Money Supply Wallpapering Over Deteriorating Economy
In the past few days alone stocks have had to ignore a spate of bad economic data. For example: Durable Goods Orders for capital expenditures fell 1.1% in September; Pending Home Sales plunged 5.6% last month and were down four months in a row; and the ADP Employment Report for October showed that just 130k private sector jobs were added last month. This is just a small snapshot of the overall data that clearly shows the economy has been growing below trend at best.
However, despite falling home sales, durable goods orders, and disappointing employment trends, the stock market is powering higher. In fact, not only are investors undaunted by the anemic economic data but they are enthused to the degree that it has sent NYSE margin debt to an all-time record high.
It should be abundantly clear to any unbiased observer that the Fed has succeeded in creating an economy fueled by debt, money printing and asset bubble creation. And, as history has clearly demonstrated, any such economy based on those conditions eventually falters.
Unfortunately for us Americans, Washington is merely proposing snake-oil solutions for the economy. The elixirs prescribed are the Affordable Care Act and more Fed-induced inflation.
Obamacare is projected to force about 80% of the 14 million consumers who buy their insurance individually to get a cancellation notice because their current policies do not meet ACA mandates. These individuals (who are mostly small business owners, the generators of job growth) will see an increase of nearly 100% on average for their new premiums. Obamacare will also thrust over 25 million people on to the health care system through government assistance. Providing premium support for millions of individuals will place a huge burden on debt and deficits that are already at a disastrous level. And placing more than 25 million individuals onto the health care grid without increasing the supply of health care can only serve to drastically push the cost curve up instead of down. Obamacare will not fix the economy; rather, it will only exacerbate its decline.
Adding to the health care woes is the view on the part of the Fed that inflation will be our panacea. The NY Times reported recently that President Obama’s nominee to head the Fed, Janet Yellen, believes a little inflation is desirable when the economy is weak. Economists like Yellen maintain that rising prices help companies increase profits and rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly. The article stated that some prominent economists desire inflation to rise by 6% for several years! It also quoted Charles Evans, President of the Chicago Fed, who went on record saying, “Let me just remind everyone that inflation falling below our target of 2 percent is costly,” And, the paper quoted Fed Chairman Ben S. Bernanke saying, “The evidence is that falling and low inflation can be very bad for an economy.”
However, the truth is inflation destroys profit margins, as the costs for crude and intermediate goods tend to rise faster than finished goods. The view that rising wages should come from inflation is faulty as well. Rising wages should be the result of increased productivity and not from depreciating money. The fact is that salaries tend to fall in real terms when overall prices are rising. Also, as the article stated, inflation does encourage consumers and governments to take on more debt; but this is exactly the wrong approach when the overall economy is in drastic need of deleveraging. Deflation causes asset prices and debt levels to fall. And, as a result, the end product is a rising standard of living and a viable economy.
But be assured our central bank won’t quit expanding the supply of money and credit until inflation is well entrenched into the economy. If QE alone doesn’t serve to dramatically expand the money supply the Fed may force banks to lend the excess reserves by relaxing capital requirements and/or through charging interest on those reserves.
Unfortunately, the bottom line here is to look for health care costs to soar, debt and deficits to rise, inflation to surge and economic growth to falter. Investors should prepare their portfolios first for a massive increase in asset bubble levels first and then for economic chaos to follow.