The Return of Inflation Or the Beginning of Y2K?

By Martin A. Armstrong

Today the markets were surprised by the sudden rise in business inventories and inflation statistics. The implication of today's numbers was clearly reflected in the price action that immediately followed - higher interest rates. The insane interpretation in currency was that the foreigners would begin to sell stocks so sell dollars while you're at it.

Today's release of the CPI (Consumer Price Index) and business inventories should have come as no surprise. We have been warning that the effect of Y2K will be inflationary - NOT doom and gloom depression as some have touted over the Internet. Many businesses have realized in the United States that there may be a disruption in supply and as such they are starting to stockpile necessary goods. This effect will keep the US economy quite strong into year-end, but there is a risk of a slowdown come next year should Y2K turn out to be a flop. This will leave these same businesses with excess inventories and as such a slowdown in purchases will cause a downturn in the US economy in 2000. We may even see another sector shift that causes the real old forgotten stocks like elevator manufacturers, electrical contractors and perhaps heating and air conditioners to emerge as the darlings of 2000. If there are severe problems with power grids causing brownouts, that is a formula for record sales of electrical motors of all sorts - including computers.

Even Coke has announced that they are accumulating a 3-month supply of raw materials needed for the manufacture of their soft drinks. Medical companies are anticipating the public to stockpile medicine and the manufacturers of those pretty bottles are running at full capacity. Every aspect of the economy is starting to heat up for Y2K and this may be the best reason of all to resign as the Treasurer of the United States while you're still on a high note.

The question of whether or not the Fed will respond to this type of inflation depends entirely upon the performance of the stock market this year and long-term inflation next year, should Y2K cause a jump in general costs of doing business. If the market cools off a bit into June BEFORE running off to new highs perhaps in August (or a test of the April high), then the Fed may stand firm with a wait and see approach. If the majority continues to ignore the Fed as a threat, then they may need to be taught a lesson or two. The Fed will ONLY raise rates if there is something else such as wages that start to show sizable growth for within that statistic lies the seeds of sustainable inflation.

The Fed itself has been experiencing its own problems thanks to the Euro and Y2K combination. The fact that the Euro does not physically exist poses serious problems when people are worried about the viability of the banking system outside of the United States. In some regions, including Europe, the issue of Y2K has been portrayed as an American plot to force companies to buy more American products. Nonetheless, the lack of attention paid to Y2K issues outside the US is having a major impact upon the demand for physical dollars. The Fed, for the first time in history, has established vaults overseas - one in Europe and one in Asia. This means that the Fed is now having to worry about the demand for dollars globally and how to facilitate that demand to avoid another major crisis next year as a result of international banking problems. Therefore, the overseas vaults of the Fed are intended to make sure that anyone who needs dollars due to banking problems in their local area will be able to get their hands on some greenbacks due to Y2K fears. The Fed is keenly aware of the Y2K issue and it is NOT likely to respond irresponsibly to a rise in inflation that is directly linked to increased stockpiling of materials. They will be far more concerned about the global banking system and only if inflation soars dramatically will the Fed respond short-term. They will also be watching not the rise in inventories or raw materials due to stockpiling, but wages. If wages start to rise, then this will translate into consumer demand inflation that is more associated with a bubble top in an economy. This could yet become a problem if consumers begin to stockpile goods for year-end in sizable quantity. The Fed may in that case have little choice but to RAISE rates in order to prevent a carry-over effect of inflation as was the case during the late 1970s.

Those who have interpreted today's numbers as bearish for the stock market may not be totally wrong short-term. We still show that volatility should begin to rise starting next week and extending largely into the week of June 14th. A low at that time could still lead to new summer highs going into mid to late August or at least a retest of those highs established in April. Nonetheless, the prospect of extending the bull market beyond 1999 (assuming a sizeable correction takes place in late 1999) is still a viable outcome. We have stated many times before, that a dollar bull market into 2003 is still a highly likely event. The failure of the Euro has merely increased that outcome and indeed the performance of gold has further demonstrated the deflationary trends that exist outside of the United States. With gold closing within 40 cents of its 19-year low, one can hardly make a case that gold will prove to be a buying opportunity. We still see gold falling to slightly BELOW $200 on the London spot market before there is even a hint of a bottom coming in place. When gold drops BELOW $200 and silver under $3, then the global trend may begin to change - but not before!

The real issue becomes the insane selling of dollars on the threat of foreign selling of stocks. This knee-jerk reaction following the morning numbers was quickly reversed and for good reason. The Europeans are NOT heavily invested in the US market and the majority of the "value" investors of Europe have almost ZERO exposure to US shares since 1994! The Japanese sold out for July 20th and have not returned. The popular view in Japan is that the US is in the middle of a "bubble top" and if anything, it is probably much easier to sell a put on the Dow than a call in Japan these days. The number one question we get from Japan is about the risk of a MAJOR crash in the US as they experienced back in 1989 in the Nikkei. Foreign participation in the US market is approaching a historical LOW at this time and in no way should the dollar be sold based upon fears of foreign capital repatriation due to a declining stock market.

