Wednesday, October 31, 2007

Inflation...the Real Problem

How could so many things be so expensive...while consumer price inflation is so modest? Oil is over $90. Other commodities are soaring...hitting new all-time highs. Labor in China and India is rising at 10% per year. How is it possible that the cost of living remains...according to the feds...under control? In other words, how could the dollar be so weak in the face of every major asset category we read about...but so strong in the face of general, consumer spending?

The answer is simple; the feds are lying. So concludes the Economist, this week’s edition. It says that an average of “all items” is going up not at 2% or 3% per year as the U.S. government claims, but at 16.7% per year! Food is going up even faster – at 31.6%.

“With each new release of economic indicators - the consumer price index, the new employment numbers, trade deficits, gross domestic product, and more - every number, bad or not so bad, is contorted into ‘happy speak’ by the talking heads responsible for keeping the good times rolling,” Strategic Investment’s Dan Amoss tells us.

“Inflation is grossly understated,” he continues. “You see the Fed exclude three of your highest-priced budget items from the CPI - energy, food and the price of your home.

“Just imagine how great your family budget would look if you didn't have to include your mortgage payment, the gas to run your car, your heating bill or the weekly grocery bill. You'd probably feel pretty rich too. But reasonable people know you just can't ignore these bills without some pretty serious consequences.

“In addition to excluding the above three, the Fed also plays a cool sleight of hand with the prices it does include. For example, we all know that a computer is twice as capable as one from five years ago, but costs about the same price. But the Fed goes ahead and adjusts the price downward to contribute a 50% decline in price in the CPI.

“So if you were to take out the adjustment tricks, inflation would probably run 3 or 4 percentage points higher than what the government will admit. Just think how fast an 8% inflation rate can eat into savings and investments.”

The subprime loan mess is a $900 billion problem, says Fortune Magazine. But there’s another problem just as big right behind it. It’s credit card debt. And it, too, is a $900 billion problem...or $915 billion, to be more precise.

Here’s the story:

As long as property prices were going up, consumers were able to borrow against their houses in order to pay off more expensive credit card debt. The credit card companies, meanwhile, were able to unload the debt on Wall Street, where it was packaged up – just like mortgage loans – into CDO derivatives and sold on to investors.

All was well until property prices stopped going up. Then, consumers could no longer easily increase their mortgage debt. This left them more reliant on credit cards, and less able to pay off their credit card debt when something went wrong.

Something always goes wrong. Disease, divorce, economic disaster – something always comes along just when you need it.

In Britain, the cycle is a little further advanced. Property prices rose faster than in the United States. And households became even more reliant on credit. When the housing boom slowed, consumers were forced to turn to credit cards. Delinquencies on credit card debt have already risen 50% in Britain. In America, delinquencies are just beginning to go up.

Problems in the housing market have a lot further to go, says Angelo Mozilo, head of Countrywide, one of the nation’s largest mortgage lenders. Countrywide reported a $1.2 billion loss on Friday.

Housing prices fell 4.4% across a sample of 20 cities in the 12 months through August, according to the Case Shiller index. Inventories of unsold houses are still at record levels, suggesting that Mozilo is right; it ain’t over yet.

Until tomorrow,

Bill Bonner
The Daily Reckoning


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