The Automatic Earth

Dorothea Lange Social Security Tattoo August 1939

“Unemployed lumber worker goes with his wife to the bean harvest, Oregon”

Don’t get me wrong, I’m not saying things will happen in this order and timeframe. Just that they’re going to if central banks and treasury departments don’t up the ante. But they will. The question becomes more important now whether it’ll be enough to continue keeping their – presumed – demons at bay. They can’t go on forever. You can inflate asset price bubbles only so much. And then people will lose faith. So the order and timeframe is definitely an option.

Deflation is already here. Everyone’s talking about lower inflation numbers than expected everywhere, but prices have been pushed up artificially in so many ways and in so many places that, even given the fact that they all ignore what inflation really is, it’s getting profoundly absurd. Ironically, a few interesting lines this week came from an unexpected corner, the Telegraph editorial staff:

 

The last thing highly-indebted Britain wants is price deflation

 

The drop in the level of inflation revealed by the Office for National Statistics took some analysts and economists by surprise. It had been anticipated that CPI inflation would fall from its 2.7% mark in September to just 2.5% last month. Instead, it plunged to 2.2%, with the biggest downward contributions coming from transport.

It sparked questions – with much of continental Europe spiralling towards deflation and risking a repeat of Japan’s own crisis – over whether the whole world could be moving into deflationary mode.

At a time of near-double-digit increases in energy bills, this might seem a rather hard case to argue, yet the fact of the matter is that even in traditionally inflationary Britain, price pressures are easing fast.

[..] … on closer scrutiny, the sort of inflation currently being seen is mainly down to so-called “administered prices”, or prices which are being deliberately pushed up by government diktat either as part of the deficit reduction programme or green agenda.

Recently announced increases in energy bills are calculated by the Bank of England to have added 15 basis points to the CPI inflation outlook, a not insignificant amount but not enough to change the big picture on inflation. Most of the pressures right now are on the downside. Some European countries are, however, already in technical price deflation. Both Spain and Sweden, for instance, have recently reported an annual fall in prices, and even parts of Germany are experiencing month-on-month price contraction.

But then the last place a highly indebted nation such as Britain wants to be in is outright price deflation. There may not be much danger of that yet for the UK but the world as a whole seems very much to be drifting in that direction. This is worrying, not least because it implies continuation into the almost indefinite future of today’s very low interest rate environment. This doesn’t seem to be doing a great deal for demand but it is certainly putting a rocket under asset prices, creating bubbles and now fairly obvious misallocation of capital.

 

I’m indebted to the Telegraph for giving a name to something I have denounced several times in the past: governments raising “inflation” levels through taxes. My argument of course is that taxes should never be counted towards inflation, because doing so would mean inflation and deflation are easy as pie to control by governments (which they are very obviously not, or this “control” would be applied all the time and there would never be any inflation or deflation). Anyway, we can now call this phenomenon “administered prices”…

The paper neglects to note that this is one of the main ways in which Japan purports to fight its deflation: through higher taxes. That will not end well. Look, one more time: inflation means an increasing money supply and/or a higher velocity of money. No more, no less, and certainly not higher prices by themselves. If the money supply increases and/or the velocity of money does, prices will rise, but only as a consequence, and across the board. Nothing to do with taxes. And if for instance the Big Six UK energy companies raise their prices through fraudulent bookkeeping, that doesn’t – and shouldn’t – count towards inflation, but towards fraud.

As for the velocity of money, you can see in this graph from Lacy Hunt and Van Hoisington (more on them later) that in the US, it’s come down in just 15 years from the highest point in more than 100 years to the lowest in the past 60 years. That is huge. That must have a tremendous influence on the economy, no matter what unemployment numbers are released, or what records stock markets set. As economic data go, the latter ones can only be entirely secondary to this:

 

When the velocity of money is that low, and we know there’s no huge increase in the money supply (though there may be in the monetary base), how can inflation numbers still be positive? Good question. You tell me.

 

That deflation (money supply and/or velocity of money shrinks and, only after that, prices and wages fall) is a growing worry, becomes clear through the following Bloomberg piece as well. It’s just that until now it remained hidden behind a veil of – mostly – central bank stimulus measures, which are behind various asset bubbles. Most of it is credit, backed by taxpayers, doled out to financial institutions and invested in stocks. Or, you know, the UK cabinet supplies cheap housing credit, people fall into the trap and buy their dream home, and, voila, “inflation” numbers go up. All nonsense designed to keep you from finding out what’s really going on, and to keep using your money to keep banks from going bankrupt. Bloomberg:

 

Central Banks Risk Asset Bubbles in Battle With Deflation Danger

 

Central banks are finding it’s easier to push up stock and home prices than it is to prevent inflation from falling short of their targets.

While declining costs for everything from gasoline to coffee can be good news for consumers, disinflation makes it harder for borrowers to pay off debts and businesses to boost profits. The greater danger comes when disinflation turns into deflation, which leads households to delay purchases in anticipation of even lower prices and companies to postpone investment and hiring as demand for their products dries up.

Federal Reserve Chairman Ben S. Bernanke and his central-bank counterparts are trying to avert the deflationary danger by pumping up their economies with lower interest rates and monetary stimulus. They have bet the run-up in stock and home prices they’ve engineered would boost consumer and corporate confidence and spur faster growth and higher inflation. Now they’re having to maintain or intensify their aid – running the risk those efforts do more harm than good by boosting equity and property prices to unsustainable levels.

“You have a wall of liquidity” that’s “leading to asset inflation and eventually to bubbles,” Nouriel Roubini, chairman of Roubini Global Economics LLC, said Nov. 7 on Bloomberg Television’s “Street Smart.”

Global inflation will be about 2.8% this year, the second-lowest since World War II, amid high unemployment in developed nations and slowdowns in emerging markets, according to Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York. Even after policy makers slashed interest rates and bought bonds, about two-thirds of 27 inflation-targeting central banks tracked by Morgan Stanley still are undershooting their goals or watching prices rise in the lower end of preferred ranges.

