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A rather eye-opening headline
appearing in the financial press is worth discussing here because it's
symptomatic of a bigger problem plaguing the economy. This problem will only
increase in the coming months and there's ample reason for believing it will
eventually undermine the cyclical bull market in stocks. The headline reads,
"Kimberly-Clark to hike prices after profit falls."
The article appearing in the
Associated Press today stated that this represents the third such price hike
for Kimberly-Clark, the maker of Huggies and
Kleenex. As the article observed, "It's a refrain that's becoming
familiar - and, to budget-conscious shoppers, tired - this spring. Rising
commodities prices are taking center stage at a number of companies, from
restaurants to clothing manufactures, who say they have no choice but to pass
along those price hikes to customers." The company said it would raise
prices for its paper products ranging from 3 to 7 percent.
As the A.P. article also aptly
observed, "During the recession, customers got used to discounts on
diapers and other items, so it's not likely that they'll take kindly to being
asked to pay more."
The increase in retail prices is
being driven by the Fed's latest quantitative easing (QE) program which began
late last fall and is scheduled to continue until late June. While it's very
much a subject of debate just how much QE2 has done to improve the economy,
what isn't debatable is the extent to which QE2 has resulted in rising
commodity prices as large institutional speculators and hedge funds have
taken advantage of the easy money and have driven key commodity prices,
notably oil and ag commodities, to ever higher
levels in recent months. The oil price increase alone is having a drastic
spillover impact on fuel and transportation costs, which adds even further to
the upward pressure on retail prices.
Fed Chairman Bernanke has repeatedly
affirmed his commitment to continuing the quantitative easing with the stated
goal of reducing the unemployment level. He also continues to downplay the
impact the Fed's loose money policy could be having
on commodity and retail price inflation. The problem is that Bernanke refuses
to see what everyone else can clearly see, namely the fact that the Fed's
excessively loose money policy is driving up the
cost of living for millions.
Bernanke and other members of the
Fed's monetary policy-setting arm have consistently stated their belief that
the Fed's accommodative monetary policies are still warranted even though a
weaker dollar has been driving commodity and energy prices higher. At last
week's FOMC meeting, Bernanke et al repeatedly upheld the Fed party line that
higher inflation is only temporary and that the threat of deflation outweighs
the short-term dislocations brought about by the Fed's inflationary policy.
In the real world, however, there's a growing fear that higher input costs -
or even the expectation for higher costs - will deter businesses from hiring.
No one really expects the Fed to
launch another round of monetary easing, or QE3, but neither do the experts
expect the Fed to begin a round of monetary tightening. It seems, though,
that Bernanke is more concerned about keeping the economy propped up through
monetary stimulus than in risking another price commodity price bubble. If he
persists in this attitude much longer it's likely we'll witness at some point
a repeat of the 2008 scenario in which an exorbitantly high crude oil price
conspired with other factors to grind economic demand to a near halt.
The re-emergence of the commodity
price bubble is already making its presence felt in rising prices at the
pump, at the grocery store and in the higher prices that corporations across
many industries are charging consumers for their products. One well known
analyst, Bert Dohmen of the Wellington Letter,
asked in a recent report, "What has fueled the new bubbles? The Fed! The
real reason for the stock market up move this year is that the Fed is
stepping on the accelerator as never before. Look at the fantastic money
growth in "Adjusted Reserves," which is the fuel for future loan
growth, if banks ever start lending again. It is directly controlled by the
Fed. In the two months ending March 23, it's growing at a 388% annualized
rate! We have never seen such growth before. Astonishing!"
As Dohmen
points out, that money has to go somewhere and it's going toward speculation
as it always does. The first quantitative easing program after the credit
crisis arguably had a salutary effect on the financial system and helped
revive investor and consumer confidence in the wake of the worst financial
disaster since the Great Depression. QE2 has been largely superfluous and has
done more to aid commodity speculators than anything else. This in turn is
exerting an upward bias on retail prices, which is raising the cost of living
for individual consumers and also putting pressure on corporate profit
margins. Sooner or later this negative influence will stop the economic
recovery dead in its tracks.
Last week was an historic occasion
for the Federal Reserve. It marked the first time in its 98-year history that
the central bank held a public press conference. One of the topics at the
press conference was the effect that the Fed's QE2 monetary easing policy
might be having on fuel prices. Fed chairman Bernanke stated, "Our
interpretation of the increase in gas prices is the economist's basic mantra
of supply and demand." On that same day the price of oil reached a new
post-2008 high.
 
In making this statement the Fed is
officially taking up the line that QE2 has had a negligible effect on the
cost of fuel. Furthermore, the Fed claims that its loose
money policy isn't filtering into the speculative markets for oil and other
commodities. In other words, the Fed is effectively denying what most
observers can plainly see.
Bernanke further stated, "The
Federal Reserve believes that a strong and stable dollar is both in the
American interests and in the interest of the global economy." As he
said this the dollar index reached a new post-2008 low.
