This is my personal blog. Travel, financial and political observations. Notes to myself and my friends. Content development for my monthly newsletter, Porter Stansberry's Investment Advisory (www.stansberryresearch.com).

Tuesday, February 28, 2006


"Oil-price increases in the past few years, unlike in the 1970s, have not fed through to any great extent into longer-term inflation expectations and core inflation,"
-- Fed Chairman, Ben Bernanke, as quoted in the Feb. 25 WSJ

I’m looking at my receipt from today’s lunch.

I ate, as I do on most weekdays, at Eddie’s of Eager Street, an old-school Baltimore grocery store. It’s located on what amounts to an alley between Cathedral Street and Charles Street. The upper crust Maryland Club is on the corner. But Eddie’s is hidden behind a gay bar. Eddie’s is not a fancy place. Most of the regulars pick up the bargain sheet at the front door. They’re the ones who buy the expiring produce and the spoiling meats at half price. Welfare zombies, crack heads and HIV patients, from the clinic across the street, wait in hopeless silence at the front of the store, waiting for their chance to display profound statistical ignorance via the state’s lottery. However, the sandwiches at the deli are great. I get the chicken salad sandwich. My wife has me convinced the red meat in my diet is largely responsible for the 20+ pounds I’ve added since our wedding. (I think it has a lot more to do with her French cooking.)

Today, I had my regular meal: chicken salad sandwich, bag o’ chips and two diet Mountain Dews, which are the best tasting diet soft drinks on the market. The sodas cost $1.39 each for 16 oz. The bag o’ chips was $0.99. And the sandwich was $5.50.

Tax, tag and title added another buck or so, bringing my total to more than $9.00 for lunch.

When I first moved to Baltimore, I ate lunch at my friend Gary’s sandwich and pizza shop, New World Bagel. Gary was a hard working Ukrainian entrepreneur with a wife and two young babies at home. (Personal factoid: When I got fired from Agora Financial Publishing in early 1999, Gary was the only person I knew who offered to invest in my new publishing company. He was a shrewd businessman.) Lunch at Gary’s eight years ago was about the same as today’s: a delicious homemade turkey sandwich, chips and a big regular coke (I was thinner then.) It cost $5.00 and change, but Gary would never charge me more than $5.00 because I was a regular customer and dealing with the small change was a pain.

Bernanke says there’s no inflation today. But judging by my lunch tickets, the value of the dollar has fallen by roughly 50% since 1999. I think most of that loss in value occurred since 2001. While I know that’s true from the financial stats I read, I also know it’s true more directly: I look at my lunch ticket. What used to cost $5.00 now costs almost $10.00.

If you’re retired, this means your standard of living has fallen in half. If you’re not retired it means all the raises you’ve earned in the last few years haven’t increased your standard of living at all, unless you’ve more than doubled your income. That’s not fair, is it?

It gets worse when you consider the times we live in. The recent reduction in the value of our currency took place during a period of tremendous gains in productivity.

As technology has improved, things should have gotten cheaper. That’s the positive trade-off from new technology. Technology tends to cause pressure on jobs. Computers have replaced secretaries, for example. But, even as jobs are lost, the benefits to society are supposed to be huge, mostly in the form of lower prices. Competition is supposed to force companies to pass along the cost savings of not having to pay secretaries to customers.

But, over the last 5 years or so, prices have doubled. And not just lunch meat prices.

How do I know, for sure, that the government is ruining the value of our currency? First, you can look at a broad range of commodity prices, like the CRB index. What you’ll find is that not only has the index moved up, almost every single component has doubled in the last few years. Here are the numbers since 2001 on a bunch of commodities, measured at their recent highs.

Aluminum… +94%
Gold… +124%
Silver… +142%
Platinum… +159%
Lead… +252%
Copper… +280%
Crude Oil… +300%
Nickel… +302%
Gasoline +578% (+333% not including the Katrina/Rita spike)
Natural Gas +807% (+429% not including the Katrina/Rita spike)

*** Source: Steve Sjuggerud, www.dailywealth.com

New technologies should be making things cheaper. But, instead, everything is getting much, much more expensive. So what happened to the benefits of that rise in productivity? I’ll tell you in a minute. First though, I want to show you my number one, top secret, warning signal of inflation: fast food prices.

I’ve always told myself I would be able to spot the next hyperinflation in the United States by watching fast food prices. Fast food companies are amazingly resilient against inflation because they invest heavily in technology, source their products from all over the world, have tremendous economies of scale, face commodity-like price competition in their market, and pay below poverty line wages.

You can see these companies’s ability to fight inflation in their value menus. For at least 15 years, Wendy’s McDonald’s and Burger King have advertised value menus or other sale items for $0.99. I’m particularly familiar with this price point because a little more than 15 years ago I was a frequent (several times weekly) customer of Burger King.

Well…customer is stretching it. I didn’t pay for any of my hamburgers back then…

In the late 1980s, in high school, I could get free Whopper sandwiches for my entire Volkswagen van (white, pop-top camper, circa 1969) load of friends, courtesy of “FREE WHOPPER” coupons that my Dad would get, by the box-load, thanks to his long friendship with the Orlando area Burger King franchisee. Back then, the sandwiches only cost $.99…but when you’re 17 and working for just above the minimum wage, even a dollar seems like a lot of money. At that age I was also hungry all the time. Free Whoppers were nothing short of nirvana.

