Will the Fed cut interest rates to alleviate the developing credit crunch, and will it have the desired effect if they do? Can lowering the cost of credit overcome risk aversion and the fear of cascading default? If not then the Fed will not be able to prevent the contraction of the money supply and the spread of contagion amid a sea of margin calls.
In Canada, oil sands fever continues unabated and a drilling frenzy may be shaping up in the Arctic. One political leader urges the defence of Arctic sovereignty, while another holds talks on North American Union well away from the public eye. In Ontario, businesses are paid not to consume power.
On the climate front, northern infrastructure faces a serious challenge as melting permafrost undermines it's foundations, while Australia experiences a 1000 year drought.
Finally, we remember that 62 years ago, the world was waking up to the beginning of the nuclear weapons age.
Stoneleigh,
I think you underestimate two things:
1. the power of the Federal Reserve System;
2. the determination of the Fed to prevent debt deflation.
For all intents and purposes, the Fed has unlimited power to fight deflation. They can legally lend unlimited amounts of money to whomever they think needs it to avoid a financial catastrophe. Although they typically lend only to banks, their charter does not limit them to this kind of lending.
All the members of the Board of Governors of the Federal Reserve System live in the shadow of the Great Depression. To a large extent, the Great Depression was caused because the Fed at that time was worried about inflation and stood by and did nothing while banks folded by the thousands. There is unwavering resolve among members of the Board of Governors that never, never again will the Fed twiddle its thumbs while debt deflation destroys the U.S. economy.
Given their powers and given their will, I think the odds against debt deflation are nine to one, because the Fed will always accept more inflation as a necessary cost to ward off the possibility of debt deflation. Thus I think the chances of a cascade of failures of major financial organizations is almost nil. Businesses will continue to borrow, consumers will continue to borrow more on their credit cards, the government will go merrily on its borrowing way to finance ever greater deficits.
I cannot visualize a scenario in which the Fed allows a debt deflation; Bernanke has said as much with his famous "helicopter" statement. Metaphorically speaking, the helicopters are loaded and the rotors are spinning; and the Fed has all the helicopters it could ever possibly need.
Inflation, normally hard to keep down, is assumed to be easy to initiate. Much like starting a fire with wet wood, in a climate of pessimism it can take a lot of matches.
How many matches Bernanke has and his willingness to deploy them doesn't convince me of whether or not a fire will ensue. This is why timing is so important in order to avoid the downward momentum getting beyond the rate of helicopter deployment.
Compounding the credit bubble is the oil chicken coming home to roost and the general perception that we are 'losing the war', whatever that means. The future of both those aspects will not be altered in the public mind by throwing money about. False confidence, like any confidence, takes time to build. There isn't any - time that is.
I agree with you in the classic sense, but this is looking like 1973 all over again, but for real this time. Vietnam was about ego, and OPEC was arbitrary. Now its really about oil. Really about oil. Adding more money won't change the fundamentals.
How many matches Bernanke has and his willingness to deploy them doesn't convince me of whether or not a fire will ensue. This is why timing is so important in order to avoid the downward momentum getting beyond the rate of helicopter deployment.
Compounding the credit bubble is the oil chicken coming home to roost and the general perception that we are 'losing the war', whatever that means. The future of both those aspects will not be altered in the public mind by throwing money about. False confidence, like any confidence, takes time to build. There isn't any - time that is.
I agree with you in the classic sense, but this is looking like 1973 all over again, but for real this time. Vietnam was about ego, and OPEC was arbitrary. Now its really about oil. Really about oil. Adding more money won't change the fundamentals.
Exactly. In the case of Bernanke's helicopter, there is only so much air as you go up in altitude. That's why they don't use helicopters to get to the space station.
In the case of the Debt engine, the 'air' is the Perception of Perpetual Growth. Banks loan money (supposedly) because you are going to be worth more than you are at the moment they loan the money. Sub-prime believes that the house will increase in value to cover the interest on the loan (the only real value to a bank: the principal is just a present number, whereas interest is Future Income).
It's all about the future, yet nobody is asking the children what they want. Most of them would say "I want Mommy and Daddy to play with me, to cook pancakes, and to get me a puppy." That's it. The wisdom of children is more than the Fed. Most of the things encouraged by the Fed's low interest rates are going to fail without cheap energy. Most of the policies of the Oil Men in Washington are working to MAKE THEM FAIL through HIGHER Prices for energy in order to line their pockets with all that cash that consumers SEEM to have, since they haven't slowed down on buying gas at 3 times it's recent cost. Why? Because they are so in debt to the banks to pay for the house they bought when money was easy to get.
Remember: Energy is the air for Bernanke's helicopter. If he gets cold and shuts off the fan (an old test pilot joke), his helicopter is going to crash on top of the refinery that is fueling his helicopter. It can't come down to a soft landing. Any reduction in altitude is a knife in the eye of Growth Perception, and any increase in altitude(lower interest rates) increases the costs of resource inputs, requiring higher altitude. He's reached the altitude ceiling of that helicopter and it's heading strait for a big, black mountain called Peak Oil.
And that, my friends, is beautiful prose for the day. Back to farming for me. The chickens are hungry.
"If you want Change from the corporatocracy, keep it in your pocket. "
It's all about the future, yet nobody is asking the children what they want. Most of them would say "I want Mommy and Daddy to play with me, to cook pancakes, and to get me a puppy." That's it. The wisdom of children is more than the Fed.
Warning: Somewhat off topic.
