STAFF NEWS & ANALYSIS
Marc Faber Sees U.S. Inflation Rising to Zimbabwe Level
By Staff News & Analysis - May 29, 2009

The U.S. economy will enter "hyperinflation" approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said. Prices may increase at rates "close to" Zimbabwe's gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe's inflation rate reached 231 million percent in July, the last annual rate published by the statistics office. "I am 100 percent sure that the U.S. will go into hyperinflation," Faber said. "The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate." – Bloomberg

Dominant Social Theme: Disaster looms?

Free-Market Analysis: Marc Faber is well known for his Gloom Boom Doom Report and for calling the beginning of the bull market in gold (among others) back in the early 2000s. But articles such as this seem problematic to us. We shall try to straighten out Faber's terminology and try to provide a clearer time-line as well. Faber is right, in our estimation, but maybe not right away.

Faber obviously understands free-market economics, but the vocabulary being used makes for confusing reading for free-market thinkers. The mainstream media uses "inflation" as a catch-all term. In fact, from a free-market perspective, inflation is an expansion in the money supply, and that has most definitely happened for the dollar given the US$10 trillion or so that the American Federal Reserve has indicated it has already shoved into the markets.

So dollar inflation has already taken place. What Faber seems to be discussing is PRICE inflation. Price inflation is certainly an outgrowth of monetary expansion, but it does not have to happen immediately as a result of monetary inflation, and there are many obstacles in the way of price inflation.

This is in our opinion the problem that people (not necessarily Faber) run into when they start to comprehend markets and the business cycle. They assume that because they understand it, it will manifest itself immediately. It likely will not. The business cycle is neither predictable nor prompt. Sometimes it is tardy. Sometimes it surprises. Sometimes it takes years to manifest itself. Sometimes decades. There is no neat path from the beginning of a business cycle to its end, and there are cycles within cycles, minor cycles, obviously, and larger cycles.

So dear reader, having clarified the difference between monetary inflation and price inflation, we now need to understand why, given the amount of dollars floating around in the world, we aren't waking up tomorrow to US$12 jam and US$24 muffins. There are many factors to take into account. Let's examine some of them.

Free-market economist Antal Fekete has made some exceptionally good points regarding inflation and money creation. One subtle point he makes is that there is a difference between electronic dollars and physical dollars. It is all well and good for the Federal Reserve to provide money center banks with trillions, but these are electronic dollars. If they never circulate, then they may not produce price inflation. The money supply has been expanded and inflation has taken place, but price inflation may lack, or lag. This has to do with the Fed's determination to provide financial stimulation ONLY through banks. Heaven forefend that the Fed and other central banks should stimulate YOUR bank account, dear reader. As Ben Bernanke said recently, "that's not our mandate," – or words to that effect anyway.

Another point is that a good deal of price deflation is built into the system currently. A reader sent us a link to an interesting article by Rick Ackerman of Rick's Place. Ackerman is a trader, and we thought the article to which we were directed was interesting. Here's a substantive excerpt:

If Dollar Is Bottoming, Killer Deflation Is Next – Has the dollar put in an important low? It looks like it, since the NYBOT Dollar Index widened the gap on Wednesday between it and a key Hidden Pivot support at 80.04 that we drum-rolled here earlier. We had been using that number as a downside target since late April, when DXY was trading just above 84; it was first touched last Friday, then exceeded by a scant 0.23 points before bouncing back. Now, if the dollar is indeed embarking on a major rally in line with our forecast, stocks are likely to fall, and gold and other precious metals to come under pressure, for the foreseeable future. These new trends may have begun to emerge yesterday, since the Dow Industrials fell 173 points and Comex June Gold reversed a promising rally early in the session to settle more than $10 below the day's highs.

The short squeeze that has powered the stock market's bear rally since March 6 corresponds precisely to a period of weakness in the dollar, and that is why we expect shares to fall hard if the dollar strengthens. Why should this be so? The simplest answer is that a rising dollar is going to catch borrowers around the world with their pants down. For despite the deleveraging of the financial system that has occurred since the U.S. mortgage market began to implode about two years ago, borrowers are still caught in a vise, and the world is still massively short dollars because that is the currency in which nearly all borrowing has been done.

Scores of millions of homeowners who are mortgaged to the hilt have implicitly bet against the dollar. So have financiers who have used derivatives to borrow dollars in some leveraged fashion. There are hundreds of trillions of dollars worth of these instruments still in play, most of them denominated in U.S. dollars, and if they cannot be rolled forward, the borrowers will have to settle up in cash. Similarly urgent demand for otherwise shunned equity shares creates short squeezes in the stock market all the time, and there is no reason why a fundamentally worthless dollar could not be squeezed higher by the same implacable forces.

Good job, Rick. And you, dear reader, please recall we have been warning you about commercial real-estate payments coming due as well as hundreds of trillions of derivatives bets that as best we can tell are yet to be unwound. Those derivatives are indeed in dollars, and they are made, in our opinion, on MATERIAL ITEMS. It isn't just a matter of winning or losing. The dollars don't merely re-circulate. These derivative bets were in some sense hedges of actual products and physical activities. And these are products and services that may have been MAL-INVESTED because of central bank money printing.

Of course, there are counteracting trends to Ackerman's deflationary sentiments. One such counteracting trend has been in the news lately and deals with the sale of massive amounts of US Treasuries, which is forcing up long-term interest rates and pushing down bond prices. Interest rate hikes would tend to be deflationary, but the Fed has an answer to that – print more money and push it out the door via the purchase of Treasuries themselves – so called monetization. Inflationary actions counteract deflationary ones yet again.

There you have it. Monetary inflation exists, but according to Fekete there is a substantive difference between electronic and paper dollars (which people will actually spend). And according to Ackerman (and as the Bell has noted), there are many dollar deflationary pressures ahead because of commercial real estate and derivatives. There is also the issue of American Treasury sales that may result in higher interest rates and force increasingly aggressive monetization by the Fed.

After Thoughts

The business cycle itself is fairly predictable. Over time, in the last phase of the cycle, inflation goes up – and because this is such a powerful cycle, we would tend to agree with Faber about some sort of hyper price-inflation. Ultimately, the amount of money that central banks and especially the Fed are going to put into the economy is going to be so massive that there will be an equally massive reaction.

When and how such a big dose of price inflation manifests itself we are not prepared to say (Ackerman seems to believe the unwinding may take five years). Certainly, we don't think it is happening tomorrow. But we don't see it not happening – and maybe sooner rather than later. Central banks will print and print until finally the economy is "stimulated" – the bubble re-inflated. We think we know where it must end. And, yes, we're buying gold – to cushion the uncertainty of the cycle itself, the possibility of a general collapse, and to prepare for the price inflation inevitably yet to come.

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