This is it! Today’s the day the Fed jacks up interest rates for the 17th time! But don’t let it fool you. It’s not going to stop inflation.
Case in point: I need new flooring in my home office. I decided on the cheapest laminate flooring I could find. I ordered it Monday, and rushed to have it installed because on July 1st, the price of the flooring is being jacked up 30% from $1.38 to $1.79 per square foot.
The labor for the installation is also going up July 1st, though not as much. It’s going to jump 16.6% from $1.50 to $1.75 per square foot.
That means the combined price increase for the job on July 1st will be 22.9%.
The immediate culprit behind the increase? The price of oil, which is driving up the cost of virtually every manufactured product under the sun.
For a couple years, many manufacturers have been absorbing the rising costs. Now, they absolutely must start passing them on to the consumer, or their profit margins and earnings will shrink badly.
But these price increases set off a whole new round of wage inflation. As the flooring installer told me:
“If the consumer is willing to pay more for the goods, then I can — and should — fetch more for my labor. It’s as simple as that.”
The problem: When this psychology spreads through the economy, wage price inflation begins to accelerate. Combined with higher raw materials prices, it’s a deadly recipe for runaway inflation.
And there’s another problem: The measures used to fight this inflation often prove counterproductive.
Rising Interest Rates
Are a Consequence of
Rising Inflation
Instead of curing inflation, rising interest rates can become a driving force behind more inflation!
Consider the following scenario: Your business is doing well, and you have a revolving credit line for your inventory. You’ve used this credit line for years.
Your cost of borrowing (interest expense) is a mere 4% or 5% on the revolving amount outstanding, which you’ve already factored into your final end-user pricing.
Now, rates are suddenly jacked up to 7% or 8%. You’re paying as much as 75% more in interest expense. You’re already starting to pass on your increased materials costs, your increased utility bills, and your increased labor costs. So you figure, why not pass on the increased loan costs, too?
Odds are that’s exactly what you’ll do. And so there you have it: This is how rising interest rates can contribute to inflation.
The big question: At what point do rising interest rates have the opposite effect, and start dampening inflation?
Answer: Historically, when interest rates are 3 to 3.75 percentage points above the rate of inflation, as measured by the Consumer Price Index (CPI).
You know how I feel about the CPI – it’s silly, artificially constructed, and manipulated by the government to show as little inflation as possible. But let’s just pretend we accept it for a moment.
The latest official rate of inflation from Washington, based on the CPI, is 4.2%.
That means interest rates would probably have to rise to a minimum of 7.2% to have any effect on inflation.
We’re not even close to that! To the contrary …
We’re at the Stage
Where All Four Forces
Are Whipping Up Inflation!
Force #1: High prices for natural resources. And in my opinion, they are destined to soon start rising again.
Force #2: Manufacturers are starting to pass on more and more of these rising costs to consumers. My new flooring is a perfect example.
Force #3: Labor is taking notice of rising prices, which means there’s potential for wages to start rising across the board. We all consume basically the same goods and services. If those costs are going up, we have to boost our incomes or we fall behind the curve.
Force #4: And lastly, no matter what Big Ben does this afternoon, interest rates are nowhere near the point where they can help stem the rising tide of inflation. If anything, interest rates are actually driving inflation higher!
I’ve said this before: Get ready for even more inflation! I was one of the first to warn of inflation way back in 1999. Since then, the situation has only been getting worse. Not only are the above four forces in motion,
but…
The Morons in Washington
Are the Root of the Problem
The government officials spend, spend, spend your money like there’s no tomorrow. Federal spending is now the equivalent of $8,805 for every man, woman and child in the country.
Since 1980, spending has risen 14 times faster than the economy’s average annual Gross Domestic Product.
And that’s why we’re racking up debt like crazy. There has never been a bigger “debt junkie” than the U.S. in the history of civilization.
Last year, total interest-bearing debt increased $3.4 trillion, five times the rate of growth in GDP …
Total debt right now: $41.7 trillion and growing every day …
That’s more than $140,000 for every man, woman and child …
Up nearly $11,000 per person in just the past year!
How does Washington handle it?
Simple: After they spend, spend, spend — they print, print, print more paper money.
They don’t give one thought to what they’re doing to your pocketbook … how they’re devaluing the money you do have, day after day, month after month.
And they’re doing it at the worst time. Washington — and, to be fair, virtually all other governments — keep spending and printing money, at a time when demand for resources is higher than it’s ever been, due to India and China’s 2.3 billion people simultaneously joining modern society.
I hope it doesn’t get worse. But you shouldn’t bet your money on hope. Take definitive measures to protect yourself:
Step #1: Own some gold. One way to do this is by purchasing gold bullion, and a convenient vehicle is 1- and 10-ounce gold ingots. For larger purchases, consider the StreetTracks Gold Shares exchange-traded fund (GLD).
You can also look into gold mutual funds. Two good ones are Scudder Gold & Precious Metals (SGLDX) and Tocqueville Gold (TGLDX).
Step #2: Own some mining shares. Sean has given you lots of great ideas over the last few months. One fund that he recommends is U.S. Global Investors Global Resources Fund (PSPFX).
Step #3: Make sure you have a stake in oil. Just yesterday, many oil stocks jumped nicely, and I expect continued strength.
Step#4: Own real companies with real assets. For an idea of the kind of companies I’m talking about, read my report “Thirteen Hot Asian Natural Resource Stocks.”
Aim to increase your real wealth because virtually everything’s going to cost you more in the future. That includes something as simple as the floors you walk on.
Best wishes,
Larry
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About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.
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