Chicken or egg: Does going to cash cause recessions?!

Americans have been content to keep over $1 trillion in checking accounts for the last year

Or should I say they have been desperate, because they have been earning nothing on it? The feeling before August 2008 going back all the way into the 1970s, thirty-five years!, meant Americans felt comfortable with 3 to 4-times less cash on hand for immediate withdrawal. The panic of 2008 continues.

Net balances first moved above $1 trillion in October 2013, but notably have surged to that level since August 2008 out of all proportion with the historical record. 

Why did M1 have its largest drop ever the week ending June 10th?

weekly change in $billions

June 3, 2013 to date

Did you know that the largest negative weekly change ever in M1 money stock in nominal terms occurred just recently on June 10th?

$109.4 billion was pulled from M1 the week ending June 10, 2013, which is money in circulation and the money on deposit in your checking account.

The swings in M1 money stock in June have been as dramatic as the swings were when America was attacked on 911.

Here are the figures from September 2001:

9-10-2001 + $001.2 billion

9-17-2001 + $124.5 billion

9-24-2001 -  $086.1 billion

10-1-2001 -  $034.1 billion

But look at what just happened in June:

6-03-2013 + $085.0 billion

6-10-2013 -  $109.4 billion

6-17-2013 -  $014.4 billion

And a measly $10 billion net has been added to M1 in the interim to July 8th.

So what terrible cataclysmic, earth shattering, civilizationally-threatening event occurred the week ending June 10th, 2013?

Baccalaureates everywhere?

Actually, as a percentage of total M1 the 911 addition to M1 represented nearly 10% of total M1 on the same date. In June 2013 the decline in M1 wasn't even 4.5% of M1.

Still, it's a disturbing indication of turbulence at the most basic level of the economy, the money in your pocket and in your checking account.

QE Is For The Banks, Nothing Else

Quantitative easing is for the banks and nothing else, despite the long-standing professorial deflections to the contrary by Ben Bernanke.

Oh, he can say it's to help housing recover, or employment, or whatever else happens to be languishing depending on the exigencies of the moment. But God forbid Ben should say what everyone ought to have understood from the beginning, that there's a huge pile of non-performing loans on the banks' books. Ben's various iterations of QE have kept him busy systematically transfering to the books of the Federal Reserve Bank of the United States significant tranches of those bad loans, and it won't be until those transfers end decisively that you can be sure that the banks are finally in the clear.

Meanwhile, have you considered that when Keynes said markets can stay irrational longer than you can remain solvent that Keynes never imagined how un-free markets were to become in the Western world? Five years out from the troubles of 2008, that the purchases of MBS continue apace should at once frighten everyone and galvanize support to reform the banking system and prioritize the commitment of its central bank to the integrity of the US dollar.

The voices warning us are out there. You just won't hear them on your television, which you should turn off at a minimum, and preferably execute loudly in your backyard with a shotgun, or drop on your driveway from a second story window. Please send film.

Consider this from Manuel Hinds, former finance minister of El Salvador and 2010 winner of the Hayek Prize, here:

"[H]igher interest rates would burst the bubbles in asset prices that monetary printing has created, bringing to the surface the losses that banks have accumulated by years of lending to unsustainable activities. Thus, the Fed is between a rock and a hard place. If it does not increase the rates of interest, excess demand will explode leading to high inflation, large current account deficits or both. If it increases interest rates, the activities that are profitable only with very low interest rates will collapse, including the equity and commodity markets. This would expose the banks to very large losses, which would trigger a serious crisis because the banks have accumulated bad assets for over a decade now and have cleansed them only partially because they trust that the government will save them without having to take painful write-offs. As a snowball going down a slope, the problem gets worse with time. ... The coming breakdown is likely to be much worse than that of 2008."

