Does Debt Matter?
Readers suggested a topic on debt. “The basic concept held by a large faction in government is that debt simply does not matter. People accept the currency as having value. If the Fed could finance all of the government debt and there is no sign of the markets becoming roiled, it’s all good. There’s no consequence.”
“We hear however, from nearly all quarters, that the ‘path we are on is unsustainable.’ This relative to the previous concept that ‘debt doesn’t matter’ sounds like lip service to assuage the masses. So - for an entity that can print money, does debt matter? The government and Fed are not like a company, a family or a state. The Fed/Gov can print money which makes it a unique economic entity.”
A reply, “The national debt may not matter. Personal debt seems to matter a lot unless you are in a favored class whose personal debt gets moved to the national debt.”
The Daily Ticker. “Just hours after the Commerce Department reported the first decline in quarterly GDP in 3-1/2 years, the Federal Reserve announced it was maintaining its policy of near-zero interest rates and $85 billion worth of long-term Treasury and mortgage-backed purchases per month. The Fed said recent economic information suggests that ‘growth in economic activity paused in recent months’ due to ‘weather-related disruptions and other transitory factors’ but household and business spending had grown and housing continued to improve. ‘Employment also expanded but ‘unemployment remains elevated,’ the Fed said.”
“Michael Pento, president of Pento Portfolio Strategies, tells The Daily Ticker that the Fed’s easing policy ‘is wrong.’ He says, ‘It would be much better to rip the Band-Aid off…allow a cathartic depression to engulf the United States for about a year…and we will emerge on the other side of that clean, with a strong currency and a sound balance sheet.’ But instead, Pento expects the Fed ‘will continue to monetize debt and may even increase it.’”
“The danger in this policy, says Pento, is that it is enabling ‘the federal government to run trillion-dollar-plus deficits — about 7 percent of GDP per annum…robbing the middle class of their purchasing power…creating bubble after bubble.’ He says the bubble will eventually burst because the Fed will stop buying securities or the market will push up interest rates or inflation will increase.”
“In the meantime, he advises investors not to fight the Fed.”
The Epoch Times. “To understand why the two drivers of growth are not working anymore, one needs to go back to the original economic road chosen to find that the problem lies in unfair income distribution. This unfair income distribution originates from manipulating real interest rates. ”
“High growth in exports was achieved by mercantilist trade policies and the undervaluation of the Chinese Renmimbi (RMB). High investment on the other hand was a direct result of extremely low real interest rates. Between 2003 and 2011, the average real interest rate on loans was about zero. This means whoever got loans from banks got money for free.”
“As a consequence, governments, large corporations, and state-owned enterprises accumulated lots of wealth in the process. Returns on capital investment were high in the past decades. In particular, as housing prices have increased over ten percent for several years, land developers and real estate companies made a huge fortune.”
“Many of the richest Chinese are associated with real estate. Local governments also increased their revenues by selling land. Revenues from land sales have increased to account for 30-50 percent of local fiscal revenues. Local governments rejoice seeing housing prices go up because it enables them to sell land at a higher price.”
“In the past decade China’s housing prices have more than doubled, widening the income gap. The rich increased their wealth through soaring housing prices, because many of them can afford to own several pieces of real estate. According to the Survey Report on China’s Family Financial Situation, the top ten percentile income group owns 85 percent of China’s household assets. The poor, on the other hand, have to put up all their savings to buy their first house and are heavily burdened by the mortgages. They become what they call ‘house slaves,’ having to spend most of their income on mortgages.”
“As house prices keep rising, people in need of housing use up all of their lifetime savings to purchase a home. Many end up with large mortgages so that most of their monthly income has to be used to pay mortgages, leaving little left for consumption of real goods. Therefore, as long as the housing bubble grows, consumption by the mass—’house slaves’ and ‘house slaves to be’—which need real disposable income growth, will only decline.”
The Oye! Times. “At present, in Toronto everywhere you go in the city, you will find a construction site, building a condo. If you drive into the city on the expressway, you will notice a wall of condos going up. It is that obvious. It is not just one, or two, going up, it is more then the entire amount of condos in the state of New York. They are expected to remain empty and house no one. Canada’s population is 35 million strong, strongly concentrated in Toronto, Montreal, Calgary, and Vancouver. We do not have a land shortage. Everything is too spread out for that. The condos that are going up are investment property. The Canada mortgage and housing corporation (CMHC) was created as a guide book for the real estate market. In reality, it represents the real estate investors, not renters, home owner, or potential first time home buyers.”
“Developers finance political campaigns. The media only reflect the opinions that come from real estate agents and the companies that they work for. They all say the real estate market is hot in Canada, not in a bubble which it has been since the 1980’s. If you did not get the memo, the real estate market in Canada is over inflated. I, like many others who live here, fully expect to see a Japanization of the Canadian housing market. What is that? Japanization was a real estate crash that happened in the 90’s in Japan, which led to home values in Japan to return to 1983 price levels. Ouch!”
“The rich in Canada need to learn such a lesson. They have no sense of social responsibility, only greed, arrogance, and stupidity. They are not even the right calibre of individual to exercise such power that would decide the fate of nations, let alone the lives of their own citizens. They just look at the balance book. If it is not in their backyard, why should they care? That is their mentality.”
From the Epoch Times editorial:
‘Overcapacity is pervasive in most of China’s industrial sectors according to statistics released by the Ministry of Industry and Information Technology. For example, China has a production capacity for crude steel of 900 million tons, up about 300 million tons from 2008. According to the Committee of Development and Reform, the steel sector has an overcapacity of 160 million tons.’
‘Overcapacity frequently leads to selling products below cost to generate revenue to service fixed costs. For the first seven months of 2012, 33.8 percent of the steel sector operated at a loss. If one excludes investment income from other sources such as property, the entire sector is losing money.’
‘Even though steel companies know that they cannot sell their steel products, they are still producing at almost full capacity. A reduction of steel production will lower GDP growth rates—an indication of administrative failure. As a consequence, none of the local governments want to see steel production reduced.’
‘China’s solar sector has perhaps the worst overcapacity. Andrew McKillop writes in his report China and the Global Economic Crisis of Overcapacity: “Massive subsidies and state intervention have driven China’s overcapacity in solar power panels and systems to more than 20 times total Chinese national market demand for these panels, and close to two times the total of world demand.”
‘Overcapacity is a serious issue in China’s manufacturing, mining, aluminum, iron ore, cement, and other industries. Continued investment will only create more problems, waste resources, and do nothing good to balance the economy. Investment in productive capacity can only grow at lower rates than before and won’t be able to meaningfully contribute to GDP growth.’
