Seeds of Hyperinflation Have Been Sown

``Many false arguments are used to defend inflationism. Least harmful is the claim that a moderate inflation does not do much harm. This has to be admitted. A small dose of poison is less pernicious than a large one. But this is no justification for administering the poison in the first place. It is claimed that in times of a grave emergency the use of means may be justified which in normal times would not be considered. But who is to decide whether the emergency is grave enough to warrant the application of dangerous measures? Every government and every political party in power is inclined to regard the difficulties it has to cope with as quite extraordinary and to conclude that any means for combatting them is justified. The drug addict, who says he will abstain from tomorrow on, will never conquer the drug habit. We have to adopt a sound policy today, not tomorrow.”-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

While “greenshoots” have been more evident in Asia and emerging markets than their OECD counterparts, as evidenced by rising reports of indices based on Purchasing Managers Index and bank lending, some have questioned the sustainability of these improvements.

For instance, acquisitions of oil and petroleum products allegedly haven’t been reflective of the economy’s demand and supply, here we quote CBI China (FT Alphaville)

``Most players expected bearish gasoil market in may amid weaker speculative demand and increased supplies. Speculative demand will probably plunge if the market gains no more support in may, but end-user demand is not likely to grow much amid gloomy economy. Meanwhile, oversupply will probably remain as supplies grow. When supplies from PetroChina and Sinopec are not seen to change, CNOOC Huizhou refinery is estimated to supply 200,000-300,000mt of gasoil to East and South China per month. Without much support from international crude, PetroChina and Sinopec may cut prices to promote sales in some regions, where they failed to fulfill their sales targets in April.

``There is little possibility for China to import any gasoil in May in view of negative import margin and weak demand from the domestic market. Meanwhile, Sinopec’s and PetroChina’s gasoil exports may be little changed from the previous three months, about 200,000-300,000mt altogether.” (emphasis added)

Moreover, China’s electricity consumption which serves as a key barometer of economic activities has equally registered a decline on a year to year basis in April (Xinhua).

Furthermore, energy bears point to the growing disconnect between rising oil prices and high inventory, see figure 5.

Figure 5: FT Alphavile: US Oil Inventories Nearly At The Brim

The Financial Times Alphaville quotes Goldman Sachs; ``Commodity prices cannot diverge for long from physical fundamentals as they are largely “spot” assets….As storage bridges the gap between today and the future, commodities that are easier to store, such as metals and agriculture, are more anticipatory.

``Thus, electricity followed by natural gas are the most spot or least anticipatory commodities given the difficulties in storing these commodities while base metals are generally the least spot or most anticipatory given their ease of storage, followed by agriculture and then oil.”

In other words, given the storage issues energy prices are supposed to reflect actual demand and supply.

But as we have earlier asserted experts tend to look at ONLY demand and supply of real goods frequently disregarding the demand and supply of money relative to real goods.

Left to markets, storage issues will find a remedy. And most likely rising oil prices could a manifestation of the diffusing liquidity in the system.

Proof?

In China, the surge in bank lending has mainly been about government induced lending rather than growth in the private sector activity, according to the Wall Street Journal (bold highlight mine),

``China’s state-controlled banks are clearly leading the lending charge, accounting for 50.5% of the new credit extended during the quarter. Foreign banks are, however, behaving more like they are elsewhere, and are not following their Chinese colleagues into the lending surge. Loans by foreign financial institutions declined by 26.4 billion yuan in the first quarter.

``The central bank’s breakdown of new medium- and long-term borrowing, the kind most likely to be used to pay for investment, shows that 50.1% went to infrastructure in the first quarter. That clearly reflects how banks are being pressed to give priority to government stimulus projects. But such lending has its own risks. “Recent bank lending has been concentrated in government projects which, while helping drive rapid investment, also requires evaluation of local governments’ ability to repay the debts,” the central bank said.

``Outside of stimulus projects, demand for credit is not as strong. Only 7.9% of new medium- and long-term lending went to manufacturing, and 11.2% to real estate development.”

Moreover, China continues to massively import iron ore which jumped 24% in April.

As we discussed in The Nonsense About Current Account Imbalances And Super-Sovereign Reserve Currency and Has China Begun Preparing For The Crack-Up Boom? China appears to be heavily acquiring commodities mostly likely designed to diversify from its US dollar reserves holdings which could function as insurance against the risks of hyperinflation or have been consolidating its potential role as primary contender to the currency reserve hegemony, presently held by the US dollar or both.

But as far as the loose connections leaving experts in the quandary, for us they all seem like puzzles falling into place.

As Ludwig von Mises wrote in Interventionism: An Economic Analysis, Inflation and Credit Expansion, ``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.”

For us, this means that the seeds for hyperinflation have been sown, and that those arguing for “timing” and the “inevitability” have been tunneling their market outlook based on Holy Grail economics as guide to investing.

Mr. Russell Napier, author of the Anatomy of the Bear Market seems to share our outlook, in an interview at the Financial Times quoted by FT Alphaville, we quote Mr. Napier (bold emphasis mine),

``The key three indicators that we’ve passed the risk of deflation are rising price of Treasury inflation protected securities, the rising price of commodities and the rising price of corporate bonds. This is not to say that this bounce is the end of the bear market…

And a decoupling with China?

Adds Mr. Napier, ``So I see inflation problems in a couple of years and I see problems with the Chinese not being as big a buyer of US treasuries simply because they will be having a great domestic consumption boom which means they’ll not run surpluses and buy these surpluses. And the crucial one people sometimes forget is the retirement of the babyboomers, the medicare costs in particular and the social security costs of this is going to be issuing a lot of treasuries into the future…

And the US will probably experience a fierce bear market in US treasuries aside from the excruciating effects to its economy due to rising interest rates…see figure 6.

Figure 6: Economagic: The End of the US Treasury Bull Market?

Again Mr. Napier, ``For the next couple of years people will see it as normalisation, if yields on Treasuries go to 4 or 4.5 per cent. People will say this is a normalisation of the treasury yield as we pass the deflation risk . There’ll be a great breath and sigh of relief that we’re going back into another business cycle, and when it looks like we may never get there equity prices will go up. But the final sting I believe is in the tail. The last treasury bear market lasted from 1946 -1981 and there’s no reason to suggest that this one will be any shorter.”

US Treasuries have been in a bullmarket since 1980s, the long cycle does indicate that an inflection point is imminent.

The last word from Mr. Warren Buffett during his latest Berkshire Hathaway’s Woodstock for Capitalists, ``Anybody who holds (US) dollar obligations from outside this country is going to get back less in purchasing power in the future”.