Archive for the ‘Monetary System’ Category
These are clear warnings signs that a rational person simply cannot ignore.
Bottom line, Nations are going bust. And the worse things get, the more desperate their tactics become. This isn’t the first time that the world has been in this position. This time is not different. History shows that there are serious, serious consequences to running unsustainably high debts and deficits. And those consequences have almost invariably involved pillaging people’s wealth, savings, livelihoods and liberties… either directly or indirectly.
What’s happening right now is playing out in textbook fashion. More taxes, more debt, more printing, more confiscation, less freedom. I’m not talking about the end of the world here, I’m talking about difficult times ahead, and the things that go beyond economics. It’s time to face facts and look at how society will change (and has already changed).
Many people will resist the change and instead cling desperately to the old system - the cycle of debt and consumption that provided jobs, stability, and prosperity. These people will have their lives turned upside down because that system is gone forever. And in case it still weren’t obvious, here is three minutes of clarity from Ron Paul and Jim Rogers…“I would expect that there is going to be a lot more chaos still to come.” – Ron Paul; “They won’t take our bank accounts…they will take our retirement accounts.” – Jim Rogers
Via Simon Black of Sovereign Man blog,
The world is truly an enormous place… and, despite the dearth of good news and positive trends out there, I still see a lot of amazing opportunities in my travels.
But it’s really important to remain grounded about the challenges that face us. As I pen this letter to you, in fact,
- The NSA’s Utah data center, which will intercept every phone call, email, and tweet sent across the Internet, is nearing completion.
- The Marketplace Fairness Act, which will create additional sales taxes on US-based Internet transactions, is set to pass the Senate next week.
- The government of Cyprus just passed the final bail-in measures, officially authorizing the direct confiscation of people’s savings in that country’s banking system.
- The Bank of Japan recently announced its intentions to double down on their already unprecedented money printing operations.
- Not to be outdone, the US Federal Reserve just announced that they will maintain their Quantitative Easing program, which dilutes the existing money supply by more than $1 trillion annually.
- At $16.83 trillion, the US federal debt is at a record high and set to breach $17 trillion early this summer.
- President Obama recently proposed to cap the tax deferral benefit on Individual Retirement Accounts in the Land of the Free
These are clear warnings signs that a rational person simply cannot ignore.
Bottom line, nations are going bust. And the worse things get, the more desperate their tactics become.
This isn’t the first time that the world has been in this position. This time is not different.
History shows that there are serious, serious consequences to running unsustainably high debts and deficits. And those consequences have almost invariably involved pillaging people’s wealth, savings, livelihoods and liberties… either directly or indirectly.
What’s happening right now is playing out in textbook fashion. More taxes, more debt, more printing, more confiscation, less freedom.
I’m not talking about the end of the world here, I’m talking about difficult times ahead, and the things that go beyond economics. It’s time to face facts and look at how society will change (and has already changed).
Many people will resist the change and instead cling desperately to the old system– the cycle of debt and consumption that provided jobs, stability, and prosperity. These people will have their lives turned upside down because that system is gone forever.
And in case it still weren’t obvious, I’d like to present Ron Paul and Jim Rogers, speaking together at our event in Chile a few weeks ago, with their own views on the situation.
“They won’t take our bank accounts…they will take our retirement accounts.” – Jim Rogers
“We are going to have a calamity in economics and political crises as economies worldwide are a lot weaker than they tell us.” – Ron Paul
“I would expect that there is going to be a lot more chaos still to come.” – Ron Paul
“There are so many distortions because we disobeyed economic law – no matter what Bernanke tell’s you.” – Ron Paul
“Bernanke’s whole intellectual career has been dedicated to the study of printing money.” – Jim Rogers
“I don’t doubt [the confiscation] at all; and they will use force and they’ll use intimidation.” – Ron Paul
Three minutes of clarity…
There seems to be a rather fundamental lack of understanding regarding what happened in Greece and what is going on in Cyprus right now.
Unfortunately that lack of understanding is intentional. See, the debt merchants of the world, despite publishing voluminous statistics that prove their schemes are unsustainable and foolish, continue to prattle on about how we must have “shared sacrifice” and such similar pablum in order to “save” people from what are claimed to be “accidents.”
People like Bernanke, LaGarde, Merkel and the other merry merchants of economic destruction must be praying every night that you do not bother to sit down with a calculator and sheet of graph paper, or worse a computer that replaces both (and makes the job easier), because if you do, whether here in the United States or in any other nation you will instantly see what has been done over the last 30 years — and what has to be done now.