Children have a very pure, caring morality. In part, because the adults around them inculcate it, basic principles of fairness etc. are important. Few tell young children, it is just great to rip off those other kindergarten kids and make money and hit other kids to make them obey. For another part, adults want children to believe they live in a stable, safe world, where morals count, because, to bring up their children, they need everyone to respect certain principles, *otherwise they can’t bring them up.* Then, there is also the basic perception of fairness, of evil, of hateful actions, of damage, or violence, that children just seem to grasp. (Naive justice.) That is a constant of human life. Yet, the basic principles are later abandoned, both by the children, and their parents. (Not in all cases of course.)
Here is Rachel Corrie in her 5th grade speech. Her destiny was exceptional, her speech is simply typical.
Children have a very pure, caring morality. In part, because the adults around them inculcate it, basic principles of fairness etc. are important. Few tell young children, it is just great to rip off those other kindergarten kids and make money and hit other kids to make them obey.
On the other hand, it is considered 'cool' by some, and a mark of individualistic non-conformity to have a bumper sticker proclaiming "My kid beat up you honor student"
Well, I took those as a humorous response to the "My Kid is an Honor Student" business, which deserved to be lampooned, kind of like putting, "Star Fleet Academy" or, "School of Hard Knocks" stickers on your rear window.
I would say Bernanke has already been round in his helicopter, but he dropped free debt instead of free money, and the consequences of that will (IMO) become apparent this year.
The Fed has acted as midwife to a credit expansion (by holding the cost of credit artificially low), but a credit expansion (as opposed to a currency inflation) can only continue until the debt which created it can no longer be serviced. I would argue that we are at or near that point now.
I don't doubt that the Fed will cut short term rates as well as attempt some sort of bailout. What I do doubt is that they can succeed for long in preventing the money supply from contracting, let alone increasing it, in the face of risk aversion spreading like wildfire. Financial panic can remove liquidity faster than the Fed can pump it in, as we've seen in recent weeks. The Fed's normal game plan depends on incentivizing ready, willing and able borrowers and lenders. If risk aversion or debt serviceability curtail either the willingness or the ability to borrow and lend, then this strategy becomes impotent.
In addition, the Fed can only cut short term rates to zero. As the Japanese discovered, zero is not low enough when the money supply is contracting (ie deflation, following von Mises and the Austrian school), because real interest rates (nominal rates minus negative inflation) can remain punishingly high. Also, under such circumstances longer term rates may remain stubbornly high despite cuts in short term rates, as a reflection of risk aversion. A high rate in nominal terms would be very high in real terms under such circumstances.
I realize that the Fed has other magic wands, but I think they'll do too little too late. Ultimately I don't see them being able to overcome the power of a financial panic (not that we're there yet, and I don't expect us to be until probably the fall). By way of analogy, what the Fed will try to do is to cure a hangover by having a few more drinks - eventually the patient dies of alcohol poisoning. Hence the thought that you can't solve a problem by doing more of what created it in the first place.
Stoneleigh - I agree with you about the interest rate bottom; Japan actually went negative for a while.?? What didn't happen was a contraction of the money supply. It was a contraction of velocity, that irascible bugbear of central bankers.
Offering money at negative rates doesn't assure that borrowers will show up to take it if they think that assets will depreciate faster than the negativity. What if they gave a party and nobody came?
It's hard to develop a hundred thousand dollars worth of action out of a forty thousand dollar wage. Inflation of the money supply without corresponding wage inflation won't turn around a mass consumer economy such as the US. The housing bubble is exhibit A of wage/asset debt disconnect.
There may not be an answer. There wasn't in Japan. For those solutionocopians out there, my sympathies, but this is looking like a classic paradigm shift right about when I would have expected it. Such things have a life of their own to lead. And they never play out quite the same way as the last.
Petro: You make good points, but the Japan example is misleading. Japan has always had a strong current account surplus which has provided strength to the Yen even with very low interest rates. The USA is actually in a situation similar to that faced by Argentina, not Japan. Japan was able to have a deep recession combined with a strong currency- it is very unlikely the USA can do the same. The structural weakness of the dollar makes deflation less likely to persist if it can occur.
Argentina borrowed in dollars, not in local currency. Poor economic management (a delusion by Menem for short-term illusory prosperity) and this mismatch of income to liabilities resulted in the breakdown.
US has the luxury (so far) of borrowing in a currency which can be debased at its own choice---though with consequences.
As it turns out---Argentina has been growing and doing well economically for the last few years after normalizing to true market values. Export of agriculture is strong.
But now, populist and foolish intervention for populist reasons is resulting in another external "debt" crisis, for fossil fuels.
I know. I was hoping that the conundrum of reserve currency/ largest debtor wouldn't cloud the issue. In all probability, the days of US reserve currency hegemony are already over and only the process of how we move to a multiple reserve system is yet to play out. I was hoping for an orderly and managed transition, but the majority of our leaders seem willing to go down with the ship.
Between the Euro and the rise of China, the writing on the wall is now almost fading from age. John K Galbraith refers to the period of the first World War as the 'great ungluing'. It was in 'The Age of Uncertainty', a very fine read. The scene seems set for another such age.
Japan never really dealt with it's bad debt problem and so hasn't been through what's facing the US now, despite nearly two decades of difficulties during which it burned through a huge surplus building things like 4-lane highways to nowhere in a vain attempt to stimulate the economy. I would argue that their problems are far from over though, and that the impact on their money supply (as opposed to problems with the velocity of money) lies largely in their future. They have yet to face the unwinding of the yen carry trade for instance, and the dislocation that will inevitably bring.
You can prevent a hangover indefinitely by taking more and then even more drinks: I think that is what the Fed will do. We are addicted to cheap and readily available credit; the Fed dare not take away the punchbowl now that some at the party are getting anxious.
