Pathetic Fed Forecasts

In the FOMC statement accompaning yesterday's 50 basis point cut of the Fed Funds rate from 3.5% to 3%, the Fed stated that "The Committee expects inflation to moderate in coming quarters".

But as the Wall Street Journal's editorial page points out, they used a nearly identical phrase in the statement accompaning the meeting in January 2007, where they claimed that "inflation pressures seem likely to moderate over time". What have actually happened since then is that inflation, far from moderating, have risen sharply. These forecasts are as pathetic as their claim that they want a strong dollar, and similarly reflects a desire to fool people into buying government bonds, as well as justifying their own interest rate cuts (or in the case of last year, refusal to raise interest rates).

EU Stops Brazilian Beef

This is the kind of news that really makes you hate the EU, and wish for Swedish withdrawal from it. EU have now decided to ban beef imports from Brazil based on some flimsy nonsensical argument about how Brazil supposedly does not track and control the beef to a sufficient extent. It is considered irrelevant that Brazil have not had a single case of mad cow disease or anything like that, or that there have never been any case of anyone getting sick from eating it.

The real reason for this ban is actually intense lobbying from Irish and British beef producers who detest the competition from the cheap Brazilian beef. The health argument is just a smoke screen for pure protectionism.

The result will be a sharp increase in the price of beef, as if food prices weren't already rising fast enough due to central bank inflation and the ethanol boom.

U.S. Real GDP Growth Turns Negative

While the headline volume number for real GDP in the U.S. stayed above zero in the fourth quarter of 2007, the more relevant terms of trade adjusted real GDP fell below zero. Nominal GDP rose 3.2% and the domestic purchases price index rose 3.8%, implying that real GDP fell with 0.6% instead of the 0.6% increase implied by the volume number. This means that properly measured, the recession began during the fourth quarter, just as I predicted back in early December.

It gets even worse if you only look at the private sector. Government demand rose from 19.4% to 19.7% of GDP, the highest since the fourth quarter of 1992. Excluding government demand, GDP fell 1.1%.

The outlook for this year looks even worse, as the increase in consumer spending and business investments during the fourth quarter of 2007 were based on large reductions in financial savings and increases in debt. With corporate profits falling the increase in business investments is very much unsustainable, although yesterday's surprisingly strong durable goods orders report indicate that many business executives are still in denial about the state of the economy. Ultimately, the weakening corporate balance sheets and the weakening economic outlook will force them to cut back on investment spending, despite the Fed's agressive rate cuts.

A similar story is true for consumers, whose zero savings rate looks very unhealthy and unsustainable considering the decline in house prices and stock prices. It therefore seems safe to say that the economic contraction will continue during 2008, and probably at an ever faster pace.

The Strong Dollar Fairy Tale

Marketwatch has an interesting story about the difference between the words and actions of U.S. policy makers. U.S. policymakers claim to want a strong dollar, yet they do everything they can in practice in order to make it weaker. The Federal Reserve is arguably the most inflationist (and Keynesian)of all western central banks and so constantly debase the value of the dollar, and the Bush administration have of course increased budget deficits, with the latest "stimulus package" being just one example.

So, why do they claim they want a strong dollar when they in practice do everything they can to make it weaker? The answer is simply that they want to screw foreign investors and fool them into buying U.S. government bonds and that way get their money and "pay them back" with a negative real interest rate. The only mystery is why foreign investors keep falling for that lie (or fairy tale as marketwatch call it. I don't think the distinction is meaningful here since you are lying if you try to make someone believe that a fairy tale is true), given the historical record of negative real interest rates and constantly depreciating dollar, and the obvious attempts by Helicopter Bernanke to accelerate inflation further.

Mathematical Traders Fail Again

Back in August, I reported on how traders using computer programs based on advanced mathematics and statistical patterns had lost huge sums of money as August experienced dramatic market fluctuations that contradicted the mathematical models, as there was for example market movements that were 20 standard deviations from the perceived normal-events that really never should occur.

But in reality, events considered impossible in mathematical models occur quite frequently. Examples of this include the stock market crash of October 1987, the market movements that destroyed the Long Term Capital Management fund and the movements in August 2007. And while perhaps not considered impossible, we have also seen market movements that contradict what statistical patterns indicate. For example, normally September is the month of the year when the stock market is weakest while January is the month when it is strongest. But this September, stock prices rose sharply while they have fallen sharply this January.

Here is an interesting Bloomberg News article about how last year, the great losers were the "quants", i.e. the traders relying on mathematical models.

This again illustrates how human behavior cannot be captured in mathematical models. Instead, what matters is understanding of sound economic theory of how the economy and the markets function and the understaning of how to apply this to market movements.

Wall Street Firms Considers Competence Irrelevant

There are two ways of getting successfull in the investment industry. Either you can like for example Jim Rogers and Peter Schiff be successful in identifying good investment objects and either invest yourself in them or advice others to do it. Or you can do a career in Wall Street firms, and create great losses for your company and for the economy as a whole by making all the wrong investment decisions, and subsequently be rewarded with huge sums of money for having created such massive losses.

The latter case sounds absurd, and it is, but unfortunately that does not mean it isn't true. One example of this was one which I already told you about, former Merrill Lynch CEO Stan O'Neal who got tens of millions of dollars in bonuses for profits that have now turned out to be fraudulent. And then after it was revealed that he had caused the company billions of dollars in losses, not only did he not have to pay back the bonuses he received for non-existing profits, but he was revarded by an additional $161.5 million in a severence package. There are many other similar examples of this on Wall Street.

And not only do Wall Street firms pay failed managers and analysts huge sums of money even after it is revealed that they are incompetent, they are still considered attractive on the Wall Street job market. The New York Times reveal in this article that two of the people most responsible for the so far at least $34 billion of losses (a sum that will likely rise a lot before this is over) suffered by Merril Lynch and Citigroup, Dow Kim and Thomas Maheras, are being swamped with job offers despite their proven incompetence. As the article puts it:

"Under the stewardship of Dow Kim and Thomas G. Maheras, Merrill Lynch and Citigroup built positions in subprime-related securities that led to $34 billion in write-downs last year. The debacle cost chief executives their jobs and brought two of the world’s premier financial institutions to their knees.

In any other industry, Mr. Kim and Mr. Maheras would be pariahs. But in the looking-glass world of Wall Street, they — and others like them — are hot properties."

The article later gives several more examples of this irrational system of rewarding failure. However, the article doesn't really go into why Wall Street is different from other industries. Why do these firms survive when they're managed by incompetent managers and analysts-and pays them absurdly high sums of money for losing money?

