Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21
Bitcoin Halvings Price Forecast and Stock to Flow Analysis - 18th Jul 21
Dell S3220DGF Unboxing and Stand Assembly - 32 Inch 165hz Curved Gaming Monitor Amazon Discount - 18th Jul 21
What Does The Fed Mean By “Transitory Inflation” And Why Is It Important To Understand? - 18th Jul 21
Will the US stock market’s worsening breadth matter? - 18th Jul 21
Bitcoin Halving's Price Projection Forecasts Trend Trajectory - 18th Jul 21
Dell S3220DGF Price CRASH to £305! 32 Inch 165hz Curved Gaming Monitor Amazon Bargain - 16th Jul 21
Google, Amazon and Netflix are Scrambling For This Rare Gas - 16th Jul 21
Sheffield Millhouses Park New Children's Play Area July 2021 Vs Old Play Area - Better or Worse? - 16th Jul 21
Inflation Soars, Powell Remains Unmoved. What about Gold? - 16th Jul 21
Goldrunner: Gold Could Jump To $1,900-$2,100 In Next 30 days – Here’s Why - 15th Jul 21
Tips For Finding The Right Influencers - 15th Jul 21
ECB Changed Monetary Strategy. Will It Alter Gold’s Course? - 15th Jul 21
NASA And Big Tech Are Facing Off Over This Rare Gas - 15th Jul 21
Will the U.S. Dollar Lose Momentum In the Second Half of 2021? - 15th Jul 21
Bitcoin Stock to Flow Model Forecasts Infinity and Beyond! - 14th Jul 21
Proteomics: The Next Truly Massive Investing Opportunity - 14th Jul 21
Massive Solar Storm to Hit Earth 2025, Coronal Mass Ejection (CME) Danger and Protection Solutions - 14th Jul 21
Is This The Best Way To Play The Coming Helium Boom? - 14th Jul 21
Meet SuperMania and its Ever-Present Sidekick, SuperMeltdown - 14th Jul 21
How NFTs Are Shaking Up Arts Trading - 14th Jul 21
Gold: High Time to Move Out of the Penthouse - 13th Jul 21
Climb Aboard! Silver Should Run Up To $38 In Next 30 Days - 13th Jul 21
How Will Remote Work Impact the U.K. economy? - 13th Jul 21
Why Helium Stocks Are Set To Soar in 2021 - 13th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Hopelessly Devoted to Inflation

Economics / Inflation Aug 12, 2014 - 07:14 AM GMT

By: Michael_Pento

Economics

In the middle of July the stock market finally awoke from its QE-induced coma and realized the Federal Reserve’s tapering, which has been going on for the last six months, was for real.  Like a child, who becomes accustomed to a parent that threatens punishment but never follows through, the market had been in denial to the Feds withdrawal of monetary stimulus. But now, thankfully, the ending of Fed asset purchases will be the pin that pops this QE-inflated market and economy.  But please do not confuse the end of QE with the Fed actually fighting inflation and selling trillions of dollars’ worth in Treasuries and mortgage backed securities (MBS)…because that will never happen.


The Fed has increased its balance sheet by an unprecedented $3.5t since 2008. They accomplished this by purchasing Treasuries and MBS from banks in exchange for Fed credit.  A credit from the Federal Reserve is a nuanced way of saying “new money”.  This new money is transferred as a credit to the banks with the idea that the Fed can and will reverse this transaction at its discretion.  Like an army releases reserves, the Fed (with the help of private banks) has marched many of these new dollars into the economy to “save us” from deflation.  Once the job is done, the Fed intends to call these dollars back and shrink its balance sheet back to pre-crisis levels.  This all sounds great in theory, but as we will soon see, the practical applications of shrinking the Fed’s massive Balance Sheet has become impossible without creating a monetary depression.  

For the past few years, the central bank’s credit and inflation has been predominantly deployed in bonds, real estate and equity assets. However, recently this new money has leaked into the government’s manipulated CPI calculation. Therefore, our government can no longer promulgate the lie that inflation is some elusive goal that it cannot achieve. And, the argument that stronger economic growth is around the corner in a context of low inflation has been fully debunked. That is why the market sold off last week. In a word, it is inflation. The Employment Cost Index (ECI) component in the GDP data put the Keynesians on “high wage inflation alert”.

But, most will be blindsided by the temporary period of deflation that will result from the end of the Fed’s massive asset purchases, as the monetary spigot for the primary beneficiary of the Fed’s credit--namely stocks and bonds—gets turned off. 

