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DEVELOPING COUNTRIES HAVE A SERIOUS INFLATION PROBLEM AND THEIR BEHAVIOR IS EXACERBATING THE PROBLEM.

DEVELOPING COUNTRIES HAVE A SERIOUS INFLATION PROBLEM AND THEIR BEHAVIOR IS EXACERBATING THE PROBLEM.

EVEN THE MEDIA IS LAUGHING

Everyone is starting to see the obvious.  The inflation numbers promulgated in the U.S. and Europe are, to be polite, inaccurate…and now the public has started to read in the popular press what we have been saying over and over again for years.  INFLATION IS A PROBLEM EVERYWHERE.

U.S. INFLATION WAS REPORTED AT 0.2% FOR APRIL…EVEN MAINSTREAM COMMENTATORS ARE LAUGHING AT THE U.S. GOVERNMENT STATISTICS

I could not help but laugh at the news I heard at about 6 AM Los Angeles time on May 14th.  I heard a radio newscaster say “Now all of you listeners don’t call me to complain. I am just reading the government report…the CPI was up .2% last month for an annual rise of about 2.4%.”

Then, later in the day I was told that on CNBC one of the anchors, Mark Haines, was laughing about the CPI, and  pointed out that the seasonally adjusted gasoline component of the CPI was only up 5.2% in April while the government said it should have been up 7.2%.  Because of this, gasoline prices component fell in the CPI, causing it to be low in April.  His co anchor commented by adding “yeah, 5.2% on top of $3.50 per gallon.”

I don’t usually listen to financial TV, but it is important to note that when a medium like financial TV (which is slow to catch on to new trends) begins making fun of the government’s inflation reports…it means the public at large is waking up.  They are waking up to the obvious fact that inflation is here and it is a lot higher than the government admits.

This is an important milestone.  The public’s recognition that they must hedge against inflation, will result in an adjustment in spending and investing behaviors.  More and more people will begin buying, investing in, and stockpiling inflation hedges like commodities, energy, food, and gold.

WE DON’T BELIEVE IN MOST CONSPIRACY THEORIES…IN OUR OPINION, THE BIG CONSPIRACY IS THE CONSPIRACY OF IGNORANCE AMONG ELECTED OFFICIALS AND POLITICAL APPOINTEES, AND THEIR DESIRE TO MAINTAIN POLITICAL POPULARITY…WHICH ALLOWS GOVERNMENT OFFICIALS AND ECONOMISTS TO KEEP REPEATING THE SAME MISTAKES CYCLE AFTER CYCLE

This is the big conspiracy.  This conspiracy of ignorance is not limited to the United States.  For example, Vietnam has started to have really serious inflation…21% today, versus 7% a year ago.  There are five main reasons for this problem using the example of Vietnam, but the problem exists in dozens of countries.

1. Subsidized prices and price controls on energy and food which stimulate consumption.

2. An undervalued currency which has been kept too low for too long.
3. New policies meant to address the problem, but that eventually serve to exacerbate them, a) more price controls, and b) export bans.  India even went so far as to suspend futures trading in several commodities.  This behavior is delusional.  Commodities are fungible, globally traded and controlled by supply and demand.  Policies like these will end in tears…not for the wrong-headed bureaucrats who implemented them, but for the citizens of the countries where these unwise and destructive policies have been implemented.

4. Government Monetary policy.  The Vietnamese money supply is expanding too fast.

5. Inflationary expectations on the part of the Vietnamese people.  They know prices will rise in the future when the government can no longer afford to subsidize, so the people hoard now.

Vietnam is only one example of a very serious problem arising in many developing nations.  They are experiencing bad inflation, and they think it will go away when food and energy prices recede.  They are missing the point.

THE ECONOMIST MAGAZINE JOINS THE CHORUS

Do you remember our letters of the last few months where we have said “INFLATION IS EVERYWHERE” and similar things like HOW INFLATION IN THE DEVELOPING WORLD WOULD BE EXPORTED TO THE DEVELOPED WORLD?  This week there is a big article about this very topic in The Economist, a publication that we at Guild Investment Management respect.
The Economist restates what we have long been saying.  Problems in developing economies are not being dealt with intelligently.  If they are not tackled immediately, the inflation growing in the developing world will create a large (and hard to manage) inflationary environment for the entire globe.  The inflation that is being experienced in Vietnam, China, India, Russia, Venezuela, Argentina, Saudi Arabia other oil exporters and many other countries worldwide will be exported to the developed countries in the same way the inflation of the developed countries in the 1970’s was exported to the developing world at that time.

THE POINT IS…IF YOU KEEP STIMULATING DEMAND WITH SUBSIDIES AND PRICE CONTROLS, AND IF YOU INSIST ON KEEPING YOUR CURRENCY TOO LOW TO STIMULATE EXPORTS, YOU WILL FOSTER AN INFLATION PROBLEM

As any pharmacist can tell you, there are side effects to every pharmaceutical.  It is the same in economics.  It may seem wise to keep your currency low and to stimulate job growth with exports, but one side effect is inflation.  If you don’t manage this side effect correctly you set yourself on a cycle of destructive inflation and debasement of your currency which can be totally devastating.  Just look at the numerous inflationary disasters that the mismanaged governments of Latin America have visited on their people during the last 40 years.

We are now at a juncture when many countries appear to be making the same unwise decisions which may have very unpleasant side effects.

Some of the side effects include the destruction of the middle class, the encouragement of speculation and dishonesty to protect one’s assets, the flight of capital abroad so that no assets remain to help the economy grow, among other unpleasant effects.

ON THE POSITIVE SIDE…MANUFACTURING IS GETTING ATTENTION IN INDIA

India has long been an economy too dependent upon services and the consumer.  Manufacturing has been a weak part of the economic equation.  For India to grow longer term, and bring its hundreds of millions of poor into the middle class, it must follow the example of China and increase the manufacturing component of the economic mix.

There is hope that such a trend is developing.
The May 22, 2008 Financial Times stated that “India is on track to meet its target to increase greatly the role of manufacturing in spite of global economic turmoil according to Ashwani Kumar, minister of state for commence and industry…the Indian government plans to push manufacturing production to more than 25 % of the overall economy by 2017 from 16-17% now.”

In order to do this, India must improve its infrastructure and create special economic zones.  If this can be done, India will have a good opportunity to become a first class power.

In our opinion, if the apologists for statism, corruption, and political gridlock within India continue to exert influence, India will not make the necessary progress to gain a position in the front rank of global economic powers.

LONG-TERM THINKING?

The O.E.C.D. [Organization for Economic Cooperation and Development] SAYS FOOD PRICES TO STAY HIGH FOR 10 YEARS

SUMMARY

We know that oil and many other commodities have gone up a lot, and we further know that they can correct at any time.  However, our basic themes remain unchanged.  Oil, food, base metal or precious metal prices may fall for a month or for six months, but longer term they will rise.

Major mistakes, especially by monetary authorities in emerging economies suggest that our old themes continue to be valid.  Should they decline in price we will purchase oil and energy, food related (fertilizers, etc), gold and precious metals, base metals and the shares of fast growing companies in fast growing countries.

The day will come when the trends supporting our themes of growth in demand and price for commodities will end…that day has not yet arrived.  When it does we will do our best to inform you in advance.

Thanks again for listening.


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