“What’s different?” asked colleague Manraaj Singh at this morning’s conference.

Early every morning, while most Americans are still in their beds, your editor joins a group of analysts and financial journalists to discuss the day’s news.

“What happened to the price of copper? Why are Asian stocks going down? Are they really going to cut rates today?” The answers are not always satisfying, but the questions keep coming.

And the question this morning was: what has really changed?

U.S. stocks held steady yesterday, but they’re down 5% so far this year. The dollar held steady yesterday too, but it is down for the year too – about 6% against the euro and the yen. The Europe- or Japan-based stock market investor has lost more than 10% of his money.

Meanwhile, the fall of the dollar has increased prices for imports. While the United States used to “import deflation” from Asia and elsewhere, now it imports inflation. Prices are rising all over the world.

Yesterday, European producer prices were reported rising at 6.1% per year. High prices have caused the biggest drop in retail sales on record. And yesterday, they had to call out the riot squad in Brussels, to battle fishermen who were kvetching about high fuel costs.

In China, retail prices are rising at an 8.5% rate – the fastest in 12 years.

In Russia, prices are going up at a 14.39% rate.

In Vietnam, the consumer price inflation rate is running at 25%.

In Venezuela, the inflation rate is 29%.

And in Zimbabwe…well, Zimbabwe is another story altogether, with inflation going up so fast they can’t even measure it. Prices are said to be increasing at 160,000% to 200,000% per year. But who can tell? There’s nothing to buy.

Back in Asia…the region’s central banks had hoped that Milton Friedman was wrong. They had hoped that a worldwide economic slowdown would reduce domestic inflation rates. So, they left their lending rates low – considerably lower than the CPI – in order to keep their economies turning over. In Thailand, for example, the central bank lends at 3.25%, while consumer prices rise at more than 6%.

Sound familiar? The United States also keeps its key-lending rate well below the inflation rate – and for the same reason. The Fed lends at 2%. Inflation was last clocked running twice as fast.

We pause here in honest admiration for our fellow investors – the kind of admiration we feel for members of a bomb disposal unit, or a knife-thrower’s assistant. What are we to think? They are lending money to world’s biggest debtor – the U.S. government – for 10 years at 3.94%. That’s yesterday’s yield on the 10-year T-note. If nothing changes, they will get nothing for their trouble. If inflation rates rise (or just happen to be understated), or the dollar falls, the speculation will blow up in their faces.

But along comes Ben Bernanke, with an apparent change of brain. Now, says the captain of the Fed’s rapid response recession-fighting team, further inflation is unwelcome in the United States of America. Supposedly, these words alone took $5 off the global oil price.

But what really has changed? Can the U.S. central bank really begin fighting inflation in a serious way?

The feds have discovered the same two things that their Asian central banker colleagues have found out: that the globalization street goes both ways…and that Milton Friedman was right. Inflation is a monetary phenomenon, observed Friedman. When you increase the amount of money in circulation, ceteris paribus, prices are going to go up. That they didn’t go up much in the last 15 years is merely because there were important other trends going on – notably, globalization, which was driving down prices. But now, traffic on the Avenida de Globalization is going in the other direction. And just as it was very difficult to cause inflation while globalized markets were cutting prices, so is it very difficult to stop inflation when globalized markets are increasing them.

*** Can the Fed really begin fighting inflation? Ah, dear reader…do you see the cruel twist to the story?

While the Fed couldn’t seem to create inflation in those wonderful years of the Great Moderation…now, it probably can’t do much to stop it. The U.S. imports an Everest of stuff from overseas. And stuff made overseas is becoming more expensive. The Fed can raise rates to try to cool the U.S. economy and reduce the amount of stuff Americans buy. But those darned Asians and Europeans can still buy more, and prices can still go up.

Besides, any further ‘cooling’ of the U.S. economy is risky. It could freeze up.

The crisis is said to be over on Wall Street. But the Financial Times says new IPOs are being taken off the schedule…short action on Lehman Bros. is at a record level (speculators are betting that the company is going down) and Moody’s says it might downgrade credit ratings for MBIA and Ambac.

The money just isn’t flowing as fluidly in Manhattan as it used to. An AP story tells us that apartment sales were off 21% in the first quarter. And over on Long Island, where the Wall Streeters have their weekend homes, lenders are said to cutting off home equity lines.

In the center of the country, bankruptcy filings are up 27% in Illinois. And out in Las Vegas, the mortgage fraud capital of the world, a $5 billion casino project has just been cancelled.