Once again the Fed is denying the
obvious. Its policies are weakening the dollar and flooding speculative
markets with fuel for additional asset price increases. Yet the Fed's claim
is that it's primary interest in maintaining price stability (i.e. a stable
dollar). The simple fact of the matter is that the Fed's money policy has
created price instability.
From the above observations we can
infer that the Fed is caught in a web of contradictions and policy blunders.
Every Fed president of our lifetime has had a defining characteristic which
has always had an indelible impact on his monetary policies. Former Fed
Chairman Alan Greenspan, for instance, was a reactionary. His monetary
policies were extremely erratic and akin to riding on a roller coaster.
Whenever the financial markets went into a tailspin or the economy weakened
he would overreact and loosen money until the problem was reversed. Then he
would become alarmed at the speculative bubbles his loose
money policies created and he would react by tightening money to an
extraordinary degree. This would of course lead to financial market turmoil,
which in turn would touch off another cycle of action and reaction for
Greenspan.
Despite his reactionary nature,
Greenspan at least had one thing in his favor, namely alacrity. He would act
quickly at the first sign of trouble. After the 1987 stock market crash he
acted promptly to reverse what was, at the time, the worst stock market crash
since 1929. His problem was that he never knew when to put the monetary
brakes on.
Bernanke's defining characteristic is
by now becoming obvious. Like his predecessor Greenspan he has a hard time
knowing when enough is enough of a particular monetary policy stance. Unlike
Greenspan, however, he is extremely slow in reacting to a developing monetary
crisis. When he took over the reigns of the Fed
from Greenspan in 2006 it was becoming increasingly obvious that Greenspan's
tight money policy from the previous years (which contributed to the bursting
of the housing bubble) would have to be reversed, at least in some measure.
Yet in the critical years 2006 and 2007 he consistently sat on his hands and
did nothing. His inaction contributed to the size and scope of the credit
crisis. By the time he finally took serious action the financial edifice was
completely engulfed by flames and the crisis was twice as bad as it would
have been otherwise.
Now we're seeing Bernanke's fatal
character flaw, namely slowness of response, coming to the fore again. He
would have been justified in stepping off the monetary accelerator last
spring after QE1 ended. Instead he decided to embark on another round of
monetary easing (QE2) and this has only resulted in the extraordinary price
increases for many essential commodities, including oil.
"I do believe that the second
round of securities purchases [QE2] was effective," Bernanke said last
week. "We saw that first in the financial markets. The way monetary
policy always works is by easing financial conditions. We saw increases in
stock prices." Unfortunately "we" also saw - and continue to
see - increases in food and fuel prices.
If Bernanke's latest statements are
any indication, he still doesn't get it. One can only wonder how high prices
will have to rise before he finally wakes up to the foolishness of his
continued loose money policy.
The other problem revealed at last
week's Fed press conference is that Bernanke still favors the now obsolete
measure of the stock market as the ultimate barometer for the overall
condition of U.S. business. While equities may still well reflect the
condition of the global economy and of U.S. multinationals like General
Electric or Coca Cola, it no longer accurately reflects the status of
smaller, domestically based businesses. Moreover, participation among middle class
Americans in the stock market has diminished drastically in recent years.
There was a time when an extended stock market rally could result in the
"wealth effect" and cause an improvement in consumer confidence and
spending. While this is still the case with wealthy Americans, stock market
rallies aren't as big a stimulus for consumer spending and investment as they
used to be.
While Bernanke remains fixated on the
stock market, a better choice would be to focus on the U.S. dollar index and
the crude oil price charts. This provides a much clearer picture of the
impacts Bernanke's money policy is having on the financial market and the
economy.
Another result of QE2 is the steady
rise in the price of gold and silver. While it can be argued that metal
prices are somewhat over-extended and "overbought" the Fed's loose money policy will only whet investors' appetites
for gold for as long as money remains loose and the dollar remains under
pressure. QE2 is scheduled to end in June, at which time many analysts expect
the Fed to launch another round of monetary easing. I have a hard time seeing
this, however. Though we're only a few weeks from the end of QE2, I suspect
the loud clamor over the rising cost of food and fuel will put sufficient
political pressure to bear on Bernanke to stop - temporarily at least -
quantitative easing. If the financial market suffers a severe correction
after QE2, as it did last spring after QE1 ended, Bernanke will undoubtedly be
tempted to press on the monetary accelerator once again.
It has long been my position that the
peaking of the 6-year cycle scheduled for around the beginning of October
this year will likely see the end of the recovery. The Fed ultimately won't
be able to halt the underlying forces of long-wave deflation but it can have
a short-term impact on mitigating deflation, which is what we're witnessing
now in the commodities market. Unfortunately the short-term impact is also
creating a potentially catastrophic distortion on retail prices that will
ultimately inflict severe economic damage before deflation makes its presence
known once again.
Clif Droke
Editor, The Daily Durban Deep/XAU Report
Clifdroke.com
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