Or this from Joseph Calhoun of Alhambra Investment Partners, here, who doesn't consider that QE is so negative for present GDP growth because it is "financing" past growth now ensconced as bad debt:

"There are any number of reasons why QE might be negatively impacting growth, from high oil prices to the diversion of capital to speculative purposes to its effects through exchange rates on other countries with which we trade. I do not claim to know the full extent of the effects of QE but most importantly, neither does Ben Bernanke. That being the case and considering the evidence to date, why does Bernanke persist in pursuing the policy? Is there some other reason for the policy other than the stated one of spurring economic growth? If so, Bernanke sure isn't telling anyone what it is."

Or this from the ever-wise John Hussman, here:

"Meanwhile, with a monetary base of $3.27 trillion and an estimated duration of at least 7 years on present Fed holdings, the recent 100 basis point move in bond yields has created a loss of over $200 billion for the Fed. The Fed reports capital of only $55 billion on its consolidated balance sheet. but then, just like major banks, the Fed does not mark its assets to market. Most likely, the Fed is now technically insolvent. Moreover, the Fed is levered more than 59-to-1 even against its stated capital. The benefits of QE seem vastly overpriced and excessively trusted, particularly in an environment where the internal debate even within the Fed is becoming more pointed. Two members already want the Fed to taper in order “to prevent the potential negative consequences of the program from exceeding its anticipated benefits.” ... We don’t observe any material economic impact from quantitative easing, and continue to believe that the key event in the recent credit crisis was the FASB move to abandon the requirement for mark-to-market accounting among financial institutions (the Fed’s zero interest policy has merely allowed banks to recapitalize themselves on the backs of savers and the elderly on fixed incomes)."

QE is financial repression of the American taxpayer for the benefit of institutions which should be wound down and broken up. How long are you going to put up with it? Can you last another five years?

The 3-Month Treasury Yield Is An "Abomination"

So says John Hussman, here:

The 3-month Treasury yield now stands at a single basis point. Unwinding this abomination to restore even 2% Treasury bill rates implies a return to less than 10 cents of monetary base per dollar of nominal GDP. To do this without a balance sheet reduction would require 12 years of 6% nominal growth (which is fairly incompatible with sub-2% yields), a more extended limbo of stagnant economic growth like Japan, or significant inflation pressures – most likely in the back half of this decade. The alternative is to conduct the largest monetary tightening in the history of the world.

Normalization of yields to even 2% implies 50% balance sheet contraction [see his last graph].

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The latter would mean a contraction of $1.55 trillion or so based on the current level, and that those securities would not mature on the balance sheet for their respective terms and come off naturally over time but quickly in a disorderly fashion, and therefore a bond market debacle is implied, and that to be defensive under this threat is to remain in cash, painful as that is.

Louis Woodhill: Gold As Money Is Inevitably Deflationary In Terms Of Its Supply

So says Louis Woodhill for Forbes, here:

"The most fundamental issue that determines the workability of a gold standard is whether it attempts to use gold as money.  Any gold standard system where the size of the monetary base is determined by the physical supply of gold will eventually suffer a deflationary collapse.  The economic catastrophe that occurred in 1930 was inevitable, given the design of the gold standard system in use at the time. ...

"The use of gold as base money would quickly become the biggest single source of demand for gold, just as was the case during the years prior to the Great Depression.  Sooner or later, this new demand for gold would cause the real price of gold to start rising.  This would automatically cause the real value of the dollar to rise, precipitating a financial and economic crisis.

"Our highly leveraged financial system simply cannot tolerate monetary deflation.  During a financial crisis, everyone tries to become more liquid at the same time.  That is, everyone tries to increase their holdings of money, because the possession of money itself is the only thing that can guarantee that you will be able to pay your debts.

"If gold is money, and money is gold, this means that, once a liquidity crisis started, the demand for gold would increase.  This would drive up gold’s real value even farther, intensifying the crisis.  A destructive feedback loop would develop, leading to a complete meltdown of the financial system and the real economy.  This is exactly what happened in 1930."

It should be added that a monetarist system, by way of contrast, cannot tolerate credit deflation, but that is exactly what the United States is now facing with total credit market debt outstanding slowing to a crawl of $1.17 trillion added per year between 2007 and 2012. At the very slowest it should be growing at a rate of $4.33 trillion per year by historical measures, and at its fastest by $8.31 trillion per year.