And this just in – California is officially suffering a drought.

Under these conditions, we’d expect Ben Bernanke to make some gestures toward protecting the dollar and reducing inflation. But we’d also expect that most of the air coming from the Fed will be hot, not cold.

“The Fed seems to be trying to create a situation whereby they are seen to be fighting inflation, simply by not lowering rates any further,” says MoneyMorning. “This is because, while the Fed may have no interest in fighting inflation, they have a big interest in fighting what they call ‘inflationary expectations’. In other words, they are more interested in fighting people’s perception of the problem, rather than the problem itself.

There was a food crisis too. In 1972, grain prices doubled and remained high until 1975. And Henry Kissinger attended a hastily arranged World Food Conference in 1974 to tackle it. He emerged from it asserting boldly no child would go to bed hungry within a decade.

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Then in ‘73 the oil crisis broke. Arab OPEC members were outraged at the West’s support for Israel in the Yom Kippur war against Egypt and Syria. It stopped shipments of oil to the US and Western Europe. At the same time all of OPEC decided to up its prices following earlier failed negotiations with the “seven sisters” – the seven biggest Western oil companies at the time.The impact of this action was a dagger to the heart of the oil-dependent industrialised world.

The price of crude went up fourfold (to $12!) and sent Britain’s already troubled economy into a tailspin. Growth stalled and inflation as measured by the old-style Retail Prices Index rose from 5% at the start of the decade to a high of almost 27% by August 1975. From a low of 5% in 1971, interest rates soon rose into double digits and hit 15% by 1976.

Spot any pattern here? History may not exactly repeat itself, but some say it has a tendency to rhyme. Today oil’s high, food prices have been shooting up and workers are industrial action is once again making the news.

Following a one day teacher’s strike yesterday, we find oil workers at the Grangemouth oil refinery in Scotland are going on a two day strike starting on Sunday. The dispute is not about pay so much as pensions. The Wall Street Journal reports:

“ Britain’s Labour government faces the biggest wave of industrial action since it came to power 11 years ago.”

Tony Blair may regret being forced out as Prime Minister, but he can have few complaints about the timing.

Why is some obscure refinery in Scotland making the news anyway? Well it’s far from obscure to those in the oil business. It is the receiving end of the major artery in the North Sea oil pipeline network. An artery that stretches from Grangemouth, south of Edinburgh, at one end to the Forties oil field some 235 miles away out in the North Sea at the other.

The pipeline transports the accumulated crude from around 70 oil fields in the North Sea, amounting to over 40% of the UK’s entire crude production (1.6m barrels/day). So it matters. It means BP may have to close the pipe, with the potential cost estimated at £50m a day. And the strike may only be for two days but it will take a week to boot up the refinery again afterwards. So twenty-four hour news is busy telling us all about it on the one hand, and telling us not to panic and flock to the nearest petrol station on the other.

So here we are after more than three decades, oil prices are high, food prices are going up and now, strikes are back. In the ‘70s the food/fuel double whammy led to stagflation – stalled growth with inflation. And this could be where we’re heading now. Deflation in the housing market forces consumers to tighten their belts and their resultant lower spending crimps growth.

The latest figure for annualised UK growth is 2.5% having hit economists’ central expectation in the first quarter at 0.4%. Its lowest since 2005 but forecast to go a good deal lower yet. Meantime those food and fuel prices keep upping the inflation gauge. CPI is 2.5% and will likely go over 3% by summer. As Bill has repeatedly said this is where the forces of asset deflation meet those of commodity “cost-push” inflation.

And on the subject of commodity inflation, this is a growing bubble that’s not getting a whole lot of attention while everyone’s busy rubbernecking the spectacular car smash that is the credit crunch. Inflation and Chinese demand make the bull case strong, but one day it too will go pop. One investment banker tells the FT his biggest worry right now is not the credit crunch; it’s the counter party risk attaching to commodity trading.

The FT notes that the Goldman Sachs Commodity index has now risen 238% in the past three years, and the mood amongst investors is that commodities can only go up. Some of the younger traders have never known oil below $50/barrel and some commodity trading firms are pretty thinly capitalised. Someday soon the commodities bust will hit the headlines too.

Meanwhile over in Japan, high food and fuel prices look to have finally called time on a decade of deflation. Japanese bonds got crushed following a headline core CPI rate that “leapt” to 1.2% for the year – its fastest pace in a decade.

Regards,

Rob Mackrill
The Daily Reckoning

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