I assume you are familiar with the term "liquidity trap," where lenders refuse to lend or borrowers refuse to borrow. This is the famous case of "pushing on a string" with monetary policy impotent. Although a liquidity trap seems to be what is in your forecast, I consider the possibility of our stumbling into one as remote. Why?
Because Americans are used to borrowing and lending--and then to borrowing ever more. I do not think financial organizations will suddenly refuse to lend out of fear, because I think they will retain confidence that the Fed can and will prevent financial collapse. It is all about confidence and expectations: If fear and panic take over, then we could indeed get stuck in a liquidity trap and have the Mother of all credit crunches (with the Great Depression being the Grandmother).
So I will try to spin a story of financial collapse:
1. The Dow Jones Industrial Average crashes down through five thousand, then falls to three thousand and even one thousand in a matter of weeks this coming October.
2. Brokerage houses and investment banks fail AS THE FED STANDS BY, PARALYZED BY FEAR AND INDECISION because the dollar is in free fall in the international financial markets.
3. By the millions, American home owners give up on the American dream of home ownership and let their homes go into foreclosure without a fight because
4. Massive cyclical and structural unemployment have thrown twenty million Americans out of work.
Now theoretically this could all happen. But the key premise, which I've screamed out in capital letters is that the Fed stands by and twiddles its thumbs. By creating liquidity the Fed can permit debt expansion. Expansion of debt and credit necessarily expands the money supply. Expansion of the money supply is inflationary, not deflationary.
Over the next dozen years I'm betting on worsening inflation, at least to double digit levels and possibly far beyond that level. As the price of oil rises the Fed will have a choice to either
1. Restrain the growth of credit and money so as to restrict inflation or
2. Expand the growth of credit and money so as to avert deflation and depression.
Helicopter Ben is not going to fight inflation at the risk of triggering another Great Depression. (By the way, the case of Japan twenty years ago was very different from the current situation faced by the U.S. Also note that Japan has had a controlled and gradual deflation that has not stopped its long-term economic growth, though it did slow it down a great deal.)
One of the nation's largest mortgage lenders, Houston-based Aegis Mortgage Corp., stopped taking new loans Monday, amid a day of news that signaled tougher days ahead for lenders and homebuyers.
U.S. mortgage lenders like Wells Fargo and Wachovia are raising interest rates and imposing stricter standards on some of their most creditworthy borrowers as slumping demand in the mortgage bond market chokes off financing.
On Friday, Wells Fargo, which is based in San Francisco, curbed its financing of so-called Alt-A loans, which are made to some borrowers with good credit ratings but without documented income, or to buyers of second homes. On the same day, Wachovia, which is based in Charlotte, North Carolina, stopped making Alt-A loans through brokers and smaller lenders and curtailed some adjustable-rate mortgages, said a spokeswoman, Christy Phillips-Brown.
"The credit crunch is here," said Keith Shaughnessy, president of Foundation Mortgage in Littleton, Massachusetts.
Now theoretically this could all happen. But the key premise, which I've screamed out in capital letters is that the Fed stands by and twiddles its thumbs. By creating liquidity the Fed can permit debt expansion. Expansion of debt and credit necessarily expands the money supply. Expansion of the money supply is inflationary, not deflationary.
Unstated in this is conversion of the debt/credit into consumer spending. The bull market from 1982, culminating with the stock market bubble of the late 1990s, was converted to consumer spending because the resulting "wealth effect" from capital gains in the 401(k)s convinced Americans they did not need to save. Cheap credit blew a real-estate bubble that appears to be deflating now and was converted to consumer spending through equity withdrawals (see, eg, Calculated Risk's charts on GDP with and without mortgage equity withdrawals). While the increased spending was the result of cheap credit, the consumers didn't see it as taking on increased debt -- in both cases, the households saw their net worth increasing.
The Fed can set the stage for cheap credit, but they have little control on where it will flow, and whether or not it will end up as consumer spending. How does the Fed get it into the hands of the consumers without having it show up as explicit debt in their household budget?
I am assuming that if you give the American consumer a chance to spend more, then he or she will do so. By pumping more cheap credit into the system, I think the Fed can keep the real economy perking along; in other words I do not see much of an increase in unemployment during the next twelve months.
To make U.S. consumers afraid to borrow and to spend, you just about have to have a significant increase in unemployment rates. In other words, if real economic growth goes negative, then the elements for a vicious circle of fear and panic and debt deflation and declining real GDP becomes possible. But the real rate of growth in GDP is positive--maybe a bit slower than a year ago, but still well into positive territory. And this positive economic growth is happening despite a rotten real estate market and weak sales for new vehicles--which I find truly remarkable.
I do not assert that Depression and deflation are impossible, only that--given the data we now have--they are extremely unlikely.
On the other hand, a severe stagflation such as we had in the late 1970s and early 1980s is entirely possible and is, in my opinion, rather likely as a response to Peak Oil. Thus I can see zero real economic growth along with double digit inflation and the prime rate back up around twenty percent. We've been there before, we can go there again.
But in my opinion, the conditions that gave rise to the Great Depression simply do not exist any more, and while Peak Oil will (I think) choke off real economic growth, the nominal GDP and the money supply can both go on increasing for years to come. True, stagflation could theoretically mutate into depression, but I think it is much likelier to mutate into increasing rates of inflation.
Debt is a monster. We can kill the monster with major and abrupt and unexpected increases in the rate of inflation. The Fed knows that. When push comes to shove, I think they will kill the debt monster and capitulate on the fight against inflation. Indeed, Ben Bernanke has said as much in his infamous "helicopter" reference: There will be no deflation on his watch.
My CC gives me those same offers. They have a nasty hook in them. Read the fine print.
What they do is charge exhorbitant rates for ordinary balances. They will set up a special teaser rate for that one "loan".
