FedUpUSA

Archive for June 5th, 2010

Anyone who doesn’t believe that “they” (the powers that be) “get it” at this point needs to remove their head from their ass:

G-20 central bankers and finance ministers agreed in a joint statement today that “within their capacity, countries will expand domestic sources of growth.” At the same time, European Central Bank President Jean-Claude Trichet told reporters that Europe’s best contribution to the global rebound is to achieve fiscal sustainability.

Those two are polar opposites.  You just heard Trichet admit that what everyone wants they cannot have.

Look folks, if you currently spend 11% of GDP by borrowing money and blowing into the economy to prop it up and you achieve “fiscal sustainability” (defined as not doing that any more) GDP will inevitably contract by the amount of stimulative borrowing you withdraw.

Geithner said at a press briefing today that “credible commitments to fiscal sustainability over the medium term” are needed to generate a durable recovery. Spain’s Finance Minister Elena Salgado said at a separate European press briefing that deficit reduction should come “no later than 2011.”

Game’s up folks – that’s six months out.

Look, let’s be straight with everyone here.  This is the current deficit additions for the first five months of 2010 (click for a larger copy):

That’s nearly $700 billion in five months.  Annualized it’s $1.68 trillion.  Last year’s total was $1.647 trillion.

Ignore the CBO and other government claims.  That which is borrowed is that which is owed, and the increase in that which is owed over a year’s time is the true deficit in the budget, irrespective of all claims otherwise.

This comes out to roughly 12% of GDP.  If we contract that deficit spending in 2011 to the European standard of no more than 3% of GDP then either GDP contracts by the difference (8-9%) or the government extracts that from you in the form of taxes.

Either way you don’t have it – it is either not produced and thus not paid or it is produced and stolen.  Irrespective of how it is achieved you are going to see roughly 10% of your “standard of living” come out of your hide.

It would be nice if it stopped there, but it both won’t and can’t.  That which you don’t have you can’t spend, which means that the “excess capacity” in the economy goes up, not down.  Employment will not increase, it will stagnate or get worse.  Budgets will have to be slashed at state, local and federal levels – like it or not.

Rather than you taking it in the chute what should happen is what I described in my last post - that is, the fraudsters and scammers in the banking and “finance” industry who sold you, and the nation, on the premise of ever-increasing debt being sustainable, should be the ones who are put out of business at the same time.

Unless we the people demand that this happen it of course will not.  The consequences of such a refusal will be profound and extraordinarily unpleasant, while those who caused this mess by their intentional and willful acts will continue to keep their ill-gotten gains.

Remember one thing folks – political promises are not debts.  They have no standing in the line other than the willingness and ability to fund them.  When that disappears, and it will, you will discover that the so-called “promises” you were made have the value of used toilet paper.

This is unavoidable, and no amount of bleating will change it.  I wish there was a solution to this problem, but there is not.  The promises made cannot be kept, not due to lack of political will but inability to continue to compound debt upon debt upon debt any longer.

We entered this downturn because people could not pay the debts they owed.  We are still in this mess because people still cannot pay.  The government attempted to shift those debts to itself, and now it is in danger of being unable to pay.

The Federal Reserve Z1 will be out on the 10th, and I will be updating the charts showing total systemic debt on that day.  I expect they will continue to show contraction, despite the efforts of government to stimulate credit demand and thus continue the expansion.

That is the end game that leads to the Mises-style “adjustment” and there is nothing that can be done to prevent it.

The government has spent two years trying to stop the contraction by replacing private credit demand with public.  The attempt to re-ignite private credit growth has failed, exactly as I expected it to and have repeatedly stated it would here on these pages.

All that has happened is that governments have now started to be unable to meet their debt commitments – so instead of businesses (and banks) going under, we now have the risk of governments going under. 

The idiots in Washington DC and indeed around the world refused to recognize that they are the gnat on the horse’s ass.  If you look at the above chart you can see it clearly – Federal Debt is a small fraction of the total in the system.  It is therefore mathematically impossible for The Federal Government to supplant and replace private credit demand and ability to pay.  Something that is 20% of the whole cannot support the whole – it’s that simple.

The sustainable long-run percentage of debt in the system is about half of what is now present.  If we were to shrink “financial instruments” and “non-financial business credit” by 60% and household credit by about half we’d be in the upper part of the sustainable range.

That’s where we’re headed – whether we like it or not – as the government is reaching the end of its ability to prop this thing up.

The knock-on effects to GDP that will engender will be hideous.  Just to go back to 2000′s GDP would knock forty percent off.  To return to a sustainable debt ratio on a $10 trillion GDP would require us to contract credit outstanding by some 55% – and that would put us at the top of the range.

I said when I began writing The Ticker that had we taken our medicine in 2001 we would have had to suffer a mild Depression – a 10-12% correction to GDP.  In 2007, we would have had to suffer a 20% correction to GDP – roughly equivalent to The Great Depression of the 1930s.

