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It
seems the Fed has given up on the idea that the country can build a viable
and stable economy through the conventional means. Instead, our central bank
has resorted to once again growing GDP and increasing employment by the
creation of asset bubbles. This is a dangerous game that no one, least of all
the Fed, knows how to play.
We
learned this past Wednesday that the FOMC decided to increase its purchases
of longer-dated Treasuries by $600 billion within the next eight months. That
means the Fed is on course to fund about 75% of our annual deficit! Such
figures are the stock in trade of banana republics. While most of the rest of
the world is fighting inflation and strengthening their currencies, we are
doing everything in our power to end the dollar's status as the world's
reserve.
Canada,
China, India, Brazil, and Australia have all recently taken steps to raise
interest rates and/or curtail bank lending. Compare that to the US, which has
left interest rates at near-zero for almost two years. While other central
bankers are tamping down expansionary rhetoric, Fed Chairman Bernanke is on
record saying that he will do everything in his power to push up inflation
(which he considers too low) and dilute the dollar. Foreign central banks and
other investors may soon reconsider their plans to park cash in
dollar-denominated assets. In fact, there has been a series of angry
statements from top economic policymakers in Beijing, Berlin, Moscow, and Sao
Paolo that show rising discontent with Washington.
The
Fed rationalized its decision to upset the global monetary order in a
November 4th op-ed by Chairman Bernanke entitled, "What the Fed did and
why." Here's an excerpt:
"Although
asset purchases are relatively unfamiliar as a tool of monetary policy, some
concerns about this approach are overstated. Critics have, for example,
worried that it will lead to excessive increases in the money supply and
ultimately to significant increases in inflation. Our earlier use of this
policy approach had little effect on the amount of currency in circulation or
on other broad measures of the money supply, such as bank deposits. Nor did
it result in higher inflation. We have made all necessary preparations, and
we are confident that we have the tools to unwind these policies at the appropriate
time. The Fed is committed to both parts of its dual mandate and will take
all measures necessary to keep inflation low and stable."
But
the facts contradict Bernanke's claims that monetary policy has not pushed up
inflation. The Fed began the current round of accommodation in September of
2007 with a 50 basis point reduction in the Fed funds rate. At that time, the
M2 money stock was $7.40 trillion. It has since jumped 18.5% to $8.77
billion. This increase is showing up in the form of higher prices.
The 19
commodities that make up the CRB Index have soared 55% since the beginning of
2009. Unless the Chairman desires to return to an environment where oil is
trading at $147 a barrel, these surging commodity prices are already placing
consumers and corporations under inflationary duress.
Here's
where the danger lies ahead. Before the recession began in 2007, the ratio
between M2 and the monetary base was about 10:1. If the Fed sticks to its
announced schedule, the size of the base should grow from $1.96 trillion to
about $2.6 trillion by June of 2011. Once banks start lending again and
expanding base money through the fractional reserve system, M2 could increase
exponentially. An increase in the money supply to $26 trillion (in line with
the historic 10-to-1 ratio) would result in a major inflationary shock.
However, even if the money multiplier were to remain much lower, the M2 money
stock would still be much higher than today. In fact, the compounded annual
increase of M2 in the last 4 weeks is currently over 9%.
Unless
Bernanke has a "road to Damascus" moment, the money supply will
continue to grow and inflation will accelerate over the course of the next
few years. To make matters much worse, the interest expense on the nation's
debt could reach over 40% of all revenue by the year 2015.
Faced
with negative real interest rates, rapidly rising inflation, and a
chronically weak dollar, foreign holders of US Treasury debt and other
dollar-denominated holdings may begin to lose their nerve. They may start to
repatriate their savings and thereby send Treasury yields soaring. The Fed -
which is the Treasury's buyer of last resort - will then be faced with a
perilous decision. The central bank will have to either join foreign sellers
of US debt in sending interest rates higher (in the hopes of giving the
dollar some footing and allowing high rates to encourage the return of real
buyers) or ramp up the printing presses to keep the long end of the yield
curve from spiking. It should be obvious that the Fed has already made that
decision. They will never allow rates to rise. The debt will be monetized.
I have
no doubt that Bernanke will be remarkably successful in his stated goal of
driving inflation higher. I simply disagree with his nonchalance about the
long-term consequences. There is currently no easy exit strategy for the Fed.
There is only the prospect of Americans suffering through either a
deflationary depression or hyperinflation. To survive such storm requires
careful planning. If only we could convince the big chief to stop doing his
rain dance...
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A
15-year industry veteran whose career began as a trader on the floor of the New
York Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
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