That is the day in which these people fear for their political if not literal necks, because once a critical mass of the population understands what has been done they will also understand that (1) it was not an accident and (2) what is being done now cannot possibly work.
About 30 years ago, if you remember, we had a nasty inflationary problem that was stoked by an oil shock. But the problem did not originate there — it came from a wage-price spiral that was initiated by those who believed that extracting ever-larger pieces of the economic pie to redistribute to others could be “absorbed” in some form or fashion. As the people’s real purchasing power declined they demanded larger wages, and at the time there was sufficient union negotiating power to force those wages upward.
But that didn’t work out because for virtually every business the largest component of cost in the goods and services it provides is found in labor. As a result those demands for higher wages were met but they immediately translated into higher prices, which resulted (once again!) in lower purchasing power in real terms. That is, the goal to be able to buy more eggs or gallons of milk with an hour’s labor failed.
So once again the workers threatened strikes, and once again wages went up. And so did prices. Oops.
There is a common misconception that Volcker “choked off” this cycle. He did no such thing. The market discerned that due to spiral of destruction in purchasing power credit had to be priced far higher than it was, and interest rates — especially time-sensitive ones — went much higher. Volcker followed that rather than fighting it, making all sorts of noise about how he was “in charge.”
You are wrong if you believe the narrative that he was in charge. He was not able to overcome the market — nobody is, not even a Fed chairman.
Notice that the red line, the MARKET rate for 13 week T-bills, moves ahead of the FOMC in most instances. Volcker was not in control — the market was.
This alarmed him. It alarmed the “monetary authorities.” But worse, at that time there was a serious problem brewing overseas that was about to ensnare our banks — the Latin American debt crisis.
Citibank, along with others, had made a lot of loans to nations south of our border. They had performed little diligence on the ability of their economies to pay back the money owed, and in fact they couldn’t pay. As this became apparent it threatened to collapse our largest banks.
The decision was taken to intentionally ignore the fact that these bonds, which our banks owned and which were not going to be repaid as agreed, were impaired. That is, our banks were given explicit permission to lie for an extended period of time about their solvency with the expectation that they could “earn” through the imposition of outrageous fees and costs on others, enough to return themselves to solvency over time.
This was the beginning of the modern financial scam that has been run serially since by governments around the world, which now threatens to blow up the EU, and which if we do not stop it will eventually blow up the United States.
At its core this premise is a fraud — that one can pretend to be able to pay tomorrow for something you have today, and it’s perfectly ok as a consequence tolie about your credit quality.
THAT is Volcker’s true legacy – explicit and intentional support of financial frauds.
Thus began this age in America:
This graph is very simple. It represents, from Fed Z1 and BEA GDP data, the gross amount of change, in dollars, for each quarter in both debt outstanding across all sectors of the economy and the gross change in domestic output. You will notice that for each quarter up until the crash there was never a change in output for even one three month period that was not simply bought on a credit card.
That is, the real change is negative becasue otherwise you are counting a given dollar twice!
That green line is the actual quarterly changed in domestic output created by economic surplus – that is, not borrowed with a claim that you’ll pay tomorrow.
We have created a 30 year long deficit in this regard and the debt that we created in order to do so remains.
The reason there is no economic growth to speak of is that the convergence point is in fact right near zero! As you can see post 2007 when the crash occurred every time you try to start spiking credit creation upward again the economy turns south in nominal terms. You saw it in 2010 and now you’re seeing it again as the early 2012 credit spike has led to a collapse in nominal GDP.
The monetary and fiscal authorities are trying to restart what they did from the 1980s through 2007 but it is not working. It is not working because it cannot work; the consumer is debt-saturated and either unwilling or unable to lever up while making the payments, even temporarily, and every time this is attempted the economy responds by contracting.
We now have five years of empirical evidence in the form of hard data that what I claimed back in 2007 — that this model would not work because it could not work — is correct.
Greece and now Cyrus also refused to abandon this “business model” even though they had the same data available to them that I have here. They continued to press the issue until it enveloped their governments. They were egged on and in fact defrauded by multiple actors including those who proclaimed that their banks were “healthy” and “passed” stress tests despite having knowledge that the collateral they were posting was trash and almost-certain to become worth less — or worthless entirely.
