Charles Gave Warns: "Should The Fed Lose Control, The Downside Move In Markets May Be Terrifying"

Tyler Durden's picture

Charles Gave of GaveKal has a fascinating summary of where the nearly five-year long experiment in central-planning has taken the US, and by implication, global economy. To wit:

What kind of failure?


By propping up asset markets, the Fed has created an illusion that wealth is being created. The next step, according to Bernanke’s plan,  should be for growth to follow. In fact, there is no reason why the rise in prices of financial assets should lead to actual investments or a rise in the median income. So far, it has not. There has been no real increase in the private sector propensity to borrow, and the danger may be that any further public sector borrowing will hasten the decline because of our “permanent asset hypothesis”.


This means that, should the Fed lose control of asset prices (is this what is now happening in Japan?), then the game will be up and the downside move in markets may well be terrifying. Most at risk would be low and medium quality credits, banks, commodity producers, and any companies with negative cash-flow.


It is obvious, then, that if Bernanke’s experiment fails, it will be a profoundly deflationary failure. The best hedges in a deflation and in financial panic are US long bonds and the US dollar. Renminbi bonds seem also to be developing safe-harbor status. In fact, we found it interesting how, in May, every bond market around the world sold-off, except for the RMB bond market.

We agree completely with Gave on his proposed "permanent asset hypothesis" (as explained further below) which is a simple derivation of what happens in a world in which the Keynesian multipler is now negative. It is what we have been saying for over a year, namely that in an environment of permanent low interest rates there is no impetus on behalf of the private sector to spend for growth, either in the form of capital spending or the hiring of incremental workers. The only net money exchange is the issuance of debt to fund dividends and stock buybacks: or simple EPS-boosting balance sheet arbitrage as shown most recently here

We also obviously agree that if and when Bernanke finally loses control, there are simply no words to describe what would ensue as a situation like that - one where not just the Fed, but every single central bank has gone all in on reflating the world's biggest asset bubble - has never been encountered before.

However, we disagree that the final outcome will be a "profoundly deflationary failure." This will be an interim step. Recall that the Fed and its private bank conspirators simply can not accept deflation as a resolution. Which means that faced with the specter of full on deflationary collapse, Ben Bernanke will simply resolve to doing what he has hinted, if jokingly, in the past: he will literally paradrop money out of helicopters. Maybe not in that fashion, but he will find a way to bypass the banking sector as a monetary transmission mechanism, and bring crisp, fresh, just off the press banknotes into the hands of consumers in order to finally get the much needed inflationary spark as too much cash chases after too few products and services.

And remember: hyperinflation is and always has been a phenomenon concurrent with the full loss of faith in a given currency, be it reserve or not. It may emerge for economic, monetary or purely political reasons. It is also why the most valuable commodity a central bank has is credibility, and faith in fiat, or fiath as we like to call it. Furthermore for those who say that the Fed has a reserve currency premium, we like to show one of our favorite charts: reserve currencies through time...

... as well as our two favorite axioms: Nothing is forever, and this time is never different.

* * *

But those are all thought experiments for the future: a future, in which if we may remind readers, not one nation in history has collapsed due to hyperdeflation...

As for the present, and going back to Gave's wonderful analysis of the can of worms Bernanke's tinkering has unleashed, here is the balance of Charles Gave's "More On the Deflationary Bust Risk" just released paper highlights:

More On the Deflationary Bust Risk

This is what I will, for the purposes of this paper, call my “Keynesian multiplier” - it is simply the arithmetical difference between growth in  wealth and growth in public debt—on which I compute the seven-year rate of change.

If the multiplier is expanding, this tells us that an increased level of debt should lead to a greater increase in the household net worth over seven years. And vice-versa. This allows us to roughly evaluate how many dollars of private wealth are created by one more dollar of public debt.

Let us look now at the relationships between our Keynesian multiplier and certain economic variables. The chart below shows that the marginal efficiency of public debt, at least in the US (public spending in emerging markets from a low base usually improves productivity) has been declining structurally since 1981. And it seems that this marginal efficiency has now reached a negative level.

One initial indication that the Keynesian multiplier was now shrinking was the US boom that followed the Clinton/Gingrich balanced budgets and era of government deleveraging between 1997 and 2000. A reality which brings us back to one of the greatest debates between Keynesians and Austrians as to whether Milton Friedman’s “permanent income hypothesis” makes sense, or not; i.e., are economic agents rational enough that when they see an increase in government debt, they will increase their savings, safe in the knowledge that they will have to pay for the debt increase down the road? Or whether economic agents are just too shortterm focused to project themselves that far?

