Economic Analysis: And Then
Came Rapid Inflation

The great majority of economists are concerned with deflation as they compare our economy today to the Japanese lost decade of the 1990s, Michael Lombardi's on the opposite side. He's very concerned about inflation.Here’s how the story plays out…

After a 25-year to 30-year leveraging period, as the credit crisis developed in 2008, a period of great deleveraging was born.

Banks, which were once all too happy to lend money to people, some of whom should have never qualified for a loan in the first place, put in tough rules for businesses and consumers who wanted to borrow money.

Consumers, after years of negative savings, started saving money. During the later part of the “leveraging” years, the personal savings rate in America was negative…consumers spent more than they made. Today, in a period of deleveraging, the personal savings rate in America is five percent—a high not seen in years.


And, despite interest rates at historical lows, corporate America remains cautious on investing. Instead of investing in plant, equipment, R&D, and people, or borrowing money to expand their businesses, corporate America has decided to sock its money away. About two trillion dollars today is sitting in the bank accounts of corporate America—a record amount.

In its desperate effort to spur economic growth to avoid another Great Depression, the government poured billions if not trillions into the economy and the Federal Reserve significantly increased the money supply as they bought securities issued by the government.

Today, we have record debt at the government level and likely the largest money supply in American history.

While I know the great majority of economists are concerned with deflation as they compare our economy today to the Japanese lost decade of the 1990s, I’m on the opposite side. I’m very concerned about inflation.

There are two big differences between Japan and the U.S. after their economic crashes. The difference leads me to believe that we will not follow the path of Japan. In fact, we will take a different path and face inflation, not deflation.

After the Japanese economy collapsed, Japan’s central bank failed to do the one thing necessary to kick-start its economy: increase the money supply. In the 12 months following April 1992, when Japan was officially recognized to be in a severe recession, the broad money supply in Japan did not change. And only 10 years after the recession started did Japan begin any type of central bank quantitative easing, known as QE.

The U.S. Federal Reserve did the opposite. Once we were recognized to be in a recession in December of 2007, the Fed flooded the system with money. The Fed cranked up the printing presses and significantly increased the broad money supply. The Fed has already gone through two sets of QE.

There is a tremendous, actually unprecedented, amount of liquidity in the U.S. economy thanks to the Fed. And that’s why I believe we will get the opposite of what Japan got. We won’t get years of deflation; we’ll get years of inflation.

Our neighbor to the north, Canada, reported this morning that its inflation rate rose to 3.2% in September. The core inflation rate in Canada is at its highest level since February 2010. In the 17-member eurozone, inflation is running at 2.5% (Economy? Stocks? This Is a Bigger Risk) and inflation in Britain is running at 5.2%.

And the number one factor pushing the inflation rate higher in industrialized countries? It’s food. Food prices in Canada are up 22.7% in the past year alone.

Throughout history, when there’s been a country with its currency devaluing, its government overextended in debt, and the fiat currency of that country in great supply, the country eventually enters a period of rapid inflation. Happened to Mexico, Argentina, Greece and many more countries…America will not escape it.

And that’s what the 10-year bull market in gold bullion has all been about: inflation, inflation and inflation. Unfortunately, the great majority of Americans are not prepared for the rapid inflation headed our way.

Michael’s Personal Notes:

Two heavyweights reported their corporate earnings this morning, surprising on the upside.

Bellwether General Electric Co. (NYSE/GE) reported that it made $3.4 billion in its latest quarter, up 11% from the same period in 2010. Bill Gates’ one-product-line wonder company, Microsoft Corporation (NYSE/MSFT), easily beat analyst expectations, as net income for the company rose 6.1% in its latest quarter to $5.74 billion.

I’ve been writing on these pages that, while corporate earnings would slow down from the torrid pace of 2009 and 2010 (Forget the Economy; These Companies Are Still Earning Big Money), they would not plummet as many “Johnny-come-lately recession-predicting analysts” had forecast this summer, as the stock market became choppy.

What this tells us…

The corporate earnings of GE are telling us that the business segment of the economy is not growing like it did in 2009 and 2010, but the earnings are still growing. Microsoft’s earnings are telling us that both consumers and businesses are still spending, albeit at a lower pace.

And this morning we hear that the world’s biggest restaurant chain, McDonald’s Corp. (NYSE/MCD), experienced an 8.6% increase in third-quarter profit. Corporate earnings at McDonald’s tell us that the low-end consumer market is still spending, just at a slower pace.

Corporate earnings from large businesses like GE, Microsoft and McDonald’s are key economic indicators in themselves. Respective earnings growth of 11%, 6.1% and 8.6% are telling us that growth is still there, but it’s not at the 18% earnings growth pace the S&P 500 was running at just a few months ago.

Against the backdrop of stable corporate earnings growth, the stock market has few competitors in respect to other investment alternatives. “Real estate” is still a dirty word for many investors. The paltry returns of U.S. Treasuries present anemic alternatives to the stock market at present.

Hence why I’ve been saying on these pages that the stock market will head higher for now (Four Reasons Why Stock Prices Will Bounce Higher Now). But, dear reader, remember that, when corporate earnings growth falls below the 10% level, weakness in the economy can hit companies quickly and corporate earnings growth of 10% can turn into NO corporate earnings growth quickly.

And that’s why all this time I believe we’ve been in a bear market rally: stocks will rise in the immediate term, as pessimism prevails and corporate earnings do not disappoint. Eventually optimism will return to stocks and that’s when the bear market will take stock prices back down. Bottom line: enjoy the trend of rising stock prices for now, as it will not last.

Where the Market Stands; Where it’s Headed:

A bear market rally in stocks was born on March 9, 2009. I’m of the opinion that this bear market rally continues to preside over the stock market today. Yes, the rally has been long and is getting tired, but I believe stock prices will continue to rise, and surprise on the upside, as the bear lures more investors back into the stock market.

What He Said:

“In 2008, I believe investors will fare better invested in T-Bills as opposed to the stock market. I’m bearish on the general stock market for three main reasons: Borrowing money in 2008 will be more difficult for consumers. Consumer spending in the U.S. is drying up, which will push down corporate profits.” Michael Lombardi in PROFIT CONFIDENTIAL, January 10, 2008. The year 2008 ended up being one of the worst years for the stock market since the 1930s.