‘Investment in the real estate sector has also grown at breakneck speed in the past years. It accounted for 13 percent of China’s GDP in 2011, pushing up associated sectors as well. During the housing bubble years, it has made a significant contribution towards China’s high GDP statistics, creating ghost towns such as Erdos in the process. However, the coexistence of soaring housing costs and high vacancy rates indicates that China’s housing bubble is ready to pop. With a price-to-income ratio at 30-to-1, the vast majority of Chinese cannot afford purchasing a home. Vacancy rates of about 30 percent demonstrate a huge mismatch between supply and demand.’
‘As demand for housing dwindled, many land developers have already left the sector. This exodus will lead to a reduction of investment, create unemployment, and also reduce demand for steel, aluminum, and other materials, which in turn will affect different sectors of the Chinese economy. Local governments will also be affected. During the past decade, easy and vast amounts of revenue from land sales have supported larger and larger local governments. Now, shrinking real estate demand directly affects local governments’ cash flow. Some may even become insolvent. Recently more and more local governments have found themselves in financial difficulties.’
‘Throughout the past decades, the RMB undervaluation has made China’s exports cheaper. While this has helped push up export volume, China’s natural resources were priced too cheaply and used up too rapidly, also creating environmental problems. Through low interest rates capital has been freely and unfairly transferred from depositors to corporations and governments, depriving ordinary Chinese people of such resources.’
‘China’s solar sector has perhaps the worst overcapacity. Andrew McKillop writes in his report China and the Global Economic Crisis of Overcapacity: “Massive subsidies and state intervention have driven China’s overcapacity in solar power panels and systems to more than 20 times total Chinese national market demand for these panels, and close to two times the total of world demand.”
Twice the total of world demand? Holy moley! There’s no way anyone else can survive in that market. The question is, is this being done on purpose to put non Chinese panel makers out of business?
On the plus side, it sounds like there might be some really good deals on solar panels in the near future.
Minor update to this story: China has contracted for 75% of the total domestic solar production in just the last few weeks, some of it due to the bad PR they got from having some of the world’s worst smog. I think the number was the equivalent of about 3 nuclear power plants in the next 12 months. One has to wonder if a country who is notorious for their ‘5 year plans’ of top down economic policy really did miscalculate their solar production capacity and when they needed it to be online to meet environmental demands? Anybody with a brain could see the China smog problem coming ten years ago by just looking at their raw fossil fuel consumption numbers.
“Overcapacity frequently leads to selling products below cost to generate revenue to service fixed costs.”
And this will work until it doesn’t anymore. And if these “fixed costs” happen to be debts then when the doesn’t work anymore phase kicks in the debts will go unpaid. And when a debt goes unpaid then whoever is on the wrong end of this debt - whoever is supposed to get paid - doesn’t.
What the Great Expansion doeth giveth, the Great Contraction doeth taketh back.
There’s another part of the Epoch Times piece linked on that page. It’s very interesting the situation China is in, and it’s relevant to the debt question. It seems the problems aren’t so much the debt itself, but the distortions created by the spending/debt. We don’t even know where we are anymore; I read this guy the other day say “the Fed owns 40% of the yield curve.”
I read this guy the other day say “the Fed owns 40% of the yield curve.”
What, short of runaway inflation, would prevent them from owning it all?
Other countries’ willingness to buy U.S. debt or to accept U.S. currency as payment.
Other countries’ willingness to buy U.S. debt or to accept U.S. currency as payment.
That would lead to rapid devaluation, wouldn’t it?
And isn’t rapid devaluation just another name for runaway inflation?
Other countries’ willingness to buy U.S. debt or to accept U.S. currency as payment.
But if they do that, who will but their crap?
“But if they do that, who will but their crap?”
And there is the reason that concerns about other countries refusing to buy U.S. debt or accept U.S. currency as payment are overblown.
And besides, I hear that you can repatriate U.S. currency to make all-cash real estate investments.
There is overcapacity in commodities, houses, you name it, yet prices remain suspended at nosebleed levels. At some point in time, they have to crash.
Why do you assume government intervention to ’stabilize’ prices couldn’t continue indefinitely?
Because I read somewhere that “something that cannot go on forever, won’t.”
“something that cannot go on forever, won’t.”
What is it about ‘price stabilization’ that would prevent it from going on forever?
Valid point.. I think there is an element of willful ignorance on the part of the markets to allow for the central bank manipulation as a means of its own survival.. I believe this willful ignorance will eventually run into a brick wall when the printing of so much new money to keep it all afloat looks like a real ponzi scheme to the masses and everyone starts to hoard gold.. then the gig is up.. don’t know when that will be, but it won’t be forever. I’m fairly certain of that..
“…and everyone starts to hoard gold…”
There will never be a point when ‘everyone starts to hoard gold,’ thanks to people like myself who have no interest.
However, the gold hoarding strategy is already a very popular and time-tested one, so it is not like there is going to be some ‘aha’ moment when ‘everyone’ suddenly loads up on the Precious™.
Rather, there is a supply-and-demand equilibrium for gold, just like for any other precious metal or commodity. Gold hoarding considerations can increase the demand and the price, but there just isn’t enough of the stuff in existence for ‘everyone’ to own some, especially when central banks with fiat money printing presses are in the competition to own it.
I further submit there are some signs the urge to hoard gold has already had its run for the present episode in financial history.
World gold demand slid in 2012 as Indians bought less
Gold buying in India fell 36% in the first half of 2012, the World Gold Council said
First Published: Thu, Feb 14 2013. 03 27 PM IST
Central banks and institutional investors stepped up their purchases of the precious metal last year but it wasn’t enough to offset the decline, according to the World Gold Council. Photo: Reuters
Updated: Fri, Feb 15 2013. 12 44 AM IST
Hong Kong: An industry groups says global gold demand slipped last year on reduced buying in India, the world’s biggest market.
Central banks and institutional investors stepped up their purchases of the precious metal last year but it wasn’t enough to offset the decline, according to the World Gold Council.
The council said Thursday that 4,405.5 metric tonnes were sold in 2012. That’s down 176.8 metric tonnes, or 4%, from 4,582.3 metric tonnes in 2011.
However, the value of gold sold last year rose to an all-time high of $236.4 billion. That’s mainly because of the rising price for the yellow metal, which rose 6% to an average of $1,669 per ounce. The council said gold buying in India fell 36% in the first half of 2012.
Just after my post above, I experienced a personal “shoeshine boy moment” for gold, when my 12-year-old son asked me, without prompting, whether I would rather own gold coins or gold bars.
I explained to him that gold coins are better, as gold bars, like houses, are lumpy assets, and hence illiquid if you need to sell a little to raise cash.
everyone starts to hoard gold.. then the gig is up.. don’t know when that will be, but it won’t be forever.
They’ve successfully devalued the dollar for 99yrs now, without having people give up on it and start hoarding gold…
If people are that complacent, why wouldn’t it work for another 100yrs?
“If people are that complacent, why wouldn’t it work for another 100yrs?”
