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The economies
of Southern Europe continue to experience extreme duress. For example, the
bad loans of Spanish banks jumped to 10.5% in August, which is up 17 straight
months and has increased from just .72% at the end of 2007. However, the
answer provided by governments and central banks to propel the economy is to
create more of the same condition that brought about the problems in the
first place. That is, to increase the level of base money in the hopes of
increasing the rate of broad money supply growth and
inflation. But despite the fact that inflation is already growing at 2.6% in
the Eurozone, Mario Draghi is still promising to do
whatever it takes to dilute the Euro's purchasing power and create more
inflation.
Official
Chinese statistics show that GDP has dropped from north of 10% for all of
2010, to just 7.4% in third quarter of this year. Other measures of growth
like power consumption are up just 1.5% from a year ago. Therefore, the PBOC
has injected record amounts of Renminbi into money
markets and has lowered the reserve requirement for banks three times in the
past year. Both measures have caused China's money supply, as measured by M2,
to increase 14.8% YOY, which is the fastest pace in 15 months.
In the U.S.,
the anemic pace of growth pervades throughout the economy. Initial jobless
claims surged 46k last week, erasing the entire drop in the week prior. In
addition, ninety three S&P 500 companies reporting earnings so far for
the third quarter have shown that profits are down 0.5%. The sad facts are
that GDP and earnings growth in America is just about flat. Therefore, the
Fed has already placed interest rates at zero percent for the last four years
and has caused M2 money supply to be up 7% YOY.
The strategy
of governments and central banks is clear; lower interest rates and pump
money into the system in order to re-inflate asset prices and releverage the economy. Although they have been very
successful at debasing their currencies, they have missed a very key point.
That is, an increase in money supply growth and inflation does not equate to
an improving economy. And when taken to the extreme levels we see today, it
instead leads to a protracted period of persistently weakening economic
growth.
Money supply
growth should never eclipse labor force + productivity growth. When inflation
rises faster than GDP, malinvestments are created
and asset bubbles form. That is especially true today as we see a
tremendously-dangerous bubble being created in all the bond markets of the
developed world. But what is also true is that government debt that is being
systematically monetized by central banks is slowly destroying any confidence
left in fiat currencies. As more and more credibility is lost in paper money,
GDP growth will continue to decrease in real terms.
As long as
governments continue to produce massive annual deficits that are purchased by
their central banks, the global economy will continue to stagnate and
inflation will increase. What is also true is that equity markets tend to
rise over time in nominal terms because excess money creation lowers the
value of currencies and raises stock prices. However, the increase in equity
values seldom keeps pace with the rate of inflation. To accomplish the goal
of achieving a real rate of return on investments after taxes and inflation
are considered, history proves that can only be supplied by owning hard
assets.
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