompetitive the economy becomes. Who does this hurt? Not the rich.
"Hey Porter, how come you don't have any female analyst's on your staff at Stansberry. Are you a sexist?" – Paid-up subscriber C. Parcells
Porter comment: We're hiring. And we hire the best people we can find to do the job... male or female... from anywhere in the world.
"I assume Curt Whitney is serious, but I know I am. Yes, I think the United States would be better off if your (hopefully) vast estate goes to the government rather than your well-educated heirs. First, your well-educated offspring will be more than capable of earning their own fortunes. Second, all estate taxes should go to improving our educational system. The focus should be on the terrible schools attended by children of parents without the resources to educate them as you've educated yours. This country should start all children off with a great education and stop wasting all those human assets. What better use for your accumulated wealth? You can't take it with you, but you've had the fun of earning it. Giving a good education to children who wouldn't have one otherwise would improve the country and make you a hero. Giving it to your children who won't need it just makes you a sugar daddy. Gates and Buffett have the right idea about that." – Paid-up subscriber M.E. Reese
Porter comment: Mary Ellen... If you think the government running our schools is a good thing for our country, I'm afraid we shouldn't even bother with this discussion. But just to humor my other subscribers, I'd like to point out that with YouTube and a library card, anyone with a little motivation can get a Harvard-quality education for free. There's a big difference between going to school and learning. Some kids and their parents have figured this out already. Vastly more people will over the next decade. And by the time I die, the entire public school system will have disappeared (thankfully).
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
October 29, 2010Inflation isn't coming, it's here... The hard facts about prosperity... The real cause of income inequality... How to protect yourself now... Why public schools will soon disappear completely...