Gary Schilling Is An Optimist


Gary continues to talk about deleveraging in the economy and markets as if there’s some of that actually going on, and which is of course used as justification for QE3:

The only thing that would restore normal global growth, I argued, was time — the five to seven years it will take for deleveraging to be completed.

But there is no deleveraging.  That’s the entire point of QE(whatever) — preventing that deleveraging!

There have been only a couple of places where any deleveraging has taken place.  Home mortgages, for example, have “de-levered” by about $1.05 trillion, or roughly 10% of the maximum amount in Q2 2008.  However, the total amount of debt owed by that same group (persons and non-profits) has decreased by only $876.490 billion during the same period.  In other words net-net leverage is still increasing (much of it in student loans!) while home mortgages have modestlydecreased in outstanding size.

Now go look at the Z1 and find me another place where credit outstanding has decreased.  You can find only one:“financial market instruments”, in other words, credit between banks that does not enter the economy itself but is used to claim that margins and similar requirements are “covered.”

There has been no de-leveraging, in short.

What there has been is an outrageous destruction in capital formation, as the capital base of the nation has been systematically destroyed and transferred to these very same financial institutions to keep them from having to recognize their insolvency.

Unfortunately that effect is negative for everyone except those major financial institutions.

This is the problem, in a nutshell, with the policies of the government and Fed; they have not been intended to “help the economy”; any such pretext disappeared after the first QE when the outcome was clearly visible in the Fed Z1.

Gary is right in that the markets are basically “stoned” on monetary effects.  But the labor force, competitiveness and most-importantly capital formation are all decimated by these “effects.”

Let’s once again go over the impact of these policies, because there remains a meme in the economic literature (especially on bubblevision) that you can get a free lunch in some way with monetary games.  That’s balderdash and dangerous, and until we excise our belief in such silly superstitions no real progress can be made.

Let us presume that there are 10,000 units of currency and credit in the economy.  Let us further presume that there are 10,000 units of production — gasoline, bread, houses, etc.  Note that “units” are of necessity not the same between production and currency/credit — that is, we’re not going to commit the open and notorious public fraud of denominating production in the same thing we’re about to vary, then claim that a change in production denominated in that other unit is somehow unit-invariant!

Now the economy slows and the 10,000 units of production leaves us with 1,000 units unsold.  We therefore now have an actual organic demand for 9,000 units of output.  The rest is sitting in a warehouse.

The monetary response to this event is to add 1,000 units of currency and credit into the economy.

What happens?

Well, let’s think about it for a minute.  The premise of the “MMT” and Keynesians is that this addition will “stimulate demand.”  So let us give them the benefit of the doubt and assume for a minute that the entire 1,000 emitted units are immediately spent, closing the demand gap.

Did the gap really get closed?

No.  Remember, we had 10,000 units of output and 10,000 units of currency, and developed a slack of 1,000 units in demand for that output.  Now we have 10,000 units of output that is demanded but there are 11,000 units of currency and credit in the system where there were 10,000 before!

Therefore we now need 1.1 units of currency or credit to buy one unit of output.  This is an immediate devaluation of the existing stock of currency and credit in the economy, and that assumes that the actual demand gap is filled!

If the demand gap is not filled, that is the Keynesians and MMT folks are wrong about the impact of the the new emitted credit and currency then it’s even worse; if there’s no increase in actual demand in unit (not monetary) terms then you’re in real trouble because now you have 11,000 units of currency and credit but 9,000 units of demanded production; the devaluation in terms of imputed balance is now 18.1% instead of 10%.

That’s a problem, right?

We tried this same game during the 1930s, in fact, and it failed.  Oh sure, we managed to devalue the currency; that’s easy.  The hard part is returning to anything approaching full employment; you simply can’t get there by debasing the currencybecause when you do so all saved capital is damaged and the excessive leverage and thus its drag on the economy remains in the system instead of being purged by bankruptcies.

Now let’s look at the impact of a tax increase to fund increased government expenditures instead of monetary games.  In gross terms both are identical; that is, both take actual purchasing power out of the economy in the same amount.

But in the case of a tax it is imposed on profits, whether corporately or individually.  That is, with the exception of property taxes virtually all taxes are imposed not on saved capital but rather on current profitable economic activity.  This leaves available saved capital to form businesses and jobs.

In the case of monetary debasement, however, all economic activity and saved capital are identically hit.  The person who has $10,000 saved for his kid’s college education sees the value in credit-hour terms debased even though he did nothing with the funds other than try to stash them in expectation of a future need.

There is no such thing as a free lunch; reality is that our government and Fed policies have had exactly nothing to do with the broader economy or the people of our nation.  They have been intended to and actually did protect exactly one group — the big financial institutions — by literally stealing the accumulated and earned wealth of every American to the tune of trillions of dollars so as to prop up large financial institutions that took on too much risk on their own volition and in addition in many cases actively deceived and defrauded the public itself!

It’s outrageous enough that an institution or industry that ripped off the public got bailed out.

It’s even worse when the people who were victimized by that industry got robbed a second time to bail them out after being victimized in the first place.

But in the end, it hasn’t worked not because the programs were too small or too weak-kneed.

It didn’t work because mathematically it can’t.

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