The answer is that the Federal Reserve keeps bailing them out by their interest rate cuts and emergency credit. As long as this continues, we can expect this irrational system to continue.

More On Decoupling

The Economist has an interesting article pointing out that emerging Asia are likely to suffer less from the U.S. recession than many people think.

As was explained in a previous article in The Economist, the dependence of exports to the U.S. is often exaggerated (admittedly, I have done so in the past too) by comparing gross exports to GDP. But since exports are measured as gross sales while GDP is measured in value added terms, such a comparison is really a case of comparing apples to pears. If you made a pure apple to apple comparison and excluded the large imported inputs for the exports, then China's exports would be only about 10% of GDP, and only a few per cent of GDP if you only look at exports to America.

It is thus not really that shocking that China's real GDP growth managed to stay at a full 11.2% in the fourth quarter, despite the fact that exports to America rose only 1% in yuan terms and so actually declined in real terms. As the article puts it:

"Those who argue that Asia cannot decouple from America are ignoring the fact that they already have. Take Malaysia: its exports to America plunged, yet its GDP growth quickened from 5.7% at the end of 2006 to 6.7% in the third quarter of last year."

Considering the fact that Euro area is far less export-oriented than Asia, it seems even less likely that it will be dragged down in any significant way by the U.S. recession. The main risks to the Euro area expansion instead consist in the financial anxiety created by exaggerated fears of recoupling (which would be a case of self-fulfilling prophecy), and also of the negative effects of possible housing busts in Spain and Ireland.

One Thing Luskin And Schiff Agrees On

In the past, Ron Paul said he had no economic advisors and that his economic advisors are dead Austrian economists like Sennholz, Mises and Hayek. Now he has actually named two economic advisors: Donald Luskin and Peter Schiff. Almost ironic considering how they not only have widely different views of the U.S. economy, but more importantly because of the hard feelings created during a heated TV-debate and subsequent communication. But apparently, they are willing to set that aside for the good cause of Ron Paul.

Luskin has previously written an article on NRO endorisng Ron Paul and Schiff has written a letter to all his 60,000 clients urging them to donate the maximum $2,300 per person to Paul's campaign.

Despite all of this, Paul looks highly unlikely to win the Republican nomination. Which is too bad, as the nomination of anyone else will ensure a Democratic victory in the Presidential election (And probably also an expanded Congressional majority, ensuring dramatic tax and spending increases). Most Republican candidates cannot explain the recession as they until now have all said the U.S. economy is in great shape because of the Bush tax cuts. They have either ignored or endorsed the Fed policies which created the current problems. Ron Paul, with his understanding of Austrian economics, can by contrast point out how the Fed is responsible for the problems and how he is the only one to have opposed these policies. As Schiff wrote in his letter:

"Unfortunately, most of the criticism of our phony economic expansion has come from the left. The mindless cheerleading of the right will leave them devoid of any credibility on economic issues. Ron Paul is the only Republican who can say “I told you so.” If, as a result of right wing rhetoric, voters blame capitalism for our problems, this nation will take a giant turn to the left. While many on the left have criticized the economy, they have mainly done so for the wrong reasons and their “solutions” will only make the situation worse."

Fed Rate Cuts Force China To Accelerate Yuan Appreciation

One of the reasons China have started to allow the yuan to rise faster, and will continue to allow it to rise faster, is the recent and likely future Fed interest rate cuts.

As Yu Yongding,former adviser to the People's Bank of China, notes, the widening interest rate gap between China and the U.S. could increase the inflow of "hot money" into China. That in turn will fuel higher money supply growth unless the exchange rate appreciates. That in turn implies that interest rate increases could prove useless in cooling down the economy.

Instead, other measures must be used, including higher reserve requirements and a higher value of the yuan versus the dollar. However, if the U.S. recession reduces exports enough, China may not need to tighten monetary policy much further, so higher reserve requirements doesn't seem necessary, appropriate or likely. A higher yuan is appropriate for other reasons and should therefore be the only measure undertaken at this point. Together, the higher yuan and the U.S. recession should reduce the current account surplus and accumulation of foreign exchange reserves enough to reduce money supply growth and price inflation to levels deemed more appropriate by the Chinese leaders.

Recoupling Financial Markets-Decoupling Economies

As was explained in the video in the previous post, the most important thing you have to remember about financial markets is that they are driven by sentiment. And sentiment means that they often sell off even when it's not justified while rallying or keeping steady when it would be justified to sell off. This means that one shouldn't take market movements as evidence of movements in the real economy.

Case in point is the recent sell off in European equity markets. Despite the fact that valuations in Europe were lower to begin with and despite the fact that the U.S. recession is likely to affect European firms much less than American firms, European stock markets have in fact fallen more than the American stock market.

Many advocates of the "recoupling"-theory, the view that the U.S. recession will cause a global recession, such as Nouriel Roubini, take this as evidence that Europe (and the rest of the world) is falling into a recession too.

Yet there is no evidence from real world economic indicators of this, at least not yet. For example, we saw today that the German Ifo business index rose. Yesterday we heard that industrial new orders rose 2.7% in November 2007 in the euro area compared to October 2007-and by 11.9% compared to November 2006. These numbers indicate a quite robust manufacturing sector in Europe. People keep overestimating the impact of the U.S. recession on Europe as they forget that gross exports to the U.S. are less than 2.5% of GDP (net exports is far less of course. Indeed, the biggest impact may in fact come not from real economic developments, but from the self-fulfilling prophecies who overestimate the extent of European dependence of the U.S. economy.

China is too handling the U.S. downturn quite well, with real GDP growth holding up at 11.2% in the fourth quarter. China is far more dependant on the U.S. than Europe is, although it should be noted that this dependence is often exaggerated and considering China's overheating tendencies, less exports to the U.S. might not be so bad after all.

Financial Markets Explained

I actually saw this first more than two months ago at Wille Faler's blogg, but I forgot to post it myself then. But better late than never, as it is really good. It is really amusing and it still gives a good description of the way things work in the financial markets. Perhaps it didn't emphasize enough the role of the central banks in sustaining these less rational aspects of modern financial markets, but it does actually imply it in the end of the video.

Expect U.S. Interest Rates To Collapse

While I did expect a large cut from the Fed (in the order of 75 to 100 basis points), I sure didn't expect them to cut already this week. Well, I guess this again illustrates why one should never underestimate the inflationary bias of the Fed. This cut will probably be followed by another cut at the meeting next week, probably by another 50 basis points.