Modifying the above idea somewhat, we have, in the past, come up with a “Permanent Asset Hypothesis” which probably best applies in asset-rich, ageing countries. Basically, as interest rates move ever lower, retirees, pension funds and insurance companies needing to a certain fixed amount of return are forced to buy ever more fixed income. So low rates and rising public debt issuance, instead of encouraging more risk and renewing animal spirits, instead pushes investors feeling ever poorer into increasingly defensive, and yield generating, assets.

In essence, the perception that assets will not generate enough income going forward encourages the average saver to increase his savings, which is the precise opposite of the stated goal. This law of unintended consequences may help explain why the private business sector’s demand for credit remains limp, even though money is being lent for free.

Of course, credit demand may also be weak because there is no immediate reason to expect the rise we have seen in US (and global) financial assets should help boost median incomes. So far it has not:

And in a world where it does not pay to borrow, one should expect a structural decline in the velocity of money to take place. Which is what the next chart is indicating:

A decline in the velocity of money is equivalent to less money circulating in the system, and should lead to a structural decline in the inflation rate:

With the Keynesian multiplier now negative, one would expect very low growth in volumes and nominal GDP. And this, of course, is what we are seeing. Despite the massive stimulus, and the improvement in the US trade balance (thanks to the energy revolution and the US manufacturing renaissance), the US economic expansion remains rather unimpressive. The recent moves in bond yields would seem to suggest that markets are expecting that the economic lift-off is finally about to arrive; either that or that Ben Bernanke will soon throw in the towel and start normalizing monetary policies. Given that the odds of the latter are lower than a snowball in hell (from afar, it usually feels as if the Fed chief has made his motto that of George Bidault’s: “I don’t know where we are going, but we will get there without detours”), it is more likely to be the former than the latter. The problem, for me, is that I struggle to believe that we are on the verge of a new global economic expansion.

Instead, if structural growth is to now be dragged lower by the fact that the Keynesian multiplier has gone negative, and with governments continuing to spend like sailors on shore leave in Hong Kong despite the drag on productivity and structural growth, then we cannot really expect long rates to move decisively higher.

* * *

Summarizing the above: if Bernanke is honestly curious why the economy remains broken, and none of his "central" tinkering has done much to boost the Keynesian multiplier and with it any prospects for real economic growth, he suggest he take a long, hard look in the mirror.

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fourchan's picture

all paper currencies seek their intrensic value, which is zero.

maskone909's picture

came here to stack some gold and drink some beer.  welp, im all outta beer.

fonestar's picture

But.. but... the deflation all around us!  Just ask anyone who eats food or drives vehicles!

Oracle of Kypseli's picture

The most eficient markets are the gray and the black, because they are based on need and the exchange medium is based on their choice.

Everything else is manipulated.


LawsofPhysics's picture


I remain long those markets, sharecriopping, and security service companies...

TruthInSunshine's picture

Japan has stated, just now (as crossing the wires), that it's about to go full-er retard on the monetary "experimentation" front.


Godspeed, Abenomics!

May the wind always be at your back, and the sun always upon your face, and may the wings of destiny carry you aloft to dance with the stars.

There's never been a more unsinkable ship than S.S. Krugman.

That MOAR DIGGING thing you've been doing for 20+ years might ultimately work to effectuate real, positive economic growth if you just do MOAR of it harder.

Pinto Currency's picture


Losing control of the bond market and financial assets will not lead to secular strengthening of the USD.

Temporalist's picture

Market moves are "terrifying" only to participants in a rigged casino with barred exits.

Herd Redirection Committee's picture

The USD is a bigger bubble than even Treasuries or the stock market.

If deflation hits, even briefly, it means that the USD bubble is being inflated one last time.  That will be your last chance to spend USD, before things go Ka-Poom (although theoretically things will have already gone Ka, so only Poom would be left).

I am more equal than others's picture

I like a good horror movie.

Terrify me.  I mean, really terrify me.

Bring it on like donkey kong.

It that all this bitch gots?

Look, I'm poking a bear with a stick...

I'm running in the dark with scissors....

I'll even vote demoncrap...

TruthInSunshine's picture

MOAR Debt and higher inflation will surely be the spark to prompt higher levels of domestic consumption in Japan.


It will be epic to see the increasingly volatile trials and tribulations of the unwind of the yen carry trade, and then the end of it.

He_Who Carried The Sun's picture

and you suggest the fed will be sleeping
on that very day, doing nothing, right...?


JimBowie1958's picture

As I understand the risk, in a rough draft way, the Fed is buying assets at face value despite their inability to be sold on the market (due to no equation to make said assessment). But the Fed persists, and the banks just buy more and more new securities with the cash the Feds give away and also buy other financial assets instead of investing it into growing the real economy. Over time they amass quite a fortune.