When the known-in-advance event occurred those same entities proclaimed that these governments now had to cede sovereignty despite being the very entities that took the collateral knowing it was junk and did not haircut it nor throw it back.
This is very much like having someone come into your gas station asking for a gallon of gasoline to commit arson with, giving it to them and then claiming innocence when they burn down a nightclub and murder 80 people.
You might be able to get away with that if you had no knowledge of what was going on but when you willfully and intentionally accepted and continued to accept garbage as “good collateral” this excuse is knowingly false.
There is no path forward for Cyprus (or Greece), or for that matter any other nation with a debt addiction that resides in any other path than repudiating the excessive debt. Yes, that means defaulting. It means that people must lose their money, and the people who lose should be those who bought or took as collateral blown debt instruments. In the case of Cyprus this means the ECB and European banks who bought and are holding the crap paper that was known impaired at the time of posting and remains so. If the ECB and European Banks refuse to accept these facts then their members must be indicted, tried, convicted and hung for their act of knowing and intentional gross fraud that was intended to and now has led to the looting of the public.
In the case of the United States we still have a monstrous amount of debt that must be removed from the system. We cannot “earn out way out of the hole”because the economy is not capable of generating sufficient organic growth to do so; it has all been debt-financed!
If we do not stop expanding the size of the Federal Government we will wind up in exactly the same place that Greece and Cyprus are, except that there is no “sugar daddy” in the form of the ECB and Germany to “dictate terms.” Only disorderly collapse awaits us if we do not cut this crap out, and do it now. We cannot slow the rate of expansion we must stop it – here, now and today.
We are far more fortunate than Cyprus, at least at present. Our imbalance is almost-entirely centered around health expense. We can take apart the medical monopolies and schemes simply by restoring the rule of law to those entities where they are currently exempt, restoring open competition, demanding level and published pricing and let the market work. The medical system’s share of the economy will collapse by 75% or more overnight. This will result in much short-term pain but it will be over almost as fast as it began as those resources will get redeployed in other areas of the economy — our competitiveness globally will skyrocket as that parasitic drain on our productivity will evaportate.
If we do not act, however, and further institutionalize the imbalance that is choking us to death then we will have the same thing happen here that is occurring in Cyprus. The medical industry is to our nation what the offshore banking industry is to Cyprus, and it uses the same sort of subterfuge and legal privilege granted to those banksters in collusion with the ECB. That is, just as the Cyprus banks posted collateral with the ECB and other Target2 institutions that both knew was impaired and yet did not force it back on the holders (thus putting a stop to the spiral before it gained critical mass and trashed their economy and nation) if we do not stop our medical firms from pulling the same crap, charging people $39,000 for a vial of antivenom that they paid $4,000 for, and which cost $100 in Mexico at the manufacturer — or charging one person $1,700 for an MRI scan that another pays $250 — we will meet the fate of Greece and Cyprus because the net impact of these policies is to drive government expansion well beyond the economy’s size and that will result in the destruction of our economic system.
There are those who have argued with my economic analysis over the last five or so years and said that we’d manage to get through this without having to take the leverage out of the system and that “it will all be ok if we just rescue X.”
The data is now in — the old model from the 1980s of using debt leverage to “generate” economic growth no longer works as it has been run to exhaustion, exactly as I put forward more than five years ago, and despite five full years of refusal to accept this and reform the system the facts are now on the table that even with all sorts of “extraordinary policy” such as QE and zero interest rates a restart of the debt-leverage system has repeatedly failed and every attempt to do so is quickly met with a decline in nominal GDP, not an advance.
WE MUST STOP NOW WHILE THERE IS STILL TIME TO DO SO.
Ben Bernanke has repeatedly maintained that his “Quantitative Easing” programs are mostly about helping out Main Street and ordinary Americans.
Unfortunately this claim is not supported by the evidence, and what’s worse is that the “tonic” is not working any more, just as a drug addict keeps needing more and more of their substance to stay “buzzed” and gets less and less effect with each dose.
QE3, the latest round, produced a short-term pop in the stock market. But we’re now back to levels essentially indistinguishable from those before it was announced, and the market’s weakness the last few weeks has been marked.
What’s worse is why the weakness has come — poor earnings across the board.
Unfortunately for Main Street you can’t produce earnings without, well, sales. There is a slowdown in sales while costs have risen; this produces lower profits. Worse, the banks cannot earn much in the way of an interest margin in a zero-rate world, so their earnings are in the toilet as well.