I also said that if the government did what they’ve now done, the damage could easily be twice that bad, with a potential 40% decline in GDP in the cards.

Is there a guarantee that things will get that bad?  No.  But is it entirely possible?  Yes, and if you believe not and want to expound on that in public you need to explain how your scenario can come about, given the clear mathematical evidence.

By Karl Denninger

The Market-Ticker

This is an unpopular set of prescriptions.  Nonetheless, it is the only thing that will work, and either our President grows a set of clankers between his legs and forces this through one way or another or we will suffer a self-fulfilling collapse when our turn comes – and it will.

1. ALL derivatives must be placed on an exchange and backed nightly with CASH margin.   Give everyone 30 or 60 days to do it, including de-constructing the “custom” derivatives to one or more “standard” and thus tradeable contracts.  All positions must be marked nightly to the market and cash margin posted by the underwater side – period.

2. 30 or 60 days hence all derivatives not so exchange-traded with cash margin proved behind each one are deemed canceled.  End of discussion.  Argue over “sanctity of contracts” if you wish, the inability in aggregate to perform is sufficient to void them.  Yes, I know, this will produce howls.  I don’t care.  That which must be done must be done.  If the GM bondholders can take this one up the chute so can the banks on these derivatives.

3. All banks and other backstopped institutions are required to sell 5% of their retained portfolios to non-bank entities and mark their portfolios to the market – no exceptions – including all off-balance sheet entities.  The “mark to fantasy”, “extend and pretend” and similar games must stop right now.  We gave the banks the right to lie for a year and demanded they recapitalize and get rid of their crap.  They laughed at the government and bonused out over $100 billion instead.  These institutions and individuals abused the “pass” we gave them – this has to end as the crisis was and is REAL!  The mark-to-market requirement must be immediate, continuing and permanent.

4. All banks and other backstopped entities are required to adhere to “one dollar of capital” behind each dollar of unsecured lending at all times, plus six percent regulatory cushion, all in either cash or short-term (26-week or shorter) T-bills.  No ifs, ands, buts or exceptions.  Give the banks three months to sell off whatever they must (or to raise additional capital on whatever terms they must) to meet these requirements.

5. The government must cut back spending to what it can support with current tax revenues at all levels – federal, state and local.  Yes, I know this will mean big cuts in state, local and federal jobs and budgets.  It has to happen.  Give the public sector unions a choice – either they accept 20% across the board cuts or they’re all fired and replaced.  Reagan did it with PATCO and we need to do it across the nation.  It doesn’t matter what a judge says if the unions sue – if there’s no money the check bounces, and that’s that.

6. The banks that are rendered insolvent by (1) – (4) above are closed.  The assets of those institutions are sold off and the capital structure takes the hit, with both bond and stockholders bearing all loss until they are both exhausted in their entirety.  At that point if the FDIC needs to step in to make depositors (and only depositors!) whole they do, borrowing on the credit of the United States Government if necessary. 

7. IF this leaves us with insufficient capital in the banking system as a whole to support the proper and necessary clearing functions for payments then the Federal Government charters ten new federal banks with $10 billion in capital each.  These new banks can then lend $100 billion each, or $1 trillion in aggregate, in new credit into the economy.  However, they remain constrained as do all other financial institutions post this change, to the new rules.

8. No bank or other financial institution may exceed $100 billion in assets and no institution of any sort may maintain any asset off balance sheet.  No exceptions.  If this asset level is exceeded the excess is escheated to the United States Government.  That instantly stops the game-playing and the above prevents interlocking “too big to fail” circumstances from developing.

9. The Fed is DIRECTED to bring credit aggregates in line with long-run GDP within the next five years.  This requires massive withdrawal of credit liquidity to the level of stable utilization, which was found in the 1950s to 1980.  That is, total systemic debt to GDP ratios of 125-175%.  I am well-aware that this means the withdrawal of more than half of all outstanding credit.  This is The Fed’s actual legal mandate -  the Executive and Congress must demand that either The Fed do this or The Fed as currently constituted must be dissolved and replaced with an institution that will!  We must also amend the Federal Reserve Act to provide for criminal penalties for future violations.

I fully understand that doing all of the above would cause an immense amount of economic pain.  It would end the games of “pulled forward demand”, asset prices that are supported not by production but by stratospheric and pyramided debt, government deficit spending with all that entails and the age of “entitlement.”

But it would have been less painful two years ago to do this than now, and if we don’t do it now it will only get worse!  If we wait for the collapse to come here the contraction will not be to 125-175% of GDP for outstanding debt, it may be all the way to zero in terms of available debt on reasonable terms!

There is no way to escape what has to happen here folks.  We are only choosing when we accept that which must happen – the removal of excess leverage and fraud from our financial system and economy.

The longer we wait to do it the more damage will accumulate as a direct and proximate result of continued attempts to paper it over and lie to the American public.

By Karl Denninger

The Market-Ticker