“We have seen, in the last months, deflationary tensions building up,” Laurent Freixe, executive vice president of Nestle SA, the world’s biggest food company, said in an Oct. 17 conference call. “There is no growth in the marketplace, so everyone is fighting for a share of a shrinking pie.” [..]

 

It might be more accurate to say we increasingly have multiple claims to the same pieces of the pie.

 

The central-bank largess is buoying world stock markets, as investors seek higher returns than they can get with government bonds. Japan’s Nikkei 225 Stock Average is up 40% this year. The MSCI World Index, which includes both emerging and developed country markets, has risen 19%. [..]

Home prices also are rising. The S&P/Case-Shiller index of property values in 20 U.S. cities climbed 12.8% in August from a year earlier, the fastest pace since February 2006. U.K. house prices increased for a ninth month in October, while apartment values in parts of Germany have jumped by an average of more than 25% since 2010. [..]

 

The easy money lacks punch because the “pipes” that carry stimulus from financial markets to the rest of the economy are “clogged,” Mohamed El-Erian, Pimco’s chief executive officer, said in an interview.

 

So why don’t you explain to us what Bernanke has done to unclog those pipes, Mo?

 

Commodity prices have fallen as demand from China and other developing economies has ebbed. The Washington-based IMF forecasts oil prices will slump 7.7% next year while non-fuel commodities will drop 2.9% in dollar terms. It also projects governments will keep cutting budgets, with the aggregate deficit of advanced nations at 4.5% of gross domestic product this year and 3.6% next year.

The region most at risk is the 17-nation euro area, where banks are deleveraging and wages are falling in nations including Spain. The ECB already is turning more aggressive after inflation slumped to a four-year low of 0.7% in October, less than half its target of just below 2%. Prices may not pick up any time soon, Draghi has warned. Unemployment is a record 12.2%, and the European Commission said last week it anticipates growth of just 1.1% in 2014.

“Deflation is not imminent, but it has to be on the mind of central bankers,” ECB Governing Council member Ewald Nowotny said yesterday in Vienna. The central bank still needs to do more because “a ‘Japanification’ of the euro area is a clear and present danger,” Joachim Fels, co-chief global economist at Morgan Stanley in London, said in a Nov. 10 report to clients.

Avoiding that fate may be hard. While Draghi has raised the possibility of charging banks to park cash at the ECB, colleagues have warned a negative deposit rate could hurt banks’ profitability and make them even less willing to lend. [..]

The Fed has found that expanding its balance sheet — now at a record $3.85 trillion — hasn’t been a panacea. Since the U.S. recession ended in June 2009, growth has fallen short of its predictions, and in nine of the last 10 estimates for 2013, policy makers have lowered their forecasts. Inflation, too, is lower than projected and has undershot the Fed’s 2% target starting in May 2012. The personal-consumption-expenditures index, the board’s preferred gauge, increased 0.9% in September from a year earlier, matching April for the lowest since October 2009. The rate will stay low in 2014, at about 1.25%, according to Sinai.

 

People are not spending, i.e. the velocity of money has fallen. A lot. And no, tempting them into more cheap credit is no solution for that. Because that means more debt. And it’s debt that is dragging economies down in the first place.

 

In Japan, the BOJ has had some success in battling deflation after swinging into action in April, when it pledged to double the monetary base through purchases of government bonds and other assets. Consumer prices excluding fresh food rose 0.7% in September from a year earlier, down from 0.8% in August, the fastest increase since November 2008. The yen has dropped about 20% against the dollar in the past year, boosting prices of imported goods. “Core inflation is now no longer negative,” said Jerald Schiff, deputy director of the IMF’s Asia-Pacific Department. That “is a major victory in the Japanese context.”

 

Yeah, but Japan does this through “administered prices”, prices which are being “deliberately pushed up by government diktat”. Again, if that could work, everybody would be doing it, and all the time.

 

While the aggressive actions that central banks have taken haven’t done all that much for global growth, they have boosted asset values worldwide, pushing home prices from Canada to Australia and Sweden to China to levels that may turn out to be unsustainable. Some Fed officials have pointed to costlier homes, farmland and bonds as causes for concern.

“We’ve seen real bubble-like markets again,” Laurence D. Fink, chief executive officer of BlackRock Inc., the world’s largest money manager with $4.1 trillion in assets, said at an Oct. 29 panel discussion in Chicago.

 

See, what these people are saying is in essence that Fed policies have not had the desired effect, or not enough of it, and now things are getting even worse, because they were so wrong, and deflation looms (even if many prefer for now to call it disinflation).

I have a problem with that. Which is that I, and others with me, have said for years that this would happen, that QE wouldn’t “help” the real economy. Just look up what debt deflation is, and it all becomes clear. It’s embarrasingly simple.

I mean, what exactly is the idea? That Ben Bernanke honestly tried to fight unemployment by stuffing the accounts Wall Street banks have with his own Fed, full of excess reserves? Because that’s all QE has resulted in in practical terms, isn’t it? I know that it has probably affected the “mood” in the markets somewhat as well, but is that really something Bernanke should fake? Is that part of his mandate as well, to fool people into believing things? I don’t see how.

Really, how wrong can a man in his position be before he’s pushed to look for alternative employment? And don’t look for any relief from Janet Yellen either, she’s been part of that same Fed all these years that continues to hand out $85 billion a month and has nothing to show for it other than some perceived moodswing and those bloated excess reserve accounts. Here’s what Yellen will say today in her nomination hearing before the Senate Banking Committee:

 

“A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases … I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy. [..] … the Fed has “made progress in promoting a strong and stable financial system, but here, too, important work lies ahead.” “Her approach is let’s do more QE now to get the job done faster,” said Laura Rosner, a U.S. economist at BNP Paribas SA in New York … “Yellen is repeating her commitment to getting the job done.”

