A Recovery Foundation Built on Sand

A Brief Review

Instead of allowing a cathartic and reconciling recession to run its course, the Fed decided last year to again bail out the economy by greatly expanding the money supply. In this latest case of artificial intervention, the expansion in the monetary base was a record-breaking trillion dollars, but that intervention has abated in the last few months. What should become clear fairly soon is that the apparent recovery in the markets and the economy has been built primarily on the devaluation of the U.S. dollar, not from a healing of the economy's fundamentals. That clarity will become evident once the dollar begins to make a brief rebound.

Temporary Sanity

For the last few months, the Fed has temporarily halted its assault on the greenback in the mistaken belief that the economic crisis has ended. Therefore, the most likely result will be a major correction in the market and a resumption of economic deterioration. Unfortunately, that should eventually cause the Fed to resume its misguided efforts to bolster growth by wrecking the currency. The Fed's conundrum is this: whether he is aware of it or not, Ben Bernanke needs to defend the dollar and raise interest rates to provide for a viable and long-lasting recovery. But the short-term effect would be a devastating recession which is, of course, politically untenable.

Negative Correlation between Dollar and Markets

The basis for the perceived healing has been a Fed-induced 12% drop in the U.S. dollar since March alone, which has caused the S&P 500 to rally 50% and copper to increase 80% in the same time period. It's just not a coincidence when the dollar goes down; stocks and especially commodities go up. But remember monetary policy works with a lag. The Fed has since halted the increase in the monetary base which reached $1.77 trillion in May of this year, and has now reduced it to $1.64 trillion today.

The result has been a sharp decrease in the rate of increase for all monetary aggregates. The monetary base is up 93% YOY but is down 4.2% since the beginning of the year. M2 is still up 8% from last year but up just 3.5% from January. And perhaps most importantly, the four week compounded annual rate of change in the monetary base is actually negative 26.3%!

What this means is that at least on a short term basis the dollar may be oversold and commodities and stocks overbought. We can hope that Ben Bernanke will not acquiesce to the desire to be reappointed and maintain this brief period of monetary sanity. If he behaves like Paul Volker and doesn't care about being liked, he will drain the excess liquidity and allow the severe economic contraction to run its course.

However as mentioned earlier, the most likely outcome will be for the Fed to rebuild the base in an effort to stem the coming slide in markets and the economy.

That's because we just haven't yet acknowledged the reality of our addiction to debt and inflation as the basis for economic activity. What I find most amazing about all this is how most in Washington and Wall Street fail to recognize what caused the crisis in the first place. The problem never was that there wasn't enough borrowing, consuming and cheap money around. The problem was that the level of debt in the country had become unsustainable. In fact, as a country we are still actually increasing our level of debt. Therefore, all our perceived healing was predicated on the devaluing of the dollar, not from the paying down of our obligations or a repudiation of our past behavior.

We just can't escape the day of reckoning. The country will most likely go through a devastating bought of inflation to avoid a strengthening dollar and further erosion in asset prices. However, a protracted period of deleveraging is still needed as a nation. What we need is to return to real economy based on a sound currency and reduced debt. That will certainly be painful in the short term, but the only way to provide a long lasting and healthy economy.

Michael Pento is the Chief Economist for Delta Global Advisors and a contributor to greenfaucet.com

Comments

[yappnmutt]

it does look like bernanke is trying to take the punchbowl away in anticipation of a recovery. the question is, can he?

i think he is trapped. the sheer volume of dollars already released and the amount needed to support the usa in the near future has already undermined the world's faith in the dollar as the reserve currency of the world. as the world diversifies out of the dollar there will be a lot of dollars with no where to go except into the devaluation of the dollar, inflation and much higher interest rates. the reversion to the mean will be long, painful and inevitable.

[joebhed]

Is Michael concerned about the "$USD" because changes to its 'relative' value represents a threat to our economic well-being, or because he may have a wrong $USD position.

The cause of all these problems is the DEBT-money system of fractional-reserve bankers.

