Can the Inflation Beast Be Tamed?

1. Inflation: Now comes the hard part
2. Problems Wall Street hadn’t started thinking about yet
3. S***’s getting real (UPS strike)
4. The U.S. military’s moral panic in Mali (Unbelievable)
5. More reader thoughts about a return of the draft

Inflation: Now Comes the Hard Part

OK, our own Jim Rickards confirms it: The Federal Reserve will have a devil of a time getting inflation back to its 2% goal.

We suspected as much last week when the Labor Department reported the official inflation rate — 3.0% year-over-year in June, down from a staggering 9.1% a year earlier.

We mentioned the observations of outside-Paradigm experts like Jim Bianco and Greg Weldon. Both of them pointed out how the big drop was driven by what statisticians call “base effects” — especially falling gas prices over the last 12 months. The point is that those statistical tailwinds start going away with next month’s report. Inflation at 3% might be as good as it gets.

Confirmation came a couple days later from Bob Prince, co-investment chief of the hedge fund giant Bridgewater Associates. Inflation “is probably going to level out where it is,” he told the Financial Times. “We’re likely to be stuck around this level of inflation.”

“The decline of inflation is not a linear process,” affirms Jim Rickards.

“The early gains were rapid and relatively easy. It was low-hanging fruit. The later gains, including getting inflation from 3.0% to 2.0% are much more difficult.”

Among the factors Jim sees on the horizon…

• Used car prices are rising again
• Airlines still have pricing power
• Americans are spending more on travel and entertainment.

But perhaps the biggest factor breathing new life into the inflationary beast is this…

“Inflation-adjusted average hourly wages rose 1.2% in June from a year earlier,” says a Wall Street Journal story citing Labor Department figures. “That marked the second straight month of seasonally adjusted gains after two years when workers’ historically elevated raises were erased by price increases.”

The Journal story is all sunshine-and-lollipops about how all that money will keep Americans’ spending power robust, “which could help the U.S. skirt a recession.”

But that’s not the whole story. Not by a long shot…

“Labor is gaining the power to get real wage increases through strikes and aggressive negotiations,” says Jim Rickards.

Case in point — the Air Line Pilots Association’s tentative deal with United, reached last weekend. Members will get pay increases of as much as 40.2% over four years.

“Even non-union labor is finding it easy to get a raise,” says Jim, “because of a skilled labor shortage and the difficulty employers have in hiring new workers.”

Take rising pay along with the bullet points cited above… and we’re looking at what Jim calls “an even more dangerous situation for the Fed.”

Recall how Fed chair Jerome Powell insisted through most of 2021 that inflation would prove to be “transitory.”

“The ‘transitory’ narrative,” Jim says, “came from the fact that the 2021 inflation was coming from supply chain disruption. That kind of inflation does tend to dampen itself as consumers reduce discretionary spending, although that took longer than the Fed expected.”

No more: “Now inflation is coming from the demand side in the form of wage increases.

“That kind of inflation feeds on itself as businesses raise prices to cover higher wages and employees demand more wage hikes to cover higher prices.”

This is the dreaded “wage-price spiral” that last reared its ugly head in the late 1970s.

“The solution then,” Jim reminds us, “was 20% interest rates and the worst recession since the end of World War II.”

It was terrible for stocks, terrible for government bonds, terrible for corporate bonds, terrible for commercial real estate. But the Fed did get inflation under control in the end.

“Let’s hope the Fed doesn’t have to go that far this time,” says Jim. “But once the inflation genie is out of the bottle, one cannot rule it out.”

[Editor’s note: We’re less than six hours away from Jim’s exclusive webcast from the Pentagon City complex in Virginia.

Jim will present a comprehensive update to his Currency Wars thesis — building on the work he started when he walked senior military brass through the Pentagon’s first financial war game in 2009.

This time, however, he won’t be addressing government officials; he’ll be addressing you.

“This briefing,” he promises, “has the potential to be the most consequential update for you and your finances that I’ve ever given.”

He has one request before getting underway tonight at 6:45 p.m. EDT.

