First off today I want to thank Ana who stepped in to fill the gap when I had to fly to Sydney urgently. Thanks Ana - heaps!

In this blog, I want to continue with Friday’s theme: that the exponential increase in M3 must eventually be reflected in the CPI figures. I say this based on the foundation of Austrian economics; but theory is one thing,as a trader still needs to see the ideas reflected in hard data.

Fortunately, the hard data is not hard to come by. Last month the US CPI had its highest rise in 26 years; this month, the CPI rose in excess of consensus.

ShadowStats has graciously consented to let me reproduce part of the CPI report it sent to its subscribers. I have attached the excerpt to this. But for me the key section is: “Adjusted to pre-Clinton (1990) methodology, annual CPI growth rose to roughly 8.6% in July from 8.3% in June, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to a 28-year high of roughly 13.4% in July, up from 12.6% in June. The alternate numbers are not adjusted for any near-term manipulations of the data”.

Note that the real inflation is around 13% as compared to the official 8.6%. After the elections, there will be some ‘catch-up’. The national statistical agencies know that they need to keep some connection to reality or their work will fall into disrepute. So we can expect some ’shocking’ numbers.

Notice that traders have chosen to ignore the facts that are there for all to see. You’d think that a high inflation number coupled with a less than robust economy would send warning sirens; instead the stock indices remain flat to bullish. This is akin to the reaction of sub-prime problem. This ‘ostrich’ reaction is well illustrated in this accounting.

I was having a conversation in late March 2007 with a couple of brokers (I shall keep their firms anonymous to save red faces). I said:

  • Me: “Don’t you think there is a crisis in the making with the sub-prime loans? If interest rates rise or for any reason, the borrowers start to default, you have a real problem in the making.”
  • Broker 1: “These are ‘AAA’ loans, default is not an issue.
  • Broker 2: “Anyway, there is such a flood of paper, the US Treasury will bail out the problem and it won’t affect us or the stock market”.

Hmmmm…..
The rest of the evening flowed along the lines outlined above. I thought at the time that ‘Blind Freddy’ would see the looming issue; but, my friends certainly didn’t or wouldn’t. It was a prime example of what Pete Steidlmayer called ‘an unexpected event‘.

My evaluation (that some time after the elections, the increases in the CPI will force the FED to raise rates) is another such idea. The exponential rise in M3 must show up in the CPI - it’s not a question of ‘if’ but ‘when’. When that occurs, given the state of the US economy, I expect the stock indices to head south.

There are two areas where I could be wrong:

  1. The timing of the rise - we may see the FED act or be forced to act before the election; and
  2. My view of the stock market’s response to the rise in rates.

Of the two, the margin for error is greater in item (1).

Time will tell if I am right; right or wrong, you heard it here first.


shadow-stats-08-15-2008.rtf


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