We've had a huge bubble in the creation of debts. Some of the fault lies with the Fed in allowing the commercial-banking sector to become under-capitalized.
But it was the other bankers, the self-regulated non-bank bankers and the investment bankers, that created MOST of the new $USD money during this first decade of the twenty-first century. It is THEY, and NOT the Fed that created the $USD derivatives-SIV worthless-paper chase.

So, take a look in the mirror, Michael. There is half the enemy and half the cause for the need for what you glibly describe as "allowing a cathartic and reconciling recession to run its course".
We're not on board, Michael. Your accusation against the Fed is hollow and misplaced. Where's the accountability for those investment banks that are looking for the grand "reconciliation" of their accounts?

What we need is a new money system.
We want a public accountability and responsibility for our economy and an end to the boom-bust, pro-cyclical results that are necessary with private debt-money.
Government issue of debt-free money.
Bankers lend real money.
IB's invest real money.
Full-reserve is the order of the future.
The Money System Common.

[larry278]

Tell it like it is & will be. We now have a depression. Bernake & his 1/2 @$$ed ideas will make the present depression deeper & prolong the present depression. The bad news duo, Tim & Larry, must be given credit for giving Bernanke his 1/2 baked & 1/2 @$$ed ideas.

[hearmeout]

Great contribution, Michael. The focus of both the Fed and the (official) government seems to be centered on getting things back to normal while conveniently ignoring the fact that normal - i.e., a society in which every sector is thoroughly over-leveraged - is what created this mess in the first place. But hey, at least there was excellent demand at last week's auction of U.S. debt, right? As long as we don't dig too deeply into the purchase orders to learn that it was the Fed, cleverly orchestrated through a handful of primary dealers, who actually acquired 47% of the treasuries. I guess if they're monetizing the debt then what's a little expansion of the money supply amongst friends?

[Michael Pento - Huffpost Blogger]

You sir are a genius. I can't tell you how happy I am to learn that someone out there gets it. Yes, the Fed is monetizing the debt. Almost all of new money growth has come from banks buying Treasury debt. Then the Fed prints more money and buys those bonds from banks. The circle of life from the Fed's point of view. It has not come from loans to the private sector to purchase capital goods that create wealth.

[olephart]

Don't forget the morgages they bought, $1.25 trillion wasn't it?

[TruelyFedUp]

How different life would be if we lived The Venus Project in a resource based economy. No economic slavery, no war, no political puppets of big money - just your own life on your own terms. Google The Venus Project and resource based economy.

Truly

[dadw5boys]

WHAT BULL !!!!!!! THIS CRASH WAS PLANNED .

PART OF THE TRI-LATERIAL COMMISIONS EFFORTS TO BRING IN THE NORT AMERICAN TRADING BLOCK !

For the US ro form the North American Trading Block the USA's standard of living and the value of the U.S. Follar had to be lowered greatly.

Well here we are. They can crash the Economy any moment with all the BAD PAPER setting in the banks.

The cool of period is crossing the T and doeing the I of all they things needed. Look out in few months when it is coldest. They would not want anyone fighting them so they cold weather will play into their hands.

Bye Bye American Pie ~~~~

[Aaror]

Inflation will be an effective means of fixing the problem. If you have debt, it will decrease in real value, and since most Americans are deep in debt, they will all come out ahead. Only folks who are filthy rich will be hurt.

[WorkingClass]

You don't think $25 bread will hurt anybody?

[ElementalPraxis]

This phony 'recovery' ( which will be short-lived ) is built on lies and on sand. The money spent so far has been used to fortify the companies draining the economy, not on companies that want to rebuild America's manufacturing capacity.

There is no such thing as a "jobless recovery." There just isn't.
When the financial giants grow rich while the people starve, that is called "looting."

America is going through an asset confiscation phase. Money will be spent inside the US, but it will be spent to purchase assets at depressed prices from distressed sellers. There's more profit in that than in putting Americans back to work.

[dadw5boys]

The only good thing is with the Government holding seats on the boards of directors they can prevent them from crashing the economy at will by dumping the bad AAA paper in the market.

The British setup a clearing house 3 months ago for bad paper.