We are about to witness the sad, but inevitable conclusion, from having a global economic system that is based on fiat currencies. This global experiment in which the quantity of money and credit is left to the discretion of just a few unaccountable individuals is about to come to a disastrous end.

  It took a few but decades to reach crescendo, but the end of the Bretton Woods monetary system in 1971 has now led to catastrophic levels of debt and inflation across the developed world. The corrupt business cycle goes like this: Politicians and bankers desire to spend and create more money than what a genuine economy’s savings (through productivity and increased labor force) can generate. Government and private bank interference in the market place continues to grow through the process of increasing the amount of aggregate debt outstanding. When this process goes unchecked for several decades-as is the case in Japan, Europe and the U.S.-debt levels become so onerous that it demands interest rates remain near zero percent in order for the economy to function.

  These zombie-like economies cannot grow in a healthy manner because they suffer from: asset bubbles; high inflation; interest rate volatility; currency instability; along with high levels of corruption, regulations and taxation. Therefore, the prescription offered by politicians is more government spending and further central bank intervention in money supply growth and interest rate manipulation.

  A great example of the bankrupt economic ideas adopted by these money printers, is the philosophy known as “Beggar Thy Neighbor”; a process in which governments and central bankers try to achieve a competitive trading advantage through the process of destroying the purchasing power of their currencies through inflation. Despite the overwhelming evidence that getting a nation deeply involved into a love affair with inflation does nothing in the way of improving economic growth, it is widely embraced today as a viable method of improving output.

  The Plaza Accord of 1985 was an agreement between the U.S. and four of its largest export destinations to dramatically lower the value of the dollar. As a direct result of this agreement, the U.S. dollar lost over 50% of its value against the Yen from 1985 to 1987. Yet, the trade deficit increased from $121.8 billion in ’85, to $151.6 billion a full two years after the devastation to the dollar began. Likewise, there was no improvement in manufacturing as a percentage of the economy either. Manufacturing represented 17.8% of GDP in 1985, and it fell to 17.4% of GDP at the end of 1987.

  In another example of the failure of inflation and money printing to fix anything, in 2005 China announced it would increase the value of its currency and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket of world currencies (the U.S. had been pressing for the Chinese to allow a weaker dollar for years and they finally acquiesced). During that time frame, the Yuan rallied from .1208 USD to .1467 USD (a move of over 20%). But the falling dollar had a negligible effect on U.S. exports. For all of 2005 the U.S. deficit with China was $201.5 billion. In 2008, three years into the dollar devaluation and Yuan appreciation, it soared to $266.3 billion (more than a 32% increase). The truth is that inflation and currency destruction makes trade and current account deficits worse not better.

  Finally, the new regime of Japan’s Prime Minister Shinzo Abe is also a wonderful example of the doomed policies that promote inflation and currency debauchery. By late 2012, he deployed Abenomics into full effect-the practice of massively increasing; government debt, central bank money printing and currency destruction. The Yen has lost 25% of its value against the dollar so far to date and Abenomics has made the Japanese currency a joke among international traders. Nonetheless, in January of this year their current account deficit soared to an all-time record high 592.8 billion Yen, or $5.7 billion.

  So let’s set the record straight. If crumbling a nation’s currency was the pathway to prosperity then all banana republics would soon become manufacturing and economic powerhouses. But that never happens.

  Trying to boost manufacturing and GDP growth by lowering the purchasing power of a currency does not “Beggar Thy Neighbor”, but instead bankrupts thyself. It does this by destroying the middle class, discouraging foreign direct investments, disincentives productivity gains and creates damaging imbalances in the economy. These imbalances eventually lead to intractable levels of debt, uncontrollable inflation and unmanageable debt service payments.

  The systemic practice of running economies on the spurious belief that inflation and currency devaluation is a necessary pursuit is about to reveal its devastating consequences on a global scale. I expect volatility in global markets similar to what was experienced during 2008 to occur in the middle of this year, as economies experience massive swings between inflation and deflation.

Pento Portfolio Strategies turned decidedly bearish on the economy last week  – moving investors into cash, gold and shorting the Japanese market.  If you would like to hear more about our investment ideas, call his executive assistant Allison Fleck at 732-772-9500 extension 1 to set up an appointment to speak with Michael directly.   

 Justine Coleman            
Pento Portfolio Strategies, LLC

Information presented is for educational purposes only.  Moreover, no viewer or listener should assume that any information or discussion presented, serve as the receipt of or substitute for, personalized advice from Pento Portfolio Strategies, LLC or from any other investment professional and is not included as an offer of solicitation for the sale or purchase of any specific securities, investments or investment strategies.