Any subsquent charges against the card ( purchases, accrued finance charges, etc. ) will incur the exhorbitant rate, and you will NOT be able to pay it off until you have first completely paid off your teaser loan, as they will credit any payments you send them against the freebie teaser first.
While you are enjoying your "cheap" loan, they are enjoying charging you exhorbitant fees for the "ordinary" part of the CC balance which there is no way for you to pay down until you have your teaser account repaid.
Its a baited cat trap. My advice is to shred those offers.
part of what hardhat says is true and part is not. i have bought houses using these types of loans(and i wont bore you with the details). yes by all means keep your credit card purchases separate from these "loans". and as long as you perform as you agree, they really will be at 3.99 or 4.99 for the life of the loan. ask a lot of questions before you borrow any money from them i.e what is the minimum payment ? assuming you deposit the "checks" in your bank, find out when the money will actually be available (typically 11 business days, i think)
currently i have a total of 4 cards, one of which i use for ordinary purchases, which i pay off each month. i hope to get them all paid off by year end.
one problem with these loans is that they are considered revolving credit, and in short the only revolving credit that will do your credit score any good is the ones you have already paid off.
I think you are essentially on target with your prediction of a return of 1970s-style stagflation. However, what is happening with price levels and currency exchange rates and financial markets will mask a more profound underlying trend: As the real price of energy in all forms (and along with them energy-intensive or energy-linked essentials like food) continue to rise inexorably, the real prices of everything else (including wages) must also inexorably fall. The GDP pie can only be sliced so many ways, and a bigger slice for energy leaves smaller slices for everything else.
Thus, while it won't technically be anything like the Great Depression, when you focus on what is really happening with all those non-energy pie slices, the practical effect as far as the daily lives of most people is concerned will be declining wages and declining living standards -- pretty similar to what folks experienced during the Great Depression. This time around, people are going to feel increasingly poor as the government and the media and their bank statements are all telling them how supposedly rich they are.
I agree with stagflation at least at first(likely now). Thinking of all the retirements and such that can be paid with worthless $ makes sense in the long haul.
What so many people miss is that the fed cannot lower rates, not this time. Most of our debt is bought by foreign investors, they won't pay for negative returns, to save our addicted US gov/lifestyle.
Helicopter Ben be damned he is stuck like a rat in a trap.
Don,on another board,I heard it said that "mr Helcopter" had already started dropping....Look at the 8-9 billion that "disappered"in Iraq...easy way to get some inflation without it showing up in statistics....
I assume you are familiar with the term "liquidity trap," where lenders refuse to lend or borrowers refuse to borrow. This is the famous case of "pushing on a string" with monetary policy impotent
It is indeed a liquidity trap that I am expecting.
I do not think financial organizations will suddenly refuse to lend out of fear, because I think they will retain confidence that the Fed can and will prevent financial collapse.
I think they are already refusing to lend out of fear, although I would say we are at the very beginning of the process at the moment. Banks may not be able to sell LBO debt to investors easily, but some deals are still happening with the banks holding the debt themselves. People can generally get mortgages even though the liars loans have mostly dried up, and they can still max out credit cards or get car loans etc. Further down the line, I wouldn't expect any of these things to still be happening. I think loans will be called in in the mother of all margin calls, and that credit will only be available to those who don't really need it, as has traditionally been the case. Fear and risk aversion can spread with lightning speed - Cramer is a case in point if you contrast his rants from three weeks ago with the most recent one.
It is all about confidence and expectations: If fear and panic take over, then we could indeed get stuck in a liquidity trap and have the Mother of all credit crunches (with the Great Depression being the Grandmother).
I agree completely that it's all about confidence and expectation. The difference is that I am fully expecting fear and panic to take over while you are not. I doubt if we'll have all that long to wait to see which way things develop. By the way, I think this depression will be worse than the last one because the scale of the excesses leading up to it is significantly greater.
Brokerage houses and investment banks fail AS THE FED STANDS BY, PARALYZED BY FEAR AND INDECISION because the dollar is in free fall in the international financial markets.
I don't think the dollar would be in free fall. As I said below (I think) to vtfarmer, I think the dollar will benefit from a flight to quality in the international debt markets as credit spreads widen. I also think it would be in great demand domestically as people try to sell all manner of assets in order to cash out or meet margin calls. I think the Fed will fail to act quickly enough because it will underestimate the speed with which fear is spreading and sucking liquidity out of the market. Arguably it is doing that already.
By the millions, American home owners give up on the American dream of home ownership and let their homes go into foreclosure without a fight because massive cyclical and structural unemployment have thrown twenty million Americans out of work.
I think loans will be called in and unemployment will skyrocket. I can indeed see many giving up their homes without a fight. Fighting takes resources, and I'm expecting those to be in short supply.
By creating liquidity the Fed can permit debt expansion. Expansion of debt and credit necessarily expands the money supply. Expansion of the money supply is inflationary, not deflationary.
I don't think the Fed will be able to create liquidity because fear can remove liquidity faster than the Fed can create it, especially when willing borrowers and lenders are hard to find (ie the liquidity trap). I think we're looking at huge debt defaults, which would be magnified by the enormous degree of leverage involved. Leverage can carry you a long way up, but it kills you very quickly on the way down. My guess is that the money supply will implode.
>I don't think the Fed will be able to create liquidity because fear can remove liquidity faster than the Fed can create it,
Bailout is likely to happen from Congress not the fed. A bailout from Congress would imply that the US gov't is guarenting loans which removes the fear factor from the equation. My guess is that we will see some a bailout from Congress soon. How much is initially bailed out is likely to shape the money supply (inflation or deflation). I think if we see a bailout of at least $250 billion we slide into inflation. Below that we'll probably have deflation. Although this a just a guestimate.