 

In other words: Yellen’s not going to change a thing, despite that fact that everything the Fed has done so far has been a huge and costly failure as far as the real economy is concerned, which is what the Fed claims to be execute QE for.

 

I am not kidding you: this is a real problem for me. Because either those who keep claiming that Bernanke and the rest of the Fed board have made nothing but honest mistakes for years are right, and I am profoundly stupid – which I don’t think I am -, or I am right and the Fed is loaded with really stupid people. And I don’t believe that either.

There is a third option, however and of course: that the Fed has not at all been doing what they say they have, and it wasn’t a long line of mistakes, but something else altogether.

Found a fitting description of that too. In a highly interesting must read piece by Yanis Varoufakis. Fitting, also, because what the Fed does is the same thing the ECB does.

 

Ponzi Austerity – A Definition and an Example

 

Ponzi austerity is the inverse of Ponzi growth. Whereas in standard Ponzi (growth) schemes the lure is the promise of a growing fund, in the case of Ponzi austerity the attraction to bankrupted participants is the promise of reducing their debt, so as to liberate them from insolvency, through a combination of ‘belt tightening’, austerity measures and new loans that provide the bankrupt with necessary funds for repaying maturing debts (e.g. bonds).

As it is impossible to escape insolvency in this manner, Ponzi austerity schemes, just like Ponzi growth schemes, necessitate a constant influx of new capital to support the illusion that bankruptcy has been averted. But to attract this capital, the Ponzi austerity’s operators must do their utmost to maintain the façade of genuine debt reduction.

The obvious thing to do, under the circumstances, would be for Athens to default on the bonds that the ECB owned. But this was something that Frankfurt and Berlin considered unacceptable. The Greek state could default against Greek and non-Greek citizens, pension funds, banks even, but its debts to the ECB were sacrosanct. They had to be paid come what may. But how? This is what they came up with in lieu of a ‘solution’: The ECB allowed the Greek government to issue worthless IOUs (or, more precisely, short-term treasury bills), that no private investor would touch, and pass them on to the insolvent Greek banks.

The insolvent Greek banks then handed over these IOUs to the European System of Central Banks (through the so called ELA program of the ECB) as collateral in exchange for loans that the banks then gave back to the Greek government so that Athens could repay… the ECB. If this sounds like a Ponzi scheme it is because it is the mother of all Ponzi schemes.

[The creation of the first Ponzi Austerity scheme in Greece] is but one example of the vicious cycle of Ponzi Austerity that is being replicated incessantly throughout the Eurozone. Its stated purpose is to reduce debts. But debt is rising everywhere. Is this a failure? Yes and no. It is a failure in terms of the EU’s stated objectives but not in terms of the underlying ones.

For, in reality, the true purpose of the ‘bailout’ loans was to effect a cynical transfer of the Periphery’s bad debts from the books (mainly) of the Northern European banks to the shoulders (mainly) of Northern Europe’s taxpayers. Sadly, this cynical transfer, effected in the name of European ‘solidarity’, led to a death dance of insolvent banks and bankrupt states – sad couples that were sequentially marched off the cliff of competitive austerity – with the awful result that large sections of proud European nations were dragged into the contemporary equivalent of the Victorian Poorhouse.

 

Great article. Great novel view of things. And a great quote. Let’s get back to the Fed.

We can say for the Fed what Varoufakis says about the ECB (and the troika):

Fed policies. A failure. Yes and no. A failure in terms of stated objectives but not in terms of the underlying ones

Is the Fed trying to revive the US economy? If they are, they have been making lots of mistakes. Lots. Too many. All they’ve done is make mistakes. Other than creating a moodswing. But those are notoriously temporary. And this one depends on financial markets expecting more and more “free money“, not on an improving economy. What do they care, if the money keeps coming anyway?

This QE game has raised the Fed balance sheet by well over $3 trillion. And ballooned the too-big-to-fail-but-dead-broke banks’ accounts with the Fed by about the same amount.

 

But still, you have these respected analysts who keep on hammering the same single tune: it’s all mistakes, none of it happens on purpose. Like Lacy Hunt at Hoisington:

 

Federal Reserve Policy Failures Are Mounting

 

[..] … when an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics. The periods between 1927 and 1939 in the U.S. (and elsewhere), and from 1989 to the present in Japan, are clear examples of the impotence of central bank policy actions during periods of over-indebtedness.

[..] … the Fed’s forecasts have consistently been too optimistic, which indicates that their knowledge of how Large Scale Asset Purchases (LSAP) operates is flawed. LSAP obviously is not working in the way they had hoped, and they are unable to make needed course corrections. [..]

If the Fed were consistently getting the economy right, then we could conclude that their understanding of current economic conditions is sound. However, if they regularly err, then it is valid to argue that they are misunderstanding the way their actions affect the economy.

During the current expansion, the Fed’s forecasts for real GDP and inflation have been consistently above the actual numbers.

One possible reason why the Fed have consistently erred on the high side in their growth forecasts is that they assume higher stock prices will lead to higher spending via the so-called wealth effect. The Fed’s ad hoc analysis on this subject has been wrong and is in conflict with econometric studies. The studies suggest that when wealth rises or falls, consumer spending does not generally respond, or if it does respond, it does so feebly. During the run-up of stock and home prices over the past three years, the year-over-year growth in consumer spending has actually slowed sharply from over 5% in early 2011 to just 2.9% in the four quarters ending Q2.

Reliance on the wealth effect played a major role in the Fed’s poor economic forecasts. LSAP has not been able to spur growth and achieve the Fed’s forecasts to date, and it certainly undermines the Fed’s continued assurances that this time will truly be different. [..]

The standard of living, as measured by real median household income, began to stagnate and now stands at the lowest point since 1995. Additionally, since the start of the current economic expansion, real median household income has fallen 4.3%, which is totally unprecedented. [..]

Over-indebtedness is the primary reason for slower growth, and unfortunately, so far the Fed’s activities have had nothing but negative, unintended consequences.

