Sunday, January 4, 2009

The Diminishing Bang of the Buck

Many such as Peter Schiff have been warning the Federal Reserve simply does not have the tools to fix our economy. As a matter of fact in his last appearance on Stock Shotz, Schiff said that the American Consumer Was done and that the Federal Reserve was essentially "out of bullets". Is the Fed out of bullets? Well if they aren't, the bullets are certainly going to be more expensive in the coming months. Take a look at the chart below which was found on the St. Louis Fed's website. It shows the drastic decline in the M1 Money Multiplier. It has had a dramatic decline and the worst part of the chart is that the MULTIPLIER HAS DROPPED BELOW 1. I will admit that this points to short term deflation. Simple common sense logic tells me that as the Fed tries to stimulate the economy, they are going to only get 95.4 cents worth of "bang" for every dollar invested. As private investors, I expect most of us demand a better return on our money. So am I changing my inflation bias? Certainly not over the long term----but I could be willing to accept that it may take longer for my thesis to develop. I believe that this "multiplier below 1 phenomenon" will ultimately MAKE INFLATION WORSE. The longer the multiplier stays below 1 and "the further below 1 it falls" the more the money supply will have to be increased to get GDP growing again. Could the drop in the multiplier be caused by credit contraction? Absolutely? If the economy gets going again will credit expand? Again the answer is ABSOLUTELY. Then the multiplier will rocket upward. So the question is will the government be willing to pour enough money into the system to expand the money supply enough to reverse the course of the multiplier and GDP. I believe they will and then the question becomes can they raise rates fast enough to control the inflation that will follow. That I do not expect they will do. So while my long term inflation thesis is stronger than ever---I am now tempering my time frame for the price declines to end and inflation to begin.

In looking at the equity markets I must ask the question "Did the money mangers anticipate this phenomenon and sell in anticipation?" or are we yet to see the effects of this multiplier downturn in the equity markets. Will the stock market be a leading indicator (we know we normally see improvements in the equity markets before we see improvement in the economy) or IS THIS TIME DIFFERENT?

In looking at the forecasts for inflation---it has been quite some time since there has been this much disagreement between the "experts". I equate that into continued (perhaps even massively increased) volatility in the markets.

We are continuing our quest to speak with many of the best minds in the business and will be bringing you many interviews in the near future. I believe that the most successful in the markets in 2009 will BE NIMBLE AND BE QUICK AND BE WILLING TO LOOK AT THE FACTS AND CHANGE COURSE. I am not afraid to admit when I am wrong---and I will show what facts are changing my mind. The above chart gives me heartburn.