What was interesting was that although the cut did lift stock prices, considering that the actual stock market decline was much smaller than the decline in futures before the opening, it lifted it by a surprisingly small amount. And today it seems stock prices might fall again in the wake of Apple Computer's latest report and general realization of the fact that the U.S. economy is in a recession. This indicates that confidence is declining so rapidly that the Fed is losing its power to lift stock prices.

That in turn will probably create even more panic at the Fed and get them to accelerate their rate cutting pace. It seems likely that interest rates will fall below 2% this year (perhaps as low as 1%) as the Fed cuts and cuts in increasingly desperate attempts to get the economy out of the recession. In the past I thought the high level of inflation would stop them, but that was because I underestimated just the extent of their inflationary bias. It is now clear that they want more inflation so as to inflate highly indebted U.S. households, companies and governments out of their debts. Officially they wont put it that way, of course, but instead claim that they expect inflation to fall because of the recession. What is remarkable is how easily bond investors are fooled by this.

This will ensure a new wave of dollar selling once the currency markets, like the stock market, snaps out of its current Wile E. Coyote mentality and realizes that there is no solid ground supporting the dollar.

Global Stockmarket's Wile E. Coyote Moment

As most of you have probably already heard, global stock markets have plummeted in recent days-and recent weeks. Why? Well, it seems global stock markets are finally waking up to the fact that the U.S. economy is in a recession and that this will hit profits of companies operating in America hard. This probably happened already the fourth quarter of last year, and I and a few others, like Jim Rogers, Peter Schiff and Nouriel Roubini, have long pointed this out, but stock investors have long deluded themselves that it isn't true. Now they're finally getting it-and now they're panicking and selling even stocks that are likely to be largely unaffected by this crisis. This creates bargain opportunities, although I wouldn't recommend buying yet. Since the crisis is likely to get even deeper, the general sell off will continue in the medium term -although some new sucker rally may come soon in the short term if, as seems likely, the Fed panics and cuts really big, deluding investors into believing it will solve the problem- , which means these undervalued stocks will get even more undervalued.

Anyway, the fact that the stock market this time reacted to the recession so late really reminds me of the Wile E. Coyote cartoon character. Wile E. Coyote in his futile hunt for the Roadrunner sometimes ran off a cliff and kept running even though there was no ground below him. Then, when being in mid-air, he looked down, and only then did he start to fall. The U.S. stock market valuations have long had no fundamental ground to stand on-but only now do investors realize it and only now is it starting to fall.

Today's Quote

Via Lew Rockwell, I see this funny quote from Arthur Burns, the Ben Bernanke of the 1970s, who as Fed chairman between 1970 and 1977 allowed inflation to get out of hand in order to please the politicians by trying to inflate more and more to hold down inflation, defended his willingness to follow the wishes of President Nixon in 1972 by saying:

"The Fed chairman has to do what the president wants, or the central bank would lose its independence."

Bulls Face Responsibility For Their False Forecasts

As those of us bearish on the U.S. economy and stock market have been proven right, the bulls are getting incrasingly uncomfortable when they are reminded about their incorrect prediction.

Jim Cramer who made a $50,000 bet with trader Eric Bolling that financial stocks would outperform gold and oil, have now been forced to pay out that sum to Bolling as financial stocks have plummeted while gold and oil have soared. Cramer was in other words about as wrong as you could get.

Cramer, in a statement blames his loss on "Federal Reserve Chairman Ben Bernanke's failure to cut interest rates more aggressively."

There are serious problems with that loss. First of all, when making forecasts about investments, you're supposed to take monetary policy actions into account and failed predictions of monetary policy is as bad as other failed predictions to the extent it affects the outcome of your investment advice. Secondly, it is more than pathetic to claim that Bernanke didn't cut rates agressively. Indeed, as is shown in the video I posted on Thursday, Cramer had forecasted only 50 basis points in interest rate cuts, as compared to the actual cut of 100 basis points. Thirdly, if the Fed had cut even more that wouldn't have affected the outcome of Cramer's bet with Bollinger. The reason for this is that oil and gold usually get as much boost from rate cuts as financial stocks.

Another bull who is being reminded of his inaccurate forecasting is Don Luskin. Luskin in this video recommends people to buy stocks, which Peter Schiff comments by saying that "if you want to lose money, sure go ahead and do that", whereupon a fierce debate which apparently caused the two to develop hard feelings toward each other.



As we all know, anyone who followed Luskin's advice of buying stocks did in fact lose money, just as Schiff predicted. And also, Schiff is clearly being proven right in his assessment of the general state of the U.S. economy. Luskin here tries to divert attention from this by implying that Schiff is obsessed with this thing and by saying that global stock markets have performed lousy too. Whether Schiff is obsessed with getting the record straight about who was right depends on what you mean by obsessed, but let's say Schiff is no more obsessed about it than Luskin is about pointing out errors in Paul Krugman's forecast. And to the extent Schiff have recommended foreign stocks, Luskin is partially right that they have performed almost as bad as U.S. stocks. However, there have been a better investment alternative than stocks and that is commodities like gold and oil, which Schiff has been very bullish about.

Johan Schück Makes The Same Observations As Me-Only Later

Johan Schück, the economics columnist at Dagens Nyheter has lately started to notice things which I noticed a long time before him-and almost all other economic commentators.

First, last week he noticed that the U.S. economy may already be in a recession, an observation I made in early December.

Now, he notices that with regards to monetary policy America is more interventionist than Europe, an observation similar to the one I made two year ago how while the micro economic policies of America is better (less interventionist) than Europe's, its monetary policy have been worse (more interventionist/inflationist) than Europe's. Although, they don't practice this consistently, in theory European central banks don't even see it as their job to stabilize the business cycle. Although they again in practice often in fact do try to intervene to prop up the economy they don't do it as much as the Fed do. As Schück puts it:

"In the United States, there is a belief in the possibility of controlling the business cycle, while the experience from Europe is that activism of that kind rarely pays off. That is not consistent with the general belief that Americans want to limit the role of government and the attitude is the opposite among Europeans"(Translated from Swedish by me)

Jim Cramer's Idiocy Illustrated

Great youtube videos illustrating what a fool rabid inflationist Jim Cramer really is. First in September 2007 he mocks the bears and tells everyone that the Dow would rise to 14,500 by year end -It ended 2007 at 13,200 and is now at 12,159- and plays "halleluja" music because the Fed's 50 basis point cut meant that they were "back with the good guys" and supposedly had saved the economy. He further mocks the idea that this would cause oil prices and inflation to rise and the dollar to fall. All of which have come true, making those of us mocked by Cramer consistently right and Jim Cramer consistently wrong.