Another piece of evidence that points toward monetary ineffectiveness is the academic research indicating that LSAP is a losing proposition. The United States now has had five years to evaluate the efficacy of LSAP, during which time the Fed’s balance sheet has increased a record fourfold.

It is undeniable that the Fed has conducted an all-out effort to restore normal economic conditions.

 

No, Lacy, that is not undeniable. I just did. And I have to wonder: why would you say that? Why would anyone? Do you really believe all you said there? That this entire group of more than average intelligent people make all these mistakes, and misinterpret all of these signals, despite having more and better access to data than anyone else, and you still don’t wonder if perhaps they’re not trying to do what they say they are? How can you claim to be an analyst if you don’t even question your most basic assumptions? How is that analysis and not apologism?

 

John Hussman writes some good market opinion, but he sort of falls into the same apology trap:

 

Leash the Dogma

 

It’s fascinating to hear central bankers talk about the economy, because in the span of a few seconds they can say so many things that simply aren’t supported by the evidence. [..] quantitative easing essentially proposes that rapid increases in the monetary base can achieve reductions in the unemployment rate. But when we examine the data, we find very little to support this view, regardless of whether the relationship is posed in terms of growth rates, levels, changes, coincident changes, or subsequent changes in unemployment. [..]

In my view, most of the response to quantitative easing reflects psychological factors rather than mechanistic ones. Certainly the scale of QE has been enormous, and suppressed short-term interest rates have undoubtedly motivated a reach-for-yield in more speculative assets. But it remains true that the amount of credit market debt in the U.S. is roughly 19 times the current size of the monetary base (with an average maturity of about 5-6 years), while the value of U.S. equities is easily over 6 times the monetary base.

So quantitative easing effectively relies on the extent to which investors shun zero-interest cash amounting to less than 3.9% of that available portfolio. In any environment where low-interest but liquid and non-volatile securities become desirable as even a small part of investor portfolios, quantitative easing is likely to lose its presumed ability to “support” financial markets. [..]

The truth is that Fed policy has the capacity to do enormous damage by adding fuel to asset price bubbles when investors are already inclined to take risk, yet has very little power to “support” asset prices when investors are inclined to avoid risk. The confidence that the Fed can, in all circumstances, drive asset prices higher is largely psychological – mostly due to misattributing the 2009 recovery to monetary policy instead of the move to end “mark to market” accounting. Yet even to the extent that stocks have been driven higher, there is very little evidence that the “wealth effect” on jobs and economic activity has been large. This is something that the Fed should have understood years ago. [..]

I continue to believe that it is plausible to expect the S&P 500 to lose 40-55% of its value over the completion of the present cycle, and suspect that whatever further gains the market enjoys from this point will be surrendered in the first few complacent weeks following the market’s peak.

 

See? they’re doing everything wrong. Ergo: boy, must they be stupid. Only, that second part is left out.

What I do find interesting is Hussman’s last claim: that it’s plausible to expect the S&P 500 to lose 40-55%. And he’s got a nice graph to show where things stand:

 

 

What can hold off a crash? Probably only more asset purchases by the Fed, and temporarily at that. Enter Janet Yellen stage left. Or does anyone doubt that the S&P would look completely different if QE had never happened? But even then. The people at the Fed are aware of the velocity of money data, they’re not nearly as thick as the analysts make them out to be. They know they’ve long lost the deflation battle. Maybe they can move people to take some of their money out of stocks and into something else, something that moves money around a bit more. Or maybe they can push some money or credit into the real economy through real estate prices. The problem there is that increasing credit doesn’t do much, if anything at all, that can be seen as positive. Not in an already hugely overindebted economy.

At some point you need to ask: stock market crash? What stock market? How is it still really a stock market if it hinges to such a large extent on the Fed pumping money into Wall Street banks? At the very least, you might question if the S&P still reflects an actual market at all, if that market is supposed to reflect what goes on in the economy, and obviously doesn’t. You might want to ask what purpose such a largely illusionary stock market has, what its use is within the larger economy. And while you’re at it, you might also want to answer what use the financial system as a whole is to the real economy, if all it does is squeeze money out of it.

We know the Fed can prop up the S&P for a while, and though we don’t know for how long, we do know that they’re running out of time. That’s what Hussman’s graph says. And wouldn’t we perhaps be better served by a market, and by data, that better reflect what’s going on in the real economy? So we know where we actually stand, and not what some moodswing or another says about that? The entire market, the entire financial system, has turned into a zombie that feeds on the American people’s life blood.

Let’s redefine all this talk, and call a spade a spade: The Federal Reserve defines and executes policies aimed at aiding the banking system, not the overall US economy. And although the Fed may claim that these are one and the same, it could have known – and it does – that they are not. The idea that supporting the banks equals supporting the US people, is just that: an idea. The Fed, more than anyone else, has access to the data that prove this. It knows how badly off the banks are.

So quit propping them up, throw open their books and let’s start restructuring. If you choose not to – here’s looking at you, Janet – stop pretending you’re acting on your dual mandate, that you have the people’s best interest at heart. There’s no evidence of that anywhere to be found in anything but words.

We may make it to Christmas without a market crash, with lots of happy expectations for record sales and a last bout of happy moodswing. That’s not that interesting. What is, is what’ll happen after that. We already have deflation, once you look past the words. And we have a stock market so grossly overvalued it can only be labeled a zombie. Record holiday sales are not going to materialize with the velocity of money at a 60-year record low. And then what, Janet? Increase QE? Double or nothing for the most costly “failure” in US history? All it takes is for people to keep believing, right?

 

 

Russell Lee Family Car February 1939
"White migrant and wife repairing clutch in their car near Harlingen, Texas"

Over the past two weeks or so, we've been seeing a very clear portrait of how sick our economies are. Not that you would know it from reading the press. The term deflation pops up only very cautiously. Could that be because people don't understand what's going on? Or are they simply afraid of the word? This is the real thing, guys. And it's going to hurt.

