The Commerce Department reported today that despite record low borrowing costs, Housing starts fell 1.5% to a 604,000 annual rate in July from June's 613,000 pace, while building permits also dropped to a 597,000 annual rate. It seems that even though money is nearly free, job stability and income growth are still elusive enough to keep the real estate market in a depression.

Yesterday saw the release of the Empire State Manufacturing Survey for August. The general business conditions index fell four points to -7.7, its third consecutive negative reading and the new orders index also remained below zero at -7.8. The future indexes offered no ray of hope either. The future general business conditions index plummeted twenty-four points to 8.7, which was its lowest level since February 2009, and the future new orders and shipments indexes fell to near-record lows, exceeded only by their September 2001 readings. The capital expenditures index was also down significantly.

But even though housing remains in a depression and the manufacturing sector is pointing towards another recession--one that actually never really ended-- money supply growth is indicating we are headed into a significant battle with inflation. Money supply growth as measured by MZM is rising at a 15% annualized rate in the last quarter and M2 has gone parabolic, rising at an 18% annualized pace in the last three months. So GDP is barely positive, yet money supply growth is soaring; and there is your stagflation.

Just because banks are making loans and increasing the money supply through the fractional reserve system doesn't necessarily equate to a booming economy. Banks can loan money for consumption or to increase production. If banks make loans for consumption or to the government, it doesn't have a direct correlation to an increase in the number of goods and services available for consumption. Therefore, money supply growth occurs in an inefficient manner. A far better form of money creation occurs when banks make loans to build factories, mines, utilities and to create capital goods.

We can only hope that commercial banks use their excess reserves this time to increase commercial and industrial loans rather than to just purchase U.S. Treasuries. Loans that are made to inflate asset prices or to consumer foreign products as occurred in the middle of the last decade will only further exacerbate inflation and get us even deeper into this multi-year recession.

This is where Bernanke has made perhaps his biggest blunder yet-and that is saying much given his follies over the past several years. By promising markets that his zero interest rate policy would remain in effect for what will amount to be at least four years in duration, he has handcuffed the Fed from draining reserves and curtailing money supply growth. Since money supply growth is already soaring we can only wonder what the rate of inflation will be and how low the dollar will go in the next few years.

Michael Pento

Euro Pacific Capital

Senior Economist/Vice President Managed Products

800-727-7922 ext. 144



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