Why Can't We All Just Keep Pretending? 09-02-09- revised 09-03-09 re-revised 09-06-09 mpg Deficits Will Matter - When?? - mpg A quote...."The defenders of supply-side economics have regaled conservatives with this slogan, "deficits don't matter," from the late 1970's until today. As far as I can determine, this was the only idea to come out of the supply-side movement that was ever agreed to by the mainstream Keynesians and Chicago School economists. They all agree: Federal deficits don't matter. Someday, yes, but not yet. Not now. Don't worry. Be happy." Gary North in the middle of his article makes the point that Federal Government borrowing "crowds out" private capital, capital which could be used more productively elsewhere in the economy. Certainly if it were a zero sum game and "capital" was limited to a fixed amount or tied to underlying collateral (real, material, assets) that would be true. But that of course is not the case, “capital” is no longer limited to a fixed amount nor has it been for quite some time. We’ve had from six hundred trillion to 1.3 quadrillion dollars worth of derivative contracts created out of thin air by the private sector in the last ten years and a completely stark raving mad Federal Reserve trying to plug up all the holes this financial crap has left in the banks' balance sheets by the Fed's own creation (so far) of almost twenty four trillion dollars worth of back-stops, guarantees and actual payouts to these financial institutions. The gold bugs and conservative economists out there have been running around for years stating these sorts of policies are going to create inflation....but they haven't, not yet anyway. According to theory, and Mr. North, if the Fed unwinds these loans and guarantees even a little bit it will cause a massive recession, and we’re already in a bad one right now. If the Fed forgives these loans or lets the banks just keep them, in other words “monetizes” the debt it will supposedly create massive amounts of inflation. But why can’t the Fed just keep loaning out more money? What’s to stop them? Obviously the dollar could suffer a severe fall (we'll assume the Fed could, and would, prop up the US-NRE's bonds by buying them continuously), but every time in the last eighteen months the US-NRE's economy started to go down hill, the US-NRE's dollar went UP, indicating foreigners, for some strange reason, like to rush toward a financial implosion rather than away from it (what some people call "safe haven buying", hah!) or perhaps the Fed's been using the derivatives market for some hanky panky regarding the dollar. Someone, somewhere, perhaps Mr. North one day, is going to have to come up with a definitive mathematical formula as to EXACTLY how far this policy can go. Michael Milken tried it, quite successfully for almost ten years with his junk bond scheme; the Fed is trying to do it with the US-NRE’s junk bonds and their own printing presses. A much bigger, more impressive, much more expensive example one might say. But why can’t the Fed just keep doing it, just keep loaning out more money to the “to big to fail” banks and other "friends of the Fed", keep rolling over all those loans at zero percent interest rates and keep backstopping everything in sight? What's wrong with constantly higher and higher PE's in the market, as appears to be occurring? Soon perhaps one day we'll all hear a lament from some market participant that it's been a terrible month for the market, which will be selling at an all time low of a P/E ratio of two hundred, three hundred, or even five hundred to one. What’s wrong with another twenty four trillion dollars in loans, backstops and guarantees, or two hundred and forty trillion, or ten thousand trillion? They're just loans, isn't that right? If the financial titans of Wall Street can keep creating holes why can't the Fed just keep filling them up with more loans? (Also known as "moral hazard.) Why can't we all keep pretending that the banks are solvent as we’ve been doing for the last eighteen months and never ask them for the loans back any time soon, like in the next hundred years? Theoretically, what’s to stop the Fed from carrying out a policy like that? Or prevent the US-NRE from continuing its policy of using military power, here and abroad, to force people to use these worthless financial instruments. After some consideration this website editor has come to the conclusion that there are three factors which will stop the Fed, and all those who use the Fed as their personal piggy bank, from continuing this policy of unlimited debt and its subsequent credit/currency expansion The first factor is the immutable law of "reversion to the mean", also know as the Market, and despite all the hidden manipulation and obfuscation by the Fed and the titans of Wall Street, the Market is still there, like an enraged, hungry, genie, waiting to exact its revenge for being bottled up for so very long. The second factor is fear, specifically the "prisoner's dilemma", or more accurately the observation that "there is no honor among thieves". At some point one or more of the larger and more corrupt, criminal institutions on Wall Street will determine it's to their advantage to get out with their ill gotten gains before the other guy does, and that decision will set off another tsunami of financial destruction. And the third factor is the increasing amounts of debt per capita being created on the downswings and currency/credit (from canceling debts) per capita being created on the upswings during each "ten year cycle" (Which by the way is an approximate and artificial number of years probably established by our elites to time their collective activities. Although it has some fundamental support in that one study has shown the positive effects of wartime currency/debt expansion usually peeks after about five years - PDF.). These swings are leading to well known and increasing systemic instabilities or booms and busts which will destroy the system. It is unlikely that the Fed will get away with this ten year cycle despite all the rosy announcements from the financial talking heads. The massive amounts of debt the Fed is creating through its own efforts, along with its attempts to create a world lending institution through the IMF to pump more of this "liquidity" into the entire international system is probably not sufficient. Even if is, the subsequent wars and/or credit/currency explosion necessary to get out of the bust will be unmanageable and will lead to another subsequent crash. - mpg |