Last time, we explored the growling evidence that in spite of a tame Consumer Price Index (CPI), real-world inflation is becoming “a thing.”
This is notable because it’s happening at a time when “velocity” … how fast money (or more accurately, “currency”) circulates … is slow due to lockdowns their fall out.
In Part 2, we delve into the rare phenomenon when a stagnant economy experiences inflation …
… and a theory that lockdowns might be more cover than cause.
So here’s Part 2 of our Theory on What’s REALLY Happening.
Click here for Part 1.
Stagflation is a word kicking around financial media … one we haven’t heard too often until recently … but are sadly old enough to remember.
Stagflation was a major issue in the 1970s.
It’s a concatenated word for “stagnant economy” and “inflation” … a circumstance when prices are going up in spite of a slow economy.
Theoretically, prices are partially driven by velocity (how fast money circulates between participants in an economy).
As money circulates faster, the economy can “over-heat”, causing prices to rise. At least that’s the theory used to justify slowing things down.
Economic slowdowns caused by lockdowns or other factors should put downward pressure on prices. So stagflation is an odd duck.
The last time the U.S. faced stagflation was the 1970s … and it’s the term most often used to describe the economy of the Jimmy Carter presidency.
However, if you understand what stagflation is and what causes it, it probably wasn’t Carter’s fault … perhaps Nixon (Carter’s immediate predecessor) was to blame. At least partially.
And really, Nixon simply tripped the trigger.
The bomb had been planted in 1944 at Bretton-Woods when the gold-backed U.S. dollar became the world’s reserve currency.
There are lots of lessons in the history of circumstances leading up to Bretton Woods … and many more around the consequences of it.
They’re well worth the study, but we don’t have time to cover all that today.
Join us on the Investor Summit and you’re sure to have MANY deep conversations about this … and many other things …
… all while watching a tropical sunset and sipping a refreshing Belizean cocktail with Peter Schiff, Ken McElroy, and the rest of our amazing Summit faculty.
Back to peeling back the layers of today’s onion …
With the benefit of hindsight, here’s a quick account of 1970s stagflation and a theory about its 21st century reincarnation.
Put on both your thinking cap AND your tinfoil hat.
Ready? Here we go …
When Nixon defaulted on the gold-backing of the dollar in 1971, the dollar collapsed. Gold and energy prices shot up. Sound familiar?
Gold is money. And energy is the basis of all economic activity.
There was no Bitcoin back then, but if there was, it probably would have spiked too … just like it is today.
These are all signs of alert money heading to the lifeboats as the dollar sinks.
So like the Titanic hitting the iceberg, casual passengers feel the impact but are unsure what’s happening or who to blame.
Of course, it behooves both the crew and the insiders to promote calm.
After all, there are only so many lifeboats. And it’s hard to maintain control of panicking people.
So PERHAPS, in order to obfuscate the reality of the collapsing dollar and the need for a reset (sound familiar?) …
… the economy had to be SLOWED … by DESIGN.
Here’s why …
Rising prices result from a blend of four dynamics …
First is supply and demand. When demand for something grows faster than the supply, the price gets bid UP. That’s Econ 101.
Of course, in a sound money system (which we do NOT have), when money bids up any particular product, it takes a bid away from other products.
Here, money is a zero-sum game … as it probably should be. It’s another topic too big for today, but one you might consider studying.
But it’s easy to understand how panicked demand against limited supply causes people to reorder their spending priorities … so some prices spike while others crash.
Think about bottled water, toilet paper, air travel and hotels when the pandemic first hit …
People stopped bidding on air travel and started bidding on essential supplies. To no surprise, bottled water and toilet paper prices spiked, while air travel and hotel prices crashed.
The next dynamic is when the dollar supply grows faster than the production of goods. This is classic inflation … too many dollars chasing the same goods.
It works like this …
Imagine there are ten dehydrated hikers, each with $1, and they’re competing for only one bottle of water. And they’re REALLY thirsty.
When the bidding starts, that one high demand bottle will get bid up to $1 … but no further … because no one has the ability to bid more than $1.