The United States at present is in the throes of a deflationary collapse of monetarist making, not of dollar currency but of credit money, and it is the principal reason for the collapse of GDP. One of the largest sources of the "currency" of credit money in recent years has been mortgages, which are now effectively unacceptable as collateral because of the rot permeating the system in the form of defaults and underwaters.

Federal Reserve policy has actually been removing such collateral from circulation, along with US Treasuries, by placing it on its balance sheet. But since there is nothing "real" behind the dollars the Fed replaces this collateral with, there is no corresponding expansion of credit in size to match the former vigor of the process.

So perhaps the Fed should QE gold instead of MBS and Treasuries to provide something real behind the money created which would give that money a surer basis in collateral.

Central banks around the world have been buying gold in quantities not seen in 30 years in order to fill the collateral gap. The Fed should join them.

Jim Cramer Still Thinks You Are A Fool. He May Be Right.

M1 since the 2008 panic

M2 since the 2008 panic

M2 is up $2.71 trillion since the crisis, M1 $1.05 trillion. That means since September 1, 2008, nearly 39% of the rise in M2 is directly the result of the increase in M1 (checkable deposits, i.e. the spending money in circulating cash and checking accounts).

Overall, M1 is up nearly 75% over the period, but M2 just 35%. But back out the M1 and M2 is up only 21% net, or $1.66 trillion. Still, that's a lot of moolah being saved and not flowing into stock markets.

Enter Jim Cramer, who here says that as CD instruments (M2) mature now, they will not be rolled over but get invested in the only thing going for return, namely stocks:

"Every-day CDs from the halcyon days of the middle of the last decade, when rates were going higher, will come due -- and the dramatic decline in the rollover CDs should force that money into the stock market. Invariably I hear that this flow won't amount to a lot of money. Just dismiss these people out of hand; they are either short or ignorant."

"Force"? "I hope" is more like it. I smell a book-talker.

Most of this CD and money market fund money is money of "households", small time stuff under $100,000. With plunging returns on savings over the period as the US Federal Reserve Bank pursues its policy of financial repression through zero interest rate policy, Cramer is hoping households will suddenly become the greater fools with markets at all time highs and plunge into stocks even though households have been net negative all along since the crisis, pulling out $250 billion from the stock markets according to widely reported figures from Standard and Poors.

In contrast to households it's the funny money which has been driving the markets higher, banks and other corporations doing stock buy-backs to the tune of $1.2 trillion net over the period. Most troubling of all, a year ago already banks were reported to be responsible for fully 32% of the ownership of the total market all on their own, rivaling the household sector's 37% share. If you want to understand how markets are up so much, you have to look there.

Suckers who took Cramer's sell advice in early October 2008, people who "need their money in the next five years", have entirely missed this bank-driven rally which has been aided and abetted by the Fed. And potentially they lost as much as 25% right up front in just the first three weeks after his sell announcement on the nationally televised NBC Today Program, before the markets opened on Monday morning, October 6, 2008, the Monday after TARP was signed.

And here he is, 4.5 years later, hoping people will take his advice again and plunge in because there's plenty of liquidity to keep markets buoyant. Well, plenty as long as you provide it.

You know. Sell low, buy high.

They should hang a warning label around that guy's neck.

Ben Bernanke Is Trying But Failing Miserably At Money Printing

And it's not exactly his fault.

Historically in the postwar period, the increase in Total Credit Market Debt Outstanding (TCMDO) has closely shadowed the increase in Total Net Worth, seemingly helping to finance it, until the late great recession when for the first time, and very briefly, net worth flagged below the level of the debt owed. (Ignoramuses in the Doomosphere everywhere cried "Insolvency" at the time, not understanding the meaning of the term "net"). Ex post facto, net worth has made a dramatic upswing while the debt owed has increased at a much reduced rate by historical standards. To quote a famous president, "That doesn't make any sense."

