For months, I've been warning that the Federal Reserve's hardheaded determination to pump trillions and trillions in ultra-cheap cash into the economy was passing the point of no return. Sure, the strategy worked great back in 2008 and 2009 when the financial crisis was raging. But now it's becoming increasingly counterproductive.
In fact, it's just making things worse for the average guy or gal on the street being squeezed between stagnant wages and higher prices. The resulting drop in consumer confidence and retail sales will act as a drag on growth in the months to come -- which, perversely, will encourage the Fed to unleash even more policy easing.
With Wall Street clamoring for more cheap play money, a dovish rotation of Fed policymakers this year, and chairman Bernanke's honor on the line, things are going to get worse before they get better. In fact, the evidence suggests we're facing a repeat of the mistakes that led to massive inflation in the 1970s and 20%+ interest rates.
This week's' report on inflation shot holes through the Fed's official stance that inflationary pressures are "subdued" and not a big concern. The takeaway is that food and fuel inflation -- gas prices are up 23% off their December lows, something I gave my readers the heads up on in early January -- is beginning to creep into core measures of inflation that the Fed focuses on. Core consumer price inflation jumped 2.3% over last year, the biggest increase since September 2008.
It isn't a one-month fluke either: On a three-month annualized basis, core CPI was up 2.2%. This is exactly what Federal Reserve Chairman Ben Bernanke doesn't want to see, since it weakens his case for more quantitative easing. Indeed, this week a Fed official called expectations for QE3 later this year a Wall Street "fantasy," as the rationale isn't supported by the facts.
Facts like these: Core consumer prices are rising between 0.55% and 0.75% faster than average worker wages. In other words, with GDP at new all-time highs, corporate profits at all-time highs, banks sitting on more than $1.5 trillion in idle cash, and crude oil lingering above $100 a barrel as gas prices surge, average Americans are falling farther and farther behind because of rising prices on the things they need.
If the Fed ignores all the data and launches QE3, expect a big temporary lift in stocks and commodities like oil before reality sets in and inflation swells even more. The truth is, more people are affected negatively by the Fed's higher inflation than they are positivity affected by temporarily higher stock prices or lower interest rates.
Stepping back, the chart above illustrates how dangerous this is all is over the long-term. It shows how the Fed's short-term policy rate (red line) is well below the core rate of inflation (blue line). This is bad news and signals irresponsibility by the Fed. Last time it happened was back in the 1970s, and it took two recessions and crushing 20%+ interest rates to undo the consequences.
What's worse is that unlike back in the 1970s, this is being done as the core CPI rate is rising, signified by the rising blue line. To use an analogy, doing QE3 now would be like a recovering burn victim dousing his barbeque in lighter fluid even though his clothes are already on fire from the lapping flames. It's wrong on a number of levels.
A lack of wage inflation indexation, widespread long-term unemployment, prevalence of negative home equity, and stagnant home prices will make this new bout of inflation even more painful than what was experienced in the 1970s and early 1980s.
Enough is enough. Bernanke, please stop the Soviet-style central planning before it's too late. You've already committed to holding rates low for more than two years. You've already engaged in Operation Twist to focus on pushing down long-term interest rates. It's time to step back and admit monetary policy can't solve the structural problems the economy faces. It's a task for Congress and the White House.
For investors, there are signs the market is pricing in stagflation -- the nasty combination of higher prices and economic stagnation. Inflation expectations are creeping higher, yet industrial commodities like copper, the metal that's said to have a Ph.D. in economics for its ability to see what's coming, are dropping out of two-month consolidation ranges.
For this reason, I continue to recommend my newsletter subscribers focus on betting against the materials sector. My new short position in Mechel Steel (MTL), which I added to the Edge Letter Sample Portfolio a few days ago, is already up nearly 5% as the broad market stagnates.
For more conservative, long-term investors, caution is warranted.
Disclosure: Anthony has recommended MTL short to his newsletter subscribers.
Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up. Contact Anthony at anthony@edgeletter.com and follow him on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
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I hate to say it, but the 99% are getting the royal shaft again and again. This Congress has done more to hurt the US of A than any I have seen in 40 years.
There is something we can do if we make it to NOVEMBER 06, 2012...elect NEW Washington D.C. politicians, yes all of them! The only criteria I ask is that they balance our Nation's budget and pay attention to the 99%...US!
I wonder if the Dow is headed toward thirteen thousand because all of this cash with the ink still wet is making its way into the markets buying any security that breaths.
Be careful Anthony! - Questioning the regime will get you banished to Fox News.
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