But if you print $9 of stimulus checks and pump them into each hiker’s account, the bid will now go to $10 … for the SAME bottle. That’s true inflation.
The water bottle didn’t change. The number of bidders and their thirst didn’t change. The ONLY thing that changed was how money dollars pumped into that tiny economy.
Inflation means it takes more dollars to buy the same goods and services with NO change to supply or demand.
The third dynamic is leverage … the ability to borrow, which brings future dollars into the present to bid up whatever is financeable.
Leverage is why student loans make education more expensive, mortgages make housing more expensive, and car loans make cars more expensive.
When you add purchasing power, the bid (and thus the price) goes UP.
Policy makers apparently don’t understand this, don’t care, or do it on purpose to enrich those who benefit from it (which is not the borrower).
When you vote or debate, politicians’ motives, and competency matter.
But when you invest, cause and effect are all that matter. So try not to let political preferences muddy your investing vision.
The fourth dynamic is VELOCITY … how quickly money circulates in the economy. The faster the money moves, the more pressure it puts on pushing prices up.
Here’s the important thing …
Seldom are rising prices the result of any single cause.
So diagnosing rising prices is about as simple as reverse engineering the ingredients in a smoothie.
Once you’ve hit puree, it’s hard to parse the components.
However, and perhaps obviously, the Wizards can and do attempt to manipulate pricing (inflation) by tinkering with the recipe.
So let’s say you’ve printed too many dollars (like THAT would ever happen) and you need to hide the lost purchasing power (inflation).
Why hide it? Because once currency users realize the currency is bad, they dump it. This can create stifling hyper-inflation and crushes credit markets.
Because currency isn’t money, its “value” is solely based on confidence. So yes, you could call it a con game. But again, that’s a much bigger discussion.
The point is to hide overprinting, you must place the blame on other components …
“Oh, oil prices are going up because of Middle East unrest. No wait, it’s because we’re running out. No? Okay, must be too much demand.”
It can be ANYTHING, except the dreaded “We printed too many dollars.”
So to stop or slow the currency collapse from becoming obvious, you’d need to retard one or more of the other dynamics.
You could hike interest rates, lower wages, or slow the velocity of the currency with taxes, regulations, restrictions, shortages, etc.
This is a list of evils which must be imposed on the economy … and you need to keep rotating them so it’s hard to diagnose. Sleight of hand comes to mind.
Making sense so far?
“Those who cannot remember the past are condemned to repeat it.”
In the 70’s, oil and gold prices shot up in the wake of defaulting on the gold-backing … as dollar holders used their dollars to buy real assets. Sound familiar?
This was a sign that too many dollars had been printed. So to curtail inflation, the Wizards behind the curtain started pulling levers.
Nixon tried price and wage controls … making it ILLEGAL for private businesses to raise prices or wages. It sounds like Venezuela, but it was 1971 USA … land of the “free”.
It was the 1970’s version of our modern day lockdowns. But it didn’t work, and it upset the citizens, so the plan was abandoned.
Then the nation was distracted … er, captivated … by the Watergate scandal as Congress moved to impeach Nixon. Sound familiar?
During all this political theater … off to the side … an “energy crisis” emerged ostensibly created by an OPEC oil embargo.
Surely, THIS was the real reason oil prices were up. “Pay no attention to that inflation behind the curtain.”
And then, “scientists” announced the world would be out of oil by the year 2000! Oh no! Quick! Everyone, conserve oil.
Now EVERYONE knew for SURE there was an oil shortage because they had to deal with it on a daily basis …
… waiting in long lines to get their limited allocation of gas. The crisis was in their face so to speak. Sound familiar?
The national speed limit was reduced to 55 miles an hour … something Sammy Hagar hated. This conserved fuel, but of course, SLOWED the economy.
So now the economy was slowing in the face of rising prices … and the term “stagflation” was born.
Of course, Nixon resigned over Watergate. Ford finished his term and tossed the citizens a nice bone when he reversed FDR’s ban on private gold ownership.
