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Could it be
that world governments and central banks are now taking drastic measures to
re-inflate their economies because they don't believe their own economic
statistics? For example, China reported that GDP growth came in at 7.6% last
quarter. That's slower growth, but still not so bad. However, China's
electricity consumption has slowed much faster than growth in official GDP
(electricity generation was unchanged in June from a year earlier at 393.4
billion kilowatt-hours), when they normally move in tandem. Turning to the
U.S., the Labor Department announced last week that initial jobless claims
fell 26k to 350k. Sounds great...but wait. Digging into the unadjusted data,
there was actually an increase of 69,971 claims for the week -- an increase
of 19% from the week prior. Now that's some seasonal adjustment!
It is really
any wonder why global governments and central banks are starting to panic? As
I indicated in last week's commentary on King World News, the European
Central Bank decided to lower its deposit rate it pays to banks to 0%. While
some foolishly believed this move would have no effect on money supply
growth, we just received empirical evidence of how banks behave when the
interest on their reserves are cut to nothing. Last week the ECB recently
reported that overnight deposits parked at the central bank plunged by the
most on record, or €484 billion in just one session. It now
seems that my theory that banks would deploy their reserves was proven
correct in just a matter of days.
The truth is
that most global central banks are now acting in a concerted and unprecedented
effort to battle deflation. South Korea cut interest rates by 25 bps and
Brazil cut rates 50 bps to a record low last week; joining China, Europe,
England and Japan in an aggressive attempt to raise asset prices. Not only
have these central banks massively increased liquidity, but they are now
moving towards taking measures to punish banks that do not do their part in
expanding the money supply.
While it is
true that banks don't depend on a tremendous level of reserves to make new
loans, it is imperative not to ignore the increase in the level of their
excess reserves. These reserves came into existence when the central banks
purchased assets from banks. A bank cannot afford to have a significant
portion of its assets, which used to be productive and earning interest, to
then become latent for an extended period of time.
However, the
key point here is that while the Bernanke Fed has sat on hold, other central
banks are cutting rates, reducing reserve requirements, buying equities and
ceasing to pay interest on excess reserves. That has caused the U.S. dollar
to rise 12% in the past year. This factor alone has stoked Bernanke's
deflation phobia to an unbearable degree.
I believe the
cyclical period of deflation that I warned about several months ago is now close
to an end. The Fed feels foolishly compelled to stop the rise of the U.S.
dollar and will soon opt to follow the lead from the ECB and stop paying
interest on excess reserves. That move will not increase bank lending to the
private sector, as much as it will force banks into purchasing even more
sovereign debt. If they Fed does indeed go down that road, I would expect to
see U.S money supply growth increase significantly, causing gold and
commodity prices to soar and the dollar tank. I would also expect to witness
the global economy sink ever further into the stagflationary
abyss.
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