When BusinessWeek agrees with you

For years, I have read those off-white, yellowish Business Outlook pages in BusinessWeak (sic.) with some disdain. The message is always loud, clear, and the same: The economy's great! Greenspan is a genius. And you really don't have anything to worry about. So increase your leverage. Invest in stocks. And go out and buy something you don't need (and increase your subscription while you're at it).

Now, just before sitting down to write this post - having crafted the bulk of it in my mind - imagine my shock as I sat down, looked at those yellowish pages, and read much of what I was going to write!

HEADLINE:
"Bernanke May Have His Work Cut Out for Him: If the economy doesn't cool down, rates could go higher than investors expect."

I will quote much of the article, as I am chagrined to admit, because it sums up my viewpoint better than I could have written myself:
"The latest UBS Index of Investor Optimism jumped sharply to its highest reading since June 2004...A bit less than two-thirds of those surveyed said it was a 'good time to invest in the financial markets.' In particular, investors don't seem overly concerned about inflation or interest rates...The results suggest that investors believe inflation will stay tame and that the Fed is all but finished raising rates. This expectation of perfect policy from the Fed is one of the biggest risks in the outlooks for both the financial markets and the economy...But what if the economy doesn't cooperate?...Also, despite the Fed's rate hikes and the runup in oil prices, the credit markets see even less risk in the economy now than they did when the Fed began tightening policy...

"Energy is once again adding to those inflation worries...The real danger to the economy and inflation is oil at $100 per barrel, the result of a classic supply shock, should actions in Iran and Nigeria result in a substantial drop in oil flowing to world markets...

"Watch the economic data closely over the next couple of months. If the numbers fail to imply that the economy is cooling down a notch, then the new Fed chairman could have a lot more work to do in 2006, a situation that would surely put a damper on investors' confidence."

And with that, the outlook ends!!!

To me, as a investor looking for that which the market and concensus opinion have not already caught, this article is worrying - not because of its content - but because lots of people are starting to write about the same stuff: higher oil, possibilities of inflation, a further rise in interest rates (short & long), and on top of all that, the chance all this growth will lead to slower growth - as interest rates rise.

This final point - the seeming paradox that growth that is too fast can actually cause a recession - is, like most things in life, not what it first appears.

My latest thinking to explain this phenomon - as well as describe the broader trend in the economy - is actually quite simple, namely:

Changes in inflation and disinflation SIGNIFICANTLY LAG changes in money supply growth. For example, when the Fed set the stage for massive money supply growth right after 2000, inflation did not appear at once. Similarly, when money supply growth began to slow in the late 1980's, a prolonged period of disinflation was not understood to be taking place until many, many years later.

If this theory (and it is just a crackpot theory - more reverse-engineered to explain observations - rather than based upon a detailed economic paper to back it up) is correct, the implications are profound. The profound implication is that the Fed sets policy too quickly, and that the damage has already been done by the time they set out to fix it. Money supply growth many quarters ago set inflation rolling, and the Fed can only now (too late in the game) raise rates and force the economy into recession. Even so, inflation may continue to occur, and we may find ourselves in a situation similar to the 1970's and early 1980's, when the Fed had to raise rates despite a massive recession to "break the back" of inflation.

Of course, the ensuing slowdown in money supply growth beginning in the 1980's set the stage for a period of steadily lower inflation, and eventually a perception that inflation had been cured. All the while interest rates were brought lower and lower, credit growth expanded, and by the mid 1990's, money supply growth began to accelerate again, speeding up significantly around 2000.

So as I doubt my own analysis and wonder why the burgeoning concensus opinion and I are no longer at odds, I go to bed thinking: hey, we might actually all be right! And when everyone starts to believe in inflation, that's when it really begins!

Sweet dreams of Oil futures and Gold bars...
And wow are those XOM LEAP calls looking nice! Up 50% since we recommended them at the beginning of this month.