No, Really? (Hard Knocks From Easy Money)


By Karl Denninger

Wow, it took this long for the mainstream media to publish a piece like this?

Super-low interest rates also ensure that the big banks, fated to be wards of the government if the new financial reform becomes law, will have generous margins between their borrowing costs and lending revenues. This will enable them to further pad their balance sheets and correct the mistakes of yesteryear.


There’s a flip side, however. It only takes simple math to know that when interest rates are kept low, so are returns on savings and investment.

Read that last sentence again.

Part of the “strategy”, if you will, is to drive money into things that are more dangerous. 

But there are plenty of people out there – indeed, perhaps most investors – who have absolutely no business being in anything with material amounts of risk.

This is the age-old cry of the people about “inflation”, yet those who argue over inflation forget that during times of inflation there’s lots of money to be made in safe investments.  13% 30 year Treasury bonds anyone?  There was a couple of year period where you could have bought 30 year Treasury instruments at yields from 13-15%.  Some people looked at that as a sucker’s game, as the United States was about to implode in a hyperinflationary disaster.

To the contrary; buying those bonds was literally the trade of a lifetime – zero risk and over the life of the bond it returned that nice safe 13% for the entire 30 years.  Indeed, some are maturing just now.

Even better, if you cashed them early the capital gains in 1995, for example, were enormous.  That position rolled into common stocks in 1995 and sold out in late 1999 would have literally made you stinking filthy rich.

But now there’s a problem.  Pension funds and other “fixed income” investors have gotten fat and stupid.  Bubble-blowing has led them setting entirely-unreasonable expectations, like 7 or 8% annualized compounded returns.

Yet there is nowhere in the Treasury complex you could earn that since 1995 – ergo, you had to take the risk of loss or adjust down your coupon expectations.

The problem with the latter is that it leaves pension funds radically underfunded, and in the out year it means they will go bankrupt. 

Not might – will.

So now you have a nasty quandry: There is no place for pension funds to meet expectations with anything that’s safe, and yet at the same time ZIRP and its cousins has led Congress to believe it can spend literally without limit, since the cost of financing an infinite deficit at zero interest, assuming you never intend to pay off the principal, is in fact zero!

There are a handful of very dangerous jackasses running around out there who believe “deficits don’t matter”, or even worse, “government can print up and spend anything it wants as it doesn’t play by the same rules; it not only can’t go bankrupt but by spending more and more it lifts the economy.”

In a word:

Reality is that such nonsense is simply more Ponzi Economics.  It is the belief that one can find a free lunch – that there’s some magical rainbow at the butt end of a unicorn that emits pretty-colored candies.

The truth is that it is unbelievably corrosive to think that we can inflate out of this, whether with printed money or with borrowed. 

If one actually “prints” then the immediate response in the marketplace is to shut down all lending of capital.  Why?  Because the person with capital has no means of assessing the damage to their purchasing power.  Remember, interest is what’s charged for the time value of money, the risk of default and the risk of dilution of your purchasing power by either naked shorting of the currency or outright unbacked emission.

The “deal” that all debt-backed currency systems make is that unbacked emission won’t happen.  Naked shorting (which is what issuing unsecured credit is against a currency) is bad enough; unbacked emission is ruinous to those who have lent capital on fixed terms.

There is no free lunch; destroying those who have term obligations such as pension funds simply means that the government now has more people coming to it with hand outstretched for a bailout.  But the ability to fund that bailout is not unlimited, Dick Cheney “deficits don’t matter” crooning aside.

The danger is that nobody knows in advance exactly where the edge of that cliff lies.  Greece and Iceland found it the hard way and suffered ruinous damage to their economies.  Neither thought the cliff was near; both engaged in hinky accounting to try to hide exactly how bad the damage was, just like the pension funds, states and federal government are doing right here, right now, in The United States.

“Austerity” connotes starving in the streets among the public but in point of fact thrift – saving back 10 or 20% of one’s income and a government that spends less than what it takes in via taxes, paying down accumulated deficits, is not a dirty word at all.

Capital seeks return, and when you engage in austerity you free capital.  The combined earnings power of the nation is incredible; government can, at best, extract perhaps a fifth of it and redirect it, but in the process loses so much to internal costs, fraud and waste that it makes a poor allocator.

Growth comes from the productive use of credit – that is, credit taken for the purpose of expanding factories, machine shops and innovative businesses that invent things like transistors and microprocessors. 

Credit used for consumption – which includes virtually all credit taken by state and federal governments – is corrosive to to the financial health of the nation over time.  The negative impacts don’t appear right away, as it is the compound nature of interest that causes the problem.  In the short term such expenditures look great, as the pulled-forward demand causes more production to take place.

But the debt left behind still needs to be serviced, and even under the argument that government essentially creates that demand by issuing, the fact remains that the exponential nature of both growth and debt means that one cannot escape from the crush that comes from the use of credit for either consumptive or speculative purpose.

The Market-Ticker