Then some triggering event, like a stock market crumbling down over a period of weeks, drives the banks to sell, sell, sell all the financials they have and buy physical assets of various kinds; art, PMs, real estate, industrial plants, etc. This sudden rush to convert their vast sums into tangible assets will quite likely spur a perception that the USD is not a solid storage of wealth, very understandably if this scenario takes place. This sell Tsunami is not a thing anyone will be able to predict to the exact day any more than a stock market correction can be predicted to the exact day.

So how can the Fed suddenly dry up all that cash that will get poured into the asset markets like a Biblical flood?

I dont see how they can. So after a long period of stagflation, the Fed will be sideswiped by the 'Sell Tsunami' and in all likelihood, caught fatally flat footed. Due to the publics widespread loss of confidence in the USD, we will then get hyperinflation.

Hope that helps.

MillionDollarBogus_'s picture

"...The Federal Reserve just released its quarterly Z.1 report – known as the “flow of funds” – which documents changes in U.S. household net worth.

In the first quarter of 2013, household net worth rose $3.003 trillion to a record $70.3 trillion. In the fourth quarter of 2013, household net worth only increased (an upward-revised) $1.397 trillion.

Around $2.3 trillion of the increase in household net worth in Q1 owes to rising asset and real estate prices..."

Bernanke's goal now is to keep the markets propped up.  Sure its an illusion, and he's the guy behind the curtain pulling the levers, but that's his job.

The next step is for consumers to do their part and spend on what they want.


TruthInSunshine's picture

Ben Blows MOAR Bubbles:  A Modern Monetary Lesson Demonstrating The High Recidivism Rate of Fiat Junkies (Newton Press)

By:  Hu Flung Poo, Ph.D.

MillionDollarBogus_'s picture

The downside move (stampede for the exits) may look like this;

The bulls are the high frequency traders and the big hedge funds.


Thulsa Doom's picture

Don't be the guy crossing the street who never saw it coming. Ouch!


Yay consumers - a million years of consumer spending could not dig us out of the pile of shit debt that bankers and politicians have buried American people underneath.

Fucking A, the American Bush way - it is your patriotic duty to mimic the powers that be, go shopping, and max out your credit cards.

Million Dollar Bogus. Apt name for modern day nursery tale consumption. 

disabledvet's picture

while i do agree "the money has already been spent" imagine an economy where we had oil...and oil only. "look at the economy that we would have been missed." i'm not calling trillion dollar deficits that have been sustained (without penalty...but in fact rewarded with lower interest rates) success. i'm just saying...imagine what is suppose to happen in a "normal world" the USA...where the risk in those deficits is IN FACT realized (Venezuela comes to mind...largest oil reserves in the world...which is currently hyperinflating i might add.) In other words THE USA HAS A HIGHLY DIVERSIFIED ECONOMY...which...IN THEORY...means that recovery is still an option. "payment is always a problem" of course in these matters. our current payment method of "stick it to the Fed's and the taxpayers" is pretty ugly to say the least. we're going to need a lot of oil, natural gas, solar cells, Fords, Chevy's, Chrysler's, spaceships, weapon systems, it output? throughput? name it. the term MAXXED OUT does indeed come to mind. yet nay...the answer is NOT in being a mimic...but doing your level best to provide...for yourself of course..and those closest to you as well. No greater truth need be said that "North Dakota's growth trajectory" (current north of 8 percent and sustained for some time now) "will not be sufficient to bail out....Bailout USA." and no, cheating via the media/NSA complex doesn't work either for all you Renminbi lovers out there. interestingly...there is a war going on...but you're gonna need to hire those vets if you want in on that moullah. that's TRILLIONS in largesse. "and those folks are hiring." good people one and all i might add.


Paper burns.

Paper gets shit upon.

Inflation destroys paper buying power.

Oh, look !

Shiney gold and silver ! 

Worth more now than ever before - in a relative to paper kinda way. 

disabledvet's picture

to ALL paper (even law now it would seem?) i agree. but before we blame "only the banks" for getting us into this mess...let us ask ourSELVES...what were our priorities or goals to begin with? "to get re-elected"? "to have power"? "to rule the world"? those don't sound like Banker objectives to me. there are providers of such things of course...and i hear bankers stand in the way of that more often than not. but are we to BLAME them for this? "what is your gold or silver worth if it is simply taken from you" as the Nazi's did...Mr. Silvergeddon? "not much" you say? Bankers take contract law very seriously i would argue. I would argue STRONGLY that that is a good thing. especially one based on a "Bill of Rights." one of those rights is to PETITION for greivances based on injuries suffered...or endured. "the Government came and stole my silver" comes to mind.

SRSrocco's picture

It looks like some of the more well known BILLIONAIRES are dumping stocks.  I would imagine we are going to see a huge crash in the broader stock markets here shortly.   Even Warren Buffet is dumping stocks.

