The Inflation Tsunami

Adam Hamilton    October 5, 2001    4607 Words


Isaac Newton, the famous English scientist of the seventeenth century, had an incredibly brilliant mind that intimately understood the immutable truth that actions have consequences.  Newton spent decades developing and refining his extensive contributions to various branches of scientific inquiry including physics, astronomy, and mathematics.


Newton forever altered the popular scientific perception of the universe with his legendary Three Laws of Motion.  His first law elaborated on the important concept of inertia and his second law on how to calculate the effects of forces applied to an object.  Newton’s third law, while it seems intuitive to us today, has had a broad impact on the way we understand much of our world far beyond the realm of physics that he was directly describing.


In his third law, Sir Isaac Newton stated, “For every action there is an equal and opposite reaction.”  Newton’s timeless wisdom has important applications in all kinds of fields of endeavor, including finance and markets, but it can perhaps still be best visualized and understood in terms of the natural realm.


One of the most awesome forces of nature as well as a perfect illustration of Newton’s Third Law of Motion is the mighty tsunamis of the world’s vast oceans.  The word “tsunami” is of Japanese origin, made from combining the Japanese words for “harbor”, “tsu”, and “wave”, “nami”.  A tsunami is literally a “harbor wave”.  As Japan is an island nation with long coastlines situated on top of one of the most seismically active areas of the world, the Japanese have lots of experience with tsunamis.


A tsunami is spawned when a deep undersea earthquake causes the floor of the ocean to shift rapidly.  As the ocean floor falls or rises in response to tectonic activity in the earth’s crust, the quake displaces vast amounts of water, millions of tons.


The enormous forces unleashed by the undersea quake, just as Newton predicted in his third law, have to act on something, and the only medium available to absorb that huge release of raw energy is the ocean water.  The water displaced by the earthquake creates a displacement wave, the forces unleashed by the rumbling earth travel through the water displacing it slightly as the energy wave propagates and spreads similar to a ripple in a pond when a child tosses in a stone.


Intriguingly, an ocean-going ship floating right on top of ground zero, the very epicenter of the quake, will almost always notice nothing when a large deep undersea earthquake is triggered.  Tsunamis in the open ocean may be only a few inches high and virtually impossible to discern.


As the titanic forces unleashed by the earth movement radiate and travel through the ocean they eventually run into shallow water.  The energy displacement wave that is all but invisible in the open ocean is bunched up and the energy is forced towards the surface as the column of water available for it to travel through contracts with the receding depth.

As the displacement wave zooms towards shore, a great pile of water is created by the force of the energy wave and it slams into beaches, often scouring coastlands clean and roaring many miles inland if the spawning earthquake was strong enough and the ocean floor dynamics channeled the energy wave to coastlands with the right topography. 


The tsunami can leave unbelievable destruction, terrible loss of life, and catastrophic loss of property in its mighty wake.  In 1896 a seven-story high tsunami struck the Sanriku coast of Japan and more than 26,000 people perished.  Over 30,000 people died in Java in Indonesia when an 1883 tsunami caused by a volcanic eruption slammed into its shore.  Tsunamis unleash enormous forces when they finally hit land.


While the cause-and-effect Newtonian physics that help explain tsunamis are not difficult to understand, it is really intriguing that the original tectonic forces unleashed by an undersea quake that lead to a tsunami are often not discernable without special seismic equipment.  Before the modern days of global seismic monitoring networks that can be used to warn people living in vulnerable coastlands to evacuate when undersea quakes occur, there was just no way of knowing when a tsunami might emerge from the deep like the Kraken to wreak havoc on an unsuspecting populace.


In the chaotic financial world following the horrible terrorist attacks, we may be witnessing the financial equivalent of an undersea quake right now.


Though few investors care at this point, since the shores are clear and the skies are azure blue, huge forces have been unleashed under the financial sea that will spawn a displacement wave that will eventually slam into the fragile coastlands of the global markets.


The United States Federal Reserve, for the umpteenth time this year, lapsed into an unmitigated-panic mode following the tragic events of September 11.  As central bankers will be central bankers, the only thing the Fed knows how to do is create money out of nothing and attempt to deluge any potential difficulties with fresh money.  If you are ever curious what response the average central bank will have for any conceivable crisis or situation under the sun, the answer will always be “run the printing presses to provide liquidity”.  To central bankers, this is always the “prudent and necessary” course of action.


In this essay we will explore the early financial seismic signs from an undersea quake caused by an explosion of money that will eventually wash up on market shores.  The coming inflation tsunami has the potential to radically alter the calm market landscape and underlying perceptions that most investors merrily take for granted today.