Despite all the debt naysayers out there, total credit market debt is not increasing at anything like it should be, and appears to be disconnected to a significant degree from the recent increase in total net worth, which is up 29% since its nadir at the beginning of 2009, or $14.7 trillion. For the whole five year period from July 2007 (the last time TCMDO doubled, going back to 1999) to July 2012, TCMDO increased at a rate of just 12% and real GDP increased just 2.9%, whereas TCMDO increased at a rate of 100% between 1949 and 2007 on average every 8.25 years. The shortest doubling times have included two periods of 6 years each, one of 6.75 years, one of 8 years, one of 9.5 years, one of 10 years, and one of 11.5 years. The very worst real GDP performance of all of those was for a 6 year doubling period when we got 14% real GDP, nearly 5 times better than we're getting now. All the rest posted real GDP of between 23% and 56%.

It is evident that Ben Bernanke's quantitative easing program (right scale) anticipated the leveling off of TCMDO (left scale). Clearly he expected the troubled banks to need a push to keep the credit money creation process going, but didn't understand how fruitless it would be. One notes that he has added about $2 trillion to the monetary base from the middle of the late great recession. By contrast, TCMDO is up (only!) $9 trillion from the beginning of 2007. By historical standards TCMDO should be up $25 trillion by now if TCMDO is to double again in ten years from 2007. And it should be up a lot more than even $25 trillion by now if it's to double sooner than ten years. At the average doubling time of 8.25 years, the $49.8 trillion of TCMDO in July 2007 should hit $99.684 trillion by October of 2015 if the postwar pattern is to continue. Instead, at the current rate of growth in TCMDO, it's going to take an unprecedented 27 years to double it, unless of course there are limits to borrowing to fuel growth, as many are beginning to tell us. In either event one can only assume there will be only pathetic real GDP growth going forward, if there is any at all.

Clearly something is horribly amiss in the transmission process of credit money creation for the first time in the postwar. Seemingly gargantuan quantities of money from the Fed through the process of quantitative easing should be seeding the banks who in turn should be creating massive amounts of credit way beyond the $9 trillion so far created. Instead, the banks are doing something else with it, by-passing the normal distribution channel. Some of the seed money is being held back to comply with increased capital requirements, to be sure, but more appears to be going directly into household net worth creation through investment gains from the stock market, enriching a very few bondholders, shareholders and banking industry players through the private trading desks of the banks, a unique development by historical standards made possible only since 1999 with the abolition of Glass-Steagall through the Gramm-Leach-Bliley Act. As an act of Congress, Ben Bernanke can't do much about that even if he is the most powerful man in the country.

In the absence of a creative policy change from the Fed whereby Congressional intent would be thwarted and money would actually reach the marketplace through a different avenue than the uncooperative banks, one must conclude that the Fed thinks it necessary to continue the various easing schemes because it judges the banks to be still too fragile to risk stopping them. That would be putting the best construction on the matter, to borrow a phrase from Luther's catechism. Either that, or the Fed itself has been completely captured by the bankers.

Velocity of Money Soared Over 35% During the Housing Bubble

Velocity of M1 money soared to unprecedented heights during the housing bubble, dating from the housing provisions in the Taxpayer Relief Act of 1997. Money changed hands at a rate over 35% faster at the peak reached in October 2007 at 10.367 than at the previous high levels around 7.4.

The burst bubble has seen velocity of M1 plunge to 6.5 today after all those years of new highs from 7.5. Velocity in the 6s was common for twenty years between the 1970s and 1990s, and looks to be again.

This is what happens when you convince Americans to unleash all the stored up capital in their homes, and squander it. Thanks Bill Clinton. Thanks Newt Gingrich.

Another Observer Notices The Broken Link Between The Monetary Base And Markets

Kopin Tan, who otherwise believes the Fed has been juicing markets, for Barron's, here:

"[W]hile the Fed tripled its balance sheet, not all that money gushed through to the real economy—one reason why inflation is just 2%—as banks funneled the money to mend their balance sheets, corporations hoarded cash, and Americans paid off loans and saved more.

