The "Where?" Part I: Intro to Inflation

In order to best protect yourself, you need to know where you are in the grand scheme of things. In order to do that, you're going to have to have some comfort level with charts and some fundamental concepts like inflation, money, and fiat to begin. There's probably no better way to understand these ideas than to look at the stock market over time. By the time you're done with the first two parts of this primer, you'll know more than 90% of people out there about money and wealth...

Note that it is going to be impossible to completely explain every facet of things. The goal here is to simply get you started, perk your curiosity, and give you some resources to continue your investigation. If you're going to follow the markets and understand what's likely going to happen in the future, you're going to have to become a student of the markets. That's going to take some time and dedication--just get on it because the hour is late.

We've included links for much of this primer so you can easily take advantage of external learning resources.

The financial markets consist of many different facets. There are stock markets, commodities markets, foreign exchange markets, bond markets, derivatives markets, and other types of markets that trade in securities.

It helps to have visibility into all of these securities markets to best understand where we are. However, first we're going to focus on the stock market, also know as the equities market.

A share of stock represents a piece of ownership of a company. If you buy stock in McDonald's, then you technically own a piece of that company and may have certain benefits of ownership (like dividends and voting rights). The stock itself is bought and sold on a stock exchange like the New York Stock Exchange (NYSE), the NASDAQ, or the Euronext.

Stocks often, though not always, reflect the health (or anticipated health) of the economy. For example, if Microsoft's business is going well because they are selling a lot of new software, then you would expect their stock price to go up. To the contrary, if their business is doing badly, investors tend to sell their stock which drives the price down (we'll cover supply and demand a bit later, so just trust us for now).

Stock indices, like the Dow Jones Industrial Average and the S&P 500, the are often used to measure the performance of specific sectors of the market. The Dow Jones Industrial Average, for example, contains the stocks of the 30 largest and most widely owned stocks in the United States. Indices are good ways of viewing the health of a particular portion of the economy. If the Dow Jones Industrial Average is rising, the expectation is that the biggest companies in the United States are expecting to make more money. That's considered a good measure of the business performance of the United States, and of course, if business is good, the implication is that people are out buying things. If they're buying things, then they must be employed and have positive belief in the future.

The S&P 500 is, for our purposes, the best measure of the health of the business of companies in the United States. As we start publishing more technical analysis, you will see that we prefer to rely on the S&P since it contains 500 companies, whereas the Dow Jones contains only 30. However, in this analysis, since we're going to use a lot of very historical data, we'll be relying on the Dow Jones since it was the first stock index published in the United States in 1896.

The first thing we want to do in our analysis of "Where?" is to look at the whole history of the US economy as measured by the Dow Jones Industrial Average and see if there's anything we can learn from it. The chart below shows the Dow Jones Industrial Average closing price from 1896 - present.


Note that below is the same chart, but with red arrows, dates, and values so that it makes the rest of this primer easier to follow.



This chart shows the price of the Dow Jones Industrial Average (which we'll call DJIA from now on) when the stock market ended for each day the stock market was open. It is a daily chart because the data has the last price for each day. We could also use weekly prices or monthly prices (and we will for different things later on). Note, you should keep in mind that the DJIA is measured in dollars. That makes sense, right? Later on this will be important.

The first thing that you should notice is that this is really tough to read the older data since this is a linear chart. Since the DJIA has risen from roughly 41 in 1896 to over 14,000 by 2007 (again, in truth that's $41 from 1896 to $14,000 by 2007), it makes the older data difficult to read. For example, in the chart above, in April of 1942, the DJIA was approximately at the 100 ($100) mark. In February of 1966, the DJIA was approximately at the 1000 ($1000) mark. By April of 1999, the DJIA was approximately at the 10,000 ($10,000) mark.

Some important notes:

• The DJIA stayed below 1000 ($1000) from May 26, 1896 until November 14, 1972--that's more than 76 years.
  
• Between 1972 and 1982, the DJIA was basically floating between $800 and $1000.
  
• In 1982, it broke out, which means it started rising like crazy. In fact, between 1982 and 2000, the DJIA rose from roughly 1000 to 11,000.
• From 2000-2007, the DJIA rose to 14,000 or so, and since then it's fallen substantially from 14,000.