Before we begin, it is crucial to understand inflation and money.  Webster’s exhaustive dictionary defines inflation in two ways.  First, inflation is a “persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency”.  This primary definition describes, in Newtonian terms, the action, “an increase in the volume of money”, leading to an opposite reaction, a “persistent, substantial rise in the general level of prices”.  A money supply increasing faster than the available pool of goods, services, and investments on which to spend it creates inflation.


Webster’s second definition of inflation is “the act of inflating”.  Today there is a horrible disservice being rendered to investors worldwide by the shallow financial media when they talk of inflation.  Per popular media propaganda, the widespread definition of inflation today has been truncated to only “a rise in prices”.  The ultimate cause as well as the leading indicator of inflation, central banks ramping up fiat currencies, is totally ignored. 


The official government stats that purport to track inflation, like the CPI, are perpetually and intentionally low-balled to save the government money.  The lower the officially reported inflation rate, the less the government has to pay out in its pension programs and in interest on its debt.  Understating inflation also has the unpleasant side effect of artificially hiding important financial warnings of impending inflation from the marketplace and investors.  Due to these statistical games, most people today blindly believe the popular hype that there is little inflation in the United States.


Yet, as the premier American English dictionary points out, inflation is not just the results, but the very act of inflating, increasing the money supply.  As we have elaborated on inflation many times in the past, we encourage you to peruse some earlier essays we have written if you would like to dig deeper on inflation and money.  Check out “Lies, Damn Lies, and CPI”, “Exploding Inflation”, “Deflating the Dow”, and “Revolt of the Long Bond” for deeper discussions on inflation.


Alan Greenspan and his interventionist Fed, continuing their disastrous track record of market manipulation after first fomenting, then nurturing, and finally popping the greatest market bubble in world history, continued to do exactly the wrong thing after the horrible events of September 11.  Greenspan and his gang ran the proverbial printing presses like never before, pumping enough money into the US economy in the first week after the attacks to make banana-republic money debasement schemes look conservative.


Our first graph reveals the absolutely unreal spike in the inflation rate of the MZM money supply.  As we mentioned in our recent “Investment Capital Under Siege” essay, MZM is “Money of Zero Maturity, the measure of the money supply for totally liquid money that can be spent immediately”.  MZM includes currency, checking accounts, and cash in money market funds.  Since the narrower M1 money supply does not include the huge money market funds that are so popular as cash management tools these days, we prefer MZM over M1 as the premier narrow money supply measure.


This graph illustrates the weekly change in MZM from the prior week annualized to show the yearly rate of change.  For instance, if MZM grew by an absolute 1% in seven days, that 1% is multiplied by 52 weeks to yield a 52% annualized growth rate of MZM.  The MZM inflation following the terrorists’ deadly political statement against US foreign policy was simply breathtaking.



If you had told me one month ago before the attacks that Greenspan, even though he is a world-champion inflationist, would have the sheer audacity to balloon the narrow MZM money supply at an almost 175% annualized rate, I would not have believed it.  Yet, after the attacks, the Fed decided it was prudent to throw the hard lessons of financial history to the winds and literally deluge the US financial system with freshly created fiat money.  It was an extraordinary monetary event, the financial equivalent of an undersea earthquake that will eventually have an enormous impact as it slams into the fragile shores of the world financial markets.


The outrageousness of this latest Fed largesse can perhaps best be appreciated by comparing it to recent history.


While the yellow line above shows the actual annualized weekly MZM changes, the blue line smoothes out a little of the great volatility in money supply creation with a 10-week moving average.  Both lines are useful to measure the seismic shock of the bitter seeds of inflation sown after the attacks by the Fed.


The first large inflationary shock of the last four years arrived in the midst of the Russian debt crisis which led to the derivatives implosion marked by the death of uber-hedge fund Long Term Capital Management.  We discussed the intriguing LTCM event in more detail in our recent essay about JPMorganChase’s world-record derivatives pyramid, “The JPM Derivatives Monster”.


On August 17, 1998 the Russian government suddenly announced that it could not pay its sovereign debt.  Elite hedge-fund LTCM was buffeted with abrupt and unpredictable volatility and lack of liquidity in various markets and its highly leveraged capital base evaporated in a matter of days as its trades turned against it.  As LTCM burned in flames and had the potential to take the whole fragile derivatives pyramid down with it through cascading cross-defaults to derivatives counterparties, the Fed did what it knows best to react to the crisis and literally deluged the economy with liquidity through MZM inflation in addition to bailing out LTCM.