Money (actually: credit) has shifted out of emerging markets by the trillions. So where did it go? Not into bonds, stocks or precious metals. Money shifted out of there too, and also by the trillions. Money isn't going anywhere, it's going "poof". It's vanishing and will never be seen again.

Markets may still rise at times to some extent, but only if and when more stimulus is flooded into the system, or people think it will be. Markets have simply been undead for the past 5 years – or so -, as long as central banks have issued stimulus. Take that away and all you're left with is zombies. And even if markets rise, or "normalize", a little in the future, this genie's out of the bottle and won't get back in: bond yields and interest rates will not go back to the extremely low levels of the past few years. Central banks' longer term control of either has always been no more than an illusion. And as for another illusion: you can't call something a "recovery" if you pay for it with more debt, that doesn't make nearly enough sense.

People think they can find the reason behind the vanishing trillions in money/credit in things Ben Bernanke may or may not have said, and perhaps in a hard stance by the Chinese central bank. But they are merely small parts of a bigger story. The problem is not that the Fed hints at tapering, it's that the US economy is too sick to stand up straight without constant and/or increasing credit infusions. A zombie economy propped up with zombie money. And that can't last. It never could.

Nothing Ben does, whether it's issuing stimulus or hinting at less stimulus, represents real value. And that, to many people focused on the illusion of value, may have become clear only when Abenomics appeared on stage, seemed a success at first and then showed its true colors in a substantial Nikkei crash. Abenomics is the Fed's QE on steroids; both follow the same trajectory, but it's a matter of the harder they come, the harder they fall. Japan wanted too much too fast, and ended up shattering the stimulus illusion worldwide. As I put it three weeks ago:

What If Stimulus Is Self-Defeating?

… in today's world stimulus is self-defeating because it's stimulus itself that reveals the weak spots in an economy, and more stimulus reveals more weak spots.

Note: this is not the same as saying all stimulus is bad, or must necessarily defeat itself. But it is, and it does, in today's world, where stimulus doesn't serve to jolt the real economy into recovery, but to hide existing debt and create only the illusion of recovery. What makes it worse is that even just about everybody who should have known this instead elects to cling to the illusion. Well, your wake up call has come, and if you still don't listen it'll come back louder next time.

Today's stimulus is self-defeating simply because it is unleashed in a toxic financial environment, ridden with hidden debt. [..] … it can only function when debts are properly restructured, defaulted upon, their holders bankrupted where applicable.

And there's no chance of that: the most prolific debt holders are Wall Street banks, and their debts have been made more secret than the latest whereabouts of Jimmy Hoffa. As long as that stays the way it is, QE is nothing but a very expensive – and very temporary – stop gap. Short term profits for the financial world, long term losses for you and me.

How much money/credit has evaporated into thin air in the last few weeks? It's impossible to even estimate, and nobody's trying, maybe because of a fear of some kind, but it's certainly multiple trillions. A Reuters article over the weekend stated that "global equity markets lost $1 trillion on Thursday alone" . And Thursday was by no means the worst of the lot. The biggest losses have come not in stock markets, but in the bond markets, and these losses will continue. Not only did central banks never have control here, what's crucial is that nobody believes anymore that they have. More from the article:

The CBOE Volatility Index, a gauge of anxiety on Wall Street, jumped 23% on Thursday to 20.49, the first time this year it has exceeded 20, an often-used dividing line between calm and stressed markets. It closed at 18.90 on Friday.

Signs of concern about high-flying assets like emerging markets can be seen in the options market, where more than 1.35 million contracts in the iShares MSCI Emerging Markets exchange-traded fund traded on Thursday – 82% of which were put options, generally used to protect against losses.

The Merrill Lynch MOVE Index, a measure of expected volatility in the U.S. Treasury market, rose to 103.7 on Friday; that index sat at 50 in early May, a multi-year low.

Volatility, nerves, uncertainty. Deadly for an economy based on make-believe. The problem is not what Bernanke says or does not say, the problem is the debt still hiding underneath the layers of stimulus. Peel those layers away and guess what you see? And nerves or no nerves, bonds are losing value fast, the losses for institutional investors, governments, central banks and other parties will be enormous. And that is deflation.

Over the weekend, the BIS came with a curious number on the losses, as quoted by Reuters :

The BIS said in its annual report that a rise in bond yields of 3 percentage points across the maturity spectrum would inflict losses on U.S. bond investors – excluding the Federal Reserve – of more than $1 trillion, or 8% of U.S. gross domestic product.

The potential loss of value in government debt as a share of GDP is at a record high for most advanced economies, ranging from about 15% to 35% in France, Italy, Japan and Britain.

"As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care," the BIS said.

Curious, because a 3 percentage point rise is a large number (so large it may well have been picked to throw people off) and losses will already be very substantial at a much lower percentage too. Moreover, in the $82 trillion or so global bond markets, a $1 trillion loss looks very low in comparison, certainly when you see the BIS claim that France, Italy, Japan and Britain can see their bonds lose a third of their value. But still, again, this is deflation.

Perhaps the clearest, most down to earth and black and white illustration of deflation comes from two graphs that Ambrose Evans-Pritchard posted overnight . Remember, deflation does not equal falling prices, they're just a consequence. Deflation is the combination of the money and credit supply with the velocity of money. We know what that means for Japan, where velocity is extremely low, and PM Abe finds out that he can try to increase the money supply, but he has no control over the velocity. Here are M1 and velocity for the US:

 

 

Not a picture that leaves many questions open, it would seem. Still, it would be good to note that these developments didn't start with the latest market turmoil. If anything, they're the best illustration we can hope for of the failure of QE and other stimulus to induce an economic recovery. It's still impossible for all intents and purposes to find even one single politician or "expert" who does not talk about a return to growth and recovery, and that, in view of what we see out there, is taking on a bizarre character.

