The Feds Have No Faith in Recovery

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 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.

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

 

Comments

[steppenwolfsayshi]

I have heard some people say that an increase in interest rates would be the best thing for the housing market because they think it would help people obtain mortgages, since they think its too unprofitable for banks to give them out. Housing prices have decreased enough in some parts of the country that people are ready to buy but they can't get loans. The new home-buyer tax credit doesn't seem to be doing much and people aren't able to refinance at the lower rate anyway. I guess policy-makers know what their doing, maybe, maybe

[ziploked]

What are you talking about? The recession has ended, if you live on Wall Street, that is. Isn't that what Capitalism is ultimately about? You can't have the rich getting richer without the poor getting poorer--if history is any indicator.

[sposton]

I am starting to think that capitalism itself is the biggest fraud perpetrated on human race, a rapidly maturing giant Ponzi scheme. You get a clear impression that the corporatocratic magicians are desperately trying to pump some new life into this dead scheme. It may take ten years, twenty years,... whatever, but I think the end is coming. The whole thing seems unsustainable to me.

[DuganS1]

Take a look at how socialism and communism did from 1980-1992. Poland, for example, saw GDP drop 6% in 1980, another 10% in 1981, and another 4.8% in 1982. That's far and away worse than what the US is experiencing. For Poland, that was a depression. Then in 1990 saw a drop in GDP of 7% in 1990, and then another 7% drop in 1991. That's another depression. Plus, those are in constant prices in their own currency, which doesn't take into account the massive drop in their currency relative to the Western currencies. They've only begun to have strong economic growth after they became a capitalist country.

http://www.economywatch.com/economic-statistics/Poland/GDP_Growth_Constant_Prices_National_Currency/

For the Soviet Union, it was even worse. In 1990, GDP was down 4.7%, in 1991 down another 6%, in 1992 down another 14.56%, in 1993 down another 9.75%, in 1994 down another 13.98%, in 1995 down another 5.27%, in 1996 down another 3.6%. The country had positive GDP growth in 1997 for the first time since 1989. That is the utter disaster of communism. The economy completely collapsed and the communist regime was over-thrown.

[guard]

The word "capitalism" is so misused that it no longer means anything. The centralized control of the economy through the Federal Reserve and commercial banks is more like communism or perhaps fascism, than anything resembling capitalism. The whole thing is quite directly government enforced and controlled.

[sposton]

We fight effects of a bubble with another bubble. What happens when this one bursts? We have equity bubble, housing bubble, east Asian bubble,... One of these will let go sooner or later and the biggest bubble in history - the US $ will finally burst itself into irrelevancy. Our standard of living is heading the Argentina way. ;-)

[greyhound2]

The new word is "Jobless Recovery". What does that mean? How can you have a recovery which is jobless? It is part of the new double-speak of two opposing words which contradict each other. Great article.

[gorgol]

With derivatives gambling...in the TRILLIONS of Dollars....you can have a "recovery" without anyone working...just look at Wall Street now. Its behaving like we're in a economy racing like a locomotive
Its all in computers...its all FAKE.

[ImmanuelGoldstein]

You are right, it's downright Orwellian,it's impossible to have a sustainable 'recovery' without job growth in a society with 70% of spending consumer based and when thw overwhelming majority of the population gets it's income from wage labor.