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The Feds Have No Faith in Recovery |
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Saturday, 07 November 2009 |
 The stock market has enjoyed a significant rally since the end of the first quarter. The Bureau of Economic Analysis reported last week that the economy grew at a 3.5% annual rate in the third quarter--a figure they achieved by that claiming inflation was running at only a 0.8% annual rate, despite a sharp drop in the dollar, a spike in commodity prices and record highs for gold.
The cyclical bull market in stocks and positive print on GDP has caused
some on Wall Street and in Washington to claim the recession has ended.
Despite all the good economic news,
an end to fiscal and monetary
stimulus is nowhere in sight, precisely because policymakers know the
happy news is artificially derived.
A closer look indicates that neither the administration nor the Federal
Reserve believes its own recovery rhetoric. They understand that the
economy will not prosper without continued life support.
I believe removing such artificial stimulus is needed so the country
can immediately begin de-leveraging and to prevent the accumulation of
yet more baneful debt. What is truly amazing is how many people on Wall
Street are foolish enough to postulate that our problems have been
solved. The stock market will not be so easily fooled for much longer.
The Great Depression Part II was narrowly averted last year by slashing
interest rates to near zero. The Fed made money virtually free because
the record level of indebtedness ($34 trillion) in the economy required
such low rates so that borrowers could service their obligations.
Otherwise a cataclysmic domino effect of defaults and bankruptcies
would have occurred. To avoid that scenario, the public sector assumed
some of the private sector's debt and then subsequently took on a
significant amount more. The debt of the nation continues to increase
at a 4.9% annual rate. All public debt is ultimately the responsibility
of the private sector to pay off--either directly or through future
taxes. As a result, the economy has never been more precarious than it
is today.
In spite of this, the stock market appears to be doing quite well.
We've seen a 57% rally off the March lows in the S&P 500. However,
if you measure the market against other assets its performance is much
less impressive. Since the beginning of 2000 the S&P is down about
50% measured in terms of a basket of currencies other than the falling
U.S. dollar. The index is down nearly 80% against the real inflation
hedge--gold!
The sad truth is that this recent market rally has been produced on the
back of a weakening dollar and the slashing of corporate overhead.
Cutting payrolls and research and product development projects are not
a prescription for sustainable growth. As I like to say, you can't burn
your furniture to keep your house warm forever. Eventually, top-line
revenue growth must emerge or Wall Street's game of
beat-the-expectations will be short lived.
It's also worth noting that a country cannot devalue itself to
prosperity and that a bull market cannot survive an inflationary
environment for long. In the short run, nominal gains in the averages
can occur since everything priced in dollars tends to increase in
value. However, the rally will be truncated unless the Fed provides
consumers and corporations with a stable currency.
The ramifications of a crumbling currency are vastly misunderstood. A
strong dollar is the cornerstone of a healthy economy. It is essential
for balanced growth and healthy investment to occur. On the other hand
a weak currency decimates the middle class and the corporate sector's
ability to maintain earnings growth. Inflation lies behind all infirm
currencies, and it is inflation that destroys the purchasing power of
consumers. The diminished value of their wallets leaves them with the
ability to buy only non-discretionary items. As a direct result,
unemployment rates soar and economic output plunges.
I believe we will suffer from a protracted period of stagflation. Money
supply, as measured by M2, has increased 5% Y.O.Y. Meanwhile the output
of goods and services is falling. As long as the money supply is
chasing a shrinking GDP pie, there will be upward pressure on prices.
Making the situation even worse is the manner in which the money supply
is growing. The quality of growth is very low because the increase in
supply is coming from commercial bank purchases of Treasury debt,
rather from an issuance of credit to the private sector for capital
goods creation. Total Loans and Leases at Commercial banks are down
8.2% from last year. Meanwhile, the amount of Treasuries held at all
commercial banks is up 20% year-on-year.
That means money supply growth is emanating from government's
misallocation and redirection of capital. It isn't being loaned out to
build mines and factories; it is instead being loaned out to increase
consumption and build even more consumer debt.
If the Treasury and Federal Reserve truly believed the economy and the
stock market were on a sustainable recovery path, talk of extending and
increasing the home buyer's tax credit would be off the table. The Fed
would already be reducing the size of the monetary base. The truth,
however, is that no one in government really believes in this recovery.
If they did, they would be hiking interest rates and the deficit would
be shrinking.
The government's realization of our precarious economic condition means
its largess will continue. Near term, that may ease some pain. So did
the artificial stimulus that gave rise to the housing boom. In the end,
a protracted period of a near-zero interest rates, along with endless
economic stimulus, will spawn another bubble and not a genuine recovery.
Source: Michael Pento, Chief Economist, Delta Global Advisors
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