That move from 1972 forward is not just a coincidence. Nixon took the United States off of the gold standard. This was a very important development, as we'll get into a bit later. But in brief, it has everything to do with inflation...

The linear chart nicely shows how large the price swings have been in the last 100+ years, but it's hard to see any patterns that we can work with.

Another way of viewing the same data is with a logarithmic chart. This makes the data easier to view. Please note that the values are not changed at all--it is simply a visual change.


And again, with arrows and values to make it easier to follow.


This chart is much more readable. The price movements are more clearly defined. In a logarithmic chart, the space between any two horizontal lines is the same percentage difference. Let's look at the same time periods we looked at in the linear chart. In April of 1942, the DJIA was approximately at the $100 mark. In February of 1966, the DJIA was approximately at the $1000 mark. That's a ten-fold increase. By April of 1999, the DJIA was approximately at the $10,000 market. That's another ten-fold increase. It's easy to see these numbers on the logarithmic chart--to know when the DJIA went up some percentage (in this case, 1000%).

If you had bought the DJIA stock index in 1942, it would have cost $100. By 1999, that $100 would have grown to $10,000.

But, looks can be deceiving. The real problem that we have today is that we **assume** (wrongfully) that the value of our money is constant. We see prices of things rise--movie tickets, groceries, fuel, etc. But we often don't think about WHY they rise--often, the value of the things we buy don't rise, but the money instead loses value. Next, we're going to have to talk a bit about what money is and is not, and what inflation is and is not. Then we're going to look at the same charts again from a different perspective.

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Perhaps the Most Important Video Clip You May See Today

The Fed and the government think printing more money is what we need to solve our problems.

Take a look at this old educational video from Harding College in 1948 and note that what we need is more innovation, more capital (which is money that comes from savings, not just printing) and more freedom.



Note that at around 6:40, the narrator makes a statement about how much our money bought in the Great Depression. If the Fed and the government get their way, costs will only rise as the economy stagnates--fewer jobs, lower pay, higher costs. It will be money that buys less not more.

At around 7:15, there is a depiction of what happens when the state takes freedom. Look familiar? Guess what, folks...we're pretty much there. The United States has been sliding into fascism for some time. This crisis is just the thing that appears to be finishing the job as the state seeks to take over healthcare, job creation, energy creation, eternal foreign wars, control over money, and an increasing police state presence.

The government controls too much. The manipulations of the economy, the weakening dollar, the financial bubbles, the rampant abuse of Wall Street--none of this would be possible without a strong government that enforces this behavior through power to monopolize. Government creates the monopoly on money and the monopoly on force. People have become dependent on government for their very survival. This is going to have catastrophic consequences in the near future.

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The BoA - Merrill - Fed - Treasury Debacle

The purpose of this soap opera currently eludes me and the staff at Dredd.

First, a brief recap...

In September of 2008, Bank of America and Merrill Lynch agreed to get married, subject to a "Material Adverse Change" clause. That clause basically stated that Bank of America could get out of the deal if they found that Merrill had undisclosed financial material that that could hurt Bank of America during their due diligence process. The merger was to be complete by January 1, 2009.

In December, Bank of America found out that Merrill had such bad financial material, and Ken Lewis, CEO of Bank of America, called then Treasury Secretary Hank Paulson to inform him that Bank of America intended to get out of the agreement.

In January, the merger went through.

In April, Ken Lewis was removed from his position of Chairman of the Board of Bank of America by shareholder vote, but he remains CEO and President.

According to testimony from Lewis in June, Hank Paulson, at the behest of Federal Reserve Chairman Ben Bernanke, threatened Lewis' job if he didn't go through with the merger in January.

Bernanke testified today in front of Congress to tell his side of the story. According to the Fed chief, there was no such threat against Lewis.

Phew. This one should give the afternoon soaps a run for their money.

Here's what we don't get.

Why would Lewis go out of his way to start problems with the Fed? This is not in his benefit over time unless there's something we don't know (which is likely).

Why would the Republicans be the group going after Bernanke? Bush appointed Bernanke as a successor to Greenspan. Is this just more distancing from Bush?

