“When sorrows come, they come not single spies, but battalions…”

Hamlet

Yesterday brought more sorrows. Stocks fell with the Dow down 227 points. Oil rose to $135. The dollar fell to $1.57 per euro. And gold hit $928.

But what’s this? Bonds strangely fell too. This could be very important, like the dog that didn’t bark. Usually, when stocks fall bonds go up. Investors anticipate lower yields as the economy cools and fewer borrowers compete for funds. But now, the bond market seems to be worried about something else…and we think we know what it is.

We have long mistrusted numbers. And we especially distrust numbers coming from the Labor Department, public officials of any sort, or Wall Street, or the media, or Congress, or the family.

“I saved a lot of money by buying this jacket,” a daughter reported yesterday. “It was on sale. Don’t you like it?”

“Well…yes…but how much would you have saved if you never bought it at all?”

“Daddy…don’t be silly…I needed a summer jacket….”

Maybe we are being silly today…but we see money slipping through our hands. And so does everyone else!

Prices are going up for nearly everything milk, bread, gasoline, liquor…all the essentials.

In the US, reports Martin Hutchinson, the official inflation numbers are the worst in 17 years…but the raw numbers are even more alarming. Of course, the raw numbers are never even mentioned. They are like a forgotten aunt, consigned years ago to a nursing home; nobody comes to call…nobody even asks about her.

In March, the raw data showed consumer prices rising at a 10% annual rate. But by the time the Labor Department’s goons got finished with it, they reported a CPI going up at an annual rate of only 3.6%. ‘Seasonal adjustments,’ they called it. Then, in April, when the raw data came in at a 7.2% annual inflation rate, they seasonally adjusted it down to only 2.4%. They didn’t seem to notice that the season had changed!

Hutchinson: “Both “adjusted” figures were greeted by the stock market with a sharp upward move. In the ten years to 2007, no seasonal adjustment has ever exceeded 0.3%, plus or minus; the probabilities that the March and April seasonal adjustments were randomly arrived at by the same method as those of the last decade were thus 0.18% and 2.3% respectively (so the probability of two such anomalies in successive months was 0.0041%, about 1 in 25,000.) If the raw March and April figures are adjusted by the average March and April seasonal adjustments of the last decade, consumer price inflation in those two months averaged 7.4% per annum.”

You can fool some of the people all the time, said Abraham Lincoln. He didn’t know any modern economists or professional fund managers. But he must have anticipated them. They’re pricing stocks and bonds as if inflation were still under control on the Labor Department’s say so.

Who knows? Maybe they’ll turn out to be right. Stranger things have happened. But here at the Daily Reckoning…we reckon prices are rising more than most people think…that’s there’s more inflation to come…and that the bond market is catching on. That’s why bond prices went down yesterday; investors are worried about inflation. At long last perhaps the bond vigilantes are awaking from their long, deep slumber.

(Readers will remember the bond vigilantes perhaps only by reputation. Back in the ‘70s inflation rates rose. Bond buyers took a terrible beating. Then, they strapped on their guns. Henceforth, it was said, the feds couldn’t get away with causing inflation; because the bond market wouldn’t let them. As soon as bond investors saw inflation coming, they would act like vigilantes selling off their bonds and forcing up yields. Higher yields cooled off the economy…and reduced inflation.

By way of full disclosure, this is not the first time we thought the bond vigilantes were saddling up and riding off to stop the Fed from destroying the dollar. At least twice in the past 5 years we thought so…only to find that they were just on their way to a saloon to join the party!)

Back to the first point that the numbers lie: A couple of English newspapers had the same suspicion that official numbers were bent and distorted, always to the downside, of course. So, they sent their reporters out into the real world to buy things.

“The results are ‘alarming,’ says one tabloid… “the most savage increase in living costs for a generation.” What did the papers actually find? The Daily Express came up with an increase in consumer prices over the last 12 months of 11.5%. The Daily Mail’s tally came in at 15%.

That’s getting to be serious inflation. And we suspect there’s more coming. And less, too.

A news story in the Financial Times tells us something very interesting. “The gap between input prices and what can be passed on to consumers is at its widest for 20 years.” For example, a 4 pint bottle of milk has gone up 16.5% in the UK. The price of milk from the farm has soared nearly three times as much 45.8%. Or take bread. Wheat is up 56.9% over the last year. But a loaf of bread has only gone up only 8.5%. Crude oil is 62% more expensive today than it was a year ago. But a can of oil…or petroleum products generally, at the retail level…are up only 25.4%.

What does this mean? Probably two things. Maybe more. First, input prices have jumped so fast retail prices have not been able to keep up. It may also mean that retailers don’t think the raw output prices are permanent…or that they, the retailers, can afford to pass them along without losing customers. It may also mean that commodity or wholesale prices have gone up too far, too fast.

One thing is certain, the gap can’t last. The retailers can’t buy oil 62% higher and sell it only 25% higher not for long. Either the price of crude comes down…or the price of retail petroleum products goes up.

Which will it be? Inflation or deflation? More inflation at the retail, consumer level…or a collapse of commodity/wholesale prices?

Our guess, as usual, is that it will be both.

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