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Walking up the dusty street from one side of town will be Fed Chairman Alan Greenspan. Approaching from the other side will be the inflation monster I introduced to you last Monday. And watching anxiously from the sidelines will be millions of investors from all over the world individuals, financial institutions, central banks, cities, states, even charitable institutions. They know how important this looming battle will be. They know it could make or break their future. The showdown is scheduled for Tuesday, November 1st, when the Fed meets to decide its next step.
Consider the facts: Fact #1. The governments own official rate of inflation, based on the last 12 months of consumer price increases, is now running at 4.7%, nearly double the pace of a year ago. Fact #2. The governments official inflation tally excludes the rising cost of housing, one of the most virulent forms of inflation in recent years. The true inflation rate is probably closer to 6%. Fact #3. So far, Ive been talking strictly about past inflation. But the actual monster Mr. Greenspan faces is current inflation. And based on Septembers numbers, its now racing along at double digits an annualized rate of over 14% based on consumer prices and an annualized rate of more than 20% based on producer prices. Fact #4. The inflation is worldwide. Britains inflation has more than doubled in the past year. In the largest seven economies of the world, the average inflation rate is now the highest in 13 years. Excluding Japan, its the highest in nearly two decades. The Danger of Inflation is No Mirage. Inflation was once called the most vexing and most intractable of all economic problems, unmovable, hard to cure. (Fortune, January 1974, p.6; Business Week, April 28, 1972, p. 21.) Karl Otto Phl, a former president of the German Bundesbank, said its like toothpaste once out of the tube, hard to get it back in again. (Economist, September 2005). Others have shown that inflation is a virus that can spread from country to country … or a cancer that can slowly destroy society from within. As the inflation moves from stage to stage, new terms are deployed to describe its progress creeping inflation, accelerating inflation, runaway inflation, rampant inflation, galloping inflation … hyperinflation. Yet, despite the plethora of terms, inflation remains largely a mystery. In the late 1970s when it was last rampaging in America, the authorities couldnt understand it let alone stop it. Now, thirty years later, theyre not even trying. Most seem to have forgotten what it can do to our country. Some are too young to even remember what it was. Why The Consequences of Perhaps the best way to understand inflation is to examine its natural consequences … Consequence #1. Inflation-fed inflation. As long as inflation was creeping along at a snails pace about 2% it was not considered contagious, and the disease was said to be benign, under control, well contained. (Fed Reserve meeting notes, 2004-2005). But as soon as it rose significantly above 3%, there began a sweeping change in the behavior of consumers, investors, companies, and even governments: They began to EXPECT inflation. They began to buy more now in anticipation of higher prices later, even if they had to borrow through the nose to make their purchases. They began to hoard more, charge more and pass along more costs down the food chain. Thats why inflationary expectations have suddenly surged and why a recent survey shows Americans now expect inflation to be over 6%. Its also why inflation is now crossing the critical threshold beyond which it cannot be easily controlled. Consequence #2. SHARPLY higher interest rates. Normally, interest rates should be significantly higher than the inflation rate. But right now, interest rates are far, far behind. This is an explosive situation that could change abruptly. And now, neither Wall Street nor Washington can deny it any longer, no matter how they try to twist the numbers:
And most analysts on Wall Street are still hoping that a quarter-point hike will be enough?! Consequence #3. An END to the economic recovery. Right now, the economic recovery is still alive. But the cracks and fissures are growing so large, its hard to imagine that the recovery can survive much longer. As long as it was just the airlines in trouble, Wall Street could blame it on 9/11 or jet fuel costs. Or, as long as it was just one auto giant Delphi going under, they could blame it on overpaid labor or underperforming management. But now, with three of the largest American industries airlines, autos and housing all going south at the same time, the blame game has got to stop and some hard-nosed, objective analysis must begin. Consider, for example … The Sad Saga of Kirk Kerkorian, In the beginning of the year, it wouldnt have made much of a difference if you invested in General Motors or you invested in Ford.
Thats when Kirk Kerkorian burst onto the scene. He figured as long as the United States economy is sound, GM must also be sound. He saw GMs stock down dramatically from its highs. He thought he had a great bargain. And he bid aggressively for a big chunk of GMs shares. Sure enough, GMs stock surged, recouping all but 5 percentage points of its losses for the year. But while GMs shares got a temporary boost from Kerkorian, Fords barely rallied … and they have now plunged to new lows. Fords shares opened the year trading at $14.66. This past Friday (10/21) they closed at $8.25. If you had invested $10,000 in the company, youd be sitting on a loss of 44%, and your shares would be worth $5,628 today. And youd be among the lucky ones! Anyone investing at the beginning of 2001 would be down to $3,359, and those buying at the peak in May 1999 would be down to $2,321.