"Between 1960 and 1999, ratcheting up the supply of money often directly lifted stock prices. In the 1970s, for instance, stocks' annual returns were 70% correlated to the growth in money supply. But that link has recently broken down: year-over-year growth in money supply slowed in 2009 and 2012, but stocks rallied in both of those years."

John Hussman Warns Correlation Is Not Causation

Here in "Two Myths and a Legend":

'This first myth is embodied in statements like “since 2009, there has been an 85% correlation between the monetary base and the S&P 500” – not recognizing that the correlation of any two data series will be nearly perfect if they are both rising diagonally. As I noted last week, since 2009 there has also been 94% correlation between the price of beer in Iceland and the S&P 500. Alas, the correlation between the monetary base and the S&P 500 has been only 9% since 2000, and ditto for the price of beer in Iceland (though beer prices and the monetary base have been correlated 99% since then). Correlation is only an interesting statistic if two series show an overlap in their cyclical ups and downs. ...

'In the case of quantitative easing, much of what we observe as “causality” actually runs the wrong way. Market declines cause QE in the first place, and the result is a partial recovery of those declines.'

FoxBusiness Is Full Of Baloney About The Monetary Base

Throughout 2007, when the stock market reached its previous all time high in October of that year, the adjusted monetary base of the United States was very stable and averaged just $851 billion.

During the financial crisis month of September 2008, however, the base leaped up from that vicinity between September 10th and September 24th to $949 billion, and by Thanksgiving 2008 had skyrocketed all the way to $1.5 trillion, near which level it remained even as late as March 2009, when the stock market plummeted to its historic lows since 2002-2003.

The increase in the monetary base was a whopping $718 billion, most of it in response to bank failures and panic on Wall Street during a narrow window of two months in the fall of 2008, but the stock market tanked 56% from the October 2007 highs anyway by the following spring.

Now FoxBusiness is arguing, here, that the increase in the monetary base from March 2009 to today, $1.3 trillion, is somehow responsible for "juicing" the stock market's remarkable 134% rise since that low.

Nevermind the stable and relatively low monetary base had nothing to do with the 2007 highs, nor did the rapid expansion of the base by $718 billion forestall the dramatic collapse of the market in 2009, but FoxBusiness wants you to believe anyway that piling up the monetary base since March 2009 by $1.3 trillion is the reason the stock market is at its lofty heights today, $11.2 trillion higher in total market cap than in March 2009.

That's embarrassingly wrong. The expansion of the monetary base has been irrelevant to the stock market, but it is an important part of keeping the banking system solvent, which is what this entire episode has been about but no one really wants to discuss anymore even as the velocity of money makes new lows, for the obvious reason that if the banks go under, everything goes under, so ixnay on the anksbay, OK?

Have FoxBusiness And EMAC Gone Just A Little Bit Nuts?

Elizabeth MacDonald writes here that FoxBusiness has proof, proof!, that the Fed is juicing the markets.

Am I the only one who thinks this is crazy?

We're supposed to believe that the value of the total stock market is up $11.2 trillion since March 2009 because the Federal Reserve expanded the monetary base by . . . $1.2 trillion during that time?!

Talk about a money multiplier. That's a ratio of 9.3:1. Obviously the Congress should get us on this program right away. They could have taken our nearly $3 trillion in the Social Security Trust Fund and turned it into $28 trillion by now. Pikers.

Money Available For Spending Is Up Over 70% Since 2008, But Total Debt Is Up 7%

M1 money supply has gone up about $1 trillion between mid-2008 and now, almost 5 years. This is basically spending money which is not being spent.

Total credit market debt fell an equivalent amount, but all of it in 2009, so one cannot say the one "offset" the other. (The extra M1 was saved over the nearly five year period. The debt was discharged somehow, through pay-downs or defaults, and relatively quickly during the year of the biggest GDP decline in post-war memory). And since early 2010, total debt is back up over $2.5 trillion. And since 2008 TCMDO is up over $3.6 trillion overall.

Somebody is ramping up debt just like before the crisis, but it's not the consumer.