I’d pull up to the drive-in speaker, lean out of the window and say, “Yes, hello…I’d like eight Whopper sandwiches and I have eight free whopper coupons.” Part of the coupon regulations stipulated that you had to tell the cashier at the time of your order that you would be using a coupon.

The woman at the other end of the speaker would then, invariably, crackle in reply, “Do you mean you’ve got four buy one, get one free coupons?”

These buy one get one free coupons were commonly used in published promotions. But I had the good coupons – owner coupons. You weren’t required to buy anything to redeem a free sandwich.

My buddies and I were ready for this question. We’d shout in reply, “No, it says FREE WHOPPER.” Another confused silence would follow. The cashier didn’t think her company was in the business of handing out free food. I imagine she was consulting with her 17-year old superior, who knowing of the special owners’ coupons explained what was going on. The speaker would soon crackle again with this admonition “Those coupons on only valid one per person.” At which point my friends and I would reply with an even louder yell, “WE KNOW…THERE’S EIGHT OF US!”

Today Burger King became the second major fast food change to bump up the introductory price of their value menu to $1.39 from $0.99. I noticed in Taco Bell’s advertising (I’m Full!) that my old college standby – the bean burrito – was now $1.39. There was a Taco Bell just down the street from the “Green House” where I lived with ten of my fraternity brothers. I could usually find enough change in our couches to pay for dinner. And sometimes I had to.

If McDonald’s and Wendy’s follow Taco Bell’s and Burger King’s lead, then you’ll know for sure that we’ve entered a new period of significant price inflation – if you didn’t know it already. As I mentioned earlier, this inflation is particularly problematic given the rapid pace of productivity gains associated with new technologies, such as computers and the Internet.

What causes inflation? Prices for individual goods and services will fluctuate, of course, according to supply and demand. But continuous broad price increases can only occur as the supply of money increases. I don’t point the finger at North Korea’s counterfeiting. I point the finger directly at the Federal Reserve, which puts out a swath of new money anytime the economy stumbles. Instead of suffering through a mild recession, in which bad investments and fool-hearty business people learn how to be more prudent, society underwrites the risks of business through inflation.

The costs of such a policy are hidden through the short memories and economic ignorance of our polity. Nevertheless, there are serious problems with this ongoing policy of debasement.

In the first place, it erodes the honesty and thriftiness of our society.

Inflation is a disincentive to saving – something that’s reflected in our society’s abysmal savings rates. After being the world’s largest creditor in the decades following World War I and World War II, America became a net global debtor in 1988. By the end of the “Reagan Revolution” America had not only spent its accumulated savings, it found itself in the hole by $178 billion. Today that figure exceeds $2.5 trillion and continues to grow at new record pace each year. Within 10 years’ time, if this trend continues, we will have borrowed several generations of income from our trading partners. Of course, this trend cannot continue; only a fool would continue to invest in a nation that is only capable of debt payments via printing press.

Inflation will also cause “malinvestment” as entrepreneurs react to inflated prices, assuming that demand will support continued investment. For example, the drilling companies are investing heavily right now in building expensive new rigs to increase onshore U.S. oil production. But this kind of drilling is only profitable at extremely high oil prices. If the current high price of oil was caused by inflation of the dollar and if the current Fed’s interest rate hikes reverse this inflation, those drilling companies will lose billions on their investment. That’s no way to run the economy.

The most serious economic problem caused by “floating” currencies that are worth nothing more than the promise of a central banker (nothing, in other words) is that there’s no reasonable way for multinational companies to hedge their exposure to different currencies over the long term. This causes stagnation in international currency flows and retards significant investment in emerging economies. For example, maybe building cars in Brazil would be a great idea for GM. But how can the carmaker protect itself from the very real risk that Brazil’s currency collapses? If that happens, all the profits it earns in Brazil will be worthless. A new plant is a multi-billion dollar investment, with a productive life of more than 30 years. It’s impossible for GM to hedge its Brazilian currency risk at any reasonable price, for such a long time. And, as a result, GM won’t invest heavily in Brazil, which perpetrates poverty in that nation and restrains the growth in global GDP.

And there’s one last concern, which to me is the most serious. It’s a philosophical issue. It’s the issue I touched on above, the effect that inflation has on retired people, employees in largely fixed wage jobs and the lower class. These people make up key constituencies in our democracy. If they lose faith in the free market, the results could be catastrophic for America. The free market is supposed to deliver utilitarian results: the great good for the greatest many. But, in our inflation-prone economy the benefits that should accrue to the “little guys” – great economic efficiencies, causing the standard of living to rise and the price of things to fall – don’t occur because these benefits are inflated away to protect debtors and banks who make bad lending decisions. As a result, there’s a growing and huge divide between those people with the incomes necessary to accrue assets like real estate, gold and equity (and enjoy the benefits of inflation) and those who do not.

This rift will eventually tear our society apart. The new lower class will most likely never understand the role inflation played in the destruction of their middle class lifestyle.

*** YOU THINK YOU’RE TOUGH: As the WSJ reported this week, in 1960 Joe Kittinger rode a 20-story balloon to the edge of the atmosphere, 19 miles above sea level. Then he jumped out of the open-air gondola. “Lord help me now,” he is reported to have said to himself as he dropped over the side. I wonder what the Lord said to himself in reply. Probably something like, “Don’t ask for my help, I told you not to get in that damn balloon…”


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