There’s nothing to suggest that sales are going to pick up in the coming days and weeks either; the latest was Richmond Fed which was terrible, showing both slowing sales and margin compression at the same time, a pair of statistics that rarely come together and are never good when they do.
So now Bernanke has a real problem, but he should have seen this coming because Japan did the same thing and got the same results. After the Nikkei originally cracked their central bank cut rates and ultimately started buying bonds, maintaining ZIRP. But while they got a nice bounce originally in the stock market look where the Nikkei is now, trading near 9,000 when it was formerly some four times higher!
We’re headed southbound folks; the economy is not recovering and it won’t because it can’t until The Fed cuts this crap out and the Federal Government stops emitting credit into the system and destroying purchasing power, trashing margins and wrecking the competitiveness of not only businesses but the fiscal health of individuals, especially those who have saved and tried to live in a reasonable fashion their entire lives.
Capital formation cannot return until these policies are changed, and there is no evidence that they will change in the offing.
As such while there are certainly opportunities in specific names, being anywhere near the stock indices over the next couple of years is likely to be a pretty ugly experience.
It’s time to take the chips off the table folks; a severe dislocation could come at any time, without warning, and if it does there is little or no room remaining within either fiscal or monetary authorities to attempt mitigating the damage.
It’s time we do away with the notion behind the incessant flow of stories and warnings about upcoming hyperinflation in the US. It can’t and therefore won’t happen, at least not for years into the future. It would be a lot more constructive – and necessary – to focus on the reality we see before us than on such a purely mythological tale. Because that’s all it is. Bubbles, and yes, that includes credit bubbles, have their own internal dynamics: they MUST pop when they reach critical mass.
Trying to prevent the pop, or even increase that mass, is futile. And even though that may be more about physics than about finance, why it is so hard to understand is beyond me. The deleveraging, a.k.a. debt deflation, has hardly begun, and it for now remains largely hidden behind a veil of QEs. That doesn’t negate the fact that ultimately QE is powerless to stop it, even as it sure manages to fool a lot of people into thinking it can.
But don’t take my word for it. You could start with – even – the IMF saying European banks will need to sell $4.5 trillion in assets through 2013. And then try to explain how that could possibly link to hyperinflation. For now: never mind.
Puru Saxena wrote a good piece on the topic recently, here are a few excerpts:
The world’s major economies are struggling and their private-sector is deleveraging (paying off debt). If history is any guide, this deflationary process is likely to continue for several years.
You will recall that heading into the global financial crisis, corporations and households in the developed world were leveraged to the hilt. During the pre-crisis era, debt was considered a birth right and for decades, the private-sector leveraged its balance-sheet. Unfortunately, when the US housing market peaked and Lehman went bust, asset values plummeted but the liabilities remain unchanged. Thus, for the first time in their lives, people in the developed world experienced the wrath of excessive leverage.
Today, the private-sector in the West is struggling and for the vast majority of households, their liabilities now exceed their assets. Furthermore, incomes have also declined (or vanished), thereby making the debt servicing even more difficult. Consequently, in order to avoid bankruptcy, the private-sector in the developed world is now trying its best to reduce its debt overhang. Instead of getting excited by near-zero interest rates and taking on even more debt, it is now doing the unthinkable and paying off its liabilities.
Figure 1 shows that despite the Federal Reserve’s carrot of almost free credit, the private-sector in the US is deleveraging. As you can see, since the bursting of the housing bubble, America’s companies and households have been accumulating large surpluses. Make no mistake, it is this deleveraging which is responsible for the sluggish economic activity in much of the developed world. Furthermore, this urge to repay debt is the real reason why monetary policy in the West has become ineffective.
If you review data, you will note that in addition to the US, most nations in Western Europe are also deleveraging and this explains why the continent’s economy is on its knees.
The truth is that such periods of deleveraging continue for several years and when the private-sector decides to repay debt, interest rates remain subdued and monetary policy becomes ineffective. Remember, during a normal business cycle, monetary easing succeeds in igniting another wave of leverage. However, when the private-sector is already leveraged to the hilt and it is dealing with negative equity, low interest rates fail to kick start another credit binge.
As much as Mr. Bernanke would like to ignore this reality, it is clear to us that this is where the developed world stands today. Furthermore, this ongoing deleveraging is the primary reason why the Federal Reserve’s stimulus has failed to increase America’s money supply or unleash high inflation. Figure 2 shows that over the past 4 years, the US monetary base has grown exponentially, yet this has not translated into money supply or loan growth.
