Some wonder why we have been so convinced that no matter what happens, that the Fed will have no choice but to continue pushing the monetary easing pedal to the metal. It is actually no secret: we explained the logic for the first time back in March of this year with "Here Is Why The Fed Will Have To Do At Least Another $3.6 Trillion In Quantitative Easing." The logic, in a nutshell, is simple: everyone who looks at modern monetary practice (as opposed to theory) through the prism of a 1980s textbook is woefully unprepared for the modern capital markets reality for one simple reason: shadow banking; and when accounting for the ongoing melt of shadow banking credit intermediates, which continues to accelerate, the Fed has a Herculean task ahead of it in restoring consolidated credit growth. Shadow banking, as we have explained many times most recently here, is merely an unregulated, inflationary-buffer (as it has no matched deposits) which provides the conventional banking credit transformations such as maturity, credit and liquidity, in the process generating term liabilities. In yet other words, shadow banking creates credit money which can then flow into monetary conduits such as economic "growth" or capital markets, however without creating the threat of inflation - if anything shadow banks are the biggest systemic deflationary threat, as due to the relatively short-term nature of their duration exposure, they tend to lock up at the first sing of trouble (see Money Markets breaking the buck within hours of the Lehman failure) and lead to utter economic mayhem unless preempted. Well, preempting the collapse in the shadow banking system is precisely what the Fed's primary role has so far been, even more so than pushing the S&P to new all time highs. The problem, however, as we will show today, is that even with the Fed's balance sheet at $2.8 trillion and set to rise to $5 trillion in 2 years, it will not be enough.
We believe an unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. The old architecture was crystallized in Washington- and IMF-inspired policy responses to the numerous sovereign defaults, banking system failures, and currency collapses. Most importantly, the previous architecture recognized limits on fiscal and central bank balance sheets. The new architecture attempts to 'back', perhaps unconsciously, the entire liability side of the global financial system. This framing is consistent with a purely political—institutional stylized—fact that it is nearly impossible to penetrate the US political parties if the message is that there are limits to their power…or that their power requires great effort and sacrifice. This is why Keynesians (at least US ones) who argue there are no limits to a fiscal balance sheet are so popular with Democrats, and why monetarists (at least US ones) who argue there are no limits to a central bank balance sheet are popular with (a decreasing number of) Republicans. Party on! Again, nobody chooses hard-currency regimes – they are forced on non-credible policymakers. Let me put it more positively. If politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have - or the consequences for Gold are extraordinary.
Remember when we said cash flow is always more important than diluting the M2 (the Fed is great at the latter, powerless at the former)? Here's why: The municipality of Acharnes in northern Athens has decided to suspend all of its operations after running out of money. The municipal council met on Thursday night and voted to stop providing anything other than basic services because of its inability to pay employees’ wages and regular expenses. In Nintendo Donkey Kong Game and Watch parlance: Game over.
The great day has come and gone when the Fed would once again ride to the action, not daring to be left behind by the ECB’s perverse vaunting of its new ‘unlimited’ programme of bond purchases. But the few, brief sentences from Bernanke contain such a miasma of error that it is hard to know where to begin if we are to restore a fresh breeze of economic rationale to this swamp of non sequiturs and wilful misunderstandings. It is not enough that crude, Krugmanite Keynesianism clings to the cheap parlour trick of using money illusion to fool unemployed wage-earners into lowering the reservation price of their labour, but now we must battle against banal, Bernankite Bubble-blowing – the hope that money illusion will fool cash-constrained asset owners instead. It is not only that Bernanke’s policies will inevitably assist the zombie companies and the obsolescent industries to absorb scarce resources (not least on bank balance sheets) to a much greater degree than is justified, there is also the danger that lax money misleads even today’s supramarginal businesses into over-estimating the depth and duration of demand for their products, ultimately undermining many otherwise sound undertakings and reducing these, too, when the cycle next turns, to the ranks of the Living Dead.
Global gold production remains at its level of the late '90s, even though prices have risen to over $1,700 per ounce from $252 per ounce in 1999 or roughly 16% per annum in dollar terms. Only Rio Tinto and Ivanhoe's Oyu Tolgoi mine in Mongolia stand out as a major new gold mines expected to begin production in the near future. Bulls note that global production has remained impervious to the price of gold. This may continue to be the case due to the increasingly obvious geological constraints being seen in the gold mining sector. Resource nationalism is beginning to become an important factor again. This will also almost certainly affect supply at a time when demand is increasing from people throughout the world and many hedge funds, pension funds and central banks’ due to geopolitical, systemic and monetary risks. The lesson of QE is that fiat currencies increasingly grow on trees. Gold does not. This is the primary reason that gold will continue to protect investors in the coming months.
