FedUpUSA

Archive for the ‘monetary theory’ Category

The facsimile of U.S. “growth” now depends entirely on Central State manipulation and stimulus of risk trades and financial slight-of-hand.

The U.S. economy has become increasingly dependent on asset bubbles, financial legerdemain, credit expansion, Federal borrowing and the manipulation of risk trades to maintain the illusion of “growth.” Compared to an economy based on organic demand and productive growth, the current U.S. economy is a travesty of a mockery of a sham, and has been since 2001.

There are a number of factors at work, but let’s start with two: the ratchet effect, and the Keynesian Project.

In the ratchet effect, increases are easy and resistance-free: it’s incredibly easy to hire more employees in bureaucracies, for example. But once the ratchet has advanced, it is nearly impossible to return to the previous tooth in the gear.

So for a city government to expand payroll from 10,000 to 20,000 employees was effortless, to reduce a 20,000 person payroll back to 10,000 is exceedingly painful.

The ratchet effect is a key feature of addiction. When one beer no longer creates a “buzz,” then the consumer drinks two, and so on, until a six-pack is the new baseline. Below that level of consumption, the addict gets panicky, for the entire necessity of creating a buzz is at risk of catastrophic failure.

The U.S. economy is now addicted via the ratchet effect to unprecedented levels of Federal borrowing and Federal Reserve credit creation and manipulation. Let’s set aside the fact that America’s Central State has by some calculations guaranteed some $13 trillion in private financial assets via TARP, AIG’s backstop, the takeover of Fannie Mae and Freddie Mac, etc.–roughly the size of the entire GDP of the nation.

Let’s focus instead on the fact that the Federal government must borrow and spend 11% of GDP ($1.5+ trillion) every year, and the Fed must buy $1 trillion in impaired private assets or new Treasury debt annually (another 7% of GDP) just to create an illusory GDP growth of 2.5% a year. So we’re spending/injecting 18% of the GDP to conjure a “growth” of 2.5%.

That means we’re spending/injecting $7 to create $1 of “growth” in GDP. And thanks to the ratchet effect, there’s no going back now without systemic disruption. Does anyone seriously believe spending $7 to birth $1 of “growth” is sustainable? If so, then let’s eliminate that $1.5 trillion deficit spending and the Fed’s $1 trillion-a-year purchases of impaired debt and Treasury bonds, and see if GDP “grows” via organic demand and production.

Everybody knows what would happen: the wheels would fall off the illusory “recovery.” The “recovery” is precisely analogous to an alcoholic who claims to be sobering up but who is actually drinking seven beers a day to get a buzz when a few years ago he only quaffed two or three a day.

Here is the Keynesian Project in a nutshell. Unfettered Capitalism works in straightforward cycles: the organic business cycle of expansion, overcapacity and overleverege inevitably leads to a credit bust in which those whose borrowing exceeds their ability to service their debt go broke, and the dominoes of overcapacity and credit expansion topple as losses mount and consumption based on increasing debt falls.

Bad debt gets wiped out, along with “pyramid-scheme” type assets (mortgaged assets are leveraged to buy more mortgaged assets) and excess capacity. As production declines, workers are laid off and consumption declines, further pressuring impaired financial assets.

As Marx had foreseen, these cycles increase in depth and severity. Though Marx invoked dialectical theory and history rather than the ratchet effect, the basic idea is the same: Capitalism becomes increasingly dependent on financial capital, and the resultant crises eventually become severe enough to take down Capitalism as a sustainable productive system.

Keynes’ proposed to counter these worsening business cycle implosions with massive injections of Central State borrowing and spending. The atmosphere of fear as assets, credit and consumption all contracted would be replaced by a revival of “animal spirits” (the magical elixir of Capitalism), consumption would be stimulated by direct government spending on capital projects and welfare (fiscal stimulus), and banking credit would be restored via stimulative Central Bank credit expansion (monetary stimulus).

But Keynes failed to grasp what Marx had intuited: the ratchet effect. Once the Central State ramped up deficit spending and expansive credit, then the organic economy became dependent on that new level of Central State spending and credit expansion.

As I described in the Survival+ analysis, in effect the central State rescued Monopoly Capital by partnering with it. This results in a financial/State Plutocracy which “saves” the organic economy by taking control of its income streams, credit creation and financial assets.