Wonder if I'll regret not putting 50 bucks down on a McMansion. If the government eventually pays them all off, it'd be useful to have a spare place for storage.
A new Round-Up has been posted at TOD:Canada.
Will the Fed cut interest rates to alleviate the developing credit crunch, and will it have the desired effect if they do? Can lowering the cost of credit overcome risk aversion and the fear of cascading default? If not then the Fed will not be able to prevent the contraction of the money supply and the spread of contagion amid a sea of margin calls.
In Canada, oil sands fever continues unabated and a drilling frenzy may be shaping up in the Arctic. One political leader urges the defence of Arctic sovereignty, while another holds talks on North American Union well away from the public eye. In Ontario, businesses are paid not to consume power.
On the climate front, northern infrastructure faces a serious challenge as melting permafrost undermines it's foundations, while Australia experiences a 1000 year drought.
Finally, we remember that 62 years ago, the world was waking up to the beginning of the nuclear weapons age.
Mish doesn't think a rate cut will help. The MMMMB (Ministry of Miracle's Magic Miracle Bucket) is empty!
http://globaleconomicanalysis.blogspot.com/2007/08/will-rate-cuts-save-e...
Yes, and I agree with him. I ran that link in my post, and it was that I was alluding to in the intro.
Stoneleigh,
I think you underestimate two things:
1. the power of the Federal Reserve System;
2. the determination of the Fed to prevent debt deflation.
For all intents and purposes, the Fed has unlimited power to fight deflation. They can legally lend unlimited amounts of money to whomever they think needs it to avoid a financial catastrophe. Although they typically lend only to banks, their charter does not limit them to this kind of lending.
All the members of the Board of Governors of the Federal Reserve System live in the shadow of the Great Depression. To a large extent, the Great Depression was caused because the Fed at that time was worried about inflation and stood by and did nothing while banks folded by the thousands. There is unwavering resolve among members of the Board of Governors that never, never again will the Fed twiddle its thumbs while debt deflation destroys the U.S. economy.
Given their powers and given their will, I think the odds against debt deflation are nine to one, because the Fed will always accept more inflation as a necessary cost to ward off the possibility of debt deflation. Thus I think the chances of a cascade of failures of major financial organizations is almost nil. Businesses will continue to borrow, consumers will continue to borrow more on their credit cards, the government will go merrily on its borrowing way to finance ever greater deficits.
I cannot visualize a scenario in which the Fed allows a debt deflation; Bernanke has said as much with his famous "helicopter" statement. Metaphorically speaking, the helicopters are loaded and the rotors are spinning; and the Fed has all the helicopters it could ever possibly need.
Inflation, normally hard to keep down, is assumed to be easy to initiate. Much like starting a fire with wet wood, in a climate of pessimism it can take a lot of matches.
How many matches Bernanke has and his willingness to deploy them doesn't convince me of whether or not a fire will ensue. This is why timing is so important in order to avoid the downward momentum getting beyond the rate of helicopter deployment.
Compounding the credit bubble is the oil chicken coming home to roost and the general perception that we are 'losing the war', whatever that means. The future of both those aspects will not be altered in the public mind by throwing money about. False confidence, like any confidence, takes time to build. There isn't any - time that is.
I agree with you in the classic sense, but this is looking like 1973 all over again, but for real this time. Vietnam was about ego, and OPEC was arbitrary. Now its really about oil. Really about oil. Adding more money won't change the fundamentals.
Exactly. In the case of Bernanke's helicopter, there is only so much air as you go up in altitude. That's why they don't use helicopters to get to the space station.
In the case of the Debt engine, the 'air' is the Perception of Perpetual Growth. Banks loan money (supposedly) because you are going to be worth more than you are at the moment they loan the money. Sub-prime believes that the house will increase in value to cover the interest on the loan (the only real value to a bank: the principal is just a present number, whereas interest is Future Income).
It's all about the future, yet nobody is asking the children what they want. Most of them would say "I want Mommy and Daddy to play with me, to cook pancakes, and to get me a puppy." That's it. The wisdom of children is more than the Fed. Most of the things encouraged by the Fed's low interest rates are going to fail without cheap energy. Most of the policies of the Oil Men in Washington are working to MAKE THEM FAIL through HIGHER Prices for energy in order to line their pockets with all that cash that consumers SEEM to have, since they haven't slowed down on buying gas at 3 times it's recent cost. Why? Because they are so in debt to the banks to pay for the house they bought when money was easy to get.
Remember: Energy is the air for Bernanke's helicopter. If he gets cold and shuts off the fan (an old test pilot joke), his helicopter is going to crash on top of the refinery that is fueling his helicopter. It can't come down to a soft landing. Any reduction in altitude is a knife in the eye of Growth Perception, and any increase in altitude(lower interest rates) increases the costs of resource inputs, requiring higher altitude. He's reached the altitude ceiling of that helicopter and it's heading strait for a big, black mountain called Peak Oil.
And that, my friends, is beautiful prose for the day. Back to farming for me. The chickens are hungry.
"If you want Change from the corporatocracy, keep it in your pocket. "
I forgot one little note to Mr. Bernanke:
Put your head between your knees. You know why.
It's all about the future, yet nobody is asking the children what they want. Most of them would say "I want Mommy and Daddy to play with me, to cook pancakes, and to get me a puppy." That's it. The wisdom of children is more than the Fed.
Warning: Somewhat off topic.