The possible problem I see is that so very many financially unsophisticated people are acutely aware of what a brilliant idea it is to buy gold as an inflation hedge — even my 12-year-old son is onto it.
The other problem is that many seem to believe central banks are creating inflationary pressures that will lead to a gold price blowout. To the contrary, all the evidence I can find suggests they are buying gold at record levels to support the price, in order to prevent a collapse.
How this plays out is beyond my ability to predict, but with so many people investing on misguided beliefs, I suspect many who go long will eventually get burned.
Overcapacity is a natural consequence of command-and-control economic governance.
For another example, look around at all the vacant homes in the U.S., which represent overcapacity in the residential real estate sector relative to demand at current price levels, which are in turn determined by command-and-control housing policy.
Dear gawd
100% agree
‘Even though steel companies know that they cannot sell their steel products, they are still producing at almost full capacity. A reduction of steel production will lower GDP growth rates—an indication of administrative failure. As a consequence, none of the local governments want to see steel production reduced.’
Is this any different than the rationale for hair-of-the-dog housing connstruction stimulus in the U.S. to mask a collapsed housing bubble?
I think our military prowess and the world’s appetite for the dollar are directly related. If you will not accept the dollar in exchange for your oil…we can just take your oil. We are the empire…debt doesn’t matter until it does.
Interesting concept. They pretend to value our dollars and we pretend we would never just take what we wanted if they refused to trade it for dollars.
‘we can just take your oil’
Yeah. Remember the 17 miles from the Baghdad airport to the “Green Zone”? The US military couldn’t even control that.
EXACTLY, which meant you had to rely on a U.S military HELICOPTER.
Well that is the idea. The dollar is worthless in the absence of the end of a gun.
Did you guys not know that or was it just skimmed over by me or you?
That’s because they wont’ fight WWII style and just level any city containing resistance.
‘That’s because they wont’ fight WWII style and just level any city containing resistance.’
Or nuke them, right Kurtz?
http://darkpassenger.tumblr.com/post/1622180276/batchiara-marlon-brando-in-apocalypse-now-via
Sherman proved it works.
Hyperinflation strikes when it becomes cheaper and easier to do your business in another medium of exchange, another currency. Eventually demand for your currency drops to very low or nonexistent levels.
On the one hand, you have Zimbabwe:
http://en.wikipedia.org/wiki/Hyperinflation_in_Zimbabwe
On the other hand, you have Japan:
http://business.time.com/2012/12/17/will-japans-new-prime-minister-start-a-debt-crisis/ - “In almost any other country, I’d say a debt crisis. Yet Japan is fortunate enough to have such a giant pool of savings that its government doesn’t have to rely on foreign money to finance its deficits”.
But what about just having the Bank of Japan finance the entire debt of the Japanese government?
“The Fed has the ability to create as much money as it wants and can use that money to purchase every scrap of federal-government debt, every scrap of outstanding mortgage-backed securities backed by federal housing agencies, and as much foreign exchange as other governments will sell it.” - http://www.economist.com/blogs/freeexchange/2012/07/monetary-policy
Krugman said something interesting - that the rules for the economy are different in good times versus bad times - “The rules that apply when you’re at full employment do not apply in a depression, which we’re in now.” - http://www.bloomberg.com/video/krugman-there-is-no-debt-crisis-create-jobs-now-oECUTLYtS4yu9r~k_gfv1Q.html
There are a lot of moving parts in the economy. Eventually, the rules will start to transition back. What then? With all the government-directed malinvestment, what then? If the government has to slam on the brakes to reign in inflation, like in the early 80s, and spark a recession, what’s the point? We’ll just be back in the state where we started.
Keynes said in the long run, we’re all dead. Krugman echoed the sentiment, said we have to do what works now and, essentially, “Damn the future, full speed ahead.”
People always look at the example of World War II. The rest of the world in ruins, the US reaching the peak of empire, and we hardly paid off an iota of government debt, yet it shrank to “manageable” levels due to growth. Of course, this begs the question that there needs to be a “manageable” level of debt, if the Fed buys it all.
Re: the Krugman quote - ““The rules that apply when you’re at full employment do not apply in a depression, which we’re in now” - what other system is like this?
The body, I suppose. One doesn’t apply treatment for hypothermia when one has a fever. Or vice versa.
“With all the government-directed malinvestment, what then? If the government has to slam on the brakes to reign in inflation, like in the early 80s, and spark a recession, what’s the point? We’ll just be back in the state where we started.”
Not everybody will be back to the state where we started.
Lots of Wall Street investment banks and hedge funds will make a great living by studying the policy machinations and exploiting them to full advantage.
We’ll just be back in the state where we started
What if the current debt is paid off with the inflated dollars, prior to the slamming-on of the brakes?
I suppose that would be the plan, no?
The rest of the world in ruins
Which means they weren’t very good customers for our goods and services, since they had no money.
“So - for an entity that can print money, does debt matter? The government and Fed are not like a company, a family or a state. The Fed/Gov can print money which makes it a unique economic entity.”
Does the answer perhaps depend on reserve currency status?
And on the currency exchange rate regime in force, including international agreements which determine the policy stances of other central banks in the global financial system?
Group of 20 Vows to Let Markets Set Currency Values
By DAVID HERSZENHORN
Published: February 16, 2013
MOSCOW — In a concerted move to quiet fears of a so-called currency war, finance officials from the world’s largest industrial and emerging economies expressed their commitment on Saturday to “market-determined exchange rate systems and exchange rate flexibility.”
In a statement issued at the conclusion of a conference here of the Group of 20, the finance ministers from the Group of 20 promised: “We will refrain from competitive devaluation. We will not target our exchange rates for competitive purposes.”
In its statement, the group also vowed to “take necessary collective actions” to discourage corporate tax evasion, particularly by preventing companies from shifting profits to avoid tax obligations. For instance, a number of big American companies, including Apple and Starbucks, have come under scrutiny recently for seeking out the friendliest tax jurisdictions.
Over all, the statement largely echoed one last week by seven top industrial nations pledging to let market exchange rates determine the value of their currencies. Currency devaluation can be used to gain competitive advantage because it makes a country’s exports cheaper.
“We all agreed on the fact that we refuse to enter any currency war,” the French finance minister, Pierre Moscovici, told reporters at the conference, which was held in a meeting center just a short walk from the Kremlin and Red Square.
In the statement on Saturday, the Group of 20 pointedly avoided any criticism of Japan, where stimulus programs backed by Prime Minister Shinzo Abe have kept interest rates near zero and flooded the economy with money — leading to a roughly 15 percent drop in the value of the yen against the dollar over the last three months.
The Japanese policies, which have reduced the cost of Japanese products around the world, were the primary cause of fears of a currency war.
In essence, the Group of 20 expressed a view that loose monetary policy, including steps that weaken currency values, are acceptable when used to stimulate domestic growth but should not be used to benefit in global trade.