Why aren't the Democrats going after Bernanke? After all, they have Larry Summers in their camp, who was Treasury Secretary for a while under Clinton. Obama's out of control spending is going to require many more Treasury auctions and money printing episodes from the Fed. There's been criticism that Ben Bernanke has been printing like crazy, but in fact, the Fed has been relatively stable for the last few months, and it is behind on monetizing the debt, according to its own published plans. This is not supportive of bigger government programs. You'd think Obama and the Dems would want to see Bernanke replaced by someone even more willing to print money even faster...

Politics and economics go hand in hand. From our standpoint, politicians are the ones that are usually to blame for most every negative economic event--this one included. Thus, it is important to keep tabs on what the rats in Washington are doing.

We're not sure what's going on, but it's worth paying attention to. Bernanke is up for reappointment in January. If Obama doesn't reappoint him, we're betting Summers gets the Fed gig. But we're also willing to bet that the next leg of the decline in the economy will be upon us by January. In that case, replacing Bernanke would be disastrous as it would put any sense of confidence in US stability in question.

Don't get us wrong here. We think the Federal Reserve and fractional reserve system as a whole needs to go. But, if we're in the stock market if or when Bernanke is replaced, that's probably a huge negative event.

This is an interesting event that's going to end up being more meaningful over the next few months. At a minimum, the banker sharks are starting to turn on one another, much like the hedge funds have. The finance world has turned into a feeding frenzy with the sharks turning on their own.

This may be a bit complex for some of our core readers that are new to all of this mess. Don't be perplexed. All of these machinations will become more clear over time. We probably need a brief report on how the Fed, Treasury and banking system work so that the conflicts are more clear.

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No Longer Imminent, But More of the Same

The Fed is all about controlling expectations. Said another way, Joseph Goebbels would be proud. You see, the Fed needs to inflate but they want to make you think they won't. That's pure propaganda in the Goebbels style. They can spin you some of the time, dear reader, but can they spin you all of the time?

As anticipated, the Fed isn't interested in raising the Fed Funds Rate. The Feds wants, nay NEEDS, to inflate. There is a belief that there must be inflation or death of the economy. To a certain extent, this is true. A fiat currency system buried in debt cannot survive a deflation. But we'll cover more of this a bit later.

The Fed has stated it will keep rates low for a really, really long time. They're going to buy more "assets," which translates into "we're going to run the printing presses some more."

Get ready folks. Devaluation of the currency is the goal of the Fed, and whether they realize it or not, the government. It's coming. You can bet on that.

Hot off of the presses: FOMC Statement. If you're not used to tracking and reading these, you should. It's one of those tools to pay attention to (though not dote over like they do on Bubblevision).

Here's the text. Bold emphasis is mine.
______________________________________________________________

Release Date: June 24, 2009

For immediate release

Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
____________________________________________________________

Maybe we're just stupid over here at Dredd, but it sounds like they want to create a bunch of cheap credit and print more money. Somehow, that's going to fix an economy that crashed because it had too much cheap money. Cheap money and credit allowed people, businesses, and government to take on more debt that they could manage. So somehow, the Fed is going to stop the debt from crashing by creating more credit so that people, businesses, and governments cna get into more debt? Does that pass your logic test, dear reader?

Remember, they can print money and work on controlling your expectations through the media, but they can't stop where the money is going to flow. If the Fed handed you a wad of cash, do you think they could predict where you're going to spend it? If you were confident about the world, maybe you'd buy a new car. If you wanted some independence from your job, maybe you'd start a business. If the prices of food, materials and fuel were rising quickly around you, maybe you'd buy all of the food, materials and fuel you could get your hands on. You know, like the Chinese are doing....

Money tends to flow where it is will be "protected." I don't know if you know this or not, but food, materials, and fuel have never been worth nothing. We suspect that the Fed is confused, uninformed, or just plain lying about inflation. When enough money floods the system, the only things worth something will be things.

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I Love the Smell of Imminent Fed Decisions In the Morning....

Bubblevision is on fire. The June FOMC decision is due any minute. The markets are buzzing and debating over the intricacies of the Fed's statement.

If you're not sure what all of this means, we'll bring you up to speed soon. We're currently working on the "Where?" analysis we mentioned yesterday.

Nonetheless, let me tell you, dear reader, what the Fed will NOT do. They will NOT raise rates. They will NOT hint about when they may raise rates. They will work to control expectations of inflation--which is ultimately laughable. Don't let the deflationary hype deter you from the reality of where this has to go.