Children have a very pure, caring morality. In part, because the adults around them inculcate it, basic principles of fairness etc. are important. Few tell young children, it is just great to rip off those other kindergarten kids and make money and hit other kids to make them obey. For another part, adults want children to believe they live in a stable, safe world, where morals count, because, to bring up their children, they need everyone to respect certain principles, *otherwise they can’t bring them up.* Then, there is also the basic perception of fairness, of evil, of hateful actions, of damage, or violence, that children just seem to grasp. (Naive justice.) That is a constant of human life. Yet, the basic principles are later abandoned, both by the children, and their parents. (Not in all cases of course.)
Here is Rachel Corrie in her 5th grade speech. Her destiny was exceptional, her speech is simply typical.
Corrie, youtube
Thanks for that Noizette.
That was great and in my opinion very relevant.
When I see bad behavior from anyone young or old I automatically think that the parents must not have taught them well.
Dick Cheney’s mom should put him over her knee.
On the other hand, it is considered 'cool' by some, and a mark of individualistic non-conformity to have a bumper sticker proclaiming "My kid beat up you honor student"
"God bless the child that got his own....
That got his own....'
Interesting message in that rather old jazz "hymnal."
Well, I took those as a humorous response to the "My Kid is an Honor Student" business, which deserved to be lampooned, kind of like putting, "Star Fleet Academy" or, "School of Hard Knocks" stickers on your rear window.
Continuing the Helicopter analogy...
I don't think Ben has the skill to try AutoRotating.
As you know AG, Ya only get one chance at AutoRotaing...
JC
AutoRotation reminded me of the Jesus nut (the big one on top that only Jesus can put back on) and then I saw your initials and it all went "click"...
The globalist helicopter might just meet Mr Grail.
:-)
Hello Don,
I would say Bernanke has already been round in his helicopter, but he dropped free debt instead of free money, and the consequences of that will (IMO) become apparent this year.
The Fed has acted as midwife to a credit expansion (by holding the cost of credit artificially low), but a credit expansion (as opposed to a currency inflation) can only continue until the debt which created it can no longer be serviced. I would argue that we are at or near that point now.
I don't doubt that the Fed will cut short term rates as well as attempt some sort of bailout. What I do doubt is that they can succeed for long in preventing the money supply from contracting, let alone increasing it, in the face of risk aversion spreading like wildfire. Financial panic can remove liquidity faster than the Fed can pump it in, as we've seen in recent weeks. The Fed's normal game plan depends on incentivizing ready, willing and able borrowers and lenders. If risk aversion or debt serviceability curtail either the willingness or the ability to borrow and lend, then this strategy becomes impotent.
In addition, the Fed can only cut short term rates to zero. As the Japanese discovered, zero is not low enough when the money supply is contracting (ie deflation, following von Mises and the Austrian school), because real interest rates (nominal rates minus negative inflation) can remain punishingly high. Also, under such circumstances longer term rates may remain stubbornly high despite cuts in short term rates, as a reflection of risk aversion. A high rate in nominal terms would be very high in real terms under such circumstances.
I realize that the Fed has other magic wands, but I think they'll do too little too late. Ultimately I don't see them being able to overcome the power of a financial panic (not that we're there yet, and I don't expect us to be until probably the fall). By way of analogy, what the Fed will try to do is to cure a hangover by having a few more drinks - eventually the patient dies of alcohol poisoning. Hence the thought that you can't solve a problem by doing more of what created it in the first place.
Stoneleigh - I agree with you about the interest rate bottom; Japan actually went negative for a while.?? What didn't happen was a contraction of the money supply. It was a contraction of velocity, that irascible bugbear of central bankers.
Offering money at negative rates doesn't assure that borrowers will show up to take it if they think that assets will depreciate faster than the negativity. What if they gave a party and nobody came?
It's hard to develop a hundred thousand dollars worth of action out of a forty thousand dollar wage. Inflation of the money supply without corresponding wage inflation won't turn around a mass consumer economy such as the US. The housing bubble is exhibit A of wage/asset debt disconnect.
There may not be an answer. There wasn't in Japan. For those solutionocopians out there, my sympathies, but this is looking like a classic paradigm shift right about when I would have expected it. Such things have a life of their own to lead. And they never play out quite the same way as the last.
Petro: You make good points, but the Japan example is misleading. Japan has always had a strong current account surplus which has provided strength to the Yen even with very low interest rates. The USA is actually in a situation similar to that faced by Argentina, not Japan. Japan was able to have a deep recession combined with a strong currency- it is very unlikely the USA can do the same. The structural weakness of the dollar makes deflation less likely to persist if it can occur.
Argentina borrowed in dollars, not in local currency. Poor economic management (a delusion by Menem for short-term illusory prosperity) and this mismatch of income to liabilities resulted in the breakdown.
US has the luxury (so far) of borrowing in a currency which can be debased at its own choice---though with consequences.
As it turns out---Argentina has been growing and doing well economically for the last few years after normalizing to true market values. Export of agriculture is strong.
But now, populist and foolish intervention for populist reasons is resulting in another external "debt" crisis, for fossil fuels.
I know. I was hoping that the conundrum of reserve currency/ largest debtor wouldn't cloud the issue. In all probability, the days of US reserve currency hegemony are already over and only the process of how we move to a multiple reserve system is yet to play out. I was hoping for an orderly and managed transition, but the majority of our leaders seem willing to go down with the ship.
Between the Euro and the rise of China, the writing on the wall is now almost fading from age. John K Galbraith refers to the period of the first World War as the 'great ungluing'. It was in 'The Age of Uncertainty', a very fine read. The scene seems set for another such age.