In the first week of September in 1998, as the Fed realized how dangerous a derivatives blow-up was to the fragile and interconnected US markets, Greenspan pulled out all the stops and inflated MZM at an annualized 43% rate.  In the following months, as the US stock markets thrashed around, the Fed blitzed the economy with added money as is evident in the rising blue 10-week moving average shown in the graph above starting after the LTCM crisis monetary inflation spike.  The Fed continued inflating for much of the remainder of 1998 and a lot of that money eventually ended up feeding the already huge US equity bubbles and driving stellar stock prices to even higher extremes.  After LTCM began to fade into the horizon, the Fed carefully tried to rein in its inflation and the blue 10-week moving-average began to trend down until Y2k.


While people tend to look back and laugh at the Y2k scare now, it was frightening at the time and the potential for chaos was very real.  Even the US government and the Fed were very concerned, and Greenspan began inflating MZM again at very high rates to attempt to stave off potential bank runs if more than a percent or two of Americans decided they wanted to cash out their fractional-reserve bank accounts.  In the hectic last week of December 1999, Greenspan and crew inflated MZM at an incredible 35% annualized rate.  The Fed was not prepared to take any chances with Y2k and once again deluged the economy with liquidity.


In the graph above, the Y2k event is marked by a clear spike in both the raw yellow annualized MZM data and the blue 10-week moving average of the annualized MZM growth rate.  Just like the money thrown at the system for the LTCM debacle, the Y2k capital injections slammed into the US equity markets and spurred the NASDAQ bubble on to its ultimate terminal apex in early March of 2000. 


Just as Isaac Newton had wisely discerned in the physical world centuries ago, actions in the financial world cause reactions, they have consequences.  When new money is created out of thin air, it eventually has to migrate somewhere.


Fiat money newly created by the Fed, once unleashed in the monetary pipeline, cannot be called back and eventually sloshes into some part of the economy.  Paradoxically, when those funds find their way into certain tangible things, like gold or oil or consumer goods, the US government and the Fed cause vast market worries about impending inflation.  On the other hand, if that very same newborn money migrates to the politically-correct investment arenas like tech stocks or residential real estate, the Fed is hailed by Wall Street like a conquering hero.  Go figure.


As we plunge ever deeper into our inflationary journey, please realize that both the LTCM debacle in 1998 and the Y2k scare in late 1999 were considered very serious market and financial problems at the time.  Take another look at the graph above and note the inflationary spikes that can almost be viewed as a measure of panic by the Federal Reserve.  Its motto could be, “When in doubt, inflate.”


Unbelievably, the Fed’s totally promiscuous and inexcusable monetary deluge in 2001 BEFORE the attacks made its inflationary antics during previous crises look like amateur night for the Fed’s financial crisis management team.  While our economic growth in the US officially languished near zero and the perma-bulls on Wall Street and the financial media relentlessly pressured Americans to “invest for the long haul” while they lost TRILLIONS of dollars worth of scarce capital, the Fed was inflating at a mind-boggling rate.


Note the large yellow inflationary spikes of the “2001 Fed Panic” circled with the gray-dotted oval above.  Provocatively, if these spikes are graphed next to the NASDAQ, the Fed almost always seems to be running its proverbial printing presses in desperate futile attempts to bailout the bleeding and whining NASDAQ speculators.  Perhaps we will further explore in a future essay how Fed MZM inflation tracks NASDAQ swoons incredibly well in 2001.


In the great Fed Panic of 2001, marked by seven frantic rate cuts for 300 basis points BEFORE the attacks, the Fed breached extreme MZM inflation levels at a 50% annualized rate not once, but twice!


The most astounding feature of the 2001 Fed Panic, however, is that the blue 10-week moving average of annualized MZM growth hovered around 25% for many weeks in early 2001!  25%!?!  Holy cow!  While the wizards at the Bureau of Labor Statistics kept telling Americans, “No, it is your imagination, prices are not going up and the cost of living is stable.  Trust us.”, the Fed was launching its most aggressive inflationary assault on Americans in decades.  While anyone who feeds a family and lives in the real world feels the painful bite of rising monetary inflation, the government calmly assures Americans that inflation is dead.  What a crock!


Incidentally, this is the same Bureau of Labor Statistics entrusted with the CPI that told us unemployment stayed flat in September 2001, even through the attacks and massive layoffs.  No joke.  In August, the BLS reported 4.9% unemployment.  In September, the month of the attacks, the BLS told us that 199,000 US jobs were lost, the largest monthly drop in more than a decade.  Yet, the official headline September unemployment number was 4.9%, the EXACT SAME AS AUGUST!  It continues to utterly blow our minds that any investor with an IQ over 80 still believes these government clowns and their fantasy statistics.  We digress. 


