By Karl Denninger
There is nothing more amusing than watching the Neo-Fraudesian economists (that’s what so-called “Keynesians” actually are) run into the wall of reality at 120 mph:
Federal Reserve chairman Ben Bernanke is waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral.
Really? A “deflationary spiral”? Is that really deflation in your pocket or is it withdrawal and mean-reversion of the outrageous hyperinflationary credit policies of the previous 20 years that is FORCED when the scam runs its course and can’t find any more participants for the Ponzi Scheme?
Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed’s balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion. But they are certain to face intense scepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts.
Really? What “key members” are those Ambrose?
The fun part of writing fiction pieces is that you never have to name your non-existent sources. The even more-fun part of it is that you can write about things that violate the laws of thermodynamics and physics, such as, for example, faster-than-light travel.
Here’s the problem with “further expansion of The Fed balance sheet” – there’s no evidence that the previous expansion did anything good. In fact, there’s plenty of evidence that it did a lot of harm by permitting institutions to claim “value” where none existed. This sort of fraud is particularly corrosive to both society and general business conditions as it is not possible for anyone to know whether their business will get “collateral relief” from such a fraudulent orgy in any future move – or whether your (correct) wager on asset prices will be turned into a loss by regulatory or legislative fiat and handout.
The capital markets serve two essential purposes in an economy: Capital formation and price discovery. They can perform neither job when the government will come in and declare the results of a race that has been run different than the actual order of the horses across the line.
“We’re heading towards a double-dip recession,” said Chris Whalen, a former Fed official and now head of Institutional Risk Analystics. “The party is over from fiscal support. These hard-money men are fighting the last war: they don’t recognise that money velocity has slowed and we are going into deflation. The only default option left is to crank up the printing presses again.”
The problem is that you can’t.
This is the fallacy of the Neo-Fraudesians – that if we just “expand M3” all will be well.
No it won’t.
0% interest rates means that it is essentially free to borrow short duration money. Buying down the long end and the marketplace has driven “long money” to under 5% (30 year mortgages) but it hasn’t mattered.
It doesn’t matter because the ability of consumers to take on more debt is exhausted – they can’t afford it, no matter how low the interest. Without employment and income you can’t pay the debt service.
Businesses refuse to hire into an unstable regulatory and monetary environment, as well they should. If you’re Honda, do you hire into the possibility that Government Motors will literally gift every American a GM car? Of course not.
Is that an extreme example? Maybe. But maybe it’s somewhat like reality too, when the government will hand people thousands of dollars of other people’s money (borrowed money at that!) not go build a bridge or road, but to sit on their hands and watch television!
Credit-based economies require recessions to maintain balance. This is a trivial mathematical proof – since nobody will lend money at less than the zero-risk return, and the zero-risk return is typically somewhere near GDP growth, it therefore follows that if you maintain monetary balance (that is, credit and monetary aggregates expand at roughly GDP) it will soon become impossible to make the interest payments (since mathematically any two exponential functions will run away from one another if one exponent is larger than the other.)
There are only two ways to prevent this:
Generate (through intentional mismanagement of credit aggregates) insane inflationary “boosts”, which typically result from tampering with liquidity so that someone is effectively paid to borrow. This always generates asset bubbles.
Permit the economy to go through a recession when the credit capacity is exceeded in aggregate. This causes the borrowers and lenders who made unsupportable loans (that is, to the weakest economic actors) to go bankrupt.
In the first case you create a credit chart that looks like this:
The second prevents such a chart, and looks more like the chart through the early 1970s – specifically:
Note that the problem starts to get out of hand in the 1970s…. but the damage isn’t immediately apparent.
There are those who will argue that Nixon’s closure of the Gold Window was responsible. Nonsense. The presence or absence of a gold window and currency peg has nothing to do with whether credit aggregates are allowed to grow beyond reason.
Indeed, the debt-to-GDP numbers spiked enormously during the 1920s and 30s – even though we were on a “gold standard.”
The problem with papering over recessions is that you don’t really avoid them – you just compound and defer their effects. When the economy starts to run into credit-capacity problems you’re then driven to embed structural deficits into government spending to keep the Ponzi Scheme going. And when that fails you become Iceland or Greece.
That it will fail is mathematically certain. We argue only over the when, not the what.
“This does nothing to expand the broad money supply. The trouble is that the Fed does not understand broad money and ascribes no importance to it,” he said. The result is a collapse of M3, which has contracted at an annual rate of 7.6pc over the last three months.
M3 is irrelevant. There’s plenty of credit available but no capacity to take it down and do anything productive with it. Attempting to force-feed more credit into the system in this circumstance only causes more damage to be compounded into the system.
AEP and the other Fraudesians are attempting to fight the laws of physics and mathematics.
It’s a fight they are mathematically destined to lose, with the only remaining question being how quickly they will throw in the towel and thus stop the accumulation of damage, choosing instead to accept the harm that has thus far been accrued.