At this stage, it is difficult to forecast when the ongoing deleveraging will end. However, we suspect that the private-sector may continue to pay off debt for at least another 4-5 years. In our view, unless the US housing market improves and real-estate prices rise significantly, American households will not be lured by record-low borrowing costs. Furthermore, given the fact that tens of millions of baby boomers are approaching retirement age, we believe that the ongoing deleveraging will not end anytime soon. Due to this rare aversion to debt, interest rates in the West will probably remain low for several years. [..]
Once you realize just how enormous that gap is (see that last graph) between the monetary base vs the money supply, and the seemingly smaller gap between monetary base vs loans and leases, maybe then you see a light a-shinin’. Maybe you never thought about things that way before, or maybe you never saw it in a graph, and you needed to see that. It surely carries a very large argument against hyperinflation.
Puru Saxena thinks there are positive signs in US housing numbers, that there’s a bottom, and he’s certainly not the only one; that’s one train everyone seems to be eager to jump on.
I’m sorry, but I think the recent alleged US housing recovery is a proverbial soap bubble. In the article below, Tyler Durden at ZH calls it a “subsidized bounce”. He also says: “two concurrent housing bubbles can not happen”, and he may well be right, but if he is, it means that perhaps what we see is a bubble within a bubble, a mother and child bubble, instead of two concurrent ones. Durden brings interesting numbers and developments to the forefront. It would be good if more people digest them, and only then decide whether this is a recovery or not.
US households are not merely deleveraging, and taken as a whole you could perhaps make a point that they’re not at all. They go one step beyond deleveraging: they’re simply and plainly defaulting.
Lately there has been an amusing and very spurious, not to mention wrong, argument among both the “serious media” and the various tabloids, that US households have delevered to the tune of $1 trillion, primarily as a result of mortgage debt reductions (not to be confused with total consumer debt which month after month hits new record highs, primarily due to soaring student and GM auto loans). The implication here is that unlike in year past, US households are finally doing the responsible thing and are actively deleveraging of their own free will.
This couldn’t be further from the truth, and to put baseless rumors of this nature to rest once and for all, below we have compiled a simple chart using the NY Fed’s own data, showing the total change in mortgage debt, and what portion of it is due to discharges (aka defaults) of 1st and 2nd lien debt. In a nutshell: based on NYFed calculations, there has been $800 billion in mortgage debt deleveraging since the end of 2007. This has been due to $1.2 trillion in discharges (the amount is greater than the total first lien mortgages, due to the increasing use of HELOCs and 2nd lien mortgages before the housing bubble popped).
In other words, instead of actual responsible behavior of paying down debt, the primary if not only reason there has been any “deleveraging” at all at the US household level, is because of excess debt which became insurmountable, not because it was being paid down, the result of which is that more and more Americans are simply handing their keys in to the bank and walking away, and also explains why the US banking system is now practicing Foreclosure Stuffing, as defined first here, as the banks know too well, if all the housing inventory which is currently in the default pipeline were unleashed, it would rip off any floor below the US housing “recovery” which is not a recovery at all, but merely a subsidized bounce, as millions of units are held on the banks’ books in hopes that what limited inventory there is gets bid up so high the second housing bubble can be inflated before the first one has even fully burst.
Naturally, two concurrent housing bubbles can not happen, Bernanke’s fondest wishes to the contrary notwithstanding, especially since as shown above, US households do not delever unless they actually file for bankruptcy, and in the process destroy their credit rating for years, making them ineligible for future debt for at least five years.
It is thus safe to say that all the other increasingly poorer US households [..] are merely adding on more and more debt in hopes of going out in a bankrupt blaze of glory just like everyone else: from their neighbors, to all “developed world” governments. And why not: after all this behavior is being endorsed by the Fed with both hands and feet.
The following graph from TD Securities ( through Sam Ro at BI ) makes a good case for the “subsidized bounce” definition Durden applies to the present US housing market. It’s no secret there’s a huge shadow inventory overhanging US housing, and now it comes out that those great new home numbers are not what everybody would like to think they are.
Many more houses are built than sold. And get shoved on top of the pile that’s already there, both the shadow inventory and the out of the closet one. Which begs the question: how long does a home stay in the “new” category? Does it take 1 year of staying empty for it to move to “existing”? 2 years, 3 years? 5? For one thing, builders and developers certainly have a huge incentive to continue to advertise it as new.
