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Fleck Rap



Note: Professor Fleckenstein provides his commentary every Wednesday evening for educational purposes - his insights are not intended as investment advice. You can find his daily comments at

IBITDA -- Inflation Before Ice Cream, Tortillas, Diesel & Ale

There's no point in talking about the overnight markets, which were a nonevent. I guess the world was marking time in front of Easy Al's testimony so he could remain Fed chairman until January 2006 (more about that below) and the CPI number. The latter turned out to be 0.6% higher, as opposed to expectations of 0.5% higher. But don't worry. For those of you who don't eat, don't drive, or use energy period for whatever purpose, inflation was only up 0.2%.

I would expect that any and all inflation indices are going to be examined, re-examined, and re-re-examined, now that the Fed has said it's paying attention to inflation. I can't get over the number of speeches that have come pouring forth from different Fed heads. There are several a day now, all with the promise to be vigilant about the inflation genie they've already let out of the bottle.

Fed Jive Times Twenty-Five

On the op-ed page of today's Wall Street Journal, for example, Chicago Fed head Michael Moskow said: "Of course, we must continue to be vigilant in monitoring developments that pose a risk to this accomplishment." His definition of the latter: "Over the past 25 years, inflation has come down from double-digit rates to a pace consistent with effective price stability." Not to put a crimp in his back-patting, but that occurred for two reasons:

First: Paul Volcker broke the back of inflation by focusing on the amount of money in the system, letting the price of money (i.e., interest rates) go wherever it wanted to. Easy Al and his current crop of money printers only focus on the price of money, spewing out as much as needed. Even when they supposedly tighten, all they do is raise the cost of it. They never restrict the supply of money.

Fed Flunks Paternity Test for Prosperity

Second: Three unique factors -- all outside the Fed's control -- came together to bring inflation down: (a) NAFTA, (b) a period of increased productivity spawned by a series of special factors, not least of which was revved-up technological innovation, combined with (c) the first post-war economic boom, which allowed us to arbitrage lots of cheap labor.

The bottom line is that this Fed had nothing to do with the lowering of the rate of inflation. Of course, this serial bubble-blowing Fed has done an incredible marketing job on various world markets, convincing participants that it will be vigilant in not letting inflation get the upper hand --when this in fact is already the case, as the Fed has provided negative real interest rates for at least the last year.

To repeat, I would expect that in the next group of months, we will see a focus on inflation/inflationary data, and the markets will oscillate between deciding the Fed's going to do something tough and that it's behind the curve. You know where I stand on the subject, but the markets clearly haven't made up their mind yet, and in fact are siding, at the margin, with the Fed being credible.

Volcker, a Veritable Vigilante

Turning to Paul Volcker, a Fed chairman truly deserving of credibility, I received an email from a reader who watched him being interviewed on Bubblevision yesterday. (I did not see the interview, but if any other readers did and can corroborate it, or if anyone has a transcript, I would like to see that.) Apparently, Volcker said there was never a very serious threat of deflation. "Not in this country," as he was quoted by the reader, who also noted Volcker's comment that we'd better get after inflation before it's too late. Obviously, the views of Volcker, who is one of my financial heroes, are similar to those I have espoused about the likelihood of deflation, and the looming problems of inflation. Gee, I wonder how he knew what to think before I was born!

Chutzpah on the Potomac

Back to the man who could never fill even the toe box of Volcker's shoes, Easy Al gave himself a gold star this morning when he told the Senate Banking Committee: "The performance of the U.S. economy has been most impressive in recent years, in the face of staggering shocks that in years past would almost surely have been destabilizing." What's ironic about that is: The financial shocks have been 100% the result of his reckless policies.

But his prepared remarks were nothing relative to the mind-boggling utterances that followed in the Q&A. Herewith a brief reprise of the headlines that passed on Bloomberg over the course of this spectacle: The "U.S. economy is 'growing in a solid fashion.'" (So why is the Fed funds rate still at 1%?) Inflation is "not likely to be a serious concern" -- and he reiterated that "changes in monetary policy are very likely to be measured." My summation of that little troika? Remember what I have been saying about the Fed being tough or trapped. Acting tough is not in the Fed's repertoire. Talking tough is in its vocabulary, but as we all know, talk is cheap.

