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I've made a living out of exposing
economic fallacies, but there's one whale that I can't seem to harpoon. Even
top-flight Wall Street analysts seem to believe that the Fed's doubling of
the monetary base after the credit crunch has not had an inflationary impact
on our economy. Their logic can be summed up like so: "The money the Fed
created and dropped from helicopters has all been caught in the trees."
In other words, the Fed is creating money, but it is just being held as
excess reserves by the banking system instead of being loaned to the public.
Therefore, the money supply hasn't truly increased, there is no money
multiplier effect, and aggregate price levels are behaving themselves.
But this is only a half-truth.
Yes, most of the money created by the Fed has been kept by commercial banks
as excess reserves. However, the Fed doesn't conjure reserves by magic. It
first creates an electronic credit by fiat, then purchases an asset held by a
financial institution. Those primary dealers then deposit that Federal
Reserve check into their reserves. The act of creating money from nothing and
buying an asset -- be it a Treasury bond or Mortgage Backed Security (MBS) --
drives up the price of that asset in the open market. Those price distortions
send erroneous signals to private buyers and sellers, eventually creating
gross economic imbalances.
Therefore, the inflation created
by the Fed first gets concentrated in whatever asset it has chosen to
purchase - before spreading throughout the economy.
In the latest example of the Fed's
monetary manipulations, Bernanke & Co. purchased $1.25 trillion in MBS.
The prices of MBS were therefore driven up (and yields down). Before that,
the Fed forced the entire yield curve lower by purchasing not only Treasury
bills but also $300 billion in notes and bonds. The Fed has also recently
indicated that it will be swapping maturing MBS for longer-dated Treasury
securities in an effort to keep its balance sheet from shrinking.
While it is true that -- for now
at least -- we have been spared from the imminent curse of skyrocketing
consumer prices, thanks to the falling money multiplier, it is blatantly
untrue that the trillion-plus dollars the Fed created have been rendered
inconsequential.
Not only has the huge buildup in
the monetary base put pressure on the US dollar and caused gold to soar, but
it has also broadcast an egregious and distortive price signal for US debt
securities. The 10-year note is now trading just above 2.5%. That yield is
near its all time record low, nearly 5 percentage points below its 40-year
average, and 13 percentage points below its record high of September 1981.
US sovereign debt should only
enjoy such historically low yields due to an overabundance of savings, low
inflation, and low debt. None of those preferable conditions currently exist.
Hence, US Treasuries are the most over-supplied, over-owned, and over-priced
asset in the history of the planet! Once the debt dam breaks, it will send
the dollar and bond prices cascading lower, and consumer prices and bond
yields through the roof.
While Wall Street and Washington
are petrified of the deflation boogieman, the real menace lurking in the
shadows is the Fed's bond bubble - and it's going to eat small investors
alive.
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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