That is the U.S. economy in a nutshell: a travesty of a mockery of a sham. The consumer became dependent on easy, cheap credit and home equity extraction to maintain his/her consumption. The student became dependent on easy, cheap credit to fund his/her increasingly costly college education. Monopoly capital became dependent on financial slight-of-hand, the debauchery of credit, fraudulent mispricing/masking of risk, stupendously leveraged bets on risk assets, etc. for its swollen profits. Politicans became dependent on unlimited borrowing and spending to keep the illusions of competence, sustainability and “growth” alive.

State and local governments became casinos, dependent on skimming the profits from asset bubbles and financial fraud. Where did New York City’s and New York State’s rising revenues come from? By playing dealer on Wall Street’s scam tables, skimming a steady share of the profits.

Where did California’s bloated state revenues come from? The skimming of capital gains from the Ponzi-scheme real estate bubble.

The stock market rally circa 2003-2008 was merely Travesty of a Mockery of a Sham Phase I. In those glory years of the Central State/Cartel-Capital manipulation, it only required $2 of stimulus and credit expansion to blow $1 in asset bubble “growth.”

But alas, the growth was bogus, illusory, a simulacrum of organic growth, a house of credit cards and fraud that toppled when one card’s overleveraged precariousness was inadvertently exposed.

Now we are in Travesty of a Mockery of a Sham Phase II. As Marx had foreseen, the crises are ratcheting up: now it’s taking $7 of State/Plutocracy intervention to conjure up a pathetic $1 in “growth.” Both are now totally dependent on the substitution of bubbles and fraud for real productive growth.

What Marx failed to foresee was the Central State’s rescue of Cartel-Capital via a partnership: the Central State is now as dependent on financial capital’s maximization of fraud and credit expansion as the Financial Plutocracy is dependent on the Central State to mask and enable its expansion of income and control.

The problem is, of course, that the system cannot support borrowing and spending $7 to create $1 of “growth” for long: eventually, as in all business cycles, the cost of borrowing will exceed the ability of the borrower to service that debt. That’s what Keynes failed to foresee: the way in which the partnership of Central State and Cartel-Capital requires ever greater credit and State debt expansion just to keep the system afloat, never mind growing.

If I loan you $1 trillion at zero interest, with no principal payments, then the cost of servicing that $1 trillion loan is zero. Pretty easy to service zero, isn’t it? That’s the core strategy of the Federal Reserve and the U.S. Treasury.

That’s been Japan’s “secret” for 20 years: as long as the lenders (the Japanese citizenry and life insurance companies, etc.) accepted near-zero interest, then the cost of borrowing additional trillions has been bearable.

But as soon as that $1 trillion requires a serious interest payment, then the ratchet-effect game ends. We are not there yet, but the endgame is no longer over the horizon.

What will TMS Phase III require? $10 in Central State stimulus for $1 in nominal GDP “growth”? Or will it be $20 for every $1 of bogus “growth”?

The stock market is a reflection of this ratcheting up of Central State/Monopoly Capital intervention and manipulation. The stock market took off in the mid-1990s in the “easy money” era, and that led to the Phase I bust of 2000-2001.

That required TMS Phase II, which led to the next asset bubble in 2007-08, and that orgy of fraud and credit/leverage expansion led to an even more severe Phase II bust 2008-09.

If the partnership attempts Travesty of a Mockery of a Sham Phase III, then the consequent bust should return the stock market to pre-Phase I levels: The Dow around 4,000 and the SPX around 400.

Neither the public nor the Standard-Issue Punditry (SIP) understand the addiction-like dynamics of the Central State/Cartel-Capital partnership’s increasingly ineffective interventions on behalf of a facsimile of normalcy and “growth.” Like the addicted junkie, the Central State/Cartel-Capital partnership is approaching the point where their “high” requires ever higher doses of smack.

Nobody knows when the higher doses finally become lethal, but we do know there is such a point.

Live debate on deflation/hyperinflation, February 10, 9 p.m. EST . Most of you are already familiar with bloggers Stoneleigh of The Automatic Earth and Gonzolo Lira. Both are well-informed, articulate and persuasive, so the exchange on a topic of importance to us all (deflation vs. hyperinflation) is sure to be compelling.

Of Two Minds

Stone Age geniuses Ook and Mook invent money, wealth and Taoism in one fell swoop.