Pump it up, until you can feel it, Pump it up, when you don't really need it...
Earlier this week, former U.S. president Bill Clinton gave the keynote address to the Democractic National Convention in an effort to lend some of his popularity to Barack Obama. With the unemployment rate still stubbornly high at 8.1%, Obama has lost many of the enthused voters who put him into the Oval Office in 2008. Clinton was tapped to deliver the speech not only because of his image of a wonkish pragmatist but because of his presiding over the booming economy of the late 1990s. Like a prized mule, Clinton was dragged out to give Democrats someone to point to and say that his policies were the hallmark of smart governance. Today, Clinton still takes credit for Greenspan’s manipulated boom. His supporters on the left love nothing more than to point at his presidency as vindication of the backwards theory that higher taxes equal more growth. Clinton wasn’t a policy wonk; he was a politician who dipped into the Social Security trust fund to give an appearance of balancing the budget while the national debt still climbed higher. Through all of his financial scandals, womanizing, aggressive foreign policy approaches, and possible cover ups, it is actually fitting that Clinton is still looked to by the political establishment as someone worthy of respect. He is representative of F.A. Hayek’s timeless lesson: in government the worst rise to the top and state power corrupts.
Simon Black recounts a recent experience as he pulled in to a gas station in Italy; he whipped out his American Express card and asked the attendant in broken Italian to turn on the pump. He acted like Simon had just punched him in the gut, wincing when he saw the credit card. "No... cash, only cash," he said. I didn’t have very much cash on me, so I drove to the next station where a similar experience awaited me. This is a trend that is typical when economies are in decline– cash is king. Businesses often won’t want to spend the extra 2.5% on credit card merchant fees... but more importantly, distrust of the banking system and a debilitatingly extractive tax system pushes people into cash transactions. You can’t really blame them.
If you haven’t heard yet, the committee which is drafting the platform for next week’s US Republican National Convention has announced that they are including a proposal to return to the gold standard. Big news. Remember, a gold standard is a monetary system in which individual currency units are fixed to an amount of gold held by the government; under a gold standard, the paper money supply cannot be expanded without also increasing the amount of gold on hand. At present, the market value of the federal government’s gold holdings only amounts to about $250 billion which constitutes a mere 2.5% of US money supply. Clearly one of the key risks in this scenario is that the US government would need to acquire as much gold as they can get their hands on, likely through Roosewellian-style gold confiscation, and if so - the safest place for your gold is going to be a snug safety deposit box in a place like Hong Kong or Singapore.
Money printing isn't creating inflation because the velocity of money has declined, right?
The lunatics are running the asylum. This is the only conclusion one can come to when considering the nonchalance with which what was once considered an extraordinary policy with a firm 'exit' in mind is now propagated as a perfectly normal 'tool' to be employed at the drop of a hat. We refer of course to so-called 'quantitative easing' (QE), which really is a euphemism for money printing. Apart from his sole focus on short term outcomes, an important point that seems not be considered by the FOMC's Rosengren this week is the question of what should happen if the 'open-ended' QE policy were to fail to achieve its stated goals. He seems to assume that it will succeed in lowering unemployment and creating 'economic growth' as a matter of course. It goes without saying that money printing cannot create a single molecule of real wealth. If it could, then Zimbabwe wouldn't be a basket case, but a Utopia of riches. We must infer from Rosengren's idea of implementing open-ended QE until certain benchmarks in terms of unemployment and 'growth' are achieved, that in case they remain elusive, extraordinary rates of money printing would simply continue until the underlying monetary system breaks down.
The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints. Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.
Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money.... What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.
For a presidential election taking place when the US debt/GDP has for the first time in 70 years crossed above 100%, in which over 50 million Americans collect food stamps and disability, in which M2 just crossed $10 trillion, in which total US debt is about to pass $16 trillion, and when total nonfarm employees in America (133,235,000) are the same as they were in April of 2005, it is quite surprising that economics has not taken on a more decisive role in the electoral debate. But while both candidates may, for their own particular reasons, not want to bring up the slow motion trainwreck that is the US economy now, in 4 years whoever is running for president will not be so lucky, because as the US debt clock shows, assuming current rates of progression, things are about to get far, far worse.
Two weeks ago we observed that the broadest money aggregate tracked by the Fed, M2, was less than $10 billion away from crossing the historic $10 trillion mark. As of this week, this number now officially has 14 digits for the first time ever, or $10,035,100,000,000 to be precise (technically the non-seasonally adjusted number crossed $10T last week, but for some reason bank deposits need to be seasonally adjusted, so waiting for the traditionally fudged data seemed appropriate). And we have a $50 billion increase in savings deposits, aka deferred buying power to those who still have the capacity to save, in one week to thank for putting $10 trillion in the rearview mirror.