Someone should start talking about what we're going to do if and when growth does not return, when recovery is not just around the corner. We've lost precious years in which we could have cleaned up our economies but didn't. We instead borrowed from the future to put lipstick on the zombie. And now, behold: we've run headfirst into deflation, the very dreaded enemy we all wish to avoid. Are the Bernanke's and Krugmans et al of this world simply not smart enough to understand what is happening, and why? Perhaps, but I'm not so sure of that. It's too obvious. Even if Krugman seems to genuinely think a federal government can never suffer from debt deflation.

You can call it something else, and everybody has until now. But that doesn't change a thing. Trying to solve a debt problem with more debt creates bigger bubbles. In the end, there's one rule that always applies: credit bubbles lead to debt deflation, and the bigger the bubble, the more deflation there will be. It's inevitable. And it's not all bad: it cleanses the system, albeit in a painful way. But the longer you try to postpone it, the more painful it becomes.

Just because our economies can no longer function without stimulus doesn't mean they can with it.

 

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Kükator Sumo wrestlers performing dohyo-iri Wikimedia Commons

Japan is not a good example of how deflation typically plays out. As Ilargi points out, they were an exporting powerhouse exporting into the biggest consumption boom the world has ever seen. They also had a very large pile of money to burn through building their four lane highways from nowhere to nowhere, since they were the world's largest creditor when their bubble burst in 1989. This is clearly not our situation.

No one will be exporting their way out of a global economic depression. In contrast, exporters are going to feel the pain big time as their markets dry up. We can expect trade wars and protectionism to abound. Take note Germany, Scandinavia, Australia, New Zealand etc etc.

We have had the inflation, only instead of a currency hyperinflation, we experienced a 30 year credit hyper-expansion. Either one amounts to an expansion of money plus credit compared to available goods and services, and is therefore inflation. Credit is equivalent to money on the way up, but not on the way down. Credit loses 'moneyness' and credit instruments are massively devalued in a great deleveraging. This is deflation by definition and it is already underway. Debt monetization is nothing in comparison with the scale of the excess claims to underlying real wealth that stand to be eliminated.

I agree that the currency of a deflating nation strengthens. This is exactly why we have been writing about the value of the US dollar increasing, which it has done. The bottom came in a long time ago, and despite the set backs that are an integral part of a fractal market, the trend is up, and will be for some time. That's not to say it will be for the long term – far from it in fact – but for now that is the case. We have made it clear that cash is a short term bet (of the order of a few years), and that the longer term strategy is to move into hard goods at the point when one can reasonably afford to do so with no debt.

Some could do so now, while others would have to wait for prices to fall, as they inevitably do in a deflation, but not immediately. Price movements follow changes in the money supply. We have been in a counter-trend reflation since 2009, and prices have risen as a result. They may continue to do so for a while after the reflation is clearly over, but then the trend will reverse.

Prices will fall, but purchasing power will fall faster, meaning that prices will rise in real terms for most people. Those who have preserved capital as liquidity will find their purchasing power enormously increased, but most others will lose purchasing power because they will have no access to credit, highly unfavourable employment circumstances, rising property taxes and very little actual money.

The fiat currency regime will eventually descend into chaos as beggar-thy-neighbour devaluations become the norm, but not everyone can devalue at will or at once. The market will decide relative values for the next while.

Money will go from where the fear is to where the fear is not. It will be leaving the European periphery, and increasingly the entire eurozone, and flooding into currencies like the USD, the Swiss franc, the Swedish krona, and temporarily the British pound. It doesn't matter if the US is downgraded. Market participants will ignore the ratings agencies and vote with their feet on a kneejerk flight to safety.

You might think that the US indicators are much closer to the hyperinflation set-up than to deflation. I would disagree of course, for reasons Ilargi has explained (plummeting velocity of money for instance). I would also point out that people extrapolate the trend of the last three years forward, but fail to anticipate trend changes. We are in one. Many markets have topped already (gold, silver, commodities, oil etc), and the rolling top of the last year or so is about to claim the American stock market as well.

The rollover in the markets will drag the real economy down with it, with a time lag, since the time constant for changes in the real economy is much longer than for the financial world where value is virtual. We are headed into the teeth of the Greatest Depression, or at least the most significant one since the fourteenth century.

Hyperinflation is simply not on the cards any time soon. The depression will proceed for many years before that becomes a serious risk, unless you live in the European periphery that is, where currency reissue is a very real risk in the relatively short term.

In those currencies, loss of faith in New Drachmas, New Pesetas or New Lira is very likely, and the periphery countries will be cut off from international debt financing, with hyperinflationary results. That is not the situation in the US at all, and won't be for quite a long time. Eventually, when international debt financing is dead and buried, then printing will be a risk and a loss of faith in the erstwhile reserve currency could be expected.

In the meantime, debts defaults are going to skyrocket, each one doing its bit to destroy the value of credit instruments, and subtract from the effective money supply. This is already underway, and the great asset grab has begun as a result. Witness the asset stripping of Greece for instance.

In Europe, endless bailouts of sovereigns and the well-connected are doing nothing to increase the money supply or the velocity of money. In contrast, the ineffectuality of governments is doing nothing more than feeding the cycle of fear by demonstrating their impotence time after time. They are trying to overcome contraction, but are fighting an irresistible headwind. It is not going to work. Europe is already in contraction, and as fear will be increasingly in the ascendancy, that will only get worse.

Government obligations will be shed right, left and centre (by governments of the right, left and centre) because they will have no choice. Yes, this will lead to anarchical unrest, and yes, this will be met with a heavy-handed repressive response. Social polarization is very much on the cards – governments vs people, haves vs have-nots, natives vs immigrants, employers vs workers, unionized vs non-unionized, Us vs Them in general terms. This will not be pretty, to say the least. Just because it is a bad thing does not mean that it cannot happen, or that government, by their actions, can make any difference to the outcome.

Bailouts are never for the little guy. The creditors hold the political power and write the rules. They will not allow debtors off the hook. Instead of repayment in money, they will take people's freedom instead, making debt slavery much more real than it is today. Debts will not be forgiven, but sold on to more aggressive debt collectors. This is already happening in the US, where debt collection is becoming increasingly unconscionable.