Suppose you had invested the $10,000 in GM instead? If you had invested at its peak, youd be down to $2,987. What about Delphi Corporation? Youd have only a meager $173. So even with Kerkorians massive infusion of capital, the industry continues to sink, and investors continue to lose money hand over fist. Certainly, if I were talking about hyped-up start-ups, gone-again fly-by-nights, or companies committing massive accounting fraud, it would be understandable. But thats not the case. Im talking about Ford, GM, and Delphi and these three companies are big: At the end of the first half, they had combined sales of nearly $200 billion. Just to give you a sense of how much that is, compare it to Google, the company making such a huge sensation on Wall Street right now. GMs, Fords and Delphis combined sales were seventy-five times Googles sales. Plus, they had total assets of $760 billion, the equivalent of 229 Googles. And, unfortunately, they also had $723 billion in debts, a whopping 1,884 times the debt that Google has accumulated so far. The Moral of the Even before interest rates rise sharply, the largest companies in one of Americas largest industries are in serious trouble. So what happens after rates rise? Answer: Interest costs on their huge debts go through the roof. Their customers, already strapped for cash and unable to finance their car purchases on the cheap, go on a buyers strike. And the entire economic recovery comes to an abrupt end. The hardest hit industries like airlines, autos and housing sink. And other sectors which have so far held up relatively well such as technology, defense and consumer companies also weaken. Consequence #4. No quick end to rising inflation and interest rates despite a weaker economy. One reason analysts are so hopeful that the Fed will be merciful next week is because they sense, consciously or otherwise, that the economic recovery is so shaky. The theory is that as soon as the economy starts to weaken a bit, interest rates will immediately stop rising, or even decline. But in the real world, thats not how it works. Even in normal times, first rates spike higher … then the economy weakens enough to warrant lower rates. Plus, these are not normal times. We have many other forces at work that are likely to drive inflation and rates higher even after the economy weakens. Heres why: First, unlike the situation that prevailed years ago, inflation is not being driven so much by demand in the United States. Its being driven primarily by demand in Asia, largely outside Mr. Greenspans realm. So even if he manages to cool things off here in the U.S., its going to take a lot more to cool things off in Asia. Second, unlike the old days, inflation isnt the only force that can drive interest rates higher.
Consequence #5. Eventually … The inflation blows itself out. Interest rates reach such a high level that they extinguish the inflationary fires. And eventually deflation falling prices returns. But thats still far away. As I told you, right now, interest rates are not higher than the pace of inflation. They are still far below inflation. So you can continue to count on more inflation. That includes: * Much higher prices for oil, gas and all forms of energy Your Next Steps In recent Money and Markets issues, weve told you what to do to prepare: Get out of long-term bonds. Get out of stocks that are vulnerable to inflation and rising rates. Hedge against inflation with investments in gold and energy. And put a big chunk of your money in short-term Treasury bills or equivalent money market funds. Now, unless you feel youve already accomplished all of this, its time to take the next steps. 1. Make a list of every asset you own not just your stock and bonds, but also your investment real estate, cash-value insurance policies, pension funds, retirement accounts and business interests. 2. Determine which are vulnerable to rising inflation and interest rates and which are not. This is not a simple task. So dont hesitate to consult with an investment adviser. Plus, also check the Weiss ratings at WWW.WeissWatchdog.com. 3. For any vulnerable bonds, stocks, real estate or other assets you want to hold, buy at least some protection with hedges. On Friday, I gave you specific instructions. If you missed that Money and Markets edition, check your e-mail. 4. Hedge against rising interest rates. And if you have money you can afford to risk, aim to turn $4,500 into as much as $50,000. 5. Stay alert. This situation could explode at almost any time, perhaps before the next Fed meeting, perhaps after. No matter what, there can be no debate that the pressure is building rapidly. No one can tell you ahead of time precisely how or when the events will unfold. But if you stay in touch, I will do my best to keep you posted. Good luck and God bless! Martin About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. 2005 by Weiss Research, Inc. All rights reserved. |
Gunfight of the Century
Just eight days from now, we will witness the biggest gunfight of the century. 
But even with the time clock ticking, Greenspan seems poorly armed and woefully out of training: The sole weapon at his disposal is sharply higher interest rates. And in all of his 18 years as Fed Chairman, he has never had a single duel with an inflation threat of this magnitude.
When the shares of one fell by a few percentage points, the shares of the other would do virtually the same. Indeed, in early April, the two were still in a dead heat: GM was down 32% for the year, and so was Ford. 
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