Overnight markets were higher, as Europe breathed a sigh of relief that the Irish stress test results were about as expected. The Spooz were firm as well, and then received an added boost when the employment data were reported to be better than previously expected, as the BLS claims 216,000 jobs were created versus the 190,000 that had been forecast. The unemployment rate also inched down to 8.8% from 8.9%.
That win at beat-the-number, government-style, was aided by 117,000 birth/death jobs, a figure 44% higher than last year’s (with the construction component of these theoretical jobs growing 50% year-over-year! — thanks to Fred Hickey for that nugget).
Thus, the job picture has improved slightly in 2011, which is not a huge surprise given the election results, QE2, and the rise of the stock market.
Fed to Install Slightly-Lower-Flow Monetary Faucets
Obviously, that data supports an argument for a little less free money from the Fed. But it is only one month’s number, and the real estate market continues to be soggy. Having said that, it is nearly certain the Fed will end QE2 in June. While some say the question is what will it take to cause it to launch QE3, I think the far bigger issue is the fact that the Fed is trapped between an unemployment rate that is too high and an inflation rate that is as well. I believe it will err in battling the former rather than the latter (although they do have the BLS helping make its job easier). That is, the Fed will remain in “easy” mode even if it is less easy than it was.
The consequences of both QE1 and QE2 have been and will be currency debasement and inflation. Regular readers know where I stand on this subject, namely, that the final outcome of Fed policies will be rather high rates of inflation.
Failing the Sniff Test
Now it seems Bill Gross may have joined the same camp, though for some slightly different reasons. In his Investment Outlook article published yesterday, headlined, “Skunked,” he details the staggering size of the financial burden of our unfunded liabilities. As he points out, this is not some theoretical estimate of future spending, but rather, “The discounted net present value of current spending, should it continue at the projected demographic rate.” The sum total is around $75 trillion. As he points out, if you use the CPI plus 1% to calculate the interest rate on the debt (which is the rate he used to discount back the government’s future liabilities), interest expenses would equal $2.6 trillion, which is about ten times higher than the current level of $250 billion.
The bottom line is he feels the size of unfunded liabilities (a consequence mainly of entitlements) means we are headed to an increased use of the printing press. Gross suggests that, when it comes to the size of our real off-balance debt, as opposed to the size of the $9.1 trillion on-balance-sheet national debt ($11-$12 trillion counting agency debt), we are “out-Greeking the Greeks.”
He sums up by saying, “the only way out of the dilemma, absent very large entitlement cuts, is to default in one (or a combination) of four ways: 1) outright via contractual abrogation — surely unthinkable, 2) surreptitiously via accelerating and unexpectedly higher inflation — likely but not significant in its impact, 3) deceptively via a declining dollar — currently taking place right in front of our noses, and 4) stealthily via policy rates and Treasury yields far below historical levels — paying savers less on their money and hoping they won’t complain.”
No One’s Default But Our Own
And finally, “Unless entitlements are substantially reformed, I am confident that this country will default on its debt; not in conventional ways, but by picking the pocket of savers via a combination of less observable, yet historically verifiable policies — inflation, currency devaluation and low to negative real interest rates.”
Those, of course, are exactly the policies we are pursuing now, which is why we are where we are. Inflation has become the order of the day and it will only intensify. Exactly when I can’t say, but it is worth pointing out that, since QE began, for about eighteen months the monetary base did not really percolate. But so far in 2011 it has exploded by 20% or so. I think that is a sign that inflation is likely to begin accelerating.
Of course, inflation is impacted by expectations. If people think prices are going to climb, they buy in advance, and vice versa. Thus, psychology plays a large role. However, as I pointed out not too long ago, the mindset is changing and the genie is out of the bottle.
“April Fooz” from the Spooz
Corporations might think they can hold prices the same and shrink the contents to make people believe nothing has changed, but when the New York Times runs an article about that practice on the front page, as occurred in the last week, you can be pretty sure people get the joke, and behavior patterns will start to change. So if inflation were a stock, I would certainly buy it aggressively, and I would buy long-dated calls on it, too.
Turning back to the market action, Spooz opened about 0.6% higher and by midday had gained almost 0.9%, buoyed by the employment data and the fact that it was the first day of the month (a nonsensical but important factoid these days). The afternoon saw a selloff that trimmed the gains by more than half and the indices settled on the lows (though still positive).
Away from stocks, the dollar closed mixed, oil added 1%, while fixed income and metals closed with small changes after having been much weaker earlier on.
*The latest issue of Grant’s Interest Rate Observer contains this quote by Malcolm Bryan, president of the Atlanta Fed, from an October 1957 speech regarding the net effect of “premeditated inflation” on the average money-saving citizen.