Critics of that view say that it amounts to a distinction without a difference because loose monetary policies stimulate growth and bolster exports at the same time.
The United States has also used a loose monetary approach to aid in the economic recovery, in the form of “quantitative easing” by which the Federal Reserve buys tens of billions of dollars in bonds each month.
The chairman of the Federal Reserve, Ben S. Bernanke, who attended the conference in Moscow, gave brief remarks on Friday indicating support for Japan’s efforts.
Faster-growing, developing countries like Brazil and China have expressed concerns about the loose monetary policies of more established economies like Japan and the United States. The money created by policies like the Fed’s quantitative easing can prove destabilizing as it enters faster-growing economies.
…
“Just hours after the Commerce Department reported the first decline in quarterly GDP in 3-1/2 years, the Federal Reserve announced it was maintaining its policy of near-zero interest rates and $85 billion worth of long-term Treasury and mortgage-backed purchases per month. The Fed said recent economic information suggests that ‘growth in economic activity paused in recent months’ due to ‘weather-related disruptions and other transitory factors’ but household and business spending had grown and housing continued to improve. ‘Employment also expanded but ‘unemployment remains elevated,’ the Fed said.”
Suppose the theory that Quantitative Easing brings down unemployment turns out to be all wrong. In that case, is it possible that Quantitative Easing would continue forever?
Or that unemployment will eventually come down for other reasons unrelated to QE, resulting in QE receiving undeserved credit?
Or even that unemployment could fall more quickly without QE than with it in place?
I frankly don’t see how you can empirically test a policy without a counterfactual.
“…household and business spending had grown and housing continued to improve.”
Do puppeteers normally get this excited when pulling strings results in puppet movement?
No, but the kids watching the show do.
Good point…it’s all about entertaining the children.
“At present, in Toronto everywhere you go in the city, you will find a construction site, building a condo. If you drive into the city on the expressway, you will notice a wall of condos going up. It is that obvious. It is not just one, or two, going up, it is more then the entire amount of condos in the state of New York. They are expected to remain empty and house no one.”
Having lived in San Diego back in 2006 and visited Honolulu and Vancouver that year, I have seen this movie before.
Too bad that Toronto lacks the same allure as a year-around tourist magnet that Vancouver, Miami, San Diego and Honolulu have to at least offer a plausible rationale for its condo mania.
They are expected to remain empty and house no one.
So the Canucks are turning Chinese?
Toronto prices are out of whack, but I think your comparison to San Diego, Honolulu is gratuitous and a bit wrong. Toronto is to Canada as New York is to the U.S. It’s the finance and deal-making capital; as such a lot of capital flows into Toronto from around the world, to be invested, distributed, etc. When U.S. firms want to do business with Canadian government or Canadian businesses, it goes through Toronto based law firms/banks/accountancies. I remember interviewing with Canadian firms in law school, e.g. Tory’s LLP, the work was virtually the same as at a NYC or DC Biglaw firm. The pay was actually the same at the time, but then US Biglaw firms raised starting salaries to 165k that summer (ridiculous, I know).
If you want to buy a mining company in Whitehorse or a oil drilling company in Calagary, it all goes through T.O. Same thing if you have a Canadian subsidiary (for tax reasons, of course!) and you want to have them reinvest their profits or issue class B stock etc etc etc. This does not explain, in any way, shape, or form why TO prices are so high. I’m just pointing out that TO is a much stronger job market than San Diego or the other places you mention. The quality of human capital is higher and TO is at the center of capital flows, whereas SD is a backwater.
Botom line, TO prices are bullshit. But TO has more good jobs than the places you mention simply because of its position in the global and regional markets.
What do good jobs have to do with overbuilding the condo market to mania proportions?
I agree it’s a mania. But the comparison to MIA, SD, etc is still off. You’d always expect *somewhat* higher prices in Toronto because of demand and ability to pay. Just like NYC or DC will always been *somewhat* higher priced than Baltimore or Philadelphia etc. The “spread” and whether it’s worth it depend on individual preferences and abilities, of course.
TO is going to fall, there is no doubt about it, but you said something like condos in TO make less sense than in SD or Honolulu and I don’t buy that and I don’t buy that.
“You’d always expect *somewhat* higher prices in Toronto because of demand and ability to pay.”
…offset by *somewhat* lower prices due to frigid weather compared to Vancouver, Honolulu or San Diego and more attractive options like NYC, Paris, London or San Francisco if high finance is your game.
I grew up in Toronto, and have a very good idea of what Toronto offers. The bottom line is, Toronto is NOT destination place people go to vacation… or retire to… or spend winters in. Toronto is an oversized version of Minneapolis. The city has done a GREAT job making a cold climate very livable… but its not Miami… or San Diego. Its not the place Japanese families dream about visiting.
So what does that mean? It means the MANY speculators are going to be very VERY sad when they can’t rent or sell their overpriced concrete boxes… and there are no vacation renters lined up to help pay their mortgages.
Of course, I think the bigger problem is the Canadian banks only guarantee mortgage rates 5 years. Rates can easily go up 4 points in 5 years… we have all seen it. If that happens, mortgage holders in Canada will see their payments double… talk about suicide loans.
“Toronto is NOT destination place people go to vacation… or retire to… or spend winters in.”
Sounds like you would have to be a greater fool to invest in condos there at the height of an epic mania, or any other time, for that matter.
“In the meantime, he advises investors not to fight the Fed.”
How does one avoid ‘fighting the Fed’ in its War on Savers, unless you are a member of the Wall Street investment bank too-big-to-fail club that can borrow from the discount window at below market rates, lend at market rates and pocket the spread?
The Economist
Free exchange
Economics
What QE means for the world
Positive-sum currency wars
Feb 14th 2013, 23:24 by G.I. | WASHINGTON, D.C.
[BLAH, BLAH, BLAH]
…
COMMENTS
…
chrisinmunich Feb 16th, 2013, 11:10
The case made for QE is a very weak and spurious one. Nothing is told about the downside and negative effects of QE.
These are:
- bubbles are created and sustained esp. In the real estate sector
- pension plans and their assets get devalued
- prudent savers pay for imprudent overstretched debtors
The illusion is nurtured that a debt problem can be resolved by monetary measures. There is hardly a more complacent report than the BoE report on the effects of QE. It reminds me of the progress report of the Central comittee of the communist party of the USSR in the eighties.
Distorting the term structure of interest rates does not necessary stimulate investment or consumption. Why should someone invest when he knows asset prices are inflated because of too low interest rates. Waiting for the bubble to burst is the better option. The same applies for consumption.
QE is actually a tax levied on savers. Central banks should be depoliticised and should stay out of distributional measures.
“Why should someone invest when he knows asset prices are inflated because of too low interest rates.”
Two explanations come to mind:
1. It depends on whose money is being invested. If one invests his own money then he takes all the risk. If the money belongs to other people (OPM) then other people take the risk.