A graph from the same source:
How this constitutes a recovery I just can’t fathom. I think that is just something people would like so much to see that they actually see it. Moreover, there remains the issue that it’s very hard for most to comprehend what debt deflation is, what its dynamics are, and what consequences it has.
We have lived through the by far biggest credit bubble in history. It should be clear to everyone that this bubble has not fully – been – deflated yet (and if it’s not, good luck). Until it has, economic recovery and housing recovery are pipedreams. And so is hyperinflation, though that may be more of a pipe nightmare. There is no way QE, or money printing, or whatever you name it, can cause hyperinflation against the tide of a deflating bubble. Once a bubble has fully burst, it is a possibility. But only then. And only if and when a country has become unable to borrow in international debt markets. Greece perhaps soon, but for the US it’s years away, if ever.
Darrel Whitten at iStockAnalyst has more:
QE Ad Infinitum: Why QE is Not Reviving Growth
In a speech in November of 2002, Fed chairman Ben Bernanke made the now infamous statement, “the U.S. government has a technology, called the printing press, that allows it to produce as many U.S. dollars as it wishes essentially at no cost,” thus earning the nickname “Helicopter Ben”. Then, he was “confident that the Fed would take whatever means necessary to prevent significant deflation”, while admitting that “the effectiveness of anti-deflation policy would be significantly enhanced by cooperation between the monetary AND fiscal authorities.”
Five years after the 2008 financial crisis, Helicopter Ben undoubtedly has a greater appreciation for the issues the BoJ faced in the 1990s. The US 10-year treasury bond (as well as global bond) yields have been in a secular decline since 1980 and hit new historical lows after the crisis. What the bond market has been telling us even before the QE era is that bond investors expect even lower sustainable growth as well as ongoing disinflation/deflation, something that Helicopter Ben has been unable to eradicate despite unprecedented Fed balance sheet deployment.
A Broken Monetary Transfer Mechanism
Effective monetary policy is dependent on the function of what central bankers call the Monetary Transmission Mechanism, where “central bank policy-induced changes in the nominal money stock or the short-term nominal interest rate impact real economy variables such as aggregate output and employment, through the effects this monetary policy has on interest rates, exchange rates, equity and real estate prices, bank lending, and corporate balance sheets.”
Yet two monetary indicators, i.e., the money multiplier and the velocity of money clearly demonstrate that the plumbing of this monetary transmission mechanism is dysfunctional. In reality, the modern economy is driven by demand-determined credit, where money supply (M1, M2, M3) is just an arbitrary reflection of the credit circuit. As long as expectations in the real economy are not affected, increases in Fed-supplied money will simply be a swap of one zero-interest asset for another, no matter how much the monetary base increases. Thus the volume of credit is the real variable, not the size of QE or the monetary base.
Prior to 2001, the Bank of Japan repeatedly argued against quantitative easing, arguing that it would be ineffective in that the excess liquidity would simply be held by banks as excess reserves. They were forced into adopting QE between 2001 and 2006 through the greater expedient of ensuring the stability of the Japanese banking system. Japan’s QE did function to stabilize the banking system, but did not have any visible favorable impact on the real economy in terms of demand for credit. Despite a massive increase in bank reserves at the BoJ and a corresponding increase in base money, lending in the Japanese banking system did not increase because: a) Japanese banks were using the excess liquidity to repair their balance sheets and b) because both the banks and their corporate clients were trying to de-lever their balance sheets.
Further, instead of creating inflation, Japan experienced deflation, and these deflationary pressures continue today amidst tepid economic growth. This process of debt de-leveraging morphing into tepid long-term, deflationary growth with rapidly rising government debt is now referred to as “Japanification”.
Two Measures of Monetary Policy Effectiveness
(1) The Money Multiplier. The money multiplier is a measure of the maximum amount of commercial bank money (money in the economy) that can be created by a given unit of central bank money, i.e., the total amount of loans that commercial banks extend/create. Theoretically, it is the reciprocal of the reserve ratio, or the amount of total funds the banks are required to keep on hand to provide for possible deposit withdrawals.
Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically. Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Following the collapse of Lehman Brothers, excess reserves exploded, climbing to $1.6 trillion, or over 10X “normal” levels. While required reserves also over this period, this change was dwarfed by the large and unprecedented rise in excess reserves. In other words, because the monetary transfer mechanism plumbing is stopped-up, monetary stimulus merely results in a huge build-up of bank reserves held at the central bank.