Now he again is hysterical and attacks the Fed for not inflating fast enough. Ironically, he also attacks the Fed for being "so consistently wrong"-which is what he has been as this video illustrates. Not even his "fact box" where he inform the viewers that the last previous Fed cut was in June 2004 is correct(The correct month is June 2003). Anyway, watch it for yourself, it is really good.

Chinese Leaders Finally Getting It?

For years, I've been arguing that it is irrational for China to hold down the value of the yuan versus the U.S. dollar. It creates excess inflation, excess dependence on exports and give American and European politicians an excuse for implementing protectionist measures.

Still, until recently they've mainly tried to reduce inflation by the for China less effective means of raising interest rates and raising bank reserve requirements. These measures is much less effective than allowing the yuan to rise and comes at a very high cost for China. But recently the rate of gains have sharply accelerated. In the latest month (January 17 2008 compared to December 17 2007), the yuan rose from 7.3805 per dollar to 7.2245 per dollar. That's a 2.1% gain in a month, which translate into an annual rate of more than 29%.

I find it unlikely that they will keep up this pace for much longer, but it seems clear that they will raise the rate of yuan appreciation versus the dollar to much higher levels than in 2007. This is good news for China-but it will mean that the price inflation problem in America will become even greater. Not only will this further boost the boom in commodity prices in dollar terms, it will make the price of imported goods from China much higher. In the past, import prices from China were generally falling but the high rate of inflation in China combined with the higher yuan have already started to raise import prices from China, and with the accelerated pace of yuan appreciation import prices from China will likely rise even faster in the future.

Bond Market Useless in Predicting Inflation

A common argument from people who belive inflation is not a problem in America is to point to the low spread between regular bonds and TIPS (Treasury Inflation Protected Securities). I've explained before why bond investors seem to systematically underpredict future inflation (see here, here and here).

Here is more concrete example of how the TIPS-regular bond spread is not a reliable inflation indicator and how it systematicallym underestimate future inflation. The Federal Reserve statistics on historical TIPS only go back to January 2003, even though TIPS have existed longer. Anyway, now 5 years have passed since then and with today's inflation statistics we can compare the TIPS-regular bond spread for 5 year securities with the actual inflation since then.

In January 3 2003, the yield on the 5 year nominal security was 2.91%. Meanwhile, the 5 year TIPS yield in January 3 2003 was 1.75%. This means that the spread was a mere 1.16% of the time, implying an average expexted inflation of 1.16%.

However, during these 5 years, the consumer price index rose from 180.9 to 210.0, an increase of 16.1%, which translates into an average annualized rate of inflation of 3,03%, or 1.87%:points higher than the rate predicted by the bond market. Which means that bond investors forecasts of inflation was 1.87%:points lower than the actual number.

This again illustrates how irrational anyone who buys U.S. government bonds is, particularly the buyers of the nominal ones. Indeed, note how the yield for the suckers who bought 5-year securities of 2.91% was lower than the rate of inflation of 3.03%. So, even before taking taxes (which are based on nominal, not real, returns)into account, they experienced a negative real return.

So, considering how they've been consistently wrong and consistently losing money, we certainly shouldn't consider their irrational investment decisions as evidence of low future inflation.

Trade Trends Provide Support For Euro Bulls

Sometimes it is argued that because the euro is higher than the various PPP values estimated by the OECD and others, this means the euro has to fall. But there is really no reason at all for such an assumption. Price levels often differ between different geographic areas, and these differentials are often very much sustainable. So, there is no direct reason for PPP to be relevant.

Indirectly, however, PPP could have an effect to the extent these differentials reflect differences in the prices of tradable goods. This will create an incentive for buying goods in low price countries and selling them in high price countries. This process will cause the real exchange rate of the high price country to fall. Note, however that this adjustment will partially take place through higher inflation in the low price country, rather than a higher nominal exchange rate. And note also that this will presuppose a weakening of the trade balance of the high price country. It is the weakening of the trade balance that constitute the process of lowering the real exchange rate of the high price country.

And we can certainly not see any weakening of the trade/current account balances of the euro area. Indeed, the euro area trade surplus appears to be rising rapidly. Germany for example saw its current account surplus rise from €14.8 billion in November 2006 to €20.0 billion in November 2007. Holland saw its trade surplus rise from €3.7 billion in November 2006 to €5.1 billion. And finally, Finland saw its current account surplus rise from €1.39 billion in November 2006 to €1.68 billion in November 2007. The total increase for these three countries add up to €6.9 billion. A swing that is even bigger in dollar terms because of the rise of the euro.

It is possible and perhaps even likely that the other euro area countries had a weaker development and saw its balances deteriorate. But it seems unlikely that the net change of these is even close to €6.9 billion, so when the total number for the euro area is released, it seems likely to show an increase in the surplus by several billion euros.

Combine this with the fact that the trade deficit have again started to rise in America and it is clear that trade far from supporting the case of euro bears, it support the case of euro bulls.

Add to this the fact that the ECB is likely to leave interest rates unchanged, while the Fed seems likely to cut interest rates agressively (The discussion about the next cut have changed from whether it will be a 25 or 50 basis point cut to whether it will be a 50 or 75 basis point cut) and it is clear that interest rate trends support the euro as well. Market interest rates (and soon also the official rate) are already lower in America even in nominal terms. Add to that the fact that inflation is much higher in America, and it seems clear that European bonds provide a far higher value than American ones.

The only thing limiting the euro's rise, aside from French and Italian politicians complaing about a too strong currency, is the irrational focus of some on PPP from some traders. Ultimately, though, the strong underlying fundamentals will push the euro well above $1.50.

Mike Shedlock's Confused Analysis of Gold

Because he keeps repeating this nonsense, I feel I must response to Mike Shedlock's absurd analysis of gold. Mike Shedlock is generally wrong about inflation, and since the facts so obviously contradict him, he keeps repeating nonsensical arguments to explain his disconnect with reality. I don't have the will, time or energy to correct him each time he presents nonsensical argument, but since he seems to repeat the argument about gold so often and because gold is so important, I will make an exception here.

The most obvious indicator of the rampant inflation we're facing is the surge in the price of gold. Gold is not a cyclical commodity, so it isn't affected by concerns over the effects of the U.S. recession, like oil and industrial metals are. Nor can it be manipulated like the government price indexes, so its rise provides good evidence of inflation-and an increasing willingness to hedge against inflation.