2. It depends on how the investor gets paid. If the investor gets paid right away then he gets to walk away with some money right away. If the investor is to get paid somewhere in the future then maybe he will not get paid at all.
If the investor is someone who combines 1 and 2 then he has it made: He gets paid right away for investing other people’s money.
If the investor is the guy who supplies the OPM then he probably does not have it made: He gets a PROMISE of an investment reward sometime in the future and if there is no reward in the future then the gets to suffer the loss.
As long as there are people who can convince other people to give up their OPM in return for a promise then there will be money flowing into investments. When the supply of OPM dries up then any investments that was supported by OPM will fall in value.
It’s one of those things that work until it doesn’t.
It’s best if the ‘investor’ is granted a federal guarantee, such as banks which make mortgage loans which they can sell to Fannie Mae or Freddie Mac. That way, if the loan sours, OPM makes you whole.
Does debt matter?
Do we have a space elevator?
Do we have mothereffin’ gargoyles built into the corners of our buildings?
Do we have ornate fountains in all our public parks?
Do we have public mass transit in all our major cities?
Do we have public orchestras and theatre groups in all our cities?
Do we have a set of people we commission just to make public art?
No? Then debt does matter, because if we didn’t have debt, we would have those things.
I don’t get your point.
I guess I wasn’t that clear. The current debt we have matters - it is preventing us from spending money on much cooler future things. Obviously some of the things I listed might be a bit silly and frivolous - but we are still having to pay for things previously purchased and having conversations about what we can and can’t afford given our current debt levels.
Even if it doesn’t matter on some academic level (debt spent on future cool infrastructure is still debt) it matters because all our financial policy right now is based on decisions about ours and the world’s current debt loads.
Is it really though? What’s to stop the Fed from simply buying all goverment debt?
There’s some fear it might be inflationary. But the possibility of this being doable is naturally very attractive to a lot of people, politicians especially.
‘What’s to stop the Fed from simply buying all goverment debt?’
I believe that since the beginning of 2013, they’ve bought more than has been issued. I wish I could paste Bernanke’s face into this image:
http://www.kirrilywhatman.com/wp-content/uploads/2012/07/speed.png
Binyamin Shalom Bernanke
“What’s to stop the Fed from simply buying all goverment debt?”
Or all the mortgage debt, for that matter? Do you remember that Pac-Man game that people used to play for hours on end back in the 1980s? The ghosts are the Fed and the dots are the debt.
January 22, 2013
“We’re going to kill the dollar”
The Fed’s Plan B
by MIKE WHITNEY
“How do you solve a problem when you’re running a 10% fiscal budget deficit? You are not going to get growth without private sector credit demand. The government’s idea right now is that we’re going to export our way out of this, and when I asked a senior member of the Obama administration last week how are we going to grow exports if we will not allow nominal wage deflation? He said, “We’re going to kill the dollar.” Kyle Bass interview.
Last week, amid growing rumors of a global currency war, the Fed’s balance sheet broke the $3 trillion-mark for the first time in history. According to blogger Sober Look: “For the first time since this program was launched (QE) it is starting to have a material impact on bank reserves … which spiked last week. 2013 will look quite different from last year. The monetary base will be expanded dramatically as long as the current securities purchases program is in place. ‘Money printing” is in now full swing.’” (“Fed’s balance sheet grows above $3 trillion, finally impacting the monetary base”, Sober Look)
Take a minute and consider the implications of the Fed’s money printing operations in relation to the above quote by market analyst Kyle Bass. Can you see what’s happening?
The Fed is acting exactly as one would expect it to act given it’s stated intention to increase inflation (currency debasement) while intensifying the class war at the same time.
How is the Fed waging class war, you ask?
Fed chairman Bernanke has been a big supporter of deficit reduction, which is code for slashing public spending. The recent “fiscal cliff” settlement raises taxes immediately on working people by ending the payroll tax holiday. As Bloomberg notes: “Everybody took a two percentage-point pay cut.” This is bound to impact consumer spending and confidence which dropped sharply last week. Here’s more from Bloomberg:
So all the worker bees (you and me) have less money to spend, which means that there’s going to be less activity, higher unemployment and slower growth. This is what all the liberal economists have been warning about for over 3 years, that is, if the government withdraws its fiscal support for the economy by reducing the budget deficits too soon, the economy will slip back into recession.
So what is the Fed doing to counter this slide and to create the illusion that nutcases who preached “austerity is good” were right?
Well, the Fed is buying mortgage-backed securities, right? So the Fed is actually dabbling in fiscal policy, assuming a role that is supposed to be played by the Congress. Now, I realise that the buying of MBS doesn’t precisely fit the definition of fiscal policy because the Fed doesn’t collect taxes and redistribute the revenue. But it sure doesn’t fit the description of monetary policy either, now does it? The Fed is not setting rates to control the flow of credit into the system. No, the Fed is buying stuff; financial assets that provide credit to loan applicants who are purchasing hard assets. That ain’t monetary policy, my friend. It is fiscal policy writ large.
The Fed is currently purchasing $45 bil per month in US Treasuries to push down long-term interest rates in order to help the banks sell more mortgages so they can reduce their stockpile of distressed homes.
And, the Fed is buying $40 billion of MBS per month to help the banks clear their books of left-over MBS and to provide funding for the banks to generate new mortgages.
Also, 95% of all new mortgages are financed through Fannie and Freddie. In other words, the government is providing all the money and taking all the risk, while all the profits go to Wall Street.
…
“There’s some fear it might be inflationary.”
More likely explanation: They buy enough assets to prevent a price collapse at a point when demand has cratered.
Which suggests there will be little price appreciation once extraordinary accommodation is eventually withdrawn.
If this whole scheme doesn’t lead to a catastrophic failure, it’ll be a remarkable thing. Wall Street executives successfully executed a gargantuan control fraud, made billions, not a single prosecution for it and got the taxpayer to pay the price and foot the bill for the whole thing.
Ta da!
This kind of thing does not bode well for the rule of law.
The guys who perpetrated the entire “control fraud” are toasting each other on their monstrous yachts, and schmoozing with politicians including the President at the White House. Lloyd Blankfein has visited at least 14 times, Jamie Dimon 13. Like George Carlin said: “It’s a big club, and you ain’t in it.”
“What’s to stop the Fed from simply buying all goverment debt?
There’s some fear it might be inflationary.”
Nothing. And the evidence is there to suggest that is their policy and will execute it. Criminals they are.
Inflation? Where?
“We’re going to kill the dollar.”
Hello $6 per gallon fuel, and a cratering economy.
Joe - good points on Toronto. They do have good incomes and solid employment for a very able population. Along with outside gamblers, housing did go well for a long time. But not anymore.
A lot of good reading today.
I’m gonna enjoy watching the Toronto bubble pop and pointing out to you guys who it wasn’t different there.