He went on to opine that "high oil prices are not hurting the economy yet," and that "evidence shows growth starting to boost wages." However, he then said: "Wage growth is not rising fast enough to boost inflation." You got that? Everything is okay and no problems really exist. Similarly, "trade imbalances should 'gradually adjust.'" Al also "debunked" the myth that consumer debt was a problem, saying that we face "no 'serious' consumer debt problem," and that furthermore, the U.S. is "'nowhere near' a consumer debt problem." (Earth to Al: Today MBNA, the country's largest credit-card provider, lowered estimates due to an increase of bankruptcy filings in March, and an increase in delinquencies.)

Al: Large and In Charge

After all that don't-worry-be-happy talk, he served up what to me is the piece de resistance: "Hedge funds help make markets more flexible," and that he saw "no purpose" in regulating hedge funds. He did find the time to take a swipe at China and its yuan manipulations, while allowing that China was "'successfully' slowing growth."
In other words, the world is a perfect place thanks to Al. Whatever mistakes he may have made have all been taken care of. Just as he has his whole career, he sees no problems anywhere (other than the one time in 1996 when he talked for 10 seconds about irrational exuberance. Of course, by the time things really got out of hand, he had exchanged his concern for pom-poms and a megaphone.)

Paging Dr. Baby Steps

Because he sees no problems, you can be sure that Dr. Baby Steps is not going to do anything to rock the boat in the asset markets. That said, he's already done enough damage that the imbalances will finally expose him once and for all as the irresponsible bubble-blower that he is.

For now, though, we happen to be in an interlude right now where folks can't see the damage coming from the Fed's prior actions. It reminds me a little of the period from the fall of 1998 to early 2000, when I was ranting and raving about what a clueless, dangerous man he was. Folks said: How can you say that? Look how wonderful things are. Well, we found out where that was headed. Now we're in another interlude period, compliments of all the stimulus. When this period ends, folks will once again see how costly he has been to their net worth.

Beneficiaries of Bozo Central-Banking

As I was saying yesterday, the next big trade is the Fed losing its credibility. Whether you want to express that view by being short stocks, or by being long metals or foreign currencies, it doesn't really matter. Though the risk/rewards are different, as well as the timing of when these ideas will work, it's all one trade.

If Al were to get wild and crank up rates, the economy will likely tank. Given all the debt we have, the dollar will tank, the financial system will be a mess, and the metals will go higher. If he decides to stay behind the curve, at some point inflation will get to the place where it can't be hidden, the dollar will go down, and the metals will go up.

That's why I keep coming back to the same place of wanting to own metals and foreign currencies, because it seems to me that no matter what happens, they are going to be winners. At the end of the day, all this paper money is worth zero. As the Fed loses its credibility, many previous mainstream assumptions will be called into question.

In going over this issue countless times in my mind, I keep coming back to the same place: The dollar is a short sale. Precious metals are going to be winners over time. Stocks are on borrowed time. I wish I knew the timing of all this, but I don't (and have demonstrated as much). Nevertheless, I am still looking for clues to try to capture this inflection point as well as I can.

Now Entering Box-Score City

Okay. Down off my soapbox and back to the market action. The currencies started out lower and then crept higher all day long, closing on the highs. They even shrugged off a better-than-expected Michigan consumer-confidence number, which was posted at 95.2, vs. expectations of 90.8. On the back of dollar weakness, precious metals were up 1% plus.

The big winner, somewhat surprisingly, was the long bond, which was up over $2 on the day. Obviously, fixed income staged a furious rally, as folks apparently decided that a 0.2% core rate, plus Al's gibberish, meant the Fed would move slowly. I guess that's what they thought. I have no idea. On the other hand, perhaps too many guys were short fixed income, as 8,000 hedge funds collided with each other, which is their wont so often these days in so many markets.

Turning to stocks, the futures were giddy preopening, indicating a rise of about 0.5% to 0.75% across the board, which is pretty much what they got. We opened at that level and kind of flopped around for a couple of hours. The market ground higher until about midday, when it started to back up. The afternoon saw a bit of a selloff that took us out near the high of the day's range. It was a split affair, with tech stocks faring better than some of the financials -- kind of odd, given the fact that the bond market did what it did.

So-So Takeaway Info

Volume was a tiny bit better, but today struck me mostly as an exercise in moving the Jell-O around the plate. I don't think much information can be gained from what transpired in stock land, other than that one might have expected a better showing from stocks, considering what the bond market did. But there's so much noise in all these markets that it's hard to draw any kind of sensible conclusion on a short-term basis.

No positions in stocks mentioned.

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