Side note: You can thank Jim Blanchard, the founder of the New Orleans Investment Conference for your freedom to own gold.
Gold ownership allowed alert citizens to hedge against inflation by converting falling dollars into gold. And they did.
Once legalized, gold shot up from $175 to over $800 an ounce. Or stated properly, gold revealed the collapse of the dollar.
Jimmy Carter was elected in 1976 and his presidency became synonymous with stagflation … not so much because he caused it, but because he didn’t fix it.
Then Ronald Reagan is elected in 1980 and inherits Carter’s Fed Chair, Paul Volcker. Reagan and Volcker took aggressive action to deal with stagflation.
The trick was to crush inflation without crushing the economy.
They did it by jacking interest rates into the TWENTIES. Think about that. The prime rate was as high as 21 percent!
While it’s true high interest rates were a drag on the economy (slowing velocity) … unlike today’s lockdowns or the 70’s fuel rationing, that’s not their primary purpose.
High interest rates slowed lending. And without getting too technical, one of the ways new currency (inflation) gets into circulation is through lending.
Today’s lockdowns , just like the 1970’s energy rationing, slowed VELOCITY.
In contract, high interest rates slows LENDING, but allow the economy to operate. In fact, a solid argument can be made that high interest rates benefit an economy.
But it’s moot because high interest rates threaten bond markets, so central banks will more readily ruin the currency than allow rates to rise.
Meanwhile, old timers know high interest rates were the catalyst for creative real estate as investors found alternatives to conventional lending.
Also, the high interest rates of Paul Volker resurrected the fallen dollar by making it appealing to hold dollar-denominated bonds.
In the early 80’s Treasuries paid as much as 14 percent!
Once the dollar was resurrected, Reagan was able to kick off a huge defense spending spree (“Star Wars”) to stimulate the stagnant economy with only moderate inflation.
This was a GREAT RESET of the dollar via interest rates … followed by 40 years of falling rates … and booming bond markets.
Meanwhile, somehow the oil crisis (and its sister crisis, a new ice age) abated and faded away into a chapter of economic history seldom discussed.
Which brings us to today … and this is just our theory … so you do your own reasoning.
If the spike in “real assets” indicates inflation, which is the sign of a collapsing dollar, and you’re in the Wizard’s seat …
… you need to find a way to hide the collapsing currency until you can reset.
Otherwise, the passengers freak out and rush the lifeboats … often trampling the crew on their way.
But with uber-trillions in global debt, jacking interest rates isn’t an option for the Wizards. It would create a chain reaction of global defaults.
And with the recent global glut of oil, it’s hard to make an argument for rationing energy based on supply problems.
Of course, you could contend for lower energy use based on emissions … so we’re expecting that.
Again, any constriction on energy is going to slow economic activity (velocity) because economies run on energy.
Lockdowns are another way to slow an economy … reducing velocity and thereby mitigating inflation.
Like Nixon’s price and wage controls, you can’t do it for long or it creates even bigger problems, not the least of which is a financial system implosion.
That’s because lockdowns stop payments and debt does bad … which is just about as bad as jacking interest rates and crashing bond prices.
This is why Peter Schiff says the Fed is painted into a corner.
If the Fed raises rates, the bond market crashes. If they print money to keep rates down, they trigger inflation and a loss of faith in the dollar.
When big money starts pouring into real assets it shows that savvy investors are losing faith in dollars. If this goes on unabated, you have hyper-inflation.
If the Fed loses control, rates will likely rise, inflation will soar, credit markets will crash, and those unprepared will get crushed.
The good news … you deserve it for sticking with us this far … is that if you’re prepared with a portfolio of real assets, low-rate fixed debt, and liquidity …
… you’ll likely see your relative purchasing power increase even as quality assets are available at bargain prices.
Of course, this is a BIG topic. But one we think every serious investor should be paying VERY close attention to RIGHT NOW.
We can’t wait to get to the Summit so we can take deep dives into all of this with smart investors and experts from around the world.
Of course, YOU are invited to join us. If you’ve read this far, you’ll LOVE the Summit.
Until next time … good investing!