The whole inflationary bubble of 2001 marked by the blue line above totally dwarfs the large LTCM-spurred inflationary binge and the much smaller Y2k inflationary extravaganza.  Even before the terrorists altered the course of history, the Federal Reserve was obviously deep in panic mode and creating unbacked fiat dollars at banana-republic type inflationary rates that defy rational explanation.


After the 2001 inflationary bubble began to wane in August, 300 tons of jet fuel was mercilessly slammed into the sides of the World Trade Center towers and the whole US financial world literally shut down, digesting the surreal events in stunned silence.


Following the 9/11 message from radical Islam, the Fed ramped the MZM money supply like it was Armageddon, pumping out MZM money at a breathtaking 168% annualized growth rate!!  Surely socialist Keynes is rejoicing in his grave.


In actual dollars, MZM grew by $172b between September 10 and September 17.  For any mathematically-challenged central bankers that may be reading this, that is roughly $25b per day, over $1b per HOUR. 


For comparison purposes, realize that the ENTIRE M1 money supply of the United States of America in 1966 was less than $172b.  While it took the US government and eventually the Fed, after it usurped the monetary helm in 1913, almost 200 years to inflate the narrow money supply of the American people to $172b, the Alan Greenspan Fed was so utterly terrified of financial collapse following the WTC collapse that it injected $172b into the US financial system in ONE WEEK!


As we marvel at this enormous MZM inflation the Fed has carelessly embarked upon, the criticism can be advanced that annualizing weekly changes is misleading.  The argument, which is valid, states that outlying data spikes like the shocking 168% annualized MZM increase after the terrorist attacks are leveled out through subsequent lower inflation weeks.  In order to address that concern, we prepared another graph.


Our second graph uses the exact same MZM dataset as above, direct from the bowels of the Federal Reserve, but it computes the year over year change in the US MZM money supply.  For instance, if the MZM is 10% higher today than it was in the same week last year, than the figure shown in the graph is 10%.  It shows the real actual growth of the MZM money supply in the US over a year.  It is unarguably the most conservative possible measure of monetary inflation and is virtually unassailable by arguments claiming it is too aggressive of a way to present the data.



The same crises we discussed above are also marked in this graph.  Both the LTCM inflationary bubble and the Y2k inflationary spike are quite evident in this far-more conservative graph.


The great Fed Panic of 2001 is even more apparent in a simple year over year MZM comparison.  Note the extreme slope and the much higher inflationary levels reached in this ongoing 2001 panic compared to the crises the Fed attempted to manage in recent years such as LTCM and Y2k.  Well before the attack, straight-up MZM inflation since last year had blown through the 15% level, dwarfing the LTCM injection of liquidity.


It is certainly hard to reconcile a 15%+ narrow monetary inflation rate, an economy with near zero growth implying the total amount of goods and services we can buy with our money is not expanding, and a suspiciously low official CPI inflation rate under 3%.  One does not have to be a world-class economist or a market expert to realize something just doesn’t smell right here.  Of course, with the political BLS foxes guarding the US statistical hen house, anything is possible, even stable unemployment through the worst US September in history.


In the graph above, note the gray dotted line around 7.5% monetary growth that is the absolute floor of Fed monetary inflation of the MZM since 1998.  The BLS reported CPI numbers that were ALWAYS far lower than this and often hovered around 2% during the same period.  Once again extreme monetary growth does not match the popular market conceptions that inflation is hovering on the edge of extinction.   


If you believe, as we do, that the Fed reacts to every potential crisis by simply turning on the monetary taps, flooding the system with funny money, the slope and magnitude of the 2001 Fed Panic indicates that the US financial system was in horrible shape in 2001 well before the Mohammedan terrorists exported their filthy seventh-century Arabic holy war to America’s shores.  After that fateful day, however, the Fed rocketed MZM up to a level approaching 20% higher than it was one year earlier.  Unreal!


But, according to Wall Street and the US government, inflation is dead!  LOL (laughing out loud)


Interestingly, the MZM inflationary rocket after the terrorist attacks simply takes inflationary growth back up to its trend line that was already well-established in 2001.  The blue arrow above follows that trend and the arrowhead marks the intercept of a renewed surge of MZM inflationary growth with that existing trend line.


MZM growth literally exploded after the terrorist attacks, but the Fed had been languishing in wholesale panic mode the entire year of 2001.