Velocity Of Spending Money Falls To Early 1990s Levels As Americans Hoard It

Meaning money isn't changing hands for new goods and services like it had been after 1996. M1 has skyrocketed from $1.4 trillion in 2008 to in excess of $2.4 trillion today (here). That's about $21 billion a month over four years being withheld from spending by consumers.

Another bubble bursts.

Americans Have Been Hoarding Spending Money Since October 27th, 2008

That's the last time M1 was at the $1.4 trillion level.

Americans haven't looked back since.

Since that date in 2008, hoarding of spending money has increased at a rate north of 66% overall. Compare that to the previous four year period from October 2004 to October 2008 when money in consumers' spending accounts increased only 8.4%.

Theoretically, in excess of $1 trillion has been removed from consumer spending over the four year period since 2008, but it has been kept in such a way that it is ready to spend, suggesting Americans have been waiting to spend the money, preparing to spend the money, or just plain saving the money in the only accounts they own where they can keep it.

I'll go with the latter.

This is an enormous sum when compared with the actual dollar increase in GDP for the three years from 2009 through Q3 2012 annualized, which is a measly $1.84 trillion. Assuming non-crisis conditions, however, these monies might have been spent instead of saved and GDP would have increased to at least $2.84 trillion instead of $1.84 trillion, or as much as 35% higher than the reality.

Parenthetically, notice the fear represented by the near verticality of allocation to this category during the debt ceiling crisis of Summer 2011, and then the resumption of the trend upward.

Another such episode will be upon us shortly.

Irrational Exuberance in Corporate Debt Reaches $7.8 Trillion v. $1.2 Trillion in Cash

"I would go a hundred percent equities if I thought that we had reached a point when equity values made sense."

"People always say stocks are cheap, stocks are cheap. They're trading 10 times forward PE, 12 times PE. The problem is, I don't know the E[arnings]."

"What if the U.S. had a balanced budget? What would GDP be? Then what would earnings be? The U.S. cannot in perpetuity run a $1.3 trillion annual deficit. I don't believe in any of the earnings numbers."

"You basically have 30 years of accumulated debt that funds consumption and that has to unwind. And as it unwinds, it's going to have implications on economic activity and it's impossible that it won't ultimately find its way back to U.S. companies."

--Andre Kovensky, Managing Director of bond and real estate investment firm, Octavia Investment, quoted here.

Stocks presently are relatively expensive when measured by the Shiller p/e, which this morning stands at 21.21, almost 34 percent elevated from the median level of 15.84 going back to 1881. Investors might want to consider that the Shiller median level itself incorporates earnings from past decades when increased borrowing by both business and government might make the metric somewhat artificially elevated anyway.

The assertion that debt "has to unwind", however, is evidenced in the post-war period by the corporate data set only in the early 1990s when aggregate quarterly debt dropped briefly by 2 percent, and in the decline just concluded when it dropped briefly by 3.5 percent or just $256 billion.

Total corporate assets, by way of contrast, have reached an all time high of nearly $30 trillion.

One wag notes that Kovensky is just talking his book.

Bonds remain at nose-bleed prices, as do all assets.   

Total Demand Deposits in January at $0.8 Trillion

GOLD AND THE U.S. MONETARY BASE, THEN AND NOW

Interesting stuff from Brett Arends two days ago at The Wall Street Journal:

Dylan Grice, a strategist at SG Securities in London, thinks global conditions today could unleash another gold boom like the one in the 1970s. ... Mr. Grice calculates that even at today's prices, the bullion that the U.S. government holds in places like Fort Knox is still only worth enough to back 15% of the U.S. monetary base. That is near a record low.

At the peak of the gold mania in 1979-80, gold prices rose so far that the backing exceeded 100%. How far would gold rise if that happened again? To around $6,300 an ounce, Mr. Grice says.

Read all about it, here.

"The Feds Have No Faith in Recovery"

Penetrating analysis here from the chief economist at Delta Global Advisors.

November 5, 2009

The Feds Have No Faith in Recovery

By Michael Pento

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 that 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 chief economist at Delta Global Advisors and a contributor to greenfaucet.com.