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By Robert Fitzwilson of The Portola Group

June 8 (King World News) - A Clash Of Powerful Forces Is Creating Enormous Chaos

Last week, we presented a chart that showed the CPI for urban wage earners over the last 60 years.  What was shocking, frankly, is that nothing mattered other than credit creation.  Changes in prevailing interest rates both up and down had virtually no discernible effect on the steady march higher in prices.  Wars, macroeconomic events, crises, the rise and fall of the business cycle, elections, none of it mattered when it came to rising prices....

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“Upon further reflection, it is even worse than what we previously thought.  Innovation and overall rising productivity, in theory, tend to promote price deflation.  We certainly can see it in our electronic devices and capabilities.  The first computer that we purchased for our business contained a whopping 32 kilobytes of random access memory (RAM).  The operating system and the software that was running it had to share the RAM as well as the available space on the floppy drive.  Our first purchase of a hard disk drive was also an amazing (at the time) 5 megabytes of capacity, costing around $5,000 adjusted for inflation in 1981.

Today, technology has drastically dropped the price of computers, storage, software and other capabilities to where the comparable costs of 1981 technology are negligible.  A smart phone comes with memory measured in gigabytes.  Even if the phone could have been built in the early 1980s, it would have been unimaginably expensive.  When bureaucrats answer complaints about soaring food costs by pointing to how cheap flat screen TVs and iPads are, we will give them that, but none of that was driven by government. 

Prices for just about everything have enjoyed immense subsidies from Nature.  The biggest subsidy toward promoting economic growth as well as lower prices has been what seemed like limitless resources.  The inheritance from Nature in the form of cheap energy, water, nutrients in the soil to grow crops, fertilizer, metals in the ground, the fish in the ocean, should have all contributed mightily along with innovation and productivity to promote falling prices, not rock steady inflation.

The central planners with their irresponsible credit creation have, astonishingly, completely negated all of the forces driving lower prices and succeeded in creating a higher CPI for decades.  Unfortunately, we are facing a toxic confluence of central banks striving to create even more immense quantities of credit, clashing with a time in human history when the subsidies we have enjoyed are transitioning from abundance to the headwind of shortages.

In addition, other than buying back their own stock with borrowed funds, corporations have been investing in machines to increase productivity.  For one thing, it means fewer human beings employed, but despite this, productivity is actually declining, not rising.  Technology is increasingly being used simply to cut labor costs, not to expand markets.  It will be tough for markets to expand with massive unemployment such as we see in Europe, especially as more and more workers displaced by the machines.

In the meantime, the bond and stock markets seem blissfully ignorant not only of risk, but the historic changes which are afoot.  We saw a bit of a retracement of the rally in fixed income last week, but with the ECB announcements by Mr. Draghi on Thursday, betting on significant increases in rates is probably a bad bet in the short run.

Fear of a meltdown in the Chinese banking system and collateral damage to Western banks should go a long way in assisting the central planners in maintaining low interest rates.  If low rates persist, investors will arbitrage the huge spread between bank deposits and yields available from dividends in the stock market.  None of this is good, and it will all add to the ultimate carnage when the current financial mess becomes chaotic.

There is no question that the equity indexes are firming again.  There have been severe corrections for component companies comprising the indexes, but it has been a rotation, not a collapse.  Given that the corrections have occurred, some very substantial, the odds do favor a continuation of the indexes moving higher.

It reminds us very much of the second half of the 1990s, when the S&P 500 kept moving up simply due to the weight of money flowing into the top 10 companies in the Index.  It was a very mechanical drive to the peak, but real nonetheless.  It all came to an end in 2001, but a lot of money was made along the way.  But because of the policy of the central banks today to relentlessly support stocks and corporations buying back stock, we could very well see a continuation of new highs, artificial or not.

Finally, the issue was raised last week about stocks being way above their moving averages.  We do not dispute that, and we certainly are not cheerleaders for the potentially catastrophic global financial markets.  However, we would ask those commentators how far above the moving averages are Picassos, farmland, mansions, classic cars, Silicon Valley startups and the like.  Commercial rents in Silicon Valley alone are up 70% in just the last year.

In a world flooded with endless money, traditional measures of valuation tend lose their absolute nature.  Everything moves toward becoming relative.  In other words, one needs to consider the relative valuation of the segment of the equity universe that is doing well versus the valuation of these other assets driven to unimaginable levels.”

© 2014 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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