Going Broke the Traditional Way

Capital cannot be consumed; it must be saved and invested wisely, skillfully. Everything else is distraction…fraud and fantasy.

Source: Bing Image Generator

Thursday, June 13, 2024

Bill Bonner, writing today from London 

History has many cunning passages, contrived corridors 

And issues, deceives with whispering ambitions, 

Guides us by vanities.  

—Gerontion, TS Eliot 

Investors heard the lure of the Lorelei yesterday.  So sweet.  Irresistible.  What lush pleasures they suggested.  What otherworldly satisfactions they offered. 

Yes, word came that inflation was “cool.”   Business Insider reports: 

Inflation came in softer than expected, with consumer prices remaining flat over the month of May. On a yearly basis, inflation was up 3.3%. That's slightly lower than the 3.4% yearly increase recorded in April, marking the second month in a row that prices have cooled. 

Bond yields plunged after the report. The 10-year US Treasury dove 11 basis points to 4.287% 

"Wednesday's weaker-than-expected CPI will allow the Fed to start cutting interest rates as soon as September since we have now seen multiple encouraging inflation readings, after the concerning spike in inflation earlier this year," Skyler Weinand, the chief investment officer of Regan Capital, said in a note. "There's a clear path to a soft landing and the Fed may very well be coming to the market's rescue in as little as three months." 

Markets Insider followed up: 

US stocks rose on Wednesday as investors took in cool inflation data and the Federal Reserve's latest guidance on rate cuts, helping the S&P 500 to another record close.  

But then, the Dow gave back all its gains when it became clear that Jerome Powell was not exactly on the rate-cut bandwagon.  It was “certainly a better inflation report than almost anyone expected,” he said.    But he added that he wanted to be sure inflation was under control before cutting rates. 

Boo hoo.  Investors will have to wait for the lavish satisfaction they crave. 

But Fed rate cuts do not magically create more real wealth.  Wealth is created by increases in productivity…with more output per unit of labor and resource input.  It is the result of hard work…and forbearance.  Immediate pleasures must be put off…lessons must be learned.  Capital cannot be consumed; it must be saved and invested wisely, skillfully.  Everything else is distraction…fraud and fantasy.   

After revealing the Fed’s decision not to cut rates any time soon, CNN added: 

‘That means borrowing costs on everything from car loans to mortgage rates will remain elevated.’ 

Lowering the cost of credit makes it easier to buy things….but it doesn’t necessarily make it easier to pay for them.  As we’ve seen, more credit creates short-term ‘fictitious’ wealth, not long-term real wealth.  Sellers record the increase in sales as a plus.  The feds record the extra sales as an increase to GDP.  But until the bill is settled, the transaction is incomplete.  

As debt increases so does the cost of debt service (interest) and the number of debtors who won’t be able to pay – including the biggest debtor in the world, the US government.  And so does the amount of wealth that is likely to vanish in the next crisis.  This is especially true when the borrowing was done under false pretenses – that is, at interest rates that are unrealistically or artificially low.   

And lo…the debt rises. 

The latest figures are out.  The Congressional Budget Office says that the feds’ deficit for the month of May was $348 billion – up $108 billion from last year.   Whew.  The CBO is forecasting deficits between 5.2% and 6.3% of GDP over the next 10 years. 

This is a nation going broke in the traditional way…by adding phony wealth and real debt.  And here at Bonner Private Research, we’re not the only ones to notice.  The Financial Times is on the case: 

The IMF’s second-in-command has urged the US to shrink its mounting fiscal burden, saying strong growth in the world’s largest economy gave it “ample” room to rein in spending and raise taxes. Gita Gopinath, the fund’s first deputy managing director, said it was time for advanced economies to “invest in fiscal consolidation” and address how they plan to bring debt burdens back down to pre-pandemic levels. 

 “For the US, we see ample ground for them to reduce the size of their fiscal deficits, also given the strength of the US economy,” she told the Financial Times in an interview. The warnings come as economists and investors fear that years of fiscal profligacy by both Democrats and Republicans are storing up trouble for the US economy.  

Yes, dear reader, there is ‘ample ground’ to cut spending.  But fraud is more agreeable than truth…and increasing debt is much more  appealing than paying it off. 

For now, policymakers and investors are enchanted by the song of the Lorelei and the fake wealth it produces.  Later, they will crash upon the rocks. 

Until tomorrow,

Bill Bonner

---

Research Note, by Dan Denning

Three years and two months ago, Federal Reserve Chair Jerome Powell said the central bank would like to see sustained inflation over 2% ‘for some time.’ Mission accomplished. Yesterday’s ‘cool’ CPI figure of 3.3% would have been hotter if not for the 9% fall in the used cars and trucks category (repos, perhaps).

Today I want to share three charts with you. These are the sort I’d normally share in my Friday Research Note for paying subscribers. But if you’re a new reader, you may not have seen them. And all of them are important to BPR’s investment strategy now, and for the rest of the year.

First, a slower rate of change doesn’t mean inflation is going down. It means—assuming it’s even accurate—that inflation is growing less fast (although still above the Fed’s ‘target’). The first chart below shows the entire price level shifted 22.26% higher in four years from May of 2020 to today. It’s this shift that’s killing the quality of life for the American Middle Class (by contrast, the S&P 500 is up 25% since the Fed started raising rates in March of 2022).

Second, the velocity of money is on the uptick. The chart below shows the year-over-year change in broad money supply (M2). Money supply ballooned with the Covid stimmes and giveaways. Then it appeared to contract, even as inflation remained ‘above target.’ Now, the very latest data point shows money supply expanding again. A ‘second wave’ of inflation is building.

When you get high inflation with a recession it’s called stagflation, a throwback to the great monetary policy mistake of the 1970s. But that’s where we may be headed. As the chart below shows, each of the last eleven recessions began either just before or right after the Fed started cutting rates (the recessions are the grey vertical lines on the chart while the blue line is the effective Fed funds rate).

Investors cheering for rate cuts should pay close attention. I’ll have more on this in my note to subscribers tomorrow. A key issue is whether a second wave of inflation will drive stocks up even higher…or commodities…and if it’s commodities…how do we position for it?