Demonstrating humankind’s remarkable ingenuity with financial and philosophical innovation, Non Sequitur’s Stone Age geniuses Ook and Mook invent money, wealth and Taoism with only sticks and stones.

A comment left by a reader on the Non Sequitur comics site reveals that Ook and Mook also invented Wealth and Taoism:

A guy I know was so certain that we’d be in economic chaos by now that he bought a substantial amount of gold. He kept prodding me that I should be buying some as well.I assured him that I had bought sufficient amounts of lead. If it became a significant issue, I’d be by to pick up his gold. 

From The Way of Chuang Tzu by Thomas Merton:

For security against robbers who snatch purses, rifle luggage, and crack safes,
One must fasten all property with ropes, lock it up with locks, bolt it with bolts.
This (for property owners) is elementary good sense.
But when a strong thief comes along he picks up the whole lot,
Puts it on his back, and goes on his way with only one fear:
That ropes, locks, and bolts may give way.
Thus what the world calls good business is only a way
To gather up the loot, pack it, make it secure
In one convenient load for the more enterprising thieves.
Who is there, among those called smart,
Who does not spend his time amassing loot
For a bigger robber than himself?

Of Two Minds

Freidrich Hayek

The Contrarian Trade of the Decade: the U.S. Dollar 

By Charles Hugh Smith

Just as a speculative thought experiment: perhaps the great contrarian trade of this decade is cash/the U.S. dollar.

The majority of economic observers seem convinced that the dollar is doomed, and not in some distant future. The basic reason for this unanimity is the reasonableness of the basic thinking, which goes like this:

The Federal Reserve and the U.S. Treasury are “printing money” and flooding the economy with easy money and credit, and the result of this debasement of the nation’s currency will be rampant inflation.

In other words, if a nation greatly expands its money supply without expanding its production of goods and services, then all that surplus money ends up chasing scarce goods and services, and you get inflation: the same sum of currency buys less and less goods and services.

This is the goal of State policy, according to the standard line of thinking: The only way the Federal Reserve and the Treasury can “save” the debt-burdened U.S. economy is by creating high inflation, which enables debtors to repay debt with “cheaper” dollars. Everyone who owns debt or low-yield bonds will lose huge chunks of their assets, but for no-asset debtors, inflation will be the cat’s meow.

But perhaps this thinking is wrong on virtually every important count.

I am indebted to my tireless and insightful blogging colleague Mish for an understanding of money supply: True Money Supply. Here is Mish’s chart of three ways to calculate money supply, and he argues persuasively for TMS1 as being the most accurate:

While the Federal Reserve successfully goosed money supply in their massive “quantitative easing” campaign, money supply is no longer expanding at a fast clip.

The critical distinction between printing press and credit is rarely discussed: is money literally being printed or is it credit-based? The distinction has profound consequences. If a government prints stacks of currency and then distributes the freshly conjured money via helicopter drops (in the visually compelling imagery of Fed Chairman Ben Bernanke’s famous “helicopter drop” quip), then the money supply has been expanded and distributed into the economy where it then leads to inflation if the production of goods and services lags money growth.

But if a government–for instance, the U.S. Treasury–prints bonds and sells those bonds to raise cash to distribute in the economy, that is not “printing money.” The Treasury bonds are traded for cash presented by purchasers; the money already exists and is simply being transferred to the State for distribution into the economy.

If money is being created via the magic of fractional reserves (that is, via bank credit), then it does not flow into the economy if those banks do not lend it and if consumers do not borrow it. As Mish has repeatedly observed, banks cannot be forced into lending nor consumers into borrowing.

It seems the money “created” by the Federal Reserve and lent to private banks at near-zero interest rates is simply sitting in the banks as reserves to offset their continuing horrendous losses. As a result, it is not flowing into the economy, and thus it cannot trigger inflation.

In contrast, a State such as Zimbabwe does run its printing presses to create money, and this explains why it suffers from hyper-inflation.

It can be argued that the billions of dollars the Fed orders into existence and then trades for Treasury bonds (i.e. to buy T-Bills) is in fact “freshly created money” that flows into the economy via Federal deficit spending. True, but then the question becomes, do these purchases of Treasuries add enough to the $13 trillion U.S. economy to offset the reduction in credit as people and businesses either pay down debt or write off uncollectable/bad debt?

According to the Wall Street Journal (Drought of Credit Hampers Recovery), consumer credit outstanding has shrunk some $119 billion, or 4.6%, from its peak in July 2008, to $2.46 trillion.

