The Real Policy Mistake


This morning I wanted to puke up my coffee while listening to CNBS, which was going on about “policy mistakes” and the Jackson Hole symposium that is opening today.

In short, the premise they’re running (along with the rest of the media) is that we’re “trying” to have a recovery, and only a policy mistake by the Central Banks can destroy it.

This is a damned lie.

The policy mistake was already made, 10 and 20 years ago, and it was both governments and central banks that made it. 

The policy mistake was to allow leverage to masquerade as growth.

Let me explain.

If I have a dollar of actual production profit that didn’t exist before, I have a dollar of growth.  It’s organic and it’s real.

But if at the same time I produce a dollar of production growth, and then expand the leverage in the system that this dollar is put through from 10x to 30x, it appears that I have three dollars of growth.

That is a lie.  I have only one dollar of actual production growth. 

What I’ve done is abused leverage to falsely state that more growth occurred than in fact took place, trading that fake reported growth for reduced risk tolerance.

That is, if I have 10x leverage in the system and a dollar of growth I need to lose 10% before I am bankrupt – that is, before all of my capital is consumed by the loss.  But if I expand that leverage to 30x then I can only lose 3% before I go under.  I have traded 2/3rds of my safety margin for a false claim of “economic prosperity.”

Central banks are supposed to prevent this from happening, as are banking regulators.  I remind readers that the Federal Reserve Act actually says:

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

“Moderate” rates are not zero, of course.  Neither are “moderate” rates 2.5%, which is where the 10 year is right now (and headed lower.)  Both of those are severely-depressed rates.

Worse, you can’t fix this with more “QE” or more “stimulus.”  The policy mistake has to be reversed.  Then – and only then – once you have returned to a reasonable level of systemic leverage through the entire economy, does monetary policy become effective once more.

Everyone is looking for a free lunch, both government and private sector.  PIMpCO’s Bill Gross, Geithner, Obama, Bernanke.  None of them want to talk about the fact that the so-called “growth” being boasted about is a damned lie and most of it through the 2000s and a lot of it in the 1990s never happened at all!  That is, we didn’t have actual growth, we had leverage expansion, which works the same way as does “multiple expansion” in the stock market – and is equally-unsustainable.

When you boil it all down our so-called “prosperity” was mostly leverage expansion and the off-shoring of the costs – sure, I can make DVD players real cheap-like if I can belch the smoke from my factory into the air and pollute the hell out of the water.  Not doing that costs money, but so long as it’s not in our back yard, and we don’t see it, we deem it “ok”.  Ditto for slave-labor style working conditions.

Mean-reversion is a bitch, as anyone who has lived through it knows.  It is also inevitable, and just like any pendulum effect, the further you push it before allowing the reversion to take place the worse and more-violent that contrary move is.  Put another way if I pick up a bowling ball and drop it on your foot from 3″ up it’s going to hurt.  If I lift that same bowling ball over my head you’re going to the hospital for what is now a mashed foot.  And if I toss it off a 20-story building and it hits you on the head, we call that “splat“.

The stored “snapback” energy of what we’ve done will be released.  We can choose to try to release it somewhat-slowly, but our policies thus far – a refusal to re-instate Glass-Steagall, a refusal to move down payments for homes back toward 20%, a refusal to put the former 14:1 leverage limits back on banks (which Henry Paulson was responsible for the removal of), a refusal to lock up any of the banksters involved in ripping off consumers along with state and local governments (despite some of those officials, particularly those in Jefferson County Alabama, having been convicted and sentenced) and a refusal to limit federal deficits to some reasonable level (e.g. 3% of GDP, as is the case in the EU) – all are evidence of our refusal to face reality. 

Instead we have chosen to hoist the bowling ball ever-higher, in the (false) belief that it won’t come crashing down on our heads – and that if we can just get it up high enough that we can’t see it any more, the energy it represents – and the damage – will have disappeared.

Economic reality is shockingly similar to physics – you can’t cheat it and you can’t bargain with it. 

You can only choose up to a certain point to accept it, and the earlier you decide to accept reality the less damage you have to endure.

It is time for Bernanke to admit the truth – and his role in creating this mess, along with promoting real, honest, and sustainable measures to bring our economy back into balance.

The Market-Ticker