Billionaires Dumping Stocks, Economist Knows Why

kchrisc's picture

Didn't all the big connected players and insiders get warnings and dump their shares before the '29 crash?

caconhma's picture

Thanks to FED, government bureaucrats became the highest paid employees. After all, they create nothing of values. However, they behave as some kind of an occupation administration similar to one we have in Afghanistan.

As soon as FED's QE programs are scaled down, US financial markets will lose at least $2.5T in markets values. As for insurance companies and municipal bonds, they will become totally insolvent in a matter of weeks.


gjp's picture

Total chump.  He may be saying the right thing now, but he was singing from the NWO hymnbook for far too long to take seriously.

Midasking's picture

which means the upside move in the markets is just as terrifying! Got Gold?

YC2's picture

More first person singular Tylers? It's just not as cool with the "I"s. all it would take is a quick find/replace.


Reggie Middleton in disguise - great chart porn !

Where is the loincloth spear beefcake photo finish, though ?

Chuck Walla's picture


"Paper money eventually returns to its intrinsic value: zero."

-- Voltaire

LawsofPhysics's picture

The only way the Fed (a private banking cartel - backed by U.S. and NATO forces) would lose control is if the dollar is no longer accepted.  It really is that simple.  Oh wait...

PiltdownMan's picture

IF they lose control?????????

Look at TIPs, the yield curve, t rates. MBS prices. It IS getting out of control.

LawsofPhysics's picture

That was sarcasm by the way.  You are an optimist, but I tend to agree.  They are losing control.  For the record, I do not view the decentralization of power and control or economic activity as a bad thing.

Citxmech's picture

The impact on the "just-in-time" delivery network (food, fuel, medicines, etc.) could be extremely unsettling, however.

RafterManFMJ's picture

But but but...this time, it's different!

SimMaker's picture

Yeah, it is different this time. Nobody had Nukes in the 1920s-30s....

francis_sawyer's picture

Was it over when the Iranians nuked Hiroshima?

Bay of Pigs's picture

Or when the Germans bombed Pearl Harbor?

(Sadly, most Americans don't know that Hawaii or Alaska were even states then).

Hippocratic Oaf's picture

Or worse, not knowing you're reference to Animal House.

All is well, all is well!!!!!!!!!!


francis_sawyer's picture

Hawaii shouldn't even be a state... The bullshit that surrounded Hawaii becoming a state belongs in the same category as Israel...

SpiceMustFlow's picture

We took it with what...200 marines?

SpiceMustFlow's picture

Sadly most Americans still believe that Alaska lies of the coast of SoCal, a tad farther West than Hawaii

g'kar's picture

Bluto: What? Over? Did you say "over"? Nothing is over until we decide it is! Was it over when the Germans bombed Pearl Harbor? Hell no!

RafterManFMJ's picture

4/3rds of Amerikans know that.

fxrxexexdxoxmx's picture

Shia's can not do shit. Just ask a Sunni.

bank guy in Brussels's picture

Sunni Muslims often quite admire the largely Shia Hezbollah of Lebanon led by Hassan Nasrallah

Those Shia fighters defeated Israel in the recent war, to the great joy of most of the Muslim world, which is predominantly Sunni, but appreciates a fellow Muslim who can defeat the Zionists

The predominantly Shia Hezbollah are one of the most impressive fighting groups in the world, given the resources they have ... on the level of the Vietnamese under General Giap who defeated the Americans

And now, Hezbollah are helping Syria defeat the US-Nato-Saudi-Qatar backed extremist groups from 30 nations that pose as the 'rebels' in Syria

Hezbollah is so admired that Sunni parents even name their children after Hassan Nasrallah


SeattleBruce's picture

"but appreciates a fellow Muslim who can defeat the Zionists...Hezbollah is so admired..." - 'fellow' Muslim.  Some of the only fellowship that Shi'ites and Sunnis have is at the end of a gun or knife.  The Iran-Iraq war (1980 - 1988) featured this for sure - to the tune of a half million dead.  The flaming up of the Shi'ite/Sunni conflict has caused no end of grief for current Iraqis, even well after the US pullout.  That's true yet again in Syria, although it's like a blood bathed puppet show there with the US, Russia, et al, all weighing in. 

Admired, appreciated - for brutal fighting ability?  Now there's the basis of a great society!  Just also ask Americans, Germans, French, Chinese, Russians and the British how raw militarism of the past 400 years has affected the building up of society...perhaps since the Shi'ites are the minority Islamic branch, they feel they have to fight brutally just to survive, and be "admired" by the majority.  Perhaps the militarists the world over follow the same drummer in an attempt to best each other in who can be most cunning and brutal in their killing.  It's no way to build a lasting society.

MeelionDollerBogus's picture

LOL. It's good to get comfortable with our newly re-written history well in advance of the rush :D