Debts will only be effectively forgiven when people have nothing useful to repay, not even their labour. By then the middle classes will probably be living in latter day Hoovervilles, like the Villas Miserias populated by the formerly middle class Argentines.

Savers will have all the buying power, IF they have managed to get their savings away from dependence on the solvency of middle men. Otherwise they will likely disappear in a giant black hole of credit destruction, as yet more excess claims to underlying real wealth.

 

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Detroit Publishing Co. Nôtre Dame de Montréal 1900 “Main altar, Church of Notre Dame, Montreal, Quebec.”

 

This is a Guest Post by long time TAE regular, El Gallinazo.

A subject that commonly comes up in TAE is what to do with your savings if you have too much to stuff in “that creative place” that Nicole often refers to. And what she suggests is that the safest place to put it is in short term treasuries. If you are a citizen or a legal alien in the USA, that means T-bills, and if your money is not tax deferred, the only sensible way to do it is via Treasury Direct. A couple of days ago one of my closer friends sent me the following piece by Robert Moore on Rick’s Picks:

T-Bills May Offer Boomers a ‘Safe’ Way to Lose

She sent it with the message, “What’s this mean?” She is never one for verbose emails. As you might imagine, the title of the article by Robert Moore, intrigued me, but as I read through it I became a bit irate, and I decided to reply with a comment. Well this comment got supersized and I thought it might have the makings of a feature on TAE. I haven’t done one for almost a year. Instead of interleaving my commentary with the offending article, I would like to present it in a continuous format. So may I suggest that you read the Moore article and perhaps some of the comments and then come back.

I found this article to be quite irritating, not because your ideas were ipso facto bogus, but that you should label anyone who might disagree with them to be a fool and ignoramus. The entire premise of your article is that we are headed into a period of immediate global inflation or hyperinflation. However, there are some very bright people, Nicole Foss (Stoneleigh) of The Automatic Earth comes first to mind, who believe that the collapse of the global Ponzi, which began in 2008, and which is slowly accelerating, will result in the short term, perhaps several years, in a global deflationary depression.

She maintains that this deflation is already under way, in the Austrian School use of the word, as a net reduction in the sum of money, credit, and velocity. Mish also believes this. The continuing collapse of the shadow banking system and consequent credit destruction are the current cause though it is soon to spread to the TBTF banks and sovereign treasury bonds. This will lead in the short term to a price deflation of paper and physical assets in terms of the USD, which can already be seen in regard to US residential real estate.

The inflationistas will counter that the Fed and the other central banks will never allow a deflationary collapse. They will “print” their way eventually into hyperinflation (HI). (I put print in quotations because expanding debt through a central bank is really quite different from actually printing paper currency for which there is no true debt holder, but simply a dilution of the currency value.) This assumes that first they would want to, and second that they can. As to the first point, probably only the Rockefellers and the Rothschilds have an accurate idea of what the cartel’s long term strategy is.

A severe deflation, which they would have prepared for as they have engineered it, would allow them to buy up the remaining physical assets of the globe for pennies on the dollar. And could they prevent it even if they wished to? The growth of the central bank’s balance sheets of the USA, ECB, UK, and Japan since the collapse started in 2008 is less than $5T. (I am leaving China out as their statistics are moot). The collapse in global real estate values alone is considerably larger, and when you include all asset classes and throw in the quadrillion dollar derivative market, it is many times that. There are many expert analysts who predict that when the defaults begin in earnest, Uncle Ben and Don Capo Draghi will be as helpless as the Wizard of Oz to stop it. They will be overwhelmed by the collapse of the Ponzi resulting in a tsunami of default.

But let me regress for a moment to contemplate the strategic plans of the NWO. Some might say that the capos of the global banking cartel have no long term strategy. That they do not even discuss this concept with each other and all their actions are based upon fear and greed with a time horizon of 72 hours. They might even argue that the Bilderbergers, like Wendy’s, simply wish to compete with McDonalds, and the Trilateral Commission and the CFR are just watering holes with good leather upholstery. But for those people who believe that the people who possess most of the world’s wealth and coercive power might deem it as useful to construct a long term business plan as a garage based entrepreneur, we might give it a little thought.

My conclusion is that the final goal is to subject the global 99% into permanent debt serfdom. But if they permit the currencies upon which those debts were structured to go into hyperinflation, then the potential debt serfs could divert a wheelbarrow full of said currency from their home heating systems and buy their way out of life long debt servitude into the bright light of freedom, if one of debt free poverty. Ah yes, as Janis wailed, “Freedom’s just another word for nothing left to lose.” So I must conclude that the NWO capos regard HI as a potential disaster to be avoided.

But any intelligent economist, meaning one of the Austrian School, will freely admit that the natural consequence of the world’s all time hugest bubble bursting is a deflationary collapse, as in deflation. And that the only way that could be conceivably avoided would be for the central banks to “print” stupendous amounts of offsetting credit. But this could lead to a global HI which are the bankers’ worst nightmare as it would essentially lead to a jubilee for the 99%.

In a severe deflationary collapse, most assets will drastically lose value in nominal terms. In my opinion, the S&P 500 is absurdly overpriced. Every time the Fed or the ECB expands their balance sheets, whether covertly (currency swaps) or openly, the so call risk assets surge. So what are the options of a person with some savings? We have the general risk assets of equities and commodity futures, physical assets such as land and buildings as well as assorted junk from China, bonds excluding the US Treasury, US Treasuries, and the precious metals.

So if deflationary collapse, which I predict, does come to pass, then all but the last two will be obvious losers in both nominal and real terms. As to precious metals, it is my opinion that they will maintain their real value over the longer term, as they have since the time of Rome. However, I believe that during the collapse, PMs will lose nominal value for two basic reasons. First, their current nominal value is artificially high because it is propped up by extreme margin leverage extended primarily by the commodity brokers (such as MF Global) and their backers (JPMC). What do you think the value of paper gold would be if there were no credit to buy it on margin? And I think we are rapidly entering a world where most credit is disappearing.

