I feel like being particularly irascible today, so here you have our future in just a few short moments…
Click that image and follow along. You’ve seen this graph before, but I have taken the liberty of moving the Federal Government’s debt to the top for reasons that will shortly become apparent.
In the latter part of 2007, continuing into 2008, credit outstanding in the broad economy began to contract. This has not happened before – indeed, it had not happened on a broad basis since The Depression.
It is this that made this recession different from the other recessions – and market movers - that we have experienced during our lifetimes.
Ben Bernanke is claimed to be the world’s “best-learned” scholar on The Depression. He knows full well that in all modern monetary systems all money is in fact debt. Therefore, the actual money in the system – not the “Ms”, but that which does and can circulate – is represented in the above chart.
Now remember: The definition of “inflation” in the monetary sense is the growth of money beyond the growth in goods and services. Deflation is the opposite.
Bernanke wrote a famous speech in which he opined that The Federal Reserve was capable of preventing “it” from happening here (Deflation.) This, by the way, was during the depths of the 2000-2003 Nasdaq Market Implosion – when many people were worried about “deflation.”
Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Certainly Ben didn’t forget that very few paper dollars are actually in circulation, did he? Indeed, virtually all “money” in circulation is nothing more or less than credit – blind promises to pay from future production the principal and interest that has been borrowed!
Realize this folks: The dollar bills in your wallet were borrowed into existence. Treasury sold debt (Bonds) against which The Fed issued paper currency!
So do we have inflation or deflation here?
Well Ben certainly asserted in 2002 that he could prevent “it”, and prevent “it” he did. Credit outstanding went from some $30 trillion when he gave that speech to $53 trillion at its peak (!) That ain’t deflation folks – indeed, it is massive, pernicious and ridiculous inflation.
But the other assertion that Bernanke made – that The Fed has control over this – is only indirectly true. That is, The Fed can “credibly threaten” to print money like a madman and shower it from Helicopters, hopefully (for them) stimulating borrowing in the private sector. Since all money is in fact debt this is indeed the creation of inflation!
But what Bernanke couldn’t control is where the money went. In this case it “went” right into housing along with commercial real estate, blowing prices all out of proportion with reality.
Now, faced with another crash, Bernanke tried to do the same thing. How is it working out?
Look at that chart again.
At no time in the 2000-2003 “deflation scare” did credit outstanding even credibly threaten to go negative.
But this time it did – in early 2008, ex-Federal Government borrowing.
Now you understand why The Federal Government, which is allegedly “separate” from The Federal Reserve, is in fact nothing more than Bernanke’s handmaiden (and vice-versa.) The Federal Government did exactly as they were TOLD, and tried to “stimulate” private credit demand with various “borrow and spend” stimulus projects.
This prevented the deflation that was occurring from being recognized in the economy from the end of 2007 through the summer of 2009.
But last quarter, Bernanke and The Government lost their fight and total outstanding credit actually declined – including The Federal Government.
Further attempts to “stimulate” private borrowing are doomed. Debtors are defaulting left and right, with Bank America (along with others) rumored to be planning to dump as many as six times as many foreclosures into the market as were processed in 2009 once the year turns over. Arrow Trucking appears to have collapsed as of this afternoon, prime jumbo loan delinquencies are skyrocketing and the FHA portfolio remains mired in trash with well over 20% of their loans delinquent or in foreclosure.
The claims that Bernanke “averted a second Depression” are outrageously false. There was no “Depression” in 1929 and plenty of market callers in ’29 and ’30 claimed that “the worst was behind us.”
Dead wrong, and for the same reason – lending collapsed as willing and able borrowers were simply nowhere to be found.
If anything Bernanke has made the situation markedly worse with his “quantitative easing” programs, in that he has created a circumstance where banks can make plenty of money by engaging in “risk-free” trades by borrowing at zero and buying Treasuries! This of course beats lending to some small (or large!) business who might go under and not repay his or her debts.
The opportunity to avoid the now-inevitable was in 2003 and perhaps in 2004. The SEC could have told Paulson to pound sand on the leverage limit removal. Bernanke could have backed not extraordinary easy policy by Greenspan, but rather a removal of excess liquidity and a zero credit expansion policy – forcing malinvestment out of the economy – until GDP began to grow on its own without credit system pumping.
Now it’s too late – the borrowing capacity of both business and consumers has hit the wall. There simply isn’t the ability to “buy more, pay later” given the actual earnings output of actors in the economy – yet that is the prescription that is required to continue to produce and consume beyond our means.
Forget it folks.
As after the ’29 crash the “reprieve” will prove transitory, not durable. Employment, credit numbers and freight all say “unsustainable bounce” and the GDP release this morning underlined that in big bold black sharpie – if you were paying attention.
The Stock Market may not be for now, but the bond market sure as hell is:
That’s the 30 year bond yield and the pattern you’re looking at is known in technical parlance as an “Inverted Head and Shoulders.” It is complete, it is a multi-year pattern, and it projects a 30-year bond yield to around 6.7-7.0%. Not tomorrow, not immediately, but the probability of this target being reached went up dramatically when the pattern confirmed this morning. It is negated conditionally (but not decisively) by a fall under 3.9% in the 30 year bond yield, and voided if the yield should fall below by a fall in the 30 year bond rate to below the head, or 2.5%.
So long as 3.9% holds one must expect a 6.7% long bond yield, and so long as 2.5% holds (way down from here!) one must be wary of a 6.7% long bond yield.
The impact of this sort of move on home values will be catastrophic. A move from today’s rates to the 7s will instantaneously subtract a further 25% from the value of every house in this nation. It will do similar things to commercial property values. In addition such a move would likely more than double government borrowing costs, shutting off government “borrow and spend” attempts almost immediately.
If this chart is correct the next part of what is to come is going to be the “big suck” part of our economic future, and last many years – perhaps as long as a decade. Just as George Bush declared “Mission Accomplished” only to have our military coming in withering attack in the coming months and years those who gave Bernanke a “victory lap” (and re-nomination) will be shown to be just dead flat wrong in the months and years ahead – not to mention those who have “jumped aboard” the claimed “economic recovery” by buying either market assets or worse, real estate.
That’s not a knife you caught if you were playing in the real estate market of late. It’s this: