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The Credit Gradient

Monetary Metals's picture


by Keith Weiner


The United States, and every country, is subject to a monetary authority and legal tender laws. Here in the U.S. we have the Federal Reserve, a central bank that plans money and credit. The Fed thought they had perfected their planning (but of course it cannot be perfected). They thought they had ended the boom and bust cycle, and brought us into a brave new era, their so-called great moderation that ended in 2008. All they really did was manage the banking system to the brink of insolvency.

Let’s try a thought experiment. Suppose the monetary central planner attempts to fix the problem of insolvency by massive injections of liquidity. The central bank buys bonds. It dictates rates near zero on the short end of the yield curve, and promises not to raise rates for years to come. What perverse outcome would we expect?

Arbitrageurs see a green light, telling them that they can safely borrow short to buy long bonds. As the price of a bond goes up, the rate of interest goes down—it’s a rigid mathematical inverse. This is how suppression of short-term rates causes suppression of long-term rates.

This poses a problem for investors. Every investor has a minimum yield he must earn in order to meet his goals, such as retirement. When the yield available in government bonds falls, this gives the investor a strong push to other bonds with higher yields. Some Treasury bond owners sell, and go into AAA corporate bonds. This, of course, pushes up bond prices and pushes down the yield. This pushes some AAA corporate investors into AA bonds. And so on.

The net yield earned by every investor is pushed lower. However, at each step in the process, the effect is diminished. The wave of credit does not quite make it all the way to the other side of the pool, where the small businesses are trying to get wet.

In a free or semi-free market, credit is generally plentiful and inexpensive for mature, large enterprises. When well managed, these companies offer a low credit risk. Conversely, it has always been difficult for startups to obtain credit. When they can get it, they have to pay dearly. In other words, there is a credit gradient.

A gradient describes a change in concentration of something as you move through a range of coordinates. For example, this is a color gradient.

Color Gradient

Of course, there is always a credit gradient. Only now, the Federal Reserve has exaggerated it to an extreme. They have made the gradient steeper.

The biggest players are drunk, chugging as much as they want. At the same time, the scrappy disruptors with the greatest opportunities to improve our world are more dehydrated than ever. Worse yet, the innovators have to try to compete for resources with the large corporations.

The credit gradient is artificially enhanced. The end result is not surprising.

I came across this paper, by the Brookings Institute. Authors Ian Hathaway and Robert Litan found that “Like the population, the business sector of the U.S. economy is aging. … The share of firms aged 16 years or more was 23 percent in 1992, but leaped to 34 percent by 2011—an increase of 50 percent in two decades.”

Entrepreneurial young companies are not hiring, or in many cases, surviving. The older, larger ones are all that remain. Their hiring is anemic compared to that of younger companies. The proof is in the labor force participation rate, which shows the percentage of working age people who are employed or seeking employment. It is now down to a level last seen during the Carter Administration in the late 1970’s.

Labor Participation Rate

Although there are other factors that contribute to this dismal reality including minimum wage and labor law, taxes, environmentalism, subsidies for crony companies, and regulations, the artificially enhanced credit gradient deserves the lion’s share of the blame.

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Sat, 08/30/2014 - 00:21 | 5161571 The_Dude
The_Dude's picture

Great article...should repost it since I dont think it got the attention it deserved...

Fri, 08/29/2014 - 12:14 | 5158870 numapepi
numapepi's picture

SPOT ON!!!!! Exactly describing one of the chief symptoms of the economic malaise of our time. Without creative destruction a market system stagnates and here we are.

This is a blog I wrote about one example of a disruptive technology that is coming online now and the probable effects on our economy ala creative destruction...

Here; http://incapp.org/blog/?p=2344



Fri, 08/29/2014 - 10:43 | 5158364 jc125d
jc125d's picture

Not a good analysis. Money is available for creditworthy smal businesses and it's cheap, alot cheaper than it should be, given the risk. But most startups lack equity and early walk aways are more common than before. It's tough for small business to survive structural impediments imposed by the parasites. It's not like they can move offshore like the great american companies that pay no taxes on their profits. The author places too mich blame on his gradient.

Fri, 08/29/2014 - 09:57 | 5158147 Stuck on Zero
Stuck on Zero's picture

I think that what the Author is trying to say is that Socialism sucks.

Fri, 08/29/2014 - 12:08 | 5158828 Zero Govt
Zero Govt's picture

or the Fed sucks 

all monopolies do

Fri, 08/29/2014 - 09:20 | 5157955 Okienomics
Okienomics's picture

Hold on a sec... I thought the high-yield aka junk bond market was booming, records amounts of cash inflow, and that were all doomed because of the imprudent bubble in the junk sector. Can't have it both ways, and the author here doesn't provide a lick of evidence to support the giant freaking conjectured leap that "the wave of credit does not make it to the other end of the pool." Nice graphic images of gradients though. Ooh, pretty pictures and a FRED chart, now THAT'S a good article! Not.

Fri, 08/29/2014 - 08:51 | 5157794 AdvancingTime
AdvancingTime's picture

 Savers are suffering from these low interest rates.The leading edge of the massive Boomer generation knows that every dollar spent is a dollar it cannot re-earn or replenish. The logical thing to do is hoard their wealth. Boomers have little choice but to, keep the car for an extra 50,000 miles, cancel remodeling projects, and make the grand-kids fund their own education. With less interest income they are purchasing  a lot fewer electronic gadgets and spending vacations in the backyard. As a result of these low interest rates this "recovery" may be greatly delayed. More on the subject of how lower interest rates have a hidden cost in the article below.


Fri, 08/29/2014 - 09:48 | 5158092 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

The gradient this author mentions is also distorting the markets through the big corp, high yield bonds. Since money is flowing into these risky bonds and they are borrowing to survive as they burn cash, huge amounts of mal-investment are occuring. Firms that should die are living on wasting vast amounts of capital. They will go bankrupt one day and drag the real economy with them. For example, see Sears, JCPenny, Radio Shack and etc.

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