The sharp increase in the price of gold thus provide conclusive evidence against the belief of Mike Shedlock and many others that we're experiencing deflation.

However. Mike Shedlock have absurdly tried to re-interprete this into a support of his deflation prediction. Here for example he tries to claim that higher gold prices is consistent with deflation in paper money by claiming that it signals "a destruction in fiat credit and a rise in the value of real money". The part about destruction of fiat credit is completely out of touch with reality as bank credit is in fact soaring and his talk about a rising value of real money is only true if you define gold as real money. But in that case his assertion is a mere tautology which says that higher value of gold is associated with higher value of gold. This tautology is of course completely irrelevant for the issue of how rising value of paper money affects the price of gold.

And there are two good reasons for believing that a hypothetical price deflation in paper dollars would lower the value of gold. First, it is the direct effect from higher value of paper dollars, which will lower the price of gold in paper dollars. Secondly,and arguably even more importantly, if there is no inflation in paper dollars it makes no sense at all to own gold, except for maybe jewelry purposes. Gold pays no interest or any other form of nominal return, so if there is no inflation, any bonds or stocks with positive nominal return is a better investment object. And so, if price deflation in paper dollars would be reality, the investment demand for gold would collapse, causing prices to collapse too, just like the great disinflation of the early 1980s caused the price of gold to collapse.

Thus ironically, the only way for Shedlock's gold forecast will be correct is if his macroeconomic analysis of inflation/deflation is incorrect. Similarly, if his macroeconomic analysis of inflation/deflation would be proven correct, his gold forecast would become dead wrong.

So, because his analysis is so absurd, the only thing we can be absolutely sure of is that he will be wrong about some important forecast.

George Reisman And Andrew Jackson On Inequality

George Reisman discusses in his latest mises.org article what I've discussed previously on this blog: namely that in addition to the many other problems monetary inflation creates, it also increases inequality.

This increase in inequality will increase in turn support for progressive taxation.To the extent these taxes hit incompetent people Wall Street who earn tens or hundreds of million dollars despite the fact that their actions have caused huge damage by participating in the bubbles created by the Fed, that is not really bad. It's not like Stan O'Neal deserved the $161.5 million in severance package in addition to the tens of millions of dollars received the previous years in bonuses, despite the fact that he caused Merril Lynch losses of tens of billions of dollars in the subprime mess. He of course didn't even deserve the bonuses since they were based on profits that have turned out to be phony.

The problem is that progressive taxes doesn't just hit undeserving and incompetent people like Stan O'Neal, it also hits genuine wealth creators.

Inflation thus implies redistribution from the deserving to the undeserving both directly and indirectly by increasing support for progressive taxation.

Today only one politician, Ron Paul, understands this. But he doesn't stand a chance of getting elected as president. But in the past, this insight was more widely spread. Read for example the words of President Andrew Jackson when he in 1832 vetoed a bill that would have made the Fed's predecessor, the Second Bank of the United States permanent:

"It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes. Distinctions in society will always exist under every just government. Equality of talents, of education, or of wealth can not be produced by human institutions. In the full enjoyment of the gifts of Heaven and the fruits of superior industry, economy, and virtue, every man is equally entitled to protection by law; but when the laws undertake to add to these natural and just advantages artificial distinctions, to grant titles, gratuities, and exclusive privileges, to make the rich richer and the potent more powerful, the humble members of society -- the farmers, mechanics, and laborers -- who have neither the time nor the means of securing like favors to themselves, have a right to complain of the injustice of their Government. There are no necessary evils in government. Its evils exist only in its abuses. If it would confine itself to equal protection, and, as Heaven does its rains, shower its favors alike on the high and the low, the rich and the poor, it would be an unqualified blessing. In the act before me there seems to be a wide and unnecessary departure from these just principles."

Andrew Jackson also famously called the Second Bank of the United States "a monster" and said that "I have it chained…I am ready with the screws to draw every tooth and then the stumps". And ultimately he did succeed in destroying the central bank he regarded as a monster. But now,ironically, the picture of the passionate central bank foe Andrew Jackson is on the 20 dollar bills issued by the resurrected monster known as the Federal Reserve.

More On Saudi Dollar Peg

Financial Times reports that Saudi Arabia faces soaring inflation and that this is widely blamed on Saudi Arabia's pegging its currency, the riyal to the U.S. dollar. Something which has put strong upward pressure on inflation as the weak currency raises import prices and as the Saudi central bank is forced to copy the Federal Reserve's inflationary policies.

Yet the Saudi government resists calls to revalue the riyal or drop the dollar peg, largely for political reasons-a decision that will continue to harm the Saudi economy as the Fed cuts rates further and the dollar continues to fall.

I find it ironic by the way that the U.S. government is apparently pressuring the Saudis to keep the dollar peg, even as they are pressuring China to do the opposite. The U.S. government seems to have no consistent policy when it comes to pegs. Either they actively oppose it as in the case of China, or they are indifferent to it as in the case of Hong Kong or they actively support it as in the case of Saudi Arabia.

Can Fiscal Stimulus Save the U.S. Economy?

More and more people realize that the Fed won't be able to stop the coming recession, although that isn't because the rate cuts is "too little, too late" as Nouriel Roubini argues (That would have implied that earlier, more agressive cuts would have saved the day), but because the rate cuts will only serve to push up inflation at this point. It won't boost the economy, and certainly not in a quantity sufficient to prevent continued economic contraction.

So, instead a lot of politicians and pundits argue for some form of fiscal action, including Hillary Clinton, President Bush (although that is only a rumour)and Larry Kudlow.

Can that save the economy? The answer is that it will be too late to prevent a recession as the recession likely started in the fourth quarter, and fiscal action will at earliest provide a boost in the second quarter, and probably not before the third quarter, making it too late prevent two quarters of contraction even if it is implemented in the second quarter. And it will probably not be implemented that soon.

Whether the fiscal action when it comes will provide a boost depends largely on what kind of fiscal action it is. In order for it to provide a meaningful boost to the economy, it need to come in the form of reductions in marginal tax rates. Here I for once completely agree with Larry Kudlow. In that case, the cuts will boost not only demand but also supply and thus raise growth.

But while most Republican presidential candidates now propose plans featuring marginal tax rate reductions, these plans unfortunately have virtually no chance of getting passed considering the Democratic control of Congress.

However, the plans proposed by Hillary Clinton and the one that reportedly will soon be proposed by Bush will only boost demand temporarily and will in fact lower supply and thus likely reduce long term growth.