Similar to the housing market in the mid-2000’s, we are about to relearn the lesson that many equity investors (especially those on margin) can only afford to hold on to an asset when prices are rising. 

However, on the other end of this cyclical period of deflation, lies a period of inflation that will make the ‘70s seem like an era of hard money.  The reason for this is in order to fight inflation the Fed will have to bring home trillions of those “money troops” it sent into the economy.  Calling the money back is going to be far more difficult than it was deploying it. 

When the Fed buys Treasury debt, most of the interest payments made go back into the government’s coffers.   In fact, by law the Treasury has claim to all income derived from the Federal Reserve; less expenses.  So the Treasury pays the Federal Reserve an interest payment and in return receives most of that payment back.  This is a pretty good deal for the Treasury, considering the Fed’s profit is in the neighborhood of $91 billion a year.  This means the Treasury not only didn’t have to find a real buyer for the newly issued debt but it also did not have to worry about paying interest on that debt.

But, it gets even better--as the bonds mature, the Fed has been rolling over the principal. Therefore, it is as if the $2.4 trillion of newly issued Treasury bonds sold to the Fed since 2008 don’t even exist. The Treasury gets reimbursed on its interest payments and never even had to worry about what the cost would be for the private market to purchase that debt.  To further sweeten the pot, the Fed has pushed rates down to unprecedented lows, leading to relatively-modest debt service payments on all of its record-breaking $17.6 trillion of outstanding debt.     

However, if the Fed wants to genuinely fight inflation, it will have to eventually raise interest rates. Ending QE will only provide temporary relief from a weakening currency. To accomplish this in sustainable fashion it will have to shrink its balance sheet back to around the same level it was prior to the Great Recession. 

How does the Fed shrink its Balance Sheet?  As we discussed, when the Fed purchases a bond from a bank it creates a credit that can be taken back at the Fed’s discretion.  Taking the credits back on a short-term basis is called a reverse repo—the Fed sells the assets back to the banking system and takes back the cash for a very limited period of time. 

But, it just cannot conduct reverse repos to the tune of trillions of dollars without putting extreme pressure on the market for private short-term loans. This means the government is not only going to have to permanently sell the over $2 trillion in bonds into the market, it will have to start paying real interest on that debt as well. And, the private market will also have to finance all the new annual deficits, which will no longer have the luxury of a trillion dollar plus annual QE program from our central bank.

The net effect of all this would be surging interest rates and a complete economic collapse. This is why I do not expect the Fed’s balance sheet to significantly contract for many years, if at all. And predict inflation will become a huge and growing problem--especially after the central bank launches another massive QE program in 2015 to re-inflate falling stock prices. 

Our government is in a horrific trap because of the record amount of debt it has issued and allowed the central bank to monetize. This is why every time the Fed tries to fight asset bubbles and bring inflation under control it will result in the creation of a monetary depression. And is also why nearly every central bank on the planet has decided the only real long-term objective is to fight against deflation and ensure inflation will always prevail.

Michael Pento is the President and Founder of Pento Portfolio Strategies and Author of the book “The Coming Bond Market Collapse.”

Respectfully,

Michael Pento
President
Pento Portfolio Strategies
www.pentoport.com
mpento@pentoport.com

Twitter@ michaelpento1
(O) 732-203-1333
(M) 732- 213-1295

Michael Pento is the President and Founder of Pento Portfolio Strategies (PPS). PPS is a Registered Investment Advisory Firm that provides money management services and research for individual and institutional clients.

Michael is a well-established specialist in markets and economics and a regular guest on CNBC, CNN, Bloomberg, FOX Business News and other international media outlets. His market analysis can also be read in most major financial publications, including the Wall Street Journal. He also acts as a Financial Columnist for Forbes, Contributor to thestreet.com and is a blogger at the Huffington Post.
               
Prior to starting PPS, Michael served as a senior economist and vice president of the managed products division of Euro Pacific Capital. There, he also led an external sales division that marketed their managed products to outside broker-dealers and registered investment advisors. 
       
Additionally, Michael has worked at an investment advisory firm where he helped create ETFs and UITs that were sold throughout Wall Street.  Earlier in his career he spent two years on the floor of the New York Stock Exchange.  He has carried series 7, 63, 65, 55 and Life and Health Insurance Licenses. Michael Pento graduated from Rowan University in 1991.
       

© 2014 Copyright Michael Pento - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Michael Pento Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in