The more important issue behind the Euro weakness is the dirty little secret that is being kept from the general media at all costs - the Euro clearing system still does NOT work! Merchants who take Visa or Master Card normally receive instantaneous cash when they deposit your transaction with their bank. This is now true for all currencies EXCEPT the Euro! Euro credit cards are taking days to clear and as such the Merchants have been the first to feel the effects of a clearing system that still does not work. Between banks, all currency transactions settle at the end of every day. Euro settlements are also taking days. Banks in London are putting Euro checks on a 4-week clearing status. The net effect, many are starting to discount the Euro in order to accept it. Even American Express has issued only 5,000 Euro based cards. This is not such a good story for a currency that was going to knock the dollar off this planet. Most central banks are still unofficially not accepting Euros as a reserve currency, which has been told to us on a confidential basis. If publicly confronted on this issue, everyone would naturally deny it, but the failure of the Euro has been expressed in its near perfect swan dive since January 1st.

The Europeans are having extreme difficulty solving the problems of the Euro. Most computers cannot calculate fractions of a currency and therein lines a far worse problem than merely Y2K. China's work around for Y2K is to simply turn their computers back 20 years. That trick will work, but calculating fractions of a currency remains impossible when such functionality never before existed. For this reason, your taxes in Germany are still payable in DMarks - not Euros.

So while the stock market remains in peril of its life in the midst of short-term sustainability, the question of long-term remains unchanged. Record new highs in August from a June low may raise the risk of a more serious correction lasting 5-6 months starting in September. Nonetheless, there remains no doubt in our mind that this is not yet a bubble top in the US and that could still await us in the future. When the ALL the foreigners are here, as was the case in Tokyo of 1989, then the big one has arrived. Nevertheless, a minimum correction of 14% appears likely with the chance of a 23% correction during the later part of 1999. With liquidity drastically reduced since July 20th, the downdrafts will be much faster and deeper. A correction of 7% into June or worse yet only a sideways movement would tend to point to a new high by August 17th. At this point in the bull market, another scare to the downside may be just what the doctor has order to breath some life back into a bull that is starting to show his age.

The Return of Inflation Or the Beginning of Y2K? - May 14th, 1999 by Martin A. Armstrong - Princeton Economics International

-- Jim Morris (prism@bevcomm.net), May 16, 1999

Answers

How many leaks does this Euro boat have at this point?

This article sees only one side of a mountain. On the other side many are moving their funds to less speculative plays.

Got cash?

-- Mike Lang (webflier@erols.com), May 16, 1999.

Dr. Martin Armstrong, your post is full of good data concerning the Euro failure, but you reach the wrong conclusions concerning Y2K.

You say: "We have been warning that the effect of Y2K will be inflationary --NOT doom and gloom depression as some have touted over the Internet" referring to current inflation threats of the US economy.

You are wrong, in that today's and next-months inflation is not the real Y2K, obviously enough, as 2000 is still seven months away. The current and possible near-future inflation is pre-Y2K, as stockpiling gains momentum.

But come Y2K proper, and electronic promises to pay of whatever nature default on each other like a falling deck of cards, it's GAME OVER if you know what I mean. If you don't agree, or don't know what y2K real serious threats are all about, please say so and join the club of the "Don't Get It"(DGI).

Dr. Armstrong, Y2K will make fun of all the current central banking illusions about "active monetary policies", Euro or not Euro, Dollars or not Dollars. That is the naked truth we all have to address.

I insist in that you please refer to a thread below (like 20 lines down) entitled "Banks & Bonds dependent upon debtors to pay".

Your information on the "dirty little secret" of the Euro's gridlock is quite pertinent though because it reaffirms Y2K's seriousness come 2000.

-- George (jvilches@sminter.com.ar), May 16, 1999.

Martin,

I believe that little, if any, of the increased inflation is due to Y2K. Rather, I think that Alan Greenspan and the Federal Reserve created it when they reduced interest rates three times and flooded the economy with liquidity. They did it to stave off the financial crisis that nearly caused a worldwide meltdown. The result of this easy money has been a stock market bubble and a recovery in Asia that is pushing up demand, particularly for oil. The Fed paid for an easing of the crisis last fall by creating a greater one that will go critical just when the world really starts to feel the effects of Y2K.

-- Incredulous (ytt000@aol.com), May 16, 1999.

I've been watching prices of groceries closely for the last 6 months or so. Up until now they have been gradually increasing in about the same proportion as the increasing expenditures for Y2K repairs. That makes sense, since inflation was low, but the costs were being passed directly on to the consumer. Very recently though, like within the last 3 weeks, prices have begun skyrocketing, and fewer items are on sale prices. I would guess that a lot of this can be attributed to the gas prices, particularly in the grocery business, heavily dependent upon transportation. So with the combination of Y2K costs and higher gas prices, reality is starting to catch up with us - the Happy Days are over.

-- @ (@@@.@), May 16, 1999.

You can see a list of Euro problem articles here.

-- caveat emptor (helpful@w/.lnks), May 16, 1999.

Notice the graph of inventories at the bottom of the page.

http://www.contraryinvestor.com/mo.htm

-- (trend@watcher.now), May 17, 1999.

See my reply to young Andy EOD2000 in this thread.

This guy MUST be believed ... after all, he has the world's first ARTIFICIAL INTELLIGENCE!!!

You people are absolutely amazing.

-- Stephen M. Poole, CET (smpoole7@bellsouth.net), May 17, 1999.