When did we say it was different there? I just said t.o. Is a stronger job market than any of those you mentioned. Significantly stronger. The mania wipes that out, of course. But if we are talking about the prices that an area should support based on local business activity and incomes and labor force quality, t.o. Would do better than san dievo, Miami, etc.
T.o. Is going to fall, as it should, perhaps extremely hard because of the 5 year mortgage rates. But still the 4th best financial job market in north America.
Btw, it’s laughable to discuss foreign buyers as a reason that a places prices will stay prepped up. That’s the thinking that started the property bubble. lets get real, in a non mania world, prices should be related more to local incomes.
“T.o. Is going to fall, as it should, perhaps extremely hard because of the 5 year mortgage rates. But still the 4th best financial job market in north America.”
Too bad that, as we learned here in the U.S., labor demand is far more correlated with the housing sector than is commonly understood, especially in the financial sector.
How many Canadian realtors, mortgage agents, BMW salespeople, carpenters, fine dining restaurant workers, and $100k a year Home Depot kitchen re-modelling specialists will be looking for unemployment checks?
I was in LA during the last crisis, and was shocked at how much of the economy was fed by the infamous home mortgage ATM machine. When people upgraded to a bigger house, they took their cash out and bought Harley’s, cars, cruises and more… then put 3.5% down on their new place. Crazy times indeed…
All this “wealth” will be eliminated overnight when housing drops. Of course… this will all come as a “shock”, because Toronto (Regina, Vancouver, Edmonton etc) is “different”.
My favorite quotes during the Vancouver boom was: “There are more Chinese multi-millionairs than the population of Vancouver”. Uggh .
My debt is bigger than yours.
Financial Times
February 17, 2013 8:02 pm
Eurozone core cashes in on cheap borrowing
By Michael Stothard and Ralph Atkins in London
Businesses in the core of the eurozone are cashing in on easy monetary policy to borrow at record low rates, while those based in the periphery are still struggling to find market funding, according to new data.
Barclays analysis of European Central Bank data suggests that companies based in the “core” of the bloc have been the main beneficiaries of the central bank’s promise last June to do “whatever it takes” to save the eurozone.
Companies based in France, Germany, Belgium and Holland were able to borrow a net €37bn of ultra-cheap debt from the markets in the second half of last year, following the announcement.
But companies based in Italy, Spain, Portugal and Greece added only about €12bn of market borrowing, with only the biggest companies such as Telecom Italia and Telefonica able to access the capital markets.
At the same time these peripheral eurozone countries faced a €65bn reduction in net bank lending, as the region’s crisis-hit banks reduced lending in a bid to strengthen balance sheets.
Bank lending also fell in the core countries, but was more than balanced out by increased capital market funding amid a positive spiral where easy market funding leads to stronger companies that are in turn more investable.
“German and French companies seem to have benefited disproportionately [from ECB action],” said Julian Callow, chief international economist at Barclays. “The ECB has clearly improved the situation but there is still evidence of [eurozone] fragmentation.”
In Spain there was a €43bn decline in bank lending in the second half compared with a mere €1.5bn in net market borrowing. German and French companies increased market borrowing by €12bn and €13bn, respectively. The fall in bank lending was smaller as well.
The data will exacerbate fears of the eurozone’s “financial fragmentation” – the sharp differences in financial conditions that has plagued the 17-country region during the past two years.
…
Greek Economy Shrinks Another 6%
By Andy Dabilis on February 15, 2013 in Economy, News, Politics
Coming on the heels of news that the country’s unemployment rate hit a record 27 percent, the Greek government got more bad news: the economy shrank 6 percent in the fourth quarter of 2012, according to the Hellenic Hellenic Statistical Authority (ELSTAT).
The data showed that the country’s recession, now in a sixth year, isn’t recovering, despite rosy projects from the government of Prime Minister Antonis Samaras that Greece will turn the corner by the end of the year and start getting out from under a crushing economic crisis and $460 billion in debt.
The preliminary data from ELSTAT confirms that 2012 was another year of deep recession for Greece, with the year’s three other quarters all showing the economy had contracted substantially. However, the rate of contraction in the fourth quarter was slightly slower then earlier in the year. In Q1, the economy shrank by 6.7 percent, in Q2 it was 6.4 percent and in Q3 it rose to 6.7 percent.
Combined, the data suggests that the Greek economy contracted by 6.4 percent in 2012, its fourth consecutive full year of recession. The Finance Ministry had forecast a contraction of 6.5 percent for 2012. The Troika of Greece’s lenders, the European Union-International Monetary Fund-European Central Bank (EU-IMF-ECB) had expected the economy to shrink by 6 percent.
Since the country’s crisis began three years ago, Greece has lost nearly 25 percent of its GDP. Looking for good news anywhere, Finance Minister Yiannis Stournaras said he would ask the Troika whether its errors in estimating the effects of austerity, so-called “fiscal multipliers” that determine how much pay cuts, tax hikes and slashed pensions would be counter-productive, would let him change some of the tax rates.
In January, chief IMF economists Olivier Blanchard and Daniel Leigh, in their report Growth Forecast Errors and Fiscal Multipliers, said the agency badly miscalculated how much austerity would hurt the Greek economy instead of helping it. They said the agency’s figures were as much as 300 percent off target.
Stournaras said that acknowledgement of error might justify some adjustments to the debt-hit country’s austerity program. “The IMF must not get caught up in academic analyses,” Stournaras said in a press briefing following a meeting of Eurozone finance ministers in Brussels. Reports said that the Greek finance ministry was considering the possibility of proposing a reduction of indirect taxes because tax revenues were far less than expected despite big increases in the rate.
…
I’m willing to bet that the cuts are what’s caused the huge drop in GDP, not the tax hikes.
Euro-Area Economy Shrinks Most Since Depths of Recession
By Marcus Bensasson - Feb 14, 2013 3:26 AM PT
A pedestrian passes a closed store advertising sales discounts in its empty window displays in Athens. Photographer: Kostas Tsironis/Bloomberg
Euro-Area GDP Falls 0.6%, Worst Since 2009
The euro-area recession deepened more than economists forecast with the worst performance in almost four years as the region’s three biggest economies suffered slumping output.
Gross domestic product fell 0.6 percent in the fourth quarter from the previous three months, the European Union’s statistics office in Luxembourg said today. That’s the most since the first quarter of 2009 in the aftermath of the collapse of Lehman Brothers Holdings Inc. and exceeded the 0.4 percent median forecast of economists in a Bloomberg survey.
The data capped a morning of releases showing that the economies of Germany, France and Italy all shrank more than forecast in the fourth quarter. European Central Bank President Mario Draghi said last week that confidence in the 17-nation bloc has stabilized and the ECB sees a gradual recovery beginning later this year, though the situation is “fragile.”