While Bush perhaps would have wanted to cut marginal tax rates, he seem to have given up on this, knowing that the Democratic Congress would never agree to it. Bush's plan will instead reportedly be about so-called "tax rebates" to the middle class. However, if, as I suspect, low-income people who don't pay any federal income tax get the rebate too, then it will be a tax rebate in name only. In practice, it will be a form of general transfer payment. But Republicans will still want to call it a "tax rebate" because it sounds better with tax cuts than spending increases. This plan will not boost supply. In fact, it will likely reduce it, particularly if they try to exclude rich people from it. That would create incentive problems at the threshold and that way reduce supply. Moreover, the so-called income effect will mean that even if all people receive the rebate, supply would still be reduced.

With increased demand and reduced supply, the main effect of this will simply be to increase price inflation, as if the Fed weren't already doing enough to increase it.

Hillary Clinton's plan is of course even worse. In addition to supporting a "tax rebate" similar to the one Bush will propose, she wants to increase spending by $70 billion through various forms of government hand-outs to groups she deem worthy of getting it. The effect of this will largely be similar to the effects of the Bush plan. Namely too boost demand and reduce supply, and so increase inflation, but not growth. And the negative incentive effects in the spending increase part of the plan will come from the fact that only low income will be eligible for it.

So, in conclusion. Fiscal action will come too late to prevent a recession. It could however shorten and make it milder it if it is designed the right way. But the way it seems likely to be designed it will mainly simply act to increase inflation and the budget deficit.

U.S. Trade Deficit Growing Again

After falling, and being down some $10 billion per month, for most of 2007, the U.S. trade deficit is again growing. It rose to $63.1 billion in November 2007, up from $57.8 billion in October 2007 and $58.5 billion in November 2006.

There were two reasons for this increase. One was of course the effect of rising oil prices. The average price of oil rose from $71 per barrel to $79, an increase that added nearly $3 billion to the deficit. The price used is as you can see a lot lower than the market prices of $90-$100 of that period. The reason for this is that a lot of the shipments are based on futures contracts signed months earlier. However, eventually the price of shipments will catch up, so we can expect the cost of imported oil to continue to rise in coming months.

The other factor was the unexpected surge in consumer spending during November, which rose 0.5% in real terms even though real disposable income fell 0.3%. As consumers increased their spending a lot faster than income, and as no increase in savings among corporations and government, this had to be financed by borrowing from foreigners, or in other words a higher trade deficit.

This in turn implies that the positive effect on GDP from that spending increase will be limited. Volume growth of GDP will likely be only slightly positive (less than 1%), and terms of trade adjusted real GDP will likely fall.

As reports indicate that consumer spending fell in December, it seems likely that the nonpetroleum trade deficit again fell back in December. The overall deficit will probably decline too, but by a lot less as the lagged effect of higher oil prices continues to push up the cost of oil imports.

Not Just Oil

The Economist's commodity price index hit a new all time high of 227.2, up 5.5% in the latest month and up 28.4% in the latest 12 months. Note that this index does not include oil, so anyone who tells you that the commodity price boom reflects the alleged "peak oil" doesn't know what they're talking about. Interestingly, even industrial metals have risen during the latest month. Although the big winner remain food commodities -up 6.1% in the latest month, up 15% the latest 2 months and up 49% in the latest 12 months- , just as Jim Rogers have predicted.

This continued commodity price boom both reflects the general commodity boom cycle Rogers described in his book Hot Commodities and the accelerating inflation America and many other countries suffer from.

Retail Fuel Margins Collapsing

The latest petroleum report from the EIA was a case of mixed news. On the one hand, inventories of crude oil fell 6.8 million barrels, while inventories of gasoline and distillates rose 5.3 million barrels and 1.5 million barrels respectively. The overall level of petroleum inventories were unchanged, in other words.

While the inventory news was a mixed news, the price story was unequivocal in that it painted a picture of soaring prices. What is interesting is that while retail prices of gasoline and diesel fuel is up 80 cents and 84 cents respectively, the spot market prices were up 100 cents and 104 cents respectively. This means that retail margins of gasoline and diesel is both down roughly 20 cents. This implies a 20-25% decline in the gross margins of gasoline stations. That in turn implies that retail prices of energy products -what's measured in official inflation indicies like the CPI and PCE deflator- will likely outperform market prices in the near future.

You Read it Here First

Merril Lynch now says the U.S. is already in a recession. While this means they are quicker to grasp this fact than most other Wall Street analysts, they were nevertheless slower to grasp this compared to another analyst, namely me, who pointed out this fact a month ago.

Swiss Current Account Surplus Soars

Reflecting the undervalued nature of the swiss franc, Switzerland's current account surplus rose sharply in the third quarter of 2007 compared to the same quarter the previous year. The surplus was 22.2 billion swiss franc, up from 17.0 billion in the third quarter of 2007. During the latest 4 quarters, the surplus was 85 billion swiss franc-or 17% of GDP.

Interestingly, all subcomponents strengthened. The trade surplus (both goods and services) rose from 9.8 billion swiss franc to 12.1 billion, and the factor income surplus rose from 10.1 billion to 12.6 billion. Even net transfers strengthened, from -3.0 billion to -2.5 billion.

To the extent a current account surplus reflects better investment return in other countries, it need not imply an undervalued currency. Yet real interest rates are no lower than in the euro area, and they are higher than in the U.S., so in this case the surplus does in fact reflect an undervalued currency.

Why the Monetary Base is Irrelevant

I received an objection to my previous post from a commentator who argued that since the monetary base in America had grown only slowly, monetary conditions really are tight. Caroline Baum argued the same in her latest Bloomberg column:

"A fire can't burn without tinder; inflation can't smolder when the Fed is creating the raw material at a snail's pace. The monetary base, which consists of bank reserves and currency, is growing at an anemic 1.1 percent rate. In inflation-adjusted terms, the base is contracting."

Yet if the commercial banks are creating it at an extremely rapid rate, inflation can take hold. As I pointed out in my previous post, bank lending has increased 6.5% (17% at an annual rate) since early August and MZM money supply has increased nearly as fast , 6.3% (16.4% at annual rate).

And what matters for the economy is total money supply and not the monetary base. A good example of this is provided by the time period of 1921-33. During 1921-29, the monetary base was nearly unchanged, yet we saw rapid growth and a stock market bubble. By contrast, the monetary base grew very fast in 1930-33, yet that was combined with a deflationary depression and a 90% decline in stock prices.

The reason for this is that despite the stagnant monetary base, money supply growth was fast during the 1920s. And despite the soaring monetary base, money supply fell sharply during the depression.

