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By
its very definition, fiat money is something created out of thin air: the
word "fiat" is Latin for "let it be done" (as in, by
decree). But the convenience that such a currency system offers central
bankers is paid at the expense of savers.
With
nothing of real or lasting value on which to anchor, the value of fiat
currencies can always blow away like ashes on a windy day.
For
the past 40 years or so, every country on the planet has relied on fiat
money.
To
a very large extent, this means that the national economies are far more
exposed to the whims of their central bankers than they have been in the
past. So, if central bankers go off their meds, the danger to the currency
becomes profound. Unfortunately, at America's Federal Reserve, it seems the
inmates are now running the asylum.
We
are being led to believe that falling prices are evil, and that only an
increase in inflation can save our economy. From the moment the financial
crisis took hold in 2008, Fed Chairman Ben Bernanke has looked to lower the
dollar's value and cause asset prices to rise - especially in real estate.
But his pitch is wildly off the mark. The Fed can't control the exact rate of
inflation, nor can it direct where inflation will be distributed across the
economy. In other words, inflation is like a knuckleball: once you let it
loose, you're never really sure where it's going to go. And Bernanke's
pitches are so wild it would make Tim Wakefield jealous.
Thus,
we are seeing rising prices everywhere except where Bernanke really wants
them - real estate. Data released last week shows that the median price of
existing homes declined 5.2% in February compared to the previous year, to
$156,100. New home prices fared even worse; the median sales price dropped to
$202,100 in February, from $221,900 a year earlier - a tumble of some 9%!
However,
commodity prices provide the arena in which the the
Fed's lack of inflation control becomes most apparent. So far this year, gold
is up over 4% and the CRB Index is up 8%.
Meanwhile,
over the same period, the dollar has dropped over 4% against other fiat
currencies, according to the Dollar Index. This has occurred despite global
economic developments that would normally benefit a currency that has
"reserve" status: Japan, the world's third largest economy, has
been taken off-line due to a catastrophic earthquake; the EU is facing
another massive bailout bill as Portugal failed to pass austerity measures;
and, a sandstorm of destabilizing revolutions is sweeping through the Middle
East. Yet, instead of providing a safe haven for skittish capital, the dollar
has recoiled.
It's
really no wonder that faith is waning. As the dangers of inflation become
increasingly apparent, there is still no prospect for a change in policy any
time soon. By all reasonable accounts, commodity prices will continue to
surge as real interest rates continue to fall. Right now, the yield on the
one year T-bill is .23%, while the YoY increase in
inflation is 2.1%. And this is using the government's twisted figures!
I
estimate real interest rates are somewhere close to -8.75%. Therefore,
investors are being thrust into the arms of precious metals and away from
dollar-based assets.
There
really isn't much choice.
However,
since the real estate market was in a prolonged and lofty bubble, it will be
the last asset class to respond to the Fed's dollar debasement strategy.
Although Bernanke is noted for his Great Depression scholarship, it should be
obvious by now that he never spent much time studying asset bubbles. If he
did, he would have learned that gold took decades to recover from its crash
in 1981. The NASDAQ is still 45% below its all-time nominal high set over a
decade ago. And, unlike housing prices, these markets were allowed to clear
themselves after their respective crashes.
Prices
dipped more than 70% before turning north in earnest. In contrast, home
prices are being kept in a rump bubble by Fed stimulus. Amazingly, since 40%
of the core CPI is owner's equivalent rent, Bernanke will continue to miss
the mark about the true level of the inflation he has created.
The
aftershock of the real estate bubble has sent millions of homes into
foreclosure, left 11% of homes vacant, and caused 23% of mortgage holders to
be without any equity in the home. Unless the Fed starts to create credit to
buy houses directly off the market, it will be very difficult to get real
estate values to move higher.
It
is clear that by trying to channel his inflation into just one asset class,
Bernanke has placed the entire US economy in severe danger. He now faces a
serious conundrum.
Does
he raise interest rates significantly to fight inflation at the cost of a
second housing market collapse, or does he sit idly by and watch the broader
economy become as unaffordable as a resetting Option-ARM mortgage? Neither
choice is pleasant, but one thing's for sure: if the bond vigilantes start to
raise interest rates for him, we'll know his knuckleball missed the strike
zone.
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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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