“The outlook for 2013 remains subdued,” said Peter Vanden Houte, an economist at ING Group NV in Brussels. “While a gradual improvement of the world economy is likely to support European exports, domestic demand is bound to remain very weak as fiscal tightening and rising unemployment will take their toll on household consumption.”
…
Financial Times
Last updated: February 14, 2013 5:28 pm
Japan remains mired in recession
By Jonathan Soble in Tokyo
Japan secured fresh ammunition against charges that it is recklessly expanding its monetary policy and weakening the yen after evidence emerged that the country’s economy was in weaker shape than most experts had believed.
Government data on Thursday that showed Japan unexpectedly remained stuck in recession last quarter could help Japanese officials at what is shaping up to be a contentious meeting of G20 finance ministers and central bankers in Moscow beginning on Friday.
Measures implemented by Japan’s new government to revive the country’s slack economy will be central to a G20 debate over global foreign exchange policy in which some have cast Japan as the instigator in a brewing “currency war”.
The steps – increased public spending and, especially, pressure on the Bank of Japan to adopt a looser monetary stance – have had the effect of significantly weakening the yen, to the delight of Toyota and other Japanese exporters and the irritation of some of Japan’s trading partners.
The yen has fallen more than 15 per cent against the dollar since November, when the election that brought the government to power was called. In response, officials in Europe and Latin America have warned of a potentially dangerous cycle of competitive devaluations should other countries seek to weaken their own currencies to keep their economies competitive.
Japan’s moves have boosted the stock market and should help return the economy to growth this year, economists say. But Thursday’s data indicated that gross domestic product fell 0.1 per cent between October and December, or 0.4 per cent on an annualised basis, the third contraction in as many quarters.
That compared with a median forecast of 0.4 per cent annualised growth in a survey of 32 economists conducted by Bloomberg News.
“Sentiment has changed along with the government, and now the question is how that will be reflected in actual behaviour,” Akira Amari, the economy minister, told reporters in a tacit acknowledgment that stimulus measures could take time to boost the real economy.
…
It’s bubble poppin’ time up in the Great White North.
More adjustment to come in home prices: Carney
BARRIE McKENNA
OTTAWA — The Globe and Mail
Published Sunday, Feb. 17 2013, 12:52 PM EST
Last updated Sunday, Feb. 17 2013, 6:44 PM EST
The correction underway in Canadian house prices is likely to persist for another two years, warns Bank of Canada Governor Mark Carney.
“We’ve seen the adjustment in the housing market. We think there’s a bit more to come over the next couple of years,” Mr. Carney told CTV’s Question Period in an interview broadcast Sunday.
Mr. Carney said rapidly rising prices experienced in Canada over the past decade are “certainly not normal” and Canadians shouldn’t count on home prices to be their main source of wealth gains.
“Real wealth is built through innovation, and it’s gained through hard work,” Mr. Carney explained in an interview taped before this weekend’s G20 finance ministers and central bankers meeting in Moscow. “It’s not through some magical asset inflation.”
In a report last week, the International Monetary Fund estimated that Canadian home prices are overvalued by an average of 10 per cent and predicted an “adjustment” over the next five years.
Canada’s housing market has been slowing since mid-2012. Housing starts and homes sales have come down, while prices appear to have peaked in many once-booming markets, such as Vancouver.
Canadians are continuing to add to their record debt levels – mainly through home mortgages and lines of credit – but the rate of increase has slowed substantially.
Canadian policy makers have “pivoted” from actively pushing homeowners to buy homes and borrow, to dissuading debt and promoting exports, said Mr. Carney, who is due to leave his job at the Bank of Canada to head the Bank of England in July.
“That’s a difficult rebalancing, but what we’re seeing, without question, is a very constructive evolution of Canadians’ attitudes towards debt and towards the housing market,” he said. “And it is moving towards a much more sustainable equilibrium.”
…
“Real wealth is built through innovation, and it’s gained through hard work,” Mr. Carney explained in an interview taped before this weekend’s G20 finance ministers and central bankers meeting in Moscow. “It’s not through some magical asset inflation.”
—————-
Hogwash. For Joe Sixpack, the ONLY way to have any kind of wealth is through asset price inflation. It’s inflation and exploitation/monopolization of global resources (often at the end of a gun) that have created the most “wealth” in this world.
We are all bubble sitters now.
Real estate - safe as houses, or overblown balloon?
Monday, 18 February, 2013, 12:00am
Bull view: quantitative squeezing
There has been a lot of talk about the housing market bubble in Hong Kong and that interest rates rises may precipitate a price collapse soon. I disagree and here’s why.
We live in a time of high inflation and low interest rates. The world is awash with cash thanks to the money-printing programmes of the world’s biggest central banks (Japan, the US, the euro zone), and even some emerging market countries).
First, most “safe” or investment grade instruments such as deposits or government bonds cannot return above the rate of inflation. This explains why Hongkongers have been buying high-yield bonds and, more recently, equities. These can generate returns above inflation but carry higher corporate, credit or supply risks. Property does not suffer these drawbacks and offers better returns than bonds and deposits.
Second, property is a great hedge on inflation, always a potential problem, thanks to global banks’ unprecendented and radical use of quantitative easing. While rental income rises alongside inflation (as any leaseholder knows), a 10-year bond issued today with a one per cent coupon will yield that same one per cent for the next 10 years.
Third, with global central banks in a “race to debase”, money supply growth should continue to run high in the double digits. If the free market were to determine interest rates, fast depreciating currencies would lead to sky-high interest rates to compensate for the risk of lost purchasing power. However, central banks will hold interest rates down near zero to boost growth.
Sceptics talk about the possibility of a housing market bubble but they are second-guessing thousands who affirm the valuations of today’s market in trades involving millions of dollars. The affordability of Hong Kong - in terms of how much a mortgage costs relative to an average family income - is well within historical norms.
A far more vexing matter is the possibility of rising interest rates. Hong Kong housing prices are highly sensitive to interest-rate rises. Rates have been low for a long time and will eventually rise. But for now, the world’s main central banks all indicate that low interest will stay for a while. This includes the US Federal Reserve, which effectively sets Hong Kong rates, which has committed to keep rates down at least until 2015.
Hong Kong property will fall, but only after another 20 per cent-plus rise has kicked in over the next few years.
Eric Wong is chairman of Bricks & Mortar Management
Ignorance is bliss right up until the point when you realize that home debtorship has lost you a bundle of money.
Financial illiteracy and home debtorship during an epic housing mania go hand-in-hand.
Global Economics
U.S. Homeowners Are Repeating Their Mistakes
By Brendan Greeley on February 14, 2013
If there’s one thing Americans should have learned from the recession, it’s the importance of diversifying risk. Middle-class households had too much of their net worth tied up in their homes and were too exposed to stocks through 401(k)s and other investments.