The monetary base is not a reflection so much of Fed policy, but demand for cash. And by cash I mean notes and coins. It is not certain why demand for cash seem to be falling. It could reflect a continued shift away from paper money to electronic money in economic transactions in America. Or, it could reflect falling global demand for U.S. Federal Reserve notes as trust in the dollar declines. In the past hundreds of billions of dollars in Federal Reserve notes have been exported to countries like Russia and many Latin American countries with high inflation as people there trusted the dollar more than their local currency. But as many of those countries have seen a decline in their previously high inflation, and as the euro to many seems like a better currency than the U.S. dollar, Federal Reserve notes are probably increasingly returning to the United States.

This is Tight Monetary Conditions?

It is generally agreed among pundits that the world has suffered a "credit crunch" since August. I am one of the few who have dissented from that view, pointing out that while the growth of some financial instruments may have slowed, this have been compensated by an accelerating growth in commercial bank lending. In the last reported week, for example, bank lending soared $49.6 billion, lifting the annualized growth rate since early August to a full 17% (6.53% during 21 weeks).

As a result, the overall level of debt just keeps rising and rising, not just in absolute but also in relative terms.

Here is a list of how various indicators have moved since the beginning of August:

Oil: +31%
Gold: +26%
CRB commodity price index:+14%
Bank lending: +6.5%
MZM money supply*: +6.3%
Baa Corporate Bond Yield:-0.15%:points
10-Year Government Bond Yield: -1.0%:point
2-Year Government Bond Yield:-1.7%:points
S&P 500: -4%
Dollar vs. Yuan: -4%
Dollar vs. Euro: -7%
Dollar vs. Yen: -9%

As you can see, every single indicator except for the stock market index S&P 500 clearly indicates looser monetary conditions. And even that indicates loose monetary conditions considering the dramatic decline in profits, which implies higher valuations. And while the spread between government bonds and corporate bonds have risen, this is entirely a result of falling government bond yields. Corporate bond yields have in fact fallen too.

*=Calculated by subtracting Small time deposits from and adding institutional MMMF:s to the M2 measure of money supply.

Ron Paul Voters Main Issue: (Austrian) Economics

Ron Paul got 10% of the votes in Iowa, more than the 7% indicated by the polls, but probably less than most supporters expected.

Anyway, if you look who Paul's voters are according to this exit poll (who is probably more accurate than the others as it says he got 10%) you can see that they are disproportionally independents (Paul got 29%, more than any other candidate), which bodes well for New Hampshire where there are a lot more independents than in Iowa. They are also dispropotionally young, with Paul gaining the support 22% of the 17-29 year olds, and have relatively low income (with 14% of people earning less than $50,000 voting for Paul). The two latter groups are probably both a result of Paul having particularly strong supports from students.

Interestingly, the main concern for these students doesn't seem to be the Iraq issue. Instead, Paul's strongest support came from people who's main concern is the economy.
As Paul has repeatedly brought up the subject of Austrian economics and the need to abolish the Fed and restore the gold standard, this again is an indication that the Paul has been successfull in spreading the message of sound economics.

U.S. Private Sector Employment Contracting

As a further confirmation of the fact that the U.S. economy has slipped into a recession was today's employment numbers which showed falling private sector employment even according to the payroll survey, despite the continued use of the misleading "birth/death model".

What few commentators have noticed, however, is the fact that not only did private sector employment fall compared to November, there is even good reason to believe that private sector employment fell compared (albeit only marginally) to December 2006!

The household employment survey showed a dramatic drop (-436,000) in employment and an increase in the unemployment rate from 4.7% to 5.0%. As I've stated previously, the monthly change in the household survey is very volatile and erratic, so one shouldn't be concerned about the monthly fluctuations. However, as an indicator of annual trends, the household survey is superior to the payroll survey because it isn't distorted by the "birth/death model". And if you look at the annual change, employment according to the household survey is up by just 262,000 compared to December 2006.

If you subtract from that the 274,000 increase in government employment, you end up with 12,000 fewer private sector jobs.

The payroll survey by contrast claims that employment rose by 1.328 million compared to December 2006. Which implies a gain of 1.054 million private sector jobs if you subtract the increase in government employment. However, more than 100% of that increase is simply assumed through the "birth/death model". That model added 1.13 million private sector jobs in 2007, meaning that actually reported private payroll employment fell by 76,000 compared to December 2006!

Thus, there is good reason to believe that the annual change of private sector employment is now negative.

And if you adjust the monthly change in December for the "birth death model" you end up with a monthly contraction in private sector employment of 107,000 and a total contraction in employment of 76,000 (As I explained last month, because the birth/death model monthly number is not seasonally adjusted, you cannot subtract that number from the seasonally adjusted change. Instead you should subtract the monthly average number of 94,000 (1.13 million/12)).

This means that had payroll employment been properly measured, we would have seen another of the NBER's recession indicators indicate that the recession has already started. Already we've seen real disposable income and industrial production fall, now payroll employment is falling too.

The Stagflation vs. Deflation Debate

I've been asked by a lot of people to comment on Mike Shedlock's recent attack on Peter Schiff, and his view that America is facing a deflationary recession rather than stagflation.

There should be little doubt for any regular reader of this blog that I disagree with Shedlock, as I've repeatedly argued for the stagflation scenario. So, why do I disagree with him? Well, to some extent it is a case of our old disagreement about the money supply definition. But I'm going to comment on Shedlock's specific fallacies in the articles.

Shedlock Fallacy #1: "There are constraints on the Fed that he ignores. For example the Fed cannot simultaneously target both money supply and interest rates. Should the Fed pursue a massive printing campaign, interest rates will rise."

No, not true at all. That's the old fallacy that interest rates will necessarily rise in response to higher inflation. But that's only true if the central bank agrees that higher inflation should be met with higher interest rates, which is often not the case, and which is why real interest rates are often negative (like now).

If the Fed decides to buy all government bonds (or corporate bonds or mortgage backed bonds) until the yield fall to whatever level they like, say 0.5% or 1%, there's nothing anyone can do to stop them since the Fed has unlimited power to create money out of thin air. Even if all private investors and foreign governments dump their bonds, the Fed can still simply buy them all with the money they create out of thin air. That implies massive inflation and extremely low interest rates at the same time.

Shedlock Fallacy # 2: "Regardless of what anyone thinks, prices can only rise to the extent that people can afford to pay for goods and services or that banks are willing to extend credit. Without a driver for jobs, and with downward pressure on wages for the jobs we do have, prices will be constrained. If somehow prices rise above people's ability or willingness to pay for them, there will be not be buyers."