“Some of what you are going to see,” he says, “is extraordinarily sensitive and has been shared behind closed doors at the CIA, and inside the Office of Net Assessment (the most secure room inside the Pentagon).”

For that reason, he’s asking that you fill out a short clearance form before attending.

Follow this link, answer three questions and you’ll be good to go tonight.]

Problems Wall Street Hadn’t Started Thinking About Yet

The seven biggest stocks have gotten so big…

[We’ll pause for audience response: HOW… BIG… ARE THEY?]

They’re so big that several major U.S. investment funds are literally barred from buying any more shares.

From the Financial Times: “Major asset managers and mutual fund specialists such as Fidelity, BlackRock, JPMorgan Asset Management, American Century and Morgan Stanley Investment Management have run into strict regulatory limits that determine whether a fund can be categorized as ‘diversified.’”

The S&P 500 is up 18% year to date… but as we’ve mentioned frequently during 2023, most of those gains have been driven by seven tech-adjacent giants: Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia and Tesla.

Result: The portfolio holdings in many funds are getting all out of whack.

“Mutual funds that register with the Securities and Exchange Commission as ‘diversified’ cannot put more than 25% of their assets into large holdings,” explains the FT — “with a large holding defined as a stock that represented more than 5% of the fund’s portfolio at the time of investment.”

If they sail past that limit, they can’t buy any more of those stocks. Case in point: BlackRock’s Technology Opportunities Fund, which can no longer buy Apple, Microsoft or Nvidia.

While the mainstream has been noticing this “concentration” during 2023… the fact is the pressures have been building for the last decade.

Six years ago in our predecessor e-letter, we were spotlighting research from Williams Market Analytics showing how the market’s returns were being juiced by what were then the “Big 5” tech stocks — Apple, Microsoft, Alphabet, Amazon and Facebook before it rebranded as Meta.

Together, the Big 5 had generated 226% returns between 2013–2017… while the rest of the S&P 500 returned a mere 27%.

Tesla has since joined the Big 5 after becoming part of the S&P 500 index in late 2020… and Nvidia came to the party amid this year’s AI craze.

Now, however, the pressures are so extreme that the keepers of the Nasdaq-100 index are rebalancing its holdings to reduce the Big 7’s influence; the changes kick in next Monday.

But that doesn’t help the fund managers. Yes, they can reclassify the funds as non-diversified, but that’s a messy process requiring a shareholder vote. Meanwhile, funds that end up running afoul of the diversification standard — and losing money getting back into compliance — could face shareholder lawsuits. What a mess…

For no obvious reason, gold is on a tear this morning — up $25 at last check to $1,980, the highest since early June. Silver’s doing OK, too — back within a few pennies of $25.

Elsewhere in the commodity complex, crude is up over a buck to $75.29 a barrel. And copper has been showing signs of life in recent days — back up to $3.83 a pound.

The major U.S. stock indexes are a mixed bag — the Nasdaq Composite slightly in the red, but the Dow up over three-quarters of a percent. The S&P 500 is splitting the difference, up a quarter percent to 4,536 — close to a 15-month high. Earnings season has resumed with Bank of America and Morgan Stanley both beating Wall Street analysts’ expectations.

➢ Yeah, right: We’re sure it’s got nothing to do with all those articles and videos showing how the stupid thing is incapable of hauling stuff without draining the battery after less than 100 miles. In other words, the only market for the electric F-150 is insecure soccer dads who feel they need it to demonstrate their masculinity.

Last in our market wrap, a couple of economic numbers to chew on…

• Retail sales grew an anemic 0.2% in June, less than expected. But May’s numbers were revised upward

• Industrial production tumbled 0.5% in June, an outcome no one among dozens of Wall Street economists was expecting. Manufacturing fell 0.3%, also unexpected. Mining/energy production was also down, along with utility output. All told, 78.9% of America’s industrial capacity was in use last month; all the gains of the previous six months have been wiped out.

UPS Strike Update: S***’s Getting Real

The Teamsters union has put the White House on notice: Butt out of our dispute with UPS.