You see, the economy is sick. Very, very sick. The Fed is trapped. There is only one way out--inflating while attempting to control expectations.

While the world waits to analyze the Fed statement, take some time to review Jesse's commentary on inflation. It will add to your knowledge base in separating fact from propaganda.

I think this Fed announcement will smell of "more of the same with marginally different spin..."

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Who, What, When, Why and Where of the Economy

There are five questions that are often reviewed when investigating a subject:

1. Who?
2. What?
3. Why?
4. When?
5. Where?

In this case, the "Who?" is us, the people that live and work within the economies of the world.

The "What?" is the economy and the financial markets. These are often different things that are confused as being one and the same. The financial markets include the corporate and government bond markets, the stock market, the over-the-counter derivatives market, etc.

Wikipedia defines economy as:

"the realized economic system of a country or other area. It includes the production, exchange, distribution, and consumption of goods and services of that area."
(Reference http://en.wikipedia.org/wiki/Economy).

In other words, the economy is the real world that we live in that exists when we create, buy, sell, and transport stuff.

Our goal at Dredd is to understand what's going to happen in the real world (which we will also call the real economy) by studying the financial markets. However, there's a trap that about which we have to be conscious. It is often believed that the stock market, in particular, foreshadows what will occur in the real economy. This is not necessarily true, and that will become more apparent as we discuss the "Where?" in detail.

The "Why?" is a long and complex topic that requires enough understanding of economics, history, and politics that it simply cannot be addressed in a single essay. The "Why?" explains exactly why were are where we are. Once you understand the "Why?" then the final outcome of this little economic downturn will become more obvious. This is where, dear reader, we need you to take some initiative for yourself and your family and do some critical thinking. If more people understood the "Why?" then we would have avoided this mess in the first place. We need more people to understand the "Why?" so that we don't have this problem again. The "Why?" is the primary reason that we have opted to write on educational topics such as money, credit, debt, inflation and deflation, capital and many other topics. This is going to take some time, so bear with us. The investigation of the "Why?" is going to challenge your belief system.

The "When?" is a complex question that involves both a better understanding of the "Why?," some fundamental analysis, and to make sure that things are on track, some technical analysis. As we move forward, our goal is to make this more clear. We have a longer term sense of where things are going, and a shorter term means of tracking the progress.

Finally, in our first real analysis for the Dredd Market Report, we're going to talk about the "Where?" If you want to protect yourself, you need to know where we are in the economic cycle. In order to get a sense of the "Where?" we must first look at the big picture, sprinkle a little bit of the "Why?" in for discussion, and get some context. Our goal is to finish this race in one piece with something to show for it. If we want to finish the race, we need to know how far we are from the finish line and what terrain we're going to encounter as we continue on. Are there "green shoots" out there or are we headed for shark infested waters?

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What Color Are Your Glasses?

As a general rule, everyone views the world through their own filter based on their own experiences. Some people are selfish. Some are giving. Some had good childhoods; some bad. There are left wingers and right wingers. There are the religious and the atheists. We are different ethnicities, come from different countries, and have different socioeconomic backgrounds. Etc, etc.

It is important to understand your own filter since it predisposes your belief system. It can cloud your judgment when non-emotional decisions are required (and in the world of markets and economics, emotion is your enemy). It is also important to understand the filter of the person with whom you're dealing.

The pirates here at Dredd Market Report are of the free-thinking sort. No one ever got away with their treasure by asking permission, thinking inside the box, or blindly following anything. We believe in the freedom of the open seas and take exception to those that would deprive us of the right to our own property, our own choices, and of course, our loot.

Over time, dear reader, this philosophy will become quite clear. We avoid labels because they color your glasses. But it won't take too long to realize that we would rather take our chances and fail than to trust in another person blindly and succeed.

Thus, when reviewing our commentary, note that our filter is one where there is an inherent distrust of consolidated power--by companies, by governments, by religion, by authority in general.

Power corrupts. Absolute power corrupts absolutely.

So you will rarely see us side with the thought that we need more government, more regulation, more centralization of power. Quite the contrary. We side with finding freedom in an unfree world.

That's the beginning, dear reader. You should know with whom you're dealing.

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