Add in the mortgages paid down, paid off or written down in excess of new mortgages issued, corporate debt retired or written off, etc. etc., and it seems the deleveraging that is underway in both consumer and corporate balance sheets is reducing credit and money supply by hundreds of billions of dollars.

The Fed purchasing $300 billion or even $500 billion in Treasury bonds simply doesn’t pump enough money into a deleveraging $13 trillion GDP-economy to create inflation. It merely offsets some of the destruction of credit going on at every level of the economy.

Thus you can have a central bank shoveling credit-created money into private banks where it sits, never entering the economy at all. How can that create inflation? Indeed, as has often been noted by Mish and others, this is what has happened in Japan for the past two decades: the central bank shovels money into private banks, who either engage in “carry trade” activities (borrowing at near-zero interest and then moving the money overseas to earn a decent yield elsewhere for easy profits) or they stash the funds to offset their ongoing losses in defaulted/impaired portfolios.

Those portfolios of impaired assets in Japanese, U.S. and European banks–just how much are they worth in a transparent “marked to market” setting? How many trillions of dollars in mortgage-backed securities, household debt, corporate debt and defaulted/impaired sovereign debt do these banks hold? If they had to sell those assets in an open market, how much would they fetch? How big would the losses be?

Nobody knows, but we can guess the losses are easily in the tens of trillions of dollars. The accounts of banks keeping defaulted mortgages on the books are legion; Japan has played the “waiting for better asset prices” game for decades, and now U.S. banks are playing the same game: accepting interest-only payments of a few hundred dollars from homeowners as an accounting gimmick to keep the loan on their books as “performing.”

This artifice does nothing to clear the actual bad debt.

And how about all those impaired off-balance sheet liabilities? Regulators are not only allowing financial institutions to continue marking assets to fantasy, they are also allowing them to continue holding assets off their legitimate balance sheets.

The ever-astute Karl Denninger of the Market Ticker blog has relentlessly exposed these frauds and accounting tricks.

Since we live in a credit-based monetary system and economy, then income and collateral are the foundations of credit/borrowing. Unfortunately for those wishing for vast expansions of borrowing to fuel inflation, real estate collateral is not just impaired, it has fallen to historic lows. We can only wonder what this chart would look like if all real estate was truly marked to market:

The point is that the collateral represented by the average U.S. household’s primary store of wealth–their home–is near-negligible. Why? As noted above, houses are still being valued far above their true market value, so any reduction in value comes straight off the equity.

For example, a house valued at $300,000 on the bank’s books justifies the $270,000 mortgage being held at full value. The homeowner supposedly has $30,000 in equity/ collateral. But if the house is actually marked to market at $250,000, the owner’s collateral vanishes and the bank’s “asset” (the mortgage) also declines in value.

Second, suddenly-prudent lenders won’t lend more than up to about 75% of loan-to-value (except for the Fantasyland 3%-down payment loans backed by FHA, which are fast-defaulting). So much of the homeowner’s equity is untouchable. The only collateral which is available to borrow against is that above 25%–perhaps 10% of the total vaulation of all homes in the U.S.

And since some 33% of all homes in the U.S. are owned free and clear (50 million mortgages, 25 million homes owned outright), then the “owners equity” is largely in the hands of those without mortgages. We might infer that anyone who resisted the temptations to use their house as an ATM machine via a home equity line of credit (HELOC) either does not want/need to borrow against their home or they are unable to for other reasons (such as low income, poor credit, etc.).

Put all this together and we can deduce that those homeowners who might desire to extract some equity from their homes via borrowing have no collateral left to borrow against.

What about other collateral, such as income? As we all know, functional unemployment/underemployment is around 17%. According to the BEA, personal income has declined by over $200 billion from 2008 to 2009. (Subtract government transfers and the number is more like $600 billion.)

The BEA table reveals that “Net increase in household liabilities” hit $1.8 trillion in 2006 and $1.4 trillion in 2007, and then fell to $146 billion in 2008. Households are no longer borrowing (adding liabilities). Meanwhile, savings jumped from $178 billion in 2007 to $470 billion in 2009.

Mortgage debt rose by $1.1 trillion in 2005, $1 trillion in 2006, $686 billion in 2007–and then fell by $106 billion in 2008. No data is available yet for 2009, but you can bet both mortgage debt and new liabilities continued plummeting.