Second, I think that many during the collapse will be forced to sell PMs, particularly gold, to meet margin calls, trying to stave off insolvency. Gold may be the only thing that anyone might be interested in buying at that point in time, and it would become a buyer’s market. I do believe, however, that gold will be the first physical asset to recover.

So here we are with US Treasury Bills as the last of the list. Let me state for the record that I am a retiree with modest savings; that most of my savings are in 13 week treasuries purchased through Treasury Direct, and that I am currently living in Mexico in very modest comfort on my Social Security checks. In short, I am one of Robert’s idiots.

Now let me direct my idiotic blather to several of his points as well as supporting commenters:

* When the currency of a country appears to be nearing collapse (most would regard this as imminent HI), then the yield on the bonds go into an exponential moon shot. This is because lenders would want to be compensated for the loss of real value as well as the probability of sovereign bond default. Greece is not a great example as it doesn’t have its own currency, but look at the current yield of their six month bonds. One might look at Argentina 2000-02 for a better example. So Robert is correct that only we idiots would invest in sovereign debt at 0 or negative nominal yields.

Say a currency does go into a deflationary collapse of 7% per annum in terms of general purchasing power, and you hold bonds with a minus 2% yield. While you are losing 2% in nominal terms, you are actually gaining a 5% yield in real terms. This appears strange to people simply because the Fed criminals have kept the country in inflation since 1913 with a few modest exceptions such as the Great Depression.

* Moore suggests that it would be smarter to kept your savings in currency under your mattress than in T-bills. First, the Fed and the NWO Banking Cartel frown upon currency. It is one of the few remaining areas of freedom and privacy in the money world. They would prefer to have every pack of gum you purchase recorded in their computers, complete with brand and number of pieces contained in the package. In order to villainize cash, anyone with large sums is ipso facto regarded by the “authorities” as either a drug dealer or a terraist. And this tends to be at the discretion of the Secretary of the Treasury or his minions. Recent “laws” in this regard deprive you of any judicial recourse, on the off chance that the courts are not totally rigged.

So anyone holding large amounts of currency is subject to it’s confiscation. Second, I challenge anyone to go to his bank, if you live in the USA, and try to withdraw, say $8000 in cash. See how easy and hassle free it is. First, they usually ask you, in writing, what it is for, like it is a loan and not your own money. When you tell them to go to hell, they tell you that Turbo Timmah made them ask it. For most, the only hassle free way to accumulate cash is to take out the daily max from your ATM. But I would imagine that the banks will shortly build a weekly or monthly limit into their ATM programs.

* Next we come to bank savings which includes CD’s. Legally your savings are a loan to the bank, and with the repeal of Glass-Steagall, your bank may go to the casino and gamble with it as it sees fit, or give it out as a bonus for their deserving traders to purchase hookers and snort. And with recent federal legislation, holders of derivative instruments are the first in line when a bank fails. Please note the transfer of $60T in derivative wagers from the Merrill-Lynch division to the BAC FDIC flagship. Wonder why they did that?

The segregated accounts at MF Global were legally more secure than any checking account, CD, or money market account. They were essentially virtual safety deposit boxes in which MFG was given the authority to take out money only upon the account holder’s explicit orders to purchase future contracts or cover margins. Yet Corzine and Dimon stole as much as $2B from these accounts without even a hiccup from Eric PlaceHolder, who was too busy running guns to the Zetas in Mexico. And you think your money in the bank is safe?

* And now we come to the FDIC. First, that Robert should accept the $250k limit at face value is bizarre. A joint account is insured up to $500k, and insurance goes by the account not by the person. So if some dude has five million bucks, he just opens up 20 accounts and puts $250k in each. No hay problema. But will the FDIC pay off on a systemic collapse of the banking system. Note that the C in FDIC stands for corporation. And it is basically broke as we breath. Are TPTB willing to monetize $5T to pay off account holders?

One may observe that the balance sheet of the Fed after all the illegal and quasi legal crap gone down over the last 4 years, including taking near worthless assets off the hands of their buddies at face value, stands at under $3T. So I don’t think so. The Boyz don’t put their money in checking accounts or CD’s and the Boyz run the show. As the late George Carlin put it, “It’s a club and you’re not in it.” I think it is far more probable that they will pay out the account holders a nominal sum, like $400 a month, until it is paid off in the 22nd century.

* As everyone interested in macroeconomics knows, since 1971 when Nixon closed the gold window, money is debt and nothing more. And the debt that supports the US currency is the Treasury debt. So the dollar is totally dependent on the confidence of the world in the US Treasury. The collapse of the Treasury would result in the dollar immediately becoming worthless, i.e. instant HI. There are some very intelligent people who believe that the NWO intends to collapse the dollar eventually and replace it with a global currency. I am one of them (though you may leave out the intelligent descriptive in my case).

And the easiest way to collapse the dollar is to collapse the confidence in the Treasury. However, in my opinion this is in the future and not the immediate future. And the advantage of buying T-bills through Treasury Direct is that you have no “private sector” broker in the middle (Jon Corzine for example) to steal them. The drawback is that you cannot use tax deferred funds to buy them. But the ominous future on tax deferred funds would be the makings of a rant for another day. It seems that people are becoming too irresponsible not to wait until after they die to withdraw them.

In a severe deflationary collapse, what appeared to be money during the bubble expansion (really credit) disappears with barely a trace as it is sucked into an alternate universe. Since the total sum of money and credit becomes a small fraction of what it was at the bubble’s peak, the vast majority of asset holders become losers both in nominal and real terms. With a few very rare exceptions, the ones who lose the least – win.

So, in summary, I remain “invested” in 13 week T-bills through Treasury Direct and have no intention of being forced into risk assets or using up my modest savings in a couple of years and then eating dog kibble.

Your faithful idiot,

El Gallinazo