Japan never really dealt with it's bad debt problem and so hasn't been through what's facing the US now, despite nearly two decades of difficulties during which it burned through a huge surplus building things like 4-lane highways to nowhere in a vain attempt to stimulate the economy. I would argue that their problems are far from over though, and that the impact on their money supply (as opposed to problems with the velocity of money) lies largely in their future. They have yet to face the unwinding of the yen carry trade for instance, and the dislocation that will inevitably bring.
Japan never really dealt with it's bad debt problem
As 'we' like looking at everything from energy - how much of the trouble could be from rising energy costs? Has anyone done an analysis?
You can prevent a hangover indefinitely by taking more and then even more drinks: I think that is what the Fed will do. We are addicted to cheap and readily available credit; the Fed dare not take away the punchbowl now that some at the party are getting anxious.
I assume you are familiar with the term "liquidity trap," where lenders refuse to lend or borrowers refuse to borrow. This is the famous case of "pushing on a string" with monetary policy impotent. Although a liquidity trap seems to be what is in your forecast, I consider the possibility of our stumbling into one as remote. Why?
Because Americans are used to borrowing and lending--and then to borrowing ever more. I do not think financial organizations will suddenly refuse to lend out of fear, because I think they will retain confidence that the Fed can and will prevent financial collapse. It is all about confidence and expectations: If fear and panic take over, then we could indeed get stuck in a liquidity trap and have the Mother of all credit crunches (with the Great Depression being the Grandmother).
So I will try to spin a story of financial collapse:
1. The Dow Jones Industrial Average crashes down through five thousand, then falls to three thousand and even one thousand in a matter of weeks this coming October.
2. Brokerage houses and investment banks fail AS THE FED STANDS BY, PARALYZED BY FEAR AND INDECISION because the dollar is in free fall in the international financial markets.
3. By the millions, American home owners give up on the American dream of home ownership and let their homes go into foreclosure without a fight because
4. Massive cyclical and structural unemployment have thrown twenty million Americans out of work.
Now theoretically this could all happen. But the key premise, which I've screamed out in capital letters is that the Fed stands by and twiddles its thumbs. By creating liquidity the Fed can permit debt expansion. Expansion of debt and credit necessarily expands the money supply. Expansion of the money supply is inflationary, not deflationary.
Over the next dozen years I'm betting on worsening inflation, at least to double digit levels and possibly far beyond that level. As the price of oil rises the Fed will have a choice to either
1. Restrain the growth of credit and money so as to restrict inflation or
2. Expand the growth of credit and money so as to avert deflation and depression.
Helicopter Ben is not going to fight inflation at the risk of triggering another Great Depression. (By the way, the case of Japan twenty years ago was very different from the current situation faced by the U.S. Also note that Japan has had a controlled and gradual deflation that has not stopped its long-term economic growth, though it did slow it down a great deal.)
"I do not think financial organizations will suddenly refuse to lend out of fear..."
What makes you think it isn't already happening?
http://www.chron.com/disp/story.mpl/front/5032292.html
"I do not think financial organizations will suddenly refuse to lend out of fear..."
Another example:
Mortgage problems hit Houston market
http://www.chron.com/disp/story.mpl/business/5032292.html
Triumvirate of collapse - Economy, Ecosystem,
Just came across this one at the RoundUp
http://www.iht.com/articles/2007/08/05/bloomberg/bxmortgage.php
Now theoretically this could all happen. But the key premise, which I've screamed out in capital letters is that the Fed stands by and twiddles its thumbs. By creating liquidity the Fed can permit debt expansion. Expansion of debt and credit necessarily expands the money supply. Expansion of the money supply is inflationary, not deflationary.
Unstated in this is conversion of the debt/credit into consumer spending. The bull market from 1982, culminating with the stock market bubble of the late 1990s, was converted to consumer spending because the resulting "wealth effect" from capital gains in the 401(k)s convinced Americans they did not need to save. Cheap credit blew a real-estate bubble that appears to be deflating now and was converted to consumer spending through equity withdrawals (see, eg, Calculated Risk's charts on GDP with and without mortgage equity withdrawals). While the increased spending was the result of cheap credit, the consumers didn't see it as taking on increased debt -- in both cases, the households saw their net worth increasing.
The Fed can set the stage for cheap credit, but they have little control on where it will flow, and whether or not it will end up as consumer spending. How does the Fed get it into the hands of the consumers without having it show up as explicit debt in their household budget?
I am assuming that if you give the American consumer a chance to spend more, then he or she will do so. By pumping more cheap credit into the system, I think the Fed can keep the real economy perking along; in other words I do not see much of an increase in unemployment during the next twelve months.
To make U.S. consumers afraid to borrow and to spend, you just about have to have a significant increase in unemployment rates. In other words, if real economic growth goes negative, then the elements for a vicious circle of fear and panic and debt deflation and declining real GDP becomes possible. But the real rate of growth in GDP is positive--maybe a bit slower than a year ago, but still well into positive territory. And this positive economic growth is happening despite a rotten real estate market and weak sales for new vehicles--which I find truly remarkable.
I do not assert that Depression and deflation are impossible, only that--given the data we now have--they are extremely unlikely.
On the other hand, a severe stagflation such as we had in the late 1970s and early 1980s is entirely possible and is, in my opinion, rather likely as a response to Peak Oil. Thus I can see zero real economic growth along with double digit inflation and the prime rate back up around twenty percent. We've been there before, we can go there again.
But in my opinion, the conditions that gave rise to the Great Depression simply do not exist any more, and while Peak Oil will (I think) choke off real economic growth, the nominal GDP and the money supply can both go on increasing for years to come. True, stagflation could theoretically mutate into depression, but I think it is much likelier to mutate into increasing rates of inflation.