No, no, no. If this were really true, we wouldn't have hyperinflation in Zimbabwe where we've seen a severe depression with regard to production and unemployment.

Shedlock is here in essence arguing for a Keynesian "aggregate demand" view of inflation, according to which stagflation is impossible. But as stagflation is a real phenonema (in its most extreme form in Zimbabwe), this argument is simply false.

Shedlock fallacy #3: "That assumption is the US dollar drops....The fundamentals in the UK and EU are as bad as in the US and the property bubbles just as big."

That's actually to some extent true with regard to the U.K.,as I recently explained, and this is why I am bearish about the pound too.

However, the situation is not as bad in the Euro area, which still has a current account surplus.

While Shedlock agrees that the yen will rise, he overlooks the more important yuan, whose continued rise vs. the dollar is a certainty and which will help push up inflation in America, both by making imports from China more expensive and as this increase their demand for commodities given a certain dollar price.

Shedlock fallacy #4: "Take away the US market for goods and China and Japan have massive overcapacity. Without exports to the US and Europe, China would crash. This situation might change 10 or so years down the road, but export economies are not remotely close to being able to ignore the US consumer, at least not now or anytime soon."

Not entirely untrue, but Shedlock overlooks the fact that China has undertaken drastic actions to restrain domestic demand in the form of umpteen increases in interest rates and bank reserve requirements. They thus have a lot of scope to compensate from falling U.S. consumer demand by simply refraining from continuing with these tightening measures or even reversing them.

Shedlock fallacy #5: "Given massive overcapacity in housing, commercial real estate, restaurants, nails salons, etc there is simply no reason for businesses to want to expand business. Nor is there any reason for banks to be willing to extend credit to all but the most credit worthy borrowers. Rising defaults may even impair capacity to the point many banks are unwilling or unable to lend at all. The only reason expansion got as carried away as it did is the psychology at the time suggested residential and commercial property would forever rise.....

....Because the Fed can encourage but not force lending, that shift in the pendulum affects the Fed greatly. The Fed can enhance the current primary trend (as it did in the creation of the housing bubble), but neither the Fed nor anyone else can reverse the primary trend.

Regardless of encouragement, who are banks going to be lending to when asset prices are falling and unemployment is headed higher? And those are conditions that both Schiff and I agree on. With enough defaults, banks will become so capital impaired they could not lend even if they wanted to! We are seeing signs of that in Citigroup already.

And as I have said before, the Fed is a private business. The Fed is not going to give away money any more than Pizza Hut is going to give away free pizzas for a year to all comers." [the last section was from Shedlock's second post]

Here Shedlock makes two fallacies. First, there is no evidence that the banks are refraining from lending, as bank lending has in fact accelerated in recent month during the alleged "credit crunch". In the 20 weeks between August 1 and December 19, commercial bank lending rose 5.85%, which is 16% at an annual rate. Many banks will likely lend on the basis of bailing out their borrowers, knowing that they will fail if they don't.

Secondly, and much more importantly, even if banks get unwilling to lend, they (and the Fed) can then simply start buying securities, and that way expand the money supply, something Murray Rothbard pointed out to the Mike Shedlocks of 1991 in his essay "Lessons of the Recession".

The one thing true Shedlock pointed out was that the stagflation vs. deflation debate mattered because it had investment implications. If we have stagflation, commodities are the place to be, if we have deflationary recession, government bonds are the place to be. To bad for Shedlock then that he and others who invest in government bonds are going to get screwed big time as inflation takes away their value.

Curiously, he argues that gold will do well in deflation (Which we might consider "Shedlock fallacy # 6"). Well, to the extent he invests in that he will be a winner despite his false view of the economy. But, he is simply wrong that gold will do well under deflation. Deflation here refers to the real value of paper dollars, not gold, and if the value of paper dollars were to rise that would imply a falling relative value of gold which unfortunately is not used as money and since 1971 lacks any link to the U.S. dollar.

His argument that gold is not an inflation hedge because it fell between 1980 and 1999 overlooks that the tight monetary policies of Paul Volcker destroyed the demand for gold as an inflation hedge. With real interest rates high, it made more sense to invest in bonds than gold. Also, massive central bank sales and the dollar rally of the late 1990s temporarily depressed gold.

Now, we see gold make a comeback because central bank sales has been limited and many emerging market bank cental bank actually buying, but most importantly because inflation is accelerating and this increases the demand for gold as an inflation hedge.

Gold Reach New All Time High

Well, I hate to say "See, I told you so"....no, that's not true, I love saying so and that's why I am doing it now. I told you when gold was at $785 in October 26 that it was a certainty that it would surpass the $850 peak from 1980 within 12 months (before October 26 2008). I also said it might happen already during 2007. That didn't happen, but it happened during the first trading day of 2008, as it reached $858 yesterday and is trading at $863. Gold will likely continue to rise during 2008 as the Fed continues to inflate during 2008 in a vain effort to pull America out of the recession. Some time during 2008, $1,000 gold seems likely.

More Evidence of Stagflation in America

The ISM manufacturing index fell to 47.7 in December-the lowest level since April 2003. The details are even more bearish. The new orders subcomponent fell to just 45.7-the lowest since 2001 recession. The production subcomponent also fell sharply and is now well below 50. The only indicator that rose and is at a high level was "prices paid"-an inflation indicator. This again confirms my long held view that America's economy is falling into stagflation.

Meanwhile, oil prices just keeps rising which will further depress growth and increase inflation, i.e. make the economy more stagflationary.

Cyprus & Malta Join Euro Area

Yesterday, Cyprus (the Greek parts) and Malta joined the euro area. This will have little effect on the euro area as a whole as their inclusion only boost euro area GDP by 0.2%. The main effect will come from the fact that this will increase the number of board members in the ECB board from 19 to 21. How these new board members will affect the decisions taken is more unclear. On the one hand, being Southern European countries are usually more pro-inflationists than Northern countries like Germany and Holland, so this could make the ECB even more inflationists. On the other hand, to the extent they base their decision on their national economies, this would make them more prone to raise rates as their economies will likely experience both high growth and high inflation the first years.

Although the fear of rising prices is usually described as a result of dealers taking advantage of the switch of currencies, that is an exaggerated problem and should to the extent it is real prove temporary as the supply and demand factors that caused the old equilibrium price haven't changed.

What however will push prices permanently higher is the ECB's inflationist policies which will raise demand so much that the equilibrium price will be pushed higher on a permanent basis.