"Walk like an Egyptian"
The Bangles
All the old paintings on the tombs
They do the sand dance don't you know
If they move too quick (oh whey oh)
They're falling down like a domino
Readers of this blog know that we have been warning for years now about the unintended consequences of the Federal Reserve’s monetary policy in response to the financial crisis of 2008. Specifically, we have shown the link between money printing by the Federal Reserve and increased commodity costs, especially agriculture.
On December 17th, 2010, 26 year old Mohamed Bouazizi, a fruit and vegetable vendor in Tunisia who had his cart confiscated by police set himself on fire to protest against rising food costs, job shortages and low wages. As news of Mohamed’s death spread, riots began to erupt all over Tunisia.
At first, the head of the military refused to put his troops onto the streets to stop the protestors. He was quickly replaced by the President. The Army then began to shoot the protestors in earnest and the death toll mounted. But the riots continued, moving from outlying cities into the heart of the capital and, at that point, the military decided to replace the President. We all know what happened next as the world watched the protestors jump borders and move into Egypt where rioters and workers had been on strike for almost a month nearly collapsing the Egyptian economy.
The biggest Arab country with a population of 82 million was on the verge of a civil war as large sections of its economy were already shut down. There hasn’t been train service in Egypt since railway workers declared a general strike and we have all seen the images of highways barricaded by protestors. Basic necessities can’t get to where they need to go, so Egyptians have seen already high food prices double and triple since the riots began. The entire power structure of the Middle East hangs in the balance and no one honestly has a clue what is going to happen next.
Naturally, the Federal Reserve wanted to distance itself from the riots in the Middle East so it unleashed an all out media offensive regarding the issue. For example, some Fed apologists are claiming that global warming is the main reason we are seeing food prices spike. Make no mistake about it however, the food, energy and metal price spikes we are seeing now are directly correlated to the failed policies of the Federal Reserve and as more and more mistakes are made we are going to see more and more demonstrations and protests across the globe.
To counter the growing view that blames the Fed for higher commodity prices, Chairman Bernanke went on the offensive by stating, “It’s entirely unfair to attribute excess demand pressure in emerging markets to US monetary policy, because emerging markets have all the tools they need to address excess demand in those countries”. In a nutshell, Bernanke told the world that the policy coordination between Central Banks that had been in place since the 2008 crisis was now over and that the rest of the world was now on its own.
Those of us who lived through the internet and housing bubbles know this tactic from the Fed very well. They have become experts at inflating an economy until it picks up steam to the point of becoming overheated. As the later stages of the investment bubble forms the Fed claims no responsibility or concern toward the asset bubble, which ultimately increases the probability for the asset bubble to break and in some cases violently.
This time around the asset bubble we are all watching from is in the form of globalization, where some emerging market companies have seen their stock prices go up 10 fold in extreme cases. While the Chinese, Indian, and Brazilian Central Banks have begun to tighten their monetary policy in an attempt to cool inflation in their respected countries, it is not likely to be successful if Chairman Bernanke keeps an ultra accommodative US monetary policy.
In his weekly column in the New York Times, Paul Krugman, an economist who perhaps is the biggest cheerleader for continued money printing by the Fed, wrote a piece claiming that global warming was THE main culprit for why we are seeing the prices of agriculture soar. We were saddened to read his article since it meant that Mr. Krugman had not read The LRG Capital Report anytime over the past couple of years- because had he done so he would have known that agricultural commodity supplies are at the lowest point they have been in decades.. not months, or years.. but decades.
With supplies being so tight, anytime we get any sort of weather related event, like a heat wave in Russia for example, prices shoot higher because there aren’t enough farmers to make up for the decrease in supply. In fact, in a recent US farming report, the average age of farmers in the US is now 58 years old and getting older by the day. If we don’t get more young people into the agricultural industry soon, in ten years the average age of a US Farmer will be 68 years old. There simply aren’t enough farmers in the world and one big reason is because of the policies of the Federal Reserve.
What Mr. Krugman doesn’t understand, or perhaps want to admit, is that when the Federal Reserve offers cheap credit the biggest beneficiary is the financial industry which pockets hefty commissions on the debased currency. For most young people coming out of college the opportunity to make a quick buck on Wall Street seems a lot better and more exciting than working long days on the farm.
So naturally, and as we have seen over the past 20 years or so in this era of cheap credit, our brightest and smartest young people end up working on Wall Street instead of manufacturing, engineering, or other industries where they are really needed. Over time these imbalances will work themselves out, but not before Mr. Krugman and the rest of the Fed deniers watch as agricultural prices move higher than anyone could have imagined.
Another and most obvious reason why we can and should blame the Federal Reserve for the inflation we are seeing around the globe today is because the Fed wants inflation. Think of the $700 billion bailout, TARP I, QE I and now QE 2. All of these programs were instituted by the Federal Reserve in an attempt to raise housing prices so that people will continue to pay their mortgage. Additionally, the Fed certainly knows that low rates encourage higher asset prices and increased speculation and that higher asset prices have a beneficial short term impact on the economy, mainly through the Wealth Effect.
The Wealth Effect is an economic theory that believes an increase in perceived wealth leads to an increase in spending. According to the Fed Chairman, QE 2 has boosted asset prices and most notably, stocks. Some studies have calculated that QE2 in fact has been responsible for an approximately 25% rise since August 26th, when the program was announced. The idea is that as the Fed continues to purchase its planned $600 billion of Treasury securities the extra liquidity finds its way into stocks temporarily lifting prices and gives pension funds and individuals the perception of having more money to spend.
So, on the one hand, you have the Chairman telling you that the Fed has had no role in rising commodity prices and on the other hand he takes credit for lifting the stock market. This kind of policy-talk thinking is hypocritical at best and a flat out lie at worst and, believe me, the rest of the world ain’t that dumb!
For investors, we believe we that we are entering a time that will be challenging for equities. This is especially true if the Fed continues with its current path of low rates, causing further pressures on commodity prices. We especially believe that oil prices are set to rise further as geopolitical tensions continue especially in the oil rich Middle East. We also believe that we are going to see much more of the kind of political upheaval we have seen in the Middle East so far during the early part of this year. Some of the countries we are watching that may indeed suffer the same fate as Egypt and Tunisia would be Pakistan, Iran and Syria for example. These are countries with low per capita incomes so when food prices rise, people and families end up getting hurt badly. The per capita income in Egypt, for example, is a mere $1,800. When food prices rise in these countries they end up taking any of the disposable income people may have had.
As the year plays out, all we can do is watch and hope that the moderates in these countries end up taking over, but as we have learned time and time again with the Middle East, anything can and will happen. In the short term, what we are witnessing now, which is the potential overthrow of some of the most brutal regimes in history, has truly caught even the most respected security officials by surprise. In the long term, what we know for sure is that the spreading revolution will bring about dramatic changes throughout the Middle East.
Regardless, the point we are trying to make is that sometimes we need to connect the dots between the actions and policies we make at home and the effect that they will have on people halfway across the world. This is especially true if we are trying to promote our companies, political system and way of life to the rest of the world. We aren’t blaming all of the world’s problems on the Federal Reserve but we do believe that the Fed needs to take responsibility for its actions and the American people deserve to know what the true side effects are from certain Fed policy actions. Higher and higher food prices are just adding more gasoline to an already very combustible Middle East. At a certain point if the Fed continues to devalue the dollar, hurting more and more people and economies as basic necessities such as food and water become more expensive and scarce, this story can quickly evolve from a monetary one to one of national security.