Twice in the last year, the Biden administration has intervened in transportation labor disputes. Last December, the White House leaned on Congress to impose a freight rail contract over the objections of four unions. Last month, the Labor Department stepped in to help hammer out a contract covering dockworkers at 29 West Coast ports.

But Teamsters boss Sean O’Brien is telling his rank-and-file there won’t be a repeat with UPS: Absent a deal when the current contract expires in 11 more days, 340,000 people will strike.

As he put it in a webcast on Sunday, “We told the White House — and I used this analogy throughout our negotiations, throughout our rallies and practice pickets — that we have taken a strong position with the White House that, you know, my neighborhood where I grew up in Boston, if two people had a disagreement and you had nothing to do with it, you just kept walking.

“And we echoed that to the White House on numerous occasions and we don’t need anybody getting involved in this fight.”

[I’m imagining the Joe Biden thought bubble here: Oh yeah, buddy? Well, I grew up in Scranton, and lemme tell ya… Eek, it wouldn’t end well for him.]

Barring a miracle, this strike is happening… and there’s no way FedEx and the Postal Service can pick up the slack.

This won’t be like the 1997 UPS strike no one remembers now — when Amazon was still selling mostly books and UPS’ unionized workforce was barely half its present size. If you need to order something online in the next few weeks, do it now.

In addition, bear in mind that UPS handles logistics for much of the medical industry: If you’re in any way reliant on medical devices or surgical supplies, talk with your health care provider about how you’ll get along for the duration of the walkout.

The U.S. Military’s Moral Panic in Mali (Unbelievable)

Anytime anyone in the U.S. government says anything about cybersecurity… just remember this.

As you might know, the U.S. armed forces have websites and email addresses ending in the suffix .mil.

Well apparently, there are untold numbers of people with .mil email addresses who get tired or lazy or whatever and end up typing .ml — a domain that belongs to the West African nation of Mali.

According to the Financial Times, “The problem was first identified almost a decade ago by Johannes Zuurbier, a Dutch internet entrepreneur who has a contract to manage Mali’s country domain.”

Since the start of this year, he’s been trying to get the U.S. authorities to pay attention — collecting 117,000 misdirected emails. Much of it is spam, some of it is routine and none of it is classified. But a few valuable things slip through, such as the travel plans for the army chief of staff when he was headed to Indonesia in May.

Here’s the thing: Zuurbier’s contract runs out next Monday — and control will revert to Mali’s government, which the FT is quick to remind us “is closely allied with Russia.”

What the FT won’t tell you — nor any other mainstream outlet — is the recent history of Mali.

The current government came to power during a coup in 2020. It turned to the Russians as a counterweight to the French. France was the old colonial power in Mali, and French troops had intervened for several years in a civil war that broke out in 2012.

Mali had a kinda-sorta functioning democracy until everything went to hell in 2012. The year before, the Obama administration carried out regime change in Libya, overthrowing Col. Gaddafi.

Huge numbers of ethnic Tuaregs from Mali served as mercenaries under Gaddafi; with no one to pay them, they headed home to Mali — bringing with them huge caches of weapons. They launched the civil war shortly thereafter, which is ongoing.

So if the U.S. military is that concerned about their missent emails ending up in the hands of “the Russians”… maybe Washington should have left well enough alone in Libya more than a decade ago. Just sayin’...

More Reader Thoughts About a Return of the Draft

“Biden is trying very hard to win the millennials' votes with his loan forgiveness programs,” a reader reminds us as our dialogue about a new military draft starts to wind down.

“Putting in a draft would completely destroy that effort, and Biden (or his handlers) should be painfully aware of that. A draft would cost him the 2024 election; that makes it a non-starter.”

“A full spectrum of viewpoints was expressed Monday regarding a new draft,” writes our final correspondent. “I think the bottom line has to be the contradiction in the words ‘forced’ and ‘service.’

“Forced = slavery, service = voluntary. I thought our goal should be to reduce or eliminate force, fraud and coercion by government?”

Dave responds: Well, that might be your goal, and mine too, but…

Best regards,

Dave Gonigam
Managing editor, Paradigm Pressroom's 5 Bullets