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In a heated debate on the February 1st episode of CNBC's "The Kudlow Report", financial
commentator Donald Luskin offered his "textbook" definition of
inflation as "an overall rise in the general price level." I
countered with the "dictionary" definition. My 1988 edition of
Webster's Dictionary defines inflation as follows: "An increase in the
volume of money and credit relative to available goods, resulting in a
substantial and continuing rise in the general price level." [Emphasis
added.] These differences are not academic and go a long way toward
explaining why economists argue so vociferously.
In an inflationary environment, general prices tend to
rise, although particular market segments tend to do so at uneven rates. This
is hardly controversial. The more disputed question is why prices rise in the
first place. As Luskin is well aware, the US Dollar is backed by nothing but
confidence and perception. Its value depends upon our collective belief in
its current and future purchasing power, and the hope that its supply will be
restricted. When its supply is increased, users of the currency lose faith in
its buying power and prices rise.
As a corollary, if dollar-holders believe that the US will
have no choice but to monetize trillions of dollars of Treasury debt in the
near future, the currency will falter. In this manner, currencies that are
backed by nothing but confidence tend to behave like stock prices. The share
value of a corporation represents the strength of the company. Likewise, the
value of a currency represents the strength of a sovereign state.
Looked at through this prism, the fate of the US dollar in
the future may not be all that different from the fate of Enron shares in
2001. In the 1990s, Enron was one of the most respected corporations in
America, and the share price soared. But once the accounting scandal broke,
and Enron's profits were proven to be illusory, the purchasing power of its
shares plummeted. Eventually, the shares became worthless.
The shares did not collapse simply because Enron issued
more shares and diluted value. The big change came when investors lost faith
in Enron. Likewise, the US dollar may lose value because of garden-variety
dilution, but the real leg down will occur if holders of US government debt
lose faith that they will be paid in full. Even if there is the mere
perception such an outcome is likely, it will cause the dollar to tank and
aggregate prices to rise.
The Fed and Treasury have set out on a deliberate strategy
of creating inflation in order to monetize most of the $14.1 trillion
national debt-- a debt that is growing by well over a trillion dollars per
year!
The charts tell the tale. There can be little doubt that
the dollar is being debased. The graph below traces the growth of the
monetary base, which consists of physical currency and Fed bank credit:
 
No doubt here. The supply of high-powered money has
exploded.
But it is not only the monetary base that has expanded;
take a look at M2, an aggregate of money and money substitutes:
Since the recession began in December, 2007, the M2 money
supply has increased by over 18%.
Next is the chart of the CRB Index, a group of 19 commodities
used to track the overall price of raw materials:
The index clearly shows a strong trend upward, suggesting
a general loss of value by the USD.
Yet, for my money, the trajectory of gold prices is the
best yardstick to measure that value of the dollar. Below is a ten-year chart
of the dollar price of gold. It is self explanatory.
Now, let's look at some charts of the US dollar vs. other
fiat currencies.
Here's a two-year chart of the USD vs. the Australian
dollar:
Here's a two-year chart of the US dollar vs. the Canadian
dollar:
Finally, a two-year chart of the US dollar vs. the
Japanese Yen:
Most dollar defenders point to the relative stability of
the hallowed Dollar Index, but this only points to a deep flaw in that index;
namely, it contains such a high percentage (58%) of the equally challenged
euro that it vastly understates the dollar's weakness.
In our recent "Kudlow Report" debate, Luskin
claimed that rising commodity prices no longer provided good inflation
signals, saying that "for the last decade or so, the canaries [commodity
prices] that we're using in this mine shaft just aren't functioning
right."
I'm not sure why Luskin has decided to stop relying on
market prices to determine the rate of inflation. Apparently, he now prefers
dubious inflation metrics provided by the very government that creates the
inflation. This is equivalent to trusting Enron's bookkeepers over an
independent audit. For a smart guy, such faith is surprising.
By contrast, US dollar-holders around the world are
increasingly losing faith in our currency and our government. They are tiring
of the Fed's 26-month marathon of zero percent interest rates, and the
Treasury's ballooning balance sheet. They are fearful that their bonds cannot
withstand the twin threats of devaluation and default. That's why the dollar
is losing its reserve currency status and inflation rates are rising. But
hey, at least Luskin can keep the faith - I just hope he doesn't mind being
the only one.
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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