So household incomes have fallen, meaning there is less collateral for new borrowing, and new liabilities and mortgages have both collapsed from nearly $3 trillion in 2006 to $46 billion in 2008. Yes, from $3 trillion in new borrowing in 2006 to a total of $46 billion in 2008.

That is deleveraging, and adding $300 billion in money supply via Federal Reserve buying of T-Bills is offsetting a meager 10% of that decline in household credit.

Now that we’ve seen that housing and income collateral have fallen off a cliff and are not recovering, and that households are deleveraging ($3 trillion they were borrowing in 2006 has fallen to a mere $46 billion–more or less statistical error or pocket change in a $13 trillion economy)–then we might ask if those who still have assets would wish to leverage them into more borrowing/debt.

The vast majority (83%) of other financial assets are held by the top 10% households. here is a chart I reprinted recently in The Stock Market As Propaganda (March 10, 2010).

Equities (stocks) currently represent about $11.4 trillion of the total $33.3 trillion in financial assets. Business assets and real estate make up the remaining $20 trillion in total assets. According to the BEA, total household assets fell from $63.9 trillion in 2007 to $52.9 trillion in 2008–a decline of $11 trillion.

The recent stock market rally and “recovery” in housing has caused a blip up in total assets, which now appears to be rolling over.

Since the bottom 80% of U.S. households only hold 7% of financial assets ($2.3 trillion spread amongst 105 million households), then their ability to leverage their declining income and modest assets into huge dollops of new debt is somewhere between low and zero.

Recall that households added $3 trillion in new borrowing in 2006 alone. So those heady bubble days of credit/money supply growth are gone for good.

Since the top 10% households own $27 trillion in financial assets, we might ask what need they would have for new debt.

We might also ask what might happen if nobody comes forward to buy $1.5 trillion in new Treasury debt every year (money needed to fund the Federal deficit of $1.5 trillion a year) at very low yields. I outlined the high probability of this happening in The Trouble With Bonds (March 18, 2010).

Interest rates will rise. Recall that the Fed does not set yields for Treasury bonds; that is set by the bond market (supply and demand). The only way for the Fed to influence the yield of T-Bills is to buy them outright, as it has been doing heavily of late. Since every other major nation is also selling bonds to fund deficits, then we can anticipate some lively competition for investor’s cash.

In the standard view that “governments just print money,” then why governments sell bonds is never explained. Why don’t all governments just print up money and spend that? Why go to all the trouble of selling bonds to raise cash to fund deficits? It comes down to the distinction between credit-based systems and currency-based systems.

Inflation is impossible in credit-based systems when credit is being paid down/destroyed/ written off and banks are wary of lending/risk and consumers refuse to (or cannot) borrow.

We might also ask what might happen to stocks, bonds and real estate valuations if interest rates rise: they tank as I explained in What If (Almost) All Assets Fall Together? (March 11, 2010).

As a side-effect, the meager assets of the bottom 90% of U.S. households would fall, and the “smart money” might well decide selling out before further declines occur is the wisest capital-preservation strategy.

Since so much debt is dollar-denominated, then there will be demand for dollars to pay down debt. That is the essence of deleveraging.

And since other assets will be falling as interest rates rise and risk aversion returns with a terrible vengeance, then “cash will be King.” Dollars will rise in value, and the best and safest return on capital will be money-market funds or short-term notes.

Rather than doom the dollar, these trends suggest the dollar could rise in purchasing power and demand for years to come. I know this is contrarian, but ponder the distinction between “printing money” and selling bonds/attempting to expand credit in a credit-averse, collateral-impaired system.

This might be one of the most important bits I write this decade. Or then again, maybe not. Only time will tell. Before chastizing me for rampant hyperbole–”most important story of the decade, bah”–please consider The Most Important Chart of the Century. Now the chart is extremely important, and I recommend reading this story, but the century is a bit young to declare “the chart of the century.” One wonders what the “chart of the century” would have been in 1910, and how prescient we would find it in hindsight.

Let’s say this is one of the most important charts of the past 50 years, which is entirely supportable.

The charts simply shows that adding debt no longer adds to GDP. So even if the Fed were able to force banks to lend to poor credit risks and deleveraging borrowers lost their sanity and added to their liabilities, then the economy still wouldn’t grow/”recover.” The “reflating the credit bubble” game is over.