Just as an undersea earthquake is only perceived by a few people with highly-specialized seismic equipment when it happens, only a few investors have taken the time to dig into the Federal Reserve monetary data and realize a monetary tectonic event has occurred.  The investing masses living on the idyllic coastlands surrounding the financial ocean where an undersea monetary quake occurred will have no idea something has happened until the inflationary displacement wave later slams into the shores and sweeps those away who have not evacuated their capital. 


Today, very few market participants, big or small, are paying any attention to extreme Federal Reserve monetary inflation in America.  Just as Newton predicted an action will cause a reaction, the inflationary tsunami spawned by the panicking Fed WILL slam into the shores of the US financial markets.  The displacement of money has already occurred, the monetary tsunami has been set in motion, and no force in the world can revoke it or stop it from hitting the financial shores.


The best that investors can do after this monetary quake is to try and discern where the inflationary tsunami will hit and how to make preparations to both shelter scarce capital from its impact and profit from its raw force.


The Fed no doubt hopes that the newly created fiat money will once again stampede into the equity markets, similar to 1999 and 2000.  This would take enormous heat off the Fed and give Alan Greenspan a small window of opportunity to retire as a loved man like he was as his equity bubble grew rather than the loathed man he has become since his bubble burst.  Some would claim the inflationary tsunami is already hitting US shores and causing the massive equity rally we have witnessed since the lows after the attacks.  Maybe they are right, but we really doubt it.


Bear markets in equities are punctuated with the record-setting rallies.  In order to lure-in as many bullish investors as possible to their doom, the bear market must allow great hope to build in the midst of its mauling.  The way to accomplish this is through huge rallies, often sparked by short-covering on technically oversold conditions and then continued by die-hard bulls who become convinced we have “Seen THE Bottom” and don’t want to miss the great “bullish” action.  This current rally unfolding as I am writing this essay has “bear market rally” stamped all over it as US equity valuations remain fundamentally grossly overvalued based on the earnings and cashflow they can spin off.


Because equities remain so overvalued and have already fallen so far thus rendering many equity perma-bulls into financial hamburger, we don’t believe the inflation tsunami will slam into this market once again, Greenspan and Wall Street hopes and dreams notwithstanding.  Also, with the US dollar languishing under the inflationary and low-interest rate onslaught, we believe foreign investors will increasingly sell their US equity and debt holdings and repatriate their currencies or migrate to other non-dollar currencies in order to avoid the continuing slide of the US dollar.


Where else can the newly born fiat money go?


The bond markets are not a good idea, as the Fed has declared open war on bond investors by pushing real interest rates negative, something we have not seen since the 1970s.  We discussed this momentous event in depth in our earlier essays “Real Rates and Gold” and “Investment Capital Under Siege”.


The dollar is falling, the equity markets in the US are in serious trouble and remain way overvalued, and the Fed has killed the incentives for buying bonds.  As the inflationary tsunami prepares to slam into US economic shores, the usual destinations for capital remain on the highly-risky open coastline.  Both bonds and stocks hate inflation as it reduces their potential real returns and causes investors to flock to the ultimate inflation refuge of gold.


To the amazement of the throngs of gold bears, gold did not give up its post-attack gains in the weeks following the attacks.  We believe part of the reason this is occurring is the rapidly increasing global investment demand for gold.  Evidence of this trend is everywhere, from COMEX trading results to anecdotal reports of legions of Americans buying gold who have never even considered it before.  Foreign investors as well are flocking to the Ancient Metal of Kings, as it has had many millennia of unparalleled success in preserving and enhancing precious and scarce investor capital through inflationary episodes of history.


As the Fed incessantly pours more inflationary jet fuel on the fires of dying US equity bubbles that should simply be left to burn out on their own, the damage to the markets will increase dramatically.  Smart money is already migrating into gold, and the latest MZM inflationary data shows it is well-justified in seeking a tangible hard-asset refuge to weather the coming inflation tsunami.


As the brilliant Sir Isaac Newton sagely pointed out, every action has an equal and opposite reaction.  The Fed decided to shake the monetary sea floor.  The quake has already happened and the monetary displacement wave is rapidly hurtling outward ready to slam into the shores of the fragile US financial markets.  As the inflation is out of the monetary pipeline and already a done deal, there is no backing out and no way of avoiding the ugly consequences.  The damage the reckless Fed inflation ultimately wreaks on US financial assets could be extraordinary.


Rather than nervously waiting on the formerly prosperous yet fragile financial market coastlands for the inflation tsunami to hit, prudent investors worldwide are climbing to the rocky and safe highlands to ride out the coming inflation tsunami in their golden fortresses high above the lethal inflationary waves.


Adam Hamilton, CPA     October 5, 2001     Subscribe at