The Oil Factor: Protect Yourself-and Profit-from the Coming Energy Crisis by Stephen Leeb & Donna Leeb

Author:Stephen Leeb & Donna Leeb [LEEB, STEPHEN]
Language: eng
Format: epub
Tags: BUS022000
ISBN: 9780759509818
Publisher: Warner Books
Published: 2004-02-11T16:00:00+00:00

An Impotent Fed

When real rates are negative, and inflation is heating up, the Federal Reserve, which controls T-bill yields, theoretically can simply raise rates enough that real rates turn positive. Presto—you’ve pulled the carpet out from under all those inflationary impulses, scattering them to the winds. This is exactly what Paul Volcker did in the early 1980s. When Volcker became Fed chairman in 1979, inflation was in the low double digits, nominal rates were a few percentage points below that, and thus real interest rates were heavily negative, below minus 1. It took Volcker a little time to get his act together and formulate a plan, and by early 1980 inflation had risen further, approaching the worst levels of World War II. Real rates had continued to deteriorate and were below minus 7. Gold was flying, and the vicious circle of which we spoke, in which high inflation begets even higher inflation, was in full swing.

Then Volcker acted, raising short-term interest rates dramatically. By the time 1982 rolled around, real rates had swung all the way back to about plus 4. They continued to climb into 1983, after which, with the exception of a few months in 1993, they remained positive until 2003. During this long stretch of positive real rates, inflation went from terrorizing the economy to a no-show. Its absence set the stage for one of the greatest periods ever for financial assets and one of the worst ever for real assets such as gold, which is perhaps the ultimate barometer of inflationary pressures.

In today’s far more debt-heavy world, however, a little more than a generation after Volcker worked his disappearing act on inflation, the same bag of tricks won’t be available. Volcker tamed inflation by acting to turn real rates sharply positive. Today, turning real rates sharply positive would be a disaster because, as we explained above, the real estate market thrives on negative real rates. And as we can’t stress too often, because of the huge overhang of consumer debt, the primary concern of policymakers has to be keeping home prices high. Negative real rates are likely to become the norm, and they will be yet another inflationary force.

If inflation really starts to soar, and real rates turn sharply negative, we’re not saying the Fed won’t try at all to cool things off. But it won’t be able to proceed with the same decisiveness and single-mindedness as Volcker did in his day. At most it will act gingerly, raising rates with great trepidation and a probable willingness to back off. The memories of 2000-2002, when rising home prices were all that saved the economy from total collapse, will surely linger, and rightfully so.

We know we’ve plied you with a lot of information. If it seems too confusing, just realize that from an investor’s point of view, there are two key points. The first is that inflation favors hard assets. And the second is that even in the absence of significant inflation, negative real interest rates also

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