One of the universal laws of economics is: when a government increases the supply of a currency by fiat, that currency's purchasing power diminishes. An absolute consequence of that action is that the nominal monetary value of most assets will tend to increase in price over time. That simple rule is the reason why I believe a short-term bottom either has likely been, or will very soon be reached in the major averages and a major secular bottom has been reached in most commodities. Why do I believe commodities have or will put in a long term bottom near today's levels? Because commodity supplies by their nature are limited and cannot be increased by decree nor can they display inflation rates commensurate with that of most currencies.
Most bears correctly believe that the policies being employed by our government will lead to an economy marked by accelerating inflation and weakening G.D.P. growth. However, the one aspect of that scenario they tend not to realize is that inflation boosts most asset classes and that includes even equities. Looking back into the history of past inflationary economies as well as those of today, you will find that the nominal value of their major indexes increased. It should be no different here in the US.
Whereas I firmly believe the efforts by our government will be pernicious for the economy in the long term, investors should not believe that global equities and commodities will perpetually be caught in a deflationary spiral. Fiat currencies rule the world and most central bankers are working overtime trying to inflate their economies into prosperity. Sadly, our Federal Reserve is a leader in that regard.
There can be little doubt that American consumers' balance sheets are under duress. Their $14 trillion in debt has now reached about 100% of annual G.D.P., record territory and far above its multi-decade average. The argument has been raised by many respected economist that since the consumer is unable to expand his balance sheet, the economy must suffer through a protracted period of deleveraging. Of course such a deleveraging process would be the only path to take in order to engender a sustainable economic recovery. But that is not the direction our government has chosen to take and they will not allow that necessary deleveraging process to run its course. Thus, it would be foolish to ignore what the Treasury Department and Federal Reserve are in the process of doing; because of their actions, our battle with deflation will only be cyclical in nature.
The reason why a deflationary depression will not occur at this time is because the consumer's balance sheet is being supplanted by the balance sheet of the government, and the government's balance sheet is unlimited. Currently, consumers may not want or be able to take on more debt. That would normally, if left to market forces, allow a deflationary environment to persist. However, the Treasury has expanded its issuance of debt, which is being bought by financial institutions. That money goes into the economy and is eventually re-deposited into the banks. The Treasury bonds purchased by the banks are then monetized by the Fed and the money supply grows. This cycle repeats and money supply skyrockets. In fact, the government has succeeded in sending the monetary base to a year-over-year increase of 28.4% and is currently growing at an annual rate of 341%! Do you really believe commodities can remain in a bear market under these monetary conditions?
The government's actions amount to an end run around the consumer. An end run can be defined as a maneuver that is used to avoid impediments, often by trickery or deceit. Unfortunately, as the government tries to "trick" the free market and the consumer, all it will end up accomplishing is engendering intractable inflation while expanding its control over the economy. However, inflation has many different manifestations and investors would be wise to show caution if believing that deflation in most asset prices (including equities) can persist much longer.
Michael Pento is a Senior Market Strategist with Delta Global Advisors and a contributor to greenfaucet.com