Thursday, April 21, 2011

The Economy: Karl Denninger, “Anatomy Of A Monetary Accident”

“Anatomy Of A Monetary Accident”
 by Karl Denninger

“Most people probably don't realize it, but we're about to have one. As John Hussman has noted, there's an extraordinary amount of "base money" in the system compared to GDP: "In terms of liquidity preference, a completion of QE2 requires liquidity preference to increase to 16 cents per dollar of nominal GDP - easily the highest level in history.” I can't find much fault with Hussman's analysis and the risks associated with it - as he has (correctly) noted there is a real problem with the IRX (13-week T-bill) and The Fed's balance sheet - and this effectively traps The Fed.

The omission that I would take issue with is the same one that I have with so many others - it's total money and credit that has to be measured against with regard to GDP.  What Bernanke is attempting to do is goad people into borrowing - that is, to take on additional leverage in their business and personal lives.  This is the only way he can "win" in the game he is playing with the economy. But since Bernanke cannot control where leverage goes (only how much "liquidity" is available in the form of leverage) he has a serious problem.  In order to continue to "prime the pump" between The Fed and The Administration he must keep the only borrower willing to continue to add debt - The Federal Government - able to do so without interest rates going up.

Each time he does this he must add to his balance sheet.  This drives the risk-free rate at the short end down.  But the amount he must add to his balance sheet for each equal-size move in the short term rates grows exponentially larger, while the economic impact of a move between 0.25% and 0.10% in short rates is minuscule since the return ratio is calculated against the spread, and the difference between a 2% spread and a 2.15% spread is very small, while the amount of balance sheet expansion necessary to produce it is large.

There's been a roughly 5.4% increase in corporate debt - but notice that it never contracted during the so-called "recession!"  That is, we never cleared the bad debt out.

The consumer, on the other hand, can't take on more leverage.  The consumer led coming out of the 2000 "recession" - in fact, he never slowed down.  But there is no evidence in the data, despite the claims of "recovery', that ordinary Americans have recovered anything at all.

The premise that we have some sort of "independent" monetary authority is a bad joke.  There's absolutely nothing independent about The Fed, Congress and the Administration at all - just as there wasn't during the time when Burns was Fed President.  What we have is a Federal Reserve that has joined hands with Congress and the Administration, both present and previous, in an intentional act of debasement to finance profligate deficit spending.

We're headed for a "monetary accident" at breakneck speed: consumer spending and debt is ultimately dependent on job and income growth.  But there has been no income growth in real household terms for ten years.  The remaining margin between income and consumption was consumed in the years between 2003-2007 with borrowing, much of it through home equity extraction.  That credit capacity has been exhausted and is no longer available.  Corporate "growth" created from the chimera of productivity growth (read: work harder, get paid less, or get fired and we move your job to China or India) has pretty-much reached its zenith as well.  What's left is government spending but continued amounts of injection of liquidity from The Fed will require ever-lower primary credit rates to remain in equilibrium, yet shoving people out the risk curve creates parabolic-style moves that have always ended in a crash on a historical basis.

In order to pull back to the point that the 13 week bill will rise to just a simple 0.25% rate - a tiny positive interest rate - The Fed would have to sell off the entire $600 billion it QE2d immediately.  A spike in credit revulsion on US bonds, even a tiny one that shoved rates higher by that small of an amount without said selloff of The Fed balance sheet, could easily result in a thirty percent jump in the CPI.  Since there is no way to couple that back into wages this would not produce the sort of "inflationary spiral" that gold and silver buyers fear - it would instead result in the utter destruction of the lower two quintiles of the American public and the near-immediate loss of civil and political order along with effective economic collapse.

Remember this well folks: If it happens it is Bernanke's direct responsibility and he, along with the rest of the FOMC and the Administration along with Congress must be held to account.

The warning signs are up now as they were in the late spring and early summer of 2008.  We're three years down the road but have fixed nothing, despite the cheerleading in the corporate and media sectors.  The lack of fear as reflected in the VIX and complacency found in companies sporting P/Es arguing for five year growth rates of 30, 40, 50, 60 or percent compounded for that entire five year period - claims of total growth from 270% to more than 900% over that same five year period, are essentially identical to the sorts of forward "expectations" that were found in the latter half of 1999 and 2007.

"This time it's different" is a common swansong, but history records that in virtually every case if you listen to the harpies and follow them, instead of stuffing cotton in your ears you will wind up severely hurt or even broke."
If the ship's sinking, taking us all down with it, I for one at least want to understand why...
- CP

No comments:

Post a Comment