Despite the hit many Americans took, there’s little sign they’ve changed their dependence on homes as the mainstay of their wealth. Last year, Christian Weller, a professor at the University of Massachusetts, looked at Federal Reserve data for households run by those over 50. The number of families with what Weller calls “very high risk exposure”—a low wealth-to-income ratio, more than three-quarters of their assets in housing or stocks, and debt greater than a quarter of their assets—had almost doubled between 1989 and 2010, to 18 percent. That number didn’t decline during the deleveraging years from 2007 to 2010; its growth just slowed to a crawl.
The Fed will conduct a new wealth survey in 2013, but don’t look for a rational rebalancing. The same pressures that drove families to save less before the recession are still in place: low income growth, low interest rates, and high costs for health care, energy, and education. Families have been borrowing less since 2007, but the rate of the decline has slowed. As soon as banks start lending again, Weller says, people will put their money back into housing. “The trends look like they’re on autopilot,” he says. “They don’t suggest that people properly manage their risk.”
In a 2012 paper for the National Bureau of Economic Research, economist Edward Wolff concluded that from 2007 to 2010, the median American household lost 47 percent of its wealth. Average wealth—a number that includes the richest Americans—declined only 18 percent. Houses make up a smaller share of the wealth of a rich family. The wealthy also benefit from better financial advice, Weller says.
A home is what economists call a consumption good; you have to live somewhere. It’s also a store of wealth. Unlike other assets, you can’t buy a portion of a house. “You want to consume a big home,” says Sebastien Betermier, an assistant professor of finance at Desautels Faculty of Management at McGill University. “But if you want to buy that home, it’s a huge investment—probably more than you really want.” Betermier, who studies consumers’ financial decisions, says homeownership makes it harder to diversify risk. Since 1983, for the richest 20 percent of U.S. households, the principal residence as a share of net worth has been around 30 percent. For the next 60 percent—most of us—housing has risen from 62 percent to 67 percent of total wealth.
To compound the problem, home equity dropped for this middle group even as home values rose. Rising house values, low interest rates, and easy refinancing encouraged property owners to take out home equity loans. And Wolff’s analysis shows the middle class reducing their cash cushion from 21 percent of assets, starting in the early 1980s, to 8 percent just before the recession. Cash is bad luck insurance; you pay a premium because you don’t earn a return on it, but it’s available in case of an emergency. Americans borrowed against their homes, spent the cash, and were left only with risk.
How can the middle class manage risk better? Financial education would help. Olivia Mitchell, a professor at the Wharton School at the University of Pennsylvania, is alarmed at how few people understand basic principles. “What we do know is that people who are more financially literate … do accumulate more wealth,” she says.
…
“Despite the hit many Americans took, there’s little sign they’ve changed their dependence on homes as the mainstay of their wealth.”
What this article seems to completely miss is the destructive impact of the hair-of-the-dog housing market stimulus measures in play to trick Americans into believing that borrowing massive amounts of money to buy a declining value asset is a smart financial move.
Is it any surprise the average American is utterly bamboozled given the Fed’s never-ending fooling games?
Investment Outlook
February 2013
Credit Supernova!
William H. Gross
They say that time is money.* What they don’t say is that money may be running out of time.
There may be a natural evolution to our fractionally reserved credit system which characterizes modern global finance. Much like the universe, which began with a big bang nearly 14 billion years ago, but is expanding so rapidly that scientists predict it will all end in a “big freeze” trillions of years from now, our current monetary system seems to require perpetual expansion to maintain its existence. And too, the advancing entropy in the physical universe may in fact portend a similar decline of “energy” and “heat” within the credit markets. If so, then the legitimate response of creditors, debtors and investors inextricably intertwined within it, should logically be to ask about the economic and investment implications of its ongoing transition.
But before mimicking T.S. Eliot on the way our monetary system might evolve, let me first describe the “big bang” beginning of credit markets, so that you can more closely recognize its transition. The creation of credit in our modern day fractional reserve banking system began with a deposit and the profitable expansion of that deposit via leverage. Banks and other lenders don’t always keep 100% of their deposits in the “vault” at any one time – in fact they keep very little – thus the term “fractional reserves.” That first deposit then, and the explosion outward of 10x and more of levered lending, is modern day finance’s equivalent of the big bang. When it began is actually harder to determine than the birth of the physical universe but it certainly accelerated with the invention of central banking – the U.S. in 1913 – and with it the increased confidence that these newly licensed lenders of last resort would provide support to financial and real economies. Banking and central banks were and remain essential elements of a productive global economy.
But they carried within them an inherent instability that required the perpetual creation of more and more credit to stay alive. Those initial loans from that first deposit? They were made most certainly at yields close to the rate of real growth and creation of real wealth in the economy. Lenders demanded that yield because of their risk, and borrowers were speculating that the profit on their fledgling enterprises would exceed the interest expense on those loans. In many cases, they succeeded. But the economy as a whole could not logically grow faster than the real interest rates required to pay creditors, in combination with the near double-digit returns that equity holders demanded to support the initial leverage – unless – unless – it was supplied with additional credit to pay the tab. In a sense this was a “Sixteen Tons” metaphor: Another day older and deeper in debt, except few within the credit system itself understood the implications.
Economist Hyman Minsky did. With credit now expanding, the sophisticated economic model provided by Minsky was working its way towards what he called Ponzi finance. First, he claimed the system would borrow in low amounts and be relatively self-sustaining – what he termed “Hedge” finance. Then the system would gain courage, lever more into a “Speculative” finance mode which required more credit to pay back previous borrowings at maturity. Finally, the end phase of “Ponzi” finance would appear when additional credit would be required just to cover increasingly burdensome interest payments, with accelerating inflation the end result.
Minsky’s concept, developed nearly a half century ago shortly after the explosive decoupling of the dollar from gold in 1971, was primarily a cyclically contained model which acknowledged recession and then rejuvenation once the system’s leverage had been reduced. That was then. He perhaps could not have imagined the hyperbolic, as opposed to linear, secular rise in U.S. credit creation that has occurred since as shown in Chart 1. (Patterns for other developed economies are similar.) While there has been cyclical delevering, it has always been mild – even during the Volcker era of 1979-81. When Minsky formulated his theory in the early 70s, credit outstanding in the U.S. totaled $3 trillion.† Today, at $56 trillion and counting, it is a monster that requires perpetually increasing amounts of fuel, a supernova star that expands and expands, yet, in the process begins to consume itself. Each additional dollar of credit seems to create less and less heat. In the 1980s, it took four dollars of new credit to generate $1 of real GDP. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result. Minsky’s Ponzi finance at the 2013 stage goes more and more to creditors and market speculators and less and less to the real economy. This “Credit New Normal” is entropic much like the physical universe and the “heat” or real growth that new credit now generates becomes less and less each year: 2% real growth now instead of an historical 3.5% over the past 50 years; likely even less as the future unfolds.
…
+12