Debt is a monster. We can kill the monster with major and abrupt and unexpected increases in the rate of inflation. The Fed knows that. When push comes to shove, I think they will kill the debt monster and capitulate on the fight against inflation. Indeed, Ben Bernanke has said as much in his infamous "helicopter" reference: There will be no deflation on his watch.
A real world observation...
A major bank, of which I have a credit card, has been offering me 0% loans for 5 months, or 4.99% for the life of the loan. ($200 processing fee)
Yesterday, I got an offer in the mail lowering that to 3.99%. for the life of the loan.
I'm not sure why the rate dropped 1% when credit markets are supposedly tightening...
Garth
Garth:
My CC gives me those same offers. They have a nasty hook in them. Read the fine print.
What they do is charge exhorbitant rates for ordinary balances. They will set up a special teaser rate for that one "loan".
Any subsquent charges against the card ( purchases, accrued finance charges, etc. ) will incur the exhorbitant rate, and you will NOT be able to pay it off until you have first completely paid off your teaser loan, as they will credit any payments you send them against the freebie teaser first.
While you are enjoying your "cheap" loan, they are enjoying charging you exhorbitant fees for the "ordinary" part of the CC balance which there is no way for you to pay down until you have your teaser account repaid.
Its a baited cat trap. My advice is to shred those offers.
Steve
garth,
part of what hardhat says is true and part is not. i have bought houses using these types of loans(and i wont bore you with the details). yes by all means keep your credit card purchases separate from these "loans". and as long as you perform as you agree, they really will be at 3.99 or 4.99 for the life of the loan. ask a lot of questions before you borrow any money from them i.e what is the minimum payment ? assuming you deposit the "checks" in your bank, find out when the money will actually be available (typically 11 business days, i think)
currently i have a total of 4 cards, one of which i use for ordinary purchases, which i pay off each month. i hope to get them all paid off by year end.
one problem with these loans is that they are considered revolving credit, and in short the only revolving credit that will do your credit score any good is the ones you have already paid off.
I think you are essentially on target with your prediction of a return of 1970s-style stagflation. However, what is happening with price levels and currency exchange rates and financial markets will mask a more profound underlying trend: As the real price of energy in all forms (and along with them energy-intensive or energy-linked essentials like food) continue to rise inexorably, the real prices of everything else (including wages) must also inexorably fall. The GDP pie can only be sliced so many ways, and a bigger slice for energy leaves smaller slices for everything else.
Thus, while it won't technically be anything like the Great Depression, when you focus on what is really happening with all those non-energy pie slices, the practical effect as far as the daily lives of most people is concerned will be declining wages and declining living standards -- pretty similar to what folks experienced during the Great Depression. This time around, people are going to feel increasingly poor as the government and the media and their bank statements are all telling them how supposedly rich they are.
I agree with stagflation at least at first(likely now). Thinking of all the retirements and such that can be paid with worthless $ makes sense in the long haul.
What so many people miss is that the fed cannot lower rates, not this time. Most of our debt is bought by foreign investors, they won't pay for negative returns, to save our addicted US gov/lifestyle.
Helicopter Ben be damned he is stuck like a rat in a trap.
Don,on another board,I heard it said that "mr Helcopter" had already started dropping....Look at the 8-9 billion that "disappered"in Iraq...easy way to get some inflation without it showing up in statistics....
It is indeed a liquidity trap that I am expecting.
I think they are already refusing to lend out of fear, although I would say we are at the very beginning of the process at the moment. Banks may not be able to sell LBO debt to investors easily, but some deals are still happening with the banks holding the debt themselves. People can generally get mortgages even though the liars loans have mostly dried up, and they can still max out credit cards or get car loans etc. Further down the line, I wouldn't expect any of these things to still be happening. I think loans will be called in in the mother of all margin calls, and that credit will only be available to those who don't really need it, as has traditionally been the case. Fear and risk aversion can spread with lightning speed - Cramer is a case in point if you contrast his rants from three weeks ago with the most recent one.
I agree completely that it's all about confidence and expectation. The difference is that I am fully expecting fear and panic to take over while you are not. I doubt if we'll have all that long to wait to see which way things develop. By the way, I think this depression will be worse than the last one because the scale of the excesses leading up to it is significantly greater.
I don't think the dollar would be in free fall. As I said below (I think) to vtfarmer, I think the dollar will benefit from a flight to quality in the international debt markets as credit spreads widen. I also think it would be in great demand domestically as people try to sell all manner of assets in order to cash out or meet margin calls. I think the Fed will fail to act quickly enough because it will underestimate the speed with which fear is spreading and sucking liquidity out of the market. Arguably it is doing that already.
I think loans will be called in and unemployment will skyrocket. I can indeed see many giving up their homes without a fight. Fighting takes resources, and I'm expecting those to be in short supply.
I don't think the Fed will be able to create liquidity because fear can remove liquidity faster than the Fed can create it, especially when willing borrowers and lenders are hard to find (ie the liquidity trap). I think we're looking at huge debt defaults, which would be magnified by the enormous degree of leverage involved. Leverage can carry you a long way up, but it kills you very quickly on the way down. My guess is that the money supply will implode.
>I don't think the Fed will be able to create liquidity because fear can remove liquidity faster than the Fed can create it,
Bailout is likely to happen from Congress not the fed. A bailout from Congress would imply that the US gov't is guarenting loans which removes the fear factor from the equation. My guess is that we will see some a bailout from Congress soon. How much is initially bailed out is likely to shape the money supply (inflation or deflation). I think if we see a bailout of at least $250 billion we slide into inflation. Below that we'll probably have deflation. Although this a just a guestimate.
Wonder if I'll regret not putting 50 bucks down on a McMansion. If the government eventually pays them all off, it'd be useful to have a spare place for storage.