If banks lend out close to the maximum allowed by their reserves, then the amount of commercial bank money equals the amount of central bank money provided times the money multiplier. However, if banks lend less than the maximum allowable according to their reserve ratio, they accumulate “excess” reserves, meaning the amount of commercial bank money being created is less than the central bank money being created. As is shown in the following FRED chart, the money multiplier collapsed during the 2008 financial crisis, plunging from from 1.5 to less than 0.8.
Further, there has been a consistent decline in the money multiplier from the mid-1980s prior to its collapse in 2008, which is similar to what happened in Japan. In Japan, this long-term decline in the money multiplier was attributable to a) deflationary expectations, and b) a rise in the ratio of cash in the non-financial sector. The gradual downtrend of the multiplier since 1980 has been a one-way street, reflecting a 20+ year dis-inflationary trend in the U.S. that turned into outright deflation in 2008.
(2) The Velocity of Money. The velocity of money is a measurement of the amount of economic activity associated with a given money supply, i.e., total Gross Domestic Product (GDP) divided by the Money Supply. This measurement also shows a marked slowdown in the amount of activity in the U.S. economy for the given amount of M2 money supply, i.e., increasingly more money is chasing the same level of output. During times of high inflation and prosperity, the velocity of money is high as the money supply is recycled from savings to loans to capital investment and consumption.
During periods of recession, the velocity of money falls as people and companies start saving and conserving. The FRED chart below also shows that the velocity of money in the U.S. has been consistently declining since before the IT bubble burst in January 2000—i.e., all the liquidity pumped into the system by the Fed from Y2K scare onward has basically been chasing its tail, leaving banks and corporates with more and more excess, unused cash that was not being re-cycled into the real economy.
Monetary Base Explosion Not Offsetting Collapsing Money Multiplier and Velocity
The wonkish explanation is BmV = PY, (where B = the monetary base, m = the money multiplier, V = velocity of money), PY is nominal GDP. In other words, the massive amounts of central bank monetary stimulus provided by the Fed and other central banks since the 2008 financial crisis have merely worked to offset the deflationary/recessionary impact of a collapsing money multiplier and velocity of money, but have not had a significant, lasting impact on nominal GDP or unemployment.
The only verifiable beneficial impact of QE, as in the case of Japan over a decade ago and the U.S. today is the stabilization of the banking system. But it is clear from the above measures and overall economic activity that monetary policy actions have been far less effective, and may even have been detrimental in terms of deflationary pressures by encouraging excess bank reserves. Until the money multiplier and velocity of money begin to re-expand, there will be no sustainable growth of credit, jobs, consumption, housing; i.e., real economic activity. By the same token, the speed of the recovery is dependent upon how rapidly the private sector cleanses their balance sheets of toxic assets.
QE falls into a black hole. And it leads into an – if possible even larger – black hole. Ben Bernanke and Mario Draghi have neither the power nor the tools to stop deleveraging and debt deflation. That’s just a myth they, and many with them who stand to benefit from that myth, like you to continue believing. It makes it all that much easier for them.
That surge in excess bank reserves (see the second graph above) comes from QE. It is your money, everyone’s money. And it does nothing to “heal” the economy you live in and depend on for your survival; it just takes away more of it all the time. That is the one thing Ben and Mario have power over: they can give money away that you will have to pay for down the line. They can lend it out to banks knowing that it will never be repaid, and not care one inch. Knowing meanwhile that you won’t either, because you don’t look at what’s down the line, you look at today, and today everything looks fine. Except for that graph, perhaps, but hey, how many people are there who understand what it says?
One thing Ben and Mario can not do, however, is create hyperinflation. They can’t even truly create any type of real inflation (which is money/credit supply x velocity vs goods and services), for that matter. They’re stuck as much as you yourself are in the dynamics of this bursting bubble.
At The Automatic Earth, Nicole – Stoneleigh – Foss and I have been saying for years that deleveraging and debt deflation are an inevitable consequence of what went before and an equally inevitable precursor of anything that may come after. And I have often said that the deleveraging will be so severe that what may come after is only moderately interesting, since you won’t hardly recognize your world once deflation has run its course. Apparently this is hard to understand, the hyperinflation myth just won’t die. What can I say? Time to get serious.